Theory 101

What is principles of accounting?

Three meanings come to mind when you ask about principles of accounting...
1. Principles of accounting was often the title of the introductory course in accounting. It was also common for the
textbook used in the course to be entitled Principles of Accounting.
2. Principles of accounting can also refer to the basic or fundamental principles of accounting: cost principle,
matching principle, full disclosure principle, revenue recognition principle, going concern assumption, economic
entity assumption, and so on. In this context, principles of accounting refers to the broad underlying concepts
which guide accountants when preparing financial statements.
3. Principles of accounting can also mean generally accepted accounting principles (GAAP). In this context, principles
of accounting includes both the underlying basic accounting principles and the official accounting
pronouncements issued by the Financial Accounting Standards Board (FASB). These official pronouncements are
the detailed rules or standards for specific topics.

 Accounting and Information System

Accounting and information system is a system of collecting, Storing and processing financial and accounting data
that are used by decision makers or provide information for decision making. Main object of AIS is to determine
profit and loss and financial position of the business.

Economic entity assumption

The economic entity assumption is a fundamental principle in accounting and financial reporting. It assumes that the
activities of a business or organization are separate and distinct from the activities of its owners, stakeholders, and
other entities. In other words, the business is treated as a separate "economic entity" that operates independently
from its owners.

Going Concern Assumption

The going concern assumption is an accounting principle that assumes a business entity will continue its operations for
the foreseeable future and will not be forced to liquidate or cease its activities. According to this assumption, a
company is considered to be a going concern unless there is significant evidence to the contrary.

Time Period Assumption

The time period principle is the concept that a business should report the financial results of its activities over a
standard time period, which is usually monthly, quarterly, or annually. Once the duration of each reporting period is
established, use the guidelines of Generally Accepted Accounting Principles or International Financial Reporting
Standards to record transactions within each period.

Monetary Unit Assumption

The monetary unit assumption states that a company should only record measurable transactions in monetary terms in
its accounting books. It argues that a transaction or business activity that is not quantifiable in a stable currency like the
dollar should not be recorded in its financial information.
Historical Cost/ Cost Principle/ Measurement Principle
The cost principle, also known as the measurement principle, is an accounting principle that states that assets and
liabilities should be initially recorded in the accounting books at their historical cost, which is the amount of cash or
cash equivalents paid to acquire or produce the asset.

Matching Principle/ Expense Recognition Principle

The matching principle requires that revenues and any related expenses be recognized together in the same reporting
period.
The matching principle, also known as the expense recognition principle, is an accounting principle that states that
expenses should be recognized in the same accounting period as the revenues they help generate. It is closely related
to the accrual basis of accounting, which recognizes revenues and expenses when they are earned or incurred,
regardless of when the associated cash flows occur.

Revenue Recognition Principle

Revenue recognition is an accounting principle that asserts that revenue must be recognized as it is earned. So the
question becomes: when is revenue considered “earned” by a company? Revenue is generally recognized after a
critical event occurs, like the product being delivered to the customer.

Full Disclosure Principle

Full disclosure principle refers to the concept that suggests that a business should report all the necessary information
in their financial statements, so that the users who are able to read the financial information are in a better position to
make important decisions regarding the company.

Fair value principle/ Fair value accounting/ Fair value measurement principle
The fair value principle is an accounting concept that requires certain assets and liabilities to be measured and reported
at their fair value.
For example: Company XYZ holds a portfolio of stocks. At the end of the accounting period, the fair value of the stocks
is determined to be $50,000. According to the fair value principle, Company XYZ would report the stocks on its financial
statements at their fair value of $50,000.

 The term debit and credit mean increase and decrease receptively. Do you agree? Explain
No, I do not agree with the statement that the terms "debit" and "credit" mean increase and decrease, respectively.
Because the term debit indicates the left side of an accounts and credit indicates the right side. In accounting, the
terms "debit" and "credit" are used to represent the directional flow of transactions and their impact on accounts.
In double-entry bookkeeping, which is the standard accounting system, each transaction has an equal and opposite
effect on at least two accounts. Debits and credits are used to record these effects.
 Accrual basis Accounting
Accrual basis Accounting recognizes business revenue and matching expenses when they are generated, not when
money actually changes hands. This means companies record revenue when it is earned, not when it is collected.

