Accounting Concepts and Conventions

1. ACCOUNTING CONCEPTS AND
CONVENTIONS
L. PRAKASH KANNAN, M.COM., M.PHIL., (PH.D.), ASSISTANT PROFESSOR,
S. J. MONISHA, II B.COM.,

2. ACCOUNTING
Accounting or accountancy is the measurement,
processing and communication of financial and non
financial information about economic entities such as
businesses and corporations. Accounting, which has
been called the “language of business” measures the
results of an organization’s economic activities and
conveys this information to a variety of users,
including investors, creditors, management and
regulators.

3. DEFINITION
• According to the American Institute of Certified Public Accountants (AICPA) “
Accounting is the art of recording, classifying and summarizing in a significant
manner and in terms of money transactions and events which are of a financial
character and interpreting the results thereof”.

4. Business
Entity
Going
Concern
Money
Measurem
ent
Dual
Aspect
Accounting
Period
Cost
Concept
Realisation
Concept
Matching
Concept
Accrual
Concept
Objective
Evidence
ACCOUNTING
CONCEPTS

5. BUSINESS ENTITY CONCEPT
• A business entity is an organisation of persons to accomplish an economic goal.
• The entity that represents the association of persons is considered distinct and
separate from the owners, managers and employees of the enterprise.
• It determines what is to be recorded and what is to be excluded from the books of
accounts.
• All business transactions of financial nature, including transactions with the owners
are recorded in the books of the business.
• The owners of the business entity have to be treated like financiers but eligible for
profits and responsible for losses.

6. GOING CONCERN CONCEPT
• This concepts assumes that a business entity has continuity of life. It will continue
for an indefinite period of time. It has no need or intention to close.
• This concept is important for valuation of assets and liabilities. Historical cost of the
fixed assets is recovered throughout their useful life by way of charging
depreciation.
• Going concern concept influences accounting practices in relation to valuation of
assets and liabilities, depreciation of the fixed assets, treatment of outstanding and
prepaid expenses and income.

7. MONEY MEASUREMENT CONCEPT
• All business transactions are measured, expressed and recorded in terms of money.
• Money, as a common denominator helps to quantify a diverse range of data to enable
determination of profit or loss and financial position.
• The money measurement concept excludes all business transactions and events
which cannot be measured in terms of money.
• The concept is invaluable in summarising business operations, assets and liabilities.
• The money measurement concept imposes certain limitations on a business unit.

8. DUAL ASPECT CONCEPT
• Every business transaction recorded in the books of accounts of a business has two
aspects – receiving of benefit and giving of benefit. Both the aspects of each
transaction much be recorded in appropriate accounts of the business.
• Dual aspect concept is the basis for double entry system of book-keeping which is
universally used.
• The governing principle of double entry system is that “for every debit there is an
equal corresponding credit”.
• The accounting equation provides an insight into the impact of each transaction on
the assets, liabilities and capital.

9. ACCOUNTING PERIOD CONCEPT
• A business unit may continue for an indefinite period. It is possible to ascertain
overall profit or loss of the business when it is liquidated. But practically it is not
possible to wait for an indefinite period.
• Accounting period concept is the basis for segregation of capital expenditure from
revenue expenditure.
• Accounting period helps to measure the income generated during the specific
accounting period which makes it possible to distribute it to the owners.
• It makes comparison of the results of one accounting period with those of another
possible, leading to comparative performance evaluation.

10. COST CONCEPT
• Accounting is a historical record of the transactions of a business entity.
• According to cost concept, assets are recorded at the price paid to acquire them. This
concept is the basis for all subsequent accounting for the assets.
• The assets are gradually depreciated on the basis of cost and the effective life of the
asset.
• The market value of assets are not considered either for valuation or depreciation of
such assets.
• Cost concept is still the predominantly used basis for valuation and depreciation of
business assets.

