Basic Accounting Concepts 2.

To know the financial condition of firm

What is Book-keeping ? 3. To provide information to management for
Book-keeping is the scicnce and art of managerial decisions
correctly recording in the books of accounts all 4.To provide information to interested parties
those transactions that result in the transfer of 5.To determine taxable income of frm
money or money's worth." -Carter
What is Accounting ? Accounting Principles
"Accounting is the art of recording, classi Accounting principles may be defined as
uine and summarising in a signiticant manner those rules of conduct or procedure which are
din terms of money transaction and events adopted by the accountants universally, while
recording the
which are in part atleast ot a linanctal character ting principlesaccounting transaction. The accoun
can be classified into two types
and interpreting the result thereof."
- American Institute of Certified Public (A) Accounting concepts and
Accountant's Committee on Terminology (B) Accounting conventions.
"Accounting is the process of identifying. Accounting Concepts
measuring and communicating economic infor
mation to permit informed judgements and deci Accounting concepts meansAccounting
sions by users of the information."
can be defined as something which
-American Accounting Association signifies a generalisation regarding accounting
principles. In other words, Accounting concepts
"Accounting is the science of recording and means those basic assump upon which the
classifying business transactions and events, science of accounting is The following are
primarily of a financial character and the art of the important acscounting concepts
making significant summaries, analysis and in Accounting Concepts
terpretations of those transactions and events and
-Separate business entity concept
communicating the results to persons who must Going concern concept
take decisions or form judgements." -Money measurement concept
Smith and Ashburne
-Cost concept
Accounting consists of following features Accounting period concept
1. Recording of Transactions and Events Realisation concept
2. Transaction and Events in term of Money Dual aspect concept
-Accrual concept
3.Classification -Matching concept
4. Summarising
5. Interpretation from results
Objects of Accountancy-Accountancy has
following objects --
I. To calculate Net Profit or Loss of t
business
7
 Concepts and

2preparation of fund
flow and cash flow
Accounting Principles,

statements which are used in the analysis

and

involves the
Conventin
interpretatiy
Accou

of financial statements.
4. Auditive Function : This
function comes on
existence.
last stage which
In small
checking
scale business, this function can h
This p
asset
legal
accounts, their facts and provide them
large scale organisation,this function is performed by externa
himself but for there
done by entrepreneur as "Auditor". information in the fo
independent person called function of preparation of accou
it does the
Apart from above function, the business.
in
found

account for the benefit of persons interested Kind

Generally Accepted Accounting Principles

business. In the absence of a systematic approach, accountant.
Accounting is the language of will be writing, will not be understood in the same
whicl
whatever they
may use their own language and uniformity in understanding of accounting records is only
sense by other concerned. Thus, the accot
the language more meaningful to the users
possible when some standard language is used. To make developed certain principles, concepts and
the professional accountants all over the world have accountants. As these principles have been
conventions which represent a consensus view of those referred as "Generally basis
recognised all over the world by accounting people. so these are generally
Accepted Accounting Principles". These principles have developed over a course of period from
vario
professional
usage, reason, common experiences, historical precedents, statement of individuals,
sugg
assu
bodies and regulation of Govermment agencies. Acce
Of course, these principles are not static and are bound to change with the passage of time in Wit
response to the changing needs of the business. futu
Alternative terms used for accounting principles have included standards, practices. acco
postulates, basic accounting assumptions or concepts, oxioms and conventions. The International
Accounting Standards Committee has by now developed thirty two accounting standards of which
two have been withdrawn. The Institute of Chartered Accountants of India has also set up a
bouy
known as "Accounting Standards Board" which has so far issued 32
India. Accounting Standards
It is noteworthy that
of physical sciences. Theyaccounting principles are not rigid and
are only the broad guidelines or thoseuniversally acceptable like thos
which financial accounting theory and practice are basic points of agreemeit o
acceptability rather than founded. They are judged on their genete
a technical concept thatuniversal acceptability to the makers and users of financial statements. I
describes the basic rules, concepts,
represent accepted accounting practices at a particular conventions and procedures
time. They represent a
accounting profession in relation to good
Features of Accounting accounting practices and procedures.consensus-view ol dis
The Principles :
there. The pineiples should be universally acceplable and the
1.
fcatures are: degree of permanence shoulo COI

