Accounting Concepts

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.

Materiality Concept:

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.

Accounting Concept and Convention

Accounting is a business language, which is used to communicate financial information to the company’s stakeholders, regarding the performance, profitability and position of the enterprise and help them in rational decision making. The financial statement is based on various concepts and conventions. Accounting concepts are the fundamental accounting assumptions that act as a foundation for recording business transactions and preparation of final accounts

Definition of Accounting Concept

Accounting Concepts can be understood as the basic accounting assumption, which acts as a foundation for the preparation of the financial statement of an enterprise. Indeed, these form a basis for formulating the accounting principles, methods and procedures, to record and present the financial transactions of the business.

These concepts provide an integrated structure and rational approach to the accounting process. Every financial transaction that occurs is interpreted taking into consideration the accounting concepts, which guide the accounting methods.

  • Business Entity Concept: The concept assumes that the business enterprise is independent of its owners.
  • Money Measurement Concept: As per this concept, only those transactions which can be expressed in monetary terms are recorded in the books of accounts.
  • Cost concept: This concept holds that all the assets of the enterprise are recorded in the accounts at their purchase price
  • Going Concern Concept: The concept assumes that the business will have a perpetual succession, i.e. it will continue its operations for an indefinite period.
  • Dual Aspect Concept: It is the primary rule of accounting, which states that every transaction affects two accounts.
  • Realization Concept: As per this concept, revenue should be recorded by the firm only when it is realized.
  • Accrual Concept: The concept states that revenue is to be recognized when they become receivable, while expenses should be recognized when they become due for payment.
  • Periodicity Concept: The concept says that a financial statement should be prepared for every period, i.e. at the end of the financial year.
  • Matching Concept: The concept holds that, the revenue for the period, should match the expenses.

Definition of Accounting Convention

Accounting Conventions, as the name suggest are the practice adopted by an enterprise over a period of time, that rely on the general agreement between the accounting bodies and help in assisting the accountant at the time of preparation of financial statement of the company.

To improve the quality of financial information, the accountancy bodies of the world may modify or change any accounting convention. Given below are the basic accounting conventions:

  • Consistency: Financial statements can be compared only when the accounting policies are followed consistently by the firm over the period. However, changes can be made only in special circumstances.
  • Disclosure: This principle states that the financial statement should be prepared in such a way that it fairly discloses all the material information to the users, to help them in taking a rational decision.
  • Conservatism: This convention states that the firm should not anticipate incomes and gains, but provide for all expenses and losses.
  • Materiality: This concept is an exception to the full disclosure convention which states that only those items to be disclosed in the financial statement which has a significant economic effect.