FINANCIAL ACCOUNTING

ACCOUNTING DEFINED
American Institute of Certified Public Accountants (AICPA), defines accounting as “an art of
recording classifying, and summarizing in a significant manner; and in terms of money and
events which are, in part at least, of a financial character and interpreting the results there
of”.

From this definition, it is clear that the

art of recording involves writing the financial transactions, immediately after they occur,
in the accounting records such as cash book, purchases book, sales book and so on, in an
orderly manner

art of classifying involves a classification of such data under appropriate heads of account
such as sales, purchases, salaries, assets and so on

art of summarizing in a significant manner consists of presenting such classified data in
such a way that is useful to the internal and external end-users of accounting statements

The American Accounting Association (AAA) defines accounting as “the process of

identifying measuring, and communicating economic information to permit informed
judgments and decisions by the users of the information”.

Significance of Accounting
Accounting is very important for every business organization. It helps to
maintain its own records of business
monitor the business activities
calculate profit or loss for a given period
fulfill legal obligations
show financial position for a given period
communicate the information to the interested parties

SYSTEMS OF BOOK-KEEPING
In financial accounting, there are two systems of book-keeping:
Single-entry book-keeping and
Double-entry book-keeping
Single-entry system is an unscientific and haphazard way of maintaining accounts. Small
business units in the unorganized sector maintain their books of accounts under single-entry
system of book-keeping.
Double-entry book-keeping is a scientific way of recording transactions based on the fact that
for every debit, there is a corresponding credit. Under double-entry system, both debit and credit
aspects of the transaction are being recorded.
Advantages of Double-entry Book-keeping
1. Information about Every Account: Under double-entry system, both aspects of a transaction
is being recorded in the books of accounts. Hence, information about every account is available
in the books of account as all accounts are to be found in the ledgers under double-entry system.
2. Helps to Know the Receivables and Payables: It helps to know how much is owed to the
creditors and how much is due from the debtors. Also it focuses on the bi1ls payable and
receivables.

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3. Arithmetical Accuracy: The arithmetical accuracy can be ascertained by preparing a
statement of debits and credits called trial balance and this is possible because both debit aspects
and credit aspects of every transaction are recorded.
4. Helps to Locate Errors: Trial balance can reveal the errors that creep in accounts while
recording the business information.
5. Helps to Ascertain Profit/Loss: The profit and loss statement can be prepared without much
difficulty under double-entry system unlike in single-entry system.
6. Helps to Know the Financial Position: Double-entry system helps to prepare balance sheet
that reveals the financial position of the business as on a particular date.
7. Monitoring and Auditing Made Easier: With double-entry system, the scope for frauds and
misappropriations is less, provided proper internal audit system is in place. Because of these
advantages double-entry system is very much popular all over the world.

TYPES OF ACCOUNT & RULES GOVERNING EACH ACCOUNT

There are three types of account. They are:
Personal account
Real account, and
Nominal account

Personal Account
These are accounts opened in the name of persons, firms, and companies with whom the firm
deals.

The rule governing personal account is:

'Debit the receiver and Credit the giver'.

Real Account
These are accounts opened in the name of assets such as land and buildings, plant and
machinery, furniture and fixtures etc.

The rule governing real account is:

'Debit what comes in and Credit what goes out'.

Nominal Account
This is also called fictitious account. It exists only for namesake. Nominal accounts cannot be
seen. Nominal accounts are those which are opened in the name of expenses, losses, profits,
incomes and gains. These cannot be physically seen. They can be felt.

The rule governing nominal accounts is:

'Debit all expenses and loses and Credit all incomes and gains'.

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 JOURNAL
MEANING AND FORMAT
Journal is a book of accounts in which all day to day business transactions are recorded in a
chronological order i.e. in the order of their occurrence. Transactions when recorded in a Journal
are known as entries. It is the book in which transactions are recorded for the first time. Journal
is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’.

Applying the principle of double entry one account is debited and the other account is credited.
Every transaction can be recorded in journal. This process of recording transactions in the
journal is’ known as ‘Journalizing’.

Format of Journal
Every page of Journal has the following format. It is a columnar book. Each column is given a
name written on its top. Format of journal is given below:

Journal
Date Particulars Ledger Dr. Amount Cr. Amount
Folio (Rs.) (Rs.)

