AFM Module 1

8/3/2019 AFM Module 1

1/28

Accounting For Management ((Module I)

TKM Institute of Management, Kollam

Study Notes, Semester I

Accounting for Managers

Module I

SyllabusIntroduction to Financial Accounting; Purpose, use and role. Financial

Accounting rules, Concepts and Conventions; Financial Accounting Transactions,The process of recording, rules of book-keeping, Journalizing, Primary and

Secondary books. Financial Accounting and Management Accounting; Generally Accepted Accounting Principles (GAAP); Accounting standards; Internationalaccounting standards; Regulatory framework of financial reporting in India.

THE ACCOUNTING SYSTEMAccounting is an ancient art, certainly as old money itself which conveys

the language of business by recording, classifying and summarizing moneytransactions & events in a significant manner and interpreting the resultsthereof.

In modern age the scope of business has been widen. The production andthe sales are made at large scale due to division of labor, specialization andscientific management. The customers of a seller are spread over throughoutthe country. Usually the seller sells their goods for cash but to increase theirsales the number of credit transactions increases. The memory of humanbeing is limited. Therefore, it is not possible to remember all the transactionsof a business. To overcome this problem, the work of recording the businesstransactions started which develops. Different methods of bookkeeping wereused in different periods. Today we can say that the bookkeeping is afoundation on which the whole structure of modern business is based.

Need for Accounting

Accounting has rightly been termed as the language of business. Itcommunicates the business operations to various parties who have somestake in the business viz., the proprietor, creditors, investors, Government andother agencies. The need for accounting is mainly for a person who is runninga business. He should know: (i) what he owns? (ii) What he owes? (iii) Whetherhe has earned a profit or suffered a loss on account of running a business? (iv)What is his financial position? i.e. whether he will be in a position to meet all

Prepared by Asst. Prof. Rajesh Janardhanan

1


2/28


his commitments in the near future or he is in the process of becoming abankrupt.

In India, Chanakya in hisArthashastra has emphasized the existence andneed for proper accounting and auditing. However the modern system ofaccounting owes its origin to Pacoili, who lived in Italy, in the 18th century.

MEANING OF ACCOUNTINGAccounting is the process of identifying, measuring and communicating

economic information to permit informed judgments and decisions by theusers of information

In the beginning the main objective of accounting was to ascertain theresult of the business (whether profit has been earned or loss has beensuffered) during a year and to show the financial position of the business as ona particular date. But which the lapse of time more and more being expectedfrom accounting. At present accounting has to meet the requirements oftaxation authorities, investors, government regulations, management andowners. This has resulted in widening to scope of accounting and may bedefined as follows:

With greater economic development resulting in changing role ofaccounting, its scope became broader. In 1966 the American AccountingAssociation (AAA) defined accounting as the process of identifying, measuringand communicating economic information to permit informed judgments anddecisions by users of information.

In 1970 the, Accounting Principles Board of AICPA also emphasized that thefunction of accounting is to provide quantitative information, primarilyfinancial in nature, about economic entities, that is intended to be useful inmaking economic decisions.

Accounting can therefore be defined as the process of identifying,measuring, recording and communicating the required information relating tothe economic events of an organization to the interested users of suchinformation. In order to appreciate the exact nature of accounting, we mustunderstand the following relevant aspect of the definition:

Economic events

Identification, Measurement, Recording and communication

Organization

Interested users of information.

Definition and Functions of Accounting

In 1941, the American Institute of Certified Public Accountant (AICPA)defined accounting as follows:


2


3/28


Accounting is the art of recording, classifying and summarising in significantmanner and in terms of money, transactions and events which are, in part, atleast of a financial character and interpreting the results thereof.

In 1966, the American Accounting Association (AAA) defined accounting asfollows:Accounting is the process of identifying, measuring and communicating

economic information to permit informed judgments and decisions by users ofthe information.

Accounting is the art of recording, classifying, analyzing, summarizing andinterpreting and the financial transactions and communicating the resultsthereof to the persons interesting in such information.Thus accounting cycle involves the following stages:1. Recording of Transactions.This is done in the book termed as Journal.2. Classifying the Transactions. This is done in the book termed as

Ledger.3. Summarizing the Transactions. This includes preparation of the trial

balance, profit and loss account and balance sheet of the business.4. Interpreting the Result. This involves computation of various

accounting ratios, etc., to know about the liquidity, solvency andprofitability of business.

An analysis of the definition brings out the following functions ofaccounting:

1. RecordingThis is the basic function of accounting. Recording is done in the book

Journal. This book may be further subdivided into various subsidiarybooks such as Cash Journal (for recording cash transactions), PurchaseJournal (for recording credit purchase of goods), Sales Journal (for recordingcredit sales of goods), etc. the number of subsidiary books to be maintainedwill be according to the nature and size of the business.

2. ClassifyingClassification is concerned with the systematic analysis of the

recorded data, with a view to group transactions or entries of one nature atone place. The work of classification is done in the book termed asLedger.

3. SummarisingThis involves presenting the classified data in a manner which is

understandable and useful to the internal as well as external end-users of


3


4/28


accounting statements. This process leads to the preparation of thefollowing statements:

(i) Trial Balance, (ii) Income Statement, and (iii) Balance Sheet

4. Dealing with Financial Transactions

Accounting records only those transactions and even in terms ofmoney which are of a financial character. Transactions which are of afinancial character are not recorded in the books of accounts.

5. Analysing and InterpretingThe recorded financial data is analysed and interpreted in a manner

that the end-users can make a meaningful judgement about the financialcondition and profitability of the business operations. The term Analysisrefers to the methodical classification of the data given in the financialstatements. The term Interpretation means, explaining the meaning and

significance of the data simplified.

6. CommunicatingThe accounting information after being meaningfully analysed and

interpreted done through preparation anddistribution of accounting reports, which includes besides the usual incomestatement and the balance sheet, additional information in the form ofaccounting rations, graphs, diagrams, funds flow statements, etc. theinitiative, imagination and innovative ability of the accountant are put totest in this process.

