DELHI PUBLIC SCHOOL- BOPAL, AHMEDABAD

CYCLE -7 NOTES -2 (2021- 22)

CHAPTER NAME: THEORY BASE OF ACCOUNTING
CLASS: XI
SUBJECT: ACCOUNTANCY
THEORY BASE OF ACCOUNTING
The theory base of accounting consists of principles, concepts, rules and guidelines developed over a period of
time to bring uniformity and consistency to the process of accounting and enhance its utility to different users of
accounting information
The Institute of Chartered Accountants of India, (ICAI), which is the regulatory body for standardisation of
accounting policies in the country has issued Accounting Standards which are expected to be uniformly adhered
to, in order to bring consistency in the accounting practices.
Generally Accepted Accounting Principles
In order to maintain uniformity and consistency in accounting records, certain rules or principles have been
developed which are generally accepted by the accounting profession.
These rules are called by different names such as principles, concepts, conventions, postulates, assumptions and
modifying principles.
Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and
reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial
statements.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental to accounting practice.
The term convention connotes customs or traditions as a guide to the preparation of accounting statements.
The important concepts have been listed as below:
1. Business entity;
2. Going concern;
3. Money measurement;
4. Accounting period;
5. Cost
6. Dual aspect (or Duality);
7. Revenue recognition (Realisation);
8. Matching;
9. Full disclosure;
10. Consistency;
11. Conservatism (Prudence);
12. Materiality;
13. Objectivity.
1. BUSINESS ENTITY CONCEPT
 Business is considered as a separate entity different from that of the owner. For the purposes of
accounting, the business and its owners are to be treated as two separate entities.
 All transactions are analysed from the point of view of business only.
 when a person brings in some money as capital it is treated as liability of the business to the owner.
 Similarly, when the owner withdraws any money from the business for his personal expenses(drawings),
it is treated as reduction of the owner’s capital and consequently a reduction in the liabilities of the
business.
 Distinction is made only to differentiate the private transactions of the owner from that of the business.
 This principle is applicable to all forms of business organizations.
2. GOING CONCERN CONCEPT
 Business is said to be having an indefinite life, for a fairly long period of time and would not be
liquidated in the foreseeable future.
 On the basis of this assumption transactions are classified into capital and revenue items.
 If this assumption is not made people will not enter into long-term contracts as they fear that the business
can wind up at any time.
 The assumption regarding continuity of business allows us to charge from the revenues of a period only
that part of the asset which has been consumed or used to earn that revenue in that period
 and carry forward the remaining amount to the next years, over the estimated Life of the asset.
3. MONEY MEASUREMENT CONCEPT
 Only transactions that are measured in terms of money are recorded in the books of accounts.
 Non-monetary transactions like quality of a product, labour unrest, competent management, even though
are important are not recorded in the book of accounts.
 Another important aspect of the concept of money measurement is that the records of the transactions are
to be kept not in the physical units but in the monetary unit.
 FOR EG: factory has a piece of land measuring 2 acres, office building containing 10 rooms,30 personal
computers, 30 office chairs and tables, a bank balance of `5 lakh,raw material weighing 20-tons, and 100
cartons of finished goods.
 For accounting purposes,therefore, these are shown in money terms and recorded in rupees and paise.
LIMITATION:The money measurement assumption is not free from limitations. changes in prices, the value of
money does not remain the same over a period of time.
As the change in the value of money is not reflected in the book of accounts, the accounting data does not reflect
the true and fair view of the affairs of an enterprise.
4. ACCOUNTING PERIOD CONCEPT
 Accounting period refers to the span of time at the end of which the financial statements of an enterprise
are prepared, to know whether it has earned profits or incurred losses during that period and what exactly
is the position of its assets and liabilities at the end of that period.
 Such information is required by different users at regular interval for various purposes, as no firm can
wait for long to know its financial results.
 So for the purpose of reporting ,the entire life of a firm is divided into time intervals.
 Each time interval is known as accounting period.
 It is usually for a year.
 The accounting year can be a calendar year,(1st January – 31st December) or th fiscal year or financial
year(1st April to 31st March of next year).
5. HISTORICAL COST
 All business transactions must be recorded in the books of accounts at their monetary cost of acquisition.
 The balance of assets and liabilities is carried forward from year to year .
 At its acquisition cost, irrespective of increase or decrease in the market value of assets.
 The use of Historical cost provides verifiable and objective Accounting information as the cost of acquisition
is easily verifiable from the purchase documents.
Limitation: An important limitation of the historical cost basis is that it does not show the true worth of the
business and may lead to hidden profits. (the assets can be replaced at higher than the value at which these are
shown in the book of accounts) leading to hidden profits.)
6. DUAL ASPECT PRINCIPLES
 This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at
two places.
 Every business transaction has two-fold aspect as it affects two parties.
 Every financial transaction involves (a) yielding of a benefit and(b) giving of that benefit.
 Every debit has a corresponding credit.
 That is why it is always said that ASSETS = LIABILITIES + CAPITAL.
 Hence any increase or decrease in total assets must simultaneously produce a corresponding increase or
decrease in total equities.

