In the previous lesson, you have studied the meaning and nature of business transactions and objectives of financial accounting. In order to maintain uniformity and consistency in preparing and maintaining books of accounts, certain rules or principles have been evolved. These rules/principles are classified as concepts and conventions. These
are foundations of preparing and maintaining accounting records. In this lesson we will learn about various accounting concepts, their meaning and significance
After seen this video, you will be able to
- explain the term accounting concept and
- explain the meaning and significance of various accounting concepts : Business
- Entity, Money Measurement, Going Concern, Accounting Period, Cost Concept,
- Duality Aspect concept, Realisation Concept, Accrual Concept and Matching
1 MEANING OF ACCOUNTING CONCEPT
Let us take an example. In India there is a basic rule to be followed by everyone thatone should walk or drive on the left hand side of the road. It helps in the smooth flowof traffic. Similarly, there are certain rules that an accountant should follow while recording business transactions and preparing accounts. These may be termed as accounting concepts. Thus, it can be said thaThe main objective is to maintain uniformity and consistency in accounting records.
These concepts constitute the very basis of accounting. All the concepts have been
developed over the years from experience and thus, they are universally accepted
rules. Following are the various accounting concepts that have been discussed in the
following sections :
- Business entity concept
- Money measurement concept
- Going concern concept
- Accounting period concept
- Accounting cost concept
- Duality aspect concept
- Realisation concept
- Accrual concept
- Matching concept
BUSINESS ENTITY CONCEPT
This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate. For example, when the owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. This concept is the very basis of accounting. Let us take an example. Suppose Mr. Sahoo started business investing
100000. He purchased goods for40000, Furniture for
20000 and plant and machinery of30000.
10000 remains in hand. These are the assets of the business and not of the owner. According to the business entity concept100000 will be treated by business as capital i.e. a liability of business towards the owner of the business.
- This concept helps in ascertaining the profit of the business as only the business
- expenses and revenues are recorded and all the private and personal expenses are
- This concept restraints accountants from recording of owner’s private/personal
- It also facilitates the recording and reporting of business transactions from the business point of view
- It is the very basis of accounting concepts, conventions and principles.
MONEY MEASUREMENT CONCEPT
This concept assumes that all business transactions must be in terms of money, that is in the currency of a country. In our country such transactions are in terms of rupees. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. For example, sale of goods worth
200000,purchase of raw materials100000, Rent Paid `10000 etc. are expressed in terms of money, and so these are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, loyality, honesty of employees are not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business concern.
- The following points highlight the significance of money measurement concept :
- This concept guides accountants about what to record and what not to record.
- It helps in recording business transactions uniformly.
- If all the business transactions are expressed in monetary terms, it will easy to
- understand the accounts prepared by the business enterprise.
- It facilitates comparison of business performance of two different periods of the
- same firm or of the two different firms for the same period.
GOING CONCERN CONCEPT
This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet; For example, a company purchases a plant and machinery of `100000 and its life span is 10 years. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it will not be proper to charge the amount from the revenues of the year in which the item is acquired. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset
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 financical 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.
- It helps in predicting the future prospects of the business.
- It helps in calculating tax on business income calculated for a particular time period.
- It also helps banks, financial institutions, creditors, etc to assess and analyses the
- performance of business for a particular period.
ACCOUNTING COST CONCEPT
Accounting cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc are recorded in the books of accounts at a price paid for them. For
example, a machine was purchased by XYZ Limited for
500000, for manufacturing shoes. An amount of1,000 were spent on transporting the machine to the factory site. In addition,
2000 were spent on its installation. The total amount at which the machine will be recorded in the books of accounts would be the sum of all these items i.e. 503000. This cost is also known as historical cost. Suppose the market price of the same is now ` 90000 it will not be shown at this value. Further, it may be clarified that cost means original or acquisition cost only for new assets and for the used ones, cost means original cost less depreciation. The cost concept is also known as historical cost concept. The effect of cost concept is that if the business entity does not pay anything for acquiring an asset this item would not appear in the books of accounts. Thus, goodwill appears in the accounts only if the entity has purchased this intangible asset for a price
- This concept requires asset to be shown at the price at which it has been acquired,
- which can be verified from the supporting documents.
- It helps in calculating depreciation on fixed assets.
- The effect of cost concept is that if the business entity does not pay anything for an
- asset, this item will not be shown in the books of accounts.
DUAL ASPECT CONCEPT
Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded.
This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realization means creation of legal right to receive money. Selling goods is real station, receiving order is not. In other words, it can be said that :
Let us study the following examples :
i. N.P. Jewelers received an order to supply gold ornaments worth
5,00,000. They supplied ornaments worth2,00,000 up to the year ending 31st December 2013 and rest of the ornaments were supplied in January 2014.
ii. Bansal sold goods for
1,00,000 for cash in 2013 and the goods have been delivered during the same year. iii. Akshay sold goods on credit for50,000 during the year ending 31st December
- The goods have been delivered in 2013 but the payment was received in
Now, let us analyse the above examples to ascertain the correct amount of revenue
realised for the year ending 31st December 2013.
The revenue for the year 2013 for N.P. Jeweller is
200000. Mere getting an order is not considered as revenue until the goods have been delivered. ii. The revenue for Bansal for year 2013 is1,00,000 as the goods have been delivered in the year 2013. Cash has also been received in the same year.
iii. Akshay’s revenue for the year 2013 is `50,000, because the goods have been delivered to the customer in the year 2013. Revenue became due in the year 2013 itself. In the above examples, revenue is realised when the goods are delivered to
The matching concept states that the revenue and the expenses incurred to earn there venues must belong to the same accounting period. So once the revenue is realised, the next step is to allocate it to the relevant accounting period. This can be done with the help of accrual concept. Let us study the following transactions of a business during the month of December,2006
(i) Sale : cash
2000 and credit1000
(ii) Salaries Paid
350 (iii) Commission Paid150
(iv) Interest Received
50 (v) Rent received140, out of which
40 received for the year 2007 (vi) Carriage paid20
30 (viii) Rent paid200, out of which `50 belong to the year 2005
(ix) Goods purchased in the year for cash
nd on credit500