ACCOUNTING SYSTEM

Business transactions may be recorded in any system, which will enable theascertainment of the profit or loss of a business and its financial position. Thefollowing are the main systems adopted by business people:

1) Cash System of Accounting : Under this system, only actual cash receiptsand payments transactions will be entered into the Books of Accounts. No

entry will be made for credit transactions. Government system ofaccounting is mostly on cash basis. Certain professional organizations alsorecord their income on cash basis, but while recording expenses they takeinto account the outstanding expenses also and prepare Income andExpenditure Account instead of Profit and loss Account.

2) Mercantile System of Accounting: This system is based on Double Entryprinciple. This Book Profit System of Accounting takes into considerationall the aspects of business transactions (BOTHCREDITANDCASHTRANSACTIONS). Thissystem is followed by most of the industrial and commercial firm. Thissystem owes its origin to an Italian Merchant Luco Pacioli who wrote a book


4


5/28


entitled De Computis et Scripturis on Double Entry Accounting in the year1494.

SYSTEM OF BOOK KEEPING

The art and technique of recording the business transactions in a set ofbooks is called as Bookkeeping. It is the process of analyzing, classifyingand recording transactions in accordance with a preconceived plan.

This recording may be done according to two ways:

1) Single Entry System: which is an incomplete maintenance ofbooks of accounts without following the Double Entry Concepts andConventions, where some business houses maintains for their conveniencekeeping only some of the essential Books of Records. Thus it is referred asincomplete double entry recording of business transactions.

2) Double Entry System: Where the transactions are recordedaccording to the Golden Rules of Accounting taking into consideration boththe aspects of a transaction (Debit and Credit) and following the AccountingConcepts and Conventions. This system maintains both Book of OriginalEntry (Journal / Subsidiary Books) and Book of Final Entry (Ledger)according to the classification of Accounts into Real, Personal & Nominal, inorder to know the state of affairs of the business by preparing the Profit andLoss Account and Balance Sheet from the Trial Balance.

BRANCHES OF ACCOUNTING

The subject of accountancy has become important for all the businessorganization in the present time. Its subject matter has been increased and ithas taken the form of accounting. Accounting subject has the followingbranches:

FINANCIAL ACCOUNTING1. Journal

2. Ledger3. Trial Balance4. Final Accounts

COST ACCOUNTING1. Cost sheet2. Job and contract costing3. Process costing4. Operating costing

MANAGEMENT ACCOUNTINGPrepared by Asst. Prof. Rajesh Janardhanan

5


6/28


7/28


(3) Management Accounting : This branch of accounting supplies necessaryinformation to the managers. On the basis of these information the evaluationof policies is done and decisions for future are taken. It includes Ratio Analysis,Analysis of financial statements, Fund flow Analysis, Cash flow Analysis etc.

(4)Tax Accounting: Every businessman has to pay various types of taxes suchas sales tax, Income tax, excise duty etc. Financial Accounting helps only indetermining the taxable income of the business. Some specific separateadjustments are needed for determination of tax liabilities. Moreover varioustypes of deductions and provisions of Acts are also taken into consideration fortax accounting.

(5) Government Accounting: Central government, state government and localbodies also undertake the work of accounting and it is called GovernmentAccounting. It differ from financial accounting. It explains the Budget andvarious other types of accounts such as consolidated fund, contingent fundand public fund account.

(6)Social Responsibility Accounting: The society provides infrastructure andthe facilities without which business cannot operate at all. Therefore thebusiness also has a responsibility towards the society. Social responsibilityaccounting is the process of identifying, measuring and communicating thecontribution of a business to the society. The contribution of a business to thesociety consist of providing employment to under privileged, providingfinancial and manpower support for public utility programmes, environmentaland ecology contribution, product quality, product safety, product durability

and customer satisfaction etc. In social responsibility accounting techniqueshave been developed for measuring the cost of these contributions and thebenefit to the society

(7) Human Resources Accounting: HR Accounting is an art and science ofevaluating the worth of human resources of a business organization in asystematic manner as a whole to the concern and the society and recordingthem for presenting the information in the financial statements tocommunicate their worth to the readers of financial statements. It is theprocess of identifying and measuring data about human resources andcommunicating this information to interested parties

Role of an AccountantAccountants are persons who practice the art of accounting. The

Accounting system and the Accountants, who maintain it, provide usefulservices to the society. Accountants can broadly be classified into twocategories:

1. Accountants in Public Practice The accountants in public practice are also known as professional

accountants. They offer their services for conducting financial audit, cost

audit, designing of accounting system and rendering other professionalPrepared by Asst. Prof. Rajesh Janardhanan

7


8/28


services for a fee. In India, there are two recognised professional bodies for

this purpose. They are: (i) the Institute of Chartered Accountants of India and(ii) the Institute of Cost and Works Accountants of India.

2. Accountants in EmploymentThese are accountants who are employed in non-business entities or

business entities. Non-business entities are diverse set of organisationsincluding Educational Institutions, Government, Churches, Museums,Hospitals, etc. their object is not to earn profit. The accountants employed bybusiness entities arte frequently called Management Accountants since theyreport to, and are part of, the entitys management. These accountantsprovide information for tax returns, budgeting, routine operating decisions,investment decisions, performance evaluation and external financialreporting of the business.

Services Rendered by an Accountant

1. Maintenance of Books of Accounts2. Auditing of Accounts3. Taxation4. Financial Services

OBJECTIVES OR FUNCTIONS OF ACCOUNTING

Now a days accounting becomes a subject of practical importancefor every business concern that may be a marketing firm, manufacturing firm,bank, transport agency, insurance company or a professional organization.Accounting attains the importance every where. Various persons areinterested in accounting work of a business concern e.g. shareholders,investors, banks, government, creditors, employees, customers etc. Thereforeaccounting has to fulfill their objectives also. For this accounting performvarious functions. Some of the important objectives or the functions ofaccounting are as follows:

(1)To keep systematic record of business transactions: The mainobjective of accounting is to keep complete record of business transactionsaccording to rules. For this purpose all the business transactions are firstlyrecorded in the journal or subsidiary books and then posted into the ledger. Thishelps to avoid the possibility of omission and fraud; moreover we can get thefinancial information at any time during the year.

