FINANCIAL AND MANAGEMENT ACCOUNTINGUnit - 1Accounting Defnation According for historical function andmanagerial function Scope of accounting Financial accounting andManagement accounting Managerial uses Diferences.Financial Accounting: Accounting concepts Convections Principles Accounting standards International Accounting standards.Unit-2Double entry system of accounting - Accounting books Preapartion ofjournal and ledger, subsidiary books - Errors and rectifcation Preparation oftrial balance and fnal accounts.Accounting from incomplete records - Statements of afairs methods-Conversion method - Preparation of Trading, Proft & Loss Account and BalanceSheet from incomplete records.Unit - 3Financial Statement Analysis - Financial statements - Nature of fnancialstatements - Limitations of fnancial statements - Analysis of interpretation-Types of analysis -- External vs Internal analysis - Horizontal vs Verticalanalysis - Tools of analysis - Trend analysis - Common size statements-Comparative statements.Ratio Analysis - Types - Proftability ratios - Turnover ratios - Liquidityratios - Proprietary ratios - Market earnings ratios - Factors afecting efciencyof ratios - How to make efective use of ratio analysis - Uses and limitation ofratios - Construction of Proft and Loss Account and Balance Sheet with ratiosand relevant fgures - Inter-frm, Intra-frm comparisons.Unit -4Fund Flow Statements - Need and meaning - Preparation of schedule ofchanges in working capital and the fund fow statement - Managerial uses andlimitation of fund fow statement.Cash Flow Statement - Need - Meaning - Preparation of cash fowstatement - Managerial uses of cash fow statement - Limitations Diferencesbetween fund How and cash tlow analysis.Unit-5Budgeting and Budgetary Control: Preparation of various types of budgets- Classifcation of budgets - Budgetary control system - Mechanism -Masterbudget.Unit-6Capital Budgeting System - Importance - Methods of capital expenditureappraisal - Payback period method - ARR method - DCF methods - NPV andIRR methods - Their rationale - Capital rationing.FINANCIAL AND MANAGEMENT ACCOUNTINGLESSONTITLE1. Accounting an Introduction2. Management Accounting3. Theory Base of Accounting - Accounting Standards4. Practical Base of Accounting - Origin and Analysis of BusinessTransactions5. Financial Statements of Proft-making Entities Manufacturing-cum-Trading Organisations6. Financial Statements of Non-Proft-making Entities7. Errors Management8. Accounts from Incomplete Records - Single Entry System9. Financial Statement Analysis10. Ratio Analysis11. Fund Flow Analysis12. Cash Flow Analysis13. Budgeting and Budgetary Control14. Capital Budgeting15. Case StudyLESSON - 1ACCOUNTING: AN INTRODUCTIONLearning outcomes; on completion of this chapter, you should be able to: Explain the nature of accounting. Identify the various branches of accounting. Explain the process of creation of fnancial statements and theirinterpolation. Explain the various objectives of fnancial statements. Identify the various uses of accounting information.INTRODUCTIONAccounting discipline deals with measurement of economic activitiesafecting infow and outfow of economic resources to develop useful informationfor decision making. At household level information about outfow and infow ofcash resources helps -.0 assess fnancial position and plan household activities.At Government level, information about infow from taxes (direct as well asindirect) and expenditure on various activities (developmental and nondevelopmental) is needed for planning and budgeting. Although accounting canbe discipline has universal applicability, but its growth is closely associated withthe developments in the business world. Thus to understand accounting as afeld of study for universal application, it is best identifed with recording ofbusiness transaction and thereby creating economic information about businessenterprises to facilitate decision making.NATURE OF ACCOUNTING: 1.2 Accountingi.is man-made;ii.has evolved over a period of time;iii.is practiced in a social system;iv.is a systematic exercise;v.is judgmentat at times;vi.follows fexible, not a rigid approach;vii.is essentially a language;viii. as a language, has a very well defned syntax of its own; andix.Communicates fnancial information for decision making.Accounting being a man-made system has evolved over a period of time toprovide fnancial information of business enterprises to users of accountinginformation. A large number of groups with varied interests in afairs of abusiness enterprise have emerged over a period of time, especially afteremergence of corporate forms of organization involving separation of ownershipmanagement. These user groups include those who; manage the activities of the enterprise( management) own the enterprise( owners/ shareholders) extend credit for supply of goods to the enterprises(creditors) buy goods from the enterprises( customers) lend money to the enterprises( banks and fnancialinformation) are employed in the enterprises (employees) intend to make investment in the enterprises(ivestors) are doing research(researchers) are engaged in collection of taxes ( sales tax and income tax authorities) formulate fscal and monetary policies (otherGovernment department) are members of the public at large(general public)Internal users of accounting information are inside the enterprise andneed information to control and plan the activities of the business to manage itefectively. These include Owners in case of non corporate enterprises andmanagers and directors in case of corporate business. Their information needsare satined through various reports which are generally prepared internal useand remain unpublished. External users of accounting information are outsidethe enterprise. The information need of these user groups are met by measuringthe desired information by following a systematic process. It results in creationof fnancial statements which are generally published to make the informationavailable to external user group for decision making. The need forcommunicating relevant and useful information to that potential internal andexternal users is always there and accounting is intended to perform that role.Thus, accounting may be defned as:"the process of identifying, measuring and communicating information topermit judgement and decision by the users" ( American AccountingAssociation)BRANCHES OF ACCOUNTING Financial Accounting:It primarily concentrates on creation of fnancial information forexternal user groups such as creditors, investors, lenders and so on. It dealswith business events which have already occurred and is, therefore, historical innature. Traditionally, the aim was to develop information about income andfnancial position on the basis of events which had taken place during a periodof time. Recent trend in corporate form of organization is to provide informationabout cash fows and earnings per sh^e also as part of published fnancialstatements.Management Accounting - The information provided by the fnancialaccounting system is signifcant but not sufcient for smooth orderly andefcient conduct of business. Management needs more information to dischargeits function of stewardship, planning, control and decision-making. Asinformation needs of management vary from enterprise to enterprise, thegrouping and reporting of information takes diferent forms. Trie diferent waysof grouping information and preparing reports as desired by managers fordischarging their functions are referred to a management accounting.Management accounting provides information to the management not onlyabout cost but also revenue, proft, investment etc., for managing business moreefciently and efectively. A very important component of managementaccounting is cost accounting which deals with cost ascertainment and costcontrol.Few other branches of accounting which are of recent origin aresocial responsibility accounting and human resources accounting. The frst oneinvolves accounting for social costs incurred by the enterprise and socialbenefts created by it while the second deals with accounting for humanresources.In the present book, we are concerned with fnancial accountingonly. The word accounting and fnancial accounting are used interchangeably.Financial accounting provides information to external user groupsin the form of published fnancial statements. As these users are involved inpreparation of fnancial statements, it is very essential that the publishedstatements have credibility and regarded as reliable by external users.Therefore, accounting, as a language for communicating information, needs tohave a strong syntax of its own for preparing credible fnancial statements.The syntax of accounting language comprises of analysis andrecording of business transactions on the basis of double Entry system of bookkeeping and the basic principles on which the practical system is based. Thetheory base; of accounting consists of Generally Accepted Accounting Principles(GAAP), Conceptual framework and Accounting Standards (AS) issued by theprofessional accounting bodies all over the world,The credibility of the fnancial statements is established throughanalysis independent examinations by a chattered accountant who certifes thatthe information provided therein gives true and fair view of the activities of tMbusiness in conformity with accepted principles and practices. This process ofattestation of account is known as auditing of accounts.MEANING OF FINANCIAL ACCOUNTINGMeasurement of accounting information involves three basic stepsas per the traditional defnition of accounting by the American Institute ofCertifed Public Accounts (AICPA) which defnes accounting as "the are ofrecording, classifying and summarizing in a signifcant manner and in terms ofmoney, transaction- and events which are negative part atleast of fnancialcharacter and interpreting the results thereof.On this basis of above information, Accounting or more precisefnancial accounting can be basically divided into two parts",A.Creation of fnancial information. B.Use of fnancial information.A. Creation of fnancial information:Creation of fnancial information involves three steps: 1. Recording:The process of creation of fnancial information starts with the occurrenceof a business transaction which can be Qualifed. The transaction is evidencedby some document such as Sales bill, Pass book, Salaries slip etc., Thesystematic record of those transactions is chronological order (i.e. the order inwhich they occur ) is made in a book called JOURNAL BOOK. The four basicquestions need to be addressed while recording namely, what to record, when torecord, how to record and at what value to record?What to record? Since-accounting is regarded as language of the business, itshould systematically record all the transaction and events which afect theresults of business and ignore the person transaction of the proprietor. Beforerecording in the journal book, all business transaction expressed in terms ofmoney. Consequently business activities which cannot be expressed in terms ofmoney such as strikes, changes in the composition of board of directors etc., arenot recorded. Thud