Unit- 1

Introduction to Accounting
Accounting is a system which identify the transaction, record those transaction of a business
organisation in a way that can be compared with the other business as well as within the
business with the past performance. Accounting is a part of our daily life a person most
common use of accounting is to Check accounts, Tax forms, Pay roll any credit taken all these
experiences focus on record keeping part of accounting. Now days due to advancement of
technology the recording part is done with the help of technology still the analysis is done by
human minds thus understanding the various concept of accounting is important.
Accounting means a process of reporting, recording, interpreting and summarising economic
data. The introduction of accounting helps the decision-makers of a company to make effective
choices, by providing information on the financial status of the business.
Definition of Accounting:
The American Institute of Certified Public Accountants (AICPA) had defined accounting as
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 financial character, and
interpreting the results thereof”.
As per Robert N. Anthony “Accounting system is a means of collecting, summarizing,
analyzing and reporting, in monetary terms, information about the business”
Functions of Accounting:
All companies use accounting to report, track, execute and predict financial transactions. The
main functions of accounting are to store and analyze financial information and oversee
monetary transactions. Accounting is used to prepare financial statements for a company's
employees, leaders, and investors. Accounting also functions to ensure the payment of funds
into and out of a company.
Accounting creates a fiscal history for any company. It is used to track expenditures from
business operations as well as a company's profits. It can also be utilized to predict financial
success and the future needs of a company to create budgets and take advantage of new growth
opportunities. Accountants use this information to prepare financial statements used by
business professionals and government officials.
The functions of accounting in a business include the following:
Business Costs and Revenue
An important function of accounting is to track business spending in relation to income. Just
like managing your personal finances, accountants record expenses and payments to keep an
accurate and up to date record of the company's funds.
Accounts Receivable
Proper accounting ensures the company receives any payment they are due. An accountant
tracks the profits of a business to ensure that revenue is continually flowing into their bank
account.
Accounts Payable
Accounts payable functions to pay the company's bills. They ensure the business pays for any
money they owe and check that it is a legitimate charge. They also help set the due dates for
payments so a company can best manage their own funds based on when money is coming in.
Payroll
Accountants deduct employee wages from company funds for pay checks. They are also in
charge of managing employee benefits if they are paid out of an employee's income.
Accounting may help decide how employees are compensated for their work based on how
wages affect the company's profits.
Financial Reporting
Accountants use digital systems to store and calculate data. If a company is publicly owned, it
must also prepare both quarterly and yearly reports for shareholders detailing the assets, profits
and losses of the business. Privately-owned companies also utilize fiscal reports like these to
understand the financial resources of their firm.
Financial Analysis
Companies use accounting to perform regular analysis of how well the business is performing.
Either outside consultant or internal personnel will look at the business as a whole to determine
what functions can be made more efficient based on financial outcomes. They may suggest
changes to employee departments or streamlined costs for production to reduce waste.
Taxes and Compliance
A business must comply with government laws and standards from the Internal Revenue
Service and the Securities and Exchange Commission, among other regulations. States also
enforce monetary guidelines for businesses. Accounting is responsible for reporting the
financial workings of the company and making sure they conform to all local and national laws
and guidelines.
Budgeting
Accounting is in charge of setting a company's budget. They use financial data from the past
as well as projections for future income to compose annual budgets. Accountants also prepare
budgets for individual departments and special projects within the company.
Objective of Accounting in Business:
To maintain a systematic record of business transactions
• Accounting is prepared to maintain a systematic record of all the financial transactions or
monetary transaction in a book of accounts
• For this purpose, all the transactions are recorded in chronological order in Journal and then
posted to principal book i.e., Ledger, Trial balance.
To ascertain profit and loss
• Every businessman is curious to know the net results of business operations periodically.
• In order to find out whether the business has earned profits or incurred losses, we prepare a
“Profit & Loss Account”.
To determine the financial position
• Another important objective is to determine the financial position of the business to check the
value of assets and liabilities.
• For this purpose, we prepare a “Balance Sheet”. To provide information to various users
To provide information to the various interested parties or stakeholders
• The information provided by accounts helps them in making good financial decisions. To
assist the management
• By analysing financial data and providing interpretations in the form of reports, accounting
assists management in handling business operations effectively
Branches of Accounting
1. Financial accounting: Financial accounting is concerned with the preparation of periodic
financial reports by using historical data of a business enterprise. The basic purpose of
these reports is to provide useful and timely information about an entity’s financial position
and its operating results to owners, managers, investors, creditors and government agencies
etc. Financial position refers to the resources and obligations of a business at any given point
of time and operating results means the net profit earned or net loss incurred by a business
enterprise during a particular period of time.

There are certain rules known as “generally accepted accounting principles (GAAP)” that each
business enterprise must follow while preparing its financial reports to ensure that the financial
information published by it is useful, reliable and comparable with other companies.

Financial accounting is also termed as the “general purpose accounting” because the
information generated by it is published for the use of everyone connected with the business
enterprise.

2. Management accounting: Management accounting system uses historical as well as

estimated data to generate useful reports and information to be used by internal management
for decision making purpose. Unlike financial accounting, the information generated by
management accounting is not published for external parties but is used by managers to
perform their core functions such as evaluation of various products and departments in terms
of profitability, selection of the best available alternatives and making other business decisions
to achieve organizational goals. As the reports generated by management accounting are not
accessed and used by any external party, the business enterprises don’t need to take care of
GAAP while drafting them.

3. Cost accounting: The cost accounting is concerned with categorizing, tracing and
collecting manufacturing costs of a business enterprise. The cost data collected so is used by
management in planning and control. A well-established cost accounting system is essential
for every business enterprise to have a proper control over its costs.
4. Tax accounting: Tax accounting deals with tax related matters of a business enterprise. It
includes computation of taxable income and presentation of financial or other information to
tax authorities as required by tax laws and regulations of a country.

The reports and information generated by financial accounting system satisfy the needs of
external parties to great extent. However, the rules and methods followed by a company for
preparing its financial accounting reports may slightly differ from those required by tax laws.
The work of a tax accountant is to adjust the net operating results and rearrange the information
generated by financial accounting to conform with the tax reporting requirements of a country.
Besides it, tax accountants also help companies minimize their tax obligations. Because of
these functions, tax accountants need to have an updated knowledge about tax laws and
regulations.

