UNIT 1
Theoretical Framework
Overview:
Accounting concepts defines the assumption on the basis of which financial statement of a business entity is prepared. Concepts are those basic assumption and condition which form the basis upon which the accountancy has been laid.
Accounting principles
- They should be based on real assumption
- They must be simple, understandable and explanatory
- They must be followed consistently
- They should be able to reflect future predictions
- They should be informational to users
Accounting convention emerges out of accounting practices, commonly known as accounting principle, adopted by various organizations over a period of time. Accounting bodies may change any of the convention to improve the quality of accounting information.
The basic accounting concept is as follows:
- Entity concept:
The concept of an entity assumes that its financial statements and other accounting information belong to a particular company that is different from its owner. Therefore, an analysis of business transactions, including costs and revenues, is expressed in terms of changes in the company's financial position.
Similarly, the assets and liabilities devoted to business activities are the assets and liabilities of the entity. The company's transaction is reported, not the company's owner's transaction. Therefore, this concept allows accountants to distinguish between personal and commercial transactions. This concept applies to sole proprietorships, partnerships, businesses, and small businesses. It may also apply to multiple companies, such as when a segment of a company, such as a department, or an interrelated company is merged.
2. Going Concern Concept:
An entity is considered to be in business unless there is evidence of opposition. Because companies are relatively permanent, financial accounting is designed with the assumption that the business will survive indefinitely in the future.
The Going Concern concept justifies the valuation of assets on a non-clearing basis and requires the use of acquisition costs for many valuations. In addition, fixed and intangible assets are amortized over their useful lives, rather than in shorter periods, in the hope of early liquidation.
This further means that the data transmitted is tentative and that the current statement should disclose adjustments to the statement over the past year revealed by more recent developments.
3. Money measurement concept:
A unit of exchange and measurement is required to uniformly account for a company's transactions. The common denominator chosen in accounting is the currency unit. Money is the lowest common denominator for measuring the exchangeability of goods and services such as labor, natural resources and capital.
The concept of monetary measurement considers accounting to be a process of measuring and communicating financially measurable company activity. Obviously, the financial statements should show the money spent.
The concept of measuring money means two limitations of accounting. First, accounting is limited to the generation of information expressed in monetary units. It does not record and convey other relevant but non-monetary information. Second, the concept of monetary measurement concerns the limitation of the monetary unit itself as a unit of measurement.
There are concerns about purchasing power, which is the main characteristic of currency units, or the amount of goods and services that money can obtain. Traditionally, financial accounting has addressed this issue by stating that the concept assumes that the purchasing power of a currency unit is stable over the long term or that price changes are not significant. Although still accepted in current financial reporting, the concept of stable monetary units is subject to continuous and permanent criticism.
4. Accounting period concept:
Financial accounting provides information about a company's economic activity over a specific period of time that is shorter than the company's lifespan. The periods are usually the same length for ease of comparison.
The period is specified in the financial statements. The period is usually 12 months. Quarterly or semi-annual statements may also be issued. These are considered provisional and differ from the annual report. Statements that cover shorter periods of time, such as months or weeks, may also be created for administrative use.
5. Cost concept:
The concept of cost is that the asset should be recorded at the exchange price, that is, the acquisition cost or the acquisition cost. Acquisition costs are recognized as an appropriate valuation criterion for recognizing the acquisition of all goods and services, costs, expenses and capital.
For accounting purposes, business transactions are usually measured in terms of the particular price or cost at which the transaction occurred. That is, financial accounting measurements are based on exchange prices, where economic resources and obligations are exchanged. Therefore, the quantity of an asset listed during a company's account doesn't indicate what the asset could also be sold for.
The concept of acquisition cost means there's little point in revaluing an asset to reflect its current value, because the company has no plans to sell its asset. Additionally, for practical reasons, accountants like better to report actual costs over market values that are difficult to verify.
6. Dual aspect concept:
This concept is at the guts of the whole accounting process. Accountants record events that affect the wealth of a specific entity. The question is which aspect of this wealth is vital. Accounting entities are artificial creations, so it's essential to understand who their resources belong to or what purpose they serve.
