Accounting Concepts and Conventions
Financial Acconting Notes BCOM NEP 2023
Generally Accepted Accounting
Principles (GAAP)
Generally Accepted Accounting Principles are the rules and
concepts which have been accepted by accounting community for sound accounting
practice. Their usefulness depends on ‘general acceptability’ rather than
‘individual acceptability’ of accounting concepts. They (GAAP) have
been formalised on the basis of usage, reason and experience.
Simply, Generally Accepted Accounting Principles (GAAP) comprises a set of rules, concept and Conventions used in preparing financial accounting reports.
Essential
features of Accounting Principles
(i)
Man made: Accounting principles are
manmade. They are not tested in a laboratory.
(ii)
Objectivity: It means accounting
principles must be based on facts and free from personal bias or judgment of
the individuals who prepares the statements.
(iii)
Usefulness/relevance: Accounting
principles must be relevant and useful to the person who is using financial
statements.
(iv)
Feasibility: The accounting principles
should be practicable or feasible.
(v)
Axiom: It denotes a statement of truth
which cannot be questioned by anyone.
Need and
Significance of GAAP
1) Consistency: Corporations, non-profits and government
organizations must prepare their financial statements in accordance with
generally accepted accounting principles (GAAP) set by the Indian Accounting
Standards Board (IASB). Accounting principles are important because they
establish a consistency that allows for more accurate and efficient viewing of
company statements and reports.
2) Standards: The
generally accepted accounting principles represent a complex, important set of
accounting definitions, methods and assumptions that create a standard method
of reporting the financial details of a business. With the GAAP, a hierarchy
exists that dictates which standard should be used and when.
3) Industry Comparisons: Potential
investors who want to direct funds to a certain type of industry without a
particular company in mind will find accounting principles an important tool as
individual businesses are reviewed. Standards allow the investor to compare and
contrast companies across a singular industry or multiple industries quickly
through balance sheet, income statement and annual report reviews.
4) Company Performance: Because
of the long-term consistency in key accounting definitions and methods,
standard company performance measures listed on financial statements and annual
reports provide a realistic view of the company's growth or lack of growth over
a period of years.
Accounting principles to be followed while preparing financial
statements are divided into two parts:
a)
Accounting concepts and
b)
Accounting Conventions
Accounting concepts
The term ‘concept’ is used to denote accounting postulates, i.e.,
basic assumptions or conditions upon which the accounting structure is based.
The following are the common accounting concepts adopted by many business
concerns.
i)
Business Entity Concept: Business entity concept implies that
the business unit is separate and distinct from the persons who provide the
required capital to it. This concept can be expressed through an accounting
equation, viz., Assets = Liabilities + Capital. The equation clearly shows that
the business itself owns the assets and in turn owes to various claimants.
ii) Money
Measurement Concept: According to this concept, only those
events and transactions are recorded in accounts which can be expressed in
terms of money. Facts, events and transactions which cannot be expressed in
monetary terms are not recorded in accounting. Hence, the accounting does not
give a complete picture of all the transactions of a business unit. 2006
iii) Going
Concern Concept: Under this concept, the transactions are
recorded assuming that the business will exist for a longer period of time.
Keeping this in view, the suppliers and other companies enter into business
transactions with the business unit. This assumption supports the concept of
valuing the assets at historical cost or replacement cost.
iv) Dual
Aspect Concept: According to this basic concept of accounting,
every transaction has a two-fold aspect, Viz., 1.giving certain benefits and 2.
Receiving certain benefits. The basic principle of double entry system is that
every debit has a corresponding and equal amount of credit. This is the
underlying assumption of this concept. The accounting equation viz., Assets =
Capital + Liabilities or Capital = Assets – Liabilities, will further clarify
this concept, i.e., at any point of time the total assets of the business unit
are equal to its total liabilities.
V)
Periodicity Concept: Under this concept, the life of the
business is segmented into different periods and accordingly the result of each
period is ascertained. Though the business is assumed to be continuing in
future, the measurement of income and studying the financial position of the
business for a shorter and definite period will help in taking corrective steps
at the appropriate time. Each segmented period is called “accounting period”
and the same is normally a year.
vi)
Historical Cost Concept: According to this concept, the
transactions are recorded in the books of account with the respective amounts
involved. For example, if an asset is purchases, it is entered in the
accounting record at the price paid to acquire the same and that cost is considered
to be the base for all future accounting.
vii)
Matching Concept: The essence of the matching concept lies in
the view that all costs which are associated to a particular period should be
compared with the revenues associated to the same period to obtain the net
income of the business.
viii)
Realisation Concept: This concept assumes or recognizes
revenue when a sale is made. Sale is considered to be complete when the
ownership and property are transferred from the seller to the buyer and the
consideration is paid in full.
ix)
Accrual Concept: According to this concept the revenue is
recognized on its realization and not on its actual receipt. Similarly the
costs are recognized when they are incurred and not when payment is made. This
assumption makes it necessary to give certain adjustments in the preparation of
income statement regarding revenues and costs.
Accounting
Conventions: Accounting
conventions are common practices, which are followed in recording and
presenting accounting information of a business. They are followed like customs
in a society. The following conventions are to be followed
to have a clear and meaningful information and data in accounting:
i)
Consistency: The convention of consistency implies that
the same accounting procedures should be used for similar items over periods.
It is essential for clear and correct understanding and interpretation of the
financial statements. It is also important for inter-period comparison.
ii) Full
Disclosure: According to this principle, all accounting
statements should be honestly prepared and all information of material interest
to proprietors, creditors, investors, etc. should be disclosed in the
accounting statements. Moreover, books of accounts should be prepared in such a
way that they become reliable, informative and transparent.
iii)
Conservatism or Prudence: This convention follows the policy of
caution or playing safe. It takes into account” all possible losses but not the
possible profits or gains”. The implication of this principle is to give a
pessimistic view of the financial position of the business.
iv) Materiality:
Materiality deals with the relative importance of accounting information. In
order to make financial statements more meaningful and to economize costs,
accountants should incorporate in the financial statements only that
information which is material and useful to users. They should ignore
insignificant details.
Also Read: FINANCIAL ACCOUNTING CHAPTERWISE NOTESUNIT 11. Preparation of Trial Balance and Preparation of Financial Statements UNIT 2Part A: Accounting for Partnership UNIT 3 UNIT 4 Some other Important Chapters
Difference between Accounting Standard and Accounting Principles
Accounting Standard is
the set of rules that should be applied for measurement, valuation,
presentation and disclosure of a subject matter. For example, measurement of
deferred tax, valuation of assets, intangibles and financial instruments etc.
and presentation and disclosure of such measurements and valuations.
Accounting Principles however,
are the fundamental principles providing a framework within which accounting
should be done. These principles also govern the formulation of Accounting
Standards. For example, Accrual accounting, Substance over legal form, Prudence
etc.