Accounting Principles

Accounting principles

To maintain uniformity and consistency in accounting records, certain rules or principles have been developed which are generally accepted by the accounting profession. These rules are called by different names such as principles, concepts, conventions, postulates, assumptions and modifying principles.

One such accounting principle which is generally accepted is "GAAP".

Generally Accepted accounting principles (GAAP) refers to the rules or guidelines adopted for recording and reporting business transactions, to bring uniformity in the preparation and the presentation of financial statements. 

These principles are also referred to as concepts and conventions. 

The accounting principles are classified into 

1.Accounting concepts

2.Accounting Conventions

Basic Accounting Concepts

The important concepts have been listed as below:

1. the Business entity

2. Money measurement

3. Going concerned

4. Accounting period

5. Cost

6. Dual aspect (or Duality)

7. Revenue recognition(Realisation)

8. Matching

important Accounting Conventions

1. Full disclosure

2. Consistency

3. Conservatism (Prudence)

4.Materiality

1. The Business entity

The concept of a business entity assumes that a business has a distinct and separate entity from its owners. The accounting records are made in the book of accounts from the point of view of the business unit and not that of the owner unless it involves the inflow or outflow of business funds.

2 . Money measurement

The concept of money measurement upholds the following points

 1. Business transactions and happenings expressed only in terms of money are to be recorded in the book of accounts.

For example, the sale of goods or payment of expenses or receipt of income, etc. and not the appointment of a manager, creativity of its research department or image of the organisation among people, etc. do not find a place in the accounting records of a firm.

 2. Transaction records should be recorded in monetary units rather than physical units so that they give a more accurate picture of how much a business is worth to an individual or institution.

Limitations:

The money measurement assumption is not free from limitations. Due to the changes in prices, the value of money does not remain the same over a period of time. The value of the rupee today on account of rising in prices is much less than what it was, say ten years back.

3. Going Concern Concept

The concept of a going concern suggests that a business will continue to operate indefinitely, i.e. for an extended length of time, and will not be liquidated (closed or dissolved) shortly. Based on this accounting assumption the value of assets is displayed on the balance sheet.

Example:

When we buy an asset, such as a personal computer, we are purchasing the services that the machine will provide during its expected life lifetime. It would be unfair to deduct the entire $50,000 from the revenue of the year in which the item is purchased.

4. Accounting Period Concept

The accounting period is the period after which an enterprise's financial statements are prepared to check whether it has made profits or losses during that period, as well as the exact position of its assets and liabilities at the end of that period. 

Different users demand such information at regular intervals for varied objectives to take various decisions based on such information. 

As a result, financial statements are created regularly, usually once a year, to ensure that users have access to up-to-date information. The accounting period refers to this period of time.

Example: The income statements must be prepared annually, according to the Companies Act of 2013 and the Income Tax Act. However, in some circumstances, interim financial statements are required. For example, at the time of a partner's retirement, the accounting term may change from the standard twelve-month period. Apart from those whose shares are listed on the stock exchange, all companies are required to disclose quarterly results to determine their profitability and financial condition at the end of each three-month period.

5. Cost concept

The cost concept requires that all assets are recorded in the book of accounts at their purchase price, which includes the cost of acquisition, transportation, installation and making the asset ready to use.

The concept of cost is historical in nature as it is something, which has been paid on the date of acquisition and does not change year after year.

Limitation 

It does not show the true worth of the business and may lead to hidden profits. During the period of rising prices, the market value or the cost at (which the assets can be replaced are higher than the value at which these are shown in the book of accounts) leading to hidden profits.

6. Dual Aspect Concept

This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. Also known as the duality principle, is commonly expressed in terms of fundamental Accounting Equation, which is as follows :

Assets = Liabilities + Capital

The two-fold effect of each transaction affects in such a manner that the equality of both sides of the equation is maintained. The two-fold effect in respect of all transactions must be duly recorded in the book of accounts of the business.

7. Revenue Recognition (Realisation) Concept

The concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realised.

Revenue is the gross inflow of cash arising from (i) the sale of goods and services by an enterprise; and (ii) use by others of the enterprise’s resources yielding interest, royalties and dividends. Secondly, revenue is assumed to be realised when a legal right to receive it arises, i.e. the point of time when goods have been sold or service has been rendered.

Thus, credit sales are treated as revenue on the day sales are made and not when money is received from the buyer. As for the income such as rent, commission, interest, etc., these are recognised on a time basis.

exceptions to this general rule of revenue recognition. 

In the case of contracts like construction work, a proportionate amount of revenue, based on the part of the contract completed by the end of the period is treated as realised. 

Similarly, when goods are sold on hire purchase, the amount collected in instalments is treated as realised.

8 Matching Concept

The matching concept states that expenses incurred in an accounting period should be matched with revenues during that period. Thus, implies that all revenues earned during an accounting year, whether received during that year or not and all costs incurred, whether paid during the year or not should be taken into account while ascertaining profit or loss for that year.

9. Full Disclosure Concept

The principle of full disclosure requires that all material and relevant facts concerning the financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes. This is to enable the users to make a correct assessment of the profitability and financial soundness of the enterprise and help them to make informed decisions.

To ensure proper disclosure of material accounting information, the Indian companies Act 1956 has provided a format for the preparation of profit and loss account and balance sheet of a company, which needs to be compulsorily adhered to, for the preparation of these statements. The regulatory bodies like Sebi, also mandate complete disclosures to be made by the companies, to give a true and fair view of profitability and the state of affairs.