Basic Rules and Principles of Accounting

USERS OF ACCOUNTING INFORMATION

Different users may need different types of information to aid their decision making.
There are two types of users: internal and external users of accounting information
Internal Users:
1. Proprietors/Owners: The business is done with the object of making profit. Financial statements provide this
information to the Proprietors/Owners
2. Managers: 1.sole proprietary - the proprietor is the manager. 2.partnership business- some or are all the partners. 3.
joint stock companies- Directors
3. Employees: The employees are interested in the financial statements on account of various profit sharing and bonus
schemes. Their interest may further increase in case they purchase shares of the company in which they are
employed. e.g.amazon
External Users:
1. Creditors: Creditors are the persons who have extended credit or loans to the company. They are also interested in
the financial statements because they will help them in ascertaining whether the enterprise will be in a position to
meet its commitment regarding payment of interest and principle
2.Prospective Investors: Prospective investor is a person who is contemplating an investment in a business. He would
like to know about profitability and financial position of the company he is considering to invest. Study of financial
statements will help him in this respect.
3. Government. The government is interested in the financial statements of the business enterprise on account of
taxation. Whether the company is complaining Labour and corporate laws?
4. Citizens: Ordinary citizens may be interested in the accounting records of the institutions with which he comes in
contact in his daily life, for example public utilities such as gas and electricity companies. In a broader sense he is
also interested in the accounts of a government company and public concern etc., as a voter and a taxpayer
BRANCHES OF ACCOUNTING
BRANCHES OF ACCOUNTING

In order to satisfy the needs of different people interested in the accounting

information, different branches of accounting have developed. They can broadly be
classified into two categories:
1) Financial accounting
2) Management accounting

1) Financial accounting: It is the original form of accounting. It is mainly confined to

the preparation of financial statements such as profit or loss and balance sheet for
the use of outsiders like shareholders, creditors, banks and financial institutions to
make informed decisions.
2) Management accounting: It is accounting for the management. i.e accounting
which provides necessary information to the management for discharging its
functions such as planning, controlling and decision making..
QUALITATIVE CHARACTERISTICS OF
ACCOUNTING INFORMATION
1.Relevance: The relevance principle stipulates that all relevant information should be included in the
financial statements. Information is considered relevant if it assist users in making decisions.
2. Reliability: Reliable information is information that can be trusted by users. Information must be objective,
free from bias and significant errors. Only reliable information will enable users to make better decisions.
3. Comparability: Comparability refers to the quality of the information that enables users to make
comparison in evaluating similarities or differences between companies, industries or over time. This
characteristic is important as comparable information is more useful.
4. Consistency: It refers to the requirement that companies are maintaining consistency in the treatment of
various items for all accounting periods. In other words, companies should not change the accounting
procedures or methods used each year. e.g. Depreciation method, closing stock valuation method etc.,
5. Materiality: Materiality is another important concept which states that an entity must account for items
that are significant to the entity’s financial statements. In other words, an amount can be ignored if the
effect on the financial statements is unimportant to user’s business decisions. The materiality of an item
depends on the size or value of the items according to the main activities and the nature of the items
involved.
6. Understandability: The understandability principle requires information to be presented in a format that
can be easily understood. The information reported should be understood by users whom are generally
assumed to have reasonable knowledge of business and economic activities.
7. Timeliness: Relevant and reliable information will be useless if you do not get the information on time.
Hence, it is extremely important to prepare the financial statements on time.
TYPES OF ACCOUNTS AND RULES OF
RECORDING
The transactions in the Journal are recorded on the basis of the rules of DEBIT and CREDIT.
For this purpose business transactions have been classified into 3 categories:
1) transactions relating to persons -For each person with whom it deals
2) transactions relating to properties and assets -Each property which business owns
3) transactions relating to incomes and expenses -Each item of income or expense
On this basis it becomes necessary for the business to keep an account

