Basic Accounting Concepts

An understanding of accounting concepts is vital to understand the process of accounting.

Accounting concepts underlying the recording of transactions:

Entity Concept Money Measurement Concept

Accrual Concept
Cost Concept

Accounting concepts underlying financial reporting: Going Concern Concept Periodicity Concept Matching Concept Prudence Substance over form Consistency

 BUSINESS ENTITY CONCEPT: A business entity is an economic unit distinct from its owner(s).

Such entity owns its assets and has its own obligations.
Only those transactions and events which affect the financial position of the business entity will be recorded in its books of accounts. In accounting, business is considered to be a separate entity from the proprietors. It implies that the business transactions must be kept completely separate from the Private affairs of the proprietors. This enables the proprietor to ascertain the true picture of the business.

 THE MONETARY UNIT CONCEPT:

If the results of operations of a business entity are to be properly accounted for, they need to be expressed and recorded in common unit of measurement.
For the purpose of accounting the common economic value of the assets / liabilities are expressed in monetary terms rather than in any physical dimensions. Accounting records only monetary transactions. Events or transactions which cannot be expressed in money do not find place in the books of accounts though they may be very useful to the business.

 The Cost Concept: According to this concept an asset is ordinarily entered in the accounting recoedd at the price paid to acquire it this cost is the basis for all subsequent accounting for the assets. To summarize, all transacitons are recorded at their monetary cost of acquisition. If an asset does not cost anything, it would not be recorded in the books. Cost concept has an advantage of bringing objectivity in the preparation and presentation of financial statements.

Accrual Concept: Income and expenses should be recognised as and when they are earned and incurred, irrespective of whether money is received or paid in connection thereof. An alternative of accrual basis of accounting is cash basis where transactions are recorded only when cash is received or paid.

 The Going Concern Concept:

In corporation laws of all countries, a company is presumed to have uninterrupted existence with continuing activity till such time as it is legally liquidated. This assumption helps in two aspects: it facilitates classification of expenditure into capital expenditure and revenue expenditure if this classification is not made all the expenses are treated at revenue expenditure which is not proper. Because of this assumption fixed assets are shown at its original cost less depreciation.

 THE DUAL ASPECT CONCEPT:

Under this concept each and every transaction is split up into two aspects. One relates to receiving the benefit and other relates to givng the benefit. Thus every business transaction involves two fold aspects and both these aspects are recorded. According to this concept assets of business will be equal to liabilities and capital Assets = Liability + Capital Capital = Assets Liabilities.

 THE ACCOUNTING PERIOD CONCEPT:

According to this concept the life of the business is divided into appropriate segments for studying the results shown by the business after segment. This segment is usually of a year, which may be a calander year of a financial year Accounts are prepared for a defined accounting period. Such period could be a quarter, half year, a year This concept is essential to measure financial performance.

 THE REALISATION CONCEPT:

According to this concept revenue is recognised when a sale is made. the sale proceeds of goods or services are realised only when the buyer is legally bound to pay for the delivery of goods or rendering the services. The concept is based on historical events of business transactions and therefore it is also known as historical record concept.

 PRUDENCE CONCEPT: This concept suggests that all possible expenses and losses should be estimated and recorded, but anticipated gains should be ignored. This concept is also called the concept of conservatism.

MATCHING CONCEPT:

While measuring periodic financial results, revenue earned during an accounting period is matched with expenses incurred (to earn the revenue) in the same accounting period. Thus, expenditure incurred during construction phase should be withheld till the business starts commercial activity and earns revenue.

SUBSTANCE OVER FORM:

While recording transactions more emphasis needs to be given to the substance of the transactions and not merely to their legal form. A transaction may appear to be an expense when looked at from legal angle (e.g., construction of road by a business entity on land owned by the municipality), but the substance of the matter may demand such expense be shown as asset (e.g., if such road is primarily used by the business entity for its business purposes). CONSISTENCY: of

A business entity frames accounting policies that lay down rules for presentation financial statements. Accounting policies, once framed, should be consistently followed. However, such policies may be changed if circumstances so warrant.