Accounting Concepts and Principles
Such Concepts include the basic premises or conditions upon which discipline of accounting is based. Accounting Concepts and Principles are set of broad practices that provide a basic framework for financial reporting. These concepts and principles provide consistency in accounting practices and ensure the reliability of financial reporting.
Some of the accounting concepts and principles:
- Accounting Relevance
- Reliability Concept
- Matching Concept
- Accrual Concept
- Duality Concept
- Completeness Concept
- Going Concern Concept
- Realization Concept
- Historical Cost Concept
Accounting Relevance concept suggests that information provided by the financial reporting should be relevant and should help the user for predicting the future and confirming the predictions.
EPS of the company has risen from Rs. 25 to Rs. 35 in two years. This information is relevant for the investors as it reflects the performance of the company and helps them to predict the future.
Information in financial reporting should be reliable. Reliability of the information can be obtained when information is materially/numerically accurate. Inaccurate information and omissions in financial reporting reduce the reliability of the information.
Non-disclosure of something evident in the financial statement can mislead the users and make information and company less reliable.
Matching concept simply states that all the expenses must be matched with the revenues in the same accounting period or vice-versa. Businesses must incur costs in order to generate revenues. Matching principle presents a more balanced and consistent view of the financial performance of the organization.
A worker worked for a month of March which is due in April. The employer should record the wages in March as expenses have occured in the month of March.
Accrual concept is one the fundamental principle of accounting which states that revenues are recognized when they are earned and expenses are recorded when they are incurred irrespective of when the cash transaction has been made.
GAAP allows preparation of financial statements on an accrual basis only (and not on cash basis). This is because under accrual concept revenues and expenses are recorded in the period to which they relate and not when they are received or paid.
Dual Concept is the basis of a double entry accounting system. Under this, every transaction has dual effects and can be classified into: Debit and Credit
Debit is the portion of the transaction that accounts for the increase in assets and expenses and decrease in liabilities, equity and income.
Credit is the portion of the transaction that accounts for the decrease in assets and expenses and increase in liabilities, equity and income.
Information must be complete in all material respects. The basis of the decision is dependent on the information and incomplete information reduces the relevance and reliability of the information. Completeness deals whether all the transactions and accounts are recorded in the financial statements.
A financial statement prepared following all the accounting principles and guidelines can be referred to as complete.
Going Concern Concept
Going Concern Concept simply suggests that a business entity is operated for an indefinite period of time. Therefore, it is assumed that the entity will realize its assets and settle its liabilities in the normal operation of the business.
If this concern is ignored, business is expected to wind up hence the valuation and future predictions of financial statements need to be prepared using a break-up basis i.e. accounting relevance and reliability is compromised.
Realization Concept is the application of the accruals concept towards the recognition of revenue. This simply states revenue should be recorded by the seller when it is earned irrespective of whether cash flow has taken place. Recognition of revenue on a cash basis may not present a consistent basis for evaluating the performance of a company over several accounting periods due to the potential volatility in cash flows.
Historical Cost Concept
This concept states that assets and liabilities should be recorded at their historical cost while presented in their financial reports. Historical cost is the amount that is originally paid to acquire the asset and this cost may be varying from the market value of the asset.
A land purchased in 2009 at Rs. 250,000 will be recorded at Rs. 250,000 in 2019 even if the current market price today i.e. Rs. 100,00,000.