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Concepts and Conventions
Concepts and Conventions
GAAP - a term that applies to the broad concepts or guidelines and detailed practices in accounting, including all the conventions, rules, and procedures that make up accepted accounting practice at a given time
ACCOUNTING PRINCIPLES
Accounting principles are the rules of action or the methods and procedures of accounting commonly adopted while recording business transactions.
Accounting principles are general decision rules, derived from objectives and concepts of accounting which govern the development of accounting techniques.
ACCOUNTING PRINCIPLES
Accounting principles are classified into two parts. (A) Accounting concepts. (B) Accounting conventions.
ACCOUNTING PRINCIPLES
Accounting concepts
Accounting conventions
(A)ACCOUNTING CONCEPTS
These are basic assumptions or fundamental proposition concerning the economic, political and sociological environment in which accounting must operate.
(A)ACCOUNTING CONCEPTS
1. Business entity concept 2. Going concern concept 3. Money measurement concept 4. Double entry concept 5. Accounting period concept 6. Cost concept 7. Realization concept 8. Matching of cost & Revenue concept 9. Accrual concept 10. The Reliability Concept
B) ACCOUNTING CONVENTIONS
Accounting conventions are traditions and customs which guide the accountant while preparing the accounting statements.
B) ACCOUNTING CONVENTIONS
1. 2. 3. 4. Convention of Full disclosure Convention of conservatism Convention of consistency Convention of Materiality
1.
1.
It is helpful in keeping business affairs strictly free from the effect of private affairs of the proprietor(s). Consequently : Amount invested by proprietor is shown as a liability in the books of the business. Amount paid for personal expenses of proprietor are shown as drawings from capital of the proprietor. It is applicable to all forms of business organisations
The gas station made Rs 250,000 in profits, while the coffee shop lost Rs 50,000. How much money did John make?
2.
The entity will continue to operate in the forseeable future. According to this concept it is assumed that the business will continue for a fairly long time to come. There is neither the intention nor the necessity to liquidate the particular business venture in the foreseeable future.
2.
Accordingly: Fixed assets are recorded at cost not liquidation value. Depreciation on fixed assets is charged over the expected lives. Deferred costs are amortized over appropriate period Prepaid expenses as treated as assets.
NOTE: This concept does not imply permanent continuance of the enterprise.
2.
If the continuity of an entity is in doubt, a liquidation approach to the balance sheet is taken, and the assets and liabilities are valued as if the entity were to be liquidated in the near future.
3.
3.
Events or transactions which cannot be expressed in money do not find place in the books of account though they may be very useful for the business. This concept helps in understanding the state of affairs of the business in a much better way.
b) The giving of that benefit The recognition of the two aspects to every transaction is known as a dual aspect analysis.
5.
The life of the business is divided into appropriate segments (accounting periods) for studying the results shown by the business after each segment.
It requires that accounting information be reported at regular intervals (accounting periods).
5.
5.
at the end of which financial statements are prepared to throw light on the results of operation during the relevant period and the financial position at the end of the relevant period.
5.
Importance: Though the life of the business is considered to be indefinite (according to going concern concept), the measurement of income and studying of the financial position of the business after a very long period would not be helpful in taking proper corrective steps at the appropriate time.
6.
Cost concept
Assets and liabilities should be recorded at historical cost i.e. costs as on acquisition.
6.
Cost concept
This cost is the basis for all subsequent accounting for the assets. This does not mean the the assets will always be shown at cost. It may be systematically reduced in its values by charging depreciation.
6.
Cost concept
Advantage: This concept brings objectivity in the preparation and presentation of financial statements. Limitation: It distorts the true worth of an asset by sticking to its original cost. Financial statements become irrelevant in case of inflation Removes cost of fixed assets by writing off their cost while asset may be in good condition Assets for which no payment has been made are not shown e.g knowledge ,skill of Human Resources.
7.
Realization concept
The revenue principle governs two things: When to record revenue and the amount of revenue to record.
.
7.
Realization concept
It deals with the determination of the point of time when revenues are earned
7.
I plan to have you make my travel arrangements.
Realization concept
Air & Sea Travel, Inc. March 12 Air & Sea Travel, Inc. April 2
Situation 2 The client has taken a trip arranged by Air & Sea Travel. Record Revenue
7.
