Accounting Concepts Part-2

4. Cost Concept: The concept is closely related to going concern concept. According to this concept. "An asset is ordinarily entered on the accounting record at the price paid to acquire it, and this cost is the basis for all subsequent accounting for the asset". If business buys a building for Rs 5,00,000, the assets would be recorded in the books at Rs 500,000, even if its market value at that time may be Rs 550,000. In case a year later the market value of this asset comes down to Rs 450,000 it will ordinarily continue to be shown at Rs 500,000 and not at Rs 450,000. The cost concept does not mean that the asset will always be shown at cost. It has also been stated above that cost becomes the basis for all future accounting for the asset. It means that asset is recorded at cost at the time of purchase but it may systematically be reduced in its value by charging depreciation. 5. Dual Aspect Concept: The economic resources of an entity are called 'assets'.The claims of various parties against these assets are called 'equities'. There are two types of equities: 1. Liabilities, which are the claims of creditors (that is, everyone other than the owners of business) and 2. Owner's Equity, which is the claim of the owners ofthe business. Since all of the assets of a business are claimed by someone (either by its owners or by its creditors) so we can say that Assets = Equities This is the fundamental accounting equation, which is the formal expression of the dual - aspect concept. As we shall see all accounting procedures are derived from this equation. To reflect the two type of equities, the equation is more commonly expressed as: Assets = Liabilities + Owner's Equity Every transaction has a dual impact on the accounting records. Accounting systems are set up so as to record both of these aspects of a transaction; this is why accounting is called a double-entry system. To illustrate the dual-aspect concept, suppose that Mr. A starts a business with a capital of Rs 30,000. There are two changes, first the business has cash (asset) of Rs 30,000 and second, the business has to pay to the proprietor a sum of Rs10,000 which is taken as proprietor's capital. This expression can be shown inthe form of following equation: Cash (Assets) = Capital (Equities) Rs 30,000 =Rs 30,000. Subsequently if the business borrows Rs15,000 from a bank, the new position would be as follows: Assets = Equities Cash Rs 30,000 + Bank Rs 15,000 = Bank loan Rs15,000 + Capital Rs30,000. The term 'accounting equation' is also used to denote the relationship of equities to assets. The equation can be technically, stated as "for every debit, there is an equivalent credit". 6. Accounting Period Concept: The users of financial statements need information that is reasonably current. Therefore, for financial reporting purposes, the life of a business is divided into a series of relatively short accounting periods of equal length. It is, therefore, absolutely necessary that after each accounting period the business must 'stop' and 'see back', how things are going. In accounting such accounting period is usually of a year. At the end of each accounting period an income statement and a balance sheet is prepared the income statement discloses the profit or loss made by business during the year while balance sheet shows the financial position of business as on the last day of the accounting period. 7. The Matching Concept: A significant relationship exists between revenue and expenses. Expenses are incurred for the purpose of producing revenue. In measuring net income for a period, revenue should be offset by all the expenses incurred in producing that revenue. This concept of offsetting expenses against revenue on the basis of "cause and effect" is called the Matching Concept. The term 'matching' means appropriate association of related revenues and expenses. In matching expenses against revenue the question when the payment was made or received is 'irrelevant'. For example if a salesman is paid commission in January,2005, for sales made by him in December, 2004. According to this concept commission expense should be offset against sales of December 2004 because this expense is incurred for producing revenue in December 2004. On account of this concept, adjustments are made for all outstanding expenses, accrued revenues, prepaid expenses and unearned revenues, etc., while preparing the final accounts at the end of accounting period. 8. Realization Concept: Accounting to this concept revenue should be recognized at the time when services are rendered. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay.