Chapter 2: Theory Base of Accounting

CHAPTER -2

THE THEORY BASE OF ACCOUNTING

Generally Accepted Accounting Principles (GAAP)

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. These rules are called by different names such as principles, concepts, conventions, postulates, assumptions and modifying principles. The term ‘principle’ 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, Generally Accepted Accounting Principles (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. For example, one of the important rule is to record all transactions on the basis of historical cost, which is verifiable from the documents such as cash receipt for the money paid. This brings in objectivity in the process of recording and makes the accounting statements more acceptable to various users. The Generally Accepted Accounting Principles have evolved over a long period of time on the basis of past experiences, usages or customs, statements by individuals and professional bodies and regulations by 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 the users. These principles are also referred as concepts and conventions. The term concept refers to the necessary assumptions and ideas which are fundamental to accounting practice, and the term convention connotes customs or traditions as a guide to the preparation of accounting statements. In practice, the same rules or guidelines have been described by one 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 the 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 in the present chapter.

Generally Accepted Accounting Principles

1.  GAAP is a collection of commonly followed accounting rules and standards in the preparation of financial statements. 
2. GAAPs are generic in nature and every country has its own GAAP, Example UK GAAP, US GAAP.
3.  In India, we have Indian Accounting Standards which are more specific to Indian Accountants.
4. These principles are referred to as concepts or principles.
5. Accountants are prepared on the basis of the principles laid down by IFRS.
6. IFRS helps in Financial statements comparison, uniformity and analysis.
7. The standards are prepared by the Financial Accounting Standards Board (FASB)
8. These principles are constantly changing due to changes in the external environment (legal, social and economic environment)
9. Cost basis principle requires that assets will be shown in the financial statements “on cost” i.e. on the purchase price. This has to be supported with the bill or voucher for correctness and trueness.

Basic Accounting Concepts

Accounting Principles

Principles of Accounting are the general law or rule adopted or proposed as a guide to action, a settled ground or basis of conduct or practice. Accounting principles are man-made. Unlike the principles of physics, chemistry, and the other natural sciences, accounting principles were not deducted from basic axioms, nor is their validity verifiable by observation and experiment. Instead, they have evolved. This evolutionary process is going on constantly; accounting principles are not “eternal truths”.

Business Entity Concept

This concept considers a business unit as a separate entity. Business and businessman are two separate entities and all the business transactions are recorded in the books of accounts from business point of view.

Dual Aspect Concept

This Concept also known as equivalence concept signifies that every business transaction has two fold effects or every transaction affects at least two accounts. This concept is, in fact, the base on  which Double Entry System of Book-Keeping is based. According to this principle, every debit has a corresponding credit.

Accounting Period Concept

According to this concept the long life of business is divided into justifiable accounting periods so as to help businessman to know the results of his investment during each such period. This period is known as accounting period and the length of this period depends on the nature of business. Accounting period may be either a calendar year (From January 1 to December 31) or the fiscal year of the Govt. (April 1 to March 31)

Going Concern Concept

This concept assumes that every business has a long and indefinite life. Since financial statements are prepared on the basis of this concept, all fixed assets are shown in the books at their cost ignoring their market value.

Cost Concept

According to this concept all fixed assets are recorded in the books at cost i.e. the price paid to acquire them. Any subsequent increase or decrease in their value will not be shown in the records except the depreciation of these assets. In subsequent years, therefore fixed assets are shown at cost less depreciation provided on them up to date. Continuous charging of depreciation on the asset will ultimately eliminate the asset from the books.

Money Measurement Concept

According to this concept only those transactions are recorded in the books of accounts which can be expressed in monetary terms. The non-financial or non-monetary transactions do not find any place in the accounting records. Money is the common denominator to denote the value of the various assets of diverse nature to give a meaningful total of these assets.

Matching Concept

This concept states that it is necessary to charge all the expenses incurred to earn revenue during the accounting period against that revenue in order to ascertain the net income or trading results of the business. The matching concept which is so closely related to accrual concept and accounting period concept helps a businessman in realizing his objective i.e. in ascertaining the trading results or profit or loss from the business. For ascertaining the net income.

 Accounting Equivalence Concept

According to this concept assets owned by the business must be equal to the funds contributed by the businessman in the form of capital. These days when business is to be carried on a large scale, funds may be borrowed from third parties to supplement the funds contributed by the proprietor.