Realization concept
To be recognized, revenue must be: Earned - goods are delivered or a service is performed Realized - cash or a claim to cash (credit) is received in exchange for goods or services
Revenue does not have to be received in cash.
7.
Realization concept
7.
Realization concept
and collectability.
8.
Matching Principle
Revenues earned during an accounting period is compared with the expenditure incurred during the same period for earning that revenue.
Revenue
Expense
Net income
Revenue
Expense
(Net loss)
8.
Matching Principle
The determination of profit of a particular accounting period is essentially a process of matching the revenue recognized during the period and the expenses incurred during the same period to obtain the revenue.
8.
Matching Principle
8.
Matching Principle
Matching concept is based on accounting period concept. On account of matching concept, adjustments are made for all prepaid expenses outstanding expenses, accrued incomes while preparing financial statements.
9. Accrual concept
Incomes and expenses should be recognised as and when they are earned and incurred, irrespective of whether the money is received or paid for it.
9. Accrual concept
Revenue is recognised when it is realised, i.e. when sale is complete or services are given irrespective of whether cash is received or not. Similarly expenses are recognised when assets or benefits are used rather than when they are paid for and in the accounting period in which they help in earning the revenue whether cash is paid or not.
9. Accrual concept
Reporting Revenue and Expense
Revenue reported when cash is received Expense reported when cash is paid Does not properly match revenues and expenses
Revenue reported when earned Expense reported when incurred Properly matches revenues and expenses in determining net income Requires adjusting entries at end of period for outstanding expenses and incomes while preparing final accounts
9. Accrual concept
This concept is used by all businesses that disclose their financial statements to various interestsed parties. The Companies Act, 1956 provides that accrual concept has to be maintained for practically all accounting purposes. The law in India provides that in cases where accrual concept cannot be followed under any circumstances, cash basis may be followed.
The Reliability Concept (Objective Evidence) RELIABILITY-The quality of information that assures decision makers that the information captures the conditions or events it purports to represent.
The Reliability Concept (Objective Evidence) Reliable data are supported by convincing evidence that can be verified by independent parties. The impact of events should be measured in a systematic, reliable manner.
Information must be free from bias. Individuals would arrive at similar conclusions using same data.
1.
Accounting reports should disclose fully and fairly the information they purport to represent.
Significant information should be disclosed in financial statements.
can
also
be
made
through
contingent liabilities Market value of investmetns The basis of valution of fixed assets, investments and stock.
1.
Financial statements should be honestly prepared and sufficiently disclose information which is of material interest to proprietors, present and potential creditors and investors.
2.
2.
Prudence is the inclusion of a degree of caution in the exercise of judgement needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not under stated.
2.
Convention of Conservatism
(Prudence)
Policy of caution & playing safe Policy of safeguarding against possible losses in world of uncertainty Assets or income are not overstated and liabilities or expenses are not under stated. Anticipated losses are shown in the form of provisions.
2.
As a result of this convention : Revenues and gains are recognized only when realized in form of cash or assets the ultimate cash realization of which can be assessed with reasonable certainty. Provisions must be made for all known liabilities, expenses and actual and probable losses.eg. Provision for doubtful debts is made Closing stock is valued at lower of cost and market price.
3.
Convention of Consistency
Accounting practices should remain unchanged from one accounting period to another.
3.
Convention of Consistency
This convention requires that once a firm has decided on certain accounting policies and methods and has used these for some time, it should continue to follow the same methods or procedures for all subsequent similar events and transactions unless it has a sound reason to do otherwise.
3.
Convention of Consistency
The comparison of one accounting period with that in the past is possible. Eliminates personal bias.
3.
Convention of Consistency
Consistency does not forbid introduction of improved accounting technique. The effect of the change (inflating or deflating the figures of profit as compared to the previous period) must be clearly stated in the financial statements by way of a note.
3.
Convention of Consistency
4.
Convention of Materiality
The accountant should attach importance to material details and ignore insignificant details.
4.
Convention of Materiality
if its omission or misstatement would tend to mislead the reader of the financial statements under consideration.
4.
Convention of Materiality
Deciding what constitutes a material detail is left to the discretion of the accountant. Materiality often depends on: The size of the organization what is material to one company might not be material to another company. Purpose - An item may be material for one purpose while immaterial for another. Amount involved - Materiality may or may not depend upon amount. Customs only round figures may be shown in financial statements to make figures manageable without affecting accuracy.