UNIT-5 FINANCIAL ACCOUNTING

INTRODUCTION
Accounting is the process of identifiying, measuring and communicating economic
information to permit informed judgments and decisions by users of information.
Meaning and Scope of Accounting
Accounting is the language of business. The main objective of Accounting is to
safeguard the interest of the business, its properties and others connected with the business
transactions. This is done by providing suitable information to the owners, creditors,
shareholders, Government, financial institutions and others related agencies.
Definition of Accounting
The American Accounting Association defines accounting as the process of identifying,
measuring and communicating economic information to permit informed judgment and decisions
by the users of the information.
According to AICPA (American Institute of Certified Public Accountants) it is defined as
the the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are in part at least of a financial character and interpreting
the result thereof.
Accounting principles:
Accounting principles are guidelines & standards, which have been accepted by the
accounting profession in preparation and presentation of accounts of the business. It is approved
and normally accepted by the government bodies & controlling authorities.
Accounting principles are not universal and permanent as they are not discovered but are
developed by man from time to time. Thus the development of accounting principles is a
continuous process.
Accounting principles are of two parts,
Concepts
Conventions




Characteristics of Accounting Concepts:-
1. Accounting concepts are continuously changing and evolving: In the event of rapidly changing
economic activities, accounting concepts also undergo frequent changes. This is a healthy sign
for the accounting fields.
This is because of the following two main reasons.
It is relatively a new field and hence it is developing with time.
Some aspects tend to change with the changes in social, economic and commercial
conditions.
2. Another important feature of accounting concepts is the interrelationship among the different
concepts. Most of the concepts do not stand by themselves; they depend on the other concepts to
a large extent.
Golden Rules of Accounting :
Personal Account: Debit the Receiver and Credit the Giver.

Real Account: Debit what Comes In and Credit what Goes Out.

Nominal Account: Debit all Expenses and Losses and Credit all Gains and Incomes.

