ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Lecture-2
Accounting Concepts and Conventions
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

LECTURE OUTCOMES
 To define accounting concepts and conventions.
 To use accounting concepts and conventions in preparing accounting books and
financial statements
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Accounting Principles
A general law or rule, adopted or professed as a guide to action, a
settled ground or basis of conduct or practice.
Man made
Accounting principles are uniform practices which entities follow to
record, prepare and present financial statements. Objectivity
An entity must prepare its financial statements as per acceptable
Usefulness/
accounting principles in order to present true and fair view of state of relevance
affairs of entity.
Accounting Feasibility
Concepts Accounting
Conventions
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Accounting Concepts vis-à-vis

Basis
Conventions Concept Convention
Accounting convention may be defined
Accounting concepts are the assumptions as a custom or generally accepted
Meaning that guide how the transactions should be practice which is adopted either by
recorded and reported. general agreement or common consent
among accountants.

Accounting conventions are

Accounting concepts have legal
Legal Position guidelines based upon custom or
acceptance.
usage or general agreement.

Accounting concepts are the basic Accounting conventions are followed

Recording Vs.
assumptions on the basis of which in preparing the Profit and loss
Financial
transactions are recorded and accounts account or Income Statement and
Statements
are maintained. Balance sheet or Position Statement.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d…
Basis Concept Convention

Role of There is no role of personal judgment Personal judgments play an

Personal or individual bias in the following of important role in the adoption of
Judgment accounting concepts. accounting conventions.

There is uniform adoption of There is no adoption of accounting

Uniform
accounting concepts in different conventions in various business
Adoption
business enterprises. enterprises.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Let us take an example

 In India there is a basic rule to be followed by
everyone that one should walk or drive on his/her
left hand side of the road.
 It helps in the smooth flow of traffic.
 Similarly, there are certain rules that an
accountant should follow while recording
business transactions and preparing accounts.
 These may be termed as accounting concept.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Accounting Concepts
 The term ‘concept’ is used to connect accounting
areas, those are the necessary assumptions and
conditions upon which accounting is based.

 These are the theories on how and why certain

categories of transactions should be treated in a
particular manner.
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Cont’d…
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

1. Business Entity Concept

The business and its owner(s) are two separate entities.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Entity and Separate Business Entity

Gautam Adani,
Individual Entity Adani Group of Industries,
Business Entity
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

HUL ANNUAL REPORT

2021-2022
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

2. Going Concern Concept

It is assumed that the entity is a going
concern, i.e., it will continue to operate for
an indefinitely long period in future and
transactions are recorded from this point
of view.
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3. Money Measurement Concept

 Accountants need a common form of
measuring the wealth and performance of the
businesses they work for.
 In accounting, a record is made only of those
transactions or events which can be measured
and expressed in terms of money.
 Examples: market conditions, technological
changes and the efficiency of management
will not be disclosed in the accounts.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Non monetary transactions are not recorded in

accounting

Innovativeness
Attitude Experience
skill TeamPassion
Honesty
work
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Example
 At the end of the year 2021, an organization had a factory on a piece of land etc.
These are expressed in different units (A) or in money terms rupees (B).
 Can financial position of the concern be determined with A or B ????

A. Units
Land 10 acres
Office building containing 50 rooms
50 personal computers
50 office chairs and tables
100 kg of raw materials
B. Rupees
Cost of factory land Rs.12 crore
Office building of Rs.10 crore
Computers Rs.10 lakhs
Office chairs and tables Rs. 2 lakhs
Raw material Rs.30 lakhs
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d…
 For accounting purposes items are to be recorded in money terms i.e., in rupees.
 In this case, the cost of factory land may be say Rs.12 crore, office building of
Rs.10 crore, computers Rs.10 lakhs, office chairs and tables Rs.2 lakhs, raw
material Rs. 30 lakhs.
 Thus, the total assets of the organisation are valued at Rs. 22 crore and Rs.42
lakhs.
 Therefore, the transactions which can be expressed in terms of money is recorded
in the accounts books, that too in terms of money and not in terms of the quantity.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Yes/No (Poll)
Say A (Yes) against the information that should be recorded in the books of accounts and
cross mark B (No) against the information that should not be recorded

(i) Health of a managing director

(ii) Purchase of factory building Rs.10 crore

(iii) Rent paid Rs.100000

(iv) Goods worth Rs.10000 given as charity

(v) Delay in supply of raw materials

ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

4. Accounting Period Concept

For measuring the financial results of a business periodically, the working life of
an undertaking is split into convenient short periods called accounting period.
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ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

5. Cost Concept
 An asset acquired by a concern is recorded in the books of accounts at historical cost
(i.e., at the price actually paid for acquiring the asset).
 The market price of the asset is ignored.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d….
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d….
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d….

