Accounting principles are the basic assumptions, rules of operation, and essential characteristics that make up the framework for the construction of accounting financial statements. In order to be useful, the accounting information must have certain characteristics, such as being dependable and practical. To be dependable,the accounting information must be unbiased, accurate, and verifiable. To be practical, accounting information must be predictable, prepared in a timely fashion, and be able to provide meaningful feedback.
Additional characteristics are that the accounting information must be consistent, comparable, serve a utilitarian need (such as cost/benefit), and make a material difference.Besides characteristics, certain operational rules are established as to the following:
• when revenue and expenses are reported;
• how expenses are matched to revenue;
• what to do when a choice can be made that might overstate or understate figures; and
• what information should be disclosed so that the reader will fully understand the circumstances under which the information is being
presented.
There are also basic assumptions upon which the reader can rely, such as:
• the information is related to the business entity only and doesn't have any unrelated information mixed in,
• the business is a going concern and won't cease operations soon;
• the financial information presented is measured in specific time intervals such as a month, quarter or year. The financial information is using a certain unit of measure such as Dollars, Rupees, Pound, etc.
• the information is presented at historical cost, i.e., when received, paid, or incurred; and
• the method of accounting being used is double-entry and not some other method.
One of the basic purposes of accounting is to provide financial information about a business enterprise to various users of accounting information for decision making purpose.The user of accounting information broadly uses the information for the purpose of assessing profitability, financial position and actual performance, investment decisions credit, decision, assessing taxes, protecting investors and public interest, setting economic policies, measuring social and environmental protection programmes and negotiating labour agreements.
(1) Stable Money Measurement : A business entity enters into numerous transactions that affect the business in varied ways. However recording,classification and summarization of these heterogeneous business transactions are measured and expressed in terms of common unit of measurement.
For accounting purpose we assume that money serves as a common denomination for expressing business transactions. The implication of this concept is that those transactions and events which may affect the business but are not measurable in money terms are not recorded in the books of account.
The second aspect of this concept is that the money provides a standard of exchangeability and implicit assumption is that the changes in purchasing power of the monetary unit are not of sufficient importance as to require adjustments. The application of the second aspect is that all the assets in the balance sheet are recorded at their historical cost not at the current price. The changes in the purchasing power of monetary units are due to the inflation, but for accounting purpose it is ignored; hence the concept is called as Stable Money Measurement Concept.
Suppose the Managing Director of a company is killed in a plane crash. To the extent that “an organisation is the lengthened shadow of a man”, the real value of the company will change immediately, and this will be reflected in the market price of the company shares. Will this have any effect as far as the account of the company are concerned?
(2) Going Concern : Going concern means that business activities will continue for a fairly long period of time unless and until the business has entered into a process of liquidation. This concept does not mean that the business will continue for an infinite period of time, but it implies that the business is going to run for fairly long period of time so as to carry out business plans.
Under this concept it is assumed that the business activities will continue for at least a period of time necessary to meet its present contractual obligations and recover the original cost of its fixed assets. This concept implies that the assets are acquired for utilization and not for resale.Under this concept utilization of resources for producing goods and realization of revenue by their sale assumes significance. Income is determined after charging cost of utilised resources to the revenue of that period. Revenue and costs are recognized as and when they are earned or incurred and recorded in the financial statement of the period which they relate to. This implies that valuation of the business is done on the basis of earning power rather than on the basis of the liquidation price of the enterprise. This concept justifies for revenue realisation. The revenue would be deemed to be realized with the transfer of ownership of goods or services rendered. Goods can be sold for cash or credit, therefore earning of revenue is different from cash collection from customers.
(3) Matching (or Accrual) : The accrual concept makes a distinction between the receipt of cash and the right to receive it, and the payment of cash and legal obligation to pay it. In actual business operations, the obligation to pay and the actual movement of cash may not coincide.The accrual concept requires recognition of revenue and expenses on a comparable basis i.e., revenue and expense are allocated to a particular accounting period on a consistent basis.
(4) Full, Fair and Adequate Disclosure : The architecture of business has evolved from proprietorship to partnership to joint stock companies or publicly held companies. Apart from this in most of the companies the public has significant interest and stakes. In addition to the stake of the general public the companies borrow from banks, government, creditors, etc.
(5) Accounting Entity : For accounting purpose it is assumed that business has separate existence and its entity is different from that of its owner(s).In simple term this means that the liabilities and assets of the business are not the liabilities and assets of the owner of the business.Accounting is done for the business entities as distinguished is done for the business entities as distinguished from the persons associated with these entities; as such the transactions of the business and those of the owners should be accounted for and reported separately. A business enterprise is an economic unit separate and apart from the owners.
