ACCOUNTING

Evolution: Accounting can be traced back to the evolution of the number

system itself. It has been there in one form or the other, since the human
beings started exchanging things. In ancient times the “kings” or “monarchs”
used to maintain “treasury records”. They used to keep records of the
incomes and expenses to the treasury.

However, the real beginning can be traced to the reference to double entry
system in the book published about 500 years ago. It was the great Italian
Mathematician, Luca Pacioli, who authored the book and got it published in
1494. Every transaction has two aspects. The double entry system provides
for recording both aspects of a transaction in such a manner as to establish
an equilibrium.

Barter System: A system, in which goods are exchanged for goods, is

called “Barter System”. For example, A to A has some surplus wheat and he
wants to have a goat. A to B has some goats and he wants some wheat.
Now, when they meet, the wheat is exchanged for goat .This is called
“Barter”. This system of exchange was prevailing before the invention of
money.

Money: In order to overcome the limitations of barter system the “money”

was invented. Money is a medium of exchange. In ancient times a piece of
leather served as money. Later, gold coins, copper coins, iron coins with the
stamp of the King etc., were used as money. In the modern times, paper
money is used. For example, Rupees, dollars etc., in the form of printed
paper act as money. Now A to A can sell wheat to some body and get money
and with this money or a part of it, he can buy goat. A to A need not go in
search of a person who can exchange goat for wheat.

Definitions:

Business: An entity which carries on trading /manufacturing and selling of

goods and services for a profit is called ‘business’. The main intention of a
business is to make profit, while trading /manufacturing and selling. For
example, a retail shop owner who sells a variety of goods is carrying on
business.

Transactions: An event in which an exchange of things takes place or a

condition occurs is called a transaction. For example, the cash paid for
purchasing stationery, salary paid, interest received etc.

Business transactions are the transactions relating to a business such as,

sale, purchase, receipt of cash etc. A machinery is subject to wear and tear
due to usage, which is a condition, considered as a transaction to be
recorded.

1
Accounting: Accounting is a body of knowledge which provides essential
information about the financial activities of an entity to facilitate informed
judgments and decisions .It is connected with identifying how transactions
and events should be described in financial reports.

Book keeping: Book keeping is the part of accounting that records

transactions and other events manually or with computers. It is the writing
part of accounting. It is concerned with how the transactions are recorded in
the books.

Double entry system: For each transaction there are two aspects. A
system which provides for the recording each of the two aspects of a
transaction, separately, to facilitate equilibrium is called “double entry
system”. It is called double entry because two entries have to be made in
the books for every transaction.

Service Rendering: From the business point of view, rendering service

refers to providing an utility to the customer for a “fees” or “fare”, for
example Laundry service, Transportation, consultancy by Doctors,
professionals etc.

Merchandising (Trading): An activity of buying and selling of goods and

services is called “Merchandising”/ “Trading”. For example, a merchant buys
Shoes from the manufacturer and sells them to the ultimate customers. He
is merchandising /trading the shoes.

Manufacturing: The process of converting raw materials in to the finished

goods ready for use is called “manufacturing”. The material is converted in
to usable finished product with the help of labor and machines. Finally they
are sold to consumers. For example manufacturing shoes in a factory.

Profit: The difference in money between the selling price (being higher)
and the cost of sales of goods or services in a business entity during a period
is called “profit”. However, if cost of sales is more than the selling price, the
difference is called “loss”. For example, if a retailer buys a pair of shoes at
Rs. 80 and sells it for Rs.100, he makes a profit of Rs. 20. On the other
hand, if he sells the same for Rs. 75, he incurs a loss of Rs. 5.

FORMS OF BUSINESS OWNERSHIP

A business can be carried on by either a single person or a small group of
persons or very large group of persons. Accordingly, the main forms of
business owner ship are 1) Sole proprietorship 2) Partnership firms 3) Joint
stock companies /Corporations. They are discussed as below:

2
 1. Sole proprietorship: A business is called proprietorship business,
when it has only one owner. A single Person as owner carries on the
business. Only one person contributes money, called capital, to the
business. However, he takes the help of others for the manufacturing,
Administration, & selling activities of the business. It is also called
proprietary concern. In sole proprietorship form of business, the
entire profit/ loss goes to the only owner. The criterion is not the size
of the business but the number of owners. A sole proprietorship
business may have billions of Rs. transactions also. A small petty
retail store is also a sole proprietary concern. The condition is that
only one person should be the owner of the business.

2. Partnership firms: A group of two or more persons to carry on a

business and to share the profit or loss, under an agreement is called
a “Partnership firm ". In this form of organization two or more
persons combine together and contribute capital to carry on the
business and the profit/loss is shared among them. Partnership
agreement is the most important binding factor. The partners enter in
to an agreement relating to capital contribution, ratio of profit/loss to
be shared, business to be carried on, interest on loan and capital,
salary to partners, nature of liability, dissolution, admission of a
partner, etc. These partnership concerns are governed by the
“partnership acts” formulated by the government.

3. Share Company or Joint Stock Company or corporation: An

association of two or more persons having a separate legal entity, to
carry on a business, registered under a state or federal statute with a
common seal and in which ownership is divided in to shares of stock,
is called “corporation” or “Joint Stock Company” or “Share Company”.
When huge capital is required to carry on the business, this form of
business ownership is formulated. The capital is contributed by a
large number of persons called Share holders. Since there is a large
number of share holders, the management is separated from the
ownership .The business is carried on by a board of directors, elected
by the share holders. These directors have to report the result of the
business operations back to the share holders every year.

Types of Business operations

A business is carried on for the purpose of making profit. There are various
types of business operations. They are:

(1) Trading/Merchandising: Buying and selling of goods for profit is called

Trading/Merchandising. A whole seller buys goods from
manufacturers and sells them to retailers. The retailers buy goods
form wholesalers and sell them to ultimate consumers. Generally,
they deal with the finished goods/merchandise. In the process they
make profit.

3
 (2) Manufacturing & Selling: Conversion of Raw Materials in to finished
goods ready for consumption is called manufacturing. Example:
Manufacturing cycle, Cement, Shoes etc. The manufacturers sell the
goods at a price which is fixed after adding a certain percentage of
profit.

(3) Rendering Service: This is a type of business operation where a

service is rendered to the customers. Under this, physical goods are
not supplied to the consumers, instead a utility-place, time,
knowledge, is provided to the customer. One cannot physically see a
service but only, can feel and utilize the service. For example,
Transportation. Bank, Education, consultancy etc.

(4) Agency/Brokering: This is a type of business operation where the

buyers & sellers are brought together to exchange goods & services.
For this operation a Commission/Brokerage is charged.

USERS OF ACCOUNTING INFORMATION:

Accounting is designed to suit the needs of many users. It is a system to

provide useful information to the users to make informed judgments.
Following are the users of accounting information:

1) Management: The proprietor, the partners, the board of directors is

all the people concerned with the management of the business. They are
required to know the financial results in the form of profit /loss, financial
position and the progress made from year to year. They are also required
to take managerial decisions. Accounting supplies crucial information to
them.

2) Shareholders: In the joint stock form of organization, shareholders

are the owners. They elect and authorize the directors to manage the
affairs and report back. They wish to know how the business is managed,
what is the share of profit, how is the financial position, health and wealth
of the company.

3) Investors: Individuals and institutions, who want to take part in the

ownership, require information about organization. Because, they want
good return for their capital, the growth and safety of the investment.

4) Bank and financial institutions: Banks and financial institutions lend

money to the business. They are more concerned with the return of the
amount lent and the interest income. Therefore, they enquire about the
financial condition of the enterprises.

5) Creditors and suppliers of goods and services: The creditors and

suppliers of goods and services need to know the credit worthiness of the
business i.e. the capacity to pay for the supplies within the specified time.
A careful verification and analysis of financial data reveals this information.

4
6) Government: The government is responsible for the socio-economic
development of a country. Various sectors like agriculture, industry and
service need proper direction. Government provides regulation and
formulates policies to show the path of development. For these purposes,
money is collected from the public through taxes. Accounting provides the
information about the profit and financial positions of the businesses on the
basis of which the tax is collected.

7) Employees: Employees need monetary and non monetary

incentives to improve the productivity and relationship with the
management. The data relating to profit, liquidity position and solvency
status, help the employee unions to bargain with the management to get
bonus and other benefits.

