Fundamental of Accounting

CA CPT
FUNDAMENTAL OF ACCOUNTING
ACCOUNTING AN INTRODUCTION
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1.1 MEANING AND SCOPE OF ACCOUNTING

1.1.1 1.1.2 1.1.3 1.1.4 1.1.5 1.1.6 1.1.7 1.1.8 1.1.9 1.1.10 1.1.11 1.1.12 INTRODUCTION MEANING OF ACCOUNTING USERS OF ACCOUNTIGN INFORMATION EVOLUTION OF ACCOUNTING AS A SOCIAL SCIENCE OBJECTIVE OF ACCOUNTING FUNCATIONS OF ACCOUNTING BOOK- KEEPING DISTINCTION BETWEEN BOOK- KEEPING AND ACCOUNTING SUB-FIELDS OF ACCOUNTING RELATIONS OF ACCOUNTING WITH OTHER DISIPLINES LIMITATIONS OF ACCOUNTING ROLE OF ACCOUNTANTS IN THE SOCIE
TABLE OF CONTENT
1.2 ACCOUNTING CONCEPTS, PRINCIPLES, AND
CONVENTIONS
1.2.1 1.2.2 1.2.3 GENERALLY ACCEPTED ACCOUNTING ARINCIPLES (GAAPs) MEANING OF ACCOUNTING CONCEPTS, PRINCIPLES, AND CONVENTIONS OVERVIEW OF ACCOUNTING CONCEPTS, PRINCIPLES, AND CONVENTIONS FUNDAMENTAL ACCOUNTING ASSUMPTIONS QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS
1.2.4 1.2.5
1.3 ACCOUNTING STANDARDS CONCEPTS, OBJECTIVES, BENEFITS

1.3.1 1.3.2 1.3.3 1.3.4 1.4.1 1.4.2 1.4.3 CONCEPTS OF ACCOUNTING STANDARDS OBJECTIVES OF ACCOUNTING STANDARDS BENEFITS AND LIMITATIONS OF ACCOUNTING STANDARDS OVERVIEW OF ACCOUNTING STANDARDS MEANING OF ACCOUNTING POLICIES SELECTION OF ACCOUNTING POLICIES CHANGES IN ACCOUNTING POLICIES
1.4 ACCOUNTING POLICIES
1.5 ACCOUNTING AS A MEASUREMENT DISCIPLINE VALUATION PRINCIPLES, ACCOUNTING ESTIMATES

1.5.1 1.5.2 1.5.3 1.5.4 1.5.5 1.5.6 1.5.7 1.5.8 MEANING OF MEASUREMENT OBJECTS OR EVENTS TO BE MEASURED STANDARD OR SCALE OF MEASUREMENT DIMENSION OF MEASUREMENT SCALE ACCOUNTING AS A MEASUREMENT DISCIPLINE VALUATION PRINCIPLES MEASUREMENT AND VALUATION ACCOUNTING ESTIMATES
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FUNDAMENTALS OF ACCOUNTING
1.1
1.1 MEANING AND SCOPE OF ACCOUNTING
Learning Objectives:
After studying this unit, you will be able to:
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8. 9.
Understand the meaning and significance of accounting. Understand the meaning of book-keeping and the distinction of accounting with bookkeeping. Appreciate the evolutionary process of accounting as a social science. Explain sub-fields of accounting. Identify the various user groups for whom accounting information is to be generated. Describe the various functions or purposes of accounting data. Understand the relationship of accounting with Economics, Statistics, Mathematics, Law and Management. Explain the limitations of accounting. Appreciate the enlarged boundary of accounting profession and the areas wherein a Chartered Accountant plays an important role of rendering useful services to the society.
1.1.1 Introduction
Economic activities are carried out by various entities, such as: Individuals, families and communities Business enterprises i.e. partnerships, co-operative societies, companies etc. Governments, central and state Local authorities e.g. municipal corporations
Such economic activities are performed through transactions and events: Transactions could mean a business, performance of an act, or an agreement e.g. Purchase and sales, expenses incurred Issue of capital and debt, investing in assets Events are happenings, which are the consequence or result of transactions e.g. End of period adjustments closing stock, depreciation, provisions Result of business profit or loss
The above entities wish to keep a systematic record of all transactions and events. Accounting discipline has been developed to serve this purpose as it deals with the measurement of economic activities involving inflow and outflow of economic resources, which helps to develop useful information for decision-making process. Accounting has universal application for capturing transactions and events carried out by various economic entities; for-profit as well as non-for-profit purposes. In order to understand accounting as a field of study for universal application, it is best identified with recording of business transactions and communication of financial information about business enterprise to facilitate decision-making.
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The aim of accounting is to meet the information needs of the rational and sound decisionmakers involved with business, and so, accounting is called the language of business.
1.1.2 Meaning of Accounting

Definitions: AICPA (American Institute of Certified Public Accountants) 1961: Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof. AIA (American Accounting Association) 1966: The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of accounts. APB (Accounting Principles Board) of AICPA 1970: The function of accounting is to provide quantitative information, primarily of financial nature, about economic entities, that is needed to be useful in making economic decisions. Modern Definition: Thus, accounting may be defined as the process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results thereof to the persons interested in such information. Procedure of Accounting: Generating Recording Financial Information Classifying Procedure of Accounting Transactions recorded from evidencing documents into Journal (primary book). Journalised transactions posted into classified accounts within Ledger (secondary book). Summarising Trial Balance Profit and Loss Statement Balance Sheet Cash Flow Statement. Analysing Linking incomes, expenses, assets and liabilities to provide meaningful basis for interpretation. Interpreting Discuss performance (profitability) and position (valuation) in past, present and future terms. Communicating Transmission of the financial statements and analysed info to end users i.e. decision-makers. Using Usage of the communicated information for decision-making by: Financial (i) Internal users, and Information (ii) External users.
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Process Of Accounting Input Economic events measured in financial terms Identification of Transactions Accounting Cycle Journalising Posting Preparing transactions to ledger trial balance Preparing final accounts
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Output Communicating information to internal and external users
1.1.3 Users of Accounting Information

Management and Owners They use accounting info to study the impact of past decisions and for deciding the future course of action by studying: Short-term liquidity Long-term solvency Activity in terms of current/non-current assets utilisation Profitability on sales/investment/equity Market related valuation. Stability, continuity and growth prospects. Ability to provide remuneration, retirement and other benefits, enhancement of employment opportunities. Whether to buy-hold-sell investment based on riskreturn potential. Assess capacity to pay dividends in future. Ability to pay interest and repay principal. Ability to pay dues, long-term prospects. Sustainability for long-term dependence. Focus on public good, scarce resource allocation, national income, tax policy etc. Contribution to local economy in term of employment and patronage to local suppliers.
Internal Users Employees Investors External Users

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Lenders Suppliers and Creditors Customers Governments and their Agencies Public
1.1.4 Evolution of Accounting as a Social Science

First Phase: Stewardship accounting (management of wealthy peoples property by stewards). Double-entry book-keeping developed in the 15th century. Second Phase: The idea of financial accounting emerged with the concept of joint stock Company and divorce of ownership from the management during the 16th century.
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Financial accounting obtained legal status due to changing relationships between the owners, economic entity and the managers; and to safeguard the interest of stakeholders. Financial accounting emerged as an information system to identify measure and communicate useful information for informed judgments and decisions by a broad group of users. Third Phase: Management accounting developed in the 20th century. Accounting information was generated to aid management decision-making in particular. It contributed a lot to improve the quality of management decisions. Current Phase: Social Responsibility Accounting is in the formative process, which aims at accounting for the social cost incurred by business as well as the social benefit created by it. The usefulness of accounting to society as a whole is the fundamental criterion to treat it as a social science. It serves social purposes, it contributes for social progress; also it is being adapted to keep pace with social progress. Therefore, accounting is treated as a social science in the 21st century. Corporate social responsibility (CSR) and corporate governance are the latest concepts related to accounting as a social science.
1.1.5 Objectives of Accounting

