BCOC-131: Financial Accounting
BCOC-131: Financial Accounting
BCOC-131: Financial Accounting
Financial Accounting
Indira Gandhi
National Open University
School of Management Studies
Block
1
THEORETICAL FRAMEWORK
UNIT 1
Nature and Scope of Accounting 5
UNIT 2
Accounting Process and Rules 23
UNIT 3
Accounting Principles 37
UNIT 4
Accounting Standards 60
Theortical Framework
PROGRAMME DESIGN COMMITTEE B.COM (CBCS)
Prof. Madhu Tyagi Prof. D.P.S. Verma (Retd.) Faculty Members
Director, SOMS, IGNOU Department of Commerce SOMS, IGNOU
University of Delhi, Delhi
Prof. N V Narasimham
Prof. R.P. Hooda
Former Vice-Chancellor Prof. K.V. Bhanumurthy (Retd.) Prof. Nawal Kishor
MD University, Rohtak Department of Commerce Prof. M.S.S. Raju
University of Delhi, Delhi
Prof. B. R. Ananthan Dr. Sunil Kumar
Former Vice-Chancellor Prof. Kavita Sharma Dr. Subodh Kesharwani
Rani Chennamma University Department of Commerce
University of Delhi, Delhi Dr. Rashmi Bansal
Belgaon, Karnataka
Dr. Madhulika P Sarkar
Prof. I. V. Trivedi Prof. Khurshid Ahmad Batt Dr. Anupriya Pandey
Former Vice-Chancellor Dean, Faculty of Commerce &
M. L. Sukhadia University Management
Udaipur University of Kashmir, Srinagar
Preparatory Course in Commerce: PCO-01 (Unit-1, 2 and 3 Revised by Dr. Sunil Kumar)
Prof. J. Satyanarayan, Osmania University, Hyderabad
Prof. V. Vishwanadham, Osmania University, Hyderabad
Dr. D. Obul Reddy, Osmania University, Hyderabad
Shri M. Satyanarayana, Badruka College, Hyderabad
Print Production
Sh. Y. N. Sharma Sh. Sudhir Kumar
Assistant Registrar (Pub.) Section Officer (Pub.)
MPDD, IGNOU MPDD, IGNOU
June, 2019
Indira Gandhi National Open University, 2019
ISBN-978-93-89200-06-5
All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any
other means, without permission in writing from the Indira Gandhi National Open University.
Further information on the Indira Gandhi National Open University courses may be obtained from
the University’s Office at Maidan Garhi, New Delhi-l10068 or website of INGOU www.ignou.ac.in
Printed and published on behalf of the Indira Gandhi National Open University, New Delhi by
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BLOCK 1 THEORETICAL FRAMEWORK
This block will introduce you to the core area in Commerce. In order to
appreciate the need for accounting, You have to practice accounting and require
a clear understanding of the nature and scope of accounting, the language used
in accounting and the principles that guide the accountant. This block also deals
with basic rules of double entry system and accounting standards which provides
the basis for accounting policies in order to prepare the financial statements.
This block is structured to cover these and other related aspects. It is hoped
that this block will provide you the necessary theoretical background to
understand and appreciate accounting in the right perspective. It covers four
units.
Unit 1 explains the nature and scope of accounting and the importance of
accounting information to various parties.
Unit 2 analyse the basic rules of double entry system and their application.
Unit 3 presents some of the terms commonly used in accounting and the basic
concepts underlying accounting.
Unit 4 deals with Accounting Standards which provides the basis for accounting
policies and for preparation of financial statements.
3
Theortical Framework
4
UNIT 1 NATURE AND SCOPE OF
ACCOUNTING
Structure
1.0 Objectives
1.1 Introduction
1.2 Need for Accounting
1.3 Objectives of Accounting
1.4 Definition and Scope of Accounting
1.5 Book-Keeping, Accounting and Accountancy
1.6 Users of Financial Accounting Information
1.7 Accounting as an Information System
1.8 Branches of Accounting
1.9 Advantages of Accounting
1.10 Limitations of Accounting
1.11 Bases of Accounting
1.11.1 Cash Basis of Accounting
1.11.2 Accrual Basis of Accounting
1.0 OBJECTIVES
After studying this unit, you should be able to:
explain the need for accounting;
identify the objectives of accounting;
describe accounting as an information system;
outline the scope and bases of accounting;
distinguish between book-keeping, accounting and accountancy;
identify the parties interested in accounting information;
describe the functions and important branches of accounting;
describe the advantages and limitations of accounting; and
state the qualitative characteristics of accounting. 5
Theortical Framework
1.1 INTRODUCTION
In this unit, we shall discuss the functions, branches, advantages, limitations, and
bases for accounting. In this unit, we also intend to elaborate on the need for
accounting and then discuss the nature, scope and importance of accounting.
The main difference between accrual accounting and cash basis of accounting
is the recognition of revenues, gains, expenses and losses. The objective of
accrual accounting is to account for the effects of transactions and events to
the extent that their financial effects are recognisable and measurable in the
periods in which they occur. The adjustments made in the final accounts in respect
of prepaid expenses (prepaid insurance, salaries paid in advance, etc.), income
received in advance (rent received in advance, interest received in advance,
etc.), income earned but not yet received (interest receivable, commission
receivable, etc.) are based on accrual accounting.
(i) Understandable
(ii) Usefulness
(iii) Relevance
Accounting information should relate to a specific time period or contain
information regarding individual business functions. Business owners often
conduct a trend analysis when reviewing financial information. The trend analysis
compares historical financial information to the company’s current accounting
period information. Irrelevant historical information can severely distort the trend
analysis process. For example, reviewing the production process for budgets
requires relevant information on the cost of materials for budgets. Cost
information on the materials to produce COGS would be irrelevant.
