NATURE AND SCOPE OF ACCOUNTING

Introduction to Financial Acounting

UNIT-1
CHAPTERR\
Nature and Scope of
1
Accounting
Need for Accounting
The main aim of a business is to earn profit. For earning profit, a businessman will
either purchase the goods in one market at certain price and sell it in another
market at
sell it to the
higher price or will convert the raw materials into finished products and
different customers at a price which will give him some percentage of profit on cost of
that the
production. But this may not be true in all cases. Sometimes it may happen
goods purchased or produced may go out of fashion and may be unsaleable simply
because of depression in the market, or keen competition. He may be able to sell the
be anxious at
goods either at a loss or at a very small margin of profit. However, he will
the end of the year to find out whether his goods taken together have been sold at a profit
or at a loss and what is financial position on a particular
date. Moreover in a big business
information is required for planning, control, evaluation of performance and decision
are recorded,
making. This information can be provided only when business transactions
classified and summarised properly. In order to achieve these purposes it would be
to a well devised system. Book-
necessary to record business transactions according
is the name given to
keeping (in elementary stage) and Accounting (in advanced stage)
such a system.
Meaning of Book-keeping
Book-keeping is the art and science of recording, classifying and summarizing
business transactions in money or money's worth accurately and systematically so that
the businessman may be abl to know his profit or loss during a specified period and also
his financial position on a particular date. Book-keeping is thus the recording of business
In the words of Carter is the science
"Book-keeping
transactions in a systematic manner.
 NATURE AND SCOPE OF ACCOUNTING
NATURE AND SCOPE OF ACCOUNTING
account. For example, all transactions relating to Shyam Sunder in the journal or vario
and art of correctly recording in books of accounts all those transactions that result in the subsidiary books will be posted to Shyam Sunder's Account. It may be noted
business transactions are that
transfer of money or money's worth." recorded and classified in such a way that it may be possible to
determine profit or loss made by the business and its financial
Meaning of Accounting date.
position on a specified
The actual record making phase (i.e. recording, classifying and summarising) of
(iv) The transactions or events of a business must be recorded in monetary
accounting is usually called book-keeping. However, accounting extends far beyond the
terms. If there are certain events which cannot be
actual making of records. Accounting is concerned with the use to which these records are measured in terms of money, they will
not be recorded in financial
put, their analysis and interpretation. An accountant should be concerned with more accounting. For example,
a quarrel between
production
than the record making phase. In particular he should be interested in the relationship manager and finance manager may be affecting the business but it cannot be measured
in terms of money and thus will not be recorded in the
between the financial results and the events which have created them. He should be books of accounts.
(w) It is the art of summarising financial
studying the various alternatives open to the firm, and be using his accounting transactions. After recording and
experience in order to aid the management to select the best plan of action for the firm. classifying financial transactions next stage is to prepare the trial balance and final
accounts with a view to
The owners and manager of a firm will need some accounting knowledge to understand ascertaining the profit or loss made during a trading period and
the financial position of the business on a
what the accountant is telling them. Investors and others will need accounting knowledge
(oi) It is an art of
particular date.
so that they may read and understand the financial statements issued by the firm and analysis and
accounting information must be analysedinterpretation
of these transactions. The
adjust their relationships with the firm accordingly. Thus accounting is a wider term and and interpreted by
and percentages or other calculating various ratios
includes the recording, classifying and summarising of business transactions in term of relationship in order to evaluate the past performance of the
business and to make sound plans for the future.
money, the preparation of financial reports, the analysis and interpretation of these
reports for the information and guidance of management. (vii) The results of such analysis must be
are to make deçisions or form
communicated to the
persons who
Definition of Accounting judgements. All information must be provided in time
and presented to the different categories of the persons so that
The main purposes of accounting are to ascertain profit loss during specified
or a
be taken at the right time. appropriate decisions may
period, to show financial position of the businese on particular date and to have control
a
over the firm's property. Such accounting records are required to be maintained to
Objects of Accounting9
The starting point for any area of
the income of the study is to set forth its boundaries
measure
business and communicate the information that it may be
so its objectives. Developments in the field of science and and determine
used by managers, owners and other parties. Accounting is a discipline which records,
classifies, summarises and interprets financial information about the activities of a
significant change in the field of accounting. The mathematics have brought about a
whole concept of
concern so that intelligent decisions can be made about the concern.
changed. Accounting has to be a versatile accounting has
system serving a large number of goals of
modern business and industry
The American Institute of Certified Public Accountants (AICPA) has defined to management in simultaneously. The type of accounting information useful
taking decisions is not necessarily the same as is needed
the Financial Accounting "the art of recording, classifying and summarising in
as a
shareholders, prospective investors and creditors. Different by
significant manner in terms of money transactions and events which in part, at least of a
required to meet the several
objectives of accounting.
accounting principles may be
the
financial character and interpreting results thereof." American Accounting
Association (AAA) defines accounting as "the process of identifying, measuring, and
The
objectives of
accounting (as given by the American
Association) are to provide information for the Accounting
communicating economie information to permit informed judgements and decisions by i) Making decisions concerning the
following
use of limited resources
purposes:
users of the information" crucial decision areas and determination of objectives and goals.
including identification of
From the above the following attributes of accounting emerge : (ii) Effectively directing and
(i) Identifying the transactions and events. Accounting identifies transactions resources.
controlling the organisation's human and materials
and events of a separate entity. A transactions is a particular type of external event (iii) Maintaining systematic records and
which can be expressed in terms of noney and bring change in the financial position of a (iv) Facilitating special functions and reporting on the custodianship of resources.
control.
business unit. An event (whether internal or external) is a happening of consequence to From the objectives as
given above three main objectives of
an entity (eg. use of raw material for production). An entity means an economic unit be given as follows: accounting can
that performs economnic activities (e.g. Reliance Industries Ltd., TISCO). 1. To ascertain whether the business
(ii) It is the art of recording business transactions. First of all financial Accounting helps us to know whether a business has
operations have been
profitable not. or
the
earned profit or suffered loss during
be accounting period.
transactions should recorded in the journal or in
subsidiary books as and when they take place so that
books of original entry known as
the
complete record of financial
It will give us an idea of
eficiency of the business. To determine
profit or loss of the accounting period, a Trading and Profit and Loss Account or
transactions is available. Income Statement is an
prepared by matching revenues and expired costs (i.e., revenue
(iit) It is the art of classifying buniness transactions. All entries in the journal expenditures) incurred for earning the revenues. In the process of determination of
profit
or
subsidiaryfindbooks
accounts to
should be classified by posting them
out at a glance the tutal effect of all such
to the appropriate ledger
transactions in a particular

or loss, it is expense or cost that is matched with revenue and not

vice versa. Thus, first
 NATURE AND SCOPE OF ACCOUNTING
of all revenue determined and then expenses incurred for
is
NATURE AND SCOPE OF ACCOUNTING
matched with the revenue for
earming the revenue are
calculating the difference known as net profit or net loss. tells us the manner in which we may attain our objectives in the best possible way. The
2. To ascertain the financial
position of the business. Balance Sheet or Position more we practice an art the more expert we become in it.