8) International organizations: In the wake of globalization movement,

the multinational companies need accounting information for
collaborations, franchises and investments.

9) Other enterprises: Accounting analysis is very useful for mergers,

amalgamations collaborations inter-firm comparison and bench marking of
the firms and companies.

10) Standardization: The professional bodies, academics and

accountants need the accounting information for the purpose of evolving
standard accounting practices, from time to time.

Accounting Concepts

1) Business Entity: When a business is started, for all practical purposes, it

is treated as independent of its owner. Once the owner invests capital to
start a business, for accounting purpose, the business is considered as a
separate unit having its own identity, distinct from its owner who created it.
This is called business entity concept. Therefore, every event of the owner
with the business is treated as a transaction that must be recorded in the
books of the business. A business cannot be physically seen. It is run by
natural persons. It is conceptually and legally, a separate entity or unit or a
person.

2) Going Concern: When a business is started, it is expected to exist for a

long period of time. The business is expected to be continuing even if the
owner is changed due to transfer from father to son, or death. Every
business is assumed to have a continued existence with profit for an
indefinite period of time. This is called going concern concept (continuing
business).Based on this assumption the accounting entries are made. For
example, when a machine is purchased for business, the machine is
expected to be with the business for an indefinite period of time and so it is
recorded as an asset at purchase cost.

3) Objective evidence: In business transaction, to make an entry in the

books, evidence of the expense or income is required. Examples of evidences

5
are invoice and vouchers for purchases, bank statement for bank balance
etc. Objective evidence means, the proof of a transaction that can be verified
with the relevant support documents. One cannot show the purchase invoice
as the evidence for payment of salary.

However, individual judgments are made in some cases where estimates are
involved. Any way the user of the accounts must believe the entries.
Adoption of objective evidence principle will minimize the accounting errors,
bias and frauds. For example, physical verification report with respect to
materials acts as an evidence of material purchased and stored.

4) Unit of measurement: All business transactions are recorded on terms

of money. Each country will have its own currency as common unit of
measurement. For example, US dollars, Japan yen, Indian rupees, Kenyan
shilling, Ethiopian birr etc. While recording and presenting accounting data,
every business enterprise will express the amounts in the country’s currency.
For example, if a business purchases 100 pairs of shoes at Rs. 120 each and
100 liters of oil at 20 Rs. per liter, then the recording is done as below:

Sr. Details Quantity Unit Price Rs. Total Amount Rs.

No.
1 Shoes 100 pairs 120 12,000
purchased
2 Oil purchased 100 liters 20 2,000
Total 14,000

Though, the details of other units of measurement such as number of

shoes, 100 liters of oil, are stated ,it is the expression of their value in
terms of Rs. that is significant. Imagine expressing the information only in
terms of 100 shoes and 100 liters of oil. Does it convey any uniformity in
information? Can you draw any inference out of it? Therefore, all these
transactions are entered in a common unit of measurement, namely Rs.

5) Accounting period: The growth of a business has to be measured over

a period of time frame. The universally accepted standard time period is
ONE YEAR. This is called accounting period. For example the year from
April 1, 2009 to March 31, 2010 (a period of twelve months). The business
profit and financial position are expressed for one year. This helps to
measure the success/failure as well as the health of the business. In
modern times, business results are reported as frequently as needed, say,
every month.

6) Matching revenue and expired cost: Expired cost refers to the

money spent relating to an item in an accounting period. For example,
salary paid, rent paid etc. In case of Assets, the usage is expressed in
terms of expired cost and not the purchase cost of assets. Revenue is the
regular income that is generated out of business transactions. For
example, sales for the period, commission received etc. Comparing the
revenue with that of expired cost during the period results in profit or loss.
If revenue is more than the expense the result is the profit and if the
revenue is less than the expense, the result is loss. Matching concept,
6
therefore, refers to the process of comparing the revenue with that of
expense during an accounting period so as to determine the profit or loss
for the business.

7) Adequate disclosure: Accounting is a system to provide useful

information to the user. A standard practice is followed to disclose all the
relevant material facts in the report. Only necessary data are reported.
This is called adequate disclosure. Whenever the individual judgment is
involved, the practice followed is stated to avoid any misinterpretation. For
example, if the method of valuing inventory is changed, it should be
disclosed.

8) Consistency: The result of one accounting period is compared with the

result of the next accounting period to know the progress made. The
comparison helps to know the direction in which the business is moving.
Comparison of the results is meaningful to the user only when the same
accounting principles are followed year after year. This is called
consistency. For example, there are several methods of valuing the
inventory. The value has an effect on the profit position. If the method is
changed in any year, the resulting profit is the result of change in the
method and not necessarily due to business operations. This will not
facilitate to form an opinion about the progress of the business. Therefore,
same accounting practice is followed every year. However, change made
only if it could be justified.

9) Materiality: In the business records, the amounts are normally

rounded off to the nearest Rs. . For example, if the amount is Rs. 198.01,
it could as well be rounded off to Rs. 198, ignoring, 0.01. It does not
matter much. In fact it saves labor, time and energy. Some times it
provides clarity also. If the administrative and stationery expenses of
recording a fraction of amount are more than the amount itself, then it is
not worth the effort of recording. It is better to ignore, if it has no
significant impact. This is called materiality concept. When non disclosure
of an item does not affect the required information to be given, then there
is no need to disclose the same. The materiality concept speaks about the
feasibility of recording and reporting of an item of expense or income.

10) Conservatism: Future is most uncertain. No body can predict the

future perfectly. In case of businesses, there is no 100% guarantee that
there will always be profit. Therefore, while presenting the financial results,
wherever individual judgments are involved, care is taken to see that only
lesser profit is shown in the current year. This is to reserve the rest of the
profit, if any for safeguarding the future uncertainty. This is called
conservatism concept. For example, while valuing the inventory at the end
of the year, the market price or the cost whichever is less, is taken. A
higher value results in higher profit and lower value in lower profit.
According to this concept, lower value is considered.

ACCOUNTING EQUATION

7
A business is, normally, started with cash. Various properties are purchased
to carry on the business. In the course of the business, it may have to owe
money to others and may have to receive money from others. They are
defined as below:

Assets: The cash and other properties owned and moneys receivable by a
business enterprise are called “Assets”. For example, cash in hand, cash at
bank, bills and amount receivables stock of goods, plant and machinery, land
etc. owned by the business.

Equities: The rights or claims on the assets of the business are called
“Equities”. For example, the owners have the right over the properties, the
creditors and suppliers have the claim over the money or goods etc.

Liabilities: That part of equities which is represented by the claims of the

creditors is called “Liabilities”. For example, bills payable and amounts
payable by the business on account purchases.

Owner’s equity: That part of the equities which is represented by the rights
of the owner/s is called “owner’s equity”. For example, capital contributed by
the proprietor, partners and shareholders.

Accounting Equation: According to the double entry principle each

transaction has two aspects and each aspect has to be recorded separately
to provide for the equilibrium.

Therefore, Assets = Liabilities + Owner’s Equity

Now, let us take an example.

Assume that, 1) A started a business with cash of Rs. 10,000 and 2) the
business has purchased supplies like stationeries “on credit” for Rs. 6,000.
On credit means, cash is not paid to suppliers now but will be paid later.

There are two transactions. In the first, the cash coming to business forms
the “asset” of the business and the owner has the right over this cash
contributed by him called , ‘capital’, which forms the “Owner’s equity”. As
the cash contributed is equal to owner’s right over it, we can establish the
relation between the two as below:

Cash (asset) = Capital (owner’s equity).

In the second transaction, the supplies (stationery etc.) coming in to

business becomes the “asset” called ‘supplies’, and the claim over this by the
suppliers on this (since the money is not yet paid) becomes the “liability” ,
8
 called ‘account payable’. As the amount of supplies is equal to the amount of
the claim over the supplies, the relation between the two can be established
as below:

Supplies (asset) = Account payable (liabilities)

The liabilities and owner’s equity are together called as “equities”.

The relation among these can be stated as below:

Liabilities
Assets = Equities +
Owner’s equity

The relation between the three can be expressed in the form of equation as
below:

Assets = Liabilities + Owner’s equity

This is called “Accounting equation”.

Now, the above example can be summarized and presented in the equation
form as below:

Assets = Liabilities + Owner’s equity

Cash + Supplies = Accounts Payable + A’s Capital

10,000 + 6,000 = 6,000 + 10,000.

