Theory Base of Accounting
Every number in a financial statement rests on a set of agreed-upon rules — accounting concepts, conventions, and standards — and this chapter gives you the full map of those rules so you can read, prepare, and question accounts with confidence.
Every board exam question on journal entries, final accounts, or depreciation is testing whether you applied these concepts correctly — and if you ever run a business, open a bank account for a startup, or study CA/B.Com, this theoretical framework is the first thing your examiner or auditor will check.
Concept
Lots of students think…
"The Cost Concept means an asset's value in the books stays the same forever — it's locked at whatever you paid for it."
Actually…
Cost Concept only controls how an asset is first recorded (at purchase price, never at a higher market price). After that, depreciation chips away at the book value every year. The concept stops values going up arbitrarily — it does not freeze them.
By the end of this chapter, you will understand the basic rules that every accountant follows — and why those rules exist in the first place. Think of it as learning the grammar of accounting.
Why rules matter in accounting
Imagine two shop owners who each sold the same amount of goods but recorded their income differently — one when cash arrives, the other when goods leave the shelf. Their profit figures would look completely different at year-end. Accounting theory exists so that every business speaks the same financial language, making records comparable and trustworthy.
A bank in Mumbai lends money to a shop in Kochi only because both follow the same accounting rules. Without those shared rules, the bank would have no way to trust the numbers on the shop's loan application.
Business Entity Concept
In accounting's eyes, a business and its owner are two completely separate people — even if the same person started both. Any money the owner puts in is treated as a loan from the owner to the business, not as the owner's own cash.
Ramesh puts ₹5 lakh of his personal savings into his printing shop. The shop's books record that ₹5 lakh as 'Capital' — money the business owes back to Ramesh. When Ramesh withdraws ₹20,000 for a family holiday, the books call it 'Drawings', not a business expense, because his personal life is separate from the shop's accounts.
Going Concern and Cost Concepts
Going Concern assumes the business will keep running forever — so you spread a big asset's cost over many years instead of treating it all as an expense today. The Cost Concept says you record an asset at what you actually paid for it, not what it might be worth later. This keeps records honest and objective.
A textile factory buys a ₹10 lakh loom. Because of Going Concern, the factory spreads that ₹10 lakh over 10 years (₹1 lakh per year as depreciation). Even if the loom's market value rises to ₹15 lakh next year, the Cost Concept means the books still show the original purchase price — never the higher market price.
Dual Aspect Concept
Every single financial transaction has two equal and opposite effects. This is the heartbeat of double-entry bookkeeping. If one account goes up, another must go down by the same amount — so the books always stay in balance.
Priya's bakery buys flour for ₹8,000 cash. Two things happen at once: Cash goes DOWN by ₹8,000, and Stock (flour) goes UP by ₹8,000. Both sides always equal each other. This is why a balance sheet always balances.
Accrual and Matching Concepts
The Accrual Concept says record income when you earn it — not when the cash actually arrives. The Matching Concept says show all the expenses you spent to earn that income in the same time period. Together, these two concepts give you the true profit for a period.
Anjali delivers a ₹6,000 salwar suit on 25 March but the customer pays in April. Under Accrual, she records ₹6,000 income in March. She also records the ₹2,000 fabric cost and ₹800 tailor wages in March (Matching). So her March profit correctly shows ₹3,200 — not a misleading ₹6,000.
Accounting Conventions
Conventions are the practical customs that make concepts work in real life. Consistency means using the same method every year so you can compare results. Full Disclosure means telling readers about anything important — like a big pending court case. Conservatism means never count a profit until it arrives, but always set aside money for a likely loss. Materiality means only big items need detailed treatment — a ₹50 pen does not need its own ledger account.
A kirana shop owner expects a customer to default on a ₹50,000 debt. Conservatism says: create a 'provision for bad debts' entry right now — do not wait and hope the money arrives. But the ₹50 staple-pin refill bought for the shop? Materiality says just bundle it with 'office expenses' — no separate entry needed.
