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Tuesday 12 April 2011

Accounting Concepts

Accounting has come to present status after a period of several hundred years. During this period certain accounting assumptions, concepts and conventions have emerged. Accounting assumptions, concepts and conventions are called Generally Accepted Accounting Principles (GAAP) since they have been commonly accepted by professional accounting world as general guidelines for preparing financial statements and reports. Thus accounting principles are rules of action adopted by accountants.

Basic Accounting Concepts

Entity Concept:

In accounting, the entity of business is considered separate from the existence of its owners. Accounts are kept for the entity as distinct from owners. Thus, money invested by the proprietor by way of capital is considered to be the liability of the business to the proprietor. If proprietor withdraws some cash or goods, they are treated as drawings but not as business expense. Capital is reduced by the amount of drawings.

Going Concern Concept:

This concept assumes that the business will exist for certain foreseeable future with the specified goal or for specified duration. Thus recording and valuation of long-term assets and liabilities are based on this assumption. Fixed assets are recorded on historical costs and written down over the expected life of the assets. Similarly long-term liabilities, i.e., debentures, preference shares, long-term loans are raised and their terms of repayment are settled on this assumption. The going concern concept is the backbone of accounting and is based on the following assumptions:

Business has an indefinite life.
Assets are depreciated on the basis of their expected life without caring for their current values.
In case of innovations or new inventions, their effect is measured in financial terms and assets are depreciated to allow for such innovations or inventions.

Money Measurement Concept:

In accounting, a record is made only of those facts or transactions that can be expressed in monetary terms. It provides a common yardstick, i.e., money for measuring, recording and summarizing the transaction. Events, which cannot be expressed in money terms, do not find a place in account books. For example, salary paid to manager is recorded in account books but his competence

Cost Concept:

According to this concept, all transactions and events are recorded in the book” of account at the actual price involved. This price is called cost. All assets are carried in the books of accounts from year to year at their acquisition cost (also called historical cost) irrespective of any change in their market value. Acquisition cost is considered highly objective, reliable, definite and free from bias. Thus when a machine is purchased for Rs. 5 lakhs, transportation expenses are Rs. 20,000, installation expenses are Rs. 10,000, the machine is valued at Rs. 5,30,000. This is the historical cost of machine.

Dual Aspect Concept :( Double Entry System)

Every transaction entered into by a firm has two aspects, viz., debit and credit. Debit represents creation of or addition to an asset or an expense or the reduction or elimination of a liability. Credit means reduction or elimination of an asset or an expense or the creation of or addition of a liability. Therefore, according to dual aspect concept, at any time, the total assets of a business are equal to its total liabilities. In the equation form:

Assets = Capital + Liabilities
Assets denote the resources owned by a business while the term liability refers to external claim. And capital is the claim of the owners against the assets of the business.

Accounting Period Concept:

All the 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. Further, this concept
assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be
of one year, six months, three months, one month, etc. But usually one year is taken as one accounting period which
may be a calendar year or a financial year.

Periodic Matching Concept and revenue concept:

The objective of running business is to earn profit in order to ascertain the profit made by the business during a period. It is necessary that the revenues of the period should be matched with the cost (Expenses) of the period. The term matching means appropriate association of related revenues and expenses.

Realization Concept:

Revenue is recognized when a sale is made. Sale is consider to be made at the point when the property in good passes to the buyer and he becomes legally liable to pay.

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