CHAPTER 1 :

ACCOUNTING PRINCIPLES
AND CONCEPTS
MEANING AND SCOPE OF ACCOUNTING

• Accounting is the language of business.

• The main objectives of Accounting is to safeguard the
interests of the business, its proprietors and others
connected with the business transactions. This is done
by providing suitable information to the owners,
creditors, shareholders, Government, financial
institutions and other related agencies.
 DEFINITION OF ACCOUNTING

• The American Accounting Association defines accounting as

"the process of identifying, measuring and communicating
economic information to permit informed judgements and
decisions by the users of the information."
• According to AICPA (American Institute of Certified Public
Accountants) it is defined as "the art of recording, classifying
and summarizing 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 result thereof."
4 MAJOR STEPS OF ACCOUNTING
The following are the important steps to be adopted in the accounting
process:
(1) Recording: Recording all the transactions in subsidiary books for
purpose of future record or reference. It is referred to as "Journal."
(2) Classifying: All recorded transactions in subsidiary books are classified
and posted to the main book of accounts. It is known as "Ledger."
(3) Summarizing: All recorded transactions in main books will be
summarized for the preparation of Trail Balance, Profit and Loss Account
and Balance Sheet.
(4) Interpreting: Interpreting refers to the explanation of the meaning and
significance of the result of final accounts and balance sheet so that
parties concerned with business can determine the future earnings, ability
to pay interest, liquidity and profitability of a sound dividend policy.
FUNCTIONS OF ACCOUNTING

From the definition and analysis of the above the main

functions of accounting can be summarized as:
(1)Keeping systematic record of business transactions.
(2)Protecting properties of the business.
(3)Communicating the results to various parties interested
in or connected with the business.
(4)(4) Meeting legal requirements.
OBJECTIVES OF ACCOUNTING
(1) Providing suitable information with an aim of
safeguarding the interest of the business and its
proprietors and others connected with it.
(2) To emphasis on the ascertainment and exhibition of
profits earned or losses incurred in the business.
(3) To ascertain the financial position of the business as
a whole.
(4) To ensure accounts are prepared according to
some accepted accounting concepts and
conventions.
(5) To comply with the requirements of the Companies
Act, Income Tax Act, etc.
DEFINITION OF BOOKKEEPING

Bookkeeping may be defined as "the art of recording the

business transactions in the books of accounts in a systematic
manner."
A person who is responsible for and who maintains and keeps a
record of the business transactions is known as Bookkeeper. His
work is primarily clerical in nature.
On the other hand, Accounting is primarily concerned with the
recording, classifying, summarizing, interpreting the financial data
and communicating the information disclosed by the accounting
records to those persons interested in the accounting information
relating to the business.
LIMITATIONS OF ACCOUNTING

(1)Accounting provides only limited information because it

reveals the profitability of the concern as a whole.
(2)Accounting considers only those transactions which can be
measured in terms of money or quantitatively expressed.
Qualitative information is not taken into account.
(3)Accounting provides limited information to the management.
(4)Accounting is only historical in nature. It provides only a post
mortem record of business transactions.
BRANCHES OF ACCOUNTING

The main function of accounting is to provide the required

information for different parties who are interested in the welfare
of that enterprise concerned. In order to serve the needs of
management and outsiders various new branches of accounting
have been developed. The following are the main branches of
accounting:
(1) Financial Accounting.
(2) Cost Accounting.
(3) Management Accounting.
(1) FINANCIAL ACCOUNTING:

Financial Accounting is prepared to determine

profitability and financial position of a concern
for a specific period of time.
WHAT IS AN EXAMPLE OF FINANCIAL ACCOUNTING?
A public company’s income statement is an example
of financial accounting. The company must follow
specific guidance on what transactions to record. In
addition, the format of the report is stipulated by
governing bodies. The end result is a financial report
that communicates the amount of revenue
recognized in a given period.
(2) COST ACCOUNTING:

Cost Accounting is the formal accounting system

setup for recording costs. It is a systematic
procedure for determining the unit cost of output
produced or service rendered.
Cost accounting involves determining fixed and variable
costs. Fixed costs are expenses that recur each month
regardless of the level of production. Examples include rent,
depreciation, interest on loans and lease expenses. Variable
costs are expenses that fluctuate with changes in production
level, such as supplies, labor, and maintenance expenses.
These costs are related to production in that the more units of a
product produced, the more expense there is associated with
the materials and labor that went into making the product.
Cost accounting determines both fixed and variable costs
associated with a product line to determine the break even
point, and then ultimately the profit. The break even point
represents the point at which expenses are covered by sales.
Profit is determined by using the break-even point as the
starting point for calculating profit. All sales beyond the break
even point are profit. Determining the number of units that need
to be sold to reach the break even point and then achieve profit
is know as cost-volume-profit analysis.
(3)MANAGEMENT ACCOUNTING:

Management Accounting is concerned with

presentation of accounting information to the
management for effective decision making and
control.
3 EXAMPLE OF MANAGEMENT OR MANAGERIAL
ACCOUNTING.
1.) Variance analysis
One of the most classical examples in management accounting is
variance analysis. In a nutshell, it comprises of comparing two values for
the same measurement. This could be comparing actual and planned
figures or two different months.
2.) Budgeting
Another important example of managerial accounting is budgeting. This
means in essence planning the future period(s) of a company. Typically
this task is a major task in a finance department and takes place from
late summer or autumn (season of the year between summer and winter
during which temperatures gradually decrease.) until the end of the year.
3.) Make or buy example
The third management accounting example we like to
discuss is “make or buy decisions”. In essence, this is the
choice between making a product in-house or buying the
product from another company.
The basic rule applying here is that a product should be
manufactured in-house if the relevant cost is lower than
the cost of purchasing the product.
ACCOUNTING PRINCIPLES

Various accounting systems and techniques are designed

to meet the needs of the management. The information
should be recorded and presented in such a way that
management is able to arrive at right conclusions. The
ultimate aim of the management is to increase profitability
and losses. In order to achieve the objectives of the
concern as a whole, it is essential to prepare the
accounting statements in accordance with the generally
accepted principles and procedures.
The term principles refers to the rule of action or
conduct to be applied in accounting.
Accounting principles may be defined as "those rules of
conduct or procedure which are adopted by the
accountants universally, while recording the
accounting transactions."
The accounting principles can be classified into two
categories:
I. Accounting Concepts.
II. Accounting Conventions.
I. ACCOUNTING CONCEPTS

Accounting concepts mean and include necessary assumptions or

postulates or ideas which are used to accounting practice and preparation
of financial statements. The following are the important accounting
concepts:
(1) Entity Concept;
(2) Dual Aspect Concept;
(3) Going Concern Concept;
(4) Cost Concept;
(5) Money Measurement Concept;
(6) Matching Concept;
(7) Realization Concept;
(8) Accrual Concept;
(9) Periodicity Concept.
II. ACCOUNTING CONVENTIONS

Accounting Convention implies that those customs,

methods and practices to be followed as a guideline for
preparation of accounting statements. The accounting
conventions can be classified as follows:
(1)Convention of Disclosure.
(2)Convention of Conservatism.
(3)Convention of Consistency.
(4)Convention of Materiality.
ACCOUNTING CONCEPT

1. Business Entity Concept: The concept assumes that the business

enterprise is independent of its owners.
2. Dual Aspect Concept: It is the primary rule of accounting, which
states that every transaction effects two accounts.
3. Going Concern Concept: The concept assumes that the business
will have a perpetual succession, i.e. it will continue its operations for
an indefinite period.
4. Cost concept: This concept holds that all the assets of the
enterprise are recorded in the accounts at their purchase price
.
5. Money Measurement Concept: As per this concept, only those
transaction which can be expressed in monetary terms are recorded in the
books of accounts.
6. Matching Concept: The concept holds that, the revenue for the period,
should match the expenses.
7. Realization Concept: As per this concept, revenue should be recorded by
the firm only when it is realized.
8. Accrual Concept: The concept states that revenue is to be recognized
when they become receivable, while expenses should be recognized when
they become due for payment.
9. Periodicity Concept: The concept says that financial statement should be
prepared for every period, i.e. at the end of the financial year
ACCOUNTING CONVENTIONS

For the purpose of improving quality of financial information, the

accountancy bodies of the world may modify or change any accounting
convention. Given below are the basic accounting conventions:
1. Consistency: Financial statements can be compared only when the
accounting policies are followed consistently by the firm over the
period. However, changes can be made only in special circumstances.
2. Disclosure: This principle state that the financial statement should be
prepared in such a way that it fairly discloses all the material
information to the users, so as to help them in taking a rational
decision.
3. Conservatism: This convention states that the firm should not anticipate
incomes and gains, but provide for all expenses and losses.

4. Materiality: This concept is an exception to the full disclosure convention

which states that only those items to be disclosed in the financial statement
which has a significant economic effect.
END OF DISCUSSION
QUIZ