Accounting Principles

Chapter 3

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Chapter Overview

• Generally Accepted Accounting Principles

• Objectives of Accounting Principles

• Accounting Concepts

• Accounting Conventions

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Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) is a term
used to describe, broadly, the body of principles that governs
the accounting for financial transactions underlying the
preparation of a set of financial statements.
• According to the American Institute of Certified Public
Accountants (AICPA), the principles, which have substantial
authoritative support, become a part of the generally accepted
accounting principles.
Accounting principles are divided into two categories:
• (i) Accounting Concepts
• (ii) Accounting Conventions
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 ACCOUNTING PRINCIPLES
• Accounting Concepts
• Accounting Conventions
The term ‘concept’ means those basic
assumptions or conditions upon which
accounting is based. The term ‘conventions’
means those customs and traditions which guide
the accountants while preparing accounting
statements.

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Difference between Concepts and Conventions
✔ The Accounting Concepts/Principles evolved out of the
practices and procedures followed by different countries and
later on established by the International Statutory Accounting
Bodies like The Institute of Chartered Accountants of India,
The Institute of Chartered Accountants of England and Wales
etc to become an Accounting Principle statutorily need to be
followed while preparing the Financial Statements. In nutshell
this has evolved out of standard practice followed by several
countries while preparing the Trading, Profit and Loss Account
and Balance Sheet.
✔ The Accounting Conventions/Practices are basically
assumptions and expected to be followed while preparing the
Financial Statements.

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CHARACTERISTICS OF ACCOUNTING PRINCIPLES:

✔ Objectivity

✔ Application

✔ Reliability

✔ Feasibility

✔ Understandability

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Accounting Concepts
1. Business Entity Concept or Separate Entity
concept
2. Going Concern Concept
3. Money Measurement Concept
4. Cost Concept
5. Dual Aspect Concept
6. Accounting Period Concept
7. Matching Concept/ Periodic matching of Costs
and Revenues Concept
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8. Realization Concept
 Accounting Conventions
• Convention of Conservatism
• Convention of Disclosure &
Materiality
• Convention of Consistency

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Business Entity Concept : Business is treated as a
separate entity from its owner and others. All the
transactions of the business are recorded in the
books of business from the point of view of the
business as an entity and even the owner is treated
as a creditor to the extent of his/her capital.

Going Concern Concept : It is believed that the

business will exists for a long time and transactions
are recorded from this point of view.

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Money Measurement Concept : In accounting, we
record only those transactions which are expressed in
terms of money. In other words, a fact which can not
be expressed in monetary terms, is not recorded in the
books of accounts.
Cost Concept : an asset is ordinarily entered in the
books of accounts at the price paid to acquire it and
this cost is the basis for all subsequent transactions.
Suppose a company purchases a car for Rs.1,50,000/-
the real value of which is Rs.2,00,000/-, the purchase
will be recorded as Rs.1,50,000/- and not any more.
Dual Aspect Concept: Each transaction has two
aspects, that is, the receiving benefit by one party and
the giving benefit by the other. This principle is the 10

core of accountancy.
Periodic matching of Costs and Revenues Concept or
Matching concept- In order to ascertain the profit made by
the business during a period, it is necessary that ‘revenues’ of
the period should be matched with the costs (expenses) of the
period.

Realization Concept: The revenue is recognized when a sale

is made. Sale is considered to be made at the point when
goods are passed to the buyer and he becomes legally liable
to pay.

Accounting Period Concept: The life of the business is

divided into appropriate segments for studying the results of
the business. A twelve month period is normally adopted for
this purpose. This time interval is called accounting period.11
Convention of Consistency: In order to enable the
management to draw important conclusions regarding the
working of the company over a few years, it is essential that
accounting practices and methods remain unchanged from
one accounting period to another. The comparison of one
accounting period with that of another is possible only when
the convention of consistency is followed.

Convention of Disclosure: This principle implies that

accounts must be honestly prepared and all material
information must be disclosed therein.

Convention of Conservation: Financial statements are

always drawn up on rather a conservative basis. That is,
showing a position better than what it is, not permitted. It is
also not proper to show a position worse than what it is. In 12

other words, secret reserves are not permitted. Concept of

conservatism is otherwise known as ‘Prudence’
 Indian Accounting Standards (IAS)
Accounting Standards are the statements of code of
practices of regulatory accounting bodies that are to be
observed in preparation and presentation of financial
statements.

In India, Accounting Standards are the guidelines

prepared by the Institute of Chartered Accountants of
India (ICAI), through its Accounting Standards Board
(ASB), for the preparation of books of accounts and
financial statements.

Objective-
To bring uniformity in the books of accounts, facilitates 13

easy interpretation and comparison of financial results.

