Unlike in the past when accounting statements were largely needed by the proprietor, these days the

accounting statements are needed by various parties who have vested interest in the business, namely,
proprietors, investors, creditors, government and many others. Accounting statements disclose the
profitability and solvency of the business to various parties. It is, therefore, necessary that such
statements should be prepared according to some standard language and. set rules. These rules are
usually called 'Generally accepted accounting principles' (GAAP). These principles have been generally
accepted by accountants all over the world as general guidelines for preparing the accounting
statements. These principles have developed over a course of period from usage, reason, common
experiences, historical precedents, statements of individuals, professional bodies and regulation of
Government agencies.

Features of Accounting Principles

1) Accounting Principles are Uniform set of Rules

Accounting principles are a uniform set of rules or guidelines developed to ensure uniformity and easy
understanding of the accounting information.

2) Accounting Principles are Man-made

Accounting principles are not right but flexible. They are bound to change with time in response to the
changes in business practices.

3) Accounting Principles are Generally Accepted

Accounting principles are bases and guidelines for accounting and are generally accepted. The general
acceptance of an accounting principle depends upon how well it satisfies the following three criteria:

 Relevance: A principle is relevant if it results in information that is useful to the user of the
accounting information.
 Objectivity: A principle is objective if it is free from personal bias or judgments of those who
furnish the information.
 Feasibility: A principle is feasible if it can be applied without undue complexity or cost.

Kinds of Accounting Principles

Accounting Principles are described by various terms such as assumptions, conventions, concepts,
doctrines, postulates, etc. These principles can be classified mainly into two categories:

1. Accounting Concepts or Assumptions

2. Accounting Conventions
1) Accounting Concepts or Conventions

As per Accounting Standard (AS-1), issued by the Institute of Chartered Accountants of India, there are
three fundamental accounting concepts or assumptions:

In order to make the accounting language convey the same meaning to all people and to make it more
meaning full most of the accountants have agreed on number of concepts which are usually followed for
preparing financial statements.

a) Going Concern Concept

As per this concept, it is assumed that the business will continue to exist for a long period in the future.
The transactions are recorded in the books of the business on the assumption that it is a continuing
[Link] is on this concept that we record fixed assets at their original cost and depreciation is
charged on these assets without reference to their market [Link] of the concept of going concern,
the full cost of the machine would not be treated as an expense in the year of its purchase [Link] is also
because of the going concern concept that outside parties enter into long-term contracts with the
[Link] this concept, the classification of current and fixed assets and short and long-term
liabilities cannot be made and such classification would be difficult to justify.

Importance: This assumption justifies allocating the cost of long-lived assets over their useful lives
rather than charging the entire cost to the year of purchase.
Example - Depreciation: A computer purchased for ₹50,000 with an estimated life of 5 years will be
charged to profit and loss over 5 years (e.g., ₹10,000 per year) rather than expensing the entire cost in
the year of purchase.

b) Consistency Concept

This concept states that accounting principles and methods should remain consistent from one year to
another. These should not be changed from year to year, to enable the management to compare the Profit
& Loss Account and Balance Sheet of the different periods and draw important conclusions about the
working of the enterprise.
If a firm adopts different accounting principles in two accounting periods, the profits of the current
period will not be comparable with the profits of the preceding period.

However, the consistency concept should not be taken to mean that it does not allow a firm to change
the accounting methods according to the changed circumstances of the business.

Otherwise, the accounting will become non-flexible and the improved techniques of accounting will not
be used.

c) Accrual Concept

In accounting, an accrual basis is used for recording transactions. It provides more appropriate
information about the performance of business enterprises as compared to a cash basis.
The accrual concept applies equally to revenues and expenses.

In the accrual concept, revenue is recorded when sales are made or services are rendered and it is
immaterial whether cash is received or not.

Similarly, according to this concept, expenses are recorded in the accounting period in which they exist
in earning the revenues whether the cash is paid for them or not. The accrual concept is often described
as a matching concept

I. Business Entity Principle

According to this concept, a business is treated as a unit separate and distinct from its owners, creditors,
managers, and others. In other words, the owner of a business is always considered distinct and separate
from the business he/she owns.

