Basic Concepts and Conventions

8/12/2019 Basic Concepts and Conventions

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UNIT -6

Basic Concepts And Conventions


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FINANCIAL ACCOUNTING

Basic Concepts And Conventions

Accounting principles are usually rules and conventions which have beenadopted as a general guide to action by the accountancy profession.

1. The Business Entity Concept

All accounts are kept in respect of business entities which are distinctfrom the persons who own or manage these entities. Sometimes thelaw makes the same distinction, as in the case of a limited companywhich is a separate legal entity from the shareholders or its Directors.

. !oneta"y Concept

Accounting uses money to express certain facts of a business and insuch a way that they can be a useful expression of the wealth of thebusiness.

#. $isto"ica% &Cost' Concept

The price paid to acquire an asset is recorded in the books and formsa basis for subsequent treatment. The result is that at any moment oftime the values recorded in the books do not necessarily reflect thecurrent value of the assets. The income of the business is measuredby the difference between the value obtained for selling its productscompared to the cost of the resources used in making them. The costs

not yet expended are shown in the balance sheet.

(. Goin) Conce"n Concept

The accounting system will treat the values on the assumption that thebusiness will continue trading. f the business decides to liquidate orbecome bankrupt then a different approach to valuation is required.

*. +ua% Aspect Concept

All business events are regarded as having a dual aspect. n allbusiness transactions equal values are exchanged. !ach transaction

involves two entries, a debit entry and a credit entry. !very debit musthave a corresponding credit, and vice versa. Since every debit has acorresponding credit, the total debits must at any time equal the totalcredits. "hether this be so or not is easily ascertained by means of aTrial #alance.


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6. Acc"ua% Concept

The income accruing to the owner of a business is not necessarily theamount of cash actually received in a period of account. $any difficultproblems arise in deciding how much income has actually accrued inany period. Accrual of income is always measured over a period of

time which is normally the accounting year. !xpenses are costsincurred in earning revenues. Those expenditures which may becharged against revenues for a period will be considered as operatingexpenses. The accrual concept is applied both in ascertaining therevenues for a period and in ascertaining the expenses to be chargedagainst the revenues.

,. The ea%isation Concept

%evenue is considered as earned on the day which it is realised andthis is when goods are transferred to the customer in exchange for a

valuable consideration. The Accountant usually uses the date theproduct is shipped to the customer or the date on the invoice,whichever is the later.

. Conse"vatis/

"hilst the accountant will be prepared to anticipate possible futurelosses, he is not prepared to bring into account possible future profits,however likely these may be. "henever a decision is to be made onthe valuation of assets he will generally decide in favour of thatvaluation which underestimates the profits or the balance sheetsvalues of the firm.

0. Consistency

This means that whilst certain alternatives are considered equallyacceptable, the accountant having adopted one, must follow thatmethod over a reasonable period of time. "hilst changes of methodsmay be made it is accepted that these should not be made frequentlynor for the purpose of mis&representing the profits of the firm.

1. !ate"ia%ity

This means that the si'e of the amount will influence the treatment of

it. (umbrous controls and procedures should not be applied to itemsof small importance. Similarly, in presenting final accounts and#alance Sheets of a large company, the figures will be rounded off tothe nearest dollar.


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22A3 - +isc%osu"e o4 Accountin) 3o%icies

The first sentence of SSA) * sums it up+ t is fundamental to theunderstanding and interpretation of financial statements that those who

use them should be aware of the main assumptions on which they arebased. The Standard therefore sets out to improve the quality ofinformation disclosed by ensuring that the principle accounting policiesadopted in drawing up a set of accounts are clearly explained in the notesto those accounts.

The terms used in the Standard are classified into three tiers+

-. undamental accounting concepts & the basic assumptions whichunderlie all accounts, and specifically+

a/ 0going concern0 & the assumption that the business will continue to tradefor the foreseeable future, and so assets are valued at historic cost, lessdepreciation if applicable, rather than at their forced sale value at theaccounting date.

b/ 0accruals0 & determines when transactions should be entered in theaccounts. %evenue and costs are recognised as they are earned orincurred rather than as money is received or paid.

c/ 0consistency0 & there should be consistency of accounting treatment oflike items each year and from one year to the next.

d/ 0prudence0 & controls when items can appear in the )rofit and 1ossAccount. ncome and profits should not be anticipated. They should beincluded in the accounts only when realised in cash or other real assets.2owever, liabilities should be included, at least as an estimate, as soon asthey are known with reasonable certainty.

*. Accounting bases & the various alternative ways these fundamentalconcepts have been or can be applied to financial transactions.

3. Accounting policies & the specific accounting bases adopted by thebusiness in question.

n some circumstances more than one accounting basis is acceptable.Accounts should therefore disclose which ones have been used so thatreaders of the accounts can more fully understand them and can makemeaningful comparisons between different businesses. n the absence ofany clear statement to the contrary it is presumed that the four

fundamental accounting concepts have been followed.


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SSA) * was issued in 4ovember -56- and remains the current standardfor company accounts. The AS# issued exposure drafts for a revisedStatement of )rinciples in -557 and $arch -555 which will eventuallyreplace SSA) * and will reduce the emphasis previously placed on theprudence and accruals concepts. 4ow replaced by %S &-8

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Basic Concepts and Conventions