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2. ACCOUNTING PRINCIPLES
2.1 INTRODUCTION:
Business entities use accounting as language of business and communicate the financial
information to various users. The financial statements should be prepared on uniform basis that enable
comparison and easy understanding. There should be consistency over a period of time in the
preparation of financial statements. If every accountant starts following his own norms and principles
in the preparation of financial statement will creates some confusion. To avoid such confusion and to
achieve uniformity in accounting principles, the financial statements have to be prepared within the
frame work called Generally Accepted Accounting Principles (GAAPs). Accounting principles, or
rules or concepts are general guidelines for accounting practices. Generally Accepted Accounting
Principles comprise a set of rules, concepts and guidelines used in financial accounting reports.
Generally Accepted Accounting Principles are a combination of authoritative standards and commonly
accepted rules of recording and reporting accounting information.
Generally Accepted Accounting Principles may be defined as those rules of action or
conduct which are derived from experience and practice and when they prove useful, they become
accepted as the accounting principles. All those accounting principles or practices which have
substantial authoritative support and meet the relevance, objectivity and feasibility will become a part
of the Generally Accepted Accounting Principles. Accounting principles are a body of doctrines
commonly associated with the theory and procedures of accounting serving as an explanation of
current practices. The standards which are laid down in order to follow uniformity are termed
as accounting principles. AICPA defined the term principles as a guide to action a settled ground or
basis of conduct or practice. Accounting principles are developed by human beings so they are not
treated as universal principles like principles of physics, chemistry and other sciences. Acceptance of
accounting principles depends on how it will meet the criteria of relevance, objectivity and feasibility.
Accounting principles are classified into two categories such as a. Accounting concepts and b.
Accounting conventions
2.2 Accounting concepts/postulates: Accounting concepts may be considered as postulates. The term
postulates mean basic assumptions or conditions on which the accounting is based. In other words,
accounting concept is a basic assumption on which the accounting system function. It is not subject to
any proof because it is only an opinion based on the assumption. The following are the important
accounting concepts:
1. Business Entity Concept: According to this concept business is treated as separate entity and is
distinct from its owner. In other words, business entity concept reveals that both business and
ownership are separate from each other. This concept is applicable to all forms of business
organizations. As per this concept only the business transactions are recorded and reported i.e., all
personal transactions of the owner are not to be recorded in the books of the firm. The personal assets
of owners (proprietorship), partners (partnership) or shareholders (companies) are not considered as
business assets. According to this concept the amount invested by owner is always treated as capital
and shown on the liabilities side of balance sheet. Similarly, all personal expenses or household
expenses which are paid out of business will be changed to capital as non-business expenses. Thus, the
owner/proprietor of business is referred as a creditor to the extent of his capital contribution and
capital is treated as liability.
NOTE: In case of proprietorship, the proprietor is not considered as separate entity from his own
business, in the eyes of law. But as per the accounting is concerned ownership is separated from
business.
2. Going concern concept: As per the accounting standard AS-1, going concern concept is a
fundamental accounting assumption which is used while preparing financial statements. The term
“Going concern” implies that an enterprise is expected to continue its operations indefinitely in the
future. According to this concept the business entity will continue to operate indefinitely and will not
liquidated in the immediate future. This concept becomes base for the valuation of assets. It will
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encourage the investors and make them to invest in the business.

A business entity is assumed to be a going concern and not a gone concern.

It is assumed that the enterprise has neither the intention nor the need to liquidate
materially the scale of its operations. Keeping this in view the suppliers and other companies enter into
business transactions with the business unit. It supports the treatment of prepaid expenses as assets even
though they may be practically unsalable.
NOTE: This concept is not applicable to joint venture.
3. Money Measurement Concept: According to this concept, only those transactions which can be
expressed in terms of money are included in the accounting records. All non-monetary i.e., which
cannot be expressed in terms of money are not find any place in the books of accounts. This concept is
one of the basic concepts of accounting. But it is said to be severe restraint on the scope of accounting
as it reduces the scope of accounting by recording monetary transactions in the books. Another
limitation of this concept is a transaction is recorded at its money value on the date of the transaction
and fails to consider the subsequent changes in the money value. As per this concept money will serve
as a common denominator to record the business transactions in the books of accounting. In absence of
this concept all transactions could be recorded at their own description and preparation of financial
statements is not possible.
4. Cost Concept: This concept is closely associated with Going Concern Concept. According to this
concept, the assets recorded at the price paid to acquire i.e., at cost not at the market value. This cost
will be the base for all subsequent accounting i.e., providing depreciation on the asset. Thus, it also
known as historical cost concept. As per this concept, the value of fixed asset will be removed from
the books of accounts by writing off its cost as depreciation. In absence of this assumption, the
financial position disclosed by the balance sheet is not true and fair and it totally depends on
subjectivity of the accountant. The cost concept does not mean that the assets are recorded at cost at
the time of purchase and subsequently its value is reduced by charging depreciation.
5. Dual Aspect Concept: Dual aspect concept is a one of the basic accounting principles. According to
this concept, every business transaction consisting of two-fold aspect such as
a.Giving aspect (yielding of benefits) b. Giving aspect (giving of benefit)

