MARWARI COLLEGE, RANCHI
(AN AUTONOMOUS UNIT OF RANCHI UNIVERSITY FROM 2009)
- Prakash Kumar, Dept. of CA
-External Expert: Suman Ji( Chartered Accountant)
__________________________________________________________________________________
Accounting Principles
➢ Accounting Principles
Accounting principles are the rules of
action or conduct adopted by accountants universally while recording accounting
transactions. GAAP refers 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
classified into two categories:
1) Accounting Concepts: They are the basic an assumption within which accounting
operates.
2) Accounting Conventions: These are the outcome of the accounting practices or principles
being followed over a long period of time.
• Features of accounting principles
(1) Accounting
principles are manmade.
(2) Accounting
principles are flexible in nature.
(3) Accounting
principles are generally accepted.
• Necessity
of accounting principles
Accounting information is meaningful
and useful for users if the accounting records and financial statements are
prepared following generally accepted accounting information in standard forms
which are understood.
• Types
of Accounting Principles
1) Accounting Entity or Business Entity
Principle: An entity has a separate existence from
its owner. According to this principle, business is treated as an entity, which
is separate and distinct from its owner. Therefore, transactions are recorded
and analyzed, and the financial statements are prepared from the point of view
of business and not the owner. The owner is treated as a creditor (Internal
liability) for his investment in the business, i.e. to the extent of capital
invested by him. Interest on capital is treated as an expense like any other
business expense. His private expenses are treated as drawings leading to
reductions in capital.
2) Money Measurement Principle: According to this principle, only those transactions that are
measured in money or can be expressed in terms of money are recorded in the
books of accounts of the enterprise. Non-monetary events like death of any
employee/Manager, strikes, disputes etc., are not recorded at all, even though
these also affect the business operations significantly.
3) Accounting Period Principle: According to this principle, the life of an enterprise is divided
into smaller periods so that its performance can be measured at regular
intervals. These smaller periods are called accounting periods. Accounting
period is defined as the interval of time, at the end of which the profit and
loss account and the balance sheet are prepared, so that the performance is
measured at regular intervals and decisions can be taken at the appropriate
time. Accounting period is usually a period of one year, which may be a
financial year or a calendar year.
4) Full Disclosure Principle: According to this principle, apart from legal requirements,
all significant and material information related to the economic affairs of the
entity should be completely disclosed in its financial statements and the
accompanying notes to accounts. The financial statements should act as a means
of conveying and not concealing the information. Disclosure of information will
result in better understanding and the parties may be able to take sound
decisions on the basis of the information provided.
5) Materiality Principle: According to this principle, only those items or information
should be disclosed that have a material effect and are relevant to the users.
Disclosure of all material facts is compulsory but it does not imply that even
those figures which are irrelevant are to be included in the financial
statements. Whether an item is material or not depends on its nature. So, an
item having an insignificant effect or being irrelevant to user need not be
disclosed separately, it may be merged with other item. If the knowledge about
any information is likely to affect the user’s
decision, it is termed as material information.
6) Prudence or Conservatism Principle: According to this principle, prospective profit should not
be recorded but all prospective losses should immediately be recorded. The objective
of this principle is not to overstate the profit of the enterprise in any case
and this concept ensures that a realistic picture of the company is portrayed.
When different equally acceptable alternative methods are available, the method
having the least favorable immediate effect on profit should be adopted.
7) Cost Principle or Historical cost
concept: According to this Principle, an asset
is recorded in the books of accounts at its original cost comprising of the
cost of acquisition and all the expenditure incurred for making the assets
ready to use. This cost becomes the basis of all subsequent accounting
transactions for the asset. Since the acquisition cost relates to the past, it
is referred to as the Historical cost.
8) Matching Principle: According to this principle, all expenses incurred by an
enterprise during an accounting period are matched with the revenues recognized
during the same period. The matching principle facilitates the ascertainment of
the amount of profit earned or loss incurred in a particular period by
deducting the related expenses from the revenue recognized in that period. It
is not relevant when the payment was made or received. This concept should be
followed to have a true and fair view of the financial position of the company.
9) Dual Aspect Principle: According to this principle, every business transaction has
two aspects - a debit and a credit of equal amount.
In other words, for every debit there
is a credit of equal amount in one or more accounts and vice-versa. The system
of recording transactions on the basis of this
principle is known as “Double Entry System”.
Due
to this principle, the two sides of the Balance Sheet are always equal and the following
accounting equation will always hold good at any point of time.
Assets
= Liabilities + Capital
Example: Ram started business with cash Rs. 1,00,000.
It increases cash in assets side and capital in liabilities-
side by Rs. 1,00,000.
Assets Rs. 1,00,000 = Liabilities + Capital Rs. 1,00,000.
10) Revenue Recognition Concept: This principle is concerned with the revenue being recognised
in the Income Statement of an enterprise. Revenue is the grass inflow of cash, receivables
or other considerations arising in the course of ordinary activities of an enterprise
from the sale of goods, rendering of services and use of enterprise resources
by others yielding interests, royalties and dividends. It excludes the amount
collected on behalf of third parties such as certain taxes. Revenue is recognised
in the period in which it is earned irrespective of the fact whether it is
received or not during that period.
11) Verifiable Objective concept: This concept holds that accounting should be free from personal
bias. This means that all business transactions should be supported by business
documents like cash memo, invoices, sales bills etc.