(iv) Reliability
Accounting information must be reliable, so that business owners can be
reasonably assured that accounting information presents an accurate picture of
the company’s financial health. Business owners often use accounting information
to secure external financing for their business. Information that is not reliable
or accurate may cause lenders and investors to question the business’s
17
Theortical Framework management ability. Business owners may also struggle to secure external
financing with poor accounting information.
(v) Comparable
Comparability allows business owners to review their company’s accounting
information against that of a competitor. Business owners use comparison to
gauge how well their companies operate under certain market conditions. Owners
often use the leading company of an industry for the comparison process. These
companies usually have the most efficient and effective business operations. Non-
comparable accounting information can make this a difficult process. For
example, business owners should consider preparing financial statements according
to standard accounting principles. The statements can then be compared to other
company’s financial standard prepared in a similar manner.
(vi) Consistent
Consistency refers to how business owners and accountants record financial
information in a company’s general ledger. Business owners need to ensure that
financial transactions are handled the same way. Inventory purchases should be
recorded the same way as yesterday, today and tomorrow. This helps companies
create accurate historical records and limit the amount of financial accounts or
journal entries included in their general ledgers.
Note : These questions will help you to understand the unit better. Try
to write answers for them. But, do not submit your answers to
the University for assessment. These are for your own practice
only.
22
UNIT 2 ACCOUNTING PROCESS
AND RULES
Structure
2.0 Objectives
2.1 Introduction
2.2 Accounting Process
2.3 What is an Account?
2.4 Classification of Accounts
2.5 Principle of Double Entry
2.6 Accounting Rules
2.7 Let Us Sum Up
2.8 Key Words
2.9 Some Useful Books
2.10 Answers to Check Your Progress
2.11 Terminal Questions/Exercises
2.0 OBJECTIVES
After studying this unit, you should be able to:
identify the different stages of accounting;
classify accounts;
analyze the dual effect of each transaction; and
apply the rules of accounting, and determine the account to be debited
and the account to be credited.
2.1 INTRODUCTION
So far you have learnt the definition of accounting, its objects, advantages, the
terms commonly used in accounting, and the basic accounting concepts relevant
to record keeping. You know accounting is the art of recording, classifying and
summarising the business transactions, and interpreting the results thereof. So,
the accounting process starts with recording of transactions and ends with the
preparation of financial statements and their analysis. In this unit, we shall first
identify the different stages involved in the accounting process and then discuss
different classes of accounts, the principle of double entry, and the rules of debit
and credit which you are expected to master.
Ledger
The left hand side is called the ‘debit side’. It is indicated by writing ‘Dr.’
(abbreviation for debit) on the left hand top corner of the account. The right
hand side known as the ‘credit side’ is indicated by writing ‘Cr.’ (abbreviation
for credit) on the right hand top corner of the account. The name of the account
is written at the top in the centre. The word ‘Account’ or its abbreviation ‘A/
c’ is added to the name of the account. The rules of recording the transactions
on the debit and credit sides shall be discussed later in this unit.
25
Theortical Framework Personal Accounts
Accounts which show dealings with persons are called ‘Personal Accounts’.
Such dealings may relate to credit purchases of goods or credit sales of goods
or loans taken, etc. A separate account is kept in the name of each person
for recording the benefits received from, or given to, the person in the course
of dealings with him. Examples are: Krishna’s Account, Gopal’s Account, Loan
from Ratanlal Account, etc.
Personal accounts also include accounts in the names of institutions or companies
called artificial persons) such as Indian Bank Account. Nagarjuna Finance Limited
Account, the Andhra Pradesh Paper Mills Limited Account, etc.
The accounts which represent expenses payable, expenses paid in
advance, incomes receivable and incomes received in advance are also
personal accounts, though impersonal in name. For example, when salaries are
due to the employees, but not paid before closing of the books of account
for the year, an account called ‘Salaries Outstanding Account’ will be opened
in the books. The Salaries Outstanding Account is regarded as a personal
account representing the employees to whom salaries are payable by the
business. Such a personal account is called Representative Personal Account’
as it represents a particular person or a group of persons. Other examples of
representative personal accounts are: Interest Outstanding Account, Prepaid
Insurance Account, Rent Received in Advance Account, Commission Outstanding
Account. etc.
Capital Account and Drawings Account are also treated as personal accounts
as they represent dealings with the owner of the business.
Real Accounts
Accounts relating to properties or assets are known as ‘Real Accounts’. Every
business needs assets such as Machinery, Furniture, etc., for running its activities.
In. book-keeping, a separate account is maintained for each asset owned by
the business. Dealings relating to purchase or sale of the asset are recorded
through this account. Furniture Account, Machinery Account, Building Account,
etc., are some examples of real accounts. Cash Account which shows receipts
and payments of cash is also a real account. They are known as real accounts
because they represent things of value owned by the business.
Nominal Accounts
Accounts relating to expenses, losses, incomes and gains are known as
‘Nominal Accounts’. Every business unit incurs certain expenses such as
payment of salaries to employees, payment of wages to workers, etc., while
carrying out its activities. It may also suffer losses such as loss by fire, loss
by theft, etc. It may also earn certain incomes and gains such as receipt of
commission, receipt of-interest, profit on sale of an asset, etc. A separate account
is maintained for recording each item of expense, loss, income or gain. Thus,
Wages Account, Salaries Account, Commission Received Account, and Interest
Received Account are all nominal accounts. Classification of accounts is
presented in Chart 2.2.
