What are the accounting concepts? how many are there, explain in brief?
In any branch of knowledge whether physics, mathematics or economics, there would be certain board assumptions on which the entire subject rests. These may be termed as fundamental assumptions or concepts. Without concepts, the entire subject itself would not exist. And even Accountancy as to follow this rule.
Fundamental concepts of Accountancy are classified into the following:
- Business Entity Concept
- Money Measurement Concept
- Going Concern Concept
- Period Concept
- Accrual Concept
- Matching Concept
- Prudence/Conservatism Concept
- Realization Concept
- Duality Concept
- Materiality Concept
- Disclosure Concept
- Consistency Concept
1.Business Entity Concept
There are various forms of organization like Sole Proprietor, Partnership & Company. While Company is considered to have an independent legal entity, the other two viz.,
When it comes to accounting, irrespective of the forms of organization, the owner is treated as a separate individual from that of business.
It is presumed that the accounts are maintained on behalf of the firm and not the owner. The capital invested by the owner is shown on the Liability side of the Balance Sheet meaning the business has to return the capital.
2.Money Measurement Concept
The next important concept in accounting is that we consider only those transactions (Things involving an exchange of values) which are capable of being expressed in terms of money. Barter transactions can’t be taken in accounting.
3. Going Concern Concept
When any person starts a venture, hr commence with the intention of running it for a very long time and earn profits. In other words, no business is started with the intention of immediate closure. A business is presumed to keep going year after year unless efforts are taken by the owners to bring it to a close in the form of winding up or Liquidation.
4.Accounting Period Concept
As seen earlier, the fundamental objective of any business is to earn profits. It is, therefore necessary to ascertain whether the business is on the right track. We should prepare some financial statements which would enable us to know whether the company has earned profits/losses. The accounts of a firm are closed at regular intervals, definitely at least once in a year, to ascertain the position. This forms the accounting period. Nowadays, the accounts are required to be published once in every quarter in the year.
\\Period Concept and Going Concern Concept work together to enable us to work to find out the financial results of the organization.
This flows from the Accounting Period Concept. here, it may be said that there are mainly two systems of accounting viz., Cash System and Mercantile System (also known as Accrual System).
Under Cash System PF accounting, a transaction is recorded in books of accounts only when cash is received or paid without regard to the accounting period for which it is meant.
As opposed to this, the Accrual System takes into account Income and Expenditure which pertain to a period. Irrespective of whether the amount is actually received or not and payments made or not. In view of this, the concept of Outstanding(Amounts Payable) and Accrued(Amount Receivables) exist in Accounting.
Look at the various concepts are interlinked each one in some or the other.
This concept is related to both the Accrual Concept and the Accounting Period Concept. It is in all fairness that the revenue earned during a period bears all the expenses relevant to that period. The essence of this concept is that we should match the revenue of the period with all the expenses that could be attributed to this revenue.
This concept says that we should not book profit unless it is realized. In addition, we should provide for expenses the movement we come to know of them even if there is a remote chance of their materializing. In other words, we want to be doubly sure that the profits shown are the barest minimum and at no time, they would become lesser. It is because of this concept that while valuing closing shock we adopt the principle of “Cost or Market value whichever is lower”. The Assets are shown at their Cost and it not realizable value also because of this concept.
8. Realisation Concept:
This concept deals with the point of time at which revenue may be deemed to be realized or when a sale can be said to have taken place.
When is Sale said to be complete?
As per the Sale of Goods Act, 1930, a sale is complete when the property (ownership) in goods is transferred from the seller to the buyer. The timing differs depending on the type of sale.
9. Duality Concept:
We have seen that as per the Business Entity concept, the firm is treated as a different form that pf the owner. And that the amount of capital is shown as Liability in the firm’s Balance Sheet.
The amount which the firm owns is called Assets and the amount it owes Liabilities.
The assets which are meant for sale and which change their form during the course of the year are termed as ‘Current Assets’. And those which help in running the business like land, building, plants and machinery, furniture, etc. are termed as ‘Fixed Assets’.
Similarly, the amounts that are to be repaid within 12 months are termed ‘Current Liabilities’. The suppliers from whom goods have been bought on credit are called ‘Sundry Creditors’. And the customers who have pay money to the firm for goods sold to then on credit are termed as ‘Sundry Debtors’.
Capital (Amount invested by owner) + Other Liabilities = Assets
This is referred to as the Fundamental Accounting Equation. Any transaction may occur, but it cannot disturb this fundamental equation.
10. Materiality Concept:
We are aware of the concept of “Management by exception” which states that the Top Management need not be apprised of normal and routine things. But only exceptions need be reported because of time constraint and the importance of the matter. Similarly, in accounting, this concept suggests that there is no point in keeping accounts of small/trivial matters.
11. Disclosure Concept:
Accounting Standard 1 (AS 1) speaks of Disclosure norms. It is an accepted fact that there are various methods of maintaining depreciation accounts, valuation of stocks, issues of materials and so on. All of them are permitted and are legal. But to give the correct view to the person who reads the financial statement. It is necessary to bring to his knowledge the method followed by each organization.
This concept requires the firm to disclose along with the financial statements, details of policies followed by them in regard to accounting.
We have seen that divergent practices exist in the maintenance of accounts. Two firms belonging to the same industry may follow different policies. While disclosure helps in a meaningful comparison of the Financial results of two organizations. Consistency ensures that a firm follows the same policy year after year.
This does not mean that this concept does not allow any leeway to the firm to change its method of accounting. a firm is at liberty to change and the change is in the bona fide interest of the company and its shareholders.
In the year when there is change, the Company has not only to disclose the fact of the change in the method of accounting. And the need for it but also the effect of such change in the current year’s profit/loss.