UNIT I

INTRODUCTION
• Accounting has been hailed by many as the “language of business”.
• Accounting is one of the key functions for almost any business; it may be handled
by a bookkeeper and accountant at small firms or by sizable finance departments
with dozens of employees at large companies.
• The American Institute of Certified Public Accountants (AICPA) defines accounting
as:
“the art of recording, classifying, and summarizing in a significant manner and in
terms of money, transactions and events which are, in part at least of financial
character, and interpreting the results thereof”
• The definition highlights the following features:

1. Accounting is considered an art

• Accounting is considered an art because it requires the use of skills and creative
judgment. One has to be trained in this discipline to be able to perform accounting
functions well.
• Accounting is also considered a science because it is a body of knowledge.
However, accounting is not an exact science since the rules and principles
are constantly changing (improved).
2. Accounting involves interconnected "phases"
• Recording pertains to writing down or keeping records of business
transactions.
• Classifying involves grouping similar items that have been recorded.
• Once they are classified, information is summarized into reports which we
call financial statements.
3. Concerned with transactions and events having financial character
• For example, hiring an additional employee is qualitative information with
no financial character. Hence, it is not recorded.
• However, the payment of salaries, acquisition of an office building, sale of
goods, etc. are recorded because they involve financial value.
4. Business transactions are expressed in terms of money
• They are assigned amounts when processed in an accounting system.
Using one of the examples above, it is not enough to record that the
company paid salaries for April.
• It must include monetary figures – say for example, Rs.20,000 salaries
expense.

5. Interpreting the results

• Interpreting results is part of the phases of accounting. Information is
useless if they cannot be interpreted and understood.
• The amounts, figures, and other data in the financial reports have
meanings that are useful to the users.

Conclusion
Accounting is the systematic and comprehensive recording of financial
transactions pertaining to a business, and it also refers to the process of
summarizing, analyzing and reporting these transactions to oversight
agencies and tax collection entities.
 Types of Accounting
1. Financial Accounting
• Financial accounting involves recording and classifying business
transactions, and preparing and presenting financial statements to be
used by internal and external users.
• In the preparation of financial statements, strict compliance with generally
accepted accounting principles or GAAP is observed.
• Financial accounting is primarily concerned in processing historical data.
2. Managerial Accounting
• Managerial or management accounting focuses on providing information
for use by internal users, the management.
• This branch deals with the needs of the management rather than strict
compliance with generally accepted accounting principles.
• Managerial accounting involves financial analysis, budgeting and
forecasting, cost analysis, evaluation of business decisions, and similar
areas.
3. Cost Accounting
• Sometimes considered as a subset of management accounting, cost
accounting refers to the recording, presentation, and analysis
of manufacturing costs.
• Cost accounting is very useful in manufacturing businesses since they have
the most complicated costing process.
• Cost accountants also analyze actual and standard costs to help managers
determine future courses of action regarding the company's operations.
 Users of Accounting Information -
Internal & External
• Accounting information helps users to make better financial decisions.
Users of financial information may be both internal and external to the
organization.
1. Internal users (Primary Users) of accounting information include the
following:
• Management: for analyzing the organization's performance and position
and taking appropriate measures to improve the company results.
• Employees: for assessing company's profitability and its consequence on
their future remuneration and job security.
• Owners: for analyzing the viability and profitability of their investment
and determining any future course of action.
• Accounting information is presented to internal users usually in the form
of management accounts, budgets, forecasts and financial statements.
2. External users (Secondary Users) of accounting information include the
following:
• Creditors: for determining the credit worthiness of the organization. Terms
of credit are set by creditors according to the assessment of their
customers' financial health. Creditors include suppliers as well as lenders
of finance such as banks.
• Tax Authorities: for determining the credibility of the tax returns filed on
behalf of the company.
• Investors: for analyzing the feasibility of investing in the company.
Investors want to make sure they can earn a reasonable return on their
investment before they commit any financial resources to the company.
• Customers: for assessing the financial position of its suppliers which is
necessary for them to maintain a stable source of supply in the long term.
• Regulatory Authorities: for ensuring that the company's disclosure of
accounting information is in accordance with the rules and regulations set
in order to protect the interests of the stakeholders who rely on such
information in forming their decisions.
• External users are communicated accounting information usually in the
form of financial statements.
 Meaning
• An accounting information system (AIS) is a structure that a business uses
to collect, store, manage, process, retrieve and report its financial data so
that it can be used by accountants, consultants, business analysts,
managers, chief financial officers (CFOs), auditors and regulatory and tax
agencies.
1. INPUT- An input device is the component of an accounting system that
captures information from source documents and transfers the data for
further processing.
2. PROCESSING- After accounting information has been input into the
accounting system, it must be processed. Processing accounting data
involves calculations, classification, summarization, and consolidation. In
manual accounting systems, this processing occurs through the
established manual methods and the recording, posting, and closing steps
in the journals and ledgers.
3. OUTPUT- Accounting outputs are financial statements that detail the
financial activities of a business, person, or other entity.
• The balance sheet, reports on a company's assets, liabilities, and
ownership equity at a given point in time. The income statement is also
referred to as profit and loss statement, or a "P&L. " This statement
reports on a company's income, expenses, and profits over a period of
time.
• A statement of changes in shareholder equity explains the changes of the
company's equity throughout the reporting period.
Characteristics of Accounting
Information
1. Understandability means that users must understand the information
within the context of the decision being made.
• This is a user-specific quality because users will differ in their ability to
comprehend any set of information.
• The first financial reporting objective is to provide comprehensible
information to those who have a reasonable understanding of business
and economic activities and are willing to study the information.

