Accounting Theory and Practice

Definition of Accounting - Need for Accounting Art Ws Science-Scope of
Accounting, Relationship Accounting with other disciplines, History of
Accounting Systems.
Accounting-An Introduction
Accounting is generally termed as the language of business throughout the
world. The language is the means of communication of ideas or feelings by
the use of conventionalised signs, gestures, marks and articulated vocal
sound. In the same way, the accounting language seaves as a means to
communicate matters relating to various aspects of business operations. As








separately, the offer to communicate is essentially from a business
enterprise to various individuals, groups and institutions that are having
interest in the operations and results of that enterprise. Now, although
accounting is generally recognised with the business, trade and profession,
the business enterprise is not the only kind of organisation that makes use
of accounting. Legal entities ranging from individual to governments use
and prepare accounting to obtain information on the financial condition
and performance of the entity in question. Just as the business enterprises
(like firms, companies, societies and institutions keep their accounts, so can
the nations and even the individual owners of the business and profession
It is necessary to have a good knowledge of accounting-grammar (in the
shape of construction of accounts, conventions, concepts, postulates,
principles, standards etc.) to interpret accounting information for purposes
of communication, reporting, decision making or appraisal.
Definition of Accounting
The role of accounting then is that of communicating the results of the
operations of a business. How does accounting accomplish this ? This is









“Accounting is the art of recording, classifying and summarising in a
significant manner and in terms of money, transactions and events which

are, in part at least, of financial character and interpreting the results
thereof. (AICPA) ”
American Accounting Association defines accounting as “the process of
identifying, measuring and communicating economic information to permit
informed judgements and decision by users of the information”.
From the above the following attributes of accounting emerge :
(i) Recording: It is concerned with the recording of financial transactions in
an orderly manner, soon after their occurrence In the proper books of
(ii) Classifying: It Is concerned with the systematic analysis of the recorded
data so as to accumulate the transactions of similar type at one place. This
is performed by maintaining the ledger in which different accounts are
opened to which related transactions are posted.
(iii) Summarising: It is concerned with the preparation and presentation of
the classified data in a manner useful to the users. This function involves
the preparation of financial statements such as Income Statement, Balance
Statement of Changes in Financial Position, Statement of Cash Flow,
Statement of Value Added.
(iv) Interpreting: Now a days, the aforesaid three functions are performed by
electronic data processing devices and the accountant has to concentrate
mainly on the interpretation aspects of accounting. The accountants should
interpret the statements in a manner useful to action. The accountant
should explain not only what has happened but also (a) why it happened,
and (b) what is likely to happen under specified conditions.
Objectives of Accounting
The following are the main objectives of accounting:

i) To keep systematic records : Accounting is done to keep a systematic
record of financial transactions, like purchase of goods, sale of goods, cash
receipts and cash payments.
ii) To ascertain the operational profit or loss : Accounting helps in
determining the net profit earned or loss suffered on account of running the
business. This is done by keeping a proper record of revenues and expenses
of a particular period.
iii) To ascertain the financial position of the business : The businessman is
not only interested in knowing the operating result, but also interested in
knowing the financial position of his business i.e., where it stands. In other
words, he wants to know what the business owes to others and what others
owe to business.
iv) To facilitate rational decision making : Apart from the owners, there are
various other parties who are interested in knowing about the position of
business, such as tax authorities, the management, the bank, the creditors,
etc. The required information is furnished to all these parties through
accounting system.
Accounting as science or art
Science is a systematised body of knowledge. It establishes a relationship of
cause and effect in the various related phenomenon. It is also based on
some fundamental principles. Accounting has its own principles e.g. the
double entry system, which explains that every transaction has two fold
aspect i.e. debit and credit. It also lays down rules of journalising. So we
can say that accounting is a science.
Art requires a perfect knowledge, interest and experience to do a work
efficiently. Art also teaches us how to do a work in the best possible way by
making the best use of the available resources. Accounting is an art as it
also requires knowledge, interest and experience to maintain the books of
accounts in a systematic manner. Everybody cannot become a good
accountant. It can be concluded from the above discussion that accounting
is an art as well as a science.
Relationship Accounting with other disciplines

Accounting is a dynamic and applied subject. Even though it is a
independent study, it has relationship with other subjects.
The subjects with the its relations are very much close are discussed below;
Accounting and Management
Accounting and Management are very closely related. Because management
depends entirely on Accounting as information store in making decisions in
financial affairs.
Accounting provides all kinds of financial information in project planning
and implementation of a business concern.
As a result the management can take decisions comfortably regarding
project planning and implementation.
The scope of Management is extended from individual life to the various
field of social life. The overall development of trading, non-trading,
government, semi-government, autonomous bodies etc. depends on
In- the modem age the responsibilities of making decisions, planning and
management have been shifted from owners to professional managerial
For this reason all functions of managers are directed to the development of
business concern.
In this respect Accounting helps the management in taking timely
decisions, interpreting and analyzing overall and information – based
Managers cannot take the best and most dynamic course of action for their
respective business concerns without the information based financial
statements and other statements of accounts.
As a matter of fact, the success of management fully depends on accounting
Accounting and Economics
The relation of Economics with Accounting is very close. Economics is a
science related to human activities to fulfill demand with limited wealth.
Economics analyses how people earn and spend, how purchasers and
sellers behave under different circumstances etc.
On the other hand Accounting records transactions of income and
expenditure measurable in terms of money and provides necessary and
relevant information to purchasers and sellers for taking decisions.
Economics studies the behaviors of buyers and sellers as a whole.
On the other hand Accounting provides all required financial information to
individual buyers and sellers for taking economic decision.

Computer has eliminated all these obstacles. . It is possible to solve mathematical problems involving millions or even billions of figures within a few seconds by computer and these can be preserved in it as well. In this perspective bringing about a synthesis between the concept of economics and accounting. ledger. with the help of computer. the concept of social sciences is being applied. Accounting is the language of business.So. In the developed countries of the modem world the application of computer is growing fast in solving accounting problems. It takes huge time and labor and even then the accuracy of Accounting cannot be hundred percent ensured. Accounting and Mathematics Accounting and Mathematics are closely related. Mathematics is an indispensable part of Accounting. preservation and verification of validity of ratio are possible very quickly. It saves time and labor. Accounting and Statistics . The word compute means counting and the meaning of computer is counter. Accounting expresses all its transactions and events of financial changes in the language of mathematics. these two subjects are interrelated. the relation between Accounting and Computer is very close. in preparing journal. Besides. At different stages of accounting addition. Because using all kinds of information and data relating transactions as per definite table and program in computer. preparation of various accounts as per need. The word “computer” has been derived from the word compute. trial balance and financial statements mathematical principles are applied. Accounting and Computer Science There is a close and effective relationship between Accounting and Computer Science. subtraction. In our country also the application of computer is increasing in the field of accounting problems. multiplication and division of arithmetic are applied.e. For this reason the processes of keeping accounts become easy and short. On the other hand Mathematics is the language of Accounting. preparation of accurate accounting is possible within very short time. In Accounting accounts of various transactions are to be recorded and the results are to be determined. So. Therefore. At all stages of accounting i.