Statement is prepared to give an idea of the financial
position of the business on a
particular date. The financial position of an enterprise is indicated by its assets on a Accounting is science because recording, classifying and summarising of business
a
transactions is done on the basis of certain principles such as principles of double entry
given date and its liabilities on that date. Excess of assets over liabilities
represent the system which are universally applicable. However, in accounting the relationship of cause
capital and is indicative of the financial soundness of an enterprise. A properly drawn up and effect is not studied which is a basic feature of pure sciences. It may, therefore, be
balance sheet gives information relating to (i) the nature and value of assets, (ii) the said that accounting is a science but not a pure science.
and of Since accounting has to be applied in different organisations and varied situations, it
nature extent liabilities,
business concern is over trading.
(iii) whether the enterprise is solvent, (iv) whether the
has not been possible to develop principles which have universal applicability. Accounting
3. To generate information. Accounting records generate such information which is based on certain concepts and conventions and is subject to some limitations. It is
may be helpful to various persons in planning, control, evaluation of performance and influenced by bias and personal judgement of the accountant. The person does
more a
decision-making. accounting
It
the
the
more
proficient he becomes in it. To this extent, accounting is still art. an
Functions of Accounting tells us
results for
manner in which some special objectives like ascertaining the trading
aperiod and the financial position of the business on a particular
date be can
Important functions of accounting are achieved.
In the light of the above discussion, it may be concluded that
1. Systematic record of business transactions. To keep systematic record of accounting is both a
science as well as an art.
business transactions, post them to the ledger, and ultimately to prepare the final
accounts is the first main function of accounting. Distinction Between Book-keeping and Accounting
2. Protecting the property of the business. For performing this function the Book-keeping is recording of the financial transactions of a business in a methodical
so that assets of
accountant is required to devise such a system of recording information
of thè assets of the concern is mannerso that information on any in
point relation them
to may be quickly obtained. A
the business are not put to wrong use and a complete record book-keeper may be responsible for keeping all the financial records of a business or only
available without any difficulty. a minor
segment such as maintenance of the customers' accounts in a departmental store.
3. Communicating results to interested parties. This function requires to supply Much of the work of a book-keeper is
clerical in nature and can be accomplished through
of the business to the various the use of mechanical and electronic
the meaningful information about the financial activities equipment.
research scholarss
parties i.e. owners, creditors, investors, employees, government, public,
On the other hand, Accounting is primarily concerned with the
of records, the
designm of the system
and the managers at the right time.
must be such
preparation of reports based on the recorded data, the interpretation of the
reports and finally communicating the results of the interpretation to persons who are
4. Compliance with legal requirements. The accounting system
Under various enactments a interested in such results. Accountants often direct and review the work of
which may be able to comply with the legal requirements. The work of book-keepers.
income tax return, return for sale accountants at the beginning may include some book-keeping but
businessman is required to file various statements e.g. accountants must possess a much higher level of knowledge,
tax purposes etc. and analytical skill than is required of the book-keepers.
conceptual understtanding
is èntrusted with the
5. Stewardship. In case of companies, the management
resources of the enterprise. The managers are expected to act as
true trustee of the fundds Important differences between Book-keeping and Accounting are as follows:
and accounting helps them to achieve the same. Points of Book-keeping Accounting
assets the management in planning, Distinction
6. Assistance to Management. Accounting
information.
evaluation of performance, control and decision making by providing required
1. Object The object of
book-keeping is to The object of accounting is to record,
determination of the profitability of prepare original books of
7. Fixing Responsibility. Accounting helps in accounts, classity, summarise, analyse
in the responsibility of
trial balance and final accounts
and to interpret the business transactions and
different departments of the enterprise and ultimately helps fixing maintain systematic records of to ascertain operating and
results & financial
departmental heads. financial results. position and to communicate to various
users.
Is Accounting a Science or an Art ? 2. Scope It has limited scope and is
concerned It has a wide scope and covers book-
With
Accounting is both a science and an art. Before we decide whether it is a science or an recording, classifying, and| keeping plus analysis and in-
terms. Summansing of business transactions. terpretation.
art or both, it is beter to know the meaning of the two 3. Level of It is restricted to clerical work and is| It is concerned with all levels of
Science may be defined as a systematised body of knowledge based
on certain Work |.done by lower,jevels of management. | management. Lower level clerks
of cause and effect
principles which have universal application. It establishes relationship prepare the accounts, medium level
report it and top level interpret it.
about any occurrence or happening. Scientific knowledge is based on observation, 4. Mutual De- Ithas to depend on accounting for| It has
experiments and testing of facts. pendence making the accounting records more| gettingtothe
depend on book-keeping for
required information from
Art, on the other hand, is the application of knowledge comprising of some accepted useful.
accounting records and for making
achieve our goals and them useful for planning, control and
theories, principles, rules, concepts and conventions. It helps us to decisionmaking.
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 NATURE AND SCOPE OF ACCOUNTING NATURE AND SCOPE OF ACCOUNTING
ranches of Accounting
9. Assistance to management. Accounting assists the
Following are the main branches
of accounting: management in taking
managerial decisions. For example, Projected Cash Flow Statement facilitates the
1.Financial Accounting. The main purpose of this branch
ascertain profit or loss during a of accounting is to management to know the future receipts and payments and to take decisions regarding
specific period, to show financial position of the business anticipated surplus or shortage of funds.
on a
particular date and to have control over
the firm's property. Such
accounting 10. Facilitate control over assets. Accounting facilitates control over assets
records are used to impart useful information to by
outsiders and to meet the legal information regarding Cash Balance, Bank Balance, Stock, Debtors, Fixed
requirements. providing
Assets, etc.
2. Cost Accounting. The main aim of cost accounting
the various activities of the business and to have cost
is to ascertain cost relating to
Limitations of Accounting
control. The cost accountant is
required to assemble and interpret cost data for the use of management in controlling Following are the main limitations of accounting:
current operations and in
planning for the future. 1. Records only monetary transactions. Accounting records only those
3. Management
Accounting. It supplies the management significant
transactions
order to assist the management to information in
discharge its various functions such as planning, transactions whichcan be in
measuredmonetary terms. Those which
cannot
bemeasured in monetary terms as conflict bebween production manager and marketing
control, evaluation of performance and decision making etc. manager, eff+cient management etc., may be very important for a concern but nott
4. Tax Accounting. Different types,of taxes have to be paid by an enterprise on recorded in the business books.
behalf of itself or on behalf of others, such
as, employees, shareholders etc. Tax 2. Effect of price level changes not considered.
Accounting transactions are
Accounting is helpful in complying with the
provisions of complex tax laws governing recorded at cost in the books. The effect of price level changes is not brought into the
income-tax, sales tax, excise duties, custom duties and estate duties.
5. Social Responsibility Accounting. It is concerned with social responsibility
books with the result that comparison of the various years becomes diff+cult. For
example, the sales to in 2011
total assets wouldbe much higher than in 2006 due to
aspects of a business. Management is held responsible for what it contributes to the
social wel being and progress. It is the process of identifying, measuring and
rising prices, fixed assets being shown at cost and not at market price.
