Saransh - Last Mile Referencer for Foundation Paper 1 - Accounting PDF

SARANSH Last Mile Referencer for FOUNDATION PAPER 1 ACCOUNTING The Institute of Chartered Accountants of India (Set up by an Act of Parliament) Board of Studies www.icai.org I https:// boslive.icai.org  PREFACE The Board of St...

SARANSH Last Mile Referencer for FOUNDATION PAPER 1 ACCOUNTING The Institute of Chartered Accountants of India (Set up by an Act of Parliament) Board of Studies www.icai.org I https:// boslive.icai.org  PREFACE The Board of Studies (BoS) is dedicated to delivering outstanding services to its students, tirelessly striving for the highest standards of education and support. It imparts quality academic education through its value added study materials, that explain concepts clearly and in simple language. Illustrations and Test Your Knowledge Questions contained therein facilitate enhanced understanding and application of concepts learnt. Revision Test Papers provides Questions & Answers to help students to update themselves to revise the concepts by solving questions contained therein. Suggested Answers containing the ideal manner of answering questions set at examination which also helps students to revise for the forthcoming examination. Mock Test Papers empower students to gauge their readiness ahead of each examination, ensuring confidence and clarity. Additionally, BoS offers engaging live virtual classes led by distinguished faculty, reaching students far and wide across the nation. To effectively engage with its students, the Board of Studies (BoS) has been publishing subject- specific capsules in its monthly Students’ Journal, "The Chartered Accountant Student," since 2017. These capsules are aimed at facilitating efficient revision of concepts covered across various topics at the Foundation, Intermediate, and Final levels of the Chartered Accountancy Course. This initiative underscores the BoS's commitment to enhancing learning and comprehension among its students through accessible and attractive educational materials. Each issue of the journal includes a capsule relating to specific topic(s) in one subject at each of the three levels. In these capsules, the concepts and provisions are presented in attractive colours in the form of tables, diagrams and flow charts for facilitating easy retention and quick revision of topics. The Board of Studies (BoS) is now introducing a comprehensive booklet titled 'Saransh - Last Mile Referencer for Foundation Paper 1 - Accounting'. This booklet aims to consolidate significant concepts across various topics in accounting, particularly those included in the syllabi at the Foundation level of CA Course. It features diagrams, flow charts, tables, and illustrated journal entries, providing a one-stop repository for key accounting topics. However, the readers are advised to refer the study material for comprehensive study and revision.Under no circumstances, this booklet substitutes the detailed study of the material provided by the Board of Studies.Further, the readers are advised to enhance their ability to address the issues and solve the problems based on fundamentals of Accounting, illustrations and questions given in the study material, revision test papers and mock test papers. By capturing essential points in a concise format, 'Saransh' will facilitate better understanding and retention of critical accounting principles, enhancing the learning experience for students preparing for their examinations and beyond. It will indeed serve as a valuable ready reckoner for readers, enabling them to grasp the essence of the subject comprehensively. Happy Reading!  PRESIDENT’S MESSAGE It is with immense pride that I introduce the Saransh booklets, a meticulously curated resource available across the Foundation, Intermediate, and Final levels of the Chartered Accountancy course. ICAI has always been dedicated to providing our students with the best possible resources to succeed in their studies and careers, and Saransh is a demonstration of this commitment. The Saransh — Last Mile Referencers have been thoughtfully designed by the Board of Studies (BoS) to serve as an invaluable companion for your studies and exam preparation. Our aim is to simplify complex concepts and provisions, making them easier to understand, memorize, and revise. However, Saransh is not a substitute for the detailed BoS study material but a supplementary tool to complement your in-depth study. The newly revamped Saransh booklets have been updated not only in content but also in their presentation. With a more logical and organized structure, enhanced visual appeal, and a user- friendly layout, these booklets are now more effective in aiding your studies. We have extended the Saransh series to cover all core areas of the Chartered Accountancy course. Whether you are studying Direct Tax Laws and International Taxation, Indirect Tax Laws, Accounting Standards, Indian Accounting Standards, Auditing, Cost and Management Accounting, Strategic Cost Management and Performance Evaluation, Company Law, or Financial Management and Strategic Management, you will find a Saransh booklet for each subject. Saransh is designed not only to help you grasp and recall essential concepts but also to guide you in approaching each subject strategically. The insights provided in these booklets will help you develop a structured approach to your studies, ensuring that you are well-prepared for your examinations. I urge you to make the most of the Saransh booklets. While these booklets will support you, it is your dedication, perseverance, and hard work that will ultimately determine your success. I wish each of you the very best in your studies and future careers. Warm regards, CA. Ranjeet Kumar Agarwal President, ICAI  TABLE OF CONTENTS S.No. Particulars Page No. 1 Chapter 1: Theoretical Framework 1-29 2 Chapter 2: Accounting Process 30-63 3 Chapter 3: Bank Reconciliation Statement 64-70 4 Chapter 4: Inventories 71-78 5 Chapter 5: Depreciation and Amortisation 79-94 6 Chapter 6: Bills of Exchange and Promissory notes 95-104 7 Chapter 7: Preparation of Final Accounts of Sole Proprietors 105-111 8 Chapter 8: Financial Statements of Not-For-Profit Organizations 112-116 9 Chapter 9: Accounts from Incomplete Records 117-120 10 Chapter 10: Partnership and LLP Accounts 121-145 11 Chapter 11: Company Accounts 146-191  BEFORE WE BEGIN Accounting is a vital area of core competence for Chartered Accountancy students.The significance of the subject can be judged from the fact that at every level of Chartered Accountant (CA) course we have a paper on Accounting and that too, the first paper at every level of CA Course. Accounting truly serves as the cornerstone of the Chartered Accountancy profession, providing a solid foundation for many other areas of expertise in the field. The paper of Accounting at CA Foundation Course is designed to provide students with a strong conceptual understanding of essential accounting principles and practices and acquaint students with the basic concepts, theories and accounting techniques followed by different entities. Know your Syllabus The paper of Accounting at Foundation Level is divided into 11 chapters which are again divided into 5 sections. Each chapter is unique and important and should be understood thoroughly for grasping the entirety of a subject. Section I Section II Accounting Process Bank Reconciliation Statement Theoretical Framework Inventories Depreciation and Amortisation Bills of Exchange and Promissory notes Section III Section IV Section V Final Account for Sole Proprietors Partnership and LLP Company Accounts Financial Statement of Accounts Not-for-Profit Organisation Accounts from Incomplete Records At the time of preparation, you should follow the sequence of chapters given in study material. The chapters of the accounting paper are structured in a logical sequence to facilitate the understanding of bookkeeping, preparation of accounts, and presentation of financial statements. This sequential arrangement helps to lay the groundwork to grasp fundamental accounting concepts appropriately. Chapter 1 and 2 serves as a foundation for later chapters or topics of accounting hence skipping or glossing over these chapters can lead to gaps in understanding and comprehending the subject. Understanding each chapter thoroughly ensures a strong foundation to build upon as you progress through your CA curriculum. You should practice all the practical questions thoroughly before the examination. Practice is key to success in any examination, especially in subjects like accounting where application and problem-solving skills are essential. Thorough practice of practical questions not only helps in mastering the concepts but also improves speed and accuracy during exams. Regular practice builds confidence and enables you to perform your best when faced with challenging problems. It's essential to dedicate sufficient time to practice practical questions to excel in examinations. How to write Answers during exams? While solving the paper in exam hall, you should first write the answer which you know the best. Starting with questions you are most comfortable with can boost your confidence and set a positive tone for the rest of the exam. Plus, it allows you to secure marks early on, giving you more time to tackle the more challenging questions later. It is advisable to attempt all the sub-parts of a question at one place. By answering all the sub-parts of a question together, can improve the overall presentation of your answers. The answers written on the answer sheet should be neat and working note should form part of your answers. Maintaining neatness and including working notes in your answers is crucial for effective communication of your understanding of concepts. Wherever necessary, suitable assumptions may be made and disclosed by way of a note. How to manage time in examination? The examination period of three hours is the most crucial time since it is the time when you apply the knowledge and skills you've acquired throughout your study period. How well you manage those three hours, how effectively you tackle the questions, and how accurately you present your answers all reflect your level of preparation. You should follow the following tips: Make optimum use of 15 minutes given for reading. Go through all the questions quickly. Select the questions that you would be attempting from all the questions. Mark the question which you will be attempting first. Allocate an estimated time for each question based on their difficulty level and marks carried keeping aside 10-15 minutes for revisions. Adhere to time allocated. Your commitment to quality effort and effective time management will enhance your understanding of the concepts and boost your performance in the CA examination. By thoroughly preparing each subject, you can optimize your time, deepen your grasp of accounting principles, and ultimately achieve success in your CA journey.  SARANSH THEORETICAL FRAMEWORK CHAPTER 1: THEORETICAL FRAMEWORK Every individual performs some kind of economic activity. Such economic activities are performed through ‘transactions and events’. Transaction is used to Event is used to mean ‘a mean ‘a business, happening, as a performance of an consequence of act, an agreement’ transaction(s), a result.’ The Committee on terminology set up by the American Institute of Certified Public Accountants formulated the following definition of accounting in 1961: “Accounting is the art of recording, classifying, and summarising 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.” In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public Accountants (AICPA) enumerated the functions of accounting as follows: “The function of accounting is to provide quantitative information, primarily of financial nature, about economic entities, that is needed to be useful in making economic decisions.” Thus, accounting may be defined as the process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results thereof to the persons interested in such information. HISTORY & DEVELOPMENT OF ACCOUNTING Luca Pacioli’s, a Franciscan friar (merchant class), book Summa de This book contains knowledge Arithmetica, Geometria, Proportion of business and book-keeping. at Proportionality (Review of He used the terms Debit (Dr.) Arithmetic and Geometric and Credit (Cr.) in his books. proportions) in Venice (1494) is These were the concepts used considered as the first book on in latin terminology double entry bookkeeping. ICAI BOS 1 SARANSH THEORETICAL FRAMEWORK Debit comes from the Italian debito which comes from the Latin debita and debeo which means owed to the proprietor. Credit comes from the Italian credito which comes from the Latin ‘credo’ which means trust or belief (in the proprietor or owed by the proprietor). OBJECTIVES OF ACCOUNTING Systematic Communicating Recording of Ascertainment of Ascertainment of Information to Transaction Result Financial Position various users Book-keeping: Manufacturing, Balance Financial Journal, Trading, Sheet Reports Ledger and Profit & Loss A/c Trial Balance FUNCTIONS OF ACCOUNTING Measurement Measures past performence and depicts current finanacial position. Forecasting Helps in forcasting future performance and financial position. Decision- Provide relevant information to the users of making accounts for rational decision making. ICAI BOS 2  SARANSH THEORETICAL FRAMEWORK Access performance achieved in relation to Comparison & targets and discloses information regarding Evaluation accoutning policies for evaluationg and comparing financial results. Control Identifies weakness and provides feedbacks to check weaknesses Government Provides necessary information to government Regulation and to exercise control. Taxation PROCEDURAL ASPECTS OF ACCOUNTING On the basis of the above definitions, procedure of accounting can be basically divided into two parts: Using the Generating financial financial information information Generating Financial Information can be explained with the help of the following chart: Generating financial Information Summar Commun Recording Classifying Analyzing Interpreting ising icating ICAI BOS 3 SARANSH THEORETICAL FRAMEWORK PROCEDURE OF ACCOUNTING It is further be divided into This is the basic function of different types of subsidiary Recording accounting where recording is books as per the nature and done in a book called "Journal." size of the business. This step is a systematic classification of the recorded it enables to find total Classifying data and then the classified expenditure incurred information is recorded into under each head. Ledgers. It is concerned with the This process leads to the preparation and presentation of preparation of Summarising the classified data useful to the financial statements i.e. Trial internal as well as the external Balance, Profit and Loss Account, users of financial statements Balance Sheet, Cash-flow Statement. The term 'Analysis' means The figures given in the financial methodical classification of the statements will not help anyone Analysing data given in the financial unless they are in a statements. simplified form. The recorded financial data is analysed and interpreted in a manner that will enable the end-users to make a meaningful judgement Interpreting about the financial condition and profitability of the business operations. ICAI BOS 4 SARANSH THEORETICAL FRAMEWORK Communicating It is concerned with the transmission of summarised, analysed & interpreted information to the end-users to This is done through enable them to make rational preparation and decisions. distribution of accounting reports. USING THE FINANCIAL INFORMATION There are certain users of accounts. Earlier it was viewed that accounting is meant for the proprietor or owner of the business, but changing social relationships diluted the earlier thinking. It is now believed that besides the owner or the management of the business enterprise, users of accounts include the investors, employees, lenders, suppliers, customers, government and other agencies and the public at large. For example, if an airlines company borrows money from a bank, buys oil from oil companies, sells tickets to the customers, has staff to be paid salaries to, all these group of people and entities are key stakeholders in that airlines business. They would like to know and understand whether the business of the company is going well or there are challenges for the company to run the business. Accounting provides the art of presenting information systematically to the users of accounts. ICAI BOS 5 SARANSH THEORETICAL FRAMEWORK ACCOUNTING PROCESS Identification of transactions Input Accounting Output Cycle Recording of Identification of Communicating transaction in the Book economic events and information to users of original entity. transactions measured in financial terms. Posting to Ledger External users: Internal users: Investors Boards of Lenders Directors Preparation of Trial Suppliers Partners Balance Govt. Managers agencies Officers Customers Preparation of Final Accounts ICAI BOS 6 SARANSH THEORETICAL FRAMEWORK LIMITATIONS OF ACCOUNTING The Balance sheet cannot reflect the value of certain factors like loyalty and skill of the personnel which may be the most valuable asset of an enterprise these days. The Balance sheet cannot reflect the value of certain factors like loyalty and skill of the personnel which may be the most valuable asset of an enterprise these days. Accounting ignores changes in some money factors like inflation etc. There are occasions when accounting principles conflict with each other Certain accounting estimates depend on the sheer personal judgement of the accountant Financial statements consider those assets which can be expressed in monetary terms. Different accounting policies for the treatment of same item adds to the probability of manipulations. In nutshell, it can be said that the language of accounting has certain practical limitations.Therefore, the financial statements should be interpreted carefully keeping in mind all various factors influencing the true picture. BOOK KEEPING Book-keeping refers to the recording of financial data relating to business operations in an and orderly manner. Complete Recording of Transactions Objectives of book-keeping Ascertainment of Financial Effect on the Business ICAI BOS 7  SARANSH THEORETICAL FRAMEWORK DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING Book-keeping Accounting Concerned with summarising of the recorded Concerned with recording of transactions. transactions. Base of accounting Language of the business Financial statements do not form part of this Financial statements are prepared on the basis process. of book-keeping records. Management takes decisions on the basis of Managerial decisions cannot be taken. these records. It has several sub-fields like financial There is no sub-field of book-keeping accounting, management accounting etc. Financial position of the business cannot be Financial position of the business is ascertained ascertained through book-keeping records. on the basis of the accounting reports. RELATIONSHIP OF ACCOUNTING AND BOOK-KEEPING CAN BE DEPICTED IN THE FOLLOWING CHART AS Accountancy Accounting Book Keeping ICAI BOS 8 SARANSH THEORETICAL FRAMEWORK SUBFIELDS OF ACCOUNTING Financial Accounting Covers the preparation and interpretation of financial statements and communication to the users of accounts Management Accounting Concerned with internal reporting to the managers of a business unit. To discharge the functions of stewardship, planning, control and decision- making, the management needs variety of information. The different ways of grouping information and preparing reports as desired by managers for discharge their functions are referred to as Management Accounting. Cost Accounting The process of accounting for cost which begins with the recording of income and expenditure or the bases on which they are calculated and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. Social Responsibility Accounting Concerned with accounting for social costs incurred by the enterprise and social benefits created Human Resource Accounting An attempt to identify, quantify and report investments made in human resources of an organisation that are not presently accounted for under conventional accounting practice. ICAI BOS 9 SARANSH THEORETICAL FRAMEWORK ACCOUNTING CONCEPTS, PRINCIPLES AND CONVENTIONS Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. Accounting principles are a body of doctrines commonly associated with theory and procedures of accounting as a guide for selection of conventions or procedures where alternatives exist. Accounting conventions emerge out of accounting practices, adopted by various organizations over a period of time. ACCOUNTING CONCEPTS Entity concept Business enterprise is a separate identity apart from its owner. All the business transactions are recorded in the business books of accounts in keeping business affairs free from influence of personal affairs of owner. Money measurement 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. ICAI BOS 10 SARANSH THEORETICAL FRAMEWORK Periodicity concept This is also called the concept of definite accounting period. As per going concern’ concept an indefinite life of the entity is assumed. For a business entity it causes inconvenience to measure performance achieved by the entity in the ordinary course of business. According to this concept, accounts should be prepared after every period & not at the end of the life of the entity. Usually, this period is one year. Hence, the periodicity concept facilitates in: Comparing of financial statements of different periods Uniform and consistent accounting treatment for ascertaining the profit and assets of the business Matching periodic revenues with expenses for getting correct results of the business operations Cost Concepts Realisation concept The value of an asset is to be It closely follows the cost determined on the basis of concept. Any change in value of historical cost, in other words, an asset is to be recorded only acquisition cost. Although there when the business realises it. are various measurement If accountants anticipate bases, accountants traditionally decrease in value they count it, prefer this concept in the but if there is increase in value interests of objectivity. they ignore it until it is realised. Matching concept All expenses matched with the revenue of that period should only be taken into consideration. In the financial statements of the organization if any revenue is recognized then expenses related to earn that revenue should also be recognized of the entity. This concept is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash ICAI BOS 11 SARANSH THEORETICAL FRAMEWORK Dual Aspect concept This concept is the core of double entry book-keeping. Every transaction or event has two aspects: It increases one It increases an It decreases Asset and It decreases one Asset and one Asset, simultaneously Asset, increases decreases decreases a increases another Asset; other Asset; Liability. Liability; Alternatively It increases It increases a It decreases It decreases one Liability, Liability, Liability, Liability, decreases increases an increases other decreases an other Asset; Liability; Asset. Liability; Conservatism Conservatism states that the accountant should not anticipate any future income however they should provide for all possible losses. For this concept there should be at least three qualitative characteristics of financial statements, namely, Prudence, i.e., Neutrality, i.e., Faithful judgement about unbiased outlook is representation the possible future required to identify of alternative losses which are to and record such values. be guarded, as well possible losses, as as gains which are well as to exclude uncertain. uncertain gains, Materiality According to materiality Any insignificant item which principle, all the items having will only increase the work of significant economic effect the accountant but will not be on the business of the relevant to the users’ need enterprise should be should not be disclosed in the disclosed in the financial financial statements. statements. ICAI BOS 12 SARANSH THEORETICAL FRAMEWORK FUNDAMENTAL ACCOUNTING ASSUMPTIONS Going Concern Consistency Accrual The financial statements Accounting policies are The effects of are prepared on the followed consistently from transactions and other assumption that an one period to another and events are recognised on enterprise is a going change in an accounting mercantile basis i.e. when concern and will policy is made only in they occur, they are continue in operation for certain exceptional recorded in the the foreseeable future. circumstances. accounting records and reported in the financial statements of the periods to which they relate. QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS Completeness Substance Prudence over Form Understanda Materiality bility Qualitative Characteristics of Financial Statements Relevance Comparability Neutrality Reliability Full, Fair & Faithful Adequate Representation Disclosures ICAI BOS 13 SARANSH THEORETICAL FRAMEWORK CAPITAL AND REVENUE EXPENDITURE AND RECEIPTS Revenue Expense relates to the operations of the Capital Expenditure, on the business of an accounting other hand, generates period or to the revenue enduring benefits and helps earned during the period or in revenue generation over the items of expenditure, more than one accounting benefits of which do not period. extend beyond that period. Considerations in determining capital and revenue expenditures The nature of business is a very important criteria in separating an Nature of expenditure between capital and revenue. eg: For a trader dealing in furniture, purchase of furniture is revenue business expenditure but for any other trade, the purchase of furniture should be treated as capital expenditure and shown in the balance sheet as asset If the frequency of an expense is quite often in an accounting year then Recurring it is said to be an expenditure of revenue nature while non-recurring nature of expenditure is infrequent in nature and do not occur often in an expenditure accounting year. Expenses for repairs of machine may be incurred in course of normal maintenance of the asset. Such expenses are revenue in nature. Purpose of expenses On the other hand, expenditure incurred for major repair of the asset so as to increase its productive capacity is capital in nature. The expenses which help to generate income/ revenue in the current Effect on revenue period are revenue in nature and should be matched against the generating revenue earned in the current period. capacity of If expenditure helps to generate revenue over more than one accounting business period, it is generally called capital expenditure. Materiality of the Relative proportion of the amount involved is another important amount consideration in distinction between revenue and capital involved ICAI BOS 14 SARANSH THEORETICAL FRAMEWORK DIFFERENCES BETWEEN CAPITAL AND REVENUE EXPENDITURES Key Differences Capital Expenditure Revenue Expenditure Any expenditure incurred to Any expenditure incurred to provide a benefit during the Period of benefit provide a benefit over a long-term current period is revenue period is capital expenditure. expenditure. Capital expenditure is incurred for the purpose of increasing the Revenue expenditure is incurred to Enhancement vs capacity of the business. maintain the earning capacity of Maintenance Alternatively, it also includes an the business. expenditure to reduce the costs of the business. Purchase of machine, car, furniture, Repairs and maintenance, salary Examples etc. of accounting staff, etc. CAPITAL AND REVENUE RECEIPTS Receipts which are On the other hand, obtained in course of receipts which are normal business not revenue in activities are revenue nature are capital receipts receipts CONTINGENT ASSETS AND CONTINGENT LIABILITIES A possible asset arises from past events Contingent Asset and their existence will be confirmed only after occurrence or non-occurrence of one or more uncertain future events. There is uncertainty As per the concept of in realisation of claim. prudence as well as the It is possible that present accounting recognition of contingent However, when the These assets are standards, an assets may result in realisation of uncertain and may enterprise should not recognition of income income is virtually arise from a claim recognise a that may certain, then the which an enterprise contingent asset. never be realised. related asset no pursues through a longer remains as legal proceeding contingent asset. ICAI BOS 15 SARANSH THEORETICAL FRAMEWORK a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or Contingent Liability a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or Example (ii) a reliable estimate of the amount of the obligation cannot be made.” A few days later from the date of Mr. X sells a machine to Mr. sale of machine, Mr. X received a Y. Any damages incurred notice from Mr. Y who is claiming by Mr. Y while using the damages of ₹20 lac. The notice machine need to be mentioned that a worker met compensated by Mr. X. with an accident during the use of the machine and is required to be compensated. Although, the receipt of the notice The receipt of this notice does not results into an event which suggest that Mr. X is liable to pay the requires recognition of a amount, although this needs to be contingent liability since there is a investigated and confirmed, as possible obligation, and that can whether the damage arose due to only be confirmed in future. any defect in the machine or it is due to negligence while operating the machine. An enterprise should not recognise a contingent liability in balance sheet, however it is required to be disclosed in the notes to accounts, unless possibility of outflow of a resource embodying economic benefits is remote. ICAI BOS 16 SARANSH THEORETICAL FRAMEWORK DISTINCTION BETWEEN CONTINGENT LIABILITIES AND LIABILITIES A liability is defined as the On the other hand, in the case present financial obligation of of contingent liability, either an enterprise, which arises outflow of resources to settle from past events. The the obligation is not probable settlement of a liability results or the amount expected to be in an outflow from the paid to settle the liability enterprises of resources embodying economic cannot be measured with benefits. sufficient reliability. DISTINCTION BETWEEN PROVISIONS AND CONTINGENT LIABILITIES Provision Contingent liability A Contingent liability is a possible Provision is a present liability of uncertain obligation that may or may not crystallise amount, which can be measured reliably (1) depending on the occurrence or non- by using a substantial degree of occurrence of one or more uncertain future estimation. events. A contingent liability fails to meet the (2) A provision meets the recognition criteria. same. Provision is recognised when Contingent liability includes present (a) an enterprise has a present obligation obligations that do not meet the arising from past events; an outflow of recognition criteria because either it is not (3) resources embodying economic benefits probable that settlement of those is probable, and obligations will require outflow of economic (b) a reliable estimate can be made of the benefits, or the amount cannot be reliably amount of the obligation. estimated. If the management estimates that it is If the management estimates, that it is probable that the settlement of an less likely that any economic benefit will (4) obligation will result in outflow of outflow the firm to settle the obligation, it economic benefits, it recognises a discloses the obligation as a contingent provision in the balance sheet. liability. ICAI BOS 17 SARANSH THEORETICAL FRAMEWORK ACCOUNTING POLICIES ACCOUNTING POLICIES Accounting Policies refer to specific accounting principles and methods of applying these principles adopted by the enterprise in the preparation and presentation of financial statements. Policies are based on various accounting concepts, principles and conventions. The areas wherein different accounting policies are frequently encountered can be given as follows: (1) Valuation of Inventories; (2) Valuation of Investments. SELECTION OF ACCOUNTING POLICIES Choice of accounting policy is an important policy decision which affects the performance measurement as well as financial position of the business entity. Selection of inappropriate accounting policy may lead to understatement or overstatement of performance and financial position. Thus, accounting policy should be selected with due care after considering its effect on the financial performance of the business enterprise from the angle of various users of accounts. Selection of Accounting Policies is based on Substance Prudence Materiality over form ICAI BOS 18 SARANSH THEORETICAL FRAMEWORK Examples wherein selection from a set of accounting policies is made Inventories are valued at Investments (long term) cost except for finished are valued at their goods and by-products. acquisition cost. Finished goods are Provision for permanent valued at lower of cost diminution in value has or market value and by- been made wherever products are valued at necessary. net realizable value. CHANGE IN ACCOUNTING POLICIES A change in accounting policies should be made in the following conditions: It is required by some Change would result statute or for in more appropriate compliance with an presentation of Accounting Standard. financial statement. ACCOUNTING AS A MEASUREMENT DISCIPLINE – VALUATION PRINCIPLES, ACCOUNTING ESTIMATES Elements of Measurement Measurement Measurement is vital aspect of accounting. Identification of Primarily transactions and events are measured Objects and Events in terms of money. Any measurement discipline deals with three basic elements of measurement viz., identification of objects and Selection of events to be measured, selection of standard or Standards or Scale scale to be used, and evaluation of dimension of measurement standards or scale. Evaluation of Dimension of Measurement Standards or Scale ICAI BOS 19 SARANSH THEORETICAL FRAMEWORK VALUATION PRINCIPLES There are four generally accepted measurement bases or valuation principles. These are: Historical Cost Current Cost It means acquisition price. For example, the businessman paid ₹7,00,000 to purchase the machine and Current cost gives an alternative spend ₹1,00,000 on its installation, its measurement base. Assets are carried acquisition price including installation out at the amount of cash or cash charges is ₹8,00,000. The historical cost equivalent that would have to be paid if of machine would be ₹8,00,000. the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. Realizable Value As per realisable value, assets are Present Value carried at the amount of cash or cash equivalents that could currently be obtained by selling the assets in an orderly disposal. Haphazard disposal As per present value, an asset is carried may yield something less. at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. ICAI BOS 20 SARANSH THEORETICAL FRAMEWORK ACCOUNTING ESTIMATES There are certain items, which are not occurred therefore cannot be measured using valuation principles but still they are necessary to record in the books of account. For example, provision for doubtful debts. In such a situation reasonable estimates based on the existing situation and past experiences are made. As a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The process of estimation involves judgements based on the latest information available. An estimate may require revision. Change in accounting estimate means difference arises between certain parameters estimated earlier and re-estimated. ACCOUNTING STANDARDS Accounting standards are written The ostensible purpose of the policy documents issued by expert standard setting bodies is to accounting body or by government promote the dissemination of or other regulatory body covering timely and useful financial the aspects of recognition, information to investors and treatment, measurement, certain other parties having an presentation and disclosure of interest in the company's accounting transactions and events economic performance. in the financial statements. The accounting standards deal with the issues of : (1) (2) recognition of measurement of events and these transactions transactions in the and events; financial statements; ICAI BOS 21 SARANSH THEORETICAL FRAMEWORK (4) the disclosure requirements (3) which should be there to enable presentation of these the public at large and the transactions and events in stakeholders and the potential the financial statements in a investors in particular, to get an manner that is meaningful insight into what these financial and understandable to the statements are trying to reflect reader; and and thereby facilitating them to take prudent and informed business decisions Accounting Standards standardise diverse accounting policies with a view to: Eliminate the non-comparability of provide a set of standard financial statements and thereby accounting policies, valuation improving the reliability of financial norms and disclosure statements; and requirements. BENEFITS OF ACCOUNTING STANDARDS Standards reduce to a reasonable extent or The application of accounting eliminate altogether standards would, to a limited extent, confusing variations in the facilitate comparison of financial accounting treatments statements of companies situated in used to prepare financial different parts of the world and also of statements. different companies situated in the same country. However, it should be noted in this respect that differences in the institutions, traditions and legal There are certain areas systems from one country to another where important give rise to differences in accounting information are not standards adopted in different statutorily required to be countries. disclosed. Standards may call for disclosure beyond that required by law. ICAI BOS 22 SARANSH THEORETICAL FRAMEWORK LIMITATIONS OF ACCOUNTING STANDARDS Difficulties in making choice between different treatments: Restricted scope: Accounting Alternative solutions to certain standards cannot override the accounting problems may each have statute. The standards are arguments to recommend them. required to be framed within the Therefore, the choice between different alternative accounting ambit of prevailing statutes. treatments may become difficult. PROCESS OF FORMULATION OF ACCOUNTING STANDARDS (AS) Identification of area for formulation of AS Constitution of study group to prepare preliminary draft Preparation of draft and its circulation to council members of ICAI and specified outside bodies Ascertainment of views of different bodies on draft Finalisation of exposure draft (E.D) Comments received on exposure draft (E.D) Modification of the draft Issue of Accounting Standard (AS) ICAI BOS 23 SARANSH THEORETICAL FRAMEWORK There are three sets of Accounting Standards to cater different categories of entities based on their nature, size, and legal framework under which they operate, ensuring that each entity follows appropriate accounting principles for financial reporting These are: Indian Accounting Standards (Ind AS) are applicable to all listed companies and Non-Banking Financial Companies (NBFCs) and to unlisted companies and unlisted NBFCs with net worth of INR 250 crores or more. Accounting Standards (AS) notified under Companies (Accounting Standards) Rules, 2021, are applicable to the companies other than those following Ind AS, as given in point (i). These companies are required to apply Accounting Standards (AS) notified under the Companies Act as Companies (Accounting Standards) Rules, 2021. Accounting Standards (AS) prescribed by ICAI are applicable for entities other than companies. LIST* OF ACCOUNTING STANDARDS IN INDIA Number of the Sl. No. Title of the Accounting Standard Accounting Standard (AS) 1. AS 1 Disclosure of Accounting Policies 2. AS 2 (Revised) Valuation of Inventories 3. AS 3 (Revised) Cash Flow Statements Contingencies and Events Occurring after the Balance 4. AS 4 (Revised) Sheet Date Net Profit or Loss for the Period, Prior Period Items and 5. AS 5 (Revised) Changes in Accounting Policies 6. AS 7 (Revised) Accounting for Construction Contracts 7. AS 9 Revenue Recognition 8. AS 10 Property, Plant and Equipment 9. AS 11 (Revised) The Effects of Changes in Foreign Exchange Rates 10. AS 12 Accounting for Government Grants 11. AS 13 Accounting for Investments 12. AS 14 Accounting for Amalgamations ICAI BOS 24  SARANSH THEORETICAL FRAMEWORK Number of the Sl. No. Title of the Accounting Standard Accounting Standard (AS) 13. AS 15 (Revised) Employee Benefits 14. AS 16 Borrowing Costs 15. AS 17 Segment Reporting 16. AS 18 Related Party Disclosures 17. AS 19 Leases 18. AS 20 Earnings Per Share 19. AS 21 Consolidated Financial Statements 20. AS 22 Accounting for Taxes on Income Accounting for Investments in Associates in 21. AS 23 Consolidated Financial Statements 22. AS 24 Discontinuing Operations 23. AS 25 Interim Financial Reporting 24. AS 26 Intangible Assets 25. AS 27 Financial Reporting of Interests in Joint Ventures 26. AS 28 Impairment of Assets 27. AS 29 Provisions, Contingent Liabilities & Contingent Assets *Note: The list of accounting standards given above does not form part of syllabus. It has been given here for the knowledge of students only. **INDIAN ACCOUNTING STANDARDS (IND AS) The Institute of Chartered Accountants of India (ICAI) being the accounting standards-setting body in India, way back in 2006, initiated the process of moving towards the International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB) with a view to enhance acceptability and transparency of the financial information communicated by the Indian corporates through their financial statements. This move towards IFRS was subsequently accepted by the Government of India. ICAI BOS 25 SARANSH THEORETICAL FRAMEWORK The Government of India in consultation with the ICAI decided to converge and not to adopt IFRSs issued by the IASB. The decision of convergence rather than adoption was taken after the detailed analysis of IFRS requirements and extensive discussion with various stakeholders. Accordingly, while formulating IFRS- converged Indian Accounting Standards (Ind AS), efforts have been made to keep these Standards, as far as possible, in line with the corresponding IFRS and departures have been made where considered absolutely essential. Certain changes have been made considering the economic environment of the country, which is different as compared to the economic environment presumed to be in existence by IFRS. LIST OF IND AS ON 1ST AUGUST, 2024 Ind AS Title of Ind AS 101 First -Time Adoption of Indian Accounting Standards 102 Share- Based Payment 103 Business Combinations 104 Insurance Contracts 105 Non-current Assets Held for Sale and Discontinued Operations 106 Exploration for and Evaluation of Mineral Resources 107 Financial Instruments: Disclosures 108 Operating Segments 109 Financial Instruments 110 Consolidated Financial Statements 111 Joint Arrangements 112 Disclosure of Interests in Other Entities 113 Fair Value Measurement 114 Regulatory Deferral Accounts 115 Revenue from Contracts with Customers ICAI BOS 26 SARANSH THEORETICAL FRAMEWORK Ind AS Title of Ind AS 116 Leases 1 Presentation of Financial Statements 2 Inventories 7 Statement of Cash Flows 8 Accounting Policies, Changes in Accounting Estimates and Errors 10 Events after the Reporting Period 12 Income Taxes 16 Property, Plant and Equipment 19 Employee Benefits 20 Accounting for Government Grants and Disclosure of Government Assistance 21 The Effects of Changes in Foreign Exchange Rates 23 Borrowing Costs 24 Related Party Disclosures 27 Separate Financial Statements 28 Investment in Associates and Joint Ventures 29 Financial Reporting in Hyperinflationary Economies 32 Financial Instruments: Presentation 33 Earnings per Share 34 Interim Financial Reporting 36 Impairment of Assets 37 Provisions, Contingent Liabilities and Contingent Assets 38 Intangible Assets 40 Investment Property 41 Agriculture ICAI BOS 27  SARANSH THEORETICAL FRAMEWORK **ACCOUNTING STANDARDS FOR LOCAL BODIES Accounting Standards for local bodies are Accounting Standards that are applicable to the local bodies whose primary objective is to deliver services to the public, rather than to make profits and generate a return on equity to investors. Consequently, the performance of such entities can be only partially evaluated by examination of financial position, financial performance and cash flows. LIST OF ACCOUNTING STANDARDS FOR LOCAL BODIES (ASLB) ASLB Title of ASLB 1 Presentation of Financial Statements 2 Cash Flow Statements 3 Accounting Policies, changes in Accounting Estimates and Errors 4 The Effects of Changes in Foreign Exchange Rates 5 Borrowing Costs 9 Revenue from Exchange Transactions 11 Construction Contracts 12 Inventories 13 Leases 14 Events After the Reporting Date 16 Investment Property 17 Property, Plant and Equipment 18 Segment Reporting 19 Provision, Contingent Liabilities and Contingent Assets 20 Related Party Disclosures 21 Impairment of Non-Cash-Generating Assets 23 Revenue from Non-Exchange Transaction (Taxes and Transfers) 24 Presentation of Budget Information in Financial Statements 26 Impairment of Cash-Generating Assets ICAI BOS 28  SARANSH THEORETICAL FRAMEWORK ASLB Title of ASLB 31 Intangible Assets 32 ‘Service Concession Arrangements: Grantor 33 First-Time Adoption of Accrual Basis Accounting Standards for Local Bodies (ASLBs) 34 Separate Financial Statements 35 Consolidated Financial Statements 36 Investment in Associates and Joint Ventures 37 Joint Arrangements 38 Disclosure of Interests in Other Entities 39 Employee Benefits 40 Entity Combinations 42 Social Benefits Financial Reporting under Cash Basis of Accounting **Note: Ind AS and ASLB given above do not form part of the syllabus. They have been discussed here for the knowledge of students only ICAI BOS 29 SARANSH ACCOUNTING PROCESS CHAPTER 2 : ACCOUNTING PROCESS DOUBLE ENTRY BOOK KEEPING Double entry system of book-keeping is a process of evolution of various accounting techniques and is the only scientific system of accounting. As per double entry system, every transaction has two-fold aspects–debit and credit and both the aspects are to be recorded in the books of accounts. Therefore, in every transaction at least two accounts are effected. ADVANTAGES OF DOUBLE ENTRY BOOK KEEPING The accuracy of the 1 accounting work can be established, through the The profit earned or device of the trial balance. loss suffered during a period can be ascertained together with 5 details. year of one red Advantages of 2 Double Entry Resu lt mpa be co may hose of with t nd previo reaso us years a ns for the ay be Book Keeping The pos financia n ge m i ch a taine d. asc tion ca l ascer end erta in n be of e ed at th thro a e ugh ch peri prep od, of fi a nan ration The system permits stat cial 4 accounts to be kept in as eme nts. much details as necessary and, therefore 3 affords significant information for the purposes of control etc. ICAI BOS 30  SARANSH ACCOUNTING PROCESS ACCOUNT In T-accounts, increase entries are made on the left side and decrease entries are made on the right side of the accounts for assets respectively and vice-versa for liabilities. These two columns are put usually in the form of an account, called the ‘T’ form. FORMAT OF ACCOUNT Date Particulars Ref. Amount Date Particulars Ref. Amount DEBIT AND CREDIT Assets = Liabilities + Capital or Assets – Liabilities = Capital To understand the equation better, let us expand it:- Assets = Liabilities + Stockholders’ Equity Assets = Liabilities + (contributed capital + beginning retained earnings + revenue - expense - dividends) the original capital introduced by the Contributed capital = owner. Beginning Retained previous earnings not distributed to the = Earnings shareholders. generated from the ongoing activities of Revenue = the business. cost incurred for the operations of the Expenses = company. earnings distributed to the shareholders Dividends = of the company. ICAI BOS 31  SARANSH ACCOUNTING PROCESS RULES FOR DEBIT AND CREDIT In T-accounts, increase entries are made on the left side and decrease entries are made on the right side of the accounts for assets respectively and vice-versa for liabilities. These two columns are put usually in the form of an account, called the ‘T’ form. Elements Sr. No. Effects of Financial Statements 1] Asset Increases Assets (Dr.) Decreases Assets (Cr.) 2] Liability Increases Liability (Cr.) Decreases Liability (Dr.) 3] Owner’s Capital Increases Capital (Cr.) Decreases Capital (Dr.) 4] Expenses Increases Expenses (Dr.) Decreases Expenses (Cr.) 5] Revenue/Income Increases Income (Cr.) Decreases Income (Dr.) 6] Profit Capital (Cr.) 7] Loss Capital (Dr.) The terms debit and credit should not be taken to mean, respectively, favourable and unfavourable things. They merely describe the two sides of accounts. A transaction is a type of event, which is