Accounting Fundamentals PDF

Accounting Fundamentals 1 Module-1: Accounting: An Introduction Notes...

Accounting Fundamentals 1 Module-1: Accounting: An Introduction Notes e Objective in The objective of this module is to introduce concepts of financial accounting such as basics of accounting rules, branched of accounting, accounting equation and nl knowledge of Generally Accepted Accounting Principles. Outcome O At the end of this module, learner will be able to- 1. Understand the meaning and significance of accounting. 2. Explain sub-fields of accounting. ity 3. Grasp the basic accounting concepts, principles and conventions and observe their implications while recording transactions and events. 4. Understand the qualitative characteristics that will help to develop the skill in course of time to prepare financial statements. rs “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of ve accounting” According to American Accounting Association (Year 1966)- ni 1.1 Introduction Business is an economic activity conducted to earn profits and increase the wealth of the owner. Business rules are based on general principles of trade social values and U the national or international boundaries legal framework. While these variables the vary for different companies and regions, the basic goal is to add value to the product or service in order to satisfy customer demand Through reporting all transactions related to the development of monetary inflows ity of sales revenue and monetary outflows of operating expenses, a business accounting system ensures an accountability. The accounting system provides the financial information needed to assess the efficacy of both current and past activities. The accounting system also provides m the data required to file reports that show the status of a business entity’s borrower liabilities, ownership equities and asset capital. )A 1.2 What is Accounting? All of us do some accounting, often without realizing it. It is a part of out life. Let us say you realize suddenly, one morning, that you need to buy a book urgently. You ask your parents for the money. “But” the parent asks, as to “What happened to the (c money you were given last week?” You either recollect how you spent it or if you believe in being systematic and have noted it in your diary you explain as to how the money was spent. Amity Directorate of Distance & Online Education  2 Accounting Fundamentals You are ‘accounting’ for the money given to you. When a homemaker tries to Notes e note down her household expenses, she either strikes the balance she has on hand at the end of the month, or determines how much she needs for the expenses which in would arise. She is thus accounting for the money she withdrew or was given to run the household. In business, however, it is a more urgent matter. A student may not be questioned nl by his parents or a homemaker may just meet her expenses as and when they come without bothering to find out how much she spent, but in business it is a must. You cannot run a business unless you know how much you owe outsiders and how much O outsiders owe you. And when you invest money in a business as an owner wouldn’t you like to know whether you’ve recovered it, increased it or lost it? 1.3 Definition of Accounting ity Definition by the American Institute of Certified Public Accountants (Year 1961): “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a rs financial character, and interpreting the result thereof”. Definition by the “The Accounting Principles Board” (APB) of the AICPA (Year 1970): ve ―Accounting is a service activity.Its function is to provide information primarily financial in nature about economic entities that is intended to be useful in making economic decisions.‖ ni With the help of above definitions, we can draw out following attributes of accounting:- Recording: Involves the reporting of financial transactions in an orderly U manner, immediately after their occurrence in the proper account books. Classifying:- Involves systematic analysis of data recorded, in order to collect transactions of a similar type at one place. This role is accomplished by ity managing the ledger in which different accounts are opened to which relevant transactions are reported. Summarising: Involves the planning and delivery of the classified data in a way that would be helpful to users. The function includes preparing financial statements, like income statement, balance sheet, financial position m adjustment statement, cash flow statement, value added statement, etc. Interpreting: Technology advancement helps the electronic data processing )A tools to perform three tasks that are being recorded, categorized and summarized. One of the key goals of maintaining accounts periodically is to view data that is subjective and can differ from person to person.The accounts clarify not only what has occurred but also as to why it has happened and a future forecast as well. (c Amity Directorate of Distance & Online Education  Accounting Fundamentals 3 1.4 Nature of Accounting Notes e Accounting is the systematic recording of financial transactions and presentation of the related information of the appropriate persons. The basic features of accounting are in as follows: 1. Accounting is a Process: A process refers to the step-by-step method of performing any specific job according to the goals or target. Accounting is identified as a process nl performing specific task of collecting, processing and communicating the financial data. This is accompanied by certain steps such as the data tracking compilation, description summarization, finalisation, and publishing. O 2. Accounting is an Art: Accounting is art of recording, classifying, summarizing and finalizing the financial data. The word −art refers to the way something is performed. It is knowledge of behaviour involving certain skills and creativity that can help attain ity specific goals. 1.5 Objectives and Scope of Accounting Accounting has a very broad scope and area of operation. It is not limited rs only to the business world but is distributed throughout all facets of society and all occupations. Nowadays, financial transactions must take place in any social institution or professional practice, whether that is income generating or not. Therefore the need to record and summarize these transactions as they occur emerges and there is a need ve to figure out the net result of the same after the expiry of a certain fixed period. To keep systematic records: Accounting is performed to keep a systematic record of financial transactions. The primary objective of accounting is to help ni collect financial data and to record it systematically for the derivation of correct and useful results of financial statements. To ascertain profitability: With the help of accounting, the profits and losses U incurred during a specific accounting period can be evaluated. With the help of a Trading and Profit& Loss Account, the profit or loss of a firm can be easily determined. To ascertain the financial position of the business: A balance sheet