(2) To calculate profit or loss of the business: The second main objectiveor the functions of accounting is to ascertain the net profit earned or losssuffered by a business concern. For this purpose a Trading and Profit and loss


8


9/28


account is prepared at the end of each accounting period. When revenue ofthe business is more than expenditure the difference is said to be profit. Inaddition to it, a businessman is able to get the following information fromaccounting.

1. How much goods have been purchased during a particular period

2. How much goods have been sold during a particular period3. How much goods have been remained unsold and what is its value.4. How much amount has been spent and earned on various heads

(3) To depict the financial position of the business: For this purpose abalance sheet is prepared on the last day of the accounting year which showsthe values of various assets on one side and the liabilities and capital on theother side. Balance sheet shows the financial position of the business. Besidesthis, from accounting a businessman can get the following information:

1. How much amounts the business has to recover from debtors.2. How much amount the business has to pay to creditors.3. Amount of opening capital and closing capital4. Amount of cash receipts and cash payments from the cashbooks.

(4) To provide informations to various parties: Various persons havevested interests in a business firm. Accounting provides useful information toall the interested parties such as: owners, managers, investors, creditors,researchers, employees, customers, banks, government departments, etc.

(5)Other objectives: Accounting functions also fulfill the followingobjectives:

To keep systematic and permanent record of all financial transactions

To use accounting records for future referenceTo fulfill the legal requirementsTo provide information about various tax liabilitiesTo check the accounting errors, frauds, and misappropriations of fundsTo know the requirements of the businessTo help in fulfilling tenders and quotationsTo provide information about profitability of various productsTo facilitate rational decision-making.To control over expenditures to minimize them.

ADVANTAGES OF ACCOUNTING

Accounting has many objectives and fulfillments of these objectives are theadvantages and usefulness of accounting:(A) Advantages to businessman:

(1) Recording of transactions: It is a systematic and complete record ofbusiness transactions whether they are personal, real, or nominal.Permanent recording of business transactions make the results morerealistic.

(2) Replacement of memory: In a large business it is very difficult for a

businessman to remember all the transactions. Accounting providesPrepared by Asst. Prof. Rajesh Janardhanan

9


10/28


records which will furnish information as and when required and thus itreplaces human memory.

(3) Provides information: Every trader wants to get the information abouthis business from time to time so accounting provides all theseinformation.

(4) Availability of net results: In accountancy at the end of the year finalaccounts are prepared from the accounts of business transactions.Gross profit is ascertained by Trading A/c and net profit is ascertainedby profit and loss A/c. Other financial statements make available thenet results of income and expenditure items also.

(5) Knowledge of financial position: Accounting helps a businessman toknow the financial position of his business.

(6) Reference in future: When the work of accounting has been performedproperly then the businessman can present the old ledgers asreferences in future. Posting up the books if accounts are treated asbusiness evidences and can be used in future as references. Booksof accounts can be presented in the courts as evidences.

(7) Comparative study: When business transaction are recorded in aproper manner then the business results can be inferred easily and theresult of different years can be compared to take proper decisions forthe future.

(8) Check the errors and frauds: When the business transactions arerecorded regularly and systematically in the books of accounts thenthe chances of errors minimize. Moreover accounting also checks thefrauds in stock and cash.

(9) Helpful in management: Mangers of business need various informationto manage the business. These information are supplied by theAccounts Department only. In a good business the AccountsDepartments has a special importance.

(10) Helpful in the sale of business: If accounts are properly maintained ithelps to ascertain the purchase price in case the businessman isinterested to sell business.

(B) Advantages to customers

(1) Proper price: A manufacturer can determine the proper cost if hisproduct through an adequate and complete recording. This furtherhelps in proper price determination and the product can be madeavailable at proper price to the consumer.

(2) Quality goods: An indirect advantage is accounting is that whenaccounting is that when Accounts Department of a business is goodthen the quality of its product will also be good which benefits theconsumers.

(C ) Advantages to Government


10


11/28


(1) Financial assistance: Govt. also gets various advantages fromaccounting. Govt. gives financial assistance in the form of subsidiesand grants to the business firms. We can take advantages of theirfinancial assistance only when we have recorded properly ourbusiness transactions .So it helps to attain the advantages of govt.policies.

(2) Knowledge of financial position of the country: Govt. can ascertainthe commercial and industrial progress of the country as a wholethrough the knowledge of progress of various trades. It is possiblewhen all the business units have proper accounting work.

(3) Granting license: If the work of accounting is performed properly itwill help the govt. in granting import, export and production licensesto the enterprises.

(4) Commercial Laws: Accounting also makes possible to frame and

amend the various commercial laws such as Company Act, MRTP Act,Consumer Protection Act etc.

(5) Tax Assessment: Traders have to pay various taxes such as Salestax, Income tax, Excise duty etc. These taxes be determined properlyif the recording in the books of accounts is done properly.Government officers also recommend the accounting .Thusbusinessman and the govt. both are benefited by the accountancy.

(D ) Advantages to employees

(1) Control: It is very important in a business that workers should be

employed according to work. How much employees can be employedat a fixed wages is also related with the Accounts Department. Thusaccounting controls the employees indirectly.

(2) Increase in salary and bonus: Accounting also helps in determiningthe salaries, bonus and other payments to the employees. With theparticipation of employees in the management the importance ofaccounting has also special status.

(E ) Other Advantages

(1) Helpful in planning: Managers of business require the estimates ofpurchase, sales expenses, costs and cash receipts for the next year,so that future plans can be framed. These information are receivedfrom Accounts Department due to accounting.

(2) Helpful in decision making: Every trader has to take decisions aboutproduction, sales etc. For e.g. whether price can be reduced toincrease sale or not. Gifts is to be presented with product or not etc.The information related to these decisions can be obtained from theAccounts department only.

(3) Helpful in borrowing: We need additional capital for expansion of the

business. This is provided by the accounting.Prepared by Asst. Prof. Rajesh Janardhanan

11


12/28


(4) Determination of goodwill: on the basis of accounts for various yearsGoodwill of the business can be calculated.

