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Accounting Concepts, Principles and Conventions Notes-CA Foundation

Accounting Concepts, Principles and Conventions Notes-CA Foundation

Q1. Introduce Accounting and GAAPs.

Answer:

Accounting is the language of business. It is not merely the systematic record of financial transactions of business organisation but also a tool to analyse the financial position of the organisation in the current period and change in the position over span of time. It enable the comparison of data with not only past period of some organisation but also with other business organisations within the same industry it is necessary that financial statements prepared for different years or for different organisation must adopt uniformity, consistency in its preparation which would enable the users to compare the same as and when required.

Suppose Mr. X, a businessman approached his CA to prepare the financial statement from the records provided by him for assuring the correctness he further give the same records to 3 other accountants. All the four accountants submit their statements to Mr. X a week later. When Mr. X read the Statements all the statement were different from one another, showing different figures under different heads, the profits of the statement also vary among themselves. Mr. X is unable to decide that which statement is true and correct about his business profits.

To prevent such situations and to build the confidence of general public and the users over the correctness of preparation of financial statements, a set of generally accepted rules have been developed which helps to bring uniformity, consistency in preparation of the financial statements which makes.the statements understandable and reliable.

Generally Accepted Accounting Principles (GAAP) is applied to accounting procedure by the accountants so as to prepare the financial statements which are uniform in nature. GAAP is the backbone of accounting system which describes rules principles, conventions, concepts on the basis of which accounting reports are prepared. GAAP are supported by accounting bodies such as ICAI.

Q2. What are Accounting Concepts ?

Answer:

  • These are the basic assumptions upon which accounting is based.
  • These concepts helps in interpreting the financial statements.

Q3. What are Accounting Principles?

Answer:

  • The rules and guidelines to be followed in preparation of financial statements.
  • The acceptance of accounting principles depends on following.
  • Usefulness, i.e. meaningful information
  • Based on realistic assumptions
  • Consistency
  • Objectivity i.e. free from personal biases
  • Simplicity i.e. easy to understand and implement.

Q4. What are Accounting Conventions?

Answer:

  • The customs or traditions or guidelines used over a period of time in preparation of accounting statements and reports.
  • These can be attend with the changing needs of today’s business environment, thus they may not have universal application.

Q5. What are Concepts, Principles and Conventions?

Answer:

(i) Accounting concepts, Principles and conventions are discussed as follows:

(a) Accounting Concepts: They define the assumptions on the basis of which financial statements of a business entity are prepared. Concepts have a universal application. They laydown the foundation on the basis of which accounting principles are formulated.

(b) Accounting Principles: These are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practice and a guide for selection of accounting alternative.

(c) Accounting Conventions: They emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. These are derived from usage and practice and need not have universal application.

(ii) Money Measurement Concept

  • Transactions and events which can be ascertained in monetary terms must from the part of accounting records.
  • Money is considered as yardstick measurement makes the accounting data meaningful and helpful for analysing the financial results of the business organisation
  • Events which may are huge importance but not as certain able in money terms are not recorded in financial statements.
  • The main focus of this concept in on monetary value i.e. the home currency in which the accounts of the enterprise are being prepared. All the transaction must be converted in the home currency and in the same denomination before forming the part of financial statement

(iii) Periodicity Concept

  • The life of business is divided into small parts usually per year so as to analyse the results after each year and also to compare the performance of different years.
  • These small divisions of the life are turned as accounting periods of the business from 1st April to 31st March.
  • The financial statements are prepared on the assumption that the entity is a going concern i.e. it will carry its operation’s for a foreseeable future period. However various uses such as investors, creditors, management, employees are interested to know the current position rather than to wait for a longer period. Thus, due to periodicity concept or accounting period concept they can get the desired information at regular intervals
  • The periodicity concept helps in comparing the financial results of different years. It focuses on matching of periodic expenses with periodic income so as to get true profit for the accounting period.

(iv) Accrual Concept

  • Transactions are recorded at the time when they occur irrespective of the fact that the settlement is on the late date.
  • If any revenue income is received but which does not belong to current period but to next period must not form the pant of current year. Similarly, if any payment is done for expenditure in an earlier year or say next year but the expense pertains to current year, the same must be recorded in the current year itself irrespective of the payment being done in different period company law mandates preparation of accounting books under accrual basis for companies.

