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CBSE NOTES ⇒ Class 11th ⇒ Accounts ⇒ 2. Theory Base of Accounting

2. Theory Base of Accounting

Accounting Principle


Accounting Definition: 


Accounting is concerned with the recording, classifying and summarising of financial transactions and events and interpreting the results thereof.

Aim of Accounting: It aims at providing information about the financial
performance of a firm to its various users such as owners, managers employees, investors, creditors, suppliers of goods and services and tax authorities and help them in taking important decisions.

Example 1: 

The investors, for example, may be interested in knowing the extent of profit or loss earned by the firm during a given period and compare it with the performance of other similar enterprises.

Example 2: 

The suppliers of credit, say a banker, may, in addition, be interested in liquidity position of the enterprise. All these people look forward to accounting for appropriate, useful and reliable information.

For making the accounting information meaningful to its internal and external users, it is important that such information is reliable as well
as comparable. The comparability of information is required both to make inter-firm comparisons, i.e. to see how a firm has performed as compared to the other firms, as well as to make inter-period comparison, i.e. how it has performed as compared to the previous years. This becomes possible only if

The information provided by the financial statements is based on consistent accounting policies, principles and practices. Such consistency
is required throughout the process of

(i) Identifying the events and transactions to be accounted for,

(ii) Measuring them,

(iii) Communicating them in the book of accounts,

(iv) Summarising the results thereof and reporting them to the interested parties.

This calls for developing a proper theory base of accounting.

Institute of Chartered Accountants of India, (ICAI): It is the regulatory body for standardisation of accounting policies in the country has issued Accounting Standards which are expected to be uniformly adhered to, in order to bring consistency in the accounting practices. These are discussed in the sections to follow.

Basic Accounting Concepts:
The basic accounting concepts are referred to as the fundamental ideas or basic assumptions underlying the theory and practice of financial accounting and are broad working rules for all accounting activities and developed by the accounting profession. The important concepts have been listed as below:
• Business entity;
• Money measurement;
• Going concern;
• Accounting period;
• Cost
• Dual aspect (or Duality);
• Revenue recognition (Realisation);
• Matching;
• Full disclosure;
• Consistency;
• Conservatism (Prudence);
• Materiality;
• Objectivity

Business Entity Concept : 
The concept of business entity assumes that business has a distinct and separate entity from its owners. It means that for the purposes of accounting, the business and its owners are to be treated as two separate entities.

Example: 

when a person brings in some money as capital into his business,
in accounting records, it is treated as liability of the business to the owner. Here, one separate entity (owner) is assumed to be giving money to another distinct entity (business unit). Similarly, when the owner withdraws any money from the business for his personal expenses(drawings), it is treated as reduction of the owner’s capital and consequently a reduction in the liabilities of the business.

Money Measurement Concept :
The concept of money measurement states that only those transactions and happenings in an organisation which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts.

Will not be recorded in the book of Accounting: 

All such transactions or happenings which can not be expressed in monetary terms, for example, the appointment of a manager, capabilities of its human resources or creativity of its research department or image of the organisation among people in general do not find a place in the accounting records of a firm.

Going Concern Concept:
The concept of going concern assumes that a business firm would continue to carry out its operations indefinitely, i.e. for a fairly long period of time and would not be liquidated in the foreseeable future. This is an important assumption of accounting as it provides the very basis for showing the value of assets in the balance sheet.

Accounting Period Concept:

Accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and what exactly is the position of its assets and liabilities at the end of that period. Such information is required by different users at regular interval for various purposes, as no firm can wait for long to know its financial results as various decisions are to be taken at regular intervals on the
basis of such information. The financial statements are, therefore, prepared at regular interval, normally after a period of one year, so that timely information is made available to the users. This interval of time is called accounting period.

The Companies Act 1956 and the Income Tax Act require that the income statements should be prepared annually. However, in case of certain situations, preparation of interim financial statements become necessary.
For example, at the time of retirement of a partner, the accounting period can be different from twelve months period. Apart from these companies whose shares are listed on the stock exchange, are required to publish quarterly results to ascertain the profitability and financial position at the end of every three months period.

Cost Concept :
The cost concept requires that all assets are recorded in the book of accounts at their purchase price, which includes cost of acquisition, transportation, installation and making the asset ready to use.

Dual Aspect Concept : 
Dual aspect is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the book of accounts. This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction.

The duality principle is commonly expressed in terms of fundamental
Accounting Equation, which is as follows :

Assets = Liabilities + Capital 

In other words, the equation states that the assets of a business are always equal to the claims of owners and the outsiders. The claims also called equity of owners is termed as Capital(owners’ equity) and that of outsiders, as Liabilities(creditors equity). The two-fold effect of each transaction affects in such a manner that the equality of both sides of equation is maintained.

The two-fold effect in respect of all transactions must be duly recorded in the book of accounts of the business. In fact, this concept forms the core of Double Entry System of accounting.

Revenue Recognition :

Revenue is the gross in-flow of cash arising from the sale of goods and services by an enterprise and use by others of the enterprise resources yielding interest royalities and divididends. The concept of revenue
recognition requires that the revenue for a business transaction should be considered realised when a legal right to receive it arises.


Matching :

The concept of matching emphasises that expenses incurred in an accounting period should be matched with revenues during that period. It follows from this that the revenue and expenses incurred to earn these revenue must belong to the same accounting period.


Full Disclosure :

This concept requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes.

Consistency :

This concepts states that accounting policies and practices
followed by enterprises should be uniform and consistent one the period of time so that results are composable. Comparability results when the same accounting principles are consistently being applied by different enterprises for the period under comparison, or the same firm for a number of periods.

Conservatism :

This concept requires that business transactions should be recorded in such a manner that profits are not overstated. All anticipated losses should be accounted for but all unrealised gains should be ignored.

Materiality :

This concept states that accounting should focus on material facts. If the item is likely to influence the decision of a reasonably prudent investor or creditor, it should be regarded as material, and shown in the
financial statements.

Objectivity :

According to this concept, accounting transactions should be recorded in the manner so that it is free from the bias of accountants and others.

Systems of Accounting :

There are two systems of recording business transactions, viz. double entry system and single entry system. Under double entry system every transaction has two-fold effects where as single entry system is known as incomplete records.

Basis of Accounting :

The two broad approach of accounting are cash basis and accrual basis. Under cash basis transactions are recorded only when cash are received or paid. Whereas under accrual basis, revenues or costs are recognises when they occur rather than when they are paid.

Accounting Standards :

Accounting standards are written statements of uniform accounting rules and guidelines in practice for preparing the uniform and consistent financial statements. These standards cannot over ride the provisions of applicable laws, customs, usages and business environment in the country.

Other Pages of this Chapter:

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