Kalpesh S. Jagtap T.Y.B.M.S. Div-A Roll No.

08B422
FINANCIAL MANAGEMENT ASSIGNMENT

What are accounting concepts and conventions?

The American Institute of Certified Public Accountants defines accounting as “the art of
recording, classifying and summarizing in a significant manner and in terms of money
transactions and events, which are, in part at least, of a financial character, and interpreting the
results thereof “.A business house must necessarily keep a systematic record of its day-to-day
transactions to enable stakeholders to get a complete financial picture of the company and to take
stock of its financial position on a periodic basis. Stakeholders include the company’s promoters,
shareholders, creditors, employees, government and the public. The accounting practice is based
on certain standard concepts, which enable accountants to convey meaningful information to all
stakeholders.

Accounting concepts :-

• The business entity concept – According to this, the business is treated as a distinct
entity from its owners. This enables the business to segregate the transactions of the
company from the private transactions of the proprietor.

• The money measurement concept – Only those transactions, which are expressed in
monetary terms are recorded in the books of accounting. Money is the common unit,
which enables various items of diverse nature to be summed up together and dealt
with.

• The cost concept – The transactions are recorded at the amounts actually involved. For
instance, a piece of land may have been purchased at Rs.1,50,000, whereas the
company considers it to be worth Rs.3,00,000. The land is recorded in the books of
accounts at Rs.1,50,000 only. Thus, an arbitrary valuation of the company’s assets is
avoided by recording the value at the actual amount involved. Since this amount
would have been mutually agreed upon by both the parties involved in the
transaction, it is an objective evaluation.

• The going concern concept – According to this concept, it is assumed that the
business will exist for a long time and transactions are recorded on this basis. This
concept forms the basis for the distinction between expenditure that will yield benefit
over a long period of time and expenditure whose benefit will be exhausted in the
short-term.

• The dual aspect concept – Business firms raise funds inany of the following ways–
# Additional capital (increase in owners’ equity)
 # Earning revenue (increase in owners’ equity)
# Profits (increase in owners’ equity)
# Additional loans (increases outside liability)
# Disposing off assets (reduces assets)
An increase in liabilities (including owners’ equity) and reduction in assets represent
sources of funds. These funds can be put to any of the following uses –
# Operational expenses (decrease in owners’ equity)
# Cash balances (increase in assets)
# Purchasing of assets (increase in assets)
# Clearing liabilities due (decrease in liabilities)
# Losses (decrease in owners’ equity)
# All increases in assets and decreases in liabilities (including owners’ equity)
represent the uses of funds. The sum of the sources of funds equals the sum of the uses of
funds. Thus, the dual aspect of accounting means that Owner’s Equity + Outside Liability
= Assets. This is the fundamental accounting equation.

• The realization concept – Accounting records transactions from the historical

perspective, i.e. it records transactions that have already occurred. It does not attempt
to forecast events; this prevents the business from presenting inflated profits based on
their expectations. A transaction is recorded only on receipt of cash or a legal
obligation to pay. Until then, no income or profit can be said to have arisen.

• The accounting period concept – Business firms prepare their income statements for a
particular period. This period, known as the accounting period, is usually the calendar
year (January 1 to December 31) or the financial year (April 1 to March 31). Some
firms, like trading firms have shorter periods such as a month or less, while others
may have longer terms. The Companies Act, 1956 has set a maximum limit of 15
months for the accounting period.

• The matching concept – According to this concept, expenses born in the production of
goods and services should be matched with revenues realized from the sale of these
goods and services. This helps determine the profits or losses for a particular
accounting period.

Accounting conventions:-

• Conservatism– According to this concept, revenues should be recognized only when

they are realized, while expenses should be recognized as soon as they are reasonably
possible. For instance, suppose a firm sells 100 units of a product on credit for
Rs.10,000. Until the payment is received, it will not be recorded in the accounting
books. However, if the firm receives information that the customer has lost his assets
and is likely to default the payment, the possible loss is immediately provided for in
the firm’s books.

• Consistency– Once the firm adopts a particular method for a particular event, it will
handle subsequent events of that type the same manner. For instance, suppose it
 provides for depreciation through the straight-line method, it will follow that method
in the subsequent years as well, unless it has sufficient reason to change the method.

• Materiality– According to this concept, the firm need not record events, which are
insignificant and immaterial. For instance, if a large manufacturing firm has accounts
receivables worth crores of rupees, it would not find it necessary to provide for a
possible bad debt worth Rs.100.

• Disclosure --The accounting convention of full disclosure implies that accounts

should make a full disclosure of all monetary or financial information that can impact
decision making of different parties. This accounting information is of interest to the
management, current and potential investors and current and potential creditors of the
business.