FINANCIAL ACCOUNTING & ANAlYSIS

UNIT I-NOTES
BBA FIRST SEMESTER (105)

Syllabus :

Meaning of Accounting:

Accounting is the analysis and interpretation of book-keeping records. It includes not

only the maintenance of accounting records but also the preparation of financial and
economic information which involves the measurement of transactions and other events
relating to the entity.

Accounting today cannot be the same as it is used to be about half century back. In the
early stages accounting developed as a result of the need of the business firms to track of
their relationship with outsiders, listing of their assets and liabilities.

In recent years changes in technology has also brought a remarkable change in the field
of accounting. It has come to be recognized as a tool for mastering the various economic
problems which a business may have to face. It systematically writes the economic
history of the organization. It provides information that can be drawn upon by those
responsible for decisions affecting the organizations future.

Definition of Accounting:

Back in 1941, the committee on Terminology of the American Institute of Certified

public Accountants (AICPA) formulated the following definition:

According to American Institute of Certified Public Accountant (AICPA), accounting is

the art of recording, classifying and summarizing the financial transactions and
communicating the results thereof to the persons interested in such information.

In 1996, The American Accounting Association (AAA) in order to emphasize the broader
perspective of Accounting , provided the following information

According to American accounting Association accounting is the process of identifying,

measuring and communicating economic information to permit informed judgments and
decisions by users of the information.
The modern accounting , therefore, is not merely concerned with record keeping but
also with a whole range of activities involving planning, control, decision-making,
problem solving, performance measurement and evaluation , coordinating and
directing , auditing , tax determination and planning , cost and management
accounting .

NEED FOR ACCOUNTING:

Accounting records business transactions with a view to prepare financial statements.

Accounting is primarily concerned with business as well as non business entities such as
schools, colleges, hospitals, government etc. A businessman who has invested his capital
in a business enterprise would like to know whether his enterprise is making profit or
incurring losses; what is his position of assets and liabilities on a particular date; he
would also like to know his capital in the business has increased or decreased and so on.
It communicates the results of the information to various parties like proprietors,
creditors, investors, government and the public. Persons like housewives, government
and other individuals make the use of accounting.

Need for accounting helps to know

 What he/she owns?
 What he/she owes?
 Whether he/she has earned a profit or suffered a loss on account of running a
business?
 What is the financial position whether he or she will be in a position to meet all
his commitments in the near future or in a process of getting bankruptcy?

Nature of Accounting

Accounting is often called the language of business. It is one of the means of

communicating information regarding the affairs of the business.

1. Accounting is a process: A process refers to the method of performing any specific

job step by step according to the objectives, or target. Accounting is identified as a
process as it performs the specific task of collecting, processing and communicating
financial information. In doing so, it follows some definite steps like collection of data
recording, classification summarization, finalization and reporting.

2. Accounting is a science and an art: Science is knowledge based on well known

principles or rulers. It is an organized knowledge based on the scientific principles which
have been developed as a result of study and experience. Of course, Accounting cannot be
termed as a “perfect science”. It is a social science depending much on human behavior and
other social and economic factors. Thus, perfect conclusions cannot be drawn. Some people ,
therefore, though not very correctly ,do not take accounting as a science.
Art is action or doing a thing. Accounting is definitely an Art. Actual keeping of record of
transactions is an art. Hence accounting is both a science and an art. It must be clearly
understood that without the through knowledge of accounting principles-concepts and
conventions one cannot become an efficient accountant. The American Institute of Certified
Public Accountants defines accounting as the art of recording, classifying and summarizing
the financial transactions. Accounting helps in achieving our desired objective of maintaining
proper accounts. Art is a technique which helps in achieving a desired objective.

3. Accounting is means and not an end: Accounting finds out the financial results and
position of an entity and the same time, it communicates this information to its users. The
users then take their own decisions on the basis of such information. So, it can be said
that mere keeping of accounts can be the primary objective of any person or entity. On
the other hand, the main objective may be identified as taking decisions on the basis of
financial information supplied by accounting. Thus, accounting itself is not an objective,
it helps attaining a specific objective. So it is said the accounting is ‘a means to an end’
and it is not ‘an end in itself.’

4. Accounting deals with financial information and transactions; Accounting records

the financial transactions and date after classifying the same and finalizes their result for
a definite period for conveying them to their users. So, from starting to the end, at every
stage, accounting deals with financial information. Only financial information is its
subject matter. It does not deal with non-monetary information of non-financial aspect.

5. Accounting is an information system: Accounting is recognized and characterized as

a storehouse of information. As a service function, it collects processes and
communicates financial information of any entity. This discipline of knowledge has been
evolved out to meet the need of financial information required by different interested
groups.

Book keeping, Accountancy and Accounting

Book keeping

Book keeping is a part of Accounting and is concerned with record keeping or

maintenance of books of accounting which is often routine and clerical in nature.