Tax accounting is also important for managers because taxes usually have a significant impact
on the expected outcomes of proposed decisions.

5. Project accounting: Project accounting is a component of overall project management. It

is a specially designed accounting system that prepares financial reports at appropriate intervals
of time to track the financial progress of a project. These reports provide vital information to
project managers in performing their project management function. The use of project
accounting is very common among companies involved in construction contracts.

6. Not-for-profit accounting: Not-for-profit accounting fulfils the accounting needs of not-

for-profit organizations (also known as non-trading concerns). It is concerned with recording
events, preparing reports, and planning operations of not-for-profit organizations such as
charities, churches, educational institutions, hospitals, government agencies and clubs etc. The
basic accounting principles and concepts used while applying not-for-profit accounting are the
same as used in regular or general-purpose financial accounting.

7. International accounting: Intentional accounting deals with the issues and complications
involved in doing trade in world or international markets. Many companies have expanded
their business internationally. Such companies need to employ accountants who possess
detailed knowledge about accounting. custom and taxation laws applicable in different
countries.

8. Government accounting: Government accounting is concerned with the allocation and

utilization of government budgets. It ensures that the central or state government funds released
for various purposes are being utilized efficiently. The proper record keeping makes the audit
of completed projects possible.

9. Social accounting: Social accounting is concerned with analysing and evaluating

organizational impact on society and its environment. It measures the social costs and benefits
of various organizational activities. For example, accountants in this area might analyse and
evaluate the use of federal and state land or the use of welfare funds in a large city. Other
accountants might analyse and evaluate the environmental impact of acid rain.

10. Forensic accounting: Forensic accounting deals with legal issues faced by business
enterprises. Accountants in this area use their knowledge, skills and techniques to deal with
legal matters such as dispute resolution, claim settlement, fraud investigation, court and
litigation cases etc.
11. Fiduciary accounting: Fiduciary accounting refers to the management of financial
records by a person to whom the custody and management of some property has been entrusted
for the benefit of another person. Estate accounting, trust accounting, and receivership are some
examples of fiduciary accounting.

12. Auditing: The term auditing generally refers to review, examination, verification,
evaluation or inspection of historical data, records or events belonging to an entity. The person
who performs the work of audit is known as auditor. In accounting and business, there are two
types of auditing – external auditing and internal auditing.

External auditing refers to the independent examination of an entity’s financial statements and
other accounting records that an entity publishes for the use of various stakeholders.
The auditor gives his opinion about the fairness of all accounting information examined by
him. An important element of “fairness” is the compliance of financial statements with the
generally accepted accounting principles (GAAP).

Internal auditing is performed to determine whether or not the policies and procedures set by
management are being followed. An important purpose of internal auditing is to evaluate
whether the activities performed by the employees at various levels are in line with the goals
set by management. Internal auditing may be performed by the existing accountants; however,
many companies employ special staff for this purpose.

Accounting Cycle:

Identifying financial transactions and events

• only those transactions and events which are of financial nature.
• Therefore, first of all, such transactions and events are identified.
Measuring the transactions
• The transactions and events are measured in terms of money which is considered as a common
unit.
Recording of transactions
• Accounting involves recording the financial transactions inappropriate book of accounts such
as Journal or Subsidiary Books.
Classifying the transactions
• Transactions recorded in the books of original entry – Journal or Subsidiary books are
classified and grouped according to nature and posted in separate accounts known as ‘Ledger
Accounts’.
Summarising the transactions
• It involves presenting the classified data in a manner and in the form of statements, which are
understandable by the users.
• It includes Trial balance, Trading Account, Profit and Loss Account and Balance Sheet.
Analysing and interpreting financial data
• Results of the business are analysed and interpreted so that users of financial statements can
make a meaningful and sound judgment.
Communicating the financial data or reports to the users
• Communicating the financial data to the users on time is the final step of accounting so that
they can make appropriate decisions. It not only record classifies and summaries the business
data but also analyse and interprets the results for the future decisions.

Distinction between Book-keeping and Accounting:

Bookkeeping: It is a component of accounting that involves the process of identifying the
financial transactions, measuring, recording and classifying those transactions that have
occurred in the course of business.
Accounting: Accounting begins where Book Keeping ends. It is a wider concept and includes
summarizing, interpreting and communicating the financial data to the users of financial
statements.
Accountancy: Accountancy refers to systematic knowledge of the accounting principles and
the techniques.

Bookkeeping Accounting

Definition

Bookkeeping deals with Accounting refers to the process of summarising,

identifying and recording financial interpreting and communicating the financial data
transactions only of an organisation.

Decision making

Data provided by bookkeeping is Management can take important decisions based

not sufficient for decision making on the data obtained from accounting

Preparation of Financial Statement

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

Analysis

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

Persons Involved

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

Determining Financial Position

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

Level of Learning

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

and analysing accounting concepts

User of Accounting Information:

