Accounting Principles and Accounting Principles and ConceptsConcepts

Accounting Principles, Accounting Principles, Conventions, ConceptsConventions, Concepts

The rules and conventions of accounting The rules and conventions of accounting are commonly referred to as principles. are commonly referred to as principles.

The double entry system of accounting The double entry system of accounting is based on set of principles which are is based on set of principles which are called Generally Accepted Accounting called Generally Accepted Accounting Principles (GAAP).Principles (GAAP).

Accounting Principles Board (USA) Accounting Principles Board (USA) describes accounting principles as describes accounting principles as follows:follows:

““Generally accepted accounting Generally accepted accounting principles incorporate the consensus at principles incorporate the consensus at a particular time as to a particular time as to which economic which economic resources and obligations should be resources and obligations should be recorded as assets andrecorded as assets and liabilitiesliabilities by by financial accounting, financial accounting, which changes in which changes in assets and liabilities should beassets and liabilities should be recordedrecorded, , when these changes are to when these changes are to bebe recordedrecorded, , how the assets and the how the assets and the liabilitiesliabilities and and changes in them should changes in them should be measuredbe measured, , what information should what information should be disclosedbe disclosed and and which financial which financial statement should be preparedstatement should be prepared.”.”

The general acceptance of an The general acceptance of an accounting principles usually accounting principles usually depends on three criteria: depends on three criteria:

Relevance Relevance ObjectivityObjectivityFeasibilityFeasibility

Accounting Principles are built Accounting Principles are built on a foundation of a few basic on a foundation of a few basic concepts.concepts.

Basic Concepts Underlying Basic Concepts Underlying the Balance Sheetthe Balance Sheet

1. 1. The Entity conceptThe Entity concept2. 2. Money Measurement ConceptMoney Measurement Concept3. 3. Going Concern ConceptGoing Concern Concept4. 4. Cost ConceptCost Concept

Concept Underlying the Income Concept Underlying the Income StatementStatement

1.1. Accounting Period ConceptAccounting Period Concept2.2. The Conservatism ConceptThe Conservatism ConceptThere are three principles or rules There are three principles or rules

which directly stand from this which directly stand from this concept:concept:

The accountants should not The accountants should not anticipate income and should anticipate income and should provide all possible losses. provide all possible losses. Faced with a choice between two Faced with a choice between two methods of valuing an asset the methods of valuing an asset the accountant should choose a accountant should choose a method which leads to the lesser method which leads to the lesser value.value.In case of valuation of current In case of valuation of current assets the accountant should assets the accountant should accept the lower of the historical accept the lower of the historical cost and net realisable value. cost and net realisable value.

3.3. The Realization ConceptThe Realization Concept

4.4. The Matching ConceptThe Matching Concept

5.5. The Consistency ConceptThe Consistency Concept

6.6. The Materiality ConceptThe Materiality Concept

7.7. Accrual ConceptAccrual Concept

8.8. Duality or Accounting Equivalence Duality or Accounting Equivalence ConceptConcept

In business, as elsewhere, funds can be In business, as elsewhere, funds can be raised in any of the following ways:raised in any of the following ways:Additional Capital (increases owners’ Additional Capital (increases owners’ equity)equity)Additional Loans (increases outside Additional Loans (increases outside liability)liability)Earning Revenue (increases owners’ Earning Revenue (increases owners’ equity)equity)Making Profits (increases owners’ equity)Making Profits (increases owners’ equity)Disposing or Reducing some of the Disposing or Reducing some of the Assets (increases assets)Assets (increases assets)

Thus, all increases in liabilities Thus, all increases in liabilities (including owners’ equity) and (including owners’ equity) and reduction in assets represent reduction in assets represent sources of funds. sources of funds.

Similarly, the funds thus raised, may be put to any of the Similarly, the funds thus raised, may be put to any of the following uses:following uses:

1.Purchasing of assets (increases assets)1.Purchasing of assets (increases assets)

2.Incurring Operational expenses (decrease owners’ 2.Incurring Operational expenses (decrease owners’ equity)equity)

3.Discharging Earlier Liabilities (decreases liability)3.Discharging Earlier Liabilities (decreases liability)

4. Keeping Idle funds so that cash balance increases 4. Keeping Idle funds so that cash balance increases (increases asset)(increases asset)

5. Suffering losses (decreases owners’ equity)5. Suffering losses (decreases owners’ equity)

Thus, all increases in assets and Thus, all increases in assets and decreases in liabilities (including decreases in liabilities (including owners’ equity) are uses of funds. owners’ equity) are uses of funds.

Thus, the accounting equivalence Thus, the accounting equivalence concept implies that: concept implies that:

Sources of Funds = Uses of FundsSources of Funds = Uses of Funds OrOrOwners’ Equity + Outside Liability = AssetsOwners’ Equity + Outside Liability = Assets

Symbols for Sources and Uses of Symbols for Sources and Uses of FundsFunds

Increase DecreaseLiability, Revenueand Profit

CR =Source

DR = Use

Asset, Expenseand Loss

DR =Use

CR =Source

A Conceptual Framework ofFinancial Accounting

Integrated into

Eg. Subject: Financial Accounting

Principle: Double Entry System

For Cash transactions For Credit transaction

Cash Book Journal

Ledger

Output: Trial Balance

Profit and LossAccountIncome andExpenditure

Profit or Losstransferred toBalance Sheet

Balance SheetAssets andLiabilities