3. No realistic information. Accounting information may not be realistic as
communicating the social effects of the business decisions to permit informed judgements
and decisions by the users of information. accounting statements prepared by following basic concepts and conventions. For
are
example, going concern concept gives us an idea that the business will continue and
Advantages of Accounting
assets are to be recorded at cost but the book value which the asset is showing may not be
Following are main advantages of accounting: actually realisable. Similarly, by following the principle of conservatism the financial
statements will not reflect the true position of the business.
1. Replacement of memory. In a large business it is very difficult for a business-
man to remember all the transactions. Accounting provides records which will furnish 4. Personal bias of Accountant affects the accounting statements. Accounting
information as and when desired and thus it replaces human memory. statements are influenced by the personal judgement of the accountant. He may select
2. Evidence in court. Properly maintained accounts are often treated as a good any method of depreciation, valuation of stock, amortisation of fixed assets, treatment of
evidence in the court to settle a dispute.
3. Settlement of taxation liability. If accounts are properly maintained, it will be
deferred revenue expenditure. Such judgement based integrity and competency of the
on
accountant will definitely affect the preparation of accounting statements.
of great assistance to the businessman in settling the income tax and sale tax liability
5. Permits alternative treatments. Accounting permits alternative treatments
otherwise tax authorities may impose any amount of tax which the businessman will
within generaly accepted accounting concepts and conventions. For example, method of
have to pay.
charging depreciation may be straight line method diminishing balance method
or or
4. Comparative study. It provides the facility of comparative study of the various
some other method. Similarly, elosing stock may be valued by FIFO (First-in-First
aspects of the business such as profits, sales, expenses etc. with that of previous year and
Out) or LIFO (Last-in-First-out) average price method. Application of different
or
helps the businessman to locate significant factor leading to the change, if any.
5. Sale of business. If accounts are properly maintained, it helps to ascertain the
methods may give different results and results may not be comparable.
6. Profit no real test of managerial performance. Profit earned during an
proper purchase price in case the businessman is interested to sell his business.
6. Assistance to the insolvent person. Ifa person is maintaining proper accounts accounting period is the test of managerial performance. Profit may be shown in excess
by manipulation of accounts by supressing such costs as depreciation, advertisement and
and unfortunately he becomes insolvent (i.e. when he is unable to pay to his creditors), he
can explain many things about the past with the help of accounts and can start a fresh life.
research and development taking excess value ofclosing stock. Consequently real idea
or
of managerial performance may not be available by manipulated profit.
7. Assistance to various parties. It provides information to various parties, i.e.,
owners, creditors, investors, government, managers, research scholars, public and 7. Historical in nature. Usually aceounting supplies information in the form of
employees and financial position of a business enterprise from their own view point. Profit and Loss Account and Balance Sheet at the end of the year. So, the information
provided is of historical interest and only gives post-mortem analysis of the past
8. Facilitate in raising loans. Accounting facilitates raising loans from lenders by
providing them the required financial information. accounting information. For control and planning purposes management is interested in
quick and timely information which is not provided by financial accounting.
 17
NATURE AND SCOPE OF ACCOUNTING
two accounts, one account is given debit while the other account is given credit with an
amount. Thus, on any date, the total of all debits must be equal to the total of
all
equal
credits because every debit has a corresponding credit.
Few Basic Terms
(&) Business Transactions. Any exchange of money or money's worth as goods and
services between two parties is called a business transaction. It may relate to purchase
and sale of goods, receipt and payment of cash and rendering of service by one party to
another. In accounting, only business transactions are recorded. A business transaction is
an event which can be expressed in terms of money. An event which cannot be expressed
in terms of money and does not affect the financial position of a business enterprise will
not be recorded in accounting. Therefore, all business transactions are events but all
events are not business transactions. When payment for a business activity is made
immediately, it is called a cash transaction but when the payment is postponed to a
future date, it is called a credit transaction.
(ii) Debtor. A debtor is a person who owes money. The amount due from him is
called debt. The amount due from a person as per the books of account is called a book
debt.
(iii) Creditor. A person to whom money is owing or payable is called a creditor.
(iv) Capital. This is the owner's financial interest or holding in the business and is
represented by the value of net assets (i.e., total assets less liabilities.)
(w) Goods. This includes all articles, commodities or merchandise in which the
business deals and are for sale purposes. Thus, cloth would be goods for a dealer in cloth,
furniture would be goods for a dealer in furniture and so on.
(vi) Assets. Any physical thing or right owned that has a money value is an asset. n
otherwords, an asset is that expenditure which results in acquiring of some property or
benefit of a lasting nature. These are purchased for use in business and not for sale
purposes. These are depreciated over the useful life of the assets.
(vii) Equity. A claim which can be enforced against the assets of the firm is called
equity. In other words, the rights to properties are called equities. Equities are of two
types: the right of creditors and the right of owners. The equities of creditors represent
debts of the business and are called liabilities. The equity of the owners is called
capital,
proprietorship or owner's equity. Thus assets must be the sum of liabilities and capital
(viii) Income. It is the favourable change in owner's equity which results from
business operations. In other words, income is an inflow of assets which results in an
increase in the owner's equity.
(ix) Expenditure. An expenditure takes place when an asset or service is
acquired.
Expenditure will include both payment of a sum immediately and a promise to pay it at a
future date.
(x) Expense. It means an expenditure whose benefit is finished or
enjoyed
immediately such as salaries, rent etc. The purchase of goods is an expenditure whereas
cost of goods sold is expense. Similarly, if an asset is acquired during the year, it is an
an
expenditure, if it is consumed during the same year, it is also an expense of the year.
(xi) Drawings. Any amount or goods withdrawn by the owner of a
business for
personal use is called drawings.
18
NATURE AND SCOPE OF ACCOUNTING
(xii) Loss. A loss is an
hand, expense
expenditure without any benefit to the concern. On the other
is incurred to result in some
benefit. Thus, amount spent on lighting is an
expense but loss due to fire is loss.
(xiii) Voucher. Any written document in
a voucher. It is an
support of a business transaction is called
objective evidence in support of a transaction.
(riv) Turnover. It means total trading income from cash
sales and credit sales.
(ru) Net worth. It means assets minus outside
increase net worth whereas losses reduce the net liabilities. Profits of a business
worth of a business.
(xvi) Insolvent A person who cannot
may pay his debts is called insolvent. His
liabilities are more than his assets.
Role of Accountants in
Society
An accountant with his
education, training, analytical mind and experience is best
qualified to provide multiple need-based services to the society. The accountants of today
can do full justice not
only to matters relating to taxation, costing,
accounting, financial layout, company legislation and procedures but management
fields relating to financial they can act in the
policies, budgetary policies and even economic principles. The
modern accountant's role in the society is
quite myriad and include mainly the following:
i) To act accountant to maintain the proper books of account which
as an
the true and fair view of the results.of the business and its portray
financial position.
(ii) To provide information and reports to the management to enable them to
discharge their duties effectively.
(iii) To act as a statutory auditor for attestation of account as
per requirement of the
law.
(iu) To provide financial advice regarding investments,
insurance, expansion, etc.
(u) To act as a service provider to assist in share
registration, arbitration,
preparation of memorandum of association, registration of a company, etc.