Understanding of financial statements:
Finance may be defined as the art and science of managing money. A financial statement
is an organized collection of data according to logical and consistent accounting procedures.
Financial statements are final results of accounting work done during the accounting period.
Financial management: Concerned with the duties of the financial managers in the business
firm.
Financial managers: Actively manage the financial affairs of any type of business, namely,
financial and non-financial, private and public, large and small, profit seeking and not-for-profit.
Financial statement: Financial statement provides a summarized view of the financial position
and operations of a firm. Therefore, much can be learnt about a firm from careful examination of
its financial statements as invaluable documents/performance reports. The analysis of financial
statement is, thus, an important aid to financial analysis.
Journal:-
Journal is the book of Original Entry or First Entry which is used for recording
of all business transaction in chronological order. Then it is posted to ledger. This process is
known as Entering. In other words record of the each transaction is called as Journal Entry.
The process of recording in the journal is called as Journalizing.
Ledger:-
A Ledger Account may be defined as a Summary statement of all transactions
relating to a person, asset, expense or income which have taken place during a given period of
time and showing their net effect. From the above definition, we can observe that Ledger is
designed as the book of second stage in the accounting cycle which is used for recorded
transactions which are classified and grouped into different head of accounts.
Trial Balance:-
To ensure the proof of completion and arithmetical correctness of the books of
account, it is essential to prepare the trial balance. In the first stage of accounting all business
transactions are recorded in Journal or Subsidiary books. Then they are transferred to ledger by
posting to relevant accounts. The fundamental principles of double entry system of accounting is
that for every debit, there must be a corresponding and equal credit. Therefore, when all the
accounts of a concern are thus balanced in the ledger at the end of the period, a statement is
prepared to show the list of debit balances on one side and credit balances on the other side. This
list so prepared is called as Trial Balance. Accordingly the total of the debit side of trial
balance must be equal to that of its credit side.
MANAGEMENT ACCOUNTING
MEANING
The term management accounting refers to accounting for the management (i.e.) accounting
which provides necessary information to the management for discharging its function. The
functions of the management are Planning, Organizing, Directing and Controlling of business
operations can be done in an orderly and effective manner.
DEFINITION
The definition given by the American Accounting Association is as follows;
Management Accounting is the application of appropriate techniques and concepts in
processing historical and projected economic data of an entity to assist management in
establishing plans for reasonable economic objectives and in the making of rational decisions
with a view towards achieving these objectives.
FUNCTIONS
A) PLANNING B) IMPLEMENTATION C) CONTROL
Planning
It is the process of deciding what action should be taken in the future. A plan may be made for
any segment or for the organization as the whole.
An important form of planning is budgeting. Budgeting is the process of planning the overall activities
Implementation
Implementation involves specific actions planned in advance to fulfill the budgets. It requires
supervision on the part of the managers. A key managerial responsibility is to change previous
plans appropriately to adjust for new conditions.
Control
It is the process to ensure that employees perform properly. Accounting information is used in
the control process as a means of communication, motivation getting attention and for appraisal.
FINANCIAL ACCOUNTING
Meaning
Financial Accounting has a single, unified structure in the sense that the information relating to
the operations of various enterprise is presented on a more or less uniform basis.
Financial Accounting designed to serve parties external to the operating responsibility of the
firm. Eg Creditors, Investors, Employees, Banks etc.It is basically concerned with the recording,
classifying and summarizing in a significant manner and in terms of money transactions and
events which are in part at least of a financial character and interpreting the result there of.
FUNCTIONS
Recording
Financial accounting ensures that all financial transactions are properly recorded. Recording
done in the book of JOURNAL.
Classifying
Classification is concerned with the systematic analysis of the recorded data with a view to group
transactions or entries of nature at one place. The work of classification done in the book of
LEDGER.
Summarising
This involves presenting the classified data in a manner which is understandable and useful to
the internal as well as external end users of accounting statements. This process lead to the
preparation of following statements.
a) Trial balance b) Income statement c) Balance sheet.
LIMITATIONS
1) Provides only limited information
2) Treats figures as single, simple and silent items.
3) Provides only a post-modem record of business transaction
4) Covers only quantifiable information
5) Fails to provide information needs of different levels of management.
COST ACCOUNTING
Cost Accounting refers to the process of determining the cost of particular product or activity. It
provides useful data for both internal and external reporting. Internal report present details of
cost information regarding cost of specific product or services while external reports contain cost
data in a summarized and aggregate form.
E.g.: Internal report refers to manufacturing cost of product; External cost refers to sales volume
of the company
OBJECTS AND FUNCTIONS OF COST ACCOUNTING
The main objects or functions of costing are as follows:
1) Analysis and Ascertainment of costs:
The main object of costing is to ascertain the cost of each product, process, department, service
or operation. For the ascertainment of costs it involves further the study, analysis and
classification of costs such as Prime cost, works cost, production costs,etc.Various methods,
systems and techniques of costing have been developed for the purpose of recording and
determining costs.
2) Presentation of costs for cost reduction and cost control:
Another important function of costing is to control and reduce costs. Unless efficiently
controlled,costs have a tendency to increase and cross the limits. Properly collected cost data
helps in controlling and maintaining cost at the lowest. The right and appropriate cost
information is made available to the right man, who needs them, at the right time and in a proper
form.

3) Planning and Decision making
Cost accounting has developed beyond its traditional function of cost determination and
cost control. It has now developed as a tool in the hands of the management for planning
and taking crucial decisions like pricing of products, introduction of a new product in the
market, make or buy decisions, expansion or contraction, replacement of machinery, shut
down decisions, wages compensation plan, choice among various alternatives,etc.
IMPORTANCE AND ADVANTAGES OF COST ACCOUNTING
a) Cost accounting as an Aid to Management:
Cost accounting helps the management in carrying out its functions, i.e.planning,
organizing, controlling, decision-making, budgeting and pricing efficiently by providing
cost information to the management.
b) Advantages to Employees
An efficient costing system reduces the cost and increases the profits of concern thus
ensuring greater security of service and increased wages to the employees. cost accounting
also helps in introducing incentive wage schemes and bonus plans which bring more
reward to efficient employees.
c) Advantages to the creditors, investors and bankers
Creditors, investors, bankers and others who lend money to the business are also benefited
by the introduction of cost accounting in a concern. It enables the creditors, bankers and
investors to judge the financial position and solvency of a concern by providing the reliable
cost data.
d) Advantages to the government and the society
Cost accounting increases the efficiency of a concern, reduces cost and increases the
profits.thus,it promotes the overall economic development of the country.

