NCERT Textbook - Theory Base of Accounting Commerce Notes | EduRev

Accountancy Class 11

Commerce : NCERT Textbook - Theory Base of Accounting Commerce Notes | EduRev

 Page 1


23 Theory Base of Accounting
LEARNING OBJECTIVES
After studying this chapter,
you will be able to:
• identify the need for
theory base of acco-
unting;
• explain the nature of
Generally Accepted
Accounting Principles
(GAAP);
• state the meaning and
purpose of the basic
accounting concepts;
• list the accounting
standards issued by
Institute of Chartered
Accountants of India;
• describe the systems
of accounting; and
• describe the basis of
accounting.
A
s discussed in the previous chapter, accounting
is concerned with the recording, classifying and
summarising of financial transactions and events
and interpreting the results thereof. It aims at
providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
investors, for example, may be interested in knowing
the extent of profit or loss earned by the firm during
a given period and compare it with the performance
of other similar enterprises. The suppliers of credit,
say a banker, may, in addition, be interested in
liquidity position of the enterprise. All these people
look forward to accounting for appropriate, useful
and reliable information.
For making the accounting information
meaningful to its internal and external users, it is
important that such information is reliable as well
as comparable. The comparability of information is
required both to make inter-firm comparisons, i.e.
to see how a firm has performed as compared to
the other firms, as well as to make inter-period
comparison, i.e. how it has performed as compared
to the previous years. This becomes possible only if
the information provided by the financial statements
is based on consistent accounting policies, principles
and practices. Such consistency is required
throughout the process of identifying the events and
Theory Base of Accounting 2
2020-21
Page 2


23 Theory Base of Accounting
LEARNING OBJECTIVES
After studying this chapter,
you will be able to:
• identify the need for
theory base of acco-
unting;
• explain the nature of
Generally Accepted
Accounting Principles
(GAAP);
• state the meaning and
purpose of the basic
accounting concepts;
• list the accounting
standards issued by
Institute of Chartered
Accountants of India;
• describe the systems
of accounting; and
• describe the basis of
accounting.
A
s discussed in the previous chapter, accounting
is concerned with the recording, classifying and
summarising of financial transactions and events
and interpreting the results thereof. It aims at
providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
investors, for example, may be interested in knowing
the extent of profit or loss earned by the firm during
a given period and compare it with the performance
of other similar enterprises. The suppliers of credit,
say a banker, may, in addition, be interested in
liquidity position of the enterprise. All these people
look forward to accounting for appropriate, useful
and reliable information.
For making the accounting information
meaningful to its internal and external users, it is
important that such information is reliable as well
as comparable. The comparability of information is
required both to make inter-firm comparisons, i.e.
to see how a firm has performed as compared to
the other firms, as well as to make inter-period
comparison, i.e. how it has performed as compared
to the previous years. This becomes possible only if
the information provided by the financial statements
is based on consistent accounting policies, principles
and practices. Such consistency is required
throughout the process of identifying the events and
Theory Base of Accounting 2
2020-21
24 Accountancy
transactions to be accounted for, measuring them, communicating them in the
book of accounts, summarising the results thereof and reporting them to the
interested parties. This calls for developing a proper theory base of accounting.
The importance of accounting theory  need not be over-emphasised as no
discipline can develop without a sound theoretical base. The theory base of
accounting consists of principles, concepts, rules and guidelines developed
over a period of time to bring uniformity and consistency to the process of
accounting and enhance its utility to different users of accounting information.
Apart from these, the Institute of Chartered Accountants of India, (ICAI), which
is the regulatory body for standardisation of accounting policies in the country
has issued Accounting Standards which are expected to be uniformly adhered
to, in order to bring consistency in the accounting practices. These are discussed
in the sections to follow.
2.1 Generally Accepted Accounting Principles
In order to maintain uniformity and consistency in accounting records, certain
rules or principles have been developed which are generally accepted by the
accounting profession. These rules are called by different names such as
principles, concepts, conventions, postulates, assumptions and modifying
principles.