 PRIMARY QUALITATIVE CHARACTERISTICS

• The primary decision-specific qualities that make accounting information

useful are relevance and reliability. Both are critical. No matter how
reliable, if information is not relevant to the decision at hand, it is useless.
Conversely, relevant information is of little value if it cannot be relied on.
a) Relevance- To make a difference in the decision process, information
must possess predictive value and/or feedback value. Generally, useful
information will possess both qualities. For example, if net income and its
components confirm investor expectations about future cash-generating
ability, then net income has feedback value for investors. This
confirmation can also be useful in predicting future cash-generating
ability as expectations are revised.
• This predictive ability is central to the concept of “earnings quality,” the
ability of reported earnings (income) to predict a company’s future
earnings.

b) Reliability- This implies that the accounting information that is presented

is truthful, accurate, complete (nothing significant missed out) and
capable of being verified (e.g. by a potential investor). The sub features
are :
 Substance over form- Substance over form is an accounting concept which
means that the economic substance of transactions and events must be
recorded in the financial statements rather than just their legal form in
order to present a true and fair view of the affairs of the entity.
 Substance over form concept entails the use of judgment on the part of
the preparers of the financial statements in order for them to derive the
business sense from the transactions and events and to present them in a
manner that best reflects their true essence. Whereas legal aspects of
transactions and events are of great importance, they may have to be
disregarded at times in order to provide more useful and relevant
information to the users of financial statements.
 Neutrality- Information contained in the financial statements must be
free from bias. It should reflect a balanced view of the affairs of the
company without attempting to present them in a favored light.
Information may be deliberately biased or systematically biased.
 Prudence concept-also known as the conservatism principle, is an
accounting principle that requires an accountant to record liabilities and
expenses as soon as they occur, but revenues only when they are assured
or realized. The prudence concept requires the accountants to be cautious
in the adoption of policies and estimations in such a way that the entity's
income and assets are not overstated and the entity's expenses and
liabilities are not understated.
 Completeness- deals with whether all transactions and accounts that
should be in the financial statements are included. For example,
management asserts that all purchases of goods and services are included
in the financial statements.
 Timeliness- The timeliness of accounting information refers to the
provision of information to users quickly enough for them to take action.
 Verifiability- Verifiability means that the accounting information
presented in financial statements must be verifiable by independent
accountants. Accounting information presented in the financial
statements is considered verifiable if two independent accountants (e.g.
auditors) can reasonably conclude on the basis of their verification that it
is a fair reflection of the underlying transactions and circumstances.
C) Comparability
• Comparability is one of the key qualities which accounting information
must possess.
• Accounting information is comparable when accounting standards and
policies are applied consistently from one period to another and from one
region to another.
• The characteristic of comparability of financial statements is important
because it allows us to compare a set of financial statements with those of
prior periods and those of other companies.
 Advantages of Accounting
1. Complete and Systematic Record:
• Accounting is based on generally accepted principles and a scientific way
of presentation of business transactions in books of accounts. As such,
accounting is a complete and systematic recording of all business
transactions. The limitations of humans, that they can not keep all
transactions in mind, is overcome by accounting because each and every
business transaction can be recorded and analyzed through same.

2. Determination of Selling Price:

• The main function of the management is decision making. Accounting
helps and guides the management to take decisions in respect of
determining selling price, deduction of cost, increase in sales etc.
3. Valuation of the Business:
• In case of sale of business or conversion of one business into another, true
and fair value of the business is calculated. Through accounting, the
correct picture can be depicted in Balance Sheet and as such the purchase
price can be determined. Balance Sheet shows the value of assets &
liabilities of the business which can be used to calculate its net worth.
4. Helps in Raising Loan:
• For further expansion, business must have sufficient funds. Sometimes,
due to paucity of funds business cannot do well. In those cases further
funds can be raised by taking loan from some financial institutions like
banks, IDBI, ICICI etc. These financial institutions lend money on the basis
of profitability and soundness of the business enterprise. The profitability
and soundness can be measured by the Trading and Profit & Loss Account
and Balance Sheet, the final results of books of accounts.
5. Evidence in Court of Law:
• The business transactions are recorded in the books of accounts
supported by authenticated documents viz. vouchers etc. Thus, the
accounts can be used as an evidence in the court of law.
6. In Compliance of Law:
• Every business has to deal with various government departments like
income tax, sales tax, custom and excise etc. Various periodic returns are
to be filed with these departments. Accounting helps in preparation and
filing of such returns.

7. Inter-Firm or Intra-Firm Comparison:

• Trading and Profit & Loss Account shows net profit earned or net loss
sustained by the business. If the accounts are maintained properly,
records relating to various expenses, sales, gross profit and net profit etc.
can be compared.
• As such, accounting helps in inter- firm and intra-firm comparison.
Comparison of accounts of two different enterprises for the same year is
known as inter-firm comparison and comparison of two different periods
for the same business enterprise is known as intra-firm comparison. The
performance of the business enterprise is then compared with the
predetermined goals and shortcomings, if any, can be rectified accordingly.
8. Facilitates Audit:
• Depending upon the size, nature and type of business, certification of
books of accounts, known as audit, is mandatory. Audit certificate issued
by the auditor on the accounts is a clean chit to organization which proves
that there are no irregularities in the organization.