decision makers will get information only about moneyaspects of the business enterprise from a accounting records.When to record? Usually business transaction is recorded only when it hasoccurred. Thus accounting is basically historical in nature.How to record? Usually business transaction has two aspects and both theseare recorded by passing analysts entry in an journal book. This system ofrecording is called double entry book keeping system.At what value to record? To record occurrence of an event in journal book,decision about the value of the transaction is needed.A number of diferent valuation bases are used in accounting invarying degrees and include historical cost, current cost, realizable value andpresent value. These valuation based generally assume signifcance in case ofvaluation of assets. Historical cost refers to amount paid / payable to acquire anasset. The current cost means the amount that would have to be paid, if theasset is to be acquired currently. The realizable value refers to the net realizablevalue of the assets if it is to be disposed. The present value of an asset is thepresent discounted value of the future infows that analysis item is expected togenerate in the normal course of business.2. Classifying:After recording monetary transactions in the journal book, nextstep is to classify the recorded information into related groups to putinformation in compact and usable forms. For e.g., all transactions involvingcash infows (receipts) and cash outfows (payments) can be grouped to developuseful information is called ledger book. Mechanism used for classifcation ofrecorded information is to open accounts which are called ledger accounts.3. Summarizing:Basic aim of accounting is to create fnancial information in a form whichwill be useful to the decision makers. To achieve this end, accounts containingclassifed information in the ledger book are balanced. After balancing of theledger book, account balances are listed statement giving names of thesesaccounts and their balance is called " TRIAL BALANCE " on the basis of trailbalance, summaries are prepared to give useful information about the fnancialresults during a time period and the fnancial position at a point of time.Reporting of summarizes of the business transaction is done in the form offnancial statements which are known as FINAL ACCOUNTS. According tointernational Accounting standard - 1 the term fnancial statements coversbalance sheet, income statements or proft and loss accounts, notes and otherstatements and explanatory material which are identifed as being part of thefnancial statements. The process of creation of fnancial information can besummarized as follows:Thus recording, classifying and summarizing are three basic stepsinvolved in creation of fnancial statement which ascertain and communicateresult of business entity. For this is assumed that business and its owner haveseparate existence. For accounting purpose, even a division of the business or abranch of it may be treated as an accounting entity.B. Use of Financial Information / Statements:Financial statements prepared by a business enterprise arepublished and are available to the decision makers. Sound division makingrequires analysis and interpretation of these fnancial statements. A verycommonly used tool for fnancial analysis is ratio analysis. However, there areother tools which are used by the decision makers to undertake analysis. Thewidely used tools for carrying out analysis are : Cash fow statement Fund fow statement Ratio analysis Comparative statement Common size statementHowever to analyze and interpret these fnancial statements, theuser should be aware of purpose and nature of these statements can bedescribed as follows :"Financial statements are prepared for the purpose of presenting aperiodical review or report on progress by management and deal with the statusof investment in the business and the results achieved during the period underAnalysis of business transaction evidenced by source document Recording Journal Book Classifcation in ledgerbookSummarization frst in trial balance and then infnancial review. They refect a combination of recorded facts, accounting, conventionsand personal judgements and judgements and conventions applied after themmaterially. The soundness of the judgement necessarily depends on thecompetence and integrity of those who make them and on their adherence toGenerally Accepted Accounting Principles and Conventions. (Bombay StockExchange Ofcial Directory).OBJECTIVES OF ACCOUNTINGThe main objective of accounting are as follows: The main records of business: In accounting, systematic record ofmonetary aspects of business events are maintained. The frst step inpreparation of fnancial statements. This is referred to as book-keeping. Calculation of proft or loss: To calculate proft earned or losses suferedduring a period of time, a business enterprise prepares an IncomeStatement. It is also referred to a trading and proft and loss account. Depiction of fnancial position: In addition to proft (or loss), sounddecision-making requires information about the fnancial position of abusiriess enterprises. To depict fnancial position of a business, fnancialposition statement is prepared. On the one hand, it gives details ofresources owned by the business enterprise. Resource owned are termedas assets. On the other hand it contains the information about obligationsof business. Obligation of the business towards outsiders and owner arereferred to as liabilities and capital respectively.Financial positionstatement is also termed as balance sheet which provide informationabout sources of fnance (e.g. outside liability and owners equity) and theresources (eg. assets) of the business. To portray the liquidity position: Financial reporting should provideinformation about how an enterprise obtains and spends cash, about itsborrowing and repayment of borrowing about its capital transactions,cash dividends and other distribution of resources by the enterprise toowners and about other factors that may afect an enterprise's liquidityand solvency. Control over the property and asset of the frm: Accounting provides up-to-date information about the various assets that the frm possess andthe liabilities the frm owes so that nobody can claim a payment which isnot due to him. To fle tax returns: This is the objective which really hardly needsemphasis. The credible accounting records provide the best bases forfling returns of both, direct as well as indirect taxes. To make fnancial information available to various groups and users:Accounting is called the language of business. It aims to communicateinformation about fnancial results and fnancial position of a businessenterprise to decision makers,USERS OF ACCOUNTING INFORMATIONUsers of accounting information can be grouped as followsOwners: Owners refers to a person or group of persons who have suppliedcapital for running the business. It refers to individual in case of joint stockcompanies. Information needs of shareholders have assumed great signifcancein the corporate business world because of separation of ownership andmanagement in case of joint stock companies owners are interested in thefnancial information, to know"about safety of amount invested and return onamount invested.Managers: For managing business proftably information aboutHnancial resultand fnancial position is needed by management By providing this information,accounting helps managers in efcient and smooth running of a businessenterprise.Investors: Prospective investors would like to know about the past performanceof the business enterprise before making investment in that concern. Byanalyzingihistorical information provided by accounting records, they can arriveat a decision about the expected return and risk involved in investing inparticular business enterprise.Creditors and Financial Institutions: Whosoever is extending credit or loan toa business'enterprise, would like to have information about its repayingcapacity, creditworthiness etc., The required information can be obtained byanalyzing and interpreting the fnancial statements of the business enterprise.Employees: Employees are concerned about job security and future prospectus.Both of these are intimately related with the performance of the businessenterprise, Thus by analyzing fnancial statements they can draw conclusionsabout their job security and future prospectus.Government: Government policies relating to taxation, providing subsidies etc.,are guided by the relevance of the industry in the economic development of thecountry and the past performance of the industry. Information about the pastperformance is provided by the accounting system, collection of taxes is alsobased on accounting records.Researchers: Researchers need fnancial information for testing hypothesis anddevelopment of theories and models. The fnancial statement provides therecorded information.Customers: (Customers who have developed loyalties to a business are ceitainlyinterested in the continuance of the business. They certainly want to knowabout the future directions of the enterprise with which they are associatingthemselves. The way to information about the enterprise is through theirfnancial statements.Public: An enterprise afects the public at large in many ways such as providerof the employment to a number of persons being a customer to many supplier aprovider of amenities on the locality, a cause of concern to the public due topollution etc., Hence public at large is interested in knowing the futuredirections of the enterprise and the only window to peep inside the enterprise istheir fnancial statements.ACCOUNTING AND THEIR DISCIPLINES:Accounting is the best understood when the other relateddisciplines are conceptually clear to the user. For e.g., a user can hardlyunderstand fnancial statements with lots of tables and graphs in it. He is notcomfortable with the basics of mathematics and statistics. Accounting is veryintimately connected with many disciplines more important of which areeconomics, law, management, statistics and mathematics.Linkage with Economics:Accounting has strong linkages with economics. It has acquired its mostimportant concepts of income and capital from economics. The accountant aswell as economist agree that capital should be maintained intact whilecalculating income and this income can be distributed without afecting capital.However, the interpretation of the two concepts by accountant and economistdifer a great deal despite similarities. The capital to an economist is like a treeand income is like a fruit on that tree. In technical terms, a stock of wealth(Tree) or assets existing at a point of time is called capital whereas fow ofbenefts from the wealth through a given periodvs called income. Hence capitaland wealth are synonyms for the economist. The methodology adopted byeconomist is fnding income is to fnd out the excess of capital at the end of theyear over the beginning of the year. If the capital increases, it is more income.However as the capital decreases it is called loss. To arrive at the value of thecapital or wealth, the present value of the future benefts is calculated