It's also important to understand what sorts of resources you manage, like cash, buildings, and land. Therefore, the accounting record system was developed to point out two main things: (a) the source of wealth and (b) the shape it takes. Suppose Mr. X decides to line up a business and transfers Rs. 100,000 from his personal checking account to a different business account.
He may record this event as follows:
Obviously, the source of wealth must be numerically adequate to the shape of wealth. S (source) must be adequate to F (form) because they're simply different aspects of an equivalent thing, that is, within the sort of equations.
In addition, transactions or events that affect a company's wealth got to record two aspects so as to take care of equality on each side of the accounting equation.
If a corporation acquires an asset, it must be one among the following:
(A) Other assets are abandoned.
(B) There was an obligation to pay it.
(C) Profitable and increased amount of cash the operator has got to pay to the owner.
(D) The owner funded the acquisition of the asset.
This doesn't mean that the transaction affects both the source and sort of wealth.
There are four categories of events that affect accounting equations:
(A) Both the source and sort of wealth are increased by an equivalent amount.
(B) Both the source and sort of wealth are reduced by an equivalent amount.
(C) Some increase without changing the source of wealth, others decrease.
(D) Some sources of wealth increase and a few decreases without changing the shape of wealth retention.
The above example shows category (a) because once you start a transaction for an entity, the source of wealth and therefore the sort of wealth, cash, increases from zero to rupees. 1,00,000. In contrast, X may plan to withdraw Rs. 20,000 cash from business.
In that case, the financial position of the entity would be:
It is essential to know why each side of the equation are reduced. By withdrawing cash, X automatically reduces the availability of personal funds to the business by an equivalent amount. Now suppose Mr. X buys a listing of products for Rs. 30,000 in cash available. His capital supply remains an equivalent, but the composition of his business assets does.
The two aspects of this transaction aren't within the same direction, but are compensatory and are increasing stocks that set a cash reduction. Similarly, sources of wealth are often suffering from transactions. So, if X gives his son Y, it becomes Rs. 20,000 shares of the business by transferring some of his own profits, the consequences are:
However, if X gives YR. He personally receives $ 20,000 in cash, and when Y puts it into the business, each side of the equation are affected. Y capital Rs. 20,000 is balanced by additional Rs. 20,000 in cash, X capital remains rupees. 80,000.
7. The concept of accrual accounting:
According to the Financial Accounting Standards Board (USA):
"Accrual accounting is that the financial impact of transactions and other events and situations that affect a corporation on cash, not only during the amount during which it had been received, but also during the amount during which those transactions, events and situations occur. Accrual accounting is paid to the corporate as more (or perhaps less) cash spent on resources and activities, also because the start and end of the method. it's associated with the method of being returned.We recognize that purchases, production, sales, other operations, and other events that affect a company's performance during a period often do not match the receipt or payment of cash for that period. "
Realization and matching concepts are central to accrual accounting. Accrual accounting measures revenue for a period of time as the difference between the revenues recognized during that period and the costs that match those incomes. In accrual accounting, the period revenue is usually not the same as the period cash receipt from the customer, and the period cost is usually not the same as the period cash payment.
8. Cash Basis Accounting:
In cash-basis accounting, sales are not recorded until the period in which they are received in cash. Similarly, costs are deducted from sales during the period in which the cash payment was made. Therefore, neither realization nor matching concepts apply to cash basis accounting.
In reality, "pure" cash-basis accounting is rare. This is because the pure cash basis approach requires the acquisition of inventory to be treated as a reduction in profit when paying the acquisition cost, not when selling the inventory. Similarly, the cost of acquiring plant and equipment items is treated as a reduction in profit if these long-lived items are paid in cash rather than after they have been used.
Obviously, such a pure cash basis approach would result in a balance sheet and income statement with limited usefulness. Therefore, what is commonly referred to as cash-basis accounting is actually a mixture of cash-basis for some items (especially cost of goods sold and period costs) and accrual-based for others (especially product costs and long-term assets). This mix is sometimes referred to as modified cash-basis accounting to distinguish it from the pure cash-basis method.
