Accounting Principles

What are Accounting Principles?

Accounting is the language of business. To understand the accounting

information and for maintaining uniformity and consistency, accounting
principles are necessary in accounting. Accounting Principles are the norms or
rules which are to be followed in treating various items of assets, liabilities,
expenses, incomes, etc.
(i) Accounting Concepts:- Accounting Concepts are the basic
assumptions or rules which are generally accepted for recording and
preparing financial statements .
(ii) Accounting Conventions :- Accounting Conventions are
the outcome of accounting principles or practices followed by an
enterprise over a period of time . Conventions may undergo a change so
that improvements in the quality of accounting information may be
achieved .
Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAPs) means the

rules or guidelines for recording and reporting business
transactions, in order to bring uniformity and consistency in the
preparation and presentation of financial statements.

Generally Accepted Accounting Principles are basic or

fundamental propositions accepted by the accountants based on
which transactions are recorded in the books of account and
financial statements are prepared.
 Principles of Accounting
•Entity Concept: This principle recognizes that the business entity's finances
are separate from the personal finances of its owners. It ensures that business
transactions are recorded independently.

•Going Concern Concept: This principle assumes that the business will
continue to operate indefinitely unless there is evidence to the contrary. It allows for
the preparation of financial statements based on this assumption.

•Money Measurement Concept: This principle states that only

transactions that can be expressed in monetary terms are recorded in the accounting
system. Non-monetary aspects such as employee morale or customer satisfaction
are not quantified.

•Cost Concept: The cost principle dictates that assets should be recorded at
their historical cost, i.e., the amount initially paid to acquire them. It provides a
reliable and objective basis for valuing assets.
 Principle: Entity Concept
The entity concept in accounting refers to the principle that a business entity's financial
transactions and records should be kept separate from the personal finances of its owners or
individuals associated with the business. According to this concept, the business is treated as
a separate legal and economic entity, distinct from its owners or employees.

How Personal and Business Transactions Are Separate:

Mr. Patel owns a small retail store in India. He invests ₹1,00,000 from his personal savings into
the business. Under the entity concept, the transactions would be recorded as follows:

•Personal Transaction: Mr. Patel's personal savings or capital account would decrease by
₹1,00,000, representing his personal contribution to the business.

•Business Transaction: The business's cash or capital account would increase by ₹1,00,000,
reflecting the capital infusion into the business.

By maintaining separate records for personal and business transactions, the entity concept
ensures that the financial statements and accounting records provide an accurate
representation of the business's financial activities.
 Examples of How the Entity Concept Is Applied in Accounting :

•Separate Bank Accounts: The business maintains its own bank account distinct from
personal accounts. All business-related transactions, such as sales revenue, purchases,
and expenses, are recorded in the business bank account.

• Financial Statements: The financial statements, including the balance sheet, income
statement, and cash flow statement, are prepared specifically for the business entity.
These statements present an accurate picture of the business's financial performance and
position without incorporating personal transactions.

•Taxation: In India, businesses file separate tax returns, such as the Goods and Services
Tax (GST) return or Income Tax return, reporting their business income, expenses, and
deductions distinct from personal tax returns of the owners or individuals associated with
the business.

•Legal Distinction: The business entity is registered under a specific legal structure, such
as a sole proprietorship, partnership, or company, which provides a legal distinction
between the personal and business affairs.
 Principle: Going Concern Concept
The going concern concept is an accounting principle that assumes a business will continue to
operate in the foreseeable future, without any intention or necessity of liquidation or cessation
of operations. According to this concept, financial statements are prepared under the
assumption that the business will remain in operation and fulfill its obligations.

Importance of Assuming the Business Will Continue to Operate:

•Accurate Valuation: Assets and liabilities are valued based on their going concern or
operational value, rather than liquidation value. This provides a more realistic representation of
the business's financial position.

•Consistency and Comparability: Assuming the business will continue to operate allows for
consistent reporting and facilitates the comparison of financial statements over time. It provides
stakeholders with meaningful information for decision-making and analysis.

•Assessment of Solvency and Financial Health: The going concern assumption enables
stakeholders to assess the solvency and financial health of the business, considering its ability to
meet its obligations and generate future cash flows.
 Examples of How the Going Concern Concept is Applied in Financial
Statements :
•Reporting of Long-term Assets: Fixed assets such as property, plant, and equipment are
reported at their historical cost or revalued amounts, assuming their usefulness and economic
benefits will continue over a significant period.

• Depreciation and Amortization: Depreciation is calculated based on the estimated useful life
of assets, assuming the business will continue to use them. Similarly, amortization of intangible
assets is determined based on the expectation of continued benefit from these assets. Social
Contributions: Donations made by a business to charitable organizations or community
development initiatives, which may have a social impact but lack direct monetary measurement,
are not typically included in financial statements.
•Research and Development: The investments made in research and development activities that
may contribute to future innovation or product improvements may not be fully recognized due
to uncertainties in their monetary benefits.

•Treatment of Liabilities: Long-term liabilities such as bonds, loans, and mortgages are reported
based on the assumption that the business will fulfill its obligations in the future. Interest
expenses and principal repayments are recognized accordingly.

•Presentation of Financial Statements: The preparation of financial statements, including the

balance sheet, income statement, and cash flow statement, is based on the going concern
assumption. This assumption is explicitly stated in the financial statements to provide
transparency to users.
 Principle: Money Measurement Concept
The money measurement concept is an accounting principle that states that only transactions
and events that can be expressed in monetary terms should be recorded in the financial
statements. It implies that accounting can only measure and report economic activities that
have a monetary value. Under this concept, non-monetary aspects such as qualitative factors or
events that cannot be quantified in monetary terms are not recorded or recognized in the
financial statements. The money measurement concept helps provide a standardized and
objective basis for recording and reporting financial information.

