Corporate Accounting and Financial Management · Introduction to Corporate Accounting

Accounting Concepts, Conventions and Principles Explained

Updated 11 October 2026 · Fact-checked

Accounting concepts, conventions and principles are the basic ground rules for preparing company accounts. Going concern, accrual and consistency are the fundamental assumptions. Prudence and materiality are conventions. To answer a question, name the rule, state what it requires, apply it to the facts, and conclude with the accounting treatment.

Understand Accounting Concepts, Conventions and Principles

Accounts must be prepared on a common footing, or no one could compare or trust them. Accounting concepts, conventions and principles give that footing. They are the rules of thumb and assumptions behind every journal entry and every financial statement.

A concept is a basic assumption or idea on which accounting rests. Examples are the business entity concept (the business is separate from its owner), the money measurement concept (only items expressible in money are recorded), the going concern concept and the accrual concept. A convention is a custom or practice that accountants follow to make statements useful and comparable. Examples are consistency, prudence (conservatism), materiality and full disclosure. A principle is a broader accepted rule, such as the cost principle or the matching principle. Together, the generally accepted ones are called GAAP. In exams, the difference between concept and convention is often asked, but the dividing line is loose. Concepts are assumptions; conventions are practices.

Three are called fundamental accounting assumptions: going concern, consistency and accrual. Under the Ind AS 1 text, you prepare financial statements on a going concern basis unless management intends to liquidate the entity or cease trading, or has no realistic alternative. Management looks at all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period. If it knows of material uncertainties that cast significant doubt on going concern, it must disclose them. If the statements are not on a going concern basis, that fact, the basis used and the reason must be disclosed.

Under Ind AS 1, an entity prepares its financial statements, except for cash flow information, using the accrual basis. Income and expenses are recorded when they are earned or incurred, not when cash moves. Rent for March that is paid in April is still a March expense.

Consistency means you follow the same accounting policies from period to period. A change is made only when the law or a standard requires it, or when it gives a better presentation, and it must be disclosed. Prudence means you do not anticipate profits but you provide for all likely losses. Materiality means you separately disclose an item only if omitting or misstating it could influence a user's decision.

These ideas also have a legal link. Under section 134(5) of the Companies Act, 2013, the Directors' Responsibility Statement must say that applicable accounting standards were followed, that accounting policies were selected and applied consistently, that judgments and estimates were reasonable and prudent, and that the annual accounts were prepared on a going concern basis.

Key rules to remember

Going concern assumption (Ind AS 1, para 25): Prepare on going concern basis unless management intends to liquidate or cease trading, or has no realistic alternative; Assess at least twelve months from the end of the reporting period (para 26). Disclose material uncertainties. If not going concern, disclose that fact, the basis used and the reason.
Accrual basis (Ind AS 1, para 27): Income and expenses are recognised when earned or incurred, not when cash is received or paid; The exception is cash flow information.
Accrued vs prepaid expense: Expense for the year = Cash paid + Outstanding at end − Prepaid at end (adjusting for opening balances); A working form of the accrual and matching ideas. Adjust for opening balances when they exist.
Prudence: Provide for all expected losses; do not anticipate profits; Example: stock valued at lower of cost and net realisable value.
Directors' Responsibility Statement (s. 134(5)): Standards followed; consistent policies; reasonable and prudent judgments; going concern basis; Clauses (a), (b) and (d) of section 134(5) link directly to these concepts.

How to solve Accounting Concepts, Conventions and Principles questions

Use this method for both theory questions and short application questions on concepts and conventions.

1Identify the rule the question is testing: going concern, accrual, consistency, prudence, materiality, matching, entity, cost or another.
2Define the rule in one or two plain sentences. Say whether it is an assumption, concept or convention.
3Give the source if the question is about law or standards: Ind AS 1 paragraphs 25 to 27, or section 134(5) of the Companies Act, 2013.
4Apply it to the facts in the question. Name the amount, period or item affected.
5Work out the accounting treatment with figures if numbers are given, such as the accrued expense, the closing stock value or the provision.
6State a clear conclusion: what is recorded, what is disclosed, and what is not.
7If asked to distinguish two ideas, write at least three points of difference and one example each.

Quickest way: Rule, facts, treatment in three lines

When to use it: Use this for short-note questions or for application questions where time is tight.

Line 1: define the concept or convention and say which group it falls in.
Line 2: give one example from the question or a simple one from a company.
Line 3: state the consequence if the rule is ignored, such as overstated profit or non-comparable years.
Add the Ind AS 1 paragraph or section 134(5) reference if the concept is going concern, accrual, consistency or prudence.

