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CLASS 11
ACCOUNTANCY

CHAPTER 2: THEORY BASE OF

ACCOUNTING

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GAAP – Generally Accepted Accounting Principles (GAAP) is a defined

set of rules and procedures that needs to be followed in order to create
financial statements, which are consistent with the industry standards.
GAAP is developed by the Financial Accounting Standards Board (FASB)

GAAP helps in ensuring that financial reporting is transparent and

uniform across industries. As financial information is based on historical
data, in order to facilitate comparison between data from various
sources, GAAP must be followed.

Accounting Concepts – Accounting concepts are the establishments to

place an interrelated bookkeeping structure in an organization.
Accounting ideas or concepts are exceptionally essential for each
organization, as this helps with staying in check with synchronization
and harmony with the businesses, concerning utilizing a homogenous
accounting concept. Each and every one of these additionally helps in
better analysis. The ideas give the management a bird’s eye view and
assist with handling the accounting framework with a similar tone to
the executives.

Business Entity Concept – The business entity concept is one of the

accounting concepts that states that the business and the owner are
two separate entities and therefore, should be considered separate
from each other. As per this concept, the financial transactions
pertaining to the business entity should be recorded separately from
the business owners’ transactions.

This concept is also known as the Economic Entity Concept, which

means that the owner of the business and the business itself are
considered two separate entities. Therefore, any transactions or events
that impact the business will be recorded and events that impact any

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other entities apart from the business will be considered as irrelevant

and not be entertained. If the transactions are not recorded in a mixed
manner (involving both business and business owners in one
statement), it will make the accounting information less usable.

Money Measurement Concept – The concept of money measurement

is associated with such transactions of a business, which can be
recorded in terms of money in the books of accounts. The records are
to be kept in monetary units alone and not in physical units. All the
assets are consequently shown in monetary terms for accounting
purposes.

Going Concern Concept – Going concern concept is one of the

accounting principles that states that a business entity will continue
running its operations in the foreseeable future and will not be
liquidated or forced to discontinue operations for any reason.

In other words, a going concern is a business that is capable of running

the daily operations and has the capital and raw materials to do so. A
business has the ability to pay off the debt during the accounting
period. There should be demand in the market for the products or
services offered by the company. There should be no changes in the
law governing the business.

Accounting Period Concept – The accounting period concept is based

on the theory that all accounting transactions of a business should be
divided into equal time periods, which are referred to as accounting
periods. The purpose of such a time period is that financial statements
can be prepared and presented to the investors and also help in
comparing the performance of the business with each time period.

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By preparing financial statements within a particular time period, a

company is able to determine the profit and loss that occurred during
the period for the business. The lack of a proper accounting period will
result in variation in results and makes it difficult to determine the
financial position of the company at that time.

Generally, an accounting period is of 12 months (1 year). While the

time period is fixed, the month can vary from company to company.

Cost Concept – The cost concept requires that all the assets must be
recorded in the books of accounts at the price at which they were
bought, which involves the cost incurred for transportation,
installation, and acquisition. The cost concept is traditional in nature as
a particular amount concerning the asset is paid on the date of
purchase and does not change year after year.

Dual Aspect Concept – The dual aspect concept indicates that each
transaction made by a business impacts the business in two different
aspects which are equal and opposite in nature. This concept forms the
basis of double-entry accounting and is used by all accounting
frameworks for generating accurate and reliable financial statements.

Revenue Recognition/Realisation Concept – According to this

principle, income is treated as being earned on the date on which it is
realised, i.e. the date on which goods or services are transferred to the
customers. Since this exchange of goods or services may be for cash or
on credit, it is not important whether cash has actually been received
or not.

Matching Concept – The matching concept states that expenses that

are incurred in an accounting period should be matching with the

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revenue earned during that period. Thus all expenses for that
accounting period whether or not paid during that year and all revenue
whether earned or not during the period should be considered to
calculate profit or loss. Hence, depreciation of the current year is
charged against the current year’s revenue. In other words, the full cost
of the asset is not treated as an expense in the year of its purchase
itself rather it is spread over its useful life.

Full Disclosure Concept – Full disclosure principle refers to the concept

that suggests that a business should report all the necessary
information in their financial statements so that the users who are able
to read the financial information are in a better position to make
important decisions regarding the company.

