Accounting Notes

Definition of accounting: The American Accounting Association (AAA) has defined accounting as,
“the process of identifying, measuring and communicating economic information to permit informal
judgments and decisions by users of information”.

Objectives of Accounting

• To maintain the systematic records of the business

• To ascertain the profit or loss of the business

• To present the financial position of the business

• To provide the financial information to the various users

• For Decision Making

Scope of Accounting

• The Scope of accounting is divided into following two parts:

1. Branches of Accounting

• Financial Accounting: It is the original form of accounting. It refers to the recording of daily
business financial transaction. Recording of the transaction is done in such a way that the
profit of the business may be ascertained after a definite period and the picture of the
financial position of the business may be presented.

• Cost Accounting: As the name indicates, this accounting is related with the ascertainment of
cost of the product in a period. Under this system, record of raw materials used in
production, wages and labour paid and other expenses incurred on production are kept to
control the costs.

• Management Accounting: The accounting which provides the necessary information to the
management is called management accounting. Under this, the analysis and interpretation
of the accounts, prepared by financial accounting, are done in a manner so that the
managers may forecast, plan for future and frame the policy.

2. Accounting as Science or an Art: Accounting is both the science and art. Study of science is
based on some principles and it is systemized. It is a science because the business
transactions are recorded on the basis of some principles and journal of transaction, ledger
posting, trial balance and preparation of final statements are done in a sequence. Art is the
creation of practical applications and rules for the completion of any work. On the basis of it,
accounting is an art as we do not only study principles of accounting but also we learn to
apply these principles in practice to record the business transaction. Thus accounting is both
science and art.
 Difference Between Bookkeeping and Accounting

Bookkeeping Accounting

Definition

Bookkeeping deals with identifying and recording financial Accounting refers to the process of summarising,
transactions only interpreting and communicating the financial data of
an organisation.

Decision making

Data provided by bookkeeping is not sufficient for decision Management can take important decisions based on
making the data obtained from accounting

Preparation of Financial Statement

Not done in the case of bookkeeping Financial statements are a part of the accounting
process

Analysis

No analysis is required in the bookkeeping Accounting analyses the data and creates insights for
the business

Persons Involved

The person concerned with bookkeeping is known as a bookkeeper The person concerned with accounting is
known as an accountant

Determining Financial Position

Bookkeeping does not show the financial position of a business Accounting helps in showing a clear
picture of the financial position of a
business
Level of Learning

No high-level learning required High-level learning required for

understanding and analysing accounting
concepts

Limitations of Accounting

• Historical Costs

• Estimates

• Verifiability

• Measurability

• No Future Assessments

• Errors and Frauds

• Accounting Policies

Accounting Concepts

“The term accounting concepts refer to basic rules, assumptions, and principles which act as a
primary standard for recording business transactions and maintaining books of accounts”.

• Business Entity Concept: This concept assumes that the organization and business owners
are two independent entities. Hence, the business translation and personal transaction of its
owner are different. For example, when the business owner invests his money in the
business, it is recorded as a liability of the business to the owner. Similarly, when the owner
takes away from the business cash/goods for his/her personal use, it is not treated as a
business expense. Thus, the accounting transactions are recorded in the books of accounts
from the organization's point of view and not the person owning the business.

• Accrual Concept: The term accrual means something is due, especially an amount of money
that is yet to be paid or received at the end of the accounting period. It implies that revenue
is realized at the time of sale through cash or not whereas expenses are recognized when
they become payable whether cash is paid or not. Therefore, both the transactions are
recorded in the accounting period in which they relate.

• Cost Concept: The accounting cost concept states all the business assets should be written
down in the book of accounts at the price assets are purchased, including the cost of
acquisition, and installation. The assets are not recorded at their market price. It implies that
the fixed assets like plant and machinery, building, furniture, etc are recorded at their
purchase price.
• Dual Aspect: The dual aspect is the basic principle of accounting. It provides the basis for
recording business transactions in the books of accounts. This concept assumes that every
transaction recorded in the books of accountants is based on dual concepts. This implies that
the transaction that is recorded affects two accounts on their respective opposite sides

• Going Concepts: The Going concept in accounting states that a business activities will be
carried by any firm for an unlimited duration This simply means that every business has
continuity of life. Hence, it will not be dissolved shortly. This is an important assumption of
accounting as it provides a base for representing the asset value in the balance sheet.

• Money Measurement Concept: The money measurement concept assumes that the
business transactions are made in terms of money i.e. in the currency of a country. In India,
such transactions are made in terms of the rupee. Hence, as per the money measurement
concept, transactions that can be expressed in terms of money should be recorded in books
of accounts.

