financial reporting, statements and analysis …present value is the present discounted value of the...

FRSA – 2019-20 – VS/GS/PSR/SKK

FINANCIAL REPORTING, STATEMENTS AND ANALYSIS

Module 1: Introduction (5 Hours) Learning Outcome: Explain conceptual framework of accounting including GAAP

Conceptual framework of Financial Accounting

Accounting as a measurement discipline

Accounting equations

Users of accounting statements

Terminology

Accounting Concepts*

Assumptions and Conventions

Introduction to Indian GAAP, Ind AS and IFRS.

I. WHAT IS ACCOUNTING? Accounting is often called the language of business. The function of a language is to facilitate communication among individuals in a society. Accounting is the common language used to communicate financial information in the world of business. Clearly, individuals who aspire to be professional accountants should be experts in accounting. Many others, such as investors, managers, employees, civil servants, police investigators, lawyers, judges, doctors and regulators, have to constantly deal with business organizations. All of them should have good knowledge of accounting terms, principles and techniques.

• The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated the following Definition of Accounting in 1961:

• “Accounting is 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 results thereof’

* Accounting: Concepts & Applications, 10e W. Steve Albrecht, Earl K. Stice, James D. Stice, and Monte R. Swain

Accounting is formally defined as a system for providing “quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.” The key components of this definition are: • Quantitative. Accounting relates to numbers. This is a strength because numbers can be easily tabulated and summarized. It is a weakness because some important business events, such as a toxic waste spill and the associated lawsuits and countersuits, cannot be easily described by one or two numbers. • Financial. The health and performance of a business are affected by and reflected in many dimensions—financial, personal relationships, community and environmental impact, and public image. Accounting focuses on just the financial dimension. • Useful. The practice of accounting is supported by a long tradition of theory. U.S. accounting rules have a theoretical conceptual framework. Some people actually make a living as accounting theorists. However, in spite of its theoretical beauty, accounting exists only because it is useful. • Decisions. Although accounting is the structured reporting of what has already occurred, this past information can only be useful if it impacts decisions about the future.


II. WHY ACCOUNTING IS ESSENTIAL?

Since a company’s financial statements affect stock prices, a manager should know accounting.

For corporate Strategy planning, without accounting numbers strategy won’t make sense.

Investment bankers want to use accounting information to value firms.

Marketing division use accounting for Profitability analysis

A start-up people want to manage the accounting and finance function of their business. Using financial numbers, they can analyze cases in marketing, operations and strategy better.

The law requires the CEO and the CFO, to certify the financial statements. A CEO should know what the items in the statements mean.

Accounting is a principal means of communicating financial information to owners, lenders, managers, and many others who have an interest in an enterprise.

III. ACCOUNTING AS A MEASUREMENT DISCIPLINE Accounting information measures performance of a business entity by way of profit or loss and shows its financial position. Thus, measurement is an important part of accounting discipline. Accounting is not an exact measurement discipline because accounting measures information mostly in terms of money which is not a stable scale, does not have universal applicability, is not stable in dimension for comparison over time. Any measurement discipline deals with three basic elements of measurement viz., identification of objects and events to be measured, selection of standard or scale to be used, and evaluation of dimension of measurement standards or scale.

Identification of Objects and Events:

As per definition of Accounting as the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by the users of the information. So accounting essentially includes measurement of ‘information’. Decision makers need past, present and future information. For external users, generally the past information is communicated. There is no uniform set of events and transactions in accounting which are required for decision making.

For example, in cash management, various cash receipts and expenses are the necessary objects and events. Obviously, the decision makers need past cash receipts and expenses data along with projected receipts and expenses. For giving loan to a business one needs information regarding the repayment


ability (popularly called debt servicing) of principal and interest. This also includes past information, current state of affairs as well as future projections. Selection of Standards or Scale:

In accounting, money is the scale of measurement (see money measurement concept), although now-a- days quantitative information is also communicated along with monetary information. Money as a measurement scale has no universal denomination. It takes the shape of currency ruling in a country.

For example, in India the scale of measurement is Rupee, in the U.K. Pound-Sterling (£), in Germany Deutschmark (DM), in the United States Dollar ($) and so on. Also there is no constant exchange

relationship among the currencies. Evaluation of Dimension of Measurement Standards or Scale

An ideal measurement scale should be stable over time. For example, if one buys 1 kg. Apple today, the quantity he receives will be the same if he will buy 1 kg. Apple one year later. That is to say a measurement scale should be stable in dimension. Money as a scale of measurement is not stable. There occurs continuous change in the input output prices. Valuation Principle Valuation related to the benefits to be derived from objects, abilities or ideas. There are 4 generally accepted measurement based on valuation principle. Historical Cost, Current Cost, Realisable Value and Present Value. (i). Historical Cost – All Fixed assets are recorded at the actual purchase price or acquisition price by following the principle of historical cost. Liabilities are recorded at an amount payable of proceeds received in exchange of the obligation. (ii). Current Cost Assets are carried out at the amount of cash or cash equivalent that would have to be paid if the similar asset was acquired currently. Liabilities are carried out at the undiscounted amount of cash or cash equivalent that would be required to settle the obligation currently.

