While
the conventions are based on what is practicable, there are certain accounting
concepts which are based on logical considerations. Accounting concepts are ideas and assumptions
which are fundamental to accounting practice.
Some of the important concepts are money measurement concepts, business entity concept, going
concern concept, duality concept, cost concept, matching concept, realization
concept and accrual concept. The
generally accepted accounting principles which are followed in several countries
(including India) are as follows:
1. Materiality Concept: The criterion of ‘True and Fair’ in the preparation of the financial statement is necessary for arriving at a reasonable conclusion on the financial health of the company. This condition brings us to the relative concept of materiality, which by its very nature can be subject to variations. An error of Rs. 1000 in finished goods inventory whose total is valued at a few lakhs of rupees is definitely meager to warrant special attention while the same will have to be attended in the case of the total stock being valued at any of few thousands.
2. Money Measurement Concept: In financial accountancy, a record is made only of information that can be expressed in monetary terms. Recording, classification and summarization of business transactions requires a common unit of measurement which is taken as money. If events cannot be quantified in monetary terms then they do not facilitate accounting. Hence, all transactions are recorded through a common denominator, namely the monetary unit. Thus, if a certain event, no matter how significant for the health or even existence of the business, cannot be measured in monetary terms, such an event is not recorded in accounting.
3. Cost Concept: Cost concept implies that in accounting, all transactions are generally recorded at cost, and not at market value. For example, if a piece of land is acquired for Rs.10 lakh, it would continue to be shown in the balance sheet at Rs.10 lakhs, even when the market value of the land rises to say Rs.20 lakhs. Why should this be so? This is because, cost concept is in fact closely related to the going concern concept. If the land is acquired for the operations of the business and would continue to be used for its operations and would not be sold shortly, then it is largely immaterial what the land’s market value is, since it is not going to be sold anyway. Thus, it is consistent with going concern concept to keep recording the land at cost, i.e. Rs.10 lakhs on an on-going basis.
4. Time Period Concept: Income (or) loss of the business is measured periodically. This is measured for a specified interval of time, called the accounting period. For the purpose of reporting to outsiders, one year is the usual accounting period.
5. Conservatism Concept: According to this principle, the principle of “anticipate no profit but provide for all probable losses” should be applied. The valuation of stock-in-trade at a lower of cost or market value and making and making the provision for doubtful debts and discount on debtors are the applications of this principle. In other words, the principle of conservatism requires that in the situation of uncertainty and doubt, the business transactions should be recorded in such a manner that the profits and assets are not overstated and the losses and liabilities are not understand.
6. Consistency Concept: Several ways of treating an event are in practice that may be recorded in accounts. The consistency concept requires that once an entity has decided on one method, it will treat all subsequent events of the same character in the same fashion unless it has a sound reason to change the method of treatment of that event. For example, if a concern is valuing its inventory by a particular method in one year it is expected to value its inventory in the subsequent years also in the same method unless there is a strong reason to change the same. Similarly, if it is charging depreciation by one method it is expected to follow the same method in the subsequent years also.
7. Business entity concept: According to this assumption, a business is treated as a separate entity that is distinct from the owner(s), and all other economic proprietors. For example, in case of proprietary concern, through the legal entity of the business and its proprietor is the same, for the purpose of accounting. They are to be treated as separate from each other. If this assumption is not followed, the financial position and operating results of a business entity cannot be ascertained. In other words, this assumption requires that for accounting purposes, a distinction should be made between (i) personal transactions and business transactions and (ii) transaction of one business entity and those of another business entity. For example, if the household expenses (Rs.5,000) of the proprietor are shown as business expenses, the profits of a business will understated to the extent of Rs.5,000.
8. Duality or accounting Equivalence concept: It is the basic principle of accounting. Every business transactions have a dual effect, i.e., the two fold effect of benefit giving and benefit receiving. The recording of both these is considered as the core of double-entry. This assumes that total assets are equal to total liabilities. This is called as the Balance sheet equation or Accounting equation. It can be stated a
Owner’s Equity + Outside Liability = Assets
Owner’s Equity = Assets – Outside liabilities
9. Accounting Period Concept: To be able to prepare the income statement for a business, the period for which it is to be prepared must be specified first. Very often the accounting period chosen is a calendar year (January 1 – December 31) or a fiscal year (April 1 – March 31). It is also not uncommon to synchronize one’s accounting period with one’s operating periods. In some businesses such as trading, the operating period may be relatively small, say a month or even less; while in other cases it may stretch well beyond a year. Depending on one’s nature of business, one may adopt a Hindu year, or the period beginning with Diwali or any other period as one’s accounting period. Under the Companies Act, a company is normally not permitted to have an accounting period extending beyond fifteen months.
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