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Accounting Concepts, Principles and Conventions CA Foundation Notes

Accounting Concepts, Principles and Conventions- CA Foundation, CPT notes, PDF

Accounting Concepts, Principles and Conventions

Accounting Concepts, Principles and Conventions

INTRODUCTION:

Usually, accounting theories are referred to as Postulates, Concepts, Principles, Doctrines, Axioms, Rules, Standard, Assumptions, Canon, etc. These are basic assumptions & norms on which the whole system of accounting is developed. These give the basic structure & outline within which the procedures & systems can be varied as per the situation & need of an entity.

2.1       ACCOUNTING CONCEPTS:

2.1.1    Meaning:

♦     Accounting Concepts is generally used to mean a ‘Notion’ only or mental idea about something.

♦     It is a principle that is taken to be self-evident or axiomatic which has already been proved to be true.

♦     In other words, it may be an assumption or axiom constituting the supposed basis of a system.

♦     It is considered to be of a more fundamental character and universally acceptable which may be applied in all possible cases. It will have greater general applicability.

♦     These postulates are either descriptive or suggestive.

♦     There is no authoritative list of these concepts.

2.1.2    Important Accounting Concepts:

The following are some of the important & generally acceptable concepts:

(1)   Periodicity Concept:

♦     Accounts are prepared for a fixed period usually a year.

♦     Only transactions of that period have to come in that year’s accounts.

♦     A period is kept uniform so that results are comparable.

♦     1st Accounting period may be usually more or less than 12 months.

♦     A business entity runs continuously hence to assess its performance and see the financial position on a regular basis, it is broken up into smaller, uniform time periods known as the accounting period.

♦     Now the Income-tax Act & Companies Act, 2013 both require the Accounting year to be from 1st April this year to 31st March of next year.

(2)   Business Entity Concept:

♦     A distinction is made between the concern & its owner.

♦     Only those transactions which affect the concern are recorded in its books of account i.e. transactions affecting owner but not the concern will not be recorded in concerns books.

Although we will study accounting of business concerns, in the same manner, personal account books can also be maintained by any individual.

(3)   Cost Concept:

♦     The assets & properties are recorded at its cost to the concern & not at its market value.

♦     Except for stock which may be valued at cost or market price whichever is lower.

♦     As per this concept, Fixed assets are recorded at their acquisition cost & then depreciated over its useful life.

♦     Ex.: Building purchased for Rs. 10 lakh. Its market value is Rs. II lakh. In account book building will be recorded at cost i.e. Rs. 10 lakh,

(4)   Dual Aspect Concept /Accounting equations:

♦     Each transaction has a double effect of equal amounts on Assets, I labilities and Capital.

♦     Therefore at any time, the accounting equation is: Assets = Liabilities + Capital or Capital = Assets – Liabilities

♦     In other words, capital, i.e. the owner’s share of the assets of a firm, is always what is left out of assets after paying off outsiders.

♦     Due to this dual aspect, we have a double-entry system of accounting.

(5)   Money Measurement Concept:

♦     Accounting records only those transactions which are expressed in monetary terms.

♦     Although quantitative records are also kept as subsidiary records but that is not part of financial account books.

♦     The use of a building (depreciation or rent) and the use of clerical services (salaries) can be added up only through money values and not otherwise.

♦     Ex. Loss of a Managerial Personal cannot have a specific monetary value, hence it cannot be recorded in account books, although it is a significant event.

(6)   Realization Concept:

♦     Income is accounted for only when it is realized.

♦     Realized means cash is received or a right to receive is established.

♦     Ex. A sale is recognized as income even when the amount is not yet collected.

♦     Income recognition (i.e. accounting) is postponed when there is no reasonable certainty of realisability.

(7)   Accrual Concept:

♦     The expenses or Income of periodic nature accrues on day to day basis.

♦     Therefore we make provision for interest etc. up to the last date of the accounting year although it may become due/payable on a later date.

♦     Following the accrual concept means following the mercantile system of accounting.

♦     Examples of such items are Interest, Rent, Salary, Depreciation, etc.

♦     As per the accrual concept/Mercantile system, income & expenses should be recognized.

♦     In the accounting period to which they relate.

♦     Not in the period in which actual money is received or paid.

♦     Ex. Loan Rs. 10 lakh taken on 1.1.06 @ 15% interest. Interest is payable annually. The accounting year ends on 31.3.06.