bydiscounting expected benefts at the required rate of return. Hence to fnd outthe worth of an asset, the economist will have to estimate the life of the assetand the likely benefts to be desired from it. The benefts will be discounted atthe requires rate of return of the asset has an exceptionally long life. Henceeconomists valuation of capital and income are highly subjective.Accountant tries to impart practicability to the concept of capital andincome. Recognizing that future benefts of an asset with long life of say 100years are difcult to estimate, the accountant puts a value of the asset at whichit was acquired. However, his attitude is quite fexible and makes use of otherbases of measurement wherever the need arises. The income of businessbelongs to a owner. The accountant fnds income as a direct result of matchingof revenue and expense of the same period. It is always calculated at the end ofa period. The matching of revenues and expense can be done on diferent basisviz accrual, cash and hybrid bases. The bases are discussed in detail later:Linkage with Mathematics:Accounting is all about fgures and operations on these fgures. Thebasic system of accounting can be very conveniently converted in themathematical form in the form of an accounting equation. Simple mathematicaloperations involved in accounting are addition, subtraction, multiplication anddivision. Besides many aspects of accounting involve calculations which involvestrong knowledge of mathematics. For e.g., calculation of interest, calculation ofthe annuity needed to depreciate an asset with a defned rate of interest over itsestimated useful life, bifurcation of a hire purchase instalment in cash pricecomponent and interest component etc.,Linkages with Statistics:Accounting is not only about the preparationof accounting information,it also involves the presentation and interpretation of accounting information.The presentation aspects involved creation of tables and graphs etc., theknowledge of which essentially lies in the discipline of statistics. One of the mostdebated topic of accounting namely infation accounting involves extensiveconversation of historical accounting information with the help of price indices,'an important constituent of the discipline of statistics. The interpretation ofaccounting information involves making absolute and relative comparison withthe help of ratio analysis. The knowledge of statistics is needed for the purpose.An important way of calculating interest is through the concept of average duedate, which is based on the knowledge of averages.Linkages with Law:Accounting essentially operates within a legal environment. Manybusiness organizations are governed by their respective statues which prescribethe many aspects of their accounting information including the presentation ofinformation. For e.g., the Indian Companies Activities, 1956 prescribes the rulesfor managerial remuneration. It also prescribes the format of balance sheet aswell as proft and loss account, The banking, insurance and electricitycompanies have also to prepare their accounts as per the requirement of therespective statutes governing them.LESSON - 2MANAGEMENT ACCOU NTINGDEFINITION OF MANAGEMENT ACCOUNTINGThe accounting activity can be classifed into two parts. FinancialAccounting and Management Accounting. Though both of them are interlinked,Management accounting is future oriented, dynamic and is made to be decisiveand control relevant.International Federation of Accountants (IFAC) defned ManagementAccounting process as "the process of identifcation, measurement,accumulation, analysis, preparation, interpretation and communication ofinformation both fnancial and operating used by management to plan, evaluateand control within an organisation and to assure use of and accountability forits resources".ICWAI published Glossary of Management Accounting terms defningManagement Accounting as "a system of collection and presentation of relevanteconomic information relating to an enterprise for planning, coordinating anddecision making",Management Accounting : Ofcial Terminology of CIMA is defnedManagement Accounting as "the provision of information required bymanagement for such purposes as:1.Formulation of policies2.Planning and controlling the activities of the enterprise3.Decision taking on alternative course of action4.Disclosure to those external to the entity (shareholders and others)5.Disclosure to employees6.Safeguarding assetsThe assets involves participation in management to ensure that there isefective: Formulation of plans to meet objectives (long-term planning) Formulation of short-term operation plans (budgeting/ proftmaking)".American Accounting Association defnes Management Accounting as "theapplication of appropriate techniques and concepts in processing historical andprojected economic data of an entity to assist management in establishing plansfor reasonable economic objectives and in the making of rational decisions witha view towards these objectives".Richard M.S. Wilson and Wai Fong Chua defne Managerial Accounting as"Managerial Accounting encompasses techniques and processes that areintended to provide fnancial and non-fnancial information to people within anorganisation to make better decisions and thereby achieve organisational controland enhance organisational efectiveness" The Management Accounting is used by management to plan the activity,evaluate performance, ensure integrity of fnancial information and toimplement the systemof reporting that is linked to organisationalresponsibilities and contributes to the efective performance measurement. Thedefnition of Management Accounting embraces all functions undertaken byaccountants in an organisation. Management Accounting needs to be dynamicand forward looking. It also comprises the preparation of fnancial reports fornon-management groups such as shareholders, creditors, regulatory agenciesand tax authorities. The role of Management Accountant is not determined byan isolated concept. It is determined by the requirements of business asExpressed in its structures.SCOPE OF MANAGEMENT ACCOUNTINGManagement Accounting includes Financial Accounting and extends tothe operation of a system of cost accounting and fnancial management. Whilemeeting the legal and conventional requirements regarding the presentation offnancial statements (proft and loss account, balance sheet and funds fowstatements) it stresses upon the establishment and operation of internalcontrols. The scope of Management Accounting, inter alia, includes: Formation, installation and operation of accounting, cost accounting, taxaccounting and information systems. Management Accountant has to construct and re-construct these systems to meet the changing needs ofmanagement functions The compilation and preservation of vital data for management planning.The account and document fles are respository of vast quantities ofdetails about the past progress of the enterprise, without which forecastsof the future is very difcult for the enterprise. The ManagementAccountant presents the past data in such a way as to refect the trendsof events to the management. Providing means of communicating management plans to the variouslevels of organisation. This, on the one hand, ensures the coordination ofvarious segments of the enterprise plans and on the other defnes the roleof individual segments in the whole plan and assists the management indirecting their activities. Providing and installing an efective system of feedback reports. Thiswould enable the management in its controlling function. By pinpointingthe signifcant deviations between actual and expected activities, and byadhering to the principles of selectivity and relevance, such reports helpin jthe installation and operation of the system of 'Management byException'. The Management Accounting is expected to analyse thedeviation by reasons and responsibility and to suggest appropriatecorrective measures in deserving cases. Analysing and interpreting accounting and other data to make itunderstandable and usable to the management. It is only through suchanalysis and clarifcation that the management is enabled to place thevarious data and fgures in proper perspective in the performance of itsfunctions. Such analysis assists management- in the location ofresponsibilities and to efect necessary changes in the organisationalsetup to achieve the objectives of the enterprise in a more efcientmanner. Assisting management in decision making by (i) providing relevantaccounting and other data and (ii) analysing the efect of alternativeproposals on the profts and position of the enterprise. ManagementAccountant helps the management in proper understanding and analysisof the problem in hand and presentation of factual information obviouslyin fnancial terms. Providing methods and techniques for evaluating the performance of themanagement in the light of the objectives of the enterprise, thus assistingin the jrnpiementation of the principle 'Management by Objectives'.Improving, modifying and sharpening the efectiveness of the existingtechniques of analysis. The Management Accountant would always thinkof increasing the practicability of existing techniques. He should be on thelook-out of the development of new techniques as well.Thus, Management Accounting serves not only as a tool in the hands ofmanagement, but also provides for a technique evaluating the performance of itsfunctions of planning/decision making and control, and at the same time,enabling the owners and other interested parties to evaluate and appraise themanagement of the enterprise.FUNCTIONS OF MANAGEMENT ACCOUNTINGManagement Accountant is one of the best assets for management. Hiscontribution has been growing with passage of time. He will continue to deliverthe goods in a magnifcent manner in future with varied experiences. Scope isexpanding and managements of various sectors are benefting. Excerpts fromthe "Preface to Statements on International Management Accounting" issued oythe international Federation of Accountants in February 1987 are reproducedbelow:"Management Accounting is used by management to;Plan - to gain an understanding, to expected business transactions andother economic events and their impact on the organisation, and to usethis understanding as a basis for a course of action to be followed by theorganisation in the future;Evaluate - to judge the implications of various past and/or future events;Control - to ensure the integrity of fnancial information concerning anorganisation's activities or its resources;Assure accountability - to implement the system of reporting that is closelyaligned to organisational responsibilities and that contributes to theefective measurement of management performance"The functions of Management Accounting can be broadly classifed into;(a) Periodic interval accounting reports, and(b) Ad hoc analysis of data decision making.It is increasingly felt that Management Accountants should involvethemselves more and more in decision making and problem solving oforganisations. The areas of decision making and problem solving are dealt inthe following paras: Strategic Management Accounting: This function