(vi) To act as an internal auditor to assist and strength the hands of the
management.
(vii) To act as tax consultant and to handle the tax matters of the business.
(viii) To act as a management consultant to
provide services regarding financial
planning of the business to provide opinions about the current state of final
monetary policies, laws of hand, etc. affecting business and suggest the changes
that should take place.
Questions
SECTION ATYPE QUESTIONS
1. (a) Define Book-keeping.
(b) What are the objectives of Book keeping?
2. What is Accounting? (BBM Bangalore, Dec. 2004 & 2008)
3. Distinguish between Book-keeping and Accounting.
(BBM Bangalore, Dec. 2007 & 2009)
4.
4. (a) What do you mcan by Accounting information?
(6) Name the users of Accounting information.
5. State four objectives of Accounting.
 ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS) 21
Sources of Indian GAAPs
The principal sources of Indian GARPs are:
i) Company law.
(ii) Accounting standards and related documents of the ICAI.
CHAPTER (iii) SEBI requirements.
(iv) Established Conventions.
2 Meaning of Accounting Principles
The term Principle' refers to fundamental belief or a
general truth which once
established does not change. It is incorrect to apply the term with
respect to
which is merely an art involving adaption for the attainment of some useful accounting
results by its
Accounting Principles applications. Application implies changing nature and hence is contradictory to the
meaning of fundamental truth implied by the term principle'.To others, the term
Principle' means rule of action or conduct and hence can be aptly applied to rules in
(Concepts and Conventions) accounting. AICPA defined the term 'Principle' "as a guide to action, a settled ground or
basis of conduct or practice." Some Accountants
prefer to use the term 'Standard' instead
of using the word Principle' but accounting principles and accounting standards are not
one and the same thing.
Accounting principles are guidelines to establish standards for
sound accounting practices and procedures in
Accounting is
the language of business. To make the language convey the same reporting the financial status and periodic
meaning to all people, accountants all over the world have developed certain rules, performance of a business. Accounting standards are written/policy documents issued by
the government or professional institutes or other regulatory body covering various
procedures and conventions, which represent a consensus view by the profession of good
accounting practices and procedures and are generally referred to as Generally Accepted aspects of recognition, measurement, treatment, presentation and disclosure of
Accounting Principle (GAAP). The Phrase 'Generally Accepted Accounting Principles' accounting transactions in the financial statements.
(GAAP) is a technical accounting term that encompasses the conventions, rules and
Characteristic of Accounting Principles
procedures necessary to define accepted accounting practices at a particular time. It
includes not only broad guidelines of general applications but also detailed practices and Following are the main characteristics of accounting principles:
procedures. These conventions, rules and procedures provide a standard by which to 1. Accounting principles are man made so
measure financial presentations. they do not have the authoritativeness as
universal principles like the principles of physics, chemistry and other natural sciences.
Thus, GAAPs are common set of accounting principles, standards and procedures
They represent the best possible guidelines based on reasons and observations and have
that companies use while preparing their financial statements. GAAPs are a combination been
of authoritative standards (set by policy boards) and simply the commonly accepted ways
developed by
accountants to enhance the usefulness of accounting data in an ever
changing society.
of recording and reporting accounting information. GAAPs recognise the importance of
2. The science of accounting is not in a finished
reportingg transactions and events in accordance with their substance. They originate from, it is in the process of evolution.
from a combination of tradition, experience and official decree and require authoritative Consequently, accounting principles are fast developing. These are influenced by business
support and some means of enforcement.
practices and customs, government agencies and other business groups.
3. The general acceptance of an
GAAPs are imposed on companies so that investors have a minimum level of accounting principle usually depends on how well it
consistency in the financial statements they use when analysing companies for meets three criteria : relevance, objectivity and feasibility. A principle is relevant to the
investment purposes. Companies are expected to follow GAAP rules when reporting their extent that it results in information that is useful to those who want to know
about a certain business. A something
financial data through financial statements. principle is objective to the extent that the accounting infor-
GAAPs are only a set of standards. There is plenty of room within GAAP for mation is not influenced by the personal bias of those who furnish the information.
The
accountants to distort figures. So even when a company uses GAAP, still there is need to .
accounting information given in the financial statements should be free from the personal
scrutinize its financial statements. Accounting statements are prepared in confirmity bias of the persons who have taken part in the
with these principles in order to place more reliance on them. The need for the common
preparation of such statements. A
principle is feasible to the extent that it can be applied without undue complexity or cost.
accounting principles becomes more apparent when we contemplate the chaotic
conditions that would prevail if every accountant could follow his own principles about Accounting principles can be classified into two categories:
the measurement of revenue and expenses. (i) Accounting concepts, and
(ii) Accounting conventions.
22 ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS) ACCOUNTING PRINCIPLES (CONCEPTSs AND CONVENTIONS)
Accounting Concepts
various claimants. Business is kept separate from the proprietor so that transactions of
Accounting concepts may be considered as postulates i.e., basic assumptionsor the business, may also be recorded with him. In case this concept is not followed affairs of
conditions upon which the science of accounting is based. Any abstract idea serving a the business will be mixed up with the private affairs of the proprietor and the true
systematised function is regarded as concepts. There is no authoritative list of these picture of the business will not be available. Thus, in the books of a sole trader, a firm or
concepts but most of the concepts have fairly general support. a
limited company, only business transactions recorded and note is taken of the
are no
Accounting Conventions personal transactions of the sole proprietor, the partners of the firm and the shareholders
The term 'conventions' denote circumstances or traditions which guide the of the company. But their transactions with the business, (e.g., capital provided to the
business, goods and amount withdrawn from the business for the personal use of the sole
accountants while preparing the accounting statements. It refers to a statement or rule of trader and the partners of the firm, income tax or life insurance premium
practice which, by common consent, express or implied, is employed in the solution of a
paid from the
business on the taxable income or life of the proprietor etc.) are recorded
given class of problem or guide behaviour in a certain kind of situation. Thus debit on the that true financial position and profitability of the business
separately so
may be disciosed. For
left-hand side and credit on the right-hand side of an account is an example of convention. example, if the proprietor of the business invests 25,000 into the business, it will be
Concepts and conventions are often used inter changeably..The basic difference deemed that he has given that much of money to the business as a loan which will be
between them is that concepts are concerned with maintenance of accounts whereas shown as a liability in the books of the firm. On receipt of the amount, Cash Account will
conventions are applicable while preparing financial statements (i.e. Profit & Loss be debited and the Proprietor's Capital Account will be credited. Similarly, on withdrawal
Account and Balance Sheet). of the amount from the business for
personal use of the proprietor, the Proprietor's
Accounting concepts and conventions are significant to the development of accounting Capital or Drawings Account will be debited and Cash Account will be credited.
theory in two ways. First, they are themselves part of an empirical process for developing It
may bementioned that the business entity concept employed in
principles of accounting. In this respect, they may be taken as belonging to the corpus of sole proprietorship is distinct from the accounting for a
accounting theory. Second, they reflect the influence of the social, economic, historical
legal concept of a sole proprietorship. The non-
business expenses, incomes, assets and liabilities of a sole
and legal forces which shape the philosophy of accounting in a given environment. Their the business accounts. proprietor are excluded from
Legally, however, a sole proprietor is personally liable for his
origin lies in a historical process of development of viable theories of accounting. business debts and be
may required to use non-business assets (i.e., his private assets) to
The concepts and conventions can be put in the form of a chart as given below make the payment to his business creditors.