Observe that the total of the left hand side of the equation (16,000) is equal
to the total of the right hand side of the equation (16,000), which sets the
equilibrium according to double entry concept.

Statement of accounting equation: A statement prepared to know the

effect of each business transaction on assets and equities and balances at
the end, is called “Statement of accounting Equation”.

Effect of transactions on the accounting equation: Each business

transaction has two-fold effect on the accounting equation the effect could
be as below:

a) Increase in asset and increase in equities (liabilities or owner’s

equity)
b) Decrease in asset and decrease in equities (liabilities or owner’s
equity),

c) Increase in one asset and decrease in another asset,

9
 d) Increase in one liability and decrease in another liability or owner’s
equity.

Such an effect will always maintain equilibrium. After the record of each
transaction, the total of assets will be equal to the total of equities.

Financial Statements for Sole Proprietorships

The users of accounting information need to know

1) what profit the organization has made during a period,
2) what is the financial position of the organization at the end of a period,
3) what is the progress made year after year. The accounting equation is
only a fundamental relation between the assets, liabilities, and owner’s
equity. It does not indicate the financial operations.

Financial statements: The accounting statements prepared for

communicating essential information to the users are called ‘financial
statements’. They are
1) Income statement
2) Statement of owner’s equity,
3) Balance Sheet and
4) Cash flow statement.

1) Income Statement: A statement prepared to show the result of

operation with respect to revenues and expenses for a specific accounting
period is called “income statement”. The excess of revenue over the
expenses is called “net income”/ “profit”. The excess of expenses over the
revenues is called “net loss”.

Revenue refers to the regular income to the organization on day-to-

day recurring transactions. The criteria are the regularity and
recurring (repeating) inflow of revenue on a day-to-day basis. It
includes actual receipts or accrual due to be received. For example,
sale of goods, and services, professional fees earned, rent received,
fares received commission received, interest received etc.
Note that the income on the sale of asset and lottery are not
considered as revenues.

Expense refers to the regular spending by the organization on day-to-

day recurring transactions for earning revenue. They are also called
expired costs. It includes items of actual or accrued payments. For
example, supplies expense, salary, rent, utilities paid etc.
Note that, payments for the purchase of assets /properties are not
considered as expenses.

10
 Capital receipt: The money received other than the revenue is called
capital receipt. For example, money received on sale of assets.

Capital expenditure: The money spent other than towards the

expenses are called capital expenditure. For example, money spent
on purchasing assets such as, land, machinery, furniture etc.
Only revenues and expenses enter the income statement directly.

2) Statement of owner’s equity: Finally, the owner of the business

has to enjoy the result of business operations. The statement prepared to
know the increase or decrease in owner’s equity over a period is called
“Statement of owner’s equity”. The equity changes due to the revenues,
expenses, additional investment to and withdrawals from the business by the
owner. The ultimate effect is either a net increase or a net decrease in
equity. In other words, the difference between the capital at the end and the
capital at the beginning of a period is either an increase or decrease in the
equity.

3) Balance Sheet: A statement showing the position of assets,

liabilities and owner’s equity as on the last date of the accounting period is
called “Balance Sheet”. It contains the details of the balances of assets,
liabilities and owner’s equity on a specific date.

4) Cash flow statement: A statement showing the cash at the

beginning of a period, actual cash receipts and payments during the period
and cash balance at the end of the period is called “Cash flow statement”.

11
 ACCOUNTING CYCLE FOR SERVICE RENDERING BUSINESSES

Introduction: Business operations can broadly be divided in to three

categories. They are 1) Service rendering 2) merchandising (trading) 3)
Manufacturing and selling

Service rendering businesses are the businesses, which provide specific

utility to the user. Service can only be felt and cannot be seen. For example,
transportation, education, consultancy, bank etc.

In transportation, goods and passengers are moved from one place to

another place called place utility. For example, taxi service. Banks collect
deposits and lend loans; educational institutions make the students
graduates. A professional Accountant solves the problems of the clients, for
example, calculating the tax liability. A doctor cures the diseases, etc.

We have seen in the preceding pages that, the transactions relating to

revenues, expenses, assets, liabilities and owner’s equity are very few.
Imagine, if there are hundreds and thousands of transactions with respect to
each item. Probably, recording looks very clumsy and confusing. It may not
help to draw any inferences. Therefore, there is a need to have a systematic
approach that is uniformly acceptable. The systematic accounting approach
is discussed as below:

Account: When several transactions occur, relating to a specific item, then

it is better to put them all in one particular place to have a complete picture
about that item, of expense, revenue, asset, liability and owner’s equity. For
example, supplies purchased on different dates can be put in one place of
recording, to have an idea of the total purchases during the period. A place
in the business book where all the related transactions of a specific item are
recorded is called an “Account”. For example, supplies account, rent
account, plant account, account payable, capital account etc.

Nature of an account: Each transaction has two aspects. In order to

provide space for recording these two aspects, an account is divided in to
two sides- left hand side and right hand side. An account can be written in
two forms: 1) T form, 2) Statement form(Standard form)

1) An account in T form is as below:

Supplies account
Account No
Date Item Post Amount Date Item Post Amount
ref. ref.

Title of the account is written on the top center. The entries are written on
both the sides of the account depending on the effect of a transaction.

12
2) An account in the statement form:

Supplies account Account

No:
Date Item Post.ref. Debit Credit Balance
Debit Credit

Debit and Credit: The effect on an account due to a transaction is

expressed in two ways for recording.

Debit: This is an accounting term, which is understood in three ways:

a) To debit: To debit means, “to make an entry” on the left hand
side of an account,
b) Debit side : Debit side refers to the “left hand side of an
account”,
c) Debit entry: Debit entry refers to “an entry” on the left hand
side of an account.

Credit: This is an accounting term, which is understood in three ways;

a) To Credit: To credit means “make an entry” on the right side of
an account,
b) Credit side : Credit side refers to the “right hand side of an
account”,
c) Credit entry: Credit entry refers to “an entry” on the right side of
an account.

Name of the account: The name of the account is written on the top
center/left corner.

Account number: Each account is given a separate number for the purpose
of identification.

Date: In this column, the year, month, and date on which the transaction
occurred is written.

Item: The name of the opposite account, which is affected in written in this
column.

Posting reference (post.ref.): The page number of the journal (explained

later) is written in this column.

Debit and Credit: The respective amounts are written in these columns.
Balance: The amount remaining at the end of the period or at the end of
each entry is called “balance”.
Debit balance, refers to the amount of debit in excess over the credit.
Credit balance, refers to the amount of credit in excess over the debit.

13
Balancing an account is an act of determining the excess of debit or credit
in each account.

In T form, the balance is determined at the end of the period and in the
statement form, the balance is found out after recording each entry.

Ledger : A ledger is a book in which all the accounts are written .This book
will have a number of pages .Specified number of pages are
“earmarked”(kept apart) for each account depending on the number of
entries. Some times a separate book is maintained for each account. A
ledger is a book of “second entry”.

CLASSIFICATION OF ACCOUNTS
Classification of accounts refers to grouping of accounts according to some
common characteristics. There are two types:

1) Based on personal or impersonal:

Personal accounts are the accounts indicated by the names of persons

related to the business through business transactions. For example, Ato
Clinton’s account, A’s account, Account payable, debtors, creditors, ABC
Company account etc.

Impersonal accounts are divided in to two parts;

Real or asset accounts are the accounts indicated by the names of the
assets, related to the business through business transactions. For example,
plant account, machinery account, land account etc.

Nominal accounts are the accounts indicate d by the names of the expenses
or revenues related to the business through business transactions. For
example, salary account, rent account, commission received account, sales
account. fares received account, etc.

2) Based on financial Statements: According to this, the accounts

are classified as A) Balance Accounts, B) Income statement
Accounts.

A) Balance Sheet Accounts: The accounts that appear in a balance

sheet are called balance sheet accounts. They are further divided in
to

a) Assets accounts,
b) Liabilities accounts, and
c) Owner’s Equity Accounts.

a) Assets Accounts: The properties owned and accounts receivable by

the business are called “Assets”. They can be i) Tangible Assets, or
ii) Intangible.

14
 (i) Tangible Assets are the assets which can be physically seen .For
example, Furniture, Land .Machinery etc.

