Suppose you are a sole proprietor and you take copies of your books of account to 3 different accountants. You ask them to prepare the financial statement on the basis of the records and ascertain the profit of the business for the year. After a few days when they will present their reports, you will be surprised that all of three reports differ with each other with respect to the calculation of profit as well as the presentation of accounts. This thing might impact your faith in the accounting profession. To avoid such a situation, a few generally accepted set of rules have been developed.
To avoid confusion among the users of financial statements and to achieve uniformity, the accounting process is applied in a conceptual framework of “Generally Accepted Accounting Policies” (GAAPs). The term GAAPs describes the set of rules developed for the preparation and presentation of financial statements and is called as concepts, conventions and policies etc. These GAAPs are the backbone of the accounting information system.
Accounting concepts are defined as the assumptions based on which financial statements of a business entity are made. Financial transactions are interpreted in the torch of concepts, which govern accounting methods. Concepts are those basic assumptions and conditions, which form the fundamentals upon which the accountancy has been laid. Further, these accounting concepts lay the foundation of accounting principles. As financial reporting involves significant professional judgments by accountants, these concepts and principles make it sure that the users of financial information are not misdirected by the adoption of accounting policies and practices that go against the true spirit of the accountancy profession. Accountants must therefore consciously consider whether the accounting treatments adopted by them in the preparation of financial statements are consistent with the accounting concepts and principles.
“Accounting principles are a body of doctrine commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for the selection of conventions or procedures where an alternative exists.”
Accounting principles are basic norms and assumptions on which the whole accounting system is established and developed.
Accounting policies must satisfy the following conditions:
- They should be based on realistic assumptions.
- They must be simple, easy to understand.
- They must be followed consistently.
- They should be able to reflect future predictions.
- They should be informative for the users.
Accounting conventions emerge out of accounting practices, usually known as accounting principles, adopted by various organizations over a period of time. These conventions are derived from convention and practice. The accountancy bodies of the world may change any of the conventions to improve the quality of the accounting information. Accounting conventions need not have universal application. But they need to be based on the prudence.