Accounting Principles

& Conventions
 What are Accounting principles?
▪ As the name suggests, accounting principles are set of rules
and guidelines by maintaining which a company should report
its financial data. To understand this, we can talk about the
most popular sets of accounting principles, i.e. Generally
Accepted Accounting Principles (GAAP).
▪ If you own a company in the India and you are public listed
company here’s what you need to do to remain in the most
important and major stock exchanges –
i. First, you need to learn the GAAP through and through.
ii. And then, you need to adhere to GAAP while reporting your
financial statements.
 What is GAAP?
▪ GAAP is a set of rules and guidelines that the companies need to
follow while reporting its financial statements.
▪ GAAP is created to ensure that the financial reporting remains
transparent and coherent throughout the process. And it also
ensures that the financial reporting done in one organization
remains consistent with the financial reporting done in another
company.
▪ The fascinating thing about GAAP is it is not similar in all geographic
locations. As per the region and the industries, GAAP is
implemented and followed upon.
▪ The publicly traded companies in the India must comply with the
Indian GAAP. Otherwise, it wouldn’t be possible for them to remain
publicly traded.
 Characteristics of GAAP
❑ Relevance: All information required for decision making must be
present on the financial statements. Nothing should be omitted or
misstated if it would cause the interpretation of the statements to
change. The information must also be prepared in a timely manner.
❑ Reliability: All information must be free of error and bias.
Information must be objective and be verifiable.
❑ Understandability: Readers of the financial statements must be
able to understand the reports. Companies will usually provide an
extensive set of notes to accompany the financial statements.
❑ Comparability: A company’s financial statements should be
comparable from year to year. Financial statements will usually
have last year’s financial printed alongside this year’s financials.
 GAAP Principles

❑ The GAAP principles are divided into two categories:

❑ Accounting Concepts: Accounting Concepts are basic

assumptions or conditions upon which science of
accounting is based.

❑ Accounting Conventions: Accounting Conventions

include those customs and traditions which are
followed up by an accountant while preparing a
financial statement.
 Accounting Concepts
Business Entity concept
Money Measurement
Going Concern
Accounting Period
Cost Concept
Dual Aspect
Revenue Recognition
Matching Concept
Accrual
 Business Entity Concept
❑ For the purpose of accounting, it is assumed that the business
has a separate and distinct entity from its owner(s) and all
other entities having transactions with it.
❑ Transactions between owner and business are recorded in the
accounting books – Capital Ac and Drawings A/c.
❑ If this assumption is not followed, the results (profits or
losses) of the business will not be true and fair and the
financial status of the business may not be correctly
measured.
 Business Entity Concept Effects
❑ Only the business transactions are recorded and
reported and not the personal transactions of the
owners.

❑ Income or profit is the property of the business

unless distributed among the owners.

❑ The personal assets of the owners or shareholders

are not considered while recording and reporting the
assets of the business entity.
 Money Measurement Concept
❑ According to this assumption all business transactions should
be recorded in terms of money, i.e., currency of the country.
❑ Only such transactions and events which can be interpreted in
terms of money are recorded.
❑ Events which cannot be expressed in money terms do not
find place in the books of account though they may be very
important for the business.
❑ The system of accounting treats all units of money as the
same irrespective of their time dimension.
Cost Concept or Historical Cost Concept
❑ According to this concept, the various assets
acquired by a firm should be recorded on the basis of
the actual amounts involved or spent.
❑ If nothing has been paid for acquiring an asset, it
would not be shown in the accounting books as an
asset.
❑ The cost concept does not mean that the assets will
always be shown at cost. The fixed asset will be
recorded at cost at the time of its purchase but it
may systematically be reduced in its value by
charging depreciation.
 Going Concern Concept
❑ According to this concept, it is assumed that the
business enterprise is a continuing one, not on the
verge of closure. Business transactions are recorded
from this point of view.
❑ On the basis of this concept, a clear distinction is
made between assets and expenses. Because of this
concept that fixed assets are valued on the basis of
cost less proper depreciation.
❑ If it is certain that a business will continue for
specified period, then the accounting records will be
kept on the basis of expected life of the business.
 Dual Aspect Concept

❑ According to this principle, every transaction has

two aspects and both the aspects are recorded in
the accounting books. This concept is the basis of
double entry system or modern accounting.
❑ The following accounting equation is drawn on the
basis of this principle:

❑ Assets = Capital (or Owner’s Equity) + Liabilities

(Claims of outsider)
 Dual Aspect Concept

❑ Transaction 1. Ram started business with cash Rs.

70,000.

Liabilities Amt Assets Amt

Ram’s Capital 70,000 Cash 70,000

Total 70,000 Total 70,000

 Dual Aspect Concept

❑ Transactions 2. Purchased furniture Rs. 8,000.

Liabilities Amt Assets Amt

Ram’s Capital 70,000 Cash 62,000
Furniture 8000
Total 70,000 Total 70,000
 Dual Aspect Concept

❑ Transactions 3. Goods purchased for Rs. 12,000 on

credit basis.