(ii) Intangible Assets are the rights obtained by the business. They are not
physically seen but only felt. For example, Patent right, copy right etc.
(these are explained at a later stage).

For the purpose of presenting in the balance sheet, the assets are divided in
to i) Current Assets and ii) Plant Assts

i) Current Assets are the assets including cash, which are converted in to
cash within one year. For example, cash, bills and notes receivables,
ending inventory, prepaid expenses etc.

ii) Plant assets, are the assets which are expected to be permanently with
the business. They are not expected to be sold within one year. They are
also called “Fixed assets”. For example, land ,furniture ,patent right,
good will etc.

b) Liabilities Accounts: The amounts that the business has to give to

others are called “Liabilities”. There are two categories:

i) Current Liabilities - Current liabilities are the liabilities which are to be paid
within one year. They are paid out of current assets. For example, Accounts
payable, notes payable, sales tax ,interest payable etc.

ii) Long term Liabilities - Long term liabilities are the liabilities which are due
for payment beyond an accounting period. For example, long tem loans,
mortgage note payable, etc.

However, such part of long term liability which falls due for payment within a
year is categorized as current liability.

c) Owner’s Equity Accounts: The Accounts that are related to the

owners of the business are called “owner’s equity Accounts”. The owner
of the business has the last claim over the properties. It means, the
business clears the outside debt first and afterwards owners can claim
the residual property. For example, Capital account, Drawings Account
etc.

B) Income Statement Accounts: The accounts that appear in the

income statement are called income statement accounts. They are
further divided in to a) Revenue Accounts b) Expenses Accounts.

a) Revenue accounts are the accounts relating to the regular incomes

to the business. Example, sales, interest received, fees received,
discount received etc.

15
 b) Expenses accounts are the accounts relating to the moneys spent
to get the revenues to the business .For example, salary, rent, interest
paid, depreciation, supplies expense etc.

Code or Index numbers: For the purpose of easy identification, the

accounts are given individual code numbers.

Debit and Credit Rule:

General Rule Debit the Account which receives,

Credit the account which gives.

Personal Account Debit the receiver, credit the giver.

Real Account Debit what comes in, credit what goes out.

Nominal Account Debit All expenses and losses

Credit All incomes, gains and profits.

The effect of a transaction is as below:

Assets: Debit increase Credit decrease.

Liabilities: Debit decrease Credit increase.
Owner’s Equity: Debit decrease Credit increase.
Owner’s drawing: Debit increase Credit decrease.
Revenues: Debit decrease Credit increase.
Expenses: Debit increase Credit decrease.

JOURNAL:
Many transactions occur during a period. Every day several transactions take
place. A transaction may not relate to an immediate previous transaction. It
is not advisable to directly enter the transactions in to the ledger accounts
situated in different places in a ledger. Therefore, there is a need for an
intermediate device. The gap between a transaction and the ledger is filled
by a book called “Journal”.

A journal is a book in which the transactions are first entered in the

chronological order in which the transactions take place. It is a book of
“Prime entry”.

Format of a two column journal:

Journal Page No.

Sl.No. Date Account Post.ref. Debit Credit

Title/Description

16
Sl No: In this column the serial number of the transactions are written.

Date: The year, month, date of the transactions are written here.

Account Title/Description: The names of the account to be debited and

credited are written in this column.

Post.ref.: (posting reference):The account number of each account is written

here.

Debit and credit: The amounts are written here.

Passing the entries in a journal: The process of entering the transactions

in a journal in a chronological order ,that is ,in the order in which they occur,
is called “passing the entries”. Or “Journalizing”.

Steps:
1) Go through the transactions one by one,
2) Identify only the two relevant accounts affected by the
transaction,
3) Apply the rule and decide which account to be debited and
which to be credited,
4) Write the serial number, year, month and the date and in the
account title column, write firstly the name of the account to be
debited and below that in the next row, with a small space left, in the
beginning, write the name of the account to be credited (opposite
account). A small description of the transaction could be written in the
next row which is called “Narration”.
5) Write the amount of debit and credit against the respective
accounts and in their columns.

Compound Journal entry: When two or more accounts are debited and
credited simultaneously, then such a journal entry is called “Compound
Journal Entry”.

Posting the journal entry to ledger:

After passing the entry in the journal, the next step in the accounting cycle is
to transfer this entry to the respective account in the ledger. A separate
space (page) is provided for each account in the ledger. The entries in an
account give the complete picture about what is happening with respect to
that account, that is, whether the amount in the account is increasing or
decreasing. At the end of an accounting period, say, a month, or a year, the
balance is shown in each account. However, if the total of debit is equal to
total of credit, then there will be no balance at all, that is Nil balance at the

17
end. The ending balance of an account becomes the opening balance of that
account in the beginning of the next period.

Posting: The process of transferring the entries in the journal to the

respective accounts in the ledger is called “Posting”. This is an act of
grouping the related entries. For example, all the cash related entries in the
journal on different dates are posted to cash account in the ledger. A
consolidated picture of cash is obtained at one place.

Steps:
1) Provide enough place for each account in the ledger book,

2) After passing an entry in the journal, take first, the account to be debited,
go to the relevant page in the ledger enter in the debit side the name of the
opposite account in the account title column, and write the amount in the
amount column of debit side.

3) Next, take the account to be credited, go to the relevant page number in

the ledger and enter in the credit side of that account, the name of the
opposite account in the account title column and write the amount in the
credit column.

4) Repeat this for all the other entries.

5) Write the year, month and date in the date column.

6) Write the page number of the journal in the post ref. column of the
respective account in the ledger.

7) Finally, at the end of the period(in case of T form account) or at the end
of each posting (in case of Statement form ) ,determine the balance and
write this balance amount in the debit side(column) or credit side(column)
as the case may be.

Distinction between Journal and Ledger

Particulars Journal Ledger

Purpose Book for recording journal Book for recording ledger
entries accounts
Nature Two columns, one for debit Two sides, debit and credit or
and another for credit four columns debit, credit and
balances.
Entry Book of original or prime or Book of second entry
first entry
Order Chronological order of Order of transactions relating
transactions in general to respective account
Bridge Bridge between transactions Bridge between the journal
and the ledger. and the trial balance.
Reference Supporting documents like Journal entries

18
 purchase invoice, payroll etc

Comparison : Journal is like a general assembly of all the students in a

college auditorium and ledger account is like a class for each faculty such as,
Accounting class, Management class, Automotive class, construction class
etc.

TRIAL BALANCE
Every day numerous transactions are entered in the journal and posted to
ledger accounts. Each task is performed by a different accounting clerk.
Journalizing could be done by a clerk, posting by another and so on. In large
firms, even the journalizing task is shared by several persons. While
performing these tasks errors may occur. Errors could occur at the time of
journalizing or posting or at the time of balancing. It becomes necessary to
verify the accuracy of the entries made, for two important reasons:1) to
uphold the purpose of double entry principle, 2) to get the accurate financial
results.

A statement prepared at the end of an accounting period to verify the

arithmetical accuracy of the amounts in the books is called “Trial Balance”. It
contains the ending balances of all the accounts. When all the transactions
are correctly journalized, posted to accounts and all the accounts are
balanced properly, the debit total must be equal to credit total. It is to check
this that a trial balance is prepared as on the last date of the accounting
period The trial balance contains the names of all the accounts and their
respective debit and credit balances. Debit column total is equal to credit
column total so that the equilibrium is established. If there is any error at
any point of entry, the debit total will not be equal to credit total. Thus a trial
balance helps to trace the error of arithmetic accuracy in the accounting. A
trial balance acts as a bridge between ledger accounts and the financial
statements. It is prepared as on a specific date for the period ended and not
for the period. This is also called “Pre-closing trial balance”.

Steps:

1) Draw a Trial balance providing columns for serial number, account

balances, account number, debit balance and credit balance,

2) Transfer the balance in each account to the trial balance to the

appropriate places,

3) Find the total of debit column and credit column. They must be equal.