Accounting Standards and IFRS
Accounting Standards are the formal, mandatory rules issued by the ICAI (Institute of Chartered Accountants of India) that tell businesses exactly how to handle specific situations. Think of the concepts we just covered as the constitution — and accounting standards as the detailed laws under it. India follows Indian GAAP, and large listed companies also follow Ind-AS, which is India's version of the international rules called IFRS.
ICAI has a specific standard that tells every company exactly how to value its closing stock — you cannot just choose any method you like. A Reliance Industries accountant and a small Mumbai trader both follow the same ICAI standard for this, so their inventories are valued in a way that outsiders can understand and compare.
Notes
Every figure in a set of accounts rests on a shared rulebook so that different businesses can be read and compared with confidence. This chapter explains that rulebook — the fundamental assumptions, GAAP and the basic accounting concepts, the systems and bases of accounting, the role of Accounting Standards and Ind-AS, and the basics of GST.
Key terms & definitions
- GAAP (Generally Accepted Accounting Principles)
- The common set of accounting rules, conventions and concepts that businesses are expected to follow while preparing financial statements, so that the accounts are reliable, consistent and comparable across firms.
- Accounting Concepts
- The basic assumptions and conditions that an accountant takes as always true while recording transactions and preparing accounts (for example Business Entity, Going Concern, Dual Aspect).
- Accounting Conventions
- Customs or practices that have developed over time and are followed while preparing accounts, such as Consistency, Full Disclosure, Conservatism (Prudence) and Materiality.
- Business Entity Concept
- The business and its owner are treated as two separate persons for accounting. Money the owner puts in is shown as Capital (a liability of the business owed back to the owner), and money taken out for personal use is Drawings.
- Going Concern Concept
- The assumption that the business will continue to operate for an indefinitely long period and has no intention of closing down, which is why the cost of long-life assets is spread over their useful life through depreciation rather than charged in full in the year of purchase.
- Dual Aspect Concept
- Every transaction has two equal and opposite effects, so total assets always equal the total of capital and liabilities. This is the foundation of double-entry book-keeping: Assets = Capital + Liabilities.
- Accrual Basis of Accounting
- A system in which revenue is recorded when it is earned and expenses are recorded when they are incurred, regardless of when the cash is actually received or paid.
- Matching Concept
- The principle that the expenses of an accounting period must be set against (matched with) the revenues earned in that same period, so that the profit or loss reported is true and fair.
- Accounting Standards (AS)
- Written, authoritative statements issued by the Institute of Chartered Accountants of India (ICAI) that prescribe the methods of measuring, recording and disclosing specific items, so as to bring uniformity and reliability to financial statements.
- Ind-AS (Indian Accounting Standards)
- Accounting standards notified by the Ministry of Corporate Affairs that are converged with (largely aligned to) the global IFRS, applied mainly by large and listed companies in India.
- IFRS
- International Financial Reporting Standards — a single set of high-quality global accounting standards intended to make financial statements comparable across countries.
- GST (Goods and Services Tax)
- A comprehensive, multi-stage, destination-based indirect tax levied on the supply of goods and services, which replaced many earlier indirect taxes under the principle of 'One Nation, One Tax'.
Why a theory base is needed (meaning and purpose of GAAP)
- Accounting information is used by many outsiders — owners, lenders, investors, tax authorities — who must be able to trust and compare the figures.
- If every business recorded transactions in its own way, the accounts of two firms could not be compared, so a shared rulebook is essential.
- GAAP is this shared rulebook: the body of generally accepted concepts, conventions, principles and standards that guide how accounts are prepared.
- GAAP makes financial statements reliable (free from bias), consistent (same treatment over time) and comparable (across firms and years).
- GAAP is not a single rigid law; it evolves as business practice and Accounting Standards develop.
Fundamental Accounting Assumptions
- Three assumptions are presumed to be followed in every set of accounts unless the firm clearly states otherwise: Going Concern, Consistency and Accrual.
- Going Concern: the business will continue for the foreseeable future; assets are therefore carried at cost less depreciation, not at break-up (sale) value.
- Consistency: the same accounting methods (for example, the same method of depreciation) are followed from one year to the next, so results can be compared.
- Accrual: revenues and costs are recognised when they are earned or incurred, not when cash moves.
