CONCEPTS, PRINCIPLES AND CONVENSIONS

- ANOVERVIEW
 ● Entity concept:
Entity concept states that business enterprise is a separate identity apart from its
owner. Accountants should treat a business as distinct from its owner. Business
transactions are recorded in the business books of accounts and owner’s
transactions in his personal books of accounts. The practice of distinguishing the
affairs of the business from the personal affairs of the owners originated only in the
early days of the double-entry book-keeping. This concept helps in keeping business
affairs free from the influence of the personal affairs of the owner. This basic concept
is applied to all the organizations whether sole proprietorship or partnership or
corporate entities.
Entity concept means that the enterprise is liable to the owner for capital investment
made by the owner. Since the owner invested capital, which is also called risk
capital he has claim on the profit of the enterprise. A portion of profit which is
apportioned to the owner and is immediately payable becomes current liability in
the case of corporate entities.

● Money measurement concept:

As per this concept, only those transactions, which can be measured in terms of
money are recorded. Since money is the medium of exchange and the standard of
economic value, this concept requires that those transactions alone that are capable
of being measured in terms of money be only to be recorded in the books of
accounts. Transactions, even if, they affect the results of the business materially, are
not recorded if they are not convertible in monetary terms. Transactions and events
that cannot be expressed in terms of money are not recorded in the business books.
For example; employees of the organization are, no doubt, the assets of the
organizations but their measurement in monetary terms is not possible therefore,
not included in the books of account of the organization. Measuring unit for money
is taken as the currency of the ruling country i.e., the ruling currency of a country
provides a common denomination for the value of material objects. The monetary
unit though an inelastic yardstick, remains indispensable tool of accounting.

● Periodicity concept:
This is also called the concept of definite accounting period. As per ‘going concern’
concept an indefinite life of the entity is assumed. For a business entity it causes
inconvenience to measure performance achieved by the entity in the ordinary
course of business.
If a textile mill lasts for 100 years, it is not desirable to measure its performance as
well as financial
position only at the end of its life.
So, a small but workable fraction of time is chosen out of infinite life cycle of the
business entity for measuring performance and looking at the financial position.
Generally, one-year period is taken up for performance measurement and appraisal
of financial position. However, it may also be 6 months or 9 months or 15 months.
According to this concept accounts should be prepared after every period & not at
the end of the life of the entity. Usually this period is one calendar year. In India we
st
follow from 1st April of a year to 31 March of the immediately following year.
Thus, for performance appraisal it is not necessary to look into the revenue and
expenses of an unduly long time-frame. This concept makes the accounting system
workable and the term ‘accrual’ meaningful. If one thinks of indefinite time-frame,
nothing will accrue. There cannot be unpaid expenses and non-receipt of revenue.
Accrued expenses or accrued revenue is only with reference to a finite time-frame
which is called accounting period.
Thus, the periodicity concept facilitates in:
(i) Comparing of financial statements of different periods
(ii) Uniform and consistent accounting treatment for ascertaining the profit and
assets of the
business
(iii) Matching periodic revenues with expenses for getting correct results of the
business
operations

● Accrual concept:
Under accrual concept, the effects of transactions and other events are recognized on
mercantile basis i.e., when they occur (and not as cash or a cash equivalent is received or
paid) and they are recorded in the accounting records and reported in the financial
statements of the periods to which they relate. Financial statements prepared on the accrual
basis inform users not only of past events involving the payment and receipt of cash but
also of obligations to pay cash in the future and of resources that represent cash to be
received in the future.
To understand accrual assumption knowledge of revenues and expenses is required.
Revenue is the gross inflow of cash, receivables and other consideration arising in the
course of the ordinary activities of an enterprise from sale of goods, from rendering services
and from the use by others of enterprise’s resources yielding interest, royalties and
dividends. For example, (1) Mr. X started a cloth merchandising. He invested ` 50,000,
bought merchandise worth ` 50,000. He sold such merchandise for ` 60,000. Customers
paid him ` 50,000 cash and assure him to pay ` 10,000 shortly. His revenue is ` 60,000. It
arose in the ordinary course of cloth business; Mr. X received 50,000 in cash and ` 10,000
by way of receivables.

● Matching concept:
In this concept, all expenses matched with the revenue of that period should only
be taken into consideration. In the financial statements of the organization if any
revenue is recognized then expenses related to earn that revenue should also be
recognized.
This concept is based on accrual concept as it considers the occurrence of expenses
and income and do not concentrate on actual inflow or outflow of cash. This leads to
adjustment of certain items like prepaid and outstanding expenses, unearned or
accrued incomes.
It is not necessary that every expense identify every income. Some expenses are
directly related to the revenue and some are time bound. For example: selling
expenses are directly related to sales but rent, salaries etc. are recorded on accrual
basis for a particular accounting period. In other words, periodicity concept has also
been followed while applying matching concept.

● Going Concern concept:

The financial statements are normally prepared on the assumption that an
enterprise is a going concern and will continue in operation for the foreseeable
future. Hence, it is assumed that the enterprise has neither the intention nor the
need to liquidate or curtail materially the scale of its operations; if such an intention
or need exists, the financial statements may have to be prepared on a different basis
and, if so, the basis used is disclosed.
The valuation of assets of a business entity is dependent on this assumption.
Traditionally, accountants follow historical cost in majority of the cases.

● Cost concept:
By this concept, the value of an asset is to be determined on the basis of historical
cost, in other words, acquisition cost. Although there are various measurement
bases, accountants traditionally prefer this concept in the interests of objectivity.
When a machine is acquired by paying ` 5,00,000, following cost concept the value
of the machine is taken as ` 5,00,000. It is highly objective and free from all bias.
Other measurement bases are not so objective. Current cost of an asset is not easily
determinable. If the asset is purchased on 1.1.1995 and such model is not available in
the market, it becomes difficult to determine which model is the appropriate
equivalent to the existing one. Similarly, unless the machine is actually sold,
realizable value will give only a hypothetical figure. Lastly, present value base is
highly subjective because to know the value of the asset one has to chase the
uncertain future.

● Realization concept:
It closely follows the cost concept. Any change in value of an asset is to be recorded only
when the business realizes it. When an asset is recorded at its historical cost of ` 5,00,000
and even if its current cost is 15,00,000 such change is not counted unless there is certainty
that such change will materialize.
However, accountants follow a more conservative path. They try to cover all probable
losses but do not count any probable gain. That is to say, if accountants anticipate decrease
in value, they count it, but if there is increase in value, they ignore it until it is realized.
Economists are highly critical about the realization concept. According to them, this concept
creates value distortion and makes accounting meaningless.

● Consistency:
In order to achieve comparability of the financial statements of an enterprise through time,
the accounting policies are followed consistently from one period to another; a change in an
accounting policy is made only in certain exceptional circumstances.
The concept of consistency is applied particularly when alternative methods of accounting
are equally acceptable. For example, a company may adopt any of several methods of
depreciation such as written-down-value method, straight-line method, etc. Likewise, there
are many methods for valuation of inventories. But following the principle of consistency it
is advisable that the company should follow consistently over years the same method of
depreciation or the same method of valuation of Inventories which is chosen. However, in
some cases though there is no inconsistency, they may seem to be inconsistent apparently.
In case of valuation of Inventories if the company applies the principle ‘at cost or market
price whichever is lower’ and if this principle accordingly results in the valuation of
Inventories in one year at cost price and the market price in the other year, there is no
inconsistency here. It is only an application of the principle.
But the concept of consistency does not imply non-flexibility as not to allow the introduction
of
improved method of accounting.
Thank You