Accounting Principles Costs & Conventions: Ravikant Agarwal

Accounting Principles Costs & Conventions
Presented by
Ravikant Agarwal
Research Scholar,
School of Business,
Faculty of Management,
Shri Mata Vasihno Devi University, Katra.
10/24/20
Accounting Principles
•What is an Accounting Principle or Concept or Convention or Standard?
•Do they mean the same thing?

Or
•Does each one has its own meaning?
Definitions
• The American Institute of Certified Public Accountants has defined the
Accounting Principle as, “a general law or rule adopted or professed as a
guide to action; a settled ground or basis of conduct or practice”.
• The Canadian Institute of Chartered Accountants has defined accounting principles

as, “the body of doctrines commonly associated with the theory and procedure of
accounting, serving as explanation of current practices and as a guide for the
selection of conventions or procedures where alternatives exist.
Rules governing the foundation of accounting actions and the principles derived
from them have arisen from common experiences, historical precedent,
statements by individuals and professional bodies and regulation of
governmental agencies”.
Key Points
• Accounting Principles serve as a guide to action.
• Accounting Principles are manmade.
• Accounting Principles are generally accepted and uniform view of the accounting
profession in relation to good accounting practice and procedures. Hence the name
Generally Accepted Accounting Principles.
• Accounting Principles, Rules of Conduct and Action are described by various terms such as
Concepts, Conventions, Doctrines, Tenets, Assumptions, Axioms, Postulates, etc. We shall
use all these terms synonymously except for a little difference between the two terms –
Concepts and Conventions.
• The term Concept is used to connote accounting postulates i.e. Necessary assumptions or
conditions upon which accounting is based.
• The term Convention is used to signify customs or traditions as a guide to the preparation
of accounting statements.
Accounting Concepts
1. Business Entity Concept

2. Going Concern Concept
3. Money Measurement Concept
4. Cost Concept
5. Dual Aspect Concept (Double Entry System)
6. Accounting Period Concept
7. Periodic Matching Of Costs And Revenues
8. Realization Concept
Accounting Concepts (Contd…)
• Business Entity Concept : the moment a business enterprise is started

it attains a separate entity as distinct from the persons who owns it. In
recording the transactions of a business, the important question is:
How do these transactions affect the business enterprise? How these
transactions affect the proprietors/owners is quite irrelevant.
• Example: if a proprietor has taken Rs.5000/- from the business for
paying house tax for his residence, the amount should be deducted
from the capital contributed by him.
• Going Concern Concept: This concept assumes that the business enterprise will
continue to operate for a fairly long period in the future. The significance of this concept
is that the accountant while valuing the assets of the enterprise does not take into
account their current resale values as there is no immediate expectation of selling it.
Moreover, Depreciation on fixed assets is charged on the basis of their expected life
rather than on their market values. When there is conclusive evidence that the business
enterprise has a limited life, the accounting procedures should be appropriate to the
expected terminal date of the enterprise. In such cases, the financial statements could
clearly disclose the limited life of the enterprise and should be prepared from the
‘quitting concern’ point of view rather than from a ‘going concern’ point of view.
•Money Measurement Concept: Accounting records only those transactions which can be
expressed in monetary terms. The importance of this concept is that money provides a
common denomination by means of which heterogeneous facts about a business enterprise
can be expressed and measured in a much better way.
Limitations:
Accounting does not take into account pertinent non-monetary items which may significantly
affect the enterprise. For instance, accounting does not give information about the poor health
of the chairman, serious misunderstanding between the production and sales manager etc.
Money is expressed in terms of its value at the time a transaction is recorded in the accounts.
Subsequent changes in the purchasing power of money are not taken into account.
• Cost Concept:
 An asset is ordinarily entered in the accounting records at the price paid to acquire it i.e., at its
cost.
 This cost is the basis for all subsequent accounting for the asset.
• However, this concept does not mean that the asset will always be shown at cost. This cost becomes
the basis for all future accounting of the asset. It means that the asset may systematically be reduced in
its value by changing Depreciation.
• The significant advantage of this concept is that it brings in objectivity in the preparations and
presentation of financial statements.
• It also does not take into account subsequent changes in the purchasing power of money due to
inflationary pressures. (Inflation Accounting)
• Dual Aspect Concept (Double Entry System):
• This concept is the core of accounting. According to this concept every business
transaction has a dual aspect. This concept is explained in detail below:
• The properties owned by a business enterprise are referred to as assets and the rights
or claims to the various parties against the assets are referred to as equities. The
relationship between the two may be expressed in the form of an equation as follows:
Equities = Assets
• Equities may be subdivided into two principal types: the rights of creditors and the
rights of owners. The rights of creditors represent debts of the business and are called
liabilities. The rights of the owners are called capital.
• Dual Aspect Concept (Double Entry System):
• Expansion of the equation to give recognition to the two types of equities results in the
following which is known as the accounting equation:
Liabilities + Capital = Assets
• It is customary to place ‘liabilities’ before ‘capital’ because creditors have priority in the
repayment of their claims as compared to that of owners. Sometimes greater emphasis is
given to the residual claim of the owners by transferring liabilities to the other side of the
equation as:
Capital = Assets – Liabilities
• All business transactions, however simple or complex they are, result in a change in the
three basic elements of the equation.
• Accounting Period Concept: According to this concept accounting