Usefulness Any rule which does not

readers is not
: Vic

useful so that accepted as an

accounting increase the utility of bu

accounting principle. So any rule to be an accounting records the

2. records become more accounting principle mu
is Objectivity
objective
: Any
when cannot be
it principle is said to mcaningful.
be
bo

influenced by the objective when it is solidly

it
3. facts,I
Feasibility
without undue :
Accounting principles are
personal bias and whims. supported by
complexity or cost and are feasible to the extent that these 4pplied
practicable. can be
Example losses (viD)

Accounting Principles, Concepts and Conventions

3.
accounts are recorded at cost less depreciation as against at market price.
The assets in the to consider all the changes in market value of
feasible because it is not obligatory
This principle is
asset until and unless it is permanent in nature. principles but in some cases 1
Generally the above three features are found in accounting
particular rule may also be adopted as
there exiSIS optimum balance between the features, any provision for bad and doubtful debts is
accounting principle, e.g.. the principle of making the
founded on feasibility and usefulness though it is less objective.
Kinds of Accounting Principles :
The accounting principles can be divided into two parts :
1. Concepts : Used to connote the postulates i.e. necessary assumptions, conditions and 1deas
which are fundamental to accounting practice.
2. Conventions : Used to signify the customs or traditions as a guide to the preparation of
accounting statements.
Accounting Concepts
Kohler has defined concept as :"A series of axioms or assumptions constituting the supposed
developed
basis ofa system of thought or an organised field of an endeavour." Accountants have
the U.S.A. has
various accounting concepts. The Association of Certified Public Accountants in
suggested 14 accounting concepts. While some of these are controversial. Prof. R. N. Anthony has
concepts.
assurmed 10 accounting concepts as important. Most of the authors agree on these 10
Accounting is a developing science and the number of accounting concepts cannot be fixed for ever.
With emerging social changes and research in accounting, many changes are likely to emerge in
future in the field of accounting theory. Following is a list of accounting concepts agreed to by
accountants :
1. Entity Concept
2. Dual Aspect Concept
3. Going Concern Concept
4. Accounting Period Concept
5. Money MeasurementConcept
6. Cost Concept
7. Matching Concept
8. Realisation Concept
9. Accrual Concept
10. Verifiable Objectivity Concep.
1. Entity Concept : According to this concepl, business is treated as a separate unit and
of a business is
distinct from its owners, creditors, managerS and ohers, In others words, the owner
Business units should bav
always considered as distinct and separate 1rom the business he owns. firm's point of
completely separate set of books and we have to reCord business iransactions from as a creditor of he
View and not from the point of view of the proprietor. The proprietor is treated
as liability of
business lo the exlent of capital invested by him in the business. The capital is treated of
the firm because it is assumed hat the frm has borrOwed funds trom iES OWn proprietors instead
on capital and
borrowine it fron outside parties. It is lor his reason that we also allow interest
and at ho
it as an expense of the business. Interest on capital reduces the protits of he firm
lo
itelt may he regarded as a hability the amount due from business its proprietor"Principles
1 "n one sense cap
Holmes), 6th edition, page 112
of Accountascy Roeland (revised by
 Principles,
Concepts and Cornvention
Accounting A
withdrawn by the proprietor
1.8 the amount goods Used from
h
Similarly Likewise CO

the capital of
the proprietor. his drawings. business but similar
increases is treated as expenditure of the pt
time it personal use
for his treated as the sh
Irom the business
business for business ppurposes are treated as his drawings.investment in securities
stock of the personal use are
used by the proprietor for his proprietor's house, his personalfrom he accounts of th
goods entity concept, the kept separate business, he recorde
Due to separatepersonal income and expenditure are doing another
and entity he net profits and
in
ns personal car proprietor has somne other business separate entity,
business entity. If the also be kept separate. In the absence of
as