9. Effective Management:
• Accounting facilitates proper feed back to the management. As such, it
helps the management in planning as well as control of different activities
of the business enterprise. It also helps the management to evaluate the
performance of the business enterprise and takes timely action to remove
the shortcomings in the management.
 Limitations of Accounting
• Financial accounting is significant for management as it helps them to
control the firm activities and in determining appropriate managerial
policies in different areas production, sales, administration, finance etc.
• Financial accounting suffers from the following limitations which have
been responsible for the emergence of Cost and Management
Accounting:
1. Transactions of non-monetary nature do not find place in accounting.
Accounting is limited to monetary transactions only. It excludes qualitative
elements like management reputation, employee morale, labour strike
etc.
2. Cost concept is found in accounting. Price changes are not considered.
Money value is bound to change often from time to time. This is a strong
limitation of accounting.
3. Acceptable alternatives are so broad based that comparisons are likely to
be confusing or misleading. For instance, inventory cost may be
ascertained by LIFO or FIFO; or stock may be evaluated at cost price or
market price.
4. Accounting policies are framed by the Accountant. The figures of balance
sheet are largely resulted by personal judgment of accountant hence it is
the subjective factor that prevails in accounting and objective factor is
ignored.
5. Recording and accounting for wages and labor is not carried out for
different jobs, processes, products or departments. This creates problems
in analyzing the cost associated with different activities.
 Accounting Concept
• Accounting follows a certain framework of core principles which makes
the information generated through an accounting system valuable. Without
these core principles accounting would be irrelevant and unreliable.
• In order to maintain uniformity and consistency in preparing and
maintaining books of accounts, certain rules or principles have been
evolved.
• These rules/principles are classified as concepts and conventions.
• These are foundations of preparing and maintaining accounting records.
 Accounting Concepts
1. Business/ Separate Entity Concept
• This concept assumes that, for accounting purposes, the business enterprise
and its owners are two separate independent entities. Thus, the business and
personal transactions of its owner are separate.
• For example, when the owner invests money in the business, it is recorded
as liability of the business to the owner. Similarly, when the owner takes
away from the business cash/goods for his/her personal use, it is not treated
as business expense.
• Thus, the accounting records are made in the books of accounts from the
point of view of the business unit and not the person owning the business.
This concept is the very basis of accounting.
• Let us take an example. Suppose Mr. Sahoo started business investing
Rs100000. He purchased goods for Rs40000, Furniture for Rs20000 and
plant and machinery of Rs30000. Rs10000 remains in hand. These are the
assets of the business and not of the owner.
• According to the business entity concept Rs100000 will be treated by
business as capital i.e. a liability of business towards the owner of the
business.
• Now suppose, he takes away Rs5000 cash or goods worth Rs5000 for his
domestic purposes. This withdrawal of cash/goods by the owner from the
business is his private expense and not an expense of the business. It is
termed as Drawings.
• Thus, the business entity concept states that business and the owner are two
separate/distinct persons. Accordingly, any expenses incurred by owner for
himself or his family from business will be considered as expenses and it
will be shown as drawings.
• Significance
The following points highlight the significance of business entity concept :
1. This concept helps in ascertaining the profit of the business as only the
business expenses and revenues are recorded and all the private and
personal expenses are ignored.
2. This concept restraints accountants from recording of owner‟s private/
personal transactions.
3. It also facilitates the recording and reporting of business transactions from
the business point of view.
4. It is the very basis of accounting concepts, conventions and principles.
 Money Measurement
• This concept assumes that all business transactions must be in terms of
money, that is in the currency of a country.
• In our country such transactions are in terms of rupees.
• Thus, as per the money measurement concept, transactions which can be
expressed in terms of money are recorded in the books of accounts.
• For example, sale of goods worth Rs.200000, purchase of raw materials
Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and
so they are recorded in the books of accounts.
• But the transactions which cannot be expressed in monetary terms are not
recorded in the books of accounts.
• For example, sincerity, loyality, honesty of employees are not recorded in
books of accounts because these cannot be measured in terms of money
although they do affect the profits and losses of the business concern.
• Another aspect of this concept is that the records of the transactions are to
be kept not in the physical units but in the monetary unit.
• For example, at the end of the year 2006, an organisation may have a
factory on a piece of land measuring 10 acres, office building containing 50
rooms, 50 personal computers, 50 office chairs and tables, 100 kg of raw
materials etc.
• These are expressed in different units. But for accounting purposes they are
to be recorded in money terms i.e. in rupees.
• In this case, the cost of factory land may be say Rs.12 crore, office
building of Rs.10 crore, computers Rs.10 lakhs, office chairs and tables
Rs.2 lakhs, raw material Rs.30 lakhs. Thus, the total assets of the
organisation are valued at Rs.22 crore and Rs.42 lakhs.
• Therefore, the transactions which can be expressed in terms of money is
recorded in the accounts books, that too in terms of money and not in terms
of the quantity
• Significance
The following points highlight the significance of money measurement
concept :
1. This concept guides accountants what to record and what not to record.
2. It helps in recording business transactions uniformly.
3. If all the business transactions are expressed in monetary terms, it will be
easy to understand the accounts prepared by the business enterprise.
4. It facilitates comparison of business performance of two different periods
of the same firm or of the two different firms for the same period.
 Going Concern Concept
• This concept states that a business firm will continue to carry on its
activities for an indefinite period of time. Simply stated, it means that every
business entity has continuity of life.
• Thus, it will not be dissolved in the near future. This is an important
assumption of accounting, as it provides a basis for showing the value of
assets in the balance sheet.
• For example, a company purchases a plant and machinery of Rs.100000
and its life span is 10 years. According to this concept every year some
amount will be shown as expenses and the balance amount as an asset.
• Thus, if an amount is spent on an item which will be used in business for
many years, it will not be proper to charge the amount from the revenues of
the year in which the item is acquired.
• Only a part of the value is shown as expense in the year of purchase and the
remaining balance is shown as an asset.
• Significance
The following points highlight the significance of going concern concept;
1. This concept facilitates preparation of financial statements.
2. On the basis of this concept, depreciation is charged on the fixed asset.
3. It is of great help to the investors, because, it assures them that they will
continue to get income on their investments.
4. In the absence of this concept, the cost of a fixed asset will be treated as
an expense in the year of its purchase.
5. A business is judged for its capacity to earn profits in future.
 Accounting Period Concept
• All the transactions are recorded in the books of accounts on the
assumption that profits on these transactions are to be ascertained for a
specified period.
• This is known as accounting period concept.
• Thus, this concept requires that a balance sheet and profit and loss account
should be prepared at regular intervals.
• This is necessary for different purposes like, calculation of profit,
ascertaining financial position, tax computation etc.
• Further, this concept assumes that, indefinite life of business is divided into
parts. These parts are known as Accounting Period.
• It may be of one year, six months, three months, one month, etc.
• But usually one year is taken as one accounting period which may be a
calendar year or a financial year.
• As per accounting period concept, all the transactions are recorded in the
books of accounts for a specified period of time.
• Hence, goods purchased and sold during the period, rent, salaries etc. paid
for the period are accounted for and against that period only.