- If any of these three is NOT followed, the fact must be disclosed in the accounts.
Basic Accounting Concepts (Part 1) — Entity, Money Measurement, Going Concern, Accounting Period
- Business Entity Concept: the firm is separate from its owner; owner's investment is Capital (a liability of the firm) and personal withdrawals are Drawings.
- Money Measurement Concept: only transactions and events that can be expressed in money are recorded; valuable but non-monetary facts (skill of staff, good location, employee morale) are not entered in the books.
- A further effect of Money Measurement is that money is assumed to have a stable value, so amounts from different years are simply added together (changes in the value of money are ignored).
- Going Concern Concept: the firm is assumed to continue indefinitely, which justifies spreading the cost of fixed assets over their useful life and classifying items as fixed or current.
- Accounting Period Concept: the indefinite life of a business is divided into fixed, equal intervals (usually one year) so that performance and position can be measured and reported regularly; in India the accounting year normally runs 1 April to 31 March.
Basic Accounting Concepts (Part 2) — Cost, Dual Aspect, Revenue Recognition, Matching
- Cost (Historical Cost) Concept: an asset is recorded at the price actually paid to acquire it, not at its current market value; this keeps records objective and verifiable.
- The Cost Concept fixes the value at which the asset is FIRST recorded — it does not freeze the value forever; book value still falls year by year through depreciation. What the concept prevents is writing the value UP to a higher market price.
- Dual Aspect (Duality) Concept: every transaction affects at least two accounts with equal debit and credit, giving the accounting equation Assets = Capital + Liabilities; this is the basis of double-entry book-keeping.
- Revenue Recognition (Realisation) Concept: revenue is treated as earned at the point the goods are sold or the service is rendered, even if the cash is received later; advance received before the sale is not yet revenue.
- Matching Concept: against the revenue of a period, all expenses incurred to earn that revenue (whether paid or still outstanding) are charged in the same period, so that the period's profit is correctly stated.
- Matching is the reason adjustments such as outstanding expenses, prepaid expenses, accrued income and depreciation are made before finding profit.
Accounting Conventions — Full Disclosure, Consistency, Conservatism, Materiality, Objectivity
- Full Disclosure: all information that is significant to users must be reported clearly in or with the financial statements (for example, pending lawsuits, large loans, change of method), so that nobody is misled.
- Consistency: accounting methods once chosen are followed every year; if a method is changed, the change and its effect must be disclosed.
- Conservatism (Prudence): do not anticipate profits, but provide for all possible losses — for example, value stock at cost or market price, whichever is lower, and create a provision for a doubtful debt.
- Materiality: only items important enough to influence a user's decision need separate, detailed treatment; trivial items may be merged with others (a low-value office item need not have its own ledger account).
- Objectivity (Verifiability): every entry should be supported by documentary evidence — bills, vouchers, receipts — so that the records are free from personal bias and can be checked.
Systems of Accounting — Double Entry and Single Entry
- Double Entry System: records both the debit and the credit aspect of every transaction; it is complete, scientific and accurate, and allows preparation of a Trial Balance to check arithmetical accuracy.
- Single Entry System: an incomplete system that records only some aspects (often only cash and personal accounts); it is used by very small businesses but is not reliable for final accounts.
- Because it captures both aspects, the Double Entry System is the accepted basis for proper accounting.
Basis of Accounting — Cash Basis vs Accrual Basis
- Cash Basis: income and expenses are recorded only when cash is actually received or paid; no entry is made for outstanding or prepaid items, so the profit shown can be misleading.
- Accrual (Mercantile) Basis: income is recorded when earned and expenses when incurred, irrespective of cash movement, so it gives a true and fair profit for the period.
- Accrual Basis records outstanding expenses, prepaid expenses, accrued income and income received in advance; Cash Basis does not.
- Accrual Basis is the recognised basis for formal financial statements and is required under the Companies Act for companies; Cash Basis may be used only for small or non-trading concerns and informal records.
- Accrual Basis is based on the Accrual, Revenue Recognition and Matching concepts.