LIMITATIONS
1) It is not an independent system of accounts.
2) It is based largely on estimates like absorption of indirect expenses or apportionment
of expenses on estimate basis.
3) There is a scope for subjectivity on items like depreciation, valuation of closing stock
etc.
4) It does not take into consideration all items of expenses and incomes example: items
of purely financial nature such as interest, finance charges,etc.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAPs)
Financial accounting is prepared in accordance with the GAPPs. Accounting is the language of
business as it is the principal means by which information about a business is communicated to
those interested in it. If therefore, the information is to be communicated effectively and
understood properly, it should be prepared in accordance with a mutually understood set of rules.
These ground rules are referred to as GAPPs.
Accounting principles are classified into two categories as i) Accounting concepts ii)
Accounting conventions.
I) ACCOUNTING CONCEPTS
The term accounting concepts is used to connot basic accounting postulates, i.e., necessary
assumptions and a condition upon which accounting is based. Some of the important accounting
concepts are as follows:
1) BUSINESS ENTITY CONCEPT
In accounting business is treated as a separate entity from its owners. Accounts are
prepared to give information about the business and not those who own it. A distinction is
made between business transactions and personal transaction and also between business
property and personal property of the owners. The business entity concept is necessary to
ascertain the results of business operations. In case the private and business transactions
are not segregated, it will not be possible to determine true protitability of the concern.
2) GOING CONCERN CONCEPT
It is presumed that the business concern will continue to exist indefinitely or at least in
the near future. The present resource of the concern is utilized to attain the long term
objectives of the business. This concept is very important in relation to the recording of
transactions and preparation of financial statements. For example, it is only this
assumption that while preparing final accounts of the concern, fixed assets are shown in
the balance sheet at diminishing balance method, i.e. going concern value
3) THE COST CONCEPT
The accounting records are based on cost concept. This concept is closely related to the
going concern concept. The assets and liabilities of a business are shown at a cost which
has been paid or agreed upon between parties. The figures are recorded on objectivity
basis. There is no room for personal assessment or bias in showing the figures. If
subjectivity is followed in records then same assets will be valued at different figures by
different individuals. Everybody will have his own view about various assets.so cost
concept is helpful in making truthful records. The records become more reliable and
comparable.
4) DUEL ASPECT CONCEPT
This concept lies at the heart of whole accounting system. Modern accounting system is
based on dual aspect concept. It is based on the principle that for every debit transaction.
There must be giver of benefit and also a taker of it. Suppose A purchase a building of
Rs.20,000,he will get building and will part with the cash for similar amount. So one
account will be debited another account will be credited The debits will be equal to
credits. The dual aspect concept has credited the system of double entry book-keeping. It
is because of this concept that the total claims of outsiders and owners are always equal
to total assets of the concern. In form of accounting or balance sheet equation. External
Liabilities + capital =Total Assets or, Total Liabilities = Total Assets or, Assets
Liabilities=Capital.
5) MONEY MEASUREMENT CONCEPT
According to this concept only those transactions are recorded in accounting which can
be expressed in terms of money. Money provides a mechanism by which real resources
can be transferred among different individuals. Money is accepted as a medium of
exchange for goods and services. One is prepared to sell ones property in exchange for
money. The debtors and creditors are willing to pay and receive money in near future.
Thus, money acts as a medium for immediate exchange for goods and services and also
as a standard for deferred payments. It is because of this concept that quantitative or non-
