Dr. Mehul Raithatha Accounting Concepts and Conventions Accounting Concepts are those basic assumptions or conditions upon which accounting is based. It helps to bring uniformity while preparing financial statements Accounting conventions refer to the common practices that are followed in recording and presenting accounting information. They are followed like customs, traditions, etc., in a society. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate appropriate recording in the books of accounts.
Dr. Mehul Raithatha Concept #1: Money Measurement Accounting records are recorded in monetary terms at value at time transaction is recorded. limitation. Some items cant be easily valued. E.g., CEOs health, effect of strike. Price changes ignored. Dr. Mehul Raithatha Concept #2: Entity Organization or activity for which accounting records are prepared. Need distinction between entities. Entity vs. owner. Entity vs. other entities Business has separate status and personal transactions of owners can not be merged Dr. Mehul Raithatha Concept #3: Going Concern Assumed to continue in operation for an indefinite period. Due to this we record receivables, payables, depreciation etc. Opposite assumption: Liquidation/bankruptcy. Only liquidation values would be meaningful. Dr. Mehul Raithatha Concept #4: Cost Terminology Assets. economic resources of an entity. recorded at cost (i.e., price paid). Book value of assets. recorded value. Fair value of assets. amount for which asset could be currently purchased or sold. Currently in India all assets are recorded at cost (acquition price) not at fair value, however revaluation is allowed under certain circumstances Dr. Mehul Raithatha Concept #5: Dual-Aspect Assets = economic resources. Equities = claims against assets. Liabilities = claims of creditors (everyone other than owners). Owners equity = claims of investors (Shareholders or stockholders equity for a corporation). Dr. Mehul Raithatha Dual Aspect Fundamental accounting equation: Assets = Liabilities + Owners equity
For a corporation: Assets = Liabilities + Stockholders equity
Assets = Liabilities + Paid-in cap. + Ret. earnings Dr. Mehul Raithatha Dual Aspect Transactions are events that affect accounting records. Every transaction has a dual impact on accounting records. Dual impact: Results in maintaining equality of accounting equation. Double-entry accounting system. Dr. Mehul Raithatha Concept #6: Accounting Period Measurement of activities for a specified arbitrary interval of time. A one-year timeframe is commonly used: Fiscal year, business year May or may not coincide with calendar year.
We follow 1 st April to 31 st March Dr. Mehul Raithatha Accounting Period Interim Reports. Reports on periods less than fiscal year. SEBI/IT department requires quarterly. Management may require monthly (or weekly, or daily). Dr. Mehul Raithatha Concept #7: Conservatism prudent reporting based on healthy skepticism builds confidence in the results.... Preference for understatement rather than overstatement of assets and earnings. If two estimates are equally likely, use the one that results in smaller assets and earnings.
Dr. Mehul Raithatha Conservatism Formally: Recognize revenues when reasonably certain. Recognize expenses when reasonably possible. Informally: anticipate no profits but anticipate all losses. Sometimes requires judgment. Dr. Mehul Raithatha Concept #8: Realization/Accrual
Revenue is recognized only when, an agreement is reached or sale is made. Cash may or may not have been received Also applicable to expenses Dr. Mehul Raithatha Accrual Basis versus Cash Basis The accrual basis of accounting recognizes revenues and expenses when they occur instead of when cash is received or disbursed.
The cash basis of accounting recognizes revenue and expense when cash is received and disbursed Dr. Mehul Raithatha Concept #9: Matching When an event affects both revenues and expenses, the effect should be recognized in the same accounting period. First determine revenues for period. Then expense matching items of cost. Dr. Mehul Raithatha Concept #10: Consistency Once an accounting method is selected, use for all subsequent events of same character. Can change if there is sound reason to change. But must be disclosed to users. Consistency over time, not for different types of transactions. Dr. Mehul Raithatha Concept #11: Materiality Full disclosure of all important information. But, insignificant events may be disregarded. Overriding concern: Would knowledge of event affect decisions of users? Application of judgment and common sense. Dr. Mehul Raithatha Fundamental accounting assumptions Going Concern, Consistency, and Accrual
Dr. Mehul Raithatha Accounting Policies Accounting policies encompass the principles, bases, conventions, rules and procedures adopted by managements in preparing and presenting financial statements. There are many different accounting policies in use even in relation to the same subject. Accounting policies are the specific accounting assumptions and the methods of applying these principles for the preparation and presentation of financial statements of an enterprise. Dr. Mehul Raithatha Different Accounting Policies Valuation of inventories Treatment of goodwill Valuation of fixed assets Treatment of contingent liabilities Valuation of investments Treatment of retirement benefits Treatment of depreciation Treatment of foreign exchange transactions
Dr. Mehul Raithatha ACCOUNTING STANDARDS Accounting Standards (AS) are written policy document issued by expert accounting body or by government or regulatory body covering the aspects of recognition, treatment, measurement, presentation and disclosure of accounting transaction and events in the financial statements.
