Learning objectives -
After studying this chapter, students will be able to :
Accounting principles, concepts and conventions are known as Generally Accepted Accounting Principles (GAAP). These principles are the base of Accounting.
Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity and consistency in the preparation and the presentation of financial statements.
Fundamental Accounting Assumptions :
1. Going Concern Assumption :
This concept assumes that an enterprise has an indefinite life or existence. It means that the intentions of the business are to continue for sufficiently longer period of time. It will not be dissolved or liquidated in the immediate future. If a machinery purchased is expected to last (to be used for) next 10 year, then the cost of machinery will be spread over the next 10 year for calculating net profit or loss of each year (Dep. Charged.)
The full cost of the machine would not be treated as expense in the year of purchase itself.
Market value of the asset is irrelevant and is not recorded in the balance sheet, as these assets are not going to be sold in the near future.
Relevance :
(a) Distinction is made between a capital expenditure and revenue expenditure.
(b) Classification of assets and liabilities into short term and long term respectively.
(c) Depreciation charged on fixed assets or fixed assets appears in the balance Sheet at book value, without having reference to their market value.
2. Consistency Assumption :
(a) It implies that accounting practices once selected and adopted, should be applied consistently year after year.
(b) Same Accounting practices will be followed for similar items year after year. This will ensure a meaningful study of the performance of the business for a number of years.(c) When the accounting principles and practices are uniformly/consistently followed from year to year that the result obtained will be comparable.
Consistency assumption does not mean that particular practices once adopted cannot be changed. The only requirement is that when a change is desirable, it should be fully disclosed in the financial statements along with its effect on income statement and financial position (Balance Sheet) of the year in which that change is made
This assumption is important when alternative accounting practices are eqally acceptable. E.g. two methods of charging depreciation, written down value method and Straight line method are equally acceptable. If a firm adopts one method in the previous year and the other method in next year, the result will not be comparable.
3. Accrual Assumption : Accrual concept applies equally to revenue and expenses.
As per this assumption, revenue is recognized when it is accrued/ earned, that is, when sale is complete or services are rendered. It is immaterial, whether the cash is received or not. E.g. if a credit sale for ϕ 15,000 of two month is made on 15th Feb. 2011, then the revenue earned is to be recorded on 15th Feb. 2011 not on the date of cash realized, i.e, after two months.
Similarly, expenses are recognized in the accounting period in which they facilitate in earning the revenues, whether the cash is paid for them or not. E.g. if at the end of year the two month salary is due but not paid. Then the expenses of salary will be recorded in the current year in which salary is due, not in the next year in which it will be paid.
Relevance : Earning of a revenue and consumption of a resource (expenses) can be accurately matched to a particular accounting period
CBSE Accountancy Class XI ( By Mr. Aniruddh Maheshwari )
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