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Accounting Concepts - Part 1

"Accounting concepts are the foundation stones on which the entire accounting system is built."

Accounting Concepts are basic assumptions and ideas that guide how we record and present financial information. They ensure consistency, comparability, and reliability.

What are Accounting Concepts?

Definition: Fundamental assumptions or conditions upon which accounting is based.

Purpose:

  • Provide a framework for recording transactions
  • Ensure uniformity in accounting practices
  • Make financial statements comparable across companies

1. Business Entity Concept

"The business and the owner are two separate entities."

Meaning: The business is treated as a person separate from its owner(s). Personal transactions of the owner should NOT be mixed with business transactions.

Implications

✅ Owner introduces ₹5 Lakhs → Business records it as a Liability (Capital)
❌ Owner's personal house purchase → NOT recorded in business books

Journal Entry when capital is introduced:

Cash/Bank A/c               Dr.    ₹5,00,000
    To Capital A/c                      ₹5,00,000
(Being capital introduced by owner)

Real Example:

  • Mukesh Ambani (owner) vs Reliance Industries (business) are separate
  • If Mukesh buys a personal yacht for $75 million, it's NOT Reliance's expense
  • If Reliance pays Mukesh a salary/dividend, it's an expense/distribution for the business

2. Going Concern Concept

"The business will continue to operate for the foreseeable future."

Meaning: We assume the business will NOT shut down or liquidate in the near term. It will continue operations indefinitely.

Implications

✅ Fixed assets valued at cost less depreciation (not forced sale value)
✅ Prepaid expenses treated as assets (will be used in future)
❌ If closing down, assets must be valued at liquidation/realizable value

Example:

  • Tata Steel bought machinery for ₹100 Crores
  • Book value after 5 years: ₹60 Crores (after depreciation)
  • If sold in distress: might fetch only ₹30 Crores
  • Going Concern says: Record at ₹60 Crores (because we're NOT closing down)

Exception: If company is under liquidation, Going Concern doesn't apply.

3. Money Measurement Concept

"Only transactions measurable in monetary terms are recorded."

Meaning: Accounting records ONLY those transactions and events that can be expressed in money. Non-monetary aspects are ignored.

What Gets Recorded vs What Doesn't

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Example:

  • Google hires Sundar Pichai as CEO
  • His salary of $200 million → Recorded
  • His leadership skills and vision → NOT Recorded (priceless but not measurable)

Limitations of Money Measurement

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Real-World Application

Case Study: Infosys vs Wipro

Both have similar financial statements (revenue, profit, assets). But:

  • Infosys: Known for better work culture, innovation
  • Wipro: Different management style, different client base

Financial statements DON'T capture these qualitative differences, yet they significantly impact long-term success.

Interaction Between Concepts

These three concepts work together:

Example Transaction: Owner starts business with ₹10 Lakhs cash

  1. Business Entity: Business records ₹10 L as liability (Capital), separate from owner
  2. Going Concern: This capital will be used in ongoing operations (not liquidation)
  3. Money Measurement: Amount is in ₹ (money), so it's recorded

Quiz: Accounting Concepts - Part 1

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