3. Theory Base of Accounting, Accounting Standards & Ind-AS

                                             

ACCOUNTING PRINCIPLE

 

                                          Accounting Principal are the rules adopted by accountants universally while recording accounting transaction. They are the norms or rules which are followed in accounting of various items of assets, liabilities, expenses, income, etc. for example, Inventory (stock) is valued at lower of its cost or net realisable value. Fixed assets should be depreciated over their expected useful life.

According to American Institute of Certified Public Accountants

“Principles of Accounting are the general law or rule adopted or proposed as a guide to action, a settled ground or basis of conduct or practice”.

STUDYNATIC

Features of Accounting

1. Accounting Principles are Man-Made – Accounting Principles are man-made and, therefore, they are the best possible suggestions based on practical experiences. They are recommended for use by all enterprises to ensure uniformity and understand ability.

• Accounting Principles are Flexible – Accounting Principles are not Rigid but flexible. Accounting Principles are not permanent but change with time

• Accounting Principles are Generally Accepted – Accounting Principles are the bases and guidelines for accounting and are generally accepted.

 
STUDYNATIC

Accounting Assumptions

1. Going Concern Assumption – According to this assumption, it is assumed that business shall continue for a foreseeable period and there is no intention to close the business or scale down its operations significantly. It is because of this concept that a distinction is made between capital expenditure, i.e., expenditure that will give benefit for a long period and revenue expenditure, i.e., one whose benefit will be consumed or exhausted within the accounting period. On the basis of this concept, fixed assets are recorded at their original cost and they are depreciated in a systematic manner over their expected useful life.

• Consistency Assumption – According to the consistency Assumption, accounting practices once selected and adopted, should be applied consistently year after year. The concept helps in better understanding of accounting information and makes it comparable with that of previous years. Consistency eliminates personal bias and helps in showing results that are comparable. The concept is particularly important when alternative accounting practices are equally acceptable. For example, two methods of charging depreciation, Written down Value Method and Straight Line Method, are equally acceptable. Under the assumption, method once chosen and applied should be applied consistently year after year to make the financial statements comparable.

• Accrual Assumption – According to the Accrual Assumption, A transaction is recorded in the books of account at the time when it is entered into and not when the settlement takes place. The concept is particularly important because it recognises assets, liabilities, incomes and expenses and when transactions relating to it are entered into.

 STUDYNATIC

Accounting Principles

1. Accounting Entity or Business Entity Principle – According to the Business Entity Principle, business is considered to be separate from its owners. Business transactions are recorded in the books of account from the business point of view and not from that of the owners. Owners being regarded as separate from business are considered as creditors of the business to the extent of their capital. Business entity principle is applicable to all forms of business organisations, whether they are sole proprietorship, partnership or companies.

1. Money Measurement Principle – According to the money Measurement Principle, transactions and events that can be measured in money terms are recorded in the book of account of the enterprise. Money is the common denominator in recording and reporting transactions.

1. Accounting Period Principle – According to the Accounting Period Principle, life of an enterprise is broken into smaller periods so that its performance is measured at regular intervals. The accounts of an enterprise are maintained following the Going Concern concepts, meaning the enterprise shall continue its activities for a foreseeable future.
2. Full Disclosure Principle – According to the principle of Full Disclosure, “There should be complete and understandable reporting on the financial statement of all significant information relating to the economic affairs of the entity.” Apart from legal requirements, good accounting practice requires all material and significant information to be disclosed. Disclosure of material information will result in better understanding. For example, the reasons for law turnover should be disclosed.

• Materiality Principle – Materiality Principle refers to relative importance of an item or an event. Means that it is a matter of exercising judgement to decide which item is material and which is not. And only those items should be disclosed that have significant effect or are relevant to the user. An item may be material for one enterprise but may not be material for another. For example, amount spent on repairs of building, say 2, 5000, is material for an enterprise having a turnover of say 10, 00,000 but it is not material for an enterprise having a turnover of say 15,00,00,000.
• Prudence or Conservatism Principle – It takes into consideration all prospective losses but not the prospective profits. The application of this concept ensures that the financial statements do not paint a better picture than what it actually is. For example, closing stock is valued at lower of cost or market value or making the provision for doubtful debts and discount on debtors in anticipation of bad debts and discount. Prudence or Conservatism Principle prescribes that anticipated expenses and losses should be accounted.

