Accounting Basics

Accounting Basics or Introdcution

Accounting Concepts, Principles and Conventions

Accounting Concepts- Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared.

Accounting Principles- Accounting principles are the body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternative exists.

Accounting principles must satisfy the following conditions:

1. They should be based on real assumptions.

2. They must be sample, understandable and explanatory.

3. They must be followed consistently.

4. They should be able to reflect future predictions.

5. They should be informational for the users.

Accounting Principles- Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations over a period of time. These conventions are derived by usage and practices.

1. Entity Concept- Entity concept states that the business enterprise is a separate identity apart from its owner. Entity concept means that the enterprise is liable to the owner for capital invested by him. Capital invested by the owner is treated by the liability of the business because of this concept and owner has the claim on the profit of the business

2. Money Measurement Concept-As per this concept, only those transactions which can be measured in terms of money are recorded. Transactions, even if they affect the results of the business materially, are not recorded if they are not convertible in monetary terms. For the examples employees of the business are the assets of the organizations but their measurement in monetary term is not possible therefore not recorded in the books of account of the organizations. This concept ignores that money is an inelastic yardstick for measurement as it is based on the implicit assumptions that purchasing power of the money is not of sufficient important as to require adjustment. Many transactions and events are not recorded in the books of accounts just because they cannot be measured in monetary terms. Therefore it is recognized by all the accountants that this concept has its own limitations and inadequacies.

3. Periodicity Concept- This is also called the period of definite accounting period. According to this concept

accounts should be prepared at the end of every accounting period. This period makes the accounting system workable and term accrual meaningful. Accounting concepts is helpful in:

1. Comparing of financial statements of different periods

2. Uniform and consistent accounting treatment for ascertaining the profit and assets of the company

3. Matching periodic revenue with expenses for getting correct results of the business operations.

4. Accrual Concepts- under accrual concept, the effects of transactions and other events recognized on mercantile basis i.e. when they occur, they are recoded whether payment has been made or not made. Accrual means recognition of revenue and costs as they are earned or incurred not as money is received or paid. The accrual concept relates to measurement of income, identifying assets and liabilities.

5. Matching Concept- In this concept all expenses matched withed the revenue of that period should only be taken into consideration. In the financial if any revenue is recognized, and then expenses related to that revenue should also be recognized. It is necessary that every expense identify every income. This concept is based on accrual concept as it considers the occurrence of the expenses and income and do not concentrate on actual inflow or outflow of cash.

6. Going Concern Concept- The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operations for the foreseeable future. The valuation of assets of the business is dependent on this assumption. Traditionally histirical cost is followed.

7. Cost Concept- By this concept, the value of van asset is to be determined on the basis of historical cost, in other words acquisition cost. This concept is followed in the interest of objectivity.

8. Realization Concept- It closely follows the cost concept. Any change in the value of assets is recorded only when it is realized. However under this concept all probable losses are considered any probable gain is not accounted for.

9. Dual Aspect Concept- This concept is the core of double entry book-keeping. Every transaction or event has two aspects. It means if the enterprise acquires an asset it has to depart from another in form payment of cash or obligation to pay in future resulting increase in liability. Accounting equation is based on this concept based on which balance sheet is prepared. Accounting equation may be explained as follows:

Assets= Capital + Liability or Assets-Capital= Liability or Assets- Liability=Capital

Accounting equation suggests the fact that for every debit there is an equivalent credit.

10. Conservatism- This concept suggests that all possible losses should be provided for but any anticipated loss should not be considered. When there are many alternative values of assets lesser value should be recorded in the books. ‘Cost price or market price whichever is lower’ is recorded in the books originated from this concept.

For this concept there qualities are required:

1. Prudence 2. Neutrality 3. Faithful presentation of alternative values.

11. Consistency-In order to achieve comparability of financial statements of an enterprise through time, accounting policies are followed consistently from one period to another; a change in accounting policies are made only in exceptional cases. The concept of consistency is applied when accounting method of accounting is equally acceptable. For example a company can adopt straight line or diminishing balance method of depreciation. But following the principles of consistency it is advisable to follow the same method of depreciation over a period of time.

Changes should be made only in the following cases:

1. To bring books of accounts in accordance with the issued Accounting Standard.

2. To compliance with the provision of law.

3. When under changed circumstances it is felt that new method will reflect more true and fair picture it the

financial statement.

12. Materiality-This principle permits other concepts to be ignored, if the effect is considered material. This principle is an exception of full disclosure. According to this principle, all the items having significant effect on the business should be disclosed in the financial statement and any insignificant item which will only increase the work of the accountant, should not be disclosed. It is on the judgement, common sense and discretion of the accountant which item is material and which is not. For example depreciation on calculator purchased is shown 100% in the year it is purchased. This is because amount of calculator is very small to be shown in the balance sheet though it is an asset of the business.

Fundamental Accounting Assumptions

1. Going concern 2. Consistency 3. Accrual

Four principal qualitative characteristics of financial statements are:

Understandability, Relevance, Reliability, and Comparability

Other Characteristics:

1. Materiality 2. Faithful Representation 3. Substance Over Form 4. Neutrality 5. Prudence

6. Full, fair and adequate disclosure 7. Completeness

Meaning and Scope of Accounting

The American Institute of Public Accountants formulated definition in 1961

Accounting is an 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 result thereof.

Procedure of Accounting

Recording Classifying, Summarizing, Analyzing, Interpreting,  and Communicating

1. Recording- This is the basic function of accounting. This is the first stage of accounting. Recording is done in the book called ‘Journal’.

2. Classifying- Classification is concerned with the systematic analysis of the recorded data. The book containing classified information is called ‘ Ledger’.

3. Summarising- This process leads to the preparation of the following financial statements:

i) Trial Balance ii) Balance Sheet iii) Profit & Loss A\C iv) Cash-Flow Statement

4. Analysing- it means methodical classification of the data given in the financial statements. It is concerned

with the establishment of relationship between the items of the Profit & Loss A\C and the Balance Sheet.

5. Interpreting- This is the final function of the accounting. The recorded financial data is analysed and

interpreted in a manner that will enable the end-users to make a meaningful judgment about the financial

condition and profitability of the business.

6. Communicating- It is concerned with the transmission of summarized, analysed and interpreted

information to the end-users.to make them enable them to take rational decision.

Users of Accounting Information:

Internal Users	External Users
Board of Directors	Investors
Partners	Investors
Managers	Suppliers
Officers	Government Agencies e.g. Income Tax
	Department
	Employees
	Customers

Objectives of Accounting

1. Systematic recording of transactions ------------Journal, Ledger

2. Ascertainment of transactions ---------------------Manufacturing A\C, Trading A\C, Profit & Loss A\C

3. Ascertainment of financial position of the business --------Balance Sheet

4. Providing information to the users for rational decisionmaking---Financial Reports

5. To know the solvency position

Functions of Accounting:

Measurement, Forecasting, Decision Making, Comparison & Evaluation, Control Government, Regulation &

Control

Book-Keeping- Book-keeping is an activity concerned with the recording of financial data relating to business operation in a significant and orderly manner.

Objectives- Complete recording of transactions and Ascertainment of financial effect on the transactions

Sub-fields of Accounting

1. Financial Accounting, 2. Management Accounting, 3. Cost Accounting, 4. Social Responsibility Accounting

5. Human Resource

Accounting Policies

Basis of selection of accounting policies: Prudence, Substance over Form, and Materiality