Objectives of Accounting
Systematic Recording of Transactions
Ascertainment of Results
Ascertainment of Financial Position
Ascertainment of Financial Position
Book-keeping i.e. Journal, Ledger, Trial Balance
Profit and Loss Statement
Balance Sheet
Financial Reports
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1.1.6 Functions of Accounting
Measurement
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Measurement of past performance and depiction of current financial position. Forecasting Forecasting future performance and financial position using past data. Decision-making Provide relevant info to users of accounts to aid their decision-making. Comparison and Assess performance in relation to past targets. Evaluation Disclose info regarding accounting policies and contingent liabilities which play important role in predicting, comparing, and evaluating the financial results. Control Identify weaknesses of the operational system, and provide feedback regarding effectiveness of measures adopted to check such weaknesses. Government Provide necessary info to the governments to exercise control over Regulation & Taxation entities as well as collect tax revenue.
1.1.7 Book-Keeping
Meaning: Book-keeping is an activity concerned with the recording of financial data relating to business operations in a significant and orderly manner. It covers procedural aspects of accounting work and embraces record keeping function. Obviously book-keeping procedures are governed by the end product, the financial statements. In India, the term financial statements means Profit and Loss Account and Balance Sheet including Schedules and Notes forming part of Accounts. A book-keeper may be responsible for keeping all the records of a business or only of a minor segment, such as position of the customers accounts in a departmental store. A substantial portion of the book-keepers work is of a clerical nature and is increasingly being accomplished through the use of mechanical and electronic devices. Accounting is based on a careful and efficient book-keeping system. The essential idea behind maintaining book-keeping records is to show correct position regarding each head of income and expenditure from time to time. Therefore, in book-keeping, the proper maintenance of books of account is indispensable for any business. Book-keeping and preparation of financial statements have legal implications also. Maintenance of books of accounts and the preparation of financial statements of a company are guided by the Companies Act, 1956, Co-operative Societies Act, special Acts for banks and insurance companies, and the Income-tax Act, 1961 in some cases. Objectives of Book-Keeping: Complete Recording of Transactions It is concerned with complete and permanent record of all transactions in a systematic and logical manner to show its financial effect on the business.
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Ascertainment of Financial Effect on the Business It is concerned with the combined effect of all the transactions made during the accounting period upon the financial position of the business as a whole.
1.1.8 Distinction between Book-Keeping and Accounting

Book-keeping It is a sub-set of accounting discipline. It is a process concerned with recording of transactions. It constitutes a base for accounting. Financial statements do not form part of this process. Managerial decisions cannot be taken on the basis of book-keeping records. There is no sub-field of book-keeping. Accounting It is the super-set of book-keeping. It is a process concerned with summarisation of recorded transactions. It is considered the language of business. Financial statements are prepared in this process on the basis of book-keeping records. Management takes important decisions based on the output of accounting process. Accounting has many branches, such as financial accounting, management accounting etc. Financial position cannot be ascertained through Financial position is ascertained on the basis of book-keeping records. accounting reports.
1.1.9 Sub-Fields of Accounting

Financial Accounting Preparation and presentation of financial statements. Interpretation of performance and position, and communication to end users. Historical in nature. Concerned with internal reporting to the owners/managers to assist them in functions of stewardship, planning, control, and decision-making. Cost accounting is its integral component. The process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. It is social cost-benefit analysis. An attempt to identify, quantify and report investments in human resources of an organisation that are not presently accounted for under conventional accounting practice.
Management Accounting
Cost Accounting
Social Responsibility Accounting Human Resource Accounting
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1.1.10 Relationship of Accounting with Other Disciplines
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Accounting, as a discipline, is closely interrelated to several other disciplines. Therefore, in order to acquire a good knowledge in accounting one should be conversant with the relevant portions of such other disciplines too. Or else, expert advice may be required to grasp those other disciplines Accounting and Economics: Economics is viewed as a science of rational decision-making, concerned with the analysis of efficient use of scarce resources for satisfying human wants. This may be viewed either from the perspective of a single firm or of the country as a whole. Accounting overlaps with Economics in the sense that, at the macro-level, accounting provides the database over which the economic decision models have been developed; micro-level data arranged by the accounting system is summed up to get macro-level database. There is a nexus between Accounting and Economics when it comes to valuation of assets. While Economics computes value of an asset as the present value of estimated futures earnings to be generated from the asset, it is difficult to estimate such earnings when the assets life is very long. Accounting has developed a workable valuation base for such assets i.e. acquisition cost. There are a lot of non-overlapping areas in Accounting such as book-keeping and communication to end users.
Accounting and Statistics: Statistical methods and approximations are actively used in Accounting for developing accounting data and their interpretation e.g. Measuring variability of accounting data over time e.g. standard deviation of sales or profits. Establishing correlations and covariances between dependent and independent data e.g. calculating financial ratios. Time-series and cross-sectional comparison of accounting data e.g. trends within a company or comparing performance of various competitors in an industry. Use of multiple discriminant analysis to identify sickness symptoms of business entities. Double-entry book-keeping can be converted into algebraic form, and fundamental accounting equation is also an algebraic expression. Mathematical techniques are used for various accounting applications such as annuity calculations in hire purchase or leasing transactions, or in depreciation calculations, or in financial ratio calculations. Econometric models and operations research techniques have been used for various decision models based on accounting data. Matrix algebra has been used for classifying and interpreting accounting data.
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Accounting and Law:
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All economic entities operate within the legal environment. As a result, accounting systems pertaining to the activities of such economic activities also fall under the purview of the applicable laws. Transactions and events are guided by the laws of the land. Laws may prescribe accounting systems or format e.g. the Companies Act compels use of accrual accounting and also prescribes formats and content of financial statements. Banking, insurance and electric supply undertakings also have to produce financial statements as prescribed by the respective legislations controlling such entities. However, legal prescription about the accounting system is the product of developments in accounting knowledge i.e. legislation about accounting system cannot be enacted unless there is a corresponding development in the accounting discipline. In that way accounting influences law and is also influenced by law. Accounting and Management: Management is a broad occupational field, which comprises many functions and encompasses application of many disciplines including those mentioned above. A large portion of accounting information is prepared for management decision-making. Although management relies on other data sources, accounting data are used as basic source documents. Accountants are well placed in the management and play a key role in the management team. Within the management team, an accountant is in a better position to understand and use such data. In other words, since an accountant plays an active role in management, he understands the data requirements. So the accounting system can be moulded to serve the management purpose.
1.1.11
Limitations of Accounting
Assumptions and Conventions: The assumptions and conventions, on which the accounting is based, become the limitations of accounting e.g. Due to money measurement principle, accounting and financial statements are not able to capture non-monetary aspects of business such as employee or customer loyalty and superior skills of trained manpower. There are occasions when accounting principles conflict with each other e.g. Accrual and prudence principles may conflict when it comes to recognising expected losses. Estimates and Subjectivity: The financial statements are never free from subjectivity factor as these are largely the outcome of personal judgement of the accountant with regard to the adoption of the accounting policies e.g.
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Provision for doubtful debts, classifying expenditure as capital or revenue, estimation of useful lives of non-current assets etc. Sometimes, accounting permits various alternative treatments to select from. This result in arbitrary selection as well as loss of comparability e.g. Choice of depreciation method or inventory valuation method. Historical Information: Profit and Loss Statement reflects past performance and Balance Sheet shows the position of the business on the day of its preparation and not on the future date while the users of the accounts are interested in knowing the position of the business in the near future and also in long run and not for the past date. Though with the emergence of some accounting standards like AS 11, AS 26, AS 28 etc., market/fair value of assets is taken into consideration but still there remains some subjectivity. Accounting ignores changes in some money factors like inflation etc.
1.1.12
Role of Accountants in the Society
Accountancy Profession: There are only a few types of profession in the world which are held in high esteem in public eyes and there is no denying the fact that the accounting profession is one of them. Goethe had called the accountants profession as the fairest invention of the human mind. Accountancy is a science as well as an art, with a keen desire to do public good. This is what makes this profession an instrument of socio-economic change and welfare of the society. An accountant with his education, training, analytical mind and experience is best qualified to provide multiple need-based services to the ever growing society. The accountants of today can do full justice not only to matters relating to taxation, costing, management accounting, financial lay-out, company legislation and procedures but they can delve deep into the fields relating to financial policies, budgetary policies and even economic principles. Areas of Service: Maintenance of books of account Statutory audit Compulsory audit under law e.g. Companies Act, Co-op. Societies Act, Income-tax Act Carried out only by Chartered Accountants Internal audit Taxation Management accounting and consultancy services Financial advise Investments, insurance, business expansion, investigations, valuations Pension schemes Other services
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Secretarial, share registration, company formation, receivership, liquidation, arbitration, cost accounting, information services
Scope for Chartered Accountants: In industry, public sector enterprises, framing fiscal policies, economic growth.
Class- Practice Questions