(1) (2) (3) (4) (5)

Problems & Solutions on Journal:

1) Journalize the following transactions in the books of Prasad.
2014 Rs.
June 1 Commenced business with cash 2,000
5 Made cash purchases of goods 400
7 Sold goods to Rama Rao 375
11 Bought goods from Kailas for cash 200
15 Paid for office stationery 50
18 Paid for wages 40
24 Incurred sundry expenses 25
29 Paid salary of office assistant 150
Solution -1 :
Journal Entries in the books of Prasad
Date Particulars L.F. Debit Credit
2014 Rs. Rs.
June 1 Cash a/c Dr. 2,000
To Capital a/c 2,000
(Being business started with)
June 5 Purchases a/c Dr. 400
To Cash a/c 400
(Being goods purchased on cash)
June 7 Rama Rao a/c Dr. 375
To Sales a/c 375
(Being goods sold on credit)

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June 11 Purchases a/c Dr. 200
To Cash a/c 200
(Being goods purchased on cash)
June 15 Stationery a/c Dr. 50
To Cash a/c 50
(Being stationery purchased)
June 18 Wages a/c Dr. 40
To Cash a/c 40
(Being wages paid)
June 24 Sundry Expenses a/c Dr. 25
To Cash a/c 25
(Being sundry expenses paid)
June 29 Salary a/c Dr. 150
To Cash a/c 150
(Being the payment of salary paid)

2) Journalise the following transactions

2014 Rs.
June 3 Received cash from Ram 5,000
4 Purchased goods for cash 500
11 Sold goods to Hari 200
13 Paid Ramakrishna 400
17 Received from Hari 100
20 Bought furniture from Raju 200
27 Paid for rent 80

Solution –2 :
Journal Entries

Date Particulars L.F. Debit Credit

2001 Rs. Rs.
June 3 Ram a/c Dr. 5,000
To cash a/c 5,000
(Being cash received from Ram)
June 4 Cash a/c Dr. 500
To Purchases a/c 500
(Being the purchase of goods for cash)
June 11 Hari a/c Dr. 200
To Sales a/c 200
(Being sale of goods to Hari on credit)
June 13 Ramakrishna a/c Dr. 400
To Cash a/c 400
(Being cash paid to Ramakrishna)
June 17 Cash a/c Dr. 100
To Hari a/c 100
(Being cash received)
June 20 Furniture a/c Dr. 200
To Raju a/c 200
(Being the purchase of furniture on cash)
June 27 Rent a/c Dr. 80
To Cash a/c 80
(Being the payment of rent)
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 LEDGER
Ledger is a book that contains several accounts. The process of preparation of accounts from the
journal into ledger is called posting in the ledger. The examples for ledger accounts include sales
account, purchases account, sales returns account, purchase returns account, bills payable
account, bills receivable account, cash account, debtors accounts, creditors accounts, and so on.

T Format of Ledger Account

The format of ledger account is of two parts:
(a) Left-hand side called debit side (Dr.), and (b) Right-hand side called credit side (Cr.)
Debit side starts with' To' and Credit side starts with 'By'. However, modem trend reveals that the
words 'To' and 'By' are not widely used in practice.

Account
Dr Cr
Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
To By

Problem:From the following transactions write journal, post them into ledger and prepare trail
balance.
2002
July 1 Prasad brought capital for starting business 40,000
2 Purchased goods for cash 10,000
6 Purchased goods from Murali 4,000
10 Sold goods to Murali on credit 10,000
12 Cash received from Murali 5,000
19 Cash paid to Murali 1,000
24 Cash paid to Das 2,000
27 Drawn for personal use 100
29 Rent paid to landlord 200
31 Salaries paid 500

Solution:
Journal Entries in the books of Prasad
Date Particulars L.F. Debit Credit
2002 Rs. Rs.
July 1 Cash a/c Dr. 40,000
To Capital a/c 40,000
(Being business started with cash)
July 2 Purchases a/c Dr. 10,000
To Cash a/c 10,000
(Being goods purchased on cash)
July 6 Purchases a/c Dr. 4,000
To Murali a/c 4,000
(Being goods purchased on credit)
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July 10 Murali a/c Dr. 10,000
To Sales a/c 10,000
(Being goods sold on credit)
July 12 Cash a/c Dr. 5,000
To Murali a/c 5,000
(Being cash received)
July 19 Murali a/c Dr. 1,000
To Cash a/c 1,000
(Being cash paid to Murali)
July 24 Das a/c Dr. 2,000
To Cash a/c 2,000
(Being cash paid to Das)
July 27 Drawings a/c Dr. 100
To Cash a/c 100
(Being cash withdrawn for personal use)
July 29 Rent a/c Dr. 200
To Cash a/c 200
(Being rent paid to landlored)
July 31 Salaries a/c Dr. 500
To Cash a/c 500
(Being salaries paid)

