Unit-3 Accounting Concepts & Conventions

3.1 Accounting Concepts

Accounting principles are built on some basic concepts. These concepts are so basic that most
financial statement authors do not consciously consider them. As mentioned earlier, they are
considered trivial. Some accounting researchers and theorists argue that some of the current
accounting concepts are wrong and need to be changed.
Nevertheless, in order to understand the accounting that currently exists, it is necessary to
understand the basic concepts currently in use. The basic accounting concepts described here
may not be the same as those listed by other authors or groups. However, these are widely
accepted and practical concepts used by financial statement authors and auditors to review
financial statements.
The Basic Accounting Concept is as follows:
1. Entity concept:
The concept of an entity assumes that its financial statements and other accounting information
belong to a particular company that is different from its owner. Therefore, an analysis of
business transactions, including costs and revenues, is expressed in terms of changes in the
company's financial position.
Similarly, the assets and liabilities devoted to business activities are the assets and liabilities of
the entity. The company's transaction is reported, not the company's owner's transaction.
Therefore, this concept allows accountants to distinguish between personal and commercial
transactions. This concept applies to sole proprietorships, partnerships, businesses, and small
businesses. It may also apply to multiple companies, such as when a segment of a company, such
as a department, or an interrelated company is merged.
2. Going Concern Concept:
An entity is considered to be in business unless there is evidence of opposition. Because
companies are relatively permanent, financial accounting is designed with the assumption that
the business will survive indefinitely in the future.
The Going Concern concept justifies the valuation of assets on a non-clearing basis and requires
the use of acquisition costs for many valuations. In addition, fixed and intangible assets are
amortized over their useful lives, rather than in shorter periods, in the hope of early liquidation.
This further means that the data transmitted is tentative and that the current statement should
disclose adjustments to the statement over the past year revealed by more recent developments.
3. Money measurement concept:
A unit of exchange and measurement is required to uniformly account for a company's
transactions. The common denominator chosen in accounting is the currency unit. Money is the
lowest common denominator for measuring the exchangeability of goods and services such as
labor, natural resources and capital.
The concept of monetary measurement considers accounting to be a process of measuring and
communicating financially measurable company activity. Obviously, the financial statements
should show the money spent.
The concept of measuring money means two limitations of accounting. First, accounting is
limited to the generation of information expressed in monetary units. It does not record and
convey other relevant but non-monetary information. Second, the concept of monetary
measurement concerns the limitation of the monetary unit itself as a unit of measurement.
There are concerns about purchasing power, which is the main characteristic of currency units, or
the amount of goods and services that money can obtain. Traditionally, financial accounting has
addressed this issue by stating that the concept assumes that the purchasing power of a currency
unit is stable over the long term or that price changes are not significant. Although still accepted
in current financial reporting, the concept of stable monetary units is subject to continuous and
permanent criticism.
4. Accounting period concept:
Financial accounting provides information about a company's economic activity over a specific
period of time that is shorter than the company's lifespan. The periods are usually the same
length for ease of comparison.
The period is specified in the financial statements. The period is usually 12 months. Quarterly or
semi-annual statements may also be issued. These are considered provisional and differ from the
annual report. Statements that cover shorter periods of time, such as months or weeks, may also
be created for administrative use.
5. Cost concept:
The concept of cost is that the asset should be recorded at the exchange price, that is, the
acquisition cost or the acquisition cost. Acquisition costs are recognized as an appropriate
valuation criterion for recognizing the acquisition of all goods and services, costs, expenses and
capital.
For accounting purposes, business transactions are usually measured in terms of the particular
price or cost at which the transaction occurred. That is, financial accounting measurements are
based on exchange prices, where economic resources and obligations are exchanged. Therefore,
the quantity of an asset listed during a company's account doesn't indicate what the asset could
also be sold for.
The concept of acquisition cost means there's little point in revaluing an asset to reflect its
current value, because the company has no plans to sell its asset. Additionally, for practical
reasons, accountants like better to report actual costs over market values that are difficult to
verify.
6. Dual aspect concept:
This concept is at the guts of the whole accounting process. Accountants record events that affect
the wealth of a specific entity. The question is which aspect of this wealth is vital. Accounting
entities are artificial creations, so it's essential to understand who their resources belong to or
what purpose they serve.
It's also important to understand what sorts of resources you manage, like cash, buildings, and
land. Therefore, the accounting record system was developed to point out two main things: (a)