Shareholders and Investors: Since shareholders and other investors have invested their
wealth in a business enterprise, they are interested in knowing periodically about the
profitability of the enterprise, the soundness of their investment and the growth prospects of
the enterprise. Historically, business accounting was developed to supply information to those
who had invested their funds in business enterprises.
Creditors: Creditors may be short-term or long -term lenders. Short-term creditors include
suppliers of materials, goods or services. They are normally known as trade creditors. Long-
term creditors are those who' have lent money for a long period, usually in the form of secured
loans. The main concern of the creditors is focused on the credit worthiness of the firms and
its ability to meet its financial obligations. They are therefore concerned with the liquidity of
the firms, its profitability and financial soundness. In other words, it can also be stated that
creditors are interested mainly in information which deals with solvency, liquidity and
profitability so that they could assess the financial standing of the firms.
Employees: The view that business organisations exist to maximise the return to shareholders
has been undergoing change as a result of social changes. A broader view is taken today of
economic and social role of management. The importance of harmonious industrial relations
between management and employees cannot be over-emphasised. That the employees have a
stake in the outcomes of several managerial decisions is recognised. Greater emphasis on
industrial democracy through employee participation in management decisions has important
implications for the supply of information to employees. Matters like settlement of wages,
bonus, and profit sharing rest on adequate disclosure of relevant facts.
Government: In a mixed economy it is considered to be the responsibility of the Government
to direct the operation of the economic system in such a manner that it sub serves the common
good. Controls and regulations on the operations of private sector enterprises are the hallmark
of mixed economy. Several government agencies collect information about various aspects of
the activities of business organisations. Much of this information is a direct output of the
accounting system, for example, levels of outputs, profits, investments, costs, and taxes, etc.
All this information is very important in evolving policies for managing the economy. The task
of the Government in managing the industrial economy of the country is facilitated if
accounting information is presented, as far as possible, in a uniform manner. It is clear that if
accounting information is distorted due to manipulations and windowdressing in the
presentation of annual accounts, it will have ill-effects on the measures the government intends
to take and the policies it wishes to adopt.
Management: Organisations may or may not exist for the sole purpose of profit. However,
information needs of the managers of both kinds of organisations are almost the same, because
the managerial process i.e., planning, organising and controlling is the same. All these
functions have one thing in common and it is that they are all concerned with making decisions
which have their own specific information requirements. The emphasis on efficient and
effective management of organisations has considerably extended the demand for accounting
information. The role of accounting as far as management is concerned was highlighted earlier
when we discussed about management accounting.
Consumers and others: Consumers' organisations, media, welfare organisations and public at
large are also interested in condensed accounting information in order to appraise the efficiency
and social role of the enterprises in different sectors of the economy, that is, what levels of
profits and outputs are being achieved, in what way the social responsibility is being discharged
and in what manner the growth is being planned by the enterprises in-accordance with the
national priorities etc. The above discussion perhaps has indicated to you that the information
needs of the various users may not necessarily be the same. Sometimes, they may even conflict
and compete with each other. In any case, the objective of accounting information is to enable
information users to make optimum decisions.
Limitations of Accounting:
Following are the limitations of accounting:
Accounting is not precise: Accounting is often subjected to personal bias or judgment.
Accounting is done on historic values of assets: Accounting records assets at their historical
cost less depreciation and does not reflect their current market value.
Ignore the effect of price level changes: Accounting statements are prepared at historical cost
and thus ignores the changes in the value of money.
Ignore the qualitative information: Accounting ignores the qualitative aspects as it records
only monetary transactions.
Affected by window dressing: Window dressing means manipulation in accounting to present
a more favourable position of the business than the actual position.

Unit – 2
Accounting Principles and Concepts
Accounting principles are the set guidelines and rules issued by accounting standards like
GAAP and IFRS for the companies to follow while recording and presenting the financial
information in the books of accounts. These principles help companies present a true and fair
representation of financial statements.
Accounting principles have been defined as the body of doctrine, commonly associated with
the theory and procedure of accounting, serving as an explanation of current practices and as a
guide L for the selection of conventions or procedures where alternatives exist.
Rules governing the guide for the selection of conventions or procedures where alternatives
exist. Rules governing the formation of accounting axioms and the principles derived from
them have arisen from common experiences, historical precedent, statements by individuals
and professional bodies and regulations of governmental agencies
At present, recommendations of the accounting principles have emanated from the professional
bodies, such as The Institute of Chartered Accountants of England and Wales, The A—
Accounting Association, The American-Institute of Certified Public Accountants The Institute
of Chartered Accountants of India, and so on.
As such, The American Institute of Certified Public Accountants (AICPA), in their Accounting
Terminology Bulletin, defines the principles as a “general law or rule adopted or proposed
as a guide to action, a settled ground or basis of conduct or practice”. Paton and Littleton,
however, prefer to use the term ‘Standard’ in place of principles.
The International Federation of Accountants have constituted the ‘International Accounting
Standards Committee’ which lays down the various accounting principles that are in practice.
These principles, of course, have been named as ‘Standards’ in order to avoid the confusion
which may arise from the term ‘Principles’.
Accounting Principles, i.e., a ‘Standard’, should always satisfy the following three rules:
(i) Usefulness (Relevance)
(ii) Objectivity and
(iii) Feasibility.
(i) Usefulness (Relevance):
The ‘Standards’ must cater to the carefulness of the accounting statements. In short, the
statements must be meaningful to the users of the same.
(ii) Objectivity:
The ‘Standards’ should have objectivity, i.e., they must be supported and supplemented by
basic facts or data and not by the whims of the individuals who prepare the statements.
(iii) Feasibility:
The ‘Standards’ must be practicable or feasible to attain. For example, inventory should be
valued at cost price or market price/realisable value whichever is lower. This is determined on
the basis of feasibility and practicability for ascertaining the costs from cost records and
market/ realisable value from the past sales or future trend. Generally the above three factors
are found in accounting standards. But exceptions are there, where a compromise is made and
an optimum balance of the three is struck.
Characteristics of Accounting Principles:
The characteristics of Accounting Principles are:
(a) Accounting principles are made and developed by men (accountants) and, as such, they do
not have the authoritativeness of universal principles, like other natural sciences, viz., Physics,
Chemistry, Mathematics etc., since they cannot be validated/proved by reference to natural
laws as in the case of physical sciences. They are the best possible suggestions based on
practical experiences, reasons and observations which have been developed by the accountants.
(b) Accounting principles are developed for common usage to ensure uniformity and
understandably. They also enhance the usefulness of facts and figures relating to economic
activities of the firm.
(c) The principles are not specifically made or enhanced by any authority.
(d) The principles are in the process of evolution, i.e., are not in their finished form. On the
other hand, they are fast developing.
(e) They are not rigid.
(f) The Principles should generally be acceptable and, for the purpose, the three criteria
(referred to above)—viz., usefulness, objectivity, and feasibility-must be fulfilled.
Importance of Generally Accepted Accounting Principles (GAAP)
Without GAAP, companies wouldn't be held to a strict set of standards, which means they'd
have a lot more leeway in deciding what information they choose to share or keep hidden.
GAAP, therefore, serves the very-important function of making sure companies and
organizations can't "cheat" on their financial reporting.
GAAP allows investors to easily evaluate companies simply by reviewing their financial
statements. If an investor is torn between two companies in the same industry, that investor can
compare their respective statements to determine which is doing a better job at generating
revenue and managing cash flow.
However, this wouldn't be possible if companies were allowed to pick and choose what
financial information to present. When applied to government entities, GAAP helps taxpayers
understand how their tax dollars are being spent.
GAAP also helps companies gain key insights into their own practices and performance.
Furthermore, GAAP minimizes the risk of erroneous financial reporting by having numerous
checks and safeguards in place. The information provided in GAAP-compliant financial
statements can therefore generally be regarded as reliable and accurate.