It only covers the following four activities:

 Identifying the transactions and events
 Measuring the identified transactions and events in a common measuring unit
 Recording the identified and measured transaction and events in the proper books
in Account
 Classifying the recorded transactions and events

DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTING

 Book keeping Accounting
Book keeping is mainly concerned Accounting is a wider concept and is
with recording of business concerned with designing, recording,
transactions in a significant and classifying and summarizing the recorded data
orderly way. and interpret them for internal and external
users
Bookkeeper has no role in Accountant may supervise the work of book
accountant’s work of interpretation. keepers recording work.
Work of book keeper is routine and Work of accountant is technical in nature and
clerical in nature requires high level of knowledge,
understanding and analytical skill.
Book keeping is done in accordance The methods and procedures adopted by
with basic concepts and conventions accountants may not be the same for all firms.
for all types of organizations.

OBJECTIVES OF ACCOUNTING:

1. To keep systematic records:

Accounting is done to keep systematic record of financial transactions. In the absence
of accounting, it is difficult to memorize all the information through human memory.

2. To protect business properties:

Accounting provides protection to business properties from unjustified and
unwarranted use.

This is possible on account of supplying the following information to the manager or

the proprietor.
The amount of the proprietors fund invested in the business.
How much the business has to pay to others?
How much the business has to recover from others?
How much the business has in the form of?
a) Fixed assets
b) Cash in hand
c) Cash at bank
d) Stock

3. To ascertain the operational profit or loss

Accounting helps in ascertaining the net profit or loss of the business. Profit and loss
account will help the management, investors, and creditors to know the financial
position of the business. Profit and loss account will help the management, investors,
creditors, government, citizen etc., in knowing whether running of the business has
proved to be remunerative or not. In case it is non profitable, the cause of such state
of affairs will be investigated and necessary remedial steps will be taken.
 4. To ascertain the financial position of a business. The profit and loss account
gives the amount of profit or loss made by the business during the particular period.
This is done through preparing the balance sheet. The balance sheet is a statement of
assets and liabilities of the business on a particular date. It is a barometer for
ascertaining the financial health of a business.

5. To facilitate rational decision making.

Accounting is the task of collection, analysis and reporting of information and it helps
in rational decision making. The American accounting association has defined the
term accounting is the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of
information.

6. Facilitating research in business operations: The financial analyst or researchers

analyze the accounting information by making use of comparative financial
statements, various ratios, cash flow statement etc. to know liquidity , profitability ,
turnover of debtors and stock of various business enterprises

FEATURS OF ACCOUNTING:

1. Recording:
It is essentially concerned with not only ensuring that all business transactions are of
financial character are, in fact, recorded but also they are recorded in orderly
manner. Recording is done in the book “Journal”. This book may be subdivided into
various subsidiary books such as cash journal, purchase journal; sales journal etc.The
number of such books may vary according to the size and nature of the business.

2. Classifying:
Classification is done in the book “Ledger”. Classification is concerned with the
systematic analysis of the recorded data, with a view to group transactions or entries
of one nature at one place. E.g. advertising, printing and stationary, traveling
expenses etc

3. Summarizing:
Summarizing involves presenting the classified data in a manner which is
understandable and useful to the internal as well as external end users of accounting
information. It involves preparation of
Trial balance
Income statement
Balance sheet

4. Dealing with financial transactions:

It records only those transactions which are related to money. Transactions which
are not of financial character are not recorded in the books of accounts. For
example if a company has a number of trusted employees, it will not be recorded in
the books of accounts.
 5. Analyzing and interpreting:
The data recorded are analyzed and interpreted in a manner that the end users can
judge the profitability position of the business. Analysis means methodical
classification of data given in the financial statements. Interpretation means
explaining the meaning and significance of data so simplified.

6. Communicating: the accounting information after being meaningfully analyzed

and interpreted has to be communicated in a proper form and manner top the users.
This is done through accounting reports, income statement, balance sheet and
additional information in the form of accounting ratios, graphs etc.

Functions of Accounting

Maintaining systematic records Business transactions are properly recorded, classified

under appropriate accounts and summarized into financial statements – income statement
and balance sheet

Communicating the financial results Accounting is used to communicate financial

information in respect of net profits or loss, assets, liabilities etc to interested parties such
as shareholders, creditors, government etc.

Meeting legal needs The provisions of various law such as companies Act, Income tax,
and sales tax require submission of various statements, i.e. annual reports, income tax
returns, returns for sales tax purposes and so on.

Protecting Business Assets: Accounting maintains proper records of various assets and
thus enables the management to exercise proper control over them with the help of the
information regarding cash balances, inventories position , position of fixed assets.

Forecasting : Accounting enables to forecast the future performance and financial

position using past accounting information.

Measurement: It is a basic function of the accounting to measure the past performance

in money terms and disclose its current financial position.

