Accountancy Class-XI Volume-I PDF

ACCOUNTANCY CLASS-XI VOLUME-I Flowcharts, MCQs, Very and Strictly following Keywords and Diagrams and Short Answer the Latest CBSE Important terms Tables for better Questions f...

ACCOUNTANCY CLASS-XI VOLUME-I Flowcharts, MCQs, Very and Strictly following Keywords and Diagrams and Short Answer the Latest CBSE Important terms Tables for better Questions for Pattern made easy conceptual Practice with understanding Solutions EDITION: 2024-25 Published By: Physicswallah Private Limited Physics Wallah Publication ISBN: 978-93-6034-252-4 MRP: 249/- Mobile App: Physics Wallah (Available on Play Store) Website: www.pw.live Youtube Channels: Physics Wallah - Alakh Pandey Commerce Wallah by PW (@CommerceWallahPW) CA Wallah by PW (@CAWallahbyPW) CA Intermediate by PW (@CAintermediatebyPW) Email: [email protected] RIGHTS All rights are reserved with the Publisher. No part of this book may be used or reproduced in any manner whatsoever without written permission from the author or publisher. In the interest of the student community: Circulation of soft copy of Book(s) in PDF or other equivalent format(s) through any social media channels, emails, etc. or any other channels through mobiles, laptops or desktop is a criminal offense. Anybody circulating, downloading, or storing, a soft copy of the book on his device(s) is in breach of the Copyright Act. Further photocopying of this book or any of its material is also illegal. Do not download or forward in case you come across any such soft copy material. DISCLAIMER A team of PW CA Wallah faculties and experts with a deep understanding of the subject has worked hard for the creation and curation of this book. While the content creators, editors and publisher have used their best efforts in preparing these books. The content has been checked for accuracy. As the book is intended for educational purposes, the author shall not be responsible for any errors contained in the book. The publication has designed the content to provide accurate and authoritative information with regard to the subject matter covered. This book and the individual contribution contained in it are protected under Copyright Act by the publisher. (This book shall only be used for educational purposes.)  Preface A highly skilled professional team of Commerce Wallah works vigorously to ensure that the students receive the best content for their school & board exams. While there are tons of commerce study resources out there, Commerce Wallah by PW stands out by offering constantly improved, top-notch materials. Commerce Wallah team continuously works to provide supreme quality study material for the Commerce students. From the beginning, the content team comprising Subject Matter Experts, Content Creators, Reviewers, DTP operators, Proofreaders, and others are involved in shaping the material to their best knowledge and experience to produce powerful content for the students. Commerce Wallah Faculties have adopted a novel style of presenting the content in easy-to-understand language and have provided the content team with expert guidance and supervision throughout the creation and curation of this book. PW Commerce Wallah strongly believes in conceptual and fun-based learning. Commerce Wallah provides highly exam-oriented content to bring quality and clarity to the students. This book adopts a multi-faceted approach to mastering and understanding the concepts by having a rich diversity of questions asked in the school and board examination and equipping the students with the knowledge for this highly crucial exam. The main objective of this book is to provide an edge to your preparation with short & crisp yet high-quality content. BOOK FEATURES This book, especially designed for commerce students contains:  Syllabus coverage as per the latest CBSE Curriculum.  Keywords and Important terms provided for better conceptual understanding.  Flowcharts, diagrams and tables in every chapter to grasp complex topics and boost understanding.  Conquer exams with MCQs, Very short and Short Answer questions for practice with detailed solutions to understand the logic behind each answer.  Contents VOLUME-I 1. Introduction to Accounting... 3-23 2. Theory Based Accounting... 24-38 3. Accounting Equation... 39-58 4. Recording of Business Transaction... 59-71 5. Journal... 72-110 6. Journal with GST... 111-137 7. Subsidiary Books... 138-172 8. Ledger... 173-188 VOLUME I  CHAPTER Introduction to 01 Accounting BASIC ACCOUNTING TERMS 1. Business Transaction: A business transaction may be defined as an economic event involving exchange of some value between two or more entities. It may be a purchase of goods, receipt of money, payment to a creditor, paying expenses, etc. It may be a cash transaction or a credit transaction. For example:  Purchase of goods on credit.  Salary paid to employees.  Electricity expenses. 2. Capital: It is the amount invested by the owner in the firm. It may be in the form of cash or kind or both. For a business entity capital is an obligation and a claim on the assets of business. So, it appears as capital on the liabilities side of the balance sheet. The amount of profits earned and additional capital introduced will increase the capital and the amount of losses incurred and the amount withdrawn will decrease it. Capital is the difference between the total assets of the business and its external liabilities. 3. Account: In reality, similar transactions are recorded, added, and removed in a single location. Typically, one refers to such a location as a “Account.” It is crucial to comprehend the definition and structure of an account before attempting to comprehend the meaning of debit and credit. A record of all commercial transactions pertaining to a specific individual or thing is called an account. In accounting, every individual asset, liability, expense, and revenue are kept in a distinct record. The location where an account is kept for such records is called an account. 4. Receipts: The sum of money received by a business during an accounting period is called the receipts of the business.  Capital receipts: The receipts that results in an increase in liabilities or a reduction in value of assets. These receipts are reflected in the Balance Sheet. For example: bank loan, proceeds from sale of an asset, etc.  Revenue receipts: The receipts that are generated through the normal activities of the business. Such receipts are reflected in the Trading and Profit and Loss Account. For example: proceeds from sale of goods or services, commission received, etc. 5. Revenue: The amounts earned by a business by selling its products or providing services to customers are called sales revenue. Other items of revenue common to many earned by businesses are: commission, interest, dividends, royalties, rent received, etc. Revenue is also called income. RECEIPTS v/s REVENUE Revenue is the total income earned by a business whereas receipt is the cash received by the business. For eg: Sales made on credit by the business is a revenue for the business but not a receipt. 6. Expenses: Costs incurred by a business in the process of earning revenue are known as expenses. The few common expenses of entities are: depreciation, rent, wages, salaries, interest, cost of heater, light and water, telephone, etc. 7. Expenditure: Spending money or incurring a liability for some benefit, service or property received is called expenditure.  Revenue Expenditure: Any expenditure incurred by business entities to maintain its day to day operations. The benefit of such expenditure is exhausted within a year. Revenue expenditure is also called expense. For eg: Rent, salary, etc.  Capital Expenditure: Any expenditure which occurred in obtaining or increasing the value of a fixed asset is known as capital expenditure. The benefits of such expenditure are for more than a year. For eg: Purchase of machinery, building, etc.  Deferred Revenue Expenditure: These expenses are of revenue nature but the benefit of such expenditure lasts for more than a year. For example: Cost of advertising campaign. 8. Profit: Profit is the excess of revenues of a period over its related expenses during an accounting period. It increases the investment of the owners. 9. Gain: The profit arising from the events or transactions which are incidental to the business such as sale of fixed assets, winning a court case, appreciation in the value of an asset are called gain. PROFIT v/s GAIN Profit is related with the operating activities of the business, whereas gain is related with the incidental or non-operating activities of the business. 10. Loss: Loss is the excess of expenses of a period over its related revenues. It decreases the investment of the owners. It is also related to money or money’s worth lost (or cost incurred) without receiving any benefit in return, e.g., cash or goods lost by theft or a fire accident, etc. It also includes loss on sale of fixed assets. 11. Sales: The total revenue generated by selling goods or providing services to the customers is called sales. The sales may be for cash or credit. 12. Sales Return or Returns Inward: When goods sold are returned by the customers due to any reason like defective quality or not as per the terms of sale, it is called sales return or returns inward. It is deducted from total sales to find the net sales. It is called “Returns Inward” because the goods are coming in the business. 13. Purchase: The total amount of goods procured by a business for use or sale is called purchase. It may be on cash or credit. In a trading concern, the goods purchased for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. 14. Purchase Returns or Returns Outward: When the purchased goods are returned to the suppliers due to any reason like defective quality or not as per the terms of purchase, it is called as purchase return. The purchase returns are deducted from the total purchases to find the net purchases. It is also known as “Returns Outward” because goods move outside the business. 4 Accountancy Volume I PW 15. Liabilities: Liabilities refer to the financial obligations of a business. It may be categorised as:  Internal liability: The liability towards the owner of the business.  External Liability: The liability towards the third parties such as banks, creditors, etc. Further the liabilities may be classified as:  Non-Current Liabilities: The liabilities that are payable after a long period of time that is more than a year.  Current Liabilities: The liabilities that are payable in the near future that is within a year.  Contingent Liabilities: The liabilities that may arise due to happening or non-happening of an uncertain event. As per Schedule III of the Companies Act 2013, a current liability means a liability that satisfies any of the following conditions: (a) Expected to be settled during the normal operating cycle of the business. (b) Due to be repaid within 12 months from the Balance Sheet date. (c) It has been incurred mainly for the purpose of being traded. (d) No unconditional right to defer settlement for at least 12 months from the date of balance sheet. 