Generally Accepted Accounting Principles

The following are the general accounting principles as mentioned earlier:
• Business Entity Assumption: It states that every business entity should be treated as
an entity that is separate from its owners. Therefore, all financial transactions should
also be distinguished in such a manner. This concept is especially important while
recording financial transactions of a sole proprietor. When the entire business with its
assets and liabilities belong to the proprietor, the financial transactions need to be
distinguished between those related to the business and those related to the proprietor
personally.
• Monetary Unit Assumption: All the financial transactions of a business should be
capable of being expressed in a monetary unit (Indian Rupees, for example) and if it is
not possible to do so, then it should not be recorded in the books of accounts of the
business.
• Accounting Period: This principle entails that the accounting process of a business
should be completed within a certain time period which is usually a financial year or a
calendar year. Thus, every transaction which relates to a particular accounting period
will form a part of the financial statements prepared for that period.
• Historical Cost Concept: As a general rule, when certain economic resources or assets
are acquired by an enterprise, they are recorded as per the cash or cash equivalent
actually spent to acquire that resource or asset on the transaction date – even if the
transaction happened the previous day or ten years ago. This would result in the value
of the remaining asset constant irrespective of the accounting period. The market value
of the asset is not taken into account unless specifically required by law or an
accounting standard.
• Going Concern Assumption: The business entity is assumed to be a going concern,
i.e., it will continue to operate for an indefinite amount of time. This assumption is
important because if the business entity were to liquidate in the near future, it would
have to restate its assets and liabilities in the accordance with the actual amount that
could be realised or payable as the case may be so as to reflect the true financial position
of the entity.
• Full Disclosure Principle: An accounting entry may not independently be able to
provide all the relevant information relating to the transaction. Hence the full disclosure
principle requires the entity to disclose all the financial information relevant to the
investor/user to assist him in decision making. At the transactional level, this is done
by recording an adequate narration with every transaction and at the financial statement
level, this is implemented by providing notes to the accounts.
 • Matching Concept: This concept requires the revenue for a particular period to be
matched with its corresponding expenditure so as to show the true profit for the period.
• Accrual Basis of Accounting: This principle requires all revenue and expenditure to
be recorded in the period it is actually incurred and not when cash or cash equivalent
has been received/spent. The earning of the income and the incurring of the expenditure
is important, irrespective of the corresponding cash flow.
• Consistency: An entity may decide to follow a particular accounting procedure in
relation to a series of transactions. Such accounting procedures need to be followed
consistently over the following accounting periods so as to facilitate comparison of the
results between two periods. For example, an entity might choose to adopt the straight-
line method of depreciation of its tangible fixed assets. This method needs to be
consistently followed even in the coming years.
• Materiality: This accounting principle allows an entity to disregard another accounting
principle if the result of the same does not affect the decision making of the user of the
financial statements. Certain errors or omissions may also be ignored if their effect is
immaterial to the financial statements. For example, when a fixed asset is purchased,
the matching concept requires the entity to recognise the expenditure over the useful
life of the asset. If an entity purchases a keyboard for Rs. 300 and the turnover of such
an entity is in crores of rupees, it would be immaterial to the user of financial statements
whether such an asset is recognised as an asset or expense. Thus, even if the computer
keyboard is considered as an expense in the year of purchase, it would not be violating
the basic accounting principles since the amount involved and the impact of the same
is immaterial.
• Conservatism: In the process of accounting, one might come across various situations
where there are two equally acceptable ways of accounting for a particular transaction.
One might even have to choose between recording a transaction or not recording the
same. In such a situation, a conservative approach should be followed. This means that
while accounting for a particular transaction, all anticipated expenses or losses will need
to be accounted for but all potential income or gains should not be recorded until
actually earned/received. This is why a provision for expenses like bad debts is made
but there is no corresponding record provided for an increase in the realisable value of
an asset.
Accounting Conventions
Accounting conventions are guidelines used to help companies determine how to record certain
business transactions that have not yet been fully addressed by accounting standards. These
procedures and principles are not legally binding but are generally accepted by accounting
bodies. Basically, they are designed to promote consistency and help accountants overcome
practical problems that can arise when preparing financial statements.
Areas Where Accounting Conventions Apply
Accounting conservatism may be applied to inventory valuation. When determining the
reporting value of inventory, conservatism dictates that the lower of historical cost or
replacement cost should be the monetary value.
Accounting conventions also dictate that adjustments to line items should not be made for
inflation or market value. This means book value can sometimes be less than market value. For
example, if a building costs $50,000 when it is purchased, it should remain on the books at
$50,000, regardless of whether it is worth more now.
Estimations such as uncollectible accounts receivables and casualty losses also use the
conservatism convention. If a company expects to win a litigation claim, it cannot report the
gain until it meets all revenue recognition principles. However, if a litigation claim is expected
to be lost, an estimated economic impact is required in the notes to the financial
statements. Contingent liabilities such as royalty payments or unearned revenue are to be
disclosed, too.
Distinction between Accounting Concepts and Accounting Conventions

BASIS FOR
ACCOUNTING CONCEPT ACCOUNTING CONVENTION
COMPARISON

Meaning Accounting concepts refers to the Accounting conventions implies the

rules of accounting which are to customs or practices that are widely
be followed, while recording accepted by the accounting bodies and
business transactions and are adopted by the firm to work as a
preparing final accounts. guide in the preparation of final
accounts.

What is it? A theoretical notion A method or procedure

Set by Accounting bodies Common accounting practices

Concerned with Maintenance of accounts Preparation of financial statement

Biasness Not possible Possible

Accounting as a measurement and Valuation System

Accounting measurement is the calculation of economic or financial activities in terms of
money, hours or other units. Overall, accounting measurement is more than just an element
that helps with comparing and evaluation of data in accounting.
Accounting information provides useful measures of performance and financial position.
Therefore it needs to provide information about value: the value of an entire business, the value
of assets and liabilities, etc.
Example of Accounting and Measurement
Two business entities are having sales of Rs.100,000. Entity A may achieve this with two
salespeople and entity B may achieve it with ten . Therefore, consequently, entity A’s sales
team is much more productive, bringing in Rs.50,000 per salesperson per week. \Whereas only
Rs.10,000 per salesperson per week for entity B.
On the other hand, if entity A has a total of 200 employees, and entity B has a total of 100, then
entity A is achieving only Rs.500 per employee (Rs.100,000/200 and entity B is achieving
Rs.1000 per employee (Rs.1,00,000/100). Hence, this might suggest that entity A has too much
administrative overhead or that entity B runs a very efficient operation.