Ledger Accounts
Dr. Cash Account Cr.
Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 1 To Capital a/c 40,000 July 2 By purchases a/c 10,000
July 12 To Murali a/c 5,000 July 19 By Murali a/c 1,000
July 24 By Das a/c 2,000
July 27 By Drawings a/c 100
July 29 By Rent a/c 200
July 31 By Salaries 500
July 31 By Balance c/d 31,200
45,000 45,000
Aug.1 To Balance b/d 31,200

Dr. Capital Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 31 To Balance c/d 40,000 July 1 By Cash a/c 40,000
40,000 40,000
Aug.1 By Balance b/d 40,000

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Dr. Purchases Account Cr.
Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 2 To Cash a/c 10,000 July 31 By Balance c/d 14,000
July 6 To Murali 4,000
14,000 14,000
Aug.1 To Balance b/d 14,000

Dr. Murali Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 10 To Sales a/c 10,000 July 6 By Purchases a/c 4,000
July 19 To Cash a/c 1,000 July 12 By Cash a/c 5,000
July 31 By balance c/d 2,000
11,000 11,000
Aug.1 To Balance b/d 2,000

Dr. Sales Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 31 To Balance c/d 10,000 July 10 By Murali 10,000
10,000 10,000
Aug.1 By Balance b/d 10,000

Dr. Das Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 24 To Cash a/c 2,000 July 31 By balance b/d 2,000
2,000 2,000
Aug.1 To Balance b/d 2,000

Dr. Drawings Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 27 To Cash a/c 100 July 31 By Balance c/d 100
100 100
Aug.1 To Balance b/d 100

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Dr. Rent Account Cr.
Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 29 To Cash a/c 200 July 31 By Balance c/d 200
200 200
Aug.1 To Balance b/d 200

Dr. Salaries Account Cr.

Date Particulars F. Amount Date F. Amount
Rs. Particulars Rs.
2002 2002
July 31 To Cash a/c 500 July 31 By Balance c/d 500
500 500
Aug.1 To Balance b/d 500

Trial Balance of Prasad as on 31-7-2002

S.No. Particulars L.F. Debit Credit

Rs. Rs.
1. Cash 31,200
2. Capital 40,000
3. Purchases 14,000
4. Murali 2,000
5. Sales 10,000
6. Das 2,000
7. Drawings 100
8. Rent 200
9. Salaries 500
Total 50,000 50,00

TRIAL BALANCE
Meaning
Trial Balance may be defined as “a statement which contains balances of all ledger accounts
on a particular date.”

Trial Balance consists of a debit column with all debit balances of accounts and credit column
with all credit balances of accounts. The totals of these columns if tally it is presumed that ledger
has been maintained correctly.

However, Trial Balance proves only the arithmetical accuracy of posting in the ledger.

PREPARATION OF TRIAL BALANCE

Trial Balance is not an account. It is only a list or schedule of balances of ledger accounts
including cash and bank balances. It is prepared on a particular date. The accounts having a debit
balance are entered in the debit amount column and credit balance accounts are entered in the
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credit amount column. The totals of the two sides of the accounts may also be used to prepare
trial balance. The sum of each column should be equal.

The standard format of a trial balance is given below:

Trial Balance of.................As at................. (closing date)
Sl. Name of the Account LF Dr. Cr.
No. Balance Balance
(Rs.) (Rs.)

Accounts showing debit balances

Asset accounts such as cash, plant& machinery, land, furniture etc.

Expenses accounts such as rent paid, salaries paid, wages paid etc.

Losses accounts such as goods destroyed in fire etc.

Debtors accounts, Purchases accounts, Sales returns account, Drawings account.

The following accounts show credit balances

Liabilities account

Incomes account

Gains account

Profits account, Creditors account, Loan account, Bank overdraft account, Sales account,
Purchase returns account, Provisions accounts such as provision for doubtful debts,
provision for discount on debtors.

Reserves & funds accounts such as General Reserve or Reserve fund, Workmen's
Compensation Fund, etc.