Accounting Concepts/Conventions(US GAAP/UK GAAP/IFRS/SOX)
▪ The Concepts and Conventions of accounting are developed by
IASC(International Accounting Standards Committee)which is in charge
of releasing International Accounting Standards(IAS)

▪ Accounting standards are written statements of uniform accounting rules

and guidelines in practice for preparing the uniform and consistent
financial statements. These standards cannot over ride the provisions of
applicable laws, customs, usages and business environment in the country.

▪ The IASC decides the preferred accounting practices worldwide and

encourages the worldwide acceptance.

▪ There are 41 International Accounting Standards

▪ Now IFRS (International Financial Reporting Standard) and SOX

(Sarbanes Oxley) Act gain more importance which came up from US
GAAP and UK GAAP
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 Indian Accounting Standards (IAS)

Out of total 32 Accounting Standards, the most common and

prominent ones are as follows:

Disclosure of Accounting Policies – AS 1

Valuation of Inventory- AS 2

Contingencies and Events Occurring after the Balance Sheet

date- AS 4

Net Profit or Loss for the period, prior period Items and
Changes in Accounting Policies- AS 5
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Revenue Recognition- AS 9
AS 1 Disclosure of Accounting Policies
AS 2 Valuation of Inventories
AS 3 Cash Flow Statements
AS 4 Contingencies and Events Occuring after the Balance Sheet Date
AS 5 Net Profit or Loss for the period,Prior Period Items and Changes in Accounting Policies
AS 6 Depreciation Accounting
AS 7 Construction Contracts (revised 2002)
AS 9 Revenue Recognition
AS 10 Accounting for Fixed Assets
AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003),
AS 12 Accounting for Government Grants
AS 13 Accounting for Investments Mandatory
AS 14 Accounting for Amalgamations Accounting
AS 15 Employee Benefits (revised 2005)
AS 16 Borrowing Costs
Standards
AS 17 Segment Reporting
AS 18 Related Party Disclosures
AS 19 Leases
AS 20 Earnings Per Share
AS 21 Consolidated Financial Statements
AS 22 Accounting for Taxes on Income.
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
AS 24 Discontinuing Operations
AS 25 Interim Financial Reporting
AS 26 Intangible Assets 16
AS 27 Financial Reporting of Interests in Joint Ventures
AS 28 Impairment of Assets
AS 29 Provisions,Contingent` Liabilities and Contingent Assets
•AS 30 Financial Instruments: Recognition and Measurement and Limited Revisions to AS 2

• AS 11 (revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28 and AS 29

•

AS 31, Financial Instruments: Presentation

•
Accounting Standard (AS) 32, Financial Instruments: Disclosures, and limited revision to
Accounting Standard (AS) 19, Leases

Non -Mandatory
Accounting
Standards
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1.Conservatism convention is applied for the valuation of
(i) Current assets (ii) Fixed assets
(iii) Current assets and fixed assets (iv) none
2. Cost concept is applied for the valuation of
(i) Current assets (ii) Fixed assets
(iii) Current assets and fixed assets (iv) none
3. The convention of conservatism, when applied to balance sheet, results in
(i) understatement of liabilities (ii) overstatement of
liabilities
(iii) understatement of assets (iv) overstatement of assets
4. A manager asks the accountant to record the bitter relationship between the
production manager and marketing manager, which has resulted in reduced
profits. Accountant answers that this aspect cannot be recorded in accounts
due to the following:
(i) consistency convention (ii) money measurement concept
(iii) separate entity concept (iv) disclosure convention
5. Proprietor inquires whether air-conditioner purchased for his residence can
be accounted for in the accounts books of the business and he receives the
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reply from the accountant that such recording is a violation of
(i) cost concept (ii) separate entity concept
(iii) materiality (iv) realisation concept
Fill in the Blanks
1. Based on assumptions and conditions ………………
2. Expressed in terms of money ………….
3. Based on customs and traditions……………………
4. Playing safe …………………….
5. Dual aspect concept ……………………
6. Equities = Assets ………………………………….
7. Reduction of capital …………………..
8. Fixed assets ………………………………..
9. Small and ignorable amount ……………………………

Money measurement concept, Accounting concept, Double entry principle,

Accounting convention, Accounting equation, Materiality, Cost concept,
Conservatism, Loss incurred by the firm

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Answers

1. Accounting concept
2. Money measurement concept
3. Accounting convention
4. Conservatism
5. Double entry principle
6. Accounting equation
7. Loss incurred by the firm
8. Cost Concept
9. Materiality

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Refernces:

1. Maheshwari, S.N., Maheshwari, S.K., Financial Accounting, 10th ed, Vikas

Publishing House.

2. Tulsian, P.C. , Financial Accounting, S. Chand &Co Ltd , India.

3. Gopal,C,R., Accounting for Managers,1st ed, New Age International Publishers

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