Accounting is the process of recording, classifying, summarizing, interpreting and reporting in monetary terms, information about an organization. Accounting is based on certain principles and rules. These accounting concepts are
1. Business entity concept
2. Money measurement concept
3. Going concern concept
4. Cost concept
5. Conservatism concept
6. Dual aspect concept
7. Accounting period concept
8. Accrual concept
9. Realization concept
10. Matching concept
11. Materiality concept
The first six concepts relate mainly to the construction of Balance Sheet and the remaining concepts relate mainly to the construction of income statement.
Business Entity Concept:
According to this concept, the business firm is regarded as a separate legal entity apart from its owners, creditors, managers and others. Based on this concept all the transactions of the business are recorded in the books of the business from the viewpoint of the business.
Money Measurement Concept:
The money measured concept underlines the fact that in accounting every event worth recording or transaction is recorded in terms of money.
Going Concern Concept:
Accounting to this concept Accounting is based on the premise that any firm is expected to operate indefinitely in the future. To find it more realistically, no firm starts operations with the intention to close down, but they intend to prosper and grow.
The underlying idea of cost concept is that,
1. assets acquired are recorded at the price paid to acquire it, that is “at cost”.
2. this cost is the basis for all subsequent accounting for the asset.
Based on this concept, accounting takes into consideration all prospective losses but ignores all prospective profits. So according tot his concept revenues are recognized only when they are reasonably certain, whereas expenses are recognized as soon as they are reasonably possible.
Dual Aspect Concept:
This is the fundamental concept of accounting. In order to understand this concept it is necessary for us to understand the meaning of two terms.
Asset is an expenditure for acquiring valuable resources which benefits the future activities of the concern.
Example: Building, land, machinery, furniture etc
Liabilities are the obligation of a business on a creditor’s claim against the assets of a business. The liabilities are classified as owners’ equity (according to business entity concept) and external liabilities. Example of external liabilities is creditors, loans from banks, capital raised through issue of debentures etc.
An increase in liabilities and reduction in assets represents sources of funds. An increase in assets and decrease in liabilities (including owners’ equity) are uses of funds.
According to dual aspect concept sum of the sources of funds must equal the sum of uses of funds. Thus, whatever funds are raised by the business, either through capital or through operations or from outsiders, must be tied up in one or the other firm of uses.
Thus, dual aspect concept implies
Sources of funds = Uses of Funds
Owners Equity + Outside Liability = Assets
Accounting Period Concept:
According to this concept the performance and the financial position of the firm is assessed for an accounting period which is normally 12 months.
Accrue means to grow; to increase; to accumulate. According to this concept income is recognized when it is earned rather than when it is collected. Similarly, expenses are accounted for when the benefit from them is derived rather when they are paid for.
According to this concept revenues are usually recognized in the period in which the goods were delivered to the customer or in which the services were rendered, but not in the period when the order is received. The amount recognized is the amount that customers are reasonably certain to pay.
According to this concept when a given transaction affects booth revenues and expenses, the effect on each should be recognized in the same accounting period.
According to materially concept the insignificant events may be disregarded but must be full disclosure of all important information.