• Cost Concept or Historical Cost Principle – According to the cost concept, an asset is recorded in the books of account at the price paid to acquire it and the cost is the basis for all subsequent accounting of the asset. Assets is recorded at cost at the time of its purchase but is systematically reduce be charging depreciation. For example, an asset is purchased for 5, 00,000 and if at the time of preparing the final accounts, even if its market value is say 4, 00,000 or 7, 00,000, yet the asset shall continue to be shown at its purchase price of 5, 00,000.

• Matching Concept or Matching Principle – An important objective of business is to determine profit periodically. It is necessary to match ‘revenues’ of the period with the ‘expenses’ of that period to determine correct profit (or loss) for the accounting period. Profit earned by the business during a period can be correctly measured only when the revenue earned during the period is matched with the expenditure incurred to earn that revenue.

1. Dual Aspect or Duality Principle – According to the Dual Aspect Concept, every transaction entered into by an enterprise has two aspects, a debit and a credit of equal amount. Simply stated, for every debit there is a credit of equal amount in one or more accounts. It is also true vice versa. For example, Nitin starts a business with a capital of 1, 00,000. There are two aspects to the transaction. On one hand, the business has an asset of 1, 00,000 (cash) while on other hand; it has a liability towards Nitin of 1, 00,000 (capital of Nitin).

• Revenue Recognition Concept – According to the Revenue Recognition Concept, revenue is considered to have been realised when a transaction has been entered into and the obligation to receive the amount is established. It is to be noted that recognising revenue and receipt of an amount are two separate aspects.
• Verifiable Objective Concept – The Verifiable Objective Concept holds that accounting should be free from personal bias. Measurements that are based on verifiable evidences are regarded as objective. It means all accounting transactions should be evidenced and supported by business documents. These supporting documents are cash memo, invoices, sales bills, etc.

 
STUDYNATIC

Accounting Standards

                          Accounting Standards are a set of guidelines, i.e., generally accepted Accounting Principles, that are followed for preparation and presentation of Financial Statements. They are accounting rules and procedures relating to measurement, recognition, Treatment, presentation and disclosure of accounting transactions in the financial statements issued by the council of the Institute of Chartered Accountants of India.

NATURE OF ACCOUNTING STANDARD

 

1. Accounting Standards are guidelines providing the framework so that credible Financial Statements are prepared.

2. The objective of setting Accounting Standards is to bring uniformity in accounting practices and to ensure transparency, consistency and comparability

3. Accounting Standards are prepared keening in view the business environment and laws of the country. It, therefore naturally means that the guidelines change with change in business environment and laws It is he cause of this that Accounting Standards are being revised from time to time. It may be noted that whenever a conflict arises between law and Accounting Standards, law will prevail.

4. Accounting Standards are mandatory in nature.

5. Accounting Standards have also been made flexible in the sense that where alternative accounting practices are acceptable, an enterprise may adopt any ofthe practices with a suitable disclosure. For example, an enterprise may charge depreciation on the Written Down Value Method or Straight Line Method.

International Financial Reporting Standards (IFRS)

 IFRS are a set of accounting standards developed by the International Accounting Standards Board (IASB), the international accounting standard-setting body. The standards issued by IASB are based on sound and clearly stated principles. Therefore, IFRS are referred to as principles-based accounting standard. This contrasts with set of standard, like Indian Accounting Standard, which contain significantly more application guidance. These standards are often referred to as rule-based accounting standards.

Indian Accounting Standards (IND-AS)

 

                 At the same time, business environment and laws in every country are different. Therefore, it is not possible to have single set of accounting standards that will apply in all the countries. International Accounting Standards Board (IASB) has issued such standards termed as International Financial Reporting Standards (IFRS). India, instead of adopting IFRS, decided to prepare its own accounting standards equivalent to IFRS. Thus, Ind-AS can be said to be converged standards of IFRS. These accounting standards are known as Indian Accounting Standards (Ind-AS).