Accounting Standards (AS) — meaning, objectives and applicability
- Accounting Standards are written, authoritative rules issued in India by the Institute of Chartered Accountants of India (ICAI) on how to measure, treat and disclose specific items.
- Objectives: to bring uniformity in accounting practice, to make financial statements reliable and comparable, to reduce the chances of fraud and manipulation, and to help auditors by setting agreed treatments.
- Standards narrow the range of choices a business has, but a reasonable degree of choice still remains in some areas.
- Applicability: standards apply to general-purpose financial statements; the level of compliance required depends on the size and class of the enterprise, with relaxations for smaller entities.
- Relationship with concepts: concepts give the broad direction (the 'constitution'), while standards give the detailed, mandatory rules (the 'laws') for specific situations — both are needed together.
IFRS and Indian Accounting Standards (Ind-AS)
- IFRS (International Financial Reporting Standards) are a single set of high-quality global standards meant to make accounts comparable across countries.
- India did not adopt IFRS as it is; instead it issued Ind-AS — Indian Accounting Standards that are converged with (substantially aligned to) IFRS but adapted to Indian law and conditions.
- Ind-AS are notified by the Ministry of Corporate Affairs and are applied mainly by large companies and listed companies, in a phased manner based on size.
- Smaller and unlisted entities generally continue to follow the existing Accounting Standards (AS) rather than Ind-AS.
Goods and Services Tax (GST) — meaning, characteristics and advantages
- GST is an indirect tax on the supply of goods and services; it replaced many earlier central and state indirect taxes (such as excise duty, service tax and VAT) under the idea of 'One Nation, One Tax'.
- Characteristics: it is comprehensive (covers most goods and services), multi-stage (levied at each stage of the supply chain) and destination-based (the tax goes to the state where the goods or services are finally consumed).
- India follows a dual GST model: for a supply within a state both CGST (collected by the Centre) and SGST/UTGST (collected by the State/UT) are charged, while for a supply between states IGST (collected by the Centre and shared with the consuming state) is charged.
- Input Tax Credit: a registered business can set off the GST paid on its purchases against the GST collected on its sales, so that tax is effectively paid only on the value it adds and the cascading 'tax on tax' is removed.
- Advantages: removes cascading of taxes, creates a common national market, widens the tax base, improves transparency and makes compliance simpler through a single tax.
Formulas & formats
- Accounting Equation (Dual Aspect): Assets = Capital + Liabilities (also written Capital = Assets − Liabilities).
- Effect of Drawings under Business Entity Concept: Closing Capital = Opening Capital + Additional Capital + Profit − Drawings.
- Cost / Book value relation: Book Value of Asset = Original (Historical) Cost − Accumulated Depreciation (asset is never written up to market value).
- GST on an intra-state supply: Total GST = CGST + SGST (each usually half of the total GST rate); on an inter-state supply: Total GST = IGST.
- Net GST payable (Input Tax Credit): GST payable to government = Output GST (on sales) − Input GST (on purchases).
Important questions & model answers
State the three Fundamental Accounting Assumptions.
1 mark- Going Concern, Consistency and Accrual.
Which accounting concept treats the owner and the business as separate persons?
1 mark- The Business Entity Concept (also called the Separate Entity Concept).
Give the full form of GAAP and of GST.
1 mark- GAAP = Generally Accepted Accounting Principles.
- GST = Goods and Services Tax.
Explain the Business Entity Concept with one example.
3 marks- The business is treated as separate and distinct from its owner for accounting purposes.
- Therefore money invested by the owner is recorded as Capital, i.e. a liability of the business owed back to the owner, and money taken out for personal use is recorded as Drawings.
- Example: if a proprietor brings in ₹5,00,000 of personal savings, the firm shows ₹5,00,000 as Capital; if he later withdraws ₹20,000 for household use it is treated as Drawings, not as a business expense.
- This keeps the firm's results free from the owner's personal transactions.
Distinguish between the Cash Basis and the Accrual Basis of accounting.
4 marks- Recording: under Cash Basis, income and expenses are recorded only when cash is received or paid; under Accrual Basis, they are recorded when earned or incurred, regardless of cash flow.
