Accrual concept

Accrual concept

According to this concept, a transaction is recorded at the time, it takes place and not at the time when settlement is done.

In other words,revenue is recorded when sales are made or services are rendered and it is irrelevant as to when cash is received against such sales. Similarly, expenses are recorded at the time when they are incurred and it is irrelevant as to when payment is made in cash for such expenses.

Thus, to find out correct profit and to show a true financial position of an enterprise at the end of accounting period, all expenses and income belonging to that particular accounting period are shown whether cash has been paid or received or not.

Example Goods are sold to Raju on 1st January 2016 on a credit of 3 months. In this instance, a sale will be recorded on 1st January 2016 although the amount will be received on 1st April 2016.

What is cost concept in Accounting?

What is cost concept in Accounting

Cost concept in Accounting-By this post, we shall study in detail the important cost concept out of 12 various accounting concepts on which accounting is based. If you have a business and you are doing cost valuation in accounting then you should know about this important cost concept.

What is the cost concept?

The cost concept is a concept of accounting which states that the value of an asset will be calculated on the basis of historical cost or acquisition cost. Such as an asset purchased at 25 lac in 1999 and same cost will be shown in 2022 financial statement in all future years.

How can you explain the cost concept?

As per this concept, the value of an asset is to be calculated on the basis of historical cost, in other words, acquisition cost. Although there are various measurement bases, accountants traditionally prefer this concept in the interests of objectivity.

When a machine is acquired by paying 5,00,000 then according to cost concept, the value of the machine is taken as 5,00,000. It is highly objective and free from all bias.

Other measurement bases are not so objective. Current cost of an asset is not easily determinable. If the asset is purchased on 1.1.1994 and such model is not available in the market, it becomes difficult to determine which model is the appropriate equivalent to the existing one.

Similarly, unless the machine is actually sold, realisable value will give only a hypothetical figure. Lastly, present value base is highly subjective because to know the value of the asset one has to chase the uncertain future.

Exemptions of the cost concept in Accounting

However, the cost concept creates a lot of misrepresentation too as shown below :

1. In an inflationary situation when prices of all commodities go up on an average, acquisition cost loses its relevance.

For example, a piece of land purchased on 1.1.1994 for 5,000 may cost 1,00,000 as on 1.1.2020. So if the accountant makes valuation of asset at historical cost, the accounts will not reflect the true position.

2. Historical cost-based accounts may lose comparability.

For example– Mr. S invested 1,00,000 in a machine on 1.1.1995 which produces 50,000 cash inflow during the year 2020, while Mr. N invested 5,00,000 in a machine on 1.1.2005 which produced 50,000 cash inflows during the year. Mr. S earned at the rate 50% while Mr. N earned at the rate 10%.

(3. Many assets do not have acquisition costs. Human assets of an enterprise are an example. The cost concept fails to recognise such asset although it is a very important asset of any organization.

Many other controversial issues have arisen in financial accounting that revolves around the cost concept which will be discussed at the advanced stage. However, later on we shall see that in many circumstances, the cost convention is not followed.

Example of cost concept?

As We know that according to this concept, the value of an asset is to be calculated on the basis of historical cost, in other words, acquisition cost.

Let’s take an example of a business that purchases a building worth 200,000 in cash or bank.

In the accounting records, following the cost concept of accounting, the value of the building will be entered at its cost price means 200000.

After four years, the value of the building rises to 1000,000. However, under the cost concept, the accounting records will continue to show the value of the building at the cost price of 200,000 less depreciation.

Historical cost is verifiable. It represents the cost that was objectively agreed upon by the buyer and seller. Hence, the basic objective of the cost concept is the measurement of accurate and reliable profits and losses for a business over a period of time.

Why cost concept is important?

Reliable:The process of showing historical cost on a business balance sheet is always the same. It doesn’t change hence it’s reliable. This is important because anyone looking at a balance sheet can get a reliable picture of the assets of the business.

Consistency: Using historical cost principle ensures that your balance sheet is consistent from period to period. This is even more important when sharing that balance sheet with outside entities, such as investors and lenders.

No adjustments required: As long as you consistently handle all your assets using the cost principle, costs will not change, always ensuring that your financial statements are accurate and not based on fluctuating fair values.

Comparable: It’s easy to compare the cost of one asset with another using the historical cost principle. This is important when making decisions about assets.

Verifiable: It’s also easy to verify historical cost because there are records underlying what’s showing on the balance sheet.

How does the cost concepts work?

An asset of a business is something in value that you buy for your business, like a laptop or furniture, and has two values:

The cost (what you paid for it when you bought it) and Its value or fair market value (what you could get for it if you sold it).

The original cost can include everything that goes into the cost, including shipping and delivery fees, setup, and training. With a few exceptions (stocks and bonds, for example), all other business assets are recorded using the historical cost principle. These assets can be anything from equipment and computers to vehicles, land, and buildings.

The cost concept states that virtually all business assets must be recorded as the value on the date the asset was bought or assumed ownership.

Further Faqs related to cost concepts

What do you mean by cost concept in accounting?