Ind -AS are notified under the companies act 2013 and are applicable to companies

1. Listed of stock exchange in India
2. Having net worth 250 crores or more
3. Their holding ,subsidiary, associate and joint venture companies

Ind-AS Based Financial Statements

The financial statements prepared under Ind-AS are:

1. Statement of Financial Position

The elements or contents of the statement are:

(i) Asset

Assets are the resources controlled by the enterprise as a result of past events and operations from which the future economic benefits shall flow to the enterprise.

(ii) Liability

Liabilities are the obligations of the enterprise from the past events and operations, which shall result in outflow of resources, i.e., assets.

2. Statement of Changes in Equity

Equity is the residual interest in the assets of the enterprise after deducting liabilities. It is the real value of shareholders’ equity.

3. Statement of Comprehensive Income

A Statement of Comprehensive Income includes two separate statements, i.e. Income Statement and a Statement of Comprehensive Income are prepared. The Statement of Comprehensive Income reconciles the income or loss as per Income Statement with total comprehensive income. The elements or contents of the statement are:

(i) Revenue

It increases the economic benefit during the accounting period as a result of business operations or increase in value of assets or decrease in liabilities. It results in increase in the value of shareholders’ equity.

(ii) Expense

It is a decrease in economic benefits in the form of outflows during the accounting periodas a result of business operations or decrease in value of assets or increase in liabilities

• Statement of cash flow
• Notes and significant accounting policies

Question and Answers

Q1. What is the matching Concept? Why should a business concern follow this concept? Discuss.

Ans – Matching concepts, the expenses for an accounting period are matched against related revenues, rather than cash received and cash paid. This concept should be followed while preparing financial statements to have a true and fair view of the profitability and financial position of a business firm. The expense must relate to the period in which the expense occurs rather than on the period of actually paying invoices. For example, if a business pays a 10% commission to sales representatives at the end of each month. If the company has 50,000 in sales in the month of December, the company will pay the commission of 5,000 next January. Every business concern should follow the matching concept primarily to know the true profit or loss made during the current accounting year. In the same year or period, the business concerned may pay or obtain payments that may or may not relate to the current year. Because of this, it might lead to overcasting the profits or loss or might as well undercasting the profit or loss because this might not reveal the true efficiency of the business and its recreations in the accounting year. This concept also shows the business’s financial status and where the business stands. It also smooths out the income statement. It is also important for an investor to study the company’s cash flow and income statement to get an idea of the company before the investment.

Q2. ‘Business Units last indefinitely.’ Mention and explain the concept on which the statement is based.

Ans – This Statement is based on going concern assumption concept. According to this assumption, it is assumed that business shall continue for a foreseeable period and there is no intention to close the business or scale down its operations significantly. It is because of this concept that a distinction is made between capital expenditure, i.e., expenditure that will give benefit for a long period and revenue expenditure, i.e., one whose benefit will be consumed or exhausted within the accounting period. On the basis of this concept, fixed assets are recorded at their original cost and they are depreciated in a systematic manner over their expected useful life.

Q3. What is Money Measurement Concept? Which one factor can make it difficult to compare the monetary value of one year with the monetary values of another year?

Ans – Money Measurement concept is an important accounting concept that is based on the theory that a company should be recording only those transactions that can be measured or expressed in monetary terms on the financial statement. Money measurement is also known as measurability concept, which states that during the recording of any financial transaction, those transaction should not be recorded which cannot be expressed in terms of monetary value. But inflation is a factor that can create difficulty while comparing the monetary values of a year with the values of another year. For example machinery of 1, 00,000 each are purchased and this event is recorded in the books with a total amount of 1, 00,000.

The factor which can make it difficult to compare the monetary values of one year with the monetary values of another year is inflation. Due to the changes in prices, the value of money does not remain the same over a period of time. The value of rupee today on account of rise in prices is much less than what it was, say ten years back.

Q4. ‘Only financial transactions are recorded in accounting.” Explain the statement.

Ans –According to money measurement principle only those transaction are recorded in the accounting which can be measured in the monetary system. In other words non financial transaction or facts will never recording the accounting. For example, working conditions in the workplace, strike by employees, the efficiency of the management, etc. will not be recorded in the books, as they cannot be expressed in terms of money.

Q5. What are the Objectives of Ind-As?

