Fundamental Accounting Concepts Explained

The first two accounting concepts, the Business Entity Concept and the Money Measurement Concept, are fundamental to accounting. Let us examine each one briefly:

Business Entity Concept

According to this concept, the business and the owner are two distinct entities. In other words, the individual and the business are separate.

Example: Mr. A starts a business named M/s Independent Trading Company and introduces capital of Rs 2,00,000 in cash. This increases the cash balance of the company by Rs 2,00,000, while simultaneously increasing the company's liability to Mr. A in the form of capital.

Money Measurement Concept

According to this concept, we can only record transactions in our accounting records that can be measured in monetary terms.

Going Concern Concept

Accounting is based on the assumption that a business unit is a going concern. We record all financial transactions with the perspective that the business will continue to operate indefinitely. Without this assumption:

• Bankers would not provide loans.
• Suppliers would not provide goods or services.
• Employees would not work effectively.
• The method of recording transactions would change entirely.

Cost Concept

This important concept is based on the Going Concern Concept. We record the value of assets at cost, rather than at net realizable value or market value. While we reduce the value of assets through depreciation, we ignore market fluctuations.

The cost concept prevents manipulation of financial records. However, a downside is that it ignores the effects of inflation, which can be significant. Despite this, the cost concept remains widely and universally accepted.

Dual Aspect Concept

Every financial transaction requires a double entry, meaning debits must always equal credits. Every transaction has a dual aspect:

• We receive a benefit.
• We provide a benefit.

Matching Concept

The matching concept is based on the accounting period concept. The expenditures of a firm for a specific period must be matched with the revenue of the same period to ascertain accurate profit or loss. This practice is globally accepted.