Understanding and Learn What? Study of Accounting Concept and Conventions!
Accounting in the past was mainly used to (1) keep control over property and assets of the business concerned and (2) ascertain and report about the profit or loss and the financial position relating to the various periods. But now a day’s accounting is used not only for the above-mentioned purposes but also for collecting, analyzing and reporting of information to the management and others at the required points of time to facilities rational decision making. Learn What? Study of Accounting Concept and Conventions!
Moreover, the accounts in the past were prepared mainly for the use of proprietor. Today financial statements are required by the proprietors, creditors, potential investors, Government and many others. The proprietors study the financial statements to know about the profitability of their business. Creditors study them to ascertain the solvency of the business. Prospective investors are interested in them for the ascertainment of the correct earning potential of the business. The government makes use of these statements for finding out the net contribution that a business can make the economic well-being of the country.
To satisfy the diverse and complex needs of those who use accounting, one needs something more than the clerical procedures, journalizing, posting, taking out trial balance and closing the books etc. The accountant should have ‘guides to action’ or ‘principles’ for completing his work of a wide dimension. The usefulness of accounting will be maximized only if there exist some generally accepted concepts regarding the nature and measurement of liabilities, assets, revenues, and expenses.
There must also be some widely supported standards of disclosure and reporting. There will be widespread understanding of and reliance on accounting statements only if they are prepared in conformity with generally accepted accounting principles. If there is no common agreement on accounting matters then complete chaotic conditions prevail as in that case, every businessman and/or every accountant could follow his own definition of revenue and expense.
Definition: The rules conventions of accounting are commonly referred to as ‘principles’. A universal definition of the ‘accounting principles’ is difficult to give. However, ‘accounting principles’ can be defined in the following two ways :
- Accounting Principle is a “General Truth” or ‘fundamental belief. This definition implies a scientific bias and therefore, its application in the face of ever-changing socioeconomic factors which affect the very basis of a business is doubtful.
- Accounting principle may be defined as a ‘rule of action or conduct’. This definition finds favor with the American Institute of Certified Public Accountants as it refers to the changing character of rules of action or conduct due to the changes in business practices etc. According to AICPA, accounting principle is a general law or rule adopted or processed as a guide to action. The accounting principles do not prescribe one way of doing things. They recognize that there are a number of ways in which one thing can be done. The accountant has considerable latitude and choice within the generally accepted accounting principles in which to express his own idea as to the best way of recording and reporting is specified account. The practice of recording and reporting may thus differ from company to company.
- It should be noted that it would be incorrect to suggest that accounting principles are a body of basic laws like those found in natural sciences like Physics and Chemistry. Accounting principles are manmade and hence are more properly associated with such items as concepts, conventions, and standards. Accounting principles were not deducted from basic atoms, not is their validity verifiable by observation and experiment in a laboratory. Accounting principles are constantly evolving, being influenced by business practices, the needs of statement users, legislation and governmental regulations the opinions and actions of shareholders, labor unions, creditors and management; and the logical reasoning of accountants. The sum total of all such influences finds its expression first in accounting theory. Some theories are accepted while some others are rejected. Theory becomes an accounting principle only when it is generally accepted.
A distinction between Fundamental Accounting Assumptions and Accounting policies has been made by the International Accounting Standards Committee (1ASC). Fundamental Accounting assumptions or postulates according to the ISC underlie the preparation of financial statement. They need not be specifically stated on the face of such statements. Their acceptance and use is assumed in the preparation of financial statements.
Disclosure with full reasons, however, must be made in case they are not followed- Accounting policies, on the other hand, encompass the principles, basis, conventions, rules, and procedures adopted by management in preparing and presenting financial statements. There are, as stated above, much different accounting and applying those which in the circumstances of the enterprise, are best suited to present properly its financial position and the results of its operations.
Following concept are:
- Business Unit Concept: A business and its owner should be treated differently, as far as their financial transactions are concerned.
- Money Measurement Concept: Only business transactions that can be expressed in terms of wealth are recorded in accounting, although records of other types of transactions can be kept separately.
- Dual aspect concept: For each credit, a related debt is made. The recording of the transaction is completed only with a double aspect.
- Concerns are going on the concept: In accounting, a business is expected to continue for a long time and fulfills its commitments and obligations. It assumes that the business will not be forced to stop working on “fire sale” prices and to eliminate their assets.
- Cost concept: Fixed assets of a business are recorded based on their original cost in the first year of accounting. After this, these properties are recorded less depreciation. There is no increase or fall in market value. The concept applies only to certain assets.
- Accounting year concept: Each business chooses a specific time period to complete the cycle of accounting process – for example, monthly, quarterly or yearly – according to a financial or calendar year.
- Matching Concept: This theory states that for every entry of revenue recorded in a given accounting period, a uniform expense entry should be recorded to accurately calculate profit or loss in any period.
- Acquisition concept: According to this concept, only after the profit is accrued. Payment of an advance or fee is not considered to be profitable unless the goods or services are distributed to the buyer.
The most commonly held convention is “historical cost convention”. For this, the cost of the transaction should be recorded on pricing at that time, and properties should be valued at their original cost. Following conventions are:
There are four main conventions in practice in accounting: conservatism, consistency, full disclosure, and materiality.
Conservatism is the convention by which, when two values of a transaction are available, the lower-value transaction is recorded. By this convention, profit should never be overestimated, and there should always be a provision for losses.
Consistency prescribes the use of the same accounting principles from one period of an accounting cycle to the next so that the same standards are applied to calculate profit and loss.
Materiality means that all material facts should be recorded in accounting. Accountants should record important data and leave out insignificant information. An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgment. Where decisions are required about the appropriateness of a particular accounting judgment, the “materiality” convention suggests that this should only be an issue if the judgment is “significant” or “material” to a user of the accounts. The concept of “materiality” is an important issue for auditors of financial accounts.
Full disclosure entails the revelation of all information, both favorable and detrimental to a business enterprise, and which are of material value to creditors and debtors.