ACCOUNTING PRINCIPLES
In Accounting, financial statements are prepared for reporting financial
performance of the business. In order to make the financial statements more
meaningful, acceptable, comparable, consistent, reliable and unbiased, it is
necessary that a uniform system of accounting based on Generally Accepted
Accounting Principles (GAAP) is followed.
“The principles, which constitute the ground rule for financial reporting are termed
as generally accepted accounting principles.”- Walter B Meigs, R.E.Meigs and
C.E.Johnson.
These principles are usually developed by professional accounting bodies like
ICAI (Institute of Chartered Accountants of India), which provides standards for
sound accounting practices and procedures. These principles are the guidelines to
make the financial statements true and fair.
ESSENTIAL FEATURES OF ACCOUNTING PRINCIPLES
1. Man made: - Accounting Principles are manmade, they are not tested in a
laboratory like other natural sciences, therefore these principles do not have
universal applicability.
2. Objectivity: - It means accounting principles must be based on facts and
free from personal bias or judgment of the individual who prepares the
statements.
3. Usefulness /relevance: - Accounting principles must be relevant and useful
to the person who is using financial statements.
4. Feasibility: - The accounting Principles should be practicable or feasible. in
case , principle is sound theoretically but its application is difficult ,then the
principle does not have much value.
Accounting
Principles
Accounting
Concepts
Accounting
Conventions
Accounting Concepts
Concept denotes the logical consideration which is generally and widely
accepted. The term is not used in the sense of a set of hard and fast rules but
rather of rules of general application which helps in the selection of
accounting methods and provides the foundation of the accounting. Various
concepts and their implications are described below:
1. Basic Entity Concept: - According to this concept, in accounting,
business unit or entity is treated different or distinct from its owners not
in the case of Joint Stock Company but also in the case of sole
proprietorship and partnership firm as well.
Implication of the above concept is that the owner and the business are
treated as two different and distinct entities and we record the
transactions from the view point of business. This explains why capital
contributed by the owner is shown as a liability in the balance sheet of
the business.
2. Money Measurement Concept: - The money measurement concept
states that all the business transactions which can be measured in
3.
4.
5.
6.
monetary terms are recorded in accounting. The money measurement
concept holds that the transactions and events, howsoever important they
may be, which cannot be measured in monetary terms are not recorded in
accounting. Money is used to measure assets, liabilities, expenses, losses,
incomes, etc.
Going Concern Concept: - Unless there is evidence to the contrary,
accounting assumes that the business will continue to exist and carry on
its operations for a long period in the future. In going concern concept, a
business is viewed as a mechanism of creating value.
Implication of the concept is that the assets of a business should be
recorded at cost, not at its realizable value. Their current resale value is
irrelevant since it is assumed that they will not be sold as such. These
will rather be used in the creation of future output values.
Accounting Period Concept: - Though life of the business is perpetual
but still it has to report the results of the activity undertaken in specific
period (normally one year). Thus, accounting attempts to present gains
earned or losses earned or suffered by the business during the period
under review. Normally ,it is the financial year (i.e. Ist April to 31st
March)
Implication of accounting period concept is that final accounts are
prepared for the ‘accounting period’ and financial position of the
business is shown at the end of the accounting period .
Cost Concept: - This concept is closely related to the going concern
concept. According to this concept, an asset is ordinarily recorded in the
books at a price at which it was acquired i.e. at its cost price. This ‘cost’
serves the basis for the accounting of this asset during the subsequent
period. The cost concept is based on the principle of objectivity.
Implication of this concept is to record the assets in the books of
accounts only at the actual cost of acquisition. For example, if the
nothing has been paid for the goodwill, it should not be shown in the
books of account.
Dual- Aspect Concept: - Dual concept may be stated as “for every debit,
there is a credit.” Every transaction should have two sided effect to the
extent of the same amount. This concept has resulted in accounting
equation which states that at any point of time the assets of any entity
must be equal (in monetary terms) to the total of owner’s equity and
outsider’s liabilities. This may be expressed in the form of equation:
A–L=P
A= L+ P
Thus, it emphasizes that the proprietory claim is the balance after
providing for outsider’s claims against the business from the total assets
of the business.
7. Revenue Recognition (Realization) Concept: - This concept
emphasizes that profit should be considered only when realized. Profit is
deemed to have accrued when property in goods passes to the buyer i.e
when sales are effected.
Implication of the concept of realization flows from the convention of
conservatism. It implies that accounting should take into consideration
profits only when the same have been realized. No anticipated profit
should be taken credit of.
8. Matching Concept: - The concept of matching requires that expenses
should be matched to the revenues of the appropriate accounting period is
the basis for determining the net profit. So we must determine the
revenues earned during a particular accounting period and the expenses
incurred to earn those revenues.