the source of wealth and (b) the shape it takes. Suppose Mr. X decides to line up a business and
transfers Rs. 100,000 from his personal checking account to a different business account.
He may record this event as follows:
Obviously, the source of wealth must be numerically adequate to the shape of wealth. S (source)
must be adequate to F (form) because they're simply different aspects of an equivalent thing, that
is, within the sort of equations.
In addition, transactions or events that affect a company's wealth have to record two aspects so as
to take care of equality on each side of the accounting equation.
If a corporation acquires an asset, it must be one among the following:
a. Other assets are abandoned.
b. There was an obligation to pay it.
c. Profitable and increased amount of cash the operator has got to pay to the owner.
d. The owner funded the acquisition of the asset.
This doesn't mean that the transaction affects both the source and sort of wealth.
There are four categories of events that affect Accounting Equation:
a. Both the source and sort of wealth are increased by an equivalent amount.
b. Both the source and sort of wealth are reduced by an equivalent amount.
c. Some increase without changing the source of wealth, others decrease.
d. Some sources of wealth increase and a few decrease without changing the shape of
wealth retention.
The above example shows category (a) because once you start a transaction for an entity, the
source of wealth and therefore the sort of wealth, cash, increases from zero to rupees. 1,00,000.
In contrast, X may plan to withdraw Rs. 20,000 cash from business.
In that case, the financial position of the entity would be:
It is essential to know why each side of the equation is reduced. By withdrawing cash, X
automatically reduces the availability of personal funds to the business by an equivalent amount.
Now suppose Mr. X buys a listing of products for Rs. 30,000 in cash available. His capital
supply remains an equivalent, but the composition of his business assets does.
The two aspects of this transaction aren't within the same direction, but are compensatory and are
increasing stocks that set a cash reduction. Similarly, sources of wealth are often suffering from
transactions. So, if X gives his son Y, it becomes Rs. 20,000 shares of the business by
transferring some of his own profits, the consequences are:
However, if X gives YR. He personally receives $ 20,000 in cash, and when Y puts it into the
business, each side of the equation is affected. Y capital Rs. 20,000 is balanced by additional Rs.
20,000 in cash, X capital remains rupees. 80,000.
7. The concept of accrual accounting:
According to the Financial Accounting Standards Board (USA):
"Accrual accounting is the financial impact of transactions and other events and situations that
affect a corporation on cash, not only during the amount during which it had been received, but
also during the amount during which those transactions, events and situations occur. Accrual
accounting is paid to the corporation as more (or perhaps less) cash spent on resources and
activities, also because of the start and end of the method. it's associated with the method of
being returned. We recognize that purchases, production, sales, other operations, and other
events that affect a company's performance during a period often do not match the receipt or
payment of cash for that period. "
Realization and matching concepts are central to accrual accounting. Accrual accounting
measures revenue for a period of time as the difference between the revenues recognized during
that period and the costs that match those incomes. In accrual accounting, the period revenue is
usually not the same as the period cash receipt from the customer, and the period cost is usually
not the same as the period cash payment.
8. Cash Basis Accounting:
In cash-basis accounting, sales are not recorded until the period in which they are received in
cash. Similarly, costs are deducted from sales during the period in which the cash payment was
made. Therefore, neither realization nor matching concepts apply to cash basis accounting.
In reality, "pure" cash-basis accounting is rare. This is because the pure cash basis approach
requires the acquisition of inventory to be treated as a reduction in profit when paying the
acquisition cost, not when selling the inventory. Similarly, the cost of acquiring plant and
equipment items is treated as a reduction in profit if these long-lived items are paid in cash rather
than after they have been used. Obviously, such a pure cash basis approach would result in a
balance sheet and income statement with limited usefulness. Therefore, what is commonly
referred to as cash-basis accounting is actually a mixture of cash-basis for some items (especially
cost of goods sold and period costs) and accrual-based for others (especially product costs and
long-term assets). This mix is sometimes referred to as modified cash-basis accounting to
distinguish it from the pure cash-basis method.
Cash-basis accounting is most often seen in small businesses that do not have large inventories
because they provide services. Examples include restaurants, hairdressers, hairdressers, and
income tax filing companies
Most of these establishments do not provide credit to their customers, so cash-basis profits may
not differ dramatically from accrual income. Nevertheless, cash basis accounting is not permitted
by GAAP for any type of entity.
9. Conservatism concept:
 This trait can be considered a reactive version of the Minimax management philosophy. That is,
it minimizes the potential for maximum loss.
The concept of accounting conservatism suggests that accounting should be cautious and
cautious until the opposite evidence emerges, where and when uncertainty and risk exposure are
legitimate. Accounting conservatism does not mean intentionally underestimating income and
