Financial Accounting

#Throwback
Process of
Accounting is an recording,
classifying,
art. summarising and
interpreting.

Financial
statements should
It has several users-
be understandable,
both internal and
comparable,
external
relevant and
reliable.
 Accounting principles
To ensure uniformity in preparation of financial statements, accounting should be based on some principles.

Financial statements should be prepared on a uniform basis so that they are understandable by all the users.

Guide to action

Known as Generally Accepted Accounting Principles (GAAP); they are the rules adopted for recording of
transactions and preparation and presentation of financial statements at a particular time.

They are the best possible suggestions based upon experience.

They should be relevant (meaningful and useful), objective (no personal bias/judgement) and feasible (able to
implement without any undue complexity).
 Accounting principles

Accounting concepts Accounting conventions

Basic assumptions on the basis of Statements of practice which
which transactions are recorded are followed as accepted
and financial statements are method by the enterprise over a
prepared. period of time.
 Accounting concepts
1. Separate Accounting Entity/ Business Entity
• An enterprise is treated as separate from its owners.
• All transactions are recorded from the point of view of the accounting
entity and not from the point of owners.
• A business does not record the owner’s personal expenses, incomes or
liabilities.
• It is applicable to all forms of organisation (sole-proprietorship,
partnership, company).
 Accounting concepts
2. Money Measurement
• Only those transactions which can be measured in terms of money are
recorded in the books of account.
• For example, employee competence or product quality is not recorded.
• Money is the basic unit of measurement.
• Thus, heterogenous facts can be expressed as numbers which can be added
or subtracted.
• Limitations:
oAll transactions and events cannot be expressed in terms of money. Thus,
accounting does not give a complete picture about the entity.
oMoney is not a stable unit of measurement. The purchasing power of money
does not remain stable.
 Accounting concepts
3. Dual Aspect
• Equity + Liability = Assets
• Assets: Resources controlled by an enterprise (Land & building, Plant
& machinery, inventory, cash, bank balance)
• Liabilities: Claims of creditors against the assets, what the enterprise
owes to creditors, lenders or other parties.
• Equity: Owner’s capital, it is the claim of the owners against the assets
• Every transaction has a two-fold effect.
• Changes in assets and changes in liabilities and equity, as the case may
be, of each transaction are recorded.
 Accounting concepts
4. Cost concept
• An asset is recorded at the price paid for it (historical cost).
• All subsequent accounting for the asset is also based upon this cost.
• Cost of the asset is systematically reduced over the life of the asset by
charging depreciation.
• Asset is not shown at its net realisable value.
 Accounting concepts
5. Verifiable Objective Evidence
• Business can record only those transactions that they can furnish
documentary proof for.
• There must be objective evidence of transactions which are capable of
verification.
• Entries must be supported by documentary evidence such as vouchers,
invoices etc.
 Accounting concepts
6. Going Concern concept
• Also known as continuity assumption
• It is assumed that an entity will continue to operate for a fairly long period
in future.
• So, financial statements are prepared assuming that the business will
continue its operations for a foreseeable future.
• Assets and liabilities are classified as current and non-current.
• Fixed assets are acquired for use and not for sale in the ordinary course of
business.
• Cost of depreciable assets is allocated over the useful life of the asset in a
systematic manner.
• Fixed assets are not shown at their liquidation value in the Balance sheet.
 Accounting concepts
7. Accounting period or periodicity
• It is the time period for which financial statements are prepared.
• Financial statements should be prepared at regular intervals to provide
information about financial position and performance of the business.
 Accounting concepts
8. Realisation concept/Revenue recognition principle
• Revenue is considered to have been earned on the date when it is
realised, that is, on the date when goods have been supplied or services
have been rendered.
• So, a seller will record the potential revenue from a transaction,
regardless of whether they have or have not received the proceeds.
• The seller recognises the transaction by creating a receivable against
the buyer’s name.
 Accounting concepts
9. Expense recognition/ Matching concept
• An expense is incurred when goods or services are consumed or used.
• Expense should be recognised in the period in which associated
revenue is recognised.
• Costs are matched with revenues.
 Accounting concepts
10. Accrual concept
• Revenues are credited to the period in which they are earned whether
they have been received or not.
• Expenses are charged to the period to which they relate whether they
have been actually paid or not.
• The principle recognises revenues and expenses as earned or incurred
ignoring the date of receipt or payment.
• We adjust for outstanding and prepaid expenses, accrued income and
income received in advance for ascertaining the profit or loss for the
period.
 Accounting conventions
1. Full disclosure
• All significant financial information must be disclosed.
• There should be full, fair and adequate disclosure.
• Full means nothing should be omitted
• Fair means that the information provided should be unbiased.
• Adequate means sufficient information is provided which can
influence the decision of the user.
 Accounting conventions
2. Materiality
• It requires that focus should be on material information.
• Information is material if the knowledge of this information is
significant to the users, and it can influence their decisions.
• It places a restriction on what should be disclosed.
• Whether an item is material or not depends on its nature and amount.
 Accounting conventions
3. Consistency
• Refers to the use of same accounting policies by a firm from period to
period.
• It is important for comparing the data reported in the financial
statements for one period with that of another period.
• Changes can be made in policies in certain circumstances, but it
should be disclosed and its effect on the financial results should also
be disclosed.
 Accounting conventions
4. Conservatism or prudence
• Anticipate no profit but provide for all possible losses.
• It is a way of dealing with uncertainty.
• Example: making provisions for bad and doubtful debts.