monetary things/transactions are either omitted or recorded separately and do not find any
place in the financial statements of a firm.
6) ACCOUNTING PERIOD/ACCURAL CONCEPT
Financial position and profitability of a concern are assessed at a interval called
Accounting period. While preparing profit and loss account of a concern all revenue
items related to that period are taken into consideration irrespective of the fact that
whether these items are paid or payable. Similarly, a balance sheet is prepared to reveal
the financial position of the concern on a particular date.
7) REALISATION CONCEPT
This concept is related to the realization of revenue. The revenue is realized either from
sale of products or from rendering of services. The sale involves a number of stages such
as receipt of order, production or assembling of goods, dispatch of goods, transfer of
ownership, and receipt of money. A question arises as to when should the revenue be
considered ? As a general principle, sales or profit on sales will be considered to be
realized when either money (cash) is realized or legal obligation is created, i.e. ownership
or title to the goods is transferred.
8) MATCHING OF COST AND REVENUE CONCEPT
As a general principle, the costs are matched to revenues to measure the profits .A
distinction between present, past and future expenditure as well as capital and revenue
expense is necessary. The revenues and cost of the same period, product or service are
matched. Similarily, the expense whose utility is to be derived over a number of years are
taken to the balance sheet as deferred revenue expenditure. Capital expenditures become
a part of cost over a number of years through depreciation.
ACCOUNTING CONVENTIONS
Accounting Conventions are the traditions, usage and customs which are in use since long. The
most important conventions which have been in use are disclosure, consistency, conservation
and materiality.
1. Convention of Disclosure:
The disclosure of all significant information is one of the important accounting conventions.
It implies that accounts should be prepared in such a way that all material information is
clearly disclosed to the reader. This information should not only include figures given in the
final accounts but also information which occurs after the preparation of balance sheet but
before the presentation of financial statements. The idea behind this convention is that
anybody who wants to study the financial statements should not be prejudiced by
concealing any facts. He should be able to make a free judgment.
2. Convention of Consistency:
The convention of consistency means that same accounting principles should be used for
preparing financial statements for different periods. It enables management to draw
important conclusions regarding the working of the concern over a longer period. It allows a
Comparison in the different periods. If different accounting procedures and processes are
Used for preparing financial statements of different years then the results will not be
comparable because these will be based on different postulates.
3. Convention of Conservatism:
The conversion of conservatism means cautious approach or policy of play safe. This
convention ensures that the uncertainties and risks inherent in business transactions should
be given proper consideration. If there is possibility of loss, it should be taken into account
at the earliest. On the other hand, a prospect of profit should be ignored upto the time it does
not materialize.
4. Convention of Materiality:
According to this convention only those events should be recorded which have a significant
bearing and insignificant things should be ignored. The avoidance of insignificant things
will not materiality affects the records of the business. It should be seen that the efforts
involved in recording the events should be worth the labour involved in it. There is no
formula in making a distinction between material and immaterial events. It is a matter of
judgment and it is left to the accountant for taking a decision.
BALANCE SHEET AND RELATED CONCEPTS
The balance sheet is a statement, which shows the financial position of a business on a particular
date. It is a statement of balance of all the accounts real, personal, Debit balances of all such
accounts represent assets and credit balances represent the liabilities. Thus, balance sheet shows
the assets and liabilities grouped properly classified and arranged in a specific manner.


