Chapter 2.

Theory Base of Accounting

Meaning of Accounting Principles

Accounting has universal application. It is the language of the business through which it
communicates to various parties who are interested in it. To make the language convey the same
meaning to all the people, accountants have agreed on a number of concepts and conventions
which they try to follow. These are called Generally Accepted Accounting Principles (GAAP).
These principles have been generally accepted by accountants all over the world as general
guidelines for preparing the financial statements. These principles have been developed from
practical experience , usage, traditions and customs.
So Accounting principles are uniform set of rules or guidelines developed to ensure uniformity
and easy understanding of the accounting information.

Accounting Principles
It includes certain basic assumptions, principles or conditions on which the accounting system is
based. In accounting the following accounting principles are popular.
1. Accounting Entity Concept :
The word entity means something having separate existence. This concept seeks to make
a distinction between the business and the proprietor and his dealing with the business is
treated as transaction. In case this concept is not followed, affairs of the business will be
mixed up with the private affairs of the proprietor and the true picture of the business will
not be available.
2. Money Measurement Concept:
According to this concept, transactions involving money or money’s worth will be
recorded in the books. Events or transactions which cannot be expressed in terms of
money will not be recorded in the books though they may be very useful for the business.
3. Going Concern Concept:
According to this concept, it is assumed that the business will last for a long time. There
is no intention and necessity to liquidate the particular business venture in the near future.
4. Accounting Period Concept:
The period of interval for which accounts are prepared and presented for ascertaining the
result and the financial position of the business is called accounting period. At the end of
the accounting period, a statement of profit and loss account and a Balance sheet is
prepared. So, generally the results and financial position are ascertained for a short time
interval, usually a year.
5. Revenue Realisation:
This concept deals with the point of time at which the revenue is earned. The revenue is
earned or recognized at the point of sale when title to goods passes from the seller to the
buyer. It irrelevant that where cash is received or not.
6. Matching Principle :
This principle states that costs or expenses of a business of an accounting period are
matched with the revenue of that period in order to ascertain the profit or loss. In other
words, revenue pertaining to a period should be compared with the expenditure incurred
for earning that revenue.

7. Full Disclosure :
This principle demands that the accounting statements should disclose all material facts
for the benefit of the users. This principle has gained more importance because majority
of business enterprises are organised as companies. In such cases there is a separation
 between ownership and management. So the management must be supplied with all
relevant information on the profitability, financial position, etc., through the published
financial statements.
8. Dual Aspect :
This is the basic principles of accounting. According to this concept, every business
transaction has dual aspects i.e., giving aspect and the receiving aspect. These dual
aspects ultimately bring in change in the composition of assets and or liabilities.
Accounting equation is developed with the help of the dual aspect concept.
9. Cost Concept :
This principle requires that all transactions should be recorded at their acquisition cost.
The cost acquisition is the cost of purchase of asset, and includes the expenses incurred in
bringing them to the intended location and making them ready for use.
10. Consistency :
The accounting practices should remain the same from one year to another. For example,
if closing stock is valued at cost or market price, whichever is lower the same practice
should be followed year after year.
11. Materiality :
This principle states that importance should be attached only to material facts ignoring
insignificant details. Otherwise accounting will be unnecessarily overloaded with minute
details.
12. Conservatism (Prudence):
This principle states that anticipated profit are not to be considered but only possible
losses, while recording business transactions. This is the policy of playing safe. For
example, a provision is made possible bad and doubtful debts against current year’s
profits.
13. Objectivity Principle
It expresses that entries in the accounting records and data recorded in the financial
statements must be capable of verification supported by some objective evidence.
Invoices and vouchers for purchase and sales, bank statements etc are examples of
objective evidence.

Systems of Accounting
Systems of recording transactions in books of accounts are classified into two :
1. Double entry system
2. Single entry system
Double entry system
It is based on the ‘ Dual Aspect Concept’ which states that for every transaction, there are two
aspects. One is receiving aspect (Debit aspect) and the other is the giving aspect (Credit aspect).
Both the aspects should be recorded in a systematic way in books of accounts. For every debit
there must be corresponding credit and vice versa.
Single entry system
An account system which is not based on double entry is known as Incomplete accounting
system or Single entry system.
It is a mixture of double entry, one entry and no entry.
It is incomplete, , inaccurate, unscientific style of account keeping.

Basis of Accounting
Considering the timing of recognition of revenue and costs, there can be two approaches to
accounting:
1. Cash basis
2. Accrual basis
1. Cash basis
This basis records only the cash transactions. As per this basis, only those incomes are recorded
which have been received in cash. Similarly only those expenses are recorded which have been
paid in cash. This basis is suitable for professional people like doctors, lawyers etc.
2. Accrual basis
This basis makes a complete records of all cash as well as credit transactions. As per this basis,
all incomes are recorded whether cash is received for them or not. Similarly all expenses are
recorded whether cash is paid for them or not. This basis is adopted by business enterprises with
profit motive.

Accounting Standards
Accounting standards are certain set of rules and guidelines based on the principles and
methods of accounting to be followed to have uniformity in terminology, approach and
presentation of results.

International Accounting Standards (IAS) issued by IASC ( International Accounting

Standard Committee)
IAS-1 : Disclosure of Accounting policies
IAS-2 : Valuation and Presentation of Inventories
IAS-3 : Consolidated Financial Statements
IAS-4 : Depreciation in Accounting
IAS-5 : Information to be disclosed in financial statements
IAS-6 : Accounting responses to changing prices
IAS-7 : Statement of Changes in Financial Position and so on…..

Accounting Standards issued by Institute of Chartered Accountant of India

As-1 : Disclosure of Accounting policies
As-2 : Valuation of Inventories As-3 : Cash Flow statement
As-4 : Contingencies and events occurring after the
Balance sheet date
As-5 : Prior period and extra ordinary items and
changes in Accounting policies
As-6 : Depreciation Accounting
As-7: Accounting for construction contracts
As-8 : Accounting for Research and Development
As-9: Revenue Recognition
AS-10: Accounting for Fixed Assets
AS-11 : Accounting for the effects of changes in Foreign
exchange rates
AS-12 : Accounting for Government grants
As-13: Accounting for Investments
AS-14 : Accounting for Amalgamations
AS-15 : Accounting for Retirement benefits in the
Financial Statements of employer
AS-16 : Borrowing Cost
AS-17 : Segment Reporting
As-18 : Related Party Disclosure
AS-19 : Leases
AS-20 : Earning per share
AS-21 : Consolidated Financial Statements
AS-22 : Accounting for tax on income
As-23 : Accounting for Investments associates in
consolidated Financial statements
As-24 : Discontinued operations
AS-25 : Interim Financial Reporting
As-26 : Intangible Assets
AS-27 : Financial Reporting of interest in Joint Ventures
AS-28 : Impairment of Assets
AS-29 : Provisions , Contingent liabilities and Contingent assets

IFRS (International Financial Reporting Standards)

IFRS are globally accepted accounting standards developed by International Accounting
Standard Board (IASB). IFRS is a set of accounting standards for reporting different types of
business transactions and events in the financial statements. The objective is to facilitate
international comparisons for true and fair valuation of a business enterprises.