FINANCIAL

ACCOUNTING

Directorate of Online Education

 UNIT-1

INTRODUCTION

Accounting is a system meant for measuring business activities, processing of

information into reports and making the findings available to decision-makers. The
documents, which communicate these findings about the performance of an organisation in
monetary terms, are called financial statements. Usually, accounting is understood as the
Language of Business. However, a business may have a lot of aspects which may not be of
financial nature. As such, a better way to understand accounting could be to call it The
Language of Financial Decisions. The better the understanding of the language, the better is
the management of financial aspects of living. Many aspects of our lives are based on
accounting, personal financial planning, investments, income-tax, loans, etc. We have
different roles to perform in life-the role of a student, of a family head, of a manager, of an
investor, etc. The knowledge of accounting is an added advantage in performing different
roles. However, we shall limit our scope of discussion to a business organisation and the
various financial aspects of such an organisation.
1.0 INTRODUCTION

Accounting can be considered the language of business. Mastery of accounting

primarily rests in ability to critically think through and synthesize the information as it applies
to a given situation. You should approach the learning of accounting the same way you would
approach learning a foreign language; It will take time and practice to ensure you remember
the concepts. There are a number of sub-disciplines that fall under the umbrella of
"accounting,” but in this course, we will be focused on financial accounting. Accounting as a
business discipline can be viewed as a system of compiled data. The word data should not be
confused with "information.” In terms of accounting, "data” should be viewed as the raw
transactions or business activity that happens within any business entity. . The word
information should be viewed as the communicated results of the data as it has happened in
the business within a specified period of time. This information is used by decision makers to
support how they determine specific courses of action within the business. This course
introduces you to financial accounting in preparation for more advanced business topics
within the business major. Recording financial information in a standard format allows
managers, investors, lenders, stakeholders, and regulators to make appropriate decisions
regarding their respective interests. In this course, the formats of focus will be identified as
the Income Statement, the Balance Sheet, Statement of Cash Flows, and Statement of
Shareholders' Equity. In this course, you will learn how to compile and analyze these
financial statements, determine the value of a firm, and compare the firm to its competitors.

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1.1 UNIT OBJECTIVES

After reading this lesson, you should be able to

➢
Define accounting and trace the origin and growth of accounting.
➢
Distinguish between book-keeping and accounting.
➢
Explain the nature and objectives of accounting.
➢
Discuss the branches, role and limitations of accounting
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1.2 ORIGIN AND GROWTH OF ACCOUNTING

Accounting is as old as money itself. However, the act of accounting was not as
developed as it is today because in the early stages of civilisation, the numbers of transactions
to be recorded were so small that each businessman was able to record and check for himself
all his transactions. Accounting was practised in India twenty three centuries ago as is clear
from the book named "Arthashastra" written by Kautilya, King Chandragupta's minister. This
book not only relates to politics and economics, but also explains the art of proper keeping of
accounts. However, the modern system of accounting based on the principles of double entry
system owes it origin to Luco Pacioli who first published the principles of Double Entry
System in 1494 at Venice in Italy. Thus, the art of accounting has been practised for centuries
but it is only in the late thirties that the study of the subject 'accounting' has been taken up
seriously.
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1.3 MEANING OF ACCOUNTING

The main purpose of accounting is to ascertain profit or loss during a specified period,
to show financial condition of the business on a particular date and to have control over the
firm's property. Such accounting records are required to be maintained to measure the income
of the business and communicate the information so that it may be used by managers, owners
and other interested parties. Accounting is a discipline which records, classifies, summarises
and interprets financial information about the activities of a concern so that intelligent
decisions can be made about the concern. The American Institute of Certified Public
Accountants has defined the Financial Accounting as "the art of recording, classifying and
summarising in as significant manner and in terms of money transactions and events which in
part, at least of a financial character, and interpreting the results thereof". American
Accounting Association defines accounting as "the process of identifying, measuring, and
communicating economic information to permit informed judgements and decisions by users
of the information.

1.3.1 Attributes of accounting

(i) Recording: It is concerned with the recording of financial transactions in an

orderlymanner, soon after their occurrence In the proper books of accounts.
(ii) Classifying: It Is concerned with the systematic analysis of the recorded data so as
toaccumulate the transactions of similar type at one place. This function is performed by
maintaining the ledger in which different accounts are opened to which related transactions
are posted.

(iii) Summarising: It is concerned with the preparation and presentation of the

classifieddata in a manner useful to the users. This function involves the preparation of
financial statements such as Income Statement, Balance Sheet, Statement of Changes in
Financial Position, Statement of Cash Flow, and Statement of Value Added.

(iv)Interpreting: Nowadays, the aforesaid three functions are performed by electronic data
processing devices and the accountant has to concentrate mainly on the interpretation aspects
of accounting. The accountants should interpret the statements in a manner useful to action.
The accountant should explain not only what has happened but also (a) why it happened, and
(b) what is likely to happen under specified conditions.

1.3.2 Definition of Accounting

According to the American Institute of Certified Public Accounts (AICPA) “

Accounting is the art of recording, classifying and summarizing in a significant manner and
in terms of money transactions and events which are of financial character and interpreting
results thereof”.

This definition highlights in a logical sequence the different steps in the accounting process
and some important attribute of the accounting.

The first step in the cycle of accounting is to identify transactions that will find place
in books of accounts. Transactions having financial impact only are to be recorded. E.g. if a
businessman negotiates with the customer regarding supply of products, this will not be
recorded. The negotiation is a deal which will potentially create a transaction and will have
exchange of money or money’s worth. But unless this transaction is finally entered into, it
will not be recorded in the books of accounts.

Secondly, the recording of the business transactions is done based on the Golden
Rules of accounting (which are explained later) in a systematic manner. Transaction of
similar nature are grouped together and recorded accordingly. e.g. Sales Transactions,
Purchase Transactions, Cash Transactions etc. One has to interpret the transaction and then
apply the relevant Golden Rule to make a correct entry thereof.
 Thirdly, as the transactions increase in number, it will be difficult to understand the
combined effect of the same by referring to individual records. Hence, the art of accounting
also involves the step of summarizing them. With the aid of computers, this task is simplified
in today’s accounting world. The summarization will help users of the business information
to understand and interpret business results.

Lastly, the accounting process provides the users with statements which will describe
what has happened to the business. Remember the two basic questions we talked about, one
to know whether business has made profit or loss and the other to know the position of
resources that are used by the business. It can be noted that although accounting is often
referred to as an art, it is a science also. This is because it is based on universally applicable
set of rules. However, it is not a pure science as there is a possibility of different
interpretation.