Unit – 3
Accounting Standards
Meaning of Accounting Standards:
Accounting standards are the written statements consisting of rules and guidelines, issued by
the accounting institutions, for the preparation of uniform and consistent financial statements
and also for other disclosures affecting the different users of accounting information.
Accounting standards lay down the terms and conditions of accounting policies and practices
by way of codes, guidelines and adjustments for making the interpretation of the items
appearing in the financial statements easy and even their treatment in the books of account.
Concept of Accounting Standards:
We know that Generally Accepted Accounting Principles (GAAP) aims at bringing uniformity
and comparability in the financial statements. It can be seen that at many places, GAAP permits
a variety of alternative accounting treatments for the same item. For example, different methods
for valuation of stock give different results in financial statements.
Such practices sometimes can misguide intended users in taking decision relating to their field.
Keeping in view the problems faced by many users of accounting, a need for the development
of common accounting standards was aroused.
For this purpose, the Institute of Chartered Accountants of India (ICAI), which is also a
member of International Accounting Standards Committee (IASC), had constituted
Accounting Standard Board (ASB) in the year 1977. ASB identified the areas in which
uniformity in accounting was required. After detailed research and discussions, it prepared and
submitted a draft to the ICAI. After proper examination, ICAI finalized them and notified for
its use in financial statements.
Nature of Accounting Standards:
On the basis of forgoing discussion we can say that accounting standards are guide, dictator,
service provider and harmonizer in the field of accounting process.
(i) Serve as a guide to the accountants:
Accounting standards serve the accountants as a guide in the accounting process. They provide
basis on which accounts are prepared. For example, they provide the method of valuation of
inventories.
(ii) Act as a dictator:
Accounting standards act as a dictator in the field of accounting. Like a dictator, in some areas
accountants have no choice of their own but to opt for practices other than those stated in the
accounting standards. For example, Cash Flow Statement should be prepared in the format
prescribed by accounting standard.
(iii) Serve as a service provider:
Accounting standards comprise the scope of accounting by defining certain terms, presenting
the accounting issues, specifying standards, explaining numerous disclosures and
implementation date. Thus, accounting standards are descriptive in nature and serve as a service
provider.
(iv) Act as a harmonizer:
Accounting standards are not biased and bring uniformity in accounting methods. They remove
the effect of diverse accounting practices and policies. On many occasions, accounting
standards develop and provide solutions to specific accounting issues. It is thus clear that
whenever there is any conflict on accounting issues, accounting standards act as harmonizer
and facilitate solutions for accountants.
Objectives of Accounting Standards:
(i) For bringing uniformity in accounting methods:
Accounting standards are required to bring uniformity in accounting methods by proposing
standard treatments to the accounting issue. For example, AS-6(Revised) states the methods
for depreciation accounting
(ii) For improving the reliability of the financial statements:
Accounting is a language of business. There are many users of the information provided by
accountants who take various decisions relating to their field just on the basis of information
contained in financial statements. In this connection, it is necessary that the financial statements
should show true and fair view of the business concern. Accounting standards when used give
a sense of faith and reliability to various users.
They also help the potential users of the information contained in the financial statements by
disclosure norms which make it easy even for a layman to interpret the data. Accounting
standards provide a concrete theory base to the process of accounting. They provide uniformity
in accounting which makes the financial statements of different business units, for different
years comparable and again facilitate decision making.
(iii) Simplify the accounting information:
Accounting standards prevent the users from reaching any misleading conclusions and make
the financial data simpler for everyone. For example, AS-3 (Revised) clearly classifies the
flows of cash in terms of ‘operating activities’, ‘investing activities’ and ‘financing activities’.
(iv) Prevents frauds and manipulations:
Accounting standards prevent manipulation of data by the management and others. By
codifying the accounting methods, frauds and manipulations can be minimized.
(v) Helps auditors:
Accounting standards lay down the terms and conditions for accounting policies and practices
by way of codes, guidelines and adjustments for making and interpreting the items appearing
in the financial statements. Thus, these terms, policies and guidelines etc. become the basis for
auditing the books of accounts.
Limitations of Accounting Standards:
Accounting standards have important role in the accounting system. Apart from their
importance, they have certain limitations also. Some of these limitations are discussed below:
Brings Inflexibility & Rigidity
It is one of the major disadvantage of accounting standards. Accounting standards basically
establish each & every principles and rules for accounting treatment. Every company is
required to follow the same principles constantly.
Therefore all companies are required to fit themselves into guidelines of accounting standards.
Every companies goes through different situations & have different financial transactions.
Sometimes it becomes difficult for them to follow the same guidelines.
Involves High Costs
Another disadvantage of following accounting standards is that it involves high costs.
Implementing accounting standards in your accounting standards is too costly.
Company need to change their entire procedures, upgrade their systems & provide their
employee’s training accordingly. Companies need to monitor whether employees are correctly
following standards. All these activities require large costs for bringing changes.
Difficult To Choose Among Alternatives
Choosing among different alternatives available is another disadvantage of Accounting
standards. Accounting standards provides many options for treatment of the same accounting
concept.
It becomes difficult for companies to decide which one is best for them. Accounting standard
does not clearly state that which one is the appropriate choice. For ex. for stock valuation there
are 3 alternatives available. These are weighted average, FIFO & LIFO method. Choosing
which one is best is difficult task.
Scope Is Restricted
The accounting standards are followed in accordance with prevailing laws &
statutes. Accounting standards cannot override the statutes & laws. These standards are created
& framed in accordance with prevailing laws. Using these standards as per the prevailing laws
can limit & restricts their scope.
Time-Consuming
Another drawback of Accounting standards is that it is time-consuming. Implementation of
accounting standards requires many steps to be followed to prepare financial report. It makes
the process of preparing financial statements complex & time-consuming.
It defines each & every step for preparation of financial reports. Accounting standards involves
income statement, trial balance & balance sheet preparation. Accountants need to strictly
comply with rules of accounting standards. It makes their work complex & rigid.

