The accrual concept makes a distinction between the receipt of cash and the right to receive it, and the payment of cash and the legal obligation to pay it. In actual business operations, the obligation to pay and the actual movement of cash may not coincide. The accrual concept recognises this distinction. In connection with the sale of goods, revenue may be received
(i) before the right to receive arises, or (ii) after the right to receive has been created.
The accrual concept provides guidelines to the accountant as to how he should treat the cash receipt and the rights related thereto. In the former case, the receipt will not be recognised as the revenue of the period for the reason that the right to receive the same has not yet arisen. In the latter case, the revenue will be recognised, even though the amount is received in the subsequent period.
Similar treatment would be given to expenses incurred by the firm. Cash payments for expenses may be made before or after they are due for payment. Only those sums, that are due and payable, will be treated as expenses. If a payment is made in advance (i.e. does not belong to the accounting period in question) it will not be treated as an expense, and the person who received the cash will be treated as a debtor until his right to receive the cash has matured. Where an expense has been incurred during the accounting period but no payment has been made, the expense must be recorded and the person to whom the payment should have been made is shown as a creditor.
The following are the essential features of this concept:
• Revenue, is recognised as it is earned.
• Costs are matched against revenues on the basis of relevant time period to determine periodic income.
• Costs, that are not charged to income, are carried forward and are kept under continuous review.
Any cost, that appears to have lost its utility or its power to generate future revenue, is written off as a loss.
8.8 SUMMARY
Accounting records the financial transactions in terms of money. Accountancy follows a set of concepts, conventions and principles. The two systems of recording entries in books of account are the single entry system and the double entry system of bookkeeping. The methods of accounting, that may be adopted for preparing the financial statements, are cash, mercantile and, hybrid system of accounting.
Accounting is a system evolved to achieve a set of objectives. In order to achieve these objectives, a systematic record of all business transactions is maintained for the interested parties. There are certain
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rules and regulations that are used as guidelines to prepare, maintain and record all business transactions in the form of accounting books. These rules and conventions are known as 'Generally Accepted Accounting Principles' or "Basic Accounting Concepts'. The concepts, can be classified into two broad groups as follows:
(a) Concepts, to be observed at the recording stage.
(b) Concepts, to be observed at the reporting stage.
(a) Concepts to be observed at the recording stage: The concepts that guide us in identifying, measuring and recording the transactions are:
(b) Concepts to be observed at the reporting stage: The following concepts have to be kept in mind while preparing the final accounts:
Consistency Concept: It envisages that the accounting information should be prepared on a consistent basis from period to period, and within the periods, there should be a consistent treatment of similar items.
Conservatism Concept: It forbids the inclusion of unrealised gains but advocates the provision for possible losses.
Business Entity: This concept separates the business from owner(s), from the standpoint of account.
Dual Aspect Concept: means that each transaction in accounts has two aspects which are expressed as 'Debit' and 'Credit' and are recorded in books of account accordingly.
Money Measurement Concept: It records only those transactions that can be recorded in monetary terms.
Cost Concept: means that the transactions are recorded at the amounts involved while the assets are always recorded at cost.
Objective Evidence Concept: It states that all transactions recorded in the books of account should be evident and supported by objective documentary evidence.
Historic Record Concept: It states that transactions are to be recorded in the books of account as and when they take place, i.e. in a chronological manner, date wise.
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Going Concern Concept: It refers to the expectation that the organisation will have indefinite life.
This assumption has an important bearing on how the assets are to be valued.
Materiality Concept: This concept admonishes that events of relatively small importance need not be given a detailed or a theoretically correct treatment. They may be ignored for a separate recording.
Disclosure: A good accounting practice that demands that all significant accounting practices and policies followed in the preparation of accounts and financial statements should be disclosed along with any other significant information materially affecting the preparation of financial statements.
Single Entry System: An incomplete or partial system of recording transactions. Under this system, only the cash book or the bank book may be maintained, on the basis of which the financial statements are prepared.
Double Entry System: A scientific system in which the business transactions are recorded in books of account in two accounts, one account is debited and the other is credited.
8.10 TERMINAL QUESTIONS
1. Examine the role of accounting concepts in the preparation of financial statements.
2. Explain and list the accounting concepts.
3. Enumerate the 'Basic Accounting Concepts".
4. Write a note on 'Double Entry System'.
5. Explain and list the accounting conventions.
6. Explain the two systems of recording transactions in the books of account.
7. Do you find any of the accounting concepts conflicting with each other? Give examples.
8. Answer whether the following statements are True or False:
(a) The materiality concept refers to the state of ignoring small items and values from accounts.
(b) The generally accepted accounting principles prescribe a uniform accounting practice.