Decision making: Accounting provides the users the relevant data to enable them make
appropriate decisions in respect of investments in the capital of the business enterprise or
to supply goods on the credit or lend money.

Evaluation: Assessing operating results in relation to pre determined goals

LIMITATIONS OF ACCOUNTING:
 1) No recording of non- monetary transactions: Accounting information is
expressed in terms of money. Non money events or transactions are omitted. The
qualitative elements like quality of management, quality of labor force, public
relations are ignored.

2) No information about the present value of the business: Fixed assets are
recorded in the accounting records at the original cost. The effect of inflation or
deflation is not taken into consideration. The impact of this practice is that the
balance sheet does not disclose the true financial position of the business enterprise.

3) Use of estimates or personal judgment: Accounting information is sometimes

based on estimates i.e., inaccurate. It is not possible to predict the degree of accuracy
and useful life of an asset for the purpose of depreciation, choice in method of
inventory valuation. Since the subjectivity is inherent in personal judgment, the
financial statements are not free from bias.

4) Unrealistic accounting information: Since the financial statements are prepared

on a going concern basis against liquidation, they report only the estimated periodic
results since the true results can be ascertained only on the liquidation of an
enterprise.

5) Danger of window dressing: Accounting may lead to window dressing: The

term window dressing means manipulation of accounts in such a way as to conceal
the vital facts and presents the financial statements in a way to show better
position than what it actually is.

6) Accounting information is not natural or unbiased: Accountants calculate

income as excess of revenues over expenses. They consider only selected revenues
and expenses. They do not involve cost of water pollution, air pollution, employees’
injuries etc.

ACCOUNTING AND OTHER DISCIPLINES:

 Accounting and statistics:

Both the accountants and statisticians are involved with the collection, classification,
analysis and presentation of data. Accounting has a close relationship with statistics. A
number of statistical techniques are used in collection, analysis and interpretation of
accounting data. E.g. Accounting ratios, standard deviation, capital budgeting,
correlation, regression, coefficient of variation etc.

 Accounting and mathematics:

Knowledge of arithmetic and algebra is necessary for accounting computation and
measurements. Dual aspect concept is expressed in the form of a mathematical; equation
i.e. accounting equation. With the advent of the computer, mathematics is becoming a
vital part of accounting. Mathematical techniques are used in accounting. Examples like
computation of depreciation, determination of loan installment.

 Accounting and economics:

Economics is concerned with rational decision making regarding efficient use of scarce
resources for satisfying human wants. Accounting is considered to be a system which
provides appropriate information to the management for taking rational decisions.
Accountants record and interpret transactions expressed in money e g cost of goods
purchased, prices of goods sold and values of assets bought and sold and so on.
Accounting deals with transactions which are of economic facts. Much of the data used
by the economist is supplied by the accountant.

 Accounting and engineering:

Engineers provide estimates on new capital proposals associated with the plant and
machinery. The accountants and engineers must cooperate with each other in bringing
about efficiency in production activities.

 Accounting and management:

A large portion of accounting information is prepared for management decision making.
Management accounting processes accounting data for decision making. This indicates
the linkage between management and accounting. Accounting is the essential se4rvice
function of management.

 Accounting and Law: accounting process and the financial data they produce are
both influenced by and assert their influence on some branches of the law of the
country. The nature of the information provided by the accounting records may
help the government to take decision in respect of ownership, distribution and use
of wealth. Hence new laws may be framed or existing laws may be amended after
a thorough examination of accounting data.

BRANCHES OF ACCOUNTING:

Economic development and technological improvements have resulted in the scale of

business operations.

Increasing the scale of the business operations and social awareness has made the
management functions more and more complex and this has resulted in development of
different branches of Accounting.
Different branches of accounting are

 Financial Accounting:

It is the original form of the Accounting. It is mainly confined to the preparation of

financial statements for the use of shareholders, debenture holders, creditors, banks
and financial Institutions. The financial statements i.e. profit and loss Account and
balance sheet, show them the manner in which operations of the business have been
conducted during a specific period.

 Management accounting:
It is concerned with the interpretation of accounting information to guide the
management for future planning, decision making and control etc. management
accounting provides information to the insiders e.g. owners, managers and employees.
Management Accounting covers various areas such as budgetary control, inventory
control, statistical methods etc.

 Cost accounting:
It is the process of accounting and controlling the cost of the product, operation or
function. The purpose of this branch of accounting is to ascertain the cost, to
control the cost and to communicate information for decision-making.

Financial accounting and management accounting are interrelated since management

accounting is to a large extent rearrangement of data provided by financial accounting.

DIFFERENCE BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL

ACCOUNTING.

