Accounting or accountancy is the measurement, processing, and communication of financial and non-financial information about economic entities such as businesses and corporations.

In this regard, accountants can be defined as highly skilled individuals who are critical to business growth and decision-making. 

Learn the key terms of accounting.

The basic accounting concepts that apply to any type of accounting, are standard across specializations. They originate from the accounting standards set by Central Government departments and recommended by the Institute of Chartered Accountants of India (ICAI). 

Accounting Concepts

Accounting
A Chartered Accountant handles the financial aspects of a business. A CA should know how to focus. Source: northwesternuniversity

If you are looking to pursue a career in accounting, then you need to first understand the basic accounting concepts, standards, and principles. Also familiarize yourself with accounting software that is the new trend of accounting.

Entity Concept

This is the most popular accounting concept and to avoid confusion between personal and business accounts. Here, assets and liabilities are documented and reported separately. The transactions and expenses of the business are also separated to ensure they do not get mixed with the owner's personal accounts. This is particularly helpful in calculating the tax liabilities of the company. 

You will notice different types of business entities in the current global economy, namely:

  1. Proprietorship.
  2. Partnership.
  3. Corporation.
  4. Government. 

The advantage of the entity concept is that each business entity is taxed separately, which can then be used to determine the financial well-being of the entity. Also, if different entities are bundled up together, it becomes an almost impossible task to financially audit them.

Accruals Concept

An accrual is a journal entry, used to document and recognize revenues and expenses that have been earned and spent, respectively. The defining factor of this concept is that the related cash amounts that have been obtained or spent are yet to be received or paid out. 

Note that auditors only accept financial statements, prepared using the accruals concept. A Financial statement prepared otherwise is not credible and is considered inaccurate. Besides, without accruals, the amount of revenue, expense, and profit or loss in a period will not correctly reflect the economic activity within a company.

Here is a list of possible accruals recorded in a business:

  • Expense accrual for interest: This is essential for a borrower (in this case, the company or any other legal entity) to register its interest expense before receiving the invoice.
  • Expense accrual for wages: This is used by an employer to accrue all additional fees earned from the last few working days of the month in order to ensure full wage realization.
  • Expense accrual for supplier goods and services: This is used to estimate the expenses for the current month before actually receiving the final invoices.
  • Sales accrual: A company can accrue revenue for the amount of work completed to date, before also receiving the invoice or bill.

Going Concern Concept

This is a one-of-a-kind accounting concept. It works on the assumption that companies will stay in business for an indefinite period of time, and will function according to current plans. Companies use this assumption to their advantage to spread the cost of an asset over this expected company life cycle instead of having to accelerate expenses immediately. This is again done using another assumption that the company will successfully meet its financial obligations with the help of its existing assets.

The implication of using this concept is that accountants defer expenses to a later period because a possible halt in operations or asset liquidation is not envisioned in the foreseeable future.

Conservatism Concept

The essential accounting concept is most beneficial if you are drawing up your risk mitigation plans. It prepares you for a phase of anticipatory loss or zero profits. This is useful in ensuring that financial statements do not overstate the entity's financial position or prosperity.

The concept is named such since it is truly conservative in accounting for profit or loss until the revenue is realized and the bank reflects the money to be in your account.

Realization Concept

Also called the recognition concept indicates the amount of revenue that should be recorded from a specific sale. It is similar to the conservatism concept in that it only accounts for revenue when money for goods and services sold, is actually received by the seller.

Businesses are advised to not pay out money in lump sum amount but rather split it into agreed-upon installment payments in order to minimize risks.

Matching Concept

Used as a major concept in cost accounting, the matching idea requires costs to be paired with revenues earned by the company. It comes with a qualification requirement that the realization concept must have been applied before the matching is done.

Note that you need to record the costs and revenues in the same time period such as a week, month, quarter, or a year to avoid deferring expenses into later period statements.

A profit and loss account or a double-entry bookkeeping system uses the matching concept.

Materiality Concept

Not every financial transaction needs to be recorded by an accountant. The materiality concept allows for this. According to many accounting experts and laws, an accountant does not have to record any material or object that is considered immaterial.

Consistency Concept

Once a business decides on the most relevant and appropriate accounting concept, it must ensure consistency in its financial accounting process to avoid discrepancies in the future.

Consistency is vital in a business setting to carefully record financial information and to help external sources understand the inner workings of a company.

Dual-Aspect Concept

This concept involves the double-entry bookkeeping system. This requires that every single business transaction must be recorded in at least two different accounts. This can be understood using the following equation:

Assets = Liabilities + Equity

Here, assets are anything that the organization owns like property or equipment, while liabilities are anything that it owes to some external entities like creditors or tax authorities.

Cost Concept

The cost concept requires accountants to record an asset, liability, or equity at the original acquisition cost. The problem with this concept is that these assets change their market values over time. In case the company wants to liquidate any of these assets, it is a difficult task to ascertain the precise value of the asset at the point in time.

The cost concept cannot be used for financial investments and is the most effective when utilized to determine short-term assets and liabilities.

Learn about the golden rules of accounting that accountants abide by.

Accounting Standards

Accounting Standards are the Bible of Accountancy.

Accounting standards are written documents and policies for recognition, measurement, treatment, presentation, and disclosures of accounting transactions in the financial statements.

In India, there are 27 accounting standards, introduced with the objective of standardizing accounting practices across the country. These standards are mandatory for any Indian company with a minimum net worth of INR 500 Cr.

Find out more about the Accounting Standards in India. 

Types of Accounting

Management accountant
Cost accountants work in tandem with financial accountants. Source: kmsindia.com

The word accounting comes from the word accountability. If you are going to be rich, you have to be accountable for your money. - Robert Kiyosaki

While there are various types of accounting roles in the market, two are very important to businesses- cost accounting and financial accounting.

What is Cost Accounting?

A variant of management accounting, cost accountants are concerned with documenting and tracking the total cost of production in a company, by assessing the variable costs in each step of production, along with the fixed costs.

The key features of cost accounting include:

  • It is an internal process, where cost accountants present findings and recommendations to help management executives to make informed business decisions.
  • Since it is an internal requirement, cost accountants are not obliged to meet any external standards like statutory compliances.
  • Cost accountants are driven by the needs of the management. In effect, they help classify the different costs of doing business.
  • Cost accounting involves process standard costing, activity-based costing, lean costing, and marginal costing. 

What is Financial Accounting?

Unlike cost accounting, financial accounting involves recording, summarizing, and reporting of all sorts of business transactions in a company. The key features of this type of accounting include:

  • Financial accounting follows the accrual or the cash concept of accounting.
  • It is meant for external reporting to entities like auditors, creditors, investors, and stakeholders.
  • The process involves the preparation of financial statements.
  •  Financial accounting is mandated by law, and as such has to comply with tax regulations and other legal statutes.

Due to the nature and purpose of the two, financial and cost accounting differ from one another in many aspects. But the are also similar in that they follow the common accounting principles and standards.

Learn more about financial accounting and its objectives.

Apply these accounting concepts to build your knowledge base as you plan a future in the vast world of accounting and finance.

Need a Accounting teacher?

Did you like this article?

5.00/5 - 1 vote(s)
Loading...

Pragnajyoti

Doctor, dog lover, traveler..