(5) Helpful in partnership: In partnership a new partner can know thefinancial position of the firm through the accounts of the firm. Anoutgoing partner with the help of accounts of the firm can easilyascertain his share to be received from the firm. In partnership thereare more than one manager hence for confidence must prevailamong them proper recording of business transactions is required.

(6) In large-scale business: Today every product is produced and sold atlarge scale. Thus business activities also enlarge. Accounting helps ineasy control of such large business.

(7) In case of insolvency: When a businessman fails to pay his liabilitieshe becomes insolvent, then the creditors torture the businessman. Ifhe has maintained proper record of business transactions he can takethe protection of the court. The court declares a businessman solvent

on the basis of books of accounts.(8) Assessment of progress: By knowing about the profit and loss, assetsand liabilities, purchases and sales income and expenditure of lastmany years we can assess the progress made by a business. It ispossible only by the accounting.

LIMITATIONS OF ACCOUNTING

Though accounting has a number of advantages yet it has some limitationsalso. Following are the major limitations of accounting.

(1)Incomplete information: In accounting only those transactions arerecorded which can be expressed in terms of money. Other events, e.g.efficiency of managers, changes in tastes of consumers, popularity ofproduct and ability of employees, Economic and political conditions ofthe country, level of competition etc though affect the success ofbusiness and financial position and managers continuously try to collectthese information, yet they cannot be expressed in terms of money andthus not represented in accounting.

(2) Influenced the by personal judgments: In accounting some principlesand concepts are obeyed. But at the end of an accounting year toascertain the net profit or loss some estimates are used. To chargedepreciation life of an asset and its scrap value are to be estimated, Baddebts are also estimated etc. The liking and disliking of the accountantaffect these estimates. Thus the results are also affected.

(3) Realizable value of business is not shown: The balance sheet which isprepared at the end of the period to present the financial position of thebusiness shows the assets at their historical costs and not at their


12


13/28


realization price. Thus it is not possible to estimate the presentrealizable value of the business.

(4)Complete control on frauds is impossible: Accountancy can check thearithmetic accuracy of books accounts but cannot check the fraudscompletely. The profit and loss at the end of the year can also be

manipulated by manipulating the value of closing stock.(5)Manipulation in accounts: If an owner shows the items of his own

interest in the books of accounts the result obtained by the accountantwill be biased and wrong.

(6)Does not provide timely information: Final accounts are prepared at theend of the accounting year. Thus they contain the information ofhistorical importance. While managers need current information formanagement and planning, which are not supplied by the accountingeasily..

FINANCIAL ACCOUNTING

Financial Accounting is concerned with the provisions of informations toexternal parties outside the organization. The outsiders who use accountinginformation have a variety of interests. Investors and shareholders want toknow the companys profit potential. The suppliers, banks, and other lenderswant to know whether a business is credit worthy. Government agenciesregulate and tax businesses and analyze the published financial statementsto make decisions.Financial accounting is concerned with recording and summarizing financial

transactions and preparing statements relating to the business according to

Generally Accepted Accounting Principles agreed on by the accountingprofession. Financial Accounting is the basis of external reporting.

Limitations Of Financial AccountingFinancial accounting works as a postmortem of business affairs

of an enterprise during the accounting year. It cannot fulfill the needs ofmodern management as A.C.Littleton has aptly said that providing ofsignificant data regarding market demand, state of competition, generalbusiness conditions, engineering, personal information, legal and regulatorylimitations are out of the sphere of financial accounting. In the changed

business scenario various new requirements such as future planning,evaluation of plans and policies, cost control, timely decisions etc. haveemerged on account of increasing size of business, technical complexities,government interferences and public awareness towards social responsibilitiesof business. Financial accounting has the following limitations.

1) Financial accounting gives only limited information to the management.It is inadequate for management in the task of decision making.

2) Managerial decisions relate to future. Hence they are made on the basisof estimates and projections. Financial accounting is inadequate for

making future projections because it provides only historical information.Prepared by Asst. Prof. Rajesh Janardhanan

13


14/28


3)The present day management is of three tier system. Different levels ofmanagement needs different information. Financial accounting fails tomeet the information needs of different levels of management.

4) Financial accounting considers only quantifiable information. Nowadaysbusiness decisions are influenced by a number of social factors. For this

many of them are ignored in financial accounting.5)The rapid change in technology and fast growth of business units have

made the task of modern management highly complicated. Financialaccounting with its simple structure is not in a position to cater theneeds of modern management.

Difference between Management Accounting and FinancialAccounting.

Management accounting cannot replace financial accounting. It takes a majorpart of the information from financial accounting and modifies the same formanagerial uses .ThereforeBoth branches of accounting are complementary to each other. But there arecertain points of differences between the two. They are given below.

(1) The primary objective of financial accounting is recording businesstransactions in a systematic way and ascertains the business results andfinancial position of a business concern. The objective of managementaccounting is to provide necessary information to the management forthe efficient discharging of its functions.

(2)Financial accounting is an external accounting because it presentsinformation to the external parties like shareholders, creditors, bank etc.

Management accounting is an internal accounting because it presentsinformation to the management.

(3)Financial accounting is concerned with historical records relating to thepast, where as Management accounting is mainly concerned with futureplans and policies.

(4)Financial accounting is compulsory, while Management accounting isoptional.

(5)Financial accounting relates to the business as a whole. Managementaccounting deals with reports about a particular department or divisionof an enterprise.

(6)In financial accounting there is more emphasis on precise data. InManagement accounting there is less emphasis on precision. Estimatesand future data are mostly used.

(7) Financial accounting is prepared in accordance with the GAAP.Management accounting is prepared according to the internalrequirements of the management.

(8) Financial accounting presents annual reports, while managementaccounting reports are of both shorter and longer durations.

