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CLASS–11 ACCOUNTANCY (055)

Chapter 3. Accounting Concepts and Principles.
1. Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting
principles refer to the rules or guidelines adopted for recording and reporting of business
transactions in order to bring uniformity in the preparation and presentation financial statements.
These principles are also referred to as concepts and conventions. From the practicality view
point, the various terms such as principles, postulates, conventions modifying principles,
assumptions, etc. have been used interchangeably and are referred to as basic accounting
concepts, in the present book. Accounting principles, concepts and conventions are commonly
known as Generally Accepted Accounting Principles (GAAP). These principles are the base of
Accounting.
2. Basic Accounting Concepts: The basic accounting concepts are referred to as the
fundamental ideas or basic assumptions underlying the theory and practice of financial accounting
and are broad working rules of accounting activities.
3. Business Entity: This concept assumes that business has distinct and separate entity from its
owners. Thus, for the purpose of accounting, business and its owners are to be treated as two
separate entities.
4. Money Measurement: The concept of money measurement states that only those
transactions and happenings in an organisation, which can be expressed in terms of money are to
be recorded in the book of accounts. Also, the records of the transactions are to be kept not in the
physical units but in the monetary units.
5. Going Concern: The concept of going concern assumes that a business firm would continue
to carry out its operations indefinitely (for a fairly long period of time) and would not be liquidated
in the near future.
6. Accounting Period: Accounting period refers to the span of time at the end of which the
financial statements of an enterprise are prepared to know whether it has earned profits or
incurred losses during that period and what exactly is the position of its assets and liabilities, at
the end of that period.
7. Cost Concept: The cost concept requires that all assets are recorded in the book of accounts
at their cost price, which includes cost of acquisition, transportation installation and making the
asset ready for the use.
8. Dual Aspect: This concept states that every transaction has a dual or two-fold effect on
various accounts and should therefore be recorded at two places. The duality principle is
commonly expressed in terms of fundamental accounting equation, which is: Assets = Liabilities +
Capital
9. Revenue Recognition: Revenue is the gross in-flow of cash arising from the sale of goods
and services by an enterprise and use by others of the enterprise resources yielding interest
royalties and dividends. The concept of revenue recognition requires that the revenue for a
business transaction should be considered realised when a legal right to receive it arises.
10. Matching: The concept of matching emphasises that expenses incurred in an accounting
period should be matched with revenues during that period. It follows from this that the revenue
and expenses incurred to earn this revenue must belong to the same accounting period.
11. Full Disclosure: This concept requires that all material and relevant facts concerning
financial performance of an enterprise must be fully and completely disclosed in the financial
statements and their accompanying footnotes.
12. Consistency: This concepts states that accounting policies and practices followed by
enterprises should be uniform and consistent one the period of time so that results are
comparable. Comparability results when the same accounting principles are consistently being
applied by different enterprises for the period under comparison, or the same firm for a number of
periods.

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13. Conservatism: This concept requires that business transactions should be recorded in such
a manner that profits are not overstated. All anticipated losses should be accounted for but all
unrealised gains should be ignored.
14. Materiality: This concept states that accounting should focus on material facts. If the item is
likely to influence the decision of a reasonably prudent investor or creditor, it should be regarded
as material, and shown in the financial statements.
15. Objectivity: According to this concept, accounting transactions should be recorded in the
manner so that it is free from the bias of accountants and others.
16. Systems of Accounting: There are two systems of recording business transactions, viz.
double entry system and single-entry system. Under double entry system every transaction has
two-fold effects whereas single entry system is known as incomplete records.
17. Basis of Accounting: The two-broad approach of accounting are cash basis and accrual
basis. Under cash basis transactions are recorded only when cash are received or paid. Whereas
under accrual basis, revenues or costs are recognises when they occur rather than when they are
paid.
18. Accounting Standards: Accounting standards are written statements of uniform accounting
rules and guidelines in practice for preparing the uniform and consistent financial statements.
These standards cannot override the provisions of applicable laws, customs, usages and business
environment in the country.
19. GST: GST is a destination tax on the consumption of goods and services levied at all stages
right from manufacturing up to the final consumption with credit of taxes paid at previous stages.