Realization Concept

According to this concept income is treated as being earned on the date on which it is realized i.e. the date on which goods or services are transferred to the customers. Since this exchange of goods or services may be for cash or on credit, it is not important whether cash has actually been received or not.

Objective Evidence Concept or Verifiable Objective Concept

This concept justifies the significance of verifiable documents supporting various transactions. According to it, each transaction should be supported by objective evidences like vouchers. Objective evidence, here, means evidence free from bias of the accountant.

Materiality

This principle emphasizes that only those transactions should be recorded which are material or relevant for the determination of income from the business. All immaterial facts should be ignored.

Full Disclosure

This concept implies that financial statements should disclose all material information which is required by the proprietor and other users to assess the final accounts of the business unit

Consistency

This principle requires that accounting practices, methods and techniques used by a business unit should be consistent. A business unit can adopt any accounting practice, but once a particular practice is chosen, it must be used for a number or years.

Conservatism or Prudence

This principle is nothing but a formal expression of the maxim “Anticipate no profits and provide for all possible losses.” In other words, it considers all possible losses but ignores all possible profits.

Timeliness of Information

Accounting information to the management should be supplied in time and frequently so that some rational decisions may be taken. If information is not supplied in time, it will obstruct the quick decision-making process of the undertaking.

Accounting assumptions

It is mandatory for every relisted company to get its accounts audited by an independent chartered accountant. 

This has to be done for the use of financial statements. Whenever a company’s accounts are closed on 31st March, the CA goes and checks the correctness of the profit and loss account balance sheet and if you are reported to shareholders that everything is true and fair.

Accounting assumptions are three points which are assumed by the CA that comma these three assumptions are followed by the company while making the final accounts that is profit and loss and balance sheet.

Going concern assumption

Under this assumption, it is assumed that the business is going to continue for the next possible future that is there is no hurdle and the company’s operations are running smoothly.

Now, why is something so obvious an important accounting assumption let's understand the help of a scenario.

Imagine a scenario where there is a fire in the companies goes down biggest godown and all the production has stopped temporarily. 

If the owner lets out this information that the production has stopped immediately the market value will go down the creditors will get upset the banks who have given loans will get alerted it will create more problems for the company because a company always wants to survive.

To protect the uses of financial statements is important for the CA to give his report on whether the fundamental accounting assumption of going concerned has been affected or not

What will happen if the going concern of a company is affected

The difference between capital expenditure and revenue expenditure is over. If there is no distinction between revenue expenditure and capital expenditure. All the major expenditures are considered as expenses and they're expensed out in the profit and loss accounts.

Accrual

In old times how did businessmen calculate their profit and losses? It was very simple to add all the cash which has been received in a given year and subtract all the payments made this year if there is any cash left in its profits.

Companies act 2013 does not follow this manner of accounting. Companies act says that it doesn't matter whether cash has been received or not in a given year. What matters is whether it was this current year's income. 

Let us say that rent per month is rs 1000 yearly rent becomes 1000 into 12000 rupees. You have been the rent for April to December that is 1000 into 9 9000 rupees but you could not pay for January 2 March 3 months 3 into 3000. 

As per accrual, it doesn't matter how much cash you have paid you have to account for the entire 12 months expense.

Similarly, it does not matter if you have received the income in cash or not what matters is it the income of the current year

Income of the current year minus expense of the current year can only give us the profit for the whole year. 

In the case of cash basis of accounting, it is difficult and almost impossible to get the profit for the whole 12 months if you are not considering income and expenses for the 12th months. 

There are four accounts that we will study in the approval system in the coming chapters namely outstanding expense prepaid expense accrued income and unearned income

Consistency

If you are planning to become a finance professional, you will realize that a companies act and income tax act gives us a few flexibility or options while preparing accounts. 

For example

There are two methods of calculating depreciation which was going to study this year. Straight-line method and written down value method. The company can choose what method suits it best. Another example which you are going to study next year. While preparing the capital account apartments can follow 2 methods fixed capital account and fluctuating capital account.

The consistency principle says whenever a company chooses anyone such a method for the next years and the coming future years the company has to be consistent with it and continue using the same method.

So if the company follows the straight-line method in this year and next year changes it to the return down value method it will be in contradiction to the principle of consistency.

Business entity principle

Let me start with an example

Ram and Shyam are two friends who want to open a firm called RS and associates. 