Conversely, business assets are not immune
from claims of the sole proprietor's
ACCOUNTING PRINCIPLES
personal creditors. In the eyes of law business and
non-business assets and liabilities are treated alike in case of a sole
in case of a partnership firm, business assets of the proprietor. Similarly,
firm are used first for
business liabilities of the firm and if paying
Accounting Conventions
a surplus remains after paying the firm's liabilities a
Accounting Concepts partner can use his share of the surplus for the payment of his private liabilities. In the
() Business Entity Consistency same way, private assets of the individual partners are first utilised for the
(i) Money Measurement ) Full Disclosure
their individual private liabilities and if there is a payment of
(i) Going Concern i ) Conservatism
it shall be treated
surplus in any partner's private estate,
Cost (iv) Materiality as part of partnership property and can be utilised for the
payment of
( (V) Dual Aspect firm's liabilities.
(vi) Accounting Peniod In case of joint stock companies, there is a legal distinction between the
shareholders) and the business. Shareholders are not liable for the debts of (i.e.,
owners
(vi) Matching
(zii) Realisation their
(i) Objective Evidence company beyond the amount of capital they have agreed to subscribe. The
(X) Accrual treatment of capital contributed by shareholders is the same as it is in case of accounting
sole trader
and partnership, except of course that the
The above concepts and conventions are explained below: capital of a joint stock company is divided into
a number of shares. Thus, the effect of the business entity concept in case of
company is to recognise its separate identity from that of its shareholders.
a joint stock
GCoUNTING CONCEPTS Gi) Money Measurement Concept
D Business Entity Concept
This concept implies that a busine: unit is separate and distinct from the persons
Money is the only practical unit of measurement that can be employed to achieve
who supply capital to it. Irespective of the form of organisation, a busines8 unit has got
homogeneity of financial data, so accounting records only those transactions which can be
expressedin terms of money though
quantitative records are also kept. The advantage of
its own individuality as distinguished from the persons who own or control it. The expressing business transactions in terms of money is that
Liabilities Capital) is an expression of the entity money serves a common
accounting equation (i.e., Assets =
denominator by means of which heterogeneous facts about a business can be
Concept because is shows that the business itself
owns the assets and in turn owes the
terms of numbers (i.e. money) which are
expressed in
capable of additions and subtractions. It can
 ACCOUNTING PRINCIPLES (CONCEPTS AND cONVENTIONS) ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS)
25
better, be illustrated by taking the assets
assets on March 31, 2011. following example. A business unit has the following are acquired for use in the business
for earning revenues and are
not meant for
resale, so they are shown at their book values and not at their current realisable values.
Cash in hand and at bank 7 But when the concern is not a going concern and is to be
25,000 ; Sundry Debtors 7 48,500
Bills Receivable values of fixed assets become relevant. liquidated, current realisable
6,500; Motor Cars 5 ; Stock 5,000 tons; Furniture 100 chairs and 20 tables; Machines
6; Building space 5,000 sq. metres and Land 10 Similarly, the going concern concept supports the treatment of
acres.
The items given in different assets even though they be
prepaid expenses as
units of measurement cannot be added together to
may virtually unsaleable. Prepaid expenses are made assets
on the
idea of the total value of the
assets owned get an assumption that the business entity will continue in future and the benefit of
value of the assets, all items should be by the business; to get an idea of the total prepaid expenses will be utilised in future. A less direct effect of the
expressed in terms of money as given below: concept is that it lays emphasis on the determination of net
going concern
Cash in hand and at bank income rather than on the
7 6,500 ; Motor Cars 7
7 25,000; Sundry Debtors 7 48,500
Bills Receivable valuation of assets. The earning capacity of the business
entity is more significant than
1,15,000 ; Stock 7 4,00,000; Furniture 7 5,000; Machines the market value of its individual assets in
7 2,50,000; judging the overall worth of a business.
Building 7 4,40,000; and Land 7 1,00,000 Total 7 13,90,000.
Because of this emphasis on the earnings, the accountant directs his attention to, the
The money measurement proper allocation of incomes and expenses to the current
concept restricts the scope of accounting as it does not
the market value of fixed assets which will not be sold. period
and does not bother about
record the fact that there is a strike in the
factory or the sales manager is not on speakings
terms with the production manager. Accounting, therefore, does not give a complete
account of the happenings in a business unit. Civ) Cost Concept
Money provides a common denominator for
measuring but it does not take care of inflation which takes place with the passage of A concept of accounting,
closely related to the going concern concept, is that an asset
time. Money is expressed in terms of value at the time a financial is recorded in the books the
transaction is recorded at price paid to acquire it and that this cost is the basis for all
in the books. Subsequent changes in the
purchasing power of money due to inflation do subsequent accounting for the asset. This concept does not mean that the asset will
not affect this amount. In the example
given above cash in hand and at bank is expressed always be shown at cost but it means that cost becomes basis for all future
at the value of 31st March, 2011, but the amounts of cars,
furniture, machines, land and the asset. Asset is recorded at cost at the time of accounting for
its purchase but is
building are in terms of rupee of five years back when they were acquired. The value of reduced in its value by systematically
charging depreciation. The market value of an asset may change
rupee of five years back was much more than value on 31st March, 2011 because the with the passage of time, but for
purchasing power of the rupee has decreased due to inflation. Thus, money measurement
accounting purpose it continues to be shown in the books
at its book value, i.e., the cost at which it
was purchased minus
concept of accounting has two major limitations: to date. depreciation provided up
The cost concept has the
(i) It restricts the scope of accounting because it is not
capable of recording advantage of bringing objectivity in the accounts.
transactions which cannot be expressed in terms of Information given in the financial statements is not influenced the
money. by
judgement of those who furnish such statements. In the absence of costpersonal
bias or
(ii) It does not take care of the effects of inflation because it assumes a concept, assets
stability of will be shown at their market values which will
depend on the subjective views of persons
money measurement unit. who furnish financial statements. However, on account of high
Generally, business entity concept and money measurement concept are called degree of inflation in the
economy in the recent past, the preparation of financial statements on the
basis of cost
fundamental accounting concepts as they go to the very roots of financial accounting. The concept has become irrelevant for judging the financial position and
alternative of either of these two concepts would change the entire nature of financial ascertaining the
profitability of the business entity. To overcome the drawbacks of cost concept, inflation
accounting. The concepts given below can be taken as procedural concepts. accounting is advocated which makes a provision for recording all items
financial statements at theircurrent values. But
regularly in the
Gii) Going Concem (or Continue of Activity) Concept and absence of legal
keeping in view the practical dificulties
provisions for inflation acounting historical cost accounting based
It is assumed that a business unit has a reasonable on cost
concept still serves as a fair and adequate basis for
expectation of continuing reporting business
business at a profit for an indefinite period of time. A business unit is deemed to be a performance.
