Lesson 02:

Accounting
concepts and
conventions

Daupadee Gamage

BSc. in Finance (Special) – First Class –USJ

CIMA Passed Finalist

Accounting concepts

– Accounting concepts are the basic assumptions and rules followed

in recording business transactions and in preparation of financial
statements.
– The main objective is to maintain uniformity and consistency in
accounting records
– These are the theories on how and why certain categories of
transactions should be treated in a particular manner.
Business entity concept

– The business and its owner(s) are two separate entities

– Any private and personal incomes and expenses of the owner(s) should not be treated as
the incomes and expenses of the business
– The books of accounts are prepared from the point of the business and not the person
owning the business
Example : when the owner invests money in the business, it is recorded as capital.
Similarly, when the owner takes away from the business cash/goods for his/her personal
use, it is treated as drawings.
A Car purchased by the owner for personal use is not Recorded in the Books Of Account
Of the Business.
Capital (Liability)

Drawings (Asset)
 Going Concern Concept

It is assumed that the entity is a going concern, i.e., it will continue

to operate for an indefinitely long period in future and transactions
are recorded from this point of view.

The business will continue in operational existence for the

foreseeable future.

Financial statements should be prepared on a going concern basis

unless management either intends to liquidate the enterprise or to
cease trading, or has no realistic alternative but to do so
 Money measurement concept

– In accounting, a record is made only of those transactions or events which

can be measured and expressed in terms of money.
– All transactions of the business are recorded in terms of money.

– It provides a common unit of measurement

Examples
– Market conditions, technological changes and the efficiency of management
would not be disclosed in the accounts
Non monetary transactions are not recorded in accounting.

Innovativeness
Attitude Experience
skill Team work
Honesty Passion
Accounting period concept

– All the transactions are recorded in the books of accounts on the assumption
that profits on these transactions are to be ascertained for a specified period.
This is known as accounting period concept
– For measuring the financial results of a business periodically, the working life of
an undertaking is split into convenient short periods called accounting period
 Historical cost concept

– Historical cost concept states that all assets are recorded in the books of
accounts at their purchase price ( Historical cost), which includes cost of
acquisition, transportation and installation and not at its market price
– Assets should be shown on the balance sheet at the cost of purchase instead
of current value
Example
– If a business buys a plot of land, paying $250,000 for it, this asset would be
recorded in the accounts of the business at the amount of $250,000. If a year
later the land could be sold for $275,000, or if it could be sold for only
$220,000, no change would ordinarily be made in the accounting records to
reflect this fact.
Historical Cost
Of

Market Value
Of
 Dual Aspect concept

– Dual aspect is the foundation or basic principle of accounting

– It provides the very basis of recording business transactions in the books
of accounts
– This concept assumes that every transaction has a dual effect, i.e. it
affects two accounts in their respective opposite sides.
– Therefore, the transaction should be recorded at two places. It means,
both the aspects of the transaction must be recorded in the books of
accounts.
 For Example:
Cash Sales Rs. 10,000

Debit • Cash Account Rs. 10,000

Credi • Sales Account Rs. 10,000

t
This Concept has resulted in

THE
ACCOUNTING
EQUATION
Realization Concept

– This concept states that revenue from any business transaction should be
included in the accounting records only when it is realised. The term
realisation means creation of legal right to receive money. Selling goods is
realisation, receiving order is not.
– Profit is earned when goods or services are provided /transferred to
customers. Thus it is incorrect to record profit when order is received,
or when the customer pays for the goods.
Matching concept

The matching principle ensures that revenues and all their associated
expenses are recorded in the same accounting period.

The matching concept states that the revenue and the expenses incurred to
earn the revenues must belong to the same accounting period

The matching principle is the basis on which the accrual accounting method
of book- keeping is built.
 Accounting Conventions

Accounting Conventions are the common practices which are universally followed
in recording and presenting accounting information of business. It helps in
comparing accounting data of different business or of same units for different
periods
Materiality

Only those transactions, important facts and items are shown which are useful
and material for the business. The firm need not record immaterial and
insignificant items.
Illustration:
Company XYZ Ltd. bought 6 months supplies of
stationary worth $600.

Question:
Should the Company spread the cost of this stationary
for 6 months by expensing off $100 per month to the
income statement?

Answer:
Based on this concept, as the amount is so small or
immaterial, it can be expensed off in the next month
instead of tediously expensing it in the next 6 months.
Full disclosure concept

Financial Statements and their notes should present all information that is
relevant and material to the user’s understanding of the statements.
 Conservatism

Revenues and profits are not anticipated. Only realized profits with reasonable certainty are
recognized in the profit and loss account.

However, provision is made for all known expenses and losses whether the amount is known
for certain or just an estimation.

This treatment minimizes the reported profits and the valuation of assets
Anticipate No Profits
but
Provide for all Losses

Accountant should always

be on side of safety.
Consistency

The accounting practices and methods should remain consistent from one
accounting period to another.

Whatever accounting practice is followed by the business enterprise, should be

followed on a consistent basis from year to year.
 For Example

Year 2009-10 2010-11 2011-12

Method of • Straight • Written • Units of

Depreciation Line Down Measure
followed Method Value Method
Method
Thank You !