Ques. 1 What are the basic accounting concepts? Explain their implications.Ans.
A renowned accountant once observed that ‘Accounting was born without notice and rearedin neglect’ Accounting was first practiced and then theorized. Certain ground rules were initially setfor financial accounting: these rules arose out of conventions. Therefore, these are called accountingconventions or concepts. We shall discuss here only the basic accounting conventions or conceptsthat are very vital to understand the process of accounting
Money Measurement Concept
Each transaction and event must be expressible in monetary terms. If an event cannot be expressedin monetary terms, then cannot be considered for accounting purposes.For Example, if you successfully pass a distance-learning Programme of a university, it willgive you a great deal of satisfaction. But that satisfaction cannot be expressed in monetary terms.Hence such an event is not fit for accounting .on the other hand, if you are robbed of Rs.1000 in atrain journey, the loss suffered can definitely be expressed in monetary terms. This concept impliesthat the legal currency of a country should be used for such measurement.
The Cost Concept
Assets such as land, buildings, plant and machinery etc. and obligations, such as loans, publicdeposits, should be recorded at historical cost (i.e., cost as on acquisition).For example, the land purchased by a business entity two years back at a cost of Rs.10 lakhshould be shown, as per the cost concept, at the same amount even today when the current price of the land may have increased five-fold. Thus, the greatest limitation of this concept is that it distortsthe true worth of an asset by sticking to the original cost.
The Going Concern Concept
One common argument put forward by the proponents of cost concept is that the assents are shownat its original cost because these are meant for use for a long period of time and not for immediateresale. Therefore, the cost concept rests on the assumption that an entity would continue its operationfor a long time. An entity is said to be a going concern if it has ‘neither the intention nor thenecessity of the liquidation or of curtailing materially the scale of the operations’ this concept isconsidered as one of the fundamental accounting assumptions. The Valuation principle of assets andliabilities depend on this concept. If an entity is not a going concern, its assets and liabilities are to be valued in an altogether different manner.
The Matching Concept
The Internet concept involved in accrual accounting is called matching concept. Revenue earned inan accounting year is offset (matched) with all the expenses incurred during the same period togenerate that revenue, thus providing a measure of the overall profitability of the economic activity.Thus, matching concept is very vital to measure of the financial results of a business. The timing of incurring expenses and earning revenues does not always match.For example, In case of a seasonal business majority of sales may take place only in four months of a year whereas fixed expenses like salaries, rent etc. are incurred throughout the year.
Concept of prudence
It says ‘Anticipate no profits but provide for all possible losses’. Prudence is the ‘Inclusion of adegree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not, overstated and liabilities or expensesare not understated’. Expected losses should be accounted for but not anticipated gains.