16. Asset: Assets are economic resources of an enterprise that can be usefully expressed in monetary terms. These are the properties of every description belonging to the business. The types of assets are: (a) Non-current Assets: Non-current assets are those assets which are held for long term use in the business with the purpose of producing goods or rendering services to earn revenue. These assets are also called fixed assets. Such assets are not meant for resale and are used to increase the profit earning capacity of the business. The fixed assets may be:  Tangible Assets: The assets that have physical existence. They can be seen and touched. For eg: Machinery, Building, etc.  Intangible Assets: The assets that have no physical existence and they cannot be seen and touched. For eg: Goodwill, patents, etc. (b) Current Assets: These assets are meant for sale or they could be converted into cash within one year. They are also known as floating or circulating assets. For example: cash in hand, bank balance, bills receivables, prepaid expenses, etc. (c) Fictitious Assets: These assets are also called nominal assets. They do not have any real value and are treated to be assets on technical ground only. They are the expenditures or losses that are shown in the Balance Sheet till they are not completely written off in the profit and loss account. As per Schedule III of the Companies Act 2013, a current asset means an asset that satisfies any of the following conditions: (a) Expected to be realised or consumed or sold during the normal operating cycle of the business. (b) Expected to be realised or consumed or sold within 12 months from the Balance Sheet date. Introduction to Accounting 5  (c) It has been held mainly for the purpose of being traded. (d) They are cash or cash equivalents unless they are restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date. 17. Discount: It is the reduction in the price of the goods sold. There are two types of discount:  Trade Discount: It is offered as deduction of a fixed percentage of list price at the time selling goods. It is generally offered by manufacturers to wholesalers and by wholesalers to retailers. It is not recorded in the books of accounts.  Cash Discount: It is allowed to the customers whose goods are sold on credit for making prompt and early payments. It is allowed at the time of payment, so it is recorded in the books along with the entry of payment. 18. Stock (Inventory): Stock includes the value of goods or some other item of business like spares, loose tools, etc. in hand on a particular date. For a trading business, stock means the goods which were purchased for reselling and are lying unsold on a particular date. These goods are called stock-in-trade. For a manufacturing business, the term inventory is used, which includes – Stock of Raw Material, Stock of Work In Progress, Stock of Finished Goods and Stock-in-Trade. Stock (inventory) may be opening stock and closing stock. Opening stock is the goods lying unsold in the beginning of an accounting period and closing stock is the goods lying unsold at the end of an accounting period. The inventory is valued on the basis of cost or net realisable value (market value) whichever is lower. 19. Trade Receivables: It includes debtors and bills receivables. 20. Debtors: Debtors are the persons whom business has sold goods or rendered services on credit basis. They are the assets for a business. For eg: If goods are sold to Mr. S on credit for `10,000, then Mr. S will be debtor of the business for `10,000. 21. Bills Receivable (B/R): It is a bill of exchange drawn on the customer whom goods are sold on credit and the customer formally agrees to pay the due amount on an agreed date. It is an asset for the business. 22. Trade Payables: It includes creditors and bills payable. 23. Creditors: Creditors are the persons from whom business has purchased goods or availed services on credit basis. They are the liabilities for a business. For example: If goods are purchased from Mr. T on credit for `10,000, then Mr. T will be creditor for the business for `10,000. 24. Bills Payable: It is a bill of exchange drawn on the business by the supplier from whom goods are purchased on credit and the business formally agrees to pay the due amount on an agreed date. It is a liability for the business. 25. Goods: Goods are the products in which the business deals in. It means the products that the business is buying or producing and selling in its normal course of business. The products purchased by the business for being used in the business are not called goods, they are called assets. For example: If a carpenter make furniture for selling them then they will be called goods whereas if he makes a table and chair for his showroom then they will be counted as asset not goods. 6 Accountancy Volume I PW 26. Voucher: The documentary evidence in support of a business transaction is called voucher. For eg: Cash memo, invoice, etc. 27. Account: It is the summary of relevant business transactions at one place relating to a person. It is a brief history of financial transactions of a particular person or item. It has two sides: debit side and credit. 28. Cost: The total amount spent on inputs by the business is called cost. It also includes the imputed cost of the inputs supplied by the proprietor. OTHER IMPORTANT TERMS 1. Proprietor: The owner of a business is called proprietor. He is the one who provides capital, takes the risk, enjoys the profits and suffers the losses. 2. Entity: Entity means something or someone having a definite individual existence. Business entity means a business enterprise that has its own existence. For example: Reliance Ltd, Big Bazaar, etc. A business entity is also known as an accounting entity. 3. Debit and Credit: The word debit is derived from the Latin word debitum which means due for that and the word credit is derived from the Latin word creder which means due to that. So, the benefit receiving aspect of a transaction is known as debit and the benefit giving aspect of a transaction is known as credit. Debit is denoted by Dr and credit by Cr. 4. Invoice: An invoice is a document issued by a seller to the buyer at the time of sale. It indicates the quantities and costs of the products or services provided by the seller and specifies the amount to be paid by the buyer and the terms of payment. It is issued in case of cash as well as credit sales. 5. Bad Debts: It is the amount that could not be recovered from the debtors due to any reason. 6. Insolvent: A person whose assets are not sufficient to meet his/her liabilities or we can say the liabilities are more than the assets. 7. Books of Accounts: The books that are used to record the business transactions are known as books of accounts. For example: Journal, ledger, cash book, etc. 8. Live Stock: Livestock are the domesticated animals raised and kept for commercial purposes. 9. Entry: Recording of the business transactions in journal or in subsidiary books is called entry. 10. Allowance: An allowance is a balance sheet contra-account that is linked with another account having an opposite value to that account and is reported as a subtraction from the linked account’s balance. 11. Solvent: A person whose assets are sufficient to meet his/her liabilities. MEANING OF ACCOUNTING Accounting has always been limited to the accountant’s duties of maintaining financial records. Nonetheless, the accounting profession is being compelled to reevaluate its position and function at both the organizational and corporate levels in light of the quickly evolving business environment of today. Instead of only recording transactions, the accountant now serves as a member who contributes information that is pertinent to the Board’s decisions. In general, bookkeeping and the creation of financial reports are only small parts of modern accounting. Introduction to Accounting 7 DEFINITION OF ACCOUNTING The American Institute of Certified Public Accountants (AICPA) had defined accounting as 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 financial character, and interpreting the results thereof”. “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 results thereof.“ –American Institute of Certified Public Accounting (AICPA) in 1941 “Accounting is the science of recording and classifying business transactions and events, primarily of a financial character and the art of making significant summaries, analysis and interpretations of those transactions and events and communicating the results to persons who must make decisions or form judgement”. –Smith and Ashburne In short, Accounting is the process of recording, classifying, summarizing, and communicating financial information to users of financial statements, so that they can make rational decisions about the entity. CHARACTERISTICS OF ACCOUNTING The following attributes or characteristics can be drawn from the definition of Accounting: 1. Identifying financial transactions and events  Accounting records only those transactions and events which are of financial nature.  So, first of all, such transactions and events are identified. 2. Measuring the transactions  Accounting measures the transactions and events in terms of money which are considered as a common unit. 3. Recording of transactions  Accounting involves recording the financial transactions of books of accounts such as Journal or Subsidiary Books. 4. Classifying the transactions  Transactions recorded in the books of original entry – Journal or Subsidiary books are classified and grouped according to nature and posted in separate accounts known as ‘Ledger Accounts’. 5. Summarising the transactions  It involves presenting the classified data in a manner and in the form of statements, which are understandable by the users.  It includes Trial balance, Trading Account, Profit and Loss Account and Balance Sheet. 6. Analysing and interpreting financial data  Results of the business are analysed and interpreted so that users of financial statements can make a meaningful and sound judgment. 7. Communicating the financial data or reports to the users  Communicating the financial data to the users on time is the final step of Accounting so that they can make appropriate decisions. 8 Accountancy Volume I PW STEPS OF THE ACCOUNTING PROCESS Accounting process is the process of collecting, recording, classifying, summarising and communicating financial information to the users for judgement and decision-making. The following steps are involved in accounting process: 1. Identification: It is the process of identifying and analysing business transactions. 2. Recording: For recording, we use ‘Journal’ or Subsidiary Books. 