The business unit should have a completely separate set of books and we have to record business
transactions from the firm’s point of view and not from the point of view of the proprietor.

The proprietor is treated as a creditor of the business to the extent of capital invested by him in the
business.

The amount withdrawn by the proprietor from the business for his/her personal use is treated as his/her
drawings.

II. Money Measurement Principle

 Only those transactions and events are recorded in accounting which are capable of being expressed in
terms of money. An event, even though it may be very important for the business, will not be recorded
in the books of the business unless its effect can be measured in terms of money with a fair degree of
accuracy.

The following are not recorded in the books due to Money Measurement Concept:

 Calibre or Quality of the management

 Image of the enterprise among people
 Loss of profit due to labor strike
 Capabilities of human resources
However, the money measurement concept suffers from the following limitations:

1. Transactions and events that are not capable of being measured in terms of money are not
recorded even though they may be very important for the enterprise. For example, the human
resources of the enterprise are very important to the enterprise.
2. Due to the changes in price level, the value of money does not remain the same over some time.
On account of rises in prices, the value of the rupee today is much less than what it was.

III. Accounting Period Principle

As the business is intended to continue indefinitely for a long period, the true results of the business
operations can be ascertained only when the business is completely up.

Thus, the entire life of the firm is divided into time intervals for the measurement of the profits of the
business. The period of 12 months is usually adopted for this purpose.

IV. Historical Cost Principle or Principle

According to this concept, an asset is ordinarily recorded in the books of accounts at the price at which it
was acquired. This cost becomes the basis of all subsequent accounting for the asset. Since the
acquisition cost relates to the past, it is referred to as historical cost.

The justification for the historical cost concept lies in the following arguments:

 This cost is objectively verifiable.

  It is justified by the going concern concept which assumes that the enterprise will continue its
activities indefinitely and thus there is no need to use the current values.
 Market values or current values of assets are difficult to determine.
Drawbacks of the historical concept are:

 Assets for which nothing is paid will not be recorded

 During periods of inflation, the figure of net profit disclosed by the profit and loss account will be
seriously distorted because depreciation based on historical costs will be charged against
revenues at current prices.
 Information based on historical cost may not be useful to management, investors, creditors, etc.

 Example: If a plant is bought for ₹50,00,000 and transport, repairs and installation cost

 ₹50,000, ₹15,000 and ₹25,000 respectively, the asset is recorded at ₹50,90,000 (sum of
purchase price and directly attributable costs).
 The cost concept provides objectivity, since cost is supported by documentary evidence, but
it may not reflect current market values in times of inflation or appreciating assets.


V. Dual Aspect Principle

According to this concept, every business transaction is recorded as having a dual aspect. In other
words, every transaction affects at least two accounts.

If one account is debited, any other account must be credited. The system of recording transactions
based on this principle is called a ‘Double Entry System’.

The concept is expressed by the Accounting Equation:Assets = Liabilities + Capital. Examples: If

Ram invests ₹50,00,000 in the business, cash (asset) increases and owner's capital (equity) increases by
the same amount. If goods worth ₹10,00,000 are purchased for cash, stock (asset) increases while cash
(asset) decreases.
The dual aspect is the basis of the double entry system of accounting which ensures both sides of the
equation remain equal.
VI. Revenue Recognition (Realization) Principle

Revenue means the amount which is added to the capital as a result of business operations. Revenue is
earned by the sale of goods or by providing a service.

Concept or revenue recognition determines the time or the particular period in which the revenue is
realized. Revenue is deemed to be realized when the title or the ownership of the goods has been
transferred to the purchase.

It should be remembered that revenue recognition is not related to the receipt of [Link] in case
of income such as rent, interest, commission, etc. are recognized on a time basis. For example, rent for
March 2024, even if received on April 2024 will be treated as revenue for the financial year ending 31
March 2024.

As per the Revenue Recognition Concept:

 Advance received against sales is not recorded as sales.

