Class 11 Accountancy

Chapter - 3
Accounting
Principles
Accounting Principles

Accounting statements disclose the

profitability and solvency of the
business to various parties. It is,
therefore, necessary that such
statements should be prepared
according to some standard language
and set rules. These rules are usually
called ‘Generally accepted accounting
principles’ (GAAP).
 Features of Accounting Principles
Accounting Principles are Uniform set of Rules :
Accounting principles are uniform set of rules or guidelines developed to
ensure uniformity and easy understanding of the accounting information.

Accounting Principles are Man-made:

Accounting principles are man-made and are derived
from experience and reason.

Accounting Principle are Flexible :

Accounting principles are not rigid but flexible. They are bound to change with
the passage of time in response to the changes in business practices.
 Accounting Principles are Generally Accepted :
Accounting Principles are bases and guidelines for accounting and are
generally accepted. The general acceptance of an accounting principle
depends upon how well it satisfies the following three criteria :

a) Relevance : A principle is relevant if it results in information that

is useful to the user of the accounting information.
b) Objectivity : A principle is objective if it is free from personal bias
or judgments of those who furnish the information.
c) Feasibility : A principle is feasible if it can be
applied without undue complexity or cost.
 Kinds of Accounting Principles

Accounting Principles are described by various

terms such as assumptions, conventions, concepts,
doctrines, postulates etc. These principles can be
classified mainly into two categories :

Accounting Concepts Accounting

or Assumptions Conventions
 Accounting Concepts or Assumptions

Following may be treated as basic

concepts or assumptions :

As per Accounting Standard (AS-1), issued by the Institute of Chartered

Accountants of India, there are three fundamental accounting concepts
or assumptions :

1. Going
2. Consistency 3. Accrual
Concern
Concept Concept
Concept
1) Going Concern Concept :-
 As per this concept it is assumed that the business will
continue to exist for a long period in the future. The
transactions are recorded in the books of the business
on the assumptions that it is a continuing enterprise.
 It is on this concept that we record fixed assets at their
original cost and depreciation is charged on these assets
without reference to their market value.
 Because of the concept of going concern the full cost of the
machine would not be treated as an expense in the year of
its purchase itself.
 It is also because of the going concern concept that outside
parties enter into long-term contracts with the enterprise.
 Without this concept, the classification of current and fixed
assets and short and long term liabilities cannot be made
and such classification would be difficult to justify.
2) Consistency Concept :-
 This concept states that accounting principles and methods should remain consistent from one year
to another. These should not be changed from year to year, ion order to enable the management to
compare the Profit & Loss Account and Balance Sheet of the different periods and draw important
conclusions about the working of the enterprise.
 If a firm adopts different accounting principles in two accounting periods, the profits of current
period will not be comparable with the profits of the preceding period.
 But the consistency concept should not be taken to mean that it does not allow a firm to
change the accounting methods according to the changed circumstances of the business.
 Otherwise, the accounting will become non-flexible and the improved techniques
of accounting will not be used.

3) Accrual Concept :-
 In accounting, accrual basis is used for recording of transactions. It provides more
appropriate information about the performance of business enterprise as compared
to cash basis. Accrual concept applies equally to revenues and expenses.
 In accrual concept revenue is recorded when sales are made or services are rendered
and it is immaterial weather cash is received or not.
 Similarly, according to this concept, expenses are recorded in the accounting period
in which they assist in earning the revenues whether the cash is paid for them or not.
 Accrual concept is often described as matching concept.
Other Accounting Concepts
4. Business Entity Concept.
5. Money Measurement Concept.

6. Accounting Period Concept.

7. Cost Concept or Historical Cost Concept.
8. Dual Aspect Concept.
9. Revenue Recognition Concept.
10. Matching Concept.
11. Objectivity Concept.
4) Business Entity Concept :-
 According to this concept, business is treated as a unit
separate and distinct from its owners, creditors, managers
and others. In other words, the owner of a business is always
considered as distinct and separate from the business he
owns.
 Business unit should have a completely separate set of books
and we have to record business transactions from firm’s point
of view and not from the point of view of the proprietor.
 The proprietor is treated as a creditor of the business to the
extent of capital invested by him in the business.
 It is for this reason that we also allow interest on capital and
treat it as an expense of the business.
 The amount withdrawn by the proprietor from the business
for his personal use is treated as his drawings.
5) Money Measurement Concept :-
 Only those transactions and events are recorded in accounting which are capable of being expressed in
terms of money. An event, even though it may be very important for the business, will not be recorded in
the books of the business unless its effect can be measured in terms of money with a fair degree of
accuracy.
 Following are not recorded in the books due to Money Measurement Concept :
a) Calibre or Quality of the Management
b) Image of the enterprise among people
c) Loss of profit due to labour strike
d) Capabilities of human resources
 However, the money measurement concept suffers from the following limitations :
a) Transactions and events which are not capable of being measured in terms of
money are not recorded even though they may be very important for the
enterprise. For example, human resources of the enterprise are very important to the enterprise.
b) Due to the changes in price level, the value of money does not remain the same over a period of
time. On account of rises in prices, the value of rupee today is much less than what it was, say ten
years back.

