Mod 1

BNU Question Paper Questions

 Explain the assumptions underlying accounting measurement. [[Link]. 1, 5 marks, Feb 2015]

 What are the differences between Financial Accounting and Management Accounting? [[Link]. 1,
5 marks, Feb 2016]

 “Expenses are used-up assets”. Explain. [[Link]. 7, 5 marks, Feb 2016]

 What are the differences between current liabilities and long-term liabilities? [[Link]. 9, 10
marks, Feb 2016]

 What is GAAP? Explain the need for GAAP. [[Link]. 1, 5 marks, Feb 2017]

 Explain the various sources of information for decision-making to the stakeholders of the
company. [[Link]. 3, 5 marks, Feb 2017]

 List the various users of financial statements and state their informational needs. [[Link]. 3, 5
marks, Feb 2018]

 Explain in detail the various concepts and conventions which influence the preparation of
financial statements. [[Link]. 8, 10 marks, Feb 2015]

 Explain the concepts underlying the preparation of financial statements. [[Link]. 1, 5 marks, Feb
2019]

 What is GAAP? Explain the need for GAAP. [[Link]. 1, 5 marks, Feb 2020]

 Explain the assumptions underlying accounting measurement. [[Link]. 1, 5 marks, Feb 2015]

 What is GAAP? Explain the need for GAAP. [[Link]. 1, 5 marks, Feb 2017 / Feb 2020]

 Explain in detail the various concepts and conventions which influence the preparation of
financial statements. [[Link]. 8, 10 marks, Feb 2015]

 Explain the concepts underlying the preparation of financial statements. [[Link]. 1, 5 marks, Feb
2019]

Business and Accounting

• Accounting is the universal language of Business and Finance.

• More CEO’s from fortune 500 companies have come up through the ranks of accounting than
from any other area in business. Currently: 54%

• Small businesses and usually fail because of poor accounting understanding.

• Marriages usually fail because of poor financial management (80% of divorces are $$$$ related.)
 • If you want to get ahead in business & marriage determine that you are going to understand
accounting basics.

Need for Accounting

 Accounting information can be used to assess past financial performance of a company and help
predict its future performance. [All kinds of organizations]

 Managers, investors, and other internal groups want the answers to two important questions:

a. How well did the organization perform?

b. Where does the organization stand?

 Accountants answer these questions with three major financial statements:

1. Balance Sheet

2. Income Statement

3. Statement of Cash Flows

Meaning and Definition

• Accounting is “the classifying, recording, and summarizing of business transactions in terms of

Or

• Accounting is “the art of classifying, recording, summarizing, and interpreting the results”.

According to the American Institute of Certified Public Accountants, 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”.

According to the American Accounting Information, “Accounting is the process of identifying, measuring,
and communicating economic information to permit informed judgements and decisions by users of the
information”.

Understanding forms of Business Organizations

• Sole Trading Concern / Sole Proprietorship

• Partnership Firms

• Companies

• Financial Institutions

• Co-operative Societies

Basic Framework of Accounting

Assets = Liabilities + Owners’ equity

Liabilities are the entity’s economic obligations to non-owners.

Owners’ equity is the excess of the assets over the liabilities.

Objectives and Purpose of Accounting

1. Maintenance of Business Records

2. Preparation of Financial Statements

3. Comparison of Results

4. Decision-Making

5. Evidence in Legal Matters

6. Provides Information to Interested Parties

7. Helps in Taxation Matters

8. Valuation of Business

Purpose of Accounting Information

1. Relevance

2. Reliability

3. Comparability

4. Understandability

5. Timeliness

6. Cost-Benefit

7. Verifiability

8. Valuation of Business

9. Neutrality

10. Completeness

Users of Accounting Information

1. Owners / Shareholders

2. Managers

3. Prospective Investors

4. Creditors, Bankers, and other Lending Institutions

5. Government
 6. Employees

7. Regulatory Agencies

8. Researchers

9. Customers

Branches of Accounting

Financial Accounting

• Recording of business transactions

• Presentation of financial data and financial statements to stakeholders

• Accounting for Revenues and Expenses and Assets and Liabilities

• Financial Position of a business as on a particular date.

Cost Accounting

 Concerned with costing information

 Purpose of cost ascertainment and cost control

Management Accounting

• Enables a business to be conducted more efficiently

• Concerned with accounting information useful to the management (decision-making)

Generally Accepted Accounting Principles (GAAPs)

 Accounting Principles are “the body of doctrines or the guidelines to establish standards for
sound accounting practices and procedures in reporting the financial status and periodic
performance of a business”.

 Accounting is based on a set of principles on which there is general agreement, not on rules that
can be “proved.”

 The principles and procedures that together make up accepted accounting practice at any given
time are known as generally accepted accounting principles (GAAPs).

 Accounting Principles can be classified into two categories:

• Accounting Concepts and

• Accounting Conventions

Accounting Concepts

Accounting Concepts are defined as basic assumptions on the basis of which financial statements of a
business entity are prepared.
They are used as a foundation for formulating various methods and procedures for recording and
presenting the business transactions.

1. Business Entity Concept or Separate Entity Concept

2. Money Measurement Concept or Monetary Unit Concept

3. Going Concern Concept (Continuity)

4. Accounting Period Concept or Time Period Concept

5. Historical Cost Concept

6. Revenue Recognition Concept or Realisation Concept

7. Matching Concept

8. Cost Recovery Concept

9. Dual Concept

10. Accrual Concept

Business Entity Concept or Separate Entity Concept:

Entity ─ The organizational unit for which accounting records are maintained.

