Accounting concepts and conventions

1. Concepts and conventions: the difference

Accounting concepts are the basic assumptions or postulates on which accounting is built — for instance, that the business is separate from its owner. Accounting conventions are customs and practices that have grown up through use and that guide how accounts are presented — for instance, that the same method should be followed year after year. Together they are called Generally Accepted Accounting Principles (GAAP). Concepts are the theory; conventions are the practice.

2. Accounting concepts

1. Business entity concept. The business is a unit separate from its owner. When Ravi brings Rs. 50,000 into his shop, the business owes him Rs. 50,000; that is why capital is shown as a liability. His household expenses paid from the shop are drawings, not business expenses.
2. Money measurement concept. Only what can be expressed in money is recorded. Ten machines and five vans cannot be added; Rs. 4,00,000 and Rs. 6,00,000 can. The morale of staff is not recorded at all.
3. Going concern concept. The business is assumed to continue for the foreseeable future and not to be wound up. Fixed assets are therefore shown at cost less depreciation, not at what they would fetch in a forced sale, and prepaid expenses are carried forward as assets.
4. Accounting period concept. The life of the business is divided into periods, usually a year (1 April to 31 March in India, which the Companies Act 2013 makes the financial year for companies), so that profit can be measured and taxes paid.
5. Cost concept. An asset is recorded at the price paid for it. Land bought for Rs. 10 lakh stays at Rs. 10 lakh even if its market value doubles.
6. Dual aspect concept. Every transaction has two aspects, a debit and a credit of equal amount. This gives the accounting equation: Assets = Liabilities + Capital.
7. Realisation concept. Revenue is recognised when it is earned, that is when goods are delivered or services rendered and the buyer becomes liable to pay — not when the order is received and not necessarily when cash comes in.
8. Accrual concept. Revenue and expenses are recorded in the period to which they relate, whether or not cash has been received or paid. Salary for March unpaid on 31 March is still an expense of that year (outstanding salary).
9. Matching concept. The expenses of a period are matched against the revenue of the same period to find the profit. Closing stock is carried forward because its cost belongs to next year’s sales.
10. Objective evidence concept. Every entry should be supported by a verifiable document: invoice, receipt, voucher.

3. The dual aspect worked

At every step assets equal liabilities plus capital. The purchase of furniture changes the form of an asset (cash to furniture) without changing the total. The profit of Rs. 4,000 on the sale increases capital.

4. Accounting conventions

1. Convention of consistency. The same accounting methods should be followed from year to year, so that results can be compared. If depreciation is charged on the straight line method one year, it should not be switched to written down value the next without good reason, and any change must be disclosed with its effect on profit.
2. Convention of full disclosure. The accounts should disclose all material information honestly. Contingent liabilities (a guarantee given, a suit pending against the firm) are shown as a footnote; the Schedule III format under the Companies Act 2013 and the accounting standards require detailed notes.
3. Convention of conservatism (prudence). “Anticipate no profit, but provide for all possible losses.” Closing stock is valued at cost or net realisable value, whichever is lower; a provision is made for doubtful debts, but no credit is taken for an expected price rise. Carried too far it creates secret reserves, so modern standards ask for prudence, not pessimism.
4. Convention of materiality. Items that would not affect the decision of a user may be treated in the simplest way. A stapler costing Rs. 150 is written off as an expense though it will last several years. Whether an item is material depends on its size relative to the business and its nature.

5. Why they matter

Without agreed concepts, two accountants given the same transactions would produce different accounts, and no reader could trust or compare them. The concepts make accounts uniform; the conventions make them comparable and honest. The accounting standards (Unit I, topic 4) are the formal, written version of many of these principles — AS 1 names going concern, consistency and accrual as the fundamental accounting assumptions, and prudence, substance over form and materiality as considerations in choosing accounting policies.

How this is examined

As a 6-mark note (“Explain accounting conventions”, January 2026, 80-mark paper), as a 10-mark essay (“Define accounting. Explain concepts of accounting”, June 2025) and as an 8-mark short note in the 100-mark paper (“Accounting concepts and conventions”, January 2026). For the note, four conventions with an example each are enough. For the essay, give at least eight concepts, and draw the dual-aspect table: a worked equation is the clearest way to show that the student understands double entry, which is the next topic.