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PRINCIPLES OF ACCOUNTING:
CHAPTER ONE: ACCOUNTING, CONVENTIONS, CONCEPTS AND PRINCIPLES.
DEFINITION:
A process of recoding business Transactions in the book of accounting is called accounting.
Accounting is a system to summarize, analyze and report financial Transactions of a business in the form of
Financial Statements.
the process of collecting, recording, summarizing and communicating financial information.
EXPLANATION:
Identifying the Transaction and Events: Accounting identifies transaction and event, which can be
expressed ion term of money and bring change in the financial position of a business unit. An event
(whether internal or external) is a happening of a consequence to an entity (e.g., use of raw material for
production) An entity means an economic unit that performs economic activities (e.g., Birla Industries Ltd.
TISCO).
Measuring the identified Transaction and Events: Accounting measures the transaction and events in
term of money.
Recording: It is the process of entering the transaction and events in the books of original entry in the
chronological manner e.g., date wise.
Classifying: It is the process of posting of entries in the ledger so that transaction of similar type is
accumulated at one place.
Summarizing: It is concerned with the preparation of Financial Statement such as Income Statement,
Balance Sheet and Cash Flow Statement.
Analyzing: It is concerned with the establishment of relationship between the various item or group of items
taken from Income statement or Balance Sheet or both. Its purpose is to identify the financial strengths and
weakness of the enterprise. It provides the basis for interpretation.
Interpreting: Interpreting is the last stage of accounting process. It is concerned with explaining the
meaning and significance of the relationship established by the analysis. In fact, interpretation is the main
function of accountant in the present condition since the routine work of recording, classifying and
summarizing business transaction business transaction can be easily handled by the electronic devices like
computers.
Communicating: It is concerned with the transmission of summarized, analyzed and interpreted
information to the user to enable them to make reasoned decisions.
SCOPE OF ACCOUNTING:
Accounting Provides information that Judge the Financial Performance of the Business and make decisions
accordingly. It also supplies sufficient financial data to management for decision making purposes. In the
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modern world, accounting system is practiced not only in all the business institutions but also in many non-
trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative Society etc. And
also, Government and Local Self-Government in the form of Municipality. The professional persons like
Medical practitioners, practicing Lawyers, Chartered Accountants etc. Also adopt some suitable types of
accounting methods. As a matter of fact, accounting methods are used by all who are involved in a series of
financial transactions. The scope of accounting as it was in earlier days has undergone lots of changes in
recent times. As accounting is a dynamic subject, its scope and area of operation have been always
increasing keeping pace with the changes in socio-economic changes. As a result of continuous research in
this field the new areas of application of accounting principles and policies are emerged. National
accounting, human resources accounting and social Accounting are examples of the new areas of application
of accounting systems.
1. Business
Accounting is widely applicable in the business sector. Today, in the modern world, most of the people are
engaged in business sector and all businessmen follow Generally Accepted Accounting Principle (GAAP) to
find out profit, loss and financial position of business firm.
2. Government organizations
Though, Government organizations do not follow Generally Accepted Accounting Principle (GAAP), it
keeps systematic records of all transactions in order to find the position of public fund.
3. Non-Government organizations
Non-government and service organizations such as NGOS, INGOs, Red Cross Society, SOS etc. which
plays a vital role in the development of nation also uses accounting. The accounting system used in these
organizations are called fund accounting.
4. Individuals
Individuals also perform economic activities to earn their livelihood. They also perform some form of
accounting to draw financial information for making personal economic decision.
NATURE OF ACCOUNTING:
Accounting is a process: it refers to performing any specific job step by step. Step by step collection
process of collecting, processing, and communicating financial information.
Accounting is an art: the word art means the ways of performing job tactically and skillfully. It includes
tactics and techniques to collect and process accounting data effectively.
Accounting Deals with financial information and transactions only: from the start to the end at every
stage accounting deals with financial information only. Financial or monetary data is the subject matter of
accounting. It does not deal with non-monetary or non-financial data.
Accounting is information system: Accounting is recognized and characterized as a storehouse of
information. As a service function, it systematically collects, processes and communicates financial
information to the intended users and therefore is considered as an informational system.
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BASIC ACCOUNTING PRINCIPLES:

Usefulness: a principle will be relevant only if it satisfies the needs of those who use it. The accounting
principles should be able to provide useful information to its users otherwise it will not serve the purpose.
Objectively: a principle is objective if it is based on facts and figures.
Feasibility/Possibility: accounting principle must be practicable. The principle should be easy to use
otherwise their utility will be limited.
CLASSIFICATION OF ACCOUNTING PRINCIPLES:
Accounting Concepts:
Accounting Conventions:
ACCOUNTING CONCEPTS: There are certain rules that an accountant should follow while recording
business transactions and preparing accounts. Accounting concept refers to the basic assumptions, rules and
principles which work as the basis of recording of business transactions and preparing accounts.
The term concept means those basic conditions upon which accounting is based.
Business entity concept: A business and its owner should be treated separately as far as their financial
transactions are concerned. This concept is applied on all the business types. The record of business is only
maintained by accounting. What owner does and did, are not recorded in the books of accounting. Business
is separated from his personal doings and not doings. For example, personal expenses and incomes do not
relate with the business, are not recorded in the business books.
Money measurement concept: Only business transactions that can be expressed in terms of money are
recorded in accounting, though records of other types of transactions may be kept separately. All the
transactions must be recorded in monetary terms such as dollar, Rupee etc.
Dual aspect concept: This is the basic concept of accounting in modern accounting based on duel aspect.
For every credit, a corresponding debit is made. The recording of a transaction is complete only with this
dual aspect.
Going concern concept: In accounting, a business is expected to continue for a fairly long time and carry
out its commitments and obligations for long period of time. This assumes that the business will not be
forced to stop functioning and liquidate its assets at “fire-sale” prices.
Cost concept: An asset is ordinarily recorded in the books at the price at which it was acquired such as its
cost price or original price. The fixed assets of a business are recorded on the basis of their original cost in
the first year of accounting. Subsequently, these assets are recorded minus depreciation. No rise or fall in
market price is taken into account. The concept applies only to fixed assets.
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Accounting year concept: According to this concept, each business chooses a specific time period to
complete a cycle of the accounting process—for example, monthly, quarterly, or annually—as per a fiscal or
a calendar year.
Matching concept: The word matching means to relate. This principle dictates that for every entry of
revenue recorded in a given accounting period, an equal expense entry has to be recorded for correctly
calculating profit or loss in a given period.
Realization or recognition concept: According to this concept, profit is recognized only when it is earned.
An advance or fee paid is not considered a profit until the goods or services have been delivered to the
buyer. Realization refers to inflows of cash or claims to cash (e.g., accounts, receivable) arising from the
sale of goods or services. Thus, if a customer buys Rs. 500 worth of items at a grocery store, paying cash,
the store realizes Rs. 500 from the sale.

ACCOUNTING CONVENTIONS: An accounting convention is a common practice used as a guideline

when recording a business transaction. It is used when there is not a definitive guideline in the
accounting standards that govern a specific situation. Thus, accounting conventions serve to fill in the gaps
not yet addressed by accounting standards.
There are four main conventions in practice in accounting: conservatism; consistency; full disclosure; and
materiality.
Full disclosure: This convention requires that accounting statements should be honestly prepared and all
significant information should be disclosed therein. That is, while making accountancy records, care should
be taken to disclose all material information. Here the emphasis is only on material information and not on
immaterial information.
This convention assumes greater importance in respect of corporate organizations where the management is
divorced from ownership.
The purpose of this convention is to communicate all material and relevant facts of financial position and the
results of operations, which have material interests to proprietor, creditors and investors.
Materiality: Materiality convention means that all material facts should be recorded in accounting.
Accountants should record important data and leave out insignificant information.
Consistency: Rules and practices of accounting should be continuously observed and applied. In order to
enable the management to draw conclusions about the operation of a company over a number of years, it is
essential that the practices and methods of accounting remain unchanged from one period to another.
Comparisons are possible only if a consistent policy of accounting is followed.
If there are frequent changes in the treatment of accounts, there is little or no scope for reliability.
Comparison of accounting period with that in the past is possible only when the convention of consistency is
adhered to.
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According to Anthony, “the consistency requires that once a company had decided on one method, it will
treat all subsequent events of the same character in the same fashion unless it has a sound “reason to do
otherwise.”
Conservatism: “Anticipate no profit and provide for all possible losses” is the essence of this convention.
Future is uncertain. Fluctuations and uncertainties are not uncommon. Conservatism refers to the policy of
choosing the procedure that leads to understatement as against overstatement of resources and income.
The consequences of an error of understatement are likely to be less serious than that of an error of
overstatement. For example, closing stock is valued at cost or market price whichever is lower. This is a
convention of caution or playing safe and is adhered to while preparing financial statements. Showing a
position better than what it is, is not permitted. Moreover, it is not proper to show a position substantially
worse than what it is.