CONCEPTUAL BASIS OF ACCOUNTING   1

Students Manual for Chapter 1

CONCEPTUAL BASIS OF ACCOUNTING

Key Words
You are suggested to visit Glossary to appreciate and review the following key words
used in this chapter:
Accounting
)) Going Concern
))
Accounting Policy
)) Institute of the Chartered Accountants of
))
Accounting Postulates
)) India (ICAI)
Accounting Principles
)) Internal Audit
))
Accounting Theory
)) International Financial Reporting Standard
))
Attention Directing
)) (IFRS)
Business Entities
)) Management Control
))
Conservatism
)) Materiality
))
Consistency
)) Monetary Expression
))
External Audit
)) Problem Solving
))
Financial Reporting
)) Property Rights
))
Full-disclosure
)) Score Keeping
))
Generally Accepted Accounting Principles
)) Timeliness
))
(GAAP)

ANNEXURES
Annexure 1.1  Three Ways of Capital Maintenance
Capital maintenance in an organization can be attained by any of the following three ways:
(a) Financial capital maintenance
(b) General purchasing power financial capital maintenance
(c) Maintenance of productive capacity
2    FINANCIAL ACCOUNTING FOR MANAGEMENT

Financial Capital Maintenance

Under the concept of financial capital maintenance, ‘Capital’ means the net assets (i.e., the excess of assets over
liabilities) or equity (i.e., share capital plus reserves and surplus) of the entity. Therefore, income is the amount of
increase in the net assets or equity of the entity, over the period. This excess, even if distributed as dividend, will
not result in a reduction of capital.
For example, if the total assets and liabilities of a firm at the beginning of a year are ` 1,00,000 and ` 80,000
respectively, the net assets of the firm at the beginning amount to ` 20,000 (being assets less liabilities). Now, if at
the end of the same period, the amount of assets and liabilities are ` 1,50,000 and ` 1,25,000 respectively, the net
assets at the end of the period would become ` 25,000. Here, the income for the period can be calculated as the
excess of net assets at the end of the period, as compared with the net assets at the beginning of the period, which
comes to ` 5,000. This amount, even if distributed, will not reduce the capital. This concept is also known as Money
Capital Maintenance. During periods of high inflation, the profits under this concept are inflated; as a result, the
maintenance of the real value of capital may not be feasible.

General Purchasing Power Financial Capital Maintenance

The concept of general purchasing power financial capital maintenance means the purchasing power of the financial
capital invested is required to be maintained. The income for the period is the change in the net assets, expressed in
monetary units of the same purchasing power. Continuing with the above example, if the rate of inflation is assumed
to be at 5 percent, the net capital at the beginning of the period is restated to ` 21,000 (adding a 5 percent increase
to ` 20,000 due to inflation). Thus, using this method the income for the period becomes ` 4,000 (being ` 25,000
less 21,000), which can be distributed as dividend without reducing the capital.

Maintenance of Productive Capacity

The concept of maintenance of productive capital suggests that the productive capacity of a firm should be main-
tained when the income is determined. In other words, income means the excess of productive capacity at the end
of the year, over the productive capacity at the beginning of the year. Taking the same example, if we assume that
the net assets required to maintain the existing productive capacity is ` 23,000, the income for the period would be
` 2,000 (` 25,000 less 23,000).
The selection of the appropriate method of capital maintenance depends on the needs of the users of the financial
statements.

Annexure 1.2  Limited Liability Partnership

Limited Liability Partnership (LLP) is a blend of the provisions of Companies Act and Partnership Act; and hence it
is a hybrid corporate business with perpetual succession and separate legal entity. It allows flexibility of Partnership
firms with the benefits of limited liability of a company. The two prime reasons for the introduction of LLP in India
are the “risk factor” and the “enhanced global competitive advantage” that an LLP offers to Indian professionals.
Thus, in the year 2006, the Limited Liability Partnership Bill was introduced in the Parliament.
It brought great relief to the partners of partnership firms, particularly, professionals like Chartered Accountants,
Company Secretaries, Cost Accountants, Lawyers, Doctors and Architects. It limits the exposure to the extent of
liability while being engaged in businesses with large firms such as Multinational Companies.
Each LLP is required to appoint two designated partners who shall be accountable for regulatory and legal com-
pliances, besides their liability as “partner, per-se” and a manager, not necessarily a partner of the LLP, who is
responsible for ensuring statutory compliance for the LLP.
 CONCEPTUAL BASIS OF ACCOUNTING   3

The possible advantages of LLP are as follows:

●● It is a legal entity separate from its partners, having perpetual succession.
●● The liability is limited to the extent of partners’ contribution – thus, a partner is shielded from the fraudulent
act of another partner.
●● Low cost of formation. Less compliance level. Thus, it is easy to establish and run with minimal interven-
tions of the Government.
●● No restriction as to maximum number of partners.
●● High level of flexibility. A Multi-disciplinary LLP can also be formed.
●● A partner is agent to LLP and thus one could bind LLP by a partners acts and not the other partners.
●● No exposure to personal assets of the partners except in the case of fraud. Only designated partners are liable
for legal compliances.
●● Death of a partner does not dissolve partnership.

