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Accounting principles are guidelines to establish standards
for sound accounting practices and procedures in reporting
the financial status and periodic performance of a business.
Accounting standards are written/policy documents issued by
the govt. or professional institutes covering various aspects
of recognition, measurement, treatment, presentation and
disclosure of accounting transactions in the financial
statements.
Accounting principles are man made so they do not have the
authoritativeness as universal principles like the principles of
physics , chemistry and other natural sciences.
The science of accounting is not in a finished form, it is in the
process of evolution.
The general acceptance of an accounting principle depends
on how well it meets 3 criteria – relevance , objectivity and
feasibility.
Accounting concepts may be considered as postulates
i.e., basic assumptions or conditions upon which the
science of accounting is based.
The term “conventions” denote circumstances or
traditions which guide the accountants while
preparing the accounting statements.
This concept implies that business unit is separate and distinct
from the person who supply capital to it. Irrespective of the firm
of organisation , a business unit has got its own individuality as
distinguished from the person who control and own it.
The accounting equation is an expression of the entity concept
because it shows that the business itself owns the assets and in
turn owes to the various claimants.
Assets = Liabilities + Capital
Business is kept separate from the proprietor so
that transactions of the business may also be
recorded with him.
In case this concept is not followed , affairs of the
business will be mixed up with the private affairs
of the proprietor and the true picture of the
business will not be available.
If the proprietor of the business invests
25000 to
the business, it will be deemed that he has given that
much of money to the business as a loan which will be
shown as a liability in the books of a firm. On receipt
of the amount, cash account will be debited and the
proprietor ‘s capital account will be credited.
 Money is the only practical unit of measurement that can be employed to
achieve homogeneity of financial data.
 Therefore accounting records only those transactions which can be
expressed in terms of money though quantitative records are also kept.
 The advantages of expressing business transactions in terms of money is
the money serves as a common denominator by means of which
heterogeneous facts about a business can be expressed in terms of
numbers which are capable of additions and subtractions.
A business units has following assets: Cash in hand and cash at bank – Rs.25000
 Sundry debtors- 48500
 Bills receivable-6500
 Motor cars -5
 Stock – 6000 tons
 Furniture- 100 chairs and 20 tables
 Machines -7
They should be expressed as follows: Cash in hand and at bank – Rs.25000
 Sundry debtors – Rs.48500
 Bills receivable- Rs.6500
 Motor cars –Rs.115000
 Stock – Rs.400000
 Furniture – Rs.5000
 Total =
Rs.600000
It is assumed that a business unit has a reasonable expectations of
continuing business at a profit for an indefinite period of time.
A business unit is deemed to be a going concern and not a gone
concern.
It will continue to operate in the future.
Transactions are recorded in the books keeping in view the going
concern aspect of the business unit.
When an enterprise was set u for a particular purpose which has
been achieved or to be achieved shortly.
When a company is declared sick by BIFR .
When an enterprise has been in the grip of severe financial crisis
and is expected to wind up shortly.
When a receiver or liquidator has been appointed in case of a
company which is to be liquidated.
The fundamental concept of accounting closely related to the
going concern concept is that an asset is recorded in the books at
the price paid to acquire it and that this concept is the basis foe
all subsequent accounting for the assets.
This concept does not mean that the assets will always be shown
at cost but it means that cost becomes basis for all future
accounting for the assets.
The cost concept has the advantages of
bringing objectivity in the accounts.
Information given in the financial statements
is not influenced by the personal bias or
judgement of those who furnish such
statement.
This is the basic concept of accounting , according to this
concept, every financial transaction involves a two fold
aspect:
Yielding of a benefit.

Giving of that benefit.
Every debit must have a corresponding credit and vice versa
and upon this dual aspect has been raised the whole
superstructure of DOUBLE ENTRY SYSTEM OF
ACCOUNTING.
If the business purchase machinery and furniture worth Rs.
25000 and Rs.5000 respectively out of Rs.40000 provided by the
proprietor of the business, the situation will be as follows..
Assets = equities
Machinery Rs.25000 + Furniture Rs.5000+ Cash Rs.10000.. =
capital =Rs.40000
Subsequently if the business purchases stock worth Rs.8000 on
credit the position will be as follows..
Machinery Rs.25000+ furniture Rs.5000+
cash Rs.10000+ stock Rs.8000= creditors
Rs.8000+capital Rs.40000.
Thus accounting equation demonstrates the
fact that foe every debit there is an
equivalent credit.
A complete and accurate picture of the degree of success
achieved by a business unit cannot be obtained until it is
liquidated, converts its assets into cash and pays off its
debts.
The final accounts must be prepared on a periodic basis
rather than waiting till the business is terminated.
Normally accounting period adopted is one year as it
helps to take any corrective action, to pay income tax, to
absorb the seasonal fluctuations and for reporting to the
outsiders. A period of more than one year reduces the
utility of accounting data.
The principle of segregating capital expenditure from
revenue expenditure is based on the accounting period
concept.
This
concept is based on the accounting period concept. It is widely
accepted that desire of making profit is the most important motivation
to keep the proprietors engaged in business activities.
 By `matching’ we mean appropriate association of related revenues
and expenses pertaining to a particular accounting period.
 To put it in other words, profits made by a business in a particular
accounting period can be ascertained only when the revenues earned
during that period are compared with the expenses incurred for
earning that revenue.
In a business enterprise which adopts calendar year as
accounting year, if rent for December 2013 was paid in January
2014, the rent so paid should be taken as the expenditure of the
year 2013, revenues of that year should be matched with the
costs incurred for earning that revenue including the rent for
December 1989, though paid in January 2014. It is on account
of this concept that adjustments are made for outstanding
expenses, accrued incomes, prepaid expenses etc. while
preparing financial statements at the end of the accounting
period.