Basis of Financial accounting Management accounting

difference
Definition Accounting designed for
outsiders is known as financial
accounting. It is concerned with
the recording of business
transactions and the periodic
preparation of income statement
and balance sheet.
It is concerned with the interpretation
of accounting information to guide
the management for future planning,
decision making and control etc.
management accounting provides
information to the insiders e.g.
owners, managers and employees.

Level of Financial accounting is simply Management accounting shows how

details shows how the business has the business has to move in future.
moved in the past
Objectives To supply information to It is to supply information for
external parties like insiders.
shareholders, creditors, banks,
 investors
Analyzing Portrays position of business as It reports on the profitability,
performance a whole performance of various divisions or
departments.
Concentration It concentrates on past and It concentrates on future and looks
looks backward forward.
Compulsion Financial accounting is an Management accounting is optional
absolute necessity
Principles It is meant for outsiders hence it It is meant for insiders hence it can
used has to follow accepted frame and adopt its own principles
principles and conventions
Data used It supplies data of past records. It supplies both for present and future
duly analyzed in detail.
Monetary It deals with only those events It deals with monetary as well as non
measurement which can be described in terms monetary events like technical
of money. innovations, change in value of
money.
Periodicity of Financial accounts are usually They are prepared at short intervals
reporting prepared yearly or half yearly as per the requirements of
management.
Precision Information is precise and most It lays emphasis on precision and
accurate approximate figurers are used.
Nature It is more objective, has rigid It is more subjective, has flexible
approach. approach.
Performance Performance appraisal is not Performance appraisal is applicable.
appraisal applicable.

DIFFERENCE BETWEEN FINANCIAL ACCOUNTING AND COST

ACCOUNTING:

Basis of difference Financial accounting Cost accounting

Objectives Financial accounting aims at Cost accounting renders
safeguarding the interest of information for the guidance
the business and its of the management for
proprietors and others proper planning,
connected with it. organizational control and
decision making.
Mode of presentation Financial accounts are Maintenance of cost records
prepared according to some is purely voluntary and,
accepted accounting therefore, there are no
concepts and conventions statutory forms regarding
their presentation
Recording In financial accounts the In cost accounts the
transactions are recorded, emphasis is more on aspects

Analyzing profit
Periodicity of reporting
Degree of accuracy
classified and analyzed in a of planning and control and
subjective manner. transactions are recorded in
an objective manner
Financial accounts reveal the Cost accounting shows the
profit of the business as a profit made on each
whole. product, job or process.
The income statements and Cost accounting is mainly
balance sheet are prepared concern reports are
and presented before the frequently submitted to the
members usually once at the management and in some
end of the accounting period. cases they are submitted
every week.
Financial accounting Cost accounting provides
provides information which information to the insiders
is more useful to the so accuracy is less.
outsider’s hence greater
accuracy is required.

END USERS OF ACCOUNTING INFORMATION:

End users of accounting information are as follows:

 Proprietors:
The main objective of every business is to earn profit. Its profitability and financial
soundness matters prime importance to the proprietors who have invested their money in
the business.

 Managers:
In a sole proprietary business, proprietor is the manager. In case of partnership business
either some or all partners participate in the management of the business. In case of joint
stock companies shareholders are the managers. Accounting information helps the
managers to analyze
 Setting objectives or targets for future periods and devising methods for attain
those objectives
 Observing and measuring the performance of the various departments
 Evaluating the performance in relation to targets set up.
 Taking corrective action as may be necessary to overcome the shortfalls.

 Creditors and short term lenders:

Creditors are those persons who have extended credit to the company. Short term lenders
as commercial banks supply money for short periods to business organizations. Bankers
and suppliers inspect the accounting information before making loans or granting credit.
This helps to ascertain whether the enterprise is in a position to pay its obligations in
time.
  Prospective investors:
Under this category there are existing shareholders and future shareholders. They are
interested in the future prosperity of the business and dividends.

 Government:
The government is interested in the financial statements of the business enterprise von
account of taxation, labor and corporate laws.

 Employees: the employees are interested in the financial statements on account of

various profit sharing and bonus schemes.

 Citizen:
An ordinary citizen may be interested in the accounting records of the institutions with
which he comes in contact with daily life e.g. bank, temple, and public utilities such as
gas, transport and electric companies.

 Regulatory agencies:
A number of regulatory agencies like Securities Exchange Board of India (SEBI), the
Insurance Regulatory Authority, and the Reserve Bank of India etc need accounting
information for the efficient operation of capital markets.

SYSTEMS OF BOOK KEEPING:

Book keeping is the art of recording business transactions in a regular and systematic
manner.

There are two systems of book keeping:

 Single entry system

 Double entry system

Single entry system is an incomplete double entry system. According to Kohler it is a

system of book keeping in which, only records of cash and personal accounts are
maintained.

Double entry system:

Every transaction has two fold effects in the form of receiving some benefit. This is a
perfect, complete and accurate system of recording business transaction. It is based on
dual aspect concept.

