THE ACCOUNTING
CONCEPTS
Chapter 2 – First Part
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
A Objectivity and Subjectivity
Objectivity is enhanced by using
methods that are generally
agreed.
 Generally agreed method is not
used, it is regarded as subjective.

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B Concepts and Convention

Concept is an idea or abstract
principle which relates to a
particular view of a subject.

Convention refers to the ways of
thinking and behaving that are
believed to be normal and right by
most people in a particular field
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C
1.
2.
3.
4.
5.
6.
7.
8.
9.
Basic Accounting Concepts
Business entity concept
Dual aspect concept
Money measurement concept
Historical cost concepts
Going concern concept
Realization concept
Accrual concept
The Matching concept
The Prudence Concept
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1
Business Entity Concept
An entity is an organization for which
accounting records are prepared.
 This concept means that the accounts of a
business shall only record the events relating
to the business and shall not record the
personal events of the owners (that do not
relate to this business).

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1
Business Entity Concept
This concept helps in maintaining the clarity of the
business position as separate from the owners
financial position.
For example, if the owner of the business provides
capital to the business, this event shall be recorded
in the book of the firm as it relates to the business.
But when the owner buys a house from his personal
funds this transaction shall not be recorded in the
books of the business.
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2
Dual Aspect Concept

Dual aspect concept states that there are
two aspects of accounting

Every accounting entry affects at least 2
accounts. This is called the dual-aspect
concept of accounting.
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2

Dual Aspect Concept
Another meaning of this concept is that all assets of
the business are either provided from the funds of
the owner or from the funds of the creditors.
This means,
 ASSETS = LIABILITIES + OWNER’S EQUITY

This is the basic accounting equation.
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3
Money Measurement Concept

This means that all information shown in the
accounts of a business is in form of money.

In other words, all assets and liabilities of a business
are shown in money terms.

Money serves as a common measurement tool and
it is easier than stating that the business has 2
buildings, 6 machines, 30,000 kilos of raw-material
etc.
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4.
Historical Cost Concept
All assets of a business are recorded at the cost at which
they were purchased.
This is called the book value (or historical cost) of the
assets.
For example, if a company purchases a machine for
20,000 AFs it will be shown at the same price and not at
the amount for which it can be sold in the market today.
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5
Going Concern Concept
Going concern concept states that a business is assumed
to continue to operate in the foreseeable future.
The assets are recorded at their original cost rather than
their current market values in the book, even the business
is operating at a loss for years.
This means that accountants do not calculate the value of
assets of the business daily and the assets appear in the
accounts at the cost at which they were purchased.
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6


Realisation concept
Realisation concept specifies the point of time at
which revenue should be recognised and recorded in
the book.
This means the business should :
• only record the amount at which the sales were
actually made, and
• and record the sales when the goods have been
delivered even if the customer has not paid cash
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6
Realisation concept
Several criteria have to be observed before realisation can
occur:
 l goods or services are provided for the buyer;
 l the buyer accepts liability to pay for the goods or
services;
 l the monetary value of the goods or services has been
established;
 l the buyer will be in a situation to be able to pay for
the goods or services.
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7
•
•
Accrual Concept
Recognizes revenues as the goods are
delivered to the customer
Recognizes expenses as they happen in
generation of revenues
For example, a shop sells goods to Ali and he
promises to repay in 30 days.
The accountant will not wait 30 days to
recognize the revenue. He will book it as soon
as the goods are given to customer.
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Accrual Basis versus Cash Basis
The accrual basis of accounting recognizes
revenues and expenses when they occur
instead of when cash is received or disbursed.
The cash basis of accounting recognizes
revenue and expense when
cash is received and disbursed.
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In Cash accounting –
•Revenues are recognized only when cash is received
•Expenses are recognized when cash is spent.
For example, a business using cash-based accounting shall not recognize revenue
when the customer takes goods and promises to pay later. In fact, they would
not even make a general entry at that time and will wait till the time the
customer pays cash to the business.
Similarly, expenses are recognized only when cash is paid.
For example, the business buys some raw-material, the whole of the cost of the
raw-material is expensed at that time. They will not wait for the time when rawmaterial is processed and sold to customer.
Cash-based accounting could give us mismatched accounts. For example, it could
show us huge profits in one year and huge losses in other years.
Therefore, only small shop-owners use cash-based accounting. Big companies
always use accrual accounting systems.
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8 Matching Concept

This concept needs that the accountant matches the
revenue with the expenses made to earn that revenue.

For example, a business purchased raw-materials worth
$2000 and total processing expenses on these materials
are $500. Then the business sold the goods for $4000.
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8 Matching Concept
The accountant should deduct the total expenses from
the revenue to get the income (profit) made by the
business, that is:
• purchases = $2000, plus
• processing expenses = $500
• TOTAL EXPENSES= $2500
PROFIT = SALES – TOTAL EXPENSES = $4000 - $2500
= $1500
So the matching-concept helps us match the expenses
with the revenue earned to get the correct income
amount.
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D Accounting Convention
Materiality /
Conservatism
Prudence
Principle of
Consistency
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1 Materiality

Materiality concept is used to judge
what sorts of transactions or items are
significant and their classification in the
financial statements.

e.g. A box of paperclips can be used for
several years. It will not be recorded as
fixed assets, because of its immaterial
value.
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2 Prudence / Conservatism

Prudence concept ensures that the
net assets and profits of a business
are not overstated.

Thus, revenues should not be
anticipated; Expenses should be
anticipated.
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3 Principle of Consistency

Consistency is to keep using the same
accounting method on similar items,
except for special cases.

Example, A company depreciates the
machinery by using reducing balance
method. The proprietor want to
overstate the profit by changing the
depreciation method. This violates the
principle of consistency.
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