The term ‘principle’ has been defined by AICPA as ‘A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct
or practice’. The word ‘generally’ means ‘in a general manner’, i.e., pertaining to
many persons or cases or occasions. Thus, Generally Accepted Accounting
Principles (GAAP) refers to the rules or guidelines adopted for recording and
reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements. For example, one of
the important rule is to record all transactions on the basis of historical cost,
which is verifiable from the documents such as cash receipt for the money
paid. This brings in objectivity in the process of recording and makes the
accounting statements more acceptable to various users.
The Generally Accepted Accounting Principles have evolved over a long period
of time on the basis of past experiences, usages or customs, statements by
individuals and professional bodies and regulations by government agencies
and have general acceptability among most accounting professionals. However,
the principles of accounting are not static in nature. These are constantly
influenced by changes in the legal, social and economic environment as well as
the needs of the users.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental
to accounting practice, and the term convention connotes customs or traditions
as a guide to the preparation of accounting statements. In practice, the same
rules or guidelines have been described by one author as a concept, by another
2020-21
Page 3


23 Theory Base of Accounting
LEARNING OBJECTIVES
After studying this chapter,
you will be able to:
• identify the need for
theory base of acco-
unting;
• explain the nature of
Generally Accepted
Accounting Principles
(GAAP);
• state the meaning and
purpose of the basic
accounting concepts;
• list the accounting
standards issued by
Institute of Chartered
Accountants of India;
• describe the systems
of accounting; and
• describe the basis of
accounting.
A
s discussed in the previous chapter, accounting
is concerned with the recording, classifying and
summarising of financial transactions and events
and interpreting the results thereof. It aims at
providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
investors, for example, may be interested in knowing
the extent of profit or loss earned by the firm during
a given period and compare it with the performance
of other similar enterprises. The suppliers of credit,
say a banker, may, in addition, be interested in
liquidity position of the enterprise. All these people
look forward to accounting for appropriate, useful
and reliable information.
For making the accounting information
meaningful to its internal and external users, it is
important that such information is reliable as well
as comparable. The comparability of information is
required both to make inter-firm comparisons, i.e.
to see how a firm has performed as compared to
the other firms, as well as to make inter-period
comparison, i.e. how it has performed as compared
to the previous years. This becomes possible only if
the information provided by the financial statements
is based on consistent accounting policies, principles
and practices. Such consistency is required
throughout the process of identifying the events and
Theory Base of Accounting 2
2020-21
24 Accountancy
transactions to be accounted for, measuring them, communicating them in the
book of accounts, summarising the results thereof and reporting them to the
interested parties. This calls for developing a proper theory base of accounting.
The importance of accounting theory  need not be over-emphasised as no
discipline can develop without a sound theoretical base. The theory base of
accounting consists of principles, concepts, rules and guidelines developed
over a period of time to bring uniformity and consistency to the process of
accounting and enhance its utility to different users of accounting information.
Apart from these, the Institute of Chartered Accountants of India, (ICAI), which
is the regulatory body for standardisation of accounting policies in the country
has issued Accounting Standards which are expected to be uniformly adhered
to, in order to bring consistency in the accounting practices. These are discussed
in the sections to follow.
2.1 Generally Accepted Accounting Principles
In order to maintain uniformity and consistency in accounting records, certain
rules or principles have been developed which are generally accepted by the
accounting profession. These rules are called by different names such as
principles, concepts, conventions, postulates, assumptions and modifying
principles.
The term ‘principle’ has been defined by AICPA as ‘A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct
or practice’. The word ‘generally’ means ‘in a general manner’, i.e., pertaining to
many persons or cases or occasions. Thus, Generally Accepted Accounting
Principles (GAAP) refers to the rules or guidelines adopted for recording and
reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements. For example, one of
the important rule is to record all transactions on the basis of historical cost,
which is verifiable from the documents such as cash receipt for the money
paid. This brings in objectivity in the process of recording and makes the
accounting statements more acceptable to various users.