 Cash basis accounting

Cash basis accounting is an accounting method that recognizes income and expenses only when cash is exchanged.
This method is simpler than the accrual basis accounting method, which records income and expenses when they
are earned or incurred.

What is GAAP?
GAAP stands for Generally Accepted Accounting Principles. It refers to a set of standardized accounting principles,
guidelines, and procedures that are widely accepted and used by companies to prepare and present their financial
statements. GAAP provides a framework for financial reporting, ensuring consistency, comparability, and transparency
in financial statements across different organizations.
GAAP incorporates three components that eliminate misleading accounting and financial reporting practices:
 10 accounting principles,
 FASB rules and standards,
 and generally accepted industry practices.

 Cost benefit principle

The cost benefit principle, also known as cost-benefit analysis, is a fundamental concept in economics that suggests
action should only be taken if the benefits derived from it are greater than the costs. This highlights the trade-offs
involved in any decision-making process.
The cost-benefit principle, also known as cost-benefit analysis, is a decision-making approach that compares the
costs of a particular action or decision against the benefits it provides.

Advantages
 Clarity in Unpredictable Situations.
 It helps you make rational decisions.
 Objective evaluation and comparison of alternatives.
 Efficient resource allocation to maximize overall benefit.
 Transparency and accountability in decision-making.

Disadvantages
 it removes gut instinct.
 Does not account for all variables.
 Subjectivity in assigning monetary values to costs and benefits.
 Simplification of complex issues, potentially overlooking important nuances.
 Future uncertainty in predicting costs and benefits accurately.
 Perpetual Inventory system
A perpetual inventory system is a method of tracking inventory levels in real-time by continuously updating records
of all inventory transactions, such as purchases, sales, and returns, through the use of technology. The system
maintains an ongoing and accurate record of inventory levels, allowing businesses to monitor stock levels, identify
issues quickly, and make informed decisions about purchasing, sales, and production.

Advantages
1. Real-time tracking: One of the biggest advantages of a perpetual inventory system is that it provides real-time
tracking of inventory levels. This means that businesses always have accurate and up-to-date information on
how much inventory they have, where it is located, and how much they have sold or used.
2. Improved accuracy: Perpetual inventory systems rely on technology to record inventory transactions
automatically, which reduces the likelihood of human errors and improves the accuracy of inventory records.
3. Cost savings: By providing real-time inventory tracking, perpetual inventory systems can help businesses avoid
stockouts and overstocking, which can result in cost savings by reducing the need for emergency orders, rush
shipping fees, and excess inventory storage costs.
4. Better decision-making: With real-time data on inventory levels, businesses can make informed decisions about
reordering products, managing stock levels, and identifying trends in consumer demand.
5. Time savings: Because inventory transactions are recorded automatically, perpetual inventory systems can save
businesses time that would otherwise be spent on manual inventory counting, tracking, and reconciling.

Disadvantages
1. High initial cost: Implementing a perpetual inventory system can be expensive, as it requires the use of
technology such as barcoding or RFID, which can involve upfront costs for equipment, software, and training.
2. Technology-dependent: Perpetual inventory systems rely heavily on technology, which means that businesses
must have reliable hardware, software, and network infrastructure in place to ensure that the system works
properly. Any technical issues with the system can result in inaccurate inventory records, which can cause
problems for the business.
3. Data entry errors: While perpetual inventory systems can reduce the likelihood of human errors, there is still a
risk of data entry errors if employees enter the wrong information or forget to record a transaction. This can
result in inaccurate inventory records, which can lead to stockouts or overstocking.
4. Maintenance and updates: Perpetual inventory systems require ongoing maintenance and updates to ensure
that they continue to function properly. This can involve costs for software updates, hardware repairs or
replacements, and employee training.
5. Security concerns: Because perpetual inventory systems rely on technology to record inventory transactions,
there is a risk of cyberattacks, data breaches, and other security concerns. Businesses must take steps to secure
their inventory data and protect it from unauthorized access or theft.
 Periodic inventory system
A periodic inventory system is a method of tracking inventory levels where physical inventory counts are taken
periodically, such as once a month, once a quarter, or once a year, to determine the quantity of inventory on hand.
The system does not keep a continuous or real-time record of inventory transactions like a perpetual inventory
system.