Example: Flipkart purchased a packing machine by paying Rs.8,00,000 when the actual price of the machinery is Rs.10,00,000. Here, the historical cost is only Rs. 8,00,000 which is the price paid for acquiring the machine.

Example: When Flipkart, takes Rs.1,00,000 loan from a bank @12% interest p.a., it is to be recorded at the amount of proceeds received in exchange for obligation being repayment of loan and payment of interest at an agreed rate. Proceeds received are Rs.1,00,000 – it is historical cost of the transactions.

Example: Tata Motors purchased a machine at Rs.8,00,000 on January 1, 2013. The similar machine if purchased now i.e. in 2019, would costs Rs.15,00,000. So as per current cost basis, the machine’s value is Rs.15,00,000.


(iii). Realisable Value Realisable value is the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at settlement values, i.e. the undiscounted amount of cash or cash equivalent to be paid. (iv). Present Value Present value is the present discounted value of the future net cash inflows that the asset is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of future net cash outflows expected to settle the liabilities in the normal course of business.

IV. ACCOUNTING EQUATION The accounting system reflects two basic aspects of a company: what it owns and what it owes. Assets are resources a company owns or controls. Examples are cash, supplies, equipment, and land, where each carries expected benefits. The claims on a company’s assets—what it owes—are separated into owner and non-owner claims. Liabilities are what a company owes its non-owners (creditors) in future payments, products, or services. Equity (also called owner’s equity or capital) refers to the claims of its owner(s). Together, liabilities and equity are the source of funds to acquire assets. The relation of assets, liabilities, and equity is reflected in the following accounting equation:

Assets = Liabilities + Equity

Assets Assets are resources a company owns or controls. These resources are expected to yield future benefits. Examples are Web servers for an online services company, musical instruments for a rock band, and land for a vegetable grower. The term receivable is used to refer to an asset that promises a future inflow of resources. A company that provides a service or product on credit is said to have an account receivable

from that customer. Liabilities Liabilities are creditors’ claims on assets. These claims reflect company obligations to provide assets, products or services to others. The term payable refers to a liability that promises a future outflow of

Example: Tata Motors purchased a machine at Rs.8,00,000 on January 1, 2013. If they sells the machine, now in 2019 they will be getting Rs.2,00,000. So, the machine has to be recorded at Rs.2,00,000 being the realizable value.

Example: MRF purchased a machine on 01.04.2002, and it is supposed to generate cash at Rs.50,000 p.a. for the next 10 years at the rate of 10% p.a. The present value of future cash flows will be calculated as follows: PV = Amount / (1+ Rate of Interest)Number of Years PV = 50,000 / (1+ 10%)10 = Rs.45455


resources. Examples are wages payable to workers, accounts payable to suppliers, notes payable to banks, and taxes payable to the government. Equity Equity is the owner’s claim on assets. Equity is equal to assets minus liabilities. This is the reason equity is also called net assets or residual equity. Equity for a non-corporate entity—commonly called owner’s equity—increases and decreases as follows: owner investments and revenues increase equity, whereas owner withdrawals and expenses decrease equity. Revenues increase equity (via net income) and result from a company’s earnings activities. Examples are consulting services provided, sales of products, facilities rented to others, and commissions from services. Expenses are the costs necessary to earn revenues. Expenses decrease equity. Examples are costs of employee time, use of supplies, and advertising, utilities, and insurance services from others. This breakdown of equity yields the following expanded accounting equation.

Assets = Liabilities + Owner’s Capital – Owner’s Withdrawals + Revenues - Expenses Transaction 1: Investment by Owner On December 1, Chas Taylor forms a consulting business, named FastForward and set up as a proprietorship, Taylor personally invests $30,000 cash in the new company

Transaction 2: Purchase Supplies for Cash FastForward uses $2,500 of its cash to buy supplies of brand name footwear for performance

Transaction 3: Purchase Equipment for Cash FastForward spends $26,000 to acquire equipment for testing footwear.


Transaction 4: Purchase Supplies on Credit Taylor decides more supplies of footwear and accessories are needed. Taylor arranges to purchase them on credit from CalTech Supply Company. Thus, FastForward acquires supplies in exchange for a promise

to pay for them later by $7,100 Transaction 5: Provide Services for Cash FastForward earns revenues by selling online ad space to manufacturers and by consulting with clients. FastForward provides consulting services to a powerwalking club and immediately collects $4,200 cash. The accounting equation reflects this increase in cash of $4,200 and in equity of $4,200. This increase in equity is identified in the far right column under Revenues because the cash received is earned by providing consulting services.

Transactions 6 and 7: Payment of Expenses in Cash FastForward pays $1,000 rent to the landlord of the building where its facilities are located. FastForward also pays the biweekly $700 salary of the company’s only employee.

Transaction 8: Provide Services and Facilities for Credit FastForward provides consulting services of $1,600 and rents its test facilities for $300 to a podiatric services center. The center is billed for the $1,900 total. This transaction results in a new asset, called accounts receivable, from this client. It also yields an increase in equity from the two revenue components reflected in the Revenues column of the accounting equation:


Transaction 9: Receipt of Cash from Accounts Receivable The client in transaction 8 (the podiatric center) pays $1,900 to FastForward 10 days after it is billed for consulting services.