1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Book-keeping is a part of accounting and is concerned with the recording of

transactions which is often routine and clerical in nature, whereas accounting performs other
functions as well, viz., measurement and communication, besides recording. An accountant is
required to have a much higher level of knowledge, conceptual understanding and analytical
skill than is required of the book-keeper. An accountant designs the accounting system,
supervises and checks the work of the book-keeper, prepares the reports based on the
recorded data and interprets the reports. Nowadays, he is required to take part in matters of
management, control and planning of economic resources.
Although in practice Accountancy and Accounting are used interchangeably yet there
is a thin line of demarcation between them. The word Accountancy is used for the profession
of accountants - who do the work of accounting and are knowledgeable persons. Accounting
is concerned with recording all business transactions systematically and then arranging in the
form of various accounts and financial statements. And it is a distinct discipline like
economics, physics, astronomy etc. The word accounting tries to explain the nature of the
work of the accountants (professionals) and the word Accountancy refers to the profession
these people adopt.
1.5 NATURE OF ACCOUNTING

The various definitions and explanations of accounting has been propounded by

different accounting experts from time to time and the following aspects comprise the nature
of accounting:
1.5.1 Accounting as a service activity
Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in making
economic decisions, in making reasoned choices among alternative courses of action. It
means that accounting collects financial information for the various users for taking decisions
and tackling business issues. Accounting in itself cannot create wealth though, if it produces
information which is useful to others, it may assist in wealth creation and maintenance.

1.5.2 Accounting as a profession Accounting is very much a profession.

A profession is a career that involve the acquiring of a specialised formal education
before rendering any service. Accounting is a systematized body of knowledge developed
with the development of trade and business over the past century. The accounting education
is being imparted to the examinees by national and international recognised the bodies like
The Institute of Chartered Accountants of India (ICAI), New Delhi in India and American
Institute of Certified Public Accountants (AICPA) in USA etc. The candidate must pass a
vigorous examination in Accounting Theory, Accounting Practice, Auditing and Business
Law. The members of the professional bodies usually have their own associations or
organisations, where in they are required to be enrolled compulsorily as Associate member of
the Institute of Chartered Accountants (A.C.A.) and fellow of the Institute of Chartered
Accountants (F.C.A.). In a way, accountancy as a profession has attained the stature
comparable with that of lawyer, medicine or architecture.

1.5.3 Accounting as a social force

In early days, accounting was only to serve the interest of the owners. Under the
changing business environment the discipline of accounting and the accountant both have to
watch and protect the interests of other people who are directly or indirectly linked with the
operation of modern business. The society is composed of people as customer, shareholders,
creditors and investors. The accounting information/data is to be used to solve the problems
of the public at large such as determination and controlling of prices. Therefore, safeguarding
of public interest can better be facilitated with the help of proper, adequate and reliable
accounting information and as a result of it the society at large is benefited.

1.5.4 Accounting as a language

Accounting is rightly referred the "language of business". It is one means of reporting
and communicating information about a business. As one has to learn a new language to
converse and communicate, so also accounting is to be learned and practised to communicate
business events. A language and accounting have common features as regards rules and
symbols. Both are based and propounded on fundamental rules and symbols. In language
these are known as grammatical rules and in accounting, these are termed as accounting
rules. The expression, exhibition and presentation of accounting data such as a numerals and
words and debits and credit are accepted as symbols which are unique to the discipline of
accounting.

1.5.5. Accounting as science or art

Science is a systematised body of knowledge. It establishes a relationship of cause
and effect in the various related phenomenon. It is also based on some fundamental
principles. Accounting has its own principles e.g. the double entry system, which explains
that every transaction has two fold aspect i.e. debit and credit. It also lays down rules of
journalising. So we can say that accounting is a science. Art requires a perfect knowledge,
interest and experience to do a work efficiently. Art also teaches us how to do a work in the
best possible way by making the best use of the available resources. Accounting is an art as it
also requires knowledge, interest and experience to maintain the books of accounts in a
systematic manner. Everybody cannot become a good accountant. It can be concluded from
the above discussion that accounting is an art as well as a science.

1.5.6 Accounting as an information system

Accounting discipline will be the most useful one in the acquisition of all the
business knowledge in the near future. You will realise that people will be constantly exposed
to accounting information in their everyday life. Accounting information serves both profit-
seeking business and non-profit organisations. The accounting system of a profit-seeking
organisation is an information system designed to provide relevant financial information on
the resources of a business and the effect of their use. Information is relevant and valuable if
the decision makers can use it to evaluate the financial consequences of various alternatives.
Accounting generally does not generate the basic information (raw financial data), rather the
raw financial data result from the day to day transactions of the business. As an information
system, accounting links an information source or transmitter (generally the accountant), a
channel of communication (generally the financial statements) and a set of receivers (external
users).

1.6 Objectives of Accounting

The Main objectives of accounting are maintaining a complete and systematic record
of all transactions and analyzing the financial position of a business. Every individual or a
business concern is interested to know the results of financial transactions and their results
are ascertained through the accounting process. A businessman can ascertain the operating
results and financial position of his business at any time through Accounting.

16.1 Identification and recording of transactions

The primary object of accounting is to identify the financial transactions and to record
these systematically in the books of accounts. As a result, the true nature of each and every
transaction is known without much exercise of memory. With this end in view the
transactions are primarily recorded in general and in a special journal and later on
permanently various accounts are kept in the ledger.

1.6.2 Ascertainment of results

Every business concern is interested to know its operating results at the end of a
particular period. The amount of profit or loss for a particular period of a business concern
can be ascertained by preparing income statement with the help of ledger account balances of
revenue nature. Surplus or deficit of revenue for a particular period of a non-trading concern
can also be ascertained by preparing income and expenditure account or statement.

1.6.3 Ascertainment of financial affairs

Ascertainment of debts-liabilities, property, and assets i.e. total financial affairs of an
organization at a particular date is another important object of Accounting.
 Financial affairs of a concern at a particular date can be ascertained by preparing a
balance sheet. The balance sheet is the statement of assets and liabilities of a concern at a
particular date.

1.6.4 Keeping accounts of cash

Cash book is a prominent book of the books of accounts. Cash receipts and cash
payments are accounted for in this book. A number of daily cash receipts, payments, cash in
hand and cash at the bank can be known from this book. Fraud, forgery, and misappropriation
of money are reduced by keeping cash book scientifically and accurately.

1.6.5 Control over assets and liabilities

For running a business successfully a businessman is to acquire various assets like
land, building, machinery etc. He is to face various debts and liabilities like accounts payable,
notes payable, loan, bank overdraft etc. side by side with die acquisition of assets. The actual
position of these debts-liabilities, property, and assets can be ascertained through the proper
keeping of accounts. A businessman can take the right steps for controlling the quantity of
assets decrease and liability increase.

1.6.6 Controlling money defalcation and cost

Prevention of money defalcation through fraud and forgery and controlling of the cost
of a concern are also the main objects of Accounting. Prevention of money defalcation and
cost control become easier if accounts are kept scientifically.