Ram and Shyam are two different beings who have their respective birth certificates driving licenses and Aadhar cards. When both of them registered a firm called RS and associates a new artificial baby is born in the eyes of the law. Rs associate is a new person different from its owners Ram and Shyam. Run associates will have a separate bank account separate address proof and a separate identity. 

The business entity principle explains that a business is a different entity from its owners.

Accounting period concept

As per the income tax act, 1962 and the companies act 2013 all the businesses in India prepare their books of accounts annually starting from the first of April and ending to ending 31st March.

Under the accounting period concept, it becomes important to calculate the profits for a given period in which can be monthly quarterly or annually. Around the World books of accounts are prepared for 12 months that is annually

Cost concept

The cost concept mandates that the acid will appear in the balance sheet on its cost price full stop for example. 

A business purchased a building for 3 lakh rupees and after 10 years the market value has raised reason to 50 lakh. According to the cost, concept acids are recorded in the balance sheet on cost price that is bracket open purchase price closed not the market value. 

What is the cost? 

Cost is considered the purchase price plus all the expenses in curd to bring the acid into using condition. 

For example, we purchase AC for 25000 and to start and make it in a working condition we spend 2000 or the carpenter and 1000 on the transportation charges. As per the cost concept, the cost of the AC is 25000 + 2000 + 10000 which is 28000. In our books, the AC will be recorded on the planting machinery head for 28000. 

Dual aspect principle or double entry principle

In accounts, every transaction happening will have at least two effects that is it will affect at least two accounts.

It is obvious but let us understands with the help of an example

You go to buy a burger at McDonald's now what is happening here you are paying rs 50 to McDonald's and you are getting one burger we are a customer so we have to think from the point of you of the business here the business is McDonald's. The two things happening in this one transaction are one McDonald's is receiving money second McDonald's product the stock is going out. 

In accountancy, everything is recorded on a double-entry system every transaction has two sides

Revenue Recognition Concept.

Let’s take an example:

Our Year of Accounting is from 1 April 2022 to 31 March 2023.  The businessman sold goods worth Rs. 30,000 on 25 march 2023 but it’s a credit sale. The money will be received in the next year on 10 April 2023.

When will you count this sale? In the year 2022-2023 or the year next to that?

As per the revenue Recognition concept and Accrual Assumption. The sale of Rs. 30,000 will be recorded in the year the Sale took Place, not when money is realized.

Matching Concept

How will we calculate the Profit for the year 2022- 2023?

It’s simple. Add all the Revenue and Incomes received in the Current Year (2022-2023) and subtract all the expenses related to generating the Revenue (Business Expenses). 

Why is this an important Accounting Principle? Let’s understand.

Suppose

Rent of Business is Rs. 20,000 p.m. Yearly Rent is Rs. 20,000*12 = Rs. 2,40,000.

Out of this Rs. 40,000 isn’t paid in Cash and is outstanding to be paid in the next year. The accountant did not fully record the Expense as it is not paid and charged only Rs. 2,00,000 in the Current Year (2022-2023).

Do you think that we got the correct profit for the year?

No, we did not. Matching concepts implies that all the revenues earned during one accounting year (whether received or not) have to be matched with the expenses incurred (Paid or outstanding) during the year to calculate the correct profit of that year.

Full Disclosure

As mandated by the Companies Act 2013, every company must disclose all information that is material and relevant to the user of financial statements.  This helps the users to make more informed decisions.

Conservatism Concept (Prudence)

Prudence concept requires that the company should:

1. Account for all losses which are anticipated in the future (even if losses have not been incurred)
2. Account for all gains only when they are realized. (Gains cannot be recorded in the anticipation of gain.)

Materiality Concept

While Accounting the company needs to follow the full disclosure concept but very small transactions for example expense on stationery, pen, and pencils are not material. Even if they are missed in the financial statements, they still give a True picture.

Because the Materiality concept requires that all material facts need to be disclosed.

Objectivity Concept

Accounting is a manmade concept. Entries are made and checked by human beings.  Human beings are not free from Bias.

That is why Accounting requires each transaction to be evidenced by proof or a bill.  Accounting needs to be objective so that the users can fairly rely on the information which is correct and based on facts.