generally external in nature. Transaction are analysed in terms of money and supported by proper documents are recorded in the books of accounts under double entry system. To analyse the dual aspect of each transaction, two approaches can be followed: Accounting Traditional Equation Approach Approach ICAI BOS 32  SARANSH ACCOUNTING PROCESS ACCOUNTING EQUATION APPROACH The relationship of assets with that of liabilities and owners’ equity in the equation form is known as ‘Accounting Equation’. Basic accounting equation comes into picture when sum total of capital and liabilities equalises assets, where assets are what the business owns and capital and liabilities are what the business owes. Under double entry system, every business transaction has two-fold effect on the business enterprise where each transaction affects changes in assets, liabilities or capital in such a way that an accounting equation is completed and equated Equity + Liabilities = Assets or, Equity + Long-Term Liabilities = Fixed Assets + Current Assets - Current Liabilities TRADITIONAL APPROACH CLASSIFICATION OF ACCOUNTS 1 Personal transactions Transactions in the journal are recorded on the basis of the rules of 2 debit and credit only. For Transactions related to the purpose of recording, assets and properties these transactions are classified in three groups 3 Transactions related to expenses, losses, income and gains Classification of Accounts Personal Impersonal Accounts Accounts Artificial Real Nominal Natural (Legal) Accounts Accounts Ram, Seeta Etc. Company, Clubs, Land, Building, Cash in hand Expenses, losses, gains, profits Co-Operative Eg- Salary , rent, interest Representative Societies O/s Liability, Capital, Drawings ICAI BOS 33  SARANSH ACCOUNTING PROCESS GOLDEN RULES OF ACCOUNTING Types of Account Account to be Debited Account to be Credited Personal Account Receiver Giver Real Account What comes in What goes out Nominal Account Expense and losses Income and gains MODERN CLASSIFICATION OF ACCOUNTS Real, nominal and personal accounts is the traditional classification of accounts. Now, let us see the modern and more acceptable classification of accounts:- Account to be Normal balance of Account to be credited Types of account debited when there account when there is: is: Asset account Debit Increase Decrease Liabilities account Credit Decrease Increase Capital account Credit Decrease Increase Revenue account Credit Decrease Increase Expenditure account Debit Increase Decrease Withdraw account Debit Increase Decrease JOURNAL Transactions are first entered in this book to show which accounts should be debited and which credited. Journal is also called subsidiary book. Recording of transactions in journal is termed as journalizing the entries. It is the book of original entry in which transactions are entered on a daily basis in a chronological order. It would be difficult to maintain the records in an orderly manner. Debits and credits are listed along with the appropriate explanations. There are basically two types of journals :- Types of Journals 1 General Journal 2 Specialized Journal ICAI BOS 34 SARANSH ACCOUNTING PROCESS PERFORMA OF JOURNAL Date Particulars L.F. Amount (Dr.) Amount (Cr.) (1) (2) (3) (4) (5) POINTS TO BE TAKEN INTO CARE WHILE RECORDING A TRANSACTION IN THE JOURNAL If journal entries are recorded in several pages then both the amount column of each page should be totalled. the balance should be written at the end of that page the same total should be carried Journal entries can be forward at the single entry (i.e. one beginning of the debit and one credit) next page. or compound entry (i.e. one debit and two or more credits or two or more debits and one credit or two or more debits and credits). In such cases, it is important to check that the total of both debits and credits are equal. ICAI BOS 35 SARANSH ACCOUNTING PROCESS ADVANTAGES OF JOURNAL ONE TWO THREE As transactions are Entries recorded in Journal forms the recorded on the journal are basis for posting the chronological order, supported by a note entries in the ledger. one can get termed as narration, This eases the complete information which is a precise accountant in their about the business explanation of the work and reduces transactions on time transaction for the the chances of error. basis. proper understanding of the entry. One can know the correctness of the entry through these narrations. ICAI BOS 36 SARANSH ACCOUNTING PROCESS ACCOUNTING FOR GST INTRODUCTION TO GST Goods and Services Tax (GST) is a comprehensive Indirect Tax which has subsumed multiple Indirect Taxes in India such as State Value added Tax (VAT) which was levied on sale of goods, Excise Duty, which was levied on manufacture or production of goods, Service Tax which was levied on provision of services etc. GST is a single tax on the supply of goods and services, right from the manufacturer to consumer. SALIENT FEATURES OF GST GST is levied on supply i.e., manufacture or sale of goods and provision of services. In other words, supply is taxable event which own its occurrence creates or attracts the liability to pay tax. Under GST, tax in levied only the value added at each stage of the supply chain. GST is a destination-based consumption tax, i.e. the tax is levied at the place where the goods or services are consumed, rather than the place where they are produced. There is no tax on tax or cascading of taxes under GST system. Under GST, there is a harmonization of laws, procedures and rates of tax across the country. ICAI BOS 37 SARANSH ACCOUNTING PROCESS TYPES OF TAXES UNDER GST GST has a dual aspect with the Centre and States simultaneously levying on a common tax base. There are three main components of GST which are: 1. Central Goods and Service Tax (CGST) is levied and collected by the Centre on the “Intra -State” supply of goods and services. 2. State Goods and Services Tax (SGST) is levied and collected by the State Governments (including Union Territories with legislature, for example Delhi, Pondicherry, Jammu and Kashmir) on “Intra state” supply of goods and services 3. Union Territory Goods and Service Tax (UTGST) is levied and collected by Union Territories without Legislatures [i.e. Andaman and Nicobar Islands, Lakshadweep, Ladakh, Dadra and Nagar Haveli & Daman and Diu and Chandigarh] on “intra-state” supply of goods and services. 4. Integrated Goods and services tax (IGST): It is the GST levied on the “inter state” supply of goods and services and is collected by the Centre. IGST is equivalent to the sum total of CGST and SGST. GST is a “Consumption Based Tax“ i.e. the tax is received by the State in which the goods or services are consumed and not by the state in which the goods and services are manufactured. Intra State GST Intra State CGST IGST SGST INPUT AND OUTPUT GST Output tax means the GST charged on Input tax means supply of goods or the credit of Input services made by a tax already paid. supplier. ICAI BOS 38  SARANSH ACCOUNTING PROCESS UTILISATION OF INPUT TAX CREDIT UNDER GST Tax credit of CGST, SGST