The Generally Accepted Accounting Principles have evolved over a long period
of time on the basis of past experiences, usages or customs, statements by
individuals and professional bodies and regulations by government agencies
and have general acceptability among most accounting professionals. However,
the principles of accounting are not static in nature. These are constantly
influenced by changes in the legal, social and economic environment as well as
the needs of the users.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental
to accounting practice, and the term convention connotes customs or traditions
as a guide to the preparation of accounting statements. In practice, the same
rules or guidelines have been described by one author as a concept, by another
2020-21
25 Theory Base of Accounting
as a postulate and still by another as convention. This at times becomes confusing
to the learners. Instead of going into the semantics of these terms, it is important
to concentrate on the practicability of their usage. From the practicability view
point, it is observed that the various terms such as principles, postulates,
conventions, modifying principles, assumptions, etc. have been used inter-
changeably and are referred to as Basic Accounting Concepts in the present
chapter.
2.2 Basic Accounting Concepts
The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and
are broad working rules for all accounting activities and developed by the
accounting profession. The important concepts have been listed as below:
• Business entity;
• Money measurement;
• Going concern;
• Accounting period;
• Cost
• Dual aspect (or Duality);
• Revenue recognition (Realisation);
• Matching;
• Full disclosure;
• Consistency;
• Conservatism (Prudence);
• Materiality;
• Objectivity.
2.2.1 2.2.1 2.2.1 2.2.1 2.2.1 Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept
The concept of business entity assumes that business has a distinct and separate
entity from its owners. It means that for the purposes of accounting, the business
and its owners are to be treated as two separate entities. Keeping this in view,
when a person brings in some money as capital into his business, in accounting
records, it is treated as liability of the business to the owner. Here, one separate
entity (owner) is assumed to be giving money to another distinct entity (business
unit). Similarly, when the owner withdraws any money from the business for his
personal expenses(drawings), it is treated as reduction of the owner’s capital
and consequently a reduction in the liabilities of the business.
The accounting records are made in the book of accounts from the point of view
of the business unit and not that of the owner. The personal assets and liabilities
of the owner are, therefore, not considered while recording and reporting the
assets and liabilities of the business. Similarly, personal transactions of the owner
are not recorded in the books of the business, unless it involves inflow or outflow
of business funds.
2.2.2 2.2.2 2.2.2 2.2.2 2.2.2 Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept
The concept of money measurement states that only those transactions and
happenings in an organisation which can be expressed in terms of money
such as sale of goods or payment of expenses or receipt of income, etc., are to be
recorded in the book of accounts. All such transactions or happenings which
2020-21
Page 4


23 Theory Base of Accounting
LEARNING OBJECTIVES
After studying this chapter,
you will be able to:
• identify the need for
theory base of acco-
unting;
• explain the nature of
Generally Accepted
Accounting Principles
(GAAP);
• state the meaning and
purpose of the basic
accounting concepts;
• list the accounting
standards issued by
Institute of Chartered
Accountants of India;
• describe the systems
of accounting; and
• describe the basis of
accounting.
A
s discussed in the previous chapter, accounting
is concerned with the recording, classifying and
summarising of financial transactions and events
and interpreting the results thereof. It aims at
providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
investors, for example, may be interested in knowing
the extent of profit or loss earned by the firm during
a given period and compare it with the performance
of other similar enterprises. The suppliers of credit,
say a banker, may, in addition, be interested in
liquidity position of the enterprise. All these people
look forward to accounting for appropriate, useful
and reliable information.
For making the accounting information
meaningful to its internal and external users, it is
important that such information is reliable as well
as comparable. The comparability of information is
required both to make inter-firm comparisons, i.e.
to see how a firm has performed as compared to
the other firms, as well as to make inter-period
comparison, i.e. how it has performed as compared
to the previous years. This becomes possible only if
the information provided by the financial statements
is based on consistent accounting policies, principles
and practices. Such consistency is required
throughout the process of identifying the events and
Theory Base of Accounting 2
2020-21
24 Accountancy
transactions to be accounted for, measuring them, communicating them in the
book of accounts, summarising the results thereof and reporting them to the
interested parties. This calls for developing a proper theory base of accounting.
