Accounting Concepts, Principles & Conventions – Summary Notes for Exam Preparation (CA Foundation Unit 2)

Accounting Concepts, Principles, and Conventions: This unit on Accounting Concepts, Principles, and Conventions provides a foundational understanding of the theoretical framework used in financial accounting. It covers key concepts like entity, money measurement, periodicity, accrual, matching, going concern, cost, realisation, dual aspect, conservatism, consistency, and materiality, which form the basis for recording and presenting financial transactions.

It also explains the three fundamental accounting assumptions—going concern, consistency, and accrual—and outlines the qualitative characteristics of financial statements, such as relevance, reliability, comparability, and faithful representation, essential for informed decision-making by stakeholders.

📘 Accounting Concepts, Principles, and Conventions – Exam Notes

✅ Learning Outcomes

• Understand basic accounting concepts, principles, and conventions
• Identify 3 fundamental assumptions: Going Concern, Consistency, Accrual
• Recognize qualitative characteristics of financial statements

📚 Core Accounting Concepts

• Entity Concept
  • Business is separate from its owner.
  • Owner’s personal expenses ≠ Business expenses
• Money Measurement Concept
  • Record only transactions measurable in money
  • Non-monetary items (e.g., employee skills) are excluded
• Periodicity Concept
  • Financials prepared for specific time period (e.g., April–March)
  • Enables comparison across periods
• Accrual Concept
  • Record revenues and expenses when they occur, not when cash is received/paid
  • Example: Recognize revenue even if payment is pending
• Matching Concept
  • Match revenues with the related expenses of the same period
  • Crucial for accurate profit measurement
• Going Concern Concept
  • Business will continue to operate indefinitely
  • Assets recorded at cost, not liquidation value
• Cost Concept
  • Assets are recorded at their original purchase price
  • Ignores inflation, which may distort asset values
• Realisation Concept
  • Revenue is recognized when it is earned, not when cash is received
  • Gain must be realized, not just expected
• Dual Aspect Concept
  • Every transaction has two sides (e.g., Asset ↑ = Liability ↑)
  • Equation: Assets = Liabilities + Equity
• Conservatism (Prudence)
  • Record all anticipated losses, but not anticipated gains
  • E.g., inventory valued at cost or market price, whichever is lower
• Consistency
  • Use the same accounting methods every period
  • Change only if it provides a better representation
• Materiality
  • Ignore trivial details that don’t affect decisions
  • Depends on the size, nature, and context of the transaction

🧱 Fundamental Accounting Assumptions

1. Going Concern
2. Consistency
3. Accrual

If not mentioned, assume they are followed in financial statements.

📈 Qualitative Characteristics of Financial Statements

• Understandability – Clear to users with basic knowledge
• Relevance – Influences decision-making
• Reliability – Free from error/bias, represents transactions faithfully
• Comparability – Enables comparison across periods and entities
• Materiality – Only significant items reported
• Faithful Representation – Shows true nature of events
• Substance Over Form – Economic reality > Legal form
• Neutrality – No bias in presentation
• Prudence – Cautious recognition of income/loss
• Full, Fair & Adequate Disclosure – Disclose all necessary info
• Completeness – No omission of material data

✍️ Sample Equation-Based Illustration

Accounting Equation:
Assets = Liabilities + Capital

Example:

• Machinery: ₹5,00,000
• Cash: ₹2,00,000
• Capital: ₹7,00,000
  → Total Assets = Total Liabilities + Capital

✅ Quick Tips for MCQs

Accrual = Revenue when earned, not cash received

Matching = Revenue ↔ Related expenses

Consistency ≠ Inflexibility (can change if justified)

Conservatism = Record probable loss, not gain

FAQs on Accounting Concepts, Principles and Conventions

1. What are accounting concepts?
   Accounting concepts are basic assumptions used to prepare financial statements, like entity, accrual, and going concern.
2. What are accounting principles?
   Principles are guidelines or rules that form the foundation for accounting practices, such as the matching principle and realisation principle.
3. What are accounting conventions?
   Conventions are commonly accepted accounting practices developed through usage, like conservatism and consistency.

4. What is the entity concept in accounting?
   It states that the business and its owner are separate entities; business transactions are recorded independently.
5. What is the money measurement concept?
   Only transactions measurable in monetary terms are recorded in the accounts.
6. What is periodicity in accounting?
   Financial statements are prepared for specific periods (e.g., yearly) to measure performance.
7. What is the accrual concept?
   Revenues and expenses are recognized when they occur, not when cash is received or paid.
8. What is the matching concept?
   Expenses should be matched to the revenues they help generate, within the same accounting period.
9. What is the going concern concept?
   Assumes that a business will continue to operate indefinitely unless there’s evidence to the contrary.
10. What is the cost concept in accounting?
    Assets are recorded at their original purchase cost, not market value.
11. What is the realisation concept?
    Income is recognized when it is earned and realizable, not when cash is received.
12. What is the dual aspect concept?
    Every transaction affects two accounts and follows: Assets = Liabilities + Equity.
13. What is conservatism in accounting?
    Anticipate all losses but no profits until realized; “recognize losses early, profits later.”
14. What is consistency in accounting?
    The same accounting methods should be followed across periods for comparability.
15. What is materiality in accounting?
    Only significant items that affect decision-making are recorded; minor ones may be omitted.

16. What are the fundamental accounting assumptions?
    Going concern, consistency, and accrual.
17. Are assumptions always disclosed in financial statements?
    If followed, no need to disclose; if not followed, they must be disclosed.

18. What makes financial statements useful to users?
    Understandability, relevance, reliability, and comparability.
19. What is faithful representation?
    Information must reflect the true economic substance of transactions.
20. What does neutrality mean in financial reporting?
    Information must be free from bias and not designed to influence decisions.
21. What is prudence in accounting?
    Exercise caution in estimation; avoid overstating assets or income.
22. What is the role of full, fair, and adequate disclosure?
    Ensures users get all relevant and reliable information to make decisions.
23. Why is substance over form important?
    Transactions are recorded based on economic reality, not just legal form.
24. What is completeness in financial statements?
    All relevant financial data must be fully included, within the limits of materiality.

25. How do accrual and matching concepts work together?
    Accrual recognizes transactions when they occur; matching links them to the correct period.
26. What is an example of conservatism in accounting?
    Inventory is valued at cost or market price, whichever is lower.
27. Why is the cost concept criticized?
    It ignores inflation and may not reflect the true value of assets.
28. Can accounting policies be changed?
    Yes, but only for legal compliance, alignment with standards, or to better reflect financial truth.
29. How does materiality differ between businesses?
    What’s material for one business may be immaterial for another—it’s context-dependent.
30. What happens if the going concern assumption is invalid?
    Financial statements must be prepared on a different basis (e.g., liquidation).

Understanding accounting concepts, principles, and conventions is essential for preparing accurate and consistent financial statements. These foundational guidelines ensure uniformity, comparability, and reliability in financial reporting, enabling stakeholders to make informed decisions.

By adhering to fundamental assumptions like going concern, consistency, and accrual, and applying qualitative characteristics such as relevance, faithful representation, and prudence, accounting maintains its role as the “language of business.” Mastery of these principles is crucial not just for exams but for real-world application in financial analysis and decision-making.