• Significance
1. It helps in predicting the future prospects of the business.
2. It helps in calculating tax on business income calculated for a particular
time period.
3. It also helps banks, financial institutions, creditors, etc to assess and
analyse the performance of business for a particular period.
4. It also helps the business firms to distribute their income at regular
intervals as dividends.
 Accounting Cost concept
• Accounting cost concept states that all assets are recorded in the books of
accounts at their purchase price, which includes cost of acquisition,
transportation and installation and not at its market price.
• It means that fixed assets like building, plant and machinery, furniture, etc
are recorded in the books of accounts at a price paid for them.
• For example, a machine was purchased by XYZ Limited for Rs.500000,
for manufacturing shoes. An amount of Rs.1,000 were spent on
transporting the machine to the factory site. In addition, Rs.2000 were spent
on its installation.
• The total amount at which the machine will be recorded in the books of
accounts would be the sum of all these items i.e. Rs.503000.
• This cost is also known as historical cost.
• Suppose the market price of the same is now Rs 90000 it will not be shown
at this value.
• Further, it may be clarified that cost means original or acquisition cost only
for new assets and for the used ones, cost means original cost less
depreciation.
• The cost concept is also known as historical cost concept.
• The effect of cost concept is that if the business entity does not pay
anything for acquiring an asset this item would not appear in the books of
accounts.
• Thus, goodwill appears in the accounts only if the entity has purchased this
intangible asset for a price.

• Significance
1. This concept requires asset to be shown at the price it has been acquired,
which can be verified from the supporting documents.
2. It helps in calculating depreciation on fixed assets.
3. The effect of cost concept is that if the business entity does not pay
anything for an asset, this item will not be shown in the books of
accounts.
 DUAL ASPECT CONCEPT
• Dual aspect is the foundation or basic principle of accounting. It provides
the very basis of recording business transactions in the books of accounts.
• This concept assumes that every transaction has a dual effect, i.e. it affects
two accounts in their respective opposite sides.
• Therefore, the transaction should be recorded at two places.
• It means, both the aspects of the transaction must be recorded in the books
of accounts.
• For example, goods purchased for cash has two aspects which are (i)
Giving of cash (ii) Receiving of goods.
• These two aspects are to be recorded.
• Thus, the duality concept is commonly expressed in terms of fundamental
accounting equation :

Assets = Liabilities + Capital

• The above accounting equation states that the assets of a business are
always equal to the claims of owner/owners and the outsiders.
• This claim is also termed as capital or owners equity and that of outsiders,
as liabilities or creditors‟ equity.
• The knowledge of dual aspect helps in identifying the two aspects of a
transaction which helps in applying the rules of recording the transactions
in books of accounts.
• The implication of dual aspect concept is that every transaction has an
equal impact on assets and liabilities in such a way that total assets are
always equal to total liabilities.
• Let us analyse some more business transactions in terms of their dual
aspect :

1. Capital brought in by the owner of the business

The two aspects in this transaction are :
(i) Receipt of cash (ii) Increase in Capital (owners equity)
2. Purchase of machinery by cheque
The two aspects in the transaction are
(i) Reduction in Bank Balance (ii) Owning of Machinery
3. Goods sold for cash
The two aspects are
(i) Receipt of cash (ii) Delivery of goods to the customer
4. Rent paid in cash to the landlord
The two aspects are
(i) Payment of cash (ii) Rent (Expenses incurred).
• Once the two aspects of a transaction are known, it becomes easy to
apply the rules of accounting and maintain the records in the books of
accounts properly.
• The interpretation of the Dual aspect concept is that every transaction has
an equal effect on assets and liabilities in such a way that total assets are
always equal to total liabilities of the business.
• Significance
1. This concept helps accountant in detecting error.
2. It encourages the accountant to post each entry in opposite sides of two
affected accounts.
 REALISATION CONCEPT
• This concept states that revenue from any business transaction should be
included in the accounting records only when it is realised.
• The term realisation means creation of legal right to receive money. Selling
goods is realisation, receiving order is not.
• Revenue is said to have been realised when cash has been received or right to
receive cash on the sale of goods or services or both has been created.

• Let us study the following examples :

(i) N.P. Jeweller received an order to supply gold ornaments worth Rs.500000.
They supplied ornaments worth Rs.200000 up to the year ending 31st March
2017 and rest of the ornaments were supplied in April 2017.
(ii) Bansal sold goods for Rs.1,00,000 for cash in 2017 and the goods have been
delivered during the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending 31st March
2017. The goods have been delivered in 2017 but the payment was received in
April 2018.
Now, let us analyse the above examples to ascertain the correct amount of
revenue realised for the year ending 31st March 2017.
(i) The revenue for the year 2017 for N.P. Jeweller is Rs.200000. Mere getting an
order is not considered as revenue until the goods have been delivered.
(ii) The revenue for Bansal for year 2017 is Rs.1,00,000 as the goods have been
delivered in the year 2017. Cash has also been received in the same year.
(iii) Akshay‟s revenue for the year 2017 is Rs.50,000, because the goods have been
delivered to the customer in the year 2017. Revenue became due in the year
2017 itself.

