Accounting Basic Concepts - Accounting Basics

What are the basic concepts of accounting?

The fundamental concepts of accounting are Business Entity Concept and Money measurement Concept.

Business Entity Concept

According to this concept, the business and the owner of the business are two different entities.

For instance, Mr A starts a new business in the name and style of M/s Independent Trading Company and introduced a capital of Rs 2,00,000 in cash. It implies that the cash balance of M/S Independent Trading Company will increase by a sum of Rs 2,00,000/-, by increasing the liability of M/S Independent Trading Company in the form of capital implying that the company is liable to pay Rs 2,00,000 to Mr A.

Money Measurement Concept

According to this concept, the transactions that can be measured in monetary terms can be booked.

Example

The value of the stock of the following items is determined and booked:

The value of the stock can be recorded by obtaining the value of the coast and jackets in terms of money. It is concluded that the values of coats and jackets are Rs 2,000 and Rs 15,000 respectively, now the value of the stock can be booked as Rs 29,500 (as a result of 5000+7500+2000+15000) in the books. The quantitative records are kept separately.

Going Concern Concept

Accounting is based on the concept that the business unit is a going concern. The financial transactions of the business are recorded keeping in view that the business unit is a going concern. Else the loan is not provided by the banker, the goods or services are not supplied by the supplier and the employees will not work properly.

For instance, an investment is made by the business in the form of fixed assets and only the depreciation of the assets is booked in the profit and loss account, and not the difference of acquisition cost of assets less net realizable value of the assets. This is because it is assumed that assets are used and profits are earned in future. On the same way the deferred revenue expenditure and the prepaid expenditure is treated. The going concern concept does not work in the following cases:

  • If a unit is declared sick (unused or unusable unit).
  • When a company is going to liquidate and a liquidator is appointed for the same.
  • When a business unit is passing through severe financial crisis and going to wind up.

Cost Concept

One more important concept based on the Going Concern Concept is the Cost Concept. The value of the assets is booked on the basis of cost and not on the net realization value or the market value. The value of the assets is reduced by providing depreciation to assets and the market value of the assets is ignored.

The manipulation regarding the net realizable value or the market value is stopped by the cost concept. The effect of inflation in the market is ignored. The cost concept is widely and universally accepted on the basis of which the accounting of a business is done.

Dual Aspect Concept

Any financial transaction is completed only when there is a double entry, in the sense that debit is always equal to credit. Thus every financial transaction has dual aspect:

  • Get some benefit, and
  • Pay some benefit.

For instance, if some stock is purchased, then it will have two effects:

  • the value of stock will increase (get benefit for the same amount), and
  • it will increase the liability in the form of creditors.

Transaction

Effect

Purchase of Stock for Rs 25,000

Stock will increase by Rs 25,000 (Increase in debit balance)

Cash will decrease by Rs 25,000 (Decrease in debit balance)

or

Creditor will increase by Rs 25,000 (Increase in credit balance)

Accounting Period Concept

The profit or loss of a firm is determined, the financial position is ascertained and the balance sheets are prepared at regular intervals of time usually at the end of each year. The one-year cycle is known as accounting period. Accounting period is maintained to take up corrective measures considering the past performance and the seasonal changes are nullified and the taxes are paid.

This concept helps in segregating the revenue and capital expenditure. Revenues expenditure are debited to the profit & loss account to ascertain correct profit or loss during a particular accounting period. Capital expenditure comes in the category of those expenses, the benefit of which will be utilized in the next coming accounting periods as well.

The correct position of the firm at regular intervals of time is ascertained by using the Accounting period.

Matching Concept

Matching concept is based on the accounting period concept. For a particular accounting period, the expenditure of a firm is matched with the revenue to ascertain the accurate profit or loss of a firm. The Matching concept is better explained with the help of an illustration.

The following data is received from M/s Globe Enterprises during the period 01-04-2012 to 31-03-2013:

S.No.
Particulars
Amount
1
Sale of 1,000 Electric Bulbs @ Rs 10 per bulb on cash basis.
10,000.00
2
Sale of 200 Electric Bulb @ Rs. 10 per bulb on credit to M/s Atul Traders.
2,000.00
3
Sale of 450 Tube light @ Rs.100 per piece on Cash basis.
45,000.00
4
Purchases made from XZY Ltd.
40,000.00
5
Cash paid to M/s XYZ Ltd.
38,000.00
6
Freight Charges paid on purchases
1,500.00
7
Electricity Expenses of shop paid
5,000.00
8
Bill for March-13 for Electricity still outstanding to be paid next year.
1,000.00

Based on the data, the profit or loss of the firm is calculated as follows:

Particulars
Amount
Total
Sale
Bulb
12,000.00
Tube
45,000.00
57,000.00
Less -
Purchases
40,000.00
Freight Charges
5,000.00
Electricity Expenses
1,500.00
Outstanding Expenses
1,000.00
47,500.00
Net Profit
9,500.00

The credit purchase and the outstanding expenses of the accounting year are added to match the expenditures and revenues during the same accounting period to ascertain the correct profit for the accounting period 01-04-2012 to 31-03-2013.

In the sense the collection of cash and the payment in cash is ignored when the profit or loss of the year is calculated.

Accrual Concept

Similar to that of the matching concept, the revenue generated in the accounting period is considered and the expenditure related and the revenue generated to the accounting period is considered. According to accrual concept, the items sold or the services rendered become a part of revenue generation, either cash is received or not. The same applies to expenses as well. All the expenses paid in cash or payable are considered and the advance payment of expenses, if any, is deducted.

Mostly cash basis of accounting is used in the sense that the cash received in a particular accounting period and the expenses paid in cash in the same accounting period is considered as the basis of accounting. The income of the firm depends on the collection of revenue in cash. On the same basis, taxes are paid.

Objective Evidence Concept

According to the Objective Evidence concept, some objective evidence should support each financial entry. For instance, the purchase and sales should be supported by purchase and sales bills, cash payment with cash memos and payments with cash receipts and bank statements. In the same fashion, the stocks are verified physically and value is verified with purchase bills. Absence of any of these implies that the value of the accounting results is not trustworthy. In such cases, the chances of manipulation will be high in accounting record and as a result the reliability on such financial statements seems to be risky.

All rights reserved © 2018 Wisdom IT Services India Pvt. Ltd DMCA.com Protection Status

Accounting Basics Topics