Concepts Principle and Conventions of Accounting

Studying Accounting in details various accounting concepts on which the whole accounting is based. Accounting concepts define the assumption on the basis of which financial statement to prepared. The accounting concept is universally applicable. Concept of accounting are based n assumption and condition, which form the basis of accountancy and on that assumptions and condition the accountancy has been laid. These concepts made the foundation on which the accounting principles are formulated.

 

1- Entity Concept: Entity concept in accounting states that business enterprise is a separate identity apart from its owner. The fundamental rule of accounting is to treat the business as distinct from its owner. All the transactions related to the business should be recorded in the books of business and owners transactions in his personal books. This concept usually applied at every business organisations whether it is sole proprietary concern or partnership or multinational companies. 

Lets take an example: Suppose Mr. Anand started business with cash investing ₹60,00,000 with which he purchased plant & machinery for ₹56,00,000 and maintain the business in his hand. The financial position will be...

Capital	60,00,000
Plant & Machinery	56,00,000
Cash	4,00,000

Now, if Mr. Anand spends 10,000 for his personal expenses from the business fund, then it should not taken as business expenses and would be charged to his capital account as drawings (anything which is taken by the proprietor from the business for his personal use) Thus this Entity Concept the revised financial position would be...

 

Liability	₹
Capital Less: Drawings	60,00,000 (10,000)
Machinery		56,00,000
Cash		3,90,000

 

2- Money measurement concept: In this concept, only those transactions are recorded which are in terms of money. The accounting is only done if the business activity is collateral to numerical values. Since money is the only common source of numerical medium of exchange and the standard of economics value, this concept are capable of being measured in terms of money in the books of accounts. If the event or transaction is not in terms of money it will not recorded in books of accounts however, if they are converted in term of money then will recorded.  

For example: The employees of the origination are the assets of the business but their measurement in monetary value is not possible therefore, not recorded in the books of accounts.

After this, Money may have taken in different currencies according to the countries. Suppose a businessman sells goods worth ₹50 lakhs at home and he also sells goods worth of 1 lakh Euro in the United Kingdom. So, the question is what is the total sales? 50 lakh + 1 lakh Euros. Which is not an accurate amount of sale. The UK Euros value in India or in other country is different. So, the Businessman as to maintain the flexibility for measurement and interpretation of accounting data. 

 

3- Periodicity Concept: Periodicity concept states that accounts should be prepared after every period and not at the end of the life of business. Usually this period is one calendar year. We generally follow from 1st April of a year to 31st March of the immediately following year. This is also called the concept of definite accounting period. 

Example: Mr. Jones started business on 1st April and maintained books of accounts at the end of the Financial year, He will close his business books and carried forward to the next year immediately. 

If Mr. Jones has started his business on 1st January then when should he start his accounting? 

The answer is He ca start preparing to the immediate period and end the books of  accounts at 31st of March. 

 

4- Accrual Concept: Firstly What does Accrual means? Understand this, Accrual means recognition of revenue and cost as they are earned or incurred and not as money is received or paid.  To Understand accrual, one should know about revenues and expenses. Expenses is a cost relating to the operations of an accounting period and revenue is earned during the period or the benefits. 

Suppose, Mr. D buys Cloths of ₹50,000 paying cash ₹20,000 and sells at ₹60,000. ₹30,000 is outstanding for Mr. D

His revenue is ₹60,000 not ₹50,000 as per Accrual concept: Revenue (-) Expense =Profit Which is ₹10,000

Financial statement is prepared on the accrual basis not only of past events involving payments and receipts of cash but also payment or receipts of cash in future. Accrual Concept provides the foundation on which the structure of present day accounting has been developed. 

 

5- Matching Concept: Matching concept of accounting, all expenses matched with the revenue of that period should only be taken into consideration. In the financial statements of the organization if any revenue is recognized then expenses related to earn that revenue should also be recognized. This concept is based on accrual concept as i consider the occurrence of expenses and income. This leads to the certain items such as prepaid and outstanding expenses, income, etc. Not necessary all items are identify some expenses and income are directly bounded.

For Example: Mr.R.K. started business. He purchased ₹10,000 goods from the supplier. He sold the goods at 14,000 and received 4,000 only. He has not paid to supplier yet.

Liability	Asset
Capital (For Profit)                                 4,000	Trade Receivable                                      10,000
Trade Payable                                         10,000	Cash                                                         4,000
14,000	14,000

In the given example, Mr. R.K. purchased 10,000 goods and sold for 14,000

Therefore he got Gross Profit (GP) = 4,000 and he haven't incurred any expense So, the Net Profit is 4,000 Which is transferred to Capital. Here He only received 4,000 but the Original revenue is 14,000 the remaining 10,000 is yet to receive. Here Matching concept take place and signifies all the revenue and expenses matched with the taken consideration.

 

6- Going Concern Concept in accounting: This Concept states that the business financial statement are normally prepared on the assumptions that the business is a going concern and will continue in future. Hence it is assumed that due to bankruptcy and assets liquidate the scale of operation need not be affect. Important thing is valuation of assets is dependent on this assumptions. 

Suppose, An accountant maintain books of accounts, the machine was 5,00,000 and installation charges are 10,000. Capital invested is 10,00,000. If the business continue the owner cannot sell the machine. As this concept indicates the assets are kept for generating benefit in future.