it is impossible on their part to extend their help in settling conflicts and cases properly. company law. cooperative law and other relevant laws. The accountant and accounts officer must have clear knowledge of partnership law. Political science gives directives in achieving welfare for the people of the society as a whole. Accounting and Political Science The main object of Political Science is to ensure law and order for establishing rule of law in the society. Because accounts of an organization are kept following accepted principles and in accordance with relevant laws. In partnership business accounts are maintained in the light of partnership act or agreement as the case may be. Similarly. The main object of these two sciences is to make arithmetical figures understandable and logical and to present these in the form of statements making them usable to owner. Keeping accounts. Otherwise. both Accounting and Law are closely related subjects. Therefore. In this context lawyers are to know the provision of laws relating to methods of accounting. For example. in Accounting after completion of some accounting processes of transactions. direction and controlling. Accounting and Law The prevailing laws of a land control trade and commerce mostly. For this reason a statistician presents the data in quite a short form of reports to the individuals or organization concerned so that they can take decision depending on this information. . analyses the quantitative data of various events and to present them to the individuals or organizations concerned. the owners and the directors of the organization concerned can take decisions. auditing of accounts of a company are mandatory as per specific provision of the companies act. industrial law. accounts of other organizations are to be kept in accordance with the provisions of the relevant law. On the other hand. So. accounts of every company are kept properly and accurately in the light of company law. Accounting and Law are closely related. directors or all others concerned. tax law. final accounts and financial statements are prepared and on the basis of various information of such financial statements. The main function of statistics is to collect classify.Accounting and Statistics are deeply related. It makes the act of planning and decisionmaking easier.

managers of a production oriented business concern should have the knowledge of engineering. So. etc. Accounting and Engineering Among the important branches of modem social sciences accounting and Engineering axe prominent. These two subjects jointly work in the process of production and building. expenditure and providing information in this regard are the tasks of Accounting. Function of accountant is to find out the ratio between money invested in plant and machineries and results arising out of it and present the same to the managers in the form of statements. . Accounting was practised in India twenty three centuries ago as is clear from the book named "Arthashastra" written by Kautilya. Besides maintaining accounts and auditing of accounts of government tax administration. expenditure of various projects. of a concern is to be accounted for. The estimation regarding types of goods and quantity of goods to be produced and amount of expenditure to be involved in machineries etc. Special type of plant and machineries are needed in factories. For this ‘ reason the entrepreneurs. Keeping proper accounts of this national income. However. Therefore there exists a close relationship between Accounting and Political Science. HISTORY OF ACCOUNTING Accounting is as old as money itself. King Chandragupta's minister. in the modem age of complex and large scale production the knowledge of accounting as well as engineering is essential for achieving target by running a business successfully.For this reason issues like national income and expenditure. but also explain the art of proper keeping of accounts. the act of accounting was not as developed as it is today because in the early stages of civilisation. arise from political science. the number of transactions to be recorded were so small that each businessman was able to record and check for himself all his transactions. national development expenditure and probable income from national prospects etc. Without the knowledge of engineering an accountant cannot provide accurate information regarding plant and machineries. directors. This book not only relates to politics and economics. income tax. are performed by accounting. These plants and machines are made by the engineers engaged in engineering work.

Theoretical concepts.Accounting principles. ii.specific rules derived from the accounting principles thataccount specific transactions and events faced by the accounting entity.Definition i. ii. the modern system of accounting based on the principles of double entry system owes it origin to Luco Pacioli who first published the principles of Double Entry System in 1494 at Venice in Italy. Accounting postulate (assume) . iv. iii.However. the art of accounting has been practised for centuries but it is only in the late thirties that the study of the subject 'accounting' has been taken up seriously The Structure of Accounting Theory -Accounting theory contains i. sociological and legal environments in which accounting must operate.Accounting techniques. Thus. A statement of the postulates and theoretical concepts. iv.portray the nature of accounting entities operating in a freeeconomy characterized by private ownership of property. political. A statement of the accounting principles based on postulates and theoretical concepts. A body of accounting techniques derived from the accounting principles. Conceptual Framework What is CF? . iii.self evident statements generally accepted by virtue of their conformity to the objectives of FS that portray economic. A statement of the objectives of financial statements.general decision rules derived from both objectives andtheoretical concepts of accounting that govern the development of accountingtechniques.

Serve as a guidelines to form a general rules. Act as a constitution for the standard-setting process. reliability comparability and timeliness and basicelements of accounting reports such as asset. expenses and profit. Enhance comparability by decreasing the number of alternative accounting methods. 2nd level. financial statements vs financial reporting andmeasurement. income.states the scope and objectives of financial reporting. Middle level.fundamentals include the qualitative characteristics of accounting info and definitions of the elements of financial statement. Consist of 3 levels:Highest level. . Determine the bounds of judgment in preparing financial statement. Overall scope of CF 1st level is objectives which identify the goals and purpose of accounting.identifies and defines the qualitative characteristics of financialinformation such as relevance. liabilities. 3rd level. function and limits of financial accounting and reporting. Benefits of CF Guide the FASB in establishing accounting standards Provide a frame of reference for resolving accounting questions in the absence of specific promulgated standards.operational guidelines that the accountant uses in establishing and applying accountingstandards include the recognition with principles and rules of recognition and measurement of the basic elements and type of information to be displayed in financial reports.A coherent system of interrelated objectives and fundamentals that lead to consistent standards andthat prescribes the nature. Lower level.

does not include an analytical judgement of the quality of an accountant’s actions. claims to those resources andchanges in them. Criticism.Decision-theory approachOverall theory of accounting ---> individual accounting system --->prediction model of user ---->Decision model of user Useful in assessing cash flow prospects.4th level.IASB Framework – focus on information needs of a wide range of usersFASB Concepts Statement No. Approaches to the Development of Accounting Theory 1.1.about enterprise resources. Does not provide for accounting techniques to be . Objectives of CF Information for decision making :…the objective of general purpose financial reporting is to provide information to users that are useful inmaking and evaluating decisions about the allocation of scarce resources. Inconsistency of practices Defense against political interference- accounting policies can be implemented by making a value judgment but there is no way of proving that the value judgments of any individual are better for society.reporting funds flow and liquidity and reporting financial position. Why CF is needed? Lack of a general theory Permissiveness of accounting practice- accounting standards allows alternative accounting practicesto be applied to similar circumstances.the display mechanisms that accounting uses to convey info include reported earnings. Objectives of Financial Reporting by Business Entity – emphasizesusefulness in investment and credit decisions.Pragmatic theories Descriptive pragmatic approach It is an inductive approach where it based on continual observation of the behaviour of accountants in order to copy their accounting procedures and principles.