Every transaction should be analysed from the point of view of a business enterprise and not that of persons who are associated with it.For example when the owner introduces cash in business, this cash is shown as Capital Liability of the business towards the owner. The introduction or withdrawal of cash does not affect the overall cash (personal plus business) position of the owner. This concept enables recording of transactions between business and its owner.This concept ensures that accounting records reflect only the activities of the business and the expenses related to common resources used for business and personal use and apportioned on some equitable basis between business and its owners.This concept applies to all form of business enterprises e.g. sole proprietorship, partnership and joint stock companies. However, the separate existence of business entity is recognized by law only in case of corporate form of enterprise, for sole proprietorship and partnership firms the law does not distinguish the owners and business separately. Hence in legal sense the owners and business may not be different for some form of business enterprise, but for accounting purpose the business and the owners would be always treated separately.
i)Apart from the reason mentioned above, can you think of any other reason for the justification of the Business Entity Concept?
ii)The proprietor of a firm withdrew Rs. 50,000 for his personal use.This was shown as an expense of the firm and hence, profits were
reduced thereby, Is this right from an accounting point of view ?
iii)The proprietor of a firm contributed Rs. 10 lakhs towards the capital of the firm. Does it mean, from an accounting point of view, that the firm had a corresponding liability towards the proprietor ?
(6) Accounting Period : Accounting period refers to span of time at the end of which and for which the financial statement are prepared to throw light on the results of operations of business during the relevant period and the financial position at the end of relevant period.As per the Going concern concept the operations of the business will continue for an indefinite period in the process of generation of income.Complete picture of the financial affairs of the business can be available only at time of the liquidation of the business, but this information will be of very little use to all of the stakeholder for decision making purpose. In order to provide timely information to all the stakeholders this indefinite period is split into smaller periods which is known as Accounting Period.
Normally the accounting period is of twelve months, but in case of new business, changes in the accounting period, preparation of interim financial statement, etc. the accounting period can be different from twelve month period. In India the accounting period starts from Ist of April and ends on 31 st of March in the following year.
(7) Cost Principle: According to this principle all the non-monetary assets of the business are shown in the books of accounts at the historical cost i.e.the price paid to acquire these assets. Non-monetary assets are rights or claims, current or fixed which cannot be converted in fixed number of rupees at a point of time. The example of current non-monetary assets are inventories, prepared expenses etc., and of fixed non-monetary assets are building, plant and machinery, furniture, etc.A company bought a building in 2004 at a cost of Rs. 50 lakhs. At the end of the Accounting Year 2004-05. its market value is Rs. 70 lakhs.The company revalues the building at Rs. 70 lakhs for the year 2004- 05. Is this practice right ?
(8) Revenue Recognition (or Realisation) : The resources of business are utilized to earn revenue by sale of goods or rendering of services. The American Accounting Association defines revenue as “the monetary expression of the aggregate of products or services transferred by an enterprise to its customers during a period of time” and according toRobert N Anthony “revenue is being considered as earned the date at which it is realized that is the date when goods or services are furnished to the customers in exchange for cash or for other valuable consideration.
(9) Dual Aspect Concept : This is, no doubt, the basic concept in accounting. Under this concept, every transaction has got a two-fold aspect : (i) yielding to or receiving of benefit and (ii) giving of the benefit.For instance, when a firm acquires an asset (receiving of the benefit) it must have to pay cash (giving of the benefit). Therefore, two accounts are to be passed in the books of accounts, one – for receiving the benefit andn the other – for giving the benefit. Thus, there will be a double entry for every transaction – Debit for receiving the benefit and credit for giving the benefit. So, for each and every debit there must be a corresponding credit and vice versa. This is the principle of Double Entry System of Accountingwhich, in other words, known as the ' Dual Aspect Concept'
(10) Balance Sheet Equation Concept : The Historical Cost Concept needs support of two other concepts for practical purposes, viz. (i) the Money Measurement Concept (already discussed above), (ii) the Balance Sheet Equation Concepts. Accounting process, however, conforms to an algebraic equation which, in other words, is involved in two laws of nature, i.e., the law of consistancy of matter and the law that every effect originates from a cause.In relation to the former, it may be deduced that all that has been received by us must be equal to all that has been given to us. (In accounts, receipts are classified as debits and giving or sacrifices are classified as credits).
i)The accounting year of a firm closes on 31 st December each year. The rent for business premises of Rs. 50,000 for the last quarter could not be paid to the owner on account of his being away in a foreign country.should the rent payable be taken into account for computing the firm’s income for the accounting year?
ii)A government contractor supplies stationery to various government offices. Some bills amounting to Rs. 10,000 were still pending with various offices at the close of the accounting year on 31 st March. Should the businessman take the revenue of Rs. 10,000 into account for computing the net profit of the period ?
iii) A company is negotiating to get an order for Rs. 5 lakhs form XYZ company. It is confident to get an order and as a result, it shows this order as a part of its sales revenue. Will you approve such an accounting treatment of probable order to be obtained in future ?
