MDU BBA NOTES
Principles of Accounting
Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared.
Certain concepts are perceived, assumed, and accepted in accounting to provide a unifying structure and internal logic to the accounting process. The word concept means an idea or notion, which has universal application. Financial transactions are interpreted in light of the concepts governing accounting methods.
Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. These conventions are derived by usage and practice.
The accountancy bodies of the world may change any of the conventions to improve the quality of accounting information. Accounting conventions need not have universal application.
In the study material, the terms ‘accounting concepts’, ‘accounting principles’, and ‘accounting conventions’ have been used interchangeably to mean those basic points of agreement on which financial accounting theory and practice are founded.
Accounting principles are a body of doctrines commonly associated with the accounting theory and procedures serving as an explanation of current practices and as a guide for selecting conventions or procedures where alternatives exist.
PRINCIPLES OF ACCOUNTING
The entity concept states that a business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. Business transactions are recorded in the business books of accounts and the owner’s transactions are in his personal books of accounts.
The practice of distinguishing the affairs of the business from the personal affairs of the owners originated only in the early days of double-entry bookkeeping. This concept helps in keeping business affairs free from the influence of the personal affairs of the owner.
Money Measurement Concept
As per this concept, only those transactions, which can be measured in terms of money are recorded. Since money is the medium of exchange and the standard of economic value, this concept requires that those transactions alone that are capable of being measured in terms of money be only to be recorded in the books of accounts.
Transactions, even if, they affect the results of the business materially, are not recorded if they are not convertible in monetary terms. Transactions and events that cannot be expressed in terms of money are not recorded in the business books.
This is also called the concept of the definite accounting period. As per the going concern concept, an indefinite life of the entity is assumed.
For a business entity, it causes inconvenience to measure performance achieved by the entity in the ordinary course of business. If a textile mill lasts for 100 years, it is not desirable to measure its performance as well as financial position only at the end of its life.
Under the accrual concept, the effects of transactions and other events are recognized
on a mercantile basis i.e., when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
Financial statements prepared on an accrual basis inform users not only of past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future.
In this concept, 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 earning that revenue should also be recognized.
This concept is based on the accrual concept as it considers the occurrence of expenses and income and does not concentrate on the actual inflow or outflow of cash. This leads to an adjustment of certain items like prepaid and outstanding expenses, and unearned or accrued incomes.
Going Concern Concept
The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations;
if such an intention or need exists, the financial statements may have to be prepared on a different basis, and, if so, the basis used needs to be disclosed.
By this concept, the value of an asset is to be determined on the basis of historical cost, in
other words, acquisition cost. Although there are various measurement bases, accountants traditionally prefer this concept in the interests of objectivity.
When a machine is acquired by paying ` 5,00,000, following the cost concept the value of the machine is taken as ` 5,00,000. It is highly objective and free from all bias. Other measurement bases are not so objective. The current cost of an asset is not easily determinable.
It closely follows the cost concept. Any change in the value of an asset is to be recorded only when the business realizes it. When an asset is recorded at its historical cost of ` 5,00,000 and even if its current cost is ` 15,00,000 such change is not counted unless there is the certainty that such change will materialize.
Dual Aspect Concept
This concept is the core of double-entry book-keeping. Every transaction or event
has two aspects:
- It increases one Asset and decreases another Asset;
- It increases an Asset and simultaneously increases Liability;
- It decreases one Asset, and increases another Asset;
- It decreases one Asset and decreases Liability.
- It increases one Liability, and decreases another Liability;
- It increases a Liability, increases an Asset;
- It decreases Liability, and increases other Liability;
- It decreases Liability and decreases an Asset.
Conservatism states that the accountant should not anticipate any future income
however, they should provide for all possible losses. When there are many alternative values of an asset, an accountant should choose the method which leads to the lesser value. Later on, we shall see that the golden rule of current assets valuation – ‘cost or market price whichever is lower’ originated from this concept.
In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another; a change in an accounting policy is made only in certain exceptional circumstances.
The concept of consistency is applied particularly when alternative methods of accounting are equally acceptable. For example, a company may adopt several methods of depreciation such as the written down-value method, straight-line method, etc.
The materiality principle permits other concepts to be ignored if the effect is not considered
material. This principle is an exception to the full disclosure principle. According to the materiality principle, all the items having a significant economic effect on the business of the enterprise should be disclosed in the financial statements and any insignificant item which will only increase the work of the accountant but will not be relevant to the users’ need should not be disclosed in the financial statements.
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