1. Prepare the Trial Balance from the following:

Rs.
Purchases 82,800
Buildings 30,000
Wages 68,000
Fuel 2,000
Creditors 18,000
Bills payable 700
Discount received 100
Sales 1,93,000
Insurance 1,300
Income Tax 3,700
Opening stock 18,000
Commission paid 300
Debtors 19,000
Bad debts 800

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 Salaries 25,000
Printing and stationary 7,600
Postage and Telegrams 3,400
Bills receivable 6,900
Cash at bank 13,000
Capital 70,000

2. From the following particulars prepare Trial Balance:

Rs. Rs.
Capital 60,000 Repairs 500
Drawings 6,000 Bad debts 1,000
Purchases 25,000 Discount allowed 1,000
Debtors 4,000 Commission received 4,000
Creditors 3,000 Insurance 1,000
Bills payable 2,000 General expenses 2,000
Sales 50,000 Depreciation 3,000
Carriage inwards 1,000 Furniture 10,000
Carriage outwards 2,000 Land and buildings 32,000
Wages 5,000 Bills receivable 3,000
Salaries 10,000 Fixed deposit with SBI 6,000
Advertisement 1,000 Opening stock 4,000
Power 1,000
Postage 500

Solution 1: Trial Balance

Debit Balances Rs. Credit Balances Rs.
Purchases 82,800 Creditors 18,000
Buildings 30,000 Bills payable 700
Wages 68,000 Discount received 100
Fuel 2,000 Sales 1,93,000
Insurance 1,300 Capital 70,000
Income tax 3,700
Opening stock 18,000
Commission paid 300
Debtors 19,000
Bad debts 800
Salaries 25,000
Printing and Stationery 7,600
Postage and Telegrams 3,400
Bills Receivable 6,900
Cash at Bank 13,000
2,81,800 2,81,800

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Solution 2: Trial Balance
Particulars Rs. Rs.
Capital 60,000
Drawings 6,000
Purchases 25,000
Debtors 4,000
Creditors 3,000
Bills payable 2,000
Sales 50,000
Carriage inwards 1,000
Carriage outwards 2,000
Wages 5,000
Salaries 10,000
Advertisement 1,000
Power 1,000
Postage 500
Repairs 500
Bad debtors 1,000
Discount allowed 1,000
Commission received 4,000
Insurance 1,000
General expenses 2,000
Depreciation 3,000
Furniture 10,000
Land and buildings 32,000
Bills Receivable 3,000
Fixed deposit with SBI 6,000
Opening stock 4,000
1,19,000 1,19,000

FINAL ACCOUNTS OF SOLE PROPRIETOR

The process of preparing final accounts of sole proprietor is of two stages:
Trading and Profit and Loss Account, and
Balance Sheet

Preparation of Trading and Profit and Loss Account

Trading and profit and loss account shows the gross profit (or gross loss) and net profit (or net
loss) respectively for the given accounting period. Trading and profit and loss account consists of
two parts:

Trading Account

Profit and Loss Account.
Trading Account
Trading account shows gross profit or gross loss for the end of a given accounting period. Gross
profit or gross loss is the excess of sales revenue over the cost of goods sold.

Gross profit = Net sales - Cost of goods sold

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The format of trading account is as follows:
Trading Account of……….for the year ending............................
Dr. Cr.
Particulars Amount Particulars Amount
To Opening stock xxx By Sales xxx
To Purchases xxx Less: sales returns xxx xxx
Less: purchase By Closing stock xxx
returns xx xxx
To Wages xxx
To Carriage inwards xxx
To Fuel and power xxx
To Coal, gas & water xxx
To Import duty xxx
To Manufacturing Exp.
To Direct expenses

To Gross profit c/d

(Transferred to profit and XXX
loss account) ------------ -----------
xxx xxx

Profit and Loss Account

Profit and loss account shows net profit or net loss for the end of a given period. From the gross
profit (or gross loss) transferred from trading account, deduct all expenses relating to office,
selling and distribution departments. Add all non-operating income such as commission or rent
received, interest received etc.

Profit and Loss Account of……….for the year ending............................

Dr. Cr.
Particulars Amount Particulars Amount
(Rs.) (Rs.)
To Office & Administration xxx By Gross profit b/d xxx
Expenses: xxx By discount received xxx
Salaries, rent, insurance xxx By commission received xxx
Telephone exp., printing & xxx By interest received xxx
stationary, postage & telegrams, xxx By income from investments xxx
legal charges, audit fees, general xxx By dividends on shares xxx
expenses etc. xxx By Miscellaneous incomes xxx
To Selling & Distribution xxx xxx
Expenses:
Advertisements, godown rent,
carriage outwards, salesmen xxx
salary, commission, bad debts xxx
xxx
To Repairs& Maintenance xxx
To Depreciation xxx
To Financial Expenses: xxx

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Interest on capital, interest on
loans, discount allowed etc. xxx
To Extra-ordinary xxx
expenditure:
Loss by fire etc. xxx
To Net Profit c/d XXX
(transferred to capital account) ---------- -----------
xxx xxx

Balance Sheet
Balance sheet is a statement of assets and liabilities of a business as on a given date. It shows a
true and fair view of financial position of a business as on a given date.

