Accounting Conventions and Accounting Concepts

(one) Relevance

The relevance convention emphasizes the fact that accounting should only make available information that is relevant and useful to achieve its objectives. For example, are companies interested in knowing what the total cost of labor has been? You are not interested in how many employees spend and how much they save.

(two) Objectivity

The objectivity convention emphasizes that accounting information should be measured and expressed by standards that are commonly accepted. For example, inventories of goods that remain unsold at the end of the year should be valued at their cost price, not at a higher price, even if they are likely to sell at a higher price in the future. The reason is that no one can be sure of the price that will prevail in the future.

(3) Feasibility

The feasibility convention emphasizes that the time, labor, and cost of analyzing accounting information must be weighed against the benefits that accrue from it. For example, the cost of ‘oiling and greasing’ machinery is so small that scrapping it per unit produced will be meaningless and will amount to wasted labor and accounting staff time.

Accounting Concepts

(one) Materiality

It refers to the relative importance of an element or event. Accounting decision makers are continually faced with the need to make judgments about materiality. Is this element big enough that information users are influenced by it? The essence of the concept of materiality is: an omission or misstatement of an item is material if, in light of the surrounding circumstances, the magnitude of the item is such that a reasonable person’s judgment based on the report is likely to would have been changed or influenced by the inclusion or correction of the article.

(two) Accounting period

Although the accounting practice believes in the concept of continuous entity, that is, the life of the business is perpetual, but still it must report the ‘results of the activity carried out in a specific period (normally one year). Therefore, accounting attempts to present the profit or loss realized or suffered by the business during the period under review. Normally, it is the calendar year (from January 1 to December 31), but in other cases it can be the fiscal year (from April 1 to March 31) or any other period depending on the convenience of the business or according to the practices commercial of the country. concerned

Due to this concept it is necessary to take into account during the accounting period, all items of income and expenses accrued at the date of the accounting year. The problem with this concept is that a proper allocation must be made between capital spending and revenue spending. Otherwise, the results disclosed by the financial statements will be affected.

(3) Realization

This concept emphasizes that profit should be considered only when it is realized. The question is at what stage profits should be considered to have increased. Either at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash. To answer this question, accounting conforms to the law (Sales of Goods Law) and recognizes the principle of law, that is, income is obtained only when goods are transferred. It means that the profit is considered to have increased when ‘ownership of the goods passes to the buyer’, viz. when sales are affected.

(4) Pareo

Although the business is a continuing affair, its continuity is artificially divided into several accounting years to determine its periodic results. This profit is the measure of a company’s economic performance and, as such, increases the owner’s equity. Since profit is an excess of income over expenses, it is necessary to collect all income and expenses related to the period under review. The concepts of realization and accrual derive essentially from the need to equate expenses with income obtained during the accounting period. Revenues and expenses shown on an income statement must relate to the same goods transferred or services provided during the accounting period. The matching concept requires that expenses be matched to revenue in the appropriate accounting period. So, we must determine the income earned during a particular accounting period and the expenses incurred to obtain this income.

(5) Entity

According to this concept, the task of measuring income and wealth is carried out through accounting, for an identifiable Unit or Entity: The unit or entity so identified is treated differently and distinctly from its owners or taxpayers. In law, the distinction between owners and business is made only in the case of joint stock companies, but in accounting, this distinction is made in the case of sole proprietorship and partnership as well. For example, property used from the company’s inventory for business purposes is treated as business expense, but similar property used by the owner, that is, the owner for his personal use, is treated as his drawings. Such a distinction between the owner and the business unit has helped accounting report profitability more objectively and fairly. It has also led to the development of “responsibility accounting” that allows us to know the profitability even of the different sub-units of the main business.

(6) Stable Monetary Unit

Accounting assumes that the purchasing power of the monetary unit, for example, the rupee, remains the same at all times. For example, the intrinsic value of a rupee is the same and the same in the year 1800 and 2000, thus ignoring the effect of the increase or decrease in the purchasing power of the monetary unit due to deflation or inflation. Even though the assumption is unrealistic and the practice of ignoring changes in the value of money is now being widely questioned, alternatives are still being suggested to incorporate the changing value of money into financial statements, i.e. the purchasing power method. (CPP) and the current cost accounting method (CCA) are in the evolutionary stage. Therefore, for the time being we have to be content with the concept of a ‘stable monetary unit’.

(7) cost

This concept is closely related to the going concern concept. According to this, an asset is normally recorded in the books at the price at which it was acquired, that is, at its cost price. This ‘cost’ serves as the basis for accounting for this asset during the subsequent period. This ‘cost’ should not be confused with ‘value’.

It should be remembered that the fact that the actual value of assets changes from time to time does not mean that the value of those assets is incorrectly recorded in the books. The book value of registered assets does not reflect their real value. They do not mean that the values ​​indicated therein are the values ​​for which they can be sold. Although assets are recorded on the books at cost, over time their value decreases due to depreciation charges. In certain cases, only assets such as ‘goodwill’ when paid will appear on the books at cost and when nothing is paid they will not appear even though this asset exists in the name and fame created by a company.

Therefore, it cannot be said that the values ​​attached to the assets on the balance sheet and the net income shown on the Profit and Loss account reflect the correct measurement of the financial position of a company, since they have no relation with the market value of the assets or their replacement values. This idea that transactions should be recorded at cost and not at some subjective or arbitrary value is known as the concept of cost. Over time, the market value of fixed assets such as land and buildings varies greatly from their cost.

These changes or variances in value are generally ignored by accountants and they continue to value them on the balance sheet at historical cost. The principle of valuing fixed assets at cost and not at market value is the underlying principle in the concept of cost. According to them, current values ​​alone will fairly represent the cost to the entity.

The cost principle is based on the principle of objectivity. Supporters of this method argue that as long as users of financial statements have confidence in the statements, there is no need to change this method.

(8) Conservatism

This concept emphasizes that profits should never be exaggerated or anticipated. Traditionally, accounting follows the rule of “anticipating profits and anticipating all possible losses”. For example, closing shares are valued at cost price or market price, whichever is lower. The effect of this is that if the market price has gone down then you anticipate the ‘anticipated loss’, but if the market price has gone up then you ignore the ‘anticipated gains’.

Critics point out that over-conservation will result in the creation of a secret reserve. This will be quite contrary to the disclosure doctrine. However, conservatism to a reasonable degree may not be criticized.

accounting equation

The dual concept can be expressed as “for every debit, there is a credit”. Each transaction must have a two-sided effect to the extent of the same amount. This concept has resulted in the Accounting Equation which states that, at any time, the assets of any entity must be equal (in monetary terms) to the total of the owner’s equity and external liabilities. This can be expressed as an equation:

AL=P

where

A represents the assets of the entity;

L represents the liabilities (third party claims) of the entity; Y

P represents the right of the owner (Capital) on the entity.

(The form of presentation of the equation AL = P is consistent with the legal interpretation of the financial position. Therefore, it emphasizes that properly speaking the property right is the balance after providing for the rights of third parties against the business of the assets business totals).