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Module I
THE ACCOUNTING SYSTEM

Accounting is an ancient art, certainly as old money itself which conveys the language of
business by recording, classifying and summarizing money transactions & events in a
significant manner and interpreting the results thereof.

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

MEANING OF ACCOUNTING
“Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by the users of information”
In the beginning the main objective of accounting was to ascertain the result of the business
(whether profit has been earned or loss has been suffered) during a year and to show the
financial position of the business as on a particular date. But which the lapse of time more and
more being expected from accounting. At present accounting has to meet the requirements of
taxation authorities, investors, government regulations, management and owners. This has
resulted in widening to scope of accounting and may be defined as follows:
With greater economic development resulting in changing role of accounting, its scope
became broader. In 1966 the American Accounting Association (AAA) defined accounting as
“the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of information.”
In 1970 the, Accounting Principles Board of AICPA also emphasized that the function of
accounting is to provide quantitative information, primarily financial in nature, about economic
entities, that is intended to be useful in making economic decisions.
Accounting can therefore be defined as the process of identifying, measuring, recording
and communicating the required information relating to the economic events of an organization
to the interested users of such information. In order to appreciate the exact nature of
accounting, we must understand the following relevant aspect of the definition:
● Economic events
● Identification, Measurement, Recording and communication
● Organization
● Interested users of information.
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ACCOUNTING SYSTEM

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

1) Cash System of Accounting: Under this system, only actual cash receipts and
payments transactions will be entered into the Books of Accounts. No entry will be
made for credit transactions. Government system of accounting is mostly on cash
basis. Certain professional organizations also record their income on cash basis, but
while recording expenses they take into account the outstanding expenses also and
prepare Income and Expenditure Account instead of Profit and loss Account.

2) Mercantile System of Accounting: This system is based on Double Entry principle.

This “Book Profit System of Accounting” takes into consideration all the aspects of
business transactions (BOTH CREDIT AND CASH TRANSACTIONS). This system is
followed by most of the industrial and commercial firm. This system owes its origin
to an Italian Merchant Luco Pacioli who wrote a book entitled “De Computis et
Scripturis” on Double Entry Accounting in the year 1494.

SYSTEM OF BOOK KEEPING

The art and technique of recording the business transactions in a set of books is called as
Bookkeeping. It is the process of analyzing, classifying and recording transactions in
accordance with a preconceived plan. This recording may be done according to two
ways:
1) Single Entry System: which is an incomplete maintenance of books of accounts
without following the Double Entry Concepts and Conventions, where some
business houses maintains for their convenience keeping only some of the
essential Books of Records. Thus it is referred as incomplete double entry
recording of business transactions.

2) Double Entry System: Where the transactions are recorded according to the
Golden Rules of Accounting taking into consideration both the aspects of a
transaction (Debit and Credit) and following the Accounting Concepts and
Conventions. This system maintains both Book of Original Entry (Journal /
Subsidiary Books) and Book of Final Entry (Ledger) according to the
classification of Accounts into Real, Personal & Nominal, in order to know the
state of affairs of the business by preparing the Profit and Loss Account and
Balance Sheet from the Trial Balance.
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BRANCHES OF ACCOUNTING

The subject of accountancy has become important for all the business organization in the
present time. Its subject matter has been increased and it has taken the form of accounting.
Accounting subject has the following branches:

FINANCIAL ACCOUNTING
1. Journal
2. Ledger
3. Trial Balance
4. Final Accounts

COST ACCOUNTING
1. Cost sheet
2. Job and contract costing
3. Process costing
4. Operating costing

MANAGEMENT ACCOUNTING
1. Ratio Analysis
2. Break event Point Analysis
3. Standard costing
4. Analysis Of Financial Statements

TAX ACCOUNTING
1. Sales Tax
2. Income Tax
3. Wealth Tax
4. Excise Duty

GOVERNMENT ACCOUNTING
1. Budget
2. Consolidated Fund
3. Contingency Fund
4. Public Accounting

SOCIAL RESPONSIBILITY ACCOUNTING

1. Social Fund
2. TQM
3. Environmental Accounting

HUMAN RESOURCES ACCOUNTING

1. Employee Inventory Management
2. HRD Operational & Administrative Aspects
3. Profitability and Work Measurement
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(1) Financial Accounting: “Financial Accounting is the art of recording, classifying and
summarizing in a significant manner and in terms of money, transactions and events which are
at least in part, of a financial character, and interpreting the results thereof.” In financial
accounting we record the business transactions in the books of accounts. Its object is to
ascertain the profit or loss and to know the financial position of the business. In this Journal,
Subsidiary books, Ledger, Trial balance, trading account, Profit & loss account and Balance
sheet are prepared.