Reaction by user is taken as evidence that financial statements are useful and relevant info. Enable regulators to assess the economic consequences of the various accounting practices they consider.Users react in a illogical manner. Focus on empirically (experimental) testing some of the assumptions made by normative accounting theorists.g. and Empirical propositions Make assumptions about the nature of a firm’s operations based on their observations. financial reports). Explain on what and how and predict accounting practice. Syntactic and Semantic theories Traditional historical cost accounting largely a syntactic theory.Normative theories (prescriptive) Concerned with policy recommendations & with ‘what should be done’ and how accounting should be practiced. 4. 3.Positive theories (descriptive) Referred as positive methodology (testing theories to real world). Some accounting theorists argue that theory has a semantic content on the basis of its inputs. Focus: Deriving ‘true income’ in accounting period where concentrate on deriving a single measure for assets and a unique profit figure.  Test importance of accounting outputs in marketplace. have preconditioned response and may not react when they should.  Survey opinions. Criticisms:. Psychological pragmatic approach Observe users’ response to accountants’ outputs (e. Based on subjective opinion of what accounts should be report and the best way to do that. There is no independent empirical operation to verify the calculated outputs. Discussing type of accounting info useful in making decision (decision usefulness) Assumptions are rarely subject to any empirical testing Theory: Based on analytic / syntactic. .challenge and does not allow for change. 2. Focus in accountant’s behaviour not on measuring the attributes of the firm.

Traditional Approach 3.Deductive approach 5. Consists of the construction of a theory that conforms to real-world practices and suggests practical solutions. justice(equitable treatment of all interested parties).Authoritarian approach Used by professional organizations.Ethical approach Consist of the concept of fairness (fair. 4.Pragmatic approach Characterized by its conformity to real-world practices (useful).usefulness to users of info & relevance to decision-making process. Consists of pronouncements for regulation of accounting practices. Concern: Explaining reasons for accounting practices. equity . Predicting role of accounting & associated info in economic decision making.Inductive approach 6. unbiased and impartial representation).Assume that accounting info is an economic and political commodity and that people actin their own self-interest. Accounting techniques & principles chosen . Attempt to provide practical solutions. Normative & positive theories – complement each other. Pragmatic & authoritarian ---> accounting theory predicted on the basis of ultimate uses of financial reports.Nontheoritical Approaches a. b.

Numerous attempts by individuals & professional & governmental organizations to participate in the establishment of concepts & principles in accounting. Focus on general economic welfare. 7. Electic approach Combination of approaches in developing accounting theory. Concepts of “internalizing” social costs & social benefits of the business. event. Assumes the existence of established social values that may be used as criteria. 8.Economic approach Emphasizes the controlling behaviour of macroeconomic indicators that result from the adoption of various accounting techniques.Sociological approach Formalization of an accounting theory emphasizes the social effects of accountingtechniques. positive) . Emerge new approaches (regulatory. behavioral. Accounting policies and techniques should reflect economic reality and depend on economic consequences. Accounting data will be useful in making social welfare judgements.and truth (true and accurateaccounting statements without misrepresentation). Has contributed to the evolution of new accounting subdiscipline known associoeconomic accounting to encourage business entities to account for the impact of their private production activities on the social environment through measurement anddisclosure in financial statements. A given accounting principles is evaluated for acceptance. 9. The choice of different accounting techniques depends on their impact on the nationaleconomic good. accountingshould serve public interests.

Consider an individual. For example. the business is treated as distinct and separate from the individuals who own or manage it. interpreted and recorded from ‘business entity’ point of view. the important question is how will it affect the business entity? How they affect the persons who own it or run it or otherwise associated with it is irrelevant. Also. An accountant steps into the shoes of the business entity and decides to account for the transactions. The limited companies are separate legal persons in the eyes of law as well. there is no distinction made between financial affairs of the outlet with that of the individual.ACCOUNTING ASSUMPTIONS (a) Business Entity Concept As per this concept. However. in accounting. who runs a small retail outlet. if the owner pays his personal expenses from business cash. The owner’s capital is the obligation of business and it has to be paid back to the owner in the event of business closure. For certain forms of business entities. When recording business transactions. the profit earned by the business will belong to the owner and hence is treated as owner’s equity. In the eyes of law. The entity concept requires that all the transactions are to be viewed. The creditors of the retail outlet can sue the individual and collect his claim from personal resources of the individual. this transaction can be recorded in the books of business entity. the records are kept as distinct for the retail outlet and the individual respectively. Application of this concept enables recording of transactions of the business entity with its owners or managers or other stakeholders. This transaction will take the cash out of business and also reduce the obligation of the business towards the owner. (b) Going Concern Concept The basic principles of this concept is that business is assumed to exist for an indefinite period and is not established with the objective of closing it . At times it is difficult to separate owners from the business. such as limited companies this distinction is easier.

that it will continue to operate as usual for a longer period of time. 3 computers etc. transactions could be added or subtracted to find out the combined effect. 10 vehicles. (d) The Accounting Period Concept We have seen that as per the going-concern concept the business entity is assumed to have an indefinite life. This is not practicable. If this assumption is not considered. pay its creditors. The application of this concept has a limitation. one will have to constantly value the worth of the assets and resource. etc. When expressed in the common measure of money. 1500 kg of raw material. In the above example. This concept enables the accountant to carry forward the values of assets and liabilities from one accounting period to the other without asking the question about usefulness and worth of the assets and recoverability of the receivables. should we wait until this indefinite period is over? Would it mean that we will not be able to assess the business performance on an ongoing basis? Does it deprive all stakeholders the right . we only consider the absolute value of the money. buy and sell goods. (c) Money Measurement Concept A business transaction will always be recoded if it can be expressed in terms of money. Now if we were to assess whether the business has made profit or loss. When transactions are recorded in terms of money. exchange rate changes. The real value of the money may fluctuate from time to time due to inflation. the accountant assumes that a business entity is a ‘going concern’ . So unless there is good evidence to the contrary. The advantage of this concept is that different types of transactions could be recorded as homogenous entries with money as common denominator. Unless each of these is expressed in terms of money.down. we could add values of different assets to find the total assets owned. we cannot find out the assets owned by the business. It will keep getting money from its customers. The going concern concept forms a sound basis for preparation of a Balance Sheet. use assets to earn profits in future. This fact is not considered when recording the transaction. A business may own ` 3 Lacs cash.

In a credit transaction. In case of a cash transaction. the expense effect also must be recognized. however. the concept of realisation talks about what revenue should be recognized. BASIC PRINCIPLES/ CONCEPTS (a) The Revenue Realisation Concept While the conservatism concept states whether or not revenue should be recognized. when the business procures goods or services with the agreement that the payment will be made at a future date. . Today’s accounting systems based on accrual concept are called as Accrual System or Mercantile System of Accounting. owner’s equity is instantly affected as cash either is received or paid. When goods are sold on credit as per normally accepted trade practices. a mere obligation towards or by the business is created. The actual collection of money from customer could be at a later date. Because an obligation to pay for goods or services is created upon the procurement thereof. revenues are not the same as cash receipts and expenses are not same as cash paid during the period. the business gets the legal right to claim the money from the the accounting information? Would it mean that the business will not pay income tax as no income will be computed? (e) The Accrual Concept The accrual concept is based on recognition of both cash and credit transactions. When credit transactions exist (which is generally the case). It says amount should be recognized only to the tune of which it is certainly realizable. Acquiring such right to claim the consideration for sale of goods or services is called accrual of revenue. This concept ensures that income unearned or unrealized will not be considered as revenue and the firms will not inflate profits. mere getting an order from the customer won’t make it eligible to recognize as revenue. Similarly. The reasonable certainty of realizing the money will come only when the goods ordered are actually supplied to the customer and he is billed. it does not mean that the expense effect should not be recognized. Thus.

