Accounting

Concepts

ACCOUNTING FOR MANAGERS

Prof. Avanti Sathe 1

Accounting Concepts:

Business Entity: The concept of Business Entity states that a

Business and its Owner are two separate entities. As per this
concept, a business should record transactions only related to
business. Proprietors personal transactions are not to be recorded in
the books of the business. For e.g.: Payment of the
Electricity bill for the residence of the owner will not be recorded
as an expense in the books of accounts. It will simply be deducted
from the capital account of the owner.

Prof. Avanti Sathe 2

Money Measurement Concept: Business transactions need to be
recorded in a common unit of measurement. Money is used as a
common measurement unit to record all the business transactions.
As a result of this concept, only monetary transactions are recorded
in the books of accounts. In India, transactions can only be
recorded in Indian currency. i.e. ‘Rupee’.

Cost Concept: The Cost concept states that all the assets
purchased should be recorded at cost price and the cost paid will be
the base for further accounting. Market price of an asset keeps
fluctuating. Hence, it becomes necessary to record the transactions
at cost price.

Prof. Avanti Sathe 3

Consistency Concept: The consistency concept states that any
policies adopted for accounting should not change frequently unless
it is the demand of the changing circumstances. Policies adopted for
accounting should be consistent and continuous. This concept does
not prevent the introduction of any new techniques or the
improvement of any existing techniques but any deviations from the
existing methods should be disclosed separately as a note.
Eg: If a concern is charging depreciation by one method it is
expected to follow the same method in the subsequent years also.

Prof. Avanti Sathe 4

Conservatism Concept: In accounting, a business should not
anticipate future profits but anticipate future losses and make
provisions for all the possible expenses. This helps create some
reserves in the books of accounts which can absorb the unexpected
expenses, if any. The Profit and Loss Account may show lower
income and in Balance sheet may overstate the Liabilities and
understate the Assets. This policy of recording is asking the
accountant ‘to play safe’ while recording transactions in the books of
accounts.

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Going Concern Concept: Going Concern Concepts states that a
business should function for a long period of time. It should not be
closed down in a short period of time. If a new business suffers
losses, it should not be closed but given a chance to make profits in
the long run. This concepts builds confidence in Investors, Creditors,
Customers and Employees.

Realization: This concept states that an income is realized only

when it is received or earned. Similarly, revenues are recorded only
when goods are sold or services are provided. Sales revenues are
considered as recognized when sales are effected during the
accounting period, irrespective of whether the payment has been
received or not.

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Accrual: Expenses are recorded when they are accrued i.e. when they become
payable. Similarly, Income is also recorded when it is accrued i.e. when it
becomes receivable. Actual payment and receipts are not concerned with
recording of the expenses or incomes. As per the Accrual concept, Incomes and
Expenses related to the specific accounting period should be recorded in the books
of accounts, irrespective of whether they have been paid or not.

Dual Aspect Concept: Every business transaction has two effects and involves
exchange of benefits. Benefit received and benefit given, both the aspects should
be recorded in the books. The system which records such dual aspects in the
books of accounts is known as Double Entry System. This principle is also
referred to as the Debit and Credit concept. The account where the benefit comes
in is debited and the account where the benefit goes out is credited.

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Disclosure: This concept states that the accounts must disclose all the
material information. Accounts should disclose true, fair and
complete information to all the related parties. The Balance sheet and
the Profit and Loss Account should present the true picture of the
financial performance and the financial position of the business. The
information disclosed should possess the qualities of relevance,
reliability, comparability and it should be easy to understand for all
the concerned authorities.

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Materiality Concept: As per this concept, it would not be very economical for a
business to record all the small details in accounting. This concept states that rather
significant and important monetary matters need to be recorded in the books of
accounts. The utility of the transaction and information should be related to the
time, efforts and the cost involved in accounting of such transactions. Items with
value/weightage on the financial condition of a business need to be recorded and
disclosed. The remaining information can be merged with other items or it may be
shown as foot notes.

Revenue Recognition Principle: Revenue is the gross inflow of cash receivable

by the business. It also includes the other considerations (cash inflows) arising out
of the ordinary activities of the business. This principle states that the revenue
earned in a particular accounting period should be recognized and recorded in the
books of accounts irrespective of whether it has been received during that period
or not.

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Matching Principle: Matching principle states that all the income
received or earned in an accounting year should be matched with
the expenses incurred in that accounting year. This concept
considers the accrual basis of accounting. Therefore, it includes all
the adjustments related to Prepaid Expenses, Outstanding
Income, Outstanding Expense and Pre-received Income. The
matching principle does not enforce that each expense should be
matched with or linked to every revenue. Expenses incurred may
or may not be directly attributable to the revenue. In cases where
relevant, the appropriate expenses should be matched against the
appropriate revenues as per this concept.

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