• In the above examples, revenue is realised when the goods are delivered to the
customers.
• The concept of realisation states that revenue is realized at the time when goods
or services are actually delivered.
• In short, the realisation occurs when the goods and services have been sold
either for cash or on credit. It also refers to inflow of assets in the form of
receivables.
• Significance

1. It helps in making the accounting information more objective.

2. It provides that the transactions should be recorded only when goods are
delivered to the buyer.
 ACCRUAL CONCEPT
• The meaning of accrual is something that becomes due especially an
amount of money that is yet to be paid or received at the end of the
accounting period.
• It means that revenues are recognised when they become receivable even
though cash is received or not received.
• The expenses are recognised when they become payable though cash is
paid or not paid. Both transactions will be recorded in the accounting
period to which they relate.
• Therefore, the accrual concept makes a distinction between the accrual
receipt of cash and the right to receive cash as regards revenue and actual
payment of cash and obligation to pay cash as regards expenses.
• Similarly, expenses are recognised at the time services provided,
irrespective of the fact when actual payment for these services are made.
• For example, if the firm received goods costing Rs.20000 on 29th March
2005 but the payment is made on 2nd April 2005 the accrual concept
requires that expenses must be recorded for the year ending 31st March
2005 although no payment has been made until 31st March 2005 though
the service has been received and the person to whom the payment should
have been made is shown as creditor.
• In brief, accrual concept requires that revenue is recognised when realised
and expenses are recognised when they become due and payable without
regard to the time of cash receipt or cash payment.
 Cash vs Accrual system of accounting
• The recognition of monetary transactions is vital for every business entity,
irrespective of its size and nature.
• There are two accounting systems, through which the transaction can be
recognized.
• They are Cash Accounting and Accrual Accounting.
• The basic difference between the two approaches to bookkeeping of an
entity is in timing, i.e. in cash accounting, the recording is done when
there is an inflow or outflow of cash.
• On the other hand, in accrual accounting, it records the income and
expense immediately when it arises.
 Cash Accounting
• The basis of accounting in which the recognition of revenues and expenses
are done only when there is actual receipt or disbursement of cash takes
place.
• In this method, in which the income or expense is recognized when the
inflow or outflow of cash exists in reality.
• The method is mostly used by sole traders, contractors and other
professionals who recognize their income when there is an inflow of cash
and report expenses when cash goes out of the entity.
• Moreover, Cash Accounting does not require high knowledge in
accounting, a person having little knowledge of bookkeeping can also
maintain records as per this system.
• One of the major benefits of Cash accounting is seen in tax, i.e. expenses
and deductions are allowed easily.
• However, the method is not recommended by the GAAP
(Generally Accepted Accounting Principles) and IFRS (International
Financial Reporting Framework) due to a number of drawbacks like:
1. It does not coincide with matching concept.
2. Time lags in the occurrence of a transaction and its recognition.
3. Lacks in accuracy.
 Accrual Accounting
• Accrual Accounting is the base of present accounting. It is also known as
the mercantile system of accounting wherein the transactions are
recognized as and when they take place.
• Under this method, the revenue is recorded when it is earned, and the
expenses are reported when they are incurred.
• As per matching concept, the expenses of a particular accounting period
are matched with its revenue.
• The accrual basis of accounting fulfills this criterion; that is why it is
regarded as an effective tool for recording receipts and payments.
• Although, some items are necessary to be adjusted at the end of the
financial year like:
1. Unearned Income
2. Accrued Income
3. Prepaid Expenses
4. Outstanding Expenses
 Key Differences Between Cash Accounting and
Accrual Accounting
1. The accounting system in which the income or expense is recognized
when an exchange of consideration is actually done is known as Cash
Accounting. Accrual Accounting, in which the income or expense is
recognized when it arises.
2. Cash Accounting is simple as compared to Accrual Accounting.
3. Cash basis of accounting is not a recognized method as per companies
act, whereas accrual basis of accounting is a recognized method.
4. In Cash accounting, the income statement, shows lower income, while in
accrual basis of accounting the income statement shows relatively higher
income.
5. Cash Accounting is not in alignment with the matching concept, whereas
the concept completely applies in Accrual Accounting.
6. The basis of cash accounting is actual receipt and payment of cash. On
the other hand, in accrual accounting, the recognition is done when the
revenue or expense occurs.
7. The degree of accuracy is more in accrual accounting, which is very less
in cash accounting.
8. Cash Accounting is suitable for sole proprietors or contractors.
Conversely, big enterprises should prefer Accrual Accounting.
 MATCHING CONCEPT
• The matching concept states that the revenue and the expenses incurred to
earn the revenues must belong to the same accounting period.
• So once the revenue is realised, the next step is to allocate it to the relevant
accounting period. This can be done with the help of accrual concept.
• Let us study the following transactions of a business during the month of
March, 2017

(i) Sale : cash Rs.2000 and credit Rs.1000

(ii) Salaries Paid Rs.350
(iii) Commission Paid Rs.150
(iv) Interest Received Rs.50
(v) Rent received Rs.140, out of which Rs.40 received for the year 2018
(vi) Carriage paid Rs.20
(vii) Postage Rs.30
(viii) Rent paid Rs.200, out of which Rs.50 belong to the year 2018
(ix) Goods purchased in the year for cash Rs.1500 and on credit Rs.500
(x) Depreciation on machine Rs.200
Let us record the above transactions under the heading of Expenses and
Revenue.

Expenses Amount (Rs) Revenue Amount

(Rs)

1. Salaries 350 1. Sales

2.Commission 150 Cash 2000
3. Carriage 20 Credit 1000 3000
4. Postage 30 2. Interest received 50
5. Rent paid 200 3. Rent received 140
Less for 2018 (50) 150 Less for 2018 (40) 100
6. Goods purchased
Cash 1500
Credit 500 2000
7. Depreciation on machine 200
Total 2900 Total 3150
• In the above example expenses have been matched with revenue i.e
(Revenue Rs.3150-Expenses Rs.2900) This comparison has resulted in
profit of Rs.250.
• If the revenue is more than the expenses, it is called profit. If the expenses
are more than revenue it is called loss.
• This is what exactly has been done by applying the matching concept.
• Therefore, the matching concept implies that all revenues earned during an
accounting year, whether received/not received during that year and all cost
incurred, whether paid/not paid during the year should be taken into
account while ascertaining profit or loss for that year.