(2) Cost Accounting: This branch of accounting has attained good importance in recent days.
Under it, the raw materials, labors and other expenses incurred in the industrial production and
business activities are recorded regularly so that production cost and per unit cost can be
ascertained and the unnecessary expenses can be checked out to control the cost. Cost
accounting helps in maintaining a desirable margin between cost and price so that business can
earn profit. It also include job and contract costing, process costing, operating costing and cost
sheet preparation.

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

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

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

(6)Social Responsibility Accounting: The society provides infrastructure and the facilities
without which business cannot operate at all. Therefore the business also has a responsibility
towards the society. Social responsibility accounting is the process of identifying, measuring
and communicating the contribution of a business to the society. The contribution of a business
to the society consist of providing employment to under privileged, providing financial and
manpower support for public utility programmes, environmental and ecology contribution,
product quality, product safety, product durability and customer satisfaction etc. In social
responsibility accounting techniques have been developed for measuring the cost of these
contributions and the benefit to the society

(7) Human Resources Accounting : HR Accounting is an art and science of evaluating the
worth of human resources of a business organization in a systematic manner as a whole to the
concern and the society and recording them for presenting the information in the financial
statements to communicate their worth to the readers of financial statements. “ It is the process
of identifying and measuring data about human resources and communicating this information
to interested parties”
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OBJECTIVES OR FUNCTIONS OF ACCOUNTING

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

(1)To keep systematic record of business transactions: The main objective of accounting is to
keep complete record of business transactions according to rules. For this purpose all the
business transactions are firstly recorded in the journal or subsidiary books and then posted into
the ledger. This helps to avoid the possibility of omission and fraud; moreover we can get the
financial information at any time during the year.
(2) To calculate profit or loss of the business: The second main objective or the functions of
accounting is to ascertain the net profit earned or loss suffered by a business concern. For this
purpose a Trading and Profit and loss account is prepared at the end of each accounting period.
When revenue of the business is more than expenditure the difference is said to be profit. In
addition to it, a businessman is able to get the following information from accounting.
1. How much goods have been purchased during a particular period
2. How much goods have been sold during a particular period
3. How much goods have been remained unsold and what is its value.
4. How much amount has been spent and earned on various heads
(3) To depict the financial position of the business: For this purpose a balance sheet is
prepared on the last day of the accounting year which shows the values of various assets on
one side and the liabilities and capital on the other side. Balance sheet shows the financial
position of the business. Besides this, from accounting a businessman can get the following
information:
1. How much amounts the business has to recover from debtors.
2. How much amount the business has to pay to creditors.
3. Amount of opening capital and closing capital
4. Amount of cash receipts and cash payments from the cashbooks.
(4) To provide information’s to various parties: Various persons have vested interests in a
business firm. Accounting provides useful information to all the interested parties such as:
owners, managers, investors, creditors, researchers, employees, customers, banks, government
departments, etc.
(5)Other objectives: Accounting functions also fulfill the following objectives:
To keep systematic and permanent record of all financial transactions
To use accounting records for future reference
To fulfill the legal requirements
To provide information about various tax liabilities
To check the accounting errors, frauds, and misappropriations of funds
To know the requirements of the business
To help in fulfilling tenders and quotations
To provide information about profitability of various products
To facilitate rational decision-making.
To control over expenditures to minimize them.
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ADVANTAGES OF ACCOUNTING

