Accounting Concepts and Convention

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1. Generally Accepted Accounting Principles (GAAP)Generally Accepted Accounting Principles are the rules and concepts which have been accepted by accounting community for sound accounting practice. Generally Accepted Accounting Principles (GAAP) comprises a set of rules, concept and guidelines used in preparing financial accounting reports. Their usefulness depends on ‘general acceptability’ rather than ‘individual acceptability’ of accounting concepts.  They (GAAP) have been formalised on the basis of usage, reason and experience.Essential features of Accounting PrinciplesAccounting principles are manmade. They are not tested in a laboratory.Accounting principles must be based on facts and free from personal bias.Accounting principles must be relevant and useful to the person who is using financial statements.The accounting principles should be practicable. 2. ACCOUNTING CONCEPTS AND CONVENTIONS2.1. Accounting concepts: The term ‘concept’ is used to denote accounting postulates, i.e., basic assumptions or conditions upon which the accounting structure is based. The following are the common accounting concepts adopted by many business concerns.Business Entity ConceptMoney Measurement ConceptGoing Concern ConceptDual Aspect ConceptPeriodicity ConceptHistorical Cost ConceptMatching ConceptRealisation ConceptAccrual Concepti) Business Entity Concept: Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it. This concept can be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The equation clearly shows that the business itself owns the assets and in turn owes to various claimants. ii) Money Measurement Concept: According to this concept, only those events and transactions are recorded in accounts which can be expressed in terms of money. Facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost. iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold aspect, Viz., 1. Giving certain benefits and 2. Receiving certain benefits. The basic principle of double entry system is that every debit has a corresponding and equal amount of credit. This is the underlying assumption of this concept. V) Periodicity Concept: Under this concept, the life of the business is segmented into different periods and accordingly the result of each period is ascertained. Each segmented period is called “accounting period” and the same is normally a year. vi) Historical Cost Concept: According to this concept, the transactions are recorded in the books of account with the respective amounts involved. For example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to be the base for all future accounting. vii) Matching Concept: The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made. Sale is considered to be complete when the ownership and property are transferred from the seller to the buyer and the consideration is paid in full. ix) Accrual Concept: According to this concept the revenue is recognized on its realization and not on its actual receipt. Similarly the costs are recognized when they are incurred and not when payment is made. 2.2. Accounting Conventions: Accounting conventions are common practices, which are followed in recording and presenting accounting information of a business. They are followed like customs in a society. The following conventions are to be followed to have a clear and meaningful information and data in accounting:i) Consistency: The convention of consistency implies that the same accounting procedures should be used for similar items over periodsii) Full Disclosure: According to this principle, all accounting statements should be honestly prepared and all information of material interest to proprietors, creditors, investors, etc. should be disclosed in the accounting statements. iii) Conservatism or Prudence: This convention follows the policy of caution or playing safe. It takes into account” all possible losses but not the possible profits or gains”. iv) Materiality: Materiality deals with the relative importance of accounting information. In order to make financial statements more meaningful and to economize costs, accountants should incorporate in the financial statements only that information which is material and useful to users. They should ignore insignificant details.3. ACCOUNTING STANDARDSAccounting Standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions for ensuring uniformity in accounting practices and reporting. These standards are prepared by Accounting Standard Board (ASB). Accounting Standards are formulated with a view to harmonise different accounting policies and practices in use in a country. Objectives or Purposes of Accounting Standards:To provide information to the users as to the basis on which the accounts have been prepared.To harmonize the diverse accounting policies & practices which are in use the preparation & presentation of financial statements.To make the financial statements more meaningful and comparable.To guide the judgment of professional accountants in dealing with those items, which are to be followed consistently from year to year.To provide a set of standard accounting policies, valuation norms and disclosure requirements.4. Methods of Accounting: Business transactions are recorded in two different ways.4.1. Single Entry: It is incomplete system of recording business transactions. The business organization maintains only cash book and personal accounts of debtors and creditors. So the complete recording of transactions cannot be made and trail balance cannot be prepared.4.2. Double Entry: Double Entry is an accounting system that records the effects of transactions and other events in at least two accounts with equal debits and credits. Under this system all accounts i.e., Personal, real and nominal accounts are maintained. It is a complete system of recording business transactions.4.3. Steps involved in Double entry system(a) Preparation of Journal: Journal is called the book of original entry. It records the effect of all transactions for the first time. Here the job of recording takes place.(b) Preparation of Ledger: Ledger is the collection of all accounts used by a business. Here the grouping of accounts is performed. Journal is posted to ledger. (c) Trial Balance preparation: Summarizing. It is a summary of ledge balances prepared in the form of a list.