26
CHART 2.2 Accounting Process
and Rules
CLASSIFICATION OF ACCOUNTS
Accounts
a) Bank A/c
b) Interest A/c
c) Interest Outstanding A/c
d) Patents A/c
e) Loan from Gopal Das A/c
f) Loose Tools A/c
g) Commission Received in Advance A/c
h) Prepaid Salaries A/c
i) Stationery A/c
j) Electricity Charges A/c
27
Theortical Framework 3. State whether the following classification of accounts is correct or not. Give
the correct classification, wherever necessary.
1. Commenced business with i) Cash A/c ii) Capital A/c Real Debit Cash comes in Proprietor
Rs. 50,000 as capital Personal Credit gives benefit
2. Bought goods for cash i) Goods A/c ii) Cash A/c Real Real Debit Goods come in Cash goes
Rs. 5,000 Credit out
3. Bought goods from Sohan i) Goods A/c ii) Sohan A/c Real Debit Goods come in Giver on
credit Rs.10000 Personal Credit Giver
4. Sold goods for cash i) Cash A/c ii) Goods A/c Real Real Debit Cash comes in Goods go
Rs. 1,500 Credit out
5. Sold goods to Vijay on i) Vijay A/c ii) Goods A/c Personal Debit Receiver Goods go out
credit Rs. 2,500 Real Credit
7. Sold old typewriter Rs. 500 i) Cash A/c RealReal Debit Cash comes in Typewriter
ii) Typewriter A/c Credit goes out
8. Purchased postage i) Postage A/c ii) Cash A/c Nominal Debit Postage is an expenseCash
stamps Rs. 50 Real Credit goes out
9. Paid salaries Rs. 6,000 i) Salaries A/c ii) Cash A/c Nominal Debit An expense Cash goes out
Real Credit
10. Received interest Rs. 200 i) Cash A/cii) Interest A/c Real Debit Cash comes in An income
Nominal Credit
Account: A summarised record which shows the effect of the transactions relating
to a particular person or thing.
Credit: Credit represents the giving aspect of a transaction.
Debit: Debit represents the receiving aspect of a transaction.
Double Entry Principle: Principle of recording both the receiving and the giving
aspects of each transaction.
Nominal Accounts: Accounts relating to expenses, losses, incomes and gains.
Personal Accounts: Accounts which relate to persons.
Real Accounts: Accounts which relate to assets.
B
Transaction First Aspect Second Aspect
Receiving/Receiver Account Giving/Giver Account
affected affected
b) Goods Goods A/c Karim & Co. Karim & Co. A/c
3. What do you understand by the Principle of Double Entry? Give the rules
of debit and credit with suitable examples.
Exercises
35
Theortical Framework Answer:
Note : These questions will help you to understand the unit better. Try to
write answers for them. But, do not submit your answers to the
University for assessment. These are for your own practice only.
36
UNIT 3 ACCOUNTING PRINCIPLES
Structure
3.0 Objectives
3.1 Introduction
3.2 Some Basic Terms
3.3 Accounting Principles
3.3.1 Concepts to be Observed at the Recording Stage
3.0 OBJECTIVES
After studying this unit, you should be able to:
explain the meaning of some basic terms of accounting;
identify assets, liabilities, incomes and expenses;
explain the need for the nature of accounting concepts;
develop familiarity with the basic concepts to be kept in mind at the recording
stage;
decide what type of transactions are to be recorded in books of account;
ascertain the amount of capital, liabilities and assets from the accounting
equation; and
describe about the two systems of book-keeping.
3.1 INTRODUCTION
In Unit 1, you learnt about the nature, scope and importance of accounting.
You know accounting is often called the ‘Language of Business’. Language is
the means of communication. Accounting also serves this function. It communicates
the results of business operations to interested parties. Let us understand this
language first. In this unit, we intend to explain some of the terms which are
commonly used in accounting and also the basic concepts underlying the
accounting system. 37
Theortical Framework
3.2 SOME BASIC TERMS
Entity: The word entity literally means a thing that has a definite individual
existence. Business entity means a specifically identifiable business enterprise like
Khanna Jewellers, Prakash Pipes Ltd., etc. An accounting system is devised
for a specific business entity (also called ‘accounting entity’).
Event and Transaction: Anything that brings about a change in the financial
position of an entity is called an ‘event’. In other words, an event is a happening
of consequence to an entity. A transaction is a particular kind of event involving
some value between two or more entities. In other words, it is any dealing
between two or more persons involving exchange of goods or services for a
consideration usually in money.
Transactions are of two kinds (i) cash transactions and (ii) credit transactions.
Cash transaction are those in which cash is involved in the exchange. For
example, purchase of goods for cash, purchase of vehicle for cash, payment
of rent etc. In case of credit transactions cash is not paid immediately, the
settlement is postponed to a later date. For example, goods are purchased on
credit on April 15, 2018 and the cash is to be paid on August 1, 2018.
Goods: The term ‘goods’ refers to articles in which the business deals. Only
those articles which are purchased for the purpose of sale are called goods.
Other articles which are purchased for the purpose of using them in the business
are not called goods. For example, in case of a fans dealer, fans are goods.
He may be having tables and chairs. But they are not goods for him. In case
of a furniture dealer, tables and chairs are goods. He may be having fans, but
they are not goods for him.
Debtor: A debtor is one who owes some amount to the business. For example,
a customer who purchases goods on credit from the business, is a debtor to
the business.
Creditor: A creditor is one to whom the business owes some amount. One
who supplies goods or provides some services on credit to the business is a
creditor.
Books of Account: These are the different sets of records, whether in the
form of bound books or loose sheets wherein the various business events and
transactions are recorded e.g., journal and ledger. If necessary, the journal and
also the ledger may be sub-divided into a number of books.
