Accounting Equation Effects Test 20

According to Business Entity Concept, a business is treated as a separate legal entity, and is distinct from it's owners. When a proprietor introduces capital in his own business, the capital is considered as liability from business point of view. Similarly, when he withdraws any money for personal use, it is treated as reduction in the liability of business. This concept is applicable to all businesses i.e. sole proprietary concern, Partnership firm, Joint stock company etc.

The basic accounting equation, also called as the balance sheet equation, represents the relationship between the assets, liabilities and capital of a business. It is the foundation for the double entry book-keeping system. For each transaction, the total debit equals the total credit. Following is the accounting equation:

Dual aspect concept is the basic concept of accounting, According to which every business transactions has a dual effect. As the name implies , the entry made for each transaction is composed of two parts- one for the debit and the other for the credit. Every debit has an equal amount of credit. So, the total of all debits equal to the total of all credits. This gives basic accounting equation:

The convention of conservatism mean that the convention of caution, or the policy of playing safe. This principle requires that in the situation of uncertainty and doubt, the business transactions should be recorded in such a manner that the profits and assets are not overstated and losses and liabilities are not understated. The following are some examples:

1. Closing stock is valued at cost price or Net realisable value, whichever is lower.

2. Joint life insurance policy  is shown only at surrender value as against the amount paid.

3. Provision for doubtful debt is created in anticipation of bad debts etc.

4. Provision for pending law suit against the firm, which may either be decided in its favour.

The process of ascertaining the amount of profit earned or the loss incurred during a particular period involves deduction of related expenses from the revenue earned during that period. 

The matching concept emphasises exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that period.

It follows from this that the revenue and expenses incurred to earn these revenues must belong to the same accounting period.

Realisation concept would apply when goods are delivered to customer. According, to this concept revenue can only be recognised when the underlying goods or services associated with the revenue has been delivered or rendered, respectively.

The cost concept requires that all assets are recorded in the book of accounts at their purchase price, which includes cost of acquisition, transportation, installation and making the asset ready to use.

According to money measurement concept, the commission payable to salesman will be recorded in the books of accounts. 

According to Business Entity Concept, a business is treated as a separate entity and is distinct from it's owners. When a proprietor introduces capital in his own business, the capital is considered as liability from business point of view. Similarly, when he withdraws any money for personal use it is treated as reduction in the liability of business.