Accounting Concepts Explained

What are Accounting Concepts?

 Accounting concepts are the essential rules and procedures that must be followed when working with accounting data, both as generated and when interpreting it. Accounting concepts are the basis of the preparation of a universal form of financial statements. In the case of accounting, it refers to procedures and rules used when calculating and reporting the profits or losses of a company.

Concepts include statements of comprehensive income, statements of stock-based income, statements of Cash flows, and Notes. These statements need to be checked against the information provided by other systems (such as tax returns), other sources of available facts, and informal communication from management.

Objectives of Accounting Concepts

  • Accounting concept Improves the functioning and efficiency of an organization.
  • Accounting concept helps a group or business work on certain tracking sets so that they can improve the performance of an operation.
  • Accounting concept primarily focuses on monitoring whether a business is operating at an optimum level, representing profits. 
  • Accounting concepts are often used alongside statistical analysis techniques to improve risk assessment and management.

9 Basic Accounting Concepts Every Small-Business Owner Should Know

1. Accrual

Accrual accounting means you record income and expenses when they are due, not when you receive the cash. This is important because a business’s financial position is better measured using accrual basis statements than cash-basis statements. Accrual basis accounts for any amount that comes in after a specific date and is needed to meet current expenses. For example, if you sell the product on a certain day and collect cash from your customers plus any profit, then the day-of-sale cash would be included in your accrual basis account. Cash basis accounting recognizes the existence of day-of-sale cash purchases and any future gains from such sales even if the actual purchase price isn’t paid until later in the accounting period.

2. Consistency

Accounting consistency means that you should follow it in every subsequent record once you choose an accounting method, such as cash or accrual accounting. This helps the business to compare performances in different accounting periods more accurately. To ensure that the data is comparable over time and therefore more valuable, consistency in accounting is highly valued. This also simplifies the process of filing small-business taxes.

3. Going Concern

The concept of a going concern says that the business is solvent and is expected to continue functioning for a reasonable number of years. This idea allows them to defer certain expenses into future accounting periods. On the other hand, if it appears that the business is about to go under, liquidation of assets might be started.

4. Conservation

Conservation is about treating similar revenues and expenses consistently. A guideline for when to recognize revenue and expense items in your financial statements is that if you have a reasonable expectation of selling the item or service, you should recognize the income at that time. If you can’t identify a specific customer with whom you’ll sign an agreement to transfer goods or services, it probably doesn’t make sense to include the revenue yet. Conservation is one of the most challenging areas in accounting because it requires organizations to make difficult judgments about what revenue is and how expenses should be treated.

5. Economic Entity

To ensure that financial statements reflect only business transactions, first, businesses should maintain separate bank accounts for personal and business purposes. Larger corporations may be required to maintain a general ledger in which all transactions are recorded. Suppose personal funds are commingled with business funds. In that case, the financial information must accurately reflect this fact — for example, by showing accounts payable to the owners and accounts receivables from the owners.

6. Materiality

The concept of materiality is considered to be one of the most important accounting concepts. It states that companies should document all-important financial transactions in their journal entries. This means that even if this results in small amounts being recorded, it’s better to give a comprehensive look at the company’s financial dealings.

7. Matching

The matching concept is one of the fundamental accounting methods used to ensure a company’s financial statement is accurate and free from errors. It states that expenses must be matched with revenues on the income statement and expense account.

8. Accounting equation

The basic accounting equation is one of the most fundamental concepts in accounting. Assets are recorded on the left side of your general ledger and debited. The left side of an accounting equation will contain the balance sheet items. The right side will accumulate either assets or liabilities. 

Assets = liabilities + owner’s equity

9. Accounting Period

The accounting period is one of the nine most important concepts in accounting. Every financial statement should be confined to the specific accounting period under consideration. This concept is very important for businesses that need to evaluate their performance regularly. To understand this concept at a deeper level, let’s take a look at three main financial statements:

  • Profit and loss statements reflect a company’s income, expenses, gains, and losses over time.
  • The income statement and statement of cash flows tell you how much money your business made or lost over a given period.
  • A balance sheet summarizes a company’s assets, liabilities, and owner’s equity as of a certain date.

An accounting concept gives a clearer picture of how business functions and its overall financial position than other businesses that use fixed time and place investments for their reporting. Accountants provide accounting concepts to companies regularly.