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Accounting Concepts and Conventions

Accounting involves recording, classifying, and summarizing financial transactions according to standardized principles and procedures. It provides important information to managers, investors, analysts, and regulators through financial statements. Generally Accepted Accounting Principles (GAAP) establish uniform standards so that financial performance can be compared across organizations. Key concepts include the business entity concept, money measurement, dual aspect, and matching revenues with expenses to determine profit or loss for a given period. Accounting conventions emphasize conservatism, consistency, materiality, and full disclosure.

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156 views

Accounting Concepts and Conventions

Accounting involves recording, classifying, and summarizing financial transactions according to standardized principles and procedures. It provides important information to managers, investors, analysts, and regulators through financial statements. Generally Accepted Accounting Principles (GAAP) establish uniform standards so that financial performance can be compared across organizations. Key concepts include the business entity concept, money measurement, dual aspect, and matching revenues with expenses to determine profit or loss for a given period. Accounting conventions emphasize conservatism, consistency, materiality, and full disclosure.

Uploaded by

P patel
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Definition and introduction to Accounting

The worldview of accounting and accountants may certainly involve some unhelpful
characters poring over formidable figures stacked up in indecipherable columns.

However, a short and sweet description of accounting does exist:

Accounting is the language of business efficiently communicated by well-organised and


honest professionals called accountants.

A more academic definition of accounting is given by the American Accounting Association:

The process of identifying, measuring and communicating economic information to permit


informed judgments and decisions by users of the information.

The American Institute of Certified Public Accountants defines accounting as:

The art of recording, classifying, summarises in a significant manner and in terms of money,
transactions and events which are, in part at least of financial character, and interpreting the
results thereof.

Accounting not only records financial transactions and conveys the financial position of a
business enterprise; it also analyses and reports the information in documents called
“financial statements.”

Recording every financial transaction is important to a business organisation and its creditors
and investors. Accounting uses a formalised and regulated system that follows standardised
principles and procedures.

The job of accounting is done by professionals who have educational degrees acquired after
years of study. While a small business may have an accountant or a bookkeeper to record
money transactions, a large corporation has an accounts department, which supplies
information to:

 Managers who guide the company.

 Investors who want to know how the business is doing.

 Analysts and brokerage firms dealing with the company’s stock.

 The government, which decides how much tax should be collected from the company.

 
Accounting Principles

Obviously, if each business organisation conveys its information in its own way, we will have
a babel of unusable financial data.

Personal systems of accounting may have worked in the days when most companies were
owned by sole proprietors or partners, but they do not anymore, in this era of joint stock
companies.

These companies have thousands of stakeholders who have invested millions, and they need a
uniform, standardised system of accounting by which companies can be compared on the
basis of their performance and value.

Therefore, accounting principles based on certain concepts, convention, and tradition have
been evolved by accounting authorities and regulators and are followed internationally.

These principles, which serve as the rules for accounting for financial transactions and
preparing financial statements, are known as the “Generally Accepted Accounting
Principles,” or GAAP.

The application of the principles by accountants ensures that financial statements are both
informative and reliable.

It ensures that common practices and conventions are followed, and that the common rules
and procedures are complied with. This observance of accounting principles has helped
developed a widely understood grammar and vocabulary for recording financial statements.

However, it should be said that just as there may be variations in the usage of a language by
two people living in two continents, there may be minor differences in the application of
accounting rules and procedures depending on the accountant.

For example, two accountants may choose two equally correct methods for recording a
particular transaction based on their own professional judgement and knowledge.

Accounting principles are accepted as such if they are (1) objective; (2) usable in practical
situations; (3) reliable; (4) feasible (they can be applied without incurring high costs); and (5)
comprehensible to those with a basic knowledge of finance.

Accounting principles involve both accounting concepts and accounting conventions. Here
are brief explanations.

Accounting Concepts vs Conventions


Concepts are the basic ideas, the theories on how and why certain categories of transactions
should be treated in a particular manner.

Once the theories have been established and tested and proved to be acceptable, the task of
the Conventions is to set out the limit of their applications.

Accounting Concepts
1. Business entity concept: A business and its owner should be treated separately as far
as their financial transactions are concerned.

2. Money measurement concept: Only business transactions that can be expressed in


terms of money are recorded in accounting, though records of other types of
transactions may be kept separately.

3. Dual aspect concept: For every credit, a corresponding debit is made. The recording
of a transaction is complete only with this dual aspect.

4. Going concern concept: In accounting, a business is expected to continue for a fairly


long time and carry out its commitments and obligations. This assumes that the
business will not be forced to stop functioning and liquidate its assets at “fire-sale”
prices.

5. Cost (Historical Cost) concept: The fixed assets of a business are recorded on the
basis of their original cost in the first year of accounting. Subsequently, these assets
are recorded minus depreciation. No rise or fall in market price is taken into account.
The concept applies only to fixed assets.

6. Accounting year concept: Each business chooses a specific time period to complete


a cycle of the accounting process—for example, monthly, quarterly, or annually—as
per a fiscal or a calendar year.

7. Matching concept: This principle dictates that for every entry of revenue recorded in
a given accounting period, an equal expense entry has to be recorded for correctly
calculating profit or loss in a given period.

8. Realisation (Accrual) concept: According to this concept, profit is recognised only


when it is earned. An advance or fee paid is not considered a profit until the goods or
services have been delivered to the buyer.

Accounting Conventions
There are four main conventions in practice in accounting: conservatism; consistency; full
disclosure; and materiality.

1. Conservatism is the convention by which, when two values of a transaction are


available, the owner-value transaction is recorded. By this convention, profit should
never be overestimated, and there should always be a provision for losses.
2. Consistency prescribes the use of the same accounting principles from one period of
an accounting cycle to the next, so that the same standards are applied to calculate
profit and loss.
3. Materiality means that all material facts should be recorded in accounting.
Accountants should record important data and leave out insignificant information.
4. Full disclosure entails the revelation of all information, both favourable and
detrimental to a business enterprise, and which are of material value to creditors and
debtors.

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