going concern and not a gone concern. It will continue
to operate in the future. According this concept, it is possible to remove the cost of fixed assets from the
to
Transactions are recorded in the books keeping in view the going concern aspect of the accounts altogether by writing off their cost as
assets are still in
depreciation against income even though
business unit. It is because of this concept that suppliers supply goods and services and good condition and are being used in the business. As a result of this
other busin ess firms enter into business transactions with the business unit. drawback secret reserves are created and the auditor
Suppliers may overlook the verification of
assets showing zero book value because
will not supply goods and services and other personswill not have business dealings with The cost concept raises another
their accounts will no longer appear in the books.
the business entity if they have the feeling that the concern will be liquidated. This problem. There are
for a concern but are not shown in the books of account
some
assets which earn income
assumption provides much of the justification for recording fixed assets at original cost cost has been incurred
on account of this
concept because
ie, acquisition cost) and depreciating them in a systematie manner without reference to
their current realisable value. It is useless to show fixed assets in the Balance Sheet at
no
"often the major asset of a
to acquire
highly
such
successful
assets.
firm
According to Glautier and Underdown,
is the knowledge
result of team work and good organisation. This asset will not
and the skill created as
their estimated realisable val ues if there is no irnmediate intention of selling them. Fixed a
appear in the accounts,
26
ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS) ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS)
since the firm has paid nothing for it, except in terms of salaries which have been written assumption provides much of the justification that the business will not be
off against yearly profits. Allied to this terminated, so
problem is the failure in making any mention in it is reasonable to divide the life of the business into
the balance sheet of the value of the human assets of the firm.... other important assets accounting periods so as to be able to
know the profit or loss of each such period and the financial
of which no mention is made in financial
accounting statements are, for example, the position at the end of such a
value to the firm of its hold on the market, which be
period. Normally acounting period adopted is one year as it helps to take
any corrective
may a very valuable asset if the firm action, to pay income-tax, to absorb the seasonal
enjoys a monopoly position, and the value of the firm's own information fluctuations and for
reporting to the
will affect the quality of its decisions." system, which outsiders. A period of more than one year reduces the utility of
The
accounting data.
principle of segregating capital expenditure from revenue
expenditure is based
(v) Dual Aspect (or Accounting Equivalence) Concept on the
accounting period concept. The revenue
transferred to the Profit and Loss Account of thatexpenditure
for a particular
This is the basic
period is
concept of accounting. According to this concept, every financial carried forward to the extent period whereas capital expenditure is
transaction involves a two-fold aspect, (a) yielding of a benefit and (6) the giving of that Thus, the accounting period
its benefit will be utilised in future accounting periods.
benefit. For example, if a business has acquired an asset, it must have concept plays a very important role in
other asset such as cash or the obligation to pay for it in future. Thus a
given up some income of a particular determining the
accounting period. It is also helpfül in ascertaining
giver necessarily fair financial position of a business the true and
implies areceiver and a receiver necessarily implies a giver. There must be a double
time.
entity on a
particular date at a
particular point of
entry to havea complete record of each business
transaction, an entry being made in the
receiving account and an entry of the same amount in the giving account. The receiving Cvii) Matching Concept
account is termed as debtor and the giving account called
is Thus every debit
creditor. This concept based on the accounting period concept. The most
is
must have a corresponding credit and vice versa and upon this dual aspect has been
raised the whole superstructure of Double Entry System of Accounting. The of running a business is to ascertain profit important objective
Accounting
Equation, [i.e, Assets Equities (or Liabilities + CapitalDI is based on dual aspect
= particular accounting period is essentially a periodically.
process of
The determination of
profit of a
concept. The term 'Assets' denotes the resourees owned by the business while the term during the period and the costs to be allocated to the matching the revenue recognised
thus, a problem of matching revenues and period to obtain the revenue. It is,
Equities' denotes the claims of various claimants including the proprietors of the expired costs, the residual
net profit or net loss for the amount
business against the assets. For example, if the business purchases machinery and
which it is
period. Revenue is considered to be earmed on thebeing the
furniture worth 25,000 and 5,000 respectively out of 7 40,000 provided by Å(the realised, i.e., on the date when the date at
the customer even goods are delivered or services rendered to
proprietor) to the business, the situation will be as follows though payment may be
also be considered to be earned at the time received at some future date. Revenue may
the cash is collected,
Assets = Equities when the sale is made or service is rendered as is the
regardless of this fact
Machinery 25,000+ Furniture 5,000 +Cash T 10,000 Capital7 40,000 and other enterprises in which practice with physicians, attorney
theoretical justification but has professional
services are source of revenue. It
Subsequently, ifthe business purchases stock worth F8,000 on credit, the position the practical has little
advantages of simplicity of
will be as follows: avoidance of the problem of
estimating losses on account of bad operationdebts. It
and
is also
Machinery 25,000 + Furniture T 5,000+Cash T 10,000 + Stock 8,000 advantageous from income tax
point of view because income
tax is
income. paid onlyon cash
=
Creditors 8,000+Capital 40,000. Like revenue, all costs incurred
Thus, accounting equation demonstrates the fact that for every debit there is an during the
related to the accounting period are taken. period are not taken, but only costs
equivalent credit. The purchase
but only depreciation on fixed assets price of fixed assets is not taken
related to the accounting period is taken.
vi) Accounting Period Concept paid in advance are excluded from the Expenses
total costs and expenses
Truly speaking, the measurement of income or loss of a business entity is relatively the total costs to arrive at the costs
attached to the period.
outstanding are added to
simple on a whole-life basis. A complete and accurate picture of the degree of success Let us take an example to make the
achieved by a business unit cannot be obtained until it is liquidated i.e., converts its matching concept clear.
A businessman
assets into cash and pays off its debts. On liquidation, it is possible to determine with purchases 100 table fans at at cost of 7 30,000. He
paid 7 1,000 as
finality its net income. But the owners, the investors and overall the Government, all are freight and insurance, 200 and octroi and carriage and rent outstanding
price of 7 40,000 against which should be matched cost 2,000.
He sells all table fans at a was
impatient and do not want, untik the dissolution of the concern, to know what has been of table
fans 30,000, freight and insurance<
the results of the business activities. All these persons are interested in regular reports 1,000, octroi and carriage 200 and
and accounts at proper intervals to know "how things are going?" This means that the
rent 2,000. The net
profit of the period would be 7 6,800, (i.e., 7 40,000 outstanding
-7 33,200),
final accounts must be prepared on a periodic basis rather than waiting till the business though some of the above expenses incurred are not paid for and sale price of some of
table fans may not have been realised as
is terminated. yet on account of being sold on credit.
It may be remembered that
Under the going concern concept it is assumed that a business entity has a profit and cash are not synonymous because their nature
is different. For example, if a business has
reasonable expectation of continuing business for an indefinite period of time. This made a profit of ? 1,00,000, it does not mean
 ACCOUNTING PRINCIPLES
(CONCEPTS AND CONVENTIONS) ACCOUNTING PRINCIPLES (CONCEPTS AND cONVENTIONS) 29
same amount of cash or cash is increased of many users of the financial statements could be maintained.
that it has the by the same amount. It is not Invoices and vouchers
for purchases and sales, bank statements for amount of cash at bank,
because there are outstanding expenses and creditors and outstanding debtors. The profit physical checking
of stock in hand etc., examples of objective evidence
earned will increase the capital of the business on the liabilities side and a corresponding are which are capable of verification.