The system of accounting which follows this concept
is called as mercantile system. In contrast to this there
is another system of accounting called as cash system
of accounting where entries are made only when cash
is received or paid, no entry being made when a
payment or receipt is merely due.
According to this concept revenue is considered as
being earned on the date at which it is realised that is on
the data when the property in goods passes to the buyer
and he becomes legally liable to pay.
This concept is criticised by economists on the ground
that if an asset has increased in value then it is
irrelevant because it has not yet been sold.
As a result of this concept ,distinction is made between
holding gains and operating gains .
Holding gains arise as a result of increase in value from
holding an asset and operating gains are realised as a
result of selling assets.
Holding gains are not recorded because property in
goods has not yet transferred but operating gains are
reported because they have resulted as a result of sale.
As far as possible, every entry in accounting
records should be supported by some objective
evidence.
Evidence should be such which will minimise the
possibility of error and intentional bias or fraud.
The provision for doubtful debts account is an
estimate of the losses expected from failure to
collect sales made on credit.
Estimation of this account should be made on
such objective factors as past experience in
collecting debtors and reliable forecasts of future
business activities.
The essence of the accrual concept is that revenue is
recognised when it is realised i.e., when sale is complete
or services are given and it is immaterial whether cash
is received or not.
Similarly according to this concept, expenses are
recognised in the accounting period in which they help
in earning the revenue whether cash is paid or not.
Thus to ascertain correct profit or loss for an
accounting period and to show the true and fair
financial position of the business at the end of the
accounting period , we make record of all
expenses and incomes relating to the accounting
period whether actual cash has been paid or
received or not.
Accounting rules , practices and conventions should
be continuously observed and applied i.e., these
should not change from one year to another .
The results of different years will be comparable only
when accounting rules are continuously adhered to
from year to year.
Example… the principle of valuing stock at cost
or net realisable value whichever is less should be
followed year after year to get comparable results.
Consistency serves to eliminate personal bias
because the accountant will have to follow
consistent rules , practices and conventions year
after year.
The rationale behind this concept is that frequent
changes in accounting treatment would make the
financial statements unreliable to the persons
who use them.
Consistency also implies external consistency i.e.
financial statements of one enterprise should be
comparable with another.
Vertical consistency is achieved when the same
accounting rules , policies , practices and
conventions are adopted while preparing interrelated financial statements of the same date.
Horizontal consistency is achieved when the same
firm adopts the same accounting practices
,policies and methods from year to year..
According to this convention, all accounting statements
should be honestly prepared and to that full disclosure of
all significant information should be made.
All information which is of material interest to
proprietors, creditors and investors should be disclosed
in accounting statements.
The basis of valuation of fixed assets,
investments and stock should be clearly stated
in the balance sheet because it is of material
interest to the proprietors, creditors and
prospective investors .
It is a policy of caution or playing safe and had its origin as a
safeguard against possible losses in a world of uncertainity.
It compels the businessman to wear a risk proof jacket for the
working rule – anticipate no profits but provide for all possible
losses.
Example closing stock is valued at cost or net realisable value,
whichever is less.
But if the net realisable value is less than the
cost, the higher amount of cost will be ignored
and stock will be valued at net realisable value
which is less than the cost.
Contingent gains and benefits from contracts to
the extent nit executed should not be accounted
fir in financial statements.
The materiality concept is the principle in accounting that states that all
important matters are to be disclosed. Items that are large enough to matter
are material items.
Materiality refers especially to:
• The level of detail appropriate for different financial reports.
• The importance of errors such as:
– Reporting expenses, revenues, liabilities, equities, or assets in
inappropriate accounts, or reporting them for incorrect reporting periods.
– Omitting or failing to report important financial data.
• The materiality concept is an established, recognized accounting
convention. Another such convention is the historical cost
convention, by which transactions are recorded at the price
prevailing when the transaction is made, and assets are valued at
original cost.
• Applying the materiality concept may call for more subjective
judgment. Moreover, the subjective judgments of senior
management, accountants, auditors, boards of directors,
stockholders, and potential business partners, can differ, especially
when competing interests are involved.
Moreover, the subjective judgments of senior management,
accountants, auditors, boards of directors, stockholders, and
potential business partners, can differ, especially when
competing interests are involved.
Financial statement items are considered material (large enough
to matter) if they could influence the economic decisions of users.
The materiality concept is the universally accepted accounting
principle that all material matters are to be disclosed.
Some of the examples of material financial information to be
disclosed are likely fall in the value of stocks, loss of markets due
to competition or Government regulation, increase in wage bill
under recently concluded agreement , etc.
An item of small value may last for three years and technically its
cost must be allocated to every one of the three years. Since its
value is small, it can be treated as the expense in the year of
purchase.
As per A.S. – 1, materiality should govern the selection and
application of accounting policies. According to the consideration
of materiality financial statement should disclose all items which
are material enough to affect evaluations or decisions.
ILLUSTRATION : Company XYZ Ltd. bought 6 months
supplies of stationary worth $600.
QUESTION : Should the Company spread the cost of
this stationary for 6 months by expensing off $100 per
month to the income statement?
ANSWER : Based on this concept, as the amount is so
small or immaterial, it can be expensed off in the next
month instead of tediously expensing it in the next 6
months.
Accounting policies are the specific accounting principles and
the methods of applying those principles that are considered by a
business concern to be the most appropriate in the
circumstances to present financial statements.