System accounting

The systems of recording transactions in the book of accounts are generally classified into two types, viz. Double entry system and Single entry system. Double entry system is based on the principle of “Dual Aspect” which states that every transaction has two effects, viz. receiving of a benefit and giving of a benefit. Each transaction, therefore, involves two or more accounts and is recorded at different places in the ledger. The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and the other is credited. Double entry system is a complete system as both the aspects of a transaction are recorded in the book of accounts. The system is accurate and more reliable as the possibilities of frauds and mis-appropriations are minimised. The arithmetic inaccuracies in records can mostly be checked by preparing the trial balance.

The system of double entry can be implemented by big as well as small organisations. Single entry system is not a complete system of maintaining records of financial transactions. It does not record two-fold effect of each and every transaction. Instead of maintaining all the accounts, only personal accounts and cash book are maintained under this system. In fact, this is not a system but a lack of system as no uniformity is maintained in the recording of transactions. For some transactions, only one aspect is recorded, for others, both the aspects are recorded. The accounts maintained under this system are incomplete and unsystematic and therefore, not reliable. The system is, however, followed by small business firms as it is very simple and flexible (you will study about them in detail later in this book).

Business Transactions

An exchange of goods or services for cash or on credit by the business with outsiders is called a transaction. In the words of L. C. Copper, “A person’s dealings in money or money’s worth are termed as transactions.”

Entity: - Business entity means a specific identifiable business enterprise like Tata, Reliance, Amul, Sony etc.

Transactions: - Exchange of goods and services for consideration.

Assets: - These are properties or economic resources of an enterprises which can be expressed in monetary terms it can be divided in two parts

(a) Non-Current Assets: Fixed assets: Tangible & Intangible (more than 1 year period)

• Tangible Assets
• Land and Building
• Plant and Machinery
• Furniture
• Office Equipments
• Intangible Assets
• Goodwill
• Patents
• Trademarks
• Copyright
• Computer software

(b) Current assets (less than 1 year period)

• Debtors
• Bills Receivable
• Cash in hand
• Cash at bank
• Cheque in hand
• Drafts in hand
• Stock
• Prepaid Expenses

Definition of Assets

“Assets are future economic benefits, the rights, which are owned or controlled by an organization or individual.” -- Finney and Miller “Assets are property or legal right owned by an individual or a company to which money value can be attached.” -- R. Brockington According to Institute of Certified Public Accountants, U.S.A; “Current Assets include cash and other assets or resources commonly identified as those which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.”

Liabilities:

These are certain obligations or dues which firm has to pay. Liabilities can be divided into two categories i.e.,Non-Current Liabilities and Current Liabilities.

Non-Current Liabilities

• Bank Loan
• Mortgage
• Loan from other financial institutions
• Other long-term liabilities

Current Liabilities

• Creditors
• Bills Payable
• Outstanding Expenses
• Bank overdraft

Trade Receivables: Debtors + Bills Receivables

Debtors: - There are persons who owe to an enterprise an amount for buying goods and services on credit.

Bills Receivables: Amount to be received againt B/R (from debtors).

Trade Payable: Creditors + Bills Payable.

Creditors: - These are persons who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit.

Bills Payable:  Amount payable against the bills (to the creditors).

Capital: It is an essential investment for commencement of every business.

Sales: It can be credit or cash, in which goods are delivered to customers: (a) Cash Sales (b) Credit Sales.

Revenues: -It is the amount which is earned by selling of products.

Expense: -It is known as cost of assets consumed or services which used.

Expenditure: -It means spending money for some benefit.

Profit: - Excess of revenues over expenses is called profit.

Gain: - It generates from incidental transaction such as sales of fixed asset, winning of court case.

Loss: - Excess of expenses over income is termed as loss.

Discount: -It is defined as concession or deduction in price of goods sold.

Voucher: -It is known as evidence in support of a transaction.

Goods: - It refers all the tangible goods (Raw material, work in progress, finished goods.)

Drawings: - Amount of goods or cash which is withdrawn from business for personal use.

Purchases: - It means of procurement of goods on credit or cash.

Stock: - It is a part of unsold goods. It can be divided into two categories.

1. Opening stock

2. Closing stock.

Balance Sheet: Balance Sheet is prepared at the end of each accounting period to ascertain the financial position of the business.

Format of Balance Sheet

Capital expenditure:

“Outlay resulting in the increase or acquisition of an asset or increase in the earning capacity of the business is capital expenses”. William pickles

Benefit of this expenditure we [business] enjoy for a long time. Capital expenditure is incurred for the purpose of enjoying long term advantage for the business.

This expenditure is mostly incurred for buying assets [tangible or intangible] which can later to be sold and converted into cash.

