Below the Explanation of Basic Accounting Concepts:
Accounting concepts form the foundation of accounting principles and practices. These concepts provide a framework for recording, interpreting, and communicating financial information.
Here are some fundamental accounting concepts:
- The Business Entity Concept
- The Monetary Concept
- The Going Concern Concept
- The Cost Concept
- The Dual Aspect Concept
- The Accounting Period Concept
- The Realization Concept
- The Accrual Concept
- The Matching Concept
‣ The Business Entity Concept
The business entity concept states that the business is treated as a separate entity from its owners or any other business. It means that the financial transactions and records of the business should be kept separate from the personal transactions of the owners.
• This concept is fundamental for maintaining accurate and reliable accounting records
Example: If John owns a retail store, he should keep separate bank accounts for personal expenses and business expenses. Personal expenses like rent for his house should not be mixed with business expenses like rent for the store.
‣ The Monetary Concept / Money Measurement concept
The monetary concept states that only transactions that can be expressed in monetary terms are recorded in accounting.
• In other words, the business events and information that cannot be expressed in monetary terms are out of the scope of accounting record.
Example: If a company has an employee who is exceptionally skilled and efficient, their value to the company may not be recorded in the accounting books since it cannot be expressed in monetary terms.
‣ The Going Concern Concept
This concept assumes that a business entity is a going concern. It will continue to operate for an indefinite period of time.
• This assumption influences the preparation of financial statements, valuing assets based on their continuing use rather than their immediate liquidation value.
‣ The Cost Concept
This concept is very close to the going concern concept and based on the principle that the assets or resources owned by a firm should be shown at the cost of their acquisition not at their current market or sale value.
• This concept ensures that financial statements reflect the actual cost of acquiring assets rather than their current market values.
Example: If a company purchased a building for $500,000 several years ago, the cost concept dictates that the building will be recorded at $500,000 in the financial statements, regardless of its current market value.
‣ The Dual Aspect Concept
The dual aspect concept, also known as the accounting equation, states that every transaction has two aspects: a debit and a credit.
• This concept ensures that the accounting equation (Assets = Liabilities + Equity) remains in balance after each transaction, providing a systematic and accurate recording of financial activities.
‣ The Accounting Period Concept
The accounting period concept divides the economic life of a business into specific and consistent time periods for reporting financial information.
• This concept allows companies to prepare financial statements for shorter periods, such as monthly, quarterly, or annually, enabling easier comparison and analysis.
‣ The Realization Concept
The realization concept, also known as revenue recognition, states that revenue should be recognized when it is earned and realizable, irrespective of when the payment is received.
• This principle ensures that financial statements accurately reflect the timing of revenue generation.
• It does not care whether it is a cash sale or credit sale.
‣ The Accrual Concept
The accrual concept states that revenue and expenses should be recognized when they are incurred, not necessarily when the cash is received or paid.
• This concept aligns with the idea of matching revenue with the expenses it helped generate, providing a more accurate depiction of the financial position.
‣ The Matching Concept
The matching concept is based on the notion that the expenses recorded in an accounting period should be matched with the revenue recorded in that period so as to calculate the profit earned or loss suffered during that period.
• It ensures that the financial statements reflect the proper relationship between expenses and the revenues
• This concept is largely followed by the accountants in preparing an income statement.