ACCOUNTING CYCLE

Basis of reporting accounting data:

During an accounting period several business transactions take place. Cash
is received for revenues and cash is paid for expenses. Some times though
19
revenues are earned, cash might not have been actually received, during an
accounting period. For example, assume that the accounting period is Jan 1
to Dec31. A doctor has provided service to a patient on Dec.10, amounting
Rs. 100. But the patient has requested the doctor that he would pay the
money in the next month, i.e., Jan. next year. This is the case of revenue
earned for the year but not actually received in that same year. Similarly the
expenses are incurred in a year but paid in the next year. Under such
circumstances, the question arises as to how to report the accounting data.
Accordingly, there are two bases for reporting the data. They are:

Cash basis: Under this, revenues and expenses are reported on the basis of
actual receipt and payment of cash, irrespective of whether revenue is
earned or not and expenses are incurred or not. Therefore ,the actual receipt
and payment of cash is important.

Accrual basis: Under this, revenues and expenses are reported on the basis
of revenue earned and expenses incurred in the period ,irrespective of
whether cash is received or not and cash is paid or not. Therefore ,earning
of revenue or incurring of expense is important and not the actual receipt or
payment. This also provides for “matching” the revenue with the related
expenses.
Most of the businesses use the accrual basis for reporting accounting data.

Adjustments: At the end of an accounting period, before preparing the

financial statements ,it is necessary to determine the exact amount of
revenue earned and expenses incurred for the period. Because, the
accounting practice is to record the exact amount of cash received and paid
during the period. Cash received may be more or less than the revenue
earned .Similarly, cash paid may be more or less than the expense incurred.
The process of bringing the amounts up to date for the accounting period is
called “Adjustments”.

They act as bridge between the trial balance and the adjusted trial balance.

These adjustments are discussed as below:

A) Deferrals: The cases where i) cash paid is more than the actual
expense of the period and ii) cash received is more than the actual revenue
earned of the period, are called “deferrals”. They are called deferrals
because the recognition of expense or revenue is postponed (deferred) for
the next period.

Case (i): Prepaid expenses: the expenses which are already paid but not
actually used by the end of the period are called “prepaid expenses”.

Illustration: Assume that the supplies purchased during a period (say,

January to December) amounted to Rs. 1,500. But the actual supplies
consumed by the end of December, amounted to Rs. 1,200. Therefore,
supplies remaining unused at the end of the period is Rs. 300 (1,500
-1,200). Supplies used is called “supplies expenses”, shown in income
statement and supplies stock unused at the end is called “supplies on hand”,
20
shown in the balance sheet as current asset. Other examples are prepaid
insurance, prepaid interest, depreciation etc.

Depreciation: The plant assets are continuously used for the purpose of
business operations to get revenues. They are subject to wear and tear due
to usage. The gradual reduction in the value of an asset due to usage is
called “depreciation”. The practice is to express this rate of reduction in the
form of percentage.

Illustration: Assume that machinery is purchased for Rs. 30,000.

Depreciation rate is 10% per year. Therefore, the depreciation for the year is
10% of Rs. 30,000 that is, Rs. 3,000.

This depreciation is an expense for the period and shown in income

statement. The cost of the machine at the end of the period is Rs.
27,000(30,000-3,000), called “book vale” .This is shown in the balance sheet
as plant asset. However, the depreciation could also be credited to
“accumulated depreciation account” and shown as current liability in the
balance sheet.

Case (ii): Revenue received in advance (revenue unearned): Revenue which

are already received but not actually earned by the end of the period are
called “revenue received in advance” or “revenue unearned.

Illustration: Assume that the rent received is Rs. 5,000, but the actual rent
for the period is only Rs. 4,000. Therefore, the rent received in advance is
Rs. 1,000 (5,000-4,000).

Rent earned, Rs. 4,000 is shown in income statement and rent unearned, Rs.
1,000, is shown in the balance sheet as current asset. Other examples are,
insurance premium received in advance, college fees received in the
beginning of the year, subscriptions to magazines etc.

B) Accruals: The cases where, i) cash paid towards an expense is less than
the actual expense for the period and ii) cash received towards a revenue is
less than the actual revenue earned for the period are called “accruals”.
They are called accruals because they are due for payment or due to be
received. They will be paid or received in the next period.

Case (i): Accrued expense: the expenses which are already incurred but not
actually paid at the end pf the period are called “accrued expenses”.

Illustration: Assume that the salary for the year at Rs. 1,000 per month is
Rs. 1,000 X 12 = Rs. 12,000. But actual salary paid is only Rs. 10,000
during the period. Therefore, the salary still to be paid, called “salary
payable” is Rs. 2,000 (12,000-10,000). Salary for the period Rs. 12,000, is
an expense, whether paid or not, and shown in income statement as salary.

Salary accrued, that is still to be paid, Rs. 2,000, is shown as salary payable
under current liabilities. Other examples are, rent payable, stationery
purchased on credit, etc.
21
Case (ii): Accrued revenue: The revenues which are already earned but not
actually received at the end of the period are called “accrued revenue”.

Illustration: Assume that the interest for the year on the note receivable
amounted to Rs. 8,000 but the actual interest received is only Rs. 6,500 at
the end of the period. Therefore, the interest still receivable (accrued) for
the period is Rs. 1,500 (8,000-6,500).

Interest for the year, Rs. 8,000, is a revenue whether received or not and
shown in income statement as interest. Interest receivable Rs. 1,500, is
shown as current asset.

Other examples are, commission receivable, consultancy fees, fares

receivable etc.

WORK SHEET WITH ADJUSTMENTS

Prior to the preparation of financial statements it is necessary to incorporate
all the adjustments in to the trial balance. A sheet prepared to make all the
adjustments is called “worksheet”. It is a working paper. It helps to:

a) record all the adjustments ,

b) verify arithmetical accuracy ,
c) arrange the data systematically,
d) provide a basis for preparing balance sheet and income
statement,
e) bridge the gap between the adjustments and financial
statements.

A worksheet contains 10 columns, two columns each for

1) Trial Balance,
2) Adjustments,
3) Adjusted trial balance,
4) Draft income statement, and
5) Draft balance sheet.

22
Accounting Standards in India

Introduction
Financial statements are prepared to summarize the end-result of all the
business activities by an enterprise during an accounting period in monetary
terms. These business activities vary from one enterprise to other. To
compare the financial statements of various reporting enterprises poses
some difficulties because of the divergence in the methods and principles
adopted by these enterprises in preparing their financial statements. In order
to make these methods and principles uniform and comparable to the extent
possible – standards are evolved.

Accounting is the art of recording transactions in the best manner possible,

so as to enable the reader to arrive at judgments/come to conclusions, and
in this regard it is utmost necessary that there are set guidelines. These
guidelines are generally called accounting policies. The intricacies of
accounting policies permitted Companies to alter their accounting principles
for their benefit. This made it impossible to make comparisons. In order to
avoid the above and to have a harmonized accounting principle, Standards
needed to be set by recognized accounting bodies. This paved the way for
Accounting Standards to come into existence.

Accounting Standards in India are issued By the Institute of Chartered

Accountants of India (ICAI). At present there are 30 Accounting Standards
issued by ICAI.

Written Documents issued by Government or Regulatory Body In India,

issued by ICAI on 21st April,1977 Initiated by Kumar Mangalam Birla,
Chairman committee of Corporate Governance for Financial Disclosures Also
initiated by Chair person of NACAS

What are Accounting Standards?

Accounting Standards are the statements of code of practice of the
regulatory accounting bodies that are to be observed in the preparation and
presentation of financial statements. In layman terms, accounting standards
are the written documents issued by the expert institutes or other regulatory
bodies covering various aspects of measurement, treatment, presentation
and disclosure of accounting transactions.

What are the objectives of Accounting Standards?

The basic objective of Accounting Standards is to remove variations in the
treatment of several accounting aspects and to bring about standardization
in presentation. They intent to harmonize the diverse accounting policies
followed in the preparation and presentation of financial statements by
different reporting enterprises so as to facilitate intra-firm and inter-firm
comparison.

23
Objectives Standardize the diverse Accounting Policies Add the reliability to
the Financial Statement Eradicate baffling variation in treatment of
accounting aspects Facilitate inter-firm and intra-firm comparison

Objective of Accounting Standards is to standardize the diverse accounting

policies and practices with a view to eliminate to the extent possible the non-
comparability of financial statements and the reliability to the financial
statements.

The institute of Chattered Accountants of India, recognizing the need to

harmonize the diverse accounting policies and practices, constituted at
Accounting Standard Board (ASB) on 21st April, 1977.

Who issues Accounting Standards in India?