A company can have various stakeholders which include creditors,

suppliers, customers, investors, etc. who use the financial information
for deciding on the course of action to be taken regarding their stance
in the business. Since the external users of financial information lack
any kind of information on how a business is run, the full disclosure
principle makes it easier to determine how a company is functioning.

Consistency Concept – The consistency principle states that businesses

should maintain the same accounting methods or principles throughout
the accounting periods so that users of the financial statements or
information are able to make meaningful conclusions from the data.

The consistency principle is useful for measuring trends in the business

which is spread across many accounting periods. If the business keeps
on changing accounting methods, it will create confusion and the
financial statements will not be comparable across accounting periods.

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Conservatism Concept – The conservatism concept is a concept in

accounting that refers to the idea that expenses and liabilities should
be recognised as soon as possible in a situation where there is
uncertainty about the possible outcome and in contrast record assets
and revenues only when they are assured to be received.

In other words, the principle of conservatism states that, if an

accountant has two possible outcomes for any accounting issue, then
he must choose the outcome which is most conservative or has the
least possible chance of profit.

Materiality Concept – The materiality concept in accounting refers to

the concept that all the material items should be reported properly in
the financial statements. Material items are considered as those items
whose inclusion or exclusion results in significant changes in the
decision-making for the users of business information. The information
present in the financial statements must be complete in terms of all
material aspects so that it is able to present an accurate picture of the
business.

Objectivity Concept – The objectivity concept in accounting is referred

to as the principle that states that financial statements should be
objective in nature. In other words, the financial information should be
unbiased and free from any kind of internal and external influence.

The financial information presented in financial statements should be

based on solid evidence and not just recorded based on some kind of
opinion. The purpose served by this principle is that it does not let the
opinions of management and accountants impact the preparation of
financial statements at any given point in time.

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Double Entry System – Double entry accounting is a form of accounting

that records both debit and credit transactions. There are two facets of
any transaction: debit and credit. Each transaction is recorded on both
the debit and credit sides.

Dual Aspect – As per double-entry accounting, it is known that any

transaction of a business is recorded in two separate accounts. The dual
aspect concept indicates that each transaction made by a business
impacts the business in two different aspects which are equal and
opposite in nature. This concept forms the basis of double-entry
accounting and is used by all accounting frameworks for generating
accurate and reliable financial statements.

Single Entry System – A single entry system records each bookkeeping

exchange with a single entry section to the bookkeeping records, as
opposed to the more normal double-entry system.

In this case, a firm keeps up with just the cash account and the records
of the debt holders account and the creditors account appropriately
and it doesn’t keep up with the records of costs, wages, resources, and
liabilities accounts, respectively.

Cash Basis of Accounting – The cash basis of accounting is referred to

as that method of accounting where the accounting system recognises
revenues and expenses only when there is inflow and outflow of cash.

In other words, the cash basis of accounting recognises the expenses

incurred and revenues earned immediately when money changes
hands between two parties involved in the transaction. In the cash
basis of the accounting system, there is no consideration for income
that is obtained from the credit accounts.

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Accrual Basis of Accounting – The accrual basis is based on the concept

that transactions are recorded as and when they occur. In other words,
businesses that follow the accrual basis of accounting need to record
revenues and expenses when a transaction occurs regardless of when
payment for the same is received or made.

The accrual basis of accounting follows the matching principle, which

states that expenses and revenues should be recognised in the same
accounting period. The accrual basis of accounting is the preferred
choice of accounting for large businesses and those businesses that
deal mostly in credit.

Accounting Standards – Accounting standards may be defined as

codified generally accel accounting principles. According to Kohler,
“Accounting standard is a mode of conduct imposed on accountants by
custom, law or professional body”. The following points highlight the
need for accounting standards: Accounting standards make accounting
procedures universally acceptable by removing the effect of diverse
accounting practices and policies. Accounting standards serve as guides
for solving one or more accounting problems. Accounting standards
provide the basis upon which financial statements are prepared.

Sole Proprietorship Unit – A sole proprietorship can be explained as a

kind of business or an organisation that is owned, controlled, and
operated by a single individual who is the sole beneficiary of all profits
or losses, and responsible for all risks. It is a popular kind of business,
especially suitable for small businesses at least for their initial years of
operation. This type of business is usually a specialised service such as
hair salons, beauty parlours, or small retail shops.

