GAAP and the first six accounting concepts
- Explain why accounting needs common rules (GAAP)
- Understand business entity, money measurement and going concern with shop examples
- Apply the accounting period and cost concepts to real numbers
- Use the dual aspect concept and the equation Assets = Liabilities + Capital
Namaste! Imagine two cricket scorers watching the same match. One counts a wide ball as a run, the other does not. At the end they show two different totals, and nobody knows who won! Accounting would face the same mess if every accountant followed his own rules. So today we learn the rule book of accounting: GAAP and the first six basic concepts. These are not boring theory. Every entry you will pass in Chapter 3 quietly follows these ideas, and the board exam asks 3 to 6 marks on them almost every year.
1. Why does accounting need a theory base?
Accounting information is used by many people: the owner, managers, a bank giving a loan, investors, suppliers and the tax department. They all want information that is reliable (they can trust it) and comparable (they can compare it).
- Inter-firm comparison: comparing one business with another business, e.g. Sharma Traders vs Gupta Traders this year.
- Inter-period comparison: comparing the same business across years, e.g. Sharma Traders 2026-27 vs 2025-26.
Both comparisons are possible only when everyone identifies, measures, records and reports transactions in the same way. That common way is the theory base of accounting: principles, concepts, rules and guidelines built up over many years. In India, the Institute of Chartered Accountants of India (ICAI) also issues Accounting Standards so that practice stays uniform (we study these in Lesson 3).
Riya's father runs a kirana shop. He tells the bank, "My shop made a good profit this year." The bank manager asks, "Did you count the ₹40,000 your customers still owe you? Did you count your house rent paid from the shop's cash as a shop expense?" Two honest people can reach two different profits unless they follow the same rules. The bank lends money only when the figures follow accepted rules.
2. Generally Accepted Accounting Principles (GAAP)
GAAP are the rules or guidelines adopted for recording and reporting business transactions, so that financial statements are prepared and presented in a uniform way.
Break the name into parts:
- Principle: a general rule used as a guide to action.
- Generally: applying to most people and most cases.
- Accepted: agreed upon by the accounting profession.
Example of a GAAP rule: record every transaction at its historical cost, which can be checked from a document such as a bill or cash receipt. Because anyone can verify it, the records become objective and users trust them.
2.1 Features of GAAP
- They have developed slowly from past experience, customs, views of experts, professional bodies and government regulations.
- They have general acceptance among accountants.
- They are not static. They change with changes in the legal, social and economic environment and in the needs of users. For example, the arrival of GST in 2017 changed how purchases and sales are recorded.
2.2 Concept, convention, postulate: are they different?
Books use many names: principles, concepts, conventions, postulates, assumptions, modifying principles. Strictly, a concept is a basic assumption or idea, and a convention is a custom or tradition followed while preparing statements. But one author calls a rule a concept and another calls the same rule a convention. So NCERT does not fight over names. It calls all of them Basic Accounting Concepts.
Basic accounting concepts are the fundamental ideas or basic assumptions underlying the theory and practice of financial accounting. They are broad working rules for all accounting activities.
| This lesson (6 concepts) | Next lesson (7 concepts) |
|---|---|
| 1. Business entity | 7. Revenue recognition (Realisation) |
| 2. Money measurement | 8. Matching |
| 3. Going concern | 9. Full disclosure |
| 4. Accounting period | 10. Consistency |
| 5. Cost | 11. Conservatism (Prudence) |
| 6. Dual aspect (Duality) | 12. Materiality |
| 13. Objectivity |
First six in order: "B-M-G-A-C-D" — Big Monkeys Go Around the Canteen Daily: Business entity, Money measurement, Going concern, Accounting period, Cost, Dual aspect.
3. Business entity concept
The business is treated as a separate entity, distinct from its owner. Accounts are kept from the point of view of the business, not the owner.
In law, a sole trader and his shop may be one person. But in accounting we pretend they are two different people who deal with each other. What follows from this?
- When the owner brings money into the business, the business owes that money to the owner. So capital is a liability of the business towards the owner.
- When the owner takes out cash or goods for personal use (drawings), the business's debt to the owner goes down. So drawings reduce capital.
- The owner's personal assets (his house, his car, his wife's jewellery) and personal liabilities are not shown in the business books.
