RENU SINGH (PGT Commerce)

UNIT-02
THEORY BASE OF ACCOUNTING
Unit at a glance:
 Introduction
 Meaning of accounting principles
 Features of accounting principles
 Necessity of accounting principles
 Basic accounting concepts
 Basis of accounting
 Nature of accounting standards
 Utility of accounting standards
 International Financial Reporting Standards (IFRS)
 Meaning and benefits of IFRS

"A mode of conduct imposed on an accountant by custom, law and professional body."-
Kohler
Introduction:
To maintain uniformity in recording transactions and preparing financial statements,
accountants should follow Generally Accepted Accounting Principles.

Meaning of Accounting Principles:

Accounting principles are the rules of action or conduct adopted by accountants universally
while recording accounting transactions.

GAAP refers to the rules or guidelines adopted for recording and reporting of business
transactions, in order to bring uniformity in the preparation and presentation of financial
statements.

Features of accounting principles:

(1) Accounting principles are manmade.

(2) Accounting principles are flexible in nature

(3) Accounting principles are generally accepted.

Necessity of accounting principles:

Accounting information is meaningful and useful for users if the accounting records and
financial statements are prepared following generally accepted accounting information in
standard forms which are understood.
Basic accounting concepts

(1) Business entity concepts

This concept assumes that business has a distinct and separate entity from its owners.
Therefore business transactions are recorded in the books of accounts from the business point

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of view and not owners. For example, If owner bring Rs. 1,00,000 as capital in business. It is
treated as liability of business to owner. Similarly if owner withdrew Rs. 5,000 from business
for personal use, it is treated as reduction of owner's capital and consequently reduction in
liability of business towards owner.

(2)Money measurement concept

This concept states that transactions and events that can be expressed in money terms are
recorded in the books of accounts. Non monetary transactions cannot be recorded in the
books like appointment of manager, capabilities of human resources ete.

Another aspect is the records of transactions are to be kept not in physical unit but in
monetary unit. For example, an organisation has 2 buildings, 15 computers, 20 office tables
are not recorded because they are physical unit and not in monetary unit.

Limitation of this concept is the value of rupee does not remain same over a period of time.
As changes in the value of money is not reflected in books does not reflect fair view of
business affairs.

(3) Going concern concept

This concept assumes that business shall continue to carry out its operations indefinitely for a
long period of time and would not be liquidated in the foreseeable future. It provides the very
hasis for showing the value of assets in the halance sheet.

An asset may be defined as a bundle of services. For example, a machine purchased for Rs.
2,00,000 and its estimated useful life say 10 years. The cost of machinery is spread on
suitable basis over next 10 years for ascertaining the profit or loss for each year. The total
cost of the machine is not treated as an expense in the year of purchase itself.

(4) Accounting period concept

Accounting period refers to span of time at the end of which financial statements are prepared
to know the profits or loss and financial position of business. Information is required to by
different users at regular intervals for decision making. For example, bankers require
information periodically because they want to ensure safety and returns of their investments,
Similarly management requires information at regular interval to assess the performance and
funds requirement. Therefore they are prepared at regular interval, normally a period of one
year. This interval of time is called accounting period.

(5) Cost concept

According to this concept all assets are recorded in the books of accounts at the parchase
price which includes the purchase price, cost of soquisition, transportation and installation.
For example, if an asset purchased for Rs. 1,00,000 and spent Rs. 10,000 on its installation.
Therefire asset will be reconfed in the books of scenunds at Rs. 1,10,000, This concupt is
historicul in usture. For example, if machice purchased for Rs. 75,000, the purchase or
acquisition price will remain same for all years to come, though its market value may change.
The usain limitation of this concept is that it does not show the true value of asset and may
lend to hidden profits

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(6) Dual aspect concept

This concept provides the very basis for recording the transaction in the books of sccounts. It
states that every transaction entered in the books has two aspects. For example, Man as
started business with cash Rs. 50,000. In this mansaction asset (cash) increases and liability
(capital of owner) also increases. This principle is also known as duality principle. This
principle is commonly expressed in fundamental accounting equacion given below.

Aseets-Liabilities Capital This equation states that assets of business are always equal to the
claims of owners and outsiders.

(7) Revenue recognition concept (Realisation concept)

According to this principle revenue is considered to have been realised when a transaction
has bern entered and obligation to receive the amount has been established. lo other words
when we nceive right to receive revenue the it is called revenac is realisel. For example, saka
made in March, 2010 and receives amoure in April, 2010. Revenue of these sales should be
recognisal in February month, when the goals sold. For example commaesion fix the Mask,
2010 even if received in April 2010 will be taken into profit and loss Acc of March, 2010
Similarly if rent for the April, 2010 is received in advance in March, 2010 i will be taken the
profit and lose Avc of the froncial year of March, 2011

(8) Matching concept

The marching concept states that expense incurred in an accounting period should be
manched with revasues Garing that period. I follows from this that revenue and expenses
incurred to cam those revenues must belong to the same scoosering period

For example, salary for the month of March, 2010 paid in April, 2010 is recorded in the profit
and loss Alc of financial year ending March, 2010 and not in the year when it realined
Similarly we reoonts cost of goods sold and not the goods punchased or produced So the cost
of unsold goods abovid be doduced from the cost of goods produced or purchased
(9) Full disclosure concept

Apart from legal requirement good socounting practice require all material and significant
information must be disclosed. Financial statements are the basic mauns of communicating
financial information to its users for taking useful financial decisions. This concepe states
thar all material and relevant fact and financial performance must he fully disclesed in
francial statement of the business. Company's act 1916 has provided a format for making
profit and Joss Ale sed balance shest, which needs to be compulsorily adhered to for
preparatice of financial statement. Disclosure of material information results in better
understanding. For example, the reasons for low tumover should be disclosed.