(9)Financial accounting is based on measurements while managementaccounting is based on judgment. Thus financial accounting is more

objective and management accounting is more subjective.Prepared by Asst. Prof. Rajesh Janardhanan

14


15/28


(10) Financial accounting records only those transactions which can be expressedin terms of money. On the other hand management accounting records notonly monetary transactions but also non-monetary events like technicalchanges, government policies etc

(11) The scope of financial accounting is not vast as compared to management

accounting. It does not include the techniques like costing, statistics,management accounting etc. It is a part of management accounting. Thescope of management accounting is most wide because financial accounting,cost accounting, statistics and other techniques are used in it.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

What is GAAP ?Generally Accepted Accounting Principles (GAAP) includes accountingconventions, rules, procedures and accounting standards, acceptedaccounting practices both promulgated and non-promulgated. GAAP are thoseprinciples, which have substantial authoritative support.In order to maintain uniformity and consistency in accounting records, certain

rules or principles have been developed which are generally accepted by theaccounting profession the ICAI. These rules are called by different names suchas principles, concepts, conventions, postulates, assumptions and modifyingprinciples.

The term principles has been defined by AICPA as A generallaw or rule adopted or professed as a guide to action, a settled ground or basisof conduct or practice. The word generally means in a general manner i.e.,

pertaining to many persons or cases or occasions. Thus, GAAP refers to therules or guidelines adopted for recording and reporting of businesstransactions in order to bring uniformity in the preparation and thepresentation of financial statements.

The GAAP have evolved over a long period of time on thebasis of past experiences, usage or customs, statements by individuals andprofessional bodies and regulations by the government agencies and havegeneral acceptability among most accounting professionals. However theprinciples of accounting are not static in nature. These are constantlyinfluenced by changes in the legal, social, and economic environment as wellas the needs of users. These principles are also referred as concepts and

conventions. The term Concept refers to the necessary assumptions and ideasthat are fundamental to accounting practice, and the term convention refersto customer or tradition as a guide to the preparation of accountingstatements. In practice the same rules and guidelines have been described byon author as a concept by another as a postulate and still by another asconvention. This at times becomes confusing to the learners. Instead of goinginto the semantics of these terms, it is important to concentrate on thepracticability of their usage. From this practicability view point it is observedthat the various terms such as principles, postulates, conventions, modifyingprinciples, assumptions etc have been used inter changeably and are referred

to as basic accounting Concepts and Conventions.Prepared by Asst. Prof. Rajesh Janardhanan

15


16/28


Basic Accounting Concepts

The basic accounting concepts are referred to as the fundamentalideas or basic assumptions underlying the theory and practice of financialaccounting and are broad working rules for all accounting activities and

developed by the accounting profession.

The important concepts have been listed as below:Conditions on which the accounting system is based are called

accounting assumptions or concepts.Accounting system is based on certain assumptions or concepts.

These assumptions constitute the foundation of accounting process. Noconcern can prepare financial statements and accounts without consideringthese assumptions. Although there is no authoritative list of assumptions,some major assumptions are as follows.

Accounting entity Concept

Money measurement Concept

Going concern Concept

Accounting period Concept

Historical cost Concept

Dual aspect Concept

Revenue recognition/Realization Concept

(1) Accounting entity concept:The concept or assumptions that business has a separate entity or

existence apart from the owners is an entityThis concept assumes that the entity of business is distinct from the its

owners. Owner is a creditor in accordance with this concept. That is whycapital account is shown on the liability side of the balance sheet. Moreoverbusiness is treated as a unit or entity separate from the persons who controland associate with it. So accounts which are prepared and maintained forbusiness entity are distinct from all categories of persons associated with it.(2) Money Measurement concept :

Under money measurement concept, only transactions expressedin terms of money are recorded in the books of accounts.

Money is common denominator in terms of which all transactions can beexpressed in a better manner. Hence under the concept of monetaryexpression or money measurement concept only those transactions which canbe expressed in terms of money are recorded in the books of account. Thisfacilitates in recording various kinds of economic activities on a uniform basis.For instance, plant, furniture, land etcWhich are generally expressed in terms of quantity, area etc are recorded interms of money value. A transaction or an event which is not measurable interms of money cannot be recorded in the books of account. For instance


16


17/28


dismissal of worker, strikes etc are very important events, but do not findtheir place in the books of account. This concept suffers from the followinglimitations.

(1)It does not consider the changes in the value of money.(2)Human resources cannot be recorded in the books of accounts,

although it is greatest asset of a concern.

(3) Going concern concept: The concept that the business will continue for a fairly long period is a

going concern concept.Under this concept it is assumed that the business concern will continue

to exist for a fairly long period. There is no intention to shut down theparticular business concern in the near future. However this concept does notimply a permanent existence of the business. But this indicates stability andcontinuity of a business for a long period to carry out its plan.

(4) Accounting period concept: The period of interval for which accounts are prepared and

presented for ascertaining the result of business is an accounting concept.The going concern concept implies that the business has a long period

of life. But however the owners and others who are interested in the businesscannot wait for such an indefinite period to know its results. Moreover suchbelated computation of financial position of a business will not serve its verypurpose. Hence the accountants specify an accounting period (say 12 months,6months, 3months,etc ) for preparing financial statements.

(5) Historical/ Cost concept:Accounting based on the actual cost of a transaction is the

principle of historical cost.Under this principle all the transactions should be recorded at their requisition

cost. The cost of acquisition is the cost of purchasing the assets and includesexpenses incurred in bringing them to the intended condition and location ofuse. However this concept does not mean that the assets are always shown atcost but will be reduced by decrease in value known as depreciation.

(6) Dual aspect:

The concept of double aspects in every transaction is a duality concept.

According to this concept every transaction has two aspects. In case

there is a debit then there is corresponding credit of the amount. Accountingequation is developed on the strength of dual aspect concept. For instancewhen there is an increase in one asset there is a corresponding decrease inother assets or increase in liabilities. Thus assets and liabilities are equal at all the times i.e. [Asset = Capital+liabilities]. The system of recording transactions with its dual concept is

known as double entry system.Prepared by Asst. Prof. Rajesh Janardhanan

17


18/28


(7) Revenue recognition

Unless money has been realized (either cash has been realized or a legalobligation to pay has been assumed by the customer) no sale can be said to

have taken place and no profit or income can be said to have arisen.

