ACCOUNTING CONCEPTS

1.

Separate Entity Concept

Examples
1.

A Certified Public Accountant has 3 rooms in a house he has rented for Rs. 3,000 per month. He has setup a singlemember accounting practice and uses one room for the purpose. Under the SEPARATE ENTITY CONCEPT, only 1/3rd of the
rent or Rs. 1,000 should be charged to business, because the other 2 rooms or Rs. 2,000 worth of rent is expended for personal
purposes.

2.

The Certified Public Accountant received Rs. 900 bill for utilities. He paid the whole amount using his business account.
According to SEPARATE ENTITY CONCEPT Rs. 600 is to be considered a withdrawal because only Rs. 300 (1/3rd) related to
business and the other Rs. 600 was for domestic purpose.

2.

Going Concern Concept

Examples
1.

An oil and gas firm operating in Nigeria is stopped by a Nigerian court from carrying out operations in Nigeria. The firm is
not a GOING CONCERN in Nigeria, because it has to shut down.

2.

A nationalized refinery is in cash flows problems but the government of the country provided a guarantee to the refinery to
help it out with all payments, the refinery is a GOING CONCERN despite poor financial position.

3.

A bank is in serious financial troubles and the government is not willing to bail it out. The Board of Directors has passed a
resolution to liquidate the business. The bank is not a GOING CONCERN.

4.

A merchandising company has a current ratio below 0.5. A creditor $1,000,000 demanded payment which the company
could not make. The creditor requested the court to liquidate the business and recover his debts and the court grants the order.
The company is no longer a GOING CONCERN.

3.

Accounting period

Examples

1.

Prime Ltd. borrowed an amount of Rs. 1.2 million from a private bank on 1 st August 2013 for a period of 1
year. The loan matured on 30th July 2014 and the loan was payed on the due date with an interest of 12%.
According to ACCOUNTING PERIOD concept the transaction will be recorded in two accounting period
1st Financial year- outstanding payment of 8 months due.
2nd Financial year- Total payment of interest-Previous 8 months.

2. ABC Ltd. Company received the payment, of goods sold in the month of March 2006, in April 2006. The
payment of March 2006, even if received in April 2006 will be treated as the revenue of the financial year

As per accounting period concept, all the transactions are

recorded in the books of accounts for a specified period of time. Hence, goods
ending March 31,2006. Because

purchased and sold during the period, rent, salaries etc. paid for the period are
accounted for and against that period only.

4.

Money Measurement

Examples
1.

The company's property, plant and equipment on 2009 balance sheet amounted to $2 billion. During 2010 inflation was
10%. The monetary unit and stable dollar assumption prohibits any adjustment to current or prior period figures to account for
the inflation.

2.

The BP oil spill in Gulf of Mexico was a natural disaster but accounting only reports the financial impact in the form of
claims paid, damages paid, cleanup costs, etc. This is due to the limitation imposed by the MONEY MEASUREMENT
CONCEPT.

5.

Dual Aspect

Examples
1.

Suppose that Mr. A starts a business with a capital of Rs.IO,OOO. There are two changes. first the business has cash
(asset) of Rs.1 0.000 and second, the business has to pay to the proprietor a sum of RS.I 0,000 which is taken as
proprietors capital. This expression can be shown in the form of following equation:
Cash (Assets) Rs. 10,000
follows:
Subsequently if the business borrows Rs.15000
Capital (Equities) Rs.IO,OOO.
from a bank, the new position would be as
Assets = Equities
Cash Rs.1 0,000 + Bank Rs. I 5000 = Bank loan Rs.15000 + Capital Rs.1 0,000.
The term accounting equation is also used to denote the relationship of equities to assets. The equation can be
technically, stated as for every debit, there is an equivalent credit.

2.

Manish, the proprietor of the business, starts his business with Cash
Rs.40,000 and Building Rs.50,000 then this fact is recorded at two places : Assets account and
Capital account. The capital of the business is equal to the assets of the business. This expression
can be shown in the form of equation as under :
Capital = Assets
Manish = Building + Cash
Rs.90,000 = Rs.50,000+Rs.40,000
If the business increases the assets by borrowing Rs.20,000, then the dual aspect of the
transaction affects the equation as under

6.

Matching

Examples
1.

$2,000,000 worth of sales are made in 2010. Total purchases of inventory were $1,000,000 of which $100,000 remained
on hand at the end of 2010. The cost of earnings is $2,000,000 revenue is $900,000 [$1,000,000 minus $100,000] and this
should be recognized in 2010 thereby yielding a gross profit of $1,100,000.

2.

A hospital pays $20,000 per month to 5 of its doctors. Monthly sales are $500,000. $100,000 worth of monthly salaries
should be matched with $500,000 of revenue generated.

