Accounting Concepts & Conventions
- ACCOUNTING CONCEPTS:-
Accounting concepts means & includes necessary assumptions or ideas which are used to accounting practice & preparation of financial statements. The following are the important accounting concepts:
- Business Entity Concept: – For accounting purpose the business is treated as a separate entity from the proprietor. It may sound to be absurd that one can sell goods to himself, but all transactions are recorded in the books of the business as per this point of view. This concept helps in keeping private affairs of the proprietors away from the business affairs. Thus if a proprietor invest Rs. 1,00,000 in business it is deemed that the proprietor has given Rs. 1,00,000 to the business. Similarly, if the proprietor withdraws Rs. 10,000 from the business it is charged to him.
- Money Measurement Concept: – In accounting, everything is recorded in terms of money. Events or transactions which cannot be expressed in terms of money are not recorded in the book of accounts even if they are very important or useful for the business. Purchase & sale of goods, payment of expenses & receipt of income are monetary transactions, which find place in accounting. Death of an executive, resignation of a manager is the events, which cannot be measured in money.
- Going Concern Concept: – It is otherwise known as Continue of Activity Concept. This concept assumes that business concern will continue for a long period to exit. In other words, under this assumption, the enterprise is normally viewed as a going concern & it is not likely to be liquidates in the near future. This assumption implies that while valuing the assets of the business on the basis of productivity & not on the basis of their realizable value or the present market value, at cost less depreciation till date for the purpose of balance sheet. It is useful in valuation of assets & liabilities, depreciation of fixed assets & treatment of prepaid expenses.
- Realization Concept: – Realization concept is also known as Revenue Recognition Concept. According to this concept profit should be accounts for only when it is actually realized. Revenue is recognized only when sale is affected or the services are rendered. Sale is considered to be made when the property in goods passes to the buyer & he is legally liable to pay. However in order to recognize receipt of cash is not essential. Even credit sale results in realization as it creates a definite asset called Account Receivable. However there are certain exceptions to this concept. E.g. hire purchase, etc.
- Accrual Concept: – The accrual system is a method whereby revenue & expense are identified with specific periods of time like a month, half year or a year. It implies recording of revenues & expenses of a particular accounting period, whether they are received / paid in cash or not. Under accrual method, the revenue & expenses relating to the particular accounting period only are considered.
- Cost Concept: – It implies that assets acquired are recorded in the accounting books at the cost or price paid to acquire it. And this cost is the basis for subsequent accounting for the assets. For accounting purpose the market value of assets are not taken into account either for valuation or charging depreciation of such assets. It brings objectivity in the preparation & presentation of financial statements. In its absence figures shown in accounting records would be subjective & questionable.
- Matching Concept: – Matching concept is closely related to accounting period concept. The chief aim of the business concern is to ascertain the profit periodically. To measure the profit for a particular period it is essential to match accurately the cost associated with the revenue. Thus, matching of cost & revenues related to a particular period is called as Matching Concept.
- Rupee Value Concept: – This concept assumes that the value of rupee is constant. In fact due to inflationary pressure, the value of rupee will be declining. Under this situation financial statements are prepared on the basis of historical costs not considering the declining value of rupee. Similarly depreciation is also charged on the basis of cost price. Thus this concept results in underestimation of depreciation & overestimation of assets in the balance sheet.
- Dual Aspect Concept: According to this concept every business transaction involves two aspects, namely for every receiving of benefit & there is a corresponding giving of benefit. The dual aspect concept is the basis of the double entry book-keeping. Accordingly for every debit there is an equal & corresponding credit.
- Accounting Period Concept:- According to this concept, income or loss of a business can be analysed & determined on the basis of suitable accounting period instead of wait for a long period i.e. until it is liquidated. Being a business is continuous affairs for an indefinite period of time the proprietors, shareholders & outsiders want to know the financial position of the concern, periodically. Thus the accounting period is normally adopted for one year. At the end of each accounting period an income statement &balance sheet are prepared.
- ACCOUNTING CONVENTIONS:-
Accounting convention implies that those customs, methods & practices to be followed as a guideline for preparation of accounting statements. The accounting conventions can be classified as follows:-
- Convention of Disclosure: The disclosure of all material information is one of the important accounting conventions. According to this convention all accounting statements should be honestly prepared & all facts & figures must be disclosed therein. The disclosures of financial information are required for different parties who are interested in the welfare of the enterprise. The Companies Act lays down the forms of profit & loss account & balance sheet. Thus convention of disclosure is required to keep as per the requirement of the Companies Act & Income Tax Act.
- Convention of Conservatism: – This convention is closely related to the policy of playing safe. This principle is often described as “anticipate no profit, and provide for all possible losses.” Thus this convention emphasizes that uncertainties & risk inherent in business transactions should be given proper consideration. For example under this convention inventory is valued at cost price or market whichever is lower. Similarly bad & doubtful debts are made in the books before ascertaining the profit.
- Convention of Consistency:- The convention of consistency implies that accounting policies, procedure & methods should remain unchanged for preparation of financial statements from one period to another. Under this convention alternative improved accounting policies are also equally acceptable. In order to measure the operational efficiency of a concern this convention allows a meaningful comparison in the performance of different period.
- Convention of Materiality:- According to Kohler’s Dictionary of Accountants Materiality may be defined as “ the characteristic attaching to a statement fact or item whereby its disclosure or method of giving it expression would be likely to influence the judgment of a reasonable person.” According to this convention consideration is given to all material events, insignificant details are ignored while preparing the profit & loss account & balance sheet. The evaluation & decision of material or immaterial depends upon the circumstance & lies at the discretion of the accountant.