Accounting Concepts

All accounting statements are prepared according to some predefined standards and
principles which are known as "Generally Accepted Accounting Principles" or "GAAP".
Importance of accounting concepts :
Reliability
Uniformity
Acceptability and validity

Important concepts
Business Entity: The concept of separate legal entity means that
a business is distinct from its owners, and accounts are prepared
from the business's perspective. Only business transactions are
recorded, not personal ones. The business is liable for the capital
contributed by the owner, and personal transactions with the
business are recorded. For example, if a proprietor uses half of a
building for personal residence, only half of the rent is deducted
as drawings from the owner's capital.

Money Measurement: Only transactions involving money are recorded in accounting

books as money acts as the medium of exchange and the country's currency is the
accounting unit. Non-monetary aspects like working conditions, employee strikes, and
management efficiency are not recorded as they cannot be expressed in monetary terms.
Money enables the measurement and understanding of diverse business facts. For
example, to derive meaningful information from assets like computers, tables, and chairs,
their monetary values (e.g., Rs. 1,50,000 for computers, Rs.15,000 for tables, and Rs. 2,500
for chairs) need to be assigned.

Cost concept: An asset is initially recorded in the books at its historical cost, which is the
acquisition cost. This cost serves as the basis for all further accounting. However, the
asset's book value is systematically reduced over time through depreciation, regardless of
any changes in its market value.

Accounting period concept: The accounting period concept refers to the division of a
company's financial activities into specific time periods, typically one year. It allows for
the systematic recording, analysis, and reporting of financial information, aiding in
decision-making, financial statement preparation, and comparison of performance over
different periods.

Going concern: The assumption that businesses will continue operating in the future,
known as the going concern concept, affects various accounting practices. This includes
valuing assets and liabilities, depreciating fixed assets, and handling outstanding
expenses and revenues. Assets are typically recorded at their historical cost, disregarding
short-term fluctuations in their value. This concept is essential for accounting students
to understand its impact on different aspects of financial reporting.
Revenue Recognition: Income is recorded when it is received or
earned. Revenues are recorded when sales are made or services
are rendered. Sales revenues are recognized when sales occur
during the accounting period, regardless of whether cash is
received immediately.

Matching concept: In accounting, revenues are matched with expenses incurred in the
same period to determine financial performance. This concept considers only expenses
related to the accounting period and requires adjustments for outstanding expenses,
prepaid revenues, and provisions for depreciation and bad debt. It ensures that revenues
are matched with expenses before calculating profit or loss.

Dual aspect: In accounting, the concept of dual effect states that

every transaction has two aspects. For example, when Akshay invests
5,00,000/- cash to start a business, the business receives 5,00,000
as an asset while also incurring a liability to pay Akshay the same
amount. This concept ensures that every debit has an equal and
corresponding credit, forming the foundation of double entry bookkeeping.

Full disclosure: Accounts must provide complete and relevant information, ensuring
fairness to related parties. Financial position (Balance Sheet) and performance
(profits/losses, income/expenses) must be honestly disclosed. Information should be reliable,
comparable, and understood by all relevant authorities.

Consistency: Accounting policies should remain consistent and unchanged unless

necessary. However, improvements and new techniques can be adopted, but they must be
disclosed. For example, a company may use the fixed installment method for depreciating
fixed assets throughout their estimated life.

Conservatism: When recording business transactions, it is important to anticipate

potential losses and provide for them. This practice encourages the creation of secret
reserves by making extra provisions. It may result in a lower reported income and an
overstatement of liabilities and understatement of assets on
the balance sheet. This approach asks accountants to be
cautious and conservative in their accounting practices.

Material: Financial statements should disclose all significant

and relevant items that may affect user decisions. Unimportant
and irrelevant items need not be included in the financial
statements according to this convention.

Objectivity: The concept of objectivity in accounting emphasizes the need for financial
information to be based on verifiable evidence and free from personal bias. It requires
accountants to rely on reliable sources, such as documents and transactions, rather than
subjective opinions or assumptions when recording and reporting financial data.
Objectivity enhances the credibility and reliability of financial statements.
 System of accounting

Basis of accounting

Cash Basis of accounting Annual Basis of accounting

Cash basis of accounting Accrual basis accounting

records revenue and expenses
when cash is received or paid.
It does not recognize accounts
receivable or accounts payable.
It is simpler but may not
accurately reflect the
financial position or
performance of a business.
records transactions when
they occur, regardless of when
cash is received or paid. It
recognizes revenues and
expenses in the period they
are earned or incurred,
providing a more accurate
financial picture.