Accounting Standards provide framework and standard accounting policies so that financial statements of different enterprises become comparable.
ACCOUNTING STANDARDS (Contd.) The Accounting Standards seek to ensure that the financial statements of an enterprise should give a true and fair view of its financial position and working results.
Accounting Standards not only prescribe appropriate accounting treatment of complex business transactions but also foster greater transparency and market discipline.
ACCOUNTING STANDARDS IN INDIA The Institute of Chartered Accountants of India (ICAI) being apex accounting body in India, has constituted the Accounting Standards Board (ASB). ASB was constituted on 21st April, 1977, with a view to harmonies the diverse accounting policies and practices in use in India and to formulate Accounting Standards. While formulating accounting standards, the ASB takes into consideration the applicable laws, customs, usages and business environment prevailing in the country. The ASB also gives due consideration to International Standards (IFRSs/ IASs) and tries to integrate them, to the extent possible, in the light of conditions and practices prevailing in India. AS 1 Disclosure of Accounting Policies AS 2 Valuation of Inventories AS 3 Cash Flow Statements AS 4 Contingencies and Events Occurring after the Balance Sheet Date AS 5 Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies AS 6 Depreciation Accounting AS 7 Construction Contracts (revised 2002) AS 8 Accounting for Research and Development (AS-8 is no longer in force since it was merged with AS-26) AS 9 Revenue Recognition AS 10 Accounting for Fixed Assets AS 11 The Effects of Changes in Foreign Exchange Rates (revised 2003), AS 12 Accounting for Government Grants AS 13 Accounting for Investments AS 14 Accounting for Amalgamations AS 15 Employee Benefits (revised 2005) AS 16 Borrowing Costs AS 17 Segment Reporting AS 18 Related Party Disclosures AS 19 Leases AS 20 Earnings Per Share AS 21 Consolidated Financial Statements AS 22 Accounting for Taxes on Income. AS 23 Accounting for Investments in Associates in Consolidated Financial Statements AS 24 Discontinuing Operations AS 25 Interim Financial Reporting AS 26 Intangible Assets AS 27 Financial Reporting of Interests in Joint Ventures AS 28 Impairment of Assets AS 29 Provisions, Contingent` Liabilities and Contingent Assets AS 30 Financial Instruments: Recognition and Measurement and Limited Revisions to AS 2, AS 11 revised 2003), AS 21, AS 23, AS 26, AS 27, AS 28 and AS 29 AS 31, Financial Instruments: Presentation AS 32, Financial Instruments: Disclosures, and limited revision to Accounting Standard (AS) 19, Leases ASB has issued 34 AS till October 2011.
In accordance with Indias assurance to converge with IFRS, a new set of standards namely, Ind AS (Indian Accounting Standards) are now being issued. The Ministry of Corporate Affairs (MCA) has notified the Ind AS on 25 February 2011.
These are being implemented in phased manner. To begin with they are applicable to companies listed abroad and large companies.
Several of the requirements of Ind AS are considerably dissimilar from policies and practices presently followed by Indian companies.
Further, while finalising the Ind AS, the Indian standard setters have modified individual IFRS, wherever necessary, to suit Indian requirements. This has resulted in differences between Ind AS and equivalent requirements under IFRS (referred to as carve outs). IND AS: SIMILAR TO IFRS Ind AS 101: First-time Adoption of Indian Accounting Standards Ind AS 102: Share based Payment Ind AS 103: Business Combinations Ind AS 104: Insurance Contracts Ind AS 105: Non-Current Assets Held for Sale and Discontinued Operations Ind AS 106: Exploration for and Evaluation of Mineral Resources Ind AS 107: Financial Instruments: Disclosures Ind AS 108: Operating Segments Ind AS 1: Presentation of Financial Statements Ind AS 2: Inventories Ind AS 7: Statement of Cash Flows Ind AS 8: Accounting Policies, Changes in Accounting Estimates and Errors Ind AS 10: Events after the Reporting Period Ind AS 11: Construction Contracts Ind AS 12: Income Taxes Ind AS 16: Property, Plant and Equipment Ind AS 17: Leases Ind AS 18: Revenue Ind AS 19: Employee Benefits Ind AS 20: Accounting for Government Grants and Disclosure of Government Assistance Ind AS 21: The Effects of Changes in Foreign Exchange Rates Ind AS 23: Borrowing Costs Ind AS 24: Related Party Disclosures (Contd.) Dr. Mehul Raithatha Ind AS 27: Consolidated and Separate Financial Statements Ind AS 28: Investments in Associates Ind AS 29: Financial Reporting in Hyperinflationary Economies Ind AS 31: Interests in Joint Ventures Ind AS 32: Financial Instruments: Presentation Ind AS 33: Earnings per Share Ind AS 34: Interim Financial Reporting
(Contd.) Dr. Mehul Raithatha Ind AS 36: Impairment of Assets Ind AS 37: Provisions, Contingent Liabilities and Contingent Assets Ind AS 38: Intangible Assets Ind AS 39: Financial Instruments: Recognition and Measurement Ind AS 40: Investment Property (Contd.) Dr. Mehul Raithatha INTERNATIONAL ACCOUNTING STANDARDS (IAS) International Accounting Standards Committee (IASC) was constituted in 1973 to formulate global accounting standards. Barring Canada, Japan and US all countries have accepted these standards. The US Financial Accounting Standards Board (FASB) is in process of eliminating differing in standards. Standards Interpretations Committee was formed in 1997, to give proper direction and interpretations.
