What is the purpose of dividing the life of the business into accounting periods?

Topic 2: Accounting Concepts

What is the Accounting Entity Concept?

Accounting Entity Concept – Each business is a separate entity from its owner.

For accounting purposes, the business is regarded as an accounting entity or a business entity. It exists as a unit by itself, separate from its owner. This means that all financial information relating to the business is recorded and reported separately from the owner’s personal financial information.

What is the Going-Concern Concept?

Going-Concern Concept – The business entity will continue to operate indefinitely.In accounting, the business is always assumed to be a going concern, i.e. to operate for an indefinite period of time.

What is the Accounting Period Concept?

Accounting Period Concept – The life of a business is divided into specific periods of time for the purpose of preparing financial reports.

The accounting period may be a month, a half-year, a full year, or any other length of time, depending on the volume and nature of the business.

What is the Historical Cost Concept?

Historical Cost Concept – All transactions of a business entity are recorded at the original cost to the business.

Resources are recorded at the actual values at which they were bought or sold, called ‘historical costs’. This means that a piece of land purchased years ago is still recorded at its original cost even though its value is considerably higher now. This practice is based on the assumption that the business is a going concern and is not likely to be liquidated, so the market or realizable value is not relevant.

Example:

Alice, owner of Courts, bought a TV at $5,000. Her friend, Miss Chew offered to buy it from her at $10,000. Based on historical cost concept, Alice should only record the TV in her books as $5,000.

What is the Matching Concept?

Matching Concept – Revenue earned during an accounting period has to be matched with the expenses associated with earning that revenue.

Example:

Impress Furniture sold a sofa set for $1,000 to a customer on 25th December 2001. The cost of the sofa set is $350. In 2002, a dining set which cost $150 was sold for $800.In this case, the sale of $1,000 should be matched with the cost of $350 for the year 2001. The sale of $800 should be matched with the cost of $150 for the year 2002.

What is the Materiality Concept?

Materiality Concept – This concept requests the disclosure of information which, if known to users, would seriously affect them in decision-making.

Example: Impress Furniture’s book-keeper forgot to record a sale of furniture $100 made in 2001. The total sales of the business for 2001 amount to $5 million.The omission to record the $100 sale is immaterial because it has no serious effect on those who use the profit figure in decision-making.

What is the Monetary Concept?

Monetary concept – This concept states that only transactions which can be measured in money terms are recorded.

What is the Prudence (also known as Conservatism) Concept?

Meaning: If an accountant is given two alternatives of reporting an item, the alternative which gives a lower profit or lower asset value should be adopted.

The following examples indicate the application of conservatism in accounting:

1. Valuation of closing stock at cost price or market price whichever is less

2. Creating provision for bad debts

3. Writing off fictitious assets from the books as early as possible

What is the Consistency Concept?

The same accounting method should be applied in each accounting period when preparing financial reports. If a certain method of accounting treatment had been applied to an item, the same method is applied in the future.

What is the Objectivity Concept?

There must be objective verifiable evidence for reporting any accounting information.According to this principle, a business transaction should be supported by documentary evidence. Objectivity means the document should contain facts in an unbiased manner. Accounting should be done without prejudice.

What is the Realisation Concept?

This concept states that income should be recorded as earned in the period in which goods or services are provided to customers by the business.

What is the Monetary Concept?

This concept means that only transactions which can be measured in money terms are recorded.

What is the meaning of accounting periods? The accounting period principle divides an organisation's lifetime into shorter periods so that its performance can be monitored on a regular basis. Company accounting is based on the Going Concern Principle, which means that the company will continue to operate for the foreseeable future. Users of financial statements, especially management and banks, need to prepare financial statements on a regular basis in order to make timely decisions. Management regularly seeks information to analyse performance and resource needs (short-term and long-term). Banks are investing money and need to ensure safety and returns, so they request accounting information on a regular basis. Similarly, the government must investigate the company's tax obligations. What are accounting periods?  From the above, the life of a company is divided into smaller periods (usually one year) called accounting periods. As per the income tax act, the accounting year period is from 1st April to 31st March. The accounting year starts on April 1st and the accounting year ends on March 31st.

Do you know?

During the accounting period,  accounting cycles are used to evaluate, collect, classify, summarise, and report financial data. The standard accounting period is 12 months. On the other hand, the start of the accounting period varies from organisation to organisation. Some companies may use the regular calendar year (January to December) as their fiscal year, while others may use the fiscal period (April to March).

What Is an Accounting Period? 

In general, the accounting year refers to the assessee's financial year or prior year, which is 12 months long. Anaccounting cycle is a series of processes for analysing, recording, classifying, summarising, and reporting financial data to create a financial report. Some processes run at the beginning of the billing period, and others run towards the end of the billing period. The accounting period begins when the books are balanced, and the accounting department prepares the annual financial statements.The accounting period for financial accounting is usually 12 months and is stipulated by law. The start of the accounting period depends on your jurisdiction. For example, one company may use a calendar year (January to December), and another company may use an accounting period (April to March). 

Previously, an assessee could choose any 12-month period he wanted as his accounting years, such as Diwali, calendar, or financial year. All Indian taxpayers must now show their income for income tax reasons based on the 12-month accounting year beginning on April 1st and ending on March 31st, referred to as the financial year, under the rules of the Income Tax Law. This accounting year or financial year is also known as the assessee's "prior year" in technical terms of the income tax law.

Also Read: Fundamentals of Accounting - Learn About Accounting Process and Steps & Basic Features of Accounting

How Does an Accounting Period Work? 

In many cases, multiple accounting periods apply at any time. For example, a company can close its June books. Even if your organisation aggregates billing data quarterly (April to  June), half (January to June), and calendar year (June), the billing period is months. Accounting periods are time frames that include specific accounting activities. It can be a week, month, or quarter, as well as a calendar year or fiscal year. Accounting periods are used to report and analyse data, and accrual accounting methods ensure consistency.

Accounting Period Types

In accounting, the following sorts of accounting periods can be seen:

1. Calendar Year

2. The Fiscal Year

3. 4–4–5 Calendar Year

Calendar Year: 

In most cases, the accounting period corresponds to the twelve-month Gregorian calendar year. The month runs from the 1st of January to the 31st of December. This natural sequence of these 12 months is followed by the accounting period.

The Fiscal Year: 

The accounting period for organisations that follow the fiscal year begins on the first day of any other month other than January.

4–4–5 Calendar Year: 

This is the most widely used calendar structure, particularly in the retail and manufacturing industries. A year is divided into four halves in the 4–4–5 calendar, and each quarter consists of thirteen weeks divided into one five-week month and two four-week months.

For business owners, investors, creditors, and government authorities, this information is critical. The time period assumption provides stakeholders with accurate and timely financial data, allowing them to make informed business decisions.

This accounting period is chosen based on the business needs and conditions, which may be too complicated to warrant other accounting periods.

Also Read: Different Types of Accounts in Accounting - 3 Types of Accounts

Requirements for Accounting Periods

The accounting period is set for reporting and analysis. Theoretically, companies want to keep growth constant over the long term to show stability and a long-term earnings outlook. The accounting strategy that supports this concept is the accrual accounting method. Accrual accounting requires input regardless of when the monetary component of an economic transaction occurs. For example, accrual accounting requires fixed assets to be depreciated over their useful life. This identification of costs over multiple accounting periods allows for relative comparisons rather than a comprehensive statement of costs when an item is paid.

Conclusion 

In this article, we learned in-depth about the accounting period as per income tax. The accounting period in financial accounting usually is 12 months and is defined by regulation. The start of the accounting period varies depending on the jurisdiction. For example, one entity may use the calendar year (January to December), while another may use the accounting period (April to March). Instead of 12 months, the International Financial Reporting Standards allow for a 52-week accounting cycle. Also, we saw the types of the accounting period. Knowing about the requirements of accounting periods is also very important. The accrual method of accounting is the accounting approach that supports this premise. Regardless of when the monetary portion of an economic transaction happens, the accrual method of accounting requires an accounting entry to be made. 
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