BASIC ACCOUNTING

PRINCIPLES & Chapter -2

CONCEPTS
INTRODUCTION
•Accounting is referred to as “the language of business” because it communicates the
financial condition and performance of a business to interested users.
•In order to become effective in carrying out the accounting procedure, as well as in
communication, there is a widely accepted set of rules, concepts and principles that
governs the application of the accounting. These concepts and principles are referred
to as the Generally Accepted Accounting Principles or GAAP.
•In this chapter, you will learn and familiarize yourself with the accounting principles
and concepts relevant in the performance of the accounting procedures. It is a
necessity to learn and understand it because you need to apply these concepts and
principles during the accounting process.
GUIDELINES ON BASIC
ACCOUNTING PRINCIPLES
AND CONCEPTS
GAAP, is the framework and guidelines of the accounting profession. Its purpose
is to standardise  the accounting concepts, principles and procedures.

Here are the basic accounting principles and concepts:

1. BUSINESS ENTITY

A business is considered a separate entity from the owner(s) and should be treated
separately. Any personal transactions of its owner should not be recorded in the
business accounting book unless the owner’s personal transaction involves adding
and/or withdrawing resources from the business.
For example, Vagabond is a business organization operating as a travel agency.Its
owners may have personal bank accounts, homes, cars, and even other businesses.
These items are not involved in the operation of the travel agency and do not appear
in Vagabond’s financial statements.
2. THE RELIABILITY OR
OBJECTIVITY PRINCIPLE
The objectivity principle states that you should use only factual, verifiable data in the
books, never a subjective measurement of values. Even if the subjective data seems
better than the verifiable data, the verifiable data should always be used.
A prime example of the objectivity principle in action is in the reporting of asset
values on a company's balance sheet. Say your company bought a land five years
ago for $50,000. You could ask five experts in commercial real estate to tell you
what it's worth today, and you might get five different opinions. They'd all be expert,
informed opinions -- but they'd still be opinions. The only thing that can be said with
objective certainty about the value of the land is that you paid $50,000 for it five
years ago. So that's the figure that will appear on your balance sheet, for as long as
you own the land.
3. THE (HISTORICAL) COST
PRINCIPLE
All business resources acquired should be valued and recorded based on the actual
cash equivalent or original cost of acquisition, not the prevailing market value or
future value. Exception to the rule is when the business is in the process of closure
and liquidation.
For example, let us assume that a business buys a tract of land for use as a building
site, paying$100,000 in cash. The amount to be entered in the accounting records for
the asset will be the cost of $100,000. If we assume a booming real estate market, a
fair estimate of the market value of the land 10 years later might be $250,000.
Although the market price or economic value of the land has risen greatly, the
amount shown in the company’s accounting records and in its balance sheet would
continue unchanged at the cost of $100,000. This policy of accounting for many
assets at their cost is often referred to as the cost principle of accounting.
4. THE GOING CONCERN
ASSUMPTION
Financial statements are prepared on the assumption that the business will remain in
operation in future periods. 
For example, a company has just purchased a 3-years Insurance Policy for $45,000.
if we assume that the company will remain in operations for 3 years or more we
wwill consider the cost $45000 for insurance as an asset which provides the services
to business over a 3 year period. On the other hand if we assume that the business is
likely to terminate in near future the insurance policy should be reported at its
cancellation value i.e. the amount refundable at canellation.
5. THE STABLE CURRENCY
ASSUMPTION
The stable dollar value assumption which means that the dollar ( or any other
currency) does not lose its purchasing power over time. The fact that the money
loses its purchasing power because of inflation is ignored while recording
transactions in accounting.
For example, if a company bought land 20 years ago for $100,000 and purchased a
second similar tract of land today for $500,000, the total cost of land shown by the
accounting records would be $600,000 following the historical costprinciple. This
treatment ignores the fact that dollars spent 20 years ago had greater purchasing
power than today’s dollar. Thus the $600,000 total for the cost of land is a mixture of
two “sizes” of dollars with different purchasing power.
ETHICS THE MOST
FUNDAMENTAL PRINCIPLE OF
ACCOUNTING
Background

In June 2005, the IESBA (formerly the Ethics Committee) issued a revised Code of Ethics for Professional Accountants. The revised Code establishes a
conceptual framework for all professional accountants to ensure compliance with the five fundamental principles of ethics:

Integrity.

A professional accountant should be straightforward and honest in all professional and business relationships

Objectivity.

A professional accountant should not allow bias, conflict of interest or undue influence of others.
CONT,,
Professional Competence and Due Care.
A professional accountant has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client
or employer receives competent professional services based on current developments in practice, legislation and techniques. A
professional accountant should act diligently and in accordance with applicable technical and professional standards when providing
professional services.

Confidentiality.
A professional accountant should respect the confidentiality of information acquired as a result of professional and business relationships
and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional
right or duty to disclose. Confidential information acquired as a result of professional and business relationships should not be used for
the personal advantage of the professional accountant or third parties.

Professional Behavior.
A professional accountant should comply with the relevant laws and regulations and should avoid any action that discredits the
profession.
QUALITATIVE CHARACTERISTICS OF FINANCIAL
REPORTING

The following are all qualitative characteristics of financial statements:

Understandability. The information must be readily understandable to users of the financial statements.
This means that information must be clearly presented, with additional information supplied in the
supporting footnotes as needed to assist in clarification.
Relevance. The information must be relevant to the needs of the users, which is the case when the
information influences the economic decisions of users. This may involve reporting particularly relevant
information, or information whose omission or misstatement could influence the economic decisions of
users.
Reliability. The information must be free of material error and bias, and not misleading. Thus, the
information should faithfully represent transactions and other events, reflect the underlying substance of
events, and prudently represent estimates and uncertainties through proper disclosure.
Comparability. The information must be comparable to the financial information presented for other 
accounting periods, so that users can identify trends in the performance and financial position of the
reporting entity.