Concepts and Conventions of Accounting
Learning Objectives
=> Define various concepts of accounting
=> Describe accounting conventions
=> Explain basis of accounting
=> List the major accounting terminologies
Accounting is a systematic process that provides necessary financial information about an entity to outsiders and stakeholders. This financial information is also helpful for company's managers and supervisors who accordingly proceed with key decision. Most of the financial entities adhere with set accounting standards and concepts that are normally used in various countries, including India.
Accounting revolves around monetary transactions. Anything not connected with finance or money has nothing to with accounting.
Business Entity Concept
A business organisation is treated separate from its owners. All the matters related to the organizations and all the matters related to owners are separate and cannot be judged as none. Therefore, besides preparing and submitting the final accounts of an organization to the concerned authorities, their owners must prepare their personal accounts and the same is submitted to the tax and compliance authorities.
Money Measurement Concept
As per this concept, only those transactions are recorded which can be measured in terms of money. Transactions which cannot be measured in terms of money should not be recorded in books of accounts. Money is a medium of exchange of goods and services. In other words, money can be defined as the intermediate used while exchanging foods and services. Money is also treated as a store of value because it can be later used for carrying out the transaction.
Going Concern Concept
this concept is based on the assumption that a business entity will continue with its operations for a prolonged period. In other words, suppliers and other companies enter into business relations with a business unit only if the latter is supposed to continue with operations. Therefore, those companies that are assumed to continue are known as a going concern. Without going concern concept, most of the companies would not be able to prepay and accrue expenses. Assets of a company are also recorded on the basis of their historical costs due to his concept.
Dual Aspect Concept
It is a fundamental convention of accounting according to which all aspects of an accounting transaction must be recognized. The dual aspect concept is the fundamental basis for the double entry accounting system. As per this system, every business transaction needs to be recorded in to recorded in two different accounts namely. debit and credit. This concept has been derived form the accounting equation which Assets that the sum total of liabilities and equities should be equal to assets of an organization.
periodicity Concept
In accounting, periodicity means that ongoing activities of the company can be divided up and the reporting can be done in annual, quarterly and monthly financial statements. In simple terms, periodicity concept refers to the act of recording any ongoing business activity within a prescribed period of time on financial statements.
Historical Cost Concept
Accounting relates to past events and accounting records are constantly maintained for consistency and better comparability. Thus, it is necessary to record transactions at their historical costs. At the time of acquiring, the original price of the asset should be recorded in the balance sheet. This concept is important because the market value of an asset can fluctuate and affect the overall accounting information, marketing it unreliable.
Matching Concept
It is the accounting practice wherein financial entities recognize revenue and related expenses within the same accounting period. Avoiding over or under statements of earnings for a period is the chief purpose of the matching concept. This concept necessitates the provision for recording various items like outstanding incomes, prepaid expenses, outstanding expenses at the termination of the accounting period.
Realization Concept
The Realisation Concept is a concept which emphasizes the amount of revenue which should be recognized in the books of accounts. According to this concept, the revenue is recognized in the books of accounts when the sales are made.
Sales are only treated in the books of accounts when the ownership of goods is transferred, and this basically implies that revenue is realized when the goods are delivered, or services are rendered.
Accrual Concept
As per the accrual concept of accounting, the recording of expenses and revenues is done after their occurrence, irrespective of the fact whether cash is involved or not. One benefit associated with accrual approach is that expenses associated with reported revenue are clearly stated in the financial statements. The important aspect of accrual concept analyses it that item net income that arises form all such transactions makes a change in the owner's equity.
Objective Evidence Concept
This concept ensures that all accounting must be based on objective evidence, every transaction recorded in the books of account must have a verifiable document in order to validate its existence. Only then, the transactions can be verified by the auditors and declared as true or otherwise. Verifiable evidence for the transactions should be free form the personal bias, i.e. it should be objective in nature and not subjective. However, the subjectivity cannot be avoided in the aspects like provision for bad and doubtful debts, the provision fro depreciation, valuation of inventory, etc, and accountants are required to disclose the regulations followed.
Accounting Standards
The general rules and concepts that govern the field of accounting are referred to as Accounting Principles. The features of Accounting Principles can be summed up in the following manner:
GAAP
The General Accepted Accounting Principles (GAAP) lays down the framework and guidelines for the financial accounting: these are normally referred to as the Accounting Standards. These accounting standards laid down the specific procedures and rules that accountants should follow while recording, summarizing and preparing the financial statements of an organization. GAAP is generally implemented in those countries which adopt the accrual bias of maintain the accounts and those who adopt cash basis generally do not use the GAAP system of Accounting.
Accounting standards are accepted in many Countries as the Generally Acccepted Accounting Principles of the accountings standards. The Accounting Standards allow the investors to make a comparison of the financial condition on a year-to-year basis and provide an assurance to investors that the company has exercised adequate controls over its operation.
Process of setting Accounting Standards:
the Accounting standards are being set by following the set standards which can be summed up in the following manner
a. Setting of an Agenda: The first and the foremost thing as per IASB is to develop high standard financial quality standards to complete the demand for dependable information which is of great value for the users of financial reports. The IASB considers the following points while proposing its agenda.