(10)Consistency coneept

This concept states that accounting practices followed by an enterprise should be uniform and
consistent over a period of time. For example if an enterprise has wkopted straight line
metisod of charging depreciatice then it has to be followed year after yeur. If we adopt written
down value method from scool year for charging depreciation than the financial information

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will not be comparable. Consistency eliminates the personal bias helps in achieving the
results that are comparable However consistency does not prohibits the change accounting
policies Necessary changes can be adopted and should be disclosed.

(11) Conservatism concept (Prudence concept)

This concept takes ito consideration all prospective losses but not the prospective profit. It
means profit should not be recorded until it realised hot all losses, even those which have
cemote possibility are to be recorded in the books. For example, valuing closing stocic at cost
er market value whichever is lower, eating, pornos for doubtful debts etc. This concept
ensures that the financial statemeres provide the real picture of the enterprise.

(12) Materiality concept

This concept states that accounting should focus on material fact. Whether the non is material
or not shall depend upon nature and amount involved in it. For example, amount spent of
repair of building Rs. 4,00,100 is material for enterprise having the sales tumover of
R4150.000 but not material for enterprise having tumover of Rs. 25.00,000. Similarly closure
of one plant materul bot stock eraser as pencils are set shosen at the act side but treated as
expenses of dat period, whether consumed or not because the amount involved in in

(13) Objectivity concept

This concept shoes that accounting should be free from personal bias. This cat he pouchle
when every Inesaction is supported by veritable documents. For example, purchase of
machinery for its her by the voucher and should be recorded in theanting Clas X

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books of accounts. Similarly other supporting documents are cash memo, invoices, receipts
provides the basis for accounting and auditing.

Basis of Accounting:

(1) Cash basis

Under this entries in the books of accounts are made when cash id received or paid and not
when the receipt or payment becomes due. For example, if salary Rs. 7,000 of January 2010
paid in February 2010 it would be recorded in the books of accounts only in February, 2010.

(2) Accrual basis

Under this however, revenues and costs are recognized in the period in which they occur
rather when they are paid. It means it record the effect of transaction is taken into book in the
when they are earned rather than in the period in which cash is actually received or paid by
the enterprise. It is more appropriate basis for calculation of profits as expenses are matched
against revenue carned in the relation thereto. For example, raw materials consumed are
matched against the cost of goods sold for the accounting period.

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Accounting Standards (AS):

"A mode of conduct imposed on an accountant by custom, law and a professional body." -By
Kohler

Nature of accounting standards:

(1) Accounting standards are guidelines which provide the framework credible financial
statement can be produced

(2) According to change in business environment accounting standards are being changed or
revised from time to time

(3) To bring uniformity in accounting practices and to ensure consistency and comparability
is the main objective of accounting standards.

(4) Where the alternative accounting practice is available, an enterprise is free to adopt. So
accounting standards are flexible.

(5) Accounting standards are amendatory in nature.

Utility of accounting standards:

(1) They provide the norms on the basis of which financial statements should be prepared.

(2) It creates the confidence among the users of accounting information because they are
reliable.

(3) It helps accountants to follow the uniform accounting practices and helps auditors in
auditing (4) It ensures the uniformity in preparation and presentation of financial statements
by following

the uniform practices.

International Financial Reporting Standards (IFRS):

To maintain uniformity and use of same or single accounting standards, International

Financial Reporting Standards (IFRS) are developed by International Accounting Standards
board (IASB).

Objectives of IASB:

(1) To develop the single set of high quality global accounting standards so users of
information can make good decisions and the information can be comparable globally.

(2) To promote the use of these high quality standards.

(3) To fulfill the special needs of small and medium size entity by following above
objectives.

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Meaning of IFRS:

IFRS is a principle based accounting standards. IFRS are a single set of high quality
accounting Standards developed by IASB, recommended to be used by the enterprises
globally to produce financial statements.

Benefits of IFRS:

(1) Global comparison of financial statements of any companies is possible

(2) Financial statements prepared by using IFRS shall be better understood with financial
statements prepared by the country specific accounting standards. So the investors can make
better decision about their investments.

(3) Industry can raise or invest their funds by better understanding if financial statements are
there with IFRS.

(4) Accountants and auditors are in a position to render their services in countries adopting
IFRS.

(5) By implementation of IFRS accountants and auditors can save the time and money.

(6) Firm using IFRS can have better planning and execution. It will help the management to
execute their plans globally.

QUESTIONS

Explain cost concept.

(1) What is mean by accounting standard? What is the main objective of accounting
standard?

(2) Explain the following concepts.

a. Business entity concept

b. Going concern concept

c. Revenue recognition concept

(3) Explain the utility of Accounting Standards.

(4) Which principle assumes that a business enterprise will not be liquidated in near future?

Ans. Going concern concept.

(5) "Closing stock is valued lower than the market price" which concept of accounting is
applied

here?

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Ans. Conservatism (prudence) concept.

(6) An asset may defined as a bundle of services explaini with an example.

(7) Under which accounting principle, quality of manpower is not recommended in the books
of

accounts?

Ans. Money measurement concept.

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