Accounting has many objectives and fulfillments of these objectives are the advantages and
usefulness of accounting:
(A) Advantages to businessman:
(1) Recording of transactions: It is a systematic and complete record of business transactions
whether they are personal, real, or nominal. Permanent recording of business transactions make
the results more realistic.
(2) Replacement of memory: In a large business it is very difficult for a businessman to
remember all the transactions. Accounting provides records which will furnish information as
and when required and thus it replaces human memory.
(3) Provides information: Every trader wants to get various information about his business
from time to time so accounting provides all these information.
(4) Availability of net results: In accountancy at the end of the year final accounts are
prepared from the accounts of business transactions .Gross profit is ascertained by Trading A/c
and net profit is ascertained by profit and loss A/c. Other financial statements make available
the net results of income and expenditure items also.
(5) Knowledge of financial position: Accounting helps a businessman to know the financial
position of his business.
(6) Reference in future: When the work of accounting has been performed properly then the
businessman can present the old ledgers as references in future. Posting up the books if
accounts are treated as business evidences and can be used in future as references. Books of
accounts can be presented in the courts as evidences.
(7) Comparative study: When business transaction are recorded in a proper manner then the
business results can be inferred easily and the result of different years can be compared to take
proper decisions for the future.
(8) Check the errors and frauds: When the business transaction are recorded regularly and
systematically in the books of accounts then the chances of errors minimize. Moreover
accounting also checks the frauds in stock and cash.
(9) Helpful in management: Mangers of business need various information to manage the
business. These information are supplied by the Accounts Department only. In a good business
the Accounts Departments has a special importance.
(10) Helpful in the sale of business: If accounts are properly maintained it helps to ascertain
the purchase price in case the businessman is interested to sell business.

(B) Advantages to customers

(1) Proper price: A manufacturer can determine the proper cost if his product through
an adequate and complete recording. This further helps in proper price determination and the
product can be made available at proper price to the consumer.
(2) Quality goods: An indirect advantage is accounting is that when accounting is that
when Accounts Department of a business is good then the quality of its product will also be
good which benefits the consumers.

(C ) Advantages to Government
(1) Financial assistance: Govt. also gets various advantages from accounting. Govt.
gives financial assistance in the form of subsidies and grants to the business firms. We can take
advantages of their financial assistance only when we have recorded properly our business
transactions .So it helps to attain the advantages of govt. policies.
(2) Knowledge of financial position of the country: Govt. can ascertain the commercial
and industrial progress of the country as a whole through the knowledge of progress of various
trades. It is possible when all the business units have proper accounting work.
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(3) Granting license: If the work of accounting is performed properly it will help the
govt. in granting import, export and production licenses to the enterprises.
(4) Commercial Laws: Accounting also makes possible to frame and amend the
various commercial laws such as Company Act, MRTP Act, Consumer Protection Act etc.
(5) Tax Assessment: Traders have to pay various taxes such as –Sales tax, Income tax,
Excise duty etc. These taxes be determined properly if the recording in the books of accounts is
done properly. Government officers also recommend the accounting .Thus businessman and
the govt. both are benefited by the accountancy.

(D ) Advantages to employees
(1) Control: It is very important in a business that workers should be employed
according to work. How much employees can be employed at a fixed wages is also related
with the Accounts Department. Thus accounting controls the employees indirectly.
(2) Increase in salary and bonus: Accounting also helps in determining the salaries,
bonus and other payments to the employees. With the participation of employees in the
management the importance of accounting has also special status.

(E ) Other Advantages
(1) Helpful in planning: Managers of business require the estimates of purchase, sales
expenses, costs and cash receipts for the next year, so that future plans can be framed. These
information are received from Accounts Department due to accounting.
(2) Helpful in decision making: Every trader has to take decisions about production,
sales etc. For e.g. whether price can be reduced to increase sale or not. Gifts is to be presented
with product or not etc. The information related to these decisions can be obtained from the
Accounts department only.
(3) Helpful in borrowing: We need additional capital for expansion of the business.
This is provided by the accounting.
(4) Determination of goodwill: on the basis of accounts for various years Goodwill of
the business can be calculated.
(5) Helpful in partnership: In partnership a new partner can know the financial position
of the firm through the accounts of the firm. An outgoing partner with the help of accounts of
the firm can easily ascertain his share to be received from the firm. In partnership there are
more than one manager hence for confidence must prevail among them proper recording of
business transactions is required.
(6) In large-scale business: Today every product is produced and sold at large scale.
Thus business activities also enlarge. Accounting helps in easy control of such large business.
(7) In case of insolvency: When a businessman fails to pay his liabilities he becomes
insolvent, then the creditors torture the businessman. If he has maintained proper record of
business transactions he can take the protection of the court. The court declares a businessman
solvent on the basis of books of accounts.
(8) Assessment of progress: By knowing about the profit and loss, assets and liabilities,
purchases and sales income and expenditure of last many years we can assess the progress
made by a business. It is possible only by the accounting.
LIMITATIONS OF ACCOUNTING

