Introduction
For meaningful and comparable financial statements, accountants in a country must follow certain generally accepted rules and practices. In India, these are collectively known as Indian GAAP (Generally Accepted Accounting Principles). Indian GAAP provides a common platform on which different business enterprises prepare and present their financial information. Within GAAP, accounting concepts and accounting conventions play a fundamental role and form the theoretical foundation of accounting, as explained in standard textbooks of Financial Accounting for B.Com (Sem I).
Indian GAAP – Meaning and Features
Indian GAAP may be defined as the body of rules, practices, principles, concepts, conventions and standards which are generally accepted and followed by accountants in India while recording transactions and preparing financial statements. It is not a single document but an evolving framework derived from:
- Legislative requirements such as the Companies Act and related rules,
- Accounting Standards (AS / Ind AS) issued by the ICAI,
- Pronouncements, guidance notes and interpretations issued by professional bodies, and
- Established accounting practices commonly followed in business.
Objectives of Indian GAAP
- To ensure that financial statements present a true and fair view of the business.
- To bring uniformity and consistency in accounting treatment and presentation.
- To make financial statements comparable across different firms and across different years.
- To provide reliable information to owners, creditors, investors, government and other users.
Characteristics of Indian GAAP
- It is based on general acceptance among accountants and regulators.
- It is dynamic in nature – new standards and practices are added with changes in business environment.
- It rests on fundamental concepts and conventions which guide recognition, measurement and disclosure.
Accounting Concepts
Accounting concepts are basic assumptions and fundamental ideas on which the entire accounting process is based. They answer the “why” and “how” of recording transactions. Important concepts discussed in the B.Com (Sem I) syllabus are:
1. Business Entity Concept
According to this concept, the business is treated as a separate entity distinct from its owner or proprietors. The capital introduced by the owner is treated as a liability of the business. Only those transactions which relate to the business are recorded in the books; personal expenses of the owner are excluded. This enables clear measurement of business profit or loss.
2. Money Measurement Concept
Under this concept, only those transactions and events which can be expressed in monetary terms are recorded in the books of accounts. Non-monetary information like efficiency of workers, reputation of management, or staff loyalty, although important, is not recorded because it cannot be measured in money with reasonable objectivity.
3. Going Concern Concept
This concept assumes that a business will continue its operations for a long period in the future and is not likely to be liquidated in the near term. On this assumption, fixed assets are recorded at cost and depreciated over their useful life rather than at their immediate sale value. Many valuations in accounting (like prepaid expenses, outstanding expenses etc.) are based on the going concern assumption.
4. Cost Concept (Historical Cost)
According to the cost concept, assets are recorded in the books at the purchase price or cost incurred to acquire them, and this cost becomes the basis of all subsequent accounting for the asset. Market value may change from time to time, but unless required by specific standard, the asset continues to appear at cost less depreciation. This gives objectivity and verifiability to accounting records.
5. Dual Aspect Concept
This concept states that every transaction has a two-fold effect on the accounting equation. For every debit, there is a corresponding credit. Hence, Assets = Capital + Liabilities. This is the basis of the double-entry system of bookkeeping and ensures arithmetical accuracy of accounts.
6. Accounting Period Concept
As the life of a business is indefinite, for the purpose of reporting, it is divided into equal time intervals called accounting periods, usually one year. At the end of every period, a Profit and Loss Account and a Balance Sheet are prepared. This enables periodic determination and reporting of profit, as required by owners, tax authorities and others.
7. Matching Concept
The matching concept requires that the expenses of an accounting period must be matched with the revenues of that period. Only those incomes and expenses which relate to the current period are taken into the Profit and Loss Account. Outstanding expenses, prepaid expenses, accrued incomes and unearned incomes are adjusted on this basis.
8. Realisation Concept
According to this concept, revenue is recognised when it is realised, i.e., when the legal right to receive payment arises and not when cash is actually received. In normal trading, revenue is realised when goods are sold or services are rendered, even if payment is received later. This concept prevents understatement or overstatement of income.
9. Accrual Concept
Under the accrual concept, incomes and expenses are recognised when they are earned or incurred and not when cash is received or paid. Thus, credit sales, outstanding expenses, accrued incomes etc. are recorded, giving a more realistic picture of profit and financial position than pure cash basis.
10. Objective Evidence Concept
This concept requires that all entries in the books should be supported by reliable documentary evidence such as invoices, vouchers, cash memos, contracts etc. This increases reliability and credibility of accounting information.
Accounting Conventions
Accounting conventions are customs or traditions which have developed over time and are followed as a matter of practical necessity. They supplement accounting concepts and guide how the principles are applied in actual practice. Important conventions are:
1. Convention of Consistency
The convention of consistency requires that the same accounting policies and procedures should be followed from one period to another for similar items. For example, if straight-line method of depreciation is used, it should not be changed frequently. Consistency helps in comparing financial statements across years. A change in method is permitted only if it leads to more appropriate presentation and must be properly disclosed.
2. Convention of Conservatism (Prudence)
This convention states: “Anticipate no profit but provide for all possible losses.” Assets and incomes should not be overstated, and liabilities and expenses should not be understated. Provision for doubtful debts, valuation of stock at cost or market price whichever is lower, and creating reserves for discounts on debtors are examples of prudence in practice.
3. Convention of Disclosure (Full Disclosure)
According to this convention, financial statements should disclose all material information which may influence the decisions of users. This includes disclosure of contingent liabilities, changes in methods, commitments, accounting policies and other significant events. The Companies Act and Accounting Standards give detailed disclosure requirements embodying this convention.
4. Convention of Materiality
The materiality convention recognises that only items which are material (significant) need strict accounting treatment and separate disclosure. Trifling items may be clubbed together or written off, e.g., small calculators may be treated as expense, stationery may be shown as a single item etc. What is material depends on the size and nature of the item and the size of the business.
Distinction between Concepts and Conventions (Quick View)
| Basis | Accounting Concepts | Accounting Conventions |
|---|---|---|
| Nature | Basic assumptions and fundamental ideas. | Practical rules of behaviour developed from usage. |
| Role | Explain how transactions should be recorded and measured. | Guide how information should be presented and disclosed. |
| Examples | Business entity, going concern, matching, accrual. | Consistency, conservatism, disclosure, materiality. |
| Degree of Formality | More theoretical and conceptual in nature. | Based on practical experience and common practice. |
Conclusion
Indian GAAP provides the overall framework within which financial accounts are prepared in India. Accounting concepts lay the theoretical foundation by stating the assumptions regarding entity, measurement, period, recognition and accrual. Accounting conventions ensure that this theory is applied in a cautious, consistent and informative manner. Together, they ensure that financial statements are reliable, comparable and present a true and fair view of the state of affairs and profit or loss of a business enterprise.