Accounting policies represent choices among different
accounting methods that can be used in recording financial
transactions and preparing financial statements.
Three consideration should govern the selection and application
by management of the appropriate accounting policies and the
preparation of financial statements.
 PRUDENCE – uncertainities inevitably surround many
transactions .this should be recognised by exercising prudence in
preparing financial statements. Prudence does not however just
the creation of secret or hidden reserves.
SUBSTANCE OVER FORM- transactions
and other events should be accounted for
and presented in accordance with their
substance and financial reality and not
merely with their legal form.
 MATERIALITY- financial statements
should disclose all items which are
material enough to affect evaluations or
decisions.

Hereby we conclude that both accounting
principles and policies are an integral part
of financial statements which need to be
adhered to.
Their presence makes accounting
treatment easier and understandable.
Short
Answer Type
Questions
1.
Define accounting concepts
and accounting conventions.
Accounting concepts :
Accounting concepts may be considered as
postulates i.e., basic assumptions or conditions
upon which the science of accounting is based.
 Accounting conventions :
The term ‘conventions’ denote circumstances
or traditions which guide the accountants while
preparing the accounting statements.

2. Write the basic difference
between concepts and
conventions.
Concepts and conventions are often
used inter-changeable. The basic
difference between them is that
concepts are concerned with
maintenance of accounts where as
conventions are applicable while
preparing financial statements i.e.,
Statement of Profit and Loss and
Balance Sheet.
3. State the accounting
concepts.










Business Entity Concept
Money Measurement Concept
Going Concern Concept
Cost Concept
Dual Aspect Concept
Accounting Period Concept
Matching Concept
Realisation Concept
Objective Evidence Concept
Accrual Concept
4. State the accounting
conventions.




Convention of Consistency
Convention of Full Disclosure
Convention of Conservatism
Convention of Materiality
3. What is matching concept?
Matching concept is based on the accounting
period concept. The most important objective
of running a business is to ascertain profit
periodically. The determination of profit of a
particular accounting period is essentially a
process of matching the revenue recognised
during the period and the cost to be allocated
to the period to obtain the revenue. It is, thus, a
problem of matching revenues and expired
costs, the residual amount being the net profit or
net loss for the period.
4. Write three fundamental
accounting assumptions.

Going concern :
The enterprise is normally viewed as a going concern,
that is, as continuing in operation for the foreseeable
future.

Consistency :
It is assumed that the accounting policies are consistent
from one period to another.

Accrual:
Revenues and costs are accrued, that is, recognised as
they are earned or incurred and recorded in the
financial statements of the periods to which they relate.
5. State the sources of
Indian GAAP.
Principle sources of Indian GAAP are:
 Company law.
 Accounting standards and related
documents of the ICAI.
 SEBI requirements.
 Established Conventions.
 Long Answer
Type Questions
Q.1. What are the basic accounting
concepts? Explain their implications.
Ans: Accounting concepts may be considered as
postulates i.e. basic assumptions or conditions upon
which the science of accounting is based.
There is no authoritative list of these concepts but
most of the concepts have fairly general support.
Business Entity
Concept
Money
Measurement
Concept
Accrual
Concept
Going
Concern
Concept
Objective
Evidence
Concept
ACCOUNTING
CONCEPTS
Realisation
Concept
Cost
Concept
Dual Aspect
Concept
Matching
Concept
Accounting Period
Concept
IMPLICATIONS
1. Accounting concepts provide a standard to
measure financial presentations.
2. Accounting concepts recognise the importance of
reporting transactions and events in accordance with
their substance.
3.Accounting concepts are common set of
accounting principles that companies use while
preparing their financial statements of the accounting
period.
4. These are imposed on companies so that investors
have a maximum level of consistency in the financial
statements they use when analysing companies for
investment purposes.
5. Accounting concepts are necessary so that
accountant could follow these concepts about the
measurement of revenue and expenses.
Q.2. Why are accounting
concepts and conventions
necessary? How do you distinguish
between accounting concepts
and conventions?
Ans: Accounting concepts and conventions are very
necessary in ascertaining the profit of the financial
companies.
1.These concepts and conventions have been made
by accounting experts. They found that if any
accountant will use these concepts and conventions
in his professional work then he can save money,
energy, time and provide effective services to
organization.
2.Accounting concepts and conventions are
necessary so that accountant could follow these
concepts about the measurement of revenue and
expenses.
3. Accounting concepts and conventions are a set of
methodologies and guidelines when preparing
financial statements, thereby ensure that accounting
information is prepared in a manner which is
consistent, true, fair and accurate.
DIFFERENCE BETWEEN ACCOUNTING
CONCEPTS AND ACCOUNTING CONVENTIONS
ACCOUNTING CONCEPTS
ACCOUNTING CONVENTIONS
1. Accounting concepts may be
considered as postulates i.e. basic
assumptions or conditions upon
which the science of accounting
is based.
1. Accounting conventions
denote circumstances or
traditions which guide the
accountants while preparing
the accounting statements.
2.Accounting concepts have
been established by professional
organizations and are standard
principles that must be followed
when preparing the financial
accounts.
2. Conventions are generally
accepted practices that can
change and are updated over
time, depending upon the
changes in the financial
reporting landscape.
ACCOUNTING CONCEPTS
ACCOUNTING CONVENTIONS
3. Accounting concepts are
officially recorded.
3. Accounting conventions are
not officially recorded and are
followed as generally accepted
guidelines.
4. Accounting concepts are
concerned with maintenance of
accounts.