Accounting Standards specified by ICAI:

The ICAI has put out a total of 32 Accounting Standards (AS-1 to AS-32), of which AS-1 to
AS-29 are mandatory. AS-6, AS-8, AS-30, AS-31, and AS-32 have been taken away by the
ICAI through different Announcements. So, as of February 1, 2022, there are really only 27
Accounting Standards of ICAI. All these accounting standards are mandatory in nature, as of
01/07/2017:
ICAI’s AS-1: Disclosure of Accounting Policies
AS-1 of ICAI deals with disclosing significant accounting policies applied in preparing and
presenting financial statements in a supplementary statement/notes to permit meaningful
comparison of financial statements of different enterprises/periods.
ICAI’s AS-2: Valuation of Inventories
AS-2 of ICAI deals with determining the value at which inventories are carried in financial
statements, including cost and net realisable value.
ICAI’s AS-3: Cash Flow Statements
AS-3 of ICAI provides information on an enterprise’s historical changes in cash and cash
equivalents through a Cash Flow Statement, which distinguishes cash flows from operating,
investing, and financing activities.
ICAI’s AS-4: Contingencies and Events Occurring After Balance Sheet Date
AS-4 of ICAI covers post-balance-sheet events and contingencies.
ICAI’s AS-5: Net profit or Loss for the period, Prior Period Items and Changes in
Accounting Policies
AS-5 of ICAI should be applied when presenting profit or loss from ordinary activities,
extraordinary items, and prior period items in the Statement of Profit and Loss, accounting for
changes in accounting estimates, and disclosing accounting policy changes.
ICAI’s AS-7: Construction Contracts
AS-7 of ICAI prescribes the accounting for construction contracts in the financial statements
of contractors.
ICAI’s AS-9: Revenue Recognition
AS-9 of ICAI covers revenue recognition in an enterprise’s P&L. The Standard addresses the
recognition of revenue from the sale of goods, the provision of services, and interest, royalties,
and dividends.
ICAI’s AS-10: Property, Plant and Equipment
The objective of AS-10 of ICAI is to prescribe the accounting treatment for property, plant and
equipment (PPE).
ICAI’s AS-11: The Effects of Changes in Foreign Exchange Rates
AS-11 of ICAI provides accounting standards for foreign currency transactions and foreign
operations, such as which exchange rate to employ and how to recognise the financial effect of
exchange rate changes.
ICAI’s AS-12: Government Grants
AS-12 of ICAI covers accounting for government grants (subsidies, monetary incentives, duty
drawbacks, etc.).
ICAI’s AS-13: Accounting for Investments
AS-13 of ICAI deals with accounting for investments in the financial statements of enterprises
and related disclosure requirements.
ICAI’s AS-14: Accounting for Amalgamations
AS-14 of ICAI deals with accounting for amalgamations and the treatment of any resultant
goodwill or reserves.
ICAI’s AS-15: Employee Benefits
AS-15 of ICAI prescribes accounting treatment and disclosure for employee perks except
employee share-based payments. It doesn’t cover employee benefit plan accounting and
reporting.
ICAI’s AS-16: Borrowing Costs
AS-16 of ICAI applies to borrowing costs. This Standard doesn’t include the actual or imputed
cost of owners’ equity, including preference share capital that’s not a liability.
ICAI’s AS-17: Segment Reporting
AS-17 of ICAI establishes rules for reporting financial information concerning a company’s
segments/products/services and geographic locations.
ICAI’s AS-18: Related Party Disclosures
AS-18 of ICAI should be used to report related party transactions and relationships. This
Standard applies to each reporting enterprise’s financial statements and a holding company’s
consolidated financial statements.
ICAI’s AS-19: Leases
AS-19 of ICAI prescribes accounting standards and disclosures for financing and operating
leases for lessees and lessors.
ICAI’s AS-20: Earnings Per Share
AS-20 of ICAI establishes criteria for determining and presenting earnings per share, which
improves performance comparisons between enterprises and accounting periods.
ICAI’s AS-21: Consolidated Financial Statements
AS-21 establishes methods and principles for consolidated financial statements. These
statements show the economic resources controlled by a parent and its subsidiary(ies) as a
single economic entity, its liabilities, and the results it produces with its resources.
ICAI’s AS-22: Accounting for Taxes on Income
The purpose of AS-22 of the ICAI is to regulate the accounting treatment of taxes on income,
as the taxable income may differ significantly from the accounting income for a variety of
reasons, creating difficulties in matching taxes against revenue for a period.
ICAI’s AS-23: Accounting for Investments in Associates
AS-23 of the ICAI to be applied in the production and presentation of consolidated Financial
Statements (CFS) by an investor when accounting for investments in associates.
ICAI’s AS-24: Discontinuing Operations
AS-24 of the ICAI establishes guidelines for reporting information on discontinuing
operations, allowing readers of financial statements to predict an enterprise’s cash flows,
earnings-generating potential, and financial position by distinguishing discontinuing and
continuing operations information. AS 24 applies to all enterprises discontinuing operations.
ICAI’s AS-25: Interim Financial Reporting
AS-25 of the ICAI is applicable if a business is required or elects to issue an interim financial
report. This standard’s aim is to regulate the minimum content of an interim financial report
and the rules for recognition and measurement in complete or condensed financial statements
for an interim period.
ICAI’s AS-26: Intangible Assets
ICAI AS-26 specifies the accounting treatment for intangible assets (i.e. identifiable non-
monetary asset, without physical substance, held for use in the production or supply of goods
or services, for rental to others, or for administrative purposes).
ICAI’s AS-27: Financial Reporting of Interests in Joint Ventures
AS-27 of the ICAI is intended to create accounting rules and reporting systems for joint venture
interests, assets, liabilities, income, and expenses in venturers’ and investors’ financial
statements.
ICAI’s AS-28: Impairment of Assets
AS-28 of the ICAI outlines the measures a business must take to ensure its assets are carried at
their recoverable value. AS 28 mandates an entity to recognise an impairment loss if an asset’s
carrying amount exceeds what may be recovered through use or sale. AS 28 addresses the
impairment of all assets unless specifically excluded.
ICAI’s AS-29: Provisions, Contingent Liabilities and Contingent Assets
AS-29 of the ICAI ensures that proper recognition criteria and measurement bases are applied
to provisions and contingent liabilities, and that sufficient information is published in the
financial statements’ notes to help users understand their nature, timing, and amount. This
Standard defines contingent asset accounting.
Note:
1. ICAI has withdrawn the AS 8 on Accounting for Research and Development.
2. ICAI Amends AS 2, AS 4, AS 10, AS 13, AS 14, AS 21, AS 29 and withdraws AS 6.
3. ICAI withdraws its Announcement on Treatment of exchange differences under AS 11
4. Companies (Accounting Standards) Amendment Rules, 2018 notified by MCA: AS 11
amended
List of ICAI’s Non-Mandatory Accounting Standards (AS 30~32)
ICAI has announced on 15/11/2016 that following Accounting Standards stands withdrawn:
i) AS 30: Financial Instruments – Recognition and Measurement;
ii) AS 31: Financial Instruments – Presentation; and
iii) AS 32: Financial Instruments – Disclosures.
Revised Accounting Standards of ICAI
ICAI is revising all Accounting Standards for non-Ind AS entities. When implemented, 32
standards in various levels of revision/formulation will replace the existing standards. ICAI
will maintain consistency/synchronization in the numbering of AS with numbering of Ind AS,
i.e. existing Accounting Standards shall be amended and renumbered suitably.
International Financial Reporting Standards:
International Financial Reporting Standards (IFRS) are a set of accounting rules for the
financial statements of public companies that are intended to make them consistent,
transparent, and easily comparable around the world.
IFRS currently has complete profiles for 167 jurisdictions, including those in the European
Union. The United States uses a different system, the generally accepted accounting
principles (GAAP).1
The IFRS is issued by the International Accounting Standards Board (IASB).
The IFRS system is sometimes confused with International Accounting Standards (IAS),
which are the older standards that IFRS replaced in 2001.
Understanding International Financial Reporting Standards (IFRS)
IFRS specify in detail how companies must maintain their records and report their expenses
and income. They were established to create a common accounting language that could be
understood globally by investors, auditors, government regulators, and other interested parties.
The standards are designed to bring consistency to accounting language, practices, and
statements, and to help businesses and investors make educated financial analyses and
decisions.
They were developed by the International Accounting Standards Board, which is part of the
not-for-profit, London-based IFRS Foundation. The Foundation says it sets the standards to
“bring transparency, accountability, and efficiency to financial markets around the world."2
IFRS vs. GAAP
Public companies in the U.S. are required to use a rival system, the generally accepted
accounting principles (GAAP). The GAAP standards were developed by the Financial
Standards Accounting Board (FSAB) and the Governmental Accounting Standards Board
(GASB).
The Securities and Exchange Commission (SEC) has said it won't switch to International
Financial Reporting Standards but will continue reviewing a proposal to allow IFRS
information to supplement U.S. financial filings.3
There are differences between IFRS and GAAP reporting. For example, IFRS is not as strict in
defining revenue and allows companies to report revenue sooner. A balance sheet using this
system might show a higher stream of revenue than a GAAP version of the same balance sheet.
IFRS also has different requirements for reporting expenses. For example, if a company is
spending money on development or on investment for the future, it doesn't necessarily have to
be reported as an expense. It can be capitalized instead.
Standard IFRS Requirements
IFRS covers a wide range of accounting activities. There are certain aspects of business practice
for which IFRS set mandatory rules.
• Statement of Financial Position: This is the balance sheet. IFRS influences the ways
in which the components of a balance sheet are reported.
• Statement of Comprehensive Income: This can take the form of one statement or be
separated into a profit and loss statement and a statement of other income, including
property and equipment.
• Statement of Changes in Equity: Also known as a statement of retained earnings, this
documents the company's change in earnings or profit for the given financial period.
• Statement of Cash Flows: This report summarizes the company's financial
transactions in the given period, separating cash flow into operations, investing, and
financing.4
In addition to these basic reports, a company must give a summary of its accounting policies.
The full report is often seen side by side with the previous report to show the changes in profit
and loss.
A parent company must create separate account reports for each of its subsidiary companies.

