Accounting Concepts and Conventions


By

Dr C R S Pillai
Professor
Pillai's Institute of Management Studies and Research
New Panvel, Navi Mumbai-410206
 


Accounting is the language through which the performance and financial status of an enterprise is communicated to the outside world. In order that the messages communicated through the accounting language is understood by the users, there should be certain common principles. Accountants all over the world agree on certain basic points on which financial accounting theory and practice are based, which are commonly referred to as 'accounting principles', 'postulates of accounting', 'accounting concepts', 'accounting conventions' and 'accounting standards'.

Accounting principles in other words are those rules of action or conduct which are adopted by the accountants universally while recording business transactions. They are a body of doctrines commonly associated with the theory and procedure of accounting, serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist. Accounting principles are also known as accounting postulates or accounting assumptions.

M W E Glautier and B Underdown would like to use 'accounting conventions' for those principles on which accounting is based. According to them " the term 'accounting conventions' serve in another sense to understand the freedom which accountants have enjoyed in determining their own rules"."We may classify accounting conventions into two broad groups-those which may be said to go to the very roots of financial accounting, which may call 'fundamental conventions' and those which bear directly on the quality of financial accounting information , which we shall describe as 'procedural conventions'. "In our view , there are only two fundamental conventions which may be said to characterize financial accounting.

(a) the entity convention which states that financial accounting information relates to the activities of a business entity only, and not to the activities of the owners.

(b) the money measurement convention which limits the recognition of activities to those which can be expressed in monetary terms. The alteration of either of these two conventions would change the entire nature of financial accounting.

There are several procedural convention which though of great importance affect the manner in which financial accounting information is selected ,analyzed and communicated .Some of these conventions are subjected to criticism , for example, the realization convention which holds that a gain in value may only result from a transaction. The following conventions are generally regarded as the most important conventions in this group.

a. going concern convention
b.  cost convention
c. realization convention
d.  accrual convention.
e.  matching convention
f. convention of periodicity
g.  convention of consistency
h.  convention of conservatism."

Ahmed Raili Belkaoui preferred to classify the basic points of agreement in accounting into accounting postulates and accounting principles. He has given the following list of postulates and principles.

Accounting Postulates

a. Entity Postulate
b. Going Concern Postulate
c. Unit of Measure Postulate
d. Accounting Period Postulate.

Accounting Principles

a. Cost Principle
b. Revenue Principle
c. Matching Principle
d. Objectivity Principle
e. Consistency Principle
f. Full Disclosure Principle
g. Conservatism Principle
h. Materiality Principle
i. Uniformity and Comparability Principle.

FASB, USA, Statement of Financial Accounting Concept No.6 has given the following classification of the basic principles of accounting.

Assumptions of Accounting      Principles of Accounting

Separate Entity Assumption      Cost Principle
Continuity  Assumption            Revenue Principle
Unit of Measure Assumption      Matching Principle
Time Period Assumption            Full Disclosure Principle

Thus we see that there is little agreement amongst the various authorities in accounting regarding the definition and classification of accounting principles.

Postulates

Accounting postulates are those basic assumptions emerging from accounting environment and which does not require further proof. They are self evident truths and do not require proof .They are non-verifiable. Belkauoi defines accounting postulates "as self-evident statements or axioms, generally accepted by virtue of their conformity to the objectives of financial statements ,that potray the economic ,political ,sociological and legal environment in which accounting must operate."

AICPA ,The Basic Postulates of Accounting has defined accounting postulates as " Postulates are few in numbers and are the basic assumptions on which principles rest. They necessarily are derived from the economic and political environment and from the modes of thought and customs of all segments of the business community. The profession ,however should make clear their understanding and interpretation of what they are, to provide a meaningful foundation for the formulation of principles and the development of rules or other guides for the application of principles in specific situations."

Concepts

Accounting concepts are also basic assumptions or truths which are accepted by people with out further proof. They are conceptual guidelines for application in the financial accounting process. According to Glenn A. Wisch and Daniel G. Short  the concepts are important because they

i) help to explain the 'why' of the accounting
ii) provide guidance to deal with new accounting problems
iii)  there is no need to memorise accounting procedures.

Principles

According to AICPA (USA) principles means " a general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice". Thus principles are general guidelines for action or conduct.

According to Robert N.Anthony and James S.Reece "Accounting principles are man made. Unlike the principles of physics, chemistry and other natural sciences ,accounting principles were not deducted from basic axioms ,nor can they be verified by observation and experiment. Instead ,they have evolved. Thus evolutionary process is going on constantly; accounting principles are not eternal truths."

According to Harr I .Wolk, Michael G.Tearney , James L.Dodd accounting principles can be classified into

i) Input oriented principles which guide the recording of business transactions .They are classified into underlying rules of operation and constructing principles.
ii) Output oriented principles are concerned with the preparation and presentation of financial statements.

Conventions

The term 'convention' includes those customs and traditions which guide the accountant while preparing the accounting statements. Conventions have their origin in the various accounting practices followed by the accountant. It is very difficult to trace the origin of the conventions and establish their authenticity as accounting principles. But by usage they have attained the status of accounting principles.