6) Accounting Period Concept :-

 As the business is intended to continue indefinitely for a long period, the true results of the business
operations can be ascertained only when the business is completely wound up.
 Thus, the entire life of the firm is divided into time-intervals for the measurement of the profits of the
business. Twelve month period is usually adopted for this purpose.
7) Cost Concept or Historical Cost Concept :- According to this concept, an asset is ordinarily recorded in
the books of accounts at the price at which it was acquired. This cost is become the basis of all
subsequent accounting for the asset. Since the acquisition cost relates to the past, it is referred to as
historical cost.
 The justification for the historical cost concept lies in the following argument :
a) This cost is objectively verifiable.
b) It is justified by the going concern concept which assumes that the
enterprise will continue its activities indefinitely and thus there is
no need of using the current values or liquidation values.
c) Market values or current values of assets are difficult to be determined.
 The drawbacks of the historical cost concept are :
a) Assets for which nothing is paid will not be recorded.
b) During periods of inflation, the figure of net profit disclosed by profit and loss account will be
seriously distorted because depreciation based on historical costs will be charged against
revenues at current prices.
c) Information based upon historical cost may not be useful to management, Investors, creditors
etc.

8) Dual Aspect Concept :- According to this concept, every business transaction is recorded as having a
dual aspect. In other words, every transaction affects at least two accounts. If one account is debited,
any other account must be credited. The system of recording transactions based on this principle is
called as ‘Double Entry System’.
9) Revenue Recognition (Realization) Concept :-
 Revenue means the amount which is added to the capital as a
result of business operations. Revenue is earned by sale of goods or by
providing a service. Concept of revenue recognition determines the time
or the particular period in which the revenue is realized.
 Revenue is deemed to be realized when the title or the ownership of the
goods has been transferred to the purchase.
 It should be remembered that revenue recognition is
not related with the receipt of cash.
 Revenues in case of incomes such as rent, interest,
commission etc. is recognized on a time basis. For example,
rent for the month of March 2023, even if received in April 2023
will be treated as revenue of the financial year ending March 31, 2023.
 As per Revenue Recognition Concept :
a) Advance received against sales is not recorded as sales.
b) Credit Sales are treated as revenue on the day sales are made and not
when the amount is received from the buyer.
10) Matching Concept :-
 This concept is very important for correct determination of net profit. According to
this concept, in determining the net profit from business operations, all costs which
are applicable to revenue of the period should be charged against that revenue.
 On the basis of this principle, outstanding expenses, though not paid in cash are
shown in the profit and loss account.
 When some expense, say insurance premium is paid partly for
the next year also, the part relating to next year will be shown
as an expense only next year and not this year.

11) Objectivity Concept :-

 This concept requires that accounting transaction should be
recorded in an objective manner, free from the personal bias of
either management or the accountant who prepares the accounts. It is possible only
when each transaction is supported by verifiable documents and vouchers such as
cash memos, invoices, sales bill, pay-in slip, correspondence, agreements etc.
 Objectivity is one of the reasons for adopting the ‘Historical Cost’ as the basis of
recording accounting transaction because cost actually paid for an asset (i.e.
historical cost) can be verified from the documents.
 Distinction between Accounting
Concepts and Accounting Conventions
S.
Basis of Distinction Accounting Concepts Accounting Conventions
No.
Accounting conventions are guidelines
1. Legal Position Accounting concepts have legal acceptance based upon custom, or usage or
general agreement.
Accounts concepts are the basic assumptions Accounting conventions are followed in
Recording Vs.
2. on the basis of which transactions are preparing the profit and loss account
Financial Statements
recorded and accounts are maintained. and balance sheet.
These are the uniform set of rules usually These are not so important as
3. Significance
followed in recording the transactions. accounting concepts.
There is no rule of personal judgement or Personal judgement may play a
4. Role of Personal individual bias in following the accounting crucial role in the adoption of
concepts. accounting conventions.
There is no uniformity in the adoption
There is uniform adoption of accounting
5. Uniform Adoption of accounting conventions in various
concepts in different enterprises.
enterprises.
Following are the main Accounting Conventions :

1 Convention of Full Disclosure

2 Convention of Materiality
3 Convention of Conservatism (Prudence)
 Convention of full disclosure :
This convention requires that all significant information relating to the economic
affairs of the enterprise should be completely disclosed. The principle is so important
that the Companies Act makes ample provisions for the disclosure of essential
information in the financial statement of a Company. Various items or facts which
do not find place in accounting statements are shown in the Balance Sheet by way of
footnotes. Such as :-

I. Contingent liabilities : For instance, a claim of a very big sum

pending in a court of law against the enterprise should be
brought to the notice of the users of the financial statements,
otherwise the statements would be misleading.
II. If there is a change in the method of valuation of stock, or for
providing depreciation or in making provision for doubtful
debts, it should be disclosed in the Balance Sheet by way of a
footnote.
III. Market value of investments should be given by way of a
footnote.
 Convention of Materiality :
This convention is an exception to the convention of full disclosure. According
to this convention, items having an insignificant effect or being irrelevant to
the user need not to be disclosed.

According to Kohler :
“Materiality is the characteristics attaching
to a statement, fact, or item whereby its
disclosure or the method of giving its
expression would be likely to influence
the judgement of a reasonable person”.
 Convention of Conversation or Prudence :
According to this convention, all anticipated losses should be recorded in the books of
accounts, but all anticipated or unrealized gains should be ignored. Following are the
examples of the application of the principle of convertism :-
i. Closing stock is valued at cost price or realizable value whichever is less.
ii. Provision for doubtful debts is created in anticipation of actual bad-debts.
iii. Joint life insurance policy is shown only at surrender value as against the amount paid.
iv. Provision for a pending law suit against the firm, which may either be decided in its favour .

Effect of Convention of Convertism :- The Convention of convertism should be

used very cautiously, otherwise it will have two effects :
i. Profit & Loss Account will disclose lower profits in
comparison to the actual profits.
ii. Balance Sheet will disclose understatement of assets
and overstatement of liabilities in comparison to
the actual values.