Theory Base of Accounting Notes
Theory base of accounting comprises of concepts, conventions, principles, rules, standards and guidelines develop, to provide uniformity and consistency to accounting records and enhance is utility, to various users (i.e. internal and external) of accounting information.
- Generally Accepted Accounting Principles(GAAP) It refers to the rules or guidelines adopted, for recording and reporting of business transactions, in order to bring uniformity in the preparation and presentation of financial statements.
- Fundamental Accounting Assumptions
- Going concern concept/assumption According to this concept, it is assumed that the business firm would continue its operations indefinitely, i.e. for a fairly long period of time and would not be liquidated in the foreseeable future. All the transactions are recorded in the books on the assumption that it is a continuing enterprise.
- Consistency concept/assumption according the consistency concept, accounting practice once chosen and followed should be consistently over the years. It directly helps to financial statement to be more understand and comparable. This concept is particular important when alternative accounting practice are equally acceptable.
- Accrual concept/assumption according to the concept, a transaction is recorded at the time takes place and not at the time when settlement done. In other words, revenue is recorded which sales are made or services are rendered and irrelevant as to when cash is received against the sales.
Similarly, expenses are recorded at the time when are incurred and it is irrelevant as to when payable.
- Accounting Principles
The various accounting principles are discussed as below:
- Business entity or accounting entity (separate entity) principle According to this principle, business is treated as a separate entity distinct from its owners. Recording of accounting information is done, considering this principle.
A separate account by the name of ‘capital’ is maintained for the money invested by the owner in the business. Business owns money to the owner to the extent of his capital just like it owns money to lenders and creditors who are outside parties to the business.
(ii) Money measurement principle According to this principle, only those transactions which can be expressed in terms of money are recorded in the books of accounts, e.g. sale of goods or payment of expenses or receipt of income, etc. Another aspect of this principle is that the transactions that can be expressed in terms of money have to be converted in terms of money before being recorded.
(iii) Accounting Period principle accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and what exactly is the position of its assets and liabilities at the end of that period. It is also known as periodicity principle or time period principle.
According to this principle, the life of a business is divided into smaller periods so that its performance can be measured on regular basis or intervals.
(iv) Full disclosure principle according to this principle, there should be reporting of all the significant information relating to the economic affairs of the business and it should be complete and understandable. The information disclosed should be material and significant which in turn results in better understanding.
(v) Materiality principle materiality principles states the relative importance of an item or an event with respect to the particular business.
Information is material, if it has the ability to influence or affect the decision-making of various parties interested in accounting information contained in financial statements.
It is a matter of judgment to decide whether a particular information is material for a business or not. Also, it depends on the nature and/or amount of that item.
(vi) Prudence or conservation principle the concept of conservation (also called ‘prudence’) provides guidance for recording transactions in the books of accounts and is based on the policy of playing safe.
Thisprinciple states that ‘Do not anticipate profits but provide for all possible losses’. In other words, we should make provisions for probable future expenses and ignore any future probable gain until it actually accrues.
(vii) Cost concept or historical cost principle according to this principle, assets are recorded in the books at the price paid to acquire it. Assets are recorded in the books of accounts at their cost price which includes cost of acquisition, transportation, installation and making the asset ready for use and this cost is the basis for all subsequent accounting of such assets.
(viii) Matching cost or matching principle according to this principle, expenses incurred in an accounting period should be matched with revenues during that period, i.e. when a revenue is recognized in a period, then the cost related to that revenue also needs to be recognized in that period to enable calculation of correct profits of the business.
The matching concept thus, states that all revenues earned during an accounting year, whether received during that year or not and all costs incurred whether paid during the year or not should be taken into account while ascertaining profit or loss for that year.
(ix) Dual aspect or duality principle dual aspect is the foundation or basic principle of accounting.
According to this principle, every transaction entered by a business has two aspects, i.e. debit and credit. There may be more than one credit. However, the total of all debits and total of all credits will always be equal words, we can say that for every debit, there is always an equal credit.
(x) Revenue recognition principle (realization principle) the concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realized. Revenue is assumed to be realized when a legal right to receive it arises, i.e. the point of time when goods have been sold or service has been rendered.
According to this principle, revenue is considered to have been realized at the time when a transaction has been entered and the obligation to receive the amount has been established.
(xi)Verifiable objective concept/objectivity concept (objective by principle) according to this principle, accounting information should be verifiable and should be free from personal bias. Every transaction should be based on source documents such as evidences should be objective which means that they should state the facts as they are, without any bias towards either side.
- System of Accounting
The systems of recording transactions in the books of accounts are generally classified into two types:
- Double entry system is based on theprinciple of ‘dual aspect’ which states that every transaction has two aspects, i.e. debit and credit. The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and the other is credited.
- Single entry system this system is not a complete system of maintaining records of financial transactions. It does not record two field effect of each and every transaction. Only personal accounts and cash book are maintained under this system instead of maintaining all the accounts. No uniformity is maintained under this system while recording transactions. The single entry system is also known as accounts from incomplete records.
- Basis of Accounting
- Cash basis of accounting under the cash basis of accounting, entries in the books of accounts are made, when cash is received or paid and not when the receipts or payment becomes due. Revenue is recognized at the time when cash is received and not at time of sale or change of ownership of goods. Expenses are recorded only at the time of actual payments. The difference between total revenue (receipts) and expenses (payments) is profit earned or loss suffered.
- Accrual basis of accounting under accrual basis of accounting, revenue is recognized when sales take place or ownership of goods and services changes whether payment for such sales is received or not, is not relevant. Accrual basis of accounting is based on realization and matching principle.
- Meaning of Accounting Standards
Accounting standards are the written statements consisting of uniform accounting rules and guidelines issued by the accounting body of the country (such as institute of Chartered Accountants of India) that are to be followed in the preparation and presentation of financial statements.
However, the accounting standards cannot override that provision of applicable laws, customs, usages and business environment in the country.
- Utility of Accounting Standards
- Basis of preparing financial statements
- Uniformity in accounting methods
- Sense of confidence to various users
- Help to auditors
- Simplifying accounting information
- Render reliability to financial statements
- Meaning of IFRS
International Financial Reporting Standards (IFRS) and issued by International Accounting System Board (IASB). IASB replacedInternational Accounting Standard Committee (IASC) in 2001. IASC was formed in 1973 develop accounting standards which have global acceptance and make different accounting statement of different countries similar and comparable.
- Objective of IASB
- To issue accounting standards which facilitates transparency and comparability to facilitate rights decisions.
- To promote use of these standards.
- To look into the concerns of small and medium enterprise having difficulties in implementation of IFRS.
- To bring uniformity in national accounting standards and IFRS.
- Benefits of IFRS
- Helpful to global enterprises
- Helpful to investors
- Helpful to industry
- Helpful to accounting professionals