Advantages
1. Simplicity: Periodic inventory systems are relatively simple and easy to implement, as they do not require the
use of technology or software to track inventory levels in real-time. This can make them a good choice for small
businesses or those with limited resources.
2. Cost savings: Because periodic inventory systems do not require the use of technology or software, they can be
less expensive to implement and maintain than perpetual inventory systems. This can be especially beneficial for
businesses with limited budgets.
3. Flexibility: Periodic inventory systems can be more flexible than perpetual inventory systems because they do
not require ongoing maintenance or updates. This can be useful for businesses that have changing inventory
needs or that do not have a consistent volume of inventory transactions.
4. Reduced data entry errors: Because periodic inventory systems do not rely on continuous data entry, there is
less risk of data entry errors or system failures causing inaccurate inventory records. This can be especially
beneficial for businesses that have a low volume of inventory transactions.
5. Privacy: Periodic inventory systems may offer more privacy for businesses that prefer to keep their inventory
levels confidential. Because the system does not track inventory in real-time, there is less risk of inventory levels
being accessed or viewed by unauthorized users.

Disadvantages
1. Limited accuracy: A periodic inventory system relies on periodic physical inventory counts to determine
inventory levels, which can result in discrepancies due to theft, breakage, or errors in recording transactions. This
can lead to inaccurate inventory records and potentially affect business decisions.
2. Limited visibility: Because a periodic inventory system does not track inventory levels in real-time, businesses
may not have a real-time view of their inventory levels or sales trends. This can make it more difficult to make
informed decisions about inventory management, purchasing, and sales.
3. Increased risk of stockouts or overstocking: Without a real-time view of inventory levels, businesses may be at
increased risk of stockouts or overstocking. This can result in lost sales, excess inventory, and increased carrying
costs.
4. Limited control: A periodic inventory system may offer less control over inventory levels and may not provide
businesses with the ability to identify and address inventory issues in real-time. This can make it more difficult to
manage inventory effectively and may lead to lost sales or reduced profitability.
5. Time-consuming: Conducting periodic physical inventory counts can be time-consuming and labor-intensive,
especially for businesses with large or complex inventories. This can result in additional costs and can take
employees away from other important tasks.
Necessity of inventory valuation
Inventory valuation is necessary to accurately reflect a business's financial health, comply with tax and legal
requirements, aid in inventory management decisions, and inform lending and investment decisions.

What Are the Objectives of Inventory Valuation?

The overall objective of inventory valuation is to help create an accurate picture of a company’s gross profitability and
financial position. To calculate the gross profit listed on the company’s income statement, a company must subtract
the cost of goods sold (COGS) from net sales (total sales — returns and discounts and any other income not related to
sales). The basic formula for COGS at the end of any accounting period is:

COGS = Beginning inventory + Purchases – Ending inventory

To determine the cost of goods sold under a periodic inventory system, the following
steps are necessary:
 Determine the cost of goods on hand at the beginning of the accounting period (Opening stack).
 And to it the cast of goods purchased.
 Subtract the cost of goods on hand at the end of the accounting period as determined by physical
inventory count. (Closing stock)

