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Accounting concepts
and conventions
ACCOUNTING CONCEPTS
Business entity concept
Money measurement concept
Going concern concept
Accounting period concept
Accounting cost concept
Dual aspect concept
Matching concept
Realisation concept
Accrual concept
ACCOUNTING CONCEPTS
Accounting
concepts define the
assumptions on the basis of which
financial statements of a business
entity are prepared
...
Business entity concept
This concept assumes that, for accounting purposes, the
business enterprise and its owners are two separate
independent entities
...
For example, when
the owner invests money in the business, it is recorded as
liability of the business to the owner
...
Money measurement concept
This concept assumes that all business transactions must be in
terms of money, that is in the currency of a country
...
Thus, as per
the money measurement concept, transactions which can be
expressed in terms of money are recorded in the books of
accounts
...
200000, Rent
Paid Rs
...
are expressed in terms of money, and so they
are recorded in the books of accounts
...
For example, sincerity, loyality are not recorded in books of
accounts because these cannot be measured in terms of money
although they do affect the profits and losses of the business
concern
...
Simply
stated, it means that every business
entity has continuity of life
...
This
is an important assumption of
accounting, as it provides a basis for
showing the value of assets in the
balance sheet
...
This is known as accounting
period concept
...
This is necessary for different
purposes like, calculation of profit,
ascertaining financial position, tax
computation etc
...
It means that fixed
assets like building, plant and
machinery, furniture, etc are recorded
in the books of accounts at a price paid
for them
...
It provides the very basis of recording
business transactions in the books of accounts
...
e
...
Therefore, the
transaction should be recorded at two places
...
Thus, the
duality concept is commonly expressed in terms
of fundamental accounting equation :
Assets = Liabilities + Capital
Matching concept
The matching concept states that the revenue and the
expenses incurred to earn the revenues must belong to
the same accounting period
...
This can be done with the help of
accrual concept If the revenue is more than the
expenses, it is called profit
...
This is what
exactly has been done by applying the matching
concept
...
Therefore, the matching concept implies that all revenues earned during
an accounting year, whether received/not received during that year and
all cost incurred, whether paid/not paid during the year should be taken
into account while ascertaining profit or loss for that year
...
Significance
It guides how the expenses should be matched with revenue for
determining exact profit or loss for a particular period
...
It is very helpful for the investors/shareholders to know the exact amount
of profit or loss of the business
...
The term realisation
means creation of legal right to receive money
...
In other
words, it can be said that : Revenue is said to have
been realised when cash has been received or right to
receive cash on the sale of goods or services or both
has been created
...
Let us study the following examples
A Jeweller received an order to supply gold
ornaments worth Rs
...
They supplied
ornaments worth Rs
...
The revenue for the year
2005 for a Jeweller is Rs
...
Mere getting an
order is not considered as revenue until the goods
have been delivered
...
1,00,000 for cash in 2006
and the goods have been delivered during the same
year
Accrual concept
The meaning of accrual is something that becomes due
especially an amount of money that is yet to be paid or
received at the end of the accounting period
...
Though cash is received or not received
and the expenses are recognised when they become
payable though cash is paid or not paid
...
Contd…
...
The
accrual concept under accounting assumes that revenue
is realised at the time of sale of goods or services
irrespective of the fact when the cash is received
...
Conventions denote customs or traditions or
usages which are in use since long
...
The accountants have to adopt the usage or
customs, which are used as a guide in the
preparation of accounting reports and
statements
...
Convention of consistency
The convention of consistency means that same
accounting principles should be used for preparing
financial statements year after year
...
But this can be
possible only when accounting policies and practices
followed by the enterprise are uniform and consistent
over a period of time
...
Convention of full disclosure
Convention of full disclosure requires that all material
and relevant facts concerning financial statements
should be fully disclosed
...
Adequate means sufficient set
of information to be disclosed
...
Full refers to complete
and detailed presentation of information
...
Let us relate it to the business
...
The business provides financial information to all interested
parties like investors, lenders, creditors, shareholders etc
...
In the same way, other parties would be interested
in the financial information according to their
requirements
...
Convention of materiality
The convention of materiality states that, to make
financial statements meaningful, only material fact
i
...
important and relevant information should be
supplied to the users of accounting information
...
The materiality of a fact depends on its nature and
the amount involved
...
Convention of conservatism
This convention is based on the principle that
“Anticipate no profit, but provide for all possible losses”
...
It is based on the policy of playing
safe in regard to showing profit
...
Profit should not be overstated
...
This is not a fair
policy and it will lead to the reduction in the capital of
the enterprise
...
But if the business anticipates any loss in the near future provision
should be made in the books of accounts for the same
...
For example, valuing closing stock at cost or market price whichever is
lower, creating provision for doubtful debts, discount on debtors, writing
off intangible assets like goodwill, patent, etc
...