Point: Receipt of cash is not always a revenue. Transaction 10: Payment of Accounts Payable FastForward pays CalTech Supply $900 cash as partial payment for its earlier $7,100 purchase of supplies (transaction 4), leaving $6,200 unpaid.

Transaction 11: Withdrawal of Cash by Owner The owner of FastForward withdraws $200 cash for personal use. By definition, increases in withdrawals yield decreases in equity.


Financial and Management Accounting The accounting system provides information to persons inside and outside the enterprise. Financial accounting is the preparation and communication of financial information for use primarily by those outside the enterprise. Its chief purpose is to provide information about the performance of the enterprise’s management to its owners. Management accounting is the preparation and communication of financial and other information to help managers plan and control operations. Management accounting information is more detailed and timely than what is available to external users

V. USERS OF ACCOUNTING INFORMATION Financial reports have diverse users. Investors and lenders are the most obvious users. Other users include analysts, advisers, managers, employees, trade unions, suppliers, customers, governments, regulatory agencies, and the public. Business enterprises increasingly report on their economic, social and environmental impact. Investors Investors are the major recipients of the financial statements of business enterprises. Investors are keen to understand the profitability of their investments and the associated risks, i.e. the likelihood of loss or low profit. Investors want accurate and timely financial statements. Accounting information enables investors to identify promising investment opportunities. Investors need information to decide which investments to buy, hold or sell. They also require information to monitor management performance and


assess the ability of an enterprise to pay dividends. While present investors have a legal right to receive periodic financial reports, potential investors too are interested in financial information. Lenders Lenders such as banks and debenture holders want to know about the financial stability of a business that approaches them for funds. They are interested in information that would enable them to determine whether their borrowers will be able to repay the loans and pay the related interest on time. Banks use credit evaluation benchmarks based on information derived from financial statements when deciding on the amount of the loan, interest rate, repayment period, and security. They also use the information for monitoring the financial condition of borrowers. Analysts and Advisers Equity analysts, bond analysts, stockbrokers, and credit rating agencies offer a wide array of information services. These specialists serve the needs of investors by providing them with skilled analyses and interpretation of financial reports. Managers and Directors Managers not only prepare the financial statements but also use the statements. For example, they need financial information for planning and controlling operations, making special decisions and formulating major plans and policies. They monitor the key financial indicators of the business and compare their firm’s performance with their competitors’. They may be interested in acquiring other firms. Under the Companies Act, a company’s directors are responsible for financial reporting. Their responsibilities include applying accounting standards and policies, maintaining accounting records, preventing and detecting fraud, preparing the financial statements on a going concern basis, laying down internal financial controls, and devising systems for compliance with laws and regulations. Therefore, directors need a good understanding of accounting. Employees and Trade Unions Employees are keen to know about their employer’s general operations, stability and profitability. Current employees have a natural interest in the financial condition of an enterprise because their jobs and salaries depend on its financial performance. Profitable businesses attract adverse notice when their employees are not seen to be benefiting from their success. Trade unions use financial reports for negotiating enhancements in wages, bonus and other benefits. Union leaders are often as good as, if not better than, analysts at dissecting financial statements. Suppliers and Trade Financiers Suppliers regard a firm as an outlet for their products and services. They use financial information to assess the likelihood of the enterprise continuing to buy from them, especially if it is a major customer. Suppliers plan their production and capacity on the basis of expected demand. Trade financiers provide short-term financial support. Suppliers and trade financiers want information to determine whether the enterprise will pay them on the dot. While lenders take a long-term view, suppliers and trade financiers usually focus on the enterprise’s near-term financial condition. Customers Present, prospective and past customers need information to evaluate the financial strength of their suppliers. Customers would like to be certain that they can count on their suppliers for future purchases and after-sales support. This is particularly important for products and services that are proprietary. For


example, car owners depend on the manufacturer for warranty repairs and continued supply of spare parts. Computer software users look to the software firm for periodic upgrade of the product. When an airline keeps losing money, customers begin to worry about the possibility of flight cancellations, the fate of their mileage points and even aircraft safety. Auditors Auditors provide assurance on the reliability of accounting information. Their reputation depends on the quality of their clients’ financial statements. They would not want to certify the financial statements of companies suspected of fraudulent or questionable accounting practices. Increasingly, auditors are sued or pulled up for negligence. Government and Regulatory Authorities The three levels of government in India – central, state and local – allocate resources and are concerned with the activities of enterprises. They require information in order to regulate the business practices of enterprises, determine taxation policies, investigate crime, and provide a basis for national income and similar statistics. The Central Board of Excise and Customs (CBEC) administers central excise and customs duties, service tax, and goods and services tax. A number of regulatory agencies are government or quasi-government bodies, such as the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), the Insurance Regulatory and Development Authority of India (IRDAI), the Telecom Regulatory Authority of India (TRAI), and the Competition Commission of India (CCI). These agencies use financial reports in order to identify abuses and violations and to protect the interests of investors and consumers. The Public The activities of business enterprises affect the members of the public in a variety of ways. For example, businesses employ people from the local community and patronize local suppliers; so the prosperity of the local community depends on their success. It is said that whenever the software industry slows down, business in upmarket restaurants and pubs in Bengaluru falls. Financial statements assist the public by providing information about the trends and recent developments in the prosperity of the enterprise and the range of its activities. Political parties, public affairs groups, consumer groups, newspapers and magazines, television channels, anti-globalization and anti-business activists and environment protection groups have a general interest in the affairs of business enterprises.