3. Classification of transactions: Classification means segregation of transactions on the basis of nature and posting them in a format known as Ledger Account. 4. Summarisation: It includes preparation of Trial Balance and Financial Statements. 5. Analysis & Interpretation: It includes an assessment of the financial reports and making some meaningful conclusions. 6. Communicating information to the users: It includes sharing the financial reports and interpreted results to the users of financial statements. OBJECTIVE OF ACCOUNTING The main objectives of accounting are: 1. To maintain a systematic record of business transactions  Accounting is used to maintain a systematic record of all the financial transactions in a book of accounts.  For this, all the transactions are recorded in chronological order in Journal and then posted to the secondary book i.e. Ledger. 2. To ascertain profit and loss  Every businessman is keen to know the net results of business operations periodically.  To check whether the business has earned profits or incurred losses, we prepare a “Profit & Loss Account”. 3. To determine the financial position  Another important objective is to determine the financial position of the business and to check the value of assets and liabilities.  For this purpose, we prepare a “Balance Sheet”. 4. To provide information to various users  Providing information to the various interested parties or stakeholders is one of the most important objectives of accounting.  It helps them in making good financial decisions. 5. To assist the management  By analysing financial data and providing interpretations in the form of reports, accounting assists management in handling business operations effectively. Introduction to Accounting 9 ADVANTAGES OF ACCOUNTING The following are the main advantages of accounting: 1. Provide information about financial performance  Accounting provides factual information about financial performance during a given period of time  Like, profit earned or loss incurred over a period and financial position at a particular point of time. 2. Provide assistance to management  Accounting helps management in business planning, decision making and in exercising control.  For this, it provides financial information in the form of reports. 3. Facilitates comparative study  By keeping systematic records and preparation of reports at regular intervals, accounting helps in making a comparison. 4. Helps in settlement of tax liability  Systematic accounting records help in settlement of various tax liabilities. Such as – Income Tax, GST, etc. 5. Helpful in raising loan  Banks and Financial Institutions grant a loan to the firm on the basis of appraisal of the financial statement of the firm. 6. Helpful in decision making  Accounting provides useful information to the management for taking decisions. LIMITATION OF ACCOUNTING Following are the limitations of accounting:  Accounting is not precise: Accounting is not completely free from personal bias or judgment.  Accounting is done on historic values of assets: Accounting records assets at their historical cost less depreciation. It does not reflect their current market value.  Ignore the effect of price level changes: Accounting statements are prepared at historical cost. So changes in the value of money are ignored.  Ignore the qualitative information: Accounting records only monetary transactions. It ignores the qualitative aspects.  Affected by window dressing: Window dressing means manipulation in accounting to present a more favourable position of the business than the actual position. BRANCHES OF ACCOUNTING The following are the main branches of accounting: 1. Financial accounting: Financial accounting involves identifying, measuring, recording, classifying, summarising business transactions, i.e. the steps to identify, record, summarise and communicate financial data. 10 Accountancy Volume I PW  2. Cost accounting: Cost Accounting is that branch of accounting which is concerned with the process of ascertaining and controlling the cost of products or services. 3. Management accounting: Management accounting is a branch of accounting concerned with the presentation of the accounting information in such a way as to assist the management in the planning and control of the activities of the undertaking and in the decision making process. 4. Tax Accounting: If Accounts are prepared with a view to compute income tax, Goods and Service Tax (G.S.T.), excise duty, import duty, etc., such accounts are called Tax Accounting. 5. Social Responsibility Accounting: The society provides infra-structure, capital, labour and other facilities to business enterprises. Thus, it is the social responsibility of the business towards the following: (i) Employees: It is the social responsibility of the business to pay fair wages to employees, open schools for their children, open hospitals, community centres, provide housing facilities to them, etc. (ii) Consumers: (i) Provide quality products at a reasonable price (ii) Provide service centres for repair of products (iii) Provide facility for home delivery (iv) Open consumer grievances redressal cell, etc. (iii) Shareholders: (i) Provide regular and good return on the capital invested (ii) Capital appreciation (iii) Provide right shares or bonus shares, etc. (iv) Society: (i) Provide community hospitals, schools (ii) Pollution control techniques should be installed (iii) Tree plantation, etc. The companies should keep a record of the amount spent on its various social responsibilities. 6. Human Resources Accounting: Employers are increasingly aware of the importance of considering their employees as valuable assets. In order to rapidly develop an entity, the relationship between employer and employee is of paramount importance. Absenteeism will increase among workers and lead to reduced production if there is no improvement in the situation of employees. BOOKKEEPING Accounting is a common term, which includes the concept of keeping records. The art of keeping records and classifying business transactions in a set of books is known as bookkeeping. The following shall therefore be included: (i) Identification of financial transactions. (ii) Measuring the transactions in terms of money. (iii) Recording the financial transactions in the books of accounts. (iv) Classifying the recorded transactions i.e., posting them in the ledger. Definitions 1. “Book-keeping is an art of recording business dealings in a set of books.” –J.R. Batliboi 2. “Book-keeping is the science and art of recording correctly in the books of accounts of all those business transactions that result in the transfer of money or money’s worth.” –R.N. Carter Introduction to Accounting 11 ACCOUNTING Accounting is a broad term and it includes book-keeping. Besides book-keeping, it also includes the following: (i) Summarisation of classified transactions i.e., preparation of Trading and Profit & Loss Account and Balance Sheet. (ii) Analysis and interpretation of financial statements (Profit and Loss Account and Balance Sheet) and drawing meaningful conclusions. (iii) Communicating the information to various end users of accounting service i.e., shareholders, debenture holders, bankers, financial institutions, creditors, employees, etc. ACCOUNTANCY Accountancy refers to systematic knowledge of the principles and the technique applied in accounting. It also stresses on the need to keep a book of accounts, summarize them and analyse and communicate accounting information to different users in an accounting service. Definition “Accountancy refers to the entire body of the theory and practice of Accounting.” –Kohler Accountancy Accounting ok-keepin Bo g DIFFERENCE BETWEEN BOOK-KEEPING AND ACCOUNTING Basis Book-keeping Accounting Definition Bookkeeping includes identifying and Accounting is the process of measuring and recording all financial transactions. recording all financial transactions that happened in an accounting year Objective The objective of Bookkeeping is to prepare The objective of Accounting is to record, original books of accounts analyze, and interpret all the transactions Scope It has a limited scope. Accounting has a wider scope as compared to Bookkeeping. Decision Making Management cannot take decisions on the basis With the help of accounting, management of bookkeeping because it is only concerned can make decisions as it is responsible for with the management of books. communicating the information. 12 Accountancy Volume I PW  Analysis The information is only recorded in the In Accounting, analysis is done to obtain bookkeeping and not analyzed. important insights into the business Skill Required There is no need of having any special skills to Accounting requires special skills because it is record the transactions in Bookkeeping analytical in nature. DIFFERENCE BETWEEN ACCOUNTING AND ACCOUNTANCY Basis Accounting Accountancy Meaning Accounting is the process that involves Accountancy is the body of knowledge that re c o rd i n g. c l a s s i f y i n g , s u m m a r i z i n g , helps in measuring, processing and recording presenting, and interpreting the financial the non-financial and financial statements. information of an organization. Scope Accounting is Narrower in scope. Accountancy is Wider In scope Dependability Accounting depends only on the bookkeeping. While accountancy depends on both the accounting and the bookkeeping. Nature of Work Accounting is the nature of work performed. Accountancy is opted as a profession. Concerned With It only contains the practical part. It contains both the theoretical as well as practical parts Based on Accounting is a concept that is totally based on Accountancy is the field of knowledge that is the knowledge of the accountancy considered to be the route to accounting Focus Accounting mainly focuses on the specified Accountancy focuses on the broader principles process of recording all the daily transactions without going into the depth and creating the reports on that basis. Use Accounting is used to understand the net Accountancy involves the decision-making income and financial position of a business and function which relies on the knowledge got to present them to concerned parties from accounting. ACCOUNTING AS A SOURCE OF INFORMATION Information is generated at every step in the accounting process. There is no end to the generation of information. It facilitates the dissemination of information between different groups of users. This information allows interested parties to make a reasoned decision. The dissemination of information is therefore an important aspect of the accounting process. The accounting should provide the following information to be useful:  provide information for making economic decisions;  serve the users who rely on financial statements as their principal source of information;  provide information useful for predicting and evaluating the amount, timing and uncertainty of potential cash-flows;  provide information for judging management’s ability to utilise resources effectively in meeting goals; and  provide information on activities affecting the society Introduction to Accounting 13 THE USERS OF ACCOUNTING INFORMATION Users may be categorised into internal users and external users. 