The Institute of Chartered Accountants of India (ICAI) recognizing the need
to harmonize the diverse accounting policies and practices at present in use
in India constituted Accounting Standards Board (ASB) on April 21, 1977.
The main role of ASB is to formulate Accounting Standards from time to
time.

Compliance with Accounting Standards issued by ICAI

Sub-section (3A) to section 211 of Companies Act, 1956 requires that every
Profit/Loss Account and Balance Sheet shall comply with the Accounting
Standards. 'Accounting Standards' means the standard of accounting
recommended by the ICAI and prescribed by the Central Government in
consultation with the National Advisory Committee on Accounting
Standards(NACAs) constituted under section 210(1) of companies Act, 1956.

Duty of Statutory Auditor for Compliance with Accounting Standards

Section 211(3A) of Companies Act, 1956 provides that every profit and loss
account and balance sheet of the company shall comply with the accounting
standards.

The statutory auditors are required to make qualification in their report in

case any item is treated differently from the prescribed Accounting Standard.
However, while qualifying, they should consider the materiality of the
relevant item. In addition to this Section 227(3)(d) of Companies Act, 1956
requires an auditor to report whether, in his opinion, the profit and loss
account and balance sheet are complied with the accounting standards
referred to in Section 211(3C) of Companies Act, 1956.

Accounting Standards in Different Nations : Accounting Standards in

Different Nations In India, 32 Accounting Standards as IAS under NACAS As
per International, there are 41 Accounting Standards called as IFRS Adopted
by 8 countries in the world 70 to 80 countries planning to adhere IFRS
Clause 50 added to the listing agreement mandatory.

24
Accounting Standards Issued by the Institute of Chartered
Accountants of India are as below:

• Disclosure of accounting policies:

• Valuation Of Inventories:
• Cash Flow Statements
• Contingencies and events Occurring after the Balance sheet Date
• Net Profit or loss for the period, Prior period items and Changes in
accounting Policies.
• Depreciation accounting.
• Construction Contracts.
• Revenue Recognition.
• Accounting For Fixed Assets.
• The Effect of Changes in Foreign Exchange Rates.
• Accounting For Government Grants.
• Accounting For Investments.
• Accounting For Amalgamation.
• Employee Benefits.
• Borrowing Cost.
• Segment Reporting.
• Related Party Disclosures.
• Accounting For Leases.
• Earning Per Share.
• Consolidated Financial Statement.
• Accounting For Taxes on Income.
• Accounting for Investment in associates in Consolidated Financial
Statement.
• Discontinuing Operation.
• Interim Financial Reporting.
• Intangible assets.
• Financial Reporting on Interest in joint Ventures.
• Impairment Of assets.
• Provisions, Contingent, liabilities and Contingent assets.
• Financial instrument.
• Financial Instrument: presentation.
• Financial Instruments, Disclosures and Limited revision to accounting
standards.

Disclosure of Accounting Policies: Accounting Policies refer to specific

accounting principles and the method of applying those principles adopted by
the enterprises in preparation and presentation of the financial statements.

Valuation of Inventories: The objective of this standard is to formulate

the method of computation of cost of inventories / stock, determine the
value of closing stock / inventory at which the inventory is to be shown in
balance sheet till it is not sold and recognized as revenue.

25
Cash Flow Statements: Cash flow statement is additional information to
user of financial statement. This statement exhibits the flow of incoming and
outgoing cash. This statement assesses the ability of the enterprise to
generate cash and to utilize the cash. This statement is one of the tools for
assessing the liquidity and solvency of the enterprise.

Contingencies and Events occurring after the balance sheet date: In

preparing financial statement of a particular enterprise, accounting is done
by following accrual basis of accounting and prudent accounting policies to
calculate the profit or loss for the year and to recognize assets and liabilities
in balance sheet. While following the prudent accounting policies, the
provision is made for all known liabilities and losses even for those
liabilities / events, which are probable. Professional judgment is required to
classify the like hood of the future events occurring and, therefore, the
question of contingencies and their accounting arises.

Objective of this standard is to prescribe the accounting of contingencies and

the events, which take place after the balance sheet date but before
approval of balance sheet by Board of Directors. The Accounting Standard
deals with Contingencies and Events occurring after the balance sheet date.

Net Profit or Loss for the Period, Prior Period Items and change in
Accounting Policies: The objective of this accounting standard is to
prescribe the criteria for certain items in the profit and loss account so that
comparability of the financial statement can be enhanced. Profit and loss
account being a period statement covers the items of the income and
expenditure of the particular period. This accounting standard also deals with
change in accounting policy, accounting estimates and extraordinary items.

Depreciation Accounting : It is a measure of wearing out, consumption or

other loss of value of a depreciable asset arising from use, passage of time.
Depreciation is nothing but distribution of total cost of asset over its useful
life.

Construction Contracts: Accounting for long term construction contracts

involves question as to when revenue should be recognized and how to
measure the revenue in the books of contractor. As the period of
construction contract is long, work of construction starts in one year and is
completed in another year or after 4-5 years or so. Therefore question arises
how the profit or loss of construction contract by contractor should be
determined. There may be following two ways to determine profit or loss: On
year-to-year basis based on percentage of completion or on completion of
the contract.

26
Revenue Recognition: The standard explains as to when the revenue
should be recognized in profit and loss account and also states the
circumstances in which revenue recognition can be postponed. Revenue
means gross inflow of cash, receivable or other consideration arising in the
course of ordinary activities of an enterprise such as: The sale of goods,
Rendering of Services, and Use of enterprises resources by other yielding
interest, dividend and royalties. In other words, revenue is a charge made to
customers / clients for goods supplied and services rendered.

Accounting for Fixed Assets: It is an asset, which is held with intention of

being used for the purpose of producing or providing goods and services. Not
held for sale in the normal course of business, expected to be used for more
than one accounting period.

The Effects of changes in Foreign Exchange Rates: Effect of Changes in

Foreign Exchange Rate shall be applicable in Respect of Accounting Period
commencing on or after 01-04-2004 and is mandatory in nature. This
accounting Standard applicable to accounting for transaction in Foreign
currencies in translating in the Financial Statement Of foreign operation
Integral as well as non- integral and also accounting for forward exchange.
Effect of Changes in Foreign Exchange Rate, an enterprise should disclose
following aspects:
• Amount Exchange Difference included in Net profit or Loss;
• Amount accumulated in foreign exchange translation reserve;
• Reconciliation of opening and closing balance of Foreign Exchange
translation reserve;

Accounting for Government Grants: Government Grants are assistance

by the Govt. in the form of cash or kind to an enterprise in return for past or
future compliance with certain conditions. Government assistance, which
cannot be valued reasonably, is excluded from Govt. grants. Those
transactions with Government, which cannot be distinguished from the
normal trading transactions of the enterprise, are not considered as
Government grants.

Accounting for Investments: It is the assets held for earning income by

way of dividend, interest and rentals, for capital appreciation or for other
benefits.

Accounting for Amalgamation: This accounting standard deals with

accounting to be made in books of Transferee Company in case of
amalgamation. This accounting standard is not applicable to cases of
acquisition of shares when one company acquires / purchases the share of
another company and the acquired company is not dissolved and its
separate entity continues to exist. The standard is applicable when acquired
company is dissolved and separate entity ceased exists and purchasing
company continues with the business of acquired company.

27
Employee Benefits: Accounting Standard has been revised by ICAI and is
applicable in respect of accounting periods commencing on or after 1st April
2006. the scope of the accounting standard has been enlarged, to include
accounting for short-term employee benefits and termination benefits.

Borrowing Costs : Enterprises are borrowing the funds to acquire, build

and install the fixed assets and other assets, these assets take time to make
them useable or saleable, therefore the enterprises incur the interest (cost
on borrowing) to acquire and build these assets. The objective of the
Accounting Standard is to prescribe the treatment of borrowing cost (interest
+ other cost) in accounting, whether the cost of borrowing should be
included in the cost of assets or not.

Segment Reporting: An enterprise needs in multiple products/services and

operates in different geographical areas. Multiple products / services and
their operations in different geographical areas are exposed to different risks
and returns. Information about multiple products / services and their
operation in different geographical areas are called segment information.
Such information is used to assess the risk and return of multiple
products/services and their operation in different geographical areas.
Disclosure of such information is called segment reporting.

