Basic Accounting Concepts

Business Entity Concept/Accounting Entity Concept

According to this concept, the business is considered as a separate business entity from its owner(s). Thus the financial information of the business will be recorded and reported separately from its owner’s personal financial information.

Going Concern

For accounting purposes, it is assumed that the business will operate for an indefinite period of time and thus considered as ‘going concern’. For this reason, the realizable value of the property owned by business will not be relevant.

Money Measurement

Only those transactions will be recorded in the financial books which can be measured in terms of money. Anything which cannot be measured in monetary terms will not be considered as a part of the accounting data.

Historical Cost

All assets will be recorded at their cost price. This means that machinery purchased years ago will be recorded at its original cost of purchase even though its value is lower now.
The reason for doing so is because the business is considered as a going concern and we need not be worried about the saleable value of the asset.

Accounting Period

The life a business is considered to be indefinite. But for accounting purposes, the life of the business is divided into specified periods of time. The period may be a month, a half year, a full year or any length of time.

Accrual Concept

Accrual concept states that revenue is recognized when it is earned and expenses when they are incurred.
Any income or revenue generated must be recorded in the books of accounts whether the payment for it is received or not. Similarly, any expense done by the business should be recorded irrespective of the fact that the business has paid for it or not.

Objectivity

Any transaction which is recorded in the accounting books should be verifiable. In other words, the transaction should backed by some proof in the form of a receipt, invoice, cheque, voucher etc.


Accounting Conventions

Consistency

According to this concept, the same accounting method should be applied in each accounting period when preparing financial reports. This makes it easy to compare results of one period with another period and the stakeholders can get a more realistic idea about the performance of the business.

Prudence

It involves being cautious while reporting accounting information. The assets should not be overstated and the liabilities should not be understated.
This is why closing stock is always valued at the lower of cost or market value so that the profits are not overstated.

Matching Principle

This principle is based on accrual concept of accounting. It states that revenue earned during a specific period has to be matched with the expenses incurred with earning that revenue. The following point should be considered:

 

  • If an item of revenue is shown in the Profit and Loss account, all expenses incurred on it, whether paid or not, should be shown as expenses in the Profit and Loss account.
  • An expense will be recorded in the books of accounts if the revenue associated with it has not been realized.
  • Incomes received in advance should not be shown in Profit and Loss account.
  • All the cost and expenses incurred on good remaining unsold at end of the year must be carried forward to next year as these goods will be sold in the next accounting period.


 

 Watch this video about Accounting Principle and policies