Balance sheet is a statement. It is not an account. Hence, it does not have debit side or credit
side. It has two sides: Liabilities side and Assets side.

Balance sheet portrays accounting equation wherein Assets = Equity (owner's equity or capital
and creditors' equity or outside liabilities). In other words, under double entry system, assets
must always be equal to capital and liabilities.

The format of balance sheet is given below:

Balance Sheet as on ………………….
Liabilities Amount Assets Amount
Rs. Rs.
Current Liabilities: Current Assets
Bank overdraft Cash in hand xxx
Sundry creditors xxx Cash at bank xxx
Bills payable xxx Bills receivables xxx
Outstanding expenses xxx Closing Stock xxx
Incomes received in xxx Sundry debtors xxx
advance xxx Prepaid expenses xxx
Long –term liabilities Accrued incomes xxx
Owner’s capital xxx Fixed Assets
Add: Net profit xx Plant and machinery xxx
----- Furniture and fixtures xxx
xxx Land and buildings xxx
Less : Drawings xx Loose tools xxx
----- Horses and carts xxx
xxx Business premises xxx
Less: Income tax xx Good will, patents, trade xxx
----- xxx marks, copy rights xxx

----------- ----------
xxxx xxxx

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 FINAL ACCOUNTS OF SOLE TRADER
1. From the following Trial Balance of Ravi, prepare final accounts for the year ended 31-3-
2005:
Debit balance Rs. Credit Balance Rs.
Drawings 4,500 Capital 24,000
Purchases 20,000 Sales 30,500
Sales returns 1,500 Discounts 1,900
Opening stock 8,000 Creditors 10,000
Salaries 4,200 Bills payable 2,500
Wages 1,200
Rent 350
Bad debts 400
Discounts 700
Debtors 14,000
Cash in hand 6,200
Insurance 400
Trade expenses 300
Printing 150
Furniture 2,000
Machinery 5,000
68,900 68,900
Adjustments: (a) Closing Stock Rs.7, 000 (b) Prepaid Insurance Rs.60 (c)Outstanding salary
Rs.500, wages Rs.200 (d) Make a provision for doubtful debts at 5% on debtors (e) Calculate
interest on capital at 5% and on drawings at 6% (f) Depreciate machinery at 5% and furniture
at 10%

Dr. Trading and Profit and Loss Account of Mr. Ravi for the year ended 31.3.2005
Cr.
To Opening Stock 8,000 By Sales 30,500
To Purchases 20,000 Less Returns 1,500 29,000
To Wages 1,200 By Closing Stock 7,000
Add: Outstanding 200 1,400
To Gross Profit c/d 6,600
36,000 36,000
To Salary 4,200 By Gross profit b/d 6,600
Add outstanding 200 4,400 By Discounts 1,900
To Rent 350 By Discount reserve on
Creditors 100
To Bad debts 400
To Discount 700
To Insurance 400
Less pre-paid 60 340
To Trade expenses 300
To Printing 150
To Provision for
Doubtful debts 700

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To Interest on
Capital 1,200
To Depreciation By Net loss c/d– 390
transfer to capital a/c
Machinery 5% 250
Furniture 10% 200
8,990 8,990

Balance Sheet of Mr. Ravi as on 31-03-2005

Liabilities Rs. Assets Rs.
Bills payable 2,500 Cash in Hand 260
Sundry Creditors 10,000 Cash at bank 5,940
Less Discount Sundry Debtors 14,000
reserve 100 9,900
Outstanding salary 200 Less provision 700 13,300
Wages 200 Closing Stock 7,000
Capital 24,000 Furniture 2,000
Add Interest 1,200 Less Depreciation 200 1,800
25,200 Machinery 5,000
Less Net Loss 390
24,810 Less Depreciation 250 4,750
Less Drawings 4,500 20,310
Prepaid Insurance 60
33,110 33,110

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 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)
Classification of Accounting Principles:
Accounting principles can be broadly classified into two categories.
Accounting Concepts, and
Accounting Conventions
Accounting Concepts:
Accounting concepts are the fundamental ideas or basic assumptions underlying the theory and
practice of financial accounting.
The following concepts are usually observed at the time of recording stage.

