Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. Certain concepts are rceive, assumed and accepted in accounting to provide a unifying structure and internal logic to accounting process. The word concept means idea or jjwa, which has universal application. Financial transactions are interpreted in the light of the concepts, which govern accounting methods. Concepts are those basic assumptions and conditions, which form the basis upon which the accountancy has been laid. Unlike physical science, accounting concepts are only result of broad consensus. These accounting concepts lay the foundation on the basis of which the accounting principles are formulated.
“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 exits.”
Accounting principles must satisfy the following conditions:
. They should be based on real assumptions;
2. They must be simple, understandable and
3. They must be followed consistently;
(a) Entity concept Entity concept states that business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from the its owner. Business transactions are recorded in the business books of accounts and owner’s transactions in his personal books of accounts. The practice of distingdishing the affairs of the business from the
personal affairs of the owners originated only in the early days of the double-entry bookkeeping. This concept helps in keeping business affairs free from the influence of the personal affairs of the owner. This basic concept is applied to all the organizations whether sole proprietorship or partnership or corporate entities.
Entity concept means that the enterprise is liable to the owner for capital investment made by the owner. Since the owner invested capital, which is also called risk capital he has claim on the profit of the enterprise. A portion of profit which is apportioned to the owner and is immediately payable becomes current liability in the case of corporate entities.
(b) Money measurement concept: 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 to be 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. Transactions and events that cannot be expressed in terms of money are not recorded in the business books. For example; employees of the organization are, no doubt, the assets of the organizations but their measurement in monetary terms is not possible therefore, not included in the books of account of the organization. Measuring unit for money is taken as the currency of the ruling country i.e., the ruling currency of a country provides a common denomination for the value of material objects. The monetary unit though an inelastjc yardstick, remains indispensable tool of accounting.
(c) Periodicity concept : This is also called the concept of definite accounting period. As per ‘going concern’ concept an indefinite life of the entity is assumed. For a business entity it causes inconvenience to measure performance achieved by the entity in the ordinary course of business.
If a textile mill lasts for 100 years, it is not desirable to measure its performance as well as financial position only at the end of its life.
So a small but workable fraction of time is chosen out of infinite life cycle of the business entity for measuring performance and looking at the financial position. Generally one year period is taken up for performance measurement and appraisal of financial position. However, it may also be 6 months or 9 months or 15 months. -
According to this concept accounts should be prepared after every period & not at the end of the life of the entity. Usually this period is one calendar year. In India we follow from 1st April of a year to 3Pt March of the inunediately following year.
Thus, the periodicity concept facilitates in
(i) Comparing of financial statements of different periods
(ii) Uniform and consistent accounting treatment for ascertaining the profit ana assets of the business
(iii) Matching periodic revenues with expenses for getting correct results of the business operations
(d) Accrual concept Under accrual concept, the effects of transactions and other events are recognised on mercantile basis i.e., when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. Financial statements prepared on the accrual basis inform users not only of past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future.
To understand accrual assumption knowledge of revenues and expenses is required. Revenue is the gross inflow of cash, receivables and other consideration arising in the course of the ordinary activities of an enterprise from sale of goods, from rendering services and from the use by others of enterprise’s resources yeilding interest, royalties and dividends. For example,
(1) Mr. X started a cloth merchandising. He invested Rs. 50,000, bought merchandise worth Rs. 50,000. He sold such merchandise for Rs. 60,000. Customers paid him Rs. 50,000 cash and assure him to pay Rs. 10,000 shortly. His revenue is Rs. 60,000. It arose in the ordinary course of cloth business; Mr. X received Rs. 50,000 in cash and Rs. 10,000 by way of receivables.
Take another example; (2) an electricity supply undertaking supplies electricity spending Rs. 16,00,OQO for fuel and wages and collects electricity bill in one month Rs. 20,00,000 by way of electricity charges. This is also revenue which arose from rendering services.
Lastly, (3) Mr. A invested Rs. 1,00,000 in a business. He purchased a machine paying Rs. 1,00,000. He hired it out for Ps. 20,000 annually to Mt B. Rs. 20,000 is the revenue of Mr. A; it arose from the use by others of the enterprise’s resources
(e) Matching concept: In this concept, all expnses matched with the revenue of that period should only be taken into consideration In the fmancial statemeEfflhe organization if any IV&i*Ü is recognized then expenses related to eam that revenue should also be recognized.
This concept is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items like prepaid and outstanding expenses, unearned or accrued incomes.
