Accounting Concepts
A few of generally accepted accounted accounting concepts may be given as under:
- The Entity Concept;
- Money Measurement Concept;
- The Going Concern Concept;
- The Cost Concept.
- The Dual-aspect Concept;
- The Accrual Concept;
- The Realization Concept;
- Accounting Period Concept;
- Matching Concept;
- Balance Sheet Equation Concept.
A detailed discussion of these concepts is undertaken as follows:
1. The Entity Concept: For accounting purposes, each business enterprise is considered as an accounting unit independent of its owners. According to this concept, the business and businessman are two separate and distinct entities. The business entity is considered to own the assets and liable for the liabilities to outsiders, including the claims or capital of the proprietors. In this connection Rolland has remarked that “In one sense capital itself is regarded as a liability, the amount due from the business to its proprietors.
The accounting entity is not necessarily a separate legal entity. For example, a sole trader or partner cannot legally separate his business affairs from his personal assets. It is only in the corporate form (limited company) of business organization that the business enterprise is treated as a separate legal entity distinct from its owners. In accounting, however, every type of business organization, be it sole trader ship or partnership, it treated as a separate accounting entity. The entity concept, therefore, establishes a clear distinction between the owners and the business.
Precisely the business entity concept defines the range and boundaries of the accountant’s activity and limits the number of transactions that are to be included in the records of an enterprise.
2. Money Measurement Concept: In accounting, only those facts, events and transactions are recorded and reported that can be expressed in terms of money. Since money is a common measuring unit or common denominator, it makes possible to record and compare dissimilar facts, events and transactions about a business. For example, a business owns a motor car, goods of Rs. 50,000, land measuring 2,000 sq. meters. These numbers cannot be added together to determine the financial position of the business because there are different measuring units for each item.
This problem is resolved by expressing the aforesaid items in terms of money.
- The unit is used in terms of rupee and not the purchasing power of money. This concept disregards the effect of changes in the purchasing power of money. The accounting records are kept on historical cost basis and the effect to changing price level in not disclosed in accounting records.
- This concept does not disclose the quality of a business or its products or its management. It also fails to record the state of proprietors health and its effect on business. The state of coordination or its absence amongst its employees is also not brought into books as per this concept.
4. The Cost Concept : The cost is the monetary price paid for the acquisition of assets for the business enterprise. Cost concept implies that an asset is recorded in the account books at a price paid to acquire it. The original or acquisition cost relates to past and, therefore, it is referred to as historical cost. It is the basis for the valuation of the assets in the financial statements. Further, example suppose that a building was purchased in the year 2007 at a cost price of Rs. 5,00,000. In he year 2007 and afterwards this asset will be shown in the balance sheet at a cost price of Rs. 5,00,000 less depreciation.
The effect of cost concept seems to be irrelevant when the price of the asset goes on increasing in the market. In such a case, the balance sheet does not exhibit a true financial position of the business. It has, therefore, become a matter of dispute among the accountants as to whether the assets should be shown in the balance sheet at historical cost or at current cost. But the majority of the accountants are in favor of disclosing the assets in the balance sheet at historical cost because it is very difficult to ascertain the current cost of the technology has not developed considerably and it is difficult to ascertain the current cost of the ancient machines. If the current cost is ascertained on the basis of price index, there are many difficulties in getting the relevant price index.
It is still a matter of controversy as to whether the current cost be ascertained on the basis of price index of the country or the companies should prepare their price index for each asset separately. In view of these difficulties, the majority of the accountants still feel that the assets should be valued on historical cost price basis and the cost concept implies this aspect.