- Outstanding / prepaid items: Cash Basis ignores outstanding expenses, prepaid expenses and accrued income; Accrual Basis records all of them.
- True profit: Cash Basis may show a misleading profit, while Accrual Basis gives a true and fair profit for the period.
- Acceptability: Accrual Basis is required for formal financial statements (and for companies under the Companies Act), whereas Cash Basis is suitable only for small or non-trading concerns and informal records.
'The Cost Concept means the value of an asset never changes in the books.' Do you agree? Explain.
3 marks- The statement is not fully correct.
- The Cost Concept only fixes the value at which an asset is FIRST recorded — its original purchase price, not its market value.
- After that, the book value falls every year through depreciation (charged under the Matching Concept).
- What the Cost Concept actually prevents is writing the asset UP to a higher market value; it does not freeze the value forever.
What are Accounting Standards? State any three of their objectives.
4 marks- Accounting Standards are written, authoritative rules issued in India by the Institute of Chartered Accountants of India (ICAI) that prescribe how specific items are to be measured, treated and disclosed in financial statements.
- Objective 1 — Uniformity: they bring uniformity to accounting practice by laying down agreed treatments.
- Objective 2 — Reliability and comparability: they make financial statements more reliable and comparable across firms and years.
- Objective 3 — Check on manipulation: by codifying methods, they reduce the scope for fraud and window-dressing and assist auditors.
- (Any three objectives are acceptable.)
Explain how the Accrual Concept and the Matching Concept together help in finding true profit.
4 marks- Accrual Concept: revenue is recognised when it is earned and expenses when they are incurred, not when cash is received or paid.
- So sales made on credit are counted as income of the period of sale, and expenses still unpaid (outstanding) are counted as costs of the period in which they arose.
- Matching Concept: against the revenue of the period, all expenses incurred to earn that revenue are charged in the same period.
- This requires adjustments such as outstanding expenses, prepaid expenses, accrued income and depreciation.
- Together they ensure that the profit or loss reported for the period is true and fair, neither overstated nor understated.
Explain the dual GST model in India and the meaning of CGST, SGST and IGST.
4 marks- India follows a dual GST model in which both the Centre and the States have the power to levy GST on the same supply.
- On a supply WITHIN a state (intra-state), two taxes are charged: CGST (Central GST, collected by the Central Government) and SGST/UTGST (State/UT GST, collected by the State or Union Territory).
- On a supply BETWEEN states (inter-state), a single tax called IGST (Integrated GST) is charged; it is collected by the Centre and the State's share is passed on to the consuming state.
- GST is a destination-based tax, so the revenue ultimately belongs to the state where the goods or services are consumed.
- Because of Input Tax Credit, a business sets off GST paid on purchases against GST collected on sales, removing the cascading 'tax on tax'.
Why is a theory base (set of concepts and standards) necessary in accounting? Explain with reference to GAAP.
6 marks- Accounting information is used by many outside parties — owners, banks, investors, suppliers and the government — who must be able to trust and compare the figures.
- If each business followed its own rules, two firms doing identical business could report very different profits, making comparison impossible.
- GAAP (Generally Accepted Accounting Principles) is the common rulebook of concepts, conventions, principles and standards that all firms are expected to follow.
- Reliability: by fixing objective methods (for example, recording assets at cost), GAAP keeps the accounts free from personal bias.
- Consistency: by requiring the same methods over time, GAAP makes one year's results comparable with another's.
- Comparability: by standardising treatment, GAAP lets a user compare different firms on a like-for-like basis.
- Accounting Standards build on GAAP by giving detailed, mandatory rules for specific items, while the basic concepts give the broad direction — both are needed so that financial statements are dependable and decision-useful.
Exam tips
- Learn the three Fundamental Accounting Assumptions (Going Concern, Consistency, Accrual) as a ready-made one-mark answer — and remember that if any one is NOT followed it must be disclosed.
- In 'name/identify the concept' questions, link the keyword in the question: separate owner → Business Entity; only money items → Money Measurement; record when earned → Revenue Recognition/Accrual; match expenses to income → Matching; lower of cost or market → Conservatism.