helps the organisationprepare long-term plans, formulate corporate strategy and forecast andevaluate the competitors. Investment Appraisal: This activity includes the (i) appraisal of long-terminvestment (ii) funding of accepted programmes projects, and (iii) post-audit of accepted programmes. Financial Management: It deals with raising of funds for investment,managing surplus funds, controlling working capital etc, Short-term ad hoc decisions: This includes analysing data for takingdecisions c i pricing, product introduction, acceptance of special ordersetc. Managing the organisation of information system: This includes not onlyorganising the enterprise's fnancial data but fulflling the informationneeds of all the segments of the organisation.FUNCTIONS OF MANAGEMENT ACCOUNTANTThe term 'Management Accountant' has many Director, Financial Director,Financial Controller, Finance Comptroller etc., are some of the terms used todesignate withtheworkManagement Accounting. Depending situation,size, nature arid organisational setup and his position in the company, theManagement Accountant may be required to perform various and variedfunctions. The importance and efectiveness of his function would also dependupon the confdence reposed in him by the top management and the functionalmanagers. His functions generally embrace each and every activity of themanagement. The essence of Management Accountant's functions are asfollows: The Management Accountant will establish, coordinate and: administerplans to facilitate the forecasting of sales, expense budgets and coststandards that will permit proft planning, capital budgeting andfnancing. The Management Accountant will formulate accounting policy andprocedures. Operating data and special reports must be prepared so thatthe performance can be compared with plans and standards, and anyvariance between actual operations and pre-determined standards can beanalysed for corrective actions by management Such comparisonsbetween actual and expected activities should help the management inproper fxation of responsibility and also in evaluation of variousfunctional and divisional heads. The Management Accountant will be responsible for the protection ofbusiness assets to the extent possible by external controls and internalauditing and insurance coverage. The Management Accountant will be responsible for tax policies andprocedures and will supervise and coordinate the reports required byvarious authorities. ; The Management Accountant must continually e aware of economic andsocial forces as well as the efect of the Government policies and actionson business activities. An analysis of the above list (obviously not exhaustive) o functions,refects the status of a Management Accountant. He is the principal ofce in-charge of the accounts of the company. He shall be responsible to the Board ofDirectors for the maintenance of adequate accounting procedures and recordson the operation of business. He shall be responsible to the President or theChairman of the Board or the Board of Directors. Thus, in his broad functionalactivities, the Management Accountant is responsible to the policy makinggroup of top management, whereas, in his administrative activities he ssresponsible to the top executive ofer.MANAGEMENT ACCOUNTING VS FINANCIAL ACCOUNTINGThe fnancial accounting classifes and records an entity's transactionsnormally in money terms, in accordance with established concepts, principles,accounting standards and legal requirements. It aims to present a 'true and fairview' jof the overall results of those transactions. Management Accounting hasbeen described as a continuous process of analysis, planning and control in thecontext of providing decision support for decision makers. ManagementAccounting is more concerned with decision making and a key role forManagement Accountant is acting as a provider of fnancial information tosupport these decisions, There are several diferences between FinancialAccounting and Management Accounting as are set out in Table 1.1.Financial Accounting and Management Accounting both appear to be similarinasmdch as both study the impact of business transactions and events of theenterprise, reports and interpret the results thereof. Both provide informationfor internals as well as external use. But Management Accounting althoughhaving its roots in Financial Accounting difers from the latter in followingrespects: Financial Accounting studies the business transactions and events for theenterprise as a whole. It does not trace the path of events with in theenterprise. Management Accounting, in additions to the study of theevents in relation to the enterprise as a whole, takes organisation in itsvarious units and segments and attempts to trace the impact and efect ofthe business transactions and events through these various divisions andsub-divisions. Thus, while the fnancial statements -proft and lossaccount, balance sheet and fow statements reveal the overall performanceand position of the enterprise. Management Accounting reports emphasison the details of operational costs, inventories, products, processes andjobs. It traces the efect and impact of the business transactions andevents on costs, inventories, processes, jobs and products. Financial Accounting is more attached with reporting the results andpositions of business to persons and authorities other than management-Government, Creditors, Investors, Owners, etc. At times, FinancialAccounting follows window-dressing tactics in order to project a betterthan actual image of the enterprise. Management Accounting isconcerned more with generating information for the use of internalmanagement and hence the information refects the real or really expectedposition. Financial Accounting is necessarily historical. It records and analysesbusiness events long after they have taken place. Management Accountinganalyses the events as they take place and also anticipates such eventsfor the future. Thus, it uses data which generally has relevance to thefuture. Since Financial Accounting data is historical in nature, it is more precisethan the Management Accounting data, which generally refects Iheexpected future, and hence could only be an estimation. This provides thenecessary rapidly to Management Accounting information. The periodicity in reporting fnancial accounts is much wider than in caseof Management Accounting. In Financial Accounting, generally, results arereported on year to year basis. In Management Accounting is free toformulate its own rules, procedures and forms because the informationgenerates is solely for internal consumption. Financial Accounting has to governed by the 'generally acceptedprinciples'. This is so because, it has to cater for the informational needsof the outsiders and legal provisions. Management Accounting is free toformulate its own rules, procedures and forms because the information itgenerates is solely for internal consumption. Financial Statements prepared under Financial Accounting consists 'ofmonetary information only. Management Accounting statements, inaddition to monetary information, also consists non-monetaryinformation viz., quantities of materials consumed, number of workers,quantities produced and sold and so on.TABLE 1.1: MANAGEMENT ACCOUNTING vs. FINANCIAL ACCOUNTINGNature Fianacial Accounting ManagementAccoutning1.Governed by 2.Basic functions 3. Users Company law etc.Transactionrecording,Publication ofexternal fnancialstatements External Needs of managersDecision supportProvision ofManagementinformation Internal 4.Availibility 5.Time focus 6.Period 7.Main emphasis 8.Speed ofprepartion 9.Form ofpresentations 10. Style anddetails 11. Criteria 12. Unitofaccount13. Nature ofdata Publicly available Past and present Usually one year Explanation Slow but detailed andaccurate whole of entity Standardized Objective, verifableand consistent Money Somewhat technical Confdential Present and futureAs appropriate Planning and control Fast but approximateSegmented to controlunits Tailored torequirement andsummarized Relevant, useful andunderstandableMoney physical units For use by non-accountantsLESSON - 3THEORY BASE OF ACCOUNTING - ACCOUNTING STANDARDSAccounting is "the process of identifying, measuring and communicatinginformation to permit judgement and decisions by the users of accounts"-American Accounting Association. It is absolutely necessary that accountinginformation contained in fnancial statements are credible and are regarded asreliable by the diferent user groups to be consistent. Preparation of fnancialstatements on uniform and consistent basis improves their comparability andcredibility. It has two aspects, namely, The fnancial statements of an enterprise for diferent accounting yearsare based on similar accounting procedures and policies so thatmeaningful comparisons over a period of time can be made1 about heprogress of the enterprise. This is commonly referred to as 'Time seriesanalysis. The fnancial statements of many enterprises at a point of time arebased on similar accounting procedures and policies so thatconclusions can be drawn about their relative performance at a point oftime. It is known as 'Cross-sectional analysis'. ,It is the function of 'Accounting Standards' -to provide a rationalstructural framework so that credible fnancial statements of the highest qualitycan be produced. According to T.P. Ghosh accounting standards are defned asunder.Accounting standards are the policy documents issued by the recognisedexpert accountancy body relating to various aspects of measurement,treatment and disclosure of accounting transactions and eventsIt is clear from the above defnition that accounting standards provide aframework for the preparation of the fnancial statements. They also draw theboundaries within which acceptable conduct lies. In the absence of accountingstandards, many alternatives will exist and will give the accountant the|leverage to colour'his accounting records the way he likes. Such 'CreativeAccounting Practices will certainly create fnancial statements which areunreliable and lower the confdence of user in the reported results.Hence theneed for a coherent pet of accounting standards is imperative. The efcientfunctioning of the fnancial system depends upon the confdence that usergroups have in the fairness and reliability of the fnancial statements of thebusinesses ana it is the function of accounting standards to create this genera)sense of confdence by providing; a structural framework within which crediblefnancial statements can be produced.The whole idea of AccountingStandards is centred around harmonisation in the accounting policies andpractices followed by businesses. The basic purpose of 'Accounting Standards' isto standardize the diverse accounting practices followed for many aspectsof accounting. The harmonisation of accounting policies and practices is neededat national level as well as international level.To tackle the problem at nationallevel, the Institute of Chartered Accountants of" India issues accountingstandards (called AS's) formulated by the Accounting Standards Board (ASB). Atinternational level, International Accounting Standards Committee (IASC)issuesInternational Accounting Standards (called lAS's). The objective of theIASC in terms of standard setting is "to work generally for the improvement andharmonisation of regulations, accounting standards and procedures relating tothe presentation of fnancial statements'. The Institute of CharteredAccountants of India is a member of IASC and has a tacit understanding withthe IASC that it would adopt the accounting standards issued by IASC after duerecognition of the conditions and practices prevailing in India. At theinternational level, IASC has issued 32 international accounting standards. Atthe national level, ICAI has issued 15 accounting standards on various issuesof accountinganda preliminary draft of a proposed accounting standard onborrowing costs is being made by the ASB in addition to the revisioncontemplated in existing standards on valuation of inventories and accountingfor construction contracts.ACCOUNTING STANDARDS (N INDIAThe Institute of Chartered Accountants of India, fully recognising the needcf harmonizing the diverse accounting policies and practices established'Accounting Standards Board' on 21st April, 1977 so that accounting as alanguage could develop along the right lines. Accounting Standard Board's(ASB) main function is to formulate accounting standards to be issued underthe authority of the council of the institute. Accounting standards provide rulesand criteria of accounting measurement. However the rules' criteria areintended lo be used if: a sociai system and hence are never intended lo be rigidas in case of physical sciences.Constitution of ASB :The consistitution of ASB gives adequate representation to all interested partiesand, at present, it consists of members of the council and representatives toindustry, banks, Company Law Board, Central Board of Direct Taxes and theComptroller and Auditor General of India, Security Exchange Board of India etc,Functions of ASB :The main function of ASB is to fomralate accounting standards. Whileformulating accounting standards, ASB takes into consideration the applicablelaws, customs, usage and business environment. The Institute is the member ofInternational Accounting Standards Committee (IASC) and has agreed tosupport the objectives of IASC. While formulating standards, it gives dueconsideration to the International Accounting Standards (IAS) issued by IASCand tries to integrate them, to the extent possible, in the light of conditions andpractices prevailing in India. It also reviews the accounting standards atperiodical intervals.FORMULATION OF ACCOUNTING STANDARDSThe following points need to be kept in mind while drafting accountingstandards, namely - The accounting standards issued are in conformity with the provisions ofthe applicable laws, customs, usage and business environment of ourcountry; The accounting standards are in the nature of laws but not laws. Thoughevery possible care is taken while drafting standards that they are inconformity with eh applicable laws, still the confict between the law andan accounting standard might arise due to amendments in the lawsubsequent to the issuance of the accounting standard. As clarifed in the'Statements of Accounting Standards', accounting standards cannot anddo not override the statute and in all such cases of conficts, theprovisions of the law will prevail and the fnancial statements should beprepared in conformity with the relevant laws Obviously, to that extent,the accounting standards shall not be applicable. However, "the institutewill determine the extenl of disclosure to be made in fnancial statementsand the related auditor's reports. Such disclosure may beby way ofappropriate notes explaining the treatment of particular items. Suchexplanatory notes will be only in the nature of clarifcation and therefore,need not be treated as adverse comments on the related fnancialstatements" The accounting standards are intended to apply only to items which arematerial and become applicable from the date as specifed by theinstitute. They are applicable to all classes of enterprise unless otherwisestated. No standard is applicable retroactively, unless otherwise stated; The accounting standards are to address the basic mattes, to the extentpossible. The idea is to confne them to essentials only and not to makethem complex.The ASB has drawn an elaborate procedure for formulating accountingstandards. However, it needs to be emphasised that the standards are issuedunder the authority of the council of the institute. The procedure involves thefollowing steps:a)Firstly, the ASB determines the broad areas in which accounting standards need to be formulated;b)Secondly, the ASB takes the assistance of the various study groups toformulate standards The preliminary drafts of the standards areprepared by the Study groupswhich take 'up the specifc subjectsassigned to them. The draft prepared by a Study Group is consideredby ASB and sent to various outside bodies like FICCI, ASSOCHAM,SCOPE, CLB, C&AG, ICWAI, ICSI, CBDT etc. and the representative ofthese bodies are also invited at a meeting of ASB for discussion. c)Thirdly, after taking into consideration their views, the draft of thestandard is issued as exposure draft for soliciting comments frommembers of the institute and public at large. The draft is issued to alarge number of institutions and is published in the journal of theinstitute. The exposure draft includes the following basic points: A statement of concepts and fundamental accounting principlesrelating to the standard; Defnitions of the terms used in the standard; The manner in which the accounting principles have been appliedfor formulating the standard; The presentation and disclosure requirements in complying withthe standard; Class of enterprises to which the standard will apply, Date from which the standard will be efective.d)Fourthly, the comments on the exposure draft are then considered by theASB and a fnal draft is prepared and submitted to the council of theinstitute;e)Lastly, the council of the institute considers the fnal draft of the proposedstandard, and if found necessary, modifes the same in consultationwith ASB. The accounting standard on the relevant subject is thenissued under the authority of the council.NATURE OF ACCOUNTING STANDARDSThe accounting standards issued by the ICAI-are recommendatory innature in the initial years. During the period a standard is recommendatory, itis expected that the accounting practices shall be brought in line with thestandard. In other words, the recommendatory period is allowed to smoothenthe process of transition so that no enterprise should have difculty inconforming to the accounting standards once they are made mandatory. Oncean accounting standard is made mandatory, it is applicable to all enterpriseswhose accounts are audited by the members.During the period an accounting standard is recommendatory, tneauditors of companies are required to recommend and persuade their cfents tocomply with the requirements of the accounting standard even though it isrecommendatory in nature. Regarding the mandatory standards, it is the dutyof the auditors to ensure that the accounting standards are followed in thepreparation and presentation of the fnancial statements. If the mandatoryaccounting standards have not beer, complied with, the auditor is required tomake adequate disclosure in his report so that the users of fnancial statementsare aware of the non-compliance on the part of the enterprise. If a member failsto do so, the Chartered Accountants Act explicitly provides that a charteredaccountant in practice will be deemed to be guilty of professional misconduct ifhe ails to invite attention to any material departure from the generally acceptedprocedure of audit applicable to the circumstancesIt is amply clear that standards on their own have no legal backing andhence, are not enforceable on the public at large. Hence the institute dependson is members for implementation of accounting standards issued by it throughtheir attest function. To make it efective, following steps are needed: Self-regulation on the part of the business organisation so that I heyadhere to these standards while fnalising their accounts; Legal backing to the accounting standards. The standards as they areissued not have no legal backing and institute depends on its memters fortheir implementation through their attest function; Publicising the use of accounting standards and making the user: ofaccounting information more informed about their right of getting a moretrue and fair picture of the results of business based on these accountingstandards; To avoid duplication of authority. If more than one authority issuesstandards, it is bound to create a confusion in the mind of the user as towhich standard needs to be followed.A recent development, worthy ofattention, is the establishment of two accounting standards by thegovernment under the Income Tax Act, 1961 which are to be followed inthe preparation of fnancial statements in case the assessee prefersmercantile basis accounting, (Accounting Standard I 'relating todisclosure of accounting policies and Accounting Standard II relating todisclosure of prior period and extraordinary items and changes inaccounting policies).To conclude, the Institute and its members are duty bound to formulateand implement accounting standards to provide objective and reliableaccounting data that would satisfy the information requirements of the users Toachieve this, problem of duality of authority should be tackled and the system ofdual accounting standards in view of its expertise in the feld. To improve theirefectiveness, it is also suggested that the standards should be given a legalbacking with strong punishment for the erring business organisations. At thesame time, to make a genuine case for recognition of accounting standards andto prevent abuse of fnancial statements, more credibility should be provided tothe process of standard setting.ACCOUNTING STANDARDS ISSUED BY THE INSTITUTE AS-1 Disclosure of Accounting Policies :The standard defnes 'Accounting Policies' as referring to the specifcaccounting principles and the methods of applying those principles adopted bythe enterprise in the preparation and presentation of fnancial statements. Itrecommends the disclosure of signifcant accounting policies adopted in thepreparation and presentation of fnancial statements in a manner that shouldform part of the fnancial statements. It also recommends that he disclosureshould normally be at one place. Any change in the accounting policies whichhas a material efect in the current period or which is reasonably expected tohave material efect in later pe\jods should be disclosed. It also emphasises thatthe disclosure of compliance with fundamental accounting assumption of GoingConcern, Consistency and Accrual is not needed. However, if they are notfollowed, the fact must be disclosed.AS-2 Valuation of Inventories :The inventories should be normally valued at 'Lower of Cost or Market'where market value means net realizable value. The historical cost of inventorycan be ascertained by use of 'FIFO', 'Average Cost', of 'LIFO' formulae. Whenorganization have diferent