Accounting Principles

Chapter 3

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Chapter Overview

• Generally Accepted Accounting Principles

• Objectives of Accounting Principles

• Accounting Concepts

• Accounting Conventions

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 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)
ARE A SET OF STANDARDS AND RULES THAT ARE RECOGNIZED
AS A GENERAL GUIDE FOR FINANCIAL REPORTING.
 ACCOUNTING PRINCIPLES
•       Accounting Concepts
•       Accounting Conventions
The term ‘concept’ means those basic
assumptions or conditions upon which
accounting is based. The term ‘conventions’
means those customs and traditions which guide
the accountants while preparing accounting
statements.

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Difference between Concepts and Conventions
 The Accounting Concepts/Principles evolved out of the
practices and procedures followed by different countries and
later on established by the International Statutory Accounting
Bodies like The Institute of Chartered Accountants of India,
The Institute of Chartered Accountants of England and Wales
etc to become an Accounting Principle statutorily need to be
followed while preparing the Financial Statements. In nutshell
this has evolved out of standard practice followed by several
countries while preparing the Trading, Profit and Loss Account
and Balance Sheet.
 The Accounting Conventions/Practices are basically
assumptions and expected to be followed while preparing the
Financial Statements. 5
CHARACTERISTICS OF ACCOUNTING PRINCIPLES:

 Objectivity

 Application

 Reliability

 Feasibility

 Understandability

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Accounting Concepts
1. Business Entity Concept or Separate Entity
concept
2. Going Concern Concept
3. Money Measurement Concept
4. Cost Concept
5. Dual Aspect Concept
6. Accounting Period Concept
7. Matching Concept/ Periodic matching of Costs
and Revenues Concept
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8. Realization Concept
 Accounting Conventions
• Convention of Conservatism
• Convention of Disclosure
• Convention of Materiality
• Convention of Consistency

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Business Entity Concept : Business is treated as a
separate entity from its owner and others. All the
transactions of the business are recorded in the
books of business from the point of view of the
business as an entity and even the owner is treated
as a creditor to the extent of his/her capital.

Going Concern Concept : It is believed that the

business will exists for a long time and transactions
are recorded from this point of view.

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Money Measurement Concept : In accounting, we
record only those transactions which are expressed in
terms of money. In other words, a fact which can not
be expressed in monetary terms, is not recorded in
the books of accounts.
Cost Concept : an asset is ordinarily entered in the
books of accounts at the price paid to acquire it and
this cost is the basis for all subsequent transactions.
Suppose a company purchases a car for Rs.1,50,000/-
the real value of which is Rs.2,00,000/-, the purchase
will be recorded as Rs.1,50,000/- and not any more.
Dual Aspect Concept: Each transaction has two
aspects, that is, the receiving benefit by one party and
the giving benefit by the other. This principle is the 10

core of accountancy.
Periodic matching of Costs and Revenues Concept or
Matching concept- In order to ascertain the profit made by
the business during a period, it is necessary that ‘revenues’ of
the period should be matched with the costs (expenses) of the
period.

Realization Concept: The revenue is recognized when a sale

is made. Sale is considered to be made at the point when
goods are passed to the buyer and he becomes legally liable
to pay.

Accounting Period Concept: The life of the business is

divided into appropriate segments for studying the results of
the business. A twelve month period is normally adopted for
this purpose. This time interval is called accounting period.11
Convention of Consistency: In order to enable the
management to draw important conclusions regarding the
working of the company over a few years, it is essential that
accounting practices and methods remain unchanged from
one accounting period to another. The comparison of one
accounting period with that of another is possible only when
the convention of consistency is followed.

Convention of Conservation: Financial statements are

always drawn up on rather a conservative basis. That is,
showing a position better than what it is, not permitted. It is
also not proper to show a position worse than what it is. In
other words, secret reserves are not permitted. Concept of
conservatism is otherwise known as ‘Prudence’ 12
Convention of Disclosure: This principle implies that
accounts must be honestly prepared and all material
information must be disclosed therein.

Convention of Materiality: As per the accounting

convention of materiality, an item is material if it can
influence the decision of users of the financial
statements. The materiality convention enables the users to
ignore all such events or items that are not relevant or
material. For instance, most companies publish their
financial statements in round figures and do not include
paise.
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 Indian Accounting Standards (IAS)
Accounting Standards are the statements of code of
practices of regulatory accounting bodies that are to be
observed in preparation and presentation of financial
statements.

