Accounting concepts

and conventions
ACCOUNTING CONCEPTS

▶ Business entity concept

▶ Money measurement concept
▶ Going concern concept
▶ Accounting period concept
▶ Accounting cost concept
▶ Dual aspect concept
▶ Matching concept
▶ Realisation concept
▶ Accrual concept
ACCOUNTING CONCEPTS

▶ Accounting concepts define the

assumptions on the basis of which
financial statements of a business
entity are prepared.
▶ Conceptsare those basic
assumptions and condition which
form the basis upon which the
accountancy has been laid.
Business entity concept
This concept assumes that, for accounting purposes, the
business enterprise and its owners are two separate
independent entities. Thus, the business and personal
transactions of its owner are separate. For example,
when the owner invests money in the business, it is
recorded as liability of the business to the owner.
Similarly, when the owner takes away from the business
cash/goods for his/her personal use, it is not treated as
business expense.
 Money measurement concept
▶ This concept assumes that all business transactions must be in
terms of money, that is in the currency of a country. In our
country such transactions are in terms of rupees. Thus, as per
the money measurement concept, transactions which can be
expressed in terms of money are recorded in the books of
accounts. For example, sale of goods worth Rs.200000, Rent
Paid Rs.10000 etc. are expressed in terms of money, and so
they are recorded in the books of accounts. But the
transactions which cannot be expressed in monetary terms are
not recorded in the books of accounts.
▶ For example, sincerity, loyality are not recorded in books of
accounts because these cannot be measured in terms of money
although they do affect the profits and losses of the business
concern.
Going concern concept

▶ This concept states that a business firm

will continue to carry on its activities for
an indefinite period of time. Simply
stated, it means that every business
entity has continuity of life. Thus, it will
not be dissolved in the near future. This
is an important assumption of
accounting, as it provides a basis for
showing the value of assets in the
balance sheet.
 Accounting period concept
▶ Allthe transactions are recorded in the books
of accounts on the assumption that profits on
these transactions are to be ascertained for a
specified period. This is known as accounting
period concept. Thus, this concept requires
that a balance sheet and profit and loss
account should be prepared at regular
intervals. This is necessary for different
purposes like, calculation of profit,
ascertaining financial position, tax
computation etc.
Accounting cost concept

▶ Itstates that all assets are recorded in

the books of accounts at their purchase
price, which includes cost of acquisition,
transportation and installation and not
at its market price. It means that fixed
assets like building, plant and
machinery, furniture, etc are recorded
in the books of accounts at a price paid
for them.
 Dual aspect concept
▶ Dual aspect is the foundation or basic principle of
accounting. It provides the very basis of recording
business transactions in the books of accounts.
This concept assumes that every transaction has a
dual effect, i.e. it affects two accounts in their
respective opposite sides. Therefore, the
transaction should be recorded at two places. It
means, both the aspects of the transaction must
be recorded in the books of accounts. Thus, the
duality concept is commonly expressed in terms
of fundamental accounting equation :
Assets = Liabilities + Capital
 Matching
concept
▶ The matching concept states that the revenue and the
expenses incurred to earn the revenues must belong
to the same accounting period. So once the revenue is
realised, the next step is to allocate it to the relevant
accounting period. This can be done with the help of
accrual concept If the revenue is more than the
expenses, it is called profit. If the expenses are
more than revenue it is called loss. This is what
exactly has been done by applying the matching
concept.
.. Therefore, the matching concept implies that all revenues earned during
an accounting year, whether received/not received during that year and
all cost incurred, whether paid/not paid during the year should be taken
into account while ascertaining profit or loss for that year.

▶ Significance

1. It guides how the expenses should be matched with revenue for

determining exact profit or loss for a particular period.
2. It is very helpful for the investors/shareholders to know the exact amount
of profit or loss of the business.
 Realisation concept
▶ This concept states that revenue from any business
transaction should be included in the accounting
records only when it is realised. The term realisation
means creation of legal right to receive money.
Selling goods is realisation, receiving order is not. In
other words, it can be said that : Revenue is said to
have been realised when cash has been received or
right to receive cash on the sale of goods or services
or both has been created.
▶ The concept of realisation states that revenue is
realized at the time when goods or services are
actually delivered.
▶ Let us study the following examples
▶ A Jeweller received an order to supply gold
ornaments worth Rs.500000. They supplied
ornaments worth Rs.200000 up to the year ending
31st December 2005 and rest of the ornaments were
supplied in January 2006. The revenue for the year
2005 for a Jeweller is Rs.200000. Mere getting an
order is not considered as revenue until the goods
have been delivered.