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

(1) Incomplete information: In accounting only those transactions are recorded which
can be expressed in terms of money. Other events, e.g. efficiency of managers, changes in
tastes of consumers, popularity of product and ability of employees, Economic and political
conditions of the country, level of competition etc though affect the success of business and
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financial position and managers continuously try to collect these information, yet they cannot
be expressed in terms of money and thus not represented in accounting.
(2) Influenced the by personal judgments: In accounting some principles and concepts
are obeyed. But at the end of an accounting year to ascertain the net profit or loss some
estimates are used. To charge depreciation life of an asset and its scrap value are to be
estimated, Bad debts are also estimated etc. The liking and unliking of the accountant affect
these estimates. Thus the results are also affected.
(3) Realizable value of business is not shown: The balance sheet which is prepared at
the end of the period to present the financial position of the business, shows the assets at their
historical costs and not at their realization price. Thus it is not possible to estimate the present
realizable value of the business.
(4) Complete control on frauds is impossible: Accountancy can check the arithmetic
accuracy of books accounts but cannot check the frauds completely. The profit and loss at the
end of the year can also be manipulated by manipulating the value of closing stock.
(5) Manipulation in accounts: If an owner shows the items of his own interest in the
books of accounts the result obtained by the accountant will be biased and wrong.
(6) Does not provide timely information: Final accounts are prepared at the end of the
accounting year. Thus they contain the information of historical importance. While managers
need current information for management and planning, which are not supplied by the
accounting easily..

FINANCIAL ACCOUNTING

Financial Accounting is concerned with the provisions of informations to external parties

outside the organization. The outsiders who use accounting information have a variety of
interests. Investors and shareholders want to know the company’s profit potential. The
suppliers, banks, and other lenders want to know whether a business is credit worthy.
Government agencies regulate and tax businesses and analyze the published financial
statements to make decisions.
Financial accounting is concerned with recording and summarizing financial transactions and
preparing statements relating to the business according to Generally Accepted Accounting
Principles agreed on by the accounting profession. Financial Accounting is the basis of
external reporting.

Limitations Of Financial Accounting

Financial accounting works as a postmortem of business affairs of an enterprise
during the accounting year. It cannot fulfill the needs of modern management as A.C.Littleton
has aptly said that “providing of significant data regarding market demand, state of
competition, general business conditions, engineering, personal information, legal and
regulatory limitations are out of the sphere of financial accounting. “In the changed business
scenario various new requirements such as future planning, evaluation of plans and policies,
cost control, timely decisions etc. have emerged on account of increasing size of business,
technical complexities, government interferences and public awareness towards social
responsibilities of business. Financial accounting has the following limitations.

1) Financial accounting gives only limited information to the management. It is inadequate for
management in the task of decision making.
2) Managerial decisions relate to future. Hence they are made on the basis of estimates and
projections. Financial accounting is inadequate for making future projections because it
provides only historical information.
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3) The present day management is of three tier system. Different levels of management needs
different information. Financial accounting fails to meet the information needs of different
levels of management.
4) Financial accounting considers only quantifiable information. Nowadays business
decisions are influenced by a number of social factors. For this many of them are ignored in
financial accounting.
5) The rapid change in technology and fast growth of business units have made the task of
modern management highly complicated. Financial accounting with its simple structure is not
in a position to cater the needs of modern management.
Difference between Management Accounting and Financial Accounting.