• Significance
1. It guides how the expenses should be matched with revenue for
determining exact profit or loss for a particular period.
2. It is very helpful for the investors/shareholders to know the exact amount
of profit or loss of the business.
Concepts vs Conventions
 Materiality
• The materiality convention is the principle in financial accounting and
reporting that firms may disregard trivial matters, but they must disclose
everything that is important to the report audience.
• Items that are important enough to matter are material items.
• The materiality concept, also called the materiality constraint, states that
financial information is material to the financial statements if it would
change the opinion or view of a reasonable person. In other words, all
important financial information that would sway the opinion of a financial
statement user should be included in the financial statements.
• The concept of materiality is relative in size and importance. Some
financial information might be material to one company but might be
immaterial to another.
• This is somewhat obvious when you think about a small company verses a
large company. A large and material expense to a small company might be
small an immaterial to a large company because of their size and revenue.
• The main question that the materiality concept addresses is does the
financial information make a difference to financial statement users. If not,
the company doesn‟t have to worry about including it in their financial
statements because it is immaterial.
• Most of the time financial information materiality is judged on qualitative
and quantitative characteristics. Professionals are often left up to their
experience and good judgment to understand what is material and what
isn‟t.

EXAMPLE
• A default by a customer who owes only Rs.1000 to a company having net
assets of worth Rs.10 million is immaterial to the financial statements of
the company.
• However, if the amount of default was, say, Rs. 2 million, the information
would have been material to the financial statements omission of which
could cause users to make incorrect business decisions.
 Consistency
• The consistency principle states that, once you adopt an accounting
principle or method, continue to follow it consistently in future accounting
periods.
• It is necessary that a company consistently apply its accounting methods
and policies from one financial year to another.
• A company can change its accounting methods and policies only and only
if there are one or more reasonable grounds to do so and the change reflects
a more accurate picture of financial performance and position of the
business in company‟s financial statements.
• EXAMPLE- Company A has been using declining balance
depreciation method for its IT equipment. According to consistency
concept it should continue to use declining balance depreciation method in
respect of its IT equipment in the following periods. If the company wants
to change it to another depreciation method, say for example the straight
line method, it must provide in its financial report, the reason(s) for the
change, the nature of the change and the effects of the change on items
such as accumulated depreciation.
 Importance/advantages of consistency
principle
1. Audit:
• The auditors give due attention to the consistency principle while auditing
financial statements of companies and demand reasons when it is not
followed by the company‟s management.
2. Ease for management:
• When accounting methods for recording similar transactions and events are
consistently applied, it provides management ease as they become familiar
with the recording procedures and accounting terminologies used during
recording.
3. Cost efficiency:
• It helps in reducing overall costs of an organization as only initial cost of
training is incurred at the time of adopting particular accounting methods
and policies.
4. Comparable financial information:
• When accounting methods are consistently applied from one financial
period to another, it results in financial reports of similar structure of
different accounting periods. This helps stakeholders in comparing the
financial performance of company with relative ease.
 Conservatism (Prudence)
• The conservatism principle is the general concept of
recognizing expenses and liabilities as soon as possible when there is
uncertainty about the outcome, but to only recognize revenues
and assets when they are assured of being received.
• Thus, when given a choice between several outcomes where the
probabilities of occurrence are equally likely, you should recognize
that transaction resulting in the lower amount of profit, or at least the
deferral of a profit.
• Similarly, if a choice of outcomes with similar probabilities of occurrence
will impact the value of an asset, recognize the transaction resulting in a
lower recorded asset valuation.
• Under the conservatism principle, if there is uncertainty about incurring a
loss, you should tend toward recording the loss. Conversely, if there is
uncertainty about recording a gain, you should not record the gain.
• The conservatism principle can also be applied to recognizing estimates.
• For example, if the collections staff believes that a cluster
of receivables will have a 2% bad debt percentage because of historical
trend lines, but the sales staff is leaning towards a higher 5% figure because
of a sudden drop in industry sales, use the 5% figure when creating
an allowance for doubtful accounts, unless there is strong evidence to the
contrary.
• The conservatism principle is the foundation for the lower of cost or market
rule, which states that you should record inventory at the lower of either its
acquisition cost or its current market value.
• The conservatism principle does not say that accountants are to be super
conservative. Accountants should be fair and objective.
• The conservatism principle says if there is doubt between two alternatives,
the accountant should opt for the one that reports a lesser asset amount or a
greater liability amount, and a lesser amount of net income.
 Full Disclosure
• The full disclosure principle states that you should include in an
entity's financial statements all information that would affect a reader's
understanding of those statements.
• The interpretation of this principle is highly judgmental, since the amount
of information that can be provided is potentially massive.
• To reduce the amount of disclosure, it is customary to only disclose
information about events that are likely to have a material impact on the
entity's financial position or financial results.
• This disclosure may include items that cannot yet be precisely quantified,
such as the presence of a dispute with a government entity over a tax
position, or the outcome of an existing lawsuit.
• Full disclosure also means that you should always report
existing accounting policies, as well as any changes to those policies (such
as changing an asset valuation method) from the policies stated in the
financials for a prior period.
• The full disclosure concept is an accounting principle that requires
management to report all relevant information about the company‟s
operations to creditors and investors in the financial statements and
footnotes.
• The purpose of the full disclosure principle is to share relevant and material
financial information with the outside world. Since outsiders don‟t know
the details of a company‟s business deals, contracts, and loans, it‟s difficult
to form an opinion of the entity.
• Relevant information to outsiders is anything that could change an external
user‟s decision about the company. This can include transactions that have
already occurred as well as future events contingent on third parties.
• Any type of information that could sway the judgment of an outsider
should be included in the financial statements in an effort to be transparent.
• According to the full disclosure principle, management should list the loans
along with terms, maturity dates, current portions, and collateral obligations
attached to the loans in the notes of the financial statements.
• With this holistic view of the company‟s debt picture, investors and
creditors can make their decisions much more easily.
• The purpose of this principle is to make companies more transparent.
 Accounting Standards
• An accounting standard is a principle that guides and
standardizes accounting practices.
• The Generally Accepted Accounting Principles (GAAP) is a group of
accounting standards widely accepted as appropriate to the field of
accounting necessary so financial statements are meaningful across a wide
variety of businesses and industries.
• An accounting standard is a guideline for financial accounting, such as how
a firm prepares and presents its business income, expenses, assets and
liabilities, and may be in accordance to standards set by the International
Accounting Standards Board (IASB).
• Accounting Standards are formulated with a view to harmonise different
accounting policies and practices in use in a country.
 Accounting Standards
• The objective of Accounting Standards is, therefore, to reduce the
accounting alternatives in the preparation of financial statements within the
bounds of rationality, thereby ensuring comparability of financial
statements of different enterprises with a view to provide meaningful
information to various users of financial statements to enable them to make
informed economic decisions.
• The Accounting Standards are issued with a view to describe the
accounting principles and the methods of applying these principles in the
preparation and presentation of financial statements so that they give a true
and fair view.
• The Accounting Standards not only prescribe appropriate accounting
treatment of complex business transactions but also foster greater
transparency and market discipline.
• Accounting Standards also helps the regulatory agencies in benchmarking
the accounting accuracy.
• Without accounting standards, there is little consistency as to the reporting
of financial information.
• Accounting standards make the financial statements credible and allow for
more economic decisions based on accurate and concise information.

