Principles and concept of Accounting | An overview

Hi, you are on this platform because you want to know the meaning of the concept “Accounting”

So we are going to be examining the meaning of the concept Accounting from the financial and business points of view.

So the concept of “Accounting” is simply the process of recording, analyzing, classifying, summarizing,
communicating and interpreting financial information so as to maximize the value of the information produced. The process reflects in aggregate, and in detail, all transactions involving the receipts, transfer and disposition of an entity’s funds and property.

It can be justified that the purpose of accounting is to provide relevant, reliable, understandable and comparable information, which may be used by:

  • Owners to help them appraise the organization’s performance and make decisions as to its future;
  • Lenders and investors to help them decide how much money and interest to devote to the business;
  • Managers and employees to enable them determine how best to devote their time and efforts towards the efficiency and effectiveness of the daily activities of their business; and
  • Governmental bodies to determine how much tax an organisation must pay.

And other users of accounting information include customers, suppliers and advisers/researchers as well as the general public.

So to achieve its purpose, accounting statements are therefore prepared to conform with Generally Accepted
Accounting Principles (GAAP) and Standards.

Branches of Accounting

The four commonly recognized branches of accounting include:

  1. Financial Accounting
  2. Cost Accounting
  3. Management Accounting, and
  4. Government Accounting

Basic concepts/terms and principles associated to Accounting

1. Accountancy

The term accountancy is used interchangeably with accounting. So it refers to the activity of preparing and auditing financial records and statements of organizations.

Used as a noun, the term could also be used to describe the profession of an accountant.

And one could thus say that a Chartered Accountant is a person who is academically qualified, skillful and proficient in the ‘accountancy’ profession.

2. Account

Here, the term “Account” refers to any document or device whereby a record is kept of flows of value measured in monetary terms. A business will thus record all of its transactions in a set of account, all transactions with persons, firms, or any particular kind are recorded. An account is opened for each person, firm or company with which the business deals; for each asset such as cash, stock, plant, etc.; for each of the main source of income profit, e.g. the sale of goods, investment income etc.; and for each item of expenditure such as purchase, business expenses, salaries and wages, etc

3. Accounting Bases

The various available methods of recording financial transactions and for the construction of financial statements from which a business might select are referred to as accounting bases. Whichever basis in selected then becomes the business’s accounting policy. Depreciation, for instance, may be based on one of several bases. Also, the receipt of cash or the commitment to pay cash may form the basis for recognizing an item of revenue or expense.

So the commonly recognized bases of accounting include:

  1. Cash Basis
  2. Commitment Basis
  3. Accrual Basis, and
  4. Fund Basis

4. Accounting Concept

Accounting Concepts are fundamental framework of ideas which underlie the preparation of accounts. So in other words, they are rules which lay down the way in which the activities of a business are recorded with a view to ensuring objectivity in financial accounting.

Therefore, Accounting concepts arose out of the desire to provide the same set of accounts for many different parties and thus to provide a measure that gains the consensus of opinion. And there is no authoritative agreement on what these concepts are, or ought to be although some attempts have been made to codify them.

So some commonly known accounting concepts are listed below:

  1. Entity concept
  2. Going concern concept
  3. Money Measurement concept
  4. Dual concept
  5. Accrual concept

5. Accounting Conventions

These refer to the generally accepted approaches to the application of accounting concepts (5) and accounting bases. They are guides developed to mitigate the effects of misinterpreting the accounting concepts and accounting bases.

So accounting conventions serve as rules for resolving uncertainties in recording items. And the three main types of conventions include Conservatism, Consistency, and Materiality.

Other minor ones include Comparability, Objectivity, Neutrality and Reliability.

6. Accounting Cycle

The accounting cycle refers to the sequential (and repetitive) accounting procedures used in recording, classifying and summarizing accounting information. It begins with the initial recording of business transactions and ends with the preparation of formal financial statements summarizing the effects of these transactions upon the assets, liabilities and owners’ equity of the business. The term ‘cycle indicates that these procedures must be repeated continuously to
enable the business to prepare new up-to-date financial statements at reasonable intervals.

Generally, the accounting cycle could be summarized sequentially as follows:

  1. Analysis of business transactions and recording them in journals as they occur.
  2. Transferring (posting) journal entries into the debit or credit sides of the ledger accounts:
  3. Preparation of a trial balance and a worksheet to enter all necessary adjustments;
  4. Preparation of financial statements – income statements, a statement of retained earnings, and a balance sheet – using the information in the trial balance and the worksheet;
  5. Making necessary adjustments to the final accounts and closing the accounts;
  6. Preparing an after-closing trial balance to prove the equality of the debit and credit balances in the ledger accounts.

