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Accounting is a systematic process of recording, classifying and summarising financial data with the object of finalisation, interpretation and presentation of the same. It is a service activity that collects, processes and communicates financial information of an enterprise.
Records and classifies data Summarizes the records maintained Finds out the net result of financial activities Exhibits the financial position of a concern Analyses and interprets financial data Communicates financial information Provides help for complying with legal necessities Validates the economic transactions Helps in best utilising the available resources
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or postulate or assumption is generally used to mean a mental notion or pattern or related ideas about accounting affairs which aim at achieving the accounting objectives. In different countries of the world, these terms have been explained differently but used interchangeably in many occasions. The different concepts used in accounting are: I. Proprietary Concept, II. Entity Concept, III.Fund Concept, IV.Monetary Measurement Concept, V.Accounting Period Concept, VI.Going Concern Concept, VII.Financial Transaction Concept, VIII.Dual Aspect Concept, IX.Matching Concept, X. Realization Concept, XI. Sequences Concept, & XII. Accounting Equation Concept 7
PROPRIETARY CONCEPT This is accepted as the oldest accounting concept developed at the end of the 16th century. It is that basic assumption where the owner of the business is considered as the centre of focus based on whom all business operations are carried out and business is not viewed separate from its owners. ENTITY CONCEPT In this concept, enterprise is viewed as a distinct unit completely separate from its owners and all the accounting activities are centered around the enterprise instead of its owners.
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FUND CONCEPT It is that accounting concept where instead of owner or separate entity an activity oriented unit is adopted as the basis of accounting. By activity oriented unit is meant one asset or a group of assets employed or created for performing any specific function. MONETARY UNIT OR MONETARY MEASUREMENT CONCEPT It is that basic assumption under which collection, measurement and presentation of accounting information are done through money because money is accepted as the dependable means of expressing different heterogeneous elements, it has universal recognition as medium of exchange and it is considered to be the 9 storehouse of wealth.
ACCOUNTING PERIOD CONCEPT In this concept, the total expected life span of the business is segregated into different small parts (usually consisting of 1 year period). Each of these small time spans is identified as separate accounting period at the end of which financial statements are prepared for finding out the end result of the transactions taken place during the said period and exhibiting the state of affairs of the concern.
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DUAL ASPECT CONCEPT It is one of the basic concepts of accounting the fundamental of which is for every debit there is a corresponding and equivalent credit. To judge each transaction on the basis of such receiving and giving benefit for the purpose of accounting is known as dual aspect concept. In dual aspect based double entry accounting system receiving of benefit by the concern is termed as debit, while giving benefit by the concern is identified as credit.
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MATCHING CONCEPT According to this concept when a given event affects both revenues and expenses, the effect on each should be recognized in the same accounting period.
REALIZATION CONCEPT Realization Concept is that concept where revenue is recognized usually when sales are made or services are rendered.
SEQUENCES CONCEPT How the accounting affairs are to be exhibited or dealt with through different probable sequences, is the subject 13 matter of Sequences concept.
concept has come out from the dual aspect of accounting. In this concept it is assumed that the entire accounting process can be represented by an algebraic equation. The main task of accounting is to record the financial transactions. Each financial transaction signifies the receiving of benefit by one party in exchange of giving benefit by the other party. From this very nature of financial transactions, the algebraic equation used in accounting has been originated. Each action has a reaction. In case of transaction also, this nature of action holds good. The benefits received by one party in any transaction are equal to the benefits given either at present or in future by another party to the former party.
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Conventions may be defined as the general agreement or usage and customary practices in social and economic life of human being which have certain bearings on the accounting functions or techniques. These are accounting policies adapted by the accounting communities on the basis of existing customs and traditions to achieve the accounting objectives. The different Conventions of accounting are: I. Convention of Disclosure, II. Convention of Materiality, III. Convention of Consistency, IV. Convention of Conservatism, V. Convention of Comparability, VI. Convention of Objectivity, VII. Convention of Historical Cost, VIII. Convention of Dependability.
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CONVENTION OF DISCLOSURE The fundamental proposition of this convention is that the financial statements are to be prepared in such a manner so that they fully disclose all the material financial information and do not conceal any material fact.
CONVENTION OF MATERIALITY As per this convention whether any information is to be disclosed in financial statements or not that depends on the relevance or significance of that information to the users. That is to say, instead of all information, only those information that are material and significant are to be stated in 16 financial statements.
CONVENTION OF CONSISTENCY The practice of applying same approaches, principles and methods of accounting in dealing with a class of events of same character in different accounting periods is identified as convention of consistency.
CONVENTION OF CONSERVATISM It is that convention where in income measurement and valuation of assets and liabilities the policies of minimum risk taking and adherence to orthodox, pessimistic and traditional techniques are followed. This convention is also named as playing safe principle. 17
stresses upon the objective evidence of the financial information recorded in accounting. Those financial information are only to be accounted for which have objective evidence and which are the outcome of factual events. It means that financial transactions recorded in accounting should be capable of being verified on the basis of documentary evidences.
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CONVENTION OF HISTORICAL COST It is one of the traditional conventions of accounting. The fundamentals of historical cost convention are:
i. ii.
