Accounting Concepts & Conventions

Understand the basic concepts and conventions used in accounting

📘 What are Accounting Concepts & Conventions?

Accounting Concepts are the basic assumptions and principles on which the accounting system is based.

Accounting Conventions are the customary practices and guidelines followed by accountants while preparing financial statements.

They help maintain uniformity, consistency and reliability in accounting records and financial statements.

📚 Important Accounting Concepts

The following concepts form the foundation of the accounting system:

1. Business Entity Concept

According to this concept, the business and its owner are treated as separate entities for accounting purposes.

Example: If the owner invests ₹1,00,000 in the business, it is recorded as capital introduced by the owner and not as ordinary business income.

2. Money Measurement Concept

Only those transactions and events which can be measured in monetary terms are recorded in the books of accounts.

Example: Purchase of machinery for ₹2,00,000 can be recorded. But the efficiency or honesty of an employee cannot normally be recorded in monetary terms.

3. Going Concern Concept

This concept assumes that the business will continue to operate for the foreseeable future and will not be forced to close down.

Because of this assumption, assets are generally recorded and depreciated over their useful life rather than being valued as if the business were immediately closing.

4. Accounting Period Concept

Although a business may continue for many years, its performance is measured for a specific period known as an accounting period.

Example: Financial statements may be prepared for one year to determine the profit or loss of that period.

5. Cost Concept

According to the cost concept, an asset is generally recorded in the books at its acquisition cost, subject to applicable accounting requirements.

Example: If machinery is purchased for ₹5,00,000, its original cost is recorded at ₹5,00,000, along with applicable costs necessary to bring it into use.

6. Dual Aspect Concept

Every business transaction has two aspects. Therefore, every transaction affects at least two accounts.

Assets = Capital + Liabilities

Example: If the owner introduces ₹1,00,000 cash into the business, cash increases and capital also increases.

7. Accrual Concept

Under the accrual concept, income and expenses are recognised in the period to which they relate, rather than only when cash is received or paid.

Example: Salary due but not yet paid is treated as an expense of the relevant accounting period.

8. Matching Concept

Expenses incurred for earning revenue should be recognised in the same accounting period as the related revenue, so that the correct profit or loss can be determined.

Example: The cost of goods sold is matched with the sales revenue generated from those goods.

9. Realisation / Revenue Recognition Concept

Revenue is recognised when it is earned in accordance with the applicable accounting requirements, rather than simply when an advance or cash is received.

Example: A sale made on credit is recognised as a sale even though the customer may pay later, subject to the applicable revenue recognition requirements.

📖 Important Accounting Conventions

Accounting conventions are practices developed over time to provide guidance and consistency in the preparation and presentation of financial information.

1. Convention of Consistency

Accounting methods should be applied consistently from one accounting period to another, unless a justified change is required.

This helps users compare the financial performance of a business over different periods.

2. Convention of Conservatism

When there is uncertainty, accounting should be approached with appropriate caution so that assets and income are not overstated and liabilities and expenses are not understated.

A commonly stated principle is: “Anticipate no profit, but provide for expected losses.”

3. Convention of Materiality

Accounting information should focus on items that are significant enough to influence the decisions of users of financial statements.

Example: A low-value office item may be treated differently from a major machine because the financial impact is not the same.

4. Convention of Full Disclosure

Financial statements should provide all material information necessary for users to understand the financial position and performance of the business, subject to applicable reporting requirements.

📝 Quick Revision

• Business Entity – Business and owner are treated separately.
• Money Measurement – Transactions measurable in money are recorded.
• Going Concern – Business is assumed to continue.
• Accounting Period – Business performance is measured for a specific period.
• Dual Aspect – Every transaction has two aspects.
• Accrual – Income and expenses are recognised in the period to which they relate.
• Consistency – Accounting methods should be applied consistently.
• Conservatism – Exercise appropriate caution under uncertainty.
• Materiality – Focus on information significant to users.
• Full Disclosure – Material information should be properly disclosed.

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