1. What is Accounting?
- Accounting is recording and summarizing all the financial transactions. Other than accounting is “Language of the business is known as Accounting.”
2. Basic Accounting Principles
- Rules adopted universally to record financial transactions is known as an accounting principle. Accounting principles, concepts and conventions are known as GAAP – General Accepted Accounting Principles. These principles are the guidelines for preparing Financial Statements. Accounting principles classified into 2 categories:
- Accounting Concept
- Accounting Conventions
a. Accounting Concept: In order to make accounting more meaningful, the accountants agreed on a large number of assumptions, which are usually followed to prepare a financial statement. The accounting concepts have the following points:
- Business Entity Concept: According to this concept, Business and Owner are two separate entities from the accounting point of view only.
- Money Measurement Concept: This defines that the transactions will be expressed in term of money only when it will be recorded in the book of account.
- Going Concern Concept: According to this concept, Business entity continues to exist indefinitely with no intention to close business.
- Cost Concept: According to this, the assets are recorded in a book at a price that needs to be getting paid.
- Duality Concept: According to this concept, every transaction has a dual effect based on the double entry system. Ex. Assets = Liabilities.
- Revenue Recognition Concept: This concept, also known as “Realization Concept.” It determines the point of time when the revenue is to be recognized.
- Accounting Period Concept: According to this concept, Business is assumed to be carried on for an indefinite period. The performance of the business is known by accounting period. The accounting period is of 1 year or 12 months is known as accounting year or financial year (1 April-31 March).
- Matching Concept: In this concept, it is compulsory to match revenues of the period with the expenses of that period to determine the correct profit or loss incurred in that period.
- Accrual Concept: According to this concept, the transactions are recorded in the books at the time when it is entered and not when the settlement takes place.
- Verifiable Objective Concept: According to this concept, Accounting should be free from personal bias. Every transaction should have true and fair proof.
b. Accounting Conventions: They are traditional conventions which act as a guide to the preparation of Accounting Statement.
- Convention of Materiality: Information which is material (important) should be included in accounting statements and which is not important is to be ignored. “This convention emphasize on avoidance of immaterial and useless information.”
- Convention of Consistency: Accounting policies once adopted cannot change. Because due to changes in accounting policies, the financial statement becomes unreliable for users. If a change is being reported in the financial statement, its effect should also be shown separately.
- Convention of Conservatism: Also known as “Convention of Prudence”. This convention emphasis on all possible future losses but not on future gains/profits.
- Convention of Full Disclosure: This disclosure includes all the significant information related to the economic affairs of the entity that should affect the reader's understanding of that information.