Cash-basis accounting is most often seen in small businesses that do not have large inventories because they provide services. Examples include restaurants, hairdressers, hairdressers, and income tax filing companies.
Most of these establishments do not provide credit to their customers, so cash-basis profits may not differ dramatically from accrual income. Nevertheless, cash basis accounting is not permitted by GAAP for any type of entity.
9. Conservatism concept:
This trait can be considered a reactive version of the Minimax management philosophy. That is, it minimizes the potential for maximum loss.
The concept of accounting conservatism suggests that accounting should be cautious and cautious until the opposite evidence emerges, where and when uncertainty and risk exposure are legitimate. Accounting conservatism does not mean intentionally underestimating income and assets. It applies only to situations where there is reasonable doubt. For example, inventories are valued at the lower end of cost or market value.
In its application to the income statement, conservatism encourages recognition of all losses incurred or may occur, but does not recognize profits until they are actually realized. Early depreciation of intangible assets and restrictions on recording asset valuations have also been motivated, at least to some extent, by conservatism. Not recognizing revenue until the sale is made is another sign of conservatism.
10. Matching concept:
The concept of matching in financial accounting is the process of matching (associating) performance or revenue (measured at the selling price of goods and services offered) with labour or expense (measured at the cost of goods and services used) over a specific period of time. is. Targets for which income has been determined.
This concept emphasizes which item of expense in a particular accounting period is expense. That is, expenses are reported as expenses for the accounting period in which revenue related to those expenses is reported. For example, if the sales of some products are reported as revenue for one year, the costs for those products are reported as expenses for the same year.
The concept of matching only needs to be met after the accountant has completed the concept of realization. First measure the revenue according to the concept of realization, then associate the costs with these revenues. Cost matches revenue, but not the other way around.
Therefore, the reconciliation process requires significant cost allocation in acquisition cost accounting. Past (history) costs are investigated and steps are taken to assign a cost element that is considered to have expired service potential or to match it with the associated revenue.
The remaining component of the cost, which is considered to have continued potential for future services, is carried over to the past balance sheet and is called an asset. Therefore, the balance sheet is just a report of unallocated past costs waiting for the estimated future service potential to expire before it matches the appropriate revenue.
11. Realization or Cognitive concept:
The concept of realization or recognition indicates the amount of revenue that should be recognized from a particular sale. Realization rules help accountants determine if revenues or expenses have been incurred. This allows accountants to measure, record, and report on financial reports.
Realization refers to the inflow of cash or cash charges (accounts receivable, accounts receivable, etc.) resulting from the sale of goods or services. Therefore, if the customer purchases Rs. If you pay 500 worth of goods in cash at a grocery store, the store will realize Rs. 500 from the sale.
If the clothing store sells Rs suits. 3,000, if the buyer agrees to pay within 30 days, the store will realize Rs. From sale to 3,000 (accounts receivable) (conservative concept), provided the buyer has a good credit record and the payment is reasonably secure.
The concept of realization states that the amount perceived as revenue is reasonably certain to be realized, that is, reasonably certain to be paid by the customer. Of course, there is room for difference in judgment as to whether or not it is "reasonably certain."
However, this concept explicitly acknowledges that the perceived revenue amount is lower than the selling price of the goods and services sold. The obvious situation is the discounted sale of goods at a price lower than the normal selling price. In such cases, the revenue will be recorded at a lower price rather than the normal price.
12. Consistency concept:
In this concept, once an organization has decided on one method, it should be used for all subsequent transactions and events of the same nature unless there is a good reason to change it. Frequent changes in accounting methods make it difficult to compare financial statements for one period with financial statements for another period.
Consistent use of accounting methods and procedures over the long term checks income statement and balance sheet distortions, and possible operations on these statements. Consistency is needed to help external users compare the financial statements of a particular company over time and make sound economic decisions.
13. Materiality concept:
The law has a doctrine called de minimis non curat lex. This means that the court does not consider trivial issues. Similarly, accountants do not attempt to record events that are not so important that the task of recording them is not justified by the usefulness of the results.