- Never say the Cost Concept freezes value forever — it only blocks writing the asset UP; depreciation still reduces book value. This nuance is a common trap.
- For 'concept vs standard' questions, write that concepts are broad assumptions (direction) while Accounting Standards are detailed mandatory rules (specific treatment) — and that both apply together.
- For GST, remember the three keywords (comprehensive, multi-stage, destination-based) and the split: intra-state = CGST + SGST, inter-state = IGST.
- Answer point-wise with the concept named first; the marking scheme awards a mark for naming the correct concept and further marks for the explanation and example.
Quick revision
- GAAP = the shared rulebook (concepts + conventions + principles + standards) that makes accounts reliable, consistent and comparable.
- Fundamental Assumptions (must be disclosed if not followed): Going Concern, Consistency, Accrual.
- Basic Concepts: Business Entity, Money Measurement, Going Concern, Accounting Period, Cost, Dual Aspect, Revenue Recognition, Matching.
- Conventions: Full Disclosure, Consistency, Conservatism (Prudence), Materiality, Objectivity.
- Accounting Equation (Dual Aspect): Assets = Capital + Liabilities.
- Cash Basis vs Accrual Basis: Accrual records earned/incurred items (outstanding, prepaid, accrued) and is required for formal accounts; Cash records only actual receipts and payments.
- Accounting Standards: issued by ICAI; objectives = uniformity, reliability, comparability, check on manipulation. Ind-AS = standards converged with global IFRS for large/listed companies.
- GST: comprehensive, multi-stage, destination-based; intra-state = CGST + SGST, inter-state = IGST; Input Tax Credit removes cascading.
The full picture
Imagine two kirana shop owners in your neighbourhood. One records revenue only when cash lands in the drawer; the other records it the moment goods leave the shelf. At year-end, their profit figures look completely different — even if they sold identical amounts. This is exactly the problem accounting theory solves. By agreeing on a shared set of concepts, conventions, and standards, every business speaks the same financial language, so a bank in Mumbai can trust the accounts of a shop in Kochi.
The foundation is a set of basic accounting concepts — fundamental assumptions that every accountant treats as always true. The Business Entity Concept says the business and its owner are two separate people in accounting's eyes. So if Ramesh invests ₹5 lakh of personal savings into his printing shop, the shop's books record that ₹5 lakh as a liability (capital) owed back to Ramesh — not as the owner's own money. The Money Measurement Concept says we only record what can be expressed in rupees. A loyal team or a great location adds real value, but since you cannot put a firm ₹ figure on it, it stays off the balance sheet.
Three more concepts shape how assets and income are reported. The Going Concern Concept assumes the business will keep running indefinitely — so when a textile firm buys a ₹10 lakh loom, it spreads the cost over, say, 10 years rather than treating the whole amount as an expense today. The Cost Concept requires recording assets at the price actually paid. That loom stays at ₹10 lakh in the books even if it is worth ₹15 lakh next year — this keeps records objective and verifiable. The Dual Aspect Concept is the heartbeat of double-entry bookkeeping: every transaction has two equal effects. When Priya's bakery buys flour for ₹8,000 cash, Cash decreases by ₹8,000 and Stock increases by ₹8,000. Both sides always balance.
The Accrual Concept and the Matching Concept work as a pair to give you the true profit for a period. Accrual says record income when it is earned and expenses when they are incurred — not when cash actually moves. So if you tutor a student in March and receive payment in April, that income belongs to March. Matching then says: show in the same period all the expenses you incurred to earn that income. If a coaching centre earned ₹2 lakh in fees in April but also spent ₹40,000 on tutors' salaries and ₹5,000 on electricity in April, all three figures go into April's profit calculation together — giving a true ₹1.55 lakh net profit, not a misleadingly high ₹2 lakh.
Conventions are the practical customs that make concepts work in real life. Consistency means once a business chooses a method — say, the written-down value method for depreciation — it sticks to it every year, making year-on-year comparisons meaningful. Full Disclosure means important facts (pending court cases, big loans, changes in accounting policy) must be openly revealed, so no one reading the accounts is misled. Conservatism (also called Prudence) says: never anticipate a profit, but always provide for a likely loss. If a debtor owes ₹50,000 but looks unlikely to pay, create a provision now — don't wait and hope. Materiality says that only significant items need detailed treatment; a ₹50 pen bought for the office does not need its own ledger account.