7. Abnormal Cost

Abnormal Costs are costs incurred in connection with an activity but which would not normally have been expected to be incurred. Events such as wastage of raw materials during production, sudden rise in material prices, infrequent and uncontrollable accidents, etc., could give rise to abnormal costs. Since abnormal costs relate to some unanticipated and non-recurring events, they do not provide information on economic performance which assist managers to manage.

The accounting treatment of abnormal costs is to exclude them from all costs, i.e. charge only normal costs to product or period costs, and then debit the costing profit and Loss account with the total of abnormal costs in the period to which they relate, that is treat them as expenses.

8. Abnormal Losses

These are losses caused by unexpected or abnormal conditions such as substandard materials, carelessness, accidents, improper mixing of ingredients, incorrect cutting of cloth by a tailor, etc.

The Accounting treatment of abnormal losses is to treat them as period costs and have them written off to the costing profit and loss account at the end of the period to which they relate. This is effected by opening a separate account to which is debited the cost of material, labor and overhead incurred as a result of the wastage.

9. Abnormal Wastage

A “waste” is a discarded substance which has no value or even negative value. Examples include sawdust, gasses, smoke, or a bottle of beer into which some pieces of broken glass have fallen with the result that the beer is unfit for consumption and must be discarded. An abnormal wastage is thus, that which leads to an unanticipated additional cost. Its significance is that it represents a loss due to avoidable causes as opposed to a necessary part of the cost of production. It should therefore, be written off separately in the costing profit and loss account.

10. Above-the line account

Above-the-line-accounts are budgetary accounts which are provided for in the estimates and are used for preparing the statement of results of operations. In other words, they are accounts which are included in the profit and loss account of a business. The “line” is that which separates the profit and loss account from the appropriation account.

In government accounting, above the line accounts are normally classified by function (e.g public safety, public works, etc); by programme (e.g Guineaworm eradication, human resource development, urban transportation) etc.

Above-the-line-accounts should be contrasted with Below-The-Line- Accounts

11. Abnormal Gain

Abnormal gain is a gain which results when the actual loss in a production process is found to be less than expected. It is calculated thus:

Abnormal gain = Expected loss – Actual loss.

So the resulting gain is credited to the profit and loss account.

12. Abridged Account

This refers to a summarized account of a business as distinct from a fully detailed financial statement. It however, covers the full financial period to which it relates.

Abridged accounts are often used where a company wishes to give information of its financial affairs in a summarized form to those who may not be statutorily entitled to, or require, a full set of accounts, e.g. its employees, and the non-investing members of the public.

13. Absorption Costing

Sometimes called full costing, absorption costing is a method of costing whereby all costs of production are charged to identified units of production. The technique is based on the concept that all normal costs of running an enterprise should be charged in some way to all the cost units produced. In other words, the cost units absorb the total costs.

Under absorption costing, each cost unit will be charged with:

  • Its direct material, labor and overhead as well as;
  • Its fair share of indirect costs, including those not directly attributable to the unit

14. Accelerated Depreciation

This is a depreciation method in which depreciation of an asset is calculated in such a way as to ensure that a large proportion of the value of an asset is written off in the early parts of its life than in the later parts. The method may be used either because it is believed that it reflects the actual patterns of the decline in value of the asset or because as a general principle it is regarded as more prudent to write off assets as quickly as possible.
Examples of accelerated depreciation methods include the Reducing Balance Method and the Sum Of The Year’s Digits Method.

15. Accrual Concept

The accrual concept in accounting is similar to the realization concept and it provides that revenue will be acknowledged when earned or due and not when
cash is paid, and costs will be taken into account when the expenditure has been incurred (or commitment to incur it has been made) and not when paid for. The concept gives rise to debtors and creditors in business transactions and may also give rise to transactions such as accrued charges and prepayments.

16. Accounting Policies

A policy is a general guide to action. It is a predetermined, selected course of action as guideline towards accepted goals and objectives. Accounting policies are thus the particular accounting basis judged by a business to be the most appropriate to its own circumstances and therefore, the one which it adopts. Anyone or more of the accounting concepts and bases
discussed in the various pages of this website could be adopted by a business as accounting policy. Accounting policies concern such matters as depreciation, stock and asset valuations and foreign currency transactions.

17. Accounting Procedures

A ‘procedure’ could be defined as series of sequentially related steps are followed to accomplish a given purpose. Accounting procedure thus, refers to a clearly defined sequence of actions prescribed for the recording of a particular type of transaction. A procedure specifies the order and timing of accounting work as well as who should do what and to what end.