DIFFERENCE BETWEEN SINGLE ENTRY SYSTEM AND DOUBLE ENTRY

SYSTEM.
 Basis of difference Double entry system
Recording of Dual aspect concept
transactions completely followed while
recording business
transactions.
Maintenance of books. In double entry system
various subsidiary books
viz, sales book, purchase
book, cash book are
maintained.
Maintenance of books of All major accounts real,
accounts. nominal and personal are
maintained.
Preparation of trial Trial balance is prepared to
balance c heck arithmetical accuracy
of the books of accounts
Accuracy of profits and Trading & profit and loss
financial position account gives the true profit
while the balance sheet
provides the true and fair
financial position.
Utility Large business unit adopt
this system
Single entry system
Dual aspect concept is not
followed for all
transactions.
In single entry system no
subsidiary books except
cash in maintained
Only personal accounts
are maintained.
Trial balance cannot be
prepared
Rough estimate of profit
and loss can be made.
Statement of affairs does
not show the true
financial position.
It is used only by very
small business units.

SYSTEMS OF ACCOUNTING:

There are basically two systems of accounting:

 Cash system
 Accrual or mercantile system

DIFFERENCE BETWEEN CASH SYSTEM AND ACCRUAL SYSTEM.

Cash system Accrual system

It is a system in which accounting entries
are made only when cash is received or
paid.
Prepaid, outstanding and received in
advance items are not appear in the
balance sheet.
Profit and loss account show a lower
profit due to the effect on income of
prepaid expenses and accrued income.
It is system in which accounting entries
are made on the basis of amounts having
become due for payment or receipt.
Prepaid, outstanding and received in
advance items are appear in the balance
sheet.
Profit and loss account show a high
profit due to the effect on income of
prepaid expenses and accrued income.
 The basis of cash based accounting is not
recognized by the companies Act, 1956.
Cash system is not followed by all
concerns.
No option is available regarding the
method of inventory valuation and
method of depreciation.
Accrual basis of accounting is
recognized by the companies Act 1956.
Most of the industrial and commercial
firms follow accrual basis of accounting.
Accountant has the option to value the
inventories at cost or market whichever
is less and also straight line or
diminishing balance method of
depreciation.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

Accounting principles follow certain guidelines. The rules that govern how accountants
measure progress and communicate financial information fall under the heading
Generally Accepted Accounting Principles (GAAP).GAAP comprises of conventions,
rules and procedures that constitute accepted accounting practices at any given time.

GAAP differ from country to country because of the legislative requirements of each
country, local accounting practices, customs, usage and business environment peculiar to
that country. E.g. in USA the financial accounting Standard Board (FASB) set up in 1973
makes major pronouncements called Statements of Financial Accounting standards. In
UK the accounting standard board set up in 1990 issues financial reporting standards. In
India, the accounting Standard Board set up by the Institute of Chartered Accountants of
India issues the accounting standards to be observed by Indian companies.

ACCOUNTING PRINCIPLES: Accounting principles may be defined as those rules of

action adopted by the accountants universally or Generally Accepted Accounting Principles
while recording accounting transaction.

These principles can be classified into two categories.

 Accounting concepts or accounting postulates

 Accounting conventions

A concept is a basic assumption on the basis of which financial statements of business

enterprises are prepared. An assumption is something that is accepted as true without
proof.

ACCOUNTING CONCEPTS:

Accounting concepts may be classified

1. Separate entity concept
2. Going concern concept
3. Money measurement concept
4. Cost concept
 5. Dual aspect concept
6. Accounting period concept
7. Matching Concept
8. Realization concept
9. Accrual Concept

Separate entity concept:

It is also known as business entity concept. This concept states that, for accounting
purposes the business enterprises and its owners are two separate entities. The
business and private transactions should be distinguished.

For example- When the owner invests money in the business, the business entity
receives the asset cash and the capital of the business is treated as a liability of the
businesses towards the owner. Similarly when the owner takes cash for his personal
use e.g paying fees for his son, the accounts would show the cash has been reduced
and the capital of the business.

In case of partnership business or sole proprietorship , though the partner or sole

proprietor are not considered as separate entities in laws, but for accounting purposes
they will be considered as separate entities.

Going concern concept:

According to this concept the business firm will continue to carry on its activities for
an indefinite period of time. There is neither the intention nor the necessity to
liquidate the particular business venture in the foreseeable future.

This assumption is not valid where the business entity has been running at a loss for a
number of years and there is no possibility for its revival.
This concept is of great help to the investors because it assumes them that they will
continue to get income for their investments.

Money measurement concept:

Accounting records only monetary transactions. Money is a common unit of

recording transactions relating to assets liabilities and capital and therefore helpful in
preparing the profit and loss account and the balance sheet. Non- monetary such as
the strike in the factory, retirement of the general manager cannot be recorded
because these events cannot be expressed in terms of money.

