Accounting – Accounting Concepts

We wrote about four basic concept of accounting, i.e. going concern, business entity, money measurement, cost concept, the dual-entry concept and the realization concept.

The seventh concept is the Accrual – If money has not been realized, it should be capable of being accrued as payable / receivable

This by far is one critical concept of accounting. What is accounting supposed to provide? A true and fair view of the business for a certain period, clearly reflecting the profit or loss for that period and the net worth of the business as at the end of that period.

Now imagine you did accounting purely based on cash, i.e. record a transaction only when cash was exchanged. Now for some license, you pay a fee, which will remain valid for a period of ten years. So, on a cash basis, you would deflate the profit for the year in which this amount was paid and inflate the same for the next nine years. Thus this accrual concept becomes important.

Another example can be that you bought goods in the current year, which you have an agreement with the seller that you will pay for them in the next financial year. But you sold the goods in the current year and received the money for sales. The profit will be distorted as the cost of purchase will not be accounted for in the current year.

Hence, it will make sense to ensure that the transaction is reflected in the books, using the accrual concept.

Next post I will talk about the prevalent systems of accounting…

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