ACCOUNTING CONCEPTS
1. CONSERVATISM CONCEPT-:
Also known as prudence concept.
It requires that profits should not be recorded until realised but all
losses, even those which may have a less possibility are to be
provided in the books of accounts.
Because of Conservatism Concept, closing stock is valued at cost
price or market price whichever is less.
EXAMPLE- creating provision for doubtful debts, discount on
debtors in anticipation of bad debts and discount.
Provide for all anticipated expenses and losses but do not account
anticipated income and profits.
2. MATCHING CONCEPT OR MATCHING PRINCIPLE-:
It implies that all revenues earned during an accounting year,
whether received during that year or not and all costs incurred
whether paid during the year or not should be taken into account
while ascertaining profit or loss for that year.
Ex- costs like depreciation of fixed assets is divided over the
periods during which asset is used.
Expenses such as salaries, rent, insurance are recognised on the
basis of period to which they relate and not when these are
paid.
Expenses incurred to earn the revenue should be recognised as
expense in the year revenue is recognised.
3. REVENUE RECOGNITION CONCEPT:-
Also known as Realization concept.
Recognizing revenue and receipt of an amount are two separate
concepts.
Receipt of an amount means receiving cash but recognising
revenue means when the right to receive cash is established.
EXAMPLE- A company sells good in February, 2021 and receives
the amount in April, 2021. Revenue of this sales should be
recognized in February, 2021 I.e. when the goods are sold
because the legal obligation to receive the amount is established
(upon sales) in February, 2021.
Revenue is recognised when the right to receive is established.
4. VERIFIABLE OBJECTIVE CONCEPT:-
Accounting should be free from personal bias.
All accounting transactions should be evidenced and supported by
business documents.
These supporting documents are cash memo, invoices, sales bills,
etc.
Transaction is recorded on the basis of evidence.
5. MATERIALITY PRINCIPLE:-
An item is regarded to be material (important) if it influences the
decision of an informed investor.
Materiality of an item would depend on its NATURE and/or
AMOUNT.
EXAMPLE- Amount spent for repairs of a building 2,50,000 Rs. is
material for a company having a turnover of 10,00,000 Rs. But it is
immaterial for a company having a turnover of say 15,00,00,000
Rs.
Also closure of a production plant, even temporarily, say because
of an environmental problem is material.
An item or disclosure is material if it will influence the decision of
the user.
6. MONEY MEASUREMENT CONCEPT:-
a. Transactions and events that can be measured in money terms
are recorded in the books of account of the enterprise.
b. Transactions and events that cannot be measured in money terms
are not recorded, howsoever important they may be to the enterprise.
c. The value of money is considered to have static value as the
transactions are recorded at the value on the transaction date.
Transactions and events that can be measured in money terms are
recorded.
7. ACCOUNTING ENTITY OR BUSINESS ENTITY PRINCIPLE:-
a. According to this concept, business is considered to be
separate from its owners.
b. Owners being regarded as separate from business are
considered as creditors of the business to the extent of their
capital.
c. Their account with the business is credited with the capital
introduced and profit earned during the year, etc. and debited by
the drawings made.
d. This principle is applicable to all forms of business
organizations, whether they are sole proprietorship, partnership
or companies.
EXAMPLE- The owner of a company lends loan to his company. It
would be strictly recorded as company’s liability and that has to
be paid back to the owner.
Entries are recorded in the books of account from the point of view of
business.
8. ACCOUNTING PERIOD PRINCIPLE:-
a. Management requires information at regular intervals to assess
the performance, banks require accounting information
periodically because they have invested money and have to
ensure its safety and returns.
b. Government too needs financial information of an enterprise to
assess its tax dues.
c. In view of the above, the life of an enterprise is broken into
smaller periods (usually one period) which is termed as
‘ACCOUNTING PERIOD’.
d. An accounting period is an interval of time at the end of which
income statement and Balance Sheet are prepared to know the
results and resources of the business.