VI. BASIC ACCOUNTING TERMS In order to understand the subject matter clearly, one must grasp the following common expressions always used in business accounting. The aim here is to enable the student to understand with these often used concepts before we embark on accounting procedures and rules. You may note that these terms can be applied to any business activity with the same connotation.

(i) Transaction: It means an event or a business activity which involves exchange of money or money’s worth between parties. The event can be measured in terms of money and changes the financial position of a person e.g. purchase of goods would involve receiving material and making payment or creating an obligation to pay to the supplier at a future date. Transaction could be a cash transaction or credit transaction. When the parties settle the transaction immediately by making payment in cash or by cheque, it is called a cash transaction. In credit transaction, the payment is settled at a future date as per agreement between the parties.

(ii) Goods/Services: These are tangible article or commodity in which a business deals. These articles or commodities are either bought and sold or produced and sold. At times, what may


be classified as ‘goods’ to one business firm may not be ‘goods’ to the other firm. e.g. for a machine manufacturing company, the machines are ‘goods’ as they are frequently made and sold. But for the buying firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell it. Services are intangible in nature which are rendered with or without the object of earning profits.

(iii) Profit: The excess of Revenue Income over expense is called profit. It could be calculated for each transaction or for business as a whole.

(iv) Loss: The excess of expense over income is called loss. It could be calculated for each transaction or for business as a whole.

(v) Asset: Asset is a resource owned by the business with the purpose of using it for generating future profits. Assets can be Tangible and Intangible. Tangible Assets are the Capital assets which have some physical existence. They can, therefore, be seen, touched and felt, e.g. Plant and Machinery, Furniture and Fittings, Land and Buildings, Books, Computers, Vehicles, etc. The capital assets which have no physical existence and whose value is limited by the rights and anticipated benefits that possession confers upon the owner are known as lntangible Assets. They cannot be seen or felt although they help to generate revenue in future, e.g. Goodwill, Patents, Trade-marks, Copyrights, Brand Equity, Designs, Intellectual Property, etc. Assets can also be classified into Current Assets and Non-Current Assets. Current Assets – An asset shall be classified as Current when it satisfies any of the following : (a) It is expected to be realised in, or is intended for sale or consumption in the Company’s normal Operating Cycle, (b) It is held primarily for the purpose of being traded , (c) It is due to be realised within 12 months after the Reporting Date, or (d) It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a Liability for at least 12 months after the Reporting Date. Non-Current Assets – All other Assets shall be classified as Non-Current Assets. e.g. Machinery held for long term etc.

(vi) Liability: It is an obligation of financial nature to be settled at a future date. It represents amount of money that the business owes to the other parties. E.g. when goods are bought on credit, the firm will create an obligation to pay to the supplier the price of goods on an agreed future date or when a loan is taken from bank, an obligation to pay interest and principal amount is created. Depending upon the period of holding, these obligations could be further classified into Long Term on non-current liabilities and Short Term or current liabilities. Current Liabilities – A liability shall be classified as Current when it satisfies any of the following : (a) It is expected to be settled in the Company’s normal Operating Cycle, (b) It is held primarily for the purpose of being traded, (c) It is due to be settled within 12 months after the Reporting Date, or (d) The Company does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date (Terms of a Liability that could, at the option of the counterparty, result in its settlement by the issue of Equity Instruments do not affect its classification) Non-Current Liabilities – All other Liabilities shall be classified as Non-Current Liabilities. E.g. Loan taken for 5 years, Debentures issued etc.

(vii) Internal Liability: These represent proprietor’s equity, i.e. all those amount which are entitled to the proprietor, e.g., Capital, Reserves, Undistributed Profits, etc.

(viii) Working Capital: In order to maintain flows of revenue from operation, every firm needs certain amount of current assets. For example, cash is required either to pay for expenses or to meet obligation for service received or goods purchased, etc. by a firm. On identical reason, inventories are required to provide the link between production and sale. Similarly, Accounts Receivable generate when goods are sold on credit. Cash, Bank, Debtors, Bills Receivable, Closing Stock, Prepayments etc. represent current assets of firm. The whole of these current


assets form the working capital of a firm which is termed as Gross Working Capital. Gross Working capital = Total Current Assets = Long term internal liabilities plus long term debts plus the current liabilities minus the amount blocked in the fixed assets. There is another concept of working capital. Working capital is the excess of current assets over current liabilities. That is the amount of current assets that remain in a firm if all its current liabilities are paid. This concept of working capital is known as Net Working Capital which is a more realistic concept. Working Capital (Net) = Current Assets – Currents Liabilities.

(ix) Contingent Liability: It represents a potential obligation that could be created depending on the outcome of an event. E.g. if supplier of the business files a legal suit, it will not be treated as a liability because no obligation is created immediately. If the verdict of the case is given in favour of the supplier then only the obligation is created. Till that it is treated as a contingent liability. Please note that contingent liability is not recorded in books of account, but disclosed by way of a note to the financial statements.

