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 statements.
- 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 information.
Top 12 Accounting Concepts
Below mentioned are the generally accepted accounting concepts 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 concept 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 Accounting, 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.
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#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 concept 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 value 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 policies 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 concept 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 conventions 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 practices 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. |
Advantages
- 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;
Disadvantages
- 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 report 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
Conclusion
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 business. In layman terms, they are the fundamental building blocks of the accounting system, with the primary objective of providing uniform and consistent financial information to relevant investors and all the stakeholders.
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