Basic Concepts of Accounting

Basic Concepts of Accounting

Basic concepts of accounting are the fundamental ideas & basic assumptions which refers to the theoretical and practical practice of financial accounting and rules for all accounting activities developed by the accounting professionals. Below mentioned is the list of all accounting concepts.

  • Business entity concept
  • Money Measurement concept
  • Going Concern Concept
  • Accounting Period Concept
  • Cost Concept
  • Dual Aspect Concept
  • Revenue Recognition Concept
  • Matching Concept
  • Full Disclosure Concept
  • Consistency Concept
  • Conservatism Concept
  • Materiality Concept
  • Objectivity

Business Entity Concept

As discussed earlier there is separate identity of a business from its owners, so as per business entity concept the business and its owners are treated as two separate entities. When a person brings money into the business as capital, it is recorded as a liability of a business to the owner of business. Therefore the owner and the business are treated as two separate entities. In the other way the owner withdraw money from business for his personal use are known as drawings which is reduced from owner’s capital as well as reduction in the business liability. All the accounting records are made in the books of accounts from the business unit point of view not from the business owner.

Money Measurement Concept of Accounting

Those business transactions and happenings which can be measure and expressed in terms of money are included in the concept of money measurement for example sales of goods, receipt of income, payment of expenses etc. These types of transactions which can be expressed in terms of money are recorded in the books of accounts of a business. Transactions which cannot be measured or expressed in terms of money are not recorded in the books. For example capabilities of human resources, appoint new managers etc. are important activities of a business but these cannot be expressed in terms of money. In this concept of money measurement is to keep record only for those business transactions which are in monetary units and not in physical units.

Going Concern Concept of Accounting

The going concern concept of accounting the assumption of accounting that provides the basis for showing the value of an asset or assets in the balance sheet of an organization. In this concept of going concern a business needs to carry out its operations indefinitely which is for a long period and would not liquidate in the foreseeable future. So this concept of accounting is related to assets of a firm which are purchased for their services according to their life span. The assumption of continuity of business allows a business firm to charge from revenue only for the part of the asset which has been consumed to earn the revenue in the specific period of time and carry forward the remaining amount to next years of its life span.
For example: when a computer is purchased for Rs.20000 with a life span of 5 years, it is not fair to charge the whole amount of Rs.20000 from revenue at once in the year of its purchase. Firm can charge Rs.4000 every year from the profit and loss account. The going concern concept is the concept of continuity.

Accounting Period Concept

Accounting period is the span of time in which at the end the financial statements of a business are prepared to know the profit and loss and actual position of assets and liabilities of a business. Different internal and external users need that information at regular intervals of time for various purposes and decision making. These intervals generally are for one year and are called the “Accounting Period”. According to Income Tax Act and Companies Act 2013 the financial statements are to be prepared annually. But for other purposes and in certain situations these can be prepared as and when needed by the business.

Cost Concept of Accounting

This concept of cost says that all the assets are recorded in the books of accounts at their original cost which is purchase price of the asset. This includes the cost of acquiring the asset, transportation and installation of the asset and makes the asset ready to use. The nature of cost concept of accounting is historical which refers to the amount paid at the time of purchase of an asset and it does not change every year. For example if a building is purchased for Rs.30 lakhs, the purchase price i.e original cost will remains the same for all upcoming years, though its market value may increase in these years. Because the original value of an asset cannot be assumed in this historical cost basis concept it may lead the business to hidden profits. During the years of rising prices, the market value which is higher than the recorded value (purchase price) leads the business to get hidden profits from the sale or replacement of asset.