Ans –

1. To provide a standard for the diverse accounting polices and principles.
2. To put an end to the non-comparability of financial statements.
3. To increase the reliability of the financial statement.
4. To provide standard which are transparent for users
5. To define the standard which are comparable over all periods presented
6. To provide a suitable starting point for accounting.
7. It contains high quality information to generate the financial reports. This can be done at a cost that does not exceed the benefits.
8. For the eradication the huge amount of variation in the treatment of accounting standards.
9. To facilitate ease of both inter-firm and intra-firm comparison.

Q6. ‘Accounting Standards have been evolved to improve the reliability and credibility of Financial Statements. Accounting standards provide the solution in case of conflicts among various groups. In the light of this statement enumerate the objectives of Accounting Standard.

Ans – The rise in diversity, complexity and globalisation of business made the study of accounting information important and essential. But the diverse accounting polices being followed and the accounting treatment of transactions and events made the accounting information less meaningful and also incomparable. A need was, thus, felt that certain minimum standard should be universally applicable, so that the accounting statements. It helps in understanding significant accounting polices adopted and applied. It helps in facilitating meaningful comparison of financial statement of two or more entities. Accounting standard enhance reliability and credibility of financial Statement. Accounting Standard provides the solution in case of conflicts among various groups.

Objectives of Accounting Standard:-

1. To formulate and publish in public interest, Accounting  Standards to be observed in the presentation of financial statement and also their worldwide acceptance; and
2. To work for the improvement and harmonisation of regulation of Accounting Standard and Procedures relating to the presentation of financial transactions.

Q7. Discuss the Accounting Convention based on the premise ‘Do not anticipate profits but provide for all losses.’

Ans – Prudence or Conservatism Principle is many a time described using the phrase “Do not anticipate a profit, but provide for all possible losses.” Stating Differently, It takes into consideration all prospective losses but not the prospective profits. The application of this concept ensures that the financial statements do not paint a better picture than what it actually is. For example, closing stock is valued at lower of cost or net realisable value (market value) or making the provision for doubtful debts and discount on debtors in anticipation of bad debts and discount. Prudence or Conservatism Principle prescribes that anticipated expenses and losses should be accounted.

Q8. Explain any Three of the following:

Ans –

1. Business Entity Concept – According to the Business Entity Principle, business is considered to be separate from its owners. Business transactions are recorded in the books of account from the business point of view and not from that of the owners. Owners being regarded as separate from business are considered as creditors of the business to the extent of their capital. For example when the proprietor introduces capital, Cash Account or Bank Account is debited and capital Account is credited. Amount in the credit of the capital is a liability of the enterprise towards the proprietor. Business entity principle is applicable to all forms of business organisations, whether they are sole proprietorship, partnership or companies.
2. Matching Concept – Matching concepts, the expenses for an accounting period are matched against related revenues, rather than cash received and cash paid. This concept should be followed while preparing financial statements to have a true and fair view of the profitability and financial position of a business firm. The expense must relate to the period in which the expense occurs rather than on the period of actually paying invoices. For example, if a business pays a 10% commission to sales representatives at the end of each month. If the company has 50,000 in sales in the month of December, the company will pay the commission of 5,000 next January. Every business concern should follow the matching concept primarily to know the true profit or loss made during the current accounting year. In the same year or period, the business concerned may pay or obtain payments that may or may not relate to the current year. Because of this, it might lead to overcasting the profits or loss or might as well undercasting the profit or loss because this might not reveal the true efficiency of the business and its recreations in the accounting year. This concept also shows the business’s financial status and where the business stands. It also smooths out the income statement. It is also important for an investor to study the company’s cash flow and income statement to get an idea of the company before the investment.
3. Consistency Concept – According to the consistency Assumption, accounting practices once selected and adopted, should be applied consistently year after year. The concept helps in better understanding of accounting information and makes it comparable with that of previous years. Consistency eliminates personal bias and helps in showing results that are comparable. The concept is particularly important when alternative accounting practices are equally acceptable. For example, two methods of charging depreciation, Written down Value Method and Straight Line Method, are equally acceptable. Under the assumption, method once chosen and applied should be applied consistently year after year to make the financial statements comparable.
4. Dual Aspect Concept – According to the Dual Aspect Concept, every transaction entered into by an enterprise has two aspects, a debit and a credit of equal amount. Simply stated, for every debit there is a credit of equal amount in one or more accounts. It is also true vice versa. For example, Nitin starts a business with a capital of rs. 1, 00,000. There are two aspects to the transaction. On one hand, the business has an asset of rs. 1, 00,000 (cash) while on other hand; it has a liability towards Nitin of rs. 1, 00,000 (capital of Nitin).