7. REVENUE RECOGNITION PRINCIPLE

 Revenue is the gross inflow of cash arising from
i) the sale of goods and services by an enterprise; and
ii)use by others of the enterprise’s resources yielding interest,royalties and dividends.
 Revenue is the amount, which as a result of operations is added to the capital.
 It is assumed to be realised when a legal right to receive it arises, i.e. the point of time when goods have
been sold or service has been rendered
 It is recognized when assets or services are used to produce revenue during a period.
 eg credit sales are treated as revenue on the day sales are made and not when money is received from the buyer
 There are some exceptions to this general rule of revenue recognition. In case of contracts like
construction work, which take long time, say 2-3 years to complete, proportionate amount of revenue,
based on the part of contract completed by the end of the period is treated as realised. Similarly, when
goods are sold on hire purchase, the amount collected in instalments is treated as realised.
8. MATCHING PRINCIPLE
 The process of ascertaining the amount of profit earned or the loss incurred during a particular period
involves deduction of related expenses from the revenue earned during that period.
 This principle indicates the procedures / rules to be followed while matching revenue and expenditure.
 Revenue should be matched with the expense if the benefit is likely to accrue in the same year. Otherwise
it should not be matched.
 Certain expenses are shown in the P/L a/c and certain expenses are shown in the B/S due to operation of
matching principle.
 The matching concept, thus, implies that all revenues earned during an accounting year, whether received
during that year, or not and all costs incurred, whether paid during the year, or not should be taken into
account while ascertaining profit or loss for that year.
9. FULL DISCLOSURE PRINCIPLE
 that the financial statements makes a full, fair and adequate disclosure of all information which is relevant
for taking financial decisions. All material (significant) information should be disclosed in financial
statements.
 Assets, expenses & revenues should be clearly stated along with their methods of valuation and grouping.
 The legal requirements if any must also be followed.
 This is to enable the users to make correct assessment about the profitability and
financial soundness of the enterprise and help them to take informed decisions.
 Examples: stating the a] methods of valuation of stock ( b) contingent liability (c) depreciation.
10. CONSISTENCY
 Accounting procedures or practices should remain the same from one year to another.
 This will enable the business to compare it results from year to year.
 Both inter-firm and inter-period comparisons are required to be made.
 This can be possible only when accounting policies and practices followed by enterprises
are uniform and are consistent over the period of time.
 If any change of method is effected it should be disclosed in that year’s financial statement.
 However, consistency does not prohibit change in accounting policies.
 Necessary required changes are fully disclosed by presenting them in the financial statements indicating
their probable effects on the financial results of business.

11. CONSERVATISM (PRUDENCE)

 “ANTICIPATE NO PROFIT BUT PROVIDE FOR ALL POSSIBLE LOSSES”
 The concept of conservatism requires that profits should not to be recorded until realised but all losses,
even those which may have a remote possibility, are to be provided for in the books of account.
 it is an important way of dealing with uncertainty and protecting the interests of creditors against an
unwanted distribution of firm’s assets.
 Valuing stock at cost or market price whichever is lower, providing for bad and doubtful debts are the
examples of the application of this principle.
 This principle tries to prevent window dressing (painting a better picture of the business when it actually
not)
 deliberate attempt to underestimate the value of assets should be discouraged as it will lead to hidden
profits, called secret reserves

12.MATERIALITY
 Accounting statements should disclose all items, which are material enough to affect evaluations or
decisions.
 Only those transactions, which are significant from the point of view of income determination, should be
recorded.
 The materiality of a fact depends on its nature and the amount involved. Any fact would be considered as
material if it is reasonably believed that its knowledge would influence the decision of informed user of
financial statements.
 Insignificant matters can be ignored.
 Eg: money spent on creation of additional capacity of a theatre would be a material fact as it is going to
increase the future earning capacity of the enterprise. Similarly information about any change in the
method of depreciation adopted or any liability which is likely to arise in the near future would be
significant information.
 when the amount involved is very small, strict adherence to accounting principles is not required. For
example, stock of erasers, pencils, scales, etc. are not shown as assets but recorded as an expense.

13. VERIFIABLE OBJECTIVE PRINCIPLE

 The concept of objectivity requires that accounting transaction should be recorded in an objective
manner, free from the bias of accountants and others.
 All accounting transactions should be supported and evidenced by business
 documents (like voucher, cash memos, invoices etc.,)
 Such documents help in conducting audit.
 This principle also states that accounting should be free from personal bias of the person who is recording
the transactions.
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