ACCOUNTING

MEANING

The process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of the
information.
The American Institute of Certified Public Accountants defines accounting as:

The art of recording, classifying, summarising 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.

Accounting not only records financial transactions and conveys the financial position of
a business enterprise; it also analyses and reports the information in documents called
“financial statements.”
 USERS OF ACCOUNTING
Accounting is primarily required for the proprietors and management. Accounting information of a
business house is useful not only to the owners but also to many internal and external parties.

INTERNAL USER EXTERNAL USERS

Owners/Proprietors Creditors
Managers Prospective Investors
Employees Government
Customers
Researchers
Foreigners
Others (Entrepreneurs, Tax Authorities, Trade
Associates, Stock Exchanges, Media, Political
Parties)
INTERNAL USERS

1) Owners/Proprietors: The business is done with a primary objective of making profit. The
accounting records reflect the profitability, financial position and the financial soundness of the
business.

2) Managers: In case of large industrial organizations, where the owners and managers are different,
the managers are responsible for the day-to-day affair of the business. The accounting records
provide the vital information of the performance of the business and analysis, which in turn helps the
management to improve the performance by taking corrective actions.

3) Employees: The employees are interested in the job security and the future growth. Both of these
are related to the performance of the business.

EXTERNAL USERS
The externals users of accounting information are as follows:

1) Creditors: Creditors are the persons who have extended credit to the company. The creditors
include the suppliers of goods and services, bankers and other lenders. The financial statements help
them in ascertaining the liquidity position of the business, i.e., the ability to meet the financial
obligation, as and when they fall due.

2) Prospective Investors: A prospective investor is interested in knowing the financial strength of

the business. The expected rate of return on investment could be estimated based on the study of the
financial statements.

3) Government: The government is interested in the financial statements from the point of view of
taxation, compliance to corporate and labour laws.

4) Customers: Customers, who have developed loyalty to a business, are interested in the
continuance of the business. They are also interested in knowing the future plans of the organization
with which they can also link their growth.

5) Researchers: Researchers need financial information for testing financial hypothesis and
development of theories and models.
6) Foreigners: The whole world has now become one big market due to modem means of transport
and communication. Many foreign agencies and entrepreneurs are interested to have collaboration.
with Indian enterprises.
Hence, the foreigners are interested to know the profitability and financial position of various
enterprises of this country. On the basis of accounting information, the foreigners make up their
mind for imports, exports also.

7) Others: Some other persons/parties are also interested in accounting information:

i) Entrepreneurs: Entrepreneurs venture to enter a particular business only after studying the
profitability and financial position of business units already working in that field.

ii) Tax Authorities: Authorities of income-tax, sales tax, etc, require accounting information of the
concerned business units.

iii) Trade Associates: Trade associations consolidate and compare the performance of their member
units and, if needed, demand certain concessions, exemptions or subsidies from the government.
This is done only after compiling the accounting information of the member units.

iv) Stock Exchanges: Stock exchanges require accounting information of companies in connection
with listing of securities and various dealings on the exchange.

v) Media: Newspapers, magazines and electronic media as radio, television, etc., collect accounting
information of various units and undertakings for bringing them to the notice of government and
masses.

vi) Political Parties: Political parties use accounting disclosures of public undertakings and various
industries in placing their views in the parliament, legislative assemblies as well as in public
meetings in order to prove economic progress of otherwise.
 ACCOUNTING CONCEPTS

 Business entity concept

 Money measurement concept
 Going concern concept
 Accounting period concept
 Accounting cost concept
 Dual aspect concept
 Matching concept
 Realisation concept
 Accrual concept
 Business entity concept

According to this concept, business is treated as a unit separate and

distinct from its owners, creditors, managers & others. In other words, the owner of a business is
always considered as distinct and separate from the business he owns. Business unit should have a
completely separate set of books and we have to record business transactions from firm’s point of
view and not from the point of view of the proprietor. The proprietor is treated as a creditor of the
business to the extent of capital invested by him in the business. The capital is treated as a liability of
the firm because it is assumed that the firm has borrowed funds from its own proprietors instead of
borrowing it from outside parties.
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.

Money measurement concept

Only those transactions and events are recorded in accounting which are capable of being expressed in terms
of money. An event, even though it may be very important for the business, will not be recorded in the
books of the business unless its effect can be measured in terms of money with a fair degree of accuracy.
For example, accounting does not record a quarrel between the production manager & sales manager; it
does not report that a strike is beginning and it does not reveal that a competitor has placed a better product
in the market. These facts or happenings cannot be expressed in money terms and thus are not recorded in
the books.