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Which of the following is not a subfield of accounting? a. Management accounting b. Cost accounting c. Financial accounting d. Book-keeping Purposes of an accounting system include all the following except a. Interpret and record the effects of business transaction b. Classify the effects of transactions to facilitate the preparation of reports c. Summarize and communicate information to decision makers d. Dictate the specific types of business enterprise transactions that the enterprises may engage in Book-keeping is mainly concerned with a. Recording of financial data b. Designing the systems in recording, classifying and summarising the recorded data c. Interpreting the data for internal and external users d. None of the above All of the following are functions of Accounting except a. Decision making b. Measurement c. Forecasting d. Ledger posting Financial statements are part of a. Accounting b. Book-keeping c. All of the above d. None of the above Financial position of the business is ascertained on the basis of a. Records prepared under book-keeping process b. Trial balance c. Accounting reports d. None of the above Users of accounting information include a. Creditors b. Lenders c. Customers d. All of the above Financial statements do not consider a. Assets expressed in monetary terms b. Liabilities expressed in monetary terms. c. Only assets expressed in non-monetary terms d. Assets and liabilities expressed in non-monetary terms
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On January 1, Sohan paid rent of ` 5,000. This can be classified as a. An event b. A transaction c. A transaction as well as an event d. Neither a transaction nor an event On March 31, 2011 after sale of goods worth ` 2,000, he is left with the closing stock of ` 10,000. This is a. An event b. A transaction c. A transaction as well as an event. d. Neither a transaction nor an event Following is the example of external users of financial statements : a. Government b. Owners c. Management d. Employees Which of the following is not a transaction? a. Goods are purchased on cash basis for ` 1,000 b. Salaries paid for the month of May, 2010 c. Land is purchased for ` 10 lacs d. An employee dismissed from the job All the following statements are objectives of accounting except a. Providing information about the assets, liabilities and capital of business entity b. Maintaining records of business c. Providing information about the performance of business entity d. Providing details about the personal assets and liabilities of the owner What is the order in which the accounting transactions and events are recorded in the books? a. Journal, Subsidiary books, Ledger, Balance sheet , Profit and loss account b. Ledger, Journal, Ledger, Balance sheet , Profit and loss account c. Journal, Ledger, Profit and loss account, Balance sheet d. Profit and loss account, Ledger, Balance sheet, Journal Financial statements are part of a. Accounting b. Book-keeping c. All of the above d. None of the above On March 31, 2012 Astha Limited purchased a machine from Universal Machineries for ` 10 lakhs, which is shown in the balance sheet as on 31st March, 2012. This is a. An event b. A transaction c. A transaction as well as an event d. Neither a transaction nor an event
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1.2 ACCOUNTING CONCEPTS, PRINCIPLES, AND CONVENTIONS
After studying this unit, you will be able to: 1. 2.
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Grasp the basic accounting concepts, principles and conventions and observe their implications while recording transactions and events. Identify the three fundamental accounting assumptions: Going Concern Consistency Accrual If these assumptions are followed, no disclosure is essential. If these are not followed specific disclosure is essential to highlight the deviations. Understand the qualitative characteristics that will help to develop the skill in course of time to prepare financial statements.
1.2.1 Generally Accepted Accounting Principles (GAAPs)