Cost concept:

According to this concept

a) An asset is ordinarily recorded in the accounting records the price paid to
acquire it, and
 b) This cost is the basis for all subsequent accounting for the assets.

The cost concept is applicable only to fixed assets and not for current assets
only fixed assets are shown in the balance sheet at their respective cost prices,
current assets are generally shown at cost price or market price whichever is
lower or less. The asset is recorded at cost at the time of its purchase, but it may
systematically be reduced in its value by charging depreciation.

Cost concept has the advantage of bringing objectivity in the preparation of

financial statements. However, on account of inflationary tendencies the
preparation of financial statements on the basis of historical cost has become
largely irrelevant for the judgment of financial position of the business. This is the
reason for growing need of inflation Accounting.

Dual aspect concept:

According to this concept every business transaction has a dual aspect or effect and it
is commonly expressed in form of a fundamental accounting equation.

Assets=equities or claims
Assets= liabilities+ capital

As a result of this dual -aspect concept, total assets must equal total equities or
claims. It is from this relationship the term balance sheet is arrived.

Where
Liabilities: creditor’s claims or outsiders equity
Capital: owner’s claims or owners equity

Accounting period concept :

According to this concept, the life of the business is divided into appropriate
segments for studying the results shown by the business after each segment.

This is because though the life of the business is considered to be indefinite, the
measurement of income and the financial position of the business after a very long
period of time would not be helpful in taking proper corrective measures at the
appropriate time. Accounting measures activities for a specified interval of time,
called accounting period.
Economic Activities of the business is separated or divided into relatively short
accounting periods of equal length and its performance is evaluated during periodic
intervals which may be monthly, quarterly, half yearly or yearly.

This concept requires that a balance sheet and profit and loss account should be
prepared at regular intervals. This is necessary for different purposes e.g. calculation
of profit, financial position etc. The length of the accounting period depends on
 the nature of the business and the needs of the owners of the business.
Accounting period is normally of one year. Companies those shares are listed on the
stock exchange are required to publish their results quarterly.

Realization concept:

Realization means as to when a transaction gives legal right to the receipt of

money. It means realization concept is related to the point of time at which revenues
is to be recognized. Thus the essence of the realization concept is the timing of
revenue recognition. The realization concept is related to revenues only and not
to the expenses

According to this concept revenue is recognized when a sale is made. Sale is

considered to be made at the point when the property in good passes to the buyer and
he becomes legally liable to pay.

For this purpose three conditions must be fulfilled:

 The goods have been transferred to the customer or service has been
performed and the customer becomes legally liable to pay.
 The revenue can be objectively measured or determined in money.
 There is an independent transaction between the business enterprise and
some other related party.

For example Nestle manufactures Maggie, and received cash of Rs. 40,000 in advance on
25 March 2015 from retailers for the supply of Maggie and the sale were made on 5 April
2015. Revenue will be realized in the month of April 2015 not in March 2015.

 Revenue is not realized in the books of account until the product is delivered.
 Revenues from interest, rent, royalty, commission etc are recognized on time.

Accrual Concept:

Accrual Concept is applicable to the recognition of both the revenues and expenses.
According to this concept, revenues are recognized when they simply become
receivable though cash is not received, and the expenses are recognized when they
simply become payable though no cash is paid immediately and both are recorded in
the accounting period to which they are related.

The accrual concept therefore makes a distinction between the actual receipt of
cash and right to receive cash as regards revenue and actual payments of cash
and obligations to pay cash as regards expenses.

Matching Concept:
 In order to ascertain the profit made by the business, the revenues and the expenses
incurred to earn the revenues must belong to the same accounting period.

The matching concept implies appropriate association of related revenues and

expenses. Matching concept is an extension of the accrual concept.

On account of this concept, adjustments are made for all prepaid expenses, outstanding
expenses, accrued income, etc, while preparing periodic reports.

ACCOUNTING CONVENTIONS:

It may be classified into 4 categories. They are

1. Conservatism
2. Full disclosure
3. Consistency
4. Materiality

Conservatism:

Accountant’s follows the rule anticipate no profit but provide for all possible losses
while recording business transactions. Accountants follow the principle of “playing
safe”. This principle affects current assets. E.g. inventory is valued at cost or market
price whichever less, providing provision for bad and doubtful debt. It goes against
the convention of full disclosure. It encourages the accountants to create secret
reserves (e.g. by creating excess bad and doubtful debts, depreciation etc) and the
financial statements do not disclose the true financial position.

The principle of conservatism may also invite criticism if not applied cautiously. For
example, when the accountant create secret reserves, by creating excess provision for bad
and doubtful debts, depreciation, etc. The financial statements do not present a true and
fair view of state of affairs. American Institute of Certified Public Accountant have also
indicated that this concept need to be applied with much more caution and care as over
conservatism may result in misrepresentation.

