Table of Contents
Definition of accounting:-
Financial accounting is an area of accounting that deals with the recording, classifying, reporting and interpreting of a business financial performance and economic conditions to interested users or stakeholders. The primary purpose of financial accounting is to provide a report in the economic performance and condition of an entity for use of stakeholders.
For more information and notes click here
Accounting Concepts:-
Basic Rules and assumptions of accounting that should be followed in recording and preparation of all business accounts and financial statements.
- Economic Entity / Business Entity / Separate Entity concept
- Money Measurement / Monetary Unit Concept
- Going Concern Concept
- Accounting Period Concept
- Accounting Cost Concept/Historical Cost Concept
- Dual Aspect Concept
- Realization Concept
- Revenue Recognition Principle
- Accrual Concept
- Matching Concept
- Substance Over Form
Money Measurement / Monetary Unit Concept/ Measurability Concept
This concept assumes that all business transactions must be in terms of money that is in the currency of a country. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts.
Transactions and events must be measurable in the form of monetary unit for better understanding and communication to the users of financial statements (Investors, Owners, and Creditors).
For example
- Sale of goods worth Rs.200000, purchase of raw materials Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are recorded in the books of accounts.
- If a business owns, 1500 kg of stock, one car, 1500 square feet of building space etc, these amounts cannot be added to produce a meaningful total of what the business owns. However if a these items are expressed in monetary terms such as stock Rs. 3,000, car Rs. 300,0000 and building Rs. 500,000, all such items can be added in better way and precise estimate about the assets of the business will be available.
Accounting Cost Concept/Historical Cost Concept
According to this concept, an asset is ordinarily entered on the accounting record at the price paid to acquire or purchase it, and this cost is the basis for the accounts during the period of acquisition/purchase and subsequent (following/succeeding) accounting periods.
The cost concept does not mean that the asset will always be shown at cost. It means that asset is recorded at cost at the time of purchase but it may systematically be reduced in its value by charging depreciation.
For Example:-
If business purchase a building for Rs. 5,00,000, the asset would be recorded in the books of account at Rs. 5,00,000, even if its market value at that time may be Rs. 5,50,000. In case a year the market value of this asset comes down to Rs. 4,50,000 it will ordinarily continue to be shown at Rs. 5,00,000 and not at Rs. 4,50,000.
Accounting Period Concept / Periodicity Principle / Time period principle
An accounting period also called a reporting period. The period over which business transactions are accumulated into financial statements (Income Statement, Balance sheet).
This concept assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be of one year, six months, three months, one month, etc. But usually one year is taken as one accounting period which may be a calendar year or a financial year.
Calendar year:-
A calendar year is a period of twelve months from January 1 to December 31. Calendar year is often used in business to compare with the financial year.
Financial Year:-
Accounting period that can start on any day of a calendar year but has twelve consecutive months at the end of which account books are closed (The year that begins from 1st of April and ends on 31st of March of the following year, is known as financial year).
It may or may not match a calendar year. Also called fiscal year or sometime called budget year. Financial year called Fiscal year in USA.
Accrual or Matching Concept
According to this accounting concept revenues and related expenses must be matched in the same accounting period rather than comparing cash received and cash payments.
The matching principle is associated with the accrual basis of accounting and adjusting entries. On account of this concept, adjustments are made for all outstanding expenses, accrued revenues, prepaid expenses and unearned revenues, etc., while preparing the final accounts at the end of accounting period.
For example:-
- If a salesman is paid commission in January, 2001, for sales made by him in December, 2,000. According to this concept commission expense should be offset against sales of December, 2,000 because this expense is incurred for producing revenue in December 2,000.
- A company consumes electricity for the whole month of January, but pays its electricity bill in February. But under “accruals accounting” the entity is bound to record the electricity expense for the month of January and not February, because the expense has originally been incurred in January.
Economic Entity / Business Entity / Separate Entity concept
According to this concept the business enterprise and its owners are two separate independent entities. Thus, the always separately record the transactions of a business and its owners.
The basic assumption is that transactions conducted by businesses are considered separated from those conducted by its owner. Therefore, it shall be recorded separately from the book of the business.
For example:-
- Let us take an example. Suppose Mr. A started business investing Rs. 100000. He purchased goods for Rs. 40000, Furniture for Rs. 20000 and plant and machinery of Rs. 30000. Rs. 10000 remains in hand. These are the assets of the business and not of the owner. According to the business entity concept Rs. 100000 will be treated by business as capital i.e. a liability of business towards the owner of the business.
Now suppose, he takes away Rs. 5000 cash or goods worth Rs. 5000 for his domestic purposes. This withdrawal of cash/goods by the owner from the business is his private expense and not an expense of the business. It is termed as Drawings.
Dual Aspect Concept / Duality Principle
Definition of accounting:-
Financial accounting is an area of accounting that deals with the recording, classifying, reporting and interpreting of a business financial performance and economic conditions to interested users or stakeholders. The primary purpose of financial accounting is to provide a report in the economic performance and condition of an entity for use of stakeholders.
For more information and notes click here
Accounting Concepts:-
Basic Rules and assumptions of accounting that should be followed in recording and preparation of all business accounts and financial statements.
Dual Aspect Concept / Duality Principle
Dual aspect concept is the underlying basis for double entry accounting system.
Every business transaction has a dual (two) impact on the accounting records (Debit and Credit). These two impact are equal and opposite in nature.
The duality concept is commonly expressed in terms of fundamental accounting equation:
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners’ equity and that of outsiders, as liabilities or creditors’ equity.
For example:-
- Let us take an example. Suppose Mr. Saleem started business investing Rs. 1,00,000.
Assets = Liabilities + Capital
Cash = + Saleem
1,00,000 = + 1,00,000
- He purchased Furniture for Rs. 20000 and machinery of Rs. 30000.
Assets = Liabilities + Capital
Cash + Furniture + Machinery = + Saleem
50,000 + 20,000 + 30,000 = + 1,00,000
Every business transaction will affect the accounting equation. It should be kept in mind that both sides of this equation will always remain equal.