(8) Accrual Concept

Normally all transactions are settled in cash , but even if cashsettlement has not taken place, it is proper to bring the transactions or theevent concerned into the business books during the particular accountingperiod as it relates to that period. For eg: Rent accrued fro the last month.Rent for the last month of the accounting period may be paid only in the nextaccounting period, but still as the event is related to the current period it willbe considered as accrued and debited in the current period itself.

The International Accounting Standards Committee (IASC) of which theInstitute of Chartered Accountants of India (ICAI) is an associate member,treats Going concern, Consistency and Accrual as the fundamentalaccounting assumptions.

Accounting Conventions regarding financial statements.

Conventions are the customs or practices, which were following for a longperiod. They are the practices or traditions, which guide the accountant whilepreparing the accounting statements. In order to make the message containedin the financial statements (Profit and Loss Account & Balance Sheet) clearand meaningful the following conventions are used:

(1)ConservatismFinancial Statements are usually drawn up on the assumption that

anticipate no profit but provide for all possible losses i.e., showing a positionbetter than what it is, is not permitted (which is called as Window-dressing). It

is also not permitted to show a position substantially worse than what it is. Inother words, secret reserves are not permitted. It is based on this conventionthat the inventory is valued at cost or market price whichever is less(2)Consistency

The accounting practices should remain the same from one year toanother- for instance, it would not be proper to value stock-in-trade accordingto one method one year and another method next year. If a change isrequired, the change& its effect should be stated clearly.

(3)Materiality/Disclosure


18


19/28


This convention suggests that the accountant should attach importance tomaterial details and ignore insignificant details. The accountant should regardan item as material if there is reason to believe that knowledge of it wouldinfluence the decision of the informed investor. For e.g., while sending eachdebtor a statement of his account, complete details up to paise have to be

given. Good accounting practices demands that all significant matters orinformation should be disclosed.

The Process of Accounting

Accounting is the art of recording, classifying, and summerising thefinancial transactions and interpreting the results therefore. Thus accounting

cycle involves the following stages:5. Recording of Transactions.This is done in the book termed as Journal.6. Classifying the Transactions. This is done in the book termed as

Ledger.7. Summerising the Transactions. This includes preparation of the trial

balance, profit and loss account and balance sheet of the business.8. Interpreting the Result. This involves computation of various

accounting ratios, etc., to know about the liquidity, solvency andprofitability of business.

Accounting Process Chart


19


20/28


Rules of Debit and Credit

1. Personal Account

Includes the accounts of persons with whom the business deals.Examples: - Debtors, Creditors, proprietor etc.Rule:

2. Real AccountIncludes the accounts which relate to such things which can be

touched, felt, measured etc. examples of such accounts are cash

account, buildings account, furniture account, stock account etc.Rule:

Debit what Comes InCredit what Goes Out

3. Nominal AccountThese accounts are opened in the books to simply explain the nature

of the transactions. They do not really exist. For example, salary, rent,commission etc.

Rule:


Transactions & Events

Purchases

Day Book

Purchases

Return Book

Sale Day

Book

Sales Return

Book

Cash Book

Journal

Proper

Ledger

AccountsTrial

Balance

Profit &

Loss A/c

Balance

Sheet

Bank

Reconciliation

Other End

of

Accounting

Period

Adjustment

s

Rectification

of Errors

20

Debit the receiverCredit the giver

Debit what Comes InCredit what Goes


21/28


Debit All Expenses and LossesCredit All Gains and Incomes

Books Maintained

I. Subsidiary Books

Subsidiary books are the subdivision of Journal usually prepared accordingto a set of pattern for academic pursuits. It constitutes the following:

(a) Purchases Day Book (Invoice Book or Bought Book orPurchases Journal)

It is the book in which all credit purchases of merchandise(goods) are recorded.(b) Sales DayBook

It is the book in which all credit sale of goods are firstrecorded.

(c) Returns Booksi) Purchases Returns/Return Outward Books:- to record the

purchase returns of goodsii) Sales Returns/Return Inward Books:- to record the sales

return of goods.

(d) Bills Receivables & Bills Payable BookThese are books in which the receipt and issue of bill of

exchanges are recorded. If the organization doesnt maintain suchbooks, the receipt and issues of bill of exchanges will be recordedin the journal proper

(e) Cash Book It is a book of account in which all receipts and payments of

cash are recorded in the chronological order irrespective ofwhether they are of capital or revenue in nature. It is both a ledgeras well as journal (as it is usually ruled like an ordinary ledgeraccount, and transactions involving either receipt or payment ofcash are recorded in it directly in the first instance). Sometimes itis treated as special journal.

(f) Journal ProperIt is a book of original entry (which retains the original form

of a journal to keep a record of those transactions for which thereis no separate book), in which transactions that could not berecorded in any of the subdivided/special journals are recorded.Usually, the following types of transactions are recorded in theJournal proper.

i) Opening Entries

ii) Closing EntriesPrepared by Asst. Prof. Rajesh Janardhanan

21

Debit All Expenses and LossesCredit All Gains and Incomes


22/28


iii) Transfer Entriesiv) Rectification Entriesv) Adjusting Entriesvi) Entries for dishonour of Billsvii) Miscellaneous Entries

JOURNALIZINGThe journal records all daily transactions of a business into the order in

which they occur. A journal may therefore be defined as a book containing achronological record of transactions. It is the book in which the transactionsare recorded first of all under the double entry system. Thus, journal is thebooks, of original record. A journal does not replace but precedes the ledger.The process of recording transaction in a journal is termed as Journalising.Journal is known as Book of Prime Entry.

A pro forma of journal is given below:

Date Properties L.F Debit(Rs.)

Credit(Rs.)

1. Date: -The date on which the transaction was entered is recorded here.2. Particulars: - the two aspects of transactions are recorded in this

column, i.e., the details regarding accounts which have to be debitedand credited.