4. Accounting conventions are
applicable while preparing
financial statements i.e.
Statement of Profit and Loss and
Balance Sheet.
Q.3. What do you mean by basic accounting
concepts and conventions? Discuss in brief
some of the important concepts and
conventions.
Ans: Accounting concepts may be considered as postulates i.e.
basic assumptions or conditions upon which the science of
accounting is based.
Accounting concepts have been established by professional
organizations and are standard principles that must be followed
when preparing the financial accounts.
Accounting conventions denote circumstances or traditions
which guide the accountants while preparing the accounting
statements.
Conventions are generally accepted practices that can change
and are updated over time, depending upon the changes in the
financial reporting landscape.
Business Entity Concept:
This concept implies that a business unit is separate
and distinct from the person who supply capital to it.
The transactions of the proprietor with the business are
recorded so that true financial position and
profitability of the business may be disclosed.
1.
2. Money Measurement Concept:
Money is the only practical unit of measurement that
can be employed to achieve homogeneity of
financial data. Therefore, accounting records only
those transactions which can be expressed in terms of
money though quantitative records are also kept.
The advantage of expressing business transactions in
terms of money is that money serves as a common
denominator.
3. Going Concern Concept:
It is assumed that a business unit has a reasonable
expectation of continuing business at a profit for an
indefinite period of time. A business unit is deemed to
be a going concern and not a gone concern.
It will continue to operate in future. The transactions
are recorded in the books keeping in view the going
concern aspect of the business unit.
4. Cost concept:
A fundamental concept of accounting closely related
to the going concern concept is that an asset is
recorded in the books at the price to acquire it and
that this cost is the basis for all subsequent accounting
for the asset.
This concept does not mean that the asset will always
be shown at cost but it means that cost becomes
basis for all future accounting for the asset.
5. Dual aspect concept:
This is the basic concept of accounting. According to
this concept, every financial transaction involves a
two fold aspect:
(a) Yielding of a benefit
(b) the giving of that benefit.
ACCOUNTING CONVENTIONS:
Convention of Consistency :
Accounting rules, practices and
conventions should be continuously
observed and applied i.e. these should not
change from one year to another. The
results of different years will be comparable
only when accounting rules are continuously
adhered to from year to year.
1.
2. Convention of Full Disclosure:
According to this convention, all accounting
statements should be honestly prepared and to that
end full disclosure of all significant information should
be made. All information which is of material interest
to proprietors, creditors and investors should be
disclosed in accounting statements.
3. Convention of Conservatism or Prudence:
Conservatism means taking the gloomy view of a
situation. It is a policy of caution or playing safe and
had its origin as a safeguard against possible losses in
a world of uncertainty.
It compels the businessman to wear a “risk proof”
jacket for the working rule: anticipate no profits but
provide for all possible losses.
4. Convention of Materiality:
An accounting concept according to which all
relatively important and relevant items ,(i.e. items, the
knowledge of which might influence the decisions of
the user of the financial statements) are disclosed in
the financial statements.
Q.4: Examine the accounting
concepts of conservatism and
materiality and their significance in
the preparation of financial
statements.
 Conservatism:
Conservatism means taking a
gloomy view of a situation. It is a policy of caution
or playing safe. It compels the businessman to wear
a risk-proof jacket, for the rule is anticipate no profits
but provide for all possible losses. For example,
closing stock is valued at cost or net realizable
value whichever is less . If net realizable value us
higher than cost, the higher amount of cost will be
ignored and stock will be valued at net realizable
value which less than cost. Other applications of
the conservatism concept can be as follows:
a)
b)
c)
d)
Research and development expenses are usually
charged as expenses of the period in which they are
incurred but benefits of research and development
will be realized in future.
Under the completed contract method revenue from
long term construction contract is recognized only
when the contract is completed substantially.
In case of “cash or delivery sales” revenue is
recognized when cash is received by the seller or his
agent and not on delivery of goods to the buyer.
As per AS4,”the amount of a contingent loss should be
provided for by a charge in the statement of profit or
loss if:
i.
ii.
It is probable that at the date of the financial
statements events subsequent thereto will confirm
that an asset has been impaired or a liability has been
incurred as at that date ,and
A reasonable estimate of the amount of the resulting
loss can be made.
Contingent gains and benefits from contracts to the
extent should not accounted for in financial
statements .”
Over optimism in reporting results is more undesirable
results than over pessimism in reporting results because
it shows position better than what actual financial
position is. But the excessive application of the
convention of conservatism could result in the creation
of secret results, which is contrary to the convention of
full disclosure. Conservatism carried beyond what is
warranted by reasonable doubts distorts earnings in as
much as net profit in one period may be understated
than what actual profit is.
• Materiality: Materiality depends on the
amount involved in the transaction. The
accountant should record an item as
material even though it is of small amount
if its knowledge seems to influence the
decision of the proprietors or auditors or
investors.
Q.5:Explain the accounting
concept of income.
 The
essence of the accrual concept is
that revenue is recognized when it is
realized, that is when sale is complete or
services are given and it is immaterial
whether cash is received or not. Similarly,
according to this concept, expenses are
recognized in the accounting period in
which they help in earning the revenue
whether cash is paid or not.