Entry: The recording or entering a transaction or event in the books of account
is called an entry.
Journal: Journal is the book of prime entry. It is used for recording all
transactions and events of a business entity in the first stage.
Ledger: The transactions recorded in the journal are transferred to a separate
book called ledger. In this book, a separate account is opened and maintained
for each item. For example, Capital Account, Salaries Account, Furniture
Account, Building Account, etc. Ledger is the main book for accounting
information and, hence, it is sometimes called the .‘king of books of account’.
Account: An account is a classified statement of transactions relating to a person
or a thing or any other subject. It is vertically divided into two parts in T shape
(alphabet T). The benefits received by that account are recorded on the left
38
hand side (technically called the ‘debit side’) and the benefits given by that Accounting Principles
account are recorded on the right hand side (technically called the ‘credit side’).
This type of recording helps in knowing the net result i.e., whether that account
has received more or given more.
To debit an account: It means making an entry for a transaction on the debit
side (left hand side) of an account.
To credit an account: It means making an entry for a transaction on the credit
side (right hand side) of an account.
On account: It refers to a part receipt or a part payment of money in respect
of earlier credit transaction(s). For example, Mr. X owes Rs. 5,000, of which
he pays Rs. 3,000. This may be termed as, ‘received Rs. 3,000 from Mr.
X on account’.
Assets: Assets are things of value or economic resources (property) owned
by the enterprise. In other words, cash or any thing which enables the business
entity to get cash or a benefit in future is an asset. Land, buildings, machinery,
vehicles, furniture, stock of goods, cash, etc., are some examples of assets.
Expenditure: Expenditure means the spending of money or incurring a liability
for some benefit/ service received by the business entity. Purchase of machinery,
purchase of furniture, payment of salaries, rent, etc., are some examples of
expenditure. If the benefit of an expenditure is limited to one year, it is treated
as an expense (also called revenue expenditure) such as payment of salaries
and rent. On the other hand, if the benefit of an expenditure is available for
more than one accounting year, it is treated as an asset (also called capital
expenditure) such as purchase of furniture and machinery.
Equities: All claims or rights over the assets of a business firm are called equities.
Equities are of two types : (i) creditors’ equity, and (ii) owners’ equity. The
claims of the outsiders are called creditors, equity or liabilities. The claim of
the owner is called owner’s equity or capital.
Liabilities: Liabilities (also called creditors’ equity) are the amount owed by
the business firm to outsiders other than the owner(s). Loan from a bank,
creditor for goods supplied, rent payable, salaries payable, interest payable to
the lenders are some examples of liabilities.
Capital: Capital is the amount invested by the owner(s). It represents the
owner’s claim on the firm’s assets and is known as owner’s equity. It is also
called net assets or net worth.
Drawings: Drawings refer to the amount withdrawn or the value of goods taken
by the proprietor for personal use from the business.
Profit: Profit is the excess of income over expenditure during a period of time.
It is owner’s equity.
Loss: In one sense, loss means money or money’s worth lost without receiving
any benefit. For example, cash or goods lost by theft or fire accident. In the
context of Profit and Loss Account, loss represents to the excess of expenditure
over income during a period of time. In either case, loss decreases the owner’s
equity.
Income: Income, also called revenue, is the amount earned by a business entity
resulting from operations which constitute its major or central activities. For
example, sale of goods or services. 39
Theortical Framework Gain: Gain is a profit that arises from events or transactions which are incidental
to business, such as sale of an asset, winning a court case, appreciation in the
value of land and buildings, etc.
Trade discount: It is a common practice these days to print the price of an
article on its package. The price so mentioned on the article is called the
‘catalogue price’ or ‘list price’. When you buy an article, the seller may agree
to give you some concession and charge a price which is less than the list
price. Such concession or reduction in price is called ‘trade discount’. This,
is an allowance given by the seller to the buyer on the list price at the time
of sale. Trade discount is generally given by the manufacturer to the wholesaler
and by the wholesaler to the retailer. Suppose a bookseller buys 10 copies
of a book ‘Principles and Practice of Accountancy’ by R. Sriram, priced at
Rs. 25. The publisher allows a discount of 10% and charges Rs. 225 net (list
price Rs. 250 minus discount of Rs. 25). The buyer pays only the net price.
Recording in books of account is also made for the net amount only. No specific
entry is required for the trade discount.
Cash discount: When goods are sold on credit, the buyer is expected to pay
the amount on or before the due date. However, if the buyer makes the payment
before the due date, the seller may allow him some reduction in the amount
due and settle the account. Such an allowance is called ‘cash discount’. It is
allowed at the time of payment. It motivates the debtor to make prompt payment.
Suppose, the books worth Rs. 225 (net amount) were sold on February 1,
2018 on credit for one month. The due date is March 1, 2018. The bookseller
offers to make the payment on February 15, 2018. The publisher accepts Rs.
220 in settlement of the account. The balance amount of Rs. 5 is the cash
discount allowed. Cash discount must be recorded in the books of account
in order to show that the party account stands cleared and nothing more remains
due from him.
Voucher: A documentary (written) evidence of a transaction is called a voucher.
For example, if we buy goods for cash we get cash memo; if we buy on credit
we get an invoice; and so on. Entries in books of account are made with the
help of such vouchers.
Solvent: A person who is in a position to pay his debts as they become due.
Insolvent: A person who is not in a position to pay his debts in full and is
so declared by the court.
Bad debts: The amount of debt which is unrealisable from a debtor who became
insolvent.