Unit – 4
Recording of Transactions
Books of Original Entry
Books of original entry are referred to as the books or journal where a business records all the
business transactions initially. The information that is contained in the books of original entry
are summarised and recorded in the general ledger, which is then used to prepare trial balance
and the financial statements.
Types of Books of Original Entry
The following are some of the types of books of original entry.
1. Purchase Journal: Purchase journal is used for recording all credit purchases done by the
business. It is also known as the Purchase day book or the invoice book. It records all the credit
purchase transactions of the core products of the business.
2. Sales Journal: Sales journal is used for recording all the sales done on credit by the business.
It is also known as Sales Daybook or Sales Journal. The credit sales transactions are recorded
for only those goods that belong to the core business operations of the company.
3. Cash Journal: Cash journal is also known as a cash book which records all the cash
transactions such as payments and receipts of the business. Cash book serves the purpose of a
ledger as well as a journal as payments and receipt entries are recorded on credit side and debit
side, respectively.
4. General Journal: The general journal is for recording all those transactions that are not
recorded in the cash book as well as the special journals. Or in other words, the general journal
is a journal which records all the non-specialised entries of the business as there is no specific
journal for such entries. The examples of such entries can be opening entries, closing entries,
rectification entries, transfer entries, entries related to purchase or sale of fixed assets.
Advantages of Books of Original Entry
Following are some of the advantages of the books of original entry.
1. Daily transactions are recorded in the books of original entry which reduces chances of any
omission.
2. The books of original entry records details as well as summary of transactions, which helps
in tracing any error in recording.
3. Transactions are recorded in a chronological order which helps in categorising the
transactions into separate ledgers.
Disadvantages of Books of Original Entry
Here are some of the disadvantages of the books of original entry.
1. Journals can be quite bulky which makes it difficult to manage data.
2. It takes a lot of time to record transactions in ledgers from the journals.
Concept of Double Entry System
Double Entry System of accounting deals with either two or more accounts for every business
transaction. For instance, a person enters a transaction of borrowing money from the bank. So,
this will increase the assets for cash balance account and simultaneously the liability for loan
payable account will also increase.
It’s a fundamental concept encompassing accounting and book-keeping in present times. Every
financial transaction has an equal and opposite effect in at least two different accounts.
Equation can be: ASSETS = LIABILITIES + EQUITY
Recording System
Double entry system records the transactions by understanding them as a DEBIT ITEM or
CREDIT ITEM. A debit entry in one account gives the opposite effect in another account by
credit entry. This means that the sum of all Debit accounts must be equal to the sum of Credit
accounts. This method of accounting and book-keeping results in the accurate depiction
of financial statements. Thus, it also lowers the rate of errors by detecting them on a timely
basis.
Advantages of Double Entry System
• This system increases the Accuracy of the accounting, through the trial balance device
• Profit and loss suffered during the Year can be calculated with details
• By following this system the company can keep the accounting records in detail which
eventually helps in controlling
• The recorded details can be used for comparison purpose as well. Details of the first
year can be compared with the second year, deviations found any during comparison
can be worked on.
Golden and Modern Rules of Accounting
The Three Golden Rules of Accounting – Real, Personal and Nominal Accounts
Traditional Approach consists of rules popularly known as the Three Golden Rules of
Accounting. These rules are applicable irrespective on all categories of the transaction. These
three most talked about and basic Golden rules of accounting are to make debit and credit in
accounting ledger by categorising each and every transaction or entry into either
• Real
• Personal or
• Nominal Accounts
Now let us take each accounting rule in detail.
Real Account
Real Accounts is a set of tangible aspects of business like furniture, cash, etc.
• If the item that belongs to the real account is coming into the business then while
making the accounting entries it should be written on the Debit side.
• If the item of real account is going out of the business then while making the accounting
entries it should be written on the Credit side.
Personal Accounts
• If the person/ group of persons/ legal body is receiving something from the business
then – Debit the receiver
• If the person/ group of persons/ legal body is paying something to the business –
Credit the payer or giver
Nominal Accounts
Nominal Accounts represents all the Expenses, Loses, Income and gains incurred while doing
business. Some common e.g. are Electricity Expenses, Telephone Expenses, Interest Received,
Profit on Sale of Machines, etc.
• If it’s an expense or loss for the business – Debit
• If it’s an income or gain for the business – credit
Classification of Accounts and Modern Rules
The first step is to identify the type of account from either of the 6 categories shown in the
below table. Once the account is determined correctly, apply modern rules of accounting to
prepare a perfect journal entry.

