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Accounting Concepts

The American Institute of Certified Public Accountants defines accounting as “the art of recording,
classifying and summarising in a significant manner and in terms of money transactions and events,
which are, in part at least, of a financial character, and interpreting the results thereof “.

A business house must necessarily keep a systematic record of its day-to-day transactions to enable
stakeholders to get a complete financial picture of the company and to take stock of its financial
position on a periodic basis. Stakeholders include the company’s promoters, shareholders, creditors,
employees, government and the public.

The accounting practice is based on certain standard concepts, which enable accountants to convey
meaningful information to all stakeholders. These concepts are as follows: -

• The business entity concept – According to this, the business is treated as a distinct entity
from its owners. This enables the business to segregate the transactions of the company
from the private transactions of the proprietor(s).
• The money measurement concept – Only those transactions, which are expressed in
monetary terms are recorded in the books of accounting. Money is the common unit, which
enables various items of diverse nature to be summed up together and dealt with.
• The cost concept – The transactions are recorded at the amounts actually involved. For
instance, a piece of land may have been purchased at Rs.1,50,000, whereas the company
considers it to be worth Rs.3,00,000. The land is recorded in the books of accounts at
Rs.1,50,000 only. Thus, an arbitrary valuation of the company’s assets is avoided by
recording the value at the actual amount involved. Since this amount would have been
mutually agreed upon by both the parties involved in the transaction, it is an objective
valuation.
• The going concern concept – According to this concept, it is assumed that the business will
exist for a long time and transactions are recorded on this basis. This concept forms the basis
for the distinction between expenditure that will yield benefit over a long period of time and
expenditure whose benefit will be exhausted in the short-term.
• The dual aspect concept – Business firms raise funds in any of the following ways–
o Additional capital (increase in owners’ equity)
o Earning revenue (increase in owners’ equity)
o Profits (increase in owners’ equity)
o Additional loans (increases outside liability)
o Disposing off assets (reduces assets)

An increase in liabilities (including owners’ equity) and reduction in assets represent sources of funds.
These funds can be put to any of the following uses –

o Purchasing of assets (increase in assets)


o Cash balances (increase in assets)
o Operational expenses (decrease in owners’ equity)
o Clearing liabilities due (decrease in liabilities)
o Losses (decrease in owners’ equity)

All increases in assets and decreases in liabilities (including owners’ equity) represent the uses of
funds.

The sum of the sources of funds equals the sum of the uses of funds. Thus, the dual aspect of
accounting means that

Owner’s Equity + Outside Liability = Assets

This is the fundamental accounting equation.

• The realisation concept – Accounting records transactions from the historical perspective, i.e.