1. Accounting Principles (GAAP)
 Accounting principles may be defined as those
rules of action or conduct which are adopted by
the accountants universally while recording
accounting transactions.
 Accounting Principles are classified as:
Accounting Concepts
Accounting Conventions

2. Important criteria for GAAP :
 (a) Relevance : The principle is relevant to the extent
it results in information that is meaningful and useful
to the user of the accounting information.
(b) Objectivity : A principle is objective to the extent
the accounting information is not influenced by
personal bias or judgement of those who provide it.
(c) Feasibility : A Principle is feasible to the extent it
can be implemented without much complexity or
cost.

3. Accounting Concepts
 Accounting Concepts refers to those basic
assumptions or postulates or conditions upon
which the science of accounting is based.
 Balance Sheet - related concepts
 Profit & Loss - related concepts

4. Balance Sheet – Basic Concepts
 The Business Entity Concept
 Going Concern Concept
 Monetary Unit Concept
 Cost Concept
 Conservatism Concept
 Accounting Equivalence Concept

5. The Profit & Loss Account and Related
Concept
 The Accounting Period Concept
 Realization Concept
 Accrual Concept
 Matching Expenses with Revenue concept

6. The Business entity concept
 This concept implies that the affairs of a business are to be
treated as being quite separate from the non-business
activities of its owners
 Personal transactions of the owner should not be included.
 In short as business has its own existence and therefore
business and owners both should be consider as different
persons.
 For e.g. A director’s private car should not be included in
the fixed assets of the company.

7. Going Concern Concept
 Accountant has to assume that business will continue to
operate in future for indefinite period of time until it is
liquidated in the immediate future.
 Continuing activity and not liquidation.
 For example: In case of basis for depreciation the cost of
a fixed assets is allocated over its useful life and it will
not be considered as the current year only.
 Thus it does not imply permanent continuance of an
enterprise but it presumes that the enterprise will continue
in operations long enough to charge against income.

8. Monetary Unit Concept
 Transactions or events which can not be expressed in
terms of money, do not find a place in the books of
accounts even though they may be very useful for the
business.
 This concept introduces many difficulties in accounting in
the sense that those assets which cannot be accurately
expressed in terms of monetary units reflected in business
accounts.
 For e.g. It is hardly possible to add thousands of square
feet of buildings space with tons of coal and numbers of
bank notes, effective sales policy because of physical
nature of their measurement units.

9. Cost Concept
 Concept deals that purpose of accounting all transaction
are recorded at their monetary cost of acquisition.
 Assets are normally shown at their original costs of
acquisition.
 Any changes in the market value after the purchase are
ignored.
 Historical cost is the most objective measure of the value
of an asset. However, it cannot reflect the current value of
an asset.

10. Cost Concept
 E.g. A fixed asset acquired at a cost of $100,000 would be
recorded at this amount in the books. Even if its market
value may have gone up or down in future, it should be
recorded at its original cost $100,000.

11. Conservatism Concept
 The accountant should always be on the side of safety.
 The Conservatism concept means that normally he will
take the figure which will understate rather than overstate
the profit.
 Provision is made for all known liabilities.
 “Anticipate no profits and provide for all possible losses
and if in doubt write off.”

12. Accounting Equivalence Concept
 Assets = Owners Equity + Liabilities
 For e.g. Mr. X had provided Rs10,00000 as the capital to
start a business, the assets owned by that company at that
stage would be a cash balance of Rs10,00000.
 Corresponding to this amount would be the equity; i.e. an
amount which could be claimed by Mr. X this relationship
is expressed as:
Assets = Equities (Claims)
In accounting terms:
Assets Equities
Cash Rs.10,00000 = Mr. A’s Equity (Capital)
Rs.10,00000

15. The Profit & Loss Account and
Related Concept
The Accounting Period Concept
 The life of business is divided into appropriate segments
for studying the results shown by the business after each
segment.
 The measurement of income & studying financial position
of the business after a very long period would not be
helpful in taking corrective steps at the appropriate time of
business with losses. Thus it requires to know at frequent
intervals ‘Stop and, see back’.

