Classification of Accounting principles

Accounting principles are also referred to as standards, assumption, postulates, concepts, convention, axioms, generally accepted accounting principles (GAAP) etc. The above term are interchangeably used though they have different connotations. We will discuss here only assumption, concepts and conventions because these terms have reasonable bearing on the accounting system.

(A) Accounting assumptions

Certain fundamental Accounting assumptions underline the preparation and presentation of financial statement. Institute of Chartered Accountants of India and International Accounting Standards Committee vide AS-1 respectively have stated the following as Fundamental accounting assumption :

(1) Going concern : Accounting records presume that the business will exist for a very long time unless the evidence available is contrary to this. Under this assumption, "the enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operation". This assumption of continuity has an important implication for the valuation of assets and liabilities accordingly, the assets of business enterprise are shown in the balance sheet at cost less depreciation and not on current realisable value. The liabilities are shown at the value what business actually whoes and not the value which would be paid in the event of liquidation or dissolution. Besides, under this concept, prepaid expenses are recognized as assets since the benefit will be utilized in future, when business entity will continue.

(2) Consistency : The principles of consistency implies that a particular Accounting method once adopted, will not be changed from year to year. This assumption is important to ensure uniformity in Accounting processed and policies. Uniformity in Accounting policies helps in interpreting intelligently the change in financial statements. If an assets is depreciated on diminishing balance method in one year, the same method of depreciation should be followed in other years also. It does not mean that once a method is available, it may be followed.

(3) Accrual : According to this assumption, revenue is recognized when it is earned and expense is recognized when obligation of payment arises. Cash may be received by or paid in advance or samultaneosly on accrual or on a later date. According to IAS-1 revenue and costs are incurred that is recognized as they are earned or incurred (and not as money is received or paid) and recording in the financial statements or the periods to which they relate".

(B) Accounting conventions

Concept denotes logical consideration and a nation which is generally and widely accepted. The term is not used in the sense of a set of hard and fast rules but rather of rules of general application which helps in the selection of Accounting methods appropriate in particular circumstances.

(1) Business entity concept : According to this concept, the task of measuring income and wealth is undertaken by Accounting for an identifiable unit or entity. The unit or entity so identified is treated different and distinct from it's owners or contributors. In law, the distinction between owners and the business is drawn only in case of joint stock Companies but in accounting, this distinction is made in the case of sole proprietor and partnership firm as well. For example, goods used from the stock of the business for business purposes are treated as business expenditure but similar goods sued by the proprietor i.e. owner for his personal sues are treated as his drawings. Such distinction between the owner and the business unit has helped Accounting in Reporting profitability more objectively and fairly. It has also lead to the Development of "responsibility Accounting" which enables us to find out the profitability of even the different sub units of the main business.

(2) Money measurement concept : All the business transaction are measured and settled in monetary terms. Money is a common denominator. It is used to measure assets, liabilities, expenses, losses, incomes, etc. Money is a medium to value the quantities. Supposed, a firm has 20 chairs, 5 tons of raw materials and 3 machines. This information is not much meaningful to keep systematic records. If one says that a firm has chair worth rs 6,000, raw material worth rs 10,000. and machines worth rs 60,000, it is more meaningful and information to keep proper record. In India, rupee is the legal currency for measurement. The money measurement concept holds that the transaction ahnd events, which cannot be measured in monetary terms are not recorded in accounting. The skill, experience and honestly of a chairman or a manager; employer and employee cordial relations; profit yeilding sales promotion policy,etc. are not recorded in the books of accounts.

(3) Accounting period concept : Though accounting practice believe in continuing entity concept i.e. life of the business is perpetual but still it has to Report the 'results of the activitiy undertaken in specific in specific period (normally one year) . Thus, accounting attempts to present the gains or losses earned or suffered by the business during the period under review. Normally, it is the financial year ( i.e. 1st April to 31st March). Due to this concept, it is necessary to take into account all items of revenue and Expenses accruing during the accounting period.

(4) Cost concept : This concept is closely related to going concern concept. According to this, an asset is ordinarily recorded in the books at the price at which it was acquired i.e. at its cost price. This 'cost' serves the basis for the accounting of this assets during the subsequent period. This cost should not be confused with value. It must be remembered that as the real worth of assets changes from time to time, it does not mean that the value of such assets is wrongly recorded in the books. The book value for the assets as recorded do not reflect their real value. They do not signify that the values noted therein are the values for which they become reduced in value on account of depreciation charges. In certain cases, only the assets like 'goodwill' when paid for will appear on the books at cost and when nothing is paid for, it will not appear even though this assets exists on name and frame created by a concern. This idea that the transaction should be recorded at cost rather that at a subjective or arbitrary value is known as Cost Concept.