For examples:

Mr. A, trader started retail business. During the year he sold goods worth Rs. 60,000 for Rs. 1,20,000 out of which only Rs. 100,000 was collected during the year. He had a closing stock of Rs. 15,000. His other business expenses for the period were Rs. 20,000 out of which Rs. 10,000 was outstanding at the year and ascertain his total profit. In accrual system, revenue and cost should be recognised as they are earned or incurred and not as money is paid or received. So profit would be:

Profit earned for the year sales1,20,000
Less:Purchase cost60,000
60,000
Less:Expenses Incurred20,000
Profit40,000

(v) Matching Concept

  • Linder this concept, expenses incurred for an accounting period are recognised in the period when the related revenue is earned.
  • This makes the owner aware of the progress or shortfall in its business after comparing the performances of different years.
  • To ascertain the true profit of the accounting period, it is important to match the revenue earned for the period with the expenses indurred in earn such revenues.

(vi) Going Concern Concept

  • The financial statements of the enterprise are prepared on the basis assumption that the entity is a going concern i.e. it will carry on its business operations for a foreseeable future.
  • It is assumed that there is no intention that the business will stop its operations is the near future and thus the expenses are classified as revenue expenditure and capital expenditure. Revenue expenditure are those whose benefits are realised in a short span of time say one year while capital expenses are those the benefit of which is realised in a long run. Use of his concept
  • Depreciation on fixed assets is changed on the basis of useful life of the asset.

(vii) Cost Concept

  • Under this concept assets are recorded at the acquisition cost .

i.e. the price paid at the terms of purchase of such asset. This cost becomes relevant for subsequent years a accounting i.e. changing the depreciation on asset over its useful life.

  • The market value, realisable value, actual worth of assets, etc. are not recognised, hence the value recorded is free from any personal bias of the makers of financial statements.

Merits:

  • Objectivity and reliability of accounting data since the information is not manipulated.
  • Simple and convenient in recording.
  • Consistency in preparation and makes the financial statements comparable.

Demerits: ‘

  • Do not consider the changes in price level due to inflation.
  • Unrealistic profit since revenue is recognised on current value which expense changed on historical cost.
  • Depreciation is changed a lower rates than required for making sufficient provision for replacement.

(viii) Realisation Concept

  • Under this concept revenue is recognised at the point of sale or at the time of reducing of the service such as incase of long term contracts, hire purchase contracts, etc.

(ix) Dual aspect concept

  • Under this concept, all the business transactions have two fold aspects which needs to be recorded in the books of accounts. It is the core of entire accounting system.
  • Every credit entry has an equivalent debit and vice-versa double entry book keeping system is based on this concepts. There is a relationship between assets and liabilities which can be expressed as

Assets = Owner’s Equity + Liabilities Or

Equity = Assets – Liabilities

(x) Conservation:

  • Underthis concept accounting entries are recorded on prudence that all the probable losses must be account for and anticipate no profits.

v This concept presents the realistic financial position of the enterprise without any window-dressing for showing better position that it actually has.

  • It encourages accountants to create provisions, overstate the liabilities and understate the assets in Balance Sheet. However this concept must be applied with caution so that the real results are not the misleading results.
  • The three qualitative characteristic for applying this concept are

(a) Produce

(b) Neutrality

(c) Faithful representation of values.

  • It is due to this concept that stock is shown on cost or market value whichever is lower.

For Example

X traders purchased goods for Rs. 30,00,000 and sold 70% of such goods during the accounting year ended 31st March 2017. The market value of remaining goods was Rs. 6,00,000. As per conservatism, the valuation stock should be valued as cost or market price whichever is lower, i.e. 6,00,000 and not Rs. 9,00,000.

