Accounting may look like a world of numbers, but in reality, it is the language used to tell the true financial story of a business. Every sale, expense, liability, or asset is recorded so that owners, banks, investors, and the government can understand how a business is performing.
This guide explains basic accounting principles in simple words. By the end of this article, you will understand:
- Why business money must be separate from personal money
- How income and expenses are recorded
- Why assets are not shown at today’s market price
- What makes accounting information useful and reliable
Why Accounting Principles Matter in Real Life
Accounting principles are not just textbook theory. They help in:
- Getting bank loans and investments
- Knowing the real profit of a business
- Comparing one year’s performance with another
- Preventing fraud and manipulation
- Making correct tax calculations
Without these rules, every business would prepare accounts in its own style and financial statements would become meaningless.
1. Business and Owner Are Separate (Entity Concept)
In accounting, the business is treated as a different person from its owner. Even if a shop is run by one individual, its money is not the owner’s personal money.
Example
If a shop owner in Delhi pays his home electricity bill from shop cash, it is not a business expense. It must be recorded as the owner withdrawing money (drawings), not as shop expenses.
This rule prevents confusion between household and business finances and shows the real profit of the business. It also helps you to calculate profit as per income tax law.
2. Business Is Assumed to Continue (Going Concern)
Accounts are prepared on the assumption that the business will run for many years and will not close tomorrow.
Because of this idea, large expenses are spread over time.
Example
A small factory in Kolkata buys a machine for ₹2,00,000 and expects to use it for 10 years. Instead of treating ₹2,00,000 as expense in one year, only ₹20,000 is charged every year as depreciation.
If the business was about to shut down, accounts would be prepared differently, showing assets at quick sale prices.
3. Accounts Use a Stable Currency (Money Measurement & Historical Cost)
All transactions must be recorded in one currency, normally Indian Rupees.
Accounting records things at the price actually paid, not at today’s market value.
Example
Furniture bought for ₹50,000 five years ago is still shown at ₹50,000 (less depreciation), even if today its price is ₹80,000. This method is called historical cost and keeps accounts based on real evidence instead of changing estimates.
4. Income and Expenses Must Match (Matching Concept)
Expenses should be recorded in the same period as the income they help to earn.
Example
If a clothing shop buys shirts in March but sells them in April, the purchase cost must be matched with April sales, not March. This ensures that the profit of each period is calculated correctly.
5. Record When It Happens, Not When Cash Moves (Accrual Concept)
Accounting records income when it is earned and expenses when they are incurred, even if cash is received or paid later.
Example
The electricity bill for March ₹5,000 is paid in April. Still, it is treated as a March expense because electricity was used in March.
6. Qualitative Characteristics of Accounting Information
For accounts to be useful, information must have certain qualities.
Relevant Information
Figures should help users judge business performance and value. Sales, profit, loans, assets, and expenses are relevant because they affect decisions like giving loans or investing.
Reliable Information
Numbers must be supported by bills, invoices, vouchers, and bank statements. Indian companies get their accounts audited so that they show a “true and fair view.”
Verifiable Information
Even estimates must be reasonable. Example: Building cost ₹1,00,000 with life of 20 years → depreciation ₹5,000 per year. Life is estimated, but based on logic and experience.
Understandable and Comparable
Accounts should be easy to understand and comparable i.e. One company’s financial statement should be comparable with another and this year’s data with last year. Using the same method every year is called consistency.
Quantifiable and Obtainable Information
Most items are shown in numbers. Matters that cannot be measured exactly (like a court case) are written in notes to accounts.
Information should be worth the cost of collecting it. Tiny unnecessary details should not delay accounts.
7. Realizable Value – Do Not Overstate Assets
Assets are normally shown at cost, but if their value falls sharply, they must be reduced.
Example
A mobile dealer has old models costing ₹1,00,000 but can now sell them only for ₹8,000. Stock must be shown at ₹8,000, not ₹1,00,000.
This prevents showing a false picture of wealth.
8. Materiality – Focus on What Matters
Only important items should be shown separately.
Example
For a company earning ₹50 lakh, a ₹2,000 mistake may not be material. For a small kirana shop earning ₹1 lakh, ₹2,000 is important.
Small items can be grouped as “miscellaneous” to keep accounts clear.
9. Conservatism – Be Careful, Not Over-Optimistic
When two reasonable choices exist, accountants choose the option that:
- Shows lower profit
- Shows lower asset value
This avoids exaggerating financial position.
Example
If inventory can be valued at ₹90,000 or ₹95,000, the lower value ₹90,000 is chosen.
But this rule should not be misused to hide profit intentionally.
Conclusion
Accounting principles act like traffic rules for financial information. They ensure that business records are separate from personal money, based on real evidence, and presented in a way everyone can understand. For beginners, these ideas build confidence to read balance sheets and income statements without fear.
As the next step, you can learn about how a Balance Sheet is structured, what an Income Statement shows, and how depreciation methods work in detail.
We hope this article helped you understand accounting principles and concepts in a clear and practical way. To continue learning, you may also find our guides on Balance Sheet basics and Income Statement explained useful.