Life of the business is broken into smaller periods of 12 months
known as accounting periods.
9. FULL DISCLOSURE PRINCIPLE:-
a. Since the financial statements are used by many different
parties it becomes important that these statements makes a full,
fair and adequate disclosure of all information which is relevant
for taking financial decisions.
b. It states that all material and relevant facts about financial
performance of an enterprise must be fully and completely
disclosed in the financial statements and their accompanying
footnotes.
c. Indian Companies Act 1956 has given a format for the
preparation of profit and loss account and balance sheet of a
company, which has to be compulsorily followed.
Disclosures should be made of items required under law and those
items which are material.
10. HISTORICAL COST CONCEPT:-
a. The cost concept states that all assets are recorded in the
book of accounts at their purchase price.
b. The concept of cost is historical in nature as it is something
which has been paid on the date of acquisition and does not
change year after year.
c. It brings the element of objectivity in recording as the cost of
acquisition is easily verifiable from the purchase documents.
d. On the other hand the market value is not reliable as it keeps
on changing.
EXAMPLE- An asset is purchased for Rs. 5,00,000 and if at the
time of preparing the final accounts, even if its market value is say
Rs. 4,00,000 or Rs. 7,00,000, yet the asset shall continue to be
shown at its purchase price of Rs. 5,00,000.
Transactions are recorded at the price paid.
11. DUAL ASPECT OR DUALITY PRINCIPLE:-
a. It states for every debit there is a credit and for every credit
there is a debit.
b. This concept states that a transaction has a two fold effect
and should be recorded at two places.
Assets = Liabilities + Capital
c. In other words the equation states that the assets of a business
are always equal to the claims of owners and the outsiders.
d. This concept forms the core of Double Entry System.
EXAMPLE- Rahul starts a business with a capital of Rs. 1,00,000.
There are two aspects to the transaction. On one hand, the
business has an asset of Rs. 1,00,000 (cash) while on the other
hand, it has a liability towards Rahul of Rs. 1,00,000 (capital of
Rahul).
12. CONSISTENCY ASSUMPTION:-
a. According to this assumption, accounting practices once
selected and adopted shall be applied consistently year after
year.
b. Consistency eliminates personal bias and helps in showing
results that are comparable.
c. The accounting practice may be changed if the law or
accounting standard requires it.
d. For both inter-firm and inter-period comparisons, the
accounting policies and practices followed by enterprises should
be uniform and consistent over the period of time.
EXAMPLE-Two methods of charging depreciation, written down
value method and straight line method, are equally acceptable.
Under the assumption, method once chosen and applied should
be applied consistently year after year to make the financial
statements comparable.
Accounting practices and principles once applied shall be applied year
after year.
13. GOING CONCERN CONCEPT:-
a. This concept assumes that business shall continue for a
foreseeable period and there is no intention to close the
business or scale down its operations significantly.
b. Because of this concept a distinction is made between capital
expenditure i.e. expenditure that will give benefit for a long period
and revenue expenditure i.e. one whose benefit will be consumed
or exhausted within the accounting period.
EXAMPLE- A machine purchased is expected to last 10 years. The
cost of the machinery is spread on a suitable basis over the next
10 years for ascertaining the profit or loss for each year. The total
cost of the machine is not treated as an expense in the year of
purchase itself.
Business will continue for a foreseeable future at the same level of
operations.
14. ACCRUAL ASSUMPTION:-
a. According to this concept, a transaction is recorded in the
books of account at the time when it is entered into and not
when the settlement takes place.
b. Profit is regarded as earned at the time the goods or services
are sold or rendered to the customer i.e. the legal title is passed
to the customer, who in turn has an obligation to pay them.
c. Similarly, expense is regarded as incurred when the goods or
services are purchased or availed and an obligation to pay for
them is assumed.
Record revenue when you invoice the customer, rather than when the
customer pays you.
Record an expense when you incur it, rather than when you pay for it.