Accounting Principles:
“Principles of Accounting are the general law or rule adopted or proposed as a guide to
action, a settled ground or basis of conduct or practice.” Accounting Principles are the
rules of action or conduct adopted by accountants universally while recording accounting
transactions. They are the norms or rules which are followed in giving accounting treatment to
various items of assets, liabilities, expenses, income, etc. These principles are classified into two
categories:
1. Accounting Concepts;
2. Accounting conventions.
1. Accounting Concepts: Accounting Concepts are the basic assumptions or fundamental
propositions within which accounting operates.
2. Accounting conventions: Accounting Conventions are the outcome of accounting practices
or principles being followed by the enterprises over a period of time.
FEATURES OF ACCOUNTING PRINCIPLES
(1) Accounting principles are manmade.
(2) Accounting principles are flexible in nature
(3) Accounting principles are generally accepted
1. Accounting Principles are Man-Made: Accounting Principles are man-made and, therefore,
they do not stand the scrutiny like the principles of natural science.
2. Accounting Principles are Flexible: Accounting Principles are not rigid but flexible.
Whenever a situation arises that requires solution, accountants arrive at a reasoned and
reasonable decision which gradually becomes the accepted Accounting Principles.
3. Accounting Principles are Generally Accepted: Accounting Principles are the bases and
guidelines for accounting and are generally accepted. The general acceptance of an Accounting
Principle usually depends on how it meets three criteria: relevance, objectivity and feasibility.
(i) Relevance: Accounting Principles are relevant if they result in information that is useful to the
users of accounting information.
(ii) Objectivity: Accounting Principles are objective if they are not influenced by the personal
bias of the persons preparing the accounting information.

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(iii) Feasibility: Accounting Principles are feasible if they can be applied without undue
complexity and cost.
Need/Necessity of Accounting Principles
Accounting information is better understood if it is prepared following the set of Accounting
Principles uniformly. It means the same Accounting Principles are followed by all entities in
preparing their final accounts.
Basic Accounting Assumptions:
(1) Going Concern Assumption: This concept assumes that an enterprise has an indefinite life
or existence. This concept assumes that business shall continue to carry out its operations
indefinitely for a long period of time and would not be liquidated in the foreseeable future. It
provides the very basis for showing the value of assets in the balance sheet. An asset may be
defined as a bundle of services. For example, a machine purchased for Rs. 2,00,000 and its
estimated useful life say 10 years. The cost of machinery is spread on suitable basis over next 10
years for ascertaining the profit or loss for each year. The total cost of the machine is not treated
as an expense in the year of purchase itself. Relevance:1. Distinction is made between capital
expenditure and revenue expenditure.2. Classification of assets and liabilities into current and
non-current. 3. Depreciation is charged on fixed assets and fixed assets appear in the balance
sheet at book value, without having reference to their market value
(2) Consistency Assumption: This concept states that accounting practices followed by an
enterprise should be uniform and consistent over a period of time. For example, if an enterprise
has adopted straight line method of charging depreciation, then it has to be followed year after
year. If we adopt written down value method from second year for charging depreciation then the
financial information will not be comparable. Consistency eliminates the personal bias helps in
achieving the results that are comparable. However, consistency does not prohibit the change
accounting policies. Necessary changes can be adopted and should be disclosed on income
statement and Balance Sheet. Relevance: It helps the management in decision-making as they
can compare the financial information of current year with that or previous years.
(3) Accrual Assumption: As per Accrual assumption, all revenues and costs are recognized
when they are earned or incurred. It is immaterial, whether the cash is received or paid at the
time of transaction or on a later date e.g., if a credit sale (Credit for two months) for Rs. 15,000 is
made on 15th Feb. 2016, then the revenue earned is to be recorded on 15th Feb. 2016, not on
the date when cash is realized, i.e., after two months. In case of Expenses, if at the end of the
year, salary for two months is due but not paid, then the expenses of salary will be recorded in
the current year in which the salary is due, not in the next year when it will be paid.
Relevance: Earning of revenue and consumption of a resource (expenses) can be accurately
matched to a particular accounting period
Basic accounting Principles.
(1) Business entity concepts: An entity has a separate existence from its owner. According to
this principle, business is treated as an entity, which is separate and distinct from its owner.
Therefore, transactions are recorded and analysed, and the financial statements are prepared
from the point of view of business and not the owner. The owner is treated as a creditor (Internal
liability) for his investment in the business, i.e., to the extent of capital invested by him. Interest
on capital is treated as an expense like any other business expense. His private expenses are
treated as drawings leading to reductions in capital. For example, if owner bring Rs. 1,00,000 as
capital in business. It is treated as liability of business to owner. Similarly, if owner withdrew Rs.
