Accounting Concepts (Part 1)

Accounting is often called as the language of the business. Accounting to become intelligible and commonly understood language, if it is based on certain Accounting Principles, Concepts and Conventions.

Let us study the Accounting Concepts:

Separate Business Entity Concept:

In Accounting we make a distinction between business and the owner. All the books of accounts records day to day business transactions from the view point of the business rather than from that of the owner. The proprietor is considered a creditor to the extent of the capital bought in the business by him. For instance, when a person invests Rs. 10 lakh into a business, it will be treated that the business has borrowed that much money from the owner and it will shown as a 'liability' in the books of accounts of the business. Similarly, if the owner of the shop were to take cash from the cash box for meeting certain personal expenditure, the accounts would show that cash had been reduced even though it does not make any difference to the owner himself. Thus, in recording a transaction the important question is how does it affects the business? For example, if the owner puts cash into the business, he has a claim against the business for capital brought in.

In so-far as a limited company is concerned, this distinction can be easily maintained because a company has a legal entity like a natural person it can engage itself on economic activities of buying, selling, producing, lending, borrowing and consuming goods and services. However, it is difficult to show this distinction in the case of sole proprietorship and partnership. Nevertheless, accounting still maintains separation of business and owner. It may be noted that it is only for the accounting purpose that partnership and sole proprietorship are treated as separate from the owner, though law does not make such distinction. In fact, the business entity concept is applied to make it possible for the owners to assess the performance of their business and performance of those who manage the enterprise. 

Money Measurement Concept:

In Accounting, only those business transactions are recorded which can be expressed in terms of money. In other words, a fact or transaction or happening which cannot be expressed in terms of money is not recorded in the accounting books. As money is accepted not only as a medium of exchange but also as a store of value. It has a very important advantage since a number of assets and equities, which are otherwise different, can be measured and expressed in terms of common denominator.

We must understand that this concept imposes two severe limitations. Firstly, there are several facts which are very important to the business, cannot be recorded in the books of accounts because they cannot be expressed in terms of money. For example, general health condition of the Managing Director of the company, working conditions in which a worker has to work, sales policy pursued by the enterprise, quality of product introduced by the enterprise, all these factors exert a great influence on the productivity and profitability of the enterprise. You will agree that all this reasons have a bearing on the future profitability of the business.

Secondly, use of money implies that we assume stable or constant value of rupee. Taking the assumptions means that the changes in the money value in future dates are conveniently ignored. For example, a piece of land purchased in 1990 for Rs. 2 lakh and another bought for the same amount in 1998 are recorded at the same price, although the first purchased in 1990 may be worth 2 times higher than the value recorded in the books because of rise in land prices. In fact, most accountants knows fully well that purchasing power of rupee does change but very few recognize this fact in accounting books and make allowance for changing price level.

Dual Aspect Concept:

Financial Accounting records all the transactions and events involving financial element. Each of such transactions requires two aspects to be recorded. The recognition of these two aspects of every transaction is known as a dual aspect analysis. According to this concept every business transactions has dual effect. For example, if a firm sells goods of Rs. 5000 this transaction involves two aspects. One aspect is the delivery of goods and the other aspect is immediate receipt of cash (in case of cash sales). In fact, the term 'double entry' book keeping has come into vogue and in this system the total amount debited always equals the total amount credited. It follows from 'dual aspect concept' that at any point of time owners' equity and liabilities for any accounting entity will be equal to assets owned by that entity. This idea is fundamental to accounting and could be expressed as the following: 

Assets= Liabilities+ Owners equity

Owners equity= Assets- Liabilities 

The above relationship is known as "Accounting Equation".  The term 'owners equity' denotes the resources supplied by the owners of the entity, while the term 'liabilities' denotes the claim of the outside parties such as creditors, debenture-holders, bank against the assets of the business. 'Assets' are the resources owned by a business. The total of the assets will be equal to the total of the liabilities plus owners capital because all assets of the business are claimed by either owners or outsiders.