ACCOUNTING CONCEPTS

AND CONVENTIONS
Presented by:
Dr. Gitika Arora Kharbanda
Accounting concepts: Accounting concepts
define the assumptions on the basis of which
financial statements of a business entity are
prepared. (Institute of Chartered Accountants
of India)
Accounting conventions: Accounting conventions
emerge out of accounting practices, commonly
known as accounting principles, adopted by
various organizations over a period of time.
These conventions are derived by usage and
practice. The accountancy bodies of the world
may change any of the convention to improve
the quality of accounting information.
Accounting conventions need not have
universal application. (Institute of Chartered
Accountants of India)
Accounting Concepts and Conventions
Business Entity Concept

Money Measurement Concept

Periodicity Concept

Accrual Concept

Matching Concept

Going Concern Concept

Cost Concept

Realisation Concept

Dual Aspect Concept

Consistency

Materiality
CONCEPT EXPLANATION EXAMPLE

Business This concept assumes that, for For example, when the owner
Entity accounting purposes, the business invests money in the business, it
Concept enterprise and its owners are two is recorded as liability of the
separate independent entities. Thus, business to the owner. Similarly,
the business and personal when the owner takes away from
transactions of its owner are the business cash/goods for
separate his/her personal use, it is not
treated as business expense

Money As per this concept, only those Although it may be a fact that a
Measurement transactions, which can be business owns Rs. 30,000 of
Concept measured in terms of money are cash, 1,000 units of raw material,
recorded. Transactions, even if, they six trucks, and so on, these
affect the results of the business amounts cannot be added
materially, are not recorded if they together to produce a meaningful
are not convertible in monetary total of what the business owns.
terms. Expressing these items in
monetary terms—Rs. 30,000 of
cash, Rs. 9,000 of raw material,
CONCEPT EXPLANATION EXAMPLE

Periodicity According to this concept accounts If a textile mill lasts for 100
Concept should be prepared after every period years, it is not desirable to
& not at the end of the life of the measure its performance as
entity. Usually this period is one well as financial position
calendar year. We generally follow only at the end of its life.
from 1st April of a year to 31st March So , it is generally divided
of the immediately following year. into small part normally
one year.
Accrual Concept Under accrual concept, the effects of Expenses incurred but not
transactions and other events are yet paid in current period
recognised on mercantile basis i.e., should be treated as
when they occur (and not as cash or a accrual/accrued expenses
cash equivalent is received or paid) under current liabilities
and they are recorded in the Expenses incurred in the
accounting records and reported in the following period but paid
financial statements of the periods to for in advance should be
which they relate. treated as prepayment
expenses under current
CONCEPT EXPLANATION EXAMPLE

Matching In this concept, all expenses Angle Machining, Inc. buys a new
Concept matched with the revenue of piece of equipment for Rs.100,000 in
that period should only be 2015. This machine has a useful life
taken into consideration. In the of 10 years. This means that the
financial statements of the machine will produce products for at
organization if any revenue is least 10 years into the future.
recognized then expenses According to the matching principle,
related to earn that revenue the machine cost should be matched
should also be recognized. with the revenues it creates. Thus, the
machine is depreciated over its 10-
year useful life instead of being fully
expensed in 2015.
CONCEPT EXPLANATION EXAMPLE
Going The financial statements are Suppose Mr. X purchased a machine
Concern normally prepared on the for his business paying Rs. 5,00,000
Concept assumption that an enterprise out of Rs. 7,00,000 invested by him.
is a going concern and will He also paid transportation expenses
continue it’s operation for the and installation charges amounting
foreseeable future. Hence, it is to 70,000. Now if he decides to back
assumed that the enterprise out and desires to sell the machine, it
has neither the intention nor may fetch more than or less than
the need to liquidate or curtail 5,70,000. So his financial position
materially the scale of its should be different. If going concern
operations; if such an intention concept is taken, increase/decrease
or need exists, the financial in the value of assets in the short-
statements may have to be run is ignored. The concept indicates
prepared on a different basis that assets are kept for generating
and, if so, the basis used needs benefit in future, not for immediate
to be disclosed. sale; current change in the asset
value is not realisable and so it
should not be counted.
CONCEPT EXPLANATION EXAMPLE

Cost Concept According to this concept an asset is When a machine is

ordinarily recorded in the books of purchased at Rs. 10 lacs
accounts at acquisition price i.e. at then following this concept,
which it is purchased. it should be recorded at Rs.
It is highly objective and free from bias. 10 lacs only.
However it suffers from various
limitation.
1. This concept ignores the current
prices prevailing in the market, so
accounts will not reflect the true
position of business.
2. Historical cost based accounts lose
comparability.
Realisation In respect of revenue, it states that the 1. If goods are sent on
Concept amount should be recognized as sale, then it should be
revenue only if it is reasonably certain recorded in sales A/c
to be realized. only if customer
In respect of Assets, it provides that if confirm its acceptance.
there is increase in value of assets, it 2. If there is anticipation
CONCEPT EXPLANATION EXAMPLE

Dual Aspect Dual concept may be stated as “for every If capital is introduced in
Concept debit there is equal and opposite credit”. business for Rs. One lac in
Every transaction should have two sided cash then
effect to the extent of same amount. Cash=Equity + Liabilities
This concept has resulted in accounting 1 lac= 1 lac+0
equation. 1 lac=1 lac
Assets= Equity + Liabilities
Consistency This assumption is important to ensure Depreciation on machine can
uniformity in accounting policies and be calculated using Straight
process. It helps to achieve Line Method (SLM) or Written
comparability of financial statements Down Value (WDV) method.
overtime. Consistency assumption If once SLM is used, then it
requires that once a particular method should be followed year
of calculation is chosen then it should after year
be followed year after year..
However, it doesn't imply non-flexibility
as not to allow the introduction of
improved method of accounting. An
enterprises can change its accounting
policy in following situations:
CONCEPT EXPLANATION EXAMPLE

Conservatis Conservatism states that the accountant The golden rule of current
m should not anticipate any future income assets valuation - ‘cost or
however they should provide for all market price whichever is
possible losses. When there are many lower’ originated from this
alternative values of an asset, concept.
an accountant should choose the method
which leads to the lesser value.
For this concept there should be at least
three qualitative characteristics of financial
statements, namely,
(i) Prudence
(ii) Neutrality, i.e., unbiased outlook
(iii) Faithful representation of alternative
values.
Materiality It refers to relative importance of an item Half pencil left at the end of
or event. An item is said to be material if accounting period may be
the knowledge of it would influence the taken as an expense rather
decision of informed investor. It states that then shown as an asset in
important details should be given due the balance sheet.
Thank you