(x) Capital: It is amount invested in the business by its owners. It may be in the form of cash, goods, or any other asset which the proprietor or partners of business invest in the business activity. From business point of view, capital of owners is a liability which is to be settled only in the event of closure or transfer of the business. Hence, it is not classified as a normal liability. For corporate bodies, capital is normally represented as share capital.

(xi) Drawings: It represents an amount of cash, goods or any other assets which the owner withdraws from business for his or her personal use. e.g. if the life insurance premium of proprietor or a partner of business is paid from the business cash, it is called drawings. Drawings will result in reduction in the owners’ capital. The concept of drawing is not applicable to the corporate bodies like limited companies.

(xii) Net worth: It represents excess of total assets over total liabilities of the business. Technically, this amount is available to be distributed to owners in the event of closure of the business after payment of all liabilities. That is why it is also termed as Owner’s equity. A profit making business will result in increase in the owner’s equity whereas losses will reduce it.

(xiii) Non-current Investments: Non-current Investments are investments which are held beyond the current period as to sale or disposal. e. g. Fixed Deposit for 5 years.

(xiv) Current Investments: Current investments are investments that are by their nature readily realizable and are intended to be held for not more than one year from the date on which such investment is made. e. g. 11 months Commercial Paper.

(xv) Debtor: The sum total or aggregate of the amounts which the customer owe to the business for purchasing goods on credit or services rendered or in respect of other contractual obligations, is known as Sundry Debtors or Trade Debtors, or Trade Payable, or Book-Debts or Debtors. In other words, Debtors are those persons from whom a business has to recover money on account of goods sold or service rendered on credit. These debtors may again be classified as under: (i) Good debts: The debts which are sure to be realized are called good debts. (ii) Doubtful Debts: The debts which may or may not be realized are called doubtful debts. (iii) Bad debts: The debts which cannot be realized at all are called bad debts. It must be remembered that while ascertaining the debtors balance at the end of the period certain adjustments may have to be made e.g. Bad Debts, Discount Allowed, Returns Inwards, etc.

(xvi) Creditor: A creditor is a person to whom the business owes money or money’s worth. e.g. money payable to supplier of goods or provider of service. Creditors are generally classified as Current Liabilities.


(xvii) Capital Expenditure: This represents expenditure incurred for the purpose of acquiring a fixed asset which is intended to be used over long term for earning profits there from. e. g. amount paid to buy a computer for office use is a capital expenditure. At times expenditure may be incurred for enhancing the production capacity of the machine. This also will be a capital expenditure. Capital expenditure forms part of the Balance Sheet.

(xviii) Revenue expenditure: This represents expenditure incurred to earn revenue of the current period. The benefits of revenue expenses get exhausted in the year of the incurrence. e.g. repairs, insurance, salary & wages to employees, travel etc. The revenue expenditure results in reduction in profit or surplus. It forms part of the Income statement.

(xix) Balance Sheet: It is the statement of financial position of the business entity on a particular date. It lists all assets, liabilities and capital. It is important to note that this statement exhibits the state of affairs of the business as on a particular date only. It describes what the business owns and what the business owes to outsiders (this denotes liabilities) and to the owners (this denotes capital). It is prepared after incorporating the resulting profit/losses of Income statement.

(xx) Profit and Loss Account or Income Statement: This account shows the revenue earned by the business and the expenses incurred by the business to earn that revenue. This is prepared usually for a particular accounting period, which could be a month, quarter, a half year or a year. The net result of the Profit and Loss Account will show profit earned or loss suffered by the business entity.

(xxi) Trade Discount: It is the discount usually allowed by the wholesaler to the retailer computed on the list price or invoice price. e.g. the list price of a TV set could be Rs. 15000. The wholesaler may allow 20% discount thereof to the retailer. This means the retailer will get it for Rs. 12000 and is expected to sale it to final customer at the list price. Thus the trade discount enables the retailer to make profit by selling at the list price. Trade discount is not recorded in the books of accounts. The transactions are recorded at net values only. In above example, the transaction will be recorded at Rs.12000 only.

(xxii) Cash Discount: This is allowed to encourage prompt payment by the debtor. This has to be recorded in the books of accounts. This is calculated after deducting the trade discount. e.g. if list price is Rs.15000 on which a trade discount of 20% and cash discount of 2% apply, then first trade discount of Rs.3000 (20% of Rs.15000) will be deducted and the cash discount of 2% will be calculated on Rs.12000 (Rs.15000 – Rs.3000). Hence the cash discount will be Rs.240 (2% of Rs.12000) and net payment will be Rs.11,760 (Rs.12,000 – Rs.240)

VII. ACCOUNTING CONCEPTS, ASSUMPTIONS AND CONVENTIONS Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts. The main objective is to maintain uniformity and consistency in accounting Records. Following are the various accounting concepts that have been discussed in the following sections:

