Lala Lajpatrai College of Commerce and Economics

Financial Accounting Submitted to Professor Priti Parekh By Dhruven Jain F.Y.BMS (A)

preserved and presented according to the concepts and conventions that follow. 146 11th September. whether they are external "financial accounts" or internally-focused "management accounts". All formal accounting statements should be created. a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. To support the application of the "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities. four of the following accounting concepts are laid down in Statement of Standard Accounting Practice number 2 (SSAP 2: Disclosure of Accounting Policies). The theory of accounting has. therefore. 2009 Accounting Concept and Conventions Introduction Accounting concepts and conventions as used in accountancy are the rules and guidelines by that the accountant lives. they are the • • • • Going concern concept Accruals or matching concept Consistency concept Prudence concept In drawing up accounting statements.Roll No. developed the concept of a "true and fair view". accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently. In the United Kingdom. Accounting Conventions .

For example. the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill. The other conventions you will encounter in a set of accounts can be summarised as follows: Monetary measurement Accountants do not account for items unless they can be quantified in monetary terms. Realisation With this convention.if the customer has been granted some credit terms.rather than just when cash actually changes hands. brand recognition. . market leadership. no account is taken of changing prices in the economy. a company that makes a sale to a customer can recognise that sale when the transaction is legal . quality of management etc. accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership . This requires transactions to be recorded at the price ruling at the time. Separate Entity This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business. and for assets to be valued at their original cost. As we can see from the application of accounting standards and accounting policies. therefore. Under the "historical cost convention".The most commonly encountered convention is the "historical cost convention". the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement. morale. The actual payment due from the customer may not arise until several weeks (or months) later . Materiality An important convention. The concept of "materiality" is an important issue for auditors of financial accounts.at the point of contract.

Matching (or "Accruals") Income should be properly "matched" with the expenses of a given accounting period. Consistency Transactions and valuation methods are treated the same way from year to year. In addition. Prudence Profits are not recognised until a sale has been completed. Users of accounts can. therefore. make more meaningful comparisons of financial performance from year to year. companies are required to disclose this fact and explain the impact of any change. Where accounting policies are changed. Entity . that a company is not going broke. a cautious view is taken for future problems and costs of the business (they are "provided for" in the accounts" as soon as there is a reasonable chance that such costs will be incurred in the future. This has important implications for the valuation of assets and liabilities. unless there is evidence to the contrary.Accounting Concepts Going Concern Accountants assume. or period to period.

000 amount deducted as a depreciation $9. financial statements show only a limited picture of the business.) Look at the following example: Truck Less depreciation expense Net Truck: $10. and records the difference as a cost of operations (depreciation expense. This concept implies that financial statements do not represent a company’s worth if its assets were to be liquidated.Accounts are kept for entities and not the people who own or run the company. For this reason. Because the “worth” of an asset changes over time it would be impossible to accurately record the market value for the assets of a company. Going Concern Accounting assumes that an entity will continue to operate indefinitely. Money-Measurement For an accounting record to be made it must be able to be expressed in monetary terms. the accounts for the business must be kept separate from those of the owner(s). but rather that the assets will be used in future operations. Cost An asset (something that is owned by the company) is entered into the accounting records at the price paid to acquire it. Even in proprietorships and partnerships. This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life. The cost concept does recognize that assets generally depreciate in value and so accounting practice removes the depreciation amount from the original cost. shows the value as a net amount.000 purchase price of the truck $1. these situations have a huge impact on the operations and financial security of the company but this information is not reflected in the financial statements. Consider a situation where there is a labour strike pending or the business owner’s health is failing.000 net book-value of the truck .

The $9000 simply represents the book value of the truck after depreciation has been accounted for. bank statement. Dual Aspect This concept is the basis of the fundamental accounting equation: Assets = Liabilities + Equity 1. 2. The rule is to recognize revenue when it is reasonably certain and recognize expenses as soon as they are reasonably possible. This means that accounting records will initiate from a source document and that the information recorded is based on fact and not personal opinion. receipts. natural year (Jan 1 – Dec 31). etc…). This figure says nothing about other aspects that affect the value of an item and is not considered a market price. All accounting transactions must keep this equation balanced so when there is an increase on one side there must be an equal increase on the other side or an equal decrease on the same side. Assets are what the company owns. or any other meaningful period such as a quarter or a month. Time Period This concept defines a specific interval of time for which an entity’s reports are prepared. Conservatism This requires understating rather than overstating revenue (income) and expense amounts that have a degree of uncertainty. Liabilities are what the company owes to creditors against those assets 3. The reasons for accounting . Objectivity The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices. This can be a fiscal year (Mar 1 – Feb 28). Equity is the difference between the two and represents what the company owes to its investors/owners.

Materiality Accounting practice only records events that are significant enough to justify the usefulness of the information. in order to accurately represent the income for the month you must report the expenses you incurred while generating that income in the same month.in this manner are so that financial statements do not overstate the company’s financial position. Consistency Once an entity decides on one method of reporting (i. the matching principle requires that revenues and related expenses be recorded in the same accounting period. Realization is assumed to occur when the seller receives cash or a claim to cash (receivable) in exchange for goods or services. each time a sheet of paper is used. the asset “Office supplies” is decreased by an infinitesimal amount but that transaction is not worth accounting for. This concept is related to conservatism in that revenue (income) is only recorded when it actually occurs and not at the point in time when a contract is awarded. if a company is awarded a contract to build an office building the revenue from that project would not be recorded in one lump sum but rather it would be divided over time according to the work that is actually being done. This ensures that differences in financial position between reporting periods are a result of changed in the operations and not to changes in the way items are accounted for. Technically.e. Realization Revenues are recognized when they are earned or realized. For instance. method of accounting for inventory) it must use that same method for all subsequent events. .000 of services in a month. Matching To avoid overstatement of income in any one period. If you bill $20. Accounting chooses to err on the side of caution and protect investors from inflated or overly positive results.

who are generally assumed to have a reasonable knowledge of business and economic activities Relevance This implies that. The bottom-line is that the ethical practice of accounting mandates reporting income as accurately as possible and when there is uncertainty. before it can be regarded as useful in satisfying the needs of various user groups. should I invest. confirm or maybe revise a view . to be useful. of accounting information in such a way that it will be understandable to users . and compare financial statements with clarity and accuracy. accounting information must assist a user to form. Key Characteristics of Accounting Information There is general agreement that. with clarity.By understanding and applying these principles you will be able to read. prepare.g.usually in the context of making a decision (e. accounting information should satisfy the following criteria: Criteria What it means for the preparation of accounting information Understand ability This implies the expression. should I lend money to this business? Should I work for this business?) Consistency This implies consistent treatment of similar items and application of accounting policies Comparability . choosing to err on the side of caution.

g. Much of the work that goes into setting accounting standards is based around the need for comparability. Reliability This implies that the accounting information that is presented is truthful. it is not biased towards a particular user group or vested interest. accurate. . In other words. complete (nothing significant missed out) and capable of being verified (e.This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. by a potential investor). Objectivity This implies that accounting information is prepared and reported in a "neutral" way.