Conceptual Frame work

Accounting Principles –
• Mean basic fundamental truth of accounting which is universally accepted & followed by
everyone & everywhere without unreasonable like or dislike.
• They are rules of action followed by accountants uniformly in recording the business
transaction in books of accounts.
• They are developed over a long period of time through usage, necessity & experience
• Accounting principles must satisfy the following conditions:
• They must be based on real assumptions
• They must be simple, understandable & explanatory
• They must be followed consistently
• They should be able to reflect future predictions
• They should be informational for the users
• Accounting principles are broadly classified as

Accounting Concepts Accounting Conventions

Entity Concept Conservatism / Prudence
Money Measurement Concept Consistency
Periodicity Concept Materiality
Accrual Concept Full Disclosure
Matching Concept
Going Concern Concept
Cost Concept
Realization Concept
Dual aspect concept

Accounting Concepts – The word concept means idea or notion which has universal
application. Accounting concepts are based on logical considerations & they imply universal
acceptance. These accounting concepts lay the foundation on the basis of which the accounting
principles are formulated
Accounting Conventions – refers to rules which have common acceptance & agreement in
accountancy. In other words customs or traditions which guide or direct the preparation of
accounts are called accounting conventions. These conventions are derived by usage & practice.
Accounting conventions need not have universal acceptance.

Entity Concept –
• Entity means something that has real separate existence
• Entity refers to status or personality
• Business enterprise is a separate identity apart from its owner
• Distinction is made between personal & business transactions
• This concept applies to all organizations
Example- Money provided by owners is treated as Capital of owner & regarded as liability of
Firm. Any drawings by owners are recorded by business i.e capital withdrawn from business
Money Measurement Concept –
• Only those transactions which can be measured in terms of money are recorded
• Transactions & events that cannot be expressed in terms of money are not recorded
example employees of the organization are no doubt the assets but their measurement in
monetary terms is not possible hence not included in books of account
• Fixed assets like land & building are expressed in terms of money & not in terms of area
or quantity
• This concept imparts the essential flexibility for measurement & interpretation of
accounting data. Example a businessman sells goods worth Rs.50 lacs at home & worth Rs 1
Lac Euros in USA so the transaction are to be recorded at uniform monetary unit i.e one
currency. Suppose 1 Euro = Rs.55 Then total sales recorded are Rs.105 Lacs (50+55) Lacs

Periodicity Concept or Accounting Period –

• This concept is called the concept of definite accounting period
• As per going concern concept an indefinite life of entity is assumed
• According to this concept accounts should be prepared after every period & not at end of
life of the entity. Usually this period is one calendar year. In India we follow 1 st April of year
to 31st March of immediately following year
• This concept makes the accounting system workable & the term accrual meaningful. If
one thinks of indefinite time frame nothing will accrue. Accrued expenses or accrued revenue
is only with reference to a finite time frame which is called the accounting period
• Periodicity concept facilitates in:
• Comparing of financial statements of different periods
• Uniform & consistent accounting treatment for ascertaining the profit & assets of
the business
• Matching periodic revenues with expenses for getting correct results from
operations
Accrual Concept –
• Accrual means recognition of revenue & costs as they are earned or incurred (i.e when
they occur) & not as money is received or paid
• Accrual concept relates to measurement of income, identifying assets & liabilities
• As per accrual concept: Revenue – Expenses = Profit
Example JD buys clothing of Rs.50000/- paying cash of Rs.20000/- & sells at Rs.60000/- of
which customer pays only Rs.50000/-.
His revenue is Rs.60000/0 & not Rs.50000/- cash received. Expenses (cost incurred for the
revenue) is Rs.50000/- & not Rs.20000/- cash paid. So the accrual concept profit is Rs.10000