Business entity concept

Money measurement concept

Going concern concept

Accounting period concept

Accounting cost concept

Dual aspect concept


Realisation concept

Accrual concept

Matching concept

Business Entity Concept This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate. For example, when the owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. Money Measurement Concept This concept assumes that all business transactions must be in terms of money, that is in the currency of a country. In our country such transactions are in terms of rupees. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. For example, sale of goods worth Rs.200000, purchase of raw materials Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, loyality, honesty of employees is not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business concern. Going Concern Concept This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet; For example, a company purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it will not be proper to charge the amount from the revenues of the year in which the item is acquired. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset. Accounting Period Concept All the transactions are recorded in the books of accounts on the assumption that profits on these transactions are to be ascertained for a specified period. This is known as accounting period concept. Thus, this concept requires that a balance sheet and profit and loss account should be prepared at regular intervals. This is necessary for different purposes like, calculation of profit, ascertaining financial position, tax computation etc. Further, this concept assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be of one year, six months, three months, one month, etc. But usually one year is taken as one accounting period which may be a financial year. The year that begins from 1st of April and ends on 31st of March of the following year, is known as financial year. As per accounting period concept, all the transactions are recorded in the books of accounts for a specified period of time. Hence,


goods purchased and sold during the period, rent, salaries etc. paid for the period are accounted for and against that period only. Accounting Cost Concept Accounting cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc. are recorded in the books of accounts at a price paid for them. For example, a machine was purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs. 1,000 were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on its installation. The total amount at which the machine will be recorded in the books of accounts would be the sum of all these items i.e. Rs.503000. This cost is also known as historical cost. Suppose the market price of the same is now Rs.90000 it will not be shown at this value. Further, it may be clarified that cost means original or acquisition cost only for new assets and for the used ones, cost means original cost less depreciation. The cost concept is also known as historical cost concept. Dual Aspect Concept Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded. Thus, the duality concept is commonly expressed in terms of fundamental accounting equation:

Assets = Liabilities + Capital The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities. Realisation Concept This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realisation means creation of legal right to receive money. Selling goods is realisation, receiving order is not. In other words, it can be said that: Revenue is said to have been realised when cash has been received or right to receive cash on the sale of goods or services or both has been created. The concept of realisation states that revenue is realized at the time when goods or services are actually delivered.

Transaction Revenue Realisation

Tanshiq Jeweller received an order to supply gold ornaments worth Rs.500000. They supplied ornaments worth Rs.200000 up to the year ending 31st December 2018 and rest of the ornaments were supplied in January 2019.

The revenue for the year 2018 for Tanshiq Jeweller is Rs.200000. Mere getting an order is not considered as revenue until the goods have been delivered


Bansal sold goods for Rs.1,00,000 for cash in 2006 and the goods have been delivered during the same year.

The revenue for Bansal for year 2005 is Rs.1,00,000 as the goods have been delivered in the year 2005. Cash has also been received in the same year.

Akshay sold goods on credit for Rs.50,000 during the year ending 31st December 2005. The goods have been delivered in 2005 but the payment was received in March 2006.

Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been delivered to the customer in the year 2005. Revenue became due in the year 2005 itself. In the above examples, revenue is realised when the goods are delivered to the customers.

Accrual Concept The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognised when they become receivable. Though cash is received or not received and the expenses are recognized when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate. Therefore, the accrual concept makes a distinction between the accrual receipt of cash and the right to receive cash as regards revenue and actual payment of cash and obligation to pay cash as regards expenses. The accrual concept under accounting assumes that revenue is realised at the time of sale of goods or services irrespective of the fact when the cash is received. For example, a firm sells goods for Rs 55000 on 25th March 2019 and the payment is not received until 10th April 2019, the amount is due and payable to the firm on the date of sale i.e. 25th March 2019. It must be included in the revenue for the year ending 31st March 2019. Similarly, expenses are recognised at the time services provided, irrespective of the fact when actual payment for these services are made. For example, if the firm received goods costing Rs.20000 on 29th March 2019 but the payment is made on 2nd April 2019 the accrual concept requires that expenses must be recorded for the year ending 31st March 2019 although no payment has been made until 31st March 2019 through the service has been received and the person to whom the payment should have been made is shown as creditor. Matching Concept The matching concept states that the revenue and the expenses incurred to earn the revenues must belong to the same accounting period. So once the revenue is realised, the next step is to allocate it to the relevant accounting period. This can be done with the help of accrual concept. Let us study the following transactions of a business during the month of December, 2006 (i) Sale: cash Rs.2000 and credit Rs.1000 (ii) Salaries Paid Rs.350 (iii) Commission Paid Rs.150 (iv) Interest Received Rs.50 (v) Rent received Rs.140, out of which Rs.40 received for the year 2007 (vi) Carriage paid Rs.20 (vii) Postage Rs.30 (viii) Rent paid Rs.200, out of which Rs.50 belong to the year 2005 (ix) Goods purchased in the year for cash Rs.1500 and on credit Rs.500 (x) Depreciation on machine Rs.200


S.No Transaction Expenses Amount

(Rs.)

Income Amount

(Rs.)

