Accounting principles are built on a foundation of a few basic concepts. These concepts are so basic that most accountants do not consciously think of them; they. PDF | 40 minutes read | On Jan 1, , Loveday A. Nwanyanwu PhD FCA FCTI and others published Some Basic Concepts of Accounting: A. BASIC ACCOUNTING CONCEPTS. INTRODUCTION. A knowledge of basic accounting principles is necessary for a full understanding of punched card data .
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An accountant is a person who does the basic job of maintaining accounts as he is the .. practice. In other words, fundamental accounting concepts are broad. Basic Accounting. Notes. Accounting Concepts. ACCOUNTANCY. In the previous lesson, you have studied the meaning and nature of business transactions. Accounting Basics. Important Disclaimer. Important Note: The text in this chapter is intended to clarify business-related concepts. It is not intended nor can it.
For example, a paper stapler costing Rs. Assets fixed and current: In what way can accounting information help in the proper allocation of resources? Objectivity principle requires that only the information based on definite and verifiable facts are to be recorded. Attempts have also been made in countries in the European Economic Community EEC , and in Canada for standardisation of accounting practices regarding disclosure and consistency of procedures.
Under double-entry bookkeeping, every transaction is recorded in at least two accounts—as a credit in one account and as a debit in another. For example, an automobile repair shop that collects Rs.
Financial statement: A financial statement is a document that reveals the financial transactions of a business or a person. The three most important financial statements for businesses are the balance sheet, cash flow statement, and profit and loss statement all three listed here alphabetically. General ledger: Journal entry: An entry in the journal that records financial transactions in the chronological order.
Profit and loss statement income statement: Single-entry bookkeeping: Under the single-entry bookkeeping, mainly used by small or businesses, incomes and expenses are recorded through daily and monthly summaries of cash receipts and disbursements.
Types of accounting: Management accounting provides financial data to managers for business development. Good notes and easy to understand. Only in concepts prudence and neutrality concepts are not identified. Thank you so much for your effort, this is a good contribution. Your email address will not be published. However, a short and sweet description of accounting does exist: A more academic definition of accounting is given by the American Accounting Association: While a small business may have an accountant or a bookkeeper to record money transactions, a large corporation has an accounts department, which supplies information to: Managers who guide the company.
Investors who want to know how the business is doing. The government, which decides how much tax should be collected from the company. Accounting Principles Obviously, if each business organisation conveys its information in its own way, we will have a babel of unusable financial data. Accounting Concepts Business entity concept: A business and its owner should be treated separately as far as their financial transactions are concerned. Money measurement concept: Only business transactions that can be expressed in terms of money are recorded in accounting, though records of other types of transactions may be kept separately.
Dual aspect concept: For every credit, a corresponding debit is made. The recording of a transaction is complete only with this dual aspect. Going concern concept: In accounting, a business is expected to continue for a fairly long time and carry out its commitments and obligations. Cost concept: The fixed assets of a business are recorded on the basis of their original cost in the first year of accounting.
Subsequently, these assets are recorded minus depreciation. As it might be cleared by the name, it is talking about some time span. The main question is in what regards is it saying time period?
Well, it is talking about the time taken for the preparation of an entity report. The format followed by the company depends on the decision of the owner. If an owner feels that it must be quarterly or monthly then that format will be followed.
Profits are basically earned with the help of resources and liabilities. However, it earning is done when the product is sold to the customer at a reasonable price. It will be recorded at the time of selling and not before it. The bestowed contract time is not recorded in it. Hence the basic accounting assumptions are done but the actual cost is added later on. If you are using a method to maintain a record then you must follow the same concept for the future endeavour too.
This will guarantee that if any changes in the financial statement are done then it was due to the change in the operation rather than the accounting entries.
It is easy for you to keep a track on things and what needs to be done in case the condition deteriorates. To ensure that the income is not overstated at any time, you need to record the expenses and revenues at the same time. For instance, if you used 30, dollars for buying the raw material then enter it in the record during the time of representing revenue.
However, it is an easy way to maintain the chart of the revenue and expenses. You will also be able to know the profit and loss of you expenses with the little help of basic accounting and finances. Hence, with the help of these principles and concept, it is easy to read, organise and link the statements of all the finances with utter precision and accuracy.
Well, the traditional methods may need a lot of manual work. But it is the best way to obtain an accurate result. And in the case of any indecision, you can always try to stumble as a caution. Just drop in your details and our corporate support team will reach out to you as soon as possible. Just drop in your details and our Course Counselor will reach out to you as soon as possible.
Fill in your details and download our Digital Marketing brochure to know what we have in store for you. It is confident to get an order and as a result, it shows this order as a part of its sales revenue. Will you approve such an accounting treatment of probable order to be obtained in future?
Materiality Concept There are many events in business which are trivial or insignificant in nature. The cost of recording and reporting such events will not be justified by the usefulness of the information derived. The materiality concept holds that items of small significance need not be given strict theoretically correct treatment. For example, a paper stapler costing Rs. However, the effort involved in allocating its cost over the three-year period is not worth the benefit than can be derived from this operation.