3. L.F.:- it means the Ledger Folio. The transactions entered in the journalare later on posted to the ledger.

4. Debit: - in this column, the amount to be debited is entered. In Realaccount, it is Debit what comes in; in Personal account, it is Debit thereceiver; in Nominal account, it is Debit all expenses or losses.

5. Credit: - in this column, the amount to be credited is shown. In Realaccount it is Credit what goes out; in Personal account, it is Credit thegiver; in Nominal account it is Credit all incomes and gains.

II. Main/Principal Book of Account (Ledger)

Ledger is a Book of Secondary Entry or Principal Book of Account, whichcontains various accounts. In other words, ledger is a set of accounts. Itcontains all accounts of the business enterprise whether Real, Nominal or


22


23/28


Personal. It is usually prepared after the journal and therefore it is a secondaryor derived record. It is the most important book for a businessman, as it isfrom the ledger that a trial balance can be prepared and from the trialbalance, the final accounts are prepared. Because of the importance of theledger it is called the King of Books of Accounts.

PostingThe term Posting means transferring the debit and credit items from

the journal to their respective accounts in the Ledger. It should be noted thatthe exact names of accounts used in the Journal should be carried to theLedger.

Posting may be done at any time. However, it should be completedbefore the financial statements are prepared. It is advisable to keep the moreactive ac counts posted to date. The examples of such accounts are thecash account, personal account of various parties etc.

The Ledger Folio (L.F) column in the journal is used at the time whendebits and credits are posted to the Ledger. The page number of the Ledgeron which the posting has been done is mentioned in the L.F. column of theJournal. Similarly a folio column in the Ledger can also be kept where the pagefrom which posting has been done from the journal may be mentioned. Thus,there are cross references in both the Journal and the Ledger.

Form of Ledger Accounts

Dr. ----------------- Account Cr.Date

Particulars J.F Amount

(Rs.)

Date

Particulars J.F Amount (Rs.)

Relationship between Journal and LedgerBoth Journal and Ledger are the most important books used under Double

Entry System of book-keeping. Their relationship can be expressed as follows:1. The transactions are recorded first of all in the Journal and then they are

posted to the Ledger. Thus, the Journal is the book of first or originalentry, while the Ledger is the book of secondary entry.

2. Journal records transaction in a chronological order, while the Ledgerrecords transaction in an analytical order.

3. Journal is more reliable in compared to the Ledger since it is the book inwhich the entry is passed first of all.

4. The process of recording transactions is termed as Journalising whilethe process of recording transactions in the Ledger is called as Posting.

Balancing of an AccountPrepared by Asst. Prof. Rajesh Janardhanan

23


24/28


The technique of finding out the net balance of an account, afterthe end of a period (say a month, a quarter or a year), by considering thetotals of both debits and credits appearing in the account is known asBalancing the Account. The balance is put on the side of the account which issmaller and a reference is given that it has been carried forward or carried

down (c/for c/d) to the next period. On the other hand, in the next period areference is given that the opening balance has been brought forward orbrought down (b/for b/d) from the previous period.

ACCOUNTING STANDARDS

Accounting Standards are written documents, policies issued by expertaccounting body or Government or other regulatory body covering the aspectsof recognition, measurement, treatment, presentation and disclosure ofaccounting transaction in the financial statement. The Institute of CharteredAccountants of India issues accounting Standards in India.Objective of Accounting StandardsThe main objective of AS is to standardize the diverse accounting policies andpractices with a view to eliminate to the extent possible the non-comparabilityof financial statements and add the reliability to the financial statements.. TheInstitute of Chartered Accountants of India, recognizing the need to harmonizethe diverse accounting policies and practices, constituted an Accounting

Standard Board (ASB) on 21st April 1977.Compliance with Accounting Standards issued by ICAISub-section (3A) to Section 211 of The Companies Act, 1956 requires thatevery Profit and Loss Account and Balance Sheet shall comply with theAccounting Standards. Thus Accounting Standards means the standard ofaccounting recommended by the ICAI and prescribed by the CentralGovernment in consultation with the National Advisory Committee onAccounting Standards (NACAS) constituted under section 210A(1) ofCompanies Act, 1956.Accounting Standards and the AuditorsAuditors are duty bound while discharging their attest function to ensure thatthe Accounting Standards issued are made mandatory by the ICAI. Section227(3) of Companies Act, 1956 requires the auditors to report whether in hisopinion the Profit/Loss Account and Balance Sheet comply with the AccountingStandards referred in Section 211(3C) of the Companies Act, 1956.Section 217(2AA)(1) of the Companies Act, 1956 states that DirectorsResponsibility Statement should include that, in the preparation of the annualaccounts the applicable Accounting Standards had been followed along withproper explanations relating to material departure.

So far the ICAI has issued 29 Accounting Standards, as given below:

AS 1. Disclosure of Accounting PoliciesPrepared by Asst. Prof. Rajesh Janardhanan

24


25/28


AS 2. Valuation of Inventories

AS 3. Cash Flow Statement

AS 4. Contingencies and Events Occurring After Balance Sheet Date

AS 5. Net Profit or Loss for the Period, Prior Period Items and Change in

Accounting Policies.

AS 6. Depreciation Accounting

AS 7. Construction Contracts

AS 8. (Withdrawn)

AS 9. Revenue Recognition

AS 10. Accounting for Fixed Assets

AS 11.The Effects of Changes in Foreign Exchange Rates.

AS 12. Accounting for Government Grants.

AS 13. Accounting for InvestmentsAS 14. Accounting for Amalgamations

AS 15. Accounting for Retirement benefits in financial Statements of

Employers

AS 16. Borrowing Costs

AS 17. Segment Reporting

AS 18. Related Party Disclosures

AS 19. Leases

AS 20. Earning Per SharesAS 21. Consolidated Financial Statements

AS 22. Accounting for Taxes on Income

AS 23. Accounting for Investments in Associates in Consolidated Financial

Statements

AS 24. Discontinuing Operations

AS 25. Interim Financial Reporting

AS 26. Intangible Assets

AS 27. Financial Reporting of Interests in Joint VenturesAS 28. Impairment of Assets

AS 29. Provisions, Contingent Liabilities and Contingent Assets

Advantages and Disadvantages of Accounting Standards

Advantages:

Standards reduce to a reasonable extent or eliminate altogetherconfusing variation in the accounting treatments used to preparethe financial statements.