1. Internal Users  Owners: Owners contribute capital in the business and thus they are exposed to maximum risk. So, they are always interested in the safety of their capital.  Management: Accounting information is used by management for taking various decisions.  Employees: Employees are interested in the financial statements to assess the ability of the business to pay higher wages and bonuses. 2. External Users  Banks and financial institutions: Banks and Financial Institutions provide loans to businesses. So, they are interested in financial information to ensure the safety and recovery of the loan.  Investors: Investors are interested to know the earning capacity of business and safety of their investment.  Creditors: Creditors provide the goods on credit. So they need accounting information to ascertain the financial soundness of the firm.  Government: The government needs accounting information to assess the tax liability of the business entity.  Researchers: Researchers use accounting information in their research work.  Consumers: They require accounting information for establishing good accounting control, which will reduce the cost of production. QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION Qualitative characteristics are the attributes of accounting information, which enhance it’s understanding ability and usefulness:  Reliability: Reliability implies that the information must be free from material error and personal bias.  Relevance: Accounting information must be relevant to the decision-making requirements of the users.  Understandability: Information should be disclosed in financial statements in such a manner that these are easily understandable.  Comparability: Both intra-firm and inter-firm comparison must be possible over different time periods. THE SYSTEM OF ACCOUNTING System of accounting There are following two systems of recording transactions in the books of accounts:  Double Entry System  Single Entry System Double-entry system  The double entry system is based on the Dual Aspect Principle.  Every transaction has two aspects, ‘a Debit’ and ‘a credit’ of an equal amount.  This system of accounting recognises and records both aspects of the transaction. 14 Accountancy Volume I PW Single entry system  Under this system, both aspects are not recorded for all the transactions.  Either only one aspect is recorded or both the aspects are not recorded for all the transactions. ADVANTAGES OF THE DOUBLE-ENTRY SYSTEM OF ACCOUNTING Following are the main advantages of the double-entry system of accounting: Scientific system  As compared to the other systems, this system of recording transactions is more scientific and useful to achieve the objective of accounting. A complete record of the transaction  Since both the aspects of transactions are considered there is a complete recording of each and every transaction.  Using these records, we are able to compute profit or loss easily. Checks arithmetical accuracy of accounts  Under this system, by preparing a Trial Balance we are able to check the arithmetical accuracy of the records. Determination of profit/loss and depiction of financial position  Under this system by preparing ‘Profit & Loss A/c’ we get to know about the profit earned or loss incurred.  By preparing the ‘Balance Sheet’ the financial position of the business can be ascertained, i.e. position of assets and liabilities is depicted. Helpful in decision making  Administration and management are able to take decisions on the basis of factual information under the double-entry system of accounting. ROLE OF ACCOUNTING Accounting is concerned with recording, classifying, summarising and interpreting the financial transactions of a company and communication to the users of accounting. It plays a lot of different roles: (i) Role as a Language of Business: As a rule, accounting is referred as the language of business. For the purposes of analysing and interpreting financial statements, they are Technical Documents to be analysed and interpreted solely by those who have a knowledge of this accounting language. (ii) Role of Information System: Accounting has become an information system these days. The management shall inform the various users of the accounting service of the collected accounting information. The information on the accounts relates to past transactions and does not provide any indication of the entity in the future. In addition, a number of qualitative information relating to the quality of management and relations between employers and employees is ignored. (iii) Role of Providing Historical Records: At the end of each financial year, accounting information shall be submitted by different users in form of a profit and loss account and balance sheet with respect to all accounts so that it is historically relevant. (iv) Role as a Service Activity: Accounting is now considered to be a service activity. In order to enable users to make useful economic decisions about a business entity, it provides them with quantitative financial information. Introduction to Accounting 15  EXERCISES MULTIPLE CHOICE QUESTIONS 1. We record in books of accounts. (a) Financial transactions (b) Non-financial transactions (c) Both financial and Non-financial transactions (d) None of these 2. Which of the following will not be recorded in books of accounts? (a) Purchase of good (b) Sale of asset (c) Selection of staff (d) Expenses of firm 3. Which is the first step of the Accounting Process? (a) Classifying (b) Analysing and Interpreting (c) Recording (d) Financial Statements 4. Qualitative characteristics of Accounting Information are: (a) Relevance (b) Reliability (c) Comparability (d) All of these 5. Which of the following is not the branch of accounting? (a) Financial Accounting (b) Cost Accounting (c) Book-keeping and Accounting (d) Management Accounting 6. Book-Keeping includes: (a) Identification of financial transactions (b) Measuring transactions in terms of money (c) Recording transactions in books of the accounts and their classification (d) All above 7. Accounting is a broad term. It includes book-keeping and also includes: (a) Summarisation of classified transactions (b) Analysis and interpretation of financial statements (c) Communicating the information to various end users (d) All above 8. Which of the following is not a business transaction? (a) Purchase goods for resale (b) Paid rent to landlord (c) Purchased car by the owner for personal use (d) Purchase of office equipment 16 Accountancy Volume I PW  9. Which of the following is a limitation of accounting? (a) Provides complete and systematic records (b) Based on accounting concepts and conventions (c) Helps in taking managerial decisions (d) Facilitates comparative study. 10. Qualitative characteristics of accounting includes: (a) Reliability (b) Relevance (c) Understandability and comparability (d) All of the above 11. Which of the following is not a qualitative characteristic of accounting? (a) Reliability (b) Relevance (c) Materiality (d) Comparability 12. Which of the following is not an external user of Accounting Information? (a) Potential Investors (b) Creditors (c) Shareholders/Proprietors (d) Financial Institutions 13. Which of the following is not an advantage of Accounting? (a) Provides information about profit or loss (b) Provides information of financial position (c) Based on historical cost (d) Helps in taking managerial decisions 14. Which is the last step of the Accounting process? (a) Preparation of Financial Statements (b) Communication of information to users (c) Analysis and interpretation of information (d) Recording of transactions 15. Which is the first step in the process of Accounting? (a) Recording of transactions (b) Classifying the transactions (c) Identifying financial transactions (d) Preparation of Financial Statements 16. Which of the following is not a Current Liability? (a) Creditors (b) Bank Overdraft (c) Term Loan (d) Short-term Loan 17. Which of the following is not a Current Asset? (a) Debtors (b) Cash (c) Computer (d) Marketable Security 18. Purchases usually refers to: (a) Purchase of Plant & Machinery (b) Purchase of Investment (c) Purchase of Goods (d) Purchase of Goods for resale 19. Which one is not a tangible asset? (a) Computer (b) Stock (c) Computer Software (d) Plant & Machinery Introduction to Accounting 17 20. A person to whom money is payable by the firm for purchase of goods is called: (a) Debtors (b) Creditors (c) Supplier (d) None of these 21. A person from whom money is receivable by the firm for sale of goods is called: (a) Debtors (b) Creditors (c) Supplier (d) None of these 22. Drawing refers to withdrawal of cash by the business entity for: (a) Payment of salary to staff (b) Payment for purchase of goods (c) Payment to meet domestic expenses (d) Payment of purchase expenses 23. Which of the following is not an intangible asset? (a) Goodwill (b) Computer Software (c) Patent (d) Computer 24. Which of the following is a capital expenditure? (a) Repair of building (b) White-wash of building (c) Carriage paid and wage paid for installation of plant (d) None of these 25. Which of the following is not a current liability? (a) Salary Outstanding (b) Bills Payable (c) Creditors (d) Bank Loan ANSWERS 1. (a) 2. (c) 3. (c) 4. (d) 5. (c) 6. (d) 7. (d) 8. (c) 9. (b) 10. (d) 11. (c) 12. (c) 13. ( ) 14. (b) 15. (c) 16. (c) 17. (c) 18. (d) 19. (c) 20. (b) 21. (a) 22. (c) 23. (d) 24. (c) 25. (d) 18 Accountancy Volume I PW  VERY SHORT ANSWER TYPE QUESTIONS 1. Define accounting. Ans. Accounting may be defined as the process of recording, classifying, summarising and communicating the financial information to the users of accounting services for making rational decisions about the entity. 2. Name any two functions of accounting. Ans. (i) Business transactions are recorded either in the journal or in the subsidiary books depending upon the size of the business and the volume of transactions. (ii) After recording of transactions in the journal or in the subsidiary books, these are posted ledger date wise. 3. Define Book-keeping. Ans. Book-keeping is the art of recording and classifying the business transactions in a set of books. 4. State any two advantages of accounting. Ans. Advantages of accounting are: (i) Provides information about profit or loss of the business. (ii) Provides information about the financial position of the business i.e., position of assets, liabilities and capital. 