Since the item obviously is immaterial when related to overall operations, the cost incurred on it may be treated as the expense of the period in which it is acquired. Some of the stationery purchased for office use in any accounting period may remain unused at the end of that period.
In accounting, the amount spent on the entire stationery would be treated as an expense of the period in which the stationery was purchased, notwithstanding the fact that a small part of it still lies in stock.
The accountant would regard the stock lying unused as immaterial. Hence, the entire amount spent on stationery would be taken as the expense of the period in which such expense was incurred.
Where to draw the line between material and immaterial events is a matter of judgement and common sense. There are no hard and fast rules in this respect. Whether a particular item or occurrence is material or not, should be determined by considering its relationship to other items and the surrounding circumstances. It is desirable to establish and follow uniform policies governing such matters.
Though it is, theoretically speaking, an asset having a life, of more than one year, the firm shows it as an expense of the year, and reduces the profit for the year. Is this accounting practice justifiable? Give reasons. Consistency Concept In practice, there are several ways to record an event or a transaction in the books of account.
For example, the trade discount on raw material purchased may be deducted from the cost of goods and net amount entered in the books, or alternatively trade discount may be shown as the income with full cost of raw material purchased entered in the books. Similarly, there are several methods to charge depreciation which is a decrease in the value of assets caused by wear and tear, and passage of time on an asset, or of valuing inventory.
The consistency concept requires that once a company has decided on one method and has used it for some time, it should continue to follow the same method or procedure for all subsequent events of the same character unless it has a sound reason to do otherwise. If for valid reasons the company makes any departure from the method it has been following so far, then the effect of the change must be clearly stated in the financial statements in the year of change.
You will appreciate that much of the utility of accounting information lies in the fact that one could draw valid conclusions from the comparison of data drawn from financial statements of one year with data from another year. Comparability is essential so that trends or differences may be identified and evaluated.
Inconsistency in the application of accounting methods might significantly affect the reported profit and the financial position. Further, inconsistency also opens the door for manipulation of reported income and assets. The comparability of financial information depends largely upon the consistency with which a given class of events are handled in accounting records year after year. Then it began charging Rs. Is this practice justified? Give reasons for your answer. Periodicity Concept Accounting Accounting Conceptsand andits Standards Functions Although the results of the operations of a specific enterprise can be known precisely only after the business has ceased to operate, its assets have been sold off and liabilities paid off, the knowledge of the results periodically is also necessary.
Those who are interested in the operating results of a business obviously cannot wait till the end. The requirements of these parties, therefore, force the accountant to report the changes in the wealth of a firm for some time periods.
These time periods in actual practice vary, though a year is the most common interval as a result of established business practice, tradition, and government requirements. Some firms adopt the calendar year, and some others the financial year of the government. The custom of using twelve-month period is applied only for external reporting.
The firms usually adopt a shorter span of interval, say one month or three months, for internal reporting purposes. The allocation of long-term costs and the difficulties associated with this process directly stem from this concept. While matching the earnings and the cost of those earnings for any accounting period, all the revenues and all the costs relating to the year in question have to be taken into account irrespective of whether or not they have been received in cash, or paid in cash.
Despite the difficulties that arise in allocations and adjustments, short-term reports i. Obviously, the utility of the periodic financial statements outweighs the difficulties.
Some other concepts, e. While going through all these concepts, probably you may have developed a feeling that they sometimes conflict with each other.
You are right. We illustrate this by considering some of these concepts in the context of valuation of business properties. Suppose a firm acquired a piece of land in for a price of Rs. Factory premises were constructed in , and operations commenced in The firm has been successful in achieving the desired profit for the past year.
The estimated current market price of this land is Rs. Should you recommend that the land be valued at Rs. Land would be carried on the Balance Sheet at its original cost of Rs. This decision is supported by several of the concepts discussed in this section.
In the first place, the stability of purchasing power of money implied in the money measurement concept prevents us from recognising accretion in values as a result of changing price levels. Then, the realisation concept will not allow unrealised profits to be included as long as land is held by the company and not sold away.
You may note that the continuity, or going concern concept, makes any possible market value of land irrelevant for the balance sheet because the firm has to continue in business, and land will be needed by it for its own use. In this connection, it could be argued that if land were shown on the balance sheet at its estimated current market value, the owner might decide to discontinue the business, sell the land and retire.
The principle of objectivity is now introduced into the argument. It can be easily seen that in a situation like this the cost of acquisition of land at Rs. In contrast, the estimate of current market value figure may be suspect. It raises many questions. Do you have a market quotation for an identical plot of land?
Has a similar plot of land been sold recently, and can we pick it up as verifiable evidence of the current market price? Further complications may be noticed if buildings and facilities have been erected on the plot of land.