Stock: The amount of goods lying unsold or unused. It also includes stock
of raw materials and semi-finished goods.
Check Your Progress A
1. Fill in the blanks :
i) A person who owes money to the firm is ………………………
ii) A person to whom the firm owes money is a ………………………
iii) All articles that are purchased for resale are called
………………………
iv) The property of the business in the form of land and buildings,
40 machinery, etc. is called ………………………
v) Drawings refer to the withdrawal of cash or goods by the owner for Accounting Principles
………………………
vi) The amount of debt……………………………………… from the
debtor is termed as bad debts.
vii) The amount invested by the owner in business is called ………………..
viii) The amount received in part is called receipt on …………..
2. State in each case whether the item shall be regarded as goods or an
asset
i) Furniture purchased by Rama Furnishers for resale.
ii) Furniture purchased by Krishna Stationery Mart.
iii) Machinery purchased by Abdul Engineering Company for use in their
factory.
iv) Electric motors purchased by Punjab Machinery Stores who deal in
machinery.
v) Power looms manufactured by KCP Ltd., for sale to a textile company.
3. Mr. Rakesh started Rakesh Trading Company with a capital of Rs. 30,000.
The company also borrowed Rs. 10,000 from the State Bank of India.
The firm purchased a delivery van for Rs. 20,000, furniture for Rs. 5,000,
typewriter for Rs. 6,000, account books and other stationery for Rs. 500.
It has purchased goods on credit from M/s Gurucharan Singh & Co., for
Rs. 4,000, and from M/s Lalwani Traders for Rs. 3,000. It has sold goods
for cash to Mr. Peter for Rs. 2,000 and Mr. Ali for Rs. 4,000. It has
also paid Rs. 300 for electricity charges, Rs. 1,000 for salaries, and Rs.
500 for rent. From the above information, list out the assets, liabilities,
incomes and expenses.
Assets : ..................................................................................................
...............................................................................................................
...............................................................................................................
Liabilities : ..............................................................................................
...............................................................................................................
...............................................................................................................
...............................................................................................................
Incomes : ...............................................................................................
...............................................................................................................
...............................................................................................................
Expenses : ..............................................................................................
...............................................................................................................
...............................................................................................................
41
Theortical Framework
3.3 ACCOUNTING PRINCIPLES
Accounting is a system evolved to achieve a set of objectives as stated in
Unit 1.2. The objectives identify the goals and purposes of financial record
keeping and reporting. In order to achieve the goals, we need a set of rules
or guidelines. These guidelines are termed here as ‘Basic Accounting Concepts’.
The term ‘concept’ means an idea or thought. Basic accounting concepts are
the fundamental ideas or basic assumptions underlying the theory and practice
of financial accounting. These concepts are also termed as ‘Generally Accepted
Accounting Principles’. These are the broad working rules of accounting activity,
developed and accepted by the accounting profession. They are evolved (and
are still evolving) over a period in response to the changing business environment
and the specific needs of the users of accounting information.
ii) concepts to be observed at the reporting stage, i.e., at the time of preparing
the final accounts.
It must, however, be remembered that some of them are overlapping and even
contradictory. They are listed out in Chart 3.1.
Chart 3.1
ACCOUNTING CONCEPTS
Concepts to be Observed Concepts to be Observed at the
at the Recording Stage Reporting Stage
Money Measurement Concept
Conservation Concept
Dual Aspect Concept
Consistency Concept
Matching Concept
Cost Concept
42
3.3.1 Concepts to be Observed at the Recording Stage Accounting Principles
Note that the totals on both sides of the Balance Sheet are equal. This equality
remains valid irrespective of the number of transactions and the items affected
thereby. It is so because of their dual effect or the assets and liabilities of the
business. 47
Theortical Framework Check Your Progress D
1. Find out the missing amounts on the basis of the accounting equation:
Capital + Liabilities = Assets
a) Rs. 10,000 + Rs. 15,000 = Rs ………………
b) Rs. 25,000 + Rs……….. = Rs. 60,000
c) Rs………… + Rs. 30,000 = Rs. 50,000
2. Show the dual effect of the following business transaction on assets and
liabilities of a business unit.
a) Purchased goods for cash for Rs. 500
b) Purchased goods on credit for Rs. 800
c) Paid Rs. 300 to a creditor
d) Received Rs. 500 from a debtor
3.3.2 Concepts to be Observed at the Reporting Stage
The following concepts have to be kept in mind at the time of preparing the
final accounts. Let us discuss them one by one:
i) Going concern concept
ii) Accounting period concept
iii) Matching concept
iv) Conservatism concept
v) Consistency concept
vi) Full disclosure concept
vii) Materiality concept
Going Concern Concept
Normally, the business is started with the intention of continuing it indefinitely
or at least for the foreseeable future. The investors lend money and the creditors
supply goods and services with the expectation that the enterprise would continue
for 1ong. Unless there is a strong evidence to the contrary, the enterprise is
normally viewed as a going (continuing) concern. Hence, financial statements
are prepared on a going concern basis and not on liquidation (closure) basis.
Certain expenses like rent, repairs, etc., give benefits for a short period, say
less than one year. But the benefit of some other expenditure like purchase
of a building, machinery, etc., is spread over a longer period. The expenditure
whose benefit is limited to one accounting year is fully charged to the Profit
and Loss Account of the year. But the cost of the items whose benefit is available
for a number of accounting years, their cost must be spread over a number
of years. Hence, only a portion of such expenditure is charged to the Profit
and Loss Account every year. The balance is shown in the Balance Sheet as
48
an asset. Let us take an example. Suppose a firm purchased a delivery van Accounting Principles
for Rs. 60,000 and its expected life is 10 years. It means the business will
use the van for a period of 10 years. So, the accountant has to spread the
cost of the van over 10 years. He would charge Rs. 6,000 (1/10 of its cost)
every year to the Profit and Loss Account in the form of depreciation, and
show the balance in the Balance Sheet as an asset. This is based on the
assumption that the business will continue for long and the asset will be used
for its expected life. Thus, this concept is regarded as the basic assumption
in accounting according to which the fixed assets are valued at historical cost
less depreciation and not at its realisable value.