(xi) Consistency

  • Under this concept all the accounting principles and policies methods are applied in a similar manner i.e. consistency in different accounting periods so that the users may make comparison of the performance for different years.
  • The method once chosen for a particular period must be applied in all subsequent periods until change required is for better presentation and disclosures.
  • Any change in a accounting policy must be reflected in notes to accounts attached with balance sheet so as to enable the users to understand the reason for change in a particular item and take rational decisions accordingly.
  • Any change in a accounting policy can be done
  • To comply with law
  • To present books as per the accounting standards
  • to reflect true and fair view in presentation of financial standards.

(xii) Materiality

  • It is a subjective term, an item material for one business may not be material for another. It usually happens due to various factors such as size of business, level of information and person requiring to take decision.
  • Materiality means the relative importance of an item. If the knowledge of a particular item affects the decision of the user it may be said to be material. In other words omission of a material item may lead to incorrect decision making.
  • Under this concept, items of material nature are disclosed separately which in material are ignored or merged with other items.

Q6. What are Fundamental Accounting Assumptions?

Answer:

There are three fundamental accounting assumptions:

(i) Going Concern (ii) Consistency (iii) Accrual.

All the above fundamental accounting assumptions are assumed to be followed in the preparation of financial statements and do not require a mention. However, if any of them is not followed then this fact should be specifically disclosed.

Q7. What are Financial Statements?

Answer:

  • Are the accounting reports prepared to ascertain the financial position and performance of the business at a given point of time.
  • It comprises of Profit and Loss Account which reflects the details of income and expenditure and the net result of such transaction [i.e. Profit / Loss] and Balance Sheet which reflects the details regarding owner’s equity outside liabilities and total assets of the business and cash flow statement which reflects the details of cash inflows and outflows during an accruing period.

Q8. What are Qualitative Characteristic of Financial Statements ?

Answer:

(a) Undefendable:

  • Financial statements must be prepared in such manner that the information can be easily understood by the users.

(b) Relevance:

  • Information must be relevant i.e. it must be communicated at the time it was required for decision making.
  • It should be able to influence the decision of user and helpful in analysing the financial position.

(c) Reliable:

  • Financial information used to prepare accounting statements must be from reliable source such as evidenced by proper supporting document such as sale bills, vouchers, etc.
  • Unreliable information may result in misleading result which may adversely affect the user.

(d) Comparable:

  • Financial statement must be comparable, i.e. it should be prepared by following relevant accounting standards, and policies so that users could compare the performance of different organisations.
  • Any changes in accounting policies must be communicated along with the monetary effect to the users requiring such statements.

(e) Material:

  • If the detail of any particular item influences the decision making of user such details is said to be material.
  • Materiality depends upon certain factors such as size of business, user statement etc.
  • AU the material facts must to disclosed in financial statement.
  • Omission of paise and showing the round figure is based on this concept.

(f) Representation:

  • Due to certain inherent limitations of accounting there are instances where adequate disclosure regarding particulars transactions may

. not be given.

  • Information or figures projected in various statement should truly represent the business. No under or over presentation of organisation’s position should be projected.
  • If any information given in statement is subject to risk of error, the certainty of such risk should be mentioned so as to make users act accordingly.

(g) Substance overform:

  • Transaction must be recorded in financial statement on the economic substance i.e. for recording the transactions a proper judgement should be made to present it in the best manner to reflect the true essence of transaction and the legal aspects may have to be given less attention to give true and fair disclosure of business affairs.

(h) Neutrality:

  • Information is financial statement must be free from personal bias.
  • Faithful representation of transactions in the financial statement makes the statement reliable.

(i) Prudence:

  • Is the degree of caution for making judgements recording any particular item of income or expense
  • Prudent concept is described as “Don’t anticipate profit, but provide for all possible losses”

(j) Completeness:

  • Transactions must be recorded properly so that the complete information is displayed about the nature of such transaction in financial statements.
  • If any omission of information misleads the decision making of user, it is said that the information is incomplete and hence not reliable.

(k) Trues & Fail Disclosures:

  • All the information relevant for decision making of user must be fully disclosed in the financial statements.
  • Financial statements must be prepared on the basis of ‘Generally Accepted Accounting Principles’ GAAP, so as the users could rely on its preparation.
  • Proper disclosure of accounting policies, contingent liabilities and other relevant information necessary to understand the statement must be given.