Matching Concept –
• All expenses matched with revenue of that period should only be taken into consideration
• It is based on accrual concept as it considers the occurrence of expenses & income & do
not concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items
like prepaid & outstanding expenses, unearned or accrued incomes.
• Periodicity concept has also been followed while applying matching concept as it is not
necessary that every expense identify every income. Some expenses are directly related to the
 revenue & some are time bound example selling expenses are directly related to sales but
rent, salaries are recorded on accrual basis for a particular accounting year.
• Periodic Profits = Periodic revenue – Matched Expenses
PK started cloth business. He purchased 10000 pcs garments @ Rs.100 per piece & sold
8000 pcs @ Rs.150 per piece during 12 mths 1st April 2008 to 31st March 2009. He paid shop
rent @ Rs.3000 per month for 11 months & paid Rs.800000/- to suppliers of garments &
received Rs.1000000/- from customers
Revenue - Sales 8000 * 150 1200000
Less: Expenses Merchandise 8000 * 100 800000
Shop Rent 3000 * 12 36000 836000
Periodic Profit = Revenue – Expenses 364000

Assets Stock 2000 * 100 200000

Debtors (1200000 – 1000000) 200000
Cash ( 1000000 – 800000-33000) 167000
Total Assets 567000

Liabilities Trade creditors ( 1000000-800000) 200000

Expense creditors 3000
Capital ( for profits) 364000
Total Liabilities 567000

Going Concern Concept –

• It is assumed that business has perpetual succession, i.e it has everlasting existence
• It is known as continuity assumption i.e continuing in operations for the foreseeable
future
• This concept recognizes the value of assets & liabilities of the enterprise on the basis
of their productivity & not on the basis of their current realizable value
• Prepaid expenses are recognized as assets since the benefits will be utilized in future
when the business entity will continue
• Helps other undertakings to make contracts with specific business units for business
dealings in future

Cost Concept –
• Value of an asset is to be determined on basis of historical cost, in other words
acquisition cost. Market value is not to be taken into account for purpose of valuation
• Assets when acquired is recorded at the cost price & gradually reduced by way of
depreciation
• Depreciation is calculated on basis of the cost price & the effective life of the asset

Realization Concept –
• Closely follows the cost concept
• Any change in value of an asset is to be recorded only when the business realizes it
• Accountants follow conservative path they cover all probable losses but do not count any
probable gain
 • Revenue is treated as realized when services are rendered or work is completed or order
for goods is executed. Advance received along with order is not treated as revenue
• Example Provision for doubtful debts is excluded from sales & only that sales is
considered which business is certain to realize for knowing profit of business

Dual Aspect Concept –

• This concept is core of double entry book keeping
• Every transaction or event has two aspects:
• It increases on asset & decreases other asset or increases one liability, decreases other
liability. Example New Machine purchased paying cash
• It increases an asset & simultaneously increases liability or increases a liability, increases
an asset. Example new machine purchased on credit
• It decreases on asset, increases another asset or decreases liability, increases other
liability. Example raised bank loan to pay off other loan.
• It decreases one asset, decreases a liability or decreases liability, decreases an asset.
Example Cash paid to repay bank loan
• Accounting equation : Assets = Capital + Liabilities is based on this concept

Convention of Conservatism –
• Refers to policy of playing safe or to be on safer side
• Accountants should not anticipate income & should provide for all possible losses
• Assets or incomes should not be overstated & liabilities or expenses should not be
understated
• The valuation of stock in trade at a lower of cost or net realizable value & making
provision for doubtful debts & discount on debtors are application of this principle

Convention of consistency –
• Accounting methods, practices & policies used must be consistent from one period to
another period. Example valuing stock at cost or market price whichever is lower or method
of depreciation (SLM /WDV) should be consistently used year after year
• Useful for comparison of performance year after year
• Gives confidence to user of accounting information

Convention of Materiality –
• This principle is an exception of full disclosure principle
• All items having significant economic effect on business should be disclosed
• Materiality depends on amount involved & the accounts affected
• Amount may be material under one situation but immaterial under another situation e.g
sale of Rs.4 lacs is material when turnover is Rs.40 Lacs but immaterial when it is Rs.4000
crs
• Materiality depends not only upon the amount of item but also upon the size of business,
level & nature of information, level of the person/ department who makes the judgement
about materiality.

