Accounting: Basic Concepts Required to be Followed

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Accounting assumptions are those principles, the acceptance and use of which are assumed to have been followed while preparing and presenting financial statements. So, following of these accounting assumptions need not be disclosed in the financial statement of the enterprises. Their disclosure is only necessary when they are not followed by the enterprises. Here is the list of Accounting Concepts which is required to be followed apart from (a) Going Concern; (b) Consistency; & (c) Accrual

The accounting postulates are self-evident statements or axioms, which are generally accepted by virtue of their uniformity to the objectives of financial statements that portray the economics, political, sociological & legal environment in which accounting must operate.

– Ahmed Belkaoui

Proprietary Concept

As per this concept, business and its owner are treated as one and same person. Business does not have any separate identity apart from its owner. Owner himself owns the assets and is liable for all business obligations.  Since business has no separate identity so at the time of closure, if the assets employed in the business are insufficient to meet liabilities related to the business, personal assets of the owner are used for settling claims of outsiders. Owner’s fund is treated as capital and not as liability. The profit or loss of the enterprise effects only owner’s fund.
In this concept, the relationship between proprietorship assets and liabilities can be expressed as follows:

O = A – L

Where,O = Owner’s fund;
A = Total assets of the business; and
L = Total liabilities of the business

Features

  • Entity: No separate entity of the concern.
  • Control on Assets: Proprietor has sole control over the assets of the concern.
  • Responsibility of Liabilities: Proprietor is solely liable to meet all obligations of the concern.
  • Profit or Loss: Proprietor enjoys the profit and bears the loss of the concern.
  • Capital: Capital provided by owner is not considered as a liability.
  • Continuity: Existence may end with death or insolvency of the owner.
  • Application: It is followed in sole-proprietorship, partnership and small family business.
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Entity Concept

As per entity concept, business is assumed as an artificial person distinct from its owner. It owns assets and is responsible to discharge its obligations. Business has perpetual succession i.e. its continuity is not effected by the non-existence of its owner. Further, owner’s fund is treated as liability for the business, which becomes due at the time of shut down.
In this concept, the relationship between assets and liabilities can be expressed as follows:

Total of Assets = Total of Liabilities

Features

  • Entity: Business has separate identity distinct from its owner.
  • Control on Assets: Business itself has control over its assets.
  • Capital: Owner’s capital is treated as liability of the business.
  • Liabilities: Business is responsible for its liability including owner’s capital.
  • Profit or Loss: Business enjoys the profit and bears the loss.
  • Continuity: Business has perpetual succession.
  • Application: Entity concept is generally applicable on company form of business.

Fund Concept

This theory views business as a collection of assets (known as fund) and full focus is given on use of such fund. Every fund is aimed at fulfilling some purpose and the assets are primary means to achieve that purpose. Fund based accounting involves preparation of financial statements fund wise. Under this method the basis of accounting is neither proprietor nor entity. It is said “fund is the unit of accounting and not of proprietorship”.
The object of accounting under this concept is not to ascertain profit or loss but to check whether the fund is utilised in the desired manner or not. The theory is based on Accounting equation:

Assets = Restriction on Assets

Where assets represent prospective services to the fund and restriction on assets means the liabilities against assets of the fund.

Money Measurement Concept

An event, which can be expressed in terms of money, is termed as transaction. For accounting purpose, an event should be converted into monetary value and then recorded. Money provides a common denomination for measurement of various transactions and ascertainment of their impact on financial position. It is the only unit, which serves as the basis of accounting. Such concept of measuring an event in terms of money is called Money Measurement Concept. Further, nowadays, business is transacted world wide in different currencies. The value of such transactions expressed in different currencies is converted into the equivalent value of home currency to form uniform monetary unit. The main defect of this assumption is that non-monetary factors like efficient management, brand name, etc., are not recorded in the accounts, though they are helpful in generating revenue.

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Accounting Period Concept

Business unit or an entity is considered to be a going concern having indefinite life. Thus, the life of the business is sub-divided into various periods, generally a year, for evaluating the performance of the management. Each such period is termed as accounting period. It should not be too long to make the information useless. Also it should not be too short so as to make burden on the management to prepare financial statement frequently in its busy schedule.

Continuity or Going Concern Concept

According to Going Concern Concept, business is assumed to be continued for foreseeable future. It means that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations. So business is expected to meet its contractual obligation and utilise its asset for foreseeable future.
As per AS 1 ‘Disclosure of Accounting Policies’ issued by the Institute of Chartered Accountants of India, going concern is a fundamental accounting assumption. It means, this concept is generally assumed in respect of all enterprises unless otherwise disclosed in the financial statement.

Dual Aspect Concept

This concept is base of double entry system of accounting. As assets are equal to liabilities or vice versa, hence every transaction has two aspects viz. –

  1. If it increases one asset then it may reduce another asset or increase a liability.
  2. If it decreases one asset then it may increase another asset or decrease a liability.
  3. If it increases liability then it may reduce another liability or increase an asset.
  4. If it decreases liability then it may increase another liability or decrease an asset.
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If debtor balance is reduced then cash balance may be increased or net-worth of the concern may decrease as bad debt is charged against profit.

Realisation Concept

As per this concept, any change in value of an asset is to be recorded only if there is certainty that such change will materialise. Revenue is recognised when its realisation is certain. For example, value of asset is not increased even the current market price is far above than its recorded value. A sale is not recognised as revenue, if the collection is doubtful by any reason.

Accrual Concept

According to this concept, revenue is recognised when it is earned and not at the time when money is received. Expenses are recognised when they are incurred and not at the time when money is paid. In other words, as the right to receive money accrues it is to be treated as income and as the liability to make payment of expenditure accrues it is to be treated as expense. For example, interest on loan given is recognised on time basis though it is not yet received in cash. This concept is also termed deferral concept as receipt or payment of the money value can be deferred.

Matching Concept

Profit refers to the revenue as reduced by the related expenditure incurred to generate such revenue. Therefore, related expenditures are matched with the revenue (for which such expenditures are incurred). Firstly, revenue of a period is recognised, then cost associated with such revenue is charged as expenses in that period. Costs, which have lost its service potentiality in generation of revenue, are charged against such revenue. On the other hand, costs, which are expected to have service potentiality are treated as assets and carried forward to the next accounting period.

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