Accounting Principles, Concepts and Conventions: formula sheet

Key formulas

Stages of accounting

Identify → Record → Classify → Summarise → Analyse and Interpret → Communicate

Questions often ask which stage an activity belongs to. Preparing the Balance Sheet is summarising.

Profit or loss from accounts

Profit = Income − Expenses (for the period)

Finding profit or loss is a core objective of financial accounting.

Financial position

Assets = Capital + Liabilities

The Balance Sheet shows this position on a particular date.

Branch and main purpose

Financial → reporting to outsiders; Cost → ascertaining and controlling cost; Management → decision-making and planning

Use this as a quick match for branch-based MCQs.

GAAP full form

GAAP = Generally Accepted Accounting Principles

Know the full form and that it means rules widely accepted for recording and reporting.

Concept vs convention

Concepts = basic assumptions; Conventions = customary practices for presenting accounts

Textbooks differ slightly in how they group items. Follow the grouping that the question or your study material uses.

Features of accounting principles

Man-made + Generally accepted + Flexible + Guide to action

Use this as a memory list for 'features' questions.

Purpose of GAAP

Uniformity + Reliability + Comparability + Understandability

These are the benefits users get from following common rules.

Accounting equation (dual aspect)

Assets = Liabilities + Capital

Every transaction keeps both sides equal. Total debits always equal total credits.

Business entity

Owner's money put in = Capital (a liability of the business to the owner)

Drawings reduce capital. They are never a business expense.

Cost concept

Book value of asset = Cost − Depreciation

Market value is ignored in the books.

Matching concept

Profit = Revenue of the period − Expenses of the same period

Use outstanding and prepaid adjustments to bring expenses to the right period.

Accrual basis

Record when earned or incurred, not when cash is received or paid

This is the key difference from the cash basis.

Consistency

Same method, period after period

Change only for a valid reason, and disclose the effect of the change.

Full disclosure

All material facts must be shown

Done through the statements and notes to accounts, such as contingent liabilities.

Materiality

Significant items shown separately; trivial items ignored or merged

Depends on the amount and the nature of the item.

Conservatism

Provide for all expected losses; do not anticipate profits

Example: stock valued at lower of cost and market price.

Concept vs convention

Concept = basic assumption; Convention = customary practice

Conventions guide judgement and presentation; they are not rigid laws.

Accounting equation

Assets = Liabilities + Capital

Must hold after every transaction. Capital = Assets − Liabilities.

Expanded equation

Assets = Liabilities + Opening Capital + Profit (or − Loss) + Additional Capital − Drawings

Profit increases capital; drawings and losses reduce it.

Profit from capital (single entry / statement of affairs)

Profit = Closing Capital − Opening Capital + Drawings − Additional Capital

Used when only assets and liabilities are known.

Accrual vs cash adjustment

Accrual expense = Cash paid + Outstanding at end − Prepaid at end (ignoring opening balances)

Opening outstanding or prepaid amounts also need adjusting if given.

Double entry rule

Total debits = Total credits for every transaction

Basis of the trial balance check.

Quick revision

• Accounting identifies, records, classifies, summarises and communicates financial information.
• Going concern: the business is assumed to continue for the foreseeable future.
• Accrual: record income and expenses when they are earned or incurred, not when cash moves.
• Matching: charge expenses against the revenue they helped to earn in the same period.
• Business entity: the business is treated as separate from its owner.
• Money measurement: only transactions that can be expressed in money are recorded.
• Historical cost: assets are recorded at the price paid to acquire them.
• Prudence (convention): provide for expected losses, but do not anticipate profits.
• Consistency (convention): use the same accounting methods from period to period.
• Materiality (convention): only items significant enough to affect decisions need separate disclosure.
• Accounting equation: Assets = Capital + Liabilities.
• Double entry is a principle: every transaction has an equal debit and credit effect.

Common mistakes

• Treating accounting as only bookkeeping. Fix: Remember that bookkeeping is only recording. Accounting also classifies, summarises and interprets.
• Calling managers external users. Fix: Managers, owners and employees are internal users. Investors, lenders, government and the public are external.
• Treating accounting principles as laws of nature that never change. Fix: Remember that accounting principles are man-made and change with business needs.
• Saying GAAP is the same in every country. Fix: GAAP means the principles accepted in a particular country. Different countries can have different GAAP.
• Treating owner's personal expenses paid from the business as business expenses. Fix: Record them as drawings. They reduce capital and are not charged to the Profit and Loss Account.
• Confusing matching and accrual concepts. Fix: Remember accrual decides when an item is recorded, and matching sets expenses against the revenue they helped earn in the same period.
• Treating conservatism as permission to understate profit heavily. Fix: Remember it means reasonable caution, not deliberately hidden reserves.
• Saying a change in method is never allowed under consistency. Fix: A change is allowed for a valid reason, with disclosure of its effect.
• Treating drawings as an expense. Fix: Drawings reduce capital directly. They never appear in the profit calculation.
• Writing Capital = Assets + Liabilities. Fix: Remember Capital = Assets − Liabilities. Capital is what is left after outsiders are paid.

Exam tips

• Questions are usually direct and one-line, so learn the keyword for each branch and user.
• Expect match-the-user questions: lender, supplier, tax authority, investor, employee.
• Watch for options that look right but give a purpose to the wrong branch.
• Learn the difference between financial and cost accounting as a short list, since it is a frequent theme.
• There is no negative marking, so attempt every question.
• Learn the full form of GAAP and the words 'generally accepted' and 'man-made'. Many MCQs test just these.
• Watch for extreme words like 'always', 'never' and 'only'. They usually make an option wrong here.
• Prepare one example each of a concept and a convention so you can classify quickly.