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Accounting Concepts

Accounting concepts define the assumptions on the basis of which the financial statements of a business entity are prepared.

The following are the important Accounting concepts:

  • Separate entity concept: According to this concept, a business is treated as a separate entity and is distinct from its owner(s). In other words, the owner of the business is always considered as distinct and separate from the business he owns. While recording transaction a distinction has to be made between personal transactions and business transactions and transaction have to be recorded from business point of view and never from the view point of owners. The concept of separate entity is applicable to all forms of business organizations.

Example: When a proprietor introduces capital in his own business, the capital is considered as liability from business point of view. Similarly, when he withdraws any money for personal use it is treated as reduction in liability of business. 


Note : In case of a proprietary concern, though the sole proprietor is not considered separate from his own entity in the eyes of law, for the purpose of accounting, they are to be treated as separate from each other.

Money Measurement Concept

According to this concept, only those transactions which are capable of being expressed in terms of money are included in the accounting records. In other words, the information which cannot be expressed in terms of money is not included in the books of accounts though they may be very useful to the business. For example, non monetary events like appointment of an employee, retirement of an accountant etc., are also material events but since it cannot be expressed in terms of money, they cannot be recorded. To make accounting records relevant, simple and understandable for the users, the different transactions expressed in different units are brought to a common unit of measurement i.e., money.


Note : Separate entity and money measurement concepts are considered as basic concepts.

Going Concern Concept

It is also known as assumption of continuity. It is assumed that the enterprise has neither the intention nor the necessity to wind up the business in the foreseeable future. The financial statements are normally prepared on the assumption that an enterprise will continue to operate for a longer period in future. The valuation of assets of a business entity is dependent on this assumption and are recorded at their cost price and the market price or the realizable value of asset is not at all considered as the asset is meant for continuous use in business and not for selling them at profit. Without this concept, the classification of current and fixed assets and short and long term liabilities cannot be made and such classification would be difficult to justify.

Periodicity Concept

According to going concern concept, the business is intended to continue indefinitely for a long period, the true results of business operations can be ascertained only when the business is wound up. But the ascertainment of profit or loss and financial position of the business on liquidation will not be helpful to various users of accounting information in knowing the periodical progress or performance of the business. Hence, the economic life of an enterprise is artificially split into periodical intervals which are termed as accounting periods.


At the end of each accounting period, financial statements are prepared to show the performance and the position of the business. Usually, an accounting period will be of 12 months, of either calendar year ending 31st December every year or financial year ending 31st March every year. However, it may also be 3 months, 6 months or 9 months. This is also known as periodicity assumption or time period assumption.

This assumption helps in

  • Comparing the financial statements of different periods
  • Uniform and consistent accounting treatment for ascertaining the profit and net assets of the business
  • Matching periodic revenues with expenses for getting the correct results of the business operations

Cost Concept

According to this concept, the asset acquired by a business concern in recorded in the books of accounts at cost or purchase price. The cost price includes cost of acquisition, transportation, installation and any other cost incurred in making the asset ready for use.

The cost concept is historical in nature as it is something, which has been paid on the date of acquisition and does not change year after year. However, the cost concept does not mean that the assets will always be shown at cost, but cost is systematically reduced from year to year by charging depreciation on account of its wear and tear or passage of time.

Note : An important limitation of historical cost basis is that it does not show the true worth of the business and may lead to hidden profit.

Realization Concept (Revenue Recognition Concept)

Generally, revenue is earned from the sale of goods or by providing the services to the customer. According to this concept, revenue is recognized only when a sale is made. Sale is considered to be complete only when the property of the goods passes to the buyer and he becomes legally liable to pay for the same. This concept does not relate with the receipt of cash, so when the order is received from the customer it does not mean that revenue is realized or earned even if the advance payment is received from the customer.


Example: If the firm gets an order for goods on 1st March, Supplies on 10th March and receives the payment on 10th April, the revenue is deemed to have been earned on 10th March, as the ownership of the goods was transferred on that day.


Note: Revenue in case of incomes such as rent, interest, commission, etc., is recognized on a time basis. For Example, rent for the month of March 2014, even if received in April 2014 will be treated as revenue for the financial year March 2014.

Exception to the Rrule of Revenue Recognition Concept

  • In case of sale on installment basis, the amount collected in installment is treated as realized
  • In case of long term construction projects, the proportionate part of revenue which is equal to part of contract completed by end of the year is recognized and realized
  • Dual aspect concept: This is the basic concept of accounting according to which every business transaction has a dual effect. As the name implies, the entry made for each transaction is composed of two parts - one for the debit and the other for the credit. Every debit has an equal amount of credit. So the total of all debits must be equal to the total of all credits. This gives the basic accounting equation:
    Assets = Liabilities + Capital
    Capital = Assets - Liabilities
    So, we can compute that
  • increase in an asset is accompanied by decrease in another asset or increase in liability
  • decrease in an asset is accompanied by increase in another asset or decrease in liability
  • increase in liability is accompanied by decrease in another liability or increase in asset
  • decrease in liability is accompanied by increase in another liability or decrease in asset

Example: Mr. Vincent sold goods for cash ₹ 2,000. The two aspects will be, receipt of cash of ₹ 2,000 and decreasing of goods ₹ 2,000

  • Accrual concept: According to accrual concept, all revenues and costs are recognized as they are earned or incurred and not as money is received or paid. Revenue is the gross inflow of cash, receivables and other considerations arising in course of ordinary activities of the enterprise. Expenses are a cost relating to the operations of an accounting period or to the revenue earned during the period, or the benefits of which do not extend beyond that period. As per this concept, any expenses incurred but not paid in the particular period or income earned but received in the particular period should be recorded as expenses and income for that period only. Also any income received but not earned in the current period i.e. payment towards product or services to be rendered in next accounting period or expenses paid in advance for product or services to be received in next accounting period should not be included in the current period.
  • Matching concept: The term ‘matching’ means appropriate association of related revenues and expenses. In determining the net profit from business, amount of profit earned or the loss incurred during a particular period involves deduction of related expenses from the revenue earned during that period. The matching concept emphasizes exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that period.
    This concept is fundamentally based on the accrual concept since it disregards the timing and amount of actual cash flow and concentrates on the occurrence of revenues and expenses. 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.

Note: Accrual, matching and periodicity concepts work together for income measurement and recognition of assets and liabilities.

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