▶ Bansal sold goods for Rs.1,00,000 for cash in 2006

and the goods have been delivered during the same
year
The revenue for Bansal for year 2005 is Rs.1,00,000
 Accrual concept

▶ The meaning of accrual is something that becomes due

especially an amount of money that is yet to be paid or
received at the end of the accounting period. It means
that revenues are recognised when they become
receivable. Though cash is received or not received
and the expenses are recognised when they become
payable though cash is paid or not paid. Both
transactions will be recorded in the accounting period
to which they relate.
Contd…
.
▶ Therefore, the accrual concept makes a distinction
between the accrual receipt of cash and the right to
receive cash as regards revenue and actual payment of
cash and obligation to pay cash as regards expenses.
The accrual concept under accounting assumes that
revenue
is realised at the time of sale of goods or services
irrespective of the fact when the cash is
received.
ACCOUNTING CONVENTIONS

▶Consistency
▶Full
Disclosure
▶Materiality
▶Conservatism
ACCOUNTING CONVENTION

▶ An accounting convention refers to common

practices which are universally followed in
recording and presenting accounting
information of the business entity.
Conventions denote customs or traditions or
usages which are in use since long. To be
clear, these are nothing but unwritten laws.
The accountants have to adopt the usage or
customs, which are used as a guide in the
preparation of accounting reports and
statements. These conventions are also
known as doctrine.
 Convention of
consistency
▶ The convention of consistency means that same
accounting principles should be used for preparing
financial statements year after year. A meaningful
conclusion can be drawn from financial statements of
the same enterprise when there is comparison
between them over a period of time. But this can be
possible only when accounting policies and practices
followed by the enterprise are uniform and consistent
over a period of time. If different accounting
procedures and practices are used for preparing
financial statements of different years, then the result
will not be comparable.
 Convention of full disclosure
Convention of full disclosure requires that all
material and relevant facts concerning financial
statements should be fully disclosed. Full disclosure
means that there should be full, fair and adequate
disclosure of accounting information. Adequate
means sufficient set of information to be disclosed.
Fair indicates an equitable treatment of users. Full
refers to complete and detailed presentation of
information. Thus, the convention of full disclosure
suggests that every financial statement should fully
disclose all relevant information. Let us relate it to
the business.
Contd….
.
The business provides financial information to all
interested parties like investors, lenders, creditors,
shareholders etc.
The shareholder would like to know profitability of the
firm while the creditor would like to know the solvency of
the business. In the same way, other parties would be
interested in the financial information according to their
requirements. This is possible if financial statement
discloses all relevant information in full, fair and adequate
manner.
 Convention of materiality

▶ The convention of materiality states that, to make

financial statements meaningful, only material fact
i.e. important and relevant information should be
supplied to the users of accounting information. The
question that arises here is what is a material fact.
The materiality of a fact depends on its nature and
the amount involved. Material fact means the
information of which will influence the decision of its
user.
 Convention of
conservatism
▶ This convention is based on the principle that
“Anticipate no profit, but provide for all possible
losses”. It provides guidance for recording transactions
in the books of accounts. It is based on the policy of
playing safe in regard to showing profit .
▶ The main objective of this convention is to show
minimum profit. Profit should not be overstated. If
profit shows more than actual, it may lead to
distribution of dividend out of capital. This is not a fair
policy and it will lead to the reduction in the capital of
the enterprise.
 Contd…
…
Thus, this convention clearly states that profit should not be recorded until it
is realised. But if the business anticipates any loss in the near future
provision should be made in the books of accounts for the same.
. For example, valuing closing stock at cost or market price whichever is
lower, creating provision for doubtful debts, discount on debtors, writing
off intangible assets like goodwill, patent, etc. The convention of
conservatism is a very useful tool in situation of uncertainty and doubts.
 FINAL ACCOUNTS
Final Accounts is the last step in the accounting process.
Trial Balance is prepared at the end of all the accounting
year to know the balances of all the accounts & to test the
arithmetic accuracy of accounts. But the basic objective of
accounting is to know about the profit or loss during the
previous year & present financial position. This can be
known only if Trading account and Profit & Loss account
and Balance Sheet are prepared at the end pf year. These
are also known as FINANCIAL STATEMENTS which
are prepared
 From Trial Balance. Final Accounts include the
preparation of :
1) Trading and Profit & Loss account and
2) Balance Sheet
as these two statements are prepared to give the
final results of the business, both of these are
collectively called as final accounts. Accounting cycle
finally ends with these statements as shown in next
slide:
ACCOUNTING CYCLE
TRANSACTIONS