Limitations of Recording Only Measurable Transactions:

•Exclusion of Non-Monetary Factors: By focusing solely on transactions with monetary

values, the concept ignores important non-monetary factors such as employee satisfaction,
brand reputation, or environmental impact, which can be crucial for decision-making.

•Incomplete Picture of the Business: The financial statements may not fully represent the
overall performance and position of a business since they do not capture the entirety of its
activities and resources.
•Inadequate Representation of Future Benefits and Risks: Some transactions that have
potential future benefits or risks may not be recorded due to the money measurement concept,
leading to an incomplete assessment of the business's future prospects.

•Ignoring Intangible Assets: The concept overlooks valuable assets such as intellectual
property, patents, or copyrights that can significantly contribute to a business's value and
competitiveness.

Examples of Transactions Not Recorded Due to the Money

Measurement Concept:
•Employee Morale: The positive impact of a motivating work environment or employee
training programs, which cannot be quantified in monetary terms, is not recognized in the
financial statements.

•Brand Reputation: The value associated with a strong brand reputation or customer loyalty,
which is difficult to measure in monetary units, is not reflected in the financial statements.

•Environmental Impact: The ecological footprint or environmental sustainability practices of a

business, although significant, may not be captured in monetary terms and, therefore, are not
recorded.
Social Contributions: Donations made by a business to charitable organizations or
community development initiatives, which may have a social impact but lack direct
monetary measurement, are not typically included in financial statements.

Research and Development: The investments made in research and development

activities that may contribute to future innovation or product improvements may not be
fully recognized due to uncertainties in their monetary benefits.
 Principle: Cost Concept
The cost concept, also known as the historical cost concept, is an accounting principle that states
that assets should be recorded and reported at their historical cost, which is the original cost
incurred to acquire or produce them. According to this concept, the value of an asset is based on
its original cost at the time of acquisition or production, rather than its current market value or
future worth.

Recording Assets at Their Historical Cost:

Under the cost concept, assets are initially recorded in the accounting books at the amount of
cash or cash equivalents paid or the fair value of non-cash considerations given to acquire them.
This historical cost is considered a reliable and objective measure of an asset's value because it is
verifiable and supported by actual transactions.

•Objectivity and Reliability: Historical cost is an objective and verifiable measure of an asset's
value. It provides a transparent and reliable basis for financial reporting.

•Simplicity: Historical cost is a straightforward and easily determinable value. It avoids subjective
assessments or fluctuations in market prices, making accounting more consistent and less prone
to manipulation.

•Comparison and Analysis: Recording assets at historical cost facilitates the comparison of
financial statements over time. It allows for the analysis of cost efficiency, profitability, and asset
performance over different periods.
 Examples of How the Cost Concept is Applied in Accounting :-

•Fixed Assets: Fixed assets such as land, buildings, machinery, and equipment are recorded at
their historical cost, including the purchase price, transportation costs, installation charges, and
any necessary modifications.

•Inventories: Inventories are valued at their cost of acquisition or production, which includes the
purchase price, transportation costs, direct labor, and applicable overhead expenses. This
ensures that the value of inventories is based on their historical cost.

•Investments: Investments in securities, such as shares or bonds, are initially recorded at their
cost of acquisition. This cost includes the purchase price, brokerage fees, and other directly
attributable costs.

•Debt Instruments: Debt instruments, such as loans or bonds, are recorded at their principal
amount or face value, representing the historical cost of borrowing or the initial investment
made.

•Research and Development Costs: Research and development costs are typically expensed as
incurred, following the cost concept. However, certain development costs meeting specific
criteria may be capitalized and recorded as intangible assets at their historical cost.
 CONCLUSION :-
In conclusion, we have explored several key accounting principles and their application in
financial accounting, specifically in the context of India. Let's recap the principles covered and
emphasize their importance in financial accounting:

•Entity Concept: The entity concept recognizes the separation of personal and business
transactions, ensuring that financial statements accurately reflect the financial activities of the
business entity.

•Going Concern Concept: The going concern concept assumes that the business will continue
to operate in the foreseeable future, allowing for the preparation of financial statements that
reflect the business's ongoing operations and financial health.

•Money Measurement Concept: The money measurement concept states that only
transactions and events that can be expressed in monetary terms are recorded in financial
statements, providing a standardized and objective basis for reporting financial information.

•Cost Concept: The cost concept requires assets to be recorded at their historical cost,
providing a reliable and objective measure of their value and facilitating consistent comparison
and analysis of financial statements over time.
 Understanding and applying these accounting principles are crucial in
financial accounting for several reasons:

•Accurate Financial Reporting: These principles ensure that financial statements provide a true
and fair view of the business's financial position, performance, and cash flows. They help in
presenting reliable and relevant information to stakeholders for decision-making.

•Compliance with Legal and Regulatory Requirements: Adhering to accounting principles

ensures that financial statements comply with the applicable accounting standards and
regulatory frameworks, promoting transparency and trust in financial reporting.

•Consistency and Comparability: By following accounting principles, financial statements are

prepared consistently over time, allowing for meaningful comparison and analysis of financial
information. This enables stakeholders to assess the business's performance, profitability, and
financial health.

•Stakeholder Confidence and Trust: Applying accounting principles promotes transparency,

accuracy, and reliability in financial reporting. This, in turn, enhances stakeholder confidence and
trust in the business's financial statements and facilitates informed decision-making.
THANK YOU

By : Jayant Rautela
Class : 11th Sapphire