Diving Deeper: Concepts, Conventions & Conditions

Accounting Concepts

Assumptions & conditions used in the preparation of financial statements are accounting concepts. Here, we’ll be breaking down some of those:

• Separate Entity

  The business and its owners are two distinct identities. They are treated as independent of each other when it comes to financial transactions. Let’s take the example of Tata Motors & its founder J.R.D. Tata. Since both are separate entities, the financial business transactions in the name of Tata Motors do not imply transactions with J.R.D Tata & both of them have a unique identity independent of each other.

  
• Money measurement

  Business transactions that can be expressed in terms of money (are measurable) are recorded in books of accounts. For instance, you purchase raw material worth INR 50,000 - this purchase will be recorded in the books of accounts. However, the quality of the raw material will not be recorded as it cannot be quantified in monetary terms.

• Dual aspect

  This concept lays the foundation of accounting. It means that every financial transaction has two effects i.e., it impacts two accounts, and it should be recorded at two places in the books of accounts. For instance, cash paid to a raw material supplier impacts your cash account as well as the supplier’s account in the books.

  
• Going concern

  For accounting, an entity is presumed to continue its operations for a reasonably long stint. It will not liquidate soon and will continue meeting up its commitments and obligations as and when they are due.

  
• Accounting period

  To provide timely information to the users, every business entity is required to present financial reports of a particular duration. Thus, the lifecycle of a business is divided into short periods for the purpose of financial reporting which can be either calendar or fiscal year. Generally, the fiscal year i.e., ending 31st March is taken for annual reporting. However, users can also seek information regarding business performance during the year. Therefore, businesses also perform quarterly reporting.

• Cost concept

  The fixed assets (also called long-lived assets) of a business are recorded based on their original costs i.e., the costs incurred to acquire them. Subsequently, the value of these assets is depreciated based on the wear and tear in each accounting period. However, no change in market price is considered.

• Accrual concept

  The accrual concept implies that the revenues are recorded by the accountants as and when they are earned even if it’s hard cash. Similarly, the expenses are recorded as and when they are incurred regardless of being paid in cash.

• Revenue recognition

  The revenue from the sale of goods is recognized by accountants when Person A has transferred related risks and ownership to Person B (the buyer). Additionally, the revenue from rendering the service is recognized when the transaction is completed & can be measured reliably. For instance, Business Today receives Rs. 50,000 as prepaid subscriptions for magazines from Masters’ Union. This revenue will not be recorded in the books of accounts until the magazines are delivered to the institution.

• Matching concept

  This concept relates to the recognition of expenses. The accountant records expenses related to revenue when revenue is earned. However, certain expenses which cannot be linked to the revenue are matched to the accounting period when they are incurred. For instance, the sales commission is linked to revenue and is recorded in the period when revenues are recognized. However, the monthly rent paid for the business is recorded based on the period it is paid for regardless of the revenues.