11. REALISATION CONCEPT
• According to the realisation concept, revenue is considered as earned on the date
when jit is realised.
• The erm ‘realisation’ implies the legal liability to pay by the buyer or user or
customer. The revenue should be recognised only when it is legally due and
realisable.
• The realisation concept is vital for determining incomes pertaining to an accounting
period. It avoids the possibility of inflating incomes and profits.

12. MATCHING CONCEPT
• The accountants are responsible to match the revenues earned during an accounting
period with the cost associated with the period to ascertain the profit earned.
• Matching of revenues and costs relevant to a specific period is call the matching concept.
• It is the basis for finding reliable profit for a period which can be safely distributed to the
owners.
• All the revenue expenses and incomes associated with the accounting period have to be
identified. Outstanding and prepaid expenses an incomes have to be properly adjusted.
Depreciation and necessary provisions have to be made.
• Matching of the costs with revenue has to be done in two stages. They are Direct costs
and Indirect costs.

13. ACCRUAL CONCEPT
• This concept makes a distinction between receipt of cash and the right to receive cash
and payment of cash and the legal obligation to pay cash in relation to revenues and
expenses respectively.
• Revenues and costs are accrued i.e., recognised as they are earned or incurred and not as
money is received or paid.
• The accrual concept is the basis for mercantile system of accounting.
• Any accrued incomes and incomes received in advance must be appropriately recorded.
• The accrual concept ensures that the profit or loss shown is on the basis of full facts
elating to all expenses and incomes.

14. OBJECTIVE EVIDENCE CONCEPT
• All accounting entries must be based on objective evidence. ‘Objective’ refers to
verifiability, reliability and absence of bias. No transactions must be recorded in the
books of accounts without verifiable documentary evidence.
• Objective evidence concept facilitates auditing of accounts and eliminates
unauthorised entries in the books of accounts, improving their reliability.
• Management decisions based on such accounts are likely to be more successful.
• Accounting achieves authenticity, accuracy and reliability by following the concept of
objective evidence.

15. ACCOUNTING CONVENTIONS
Convention of disclosure
Convention of consistency
Convention of materiality
Convention of conservatism

16. CONVENTIONS OF FULL DISCLOSURE
• According to this convention, all accounting statements should be prepared honestly.
• This should be evident through the transparency of the statement.
• The statement should disclose fully all the significant information.
• Facts, figures and the details which are of material interest to the owners, investors,
creditors etc., must be clearly presented in the financial statements.
• This type of disclosure needs proper classification, summarisation. Aggregation and
explanation of the numerous business transactions.
• the convention of disclosure is gaining importance due to the shift in the growth of
business organisations.

17. CONVENTION OF CONSISTENCY
• The basic aim of the doctrine of consistency is to preserve the comparability are
reliability of financial statements.
• According to this convention the rules practices and concepts used in accounting
should be continuously observed and applied year after year.
• Valuation of stock can be done indifferent acceptable ways like average price method
or cost price method. It can also be on the basis of cost or market price whichever is
lesser.
• The convention of consistency makes the financial statements more reliable and
comparable for the needs of the end users.

18. CONVENTION OF MATERIALITY
• Materiality means ‘relative importance’. All important items and facts should be
disclosed in accounting statements.
• Unimportant and immaterial details need not be separately given. Otherwise, the
accountant becomes over burdened with unnecessary details.
• The test of materiality can be applied to three aspects (i) information (ii) amounts
(iii) procedures.
• The term ‘Material’ is subjective, amenable for interpretation of individual
accountants.

19. CONVENTION OF CONSERVATISM
• Conservatism is a policy of caution or ‘playing safe’. It demands taking a ‘gloomy’
view of a situation.
• Conservatism is the defensive accounting mechanism against ‘uncertainty’.
• The convention of conservatism demands that the least favourable situation to the
firm will materialise and precautions should be taken on that basis.
• When stock are valued, the usual principle followed is ‘cost or market price
whichever is lower’. If market price is more than cost, stock is shown at cost only.
• It should not be taken to extremes where it can distort the operating results and
financial position of a business unit.