assets. It applies only to situations where there is reasonable doubt. For example, inventories are
valued at the lower end of cost or market value.
In its application to the income statement, conservatism encourages recognition of all losses
incurred or may occur, but does not recognize profits until they are actually realized. Early
depreciation of intangible assets and restrictions on recording asset valuations have also been
motivated, at least to some extent, by conservatism. Not recognizing revenue until the sale is
made is another sign of conservatism.
10. Matching concept:
The concept of matching in financial accounting is the process of matching (associating)
performance or revenue (measured at the selling price of goods and services offered) with labour
or expense (measured at the cost of goods and services used) over a specific period of time. is.
Targets for which income has been determined.
This concept emphasizes which item of expense in a particular accounting period is expense.
That is, expenses are reported as expenses for the accounting period in which revenue related to
those expenses is reported. For example, if the sales of some products are reported as revenue for
one year, the costs for those products are reported as expenses for the same year.
The concept of matching only needs to be met after the accountant has completed the concept of
realization. First measure the revenue according to the concept of realization, then associate the
costs with these revenues. Cost matches revenue, but not the other way around.
Therefore, the reconciliation process requires significant cost allocation in acquisition cost
accounting. Past (history) costs are investigated and steps are taken to assign a cost element that
is considered to have expired service potential or to match it with the associated revenue.
The remaining component of the cost, which is considered to have continued potential for future
services, is carried over to the past balance sheet and is called an asset. Therefore, the balance
sheet is just a report of unallocated past costs waiting for the estimated future service potential to
expire before it matches the appropriate revenue.
11. Realization or Cognitive concept:
The concept of realization or recognition indicates the amount of revenue that should be
recognized from a particular sale. Realization rules help accountants determine if revenues or
expenses have been incurred. This allows accountants to measure, record, and report on financial
reports.
Realization refers to the inflow of cash or cash charges (accounts receivable, accounts
receivable, etc.) resulting from the sale of goods or services. Therefore, if the customer purchases
Rs. If you pay 500 worth of goods in cash at a grocery store, the store will realize Rs. 500 from
the sale.
If the clothing store sells Rs suits. 3,000, if the buyer agrees to pay within 30 days, the store will
realize Rs. From sale to 3,000 (accounts receivable) (conservative concept), provided the buyer
has a good credit record and the payment is reasonably secure.
The concept of realization states that the amount perceived as revenue is reasonably certain to be
realized, that is, reasonably certain to be paid by the customer. Of course, there is room for
difference in judgment as to whether or not it is "reasonably certain."
However, this concept explicitly acknowledges that the perceived revenue amount is lower than
the selling price of the goods and services sold. The obvious situation is the discounted sale of
goods at a price lower than the normal selling price. In such cases, the revenue will be recorded
at a lower price rather than the normal price.
12. Consistency concept:
In this concept, once an organization has decided on one method, it should be used for all
subsequent transactions and events of the same nature unless there is a good reason to change it.
Frequent changes in accounting methods make it difficult to compare financial statements for
one period with financial statements for another period
Consistent use of accounting methods and procedures over the long term Cheque income
statement and balance sheet distortions, and possible operations on these statements. Consistency
is needed to help external users compare the financial statements of a particular company over
time and make sound economic decisions.
13. Materiality concept:
The law has a doctrine called de minimis non curat lex. This means that the court does not
consider trivial issues. Similarly, accountants do not attempt to record events that are not so
important that the task of recording them is not justified by the usefulness of the results.
The concept of materiality means that transactions and events that have a non-significant or non-
significant impact must not be recorded and reported in the financial statements. Recording of
non-essential events is claimed to be unjustifiable in terms of their low usefulness to subsequent
users.
For example, conceptually, a brand-new paper pad is an asset of an entity. Each time someone
writes on the pad's page, some of this asset is exhausted and retained earnings are reduced
accordingly. Theoretically, it is possible to see how many partially used pads the company owns
at the end of the accounting period and display this amount as an asset.
However, the cost of such efforts is clearly unreasonable, and accountants are not willing to do
this. The accountant took a simpler action, albeit inaccurate, that the asset was exhausted
(expenditure) when the pad was purchased or when the pad was issued to the user from the
consumable inventory.
Unfortunately, there is no consensus on what it means to be important and the exact line that
distinguishes between important and unimportant events. Decisions depend on judgment and
common sense. The accounting creator is meant to interpret what is important and what is not.

