Accounting
concepts and conventions
Accounting principles: concepts and conventions
Accounting principles = concepts
+ accounting conventions commonly known as GAAP (Generally accepted accounting principles) based on which financial statements are to be prepared. Accounting principles are divided into two parts, concepts, and conventions.
+ accounting conventions commonly known as GAAP (Generally accepted accounting principles) based on which financial statements are to be prepared. Accounting principles are divided into two parts, concepts, and conventions.
(A).
Accounting concepts:
Accounting concept refers to
the basic assumptions and rules and principles which work as the basis of
recording of business transactions and preparing accounts.
the basic assumptions and rules and principles which work as the basis of
recording of business transactions and preparing accounts.
1) Going concern concept:
According to this, it is assumed that business shall continue for a foreseeable
period and there is no intention to close
the business or scale down its operations. It is because of this concept that a distinction between capital & revenue expenditure.
period and there is no intention to close
the business or scale down its operations. It is because of this concept that a distinction between capital & revenue expenditure.
2) Consistency assumptions–
Accounting practices once selected and adopted should be
applied consistently year after year. Change if the law or accounting standard
requires, straight-line method and written down value method.
applied consistently year after year. Change if the law or accounting standard
requires, straight-line method and written down value method.
3) Accrual concepts-
A transaction is recorded in the books of accounts at the time when it is
entered into and not when the settlement takes place. Thus revenue is
recognized when it is realized. The concept is particularly important because
it recognizes the assets, liabilities, income, and expenses as and when
transactions relating to it are entered into.
entered into and not when the settlement takes place. Thus revenue is
recognized when it is realized. The concept is particularly important because
it recognizes the assets, liabilities, income, and expenses as and when
transactions relating to it are entered into.
4) Accounting entity or
business entity-
According to the business entity, principle business is
considered to be separate and distinct from its owners. Business transactions, therefore, are recorded in the books of accounts from the business point of view
and not from that of the owners. The accounting entity principle is useful as from its responsibility accounting has developed.
considered to be separate and distinct from its owners. Business transactions, therefore, are recorded in the books of accounts from the business point of view
and not from that of the owners. The accounting entity principle is useful as from its responsibility accounting has developed.
5) Money measurement
principle-
According to the money measurement principle, transactions and
events that can be measured in money terms are recognized in the books of
accounts of the enterprise. Money is the common denominator in recording & reporting
all the transactions.
events that can be measured in money terms are recognized in the books of
accounts of the enterprise. Money is the common denominator in recording & reporting
all the transactions.
6) Accounting period
principle:
According to the accounting period principle the life of an
enterprise is broken into smaller periods so that its performance is measured
at regular intervals. The life of the enterprise is broken into smaller periods
which is termed as the accounting period. An accounting period is an interval of
time at the end of which income statement (P & l account or statement of profit
& loss in the case of companies and balance sheet are prepared to know
the result and resources of the business.
enterprise is broken into smaller periods so that its performance is measured
at regular intervals. The life of the enterprise is broken into smaller periods
which is termed as the accounting period. An accounting period is an interval of
time at the end of which income statement (P & l account or statement of profit
& loss in the case of companies and balance sheet are prepared to know
the result and resources of the business.
7) Full disclosure principle
–
There should be complete and understandable reporting on the financial
statement of all significant information relating to the economic affairs of
the entity. Good accounting practice requires all material and significant
information to be disclosed. The reason for low turnover should be disclosed.
statement of all significant information relating to the economic affairs of
the entity. Good accounting practice requires all material and significant
information to be disclosed. The reason for low turnover should be disclosed.
8) Materiality concept –
It refers to the relative importance of an item or an event. An item should be
regarded as material if there is a reason to believe that knowledge of it would
influence the decision of informed investors.
regarded as material if there is a reason to believe that knowledge of it would
influence the decision of informed investors.
9) Prudence or conservatism
principle-
Do not anticipate a profit but provide for all possible losses.
It takes into consideration all prospective losses but not the prospective
profit. The financial statement presents a realistic picture of the state of
affairs of the enterprise and does not paint a better picture than what it
actually is conservatism does not record anticipated revenue but provide all anticipated
expenses & losses. It may be used to create a secret reserve.
It takes into consideration all prospective losses but not the prospective
profit. The financial statement presents a realistic picture of the state of
affairs of the enterprise and does not paint a better picture than what it
actually is conservatism does not record anticipated revenue but provide all anticipated
expenses & losses. It may be used to create a secret reserve.
10) Cost concept or
historical concept–
According to this asset is recorded in the books of
accounts at the price paid to acquire it and the cost is the basis for all subsequent
accounting of the assets should be shown in the book of accounts at its book
value. Cost concept brings objectivity in the preparation and presentation of
financial statements. They are not influenced by personal bias or judgment.
accounts at the price paid to acquire it and the cost is the basis for all subsequent
accounting of the assets should be shown in the book of accounts at its book
value. Cost concept brings objectivity in the preparation and presentation of
financial statements. They are not influenced by personal bias or judgment.