Objectives of Preparing a Balance Sheet
Principal objective: The main purpose of preparing balance sheet is to know the
financial position of the business at a particular date.
Subsidiary Objectives: Though the main aim is to know the exact financial position of
the firm at a particular date, yet it serves other purpose as well.
It gives information about the actual and real owners equity, yet some other liabilities
are to be accounted for against it also.
It helps the firm to make provisions against possible future losses. A provision is made in
the form of the reser
What information does it convey to an outsider?
Balance sheet is prepared with a view to measure the true financial position of a business
concern at a particular point in time. It shows the financial position of a business in a systematic
form.
The various groups interested in the company can draw useful inferences from an analysis of the
information contained in the balance sheet.
Similarly, other interested parties like regulatory and developmental agencies of the government,
consumer, and welfare organizations can derive useful conclusions from a study of the balance
sheet about the working of the corporate sector and its contribution to the national economy.
CLASSIFICATION OF BALANCE SHEET ITEMS:
Owners Equity
Assets Fixed Assets
Accrued Liabilities
Contingent liability
Accounts Receivables
Owners Equity
Owners equity is the residual interest in the assets of the enterprise. Therefore the owners
equity section of the balance sheet shows the amount the owners have invested in the entity.
However, the terminology Owners Equity varies with different forms of organization
depending upon whether the enterprise is a joint stock company or sole
proprietorship/partnership concern.
Assets
The entire property of all kinds possessed by or owing to a person or organization is called
Assets.Assets are valuable resources owned by a business and acquired at a measurable money
cost. They may be
Fixed Assets:
These are those assets, which are acquired for relatively long periods for carrying on the
business of the enterprise. Such assets are not meant for resale. For example, Land and Building,
plant and machinery etc.
Current Assets:
These assets are also termed as Floating or Circulating Assets. Such assets are acquired with
the intention of converting them into their values constantly. The essential difference between
Current Assets and Fixed Assets is that the current assets are held essentially for a short
period and they are meant for converting into cash. Unsold stock, debtors bills receivables, bank
balance, cash in hand, etc are some of the examples of current Assets.
Fictitious Assets:
Assets of no real value but included in the balance sheet for legal or technical reasons, e.g.,
preliminary expenses.
Tangible and Intangible Assets:
Tangible assets are those assets, which can be seen and touched i.e. assets having their physical
existence e.g. assets having their physical existence e.g. land and building, plant and machinery,
furniture and fixtures, stock-in-trade, cash, etc.
Intangible assets cannot be normally soli in the open market since they are not having any
physical existence e.g. Good will, patents, trademarks, prepaid expenses etc.
Liquid Assets:
Assets that can be easily converted into cash like Bank account, Bills receivable, etc. As a matter
of fact, all current assets excluding stock-in-hand and prepaid expenses are called liquid assets.
Wasting Assets:
These are the assets which are exhausted with, or which lose themselves in, the goods they
produce. Mines and quarries are common examples of such assets. Copyright, patents,
trademarks, etc. are also classified as wasting assets since they get exhausted with the lapse of
time.
FIXED ASSETS
These are those assets, which are acquired for relatively long periods for carrying on the
business of the enterprise. Such assets are not meant for resale. For resale. For example, Land
and Building, plant and machinery, etc. Current Assets provide benefits to the organization by
their exchange into cash. In the case of fixed assets, value addition arises by facilitating the
process of production or trade.
Fixed assets normally include assets such as land, building, plant, machinery, etc. All these
items, with exception of land are depreciated. Land is not subject to depreciate and hence shown
separately from other fixed assets.
ACCRUED LIABILITIES
Accrued Liabilities represents expenses or obligations incurred in the previous accounting
period but the payment for the same will be made in the next period. In many cases where
payments are made periodically, such as wages, rent and similar items, the last months payment
many appear as accured liabilities.(especially if the practice is to pay the same on the first
working day of a month. This obligation shown on the balance sheet indicates that the firm owed
the said amount on the balance sheet date.
ACCOUNTS RECEIVABLES
Accounts receivables are amounts owed to the company by debtors. This is the reason why we
also use the term sundry debtors to denote the amounts owed to the firm. This represents
amounts usually arising out of normal commercial transactions. In other words, accounts
receivable or sundry debtors represents unpaid customer accounts. These are also known as
trade receivables, since they arise out of normal trading transactions. Trade receivables arise
directly from credit sales and as such provide important information for management and
outsiders. In most situations these accounts are unsecured and have only the personal security of
the customer.
PROFIT AND LOSS ACCOUNT CONCEPT
The determination of Gross profit or gross loss is done by preparation of Trading account. But
it does not reveal the Net profit or Net loss of a concern during the particular period. This is the
second part of the income statement and is called as Profit and Loss account. The purpose of
preparing the profit and loss account to calculate the Net profit or Net loss of a concern. Net
profit refers to the surplus which remains after deducting related trading expenses from the gross
profit. The trading expenses refer to inclusive of office and administrative expenses, selling and
distribution expenses.
In other words, all operating expenses such as office and administrative expenses, selling and
distribution expenses and non operating expenses are shown on the debit side and all operating
and non operating gains and incomes are shown on the credit side of the profit and loss account.
The difference of two sides is either Net profit or Net loss. Accordingly, when total of all
operating and non-operating expenses is more than the Gross profit and other non-operating
incomes, the difference is the Net profit and in the reverse case it is known as Net loss. This Net
profit or Net loss is transferred to the capital account of balance sheet.
PROFIT AND LOSS ACCOUNT RELATED CONCEPTS
Components appearing on debit side of the profit and loss A/c
Those expenses incurred during the manufacturing process of convention of raw materials into
finished goods will be treated as direct expenses which are recorded in the debit side of the
Trading account. Any expenditure incurred subsequent to that will be known as indirect expenses
to be shown in the debit side of the profit and loss account. The indirect expenses may be
classified into 1) Operating Expenses and 2) Non-Operating expenses.
1) Operating Expenses:
It refers those expenses as the day-to-day expenses of operating a business include office
& administrative expenses, selling and distribution expenses.
2) Non-Operating Expenses:
These expenses incurred other than operating expenses. Non-operating expenses which
are related to a financial nature. For example, interest payment on loans and overdrafts,
loss on sale of fixed assets, writing off fictitious assets such as preliminary expenses,
under writing commission etc.