Annexure 1.3  One Person Company

According to the new Companies Act, 2013, a ‘One Person Company’ (OPC) means a company which has only one
person as a member. It is thus a one shareholder corporate entity, where despite having just one person, legal and
financial liability is limited to the company alone.
The reason why earlier Companies Act, 1956 had made it compulsory for a company to have a minimum of two
members was so that it could clearly separate it from a sole proprietorship, a form of carrying out business which
is categorically excluded from the Act (see, Table 1.1 for details). However, the hypocrisy of this provision was too
glaring to ignore. People started forming companies by adding a nominal member/director and allotting them one
single share, which is the minimum requirement for a director as per the Act, and retaining the rest of the shares for
themselves. Thus a person could enjoy the status and benefits of a Company while operating and functioning like a
proprietary concern for all practical purposes.
Besides this, entrepreneurs found themselves investing their creative energy in unproductive paperwork and
legal formalities which a full blown private limited company necessitated. Hence, the J.J. Irani Committee in 2005
suggested OPC with a simpler regime through exemptions so that the single entrepreneur is not compelled to fritter
away his time, energy and resources on procedural matters.”
The major advantage of the OPC will be that apart from completing basic procedural formalities for oneself, the sole
member needn’t delve into other time consuming procedures and focus fully on functionality and scalability. At the same
time, this sole member can hire employees in the name of the company, transact as an agent of the company and even appoint
a full-fledged board to allow a corporate style of operation. For example, from a procedural point of view, the Companies
Bill grants certain relaxations to OPC which are not otherwise available to a private limited company. For instance, an OPC
is not mandated to convene an annual general meeting, extraordinary general meeting and other board meetings subject to
certain conditions. Moreover, reporting requirements with the Registrar of Companies are toned down for an OPC.
Further prominent features of OPC includes the sole shareholder is required to appoint a nominee (with such
nominee’s written consent) who would take charge of the company in case of the shareholder’s death. Further, such
a nominee may be changed any time in the manner prescribed under the Companies Bill.
On the negative side, from a taxation point of view, the concept of OPC may not appeal to smaller proprietor-
ships since the base rate of tax of a company is quite steep (30% approx) and may result in a higher incidence of
taxation for the smaller sole ventures.
Source: “One is company: A glance at OPC,” The Hindu Business Line Dec. 17, 2011, print.
“Analysis: OPC under the Companies Bill,” Business Standard Aug. 27, 2011, print.
4    FINANCIAL ACCOUNTING FOR MANAGEMENT

Annexure 1.4  India’s Roadmap of Convergence with IFRS

The adoption of the International Financial Reporting Standards (IFRS) by Indian firms is one of the most significant
financial accounting and reporting changes in the history of Indian corporate accounting.
On February 16, 2015, the Ministry of Corporate Affairs (MCA) notified the Companies (Indian Accounting
Standards) Rules, 2015 (the ‘Rules’). The Rules specify the Indian Accounting Standards (Ind AS) applicable to
certain class of companies and set out the dates of applicability.
The key requirements of the Rules with regard to the class of companies that will be required to follow Ind AS
and the date of adoption by such companies are as under:

Voluntary Adoption
Companies may voluntarily adopt Ind AS for financial statements for accounting periods beginning on or after
April 1, 2015, with the comparatives for the periods ending March 31, 2015 or thereafter. Once a company opts to
follow the Ind AS, it will be required to follow the same for all the subsequent financial statements.

Mandatory Adoption
For the accounting periods beginning For the accounting periods beginning
on or after April 1, 2016 on or after April 1, 2017
The following companies will have to adopt Ind AS for finan- The following companies will have to adopt Ind AS for finan-
cial statements from the above mentioned date: cial statements from the above mentioned date:
• Companies whose equity and/or debt securities are listed or • Listed companies having net worth of less than ` 500 crore.
are in the process of listing on any stock exchange in India • Unlisted companies having net worth of ` 250 crore or more
or outside India (listed companies) and having net worth of but less than ` 500 crore.
` 500 crores or more. • Holding, subsidiary, joint venture or associate companies of
• Unlisted companies having a net worth of ` 500 crores or the listed and unlisted companies covered above.
more.
• Holding, subsidiary, joint venture or associate companies
of the listed and unlisted companies covered above.
Comparative for these financial statements will be periods Comparative for these financial statements will be periods
ending March 31, 2016 or thereafter. ending March 31, 2017 or thereafter.

