Ch1 Handout

FAM 3/e, Tata McGraw Hill PGCBM-21,2012
Chapter 1: Introduction
Conceptual Basis of Accounting Accounting
Financial Accounting
Accounting Analysis
PGCBM-21
MANAC Course
Used for Reporting Providing Information for
Planning and Control
Prof. Ram Kumar Kakani
Audience: Outside World
(Government bodies, Audience: Internal
Societies, etc) (Managers and Investors)
Financial Accounting for Management, 3/e by Ramachandran & Kakani 1 Financial Accounting for Management, 3/e by Ramachandran & Kakani 2
“Copyright © 2011, by Tata McGraw Hill Education Private Limited." “Copyright © 2011, by Tata McGraw Hill Education Private Limited."
Financial Accounting – Evolution Accountant as a Historian

 Evidence of recording of economic  Accountant can be perceived as a historian – who keeps
transactions in ancient civilizations records
 As historian the accountant has the duty to:
 Franciscan Monk Fra Luca Pacioli (1445-
(  Respect the facts
1515) as the father of modern accounting Pacioli structured and
organized the initial  To see the facts are accurate
 His Summa de Arithmetica, Geometria,
accounting system
based on the ‘benefit
 Bring into focus, all known and knowable relevant facts
Proportioni et Proportionalita, is considered and sacrifice’ principle  Finally, provide an interpretation of the history proposed
as the first text on accounting
Financial Accounting – Evolution Foundations of Accounting

 Product of economic environment  Three basic ideas, which gained currency along with
 Gradually evolved as a profession with the development of the growth in the economic activity, can be considered
economic activity as the foundation of accounting system
 especially … Industrial Revolution
 Scope and nature of accounting is closely associated with the
gradual changes in the field of organization and management of Three Founding
Ideas of Accounting
organizations
 In the modern IT era, accounting is getting integrated into
software packages and constantly adapting itself
Capital Productive Profitable
Maintenance Capital Operations
Ramachandran & Kakani 1

Capital Maintenance Productive Capital

 The idea is to preserve and maintain resources used for generating  Productive organization of modern industrial society is founded on the
wealth use of capital
 Implies the generation of wealth while keeping intact the  ‘Wealth’ is used for generation of further wealth
resource used for such generation
 Accumulation and deployment
p y of large-scale
g pproductive capital
p involves
the problem of maintenance and preservation of such resources
 Income (during the year) = Capital at the end of the year – Capital
at the beginning  Consider the Oil Wells owned by the Oil Companies – Would that be
productive capital if it does not result in any revenue during a particular
 If the above figure is negative, there is ‘capital erosion’ period?
 Throws up the important information function of the valuation of such
 Continuous capital erosion threatens business survival resources.
Profitable Operations Development of Accounting

 When productive capital is to be used on a large scale for  Early medieval commerce was agency book-keeping for a
economic activities, the idea of profit becomes the motive specified venture
force
 This induces one to go in for future consumption in  Development of Joint Stock Companies
preference
f tto presentt consumption
ti  Operating
O ti iindividuals
di id l were nott th
the owners
 Resources can be deployed for large number of alternative  Investment Banking – keeping records for inspection
uses. There is an important criterion for making decisions in
the exercise of choice
 Large scale manufacturing and service organizations
 This coupled with the idea of maintenance of capital makes  creation of artificial juridical entities based on common
the problem of measurement of profit crucial to accounting. stock of capital collected from large number of investors
Accounting as a Measurement &

… Development of Accounting Valuation System
 Recording and summarizing of business related events
and transactions for the purpose of financial reporting  Basic orientation of financial accounting is income
determination
 Two basic principles
 O
Oriented
e ed towards
o a ds aan eentity-
y a bus
business
ess uunit
 Form
F off th
the ‘‘account’t’ – the
th bbasic
i iinformation
f ti fformats
t
 Equilibrium of the complete set of accounts forms the
foundation of the accounting system  Tries to prescribe a series of concepts, standards, postulates
and principles
 Accounting theory as a doctrine is explanatory in nature and

the underlying reasoning and justifications are related to
practice

Definition of accounting Valuation in Accounting

Valuation could
 Multiple definitions exist trace values
through the entire
According to American Institute of Certified Public Accountants Causal network of
(AICPA) – Duality of Networking transformations,
Values among Values which forms the
basis of all
“accounting is the art of recording, classifying and Valuation
V l ti iin
Accounting
economic activity
Benefit and
summarizing in a significant manner and in terms of Sacrifice
money, transactions, and events, which are, in part at aspect of every
least, of a financial character, and interpreting the results economic
transaction Exchange of a
thereof.” Transformation
utility
of Values differential to a
monetary
differential
Four Types of Business