Full disclosure:

According to this convention the accounting reports should disclose true and fair
information to proprietors, creditors, investors, employees, public and the
government.

No multipurpose statement has been devised as yet to serve the requirements of

different users like creditors, investors, government, etc. Therefore, whatever the
details are available, that must be honestly reported and additional information must
be appended to the financial statements. It would be more appropriate if the
 summary of the accounting practices followed in the preparation of financial
statements is appended.

Consistency:

Consistency means that same accounting practices will be used for similar items from
one accounting period to another.

It means that accounting information is useful only if it can be compared with the
similar information within the same firm for few years and with similar information
between two or more firms for the same period.

This is possible only when accounting practices remain unchanged from one period to
another. e.g. if the stock should be valued at cost or market price whichever less,
depreciation is charged on fixed assets by diminishing balance method, the principle
should be followed by year after year. Consistency does not mean inflexibility. It
does not forbid introduction of the improved techniques. Accounting being social
science, there is a scope for desirable changes as a result of changes in circumstances
in which accounting operates.

Materiality:

The term materiality is a subjective term. The accountant should regard an item as
material if there is reason to believe that knowledge of it would influence the
decision of the investor. i.e. to invest or not to invest in the enterprise or give loan or
not to give loan to a firm etc. An item may be important from the point of view of one
type of user is insignificant to the other.

Benefits, Objectives and Scope of Accounting Standards, Introduction

to Accounting Standards Issued by ICAI

Accounting standards are written policy documents issued by expert accounting body
or by government or its regulatory body covering such aspects as recognition,
measurement, presentation and disclosure of accounting transactions in the financial
statements.

Accounting standards are the codified forms of generally accepted accounting

principles. Accounting standards consists of detailed rules to be adopted for
treatment of various items in accounting before the financial reports are presented to
the external and internal users.

Accounting standards are designed to harmonize diverse accounting practices i.e.

methods and procedures, to achieve uniformity and consistency in internal and
external reporting practices.
 Accounting standards primarily concerned with the financial measurements i.e.,
operating income and financial position) and disclosures used in the preparation of
different types of financial statements.

The essence of the accounting standards is that they provide specific guidelines as to how
the various items go to make up the financial statements should be dealt with in the
accounts and disclosed in the annual reports relating to net income and financial position.

NATURE OF ACCOUNTING STANDARDS

The essence of accounting standards is that they provide specific guidelines as to how the
various items which go to make up the financial statements should be dealt within
accounts and disclosed in the annual reports relating to net income and financial position.

 Accounting standards prescribe a model code of accounting policies and

practices for the guidance of the accountants as to how transactions and events
are to presented and disclosed in the financial statements.

 Accounting standards provide the most suitable accounting method to solve

one or more accounting problems.

 Accounting standards clearly communicate to the users of the financial

information the basis on which financial statements have been prepared.

 Accounting standards eliminate or remove the use of several or various

accounting policies and practices so that financial statements of different firms
become comparable.

BENEFITS OF ACCOUNTING STATNDARDS:

Recognizing the need to reduce the number of alternative accounting policies and
practices , the institute of chartered accountants of India( ICAI) constituted an
Accounting Standard Board (ASB ) on April 21,1977. The main function of ASB is to
formulate the accounting standards from time to time and they are issued by council
of ICAI. While formulating the Accounting Standards, ASB will take into
consideration the applicable laws, customs, usages and requirements of business
enterprises. ICAI is the member of International Accounting Standard Board (IASB)
and ASB gives due consideration to International Accounting standards and try to
integrate them, to extent possible, in the light of the practices prevailing in India.

The benefits are as follows:

 1. To improve the credibility and reliability of the financial statements. The
accounting standards create a sense of confidence amongst the users of the
accounting information by proving a structure of uniform guidelines which
improve the credibility and reliability to the financial information.

2. Easy intra- firm and inter- firm comparability: As the same accounting
methods and policies are adopted in the preparation and presentation of financial
statements , accounting standards facilitate or help in comparing the financial
statements of various years of same enterprise(Intra- firm) and among various
enterprise(Inter – Firm).

3. True and fair view of the financial position: In order to present a true and fair
view of the financial position of for the users of accounting information it is
necessary to use accounting standards.

4. Reduction in alternative practices: Accounting standards reduce or bring down

the number of alternative accounting practices for recording and presenting
business transactions.

5. Improve the quality of financial reporting : Accounting standards improve

quality of the financial reporting in the sense that the financial reports are
prepared not only standards formats but also easily understandable common terms
with the same meanings attached to them

6. Benefits to accountants and auditors. The use of accounting standards helps to

mitigate the occurrence of frauds and provide transparency to the accounting data. Hence
the accounting standards benefit not only to the accounting entity but also to accountants
and auditors.