The roadmap will not be applicable to:

●● Companies whose securities are listed or in the process of listing on SME exchanges.
●● Companies not covered by the roadmap in the “Mandatory adoption” categories above.
●● Insurance companies, banking companies and non-banking finance companies.
These companies should continue to apply existing Accounting Standards prescribed in the Annexure to the Com-
panies (Accounting Standards) Rules, 2006, unless they opt for voluntary adoption. Insurance companies, banking
companies and non-banking finance companies cannot voluntarily adopt the Ind ASs. Separate road map for these
companies will be submitted.
However, it is to be noted that the regulator have been revising and extending these timeliness largely due to
interval pressures by ICAI such as resolution of taxation issues relating to the transition to Ind AS.
Source: “Indian GAAP IFRS and Ind AS a Comparison,” Delloitte Report Feb. 26, 2015. print.
“Breather for Indian Firms on IFRS,” Hindu business Line Feb. 26, 2012. print.
 CONCEPTUAL BASIS OF ACCOUNTING   5

Annexure 1.5  Additional Reading Material

Arthashastra and Link to Accounting

Chanakya’s Arthashastra

National Security issues
including Foreign Policy
Administration of Justice
Economic Development
including Crime and
Policies
Punishment issues

Labor Financial Others

Taxation Accounting
Management Management

Structure organization to Create comprehensive Rules

“Virtue Ethics” to Maintain
create minimal conflict & & Regulations for
Ethical Values
agency issues Implementation

Footnotes: “Virtue Ethics” is an approach to Ethics that emphasizes an individual’s character as the key element of ethical thinking, rather
than rules about the acts themselves (Deontology) or their consequences (Consequentialism).
Note: This write-up will make more sense – if read along with chapter 1 opener titled “Chanakya on the scope and methodology of
accounting”

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Accounting Profession and Economic Development

The fact that accounting is a late entrant to professional status is due to the fact that these organized economic activ-
ity of the earlier epochs in history, was not sufficient to support and sustain an independent profession of account-
ing. After all, accounting is concerned with processing and reporting economic information to decision makers and
as such, the demand for such a service could not have arisen without the development of economic activity which
needed such information for decision making.
Economic transactions form the basis of accounting. Some form of recording of economic transactions was un-
dertaken in almost all the ancient civilizations. In Babylon and Egypt, and in Rome and Greece, these records were
kept both for private and public purposes. The development and acceptance of the organized form of accounting
took place only around the fourteenth century.
Note: This write-up will make more sense – if read along with chapter 1, section 1.1: Evolution of financial accounting

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6    FINANCIAL ACCOUNTING FOR MANAGEMENT

Leonardo da Vinci and Pacioli’s Contribution to Accounting!

We look upon the Franciscan, Monk Fra Luca Pacioli (1445-1517), as the father of modern accounting. He was also
a close friend and tutor to Leonardo da Vinci. Summa de Arithmetica, Geometria, Proportioni et Proportionalita,
published in 1494, is considered as the first text on accounting. By the time Pacioli published his later work, De Divina
Proportione, in 1509, he was so well respected that Leonardo da Vinci contributed several engravings for his text.

Luca Pacioli

Merchants had been using a system of recording transactions, recognising the benefit and sacrifice aspects, for over
three hundred years by the time Pacioli published his text. However, the system became a standard for merchants and
businessmen only after Pacioli structured and organised it in his books. Although Luca Pacioli is not the inventor of the
accounting system, his codifying and publishing of the system has rightfully earned him the title of ‘Father of Accounting’.
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Table 1.1a   with Specific Features of the Five Types of Business Entities

One Person Partnership Limited Liability Company*

Company (OPC) Partnership (LLP)
Owner Sole Proprietor Partners Partners Shareholders
Number of One Person Minimum: 2 Minimum:2 In case of Private Limited Company:
Owners/ Maximum: 20 Maximum: No Limit Minimum: 2 and Maximum: 200;
Shareholders (10 in case of In case of Public Limited Company: Min-
banking busi- imum: 7 and Maximum: No Limit (But
ness) limited by the number of shares issued)
Can corporate No No Yes Yes
bodies partici-
pate as a partner?
Management Board of Partners Designated Board of Directors
Control Directors** Partners***
Liability Limited Unlimited Limited Limited

Footnotes: *Limited liability companies can be further bifurcated into two types – private limited and public limited. Even within the public
limited companies there can be further bifurcation into two types – listed and unlisted companies. **The law requires OPC to be started by only
residents of India. It also requires OPC to have state the nominee at the time of registration. ***The law requires every LLP to have at least two
Designated Partners and at least one of the Designated Partners shall be a resident of India.
Note: This write-up will make more sense – if read along with chapter 1, section 1.5: Forms of business entities.