Related Party Disclosure: Sometimes business transactions between

related parties lose the feature and character of the arms length
transactions. Related party relationship affects the volume and decision of
business of one enterprise for the benefit of the other enterprise. Hence
disclosure of related party transaction is essential for proper understanding
of financial performance and financial position of enterprise.

Accounting for leases: Lease is an arrangement by which the lesser gives

the right to use an asset for given period of time to the lessee on rent. It
involves two parties, a lessor and a lessee and an asset which is to be
leased. The lessor who owns the asset agrees to allow the lessee to use it for
a specified period of time in return of periodic rent payments.

Earning Per Share: Earning per share (EPS) is a financial ratio that gives
the information regarding earning available to each equity share. It is very
important financial ratio for assessing the state of market price of share. This
accounting standard gives computational methodology for the determination
and presentation of earning per share, which will improve the comparison of
EPS. The statement is applicable to the enterprise whose equity shares or
potential equity shares are listed in stock exchange.

28
Consolidated Financial Statements: The objective of this statement is to
present financial statements of a parent and its subsidiary (ies) as a single
economic entity. In other words the holding company and its subsidiary (ies)
are treated as one entity for the preparation of these consolidated financial
statements. Consolidated profit/loss account and consolidated balance sheet
are prepared for disclosing the total profit/loss of the group and total assets
and liabilities of the group. As per this accounting standard, the consolidated
balance sheet if prepared should be prepared in the manner prescribed by
this statement.

Accounting for Taxes on Income: This accounting standard prescribes the

accounting treatment for taxes on income. Traditionally, amount of tax
payable is determined on the profit/loss computed as per income tax laws.
According to this accounting standard, tax on income is determined on the
principle of accrual concept. According to this concept, tax should be
accounted in the period in which corresponding revenue and expenses are
accounted. In simple words tax shall be accounted on accrual basis; not on
liability to pay basis.

Accounting for Investments in Associates in consolidated financial

statements: The accounting standard was formulated with the objective to
set out the principles and procedures for recognizing the investment in
associates in the consolidated financial statements of the investor, so that
the effect of investment in associates on the financial position of the group is
indicated.

Discontinuing Operations: The objective of this standard is to establish

principles for reporting information about discontinuing operations. This
standard covers "discontinuing operations" rather than "discontinued
operation". The focus of the disclosure of the Information is about the
operations which the enterprise plans to discontinue rather than disclosing
on the operations which are already discontinued. However, the disclosure
about discontinued operation is also covered by this standard.

Interim Financial Reporting (IFR): Interim financial reporting is the

reporting for periods of less than a year generally for a period of 3 months.
As per clause 41 of listing agreement the companies are required to publish
the financial results on a quarterly basis.

Intangible Assets: An Intangible Asset is an Identifiable non-monetary

Asset without physical substance held for use in the production or supplying
of goods or services for rentals to others or for administrative purpose.

Financial Reporting of Interest in joint ventures: Joint Venture is

defined as a contractual arrangement whereby two or more parties carry on
an economic activity under 'joint control'. Control is the power to govern
the financial and operating policies of an economic activity so as to obtain
benefit from it. 'Joint control' is the contractually agreed sharing of control
over economic activity.

29
Impairment of Assets: The dictionary meaning of 'impairment of asset' is
weakening in value of asset. In other words when the value of asset
decreases it may be called impairment of an asset. As per AS-28 asset is
said to be impaired when carrying amount of asset is more than its
recoverable amount.

Provisions, Contingent Liabilities And Contingent Assets: Objective of

this standard is to prescribe the accounting for Provisions, Contingent
Liabilities, Contingent Assets, Provision for restructuring cost.

Provision: It is a liability, which can be measured only by using a substantial

degree of estimation.

Liability: A liability is present obligation of the enterprise arising from past

events the settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits.

Financial Instrument: Recognition and Measurement, issued by The

Council of the Institute of Chartered Accountants of India, comes into effect
in respect of Accounting periods commencing on or after 1-4-2009 and will
be recommendatory in nature for an initial period of two years. This
Accounting Standard will become mandatory in respect of Accounting periods
commencing on or after 1-4-2011 for all commercial, industrial and business
Entities except to a Small and Medium-sized Entity. The objective of this
Standard is to establish principles for recognizing and measuring Financial
assets, financial liabilities and some contracts to buy or sell non-financial
items. Requirements for presenting information about financial instruments
are in Accounting Standard.

Financial Instrument: presentation: The objective of this Standard is to

establish principles for presenting financial instruments as liabilities or equity
and for offsetting financial assets and financial liabilities. It applies to the
classification of financial instruments, from the perspective of the issuer, into
financial assets, financial liabilities and equity instruments; the classification
of related interest, dividends, losses and gains; and the circumstances in
which financial assets and financial liabilities should be offset. The principles
in this Standard complement the principles for recognizing and measuring
financial assets and financial liabilities in Accounting Standard Financial
Instruments:

30
Financial Instruments, Disclosures and Limited revision to
accounting standards: The objective of this Standard is to require entities
to provide disclosures in their financial statements that enable users to
evaluate:
• the significance of financial instruments for the entity’s financial
position and performance; and
• the nature and extent of risks arising from financial instruments to
which the entity is exposed during the period and at the reporting
date, and how the entity manages those risks.

How many Accounting Standards have been prescribed? Are these

applicable to all companies irrespective of its size?

In all 29 Accounting Standards have been prescribed. However their

applicability is dependent on its size – Level I / II / III Company. The
following table lists out the Accounting Standards and its applicability.

Level I Company:
Enterprises, which fall in any one or more of the following categories, at any
time during the accounting period, are classified as Level I enterprises:

i) Enterprises whose equity or debt securities are listed whether in

India or outside India.
ii) Enterprises, which are in the process of listing their equity or debt
securities as evidenced by the board of directors’ resolution in this
regard.
iii) Banks including co-operative banks.
iv) Financial Institutions
v) Enterprises carrying on insurance business.
vi) All commercial, industrial and business reporting enterprises,
whose turnover for the immediately preceding accounting period on
the basis of audited financial statements exceeds Rs. 500 million.
Turnover does not include ‘other income’.
vii) All commercial, industrial and business reporting enterprises
having borrowings, including public deposits, in excess of Rs. 100
million at any time during the accounting period.
viii) Holding and subsidiary enterprises of any one of the above at any
time during the accounting period.

Level II Company:
Enterprises, which are, not Level I enterprises but fall in any one or more of
the following categories are classified as Level II enterprises;
i) All commercial, industrial and business reporting enterprises whose
turnover for the immediately preceding accounting period on the basis of
audited financial statements exceeds Rs. 4 million, but does not exceed Rs.
500 million. Turnover does not include ‘other income’.

31
ii) All commercial, industrial and business reporting enterprises having
borrowing, including public deposits, in excess of Rs. 10 million but not in
excess of Rs. 100 million at any time during the accounting period.
iii) Holding and subsidiary enterprises of any one of the above at any time
during the accounting period.

Level III Company:

Enterprises, which are not covered under Level I and Level II are considered
as Level III enterprises.

Applicability
Level II and Level III enterprises are considered as SMEs

Level I enterprises are required to comply fully with all the accounting
standards.

No relaxation is given to Level II and Level III enterprises in respect of

recognition and measurement principles. Relaxations are provided with
regard to disclosure requirements. Accordingly, Level II and Level III
enterprises are fully exempted from certain accounting standards, which
mainly lay down disclosure requirements. In respect of certain other
accounting standards, which lay down recognition, measurement and
disclosure requirements, relaxations from certain disclosure requirements
are given.