• Accounting Period Concepts: Accounting period concepts state that all the transactions
recorded in the books of account should be based on the assumption that profit on these
transactions is to be ascertained for a specific period. Hence this concept says that the
balance sheet and profit and loss account of a business should be prepared at regular
intervals.

• Realization Concept: The term realization concept states that revenue earned from any
business transaction should be included in the accounting records only when it is realized.
The term realization implies the creation of a legal right to receive money. Hence, it should
be noted that selling goods is considered as realization whereas receiving order is not
considered as realization

• Matching Concepts: The Matching concept states that revenue and expenses incurred to
earn the revenue must belong to the same accounting period. Hence, once revenue is
realized, the next step is to assign the relevant accounting period.

Accounting Conventions

• Accounting conventions are certain restrictions for the business transactions that are
complicated and are unclear. Although accounting conventions are not generally or legally
binding, these generally accepted principles maintain consistency in financial statements.
While standardized financial reporting processes, the accounting conventions consider
comparison, full disclosure of transaction, relevance, and application in financial statements.

• Four important types of accounting conventions are:

• Conservatism: It tells the accountants to err on the side of caution when providing the
estimates for the assets and liabilities, which means that when there are two values of a
transaction available, then the always lower one should be referred to.

• Consistency: A company is forced to apply the similar accounting principles across the
different accounting cycles. Once this chooses a method it is urged to stick with it in the
future also, unless it finds a good reason to perform it in another way. In the absence of
these accounting conventions, the ability of investors to compare and assess how the
company performs becomes more challenging.
 • Full Disclosure: Information that is considered potentially significant and relevant is to be
completely disclosed, regardless of whether it is detrimental to the company.

• Materiality: Similar to full disclosure, this convention also bound organizations to put down
their cards on the table, meaning they need to totally disclose all the material facts about the
company. The aim behind this materiality convention is that any information that could
influence the person’s decision by considering the financial statement must be included.

GAAP (Generally Accepted Accounting Principles)

• Generally Accepted Accounting Principles or GAAP is a defined set of rules and procedures that needs
to be followed in order to create financial statements, which are consistent with the industry
standards.
• GAAP helps in ensuring that financial reporting is transparent and uniform across industries. As
financial information is based on historical data, therefore in order to facilitate comparison between
data from various sources, GAAP must be followed.
• GAAP is developed by the Financial Accounting Standards Board (FASB)

The following GAAP principles can be discussed:

 • Principle of Consistency: This principle ensures that the organizations use consistent standards while
recording the transactions.
• Principle of Regularity: This principle states that all the accountants abide by the rules and regulations
as per GAAP.
• Principle of Sincerity: This principle states that an accountant should provide an accurate depiction of
the financial situation of a business.
• Principle of Permanence of Method: This principle states that consistent practices and procedures
should be followed for financial reporting purposes.
• Principle of Prudence: This principle states that financial data should be reasonable, factual and
should not be based on any speculation.
• Principle of Continuity: This principle states that the valuation of assets is based on the assumption
that the business will be continuing its operations in the future.
• Principle of Materiality: These principal lays emphasis on the full disclosure of the true financial
position of the business.
• Principle of Periodicity: This principle states that business entities should abide by the commonly
accepted accounting periods for financial reporting such as yearly, half-yearly, etc.
• Principle of Non-compensation: This principle states that no business entities should expect
compensation in return for providing accurate information in financial reporting.
• Principle of Good Faith: This principle states that all the parties involved in financial reporting should
be honest in reporting the transactions.

International Financial Reporting Standards (IFRS)

• IFRS is an international standard for accounting and financial reporting
• The International Accounting Standards Board (IASB) is an independent accounting organization
situated in London (IASB)
• As we all know, several countries have their GAAP
• Each country has its own GAAPs. India has IAS.
• It also affects multinational corporations with branches worldwide
• So, the IFRS was created to provide a global accounting standard
• Around 120 nations now use IFRS. Soon, more will follow
• As a result, all companies worldwide will report their accounts following the same rules
• As a result, nations will be more compatible and uniform

Human Resource accounting: Human resource accounting is the accounting methods, systems, and techniques,
which coupled with special knowledge and ability, assist personnel management in the valuation of personnel
in their knowledge, ability and motivation in the same organization as well as from organization to
organization.

Social Responsibility Accounting allows organizations to allocate resources strategically toward social and
environmental initiatives. It helps identify areas where investments can have the most significant positive
impact.