Q.6: Explain the meaning and
significance of the following :
a)
b)
c)
d)
e)
f)
g)
The Going concern concept
The Money Measurement concept
The Cost concept
The Business Entity concept
The Matching concept
The Accounting Period concept
Dual Aspect concept
a) Going Concern Concept: It is assumed that a business unit has a
reasonable expectation of continuing business at a profit for an
indefinite period of time. A business unit is deemed to be a Going
Concern and not a Gone Concern. It will continue to operate in
the future. Transactions are recorded in the books keeping in view
the Going Concern aspect.
b) Money Measurement Concept: Accounting records only those
transactions which can be expressed in terms of money though
quantitative records are also kept. Money provides a common
denominator for measuring but it does not take care of inflation,
which takes place with the passage of time.
c) Cost Concept: A fundamental concept of accounting closely
related to Going Concern concept is that an asset is recorded in
the books at the price paid to acquire it and that this cost is the
basis for all subsequent accounting for the asset. This concept
does not mean that the asset will always be shown at cost, but it
means that cost becomes basis for all future accounting for the
asset.
d) Business Entity Concept: This concept implies that a
business unit is separate and distinct from the person
who supplies capital to it. Irrespective of the form of
organization, a business unit has got its own individuality
as distinguished from the person who owns or controls it.
The accounting equation i.e. assets = liabilities + capital
is an expression of the entity concept because it shows
that the business itself owns the assets and in turn owes
to various claimants.
e) Matching Concept: The determination of profit of a
particular accounting period is essentially a process of
matching the revenue recognized during the period
and the cost to be allocated to the period to obtain the
revenue. It is thus a problem of matching revenues and
expired costs. The residual amount being the net profit
or net loss for the period.
f)
Accounting Period Concept: Normally, accounting period
adopted is one year as it helps to take any corrective
action to pay income tax to absorb the seasonal
fluctuations and for reporting to the outsiders. A period of
more than one year reduces the utility of accounting data.
The principle of segregating capital expenditure from
revenue expenditure is based on the account period
concept.
g) Dual Aspect Concept: This is the basic concept of
accounting. According to this concept, every financial
transaction involves a two fold aspect, (a) yielding of a
benefit and (b) the giving of that benefit. There must be a
double entry to have a complete record of each business
transaction, an entry being made in the receiving account
and an entry of the same amount in the giving account.
Q7.
“Accrual concept
is essentially the
matching concept”.
Explain the statement.
In cash accounting, you record transactions in your books only when
you receive cash or you pay out cash. Say you own a small business
that produces crafts, and you sell 500 finished pieces to a retailer for
$5 apiece. Under cash accounting, if you were paid in cash, you
would immediately record $2,500 in revenue. But if you sold the items
on credit, you wouldn't record the revenue until you actually got the
cash. In accrual accounting, you recognize revenue whenever you
earn it, regardless of when the money comes in. In the same
scenario, you would record $2,500 in revenue immediately, whether
you sold the items for cash or on credit.
The matching concept exists only in accrual accounting. This
principle requires that you match revenues with the expenses
incurred to earn those revenues, and that you report them both at
the same time. This means that if you owned a store and spent
money to purchase items for your inventory, you wouldn't record that
expense until you sold the items for revenue. Further, you would
record only the portion of the expense attributable to each individual
item as it got sold. Similarly, if you ran a crafts business, you wouldn't
record the expenses involved in producing those crafts until you
actually sold the items you had produced.
GAAP serves as a common language among accounting
and finance professionals, thereby allowing stakeholders
to compare financial statements across corporations and
vast time spans. An investor who wishes to invest in the
automobile industry, for example, can meaningfully
compare the profit figures of two automakers only if they
were prepared using the same principles. Similarly,
managers can only draw realistic conclusions about their
divisions' performance if their accountants stick to a set of
consistent principles over time. GAAP also minimizes the
risk of unintentional errors through implementation of
checks and safeguards, and provides confidence to the
users of financial statements.
The accounting entity concept recognizes a specific
business enterprise as one accounting entity, separate
and distinct from the owners, managers, and employees
of that business.
The going concern principle, also known as continuing
concern concept or continuity assumption, means that a
business entity will continue to operate indefinitely, or at least
for another twelve months.
Financial statements are prepared with the assumption that
the entity will continue to exist in the future, unless otherwise
stated.
The going concern assumption is the reason assets are
generally presented in the balance sheet at cost rather that
at fair market value. Long-term assets are included in the
books until they are fully utilized and retired.
Q9. “Without accounting concepts and
conventions objective, reliable, consistent
and comparable accounts cannot be
maintained.” comment.
Separate entity concept:
 This
concept assumes that, for accounting purposes, the
business enterprise and its owners are two separate
independent entities. Thus, the business and personal
transactions of its owner are separate.
 For example, when the owner invests money in the
business, it is recorded as liability of the business to the
owner. Similarly, when the owner takes away from the
business cash/goods for his/her personal use, it is not
treated as business expense.
Money Measurement concept:


This concept assumes that all business transactions must be in terms
of money.
In our country such transactions are in terms of rupees. Thus, as per
the money measurement concept, transactions which can be
expressed in terms of money are recorded in the books of accounts
Going concern concept:
•
This concept states that a business firm will continue to carry
on its activities for an indefinite period of time.
• Simply stated, it means that every business entity has
continuity of life. Thus, it will not be dissolved in the near future.
This is an important assumption of accounting, as it provides a
basis for showing the value of assets in the balance sheet.
Accounting period concept:
The
life of an entity is divided into short
economic time periods on which
reporting statements are fashioned. All
the transactions are recorded in the
books of accounts on the assumption
that profits on these transactions are to
be ascertained for a specified period.
This is known as accounting period
concept.