1.6.7 Providing economic data

Another noble object of Accounting is to provide the concerned parties with all
economic information preparing financial statements and reports etc. in time.

1.6.8 Helping tax fixation

Accounts prepared on the basis of accepted accounting principles in considered
reliable to the income tax and VAT authorities for easy determination and settlement of tax
and VAT.
1.6.9 Determination and evaluation of policy
The object of Accounting is to help the management in determining and evaluating
the management policies in running the business successfully by supplying necessary,
information, interpreting and analyzing the financial statements.

1.6.10 Testing the arithmetical accuracy of accounts

One of the main objects of scientific methods of accounting is to make sure that
accounts have been kept in a proper way. The arithmetical accuracy of accounts kept in the
ledger can be assured by preparing a trial balance. Agreement of a trial balance is the proof of
the arithmetical accuracy of accounts. The advantage in taking loan’s Due to insufficiency of
capital, borrowing capital from outsiders is felt necessary to run a business. Loan givers are
not willing to give a loan without knowing the financial position of a business. Financial
statement of a business concern reflects the solvency or loan repayment capability of that
concern.

1.6.11 Acceptability to others

Banks or financial institutions are interested to know the accurate financial position of
a business concern for sanctioning loans. On the other hand, government or other authorities
may also ask about the financial position of a business concern for various reasons. In these
cases the accounts maintained in a disciplined way become easily acceptable to the interested
institutions or authorities.

1.6.12 Creation of values and accountability

The object of accounts maintained in an acceptable way is to create higher values
among individuals and organizations and thereby creating awareness in preventing money
defalcation, misappropriation of fund and cost control by ensuring transparency and
accountability.

1.6.13 Following legal bindings and prohibition

As all kinds of business organizations have to abide by some legal bindings and prohibitions,
they are to maintain their accounts accurately.
1.7 Advantages of Accounting

1.7.1 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
cannot keep all transactions in mind, is overcome by accounting because each and every
business transaction can be recorded and analyzed through same.

1.7.2 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.

1.7.3 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.

1.7.4 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.

1.7.5 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 evidence in the
court of law.
1.7.6 Incompliance 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.

1.7.7 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.

1.7.8 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.

1.7.9 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.

1.8 LIMITATIONS OF ACCOUNTING

1.8.1 Ignores qualitative aspects of transactions

Business Transactions which are of monetary nature only find a place in accounting.
Transactions which not related to money do not find a page in accounting. It ignores
qualitative elements like management reputation, employee morale, labour strike etc.
1.8.2 Biased accounting information
 Another limitation of accounting results are based on the information provided to it.
The management may be biased and feed manipulative data to confirm its point view. An
accountant can reveal the result of business, as wanted by the owners of the business. This
may be done by erasing certain accounts, increasing or diminishing the amounts of specific
accounts, under-estimating or over-estimating the value of assets. For example, a purchase of
furniture has appeared as a purchase of goods this will reduce the profit.

1.8.3 Ignorance about the present value of business

While keeping the books of accounts of an ongoing concern i.e., the business will be
carried on for an indefinite period. With this standard in view, we show the value of our
assets in the balance sheet at its book value, not at the market value. Sometimes certain assets
might be valueless in the market but yet we keep on showing it in the books of accounts.
Hence, accounting fails to reveal the present value of the business concern.

1.8.4 Inexactness

Accounting evaluates profit or loss of the business on the basis of the real and planned
estimates. Accountants make the valuation of the stock, determine the method of depreciation
and maintain various provisions in any way, they like. Different firms have their own
different methods of providing depreciation and valuation of the stock. Hence, the results of
the business will change with the adjustment in the practice.

1.9 TYPES OF ACCOUNTING

The financial literature classifies accounting into two broad categories, viz, Financial
Accounting and Management Accounting. Financial accounting is primarily concerned with
the preparation of financial statements whereas management accounting covers areas such as
interpretation of financial statements, cost accounting, etc. Both these types of accounting are
examined in the following paragraphs.
1.9.1 Financial accounting

As mentioned earlier, financial accounting deals with the preparation of financial

statements for the basic purpose of providing information to various interested groups like
creditors, banks, shareholders, financial institutions, government, consumers, etc. Financial
statements, i.e. the income statement and the balance sheet indicate the way in which the
activities of the business have been conducted during a given period of time. Financial
accounting is charged with the primary responsibility of external reporting. The users of
information generated by financial accounting, like bankers, financial institutions, regulatory
authorities, government, investors, etc. want the accounting information to be consistent so as
to facilitate comparison. Therefore, financial accounting is based on certain concepts and
conventions which include separate business entity, going concern concept, money
measurement concept, cost concept, dual aspect concept, accounting period concept,
matching concept, realization concept and conventions of conservatism, disclosure,
consistency, etc. All such concepts and conventions would be dealt with detail in subsequent
lessons.

The significance of financial accounting lies in the fact that it aids the management in
directing and controlling the activities of the firm and to frame relevant managerial policies
related to areas like production, sales, financing, etc. However, it suffers from certain
drawbacks which are discussed in the following paragraphs. The information provided by
financial accounting is consolidated in nature. It does not indicate a break-up for different
departments, processes, products and jobs. As such, it becomes difficult to evaluate the
performance of different sub-units of the organisation. Financial accounting does not help in
knowing the cost behaviour as it does not distinguish between fixed and variable costs. The
information provided by financial accounting is historical in nature and as such the
predictability of such information is limited.
The limitations of financial accounting, however, should not lead one to believe that it
is of no use. It is the basic foundation on which other branches and tools of accounting
analysis are based. It is the source of information, which can be further analysed and
interpreted according to the tailor-made requirements of decision-makers.

1.9.2 Management accounting

Management accounting is ‘tailor-made’ accounting. It facilitates the management by

providing accounting information in such a way so that it is conducive for policy making and
running the day-to-day operations of the business. Its basic purpose is to communicate the
facts according to the specific needs of decision-makers by presenting the information in a
systematic and meaningful manner. Management accounting, therefore, specifically helps in
planning and control. It helps in setting standards and in case of variances between planned
and actual performances, it helps in deciding the corrective action. An important
characteristic of management accounting is that it is forward looking. Its basic focus is one
future activity to be performed and not what has already happened in the past. Since
management accounting caters to the specific decision needs, it does not rest upon any well-
defined and set principles. The reports generated by a management accountant can be of any
duration– short or long, depending on purpose. Further, the reports can be prepared for the
organisation as a whole as well as its segments.

