Accounting Principles: Top 9 Accounting Concepts & Conventions

At the same time, the liability of M/s Independent Trading Company in the form of capital will also increase. It means M/s Independent Trading Company is liable to pay Rs 2,00,000 to Mr A. The financial statement must disclose all the relevant and reliable information in accordance with the full disclosure principle. In books of account building will be recorded at cost i.e. ₹ 10 lakh. Future incomes are wot anticipated rather related expenditures are carried forward to future period like prepaid expense & closing stock. If any income is credited in the P&L A/c then all expenses incurred or to be incurred for earning this income, should also be debited in the same years P&L A/c.

Now imagine, if each business prepares the financial statement in their own way, we all will have hundreds of thousands of financial statements formats trying to convey the same information. This becomes practically impossible for a business compare and read the other companies’ statements. Here is why Accounting principles helps to bridge the gap and aims to bring some level of uniformity in financial reporting.

Receipt of income, payment of expenses, purchase, sale of assets, etc. are monetary transactions. Accounting principles major pillar is money measurement. Accounting agreements are certain complex business boundaries that are complex and unclear. Although the accounting agreements are not legally binding or binding, these generally accepted terms maintain consistency in the financial statements.

ACCOUNTING CONVENTIONS

Accounts are prepared for a fixed period usually a year. It is considered to be of a more fundamental character and universally acceptable which may be applied in all possible cases. We accounting concepts and conventions are pioneers in the field of Modern Teaching for Commerce Students since year 2000. We have multiple Locations in Gujarat and thousands of Students have lived and learned @ U WILL.

May not fully reflect the true economic reality of a company or its financial position. CAs, experts and businesses can get GST ready with Clear GST software & certification course. Our GST Software helps CAs, tax experts & business to manage returns & invoices in an easy manner. Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. Clear can also help you in getting your business registered for Goods & Services Tax Law.

Accounting concepts are based on economic reality, whereas accounting conventions are based on practicality and feasibility. This statement shows the changes in shareholders equity for the accounting period. Accounting is a vast function, it varies depending on the purpose it is used for. Financial accounting is used for business analysis, by parties external to the organization. The business transactions undertaken by the owner are altogether different from the personal transactions undertaken by him. The Going concept in accounting states that a business activities will be carried by any firm for an unlimited duration This simply means that every business has continuity of life.

The real cost may vary over time (e.g. depreciation of assets/inflation) but this will not affect in reporting purposes. GAAP targets to adjust and standardise accountancy practices by providing a framework to make sure companies and organisations are clear and honest in their financial reporting. Accounting principles act as a doctrine for accountants theory and procedures, in preparing their accounting systems. Both aim to ensure that financial statements provide a true and fair view of an organization’s financial position and performance.

If it decreases a liability, it increases another liability or decreases an asset. When a business unit is passing through severe financial crisis and going to wind up. According to this concept, the business and the owner of the business are two different entities.

Similarities between Accounting Concept and Accounting Convention

They are applicable either to all or certain types of accounting entities. The purchasing power or value of money does not remain stable. The value changes due to changes in general level of prices in the economy.

• It also allows the reader to make accounting entries and prepare cash books and other accounts necessary while running a business.
• In other words, capital, i.e. the owner’s share of the assets of firm, is always what is left out of assets after paying off outsiders.
• It focuses to understand the business rules and regulations that are needed to be followed by all sorts of business unit, and thus simplifying the elaborate and comparable financial information.
• Accounting conventions, on the other hand, refer to the established practices and rules that are commonly used in accounting, such as the use of double-entry accounting and the historical cost convention.
• It states that revenue is earned at the time of sale through cash or not whereas expenditures are recognized when they become payable whether cash is paid or not.
• External stakeholders (for example investors, banks, agencies etc.) depend on these principles to trust that a company is giving correct and relevant information in their financial statements.

To compare the results of different years, it is necessary that accounting rules, principles, conventions and accounting concepts for similar transactions are followed consistently and continuously. Reliability of financial statements may be lost, if frequent changes are observed in accounting treatment. Consistency also states that if a change becomes necessary, the change and its effects on profit or loss and on the financial position of the company should be clearly mentioned.