The concept of materiality means that transactions and events that have a non-significant or non-significant impact must not be recorded and reported in the financial statements. Recording of non-essential events is claimed to be unjustifiable in terms of their low usefulness to subsequent users.
For example, conceptually, a brand-new paper pad is an asset of an entity. Each time someone writes on the pad's page, some of this asset is exhausted and retained earnings are reduced accordingly. Theoretically, it is possible to see how many partially used pads the company owns at the end of the accounting period and display this amount as an asset.
However, the cost of such efforts is clearly unreasonable, and accountants are not willing to do this. The accountant took a simpler action, albeit inaccurate, that the asset was exhausted (expenditure) when the pad was purchased or when the pad was issued to the user from the consumable inventory. Treat as.
Unfortunately, there is no consensus on what it means to be important and the exact line that distinguishes between important and non-important events. Decisions depend on judgment and common sense. The accounting creator is meant to interpret what is important and what is not.
Perhaps the importance of an event or transaction can be determined in terms of financial position, performance, changes in an organization's financial position, and its impact on user evaluations or decisions.
14. Full disclosure concept:
The concept of full disclosure requires companies to provide all relevant information to external users for the purpose of sound economic decisions. This concept means that information that is substantive or of interest to the average investor is not omitted or hidden from a company's financial statements.
Accounting Principles
The basic assumptions and concepts mentioned above have been modified to make accounting information useful to a variety of stakeholders. The principles of these changes are as follows:
Principles are:
1. Cost-benefit
2. Importance
3. Consistency
4. Be cautious
- Cost-benefit principle
This amended principle states that the cost of applying the principle must not exceed the benefits obtained from it. If the cost is greater than the profit, then the principle needs to be changed.
2. Materiality principle
The principle of materiality requires that all relatively relevant information be disclosed in the financial statements. Important non-essential information is omitted or merged with other items.
3. Principle of consistency
The purpose of the principle of consistency is to maintain the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously adhered to and applied annually. Comparing the financial results of a business between different accounting periods is important and meaningful only if you follow consistent practices in reviewing them. For example, asset depreciation can be provided in a variety of ways, but whichever method you choose, you must do it on a regular basis.
4. Principle of prudence (conservatism)
The principle of prudence takes into account all expected losses, but leaves all expected benefits. For example, when valuing a stock in trade, the lower of the market price and cost is taken into account.
Key takeaways:
- Accounting rules are guidelines that help companies determine how to record business transactions that are not yet fully covered by accounting standards.
- They are generally accepted by accounting institutions, but are not legally binding.
- Accounting rules no longer apply if the supervisory body has guidelines that address the same topics as accounting rules.
- There are four widely recognized accounting rules. Conservatism, consistency, full disclosure, and importance.
- Accounting policies are the procedures that a company uses to prepare financial statements. Unlike accounting principles, which are rules, accounting policies are the basis for following those rules.
- Accounting policies may be used to legally manipulate revenue.
- The choice of a company in its accounting policy indicates whether management is willing or conservative in reporting its revenue.
- Accounting policies should still adhere to generally accepted accounting principles (GAAP).
References
- Robert N Anthony, David Hawkins, Kenneth A. Merchant,Accounting: Text and Cases.
- McGraw-Hill Education.
- Charles T. Horngren and Donna Philbrick, Introduction to Financial Accounting, Pearson.
- M.C.Shukla, T.S. Grewal and S.C.Gupta. Advanced Accounts,Vol-I, S. Chand & Co.
- S.N.MaheshwariandS.K.Maheshwari, Financial Accounting,Vikas Publishing House.
- P.C. Tulsian, Financial Accounting, Pearson Education.
- Compendium of Statements and Standards of Accounting,The Institute of Chartered
- Accountants of India, New Delhi.
- Rajasekaran, Financial Accounting, Pearson.
- Mukherjee and Mukherjee, Financial Accounting I, Oxford.
- Amitabha Mukherjee, Mohammed Hanif, Financial Accounting I, McGraw Hill Education.
