CHAPTER 2

THEORY BASE OF ACCOUNTING

 Theory Base of Accounting

The theory of accounting explains principles, concepts, rules and guidelines

which were formed, developed and gradually changed time to time to:

 bring uniformity and consistency in the process of accounting.

 enhance utility of accounting information to users of accounting

information.

 set a universal guidelines to record the transactions and events.

 Basic Accounting Concepts and Conventions

These concepts are used for recording business transactions, preparing

financial statements and presenting accounting information in the best

possible manner. These concepts comprise of basic accounting assumptions.

Various Accounting Concepts and Conventions are as follows:

 Business Entity Concept

This concept treats business as a separate identity from its owner. All

business transactions are recorded in the books of business from the

business’s point of view not from the owner’s point of view.

For example: Started business with cash Rs 1,00,000. According to the

Business Entity Concept, business being a separate entity needs to pay back
 this amount at the time of closure. Thus Rs 1,00,000 is a liability for the

business.

 Money Measurement Concept

According to this concept, only those events are recorded in the books of

account, to which money value is attached or which can be expressed in

monetary terms.

 Going Concern Concept

This concept holds that the business will continue its operation for

indefinite period, irrespective of its owners. The purpose of this concept is to

differentiate between capital expenditure and revenue expenditure.

 Accounting Period Concept

According to this concept, the life of an enterprise is divided into different

accounting period (say years, half-yearly, quarterly, days), so that the

performance of the business in each period and at regular intervals can be

measured and assessed.

 Cost Concept

According to this concept, all assets of a business are recorded at their

acquisition price (i.e. the price paid to acquire them) and not at their

current market price. The acquisition price forms the basis for charging
 depreciation and maintaining other accounting records of the asset in the

subsequent periods.

 Dual Aspect Concept

According to this concept, all the transactions that are recorded in the

books of account have dual aspects. In other words, every transaction effects

two accounts simultaneously, i.e. debit and credit.

 Revenue Recognition Concept

According to this concept, revenue is recognised when the right of receiving

of the revenue is established and not when the revenue is actually received.

For Example: Goods sold on credit Rs 5,000 on January 01 and the

payment is received on February 11. In this case, revenue is recognised in

the month of January and not in February, as the right of receiving the

amount is established in January.

 Matching Concept

This concept suggests that in order to ascertain actual profit or loss made

during a period, expenses incurred (during the period) for earning revenues

should be matched with their related revenues earned during that particular

period. In other words, both the expenses and revenues should belong to the

same accounting period.

 Consistency Concept

This concept suggests that the accounting policies and practices once

adopted should be followed from year to year. In other words, accounting

practices should not be frequently changed. Adherence to Consistency

 Concept infuses higher degree of consistency and thereby enabling

meaningful comparison and better assessment of the performance of the

business over the years.

 Full Disclosure Concept

According to Full Disclosure Concept, besides disclosing statutory required

information, vital information that is significant and relevant to the

different users of accounting information must also be disclosed.

 Conservatism Concept

This concept holds that in order to ascertain profit or loss made during an

accounting period, all anticipated losses should be deducted from the

revenues but all anticipated profits should not be taken into consideration

until and unless they are realised.

 Materiality Concept

This concept implies that only those items which may affect the decisions of

the informed investors are considered as material. Materiality of an item

depends on the nature and the amount of the item.

 Objectivity Concept

According to this concept, transactions recorded in the books of accounts

should be free from personal bias. In other words, transactions recorded

should be objective, i.e. should be supported by verifiable evidences.

 Cash basis – In the cash basis of accounting, expenses are considered

only when they are paid and not at the time when they are due.

Similarly, revenues are considered only when they are actually

received and not when the right of receiving them is established

 Accrual basis – Under the accrual basis of accounting, expenses are

considered only when they are due for payment and not when the

payment is actually made. Similarly revenues are considered only

when the right of receiving them is established and not when they are

actually received.

 Accounting Standards

Accounting professionals all across the world need to follow

accounting practices abided by the accounting standards. In other

words, Accounting Standards comprise of a set of accounting

guidelines that are issued by the main accounting body. In India,

accounting standards are issued by The Institute of Chartered

Accountants of India (ICAI).

 Usefulness and Significance of Accounting Standards

o These provide a set of ruler on the basis of which accounts

are maintained.
 o These infuse greater uniformity and easy comparability of

financial statements of different firms and different industries.

 Need of International Financial Reporting Standards (IFRS)

1. To keep a check on manipulation associated with the figures related to
financial statements.
2. Helps the economies of world to establish global harmony, uniformity and
comparability in the process of preparation of their financial statements.
3. Makes flow of foreign investments smooth across the countries.

 Goods and Service Tax

 An indirect collective tax levied on the consumption of both goods and
services under a single tax structure. It is a destination based tax system.
 GST is categorized in three ways
 Central GST- Levied and collected by central government being 50%
of the applicable tax rate

 State GST -Levied and collected by state government being 50% of

the applicable tax rate

 Integrated GST-Levied and collected by central government being

100% of the applicable tax rate and shared equally with the state
government

 Characteristics of GST
1. Single tax structure meant for indirect taxes
2. Destination based tax
3. Comprehensive tax structure as it covers both the goods and services
4. Assesses under GST get the benefit of Input tax credit
5. Abolishes different tax structures
6. Both Centre and State Governments have equal share in IGST
7. Covers territorial water rights up to 12NM

 Advantages of GST
 1. Abolition of different tax structures
2. Widening of tax bases
3. Benefit of Input tax credit
4. Equal share for both Centre and States.
5. Single Tax Structure-
6. Neutralization to process, business models, structure and location
7. Increase in export
8. Voluntary registration
9. Increased demand and production of goods services

 GST Set Off Procedure

Input Tax Credit IGST CGST SGST
IGST First Second Last
CGST Last First Nil
SGST Last Nil First

 Applicability of GST
Computation of GST is applicable in the following chapters:
 Journal Entries

 Ledger

 Cash Book

 Day Books

 Petty Cash Book

 Accounting for depreciation

 Bills of Exchange

 Final Accounts of Sole Proprietorship