Convention of Full Disclosure –

 • All financial statements should be honest & should act as means of conveying & not
concealing
• Financial statements must disclose all relevant & reliable information which they purport
to represent so that information may be useful to users
• Disclosure should be full, fair & adequate

Qualitative Characteristics of Accounting Information-

• Reliability- To be useful information must be reliable when it is free from
material error & bias & can be depended upon by users. Reliability of Financial
statements is dependant on-
• Faithful Representation- To be reliable, information must represent faithfully
the transaction & other events which either purports to represent or could
reasonably be expected to represent
• Substance over Form- It is necessary that the transactions & other events are
accounted for & presented in accordance with their substance & economic reality
& not merely by their legal form
• Neutrality- To be reliable information contained in financial statements must be
neutral
• Prudence- Is the inclusion of a degree of caution in making the estimate required
under conditions of uncertainties so that assets or incomes are not overstated&
liabilities or expenses are not understated
• Completeness- To be reliable the information in financial statements must be
complete within the bounds of materiality & cost
• Relevance- Information has relevance when it influences the economic decisions
of the users by helping them to evaluate the past, present or future events or
conforming or correcting their past evaluation. The relevance of information is
affected by its nature & materiality
• Understandability- Information must be readily understandable by users
• Comparability- Financial statements should be comparable & users should be
informed of accounting policies , any changes in those policies & effects of such
changes

Constraints on Relevant & reliable information-

• Timeliness- Undue delay in reporting information may loose its relevance. Listed
companies have to publish half yearly results which provides timely information to
investors or potential investors to make their investment decision
• Balance between Benefit & Cost- Benefits derived from information should
exceed cost of providing it. In India Companies save expenditure relating to
publication of annual reports & give abridged accounts to its shareholders as many
investors do not use the information contained in annual reports
• Balance between Qualitative Characteristics is often necessary
• True & Fair view/ Fair Presentation

Accounting Standards –
 • Is a selected set of accounting policies or broad guidelines regarding the principles &
methods to be chosen out of several alternatives
• Standards confirm to applicable laws, customs, usage & business environment
• Adoption & application of accounting standards ensures uniformity, comparability &
qualitative improvement in the preparation & presentation of financial statements.

Indian Accounting Standards –

• Accounting standards in India are issued by the Institute of Chartered Accountants of
India
• Objectives of AS is to standardize the diverse accounting policies & practices with a view
to eliminate to the extent possible non comparability of financial statements & add reliability
• Accounting standards board (ASB) shall determine the broad areas in which accounting
standards need to be formulated & priority in selection. ASB has representatives from govt
bodies & industries
• Till date Institute has issued 29 accounting standards

Accounting Standards issued By ICAI –

Number of Title of the Date from

Accounting Accounting which
Standard standard mandatory Accounting Standard deals with
Accounting policies adopted in preparation &
presentation of financial statement e.g method of
Disclosure of depreciation, valuation of stock, valuation of
Accounting investment & fixed assets, change in method once
AS-1 policies 1/4/1993 adopted & effect of such change on profit

Method adopted for valuing inventory, cost formula

AS-2 Valuation of used, classification of inventories like finished goods,
(Revised) inventories 1/4/1999 WIP, spare parts & carrying amount

Statement explaining cash movement from operating

AS-3 Cash flow activity, investing activities & financing activity. It
(Revised) statement 1/4/2001 assesses ability to generate & utilize cash
Contingencies & Accounting of contingencies & events which take
events occurring place after balance sheet date but before approval by
AS-4 after the balance board of directors, provision for loss, if loss is
(Revised) sheet date 1/4/1998 provided effect on profit
Net profit or loss
for the period,
prior period items Extraordinary items like loss due to earthquake,
& change in refund of grants, prior period items & changes in
AS-5 Accounting policies regarding provision for debtors, liabilities.
(Revised) Policies 1/4/1996 Their effect on profit
Method of depreciation , change in method &
estimated life of an asset, sale of fixed asset, effect of
AS-6 Depreciation revaluation, total cost, depreciation amount &
(Revised) accounting 1/4/1995 treatment for above transactions
AS-7 Construction Method used to determine stage of completion of
(Revised) contracts 1/4/2002 contract & revenue recognition
Accounting for
research & Withdrawn pursuant to AS26 becoming
AS-8 development mandatory
When revenue should be recognized in Profit & loss
Revenue account & circumstances in which it can be
AS-9 recognition 1/4/1993 postponed