Components appearing on credit side of profit & loss account
The following are the components are shown on the credit side:
1) Gross profit brought down from Trading Account
2) Operating Income: It refers to income earned from the operation of the business
excluding Gross profit and Non-operating incomes.
3) Non-Operating Income:
Non-Operating incomes refer to other than operating income. For example, interest on
investment of outside business, Profit on sale of fixed assets and dividend received etc.
FORMAT
TRADING ACCOUNT FOR THE YEAR ENDED------------------

Particulars Amt Amt Particulars Amt Amt

To Opening stock By sales
To Purchase (-) sales returns
(-) Purchase return By closing stock
To carriage inward By gross loss
To Freight (balancing figure)
To clearing charges
To wages
To Direct Expenses
To Gross Profit
(Balancing Figure)








P&L ACCOUNT FOR THE YEAR ENDED------------------
PARTICULARS Amt Amt Amt Amt
To gross loss By gross profit
To salaries By interest received
To office rent By discount received

To office expenses/general By commission received
Expenses/Administrative By bad debts recovered
expense/
Sundry expenses By net loss transferred to
To telephone charges/rents Balance sheet
To rent and taxes
To insurance
To printing and stationary
To audit fees
To postage and telegram
To interest paid
To bank charges
To commission paid
To discount allowed
To advertisement
To bad debts
To carriage outward
To depreciation
To net profit transferred
To balance sheet








BALANCE SHEET

LIABILITIES ASSETS
Capital Goodwill
(+) Net profit Land
(-)Net loss Building
Drawing House holds
Reserves and surplus Railway sidings
Debentures Plant and machinery
Equity share Patents and trademarks
Preference shares Livestock
Loan and advances Vehicles
Short term loans Stock
Sundry creditors Sundry debtors
Bills payable cash and bank balance
Outstanding expenses Prepaid expenses
Provision for taxation Preliminary expenses
Prepaid dividend Closing stock










INFLATION ACCOUNTING

INTRODUCTION
The basic objective of Accounting is the preparation of financial statements is a way that
they give a true and fair view of the operating results and the financial position of the business to
its various users, namely investors, creditors, management, Government, trade unions, research
institutions etc. These financial statements are prepared based on certain accounting concepts
and conventions. The money measurement concept is a basic attribute of accounting.
The money measurement concept states that only those business transactions that are
capable of being expressed in terms of money can be recovered in the books of account. It also
assumes that the monetary unit used for recording the transaction is stable in nature. However,
this is not true in practice as many countries, developed as well as developing, have been
experiencing inflation of high magnitude in recent times. Inflation refers to state of continuous
rise in prices. It brings downward changes in the purchasing power of monetary unit. Thus,
financial statements prepared without taking into account the change in purchasing power of the
monetary unit lose their significance. There is a demand that business enterprises should prepare
inflation adjusted financial statements. The different ways through which financial accounts can
be adjusted for changing prices is studied under the subject Inflation Accounting. Given that
price changes can also be downward, it is more appropriately called Accounting for price level
changes.

METHODS OF ACCOUNTING FOR PRICE LEVEL CHANGES
There is no consensus on the method to be adopted for adjusting the financial statements
for price level changes. Price level changes can be broadly classified into general price level
changes and specific price changes. General Price changes reflect the overall increase or
decrease in the value of monetary unit. The changes in wholesale price index (WPI) or the
consumer price index (CPI) are examples of such price level changes. Specific price refer to
changes in the price of a specific asset. It is important to note that the price of a particular asset
may not follow the same trend as WPI or CPI.
They are:
1. Current Purchasing Power (CPP) method, based on changes in general price level changes
2. Current Cost Accounting (CCA) method, based on changes in prices of specific assets.