Accounting Period Concept
You know the going concern concept assumes that the business will continue
for a long period, almost indefinitely. But the businessmen cannot postpone the
preparation of financial statements indefinitely. Therefore, he prepares them
periodically. This will also enable other interested parties such as owners,
investors, creditors, tax-authorities to make periodic assessment of its performance.
So, the life of the business enterprise is divided into what are called accounting
periods’. The profit or loss and the financial position at the end of each such
accounting period is regularly assessed.
Conventionally, duration of the accounting period is twelve months. It is called
an ‘accounting year’. Accounting year can be a calendar year i.e., January 1
to December 31 or any other period of twelve months, say, April 1 to March
31 or Dewali to Dewali.
Normally, the final accounts are prepared at the end of each accounting year.
The Profit and Loss Account is prepared for the year so as to ascertain the
profit earned or loss incurred during that year, and the balance sheet is prepared
as at the end of the year, so as to show the financial position as on that date.
However, for internal management purposes, accounts can be prepared even
for shorter periods, say monthly, quarterly or half yearly.
Check Your Progress D
1. What is the assumption under Going Concern Concept?
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2. What is the accounting implication of Going Concern Concept?
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3. What is the significance of an Accounting Period?
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Theortical Framework 4. What is the purpose of preparing the Profit and Loss Account?
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5. What does Balance Sheet reveal?
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Matching Concept
This is also called ‘Matching of Costs against Revenues Concept’. To work
out profit or loss of an accounting year, it is necessary to bring together all
revenues and costs pertaining to that accounting year. In other words, expenses
incurred in an accounting year should be matched with the revenues earned
during that year. The crux of the problem, therefore, is that appropriate costs
must be matched against appropriate revenues. For this purpose, first we have
to recognise the inflows (revenues) during an accounting period and the costs
incurred in securing those inflows. Then, the sum of the costs should be deducted
from the sum of the revenues to arrive at the net result of that period. Let
us now understand how to recognise the revenues and costs in relation to
an accounting period. For this purpose, the following rules are followed :
The Timing of Revenue Recognition
Revenue is recognised in the period in which it is earned or realised. The revenue
recognition is primarily based on realisation principle which clearly states that
in identifying revenues with a specific period one must look to when the various
transactions occurred rather than to the period in which cash inflow occurred.
Thus,
i) In case of the sale of goods (or services) revenue is regarded as realised
when sales actually take place and not when cash is received. In other
words, credit sales are treated as revenue when sales are made and not
when money is received from the debtors.
ii) Income such as rent, interest, commission etc. are recognised on a time
basis. The revenue from such items is taken to the Profit and Loss Account
of the year during which it is earned. Let us assume that the business
purchased some government securities on October 1, 2018 for Rs. 20,000
carrying interest at 12 per cent. The interest is payable half yearly on April
1 and October 1 every year. The first instalment of interest (Rs. 1,200)
is received on April 1, 2019. The Profit and Loss Account is being prepared
for the year 2018 (January 1, 2018 to December 31, 2018). The interest
amounting to Rs. 600 earned during. October 1 to December 31 must
be shown as the income from interest on investments in the Profit and
50 Loss Account for 2018 though the amount has not been received in 2018.
The Timing of Costs Recognition Accounting Principles
The matching principle holds that the expenses should be recognised in the same
period as the associated revenues. Thus,
i) The cost of goods have to be matched with their sales revenue. This means
that while preparing the Profit and Loss Account for a particular year, you
should not take the cost of all the goods produced during that year, but
consider only the cost of goods that have actually been sold during that
year. The cost of goods sold is arrived at by deducting the cost of closing
stock from the cost of goods produced.
ii) Expenses such as salaries, wages, interest, rent, insurance, etc., are
recognised on time basis. In other words, they are related to the year in
which the service is obtained or the expense is incurred, whether paid
immediately or payable at a later date.
iii) Costs like depreciation on fixed assets are also allocated on time basis.
Thus, all revenue earned during an accounting year, whether received or not,
and all costs incurred, whether paid or not have to be taken into account while
preparing the Profit and Loss Account for the year. Similarly, any amount received
or paid during the current year which actually relates to the previous year or
the following accounting year, must be eliminated from the current year’s revenue
and costs. This gives rise to another aspect viz., the accrual basis of accounting
about which you will learn later.
The Matching Concept thus has the following implications for the ascertainment
of profit or loss during a particular period.
1. We should ensure that costs should relate to the same accounting period
as the revenues. For example, when we prepare the Profit and Loss Account
for 2017, we shall take into account all those incomes that were earned
during 2017, and similarly consider only those costs which were incurred
in 2017. Any costs or incomes which relate to 2018 shall be excluded.
2. We should ensure that all costs incurred during the accounting period
(whether paid or not) and all revenues earned during that year (whether
received or not) are fully taken into account.
3. We should consider only those costs which relate to the revenue taken
into account. This is the reason why we consider only the cost of goods
sold, and not the cost of goods produced during that period.
Check Your Progress E
1. What is the main implication of the Matching Concept?
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2. Name three items of revenues.
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Theortical Framework 3. Name three items of costs.
