3 Accounting Concepts and Conventions

Note: - Everyone who wants to become an accountant, those are all definitely wanted to apply everywhere rules and regulations of accounting, that is nothing else called Accounting Concepts and Conventions. Please stick on it with every concepts and conventions with every point in accounting language.

Accounting Concepts – Rules

1. Business Entity Concept: -

• Business has a separate and distinct entity from that of its owners, creditors and employees managing it.

• As the owner and the business are viewed as separate entities, the amount invested by the proprietor is treated as a liability for the business.

• Do not include the private assets and liabilities of the owner with the business assets and liabilities. 

2. Money Measurement Concept

• Monetary Terms Transactions. 

3. Going Concern Concept 

• The business would continue its operations indefinitely for a long period of time.

• It would not be liquidated in the foreseeable future.

4. Accounting Period Concept

• Indefinite life span of a firm into smaller time units for measurement of performance      and understanding the financial position.

• Usually the Accounting Period starts on April 1st of the previous year and ends on March 31st of the next year.

5. Cost Concept 

• The value of an asset is to be determined based on the historical cost or cost of acquisition.

6. Dual Aspect Concept – Double Entry System

Format:-

• Two aspects of accounting are Debit & Credit.

Debit a/c Dr xxx        Benefit receiving aspect / In coming aspect 

To Credit a/c xxx     Benefit giving aspect / Out going aspect

Note:- xxx – Amounts – Corresponding amt’s to be equal.

Double Entry Book Keeping was introduced by Lucas Pacioli , an Italian in the year 1494. 

7. Revenue Recognition (Realization) Concept

• Any change in the value of an asset is to be recorded only when the business realizes it.

• Revenue Recognition refers to sale of – Goods, Services and Holding assets.

• This concept requires that the revenue must be included in the records only when it is realized.

Example: - The book value of land and buildings as per the historical cost or acquisition cost is Rs.8,88,000/-. The current market rate is Rs.45,00,000/-. Such a change is not counted unless it is materialized. 

8. Matching Concept

• To know the amount of profit earned or the loss sustained during a period, the expenses should be deducted from the revenue earned during that period.

• Revenue is recognized when a sale is complete or service is rendered and not when cash is received.

• Similarly, an Expense is recognized, when an asset or service has been used to generate revenue and not when the cash is paid. 

9. Accrual Concept

• Accrual Concept makes distinction between receipt of cash and right to receive cash and payment of cash and the legal obligation to pay cash.

• Revenues and costs are accrued i.e. recognized as earned or incurred and not as money is received or paid.

• Accrual Concept is the basis for mercantile system of accounting.

• Example: - Phone bill

10. Objectivity Evidence Concept

• This concept requires that each recorded transaction in books of accounts should have an adequate evidence to support it.

• Evidence can be any document.

• Objectivity Evidence Concept facilitates auditing of accounts and eliminates unauthorized entries in the books of accounts, improving their reliability. 

Accounting Conventions – Regulations

1. Full Disclosure Convention

• Financial statement discloses all relevant information in full, fair and adequate manner.

• In other words,

• All relevant facts and materials concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes honestly.

2. Consistency Convention

• Inter firm comparison and inter period comparison of the financial statements can be done only if uniform and consistent policies and practices in accounting are followed.

• For instance, an investor cannot assess the performance of two firms operating in an industry (say Textile Industry), if one firm follows Accrual Basis of Accounting while the other follows Cash Basis of Accounting. 

3. Conservatism Convention (Prudence)

• The word ‘Prudence’ means carefulness, caution or forethought.

• “Anticipate (expect) no profit provide for all possible losses” is the watch word for this convention.

• Based on this concept, a percentage of money is allocated as a provision for bad and doubtful debts, provision for contingencies etc, taking into account the loss expected. 

4. Materiality Convention

• Accounting should focus on material facts only.

• For instance, stocks of erasers, pencils, consumable stores etc. are not shown as assets.

• They are treated as an expense for that period, whether consumed or not.

• Materials having shortest life span or consider lesser in value are come under this Convention. 

5. Timeliness Convention

• Accounting information should be immediately recorded, processed and made available to its users so that it remains relevant and the information is not old.