- A personal transaction of the owner is recorded only if business money comes in or goes out because of it.
Mr. Sharma owns "Sharma Traders", a stationery shop. On 5 April 2026 he pays his daughter's school fee of ₹12,000 from the shop's cash box. Is this a shop expense? No! The school fee is his family's expense. But shop cash has gone out, so the books record it as drawings of ₹12,000 (capital goes down, cash goes down). If he had paid the fee from his own pocket, the shop's books would record nothing at all.
- Capital brought in: ₹4,00,000. From the store's view, it owes this to Anil.
- Flat and car loan are personal. They do not touch the store's money, so they are not recorded.
- Family trip: ₹25,000 of store cash went out for a personal purpose. Record as drawings. Capital = 4,00,000 − 25,000 = ₹3,75,000.
Neha starts a boutique with capital of ₹3,00,000. During the year she withdraws ₹15,000 cash for household use and takes clothes worth ₹5,000 from the shop for her sister's wedding. Ignoring profit, what is her capital at the end of the year (in ₹)?
Capital = 3,00,000 − 20,000 = ₹2,80,000
Students often write "capital is an asset of the business because the owner brought it". Wrong! Cash brought in is the asset. Capital is the business's liability (obligation) towards the owner.
4. Money measurement concept
Only those transactions and events that can be expressed in money are recorded in the books, and they are recorded in money units (₹ and paise), not in physical units.
This rule has two parts.
4.1 Part one: if it cannot be measured in money, it is not recorded
A sale of goods, payment of rent, receipt of interest: all have a rupee value, so they are recorded. But these are not recorded, however important they are:
- appointment of a new manager (the salary paid later is recorded, the appointment itself is not),
- skill and honesty of the staff, creativity of a design team,
- the goodwill and reputation of the shop in the town,
- a quarrel between two partners, or a strike announced for next week.
4.2 Part two: record in money, not in kg, metres or pieces
Suppose a shop has 1 plot of land, a 3-room building, 4 computers, 20 chairs, 500 kg of stock and some money in the bank. Can you add "1 plot + 3 rooms + 4 computers + 500 kg"? No. Different units cannot be added. Convert everything into rupees, and the total becomes meaningful.
- In physical units the items cannot be added (plot, kg, pieces, computers).
- In money: 25,00,000 + 15,00,000 + 1,20,000 + 80,000 + 4,50,000 + 2,50,000
4.3 Limitation: the value of money changes
Because of rising prices, ₹1 lakh today buys much less than ₹1 lakh bought fifteen years ago. Yet the balance sheet happily adds a building bought in 2008 for ₹20 lakh and a machine bought in 2026 for ₹20 lakh as if both rupees were equal. Since the books do not adjust for the changing value of money, accounting figures may not show a fully true and fair picture. This limitation is a favourite 3-mark question.
5. Going concern concept
The business is assumed to continue its operations for a fairly long (indefinite) period and will not be closed down (liquidated) in the foreseeable future.
Why is this assumption so important? Because it decides how we treat long-life assets. Think of an asset as a bundle of services. When a coaching centre buys a projector for ₹60,000 that will work for 5 years, it is really buying 5 years of service. It would be unfair to charge the whole ₹60,000 against the income of the first year alone. Since we believe the centre will run for years, we charge only the part used up each year (₹12,000 per year) and carry the rest forward. This yearly charge is called depreciation (Chapter 7).
- Going concern: the shop will run for years, so spread the cost over the life. 60,000 ÷ 5 = ₹12,000 per year.
- Remaining ₹48,000 is carried forward as an asset in the balance sheet at the end of year 1.
- If the shop were closing this year, there is no "future" to carry the cost to. The asset would be valued at what it can be sold for, and the whole loss would fall in this year.
A mobile store buys a glass display counter for ₹72,000. It is expected to be used for 6 years. Under the going concern concept, what amount is charged against each year's revenue (in ₹)?
Going concern is also why the balance sheet shows fixed assets at cost less depreciation, and not at the price they would fetch in a distress sale today.
6. Accounting period concept
Accounting period is the span of time at the end of which financial statements are prepared, to know the profit or loss of that period and the position of assets and liabilities at its end.
