Accounting principles or basis may be defined as those rules of action or
conduct, which are followed by the accountants universally while recording the
transactions. Thus the uniformity in understanding the accounting records is
possible only when some standard language is used.
With a view to making the
accounting language a standard language, certain accounting principles concepts
and conventions have been developed over a course of period, so that affairs of
a business concerns are made understood to others as well as to those who own or
manage it. Accounting principles can be divided into two kinds.
- Accounting Concepts.
- Accounting Conventions.
These are certain basic assumptions according to which accounting work is
conducted. Accounting is the language of the business. In accountancy some words
or phrases are used in a special sense. Accounting work is conducted on certain
rules and regulations based on these words or phrases. For examples, in accounting it is assumed that a business concern will continue for an indefinite
period (going concern concepts) each transaction involves two parties, (dual
aspects concepts). Thus the accountant must have thorough knowledge about the
concepts. The following are the important accounting concepts:
- Business entity concept.
- Going concern concept.
- Cost concept.
- Money measurement concept.
- Dual aspect concept.
- Accounting period concept.
- Realization concept.
- Matching concept
Business Entity Concept:
According to this concept, the business is treated as a unit or entity
separate form its owners, creditors and others. All the transactions of the
business are recorded in the books of accounts from the
point of view of the business as an entity and even the owner is regarded as a
creditor to the extent of his capital. The concept of separate entity is
applicable to all forms of business organizations. Without such a distinction, the
affairs of the business will be mixed up with the private affairs of proprietor
and the true picture will not be available.
Going Concern Concept:
Under this concept it is assumed that a business concern will continue for an
indefinite period and the transactions are recorded in the books. Keeping in
view this concept, it is assumed that the enterprise has neither the attention
nor the necessity of liquidation of curtailing the scale of the operations.
If this assumption is not followed, the fact should be disclosed with reasons. Due to this concept, fixed assets are depreciated on their
expected life rather than on the basis of market value.
Dual Aspect Concept:
This principle is the core of accountancy. All business transactions are
recorded as having a dual aspect. Under this concept "for every debit, there is
a credit." For example, Mr. X the proprietor of the business, starts his
business with cash $100,000 and building worth $200,000 then this fact
is recorded at two places assets account and capital account. The capital of
the business is equal to the assets of the business. This expression can be
shown in the form of equation as under:
Capital = Assets
Capital = Building + Cash
300,000 = 200,0000+100,000
If the business increases the assets by borrowing $20,000 then the dual aspect of the this transaction affects the equation as
Capital + Liabilities = Assets
Capital + Loan = Building + Cash
300,000 + 200,000 = 200,000 + 120,000
Briefly the dual aspect can be
expressed as under:
Capital + Liabilities = Assets
The system of recording the transactions based on this concept is called "double
The basic idea of the cost concept is that asset is recorded at the price paid
to acquire it and this cost is the basis for all subsequent accounting for the
asset. The assets recorded at cost price at the time of purchase are
systematically reduced by the process called depreciation. These assets will
ultimately disappear from the balance sheet when there economic life is over and
they have been fully depreciated and sold as scrap. The cost also implies that
if nothing has been paid for acquiring something then it would not be shown in
the accounting books as an asset. The underlying' principle of the cost concept
is that fixed assets are shown at cost price and not at the market price. Under
this concept the records become more reliable, comparable and truthful.
Money Measurement Concept:
This concept underlines the fact that only those transactions, which are
expressed in monetary terms, are recorded. In other words those transactions or
events, which cannot be expressed in terms of money are not recorded in the
books though they may be very useful for the business. For example, if a
business has an efficient dedicated manager, it is definitely an asset to the
business, but since the monetary measurement is not possible of this fact so it
is not shown in the books. In view of the above condition this concept puts a
serious handicap on the usefulness of accounting records for management.
