Accounting Concepts, Principles and Conventions – CA Foundation Accounts Study Material

Accounting Concepts, Principles and Conventions – CA Foundation Accounts Study Material is designed strictly as per the latest syllabus and exam pattern.

Accounting Concepts, Principles and Conventions – CA Foundation Accounts Study Material

Question 1.
What are Accounting Concepts, Principles & Conventions?
Answer:
Usually, accounting theories are expressed (referred) as Postulates, Concepts, Principles, Doctrines, Axioms, Rules, Standard, Assumptions, Canon etc. These are basic assumptions & norms on which the whole system of accounting is developed. These gives the basic structure & outline within which the procedures & systems can be varied as per the situation & need of an entity.

Accounting Concepts:
Meaning:

• Accounting Concepts is generally used to mean a ‘Notion’ only or mental idea about something.
• It is a principle which is taken to be self-evident or axiomatic (Le., something which does not require to be proved) which has already been proved to be true.
• In other words, it may be an assumption or axiom constituting the supposed basis of a system.
• It is considered to be of a more fundamental character and universally acceptable which may be applied in all possible cases. It will have greater general applicability.
• These postulates are either descriptive (explanatory) or suggestive (normative).
• There is no authoritative list of these concepts.

Accounting Principles:
Meaning:

• Accounting principles are the norm or rules which are to be followed in treating various items of Assets, Liabilities, Expenses, Incomes etc.
• Example – (i) Inventory should be valued at lower of cost & net reliable value, (ii) Fixed Assets should be depreciated over its useful life, (iii) Valuation norms for current & permanent investments etc.
• An accounting principle can have alternative methods to apply it. Like in case of inventory we have methods of cost measurement by FIFO or weighted average.

Accounting Conventions:
Meaning:

• It refers to the general agreement on the usage and practices in social or economic life, i.e., it is a customary practice, rule, method or usage.
• In other words, it is an accounting procedure followed by the accounting community on the basis of long-standing customs.

Question 2.
What are Fundamental Accounting Assumptions? Explain them in detail.
Answer:
Fundamental Accounting Assumptions:

• Fundamental accounting assumptions underline the preparation and presentation of financial statements.
• They are usually not specifically stated because their acceptance and use are assumed.
• Disclosure is necessary if they are not followed.
• The Institute of Chartered Accountants of India issued Accounting Standard (AS-1) ‘Disclosure of
• Accounting Policies’ according to which the following have been generally accepted as fundamental accounting assumptions: (i) Going Concern, (ii) Consistency and (iii) Accrual.

Question 3.
Periodicity concept.
Answer:
Periodicity concept:

• Accounts are prepared for a fixed period usually a year.
• Only transactions of that period has to come in that year’s accounts.
• Period is kept uniform fa period of 12 months) so that results are com¬parable.
• 1st Accounting period may be usually more or less than 12 months.
• A business entity runs continuously (going concern) hence to assess its performance and see the financial position on regular basis, it is broken up into smaller, uniform time periods known as accounting period.
• Now the Income-tax Act & Companies Act, 2013 both requires the Accounting year to be from 1 st April this year to 31 st March of next year.

Question 4.
Business Entity Concept
Answer:
Business Entity Concept:

• A distinction is made between the concern & its owner.
• Only those transaction which affects the concern is recorded in its books of account i.e. transactions affecting owner but not the concern will not be recorded in concerns books.

Although, we will study accounting of business concerns, but in the same manner personal account books can also be maintained by any individual.

Question 5.
Cost Concept
Answer:
Cost Concept:

• The assets & properties are recorded at its cost to the concern & not at its market value.
• Except stock which may be valued at cost or market price whichever is lower.
• As per this concept Fixed assets are recorded at their acquisition cost & then depreciated over its useful life.
• Example : Building purchased for ₹ 10 lakh. Its market value is ₹ 11 lakh. In account book building will be recorded at cost i.e. ₹ 10 lakh.

Question 4.
Dual Aspect Concept
Answer:
Dual Aspect Concept:

• Each transaction has double effect of equal amounts on Assets, Liabilities and Capital (Expenses & Income will result in to profit/loss which is part of capital).
• Therefore at any time the accounting equation is: Assets = Liabilities + Capital or Capital = Assets – Liabilities
• In other words, capital, i.e. the owner’s share of the assets of firm, is always what is left out of assets after paying off outsiders.
• Due to this dual aspect, we have double entry system of accounting.

Question 5.
Money Measurement Concept
Answer:
Money Measurement Concept:

• Accounting records only those transactions which are expressed in monetary terms.
• Although quantitative records are also kept as subsidiary records but that is not part of financial account books.
• The use of a building(depreciation or rent) and the use of clerical services (salaries) can be added up only through money values and not otherwise.
• Example – Loss of a Managerial Personnel cannot have a specific monetary value, hence, cannot be recorded in account books although it is significant event.

Question 6.
Realization Concept.
Answer:
Realization Concept:

• Income is accounted only when it is realised.
• Realised means cash is received or a right to receive is established.
• Example – A sale is recognised as income even when amount is not yet collected.
• Income recognition (Le. accounting) is postponed, when there is no reasonable certainty of realisability.

Question 7.
Accrual Concept.
Answer:
Accrual Concept:

• The expenses or Income of periodic nature accrues on day to day basis.
• Therefore we make provision for interest etc. up to last date of accounting year although it may become due/payable on a later date.
• Following accrual concept means following mercantile system of accounting.
• Example of such items are Interest, Rent, Salary, Depreciation etc.
• As per accrual concept/Mercantile system, the income & expenses should be recognised (Le. accounted):
• In the accounting period to which they relate (Le. the period in which benefit/goods/services is given or taken)
• Not in the period in which actual money is received or paid.

