Lec3.Accounting Principles

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BASIC FINANCIAL CONCEPTS

ACCOUNTING
Accounting may be defined as the process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results thereof to the persons interested in such informations. An analysis of the definition brings out the following functions of accounting: 1. Recording 2. Classifying 3. Summarising 4. Deals with financial transactions 5. Analyses and interprets 6. Communicates.

Objectives of Accounting
1. To keep systematic records 2. To protect business properties 3. To ascertain the operational profit or loss. 4. To ascertain the financial position of business. 5. To facilitate rational decision-making.

ACCOUNTING PRINCIPLES
Accounting principles can be subdivided into two categories

Accounting Concepts Accounting Conventions

ACCOUNTING PRINCIPLES

Accounting Concepts

Accounting Conventions

The term concept is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based. The term convention is used to signify customs and traditions as a guide to the presentation of accounting statements.

Accounting Concepts Business Entity Concept Money Measurement Concept Cost Concept Going Concern Concept Dual Aspect Concept Realization Concept Accounting Period Concept

Accounting Conventions

Convention of Consistency
Convention Materiality of Disclosure &

Convention of Conservation

Business Entity Concept : Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital. Money Measurement Concept : In accounting, we record only those transactions which are expressed in terms of money. In other words, a fact which can not be expressed in monetary terms, is not recorded in the books of accounts.

Cost Concept :Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions. Going Concern Concept : It is beleived that the business will exists for a long time and transactions are recorded from this point of view. Dual Aspect Concept :Each transaction has two aspects, that is, the receiving benefit by one party and the giving benefit by the other. This principle is the core of accountancy.

Realization Concept: Accounting is a historical record of transactions. It records what has happened. It does not anticipate events. This is of great important in preventing business firms from inflating their profits by recording sales and income that are likely to accrue. Accounting Period Concept:Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation. But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible. So a twelve month period is normally adopted for this purpose. This time interval is called accounting period.

Convention of Consistency: In order to enable the management to draw important conclusions regarding the working of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another. The comparison of one accounting period with that of another is possible only when the convention of consistency is followed. Convention of Disclosure:This principle implies that accounts must be honestly prepared and all material information must be disclosed therein. The contents of Balance Sheet and Profit and Loss Account are prescribed by law. These are designed to make disclosure of all material facts compulsory.

Convention of Conservation: Financial statements are always drawn up on rather a conservative basis. That is, showing a position better than what it is, not permitted. It is also not proper to show a position worse than what it is. In other words, secret reserves are not permitted.

SYSTEMS OF ACCOUNTING
SYSTEMS OF BOOK-KEEPING

Book-Keeping is the art of recording business transactions in a regular and systematic manner. This recording of transactions may be done according to the following systems:
Double Entry System : This system takes into account every business transaction in its double aspect. This system recognises that every transaction has a two-fold effect.

Accounting Equation
The system of double entry of book-keeping can very well be explained by the following accounting equation ASSETS = EQUITIES The properties owned by business are called ASSETS. The rights to the properties are called EQUITIES. The Equities may be sub-divided into two principal types: the rights of the creditors and the rights of the owners.

The equity of creditors represents debts of the business and are called liabilities. The equity of the owners is called capital, or proprietorship or owners equity. ASSETS = LIABILITIES + CAPITAL or ASSETS LIABILITIES = CAPITAL.

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