11 Accounting Concepts

11 Accounting Concepts accountingrevenue.com/11-accounting-concepts.html Sanjoy19

August 5, 2020

What is Accounting Concepts: Accounting Concepts are basically the accounting assumptions that should be followed while preparing the financial statements and accounts. Accounting concepts are those basic assumptions upon which the process of accounting depends. They are perceived, presumed, and accepted in the accounting arena to ensure a unifying structure and internal logic to the accounting process. Accounting concepts is also termed as Accounting Postulates.

Accounting concepts is part of accounting principles Learning Objectives: Accounting concepts.

After studying this unit,you will be able to:

Features of Accounting concepts : some important features of accounting concepts : a. Accounting concepts are the ideas that are universally applicable. b. Accounting concepts are the assumptions and ideas that are fundamental to accounting practices. c. Accounting concepts are the bases upon which the superstructure of accounting are developed. d. Accounting concepts extend their hands of support to the structure of accounting.

Classification of Accounting Concepts : Classification of accounting concepts can be diagrammatically represented as follows:

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Classification of Accounting Concepts.

The classification of Accounting concepts are stated below.

1. Business Entity Concepts: Entity concept of accounting assumes that an enterprise has a separate identity completely distinct from its owner and all the accounting activities are centered around the enterprise.

Therefore, the business enterprise is considered as the center of focus around which all the business operation are carried on, According to this concept, all the assets employed in the business are owned by the equity and at the same time liable to both the claim on the resources (i.e, assets) to outsiders (i.e, creditors) and the claim to the insiders (i.e, shareholders).

Joint-stock Company is that form of organization where the law recognizes the separate legal entity of the business distinct from its owners i.e, the shareholders.

According to this Accounting concepts, all the transactions are carried on from the angle of the entity and not from the angle of the owner. The basic objective behind this concept is that accounts are not only maintained to safeguard the interest of owners but to do the same to safeguard the interest of all the parties related to the enterprise in an impartial manner.

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Again income earned by the entity is viewed as the income earned by the entity and not of the owners. only a portion of the profit which is earmarked for distribution as a dividend to the shareholders belongs to the owners.

The entity concept does not put any special care to owners equity. Accounting to this concept Owner’s equity is treated at par with external liabilities. The term equity is not used in an objective sense but in the abstract sense.

2. Money Measurement Concepts : Money measurement Accounting concepts consider money as the basic unit, on the basis of which accounting data are recorded in the books of accounts. Money is the only practical unit of measurement that can be employed to bring homogeneity to different heterogeneous financial information, so as to record all those transactions which can be expressed in terms of money.

Now, the information or economic events that can not be expressed in terms of money are not required to be recorded in the books of accounts. Consequently, Non-monetary events like death, change in demand, managerial efficiency, Government policy, market potential, labor relation etc.

Which have significant bearing are out of the periphery of accounting activities because they are not measurable in terms of money.

The advantage of expressing business transactions in terms of money is that money serves as the common denominator which enables us to express different heterogeneous items of the business meaningfully in the financial statement.

The causes behind the development of this concept are : (a) Money is serving as a dependable unit of expressing different heterogenous items; (b) It is the statehouse of wealth; (c) Money got universal recognition for the medium of exchange.

Money measurement Concepts enable a better understanding of the state of affairs of the business. Moreover, the use of this concept facilitates a better intra- comparison of the accounting information.

In this Accounting concepts, it is assumed that the purchasing power or value of money remains constant over a period of time or be subject to very negligible change.

The main drawback of this concept, it does not take care of inflation, which affects the purchasing power of the monetary unit.

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For instance, the rupee value of last year may have some value in the subsequent year because the purchasing power of the rupee has decreased due to a change in the price level. Moreover, it suffers from territorial limitations. It gets affected seriously by economic differences between various territories as well as political and social differences.

There are few non-monetary events that affect the profitability and financial position of the business firm. But since they are not measurable in terms of money, hence they are not shown in the financial statement. As such the financial statement fails to exhibit the true and fair view of the state of affairs of the business.

3.Going Concern Concept : The basic notion of the going concern concept is that the business entity is supposed to continue for an indefinite period of time and there is the least possibility of liquidation or closing down within a foreseeable time period. The business will operate continuously without any break.