Accounting developed as the common language for the monetary expression of business and economic performance and financial position
Various stakeholders take important decisions based on the financial information communicated through accounting reports
it is pertinent that financial statements prepared by different enterprises are preapred on a uniform basis and there is consistency in such prepration over time to enhance comparability
To achieve such uniformity and consistency, accounting process is applied within the conceptual framework of Generally Accepted Accounting Principles (GAAPs)
The term GAAPs is used to describe rules developed for the preparation of the financial statements and is called concepts, conventions, postulates, principles etc.
Some rules have been converted into accounting standards issued by the regulatory authority for the standardisation of accounting policies to be followed under specific circumstances
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1.2.2 Meaning of Accounting Concepts, Principles, and Conventions
Accounting Concepts:
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Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. Certain concepts are perceived, assumed and accepted in accounting to provide a unifying structure and internal logic to accounting process. The word concept means idea or notion, which has universal application. Financial transactions are interpreted in the light of the concepts, which govern accounting methods. Concepts are those basic assumptions and conditions, which form the basis upon which the accountancy has been laid. Unlike physical science, accounting concepts are only result of broad consensus. These accounting concepts lay the foundation on the basis of which the accounting principles are formulated. Accounting Principles: Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting, serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist. Accounting principles must satisfy the following conditions: They should be based on real assumptions; They must be simple, understandable and explanatory; They must be followed consistently; They should be able to reflect future predictions; and They should be informational for the users. Accounting Conventions: Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. These conventions are derived by usage and practice. The accountancy bodies of the world may change any of the convention to improve the quality of accounting information. Accounting conventions need not have universal application.
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1.2.3 Overview of Accounting Concepts, Principles, and Conventions
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Generally Accepted Accounting Principles (GAAP)
Concepts
Conventions
1. Entity
1. Conservatism 2. Consistency 3. Materiality
2. Money Measurment
3. Periodicity 4. Accrual 5. Matching 6. Going Concern 7. Cost 8. Realisation 9. Dual Aspect
Entity Concept: Business enterprise is a separate entity apart from its owner(s). Entity concept helps in keeping business affairs free from the influence of the personal affairs of the owner(s). Both affairs are recorded in the separate books of accounts. This concept was developed in early days of the evolution of double-entry book-keeping. The enterprise is liable to the owner(s) for the capital investment by the owner(s). Since the owner(s) invested risk capital, they have a claim on the profits of the enterprise.
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Money Measurement Concept: Only those transactions and events, which can be measured in terms of money, are recorded in the books of accounts. Transactions are to be recorded in uniform monetary unit i.e. currency of the ruling country to which the enterprise belongs. Thus, foreign currency transactions and events must be translated into ruling currency units for inclusion in the books of accounts. This concept ignore the changes in purchasing power of monetary unit i.e. it makes money an inelastic yardstick for measurement. Entity and money measurement are viewed as the basic concepts on which other procedural concepts hinge.
Periodicity Concept: A.k.a. the concept of definite accounting period. Even though business is a going concern with indefinite life, it is logical to break down infinite life into workable finite fractions of time over which performance and position can be measured. Thus, accounts should be prepared after every finite period rather than at the end of the life of the business. This concept makes the term accrual meaningful because nothing accrues in infinity. Periodicity concept facilitates application of uniform and consistent accounting treatment for ascertaining performance and position; matching of expenses and revenues on accrual basis to derive correct results; and Comparison of financial statements of different periods. Accrual Concept: Under accrual concept, the effects of transactions and other events are recognised on mercantile basis i.e., when they occur (and not as cash or a cash equivalent are received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid. The accrual concept relates to measurement of income, identifying assets and liabilities. Financial statements prepared on the accrual basis inform users not only of past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the future e.g. Cash Movement Prior to Accounting Recognition Advance from Customers (Liability) Prepaid Expenses (Asset)
Revenue Expenses
Cash Movement After Accounting Recognition Trade Receivables (Asset) Accrued (Unpaid) Expenses (Liability)
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Under accrual basis of accounting Accrued Revenue Accrued Expenses = Accrued Profit (Loss)
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For a business enterprise following cash basis instead of accrual basis of accounting Cash Received in the Ordinary Course of Business Cash Paid in the Ordinary Course of Business = Cash Profit (Loss) Thus, accrual concept results in better matching of revenues and related expenses. Matching Concept: In the financial statements of an enterprise, if any revenue is recognised then expenses related to earn that revenue should also be recognised. This concept is based on accrual concept as it considers the occurrence of expenses and income and does not concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items like prepaid and outstanding expenses, unearned or accrued incomes. Unless all the expenses which were incurred to generate revenue earned in a period are correctly matched against such revenue, reliable profit (loss) cannot be calculated. Periodicity gives rise to accrual accrual leads to better matching together, periodicity + accrual + matching help in reliable income measurement and recognition of assets and liabilities. CLASS QUIZ 1 A businessman started retail trading business by contributing a cash of ` 5 lakhs on 1st March 2012. He entered into the following transactions during the first month: He purchased on credit 30,000 units of a product for resale @ ` 12 per unit during March. He was able to sell 22,000 units @ ` 17 per unit during the first month. An annual rent of ` 60,000 was paid in the first month. He paid ` 3 lakhs to the suppliers. He also received 3.50 lakhs from the customers. Salary of ` 18,000 for the month of March was paid in April 2012.
Prepare the financial statements of the business for the year ended 31 st March 2012.
Going Concern Concept: The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed. The valuation of assets of a business entity is dependent on this assumption. Traditionally, accountants follow historical cost basis for majority of non-current assets. If going concern concept is taken, increase/decrease in the value of assets in the short-run is
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ignored. The concept indicates that assets are kept for generating benefit in future, not for immediate sale; current change in the asset value is not realisable and so it should not be counted. Thus, going concern concept leads to distinction between capital and revenue expenditure classification of assets and liabilities into non-current and current charging of depreciation on non-current assets based on their estimated useful life Deferring expenditure or income to future years. Going concern is also one of the fundamental accounting assumptions. Cost Concept: As per this concept, the value of an asset is to be determined on the basis of historical cost, in other words, acquisition cost. Although there are various measurement bases, accountants traditionally prefer this concept in the interests of objectivity. Other measurement bases such as current cost, realisable value, and present value are not as objective as cost basis because they may require subjective estimation. However, in some circumstances, cost concept may not be followed e.g. when conservatism concept is applied, an asset may be shown at the lower of cost and realisable value. Though this concept has the merit of objectivity in terms of measurement of historical cost, it also creates distortions in the financial statements as listed below In an inflationary situation when prices of all commodities go up on an average, acquisition cost loses its relevance e.g. a piece of land purchased for ` 50,000 in 1990-91 will continue to be shown at that cost in the balance sheet of 2011-12 even though its market value could be ` 10,00,000. Historical cost-based accounts may lose comparability e.g. continuing with the above example of land purchased in 1990-91, assume that the said business generates a revenue of ` 20,00,000 using that land. Another company which was promoted in 201112 and purchased identical land for ` 10,00,000 has also generated revenue of ` 20,00,000. Which business is more efficient in use of land? Since land is shown at historical cost in both cases, their efficiency is not comparable. Many assets do not have acquisition costs e.g. human assets of an enterprise. The cost concept fails to recognise such asset although it is a very important asset for any enterprise.
Realisation Concept: It closely follows the cost concept. Any change in value of an asset is to be recorded only when the business realises it e.g. in the above example of land acquired for ` 50,000, even if its current cost is ` 10, 00,000 such change is not accounted for unless there is certainty that such change will materialise. However, accountants follow a more conservative path. They try to cover all probable losses but do not count any probable gain i.e. if accountants anticipate decrease in value they count it, but if there is increase in value they ignore it until it is realised.
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Economists are highly critical about the realisation concept, claiming that this concept creates value distortion and makes accounting meaningless. Accounting has found a way out of this criticism in that revaluation of assets has become a widely accepted practice when the change in value is of permanent nature. Accountants adjust such value change through creation of revaluation (capital) reserve. Thus, the concepts of going concern, cost concept and realisation give the valuation criteria whereby non-current assets are generally valued at acquisition cost. Dual Aspect Concept: This concept is to the core of double entry book-keeping. Every transaction or event has two aspects, which ensures that the following accounting equations always remain in balance
Assets (A) = Liabilities (L) + Equity (E) Equity = Assets Liabilities Non-current Assets + Current Assets = Non-current Liabilities + Current Liabilities + Equity Non-current Assets + (Current Assets Current Liabilities) = Non-current Liabilities + Equity Equity = Non-current Assets + Working Capital Non-current Liabilities The above fundamental equation also captures incomes and expenses because incomes increase the equity and expenses decrease the equity. Equity = Capital + Income Expenses Distributions Equity = Capital + Net profit - Distributions Equity = Capital + Retained Earnings Capital + Retained Earnings = Assets + Liabilities
Dual effects of transactions on the fundamental equation is demonstrated below First Effect Increase in an asset Decrease in an asset Increase in a liability Decrease in a liability Increase in equity Decrease in equity Second Effect Decrease in another asset Increase in liability Increase in another asset Increase in an asset Decrease in another liability Decrease in an asset Increase in asset Decrease in a liability Decrease in an asset Increase in a liability Example Asset purchased in cash Asset purchased on credit Sale of old asset in cash Bank loan taken Debentures issued to lender Payment to trade creditors Issue of shares Conversion of debentures Buyback of shares Proposed dividend
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CLASS QUIZ 2 Develop the accounting equation from the following data, and find out the net profit for the year ended 31st March 2012 Particulars 1st April 2011 31st march 2012 Equity Capital 8,00,000 ? Bank Loan 10,00,000 10,00,000 Trade Creditors 2,00,000 2,25,000 Fixed Assets 12,50,000 11,25,000 Trade Receivables 3,80,000 4,50,000 Inventories 2,65,000 3,80,000 Cash & Bank 1,05,000 2,20,000 Conservatism (Prudence): Conservatism states that the accountant should not anticipate income and should provide for all possible losses. As per the ICAI framework, prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated, and Liabilities or expenses are not understated. When there are many alternative values of an asset, an accountant should choose the method which leads to the lesser value. The golden rule of current assets valuation - cost or market price, whichever is lower originated from this concept. Many accounting authors, however, are of the view that conservatism essentially leads to understatement of income and wealth and it should not be the basis for the preparation of financial statements. Consistency: In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another; a change in an accounting policy is made only in certain exceptional circumstances. The concept of consistency is applied particularly when alternative methods of accounting are equally acceptable e.g. methods of depreciation or inventory valuation. However in some cases though there is no inconsistency, they may seem to be inconsistent apparently e.g. in the valuation of stock in one year at cost price and the market price in the other year, there is no inconsistency here. It is only an application of the principle. The concept of consistency does not imply non-flexibility as not to allow the introduction of improved method of accounting. A change in an accounting policy should be made only if: The adoption of a different accounting policy is required by statute or for compliance with an accounting standard, or If it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise.
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Materiality: Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. According to materiality principle, all the items having significant economic effect on the business of the enterprise should be disclosed in the financial statements; and any insignificant item which will only increase the work of the accountant but will not be relevant to the users need should not be disclosed in the financial statements. Materiality principle permits other concepts to be ignored, if the effect is not considered material. Thus, this principle is an exception of full disclosure principle. Materiality is a subjective term. An accountant uses judgment, common sense and discretion to decide which item is material and which is not. Materiality has both quantitative and qualitative aspects Materiality by Quantity (i.e. Size) Quantitative threshold, individual or in the context of the whole. e.g. stationary purchased is always expensed even if part of is left in stock. e.g. assets costing ` 5,000 or less are depreciated 100% in the year of purchase. Materiality by Quality (i.e. Nature) Nature of information in terms of persons involved, legality, potential misstatement. e.g. penalty for violation of law, however small it is. e.g. abnormal losses, whether small or large in monetary terms.
1.2.4 Fundamental Accounting Assumptions

