Introduction
The theory base of accounting provides a foundation of principles, concepts, and guidelines that bring uniformity and consistency to financial reporting. These are essential for producing reliable and comparable financial statements.
1. Generally Accepted Accounting Principles (GAAP)
- GAAP are rules and guidelines for recording and reporting business transactions.
- They ensure uniformity in preparing financial statements.
- GAAP includes principles, concepts, conventions, and postulates which have evolved over time.
2. Basic Accounting Concepts
Business Entity Concept
- The business is treated as a separate entity from its owners.
- All transactions are recorded from the business’s perspective, not the owner’s.
Money Measurement Concept
- Only transactions that can be expressed in monetary terms are recorded.
- Non-monetary factors like the quality of management or employee skill are not recorded.
Going Concern Concept
- Assumes that a business will continue its operations indefinitely and not liquidate in the near future.
- Asset values are spread over time to match their usage, reflecting this assumption.
Accounting Period Concept
- Financial results are reported at regular intervals, typically annually.
- This allows timely decision-making and comparison of financial performance over time.
Cost Concept
- Assets are recorded at their historical cost, i.e., the price paid for them, not their current market value.
- While objective, this method can lead to undervaluing assets over time.
Dual Aspect Concept
- Every transaction has a dual effect, affecting at least two accounts (e.g., increasing assets and increasing liabilities).
- Expressed as the Accounting Equation:
Assets = Liabilities + Capital
Revenue Recognition (Realisation) Concept
- Revenue is recorded when a legal right to receive it arises, not when cash is actually received (e.g., on credit sales).
Matching Concept
- Expenses must be matched with the revenues they helped generate within the same accounting period.
- This ensures a clear picture of profit and loss.
Full Disclosure Concept
- Financial statements must disclose all material and relevant facts for decision-making.
- Transparency is key, allowing users to assess the company's true financial health.
Consistency Concept
- Uniform accounting policies should be followed from period to period to ensure comparability.
- Changes in policies must be disclosed.
Conservatism (Prudence) Concept
- Anticipate and record all potential losses but do not recognize unrealized gains until they are certain.
- This ensures that profits are not overstated.
Materiality Concept
- Only material facts that can influence decision-making should be recorded.
- Insignificant items (e.g., stationery) can be treated as expenses instead of assets.
Objectivity Concept
- Transactions should be recorded based on verifiable evidence (e.g., receipts, invoices), ensuring unbiased and factual reporting.
3. Systems of Accounting
- Double Entry System: Every transaction has a dual effect on at least two accounts (e.g., debit and credit).
- Single Entry System: Incomplete method where only personal accounts and cash transactions are recorded. It is less reliable.
4. Basis of Accounting
- Cash Basis: Transactions are recorded only when cash is received or paid.
- Accrual Basis: Transactions are recorded when they occur, regardless of when cash is exchanged. This method is preferred for its accuracy in matching revenues and expenses.
5. Accounting Standards
- Issued by the Institute of Chartered Accountants of India (ICAI) to ensure uniformity and comparability of financial statements.
- Benefits: Eliminate variations, enhance transparency, and improve reliability.
- Limitations: May lack flexibility and cannot override legal provisions.
6. Goods and Services Tax (GST)
- GST is a destination-based tax levied on consumption. It replaced multiple indirect taxes and is applicable at all stages of the supply chain.
- Components:
- CGST: Central Goods and Services Tax.
- SGST: State Goods and Services Tax.
- IGST: Integrated Goods and Services Tax, applicable for inter-state transactions.
Key Terms in Accounting Concepts
- Business Entity: Separation between owner and business.
- Money Measurement: Record only transactions measurable in monetary terms.
- Going Concern: Business will continue indefinitely.
- Cost Concept: Record assets at their purchase price.
- Dual Aspect: Every transaction affects two accounts.
- Revenue Recognition: Recognize revenue when the right to receive it arises.
- Matching: Match expenses with revenues in the same period.
- Full Disclosure: Provide all relevant and material information.
- Consistency: Uniform policies for comparability.
- Conservatism: Anticipate losses but ignore unrealized gains.
- Materiality: Record only significant financial information.
- Objectivity: Transactions should be free from bias, based on verifiable evidence.
Advantages of GST
- Abolishes multiple taxes.
- Simplifies compliance and increases tax base.
- Promotes manufacturing and exports by reducing production costs.
This document builds a strong foundation for understanding accounting principles and standards, ensuring uniformity, comparability, and reliability in financial reporting. Let me know if you need specific sections to be expanded or additional explanations!