Additional characteristics are that the accounting information must be consistent, comparable, serve a utilitarian need (such as cost/benefit), and make a material difference.Besides characteristics, certain operational rules are established as to the following:
• when revenue and expenses are reported;
• how expenses are matched to revenue;
• what to do when a choice can be made that might overstate or understate figures; and
• what information should be disclosed so that the reader will fully understand the circumstances under which the information is being
presented.
There are also basic assumptions upon which the reader can rely, such as:
• the information is related to the business entity only and doesn't have any unrelated information mixed in,
• the business is a going concern and won't cease operations soon;
• the financial information presented is measured in specific time intervals such as a month, quarter or year. The financial information is using a certain unit of measure such as Dollars, Rupees, Pound, etc.
• the information is presented at historical cost, i.e., when received, paid, or incurred; and
• the method of accounting being used is double-entry and not some other method.
One of the basic purposes of accounting is to provide financial information about a business enterprise to various users of accounting information for decision making purpose.The user of accounting information broadly uses the information for the purpose of assessing profitability, financial position and actual performance, investment decisions credit, decision, assessing taxes, protecting investors and public interest, setting economic policies, measuring social and environmental protection programmes and negotiating labour agreements.
(1) Stable Money Measurement : A business entity enters into numerous transactions that affect the business in varied ways. However recording,classification and summarization of these heterogeneous business transactions are measured and expressed in terms of common unit of measurement.
For accounting purpose we assume that money serves as a common denomination for expressing business transactions. The implication of this concept is that those transactions and events which may affect the business but are not measurable in money terms are not recorded in the books of account.
The second aspect of this concept is that the money provides a standard of exchangeability and implicit assumption is that the changes in purchasing power of the monetary unit are not of sufficient importance as to require adjustments. The application of the second aspect is that all the assets in the balance sheet are recorded at their historical cost not at the current price. The changes in the purchasing power of monetary units are due to the inflation, but for accounting purpose it is ignored; hence the concept is called as Stable Money Measurement Concept.
Suppose the Managing Director of a company is killed in a plane crash. To the extent that “an organisation is the lengthened shadow of a man”, the real value of the company will change immediately, and this will be reflected in the market price of the company shares. Will this have any effect as far as the account of the company are concerned?
(2) Going Concern : Going concern means that business activities will continue for a fairly long period of time unless and until the business has entered into a process of liquidation. This concept does not mean that the business will continue for an infinite period of time, but it implies that the business is going to run for fairly long period of time so as to carry out business plans.
Under this concept it is assumed that the business activities will continue for at least a period of time necessary to meet its present contractual obligations and recover the original cost of its fixed assets. This concept implies that the assets are acquired for utilization and not for resale.Under this concept utilization of resources for producing goods and realization of revenue by their sale assumes significance. Income is determined after charging cost of utilised resources to the revenue of that period. Revenue and costs are recognized as and when they are earned or incurred and recorded in the financial statement of the period which they relate to. This implies that valuation of the business is done on the basis of earning power rather than on the basis of the liquidation price of the enterprise. This concept justifies for revenue realisation. The revenue would be deemed to be realized with the transfer of ownership of goods or services rendered. Goods can be sold for cash or credit, therefore earning of revenue is different from cash collection from customers.
(3) Matching (or Accrual) : The accrual concept makes a distinction between the receipt of cash and the right to receive it, and the payment of cash and legal obligation to pay it. In actual business operations, the obligation to pay and the actual movement of cash may not coincide.The accrual concept requires recognition of revenue and expenses on a comparable basis i.e., revenue and expense are allocated to a particular accounting period on a consistent basis.
(4) Full, Fair and Adequate Disclosure : The architecture of business has evolved from proprietorship to partnership to joint stock companies or publicly held companies. Apart from this in most of the companies the public has significant interest and stakes. In addition to the stake of the general public the companies borrow from banks, government, creditors, etc.
(5) Accounting Entity : For accounting purpose it is assumed that business has separate existence and its entity is different from that of its owner(s).In simple term this means that the liabilities and assets of the business are not the liabilities and assets of the owner of the business.Accounting is done for the business entities as distinguished is done for the business entities as distinguished from the persons associated with these entities; as such the transactions of the business and those of the owners should be accounted for and reported separately. A business enterprise is an economic unit separate and apart from the owners.
