Accounting concept and convention

Definition of accounting concept

The main objective is to maintain uniformity and consistency in accounting records. These concepts constitute the very basis of accounting. All the concepts have been developed over the years from experience and thus they are universally accepted rules.

Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts.

Accounting concepts are those bases, rules, principles, and procedures adopted in preparing and presenting financial statements.

A substantial number of alternative postulates, assumptions, principles and methods adopted by a reporting entity in the preparation of its accounts can significantly affect its results of operations, financial position and changes thereof. It is therefore, essential to understand, interpret and use financial statements, whenever there are several acceptable accounting methods. This follows that those who prepare them disclose the main assumptions on which they are based.

The fundamental accounting concepts that guide the financial reporting of all enterprises are described below:

      1.               Business entity concept

The business is viewed as a distinctly different and independent of the owner and is to be viewed as an entity on its own. This means that the business transactions are to be recorded and the factors of the dual aspect are to be determined from the point of the view of the business. This means even in the case of a sole trader the owners’ transactions are to be recorded as if it is from any other person like.

2.            Going Concern Concept:

Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time, i.e., a business unit is considered to be a going concern and not a liquidated one. Keeping this in view, the suppliers and other companies enter into business transactions with the business unit. This assumption supports the concept of valuing the assets at historical cost or replacement cost. This concept also supports the treatment of prepaid expenses as assets, although they may be practically unsaleable.

3.            Periodicity Concept or Accounting Period Concept
This simple concept recognizes that profit occurs over time, and we cannot usefully speak of the profit for a period until we define the length of the period. The maximum length in which:

a.                      it is capable of objective measurement, and

b.                      The asset value receivable in exchange is reasonably certain.

For instance, if an asset such as stock is disposed off, either on cash or credit basis, the proceeds should be recognized as revenue realized for that period.

4.            Cost Concept

All business transactions will be recorded on the basis of the costs and not on the basis of its value to the business even though it may be important from the point of the business.

5.            Money Measurement Concept:

In accounting all events and transactions are recode in terms of money. Money is considered as a common denominator, by means of which various facts, events and transactions about a business can be expressed in terms of numbers. In other words, facts, events and transactions which cannot be expressed in monetary terms are not recorded in accounting. Hence, the accounting does not give a complete picture of all the transactions of a business unit. This concept does not also take care of the effects of inflation because it assumes a stable value for measuring.

6.            Dual Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are

a.                   Giving of cash

b.                  Receiving of goods

These two aspects are to be recorded.

Thus, the duality concept is commonly expressed in terms of fundamental accounting equation:

              Assets = Liabilities + Capital

The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners’ equity and that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities.

7           Matching Concept:

The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business. Under this concept, the accounting period concept is relevant and it is this concept (matching concept) which necessitated the provisions of different adjustments for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course of preparing the financial statements at the end of the accounting period.

8              Historical Cost Concept
This concept states simply that resources (assets) acquired by the business should be recorded at their original purchased prices. It follows on from the monetary measurement concept discussed further and tells us how the item can actually be measured. This is a well-known concept that has gained a worldwide support in the past; however, it no longer receives such support.

9              Realisation Concept

This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realisation means creation of legal right to receive money. Selling goods is realisation, receiving order is not.

In other words, it can be said that: Revenue is said to have been realised when cash has been received or right to receive cash on the sale of goods or services or both has been created.

10      Accrual Concept
The concept states that all expenses in which the services have been enjoyed but not paid for must be captured in preparing the financial statements of such Entities. For instance, electricity bills for a given period must be considered in drawing up the accounts for the period whether or not payment for consumption has been made.

      Accounting Convention'

An accounting convention consists of the guidelines that arise from the practical application of accounting principles. It is not a legally binding practice; rather, it is a generally accepted convention based on customs and designed to help accountant overcome practical problems that arise out of the preparation of financial statement 

The following conventions are to be followed to have a clear and meaningful
information and data in accounting:

1.      Consistency:

The convention of consistency refers to the state of accounting rules, concepts, principles, practices and conventions being observed and applied
constantly, i.e., from one year to another there should not be any change. If

Consistency is there, the results and performance of one period can he compared easily and meaningfully with the other. It also prevents personal bias as the persons involved have to follow the consistent rules, principles, concepts and conventions. This convention, however, does not completely ignore changes. It admits changes wherever indispensable and adds to the improved and modern techniques of accounting.

2.      Conservatism (Prudence)
This concept refers to the accounting practice of recognizing all possible
losses, but not anticipating possible gains. This will tend to lead to anunderstatement of profits and to an understatement of asset values with no corresponding understatement of liability. This concept seems to contradict the Going Concern, Materiality, Historical Cost and Objectivity concepts (SAS 1- Disclosure of Accounting Policies).

3.      Materiality:

American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.” It refers to the relative importance of an item or event. Materiality of an item depends on its amount and its nature.

Theoretically, all items, large or small, should be treated alike. Materiality convention implies that the economic significance of an item will to some extent affect its accounting treatment.

Materiality in its essence is of relative significance. In the sense that some of the unimportant items are either left out or included with other items.

4       Disclosure:

This convention requires that accounting statements should be honestly prepared and all significant information should be disclosed therein. That is, while making accountancy records, care should be taken to disclose all material information. Here the emphasis is only on material information and not on immaterial information.

The purpose of this convention is to communicate all material and relevant facts of financial position and the results of operations, which have material interests to proprietor, creditors and investors.