Accounting Concepts

Introduction:

Accounting is language of business hence to convey the same meaning to all people world wide, accounts have developed certain rules, procedures and conventions, which are known as “Generally Accepted Accounting Principles” (GAAP). These are known are concept and conventions of accounting. Accounting concepts are considered as the basic assumptions or conditions on which the science of accounting is based. Whereas the accounting conventions are known as the circumstances or traditions, which guide the accountants while preparing the accounts.

Concepts:

It is used to denote accounting assumptions and notions which are widely accepted and fundamental to the science of accounting. The important accounting concepts are

Business Entity Concept:

While recording the transactions in the books of accounts, it should be noted that business and owners are separate distinct entities in the eyes of accounting all transactions of the business are recorded in the books of accounts from the point of view of the business and not from the point of view of the owner. In case of sole proprietary concern and partnership firm, though legal entity of business and owner is the same (legally) they are treated as separate entities. Therefore, capital and drawings accounts are to make a distinction between personal transactions and business transactions. The owners are treated as creditors for the amount invested in the business, and debtor to the extent of cash or goods taken (drawings) for their personal use. For example, college fees of proprietor’s child paid by the business is treated as drawings not as expenditure of the business.

Money Measurement Concept:

According to this concept, only those monetary transactions, which are capable of being expressed in terms of money, are included in the accounting records. In other words, the information which can not be expressed in terms of money is not included in accounting records. For example, dedicated employees, dead lock in the management may be important for the enterprise, but these facts are not recorded in the books of accounts as they can not be expressed in monetary value. All incomes, expenses/costs, assets and liabilities of the business, are expressed in terms of monetary value i.e. rupees/dollars/pounds etc.

Cost Concept:

According to this concept, the transactions are recorded ‘at cost’ in the books of accounts. For example, if building is purchased for Rs. 8,00,000/- but its market value is Rs. 10,00,000/-. It is to be recorded at Rs. 8,00,000/- only because the actual expenditure incurred is Rs. 8,00,000/- not to be recorded at market value of Rs. 10,00,000/-.

Going Concern Concept:

This concept assumes that business will continue to exist for a fairly long period of time. It presumes the life of the business to be perpetual and there is no intention to liquidate business in the foreseeable future. Because of these assets are divided into current assets (convertible into cash with in one year) and fixed assets (used in the business for a long period, or for a period more than one year) and liabilities as current liabilities and long term liabilities.

Accounting Period Concept:

The life of the business is considered to be indefinite, but the measurement of income can not be postponed for a very long period of time. Therefore, it is necessary to have a period for which the operational results are assessed for external reporting. Hence a period of one year i.e. twelve months is considered as accounting period. It may be a Calendar year (January to December. Or any period of one year. In India, the accounting period begins on 1^st April every year and ends on 31^st  March every year. This concept implies that at the end of each accounting period, financial statements i.e. profit & loss account and balance sheets are to be prepared. It is mandatory under Income
Tax Act to assess profit of the business every year and determine tax liability.

Dual Aspect Concept:

This is one of the most fundamental concept of accounting. It may be stated that every debit there is a corresponding credit. Every business transactions has a dual effect. One is receiving aspect and the other is giving aspect. Therefore, for every debit there is an equal corresponding credit. For example, Machine purchased for Rs.25,000. In this transaction, business is receiving Machine and that increase the balance of Machine account by Rs. 25,000 and at the same time it reduces the balance of cash by Rs. 25,000. Hence, the value received is equal to the value given.

Accrual Concept:

This concept implies that revenue is recognized in the period in which it is earned irrespective of the fact whether it is received or not during that period. For example, commission Rs. 2,000 earned in the year 2008, but received in cash in the year 2009, then the commission is to be taken as income for the year 2008 only, not as income of the year 2009.

Realization Concept:

According to this concept, the revenue should be considered only when it is realized. Any business transaction should be recorded only after it actually taken place. Production of goods does not mean that the total production is sold, it should be recorded only when they are sold and cash realized or obligation created.

Matching Concept:

This concept is based on accounting period concept which requires that they should be a periodic matching of cost incurred and revenues earned during the accounting period. The purpose is to ascertain profit periodically. For example, the total cost of goods purchased during the accounting year. The unsold stock of goods are Rs. 50,000. Goods costing Rs. 1,00,000 sold for Rs. 1,25,000 during the year. The unsold stock of goods are Rs. 50,000which may be sold in the following year. Therefore the profit for the year is Rs.25,000. That is to produce the income (sales) of Rs. 1, 25,000; the cost of goods sold (expenditure incurred) was Rs. 1, 00,000. Hence it is essential to match the incomes with their corresponding expenses incurred during the accounting year. Matching does not mean that expenses must be identified with revenues. While ascertaining profit, other appropriate cost which are not directly related to cost of goods sold are to be taken into consideration e.g. Rent paid, Interest paid, and Depreciation etc., thus appropriate costs have to be matched against the appropriate revenues for the accounting period.