Conceptual Framework of Accounting
What is examined
This domain tests the accounting concepts and conventions that explain why entries are made as they are, plus the meaning and role of accounting standards. Expect questions asking you to name the concept applied in a given situation and to distinguish cash basis from accrual basis.
Concepts you must be able to apply
- Business entity: the firm is separate from its owner, so capital is a liability of the business.
- Money measurement: only transactions measurable in money are recorded.
- Going concern: the business will continue for the foreseeable future, so assets are not valued at break-up prices.
- Accounting period and matching: the life of the firm is divided into periods, and the expenses of a period are matched against its revenues.
- Accrual: revenue and expense are recognised when earned or incurred, not when cash moves.
- Historical cost, dual aspect, revenue recognition (realisation), consistency, full disclosure, materiality, conservatism (prudence) and objectivity.
Conservatism, consistency, materiality and full disclosure are often listed separately as conventions; the rest are treated as concepts.
Accounting standards
Accounting standards are written policy documents issued by a body such as the Accounting Standards Board of the ICAI, and they make financial statements comparable. India has converged with IFRS through Ind AS, while the earlier AS series still governs many smaller entities.
Worked example
A firm received ₹2,00,000 in March 2024 as an advance for goods delivered in April 2024. Reasoning: under accrual and revenue recognition, revenue arises when the sale is complete, not when cash arrives, so the ₹2,00,000 is a liability (advance from customers) at 31 March 2024 and becomes revenue in the next period. Under a pure cash basis it would be income of March, which is why cash-basis profit is not accepted for final accounts.
Traps
Confusing conservatism with consistency; saying going concern means the business is profitable; charging the owner's household electricity bill to the business (a breach of business entity); ignoring materiality when deciding whether to adjust a trivial amount.