5. Name any two limitations of accounting. Ans. Limitations of accounting are: (i) It is based on accounting concepts and conventions. For instance: (a) Fixed assets are valued at historical costs; (b) Provision for doubtful debts is made on the basis of principle of conservatism. (ii) It is based on personal judgement. For instance: depreciation and provision for doubtful debts are based on personal judgement of the accountant. 6. Name any two types of accounting information. Ans. (i) Provides accounting information for making analysis and interpretation of financial statements. (ii) Provides information about corporate social responsibilities of the entity. 7. Explain in brief about accounting (each part of 1 mark) (i) Window dressing in accounting. (ii) Reliability (iii) Relevance (iv) Understandability (v) Comparability (vi) Based on Historical Cost Introduction to Accounting 19 Ans. (i) Window dressing in accounting: If the management of the business entity prefers to show more or less profit than the true and fair profit, it is called window dressing in accounting. It can be done by over or under valuation of closing stock, by showing revenue expenditures as capital expenditure and vice versa. (ii) Reliability: Reliability means that users of the accounting information must be provided information on which they can depend and rely upon. This is possible only when it is free from personal biasness and transactions are supported by verifiable evidences. (iii) Relevance: The accounting information depicted by the financial statements must be relevant keeping in view the informational need of various users. For instance information about segments, departments and accounting conventions be disclosed. (iv) Understandability: The various users of accounting information possess reasonable knowledge of the business. The management should provide information which is not only understandable but reliable and relevant too. (v) Comparability: The management should use accounting period, accounting concepts and conventions consistently so that the financial information can be compared with the past and with similar firms. (vi) Based on Historical Costs: Fixed assets are shown in the balance sheet at their original cost (historical cost) while they should be shown at their current market price. Thus, fixed assets do not reveal true and fair value and consequently balance sheet does not reveal true financial position of the business entity. 8. Who are internal users of the accounting service? Ans. Management, Directors and Officers, Shareholders and Employees of the entity are the internal users. 9. Name the external users of accounting information. Ans. Potential investors, bankers and financial institutions, creditors, employees, researchers, government, etc. are the external users of accounting information. 10. Who uses published and unpublished accounting information? Ans. Internal user-management. 11. Who uses published accounting information? Ans. All external users like shareholders, proprietors, bankers, financial or to actuate Windows institutions, creditors, employees, researchers, etc. 12. Explain accounting as a language of business. Ans. Accounting is now considered as a language of business. Financial statements are technical documents and they can be analyzed and interpreted by only those who are fully conversant with the accounting process. Thus, accounting is rightly considered as a language of the business. 20 Accountancy Volume I PW 13. What are business transactions? Ans. Business transactions refer to financial transactions entered into between two parties involving exchange of goods or services for monetary consideration eg., purchase of goods, sale of goods, payment of salary, rent; receipt of cash from debtors etc. 14. What is meant by capital? Ans. Amount invested by the proprietor or owners in the business in the form of cash or assets is called capital. 15. What is meant by current liability? Ans. A liability shall be classified as current when it satisfies any one of the following criteria: (i) It is expected to be settled in Company’s normal operating cycle; (ii) It is held primarily for the purpose of being traded; or (iii) It is due to be settled within 12 months after the reporting date. 16. What are non-current liabilities? Ans. Non-current liabilities are those liabilities which are not current liabilities.. In short, liabilities payable after a long period of time (i.e., after 12 months or after operating cycle whichever is more) are termed as non-current liabilities. It includes debentures, long-term loan, mortgage loan, Bank loan, etc. 17. Give two examples of current liabilities. Ans (i) Creditors, (ii) Bank Overdraft. 18. Name two non-current liabilities. Ans. (i) Debentures (ii) Bank Loan. 19. What are Assets? Ans. Assets are economic resources of an individual or business enterprise that can be expressed in terms of money e.g., land, building, cash, debtors, etc. 20. Give two examples each of tangible and intangible assets. Ans. (a) Tangible Assets: (i) Computer, (ii) Machinery (iii) Furniture (b) Intangible Assets: (i) Goodwill, (ii) Patent (iii) Branding 21. What are fixed assets? Ans. Assets which are purchased in the business with a view to produce goods or services and which are not meant for resale are called fixed assets e.g., land, building, machinery, furniture, etc. Introduction to Accounting 21 22. Give two examples of tangible assets. Ans. (i) Land (ii) Plant (iii) Computer. 23. What do you mean by capital receipt? Ans. The money received by the business entity from proprietor or partners as capital or money received by issuing share capital, debentures or raising bank loan is a capital receipt. Similarly, money received or receivable by the business entity from sale of fixed asset is also a capital receipt. 24. What is gain? Ans. Gains are profit arises from transactions which are incidental to business e.g., profit earned from sale of investment or fixed assets. Profit in the nature of gains are non-recurring in nature. 25. What is discount? Ans. A reduction in the price of goods by the business entity to its customers is called a discount. It may be in the form of trade discount or cash discount. 26. What is meant by discount allowed? Ans. If cash discount is allowed to debtors to induce them to make prompt payment, it is called discount allowed. It is a loss so it is treated as an expense and is debited to Profit & Loss A/c 27. Distinguish between external and internal transactions. Ans. Transactions between firm and other party are called external transactions eg, sale of goods to Ram. While transactions which does not involve second party are called internal transactions eg, charging depreciation on machinery, creation of provision for doubtful debt on debtors. 28. What is liquid asset? Ans. Assets which are available to business entity in the form of cash or which are likely to be converted into cash within a very short period are called liquid assets e.g., debtors, bills receivable, marketable securities, etc. 29. What is meant by deferred revenue expenditure? Ans. If the benefit of a revenue expenditure is likely to accrue to firm over a period of several years, it is called deferred revenue expenditure e.g., advertisement development or advertisement campaign. 30. What is Trade Discount? Ans. A reduction in the price of goods at a fixed percentage on the list price or catalogue price by the seller to buyer is called a trade discount. The objective of giving reduction is that ultimate consumer of goods get the product at the list price 22 Accountancy Volume I PW  SHORT ANSWER QUESTIONS 1. Briefly state the characteristics (features/attributes) of accounting. 2. What is meant by summarisation of accounting information? 3. What is the basic purpose of financial accounting? 4. Differentiate between accountancy and accounting. 5. Name the qualitative characteristics of accounting and explain any two of them. 6. Differentiate between reliability and relevance of accounting information. 7. “The role of accounting has changed with the economic development.” Comment. 8. Differentiate between recording and classification of financial transactions in accounting. 9. What do you mean by financial accounting? State its end product. 10. Distinguish between current liability and non-current liability. 11. What are assets? Name its types. 12. Explain the term: (i) Purchases, (ii) Sales 13. What is a stock? What is included in the stock of a manufacturing concern? Introduction to Accounting 23  CHAPTER 02 Theory Based Accounting The accounting information will be meaningful to its internal and external users only if it is reliable and comparable. The comparability of information means it should be capable of making inter-firm comparisons as well as intra-firm comparison. This will be possible only if the information provided by the financial statements is based on consistent accounting policies, principles and practices. Such consistency is required throughout the process of identifying the events and transactions to be accounted for, measuring them, communicating them in the book of accounts, summarising the results thereof and reporting them to the interested parties. This is why we need to develop a proper theory base of accounting. GENERALLY, ACCEPTED ACCOUNTING PRINCIPLES (GAAP) The accounting profession has created a number of generally accepted rules or principles to ensure uniformity and consistency in accounting records. These guidelines go by a variety of titles, including postulates, assumptions, norms, principles, and modifying principles. Every science is based upon some principles and rules and we must know those principles and rules to study it. The American Institute of Certified Public Accountants (AICPA) has defined principle as: ‘‘A general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice.’’ To study accountancy, we also need to study the rules and principles on which it is based and these principles are commonly known as GAAP. The Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial statements. The majority of accounting professionals accept the generally accepted accounting principles, which have developed over a long period of time based on prior experiences, usages or conventions, statements made by people and professional bodies, and legislation by government agencies. Unlike scientific principles, accounting concepts are dynamic in nature. These are adaptable and impacted by shifts in the legal, social, and economic spheres in addition to user needs. FEATURES OF ACCOUNTING PRINCIPLES 1. The accounting principles make the information more meaningful and helpful and thus they increase the utility of records to its readers. 2. The accounting principles are supported by facts and cannot be influenced by personal bias and thus they help in determining the true financial position of an enterprise. 