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4. Fill in the blanks.
i) Profit is the excess of revenue over ……………………………
ii) Costs incurred during an accounting year should be matched against
…………………………………….
iii) Revenue realisation does not mean that revenue must be realised
in……………………………..
iv) Cost of goods are matched with their sales revenue.......................?
v) Revenue such as interest, commission, etc., are recognised as earned
with reference to …………………………………….
i) Expenses such as wages, rent, etc., are recognised on …………..basis.
Conservatism Concept
This is also known as Prudence Concept understatement of assets or revenues,
and overstatement of liabilities or costs. This is in accordance with the traditional
view which states ‘anticipate no profits but anticipate all losses’. In other words,
you should account for profits only when they are actually realised. But in
case of losses, you should take into account even those losses which may be
a remote possibility. This is why closing stock is valued at cost price or market
price whichever is lower. Provision for doubtful debts and provision for discounts
on debtors are also made according to this concept.
Consistency Concept
The principle of consistency means ‘conformity from period to period with
unchanging policies and procedures’. It means that accounting method adopted
should not be changed from year to year. For example, the principle of valuing
closing stock ‘at cost price or market price whichever is lower’ should be
followed year after year. Similarly, if depreciation on fixed assets is provided
on straight line basis, it should be followed consistently year after year.
Consistency eliminates personal bias and helps in achieving comparable results.
If this principle of consistency is not followed, the accounting information about
an enterprise cannot be usefully compared with similar information about other
enterprises and so also within the same enterprise for some other period.
Consistent use of the same methods and bases from one period to another,
enhances the utility of the financial statement.
However, consistency does not prohibit change. Desirable changes are always
welcome. But such changes should be completely disclosed while presenting
the financial statements.
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Full Disclosure Concept Accounting Principles
You know the financial statements are the basic means of communicating financial
information to all interested parties. These statements are the only source for
assessing the performance of the enterprise for investors, lenders, suppliers, and
others. Therefore, financial statements and their accompanying foot-notes should
completely disclose all relevant information of a material nature which relate to
the profit and loss and the financial position of the business. This enables the
users of the financial statements to make correct assessment about the profitability
and financial soundness of the enterprise. It is therefore, necessary that the
disclosure should be full, fair and adequate.
Materiality Concept
This concept is closely related to the Full Disclosure Concept. Full disclosure
does not mean that everything should be disclosed. It only means that all relevant
and material information must be disclosed. Materiality primarily relates to the
relevance and reliability of information. An item is considered material if there
is a reasonable expectation that the knowledge of it would influence the decision
of the users of the financial statements. All such material information should be
disclosed through the financial statements and the accompanying notes. For
example, commission paid to sole selling agents, if any, should be disclosed
separately in the Profit and Loss Account. Similarly, if there is a change in the
method or rate of depreciation, this fact must be duly reported in the financial
statements.
A strict adherence to accounting principles is not required for items of little
significance or of non-material nature. For example, erasers, pencils, scales, etc.,
are used for a long period, but they are not treated as assets. They are treated
as expenses. This does not affect the amount of profit or loss materially.
Similarly, while showing the amounts of various items in the financial statements,
they can be approximated up to paise. Even if they are shown to the nearest
rupee or hundreds, there may not be any material effect. For example, if an
amount of Rs. 1,45,923.28 is shown as Rs. 1,45,900 it does not make much
difference for assessment of the performance of the enterprise.
However, there are no specific rules for ascertaining material or non-material
items, It is just a matter of personal judgement.
Check Your Progress F
1. What is the aim of Conservatism Concept ?
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2. What do you mean by the Principle of Consistency?
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Theortical Framework 3. Why is full disclosure of relevant information considered necessary?
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4. How do you make a distinction between material and non-material items?
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4. The assets of a business on December 31, 2018 are Rs. 50,000 and capital
is Rs. 30,000. Find out the amount of liabilities. (Ans: Rs. 20,000)
Find out the amount of capital on that date. (Ans: Rs. 55,000).
a) Conservatism
b) Consistency
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c) Full Disclosure
d) Materiality
10. Explain briefly the main accounting concepts to be observed at the time
of preparing final accounts.
Note : These questions will help you to understand the unit better. Try to
write answers for them. But, do not submit your answers to the
University for assessment. These are for your own practice only.
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Theortical Framework
UNIT 4 ACCOUNTING STANDARDS
Structure
4.0 Objectives
4.1 Concept of a Accounting Standards
4.2 Benefits of Accounting Standards
4.3 Procedure for Issuing AS in India
4.4 Salient Features of First Time Adoption of Indian Accounting Standards
(Ind-AS):101
4.5 Currently Prevailing Accounting Standards in India
4.6 International Financial Reporting Standards
4.7 Need and Procedure of IFRS
4.8 Convergence to IFRS
4.9 Distinction between Indian AS and International AS
4.10 Measurement of Business Income
4.11 Objectives of Measurement of Business Income
4.12 Approaches for Measuring Income
4.13 Accounting Concept that is relevant to Measurement of Business Income-
Realization Concept
4.14 Let Us Sum Up
4.15 Key Words
4.16 Some Useful Books
4.17 Terminal Questions
4.0 OBJECTIVES
After studying this unit, you should be able to:
explain the concept of the accounting standards;
discuss the benefits of accounting standards;
discuss the procedures of issuing accounting Standards in India;
describe International Financial Reporting Standards, GAAP, IAS etc;
develop the insights about the need and procedure of issuing IFRS;
understand how Indian economy is converging towards implementing IFRS.
make comparison between Indian AS and International AS;
describe the procedure for measuring business income;
explain the accounting concepts that are relevant to measurement of business
income; and
state the objectives of measurement of business income of business income.