11) Matching concept –
It is necessary to match revenues of the period with the expenses of that
period to determine the correct profit or loss for the accounting period. As per
this concept, adjustments are made for all outstanding expenses, prepaid
expenses, accrued income, unearned income. The expenses for an accounting
period are matched against related revenues rather than cash received & cash
paid.
period to determine the correct profit or loss for the accounting period. As per
this concept, adjustments are made for all outstanding expenses, prepaid
expenses, accrued income, unearned income. The expenses for an accounting
period are matched against related revenues rather than cash received & cash
paid.
12) Dual concept or duality-
The transactions entered into by an enterprise have two aspects a debit and
a credit of equal amount. For every debit, there is a credit of equal amount in
one or more accounts. Capital = assets.
a credit of equal amount. For every debit, there is a credit of equal amount in
one or more accounts. Capital = assets.
13) Revenue recognition
concept–
Revenue is considered to have been realized when a transactions
has been entered into and the obligation to receive the amount has been
established.
has been entered into and the obligation to receive the amount has been
established.
14) Verifiable objective
concept–
It holds that accounting should be free from personal bias. It
means all accounting transactions should be evidenced and supported by business
documents. These supporting documents are cash memos, invoices, sales bills, etc and
they provide the basis for accounting & audit.
means all accounting transactions should be evidenced and supported by business
documents. These supporting documents are cash memos, invoices, sales bills, etc and
they provide the basis for accounting & audit.
(B). Accounting conventions:
An accounting convention is a
common practice used as a guideline when recording a business transaction. It is
used when there is not a definitive guideline in the accounting standards that
govern a specific situation.
common practice used as a guideline when recording a business transaction. It is
used when there is not a definitive guideline in the accounting standards that
govern a specific situation.
An accounting convention refers
to a common practice that is universally followed in recording and presenting
accounting information of the business entity. conventions denote customs or
traditions or usages which are in use for long. To be clear, these are
nothing but unwritten laws. The accounts have to adopt the usage or customs,
which are as a guide in the preparation of accounting reports and statements. These
conventions are also known as doctrine.
to a common practice that is universally followed in recording and presenting
accounting information of the business entity. conventions denote customs or
traditions or usages which are in use for long. To be clear, these are
nothing but unwritten laws. The accounts have to adopt the usage or customs,
which are as a guide in the preparation of accounting reports and statements. These
conventions are also known as doctrine.
(1) convention of consistency:
The conventions of consistency mean that the same accounting
principles should be used for preparing financial statement year after year. A meaningful
conclusion can be drawn from the financial statement of the same enterprise when
there is a comparison between them over a period of time but this can be possible
only when accounting policies and practices followed by the enterprise are uniforms,
and consistent over a period of time. If different accounting procedures and
practices are used for preparing financial statements for different years. Then the
result will not be comparable.
principles should be used for preparing financial statement year after year. A meaningful
conclusion can be drawn from the financial statement of the same enterprise when
there is a comparison between them over a period of time but this can be possible
only when accounting policies and practices followed by the enterprise are uniforms,
and consistent over a period of time. If different accounting procedures and
practices are used for preparing financial statements for different years. Then the
result will not be comparable.
(2) convention of full disclosure:
Convention of full disclosure requires that all material
and relevant facts concerning financial statements should be fully disclosed. Full
disclosure means that there should be full, fair and adequate disclosure of
accounting information. Adequate means a sufficient set of information to be
disclosed. Fair indicates an equitable treatment of users. Full refers to a complete and detailed presentation of information. Thus, the convention of full
disclosure suggests that every financial statement.
and relevant facts concerning financial statements should be fully disclosed. Full
disclosure means that there should be full, fair and adequate disclosure of
accounting information. Adequate means a sufficient set of information to be
disclosed. Fair indicates an equitable treatment of users. Full refers to a complete and detailed presentation of information. Thus, the convention of full
disclosure suggests that every financial statement.
(3) conventions of materiality:
The convention of materiality states that, to make
financial statements meaningful, only material fact. Important and relevant information
should be supplied to the users of accounting information. The question that
arises here is what is a material fact. The material fact depends on
its nature and the amount involved. The material fact means the information of which
will influence the decision of its user.
financial statements meaningful, only material fact. Important and relevant information
should be supplied to the users of accounting information. The question that
arises here is what is a material fact. The material fact depends on
its nature and the amount involved. The material fact means the information of which
will influence the decision of its user.
(4) convention of conservatism:
This convention is based on the principle that ‘’Anticipate
no profit, but provide for all possible losses’’. It provides guidance for
recording transactions in the books of accounts. It is based on the policy of
playing safe in regard to showing profit.
no profit, but provide for all possible losses’’. It provides guidance for
recording transactions in the books of accounts. It is based on the policy of
playing safe in regard to showing profit.
The main objective of this convention
is to show the minimum profit. Profit should not be overstated. If profit shows
more than actual, it may lead to the distribution of dividends out of capital. This is
not a fair policy and it will lead to a reduction in the capital of the
enterprise.
is to show the minimum profit. Profit should not be overstated. If profit shows
more than actual, it may lead to the distribution of dividends out of capital. This is
not a fair policy and it will lead to a reduction in the capital of the
enterprise.