Going concern concept

As per this concept it is assumed that the business will continue to exit for a long period in the future. The
transactions are recorded in the books of the business on the assumption that it is continuing enterprise.
This is an important assumption of accounting, as it provides a basis for showing the value of assets in the
balance sheet.

Accounting period concept

A business has compulsorily to adopt financial year beginning on 1st April and ending on 31st March in the
next calendar year as its accounting period. Apart from this, companies whose shares are listed on the stock
exchange are required to publish quarterly results to depict the profitability and financial position at the end
of three months period.

Accounting Cost Concept

According to this concept, an asset is ordinarily recorded in the books of accounts at the price at which it
was acquired. This cost becomes the basis of all subsequent accounting for the asset. The cost concept or
historical cost concept does not mean that assets will be continuously shown at their acquisition price for as
long as the business entity owns them. Their cost is systematically reduced from year to year by charging
depreciation and the assets are shown in the balance sheet at cost less depreciation.
 Dual Aspect Concept
According to this concept, every business transaction is recorded as having a dual aspect. In other words,
every transaction affects at least two accounts. If one account is debited, any other account must be credited.
The system of recording transactions based on this concept is called as ‘Double Entry System’. It is because
of this principle that the two sides of the balance sheet are always equal and the following accounting
equations hold good at any point of time:

Assets = Liabilities + Capital

Or
Capital = Assets – Liabilities

Matching concept

This concept is very important for correct determination of net profit. According to this concept, in
determining the net profit from business operations, all costs, which are applicable to revenue of the period,
should be charged against that revenue.

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. In other words, it can be said that : 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.
The concept of realisation states that revenue is realized at the time when goods or services
are actually realized.

FOR EXAMPLE
A Jeweller received an order to supply gold ornaments worth Rs.500000. They supplied ornaments worth
Rs.200000 up to the year ending 31st December 2005 and rest of the ornaments were supplied in January
2006. The revenue for the year 2005 for a Jeweller is Rs.200000. Mere getting an order is not considered as
revenue until the goods have been delivered.

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. Though cash is received or not received and 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.
The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or
services irrespective of the fact when the cash is received.
 ACCOUNTING CONVENTIONS

An accounting convention refers to common practices which are universally followed in recording
and presenting accounting information of the business entity. Conventions denote customs or
traditions or usages which are in use since long. To be clear, these are nothing but unwritten laws.
The accountants have to adopt the usage or customs, which are used as a guide in the preparation
of accounting reports and statements. These conventions are also known as doctrine.

These Accounting Conventions are given below:

 Consistency
 Full Disclosure
 Materiality
 Conservatism

Convention of consistency
The convention of consistency means that same accounting principles should be used for preparing
financial statements year after year. A meaningful conclusion can be drawn from financial statements of the
same enterprise when there is comparison between them over a period of time. But this can be possible
only when accounting policies and practices followed by the enterprise are uniform and consistent over a
period of time. If different accounting procedures and practices are used for preparing financial statements
of different years, then the result will not be comparable.

Convention of full disclosure

Convention of full disclosure requires that all material and relevant facts concerning financial statements
should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of
accounting information. Adequate means sufficient set of information to be disclosed. Fair indicates an
equitable treatment of users. Full refers to complete and detailed presentation of information. Thus, the
convention of full disclosure suggests that every financial statement should fully disclose all relevant
information. Let us relate it to the business.
The business provides financial information to all interested parties like investors, lenders, creditors,
shareholders etc. The shareholder would like to know profitability of the firm while the creditor would like
to know the solvency of the business. In the same way, other parties would be interested in the financial
information according to their requirements. This is possible if financial statement discloses all relevant
information in full, fair and adequate manner.
 Convention of materiality

The convention of materiality states that, to make financial statements meaningful, only material fact i.e.
important and relevant information should be supplied to the users of accounting information. The
question that arises here is what is a material fact. The materiality of a fact depends on its nature and the
amount involved. Material fact means the information of which will influence the decision of its user.

Convention of conservatism

This convention is based on the principle that “Anticipate no profit, but provide for all possible losses”. It
provides guidance for recording transactions in the books of accounts. It is based on the policy of playing
safe in regard to showing profit .
The main objective of this convention is to show minimum profit. Profit should not be overstated. If profit
shows more than actual, it may lead to distribution of dividend out of capital. This is not a fair policy and it
will lead to the reduction in the capital of the enterprise.
Thus, this convention clearly states that profit should not be recorded until it is realised. But if the business
anticipates any loss in the near future provision should be made in the books of accounts for the same.

For example, valuing closing stock at cost or market price whichever is lower, creating provision for
doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent, etc. The convention
of conservatism is a very useful tool in situation of uncertainty and doubts.