INDIAN CONTEXT
• The „Accounting Standards‟ are issued by the “Accounting Standards
Board (ASB)” of the ICAI to establish uniform standards which have to be
complied with to ensure that financial statements are prepared
in accordance with generally accepted accounting standards.
• These standards are mandatory on the dates specified either in the
respective document or by notification issued by the Council of the ICAI.
• Basically, the Accounting standards of the ICAI are to ensure that accounts
are prepared uniformly and in line with the Indian GAAPs for better
understanding of the users.
ICAI has announced on 15 Nov. 2016 that ‘AS 30- Financial Instruments: Recognition
and Measurement’, ‘AS 31- Financial Instruments: Presentation’, ‘AS 32- Financial
Instruments: Disclosures’ stands withdrawn.
 Benefits
(i) Standardization of alternative accounting treatments: Standards reduce
to a reasonable extent or eliminate altogether confusing variations in the
accounting treatments used to prepare financial statements.
(ii) Requirements for additional disclosures: There are certain areas where
important information are not statutorily required to be disclosed. Standards
may call for disclosure beyond that required by law.
(iii) Comparability of financial statements: The application of accounting
standards would, to a limited extent, facilitate comparison of financial
statements of companies situated in different parts of the world and also of
different companies situated in the same country. However, it should be
noted in this respect that differences in the institutions, traditions and legal
systems from one country to another give rise to differences in accounting
standards adopted in different countries.
(iv) Facilitates informed decision making
 Limitations
(i) Difficulties in making choice between different treatments: Alternative
solutions to certain accounting problems may each have arguments to
recommend them. Therefore, the choice between different alternative
accounting treatments may become difficult.
(ii) Lack of flexibilities: There may be a trend towards rigidity and away from
flexibility in applying the accounting standards.
(iii) Restricted scope: Accounting standards cannot override the statute. The
standards are required to be framed within the ambit of prevailing statutes.
 Procedure for Issuing an Accounting
Standard
• The Institute of Chartered Accountants of India, recognizing the need to
harmonies the diverse accounting policies and practices at present in use in
India, constituted an Accounting Standards Board (ASB) on 21st April,
1977.
• The main function of ASB is to formulate accounting standards so that such
standards may be established by the Council of the Institute in India.
• While formulating the accounting standards, ASB will take into
consideration the applicable laws, customs, usages and business
environment.
• The Institute is one of the Members of the International Accounting
Standards Committee (IASC) and has agreed to support the objectives of
IASC.
• While formulating the Accounting Standards, ASB will give due
consideration to International Accounting Standards, issued by IASC and
try to integrate them, to the extent possible, in the light of the conditions
and practices prevailing in India.
 Steps
• The ASB determines the broad areas in which Accounting Standards need
to be formulated and the priority in regard to the selection thereof.
• In the preparation of Accounting Standards, the ASB will be assisted by
Study Groups constituted to consider specific subjects. In the formation of
Study Groups, provision will be made for wide participation by the
members of the Institute and others.
• The draft of the proposed standard will normally include the following:
(a) Objective of the Standard,
(b) Scope of the Standard,
(c) Definitions of the terms used in the Standard,
(d) Recognition and measurement principles, wherever applicable,
(e) Presentation and disclosure requirements.
• The ASB will consider the preliminary draft prepared by the Study Group
and if any revision of the draft is required on the basis of deliberations, the
ASB will make the same or refer the same to the Study Group.
• The ASB will circulate the draft of the Accounting Standard to the Council
members of the ICAI and the following specified bodies for their
comments:

(i) Department of Company Affairs (DCA)

(ii) Comptroller and Auditor General of India (CAG)
(iii) Central Board of Direct Taxes (CBDT)
(iv) The Institute of Cost and Works Accountants of India (ICWAI)
(v) The Institute of Company Secretaries of India (ICSI)
(vi) Associated Chambers of Commerce and Industry (ASSOCHAM),
Confederation of Indian Industry (CII) and Federation of Indian Chambers
of Commerce and Industry (FICCI)
(vii) Reserve Bank of India (RBI)
(viii) Securities and Exchange Board of India (SEBI)
(ix) Standing Conference of Public Enterprises (SCOPE)
(x) Indian Banks‟ Association (IBA)
(xi) Any other body considered relevant by the ASB keeping in view the nature
of the Accounting Standard.
• The ASB will hold a meeting with the representatives of specified bodies to
ascertain their views on the draft of the proposed Accounting Standard. On
the basis of comments received and discussion with the representatives of
specified bodies, the ASB will finalize the Exposure Draft of the proposed
Accounting Standard.
• The Exposure Draft of the proposed Standard will be issued for comments
by the members of the Institute and the public.
• The exposure Draft will specifically be sent to specified bodies (as listed
above), stock exchanges, and other interest groups, as appropriate.
• After taking into consideration the comments received, the draft of the
proposed Standard will be finalized by the ASB and submitted to the
Council of the ICAI.
• The Council of the ICAI will consider the final draft of the proposed
Standard, and if found necessary, modify the same in consultation with the
ASB.
• The Accounting Standard on the relevant subject will then be issued by the
ICAI.
 AS 1
Accounting Standard 1 – Disclosure of Accounting Policies