1. Current Purchasing Power method:
a) Conversion Factor
b) Calculation of Net Monetary Gain/Loss
c) Impact of change in price level on Monetary Items
d) Calculation of Monetary Gain/Loss
e) Valuation of Inventory and Cost of goods sold
i) FIFO
ii) LIFO
f) Fixed Assets and Depreciation
g) Other Points
i) Taxation
ii) Interest on Debentures
iii) Dividends
iv) Capital
Current Purchasing Power (CPP):
CPP Method of inflation accounting seeks to use general purchasing power price of money rather
than specific indices to convert the historical figures into relevant figures of purchasing power
for the end of the period in review.
In simple terms, the conversion process of historical figures into CPP figures involves two steps:

Multiplying the Historical Cost figures by the price index at the end of the
period;
Dividing the figures obtained in Step (i) above by the index which existed at the
date of original transaction.
e.g. : Historical Cost figures

1.1.85 - Fixed Assets - Rs. 2,00,000/-
Index on 1.1.85 - 120
Index on 31.12.87 - Date of review 150
Conversion = 2,00,000 X 150 = Rs. 2,50,000
120
The conversion process is discussed below in following 3 sections:

a. Balance Sheet at the beginning of the year;
b. Profit and Loss a/c for the year and
c. Balance sheet at the end of the year

a. Balance sheet at the beginning of the year:
For the sake of convenience, the Balance Sheet is viewed as comprising of 3 parts:
1. Monetary Assets;
2. Non-Monetary Asset and
3. Shareholders Fund

1. Monetary Assets:

They comprise of Debtors, cash, creditors etc. The CPP method assumes that the value of
these assets on the Balance sheet date reflect the CPP as at the end of the previous year.
These figures are converted into CPP figures as follows:

Index at the end
Historical Cost X ------------------------------------------------
Index on the date of Balance Sheet



2. Non-Monetary Assets

These are discussed in 3 heads:

i. Fixed Assets

Index at the end
Historical Cost figures X ------------------------------------------------
Index on the date of Acquisition


ii. Depreciation
Index at the end
Accumulated Depreciation X ------------------------------------------------
Index on the date of Acquisition

If assets are acquired over a period of time, calculations would have to be made
separately for each of the acquisition.

iii.Stock
In converting Historical cost figures of stock, the first step is to identify the period
during which the items in stock were purchased and then a price index representative
of the price level during such period is identified.

iv.Shareholders Funds:
It is not possible to convert shareholders funds i.e. share capital + Accumulated
Reserves on historic cost figures into CPP figure by multiplying with any specific
index. It is arrived at by subtracting all liabilities at CPP from the assets both fixed
and current at CPP.


b. Profit and Loss Account:
Discussed under four sections:
1. Stock at the beginning of the year
2. Transactions during the year
3. Depreciation written off for the year and
4. Loss of purchasing power during the year because of holding monetary assets.

1. Stock at the beginning of the year:
Same as discussed under Non-Monetary Assets.
2. Transactions during the year:
Normally the CPP assumes transactions occur evenly throughout the year. In such cases, average
price index for the year is used. But in cases where the transactions occur unevenly, it is
necessary to use a weighted average index or to convert for eg. Using each quarters transactions
separately.
3. Depreciation written off for the year:
First Step: Value assets on CPP basis
Second Step: Apply rates of depreciation to cost of assets expressed in CPP terms.

4. Loss of purchasing power for holding net monetary assets:
Step I: Loss on opening balance of net monetary assets i.e. Debtors + Cash Creditors

(Index at the end Index at the beginning of
the year)
Non Monetary Assets at the X ---------------------------------------------------------------
----------
Beginning of the year Index at the beginning of the year

Step II: Increase / Decrease in Net Monetary assets
Net Monetary assets at beginning Net Monetary assets at the end of the year
Step III: Loss on increase / Decrease in Net Monetary Assets

(Index at the end Average Index for the year)
Figure in Step II X -------------------------------------------------------------------------
Average Index for the year
Step IV: Add figure in Step I to figure in Step III

The above process of calculation assumes that the figure of net monetary assets at the end of the
year comprises of 2 parts:
i. Opening balance of net monetary assets and
ii. Increase / Decrease in Net Monetary assets during the year.

c. Balance Sheet at the end of the year:
Discussed under 3 heads:

i. Non-Monetary assets:
a) Fixed Assets & Depreciation - Same treatment as in the case of opening
balance sheet
b) Stock Method adopted in Profit and Loss A/c
ii. Monetary No need for conversion since monetary assets at the end
of the year are already expressed in terms of CPP.
iii. Shareholders funds = Assets(CPP) Liabilities(CPP)

