Accounting Principles / Theory Base of Accounting
Class 11 Accountancy Notes - Chapter 3
NCERT Note: In the NCERT Class 11 Accountancy curriculum, this topic is covered under Chapter 2:
"Theory Base of Accounting." While DK Goel divides these into strict "Concepts" and "Conventions,"
NCERT groups them all broadly under the single umbrella of "Basic Accounting Concepts." Both
books cover the exact same core principles.
Meaning and Nature of Accounting Principles
• Accounting statements are needed by various parties with a vested interest, such as
proprietors, investors, creditors, and the government.
• These statements must be prepared according to a standard language and set of rules known
as Generally Accepted Accounting Principles (GAAP).
• These principles developed over time through usage, reason, common experiences, historical
precedents, and professional bodies.
• Uniform set of Rules: They ensure uniformity and easy understanding of accounting
information.
• Man-Made: They are derived from experience and reason, lacking the universal applicability
of natural sciences like physics or chemistry.
• Flexible: They are not rigid and change with time, business practices, and government
policies.
• Generally Accepted: Acceptance depends on three criteria: Relevance (useful to the user),
Objectivity (free from personal bias and verifiable), and Feasibility (can be applied without
undue cost).
• Need: They bring consistency to the accounting process, making information reliable and
comparable across different firms and previous years.
Fundamental Accounting Concepts / Assumptions (As per AS-1)
1. Going Concern Concept
• It is assumed that the business will continue to exist for a long period in the future.
• Fixed assets are recorded at their original cost, and depreciation is charged without reference
to their market value.
• This concept justifies why outside parties enter into long-term contracts and why prepaid
expenses are shown as assets.
2. Consistency Concept
• Accounting principles and methods should remain consistent from one year to another to
enable the comparison of financial statements.
• Methods can only be changed for better disclosure of profits and financial position, but the
change and its justification must be stated clearly in footnotes.
3. Accrual Concept / Matching Concept
• Revenue is recorded when sales are made or services are rendered, regardless of when cash is
actually received.
• Expenses are recorded in the period they assist in earning revenues, regardless of when cash
is actually paid.
• These fundamental assumptions are taken for granted in financial statements; any deviation
must be specifically disclosed.
Other Accounting Concepts
4. Business Entity Concept / Economic Entity Concept
• The business is treated as a unit separate and distinct from its owners, creditors, and
managers.
• The proprietor is treated as a creditor to the extent of capital invested, which is why capital is
categorized as a liability.
• Interest on capital is treated as a business expense, and personal assets or expenses of the
proprietor are kept completely separate from business accounts.
5. Money Measurement Concept
• Only transactions and events capable of being expressed in terms of money are recorded in
accounting.
• Non-monetary events, like the quality of management or a labour strike, are not recorded
regardless of their actual importance to the firm.
• A major limitation is that the value of money changes over time due to inflation, which is not
reflected in the books.
6. Accounting Period Concept
• The entire life of the firm is divided into time intervals, usually a twelve-month period, to
measure business profits.
• This provides timely results for managers and investors to take corrective steps, rather than
waiting until the business is completely wound up.
7. Cost Concept / Historical Cost Concept
• An asset is ordinarily recorded in the books at its initial acquisition price.
• Subsequent increases or decreases in market value are generally not recorded, though the
asset's cost is systematically reduced by charging depreciation year to year.
• This cost is objectively verifiable but suffers during periods of inflation when it can seriously
distort actual profit figures.
8. Dual Aspect Concept / Duality
• Every business transaction affects at least two accounts, forming the strict basis of the Double
Entry System.
• This ensures the two sides of the Balance Sheet are always equal, maintaining the equation:
Assets = Liabilities + Capital.
9. Revenue Recognition Concept / Realisation Concept
• Revenue is deemed to be realised when the title or ownership of goods is legally transferred to
the purchaser.
• It is not tied to the actual receipt of cash.
• Exceptions to this rule include sales on an instalment basis, long-term construction projects,
and mining operations.
10. Matching Concept
• To determine accurate net profit, all costs applicable to the revenue of a specific period should
be matched strictly against that revenue.
• Outstanding expenses are included, prepaid expenses relating to future years are treated as
assets, and closing stock is carried forward to the next year.
11. Objectivity Concept
• Transactions must be recorded in an objective manner, completely free from the personal bias
of the management or accountant.
• This requires documentary evidence such as cash memos, invoices, and sales bills to actively
verify transactions.
Accounting Conventions
1. Convention of Full Disclosure
• All significant information relating to the economic affairs of the enterprise must be
completely disclosed to interested users.
• Essential facts that do not fit in the standard statements, such as contingent liabilities, changes
in valuation methods, or the market value of investments, must be shown in the Balance Sheet
via footnotes.
2. Convention of Materiality
• This acts as an exception to full disclosure, stating that items with an insignificant economic
effect or relevance need not be separately disclosed.
• Unimportant items can be merged or left out entirely to avoid overburdening the statements.
• Materiality depends heavily on the specific nature and size of the business.
3. Convention of Conservatism / Prudence Concept
• All anticipated losses should be recorded, but all anticipated or unrealized gains should be
completely ignored.
• Examples include valuing closing stock at cost or realisable value (whichever is less) and
creating provisions for doubtful debts.
• This strict "playing safe" policy can lead to the creation of secret reserves by understating
assets and overstating liabilities.
Distinction Between Concepts and Conventions
Basis of Distinction Accounting Concepts Accounting Conventions
Guidelines based solely upon
Legal Position Have strict legal acceptance. custom, usage, or general
agreement.
Recording Vs Basic assumptions used for Customarily followed in preparing
Financial recording transactions and the profit and loss account and
Statements maintaining accounts. balance sheet.
Uniform set of rules usually Not as critically important as
Significance
followed rigidly in recording. accounting concepts.
Role of Personal There is no role for personal Personal judgment may play a
Judgment judgment or individual bias. crucial and active role.
There is no strict uniformity in
There is uniform adoption across
Uniform Adoption adoption across various
different business enterprises.
enterprises.