Fundamentals of Financial and Cost Accounting · Four Frameworks of Accounting and Forms of Organization

Accounting Concepts, Principles and Conventions Explained

Updated 10 October 2026 · Fact-checked

Accounting concepts, principles and conventions are the basic rules and assumptions that guide how transactions are recorded and reported. Concepts such as going concern, accrual, matching and entity are the foundation. Conventions such as consistency, conservatism and materiality guide judgement. To solve questions, read the situation and match it to the right idea.

Understand Accounting Concepts, Principles and Conventions

Accounting needs common ground rules. Without them, two accountants could record the same transaction in two different ways and the statements could not be compared. Concepts, principles and conventions supply that common ground.

Concepts are the basic assumptions on which accounting is built. Conventions are customs or practices that accountants follow to bring clarity and fairness, especially where judgement is needed. In exams the two words are often used loosely, so focus on what each idea says and when it applies.

The main concepts are:

Business entity: the business is separate from its owner. The owner's personal expenses are not business expenses.
Money measurement: only items that can be expressed in money are recorded.
Going concern: the business will continue for the foreseeable future. So assets are not valued at forced-sale prices.
Accrual: income and expenses are recorded when they are earned or incurred, not when cash moves.
Matching: expenses of a period are set against the revenue they helped earn in that same period.
Cost: assets are recorded at the price paid to acquire them.
Dual aspect: every transaction has two effects, a debit and an equal credit.
Accounting period: life is divided into periods, usually a year, to report results.
Realisation: revenue is recognised when the sale is made or service is rendered, not when the order is received.

The main conventions are:

Consistency: use the same accounting methods from year to year so results can be compared. A change is allowed only for good reason and must be disclosed.
Conservatism (prudence): provide for all expected losses but do not record expected profits.
Materiality: record and disclose items that are significant enough to influence decisions. Trivial items can be treated simply.
Full disclosure: all significant information must be reported.

A quick way to remember the link: accrual decides when to record, and matching decides which period an expense belongs to. Unexpired costs such as prepaid expenses are carried forward because of matching, as their cost belongs to the future period. Going concern is the supporting assumption that lets the business enjoy that benefit in the future.

Key formulas to remember

Going concern: Business continues → fixed assets are shown at cost less depreciation, not at break-up value; If closure is expected, the going concern idea no longer applies.
Accrual: Income = when earned; Expense = when incurred (cash timing is ignored); Outstanding expenses and accrued income arise from this.
Matching: Profit = Revenue of the period − Expenses incurred to earn that revenue; Needs accrual first. Prepaid items are carried forward and outstanding items are added.
Conservatism: Provide for all expected losses; ignore expected gains; Example: stock valued at cost or net realisable value, whichever is lower.
Dual aspect: Assets = Liabilities + Capital; Every transaction affects two accounts with equal debit and credit.
Business entity: Owner's personal expenses paid out of business funds → Drawings, not business expense; Capital introduced is an amount the business owes to the owner, shown as Capital (owner's equity), separate from outside liabilities in Assets = Liabilities + Capital.

How to solve Accounting Concepts, Principles and Conventions questions

Most questions give a short situation or a definition and ask which concept or convention applies. Use this method.

1Read the situation and underline the key action, such as stock valued lower, same method used again, or expense paid in advance.
2Decide what the question tests: timing of recording, period matching, valuation, owner versus business, or comparability.
3Match keywords. Continue for the future means going concern. Earned or incurred means accrual. Same period means matching. Same method means consistency. Provide for loss means conservatism. Unimportant amount means materiality.
4Check whether the idea is a concept or a convention if the question asks for that.
5Test each option against the situation and cross out those that describe a different idea.
6Pick the one option that fits the exact action, not just the general theme.

Quickest way: Keyword matching

When to use it: Use this for one-line MCQs where you must name the concept or convention.

Spot the trigger word in the question.
Link it to one idea: future continuity, earned or incurred, same period, same method, expected loss, small amount, separate owner.
Eliminate options that describe cash basis or different ideas.
If two options seem close, ask which one explains the action itself. Prepaid expenses are carried forward because of matching, as the cost belongs to the future period. If the question asks about the timing of recognition irrespective of cash, choose accrual.