5,000 from business for personal use, it is treated as reduction of owner’s capital and
consequently reduction in liability of business towards owner.
(2) Money Measurement Principle: According to this principle, only those transactions and
events that can be expressed in money terms are recorded in the books of accounts of the
enterprise. Non-monetary events like death of any employee, appointment of manager,
capabilities of human resources, strikes, disputes etc., are not recorded at all, even though these
also affect the business operations significantly. Limitations: 1. It ignores the qualitative aspect
Sibi Joseph Sir M.Phil., MBA, M. Com, B.Ed., M.A.
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e.g., efficient human resources (Assets), satisfied customers (Assets) and dishonest employees
(liabilities). 2. Value of money (currency) is not stable: -Limitation of this concept is the value of
rupee does not remain same over a period of time. As changes in the value of money is not
reflected in books does not reflect fair view of business affairs. 3. Another aspect is the records of
transactions are to be kept not in physical unit but in monetary unit. For example, an organisation
has 2 buildings, 15 computers, 20 office tables are not recorded because they are physical unit
and not in monetary unit.
(3) Accounting Period Principle: According to this principle, the life of an enterprise is divided
into smaller periods so that its performance can be measured at regular intervals. These smaller
periods are called accounting periods. Accounting period is defined as the interval of time, at the
end of which the profit and loss account and the balance sheet are prepared, so that the
performance is measured at regular intervals and decisions can be taken at the appropriate time
by different users. Accounting period is usually a period of one year. Relevance: 1. This
Assumption requires the allocation of expenses between capital and revenue.
2. Portion of capital expenditure that is consumed during the current year is charged to the
Income statement and the remaining portion i.e., the unconsumed portion is shown as an asset in
the Balance Sheet.
3. As per the income tax law, tax on income is calculated on annual basis from 1st April to 31st
March (Financial Year)
4. Timely decision for corrective measures can be taken by the Management by using these
financial statements.
(4) Cost Principle: According to this concept all assets are recorded in the books of accounts at
the purchase price which includes the cost of acquisition, transportation, installation etc incurred
for making the assets ready to use. This cost becomes the basis of all subsequent accounting
transactions for the asset, since the acquisition cost relates to the past, it is referred to as the
Historical cost. Example: Machinery was purchased for Rs. 1,50,000 in cash and Rs. 20,000 was
spent on the installation of machine, then Rs. 1,70,000 will be recorded as the cost of machine in
the books and depreciation will be charged on this cost. If the market value of the machine goes
up to Rs. 2,00,000 dues to inflation, then the increased value will not be recorded. This cost is
systematically reduced year after year by charging depreciation and the assets are shown in the
balance sheet at book value (cost - depreciation). The main limitation of this concept is that it
does not show the true value of asset and may lead to hidden profits.
(5) Dual Aspect Principle: According to this principle, every business transaction has two
aspects - a debit and a credit of equal amount. In other words, for every debit there is a credit of
equal amount in one or more accounts and vice-versa. The system of recording transactions on
the basis of this principle is known as “Double Entry System”. Due to this principle, the two sides
of the Balance Sheet are always equal and the following accounting equation will always hold
good at any point of time. Assets = Liabilities + Capital. This equation states that assets of
business are always equal to the claims of owners and outsiders. For example, Man as started
business with cash Rs. 50,000. In this transaction asset (cash) increases and liability (capital of
owner) also increases.
(6) Revenue recognition concept (Realisation concept)
According to this principle revenue is considered to have been realised when a transaction has
been entered and obligation to receive the amount has been established. In other words when we
receive right to receive revenue than it is called revenue is realised. For example, sales made in
March, 2010 and receives amount in April, 2010. Revenue of these sales should be recognised in
March month, when the goods sold. For example, commission for the March, 2010 even if
received in April 2010 will be taken into profit and loss A/c of March, 2010. Similarly, if rent for the
April, 2010 is received in advance in March, 2010 it will be taken the profit and loss A/c of the
financial year of March, 2011.