Every transaction should be analysed from the point of view of a business enterprise and not that of persons who are associated with it.For example when the owner introduces cash in business, this cash is shown as Capital Liability of the business towards the owner. The introduction or withdrawal of cash does not affect the overall cash (personal plus business) position of the owner. This concept enables recording of transactions between business and its owner.This concept ensures that accounting records reflect only the activities of the business and the expenses related to common resources used for business and personal use and apportioned on some equitable basis between business and its owners.This concept applies to all form of business enterprises e.g. sole proprietorship, partnership and joint stock companies. However, the separate existence of business entity is recognized by law only in case of corporate form of enterprise, for sole proprietorship and partnership firms the law does not distinguish the owners and business separately. Hence in legal sense the owners and business may not be different for some form of business enterprise, but for accounting purpose the business and the owners would be always treated separately.
i)Apart from the reason mentioned above, can you think of any other reason for the justification of the Business Entity Concept?
ii)The proprietor of a firm withdrew Rs. 50,000 for his personal use.This was shown as an expense of the firm and hence, profits were
reduced thereby, Is this right from an accounting point of view ?
iii)The proprietor of a firm contributed Rs. 10 lakhs towards the capital of the firm. Does it mean, from an accounting point of view, that the firm had a corresponding liability towards the proprietor ?
(6) Accounting Period : Accounting period refers to span of time at the end of which and for which the financial statement are prepared to throw light on the results of operations of business during the relevant period and the financial position at the end of relevant period.As per the Going concern concept the operations of the business will continue for an indefinite period in the process of generation of income.Complete picture of the financial affairs of the business can be available only at time of the liquidation of the business, but this information will be of very little use to all of the stakeholder for decision making purpose. In order to provide timely information to all the stakeholders this indefinite period is split into smaller periods which is known as Accounting Period.
Normally the accounting period is of twelve months, but in case of new business, changes in the accounting period, preparation of interim financial statement, etc. the accounting period can be different from twelve month period. In India the accounting period starts from Ist of April and ends on 31 st of March in the following year.
(7) Cost Principle: According to this principle all the non-monetary assets of the business are shown in the books of accounts at the historical cost i.e.the price paid to acquire these assets. Non-monetary assets are rights or claims, current or fixed which cannot be converted in fixed number of rupees at a point of time. The example of current non-monetary assets are inventories, prepared expenses etc., and of fixed non-monetary assets are building, plant and machinery, furniture, etc.A company bought a building in 2004 at a cost of Rs. 50 lakhs. At the end of the Accounting Year 2004-05. its market value is Rs. 70 lakhs.The company revalues the building at Rs. 70 lakhs for the year 2004- 05. Is this practice right ?
(8) Revenue Recognition (or Realisation) : The resources of business are utilized to earn revenue by sale of goods or rendering of services. The American Accounting Association defines revenue as “the monetary expression of the aggregate of products or services transferred by an enterprise to its customers during a period of time” and according toRobert N Anthony “revenue is being considered as earned the date at which it is realized that is the date when goods or services are furnished to the customers in exchange for cash or for other valuable consideration.
(9) Dual Aspect Concept : This is, no doubt, the basic concept in accounting. Under this concept, every transaction has got a two-fold aspect : (i) yielding to or receiving of benefit and (ii) giving of the benefit.For instance, when a firm acquires an asset (receiving of the benefit) it must have to pay cash (giving of the benefit). Therefore, two accounts are to be passed in the books of accounts, one – for receiving the benefit andn the other – for giving the benefit. Thus, there will be a double entry for every transaction – Debit for receiving the benefit and credit for giving the benefit. So, for each and every debit there must be a corresponding credit and vice versa. This is the principle of Double Entry System of Accountingwhich, in other words, known as the ' Dual Aspect Concept'
(10) Balance Sheet Equation Concept : The Historical Cost Concept needs support of two other concepts for practical purposes, viz. (i) the Money Measurement Concept (already discussed above), (ii) the Balance Sheet Equation Concepts. Accounting process, however, conforms to an algebraic equation which, in other words, is involved in two laws of nature, i.e., the law of consistancy of matter and the law that every effect originates from a cause.In relation to the former, it may be deduced that all that has been received by us must be equal to all that has been given to us. (In accounts, receipts are classified as debits and giving or sacrifices are classified as credits).
i)The accounting year of a firm closes on 31 st December each year. The rent for business premises of Rs. 50,000 for the last quarter could not be paid to the owner on account of his being away in a foreign country.should the rent payable be taken into account for computing the firm’s income for the accounting year?
ii)A government contractor supplies stationery to various government offices. Some bills amounting to Rs. 10,000 were still pending with various offices at the close of the accounting year on 31 st March. Should the businessman take the revenue of Rs. 10,000 into account for computing the net profit of the period ?
iii) A company is negotiating to get an order for Rs. 5 lakhs form XYZ company. It is confident to get an order and as a result, it shows this order as a part of its sales revenue. Will you approve such an accounting treatment of probable order to be obtained in future ?
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