•Entry in the books of

•Original Entry
•(ORIGINAL RECORD)
•Posting in the concerned
•Ledger account
•(CLASSIFICATION)
•Balancing of Real &
•Personal accounts
•Preparation of
•Trial Balance
•(CHECKING THE
•ACCURACY)
•Preparation of final accounts
•(summary)
 Types of Financial
Statement
Final accounts or financial statements can be divided in
two parts:-

1) Trading and Profit & Loss Account

2) Balance Sheet
 Trading Account
Trading account is prepared by trading concerns i.e.,
concerns which purchase and sell finished goods, to know
the gross profit or gross loss incurred by them from
buying and selling of goods during a particular period of
time. Gross profit or gross loss is the difference between
the cost of goods sold and the proceeds of their sale. If the
sale proceeds exceed the cost of goods sold , gross profit is
made. Otherwise,gross loss is made.
Specimen Proforma of Trading Account
Dr Trading Account of …….. For the year ending……... Cr

Particulars Amt. Particulars Amt.

To Opening Stock By Sales

To Purchases Less: Returns
Less: Returns By Closing Stock
To Direct Expenses: By Gross Loss c/d*
Carriage Inward
Wages
Wages & salaries
Fuel & power
Coal, water & gas
Octroi
 Profit & Loss Account
For non-corporate business organisation Profit & Loss
account is second part of income statement. It is prepared
to know the net loss of business during a particular
period. Every businessman has to spend on expenses other
than on manufacture or purchase of goods which are
called indirect expenses. There can be other incomes
except sales. So gross profit or loss is adjusted keeping in
view these indirect expenses and other incomes to find out
net profit or net loss.
 Proforma of Profit & Loss
Account
Particulars Amt. Particulars Amt.

Particulars Particulars
To Gross Loss b/d By Gross Profit b/d
To Establishment Charges By other expenses
To Administrative Charges By Net Loss
To Selling & Distribution (transferred to capital
expenses account)
To Financial Charges
 Balance Sheet
Balance Sheet is a component of financial statements
which shows balances of capital, liabilities & assets. All
nominal accounts are closed by transferring these to
Trading & Profit & Loss Account. Only personal & real
accounts are left.
Balance Sheet is the final phase in accounting cycle. It is
a ‘mirror’ which reflects the true position of the assets &
liabities of the business on a particular date.
“A statement of financial position of economic unit
disclosing as at a given moment of time its assets, liabilities
& ownership equities. Eric [Link]
 Balance Sheet as on
……………………
Liabilities Amt. Assets Amt.
Capital Fixed Assets:

Add: Net Profit Goodwill

Less: Drawings Land and Buildings
Fixed Liabilities: Plant & Machinery
Long term loan Motor Vehicles
Public deposits Furniture
Current Liabilities: Patents & Trade Marks
Unexpired Income Live Stock
Short Term Loans Loose Tools
Trade Creditors Investments
Bank Overdraft
 INTRODUCTION
Working capital management is a business process that helps
companies to make effective use of their current assets and optimize
cash flow. Working capital is essential to the health of every
business and improving your working capital position can provide a
boost to the operational efficiency of a business, but managing it
effectively is something of a balancing act . Companies need to have
enough cash available to cover both planned and unexpected costs,
while also making the best use of the funds available to fuel growth.
This is achieved by the effective management of accounts payable,
accounts receivable, inventory, and cash.
It has been often observed that the shortage of working capital leads
to the failure of a business. The proper management of working
capital may bring about the success of a business firm.
The management of working capital includes the management of
current assets and current liabilities. A number of companies for
the past few years have been finding it difficult to solve the
increasing problems of adopting seriously the management of
working capital.
A firm may exist without making profits but cannot survive without
liquidity. The function of working capital management in an
organization is similar that of the heart in a human body. Also it is
an important function of financial management. The financial
manager must determine the satisfactory level of working capital
funds and also the optimum mix of current assets and current
liabilities. He must ensure that the appropriate sources of funds are
used to finance working capital and should also see that short
term obligation of the business are met well in time.
 Concept of Working Capital Management