Questions for Practice and Conceptual Clarity only (The questions below have been given for building the basics and increasing knowledge of the students)

Multiple Choice Questions

  1. Provision for bad and doubtful debts is result of:

(a) Conservatism concept

(b) Going concern concept

(c) Disclosure concept

(d) Consistency concept

  1. Recording of Fixed Assets at Cost ensures adherence of:

(a) Conservatism

(b) Cost Concept

(c) Going Concern Concept

(d) Accrual Concept

  1. Fundamental Accounting Assumptions are:

(a) Going Concern, Conservatism, Accrual

(b) Going Concern, Matching, Consistency

(c) Going Concern, Consistency, Accrual

(d) Going Concern, Entity, Periodicity

  1. When Fixed assets are sold:

(a) Total assets will increase

(b) Total liabilities will increase

(c) Total assets will decrease

(d) There is no change in total assets

  1. The Accounting Equation is based on:

(a) Going Concern Concept

(b) Dual Aspect Concept

(c) Money Measurement Concept

(d) All of these

  1. __________ Concept is the basic idea that the business is separate from owner.

(a) Dual Aspect

(b) Entity

(c) Realization

(d) Materiality

  1. The owner of a company included his personal medical expenses in the company’s income statement. Indicate the principle that is violated.

(a) Cost principle

(b) Conservatism

(c) Disclosure

(d) Entity Concept

  1. Two primary qualitative characteristics of financial statements are:

(a) Understandability and Materiality

(b) Relevance and Reliability

(c) Materiality and Reliability

(d) Relevance and Understandability

  1. Money owed from an Outsider is a:

(a) Asset

(b) Liability

(c) Expense

(d) Capital

  1. Cost of Machinery Rs. 10,00,000

Installation charges                              Rs. 1,00,000

Market Value on 31.3.06                   Rs. 12,00,000

While finalizing the accounts, if the company values the machinery at Rs.12,00,000. Which concept is violated by the Company?

(a) Cost

(b) Matching

(c) Realization

(d) Periodicity

  1. Capital as on 1 -4-05 Rs. 90,000

Capital introduced                                   Rs. 25,000

Drawings made                                       Rs. 35,000

Capital as on 31 -3-06                          Rs. 1,25,000

What is the amount of profit added to the Capital?

(a) Rs. 50,000

(b) Rs. 60,000

(c) Rs. 75,000

(d) Rs. 45,000

  1. GAAP’s are:

(a) Generally Accepted Accounting Policies

(b) Generally Accepted Accounting Principles

(c) Generally Accepted Accounting Provisions

(d) None of these

  1. __________ refer to the general agreement on the usage and practices in social or economic life:

(a) Accounting Assumptions

(b) Accounting Conventions

(c) Accounting Policies

(d) Accounting Principles

  1. Double Entry Principle means:

(a) Writing twice the same entry

(b) Writing ail the entries twice in the book

(c) Having debit for every credit and credit for each debit

(d) All of the above

  1. No inference of profit and the provision making policy for all possible losses is due to:

(a) Convention of Consistency

(b) Convention of Conservatism

(c) Convention of Disclosure

(d) Convention of Materiality

  1. The underlying accounting principle necessitating amortization of Intangible Assets is/are:

(a) Cost Concept

(b) Realization Concept

(c) Matching Concept

(d) Both ‘b’ and ‘c’

  1. “Holding gains in relation to stocks should not be used for payment of dividend.” Which one of the following accounting principle is involved in this?

(a) Consistency

(b) Cost

(c) Materiality

(d) Realization

  1. If Going Concern Concept is no longer valid, which of the following is true?

(a) All prepaid assets would be completely written off immediately

(b) The allowance for uncollectible accounts would be eliminated

(c) Intangible assets would continue to be carried at net amortized historical cost

(d) Land held as an investment would be valued at its realizable value

  1. Ram starts business with Rs. 90,000 and then buys goods from Shyam on credit for Rs. 23,000. The accounting equation based on Assets = Capital + Liabilities will be:

