FINANCIAL

ACCOUNTING –I
By Vikas Sir
The Institute of Chartered Accountants of India (ICAI) defines
accounting as follows:
"Accounting is the art of recording, classifying and
summarizing in a significant manner and in terms of
money, transactions and events which are, in part at
least, of a financial character, and interpreting the
results thereof."
Process of
Accounting

•Invoices/Bills
•Journal
•Ledger
•Trial Balance
•Trading & Profit & Loss A/c
•Balance Sheet
•Reports
Accounting concepts are a set of general conventions that can be used as guidelines when dealing
with accounting situations. These concepts have also been integrated into the various accounting
standards, so that a user will not implement a standard and then find that it is in conflict with one
of the accounting concepts.
 1] Business Entity Concept

• This accounting concept separates the business from its owner. As

far as accounting is concerned the owner and the business are two
separate entities.
• This will help the accountant identify the business transactions from
the personal ones.
• So for example, if the owner brings in additional capital into the
business, we will treat this as a liability on the balance sheet of the
business.
 2] Money Measurement Concept

• This accounting concept states that only financial transactions will

find a place in accounting. So only those business activities that can
be expressed in monetary terms will be recorded in accounting. Any
other transaction, no matter how significant, will not find a place in
the financial accounts.
• So for example, if the company underwent a
major management overhaul this would have no effect on the
accounting records. This concept is actually one of the major
drawbacks of accounting.
 3] Going Concern Concept

• The going concern concept assumes that a business will continue to

operate indefinitely.
• So it assumes that for the foreseeable future the business will not be
winding up. This leads to the assumption that the business will not
have to sell its assets any time soon and it will meet all its obligations
as well.
• So it justifies the financial statements as a part of a continuous series
of statements. The current statements are tentative and only reflect
the financial position of that particular period of time.
 4] Accounting Period Concept

• Every organization, according to its needs, chooses a specific period of

time to complete an accounting cycle. Generally, the time chosen is a
year we call the accounting year. The time period is mentioned in the
financial statements.
• So the indefinite life of an organization is divided into shorter,
generally equal time period. This facilitates a comparison of
performances.
 5] Cost Concept

• This accounting concept states that all assets of the firm are entered
into the books of account at their purchase price (cost of acquisition
+ transport + installation etc). In the subsequent years to, the price
remains the same (minus depreciation charged).
• The market price of the asset is not taken into consideration.
 6] Dual Aspect Concept

• This concept is the basic principle of accounting, it is the heart and

soul. It basically is one of the golden rules of accounting – for every
credit, there must be a corresponding debit. So every transaction we
record must have a two-fold effect, i.e. it will be recorded in two
places. This is the core concept of the double-entry system of
accounting.
• So let us see an example of this in action. Say the business buys an
asset worth Rs 10,000/-. So now the Fixed Assets of the company will
increase bt 10,000/-. But at the same time, the bank or cash balance
will reduce by 10,000/-. And so the transaction will have a dual effect
in accounting. And also the Balance Sheet will stay balanced.
 7] Realisation Concept

• According to the realization accounting concept, revenue is only

recognized when it is realized. Now revenue is the cash inflow for a
business arising from the sale of goods or services. And we assume
this revenue as realized only when it legally arises to be received. So
in simpler terms, the profit earned will be recorded when it is
actually earned.
 8] Matching Concept

• This concept states that the revenue and the expenses of a

transaction should be included in the same accounting period. So to
determine the income of a period all the revenues and expenses
(whether paid or not) must be included.
• The matching accounting concept follows the realization concept.
First, the revenue is recognized and then we match the costs
associated with the revenue. So costs are matched with revenue, the
reverse would be an incorrect system.
 9] Full Disclosure Concept

• This concept states that all relevant information will be disclosed in

the accounting statements. A lot of external users depend on these
financial statements for their information to make investing decisions.
So no information/transactions etc of relevance to anyone of them
will be omitted from these statements for the benefit of the company.
 10] Consistency Concept

• Once the company decides on a certain accounting policy it should

not be frequently changed. Unless there is a statutory requirement or
it allows better representation of the accounts accounting policies
should be consistent for long periods of time. This allows users to
make inter-firm and inter-period comparisons. Also, frequent changes
in policies may be to manipulate the accounts and this must be
prevented.
 11] Conservatism Concept

• This accounting concept promotes prudence in accounting. It states

that profit should not be included until it is realized. However, losses
even those not realized but with the remote possibility of occurring
should be included in the financial statements.
• So all losses are recognized – those that have occurred or are even
likely to occur. But only realized profits are recognized.
 12] Materiality Concept

• Materiality states that all material facts must be a part of the

accounting process. But immaterial facts, i.e. insignificant information
should be left out.
• The materiality of a transaction will depend on its nature, value and
its significance to the external user. If the information can affect a
person’s investing decision then it is definitely a material fact.
 13] Objectivity Concept

• Finally, we come to the last accounting concept – objectivity.

