Assignment N# 02

Principles, Concepts, Conventions & Standards of Accounting

What are Accounting Principles?

Accounting principles are the rules and guidelines that companies must follow when reporting
financial data. The Financial Accounting Standards Board (FASB) issues a standardized set of
accounting principles in the U.S. referred to as generally accepted accounting
principles (GAAP).

What Is GAAP?

GAAP is a set of rules used for helping publicly-traded companies create their financial
statements. These rules form the groundwork on which more comprehensive, complex, and
legalistic accounting rules are based.

What Are the Principles of Accounting?

The best way to understand the GAAP requirements is to look at the ten principles of accounting

1.ECONOMIC ENTITY PRINCIPLE: The business is considered a separate entity, so the

activities of a business must be kept separate from the financial activities of its business owners.

2.MONETARY UNIT PRINCIPLE: The monetary unit assumption means that only
transactions in U.S. dollar amounts can be included in accounting records. It’s important to note
that accountants ignore the effects of inflation on the recorded dollar amounts.

3.TIME PERIOD PRINCIPLE: The business activities may be reported in short, distinct time
intervals which may be weeks, months, quarters, a calendar year or fiscal year. The time interval
has to be identified in the headings of the financial statements such as the income statement,
statement of cash flow and stockholders’ equity statement.

4.COST PRINCIPLE: The cost principle mentions the historical cost of an item. This refers to
cash or cash equivalent that was paid to purchase an item in the past. This asset amount is
adjusted for inflation. The historical cost is reported on the financial statements.

5.FULL DISCLOSURE PRINCIPLE: All information that is relative to the business and is
important to a lender or investor must be disclosed in the content of the financial statements or in
the notes to the statements. This is the reason that numerous footnotes are attached to financial
statements.

6.GOING CONCERN PRINCIPLE: This accounting principle refers to the intent of a

business to carry on its operations and commitments into the foreseeable future and not to
liquidate the business.
7.MATCHING PRINCIPLE: The matching principle requires that businesses use the accrual
basis of accounting and match business income to business expenses in a given time period. For
example, the commissions for sales should be recorded in the same accounting period that sales
income was made (and not when they were paid).

8.REVENUE RECOGNITION PRINCIPLE: Under the accrual basis of accounting, the

revenues must be reported on the income statement in the period in which it is earned. This
means that as soon as a product is sold, or the service has been performed, the revenues are
recognized. This is regardless of whether the money is received or not.

9.Materiality principle: The materiality principle refers to the misstatement in accounting

records when the amount is insignificant or immaterial. Because of the materiality principle,
financial statements usually show amounts rounded to the nearest dollar.

10.CONSERVATISM PRINCIPLE: If accountants are unsure about how to report an item,

conservatism principle calls for potential expenses and liabilities to be recognized immediately.
It directs the accountant to anticipate the losses and choose the alternative that will result in less
net income and/or less asset amount. For example, potential lawsuits may be regarded as losses
and are reported but the financial data representation should be done “as it is” and not based on
any speculation.

Accounting Concepts?

Accounting concepts are a set of general conventions that can be used as guidelines when
dealing with accounting situations. These concepts have also been integrated into the
various accounting standards, so that a user will not implement a standard and then find that
it is in conflict with one of the accounting concepts.

Following Accounting concepts:

1.Business entity concept: A business and its owner should be treated separately as far as their
financial transactions are concerned.

2.Money measurement concept: Only business transactions that can be expressed in terms of

money are recorded in accounting, though records of other types of transactions may be kept
separately.

3.Dual aspect concept: For every credit, a corresponding debit is made. The recording of a
transaction is complete only with this dual aspect.

4.Going concern concept: In accounting, a business is expected to continue for a fairly long
time and carry out its commitments and obligations. This assumes that the business will not be
forced to stop functioning and liquidate its assets at “fire-sale” prices.