(a) 1,13,000 =90,000 + 23,000

(b) 1,13,000 = 1,13,000 + 0

(c) 90,000 = 67,000 + 23,000

(d) 67,000 = 90,000-23,000

  1. Window dressing of Accounts means:

(a) Presenting accounts in beautiful manner

(b) Showing more losses to avoid Income Tax

(c) Showing more profits to attract Investment

(d) All of the above

  1. Which financial statement represents the accounting equation

ASSETS=LIABILITIES+OWNER’S EQUITY

(a) Income Statement

(b) Cash Flow Statement

(c) Balance Sheet

(d) Funds Flow Statement

  1. Ram purchased a car for Rs. 10,000 paid Rs. 3,000 as cash and balance amount will be paid in three equal installments. Due to this:

(a) Total assets increase by Rs. 10,000

(b) Total liabilities increase by Rs. 3,000

(c) Assets will increase by Rs. 7,000 with corresponding increase in liability by Rs. 7,000

(d) Both (b) and (c)

  1. During life-time of an entity accountants prepare financial statements at arbitrary points of time as per:

(a) Prudence

(b) Consistency

(c) Periodicity

(d) Matching

  1. The Accounting Convention of Matching means:

(a) Profit for the period to be matched with sales revenue

(b) Profit for the period to be matched with investment

(c) Expenses of one period to be matched against the expenses of another period

(d) Expenses of one period to be matched against the revenue of the same period

  1. Recording of capital contributed by the owner as liability ensures adherence of principle of

(a) Matching

(b) Going concern

(c) Double entry

(d) Separate entity of business

  1. Omission of paise and showing the round figures in financial statements is based on:

(a) Conservatism concept

(b) Consistency concept

(c) Materiality concept

(d) Realization concept

  1. Accounting does not record non-financial transactions because of:

(a) Accrual concept

(b) Cost concept

(c) Continuity concept

(d) Money Measurement concept

  1. Which of these is not a fundamental accounting assumption?

(a) Going concern

(b) Consistency

(c) Conservatism

(d) Accrual

  1. Fixed assets and Current assets are categorized as per concept of:

(a) Separate entity

(b) Going concern

(c) Consistency

(d) Time period

  1. The obligations of an enterprise other than owner’s fund are known as:

(a) Assets

(b) Liabilities

(c) Capital

(d) None of these

  1. Which concept requires that those transactions which can be expressed in terms of money should be recorded in books of account?

(a) Business Entity

(b) Dual Aspect

(c) Money measurement

(d) None of these

Answer

1.(a)2.(b)3.(c)4.(d)5.(b)
6.(b)7.(d)8.(b)9.(a)10.(a)
11.(d)12.(b)13.(b)14.(c)15.(b)
16.(c)17.(d)18.(d)19.(a)20.(c)
21.(c)22.(c)23.(c)24.(d)25.(d)
26.(c)27.(d)28.(c)29.(b)30.(b)
31.(c)

Short Practice Questions

  1. Write Short Notes on

(i) Entity Concept

(ii) Periodicity Concept

(iii) Accrual Concept

(iv) Fundamental Accounting Assumptions

(v) Accounting Convention

(vi) Materiality Concept

  1. Discuss accounting conceptbased on presumption that do not anticipate profits but provide for all probable losses.

[Hint: Refer Question 5 Part (x)]

  1. What is the importance of adopting consistency concept in preparation of financial statement.

[Hint: Refer Question 5 Part (xi)]

  1. What is a financial statement enumerate its characteristics.

[Hint: Refer Question 7]

Past Year Questions and answers

Objective Questions

1996 – Nov [5] State with reasons whether the following statement is True or False.

  1. In accounting all business transactions are recorded as having dual aspect. (2 marks)

Answer:

True: Being associated with the system of double entry book keeping, every transaction has a two-fold effect in accounting whereby one account is debited and another is credited by the same amount.

1998 – May [5] State with reasons whether the following statement is true or false:

(7) Accrual concept implies accounting on cash basis. (2 marks)

Answer:

False: Accrual concept implies accounting done on due or accrual basis. It involves the recognition of revenues and costs as they accrue irrespective of the actual receipts or payments.