Important Topics in Accounting

As per Concept of Conservatism, the accountant should provide for all possible losses, but should not anticipate income. But it does not justify Creation of hidden reserve by deliberate understatement of Assets & incomes & overstatement of Liabilities & expenses. Consistency means the same Accounting principles & policies are followed, which were followed for preparing previous years accounts. To meet this requirement we make provision for closing stock, outstanding/prepaid expenses & outstanding/Advance income.

Accordingly, any expenses incurred by the owner for himself or his family from business will be considered as expenses and it will be represented as drawings. In this concept, all expenses matched with the revenue of that period should only be taken into consideration. In the financial statements of the organisation, if any revenue is recognised, then expenses related to earn that revenue should also be recognised. The cost concept stops any kind of manipulation while taking into account the net realizable value or the market value. On the downside, this concept ignores the effect of inflation in the market, which can sometimes be very steep. Still, the cost concept is widely and universally accepted on the basis of which we do the accounting of a business unit.

Business Entity Concept

The proprietor of the business is treated as creditor for the capital introduced by him due to concept. This consistency makes the information of different accounting year, comparable. If income is preponed for matching, it will be violation of realisation Concept & will also be against prudence principle.

This helps the investors or shareholders to know the exact profit and loss of the business. The accounting cost concept implies all the business assets should be written down in the book of accounts at the price assets are bought, including the cost of acquisition and installation. It states that the fixed assets like plant and machinery, building, furniture, etc are noted at their cost price. For example, a machine was bought by ABC Limited for Rs.10,00,000, for manufacturing bottles. Thus, the total amount at which the machine will be noted in the books of accounts would be the total of all these items i.e.

To promote better understanding of financial statements. In case of professionals such as doctors, engineers, chartered accountants, advocates revenue is recognised when it is actually collected and not when services are rendered by them. It is because the professionals are not sure of getting the payment from their clients. Where a contract is large enough to extend over a number of years, it is usual to credit a part of the profit to the profit and loss account each year.

In other words, the revenue concept states that revenue is realized when cash is received or the right to receive cash on the sale of goods or services or both have been created. The dual concept implies that every transaction has a similar effect on assets and liabilities in such a way that the value of total assets is always equal to the value of total liabilities. In brief, the accrual concept states that revenue is recognized when realized and expenses are recognized when they become due and payable irrespective of the cash receipt or cash payment. Realisation deals with the timing of recognition of revenue. If a bank loan of ` 5,00,000 is arranged it results in an increase in bank balance of ` 5,00,000 and an obligation to pay the bank loan of the same amount of ` 5,00,000. Accounting period helps us ascertain correct position of the firm at regular intervals of time, i.e., at the end of each accounting period.

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The purpose of having an accounting period is to take corrective measures keeping in view the past performances, to nullify the effect of seasonal changes, to pay taxes, etc. Accounting conventions are certain restrictions for the business transactions that are complicated and are unclear. Although accounting conventions are not generally or legally binding, these generally accepted principles maintain consistency in financial statements. While standardized financial reporting processes, the accounting conventions consider comparison, full disclosure of transaction, relevance, and application in financial statements. To ensure uniformity in accounting, certain accounting principles, concepts or conventions are used while writing accounts and preparing financial statements. The terms – principle, concept, convention, doctrine, postulate and assumption are sometimes used interchangeably.

The Accounting Principles, concepts, and conventions form the basis for how business transactions are recorded. A number of principles, concepts, and conventions are developed to ensure that accounting information is presented accurately and consistently. Some of these concepts are briefly described in the following sections. Check out Taxmann’s Accounting for Everyone | GE-4 | UGCF which is a comprehensive, authentic textbook on ‘Accounting for Everyone’.

Except stock which may be valued at cost or market price whichever is lower. Although, we will study accounting of business concerns, but in the same manner personal account books can also be maintained by any individual. An accounting principle can have alternative methods to apply it. Like in case of inventory we have methods of cost measurement by FIFO or weighted average. In other words, the revenue concept implies that revenue is realized when cash is received or the right to receive cash on the sale of goods or services or both have been generated. The dual concept states that every transaction has a same effect on assets and liabilities in such a way that the value of total assets is always same as the value of total liabilities.