Ans. Concepts to be Observed at the Recording Stage
The
concept which guide us in identifying, measuring and recording the transactions
are :
1) Business Entity Concept
2)
Money Measurement Concept
3)
Objective Evidence Concept
4) Historical Record Concept
5)
Cost Concept
6)
Dual Aspect Concept
Let us explain
them one by one and learn the accounting implications of each concept.
1) Business
Entity Concept
According
to this concept business is treated as a separate entity from its owners. All
transactions of the business are recorded in the books of the firm. Business
transactions and business property are different from personal transactions and
personal property. If business affairs are mixed with private affairs, the true
picture of the business is not available. The owner of the firm is treated as a
creditor to the extent of his capital. From the accounting point of view the
owner is different and the business is different. Therefore, under this concept
the capital contributed by the owner of the firm is the liability to the firm
and the owner is regarded as the creditor of the firm. However, personal
expenditure of the owner is met from business funds it shall be recorded in the
business books as drawings by the owner and not as business expenditure.
The
business entity concept is applicable to all form of business organisation.
This distinction can be easily maintained in the case of a limited company
because the company has a separate legal entity of its own. But such
distinction becomes difficult in case of a sole proprietorship or partnership,
because in the eyes of law sole proprietor or partners are not considered
separate entities. They are personally liable for all business transactions.
But for accounting purpose they are treated as separate entities. This enables
them to ascertain the profit or loss of the business more conveniently and
accurately.
2) Money
Measurement Concept
Usually
business deals in a variety of items having different physical units such as
kilograms, quintals, tons, meters, liters, etc. If the sales and purchase of
different items are recorded in the physical terms, it will pose problems. But
if these are recorded in common denomination their total become homogeneous and
meaningful. Therefore, we need a common unit of measurement. Money does this
function. It is adopted a common measuring unit for the purpose of accounting.
All recording, therefore, is done in terms of the standard currency of the
country where business is set up. For example, in India, it is done in terms of
Rupees. In USA it is done in terms of US dollars and so on.
Another
implication of money measurement concept is that only those transactions and
events are recorded in the books of accounts which can be expressed in terms of
money such as purchases, sales, salaries etc. Other happenings (non-monetary)
like labour management relations, sales policy, labour unrest, effectiveness of
competition, a team of dedicated and trusted employees etc., which are vital importance
to the business concern do not find place in accounting. This is because their
effect is not measurable and quantifiable in terms of money.
Another
limitation of this concept is that it is based on the assumption that the money
value is constant which is not true. The value of money changes over a period
of time. The value of rupee today is much less than what it was in 1971. This
is due to a fall in money value. Thus this concept ignores the qualitative
aspect of things and the impact of inflationary changes is not adjustable in
this principle. That is why accounting data does not reflect the true and fair
view of the affairs of business.
Now-a-days
it is considered desirable to provide additional data showing the effect of
changes in the price level on the reported income and the assets and
liabilities of the business.
3) Objective
Evidence Concept
The
term objectivity refers to being free from bias or free from subjectivity.
Accounting measurements are to be unbiased and verifiable independently. For
this purpose all accounting transactions should be evidenced and supported by
documents such as invoices, receipts, cash memos etc. These supporting
documents (Vouchers) form the basis for making entries in the books of account
and for their verification by auditors. As per the items like depreciation and
the provision for doubtful debts where no documentary evidence is available,
the policy statements made by the management are treated as the necessary
evidence.
4) Historical
Record Concept
Recording
the transactions in the books of account will be done only after identifying
the transactions and measuring them in terms of money. According to the
historic record concept we record only those transactions which have actually
taken place in the business during a particular period of time and not those
transactions which may take place in future. It is because accounting record
presupposes that the transactions are to be identified and objectively
evidenced. This is possible only in the case of past (actually happened)
transactions. The future transactions can hardly be identified and measured
accurately. You also know that all transactions are to be recorded in
chronological (date wise) order. This leads to the preparation of a historical
record of all transactions. It also implies that we simply record the facts and
nothing else.
One
limitation of this concept is that the impact of future uncertainties has no
place in accounting. Management needs information for future planning not only
of the past but also for future. You know that we will also make a provision
for some expected losses such as doubtful debts at the time of ascertaining
profit or loss of the business which is contrary to the historic record
concept. But it is not a routine item. This is done in accordance with another
concept called conservation concept which you will study later.
5) Cost Concept
The
price paid (or agreed to be paid in case of a credit transaction) at the time
of purchase is called cost. Under this concept fixed assets are recorded in the
books of account at the price at which they are acquired. This cost is the
basis for all subsequent accounting for the asset. For example, when an asset
is acquired for Rs. 1,00,000, it is recorded in the books of account at Rs.
1,00,000 even though the market value may be different later. But the asset is
shown in the books at cost price.
You
know that with passage of time the value of an asset decreases. Hence, it may
systematically be reduced from year to year by charging depreciation and the
assets be shown in the balance sheet at the depreciated value. The depreciation
is usually charged at a fixed percentage on cost. It bears no relationship with
the changes in its market value. This makes it difficult to assess the true
financial position of the concern and it is, therefore, considered an important
limitation of the cost concept.
Another
limitation of the cost concept is that if the business pays nothing for an item
it acquired, then this will not appear in the accounting records as an asset.
Thus, all such events are ignored which affect the business but have no cost.
Examples are : a favourable location, a good reputation with its customers,
market standing etc. The value of an asset may change but the cost remains the
same in the books of account. As such the book value of an asset as recorded do
not reflect their real value. It should, however, be noted that the cost
concept is applicable to the fixed assets and not to the current assets.
In spite of the above limitations the cost
concept is preferred because firstly, it is difficult and time consuming to
ascertain the market values and secondly, there will be too much of
subjectivity in assessing current values. However, this limitation can be
overcome with the help of inflation accounting.
6) Dual Aspect
Concept
This
is a basic concept of accounting. According to this concept every business
transaction has a two-fold effect. In commercial context it is a famous dictum
that “every receiver is also a giver and every giver is also a receiver”. For
example, if you purchase a machine for Rs. 8,000, you receive machine on the
one hand and give Rs. 8,000 on the other. Thus, this transaction has a two-fold
effect i.e.,(i) increase in one asset, and (ii) decrease in another asset.
Similarly, if you buy goods worth Rs. 500 on credit, it will increase an asset
(stock of goods) on the one hand and increase a liability(creditors) on the
other. Thus, every business transaction involves two aspects (i) the receiving
aspect, and (ii) the giving aspect. In case of the first example you find that
the receiving aspect is machinery and the giving aspect is cash. In the second
example the receiving aspect is goods and the giving aspect is the creditor. If
complete record of transactions is to be made, it would be necessary to record
both the aspects in books of account. This principle is the core of double
entry book-keeping and if this is strictly followed, it is called “Double Entry
System of Book-keeping’.
Let
us understand another accounting implication of the dual aspect concept. To
start with, the initial funds (capital) required by the business are
contributed by the owner. If necessary, additional funds are provided by the
outsiders (creditors). As per the dual aspect concept all these receipts create
corresponding obligations for their repayment, In other words, a contribution
to the business, either in cash or kind, not only increases its resources
(assets), but also its obligations (liabilities/equities) correspondingly.
Thus, at any given point of time, the total assets and the total liabilities
must be equal.
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