Dr. Mehul Raithatha INTERNATIONAL ACCOUNTING STANDARDS (Contd.) IASB was constituted in 2001 to prescribe norms for treatment of items on preparation and presentation of Financial statements. ISAB adopted all 41 standards issued by IASC and are designated International Accounting Standards (IASs). IASB publishes its Standards called International Financial Reporting Standards (IFRSs). Dr. Mehul Raithatha INTERNATIONAL ACCOUNTING STANDARDS THE LIST IAS 1 Presentation of Financial Statements IAS 2 Inventories IAS 7 Cash Flow Statements IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events After the Balance Sheet Date IAS 11 Construction Contracts IAS 12 Income Taxes IAS 16 Property, Plant and Equipment IAS 17 Leases
Dr. Mehul Raithatha INTERNATIONAL ACCOUNTING STANDARDS THE LIST (Contd.) IAS 18 Revenue IAS 19 Employee Benefits IAS 20 Accounting for Government Grants and Disclosure of Government Assistance IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs IAS 24 Related Party Disclosures IAS 26 Accounting and Reporting by Retirement Benefit Plans IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 29 Financial Reporting in Hyperinflationary Economies Dr. Mehul Raithatha INTERNATIONAL ACCOUNTING STANDARDS THE LIST (Contd.) IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Presentation IAS 33 Earnings per Share IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property IAS 41 Agriculture
Dr. Mehul Raithatha GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)
To avoid confusion and to achieve uniformity, accounting process is applied within the conceptual framework of GAAP. The Financial Statements of entity cannot be said to be showing a true and fair view, unless these Financial Statements have been drawn up on GAAP. GAAP consists of four components: The requirements of law The judgments by courts of law Pronouncement by the governing bodies (Like ICAI, FASB in US) Requirements of regulatory authorities (Like RBI, SEBI, SEC in US )
Dr. Mehul Raithatha GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) (Contd.) Each country has its own GAAP like US GAAP, Indian GAAP. Though the term GAAP is used predominantly in the US.
GAAP are the backbone of the accounting information system, without which whole system cannot even stand erect.
With current efforts of harmonisation in Accounting Standards, one may hope that by 2015: Most of the countries will converge their Standards to global standards All larger corporate would make their financial statements in conformity with International Standards.
Dr. Mehul Raithatha International Financial Reporting Standards (IFRS)
International Financial Reporting Standards (IFRS) are a set of accounting standards, developed by the International Accounting Standards Board (IASB), London, that are becoming the global standard for the preparation of public company financial statements. Dr. Mehul Raithatha List of IFRS IFRS 1: First-time Adoption of International Financial Reporting Standards IFRS 2: Share-based Payment IFRS 3: Business Combinations IFRS 4: Insurance Contracts IFRS 5: Non-current Assets Held for Sale and Discontinued Operations IFRS 6: Exploration for and Evaluation of Mineral Assets IFRS 7: Financial InstrumentsDisclosures IFRS 8: Operating Segments Dr. Mehul Raithatha Short questions The proprietor of a firm withdrew Rs 56,000 for his personal use. This was shown as an expense of the firm. Profits were reduced to pay a lower tax. Is this right from accounting point of view? Dr. Mehul Raithatha The CEO of a company is killed in a plane crash. To the extent an organisation is the lengthened shadow of a man, the real value of the company will change immediately and this will be reflected in the market price of the company shares. Will this have any effect as far as the accounts of the company are concerned? Give appropriate reasons.
Dr. Mehul Raithatha A company revalues its buildings, which were purchased at a cost of Rs 10, 00,000 in 1995 to Rs 90, 00,000 in 2010, and records the difference of Rs 80, 00,000 as profit for the year 2003. Is this practice right? Give reasons.
Dr. Mehul Raithatha The accounting year of a firm closes on 31st December each year. The rent for business premises of Rs 45,000 for the last quarter could not be paid to the owner on account of his being away in a foreign country. Should the rent payable be taken into account for computing the firms profit for the accounting year? Give reasons.
Dr. Mehul Raithatha A government contractor supplies stationery to various government offices. Some bills amounting to Rs 10,000 were still pending with various offices at the close of the accounting year on 31st March. Should the businessman take the revenue of Rs 10,000 into account for computing the net profit of the period?
Dr. Mehul Raithatha A company had been charging depreciation on a machine at Rs 10,000 per year for the first three years. Then it began charging Rs 9,000 for the fourth year and Rs 7,800 for the fifth year and so on. Is this practice justified? Give reasons for your answer.