What are the basic principle of accounting?

What are the basic principle of Accounting?

1. Convention of Conservatism

All we know that the world of uncertainty. So, it is always better to follow the policy of playing safe.

Also, this is the principle behind the convention of conservatism. According to this convention the accountant must be very careful while recognizing increases in the enterprises profits rather than recognizing decrease in profits you would say that why we need to do that because the accountants have to follow the rule anticipate no profit but provide for all possible losses while recording business Transactions.

This convention said that the inventory is valued at cost or market price which ever less we can understand by following example:-

  • When the market price of the inventories has below down its cost price it is shown at market price
  • The possible loss is provided and when it is above the cost price it is shown at the cost price
  • It is for the same reason that provision for bad and doubtful debts, provision for fluctuation in investments, etc., are created.

This Convention of Conservatism concept affects principally the current assets. The main function of accounting is to provide correct and full information about the business enterprise.

But this function affects by the convention of conservatism for the reason of being this is pointed out by the critics. They argue that it encourages the accountant to build secret reserves by resorting to excess provision for bad and doubtful debt etc. by the reason of that not only the income is affected but also the financial state of affairs of the business. Furthermore, it is also against the convention of full disclosure

2. Convention of Full disclosure:

The newly forms of joint stock company of business organisation resulted in the separation of ownership and management. This should have the necessary the full disclosure of accounting information should be honestly prepared about the enterprise or to the owners and various other interested parties. For the reason of being it became the ‘convention of full disclosure’ is very important.

As per this convention the accounts must be honestly prepared and all material information must be adequately disclosed therein. But it does not mean that all information that someone desires are to be disclosed in the financial statements. It only implies that there should be adequate disclosure of information which is of considerable importance to owners, investors, creditors, Government etc.

As per the Sachar committee Report (1978) it has been emphasized that openness in Company affairs is the best way to secure responsible behavior.

As per this convention that Companies Act, Banking Companies Regulation Act, Insurance Act etc. have prescribed performance of financial statements to enable the concerned companies to disclose sufficient information. The practice of appending notes relative to various facts on items which has not shown in financial statements which should be shown as by following example: –

  • Contingent liabilities appearing as note.
  • Market value of investment appearing as a note.
  • Schedule of advances in case of banking companies.

3. Convention of Consistency:

According to this concept it is important that accounting procedures, practices and method should remain unchanged from one accounting period to another. For example,

  • If material issues are priced on the basis of FIFO method the same basis should be followed year after year.
  • Similarly, if depreciation is charged on fixed assets according to diminishing balance method it should be follow as subsequent year also.
  • However, if Introduction of a new technique result in up or down the figures or profit as compared with the previous periods, the fact should be well disclosed in the financial statement.

4. Convention of Materiality

As per this convention is that accountant should have to attach importance to material details and ignore insignificant details. If we could not follow this convention the accounting will overburdened by unnecessarily things.Now question has arisen that what is materials details and what is not this question should be discretion of individual accountant.

According to American Accounting Association

“An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.”

I have given some example for your kind reference:-

  • A company purchased 6 months supplies of stationary with the amount 600/- INR and question is should the company spread the cost of this stationary for 6 months by expensing off 100/- INR per month in the income statement, so as per this concept as the amount is so small or immaterial, it can be expensed off in the next month instead of tediously expensing it in the next 6 months.
  • Fall in the value of stock, loss of markets due to competition, change in the demand pattern due to change in Government regulations etc.
  • Ignoring of paise while preparing company financial statement rounding of income to nearest ten for tax purposes etc.

So, we have above discussed about Principles of Accounting which is also called Accounting Conventions.

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Happy Reading!!😊

Nadeem Khan, M.Com, M.B.A

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