objectivity and consistency of accounting data which should disclose the true and fair view of the state of affairs of a firm. The revenue to be recognized will be ` 24. (c) Full Disclosure Concept As per this concept. as the goods go out of the business. The net effect of these two effects will reflect either profit or loss. all significant information must be disclosed. Both the effects must be recognized in the same accounting period.50 lacs. To generalize. This principle is going to be popular day by day as per Companies Act. in practice the doubtful amount of ` 50 thousand (2% of ` 25 lacs) is often considered as expense. full disclosure must be made for such material information which are useful to the users of accounting information. both must be recognized in the same accounting period. aggregated and explained for the purpose of presenting the financial statements which are useful for the users of accounting information. which reduces owner’s equity by the cost of goods sold. This is the principle of matching concept. Accounting data should properly be clarified. 1956 major provisions for disclosure of essential information about accounting data and as such. One cannot recognize only the revenue effect thereby inflating the profit or only the expense effect which will deflate the profit. . both these aspects must be recognized during the same accounting period. Thus. In order to correctly arrive at the net result. this principle emphasizes on the materiality. The experience and past data shows that generally 2% of the amount is not realized.Consider that a store sales goods for ` 25 lacs during a month on credit. when a given event has two effects – one on revenue and the other on expense. (b) The Matching Concept As we have seen the sale of goods has two effects: (i) a revenue effect. summarized. Practically. Although conceptually the revenue to be recognized at this value. is not very easy. concealment of material information. at present. which results in increase in owner’s equity by the sales value of the transaction and (ii) an expense effect.

00. it will involve use of one or the other resource of the business to create or settle one or more obligations. This could be shown as: Assets = Liabilities + Capital In other words. The obligations could be towards owners (called as owner’s equity) and towards parties other than the owners (called as liabilities). When a business transaction happens. the money will be paid back to him. the business has got a resource of cash worth ` 25 lacs (which is its asset).g. Luca Pacioli in the year 1495. Suresh’s equity ` 25. now let us consider he borrows ` 15 lacs from bank. whereas the claims of various parties on business are called obligations. Suresh (` 25 lacs) = Liability of business towards Mr. that is why it is called as Double-entry system of accounting. Here. The dual aspect of this transaction-on one hand the business cash will increase by ` 15 lacs and a liability towards the bank will be created for ` 15 lacs. Suresh starts a business with the investment of ` 25 lacs. Accounting systems are set up to simultaneously record both these aspects of every transaction. Continuing with our example of Mr. e. Suresh (` 25 lacs) We know that liability of the business could be towards owners and parties other than owners. In its present form the double entry system of accounting owes its existence to an Italian expert Mr. Assets = Liabilities + Owner’s equity .(d) Dual Aspect Concept The assets represent economic resources of the business. Cash brought in by Mr. but at the same time it has created an obligation of business towards Mr.000 = Liabilities ` nil + Mr. consider Mr. this equation could be re-written as: Assets = Liabilities + Owner’s equity Cash ` 25. Suresh that in the event of business closure. This powerful concept recognizes that every business transaction has dual impact on the financial position.00. Suresh.000 This is the fundamental accounting equation shown as formal expression of the dual aspect concept.

000 + Mr.00.50 crores. Whenever an asset is bought. the data which will be available will neither be reliable nor be dependable. the basic accounting equation will always balance or be equal.g.00.000 The student must note that the dual aspect concept entails recognition of the two effects of each transaction. reliability and trustworthiness that are very useful for the purpose of displaying the accounting data and information to the users. We will now see some more concepts that are important for preparation of Profit and Loss Account or Income Statement. it is recorded at its actual cost and the same is used as the basis for all subsequent accounting purposes such as charging depreciation on the use of asset. Suresh’s equity ` 25.e. which will be calculated with reference to the actual cost.Cash ` 40. documentary evidence of transactions must be made which are capable of verification by an independent respect. These effects are of equal amount and reverse in nature. The above concepts find the application in preparation of the Balance Sheet which is the statement of assets and liabilities as on a particular date. After recording both aspects of the transaction.. if a production equipment is bought for ` 1. It will obviously be reduced by the amount of depreciation. (f) Historical Cost Concept Business transactions are always recorded at the actual cost at which they are actually undertaken. . (e) Verifiable Objective Evidence Concept Under this principle.000 = Liabilities ` 15. these should be biased data. e. The actual value of the equipment may rise or fall subsequent to the purchase. In the absence of such verification. How to decide these two aspects? The golden rules of accounting are used to arrive at this decision. the asset will be shown at the same value in all future periods when disclosing the original cost.00. but that is considered irrelevant for accounting purpose as per the historical cost concept. accounting data must be verified. i. In other words. The basic advantage is that it avoids an arbitrary value being attached to the transactions. Verifiability and objectivity express dependability.

It proposes that while accounting for various transactions.g. the equation takes the following form – Asset = Liabilities or.. we can write the above in the following form – Expenses + Losses + Assets = Revenues + Gains + Liabilities And if expenses and losses. CONVENTIONS/ MODIFYING PRINCIPLES (a) The Concept of Materiality This is more of a convention than a concept. and incomes and gains are set off. Generally. What this convention claims is to attach importance to material details and insignificant details should be ignored while deciding certain accounting treatment. This does not mean that the accountant should exclude some transactions from recording. e. on an ongoing basis. the effect is said to be . (g) Balance Sheet Equation Concept Under this principle. even ` 20 worth conveyance paid must be recorded as expense. the assets are shown at their historical costs as reduced by depreciation.The limitation of this concept is that the Balance Sheet does not show the market value of the assets owned by the business and accordingly the owner’s equity will not reflect the real value. So. However. the Accounting Equation. The concept of materiality is subjective and an accountant will have to decide on merit of each case. appears as :Debit = Credit Naturally every debit must have a corresponding credit and vice-e-versa. all which has been received by us must be equal to that has been given by us and needless to say that receipts are clarified as debits and giving is clarified as credits. Asset = Equity + External Liabilities i.e. The basic equation. only those which may have material effect on profitability or financial status of the business should have special consideration for reporting.

the same may not be considered for recognizing as inventory on account of materiality of amount. the whole of the remaining amount could be expensed out in the fourth year. It will follow that the asset will be depreciated over a period of 5 years at the rate of ` 2 lacs every year. The materiality could be related to information. (b) The Concept of Consistency This concept advocates that once an organization decides to adopt a particular method of revenue or expense recognition in line with the other concepts.material. amount. If postal stamps of ` 500 remain unused at the end of accounting period. audit fees. unless there is a valid reason for change in the method. An asset of ` 10 lacs is purchased by a business. Suppose the firm applies the same depreciation rate for the first three years and due to change in technology the asset becomes obsolete. loan to directors. Consider an example. It is estimated to have useful life of 5 years. The insistence of this concept would result in avoidance of window dressing the results by choosing the accounting method by convenience and thereby either inflating or understating net income. The estimate of useful life and the rate of depreciation cannot be changed from one period to the other without a valid reason. However. e. the same should be consistently applied year after year. Some transactions are by nature material irrespective of the amount involved. it may be difficult to be consistent if the business entities have two factories in different countries which have different statutory requirement for accounting treatment. if the knowledge of an event would influence the decision of an informed stakeholder. Say. Error in description of an asset or wrong classification between capital and revenue would lead to materiality of information. . procedure and nature.g. Lack of consistency would result in the financial information becoming non-comparable between the different accounting periods. Certain accounting treatments depend upon procedures laid down by accounting standards.