Why is the historical cost

concept important?
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6. Dual Aspect Concept

For Every Debit, there is a Credit
Every transaction should have a two- sided effect to the extent of
same amount
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Example
 Mohan started a business with Rs 5,00,000 as a primary investment.

1. It will increase the assets of the business by Rs 5,00,000. (Cash increases)

2. Capital of the business increases by Rs. 5,00,000.
 Now, let’s say Mohan needed to purchase some goods for an amount of Rs
1,00,000.
1. Purchasing goods increases assets (stock) of the business by Rs 1,00,000.
2. It reduces another asset of the business, i.e., cash is reduced by Rs.1,00,000.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d…
 Similarly, if Mohan has to buy equipment on credit for an amount of 10,00,000
from an equipment manufacturing company
1. Purchasing of new equipment on credit increases the asset base of the business
by Rs. 10,00,000
2. Purchasing of new equipment on credit results in increasing the liabilities of the
business (repay to creditors) by Rs. 10,00,000.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

7. Realization Concept
Profit is earned when goods or services are
provided /transferred to customers.

Thus it is incorrect to record profit when

order is received, or when the customer pays
for the goods.

‘when the legal title to

the goods is transferred’
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Example
Kanishka Jeweller received an order to supply gold
ornaments worth Rs. 500000.

They supplied ornaments worth Rs.200000 up to the

year ending 31st December 2021 and rest of the
ornaments were supplied in January 2022.

What is the amount of revenue realized for 2021?

ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d…
The revenue for the year 2021 for N.P. Jeweller is Rs.200000.

Mere getting an order is not considered as revenue until the goods have been
delivered.
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8. Matching Concept
A salesperson makes a 5% commission on
every sale they make in the month of January,
but their commission isn't paid until February.
This means that if they sell $100 worth of
products in January, the company will pay
them $5 in February. Despite this, the amount
of commissions they earned—in this case $5—
is required to be reported on the January
statement with the January product sales of
$100.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Accounting Conventions
 Accounting Conventions are the common practices which are universally followed in
recording and presenting accounting information of business.

 It helps in comparing accounting data of different business or of same units for different
periods.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

1. Materiality
 Only those transactions, important facts
and items are shown which are useful and
material for the business.
 The firm need not record immaterial and
insignificant items.
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Example
 A large company has a building in the hurricane zone during Hurricane Sandy.
 The company building is destroyed and after a lengthy battle with the insurance company,
the company reports an extra ordinary loss of $10,000.
 The company has net income of $10,000,000.
 Is it a material information?
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Example
 Assume the same example above except the company is a smaller company with only
$50,000 of net income.
 Now the loss is 20% of net income.
 Is it a material information?
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Poll
 ABC LTD has a yearly turnover of $100 million. Which of the following information is material to
the users of its financial statements?

a) ABC LTD has been sued by XYZ LTD for $10 million as damages for breach of contract. The
decision of the Court is still pending.

b) ABC LTD sold goods worth $1 million to its subsidiary DEF LTD.

c) ABC LTD does not disclose details of its operating lease in respect of an office space rented at
$10,000 per annum.
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2. Full Disclosure
Financial Statements and their notes
should present all information that is
relevant and material to the user’s
understanding of the statements.
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ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

3. Conservatism
The Game B/W ANTICIPATION and REALISATION
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

Cont’d…
• Making Provision for Bad and Doubtful Debts
• Showing Depreciation on Fixed Assets, but not appreciation
• Stock valuation sticks to rule of the lower of cost and net realizable value

Let us assume that a company XYZ Ltd. is embroiled in a patent lawsuit. XYZ Ltd. is
suing ABC Ltd for patent infringement and is expecting to win a substantial settlement.
Since the settlement is not a surety, XYZ Ltd. does not record the gain in the financial
statements.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I

4. Consistency
 The accounting practices and methods should remain consistent from one
accounting period to another.
 Whatever accounting practice is followed by the business enterprise,
should be followed on a consistent basis from year to year.
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I
ACCM506 – FINANCIAL REPORTING, STATEMENTS AND ANALYSIS – I