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(7) Matching Principle: According to this principle, expense incurred in an accounting period
should be matched with revenues recognised during that period. The matching principle facilitates
the ascertainment of the amount of profit earned or loss incurred in a particular period by
deducting the related expenses from the revenue recognized in that period. It follows from this
that revenue and expenses incurred to earn these revenues must belong to the same accounting
period. For example, salary for the month of March, 2010 paid in April, 2010 is recorded in the
profit and loss A/c of financial year ending March, 2010 and not in the year when it realized.
Similarly, we records cost of goods sold and not the goods purchased or produced. So, the cost of
unsold goods should be deducted from the cost of goods produced or purchased.
The following treatment of expenses and revenues are done due to matching principle.
1. Ascertainment of Prepaid Expenses.
2. Ascertainment of Income received in advance.
3. Accounting of closing stock.
4. Depreciation charged on fixed assets
(8) Prudence Principle (Conservatism): According to this principle, prospective profit should
not be recorded but all prospective losses should immediately be recorded. The objective of this
principle is not to overstate the profit of the enterprise in any case and this concept ensures that a
realistic picture of the company is portrayed. When different equally acceptable alternative
methods are available, the method having the least favourable immediate effect on profit should
be adopted, e.g.,
1. Valuation of stock at cost or realizable value, whichever is lower.
2. Provision for doubtful debts and provision for discount on debtors is made.
(9) Full Disclosure Principle: According to this principle, apart from legal requirements, all
significant and material information related to the economic affairs of the entity should be
completely disclosed in its financial statements and the accompanying notes to accounts.
Companies Act 1956 has provided a format for making profit and loss A/c and balance sheet,
which needs to be compulsorily adhered to for preparation of financial statement. The financial
statements should act as a means of conveying and not concealing the information results in
better understanding. For example, the reasons for low turnover should be disclosed. E.g.,
footnotes such as: 1. Contingent liabilities in respect to a claim of a very big amount against the
business are pending in a Court of Law. 2. Change in the method of providing depreciation. 3.
Market value of investment
(10) Materiality Principle: Disclosure of all material facts is compulsory but it does not imply
that even those figures which are irrelevant are to be included in the financial statements.
According to this principle, only those items or information should be disclosed that have a
material effect and are relevant to the users. So, an item having an insignificant effect or being
irrelevant to user need not be disclosed separately, it may be merged with another item. If the
knowledge about any information is likely to affect the user’s decision, it is termed as material
information. It should be noted that an item material for one enterprise may not be material for
another enterprise, e.g., an expense of Rs. 50,000 is immaterial for an enterprise having a
turnover of Rs. 100 crores but it is material for an enterprise having a turnover of Rs. 10,00,000.
Similarly closure of one plant material but stock eraser and pencils are not shown at the asset side
but treated as expenses of that period, whether consumed or not because the amount involved in
it are low.
(11) Objectivity concept
This concept states that accounting should be free from personal bias. This can be possible when
every transaction is supported by verifiable documents. For example, purchase of machinery for
Rs. 30,000 should be supported by the voucher and should be recorded in the books of accounts.
Similarly, other supporting documents are cash memo, invoices, receipts provide the basis for
accounting and auditing.
GAAP (Generally Accepted Accounting Principles)

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GAAP refers to the rules or guidelines adopted for recording and reporting of business
transactions, in order to bring uniformity in the preparation and presentation of financial
statements.
Accounting Standards (AS):
The accounting principles or GAAP have been developed in the form of concepts and conventions
to bring comparability and uniformity in the financial statements. So, it was felt that certain
minimum standards should be universally applicable, so that the accounting statements have the
qualitative characteristics of reliability, relevance, understandability and comparability.
International Accounting Standard Committee (IASC) was set up in 1973. (Now renamed as
International Financial Reporting Committee IFRC). The Institute of Chartered Accountants of
India (ICAI) and the Institute of Cost and Works Accountants of India (ICWAI) are members of
this committee.
Concept of Accounting Standards
Accounting standards are written statements, issued from time-to-time by institutions of
accounting professionals, specifying uniform rules and practices for drawing the financial
statements.
NATURE / OBJECTIVES OF ACCOUNTING STANDARDS
(1) Accounting standards are guidelines which provide the framework credible financial statement
can be produced.
(2) According to change in business environment accounting standards are being changed or
revised from time to time
(3) To bring uniformity in accounting practices and to ensure consistency and comparability is the
main objective of accounting standards.
(4) Where the alternative accounting practice is available, an enterprise is free to adopt. So,
accounting standards are flexible.
(5) Accounting standards are amendatory in nature.