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 CONCEPTUAL BASIS OF ACCOUNTING   7

More on Conceptual Basis, its Needs and Conventions

Accounting concepts are formed primarily by observation and are established through agreement. They are partially
of a technical nature. Most of the concepts, evolved over the years, have been generally accepted as postulates. Some
of the basic concepts, generally accepted as the basis of accounting, are to be clearly understood for the purpose of
learning the accounting methodology.
Some of the popular accounting concepts are separate entity, matching, conservatism, consistency, going
concern, and money measurement. These various, widely accepted accounting concepts are also referred to as
accounting conventions. Different schools of thoughts have a different view regarding these accounting concepts.
Most experts feel that separate entity, consistency and money measurement are fundamental concepts, while
others are procedural.
IFRS converged Indian Accounting Standard 1 (Ind AS1) on “Presentation of Financial Statements” states
that the fundamental accounting assumptions are going concern, consistency and accrual. They are usually
not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not
followed.
Note: This write-up will make more sense – if read along with chapter 1, section 1.7: Conceptual basis of accounting.

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From the Horse’s Mouth – Accounting is like Scorekeeping

Accounting and financial reporting are like scorekeeping. How well you keep the score is the issue. You ask me,
why in the Western and other countries - where there is better accounting and more sophisticated accounting, or
accounting to which we in India aspire to reach in the next five years – there are failures such as Lehman, AIG and
such. Accounting is scorekeeping. It is a measurement of wealth, performance and liquidity.
Our argument is, let us do scorekeeping on a parameter that is internationally recognized. Now, because you
have a good scorer does not mean in the language of cricket, your batsman should always score centuries. If Virat
Kohli or other batsmen do not succeed in South Africa that doesn’t mean you should not have a good scorekeeper
in the system.
Well, there are other business reasons for failure. Greed is one cause. In the examples mentioned above -
Sub-prime lending, for instance, is lending against inadequate security. In fact, the current failures call for better
accounting, better scorekeeping. Thus, as an accountant I am a scorekeeper. I’ll give you the score, and also give
you the quality of that score.
Note: This write-up will make more sense – if read along with chapter 1, section 1.10: Purposes of accounting information
Source: “Accounting is like scorekeeping,” The Hindu Business Line Sep. 22, 2008, print.

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ONGC and its Stakeholders

Oil & Natural Gas Corporation Limited (ONGC) is a multinational energy company headquartered in Deh-
radun, India. It is a public sector undertaking with a manpower of over 33,000 professionals. It is one of the
largest oil and gas exploration & production firm with a market capitalization of over INR 2 trillion. Table
below gives few reasons why some of the stakeholders would be interested in looking at the financial state-
ments of the company:
8    FINANCIAL ACCOUNTING FOR MANAGEMENT

Stakeholder Would be interested due to

Government and its agencies To look at income tax and other tax liabilities of the firm
Top Managers, Officers, Workers and their Unions Potential for pay hikes, bonus, and incentive deals
Public The Ethical and environmental activities of the firm
Long-term Lenders, Present and Potential Shareholder Whether the firm has a long-term future
Equity analysts and fund managers Profitability and share performance
Customer The ability of the firm to take a bigger order, carry on providing
a service
Supplier & Other Creditors To decide whether to offer the firm its products on credit and if
so at what terms

Note: This write-up will make more sense – if read along with chapter 1, section 1.12: Users of accounting information

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ADDITIONAL READING MATERIAL

 1.1  Evolution of Accounting

Accounting Profession in The Twenty-First Century

Given large changes in the business environment and information computing (say, cloud computing and hosting),
the accountant, the accounting firm, and the accounting profession of the twenty-first century are quite differ-
ent from what existed earlier. In contrast to a bookkeeper manually recording entries in a large bound volume
(khata), an accountant is now responsible for information regarding all facets of a business and is dependent on
the latest technology for processing that information. In contrast to small local firms (say, local accounts firm in
New York), accounting firms now can be varying-sized international organizations located elsewhere (say, Pune)
with reported revenues of thousands-to-billions of dollars.
In addition to the traditional audit/attest information, accounting firms provide their clients with tax services,
financial planning, system analysis, consulting, and legal services. Today, the profession is comprised of mil-
lions of people working in public and private firms as well as profit and non-profit enterprises (such as, Deloitte,
KCSPL and WNS).
Source: Carol Normand and Charles Wootton, Accounting: Historical Perspectives, Encyclopedia of Business and Finance, 2nd ed,
2007, Encyclopedia. Web, Dec 21, 2015.

