Concepts, Principles and Convention- An overview

Concepts, Principles and Convention- An overview

Following are widely accepted accounting concepts:-

 (1)         Separate Entity Concept or Entity Concept or business entity concept

              Business Entity Concept considered business enterprises as a Separate Entity  & having separate identity distinct from its owner. Therefore business transactions are recorded in the books of accounts from business point of view and not from the owner. Therefore amount invested by owner into the business is also treated as liability(internal)  for business. 

 (2)             Money Measurement Concept

               According to this concept, only those transactions which can be expressed in money should be recorded in                       

               the books of accounts .

                   Transactions and events, that cannot be expressed in money are not recorded in books of accounts, even if       

                  they are very useful or affect the result of business.

 (3)           Periodicity Concept/Accounting period concept

                  According to this concept, the life of an enterprise is broken into smaller periods so that its performance can be measured at regular interval. Generally one year period is taken up for performance measurement and appraisal of financial position. So life of the enterprise is divided into smaller periods(usually one year) which is termed as ‘accounting period.’ At the end of accounting period, we prepare financial statements.

 Periodicity Concept helps in numbers of ways

(1)             Compare financial statements of different periods.

(2)             Uniform and consistent accounting treatment for ascertaining profit or loss and assets of the business.

(3)             Match periodic revenues with expenses for getting correct results of business.

 (4)  Accrual Concept

Accrual means recognition of revenue and expenses as they are earned or incurred and not when cash or money is received or paid. Revenue means gross inflow of cash, receivables and other consideration arises in the ordinary course of business activities from sale of goods, rendering services and using other enterprises resources yielding interest, royalties and dividends. Expenses are cost relating to revenue earned for a particular period.

 ( 5 )     Matching Concept:

For ascertaining profit and loss for a particular period, expenses should be matched with revenue of that period. In financial statement, it is necessary to match revenue of the period with the expenses of that period to determine correct profit or loss.

 (6)           Going Concern Concept :

                  According to this concept, it is assumed that enterprise will continue its operation for indefinite period of time. It is assumed that an enterprise neither has intention nor the need to liquidate or wind up and curtail its scale of operation. It is because of this concept a distinction is made between assets and expense, fixed  and current assets / liabilities.

 (7)           Cost Concept/Historical cost concept:

                According to this concept, value of asset is determined on the basis of historical cost or acquisition cost or price paid for acquisition of asset. 

     It has following limitations:-

-                 In an inflationary situation when price of all commodities go up on an average, acquisition cost loses its relevance.

-                 Historical cost-based accounts may lose comparability.

-                 Many assets do not have acquisition cost like Human Resources.

8. Conservatism/ prudence concept :-

It states that accountant should not anticipate income but should provide for all possible losses.

Where there are many alternative value of asset an accountant should choose method which shows lesser value.

Conservatism essentially leads to understand-ability of income and wealth and should  be the basis for the preparation of financial statements.

 9 Consistency : - The accounting policies are followed consistently from one period to another to achieve comparability of financial statements from one period to another period.

-The concept of consistency is applied where different methods of accounting are equally acceptable.

For e.g.:- A company may adopt any depreciation method, straight line method, WDV method etc, similarly there are many methods for valuation of stocks in hand. But the company should follow the principal of consistency over years.

 An enterprise should change its accounting policy in any of the following circumstances only.

(i)                 Bringing  books of accounts in accordance with the issued  accounting standards,

(ii)                To compliance with provision of law.

(iii)              When it is felt that new method will reflect more true and fair picture in the financial statement .

 10 Materiality : Materiality principle refers to the relative importance of an item or event. According to American Accounting Association, “ an item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of an informed investor. Thus whether an amount is material or not, will depend on its amount, nature, size of business and level of person taking decision.

- It is an exception of full disclosure principal. As per this principle the items effecting significantly on the business of enterprises should be only disclosed separately in the financial statements.

11. full disclosures principles: each and every item should be properly disclosed in preparation of financial statements.

 Fundamental Accounting assumptions(FAA) :- There are three fundamental accounting assumptions:

(i)                   Going Concern

(ii)                  Consistency

(iii)                 Accrual

When nothing is written about the fundamental accounting assumptions in the financial statements then it is assumed that these accounting assumptions have been followed in preparation of financial statements. It should be specifically disclosed if any of these assumption is not followed.

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