items in inventory, each item may be dealt withseparately, or similar items may be dealt with as a group.The historical cost of manufactured inventories may be arrived on thebasis of either direct costing or absorption costing. Where absorption costing isused, the fxed costs should be based on the normal level of production.Overheads other than production overheads should be included as part of theinventory' cost only 10 the extent that they clearly relate to putting theinventories in their present location and condition.The accounting policy in respect of inventories should be properlydisclosed and any change in it which has a material efect in the currentaccounting period or which is reasonably expected to have material efect inlater periods should be disclosed. The amount by which an item in the fnancialstatements is afected by such change should also be disclosed to the extentascertainabfe. Where such amount is not ascertainable, wholly or in part, thefact should be indicated.The 'Specifc Identifcation Method', 'Adjusted Selling Price Method','Standard Cost Method' and 'Base Stock Method' are to be used in specifccircumstances. However, if base stock method is used, the diference betweenthe value at which it is carried and the value by applying the method at whichstock in excess of the base stock is valued should be disclosed. AS-3 Changes in Financial Position :A statement of changes in fnancial position should be published alongwith its published accounts. Such a statement should be prepared andpresented for the period covered by the proft and loss account and for thecorresponding period.It may be prepare on working capital basis or cash basis.It emphasises that the funds provided from operation and used in the operationbe shown separately and the form of statement should be most informative inthe circumstances. However, the standard is no longer vaJid as it has beensuperseded by new standard AS-3 (Revised) Cash Flow Statement issued inMarch, 1997.AS-3 (Revised) Cash Flow Statement:The cash fow statement should report cash fows coring the periodclassifed by operating, investing and fnancing activities. An enterprise shouldreport cash Hows from operating activities using either (a) direct method; or (b)indirect method. The infow and outfow from the investing and fnancingactivities should be shown separately. Investing and fnancing transactions thatdo not require the use of the cash or cash equivalents and should present areconciliation of the amounts in its cash fow statement with the equivalentitems reported in the balance sheet.The enterprise should also disclose theamount of signifcant cash and cash equivalents balances that are not availablefor use by it.AS-4 (Revised) Contingencies and Events Occurring after the Balance SheetDate :A contingency is a condition or situation, the ultimate outcome of which,gam or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain events. A contingent loss should berecognised if (a) it is probable that future events will confrm that ari asset hasbeen impaired or a liability has been incurred on the balance sheet date^ and(b) a reasonable estimate of the amount of the resulting loss can be made. Acontingent gain should not be recognised. If either of the two conditionsmentioned above are not met, a disclosure should be made of the existence ofthe contingency specifying: the nature of the contingency; the uncertainties which may afect the future outcome;: an estimate of the fnancial efect, or a statement that such ail estimatecannot be made. Assets and liabilities should be adjusted for events occurring after balancesheet date that provide additional evidence to assist the estimation of theamounts relating to conditions existing at the balance sheet date (for: example,insolvency of a debtor subsequent to fnalisation of fnancial statements) or thatindicate that the fundamental accounting assumption of going concern is notappropriate. Dividends, proposed (or declared) by the enterprise: after thebalance sheet date but before approval of the fnancial statements, andpertaining to the period covered by fnancial statement, should be adjusted.Adjustments to assets and liabilities are not appropriate for events occurringafter the balance sheet date, if such events do not relate to conditions existing atthe balance sheet date (for example, decline in market value of the investment).Disclosure should be made in the report of the approving authority of thoseevents occurring after the balance sheet date that represent material changesand commitments afecting the fnancial position of the enterprise specifying: the nature of the event; I an estimate of the fnancial efect, or a statement that such an estimatecannot be made.AS-5 (Revised) Net Proft or Loss for the Period, Prior hems and Changes inAccounting Policies :The objective of this standard is to prescribe the classifcation and disclosure ofcertain items in the statement of proft and loss so that all enterprises prepareand present their fnancial statements on a uniform basis to improve 'theircomparability. It explains that proft or loss of a period comprises of ordinaryactivities, extraordinary activities and prior period items and all three need tobe disclosed separately. It also includes the impact of change in accountingestimates and change in accounting policies.Ordinary activities are any activities which are undertaken by anenterprise as part of its business and such related activities in which theenterprise engages in furtherance of, incidental to, or arising from, theseactivities. Extraordinary items are incomes or expenses that arise from eventsor transactions that are clearly distinct from the ordinary activities of theenterprise and, therefore, are not expected to recur frequently or regularly. Priorperiod items are'income or expenses which arise in the current period as aresult of errors or omissions in the preparation of the fnancial statements ofthe one or more prior periods. The net proft or loss for the period comprises thefollowing components, each of which should be disclosed on the face of thestatement of proft and loss; proft or loss from ordinary activities; and extraordinary items.Prior period items are normally included in the determination of net proftor loss for the current period. An alternative approach is to how such items inthe statement of proft and loss after determination of current net proft or loss.The second approach seems better because that will help ascertain the result ofcurrent period unafected by the mistakes of the past, in either case, theobjective is to indicate the efect of such items on the current proft or loss.Change in Accounting Estimates Vs. Change in Accounting Policies:A distinction should always be made between change in accounting estimatesand changes in accounting policies. When it is difcult to distinguish betweenthe change in accounting estimate and change in accounting policies, it shouldbe regarded as change in accounting estimate, with appropriate disclosure inthe periods of change, which may be current period only or current period aswell as future periods. The efect of change in an accounting estimate should beclassifed as ordinary or extraordinary depending upon whether the originalestimate was regarded as ordinary or extraordinary item. However, the revisionof estimate, by its nature, cannot be called extraordinary or prior period item.When change in accounting estimate/ change in accounting policy takes placewhich has a material efect, its nature and amount should be disclosed. If theefect is not ascertainable, the fact should be disclosed in the fnancialstatement.AS-6 (Revised) Depreciation Accounting :The depreciable amount of an asset comprising of its historical cost, orother amount substituted for historical cost in the fnancial statements, less theestimated realizable value should be allocated on a systematic basis to eachaccounting period during the useful life of the asset. The historical cost mayundergo revision arising as a result of increase or decrease in long term liabilityon account of exchange rate fuctuations, price adjustments, changes in dutiesor similar factors. The useful life of the asset may itself be subjected to revision,in which case, the unamortised balance of the asset be depreciated over itsremaining life. Any addition or extension to an existing asset should bedepreciated along with the original asset, unless the extension has a separateidentity, in which case it should be depreciated on the basis of an estimate of itsown life. Where depreciable asses are disposed of, discarded, demolished ordestroyed, the net surplus or defciency, if material, is disclosed separately. Thechange of method, if warranted, should be done with retrospective efect fromthe date of asset coming to use. In case of revaluation of asset, the revaluedamount should be amortised over the remaining useful life of the asset. Theinformation to be included in the fnancial statements should comprise ofhistorical cost or any substituted amount, total depreciation for the period inrespect of each class of asset and related accumulated depreciation. Thefollowing information should be disclosed in the fnancial statements along withdisclosure of other accounting policies: depreciation methods used; and depreciation rates or the useful lives of the asset, if they are diferent fromthe principal rates specifed in the statute governing the enterprise.AS-7 Accounting for Construction Contracts :The standard deals with the problem of allocation of revenues and relatedcosts to the accounting periods over the duration of the contract. The long termconstruction contracts could be fxed price contracts where contractor agrees toa fxed contract price or cost plus contracts where the contractor is reimbursedfor allowable or otherwise defned costs, and is also allowed a percentage ofthese costs or a fxed fees. Both these contracts can be accounted by eitherpercentage of completion method or completed contract method. Underpercentage of completion method, the amount of revenue recognised isdetermined with reference to the stage of completion of the contract activity atthe end of each accounting period. The completed contract method is based onresults as determined when the contract is completed or substantiallycompleted.Proft in the case of fxed price contract should be recognised when thework has progressed to a reasonable extent- say 25 or 30%. While recognisingproft under percentage of completion method, the appropriate allowance forfuture unforeseeable facts should be made on either a specifc or percentagebasis. A foreseeable loss on entire contract should always be provided for in thefnancial statements irrespective of the amount of work done and the method ofaccounting followed. Disclosure of changes in accounting policy used forconstruction contracts should be made in the fnancial statements giving theefect of the change and its amount.AS-8 Accounting for Research and Development:The prescribed research and development costs outlined in para 7 of Hiestandard relating to a business should be charged to the revenues of the periodin which they are incurred unless the criteria mentioned in para 9 of