1999 – Nov [5] State with reasons whether the following statement is true or false:

(iii) Companies can keep their accounts under cash basis. (2 marks)

Answer:

False: It is mandatory for companies to keep their accounts under accrual basis as per the provisions of Company Law.

2003 – May [5] State with reasons whether the following statements are true or false:

(ii) The value of human resources is generally shown as assets in the Balance Sheet. (2 marks)

(iii) Revenue are matched with expenses in accordance with the matching principle. (2 marks)

(iv) The financial statement must also disclose the relevant and reliable information in accordance with the Full Disclosure Principle. (2 marks)

Answer:

(ii) False: The human recourse still cannot be defined in terms of money.

(iii) True: The matching concept involves that the revenue earned in an accounting year is matched with the expenses incurred during the same period to generate that revenue.

(iv) True: The financial statement must also disclose the relevant and reliable information as per AS-1 i.e. Disclosure of Accounting policies.

2003 – Nov [5] State with reasons whether the following statement is true or. false:

(ii) The economic life of an enterprise is artificially split into periodic intervals in accordance with the going concerns assumption. (2 marks)

Answer:

True: As it facilitates the determination of revenue and expenses of a specific period.

2004 – Nov [5] State with reasons whether the following statements are true or false:

(i) Accounting principle is general rule followed in preparation of Financial Statements. (2 marks)

(ix) Capital is equal to assets less external liabilities. (2 marks)

Answer:

(i) True: Accounting principles suggests the rules of action, which are universally accepted by the accountants for the recording of accounting transactions.

(ix) True: Capital + Reserves & Surplus (internal liabilities) = All Assets – External Liabilities

2005 – Nov [5] State with reasons whether the following statement is true or false:

(ii) As per the concept of conservatism, the accountant should provide for all possible losses, but should not anticipate income. (2 marks)

Answer:

True: Concept of conservation states that the accountants should not anticipate income and should provide for all possible losses.

2006 – Nov [5] State with reasons whether the following statement is true or false:

(ix) All significant accounting policies adopted in preparation and presentation of financial statements must be disclose. (2 marks)

Answer:

True: Disclosure of significant accounting policies must form part of the financial statements and these policies must be disclosed separately, at one place in annual report e.g., policies relating to valuation of inventory, deprecation accounting, etc.

Short Notes

1996 – May [6] Write short note on of the following

(2) Fundamental Accounting Assumptions (5 marks)

Answer:

Fundamental Accounting Assumptions: Fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed. The Institute of Chartered Accountants of India issued Accounting Standard (AS 1) on ‘Disclosure of Accounting Policies’ according to which the following have been generally accepted as fundamental accounting assumptions:

  1. Going concern: The enterprise is normally viewed as a going concern, i.e. as continuing operations for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.
  2. Consistency: It is assumed that accounting policies are consistent from one period to another.
  3. Accrual: Revenues and costs are accrued, i.e. recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate.

1998 – Nov [6] Write short note on the following:

(i) Going concern concept. (5 marks)

Answer:

Going concern concept: It means that the business will go on indefinitely i.e. the business is not going to be liquidated in foreseeable future. This concept is a fundamental to the accounting theory. The Balance sheet is prepared on the basis of this concept and the prepaid expenses are shown as assets in the B/S because of this concept only. The creditors supply the goods and services expecting the continuation of business for a long period.

2000 – May [6] Write short note on the following:

(a) Periodicity Concept. (5 marks)

Answer:

The life of business is based on going concern assumption and the measurement on the basis of this assumption is not possible for a long period. The owner cannot wait for such a long time, so a small workable fraction of time is selected from an unending life cycle of the business enterprise for measuring the performance and looking at the financial position. Generally, a period of one year is taken for measuring and appraising the performance of the financial position. Thus, the periodicity concept makes the accounting system and the term ‘accrual’ workable.

2003 – Nov [6] Write short note on the following:

(b) What is- meant by Accounting Policies? Give four examples of Accounting Policies? (5 marks)

Answer:

Accounting Policies:

Accounting policies means specific methods or principles of accounting adopted by an enterprise for a particular transaction or event in the preparation and presentation of financial statements. While adopting a particular accounting policy, main consideration should be to prepare financial statement so as to represent true and fair view of the state of affairs of the enterprise.