Fundamental Accounting Assumptions Under the Indian GAAP:
Going Concern Consistency Accrual
Disclosure: If the fundamental accounting assumptions are followed in the preparation of financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.
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1.2.5 Qualitative Characteristics of Financial Statements
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Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. They are as follows: Understandability Relevance Materiality Reliability Faithful Representation Substance Over Form Neutrality Prudence Full Disclosure Completeness Comparability
Understandability: Information in financial statements must be readily understandable by users who have a reasonable knowledge of business and economic activities and accounting and study the information with reasonable diligence. Information about complex matters that should not be excluded from the financial statements merely on the ground that it may be too difficult for certain users to understand. The predictive and confirmatory roles of information are interrelated e.g. current information helps in future predictions and play a confirmatory role for past predictions. The ability to make predictions from financial statements is enhanced by the manner in which information on past transactions and events is displayed e.g. the predictive value of the statement of profit and loss is enhanced if unusual, abnormal and infrequent items of income and expense are separately disclosed.
Materiality: The relevance of information is affected by its materiality. Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item or error, judged in the particular circumstances of its misstatement. Materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which the information must have if it is to be useful.
Reliability: To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading e.g. contingent liabilities.
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Faithful Representation: To be reliable, information must represent faithfully the transactions and other events it either purports to represent or could reasonably be expected to represent. Thus, for example, a balance sheet should represent faithfully the transactions and other events that result in assets, liabilities and equity of the enterprise at the reporting date which meet the recognition criteria. Most financial information is subject to some risk of being less than a faithful representation of that which it purports to portray, less due bias but more due to identification and measurement difficulties involved e.g. internally generated goodwill is not recognised in the financial statements due to such difficulties. Substance over Form: If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of some transactions and events may not be consistent with its legal form e.g. if an immovable property is sold and beneficial interest in it is transferred to the buyer, it is appropriate to recognise such sale even if the legal documentation is pending and title is not transferred till the year end.
Neutrality: To be reliable, the information contained in financial statements must be neutral, that is, free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgement in order to achieve a predetermined result or outcome e.g. loss due to theft is included in miscellaneous expenses to hide the inefficiency.
Prudence: Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, the exercise of prudence does not allow, for example, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would then not be neutral and, therefore, not have the quality of reliability.
Full, Fair, and Adequate Disclosure: The principle of full disclosure implies that nothing should be omitted. Principle of fair disclosure implies that all the transactions recorded should be accounted in a manner that financial statements give true and fair view of the results of the business of the enterprise. Adequate disclosure implies that the information influencing the decision of the users should be disclosed in detail and should make sense.
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Completeness: To be reliable, the information in financial statements must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance. Comparability: Users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial position, performance and cash flows. Users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, performance and cash flows. Comparability can be enhanced by the following actions Consistency in measurement and presentation of financial effects of transactions and events. Disclosure of accounting policies employed in preparation of financial statements and any change therein, so that users can perceive their impact on comparability. Compliance with the applicable accounting standards. Showing corresponding information for the preceding periods in the financial statements.
The need for comparability need not be confused with mere uniformity. Comparability may be compromised in the years in which new or improved accounting standards and practices are introduced for enhancing the reliability and relevance of financial statements.
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Multiple Choice Questions

1. All the following items are classified as fundamental accounting assumptions except a. Consistency b. Business entity c. Going concern d. Accrual Two primary qualitative characteristics of financial statements are a. Understandability and materiality b. Relevance and reliability c. Neutrality and understandability d. Materiality and reliability Vinayak Limited follows the reducing balance method of depreciating plant and machinery year after year to pursue a. Comparability b. Convenience c. Consistency d. All of the above Firm X purchased a loader for ` 5,00,000, making a down payment of ` 1,00,000 and signing a ` 4,00,000 bill payable due in 90 days. As a result of this transaction a. Total assets increased by ` 5,00,000 b. Total liabilities increased by ` 4,00,000 c. Total assets increased by ` 4,00,000 d. Total assets increased by ` 4,00,000 with corresponding increase in liabilities by ` 4,00,000 Dolby Enterprises purchased goods for ` 16,00,000 and sold 3/4th of the goods amounting ` 17,00,000 and met expenses amounting ` 1,75,000 during the year 2011-12. It has computed net profit as ` 3,25,000. Which of the accounting concept was followed by the firm? a. Entity b. Periodicity c. Matching d. Conservatism A company purchased goods for ` 58,00,000 and sold 75% of such goods during the accounting year ended 31st March, 2012. The market value of the remaining goods was ` 14,10,000. It valued the closing stock at cost. The company violated the concept of a. Money measurement b. Conservatism c. Cost d. Periodicity Assets are held in the business for the purpose of a. Resale b. Conversion into cash c. Earning revenue d. None of the above Revenue from sale of products, is generally, realized in the period in which a. Cash is collected. b. Sale is made c. Products are manufactured d. None of the above
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3.
4.
5.
6.
7.
8.
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10.
11.
12.
13.
14.
15.
16.
The concept of conservatism when applied to the balance sheet results in a. Understatement of assets b. Overstatement of assets c. Overstatement of capital d. None of the above Decrease in the amount of creditors results in a. Increase in cash b. Decrease in cash c. Decrease in assets d. No change in assets The determination of expenses for an accounting period is based on the principle of a. Objectivity b. Materiality c. Matching d. Periodicity Economic life of an enterprise is split into the periodic interval as per a. Entity b. Matching c. Going concern d. Accrual If an individual asset is increased, there will be a corresponding a. Increase of another asset or increase of capital b. Decrease of another asset or increase of liability c. Decrease of specific liability or decrease of capital d. Increase of drawings and liability Purchase of machinery for cash a. Decreases total assets b. Increases total assets c. Retains total assets unchanged d. Decreases total liabilities A proprietor, Mr. A has reported a profit of ` 1,25,000 at the end of the financial year after taking into consideration the following amounts (i) The cost of an asset of ` 25,000 has been taken as an expense. (ii) Mr. A is anticipating a profit of ` 10,000 on the future sale of a car shown as an asset in his books (iii) Salary of ` 7,000 payable in the financial year has not been taken into account. (iv) Mr. A purchased an asset for ` 75,000 but its fair value on the date of purchase was ` 85,000. Mr. A recorded the value of asset in his books by ` 85,000. On the basis of the above facts, answer questions 15 to 18: What is the correct amount of profit to be reported in the books? a. ` 1,25,000, b. ` 1,35,000, c. ` 1,50,000, d. ` 1,33,000 Which measurement base should be followed in the statement (iv)? a. Historical cost b. Current cost c. Replacement cost d. Present value
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18.
19.
20.
21.
22.
23.
24.
Which concept should be followed in the statement (ii)? a. Conservatism b. Materiality c. Historical cost d. Accrual Which concept should be followed in the statement (iii)? a. Materiality b. Historical cost c. Current cost d. Accrual Fundamental accounting assumption is a. Materiality b. Business entity c. Going concern d. Dual aspect Mr. A purchased a machinery costing ` 1,00,000 on 1st October, 2009. Transportation and installation charges were incurred amounting ` 10,000 and ` 4,000 respectively. Dismantling charges of the old machine in place of which new machine was purchased amounted ` 10,000. Market value of the machine was estimated at ` 1,20,000 on 31st March 2010. While finalising the annual accounts, A values the machinery at ` 1,20,000 in his books. Which of the following concepts was violated by A? a. Cost concept b. Matching concept c. Realisation concept d. Periodicity concept. Which financial statement represents the equation, Assets = Liabilities + Owners equity? a. Income Statement b. Statement of Cash flows c. Balance Sheet d. None of the above Economic life of an enterprise is split into the periodic interval as per ________ concept. a. Money Measurement b. Matching c. Periodicity d. Accrual Business unit is separate and distinct from the person who supply capital to it, is based on a. Money measurement concept b. Going concern concept c. Business entity concept d. Dual aspect concept State the case where the going concern concept is applied? a. When an enterprise was set up for a particular purpose, which has been achieved, or to be achieved shortly b. When a receiver or liquidator has been appointed in case of a company which is to be liquidated c. Fixed assets are acquired for use in the business for earning revenues and are not meant for resale d. When an enterprise is declared sick
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25.
CHAPTER - 1
26.
27.
28.
29.
30.
31.
32.
33.
Ram started business with cash ` 50,000 Purchased goods from Mohan on credit ` 20,000 Sold goods to Shyam (costing ` 3,000) for cash ` 3,600 The accounting equation on the basis of the above transactions will be a. Assets ` 70,600 = Liabilities ` 3,600 + Owners equity ` 67,000 b. Assets ` 70,600 = Liabilities ` 50,600 + Owners equity ` 20,000 c. Assets ` 70,600= Liabilities ` 20,000 + Owners equity ` 50,600 d. None of the three Transactions between owner and business are recorded as per a. Periodicity concept b. Going concern concept c. Prudence concept d. Business Entity concept The substance of the transactions gets preference over legal position. The transactions and events recorded in the books of account and presented in the financial statements, should be governed by the substance of such transactions and not merely by their legal form as per the concept of a. Faithful representation b. Substance over form c. Neutrality d. Fair disclosure Assets should be valued at the price paid to acquire them is based on: a. Accrual concept b. Cost concept c. Money measurement concept d. Realisation concept It is generally assumed that the business will not liquidate in the near foreseeable future Because of______________ concept. a. Periodicity b. Materiality c. Matching d. Going concern Which of the following is correct? a. Capital is equal to assets plus liabilities b. Assets is equal to liabilities minus capital c. Liabilities is equal to capital plus assets d. Capital is equal to assets minus liabilities According to which concept, the owner of an enterprise pays the interest on drawings? a. Accrual concept b. Conservatism concept c. Dual aspect concept d. Entity concept Profit leads to increase in a. Assets b. Capital c. Both (a) and (b) d. Neither (a) nor (b) Mr. Ashok buys clothing of ` 50,000 paying cash ` 20,000. What is the amount of expenses per the accrual concept?
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a. ` 50,000 b. ` 20,000 c. ` 30,000 d. Nil According to money measurement concept, currency transactions and events are recorded in the books of accounts a. In the ruling currency of the country in which transaction takes place b. In the ruling currency of the country in which books of account are prepared c. In the currency set by the ministry of finance d. In the currency set by the Government Advance received from customers is not taken as sale is based on a. Money measurement concept b. Accrual concept c. Consistency concept d. Conservation At the end of the accounting period the provision is made for the amount outstanding for the electricity that has been consumed during the said period. This statement is based on a. Accrual concept b. Matching c. Realisation d. Money measurement Human assets have no place in accounting records is based on _____ a. Money measurement concept b. Accrual concept c. Consistency d. Conservatism
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1.3
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ACCOUNTING STANDARDS CONCEPTS, OBJECTIVES, BENEFITS
1. Understand the Concept of Accounting Standards. Identify the three fundamental accounting assumptions: 2. Grasp the objectives, benefits and limitations of Accounting Standards. 3. Learn the system of evolution of Accounting Standards by the Council of the Institute of Chartered Accountants of India. 4. Familiarise with the brief overview of Accounting Standards in India.
1.3.1 Concepts of Accounting Standards