Accounting Period Concept:
Since the life of the business is assumed to be indefinite (going concern
concept) the measurement of the income, according to the above concept, is not
possible for a very long period. The proprietor of the business cannot wait for
such a long period as the determination at the end of the life of the business
would render such a measurement of income useless. It will be too
late to take corrective steps at the time.
Thus it is necessary to know at frequent intervals "how the things are going".
Therefore, accountants choose some shorter and convenient time for the
measurement of the income. Twelve months period is usually adopted for this
purpose. This time interval is called accounting period. The accounting period
can begin on any day.
Revenue is considered as earned on the day, which is realized, and this is when
goods are transferred to the customers in exchange for a valuable consideration.
The accountants usually use the date, the product is shipped to the customer or
the date of the invoice whichever is the better. This is of great importance in
stopping business firms from inflating their profits by recording sales and
incomes that are likely accrue. Unless money has been realized either cash has
been received or legal obligation to pay has been assumed by the customers. No
sale can be said to have been taken, and no profit or income can be said to have
It is the recognized fact that the desire of making profit is the most
important factor to keep the proprietor engaged in business activities. In order
to ascertain the profit the expenses are compared with revenue. The revenues and expenses of those particular periods are
matched. In determining the net income from business all costs that are
applicable to revenue of the period should be charged against that revenue. A
distinction between capital and revenue incomes and expenditure is also
necessary. Therefore, the revenue and expenses of one year are usually
considered for this purpose and the basic equation for ascertaining the income
Revenue- Expenses = Net Income
In practice, certain universally accepted rules, customs or traditions have been
developed with or without the knowledge of accountants. All these rules, customs
and traditions are called accounting conventions, which guide the accountants in preparing the accounting statements. Nobody can challenge the
justifiability of these conventions and apply them unhesitantly in accounting
work. For example, the left hand side of an account records debit transaction
and the right hand side, credit transactions, a period of 12 months is taken as
The following are the important accounting conventions:
- Convention of consistency
- Convention of conservatism
- Convention of disclosure
- Convention of materiality
Convention of Consistency:
Consistency is a fundamental assumption. Under this convention it is assumed
that accounting practices and policies are consistent from one period to
another. For example if the deprecations charged on fixed assets according to
the diminishing balance method, it should be done year after year. If due to
unavoidable circumstances changes become necessary, the change and its effect
should be stated clearly. In order to enable the management to draw important
conclusions regarding the work of the company over a number of years, it is essential that accounting practices and methods remain unchanged from one
accounting period to another. The comparison of one accounting period with
another is possible only when the convention of consistency is followed.
Convention of Full Disclosure:
It is very important convention which apart from legal requirements,
demands that significant information should be disclosed. This convention
implies that accounts should be prepared in such a way that all material
information is clearly disclosed to the reader. For example not only various
assets to be stated but also the mode of valuation should be disclosed.
The concept of full disclosure calls not only for disclosure of all financial
facts, but also for the presentation of such facts in a manner that will lead to
their proper interpretation. It should be pointed out that full disclosure calls
for setting forth all matters that are material in nature, not simply more
detail. Disclosure depends on the materiality.
Convention of Conservatism:
This is the policy of playing safe, it takes into consideration all
prospective losses but leaves all prospective profits. Whenever a decision is to be made on the valuation of the
assets, it will generally be decided in favor of that valuation which
underestimates the profits. On account of this convention, the stock in trade is
valued at market or cost price whichever is less. The concept of conservatism
provides time-tested guidelines for making these choices. Under this approach neither
the window dressing i.e. showing a position better than what it is, permitted
nor it is shown substantially worse than what it is.
Convention of Materiality:
An item should be
regarded as material if there is a reason to believe that knowledge of it would
influence the decision of the user of information. According to the principle of
materiality unimportant items are either left out or merged with other items.
Sometimes items are shown as foot-notes or in parentheses according to their
relative importance. It should be noted that an item that is material for one concern may
be immaterial for another. And similarly, an item that is material in one year
may not be material in the next year.