Financial Accounting - Accounting Concepts

 

FINANCIAL ACCOUNTING

Accounting Concepts

 

Introduction

Accounting concepts are those basic assumptions and conditions on the basis of which financial statements of a business entity are prepared. The word concept means idea or notion, which has universal application. Financial transactions are interpreted in the light of the accounting concepts which govern the accounting methods. Unlike physical science, accounting concepts are only result of broad consensus. These accounting concepts lay the foundation on the basis of which the accounting principles are formulated. The following are the widely accepted accounting concepts:

 

1.          Entity concept,

2.          Money measurement concept,

3.          Periodicity concept,

4.          Accrual concept,

5.          Matching concept,

6.          Going concern concept,

7.          Cost concept,

8.          Realisation concept,

9.          Dual aspect concept,

10.   Conservatism concept (Concept of Prudence),

11.   Consistency concept,

12.   Materiality concept.

 

Entity concept

Entity concept states that business enterprise is a separate identity apart from its owner. In other words, a business enterprise is said to have a distinct entity from its owner. Business transactions are recorded in the books of accounts of the business and owner’s transactions are recorded in his personal books. The practice of distinguishing the affairs of the business from the personal affairs of the owner helps in keeping the business affairs free from the influence of the personal affairs of the owner. On the basis of this concept, capital invested by the owner of a business into the business is treated as the liability of the business to its owner.

 

Money measurement concept

As per this concept, only those events which can be measured in terms of money are recorded in the books of accounts. Events, even if they affect the results of the business materially, are not recorded in the books of account, if they are not convertible in monetary terms.

 

Periodicity concept

According to this concept, accounts should be prepared after every period and not at the end of the life of the entity. Usually this period is one calendar year. However, it may also be 6 months or 9 months or 15 months. Therefore, as per this concept, accounting records and accounting results are generated with respect to a specific accounting period which is usually a year and which may be broken into monthly and quarterly. This concept facilitates in:

i.            Comparing the financial results of different periods;

ii.          Comparing the financial results of a business with that of another similar business in the same industry with respect to the same accounting period;

iii.       Matching the periodic revenues with the periodic expenses for getting the correct results of the business operations;

iv.     Maintaining the uniformity and consistency in accounting treatments of different transactions for ascertaining the profits of the business correctly.

 

Accrual concept

Under this concept, the effects of transactions and the other events are recognised on mercantile basis, i.e. transactions are recorded when they occur (but not necessarily when cash is received or paid). Accrual means recognition of revenue and cost as they are earned or incurred and not as money is received or paid. The accrual concept relates to measurement of income identifying the assets and liabilities with respect to revenues and expenses. This concept provides the foundation on which the structure of present day accounting has been developed.

 

Matching concept

According to this concept, only the expenses of a period matching with the revenue of that period should be taken into consideration for accounting purpose. In other words, in preparing the financial statements if any revenue is recognised for a particular period, the related expenses incurred during the same period to earn that revenue should also be recognised for the same period.

 

Going concern concept

According to this concept, it is assumed that the enterprise has neither the intention nor the requirement to close down and it will continue to operate for the foreseeable future. The valuation of a business entity is made on the basis of this assumption.

 

Under going concern concept, increase/decrease in the value of assets in the short-run is ignored. The concept indicates that assets are kept for generating benefit in future, not for immediate sale. Accordingly, current change in the value of an asset is not realisable and so it should not be counted.

 

Cost concept

As per this concept, the value of an asset is to be determined on the basis of historical cost i.e. on the basis of its acquisition cost.

 

Realisation concept

As per this concept, any change in the value of an asset is to be recorded only when the business realises it. But more practically, although the anticipated increase in the value of an asset is ignored until it is realised or unless there is certainty of its realisation, anticipated decrease in the value of the same is recorded.

 

Dual aspect concept

This concept is the core of double entry book-keeping system. As per this concept, every transaction has two aspects as follows:

(1)  If value of some asset is increased, either

(a)   Value of some other asset/assets will be decreased, or

(b)   Value of some liability/liabilities will also be increased, or

(c)   Both.

 

(2)  If value of some asset is decreased, either

(a)   Value of some other asset/assets will be increased, or

(b)   Value of some liability/liabilities will also be decreased, or

(c)   Both.

 

(3)  If value of some liability is increased, either

(a)   Value of some other liability/liabilities will be decreased, or

(b)   Value of some asset/assets will also be increased, or

(c)   Both.

 

(4)  If value of some liability is decreased, either

(a)   Value of some other liability/liabilities will be increased, or

(b)   Value of some asset/assets will also be decreased, or

(c)   Both.

 

Conservatism concept (Concept of Prudence)

As per this concept, the accountant should not anticipate income, but should provide for all possible losses. When there are many alternative methods for valuation of an asset, an accountant should choose the method which leads to the lesser value. In other words, according to this concept, it is not prudent to count unrealised gain, but it is desirable to guard against all possible losses.

 

Consistency concept

According to this concept, the accounting policies and methods should be followed by an enterprise consistently from one period to another, in order to achieve comparability of the financial statements of the enterprise through time. Any change in an accounting policy should be made only in certain exceptional circumstances as follows:

(a)     To bring the books of accounts in accordance with the issued Accounting Standards.

(b)     To comply with the provisions of law.

(c)     To ensure that books of accounts show true and fair picture of financial position of the business enterprise.

 

Materiality concept

As per this concept, all the items having significant economic effect on the business of the enterprise should be disclosed in the financial statements and any insignificant item which is not relevant so far as the need of the users is concerned should not be disclosed in the financial statements.