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Accounting - 7707

Accounting Principles and Policies

Paper-2

Accounting Principles and Policies

Accounting Principles and Policies:

Accounting concepts are basic principles and guidelines which all business should follow when presenting financial statements if the business does not follow these accounting concepts, the financial statements will not follow these accounting concepts, the financial statements will not give an accurate and fair view of the business performance, and hence the financial statements will be misleading.

Accounting concepts are as follows:

Dual aspect concept
Money measurement concept
Business entity concept
Going concern concept
Historical cost concept
Consistency concept
Materiality concept
Prudence concept
Accrual concept
Matching concept
Substance over form concept
Realization concept

Below is a brief explanation of these concepts keeping in mind the syllabus and its requirements:

1. Dual Aspect Concept:

This concept states that accounting is based on the double-entry system, which means an equal amount of credit follows every debit.

Example:

Bank DR 2000
Cash DR  5000
            Capital CR 7000

2. Money Measurement Concept:

This concept states that only those things will be recorded in the books of accounts that have a monetary value, i.e., anything that can be traded with money. Anything that does not have a monetary value will not be recorded in the books of account.

Example: the skill of an employee 


If an employee does great with a project and the employer appreciates by saying some kind words of appraisal in front of his fellow mates, this will not be recorded in the books because that appreciation does not have a monetary value.

3. Business entity concept:

This concept states that a business is a separate legal entity, different from its owners. It has its name, own bank account, and is responsible for its actions. It can sue and can be sued.

Example:

The concept of drawings exists because of the business entity concept. If an owner borrows something from the business, whether cash or inventory, it must be returned because it is business property.

4. Going concern concept:

This concept states that the business will continue its course of operations in the foreseeable future. The foreseeable future is different for different businesses varying from one year to ten years. If the going concern of the business hampers, it is the responsibility of the business to inform all the relevant stakeholders that the business is about to wind up and discontinue its existence.

5. Historical cost concept:

This concept states that non-current assets should be recorded in the books of account at their original cost that is their purchase price plus all capital expenditures despite any loss in the value of a non-current asset. All losses in the value of a non-current asset should be separately recorded as a provision for depreciation. Assets will be recorded at their historical cost until and unless they are revalued or disposed of.

6. Consistency concept:

This concept states that accounting policies and procedures should remain consistent from one accounting period to another. Policies should not change frequently. Only if the business feels that the existing policy is not reflecting an accurate and fair view of the business performance, then the business can make relevant changes in their policy, but once the policy has been changed, the business will not be allowed to revert to the old policy.

7. Materiality concept:

This concept states that an item that is an asset for one business can be an expense for a much larger business. For example, a calculator may be an expense for a more extensive business but would be an asset for a smaller business.

8. Prudence concept:

This concept states that expected losses are to be recorded as soon as they are expected, while expected profits are not to be recognized until they are realized. The Prudence concept promotes prudent behavior. That is, the business should never overstate the profits and should show the worst-case scenario.

Example:

Provision for bad debts and provision for depreciation.

9. Accrual Concept:

This concept states that expenses should be recorded as soon as they are incurred irrespective of the fact whether they are paid or not. Similarly, revenues should be recorded as soon as they are earned irrespective of the fact whether they are received or not. In accounting, we do not follow the cash concept, which states that we will record When cash comes into the business and when cash goes out of the business.

10. Matching Concept:

This concept states that we will match the expenses of one accounting period with the revenues of that period.

11. Substance Over Form:

This concept states that if an asset is bought on hire purchase or lease, then despite the fact the asset is not yet owned by the business, it is still treated as non-current assets, and the amount not yet paid will be treated as a liability. Furthermore, this asset will also be depreciated. This concept is also known as the commercial reality concept.

12. Realization Concept:

This concept states that revenue is to be realized the moment a deal is signed between the two parties irrespective of the fact whether goods are delivered or not and whether payments are made or not.

ACCOUNTING POLICIES:

These policies describe and are a tool for measuring the usefulness of financial statements produced at the end of the year.

1. Relevance:

The statement of financial statements shows the position of a business at the particular date, which will be further used for the decision making of that business, and thus it is of utmost importance that the statements are relevant and correct about the transactions made in the year for promising stability I future.

2. Reliability:

The information in financial statements can be deemed reliable if:

Users can depend on the information considering them to be the exact representation of transactions and events in question.
The information presented can be verified individually 
They are bias-free
They are free from significant errors
They are prepared with appropriate caution with application to any necessary estimate or judgment. 

3. Comparability:

One of the primary purposes of preparing financial statements is to compare its previous year’s performance and other competitor companies and thus it should be prepared in a way that it implies all the accounting concepts and when all the statements are made on these concepts it will be easier to compare, judge the position and identify the similarities and differences between the information.

4. Understandability:

This policy states that the financial statements should be clear enough that they are easily understood by the stakeholders who know at least the basics of accounting activities to study the statements and make a sound decision and judgment.

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