Check Your Concepts 1!

State whether the following statements are True or False:
(a) Historically, accounting developed as a system for reporting information to the managers.
(b) Modern management accounting is intended at reporting the activities of the entity to owners so as to
enable them to plan and control the activities of the entity.
 CONCEPTUAL BASIS OF ACCOUNTING  9

QR CODES
1.2 Development of Accounting
Overview of Accounting Information Systems
We all must have read that an information system is a process for collecting data, processing the
data into information, and distributing that information to users. The purpose of a computer-
based accounting information system (AIS) is to formally collect, store, process and tabulate
financial and accounting data to produce meaningful reports that decision-maker managers or
other interested parties can use to make decisions. AIS-led Accounting-data frameworks structure
information preparing framework utilizing programming.
Trying to run business in the 21st century without an accounting information system is like trying to drive a
railway train on the road. In the modern world of computerization, businesses will fail without adequately designed
accounting information system. And, reasons would include failure to file compliances, pay taxes, collect revenues,
pay bills, pay salaries and such.
AIS enables expanded speed of handling the financial numbers, and quick association to simplify financial
reporting for purposes of making well-informed decisions. The components of the AIS process includes: people,
procedures, data, software, devices and security. The software is on a computing device, and the security is inbuilt
in the software. People put together procedures and enter data into the accounting software. For example, AIS is
used to analyze the effectiveness of the company’s pricing structure by looking at sales and costs data. Auditors use
the AIS to assess a company’s internal controls and compliance with the Companies Act, 2013. Ideally, the AIS
designed should not only meet the needs of the people who will be using it but also improve efficiency.
AIS can be categorized in various ways:
● AIS Categories based on Processing Mode: Batch processing systems, online batch systems and online real-
time systems.
● AIS Categories based on System Objectives: Transaction processing systems, decision support systems and
expert systems.
● AIS Categories based on Interaction with Environment: Transformational systems, transaction processing
systems, and Reactive systems.
● AIS Categories based on Age: manual systems, legacy systems and integrated IT systems.
There are a wide range of AIS-linked professional courses leading to certifications given by global professional Account-
ing Information System Organization. It enables one to apply information systems technology to accounting processes.

1.3 Accounting as a Measurement and Valuation System

Check Your Concepts 2!
State whether the following statements are True or False:
(a) Ideas of capital maintenance, productive capital, and profitable operations supported by commerce and
credit, form the pillars up on which accounting is built.
(b) Accounting as a measurement and valuation system, recognizes the doubleness of values by taking into
account, both the benefit and sacrifice involved.
10    FINANCIAL ACCOUNTING FOR MANAGEMENT

1.4  Forms of Business Entities

What Type of Business Entity Should One Prefer

Business owners are required to choose the optimal business structure not only at the start, but they also must con-
tinually reassess their original choice. The appropriate choice will inevitably shift, as the business evolves (for ex-
ample, see Case # 3 of chapter one). Some of the factors that enable the owners in making the appropriate choice are:
●● Size of the capital and its availability
●● Legal structure of a country
●● Purpose and scope of business
●● Size of business operation
●● Tax structure of a country for different types of organizations

1.5  Basic Framework of Accounting

Country-wise GAAP and its Analogy with Eating Habits

Imagine you are on world tour. And you have dinner invitations from local families in internal areas of China,
Europe and India. By default, your style of eating will have to adapt to local context. In other words, while the
purpose at everyplace is same (food consumption) – yet, you should be prepared to eat with chop-stic in China;
with knife & fork in Europe; and such. Thus, local context necessitates different requirements.
Similarly, across the globe, the basic purpose of using financial information remains unchanged yet we may
observe the country-wise GAAP being molded by the local business environment (culture, traditions, business
norms, tax laws and such). Table 1.3 illustrates this in brief.

Check Your Concepts 3!

State whether the following statements are True or False:
(a) Business entities once selected cannot change their form with time.
(b) The conventions of accounting are inflexible, and not much is left to the judgment of the individual ac-
countant.

