Introduction
Accounting Concepts and Accounting Conventions form the foundation of accurate financial reporting. They ensure that all financial statements are prepared in a uniform, comparable, and reliable manner.
- Accounting Concepts are the basic assumptions and principles that guide how transactions should be recorded.
- Accounting Conventions are the guidelines or practices that accountants follow to ensure consistency and fairness in reporting.
Together, they bring clarity, transparency, and accuracy to financial statements.
A) Accounting Concepts
Accounting Concepts are fundamental rules and assumptions that form the basis of preparing financial statements. They ensure that financial information is recorded in a systematic and logical manner.
1. Entity Concept
This concept states that the business and the owner are treated as two separate independent entities. The business has its own accounts, separate from the personal accounts of the owner.
Example:
If the owner brings ₹50,000 into the business:
Cash A/C ……………. Dr 50,000
To Capital A/C ……………. 50,000
This shows it is the business receiving money from the owner, not a personal transaction.
2. Money Measurement Concept
Only those transactions which can be measured in money are recorded in the books of accounts. Qualitative factors cannot be recorded.
Example:
- Employee loyalty → Not recorded
- A machine purchased for ₹2,00,000 → Recorded
3. Periodicity Concept
The life of a business is divided into specific time periods (such as monthly, quarterly, or yearly) to prepare financial statements.
Example:
A company prepares its financial statements from 1 April to 31 March every year to measure performance for that period.
4. Accrual Concept
Revenue and expenses are recorded when they are earned or incurred—not when cash is received or paid.
Example:
You provide services worth ₹15,000 in March but receive cash in April. Revenue will be recorded in March, because that’s when it was earned.
5. Matching Concept
Expenses should be matched with the revenue of the same accounting period to calculate correct profit.
Example:
A machine costing ₹1,00,000 is used for 10 years. Depreciation of ₹10,000 per year is matched with the revenue earned each year.
6. Cost Concept
Assets are recorded at their purchase cost, and this cost is the basis for all future accounting (except when revaluation is required by law).
Example:
Land purchased for ₹5,00,000 is recorded at ₹5,00,000 even if its market value increases to ₹8,00,000.
7. Realisation Concept
Revenue is recognized when the risk and ownership of goods are transferred to the customer, not when cash is received.
Example:
Goods worth ₹25,000 sold on credit today must be recorded as sales today, not when the customer pays later.
8. Dual Aspect Concept
Every transaction has two aspects—one debit and one credit. This forms the foundation of double-entry accounting.
Example:
If the business buys furniture worth ₹5,000 for cash:
Furniture A/C ………. Dr 5,000 To Cash A/C ……………. 5,000
One account increases, and another decreases.
B) Accounting Conventions
Accounting Conventions are customs or guidelines that have become accepted over time to bring consistency and comparability to accounting practices.
1. Conservatism Convention
While preparing financial statements, anticipated losses are recorded, but anticipated profits are not.
Example:
If it is estimated that ₹3,000 from debtors may not be recovered:
Bad Debts Expense A/C …….. Dr 3,000 To Provision for Bad Debts A/C …….. 3,000
2. Consistency Convention
The same accounting methods and procedures must be used from one period to the next to enable comparison.
Example:
If depreciation is calculated using SLM this year, the same method must be used next year unless a valid reason is disclosed for changing it.
3. Materiality Convention
Only those items that are significant enough to influence the decisions of users should be recorded or disclosed.
Example:
A stapler costing ₹100 is recorded as an expense, not an asset, because the amount is too small to affect financial statements.
4. Disclosure Convention
The Disclosure Convention states that all material and relevant information must be fully disclosed in the financial statements or in the notes to accounts so that users can make informed decisions.
It ensures transparency, clarity, and fair presentation of financial statements.
Example:
A company is facing a court case that may result in a loss of ₹10,00,000. Even though the loss has not happened yet, it must be disclosed in the Notes to Accounts as a Contingent Liability.
Summary
Accounting Concepts and Conventions form the backbone of reliable financial reporting by providing structure, clarity, and uniformity. While concepts define the core principles for recording transactions, conventions ensure consistency and fairness in practice. Together, they enhance the accuracy, transparency, and comparability of financial statements. Mastering these fundamentals is key to maintaining trustworthy and compliant financial records.
Connect with Us
To ensure your business follows the right practices, connect with us for professional Accounting, Bookkeeping, Virtual CFO Services, Cash Flow Management, and Payroll Outsourcing.
