What is Accounting Concepts?
Accounting concepts are the basic rules, assumptions, and conditions that define the parameters and constraints within which the accounting operates. In other words, accounting concepts are the generally accepted accounting principles, which form the fundamental basis of preparation of universal form of financial statements consistently.
Objectives of Accounting Concepts
- The main objective is to achieve uniformity and consistency in the preparation and maintenance of financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels..
- It acts as the underlying principle, which assists accountants in the preparation and maintenance of the business records.
- It aims to achieve a common understanding of rules or assumptions to be followed by all types of entities, thereby facilitating comprehensive and comparable financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc..
Top 12 Accounting Concepts
Below mentioned are the generally accepted accounting conceptsGenerally Accepted Accounting ConceptsGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors. used widely around the world.
#1 – Entity Concept
Entity concept is a concept which explains to you that your business is different than you. It tells you that the business owner and the owner are two separate entities. The statute recognizes the entity as an artificial person. The entity is required to prepare its own set of financial statements and record its business transactions accordingly.
#2 – Money Measurement Concept
Money Measurement conceptMoney Measurement ConceptAccording to the money measurement concept of accounting, a company should only record in its financial statement only those events or transactions that are measured in terms of money. If assigning the monetary value to the transactions is not possible, it will not be recorded in the financial statement. states that only those transactions are recorded and measured in monetary terms. In simple words, only financial transactions are recorded in books of accounts.
#3 – Periodicity Concept
Periodicity concept states that the entity or the business needs to carry out the accounting for a definite period, usually the financial year. The period for drawing of financial statements can vary from monthly to quarterly to annually. It helps in identifying any changes occurring over different periods.
#4 – Accrual Concept
According to Accrual AccountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. , the transaction is recorded on a mercantile basis. In other words, transactions are to be recorded as and when they occur, not as and when the cash is received or paid, and for the period to which the transaction pertains.
#5 – Matching Concept
The matching concept is linked to the Periodicity concept and Accrual concept. The matching concept states that the period for which revenue has been considered, the entity needs to account for expenses only relating to that period. It means that the entity has to record revenue and expenses for the same period.
#6 – Going Concern Concept
Going concern conceptGoing Concern ConceptGoing Concern concept is an accounting principle which states that the accounting statements are formulated with a belief that the business will not be bankrupt or liquidated for the foreseeable future, which generally is for a period of 12 months. is an assumption that the business will be carried on an ongoing basis. Thus, the books of accounts for the entity are prepared such that the business will be carried on for years to come.
#7 – Cost Concept
Cost concept states that any asset that the entity records shall be recorded at historical cost value, i.e., the acquisition cost of the asset.
#8 – Realization Concept
This concept is related to the cost concept. The realization concept states that the entity should record an asset at cost until and unless the realizable valueThe Realizable ValueRealizable value is the net consideration from sales proceeds of any assets in the normal course of business after deduction of incidental expenses. It is common for the valuation of inventories under International Financial Reporting Standards and other accepted accounting policies. of the asset has been realized. Practically, it will be correct to say that the entity will record the realized value of the asset once the asset has been sold or disposed of off, as the case may be.
#9 – Dual Aspect Concept
This concept is the backbone of the double-entry bookkeeping system. It states that every transaction has two aspects, debit and credit. The entity has to record every transaction and give effect to both the elements of debit and credit.
#10 – Conservatism
This conservatism concept states that the entity needs to prepare and maintain its book of accounts on a prudent basis. Conservatism says that the entity has to provide for any expected losses or expenses; however, it does not recognize future revenue expected.
#11 – Consistency
The accounting policiesThe Accounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level. are followed consistently to achieve the intention of comparing the financial statements of various periods or for that matter of multiple entities.
#12 – Materiality
The materiality conceptMateriality ConceptIn any financial accounting statements, there are some transactions that are too small to be recognized and such transactions might not have any impact on the analysis of the financial statement by an external observer; removal of such irrelevant information to keep the financial statement crisp and consolidated is called as the concept of materiality. explains that the financial statements should show all the items having a significant economic effect on the business. It allows ignoring the other concepts if the item to be disclosed is having an insignificant impact on the business of the entity, and the efforts involved in recording the same is not worthwhile.
Importance of Accounting Concept
- The importance of the accounting concept is visible in the fact that its application is involved at each and every step of a recording a financial transaction of the entity.
- Following the generally accepted accounting concepts helps in saving time, efforts, and energy of the accountants, as the framework is already set.
- It improves the quality of financial statements and reports with respect to understandability, reliability, relevance, and comparability of such financial statements and reports.
Accounting Concept vs. Convention
In common parlance, accounting concepts and accounting conventionsAccounting ConventionsAccounting conventions are specific guidelines for complicated and unclear business transactions, not compulsory or legally binding, but these generally accepted principles maintain consistency in financial statements. These conventions help in standardizing the financial reporting process, disclosure of transactions, and relevance. are used interchangeably. However, there are quite a few differences in both these terms.
|Accounting Concepts||Accounting Convention|
|Refers to a set of rules and assumptions to be followed while recording financial transactions.||This refers to generally accepted practices followed by the accountants.|
|The accounting bodies of the country set the rules and assumptions to be followed, generally in line with internationally accepted accounting policies.||Conventions are basically the implied accounting practicesAccounting PracticesAccounting practice is a set of procedures and controls used by an entity's accounting department to keep track of accounting records and entries. Other reports are generated based on accounting records, such as financial statements, cash flow statements, fund flow statements, payroll, tax workings, payment and receipts statements, and so on, and they form the basis of the auditor's reliance while auditing the financial statements. followed by an entity. The same is not governed by any accounting authority; however, there a general agreement between the accounting bodies for acceptance of the conventions in practice.|
|To be followed at every step of recording the transactions of the business.||To be followed while preparing financial statements of the entity.|
|It is a theoretical approach for the preparation and maintenance of books of accounts.||It is a procedural approach that comes into picture post books that are prepared.|
- A detailed and tallied financial information clearly provide information about the asset viz a vis. the liabilities of the entity;
- Useful information to help the management of the entity make an economic decision;
- Provide financial information to the investors and show the financial status of the entity;
- A clear understanding of how each and every business transaction has been recorded;
- Uniformly accepted financial report – which assists in better understanding of financial information;
- In case of accounting concept is not followed at every step of the recording of financial transaction,
- Chances of omission and misstatements of financial reporting increase;
- Difficult to trace where the exclusion has taken place;
- Wrongly reported financial transactions lead to issues in interpretation and analysis of financial information;
- The financial reportFinancial ReportFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. is no longer reliable;
- It ousters the scope for the recording of non-monetary transactions;
- It does not provide for reporting of transactions that are not material. However, materiality level is different for different entities, and thus it can ruin the comparability aspect of financial statement of various entities;
- Since it does not allow recognizing of assets at its realizable values, the financial statements do not provide the actual picture of the financial status of the entity
Accounting concepts are the generally accepted rules and assumptions that assist accountants in the preparation of financial statements. It provides the framework for recording the financial transactions of the businessTransactions Of The BusinessA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.. In layman terms, they are the fundamental building blocks of the accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm., with the primary objective of providing uniform and consistent financial information to relevant investors and all the stakeholders.
This has been a guide to What is Accounting Concept & its Definition. Here we discuss the types of accounting concepts and objectives along with importance, advantages, and disadvantages. You can learn more about from the following articles –