The importance of accounting theory  need not be over-emphasised as no
discipline can develop without a sound theoretical base. The theory base of
accounting consists of principles, concepts, rules and guidelines developed
over a period of time to bring uniformity and consistency to the process of
accounting and enhance its utility to different users of accounting information.
Apart from these, the Institute of Chartered Accountants of India, (ICAI), which
is the regulatory body for standardisation of accounting policies in the country
has issued Accounting Standards which are expected to be uniformly adhered
to, in order to bring consistency in the accounting practices. These are discussed
in the sections to follow.
2.1 Generally Accepted Accounting Principles
In order to maintain uniformity and consistency in accounting records, certain
rules or principles have been developed which are generally accepted by the
accounting profession. These rules are called by different names such as
principles, concepts, conventions, postulates, assumptions and modifying
principles.
The term ‘principle’ has been defined by AICPA as ‘A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct
or practice’. The word ‘generally’ means ‘in a general manner’, i.e., pertaining to
many persons or cases or occasions. Thus, Generally Accepted Accounting
Principles (GAAP) refers to the rules or guidelines adopted for recording and
reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements. For example, one of
the important rule is to record all transactions on the basis of historical cost,
which is verifiable from the documents such as cash receipt for the money
paid. This brings in objectivity in the process of recording and makes the
accounting statements more acceptable to various users.
The Generally Accepted Accounting Principles have evolved over a long period
of time on the basis of past experiences, usages or customs, statements by
individuals and professional bodies and regulations by government agencies
and have general acceptability among most accounting professionals. However,
the principles of accounting are not static in nature. These are constantly
influenced by changes in the legal, social and economic environment as well as
the needs of the users.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental
to accounting practice, and the term convention connotes customs or traditions
as a guide to the preparation of accounting statements. In practice, the same
rules or guidelines have been described by one author as a concept, by another
2020-21
25 Theory Base of Accounting
as a postulate and still by another as convention. This at times becomes confusing
to the learners. Instead of going into the semantics of these terms, it is important
to concentrate on the practicability of their usage. From the practicability view
point, it is observed that the various terms such as principles, postulates,
conventions, modifying principles, assumptions, etc. have been used inter-
changeably and are referred to as Basic Accounting Concepts in the present
chapter.
2.2 Basic Accounting Concepts
The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and
are broad working rules for all accounting activities and developed by the
accounting profession. The important concepts have been listed as below:
• Business entity;
• Money measurement;
• Going concern;
• Accounting period;
• Cost
• Dual aspect (or Duality);
• Revenue recognition (Realisation);
• Matching;
• Full disclosure;
• Consistency;
• Conservatism (Prudence);
• Materiality;
• Objectivity.
2.2.1 2.2.1 2.2.1 2.2.1 2.2.1 Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept
The concept of business entity assumes that business has a distinct and separate
entity from its owners. It means that for the purposes of accounting, the business
and its owners are to be treated as two separate entities. Keeping this in view,
when a person brings in some money as capital into his business, in accounting
records, it is treated as liability of the business to the owner. Here, one separate
entity (owner) is assumed to be giving money to another distinct entity (business
unit). Similarly, when the owner withdraws any money from the business for his
personal expenses(drawings), it is treated as reduction of the owner’s capital
and consequently a reduction in the liabilities of the business.
The accounting records are made in the book of accounts from the point of view
of the business unit and not that of the owner. The personal assets and liabilities
of the owner are, therefore, not considered while recording and reporting the
assets and liabilities of the business. Similarly, personal transactions of the owner
are not recorded in the books of the business, unless it involves inflow or outflow
of business funds.
2.2.2 2.2.2 2.2.2 2.2.2 2.2.2 Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept
The concept of money measurement states that only those transactions and
happenings in an organisation which can be expressed in terms of money
such as sale of goods or payment of expenses or receipt of income, etc., are to be
recorded in the book of accounts. All such transactions or happenings which
2020-21
26 Accountancy
can not be expressed in monetary terms, for example, the appointment of a
manager, capabilities of its human resources or creativity of its research
department or image of the organisation among people in general do not find a
place in the accounting records of a firm.