With the passage of time, the market value of fixed assets like hand land and building vary greatly from their cost. These changes or variations are generally, ignored by the accountants and they continue to value them at historical cost (i.e. the cost at which purchased). The method of valuing the fixed assets at their cost and not at market value is the underlying principle in cost concept. The cost Concept is based on the principle of objectivity.

(5) Dual aspect Concept : Dual concept may be stated as "for every debit there is a credit". Every transaction should have two sided effect to the extent of the same amount. This Concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms ( to the total of owners equity and outsider's liabilities. This may be expressed in the firm of equation:

A--L= C

Where A stands Assets.

L stands as Liabilities

and C states Capital of the business

(6) Revenue Recognition (Realisation) Concept : This concept emphasizes that profit should be considered only when realized. The question is at what stage profit should be deemed to have accrued? Whether at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash? For answer this question, the accounting is in conformity with the law (Sales of Goods Act) and recognises the principle of law i.e. the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when property in goods passes to the buyer i.e. when sales are effected.

(7) Matching concept : Though the business is a continuous affairs yet its continuity is artificially split into several accounting years of determining it's periodic results. This profit is the measures of Economic performance of a concern and as such it increases proprietors equity. since profit is an excess of revenue over expenditure it becomes necessary to bring together all revenues and expenses relating to the period under review. The realisation and accrual concepts are essentially derived from the need of matching Expenses shown in an income statement must both refer to the same goods transferred or services rendered during the accounting period. The matching concept requires that expenses should be matched to the revenues for the appropriate accounting period. So, we must determine the revenue earned during a particular accounting period and the expenses incurred to earn these revenues.

(8) Stable Monetary Unit concept : Accounting presumes that the purchasing power of monetary unit, say rupee, remains the same throughout, thus ignoring the effect to rising or falling purchasing power of monetary unit due to deflation or inflation. Inspire of the fact that the assumption is unreal and the practice of ignoring changes in the value of money is now being extensively questioned, still the alternatives suggested to incorporate the changing value of money in Accounting statement viz., current purchasing power method (CPP) and current cost accounting method (CCA) are in evolutionary stage. Therefore, for the time being, we have to be content with the stable monetary unit concept.

(C) Accounting Conventions

The term Convention means as established usage. Conventions are based on customs and practicability, which may have some logic behind it's usage. The writing of the words 'To' and 'By' along with the names of the persons, properties or expenses and income respectively on the debit and credit side of the account is a convention followed in the U.K. , India and other countries but not in U.S.A. The convention are discussed as follows :

(1) Full disclosure : The doctrine of disclosure suggest that the financial statement should act as a full means of conveying and not concealing. The financial statements must disclose all the material, relevant and reliable information which may be more beneficial to the shareholders, creditors, bankers etc. If some material information is not shown in the balance sheet, the practice of appending notes has developed as a result of principle of full disclosure. It is necessary that the information is accounted for and presented in accordance with it's substance and Economic reality and not merely with it's legal form.

Disclosure of material facts does not mean leaking out the business secrets, but disclosing all relevant information for the use of creditors and investors. It builds the confidence and faith among them. Earlier, the disclosure of useful information with the users was voluntary but now the enactment of law of Right to information has rolled the ball in the court of creditors and investors. They can seek any relevant information from the enterprises without much difficulty.

(2) Conservatism or prudence : Business is prone to risks and uncertainties. No one can guess future business happenings with perfect certainty. Prudence in financial statement requires "anticipate no profits, but provide for all losses". In other words, accountants follows the policy of playing safe. If Market price of stock is more than cost, the stock is recorded at cost, as the unrealized profit from the increase in the market price is ignored. But, if the market price of stock is lower than the cost, it is recorded at market price because we should make sufficient provision for unforseen losses. So, the stock is recorded at cost or Market price, whichever is lower. Other examples of conservatism are : maintaining provision for doubtful debts showing depreciation only on fixed assets but not appreciation; valuation of investment at cost or Market price whichever is less; ignoring provision for discount on creditors, etc.

(3) Materiality : It refers to the relative importance of an item or event. Those who make accounting decision continually confront the need to make the judgement regarding Materiality. Is this item large enough for user of the information to be influenced by it? The essence of the Materiality concept is : the omission or mis statement of an item is material if, in the light of surrounding circumstances, the magnitude of the item in such that it is probable that the judgement of a reasonable person relying on the report would have been changed or Influenced by the inclusion or correctness of the item.

"an item should be regarded as material, if there is a reason to believe that knowledge of it would influence the decision of informed investors" American Accounting Association (AAA).

(4) Objectivity : Every Accounting transaction is recorded on the basis of some documentary evidence. Investors, bills, cash memos are some of the vouchers used as documentary evidence for recording business transactions. It implies verifiability which mean the true and accurate information is reported. Objectivity connotes reliability and trustworthiness. The accounting information is objective, if it is not influenced by personal bias or judgment of those who provide it. Accounting records maintained on the basis of Proper documentary evidence produced genuine results and are legally acceptable.

Search This Blog