Fundamental Accounting Principles and Rules
Accounting Concepts and Conventions – 20
Accounting is called the language of business. To ensure that financial statements are prepared in a meaningful and uniform manner, accountants follow certain basic rules, assumptions, and principles. These are known as Accounting Concepts and Conventions. They provide a framework within which accounts are prepared so that they become reliable, comparable, and understandable for users.
Part I: Accounting Concepts
Accounting concepts are basic assumptions on which the entire accounting system is based. The most important accounting concepts are:
- Business Entity Concept – The business is treated as separate from the owner. Personal expenses are not recorded. Example: If the owner withdraws ₹5,000 for personal use, it is recorded as Drawings.
- Money Measurement Concept – Only transactions measurable in monetary terms are recorded. Qualitative factors like employees’ skills or brand reputation are ignored. This ensures uniformity in reporting.
- Going Concern Concept – The business is assumed to continue indefinitely. Assets are recorded at cost price, not liquidation value, and depreciation is provided.
- Cost Concept – Assets are recorded at the original purchase price (historical cost). Market value changes are ignored. Example: A machine bought for ₹80,000 is recorded at ₹80,000.
- Dual Aspect Concept – Every transaction has two effects: debit and credit. This is the basis of the double-entry system. The equation is: Assets = Liabilities + Capital.
- Matching Concept – Expenses are recorded in the same period as the revenue they help generate. Example: Depreciation is matched with the revenue it helps generate.
- Accrual Concept – Revenues and expenses are recorded when earned or incurred, not when cash is received or paid. Example: Salary due in March but paid in April is recorded in March.
- Realisation (Revenue Recognition) Concept – Revenue is recognized only when earned, not when payment is received. Example: Goods sold on credit are treated as sales.
- Conservatism (Prudence) Concept – Do not anticipate profits; provide for possible losses. Stock is valued at the lower of cost or market price. This prevents the overstatement of income or assets.
Part II: Accounting Conventions
Accounting conventions are customs followed by accountants for consistent reporting.
- Convention of Consistency – The same accounting methods must be used year after year. Any changes should be disclosed.
- Convention of Full Disclosure – All important information affecting decisions must be disclosed, often using notes, footnotes, or annexures. Example: Disclosure of contingent liabilities or accounting policies.
- Convention of Materiality – Only significant items are shown separately; minor items are grouped together. Example: Small tools are written off immediately.
- Convention of Conservatism – This emphasizes caution: anticipate losses, but not profits. Assets are valued at the lower of cost or market price.
Importance of Concepts & Conventions
These principles ensure uniformity, reliability, and comparability of financial statements. They also assist auditors, build credibility, and provide the theoretical base for accounting standards.
Conclusion
Accounting concepts and conventions form the foundation of accounting and ensure that financial statements present a true and fair view of the business.