Accounting concepts are the basic rules, assumptions, and conditions that define the parameters and constraints within which accounting operates. In other words, accounting concepts are generally accepted accounting principles, which form the fundamental basis of consistently preparing the universal form of financial statements.
Objectives of Accounting Concepts
- The main objective is to achieve uniformity and consistency in preparing and maintaining financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.
- It acts as the underlying principle that assists accountants in preparing and maintaining 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 informationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more.
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Top 12 Accounting Concepts
Below mentioned are the generally accepted accounting conceptsGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more used widely around the world.
#1 – Entity Concept
The entity concept is a concept that explains to you that your business is different from yours. 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 must prepare its own set of financial statements and record its business transactions accordingly.
#2 – Money Measurement Concept
Money Measurement conceptAccording to the money measurement concept of accounting, a company should only record in its financial statement only those events or transactions that are measured in terms of money. If assigning the monetary value to the transactions is not possible, it will not be recorded in the financial statement.read more 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
The 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 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 AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more, 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 the transaction pertains.
#5 – Matching Concept
The matching conceptThe Matching Principle of Accounting provides accounting guidance, stating that all expenses should be recognized in the income statement of the period in which the revenue related to that expense is earned. This means that, regardless of when the actual transaction is made, the expenses that are entered into the debit side of the accounts should have a corresponding credit entry in the same period.read more is linked to the Periodicity concept and Accrual concept. The matching concept states that during 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 conceptGoing Concern concept is an accounting principle which states that the accounting statements are formulated with a belief that the business will not be bankrupt or liquidated for the foreseeable future, which generally is for a period of 12 months.read more assumes that the business will be carried out 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
The cost concept states that any asset that the entity records shall be recorded at historical cost value, i.e., the asset’s acquisition cost.
#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 valueRealizable value is the net consideration from sales proceeds of any assets in the normal course of business after deduction of incidental expenses. It is common for the valuation of inventories under International Financial Reporting Standards and other accepted accounting policies.read more 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 debit and credit elements.
#10 – Conservatism
This conservatism conceptThe conservatism principle of accounting guides the accounting, according to which there is any uncertainty. All the expenses and liabilities should be recognized. In contrast, all the revenues and gains should not be recorded, and such revenues and profits should be recognized only when there is reasonable certainty of its actual receipt.read more 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 policiesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level.read more 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 conceptIn any financial accounting statements, there are some transactions that are too small to be recognized and such transactions might not have any impact on the analysis of the financial statement by an external observer; removal of such irrelevant information to keep the financial statement crisp and consolidated is called as the concept of materiality.read more 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 has an insignificant impact on the entity’s business, and the efforts involved in recording the same are not worthwhile
Importance of Accounting Concept
- The importance of the accounting concept is visible in the fact that its application is involved in every step of recording a financial transaction of the entity.
- Following the generally accepted accounting concepts helps save the accountants’ time, effort, and energy, as the framework is already set.
- It improves the quality of financial statements and reports concerning the understandability, reliability, relevance, and comparability of such financial statements and reports.
Accounting Concept vs. Convention
In common parlance, accounting concepts and accounting conventionsAccounting conventions are specific guidelines for complicated and unclear business transactions, not compulsory or legally binding, but these generally accepted principles maintain consistency in financial statements. These conventions help in standardizing the financial reporting process, disclosure of transactions, and relevance.read more are used interchangeably. However, there are quite a few differences in both these terms.
Refers to a set of rules and assumptions to be followed while recording financial transactions. | It 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 the implied accounting practicesAccounting practice is a set of procedures and controls used by an entity's accounting department to keep track of accounting records and entries. Other reports are generated based on accounting records, such as financial statements, cash flow statements, fund flow statements, payroll, tax workings, payment and receipts statements, and so on, and they form the basis of the auditor's reliance while auditing the financial statements.read more followed by an entity. Any accounting authority does not govern the same; however, there is a general agreement between the accounting bodies to accept 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 preparing and maintaining of books of accounts. | It is a procedural approach that comes into prepared picture post books. |
Advantages
- A detailed and tallied financial information provides 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 every business transaction has been recorded;
- Uniformly accepted financial report – which assists in better understanding of financial information;
Disadvantages
Conclusion
Accounting concepts are the generally accepted rules and assumptions that assist accountants in preparing financial statements. In layman’s terms, they are the fundamental building blocks of the transactions of the businessA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more. In layman terms, they are the fundamental building blocks of the accounting systemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm.read more, with the primary objective of providing uniform and consistent financial information to relevant investors and all the stakeholders. It provides the framework for recording the financial transactions of the business.
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