GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
1.1
Introduction
1.2
Definition of Accounting
Principles
1.3
Features of Accounting
1.4
Classification of Accounting
Principles
1.5
Accounting Concepts
1.6
Accounting Conventions
1.7
Accounting Standards
1.8
Self Assessment Questions
1.1
INTRODUCTION
Accounting is the language of business. Affairs of a
business unit are made understood to others as well as to those who own or
manage it through accounting information which
has to be suitably recorded, classified, summarized and presented.
In order to make this language to convey the same
meaning to all people, it is necessary that it should be based on certain
uniform scientifically laid down standards. These standards are termed as accounting principles.
Accounting principles may be defined as those rules of action or conduct which
are adopted by the accountants universally while recording accounting
transactions. Since these accounting principles are accepted and
followed by accountants all over the world in the same manner, it is termed as
Generally Accepted Accounting Principles (GAAP)
1.2 DEFINITION OF
ACCOUNTING PRINCIPLES
Accounting
principles refer, to certain rules, procedures and conventions which represent
a consensus view by those indulging in good accounting practices and
procedures. It brings uniformity in the preparation of financial statements. To
be more reliable, accounting statements are prepared in conformity with these
principles.
“Accounting
principles are the rules, regulations & principles which are to be followed
while preparing financial statements”.
The
American Institute of Certified Public Accountants (AICPA) defines accounting
principles as “a general law or rule adopted or professed as a guide to action,
a settled ground or basis of conduct or practice.”
In short, accounting principles are usually
the concepts and conventions which have been adopted as a general guide by the
accountants all over the world.
1.3 FEATURES OF
ACCOUNTING PRINCIPLES
The following are the main features of accounting
principles:
a) Usefulness: A principle will be
relevant only if it satisfies the needs of those who use it. The accounting principles should be able to provide useful
information to its users otherwise it will not serve the purpose.
b) Objectivity: A principle will be said
to be objective if it is based on facts and figures. There should not be a
scope for personal bias. If the principle can be influenced by the personal
bias of users, it will not be objective and its usefulness will be limited.
c) Feasibility: The accounting principle should be practicable. The principles
should be easy to use otherwise their utility will be limited.
1.4 CLASSIFICATION OF
ACCOUNTING PRINCIPLES
Accounting principles can be classified into two kinds:
1.
Accounting
Concepts:
The term concepts includes those basic assumptions or conditions upon which accounting is based.
The term concepts includes those basic assumptions or conditions upon which accounting is based.
2.
Accounting
Conventions:
The term "conventions" includes those customs or traditions which guide the accountants while preparing the accounting statements.
The term "conventions" includes those customs or traditions which guide the accountants while preparing the accounting statements.
1.5 ACCOUNTING CONCEPTS
The following are the important accounting concepts:
5.
Cost
Concept
The explanation of these concepts is as follows:
1)
Business Entity Concept: In accounting, business is treated as separate
entity from its owners. The 'Business' and 'owner' are taken as two separate
entities. A distinction is made between business transactions and personal
transactions. The accountant is interested to record transactions relating to
business only. The private transactions
of the owner will be recorded separately and will have no bearing on the
business transactions. All the transactions of the business are recorded in the
books of the business from the point of view of the business as an entity and
even the proprietor is treated as a creditor to the extent of his capital. .
Without such a distinction, the affairs of the business will be mixed up with
the private affairs of the proprietor and the true
picture of the firm will not be available.
2)
Going Concern Concept: According to going
concern concept it is assumed
that the business will exist for a long time in future. Transactions are
recorded in the books keeping in view the going concern aspect of the business
unit. While recording business transactions in the book of accounts, we assume
that the business will be carried on indefinitely. This is why, the business
purchase fixed assets like Land and Building, Plant and Machinery, Vehicles and
Furniture etc. If the assumption of going concern is not there, we would hire
these assets and not purchased. These assets have been acquired for use and not
for sale, so we maintain individual assets account and charge necessary
depreciation on it.
3) Money Measurement Concept: In accounting, we identify and
recorded only those business transactions which can be measured in term of
money. Accounting transaction must have their monetary value. Transactions or events
which cannot be expressed in money do not find place in the books of
accounts though they may be very useful for the business. For example, if a
business has got a team of dedicated and trusted employees, it is definitely an
asset to the business, but since their monetary measurement is not possible,
they are not shown in the books of business.
4) Accounting period concept: Under this concept, the life of the business is
segmented into different periods and accordingly the result of each period is
ascertained. Though the business is assumed to be continuing in future (as per
going concern concept), the measurement of income and studying the financial
position of the business for a shorter and definite period will help in taking
corrective steps at the appropriate time. Each segmented period is called
“accounting period” and the same is normally a year. The businessman has to
analyze and evaluate the results ascertained periodically. Accounting period is of two types- financial year (1st Apr to 31st March) & calendar year (1st Jan to 31st Dec). For taxation purposes financial year is adopted as prescribed by
the Govt.