business should The concept of separate entity is applicable be

of that business known.
entity cannot be proprietorship, a company. Though it
financial position of a partnership or
formns of business organisations, Le. sole partnership but it is legal entity in the corporate
to all sole proprietorship and
is not legal entity in case of
form of organisation.
In brief : and not the personal transactions of the oWner.
recorded
(a) Only business transactions are shareholders are not considered while recording the
(b) Personal assets of the owners or
assets of the firm.
to owners.
(C) Income is the property of the firm unless distributed of book-keeping.
2. Dual Aspect Concept : This concept is based on double entry atsystem two aspects of the
This is the core concept of accountancy. Every business transaction effects least
business. Every transaction has two sides at least. If one account is debited, any other account must
be credited. Every financial transaction involves duality of effects--(1) Yielding of a benefit, and
(2) The giving of that benefit.
The principle is based on the famous Newton's Law of Motion i.e. to every action there is
always an equal and opposite reaction. Under this concept every debit must have a corresponding
credit and vice-versa and upon this dual aspect has been raised the whole structure of double
entry system of accounting. On the basis of this principle the Accounting
i.e. Equation is developed.
Assets = Liabilities +
Whenever a transaction is to be recorded, it has toCapital
be recorded in two or more
balance the equation. If a transaction atfects accounts tO
(increases or
will also affect increase or decrease) the other side of decreases) the one side of the equation, it
deerease another account on the same side of the the equation or
equation. Equation increase one account and
remains balanced whenever a
transaction takes place.
Example : A starts his business with?4 lakh in
bank and these 5 lakhs have been utilised to buy cash and
some assets. takes loan of R1 lakh from the
a
Assets =
t5 Lakhs Liabilities
+
= 1 Lakh +Capital 4 Lakh
3. Going Concern Concept : Kohler in his
concept as "any enterprise which is expected to dictionaryfor
accountants, defined
continuecontinue, operating
Concem
in thegoing
concept assumes that the business will
transactions are recorded in the books of the to exist for a
business
enterprise. It is on this assumption that we record fixed on the
indefinitely
long future. This
period in the future. The
is charged on these assets
without reference to their at assumpion
assets their that it is a continuing
market value. original cost and depreciation
purchased which would last say. for he next 10 years, For
the example, willif a spread
the next 10 years for calculating the net
profit or loss of f cost of this machinery is
each year. machinery
Because the be over
going
assumptionof
 proVe ole
profitand eof
W

1.9
and Conventions
Accounting Principles, Concepts
treated as an expense in the year of is
machine would not be in the balance
cOncem concept the full cost of the irrelevant and is not recorded
assets is
value of the fixed
purchase itself. The market future.
sheet, as these assets are not
going to be sold in the near parties enter into long-term
contracis
concern concept that outside
ts the result of thegoingand purchase the debentures and shares of the
enterprise. Another
assets
with the enterprise, give loansprepaid expenses, which have no realizable value are shown as this
example of this concept is that benefit of such expenses will be received in future. Without
in the balance sheet, because thecurrent and fixed assets and short and fixed term liabilities cannot
assumpion, the classification of justify.
be made and such classification would be difficult to
Period Concept : As per going concern concept business is intended to
4. Accounting of the business operation can be ascertained
continue indefinitely for a long period, the true resultascertainment of profit after a very long period p
only when the business is completely liquidated. But investors and others because it will be too late to
of little use to the proprietors, managers,
will be financial statements need to know the results of
take corrective steps at that time. The users of the is divided into time-intervals for
the business at frequent intervals. Thus, the entire life of the firmperiod is usually adopted for this wa

the measurement of the profits of the business. Twelve month's

compulsorily to adopt financial
e

purpose. According to the amended income tax law, a business has calendar year as its accounting ges
year beginning on Ist April and ending on 31st March in the next
period.
5. Money Measurement Concept : Measurement unit is necessary for accounting. Only
cre

in expressed
those transactions and events are recorded in accounting which are capable of being aset
business, will not be
terms of money. An event, even though it may be very important for the a fair
ma