Finally, Accounting Standards are the formal, mandatory rules issued by the Institute of Chartered Accountants of India (ICAI) that tell businesses exactly how to handle specific situations — how to value inventory, how to recognise revenue, how to account for leases. India follows Indian GAAP (Generally Accepted Accounting Principles) based on ICAI standards, while large listed companies also align with Ind-AS (India's version of IFRS, the International Financial Reporting Standards). Think of concepts as the constitution and standards as the detailed laws passed under it. Both are needed: concepts set the direction, standards give the exact steps.
An Indian example
Anjali runs a small boutique in Kochi. On 25 March she delivers a custom salwar suit worth ₹6,000 to a customer who promises to pay in April. Under the Accrual Concept, Anjali records ₹6,000 as income in March — the month the work was done — not in April when the cash arrives. She also records the cost of fabric (₹2,000) and the tailor's wages (₹800) in March, following the Matching Concept, so her March profit correctly shows ₹3,200. Her sewing machine, bought two years ago for ₹40,000, still sits in the books at ₹40,000 less accumulated depreciation — never revalued upward, because the Cost Concept demands objectivity. And because she runs her boutique as a registered business, even the ₹20,000 she personally withdrew for a family vacation is recorded as 'Drawings', not a business expense — that is the Business Entity Concept keeping her accounts clean. When Anjali's accountant files her GST returns and prepares her annual accounts, every figure traces back to one of these foundational rules.
Key concepts covered
- Accounting principles (GAAP)
- Concepts: business entity, money measurement, going concern, cost, dual aspect, accrual, matching
- Conventions: consistency, full disclosure, conservatism, materiality
- Accounting standards & IFRS overview
Common misconceptions to watch for
- Misconception: The Cost Concept means an asset's value in the books never changes. Correction: Cost Concept fixes how the asset is first recorded (at purchase price, not market price), but the book value does fall every year through depreciation. What the Cost Concept prevents is writing the value UP to a higher market price — it does not freeze the value forever.
- Misconception: Accounting Concepts and Accounting Standards are just two names for the same thing. Correction: They work at different levels. Concepts are broad foundational assumptions (like Going Concern or Dual Aspect) that apply everywhere, always. Standards are specific, mandatory rules issued by ICAI that tell you exactly how to handle one situation — for example, precisely how to value closing stock or when to recognise revenue from a long-term contract.
- Misconception: A business can choose either Cash Basis or Accrual Basis — both are equally acceptable for official accounts. Correction: Accrual Basis is mandatory under GAAP for any formal set of accounts (bank loan applications, GST filings, company financial statements). Cash Basis may be used for personal records or rough tracking, but it is not acceptable for statutory or published financial statements.
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Stop Memorizing Rules: Golden Rules of Accounting Fast
Questions
A textile company purchases machinery for ₹5,00,000 on 1 April 2023; market value rises to ₹6,00,000 by 31 March 2024. On 28 March 2024, the company invoices ₹2,50,000 for goods delivered; payment arrives 5 April. A ₹10,00,000 bank loan is due for repayment in 18 months. Classify each item under relevant accounting concepts and explain why each treatment is mandatory.
- 1Examine machinery cost vs. market value: Cost Concept governs initial recording.Cost Concept requires recording assets at original purchase price (₹5,00,000), not current market value (₹6,00,000). Market values fluctuate; cost is objective and verifiable. GAAP mandates cost-based recording, protecting balance sheet stability and comparability.
Question 1 of 5 · medium
An accountant asks: 'Should I follow Cost Concept or the depreciation standard for machinery?' What is the most accurate answer?
Quiz
Test yourself — pick an answer, then hit "Check" to see the explanation and your running score.
Question 1 of 5 · medium
An accountant asks: 'Should I follow Cost Concept or the depreciation standard for machinery?' What is the most accurate answer?
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