Implication of this concept is that meaningful information can be
ascertained relating to the profits of any entity only if the revenues of the
same accounting period are matched against the expenses of the same
accounting period. For example ,salary paid in January 1998 relating to
December 1997 should be treated as the expenditure for 1997 and not
1998.
9. Accrual Concept: - Accounting attempts to recognize non-cash events
and circumstances as they occur. Accrual is concerned with recognizing
assets ,liabilities or income from amounts expected to be received or paid
in future .Thus, we make record of all expenses and incomes relating to
the accounting period whether actual cash has been disbursed or received
or not. Common examples of accruals include purchase and sale of goods
or services on credit, interest outstanding, etc.
10.Stable Monetary Unit Concept :- Accounting presumes that the
purchasing power of monetary unit, say Rupee ,remains the same
throughout the year ,thus ignoring the effect of rising or falling
purchasing power of monetary unit due to inflation or deflation . In spite
of the fact that the assumption is unreal and practice of ignoring changes
in the value of money is now being extensively questioned.
Implication of the above concept is that variations in the intrinsic value
of monetary unit say Rupee is ignored by the traditional financial
accounting. For example, a piece of land was purchased in1985 for
10,000, further no depreciation is provided on land . In the present case,
land shall continue to be valued by the business at Rs. 10,000.
ACCOUNTING CONVENTIONS
An accounting convention is a modus operandi of universally accepted
system of recording and presenting accounting information to the concerned
parties. Conventions are based on customs and practability, which may have some
logic behind its usage. . Accounting conventions help in comparing accounting
data of different business units or of the same unit for different periods. These have
been developed over the years.
1. Convention of Materiality or Relevance: The convention of Materiality
emphasizes the fact that only such information should be made available by
accounting that is relevant and helpful for achieving its objectives. The relevance
of the items to be recorded depends on its nature and the amount involved. It
includes information, which will influence the decision of its client. This is also
known as convention of materiality. For example, business is interested in knowing
as to what has been the total labour cost. It is neither interested in knowing the
amount employees spend nor what they save.
2. Convention of objectivity: The convention of objectivity highlights that
accounting information should be measured and expressed by the standards which
are universally acceptable and every transaction which is recorded in the
accounting should be based on some documentary evidence which are cash
memos, invoices, bills and vouchers. For example, unsold stock of goods at the end
of the year should be valued at cost price or market price, whichever is less and not
at a higher price even if it is likely to be sold at a higher price in the future.
3. Convention of feasibility: The convention of feasibility emphasizes that the
time, labour and cost of analyzing accounting information should be comparable to
the benefits arising out of it. For example, the cost of 'oiling and greasing' the
machinery is so small that its break-up per unit produced will be meaningless and
will amount to wastage of labour and time of the accounting staff.
4. Convention of consistency: The convention of consistency means that the
same accounting principles should be used for preparing financial statements year
on year. An evocative conclusion can be drawn from financial statements of the
same enterprise and this is possible only when accounting policies and practices
followed by the enterprise are uniform and consistent over a period. If dissimilar
accounting procedures and practices are followed for preparing financial
statements of different accounting years, then the result will not be analogous.
Generally, a businessman follows the above-mentioned general practices or
methods year after year. For example, while charging depreciation on fixed assets
or valuing unsold stock, if a particular method is used it should be followed year
after year, so that the financial statements can be analyzed and a comparison made.
5. Convention of full disclosure: Convention of full disclosure states that all
material and relevant facts concerning financial statements should be fully
disclosed. Full disclosure means that there should be complete, reasonable
and sufficient disclosure of accounting information. Full refers to complete
and detailed presentation of information. Thus, the convention of full
disclosure suggests that every financial statement should disclose all
pertinent information. For example, the business provides financial
information to all interested parties like investors, lenders, creditors,
shareholders etc. The shareholder would like to know the profitability of the
firm while the creditors would like to know the solvency of the business.
This is only possible if the financial statement discloses all relevant
information in a complete, fair and an unprejudiced manner.
6. Convention of conservatism: This concept states that profits should never be
overstated or anticipated. However, if the business anticipates any loss in the near
future, provision should be made for it in the books of accounts, for the same.i.e
anticipate no profits but provide for all losses. For example, creating provision for
doubtful debts, discount on debtors, writing off
Intangible assets like goodwill, patent and so on should be taken in to
consideration
Traditionally, accounting follows the rule 'anticipate no profit and provide for all
possible losses.' For example, the closing stock is valued at cost price or market
price, whichever is lower. The effect of the above is that in case market price has
come down then provide for the 'anticipated loss', but if the market price has
increased then ignore the 'anticipated profits'. The convention of conservatism is a
valuable tool in situation of ambiguity and qualms.