As far as possible, every entry in accounting records should be
increase in the assets of the business will be made. Similarly, an increase in cash does
objective evidence. Evidence should be such which will minimise thesupported
by some
not mean increase in
possibility of error
profit. Cash may have increased because of issue of shares or sale and intentional bias or fraud. Evidence is not always conclusively
of a fixed asset. Thus, income is tied to increase in owner's
equity and has no direct link objective for there are
numerous occasions in accounting where judgements and other subjective factors
to changes in cash. play
part. In such situations, it should be seen that most objective evidence available should
Application of matchingexpenses
difficulties. There are some
in practice, however, isshare
conceptlike
preliminary expenses,
beset with certain
issue expenses,
be used. For example, the Provision for Doubtful Debts Account is an estimate of the
losses expected from failure to collect sales made on credit. Estimation of this account
advertisement expenses ete., which are not readily identifiable against the revenue of
particular period. Similarly, how much of the capital expenditure should be written off by
a should be made on such objective factors as past
reliable forecasts of future business activities.
experience in collecting debtors and
way of depreciation during the particular period poses the question of finding out the
expected life of the asset. Likewise, in case of long term contracts when amount is not (x) Accrual Concept
received in proportion to the work executed, the expenditure to be carried forward not The essence of the accrual concept is that revenue is recognised when it is realised,
related to the income received may present some difficulties. In spite of these practical that is when sale is complete or services are given and it is immaterial whether cash is
difficulties, the matching concept stands on firm footing and should be followed while received or not. Similarly, according to this concept, expenses are recognised in the
preparing financial statements to have a true and fair view of the profitability and accounting period in which they help in earning the revenue whether cash is paid or not.
financial position of a business entity. Thus, to ascertain correct profit or loss for an accounting period and to show the true and
fair financial position of the business at the end of the accounting period, we make record
(viii) Realisation Concept of all expenses and incomes relating to the accounting
period whether actual cash has
been paid or received or not. Therefore, as a result of the accrual concept, outstanding
According to this concept, revenue is considered as being earned on the date at which
realised, i.e., on the date when the property in goods passes to the buyer and he
it is expenses and outstanding incomes are taken into consideration while preparingfinal
becomes legally liable to pay. This can be made clear by taking the following example: accounts of a business entity.
A customer at Ranchi places an order with a manufacturer at Delhi on 1st January.
On receipt of order, the manufacturer manufactures goods and
delivers them to the ACcOUNTING CONVENTIONS
customer at Ranchi on 1st February who makes payment
of goods on March 1 after
revenue was realised not on January
Convention of Consistency
enjoying the credit period of one month. In this case,
1, when order was received nor on March 1,
when cash was realised but on February 1, Accounting rules,practices and conventions should be continuously observed and
applied ie, these should not change from one year to another. The results of different
when goods were delivered to the customer
years will be comparable only when accounting rules are continuously adhered to from
of goods sold on hire-purchase
However, in case of hire-purchase sales, the ownership year to year. For example, the principle of "valuing stock at cost or market price
delivered but it passes when the last
does not pass to the purchaser when the goods are
instalment is paid. But sales are presumed to have been
made to the extent of down whichever ifis lower" shouldbe followed year after year to get comparable results.
payment, instalments received and
instalments due, but not received. Similarly, depreciation on fixed assets is provided on straight line method, it should be
done year after year. Consistency serves to eliminate personal bias because the
the ground that if an asset has
The realisation concept is criticised by economists on accountant will have to follow consistent rules, practices and conventions year after year.
sold. In other words,
increased in value then it is irrelevant because it has not yet been The rationale behind this concept is that frequent ehanges in accounting treatment,
this concept, distinction
unrealised gains are not considered in accounting. As a result of would make the financial statements unreliable to the persons who use them.
arise as a result of
is made between holding gains and operating gains. Holding gains
increases in value from holding a n asset and operating gains
are realised as a result of Consistency also implies external consistency, ie., the financial statements of one
selling assets. Holding gains are not recorded
because property in goods has not yet enterprise should be comparable with another. It that every enterprise should
means
transferTed but operating gains are reported because they have resulted
as a result of follow same accounting methods, and procedures of recording and reporting business
sale.
transactions. The development of international and national accounting standards is due
to the convention of consistency.
Cix) Objective Evidence Concept This convention does not completely prohibit changes. It does not debar from
Objectivity cannotes reliability, trustworthiness and verifiability, which
means that introducing improved accounting techniques. However, if a change becomes desirable, the
change and its effect on profits and financial position as compared to the previous year
evidence in ascertaining the correctness of the
informationreported.
there is Bome
should be clearly stated in the financial statements. In the words of Yorston, Smith and
statements must be based on
Entries in accounting records and data reported in financial
adherence to this principle, the confidence
objectively determined evidence. Without close
30
ACCOUNTING PRINCIPLES (CONCEPTS AND cONVENTIONS) ACCOUNTING PRINCIPLES (CONCEPTSAND CONVENTIONS)
Brown 'Consistency serves to eliminate personal bias and to even out personal material interest to the proprietors, creditors and prospective investors. In 1945, the
to ignore changed conditions orjudgement
but it must not become a fetish so as
improvements in technique. need for Cohen Committee enquiring into company practices in England made the following
observations regarding the convention offull disclosure
The rationale for following the convention of
consistency is made clear in the "We are in favour of as much disclosure as practicable. It is also
following example: important in our
opinion to ensure that there should be adequate disclosure and publication of the result of
For example, a
company purchased a fixed asset for 1,00,000 and it
charges the companies so as to dissipate any suggestion that hidden profits are being
depreciation 20% onstraight line method. At the end of the second year, the book value accumulated by industrial concerns to the detriment of consumers and those who work
of the assets will be: for industry.
On the other hand, if there is detailed disclosure in the and
no
profit loss account
Cost of the fixed asset undisclosed reserves accumulated in the past periods may be used to swell the
Less: 20% depreciation for
1,00,000
years when the company is faring badly and the shareholders
profits in
1st year 20,000 may be misled into
80,000 thinking that company is making profit. When such is the case..... the practice has the
Less: 20% depreciation for 2nd year unfortunate results that shareholders and investors and their advisers
20,000 have not the
Book value at the end of 2nd year information to enable them to estimate the real value of the shares."