Ans. Interest for 3 months from 1.1.06 to 31.3.06 Rs. 37,500 will have to be accounted even though it is neither paid, nor due, but only accrued.

Accrual is a Fundamental accounting assumption.

(8)   Going Concern Concept:

♦     It implies that the concern will be continuing the business 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.

♦     II such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis is disclosed.

♦     Because of this, expenditure is divided into capital & Revenue expenditure & the fixed Assets are valued at cost less Depreciation.

♦     Because of this account of the whole life is divided into smaller accounting periods (periodicity concept).

Going concern is a fundamental accounting assumption.

(9)   Matching principle:

♦     If any income is credited in the P & L A/c then all expenses incurred or to be incurred for earning this income, should also be debited in the same year’s P & L A/c.

♦     Similarly, if expenses are debited the corresponding income should also be credited in the same P&L A/c.

♦     To meet this requirement we make provision for closing stock, outstanding/prepaid expenses & outstanding/Advance income.

♦     Future incomes are not anticipated rather related expenditures are carried forward to a future periods like prepaid expense & closing stock.

♦     If income is pre-posed for matching, it will he violation of realization Concept & will also be against prudence principle.

(10) Substance over form :

♦     As per the concept of Substance over form, the transaction should be recognized as per the economic reality of the transaction & not mere legal form.

Ex.: A sales land to ‘B’ and gives possession of the land to B & receives full consideration. But sale deed is not yet registered for want of NOC from the local authority.

Ans.: As per substance over form concept, A should recognize the sale of land and consequent profit or loss and B should recognize Land as an asset in its books. Both will make suitable disclosure in notes to accounts.

2.2 ACCOUNTING PRINCIPLES:

♦     Accounting principles are the norm or rules which are to be followed in treating various items of Assets, Liabilities, Expenses, Incomes, etc.

♦     Ex. (i) Inventory should be valued at lower of cost & net reliable value, (ii) Fixed Assets should be depreciated over its useful life, (iii) Valuation norms for current & permanent investments, etc.

♦     An accounting principle can have alternative methods to apply it. Like in case of the inventory we have methods of cost measurement by FIFO or weighted average.

2.3 ACCOUNTING CONVENTIONS:

2.3.1    Meaning:

♦     It refers to the general agreement on the usage and practices in social or economic life, i.e., it is a customary practice, rule, method or usage.

♦     In other words, it is an accounting procedure followed by the accounting community on the basis of longstanding customs.

2.3s.2 Accounting Conventions are as follow:-

  1. Convention of Disclosure:

♦     All material information which is relevant for the proper disclosure of true & fair position should be disclosed prominently in the accounts & financial statements.

♦     Disclosure of specified information is required by law and by Accounting Standards also, which is the minimum disclosure.

  1. Convention of Materiality:

♦     All material i.e. important/significant items or information should be properly accounted & disclosed in the accounts & financial statements.

♦     That means immaterial items can be given a convenient accounting treatment.

♦     Ex. Stationery, Postage, such items are treated as an expense in the period of purchase even though some unconsumed balance may be there.

  1. Convention of Consistency:

♦     Consistency means the same Accounting principles & policies are followed, which were followed for preparing the previous year’s accounts.

♦     Same accounting principles & policies should be followed consistently from year to year unless the change is required:

■     to comply with some legal/statutory requirement or

■     to comply with Accounting Standards or

■     to show better information.

■     This consistency makes the information about different accounting year, comparable.

It is a fundamental accounting assumption.

  1. Convention of Prudence/Conservative approach:

♦     An accountant is supposed to be conservative therefore expenses or losses are provided if there is a possibility of its occurrence, but incomes are provided only if there is the certainty of its earning.

♦     It is an application of caution while estimating & accounting, such that expense & liabilities are not understated & income & assets are not overstated.

♦     But it does not justify the Creation of hidden reserve by deliberate understatement of Assets & incomes & overstatement of Liabilities & expenses.

2.4 FUNDAMENTAL ACCOUNTING ASSUMPTIONS:

♦     Fundamental accounting assumptions underline 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)’Disclosure of Accounting Policies’ according to which the following have been generally accepted as fundamental accounting assumptions:

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

 

*This article contains all topics about Accounting Concepts, Principles and Conventions.

For notes on all CA foundation topics, you can visit this article CA foundation note

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