Accounting Principles & Concepts: Rules, Assumptions & Real-World Applications

Core Accounting Principles (Rules)

Accounting principles are universal guidelines that ensure consistency, reliability, and comparability in financial reporting. They are not laws but best practices followed globally.

1. Dual Aspect Concept (Duality Principle)

Definition: Every financial transaction has two equal and opposite effects—one debit and one credit. This is the foundation of double-entry bookkeeping.

How it works:

• Assets = Liabilities + Owner’s Equity (Accounting Equation)
• If one side increases, the other must adjust to balance it.

Visual: T-Account for Duality Real-World Example (eSewa): When you pay NPR 1,000 for an electricity bill via eSewa:

• Your bank account (Asset) decreases by NPR 1,000 (Debit).
• eSewa’s liability to NTC increases by NPR 1,000 (Credit).
• The duality concept ensures both sides are recorded.

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2. Accrual Basis of Accounting

Definition: Revenues and expenses are recorded when they are earned or incurred, not when cash is received or paid. This differs from cash basis accounting, which records transactions only when cash changes hands.

Comparison Table: Accrual vs. Cash Basis

Visual: Accrual vs. Cash Basis Flow

Real-World Example (Pathao Driver): A Pathao driver earns NPR 2,000 for a ride but the passenger pays next day. Under accrual basis, the driver records NPR 2,000 as revenue immediately (even if cash is received later). Under cash basis, revenue is recorded only when paid.

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3. Matching Principle (Revenue-Expense Matching)

Definition: Expenses must be matched with the revenues they help generate in the same accounting period. This ensures accurate profit calculation.

How it works:

• If a business pre-pays rent for 3 months, only 1 month’s rent is expensed in the current month.
• If a business earns revenue but hasn’t received cash, it still records the revenue (e.g., NEPSE stock dividends declared but not paid).

Worked Example: Kathmandu Retail Shop Scenario:

• January 1: Shop pays NPR 30,000 rent for 3 months (Jan–Mar).
• January 31: Prepare monthly financial statements.

Journal Entry (Jan 1):

| Date       | Particulars               | Dr (NPR) | Cr (NPR) |
|------------|---------------------------|----------|----------|
| 2024-01-01 | Prepaid Rent A/c           | 30,000   |          |
|            | To Cash A/c               |          | 30,000   |

Adjusting Entry (Jan 31): Only 1 month’s rent (NPR 10,000) is expensed in January.

| Date       | Particulars               | Dr (NPR) | Cr (NPR) |
|------------|---------------------------|----------|----------|
| 2024-01-31 | Rent Expense A/c          | 10,000   |          |
|            | To Prepaid Rent A/c       |          | 10,000   |

Real-World Example (Ncell): Ncell pre-pays for server maintenance (e.g., NPR 500,000 for a year). Under the matching principle, only NPR 41,667 (500,000/12) is expensed each month, not the full amount in one go.

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4. Going Concern Concept

Definition: A business is assumed to continue operating indefinitely unless evidence suggests otherwise (e.g., bankruptcy). This means:

• Assets are recorded at cost (not liquidation value).
• Long-term assets (e.g., machinery) are depreciated over time, not sold immediately.

Example: If a Khalti merchant buys a server for NPR 500,000, it is recorded at NPR 500,000 (cost price), not its resale value (NPR 300,000).

What if the business closes?

• The going concern assumption is violated.
• Assets are recorded at net realizable value (what they can be sold for).

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5. Materiality Concept

Definition: Only significant (material) transactions are disclosed in financial statements. Trivial items can be ignored.

Example:

• A Nepal Bank Limited buying a NPR 500 pen may not record it separately but group it under "Miscellaneous Expenses".
• A NPR 5,000,000 loan must be fully disclosed.

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6. Conservatism (Prudence) Principle

Definition: When in doubt, choose the option that is least favorable to profits. This avoids overstating assets or understating liabilities.

Examples:

1. Inventory Valuation:
   • If inventory can be sold for NPR 10,000 but its cost is NPR 12,000, record it at NPR 10,000 (lower value).
2. Bad Debts:
   • If a customer owes NPR 50,000 but may not pay, record a provision for bad debts to reduce revenue.

Real-World Example (Daraz Seller): A Daraz seller has NPR 20,000 in pending orders. If some buyers may default, the seller records only the likely collectible amount (e.g., NPR 18,000), not the full NPR 20,000.

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7. Consistency Principle

Definition: A business must use the same accounting methods year after year to ensure comparability of financial statements.

Example:

• If a company depreciates machinery using the straight-line method in 2023, it cannot switch to reducing balance method in 2024 without explanation.

Violation Example: A Nepalese restaurant changes inventory valuation from FIFO to LIFO mid-year. This makes profit comparisons difficult.

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8. Full Disclosure Principle

Definition: Financial statements must reveal all relevant information that affects decision-making.