5. The Dual-aspect Concept : This concept is based on double entry system of book-keeping which means that a record of each transaction is made in two separate accounts – Once on the debit side of an account and second time on the credit side of another account. For example, suppose a proprietor has introduced Rs.1,00,000 in the business. This transaction will increase Rs.1,00,000 in cash on the assets side and will also increase Rs.1,00,000 in the capital account on the liabilities side. In another example, it is assumed that the business had purchased goods worth Rs.5,00,000 on credit, this transaction will increase Rs.5,00,000 in the stock on the assets side and will also increase Rs.5,00,000 in creditors on the liabilities side. Thus, it is clear that an increase on the liabilities side of the balance sheet. Therefore, balance sheet is just like a scale and if weight is increased or decreased on one side, the same must be added to or removed from the other side. This is the essence of the dual-aspect concept.
6. The Accrual Concept : The accrual concept is concerned with the period in which the revenues and expenses are to be related. In other words once the revenue is realized the next step is to allocate it among the accounting periods if necessary and this is achieved with the help of accrual concept which also relates expenses to revenue for a given accounting period. It is true to say that matching concept finds its true expression in accrual basis.
The matching concept implies that the revenues for the current year only should be matched with the expenses for current year. The expenses for the current year include the following:
- Such revenue expenses as relate to the current year and the payment of which has been made in the current year;
- Such revenue expenses as relate to the current year and the payment of which had been made in the previous year;
- Such revenue expenses as relate to the current year and the payment of which has not been made in the current year but will be made in future.
Similarly the revenues for the current year will include the following:
- Such revenues as relate to the current year and are received in the current year;
- Such revenues as relate to the current year and were received in the previous year.
- Such revenues as relate to the current year and are not received in the current year but will be received in future.
7. The Realisation Concept: The important aspect of the realization concept is to determine the point of time at which the revenue is to be recognized and this is referred to as timing of revenue recognition. For example, suppose an order was received from a customer in January, 2007 the goods were manufactured as per this order in February, 2007; and the delivery of goods was made in March, 2007; the payment of which was received in April, 2007. According to realization concept the revenue from this sale would be deemed to accrue in March, 2007, when the possession and title of the goods were transferred to the customer, though its payment was received in April, 2007.
8. The Accounting Period Concept : It is assumed that a business will be carried on for an indefinite period. It is, therefore, necessary to divide this indefinite period into different accounting periods for one year which is known as accounting year or financial year of the business. The revenues and expenses for this year are matched and a profit or loss account it prepared for that year which shows the net profit or net loss for that period. A balance sheet is also prepared at the end of the accounting period which discloses the financial position of the business on a particular date. Thus, the accounting period concept implies the period for which the entries are make in accounting record and at the end of which the account books are closed and financial statements prepared.
9. The Matching Concept : The matching concept is based on the principle that the expenses for a particular accounting period should be matched with the revenues for that period only. Such matching of expenses with the revenues is described as matching concept. On the basis of this concept, the outstanding expenses at the end of the year are matched with the revenues, while the prepaid expenses are not matched.
The following difficulties arise while matching expenses with revenues :
- There are some expenses which cannot be matched with the revenues of a particular accounting period. For example, preliminary expenses, expenses relating to issue of shares and debentures, advertisement expenses are of this nature.
- Similarly, it is not easily ascertainable as to how much amount should be charge as depreciation on particulars fixed asset.
- The same difficulty arises in relation to long-term contracts.
In the form of equation : Debit = Credit
According to accounting principles, all the expenses, losses and assets are debited while all the incomes, gains and liabilities are credited. Therefore, the form of equation appears as follows :
Expenses + Losses + Assets = Incomes + Gains + Liabilities
Or
Assets = Income + Gains + Liabilities – Expenses – Losses
= Net Profit or (-) Net Loss + Liabilities
The Liabilities may be due to outsiders or to the proprietors of the business, so the equation appears as:
Assets = Net Profit or (-) Net Loss + External Liabilities + Due to Proprietors
After adjusting the net profit or net loss in the amount due to proprietors the amount of equity is determined and the equation takes the form as follows:
Assets – Equity + External Liabilities
Or Equity (Proprietor Fund) = Assets – Liabilities
The whole accounting procedure is based on this equation.
