A renowned Accountant once observed that ‘Accounting was born without notice and reared in neglect.’ Accounting was first practiced and then theorized. Certain ground rules were initially set for financial accounting: these rules arose out of conventions. Therefore, these are called accounting concepts.
The basic accounting concepts are-
a) The Entity Concept
b) Money Measurement Concept
c) The Cost Concept
d) The Going Concern Concept
e) The Periodicity Concept
f) The Accrual Concept
g) The Matching Concept
h) Concept of Prudence
i) The Realization Concept
1) The Entity Concept: A business is an artificial entity distinct from its proprietor(s). A business entity is an economic unit that owns its assets and has its own obligations. The owner(s) may have personal bank accounts, real estate, and other assets, but these will not be considered as assets of the business. A business entity may be in the form of a sole proprietorship form of business, the sole proprietor is considered fully responsible for the welfare of the entity and, in the eyes of law, the sole proprietor and the business are not considered to have a separate existence. For accounting purposes, however, they are separate entities. A partnership form of business has more than one owner who has “agreed to share profits of a business carried on by all or any of them acting for all”. A corporate entity is a separate legal entity, entirely divorced from its owners (called equity shareholders). A sole proprietorship business normally comes to an end with the expiry of the owner, a partnership firm may cease to operate or, at least, there will be reconstruction of the agreement on the expiry of an owner (called partner) but a corporate entity
is not disturbed at all on the expiry of any equity is not disturbed at all on the expiry of any equity shareholder
2) Money Measurement Concept: Each transaction and event must be expressible in monetary terms. If an event cannot be expressed in monetary terms, it cannot be considered for accounting purposes. For example, if you successfully pass a Distance Learning Programmes of a University, it will give you a great deal of satisfaction. But that satisfaction cannot be expressed in monetary terms. Hence such an event is not fit for accounting. On other hand, if you are robbed of Rs. 1,000 in a train journey, the loss suffered can definitely be expressed in monetary terms. This concept implies that the legal currency of a country should be used for such measurement.
3) The Cost Concept: Assets such as land, buildings, plant and machinery etc, and obligations, such as loans, public deposits, should be recorded at historical cost (i.e. cost as on acquisition). For example, the land purchased by a business entity two years back at a cost of Rs. 10 Lakh should be shown, as per the cost concept, at the same amount even today when the current price of the land may have increased five-fold. Thus, the greatest limitation of this concept is that it distorts the true worth of an asset by sticking to its original cost.
4) The Going Concern Concept: One common argument put forward by the proponents of cost concept is that the assets are shown at its original cost (net of depreciation) because these are meant for use for a long period of time and not for immediate resale. Therefore, the cost concept rests on the assumption that an entity would continue its operation for a long time. An entity is said to be a going of curtailing materially the scale of the operations’. This concept is considered as one of the fundamental accounting assumptions. The valuation principle of assets and liabilities depend on this concept. If an entity is not a going concern, its assets and liabilities are to be valued in a altogether different manner.
5) The Periodicity Concept: The activities of a going concern are continuous flows. In order to judge the performance of a business entity, one cannot wait for eternity to see the business coming to a halt. Therefore, the best way to judge a business is to have a periodic performance appraisal. Such a period to measure business performance is called an accounting period. The result of operations of an entity are measured periodically, i.e., in each accounting period. Different business unit may follow different accounting periods depending on convenience. For example, one entity may follow calendar year as the accounting period, while the other one may follow the fiscal year (April to March) as
the accounting period. However, in India
6) The Accrual Concept: It suggests that incomes and expenses should be recognized as and when they are earned and incurred, irrespective of whether the money is received or paid in connection thereof. This concept is used by all businesses that disclose their financial statements to various interested parties. In fact, the Companies Act, 1956 provides that accrual concept have to be maintained for practically all purposes. The alternative to the accrual basis of accounting is called ash basis of accounting. The law in India
7) The Matching Concept: The inherent concept involved in accrual accounting is called matching concept. Revenue earned in an accounting year is offset (matched) with all the expenses incurred during the same period to generate that revenue, thus providing a measure of the overall profitability of the economic activity. Thus, matching concept is very vital to measure the financial results of a business. The timing of incurring expenses and earning revenues does not always match. For example, in case of a seasonal business, majority of sales may take place only in four months of a year whereas fixed expenses, majority of sales may take place only in four months of a year whereas fixed expenses like salaries, rent etc. are incurred throughout the year. Matching concept suggests that the expenses incurred to generate revenue are to be matched against that revenue to find out the profitability.
8) Concept of Prudence: It says ‘anticipate no profits but provide for all possible losses’. Prudence is the ‘inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that asset or income or not, overstated and liabilities or expenses are not understated.’ Expected losses should be accounted for but not anticipated gains.
9) The Realization Concept: The realization concept tells that to recognize revenue it has to be realized’. Realization principle does not demand that the revenue has to be received in cash. Revenue from sales transactions should be recognized when the seller of goods has transferred to the buyer the property in the goods for a price and no uncertainty exists regarding
10) The consideration that it will be derived from the sale of goods. Revenue arising from the use by others of enterprises resources yielding interest, royalties and dividends should only be recognized when no uncertainly exists as to its measurability and collectivity.
Journal Entries:
Accounting transections are recorded thourgh journal entries, that shows Date, Voucher No, Narration, Qty, Rate, Debit and credit, and Balance, this is also called Journal Ledger.
financial statements are the final product of an accounting system. A typical set of financial statement included
1. Balance sheet.
2. Income statement.
It shows financial position of an accounting entity on a particular date. Balance sheet is also called statement of financial position. Income Statement is the summary of revenues and expenses for an accounting period. It measures the results of operations of the accounting entity in term of profit or loss for the period covered. it is also called statement of operations.
Income statement:
The standard formate for preparing income statement is presented below.
Company Name
Income Statement
For the year ending December 2010
Rs.
Net Sales 4,580,000/-
Cost of Goods sold 3,145,000/-
Gross Profit 1,435,000/-
Operating Expenses
Marketing Expenses 655,000/-
Administration Expenses 302,000/-
957,000/-
Income from Operations 478,000/-
Other Income and Expenses Items:
Dividend income on investments 48,000/-
Interest expenses on debentures 30,000/-
Net deducation 18,000/-
Net Income 460,000/-
The income statement illustrated above is called multiple-Step income statement because it calculates gross profit. income from operations and net income in successive steps. It is also called functional formate Income statement because the expenses are presented according to their functional or objective classification. This formate is also referred to as traditional formate.