In India, Accounting Standards are the guidelines

prepared by the Institute of Chartered Accountants of
India (ICAI), through its Accounting Standards Board
(ASB), for the preparation of books of accounts and
financial statements.

Objective-
To bring uniformity in the books of accounts, facilitates 14

easy interpretation and comparison of financial results.

 Indian Accounting Standards (IAS)

Out of total 32 Accounting Standards, the most common and

prominent ones are as follows:

 Disclosure of Accounting Policies – AS 1

 Valuation of Inventory- AS 2

 Contingencies and Events Occurring after the Balance Sheet

date- AS 4

 Net Profit or Loss for the period, prior period Items and
Changes in Accounting Policies- AS 5
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 Revenue Recognition- AS 9
1.Conservatism convention is applied for the valuation of
(i) Current assets (ii) Fixed assets
(iii) Current assets and fixed assets (iv) none

2. Cost concept is applied for the valuation of

(i) Current assets (ii) Fixed assets
(iii) Current assets and fixed assets (iv) none

3. The convention of conservatism, when applied to balance sheet, results in

(i) understatement of liabilities (ii) overstatement of liabilities
(iii) understatement of assets (iv) overstatement of assets

4. A manager asks the accountant to record the bitter relationship between the production manager
and marketing manager, which has resulted in reduced profits. Accountant answers that this aspect
cannot be recorded in accounts due to the following:
(i) consistency convention (ii) money measurement concept
(iii) separate entity concept (iv) disclosure convention

5. Proprietor inquires whether air-conditioner purchased for his residence can be accounted for in
the accounts books of the business and he receives the reply from the accountant that such
recording is a violation of
(i) cost concept (ii) separate entity concept
(iii) materiality (iv) realization concept 16
 The following items guide the ASB when it creates accounting
standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption

Match each item above with a description below.

1. Ability to easily evaluate one company’s results Comparability
relative to another’s.
2. Belief that a company will continue to operate for the
foreseeable future. Going concern

3. The judgment concerning whether an item is large

enough to matter to decision-makers. Materiality

LO 7 Discuss financial reporting concepts.

 The following items guide the FASB when it creates accounting
standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption

Match each item above with a description below.

4. The reporting of all information that would make a Full disclosure
difference to financial statement users.
5. The practice of preparing financial statements at
regular intervals. Periodicity

6. The quality of information that indicates the

information makes a difference in a decision. Relevance

LO 7 Discuss financial reporting concepts.

 The following items guide the FASB when it creates accounting
standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption

Match each item above with a description below.

7. Belief that items should be reported on the balance Historical cost
sheet at the price that was paid to acquire the item.
8. A company’s use of the same accounting principles
and methods from year to year. Consistency

9. Tracing accounting events to particular companies.

Economic entity

LO 7 Discuss financial reporting concepts.

 The following items guide the FASB when it creates accounting
standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption

Match each item above with a description below.

10. The desire to minimize errors and bias in financial Faithful
statements. representation
11. Reporting only those things that can be measured in Monetary unit
dollars.

LO 7 Discuss financial reporting concepts.

Fill in the Blanks
1. Based on assumptions and conditions ………………
2. Expressed in terms of money ………….
3. Based on customs and traditions……………………
4. Playing safe …………………….
5. Dual aspect concept ……………………
6. Equities = Assets ………………………………….
7. Reduction of capital …………………..
8. Fixed assets ………………………………..
9. Small and ignorable amount ……………………………

Money measurement concept, Accounting concept, Double entry

principle, Accounting convention, Accounting equation, Materiality, Cost
concept, Conservatism, Loss incurred by the firm
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Answers

1. Accounting concept
2. Money measurement concept
3. Accounting convention
4. Conservatism
5. Double entry principle
6. Accounting equation
7. Loss incurred by the firm
8. Cost Concept
9. Materiality

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Refernces:

1. Maheshwari, S.N., Maheshwari, S.K., Financial Accounting, 10th ed, Vikas

Publishing House.

2. Tulsian, P.C. , Financial Accounting, S. Chand &Co Ltd , India.

3. Gopal,C,R., Accounting for Managers,1st ed, New Age International Publishers

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