recorded in the books of the business unless its effect can be measured in terms of money with
degree of accuracy.
Money is the common measure. The various assets or transactions having different units
cannot be properly recorded, so it is necessary to quantify then in termns of money. 1lakh Cash. S
For example : The various assets of business say, 4 Machines, 1 Building,
tones of Raw Materials carnnot be aggregated. They are therefore converted into mnoney value, Such
as, Machinery 4 lakhs, Building 5 Lakhs, Cash 1Lakh and Raw Materials worth 50,000.
concept
There are two serious limitations of this
(i) Oualitative factors such as general health condition of the Chairnan of the company.
workine conditions, trade union and management relationship. honesty and lovalty of
employees cannot be measured in terms ot money so these are not recorded in the booke
of view.
while these factors are more important from the business point
on the dato of
(ii) As per this concept transactions are recorded at their money values
occurrence and it does not record turther ehanges in the value of money. Money does not
nrovide any stable measurement, or yardstick for this purpose. So it requires the
change in price
measurement of the effcct of inflation or to report the correct
financial position.
amount of profits and
be determined on the
6. Cost Concept :According to this concepl, he value of an asset is totherefore,
past and it is referred
basis of acquisition cost. The original or acquIsition cost relates into the financial statements. Further
lo as historical cost. It is the basis for the valuation of the assets examol
COst concept means original or acquisition cost less depreciation year charged on the asset. For thie,
In the 2002 and afterwands
tachinery was purchased in 2002 at a cost oft R TLakh. Lakh less depreciation
will be shown in the balancesheet at a cost price of ?1
 Concepts and Conventions
Accounting Principles,
1.10
when the price of the asSset goes on
irrelevant financial position
effect of cost concept seems to be not exhibit a true
The does
market. In such a case, the balance sheet the accountants as to whether
increasing in the of dispute anong
the business. It has, therefore, become a matterhistorical cost or at current cost. But the majority
of
assets should be shown in the balance sheet at historical cost specially for those
assets on
the the assets at
favour of disclosing technology has not developed
of the accountants are in charged. They also feel that the current
which depreciation has been to ascertain the current cost of the ancient machines. If therelevant
considerably and it is difficult index, there are many difficulties in getting
the
basis of price
cost is ascertained on the
price index. the current cost be ascertained on he basis of
as to whether
It is still a matter of controversy should prepare their price index for each asset
the companies
price index of the country or difficulties, the majority of the accountants still feel that the assets
separately. In view of these the cost concept implies this aspect.
should be valued on historical cost price basis andvery important for correct determination of net
7. Matching Concept: This concept is profit from business operations, all costs
profit. According to this concept, in determining the net that revenue. Accordingly
which are applicable to revenue of the period should be charged againstand then costs incurred for
for matching costs with revenue, first revenues should be recognised matching
generating that revenue should be recognised. Following points must be considered while
costs with revenue
1. When an item of revenue is included in the profit and loss account, all expenses incurred
on it, whether paid or not, should be shown as expenses in the Profit and Loss account.
On the basis of this concept, outstanding expenses, though not paid in cash, are shown in
the Profit and LOSs account.
2. When some expenses, say insurance, is paid partly for the next year also, the part relating
to next year will be shown as an expense only next year and not this year. This means
that, that part of the insurance against which benefit will be derived or revenue will be
earned in future should be shown in the balance sheet as an asset and the rest is treated as
an expense during the current year.
3. Cost of the goods remnaining unsold at he end of the year together with the
expenses
incurred on it must be carried forward to the next year, as these goods will be sold only
during the next period. As such, the closing stock is caried over to the next
opening stock.
period as
4. Similarly, incomes receivable must be added in
revenues and incomes received in advance
must be deducted from revenues.
8. Realisation Concept : This concept is defined by Kohler as under :
(A) A concept which gives accounting
recognition t0 an
of goods or services only, when an inflow or outflowexchange transaction, such as sale
(B) The realisation principle holds hat revenue of cash equivalent results.
should
gains or losses at the point of sales in an arms length
be recognised with
accompanying
virtually complete. This is a widely used practice." transaction if the earning process is
This concept includes following points :
G) Revenue should be recognised in the
period in which the sale is deemed to have accrued.
(Gi) Revenue from services rendered is
recognised when services have been performed to the
satisfaction of the customer, and are billable.
(iii) Revenue fromn disposal of assets, other than products, is
recognised at the date of sale.
 Concepts and Conventions
Acce inting Principles, such as interest, rent and
assets,
permitting others to use enterprise
0) Kevenue from as time passes or as the assets are
used.
received but when
royalties is recognised when a sale order is
tangible products, revenue is recognised not rather when the product IS
ror are manufactured, but
contractis signed, not when goods
shipped or delivered to a customer. period in whËch he revenues
concept is concerned with the
Acerual Concept : The accrual revenue is realised the next step is to allocate
related. In other words once the
dhd expeIses are to be is achieved with the help of accrual concept
t among the accounting period if necessary and this
It is true to say that matching
Which also relates expenses to revenue for a given accounting period.
concept finds its true expression in a accrual basis.
only should be matched
The matching concept implies that the revenues for the current year
with the expenses for current year. The expenses for the current year include the following
() Such revenue expenses as relate to the current year and the payment of wihich has been
made in the curTent year;
(i) Such revenue expenses as relate to the current year and the payment of which had been
made in the previous year;
(iii) Such revenue expenses as relate to the current year and the payment of which has not
been made in the current year but will be made in future.
Similarly the revenues for the current year will include the following :
(a) Revenues related to the current year and are received in the current year;
(b) Revenues related to the current year and were received in the previous year.
(c) Revenues related to the current year and are not received in the current year but will be
received in future.
10. Verifiable Objective Concept : This concept means that all accounting transaction that
are recorded in the books of accounts should be evidenced and supported by business documents.
These supporting documents are cash memos, invoices, vouchers, bank deposit slips, bill
receivables, correspondence, agreements etc. These documents supply the necessary infornation on
the basis of which entries are made in the books of accounts. Also these documents provide a base
for audit.
This principle also requires that accounting data should be free from the personal bias of
either mnanagerment or the accountant who prepares the accounts. Accountants should follow h
uniform method for stock valuation, estimating the likely amount of bad debts, allocation of certain
costs over various periods etc.
Accounting Conventions
Accordine to Kohler "Convention is a statement or rule of practice which, by common
guides behaviour in a certain ind
Consent, is implied in the solution ofa given class of problems or thus, the use of straieh1 line
of situation"". An axiom and convention may be ndistnguIshable,
to take on the character of an v
depreciation long regarded as a conventions, has tended
accountant, such as measures of materiality
Convention dictates many of the activities of the public audit reports etc.
features of
Syle and content of financial statements, the n nternational Accounting standarde
Conventions have been termed as accounting policies
are known as accounting coventions, whieh
practice the generally accepted accounting policies
a long time.
ve Deen adopted by accountants for
 Concepts and Conventi.
Accounting Principles,
Accou