This expenditure is incurred to increase the earning capacity of the business.

Some examples of capital expenditure:

• Expenditure which are only for acquisition of fixed Assets
• Expenditure which are used for the extension or improvement in fixed Assets
• Legal charges incurred
• purchase of land, building,
• Purchase of furniture,
• Or any fixed asset for permanent use in the business.

Revenue expenditure: Mostly benefit of this expenditure we [business] enjoy only within the current year. Expenses of administration, manufacturing, selling expense, Office expense and all day to day expenses of the current year, are example of revenue expenditure.

According to Kohlar, it is “an expenditure charged against operation: a term used to contrast with capital expenditure.”

There are 2 systems of Accounting

1. Double Entry System

Every transaction has 2 effects (Debit and Credit).

Eg 1: One person is receiving, another person is giving

Eg. 2: Suppose Ramesh purchases an office table by giving cash; the office table is coming in and cash is going out.

2. Single Entry System

Because every transaction has 2 sides; maintaining accounts on the basis of a Single entry is not considered reliable under the Companies Act 2013.  Although small businessmen adopt this method for ease of Accounting. 

Basis of Accounting:1. Cash Basis of Accounting 2. Accrual Basis of Accounting

 Cash Basis of Accounting:

 Under this method only cash transactions are recorded in the books of accounts. Entries are made only if cash is received or paid.

Accrual Basis of Accounting:

Under this method all transactions are recorded in the books of accounts (Cash and Non-Cash). Entries are made on the Accrual basis, it means cash and Non-cash both transactions are recorded in the books of accounts.

Source of Documents

All financial transactions are recorded in the books of accounts on the basis of source document or on the basis of some evidence. Source documents are helpful to prove that a transaction is actually made or not.

Cash Memo: Cash Memo is A bill of sale, it is a written document by a 'seller' to a purchaser,

reporting that on a specific date, a particular sum of money or other "value received",

Invoice or Bill : When goods are sold on credit, An invoice or bill is issued on the name of the buyer, indicating the products, quantities, and agreed prices for products or services, the seller has provided the buyer.

Receipt : A receipt is a written acknowledgment that a specified a sum of money has been received from the customer as an exchange for goods or services. The receipt is evidence of purchase of the goods or service.

Pay-in-Slip : Pay in slip is a form that is filled when the money is deposited by a customer in to his bank account.

Cheque: A cheque is a document (usually a piece of paper) that orders a payment of money. The

person writing the cheque, the drawer, usually has a account where the money is deposited.

Debit Note : When we return goods back to the supplier, a debit not is made on the name of

supplier, it means his account his debited. Debit Note proves that a debit entry has been made to a

debtor's or creditor's account.

Credit Note: When we receive goods back from our customer, then a credit not is made on the

name of the customer, it means customer’s account is credited.

Meaning of Voucher : Voucher is the documentary proof or evidence in support of a transaction.

For example when we purchase goods for cash, we get cash memo, and when we purchase goods

on credit, we get an invoice, when we make payment we get Receipt.

Types of Vouchers

There are two types of vouchers a) Cash Voucher b) Non Cash Voucher

Cash Vouchers: Cash vouchers are prepared for cash transactions only, when cash is received or

paid. There are two types of cash vouchers: a) Debit Vouchers b) Credit Vouchers

Debit Vouchers: Debit vouchers are prepared only for cash payments

Credit Vouchers : Credit vouchers are the opposite side of debit vouchers, Credit vouchers are prepared when we receive cash

Preparation of accounting vouchers: All business transactions recorded in the books of

accounts can be compared with the source documents. Accounts are debited or credited on the

basis of these source documents. After deciding, that what to be debited or credited, the next step

is the preparation of the vouchers.

Meaning of Accounting Equation

The Accounting Equation' is based on the double-entry book keeping system. For every debit there must be a credit. The accounting equation states that the sum of the Total assets must be equal to the sum of the liabilities.

Assets = Liabilities + Capital

Or

 Capital = Assets - Liabilities

 Or

 Liabilities = Assets - Capital

 Or

 Assets = Total Liabilities or Total Equity

 Or

 Total Assets = Internal Liabilities + External Liabilities

 

Basis of Accounting:

Cash Basis of Accounting: Under this method only cash transactions are recorded in the books of accounts. Entries are made only if cash is received or paid.