Management accounting cannot replace financial accounting. It takes a major part of the
information from financial accounting and modifies the same for managerial uses .Therefore
Both branches of accounting are complementary to each other. But there are certain points of
differences between the two. They are given below.
(1) The primary objective of financial accounting is recording business transactions in a
systematic way and ascertains the business results and financial position of a business
concern. The objective of management accounting is to provide necessary information to
the management for the efficient discharging of its functions.
(2) Financial accounting is an external accounting because it presents information to the
external parties like shareholders, creditors, bank etc. Management accounting is an
internal accounting because it presents information to the management.
(3) Financial accounting is concerned with historical records relating to the past, where as
Management accounting is mainly concerned with future plans and policies.
(4) Financial accounting is compulsory, while Management accounting is optional.
(5) Financial accounting relates to the business as a whole. Management accounting deals with
reports about a particular department or division of an enterprise.
(6) In financial accounting there is more emphasis on precise data. In Management accounting
there is less emphasis on precision. Estimates and future data are mostly used.
(7) Financial accounting is prepared in accordance with the GAAP. Management accounting is
prepared according to the internal requirements of the management.
(8) Financial accounting presents annual reports, while management accounting reports are of
both shorter and longer durations.
(9) Financial accounting is based on measurements while management accounting is based on
judgment. Thus financial accounting is more objective and management accounting is more
subjective.
(10) Financial accounting records only those transactions which can be expressed in terms of
money. On the other hand management accounting records not only monetary transactions
but also non-monetary events like technical changes, government policies etc
(11) The scope of financial accounting is not vast as compared to management accounting. It
does not include the techniques like costing, statistics, management accounting etc. It is a
part of management accounting. The scope of management accounting is most wide
because financial accounting, cost accounting, statistics and other techniques are used in it.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

What is GAAP ?
Generally Accepted Accounting Principles (GAAP) includes accounting conventions, rules,
procedures and accounting standards, accepted accounting practices both promulgated and
non-promulgated . GAAP are those principles , which have substantial authoritative support.
In order to maintain uniformity and consistency in accounting records, certain rules or
principles have been developed which are generally accepted by the accounting profession the
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ICAI. These rules are called by different names such as principles, concepts, conventions,
postulates, assumptions and modifying principles.
The term principles has been defined by AICPA as “A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct or practice”. The
word “generally” means in a general manner i.e., pertaining to many persons or cases or
occasions. Thus, GAAP refers to the rules or guidelines adopted for recording and reporting of
business transactions in order to bring uniformity in the preparation and the presentation of
financial statements.
The GAAP have evolved over a long period of time on the basis of past
experiences, usage or customs, statements by individuals and professional bodies and
regulations by the government agencies and have general acceptability among most accounting
professionals. However the principles of accounting are not static in nature. These are
constantly influenced by changes in the legal, social, and economic environment as well as the
needs of users. These principles are also referred as concepts and conventions. The term
Concept refers to the necessary assumptions and ideas that are fundamental to accounting
practice, and the term convention refers to customer or tradition as a guide to the preparation of
accounting statements. In practice the same rules and guidelines have been described by on
author as a concept by another as a postulate and still by another as convention. This at times
becomes confusing to the learners. Instead of going into the semantics of these terms, it is
important to concentrate on the practicability of their usage. From this practicability view point
it is observed that the various terms such as principles, postulates, conventions, modifying
principles, assumptions etc have been used inter changeably and are referred to as basic
accounting Concepts and Conventions.

Basic Accounting Concepts

The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and are broad working
rules for all accounting activities and developed by the accounting profession. The important
concepts have been listed as below:
“Conditions on which the accounting system is based are called accounting assumptions or
concepts.”
Accounting system is based on certain assumptions or concepts. These assumptions
constitute the foundation of accounting process. No concern can prepare financial statements
and accounts without considering these assumptions. Although there is no authoritative list of
assumptions, some major assumptions are as follows.
● Accounting entity Concept
● Money measurement Concept
● Going concern Concept
● Accounting period Concept
● Historical cost Concept
● Dual aspect Concept
● Revenue recognition/Realization Concept

(1) Accounting entity concept:

“The concept or assumptions that business has a separate entity or existence apart from
the owners is an entity”
This concept assumes that the entity of business is distinct from the its owners. Owner is a
creditor in accordance with this concept. That is why capital account is shown on the liability
side of the balance sheet. Moreover business is treated as a unit or entity separate from the
persons who control and associate with it. So accounts which are prepared and maintained for
business entity are distinct from all categories of persons associated with it.
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(2) Money Measurement concept :

“Under money measurement concept, only transactions expressed in terms of money
are recorded in the books of accounts.”
Money is common denominator in terms of which all transactions can be expressed in a
better manner. Hence under the concept of monetary expression or money measurement
concept only those transactions which can be expressed in terms of money are recorded in the
books of account. This facilitates in recording various kinds of economic activities on a
uniform basis. For instance, plant, furniture, land etc
Which are generally expressed in terms of quantity, area etc are recorded in terms of money
value. A transaction or an event which is not measurable in terms of money cannot be
recorded in the books of account. For instance dismissal of worker, strikes etc are very
important events, but do not find their place in the books of account. This concept suffers from
the following limitations.
(1) It does not consider the changes in the value of money.
(2) Human resources cannot be recorded in the books of accounts, although it is greatest asset
of a concern.