following types : preparing the books oe

Accounting conventions are of This convention suggests hat while of accounts such he ac
Disclosure : the users used.
1. Convention of which are likely to affect the views of properl
accounts all material facts government, society etc. should be disclo
bankers, employees, Companies Act which containe adopto
owners, creditors, lenders,compulsion of proper disclosure under statements. The
disclosed. Because of the statements and appending notes in the Howe

provisions regarding preparation

of financial
form of financial statements and which are stated
is made in the
disclosure of accounting information decision-making purpose. So all material information chang
for their honesty. There should be no
made available to various parties
statements with complete accuracy and be re
should be disclosed in these other
ambiguity in the facts.
liabilities are shown outside the Balance Sheet in the formm of notes. and I
For example : Contingent AS-I : Disclosure of Accounting Policies has been issued
Aseparate accounting standard Le. diffe
which is mandatory from Ist April, 1991. events occuring after the balance sheet date and
on p
The Convention of Disclosure also applies to prino
the date on which the financial statements are issued.
principle oI full
2. Convention of Materiality : The principle is an exception to the
disclosure. As such, it is termed as modifying principle. According to this principle, items having an
insignificant effect or being irelevent to the user need not be disclosed. These unimportant items
are either left out or merged with other items, otherwise accounting statements will be unnecessarily
over-burdened.
American Accounting Association defines materiality as under :
"An item should be regarded as material if there is reasons to believe that knowledge of it
would influence decision of informed investor."
Kohler says, "Materiality is the characteristics attaching to a statement, fact or item whereby
its disclosure or the method of giving its expression would be likely to influence the judgement of in
a reasonable person." sec
It should be noted that what is material for one concern may be immaterial for another. For
instance, the cost of snall tools may be material for a small repair workshop, but the same figure Ac
may be immaterial for Escorts Limited. Similarly, the nature of the transaction should also be taken
into consideration. A difference of 500 in the valuation of stock may be
but the difference of 500 in cash could be termed material. regarded as immaterial.,
Thus, the
importance of each transaction or even to determine its materiality. accountant should judge the
3. Convention of Consistency : This principle states that accounting
should remain consistent from one year to another. principles and methods
These should not be changed from ma
in order to enable the
management to compare the results of the two periodsvear to year.
and draw
ba
important conclusions about the working of the enterprise. If a firnms of
principles in two accounting periods, the protits of current period adopts different accounting th
profits of the preceding period. For example, a will not be comparable with the
firm can
depreciation, ie. straight line method, written down valuechoose any orone of the several methods of
expected that the method once chosen will be method any other method. But it 1s
method of stock valuation or making provision for followed consistently year after vear Likewise, the ca