1.6  Conceptual Basis of Accounting

A Take on Flexibility of Accounting (in lighter vein)

One of the largest Indian public sector enterprise in the steel industry was having interviews for promotion of
their accountants. The interview panel asked the first candidate, “What do you believe our income will be this
year end?” The accountant said, “` 4,600 crores.” The panel asked the other candidate the same question, and
the answer was, “What would you like it to be?” Now, you can think of who got promoted?
 CONCEPTUAL BASIS OF ACCOUNTING  11

The accounting principles offer practical flexibility, it is important that a consistent treatment be provided
from time to time, otherwise it would be tough to interpret financial statements. Perhaps no choice of methods
should be permitted in accounting. Give us your thoughts?
Source: Interview with Syed Shabbirul Haque (MBA, IIM Kolkata), Ex-Employee & Junior Manager, Steel Authority of India Limited,
Dec. 23, 2014.

IND AS 1 on Concepts
IFRS converged Indian Accounting Standard 1 (Ind AS1) on “Presentation of Financial Statements” states that
the fundamental accounting assumptions are going concern, consistency and accrual. They are usually not spe-
cifically stated in financial statements because their acceptance & use are assumed. Disclosure is necessary if
they are not followed.

Delving into “Business Entity” Principle

The focus on ‘business entity’ concept is upon events as they affect a specific area of attention and
efforts of an organization. This business entity may be a consolidated group of many interrelated
companies, or a specific production unit, a division or a department of an enterprise. For instance,
this entity may be a public limited firm (say, Tata Motors Limited), or consolidated group (say,
Tata Group), or a specific manufacturing unit (say, Pune Unit of Tata Motors), a specific division
(say, Axle Division of Tata Motors) or a specific department of an enterprise (say, Marketing
Department of Tata Motors).
A financial transaction arises when the economic characteristics of the things of value possessed or claims against
such possessions of an entity, change. This cannot be clearly defined and delineated unless the entity, to which these
changes are to be related, can be identified. In this context, transactions, which are to be recorded, are defined in relation
to the entity for which the records are being maintained. Thus, a case in point is the insurance premium of the owners
property (say, Shah Rukh Khan) should be excluded from the expenses of the business (Red Chilies Entertainment).

Illustration QR2
Gurupreet Vs Gurupreet Traders Limited
Gurupreet Traders Limited borrowed money & invested in business. When lenders asked Gurupreet to return
the invested money, Gurupreet responded by stating that he invested them into business & it went bankrupt.
Thus, he can’t be personally held liable for loss in business & they are separate legal entities! Is he right?
Yes he is. The underlying principle is “Separate Legal Entity”. A Person cannot be held personally liable for
the profit & loss of the trading firm.

As illustrated above, on a few occasions, this concept remains only an accounting fiction, as the law does not accept
the distinction. Sole proprietorships and partnerships are the best examples where the liability of the entity is to be
met by the proprietor or the partners, if the entity is not able to meet its liabilities out of the available funds (refer
Chapter 1, Table 1.1 for details).
12  FINANCIAL ACCOUNTING FOR MANAGEMENT

Assessing ‘Going Concern’ and More

Historically, the moving away of business activities from closed one-time ventures to continuing
enterprises, necessitated this ‘Going concern’ concept. This concept assumes that entity will con-
tinue to operate under the same economic conditions and in the same general environment, but
does not assume that business will be profitable as long as it exists. Going concern also assumes
that the claims against the entity will be paid on the maturity of such claims (say, loan will be
repaid when matured and not when an entity has cash).
Going Concern assumes that the entity has neither the intention nor the necessity to liquidate or curtail materially
the scale of its business operations. In assessing whether an entity is a going concern, usually a detailed analysis
is not required if the entity has a history of profitable operations and has access to financial resources. However, in
certain situations detailed analysis is required. There IFRS (IAS 1, Presentation of Financial Statements) stipulates
that in assessing if the going concern assumption is appropriate the management should take into account all avail-
able information about the future.
As a thumb rule, the period covered should be about twelve months from the balance sheet date. The assess-
ment of the validity of the going concern assumption involves judgment about outcome of events and conditions,
which is uncertain. Examples of events and conditions that individually or collectively give rise to significant
uncertainty on the ability of an entity to continue its operations are: net liability or net current liability posi-
tion; absence of realistic prospect for renewal or repayment of long term loan approaching maturity, inability to
comply with key terms of loan agreements, adverse financial ratios, loss of key management personnel without
replacement, labor difficulties or shortage of essential inputs, non-compliance with statutory requirements, and
change in the government policy.
Often, start-ups end up getting liquidated (example: Medinfi Healthcare and JustLikeNew). After a decision to
liquidate the entity is taken, these start-ups tend to restate their financial numbers that were stated earlier using the
‘going concern’ concepts.
Source: “A going concern,” Business Standard May 04. 2009, print.

