Notes - Accounting

18. Accounting

 

18.1 Meaning of Accounting

 

Accounting is the process of identifying, recording, classifying, summarising, interpreting and communicating financial information relating to an organisation to the interested users for judgement and decision-making.

 

18.1.1 Characteristics of Accounting

 

Following are the characteristics of accountings

 

The definition of accounting brings following characteristics (attributes) of accounting

1. Identification It involves identification of those transactions and events which are of financial nature and relate to the organisation. It should be remembered that transaction is the process of give and take and event is the end result of the transaction(s).
2. Measurement Only those business transactions and events, which can be quantified or measured in monetary terms, are considered.
3. Recording It is the process of entering business transactions of financial character in the books of original entry in terms of money.
4. Classifying It can be defined as the process of grouping transactions or entries of one nature at one place.
5. Summarising It involves presenting the classified data in a manner which is understandable and useful to various users of accounting statements.
6. Analysis and Interpretation Analysing and interpreting the financial data helps users to make a meaningful judgement of the profitability and financial position of the business.
7. Communication It involves communicating the financial statements to the various users i.e. management and other internal and external users.

 

18.1.2 Objectives of Accounting

 

Following are the objectives of accounting

1. To maintain systematic and complete record of business transactions.
2. To ascertain the profit earned or loss incurred during a particular accounting period.
3. To ascertain the financial position of business.
4. To provide useful information to various interested parties.

 

Book-Keeping, Accounting and Accountancy

 

Book-keeping, accounting and accountancy are different but interrelated terms. Book-keeping It is an art of recording in the books of accounts, the monetary aspect of commercial and financial transactions. It is a part of accounting. It is concerned with identifying, recording and classifying economic transactions and events. Accounting It is a wider concept than book-keeping. It starts where book- keeping ends. It is concerned with summarising the economic transactions, analysis and interpretation of economic transactions and events and communicating the results to the final users. Accountancy It refers to the entire body of the theoretical knowledge of accounting. It is the theory part of accounting whereas accounting relates to applying the knowledge of accountancy.

 

18.2 Accounting Process or Cycle

 

It starts with identifying financial transactions, involves recording, classifying and summarising and ends with interpreting accounting information to various concerned parties. Accounting process can be explained with the help of the diagram given below

18.2.1 Branches of Accounting

 

Financial, cost and management accounting are the three main branches of accounting.

(i)   Financial Accounting It is concerned with recording of business transactions of financial nature in a systematic manner, to ascertain the profit or loss of the accounting period and to present the financial position of the business. The end product of financial accounting is trading and profit and loss account and balance sheet.

 

(ii)  Cost Accounting It is concerned with the ascertainment of total cost and per unit cost of goods/services produced/provided by a business firm.

 

(iii) Management Accounting It is concerned with presenting the accounting information in such a manner that helps the management in planning and controlling the operations of a business and in decision-making.

 

18.2.2 System of Accounting

 

The system of recording transactions in the books of accounts are generally classified into two types

1. Double Entry System

• Double entry system of accounting was developed by Luca Pacioli in Italy in 15th century. Double entry system is based on the principle of dual aspect which states that every transaction has two aspects i.e. debit and credit.
• The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and other is credited.

 

2. Single Entry System

• This system is not a complete system of maintaining records of financial transactions. It does not record two-fold effect of each and every transaction. Only personal accounts and cash book are maintained. No uniformity is maintained under this system while recording transactions.
• The single entry system is also known as accounts from incomplete records. The accounts maintained under this system are incomplete and unsystematic and therefore, not reliable.

 

18.2.3 Basis of Accounting

 

Profits or losses of a business can be determined by following cash basis accounting or on accrual (mercantile) basis accounting.

 

(i) Cash Basis of Accounting

• Under the cash basis of accounting, entries in the books of accounts are made, when cash is received or paid and not when the receipts or payment becomes due. Revenue is recognised at the time when cash is received and not at the time of sale or change of ownership of goods from seller to buyer.
• Expenses are recorded only at the time of actual payments. The difference between total revenue (receipts) and expenses (payments) is profit earned or loss suffered.

 

(ii) Accrual Basis of Accounting

• Under accrual basis of accounting, revenue is recognised when sales take place or ownership of goods and services changes from seller to buyer, whether payment for such sales is received or not, is not relevant.
• Accrual basis of accounting is based on realisation and matching principle. Companies Act, 2013 requires companies to follow accrual basis of accounting, in maintaining books of accounts.

 

 

 

18.3 Accounting Information

 

Accounting information refers to the financial statements generated through the process of book-keeping and accounting. The financial statements so generated are the income statement (profit and loss account) and the position statement (balance sheet). Every step in the process of book- keeping and accounting generates information for different user groups which enables them to take appropriate decisions.

 

18.3.1 Qualitative Characteristics of Accounting Information

 

Qualitative characteristics are the attributes of accounting information which tend to enhance its understandability and usefulness. In order to assess whether accounting information is useful, it must possess the following characteristics

 

(i) Reliability

• It means the users must be able to depend on the information. It must be factual and verifiable.
• A reliable information should be free from error and bias,

 

(ii) Relevance

• Accounting information presented by financial statements must be relevant to the decision-making needs of the users. Unnecessary and irrelevant information should not be included.
• To be relevant, information must be available in time, must help in prediction and feedback, and must influence the decisions of users.

 

(iii) Understandability  

It implies that the accounting information provided to the decision-makers must be interpreted by them in the same sense as it was prepared and conveyed to them.

 

(iv) Comparability

• It means that the users should be able to compare the accounting information. To be comparable, accounting reports must belong to a common period and use common unit of measurement and format of reporting.
• When accounting information of a period is compared with that of other period, it is known as intra-firm comparison.
• When accounting information of an enterprise is compared with that of other enterprises, it is known as inter-firm comparison.

