Understanding Accounting Principles: Concepts and Conventions

UNIT-1: Introduction Topic Name: Accounting Principles: Concepts and Conventions Semester-I Core-I / Major-1.1 Financial Accounting Dr. Nisha Jain Asst. Professor Department of Commerce BJB Autonomous College, Bhubaneswar

Generally Accepted Accounting Principles (GAAP) Accounting is the language of global business. The phrase Generally Accepted Accounting Principles (GAAP) are common set of accounting principles, standards and procedures that companies use while preparing their financial statements. GAAPs recognise the importance of reporting transactions and events in accordance with their substance. GAAPs are imposed on companies in order to ensure consistency, reliability and transparency in financial reporting

Meaning of Accounting Principles Accounting Principles are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist. Accounting Principles must satisfy the following conditions: 1. They should be based on real assumptions. 2. They must be simple, understandable and explanatory. 3. They must be followed consistently. 4. They should be able to reflect future predictions. 5. They should be informational for the users.

Classification of Accounting Principles: Accounting Principles can be classified into two categories: 1. Accounting Concepts 2. Accounting Conventions Accounting Concepts: These are basic assumptions or conditions upon which the science of accounting is based. Accounting Conventions: These denote circumstances or traditions which guide the accountant while preparing the accounting statements.

Accounting Principles Accounting Concepts 1. Business Entity 2. Money Measurement 3. Going Concern 4. Historical Cost 5. Dual Aspect 6. Accounting Period 7. Matching 8. Realisation 9. Objective Evidence 10. Accrual 11. Timeliness AccountingConventions 1. Consistency 2. Full Disclosure 3. Conservatism 4. Materiality

Accounting Concepts: 1. Business Entity: This concept implies that a business unit is separate and distinct from the persons who supply capital to it I.e., the owners. Accountants should treat a business as distinct from its owner. This concept helps in keeping the business affairs free from the influence of the personal affairs of the owner. Entity Concept means that the enterprise is liable to the owner for capital investment made by the owner 2. Money Measurement: As per this concept, only those transactions which can be measured in terms of money are recorded. Since money is the medium of exchange and the standard of economic value, this concept requires that those transactions alone that are capable of being measured in terms of money be only recorded in the books of accounts. Transactions, even if they affect the results of the business materially, are not recorded if they are not convertible in monetary terms.

Accounting Concepts: 3. Going concern, concept The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Hence it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations. It is because of this concept that suppliers, supply goods and services and other business firms entered into business transactions with the business unit. 4. Historical cost concept. A fundamental concept of accounting, closely related to the going concern concept is that an asset is recorded in the books of books at the price paid to acquire it and that this cost is the basis for all subsequent accounting for the asset. This concept does not mean that it will always be shown at cost, but it means that cost becomes the basis for all future accounting for the asset.

Accounting Concepts: 5. Dual Aspect Concept: This is the basic concept of accounting. According to this concept, every financial transaction has a two equal and opposite effects on accounting records. This means that for every debit entry there is a corresponding credit entry and vice versa. There must be a double entry to have a complete record of each business transaction. The total amount of debits must always equal the total amount of credits. The Accounting Equation i.e., Assets= Liabilities + Equity is based on the Dual Concept. For example: If a company buys equipment for Rs 5000/- its asset increase by 5000 /-and its cash another asset decreases by Rs. 5000/- 6. Accounting Period Concept: Also called as the Periodicity concept. According to this concept, the accounts must be prepared on a periodic basis rather than waiting till the business is terminated. Usually this period is one calendar year. Generally the period starting from 1st April till 31st March of the immediately following year is considered.

Accounting Concepts: 7. Matching Concept: This concept states that all expenses matched with the revenue of that period should only be taken into consideration In the financial statements of the organisations if any revenue is recognised then expenses related to earn that revenue should also be recognised. In other words, when a company earns revenue , the costs associated with earning such revenue such as cost of goods sold, wages and other operating expenses, should be recorded in the same period, regardless of when the actual cash transactions occur. 8. Realisation Concept: According to this concept, revenue is considered as being earned on the date at which it is realised, I.e., on the date on which the property in goods passes to the buyer and he becomes legally liable to pay. It closely follows the cost concept. Any change in the value of an asset is is to be recorded only when the business realises it when an asset is recorded at its historical cost of five lakh and even if its current cost is 15,00,00 such change is not counted unless there is certain that a change will materialise.

Accounting Concepts: 9. Objective Evidence Concept: The objective evidence concept in accounting refers to the principle that financial information should be supported by verifiable data and documentation, ensuring accuracy and reliability. This means that every financial transaction recorded in the books must be based on objective factual evidence such as receipts, invoices, bank statements, or contracts. The purpose of this concept is to prevent the recording of financial data based on personal judgement or estimates without proper substantiation, enhancing the credibility and transparency of financial statements. It also aids auditors in verifying the accuracy of company s financial records. 10. Accrual concept: According to this concept, the revenue and expenses should be recorded in the period in which they are earned or incurred, regardless of when the cash is actually received or paid This concept ensures that financial statements reflect the true economic activity of a business over a specific period For example, under the approval concept, if a company delivers goods or services in a given period, it will record the revenue in that period even if the customer pays later, similarly expenses a recorded when they are incurred, not necessarily when payment is made.

Accounting Concepts: 11. Timeliness Principle The timelines, principle in accounting refers to the requirement that financial information must be provided to users in time for it to be relevant and useful for decision making. This means that accounting reports and financial statement should be prepared and made available as quickly as possible after the end of the reporting period, ensuring that the information is still current and can influence economic decisions. Delays in providing financial information can reduce its value as outdated information might not reflect the current financial situation of a business.

Accounting Conventions: 1.Convention of Consistency: According to this convention, once a company adopted a specific accounting method of policy, it should consistently apply it from one accounting period to the This ensures that financial statements are comparable overtime, allowing users such as investors, auditors to track, company, performance, and financial position accurately For example, if a company uses a straight line method for depreciating assets, it should continue using that method in future periods. Unless a valid reason or significant change in the business environment requires a switch. 2. Convention of Full Disclosure: According to this convention all material information that could influence a reader s understanding of a company s financial statements must be fully and transparently disclosed This includes any relevant financial facts, policies or events that are significant enough to affect the decision making of investors, creditors or other stakeholders. Material information could include pending lawsuits, significant transactions, changes in accounting policies or potential risks that may impact the company s financial condition.

Accounting Conventions: 1.Convention of Conservatism/Prudence: This convention requires accountants to exercise caution and choose that option that least overstates the assets, revenues or profits and least understates liabilities, expenses or losses. The rule followed is Anticipate no profits but provide for all possible losses. Under the conservatism convention potential losses are recognised as soon as they are reasonably possible, while gains are only recognised when they are certain For example, closing stock is valued at cost or net realisable value, which ever is less, based on this Convention. 2. Convention of Materiality: According to this convention only significant or material financial information should be disclosed in financial Statements. Information is considered material if its omission or misstatement could influence the economic decisions of the users, such as investors, creditors or regulators. Materiality depends on the size, nature and context of the item. For eg., A minor expenditure of Rs 50 for the purchase of a paper weight may be treated as an expense for the period rather than treating as an Asset.