BASIC ACCOUNTING CONCEPTS

BASIC  ACCOUNTING  CONCEPTS

     Accounting  is based on certain assumptions.  These assumptions are known as basic  accounting  concepts. Those basic accounting concepts are as follows.

• Business entity concept : This concept states that the business and its owners are two separate and  distinct  entities. According to this concept, all transactions of the business have to be accounted for from the viewpoint of the business and not from the view point of its owners. The distinction between the business  and its owners is essential in order to ascertain the true picture  of a business.  If the two are not  separated for accounting purposes, the transactions of the busiess will be mixed up with the personal  transactions of its owners  and the true picture of the business can not obtained.

• Going  concern concept : This concept implies that a business has an indefinite life and it exists for a long period of  time. All business tranactions are performed and recorded from this point of view. The long- term expenditures such as the purchase of land, building and  machinery that the business makes are recorded  in books of  account assuming  that  it will exist and run for a long period  of time.  Their  costs and not the current resale values are recorded spreading over their estimated working  lives. Therefore, the balance sheet always shows fixed assets at cost after subtracting the depreciation.

• Money measurement concept :  This concept assumes that only those business tranactions which are measured and expressed in monetary terms have to be taken into account. It is so assumed  because money provides a common measure for different goods, services, assets and  liabilities. This concept also assumes that  monetary units such as 'rupee' are stable units in value , but this assumption may not be  true in reality. Therefore, in spite of a decrease in the purchasing power of money, accounting  is performed assuming that the value of money is stable over time.

• Accounting period concept : The accounting period concept implies that for the purpose of reporting financial information, the whole life of the  business is divided into imaginary  time- intervals. Each time interval is called  an accounting period which is normally  of one year. In Nepal, it begins on the 1st of Shrawn  every year and ends  on the last day of Asad the next year. At the end of each accounting  year, financial statements are drawn to ascertain the  profit  or loss and the financial position of the  business, and are reported  to their users such as owners, managers and creditors.

• Revenue concept-This concept is also called realization concept. The concept states that revenue is assumed  to be earned when it is realized . According to the concept, revenue is realized when goods  are transferred to the buyers  and services are provided to the clients for  cash, or for assets or in  anticipation of  realizing the value of sales on a future date. It is not  necessary that the revenue must be realized in cash.  Besides , revenue is  earned in the period when it is realized. However, revenue  realized is always net  of goods returned from the customer  and bad debts.

• Cost concept :  This concept implies that the cost of anything  such as a service or an asset is recognised when it is incurred and not when cash  is paid for it.  According to the concept, the  cost is assumed to be incurred when the service or the asset is used to generate  revenue .  Besides, the concept assumes that  the asset is taken into account at the cost of its purchase and not at its market value. This concept , however does not mean that the cost of purchase appears in the books every year. Since an asset  has a limited life, its cost  is written  off every year over its life. Thus, the books show the asset at the purchasing  cost less its depreciation up- to- date.

• Matching concept: This concept provides guidelines as to how the profit or loss of a business should be determined. The  concept , therefore, states that  revenue earned in a period has to be matched with  the expenses incurred  in the same period so as to find  out the true  profit or loss  of the business. While matching the expenses with the revenue , the latter should be realized first and then only the expenses  relating to the revenue should be recognized . Any expense or revenue of the previous  or the next year  should not be matched with those of this  year. If they are matched, the true profit or loss can not be  ascertained.