It is not necessary that every expense identify every income. Some expenses are directly related to the revenue and some are tim.e bound. For example:- selling expenses are directly related to sales but rent, salaries etc are recorded on accrual basis for a particular accounting period.other words periodicity concept has also been followed while applying matching concept.
Mr. P K started cloth business. He purchased 10,000 pcs. garments @ Rs. 100 per piece and
sold 8,000 pcs. © Rs. 150 per piece during the accounting period of 12 months 1st January to
31st December, 2005. He paid shop rent © Rs. 3,000 per month for 11 months and paid
Rs. 8,00,000 to the suppliers of garments and received Rs. 10,00,000 from the customers.
Let us see how the accrual and periodicity concepts operate.
(e) Matching concept: In this concept, all expnses matched with the revenue of that period should only be taken into consideration In the fmancial statemeEfflhe organization if any IV&i*Ü is recognized then expenses related to eam that revenue should also be recognized.
This concept is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items like prepaid and outstanding expenses, unearned or accrued incomes.
It is not necessary that every expense identify every income. Some expenses are directly related to the revenue and some are tim.e bound. For example:- selling expenses are directly related to sales but rent, salaries etc are recorded on accrual basis for a particular accounting period. fri other words periodicity concept has also been followed while applying matching concept.
Mr. P K started cloth business. He purchased 10,000 pcs. garments @ Rs. 100 per piece and sold 8,000 pcs. © Rs. 150 per piece during the accounting period of 12 months 1st January to 31st December, 2005. He paid shop rent © Rs. 3,000 per month for 11 months and paid Rs. 8,00,000 to the suppliers of garments and received Rs. 10,00,000 from the customers.
Let us see how the accrual and periodicity concepts operate.
Suppose Mr. X purchased a machine for his business paying Rs. 5,00,000 out of Rs. 7,00,000 invested by him. He also paid transportation expenses and installation charges amounting to Rs. 70,000.
(g) Cost concept By this concept, the value of an asset is to be determined on the basis of historical cost, in other words, gsition cost. Although there are various measurement bases, accountants traditionally prefer this concept in the interests of objectivity. When a machine is acquired by paying Rs. 5,00,000, following cost concept the value of the machine is taken as Rs. 5,00,000. It is highly objective and free from all bias. Other measurement bases are not so objective. Current cost of an asset is not easily determinable. If the asset is purchased on 1.1.82 and such model is not available in the market, it becomes difficult to determine which model is the appropriate equivalent to the existing one. Similarly, unless the machine is actually sold,
realisable value will give only a hypothetical figure. Lastly, present value base is highly subjective
because to know the value of the asset one has to chase the uncertain future.
However, the cost concept creates a lot of çlistojon too as outlined below
(a) In an inflationary situation when prices of all commodities go up on an average, acquisition cost loses its relevance. For example, a piece of land purchased on 1.1.82 for Rs. 2,000 may cost Rs. 1,00,000 as on 1.1.2006. So if the accountant makes valuation of asset at historical cost, the accounts will not reflect the true position.
(b) Historical cost-based accounts may lose comparability. Mr. X invested Rs. 1,00,000 in a machine on 1.1.82 which produces Rs. 50,000 cash inflow during the year 20Q6, while Mr. ‘I’ invested Rs. 5,00,000 in a machine on 1.1.92 which produced Rs. 50,000 cash inflows during the year. Mr. X earned at the rate 20% while Mr. Y earned at the rate 10%. Who is more-efficient ? Since the assets are recorded at the historical cost, the results are not comparable. Obviously it is a corollary to (a).
(h) Rca lisation concept: It closely follows the cost concept. Any change in value of an asset is to be recorded only when the business realises it. When an asset is recorded at its historical cost of Rs. 5,00,000 and even if its current cost is Rs. 15,00,000 such change is not counted unless there is certainty that such change will materialise.
However, accountants follow a more conservative path. They try to cover all probable losses but do not count any probable gain. That is to say, if accountants anticipate decrease in value they count it, but if there is increase in value they ignore it until it is realised. Economists are highly critical about the realisation concept. According to them, this concept creates value distortion and makes accounting meaningless.
U) Dual aspect concept This concept is the core of double entry book-keeping. Every transaction or event has two aspects:
(1) It increases one, Asset and decreases other Asset;
(2) It increases an Asset and simultaneously increases Liability;
•k3 It- decreases one Asset, increases another Asset;
(4) It decreases one Asset, decreases a Liability.
Alternatively:
(5) It increases one Liability, decreases other Liability;
(6) It increases a Liability, increases an Asset;
(7) It decreases Liability, increases other Liability;
(8) It decreases Liability, decreases an Asset.
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