Accounting cost concept:

Accounting cost concept states that all assets are recorded in
the books of accounts at their purchase price, which includes
cost of acquisition, transportation and installation and not at
its market price. It means that fixed assets like building, plant
and machinery, furniture, etc are recorded in the books of
accounts at a price paid for them. For example, a machine
was purchased by XYZ Limited for Rs.500000, for
manufacturing shoes. An amount of Rs.1,000 were spent on
transporting the machine to the factory site. In addition,
Rs.2000 were spent on its installation. The total amount at
which the machine will be recorded in the books of accounts
would be the sum of all these items i.e. Rs.503000. This cost
is also known as historical cost.
Matching Concept:
 The
matching concept states that the revenue
and the expenses incurred to earn the
revenues must belong to the same accounting
period. So once the revenue is realised, the
next step is to allocate it to the relevant
accounting period. The matching concept
implies that all revenues earned during an
accounting year, whether received/not
received during that year and all cost incurred,
whether paid/not paid during the year should
be taken into account while ascertaining profit
or loss for that year.
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 (i) Giving of cash
(ii) 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
Realisation concept
This concept holds to the view that profit can only
be taken into account when realisation
has occurred.
According to this concept revenue is recognised
when a sale is made. Sale is considered to be
made at the point when the property in goods
passes to the buyer and he becomes legally
liable to pay.
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
ACCOUNTING CONVENTIONS
The term ‘conventions’ includes those customs or traditions which
guide the accountant while preparing the accounting statements.
Accounting Conventions
Conservatis
m
Full
Disclosure
Consistency
Materiality
Conservatism
This convention is based on the principle that
“Anticipate no profit, but provide for all possible
losses”. It provides guidance for recording
transactions in the books of accounts. It is based on the
policy of playing safe in regard to showing profit. The
main objective of this convention is to show minimum
profit. Profit should not be overstated. If profit shows
more than actual, it may lead to distribution of dividend
out of capital. This is not a fair policy and it will lead to
the reduction in the capital of the enterprise
Full Disclosure
Convention of full disclosure requires that all material
and relevant facts concerning financial statements
should be fully disclosed. Full disclosure means that
there should be full, fair and adequate disclosure of
accounting information.
Consistency
The convention of consistency means that same
accounting principles should be used for preparing
financial statements year after year. For example: if a
stock is valued at “cost or market price whichever is
less”, this principle should be followed year after year.
Materiality
 The
convention of materiality states that, to
make financial statements meaningful, only
material fact i.e. important and relevant
information should be supplied to the users of
accounting information. The question that
arises here is what is a material fact. The
materiality of a fact depends on its nature and
the amount involved. Material fact means the
information of which will influence the
decision of its user.
Q10. Explain the major conventions (or
doctrine) followed in the preparation of
financial statements .
Ans. There are four major conventions
which are followed in the preparation of
financial statements. These conventions are
as follows:
1. Convention of Consistency
2. Convention of full disclosure
3. Convention of conservatism
4. Convention of materiality
1. Convention of Consistency
Accounting rules ,practices and conventions should be
continuously observed and applied i.e. these should not
change from one year to another . The results of different
years will be comparable only when accounting rules are
continuously adhered to from year to year.
For example the principle of “valuing stock at
cost or market price
whichever is lower “
should be followed “year after year to get
comparable results.”
2.Convention
of Full Disclosure
According to this convention , all accounting
statements should be honestly prepared and to
that end full disclosure of all significant
information should be made. All information
which is of material interest to proprietors ,
creditors and investors should be disclosed in
accounting statements .
3. Convention Of Conservatism
Literally speaking conservation
means taking the gloomy view of a
situation. It is policy of caution or
playing had its origin as a safeguard
against possible losses in world of
uncertainty. It compels the
businessman to were a “risk-proof”
jacket for the working rule is: “
anticipate profit for all possible
For example ,closing stock is valued at cost or
losses.”
market price .whichever is lower .if market price is
higher than the cost ,the higher amount is ignored
in the accounts and closing stock will be valued at
cost which is lower than the market price.
4. Convention of Materiality
An accounting concept according to which all
relatively important and relevant items ,i.e.,
items, the knowledge of which might
influence the decisions of the user of the
financial statements are disclosed in the
financial statements.
Materiality depends on the amount involved
in the transaction.
For example ,minor expenditure of rupees
10 for the purchase of waste basket may be
treated as an expense of the period than an
asset .
Q11. Discuss conventions regarding financial
statements.
Ans. There are four conventions regarding financial
statements: -
Convention of Consistency:
Accounting rules ,practices and conventions should be
continuously observed and applied i.e. these should not
change from one year to another . The results of different
years will be comparable only when accounting rules are
continuously adhered to from year to year.
Convention of Full Disclosure
According to this convention , all accounting statements
should be honestly prepared and to that end full disclosure
of all significant information should be made. All
information which is of material interest to proprietors ,
creditors and investors should be disclosed in accounting
statements .
Convention of Conservatism:
Literally speaking conservation means taking
the gloomy view of a situation. It is policy of
caution or playing had its origin as a
safeguard against possible losses in world of
uncertainty. It compels the businessman to
were a “risk-proof” jacket for the working rule
is: “ anticipate profit for all possible losses.”
Convention of Materiality:
An accounting concept according to which all relatively
important and relevant items ,i.e., items, the knowledge
of which might influence the decisions of the user of the
financial statements are disclosed in the financial
statements.
Materiality depends on the amount involved in the
transaction.
Q12. Describe in detail the accounting
convention which states the rule “anticipate
no profit but provide for all the possible losses.”
Ans. Literally speaking conservation means taking the
gloomy view of a situation. It is policy of caution or
playing had its origin as a safeguard against
possible losses in world of uncertainty. It compels
the businessman to were a “risk-proof” jacket for
the working rule is: “ anticipate profit for all
possible losses.”
