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ACCOUNTING PRINCIPLES Basic Concepts Of Accounting Paridhi PGDM-Communications Roll No-44

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

ACCOUNTING DEFINED: Accounting is a set of concepts and techniques that are used to measure and report financial information about an economic unit. The economic unit is generally considered to be a separate enterprise. The information is potentially reported to a variety of different types of interested parties. These include business managers, owners, creditors, governmental units, financial analysts, and even employees. In one way or another, these users of accounting information tend to be concerned about their own interests in the entity. Business managers need accounting information to make sound leadership decisions. Investors hold out hope for profits that may eventually lead to distributions from the business" Creditors are always concerned about the entity's ability to repay its obligations. Governmental units need information to tax and regulate. Analysts use accounting data to form their opinions on which they base their investment recommendations. Employees want to work for successful companies to further their individual careers, and they often have bonuses or options tied to enterprise performance. Accounting information about specific entities helps satisfy the needs of all these interested parties. The diversity of interested parties leads to a logical division in the discipline of accounting: financial accounting and managerial accounting. Financial accounting is concerned with external reporting of information to parties outside the firm. In contrast, managerial accounting is primarily concerned with providing information for internal management FINANCIAL ACCOUNTING: Consider that financial accounting is targeted toward a broad base of external users, none of whom control the actual preparation of reports or have access to underlying details. Their ability to understand and have confidence in reports is directly dependent upon standardization of the principles and practices that are used to prepare the reports. Without such standardization, reports of different companies could be hard to understand and even harder to compare. As a result, there are well organized processes to bring consistency and structure to financial reporting. In the United States, a private sector group called the Financial Accounting Standards Board (FASB) is primarily responsible for developing the

rules that form the foundation of financial reporting. With the increase in global trade, the International Accounting Standards Board (IASB) has been steadily gaining prominence as a global accounting rule setter. Financial reports prepared under the generally accepted accounting principles (GAAP) promulgated by such standard setting bodies are intended to be general purpose in orientation. This means they are not prepared especially for owners, or creditors, or any other particular user group. Instead, they are intended to be equally useful for all user groups. As such, attempts are made to keep them free from bias (neutral). MANAGERIAL ACCOUNTING: In sharp contrast to financial accounting, managerial accounting information is intended to serve the specific needs of management. Business managers are charged with business planning, controlling, and decision making. As such, they may desire specialized reports, budgets, product costing data, and other details that are generally not reported on an external basis. Further, management may dictate the parameters under which such For instance, GAAP may require that information is to be accumulated and presented.

certain research costs be deducted immediately in computing a business's externally reported income; on the other hand, management may see these costs as a long-term investment and stipulate that internal decision making be based upon income numbers that exclude such costs.

FUNDAMENTAL ACCOUNTING CONCEPTS AND ASSUMPTIONS: Externally communicated accounting information must be prepared in accordance with accounting standards that are understood by both the senders and the users of the information. These standards are known as Generally Accepted Accounting Principles (GAAP), and provide the general framework for determining what information is included in the financial statements and how this information is to be presented. Since accounting is a service activity, these principles reflect the needs of the society and not those of the accountants or any other single constituency. These are the guidelines for measurement and presentation of accounting information and are used by professional accountants in preparing accounting information and reports

There are 12 general accounting principles: The Money Measurement Entity Going concern Cost Dual aspect Accounting period Conservatism Realization Matching Consistency Materiality Objectivity

The Money Measurement Concept:

Record should be made of that information that can be expressed in monetary terms Although the business may own seven buildings, five boilers, fifty cars, thirty trucks, you cannot add them together simply like that and get to know what the business is worth. Expressing these items in monetary terms by saying that one has buildings worthRs15 crores, boilers worth Rs 50 lac, cars worth Rs 1 crore and trucks worths 2 crores would make it easier for one to add up these items by adding their monetary values.

We may not be able to add apples and oranges directly but we can add them easily by expressing them in their monetary terms. So the money provides a common denominator by which the resources and other factors about the business entity can be expressed and valued. Expressing in monetary terms also helps in understanding the changes their impact on the value of the resources. As you see this concept imposes a severe limitation on the scope of accounting. It is impossible for the accounting to record or report the health of the key people in the organization or the plant that is not working or the labor is going on strike or that the key people are leaving the organization and other important factors that may have a direct bearing on the future of the organization.

Entity Concept:
Accounts can only be kept for entities which are different from the persons who are associated with these entity. For accounting purposes, an entity is the organizational unit for which accounting records are maintained, e.g., Joseph Labrador Accounting Firm. Under entity concept, the business is regarded as having a separate and distinct personality from that of the owner/s generating its own revenue, incurring its own expenses, owning its own assets, and owing its own liabilities (Smith, Keith, et al, 1993). This means that the Personal transactions of owners must not be combined with transactions of the business. This concept also requires that an accountant record only those financial occur between the entity being accounted for and other parties. Thus, the accounting entity assumption establishes boundaries or limits as to what information should be included in the financial statements of a given company A business event that can be measured in terms of money that affects the enterprise. This would give rise to an exchange between the business and another party: value received and value parted with. activities that

Example: A barber provides services to a customer by trimming the latters hair: value parted with by the barber will be his service and time; and the value received is the payment made by the client.