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Partnership Firm – A partnership firm is a type of business entity that is

formed by the association of two or more members who have agreed
to share the profits of the business, which is carried on by all partners
or one partner acting for all.

According to the Indian Partnership Act, 1932, Section 4 defines

Partnership as – “An agreement between persons who have agreed to
share profits of the business carried on by all or any one of them acting
for all.”

The members involved in the partnership are known as partners

individually, while they are jointly known as a firm. The agreement on
which terms and conditions of a partnership are written is known as
Partnership Deed.

Societies – A society is a group of people participating in continuous

social connection, or a broad social group occupying the same social or
spatial territory, normally exposed to the same political power and
cultural standards that are dominant. Society consists of people who
have decided to work together through mutual advantage.

Trusts – Trust is a special form of organisation that emerges out of a

will. The will maker exclusively transfers the ownership of a property to
be used for a particular purpose. If the purpose is to benefit particular
individuals, it becomes a ‘Private Trust’ and if it concerns some purpose
of the common public or the community at large, it is called a ‘Public
Trust’.

Hindu Undivided Family – Hindu Undivided Family business is a precise

kind of business structure found only in India. This is one of the classical
methods of business structure in the nation. It is administered by the

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Hindu Law. The source of membership in the company is birth in a

family and 3 consecutive generations can be members of the company.

The business is managed by the head of the family (eldest member) and
he is called Karta. However, all the members hold equal ownership over
the property of an ancestor, and they are called co-parceners.

Association of Persons – Association of Persons (AOP) is a group of

persons who come together for achieving a common goal and common
objective, they have the same mindsets towards running a company.
Members of the AOP can be natural or artificial persons.

Cooperative Societies – Cooperative societies are formed with the aim

of helping their members. This type of business organisation is formed
mainly by weaker sections of the society in order to prevent any type of
exploitation from the economically stronger sections of the society.

Cooperative societies need to be registered under the Cooperative

Societies Act, 1912 in order to function as a legal entity. Members of
the society raise the capital within themselves.

Companies – A company is a legal entity established by a group of

individuals to employ and regulate a business firm. A company may be
coordinated in different ways for financial liability and tax purposes,
relying upon the corporate law of its administration. The line of a
business concern in an enterprise is in, will normally ascertain which
business substructure it picks, for instance, a partnership, a
corporation, or a proprietorship. In such a case, a company may be
contemplated as a business kind. Hence, companies can be classified
either on the basis of the liability of their core members or on the
ground of the total number of members.

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International Financial Reporting System (IFRS) – IFRS refers to the

international financial reporting standards that are followed globally
and includes instructions on how certain transactions should be
reported in financial statements. IFRS is issued by the International
Accounting Standards Board (IASB).

Goods and Service Tax (GST) – GST is a tax levied when a consumer
buys a good or service. It is meant to be a single, comprehensive tax
that will subsume all the other smaller indirect taxes on consumption
like service tax, etc. It subsumed 17 large taxes and 13 cesses. It is a
single tax on the supply of goods and services, right from the
manufacturer to the end consumer. This is how it is done in most
developed countries. More than 160 countries have implemented this
system of taxation. GST does not tax or get into specific commodities.

Direct Tax – A direct tax can be defined as a tax that is paid directly by
an individual or organisation to the imposing entity (generally the
government). A direct tax cannot be shifted to another individual or
entity. The individual or organisation upon which the tax is levied is
responsible for the fulfilment of the tax payment.

The Central Board of Direct Taxes deals with matters related to levying
and collecting Direct Taxes and the formulation of various policies
related to direct taxes. A taxpayer pays a direct tax to a government for
different purposes, including real property tax, personal property tax,
income tax or taxes on assets, FBT, Gift Tax, Capital Gains Tax, etc.

Indirect Tax – The term indirect tax has more than one meaning. In the
colloquial sense, an indirect tax such as sales tax, a specific tax, value-
added tax (VAT), or goods and services tax (GST) is a tax collected by an

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intermediary (such as a retail store) from the person who bears the
ultimate economic burden of the tax (such as the consumer).

The intermediary later files a tax return and forwards the tax proceeds
to the government with the return. In this sense, the term indirect tax
is contrasted with a direct tax which is collected directly by the
government from the persons (legal or natural) on which it is imposed.

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