For e.g.

  1. Valuation of fixed assets, stock, goodwill, investment, etc.
  2. Method of depreciation, amortization.
  3. Treatment of goodwill, contingent liabilities.
  4. Conversion of foreign currency items.

2004 – Nov [6] Write short note on the following:

(iii) Accounting Convention. (5 marks)

Answer:

Accounting Convention: In order to make universally accepted system of book keeping system some principles or conventions are used by the all accountants.

Some of the most fundamental principles/conventions are as follows:

(1) Separate entity principle: It means that the business is treated as a separate and distinct from the proprietor. All the transactions of the business are recorded in the books of the business from the point of view of the business as an entity. The proprietor is treated as a creditor to the extent of his capital

(2) Going concern principle: Means that business will go on indefinitely, i.e. business is not going to be liquidated in foreseeable future. This concept is fundamental to accounting theory. Following points signify the importance of this concept

(i) On the basis of this concept we prepare Balance Sheet.

(ii) Prepaid expenses are shown as assets in the balance sheet only because of this concept.

(3) Money measurement principle: Means that only those transaction, which can be expressed in terms of money, are recorded in the books of account. It implies that transactions or fact, which cannot be expressed in terms of money, are not recorded in the books of accounts, though they may be very useful for the business.

This concept makes the accounting data homogenous and helps in understanding the affairs of the business.

(4) Cost concept: Closely related to going concern concept. According to the concept, assets are recorded in the accounting records at the price paid to acquire them and the cost will be the basis for all subsequent accounting for the asset.

The cost concept does not mean that the asset will always be shown at cost. It has also been stated above that cost becomes the basis for all future accounting for the asset. It means that asset is recorded at cost at the time of it’s purchase about it may systematically be reduced in it’s value by charging depreciation.

The become largely irrelevant for judging the financial position of the business. This is the reason for the growing importance of inflation accounting.

(5) Dual Aspect Principle: It is the core of accounting according to this principle, all business transactions involve two fold aspects and both the aspects have to be recorded in the books of account.

In order to understand this principle, it is necessary for us to understand simultaneously the meaning of three terms (i) Assets (ii) Capital (iii) Creditors (External liabilities).

Since total assets of the business are acquired out of the money contributed by the proprietors and creators of the business, it is easy to express the effects of the transaction as under.

Capital + Liabilities = Assets

The above relationship is known as the “Accounting Equation.”

Note: Since all this is looked at from the business point of view, there is a dual aspect of all transactions.

The system of recording transaction based on this concept is called “double entry system”.

(6) Accounting Period Principle: Suggests that life of the business is divided into appropriate segments for studying the results shown by the business after segmentation. This is because though the life of the business is considered to be indefinite, the measurement of income and studying the financial position of the business after a very long period would not be helpful in taking proper corrective steps at the appropriate time interval, the business-man must ‘stop’ and ‘see back’ how things are going on. In accounting such a segment or time interval is called accounting period. It is usually of one year.

This concept facilitates the preparation of financial statements. The principle of segregating capital expenditure from revenue expenditure is based on this concept. At the end of each accounting period, an income statement disclosing the income of business is prepared. Alongwith income statement, a statement of financial position i.e. Balance Sheet is also prepared.

(7) Periodic matching of Cost and Revenue Principle: This is based on the accounting period concept. The paramount objective of running a business is to earn profit. In order to ascertain the profit made by the business during a period, it is necessary that revenues of the period should be matched with the cost of the period.

(8) Realization Principle: It is related to recognition of revenues. According to this concept, revenue should be recorded only when it is realized. When the property in goods or services are passed to the buyer and he becomes legally liable to pay.

(9) Consistency Principle: Accounting rules, practices and conventions should be continuously observed and applied i.e. these should not change from 1 year to another. Continuation of one practice for a number of years indicate consistency e.g. if an asset is depreciated on diminishing balance method in 1 year the same method of depreciation be adopted in other year also.

(10) Disclosure Principle: According to this convention, financial statements should be honestly prepared and to the end full disclosure of all significant information should be made. All information which is of material interest to proprietor, creditors and investors should be disclosed in the financial statements.