(d) Preparation of Final Account: At the end of the accounting period to know the achievements of the organization and its financial state of affairs, the final accounts are prepared.4.4. Advantages of Double Entry SystemThis system is the only scientific system of recording business transactions.Complete record of all business transactions.By the use of this system the accuracy of accounting book can be established through Trail balance. The profit earned or loss suffered during a period can be ascertained by the preparation of Profit and Loss Account.The financial position of the firm can be ascertained at the end of each period, through the preparation of balance sheet.4.5. Disadvantages of Double Entry SystemIt requires expert knowledge, so it cannot be prepared by a layman.It is a very lengthy process. it requires a larger number of books.It is expensive because an expert is to be employed for this Purpose. If a transaction is omitted to be recorded in the books of accounts, it cannot be detected by double entry system because they do not affect a trial balance.4.6. Merits of Single Entry System:-(1) It is an easy and simple method of maintaining books of accounts.(2) It is conventional and economical.(3) It is less time consuming.4.7. Demerits of Single Entry System:-(1)It is not a scientific method of accounting because it does not record the two-fold aspect of each transaction.(2)No trial balance can be prepared under Single Entry System.(3)The arithmetical accuracy of the books cannot be checked in the absence of trial balance.(4)In the absence of various checks, Fraud is more easily committed and it is very difficult to detect.(5)In the absence of Real and nominal accounts the true financial position of the business cannot be ascertained.4.8. Difference between Double Entry System and Single Entry SystemBasisDouble Entry SystemSingle Entry SystemSystemUnder this system, both aspect of each transaction are record.Under this system, both aspect of each transaction are not recorded.Types of accountsIn this system, Personal, Real and Nominal accounts are kept fully.In this system, only Personal Accounts are kept and Real and Nominal Accounts are ignored.Arithmetical accuracyUnder this system, arithmetical accuracy can be checked by preparing Trial Balance at any moment of time.Under this system, arithmetical accuracy cannot be checked because to Trial Balance can be prepared.Final accountsIn this system, Trading, Profit and Loss Accounts and balance sheet can be prepared.In this system, Trading, Profit And Loss Accounts and Balance sheet cannot be prepared.Concepts and conventionsThis system is scientific and follows certain rules.This system is unscientific and does not follow any concrete rules.5. BASES OF ACCOUNTING: There are three bases of accounting in common usage which are:1. Cash basis2. Accrual or Mercantile basis3. Mixed or Hybrid basis.Accounting on ‘Cash basis’: Under cash basis of accounting, entries are recorded only when cash is received or paid. No entry is passed when a payment or receipt becomes due. Government system of accounting is mostly on cash basis. Accrual Basis of Accounting or Mercantile System: Under accrual basis of accounting, accounting entries are made on the basis of amounts having become due for payment or receipt. Incomes are credited to the period in which they are earned whether cash is received or not. Similarly, expenses and losses are detailed to the period in which, they are incurred, whether cash is paid or not. The profit or loss of any accounting period is the difference between incomes earned and expenses incurred, irrespective of cash payment or receipt. Mixed or Hybrid Basis of Accounting: When certain items of revenue or expenditure are recorded in the books of account on cash basis and certain items on mercantile basis, the basis of accounting so employed is called ‘hybrid basis of accounting’. For example, a company may follow mercantile system of accounting in respect of its export business and cash basis for subsidies and duty drawbacks on exports to be received from government.6. Accounting Equation:The accounting equation is the fundamental equation upon which all double entry accounting is based. Whatever business possesses in the form of assets is financed by proprietor or by outsiders. This equation expresses the equality of assets on one side and the claims of outsiders (liabilities) and owners or proprietors on the other side. Accounting equation signifies that the assets of a business are always equal to the total of liabilities and capital. This relationship is expressed as under:Assets = Liabilities + Capital“Accounting Equation remains intact under all circumstances”. This statement can be proved through following examples.Example.1. Suppose Mr. X starts his business and the following transactions take place: He started business with cash Rs. 5, 00,000 have been introduced by Mr. X in terms of cash, which is the capital for the business concern. Hence on one hand, the asset (cash) has been created to the extent of Rs. 5, 00,000.Assets= Capital+ LiabilitiesCash = 500000500000NilExample.2.He purchased furniture for cash worth Rs. 50,000.This transaction has its effect only on the assets, as one asset has been purchased against the other. In this transaction, furniture is purchased against cash given. Furniture and cash both are assets. Hence furniture is introduced by Rs. 50,000.Assets= Capital+ LiabilitiesCash= 500000-50000=450000Furniture = 50000500000NilExample.3. He purchased goods for cash Rs. 10,000This transaction has its effect only on the assets, as one asset has been purchased against the other. In this transaction, goods are purchased against cash given. Goods (Stock) and cash both are assets. Hence Stock is introduced by Rs. 10,000.Assets= Capital+ LiabilitiesCash= 450000 – 10000= 440000Furniture = 50000Stock = 10000500000NilExample.4. Rent paid Rs. 10,000This transaction has its effect on cash and capital since rent is expenses and all the expenses directly affects capital. Assets= Capital+ LiabilitiesCash= 440000 – 10000= 430000Furniture = 50000Stock = 10000500000 – 10000 = 490000NilExample.5. Goods purchased on credit Rs. 10000.This transaction has its effect on stock and creditors. Goods purchased are assets and since cash is not paid, the amount of goods purchased is shown as liability.Assets= Capital+ LiabilitiesCash= 440000 – 10000= 430000Furniture = 50000Stock = 10000 + 10000= 20000500000 – 10000 = 49000010000From the above examples, it is clear that Accounting Equation is true under all circumstances.


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