(6) To prevent frauds and manipulation by codifying the accounting methods and practices.
(7) To improve reliability of the financial statements: Statements prepared by using accounting
standards are reliable for various users, because these standards create a sense of confidence
among the users.
Utility of accounting standards:
(1) They provide the norms on the basis of which financial statements should be prepared.
(2) It creates the confidence among the users of accounting information because they are reliable.
(3) It helps accountants to follow the uniform accounting practices and helps auditors in auditing.
(4) It ensures the uniformity in preparation and presentation of financial statements by following
the uniform practices.
International Financial Reporting Standards (IFRS): To maintain uniformity and use of
same or single accounting standards, International Financial Reporting Standards (IFRS) are
developed by International Accounting Standards board (IASB).
Objectives of IASB:
(1) To develop the single set of high-quality global accounting standards so users of information
can make good decisions and the information can be comparable globally.
(2) To promote the use of these high-quality standards.
(3) To fulfil the special needs of small and medium size entity by following above objectives.
Meaning of IFRS: IFRS is a principle-based accounting standard. IFRS are a single set of high-
quality accounting Standards developed by IASB, recommended to be used by the enterprises
globally to produce financial statements.
Following financial statements are produced under IFRS:
1. Statement of financial position: The elements of this statement are: a. Assets b. Liability c.
Equity
2. Comprehensive Income statement: The elements of this statement are: a. Revenue

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b. Expense
3. Statement of changes in Equity
4. Statement of Cash flow
5. Notes and significant accounting policies
Benefits of IFRS:
(1) Global comparison of financial statements of any companies is possible
(2) Financial statements prepared by using IFRS shall be better understood with financial
statements prepared by the country specific accounting standards. So, the investors can make
better decision about their investments.
(3) Industry can raise or invest their funds by better understanding if financial statements are
there with IFRS.
(4) Accountants and auditors are in a position to render their services in countries adopting IFRS.
(5) By implementation of IFRS accountants and auditors can save the time and money.
(6) Firm using IFRS can have better planning and execution. It will help the management to
execute their plans globally.
Main difference between IFRS and IAS (Indian Accounting Standards)
1. IFRS are principle based while IAS are rule based.
2. IFRS are based on Fair Value while IAS are based on Historical Cost.
Basis of Accounting
There are two bases of ascertaining profit or loss, namely: (1) Cash Basis, and (2) Accrual Basis.
(1) Cash Basis of Accounting: Under this system of accounting, transactions are recorded in
the books of accounts only on the receipt/ payment of cash and not when the receipt or payment
becomes due.The income is calculated as the excess of actual cash receipts (in respect of sale of
goods, services, properties etc.) over actual cash payments (regarding purchase of goods,
expenses, rent, electricity, salaries etc.) Entry is not recorded when a payment or receipt is merely
due i.e., outstanding expenses, accrued incomes are not treated. This method is contradictory to
the matching principle. For example, if salary Rs. 7,000 of January 2018 paid in February 2019 it
would be recorded in the books of accounts only in February, 2019.
(2) Accrual Basis of Accounting: Under this system of accounting, revenue and expenses are
recorded when they are recognized i.e., Income is recorded as Income when it is accrued (when
transaction takes place) irrespective of the fact whether cash is received or not. Similarly,
expenses are recorded when they are incurred or become due and not when the cash is paid for
them. Under this system, expenses such as outstanding expenses, prepaid expenses, accrued
income and income received in advance are identified and taken into account. Under the
Companies’ amendments Act 2013, all companies are required to maintain their accounts
according to accrual basis of accounting. For example, raw materials consumed are matched
against the cost of goods sold for the accounting period
Difference between accrual basis of accounting and cash basis of accounting
Basis Accrual basis Cash basis
1. Transactions Both cash and credit transactions Only cash transactions are
are recorded. recorded.
2. Profit or Loss Profit or Loss is ascertained Correct profit/loss is not
correctly due to complete record ascertained because it records only
of transactions. cash transactions.
3. Distinction between This method makes a distinction This method does not make a
Capital and Revenue between capital and revenue distinction between capital and
items items. revenue items.
4. Legal position This basis is recognized under This basis is not recognized under
the Companies Act. the Companies Act.

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COMMERCE FACULTY, ST. XAVIER’S SR.SEC.SCHOOL, CIVIL LINES, DELHI, NCR. 9999717997