Majid 12 3762 1 Accounting Principles and Concepts

Accounting Concepts, Principles and Basic Terms
Definition and introduction

Accounting is the language of business efficiently communicated by well-organized and honest
professionals called accountants.
A more academic definition of accounting is given by the American Accounting Association:
“The process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.”
The American Institute of Certified Public Accountants defines accounting as:
“The art of recording, classifying, summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least of financial character, and interpreting the
results thereof.”
Accounting not only records financial transactions and conveys the financial position of a
business enterprise; it also analyses and reports the information in documents called “financial
statements.”
Recording every financial transaction is important to a business organization and its creditors
and investors. Accounting uses a formalized and regulated system that follows standardized
principles and procedures.
The job of accounting is done by professionals who have educational degrees acquired after
years of study. While a small business may have an accountant or a bookkeeper to record money
transactions, a large corporation has an accounts department, which supplies information to:
 Managers who guide the company.
 Investors who want to know how the business is doing.
 Analysts and brokerage firms dealing with the company’s stock.
 The government, which decides how much tax should be collected from the company.
Accounting Principles
Obviously, if each business organization conveys its information in its own way, we will have a
babel of unusable financial data.
Personal systems of accounting may have worked in the days when most companies were owned
by sole proprietors or partners, but they do not anymore, in this era of joint stock companies.
These companies have thousands of stakeholders who have invested millions, and they need a
uniform, standardized system of accounting by which companies can be compared on the basis
of their performance and value.
Therefore, accounting principles based on certain concepts, convention, and tradition have been
evolved by accounting authorities and regulators and are followed internationally.
These principles, which serve as the rules for accounting for financial transactions and
preparing financial statements, are known as the “Generally Accepted Accounting Principles,” or
GAAP.
The application of the principles by accountants ensures that financial statements are both
informative and reliable.
It ensures that common practices and conventions are followed, and that the common rules and
procedures are complied with. This observance of accounting principles has helped developed a
widely understood grammar and vocabulary for recording financial statements.
However, it should be said that just as there may be variations in the usage of a language by two
people living in two continents, there may be minor differences in the application of accounting
rules and procedures depending on the accountant.
For example, two accountants may choose two equally correct methods for recording a particular
transaction based on their own professional judgement and knowledge.
Accounting principles are accepted as such if they are (1) objective; (2) usable in practical
situations; (3) reliable; (4) feasible (they can be applied without incurring high costs); and (5)
comprehensible to those with a basic knowledge of finance.
Accounting principles involve both accounting concepts and accounting conventions. Here are
brief explanations.
Accounting Concepts
1. Business entity concept: A business and its owner should be treated separately as far as
their financial transactions are concerned.
2. 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.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording of a
transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly
long time and carry out its commitments and obligations. This assumes that the business
will not be forced to stop functioning and liquidate its assets at “fire-sale” prices.
5. Historical Cost concept: 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.
6. Accounting year/Periodicity 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.
7. Matching concept: 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.
8. Realization 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.
Accounting Conventions
There are four main conventions in practice in accounting: conservatism; consistency; full
disclosure; and materiality.
1. Conservatism is the convention by which, when two values of a transaction are
available, the lower-value transaction is recorded. By this convention, profit should never
be overestimated, and there should always be a provision for losses.
2. Consistency prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit and
loss. (i.e. Depreciation method should be same year to year)
3. Materiality means that all material facts should be recorded in accounting. Accountants
should record important data and leave out insignificant information.
4. Full disclosure entails the revelation of all information, both favorable and detrimental to
a business enterprise, and which are of material value to creditors and debtors.
Basic Accounting Terms

Here is a quick look at some important accounting terms.
Accounting equation: The accounting equation, the basis for the double-entry system (see
below), is written as follows:
Assets = Liabilities + Stakeholders’ equity
This means that all the assets owned by a company have been financed from loans from creditors
and from equity from investors. “Assets” here stands for cash, account receivables, inventory,
etc., that a company possesses.
Accounting methods: Companies choose between two methods—cash accounting or accrual
accounting. Under cash basis accounting, preferred by small businesses, all revenues and
expenditures at the time when payments are actually received or sent are recorded. Under accrual
basis accounting, income is recorded when earned and expenses are recorded when incurred.
Account receivable: The sum of money owed by your customers after goods or services have
been delivered and/or used.
Account payable: The amount of money you owe creditors, suppliers, etc., in return for goods
and/or services they have delivered.
Assets (fixed and current): Resources owned by a business. Current assets are assets that will
be used within one year. Fixed assets are assets that will be used more than one year
For example, cash, inventory, and accounts receivable (see above). Fixed assets (non-current)
may provide benefits to a company for more than one year—for example, land and machinery.
Balance sheet: A financial report that provides a gist of a company’s assets and liabilities and
owner’s equity at a given time.
Capital: A financial asset and its value, such as cash and goods. Working capital is current
assets minus current liabilities.
Cash flow statement: The cash flow statement of a business shows the balance between the
amount of cash earned and the cash expenditure incurred.
Credit and debit: A credit is an accounting entry that either increases a liability or equity
account, or decreases an asset or expense account. It is entered on the right in an accounting
entry. A debit is an accounting entry that either increases an asset or expense account, or
decreases a liability or equity account. It is entered on the left in an accounting entry. (Debit=
anything which comes in, Credit= anything which go out.)
Double-entry bookkeeping: Under double-entry bookkeeping, every transaction is recorded in
at least two accounts—as a credit in one account and as a debit in another.
For example, an automobile repair shop that collects Rs. 10,000 in cash from a customer enters
this amount in the revenue credit side and also in the cash debit side. If the customer had been
given credit, “account receivable” would have been used instead of “cash.”
Financial statement: A financial statement is a document that reveals the financial transactions
of a business or a person. The three most important financial statements for businesses are the
balance sheet, cash flow statement, and profit and loss statement.
General ledger: A complete record of financial transactions in a specific account over the life of
a company. Like all cash entries are recorded in cash ledger, sales entries are recorded in sales
ledger, etc.
Journal entry: Any general entry in the journal that records financial transactions in the
chronological order.
Profit and loss statement (income statement): A financial statement that summarizes a
company’s performance by reviewing revenues, costs and expenses during a specific period.
Single-entry bookkeeping: Under the single-entry bookkeeping, mainly used by small or
businesses, incomes and expenses are recorded through daily and monthly summaries of cash
receipts and disbursements.

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What are the main accounting principles?

What are some important accounting terms explained?

Accounting Concepts, Principles and Basic Terms

Definition and introduction

Basic Accounting Terms

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