Business Entity Concept

Dual Aspect Concept

Going Concern Concept

Money Measurement Concept

Objective Evidence Concept

Cost Concept

Accounting Period Concept

Accrual Concept

Matching Cost Concept

Historical Record Concept

1. Business Entity Concept: This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities. Thus, the business and personal
transactions of its owner are separate.
2. Dual Aspect Concept:
Dual aspect is the foundation or basic principle of accounting. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. It means, both the aspects of the
transaction must be recorded in the books of accounts.
3. Going Concern Concept:
This concept states that a business firm will continue to carry on its activities for an indefinite
period of time. Simply stated, it means that every business entity has continuity of life. Thus, it
will not be dissolved in the near future.

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4. Money Measurement Concept:
This concept assumes that all business transactions must be in terms of money that is in the
currency of a country. In our country such transactions are in terms of rupees.
Thus, as per the money measurement concept, transactions which can be expressed in terms of
money are recorded in the books of accounts.
5. Objective Evidence Concept:
According to this concept all accounting transactions should be evidenced and supported by
objective documents. The documents include invoices, receipts, cash memos etc.
6. Cost Concept:
Accounting cost concept states that all assets are recorded in the books of accounts at their
purchase price, which includes cost of acquisition, transportation and installation and not at its
market price. It means that fixed assets like building, plant and machinery, furniture, etc are
recorded in the books of accounts at a price paid for them.
7. Accounting Period Concept:
Accounting period is the period followed by a business concern for maintaining accounts to
know profit or loss. Usually, one year will be the accounting period starting from 1st April and
ending 31st March (Financial Year) or 1st January to December 31st (Calendar Year). The profit
or loss for such period is ascertained. While measuring the profit, incomes or expenses of that
period only are to be considered.
8. Accrual Concept:
Revenue is said to be recognized only when the sale is made, not when the sale proceeds are
collected. In other words, the accountant does not usually recognize revenue until it is
considered to have been realized. It is necessary that the revenue is to be recognized before cash
is received.
9. Matching Cost Concept:
According to this principle, the expenses incurred in an accounting period should be matched
with the revenues recognized in that period. For example, if revenue is recognized on all goods
sold during a period, cost of those goods sold should also be charged to the period.
10. Historical Record Concept:
The accounts book shows only those transactions which have actually taken place and not those
which not take place in future. All transactions in accounting are to be recorded in the books in
chronological order. This means the preparation of a historical record for all transactions.
Hence, the concept is called as the historical record concept.
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Accounting Conventions:
Conventions are the customs or traditions guiding the preparation of accounting statement. They
are adapted to make financial statements clear and meaningful.
1. Full Disclosure Concept:
This concept deals with the convention that all information which is of material importance
should be disclosure in the accounting statements. The Companies Act,1956 makes it
compulsory to provide all the information in the prescribed form. The accounting reports should
disclose full and fair information to the proprietors, creditors, investors and others. This
convention is specially significant in case of big business like Joint Stock Company where there
is divorce between the owners and the managers.
2. Materiality concept:
Under this concept the trader records important facts about the commercial activities in the form
of financial statements. If any unimportant information is to be given for the sake of clarity, it
will be given as footnotes.
The convention of materiality states that, to make financial statements meaningful, only material
fact i.e. important and relevant information should be supplied to the users of accounting
information. The question that arises here is what a material fact is. The materiality of a fact
depends on its nature and the amount involved. Material fact means the information which will
influence the decision of its user.
3. Consistency Concepts:
The convention of consistency means that same accounting principles should be used for
preparing financial statements year after year. A meaningful conclusion can be drawn from
financial statements of the same enterprise when there is comparison between them over a period
of time. But this can be possible only when accounting policies and practices followed by the
enterprise are uniform and consistent over a period of time. If different accounting procedures
and practices are used for preparing financial statements of different years, then the result will
not be comparable.
For example, a company may adopt straight line method, written down value method, or any
other method of providing depreciation on fixed assets. But it is expected that the company
follows a particular method of depreciation consistently.

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4. Conservatism Concept:
This convention warns the trader not to take unrealized income into account. That is why the
practice of valuing stock at cost or market price, whichever is lower is in vogue.
It takes into consideration all prospective losses but leaves all prospective profits.
Following are the examples of application of conservatism:

Making Provision for doubtful debts and discount on debtors

Not providing for discount on creditors

Valuing stock in trade at cost or market price whichever is less

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