Type of Accounts Debit Credit

Asset Increase Decrease
Liability Decrease Increase
Capital Decrease Increase
Revenue Decrease Increase
Expense Increase Decrease
Drawings Increase Decrease
Tip – Memorize the word (CRADLE) which means “small bed for a baby” in the
English language.
C – Capital, R – Revenue, A – Assets, D – Drawings, L – Liability, E – Expense
Another way to look at modern rules of accounting is,

Subsidiary Books Meaning:

The Subsidiary books are known as the books of original entry. In daily business transactions,
a majority of the transactions are either related to sales, or to purchases or to cash. Thus, we
record the transactions of the same or similar nature in one place, that place is a subsidiary
book. We record the transactions chronologically to facilitate the accountant.
Advantages of Subsidiary Books
The advantages of the subsidiary book are as follows:
1. Proper With Systematic Record of the Business Transactions: The business transactions
are classified and grouped properly in cash and non-cash transactions, these are further
classified as credit purchases, credit sales, and returns, etc. The books facilitate individual
transactions, as they can be properly and systematically recorded in the subsidiary books.
2. Convenience While Posting: The transactions of a nature are recorded at a single place, in
one of the subsidiary books. Example, all the credit purchases of the goods are recorded in the
purchases book while all the credit sales of goods are recorded in the sales book.
3. Efficiency: The work is being divided here which gives the advantage of specialization.
When the same work is done by a person repeatedly and continuously the person becomes
efficient in handling it.
4. Helpful in Decision Making: Subsidiary books provide accurate and complete details about
each type of transaction separately. Thus, the management can use the information as the basis
for deciding the future actions.
5. Errors and Frauds are Prevented: The Internal check becomes more effective as now the
work can be divided in such a manner, where the work of one person is automatically checked
by another person. With this internal check, the possibility of occurrence of the errors or fraud
may be avoided and to the least minimized.
6. Availability of Requisite Information at a Glance: The transactions are entered in only
one journal thus, it becomes difficult to locate the information about a particular item. When
the subsidiary books are maintained, the details about a particular type of transaction can be
easily obtained from the subsidiary books. The maintenance of these subsidiary books helps in
obtaining the necessary information at a single glance.
Unit – 5
Ledger
Meaning of Ledger:
A ledger in accounting refers to a book that contains different accounts where records of
transactions pertaining to a specific account is stored. It is also known as the book of final
entry or principal book of accounts. It is a book where all transactions either debited or
credited are stored.
A ledger account is a combination of all the ledgers and contains information related to all the
accounting activities of an organisation. It is regarded as the most important book in
accounting as it helps in creating a trial balance that acts as a precursor to the preparation of
financial statements.
The information stored in a ledger account contains both starting and ending balances which
are adjusted during the course of the accounting period with respective debits and credits.
A ledger contains different components which include the various transaction elements such
as date, amount, particulars and l.f (ledger folio). Individual transactions are contained within
a ledger account and are identified by a transaction number or any other type of notation.
Ledger Format
The ledger consists of two columns prepared in a T format. The two sides of debit and credit
contain date, particulars, folio number and amount columns. The ledger format is as follows.

Ledger Account Example

Following are some examples of ledger accounts
1. Accounts receivable
2. Cash
3. Depreciation
4. Accounts payable
5. Salaries and wages
6. Revenue
7. Debt
8. Inventory
9. Stockholders’ equity
10. Office expenses
Ledger Posting
The process of transferring entries from a journal to the respective ledger accounts is known
as ledger posting. For this process, first, the entries are recorded in journals and then
transferred to their respective ledger accounts.
Importance of Ledger:
• Transactions relating to a particular person, item or heading of expenditure or income
are grouped in the concerned account at one place.
• When each account is periodically balanced it reflects the net position of that account.
• Ledger is the stepping stone for preparing Trial Balance – which tests the arithmetical
accuracy of the accounting books.
• Since the entries recorded in the journal are referenced into ledger the possibility of
errors of defalcations are reduced to the minimum.
• Ledger is the destination of all entries made in journal or sub-journals.
• Ledger is the “store-house” of all information which subsequently is used for
preparing final accounts and financial statements.