Meaning: Accounting standards are written policy documents; issued by expert accounting body (e.g. the ICAI) or by government or other regulatory body; Covering the aspects of recognition, measurement, presentation and disclosure of accounting transactions and events in the financial statements. Issues Addressed by Accounting Standards: The 4 pillars of accounting standards: Recognition Principles Recognition of transactions and events in the financial statements Measurement Principles Measurement of transactions and events through accounting policies and valuation norms Presentation Requirements Presentation of transactions and events in a manner that is meaningful and understandable to the reader of financial statements Disclosure Requirements Disclosure requirements which enable the reader to take prudent and informed economic decisions
1.3.2 Objectives of Accounting Standards

Harmonise accounting policies and practices followed by different business entities in order to reduce diversity in them and standardise them so that understandability as well as comparability across time and entities are achieved. Improve relevance and reliability of financial statements across time and entities by eliminating unnecessary and irrational accounting or valuation choices. Promote high quality reporting of both performance and position in the financial statements. Ensure that accounting policies and practices are within the applicable legal framework.
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1.3.3 Benefits and Limitations of Accounting Standards
Benefits of Accounting Standards:
CHAPTER - 1
They promote true and fair view of financial performance and position in the general purpose financial statements. They reasonably reduce or eliminate confusing variations in accounting treatments used to prepare financial statements. They call for additional important information to be disclosed in the financial statements even if such information is not required under any law. Application of accounting standards facilitates and improves comparison of financial statements locally as well as globally, to a limited extent. Limitations of Accounting Standards: Accounting standards may offer alternative treatments to accounting issues. Each alternative will have its own merit, making choice between them quite difficult. Given choice, business entities may choose alternatives which help in manipulation of performance or position data. If accounting standards are not updated in tune with changing business practices, there may be a trend towards rigidity and away from flexibility in their application. Accounting standards cannot override the law, and are required to be framed within the prevailing statutes.
1.3.4 Overview of Accounting Standards

AS 1 Title Disclosure of Accounting Policies Issue / Revision Overview Year 1979 Presentation and disclosure requirements for significant accounting policies followed in preparing financial statements. Disclosure if fundamental assumptions are not followed. Revised Measurement of inventory at lower of 1999 cost and net realisable value. Disclosure of inventory valuation methods used. Revised Presentation of cash flows, classified into 1997 operating, investing, and financing activities. Revised Most contingencies are now covered by 1995 AS 29 w.e.f. 2004. Adjustments or disclosure for material events occurring between the balance sheet date and the date of approval of financial statements.
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Valuation of Inventories
Cash Flow Statements
Contingencies and Events Occurring After the Balance Sheet Date
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5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies Revised 1997
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Presentation within P&L statement exceptional ordinary items, extraordinary items and prior period items. Accounting for changes in accounting estimates. Disclosure of changes in accounting policies. Measurement, presentation and disclosure of depreciation on tangible fixed assets. Recognition, measurement, presentation and disclosure for construction contract revenue/costs. Stands withdrawn from the date AS 26 becomes mandatory. Recognition, presentation and disclosure of revenue from ordinary activities i.e. sale of goods, rendering of services, use by others of enterprise resources yielding interest, royalties and dividends. Recognition, measurement, presentation and disclosure requirements for the tangible fixed assets. Recognition, measurement, presentation and disclosure requirements for foreign currency transactions, foreign operations, and forward exchange contracts. Recognition, measurement, presentation and disclosure requirements for government grants. Measurement, presentation and disclosure requirements for current and long-term investments. Recognition, measurement, presentation and disclosure requirements for amalgamations in the nature of merger/purchase and resultant goodwill/reserves. Recognition, measurement, presentation and disclosure requirements for shortterm, post-employment, other long-term and termination benefits of employees. Recognition, measurement, presentation
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Depreciation Accounting
Revised 1994 Revised 2002 Withdrawn 2003 1985
Construction Contracts
8 9
Accounting for Research and Development Revenue Recognition
10
Accounting for Fixed Assets
1985
11
The Effects of Changes in Foreign Exchange Rates
Revised 2003
12
Accounting for Government Grants Accounting for Investments
1991
13
1993
14
Accounting for Amalgamations
1994
15
Employee Benefits
Revised 2005
16
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Borrowing Costs
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2000
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and disclosure requirements for borrowing costs. Presentation and disclosure requirements for reportable business segments and geographic segments within business. Disclosure for related parties and transactions with them. Recognition, measurement, presentation and disclosure requirements for finance and operating leases in the financial statements of both lessors and lessees. Measurement, presentation and disclosure requirements for basic as well as diluted EPS. Measurement, presentation and disclosure requirements for consolidated financial statements prepared by parent enterprises having one or more subsidiaries. Recognition, measurement, presentation and disclosure requirements for income taxes, including deferred taxes. Measurement, presentation and disclosure requirements for investment in associates in consolidated financial statements using equity method. Recognition, measurement, presentation and disclosure requirements for discontinuing operations. Recognition, measurement, presentation and disclosure requirements for interim financial reports. Recognition, measurement, presentation and disclosure requirements for intangible assets and their amortisation. Measurement, presentation and disclosure requirements for investment in joint ventures using proportionate consolidation method. Recognition, measurement, presentation and disclosure requirements for impairment of individual assets and cash generating units.
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17
Segment Reporting
2000
18 19
Related Party Disclosures Leases
2000 2001
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Earnings Per Share
2001
21
Consolidated Financial Statements
2001
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Accounting for Taxes on Income Accounting for Investments in Associates in Consolidated Financial statements Discontinuing Operations
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2001
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2002
25
Interim Financial Reporting
2002
26
Intangible Assets
2002
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Financial Reporting of Interests in Joint Ventures
2002
28
Impairment of Assets
2002
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29 Provisions, Contingent Liabilities and Contingent Assets Financial Instruments: Recognition and Measurement 2003
CHAPTER - 1
Recognition, measurement, presentation and disclosure requirements for provisions, contingent liabilities / assets. The objective of this Standard is to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset. The objective of this Standard is to require entities to provide disclosures in their financial statements that enable users to evaluate the significance of financial instruments for the entitys financial position and performance and the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks.
30
2008
31
Financial Instruments: Presentation
2008
32
Financial Instruments: Disclosures
2008

1. Accounting Standards in India are issued by a. Central Govt. b. State Govt. c. Institute of Chartered Accountants of India d. Reserve Bank of India. Accounting Standards a. Harmonise accounting policies b. Eliminate the non-comparability of financial statements c. Improve the reliability of financial statements d. Do all of the above How many Accounting Standards have been issued by the ICAI? a. 25 b. 29 c. 32 d. 31
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It is essential to standardize the accounting principles and policies in order to ensure a. Transparency. b. Consistency. c. Comparability. d. All of the above All of the following are limitations of Accounting Standards except a. The choice between different alternative accounting treatments is difficult b. There may be trend towards rigidity c. Accounting Standards cannot override the statute. d. All of the above Accounting has certain norms to be observed by the accountants in recording of transactions and preparation of financial statements. These norms reduce the vagueness and chances of misunderstanding by harmonizing the varied accounting practices. These norms are a. Accounting regulations b. Accounting notes c. Accounting standards d. Accounting framework Accounting standards are a. Basis for selection of accounting policy b. Set of broad accounting policies to be followed by an entity c. Basis for establishing and managing an entity d. All of the above
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1.4 ACCOUNTING POLICIES
CHAPTER - 1
1. Understand the meaning of Accounting Policies. 2. Familiarise with the situations under which selection from different accounting policies is required. 3. Grasp the conditions where change in accounting policy can be made and the consequences arising from such changes.
1.4.1 Meaning of Accounting Policies