Conservatism: How Conservative should One be?

The meaning of conservatism (prudence) is acting with or showing care and thought for the
future. In accounting, as a rule, the historical costs of acquiring an asset are regarded as the
ceiling for its valuation. Usually, an asset may be written up only in case of an exchange, but
it may be written down without an exchange. Even the accounting rules such as ‘lower of cost
or market price’, for the valuation of inventories, clearly indicate that the assets can be written
down when their replacement costs decline, but they are never written up when replacement
costs increase.
Thus, conservatism is the inclusion of a degree of caution in the exercise of the judgment needed to make esti-
mates under conditions of uncertainty, and it should not go beyond an appropriate level of ‘caution’. Every individual
or organization suffers from one or more natural bias. A listed enterprise is influenced to report better profitability
to meet market expectations, a sales manager would always be interested in reflecting higher sales, and a closed held
business may be influenced to show low profitability to minimise tax. Prudence as a concept pushes us to identify
our natural bias and counter those when dealing with matters requiring the exercise of judgments or estimates. In that
sense, conservatism is much bigger than just an accounting concept — rather, it is the value that each of us should
imbibe in our actions, and exercise whenever faced with a challenge to make a key judgment.
 CONCEPTUAL BASIS OF ACCOUNTING   13

Any accountant will tell you that conservatism is ensuring that assets or income are not overstated, and liabilities
or expenses are not understated. Those supporting the concept of conservatism believe that there should be a distinc-
tion between ‘bad’ conservatism (deliberate misstatement, which is unacceptable) and ‘good’ conservatism (caution
in making the judgments necessitated by uncertainty, which is desirable). Excess conservatism only purports the
latter. They argue that exercise of prudence does not allow, for example, the creation of hidden reserves or excessive
provisions, the deliberate understatement of assets or income, or overstatement of liabilities or expenses.
Thus, conservatism is not to artificially smoothening income, reducing profits in good years to provide a cushion
to camouflage results in the poor years, making it difficult to understand the entity’s performance. It is to present a
picture of financial information with a thought for the future.
Source: “For the right kind of ‘prudence’,” The Hindu Business Line Jan. 05, 2014, print.

1.7  Accounting Policies

Check Your Concepts 4!
State whether the following statements are True or False:
(a) The process of management reporting involves the provision of information for decision making with
respect to only making plans for the future.
(b) Accounting has some broad guidelines, such as, going concern, business entity, prudence, and consistency,
which are to be used as guideposts for assistance.

1.8  Purposes of Accounting Information

Check Your Concepts 5!
State whether the following statements are True or False:
(a) Universal objectives of accounting practice includes ‘income determination’.
(b) Accounting system is also concerned with the provision of information for solving tricky situations.

1.9  Users of Accounting Information

Check Your Concepts 6!
State whether the following statements are True or False:
(a) The process of management reporting involves the provision of information for decision making with
respect to control of day to day operations of the entity, as well as for making plans for the future.
(b) Financial statements is for internal users of the company, to aid in their decision-making function, and
hence, needs to be confidential in nature.
14  FINANCIAL ACCOUNTING FOR MANAGEMENT

Musing on International Prospects for Accountants in India

I have observed a large number of accounting experts thanking the Father of Accounting, Luca
Pacioli, for giving them a source of daily bread and creating enough intellectual musings in their
mind. The field for modern accounting careers is a wide range and includes:
● Commerce and Industry: Internal Audit, Cost Analyst, Investment Analyst, Account-
ing Information System Staff, Financial Analyst, Budget Analyst, Credit Analyst, Cost
Accountant, Controller/Comptroller, Information System Auditor, Loan Officer, Budget
Officer, Insolvency Professional
● Public Practice: Analyst, Consulting Staff, Advisor. In modern times, Public Practice category faces hurdles
such as – pressure from client, corporate services opportunity of rendering cannot be performed. Further,
the control and management lies in hands of founder.
● Government: Government Accountancy and Audit, Financial Services Manager, Audit Services Manager,
Auditor, Audit Examiner, Accounting Examiner, Treasury Agent, State Accountant, Revenue Officer, Budget
Officer, Financial Services Specialist.
The traditional areas of accounting like doing individual return filing, bank audit, tax audit of (politically linked)
individuals/organizations are seeing automation and seem to be having less growth opportunities. A less explored
option having huge demand is working for the knowledge process outsourcing (KPO) industry. The sheer breadth
of roles therein allows one to find accounting work that helps you specialize in range of niche fields such as audit,
taxation, legal, accounting, analytics, and financial services. Services providers such as Barclays, City Bank, Credit
Suisse Deutsche Bank, Genpact, and HSBC have been recruiting tens of thousands people every year with about
25% going to Hyderabad alone. Delhi (NCR), Bangalore, Pune and Chennai being other cities that are attracting new
talent. In the past few years, the hiring has been only increasing. The hiring is primarily in areas of finance account-
ing and transaction processing. This also leads to a fission effect of further jobs such as third party analytics services.
These KPO organizations offer more than international level work experience by having wider exposure in niche
domains (say, credit rating, portfolio risk management), working with global clients and such. The upcoming areas
include Taxation International taxation involving foreign party, Management consultancy services including Proj-
ect Financing Mergers acquisition and preparing Valuation reports, Preparing Consolidated financial statement for
companies. (doing IFRS / IND AS consultancy); Auditing Statutory audit of Companies; Internal /management
audit of companies; Cooperative audits; Forensic audit and such.
Source: Information through professional networks.

