Monday, October 22, 2012

Accounting concepts and Conventions

Accounting concepts: The term ‘concept’ is used to denote accounting postulates, i.e., basic assumptions or conditions upon which the accounting structure is based. The following are the common accounting concepts adopted by many business concerns.
                           i.      Business Entity Concept
                         ii.      Money Measurement Concept
                        iii.      Going Concern Concept
                       iv.      Dual Aspect Concept
                         v.      Periodicity Concept
                       vi.      Historical Cost Concept
                      vii.      Matching Concept
                    viii.      Realisation Concept
                       ix.      Accrual Concept

i) Business Entity Concept: Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it. This concept can be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself owns the assets and in turn owes to various claimants.
ii) Money Measurement Concept: According to this concept, only those events and transactions are recorded in accounts which can be expressed in terms of money. Facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. Hence, the accounting does not give a complete picture of all the transactions of a business unit.
iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost.
iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold aspect, Viz., certain benefits and 2. Receiving certain benefits. The basic principle of double entry system is that every debit has a corresponding and equal amount of credit. This is the underlying assumption of this concept. The accounting equation viz., Assets = Capital + Liabilities or Capital = Assets – Liabilities, will further clarify this concept, i.e., at any point of time the total assets of the business unit are equal to its total liabilities.
V) Periodicity Concept: Under this concept, the life of the business is segmented into different periods and accordingly the result of each period is ascertained. Though the business is assumed to be continuing in future, the measurement of income and studying the financial position of the business for a shorter and definite period will help in taking corrective steps at the appropriate time. Each segmented period is called “accounting period” and the same is normally a year.
vi) Historical Cost Concept: According to this concept, the transactions are recorded in the books of account with the respective amounts involved. For example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to be the base for all future accounting.
vii) Matching Concept: The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.
viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made. Sale is considered to be complete when the ownership and property are transferred from the seller to the buyer and the consideration is paid in full.
ix) Accrual Concept: According to this concept the revenue is recognized on its realization and not on its actual receipt. Similarly the costs are recognized when they are incurred and not when payment is made. This assumption makes it necessary to give certain adjustments in the preparation of income statement regarding revenues and costs.
Accounting Conventions: Accounting conventions are common practices, which are followed in recording and presenting accounting information of a business. They are followed like customs in a society. The following conventions are to be followed to have a clear and meaningful information and data in accounting:
i) Consistency: The convention of consistency implies that the same accounting procedures should be used for similar items over periods. It is essential for clear and correct understanding and interpretation of the financial statements. It is also important for inter-period comparison.
ii) Full Disclosure: According to this principle, all accounting statements should be honestly prepared and all information of material interest to proprietors, creditors, investors, etc. should be disclosed in the accounting statements. Moreover, books of accounts should be prepared in such a way that they become reliable, informative and transparent.
iii) Conservatism or Prudence: This convention follows the policy of caution or playing safe. It takes into account” all possible losses but not the possible profits or gains”. The implication of this principle is to give a pessimistic view of the financial position of the business.
iv) Materiality: Materiality deals with the relative importance of accounting information. In order to make financial statements more meaningful and to economize costs, accountants should incorporate in the financial statements only that information which is material and useful to users. They should ignore insignificant details.


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