Personal Accounts - DEBIT THE RECEIVER

CREDIT THE GIVER
Real Accounts - DEBIT WHAT COMNES IN
CREDIT WHAT GOES OUT
Nominal Accounts - DEBIT ALL EXPENSES AND LOSSES
CREDIT ALL INCOMES AND GAINS
ACOUNTING CONCEPTS
1. Business Entity Concept ( Separate Entity Concept)
Business Entity concept advocates that the Business is separate from the owners. Business is shown a separate
legal entity. In Financial statements even owners are shown as outside parties represented by their account
say Capital /Equity. This separates the transactions of the business with personal transactions of the
owners
2. Going Concern Concept
The Going Concern Concept implies that the firm will continue to operate in the near foreseeable future. The
operational implication of this concept is that assets are not shown in Balance Sheet at their realizable
market value, which implies liquidation value.
3. Dual Aspect Concept
The Dual aspect concept implies that all accounting transactions are with 2 aspects-Debit and Credit. Every
debit will have an equal and opposite credit. It means for every debit there should be a corresponding
credit.
4. Money Measurement Concept
Accounting records and states only those facts about a business firm, which can be expressed in monetary
terms. In other words, business events and facts that cannot be expressed in monetary terms, howsoever
important they may be, are excluded.
5. Cost Concept /Historic Cost Concept
Assets/resources owned by the firm are shown at their acquisition cost and not at current market
value/current worth. Market valuation of assets in use is not only difficult to be made but also is related to
subjectivity. Besides, market values may be constantly subject to change.
6. Accounting Period Concept
Accounting Period Concept requires that statement of profit or loss should be prepared at periodic intervals for
purposes such as performance evaluation and determination of taxes. Conventionally, the time span
covered is one year.
7. Revenue Recognition
This principle states that revenue must be recognised as and when they are earned. Recognising revenue
means the amount is recorded in the account. This principle indicates that although cash has not been
received, but goods have been delivered or services have been performed, and thus revenue should be
recognised. The opposite also applies, if you have received cash in advance but have not performed any
service or provided any goods to your customer, you cannot record the amount of cash received as
revenue. In other words, revenue is recognised when earned rather than when cash is received. This notion
of recognising revenue when it is earned and not when cash is received is called accrual accounting.The
same applies to the recognition of expenses, where expenses should be recognised when it is incurred not
when cash changes hand. If you have received the goods or services, although payments are to be made in
the future, expense must be recognised at that time.
ACCOUNTING EQUATION
The dual aspect concept or double entry bookkeeping of accounting ensures that every Debit has an
equal and opposite credit this results in the accounting equation that
Assets = Liabilities + Capital
 The basic accounting equations can be expanded to include items of owner’s equity. There are four
items that can affect the owner’s equity, and they are
 Capital investments: they will increase owner’s. equity.
 Drawings: they will decrease owner’s equity
 Revenues: they will increase the owner’s equity.( Profit)
 Expenses: they will decrease the owner’s equity.( Loss)
The accounting equation can be understood with the help of the following
transactions.
Transaction 1. A starts business with a capital of Rs.10,000.
There are two aspects of the transaction. The business has received cash of Rs. 10,000. On the
other hand it also shown as that the business owes this amount to A.
 Transaction 2. The business purchases furniture for cash worth rupees
2000. The position of his business will be as follows

 Transaction 3. The business takes a bank loan of Rs. 5, 000. The

position of his business will be as follows

The bank loan is a liability that the business owes this amount to Bank
 Assets= Capital + Liability
 Rs. 15,000 = Rs. 5,000+ Rs. 10,000
BASIS OF ACCOUNTING
There are two different basis of accounting. 1. Cash basis of accounting, 2.
Accrual basis of accounting

1. Cash Basis Accounting:

Revenue is reported on the income statement only when cash is received. Expenses are only recorded
when cash is paid out. The cash method is mostly used by small businesses and for personal
finances.
2. Accrual Accounting Method
Revenue is accounted for as and when it earned. Unlike the cash method, the accrual method records
revenue when a product or service is delivered to a customer with the expectation that money will
be paid in the future. Expenses of goods and services are recorded despite no cash being paid out
yet for those expenses.

Hence the main difference between accrual and cash basis accounting lies in the timing of when
revenue and expenses are recognized. The cash method is a more immediate recognition of revenue
and expenses, while the accrual method focuses on anticipated revenue and expenses