Example.
Loan ₹ 10 lakh taken on 1.1.06 @ 15% interest. Interest is payable annually. Accounting year ends on 31.3.06.
Answer:
Interest for 3 months from 1.1.06 to 31.3.06 ₹ 37,500 will have to be accounted even though it is neither paid, nor due, but only accrued.
Accrual is a Fundamental accounting assumption.

Question 8.
Going Concern Concept
Answer:
Going Concern Concept:

• It implies that the concern will be continuing the business for foreseeable future.
• It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.
• If such an intention or need exist, the financial statements may have to be prepared on a different basis and, if so, the basis is disclosed.
• Because of this, expenditure is divided into capital & Revenue expenditure & the fixed Assets are valued at cost less Depreciation.
• Because of this account of the whole life is divided into smaller accounting periods (periodicity concept).

Going concern is a fundamental accounting assumption.

Question 9.
Matching Principle.
Answer:
Matching Principle:

• If any income is credited in the P&L A/c then all expenses incurred or to be incurred for earning this income, should also be debited in the same years P&L A/c.
• Similarly if expenses are debited the corresponding income should also be credited in the same P&L A/c.
• To meet this requirement we make provision for closing stock, outstanding/prepaid expenses & outstanding/Advance income.
• Future incomes are wot anticipated rather related expenditures are carried forward to future period like prepaid expense & closing stock.
• If income is preponed for matching, it will be violation of realisation Concept & will also be against prudence principle.

Question 10.
Substance over form.
Answer:
Substance over form:
As per concept of Substance over form, the transaction should be recognized as per the economic reality of the transaction & not mere legal form.

Example.
A sales land to ‘B’ and gives possession of the land to B & receives full consideration. But sale deed is not yet registered for want of NOC from local authority.
Answer:
As per substance over form concept, A should recognize sale of land and consequent profit or loss and B should recognize Land as an asset in its books. Both will make suitable disclosure in notes to accounts.

Question 11.
Convention of Disclosure.
Answer:
Convention of Disclosure:

• All material information which is relevant for the proper disclosure of true & fair position, should be disclosed prominently in the accounts & financial statements.
• Disclosure of specified information is required by law and by Accounting Standards also, which is the minimum disclosure.

Question 12.
Convention of Materiality
Answer:
Convention of Materiality:

• All material i.e. important/significant items or information should be properly accounted & disclosed in the accounts & financial statements.
• That means immaterial items can be given a convenient accounting treatment.
• Example – Stationery, Postage, such items are treated as expense in the period of purchase even though some unconsumed balance may be there.

Question 13.
Convention of Consistency
Answer:
Convention of Consistency:
1. Consistency means the same Accounting principles & policies are followed, which were followed for preparing previous years accounts.

2. Same accounting principles & policies should be followed consistently from year to year unless change is required:

• to comply with some legal/statutory requirement or
• to comply with Accounting Standards or
• to show better information.

This consistency makes the information of different accounting year, comparable.
It is a fundamental accounting assumption.

Question 14.
Convention of Prudence
Answer:
Convention of Prudence/Conservative approach:

• An accountant is supposed to be conservative therefore expenses or losses are provided if there is possibility of its occurrence, but incomes are provided only if there is certainty of its earning.
• It is application of a caution while estimating & accounting, such that expense & liabilities are not understated & income & assets are not overstated.
• But it does not justify Creation of hidden reserve by deliberate understatement of Assets & incomes & overstatement of Liabilities & expenses.

Question 15.
Distinguish between Going Concern concept and Cost concept
Answer:
Going Concern Concept:

• It implies that the concern will be continuing the business for foreseeable future.
• It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.
• If such an intention or need exist, the financial statements may have to be prepared on a different basis and, if so, the basis is disclosed.
• Because of this, expenditure is divided into Capital & Revenue Expenditure & the Fixed Assets are valued at cost less Depreciation.
• Because of this account of the whole life is divided into smaller accounting periods, (periodicity concept) Going concern is a fundamental accounting assumption.

Cost Concept:

• The assets & properties are recorded at its cost to the concern & not at its market value.
• Except stock which may be valued at cost or market price which ever is lower.
• As per this concept Fixed assets are recorded at their acquisition cost & then depreciated over its useful life.
• Example – Building purchased for ₹ 10 lakh. Its market value is ₹ 11 lakh. In books of account building will be recorded at cost i.e. ₹ 10 lakh.

True or False

Question 1.
Prudence is a concept to recognize unrealized profits and not losses.
Answer:
False: Prudence is a concept to recognize future or anticipated losses and not profits.

Question 2.
As per AS-1, Fundamental Accounting Assumptions are Going Concern, Full Disclosure and Accrual Concept.
Answer:
False: As per AS-1, Fundamental Accounting Assumptions are Going Concern Concept, Consistency and Accrual Concept.

Question 3.
The financial statement must disclose all the relevant and reliable information in accordance with the full disclosure principle.
Answer:
True: The financial statement must disclose all the relevant and reliable information to comply with AS-1 Disclosure of Accounting Policies.

Question 4.
Accrual concept implies accounting on cash basis.
Answer:
False: Accrual concept implies accounting on ‘accrual’ basis not on cash basis.

Question 5.
As per Concept of Conservatism, the accountant should provide for all possible losses, but should not anticipate income.
Answer:
True: As per Concept of Conservatism, the accountant should provide for all possible losses, but should not anticipate income.

Question 6.
The economic life of an enterprise is artificially split into periodic intervals in accordance with the going concern assumptions.
Answer:
True: The economic life of an enterprise is artificially split into periodic intervals in accordance with the accounting period concept. The going concern assumption states that an enterprise will continue its operation for indefinite period of time.