Accounting principles means the accounting rules. These accounting rules are followed while preparing the accounting statements. Earlier in the past when accounting statements were largely needed by the proprietor, these days the accounting statements are needed by various parties who have vested interest in the business, namely, proprietors, investors, creditors, government and many others. Therefore, it is such statements should be prepared according to accounting principles.
Characteristics Of Accounting Principles
(i) Accounting principles are uniform set of rules or guidelines developed to ensure uniformity and easy understanding of the accounting information.
(ii) Accounting principles are man made and are derived from experience and reason. They are not laboratory tested and hence they lack universal applicability like the principles of physics, chemistry and other natural sciences.
(iii) Accounting principles are not static and are bound to change with the passage of time in response to the changes in business practices, government policies and needs of the users of accounting information.
(iv) The general acceptance of an accounting principle depends upon how well it statisfies the following three criteria :
- Relevance : A principle is relevant if it results in information that is useful to the user of the accounting information.
- Objectivity : A principle is objective if it is free from personal bias or judgements of those who furnish the information. Objectivity also implies verifiability which means that there is some way of finding out the truthfulness or correctness of the information reported.
- Feasibility : A principle is feasible if it can be applied without undue complexity or cost.
Need of Accounting Principles
In order to make the accounting information meaningful to its internal and external users, it is significant that such information is reliable as well as comparable. The comparability of information is required to see how a firm has performed as compared to the other firms and 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 some set rules known as policies, principles and conventions. These rules (usually called GAAP) bring uniformity and consistency to the process of accounting and enhance its utility to different users of accounting information.
Kinds of Principles Of Accounting
Accounting principles are described by various terms such as assumptions, conventions, concepts, doctrines, postulates etc. These principles can be classified mainly into two categories (1) Accounting Concepts or Assumptions (2) Accounting Conventions
(1) Accounting Concepts or Assumptions
In order to make the accounting language convey the same meaning to all people and to make it more meaningful, most of the accountants have agreed on a number of concepts which are usually followed for preparing the financial statements. These concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these basic Concepts or Assumptions.
(I) Business Entity Concept – According to this concept, business is treated as a unit separate and distinct from its owners, creditors, managers and others. In other words, the owner of a business is always considered as distinct and separate from the business he owns. Business unit should have a completely separate set of books and we have to record business transactions from firm’s point of view and not from the point of view of the proprietor.
(II) Money Measurement Concept – Only those transactions and events are recorded in accounting which are capable of being expressed in terms of money. An event, even though it may be very important for the business, will not be recorded in the books of the business unless its effect can be measured in terms of money with a fair degree of accuracy.
(III) Going Concern Concept – As per this concept it is assumed that the business will continue to exist for a long period in the future. The transactions are recorded in the books of the business on the assumption that it is a continuing enterprise. It is on this concept that we record fixed assets at their original cost and depreciation is charged on these assets without reference to their market value. For example, if a machinery is purchased which would last, say, for the next 10 years, the cost of this machinery will be spread over the next 10 years for calculating the net profit or loss of each year. Because of the concept of going concern the full cost of the machine would not be treated as an expense in the year of its purchase itself. The market value of the fixed assets is irrelevant and is not recorded in the balance sheet, as these assets are not going to be sold in the near future.
(IV) Dual Aspect Concept – According to this concept, every business transaction is recorded as having a dual aspect. In other words, every transaction affects atleast two accounts. If one account is debited, any other account must be credited. The system of recording transactions based on this concept is called as ‘Double Entry System’. It is because of this principle that the two sides of the Balance Sheet are always equal.
(V) Matching Concept – This concept is very important for correct determination of net profit. According to this concept, in determining the net profit from business operations, all costs which are applicable to revenue of the period should be charged against that revenue. Accordingly, for matching costs with revenue, first revenues should be recognised and then costs incurred for generating that revenue should be recognised.
(VI) Objectivity Concept – This concept requires that accounting transaction should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts. It is possible only when each transaction is supported by verifiable documents and vouchers such as cash memos, invoices, sales bill, pay-in slip, correspondence, agreements etc.
(2) Accounting Conventions
An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants.
(I) Convention of full disclosure – This principle requires that all significant information relating to the economic affairs of the enterprise should be completely disclosed. In other words, there should be a sufficient disclosure of information which is of material interest to the users of the financial statements such as proprietors, present and potential creditors, investors and others.
(II) Convention of Consistency – This convention states that Principles Of Accounting and methods should remain consistent from one year to another. These should not be changed from year to year, in order to enable the management to compare the Profit & Loss Account and Balance Sheet of the different periods and draw important conclusions about the working of the enterprise. If a firm adopts different accounting principles in two accounting periods, the profits of current period will not be comparable with the profits of the preceding period.
(III) Convention of Conservatism or Prudence :- According to this convention, all anticipated losses should be recorded in the books of accounts, but all anticipated unrealized gains should be ignored. In other words, conservatism is the policy of playing safe. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty. Likewise, when there are different alternatives for recording a transaction, the one having least favourable immediate effect on profits or capital should be adopted.
(IV) Convention of Materiality – This convention is an exception to the convention of full disclosure. According to this convention, items having an insignificant effect or being irrelevant to the user need not be disclosed. These unimportant items are either left out or merged with other items, otherwise accounting statements will be unnecessarily overburdened.