Accounting concepts, conventions

and principles
• Accounting concepts
Concepts are ideas or notion about the applicability of a particular method.
The concepts guide how transactions should be recorded and reported.

Accounting concepts have been established by professional organisations and

are standard principles that must be followed when preparing financial
accounts.

Followed may be treated as basic concepts:

Business entity concepts:

According to this assumption, a business is treated as a seperate entity i.e. distinct from its
owners and all other economic proprietors.
Business unit should have a completely separate set of book and we have to record business
transaction from firm’s point of view and not from the point of view of the proprietor. The
proprietor is treated as a creditor of the business to the extent of capital invested by him in
the business.

Business entity assumption is applicable to all types of business organisations viz. Sole
proprietorship, partnership firm, companies etc. It should be noted that in case of companies,
the legal relationship of company and its shareholders is also separate as against a sole
proprietorship and partnership firms.
Example
Mr. John has acquired a floor of a building having 3 halls for Rs.1,50,000 per month. He uses
two halls for his business and one for personal purpose. According to business entity concept,
only 1,00,000 (the rent of two halls) is a valid expense of the business.

Going concern:
The financial statement are normally prepared on the assumption that an enterprise is a
going concern and will continue in operation for the foreseeable future. It is also known as
continuity assumption. It is assumed that the enterprise has neither the intention nor the
necessity of liquidation of company. It is on this concept that we record fixed assets at their
original cost and depreciation is charged on the assets without reference to their market
value.
Example 1
An organization produces a compound called Chemical X. Unexpectedly, the federal
government imposes a limitation on the production, export, import, sale, and marketing of
this compound in the country.

Given these circumstances, if Chemical X is the only product the company produces, the
business will no longer be classified as a going concern.

Example 2
The National Company has fallen into serious financial problems and cannot cover its duties.
Due to this, the federal government provides the company with a bailout package and also a
guarantee to clear all its credit payments.

Regardless of its weak financial standing, the National Company is still considered a going
concern.

Example 3
The Eastern Company has closed a division but will continue working in its other divisions as
usual. The business is a going concern because the closing down of a small portion of
business does not impair the capacity of the enterprise to continue indefinitely in the future.

Cost concept:
This cost is the basis of valuation of the assets in the financial statements. It is highly
objective and free from all bias. This concept requires that Accounting transaction should be
recorded in financial manner, free from the person bias of either the management or the
accountant, who prepare the account. In other words, this principle requires that each
recorded transaction/event in the books of accounts should have an adequate evidence to
support it.
Under the cost concept of accounting, an asset should be recorded at the cost at which it was
purchased, regardless of its market value.
Example
When there is a trade-in, a company can get a great deal of a car. The car might have a value
of $20,000, but they pay $15,000 for it. When recording on the balance sheet, the company
will use $15,000 as the actual amount paid even though the car has a value of $20,000.

Stable money value concept:

According to this concept only those transactions and events are recorded in accounting
which are capable of being expressed in terms of money. In other words, the information
which cannot be expressed in terms of money is not included in accounting records. Since,
money is the medium of exchange and the standard of economic value, this concept requires
that transaction alone, that are capable of being measured in terms of money, can be only
recorded in the books of accounts.
Example
If a building is purchased for Rs 100000 in 2008 and the value of the building has increased
substantially in 2010, it will still be shown in the balance sheet of 2010 Rs 100000 less
provision for depreciation.

Thus stable money value concept has given rise to an important problem of treatment of
changes in price level in accounting.
 • Accounting Conventions and principles
A convention may be described as a rule of statement of practice which by general
agreement or common consent expressed or implied as an accepted method of procedure.

Principle means a general law or rule adopted or professed as a guide of action, a settled
ground or basis of conduct of practice.

Matching:
The matching principle facilitates to ascertain the amount of profit or loss incurred in a
particular period by deducting the related expenses from the revenue recognised during the
period. Accordingly, the expenses incurred in an accounting period should be matched with
the revenue recognised in that period. For matching costs with revenue, first revenues should
be recognised and then cost incurred for generating that revenue should recognised.

Consistency:
This convention states that accounting principles and methods should remain consistent from
one year to another. These should not be changed from year-to-year, in order to enable the
management to compare the profit and loss account and balance sheet of the different
period and draw important conclusion about the working of the enterprise. The concept of
consistency is applied particularly, when alternative method of accounting are equally
acceptable.

Accrual:
In accounting, accrual basis is used for recording of transactions. It provides more
appropriate information about the performance of business enterprise as compared to cash
basis. Accrual concept is applied equally to revenue and expenses. In this concept, the effects
of transactions and other events are recognised on mercantile basis, i.e, when they occur and
they are recorded in the accounting records and reported in the financial statements of the
period to which they relate.

Conservatism:
According to this convention, all anticipated losses should be recorded in the books of
accounts, but all anticipated profit or unrealised gains should be ignored. In other words, we
can say that conservation is a policy of playing safe. Provisions is made for all known
liabilities and losses even though the amount cannot be determined with certainty.

Materiality:
Materiality principle permits other concepts to be ignored, if the effect of transactions/event
is not considered material. This principle is the exception of full disclosure principle.
According to this convention, items having an insignificant effect or being irrelevant to the
user need not be disclosed.
According to American Accounting Association (AAA), “An item should be regarded as
material, if there is reason to believe that knowledge of it would influence decision of
informed investor.”
Disclosure:
This principle requires that all significant information relating to the economic affairs of the
enterprise should be completely disclosed. There should be a sufficient disclosure of
information, which is of material interest to the users of the financial statement. The
principle is so important that the Companies Act, make amole provisions for the disclosure of
essential information in the financial statement of a company.

Periodicity:
It is also known as time period assumption. As per ‘going concern’ assumption, an indefinite
life of the entity is assumed, so the economic life of an enterprise is artificially split into
periodic intervals which are known as accounting period, at the end of which an income
statement and position statement are prepared to show the performance and financial
position.