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ACCOUNTING CONCEPTS, PRINCIPLES AND CONVENTIONS - AN OVERVIEW

A generally accepted set of rules can provide uniformity in the accounting system, the accounting
procedure and presentation of accounting results. In developing the structure of accounting theory and
to relate the theory to its practice, the accounting profession has agreed to take for granted certain
basic concepts. These concepts help accounting statements to become comparable, leading to better
analysis and comparison of performances. These concepts are sometimes referred to as assumptions,
conventions, principles, postulates or doctrines and the like. These terms in financial accounting are
used synonymously and interchangeably to mean those basic points of agreement on which financial
accounting theory and practice are founded. The following are the widely accepted accounting
concepts;
(a). Entity Concept
Entity concept states that business enterprise is a separate identity apart from its owners. This
distinction enable us to (i) record the transactions between the firm and its owners and (ii) give the
clear picture of the affairs of the business. Under this concept, business transactions are recorded in
the business books of accounts and owner's transactions in his personal books of accounts. This
basic concept is applied to all the organizations whether sole proprietorship or partnership or
corporate entities. Under this concept, enterprise is liable to the owner for capital investment made
by him. Since the owner has invested capital (also called risk capital), he has claim on the profit of
the enterprise.

(b). Money Measurement Concept


As per this concept, only those transactions, which can be measured in terms of money are recorded.
Since money is the medium of exchange and the standard of economic value, this concept requires
that those transactions alone that are capable of being measured in terms of money be only to be
recorded in the books of accounts. Events that cannot be expressed in terms of money are not
recorded in the business books. E.g. employees of the organization are, no doubt, the assets of the
organizations but their measurement in monetary terms is not possible therefore, not included in
the books of account of the organization. Measuring unit for money is taken as the currency of the
ruling country i.e., the ruling currency of a Country provides a common denomination for the value
of material objects.

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(c). Periodicity Concept


Periodicity means segmentation of the infinite life cycle of the organisation into small but workable
fraction of time for measuring performance and appraisal of financial position. As per this concept
accounts should be prepared after every period & not at the end of the life of the entity. Usually this
period is one calendar year. In India we follow from 1st April of a year to 31st March of the
immediately following year. The periodicity concept facilitates in;
i.

Comparing of financial statements of different periods.

ii. Uniform and consistent accounting treatment for ascertaining the profit and assets of the
business.
iii. Matching periodic revenues with expenses for getting correct results of the business operations.

(d). Accrual or Matching Concept


Any increase in the owners equity is called revenue and any decrease in it is called expenses. Income
is the excess of revenues over expenses. In calculating profit for any financial period, expenses and
revenues are matched in a more realistic way, i.e. they concern the same goods and the same time
period. The accrual concept is an accounting system which receognises revenues and expenses as
they are earned or incurred, respectively without regard to the date of receipt or payment. This
concept is one of the consequences of the periodicity concept. In the preparation of Profit & Loss
A/c for an accounting period, revenues and expenses are recognised as they are earned or incurred
respectively, and not when cash is received or paid. This concept requires proper apportionment of
expenses to time periods by the inclusion of prepayments and accruals in a Balance Sheet.
Since matching concept is an essential part of accrual accounting, these two are often used
interchangeably. Like accrual concept, the matching concept also results from periodicity concept.
The matching concept requires that the expenses of an accounting period should be matched
against the related incomes.

(e). Going Concern Concept


The financial statements are prepared on the assumption that an enterprise is a going concern and
will continue to remain in operation into the foreseeable future. Hence, it is assumed that the
enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its
operations; if such an intention or need exists, these statements may have to be prepared on a
different basis and, if so, the basis used is disclosed. Traditionally, accountants follow historical cost
in majority of the cases.