Common mistakes in Accounting Concepts, Conventions and Principles

Treating accrual as the same as cash basis
Students think of income as money received.
Fix: Record income when earned and expenses when incurred. Cash timing only affects receivables, payables, prepayments and accruals.
Saying going concern means the company will never close
The name sounds like a guarantee.
Fix: It is an assumption that the entity will continue, unless management intends to liquidate or cease trading or has no realistic alternative. Assessment covers at least twelve months after the reporting period.
Confusing prudence with deliberately understating profit
Students read it as always being pessimistic.
Fix: Prudence means no anticipation of profit and provision for likely losses. It does not allow creating hidden reserves.
Believing consistency forbids any change in policy
The word suggests rigidity.
Fix: Change is allowed when required by law or a standard, or when it gives a better presentation. Disclose the change and its effect.
Disclosing every tiny item separately in the name of materiality
Students think more detail is always safer.
Fix: Materiality asks whether omission or misstatement could influence users' decisions. Small items can be grouped.
Giving the difference between concept and convention without examples
Students memorise definitions only.
Fix: Write concepts as assumptions (entity, going concern) and conventions as practices (consistency, prudence), and give an example for each.

Worked examples

Example 1

Sundaram Textiles Ltd pays factory rent of ₹1,20,000 for the year ending 31 March 2027. Of this, ₹30,000 relates to April 2027 to June 2027 and was paid in advance. Salaries of ₹45,000 for March 2027 will be paid in April 2027. Explain the concept applied and compute the expense to be charged for the year for each item.

Show the solution

The accrual concept applies: expenses are recognised when incurred, not when paid. Ind AS 1 requires the accrual basis, except for cash flow information.
Rent: the amount paid is ₹1,20,000. The part for April to June 2027 is ₹30,000, which belongs to the next year. It is a prepaid expense.
Rent charged to the year = ₹1,20,000 − ₹30,000 = ₹90,000.
Salaries: ₹45,000 for March 2027 was incurred in the year even though it is unpaid. It is an outstanding expense.
Salaries charged to the year include ₹45,000, which is also shown as a liability at the year end.

Answer: Rent expense is ₹90,000, with ₹30,000 shown as prepaid rent in current assets. The March salary of ₹45,000 is charged to the year and shown as outstanding. This follows the accrual concept.

Example 2

Meridian Pharma Ltd held closing stock that cost ₹8,00,000. Its net realisable value at year end is ₹6,50,000. The directors want to carry it at cost to show a higher profit. Advise with reference to accounting conventions.

Show the solution

The convention concerned is prudence (conservatism): do not anticipate profits, provide for likely losses.
Stock is valued at the lower of cost and net realisable value.
Cost is ₹8,00,000. Net realisable value is ₹6,50,000. The lower figure is ₹6,50,000.
The write-down is ₹8,00,000 − ₹6,50,000 = ₹1,50,000, charged to profit and loss.
Carrying at cost would overstate profit and assets by ₹1,50,000 and would not give a true and fair view. Under section 134(5)(b) of the Companies Act, 2013, the directors must state that judgments and estimates were reasonable and prudent.
Consistency also matters: the company should apply the same valuation policy every year.

Answer: Stock must be valued at ₹6,50,000. A loss of ₹1,50,000 is recognised in the year. Carrying it at ₹8,00,000 would breach prudence.

Exam tips

Write definition, example and consequence for each concept. This pattern suits short-note questions.
In distinction questions, give at least three points of difference in a clear two-column style using plain lines.
Quote Ind AS 1 paragraph 25 for going concern and paragraph 27 for accrual. Link to section 134(5) when the question touches directors' reporting.
In application questions, show the arithmetic for prepaid, outstanding or stock write-down before the conclusion.
Do not call a rule a concept or a convention too firmly if unsure. Say it is a basic accounting assumption or practice and explain it.

Practice questions from Introduction to Corporate Accounting

Accounting Concepts, Conventions and Principles 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, Conventions and Principles: frequently asked questions

What is the difference between accounting concepts and conventions?

Concepts are basic assumptions on which accounting is built, such as business entity and going concern. Conventions are customs or practices that guide how accounts are prepared, such as consistency, prudence and materiality. The boundary is not sharp, so always explain with examples.

Which are the fundamental accounting assumptions?

Going concern, consistency and accrual are treated as the fundamental accounting assumptions. Under Ind AS 1, going concern and accrual are stated in paragraphs 25 and 27. Consistency is also reflected in section 134(5)(b) of the Companies Act, 2013.

How long must management look ahead when assessing going concern?

Ind AS 1 says management considers all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period. The depth of analysis depends on the facts. A profitable entity with ready access to funds may need little analysis.

Can a company change its accounting policy?

Yes, if a law or standard requires it, or if the change gives a better presentation. The change should be disclosed with its effect. Changing policy freely without reason defeats the consistency convention.