Example:

• A bank loan must disclose:
  • Interest rate.
  • Repayment terms.
  • Any collateral pledged.

Real-World Example (NEPSE Companies): NEPSE-listed companies (e.g., Nabil Bank, Himalayan Bank) must disclose:

• Related-party transactions (e.g., loans to directors).
• Pending litigations (e.g., tax disputes).

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Core Accounting Concepts (Assumptions)

These are foundational beliefs that shape accounting practices.

1. Money Measurement Concept

Definition: Only transactions measurable in money are recorded. Non-financial items (e.g., employee morale, brand reputation) are not recorded.

Example:

• A Kathmandu hotel cannot record customer satisfaction scores in its books.
• It can record NPR 50,000 spent on customer feedback surveys.

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2. Business Entity Concept

Definition: A business is separate from its owner(s). Personal transactions are not mixed with business transactions.

Example:

• If the owner of a local shop takes NPR 10,000 cash for personal use, it is recorded as:

  | Date       | Particulars               | Dr (NPR) | Cr (NPR) |
  |------------|---------------------------|----------|----------|
  | 2024-02-01 | Drawings A/c               | 10,000   |          |
  |            | To Cash A/c               |          | 10,000   |
  

Real-World Example (WhatsApp Business Account): If a freelancer uses a separate WhatsApp Business account for clients, personal chats are not recorded in business books.

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3. Time Period (Periodicity) Concept

Definition: A business’s life is divided into artificial time periods (e.g., monthly, yearly) for reporting.

Example:

• Nepal’s fiscal year runs from July 1 to June 30.
• Companies prepare quarterly reports (e.g., Nepal Rastra Bank’s financial statements).

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4. Cost Concept

Definition: Assets are recorded at their original purchase cost, not their current market value.

Example:

• A computer bought for NPR 50,000 in 2020 is still recorded at NPR 50,000 in 2024 (unless impairment occurs).

Exception: If an asset’s market value drops significantly (e.g., NPR 30,000), it may be written down.

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The Accounting Cycle: How Principles & Concepts Work Together

Real-World Trace: NTC’s Monthly Accounting

1. Transaction: NTC collects NPR 200,000,000 in electricity bills (revenue).
2. Journal Entry: Debit Cash A/c, Credit Revenue A/c.
3. Adjusting Entry: If NPR 50,000,000 is uncollectible, record:

   | Date       | Particulars               | Dr (NPR) | Cr (NPR) |
   |------------|---------------------------|----------|----------|
   | 2024-06-30 | Bad Debts Expense A/c     | 50,000,000|          |
   |            | To Provision for Bad Debts A/c |          | 50,000,000|
   

4. Financial Statement: Shows net revenue = NPR 150,000,000 (after bad debts).

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In the Real World

1. Khalti & eSewa (Dual Aspect & Accrual Basis)

   • When you pay NPR 1,000 for a mobile recharge, Khalti debits your wallet (Asset ↓) and credits Ncell’s account (Liability ↑).
   • If Ncell earns NPR 100,000,000 in a month but only receives NPR 80,000,000 in cash, it still records full revenue (NPR 100,000,000) under accrual basis.

2. Daraz & Pathao (Matching Principle)

   • A Daraz seller ships an order worth NPR 5,000 but gets paid next week. The NPR 5,000 is recorded as revenue immediately (not when cash is received).
   • A Pathao driver pre-pays for fuel (NPR 20,000 for a month). Only NPR 5,000 is expensed per week (matching principle).

3. Nepal Rastra Bank (Conservatism & Full Disclosure)

   • If NRB lends NPR 10,000,000,000 to banks but expects NPR 500,000,000 in bad loans, it records a provision to show realistic profits.
   • NRB discloses all risks (e.g., inflation impact) in its annual report.

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Exam Tip

1. Dual Aspect is the most tested concept—always check if debit = credit in journal entries.
2. Accrual vs. Cash Basis is a common comparison question. Know when to use each.
3. Matching Principle is key for adjusting entries (e.g., prepaid expenses, accrued income).
4. Real-World Applications (e.g., Khalti, Daraz, NEPSE) are highly likely in exam scenarios. Relate theory to Nepali businesses.
5. T-Accounts & Journal Entries must be balanced. Even a NPR 1 mismatch can cost marks.
6. Memorize the Accounting Equation: Assets = Liabilities + Owner’s Equity (Use it to verify entries.)
7. For numerical problems, always:
   • Identify the principle/concept applied.
   • Show workings (e.g., depreciation calculations).
   • Link to a real business (e.g., "This is how Nabil Bank would record...").

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Final Checklist Before Exam: ✅ Can I explain dual aspect with a T-account? ✅ Do I know accrual vs. cash basis differences? ✅ Can I prepare adjusting entries for prepaid/accrued items? ✅ Do I understand conservatism vs. full disclosure? ✅ Can I apply concepts to Khalti, Daraz, or NEPSE?