Human Resource Accounting
Human Resource Accounting is a method to measure the effectiveness of personnel
management activities and the use of people in an organization.
Approaches to Human resource accounting was first developed 1691 the next stage was during
1691-1960 and third phase post-1960. There are two approaches to HRA. Under the cost
approach, also called human resource cost accounting method or model, there is a) Acquisition
cost model and b)replacement cost model. Under the value approach there are a) present value
of future earnings method, b) discounted future wage model, c) competitive bidding model.
Cost approach
This approach is also called as acquisition cost model.This approach is developed by Brummet,
Flamholmay tz and Pyle but the first attempt towards employee valuation made by a foot ware
manufacturing company R. G. Barry Corporation of Columbus, Ohio with the help of Michigan
University in the year 1967 . This method measures the organizations investment in employees
using the five parameters: recruiting, acquisition; formal training and, familiarization; informal
training, Informal familiarization; experience; and development. this model suggest instead of
charging the costs to p&l accounting it should be capitalized in balance sheet.the process of
giving an status of asset to the expenditure item is called as capitalization. in case of human
resource it is necessary to amortize the capitalized amount over a period of time. so here one will
take the age of the employee at the time of recruitment and at the time of retirement. out of these
a few employee may leave the organization before attaining the superannuation. This is similar
to a physical asset. e.g.:- If company spends one lakh on an employee recruited at 25 years, and
he leaves the organization at the age 50, he serves the company for 25 years (his actual
retirement age was 55 years). The company has recovered rupees 83333.33 so the unamortized
amount of rupees 16666.66 should be charged to p&l account i.e.
100000\30=3333.33
3333.33*25=83333.33
100000-83333.33=16666.67
This method is the only method of human resource accounting which is based on sound
accounting principles and policies.
Limitations
The valuation method is based on false assumption that the dollar is stable.
Since the assets cannot be sold there is no independent check of valuation.
This method measures only the costs to the organization but ignores completely any
measure of the value of the employee to the organization (Cascio 3).
It is too tedious to gather the related information regading the human values.
Replacement Cost approach
This approach measures the cost of replacing an employee. According to Likert (1985)
replacement cost include recruitment, selection, compensation, and training cost (including the
income foregone during the training period). The data derived from this method could be useful
in deciding whether to dismiss or replace the staff.
Limitations
Substitution of replacement cost method for historical cost method does little more than
update the valuation, at the expense of importing considerably more subjectivity into the
measure. This method may also lead to an upwardly biased estimate because an
inefficient firm may incur greater cost to replace an employee (Cascio 3-4).
Present Value of Future Earnings
Lev and Schwartz (1971) proposed an economic valuation of employees based on the present
value of future earnings, adjusted for the probability of employees death/separation/retirement.
This method helps in determining what an employees future contribution is worth today.
According to this model, the value of human capital embodied in a person who is y years old, is
the present value of his/her future earnings from employment and can be calculated by using the
following formula:
E(V
y
) = P
y
(t+1) I(T)/(I+R)
t-y


T=Y Y

where E (V
y
) = expected value of a y year old persons human capital T = the persons
retirement age P
y
(t) = probability of the person leaving the organisation I(t) = expected earnings
of the person in period I r = discount rate
Limitations
The measure is an objective one because it uses widely based statistics such as census
income return and mortality tables.
The measure assigns more weight to averages than to the value of any specific group or
individual (Cascio 4-5).
Value to the organization
Hekimian and Jones (1967) proposed that where an organization had several divisions seeking
the same employee, the employee should be allocated to the highest bidder and the bid price
incorporated into that divisions investment base. For example a value of a professional athletes
service is often determined by how much money a particular team, acting in an open competitive
market is willing to pay him or her.
Limitations
The soundness of the valuation depends wholly on the information, judgment, and
impartiality of the bidder (Cascio 5).
Expense model
According to Mirvis and Mac, (1976) this model focuses on attaching dollar estimates to the
behavioral outcomes produced by working in an organization. Criteria such as absenteeism,
turnover, and job performance are measured using traditional organizational tools, and then costs
are estimated for each criterion. For example, in costing labor turnover, dollar figures are
attached to separation costs, replacement costs, and training costs.