3. The accounting principles are practical and feasible as they are guided by practical experience and observation rather than theory.  4. The accounting principles are flexible in nature and can be changed according to a particular situation to provide a well-reasoned solution. 5. The accounting principles are generally accepted all over the world as they have been developed through the requirements and experience of accountants and therefore satisfy the criteria such as relevance, objectivity, feasibility, etc. BASIC ACCOUNTING CONCEPTS 1. Business Entity Concept: As per this concept, the business and the proprietor will be treated to be two separate entities and all the business transactions will be recorded in the books of accounts from the view point of the business and not the proprietor. The proprietor is treated as a creditor to the extent of the capital provided by him. The business entity concept is utilised in the accounting equation: Assets = Capital + Liabilities Capital is the financial input of the owner and the liability of the business towards the owner. It is treated as the internal liability of the business. The profit earned by the business during an accounting period is a favourable thing for the business, but it is treated as a liability while determining the financial position of a business due to this concept because profit is the obligation of the business to the owner(s). 2. Money Measurement Concept: According to this concept, only those transactions are recorded in the books of accounts that could be expressed in the terms of money. For example: The salary paid to manager `50,000 will be recorded in the books of accounts as it can be expressed in terms of money but due to the resignation of the sales manager, the business activities remained disturbed for few weeks will not be recorded as this could not be expressed in monetary terms. The two drawbacks of this concept or principle are: (a) Non-monetary transactions are not recorded irrespective of their importance. (b) The change in the value of money is not considered. 3. Going Concern Concept: As per this concept, it is assumed that the business will exist for a long and indefinite period of time. This means that there is neither any intention nor the necessity to wind up the business in the near foreseeable future. It is also known as continuity assumption. This is an important assumption of accounting because it provides the basis for showing the value of assets in the balance sheet. The going concern assumption facilitates the recording of transactions in the following manner: (a) Distinction between Capital and Revenue Expenditure (b) Recording of Assets at Original Cost and Depreciation Charged Systematically (c) Non-recording of Market Value of Fixed Assets (d) Long-term Contracts with External Parties (e) Recording of Prepaid Expenses as Assets (f) Classification of Assets and Liabilities Theory Based Accounting 25 4. Accounting Period Concept: As per the Going Concern Concept, a business is supposed to continue for a long run or we can say for an indefinite period of time. So, the results of business operations cannot be ascertained before the closure of the business operations; but the users of the accounting information cannot wait for such a long period of time. They require financial statements and periodic reports at regular intervals to know the operational results and the financial position of the business. Therefore, it becomes necessary to close the accounts at regular intervals and this is the underlying principle of Accounting Period Concept. Usually a period of one year is considered as one accounting period, which may be a calendar year or a financial year. This accounting period is known as accounting year. 5. Cost Concept: The Cost Concept is historical is nature as it suggests that all assets shall be recorded in the book of accounts at their purchase price including the cost of acquisition. The advantages of cost concept are: (a) It is verifiable as the cost considered was arrived at on the basis of actual transaction (b) It is reliable as the documentation exists to prove the transaction and the cost incurred (c) It is justified as it is based on the assumption of going concern and thus it is not required to exhibit or use the current/liquidation values. (d) The values can be easily determined. (e) This concept provides a strong and valid basis as the market value of assets change from time to time and it is hard to track them. However, this concept has certain limitations also: (a) It ignores recording of assets that cannot be expressed in terms on money like brand image, etc. (b) The profit is inflated or understated as the depreciation is charged on the basis of historical cost (c) The Information derived using this concept has limited usage amongst creditors, investors, management, etc. 6. Dual Aspect Concept: This concept is the foundation of accounting. The books of accounts are maintained as per this principle only. As per this concept, every business transaction has dual effect and thus it should be recorded at two places. It states that for every debit there is an equal amount of credit. It is also known as the Balance Sheet concept. For example: Purchase of goods for cash `5000 will increase the stock of goods and at the same time will decrease the cash balance by the same amount. 7. Consistency Concept: This concept states that the accounting rules, concepts, principles, practices and conventions should be observed and applied constantly, i.e., from one year to another, there should not be any change in method. Consistency makes the results and performance of one period easily comparable with the other period. The persons involved in maintaining accounts have to follow the consistent rules, principles, concepts and conventions and thus it also prevents personal bias. In case of any change in the accounting practice due to the requirement of law or Accounting Standards the a proper disclosures for such a deviation from conventions being followed must be made along with the impact of such deviation on the profit and loss of the concern. 26 Accountancy Volume I PW  Therefore, the benefits of consistency concept are: (a) It facilitates intra-firm and inter-firm comparison. (b) It eliminates the chances of any personal bias. (c) It supports a particular choice of accounting practice when two or more methods or alternative accounting practices are available and each equally acceptable. 8. Revenue Recognition Concept: According to this concept, the revenue for a business transaction should be included in the accounting records only when it is realised. A revenue is assumed to be realised when a legal right to receive it arises, that is why credit sales are recorded as revenue but any income received in advance is not considered as revenue. 9. Matching Concept: This concept emphasises on the process of ascertaining the amount of profit earned or the loss incurred during a particular period by deducting of related expenses from the revenue earned during that period. The matching concept states that the expenses incurred in an accounting period should be matched with revenues during that period. 10. Principle of Full Disclosure: The principle of full disclosure emphasises on the importance of providing accurate, full and reliable information and data in the financial statements which is of material interest to the users of such statement. The principle of full disclosure requires that all material information must be impartially and honestly disclosed either on the face of the financial statements or in the notes to the financial statements. This principle is very useful for the users such as owners, bankers, investors, creditors, employees, government agencies, etc. since they have great interest in the proceedings of the business. However, this principle does not require that all information that one desires to get should be included in accounting statements. If there is enough information included that the users will find materially interesting, then it is sufficient. 11. Materiality Concept: According to this concept, the items having an insignificant effect or being irrelevant need not to be disclosed, but the main and important information of business must be disclosed impartially. According to American Accounting Association, ‘‘An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investors.’’ As per this concept, accounting should focus on material facts and the efforts should not be wasted in recording and presenting facts that are immaterial in the determination of income. 12. Conservatism (Prudence) Concept: This concept follows the policy of caution or playing safe and thus it is very important in the present day uncertainties. It states that all the possible losses shall be taken into account but not the possible profits or gains. Thus, it is often in the regard of principle of conservatism that, “Do not anticipate a profit but provide for all possible losses.” It is because of this principle that provisions are maintained by businesses for all likely losses and all known liabilities such as provision for doubtful debts, provision for depreciation, etc. The advantages of this principle are: (a) It protects against contingent future losses and liabilities. (b) It ignores the potential gains and incomes and thus prevents overstatement of assets. (c) It presents a true and fair vies of the state of affairs of a business. (d) It avoids window dressing of financial statements. Theory Based Accounting 27 13. Accrual Concept: According to this concept, the revenue is recognised as and when it is realised and not on its actual receipt. Similarly, the cost is recognised as and when it is incurred and not when payment is made. As per this concept, the revenue is recorded when sales are made or services are rendered, whether cash is received or not and all the expenses and incomes relating to the accounting period are recorded whether actual cash has been paid or received or not. To determine the actual profit or loss for the accounting period, this assumption must be made and adhered to. 14. Objectivity Concept: According to this theory, all accounting transactions must be objectively documented and free from the management’s or the accountant’s personal prejudice when preparing the accounts. It is only feasible if every transaction is backed by authentic documents and vouchers, such as agreements, cash memos, invoices, sales bills, pay-in slips, and communications. For instance, if the products are being bought with cash, the transaction needs to be accompanied by a cash receipt for the amount paid; if the goods are being bought on credit, a copy of the invoice or delivery challan is required. The invoice or cash receipt serves as an impartial foundation for transaction verification and serves as official documentation of the transaction. BASIS OF ACCOUNTING There are two bases regarding the