Accounting Concepts and Conventions

Accounting concepts are the necessary or conditions upon which accounting is based; they are postulates, assumptions, or conditions upon which accounting is based. Given below are accounting concepts and conventions, particularly useful for students.

1) Business entity Concept

For accounting purposes, the business is treated as a separate entity. In the business activity, for example, if the proprietor brought capital of Rs 100000/- into the business, it means that the proprietor has invested Rs 100000/- in the business; it is shown as a liability in the books of business because the business has to repay Rs 100000/- to the proprietor. Similarly, similarly if the proprietor withdraws Rs 100000/- from the business, the same is repayable to the business by him.

This concept is applicable in all forms of business organizations, although in the eyes of law proprietors or partners and their businesses are one and the same for accounting purposes, they are regarded as separate entities, so this is called a business entity concept.

2) Money measurement concept

In accounting everything is recorded as money; for every event and transition, when we cannot express it in terms of money, it is not recoded in the books of accounts, even if they are important and useful for the business.

3) Cost Concept

This concept does not recognize the release value, the replacement value, or the real worth of an asset. Thus, as per the cost concept,

i) An asset is recorded in the books as per the price paid to acquire it at its cost price.

ii) Cost is basic for all subsequent accounting of the asset.

For example, a land purchase for 100000/- will be recoded in the books of accounts at the value of 100000/- (including expenses incurred), even if the market value is 200000/- or 60000/-.

The cost concept brings objectivity in the preparation of the financial statement; it implies that the figures shown in the accounting record should be based on the evidence and not on the subjective views.

4) Consistency concept

The comparison of one accounting period with another is possible only when the conversion of consistency is followed; for example, a company may adopt the SLM method, the WDV method, or any other method for providing depreciation for fixed assets, but it is expected that the company follow a particular method every year consistently, so a change in the method of depreciation would be inconsistency.

5) Conservatism

It refers to the policy of playing safe; as per this convention, all prospective losses are taken into consideration but not all prospective profit's; in other words, "anticipate no profit but provide for all possible losses." The following are the examples.

a) Making provision for doubtful debts, taxation, etc.

b) Value of stock in trade at cost or market value, whichever is lower

c) Creating provisions against investment for fluctuation in price.

6) Going Concern

As per this concept, it is assumed that the business concern will continue for a fairly long time, unless and until it has entered into a state of liquidation. Since the business concern is to be kept continuously for a long period of time, financial and accounting policies are directed towards maintaining such continuity of activity.

7) Realization concept

According to this concept, profit should be accounted for only when it is actually realized. Revenue is recognized only when sales are effected or services are rendered; to recognize revenue, receipt of cash is not essential. Even credit sales result in realization as they create a definite asset called "account receivable." However,  there are certain exceptions to the concept, like contract accounts, hire purchases, etc.; similarly, income like commission, interest, rent, etc. are shown in the profit & loss account on an accrual basis, though they may not be realized in cash on the date of preparing accounts.

8) Accrual concept

The accrual system is a method whereby revenue and expenses are identified with a specific period of time, like a month, half-year, or year; it implies recording of revenues and expenses of a particular accounting period, whether they are received or paid in cash or not. Under the accrual method, only the revenues and expenses relating to that particular accounting period are considered.

9) Dual Aspect Concept

This is the basic concept of accounting. As per this concept, every transition of business has a dual effect. For example, Mr. A starts business with cash of Rs 100000/-. There are two aspects of the transactions; in this, one is the asset account and another is the capital account, so the business gets the asset (cash) of Rs 100000/-, and on the other hand, the business owes Rs 100000/- to Mr. A.

10) Convention of Disclosure

This means that the accounts must be honestly prepared and they must disclose all information; the accounting report should disclose full and fair information to the creditors, investors, and others; this concept is especially significant in the case of big business.

However, it does not mean that all information or information of any kind is to be included in accounting statements. The term disclosure only implies that there must be sufficient disclosure of information that is in the interest of the creditors, investors, , and other.

11) Convention of Materiality

The accountant should attach importance to material details and ignore insignificant details; if this is not done, accounts will be overburdened with minute details; therefore, keeping the conversion of materiality in view, unimportant items are either left out or merged with other items; some items are shown as footnotes like contingent liabilities, market value investments, etc.

The accountant should judge the relative importance of each item of every transition, its essentiality, significance, and substantiality; it is the relative importance that matters more. .