ACCOUNTING PRINCIPLES
Accounting is nothing more than the measurement of the processes to reflect what has happened to a business over a relevant period of time. The assets are measured by the Balance Sheet, while the profit and cash parts are measured by the Income Statement / Profit and Loss Account and the Cash Flow Statement respectively. For measuring them, accounting principles are used which are segregated into Accounting Concepts and Conventions
ACCOUNTING CONCEPTS AND CONVENTIONS
ACCOUNTING CONCEPTS
In order to make the accounting language convey the same meaning to all people & to make it more meaningful, most of the accountants have agreed on a number of concepts which are usually followed for preparing the financial statements. These concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these concepts.
1) BUSINESS ENTITY CONCEPT : According to this concept, Business is treated as separate & distinct from its members Separate set of books are prepared. Proprietor is treated as creditor of the business. For other business of proprietor different books are prepared.
2) MONEY MEASUREMENT CONCEPT: Only those transactions, which are expressed in monetary terms are recorded in the books of accounting. Money is the common unit, which enables various items of diverse nature to be summed up together and dealt with.
3) GOING CONCERN CONCEPT: According to this concept, it is assumed that the business will exist for a long time and transactions are recorded on this basis. This concept forms the basis for the distinction between expenditure that will yield benefit over a long period of time and expenditure whose benefit will be exhausted in the short-term.
4) ACCOUNTING PERIOD CONCEPT: Business firms prepare their income statements for a particular period. This period, known as the accounting period, is usually the calendar year (January 1 to December 31) or the financial year (April 1 to March 31). Some firms, like trading firms have shorter periods such as a month or less, while others may have longer terms. The Companies Act, 1956 has set a maximum limit of 15 months for the accounting period.
5) COST CONCEPT: The transactions are recorded at the amounts actually involved. For instance, a piece of land may have been purchased at Rs.1,50,000, whereas the company considers it to be worth Rs.3,00,000. The land is recorded in the books of accounts at Rs.1,50,000 only. Thus, an arbitrary valuation of the company’s assets is avoided by recording the value at the actual amount involved. Since this amount would have been mutually agreed upon by both the parties involved in the transaction, it is an objective valuation.
6) DUAL ASPECT CONCEPT: Every transaction recorded in books affects at least two accounts. If one is debited then the other one is credited with same amount. This system of recording is known as “DOUBLE ENTRY SYSTEM”. This gives rise to the statement
ASSETS = LIABILITIES + CAPITAL
7) REALISATION CONCEPT: Every transaction in accounting need to be recorded basing on its realization. Accounting records transactions from the historical perspective, i.e. it records transactions that have already occurred. It does not attempt to forecast events; this prevents the business from presenting inflated profits based on their expectations. A transaction is recorded only on receipt of cash or a legal obligation to pay. Until then, no income or profit can be said to have arisen.
8) MATCHING CONCEPT: All the revenue of a particular period will be matched with the cost of that period for determining the net profits of that period. Accordingly, for matching costs with revenue, first revenue should be recognised & then costs incurred for generating that revenue should be recognised.
Following points must be considered while matching costs with revenue-:
Outstanding expenses though not paid in cash are shown in the P&L a/c.
Prepaid expenses are not shown in the P&L a/c.
Closing stock should be carried over to the next period as opening stock.
Income receivable should be added in the revenue & income received in advance should be deducted from revenue.
9) ACCRUAL CONCEPT: In this concept revenue is recorded when sales are made or services are rendered & it is immaterial whether cash is received or not. Same with the expenses i.e. they are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not.
10) OBJECTIVE EVIDENCE CONCEPT: Accounting transactions should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts. It is possible only when each transaction is supported by verifiable documents & vouchers such as cash memos, invoices.
ACCOUNTING CONVENTIONS
An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants. It refers to common practices which are universally followed in recording and presenting accounting information of the business entity. They are followed like customs, tradition, etc. in a society. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting Conventions help in comparing accounting data of different business units or of the same unit for different periods. These have been developed over the years
1) CONVENTION OF FULL DISCLOSURE
Information relating to the economic affairs of the enterprise should be completely disclosed which are of material interest to the users. Proforma & contents of balance sheet & P&L a/c are prescribed by Companies Act. It does not mean that leaking out the secrets of the business.
2) CONVENTION OF CONSISTENCY
Accounting method should remain consistent year by year. This facilitates comparison in both directions i.e. intra firm & inter firm. This does not mean that a firm cannot change the accounting methods according to the changed circumstances of the business.
3) CONVENTION OF CONSERVATISM
All anticipated losses should be recorded but all anticipated gains should be ignored. It is a policy of playing safe. Provisions are made for all losses even though the amount cannot be determined with certainty.
4) CONVENTION OF MATERIALITY
According to American Accounting Association, “An item should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor.”
It is an exception to the convention of full disclosure. Items having an insignificant effect to the user need not to be disclosed.