Accrual Basis of Accounting: Under this method all transactions are recorded in the books of accounts (Cash and Non-Cash). Entries are made on the Accrual basis, it means cash and Non-cash both transactions are recorded in the books of accounts.

Source of Documents

All financial transactions are recorded in the books of accounts on the basis of source document or on the basis of some evidence. Source documents are helpful to prove that a transaction is actually made or not.

Cash Memo: Cash Memo is A bill of sale, it is a written document by a 'seller' to a purchaser, reporting that on a specific date, a particular sum of money or other "value received",

Invoice or Bill: When goods are sold on credit, An invoice or bill is issued on the name of the buyer, indicating the products, quantities, and agreed prices for products or services, the seller has provided the buyer.

Receipt: A receipt is a written acknowledgment that a specified a sum of money has been received from the customer as an exchange for goods or services. The receipt is evidence of purchase of the goods or service.

Pay-in-Slip: Pay in slip is a form that is filled when the money is deposited by a customer in to his bank account.

Cheque: A cheque is a document (usually a piece of paper) that orders a payment of money. The person writing the cheque, the drawer, usually has a account where the money is deposited.

Debit Note: When we return goods back to the supplier, a debit not is made on the name of supplier, it means his account his debited. Debit Note proves that a debit entry has been made to a debtor's or creditor's account.

Credit Note: When we receive goods back from our customer, then a credit not is made on the name of the customer, it means customer’s account is credited.

Meaning of Voucher: Voucher is the documentary proof or evidence in support of a transaction. For example when we purchase goods for cash, we get cash memo, and when we purchase goods on credit, we get an invoice, when we make payment we get Receipt.

Types of Vouchers

There are two types of vouchers a) Cash Voucher b) Non Cash Voucher

Cash Vouchers: Cash vouchers are prepared for cash transactions only, when cash is received or paid. There are two types of cash vouchers: a) Debit Vouchers b) Credit Vouchers

Debit Vouchers: Debit vouchers are prepared only for cash payments.

Credit Vouchers : Credit vouchers are the opposite side of debit vouchers, Credit vouchers are prepared when we receive cash

Preparation of accounting vouchers: All business transactions recorded in the books of accounts can be compared with the source documents. Accounts are debited or credited on the basis of these source documents. After deciding, that what to be debited or credited, the next step is the preparation of the vouchers.

Meaning of Accounting Equation

The Accounting Equation' is based on the double-entry book keeping system. For every debit there must be a credit. The accounting equation states that the sum of the Total assets must be equal to the sum of the liabilities.

Assets = Liabilities + Capital

                  Or

 Capital = Assets - Liabilities

                 Or

 Liabilities = Assets - Capital

                 Or

 Assets = Total Liabilities or Total Equity

               Or

 Total Assets = Internal Liabilities + External Liabilities

Please read the case study

Suppose the grocery owner pay the rent of Rs.1000 per month. Yearly rent comes out to be 1000×12 that is Rs.12,000 annually. COVID-19 affected a lot of businesses so the grocery owner could not be six

 months of rent. COVID-19 affected a lot of businesses so the grocery owner could not be six months of rent. So in the current year the grocery owner paid six months’ rent that is 6000 in cash be next year And 6000 is outstanding which will pay next year

There are 2 basis of Accounting 1) Cash basis Accounting And Accrual Basis Accounting

Cash Basis Accounting: Cash basis is the simplest form of accounting. Suppose you are a small businessman who owns a grocery shop. Under cash basis accounting all the shop owner needs to do is add all the cash coming in in one year and subtract all the cash he’s which is going out as payments. It can be a profit or loss.

Under cash basis accounting the owner will record the cash only cash payments that are he will record a rent of 6000. In cash basis accounting full 12 months’ rent is not charged here. If hundred percent of rent is not charged then I will be getting the correct profit? This is the reason companies act 2013 does not allow a company to prepare its books on the basis of cash basis accounting. Cash basis accounting is only followed by a very small business man

Accrual Basis of Accounting

Under accrual basis accounting the companies act 2013 requires the owner to charge all the incomes and expenses of 12 months so that the correct profit for 12 months can be arrived.

So here irrespective of how much cash has been paid for rent we will record the entire 12,000 as rent in arriving the profit/loss for the year.

There are 4 Accounts Relating to Accrual concept which we will study in the next chapter.

Outstanding Expenses, Prepaid expenses, Accrued Income and Unearned Income.

