Accounting Principles

Chapter Two

Introduction

Financial Accounting End Products

Balance Sheet Profit and Loss Account Statement of Changes in Financial Position

Generally Accepted Accounting Principle (GAAP)

These are certain norms and standards on which financial accounts are prepared. Based on experience, usage, reason, convention and necessity. Ensures uniformity so that financial reports can be understood properly and communicated effectively.

GAAP - Principles

Money Measurement Concept

Expression of facts in monetary terms. Monetary terms provide a common denominator.

Different costs have different units Labor Hours, Electricity units, RM Kgs

Fact that cannot be expressed in monetary terms is excluded. Transactions recorded at their value at the time they take place. No effect of changes in purchasing power of money.

GAAP - Principles

Business Entity Concept

Business has a separate entity from its owners. All transactions recorded from the viewpoint of the firm and not owners. Enables to judge performance of the management.

GAAP - Principles

Going Concern concept

Business will continue to operate in future and will not cease doing business. Value of assets historical value and not resale value. Asset will be used in creating future output values.

GAAP - Principles

The Cost Concept

Asset is shown at cost and not current market value or current worth. It provides objective basis of accounting. Cost based system is more feasible. Difficulty in estimating market value.

GAAP - Principles

The Duality concept

Financial Accounting based on double entry system. There are two aspects for each transaction. Cash put into business: Rs. 100,000.

Cash = 100,000 ; Capital = 100,000

Assets = Liabilities + Equity

GAAP - Convention

Conservatism

Anticipate no profit; provide for all possible losses. Profit to be accounted only when realised but expenses to be accounted actual as well as anticipated.

GAAP - Convention

The Accrual concept the matching concept

Expenses recognised in a particular accounting period should be matched with revenues recognised in that period. Determine revenues for the particular accounting period and then determine expenses associated with it.

GAAP - Convention

The Realisation concept

Revenue is considered as earned on the date it is realised. Nothing to do with actual receipt of cash. Consistently apply chosen alternative over time. Alternative chosen to value the stock to be applied consistently in subsequent accounting periods. Facilitates comparision over different accounting periods.

The Consistency concept

GAAP - Convention

The Full Disclosure concept

The Materiality concept

Honestly and sufficiently disclose information to all stakeholders Internal as well as External Stakeholders Shareholders, Employees, Suppliers Creditors, Government, Stock Exchange, Society
Attach importance to material details and ignore insignificant details. Rounding to nearest Rs. 1000. Clubbing of small item expenditure.

Accounting Standards Board

Established in 1977 by The Institute of Chartered Accountants of India. To formulate the Accounting Standards. Consists of representatives from CAG, CBDT, ICWA, ICSI, FICCI, CII, RBI, SEBI, Financial Institutions etc.

Accounting Standards

Twenty nine definitive standards (Pg. 1.27) Compliance with Accounting Standards is mandatory. However, they do not override provisions of the Law, if there is any non- conformity with the Law.

AS 1: Disclosure of Accounting Policies

Fundamental Accounting Assumptions

Going Concern Consistency Accrual concept Prudence Substance over form Materiality

Accounting Policies

Fundamental Accounting Assumptions vs. Policies

Assumptions Are basis for preparing Financial Accounts. Necessary to be complied. If not followed, reasons to be disclosed.

Policies Specific accounting principles & methods eg. Stocks,Depreciation. Management may make a choice. Disclosure as to which Policy has been followed in Notes to Accounts.

Systems of Book - Keeping

Single entry system Double Entry system

Difference between Double and Single Entry system

Single Entry Dual aspect is not followed. Some transactions may not be recorded. Only personal A/cs maintained. No Trial Balance. Rough P&L and B/S Very small Businesses.

Double Entry Dual aspect completely followed.

All A/cs maintained. Trial balance must. Accurate P&L and B/S. All other entities.

Systems of Accounting

Cash system of Accounting Accounting entries made only when cash is received or paid. Government system of Accounting is mostly on this system. Mercantile or Accrual system of Accounting Accounting entries are made on the basis of amounts having become due for payment or receipt.

Example: Rent on page 1.34

Contents of Balance Sheet

Balance Sheet

Statement of financial position Formats : Account Form and Report form

Assets RHS; Liabilities LHS In order of decreasing liquidity

Assets

Valuable, Cash or convertible into cash and can provide future benefits to the firm. Resource must be owned Should be acquired at a measurable money cost

Contents of Balance Sheet

Fixed Assets: Retained on long - term basis

Tangible and Intangible Fixed Assets

Intangible Assets: Reflect Rights of the firm

Current Assets

Cash Marketable Securities Accounts Receivable Notes/ Bills Receivable Inventory

Contents of Balance Sheet (Contd)

Investments Other Assets : Deferred Charges

Contents of Balance Sheet (Contd)

Liabilities

Claims of outsiders against the firm.

Current Liabilities

Trade Credit Short term Bank Credit Tax Payable Accrued Expenses Outstanding Wages, Salaries Deferred Income Receipt of income in advance

Contents of Balance Sheet (Contd)

Long- term liabilities

Long term borrowings

Debenture, Bonds, Mortgages

Term loan Preference Shareholders Ordinary Shareholders

Owners Equity

Paid - up Capital + Retained Earnings

Contents of Profit and Loss Account

Profit and Loss Account

Portrays the operations over a particular period of time. Reports results of operations in terms of income, net profit for the year. Usual account form Step - form

Presented broadly in two forms:

Contents of Profit and Loss Account (Contd)

Revenues

Sale of products/goods/services

Gross Sales less returns and sales discounts Earning interest, rent, dividend, royalty, commission etc.

Supply of firms resources to others

Sale of asset like plant, investments

Contents of Profit and Loss Account (Contd)

Expenses

Cost of earning revenues Material cost, labor cost and other manufacturing expenses Salary, rent, rates and taxes, staff welfare expenses

Cost of goods sold

General and Administrative expenses

Selling Expenses Depreciation Interest Provision for Tax

Contents of Profit and Loss Account (Contd)

Net Income/Profit

Revenues Expenses = Profit/Loss

Appropriation

Provision for Dividends etc. Retained Earnings

This retained earnings is transferred to Reserves and Surplus Account which is reflected in the Balance - sheet

Assignment

Test Questions Objective and Essay type Pg. 1.35. No Practical Problems.