Accounting conventions and accounting concepts

(1) relevance

The relevant convention emphasizes that accounting should only provide information that is relevant and useful for achieving its objectives. For example, companies are interested in knowing what the total labor costs were. It is not interested in knowing how much employees are spending and what they are saving.

(2) objectivity

The convention of objectivity emphasizes that accounting information should be measured and expressed according to generally accepted standards. For example, at the end of the year unsold inventory should be valued at its cost price and not at a higher price even if it is likely to be sold at a higher price in the future. The reason for this is that no one can be sure which price will prevail in the future.

(3) feasibility

The feasibility convention emphasizes that the time, effort, and cost of analyzing accounting information should be weighed against the benefit that it provides. For example, the cost of “oiling and greasing” the machines is so small that breaking it down per unit produced is meaningless and tantamount to wasting the labor and time of the accounting staff.

accounting concepts

(1) materiality

It refers to the relative importance of an item or event. Those making accounting decisions are constantly faced with the need to make judgments of materiality. Is this element large enough that users of the information can be affected by it? The essence of the concept of materiality is that an omission or misstatement of a matter is material if, in light of the surrounding circumstances, the scope of the matter is such that it is probable that a reasonable person, relying on the report, would judge it have been altered or influenced by the inclusion or correction of the article.

(2) billing period

Although the accounting practice believes in the concept of going concern, meaning the life of the business is indefinite, it is still required to report the “results of activities performed over a period of time (usually a year). Therefore, accounting tries to present the profits or losses made or suffered by the company during the reporting period. Usually it is the calendar year (January 1 to December 31), but in other cases it may be the fiscal year (April 1 to March 31) or some other period depending on the expediency of the business or according to business practices in the country concerned .

Because of this concept, it is necessary during the accounting period to take into account all income and expenses that accrue on the day of the accounting year. The problem this concept faces is that an appropriate attribution should be made between capital and revenue expenditures. Otherwise, the results reported in the annual financial statements will be affected.

(3) realization

This concept emphasizes that profits should only be taken into account when they are realised. The question is at what stage should the profit be considered accrued. Whether at the time the order is received, or at the time the order is executed, or at the time the money is received. To answer this question, the bookkeeping complies with the law (purchase law) and recognizes the legal principle that sales are only achieved when the goods are handed over. This means that the profit is deemed to have accrued when “title of the goods passes to the buyer”, ie when the sale is affected.

(4) Appropriate

Although the business is a continuous affair, its continuity is artificially divided into several accounting years to determine its periodic results. This profit is the measure of a company’s economic performance and as such increases equity. Since profit is an excess of income over expenses, it is necessary to sum up all income and expenses for the period under consideration. The realization and delimitation concepts are essentially derived from the need to reconcile expenditure with income generated during the accounting period. The income and expenses recognized in an income statement must both relate to the same goods transferred or services provided during the accounting period. The matching concept requires that the expenses are assigned to the income of the corresponding accounting period. So we need to identify the income generated during a given accounting period and the expenses incurred to generate that income.

(5) Unit

According to this concept, the task of measuring income and wealth is performed by accounting for an identifiable unit or entity: the unit or entity so identified is treated differently and distinct from its owners or contributors. Legally, a distinction is only made between owners and companies in the case of corporations, but also in the case of sole proprietorships and partnerships. For example, goods used from the company’s inventory for business purposes are treated as business expenses, but similar goods used by the owner, ie owner, for his personal use are treated as his drawings. This distinction between the owner and the business unit has helped make accounting for profitability more objective and fair. It has also led to the development of “Responsibility Accounting” which allows us to find out the profitability of even the different sub-units of the main business.

(6) Stable currency unit

Accounting assumes that the purchasing power of a monetary unit, say rupee, remains the same throughout. For example, the intrinsic value of a rupee in 1,800 and 2,000 is the same and the same, ignoring the effect of rising or falling purchasing power of a monetary unit due to deflation or inflation. Despite the fact that the assumption is unreal and the practice of ignoring the change in the value of money is now widely questioned, the proposed alternatives for accounting for the change in the value of money on balance sheets remain, namely the current Purchasing Power Method (CPP) and Electricity Cost Accounting Method (CCA) are in the evolution phase. We must therefore be content with the concept of the “stable monetary unit” for the time being.

(7) Costs

This concept is closely related to the going concern concept. According to this, an asset is regularly entered in the books with the purchase price, ie with its purchase price. This “cost” is used as the basis for accounting for that asset in the subsequent period. This “cost” should not be confused with “value”.

It must be remembered that the actual value of assets will change from time to time, this does not mean that the value of such assets will be incorrectly recorded in the books. The recorded book value of the assets does not reflect their real value. They do not imply that the values ​​stated therein are the values ​​at which they may be sold. Although assets are recorded on the books at cost, they lose value over time due to depreciation. In certain cases, only the assets such as “goodwill” appear in the books at cost when paid, and when nothing is paid they do not appear, even though that asset is based on the name and fame created by a company.

Therefore, the values ​​attached to assets on the balance sheet and the net earnings recorded on the income statement cannot be said to reflect a correct assessment of a company’s financial condition as they bear no relation to the market value of the assets or their replacement values. This idea that transactions should be recorded at cost rather than at a subjective or arbitrary value is known as the concept of cost. Over time, the market value of tangible assets such as land and buildings fluctuates widely from their acquisition cost.

These changes or fluctuations in value are generally ignored by accountants and continue to be valued at cost on the balance sheet. The principle of valuing fixed assets at cost rather than market value is the underlying principle of the cost concept. Accordingly, the current values ​​alone will adequately represent the costs for the company.

The cost principle is based on the principle of objectivity. Proponents of this method argue that as long as financial statement users have confidence in the claims, there is no need to change this method.

(8th) conservatism

This concept emphasizes that profit should never be overstated or expected. Traditionally, accounting follows the rule “do not expect a profit and consider all possible losses. For example, closing inventory is valued at cost price or market price, whichever is lower. The implication of the above is that if the market price has decreased then consider the “expected loss” but if the market price has increased then ignore the “expected gains”.

Critics point out that conservation to an excessive degree leads to the creation of a secret reserve. This will go quite against the disclosure doctrine. Reasonable conservatism, however, must not be criticized.

accounting equation

The dual concept can be stated as “for every debit there is a credit”. Every transaction should have equal bilateral effect. This concept has led to an accounting equation that states that a company’s assets must equal (in monetary terms) the sum of its equity and liabilities at all times. This can be expressed in the form of an equation:

AL = P

Where

A represents company assets;

L stands for liabilities (receivables from third parties) of the company; and

P stands for the claim of the owner (capital) to the company.

(The form of representation of the equation AL = P corresponds to the legal interpretation of the financial position. This emphasizes that the property claim in the actual sense is the balance after deduction of the foreigner’s claims against the company from the total assets of the company).