(3) Going concern concept:

“ The concept that the business will continue for a fairly long period is a going concern
concept”.
Under this concept it is assumed that the business concern will continue to exist for a
fairly long period. There is no intention to shut down the particular business concern in the
near future. However this concept does not imply a permanent existence of the business. But
this indicates stability and continuity of a business for a long period to carry out its plan.

(4) Accounting period concept:

“ The period of interval for which accounts are prepared and presented for ascertaining
the result of business is an accounting concept.”
The going concern concept implies that the business has a long period of life. But
however the owners and others who are interested in the business cannot wait for such an
indefinite period to know its results. Moreover such belated computation of financial position
of a business will not serve its very purpose. Hence the accountants specify an accounting
period (say 12 months, 6months, 3months,etc ) for preparing financial statements.

(5) Historical/ Cost concept:

“Accounting based on the actual cost of a transaction is the principle of historical
cost.”
Under this principle all the transactions should be recorded at their requisition cost. The cost
of acquisition is the cost of purchasing the assets and includes expenses incurred in bringing
them to the intended condition and location of use. However this concept does not mean that
the assets are always shown at cost but will be reduced by decrease in value known as
depreciation.

(6) Dual aspect:

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

According to this concept every transaction has two aspects. In case there is a debit
then there is corresponding credit of the amount. Accounting equation is developed on the
strength of dual aspect concept. For instance when there is an increase in one asset there is a
corresponding decrease in other assets or increase in liabilities.
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Thus assets and liabilities are equal at all the times i.e. [Asset = Capital +liabilities]. The
system of recording transactions with its dual concept is known as double entry system.

(7) Revenue recognition

Unless money has been realized (either cash has been realized or a legal obligation to pay
has been assumed by the customer) no sale can be said to have taken place and no profit or
income can be said to have arisen.
(8) Accrual Concept

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

The International Accounting Standards Committee (IASC) of which the Institute of

Chartered Accountants of India (ICAI) is an associate member, treats Going concern,
Consistency and Accrual as the fundamental accounting assumptions.

Accounting Conventions regarding financial statements.

Conventions are the customs or practices, which were following for a long period. They are the
practices or traditions, which guide the accountant while preparing the accounting statements.
In order to make the message contained in the financial statements (Profit and Loss Account &
Balance Sheet) clear and meaningful the following conventions are used:
(1)Conservatism
Financial Statements are usually drawn up on the assumption that “anticipate no profit
but provide for all possible losses” i.e., showing a position better than what it is, is not
permitted (which is called as Window-dressing). It is also not permitted to show a position
substantially worse than what it is. In other words, secret reserves are not permitted. It is based
on this convention that the inventory is valed at “cost or market price whichever is less”
(2)Consistency
The accounting practices should remain the same from one year to another- for instance, it
would not be proper to value stock-in-trade according to one method one year and another
method next year. If a change is required, the change& its effect should be stated clearly.

(3)Materiality/Disclosure
This convention suggests that the accountant should attach importance to material details
and ignore insignificant details. The accountant should regard an item as ‘material’ if there
is reason to believe that knowledge of it would influence the decision of the informed
investor. For e.g., while sending each debtor a statement of his account, complete details up
to paise have to be given. Good accounting practices demands that all significant matters or
information should be disclosed.

ACCOUNTING STANDARDS
Accounting Standards are written documents, policies issued by expert accounting body or
Government or other regulatory body covering the aspects of recognition, measurement,
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treatment, presentation and disclosure of accounting transaction in the financial statement.