If a business will run "forever" (going concern), can the owner wait 30 years to find out whether he made a profit? Of course not. The bank, the tax department and the owner himself need results at regular intervals. So the long life of the business is cut into equal slices, normally one year.
- In India, the financial year runs from 1 April to 31 March. For example, FY 2026-27 = 1 April 2026 to 31 March 2027.
- The Companies Act, 2013 and the Income Tax Act require statements to be prepared every year.
- Interim statements for a shorter period may be needed, for example when a partner retires in the middle of the year.
- Companies whose shares are listed on a stock exchange publish quarterly results (every three months).
Going concern says "the story is long". Accounting period says "but we will read it one chapter (year) at a time".
7. Cost concept
All assets are recorded in the books at their cost (purchase price), which includes the cost of acquisition, transportation, installation and all costs of making the asset ready for use.
- Every rupee spent to bring the machine to working condition is part of its cost.
- 1,80,000 + 6,000 + 9,000 + 5,000
A printing shop buys a used printing machine for ₹2,40,000. Freight to the shop ₹7,500, installation charges ₹12,500, repairs before first use ₹5,000. After it starts running, the owner pays ₹4,000 as the first year's insurance. At what amount is the machine recorded (in ₹)?
7.1 Historical in nature
Cost is what was paid on the date of purchase, so it does not change year after year. If a shop was bought for ₹30 lakh and its market value rises to ₹50 lakh, the books still show ₹30 lakh (less depreciation where applicable).
- Merit: the cost can be verified from the purchase bill, so recording is objective. Market value keeps changing and differs from person to person, so it is not reliable.
- Limitation: historical cost does not show the true present worth of the business. In times of rising prices, assets are shown at less than their market or replacement value, creating hidden profits.
Under GST, if the business can take input tax credit of the GST paid on the machine, that GST is recovered from the government and is not added to the machine's cost. You will see this in the GST entries of Chapter 3.
8. Dual aspect concept
Every transaction has a two-fold effect and must be recorded at two places, i.e. at least two accounts are affected.
Assets = Liabilities + Capital
This is the foundation of accounting and the base of the double entry system. Whatever a business owns (assets) has been financed either by outsiders (liabilities, the creditors' claim) or by the owner (capital, the owner's claim). So both sides of the equation must always be equal.
- (i) Cash (asset) +5,00,000; Capital +5,00,000. A = 5,00,000; L + C = 0 + 5,00,000.
- (ii) Stock (asset) +1,20,000; Cash (asset) −1,20,000. One asset up, another down. Totals unchanged.
- (iii) Furniture (asset) +40,000; Creditor (liability) +40,000.
After Cash Stock Furniture = Creditors + Capital (i) 5,00,000 0 0 0 5,00,000 (ii) 3,80,000 1,20,000 0 0 5,00,000 (iii) 3,80,000 1,20,000 40,000 40,000 5,00,000
Meena starts a stationery shop with ₹2,00,000 cash. She takes a bank loan of ₹1,00,000 (received in cash) and buys goods on credit for ₹50,000. What are her total assets now (in ₹)?
Assets = 1,50,000 + 2,00,000 = ₹3,50,000 (Cash 3,00,000 + Stock 50,000).
A shop owner's personal gold jewellery is not shown in the shop's balance sheet. Which concept is being followed?
9. Quick check
- Going concern
- Business entity
- Money measurement
- Dual aspect
- Going concern concept
- Money measurement concept
- Business entity concept
- Accounting period concept only
Board tip: For a 3-mark "explain the concept" question, write (1) the one-line meaning, (2) one or two implications, and (3) a small example with ₹ figures. Underline the concept's name.
📌 Points to remember (Quick Revision)
- GAAP are generally accepted rules for recording and reporting; they evolve and are not static. NCERT calls all such rules "basic accounting concepts".
- Business entity: business and owner are separate; capital is a liability of the business to the owner, drawings reduce capital.
- Money measurement: only money-measurable events are recorded, in ₹ not physical units; limitation — the value of money changes.
- Going concern: business will continue indefinitely, so asset cost is spread over its useful life.
- Accounting period: results are found at regular intervals, normally 1 April to 31 March; cost concept records assets at cost including all costs to make them ready for use.
- Dual aspect: every transaction affects at least two accounts; Assets = Liabilities + Capital always.
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