thestandard are met, in which case, the charging of these expenses can be deferredto future accounting periods. The research and development costs, once writtenof, arc never reinstated in accounts. The deferred research and developmentcost should be allocated on a systematic basis to future accounting periods byreference to either to the sale or use of the product or process or to the timeperiod over which the product or process is expected to be sold or unused. If atany point of time, criteria for deferral as detailed in para 9 are not met, theunamortised balance of research and development expenditure should becharged to the proft and loss account. When the criteria for deferral continue tobe met but the amount of the deferred research and development costs andother relevant costs exceed the expected flture revenues/ benefts relatedthereto, such expenses should be charged as an expense immediately. Theamount charged to proft and loss account should be explicitly disclosed andunamortised research and development costs should be shown in the balancesheet under the head "Miscellaneous Expenditure". ,AS-9 Revenue Recognition :The standard mainly deals with the timing of revenue. Revenue is defnedas "gross infow of cash, receivable or other consideration arising in the courseof ordinary activities of an enterprise from the sale of goods, from the renderingof services, and from the use by others of enterprise resources yielding interest,royalties and dividends. The revenue is recognised in case of sale when: the seller of goods has transferred the property in goods tci the buyeralong with signifcant risks and rewards of the ownership and seller hasno efective control over goods transferred; ;no signifcant uncertainty exists regarding the amount of theconsideration that will be derived from the sale.The revenue from rendering of services is recognised either undercompleted service method or proportionate completion method. Completedservice method is a method of accounting which recognises revenue in thestatement of proft and loss only when the rendering of services under acontract is completed or substantially completed. Proportionate completionmethod is a method of accounting which recognises revenues in the statementof proft and loss proportionately with the degree of completion of services undera pontract.Revenue arising from interest is recognised on a time proportion basis, royaltieson an accrual basis and dividends from investments in shares when the owner'sright to receive payment is established.AS-10 Recounting for Fixed Assets :Fixed asset is an asset held with the intention of being used for thepurpose of producing or providing goods or services and is not he!d for :he saisin the notarial course of business. The gross book vaiue of a fxed asset shoulobe either historical cost or a revalued amount.The cost of a fxed asset shouldnormally comprise of its purchase price and other attributable cost of bringingthe asset to its working condition for its intended use. Financing costs relatingto deferred credits or to borrowed funds attributable to construction oracquisition of fxed assets for the period up to the completion of construction oracquisition of fxed assets should also be included in the gross book value of theasset to which it relates.When a fxed asset is acquired in exchange or in partexchange for another asset, the cost of the asset required should be recordedeither at fair market value or at the net book value of the asset given up,adjusted for any balancing; payment or receipt of cash or other consideration.Subsequent expenditures related to an item of fxed asset should be added to itsbook value only if they increase the future benefts from the existing assetbeyond its previously assessed standards of performance. Material items retiredfrom active use and held for disposal should be stated at the lower of their netbook value and; net 44haracteri value. Losses arising from the disposal of fxedasset carried at cost should be 44haracteri in the proft and loss account.Normally the entire class of asset should be revalued and revaluationshould never result in the net book value of the class of asset being greater thanthe recoverable amount of assets of that class. Gain on revaluation shouldnormally be taken to the owners interest in the form of Revaluation ReserveAlternatively it could be taken to proft and loss account. Loss on revaluationshould normally be taken to proft and loss account except that such a decreaseis related to; an increase which was previously recorded as a credit to therevaluation reserve and which has not been subsequently reversed or44haracte, it may be charged directly to that account. On disposal of apreviously revalued item of fxed asset, the diference between net disposalproceeds and the net book value should be charged or credited to the proft andloss statement except that to the extent that such a loss is related to anincrease which was previously recorded as a credit to revaluation reserve andwhich has not been subsequently reversed or 44haracte, it may be chargeddirectly to that account. Goodwill should he recorded in the books only whensome consideration in money or moneys worth has been paid for it.A properdisclosure of the gross and net book value of the asset as well as relevantamount, if the assets are stated at revalued amounts should be made.AS-H (Revised) Accounting for tbc Efects of Changes in Foreign ExchangeRates :The standard deais with (a) accounting for transactions in foreigncurrencies; and (b) translating the fnancial statements of foreign branches forinclusion in the fnancial statements of the enterprise. The standard details themethods to be adopted for converting foreign transactions denominated inforeign currency in the reporting currency defned as currency used inpresenting the fnancial statements of the enterprise. The standard recommendsproper disclosure of the exchange diferences arising on foreign currencytransaction. Disclosure is also encouraged of an enterprises foreign currencyrisk management policy.AS-12 Accounting for Government Grants :Government grants are assistance by government in cash or kind to anenterprise for past or future compliance with certain conditions. Governmentgrants can be 45haracteri in accounts on the basis of capital approach orIncome approach, based on nature of relevant grant. However, the governmentgrant should not be 45haracteri until there is reasonable assurance that (i) theenterprise will comply with the conditions attached to them; and (ii) the grantwill be received. A proper disclosure should be made of the accounting policyadopted for government grants, including the methods of presentation in thefnancial statements including the nature and extent of government grant45haracteri in the fnancial statements, including grants of non-monetaryassets given at a concessional rate or free of cost.AS-13 Accounting for Investments :The standard deals with accounting for investment in fnancial statementsof enterprises and related disclosure requirements. An enterprise shoulddisclose current investments and long-term investments distinctly in thefnancial statements. A current investment is an investment that by its naturereadily realizable and is intended to be used for not more than one year from thedate on which such investment is made. A long-tern investment is aninvestment other than a current investment. The cost of acquisition shouldinclude charges such as brokerage, fees and duties. If an investment is acquiredby issue of share or other security, the acquisition cost should be fair value ofthe security issued. IF an investment is acquired in exchange for another asset,the acquisition cost should be the determined cost with reference to the fairvalue of the asset given up. Investment properties should be treated as long-term investments.Current investments should be carried in the fnancial statements at thelower of cost and fair market value determined either on an individualinvestment basis or by category of investments, but not on an overall (or global)basis. Long-term investments should be carried at their cost, although aprovision for diminution in their value, other than temporary, should be made.Any change in the carried value of the investment should be carried to the proftand loss account. Proft or loss on disposal of investments should be46haracteri and shown in the proft and loss account. Signifcant disclosurerequirements are also inserted in the standard and include among other things,the disclosure of accounting policy for determination of carrying amount ofinvestments, classifcation of investments, proft and loss on disposal ofinvestments and changes in carrying amounts of these investments, for currentand long-term investment separately and aggregate amount of quoted andunquoted investments.AS-14 Accounting for Amalgamation :The standard deals with the accounting for amalgamation and thetreatment of any resultant goodwill or reserves. Amalgamation is 46haracterizedas either in the nature of merger or purchase depending upon fve conditionsenumerated. Amalgamation in the nature of merger is accounted for by Poolingof interest method and amalgamation in the nature of purchase is accounted byPurchase method. The consideration for the amalgamation means ihe aggregateof the shares and other securities issued and the payment made in the form ofcash or other assets by the transferee company to the shareholders of thetransferor company.The identity of all the reserves in amalgamation in the nature of merger ispreserved. However, in the case of amalgamation in the nature of purchase, onlystatutory reserves are preserved by giving debit to a new account calledAmalgamation Adjustment Account. Goodwill only arise in case of Purchasemethod. Goodwill arising on amalgamation is amortised over a period notexceeding fve years unless a somewhat longer period can be justifed. When anamalgamation is efected after the balance sheet date but before the issuance ofthe fnancial statements of either party to the amalgamation, disclosure shouldbe made in accordance with AS-4 but the amalgamation should not beincorporated in the fnancial statements.AS-15 Accounting for Retirement Benefts in the Financial Statements ofEmployers:The standard deals with the accounting of retirement benefts consistingof (a) Provident funds; (b) Superannuation/ pension; (c) Gratuity; (d) Leaveencashment beneft on retirement; (e) Post retirement health and welfareschemes; and (f) Other retirement benefts in the fnancial statements ofemployers. The contribution of the employer towards the provident fund andother contribution schemes should be charged to the statement of proft andloss for the period. The accounting treatment of gratuity and other beneftschemes will depend on the type of arrangement which the employer has chosento make. Any alterations in the retirement beneft costs should be charged orcredited to the statement of proft and loss as they arise in accordance with AS-5.LESSON-4PRACTICAL BASE OF ACCOUNTING ORIGIN AND ANALYSIS OF BUSINESSTRANSACTIONSAccounting process begins with the origin of business transactions and isfollowed by analyses of these