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(f). Historical Cost Concept


By this concept, the value of an asset is to be determined on the basis of historical cost, i.e.
acquisition cost. Although there are various measurement bases, accountants traditionally prefer
this concept in the interests of objectivity. When a machine is acquired by paying A 5,00,000,
following cost concept the value of the machine is taken as A 5,00,000. It is highly objective as based
on and free from all bias. Other measurement bases are not so objective. Current cost of an asset is
not easily determinable. If the asset is purchased on 1.1.2002 and such model is not available in the
market, it becomes difficult to determine which model is the appropriate equivalent to the existing
one. Similarly, unless the machine is actually sold, realisable value will give only a hypothetical
figure. Lastly, present value base is highly subjective because to know the value of the asset one has
to chase the uncertain future.

(g). Realisation Concept


Any change in value of an asset is to be recorded only when the business realises it. When an asset is
recorded at its historical cost of A 5,00,000 and even if its current cost is A 15,00,000 such change is
not counted unless there is certainty that such change will materialize. However, accountants follow
a more conservative path. They try to cover all probable losses but do not count any probable gain.
That is to say, if accountants anticipate decrease in value they count it, but if there is increase in
value they ignore it until it is realised. Economists are highly critical about the realisation concept.
According to them, this concept creates value distortion and makes accounting meaningless.

(h). Conservatism Concept


Conservatism concept requires that assets and profits should not be overstated and revenues are
never anticipated, being recognised only when there is a reasonable certainty about its realisation.
At the same time, provision must be made for all possible liabilities, whether the amount is known
with certainty or is based on estimation. This concept requires that when there are many alternative
values of an asset, an accountant should choose the method which leads to the lesser value. Since,
this concept requires the accountant to underplay favourable prospects, it is often stated as follows,
Recognise all losses and anticipate no gains.
The Realisation Concept also states that no change should be counted unless it has materialised. The
Conservatism Concept puts a further brake on it.

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(i). Dual Aspect Concept


This concept is the core of double entry book-keeping. Every transaction or event has two aspects.
This concept is based around the fact that every time something is given, someone else will receive
it. As per Duality concept, the claim against the total assets of a business unit are by the creditors
and the owners. Therefore, at any point of time, total assets of the business are equal to its total
liabilities. Liabilities to outsiders are known as liabilities but liability to owners, in accounting
parlance, is referred to as Capital. This concept expresses the relationship that exists among assets,
liabilities and the capital, in the form of an accounting equation which is expressed in the following
form; Assets = Liabilities + Capital
The effect of transactions on the above equation can be seen as below;
(1) Increases in an Asset, increase in capital e.g. owner introduces the capital;
(2) Increases in an Asset, increase in a liability e.g. purchased plant on credit;
(3) Increases in an Asset, decrease in another asset e.g. purchased plant in cash;
(4) Decreases in one Asset, decreases in a Liability e.g. creditors paid off by cheque;
(5) Decrease in Capital, increases in a Liability e.g. drawings by arranging a bank overdraft;
(6) Decrease in Capital, decreases an Asset e.g. drawings in cash;
(7) Decrease in a liability, increase in another liability e.g. creditors paid off by arranging loan;
(8) Decrease in a liability, increase in Capital e.g. further capital introduced to pay-off creditors.

(j). Consistency Concept


Consistency concept relates to the method of measurement in accounting. Accounting principles are
not static. It is possible to adopt a variety of principles and procedures for financial events. If, in
treating a given event, two or more methods are used, it may yield conflicting results. Whatever,
accounting method a business unit decides to adopt, a consistent approach has to be followed.
It is very important that the accountant be consistent in applying principles and procedures to similar
situations, because inconsistency in reporting can cause misleading interpretations and therefore,
wrong conclusions. The user must be sure that the accounts for a particular business unit for
successive years are comparable with each other. Comparability does require that the entity apply
the same accounting principles on a consistent basis.
Though consistency is obligatory for sound financial accounting, this does not mean that changes
cannot be made in a business units accounts. In the event of any change (when there are goods
reasons for it), a note must be appended along with the statements indicating the alterations.

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