Q9. Explain the following Accounting principles/concepts:

Ans –

1. Accrual Concept – According to the Accrual Assumption, A transaction is recorded in the books of account at the time when it is entered into and not when the settlement takes place. The concept is particularly important because it recognises assets, liabilities, incomes and expenses and when transactions relating to it are entered into. Similarly, if M/s. RSM & Co. makes a sale of goods to M/s. VS & Co. on 27^th February, 2021 for 15,000 on credit of two months, the sale must be recorded on 27^th April, 2021. The transaction is recorded because the revenue has been earned, although the amount has not been received. M/s.  VS & CO. should also record the purchase in its books of account has not been paid.
2. Business Entity concept – According to the Business Entity Principle, business is considered to be separate from its owners. Business transactions are recorded in the books of account from the business point of view and not from that of the owners. Owners being regarded as separate from business are considered as creditors of the business to the extent of their capital. For example when the proprietor introduces capital, Cash Account or Bank Account is debited and capital Account is credited. Amount in the credit of the capital is a liability of the enterprise towards the proprietor. Business entity principle is applicable to all forms of business organisations, whether they are sole proprietorship, partnership or companies.
3. Money Measurement Concept – According to the money Measurement Principle, transactions and events that can be measured in money terms are recorded in the book of account of the enterprise. Money is the common denominator in recording and reporting transactions.

Q10. Explain the Business Entity Concept with Example.

Ans – According to the Business Entity Principle, business is considered to be separate from its owners. Business transactions are recorded in the books of account from the business point of view and not from that of the owners. Owners being regarded as separate from business are considered as creditors of the business to the extent of their capital. For example when the proprietor introduces capital, Cash Account or Bank Account is debited and capital Account is credited. Amount in the credit of the capital is a liability of the enterprise towards the proprietor. Business entity principle is applicable to all forms of business organisations, whether they are sole proprietorship, partnership or companies.

Q11. What are Accounting Standards? Name any two Accounting Standards.

Ans – Accounting Standards are a set of guidelines, i.e., generally accepted Accounting Principles, that are followed for preparation and presentation of Financial Statements. They are accounting rules and procedures relating to measurement, recognition, Treatment, presentation and disclosure of accounting transactions in the financial statements issued by the council of the Institute of Chartered Accountants of India.

1. International Financial Reporting Standards (IFRS) – IFRS are a set of accounting standards developed by the International Accounting Standards Board (IASB), the international accounting standard-setting body. The standards issued by IASB are based on sound and clearly stated principles. Therefore, IFRS are referred to as principles-based accounting standard. This contrasts with set of standard, like Indian Accounting Standard, which contain significantly more application guidance. These standards are often referred to as rule-based accounting standards.
2. Indian Accounting Standards (IND-AS) – At the same time, business environment and laws in every country are different. Therefore, it is not possible to have single set of accounting standards that will apply in all the countries. International Accounting Standards Board (IASB) has issued such standards termed as International Financial Reporting Standards (IFRS). India, instead of adopting IFRS, decided to prepare its own accounting standards equivalent to IFRS. Thus, Ind-AS can be said to be converged standards of IFRS. These accounting standards are known as Indian Accounting Standards (Ind-AS).

Q12. Define Accounting Standards. Explain its any two objectives.

Ans – Accounting Standards are a set of guidelines, i.e., generally accepted Accounting Principles, that are followed for preparation and presentation of Financial Statements. They are accounting rules and procedures relating to measurement, recognition, Treatment, presentation and disclosure of accounting transactions in the financial statements issued by the council of the Institute of Chartered Accountants of India.

Objectives of Accounting Standard:-

1. The main aim to improve the reliability of financial statements. Now because the financial statements have to be made following the standards the users can rely on them. They know that not conforming to these standards can have serious consequences for the companies.
2. Then there is comparability. Following these standards will allow for inter-firm and intra-firm comparisons. This allows us to check the progress of the firm and its position in the market.