16. Realization Concept
 This concept holds to the view that profit can only be
taken into account when realization has occurred.
 When goods produced are transferred or required services
are rendered to a customer either for cash or for some other
assets or for a promise to pay cash in future.
 Generally, sales revenue arising from the sale of goods is
recognized when the goods are delivered to the customers.

17.  For e.g. Profit is earned when goods or services are
provided to customers. Thus it is incorrect to record profit
when order is received, or when the customer pays for the
goods.

18. Accrual concept
 The accrual concept says that net profit is the difference
between revenues and expenses.
 Income and costs are recognized as they are earned and
incurred but not as they are received or paid.
 For e.g. Income due but not received, outstanding
expenses, Prepaid expenses etc.

19. Matching Expenses with Revenue
concept
 To ascertain the actual profit or loss of a given period, total
revenue of the given accounting period is compared
(matched) with total expenses for that period.
 If the income or revenue is more than the expenses than
the difference is known as profits & vice a versa.
 In matching process, adjustments are to be made for all
outstanding expenses, and unearned incomes etc.

20. Accounting Conventions
 An accounting convention is defined as, “a
rule of practice, which has been sanctioned
by general custom or usage. They are lamp
posts to procedures employed in the
collection, measurement and reporting of
financial data.”

21. Accounting Conventions
 Conservatism/Prudence
 Consistency
 Materiality
 Full Disclosure

22. Conservatism/Prudence
It is a policy of “Playing safe.”
Prudence also means early recognition of
unfavorable events.
Working rule relating to the conservatism is –
“Anticipate no profits and provide for all
possible losses and if in doubt write off.”

23.  Examples:
 Making provisions for doubtful debts in anticipation of
actual Bad debts.
 Creating Investment Fluctuation Reserve
 Applying Written Down Value (WDV) Method of
depreciation as against Straight line method.
 Providing for the loss on issue of debenture, when the
same are issued at par but redeemable at premium.

24. Consistency
 The consistency convention principle implies that
accounting practices and methods remain unchanged
from on accounting period to another accounting
period.
 For example, using only one method for valuation in
accountancy for longer duration of time.

25. Types of Consistency
 Vertical Consistency: is maintained within the
interrelated financial statement of the same date.
 Horizontal Consistency: is maintained between financial
statements from one year to another year and subsequent
years.
 Third Dimensional Consistency: enables the comparison
of the performance of a business enterprise with the
performance of another business enterprise in the same
type of industry, and preferably on the same date.

26. Materiality
 The AAA defines the term materiality as – “An item
should be regarded as material if there is reason to believe
that knowledge of it would influence the decision of
informed investor.”
 It is observed that an item, material in one year may not be
material in the next year.
 For example, an item, Bad debts shown in the previous
accounting periods, the same amount may not become
important in the subsequent year.

27. Full Disclosure
 Disclosure may be defined as “the communication of
financial information about the activities of a business
enterprise to the interested parties for facilitation of their
economic decisions.”
 Sacher Committee Report on this aspect emphasises that –
“Openness in company affairs is the best way to secure
responsible behavior.”

28. Basis for measurement
The basis for measuring the items in the financial
statement should be
 Reliability
 Relevance
 Consistency
 Comparability
 Understandability and
 Standardization

29. Short Questions
True/False
 The “Entity concept of accounting” is not applicable to
sole trading concerns and partnership concerns.
 The Accounting equivalence concept results in the
accounting equation = Capital + Liabilities = Assets
 The conservatism has usually the effect of “anticipate no
losses & provide for possible profits.”
 “Monetary Unit Concept” takes into account monetary as
well as non monetary units.

30. Composition of financial statements
Financial Statements
Summary of Financial transactions which can be classified into
Capital Nature Revenue Nature

31. Classification
Items of capital
nature are reflected
in the
Items of revenue
nature are reflected
in the
Balance Sheet Profit & Loss account
The impact on Cash Balances due to the operations and
financing activities during the period.
Cash Flow Statement