Definition
On the basis of forgoing discussion, we can say that accounting standards are
guide, dictator, service provider and harmonizer in the field of accounting process.
Act as a harmonizer: Accounting standards are not biased and bring uniformity
in accounting methods. They remove the effect of diverse accounting practices
and policies. On many occasions, accounting standards develop and provide
solutions to specific accounting issues. It is thus, clear that whenever there is
any conflict on accounting issues, accounting standards act as harmonizer and
facilitate solutions for accountants.
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Acounting Standards
Basic of Accounting Ind-AS
Distinction Standards(AS)
Need When businesses were not Today, businesses have become
that complicated and complicated and a globalised world is
accounting was done at in the need of a comprehensive
local level, then accounting standards that can be
accounting standards consistently applied globally and
based on local GAAP facilitate compatibility. Introduction of
were enough. Ind-AS is the need of the hour for India
to compete in this globalised world
The basic objective of Ind-AS are Indian version of IFRS
Objective Accounting standards is to because it will be impractical to just
remove variation in the adopt the IFRS blindly without taking
treatment of several into consideration the current Indian
accounting aspects and to scenario. International Financial
bring about standardization Reporting Standards are principles
in presentation. They based standards, interpretation and the
intent to harmonize the framework adopted by the
diverse accounting policies
International Accounting Standards
in the preparation and
Board (IASB). Since India is a
presentation of financial
member country so it has to adopt
statements by different
these standards. However, any
reporting enterprises so as
to facilitate intra-firm and changes in these IFRS would have an
inter-firm comparison. impact on books of Indian companies
to adopt these IFRS as and when
amended. So to fill the difference, Ind-
AS have been introduced which is
nothing but IFRS. These standards
have been made applicable to Indian
companies through a road map i.e., in
a systematic manner. The benefit of
these standards is that any change in
IFRS would not impact Ind- AS
directly. The Ministry of corporate
affairs can analysis such changes and
incorporate the same in Ind-AS if it
thinks it is suitable.
Pervasiveness AS are not so pervasive or Ind-AS are pervasive and cover every
widespread. area comprising reported revenues,
expenses, assets, liabilities and equity.
Basis AS are driven by ‘legal’ Ind-AS focus on ‘substance’ rather
form in a number of areas than the legal form. They are principal
and are rule based. based, Ind-AS will also result in
accounting which more closely reflects
the underlying business rationale and
true economics of transaction.
Disclosure Disclosure requirements Disclosure requirements are more
requirements are comparatively less comprehensive and multifold under
detailed. Ind-AS to enhance the transparency
and accountability of financial
statements.
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Theortical Framework The government of India has issued notification regarding Ind- AS. Following
is the list of Ind-AS notified:
1) Ind-AS 1 Presentation of Financial Statements
2) Ind-AS 2 Inventories
3) Ind-AS 7 Statement of Cash Flows
4) Ind-AS 8 Accounting Policies, Changes in Accounting Estimates and
Errors
5) Ind-AS 10 Events after the Reporting Period
6) Ind-AS 11 Construction Contracts
7) Ind-AS 12 Income Taxes
8) Ind-AS 16 Property, Plant and Equipment
9) Ind-AS 17 Leases
10) Ind-AS 18 Revenue
11) Ind-AS 19 Employee Benefits
12) Ind-AS 20 Accounting for Government Grants and Disclosure of
Government Assistance
13) Ind-AS 21 The Effects of Changes in Foreign Exchange Rates
14) Ind-AS 23 Borrowing Costs
15) Ind-AS 24 Related Party Disclosures
16) Ind-AS 27 Consolidated and Separate Financial Statements
17) Ind-AS 28 Investments in Associates
18) Ind-AS 29 Financial Reporting in Hyper-inflationary Economies
19) Ind-AS 31 Interests in Joint Ventures
20) Ind-AS 32 Financial Instruments: Presentation
21) Ind-AS 33 Earnings per Share
22) Ind-AS 34 Interim Financial Reporting
23) Ind-AS 36 Impairment of Assets
24) Ind-AS 37 Provisions, Contingent Liabilities and Contingent Assets
25) Ind-AS 38 Intangible Assets
26) Ind-AS 39 Financial Instruments: Recognition and Measurement
27) Ind-AS 40 Investment Property
Check Your Progress B
1. Define the term ‘IFRS’.
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72 .................................................................................................................
2. What is the need of forming IFRS? Acounting Standards
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3. What are the challenges of converging accouniting standards to IFRS in
India?
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4. Describe the difference between AS and Ind-AS?
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Theortical Framework Example: Motor Hundai is a car Dealer. It receives orders from the customers
in advance against 20% down payment. Motor PLC delivers the cars to the
respective customers within 30 days upon which it receives the remaining 80%
of the list price. In accordance with the revenue realization principle, motor
Hundai must not recognize any revenue until the cars are delivered to the
respective customers as that is the point when the risks and rewards incidental
to the ownership of the cars are transferred to the buyers.
Importance
Application of the realization principle ensures that the reported performance
of an entity, as evidenced from the income statement, reflects the true extent
of revenue earned during a period rather than the cash inflows generated during
a period which can otherwise be gauged from the cash flow statement.
Recognition of revenue on cash basis may not present a consistent basis for
evaluating the performance of a company over several accounting periods due
to the potential volatility in cash flows.
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9. With the increasing globalisation of financial markets and of companies, the
use of a single set of financial reporting standards across countries is viewed
as having increased the comparability of financial statements across borders.
10. India has decided to converge its existing accounting standards to IFRS.
In India, the converged accounting standards are called Ind-AS.
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