Basic Accounting Concepts

Prof.Vanita Patel.

Prin.L.N.Welingkar Institute of Management

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Development & Research, Mumbai.
 11 Basic Concepts
1. Money measurement.
2. Entity.
3. Going concern.
4. Cost.
5. Dual aspect.
6. Accounting period.
7. Conservatism.
8. Realization.
9. Matching.
10. Consistency.
11. Materiality.

Prin.L.N.Welingkar Institute of Management

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Development & Research, Mumbai.
 Concept #1:
Money Measurement
• Accounting records are recorded in monetary terms at value ,at the time transaction is
recorded.

• Example: 1.Suppose a business owns 1,00,000 of cash, 300 kg of raw material, 3 trucks and
20,000 square feet of land and so on. One cannot add these amount and came up with a
meaningful conclusion. However if we express above items in monetary terms, then a
conclusion can be made out.
• Suppose business has 1 lakh cash, 50,000 of raw material, 7 lakh of trucks and 20 lakh of
land. Now we can add it up and can easily find out what the business owns. In simple words,
record only those transaction that re expressed in monetary terms in books of accounts.
• 2.ABC Plc. has recognized an asset worth 500,000 naming it after a brand it recently
launched. Brand is a hit and customers are pouring in large numbers. Concluding on these
basis, ABC is of the opinion that brand itself has a recognition in the market and must be
recognized in the books and will be amortized over 5 years period.
• Management has reached the figure of 500,000 considering 200,000 as development cost
and 300,000 for brand-tag-premium as management finds the tag alone attracts customers.
• Solution: ABC Plc. can recognize 200,000 in the books if and only if such costs qualify the
underlined conditions for cost capitalization otherwise will be treated as periodic expense in
the period incurred. 300,000Prin.L.N.Welingkar
cannot be capitalized
Institute of as entity has no reasonable way of
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Development & Research, Mumbai.
measuring the value of brand unless it is sold.
 Concept #2: Entity
• Organization or activity for which accounting records are prepared.
• Business entity concept requires a business to be treated as an
entity different and distinct from its owners.
• Example: A CA has 3-room house he has rented for Rs.3,0000 per
month. He has setup a single-member accounting practice and uses
one room for the purpose of business. Under the business entity
concept, only 1/3rd of the rent or Rs.10,000 should be charged to
business, because the other 2 rooms or Rs.20,000 worth of rent is
expended for personal purposes.

• He received Rs.900 bill for utilities. He paid the whole amount using
his business account. Rs.600 is to be considered a withdrawal
because only Rs.300 (1/3rd) is related to business and the other
Rs.600 was for domestic purpose.

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Development & Research, Mumbai.
 Concept #3: Going Concern
• Assumed to continue in operation for an indefinite
period.
• Going concern concept means the ability of a Business
to ‘run profitable’ for an indefinite period of time until
the concern is stopped due to bankruptcy and its assets
were gone for liquidation.
• Example: In May 2018, Samsung was slammed with
half a billion dollars fine for violating Apple copyrights.
Despite a hefty amount Samsung is still a going
concern with strong financial position.

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Development & Research, Mumbai.
 Concept #4: Cost
Terminology
 Assets: economic resources of an entity,recorded at
cost (i.e., price paid).
 Book value of assets: recorded value.
 Fair value of assets:amount for which asset could be
currently purchased or sold.
• Example: A business buys a building worth Rs.10 cr in
cash. In the accounting records, the value of the
building will be entered at its cost price, i.e. 10 Cr. After
four years, the value of the building goes up to 25 cr.
However, the accounting records would continue to
show the value of the building at the cost price of 10 cr
less depreciation.

