Accounting Concepts, Convention and Principles
Now we shall discuss these accounting principles, conventions and concepts in an elaborated manner as follows:
1. Business Entity Concept – according to this concept business enterprise is treated as a separate entity apart from its owner. This is the reason that owner A/c is shown as a liability for the business entity. Business transactions are recorded in the books of account owner’s transactions in his personal books of account. This concept helps in keeping the business affairs of free from personal affairs of the owner.
Ex– Mr. John stated business by investing $ 500000 with which he purchased machinery for $ 300000 and retained balance as cash in hand. It will be presented in the financial statements as follows
Cash in hand
This means that enterprise owes to Mr. John $500000.
2. Money Measurement Concept –As per this concept, only those transactions are recorded in books of account which can be measured in terms of money. Since money is a common standard of payment and capable of being recorded only monetary items takes place in books of account. Transactions, even if they affect the result of the business enterprise but not capable of measured in terms of money are not recorded in business books.
For example, the employees of an organisation are the most valuable asset to a business enterprise but as they cannot be measured in terms of the money they are not recorded in terms of money. Generally, the transactions are recorded in terms of ruling currency of the country in which business enterprise is situated.
Another aspect of this concept is that the records of the transactions are to be kept not in the physical units but in the monetary unit. For example, at the end of the year 2011, an organization may have a factory on a piece of land measuring 15 acres, office building containing 50 rooms, 50 personal computers, 30 office chairs and tables, 120 kg of raw materials etc. These are expressed in different units. But for accounting purposes, they are to be recorded in money terms. In this case, the cost of factory land maybe say $1 million, office building of $10 millions, computers $10 million, office chairs and tables $2 millions, raw material $3 millions etc.
3. Matching concept- in this concept, all expenses are matched with the revenue of that period should only be taken into consideration. Any past or future years expenses and revenues are excluded using certain adjustments. This concept is based on the accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of the cash. It leads to adjustment of certain items like prepaid and outstanding items unearned or accrued incomes.
It is not necessary that every expense identifies every income. Some expenses are related to revenue and some are time bound. For e.g. Selling expenses are related to sales but rent, salaries etc. are recorded on the accrual basis for the particular accounting period.
Let take an example – suppose Mr John started the retail business of cloth. He purchased 5000 pcs. Of the cloth @ $100 per piece and sold 4000 pcs @ $150 per piece during the accounting period 1st January 2010 to 31st December 2010 and pays rent for the premises at the end of the each month i.e. for 11 months @ $ 2000 each and paid to suppliers $400000 and received $ 500000 from customer. Now we shall see how this concept work-
As per the concept of accrual the revenue for the period shall be recognised as $6, 00,000 (4000 pcs X $150 each) which accrued and not the cash received i.e. $ 400000 and rent for the premises shall be recorded for whole 12 months i.e. $24000 and not $22000 i.e. 11 months X $2000 each.
4. Going concern Concept– The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation. Simply stated, it means that every business entity is assumed to have infinite life and, it will not be dissolved in the near future. This is an important accounting assumption, as it provides a basis for showing the value of assets on the balance sheet.
For example, a company purchases a plant and machinery of $100000 and its life span is 10 years According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for more than one year, it will not be proper to charge the entire amount from the revenues of the year in which the item is acquired. Only a proportionate value is shown as the expense in the year of purchase and the remaining balance is shown as an asset on the balance sheet.