Another important aspect of the concept of money measurement is that the
records of the transactions are to be kept not in the physical units but in the
monetary unit. For example, an organisation may, on a particular day, have a
factory on a piece of land measuring 2 acres, office building containing 10 rooms,
30 personal computers, 30 office chairs and tables, a bank balance of `5 lakh,
raw material weighing 20-tons, and 100 cartons of finished goods. These assets
are expressed in different units, so can not be added to give any meaningful
information about the total worth of business. For accounting purposes,
therefore, these are shown in money terms and recorded in rupees and paise. In
this case, the cost of factory land may be say ` 2 crore; office building ` 1 crore;
computers `15 lakh; office chairs and tables ` 2 lakh; raw material ` 33 lakh
and finished goods ` 4 lakh. Thus, the total assets of the enterprise are valued at
` 3 crore and 59 lakh. Similarly, all transactions are recorded in rupees and
paise as and when they take place.
The money measurement assumption is not free from limitations. Due to the
changes in prices, the value of money does not remain the same over a period of
time. The value of rupee today on account of rise in prices is much less than
what it was, say ten years back. Therefore, in the balance sheet, when we add
different assets bought at different points of time, say building purchased in
1995 for ` 2 crore, and plant purchased in 2005 for ` 1 crore, we are in fact
adding heterogeneous values, which can not be clubbed together. As the change
in the value of money is not reflected in the book of accounts, the accounting
data does not reflect the true and fair view of the affairs of an enterprise.
2.2.3 2.2.3 2.2.3 2.2.3 2.2.3 Going Concern Concept Going Concern Concept Going Concern Concept Going Concern Concept Going Concern Concept
The concept of going concern assumes that a business firm would continue to
carry out its operations indefinitely, i.e. for a fairly long period of time and would
not be liquidated in the foreseeable future. This is an important assumption of
accounting as it provides the very basis for showing the value of assets in the
balance sheet.
An asset may be defined as a bundle of services. When we purchase an
asset, for example, a personal computer, for a sum of ` 50,000, what we are
buying really is the services of the computer that we shall be getting over its
estimated life span, say 5 years. It will not be fair to charge the whole amount of
` 50,000, from the revenue of the year in which the asset is purchased. Instead,
that part of the asset which has been consumed or used during a period should
be charged from the revenue of that period. The assumption regarding continuity
2020-21
Page 5


23 Theory Base of Accounting
LEARNING OBJECTIVES
After studying this chapter,
you will be able to:
• identify the need for
theory base of acco-
unting;
• explain the nature of
Generally Accepted
Accounting Principles
(GAAP);
• state the meaning and
purpose of the basic
accounting concepts;
• list the accounting
standards issued by
Institute of Chartered
Accountants of India;
• describe the systems
of accounting; and
• describe the basis of
accounting.
A
s discussed in the previous chapter, accounting
is concerned with the recording, classifying and
summarising of financial transactions and events
and interpreting the results thereof. It aims at
providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
investors, for example, may be interested in knowing
the extent of profit or loss earned by the firm during
a given period and compare it with the performance
of other similar enterprises. The suppliers of credit,
say a banker, may, in addition, be interested in
liquidity position of the enterprise. All these people
look forward to accounting for appropriate, useful
and reliable information.
For making the accounting information
meaningful to its internal and external users, it is
important that such information is reliable as well
as comparable. The comparability of information is
required both to make inter-firm comparisons, i.e.
to see how a firm has performed as compared to
the other firms, as well as to make inter-period
comparison, i.e. how it has performed as compared
to the previous years. This becomes possible only if
the information provided by the financial statements
is based on consistent accounting policies, principles
and practices. Such consistency is required
throughout the process of identifying the events and
Theory Base of Accounting 2
2020-21
24 Accountancy
transactions to be accounted for, measuring them, communicating them in the
book of accounts, summarising the results thereof and reporting them to the
interested parties. This calls for developing a proper theory base of accounting.
The importance of accounting theory  need not be over-emphasised as no
discipline can develop without a sound theoretical base. The theory base of
accounting consists of principles, concepts, rules and guidelines developed
over a period of time to bring uniformity and consistency to the process of
accounting and enhance its utility to different users of accounting information.