transactions. After origin and analysis oftransactions comes recording, classifcation and summarization of businesstransactions culminating in preparation of fnancial statements,Origin of Business TransactionsAccounting deals with business transactions which have already takenplace, As fnancial accounting concentrates on monetary transactions of thepast it is basically historical in nature. Since it amounts to making recordingand analysis of historical information only, it is also known as post-mortemaccounting. For recording business transactions, it is necessary that thesetransactions are evidenced by an appropriate document such as cash memo purchase bill, sales bill, cheque book, pass book, salary slip, etc., Documentwhich provides evidence cf the transaction is called the Source Document. Analysis of Business TransactionsIn accounting record is made of monetary transactions which areevidenced by a source document and double entry system is applied forrecording. According to J.R Batliboi every business transaction has a two-foidefect and that it afects two accounts in opposite directions and if a completerecord were to be made of such transaction, it would be necessary to debit oneaccount and credit another account. It is this recording of the two-fold efect ofevery transaction that has given rise to the term Double Entry SystemTo analyze the dual aspect of each transactions and to fnd out theaccounts to be debited and credited following two approached can be followed.7.Accounting Equation Approach8.Traditional Approach.9.Accounting Equation Approach:Equality of assets on one hand and liabilities and capital on the otherhand is called basic accounting equation and is written asASSETS = LIABILITIES + CAPITALexpected Where assets refer to resources which are owned by businessenterprise and are to beneft future operations, liabilities are debts payable toparties external to business and capital means the amount payable to owners ofthe business enterprise (also called owners equity )The dual aspect of some business transactions is analyzed as follows:10. Introduction of resources by the owner:Rs. 5,00,000 cash and furniture worth Rs. 20, 000 invested by the ownerin the business.Introduction of Rs.5,00,000 cash increases business cash by Rs. 5,00,000and it creates analysis obligation to pay Rs. 5,00,000 to the owner which isrecorded as capital. In terms of accounting equation its efect is asfollows:ASSETS = LIABILITIES + CAPITALCash (Rs.5,00,000) =__ + capital (Rs.5,00,000)Further, if furnitureworthRs.20,000 isprovidedbythe proprietor,theaccounting equation appears as under:Cash +Furniture = Capital(Rs.5,00,000) (Rs.20,000) - +(5,00,000 +20,000 )Rs. 5,20,000 Rs.5,20,00011. Purchase of assets for cash and / or credit : Purchased building for Rs,2,00,000 and paid Rs. 10,000 cashimmediately. It increases business assets or resources by Rs, 1,90,000 as cashdecreases by Rs. 10,000 and building increases by Rs.2,00,000. It also createsan obligation to pay Rs. 1,90,000 in future. The accounting equation nowappears as follows;Cash+Furniture =Creditors for building + Capital (Rs.5,00,000 (Rs.20,000) (Rs.1,90,000)(Rs.5,20,000) Rs. 10,000)+ Building (Rs. 2,00,000)-7,10,000 =Rs.7,10,000 12. Paid into bank Rs.3,00,000It decreases cash balance and increase bank balance and thus, have nonet efect on total assets as shown below:Cash+Bank =Creditors for building +Capital (Rs.4,90,000(Rs.1,90,000)(Rs.5,20,000)13. (Rs. 3,00,000)+ Furniture+ Building (Rs. 20,000) (Rs. 2,00,000) -7,10,000 =Rs.7,10,000 14. Payment of Rs. 1,90,000 by cheque to creditors for building :It decreases bank balance by Rs.1,90,000 and creditors for building byRs. 1,90,000 as shown below:Cash+Bank=Creditors for building +Capital (Rs.1,90,000 (Rs. 3,00,000) (Rs.1,90,000) (Rs.5,20,000) - Rs. 1,90,000) - Rs. 1,90,000)+ Furniture+ Building (Rs. 20,000) (Rs. 2,00,000) Rs. 5,20,000 =Rs. 5,20,00015. Purchase of goods for Cash/Credit:Business enterprise purchase goods worth Rs. 50,000 for cash andRs.20,000 on credit.It increases stock of goods by Rs. 70,000, decreases cash by Rs.50,000and creates analysis obligation to pay. Rs.20,000 to the supplier of goods. Afterthis accounting equation appears as follows:Cash+Bank +Stock of goods = Creditors + Capital (Rs.1,90,000(Rs. 1,10,000) (Rs.70,000) (Rs.20,000)(Rs.5,20,000) 16. 50,000)+ Furniture+ Building (Rs. 20,000) (Rs.2,00,000) Rs. 5,40,000 = Rs.5,40,00017. Rs. 40,000 cash and Rs.20,000 goods withdrawn for personaluse:It decreases cash by Rs.40,000 and goods by Rs.20,000. At the same time, itdecreases capital by Rs.60,000 as shown below:Cash + Bank+ Stock of goods =Creditors + Capital (Rs. 1,40,000 (Rs. 1,10,000) (Rs.70,000(Rs.20,000)(Rs.5,20,000- 50,000)-Rs,20,000) - Rs.60,000) +Furniture+ Building (Rs. 20,000) (Rs.2,00,000) Rs. 4,80,000 =Rs.4,80,000ifaccounting equation after above transactions is to be presented in the form ofbalance sheet, it will appear as follows :Balance SheetLiabilities Amount Assets amountCapital4,65,000 Cash 1,25,000Creditors20,000 Bank 1,10,000Stock 30,000Furniture 20,000Building2,00,0004,85,000 4,85,000Classifcation of Accounts and rules for Recording Transactions :For recording business transaction all accounts are divided into threecategories,1) Assets Account2) Liability Account3) Capital AccountFor recording changes in assets, liabilities and capital two basicrules are followed :Rule No. 1 for recording changes in assets : Increase in asset is debited and decrease in asset in credited.Rule No. 2 for recording changes in liabilities and capital : Increase in liabilities and capital are credited and decrease in liabilitiesand capital are debited.TransactionNo.Assets =Cash + Bank + Stock+Furniture+Building =Creditors forBuilding+TradeCreditors +Capital1. 5,00,000- - 20,000 - = - - 5,20,0002. 5,00,000- 10,000----20,000--+2,00,000= -+1,90,000--5,20,000-3. 4,90,000-3,00,000-+3,00,000--20,000-2,00,000-= 1,90,000---5,20,000-4. 1,90,000-3,00,000-1,90,000--20,000-20,000-= 1,90,000-1,90,000--5,20,000-5. 1,90,000- 50,0001,10,000--+70,00020,000-20,000-= ---+ 20,0005,20,000-6. 1,40,000- 40,0001,10,000-70,000-20,00020,000-20,000-= --20,000-5,20,000- 60,0007. 1,00,000+ 25,0001,10,000-50,000-20,00020,000-20,000-= --20,000-4,60,000+ 50,0008. 1,25,0001,10,000 30,000 20,000 20,000 = - 20,000 4,65,000Analysis of Changes in Capital AccountIncreases and decreases in capital account can take place due tointroduction of capital, withdrawal of cash, goods and other assets for personaluse ( called drawings ), revenue and income earned ( resulting in increase incapital) and expenses incurred ( resulting in decrease in capital). Recording theefect of all these transactions directly in the capital account will make itunwieldy. In actual practice, net efect of revenue and expense transactionduring an accounting period as shown by proft and loss account is transferredto capital account. Similarly cumulative efect of drawings during an accountingperiod is recorded in the capital account at the end of the accounting period.For this purpose, temporary capital accounts are opened. These are calledtemporary accounts because these accounts start with zero balance in thebeginning of the accounting period and at the end of the accounting period,these account are closed and their net efect it transferred to capital account.These include:a) Revenue Account(mcluding other incomes and gains)b) Expense Account(mcludmg losses)c) Drawing Account.As these accounts record changes which afect capital account only, no separaterule is required for recording changes in temporary accounts. For example:i. Revenue increases capital and decrease in capital is credited, thereforerevenue earned is credited to revenue account.ii. Expense decreases capital and decrease in capital is debited, therefore,expenses are debited to expense account.iii. Drawings decrease capital and decrease in 'capital is debited,therefore, the value of assets withdrawn for personal use is debited todrawings account.Thus capital at the end of the period may be calculated as follows:Closing capital = Opening capital + Additional capital- Drawings +Revenue and Gains- ExpensesTo sum up, under accounting equation approach all accounts aredivided into three, categories namely, assets, liabilities and capital. Capitalaccount is further sub-divided into permanent and temporary account Forrecording changes in assets Rule NO. 1 is applied and to record increases anddecreases in liabilities and capital Rule N0.2 is followed.Illustration:Prepare a statement showing analysis of transactions, title andnature of afected accounts, relevant rule of recording and the account to bedebited and credited on the basis of transactions of Mr. X for the month ofDecember,1998. Transactions for the month of December, 1998, were asfollowsRs.1. Received cash form debtors 20,0002. Deposited cash in bank 4,0003. Payment to creditors bycheque4,0004. Machine purchased for10,0005. Traveling Expenses 5,000Statement Showing Analysis of TransactionsTransactions Analysis Title andNature ofAccountRule EntryReceived cashfrom debtorsRs. 20,000Increase cash Decrease the amount Cash Asset Debtor AssetDebit increase in assets Credit Debit cashCredit Debtorsdue from debtors decrease in asset Depositedcash in bankRs. 4000Increase bank balance Decreases cash in hand Bank assetCash - assetDebit increase in asset Credit decrease increase asset Debit bank Credit cashPayment tocreditors bychequeRs.4,000Decreases amount payable to creditors decreases bank balance Creditors Liability Bank Asset Debit decrease in liability Credit decrease in asset Debit creditors Credit BankMachinerypurchasedRs.10,000Increases machinery Decreases cash in handMachinery assetCash - assetDebit increase in assetCredit decrease in asset Debit machinery Credit cashTravelingExpenses incurred on Traveling expense-Debit Debit traveling expensesRs.5000travel increases cash in hand decreases Temporary capital (Expense) Cash - Assetincrease in expensesCredit decrease in asset ExpensesCredit cash

Analysis of Valuation of Assets and LiabilitiesFinancial accounting is basically historical in nature and businesstransactions are accounted at their value on the date of the transactions. As aresult asset and liabilities also appear at historical value. To portray true andfair fanancial position in balance sheet some of the assets and liabilities needrevaluation to show these items at realistic, and not historical, level in thebalance sheet. To achieve this objective without changing asset and liabilitiesbalances in accounting records, valuation records, valuation accounts areopened to account for increase or decrease in historical value of these items. Rules relating to analyze to assets and liabilities can be extended toaccommodate analysis of valuation accounts as follows: 1. Valuation of Assets:Various valuation accounts generally opened to account for decreae in thevalue of assets are provision for discount on debtors account, provision fordoubtful debts account, stock reserve account, investment fuctuation reserveaccount, provision for (or accumulated) depreciation account and so on. Theaccounts are opened to bring and report assets at their reduced level. As decrease in as