Accounting Conventions and Accounting Concepts
(1) Relevance
The custom of relevance emphasizes the fact that only such information should be made ready by accounting as is relevant and useful for achieving its objectives. For example, business is interested in knowing as to what has been total labor cost? It is not interested in knowing how much employees spend and what they save.
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(2) Objectivity
The custom of objectivity emphasizes that accounting information should be measured and expressed by the standards which are ordinarily acceptable. For example, stock of goods lying unsold at the end of the year should be valued as its cost price not at a higher price even if it is likely to be sold at higher price in future. Guess is that no one can be sure about the price which will prevail in future.
(3) Feasibility
The custom of feasibility emphasizes that the time, labor and cost of analyzing accounting information should be compared vis-à-vis benefit arising out of it. For example, the cost of ‘oiling and greasing’ the machinery is so small that its break-up per unit produced will be meaningless and will number to wastage of labor and time of the accounting staff.
Accounting Concepts
(1) Materiality
It refers to the relative significance of an item or event. Those who make accounting decisions continually confront the need to make judgments regarding materiality. Is this item large adequate for users of the information to be influenced by it? The essence of the materiality idea is : the omission or misstatement of an item is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a uncostly person relying on the report would have been changed or influenced by the inclusion or correction of the item.
(2) Accounting period
Though accounting custom believes in lasting entity idea i.e. Life of the business is perpetual but still it has to report the ‘results of the action undertaken in definite period (normally one year). Thus accounting attempts to gift the gains or losses earned or suffered by the business during the period under review. Normally, it is the calendar year (1st January to 31st December) but in other cases it may be financial year (1st April to 31st March) or any other period depending upon the convenience of the business or as per the business practices in country concerned.
Due to this idea it is valuable to take into inventory during the accounting period, all items of income and expenses accruing on the date of the accounting year. The question confronting this idea is that allowable funds should be made between capital and income expenditure. Otherwise the results disclosed by the financial statements will be affected.
(3) Realization
This idea emphasizes that profit should be considered only when realized. The request is at what stage profit should be deemed to have accrued? whether at the time of receiving the order or at the time of carrying out of the order or at the time of receiving the cash. For answering this request the accounting is in conformity with the law (Sales of Goods Act) and recognizes the principle of law i.e. The income is earned only when the goods are transferred. It means that profit is deemed to have accrued when ‘property in goods passes to the buyer’ viz. When sales are affected.
(4) Matching
Though the business is a continuous affair yet its continuity is artificially split into any accounting years for determining its periodic results. This profit is the part of the economic carrying out of a concern and as such it increases proprietor’s equity. Since profit is an excess of income over expenditure it becomes valuable to bring together all revenues and expenses relating to the period under review. The realization and accrual concepts are essentially derived from the need of matching expenses with revenues earned during the accounting period. The income and expenses shown in an income statement must both refer to the same goods transferred or services rendered during the accounting period. The matching idea requires that expenses should be matched to the revenues of the thorough accounting period. So we must conclude the income earned during a singular accounting period and the expenses incurred to earn these revenues.
(5) Entity
According to this concept, the task of measuring income and wealth is undertaken by accounting, for an identifiable Unit or Entity: The unit or entity so identified is treated distinct and obvious from its owners or contributors. In law the disagreement between owners and the business is drawn only in the case of joint stock companies but in accounting this disagreement is made in the case of sole proprietor and partnership firm as well. For example, goods used from the stock of the business for business purposes are treated as a business expenditure but similar goods used by the proprietor i.e. Owner for his personal use are treated as his drawings. Such disagreement between the owner and the business unit has helped accounting in reporting profitability more objectively and fairly. It has also led to the development of “responsibility accounting” which enables us to find out the profitability of even the distinct sub-units of the main business.
(6) stable Monetary Unit
Accounting presumes that the purchasing power of monetary unit, say Rupee, remains the same throughout. For example, the intrinsic worth of one Rupee is same and equal in the year 1,800 and 2,000 thus ignoring the corollary of rising or falling purchasing power of monetary unit due to deflation or inflation. In spite of the fact that the assumption is unreal and the custom of ignoring changes in the value of money is now being extensively questioned, still the alternatives recommend to join the changing value of money in accounting statements viz., current purchasing power formula (Cpp) and current cost accounting formula (Cca) are in evolutionary stage. Therefore, for the time being we have to be article with the ‘stable monetary unit’ concept.
(7) Cost
This idea is intimately linked to the going concern concept. Agreeing to this, an asset is ordinarily recorded in the books at the price at which it was acquired i.e. At its cost price. This ‘cost’ serves the basis for the accounting of this asset during the subsequent period. This’ cost’ should not be confused with ‘value’.
It must be remembered that as the real worth of the assets changes from time to time, it does not mean that the value of such an assets is wrongly recorded in the books. The book value of the assets as recorded do not reflect their real value. They do not signify that the values noted therein are the values for which they can be sold. Though the assets are recorded in the books at cost, in procedure of time, they become reduced in value on inventory of depreciation charges. In obvious cases, only the assets like ‘goodwill’ when paid for will appear in the books at cost and when nothing is paid for, it will not appear even though this asset exists on name and fame created by a concern.
Therefore, the values attached to the assets in the balance sheet and the net income as shown in the profit and Loss inventory cannot be said to reflect the literal, estimation of the financial position of an undertaking, as they do not have any relation to the shop value of the assets or their exchange values. This idea that the transactions should be recorded at cost rather than at a subjective or arbitrary value is known as Cost Concept. With the tube of time, the shop value of fixed assets like land and buildings vary greatly from their cost.
These changes or variations in the value are ordinarily ignored by the accountants and they continue to value them in the balance sheet at historical cost. The principle of valuing the fixed assets at their cost and not at shop value is the underlying principle in cost concept. Agreeing to them, the current values alone will fairly laid out the cost to the entity.
The cost principle is based on the principle of objectivity. The supporters of this formula argue so long as the users of the financial statements have belief in the statements, there is no necessity to turn this method.
(8) Conservatism
This idea emphasizes that profit should never be overstated or anticipated. Traditionally, accounting follows the rule “anticipate no profit and furnish for all possible losses. For example, the windup stock is valued at cost price or shop price, whichever is lower. The corollary of the above is that in case shop price has come down then furnish for the ‘anticipated loss’ but if the shop price has gone up then ignore the ‘anticipated profits’.
Critics point out that conservation to an excess degree will corollary in the creation of inexpressive reserve. This will be quite contrary to the philosophy of disclosure. However, conservatism to a uncostly degree may not come in for criticism.
Accounting Equation
Dual idea may be stated as “for every debit, there is a credit.” Every transaction should have two sided corollary to the extent of same amount. This idea has resulted in Accounting Equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner’s equity and outsider’s liabilities. This may be expressed in the form of equation:
A-L = P
where
A stands for assets of the entity;
L stands for liabilities (outsider’s claims) of the entity; and
P stands for Proprietor’s claim (Capital) on the entity.
(The form of presentation of equation A-L = P is consistent with the legal interpretation of financial position. Thus it emphasizes that properly speaking the proprietary claim is the balance after providing for outsider’s claims against the business from the total assets of the business).
Accounting Conventions and Accounting Concepts
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