timing of recognition of revenue and costs 1. Cash Basis 2. Accrual Basis. Cash Basis of Accounting: Under cash basis of accounting, entries are recorded only when cash is received or paid, that is only in case of cash outflow and inflow. When a receipt or payment is due, no entry is passed. Thus, credit transactions are not recorded under this basis of accounting. The adjustments like outstanding expenses, accrued income are not considered under this method of accounting. Therefore, excess of receipts over payments during an accounting period is represented as income under the cash basis of accounting. The majority of the government accounting system has a cash basis. Advantages of Cash Basis of Accounting (a) It is simple, easy and realistic method of accounting. (b) People with conservative instinct find it suitable to adopt this method. (c) Estimates and personal judgments are not required in this method. (d) It is suitable for those organisations where most of the transactions are on cash basis. Disadvantages of Cash Basis of Accounting (a) Profit and loss cannot be ascertained clearly and accurately. (b) Matching principle of accounting is not followed in this method. (c) Financial position of the enterprise is not depicted clearly. (d) This method is not recognised by the Companies Act, 2013. Accrual Basis of Accounting or the Mercantile System: Under accrual basis of accounting, the accounting entries are made as and when they become due for payment or receipt. This means that the entries are not only made for actual receipts or payments of cash but also for amounts having 28 Accountancy Volume I PW become due for payment or receipt. Transactions involving cash and credit are noted in the books of accounts. Whether or whether cash is received, income is credited to the period in which it is earned. Similarly, whether or not cash is paid, losses and expenses are detailed according to the time in which they occur. Regardless of monetary payments or receipts, the difference between incomes earned and expenses incurred determines the profit or loss for any given accounting period. Every business must keep its books of accounts up to date using the accrual method of accounting. Because it is typically used by business entities, it is therefore known as the mercantile basis of accounting. Advantages of accrual basis (a) Profit or loss for the particular period is ascertained properly. (b) It is helpful in presenting the true financial position of business. (c) Matching principles of accounting is followed in this method. (d) This method is recognised by the Companies Act, 2013. Disadvantages of accrual basis (a) It is little bit complex method to understand. (b) Estimates and personal judgment are required in this method. ACCOUNTING STANDARDS Introduction (The present era of industrialization and globalization necessitated the study of accounting information by the various users but the diversity in the accounting policies and in the treatment of transactions made the financial statements less meaningful and uncomparable. A need was felt to formulate certain minimum accounting standards which should be universally acceptable so that the financial statements should possess the qualitative features of reliability, relevance, understandability and comparability.) (The Institute of Chartered Accountants of India set up the Accounting Standards Board (ASB) in April, 1977 to identify the areas of accounting where alternative and diverse practices were followed. ASB was, therefore, asked to draft the accounting standards in view of the legal provisions of the country. ASB submitted the draft accounting standards to Institute of Chartered Accountants of India. Upto 1st April, 2010, 32 accounting standards have been issued by ICAI. MEANING OF ACCOUNTING STANDARDS Accounting Standards (AS) are written statements of uniform accounting rules and guidelines issued by the accounting body of the country (Institute of Chartered Accountants of India) to be followed while reparing and presenting the financial statements. These accounting rules and procedures are related to measurement, valuation and disclosure of accounting informations in the financial statements. As per Kohlar, “Accounting standards are a code of conduct imposed on accountants by custom, law and a professional body.” NATURE AND OBJECTIVES OF ACCOUNTING STANDARDS (i) Accounting standards are the guidelines to the accounting professionals so as to enhance the reliability of financial statements among its users. (ii) The basic objective of accounting standards is to bring uniformity in the accounting practices and to ensure consistency and comparability in the financial statements over inter-period and from other similar firms. Theory Based Accounting 29 (iii) These accounting standards are mandatory in nature. (iv) With the change in the economic environment and law of the nation, accounting standards are subject to change from time to time but in no case they will override the provisions of law. (v) Where alternative accounting practices are available, accounting standards prescribe a preferred accounting practice, however management is free to use any accounting practice by giving suitable disclosures. If the management prefers to change the existing accounting practice, the change in practice must be disclosed along with its financial impact e.g., change in the method of charging depreciation. IMPORTANCE OF ACCOUNTING STANDARDS (i) Accounting standards provide accounting rule and guidelines for the preparation of financial statements. (ii) They ensure consistency and uniformity in the financial statements and thus, make them comparable over periods and from other similar firms. (iii) The accounting standards are mandatory in nature so auditor has to ensure the compliance of these standards. This enhances the reliability of financial statements among the various users of accounting service. (iv) The mandatory nature of accounting standards ensure complete disclosure of accounting policies and practices. Thus, reliability of financial statements is further enhanced. Accounting Standards issued by the Institute of Chartered Accountants of India The Council of Institute of Chartered Accountants of India has issued 32 accounting standards so far but as per Companies (Accounting Standards) Rule, 2006 notified till 31st August 2011, in pursuant to Section 211 (3-C) of Companies Act, 1956 and Sec. 129 of Companies Act, 2013, 28 accounting standards i.e., AS 1 to 7 and AS-9 to 29 are operational. AS-8 has been withdrawn by ICAI. The compliance of operating accounting standards is mandatory. These accounting standards are as follow: AS. No. Title AS-1 Disclosure of Accounting Policies AS-2 Valuation of Inventories (Revised) AS-3 Cash Flow Statement (Revised) AS-4 Contingencies and Events Occurring after the Balance Sheet Date (Revised) AS-5 Prior Period and Extraordinary Items and Changes in Accounting Policies AS-6 Depreciation Accounting (Revised) AS-7 Accounting for Construction Contracts AS-8 Accounting for Research and Development AS-9 Revenue Recognition AS-10 Accounting for Fixed Assets AS-11 Accounting for the Effects of Changes in Foreign Exchange Rates (Revised) AS-12 Accounting for Government Grants AS-13 Accounting for Investments AS-14 Accounting for Amalgamations AS-15 Accounting for Retirement Benefits in the Financial Statements of Employers AS-16 Borrowing Costs 30 Accountancy Volume I PW  AS. No. Title AS-17 Segment Reporting AS-18 Related Parties Disclosures AS-19 Leases AS-20 Earnings Per Share AS-21 Consolidated Financial Statements AS-22 Accounting for Taxes on Income AS-23 Accounting for Investments in Associates in Consolidated Financial Statements AS-24 Discontinuing Operations AS-25 Interim Financial Reporting AS-26 Intangible Assets AS-27 Financial Reporting of Interests in Joint Venture AS-28 Impairment of Assets AS-29 Provisions, Contingent Liabilities and Contingent Assets AS-30 Financial Instruments: Recognition and Measurement AS-31 Financial Instruments Presentation AS-32 Financial Instrument: Disclosures INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) Introduction With the emergence of industrialization and automation at global level, various multi nation companies (MNC’s) have emerged having branches in different countries. The accounting concepts and conventions vary from country to country so financial information was not comparable. Thus, it was felt to have a common set of accounting and financial reporting standards so as to understand and compare the financial information worldwide. With this aim in view, International Accounting Standard Committee (IASC) was established in 1973 through an agreement by professional accounting bodies from U.K., U.S.A., Canada, France, Germany, Japan, Australia, Maxico, Netherlands and Ireland. The Institute of Chartered Accountants of India joined IASC as an associate member in 1974 and joined the board in 1993. IASC has issued 41 accounting standards known as International Accounting Standards (IAS). The objective was to develop accounting standards which would be acceptable worldwide so that financial reporting be improved internationally International Accounting Standards Boards (IASB) and International Financial Reporting Standards (IFRS). In the year 2001, IASC was replaced with International Accounting Standards Board (IASB). IASB reviewed all the 41-IAS and scrapped 12-IAS. So effective IAS are 29 now. The accounting standards issued by IASB are termed as International Financial Reporting Standards (IFRS). MEANING OF IFRS International Financial Reporting Standards (IFRS) are the accounting standards developed by International Accounting Standard Board (IASB). IASB has developed 10 principles based accounting standards so far known as - IFRS. These are as under:) Theory Based Accounting 31  IFRS Issued by AISB S. No. Tittle 1. IFRS 1 First time Adoption of International Financial Reporting Standards. 2. IFRS 2 Share-Based Payment 3. IFRS 3 Business Combinations 4. IFRS 4 Insurance Contracts 5. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. 6. IFRS 6 Exploration for and Evaluation of Mineral Resources 7. IFRS 7 Financial Instruments: Disclosures 8. IFRS 8 Operating Segments 9. IFRS 9 Financial Instruments 10. IFRS for Small and Medium Enterprises. It provides standards applicable to private entities (those are not public accountable as defined in this standard). The International Accounting Standards (IAS) presently in force are remaining 29 which are as under: S. No. Tittle 1. IFRS 1 Presentation of Financial Statements 2. IFRS 2 Inventories 3. IFRS 7 Cash Flow Statements 4. IFRS 8 Net Profit or Loss for the Period, Fundamental Errors and changes in Accounting Policies 5. IFRS 10 Events after Balance Sheet-Date 6. IFRS 11 Construction Contracts 7. IFRS 12 Income Taxes 8. IFRS 16 Property, Plant and Equipment 9. IFRS 17 Leases 10. IFRS 18 Revenue 11. IFRS 19 Employee Benefits 12. IFRS 20 Accounting of Govt. Grants and Disclosure of Govt. Assistance 13. IFRS 21 The Effects of changes in Foreign Exchange Rates 14. IFRS 23 Borrowing Costs 15. IFRS 24 Related Party Disclosures 16. IFRS 26 Accounting & Reporting by Retirement Benefit Plans. 