Presentation of fixed assets like gross & net book

value at beginning & at the end of year showing
Accounting for addition, deduction, revaluation their treatment,
AS-10 fixed assets 1/4/1993 expenditure during construction period & treatment
Effects of changes Accounting for transactions in foreign currencies,
AS-11 in Foreign translating statement of financial operation &
(Revised) exchange rates 1/4/2004 accounting for forward contracts
Accounting for Recognition of grants, accounting treatment of
government various govt grants, refunds of grants & their
AS-12 grants 1/4/1994 treatment
Policies followed for valuation of investments,
Accounting for classification, disposal of investments & accounting
AS-13 investments 1/4/1995 treatment
Accounting treatment in books of transfer company
Accounting for like method of accounting, reserves, treatment of
AS-14 amalgamation 1/4/1995 goodwill
Accounting for
retirement
benefits in the
financial
statements of Various retirement benefits, accounting treatment of
AS-15 employees 1/4/1995 various schemes
Treatment of borrowing cost (interest+ other costs) in
accounting whether such cost should be included in
AS-16 Borrowing costs 1/4/2001 cost of asset or not
Information to access the risk & return of multiple
products/ services & its operation in different
geographical areas: helps to understand performance
AS-17 Segment reporting 1/4/2001 of such enterprises
Disclosure of related party transactions for proper
understanding of financial performance & financial
position of enterprise. Standard gives related party &
Related party transactions & gives disclosure requirement in
AS-18 disclosure 1/4/2001 financial statements
Accounting for Accounting treatment of various types of leases,
AS-19 leases 1/4/2001 recogniotion of income, sale & lease back
Deals with computational methodology for
Earnings per determination & presentation of earnings per share,
AS-20 share 1/4/2001 which will improve comparision of EPS
 How to prepare financial statements of holding
Consolidated company & its subsidary as a single entity. i.e how to
financial present consolidated balancesheet & profit & loss
AS-21 statements 1/4/2001 account
1/4/2001
Accounting for 1/4/2002 Prescribes accounting treatment for taxes on income.
AS-22 taxes on income 1/4/2006 Taxes shall be accounted on accrual basis
Accounting for
investments in
associates in Gives principles & procedures for recognizing
consolidated investments in associates in consolidated financial
financial statements of investors so that effect of investment in
AS-23 statements 1/4/2002 associates on financial position of group is indicated
Disclosure of information of operations which
enterprise plans to discontinue, disclosure of pretax
Discontinuing profit or loss & tax expenses, gain or losses on
AS-24 operations 1/4/2004 disposal of assets, settlement of liabilities
Prescribes minimum content of interim financial
Interim financial report & principles for recognition & measurement in
AS-25 reporting 1/4/2002 complete financial statement for interim period
Accounting treatment for intangible assets,
recognition of assets, amount to be recorded in
books, amortization method, disclosure in financial
AS-26 Intangible assets 1/4/2003 statements

Financial reporting Financial reporting in jointly control operation, jointly

of interest in joint controlled assets reporting & recognition in financial
AS-27 venture 1/4/2002 statements in case of jointly controlled entities
Indication of impairment, effect on depreciation,
1/4/2004 recognition of impairment loss for individual asset &
Impairment of 1/4/2006 cash generating unit, discontinuing operations, steps
AS-28 assets 1/4/2008 for measurement & reversal of losses
Provisions
contingent
liabilities & Accounting treatment, recognition, measurement,
AS-29 contingent assets 1/4/2004 disclosure of provision, contingent liabilities & assets

Accounting Policies –
• Refer to specific accounting principles & methods of applying these principles adopted
by the enterprise in the preparation & presentation of financial statements
• There is no single list of accounting policies which are applicable to all enterprises in all
circumstances
• Areas wherein different accounting policies are frequently encountered are as follows:
• Methods of depreciation, depletion & amortization
• Treatment of expenditure during construction
• Conversion or translation of foreign currency items
• Valuation of inventories / Valuation of investments / Valuation of fixed assets
• Treatment of goodwill / Treatment of retirement benefits
• Treatment of contingent liabilities
• Recognition of profit on long term contracts
• Selection of Accounting policy is based on – Prudence, Substance over Form &
Materiality
• Change in accounting policies should be made-
• if it is required by some statute
• for compliance with an accounting standard
• change would result in more appropriate presentation of financial statement