Is it possible to estimate the value of land without factory buildings and other facilities constructed on it? These concepts postulates or conventions , however, permit a variety of alternative practices to co-exist. As a result, the financial results of different companies cannot be compared and evaluated unless full information is available about the accounting methods which have been used. The variety of accounting practices have made it difficult to compare the financial results of different companies.
Further, the alternative accounting methods have also enabled, the reporting of different results, even by the same company. Need for Standards: The information contained in published financial statements is of particular importance to external users, such as shareholders and investors.
Without such information they would not be able to take the right decisions about their investments. As in several other countries, Parliament in India specified in the Companies Act, the type and minimum level of information which companies should disclose in financial statements. It is the responsibility of the accounting profession to ensure that the required information is properly presented.
It is evident that there should not be too much discretion to companies and their accountants to present financial information the way they like. In other words, the information contained in financial statements should conform to carefully considered standards. Public confidence in accounting information contained in financial statements will grow if they are satisfied as to the logic, consistency and fairness of the figures shown therein.
For instance, a company could incur a loss and still pay dividends by manipulating the loss into a profit. In the long run, this course may have a disastrous effect on the company and its investors.
You would be better able to appreciate the function of accounting standards by relating them to the basic purpose of financial statements, which is the communication of information affecting the allocation of resources. Ideally, such information should make it possible for investors to evaluate the investment opportunities offered by different firms and to allocate scarce resource to the most efficient ones.
In theory, this process should result in the capital distribution of resources within the economy, and should maximise the potential benefit to society. In this context, unless there are reasonably appropriate standards, neither the purpose of the individual investor, nor that of the nation as a whole, can be served. The purpose is likely to be served if the accounting methods used by different firms for presenting information to investors allow correct comparisons to be made.
For example, they should not permit a company to report profits which result simply from a change in accounting methods rather than from increase in efficiency. If companies were free to choose their accounting methods in this way, the consequences might be that deliberate distortions are introduced, leading eventually to misapplication of resources in the economy. The relatively less efficient companies will be able to report fictitious profits, and as a result scarce capital of society will be diverted away from the more efficient companies which have adopted more strict and consistent 30 accounting methods.
Accounting Accounting Conceptsand andits 2. In developing such principles, however, the accounting profession has to reflect the realities of social, economic, legal and political environment in which it operates. Besides academic research, regulatory and tax laws of the government, e. Stock exchanges and other regulatory agencies like the Securities and Exchange Board of India SEBI have laid down rules for disclosure and the extent of accounting information. Since the environment, in which business operates, undergoes constant changes as a result of changes in economic and financial policies of the Government and changes in the structure of business, continued evaluation of the relevance of generally accepted accounting principles is required.
In this sense, the principles of accounting are not ever-lasting truths.
You will appreciate that it is the development of relevant accounting principles in tune with the present day needs of the society that would make it possible for the business enterprises to develop financial statements which would be acceptable and of value to the end users.
Now, we give you a brief account of the development of standards in the United Kingdom, the United States of America, India, and other countries. Though the Institute of Chartered Accountants in England and Wales began making recommendations since , real progress started with the establishment of the Accounting Statements Committee ASC by the Institute in in the wake of public criticism of financial reporting methods which permitted diverse practices.
As a result of diversity in practices some big investors had suffered heavy losses on their investments in well-known companies. The main objective of the ASC has been to narrow areas of difference and in the variety in accounting practices. Comments made on exposure draft are taken into consideration when drawing up a formal statement of the accounting methods for dealing with that specific topic. Once the statement of standard accounting practice is adopted by the accounting profession the fact that a statement has been issued by the Institute in itself signifies the acceptance by the profession , any material departure by any company from the standard practice in presenting its financial reports is to be disclosed in that report.
So far, nineteen statements of standard accounting practice, in addition to some exposure drafts under consideration, have been issued by the ASC. The SEC is the Government agency that regulates and controls the issuance of, and dealings in, securities of the companies.
A research-oriented organisation called the Accounting Principles Boards APB was formed in to spell out the fundamental accounting postulates. The FASB issues statements from time to time, articulating the generally accepted accounting principles. Standards at International Level: In view of the growth of international trade and multinational enterprises, the need for standardisation at the international level was felt. An International Congress of Accountants was organised in Sydney.
Australia in to ensure the desired level of uniformity in accounting practices. Keeping this in view, the International Accounting Standards Committee IASC was formed and was entrusted with the responsibility of formulating international standards. All the member countries of IASC resolved to conform to the standards developed by IASC, or at least to disclose variations from recommended standards.
After its formation in , the IASC has issued 40 international accounting statement to date.
Attempts have also been made in countries in the European Economic Community EEC , and in Canada for standardisation of accounting practices regarding disclosure and consistency of procedures. In line with the procedure followed in other countries, the preliminary drafts prepared by the study groups and approved by ASB are circulated amongst various external agencies, including the representative bodies of trade, commerce, and industry.
So far, twenty eight standards have been issued by ASB, a brief description of which is provided in Appendix I to this unit.