Concepts and Conventions of Accounting


Meaning of Accounting

Accounting can be defined as analyzing, recording, classifying, summarizing all the financial transactions and interpreting the result to the person who is interested in such information. The financial statements used in accounting are the summary of financial transactions over an accounting period. It is prepared for a specific period of time basically for a period of 1 year. It contains analyzing of the business transactions in such a manner that it can be recorded in books of accounts. In small organizations it is recorded by book keeper or the accountant and in large companies there are dozens of employees working in making accounts of the company.

Concepts of Accounting

Separate Legal Entity Concept

Company has a separate legal entity in the eyes of law. Owner and business are two separate entities and they are not liable for each other. The company can sue and can be sued also. The separate entity of business helps the accountant to identify the transactions of the business from the personal ones. This is followed by every form of organization.
Example: If the owner of the company brings additional capital in the company it will be treated as a liability.

Going Concern Concept

It assumes that the business will continue for indefinite period of time. The financial statements are normally prepared on this assumption that the organization will continue for indefinite period and its operations will continue for foreseeable future. Company will continue even after the death of the owner of the company.
Example: If the owner dies than also the company will continue its operations.

Accounting Period Concept

Every company has a specific period of time to complete the accounting cycle. This period is normally of one year and it is called accounting year, it is also mentioned in the financial statement of the company. The life of the company is divided into equal time period which is normally of one year. It is used to evaluate the performance of the company and it also gives timely information to shareholders and the outsiders who wants to invest in the company.

Cost Concept

In this concept of accounting the purchase of assets of the company are taken into books of accounts at the purchase price. Purchase price means the total cost it takes including Installation, transportation or anything which cost with that asset. The market price of the asset is not taken into consideration. 

Realization concept

In realization concept the revenue is taken when it is earned. Revenue arising from the sale of goods and services of the company, this revenue is assumed to be revenue when it is received by the company as cash inflow. Expected gains are not recorded in the books of accounts, only actual profit is taken into account.

Accrual Concept

In this concept, income is recorded in the accounting period in which it is earned. Accrued income must be recognized in the accounting period in which it arisesrather than the period in which it is received. Expenses are recorded when they are incurred, accrued expenses are recognized in the accounting period rather than when they are actually paid.

Matching Concept

In this concept, expenses of the period is matched with the revenue of the same period should only be taken into consideration. Every expense related to the earn that revenue should also be recognized. It considers the expense and income of the period, not the actual inflow and outflow of cash.

Conventions of Accounting

Convention of Conservatism

According to this accounting convention, two values of a transaction are available, value which is lower among the two values is considered. It is to ensure that profit should not be overestimated and there must be some provision for the losses. This convention says that it is better to show less income and resources rather than showing them overestimated.

Convention of Consistency

In this convention of accounting, accounts are prepared on the same rules and practices over a period of time and they are continuously observed and applied. For every year the rules and practices should remain same to draw a conclusion on the operations of the company. The methods and rules of accounting should remain unchanged from one period to another.

Convention of Disclosure

This convention is to provide the real face of the company is disclosed honestly therein. This convention is to communicate all the information and disclose the real financial position of the business. As the management and ownership in the company are different, so there should be a full disclosure of information in front of the owners or shareholders of the company.

Convention of Materiality

Materiality is the convention in which all the material information or important information which can influence the decision of the person who is looking at financial statement should be disclosed. In the accounts all the important data should be recorded and all the insignificant data should be left.