As the business will not be closed down in the foreseeable future, it is expected that the business may be able to meet its contractual obligation (or debt) and utilize its economic resources (or assets) according to its predetermined plans.

It is also due to the going concern concept, the external equities enter into long term agreement with the business firm, provide loans, and participate in the fresh issue of debentures and shares of the company.

Another example of this concept is unexpired (i.e. prepaid) expenses which although have no realizable value but still it is shown in the assets side of the Balance Sheet because benefits of such expenses will be rea; used in the future. Moreover, it is because of this concept, assets may be classified into two parts fixed and current and liabilities into short-term and long- term.

This concept will provide surety about the future stability of the concern representing the continuous production of goods and services. it also assists the concern to show the assets consumed are expensed away and the residual are shown at their acquisition cost rather than its current purchase price.

Practically it would not be justified to show the assets at the current purchase price because it would not be sold out rather will be utilized in the process of production of goods and services. Thus, this concept assumes the business concern as a center of focus for creating values.

4. Accounting Period Concept : The accounting period refers to that span of time at the end of which financial statements (such as Profit & Loss Account and Balance Sheet) are prepared to reflect the operating performance and financial position of an enterprise respectively.

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The financial statements are usually prepared at regular intervals normally after a period of one year so that timely information may be made available to different users of accounting information such as owner, managers, employees, investors, suppliers, and so on.

The periodicity assumption assists the business in assessing its worth after a time interval of one year. It focuses that the expenditure whose benefit will accrue over more than one accounting period should be properly apportioned between such periods. An example of such expenditure is the amortisation of intangibles. It requires a process of estimation.

Although the periodicity assumption ensures the periodic reporting of operating result and financial position of the business but still it exhibits few measurement problems such as allocation of the cost of capital expenditure to the successive accounting period, contracts covering several accounting periods, etc.

However, solutions to these kinds of problems can be resolved through partly not completely by the exercise o personal judgments, experience, or knowledge.

5. Accrual Concept: It is one of the basic accounting concepts relating to the ascertainment of income. This concept refers to the process of matching expenses with revenue recognized (realized) during an accounting period regardless of actual inflow and outflow of cash.

While matching expenses with the revenue it is not necessary to investigate whether cash has been paid for those expenses or whether cash has been received against the revenue. Revenue is recognized only at the point of time when the sale is made irrespective of the time of realization of cash.

It may be realized simultaneously or beforehand or remain accrued. Similarly, cost may be considered as expenses only when its benefits expire during the process of revenue generation. Irrespective of the fact whether cash has been paid simultaneously or in the part or remain outstanding.

Therefore, according to the accrual concept, the cardinal principles of recognization of revenue and expenses is that whether they have actually taken place during the accounting period instead of cash has been received or disbursed for them.

Accrual concept is the most logical modern and popular concept in the present-day accounting. It puts emphasis on fair measurement of operating results and the financial position of the business firm during an accounting period. Credit transactions is also play an important role.

So this should not be lost sight off, otherwise operating results disclosed by the books of accounts will be misleading. As such, by following this concept all transactions are recognized in the financial statement only when they actually occurred irrespective of 5/11

received or disbursement of cash.

6. Dual Aspect Concept : The dual aspect concept is one of the important basic Accounting concepts. The fundamental of this concept is, every financial transaction involves a two-fold aspect (a) Debit and (b) Credit. The double entry system of accounting has been developed on the basis of this concept.

According to this accounting concepts, every debit must have a corresponding credit and vice-versa. On the basis of this principle the Accounting Equation is developed as : Assets = Equities = Liabilities + Capital In other words, the Accounting Equation may be represented as follows : Resources owned by the business = Claim of various claimants (including owners) against the assets of the business firm.

Hence, any increase or decrease in total assets there must be a corresponding increase or decrease in the equities. Duality always equate resources and source changes. It holds good in all circumstances. This principle can be compared with the Newton’s Law of Motion, viz: Every action has always an equal and contrary reaction.

Every debit has an equal amount of corresponding credit. Thus, the total of all debits must be equal to the total of all credits. It implies that every transaction must affect at least two accounts in such a manner that the identity of the accounting equation must always hold good. This phenomenon of account prevails due to the existence of a twofold aspect of each and every transaction.