The Institute of Chartered Accountants of India issues accounting Standards in India.
Objective of Accounting Standards
The main objective of AS is to standardize the diverse accounting policies and practices
with a view to eliminate to the extent possible the non-comparability of financial
statements and add the reliability to the financial statements.. The Institute of Chartered
Accountants of India, recognizing the need to harmonize the diverse accounting policies
and practices, constituted an Accounting Standard Board (ASB) on 21st April 1977.
Compliance with Accounting Standards issued by ICAI
Sub-section (3A) to Section 211 of The Companies Act, 1956 requires that every Profit and
Loss Account and Balance Sheet shall comply with the Accounting Standards. Thus
Accounting Standards means the standard of accounting recommended by the ICAI and
prescribed by the Central Government in consultation with the National Advisory
Committee on Accounting Standards (NACAS) constituted under section 210A(1) of
Companies Act, 1956.
Accounting Standards and the Auditors
Auditors are duty bound while discharging their attest function to ensure that the
Accounting Standards issued are made mandatory by the ICAI. Section 227(3) of
Companies Act, 1956 requires the auditors to report whether in his opinion the Profit/Loss
Account and Balance Sheet comply with the Accounting Standards referred in Section
211(3C) of the Companies Act, 1956.
Section 217(2AA)(1) of the Companies Act, 1956 states that Directors Responsibility
Statement should include that, in the preparation of the annual accounts the applicable
Accounting Standards had been followed along with proper explanations relating to
material departure.

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

AS-1 . Disclosure of Accounting Policies
AS-2 . Valuation of Inventories
AS-3 . Cash Flow Statement
AS-4. Contingencies and Events Occurring After Balance Sheet Date
AS-5. Net Profit or Loss for the Period, Prior Period Items and Change in Accounting
Policies.
AS-6. Depreciation Accounting
AS-7. Construction Contracts
AS-8. (Withdrawn)
AS-9. Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 The Effects of Changes in Foreign Exchange Rates.
AS-12 Accounting for Government Grants.
AS-13 Accounting for Investments
AS- 14 Accounting for Amalgamations
AS- 15 Accounting for Retirement benefits in financial Statements of Employers
AS-16 Borrowing Costs
AS-17 Segment Reporting
AS-18 Related Party Disclosures
AS-19 Leases
AS- 20 Earning Per Shares
AS- 21 Consolidated Financial Statements
AS- 22 Accounting for Taxes on Income
AS-23 Accounting for Investments in Associates in Consolidated Financial Statements
AS-24 Discontinuing Operations
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AS-25 Interim Financial Reporting

AS-26 Intangible Assets
AS-27 Financial Reporting of Interests in Joint Ventures
AS-28 Impairment of Assets
AS-29 Provisions, Contingent Liabilities and Contingent Assets

Advantages and Disadvantages of Accounting Standards

Advantages:
♦ Standards reduce to a reasonable extent or eliminate altogether confusing variation in
the accounting treatments used to prepare the financial statements.
♦ There are certain areas where important information is not required by law to be
disclosed, standards may call for disclosure beyond that required by law.
♦ It facilitates comparison of financial statements of different companies situated at
different places.

Disadvantages of setting Accounting Standards:

♦ There may be a trend towards rigidity and away from flexibility in applying
Accounting Standards.
♦ Differences in Accounting Standards are bound to be because of differences in the
traditions and legal system from one country to another.
♦ Accounting Standards cannot override the law. The Standards are required to be framed
within the ambit of prevailing statute even though it is not an acceptable standard.
International Accounting Standards
International Accounting Standards Board (IASB) issues International Accounting
Standards. International Accounting Standards Committee (IASC), the London based
group responsible for developing IASs has been in existence for over 20 years. The IASC
comprises of the professional accountancy bodies of over 75 countries (including the
Institute of Chartered Accountants of India) IASB so far have issued 41 IASs and 6 IFRS
(International Financial Reporting Standards)
The list of IAS includes:

IAS 1 Presentation of Financial Statements

IAS 2 Inventories
IAS 7 Cash Flow Statements
IAS 8 Accounting Policies, Change in Accounting estimates and errors
IAS10 Events after the Balance Sheet Date
IAS11 Construction Contracts
IAS12 Income Taxes
IAS14 Segment Reporting
IAS16 Property, Plant and Equipment
IAS17 Leases
IAS18 Revenue