1.9.3 Cost accounting

One important variant of management accounting is the cost analysis. Cost

accounting makes elaborate cost records regarding various products, operations and
functions. It is the process of determining and accumulating the cost of a particular product or
activity. Any product, function, job or process for which costs are determined and
accumulated, are called cost centres. The basic purpose of cost accounting is to provide a
detailed breakup of cost of different departments, processes, jobs, products, sales territories,
etc., so that effective cost control can be exercised. Cost accounting also helps in making
revenue decisions such as those related to pricing, product-mix, profit-volume decisions,
expansion of business, replacement decisions, etc.

The objectives of cost accounting, therefore, can be summarized in the form of three
important statements, viz, to determine costs, to facilitate planning and control of business
activities and to supply information for short- and long-term decision. Cost accounting has
certain distinct advantages over financial accounting. Some of them have been discussed
succeeding. The cost accounting system provides data about profitable and non-profitable
products and activities, thus prompting corrective measures. It is easier to segregate and
analyse individual cost items and to minimize losses and wastages arising from the
manufacturing process. Production methods can be varied so as to minimize costs and
increase profits. Cost accounting helps in making realistic pricing decisions in times of low
demand, competitive conditions, technology changes, etc. Various alternative courses of
action can be properly evaluated with the help of data generated by cost accounting. It would
not be an exaggeration if it is said that a cost accounting system ensures maximum utilization
of physical and human resources. It checks frauds and manipulations and directs the
employer and employees towards achieving the organisational goal.
1.10 TYPES OF ACCOUNTS

There are mainly three types of accounts in accounting: Real, Personal and
Nominalaccounts

1.10.1 Real Accounts

➢ All assets of a firm, which are tangible or intangible, fall under the
category “Real Accounts“.

➢ Tangible real accounts are related to things that can be touched and felt
physically.Few examples of tangible real accounts are building, machinery, stock,
land, etc.

➢ Intangible real accounts are related to things that can’t be touched and
feltphysically. Few examples of such real accounts are goodwill, patents, trademarks,
etc.

1.10.1.1 Golden rule for real accounts

➢
Debit what comes in
➢
Credit what goes out

1.10.2 Personal Accounts

These accounts are related to individuals, firms, companies, etc. A few examples of
personal accounts include debtors, creditors, banks, outstanding/prepaid accounts, accounts
of credit customers, accounts of goods suppliers, capital, drawings, etc.

1.10.2.1 Natural personal accounts

This type of personal accounts is the simplest to understand out of all and includes all
of God’s creations who have the ability to deal, who, in most cases, are people. E.g. Kumar’s
A/C, Adam’s A/C, etc

1.10.2.2 Artificial personal accounts

Personal accounts which are created artificially by law, such as corporate bodies and
institutions, are called Artificial personal accounts. E.g. Pvt Ltd companies, LLCs, LLPs,
clubs, schools, etc.
1.10.2.3 Representative personal accounts

Accounts which represent a certain person or a group directly or indirectly. E.g. Let’s
say that wages are paid in advance to an employee – a wageprepaid account will be opened in
the books of accounts. This wages prepaid account is a representative personal account
indirectly linked to the person.

1.10.2.4 Golden rule for personal accounts

➢
Debit the Receiver
➢
Credit the Giver

1.10.3 Nominal Accounts

Accounts which are related to expenses, losses, incomes or gains are called Nominal
accounts. The dictionary meaning of the word “nominal” is “existing in name only” and the
meaning remains absolutely true in accounting sense too, because nominal accounts do not
really exist in physical form, but behind every nominal account money is involved. E.g.
Purchase A/C, Salary A/C, Sales A/C, Commission received A/C, etc.

The final result of all nominal accounts is either profit or loss which is
then transferred to the capital account.

1.10.3.1 Golden rule for nominal accounts

➢ Debit all expenses and losses

➢ Credit all Incomes and Gains

1.11 METHODS OF ACCOUNTING

There are several types of accounting that range from maintaining records, auditing to
preparing income tax returns. Accounting professional trend to specialize in one of these field
as their career option as accountant.
1.11.1 Financial Accounting

Under this accounting, primary focus is towards accuracy of financial data towards
external reports. Accounting professionals with specialized in external reporting requires in-
depth knowledge on accounting framework like IFRS (International Financial Reporting
Standards), GAAP (Generally Accepted Accounting Principles), or government standards of
the country such as Securities and Exchange Commission of USA, Securities and Exchange
Board of India, etc. There is likewise regulator track, which requires join awareness of
management and financial accounting. Financial accounting is one of the common branches
of accounting.

1.11.2 Management Accounting

These branches of accounting are maintained by companies only for internal

purposes. It’s in-depth information about company rather than the information available to
the public. This information is use by an organisation to control and define strategic goals.
Data may be used to structure budget planning, forecasts, organisation goals. Such types of
accounting are maintained purely for the purpose of companies management strategic
decisions.

1.11.3 Cost Accounting

Management accounting is further divided into cost accounting. Main purpose to

maintain a cost accounting technique is to control and monitor effective cost of production.
Such branches of accounting are mostly preferred by manufacturing companies for
controlling and maintaining costs.

1.11.4 Public Accounting

Under this type of accounting, primary objective is to examine the financial

statements and supporting documents of client companies. This assures that financial
proclamations collected by customers genuinely exhibit financial position of an entity.
Professionals who are involved in public accounting required in-depth knowledge on
accounting frameworks and reviewing type of personality to become an audit partner.

1.11.5 Government Accounting

It’s one of the branches of accounting system which manages funds uniquely. It is
also known as federal accounting. Time to time disbursement of cash for various
expenditures offered on account of governmental services. These services are requested by a
government entity. Governmental Accounting also maintains accounts for public sector
companies. This financial and performance overview assist government in budgetary and
various other decisions, Professionals need to have various different skill sets and specialized
accounting within this area to accomplish government accounting.

1.11.6 Forensic Accounting

These types of accounting techniques are followed for examining and investigating
disputed or lawsuit cases. Forensic Accounting plays a role of witnesses in courts of law for
financial criminal or financial disputes cases. These accounting assess financial effect of loss
or detection of financial fraud. Specialized forensic accountants are hired for cases like
damage claims, insurance claims, suspect fraud and claims, business valuations or any other
finance related matters.

1.11.7 Tax Accounting

All tax related matters are categorized into Tax Accounting. It is represented by the
assessment rules recommended by the countries tax laws. Tax accounting rules, standards
and principles are different than financial statement prepared for public reviews.
Professionals with tax accountants then perform adjustments into financial statements with
implementing standards and principles of tax accounting described under countries tax laws.
This information is afterwards used for tax estimation and tax planning.

1.11.8 Project Accounting

Under these branches of accounting, financial reports and financial statements are
been prepared to track the progress of the project. One of the main components of project
management is to maintain project accounting. This will assist management in various
decision making steps. Project accounting is the specialized branch of management
bookkeeping focusing primarily on success of new launched projects. Those companies who
want to keep track on projects rely on Project accounting for example: construction projects,
road projects, bridge projects, rail projects, etc.

