Theory Base of Accounting,
AS and IFRS
Master the 5 Accounting Concepts, 10 Accounting Principles, Accounting Standards and IFRS โ the theoretical foundation that governs every accounting entry ever made. Notes, 20 MCQs, and a 20-question built-in quiz.
The Rules Behind Every Entry
Every journal entry you write, every financial statement you prepare โ they are all governed by a set of agreed-upon rules, concepts, and principles. Chapter 3 explains why accounting is done the way it is. Without this theoretical foundation, accounting would be guesswork. CBSE exams frequently ask questions from this chapter in both MCQ and short-answer formats.
Accounting concepts (also called accounting assumptions or postulates) are the basic conditions or assumptions upon which the science of accounting is based. They are universally accepted guidelines that every accountant follows.
1. Going Concern Assumption
Going Concern Assumption
It is assumed that the business will continue to operate for an indefinitely long period in the future โ it will not be wound up or sold in the near future.
Because of this assumption, accountants record assets at their historical cost rather than market value (since there is no intention to sell them). Depreciation is also charged based on the expected useful life of the asset rather than its current realisable value.
2. Consistency Assumption
Consistency Assumption
Once an accounting method or policy is adopted, it should be followed consistently from year to year. The same method should not be changed arbitrarily from one period to another.
Consistency ensures that financial statements of different years can be meaningfully compared. If depreciation is charged using the Straight Line Method (SLM) in Year 1, it should continue to be charged using SLM in subsequent years โ unless there is a valid reason to change and the change is clearly disclosed.
3. Accrual Assumption
Accrual Assumption
Revenue is recognised when it is earned (not when cash is received), and expenses are recognised when they are incurred (not when cash is paid). This is the foundation of the accrual basis of accounting.
The Accrual concept ensures that the Profit & Loss Account shows the true profit for the period โ not just the cash inflows and outflows. All income earned during the period is credited, and all expenses incurred during the period are debited, regardless of whether cash has been received or paid.
| Item | Accrual Treatment | Example |
|---|---|---|
| Accrued Income | Recognised as income even if cash not yet received | Rent earned but not yet received โ debited to Accrued Rent A/c, credited to Rent Received A/c |
| Income Received in Advance | NOT recognised as income in current period | Advance subscription received โ shown as a liability until the service is provided |
| Outstanding Expense | Recognised as expense even if cash not yet paid | Salaries due but not paid โ debited to Salary A/c, credited to Outstanding Salaries A/c |
| Prepaid Expense | NOT fully recognised as expense in current period | Insurance paid for 15 months โ only 12 months charged to P&L; balance is Prepaid (Asset) |
4. Money Measurement Assumption
Money Measurement Assumption
Only those transactions and events that can be expressed in terms of money are recorded in the books of accounts. Events that cannot be measured in money are not recorded.
Money serves as the common unit of measurement โ it allows different types of assets, liabilities, incomes, and expenses to be added together and compared in the financial statements.
5. Accounting Entity (Business Entity) Assumption
Accounting Entity Assumption
For accounting purposes, the business is treated as an entity completely separate and distinct from its owner(s). The business has its own identity, its own assets and liabilities, and its own books of accounts.
This assumption forms the basis of the whole system of accounting. Because the business is separate from the owner, when the owner invests money, the business owes it back to the owner โ hence Capital is shown as a liability of the business to the owner.
โข Owner invests โน10,00,000 โ Business treats it as Capital (liability to owner), not as its own money
โข Owner takes cash home for personal use โ Recorded as Drawings (reduces Capital), not as business expense
โข Owner's personal car โ Not recorded in business books at all
โข Owner's personal loan โ Not a business liability
This concept applies to all forms of business โ sole proprietorship, partnership, company. Even though a sole proprietor and their business are the same legal person, for accounting purposes they are treated as separate entities.
Accounting Principles (also called Generally Accepted Accounting Principles โ GAAP) are the rules and guidelines that govern how transactions are recorded and reported. The CBSE syllabus lists the following 10 principles:
Matching Principle (Matching Concept)
Expenses of a period must be matched against the revenues of the same period. All costs incurred to earn revenue must be recognised in the same period as that revenue โ not earlier, not later. This is why adjustments (accruals, prepayments) are made.
Cost / Historical Cost Principle
Assets are recorded at their original purchase price (historical cost) and not at market value. The cost principle provides objectivity โ the purchase price is a verified fact, while market value is subjective and changes daily.
Prudence / Conservatism Principle
Anticipate all possible losses and provide for them immediately, but do not anticipate profits until they are actually realised. When in doubt, choose the method that understates โ not overstates โ assets and profits.
Materiality Principle
Only information that is significant enough to influence the decisions of a user needs to be separately disclosed. Insignificant (immaterial) items can be clubbed together or ignored without compromising the usefulness of accounts.
Full Disclosure Principle
All information that is material and relevant to users must be fully disclosed in the financial statements or in the notes to accounts. Users should not be misled by omission of important information.
Accounting Period Principle
The life of a business is divided into fixed periods (usually 12 months) called accounting periods. Financial statements are prepared at the end of each period so that performance can be measured and compared periodically.
Dual Aspect Principle (Duality)
Every transaction has two equal and opposite aspects โ a debit and a credit. This is the foundation of the Double Entry System. The accounting equation (Assets = Capital + Liabilities) always remains balanced because of this principle.
Revenue Recognition Principle
Revenue is recognised (recorded) when it is earned โ when the sale is complete or the service is rendered โ not when payment is received. This aligns with the Accrual concept and prevents premature or delayed recognition of income.
Verifiable Objective (Objectivity) Principle
All accounting entries must be supported by objective, verifiable evidence โ source documents like invoices, receipts, vouchers, bank statements. Accounting should be free from personal bias; figures should be backed by documentary proof.
Matching Principle โ Application
Adjustments for outstanding expenses, prepaid expenses, accrued income, and income received in advance are all direct applications of the Matching Principle โ ensuring revenues and expenses of the same period are matched correctly.
Matching ยท Cost ยท Prudence ยท Materiality ยท Full Disclosure ยท Accounting Period ยท Dual Aspect ยท Revenue Recognition ยท Verifiable Objective ยท Matching Application
Remember: MC PM FAD RVM
Accounting Standards โ Meaning and Nature
Accounting Standards (AS) are written policy documents issued by an expert regulatory body that establish rules, guidelines, and procedures for recording and reporting specific types of transactions in financial statements.
IFRS โ International Financial Reporting Standards
IFRS are a set of accounting standards developed by the International Accounting Standards Board (IASB) โ a global body based in London โ to create a single set of high-quality, globally accepted financial reporting standards.
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20 MCQs โ Theory Base of Accounting, AS and IFRS
Mixed difficulty โ covers all three parts of the chapter. Correct answers highlighted green.
Chapter 3 โ Live Quiz
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