1.10 Globalization and Accounting Standards

“Benefits of IFRS would start from 2018”

In an interview to the Business Standard newspaper, Ian Mackintosh, vice-chairman, IASB, told that greater
transparency in financial reporting and higher level of disclosure are likely to lower the cost of capital for Indian
businesses in the long term. Edited excerpts:
● Has the accounting profession become more globalized with the adoption of IFRS in the past 10 years?
… the number of countries using the standard (IFRS) has been growing. In an in-depth survey of 140
countries, we found 114 used the IFRS. This means for accountancy, there is a common language. In
 CONCEPTUAL BASIS OF ACCOUNTING   15

some ways, this is globalization of the accountancy profession. So, people can move from country to
country with the basic background of IFRS. It has been quite a revolution in past 14 years. What drove
it essentially was the globalization of the markets. It became obvious you needed a common language
for financial reporting, as everyone had a different financial reporting standard. We are very happy that
India is joining in at this stage.
●● How well prepared is corporate India and the government?
The government announced it in its Budget last year and seems determined to achieve it this time - April
1, 2016. The Reserve Bank of India has put out a consultation paper for making banks compliant by 2018.
The gap after that is of insurance companies.
  The next challenge is to get companies organized. Europe introduced IFRS in 2005, and there compa-
nies are happy that it has lowered the cost of capital. Over the long term, Indian companies should also
expect tangible benefits.
●● How long will it take for companies to start getting those benefits?
Generally, results start to come out after two years of applying the standards. It would be reasonable to
expect the benefits would start to flow in around 2018. For foreign investors looking at India, it takes time
to trust and understand the financial situation that companies are in.
Source: “Benefits of IFRS would start to flow in 2018: Ian Mackintosh,” Business Standard Nov. 29, 2015, Print.

1.11  Branches of Accounting

Check Your Concepts 7!
State whether the following statements are True or False:
(a) Accounting can be broadly divided into two branches, social accounting and government accounting.
(b) ICAI is progressively working towards convergence reflecting “Indian conditions” in the IFRS.

Exercises

Fill in the Blanks

Fill in the blanks based on the relevant concept applicability:
1. concept applies when Abdul Agro Limited bought a grinding machine and recorded the pur-
chase at the amount of cash paid to purchase it.
2. Using the same method of accounting over a considerable period is referred to as the
principle.
3. If an accountant overstates a business entities resources (or material assets) then we can state that he is vio-
lating the principle of accounting.
16    FINANCIAL ACCOUNTING FOR MANAGEMENT

4. M/s Gagan Cycle Ltd. …

a. The accounts of M/s. Gagan Cycle Ltd. show a profit of ` 88,000 for the year. This includes an amount
of ` 25,000 relating to an order just received. Based on this information, what will be the profit?
b. The corrected profit would be `  because we should apply the concept.
5. M/s Manish Boutique Ltd. …
During the year, Manish Malhotra had taken home some clothing fabric from his boutique, to present his
wife a new suit for her birthday. He has included the cost of this stock (` 12,000) as a business expense while
calculating the profits, which came to ` 62,000. Based on this information, what will be the profit?
a. The concept applies here and the profit figure should be `  .

Answers to the “Check Your Concepts”

1. Check Your Concepts 1! 5. Check Your Concepts 5!

(a) False (a) True
(b) False (b) True
2. Check Your Concepts 2! 6. Check Your Concepts 6!
(a) True (a) True
(b) True (b) False
3. Check Your Concepts 3! 7. Check Your Concepts 7!
(a) True (a) False
(b) False (b) True
4. Check Your Concepts 4!
(a) False
(b) True