Cast flow assumption/ inventory costing method

The cost flow assumption, also known as inventory costing method, is a way of determining how the cost of goods sold
(COGS) and the value of ending inventory are calculated. There are several cost flow assumptions, including:
1. First-In, First-Out (FIFO): This method assumes that the first goods purchased are the first goods sold. In other
words, the oldest inventory is sold first, and the most recent inventory remains in the ending inventory.
2. Last-In, First-Out (LIFO) (IFRS doesn't allow LIFO): This method assumes that the most recently purchased goods are
the first goods sold. In other words, the newest inventory is sold first, and the oldest inventory remains in the
ending inventory.
3. Weighted Average Cost (WAC): This method assumes that the cost of each unit of inventory is the weighted
average of all the costs associated with the inventory on hand. The weighted average cost is calculated by
dividing the total cost of inventory by the total number of units of inventory on hand.

FOB shipping point

FOB shipping point means that ownership and responsibility for the goods transfer from the seller to the buyer at the
point of shipment. In other words, once the goods are loaded onto the carrier at the seller's location, the buyer
assumes responsibility for any damage or loss that occurs during transit. The buyer also pays the shipping costs
associated with the delivery of the goods to their destination.

FOB destination
FOB destination means that ownership and responsibility for the goods transfer from the seller to the buyer at the
point of delivery. In other words, the seller retains ownership and responsibility for the goods during transit and is
responsible for any damage or loss that occurs during delivery. The seller also pays the shipping costs associated with
the delivery of the goods to their destination.
Last-In, First-Out (LIFO)
This method assumes that the most recently purchased goods are the first goods sold. In other words, the newest
inventory is sold first, and the oldest inventory remains in the ending inventory. This method is commonly used when
inventory costs are increasing, as it results in a lower cost of goods sold and a higher ending inventory value.

Weighted Average Cost (WAC)

This method assumes that the cost of each unit of inventory is the weighted average of all the costs associated with the
inventory on hand. The weighted average cost is calculated by dividing the total cost of inventory by the total number
of units of inventory on hand. This method is commonly used when inventory items are homogeneous and the costs of
the items do not fluctuate significantly.

FOB shipping point

ক্রেতার বইয়ে জাবেদা,

Merchandise Inventory – Carriage Inward – Dr

Dr Cash/bank –
Cash/bank - Cr Cr
(Perpetual) (Periodic)
[Note: বিক্রয় বই বা বিক্রেতার জন্য কোনো জাবেদা দিতে হবে না]

FOB destination

Carriage Inward/ Freight out – Dr

Cash/bank – Cr
(For both Periodic Perpetual)

[Note: ক্রেতার জন্য কোনো জাবেদা দিতে হবে না]

Consigned Goods
Consigned goods are products not owned by the party in physical possession of them. The party holding the goods (the
consignee) has typically been authorized by the owner of the goods (the consignor) to sell the goods. Once goods sold,
the consignee retains a commission and forwards all remaining sale proceeds to the consignor.

Special Journal
Special Journals are all accounting journals in an organization except the general journal. All the transactions of similar
transactions are recorded in an organized form that helps the company's accountants and bookkeepers keep track of
all different business activities properly.

Meaning of journal and journalizing

A business transaction is first recorded in a journal, also called a Book of Original Entry. Your journal keeps a record of
all your business transactions, tracking them in chronological order, as they happen. Adding new journal entries is
called journalizing
Advantages of Subsidiary Ledgers
“A subsidiary ledger is a group of accounts with a common characteristic. The accounts are assembled together to
facilitate the accounting process by freeing the general ledger from details concerning individual balances.”
Using subsidiary ledgers serves with several advantages. The advantages of subsidiary ledgers are as follows:
1. They show in a single account transaction affecting one customer or one creditor, thus providing up-to-date
information on specific account balances.
2. They free the general ledger of excessive details. As a result, a trial balance of the general ledger does not contain
vast numbers of individual account balances.
3. They help locate errors in individual accounts by reducing the number of accounts in one ledger and by using
control accounts.
4. They make possible a division of labor in posting. One employee can post to the general ledger while someone
else posts to the subsidiary ledgers.