Accounting Policies refer to specific accounting principles and methods of applying these principles adopted by the enterprise in the preparation and presentation of financial statements. Policies are based on various accounting concepts, principles and conventions that have already been discussed till now. There is no single list of accounting policies which are applicable to all enterprises in all circumstances. Enterprises operate in diverse and complex environmental situations and so they have to adopt various policies. The choice of specific accounting policy appropriate to the specific circumstances in which the enterprise is operating, calls for considerate judgement by the management. The ICAI has been trying to reduce the number of acceptable accounting policies through Guidance Notes and Accounting Standards in its combined efforts with the government, other regulatory agencies and progressive managements. Already it has achieved some progress in this respect. Examples of areas wherein different accounting policies are frequently encountered can be given as follows: Methods of depreciation, depletion and amortisation; Valuation of inventories; Valuation of investments.
1.4.2 Selection of Accounting Policies

The primary consideration in the selection of accounting policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of: The state of affairs of the enterprise as at the balance sheet date; and The profit and loss for the period ended on that date. The above selection becomes challenging because no unified an exhaustive list of accounting policies can be suggested which has universal application. Recommended selection criteria:
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Profits are not anticipated, but losses are provided even if uncertain. e.g. provision for doubtful debts
CHAPTER - 1
Prudence
Substance over Form
accounting treatment of transactions and events should be governed by their true substance and not merely their legal form e.g. asset sold during the year, but legal title transfers in the next year
Materiality
Financial statements should disclose all material items the knowledge of which can might influence the decisions of users e.g. assets with insignificant values
1.4.3 Changes in Accounting Policies

A change in accounting policies should be made only if: It is required by a statute or for compliance with an Accounting Standard. Change would result in a more appropriate presentation of financial statements. Any change in an accounting policy which has a material effect on the financial statements should be disclosed. Moreover, the impact of and the adjustments resulting from such change should be shown in the financial statements of the period in which such change is made. Unless the effect of such change in accounting policy is quantified, the financial statements may not help the users of accounts. Therefore, it is necessary to quantify the effect of change on financial statement items like assets, liabilities, profit/loss.

1. A change in accounting policy is justified a. To comply with accounting standard b. To ensure more appropriate presentation of the financial statement of the enterprise c. To comply with law d. All of the above Accounting policy for inventories of Star Enterprises states that inventories are valued at the lower of cost determined on weighted average basis and net realizable value. Which Accounting principle in followed in adopting the above policy? a. Materiality b. Prudence c. Substance over form d. All of the above
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The areas wherein different accounting policies can be adopted are a. Providing depreciation b. Valuation of inventories c. Valuation of investments d. All of the above Selection of an inappropriate accounting policy decision may a. Selection of an inappropriate accounting policy decision may b. Understate/overstate the performance and financial position of a business entity c. Overstate the performance a business entity d. Understate financial position a business entity Accounting policies refer to specific accounting a. Principles. b. Methods of applying those principles c. Both (a) and (b) d. None of the above M/s ABC Brothers, which was registered in the year 2000, has been following Straight Line Method (SLM) of depreciation. In the current year it changed its method from Straight Line to Written Down Value (WDV) Method, since such change would result in the additional depreciation of ` 200 lakhs as a result of which the firm would qualify to be declared as a sick industrial unit. The auditor raised objection to this change in the method of depreciation. The objection of the auditor is justified because a. Change in the method of depreciation should be done only with the consent of the auditor b. Depreciation method can be changed only from WDV to SLM and not vice versa c. Change in the method of depreciation should be done only if it is required by some statute or change would result in more appropriate presentation of financial statement or for compliance with the accounting standard d. Method of depreciation cannot be changed under any circumstances Change in the method of depreciation is change in ________. a. Accounting estimate b. Accounting policy c. Measurement discipline d. None of the above The determination of the amount of provision for doubtful debts is an accounting a. Policy b. Estimate c. Parameter d. None of the above The accounting policies once adopted are not changed unless there is a genuine need for such change is based on a. Money measurement concept b. Accrual concept c. Consistency d. Conservation
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1.5
CHAPTER - 1
ACCOUNTING AS A MEASUREMENT DISCIPLINE - VALUATION PRINCIPLES, ACCOUNTING ESTIMATES
After studying this unit, you will be able to: 1. 2. 3. 4. 5. 6. Understand the meaning of measurement and its basic elements. Know how far accounting is a measurement discipline if considered from the standpoint of the basic elements of measurement. Distinguish measurement with valuation. Learn the different measurement bases namely historical cost, realisable value and present value. Understand the measurement bases which can give objective valuation to transactions and events. Understand that the traditional accounting system mostly uses historical cost as measurement base although in some cases other measurement bases are also used.
1.5.1 Meaning of Measurement

Measurement is vital aspect of accounting. Primarily, transactions and events are measured in terms of money. Prof. R. J. Chambers defined measurement as: assignment of numbers to objects and events according to rules specifying the property to be measured, the scale to be used and the dimension of the unit. According to this definition, the three elements of measurement are as under: Identification of objects and events to be measured; Selection of standard or scale to be used; Evaluation of dimension of measurement standard or scale.
1.5.2 Objects or Events to be Measured

Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of the information. Therefore, accounting essentially includes measurement of information. Decision makers need past, present and future information. Examples of information objects and events: For external users, generally the past information is communicated through financial statements. For example, in cash management, various cash receipts and expenses are the necessary objects and events. Obviously the decision makers need past cash receipts and expenses data along with projected receipts and expenses. For giving loan to a business one needs information regarding the repayment ability (popularly called debt servicing) of principal and interest. This also includes past information, current state of affairs as well as future projections.
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Past and present objects and events can be measured with some degree of accuracy but future events and objects are only predicted, not measured.
1.5.3 Standard or Scale of Measurement

In accounting, money is the scale of measurement (see money measurement concept), although now-a-days quantitative information is also communicated along with monetary information. Money as a measurement scale has no universal denomination. It takes the shape of currency ruling in a country e.g. `, , $, , etc. There is no constant exchange relationship among the currencies i.e. currency exchange rates change frequently. As a result, money as a measurement scale has become quite volatile for transactions and events across countries. CLASS QUIZ 3 An Indian company borrowed $ 80,000 on 1st October 2011 for one year. It prepared its balance sheet on 31st March 2012, and repaid the said loan on 30th September 2012. Measure the loan in Indian rupees on the date loan was taken, on the balance sheet date, and on the date of its repayment, if the exchange rates between rupee and dollar were as under: 1st October 2011 $ 1 = ` 52.10 31st March 2012 $ 1 = ` 53.60 th 30 September 2012 $ 1 = ` 53.15
1.5.4 Dimension of Measurement Scale

An ideal measurement scale should be stable over time in dimension e.g. 1 kg. in weight, 1 dozen in number, or 1 km. in distance remain same over time. Money as a scale of measurement is not stable e.g. Due to continuous change in the input output prices, the same quantity of money may not have the ability to buy same quantity of identical goods at different dates. Thus information of one year measured in money terms may not be comparable with that of another year due to changing prices. CLASS QUIZ 4 In its first year, a company produced 12,000 units of a product for ` 3,60,000 and sold all the units for ` 4,80,000. In the second year, the said company manufactured 11,000 units for ` 4,40,000 and sold all of them for ` 5,50,000. Measure the change in this companys performance in monetary terms and physical terms. To conclude, Accounting measures information mostly in money terms which is not a stable scale having universal applicability and also not stable in dimension for comparison over the time. Thus, Accounting is not an exact measurement discipline.
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1.5.5 Accounting As a Measurement Discipline