60,000
Gii) Convention of Conservatism (or Prudence)
Now, if the method is changed to reducing balance method in the second year, the
book value of the asset at the end of 2nd year will be: Literally speaking, conservatism means taking the gloomy view of a situation. It is a
policy of caution or playing safe and had its origin as a safeguard against possible losses
in a world of uncertainty. It
Cost of the fixed asset
compels the businessman to wear a
"risk-proof" jacket, for
1,00,000 the working rule is : anticipate
Less: 20% depreciation for
no-profits, but provide for all possible losses." For example,
1st year 20,000 closing stock is valued at cost or market price whichever is lower. If market price is
80,000 higher than the cost, the higher amount is ignored in the accounts and closing stock will
Less: 20% depreciation for 2nd year
Book value at the end of 2nd year
80,000 x
2000 ,000 be valued at cost
than the cost, the
which is lower than the market price. But if the market price is lower
64,000 higher amount of cost will be ignored and stock will be valued at
market price which is lower than the cost. Thus, the
in the valuation of stock.
principle of conservatism is inherent
The effect of change will be that depreciation of 7 20,000 will be reduced to 16,000
in the second year making an increase of 4,000 in profit and asset will be shown in the Over optimism in reporting results in more undesirable than over
because it shows position better than what actual financial
passionism results
Balance Sheet at < 64,000 and not at 60,000. position is. But the excessive
The above cited example brings into light the importance of consistency convention. application of the convention of conservatism could result, in the creation of secret
The auditor should, therefore, refuse to certify the accounts of a company if the reserves, a practice which is contrary to the convention of full disclosure. Conservatism
accounting procedures have not been consistently followed or if there is any departure in
carried beyond what is warranted by reasonable doubts distorts earnings in as much as
the consistency principle, it must be clearly disclosed in the financial statements along
net profit in one period may be understated than what actual profit is. Keeping in view
with its effects. this, current accounting thought has shifted somewhat from the principle of
conservatisn. The concepts of consistency, full disclosure, materiality and objectivity take
Ci) Convention of Full Disclosure precedence over conservatism and the latter should be factor only when the others do
a
not play a significant part.
According to this convention, all accounting statements should be honestly prepared
and to that end full disclosure of all significant information should be made. All iv) Convention of Materiality
information which is of material interest to proprietors, creditors and investors should be
Whether something should be disclosed or not in the financial statements will depend
disclosed in accounting statements. An obligation is placed on the accounting profession
on whether it is material or not. Materiality depends on the amount involved in the
to see that the books of accounts prepared on behalf of others are as reliable and
transaction. Forexample, minor expenditure of 20 for the purchase of a waste basket
informative as circumstances permit. The
most of big business units are
convention is becoming popular these days may be treated as an expense of the period rather than an asset.
because in the form of joint
is divorced from management. The
stock companies where
Act, 1956 has prescribed the
Companies
Custom also influences materiality. For example, only round figures (to the nearest
ownership rupee) may be shown in the financial statements to make the figures manageable without
forms in which financial statements are
to be prepared. The Act makes ample provisions affectingthe accuracy of the accounting data. Similarly, for income tax purposes the
for the disclosure of essential information that there is no chance of any material
income has to be rounded to nearest ten rupees.
information being left out. For example, the basis of valuation of fixed assets,
is of
investments and stock should be clearly stated in the Balance Sheet because it
 ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS) 33
ACCOUNTING PRINCIPLES (CONCEPTS AND CONVENTIONS)
rm"materiality" is a subjective term. The accountant should record an item as
aleven though it is of small amount and its knowledge seems to influence the
man 0f the proprietors or auditors or investors. For
example, commission Questions
deing aEents should be disclosed separately in the Profit and Loss Account.paid
to sole
Similarly,
amount due to directors or other officers of the bank should be disclosed separately in the SECTION ATYPE QUESTIONS
Ralance Sheet of a bank to know the amount of advances due from the directors or
Conventions.
officers who are managing the affairs of the bank. 1. Define Accounting Concepts and Accounting
2. Distinguish between concepts and conventions.
Accounting Principles relating to Profit and Loss Account 3. What is Matching Concept?
Following are the main principles which are related to the preparation of 4. State three fundamental accounting ass umptions.
profit and loss account: 5. What is an accounting policy ?
) Accounting period concept (ii) Accrual concept, (ii) Realisation concept, 6. State the provisions relating to disclosure of accounting policies.
7. Give four items which are treated as accounting policies.
(iv) Materiality concept, (u) Matching. (BBM, Bangalore, 2004)
All these have been discussed in the previous pages of this chapter. 8. Write short note on accounting concepts practices.
9. State two accounting conventions.
Accounting Principles relating to Balance Sheet 10. What is dual aspect concept ? (BBM, Barngalore)
related to the of 11. What is meant by Business Entity Concept? (BBM, Bangalore)
Following are the main principles which are preparation
balance sheet: OR
Explain the Business Entity Concept. (BBM, Bangalore)
(i) Entity concept, (il) Money Measurement Concept, üii) Going Concern Concept,
12. Discuss the meaning and importance of GAAP? (BBM, Bangalore)
(iv) Cost Concept, (v) Conservatism Concept, (ui) Dual aspect concept.
13. What are accounting conventions ? (BBM, Bangalore)
All these have already been discussed in the previous pages of this chapter.
Fundamental Accounting Assumptions SECTION BTYPE QUESTIONS
Certain fundamental accounting assumptions are followed in the preparation and 1. What are the basic accounting concepts and explain implication.
their
stated because
presentation of financial statements. 'They are usually not specifically not followed. the accounting concepts of conservatism and materiality and their significance
if
their acceptance and use are assumed. Disclosure is necessary they
are 2. Examine
che preparation of financial statements.
a s fundamental accounting conventions ? Name them and explain any two
Following have been generally aceepted 3. What are accounting concepts and
assumptions: accounting concepts in detail.
this statement.
viewedgoing concern, is, that "Accrual concept is essentially the matching concept." Explain
(a) Going Concern. The enterprise is normally as a as 4.
that the enterprise has 5. "Entity" and "Continuity" concepts are inter-related. Comment
continuing in operation for the foreseeable future. It is assumed
of curtailing materially the scale consistent and
neither the intention nor the necessity of liquidation or and conventions objective, reliable,
6. "Without accounting conceptsmaintained." Comment.
of the operations. comparable accounts cannot be
which the accounts maintained
The focus of the accounting is business enterprise for
are
consistent from
(6) Consistency. It is assumed that accounting policies
are one
7.
and not its proprietors." Do you agree with
this statement ? Explain it.
period to another.
profit depends upon proper matching of costs and
revenues."
as they are earned "The ascertainment of correct
(c) Accrual. Revenues and costs are accrued, that is, recognised
8.
Critically examine this statement in thelight of "Matching Concept" of accounting.
or incurred (and not as money
is received or paid) and recognised in the financial
and conventions and explain the Realisation
statements of the periods to which they relate.
9. (a) Name the various accounting concepts
Concept and Business Entity Concept.
Ifthe above assumptions are followed in the preparation and presentation of financial of accounting ?
(b) How does money measurement concept limit the scope
statements, no specific disclosure is necessary as these are the fundamental accounting 10. Comment on the following:
assumptions which must be followed. If fundamental accounting assumption is not
a
(a) Realisation concept.
followed, the fact should be disclosed in the financial statements. (6) Consistency and conservatism in Accounting.
The three fundamental accounting assumptions are part of the generally accepted Postulates.
11. What are Accounting Postulates ? Discuss any two important Accounting
accounting principles, concepts and conventions. It may be mentioned that there is no
? List several
conflict between accounting assumptions and accounting concepts. 12. What is meant by the term "generally accepted accounting principles"
sources of generally accepted accounting principles.