The Right Shares refers to those issues of shares which a company offers to their existing shareholders at a
discounted price. The company's shareholders have rights to accept or reject the proposal and also there are
minimum criteria for subscriptions of the share if the shareholder accepts the proposal.

Deferred revenue expenditure refers to those expenses which will be incurred in the current accounting period
but the benefits of the expenses will be applicable over several accounting periods. Example: Expenditure on
marketing for launching a new product.

A sinking fund is a fund created specifically to save or set aside money to pay off a debt or a bond. A company
may face an immense outlay when the time comes to pay off debts and bonds issued in the past. In this case, a
sinking fund helps soften the impact of this large cost.

The advantages of a petty cash book are as follows:

 Minimizes labor.
 It is easy to record transactions in a petty cash book.
  Avoids confusion by recording petty expenses separately.
 It saves time and effort of the chief cashier.
 It is audited at the end of an accounting period, therefore there is less chance of errors.
Disadvantages of petty cash funds include their vulnerability to theft and misuse, and the need to monitor and
balance them periodically.

The American Accounting Association (AAA) has defined accounting as, “the process of identifying, measuring
and communicating economic information to permit informal judgments and decisions by users of
information”.

Internal users/parties
These are individuals that take part in the day-to-day running of the organisation. These parties include;
Managers/Directors
Employees, trade unions and pensioners
Managers/Directors
These are individuals who run the organization on behalf of the owners. They have to ensure that the
organization is profitable, grows, survives and that the owners get a dividend or return on their investment.
They monitor the performance of the organization and have to ensure that shareholders’ resources are well
managed and invested. Managers also have to manage costs and ensure that the proper prices are set. They
are also charged with the duty of strategic planning of the organization. For all these, they need financial
accounting information.
Employees and trade unions
These need accounting information of the employing organization for two major reasons;
They want to agitate for better pay and working conditions. They directly or through their trade unions
examine the Income Statement / Statement of Comprehensive Income of the employing organization to
establish its revenue and expenditure and whether it is making profits or losses or surpluses or deficits. If it is
making profits or surpluses, they will use the Income Statement to agitate for better pay.
They also need accounting information of the employing organization in order to judge their job security or
continued employment. They examining the financial statement of the organization to see if it is profitable,
growing and is a going concern. If they discover that it is not a going concern, they start searching for
alternative employment before they are laid off due cost-cutting measures or before the organization finally
collapses.

External users/parties
These do not take part in the day-to-day running of the organization but are interested in its financial
performance. They rely on the accounting information of the organizations in which they have interest in order
to make decisions. The include;
Investors/Owners
These are individuals or parties that invest their money into an organization. The are divided into the following
two categories
Actual investors/owners/shareholders – These are individuals who have already invested their money into an
entity or organization. The need accounting information of the organizations into which they invest so that they
establish whether their funds are well invested, increasing and whether they will earn a dividend or return.
Through the auditors that they appoint, they monitor the financial status of the organization and establish
whether resources are well utilized or not.
Potential/prospective Investors – these are individuals who are considering investing or buying shares in an
organization. They examine financial statements to try and predict whether the company has growth potential,
survival potential and profit-making potential. They do this through financial analysts. The need to know
whether investing is worthwhile and whether they will get a return on their investment.
Trade Creditors (suppliers)
These are parties that supply the organization on credit. Before they supply on credit, they perform credit
analysis on the intending client. They establish whether the customer has capacity to pay. This is through credit
analysis with the help of financial statements.
Lenders
These include banks, Microfinance Institutions and other individuals and institution that extend loans to the
organization. They need to establish whether the potential borrower can pay back the loan. They analyses the
financial statements of the borrower especially the revenue, cashflows, assets and liabilities.
Donors
The donate money to different organizations, association, governments, institutions and department intended
to achieve clearly stated objectives. They constantly monitor their money and occasionally request for the
financial information of the beneficiary so that the establish whether the money they donated was put to
proper use.
Government
Government needs accounting information for three major reasons;
For tax collection. Thorough tax bodies, government collects taxes from individuals and
organizations/companies. Financial statements of an organisation show the revenue and expenditure or
income and expenses. They also show whether there was profit or loss. In order for the tax body to assess
taxes, returns have to be submitted. The returns submitted are financial statements of the tax paying
organisation.
Government also wants to monitor the performance of its ministries, parastatals, department, local
governments, institutions, units and projects. Since these benefit from public resources/money, they need to
show that the money is well utilised. They therefore submit financial reports to government.
Government also need accounting information in order to know the effect of its policies on businesses and the
economy. If a policy/law is enacted and government is interested in knowing how it affected businesses, it will
request for financial reports from the different organisations in the affected sector. The reports will be analysed
and a decision made whether to continue with, amend or suspend the policy.
General public
The public includes members of society, journalists, students, consumer groups, environmental pressure
groups, researchers and all parties interested in ensuring that business operate in a socially acceptable manner.
They need to know the social benefits created and the costs incurred by the enterprise on society. Researcher
will also use the financial information for creation of knowledge.