• This concept states the obvious assumption that the accounting
transaction recorded should be objective, i.e. free from any bias of
the person recording it.
• So each transaction should be verifiable by supporting documents like
vouchers, bills, letters, challans, certificates, invoices etc.
 Accounting standards (AS)
• Accounting standards (AS) are written documents and policies that provides
principles for recognition, measurement, treatment, presentation and disclosures
of accounting transactions in the financial statements. These Accounting
Standards are recommended by Institute of Chartered Accountant of India (ICAI)
and becomes applicable to entities only when Central Government notifies it.
Currently, there are 27 Accounting standards in total. Accounting standards have
been introduced with the objective to standardise accounting practices as this
will help in comparing the financial statements of different entities falling in the
same industry to which such accounting standards are applicable.
• This year we will be studying three of the accounting standards namely:
1. AS-1 Disclosure of Accounting Policies
2. AS-9 Revenue Recognition &
3. AS-2 Valuation of Inventories
 AS 1 – Disclosure of Accounting
Policies
• The purpose of this standard is to promote better understanding of financial
statements by establishing the practice of disclosure of significant accounting
policies followed and the manner in which they are disclosed in the financial
statements. Such disclosure would also facilitate a more meaningful comparison
between financial statements of different organisations.
 Features of AS-1
• All significant accounting policies used in the preparation and presentation of
financial statements should be disclosed.
• The disclosure should form part of the financial statements, normally in one
place.
• Any change in the accounting policies which has a material effect in the current
period or is expected to have a material effect in later periods should be
disclosed.
• In case of a change in accounting policies which has a material effect in the
current period, the amount by which any item in the financial statements is
affected should also be disclosed to the extent it can be calculated. Where such
amount is not ascertainable, wholly or in part, the fact should be indicated.
• If the fundamental accounting assumptions of Going Concern, Consistency and
Accrual are followed in financial statements, specific disclosure is not required. If
a fundamental accounting assumption is not followed, the fact should be
disclosed.
 AS – 2 Valuation of Inventories
Accounting Standards 2 (AS 2) primarily deals with the valuation and
accounting treatment of inventories.
• Features of AS-2
1.Recognition of Inventory: AS 2 defines inventory as assets that are held for sale
in the ordinary course of business, in the process of production for such sale, or in
the form of materials or supplies to be consumed in the production process or in
rendering of services.
2.Measurement of Inventory: Inventories should be measured at the lower of cost
and net realizable value (NRV). Cost should include all costs of purchase, costs of
conversion, and other costs incurred in bringing the inventories to their present
location and condition.
3.Cost Formulas: AS 2 allows different cost formulas for the measurement of cost
of inventories, such as FIFO (First In, First Out), Weighted Average Cost, and
Specific Identification. The chosen formula should reflect the flow of goods and
the circumstances of the entity.
4. Net Realizable Value (NRV): NRV is the estimated selling price in the ordinary
course of business, less the estimated costs of completion and the estimated
costs necessary to make the sale. If the NRV of inventories is lower than their
cost, AS 2 requires the inventories to be written down to the lower of cost or
NRV.
5.Consistency: AS 2 emphasizes the importance of consistency in the methods
used for determining the cost of inventories and the cost formula adopted.
Changes in cost formulas are allowed only in exceptional circumstances and
require disclosure.
6.Disclosure: The standard requires specific disclosures in the financial statements
regarding accounting policies adopted in measuring inventories, including the
cost formula used, the total carrying amount of inventories, and the amount of
inventories recognized as an expense during the period.
7.Exceptions: AS 2 provides exceptions for certain types of inventories, such as
work in progress arising under construction contracts, financial instruments, and
biological assets related to agricultural activity, which are covered under other
EXPENDITURE & RECEIPTS
 Business Transactions
• Business Activities (Selling goods & Services)
• Gives rise to Revenue Income & Expenditure

• Investment (Purchasing Assets)

• Gives rise to Capital Expenditure

• Financing (Raising money for investment)

• Gives rise to Capital Reciepts
 Types

• Revenue Expenditure
• Capital Expenditure

• Revenue Receipts
• Capital Receipts
 Capital Expenditure
I) Capital Expenditure means an expenditure carrying probable future
benefits
• Types : All assets (Capital, Fixed, Current, Depreciable, Wasting, Ficticious)
• Examples: Acquisition of Fixed assets
• Expenditure during construction ?Pre Operative exp
• Expenditure that improves standard performance of existing asset
• Cost of Addition/ Extension
• Investments
• Cost of Acquisition of Intangible Assest
 Revenue Expenditure
• Revenue expenditure means an expenditure from which no future
benefit is expected.
• An expenditure charged against operation.
Common Examples:
1. Cost of Production (Purchase of goods, Wages, Factory Exp, Power)
2. Cost of Administration (Salaries to Office Staff, Rent, Printing &
Stationery, etc),
3. Cost of Selling & Distribution(Salaries to salesman, Travelling, Freight
outward etc),
4. Cost of Finance(Interest on Loans)
 Capital Receipts
• Capital Receipts means an amount received by a concern in course of
its financing activity (Obtaining money as capital or loan or sale of
assets).
 Revenue Receipts
• Revenue Receipts means the receipts from customers for sale of goods, for
services given, or for use of funds (loans, capital) or use of assets.
• Example
1. Sale of goods
2. Rendering Services
3. Interest/Dividend received
4. Royalty
5. Insurance claims
6. Recoveries & Refunds
7. Govt Grants