=> The relevance to the users
=> The existing guidance available
=> The possibility of the Convergence
Planning the Project: The next step is the planning for the project. The Accounting Standards Boards decides Whether to develop the project alone or with the other standard- Setter. The International Accounting Standards Board (IASB) assesses the issuance of the standards against the following criteria:
=> Classifying
=> Correcting
=> Completed on the timely basis
b. Developing and publishing the Discussing Paper: The there step is the Accounting Standard Board publishing its discussion paper for the General comments of the public; it contains the comprehensive view about the topic, and approaches to resolve issues. if any.
c. Developing and publishing the exposure draft: One of the main medium of IASB form consulting with public is exposure draft. Unlike a discussion draft, an exposure draft sets out a specific proposal in form of proposed IFRS. The development of exposure draft starts at IASB where the issues are considered usually based on staff research and recommendations. The comments received from the discussion paper and suggestions given by IFRS Advisory council are also considered. Once all the issues are resolved at the meeting. IASB then instructs the staff to draw the exposure draft
The Accounting Standards in India are notified by the Ministry of the Corporate Affairs. These accounting standards in India are formulated by the Accounting Standard Board of thee Institute of Chartered Accountants of India. In India, two kinds are formulated by the Accounting Standard Board of the Institute of Chartered Accountants of India. In India, two kinds of the Accounting Standards are applicable:
1. The existing Accounting Standard under the under Companies (Accounting Standard) Rules, 2006.
2. IFRS Converged Indian Accounting Standards.
The objective of laying down the Accounting Standard is to remove the variations in treating the various accounting aspects and to bring uniformity in the presentation of the financial statements. The Accounting Standards tends to harmonies diverse accounting policies and help in the preparation of financial accounts.
The major accounting standards can be summarized in the following manner:
a. Accounting Polices Disclosures: The Accounting Standard A1 is related to the revelation of important accounting policies that are followed during preparation and presentation of financial statements.
b. Inventory Valuation: This is an Accounting Standard-2. This Accounting standard deals with the method of computation of the closing stock, and it is imperative to note that the closing stock is not shown in the balance sheet unless and until it if sold.
c. Cash Flow Statement: The Accounting Standard-3 deals with the Cash Flow Statement.
d. Contingencies and Events happening after the date of Balance sheet: The Accounting Standard-4 deals with the contingencies and events happening after the date of Balance sheet.
e. Net profit and loss: Accounting Standard 5 discusses net profit and loss for the period.
Besides the above accounting standards there are various other accounting standards such as:
=> Accounting Standard-6 which deals with the Depreciation.
=> Accounting Standard-7 for the construction contract.
=> Accounting Standard-8 for research and development.
=> Accounting Standard-9 for the revenue recognition.
=> Accounting Standard-10 for the Fixed Assets.
=> Accounting Standard--11 for taking into consideration the exchange rate fluctuations.
=> Accounting Standard-12 for the Governmental Grants.
=> Accounting Standard-13 for Investments.
=> Accounting Standard-14 for the Amalgamations.
=> Accounting Standard-15, for Employee benefits.
International Financial Reporting Standards (IFFRS):
International Financial Reporting Standards can be defined as common global language used for the business affairs to make the company accounts understandable and comparable across the international borders. Since now the business of different companies is not restricted to one country, IFRS providers the guidelines which allow companies to prepare the financial statements in such a manner that it to widely accepted.
IFRS are the set of accounting Standard Board has been formulated. The primary objective of IFRS is to harmonies the accounts of those countries which operate in multiple countries and to make their accounts comparable.
The four primary objectives of IFRS are as follows:
a. Development of an accounting standard which is transparent and information present in them should be helpful for the investors and other participants to make necessary accounting decisions.
b. promoting the use of set standards.
c. Considering any special need of small sized entities.
d. Allowing convergence fo national and internal accounting standards along with IFRS for obtaining a high quality solution.
IFRS is used in many countries; some of the countries using IFRS are as following: India, Hong Kong, Australia, Malaysia, Pakistan, etc.
The main use of the IFRS is to make financial statements readable and comparable by the stakeholders of the different countries.
Accounting Conventions
The common practice which is used as a guideline at the time of recording business transactions is known as accounting convention. It is applicable when a definitive guideline is missing in the accounting standards that could be used in that specific situation. In simple terms. accounting conventions cover such gaps that are unfilled as per accounting standards.
Accounting conventions are necessary in the profession of accounting because most of the transactions are recorded as per them.
Following are the parts of the accounting conventions:
=> Consistency
=> Disclosure
=> Conservatism
Basis of Accounting
The methodology under which expenses and revenues are recognized in the financial statement of the business is referred as the basis of accounting.
The three basis of accounting in common usage are as follows:
Accounting on cash basis
Accrual Basis of Accounting or Mercantile System
Mixed or hybrid basis of accounting
Main Accounting Terminologies
It is necessary to understand some basic accounting terms which are used daily in the business world. These terms are called accounting terminologies. Some of the common accounting terminologies are as follows:
=> Account
=> Assets
=> Capital
=>Creditor
=>Debtors
=>Drawings
=>Discount
=>Expense
=>Expenditure
=>Goods
=>Liability
=>Proprietor
=>Purchases
=>Insolvent
=>Invoice
=>Loss
=>Revenue
=>Sales
=>Solvent
=>Stock
=>Transaction
=>Voucher
Accounting Equations:-
it is already stated that each business transaction involves two namely, debit and credit. it is necessary to keep the record of both the aspects. the property owned by a business is known as assets and the right to properties are referred as equities of the business. Equities can be further categorized into equity of creditors as equity of owners. these equities are also known as internal equity and external equity. The owners equity in the asset is represented by internal equity and the outsider's interest in an asset is represented in the form of external equity.
Capital=Assets-Liabilities
Or
Liabilities=Assets-Capital
These equations are the cornerstone of the double entry book-keeping system. As every transaction and event has two aspects, these equations are deemed important.
following are the rules of accounting equation:
=> Assets
=> Liabilities
=> Capital
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