Basic Accounting Concepts are:
· Entity Concept
separate from the existence of its owners. Accounts are kept for the entity as distinct from owners.
· Money Measurement Concept
a record is made only of those facts or transactions that can be expressed in monetary terms. The main advantage of money measurement concept is that even a layman is able to understand and appreciate the things stated in terms of money. However, the concept suffers from the following flaws:
a. Money does not have a constant value. The value of money changes because of inflation or deflation in the country.
b. All business assets cannot be measured in money terms. It is very difficult to calculate the value of goodwill or measure the competency or morale of employees.
· Going Concern Concept
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. Loan repayment are settled on this assumption.
o Business has an indefinite life.
o Assets are depreciated on the basis of their expected life without caring for their current values.
· Cost Concept
recorded in the book" of account at the actual price involved. . irrespective of any change in their market value. Acquisition cost is considered highly objective, reliable, definite and free from bias. the cost concept creates difficulties in its application in the following situations:
(a) Due to price rise, the financial position of a firm depicted on cost concept basis does not reflect true picture.
(b) Financial statements of two or more firms ,are not comparable due to changes in prices.
(c) Depreciation is computed on historical cost. This understates depreciation when current value of an asset is very high. So it becomes necessary to revalue the assets.
(d) This concept implies recording of all assets for which costs have been incurred but the assets like managerial competence, reputation or goodwill of the firm acquired over a period of time are not recorded.
(e) The exception to this concept of valuing assets at cost irrespective of its market value is the valuation of inventories. According to AS-2, inventories should be valued at cost or market price whichever is lower.
· Dual Aspect Concept
Assets = Capital + Liabilities
Every transaction entered into by a firm has two aspects, viz., debit and credit
· Full Disclosure Concept
Are for stakeholder , full information , any change in policy , accounting principles should be followed , proper annexure should be provided.
· Objectivity Concept
all accounting records should be supported by proper documents, e.g., invoices, cash memos, correspondence, agreements etc.
· Accrual Concept
revenue and costs are recognized as they are earned or incurred (and not as money is received or paid). helps in depiction of time financial position of the enterprise.
Accounting concepts related to income measurement are:
· The Time Period Concept (Periodicity Concept)
This concept indicates that the profitability of entity is to be measured periodically. The period for which income is measured is called the accounting period. Eg: for income tax purposes, financial year beginning on 1st April and ending on 31st March. However, for internal reporting the profitability report can be prepared monthly, quarterly or half yearly to facilitate better control and evaluation of performance.
· The Revenue Recognition (Realization) Concept
According to this concept, revenue is considered as being earned on the date on which it is realized. In case of sale of goods or service, revenue will be recognised when the seller of goods has transferred to the buyer the property in goods and no significant uncertainty exists regarding the sales price.
· The Matching Concept
Cost of goods sold and operating expenses incurred during the current financial period are recognized as expenses of the current financial period and will be matched with the revenue of the current period. Incomes received in advance or relating to earlier periods must not be taken into account. Similarly, expenses paid in advance are also to be ignored while computing the income of current accounting period.
· The Materiality Concept
Materiality is 'the characteristic attaching to a statement, fact or item whereby its disclosure or the method of giving it expression would be likely to influence the judgment of a reasonable person.' Financial statements should disclose all material items, that might influence the decisions of the user of the financial statements. Thus when the event is material, it should be disclosed. But if the item or event is immaterial, it may not be disclosed.
· The Consistency Concept
Accountancy principles generally allow more than one method of describing identical operating situations. Eq: st. line depreciation or exponential depreciation method. It is for this reason that the consistency principle requires that the basis of income measurement and preparation of financial statements should remain consistent for intra-firm and inter-firm comparison
· The Conservatism (Prudence) Concept
This requires understating rather than overstating revenue (income) and expense amounts that have a degree of uncertainty. The rule is to recognize revenue when it is reasonably certain and recognize expenses as soon as they are reasonably possible. The reasons for accounting in this manner are so that financial statements do not overstate the company’s financial position. Accounting chooses to err on the side of caution and protect investors from inflated or overly positive results.
1. Inventories are valued at lower of cost or market price.
2. Providing for doubtful debts and discount allowed to debtors but ignoring the probable discount received from creditor till the time final payments are made.
3. All the fixed assets are valued on historical costs irrespective of their market price except in the case of revaluation of business.
4. Preference of written down value method over straight-line method of depreciation, since the earlier one, provides for more depreciation in the initial years of use.
5. Valuing Joint Life Insurance Policy at its surrender value irrespective of amount of installments paid.
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Corporate Finance: A Focused Approach -1st Edition
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Michael C. Ehrhardt , Eugene F. Brigham
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