1 Sales (Cash – Rs.2000 & Credit Rs. 1000) 3000

2 Interest Received 50

3 Rent Received (140 Less Rs.40 for 2007) 100

4 Salaries 350

5 Commission 150

6 Postage 30

7 Rent Paid (Rs.200 Less Rs. 50 for 2005) 150

8 Carriage 20

9 Goods Purchased (Cash –Rs.1500 & Credit – Rs.500)

2000

10 Depreciation on Machine 200

Total 2900 3150

Profit 250

In the above example expenses have been matched with revenue i.e. (Revenue Rs.3150-Expenses Rs.2900) This comparison has resulted in profit of Rs.250. If the revenue is more than the expenses, it is called profit. If the expenses are more than revenue it is called loss. This is what exactly has been done by applying the matching concept. Accounting Conventions An accounting convention refers to common practices which are universally followed in recording and presenting accounting information of the business entity. They are followed like customs, tradition, etc. in a society Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting Conventions help in comparing accounting data of different business units or of the same unit for different periods. These have been developed over the years. The most important conventions which have been used for a long period are:

Convention of consistency.

Convention of full disclosure.

Convention of materiality.

Convention of conservatism. Convention of consistency The convention of consistency means that same accounting principles should be used for preparing financial statements year after year. A meaningful conclusion can be drawn from financial statements of the same enterprise when there is comparison between them over a period of time. But this can be possible only when accounting policies and practices followed by the enterprise are uniform and consistent over a period of time. If different accounting procedures and practices are used for preparing financial statements of different years, then the result will not be comparable. While charging depreciation on fixed assets or valuing unsold stock, once a particular method is used it should be followed year after year so that the financial statements can be analysed and compared provided the depreciation on fixed assets is charged or unsold stock is valued by using particular method


year after year. This can be further clarified as: in case of charging depreciation on fixed assets accountant can decide to adopt any one of the methods of depreciation such as diminishing value method or straight line method. Similarly, in case of valuation of closing stock it can be valued at actual cost price or market price or whichever is less. However precious metals like gold, diamond, minerals are generally valued at market price only. Convention of Full Disclosure Convention of full disclosure requires that all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of accounting information. Adequate means sufficient set of information to be disclosed. Fair indicates an equitable treatment of users. Full refers to complete and detailed presentation of information. Let us relate it to the business. The business provides financial information to all interested parties like investors, lenders, creditors, shareholders etc. The shareholder would like to know profitability of the firm while the creditor would like to know the solvency of the business. In the same way, other parties would be interested in the financial information according to their requirements. This is possible if financial statement discloses all relevant information in full, fair and adequate manner. For example: As per accounts, net sales are Rs. 150,000, it is important for the interested parties to know the amount of gross sales which may be Rs. 200,000 and the sales return Rs. 50,000. The disclosure of 25% sales returns may help them to find out the actual sales position. For example, in a balance sheet the basis of valuation of assets, such as investments, inventories, land and building etc. should be clearly stated. Similarly, any change in the method of depreciation or in making provision for bad debts or creating any reserve must also be shown clearly in the Balance Sheet. Therefore, whatever details are available, that must be honestly provided. Additional information should also be given in the financial statement. Convention of Materiality The convention of materiality states that, to make financial statements meaningful, only material fact i.e. important and relevant information should be supplied to the users of accounting information. The question that arises here is what is a material fact. The materiality of a fact depends on its nature and the amount involved. Material fact means the information of which will influence the decision of its user. For example, a businessman is dealing in electronic goods. He purchases T.V., Refrigerator, Washing Machine, Computer etc. for his business. In buying these items he uses larger part of his capital. These items are significant items; thus should be recorded in books of accounts in detail. At the same time to maintain day to day office work he purchases pen, pencil, match box, scented stick, etc. For this he will use very small amount of his capital. But to maintain the details of every pen, pencil, match box or other small items is not considered of much significance. These items are insignificant items and hence they should be recorded separately. Thus, the items that are significantly important in recording the details are termed as material facts or significant items. The items that are of less significance are immaterial facts or insignificant items. Convention of Conservatism This convention is based on the principle that “Anticipate no profit, but provide for all possible losses”. It provides guidance for recording transactions in the books of accounts. It is based on the policy of playing safe in regard to showing profit. The main objective of this convention is to show minimum profit. Profit should not be overstated. If profit shows more than actual, it may lead to distribution of dividend out of