7.Cost Concept : According to this principle, an asset should be recorded in the books of accounts at the acquisition price which includes the cost of acquisition, transaction, installation, and making the asset ready to use and this acquisition price becomes the basis for all future accounting in respect of such asset.

At the date of acquisition although asset is recorded at cost but subsequently its value is scaled down by way of depreciation. Even if with the passage of time, the market value of an asset continuously changes but still it should be shown at cost less depreciation provided up to date.

The justification for the use of this concept line in the fact that it is objectively verifiable.

Information stated in the financial statement is no way influenced by the personal judgment of those who prepare such financial statements.

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Due to the high degree of inflation in the present-day economy, it appears to be unjustified to prepare the financial statements on the basis of cost concept because it will be impossible to disclose the actual financial position of the business and ascertain the financial result of the business concern.

According to this concept, the entire cost of fixed assets may be written off by way of depreciation against income, even yet the assets are in good workable condition and are being used in the process of production. Consequently, it paves the way towards the creation of a secret reserve.

This principle is subject to yet another drawback. There are few assets that even earn income for the business but unable to show in the books of accounts because it has no cost viz favorable location, increasing the reputation of the business firm, etc.

8. Matching Concept : According to this principle, the expenses in a particular accounting period should be matched with the revenue realized in that accounting period.

For instance, when the sales value of any goods or services reported as revenue in a year, then the cost incurred for that goods or services should be reported as an expense of the same year.

Thus, for matching expenses with revenue, the first revenue of a particular accounting period should be recognized on the basis of the realization concept and then the cost associated with these revenues should be charged as expenses of the same period. Only those cost should be recognized whose service potential have expired in the process of revenue generation and these should be allocated or matched with such revenues.

The remaining cost whose service potential have not yet expired are to be carried forward in the future by reporting it as an asset in the Balance Sheet. Thus, for matching expenses with revenue, the necessary condition is that : (a) The expenses must be related to earning of revenue and (b) It should be related to the same accounting period to which the revenue realized relates.

As per the matching concept, the accounting equation will be : I=R-E where I= Income, R= Revenue realized in an accounting period and E= Total expired cost for earning the revenue.

There is the existence of a lot of subjectivism in the process of allocation of various costs like inventory, fixed assets, advertisement, etc. It is done on the basis of the evaluation of expired and unexpired service potential of historical cost.

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9. Realization Concept : This principle is also known as the revenue realization principle. According to this principle, revenue is considered to be earned at the point of time at which it is realized i.e. at the point which the property in the goods transfers to the buyers and he becomes legally liable to pay.

Truly speaking revenue is recognized only when goods are sold out or service is rendered. Therefore, this principle of recognization of revenue at the date of sale or service rendered is called a realization concept.

According to this principle, the time of recognition of revenue is the main focal point of attention. The property of goods or the benefits of services is transferred from buyer to seller as soon as the goods are sold or service has rendered.

Thus, credit sales are treated as revenue on the day sales are made not the date when money is realized from the customer. For the business firms from inflating their profits by recording income that is likely to accrue.

However. there are few exceptions to this rule. In the case of contractual work, only a proportionate amount of revenue, based on the part of the contract completed by the end of the period is considered as realized. Similarly, in case of hire purchases, sales, to the extent of installment receivable in a particular accounting period is treated as realized.

10. Fund Concept: Under this concept, the basis of accounting is an “operational unit” within an entity. The collection of assets belonging to the operational unit is known as “Fund”.

If a college wants to develop its buildings and creates a Building Fund, such Fund will be represented by some investments or cash. Any related collection will be spent on the development of the building only. This concept is usually applied in non-profit seeking concerns, trusts, etc.

11. Deferred concept: The expenses incurred or the revenues earned during an accounting period may not be related fully to that period only. Similarly, expenses or incomes of the current accounting period may be paid or realized in future years.

Thus it becomes necessary to set aside some portions of expenses or incomes for the coming accounting period. This is commonly known as a deferral concept. It is an offshoot of the periodicity concept.