 Credit sales are treated as revenue on the day sales are made and not when the amount is received
from the buyer.
 Exceptions and special treatments: For long-term contracts (e.g., construction) that span
several accounting periods, revenue is recognised in proportion to the stage of
completion (percentage of completion method) so that revenue and related costs are
recognised in the same periods.
In hire-purchase transactions where payment is received in instalments, amounts actually
received may be treated as realised in the books while the uncollected instalments are recognised
as receivables.
VII. Matching Principle

This concept is very important for the correct determination of net profit. According to this concept, in
determining the net profit from business operations, all costs that apply to the period’s revenue should
be charged against that revenue.

Based on this principle, outstanding expenses, though not paid in cash are shown in the profit and loss
account.

When some expense, say insurance premium is paid partly for the next year also, the part relating to next
year will be shown as an expense only next year and not this year.

Example: To compute profit for a year, the cost of goods sold should reflect only the cost of
goods actually sold in that year, not the cost of all goods produced or purchased.
This principle ensures profit or loss for a period reflects the correct pairing of incomes and
expenses.

VIII. Objectivity Principle

This concept requires that accounting transactions should be recorded objectively, free from the personal
bias of either management or the accountant who prepares the accounts.

It is possible only when each transaction is supported by verifiable documents and vouchers such as cash
memos, invoices, sales bills, pay-in-slip, correspondence, agreements, etc.

Objectivity is one of the reasons for adopting the ‘Historical Cost’ as the basis of recording accounting
transactions because the cost paid for an asset (i.e. historical cost) can be verified from the documents.

Difference between Accounting Concepts and

Accounting Conventions

Basis Accounting Concepts Accounting Conventions

Legal Position Accounting concepts have legal Accounting conventions are

acceptance. guidelines based on custom, usage, or
 general agreement.

Recording Vs. Accounting concepts are the basic Accounting conventions are followed
Financial assumptions based on which transactions in preparing the profit and loss
Statements are recorded and accounts are maintained. account and balance sheet.

These are the uniform set of rules usually These are not as important as
Significance
followed in recording transactions. accounting concepts.

There is no role of personal judgment or Personal Judgement may play a

Role of Personal individual bias in following the accounting crucial role in the adoption of
concepts. accounting conventions.

There is no uniformity in the

There is a uniform adoption of accounting
Uniform Adoption adoption of accounting conventions
concepts in different enterprises.
in various enterprises.

Concepts Vs. Conventions

Accounting Conventions
The following are the main accounting conventions:

1. Full Disclosure
2. Materiality
3. Prudence/Conservatism
1) Full Disclosure Convention

This convention requires that all significant information relating to the economic affairs of the enterprise
should be completely disclosed.

This convention is so important that the Companies Act makes ample provisions for the disclosure of
essential information in the financial statements of a company like contingent liabilities, important
information related to stocks in the footnote, etc.

Financial statements are the primary communication between those who manage the enterprise and
the owners or other external users; full disclosure promotes transparency and a true and fair view.
Statutory provisions (for example formats prescribed under company law) and regulatory bodies
(for example SEBI) mandate disclosures to ensure adequate information is provided.
2) Materiality Convention

This convention is an exception to the convention of full disclosure. According to this convention, items
having an insignificant effect or being irrelevant to the user need not be disclosed.

3) Prudence/Conservatism Convention

According to this convention, all anticipated losses should be recorded in the books of accounts, but all
anticipated or unrealized gains should be ignored.

Following are the examples of the application of this convention:

 Closing stock is valued at cost price or realizable value whichever is less.

 Provision for doubtful debts is created in anticipation of actual bad debts.
 A joint life insurance policy is shown only at surrender value or against the amount paid.
 Provision for a pending lawsuit against the firm, which may be decided in its favor.
 This avoids overstating profits and protects the interests of creditors and other stakeholders.
Common applications: valuing closing stock at the lower of cost or net realisable value,
creating provisions for doubtful debts, and making provisions for contingent liabilities.
 Example: If the market value of the stock falls below cost, the stock should be shown at the
lower value; a rise in market value is not recognised until the stock is sold.
 Deliberately understating asset values to build secret reserves (hidden profits) is dishonest and
unacceptable.