likely bad debts should remain (i

the previous years. consistent win be
But the principle of
change the accounting methodsconsistency should not be taken to mean that it does not b
according to the changed circumstances of the allow a firml
business, OtherwISC
 1.13

and Conventions
Acgbunting Principles, Concepts of accounting will not be
improved techniques the better
non-flexible and the method will lead to
become a particular
ue accounting will that change in changed method may
be
used. As such, if the accountant feels business, the
position of the adopted.
disclosure of the profits and the financial of the business, the changed method may be
position for the change, must De
ddopled. However, the nature and the changeof method and justification
the
However, the nature and effect of enable the users of the financial statements to be aware of
to
Staled clearly by way of footnotes
change.
According to this convention, all anticipated losses should
4. Convention of Conservatism : all anticipated or unrealised gains should be ignored. n
be recorded in the books of accounts, but safe. Provision is made for all known liabilities
Oher words, conservatism is the policy of playing
though the amount cannot be determined with certainty. Likewise, when there are
and losses even
alternatives for recording a transaction, the one having least favourable imme diate effect
different the application of the
on profits or capital should be adopted. Following are the examples of
principle of conservatism :
(i) Closing stock is valued at cost price or market price whichever is less.
(i) Provision for doubtful debts is created in anticipation of actual bad-debts.
(iii) Joint Life Insurance Policy is shown at surrender value as against the amount paid.
decided in
(iv) Provision for a pending law suit against the firm, which may or may not be
its favour.
(v) Amortization of goodwill which has inde finite life.
(vi) Not providing for discount on creditors.
(vil) Consideration of the loss relating to premium on the redemption of debentures when
they are redeemable at premiums, at the time of their issue.
The principle of conservatism, however, should be used very cautiously, otherwise it results
in understatement of profits and assets and overstatement of liabilities, which means the creation of
of full disclosure.
secret reserves which is in direct conflict with the principle
The Institute of Chartered Accountants of India issued Accounting Standard-1:Disclosure of
assumptions:
Accounting Policies', which states hat there are three fundamental accounting
Consistency, 3. Acerual.
1. Going concern, 2. previous pages.
These assumptions have been discussed in detail in the
Accounting Equation
acCording to which double entry ie
Accounting equation is based on dual aspect concept,
entire systemof recording business transactions ie
made for each transaction in debit and credit. The
accounting equation. It signifies that the aSsels of a business are always equal to the total
based on equivalence o
Liabilities. Accounting equation iS an accounting formula expressing
of Capital and of the business cOncerm. Accordingly each
transaction
the two expressions of Assets and Liabilities the financial position of a business. Each businees
on
will have simultaneously two-fold effect time it has also liabilities equal to the assets. Assets (AN
same
COncern possesses assets and at the classified as-) Internal Liabilities or Canital (C): oe
liablities are
Cannot exceed liabilities. Total Liabilities (C)
which are o
inciude hOse ltabilities of business iabilitiae
Internal
(1) External Liabilities (L), and extemal liabilities (L) include those
of the business
e paid to the proprietor
business which are payable to outsiders.