Entities
Illustration – Valuation of a Machine Sole Proprietorship Partnership
Limited Liability
Company
Partnership
S R Batliboi & Garware Marine
Keshubhai, a cotton yarn manufacturer, purchased a machine paying Examples
M/s Prabhudas &
Sons;Anil Pan Shop
Company;
Ai Jai Kai LLP;
RP Associates LLP
Limited; Amsar
Delhi Traders Private Limited
cash Rs. 70,000. At which value do you record this transaction?
Owner Sole Proprietor Partners Partners Shareholders
Minimum: 2 Minimum: 2 Minimum: 7
Historical Cost No. of Shareholders One Person Maximum: No
Maximum: 20 Maximum: No Limit
Limit
Current (Replacement) Cost Management Designated
Proprietor Partners Board of Directors
Net Realizable Value Control Partners
Liability Unlimited Unlimited Limited Limited
Present Value Legal Registration No Provision Voluntary Compulsory Compulsory
Depends on Depends on
Flexibility Maximum Comparatively Less
 Due to its many advantages, historical cost is the most used in the Partners Partners
field of accounting Source of Equity Proprietor brings in Partners bring in the Partners bring in Shareholders brings
Funds the funds funds the funds in the funds
Generally Accepted Accounting

Basic Framework of Accounting Principles - GAAP
 Concept refers to an idea, a general notion, thought or assumption.  Combination of authoritative standards (set by policy
boards) and the accepted ways of doing accounting
 Standards are something established for use as a rule, intended to
act as a basis of comparison and reference in measuring, quantity,  Differs from country to country based on the accounting
andd or quality
lit andd assigning
i i value
l principles and standards adopted in that country
 Postulates are assumptions; they are taken to be true or real  Rules that business entities are expected to follow while
preparing their financial statements
 Principles refer to a law, the method or a rule of conduct.
Concepts Standards Postulates Principles


Accounting Standards-setting Interpreting GAAP and Accounting Standards

Organization in Selected Countries
GAAP Accounting Standards
Country Policy Setting Board
Accounting practices holding sway Authoritative standards (set by policy
Australia Australian Accounting Standards Board (AASB) sets GAAP in a country. boards)
Canadian Accounting Standards Board (CASB) of the Canada Institute of
Canada Country specific International standards exist
Chartered Accountants (CICA) sets GAAP in Canada
Accounting Standards Board (ASB) of the Institute of Chartered Accountants

India of India (ICAI) is the body entrusted with the work of preparing the Indian GAAP is to be followed in the pecking order of:
standards.
1. Accounting Standards laid down by ICAI
Accounting Standards Board (ASB) is comprised of nine members drawn 2. Statements issued by the ICAI.
U.K.
from different user groups. 3. Guidance notes issued by the ICAI.
Financial Accounting Standards Board (FASB) is the body solely in charge of 4. Expert Advisory opinions issued by the ICAI
U.S.A. 5. Technical guides and monographs issued by the ICAI.
issuing standards.
Basic concepts of accounting –

Conceptual Basis accepted as principles
 Concepts are essential ideas that permit the  Property Rights
identification and classification of phenomena or other  the right of accounting entities to possess and alienate
ideas property – value
 A concept must state all that the given class includes  B

Business
i Entity
E tit
and all that it excludes  the entity is separate and distinct from the owners and the
entity is liable to the owner
 Formed primarily by observation and established  Hence, in a limited liability company, the enterprise is
liable to the owner (shareholder) based on the proportion
through agreement
of the capital investment (share capital) made by the latter
Concepts … Accounting Concepts

 Going Concern  Matching
 entities have a life of infinite duration, unless facts are  Determining the profits after charging the expenses of a
known that indicate otherwise period with the revenues earned in the same period
 the basis of valuation of resources is influenced more by
their future utility to the business entity than by their  Realization
current market valuation  Determines the point of time when revenue and hence
returns (or profits) can be recognized objectively,
 Money Measurement unbiased, and with certainty
 Representation in a common denominator and amenable
to summarization by addition & subtraction  Consistency
 Once a choice is made for the treatment of a transaction,
the same is consistently followed

Concepts … Concepts …
 Diversity among Independent Entities  Dependability of Data
 There are wide variations in the organization and operations of  Accounting entities ensure the standard of internal controls to
entities  requirements and demands are different ensure that the data used as the basis of accounting records
are controlled to ensure their quality
 C
Conservatism
ti
 “Anticipate no gains, but provide for all possible losses” and “if  Materiality
in doubt, write it off”  Necessitated by practicability and feasibility
 Results in an understatement of profits and values
 Close nexus with idea of ‘capital maintenance’  Timeliness
 The idea of accounting periods is used so as to ensure
regularity and timeliness of reporting
Accounting Policies Objectives of Accounting

 Specific accounting principles and the methods of applying  Income determination
these principles for the preparation and presentation of  For rational economic decision-making
financial statements of an enterprise
 Financial reporting
 based upon the accounting concepts followed by the
enterprise  Summarized as all those things g of value owned byy the
entity and all the claims against these possessions
 Areas of applicability
 Disclosure
 Valuation of Inventories, Fixed Assets, Investments
 All the relevant & pertinent information is supplied to the
 Role of ICAI information users
 Guidance Notes
Purposes Of Accounting
Information Accounting & Management Control
Purposes of
 Control means the process of keeping the organization in
Accounting Information
course
 This involves measurement through the control system
 The controller (accountant) and managers obtain information,
which
hi h enables
bl ththem tto di
diagnose th
the situation
it ti
Score Attention Problem
Keeping Directing Solving
Reporting on Signaling the user about Provision of such

the financial the need to take a information that would
health decision enable to find solutions