Q13. Define Accounting Standards. Who is responsible for issuing Accounting Standards in India?

Ans – Accounting Standards are a set of guidelines, i.e., generally accepted Accounting Principles, that are followed for preparation and presentation of Financial Statements. They are accounting rules and procedures relating to measurement, recognition, Treatment, presentation and disclosure of accounting transactions in the financial statements issued by the council of the Institute of Chartered Accountants of India. Generally These Accounting Standards are issued by any accounting body or regulatory authority and even sometimes by the government. The Accounting Standard Board (ASB) of the Institute of Chartered Accountants of India (ICAI) has framed and issued these set of standards. The application of Accounting Standards (AS) not only ensures the transparency, reliability and consistency but also sets the formal boundaries within which the financial transactions should be reported by any business entity.

Q14.What are the two basic objectives of having Accounting Standards?

Ans –

Objectives of Accounting Standard:-

1. The main aim to improve the reliability of financial statements. Now because the financial statements have to be made following the standards the users can rely on them. They know that not conforming to these standards can have serious consequences for the companies.
2. Then there is comparability. Following these standards will allow for inter-firm and intra-firm comparisons. This allows us to check the progress of the firm and its position in the market.

Q15. Explain the following briefly with appropriate example:

Ans –

1. Revenue Recognition (Realisation) Concept – According to the Revenue Recognition Concept, revenue is considered to have been realised when a transaction has been entered into and the obligation to receive the amount is established. It is to be noted that recognising revenue and receipt of an amount are two separate aspects.
2. Conservation or Prudence Concept – It takes into consideration all prospective losses but not the prospective profits. The application of this concept ensures that the financial statements do not paint a better picture than what it actually is. For example, closing stock is valued at lower of cost or net realisable value (market value) or making the provision for doubtful debts and discount on debtors in anticipation of bad debts and discount. Prudence or Conservatism Principle prescribes that anticipated expenses and losses should be accounted.
3. Money Measurement Concept – According to the money Measurement Principle, transactions and events that can be measured in money terms are recorded in the book of account of the enterprise. Money is the common denominator in recording and reporting transactions.

Q16. Explain the following:

Ans –

1. Going Concern Concept – According to this assumption, it is assumed that business shall continue for a foreseeable period and there is no intention to close the business or scale down its operations significantly. It is because of this concept that a distinction is made between capital expenditure, i.e., expenditure that will give benefit for a long period and revenue expenditure, i.e., one whose benefit will be consumed or exhausted within the accounting period. On the basis of this concept, fixed assets are recorded at their original cost and they are depreciated in a systematic manner over their expected useful life.
2. Dual Aspect Concept – According to the Dual Aspect Concept, every transaction entered into by an enterprise has two aspects, a debit and a credit of equal amount. Simply stated, for every debit there is a credit of equal amount in one or more accounts. It is also true vice versa. For example, Nitin starts a business with a capital of rs. 1, 00,000. There are two aspects to the transaction. On one hand, the business has an asset of rs. 1, 00,000 (cash) while on other hand; it has a liability towards Nitin of rs. 1, 00,000 (capital of Nitin).

Q17. (i) What is the principle of conservation or prudence?

         (ii) What are the Objectives of IFRS (Any Two)?

Ans – 

1. Conservatism Principle is a concept in accounting under GAAP that recognizes and records expenses and liabilities-uncertain, as soon as possible but recognizes revenues and assets when they are assured of being received. It gives clear guidance in documenting cases of uncertainty and estimates. Major accounting principles and guidelines listed under UK GAAP, which is a regulatory body of policies and standards of accounting that all accountants across the globe need to follow which reporting the business’s financial activity. The principle of conservatism is mostly concerned with the reliability of the financial statements of a business entity.
2. Create a common law – One of its key objectives is to ensure that common law is introduced and adopted by as many jurisdictions and countries as possible to bring everyone on the same page. It ensures that everyone follows the same guidelines and adopts a universal way of reporting business activities.

Assist in preparation of reliable financial records – By following International Financial Reporting Standards, the data presented in the books of accounts are likely to be accurate, reliable, uniform, and appropriate within the bounds of its rules. The high quality of financial records assists investors in making informed economic decisions.

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