Common mistakes in Accounting Concepts, Principles and Conventions

Treating accrual and cash basis as the same
Students link recording with receiving or paying cash.
Fix: Remember that accrual records when income is earned or expense is incurred, whatever the cash timing.
Mixing matching with accrual
Both deal with timing and appear together in adjustments.
Fix: Accrual says when to recognise. Matching says set expenses against the related revenue of the same period.
Thinking conservatism allows hidden profits or excess provisions
The phrase 'play safe' is taken too far.
Fix: It means provide for expected losses and do not anticipate gains. It does not allow deliberate understatement of profit.
Calling a change of method acceptable at will under consistency
Students read consistency as never changing.
Fix: A change is allowed for a valid reason, such as a legal requirement or better presentation, and must be disclosed.
Applying going concern when the business is closing
Students memorise the definition without its condition.
Fix: The concept holds only if there is no intention or need to wind up. Otherwise assets are valued at realisable amounts.
Recording the owner's personal expenses as business expenses
Small business owners mix personal and business money.
Fix: Apply business entity: treat such items as drawings, which reduce capital.

Worked examples

Example 1

Ravi Traders paid an insurance premium of ₹12,000 on 1 January for the full year ending 31 December. The books close on 31 March. How much is charged to the profit and loss account for the year ending 31 March, and which concept supports it?

Show the solution

The premium covers 12 months, so the monthly cost is ₹12,000 ÷ 12 = ₹1,000.
From 1 January to 31 March is 3 months.
Expense for the year = 3 × ₹1,000 = ₹3,000.
Unexpired portion = ₹12,000 − ₹3,000 = ₹9,000, carried forward as prepaid insurance.
Only the cost related to the period is charged against that period's revenue, so the matching concept applies, with accrual deciding that the expense is recognised as the period passes, whatever the cash timing. The unexpired ₹9,000 belongs to the next period, so it is carried forward as prepaid. Going concern is only a background assumption here and is not the answer.

Answer: ₹3,000 is charged to profit and loss; ₹9,000 is a prepaid asset. This follows the matching concept (with accrual).

Example 2

Meera Stores has closing stock that cost ₹80,000. Its expected selling price is ₹95,000 and the cost of selling is ₹5,000. At what value should the stock be shown, and which convention applies?

Show the solution

Net realisable value = selling price − selling cost = ₹95,000 − ₹5,000 = ₹90,000.
Compare cost ₹80,000 with net realisable value ₹90,000.
Stock is valued at the lower of the two, which is ₹80,000.
The expected gain of ₹10,000 is not recorded until the sale is made.
This follows conservatism and also the realisation concept.

Answer: Stock is shown at ₹80,000 (cost), based on conservatism.

Exam tips

Learn one trigger word for each concept and convention. Most MCQs can be solved by that alone.
Watch for pairs that are often confused: accrual versus matching, consistency versus conservatism, going concern versus accounting period.
If a question asks for a concept versus a convention, remember that concepts are basic assumptions and conventions are practices that guide judgement.
Do a simple calculation when needed, such as prepaid share or lower of cost and net realisable value, then name the concept.
There is no negative marking, so attempt every question and eliminate wrong options first.

Practice questions from Four Frameworks of Accounting and Forms of Organization

Accounting Concepts, Principles and Conventions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Accounting Concepts, Principles and Conventions: frequently asked questions

What is the difference between accounting concepts and conventions?

Concepts are basic assumptions on which accounting is built, such as going concern and business entity. Conventions are customary practices that guide judgement, such as consistency and conservatism. In MCQs, focus on matching the situation to the idea.

What is the difference between the going concern and accrual concepts?

Going concern assumes the business will continue, so assets are not valued at forced-sale prices. Accrual decides when income and expenses are recorded, which is when they are earned or incurred. One is about continuity and the other is about timing.

What is the matching concept with an example?

Matching sets the expenses of a period against the revenue they helped earn in that period. If rent for 12 months is paid but only 9 months fall in this year, only 9 months of rent is charged to profit and loss.

Does conservatism mean we can understate profit?

No. It means providing for expected losses and not recording expected profits. Deliberately hiding profit would go against fair presentation.