17. IFRS 27 Consolidated Financial Statements 18. IFRS 28 Investments in Associates 32 Accountancy Volume I PW  S. No. Tittle 19. IFRS 29 Financial Reporting in Hyperinflationary Economies 20. IFRS 31 Financial Reporting of Interests in Joint Ventures 21. IFRS 32 Financial Instruments: Disclosures and Presentations 22. IFRS 33 Earning Per Share 23. IFRS 34 Interim Financial Reporting 24. IFRS 36 Impairment of Assets 25. IFRS 37 Provisions, Contingent Liabilities and Contingent Assets 26. IFRS 38 Intangible Assets 27. IFRS 39 Financial Instruments: Recognition and Measurement 28. IFRS 40 Investment Property 29. IFRS 41 Agriculture Difference between IFRS and Accounting Standards (AS) issued by Institute of Chartered Accountants of India. 1. The IFRS are principle based accounting standards while Indian GAAP (Generally Accepted Accounting Standards) or AS (accounting standards) are rules based accounting standards. 2. IFRS do not prescribe any format of Balance Sheet while Indian laws prescribe a specific format of Balance Sheet and Statement of Profit & Loss. 3. IFRS are based on Fair Value Concept while Indian Accounting Standards are based on Historical Cost Concepts. 4. Besides these, various differences also emerge on treatment of various items in various areas such as useful life of tangible assets, prior period items, extraordinary items, impact on fixed assets and so on. Use of IFRS in India Since Institute of Chartered Accountants of India had joined the IASC board in 1993 and it has also issued 32 Accounting Standards (AS) so far of which AS 1 to 7 and 9 to 29 are mandatory in nature. In India, the National Advisory Committee on Accounting Standards advised the Ministry of Corporate Affairs, Govt. of India to converge the Indian Accounting Standards in line with IFRS. The Govt. of India has issued notification in this respect. The converged accounting standards are now called Ind-AS. Till this date, 41 Ind AS have been issued and notified which are as under.) Compliance of Ind AS in the phased manner as per M.C.A. notification in 2015 Financial Year Mandatory Applicable to 2016-17 Companies (Listed and Unlisted) whose net worth is equal to or exceeds 500 crores. 2017-18 Unlisted companies whose net worth is equal to or exceeds `250 crores and all listed companies. 2018-19 All Banks, NBFC’s and Insurance Companies whose net worth is equal to or exceeds `500 crores. Theory Based Accounting 33  EXERCISES MULTIPLE CHOICE QUESTIONS 1. Closing stock is valued as per Principle of conservation at: (a) Cost Price (b) Market Price (c) Cost or market price whichever is less (d) Its real price 2. Depreciation on fixed assets is charged based on? (a) Going Concern Assumption (b) Matching Concept (c) Consistency Assumption (d) All of these 3. Stock of pencil, eraser and inkpot is not shown as asset rather these are shown as revenue expenditure based on: (a) Principle of Prudence (b) Materiality Principle (c) Historical Cost Principle (d) Matching Concept 4. “Revenue is recognised when sale is made or service is rendered rather than cash is received” is based on: (a) Matching Principle (b) Going Concern Assumption (c) Accrual Assumption (d) All of these 5. Expenses like salary, rent, insurance etc. are recognised on the basis of period to which they relate and not when they are paid based on: (a) Going Concern Assumption (b) Matching Principle (c) Accounting Period Principle (d) All of these 6. Contingent Liability is shown below the Balance Sheet on the basis of: (a) Materiality Principle (b) Going Concern Assumption (c) (Full Disclosure Principle (d) Matching Concept 7. Principle of Conservation/Prudence is applied to: (a) Valuation of closing stock at cost or market price whichever is less (b) Creation of provision for doubtful debt (c) Writing off intangible assets like goodwill, patent, trademark etc. (d) All of the above 8. Same accounting methods be used based on ____________ principle. (a) Prudence (b) Materiality (c) Consistency (d) Full Disclosure 9. Profit of the business is computed based on: (a) Matching Concept (b) Recognition Concept (c) Principle of Conservation (d) All of these 34 Accountancy Volume I PW 10. The owner of a business is treated as creditor of the business to the extent of his capital based on ____________ (a) dual aspect concept (b) cost concept (c) business entity concept (d) money measurement concept 11. IAS Stands for (a) International accounting standard committee (b) Indian accountings standard committee (c) International accounting standard company (d) Indian accounting standard company 12. IASB Stands for (a) International accounting standard Board (b) International accounting standard Board (c) Indian accounting standard Board (d) None of the above 13. ICAI established under (a) Chartered accountant act 1994 (b) Company act 1956 (c) Partnership act 1930 (d) Company act 2013 14. When accounting standard board has been constituting (a) 21 Feb 1977 (b) 21 March 1977 (c) 21 April (d) 21 May 1977 15. IAS in accounting stands for (a) Indian administrative services (b) International accountings standard (c) Indian accounting standard (d) None of the above 16. Income taxes Comes under (a) Ind AS 11 (b) Ind As 12 (c) Ind AS 13 (d) Ind AS 14 17. Intangible assets comes under (a) AS 22 (b) AS 23 (c) AS 24 (d) AS 26 18. GAAP of Indian has been established by (a) MCA (b) ICAI (c) Ministry of France (d) ICSI 19. How many numbers of accounting standard have been issued by ICAI (a) 38 (b) 41 (c) 32 (d) 12 20. The global recognized set of standards for the preparation of financial statement by business entity used in multiple countries is termed as (a) IFRS (b) ICAI (c) ASB (d) IAS ANSWERS 1. (c) 2. (1) 3. (b) 4. (c) 5. (b) 6. (c) 7. (d) 8. (c) 9. (1) 10. (1) 11. (a) 12. (1) 13. (1) 14. (c) 15. (b) 16. (2) 17. (d) 18. (2) 19. (c) 20. (1) Theory Based Accounting 35  VERY SHORT ANSWER TYPE QUESTIONS 1. Name two features of accounting principles. Ans. (i) Accounting principles are man-made based on experience so they are not exact as principle of natural science. (ii) Accounting principles are theory base of accounting. They act as guide for accounting. 2. What is meant by accounting assumptions or concepts? Ans. The accounting concepts are fundamental assumptions within which the accounting operates. They are generally accepted accounting rules and business transactions are recorded in the books of accounts based on the concepts or assumptions. 3. What is meant by accounting period principle? Ans. As per principle of going concern, life of business is fairly long and users of accounting service cannot wait or the financial statements till the liquidation of the business. It is therefore, prudent that all business should prepare their financial statements on a periodic basis, normally on yearly basis. As per companies Act, 2013 and Income Tax Act, 1961, accounting period is counted from 1st April to 31st March on yearly basis. 4. State materiality principle. Ans. The principle of materiality requires the accounting of material facts in the books of accounts. An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of an informed investor. 5. What is meant by prudence or conservatism principle? Ans.According to principle of conservatism or prudence, if the management anticipate loss, provision should be made for loss but if it anticipates profit, it should not be recorded in the books of accounts unless and until it is realised. 6. Why is owner’s capital considered as liability to firm? Ans. According to business entity concept, business is considered a separate entity distinct from its owner (s). Thus, owner of the business is considered as creditor of the firm to the extent of his capital. 7. Give two reasons for showing the fixed assets at their historical cost. Ans. Fixed assets are shown at historical cost because: (i) The cost price paid for purchase of asset is verifiable from cost records. (ii) It is difficult to determine the market price of each asset. Moreover, the valuation of asset will vary from person to person. 8. What is verifiable objective concept? Ans. The verifiable objective concept requires that accounting transactions should be recorded in an objective manner and should be free from personal bias of the accountant. This is feasible if transactions are supported by documentary evidence and vouchers. 36 Accountancy Volume I PW  9. What is the need of having accounting principles? Ans. The accounting principles are needed to make financial statements in a standardized form so that they serve the end users of financial statements in a better way 10. Explain the matching concept or matching principle. Ans. According to matching concept, expenses incurred in an accounting period should be matched with revenue during that period. Since accounts are prepared on accrual basis so expenses incurred in an accounting period are matched with revenue recognized in that period. 11. What is the need of having Accounting Standards? Ans. To avoid the diversity in the accounting policies and in the treatment of transactions in the financial statements in the present era, a need was felt to formulate certain minimum accounting standards which should be universally acceptable. 12. How many Accounting standards have been released so far in India? Are all of them mandatory? Ans. 32 accounting standards have been issued so far. All of them are not mandatory. AS 1 to 7 and 9 to 29 are operational and hence, mandatory. 13. Name any three Accounting Standards. Ans. (i) Cash Flow Statements (Revised) AS-3 (ii) Depreciation Accounting (Revised) AS-6 (iii) Revenue Recognition AS-9 14. Is the use of Accounting Standards mandatory in India? Ans. Yes, use of accounting standards is mandatory in India under Companies Act, 2013. 15. Name any two reasons to support the nature of accounting standards. Ans. (i) The accounting standards are mandatory in nature. (ii) The basic objective of accounting standards is to bring uniformity and consistency in the accounting practices so as to ensure comparability in the financial statements over inter- period and from other similar firms. 16. How many International Accounting Standards (IAS) have been superseded by IASB? Ans. 12-IAS out of 41 developed. 17. Whether Indian Government has agreed to comply with IFRS? If yes, from which date. Ans. India Government has made the compliance of converged IFRS w.e.f. 1st April, 2016 in a phased manner. 18. What are IFRS (International Financial Reporting Standards)? Ans. The accounting standards developed and issued by IASB are called IFRS. Theory Based Accounting 37