1.11.9 Social Accounting

A corporate Social Responsibility Reporting or Sustainability Accounting term refers

to social branches of accounting. Primarily objective of organization’s behind implementing
social accounting is to track environmental reports. Organization looks forward for social and
ecological environmental reports. Social accounting is a new types of accounting followed by
organizations these days. It is still under phases of improvement. Considering growing
awareness about environment among public has lead organizations to maintain such kind of
accounts.

1.12 METHODS OF ACCOUNTING SYSTEM

Basically all methods of accounting are classified under two categories:

1. Single entry system

2. Double entry system

1.12.1 Single entry system

Single entry accounting systems record only one side of every transaction, this happens
because they use one entry to record every transaction. Therefore single entry system does
not use nominal and real accounts. The emphasis is on cash and accounts receivable. Single
entry system is used by small firms that have just started business. Such firms do not have the
resources that are required to put up a full-fledged accounting system in place. Hence they
begin with a single entry accounting system. However as and when their business grows most
firms are compelled to adopt the double entry system. This is because the single entry system
is highly inefficient and can be used only by sole proprietors when the scale of business is
very small and the transactions to be undertaken are not very complicated.

1.12.1.1 Incomplete Records

The biggest problem with single entry bookkeeping system is that of incomplete
records. Single entry system records only transactions that the firm is undertaking with
external parties. There are numerous transactions within the firm that are of vital importance
and need a place in the financial statements. However, the single entry system ignores these
needs and gives incomplete information to the management.

1.12.1.2 No Reconciliation

Single entry accounting system does not have provisions for reconciliation of
accounts. This means that the system does not have inbuilt error detection. Therefore, if a
clerk is doing the task of making entries in the book, the system may be prone to clerical
errors. This could lead to management having insufficient information or no information
when they have to make decisions.

1.12.1.3 Possibility of Fraud

Single entry accounting system is highly prone to frauds and embezzlement. There is only
one book of account rather than an elaborate accounting system. Hence, the internal checks
are few. In fact they are non-existent. The person making the accounts could single handily
manipulate the books of accounts and misappropriate the resources of the firm.

1.13 DOUBLE ENTRY SYSTEM

Accounting is an art of recording, classifying and summarizing the transactions of financial

nature measurable in terms of money and interpreting the results thereof. Two methods for
accounting are Single Entry System and Double Entry System. Mostly, we convert to Double
Entry for better accounting purposes. Double Entry System of accounting deals with either two or
more accounts for every business transaction. For instance, a person enters a transaction of
borrowing money from the bank. So, this will increase the assets for cash balance account and
simultaneously the liability for loan payable account will also increase. It’s a fundamental
concept encompassing accounting and book-keeping in present times. Every financial transaction
has equal and opposite effect in at least two different accounts.

Equation can be: ASSETS = LIABILITIES + EQUITY

Double entry system records the transactions by understanding them as a Debit items or
Credit Items. A debit entry in one account gives opposite effect in another account by credit entry.
This means that the sum of all Debit accounts must be equal to the sum of Credit accounts. This
method of accounting and book-keeping results in the accurate depiction of financial statements, thus,
it also lowers the rate of errors by detecting them on a timely basis.

1.13.1. Debit and Credit

Debits and Credits are essentials to enter data in a double entry system of accounting
and book-keeping. While posting an accounting entry, an entry on the left side of the account
ledger is a debit entry and right side entry is a credit entry.
 Finally, to complete an entry the total of the Debit side and the Credit side should be
equal. All debits do not always equate to increase the account nor do all credits equate to
decrease the accounts. A debit entry might increase one account and at the same time
decrease another account.

➢
The word Debit is derived from Latin word Debitum means Due for that. In short, the
benefit receiving aspect of a transaction is known as debit.

➢
The word Credit is derived from the Latin word Creder which means Due to that. The
benefit giving aspect of a transaction is known as credit.

The abbreviations Dr for debit and Cr for Credit are usually used.

1.13.2 Advantages of double entry system of book-keeping

1.13.2.1 Scientific

The double-entry book-keeping system is a scientific system of book-keeping. Double-entry

system has its own set of principles and rules. Under those principles and rules, two aspects
of every financial transaction are recorded.

1.13.2.2 Systematic

A systematic technique is followed in recording financial transaction in double-entry book-

keeping system. It records financial transactions in a systematic and chronological order with
suitable narration of the financial transaction.

1.13.2.3 Complete

Double-entry system is a complete system of book-keeping. It records not only each and
every financial transaction, but also each aspect of the transaction.

1.13.2.4 Accuracy

Double-entry book-keeping system is based on the double-entry principle which

means ' for every debit amount there is a corresponding credit amount'. Such a method of
debit and credit can help ensure arithmetical accuracy of the recordings of financial
transactions.
1.13.2.5 Profit or Loss

Double-entry book-keeping system helps to ascertain the true profit or loss of a

business by preparing the profit and loss account for a given period.

1.13.2.6 Financial Position

Double-entry book-keeping system also helps to reveal information about the

financial position of the business by preparing a statement called balance sheet.

1.13.2.7 Control

Double-entry book-keeping system keeps a detailed record of financial transactions.

Therefore, the recording of financial transactions in books provides necessary information for
the purpose of costs control.

1.13.2.8 Decision Making

Double-entry book-keeping system communicates financial information that

is necessary for taking decisions by a business. Double-entry book-keeping system also
provides necessary information to different users such as owners, managers and creditors for
their decision making purposes.

1.14 ANSWER TO “CHECK YOUR PROGRESS”

1. What is accounting?
2. What are the objectives of Accounting?
3. What is Book-Keeping?
4. What do you understand by Debit and Credit?
5. Describe the three kinds of personal Accounts?
6. What is accounting? What is the need for it?
7. Explain the steps in process of Accounting in detail
8. Briefly describe various Branches of Accounting.
9. Explain the methods of Accounting

1.15 FURTHER READING

1. S.N.Maheswari, Advanced Accountancy

2. R.L.Gupta, Advanced Accountancy
3. T.S.Reddy and A.Murthy, Financial Accounting
4. M.C.Sukhla and T.S.Gfrewal, Advanced Accounting
2.0 INTRODUCTION

A widely accepted set of rules, conventions, standards, and procedures for reporting financial
information, as established by the Financial Accounting Standards Board are called Generally Accepted
Accounting Principles (GAAP). These are the common set of accounting principles, standards and procedures
that companies use to compile their financial statements. GAAP are a combination of standards (set by policy
boards) and simply the commonly accepted ways of recording and reporting accounting information. GAAP is
to be followed by companies so that investors have a optimum level of consistency in the financial statements
they use when analyzing companies for investment purposes. GAAP cover such aspects like revenue
recognition, balance sheet item classification and outstanding share measurements.