Accounting Standards

History and Development of Accounting Standards

The International Accounting Standards Committee (IASC) came into existence on 29th June 1973.

The main objectives of IASC are to develop the accounting standards. In India the Institute of

Charted Accountants of India (ICAI) had constituted the ‘Accounting Standards Board’ in April

1977 for developing the Accounting Standards

Meaning of Accounting Standards:

Accounting standards are the rules in written form that ensure the uniformity of accounting Standards, and provide guidance for the preparation, presentation and reporting of accounting information.

Features/Characteristics/Nature of Accounting Standards:

a) Provide Guidance to the Accountants ;

b) Brings Uniformity;

c) Accounting Standards are flexible ;

d) Provide information

Advantages of Accounting Standards

a) Helpful in bringing the uniformity

b) Helpful in improving the reliability of financial statements

c) Helpful in resolving the conflicts among the users of financial information.

Accounting Standards issued by the ICAI: Amendment is made recently in the section 211 of

companies act 1956. According to this amendment, the financial statements (Profit and Loss

Account and Balance Sheet) of a company should comply with the Accounting Standards. The

Council of the Institute of Charted Accountants of India has so far issued the following 32

Accounting Standards (AS).

Process of Accounting:

(1) Collecting and identifying financial transactions

(2) Recording

(3) Classifying

(4) Summarizing

(5) Deals with financial transactions

(6) Analysis and Interpretation

(7) Communicates

Accounting Standards

History and Development of Accounting Standards

The International Accounting Standards Committee (IASC) came into existence on 29th June 1973. The main objectives of IASC are to develop the accounting standards. In India the Institute of Charted Accountants of India (ICAI) had constituted the ‘Accounting Standards Board’ in April 1977 for developing the Accounting Standards

Meaning of Accounting Standards:

Accounting standards are the rules in written form that ensure the uniformity of accounting Standards, and provide guidance for the preparation, presentation and reporting of accounting information.

Features/Characteristics/Nature of Accounting Standards:

a) Provide Guidance to the Accountants.

b) Brings Uniformity.

c) Accounting Standards are flexible.

d) Provide information.

Advantages of Accounting Standards

a) Helpful in bringing the uniformity.

b) Helpful in improving the reliability of financial statements.

c) Helpful in resolving the conflicts among the users of financial information.

Accounting Standards issued by the ICAI:

Amendment is made recently in the section 211 of companies act 1956. According to this amendment, the financial statements (Profit and Loss Account and Balance Sheet) of a company should comply with the Accounting Standards. The Council of the Institute of Charted Accountants of India has so far issued the following 32 Accounting Standards (AS).

Process of Accounting:

• Collecting and identifying financial transactions
• Recording
• Classifying
• Summarizing
• Deals with financial transactions
• Analysis and Interpretation
• Communicates

The Institute of Chartered Accountants of India defines Accounting Standards as

The written policy documents issued by the expert accounting body cover the aspects of recognition measurement presentation and disclosure of accounting transactions in financial statements.

 Accounting standard lays down standard accounting policies valuation techniques and disclosure requirements. It helps with comparing the financial statements of the company with other companies.

Benefits of accounting standards 

By following accounting standards the accountant has the following benefits of accounting standards by setting accounting standards the accountant has the following benefits

1. Eliminate confusing variations in accounting treatment used to prepare accounting statements
2. Standards make the call for disclosures in the financial statements which are not required by law and is always better for the user of financial statements.
3. Accounting standards facilitates makes possible comparison of financial statements of companies situated in different parts of the world. For example, the financial statements of Pizza Hut in India and Pizza Hut in the US will be comparable because of accounting standards

Limitations of Accounting Standards

1.  Accounting standards give solutions and choices between alternative accounting treatments. The accountants find it difficult to make a choice between these different treatments
2.  Accounting standards cannot override the statute the standards or to be framed or made with a restricted scope

Applicability of accounting standards (Who all need to follow as)

1. Sole Proprietor
2. Joint Hindu Undivided Family
3. Trusts
4. Societies
5. Cooperatives
6. Companies
7. Association of persons

Basically, ALL forms of business organizations need to follow AS.

Need for Accounting Standards

1.  Accounting standards make the financial statements of different companies, across different countries comparable with each other.
2.  Accounting standards help us provide full information as the standards focus on full disclosure of information in the financial statements
3.  Accounting standards provide us with various alternate accounting solutions and treatments which can be followed by the entity