Quick Revision : some important accounting concepts are: 8/11

Classifications of accounting concepts. i.Business entity Accounting concepts: This concept emerged with the introduction of Joint Stock Companies in the nineteenth century. Accounting to it any form of business is considered as an entity separate from its owners, employees, and other parties associated with it. Transactions of the business with such individuals are recorded by the Accounting.

This concept helps to give a true and correct view of the financial condition of a business. It does not mix up the business affairs with the private affairs of the owners, etc. From this concept, the idea of responsibility accounting has emerged. It helps to ascertain the operating results of each department or division separately and ensures effectiveness at each point of operations. ii.Going concern concept: Except for terminable ventures, a business is expected to continue for a reasonably long time. So, transactions are to be recorded in such a way that benefits likely to accrue in the future out of money spent at present or the future results of current events are taken into consideration.

The business is considered as a going concern. under its assets and liabilities are valued on the basis of their productivity. Assets are held for re-use. So, their expected realizable values are ignored. For example, any prepaid expense is considered as an asset. Because it is assumed that the business will continue and enjoy the benefit of the expense in the future. iii.Periodicity concept: The operation of a business is expected to continue for a reasonably long period. For effective accounting, the life ao the business is divided into different periods or time spans of equal duration, commonly known as accounting period or year. The accounting results of each period are separately ascertained.

It helps to compare among the said results of different period. It is extremely useful for(a)measurement of assets and liabilities,(b) correct calculation of profit, and (c) the segregation of capital expenditure from revenue expenditure. iv.Money measurement concept: Accounting is the art of recording. Classifying and summarising events and transactions in terms of money. So only those facts of a concern which can be expressed or interpreted in terms of money find their place in Accounting. Money is a medium of exchange.

It acts as the common denominator. Events or items having a value in exchange in 9/11

terms of money are considered in Accounting. It the principal of a college retires, the accounting should calculate the retirement benefits payable to him on retirement. He cannot measure the loss in the academic field. The monetary value attached to an asset or item should be transferable and external to man. v.Dual aspect concept: The world runs on the principle of “give and take�.If there is a giver, there shall be a receiver. For any transaction, two aspects namely giving a benefit and receiving a benefit should be recorded.No one side can be dispensed with. Rather for each transaction ane side debited and the other side is credited.

The principle of recording both sides is the result of the dual aspect concept. It presumes that any transaction will have an effect on assets on one hand and either on the claims of creditors or on the owner’s equity on the other. vi.Matching concept: Income or surplus is the excess of inflows or revenues over outlay or cost. Where costs are more, the result is a loss or a deficit.

For the purpose of measuring the periodical income, etc.the expired costs have to be matched against the revenues emerging during the accounting period. This is known as the matching cost Accounting concepts.

Revenues may be recognized (a) at the point of sale (b) during the process of production (c) on completion of production or (d) only on receipt of selling price.

For matching expired costs against such revenues the Accounting may consider (a) direct costs which cause the earning of revenue, (b) periodical costs like office rent, (c)allocated costs of fixed assets like depreciation,(d)other revenue expenditure like donations and (e) the cost of materials consumed, etc. vii.Realization concept: After the goods are sold the Accountant must be sure that the buyer is now legally liable to pay the price. Revenue should not be recognized only if an order has been received.

The underlying principle of the realization concept demands that revenue is to be treated as realized only from the legal sale of goods or from a legal rendering of service during an accounting period. viii. Accrual concept: It is a concept closely associated with the matching concept. Accounting to this concept revenue should be recognized when realized and not when actually received. Similarly, costs should be recognized when incurred and not at the point of actual payment.

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So at the time of preparing the Profit and Loss Account or Income & Expenditure Account, some adjustments have to be made. Regarding revenues, any receipt for the next year should be deducted but revenue recognized but not received within the current year should be added.

Similarly, prepaid costs should be excluded and costs incurred but not paid in the current year should be added. Under the cash basis of accounting, revenue is recognized when actually received and cost recognized when paid. As a result, the matching of costs against revenues cannot be perfect. Tish concept helps us to define income and expenses. An income causes an increase in the owner’s equity.

An expense causes a decrease of the owner;s equity. If due to a transaction, no change of the equity occurs, there cannot be any income or expense there. Rather ane asset has increased causing an equal decrease of another asset or equal increase of external liabilities.

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