CHAPTER - 1
We have already discussed that accounting process involves various steps such as recording, classifying, summarising, analysing, interpreting, and communicating. The very first step in Accounting is the measurement of transactions and events, even before book keeping starts. Thus, can we say that accounting is a measurement discipline? Although measurement is an important part of accounting discipline, a large set of theorems governs the whole measurement sub-system called Accounting. In addition to measurement, various other concepts, conventions and assumptions go into preparing financial statements as the output of Accounting. Accounting procedures such as recording, classifying, summarising, and communicating do not fall within the purview of measurement discipline. Therefore, we cannot simply say that Accounting is a measurement discipline. However, in accounting, money is the unit of measurement. So, let us take one thing for granted that all transactions and events are to be recorded in terms of money only. Quantitative information is also required in many cases, but such information is only supplementary to the monetary information.
1.5.6 Valuation Principles

Important Valuation Principles Historical Cost Historical Cost Basis: Liabilities Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. e.g. a bank loan of ` 3,00,000 was taken for 10 years @ 12% p.a. on 1st April 2005. What is the historical cost this bank loan on 31st March 2011? Current Cost Realisable Value Present Value
Assets Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire them at the time of their acquisition.
e.g. On 1st April 2005, a new asset was acquired against an exchange of old asset and cash payment of ` 1,00,000. The old asset has carrying amount of ` 5,30,000 and fair value of ` 4,05,000. It is to be depreciated equally over 10 years. What is the historical cost of the new asset on 31st March 2011?
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Current Cost Basis:
CHAPTER - 1
Assets Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset were acquired currently. e.g. if the above asset has carrying amount of 2,02,000 and can be purchased at ` 3,00,000 on 31st March 2011, what is its current cost? Realisable Value Basis:
Liabilities Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. e.g. if the above bank loan can be prepaid with 2% penalty, what is its current cost on 31st March 2011?
Assets Liabilities Assets are carried at the amount of cash or cash Liabilities are carried at their settlement equivalents that could currently be obtained by values, that is, the undiscounted amounts of selling the asset in an orderly disposal. cash or cash equivalents expected to be required to settle the liabilities in the normal course of business. e.g. if the above asset has carrying amount of e.g. what is the realisable value of the above 2,,02,000, can be purchased at ` 3,0,000, but can bank loan on 31st March 2011? be sold at ` 2,90,000 on 31st March 2011, what is its realisable value? Present Value Basis:
Assets Liabilities Assets are carried at the present value of the Liabilities are carried at the present value of future net cash inflows that the item is expected the future net cash outflows that are expected to generate in the normal course of business. to be required to settle the liabilities in the normal course of business. e.g. if the above asset is expected to generate net e.g. what is the present value of the above cash inflow of ` 60,000 every year for the next bank loan on 31st March 2011 if the discount four years, what is its present value on 31st March rate is 15% p.a.? 2011 if the discount rate is 15% p.a.? Note: Present Value of A Single Amount P ( ) Present Value of an Annuity A [ ( ) ]
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1.5.7 Measurement and Valuation
Value relates to the benefits to be derived from objects, abilities or ideas.
CHAPTER - 1
To the economist, value is the utility (i.e. satisfaction) of an economic resource to the person contemplating or enjoying its use. In accounting, to mean value of an object, abilities or ideas, a monetary surrogate is used i.e. value is measured in terms of money. Economists often use ordinal scale (qualitative) to indicate the level of satisfaction. However, accountants use only cardinal scale (quantitative) to measure value.
1.5.8 Accounting Estimates

We have learnt how to measure transactions which had already taken place and for which either some value/money has been paid or some valuation principles are to be adopted for their measurement. On the other side, for transactions and events which have still not occurred, values are derived using reasonable estimates based on the existing situation and past experiences e.g. provision for doubtful debts. The measurement of certain assets and liabilities is based on estimates of uncertain future events. As a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. Therefore, the management makes various estimates and assumptions of assets, liabilities, incomes and expenses as on the date of preparation of financial statements e.g. Estimation of useful life and residual value of an asset and computation of depreciation Provision for retirement benefits of employees or provision for taxes An estimate may require revision if changes occur regarding circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments.
1. Measurement discipline deals with a. Identification of objects and events b. Selection of scale c. Evaluation of dimension of measurement scale d. All of the above 2. All of the following are valuation principles except a. Historical cost b. Present value c. Future value d. Realisable value
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3. Book value of machinery on 31st March, 2011 10,00,000 Market value as on 31st March, 2011 11,00,000 As on 31st March, 2011, if the company values the machinery at ` 11,00,000, which of the following valuation principle is being followed? a. Historical Cost b. Present Value c. Realisable Value. d. Current Cost Mohan purchased a machinery amounting ` 10,00,000 on 1st April, 2001. On 31st March, 2011, similar machinery could be purchased for ` 20,00,000 but the realizable value of the machinery (purchased on 1.4.2001) was estimated at ` 15,00,000. The present discounted value of the future net cash inflows that the machinery was expected to generate in the normal course of business was calculated as ` 12,00,000. Based on the above facts, answer questions 4 to 7. 4. The current cost of the machinery is a. ` 10,00,000. b. ` 20,00,000. c. ` 15,00,000. d. ` 12,00,000. 5. The present value of machinery is a. ` 10,00,000 b. ` 20,00,000 c. ` 15,00,000 d. ` 12,00,000 6. The historical cost of machinery is a. ` 10,00,000 b. ` 20,00,000 c. ` 15,00,000 d. ` 12,00,000 7. The realizable value of machinery is a. ` 10,00,000 b. ` 20,00,000 c. ` 15,00,000 d. ` 12,00,000 8. Change in accounting estimate means a. Differences arising between certain parameters estimated earlier and re-estimated during the current period b. Differences arising between certain parameters estimated earlier and actual results achieved during the current period c. Differences arising between certain parameters re-estimated during the current period and actual results achieved during the current period d. Both (a) and (b)
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Fundamental of Accounting

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CA CPT

1.1 MEANING AND SCOPE OF ACCOUNTING

1.2 ACCOUNTING CONCEPTS, PRINCIPLES, AND

1.3 ACCOUNTING STANDARDS CONCEPTS, OBJECTIVES, BENEFITS

1.4 ACCOUNTING POLICIES

1.5 ACCOUNTING AS A MEASUREMENT DISCIPLINE VALUATION PRINCIPLES, ACCOUNTING ESTIMATES

1.1.2 Meaning of Accounting

Output Communicating information to internal and external users

1.1.3 Users of Accounting Information

Internal Users Employees Investors External Users

1.1.4 Evolution of Accounting as a Social Science

1.1.5 Objectives of Accounting

Systematic Recording of Transactions

Ascertainment of Financial Position

Ascertainment of Financial Position

Book-keeping i.e. Journal, Ledger, Trial Balance

Profit and Loss Statement

1.1.8 Distinction between Book-Keeping and Accounting

1.1.9 Sub-Fields of Accounting

Social Responsibility Accounting Human Resource Accounting

Role of Accountants in the Society

Class- Practice Questions

1.2.1 Generally Accepted Accounting Principles (GAAPs)

Generally Accepted Accounting Principles (GAAP)

1. Conservatism 2. Consistency 3. Materiality

1.2.4 Fundamental Accounting Assumptions

Going Concern Consistency Accrual

Multiple Choice Questions

ACCOUNTING STANDARDS CONCEPTS, OBJECTIVES, BENEFITS

1.3.1 Concepts of Accounting Standards

1.3.2 Objectives of Accounting Standards

1.3.4 Overview of Accounting Standards

Cash Flow Statements

Contingencies and Events Occurring After the Balance Sheet Date

Revised 1994 Revised 2002 Withdrawn 2003 1985

Accounting for Research and Development Revenue Recognition

Accounting for Fixed Assets

The Effects of Changes in Foreign Exchange Rates

Accounting for Government Grants Accounting for Investments

Accounting for Amalgamations

Related Party Disclosures Leases

Earnings Per Share

Consolidated Financial Statements

Interim Financial Reporting

Financial Reporting of Interests in Joint Ventures

Financial Instruments: Presentation

Financial Instruments: Disclosures

Multiple Choice Questions

1.4.1 Meaning of Accounting Policies

1.4.2 Selection of Accounting Policies

Substance over Form

1.4.3 Changes in Accounting Policies

Multiple Choice Questions

ACCOUNTING AS A MEASUREMENT DISCIPLINE - VALUATION PRINCIPLES, ACCOUNTING ESTIMATES

1.5.1 Meaning of Measurement

1.5.2 Objects or Events to be Measured

1.5.3 Standard or Scale of Measurement

1.5.4 Dimension of Measurement Scale

1.5.6 Valuation Principles

1.5.8 Accounting Estimates