For example , closing stock is valued at
cost or market price ,whichever is lower .if
market price is higher than the cost ,the
higher amount of stock is ignored in the
accounts and closing stock is valued at
cost which is lower than market price.
Q13. Explain the accounting
concept of periodic matching of
costs and revenue.
Periodic Matching of Costs and Revenues: This
concept is based on the accounting period concept. It
is widely accepted that desire of making profit is the
most important motivation to keep the proprietors
engaged in business activities. Hence a major share of
attention of the accountant is being devoted towards
evolving appropriate techniques of measuring profits.
One such technique is periodic matching of costs and
revenues.
In order to ascertain the profits made by the business during
a period, the accountant should match the revenues of the period
with the costs of that period. By `matching’ we mean appropriate
association of related revenues and expenses pertaining to a
particular accounting period. To put it in other words, profits
made by a business in a particular accounting period can be
ascertained only when the revenues earned during that period are
compared with the expenses incurred for earning that revenue.
The question as to when the payment was
actually received or made is irrelevant. For e.g. in a
business enterprise which adopts calendar year as
accounting year, if rent for December 1989 was paid in
January 1990, the rent so paid should be taken as the
expenditure of the year 1989, revenues of that year
should be matched with the costs incurred for earning
that revenue including the rent for December
1989, though paid in January 1990. It is on account of
this concept that adjustments are made for outstanding
expenses, accrued incomes, prepaid expenses etc. while
preparing financial statements at the end of the
accounting period.
The system of accounting which follows
this concept is called as mercantile system.
In contrast to this there is another system
of accounting called as cash system of
accounting where entries are made only
when cash is received or paid, no entry
being made when a payment or receipt is
merely due.
Q14. Briefly explain the
convention of materiality.
Give examples.
Materiality Information is material if its omission or misstatement could
influence the economic decisions of users taken on the basis of the
financial statements (IASB Framework).Materiality therefore relates to the
significance of transactions, balances and errors contained in the
financial statements. Materiality defines the threshold or cutoff point
after which financial information becomes relevant to the decision
making needs of the users. Information contained in the financial
statements must therefore be complete in all material respects in order
for them to present a true and fair view of the affairs of the entity.
Materiality is relative to the size and particular circumstances of individual
companies.
Example - Size
A default by a customer who owes only $1000 to a company having net
assets of worth $10 million is immaterial to the financial statements of the
company.
However, if the amount of default was, say, $2 million, the information
would have been material to the financial statements omission of which
could cause users to make incorrect business decisions.
Example - Nature
If a company is planning to curtail its operations in a geographic segment
which has traditionally been a major source of revenue for the company in the
past, then this information should be disclosed in the financial statements as it
is by its nature material to understanding the entity's scope of operations in the
future.
Materiality is also linked closely to other accounting concepts and principles:
Relevance: Material information influences the economic decisions of the users and is therefore
relevant to their needs.
Reliability: Omission or misstatement of an important piece of information impairs users' ability
to make correct decisions taken on the basis of financial statements thereby affecting the
reliability of information.
Completeness: Information contained in the financial statements must be complete in all material
respects in order to present a true and fair view of the affairs of the company.
Q15. Briefly discuss the basic
accounting concepts and fundamental
accounting assumptions. Is there a
conflict between the two?
The Accounting Standard (AS-1) ‘Disclosure of Accounting Policies’ issued
by Institute of Chartered Accountants of India, which states that there
are three fundamental accounting assumptions:
1.
2.
3.
Going Concern
Consistency
Accrual
Going concern: The enterprise is normally viewed as a going concern, i.e. as continuing
operations for the foreseeable future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation. If an enterprise is not a going concern Valuation of its assets and liabilities on historical cost becomes irrelevant and as a
consequence its profit/loss may not give reliable information.
It is assumed that accounting policies are
consistent from one period to another. This adds the
virtue of comparability to accounting data. It
comparability is lost, the relevance of accounting data for
users’ judgment and decision making is gone.
Consistency:
Accrual : Revenues and costs are accrued, that is,
recognized as they are earned or incurred (and not as money
is received or paid) and recorded in the financial statements
of the periods to which they relate. This assumption is the
core of accrual accounting system.
Disclosure requirements -If the fundamental accounting
assumption, viz. going Concern, Consistency, and Accrual are
followed in financial statements, specific disclosure is not
required. If a fundamental accounting assumption is not
followed, the fact should be disclosed. These are called
fundamentals because these are to be followed and their
disclosure in the financial statements is required if these are not
followed. Otherwise there is no conflict between accounting
concepts and fundamental accounting assumptions. In fact,
fundamental accounting assumptions are part of the basic
accounting concepts.
Q19. What do you mean by
fundamental accounting assumptions?
Fundamental Accounting Assumptions:
Following are recognized by the International Accounting
Standards Committee and the Institute of Chartered Accountants
of India as fundamental accounting assumptions as per
International Accounting Standard 1 and Indian Accounting
Standard 1. They are reproduced below:
 Going Concern. The enterprise is normally viewed as a going
concern, that is , as continuing in operation for the foreseeable
future. It is assumed that the enterprise has neither the intention
nor the necessity of liquidation or of curtailing materially the
scale of its operations.


Consistency. It is assumed that the accounting policies are
consistent from one period to another.
Accrual. Revenues and costs are accrued , that is , recognised as
they are earned or incurred (and not as money is received or paid)
and recorded in the financial statements of the periods to which
they relate.
