IGNOU : M.COM : MCO 5 : UNIT 1 : Q - 4. What are the accounting concepts to be observed at the reporting stage ? Explain in detail.

Ans. Concept to be Observed at the Reporting Stage

The following concepts have to be kept in mind while preparing the final accounts:

1. Going concern concept             

2. Accounting period concept

3. Matching concept

4. Conservatism concept

5. Consistency concept

6. Full disclosure concept

7. Materiality concept

Let us discuss the above concepts one by one

1) Going Concern Concept

According to this concept it is assumed that every business would continue for a long period. Keeping this in view, the investors lend money and the creditors supply goods and services to the concern. For all practical purpose the business is normally treated as a going concern unless there is a strong evidence to the contrary. The current disposal value is irrelevant for a continuing business. Recording of transactions in accounting is judged whether the benefits from expenses are immediate (short period, say less than one year) or a long term. If the benefits from expenses are immediate it is treated as a revenue or if the benefits are for long term, it is to be treated as capital depending upon the nature of expenses. Short term benefits expenses like rent, repairs etc. are limited to one year therefore such expenses are fully debited to profit and loss account of that year. On the other hand, if the benefit of expenditure is available for a longer period, it must be spread over a number of years. Therefore, only a portion of such expenditure will be debited to profit and loss account. The balance of expenditure is shown as an asset in the Balance Sheet. Similarly fixed assets are recorded at original cost and are depreciated in a proper manner and while preparing the balance sheet, market price of fixed asset are not considered.

2) Accounting Period Concept

You know that the going concern concept assumes that life of the business is indefinite and the preparation of income and positional statements after a long period would not be helpful in taking appropriate steps at the right time. Therefore, it is necessary to prepare the financial statements periodically to find out the profit or loss and financial position of the business. It also helps the interested parties to make periodical assessment of its performance. Therefore, accountants choose some shorter period to measure the results and one year has been generally accepted as the accounting period. However, accounts can also be prepared even for a shorter period for internal management purposes. But one year accounting period is recognised by law and taxation is assessed annually. Acconting period may be a calender year i.e., January 1 to December 31 or any other period of twelve months, say April 1 to March 31 or Diwali to Diwali or Dasara to Dasara. The final accounts are prepared at the end of each accounting period and the financial reports thus, prepared facilitate to make good decision, corrective measures, business expansion etc. and also enable the end users to make an assessment of the progress of the enterprise.

3) Matching Concept

Matching concept is based on the accounting period concept. The matching concept is also called Matching of costs against revenue concepts. To ascertain the profit made by the business during a particular period, the expenses incurred in an accounting year should be matched with the revenue earned during that year. The term ‘matching’ means appropriate association of related revenues and expenses. For this purpose, first we have to recognize the revenues during an accounting period and the costs incurred in securing those revenues. Then the sum of costs should be deducted from the sum of revenues to get the net result of that period. The question when the payment was received or made is irrelevant. In other words, all revenues earned during an accounting period, whether received or not and all costs incurred, whether paid or not have to be taken into account while preparing the final accounts. Similarly, any amount received or paid during the accounting period which actually relates to the previous accounting period or the following accounting period must be eliminated from the current accounting period’s revenues and costs. Therefore, adjustments are to be made for all outstanding expenses, accrued incomes, prepared expenses and unearned incomes, etc., while preparing the final accounts at the end of the accounting period. By application of this concept, the owner of the business easily know about the operating results of his business and can make effort to increase earning capacity.

4) Conservation Concept

This concept is also known as Prudent Concept. It ensures that uncertainties and risks inherent in business transactions should be given a proper consideration. Conservatism refers to the policy of choosing the procedure that leads to understatement of assets or revenues, and over statement of liabilities or costs. The consequence of an error of understatement is likely to be less serious than that of an error of over statement. On account of this reason, accountants generally follow the rule ‘anticipate no profit but provide for all possible losses. In other words, profits are taken into account only when they are actually realized but in case of losses, even the losses which may arise due to a remote possibility should also be taken into account. That is the reason why the closing stock is valued at cost price or market price whichever is less. Similarly, provision for doubtful debts and provision for discounts on debtors are also made. This reflects a generally pessimistic attitude of the accountant, but it is regarded as the best way of dealing with uncertainty and protecting creditors against an unwarranted distribution of the firm’s assets as dividends.

5) Consistency Concept

The principle of consistency means that the same accounting principles should be used for preparing financial statement for different periods. It means that there should not be a change in accounting methods from year to year. Comparisons are possible only when a consistent policy of accounting is followed. If there are frequent changes in the accounting treatment there is little scope for reliability. For example, if stock is valued at ‘cost or market price whichever is less, this principle should be followed year to year. Similarly if deprecation on fixed assets is provided on straight line basis, it should be followed consistently year after year. Consistency eliminates personal bias and helps in achieving comparable results. If this principle of consisting is not followed, the accounting information about an enterprise cannot be usefully compared with similar information about other enterprises and so also within the same enterprise for some other period. Consistency principle enhances the utility of the financial statements.

However, consistency does not prohibit change. When a change is desirable, the change and its affect should be clearly stated in financial accounts.

6) Full Disclosure Concept

This concept states that the financial statements are to be prepared honestly and all significant information should be incorporated there in because these statements are the basic means of communicating financial information to all interested parties. Therefore, these statements should be prepared in such a way that all material information is clearly disclosed to the persons interested in its affairs . The purpose of this concept is that any body who wants to study the financial statements should not be prejudiced by concealing any facts. It is, therefore, necessary that the disclosure should be fair and adequate to make impartial judgement. This concept assumes greater importance in respect of Joint Stock Company type of organisations where ownership is divorced from management. The Joint Stock Companies Act, 1956 requires that Profit and Loss Account and Balance Sheet of a company must give a true and fair view of the state of affairs of the company and also provided prescribed form in which these statements are to be prepared so that significant information may not be left out.

7) Materiality Concept

This concept is closely related to the full disclosure concept. Full disclosure does not mean that everything should be disclosed. It only means that relevant and material information must be disclosed. American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decisions of informed investor”. Materiality primarily relates to the relevance and reliability of information. All material information should be disclosed through the financial statements accompanied by necessary notes. For example commission paid to sole selling agents, and a change in the method of rate of depreciation, if any, must be duly reported in the financial statements.