Accounting Concepts

The best way to identify the current situation of the businesses is the financial
statement. But if these statements get varied among the entities the stakeholders
and decision makers will be in trouble to get a clear view about the business. To
avoid this shortcoming the usage of accounting concepts has emerged.
Accounting concepts are based on different principles, basic assumptions and
traditions

The following concepts are discussed under accounting concepts

1.​ Money measurement

2.​ Accounting Entity concept
3.​ Going concern
4.​ Accruel concept
5.​ Historical concept
6.​ Consistency concept
7.​ Prudence concept
8.​ Dual aspect concept
9.​ Realization concept
10.​Periodic concept
11.​Materiality concept
12.​Matching concept
13.​Disclosure concept

1.​ Money measurement concept

In this concept the inputs which can be measured by Money are only used in
accounting The following assumptions are considered in this concept

1.​ The value of money is fixed

2.​ The inflation does not affect
Shortages/ Limitations

1.​ Some important information will not be recorded in the financial

statements because they cannot be measured by Money

Ex : Employee efficiency; Increase of the quality of goods, Identifying the

competition and the research results creativity

●​ The real value of the money changes frequently

●​ Taking estimations on items which do not have a financial value directly

Ex ; Good will , Depreciation

Relevance to the financial statements

1.​ All the transactions are presented in mode of money
2.​ All the items bought are valued under the historical cost of the money
3.​ Avoid the recording of items which cannot be measured by money

2. Accounting Entity concept (Institutional/Business entity)

This concept says that the business has an independent concern separated from
the owner.
It means the business and the owner are two separated parties

Importance

1.​ The accounting is some to the entity not to the owner

2.​ Owner private transactions are not recorded in the business
3.​ If there are branches/departments of the business accounts should be
prepared separately

Relevance of the statement

1.​ The name of the business should be used above the F/statement
Ex : Damro company
2.​ Keeping account by owner’s name
Ex : Capital, Drawings, Current alc
 3.​ Historical cost

The concept shows that the resources of the business should be valued at the
historical(true value) of them

Shortages/Limitations

1.​ The assets which are acquired without a cost are not included in the
statements
2.​ The present value of the resources are not shown in the statements
3.​ The stock is not considered in this concept(produce/dochrin) Relevance
to the statement
a.​ Fixed assets are recorded in the financial statements at the
historical cost
b.​ Fixed assets are depreciated at the cost

4.​ Consistency concept

There are many ways to record a transaction but this concept states that only
one method should be used to post the entries
If the method of posting is changed the results and the comparison of the
financial statements will be inaccurate
But if there is a need to change. The concept for better upliftment of the
business there's no barrier by this concept

The Relevance of the statement

1.​ Using one method to desperate the Fixed assets
2.​ Calculation of stock in FIFO or methods
 ..5. Going concern concept

This states that a business continues its operations over a long period[unlimited]
of time

Occasions where this concept is not applicable

1.​ For the joint ventures which are operated for a certain result or period
2.​ Businesses which are unprofitable
3.​ For the businesses which are about to dissolve
According to this concept, to report the accurate details of a business. The
business should stop its operations

Relevance to the statements

1.​ Fixed assets are recorded at cost and provision for Depreciation
2.​ Classification of assets as current and non-current in the balance sheet
3.​ Showing the debtors and creditors in the balance sheet
4.​ Good will and Intangible assets are shown in the balance sheet

1. Fixed assets are recorded at cost with provision for depreciation.

2. Classification of assets as current and non-current in the balance sheet.

3. Showing the debtors and creditors in the balance sheet.

4. Goodwill and intangible assets are shown in the balance sheet.

6. Accrual Concept

All the expenses and income should be taken into consideration when
calculating the profit/loss for the year. This means that all the received and
accrued expenses and income should be taken in the calculation of the profit.
Relevance to the statements:

1. Posting to the P&L account by adjusting the opening and closing accrued and
prepaid expenses with the amount relevant to the period.

2. Posting to the P&L account by adjusting the closing and opening for accrued
and prepaid income with the amount relevant to the period.

7. Prudence Concept (Doctrine)

When calculating the profit or loss of a business, it should not be overstated,

especially the profit. Following points are expressed through this.
(It is ok to understate a profit but cannot be overstated)

1. Unrealized profits should not be accounted for.

●This means that unearned or uncertain income should not be accounted for..

2. A provision should be made on behalf of the future losses.

●The assets which affect the profit or loss should be valued at their lowest cost.
(Realization concept)

Relevance to the statements

1.​ Closing stocks is estimated to the lower of net realize value or cost
2.​ Accounting is not done for unrealized profits
a.​ Making provisions for the unrealized profits on productions
b.​ The value of goods sent on the selling or return inwards policy
should be removed
3.​ Making provisions for future losses
Ex ; Provision for doubtful debts
4.​ Adjusting depreciation for non-current assets
 8. Realization concept

Only realized income should be taken into consideration when preparing

accounts. The time when a transaction is done should be treated as the time of
earning the income.
If an income is yet to be earned within the accounting period, if it is not
realized, it should not be accounted

The realization of an income is not the receiving of that income via money. It's
the confirmation of the transaction as an income.

Ex: The realization of a trade business is the issuing of the invoice and in a
service business it's issuing of the bill.

Relevance to the Statements

1. Credit sales are included in sales income.

2. Provisioning for unrealized profits.
3. Removing the value of the goods remaining from the stock sent on selling or
return inwards.

Occasions where realization concept is not used:

1. Keeping a provision for unfinished contracts in the construction business.

2. Accounting only the installments received in a finance business.
 9. Matching Concept

Identifying the expense of the income earned during a certain period of time.
All the paid and accrued expenses should be taken into consideration.

Relevance to the Statements

1. Adjusting depreciation for non-current assets.

2. Using the closing stock when calculating the gross profit.
3. Provisioning the doubtful debts.

10. Dual Aspect Concept

This concept shows that all the transactions have an effect on both entries as
Debit and Credit. As the basic foundation of Accounting the following formula
is presented:

Assets = Equity + Liabilities

The objective of this concept is to check the accuracy of the accounting.

Relevance to the Statements:

1. Keeping double entries for each transaction as Debit and Credit.

2. Checking the accuracy of accounting by preparing a balance sheet.
 11. Materiality Concept

When classifying an item according to the principals of accounting this states

that it should be done on the proportional value.

Importance
1. Important when deciding the Capital and Revenue expenses.
2. To decide whether to keep a separate account for an item.
●If a transaction affects the profitability of financial position the accounting
should be done.
●​ But if a standard or a law states that accounting should be done whether
the value of the item is low, then this is not applicable

Effect on the statements

1.​ The non-current assets with a very lesser value are terminated treating as
a revenue expense

12. Disclosure concept

●This concept says that all the information should be enclosed in the financial
statements without hiding something.

●So all the accounting policies should be revealed and hiding the revenue,
preparing fraudulent statements, provisioning over amounts from the profit,
recording higher amounts in expenses, keeping unrevealed reserves should not
be done. This concept is important for companies.

●Doctrine Concept and the disclosure concepts crashes each other because these
two concepts state two different ideas.

●Historical Cost Concept shows that stock should be valued at cost and
Doctrine Concept shows that stock should be valued to the lowest of cost and
NRV.
Limitations of the Concepts
1. Missing some important transactions because only the items which are
measurable by money are recorded.
2. Comparison between businesses is difficult because all the businesses do not
use concepts.
3. People who prepare accounts have less knowledge on concepts.
4. Many values of the statements show their value at the historical cost and they
are not up to the date.