Adjusting entry
An adjusting entry is an entry made to assign the right amount of revenue and expenses to each accounting period. It
updates previously recorded journal entries so that the financial statements at the end of the year are accurate and up-
to-date.

Closing entry
A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary
account to a permanent account.
If a transaction cannot be recorded in a special journal it will be recorded in general journal. Adjusting entries, closing
entries, etc. are the examples of general journal.

When do companies normally post to the subsidiary accounts and general ledger accounts?
Companies typically post transactions to subsidiary accounts and the general ledger on a regular basis, often daily or
weekly. This allows for accurate and up-to-date financial information to be maintained and readily available for analysis
and decision-making.

For subsidiary accounts, transactions are usually posted as they occur in order to maintain a real-time balance for each
individual account. This means that each time a transaction is made, it is recorded in the relevant subsidiary account,
such as accounts receivable or accounts payable.

For the general ledger, transactions are typically posted in batches, either daily or weekly. This involves gathering all
the transactions that have occurred over the specified period and entering them into the general ledger. Once all the
transactions have been recorded, the general ledger can be used to create financial statements and other reports.

It is important for companies to post transactions in a timely and accurate manner to ensure that their financial
information is reliable and useful for decision-making purposes.
Income Summary
The income summary is a temporary account used to make closing entries. All temporary accounts must be reset to
zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The
income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a
permanent account on the balance sheet.

Permanent Accounts
Permanent accounts are accounts that show the long-standing financial position of a company. Balance sheet accounts
are permanent accounts. These accounts carry forward their balances throughout multiple accounting periods.

Temporary Accounts
Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single
accounting period. The balances of these accounts are eventually used to construct the income statement at the end of
the fiscal year.

Four types of special Journals are frequently used to record transaction

These are:
Purchases Journal:
All purchase of merchandise on account
Sales Journal
All sale of merchandise on account.
Cash receipt Journal
All cash received (including cash sales)
Cash payment Journal
All cash paid (including cash purchases)

A trial balance has some limitations:

 It does not prove that all transactions have been recorded.
 It does not prove that the ledger is correct.
 It cannot find the mixing entry from the Journal.
 It cannot find the missing entry from the ledger.
 It cannot protect the repeated postings.
 It cannot protect the offsetting errors.
 It cannot protect the errors of principles.
 It cannot protect the errors of omission.
 Numerous errors may exist even though the trial balances column agree.
In general, there are two types of users of accounting information; Internal and external users.
Internal users
Internal users are people within a business organization who use financial information. Example of internal users are
managers, supervisory etc.
External users
External users are people outside the business entity/ organization who use accounting information. Example of
external are suppliers, bank. Customers, shareholders etc.

Accounting is often referred to as the "language of business". Because of provides vital information regarding cost and
earning, profit and loss, liabilities and assets for decision making, planning and controlling processes within a business.
The main objectives of accounting is to record financial transactions in books of accounts to identify, measure and
communicate economic information.

Worksheet is not a permanent accounting record and its use is not needed in the accounting cycle. The worksheet is
not a formal mothed for collecting and resolving information required for accounting statements. Worksheet is a
document used in the accounting department for inspecting and modelling the balances of accounts. It is beneficial for
assuming that the accounting entries are obtained accurately.

Qualitative characteristics of accounting: 6 types

1. Relevance
2. Faithful representation
3. Comparability
4. Verifiability
5. Timeliness
6. Understandability.
Objectives of PPF (Property, plant & Equipment)
1. Recognition
2. Measurement
3. Presentation
4. Disclosure

Account
An account is a record in an accounting system that tracks the financial activities of a specific asset, liability, equity,
revenue, or expense. These records increase and decrease as the business events occur throughout the accounting
period. Each individual account is stored in the general ledger and used to prepare the financial statements at the end
of an accounting period.
Four types of adjusting entries:
 Deferred expense,
 deferred revenue,
 accrued expense,
 accrued revenue.