Sr.No. Particulars Applicability

1 Disclosure of Accounting Policies I, II, III
2 Valuation of Inventories I, II, III
3 Cash Flow Statements I
4 Contingencies and Events Occurring I, II, III
After the Balance Sheet Date
5 Net Profit or Loss for the period, Prior I, II, III
period Items and Changes in Accounting
Policies.
6 Depreciation Accounting I, II, III
7 Construction Contracts I, II, III
8 Accounting for Research and AS WITHDRAWN
Development (This standard has been
withdrawn w.e.f. 01.04.2004 for all
levels of enterprises and AS 26 is
applicable)
9 Revenue recognition I, II, III
10 Accounting for Fixed Assets I, II, III
11 The Effect of Changes in Foreign I, II, III
Exchange Rates
12 Accounting for Government Grants I, II, III
13 Accounting for Investments I, II, III
14 Accounting for Amalgamations I, II, III
15 Accounting for Retirement Benefits in I, II, III

32
 the Financial Statements of Employers
16 Borrowing Costs I, II, III
17 Segment Reporting I
II-with modification
III- with modification
18 Related Party Disclosures I
II-with modification
III-with modification
19 Leases I
II-with modification
III- with modification
20 Earning Per Share I
II-with modification
III- with modification
21 Consolidated Financial Statements I
22 Accounting for Taxes on Income I, II, III
23 Accounting for Investments in I
Associates in Consolidated Financial
Statements
24 Discontinuing Operations I
25 Interim Financial Reporting I
26 Intangible Assets I, II, III
27 Financial Reporting of Interests in Joint I-with clarification
Ventures II-with clarification
III-with clarification
28 Impairment of Assets I-with clarification
II-with clarification
III-with clarification
29 Provisions, Contingent Liabilities and I
Contingent Asset

Evolution and Types of AS : Evolution and Types of AS

AS 1-Disclosure of Accounting Policies: AS 1-Disclosure of Accounting

Policies Specific policies adapted to prepare FS Should be disclosed at one
place Purpose :- Better understanding of FS Better comparison analysis
Mostly needed w.r.t Depreciation

AS 2- Accounting for Inventories: AS 2- Accounting for Inventories Used

for computation of Cost of inventories and to show in BS till it is sold
Consists of:- Raw Materials Work in progress Finished goods Spares, etc

Measurements of Inventories :Measurements of Inventories

Determination of Cost of Inventories Cost of purchase (Purchase price, duties
& taxes, freight inwards) Cost of conversion Determination of Net realizable
value Comparison of cost and net realizable

33
AS 3- Cash Flow Statements :AS 3- Cash Flow Statements Incoming and
outgoing of cash Act as barometer to judge surplus and deficit Explain Cash
flow under 3 heads :- Cash flow from operating activities Cash flow from
financing activities Cash flow from investing activities

AS 4- Contingencies and events occurring after BS date :AS 4-

Contingencies and events occurring after BS date For maintaining Provision
of Bad debts Generally uses Conservative concepts of Accounting like
Bankruptcy, frauds & errors.

AS 5- Net profit or loss for the period, prior period items and change
in Accounting policies: AS 5- Net profit or loss for the period, prior period
items and change in Accounting policies Ascertain certain criteria for certain
items Include income and expenditures of Financial year Consists of 2
component Profit and loss of ordinary activities Profit and loss of extra
ordinary activities

AS 6- Accounting for Depreciation :AS 6- Accounting for Depreciation A

non-cash expenditure Distribution of total cost to its useful life Occurs due to
obsolescence Different methods of computation Straight line method ( SLM )
Written-down value or diminishing value (WDV)

AS 7- Construction Contract: AS 7- Construction Contract specifically

negotiated for construction of Asset or combination of Assets closely inter-
related

AS 8- Accounting for R&D :AS 8- Accounting for R&D To deal with

treatment of Cost of research and development in the financial statements,
identify items of cost which comprise R&D costs lays down condition R&D
cost may be deferred and requires specific disclosures to be made regarding
R&D costs.

AS 9- Revenue Recognition: AS 9- Revenue Recognition Means gross

inflow of cash and other consideration like arising out of :- Sale of goods
Rendering services Use of enterprise resources by other yielding interest,
dividend and royalties.

AS 10- Accounting for Fixed Assets :AS 10- Accounting for Fixed Assets
Called as Cash generating Assets Expected to used for more than a
Accounting period like land, building, P/M, etc Shown at either Historical or
Revalued value

AS 11- Effect of change in FOREX Rates :AS 11- Effect of change in

FOREX Rates Classification for Accounting treatment:- Category I: Foreign
currency transactions: a) buying and selling of goods or services b) lending
and borrowing in foreign currency c) Acquisition and disposition of assets
Category II: Foreign operations: a) Foreign branch b) Joint venture c)
Foreign Subsidiary Category III: Foreign Exchange contracts: a) For
managing Risk/hedging b) For trading and Speculation

34
AS 12- Accounting for Govt. Grants :AS 12- Accounting for Govt. Grants
Assistance provided by Govt. in cash or in kind like Grants of Assets like P/M,
Land, etc Grants related to depreciable FA Tax exemptions in notified area

AS 13- Accounting for Investments :AS 13- Accounting for Investments

Assets held for earning incomes like dividend, interest, rental for capital
appreciation, etc It involves:- Classification of Investment Cost of
Investment Valuation of Investment Reclassification of Investment Disposal
of Investment Disclosure of Investment in FS

AS 14- Accounting for Amalgamation: AS 14- Accounting for

Amalgamation Section 391 to 394 of Companies Act, 1956 governs the
provision of amalgamation. Disclosures: Names and nature of amalgamating
companies Effective date of amalgamation Method of Accounting used
Particulars of scheme sanctioned under a statute

AS 15- Employees Benefits :AS 15- Employees Benefits All forms of

consideration given by enterprise directly to the employees or their spouses,
children or other dependants, to other such as trust, insurance companies in
exchange of services rendered.

AS 16- Borrowing Costs :AS 16- Borrowing Costs Interest and cost
incurred by an enterprise in connection to the borrowed funds. Availed for
acquiring building, installed FA to make it useable and saleable.

AS 17- Segment Reporting :AS 17- Segment Reporting It consists of 2

segment:- Business segment Geographical segment Information and
different risk and return reporting.

AS 18- Related party disclosure :AS 18- Related party disclosure Related
party are those party that controls or significantly influence the management
or operating policies of the company during reporting period Disclosure:
Related party relationship Transactions between a reporting enterprises and
its related parties. Volume of transactions Amt written off in the period in
respect of debts

AS 19- Accounting for Leases :AS 19- Accounting for Leases Agreement
between Lessor And Lessee Two types of leases: Operating lease Finance
lease Different from Sale Classification to be made at the inception

AS 20- Earning per share :AS 20- Earning per share Earning capacity of
the firm Assessing market price for share AS gives computational
methodology for determination and presentation of EPS 2 types of EPS

AS 21- Consolidated Balance Sheet :AS 21- Consolidated Balance Sheet

Accounting for Parent and Subsidiary company in single entity Disclosure:-
List of all subsidiaries Proportion of ownership interest Nature of relation
whether direct or indirect
35
AS 22- Accounting for taxes and income :AS 22- Accounting for taxes
and income Tax accounted for period in which are accounted It should be
accrued and not liability to pay Deals in 2 measurements:- Current tax
Deferred tax

AS 23- Accounting for investments in Associates in CFS :AS 23-

Accounting for investments in Associates in CFS Objectives to set out
principles and procedures for recognizing the investment associates in CFS of
the investors, so that effect of investments in associates on financial position
of group is indicated.

AS 24- Discontinuing operations :AS 24- Discontinuing operations

Establishes principles for reporting information about discontinuing
operations Covers discontinuing operations rather than discontinued
operation

AS 25-Interim Financial Reporting (IFR) :AS 25-Interim Financial

Reporting (IFR) Reporting for less than a year, i.e., 3 months Clause 41 says
publish financial results on quarterly basis Objective is to provide frequently
and timely assessment

AS 26- Intangible Assets :AS 26- Intangible Assets No physical existence

Can not be seen or even touched 3 featured as per AS Identifiable Non-
monetary assets Without physical substance

AS 27- Financial Reporting of interest in Joint Venture :AS 27-

Financial Reporting of interest in Joint Venture What is joint venture? Three
types of JV in case of Financial reporting

AS 28- Impairment of Assets :AS 28- Impairment of Assets Weakening of

Assets value Occurs when carrying cost more than recoverable amt Carrying
cost = Cost of assets –Accumulated Depreciation

AS 29- Provision, contingent liabilities and assets :AS 29- Provision,

contingent liabilities and assets Provisions:- It is a Liability Settlement should
result in outflow Liability is result of obligating event Contingent liabilities:-
Obligation arises of past event Existence confirmed when actually occurred
of uncertain future Contingent Asset Same as Contingent liability

Financial Instruments :Financial Instruments AS 30 – Recognition and

Measurement AS 31 – Presentation AS 32 – Disclosures Has not been made
mandatory (expected in 2009)

36