5) Cost Concept: According to this concept, all transactions relating to a
business such as purchase of goods and services, acquisition of assets,
expenses etc. are recorded at the price at which it was acquired i.e., at its
cost price. This cost serves the basis for the accounting of this asset during
the subsequent period. In case of fixed
assets, only written down value (i.e. cost – depreciation) is shown in the
balance sheet in the subsequent years. For example, value of the land increases
to Rs. 10, 00,000, it will continue to be shown as Rs. 5, 00,000 in the books
of accounts, but not as Rs. 10,00,000.
6)
Dual
Aspect Concept:
This
is the basic concept of accounting. Modern accounting system is based on dual aspect concept. Dual
concept may be stated as "for every debit, there is a credit". Every
transaction should have two sided effect to the extent of same amount. For
example, if A starts a business with a capital of Rs.1, 00,000. There are two
aspects of the transaction. On the one hand the business has assets of Rs.1,
00,000 while on the other hand the business has to pay to the proprietor a sum
of Rs.1, 00,000 which is taken as proprietor's capital.
The
accounting equation viz., Assets = Capital + Liabilities or Capital = Assets –
Liabilities, will further clarify this concept, i.e., at any point of time the
total assets of the business unit are equal to its total liabilities.
Liabilities here relate both to the outsiders and the owners. Liabilities to
the owners are considered as capital.
7)
Matching
Concept: The essence of the matching concept lies in the view
that all costs which are associated to a particular period should be compared
with the revenues associated to the same period to obtain the net income of the
business.
Under this
concept, the accounting period concept is relevant and it is this concept
(Matching
concept) which necessitated the provisions of different adjustments for
recording
outstanding expenses, prepaid expenses, outstanding incomes, incomes
received
in advance, etc., during the course of preparing the financial statements at
the end of the accounting period.
8) Realisation
Concept: This concept assumes or
recognizes revenue when a sale is made. Sale is considered to be complete when
the ownership and property are transferred from the seller to the buyer and the
consideration is paid in full. However, there are two exceptions to this
concept, viz., 1. Hire purchase system where the ownership is transferred to
the buyer when the last installment is paid and 2. Contract accounts, in which
the contractor is liable to pay only when the whole contract is completed, the
profit is calculated on the basis of work certified each year.
1.6 ACCOUNTING CONVENTIONS
The
following conventions are to be followed to have a clear and meaningful
information
and data in accounting:
1.
Convention of Consistency
2.
Convention of Full Disclosure
3.
Convention of Consistency
4.
Convention of Materiality
i)
Convention of Consistency: The convention of consistency refers to the state of
accounting rules, concepts, principles, practices and conventions being
observed and applied constantly, i.e., from one year to another there should
not be any change. If consistency is there, the results and performance of one
period can he compared easily and meaningfully with the other.
ii)
Convention of Full Disclosure: The convention of disclosure stresses
the importance of providing accurate, full and reliable information and data in
the financial statements which is of material interest to the users and readers
of such statements. This convention is given due legal emphasis by the
Companies Act, 1956 by prescribing formats for the preparation of financial
statements.
iii)
Convention of Conservatism: This convention follows the policy of
playing safe. It takes into account all possible losses but not the possible
profits or gains. It compels a businessman to wear a ‘risk-proof’ jacket, as
the working rule is: “anticipate no-profit, but provide for all possible
losses”. Thus, the convention of conservatism should be applied very
cautiously.
iv) Convention
of Materiality:
According to this
convention only those events or items should be recorded which have a
significant bearing and insignificant things should be ignored. This is because
otherwise accounting will be unnecessarily over burden with minute details.
1.7 ACCOUNTING STANDARD
Accounting standards are the rules that ensure
uniformity of preparation, presentation & reporting of accounting
information, and thus deal mainly with financial measurements and disclosures.
Acc. To Kohler, “Accounting standard is a mode of conduct, imposed by custom,
law or professional body for the benefit of public accountants and accountants
generally.”
These accounting standards aim to improve
credibility and reliability of financial statements through a reform in theory
and practice within the legal framework to cater to the needs of the changing
socio-economic requirements of the corporate world. The accounting standards
facilitate uniformity of processing, presentation, and reporting of accounting
information to make it more meaningful and comparable.
1.8 SELF ASSESSMENT QUESTIONS
Q1) What are accounting principles? Discuss in detail the
accounting concepts and conventions.
Q2) Write a short note on Accounting Standards.
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