There may be seasonal industries also. every bank verifies the cash balance with their cash book and within the day.(c) The Conservatism Concept Accountants who prepare financial statements of the business. Some of them follow the principles. (e) Industry Practice As there are different types of industries. In short. the same must be completed. each industry has its own characteristics and features. would liketo give a favourable report on how well the business has performed during an accounting period. Normally. This philosophy of prudence leads to the conservatism concept.e. Principle of timeliness is also followed by banks. every transaction must be recorded in proper time. transaction should be recorded datewise in the books. prudent reporting based on skepticism builds confidence in the results and in the long run best serves all the divergent interests of users of financial statements. Delay in recording such transaction may lead to manipulation. misappropriation etc. when the transaction is made. This is because business is done in situations of uncertainty. This principle is followed particularly while verifying day to day cash balance. Every industry follows the principles and assumption of accounting to perform their own activities. i. of cash and goods. the same must be recorded in the proper books of accounts. misplacement of vouchers. For years. like other human being. concepts and . This can be stated as (i) Delay in recognizing income unless one is reasonably sure (ii) Immediately recognize expenses when reasonably sure (d) Timeliness Concept Under this principle. However. this concept was meant to “anticipate no profits but recognize all losses”. The concept underlines the prudence of under-stating than over-stating the net income of an entity for a period and the net assets as on a particular date.

Accounting Standards To promote world-wide uniformity in published accounts. Insurance companies prepare Revenue Account just to ascertain the profit/loss of the company and not Profit and Loss Account. non trading organizations prepare Income and Expenditure Account to find out Surplus or Deficit. Insurance companies maintain their accounts in a specific manner. as established by the Financial Accounting Standards Board are called Generally Accepted Accounting Principles (GAAP). GAAP are a combination of standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information. conventions. This process of harmonisation will make it easier for the users and preparers of financial statement to operate across international boundaries. IASC exist to reduce the differences between different countries’ accounting practices. standards to be observed in the presentation of audited financial statements and to promote their worldwide acceptance and observance. These are the common set of accounting principles. balance sheet item classification and outstanding share measurements. GAAP cover such aspects like revenue recognition. standards. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES A widely accepted set of rules. GAAP is to be followed by companies so that investors have a optimum level of consistency in the financial statements they use when analyzing companies for investment purposes. the International Accounting Standards Committee (IASC) has been set up in June 1973 with nine nations as founder members. The purpose of this committee is to formulate and publish in public interest. e. Similarly. and procedures for reporting financial information.g Electric supply companies. The accounting practice which has always prevailed in the industry is followed by it.conventions in a modified way. In our country. the Institute of Chartered Accountants of India has constituted Accounting . standards and procedures that companies use to compile their financial statements.

Standard Board (ASB) in 1977. that should be followed by all business concerns in India.  Amendment to AS 2.Prior Period Items and Changes in Accounting Policies  AS 6 Depreciation Accounting  AS 7 Construction Contracts (revised 2002)  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 . 6. pursuant to issuance of amendments to Accounting Standards by the MCA (September 2016)  AS 1 Disclosure of Accounting Policies  AS 2 Valuation of Inventories  AS 3 Cash Flow Statements  AS 4 Contingencies and Events Occuring after the Balance Sheet Date  AS 5 Net Profit or Loss for the period. 4. 13. The ASB has been empowered to formulate and issue accounting standards. 14. 21 and 29 issued by the Institute of Chartered Accountants of India. 10.

 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. as well as accounting for the economic values of people to an organisation. AS 20 Earnings Per Share  AS 21 Consolidated Financial Statements  AS 22 Accounting for Taxes on Income. It also involves measuring economic value of people to organisations. In short. . they intend to make it clear that the term 'human resource' recognises people who form organisational resources. Thus. It involves accounting for investment in people and their replacement costs. They further explain the value of an employee to the firm as "the present value of the difference between wage and marginal revenue productn." . it involves measuring the costs incurred by business firms and other organisations to recruit. An employee's value drives from the ability of the firm to pay less than the marginal revenue product. select. According to Flamholtz and Lace (1981): "Human Resourie Accounting may be defined as the measurement and reporting of the cost and value of people as organisational resources. train and develop human resources.Contingent` Liabilities and Contingent Assets THE CONCEPT OF HUMAN RESOURCE ACCOUNTING (HRA) The subject of offering measures of the values of people to the organisation through human resource accounting is an essential component of HRP at all levels. hire.

If the value of human assets is ignored. In the words'of R. for under conventional accounting practice". Two firms having identical physical assets and operating in the same market may have different returns due to differences in human assets.. ."human resource accounting is an attempt to identify and report investment made in resources of the organisation that are not presently accounted.Barry Corporation. "Human resource accounting in the measurement of the cost and value is a term used to describe a variety of proposals that seek to report and emphasise the importance of human resources knowledgeable. Vice President. Behavioural scientists concerned with management of organizations pointed out the following reasons for HRA: 1.To quote Davidson. 2. The productivity and profitability of a firm largely depends on the contribution of human assets. 3. the company which undertook pioneering work (1960s) in developing human resource accounting . no information is made available about the human resources employed in an organization. and without people the financial and physical resources cannot be operationally effective. Woodruff further considers it to be an information system that tells management what changes over time are occurring to the human resources of the business. The expenses related to the human organization are charged to current revenue instead of being treated as investments. trained and loyal employees in a company's earning process and total 'assets".L. . the total valuation of the firm becomes difficult. to be amortized over a period of time. with the result that magnitude of net income is significantly distorted. RG. Need for HRA: The need for human asset valuation arose as a result of growing concern for human relations management in the industry. $Voddmff Jr. This makes the assessment of firm and inter-firm comparison difficult. Under conventional accounting.

8. 3. 7. Methods of Valuation of Human Resources: There are certain methods advocated for valuation of human resources. opportunity cost method and standard cost method. 6. Increasing managerial awareness of the value of human resources. which are explained as follows: 1. replacement cost method. The system of HRA discloses the value of human resources. 2.4. Enabling management to monitor the use of human resources. For better human resource planning. present value method. These methods include historical method. Assisting in effective utilization of manpower. developing. 4. Expenses on recruitment. allocating and maintaining human resources. etc. which helps in proper interpretation of return on capital employed. the important act of management on human assets cannot be perceived. For better decisions about people. are treated as expenses and written off against revenue under conventional accounting. 5. All methods have certain benefits as well as limitations. Assisting in developing effective management practices. . since the benefits are accrued over a period of time. Benefits of HRA: There are certain benefits for accounting of human resources. All expenses on human resources are to be treated as investments. training. Objectives of HRA: Rensis Likert described the following objectives of HRA: 1. If the value of human resources is not duly reported in profit and loss account and balance sheet. Finding depreciation or appreciation among human resources. based on improved information system. Providing cost value information about acquiring. 5.

