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Accounting Concepts

Accounting concepts and conventions generally have no regulatory backing but accounting
standards that are prepared by the regulating agencies use such concepts and conventions.
Accounting concepts and conventions are evolved over a long period of time and are fundamental
to accounting system. The following are few such important concepts and conventions which are
used in preparing accounting statements.
1. The Entity concept
This concept emphasis that a business entity is separate and distinct from its owners. The
accounts and financial statements should show the affairs of the business not that of the owner. In
other words, even if there is any transaction between owners and the business unit or any
transactions performed by the business unit on behalf of owners, it should be reflected in the
account as if owner is different from business unit. For instance, if the company pays for personal
air-travel cost of the owners, it should be shown as receivables from the owners. In the company
form of business organization, such distinction is obvious because the law itself defines company
as a separate legal entity. ven in other forms of organisations, though there is no such legal
distinction, the owners and firm are treated two separate entity for accounting purpose so that the
performance of the business can be measured better.
2. The Going Concern concept
The company or business is presumed to be healthy and likely to continue in business for the
foreseeable future. This concept assumes importance in recognising assets and liabilities. If the
assumption fails to hold, then all e!penses including e!penses incurred for purchased of fi!ed
assets are to be shown e!penses. All assets are to be shown on li"uidation value as if the company
will be li"uidated at the end of the period. #y applying going concern concept, one can
reasonably spread the e!penditure over a period of time if the benefit of such e!penditure also
spreads over a time period.
3. The Money measurement concept:
$oney measurement concept re"uires accounting system to record transactions only if such
transactions can be measured on monetary basis. In other words, those events that cannot be
measured in money terms cannot be entered in the books. There is no way to measure customers%
satisfaction or production e!cellence or human resources value in accounting. In that sense,
accounting is not integrating itself with other functions and today a typical performance
measurement includes several other non-monetary measurements.
4. The Historical Cost concept
This concept e!plains how the value of any transaction should appear in the books. &uppose the
business has ac"uired an asset for 's. () lakh at the beginning of the accounting year and its
value at the end of the year is 's. (* lakhs. +hat should be the value of the asset shown in
balance sheet, If we assume that the company is going to be there for a long time -going concern
concept., we should not bother year to year changes in value and hence the capital appreciation is
not relevant. In accordance with this going concern concept, the historical cost concept says the
assets or any transaction has to be entered initially at historical cost. &imilarly, when a company
buys some machines say computers in bulk, it might get a price different from the normal price.
/ere again the company can recognise only the price it has paid to the seller as asset. This
concept is violated in certain cases where the concept itself re"uires the users to use such lower
5. The Materiality concept
All monetary transactions are to be recorded and reported in the accounting system. /owever, the
treatment of an item depends on the importance of the item. The treatment is normally related to
recognising the e!penditure as capital and revenue. For instance, if an airline buys coat hangers
or, your company purchasing staplers to be used by the employees. Are they assets or e!penses,
Applying the definition of assets, they are actually assets since they are not held for sale and used
in the process of manufacturing a product or service. #ut they are not significant in value.
. The Matching Concept
The matching concept re"uires revenue and e!penses be matched to derive a reasonable value of
profit.. 0sually, the matching concept is applied by first determining revenue for the period, and
then matching items of e!penses that gave rise to these revenues. For e!ample, if a firm sold 1)))
units of finished products, then costs related to manufacturing and selling of 1))) units is to be
identified and matched. It may not be possible in many cases that the e!penditure will
actually relate to earning of the revenue but still will be deducted from the revenue to
derive profit. These e!penses are in the nature of period cost, that is whether there is a
revenue or not, they may have to be incurred.
!. The Accrual concept
Accounting transactions generally end up with cash. That is, a sale is ultimately realised and
e!penses are generally paid. The "uestion is should accounting system wait for the cash before
recording the same. The reason is accrual concept. +hen it comes to revenue or e!penses, accrual
concept is consistent with matching concept. If a sale is made, whether e!penses on account of
sale is paid or not, they are to be recognised. For instance, an advertisement was released on
2ecember *1 but the amount was paid on 3
April. &ince the e!penses have been accrued, they
need to be recognised in the accounts. &imilarly, if a loan is taken in 4anuary and ne!t interest has
to be paid at the end of 4une, interest e!penses for the period of 4anuary to $arch are to be
recognised when closing the books of accounts in the month of $arch
5. Realisation Concept
'ecognizing concept says that the revenue is earned when the goods are transferred or
services rendered. This concept emphasizes that profit should be considered when
realized. -+e need not wait for the receipt of money .
". The Conser#atism concept
.'ecognise losses at the earliest and postpone the gains until actually realised. For instance, if the
company believes some of its credit sales are not realisable, then it should provide for them as
bad debts from the profits. &imilarly, the value of inventory or short-term investments may have
to be reduced and losses be recognised if the market price of inventory or short-term investments
decline from the cost of ac"uisition.
1$. The Consistency concept
6onsistency concept indicates that the company cannot keep changing its accounting policies
"uite often. If a company decides to depreciate its assets on a straight-line basis of accounting,
then it is e!pected to continue the same consistently so that once a firm has chosen a particular
method of accounting, it should adhere to that method in the future, so as to allow for the most
meaningful comparisons on a year-on-year basis. 7nly when there are compelling reasons, they
should go for a change and that change should be reported in the notes to accounts along with the
financial impact of the same.