This concept is closely associated with Double Entry System of accounting principle. Dual aspect
concept states that for every debit there must be corresponding and equal credit. Accounting equation
is developed as per this concept.
Accounting equation: Assets = capital + Liabilities
Capital = Assets – Liabilities
Dual aspect concept is the basis for Double Entry System of book-keeping. This concept reveals the
following
a. Increase in an asset is accompanied by a decrease in another asset.
b. Increase in an asset is accompanied by an increase in liability.
c. Decrease in an asset is accompanied by an increase in another in another asset.
d. Decrease in an asset is accompanied by a decrease in liability.
e. Increase in liability is accompanied by a decrease in another liability.
f. Increase in liability is accompanied by an increase in asset.
g. Decrease in liability is accompanied by an increase in another liability.
h. Decrease in liability is accompanied by a decrease in asset.
6. Accounting period concept: This concept is also known as periodicity concept. As per the going
concern concept the life of the business is indefinite. Measurement of income/loss of a business entity
for the whole period is simple, but it should not reveal the degree of success until it is liquidated. At
the same time the business man/proprietor cannot wait for such a long period to know the income or
loss. Therefore, life of an enterprise is split into periodical intervals, known as accounting periods. The
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accountant should choose convenient period of time to assess the profit or loss. Usually, an accounting
period will be 12 months. Either the calendar year i.e., from 1st January to 31st December or financial
year i.e., from 1st April to 31st March of every year will be adopted as an accounting period. At the end
of each accounting period, financial statements are prepared. All prepaid expenses/outstanding
expenses or Accrued revenues are considered as per accounting period only.
7. Matching concept: Matching concept is associated with accounting period concept. According to the
matching concept, the expenses incurred in one accounting period should be matched with the
revenues recognized in that period. In order to calculate profit or loss of an accounting period, it is
necessary to match all expenses incurred in an accounting year with the revenues earned during that
accounting period. In other words, after revenue recognition, all expenses which are incurred to earn
such revenue, during the accounting period, will be charged against the revenues to determine the net
income/loss of the business enterprise. Symbolically;
Net income = Revenues – Expenses (which are incurred to earn revenue.)
Accrual concept, matching concept and accounting period concepts work together for income
measurement and recognition of assets and liabilities.
8. Accrual concept: The term “accrual” means the recognition of events as they occur, rather than in the
period of their incurrence, receipt or payment. The accrual concept recognizes revenue with it is
earned rather than when it is collected. Similarly, it recognizes expenses when it is incurred rather than
when it is paid. In their words, as per this concept, the date of transaction is taken for accounting
process and not the date of actual receipt of revenue or the date process and not the date of actual
receipt of revenue or the date of actual payment for cost. In absence of this concept the financial
statements will not reveal true and fair view of the affairs of the business.
According to this concept, all revenues and costs are
recognized as they are earned or incurred and not as money is received or paid. Expense incurred but
not paid in the particular period or income earned but not received in the particular period should be
recorded as expense and income of that period.
9. Realization concept: According to this concept revenue is recognized when a sale is made. When
goods pass to the buyer and he becomes legally liable to pay for it, regarded as sales. There Hire
purchase system where the ownership is transferred to the buyer after the payment of last installment
and contract accounts where contractor is liable to pay only after the completion of contract.
2.3 Accounting conventions: Accounting conventions mean customs and traditions which guide the
accountant while preparing the accounting statements. These emerge out of accounting practices used
by business entities. The following are the important accounting conventions.
1. Convention of consistency: As per convention of consistency accounting practices should remain
unchanged from period to period. In other words, same accounting methods will be followed for every
year. For example, if stock is valued at cost or market price whichever is lower, the same principle
should be followed over the years. Similarly, if Diminishing Balance Method is followed for providing
depreciation on fixed assets, the entity should follow the same year or after years. This convention
facilitates easy comparison different year’s financial statements. Accounting standard (AS)-1 states
that consistency is the basic assumption and it is assumed that accounting policies are consistent from
one period to another. As per AS-1, if the entity not followed this convention, it should be disclosed
with specific reason for not complying with this. A change in an accounting policy should be allowed
in certain exceptional circumstances and the same should be disclosed as note.
Convention of consistency does not mean inflexible and does not prohibit the implementation of
improved accounting techniques. If change is desirable, the change and its effect on profits and
financial position should be clearly stated in the financial statements.
2. Convention of Full Disclosure: The convention of full disclosure implies that every financial
statement should fully disclose all pertinent information which is necessary to users. This convention
implies that accounts must be honestly prepared and all material information must be disclosed
therein. All information which is of material interest to proprietors, creditors and investors should be
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disclosed. The practice of appending notes to the accounting statements is in pursuant to the
convention of full disclosure. This convention is given due legal emphasis by the Companies’ Act,
1956 by prescribing formats for the preparation of financial statements. However, the term disclosure
does not mean all information that one desires to get should be included in accounting statements.
3. Convention of conservatism (prudence): It is a policy of caution or playing safe. Prudence means
early recognition of unfavourable events. It takes into consideration all prospective losses but leaves
all prospective profits. As per this convention, the businessman has to wear a risk proof jacket i.e., he
could not anticipate profit but he could make provision for all losses. In other words, the businessman
should have pessimistic view rather than an optimistic view. As per this convention the profit and loss
account will show lower income and financial position disclosed by the balance sheet will be
understated. Therefore, principles of conservatism should be applied cautiously.
Example: While valuing stock in trade, market price or cost whichever is less is considered. Making
provision for doubtful debts in anticipation of actual bad debts. Creating provision against fluctuation
in the price of investments.
4. Convention of Materiality: According to this convention, only those transactions which are
materialistic and important for decision making should be recorded. Recording of immaterial and
insignificant items may be avoided. As per American Accounting Association materiality means an
item should be regarded as material if there is reason to believe that knowledge of it would influence
the decision of informal investor.
In other words, this concept reveals that the items or events having an insignificant economic
effort or not being relevant to the users need not be described. Therefore, this convention limits
unnecessary disclosures.
The term materiality is a subjective term, accountant record an item as material even though it is
of small amount as it has influence on decision making. At the same time, an item material for one
concern may be insignificant material to another and an item of material of one year may become
immaterial to another year. As per As-1, convention of materiality should govern the selection and
application of accounting principles.