capital. This is not a fair policy and it will lead to the reduction in the capital of the enterprise. Thus, this convention clearly states that profit should not be recorded until it is realised. But if the business anticipates any loss in the near future, provision should be made in the books of accounts for the same. For example, valuing closing stock at cost or market price whichever is lower, creating provision for doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent, etc. The convention of conservatism is a very useful tool in situation of uncertainty and doubts. INTRODUCTION TO INDIAN GAAP, IND AS AND IFRS. Indian GAAP (Generally Accepted Accounting Principles) GAAP is the collection of accounting conventions, assumptions, concepts and rules. The sources of Indian GAAP (IGAAP) include the Companies Act 2013, accounting standards, and the ICAI’s pronouncements. Accounting standards specify the acceptable methods from the wide array of accounting choices allowed by GAAP. Indian GAAP primarily comprises 18 accounting standards (AS) issued by the Institute of Chartered Accountants of India (ICAI). To aid interpretation, the ICAI has also issued guidance notes and 'expert opinions' on specific queries raised by companies and accountants. Of the three, however, only the standards are mandatory in application. In addition, the Indian Companies Act 1956 and various other industry-specific statutes prescribe certain minimum disclosures in the financial statements. Companies listed on the stock exchanges also need to comply with a few other accounting rules such as preparing cash flow statements and accounting for stock-based compensation. Indian GAAP mirrors international GAAP in the key accounting principles such as going concern, consistency, accruals, prudence, substance over form and materiality. The most significant accounting differences at present are absence of consolidation and deferred tax accounting. There are other differences relating to disclosures such as segment reporting, disclosure of related party transactions, and so on. However, all these differences are expected to disappear soon with the introduction of new standards. Indian Accounting Standards (Ind AS) The global financial crisis in 2008 highlighted the need for strengthening the international financial regulatory system. In September 2009, the Group of 20 countries (G20) – that includes India – called on international accounting bodies to work for a single set of high quality, global accounting standards and complete their convergence project by June 2011. In February 2011, the Ministry of Corporate Affairs notified the converged standards, known as the Indian Accounting Standards (Ind AS). The MCA proposed to implement them in phases beginning April 1, 2011. In the Union Budget 2014 presented to Parliament on July 10, 2014, the Finance Minister stated that there was an urgent need to converge the current Indian accounting standards with IFRS. He proposed adoption of the new Indian Accounting Standards (Ind AS) from the financial year 2015-16 voluntarily and from the financial year 2016-17 mandatorily. On February 16, 2015 and March 30, 2016, the MCA notified Ind AS under the Companies Act 2013. These would replace Accounting Standards (AS) issued by the government in 2006. Companies may opt to comply with Ind AS for financial statements for accounting periods beginning on or after April 1, 2015. All listed companies and some unlisted companies must comply with Ind AS for accounting periods


beginning on or after April 1, 2016. The RBI and the IRDAI have directed banks and insurers to comply with Ind AS for financial statements for accounting periods beginning from April 1, 2018. Ind AS 101 First-time adoption of Ind AS Ind AS 102 Share Based Payment Ind AS 103 Business Combination Ind AS 104 Insurance Contract Ind AS 105 Non-Current Assets Held for Sale and Discontinued Operations Ind AS 106 Exploration for and Evaluation of Mineral Resources Ind AS 107 Financial Instruments: Disclosures Ind AS 108 Operating Segments Ind AS 109 Financial Instruments Ind AS 110 Consolidated Financial Statements Ind AS 111 Joint Arrangements Ind AS 112 Disclosure of Interests in Other Entities Ind AS 113 Fair Value Measurement Ind AS 114 Regulatory Deferral Accounts Ind AS 115 Revenue from Contracts with Customers (Applicable from April 2018) Ind AS 1 Presentation of Financial Statements Ind AS 2 Inventories Accounting Ind AS 7 & in only AS 3 Statement of Cash Flows Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors Ind AS 10 Events occurring after Reporting Period Ind AS 11 Construction Contracts (Omitted by the Companies (Indian Accounting Standards) Amendment Rules, 2018) Ind AS 12 Income Taxes Ind AS 16 Property, Plant and Equipment Ind AS 17 Lease Ind AS 18 Revenue (Omitted by the Companies (Indian Accounting Standards) Amendment Rules, 2018) Ind AS 19 Employee Benefits Ind AS 20 Accounting for Government Grants and Disclosure of Government Assistance Ind AS 21 The Effects of Changes in Foreign Exchange Rates Ind AS 23 Borrowing Costs Ind AS 24 Related Party Disclosures Ind AS 27 Separate Financial Statements Ind AS 28 Investments in Associates and Joint Ventures Ind AS 29 Financial Reporting in Hyper Inflationary Economies Ind AS 32 Financial Instruments: Presentation Ind AS 33 Earnings per Share Ind AS 34 Interim Financial Reporting Ind AS 36 Impairment of Assets Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets Ind AS 38 Intangible Assets Ind AS 40 Investment Property Ind AS 41 Agriculture


IFRS – International Financial Reporting Standards IFRS is the international accounting framework within which to properly organize and report financial information. It is derived from the pronouncements of the London-based International Accounting Standards Board (IASB). It is currently the required accounting framework in more than 120 countries. IFRS requires businesses to report their financial results and financial position using the same rules; this means that, barring any fraudulent manipulation, there is considerable uniformity in the financial reporting of all businesses using IFRS, which makes it easier to compare and contrast their financial results. IFRS is used primarily by businesses reporting their financial results anywhere in the world except the United States. Generally Accepted Accounting Principles, or GAAP, is the accounting framework used in the United States. GAAP is much more rules-based than IFRS. IFRS focuses more on general principles than GAAP, which makes the IFRS body of work much smaller, cleaner, and easier to understand than GAAP. IFRS covers a broad array of topics, including:

Presentation of financial statements Revenue recognition Employee benefits Borrowing costs Income taxes Investment in associates Inventories Fixed assets Intangible assets Leases Retirement benefit plans Business combinations Foreign exchange rates Operating segments Subsequent events Industry-specific accounting, such as mineral resources and agriculture

There are several working groups that are gradually reducing the differences between the GAAP and IFRS accounting frameworks, so eventually there should be minor differences in the reported results of a business if it switches between the two frameworks. There is a stated intent to eventually merge GAAP into IFRS, but this has not yet occurred.

There will be a reduced cost for companies once the two accounting frameworks are more closely aligned, since they will not have to pay to have their financial statements restated to show results under the other framework in cases where they need to report their results in locations where the other framework is required.

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