2.1 UNIT OBJECTIVES

➢
Introduction
➢
Meaning of accounting principles
➢
Features of accounting principles
➢
Necessity of accounting principles
➢
Basic accounting concepts and Conventions

2.2 ACCOUNTING CONCEPTS AND CONVENTIONS

The accounting information is published in the form of financial statements. The three basic
financial statements are :

(i) The Profit & Loss Account that shows net business result i.e. profit or loss for a
certain periods

(ii) The Balance Sheet that exhibits the financial strength of the business as on a
particular dates

(iii) The Cash Flow Statement that describes the movement of cash from one date to
the other.

As these statements are meant to be used by different stakeholders, it is necessary that

the information contained therein is based on definite principles, concrete concepts and well
accepted convention.

Accounting principles are basic guidelines that provide standards for scientific accounting
practices and procedures. They guide as to how the transactions are to be recorded and
reported. They assure uniformity and understandability. Accounting concepts lay down the
foundation for accounting principles. They are ideas essentially at mental level and are self-
evident. These concepts ensure recording of financial facts on sound bases and logical
considerations. Accounting conventions are methods or procedures that are widely accepted.
When transactions are recorded or interpreted, they follow the conventions. Many times,
however, the terms-principles, concepts and conventions are used interchangeably.

Professional Accounting Bodies have published statements of these concepts. Over

years, many of these concepts are being challenged as outlived. Yet, no major deviations
have been made as yet. Path breaking ideas have emerged and the accounting standards of
modern days do require companies to record and report transactions which may not be
necessarily based on concepts that are in vogue for long. It is essential to study accounting
from the basic levels and understand these concepts in entirety.

2.2.0 Theory Base of Accounting

All the stakeholders of the accounting information of any firm, require it to be

accurate, reliable and most importantly, comparable. This can be achieved only if there is
uniformity in accounting policies and rules that are followed by various firms. This
consistency is essential throughout the process of accounting, right from identification to
summarizing and reporting of the information. Hence, the need for a theory base of
accounting is evident. The theory base of accounting includes principles, concepts, rules and
guidelines, which are developed over a period of time to bring consistency to the process of
accounting and better its utility to its stakeholders.

In addition to this, ICAI (Institute of Chartered Accountants of India), the regulatory

body for standardization of accounting policies in India, has issued a set of accounting
standards, which are expected to be abided by all, for the purpose of bringing consistency in
the accounting practices.

Theory Base of Accounting: Generally Accepted Principles

The Generally Accepted Accounting Principles (GAAP) refer to the rules or

guidelines adopted for recording and reporting of business transactions, in order to bring
uniformity and consistency in the preparation and the presentation of financial statements.
These principles of accounting are not static in nature and are constantly influenced by the
social, legal and economic environment surrounding the firms and the system.
2.2.1 Theory Base of Accounting: Basic Concepts

There concepts are primarily the fundamental ideas underlying the theory base of
accounting and hence can be considered as broad working rules for all accounting activities.
These concepts are as under:

2.2.1.1 Business Entity Concept

The concept of business entity states that a firm or business is a distinct entity from its
owners. Hence, for the purpose of accounting, the business and its owners are treated as two
different persons. Therefore, when an owner brings in capital into the business, it is treated as
a liability of the business. Also, the accounting records are made from the point of view of
the firm and not the owner. Likewise, the personal assets and liabilities of the owners are not
to be considered while reporting for the business.

2.2.1.2 Money Measurement Concept

The concept of money measurement relates to those transactions of a business, which

can be recorded in terms of money in the books of accounts. The records of the same are to
be kept not in physical, but monetary units alone. All the assets are hence shown in monetary
terms for accounting purposes. There are some limitations to this concept. Owing to the
changes in prices, the value of money does not remain consistent over time. As this change
does not reflect in the books of accounts, the accounting data does not show a true and fair
view of the actual scenario.

2.2.1.3 Going Concern Concept

This concept states that a business firm will carry on its business for an indefinite
period of time and would not be liquidated at any pre-decided point of time. In simple terms,
it will go on forever. This is an important concept as it offers the fundamental basis for
projecting the value of assets in the balance sheet.

This assumption regarding the continuity of the business necessitates us to charge

from the revenue (for any asset bought and used), only that part of the asset which has been
consumed or used, and the remaining is carried forward to the next year. If the continuity
assumption did not exist, the whole cost of the asset would have been charged from the
revenue of the year in which it was purchased.
2.2.1.4 Accounting Period Concept
Accounting period is the span of time at the end of which, the financial statements of
a firm are prepared, to assess its profits and losses, and to understand the position of its assets
and liabilities. This is essential for easy availability of information to the users of the
accounting information in a timely manner. Therefore, the financial statements are prepared
at regular intervals, usually a period of one year. In certain cases, interim statements to are
prepared if need be.

2.2.1.5 Cost Concept

This concept necessitates that all the assets must be recorded in the books of accounts
at the price at which they were purchased, which includes the cost incurred for acquisition,
transportation and installation (along with any other costs required to make the assets fit for
use). The cost concept is historical in nature as the respective amount pertaining to the asset
is paid on the date of acquisition and does not change year after year. This brings in
objectivity in the records as the costs are easily verifiable from the purchase documents. The
market value basis, in contrast, is more complex since the value keeps changing, thus making
comparisons between different periods difficult. The negative side to this concept is that the
true worth of the business is not clear and this may lead to hidden profits.

2.2.1.6 Dual Aspect Concept

This concept highlights that every transaction has a two-fold effect and hence, must
be recorded at two places. In simpler words, at least two accounts are will be involved in the
recording of any transaction. This is also referred to as duality principle, which can be
simplified as:

Assets =Liabilities + Capital

Therefore, the assets of a business are always equal to the sum of owners’ capital and
outsiders’ claims. This equation ensures that the equality on both sides is maintained. This
concept forms the core of the Double Entry System of Accounting.

2.2.1.7 Revenue Recognition (Realization) Concept

This concept necessitates that revenue from any business transaction should be
recorded only when it is realized. Revenue is the gross inflow of cash arising from the sale of
goods and services and any use of the enterprise’s resources yielding interest, royalties or
dividends. Revenue is realized when a legal right to receive arises (that is, when goods are
sold or services are rendered). Thus, credit sales are considered to be revenue on the day the
sale is made, and not when the money is transferred.

2.2.1.8 Matching Concept

For assessment of the profits earned or the losses incurred, expenses are deducted from the
revenue of a particular period. The matching concept says that the expenses incurred in any
accounting period must be matched with the revenues of the same period. Thus, the revenues
and the expenses incurred to earn these revenues must belong to the same time period. Like
revenues, an expense is considered to be incurred, not when the money is paid but when the
asset has been used to generate revenues.

