In order to maintain uniformity and consistency in books of accounts, certain rules or principles have been evolved which are generally accepted by the accounting profession. These rules are known by different names such as principles, concepts, conventions, postulates, assumptions and modifying principles.
The concept of materiality requires that in accounting we should focus on material facts. Efforts should not be wasted in recording and presenting those facts, which are immaterial in the determination of income of the business.
Nature and the amount involved in a fact determines its materiality. We consider any fact as material if its knowledge will influence the decision of informed user of financial statements.
For example:- expenses incurred on creation of additional capacity of a theatre would be a material fact as it is going to increase the future earning revenue of the enterprise.
The financial statements and the accompanying notes shall disclose the appropriate information about material facts. When the amount involved is very small, strict adherence to accounting principles is not necessary.
For example, we do not show stationery items etc. are as assets. Purchase of Stationery in an accounting period is an expense of that period, whether we consume it or not.
Learn more about Trial Balance and Errors here in detail.
As per this principle, accounting information should allow comparisons over a period of time as well as with the working of other enterprises.
Thus, we need to make both inter-firm and inter-period comparisons. This is possible only when the entity follows uniform and consistent accounting policies and practices over the period of time.
For example, an investor wants to evaluate the financial performance of a firm in the current year as compared to that in the previous year.
He may compare this year’s net profit with that in the previous year. But, if the accounting policies followed, say with respect to depreciation in the two years are different, the net profit will not be comparable.
Because the method followed for the valuation of stock in the last two years is inconsistent. It is important to adopt the concept of consistency in the preparation of financial statements so that the results of the two accounting periods are comparable.
The concept of conservatism also known as prudence. It provides guidance for recording transactions in the book of accounts and is based on the policy of playing safe.
The concept states that a conscious approach should be followed in ascertaining income so that profits of the entity are not overstated.
If the profits ascertained by an entity are more than the actual, they may lead to the distribution of dividend out of capital. It is not fair as it will lead to a reduction in the capital of the entity.
This concept requires that we shall not record the profits until we realize them. But in case of losses, we record them even if they have a remote possibility of occurrence.
For example, valuing closing stock at cost or market value whichever is lower, creating a provision for doubtful debts, discount on debtors, writing of intangible assets like goodwill, patents, etc.
Therefore, if the market value of the goods decreases, we shall show the stock at the market value in the books of accounts but if the market value increases, we shall not record the gain in books.
This approach of recording the losses but not recording the gains until we realize them is the conservatism approach.
As per this principle, every accounting transaction must be recorded in proper time. Generally, when the transaction occurs, the same must be recorded in the appropriate books of accounts. In short, we record a transaction in the books dates wise i.e in chronological order.
Unnecessary delay in recording of accounting transaction may lead to manipulation, misplacement of vouchers, misappropriation etc. of cash and goods.
This principle is adopted particularly while verifying day to day cash balance. The principle of timeliness is also followed by banking organizations, i.e. every banking organizations verifies the cash balance with their cash book and within the day, the same must be completed.
As there are different types of industries, each type of industry has its own characteristics and features. There may be seasonal industries or non-seasonal industries.
Every industry adopts the principles and assumption of accounting to perform its own activities. Some industries adopt the principles, concepts, and conventions in a modified way.
The accounting practice which has always prevailed in the industry should be followed by the same types of industries. e.g., Electric supply companies, Insurance companies maintain their accounts in a specified manner.
Insurance companies prepare Revenue Account just to ascertain the profit/loss of the insurance company and not Profit and Loss Account. Similarly, non-trading organizations prepare Income and Expenditure Account to ascertain the Surplus or Deficit.
Solved Example for You
Fill in the correct word:
- We should focus on material fact in accounting is called _______________concept.
- The accounting concept that refers to that a conscious approach should be followed in ascertaining income of the entity is known as _______________.
- Every accounting transaction must be recorded in the books of accounting at the proper time i.e. when they occur. This concept is known as _______________.
- The _______________concept requires that the same accounting policies and methods should be used from one accounting period to the next.
- As per _______________ concept, The accounting practice which has always prevailed in the industry should be followed by the same types of industries.
- Materiality 2. Conservatism 3. Timeliness
- Consistency 5. Industry practice.