Competitors
These need accounting information of other firms in the same industry. The need to know how well they are
performing compared to their counterparts in the same business. They also need to know the strategies that
the competitors are using to that the adopt them or even devise better ones. This information can be got from
the accounting records of the competing firms.
Financial Advisors, Consultants and Analysts
These need financial information in order provide information on the best performing companies and advise
on how others can improve their performance.
Customers
These need accounting information of companies or organisations supplying them vital in puts in order to
establish whether they will continue getting the inputs. If the supplying organisation is in poor financial health
and supplies vital inputs, it is likely that it may not be able to supply any more. This will eventually affect the
customer’s business which may also collapse or opt for more expensive suppliers.
Insurance Companies
These need accounting information for organisations requesting for insurance in order to establish the nature
of policy, the extent risk and amount of premium. Some companies insure against bad debts, other insure
against losses. Before such an insurance cover is granted, an analysis of financial statements is done and it is
from such that an insurance company can determine how much the client should pay.

Depreciation is allocating the cost of assets to the business over the useful life of the asset. It is thus a process
of allocation and not of valuing the assets.

NEED FOR PROVIDING DEPRECIATION

The need for providing depreciation in accounting records arises due to any one or
more of the following objectives to be achieved:
(a) To ascertain true results of operations: For proper matching of costs with
revenues, it is necessary to charge the depreciation (cost) against income (revenue) in
each accounting periods. Unless the depreciation is charged against income, the result
of operations would stand overstated. As a result, the Income Statement would fail to
present a true and fair view of the result of operations of an accounting entity.
(b) To present true and fair view of the financial position: For presenting a
true and fair view of the financial position, it is necessary to charge the depreciation. If
the depreciation is not charged, the unexpired cost of the asset concerned would be
overstated. As a result, the Position Statement (i.e. the Balance Sheet) would not present
a true and fair view of the financial position of an accounting entity.
(c) To ascertain the true cost of production: For ascertaining the cost of
production, it is necessary to charge depreciation as an item of cost of production. If
the depreciation on fixed assets is not charged, the cost records, would not present a
true and fair view of the cost of production.
(d) To comply with legal requirements: In case of companies, it is compulsory
to charge depreciation on fixed assets before it declares dividend [Sec. 205(1) of the
Companies Act, 1956].
(e) To accumulate funds for replacement of assets: A portion of profits is set
aside in the form of depreciation and accumulated each year to provide a definite amount
at a certain future date for the specific purpose of replacement of the asset at the end
of its useful life.

In order to assess depreciation amount to be charged in respect of an asset in an

accounting period the following three important factors should be considered:
1. Cost of the asset: The knowledge about the cost of the asset is very essential
for determining the amount of depreciation to be charged to the profit and
loss account. The cost of the asset includes the invoice price of the asset
less any trade discount plus all costs essential to make the asset usable.
Cost of transportation and transit insurance are included in acquisition cost.
However, the financial charges such as interest on money borrowed for the
purchase for the purchase of the asset, should not be included in the cost of
the asset.
2. Estimated life of the asset: Estimated life generally means that for how
many years or hours an asset could be used in business with ordinary repairs
for generating revenues. For estimating useful life of an asset, one must begin
with the consideration of its physical life and the modifications, if any, made,
factors of obsolescence and experience with similar assets. In fact, the
economic life of an asset is shorter than its physical life. The physical life
is based mostly on internal policies such as intensity of use, repairs,
maintenance and replacements. The economic life, on the other hand, is based
mostly on external factors such as obsolescence from technological changes.
3. Scrap. Value of the Asset: The salvage value of the asset is that value which
is estimated to be realized on account of the sale of the asset at the end of
its useful life. This value should be calculated after deducting the disposal
costs from the sale value of the asset. If the scrap value is considered as
insignificant, it is normally regarded as nil

green accounting. Definition English: Green accounting is a type of accounting that attempts to factor
environmental costs into the financial results of operations. It has been argued that gross domestic product
ignores the environment and therefore policymakers need a revised model that incorporates green accounting.