2.2.1.9 Full Disclosure Concept

The accounting information provided by financial statements has many stakeholders
like investors, creditors, debtors, etc. These statements therefore need to make full and fair
disclosure of all the information which may be relevant to any of the stakeholders to make
any financial decisions. This enables its users to make correct assessment about the risks,
opportunities and the overall financial soundness of the enterprise.

2.2.1.10 Consistency Concept

The accounting information from the financial statements is used for inter-firm and
intra-firm comparisons. Therefore, the accounting policies and practices compulsorily need to
be consistent over a period of time. This helps in eliminating personal bias and assists in
achievement of comparable results.

2.2.1.11 Conservatism Concept

This concept states that a conscious effort should be made for ascertaining the income
of a firm in order to ensure that the profits are not overstated or understated. Hence, this
concept mandates that the profits should not be recorded unless realized and the losses should
be anticipated and recorded henceforth. This is necessary for dealing with uncertainty and
protecting the interests of creditors against unwanted distribution of firm’s assets.

2.2.1.12 Materiality Concept

This concept necessitates that the books of accounts should only focus on the materialistic
aspect. All immaterial information should be ignored. The materiality of a fact depends on its
nature and the money involved. Any fact is considered material if its knowledge influences
the decisions of its users. All such materialistic information must be disclosed for the
facilitation of its users.

2.2.1.13 Objectivity Concept

This concept requires the recording of transactions to be highly objective. Hence, each
transaction must necessarily be supplemented with the required documents for verification
purposes. This helps in verifying the actual costs of assets via means of the documents.
Ascertaining assets’ market value is difficult, and hence, using market value basis will lead to
compromising on the information’s objectivity.

2.3 ACCOUNTING CONVENTIONS

Conventions in accounting have been evolved and developed to bring about

uniformity in the maintenance of accounts. 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.

Following are the important accounting conventions in use:

2.3.1 Convention of Disclosure

This convention requires that accounting statements should be honestly prepared and
all significant information should be disclosed therein. That is, while making accountancy
records, care should be taken to disclose all material information. Here the emphasis is only
on material information and not on immaterial information. This convention assumes greater
importance in respect of corporate organisations where the management is divorced from
ownership. That is why forms of Balance Sheet and Profit and Loss accounts are prescribed
in Schedule VI of the Companies Act, 1956; so that significant information may not be left
out to be disclosed.

The purpose of this convention is to communicate all material and relevant facts of
financial position and the results of operations, which have material interests to proprietor,
creditors and investors. Sometimes, there may be time gap between the preparation of
Balance Sheet and its publication and if there are material events — bad debts, destruction of
plant or machinery etc., which occurred in the time gap, may also be known to users
proprietors, creditors etc. In short, full disclosure of all relevant facts in accounts is a
necessity in order to make accounting record useful. Therefore, full disclosure is a very
healthy convention, and is important.

2.3.,2 Convention of Consistency

Rules and practices of accounting should be continuously observed and applied. In
order to enable the management to draw conclusions about the operation of a company over a
number of years, it is essential that the practices and methods of accounting remain
unchanged from one period to another. Comparisons are possible only if a consistent policy
of accounting is followed. If there are frequent changes in the treatment of accounts there is
little or no scope for reliability. Comparison of accounting period with that in the past is
possible only when the convention of consistency is adhered to. According to Anthony, “the
consistency requires that once a company had decided on one method, it will treat all
subsequent events of the same character in the same fashion unless it has a sound “reason to
do otherwise.”

This convention plays its role particularly when alternative accounting practice is
equally acceptable. Moreover, consistency serves to eliminate personal bias. But if a change
becomes desirable, the change and its effect should be clearly stated in the financial
statements. Accounts should lend themselves easily to comparisons and contrasts. This
convention increases accuracy and comparability of accounting information for prediction or
decision making. This convention does not prohibit changes. If there is any change, its effect
should be clearly stated in the financial statements.

2.3.3 Convention of Conservatism

“Anticipate no profit and provide for all possible losses” is the essence of this
convention. Future is uncertain. Fluctuations and uncertainties are not uncommon.
Conservatism refers to the policy of choosing the procedure that leads to understatement as
against overstatement of resources and income. The consequences of an error of
understatement are likely to be less serious than that of an error of overstatement. For
example, closing stock is valued at cost or market price whichever is lower. This is a
convention of caution or playing safe and is adhered to while preparing financial statements.
Showing a position better than what it is, is not permitted. Moreover, it is not proper to show
a position substantially worse than what it is.
Following are the examples:

(a) The value of an asset should not be overestimated.

(b) The value of a liability should not be underestimated.

(c) The profit should not be overestimated.

(d) The loss should not be underestimated.

Such conservatism is generally accepted to present a true and fair value of business in
the financial statements.

2.3.4 Convention of Materiality:

American Accounting Association defines the term materiality as “An item should be
regarded as material if there is reason to believe that knowledge of it would influence the
decision of informed investor.” It refers to the relative importance of an item or event.
Materiality of an item depends on its amount and its nature. Theoretically, all items, large or
small, should be treated alike. Materiality convention implies that the economic significance
of an item will to some extent affect its accounting treatment. Materiality in its essence is of
relative significance. In the sense that some of the unimportant items are either left out or
included with other items. For instance, acquisition of items like fountain pen, stapler, pin
cushion, punching machine etc., can be treated as part of assets, when considering their
durability and span of life. But, it is not necessary to maintain separate ledgers. Such low cost
items can be treated as expense for the period. Therefore, unimportant items are either left out
or merged with other items. The reason for this different treatment lies in the magnitude of
their amount. The dividing line between material and immaterial varies according to the
company, the circumstances of the transactions and economic significance. It should also be
noted that an item considered to be material for one business firm, may be immaterial for
another firm.

Similarly, an item of material in a year may not be material in the subsequent years.
Similarly, most of the companies publish their financial statements in whole rupees round
figures, by ignoring paise. Omission of paise is immaterial, i.e., insignificant when figures
appear in lakhs. In short, all material information should be disclosed that is necessary to
make the financial statements clear and understandable.
 2.4ACCOUNTING STANDARDS

Accounting standard is a method or an approach established and issued by recognized

expert accountancy body. It is used in preparing financial statement viz., Profit & Loss
Account and Balance Sheet of various concerns operating different fields. The main purpose
of formulating accounting standard is to standardize the diverse accounting policies with
views eliminating to the extent possible the incomparability of information provided in
financial statements within or across the organization. So that the users of aforesaid
statements don’t get confused while evaluating the results to take various decisions viz., to
subscribe in equality shares, or subscribe in debenture of that concern. To discuss on whether
such standards are necessary in present days it will be beneficial to go through the advantages
and disadvantages which they are said to provide.