Apart from these, the Institute of Chartered Accountants of India, (ICAI), which
is the regulatory body for standardisation of accounting policies in the country
has issued Accounting Standards which are expected to be uniformly adhered
to, in order to bring consistency in the accounting practices. These are discussed
in the sections to follow.
2.1 Generally Accepted Accounting Principles
In order to maintain uniformity and consistency in accounting records, certain
rules or principles have been developed which are generally accepted by the
accounting profession. These rules are called by different names such as
principles, concepts, conventions, postulates, assumptions and modifying
principles.
The term ‘principle’ has been defined by AICPA as ‘A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct
or practice’. The word ‘generally’ means ‘in a general manner’, i.e., pertaining to
many persons or cases or occasions. Thus, Generally Accepted Accounting
Principles (GAAP) refers to the rules or guidelines adopted for recording and
reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements. For example, one of
the important rule is to record all transactions on the basis of historical cost,
which is verifiable from the documents such as cash receipt for the money
paid. This brings in objectivity in the process of recording and makes the
accounting statements more acceptable to various users.
The Generally Accepted Accounting Principles have evolved over a long period
of time on the basis of past experiences, usages or customs, statements by
individuals and professional bodies and regulations by government agencies
and have general acceptability among most accounting professionals. However,
the principles of accounting are not static in nature. These are constantly
influenced by changes in the legal, social and economic environment as well as
the needs of the users.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental
to accounting practice, and the term convention connotes customs or traditions
as a guide to the preparation of accounting statements. In practice, the same
rules or guidelines have been described by one author as a concept, by another
2020-21
25 Theory Base of Accounting
as a postulate and still by another as convention. This at times becomes confusing
to the learners. Instead of going into the semantics of these terms, it is important
to concentrate on the practicability of their usage. From the practicability view
point, it is observed that the various terms such as principles, postulates,
conventions, modifying principles, assumptions, etc. have been used inter-
changeably and are referred to as Basic Accounting Concepts in the present
chapter.
2.2 Basic Accounting Concepts
The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and
are broad working rules for all accounting activities and developed by the
accounting profession. The important concepts have been listed as below:
• Business entity;
• Money measurement;
• Going concern;
• Accounting period;
• Cost
• Dual aspect (or Duality);
• Revenue recognition (Realisation);
• Matching;
• Full disclosure;
• Consistency;
• Conservatism (Prudence);
• Materiality;
• Objectivity.
2.2.1 2.2.1 2.2.1 2.2.1 2.2.1 Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept Business Entity Concept
The concept of business entity assumes that business has a distinct and separate
entity from its owners. It means that for the purposes of accounting, the business
and its owners are to be treated as two separate entities. Keeping this in view,
when a person brings in some money as capital into his business, in accounting
records, it is treated as liability of the business to the owner. Here, one separate
entity (owner) is assumed to be giving money to another distinct entity (business
unit). Similarly, when the owner withdraws any money from the business for his
personal expenses(drawings), it is treated as reduction of the owner’s capital
and consequently a reduction in the liabilities of the business.
The accounting records are made in the book of accounts from the point of view
of the business unit and not that of the owner. The personal assets and liabilities
of the owner are, therefore, not considered while recording and reporting the
assets and liabilities of the business. Similarly, personal transactions of the owner
are not recorded in the books of the business, unless it involves inflow or outflow
of business funds.
2.2.2 2.2.2 2.2.2 2.2.2 2.2.2 Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept Money Measurement Concept
The concept of money measurement states that only those transactions and
happenings in an organisation which can be expressed in terms of money
such as sale of goods or payment of expenses or receipt of income, etc., are to be
recorded in the book of accounts. All such transactions or happenings which
2020-21
26 Accountancy
can not be expressed in monetary terms, for example, the appointment of a
manager, capabilities of its human resources or creativity of its research
department or image of the organisation among people in general do not find a
place in the accounting records of a firm.