The cost concept is an accounting principle that records assets at their respective cash amounts at the time the asset was purchased or acquired. The amount of the asset that is recorded may not be increased for improvements in market value or inflation, nor can it be updated to reflect any depreciation.

What are the basic cost concepts?

Understand basic cost concepts

1.Total

2.Average

3.Fixed

4.Variable

5.and Marginal costs.

If I use the cost concept, should I still depreciate assets?

Yes. Using the cost concept will record the asset cost at its original cost, but you will still have to depreciate the asset, as in most cases it will continue to lose value, or depreciate.

Should you use the cost concept?

If you currently use accrual accounting in your business and wish to be GAAP compliant, you should be using the cost principle. Since publicly owned companies are required to be GAAP compliant, they should be using the historical cost principle as well.

 

Continuity concept

Continuity concept

Accounting supposes that the business as an accounting entity will continue to operate for a long time in the future, unless there is superior evidence to the contrary. The enterprise is seemed as a going concern, which is as continuing in operation, in any case in the foreseeable future. The owners have no purpose, nor have they the requirement to wind up or liquidate its operations.

This assumption is of considerable significance, for it implies that the business is looked as a mechanism for adding value to the resources it uses. The success of the business can be measured through the difference between output values as sales or revenues and input values as expenses. Thus, all unused resources can be reported at cost quite than at market values as, as per to the continuity concept, the future instead of selling them out rightly in the market.

The assumption about the business is not expected to be liquidated in the foreseeable future, actually establishes the basis for a lot of of the valuations and allocations in accounting. For illustration, depreciation or amortization procedures rest on this concept. This is this assumption that underlies the decision of investors to commit capital to enterprise. The notion holds that continuity of business activity is the sensible expectation for the business unit for that the accounting functions is being performed. Merely on the origin of this assumption can the accounting process continue stable and attain the objective of correctly recording and reporting on the capital invested, the position of the enterprise and the efficiency of management as a going concern. In this assumption neither liquidation values nor higher current market values are of particular importance in accounting. This assumption gives a origin for the application of cost in accounting for assets.

Though, if the accountant has good reasons to believe that the business, or a few part of it, is going to be liquidated, or which it will cease to operate as like in a year or two, then the resources could be reported on their recent values or liquidation values.

What is Money Measurement Concept?

What is Money Measurement Concept?

Money measurement concept is an important accounting concept that is based on the theory that a company should be recording only those transactions that can be measured or expressed in monetary terms on the financial statement.

Money measurement concept is also known as Measurability Concept, which states that during the recording of any financial transactions, those transactions should not be recorded which cannot be expressed in terms of monetary value.

Characteristics of Money Measurement Concept

Following are some of the characteristics of the money measurement concept

1. It takes money as a common parameter for the measurement of performance of a company.

2. It records only those transactions that can be recorded in monetary value.

3. Presenting the value of business in monetary terms helps in ease of communication between management and the stakeholders.

4. It does not take into account the impact of inflation on the recording of transactions.

Importance of Money Measurement Concept

As money is regarded as a common unit of recording transactions related to the income, profit, loss, capital, assets and liabilities of a business, it becomes easier to record and present business transactions into the financial statements such as Profit and Loss statement and Balance Sheet.

Exceptions to Money Measurement Concept

Examples of transactions that cannot be recorded in monetary value

1. Employee skill set and quality

2. The efficiency of the administration

3. Product and service quality

4. Employee and stakeholders satisfaction level

5. Safety measures of the company in order to prevent any hazard.

Advantages of Money Measurement Concept

Following are some of the advantages of the money measurement concept

1. It helps in maintaining business records by recording all transactions that are having monetary value.

2. It is helpful in preparation of financial statements (such as Profit and Loss Statement, Income Statement)

3. As the financial transactions are recorded in a proper manner, it becomes easy when two separate accounting periods are compared.

4. It provides a clear picture of the financial transactions and state of the business which help in assessing the investors in knowing the status of their investment.

Limitations of Money Measurement Concept

Some of the limitations of the money measurement concept are as follows:

1. It does not take into account the impact of non-monetary events on business.

2. It ignores the impact of inflation on historic costs

Business Entity concept

Business Entity concept

The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner. Without this concept, the records of multiple entities would be intermingled, making it quite difficult to discern the financial or taxable results of a single business. Here are several examples of the business entity concept:

A business issues a $2,000 distribution to its sole shareholder. This is a reduction in equity in the records of the business, and $2,000 of taxable income to the shareholder.

The owner of a company personally acquires an office building, and rents space in it to his company at $6000 per month. This rent expenditure is a valid expense to the company, and is taxable income to the owner.

The owner of a business loans $100,000 to his company. This is recorded by the company as a liability, and by the owner as a loan receivable.

There are many types of business entities, such as sole proprietorships, partnerships, corporations, and government entities.

Reasons for the Business Entity Concept

There are a number of reasons for the business entity concept, including the need to separately track taxes, financial performance, and financial position for each entity. It is also useful for when an organization is liquidated, to determine the amounts of payouts to the various owners. Further, the business entity concept is needed from a liability perspective, to ascertain the assets available in the event of a legal judgment against a business entity. And finally, it is not possible to audit the records of a business if the records have been combined with those of other entities and/or individuals.