Illustration on using Accounting

Information Illustration…
 A firm sells three products P1, P2, P3. Profit of the firm is  The Problem:
declining  Decrease in profits during the period - as a result of overall
increase in the cost of goods sold
Year 1 Year 2
 Now, which product is losing money?
Year 1 Year 2
Sales Rs 1,000 Rs 1,000
P1 P2 P3 P1 P2 P3
Less: cost of goods sold 400 500
Sales 300 300 400 400 400 200
Gross margin 600 500
Less: COGS 150 150 100 200 200 100
Less: Depreciation 200 200 Gross margin 150 150 300 200 200 100
Other operating expenses 100 100
Sales of P3 have decreased.
Profit Rs 300 Rs 200
Cost of sales to sales of P3 has doubled
Accounting Information users Class Discussion…

 Stakeholders are the ones who have an interest in what Stakeholder Area of interest
happens as a result of the entities activities
Government Tax liabilities of the firm
 Stakeholders classified as
 Internal users viz., managers Unions & staff Potential for pay awards and bonus deals
 External users viz., creditors, equity investors, government, Public/Society Ethical & environmental activities of the firm
and society Lenders Whether the firm is has a long-term future
Shareholders Profitability and share performance
Customers Ability of the firm to carry on providing a service
or producing a product
Note: These should not be regarded as the 'only' answers
BHEL and its Stakeholders IASB and Need for IFRS

Stakeholder Would be interested due to  During the last couple of decades, efforts to make accounting
Government & its agencies Income tax & other tax liabilities
information more useful have increased …
 Leading to the creation of IASB i.e., International Accounting
Top Managers, Workers, Unions Potential for pay hikes, bonus, and incentives
Standards Board … a body consisting of members from many
Public Ethical and environmental activities countries.
Long-term Lenders, Present & Whether the firm has a long-term future  The IASB proposed a ‘convergence’ concept with a hope that
Potential Shareholders similar economic transactions should result in similar accounting
Fund managers & Analysts Profitability & share performance approach (across different jurisdictions)
Customer Ability to take a bigger order, etc  Leading to a series of standards, known as, the International
Financial Reporting Standards (IFRS)
Supplier & Other Creditors Whether to offer the firm credit and if so, terms

Branches of Accounting Enterprise Accounting

 Specifically addresses issues of measurement and valuation in
Accounting the context of business enterprises
 Has evolved into two disciplines
 Financial Accounting
Government Enterprise Social  Providing
P idi fifinanciali l iinformation
f ti relating
l ti tto th
the entity
tit tto
Accounting Accounting Accounting ‘outsiders’
 Management/Cost Accounting
 Reporting the activities of the entity to managers so as to
enable them to plan and control the activities of the entity
Financial Management vis-à-vis other competing entities
Accounting Accounting
Organizational Structure vis-à-vis

Role of Accounting
CEO

EXTE
CFO
ERNAL AUDIT
Thank
h k You
Accounts Accounts
Finance
Officer 1 Officer 2
Officer
Clerk 1 Clerk 2 Clerk 3
INTERNAL AUDIT
Financial Accounting for Management, 3/e by Ramachandran & Kakani 39 40
“Copyright © 2011, by Tata McGraw Hill Education Private Limited."

Ch1 Handout

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ch1 Handout

Uploaded by

Copyright:

Available Formats

FAM 3/e, Tata McGraw Hill PGCBM-21,2012

Financial Accounting – Evolution Accountant as a Historian

Financial Accounting – Evolution Foundations of Accounting

Ramachandran & Kakani 1

Capital Maintenance Productive Capital

Profitable Operations Development of Accounting

Accounting as a Measurement &

 Accounting theory as a doctrine is explanatory in nature and

Ramachandran & Kakani 2

Definition of accounting Valuation in Accounting

Four Types of Business

Generally Accepted Accounting

Concepts Standards Postulates Principles

Ramachandran & Kakani 3

Accounting Standards-setting Interpreting GAAP and Accounting Standards

Accounting Standards Board (ASB) of the Institute of Chartered Accountants

Basic concepts of accounting –

 A concept must state all that the given class includes  B

Concepts … Accounting Concepts

Ramachandran & Kakani 4

Accounting Policies Objectives of Accounting

Reporting on Signaling the user about Provision of such

Ramachandran & Kakani 5

Illustration on using Accounting

Accounting Information users Class Discussion…

BHEL and its Stakeholders IASB and Need for IFRS

Ramachandran & Kakani 6

Branches of Accounting Enterprise Accounting

Organizational Structure vis-à-vis

Ramachandran & Kakani 7

You might also like