What are Accounting Concepts?
The underlying rules, assumptions, and conditions that establish the parameters and restrictions within which accounting operates are known as accounting concepts. In other words, accounting concepts are generally accepted accounting principles that serve as the foundation for regularly preparing universal financial accounts.
Basic accounting concepts will also assist you in making timely but informed operational decisions on a daily basis. As an entrepreneur, this will save you time and money, two of your most significant resources. Even if you use accounting software for your firm, you need have a basic awareness of these ideas.
Finally, knowing the fundamentals of accounting will help you have productive conversations with your financial advisors as you strategize for your company’s future.
Objectives of Accounting Concepts
- The main objective of accounting concepts is to establish uniformity and consistency in financial statement preparation and maintenance.
- It serves as a foundational idea for accountants in the preparation and maintenance of business records.
- Its goal is to develop a common understanding of the norms or assumptions that all types of companies must follow, allowing for more comprehensive and comparable financial data.
Basic Accounting Concepts
Business Entity Concept: According to the business entity concept, business’s transactions must be recorded separately from those of its owners or other businesses. This necessitates the use of separate accounting records for the organization that are fully free of any other entity’s or the owner’s assets and liabilities. Without this idea, several businesses’ records would be mixed together, making it difficult to distinguish the financial or taxable results of a single company. For example, The only shareholder of a company receives a $1,000 payout. This results in a loss of equity in the company’s books, as well as $1,000 in taxable income for the shareholder.
Money Measurement Concept: The money measurement concept is an essential accounting concept that is based on the premise that a corporation should record only those transactions on the financial statement that can be quantified or described in monetary terms.
Money measurement idea, also known as Measurability Concept, asserts that while recording financial transactions, transactions that cannot be stated in terms of monetary worth should not be recorded.
Periodicity Concept: The notion of periodicity states that an institution or corporation must account for a specific period of time, usually a financial year. The frequency with which financial statements are prepared can range from monthly to quarterly to annually. It aids in the detection of any changes that occur throughout time.
Accrual Concept: The accrual basis of accounting is based on the principle of recording revenues and expenses as they are incurred. The usage of this approach has an impact on the balance sheet, as receivables and payables may be reported even if there is no accompanying cash receipt or payment.
Both generally accepted accounting principles (GAAP) and international financial reporting standards support the accrual basis of accounting (IFRS). Both of these accounting frameworks offer guidance on how to account for revenue and expense transactions when there are no cash receipts or payments to trigger the recording of a transaction under the cash basis of accounting.
Matching Concept: The matching concept is linked to the Accrual and Periodicity concepts. According to the matching principle, the entity must account for just those expenses that are related to the period for which revenue is being examined. It implies that the organization must keep track of both revenue and expenses for the same time period.
Going Concern Concept: A going concern is an accounting term for a corporation that has the financial resources to continue functioning indefinitely unless it can show otherwise. The ability of a corporation to produce enough money to stay afloat or avoid bankruptcy is sometimes referred to by this word. If a company is no longer in operation, it has gone bankrupt and its assets have been liquidated.
Cost Concept: All acquisitions of items (e.g., assets or items needed for expenditure) should be recorded and held in books at cost, according to the cost concept of accounting. As a result, unless otherwise mentioned, if a balance sheet shows an asset at a given value, it should be presumed that this is its cost. For example, If a building is purchased for $500,000, for example, it will remain in the books at that price regardless of its market worth.
Realization Concept: This concept is linked to the concept of cost. The realization idea states that an asset should be recorded at cost until and unless the asset’s realizable value is realized. In practice, it’s true to say that the entity will record the asset’s realized value once it’s been sold or disposed of, as the case may be.
Dual Aspect Concept: According to the dual aspect concept, every company transaction must be recorded in two independent accounts. This idea underpins double entry accounting, which is required by all accounting systems in order to produce trustworthy financial accounts. The theory is based on the accounting equation, which states:
Assets= Equity+ Liabilities
The accounting equation is obvious in the balance sheet, where all assets must equal all liabilities and equity. Most company transactions will have an effect on the balance sheet in some form, therefore at least one portion of every transaction will involve assets, liabilities, or equity.
Conservatism Concept: When there is uncertainty about the outcome, the conservative principle states that expenses and liabilities should be recognized as soon as feasible, while income and assets should only be recognized when they are guaranteed to be received. When offered a choice between numerous events with equal probabilities of occurrence, you should acknowledge the transaction that results in a smaller profit, or at the very least a profit deferral. Recognize the transaction resulting in a lower recorded asset valuation if a choice of outcomes with similar probabilities of occurrence may effect the value of an asset.
Consistency Concept: According to the consistency principle, businesses should employ the same accounting procedures or principles throughout their accounting periods so that users of financial statements or information can draw meaningful inferences from the data.
The consistency concept is important for determining company patterns that span multiple accounting periods. If a company’s accounting techniques are constantly changing, it will cause confusion and financial statements will not be comparable between accounting periods.
The concept of materiality in accounting relates to the idea that all material elements should be appropriately recorded in financial statements. Material elements are those whose inclusion or absence causes major changes in the decision-making process for business information users.
The concept of materiality also allows for the disregard of other accounting principles if doing so has no impact on the financial statements of the company in question.
As a result, the financial statements’ information must be complete in terms of all material aspects in order to present an accurate picture of the business. The users of financial statements can be shareholders, auditors and investors, etc.