 

18.3.2 Users of Accounting Information

 

Users of accounting information may be categorised into internal users and external users.

 

1. Internal Users

These are the persons within the organisation, who are interested in knowing the accounting information of the business. The various internal users are owners, management, employees and workers.

 

2. External Users

These are the persons outside the organisation, who are interested in knowing the accounting information of the business. The various external users are

(i) Investors and potential investors

(ii) Unions and employee groups

(iii) Lenders and financial institutions

(iv) Suppliers and creditors

(v) Customers

(vi) Government and other regulators

(vii) Social responsibility groups

(viii) Competitors

 

18.4 Generally Accepted Accounting Principles (GAAP)

 

These principles refer to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and presentation of financial statements. These principles are based on past experiences, usages or customs, statements by individuals and professional bodies, and regulations by government agencies. These principles are not static in nature and are influenced by changes in the legal, social and economic environment.

 

18.4.1 Classification of Accounting Principles

 

Accounting principles are sub-divided into concepts and conventions. ‘Concepts’ refer to the necessary assumptions and ideas which are fundamental to accounting practice and ‘conventions’ refer to customs or traditions which serve as a guide to the preparation of accounting statements.

 

Accounting Concepts/Assumptions

1. Going Concern Assumption This concept assumes that a business firm would continue to carry out its operations indefinitely for a very long period of time and there is no intention to close the business or scale down its operations significantly.
2. Consistency This assumption states that the accounting practices once selected and adopted, should be applied consistently year after year. This will help in better understanding of inter firm and intra firm comparison of financial statements.

 

3. Accrual According to this assumption, revenue is recognised when the goods are sold or services are rendered whether cash has been realised in the same accounting year or not. Similarly expenses are recognised as expenses in the same accounting year in which revenue relating to it, is recognised whether cash has been paid or not.

 

Accounting Conventions/Principles

1. Business Entity Concept This concept assumes that business has a separate and distinct entity from its owners.
2. Money Measurement Concept This concept states that only those transactions and happenings in an organisation which can be expressed in terms of money are to be recorded in the books of accounts.
3. Accounting Period Concept This concept refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and the position of its assets and liabilities at the end of that period.
4. Cost Concept This concept requires that all assets are recorded in the books of accounts at their purchase price which includes cost of acquisition, transportation, installation and making the asset ready for use.
5. Dual Aspect Concept This concept states that every transaction has a two-fold effect and should therefore be recorded at two places. It is the basic principle of accounting.
6. Revenue Recognition Concept According to this concept, revenue is considered to have been realized when a transaction has been entered into and the obligation to receive the amount has been established.
7. Matching Concept This concept states that the expenses incurred in an accounting period should be matched with the revenues of that period to ascertain the amount of profit earned or loss incurred.
8. Materiality Concept The concept of materiality requires that accounting should focus on conveying material information only. Material information is one which has the capacity to influence a decision.
9. Objectivity Concept This concept requires that accounting transaction should be recorded in an objective manner, free from the bias of the accountants and should be supported with documentary proof.
10. Full Disclosure Concept The principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in financial statements and also their accompanying foot notes.
11. Convention of Conservatism This convention requires that profits should not be recorded unless realised but all losses, even those which may have a remote possibility are to be provided for in the books of accounts.

 

18.5 Meaning of Accounting Standards

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Accounting standards are the written statements consisting of uniform accounting rules and guidelines issued by the accounting body of the country (such as Institute of Chartered Accountants of India) that are to be followed while preparation and presentation of financial statements.

However, the accounting standards cannot override the provision of applicable laws, custom, usages and business environment in the country.

 

 

 

18.5.1 List of Accounting Standards

 

The council of the Institute of Chartered Accountants of India has so far issued 32 Accounting Standards (AS).

These accounting standards are mandatory in the sense that these are binding on the member of the institute.

           

AS No.	Title
AS-1	Disclosure of Accounting Policies
AS-2	Valuation of Inventories (Revised)
AS-3	Cash Flow Statement (Revised)
AS-4	Contingencies and Events Occurring after the Balance Sheet Date (Revised)
AS-5	Net Profit or Loss for the Period, Prior Period and Extraordinary Items and Changes in Accounting Policies
AS-6	Depreciation Accounting (Revised)
AS-7	Accounting for Construction Contracts
AS-8	Accounting for Research and Development (It has since been withdrawn.)
AS-9	Revenue Recognition
AS-10	Accounting for Fixed Assets
AS-11	Accounting for the Effect of Changes in Foreign Exchange Rates (Revised)
AS-12	Accounting for Government Grants
AS-13	Accounting for Investments
AS-14	Accounting for Amalgamations
AS-15	Accounting for Retirement Benefits in the Financial Statements of Employers
AS-16	Borrowing Costs
AS-17	Segment Reporting
AS-18	Related Parties Disclosures
AS-19	Leases
AS-20	Earnings Per Share
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
AS-25	Interim Financial Reporting
AS-26	Intangible Assets
AS-27	Financial Reporting of Interests in Joint Venture
AS-28	Impairment of Assets
AS-29	Provisions, Contingent Liabilities and Contingent Assets
AS-30	Financial Instruments: Recognition and Measurement
AS-31	Financial Instruments; Presentation
AS-32	Financial Instruments: Disclosures

 

18.5.2 Accounting Equation

 

It is an equation which signifies that the assets of a business are always equal to the total of its liabilities and capital (owner’s equity). It is also called the balance sheet equation as the accounting equation depicts the fundamental relationship among the components of balance sheet.

It can be expressed as Assets = Capital + Liabilities