2. therefore. 6. and skills are considered valuable assets. firms are providing only as additional information. 4. which can go wrong at any time. there is always a bone of contention among the firms that which method is an ideal one. devotion. This system can increase productivity because the human talent. So. 2. Limitations of HRA: HRA is yet to gain momentum in India due to certain difficulties: 1. It is believed that human resources do not suffer depreciation. which is not possible under this method. which helps in preventing misuse of human resources by the superiors as well as the management. 3. For example. There are no standardized procedures developed so far. which is far from possible. 3. Managerial decision-making can be improved with the help of HRA. the valuation seems to be unrealistic. Under conventional accounting. The lifespan of human resources cannot be estimated. The implementation of human resource accounting clearly identifies human resources as valuable assets. It helps in efficient utilization of human resources and understanding the evil effects of labour unrest on the quality of human resources. certain standards are accepted commonly. Development of Human Resource Accounting (HRA): . 6. The valuation methods have certain disadvantages as well as advantages. All the methods of accounting for human assets are based on certain assumptions. 5. it is assumed that all workers continue to work with the same organization till retirement. 5. which can boost the morale of the employees. which can also prove otherwise in certain firms. So. 4. and in fact they always appreciate. It can assist the management for implementing best methods of wages and salary administration.

Human Capital In Early Economic Thought Throughout history economists have been concerned with the concept of human capital. Several motives for treating human beings as capital and valuing them in monetary terms were expounded. Of these a central motive is apparent—to serve as a basis for making a decision or to influence the decisions of others. varied widely from one advocate to another. the debate itself is by no means novel. two methods of estimating the value of human beings emerged—(i) the cost-ofproduction and (ii) the capitalized earnings procedures. Its purpose is to impart the perspective essential to a thorough understanding of the pros and cons of human resource accounting systems. a small group of relatively unknown economists un-dertook to develop techniques to measure the worth of human capital. the concept of human resource accounting is deeply rooted in the history of economic thought. Meanwhile. To provide a desirable perspective of the current debate and thus a basis for an accurate assessment of the probable impact of human resource accounting. a familiarity with the development of the concept is necessary.Recent years have witnessed the emergence of numerous trea-tises on the relative merits of human resource accounting. The intent of this article is to trace the historical evolution of human resource accounting to its present stage of development. The capitalized earnings procedure consists of estimating the present value of an individual’s future in-come stream. these two early approaches parallel closely the two basic approaches to human resource ac-counting currently advocated in the current literature. but their treatment was limited to including human beings and their skills in a definition of capital. As described below. while consistent with one of the two general approaches. One of . Indeed. Early Valuation Methods Specific methods of human asset valuation. Basically. In the cost-of-production approach costs incurred in “producing” a human asset are estimated. While the unprecedented pervasiveness of human resource literature suggests that the topic is new to our era.

Marshall’s view. His theoretical approach took on a capitalized-netearnings flavor. Human Resources As Consumption Expenditures Marshall’s view of human capital as being “unrealistic” was per-haps a major contribution to the virtual exclusion of the concept of human resources from the main stream of economic thought from the beginning of the twentieth century to the recent renewal of interest. However. The former would include property consisting of the capi-talized value of earning capacity. this first attempt at human asset valuation estimated the value of the stock of human capital by capitalizing the wage bill in perpetuity at the market interest rate.the first attempts to estimate the money value of human beings was made around 1691 by Sir William Petty [10]. is certainly descriptive of the general view that it was neither appropriate nor practical to apply the concept of capital to human beings. He advocated the substitution of a property tax for the existing English income tax system. He reasoned that expenditures for rearing children were costs to their parents and that this cost might be estimated and taken as a measure of their monetary value. Petty considered labor the “father of wealth” and thus felt that labor must be included in any estimate of national wealth. Ernst Engel’s writings around 1883 recommended a cost-of-pro-duction procedure for estimating the monetary value of human beings [3]. His procedure for estimating capitalized earning capacity was to calculate the present value of an individual’s net future earnings. Accordingly. a “composite” version reflecting Farr’s capitalized earn-ings and anticipating Engel’s cost-of-production approach surfaced when Wittstein argued that an individual’s lifetime earnings are equal to his lifetime maintenance cost plus education [19].1 In 1867. Marshall held that it would be out of touch with the marketplace to treat humans as capital in practical analysis. the wage bill being determined by deducting property income from national income. if not a causal factor. Alfred Marshall was perhaps the most forceful proponent of the concept of human assets [14]. . departing from his con-ceptual arguments. The first truly scientific procedure for finding the money value of human beings was devised in 1853 by Farr [4].

Besides this accepted assessment. can reasonably be attributed to return on investment in humans. it has been all too convenient in marginal productivity analysis for economists to treat labor as if it were a unique bundle of innate abilities that are wholly free of capital. They sought to evaluate these programs in -terms of return on investment. essentially unexplained by classical analysis.” accountants established that these expenditures were “expense” rather than “assets. Particularly. economists sought to influence the direction of the massive investment in these social programs. Increasingly massive investments by industry in human assets have been cited as compounding the impact of the error of excluding human assets from capital [17]. Additionally.2 When economists began to treat investments in human resources as “consumption” rather than “investments. accounting theorists ignored human assets as the concept was simultaneously ignored in economic analysis. Expenditures for humans were viewed as “consumption. Mincer has demonstrated the causal relationship between amount of training and interoccupational differentials in personal income [15]. Because of the close conceptual relationship between early accounting and economics. various other reasons prob-ably help explain the exclusion of humans from the concept of economic capital. Several of the underlying concepts of modern accounting theory are derived from classical economic theory and many of these matured during the period in which human capital was excluded from practical consideration by economists. The large increases in real earnings of workers. Generally.” in economic jargon. These reasons were probably sufficient to exclude human capital from the core of economic thought for several decades. Moreover.” This treatment by economists had a significant impact upon the treatment accorded human resource expenditures by accountants. This desire led to the necessity of thinking of such expenditures as capital rather than consumption expenditures. . rather than as “investments.” Renewed Interest in Labor Intensive-Specialized Economy The advent of massive governmentally supported social programs in the decade of the 1960’s rekindled the interest of economists in human assets. the mere thought of investments in humans was offensive to most people.

al. Research in human resource accounting reflects the two routes evidenced in contemporary accounting theory. The model of Brummet. One segment of the research is directed toward the investigation of concepts for the measurement of human resource costs: original cost. Until then. Flamholtz. The Beginning of Human Resource Accounting The revival of interest by economists in the topic of human capital was accompanied by. Other researchers have developed models . and opportunity cost. original cost. accountants had considered the problem of valuing human resources to be part of the larger problem of valuing goodwill. is illustrated in the works of Brummet. and Pyle who individually and collectively have developed concepts. an examination of the concept of human resource accounting by accounting theorists. This branching of current research in human resource accounting closely parallels the “cost-of-produc-tion” and “capitalized earnings” measurement approaches taken by early economists many decades ago. Labor’s increasing marginal product can be attributed in part to expenditures for training.The contribution of labor toward the growth rate of real national income is increasing as a percentage while the percentage contrib-uted by physical capital is decreasing. These projects and limited implementation of research results is subsumed under the title of human resource accounting. The recent research in this area attempts to distinguish economic values attributable to the human resources of a firm from the values attributable to other components of goodwill. is a generalized model which can be extended to incorporate replacement costs. and techniques for measuring the historical cost of human resources [1]. Another segment investigates the determinants of the value of human resources of employees as a group or of individual employees. Re-search by Thurow directed attention toward the existence of human capital resulting from investments in training programs [18]. et. replacement cost. or perhaps caused. that the real economic value of the investment may be significantly different than its cost [15]. The first of these measurement concepts. Attempts to measure human resource cost have resulted in the development of three different concepts and measurement models. models. Concern has been expressed over the historical cost concept—namely.

