The concept of accounting relates to how a business keeps track of its financial activities. It involves recording and reporting transactions to various interested parties. The information gathered from these transactions helps management and outside agencies make decisions. It can also help businesses build goodwill by providing information that is unbiased and verifiable.
For instance, a business may acquire land for a specific price. The land is then recorded on the books at the cost of acquisition. However, that land may increase in value by two times its original cost within two years. Under the cost concept of accounting, the acquisition cost will appear on the balance sheet, but not the present value of the land.
Another important concept of accounting is money measurement. This concept of accounting states that transactions should be measured in money. It also limits the type of information recorded in the books of accounts. For example, a sales invoice will not record the research department’s creativity. It will also not record sales that were not realized. It is vital to record sales and purchases accurately in order to avoid financial irregularities.
The basic idea of accounting is to keep track of financial transactions and maintain control over those activities. This is important as business transactions occur every day. If these transactions are not recorded, it becomes difficult to calculate profits and credit balances. This is the primary function of accounting. The concept of accounting helps a business make informed decisions and improve its profitability.
Accounting distinguishes between revenue expenditure and capital expenditure. Businesses use the double-entry concept when keeping records. Each transaction has two aspects: cash required for the purchase and an obligation to pay in the future. This concept is what lays the foundation for the double-entry system of book keeping. It is the basis for determining income and expense, and helps a business calculate its profits and losses.
The conservative concept of accounting states that an organization should record all transactions prudently. It should also account for losses and expenses that are yet to be realized. This concept is important in times of uncertainty, as it protects creditors. A conservative approach to accounting also ensures that businesses can manage their cash flow without overpaying. Once the accounting cycle is completed, a company will have financial statements that are comparable and accurate. Accounting is a process where many people are involved.
A business entity is a separate entity from its owner. Hence, its accounting records are separate and independent from the owner’s personal finances. This allows the business owner to avoid personal liabilities, while building creditworthiness. This concept allows the business owners to make the right decisions for the business. It can also help stakeholders make appropriate decisions, as it enables them to make the right business decisions.
The matching concept dictates that revenues and expenses should be matched. Revenue can be earned in one period, while costs can be incurred in the next. The same goes for expenses related to revenue.