5.Cost concept: The fixed assets of a business are recorded on the basis of their original cost in
the first year of accounting. Subsequently, these assets are recorded minus depreciation. No rise
or fall in market price is taken into account. The concept applies only to fixed assets
 .
6.Accounting year concept: Each business chooses a specific time period to complete a cycle of
the accounting process—for example, monthly, quarterly, or annually—as per a fiscal or a
calendar year.

7.Matching concept: This principle dictates that for every entry of revenue recorded in a given
accounting period, an equal expense entry has to be recorded for correctly calculating profit or
loss in a given period.

8.Realization concept: According to this concept, profit is recognized only when it is earned.

An advance or fee paid is not considered a profit until the goods or services have been delivered
to the buyer.

Accounting Conventions?
Accounting conventions are guidelines used to help companies determine how to record certain business

transactions that have not yet been fully addressed by accounting standards.

There are four main conventions in practice in accounting: Conservatism, Consistency, Full
disclosure, And materiality.

1.Conservatism:  is the convention by which, when two values of a transaction are available, the
lower-value transaction is recorded. By this convention, profit should never be overestimated,
and there should always be a provision for losses.

2.Consistency: prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit and loss.

3.Materiality: means that all material facts should be recorded in accounting. Accountants

should record important data and leave out insignificant information.

4.Full disclosure: entails the revelation of all information, both favorable and detrimental to a
business enterprise, and which are of material value to creditors and debtors.

Accounting Standards?

The term ‘Accounting Standard’ may be defined as written statements issued from time to time
by institutions of the accounting profession or institutions in which it has sufficient involvement
and which are established expressly for this purpose.

Accounting standards are authoritative standards for financial reporting and are the primary
source of generally accepted accounting principles (GAAP).

Accounting standards specify how transactions and other events are to be recognized, measured,
presented and disclosed in financial statements. Their objective is to provide financial
information to investors, lenders, creditors, contributors, and others that is useful in making
decisions about providing resources to the entity.
Types of Accounting Standards:

Accounting Standards may be classified by their subject-matter and by how they are enforced.
According to subject-matter, standards may be as follows:

1.Disclosure Standards: Such standards are the minimum uniform rules for external reporting.
They require only an explicit disclosure of accounting methods used and assumptions made in
preparing financial statements. Such a standard is likely to be controversial or creates conflicts of
interest, particularly since it does not constrain the choice of accounting policies or items to be
disclosed.

2.Presentation Standards: They specify the form and type of accounting information to be
presented. They may specify that certain financial statements be presented (e.g., a funds-flow
statement) or that items be presented in particular order in financial statements. Such standards
place only a little more constraint upon the choice of accounting policies than disclosure
standards and aim to reduce the costs to users of utilizing financial statements.

3.Content Standards: These standards specify the accounting information which is to be

published.

There are three aspects to such standards:

(a) Disclosure: Disclosure Content standards which specify only the categories of information to
be disclosed.

(b) Specific: Specific Construct standards which specify how specific items should be reported
in accounts, e.g., a standard which specifies that finance leases be capitalized and disclosed in
balance sheet.

(c) Conceptually: Conceptually Based standards which specify the accounting treatment of
items based upon a coherent and complete framework of accounting. Another classification of
accounting standards may be based upon their method of preparation and enforcement.
Such standards are:

(1) Evolutionary and Voluntary Compliance Standards:

Such standards have evolved as best practices and represent the conventional approach to
accounting. As such, their general acceptability implies voluntary compliance by individual
companies.

(2) Privately Set Standards:

Private accountancy bodies may formulate standards and devise means for their enforcement.
Other bodies such as trade associations or stock exchanges may set accounting standards for
companies as a condition of membership or listing. Enforcement powers are thus more readily
available.

(3) Governmental Standards:

These standards may be laws relating to company accounting practices and disclosure, as in the
case of the Indian Companies Acts, or tax rules defining taxable profit. Alternatively,
Government departments or agencies may regulate accounting practices for certain industries. It
is significant to note that the above two classifications are complementary and not competitive.