CONVENTION OF DEPENDABILITY this is the convention under which the factor of dependence of users on accounting information is emphasized upon. The users of accounting information like owners, creditors, investors etc. very often take vital decisions based on the information supplied in financial statements. 19
An item is valued and recorded in accounting at their exchange price on the date of acquisition. In all the years starting from the year of acquisition assets are valued on the basis of past cost or original cost (less depreciation).
Accounting Standard is a common standard for accounting and reporting. Accounting Standards contain the principles governing accounting practices and determine the appropriate treatment of financial transactions. Accounting Standards are formulated with a view to harmonise different accounting policies and practices in use in a country. The objective of Accounting Standards is, therefore, to reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make 20 informed economic decisions.
ACCOUNTING STANDARDS
AS 1 Disclosure of Accounting Policies AS 2 Valuation of Inventories AS 3 Cash Flow Statements AS 4 Contingencies and Events Occurring after the Balance Sheet Date AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies AS 6 Depreciation Accounting AS 7 Construction Contracts AS 8 Accounting for Research and Development (Withdrawn pursuant to AS 26 becoming mandatory)
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AS 21 Consolidated Financial Statements AS 22 Accounting for Taxes on Income AS 23 Accounting for Investments in Associates in Consolidated Financial Statements AS 9 Revenue Recognition AS 10 Accounting for Fixed Assets AS 11 The Effects of Changes in Foreign Exchange Rate AS 12 Accounting for Government Grants AS 13 Accounting for Investments AS 14 Accounting for Amalgamations AS 15 Employee Benefits AS 16 Borrowing Costs AS 17 Segment Reporting
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AS 18 Related Party Disclosures AS 19 Leases AS 20 Earnings Per Share AS 24 Discontinuing Operations 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 AS 30 Financial Instruments: Recognition and Measurement AS 31Financial Instruments: Presentation
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Say Mr. R goes to a shop and buys some goods worth Rs.100 for cash. So Mr. R gives Cash and receives Goods The transaction will be recorded in the books of Mr. R to show the decrease in cash by Rs.100 and increase of stock of goods by Rs.100. On the other hand, the shop gives Goods and receives Cash. Now in the books of the shop, the transaction will be recorded to show the decrease in the stock of goods by Rs.100 and increase in its cash by Rs.100.
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Now let us see and explain how two accounts are affected by a financial transaction.
ASSETS
Assets are the economic resources or rights to prospective future economic benefits or services including certain deferred charges owned by an entity and these economic resources or rights accrue out of past transactions.
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ASSETS
REAL ASSETS FICTITIOUS OR UNREAL CONTINGENT ASSETS ASSETS CURRENT ASSETS
FIXED ASSETS
TANGIBLE INTANGIBLE TANGIBLE INTANGIBLE FIXED ASSETS FIXED ASSETS CURRENT ASSETS CURRENT ASSETS WASTING ASSETS NON-WASTING LIQUID ASSETS ASSETS CIRCULATING ASSETS
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LIABILITIES
Liabilities may be considered as a monetary or financial obligation payable otherwise than gratuitously by an entity to any source from which it has received some benefit.
LIABILITIES
EXTERNAL LIABILITIES
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The recording of business transactions in books of account results in an Accounting Equation. A business needs resources. These resources have to be supplied to the business by someone. The resources possessed by the business are known as ASSETS. To begin with, these resources are supplied by the owner of the business. The total amount supplied by him is known as CAPITAL or OWNERS EQUITY. If the proprietor is the only supplier of resources, i.e. assets, the following equation would hold true:
CAPITAL = ASSETS This can be illustrated with an example.
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Suppose Ram starts a business with Rs.5000 cash. Then the Accounting Equation would be
CAPITAL = ASSETS RAMS CAPITAL Rs.5000 = CASH Rs.5000 Some resources of the business are also provided by some persons other than the owner. The amounts owing by the business for these resources are known as LIABILITIES. In view of legal distinction between the claims of creditors (outside liabilities) and those of owners (ownership liabilities or owners equity or capital), the Equation can now be expressed as: CAPITAL + LIABILITIES = ASSETS
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The two sides of the Equation are always equal. On the right-hand side are the resources, i.e. assets possessed by the business. On the lefthand side are the sources from which these resources were obtained. The 2 sides will always be equal, no matter how many transactions are entered into. The Balance Sheet of a business is an expression of the Accounting Equation (also known as Balance Sheet Equation).
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CREDITORS
DEBTORS
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REAL ACCOUNTS
Debit what comes in Credit what goes out
PERSONAL ACCOUNTS
Debit the receiver Credit the giver
NOMINAL ACCOUNTS
Debit all expenses and losses Credit all gains and profits
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OVERVIEW
EQUITY
Equity Goodwill Capital Preference Land & Building Capital
FIXED ASSETS
CURRENT LIABILITIES
Creditors
CURRENT ASSETS
Debtors Cash
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LIABILITIES
Fixed Assets
ASSETS
Loan Funds
Bills Payable Creditors Unclaimed Dividend Provision for Taxation Proposed Dividend
Goodwill Land and Building Plant & Machinery Furniture & Fittings Patents, Trademarks, Designs, Copyrights Livestock
Fictitious Assets
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