Accounting Principles

Document Sample
Accounting Principles Powered By Docstoc
					Basic accounting principles are the general decision rules which govern the development of
accounting techniques. These principles, do not violate or conflict with the four basic
assumptions discussed above, but refine the application thereof. The following are the basic
accounting principles:
   Duality (Dual Aspect Principle)
   Revenue Recognition Principle
   Historical Cost Principle
   Matching Principle
   Full Disclosure Principle
   Objectivity
   •   Role of Accounting
       Accounting is not an end in itself; it is a means to an end. It performs the service activity
       by providing quantitative financial information that helps the users in making better
       business decisions....

Duality
This principle states that every transaction has two aspects. It therefore, implies that minimum
two accounts will be involved in recording a transaction. When an investment is made by the
owner in the business, it results in increase in an asset and increase in owner's equity. Thus, this
transaction is recorded considering these two aspects, i.e. asset and owner's equity. Every
transaction will affect the accounting equation, whereby, there will be corresponding increase or
decrease on both sides of the equation or increase and decrease on one side of the equation. The
accounting equation is given below:
Assets = Liabilities + Owner's Equity
The enterprise can acquire an asset by sacrificing another asset, incurring the liability or
receiving it from owner (resulting in increase in owners' equity). The use of accounting equation
for processing of business transaction is discussed in the next chapter.
   •   Accounting Assumptions
       Assumptions are traditions and customs, which have been developed over a period of
       time and well accepted by the profession. Basic accounting assumptions provide a
       foundation for recording the transactions...
   •   Accounting as an Information System
       Earlier, the accounting work was entirely manual and accounting department used to take
       excessively long time in processing the transactions and generating the accounting
       reports. The modern technology has...
   •   Characteristics of Accounting Information System
       The objective of accounting is to provide information about the financial position,
       performance and changes in financial position of an enterprise that is useful to wide range
       of users in making economic...
   •   Basic Terms in Accounting
       There are two basic financial statements which are prepared by an enterprise: Profit &
       Loss Statement, and Balance Sheet. The three components of a balance sheet can be
       stated in the form of following...

Revenue Recognition Principle
Revenue recognition (Revenue realization) principle helps in ascertaining the amount and time of
recognizing the revenues from the business activities. Revenues are the amount a business earns
by selling its products or providing services to the customers. The revenue is deemed to have
been earned in the period in which the sale has taken place or services have been performed to
the satisfaction of the customer and the revenue has been received or becomes receivable.
However, there may be situations where, within the accounting period, sale may not have
concluded or services have not been fully rendered. This poses the problem of revenue
recognition.
Normally, the revenue is recognized at the point of sale when title to the goods passes from the
seller to the buyer. However, there are few exceptions to this rule of revenue recognition.
In a situation where the government has appointed an authority to acquire entire production, such
as refine of gold, the revenue may be recognized on the completion of the refining irrespective of
the fact of physical transfer of goods.
In case of work to be completed on contractual basis taking longer period of time such as road
construction, bridge construction, the revenue may be recognized on the basis of cash received
on partially completed and certified works. In such contracts, payment is made on the basis of
the terms of contract, which specify partial payment in relation to the work certified and
completed. On the completion of contract, the remaining amount is treated as sales.
In some cases, revenue may be realized at the time of receiving cash and not at the time of
providing services.
For example, a lawyer may charge the fee from his client and treat it as revenue earned for the
current period, whereas legal services may be provided in future.
The basic test, as discussed above, is used to ascertain the revenue. The revenue from permitting
other entities to use the enterprise's asset is to be recognized as the time passes or as the asset is
used. The rent from the premises let out or interest on money loaned will be recognized on the
basis of passage of time. The royalty may be recognized on the basis of production/ sale of the
products.

Historical Cost Principle
Historical cost principle requires that all transactions should be recorded at their acquisition cost.
The cost of acquisition refers to the cost of purchasing the asset and expenses incurred in
bringing the asset to the intended condition and location of use. In other words acquisition cost is
equal to buying price plus all expenses incurred to put the asset to use. The cost is historical in
nature and will not change year after year. This implies that no adjustment is made for any
change in the market value of such assets.
The advantage of using historical cost for recording the transactions is that it is objective,
verifiable and reliable. Thus, it imparts reliability to the financial statements.
Matching Principle
Matching principle requires that the expenses should be matched with the revenues generated in
the relevant period. The simple rule that followed in this context is, ‘let expenses follow
revenues'.
The Matching Principle by relating expenses to the associated revenues helps in measuring
income (profit) for the given period. It is of great significance since the performance of an entity
is usually measured in terms of income earned by the entity.
We do not recognize the expense when cash is paid or when a product is produced. It is
recognized when the service or the product actually contributes to the revenue. Therefore,
expenses are not related to the period of cash outflow but to the period in which the revenues are
generated. The matching principle requires that part of the cost of fixed assets used in the
operations of the business, known as depreciation, is treated as expense of the period. Likewise,
in case revenues received in advance for which the services have not been rendered will be
treated as 'unearned income', and hence, it will be carried forward to the following accounting
period.

   •   Trial Balance
       A trial balance is a summary of balances of all accounts recorded in the ledger. The trial
       balance is prepared at the end of a chosen period which may either be monthly, quarterly,
       half-yearly or annually or...
   •   Suspense Account
       In spite of best efforts, locating errors is not an easy task and may take some time. Unless
       detected and located, errors cannot be corrected. To avoid delay in the preparation of
       financial statements, the...

Full Disclosure Principle
Full disclosure principle requires that all those facts that are necessary for discharging the
accountability and proper understanding of the financial statements must be revealed. All
material information should be disclosed fully and completely, which is relevant for decisions to
be taken by users. The information may be disclosed in the main body of the financial
statements, schedules and annexure, and the footnotes appended thereto. Further, it requires that
any significant event, which takes place after the balance sheet date and is likely to affects the
financial status of the enterprise significantly, should also be reported in notes to financial
statements. There might be some claims pending against the firm, which if not revealed in the
financial statements will mislead the users. The regulatory bodies like SEBI mandates
disclosures to be made by the companies to portray true and fair view of business operations to
ensure discharge of accountability. Accountability is said to have been discharged if complete
information is delivered with due diligence by the prepares (management and accountants) of
that information, so that the economic interest of the users of the information is not adversely
affected.
Objectivity Principle
The principle of objectivity implies that the accounting data should be verifiable and free from
any bias. In fact, to generate the reliable accounting information, the basic requirements are
neutrality (free from bias) and verifiability. The historical cost recorded in the books is on the
basis of original documents, which contain the information, which is not affected by the personal
bias. Therefore, the accounting entries are recorded on the objective basis and is verifiable from
the source documents. Historical cost accounting, therefore, is preferred inspite of its
shortcomings due to objectivity.

				
DOCUMENT INFO
Shared By:
Categories:
Stats:
views:1
posted:9/19/2011
language:English
pages:4
About my name is Mohsin Ali