➢ Fundamental Accounting Assumptions
1) Going Concern Assumption: This concept assumes that an enterprise has an indefinite life
or existence. It is assumed that the business does not have an intention to
liquidate or to scale down its operations significantly. This concept is
instrumental for the company in:
1. Making a distinction between capital expenditure and
revenue expenditure.
2. Classification of assets and liabilities into current and
non-current.
3. Providing depreciation charged on fixed assets and
appearance in the Balance Sheet at book value, without having reference to
their market value.
4. It may be noted that if there are good reasons to believe
that the business, or some part of it, is going to be liquidated or that it
will cease to operate (say within a year or two), then the resources could be
reported at their current values (or liquidation values).
2) Consistency Assumption: According to this assumption, accounting practices once selected
and adopted, should be applied consistently year after year. This will ensure a
meaningful study of the performance of the business for a number of years.
Consistency assumption does not mean that particular practices, once adopted,
cannot be changed.
The only requirement is that when a
change is desirable, it should be fully disclosed in the financial statements
along with its effect on income statement and Balance Sheet.
Any accounting practice may be changed
if the law or Accounting standard requires so, to make the financial
information more meaningful and transparent.
3) Accrual Assumption: As per Accrual assumption, all revenues and costs are
recognized when they are earned or incurred. This concept applies equally to
revenues and expenses.
It is immaterial, whether the cash is
received or paid at the time of transaction or on a later date.
➢ Bases of Accounting
There are two bases of ascertaining
profit or loss, namely:
1) Cash basis
Under this, entries in the books of
accounts are made when cash id received or paid and not when the receipt or
payment becomes due.
For example, if salary Rs. 7,000 of January 2010 paid in
February 2010 it would be recorded in the books of accounts only in February,
2010.
2) Accrual basis
Under this however, revenues and costs
are recognized in the period in which they occur rather when they are paid. It
means it record the effect of transaction is taken into book in the when they
are earned rather than in the period in which cash is actually received or paid
by the enterprise. It is more appropriate basis for calculation of profits as
expenses are matched against revenue earned in the relation thereto.
For example, raw materials consumed are matched against the
cost of goods sold for the accounting period.
Difference between accrual basis of
accounting and cash basis of accounting
|
Basis
|
Accrual Basis of Accounting
|
Cash Basis of accounting
|
|
1) Recording of
Transactions
|
Both cash and credit
transactions are recorded.
|
Only cash transactions are
recorded.
|
|
2) Profit or Loss
|
Profit or Loss is ascertained correctly
due to complete record of transactions.
|
Correct profit/loss is not
ascertained because it records
only cash transactions.
|
|
3) Distinction
between Capital
and Revenue
items
|
This method makes a
distinction between capital
and revenue items.
|
This method does not make a distinction
between capital and revenue items.
|
|
4) Legal position
|
This basis is recognized under the
companies Act
|
This basis is not recognized under the
companies Act or any other act.
|
➢ Accounting Standards (AS)
“A mode of conduct imposed on an
accountant by custom, law and a professional body.” – By Kohler
• Concept
of Accounting Standards
Accounting standards are written
statements, issued from time-to-time by institutions of accounting
professionals, specifying uniform rules and practices for drawing the financial
statements.
• Nature
of accounting standards
1) Accounting
standards are guidelines which provide the framework credible financial statement
can be produced.
2) According to
change in business environment accounting standards are being changed or revised
from time to time.
3) To bring
uniformity in accounting practices and to ensure consistency and comparability is
the main objective of accounting standards.
4) Where the
alternative accounting practice is available, an enterprise is free to adopt.
So accounting standards are flexible.
5) Accounting standards are amendatory in nature.
• Objectives
of Accounting Standards
1) Accounting standards are required to
bring uniformity in accounting practices and policies by
proposing standard treatment in preparation of financial statements.
2) To improve reliability of the
financial statements: Statements
prepared by using accounting standards are reliable for various users, because
these standards create a sense of confidence among the users.
3) To prevent frauds and manipulation by codifying the accounting methods and practices.
4) To help Auditors: Accounting standards provide uniformity in accounting
practices, so it helps auditors to audit the books of accounts.
➢ IFRS International Financial Reporting
Standards
This term refers to the financial
standards issued by International Accounting Standards Board (IASB). It is the
process of improving the financial reporting internationally to help the
participants in the various capital markets of the world and other users.
• IFRS
Based Financial Statements
Following financial statements are
produced under IFRS:
1) Statement of
financial position: The elements of this statement are:
(a) Assets
(b) Liability
(c) Equity
2) Comprehensive
Income statement: The elements of this statement are (a) Revenue (b) Expense.
3) Statement of
changes in Equity.
4) Statement of
Cash flow.
5) Notes and
significant accounting policies.
• Objectives
of IFRS
1) To develop the
single set of high quality global accounting standards so users of information
can make good decisions and the information can be comparable globally.
2) To promote the use of these high quality standards.
3) To fulfill the special needs of small and medium size entity by
following above objectives.
• Benefits of IFRS
1) Global comparison of financial statements of any companies is
possible.
2) Financial statements prepared by using IFRS shall be better
understood with financial statements prepared by the country specific
accounting standards. So the investors can make better decision about their
investments.
3) Industry can raise or invest their funds by better understanding
if financial statements are there with IFRS.
4) Accountants and auditors are in a position to render their
services in countries adopting IFRS.
5) By implementation of IFRS accountants and auditors can save the
time and money.
6) Firm using IFRS can have better planning and execution. It will
help the management to execute their plans globally.