The Going Concern Concept:

Accounting records, events and transactions on the assumption that the entity will continue to operate for an indefinitely long period of time. The going concern concept is the backbone of accounting and is based on the following assumptions: i) Business has an indefinite life.

ii) Assets are depreciated on the basis of their expected life without caring for their current values

The Cost Concept:

Assets are always shown at their cost price rather than their market price Every transaction must be recorded at its acquisition price. This does not mean that the asset will always be shown at the cost price. It means that the asset is recorded at its cost price and is systematically reduced or increases in value by charging depreciation/appreciation. This is applicable to fixed assets and not the current assets. Assets, i.e., resources acquired by the business, must be recorded at acquisition price (i.e., what you have to give up in exchange for an ownership of an asset) and no adjustments are to be made on this valuation in later periods. The cost principle assumes that assets are acquired in business transactions conducted at arm's length transactions, i.e., transactions between a buyer and a seller at the fair value prevailing at the time of the transaction

 . For noncash transactions conducted at arm's length, the cost principle assumes that the market value of the resources given up in the transaction provides reliable evidence for the valuation of the item acquired. The cost principle provides guidance primarily at the initial acquisition date. Once acquired, the original cost basis of some assets is then subjected to depreciation, depletion, amortization, etc. over time to reflect the said assets in the balance sheet in a more realistic valuation

Dual Aspect Concept:

The value of the assets owned by the company is equal to the claims on these assets. This is the basic concept of accounting. Every Dr entry has its corresponding Cr entry. This concept can be expressed as ASSETS = CAPITAL + LIABILITIES

Accounting Period Concept:

Accounting measures activity for a specified interval of time, usually a year. At the end of each period an income statement and balance sheet are prepared for finding the profit and loss and financial position of the business as on the last day of the accounting period.

Conservatism:
This concept states that anticipate no profit and provide for all possible losses, i.e., all likely losses should be recognized even if they have not yet occurred and profits should be recognized only when they have been earned. In other words, the profits should never be overstated, though they may be understated. For example, costing of inventory, investments etc. The concept has a powerful influence in valuing assets and measuring net income. When faced which uncertainties, the accountant traditionally leans towards the direction of caution, choosing the method that would give the business a less favorable financial condition and lowers net income. The reasoning behind this assumption is that investors prefer information that does not unnecessary raise expectations. For example: In recognizing assets, preferably the lower of two alternative valuations would be recorded. In recognizing liabilities, preferably the higher of two alternative amounts would be recorded. In recording revenues, expenses, gains, and losses where there is reasonable doubt as to the appropriateness of alternative amounts, the one having the least favorable effect on net income should be preferred. Conservatism assumes that when uncertainty exists, the users of financial statements are better served by understatement than by overstatement of net income and assets

Realization Concept:
The sale is considered to have taken place only when either the cash is received or some third party becomes legally liable to pay the amount. According to this concept only those transactions are recorded in accountings which have actually taken place and not the ones that will take place in the future.

 Revenue or income is the inflow of assets that results from producing goods or rendering services. Revenue is not earned all at one point in time. Instead, the earning process extends over a considerable length of time. The revenue realization concept provides that income is recognized when earned regardless whether cash is received. This means that both of the following conditions are met: The earning process is essentially complete; An exchange has taken place (Smith, Keith, et al, 1993).These two conditions for most of the companies are met at the time goods are sold or services rendered. To wit: Two points of income recognition: Income is considered earned when services are fully rendered. Income is considered earned when goods or merchandise are fully delivered

Matching Concept:
Matching means appropriate association of related revenues and expenses. The profit of the business is ascertained only when the revenue earned during a particular period is compared with the expenditure incurred for earning that particular revenue. This concept states that all expenses incurred to generate revenues must be recorded in the same period that the income are recorded to properly determine net income or net loss of the period. There is a cause-and-effect relationship between revenue and expense recognition implicit in this definition Revenues are inflows of resources resulting from providing goods or services to customers.

 For merchandising companies like Shoe Mart, the main source of income is sales revenue derived from selling merchandise. Service firms such as SGV and Company generate revenue by providing services

Consistency:
According to this convention, an enterprise should be consistent in the accounting policies from one accounting period to another period. This, however, does not prevent adoption of changes in accounting policies and practices if these are warranted by changed conditions. Reasons for such changes and the implications of changed policies need to be disclosed in the annual report.

Materiality:
It states that the cost of data collection in terms of time,

e f f o r t s , a n d expense should not exceed the benefits to be derived from such an effort. The convention emphasizes that accounting should be concerned with

significant and material events for recording purposes. This concept refers to relative importance of an item or event. An item/event is considered material if knowledge of it would influence the decision of prudent users of financial statements. To illustrate an instance where strict conformity with GAAP is not necessary because an item is immaterial, consider a low-cost asset, such as a P150 waste can. This item can be recorded as an expense in full when purchased rather than an asset subject to depreciation. The peso amount involved is simply too small for external users of financial reports to worry about.

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