Basic Accounting Concepts

Introduction

Accounting works on certain principles, ethics, morals and mathematical formulae. For a systematic accounting process, there should be a structured, measurable, rationalized concepts on which accounting is based. This article briefs the basic concepts in accounting practice

Table of Content

  1. Introduction
  2. Business Entity Concept OR separate entity and economic entity concept
  3. Money Measurement Concept
  4. Matching Concept in accountancy
  5. concept of Revenue Recognition (Revenue Realization)
  6. Concept of Full Disclosure
  7. Going Concern Concept
  8. Accounting Period Concept
  9. Cost Concept

  10. Dual aspect concept

  11. Revenue recognition concept

  12. Conservatism concept

  13. Materiality Concept

A.Business Entity Concept OR separate entity and economic entity concept

Under this concept, a business and its owner should be treated separately as far as their financial transactions are concerned. In other words, while recording the financial transactions of a business, we must be very straight and clear that, accountants must take into account of only the events that will affect his/her particular business and not to consider if these transactions are affecting anyone else’s business. For example, you brought an additional power generator by paying 50,000 Rupees and this has a direct benefit to you but it is a drawback for the building owner of the space you rented, here the loss incurred to the owner will nowhere come under your accounts.  This concept will also prevent mixing up of your business with others

B. Money Measurement Concept

It is the expression of how a monetary source is kept in an office or the organization. Money measurement relates to those transactions of a business, which are recorded and kept in notes, cheques, DDs, etc but not in the form of currency directly. It is advised that every company must follow this principle to avoid loss, theft, etc. So for accounting purposes, all the assets must be shown in terms of monetary records.  But the drawback is that the changes in currency value will affect the recordings as the value of money keeps changing over time.

C. Matching Concept in accountancy

The matching concept refers to the principle of timeliness of recordings. In an accounting practice. Matching concept means firms must recognize the revenues and their related expenses in the same accounting period, it is usually the quarter or sometimes within the given year. For example, in an account book, the 1st quarter refers to the revenues and expenses calculated and recorded between the 1st of April to  30th of June. The matching concept will help to avoid wrong documentation by over-representation or under-representation of monetary information. The expenses incurred to earn these revenues must belong to the same accounting period. This principle is used under various circumstances like matching the cost of goods and services with revenues, revenues with expenses and so on. Matching can be revenues and expenses OR cost of goods with sales.

D. Concept of Revenue Recognition (Revenue Realization)

It means, the application of the accruals concept towards the recognition of revenue (income). Revenues are recognized by the seller when they truly earned as cash. He must make sure that the transaction has been received completely.  The concept of revenue recognition has a condition in which the revenue for a business transaction should be included in the accounting records only when it is realized. The revenue is said to be earned when an enterprise earned by selling goods or services or both as well as it renders the services and transfers the associated rewards and benefits to the buyer. 

E. Concept of Full Disclosure

Full disclosure helps to enhance the transparency among the investors, the public and the members of an organization. The full disclosure concept is an accounting principle requires management to report the business-related and relevant information about the company's operations to the shareholders, creditors and the financial organizations who are a part of the company. The disclosure must be made either in physical form or electronically with duly signed authority with the consent of board members. The information can be material facts/relevant facts concerning the financial performance of an enterprise, or any events, significant risks, and economic laggards, etc. This can aid the users to make correct assessment about the profitability and the current position of an organization. Bodies like SEBI will mandate the legally listed companies to disclose information for every quarter. Delay in submission will attract a penalty.

F. Going Concern Concept

This means a business is a never-ending process. In other words despite risks and external influences, a  firm will carry on its business with no set time limit and it is not going to be liquidated at a pre-decided point of time. This concept will boost the projection of the core value of assets in the balance sheet. This assumption regarding the continuity of the business necessitates us to charge from the revenue (for any asset bought and used), only that part of the asset which has been consumed or used, and the remaining is carried forward to the next year. In an unavoidable circumstance, if the company goes bankrupt then, the total cost of the asset will be charged from the revenue of the current year in which it was purchased.

G. Accounting Period Concept:

It states that the financial documents, recordings, filings have a set time limit and the financial statements of a given firm will be prepared, to quantify its profits and losses also to gain an insight into the position of its assets and liabilities.  This will ensure ease of understanding of the accounts for its use as the period will be short. It is usually on a quarterly and annual basis. So, to ensure perfection, the financial statements are prepared at regular intervals.

H. Cost Concept: 

This concept means, while recording the true value of an asset of any form, it is mandatory to record the value at the time of purchase instead of the present value. The cost might include, the cost incurred for acquisition, distribution, packing, transportation, installation, and initial maintenance, etc.  So the cost concept is historical in nature because the desired amount of an asset or good is paid on the date of acquisition itself and it does not change year after year. If the recording is done on a market value of the asset then it is more complex as the value keeps changing so, the negative side to this concept is that the true worth of the business is not clear and this may lead to hidden profits.

I. Dual aspect concept:

This means that every transaction has a hidden effect hence, it must be recorded in two places. In other words, at least two accounts must be involved who record them in 2 different records. It is also known as the duality principle.

J.revenue recognition concept:

The revenue from any source must be recorded only when it is realized. Revenue refers to the gross inflow of cash as a result of the sale of goods and services as well as any other enterprise’s efforts within the scope of its resources which can also be interest, royalties or dividends. So, precisely the revenue is realized only when the enterprise is in a legal position to claim that amount, therefore, credit sales are considered to be the revenue on the day the sale is made, and not when the money is transferred.

K. Conservatism concept:

This is to ensure not to falsify the information to the public. In other words, a clean and genuine recording of income and losses with no scope for overstatement and understatement. This will mandate the profits should not be recorded unless realized and the losses should be anticipated and recorded henceforth.  This will also help in building trust with customers and investors.

L.Materiality Concept:

According to this, the books of accounts must focus only on the materialistic aspect and immaterial information should be ignored. In other words no scope for assumptions or rough estimations of things.



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