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Accounting concepts
Accounts are records of financial transactions. Information that is used in accounts is initially entered into books of prime entry, which may simply be paper or computer records. This helps with financial planning. From there the information will be entered into a double entry system in a book (or computer programmed) called the ledger. Each account is kept on a separate page in the ledger, and every account has two sides - a debit and a credit side. Information will then be extracted so that it can be presentedinafinancial report.
The accounting equation. An essential component of accounting is what is referred to as the accounting equation, which in a nutshell means that the assets of the organization (what it owns or is owed by others) is equal to the liabilities of the organization In this country there are a variety of accounting conventions and standards which must be adhered to. In preparing final accounts there are a number of key accounting concepts which you need to be familiar with:
Following are the various accounting Concepts that have been discussed in the following sections:
1. Business entity concept
2. Money measurement concept
3. Going concern concept
4. Accounting period concept
5. Accounting cost concept
6. Duality aspect concept
7. Realization concept
8. Accrual concept
9. Matching concept
Business entity concept
This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate. For example, when the owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. This concept is the very basis of accounting.
Money Measurement Concept
This concept assumes that all business transactions must be in terms of money that is in the currency of a country. In our country such transactions are in terms of rupees. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. For example, sale of goods worth Rs.200000, purchase of raw materials. Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, loyalty, honesty of employees are not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business concern..
Going Concern Concept
This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet; For example, a company purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it will not be proper to charge the amount from the revenues of the year in which the item is acquired. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset.
Accounting Period Concept
All the transactions are recorded in the books of accounts on the assumption that profits on these transactions are to be ascertained for a specified period. This is known as accounting period concept. Thus, this concept requires that a balance sheet and profit and loss account should be prepared at regular intervals. This is necessary for different purposes like, calculation of profit, ascertaining financial position, tax computation etc. Further, this concept assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be of one year, six months, three months, one month, etc. But usually one year is taken as one accounting period which may be a calender year or a financial year.
As per accounting period concept, all the transactions are recorded in the books of accounts for a specified period of time. Hence, goods purchased and sold during the period, rent, salaries etc. paid for the period are accounted for and against that period only.
Accounting cost concept
Accounting cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc are recorded in the books of accounts at a price paid for them. For example, a machine was purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000 were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on its installation. The total amount at which the machine will be recorded in the books of accounts would be the sum of all these items i.e. Rs.503000. This cost is also known as 22historical cost. Suppose the market price of the same is now Rs 90000 it will not be shown at this value. Further, it may be clarified that cost means original or acquisition cost only for new assets and for the used ones, cost means original cost less depreciation. The cost concept is also known as historical cost concept. The effect of cost concept is that if the business entity does not pay anything for acquiring an asset this item would not appear in the books of accounts. Thus, goodwill appears in the accounts only if the entity has purchased this intangible asset for a price.
Dual Aspect Concept
Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded. Thus, the duality concept is commonly expressed in terms of fundamental accounting equation :
Assets = Liabilities + Capital
The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners equity and that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities. Let us analyses some more business transactions in terms of their dual aspect:
Realization Concept
This concept states that revenue from any business transaction should be included in the accounting records only when it is realized. The term realization means creation of legal right to receive money. Selling goods is realization, receiving order is not in other word Revenue is said to have been realized when cash has been received or right to receive cash on the sale of goods or services or both has been created..
Accrual Concept
The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognised when they become receivable. Though cash is received or not received and the expenses are recognized when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate. Therefore, the accrual concept makes a distinction between the accrual receipt of cash and the right to receive cash as regards revenue and actual payment of cash and obligation to pay cash as regards expenses. The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or services irrespective of the fact when the cash is received. For example, a firm sells goods for Rs 55000 on 25th March 2005 and the payment is not received until 10th April 2005, the amount is due and payable to the firm on the date of sale i.e. 25th March 2005 It must be included in the revenue for the year ending 31st March 2005. Similarly, expenses are recognised at the time services provided, irrespective
Matching Concept
The matching concept states that the revenue and the expenses incurred to earn the revenues must belong to the same accounting period. So once the revenue is realised, the next step is to allocate it to the relevant accounting period. This can be done with the help of accrual concept. Accounting of limitation The Followings are the Main Limitations of Accounting
Accounting is of Historical Nature
Net effect of transactions are recorded in financial accounting which has happened in past. These accounts is just postmortem of all events of business in past .These record does not help for future planning and other managerial decisions. Financial accounting shows the profitability of business but it is failure to tell that is it good or bad. Financial accounting is also failure to know the reasons of low profitability position.
Accounting Deals With Overall Profitability
Accounts of business are made by a way which shows only overall profitability .It does not shows net profit per product , or per department or according to job . Thus to find difficult to all activities which do not give profit. So, it creates inefficiency in business activities.
Absence of Full Disclosure of Facts In financial accounting we record only those activities and transactions which we can show or describe in money. There are many other facts of business which are non financial and non monetary like efficient management, demand of products of firm, good relations in industry, good working environments which cannot be known by financial accounting. Accounting Reports are Interim Report of Business Financial statements made by accounting is the interim report of firm’s all business work but financial position and profitability which are shown in it is not fully true . Due to adopting cost concept, all transactions are recorded on it real cost but by changing in the time; it is the need of time to adjust cost of assets and liabilities according to inflation of market. Because, financial accounting does not records according to inflation so its result does not show true position of business. Incomplete Knowledge of Costs
from cost point of view, financial accounting is incomplete. In financial accounting, accountant does not calculate each and every product’s total cost. So, financial accounting does not help to determine the price of product of business. No Provision of Cost Control Financial accounting does not help business organization for controlling the cost. Because, there is no provision of controlling cost in it. In financial accounting, we write cost, if we paid any expenses. Thus there is no provision of improvement in financial accounting. Except this, there is no any other way to inspect all expenses. Accounting Statements are Affected From Personal Judgment Many events of accounting statements are affected from personal judgment of accountant. Method of calculating depreciation, rate of provision of doubtful debts and stock valuation method are decided by accountant. Thus, financial statements do not show true and fair view of business. Accounting transactions are recorded at cost in the books The effect of price level changes is not brought into the books with the result that comparison of the various years becomes difficult. For example, the sale to total asset in 2009 would be much higher than in 2002 due to rising prices, fixed assets being shown at the cost and not at market price.
Reference
Kermit D.Larson, William W. Pyle (1986) “Financial Accounting” 3th edition, USA. K. fred Skousen, Earl K. Stice, (1993) “Intermediate Accounting” 13th edition, ITP Company, United States of America. Murray, Neumann, Elgrs, (2000) “Financial Accounting and Introduction” 2th edition, United States of America. Needless, Anderson, Caldwell (1993) “Principles of Financial Accounting” 5th edition, Houghton Mifflin Company, Boston, Toronto. Weyoandt, Kieso, Kimmel, (2003) “Financial Accounting” 4th edition, John Wiley Fsons INC, United States of America.
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