(11) Conservatism Principle: Conservatism means taking the gloomy side of the situation. Future is uncertain. Though an estimate is made about future events and circumstances, but no one can guess the future with perfect certainty in business. Hence, some arrangements or provision is made to meet the future uncertainties. Every sincere business makes an estimate of future loss and then some provision for it is made such as provision for bad debts. Businessmen mostly ignore the items of future profit. This tendency is termed as conservatism and it is very natural tendency and is in existence since long.

(12) Materiality Principle: According records should be made of all material facts and immaterial items may be mixed out with material items and then recorded or they may be ignored. This is a convention. Materiality is a very important convention which occupies not only a key position in accounting but forms a base for accounting.

2005 – Nov [6] Write short notes on the following:

(i) Accrual basis of Accounting. (3 marks)

(ii) Qualitative characteristics of Financial Statements. (3 marks)

Answer:

(i) Accrual basis of Accounting: Accrual or mercantile basis of accounting refers to a system of recording revenues and expenses whether or not they have been received or paid in cash at the time of recording.

Accounting on accrual basis signifies that owner’s equity is effected by the profit earned or loss suffered by an enterprise during the accounting period and not as money is received or paid.

Therefore, while ascertaining the profit or loss, not only those expenses which have been paid in cash should be considered, but also expenses which have become due though not paid should be taken into account.

Similarly all the incomes earned during the accounting period should be considered whether they have been received in cash or not.

(ii) Qualitative Characteristics of Financial Statements: Financial statements have some qualitative characteristics so that they may provide more information to the users. These are the qualitative characteristics of financial statements:

(1) Understandability;

(2) Relevance;

(3) Reliability; and

(4) Comparability;

(5) Faithful Representation;

(6) Completeness.

(1) Understandability: Required quality of information should be provided so that financial statements become more understandable for users. For this reason, it is assumed that users have a reasonable knowledge of business and economic activities and they study information with reasonable diligence. Information regarding complicated matters should be included in the statement because of it’s relevance to the economic decision-making needs of the users and it should not be excluded merely on the ground that it may be too difficult for some users to understand.

(2) Relevance: Incorporate that information in the financial statement which is relevant for decision making. Quality of relevance of the information is determined when it influences the economic decisions of users.

(3) Reliability: Information must be reliable. Level of reliability of the information is high when it is free from material errors and biased decisions. Information may be relevant but so unreliable in nature or representation that its recognition may be badly misleading.

(4) Comparability: Financial Statements should be prepared in such a way that users of the financial statements must be able to compare their information with other information or financial statements in order to identify trends in performance, Cash flows, and financial position.

(5) Faithful Representation: Information must be represented faithfully so that its degree of reliability is high.

(6) Completeness: In order to present more reliable information in the financial statements it must be complete within the boundary of materiality and cost. An omission of information may cause information to be false or misleading and therefore unreliable and deficient in terms of relevance.

2006 – May [6] Write short note on the following:

(i) Fundamental Accounting Assumptions. (5 marks)

Answer:

Please Refer 1996 – May [6] (2) on page no. 53

2006 – Nov [6] Write short note on of the following:

(i) Money measurement concept             (5 marks)

Answer:

Money measurement concept: Accounting records only those transactions which are expressed in monetary terms. As per this concept a transaction is recorded in terms of money. 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 are only to be recorded in the books of account. Money i.e., the ruling currency of a country provides a common denomination for the value of material objects.

Distinguish Between

2019 – June [1] (b) Distinguish between Going Concern concept and Cost concept. (4 Marks)

Answer:

Distinction between Going Concern and cost concept Going Concern Concept:

The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue operation for the foreseeable future. Hence, it is assumed that enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations.

If such intention exists the statements will have to prepared on different basis, and such the basis so used should be disclosed valuation of assets of an entity is based on this assumption. Accountants follow historical cost in majority cases.

Cost Concept:

By this concept, the value of an asset is to be determined on the basis of historical cost, in other words, acquisition cost. Accountants prefer this concept in the interest of objectivity.

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