2.4.1 ADVANTAGES OF ACCOUNTING STANDARD

1. It provides the accountancy profession with useful working rules.

2. It assists in improving quality of work performed by accountant.
3. It strengthens the accountant’s resistance against the pressure from directors to use
accounting policy which may be suspected in that situation in which they perform their
work.
4. It ensures the various users of financial statements to get complete crystal information on
more consistent basis from period to period.
5. It helps the users compare the financial statements of two or more organisaitons engaged in
same type of business operation.

2.4.2 DISADVANTAGES OF ACCOUNTING STANDARD

1. Users are likely to think that said statements prepared using accounting standard are
infallible.
2. They have been derived from social pressures which may reduce freedom.
3. The working rules may be rigid or bureaucratic to some user of financial statement.
4. The more standards there are, the more costly the financial statements are to produce.
 Accounting Title of Accounting Standard
Standard No.
Mandatory Standards
AS-1 Disclosure of Accounting Policies
AS-2 Valuation of Inventories(Revised)
AS-3 Cash Flow Statement
AS-4 Contingencies and Events Occurring after the Balance Sheet Date
AS-5 Net Profit or Loss for the Period, Prior Period Items and Change in
Accounting Policies
AS-6 Depreciation Accounting
AS-7 Construction Contracts
AS-8 Accounting for Research and Development (withdrawn)
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 Effects of Changes in Foreign Exchange Rates
AS-12 Accounting for Government Grants
AS-13 Accounting for Investments
AS-14 Accounting for Amalgamation
AS-15 Employee Benefits
AS-16 Borrowing Costs
AS-17 Segment Reporting
AS-18 Related Party Disclosure
AS-19 Accounting for Leases
AS-20 Earnings Per Share
AS-21 Consolidated Financial Statements
AS-22 Accounting for Taxes on Income
AS-23 Accounting for Investment in Associates in Consolidated Financial
Statements
AS-24 Discontinuing Operations
AS-25 Interim Financial Reporting
AS-26 Intangible Assets
AS-27 Financial Reporting of Interest in Joint Venture
AS-28 Impairment of Assets
AS-29 Provisions, Contingent Liabilities and Contingent Assets
Non-Mandatory Standards
AS-30 Financial Instruments: Recognition and Measurement
AS-31 Financial Instruments: Presentation
AS-32 Financial Instruments: Disclosures

This standard deals with disclosure of significant accounting policies followed in the
preparation and presentation of the financial statements and is mandatory in nature. The
accounting policies refer to the specific accounting principles adopted by the enterprise.

Proper disclosure would ensure meaningful comparison both inter/intra enterprise and
also enable the users to properly appreciate the financial statements. Financial statements are
intended to present a fair reflection of the financial position financial performance and cash
flows of an enterprise.

Areas involving different accounting policies by different enterprises are:

• Methods of depreciation, depletion and amortization
• Treatment of expenditure during construction
• Treatment of foreign currency conversion/translation.
• Valuation of inventories
• Treatment of intangible assets
• Valuation of investments
• Treatment of retirement benefits
• Recognition of profit on long-term contracts
• Valuation of fixed assets
• Treatment of contingent liabilities

2.5 INDIAN ACCOUNTING STANDARDS

2.5.1 Introduction to Indian Accounting Standards

Indian Accounting Standards is converged standards for IFRS (International

Financial Reporting Standards). Ind AS are documents and policies that provide principles
for recognition, measurement, treatment, presentation and disclosures of accounting
transactions in the Ind AS financial statements.

For example: Ind AS 16 on Property, Plant and Equipment (PPE) will provide
principles on the criteria on the basis of which PPE is recognised, what all cost will form part
of PPE, how to treat those cost and how to present PPE in the financial statement and
relevant disclosures. Ind AS are prepared keeping IFRS in mind, in actual these are IFRS in
their converged form.There are 41 Ind AS notified till now.

2.5.2 Benefits of Indian Accounting Standards

2.5.2.1 Wider acceptability

Since Indian AS are converged form of IFRS which are widely acceptable and will
give confidence to the user of financial statements.
 2.5.2.2 Comparability of Financials
Financial statements prepared using Ind AS are easily comparable with the financial
statements prepared by companies of other countries.

2.5.2.3 Changes in standards as per economic situations

Principles of Ind AS are revised/modified in case there is any major change in
economy. Ind AS 29 is ‘Financial Reporting in hyperinflationary Economies’ which deals
with situations related to inflation.

2.5.2.4 Attracts Foreign Investment

Adopting Ind AS may attract foreign investors to invest in Indian Companies as that
will ensure better comparability with similar companies across the globe.

2.5.2.5 Saves financial statement preparation cost

For multinational companies, it will be beneficial as it will be able to use the same
accounting standards in all the markets in which they operate. This will save preparation
costs of aligning financial statements of Indian company with other operations.

2.5.2.6 Indian Accounting Standards Applicability

Indian Accounting Standards are applicable to specified category of companies is as
follows:
Mandatory requirement: Companies are required to follow Indian Accounting
Standardfrom Financial year 2015-2016. For Financial year 2018-19, following is the limit
for companies required to follow Indian Accounting Standards:
1. Companies whose equity or debt securities are listed or are in the process of being listed on
any stock exchange in India or outside India;
2. Unlisted companies having net worth of Rs. 250 crore or more; and
3. Holding, subsidiary, joint venture or associate companies of companies covered in point (1)
and (2) above.
Non-Banking Financial Companies (NBFCs)
1. NBFCs having net worth of rupees five hundred crore or more;
2. Holding, subsidiary, joint venture or associate companies of
2018-19 companies covered under point (1) above.

1. NBFCs whose equity or debt securities are listed or in the

process of listing on any stock exchange in India or outside India
2019-2020 and having net worth less than Rs. 500 crore;
2. NBFCs, that are unlisted companies, having net worth of Rs.
250 crore or more but less than Rs. 500 crore; and
3. Holding, subsidiary, joint venture or associate companies of
companies covered under point (1) and (2) above.
Voluntary applicability:
Company may voluntarily apply Indian accounting standards (Ind AS).

Requirement to follow Accounting Standards:

Corporate entities are required to follow standard of accounting (Ind AS where
applicable) while preparing its financial statements as per Section 129 of the Companies Act,
2013.

In case of conflict between Act and Indian Accounting standards:

In case there is any conflict between provisions of any applicable Act and Indian
Accounting Standard (Ind AS), the provisions of the Act shall prevail to that extent.

2.6CHECK YOUR ANSWER TO QUESTIONS

1. What do you understand by basic accounting principles, postulates, concepts

and conventions?
2. What are the characteristics of Accounting concepts and conventions?
3. What is mean by accounting standard? What is the main objective of accounting
standard?
4. Explain the utility of Accounting Standards.