There are two concepts of working capital viz. quantitative and

qualitative. Some people also define the two concepts as gross
concept and net concept.
According to quantitative concept, the amount of working capital
refers to ‘total of current assets’. Current assets are considered to
be gross working capital in this concept.
The qualitative concept gives an idea regarding source of financing
capital. According to qualitative concept the amount of working
capital refers to “excess of current assets over current liabilities.”
L.J. Guthmann defined working capital as “the portion of a firm’s
current assets which are financed from long–term funds.”
The excess of current assets over current liabilities is termed as ‘Net
working capital’. In this concept “Net working capital” represents
the amount of current assets which would remain if all current
liabilities were paid.
Both the concepts of working capital have their own
points of importance. “If the objectives is to measure the
size and extent to which current assets are being used,
‘Gross concept’ is useful; whereas in evaluating the
liquidity position of an undertaking ‘Net concept’ becomes
pertinent and preferable. It is necessary to understand the
meaning of current assets and current liabilities for
learning the meaning of working capital, which is
explained below.
 Current assets – It is rightly observed that “Current assets have a
short life span. These type of assets are engaged in current
operation of a business and normally used for short– term
operations of the firm during an accounting period i.e. within twelve
months.
The two important characteristics of such assets are,
(i) short life span, and
(ii) swift transformation into other form of assets. Cash balance may
be held idle for a week or two; account receivable may have a life
span of 30 to 60 days, and inventories may be held for 30 to 100
days.
Current liabilities – The firm creates a Current Liability towards
creditors (sellers) from whom it has purchased raw materials on
credit. This liability is also known as accounts payable and shown in
the balance sheet till the payment has been made to the creditors.
The claims or obligations which are normally expected to mature
for payment within an accounting cycle (1 year) are known as
current liabilities. These can be defined as “those liabilities where
liquidation is reasonably expected to require the use of existing
resources properly classifiable as current assets, or the creation of
other current assets, or the creation of other current liabilities.”
 Crowdfunding
Crowdfunding is a method of raising capital through the
collective efforts of a large number of individual investors.
Crowdfunding is done primarily online via social media and
websites.
So Crowdfunding is the practice of funding a project or
venture by raising small amounts of money from many
people, basically via the Internet or such dedicated websites.
 Types of Crowdfunding

Basically there are three types of crowdfunding. Namely;

1. Equity-Based Crowdfunding
2. Reward-Based Crowdfunding
3. Donation-based crowdfunding
1. Equity-Based Crowdfunding:-
Equity crowdfunding allows contributors to become
part-owners of the company by trading capital for equity
shares. The equity owners receive a financial return (share of
the profits in the form of a dividend or distribution.) in the
proportion of their contribution. This is the most popular form
of crowdfunding.
2. Reward-Based crowdfunding:-
Reward-based crowdfunding, involves individuals
contributing to a business in exchange for a reward typically a
form of the product or service which the company offers.
In this type of funding distance between the creator and
investor does not matter. Many characteristics of
rewards-based crowdfunding known as non-equity
crowdfunding.
This type of funding is used in many cases like; funding for
free software development, motion picture promotion,
scientific research, civic projects, and new inventions etc.
3. Donation-based crowdfunding:-
It is a way to source money for a project by asking a large
number of contributors to individually donate a small amount
without any expectation of return.
This type of funding is done mainly for social causes and
nothing is expected in return for such funding. Common
initiatives for such funding include; natural calamities,
disaster relief, charities, and medical bills.
 Benefits of crowdfunding:-
1. It provides funding to many new ideas.
2. It provides incentives to many new startups in the country.
3. Crowdfunding is helpful in promoting social cause at the
time of natural calamities.
4. It is also helpful in arranging money for those poor people
who can’t afford the expenses of severe diseases like cancer
and kidney transplant etc.
5. One of the best things about online crowdfunding is its
ability to centralize and streamline fundraising efforts.