In this study the basic principles on which accounting is based are proposed to be classified into 'Accounting Concepts ' and 'Accounting Conventions'. All those basic assumptions or conditions upon which the science of accounting is based are grouped under accounting  concepts .Those customs or traditions which guide the accountant while preparing the accounting statements are included under the head accounting conventions.

Accounting Concepts

a. Separate Entity Concept
b. Going Concern Concept
c. Money Measurement Concept
d. Cost Concept
e. Dual Aspect Concept
f. Periodic Matching of Cost and Revenue Concept
g. Realization Concept

Accounting Conventions

a. Convention of Conservatism
b. Convention of Full Disclosure
c. Convention of Consistency
d. Convention of Materiality.

Let us examine one by one the various concept and conventions and see what they mean

Separate Entity Concept

In separate entity concept the business is treated as a separate entity from the owner event though statutes recognise no such distinct entity. In accounting the concept of separate entity is applicable in the case of all organisations. This concept is very much relevant in the case of sole proprietorship entities and partnerships. In the case of a company it is recognised as a separate entity by statutes as well as from the accounting point of view.The separate entity concept helps to keep the affairs of the business separate from the private affairs of the proprietor.

Going Concern Concept

This concept assumes that the business will continue for a fairly long period of time in future. There is no need of forced sale of the assets of the entity. Otherwise every time the annual financial statements are prepared the probable losses on account of the possible sale of assets should be accounted. This would distort the operating result as revealed by the profit and loss account and the financial position depicted in the balance sheet. On the basis of this principle depreciation is charged on fixed assets on the basis of expected life rather than its market value and intangible assets are amortized over a period of time .The annual financial statements are considered to be interrelated series of statements.

Money Measurement Concept

Money is the unit in which economic events affecting a business entity are measured. The money measurement concept implies that accounting could measure and report only those transactions and events which could be measured in terms of money. It cannot account for qualitative aspects like employee relations, competitive market, advantages of the entity over others etc. This concept imposes a restriction on the ability of the financial statements to present a correct picture of the entity as those events which are unable to be quantified in money terms are left out. Further the money as a unit of measurement is not stable. The variations in the value of money fails to present a correct picture of the operating results and financial position of the entity. Over a period of time the value of money fluctuates and even when we are employing the same unit of money the values represented by them are not equal. Thus money as a unit of measurement fails.

Cost Concept

The basis on which assets are recorded in the books of accounts is the cost- that is the price paid to acquire them. Cost will form the basis of which further accounting will be done as regards the asset. No adjustment is made in the cost to reflect the market value of the asset. The cost concept does not imply that asset will always appear at cost in the balance sheet. It only means that cost will be the basis for further accounting treatment. The cost of the asset may be reduced gradually by the process of charging depreciation.

Further the cost concept means that if nothing is paid for the acquisition of an asset it cannot be shown as an asset in the books of account. Cost concept brings objectivity in the preparation and presentation of financial statements. The assets appearing in the books should be based on objective evidence and not on the subjective view of the person who makes such statements or of some other person.

Paul Grady has observed the cost concept in the following words.

" Value as used in accounts signifies the amount at which an item is stated in accordance with the accounting principles related to that item. Using the word value in this sense, it may be said that balance sheet values generally represent cost to the accounting unit or some modifications there of; but sometimes they are determined in other ways, as for instance on the basis of market values or cost of replacement, in which cases the basis should be indicated in financial statements. The word value should seldom if ever,  be used in accounting statement with out a qualifying objective."

Dual Aspect Concept
The basic equation of accounting is
Assets = Equities
Or
Assets = Outsiders' Equity + Owners' Equity
Or
Assets = Liabilities + Capital

Every transaction affecting an entity has dual aspect on the accounting records. Both aspects are recorded in the books of accounts. Hence accounting is called ' double entry system'. The two aspects are expressed as 'debit' and 'credit '.In other words ' for every debit there is an equivalent credit'.

The term 'assets' denotes the resources owned by a business while equities denote the claims of various parties against the assets. Equities are two types

i) Owners' Equity and
ii) Outsiders' Equity

Owners' equity otherwise called 'capital' denotes the claims of the owners against  the assets of the entity where as outsiders' equity denotes the claims of creditors, debenture holders ,lenders etc against the assets of the entity.

The dual aspect of transaction may result in change in the assets and equities of the organization and make them equal.
 

--> Article continued on next page, click here  -->

Source: E-mail July 7, 2011

          

Articles No. 1-99 / Articles No. 100-199 / Articles No. 200-299 / Articles No. 300-399 / Articles No. 400-499/ Articles No. 500-599
Articles No. 600-699 / Articles No. 700-799 / Articles No. 800-899 / Articles No. 900-1000 / Articles No. 1001-1100
Articles No. 1101-1200 / Articles No. 1201-1300 / Articles No. 1301 Onward / Faculty Column Main Page