Another important aspect of the concept of money measurement is that the
records of the transactions are to be kept not in the physical units but in the
monetary unit. For example, an organisation may, on a particular day, have a
factory on a piece of land measuring 2 acres, office building containing 10 rooms,
30 personal computers, 30 office chairs and tables, a bank balance of `5 lakh,
raw material weighing 20-tons, and 100 cartons of finished goods. These assets
are expressed in different units, so can not be added to give any meaningful
information about the total worth of business. For accounting purposes,
therefore, these are shown in money terms and recorded in rupees and paise. In
this case, the cost of factory land may be say ` 2 crore; office building ` 1 crore;
computers `15 lakh; office chairs and tables ` 2 lakh; raw material ` 33 lakh
and finished goods ` 4 lakh. Thus, the total assets of the enterprise are valued at
` 3 crore and 59 lakh. Similarly, all transactions are recorded in rupees and
paise as and when they take place.
The money measurement assumption is not free from limitations. Due to the
changes in prices, the value of money does not remain the same over a period of
time. The value of rupee today on account of rise in prices is much less than
what it was, say ten years back. Therefore, in the balance sheet, when we add
different assets bought at different points of time, say building purchased in
1995 for ` 2 crore, and plant purchased in 2005 for ` 1 crore, we are in fact
adding heterogeneous values, which can not be clubbed together. As the change
in the value of money is not reflected in the book of accounts, the accounting
data does not reflect the true and fair view of the affairs of an enterprise.
2.2.3 2.2.3 2.2.3 2.2.3 2.2.3 Going Concern Concept Going Concern Concept Going Concern Concept Going Concern Concept Going Concern Concept
The concept of going concern assumes that a business firm would continue to
carry out its operations indefinitely, i.e. for a fairly long period of time and would
not be liquidated in the foreseeable future. This is an important assumption of
accounting as it provides the very basis for showing the value of assets in the
balance sheet.
An asset may be defined as a bundle of services. When we purchase an
asset, for example, a personal computer, for a sum of ` 50,000, what we are
buying really is the services of the computer that we shall be getting over its
estimated life span, say 5 years. It will not be fair to charge the whole amount of
` 50,000, from the revenue of the year in which the asset is purchased. Instead,
that part of the asset which has been consumed or used during a period should
be charged from the revenue of that period. The assumption regarding continuity
2020-21
27 Theory Base of Accounting
of business allows us to charge from the revenues of a period only that part of
the asset which has been consumed or used to earn that revenue in that period
and carry forward the remaining amount to the next years, over the estimated
life of the asset. Thus, we may charge ` 10,000 every year for 5 years from the
profit and loss account. In case the continuity assumption is not there, the whole
cost (` 50,000 in the present example) will need to be charged from the revenue
of the year in which the asset was purchased.
2.2.4 2.2.4 2.2.4 2.2.4 2.2.4 Accounting Period Concept Accounting Period Concept Accounting Period Concept Accounting Period Concept Accounting Period Concept
Accounting period refers to the span of time at the end of which the financial statements
of an enterprise are prepared, to know whether it has earned profits or incurred
losses during that period and what exactly is the position of its assets and liabilities at
the end of that period. Such information is required by different users at regular
interval for various purposes, as no firm can wait for long to know its financial results
as various decisions are to be taken at regular intervals on the basis of such
information. The financial statements are, therefore, prepared at regular interval,
normally after a period of one year, so that timely information is made available to the
users. This interval of time is called accounting period.
The Companies Act 2013 and the Income Tax Act require that the income
statements should be prepared annually. However, in case of certain
situations, preparation of interim financial statements become necessary.
For example, at the time of retirement of a partner, the accounting period can
be different from twelve months period. Apart from these companies whose
shares are listed on the stock exchange, are required to publish quarterly
results to ascertain the profitability and financial position at the end of every
three months period.
Test Your Understanding - I
Choose the Correct Answer
1. During the life-time of an entity accounting produce financial statements in
accordance with which basic accounting concept:
(a) Conservation
(b) Matching
(c) Accounting period
(d) None of the above
2. When information about two different enterprises have been prepared presented
in a similar manner the information exhibits the characteristic of:
(a) Verifiability
(b) Relevance
(c) Reliability
(d) None of the above
2020-21
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