and Pyle [1] as well as Lev and Schwartz [12] have suggested methods to arrive at the value of employees as a group. In a different approach. The end result of the operation of such models is a measure o f the cost to replace individuals occupying organizational position. the suggestions to value human assets at historical or original cost are accounting adaptations of the “cost of produc-tion” techniques developed by Engels in 1883 and suggested by Shultz in 1960. for example. have suggested a system of competitive bidding to obtain managerial assessments of opportunity cost of human assets. Brummet. Likert’s model per se is not intended to measure the value of human resources. Growing out of the studies on organization and leadership at the University of Michigan’s Institute for Social Research. Like the other measurement concepts.for the measurement of human resource replacement cost [6]. an-other is directed toward the investigation of the determinants of the value of human assets. opportunity cost measurement has its critics as well [8]. Proposals to obtain replacement or opportunity cost measures parallel the current conceptual debate in accounting theory to fi nd an acceptable alternate to historical cost. . Hermanson proposed two possible techniques for the monetary valuation of the total human assets of a firm [7]. With the exception of Likert’s model. Additionally. Perceived deficiencies in the replacement cost approach to measurements led others to develop the concept of opportunity cost to value human resources. but the efficiency of various types of management systems. Flamholtz has attempted to develop a model of the determinants of an individual’s value to a firm [5]. At the core of the proposals is the realization that the value of people to an organization is the present worth of the future services they are expected to render—the “capitalized earnings” approach. Essentially. While one segment of accounting research in human resource accounting has been directed toward measurement concepts. Flamholtz. The development of this theory is proceeding from two different approaches. Likert [13] and others have attempted to develop a model of determinants of a group’s value to an organization. Hekimian and Jones. the methods proposed for determining the value of employees or groups of employees to an organization are similar in principle to the proposal of the econo-mist William Farr.

In both proposals the impact of the economic concept of value is apparent. Monetary measures include (a) Historical cost method It suggests capitalizing the expenditure of the firm incurred on recruitment and selection. training and development of the employees and treats them as the assets of the organization for the purpose of HR accounting. Hermanson’s suggested methods attempt to provide protection against manipulation by management. The proposal of Lev and Schwartz to capitalize future compensation is an adaptation directly comparable to that of William Farr. However this method may not reflect either the actual cost or the contribution associated with HR (c) Opportunity cost method This model envisages the computation of monetary value and the allocation of people to the most promising activity and thereby assesses the . The total performance has to be judged in relation with the total cost associated with the HR to reflect its value. Pyle. This would serve as a basis to value human resources. The forecasted end-result variables would serve as a basis to forecast future contributions by employees. The proposals utilize capi-talized current excess earnings or modified future employee earn-ings as a measure of human capital. Methods of Valuation of Human Resources Accounting There are several methods of HR valuation and accounting and these are broadly divided into two categories: The monitory measures and nonmonetary measures. This method suffers from a limitation that the capitalization of costs does not reflect its true value. and Brummet have suggested that measurement of the present state of the causal and intervening variables would provide a basis to forecast future end-result variables. (b) Replacement cost method The cost of replacement of individual and the re-building cost of organization is assessed to reflect the HR asset value of the individuals and the organization. Flamholtz.Likert. Flamholtz’s suggestion for the valuation of an individual utilizes a series of capitalizations corresponding to the service states the individual is expected to occupy.

Ohio with the help of machingon university in the year 1967 . experience.opportunity cost of main employees through competitive bidding among the investment centre. and development. acquisition. output. so here one will take the age of the employee at the time of recruitment and at the time of . Flamholmay tz and Pyle but the first attempt towards employee valuation made by a foot ware manufacturing company R. transferability and promote-ability are measure using personal research. This method measures the organization’s investment in employees using the five parameters: recruiting.This approach is developed by Brummet. The payments made to the employees in the form of salary. and these in turn affect the output variables like production. Casual variable include leadership style and behaviour. motivation. (b) Discounted present value of future earnings This method was use by Rencis Likert who proposed three sets of variablescasual. allowances and benefits are estimated and discounted appropriately to arrive at the present economic value of the individual. this model suggest instead of charging the costs to p&l accounting it should be capitalized in balance sheet.the process of giving an status of asset to the expenditure item is called as capitalization. Barry Corporation of Columbus. informal training. appraisal techniques or other objective methods. The promoteability and transferability are measured in terms of potential using psychometric tests and subjective evaluations. Informal familiarization. formal training and. These helped in measuring the effectiveness over a period of time. profit etc. familiarization. Historical cost approach: This approach is also called as aqvisition cost model. commitment to goals etc. (d) Economic value method The value of human resource is evaluated on the basis of contribution they are likely to make in the organization during their stay with the organization. intermediate. (2) Non-monetary measures: (a) Expected realizable value method The elements of expected realizable value like the productivity. The productivity is measured by objective indices and managerial assessment. in case of human resource it is necessary to amortize the capitalized amount over a period of time. G. sales. the intermediate variable are morale.

at the expense of importing considerably more subjectivity into the measure.33 so the unamortized amount of rupees 16666.67 This method is the only method of human resource accounting which is based on sound accounting principals and policies.e.retirement.33 3333. According to Likert (1985) replacement cost include recruitment. This method helps in determining what an employee’s future contribution is worth today.66 should be charged to p&l account i. he serves the company for 25 years but actually his retirement age was 55years. is the present value of his/her future earnings from employment and can be calculated by using the following formula: E(Vy) = Σ Py(t+1) Σ I(T)/(I+R)t-y . This is similar to physical asset e.g:. According to this model. The data derived from this method could be useful in deciding whether to dismiss or replace the staff.33=16666. 1000000=3333. the value of human capital embodied in a person who is ‘y’ years old. selection. out of these a few employee may leave the organization before attaining the superannuation. and training cost (including the income foregone during the training period).If company spends one lakh on an employee recruited at 25years he lives the organization at the age 50. • Since the assets cannot be sold there is no independent check of valuation. Limitations: • The valuation method is based on false assumption that the dollar is stable.33 100000-83333.33*25=83333. the company has recovered rupees 83333. • This method measures only the costs to the organization but ignores completely any measure of the value of the employee to the organization (Cascio 3). Limitations: • Substitution of replacement cost method for historical cost method does little more than update the valuation. Present Value of Future Earnings: Lev and Schwartz (1971) proposed an economic valuation of employees based on the present value of future earnings. adjusted for the probability of employees’ death/separation/retirement. compensation. Replacement Cost approach This approach measures the cost of replacing an employee. This method may also lead to an upwardly biased estimate because an inefficient firm may incur greater cost to replace an employee (Cascio 3-4).