Separate entity concept ─ The activities of an entity are to be separate from those of its individual
owners.

• Proprietorship

• Partnership

• Corporation

Monetary Measurement Concept:

 Accountants measure only those economic activities that can be measured in monetary terms.

[i.e. Indian Rupees are used in India; whereas Australian dollars ($) are used in Australia, likewise,
Japanese Yens (¥) are used in Japan].

Limitations of Money Measurement Concept

 Some transactions are difficult to measure in monetary terms e.g. cost of quality employees

 Value of money change over time e.g. inflation means value of money falls

 Changes in currency rates regularly, making it difficult to measure value.

Going Concern Concept (Continuity)

 An entity will have a continuing existence for the foreseeable future.

Accounting Period Concept or Time Period Concept

 It is an interval of time at the end of which the income or revenue statement and balance sheet
are prepared to show the results of operations

Historical Cost Concept

 Accountants record the value of assets in their original price (when they are purchased).

 All transactions are recorded at historical cost.

 Historical cost is assumed to represent the fair market value of the item at the date of the
transaction because it reflects the actual use of resources by independent parties.

Revenue Recognition Concept or Realisation Concept

 The recognition principle specifies when a company should record revenue in the accounting
records.

 Companies recognize revenue when it is both earned and realized or realizable.

Matching Concept (costs and expenses)

 All costs and expenses incurred in generating revenues must be recognized in the same
reporting period as the related revenues.

 This process of matching expenses with recognized revenues determines the amount of net
income reported on the income statement.

Cost Recovery Concept

 The heart of recognizing expense is the cost recovery concept. Companies carry forward as
assets such items as inventories, pre-payments, and equipment because they expect to recover
the costs of these assets in the form of cash inflows in future periods.

 At the end of each period, accountants examine evidence to assure themselves that they should
not write off these assets—the unexpired costs—as an expense of the current period.

Dual Concept

 This concept is based on double entry book-keeping which means that accounting system is set
up in such a way that a record is made up of two aspects of each transaction that affects the
records.

 The total amount debited is always equal to the total amounts credited. (For every debit there
should be a equal and corresponding credit)

 At any point of time, total assets of a business are equal to its total liabilities.

 Accounting Equation:

• Assets = Liabilities + Capital, OR

Accrual Concept

• Business transactions are recorded when they occur and not when the related payments are
received or made.

• Accrued revenues and costs are recognized as they are earned and incurred and recorded in the
financial statements of the period.

• Adjustment entries relating to outstanding and prepaid expenses and income received in
advances, etc. are made (impact P&L a/c and Balance Sheet).

 The term ‘convention’ denotes customs or traditions or practices based on general agreement
between the accounting bodies which guide the accountant while preparing the financial
statements.

 In fact, financial statements such as profit and loss account and balance sheet are prepared
according to the accounting conventions.

 They are classified into:

a) Convention of Consistency

b) Convention of Full Disclosure

c) Convention of Conservatism

d) Convention of Materiality

Convention of Consistency:

 The consistency convention implies that the accounting practices should remain the same from
one year to another.

 The results of different years will be comparable only when accounting rules are continuously
adhered to from year to year.

 The rationale clarifies that frequent changes in accounting treatment would make the financial
statements unreliable to the persons who use them.

Convention of Disclosure:

 A good accounting practice demands all significant information should be fully and fairly
disclosed in the financial statements.

 All information which is of material interest to proprietors, creditors, and investors should be
disclosed in the financial statements.

Convention of Conservatism:

 The accountant should not anticipate income and should provide for all possible losses, and
  Faced with the choice between two methods of valuing an asset the accountant should choose a
method which leads to the lesser value.

 Examples:

1. Making provision for bad debts in respect of doubtful debts.

2. Amortizing intangible assets like goodwill, patents, trade marks, etc.

Convention of Materiality:

 Accountants (professional expertise and judgement) should report only what is material and
ignore insignificant details while preparing the final accounts.

Accounting Standards

 Accounting Standards are written policy documents issued by expert accounting body or by
government or any other regulatory body.

 Accounting Standards cover the aspects of recognition, measurements, presentation, &

 The objective of setting standards is to bring about uniformity in financial reporting and to
ensure consistency and comparability in the data published by enterprises.

 Accounting Policies refers to the specific accounting principles and the methods of applying
those principles adopted by the enterprise in the preparation and presentation of financial
statements.

CLASSIFICATION OF ACCOUNTS

PERSONAL ACCOUNT

Personal Accounts are accounts of persons with whom a concern carries on business. Personal accounts
may be:

Accounts of natural or physical persons i.e. accounts of human beings.

Ex: Ram account; Sundar account, etc.

Accounts of artificial or legal persons i.e. accounts of partnership firms; companies; clubs; associations;
banks; Government Institutions; schools and colleges etc.

Representative personal accounts i.e. accrued expenses account; outstanding expenses account;
income received in advance account.

REAL ASSETS OR PROPERTY ACCOUNTS

Real accounts are accounts of properties, assets, or things owned by a concern and in which the
business is carried on. Real accounts may be:
Accounts of tangible assets i.e. assets which are physical existence and which can be seen, touched, felt,
bought, and sold) such as goods account, cash account, furniture account, vehicles account, machinery
account, etc.

Accounts of intangible assets i.e. assets which do not have physical existence and which cannot be seen
and touched, but can be bought and sold such as goodwill account, patents account, copy rights
account, etc.