IAS19 Employee Benefits

IAS20 Accounting for Government Grants and disclosure of Government Assistance
IAS21 The effect of Changes in Foreign Exchange Rates
IAS23 Borrowing costs
IAS24 Related Party Disclosure
IAS26 Accounting and Reporting by Retirement Benefits Plan
IAS27 Consolidated and Separate Financial Statements
IAS28 Investments in Associates
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IAS29 Financial Reporting in Hyper Inflationary Economies

IAS30 Disclosure in the Financial Statements of the Banks and similar Financial
Institutions
IAS31 Interest in Joint Ventures
IAS32 Financial Instruments: Disclosure and Presentation
IAS33 Earnings Per Share
IAS34 Interim Financial Reporting
IAS36 Impairment Assets
IAS37 Provisions, Contingent Liabilities and Contingent Assets
IAS38 Intangible Assets
IAS39 Financial Instruments: Recognition and Measurement
IAS40 Investment Property
IAS41 Agriculture

IASB has issued the following six IFRS (International Financial Reporting
Standards): -
IFRS-1 First time Adoption of IFRS
IFRS-2 Share Based Payments
IFRS-3 Business Combination
IFRS-4 Insurance Contracts
IFRS-5 Non-current assets held for sale and discontinued operations
IFRS-6 Exploration for and evaluation of mineral resources.

Regulatory Framework of Financial Reporting in India

The regulations that govern Financial Reporting by a business entity can vary depending on
the entity’s legal form. Thus regulations governing the financial reporting by limited
liability companies can differ considerably from the regulations governing Partnerships.
Partnership reports will cover the provisions mentioned under the Indian Partnership Act
1932. Companies registered under The Companies Act 1956 can be of several types. For
example, companies registered under section 25 of the Act are essentially nonprofit
entities, similarly special provisions may be applicable to Government Companies under
Section 617 of the Act, and Section 3 will be applicable to Public Limited Companies.
Some of the public Limited companies under the Act will also be listed on one or more
stock exchanges. Such companies will cover the special provisions applicable to Financial
Reporting enunciated by the SEBI (Securities Exchange Board of India) and by the various
stock exchanges. Financial reports that are put by business entities in the public domain can
be classified as:
a) Regular Financial Reports such as the Annual Report and the Half Yearly Report and
b) Financial Reports issued at the time of public offering of shares.
Section 209 Sub section 3 of the companies Act 1956 requires that the Books of Account
should be kept on accrual basis and according to the Double Entry System of
Accounting. Sub section 4 of Section 209 requires companies to preserve their books for
a period of at least eight years. Under Section 210 of the Act it is the duty of the Board of
Directors to lay before the Annual General Meeting (AGM) the Balance sheet and Profit
and Loss Account of the company. Section 211 of the Act deals with the form and
contents of the Financial Statements. The Balance Sheet is required to be prepared in
accordance with form setout in Part I Schedule VI to the Act and the Profit and Loss
Account is to be prepared in accordance with Part II of Schedule VI of the Act. Section
212 to 214 of the Act deals with accounts of Subsidiary companies. The Balance Sheet
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and Profit and Loss Account have to be signed by the Company Secretary and at least
two of the directors of the Company. The Auditors Report like the Board of Directors’
report under Section 217 must cover all the annexure to the Balance Sheet and shall be
attached to the Balance sheet. A Copy of the Annual Report is required to be sent to the
company’s shareholders at least twenty-one days before the date of the AGM. Three
copies of the Balance Sheet and the Profit and loss account should be filed with the
Registrar of Companies within 30 days form the date of the AGM at which financial
statements were laid. According to Section 220(1), only Balance Sheet of a Private Ltd.,
Company is a public document. The Profit and Loss account of a private limited
company is open only to the shareholders of the company. Under section 226 of the Act
only Chartered Accountants within the meaning of the Chartered Accountants Act, 1949
are qualified to be appointed as the auditors of a company. Section 227 of the Act defines
the powers and duties of auditors. Companies Act requires disclosing, whether its
Accounting Policies are in accordance with Accounting Standards issued by the ASB of
the ICAI. Sections 205 to 208 of the Act deals with the payment of Dividends, which also
have bearing on the Financial Reports of Companies; which could be paid only out of
profits arrived at after providing for Depreciation in accordance with the provisions of
subsection 2 of Section 205.
SEBI regulations also influence the contents of periodic reports of listed companies.