measures activities for a specified interval of time called the accounting
period. For the purpose of reporting to various interested parties one year
is the usual accounting period.
Example: If for ten years no accounts have been prepared and if the
business has been consistently incurring losses, there may not be any
capital at all at the end of the tenth year which will be known only at that
time. This would result in the compulsory winding up of the business. But,
if at frequent intervals information are made available as to how things are
going, then corrective measures may be suggested and remedial action
may be taken. ‘frequent accounting makes for only friendship’.
• Periodic Matching Of Costs And Revenues: In order to ascertain the profits made by the
business during a period, the accountant should match the revenues of the period with the
costs of that period. By ‘matching’ we mean appropriate association of related revenues
and expenses pertaining to a particular accounting period.
• In other words, profits made by a business in a particular accounting period can be
ascertained only when the revenues earned during that period are compared with the
expenses incurred for earning that revenue. The question as to when the payment was
actually received or made is irrelevant.
• It is on account of this concept that adjustments are made for Outstanding Expenses,
Accrued Incomes, Prepaid Expenses etc. While preparing financial statements at the end of
the accounting period.
• The system of accounting which follows this concept is called as Mercantile System. In
contrast to this there is another system of accounting called as Cash System of accounting
where entries are made only when cash is received or paid, no entry being made when a
payment or receipt is merely due.
• Accrual Concept: The meaning of accrual is something that becomes due especially
an amount of money that is yet to be paid or received at the end of the accounting
period.
It means that revenues are recognised when they become receivable.Though cash
is received or not received and the expenses are recognisedwhen they become
payable though cash is paid or not paid.
Both transactions will be recorded in the accounting period to which they relate.
Therefore, the accrual concept makes a distinction between the accrual receipt of
cash and the right to receive cash as regards revenue and actual payment of
cashand obligation to pay cash as regards expenses.
• Realization Concept: Realization refers to inflows of cash or claims to cash like bills
receivables, debtors etc. Arising from the sale of assets or rendering of services.
According to realization concept, revenues are usually recognized in the period in
which goods were sold to customers or in which services were rendered.
• Sale is considered to be made at the point when the property in goods passes to
the buyer and he becomes legally liable to pay.
• A second aspect of the realization concept is that the amount recognized as
revenue is the amount that is reasonably certain to be realized.
• Even though goods sold on credit are recorded as sale at full value, the realization
may be less than the invoiced/billed amount , the bad debts are estimated and
treated as an expense and the effect on net income/profits is the same.
Accounting Conventions
The most important conventions which in use for a long time are:
• Convention of consistency.
• Convention of full disclosure.
• Convention of materiality.
• Convention of conservatism.
Accounting Conventions (Contd…)
• Convention of Consistency: The convention of consistency means that same
accounting principles should be used for preparing financial statements year after
year.
A meaningful conclusion can be drawn from financial statements of the same
enterprise when there is comparison between them over a period of time. This can
be possible only when accounting policies and practices followed by the enterprise
are uniform and consistent over a period of time.
Examples: Calculation of Depreciation, Valuing Closing Inventory
Three types of Consistency: Vertical (Same Organization), Horizontal (Time Basis) &
Dimensional (Two Organizations in same trade)
• Convention of Full Disclosure: All Material and Relevant facts concerning the
financial statements should be fully disclosed. Full disclosure means that there
should be full, fair and adequate disclosure of accounting information. Adequate
means sufficient set of information to be disclosed. Fair indicates an equitable
treatment of users. Full refers to complete and detailed presentation of information.
The shareholder would like to know profitability of the firm while the creditor would
like to know the solvency of the business.
The Companies Act 2013, under schedule III has provided formats for the preparation
of Profit and Loss account and Balance Sheet of a company. The regulatory bodies
like Securities and Exchange Board of India (SEBI) has also made compulsory for
complete disclosures by registered companies.
• Convention of Materiality: The convention of materiality states

that, to make financial statements meaningful, only material fact
i.e. important and relevant information should be supplied to
the users of accounting information.
Example: Machinery Vs Stationery
Important and significant items should be recorded in their
respective heads and all immaterial or insignificant transactions
should be clubbed under a different accounting head.
• Convention of Conservatism: This convention is based on the principle that
“Anticipate no profit, butprovide for all possible losses”.
The main objective of this convention is to show Minimum Profit. Profit should not
be overstated. If profit shows more than actual, it may lead to distribution of
dividend out of capital. This is not a fair policy and it will lead to the reduction in the
capital of the enterprise.
Thus, this Convention clearly states that profit should not be recorded until it is
realised. But if the business anticipates any loss in the near future, provision should
be made in the books of accounts for the same.
Examples: valuing closing stock at cost or market price whichever is lower, creating
provision for doubtful debts, discount on debtors, writing off intangible assets like
goodwill, patent, etc.
Queries???

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Accounting Principles Costs & Conventions

•What is an Accounting Principle or Concept or Convention or Standard?

•Do they mean the same thing?

• The Canadian Institute of Chartered Accountants has defined accounting principles

1. Business Entity Concept

• Business Entity Concept : the moment a business enterprise is started

• Accounting Period Concept: According to this concept accounting

• Convention of Materiality: The convention of materiality states

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