Dual Aspects Concept of Accounting

The basic foundation of principles of accounting is the Dual Aspect Concept. All the transactions of a business are recorded in the books of accounts on the basis of dual aspect concept. This concept of dual aspects says that every transaction has a dual effect or two side effects and should be recorded at two places. In other words, there must be at least two accounts involved in recording a business transaction. This type of dual effect can be applied on all the business transactions and is also called the duality principle of accounting. Duality principle in fundamental accounting equation can be expressed as:

Assets = Liabilities + Capital

This equation says that the assets of a business are equals to the claims of owners and the outsides. These claims of owners are called the equity of owners and are termed as Capital or owners equity. The claim of outsiders is termed as the liabilities or creditors equity. The dual aspect of each transaction affects in a manner so that the equity of both sides of the equation is maintained and matched.

Revenue recognition Concept of Accounting

The Revenue Recognition Concept of Accounting requires that the revenue of a transaction or transactions should be recorded in the books or accounts only after its realization. Revenue is the amount of incomes (Cash Inflow) that inflow in the business from sale of goods and services and other resources used by business firm to generate revenue like royalties, interests, dividends etc. Concept of Revenue Recognition refers to the revenue which is actually earned and after realizing the actual revenue it is recorded in the books of accounts. Revenue is assumed to be realized when a legal right arises to receive it. When a sale is made or a service has been provided on credit basis, credit sales are treated as revenue at the time of goods sold or services provided not at the time of receiving the money from its buyers.

Matching Concept

Matching Concept of Accounting is the process of determining the profit and loss for a particular period of time which involves all the expenses that needs to be deducted from the revenue generated for that period. Concept of matching in accounting says that both expenses and revenue of a transaction should be included in same accounting period so that the actual profit or loss can be determined. The matching concept of accounting implies that all the revenue generated during the accounting period, whether received or not received during the year and all expenses and costs whether paid or not paid during the year should be taken into account to ascertain the profit and loss for the year.

Full Disclosure Concept

Full disclosure means all the information including material and important facts concerned to financial performance of a business which must be completely disclosed with the help of financial statements and footnotes etc. prepared time to time. The information given in the financial statements enables its users to make correct assessments and decisions to increase profitability of the business. Information provided in financial statements is used by many groups of people, investors, creditors of the company, suppliers and many other people to make important decisions as per their need. A proper format of profit and loss account and Balance Sheet has been provided by the Indian Companies Act 1956 and are compulsory for every company to ensure proper disclosure of material accounting information. SEBI has also mandate the disclosure to be made by companies to view the true and fair profitability of a business for a particular accounting period.

Consistency Concept of Accounting

Consistency concept is related to the comparison of financial statements of a company over a period of time as well as with other companies and competitors. Both inter-firm and inter-period comparisons are important for a business and are possible only if the practices and business policies are uniform and consistent for the accounting period. To make a meaningful comparison between the financial results of two companies it is important to follow the same policies and accounting methods while preparation of financial statements. However, these accounting methods and policies can be changes if necessary. Concept of Consistency does not prohibit any change in policies and accounting methods.

Conservatism Concept of Accounting

The concept of conservatism is based on the policy of playing safe and provides guidance to record transactions in the accounting books. Conservatism concept states that the profit of a business should not be recorded in the books until it is realized and losses even those which may have a remote possible are to be recorded in the books. This approach of providing for losses and not recognizing the gains until it is realized is called the conservatism approach. This concept of conservatism of accounting is also called the concept of prudence.

Materiality Concept of Accounting

The concept of materiality in accounting refers to the recording and presenting of material facts only and efforts should not be wasted in recording and presenting immaterial facts. Material facts mean the information that is useful for its users to make necessary decision for investing in a business. Insignificant and useless information should not be recorded and presented in the financial statements. Materiality facts are depends upon its nature and significance. Any fact that includes an amount and influence to help the user to make decisions then it is considered as material fact.

Objectivity Concept of Accounting

The recording of accounting transactions in an objective manner, free from the bias of accountants and other persons, is required by Objectivity concept. It is possible if each transaction is supported by its verifiable documents or documentary evidence like, invoices, vouchers, letters, challans and certificates etc. so the Objectivity concept of accounting requires that all the accounting transactions should be verifiable and have valid supported documentary proof.

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