Liabilities Amt Assets Amt

Ram’s Capital 70,000 Cash 62,000
Creditor 12000 Furniture 8000
Stock 12000
Total 82,000 Total 82,000
Realization or Revenue Recognition Concept

❑ According to this concept revenue is recognized only

when a sale is made.
❑ No sale can be said to have taken place, unless money
has been realized i.e., cash has been received or a legal
obligation to pay has been assumed by the customer.
❑ It prevents business firms from inflating their profits by
recording incomes that are likely to accrue i.e. expected
incomes or gains are not recorded.
 Exceptions to Realization Concept:

❑ Long-term contracts: In long-term contracts where, the

payments are received in installments on the basis of
work completed and certified. In such cases, revenue is
considered realized normally in a proportion of work
completed or cash realized or any other reasonable
basis.

❑ Ready market: Some goods have a ready market. For

example, gold, silver, etc. In such cases revenue is
considered recognized as soon as these are
manufactured as these can be sold in the market easily.
 Accrual Concept
❑ Business transactions are recorded as and when they occur and not
when the related payments are received or made. This concept is
called accrual basis of accounting.
❑ Accrued revenues and costs are recognized as they are earned and
incurred and recorded in the financial statements of the period.
❑ On the basis of this concept, adjustment entries relating to
outstanding and prepaid expenses and income received in advance
etc. are made.
❑ They have their impact on the Income Statement and the Balance
Sheet.
 Accounting Period Concept
❑ The users of financial information need periodical
reporting relating to the performance of the
business.
❑ It is an interval of time at the end of which financial
statements are prepared and communicated.
❑ Normally, the accounting period consists of twelve
months.
❑ However, there is no restrictions on the business
entities on providing information at more frequently
intervals to investors, if they wish.
 Matching Concept

❑ According to matching principle, the revenue of a

given period should be matched with the expenses
of the same period.

❑ According to this concept, adjustments should be

made for all outstanding expenses, accrued incomes,
prepaid expenses and unearned incomes etc. while
preparing the final accounts at the end of the
accounting period.
 Accounting Conventions

Consistency Convention

Conservatism or Prudence Convention

Convention of Full Disclosure

Convention of Materiality
 Consistency Convention

❑ According to this convention, financial statements

should be prepared on the same basis as that of the
preceding period.
❑ Whatever may be the accounting policies or
methods, once decided, these are to be followed
consistently.
❑ This provides comparability to accounting data of
the same enterprise over the periods or data of
different enterprises of the same period or both.
 Consistency Convention

❑ Whenever there is any change in policy the results of

the enterprise and financial position may be
affected.

❑ Nature and effect of such change and the

justification of the change must be informed to the
users of accounting information by way of foot
notes.
Consistency Convention: Examples

Change in the
method of
providing
depreciation.
Change in the
Change in the
basis of making
method of
provision for
valuation of
bad and
stock.
doubtful debts.

Examples
 Conservatism or Prudence Convention

❑ It is a policy of playing safe or with caution. According to Conservatism or

Prudence convention,
❑ The accountant should not anticipate income and should provide for all
possible losses, and
❑ Faced with the choice between two methods of valuing an asset the
accountant should choose a method which leads to the lesser value.
❑ The main objective this convention is that the financial statements should
disclose the actual results.
❑ It should be noted that no deliberate attempt be made to understate the
profits and values of assets.
❑ Closing stock is valued at cost or market price whichever is less.
❑ A provision for bad and doubtful debts on debtors is made in anticipation
of actual bad debts in future.
 Convention of Full Disclosure
❑ According to this Convention, all facts which are significant
and necessary to make financial statements complete and
understandable, must be disclosed.
❑ Significance of information is viewed from the point of the
users of financial information.
❑ The disclosure can be done either in financial statements or in
foot notes given at the end of financial statements.
❑ Disclosure of many facts is required not only under legal
provisions but also to make the accounting system fair and
transparent.
❑ The information to be disclosed may relate to current
accounting period, previous period or to post-Balance Sheet
date.
 Convention of Full Disclosure

❑ Following are the important facts usually disclosed in the

financial statements:
I. Change in method of providing depreciation.
II. Change in method of valuation of closing stock.
III. Basis of making provision for bad and doubtful debts.
IV. A big loan taken by the company, after the date of preparing
balance sheet.
V. Liabilities which are Contingent are always shown as foot
notes.
 Convention of Materiality

❑ The full disclosure principle requires that all facts which are significant
and necessary to make financial statements complete and
understandable, must be disclosed.
❑ The materiality principle is an exception to the full disclosure. According to
the materiality principle, items or events, having insignificant economic
effect, or not being relevant to the user, need not to disclosed.
❑ Materiality is a relative term and depends on its nature and the amount
involved.
❑ An item should be regarded as material if there is reason to believe that
knowledge of it would influence the decision of informed investors.
❑ Thus, what is material is a matter of exercising discretion. It is to be noted
that an item may be material for one company and the same item may be
immaterial for the other company.
IFRS (International Financial Reporting Standards)

❑ International Financial Reporting Standards (IFRS) is a set of accounting

standards developed by an independent, not-for-profit organization called
the International Accounting Standards Board (IASB) stating how
particular types of transactions & other events should be reported in
financial statements.
❑ IFRS are principle-based standards, interpretations & the framework
adopted by the International Accounting Standards Board(IASB).
❑ IFRS comprise of:
I. 9-IFRS-standards issued after 2001 by IASB.
II. 29-International Accounting Standards (IAS)-standard issued before
2001 by IASC which are still valid.
III. 16-Interpretations issued by International Financial Reporting
Interpretations committee (IFRIC) after 2001.
IV. 11-interpretations issued by Standing Interpretations Committee
(SIC) before 2001.
Thank You