7.

Accrual Concept

Examples:
1.

An airline sells its tickets days or even weeks before the flight is made, but it does not record the payments as revenue
because the flight, the event on which the revenue is based has not occurred yet.

2.

An accounting firm obtained its office on rent and paid $120,000 on January 1. It does not record the payment as
an expense because the building is not yet used. While preparing its quarterly report on March 31, the firm expensed out three
months' rent i.e. 30,00 [$120,000/12*3] because 3 months equivalent of time has expired.

3.

A business records its utility bills as soon as it receives them and not when they are paid, because the service has already
been used. The company ignored the date when the payment will be made.

8.

Cost concept

Examples
1.

100 units of an item were purchased one month back for $10 per unit. The price today is $11 per unit. The inventory shall
appear on balance sheet at $1,000 and not at $1,100.

2.

The company built its ERP in 2008 at a cost of $40 million. In 2010 it is estimated that the present value of the future
benefits attributable to the ERP is $1 billion. The ERP shall stand on balance sheet at its historical costs less accumulated
depreciation.

ACCOUNTING CONVENTIONS
1. CONVENTION OF PRUDENCE OR CONSERVATISM
Examples
1. ABC Jeweller purchased 1kg of gold during the year 2013, at the rate of Rs.
18,000/10gms. At the end of the year half of the gold remains unsold. The current market
price of the gold is Rs. 21,000/10gms. According to the CONVENTION OF PRUDENCE
OR CONSERVATISM this transaction would be recorded at the Cost Price and if the
current market price of the gold is Rs. 17,000/10gms then it will be recorded at the
Market Price. Thus , according to this principle we record our transactions at cost price or
market price whichever is lower so that all anticipated losses are be recorded in the
books of accounts, but all anticipated gains are ignored.
2. Sun Pharma Ltd. is facing a court case under which it may be liable to pay Rs. 5 lakhs to
one of its dealers. The legal advisor thinks that there is a high possibility for the company
to loose this case. According to the CONVENTION OF PRUDENCE OR
CONSERVATISM the should make the provision for payment of Compensation as
contingency is going to arise in future.

2. Materiality Concept
Examples

a. Company A is a big company having net assets worth $10 million . Mr. A is a
defaulter who owes company $1000. According to MATERRIALITY CONCEPT a
default by a customer who owes only %1000 to a company having net assets of
worth $10 million is immaterial to the financial statements of the company.

b. A small company bookkeeper doesn't do a very good job of keeping track of expenses.
Most random expenses get recorded in the miscellaneous expense account. At the end
of the year the miscellaneous expense account has a total of $1424.25 in it. The total net
income of the company is $36,940. According to MATERIALITY CONCEPT the
miscellaneous account is immaterial to the overall financial picture of the company and
there is no need to reclassify the expenses in it.
c. A large company has a building in the hurricane zone during Hurricane Sandy. The
company building is destroyed and after a lengthy battle with the insurance company, the
company reports an extra ordinary loss of $10,000. The company has net income of
$10,000,000. The materiality concept states that this gain is immaterial because the
average financial statement user would not be concerned with something that is only 1%
of net income.

3. Consistency Concept
Examples
1.

Company A has been using declining balance depreciation method for its IT equipment. According to consistency concept
it should continue to use declining balance depreciation method in respect of its IT equipment in the following periods. If the
company wants to change it to another depreciation method, say for example the straight line method, it must provide in its
financial report, the reason(s) for the change, the nature of the change and the effects of the change on items such as
accumulated depreciation.

2.

Company B is a retailer dealing in shoes. It used first-in-first-out method of inventory valuation in respect of shoes at
Branch X and weighted average inventory valuation method in respect of similar shoes at Branch Y. Here, the auditors must
investigate whether there are any valid reasons for the different treatment of similar inventory located at different locations. If
not, they must direct the company to use any one of the valuation method uniformly for the whole class of inventory.

4. Substance Over Form

Examples
1.

A lease might not transfer ownership to the leasee but the leasee has to record the leased items as an asset if it intends to
use it for major portion of its useful life or where the present value of lease payment is fairly equal to the fair value of the asset,
etc. Although legally the leasee is not the owner, so the leased item is not his asset, but from the perspective of the underlying
economics the leasee is entitled to the benefits embedded in the use of the item and hence it has to be recorded as an asset.

2.

A company is short of cash, so it sells its machinery to the bank and obtains it back on a lease. It is called sale and
leaseback. Although the legal ownership has transferred but the underlying economics remain the same and hence under the
substance over form principle the sale and subsequent leaseback are considered one transaction.

3.

If two companies swap their inventories they will not be allowed to record sales because not sales has occurred even if
they have entered into valid enforceable contracts.