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 Concept #5: Dual-Aspect
• Transactions are events that affect accounting records.
• Every transaction has a dual impact on accounting records.
• Dual impact:
• Results in maintaining equality of accounting equation.
• Double-entry accounting system
• Example: Mr. A had provided Rs.500,000 in cash as the capital to start a
business styled ‘Modern Traders’, the assets owned by that company at
that stage would be a cash balance of Rs.500,000. Corresponding to this
amount would be the equity, i.e. an amount which could be claimed by
Mr. A. This relationship is expressed as:

• Assets= Liabilities+Owner’s Equity

• In accounting terms, this transaction would be represented as follows:

• Assets= Cash:Rs. 500,000=Owner’s Equity:Rs.500,000

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 Concept #6:
Accounting Period
• Measurement of activities for a specified
period of time.
• A one-year timeframe is commonly used:
Generally, Fiscal year.
• Example: India follows Fiscal year, which starts
from April 1st and ends at 31st March in the
following year.

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 Concept #7:
Conservatism
• “ prudent reporting based on healthy skepticism…”
• “builds confidence in the results....”
• Preference for understatement rather than overstatement of assets and
earnings.
• If two estimates are equally likely, use the one that results in smaller
assets and earnings.
• Example: A hypothetical situation where one company (ABC) is set to sue
another company (XYZ) for copyright infringement.
• Company ABC would expect to win a large settlement by suing XYZ but
there is a fair degree of uncertainty involved. As no one knows for sure the
outcome of the lawsuit, ABC would not record the transaction in its
financial transaction. The company might or might not win the amount
and in the case of the latter, the shareholders would be presented with a
misleading picture.
• However, if the company was to expect to lose the lawsuit it would need
to record the loss it expects to incur.

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 Concept #8:
Realization
• Indicates amount of revenue that should be
recognized.
• Conservatism indicates when.
• Recognize amount that is reasonably certain to be
realized.
• Example: Mr. A sold goods worth of Rs.2,000 to Mr. B,
the later agrees on the proposal that goods will be
transferred after 15 days. After receiving goods Mr. B
makes payment after 10 days. Here according to the
Realization Principle of Accounting, sales are
considered when the goods are transferred from Mr. A
to Mr. B.

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Development & Research, Mumbai.
 Concept #9:
Matching
• When an event affects both revenues and expenses, the
effect should be recognized in the same accounting period.
• Example: A company has a policy to pay a bonus of 1% on
its sales in a quarter, to every single sales representative.
Now if the company has 4 sales representatives and each of
them secured sales of Rs.100,000 in the first Quarter of the
year, each of them earned a bonus of Rs.1000. As there are
4 of them the total bonus expense to be paid by the
company would be Rs.4,000 (4 × Rs.1000). If for instance
the company paid the bonus in the month of May which
falls in the second quarter of the year, the matching
concept requires the company to record this expense in the
first quarter and not in the second quarter, because this
expense relates the revenues generated in the first quarter.
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Development & Research, Mumbai.
 Concept #10:
Consistency
• Once an accounting method is selected, use for all subsequent events of
same character.
• Can change if there is sound reason to change.
• But must be disclosed to users.
• Consistency over time, not for different types of transactions.
• Example: In a board meeting, the PQR company decided to change its
accounting methods of recording revenue from when the customers
actually receive the goods to when the goods are dispatched to the
customers, the reason for doing so was a truer representation of sales of
the company as many customers were from varying cities which resulted
in about 35% of sales being recorded with a delay of 2-5 days. The change
would improve the sales representation of PQR during a particular
financial year and present a truer picture of business of PQR. PQR also
documented the change in notes to the financial statements along with
date of change, reason of change and date from which the change would
take place.

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 Concept #11:
Materiality
• Full disclosure of all important information. But, insignificant events may
be disregarded.
• In other words, all important financial information that would sway the
opinion of a financial statement user should be included in the financial
statements.
• Example: A large company has a building in the hurricane zone. During
hurricane, the company building is destroyed and after a lengthy battle
with the insurance company, the company reports an extra ordinary loss
of Rs.10,000. The company has net income of Rs.10,000,000. The
materiality concept states that this loss is immaterial because the average
financial statement user would not be concerned with something that is
only .1% of net income.
• Assume the same example above except the company is a smaller
company with only Rs.50,000 of net income. Now the loss is 20% of net
income. This is a substantial loss for the company. Investors and creditors
would be concerned about a loss this big. To the smaller company, this
Rs.10,000 would be considered material.

Prin.L.N.Welingkar Institute of Management

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Development & Research, Mumbai.