25


26/28


There are certain areas where important information is notrequired by law to be disclosed, standards may call for disclosurebeyond that required by law.

It facilitates comparison of financial statements of different

companies situated at different places.

Disadvantages of setting Accounting Standards:

There may be a trend towards rigidity and away from flexibility inapplying Accounting Standards.

Differences in Accounting Standards are bound to be because ofdifferences in the traditions and legal system from one country toanother.

Accounting Standards cannot override the law. The Standardsare required to be framed within the ambit of prevailing statuteeven though it is not an acceptable standard.

International Accounting StandardsInternational Accounting Standards Board (IASB) issues InternationalAccounting Standards. International Accounting Standards Committee (IASC),the London based group responsible for developing IASs has been in existencefor over 20 years. The IASC comprises of the professional accountancy bodiesof over 75 countries (including the Institute of Chartered Accountants of India)IASB so far have issued 41 IASs and 6 IFRS (International Financial ReportingStandards)The list of IAS includes:

IAS 1 Presentation of Financial StatementsIAS 2 InventoriesIAS 7 Cash Flow StatementsIAS 8 Accounting Policies, Change in Accounting estimates and errorsIAS10 Events after the Balance Sheet DateIAS11 Construction ContractsIAS12 Income TaxesIAS14 Segment ReportingIAS16 Property, Plant and EquipmentIAS17 Leases

IAS18 Revenue

IAS19 Employee BenefitsIAS20 Accounting for Government Grants and disclosure of GovernmentAssistanceIAS21 The effect of Changes in Foreign Exchange RatesIAS23 Borrowing costsIAS24 Related Party DisclosureIAS26 Accounting and Reporting by Retirement Benefits PlanIAS27 Consolidated and Separate Financial StatementsIAS28 Investments in Associates


26


27/28


IAS29 Financial Reporting in Hyper Inflationary EconomiesIAS30 Disclosure in the Financial Statements of the Banks and similar FinancialInstitutionsIAS31 Interest in Joint VenturesIAS32 Financial Instruments: Disclosure and Presentation

IAS33 Earnings Per ShareIAS34 Interim Financial ReportingIAS36 Impairment AssetsIAS37 Provisions, Contingent Liabilities and Contingent AssetsIAS38 Intangible AssetsIAS39 Financial Instruments: Recognition and MeasurementIAS40 Investment PropertyIAS41 Agriculture

IASB has issued the following six IFRS (International FinancialReporting Standards): -IFRS-1 First time Adoption of IFRSIFRS-2 Share Based PaymentsIFRS-3 Business CombinationIFRS-4 Insurance ContractsIFRS-5 Non-current assets held for sale and discontinued operationsIFRS-6 Exploration for and evaluation of mineral resources.

Regulatory Framework of Financial Reporting in India

The regulations that govern Financial Reporting by a business entity can varydepending on the entitys legal form. Thus regulations governing the financialreporting by limited liability companies can differ considerably from theregulations governing Partnerships. Partnership reports will cover theprovisions mentioned under the Indian Partnership Act 1932. Companiesregistered under The Companies Act 1956 can be of several types. Forexample, companies registered under section 25 of the Act are essentiallynonprofit entities, similarly special provisions may be applicable toGovernment Companies under Section 617 of the Act, and Section 3 will beapplicable to Public Limited Companies. Some of the public Limited companies

under the Act will also be listed on one or more stock exchanges. Suchcompanies will cover the special provisions applicable to Financial Reportingenunciated by the SEBI (Securities Exchange Board of India) and by thevarious stock exchanges. Financial reports that are put by business entities inthe public domain can be classified as:

a) Regular Financial Reports such as the Annual Report and the HalfYearly Report and

b) Financial Reports issued at the time of public offering of shares.Section 209 Sub section 3 of the companies Act 1956 requires that the Booksof Account should be kept on accrual basis and according to the Double

Entry System of Accounting. Sub section 4 of Section 209 requires companiesPrepared by Asst. Prof. Rajesh Janardhanan

27


28/28


to preserve their books for a period of at least eight years. Under Section 210of the Act it is the duty of the Board of Directors to lay before the AnnualGeneral Meeting (AGM) the Balance sheet and Profit and Loss Account of thecompany. Section 211 of the Act deals with the form and contents of theFinancial Statements. The Balance Sheet is required to be prepared in

accordance with form setout in Part I Schedule VI to the Act and the Profit andLoss Account is to be prepared in accordance with Part II of Schedule VI of theAct. Section 212 to 214 of the Act deals with accounts of Subsidiarycompanies. The Balance Sheet and Profit and Loss Account have to be signedby the Company Secretary and at least two of the directors of the Company.The Auditors Report like the Board of Directors report under Section 217 mustcover all the annexure to the Balance Sheet and shall be attached to theBalance sheet. A Copy of the Annual Report is required to be sent to thecompanys shareholders at least twenty-one days before the date of the AGM.Three copies of the Balance Sheet and the Profit and loss account should befiled with the Registrar of Companies within 30 days form the date of the AGMat which financial statements were laid. According to Section 220(1), onlyBalance Sheet of a Private Ltd., Company is a public document. The Profit andLoss account of a private limited company is open only to the shareholders ofthe company. Under section 226 of the Act only Chartered Accountants withinthe meaning of the Chartered Accountants Act, 1949 are qualified to beappointed as the auditors of a company. Section 227 of the Act defines thepowers and duties of auditors. Companies Act requires disclosing, whether itsAccounting Policies are in accordance with Accounting Standards issued by theASB of the ICAI. Sections 205 to 208 of the Act deals with the payment ofDividends, which also have bearing on the Financial Reports of Companies;

which could be paid only out of profits arrived at after providing forDepreciation in accordance with the provisions of subsection 2 of Section 205.SEBI regulations also influence the contents of periodic reports of listedcompanies.


28

AFM Module 1

Documents

Transcript of AFM Module 1