Accounting Concepts :
Accounting concepts are defined as basic assumptions on the basis of which financial statements of a business entity are prepared. They are used as a foundation for formulating various methods and procedures for recording and presenting the business transactions. The important accounting concepts are given below:
(i) Business Entity Concept: According to this concept, business is treated as an entity separate from its owners. It is treated to have a distinct accounting entity which controls the resources of the concern and is accountable thereof. Accounts are kept for a business entity as distinguished from the person(s) owning it. All transactions of the business are recorded in the books of the business from the point of view of the business. Transactions are also recorded between the owner and the business, for instance, when capital is provided by the owner, the accounting record will show the business as having received so much money and as owing to the proprietor. This concept is based on the sense that proprietors entrust resources to the management and the management is expected to use these resources to the best advantage of the firm and to account for the resources placed at its disposal. Hence, in accounting for every type of business organization, be it sole tradership or partnership or joint stock company, business is treated as a separate accounting entity.
The failure to recognize the business as a separate accounting entity would make it extremely difficult to evaluate the performance of the business since the private transactions would get mixed with business transaction. The overall effect of adopting this concept is:
– Only the business transactions are recorded and reported and not the personal transactions of the owners.
– Income or profit is the property of the business unless distributed among the owners.
– The personal assets of the owners or shareholders are not considered while recording and reporting the assets of the business entity.
(ii) Money Measurement Concept: Money measurement concept holds that accounting is a measurement and communication process of the activities of the firm that are measurable in monetary terms. Thus, only such transactions and events which can be interpreted in terms of money are recorded. Events which cannot be expressed in money terms do not find place in the books of account though they may be very important for the business. Non-monetary events like, death, dispute, sentiments, efficiency etc. are not recorded in the books, even though these may have a great effect. Accounting therefore, does not give a complete account of the happenings in a business or an accurate picture of the conditions of the business. Thus, accounting information is essentially in monetary terms and quantified.
The system of accounting treats all units of money as the same irrespective of their time dimension. This has created doubts about the utility of the accounting data, leading to the introduction of inflation accounting.
(iii) Cost Concept: According to cost concept, the various assets acquired by a concern or firm should be recorded on the basis of the actual amounts involved or spent. This amount or cost will be the basis for all subsequent accounting for the assets. The cost concept does not mean that the assets will always be shown at cost. The fixed asset will be recorded at cost at the time of its purchase but it may systematically be reduced in its value by charging depreciation. These assets ultimately disappear from the balance sheet when their economic life is over and they have been fully depreciated and sold as scrap. It may be noted that if nothing has been paid for acquiring something, it would not be shown in the accounting books as an asset. Cost concept is not much relevant for investors and other users because they are more interested in knowing what the business is actually worth today rather than the original cost.
(iv) Going Concern Concept: Business transactions are recorded on the assumption that the business will continue for a long-time. There is neither the intention nor the necessity to liquidate the particular business venture in the foreseeable future. Therefore, it would be able to meet its contractual obligations and use its resources according to the plans and pre-determined goals. It is on this concept that a clear distinction is made between assets and expenses. Transactions are recorded in such a manner that the benefits likely to accrue in future from money spent now or the future consequences of the events occurring now are also taken into consideration. It is because of this concept that fixed assets are valued on the basis of cost less proper depreciation keeping in mind their expected useful life ignoring fluctuations in the prices of these assets.
However, if it is certain that a business will continue for a limited period, then the accounting records will be kept on the basis of expected life of the business and there will be no need for such detailed accounting information as to revenue and capital expenditure. When an enterprise liquidates a branch or one segment of its operations, the ability of the enterprise to continue as a going concern is not impaired. But the enterprise will not be considered as a going concern if it goes into liquidation or it has become insolvent. If the assumption of the going concern is not valid, the financial statements should clearly state this fact.
(v) Dual Aspect Concept: This concept is based on double entry book-keeping which means that accounting system is set up in such a way that a record is made of the two aspects of each transaction that affects the records. The recognition of the two aspects to every transaction is known as dual aspect concept. Modern financial accounting is based on dual aspect concept. One entry consists of debit to one or more accounts and another entry consists of credit to some other one or more accounts. However, the total amount debited is always equal to the total amount credited. Therefore, at any point of time total assets of a business are equal to its total liabilities. Liabilities to outsiders are known as liabilities, but a liability to owners is referred to as capital. Thus, this concept expresses the relationship that exists among assets, liabilities and the capital in the form of an accounting equation which is as follows:
Assets = Liabilities + Capital, or
Capital = Assets – Liabilities
Since accounting system requires recording of the two aspects of each transaction, this concept shows the effect of each transaction on them. Assets and liabilities are two independent variables and capital is the dependent variable, for it is the difference between assets and liabilities. Any change in any one of these three, must lead to a change in any of the other two.
(vi) Realisation Concept: According to this concept revenue is recognised only when a sale is made. Unless money has been realised i.e., cash has been received or a legal obligation to pay has been assumed by the customer, no sale can be said to have taken place and no profit can be said to have arisen. It prevents business firms from inflating their profits by recording incomes that are likely to accrue i.e. expected incomes or gains are not recorded.
(vii) Accrual Concept: Every transaction and event affects, one or more or all the three aspects viz., assets, liabilities and capital. Normally all transactions are settled in cash but even if cash settlement has not taken place, it is proper to record the transaction or the event concerned into the books. This concept implies that the income should be measured as a difference between revenues and expenses rather than the difference between cash received and disbursements. Business transactions are recorded when they occur and not when the related payments are received or made. This concept is called accrual basis of accounting and it is fundamental to the usefulness of financial accounting information.
It is not necessary that there is an immediate settlement in cash for any transaction or event therefore accrued revenues and costs are recognized as they are earned and incurred and recorded in the financial statements of the period. On the basis of this concept, adjustment entries relating to outstanding and prepaid expenses and income received in advance etc. are made. They have their impact on the profit and loss account and the balance sheet.
(viii) Accounting Period Concept: It is customary that the life of the business is divided into appropriate parts or segments for analyzing the results shown by the business. Each part or segment so divided is known as an accounting period. It is an interval of time at the end of which the income or revenue statement and balance sheet are prepared in order to show the results of operations and changes in the resources which have occurred since the previous statements have been prepared. Normally, the accounting period consists of twelve months.
(ix) Revenue Match Concept: This concept is based on accounting period concept. In order to determine the profit earned or loss suffered by the business in a particular defined accounting period, it is necessary that expenses of the period should be matched with the revenues of that period. The term ‘matching’ means appropriate association of related revenues and expenses. Therefore, income made by the business during a period can be ascertained only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue. According to this concept, adjustments should be made for all outstanding expenses, accrued incomes, unexpired expenses and unearned incomes etc. while preparing the final accounts at the end of the accounting period.