If fundamental accounting assumptions are not followed in the
preparation and presentation of financial statements, the fact
should be disclosed. If these are followed , no specific disclosure is
necessary. These are called fundamental because these are to be
followed and their disclosure in the financial statements is required
if these are not followed. Otherwise there is no conflict between
accounting concepts and fundamental accounting assumptions. In
fact, fundamental accounting assumptions are part of the basic
accounting concepts
Q20. (a) Briefly state the three major characteristics which
should be considered for the purpose of selection and
application of accounting policies.
Characteristics of Accounting Principles
Following are the main characteristics of accounting
principles:
 Accounting principles are man made so they do not have
the authoritativeness as universal principle like the
principle of physics, chemistry and other natural sciences.
They represent the best possible guidelines based on
reasons and observations and have been developed by
accountants to enhance the usefulness of accounting data
in an ever changing society. Accounting is a social science
and is the natural result of economic phenomena.


The science of accounting is not in a finished form, it is in the
process of evolution. Consequently , accounting principles are fast
developing. These are influenced by business practices and
customs, government agencies and other business groups.
The general acceptance of an accounting principle usually
depends on how well it meets three criteria : relevance, objectivity
and feasibility . A principle is relevant to the extent that it results
in information that is useful to those who want to know
something about certain business. A principle is objective to the
extent that the accounting information is not influenced by the
personal bias of those who furnish the information. The
accounting information given in the financial statements should
be free from the personal bias of the persons who have taken part
in the preparation of such statements. A principle is feasible to
the extent that it can be applied without undue complexity or
cost.
20. (b) State the concept of materiality.
An accounting concept according to which all relatively important and
relevant
items,(i.e., items, the knowledge of which might influence the decisions of the
user of
the financial statements) are disclosed in the financial statements.
Whether something should be disclosed or not in the financial statements
will
depend on whether it is material or not. Materiality depends on the amount
involved
in the transaction . For example, minor expenditure of Rs10 for the purchase of
waste
basket may be treated as an expense of the period rather than an asset.
The term “materiality ’’ is a subjective term . The accountant should
record an
item as material even though it is of small amount if its knowledge seems to
influence the decision of the proprietors or auditors or investors. For example,
commission paid to sole selling agents should be disclosed separately in the
Statement
of Profit and Loss.

20. (c) Transactions and events are guided by generally
accepted accounting principles subject to laws of land.
Comment.

The Phrase ‘ Generally Accepted Accounting
Principles’(GAAP) is a technical accounting term that
encompasses the conventions , rules and procedures
necessary to define accepted accounting practices at a
particular time. It includes not only broad guidelines of general
applications but also detailed practices and procedures .
These rules and procedures provide a standard to measure
financial presentations.
GAAPs are only a set of standards. There is plenty of room
within GAAPs for accountants to distort figures. So even when a
company uses GAAP , still there is need to scrutinize its
financial statements. Accounting statements are prepared in
conformity with these principles in order to place more
reliance on them. The need for the common accounting
principles becomes more apparent when we contemplate the
chaotic conditions that would prevail if every accountant
could follow his own principles about the measurement of
revenue and expenses.
Q21. List out any four accounting
concepts .
(1)
Business Entity Concept
This concept implies that a business unit is separate and
distinct from the person who supply capital to it. Irrespective
of the form of organization , a business unit has got its own
individually as distinguished from the person who own or
control it. The accounting equation (i.e. Assets=
Liabilities+Capital) is an expression of the entity concept
because it shows that the business itself owns the assets and in
turn owes to the various claimants.
(2) Money Measurement Concept
Money is the only practical unit of measurement that can be employed to achieve homogeneity of
financial data. Therefore, accounting records only those transactions which can be expressed in
terms of money though quantitative records are also kept. The advantages of expressing
business transactions in terms of money is that money serves a common denominator by means
of which heterogeneous facts about a business can be expressed in terms of numbers (i.e. money)
which are capable of additions and subtractions.
A business unit has the following assets on March, 31, 2014.
Cash in hand and at bank Rs 25000, Sundry Debtors Rs 48500, Bills Receivable Rs 6500,
Motor Cars 5, Stock 6000 tons, Furniture 100 chairs and 20 tables, Machines 7, Building
space 5000 sq. meters, Land 10 acres
The items given in different units of measurement cannot be added together to get an idea
of the total value of the assets owned by the business. To get an idea of the total value of the
assets, all items should be expressed in terms of money as given below:
Cash in hand and at bank Rs 25000, Sundry Debtors Rs 48500, Bills receivable Rs 6500,
Motor Cars Rs 115000, Stock Rs 400000, Furniture Rs 5000, Machines Rs 250000, Building
Rs 440000, Land Rs 100000, Total= 1390000.
(3) Going Concern Concept
It is assumed that a business unit has a reasonable expectation of
continuing business at a profit for an indefinite period of time. A
business unit is deemed to be a going concern and not a gone concern. It
will continue to operate in the future . Transactions are recorded in the
books keeping in view the going concern aspect of the business unit.
It is because of this concept that suppliers supply goods and services
and other business firms enter into business transactions with the
business unit. Suppliers will not supply goods and services and other
person will not have business dealings with the business entity if they
have the feelings that the concern will be liquidated. This assumption
provides much of the justification for recording fixed assets at original
cost (i.e. acquisition cost) and depreciating them in a systematic manner
without reference to their current realisable value.
(4) Accrual Concept
The essence of the accrual concept is that revenue
is recognized when it is realized, that is when sale is
complete or services are given and it is immaterial
whether cash is received or not. Similarly, according
to this concept, expenses are recognized in the
accounting period in which they help in earning the
revenue whether cash is paid or not.