 Meaning of accounting policies

They are specific accounting principles and methods of applying those in
preparation and presentation of financial statements of an entity.
 Areas where different accounting policies are followed

1. Valuation of inventory:
LIFO (Last in First out)
FIFO (First in First out)
Weighted Average
2.Valuation of investments
3.Depreciation methods:
SLM Method (Straight Line Method)
WDV Method (Written down Value Method)
 Need for disclosure of accounting policies?
• It‟s mandatory to disclose the accounting policies followed in preparation
of financial statements. The reason behind this is for ” better understanding
of financial statements and assets and liabilities in balance sheet and profit
& loss account are significantly affected by those accounting policies.”

 Disclosure of Fundamental Accounting Assumptions

• Generally it‟s assumed that financial statements are prepared on the basis of
fundamental accounting assumptions. Following are the fundamental
accounting assumptions:

1.Going concern:
It means the entity has an intention of continuing its operations for
foreseeable future. Foreseeable future means coming one or two years. In
other words neither there is an intention of discontinuance of business, nor
necessity of liquidation of organization and discontinuance of major
operations of the business.
2.Consistency:
It means that same accounting policies are followed from one period to
another.
3.Accrual:
It means that the financial statements are prepared on mercantile basis in
which the transactions and other events are recognized when they occur
and they are recorded in the accounting period to which they relate

 Change in accounting policies:

• A change in accounting policies should be made in the following conditions
• Adoption of different accounting policies is required by law.
• Adoption of different accounting policies is required for compliance of
accounting standards.
• For more appropriate presentation of financial statements.
• If nothing has been there in the financial statements about the compliance
of fundamental accounting policies it can be assumed that they are
followed in preparation of financial statements.
 Considerations in selection of accounting policies
The primary consideration in the selection of accounting policies by an
enterprise is that the financial statements prepared and presented on the
basis of such accounting policies should represent a true and fair view of
the state of affairs of the enterprise as at the balance sheet date and of the
profit or loss for the period ended on that date.
For this purpose, the major considerations governing the selection and
application of accounting policies are:—

• 1. Prudence:
It means making estimates which is under the conditions of uncertainty.
• 2.Substance over form:
It means that the transaction should be accounted for in accordance with
actual happening and economic reality and not by the legal form.
• 3.Materiality:
Financial statements should disclose all the items and facts which are
sufficient enough to influence the decisions of users of financial statements.
 International Financial Reporting
Standards (IFRS)
• International Financial Reporting Standards (IFRS) are a set of
international accounting standards stating how particular types of
transactions and other events should be reported in financial statements.
• IFRS are issued by the International Accounting Standards Board (IASB),
and they specify exactly how accountants must maintain and report their
accounts.
• The goal of IFRS is to provide a global framework for how public
companies prepare and disclose their financial statements. IFRS provides
general guidance for the preparation of financial statements, rather than
setting rules for industry-specific reporting.
• IFRS were established in order to have a common accounting language, so
business and accounts can be understood from company to company and
country to country.
 IFRS and Convergence with AS
• Each nation follows its own accounting standards and policies.
• In the previous couple of decades, the worldwide monetary situation has
changed drastically. Presently there are transnational organizations that
work in numerous countries.
• So now there is a necessity for a standard that can be accepted
worldwide.
• At this point of situation, IFRS came into the picture.
• ICAI’s Accounting Standard Board (ASB) is the one who formulates Indian
Accounting Standards as per the Ministry of Corporate Affair. These
standards are furnished keeping the financial condition and practices of
India in mind. They are made to suit the Indian organizations and the
divulgence necessities of the Indian government.
• On the contrary, IFRS are framed as per the worldwide standards and
condition. Convergence would mean crossing over any barrier between
the two, i.e. the IFRS and the Indian AS. Convergence will include an
arrangement of the two sets of standards.
• The trade-off is finished by embracing the policies of the IFRS either
completely or in a part.
 Benefits of Convergence

• 1] Beneficial to the Economy

• If the accounting standards are converged it will promote international business
and increase the influx of capital into the country. This will help India’s economy
grow and expand. International investing will also mean more capital for domestic
companies as well.
• 2] Beneficial to Investors
• Convergence is a boon for investors who wish to invest in foreign markets or
economies. It makes it much easier for them to study and compare the financial
statements of foreign companies. Since the financial statements are made using
the same set of standards it is also easier for the investors to understand and
analyze them.
• 3] Beneficial to the Industry
• With globally accepted standards the industry can also surge ahead. So
convergence is important for the industry as well. It will allow the industry to lower
the cost of foreign capital. If companies are not burned by adopting two different
sets of standards it will allow them easier entry into the market.
• 4] More Transparency
• Convergence will benefit the users of the financial statements as well. It
will make it easier for them to understand the financial statements. And
this will generate better transparency and raise the confidence of the
investors to invest funds.
• 5] Cost Saving
• Firstly it will exempt companies from maintaining separate accounting
books according to separate standards. This will save a lot of work hours
and money for the finance department. And also planning and executing
auditing will also become easier.
• It will be especially helpful for those companies that have subsidiaries in
many countries. And the cost of capital will also reduce since capital would
be more accessible and easily available.
 Difficulties of convergence with the
IFRS

1. Other than the Accounting Standards, India has many rules and
regulations to implement them. These rules will have to be updated as
well.
2. Accounting is done via software these days, like Tally, Oracle, etc.
Convergence with IFRS means this software will have to be updated at
great costs.
3. Also, there is a lack of trained and efficient personnel. The accountants,
auditors, etc will have to undergo training and learning programmes for
the updated standards.
IFRS in India
• https://www.isme.in/ifrs-convergence-in-
india-need-benefits-challenges/