Financial Accounting Principles

FINANCIAL ACCOUNTING PRINCIPLES

NATURE OF ACCOUNTING PRINCIPLES:-

The dictionary meaning of the word principle is:''a fundamental truth or law as the basis of action.'' The term principle generally suggests universal application of rules and a degree of permanence which is not possible in accounting. Accounting is a social science and not a physical science. Thus the essential feature of accounting principles is that they are flexible rather than precise or rigid. Accounting principles are man made and are derived from experience and reason. Accounting principles are judged on their general acceptability rather than universal acceptability to the makers and users of financial statements. Hence they are popularly called Generally Accepted Accounting Principles(GAAP)

CHARACTERISTICS OF ACCOUNTING PRINCIPLES

(i) Accounting principles have been developed to ensure uniformity and easy understanding of the accounting information.

(ii) Accounting principles are man-made in the sense that like that of principles of physical science such as chemistry, physics etc. are not laboratory tested principles. They are simple guidelines based on usage, reason and observations over a period of time.

(iii) Accounting principles are not final statements. They are subject to modifications depending on the changes in business practices, government policies and requirements of the users of accounting information.

(iv) The generally accepted principles depend upon how well these principles meet or satisfy three conditions namely:

(a) Relevance:- A principle is relevance if it results in information that is meaningful and useful to the users of the financial statements.

(b) Objectivity:- Similarly a principle is objective to the extent that accounting information is free from personal bias or judgement of those who provide it. objectivity means verifiability, that is, there is some way of finding out the correctness of the information reported.

(c) Feasibility:- A principle is feasible if it can be used without much complexity or cost. It applies to time, labour and cost. It applies to time, labour and cost of providing accounting information and its accuracy in relation to probable use and resulting benefits.

THE ENTITY CONCEPT

 The entity concept assumes that the firm or enterprise and its owners are two separate entities for accounting purposes. For example when the owner invests or introduces money in the business, business entity receives the asset cash and the capital of the business is treated as a liability of the business entity towards its owner. Similarly when the owner withdraws the cash for his personal use the account will show that cash in the business is reduced and so too his capital though his personal cash has increased. In this way the business and personal transactions are not mixed up. 

MONEY MEASUREMENT CONCEPT

In accounting a record is made only of those transactions or events which can be expressed of money only. Money means currency of the country,e.g., Rupee in India, dollar in USA and so on. Non monetary events such as strike in the factory, retirement of general manager etc., cannot be recorded because these events cannot be expressed in terms of money.

THE GOING CONCERN CONCEPT

Every business enterprise is assumed to be a going concern in the sense that it has a continuity of life and there is a neither the intention nor the necessity to dissolve the firm in the near foreseeable future. However it must be clear that going concern concept does not mean permanent continuance of the business firm. All that it means is that the firm will continue long enough to carry out the present plans and meet future obligations.

THE COST CONCEPT

The cost concept means that a fixed asset like building or machine or furniture etc., is recorded in the books of accounts at the price actually paid for it; it is called its acquisition cost which includes purchase price , the amount spent in installing and all expenses paid in making the asset ready to use. The cost  concept is applicable only to fixed assets and not for current assets because only fixed assets are shown in the balance sheet at their respective cost prices; current assets are generally shown at cost price or market price whichever is less. 

PERIODICITY CONCEPT

The accounting period concept is related to going concern concept which presumes that a business is likely to continue for an indefinite period of time. The true income or loss can be ascertained only on the closure of the business by comparing the capital at the end arrived after adjustment for drawing in cash and goods and introduction of additional capital by the owner at with the capital at the start of business.

THE REALISATION CONCEPT

In accounting, income or profit means excess of revenue over expenses. The realisation concept is related to revenues only and not to the expenses. Revenues are gross inflow of cash or bills receivable or other considerations from the following activities of the business enterprise:

(i) Sale of goods

(ii) Rendering of services such as repair job, consultancy, installation of machinery and so on.

(iii) The use by others of entity yielding interest, rent, royalty, dividends and the like.

THE ACCRUAL CONCEPT

The accrual concept is applicable to the recognition of both the revenues and expenses. The accrual concept means that all the transactions must be recorded whether they are settled in cash or not. According to this concept, revenues are recognized when they simply become receivable though cash is not received, and expenses are recognized when they simply become payable though no cash is paid immediately and both are recorded in the accounting period to which they are related.