Accounting Concepts, Principles, Bases and Policies

Generally Accepted Accounting Principles (GAAP)

Accounting principles are basic rules of action, which are adopted by the accountants while recording transactions and preparing and presenting financial statements. These are the doctrines associated with theory and current practices of accounting.

GAAP are accepted universally and consists of :

• Accounting Concepts : basic assumptions or conditions guiding the accountants while preparing accounting statements. There are five basic concepts of accounting :

1. Business entity concept states that the business is a separate entity and it is different from the owners or proprietors. This has legal as well as accounting implications. The business transactions of the company can be segregated from those of the owners.
2. Going concern concept states that the business is assumed to continue fairly for a long period of time and that there is no need to shut it down.
3. Money measurement concept : All transactions of a business are recorded in terms of money. Some transaction like cost of input or profit are already in terms of money, but some that cannot be monetized are ignored like brand value of a company.
4. Periodicity concept : as per going concern, a business is meant to be ongoing. But to look back on performance, take corrective actions the operating period is split into regular intervals called accounting periods.
5. Accrual concept states that expenses incurred and income earned for an accounting period must be recorded in the same period whether expenses are paid and income is actually received or not.

• Accounting Conventions : customs and traditions that guide the accountants while preparing accounting statements. There are ten types of accounting conventions :

1. Convention of income recognition : revenue is considered as being earned on the date on which it is realized, that is the date on which goods and services are transferred to customers for cash or on promise.
2. Convention of matching cost and revenue : revenue earned during a period is compared with the expenses incurred to earn that income, irrespective of whether the expense was paid or not.
3. Convention of historic cost : says that all transactions are recorded at the value at which they were incurred and all assets are recorded at the value of acquisition irrespective of market value etc. Such a value is called Historical Cost and this principle is called convention of 'Cost'.
4. Convention of full disclosure : requires a business to disclose :
1. All accounting policies adopted in preparing and presenting the financial statements.
2. Any change in accounting policies and the reasons thereof.
3. The implication(in terms of money) of the change in policies.
5. Convention of double aspect : states that every transaction has two aspects. One is the receiving aspect and the other one is the giving aspect, debit and credit.
6. Convention of modifying
7. Convention of materiality : states that the benefit derived from measuring, recording and processing a transaction must justify the cost of doing it.
8. Convention of consistency : requires that the accounting policies be same from year-to-year. This helps in easy comparison of financial data with previous data. The accounting policy can only be changes when :
1. It is justified by law
2. the new policy better reflects the financial standing or position
9. Convention of conservatism : accountants follow the rule "anticipate no profits but provide for all anticipated losses". When a loos is anticipated, sufficient provision must be made. IF a profit is anticipated, it should not be recorded until it is actually realized.

Accounting Policies : are specific accounting principles and methods of accounting adopted by a business while preparing and presenting the financial statements. Major considerations in the selection and application of accounting principles :

• Prudence
• Substance over form
• Materiality

Change in accounting policy : is recommended only if

1. If it is required by statute for compliance with an accounting standard.
2. If it is considered that the change would results in a more appropriate presentation of statements

Disclosure in case of change in accounting policies : must be done irrespective of whether the change has material effect in current period and irrespective of whether the effect of change is ascertainable.

Mandatory and Voluntary disclosures : 

The minimum disclosure a business must and should give as required by government, statutory or accounting bodies is called mandatory disclosure.

The company may decide to disclose additional information over and above the mandatory disclosure which is known as voluntary disclosure.

Previous Topic : Financial Accounting Basic Terminologies

Financial Accounting Basic Terminologies

1. Transaction : the transfer of money, goods or services from one person or account to another person or account. These are :
1. Cash Transactions
2. Credit Transactions
3. Paper Transactions
2. Capital : Funds brought in to start a business
3. Share : one unit of the total company's capital
4. Assets : a resource legally owned y the enterprise. Assets can be classified based on purpose :
1. Fixed Assets : resources help for use in production of goods or services and are not for resale. Ex : land, plant, machinery etc.
2. Current Assets : resources held or receivable withing the year or the company's operating cycle. These are intended to be converted into cash. Ex: stocks, bill receivable cash at bank etc.
3. Liquid Assets : those which can be easily converted into cash.
4. Fictitious Assets : those which cannot be written off during the period of their incidence. Ex: promotional expenses
5. Liability : a financial obligation of an enterprise, which when settled results in an outflow of resources. Ex: loans payable
6. Current Liability : an obligation that has to be satisfied within a year.
7. Equity :  the residual interest in the asset of the enterprise after deducting all its liabilities.
8. Joint Stock Company : the capital for this company is contributed by shareholders.
9. Goods : merchandise, commodities, products etc in which a trader deals. Goods account is divided into :
1. Purchases
2. Sales
3. Purchases return or returns outward
4. Sales returns or returns inward
5. Opending stock
6. Closing stock
10. Inventory : goods held by a business for sale or consumption in production. Ex : raw materials
11. Drawings : goods, money or any asset withdrawn by the owner for his own personal expenses.
12. Debtor : A debtor is a person who owns money to a business. Types of debtors :
1. Trade Debtor
2. Loan Debtor
3. Debtor for asset sold
4. Debtor for service rendered
13. Debt : amount due from a debtor to this business. Types of debts:
1. Good Debt
2. Bad Debt
3. Doubtful Debt
14. Creditors : a person to whom business owes money. Types of creditors :
1. Trade Creditor
2. Loan Creditor
3. Creditor for asset pyrchased
4. Expenses Creditor
15. Loss : money or woth of money given up without any benefit in return. A situation when expenses exceed th expenditure.
16. Profit : a situation where revenue earned by the business is greated then its expenses.
17. Journal : a dail record of all business transactions. The first entry into the accounting system.
18. Ledger : an account book where all transactions are grouped and all accounts are maintained. Books of final entry.
19. Narration : breif explanation of a journal entry.
20. Posting : transferring the information from journal to ledger.
21. Voucher : a document which serves as an evidence for transactions.
22. Trial Balance : a list of all ledger account balances on a given day.
23. Balance Sheet : a financial statement which shows the amount and nature of a business' assets and liabilities.

Previous Topic : Financial Accounting Introduction 
Next Topic : Accounting Concepts, Principles, Bases and Policies

Financial Accounting Introduction

Accounting is one of the oldest, structured management information system. Accounting as an information system deals with the identification, measurement and communication of economic information to enable decision making.

Accounting : is the application of various accounting principles and methods of book-keeping.

Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of the information.

Book-keeping : is defined as the science and art of recording business transactions in a systematic manner in a certain set of books known as book of accounts.

Functions of book-keeping :

• Identifying the transactions and events : When goods, services or money is transferred from one person or account to another, it is called a transaction. The first step in the accounting process is to identify transaction with financial character that must be recorded in the book of accounts.
• Measuring : expressing the value of events and transactions in terms of money.
• Recording : recording of identified transactions. The book in which transactions of financial character are first recorded is called Journal.
• Classifying : grouping of transactions of similar nature. The book in which groups of similar transactions are periodically entered is called Ledger. This transfer of recorded transactions to Ledger is also called Posting.
• Summarizing : summarizing all the transactions is required to know if the business has made any profit or loss. This step prepares the income, expense, balance etc statements.
• Analyzing : establishing relationship among various items from the statements produced in above step. This helps to identify the financial strengths and weaknesses of the business.
• Interpreting : the step where end users make judgements about their finanacial positions.
• Communicating : communicating the analyzed and interpreted data in the form of financial statements of reports to users of that information.

Next Topic : Financial Accounting Basic Terminologies