Perhaps the importance of an event or transaction can be determined in terms of financial

position, performance, changes in an organization's financial position, and its impact on user
evaluations or decisions.
14. Full disclosure concept:
The concept of full disclosure requires companies to provide all relevant information to external
users for the purpose of sound economic decisions. This concept means that information that is
substantive or of interest to the average investor is not omitted or hidden from a company's
financial statements.
3.2 Accounting Conventions
The four main accounting conventions are materiality, complete disclosure, consistency, and
conservatism.
1. Conservatism: Conservatism is the practice of recording the lower-value transaction
when there are two possible values for a transaction. According to this rule, profits
should never be exaggerated, and there should always be a reserve for losses.
2. Consistency: In order to ensure that the same standards are used to calculate profit
and loss, consistency dictates the application of the same accounting principles from
one period of an accounting cycle to the next.
3. Materiality: All relevant facts must be documented in accounting according to the
concept of materiality. Accountants should note significant information and omit
irrelevant material.
4. Full disclosure: The disclosure of all information that is relevant to creditors and
debtors and that is both favourable and unfavourable to a business enterprise is
referred to as full disclosure.

3.3 Book-keeping & Accounting

Bookkeeping is the recording of financial transactions, and is part of the process of accounting in
business. Transactions include purchases, sales, receipts, and payments by an individual person or an
organization/ corporation.

Whereas accounting is responsible for interpreting, classifying, analyzing, reporting, and summarizing
the financial data.
3.4 Users of Accounting Information
The owners and managers place a high priority on accounting. However, the organization's
accounting reports are also of interest to bankers, creditors, etc.
Following is the list of Users of Accounting Information
1. Owners/Shareholders
2. Managers
3. Prospective Investors
4. Creditors, Bankers, and other Lending Institutions
5. Government
6. Employees
7. Regulatory Agencies
8. Researchers
9. Customers
3.5 Summary

 Internal users are people within your business organization who use financial
information. Examples of internal users are owners, administrators, and employees.
  An external user is someone outside the entity (organization) that uses the accounting
information.
 Accounting is a necessary function for decision making, cost planning, and economic
performance measurement, regardless of the size of the business.
 The qualitative characteristics or quality required for information play a major supporting
role in the usefulness of decision making in accounting theory, the approach of decision-
making models.

3.6 Keywords

1. Entity concept: The concept of an entity assumes that its financial statements and other
accounting information belong to a particular company that is different from its owner.
2. Accounting period concept: Financial accounting provides information about a
company's economic activity over a specific period of time that is shorter than the
company's lifespan. The periods are usually the same length for ease of comparison.
3. Matching concept: The concept of matching in financial accounting is the process of
matching (associating) performance or revenue (measured at the selling price of goods
and services offered) with labour or expense (measured at the cost of goods and services
used) over a specific period of time. is. Targets for which income has been determined.
4. Stakeholders: The term stakeholders include all the parties who has direct or indirect
interest in the business. It can be shareholders, creditors, bankers, debtors, customers,
employees, etc.
3.7 Self-Assessment Questions
1. Explain the meaning and importance of the concept of going concern.
2. What is meant by the concept of a business entity?
3. Describe the meaning and importance of money measurement concepts.
4. What do you mean by accounting concepts? Explain four accounting concepts.
5. Give an example to illustrate the consistency rules.
6. Explain conservative accounting practices with examples.
7. Explain the conventions of materiality.
8. Please state the meaning and importance of the dual aspect concept.
9. Queries various entities to list various accounting periods where these entities do not
follow the same accounting practices
10. Make decisions in the following situations:
a. A firm has unsold inventory at the end of the year. The cost is 20,000 yen and the
market price is 25,000 yen. At what price should unsold inventory be recorded?
b. If the cost in the above case is 21,000 yen, how would you judge?

3.7 References
1. Basic Financial Accounting for Management- Paresh Shah -Oxford University
Press
2. An Introduction to Accounting S N Maheswari and S K Maheswari, Vikas
3. Modern Accountancy Volume-1- A Mukherjee and M Hanif-TMH