Expense model: According to Mirvis and Mac. and then costs are estimated for each criterion. • The measure assigns more weight to averages than to the value of any specific group or individual (Cascio 4-5). replacement costs. and job performance are measured using traditional organizational tools.Bernard M. For example. turnover. In a country like India the problem is more acute with its developing economy". inflation has become a world wide phenomena since the second world war. . judgment. Accounting for Price Level Changes/ Inflation Accounting "Inflation is the most important fact of our time. For example a value of a professional athlete’s service is often determined by how much money a particular team. (1976) this model focuses on attaching dollar estimates to the behavioral outcomes produced by working in an organization. Value to the organization: Hekimian and Jones (1967) proposed that where an organization had several divisions seeking the same employee. acting in an open competitive market is willing to pay him or her. Criteria such as absenteeism. Limitations: • The soundness of the valuation depends wholly on the information. the single greatest peril to our economic health". enlarging plan outlays without corresponding increase in productivity and various types of subsidies have given an impetus to inflation. in costing labor turnover. Governments ever rising administrative expenditure.T=Y Y where E (Vy) = expected value of a ‘y’ year old person’s human capital T = the person’s retirement age Py (t) = probability of the person leaving the organisation I(t) = expected earnings of the person in period I r = discount rate Limitations: • The measure is an objective one because it uses widely based statistics such as census income return and mortality tables. and training costs. dollar figures are attached to separation costs. Each one of us experience the . the employee should be allocated to the highest bidder and the bid price incorporated into that division’s investment base. and impartiality of the bidder (Cascio 5). Baruch Prices of various goods and services have been rising at an alarming rate"Though the history of mankind is a history of rising prices.

Money as a medium of expression of value and measure of economic activity is expected to have a constant value. Since nominal values of assets. Money is the medium of expression of values in modern life. Meenakshi Prakashan. For measuring anything. of an overstatement of profits and an understatement of assets during inflation conversely there is an understatement of profits and an overstatement of assets when there is deflation. Neither can we wish away inflation nor can we remain insensitive spectators. Consequently. action under MRTP Act. According to the American Institute of certified Public Accountants (AICPA). But this expectation has been Sanjeev Pandit.upwards or downwards . actions regarding . P. Changing value of' money has resulted in a chaos and distortion while reporting results of economic activities of business enterprises. Fixed assets are the main victims of inflation or in other sense the effect of inflation is more pronounced in the case of these types of assets: The depreciation is calculated on the historical cost basis which is usually lower than that of those calculated at replacement value. profits and other items from corporate accounts form the basis of many other decisions having important effects. Such problems have the effect of distorting the accounting results in various ways. One is current assets and the other is fixed assets. Mainly two types of assets are included in the Balance Sheet. Effects of various economic activities are measured and expressed in terms of money. belied. Inflation and its Impact on Financial Statements : The monetary postulate underlying historical cost accounting does not holdgood during the period of changing prices. Purchasing power gains. among others. "Inflation Accounting is a system for accounting which purports to record as a built in mechanism all economic events in terms of current cost".impact of inflation in everyday life.losses occurs simply because the firm is holding some monetary liabilities and assets which gain or lose purchasing power during inflation.i. stock shows at cost or market price whichever is lower. These distortions are manifested in the form. Inflation Accounting. like calculation of tax liability. Problems associated with inflation must be brought in to sharp focus to understand their magnitude. "Constant value of money"'has remained a very unrealistic assumption. it is mandatory that the measure itself is prices. a host of problems began to creep in to the accounts with the movement . Second the operating expenses and incomes are taken at current prices. Meerut 1989 India.

This malady may be corrected only by inflation accounting. general price change through inflation undermines the stability of the value of the currency unit. Reducing the purchasing power of the pound through inflation means that comparison of amounts measured in pounds at different times is distorted. the valuation model which adjusts asset values for general changes in prices may result in asset values that are considered to be an entire fiction. One response to the problems of price change is to restate the financial statements produced on a historical cost basis by adjusting for the change in purchasing power. known as current purchasing power accounting (CPPA) was put forward in the UK but. The capital increase shown between the restated statements of financial position would be the current purchasing power profit. This is commonly referred to as real financial capital maintenance. In addition. The unit of measurement that would then be employed would be the pound of current purchasing power at the year end. Monetary items in the closing statement of financial position would require no adjustments as they are already stated in current terms. Current purchasing power accounting Price change has two broad impacts on the accounting approaches which have been described. it has been largely rejected. The purchasing power of the owners’ capital would be maintained since it is restated in these terms. However.various controls imposed by the Government and so on. This approach involves only limited adjustment from historical cost and. since these can be based on publicly available indices such as the retail price index (RPI). The procedure is to restate the opening and closing statements of financial position by indexing all items in the opening statement of financial position and all non-monetary items including owners’ capital in the closing statement of financial position using general price level indices. a value without the external evidence that would meet the needs of prudence and realisation. First. "The distortion in corporate accounts introduced by inflation may have a much wider effect than a mere misrepresentation of accounts". Current cost accounting . since the upward revaluation of assets by indexing them would be. Assets do not all change prices in line with inflation. increasingly. the increase that is being reported would be a combination of realised and unrealised gains. A version of this approach. given the limitation identified and others. reliability is not substantially reduced.

e. and a monetary working capital adjustment.e. known as a gearing adjustment. modifying depreciation to one based on the current cost of assets rather than the historical cost. i. These are a depreciation adjustment. Considerable subjectivity is involved in identifying suitable specific price level indices for each of the possible specific price changes. There has been much debate about whether there should also be a fourth adjustment. The resulting reduction in reliability together with the costs of implementing the approach with all its complexities are considered to outweigh the advantages. . This is aptly described as operating profit. which recognises revenues only when they are realised. and generally regarded as beyond the introductory level. adjusting for the price change of purchases during the creditor period and sales during the debt collection period. showing the ability of a business to produce revenues over and above the current cost of producing them through operating activities. particularly where the period of holding assets is relatively short and hence the impact of the adjustments is small. adjusting inventory values and purchases to current costs. a cost of sales adjustment. Any adjustments necessary to eliminate holding gains from profit would be those necessary to restate historical costs. to current costs. Measuring profit in relation to opening and closing capital restated to include holding gains of the period produces a concept of physical/operating capital maintenance. included in the comprehensive income statement. This is intended to reflect the benefits of having debt capital during periods of increasing prices. will produce periodic profits which represent both the results of the current year’s operations and gains made in previous periods which are only realised in the current period (although gains which are unrealised in the current period are excluded). Instead. gains from continuing to own assets during price rises. they can be regarded as holding gains. Current cost accounting has been widely abandoned as a result. i. The last two adjustments are relatively complicated. One response to this problem is to recognise unrealised gains in the period to which they relate but to treat these not as part of operating profit. A version of this approach known as current cost accounting (CCA) includes such adjustments in three components. Profit would be restated by eliminating holding gains. identifying the gains that can be withdrawn while permitting a business to own the same physical assets.The second major aspect of price change is the specific price changes in asset values. The historical cost approach.