Accounting Standards

Accounting standards are rules and guidelines that govern the measurement, presentation,
and disclosure of financial information. They ensure consistency, comparability, and
transparency in financial reporting to provide accurate and reliable information for
decision-making and financial analysis.
In India, accounting standards are issued by The institute of chartered accountants of
India (ICAI).

Need & significance

To promote better understanding of financial statements.
To help accountants to follow uniform procedures and practices.
To facilitate meaningful comparison of financial statements of two or more entities.
To enhance reliability of financial statements.
To meet the legal requirements effectively.

International Financial Reporting Standards (IFRS)

IFRS is a set of accounting standards developed by the International Accounting
Standards Board (IASB). It provides guidelines for the preparation and presentation of
financial statements used by companies globally. IFRS aims to enhance transparency,
comparability, and reliability of financial reporting, allowing investors and stakeholders to
make informed decisions. It is widely adopted by countries around the world to promote
consistency in financial reporting practices across borders.
Accounting Standards in India
The Institute of Chartered Accountants of India (ICAI) issues the Standards of Accounting
in India. The Accounting Standards Board (ASB), established by the ICAI, formulates these
standards by considering applicable laws, customs, business environment, and international
accounting standards. To ensure compatibility with global accounting practices, Indian
Accounting Standards (Ind AS) have been developed by modifying International
Accounting Standards. While large companies follow Ind AS, smaller businesses can still use
the existing Accounting Standards (AS), but eventually, all Indian entities are expected to
adopt Ind AS.

Goods and service tax

Goods and Services Tax (GST) is levied on the supply of goods and services. It is a
comprehensive indirect tax system that replaces multiple indirect taxes at the national
level. GST aims to streamline taxation, promote ease of doing business, and create a unified
market by eliminating cascading effects and ensuring a simplified tax structure.

CGST: Central Goods and Services Tax. It is a tax levied by the central government on the
supply of goods and services within a state.
SGST: State Goods and Services Tax. It is a tax levied by the state government on the
supply of goods and services within a state.
IGST: Integrated Goods and Services Tax. It is a tax levied by the central government on
the supply of goods and services between different states in India.

Features of GST
Single Tax System: GST replaces multiple indirect taxes with a unified tax system,
streamlining the taxation process.
Input Tax Credit: Businesses can claim credit for the taxes paid on inputs, reducing the
cascading effect of taxes and promoting efficiency.
Transparent and Accountable: GST brings transparency by providing a comprehensive
trail of transactions, enabling better compliance and reducing tax evasion.
Harmonization of Taxes: GST harmonizes tax rates and structures across states,
promoting uniformity and simplification in the taxation system.

Advantages of GST
Streamlined Tax System: GST simplifies the taxation structure by replacing multiple
indirect taxes with a single comprehensive tax, making it easier to understand and
comply with tax regulations.
Increased Transparency: GST promotes transparency by requiring businesses to maintain
proper records and file regular returns, reducing the scope for tax evasion and fostering
a more accountable business environment.
Elimination of Cascading Effect: GST eliminates the cascading effect of taxes, also
known as "tax on tax," by allowing businesses to claim input tax credits, thereby reducing
the overall tax burden and making goods and services more affordable.
 Promotes Ease of Doing Business: GST reduces the compliance burden on
businesses by providing a unified tax regime across states, eliminating the
need to navigate multiple tax laws and procedures, thus fostering a
conducive environment for trade and investment.

Important questions with answers

Question Why conservatism concept is necessary?

Answer Risk management: By adopting a conservative approach, the principle helps
organizations manage risks effectively. It encourages early recognition of
potential losses and liabilities, enabling timely decision-making and appropriate
risk mitigation strategies.

Question Explain material principle.

Answer Financial statements should disclose all significant and relevant items that may
affect user decisions. Unimportant and irrelevant items need not be included in
the financial statements according to this convention.

Question Difference between cash and accrual basis of accounting.

Answer Cash basis records revenue and expenses when cash is received or paid, while
accrual basis records revenue and expenses when they are earned or incurred,
regardless of cash flow.

Question What is the need of International Financial Reporting Standards?

Answer IFRS establishes a globally accepted framework for financial reporting,
promoting transparency, comparability, and consistency in financial statements.
It enhances investor confidence, facilitates global business transactions, and
enables meaningful analysis and decision-making across borders.

Question Explain GST.

Answer GST, or Goods and Services Tax, is a consumption-based tax levied on the supply
of goods and services, aiming to streamline and simplify the taxation system
while promoting economic growth.

*NOTE : Worksheet (Important questions of all typology with

answers) is provided as a seperate PDF on website
padhleakshay.com*