(c) The conservatism concept leads to the exclusion of all unrealised profits.
9. Name the accounting concept that is violated in any of the following situations:
(a) Rs. 1,00.000 figure for inventory in a balance sheet, is the amount for which it could be sold on the balance sheet date.
(b) The balance sheet of a retail store, which has experienced a gross profit of forty per cent on sales, contains an item of a merchandise inventory of Rs. 1,15,00,000: Merchandise inventory (at cost) Rs. 69,00,000.
(c) Company M does not charge annual depreciation, preferring instead to show the entire difference between the original cost and proceeds of sale as a gain or loss in the period when the asset is sold. It has followed this practice for many years.
10. Problems:
(a) A company revalues its buildings which were purchased at a cost of Rs. 5,00,000 in 1985 to Rs. 50,00,000 in 2003 and records the difference of Rs. 45,00,000 as profit for the year 2003.
Is the practice right?
(b) The accounting year of a firm closes on 31 December each year. The rent for business premises of Rs. 50,000 for the last quarter could not be paid to the owner because of his being away in a foreign country. Will the rent payable, be taken into account for computing the firm's income for the accounting year?
(c) A government contractor supplies stationery to various government offices. Some bills amounting to Rs. 10,000 were still pending with various offices at the close of the accounting
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year on 31 st March. Should the businessman take the revenue of Rs. 10,000 into account for computing the net profit of the period?
11. Accounting concepts are:
(a) Broad assumptions
(b) Methods of presenting financial accounts
(c) Bases selected to prepare a specific set of accounts (d) None of the above
12. For nominal accounts, the fundamental rule of debit and credit is, debit expenses and losses and credit
(a) The giver (b) What goes out (c) Incomes and gains (d) None of the above
13. In bookkeeping, is the Capital Account a real account?
(a) Yes (b) No
14. Where should a withdrawal of cash from business by the proprietor be credited?
(a) Drawings (b) Proprietor's A/c (c) Capital A/c (d) Cash A/c
15. In accordance with the going concern concept in accounting, a business is considered as having an indefinite life.
(a) Yes (b) No
16. What is a Nominal Account?
(a) An account of each person or firm with whom the trader deals (b) An account of each head of expense or source of income
(c) An account of each property or possession dealt in by the trader in his business (d) None of these
17. What is the fundamental rule of debit and credit with regard to assets or real accounts?
(a) Debit the receiver and credit the giver
(b) Debit what comes in and credit what goes out (c) Debit expenses and losses and credit gains (d) All the above
18. How do profits made from normal operations retained in business appear in the balance sheet?
(a) Under capital
(b) Under capital, reserves and surplus (c) Under cash in hand, at the bank (d) None of the above
19. Where does the net profit appear in the balance sheet?
(a) Liabilities side (b) Assets side (c) Either (a) or (b) (d) None of these
20. In double entry bookkeeping, entry is balanced with a corresponding __________ entry.
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21. The proprietor of a firm withdrew Rs. 50,000 for his personal use. This was shown as an expense of the firm. Profits were reduced to pay a lower tax. Is this right from accounting point of view?
22. Suppose the managing director of a company is killed in a plane crash. To the extent an organisation is the lengthened shadow of a man, the real value of the company will change immediately and this will be reflected in the market price of the company's shares. Will this have any effect as far as the accounts of the company are concerned?
23. A company had been charging depreciation on a machine at Rs. 20,000 per year for the first three years. Then it began charging Rs. 12,000 for the fourth year and Rs. 8,000 for fifth year and so on.
Is this practice justified? Give reasons for your answer.
24. Fill in the blanks:
(a) The proprietor has separate _________ from the business.
(b) Objective evidence means _________ evidence.
(c) Dual aspect concept means recording of _________ effects of a transaction.
(d) Business transactions are recorded at __________ cost.
(e) _________ is the common unit of measurement.
(f) The system of recording transactions based on dual aspect concept is called ______ . 25. Find out the two accounts involved in the following transactions:
(a) Purchased goods on credit from Ramesh Rs. 60,000.
(b) Paid rent to landlord Rs. 500.
(c) Received interest on Government Securities Rs. 400.
(d) Purchased a typewriter for Rs. 5,000.
(e) Proprietor paid Rs. 500 towards tuition fee on his son.
26. Complete the following accounting equations:
(a) Capital Rs. 40,000 + Liabilities Rs. 15,000 = Assets Rs. _____ . (b) Capital Rs. 65,000 + Liabilities Rs. ____ = Assets Rs. 80,000.
(c) Assets Rs. 90,000 - Liabilities Rs. ____ = Capital Rs. 50,000.
(d) Capital Rs. ____ + Liabilities Rs. 20,000 = Assets Rs. 90,000.