18. Accounting Rate of Return (ARR)

This is an investment appraisal technique which involves a crude arithmetical determination of the rate of return offered by an investment project. It should be contrasted with the theoretical and more acceptable Internal Rate of Return (IRR). ARR defers from other capital budgeting methods in that profits, rather than cash flows, are used.

Accounting rate of return is given by:
ARR = Average Annual Profit multiply by 100 divided by Average Annual Investment 1

ARR is a more comprehensive measure of economic performance than a measure of productivity since it includes the capital employed figure.

19. Accounting Technician

In general terms, a technician is a person who is skilled in the technique of a particular science or craft. Accounting technician is thus described as a person who works on accounting process at a level above merely clerical (book-keeping) but below the level of operation of a fully qualified accountant. An accounting technician may prepare the draft final accounts of a business but an accountant would be needed to complete these and to interpret them. The Institute of Chartered Accountants of Nigeria (ICAN) in 1988 inaugurated the Accounting Technicians Scheme (ATS). Evaluating the Schemes Certificate in one of its releases, the ICAN states that, “… an accounting technician is a middle level officer who operates between the clerical staff in the Accounts Department and the professional accountant. Essentially, he/she should be able to work through a set of data up to trial balance and, in small and middle organizations prepare the final statements”.

20. Accrual

To accrue’ means to allow something to accumulate over a period of time. In accounting accrual refers to a liability arising from goods and services provided to a business in form of a continuous supply, consumed up to an accounting date but not paid for by that date.

Accruals are required in order that matching in the calculation of profit can be achieved. Electricity, gas, rent, telephone charges, and rates are common subjects
of accrual. Such accumulated costs are referred to as accrued costs. The accounting treatment of accruals is to adjust them (i.e. add to or subtract from the relevant items) in the profit and loss account and show them on the balance sheet as current liabilities. Accrued income is credited to the profit and loss account and shown on the balance sheet as current assets.

21. Accrual Basis (Accural Accounting)

This refers to that basis of preparing financial statements in strict compliance with the accrual concept. It takes into account not merely amounts paid and received but also expenses accrued but not paid, and for income accrued but not received. The accrual basis is the normal method for the preparation of accounts
of commercial organizations. The accruals basis makes the distinction between the receipts of cash and the
right to receive cash and the payment of cash and the legal obligation to pay cash.

22. Accumulated Depreciation

Accumulated depreciation is the total amount of depreciation provided on a fixed asset from its date of purchase to the present time. The accumulated depreciation figure will thus include depreciation for several years. Fixed assets are normally shown on the balance sheet at their purchase prices less accumulated provisions for depreciation.

23. Accumulated Fund

Accumulated fund is a term used in the accounts of non-profit-making organizations (clubs, churches, etc) which is analogous to the capital of profit-making organizations. We can, therefore, describe accumulated fund as an item on the balance sheet of a non-profit-making organization representing the net investment (Assets less liabilities) in the organisation of its contributing members. In a profit-making organisation: the relationship between normal and abnormal wastage can be expressed thus:

  • Abnormal Wastage = Actual Wastage – Normal Wastage;
  • Normal Wastage = Actual Wastage – Abnormal Wastage;
  • Actual Wastage = Normal Wastage + Abnormal Wastage.

Assets – Liabilities Capital, but in a Non-profit-making organisation: Assets – Liabilities = Accumulated Fund.

Note that in profit-making organizations the concept of capital is associated with proprietorial rights and with the earning of profit, but the reverse is the case with the concept of accumulated fund which is not associated with profit-making.

24. Acid Test Ratio

Acid-test ratio is a variant of the current ratio and it expresses the ratio of liquid assets to current liabilities (liquid assets here refer to those assets which
are in cash or near cash form, e.g. cash, bank balances and debtors). Acid test ratio is regarded as the ultimate test of a businesses’ short-term ability to pay their debts.

The ratio is given by:
Acid test ratio = liquid Assets (current assets – stock) divided by Current liabilities.

Traditionally, an acid test ratio of 1:1 is considered healthy, but much depends upon how soon each class of liability must be paid.

25. Acquisition

Acquisition is the amalgamation with a company’s business of a previously independent business by the purchase of that business from its owners. The consideration for the purchase may be cash or it may be shares in the acquiring company. The acquired company then becomes the branch or subsidiary of the acquiring company.

An acquisition must be distinguished from a combination in which no purchase consideration is paid.