7. Efficiency of Management: Accounting standards are useful in measuring the

efficiency of the management regarding the profitability, liquidity, solvency and general
progress off the enterprise. In the absence of accounting standards it is difficult to
evaluate the managerial stewardship because there is no basis of comparing the financial
results of one enterprise with another.

8. Reform in accounting theory and practice

A lot of research work continues to be undertaken to study the alternative possibilities

for defining and measuring the accounting performance.

OBJECTIVES OF ACCOUNTING STANDARDS:

1. The main purpose is to provide information to the users as to the basis on

which the accounts have been prepared.
 2. Accounting standards remove the effect of diverse accounting practices and
policies so that financial statements become more meaningful and
comparable.
3. Accounting standards increase the comparability
4. Accounting standards increase the credibility and understandability

SCOPE OF ACCOUNTING STANDARDS ISSUED BY ICAI

1. Efforts should be made to issue Accounting Standards which are in conformity

with the provisions of the applicable laws, customs, usages and business
environment in India.
2. The accounting standards are intended to apply the items which are material. Any
limitation with regard to the applicability of a specific accounting standard will be
made clear by the ICAI from time to time.
3. The ICAI will use its best endeavors to persuade the government, appropriate
authorities and business community to adopt the accounting standards Inorder to
achieve uniformity in preparation of financial statements.
4. The emphasis of the accounting standards would be on account ting principles.
5. The standards formulated by the ASB include paragraphs in bold italic type and
plain type, which have equal authority.
6. Accounting standard Board may consider any issue regarding interpretation of
accounting standards.

INTRODUCTION TO ACCOUNTING STANDARDS ISSUED BY ICAI

The Institute of chartered accountants of India (ICAI) has issued 32 accounting standards.
While auditing the accounts, it will be the duty of the auditors to examine whether
accounting standard is compiled with the presentation of the financial statements.

Accounting standards issued by the Institute of Chartered Accountants of India

(ICAI)

No Title Mandatory for

accounting
period
beginning on or
after
AS1 Disclosure of accounting policies 1.4.1991
AS2( Revised) Valuation of inventories 1.4.1999
AS3( Revised) Cash flow statements 1.4.2001
AS4( Revised) Contingencies and events occurring after the 1.4.1995
balance sheet date
AS5( Revised) Prior period and extra ordinary items and 1.4.1996
changes in accounting policies
AS6( Revised) Depreciation accounting 1.4.1995
AS7( Revised) Accounting for Construction contracts 1.4.2003
AS8 Accounting for research and developments ( 1.4.1991
withdrawn w.e.f. 1.4.2003)
AS9 Revenue recognition 1.4.1991
AS10 Accounting for fixed assets 1.4.1991
AS11(Revised Accounting for the effect of changes in foreign 1.4.2004
2003) exchange rates
AS12 Accounting for government grants 1.4.1995
AS13 Accounting for investments 1.4.1995
AS14 Accounting for amalgamations 1.4.1994
AS15 Accounting for retirement benefits in the 1.4.1995
financial statements of employers( withdrawn
w.e.f. 1.4.2006)
AS15(Revised Employee benefits 7.12.2006
2005)
AS16 Borrowing Costs 1.4.2000
AS17 Segment Reporting 1.4.2001
AS18 Related Party Disclosures 1.4.2001
AS19 Leases 1.4.2001
AS20 Earnings per Share 1.4.2001
AS21 Consolidated Financial statements and 1.4.2001
accounting for investments in subsidiaries in
separate financial statements.
AS22 Accounting for taxes on income 1.4.2001
AS23 Accounting for investments in associates 1.4.2002
AS24 Discontinuing operations 1.4.2004
AS25 Interim financial reporting 1.4.2002
AS26 Intangible assets 1.4.2003
AS27 Financial reporting of interests in joint ventures 1.4.2002
AS28 Impairment of assets 1.4.2004*
AS29 Provisions, Contingent liabilities and Contingent 1.4.2004
assets
AS30 Financial instruments: Recognition and 1.4.2011
measurement
AS31 Financial instruments: Presentation 1.4.2011
AS32 Financial instruments: Disclosures 1.4.2011

*Mandatory i) for enterprises whose debt or securities are listed on a recognized stock
exchange in India and ii) all other commercial or industrial enterprises whose turnover
for the accounting period exceeds 50 Crores.

DIFFERENCE BETWEEN FUNDAMENTAL ACCOUNTING PRESUMPTIONS

AND ACCOUNTING POLICIES:
Fundamental accounting presumptions
Fundamental accounting presumptions
are assumed to have been used and
accepted in the preparation of financial;
statements.
In case of Fundamental accounting
presumptions the management has no
discretion.
Fundamental assumptions are not
followed; the fact has to be disclosed
together with results.
Accounting policies
No such presumption can be used in
case of accounting policies.
In case of accounting policies, the
management may make a choice.
In case of account ting policies
disclosure has to be made about the
policy which has been followed by the
management.