or a ity statement indicates the financial position of a Company as on a particular date. A properly drawn balance sheet gives us an indication of the value of assets, the nature and value of a liability, and also the capital position of the firm. Thus, the soundness of any business entity can be easily ascertained. m To assist in decision-making: To take decisions for the future, there is a need for accurate financial statements. One of the main objectives of accounting is to take the right decisions at the right time. Thus, accounting gives the platform to plan for )A the future with the help of past records. To fulfill law compliance: Business entities like organizations, trusts, and societies are being run and governed according to different legislative acts. Similarly, different taxation laws (direct-indirect tax) are also applicable to every business house. It is requires to keep and maintain various types of accounts (c and records as prescribed by corresponding laws of the land. Accounting helps in running a business in compliance with the law. Amity Directorate of Distance & Online Education  4 Accounting Fundamentals 1.6 Branches of Accounting Notes e Accounting is an old science that aims at keeping records of various transactions. Accounting is considered essential for record-keeping of all the receipts and payments in as well as the income and expenditures. Accounting can be broadly classified into three categories: nl 1. Financial Accounting Financial accounting is aimed at identifying an accounting year’s results in terms of profits or losses and assets and liabilities. To do this it is important that numerous O transactions are documented systematically. Financial accounting is characterized as an art and science of systematically classifying, analyzing and reporting business transactions in order to prepare a report at the end of the year to assess the details of the related year. ity Financial accounting involves the following terms - Business Transactions: A business transaction is any activity that creates a kind of legal relationship. For example, the purchase and sale of goods, rs appointing an employee and paying salary, payment of various expenses, purchase of assets, etc. Classification of Transactions: Before recording any transaction, it is essential to classify it. A transaction can be classified as a cash and credit transaction. ve Similarly, transactions of receiving income and expenditure payment can be segregated. Recording of Transactions: The essence of financial accounting is the ni recording of transactions. In accounting terms, recording of the transaction is known as entry, and there are specific rules for recording various transactions in books of accounts. U 2. Cost Accounting Cost accounting is intended to capture a Company’s production costs by assessing the input costs for each production phase, as well as fixed costs such as depreciation ity of an equipment. Cost accounting must analyze and record these costs independently first, and then compare the results with expected or measurable outcomes to help the Company assess financial performance. Cost accounting is often used within a Company to facilitate decision-making, and financial management is typically seen by the investor’s external community. Cost accounting can also be useful in budgeting and m setting up cost control systems as a method for management, which can increase the Company’s net profits in the long run. )A 3. Management Accounting Management accounting is the application of professional knowledge and skills for the preparation and presentation of accounting information in such way that assists the management in the formulation of policies and also in planning and controlling the operations of the organization. The main purpose of management accounting is to (c provide information to the management team at all levels within the organization for the following purposes: Amity Directorate of Distance & Online Education  Accounting Fundamentals 5 (a) Formulating the policies––strategic planning Notes e (b) Planning the activities of the organization––corporate planning (c) Controlling the activities of the organization in (d) Decision-making––long-term and tactical (e) Performance appraisals at strategic and operational level - A management nl accounting/cost statement provides information to allow managers to plan, control and organize the activities of the business. The purpose of a costing/management accounting information system is: O 1. Provide information about the cost of the product to be used in financial statements. 2. Provide information for planning, organizing and controlling. ity 1.6.1 Difference between Management Accounting and Financial Accounting rs S.no Management Accounting Financial Accounting 1 Management Accounting is primarily Financial Accounting is based on the based on the data available from Financial monetary transactions of the Company. ve Accounting 2 Reports prepared in Management Reports as per Financial Accounting are Accounting are meant for management meant for the management as well as for and as per management requirement. shareholders and creditors of the concern. ni 3 It provides necessary information to Its main focus is on recording and the management to assist them in classifying monetary transactions in the the process of planning, controlling, books of accounts and preparation of U performance evaluation and decision financial statements at the end of every making accounting period. 4 Reports may contain both subjective and Reports should always be supported by ity objective figures. relevant figures and it emphasizes on the objectivity of data. 5 Reports are not subject to statutory audit. Reports are always subject to statutory audit. m 6 It evaluates the sectional as well as the It ascertains , evaluates and exhibits the entire performance of the business. financial strength of the whole business )A 1.7 Book Keeping As defined by Carter, ‘Book-keeping is a science and art of correctly recording in books of accounts, all the business transactions resulting in the transfer of money or money’s worth’. Book-keeping is an activity concerned with recording and classifying (c financial data related to business operation as per the order of its occurrence. Book- keeping is a mechanical task that involves - Amity Directorate of Distance & Online Education  6 Accounting Fundamentals The collection of basic financial information. Notes e Identification of events and transactions with a financial character i.e., economic transactions. in Measurement of economic transactions in terms of money. Recording financial effects of economic transactions as per its order of occurrence. nl Classifying the effects of economic transactions. Preparing organized statement known as trial balance. O 1.7.1 Difference between Book keeping and Accounting S.n Book Keeping Accounting ity 1 Purpose of book-keeping is to keep Purpose of accounting is to find results systematic record of transactions and of operating activity of business and to events of financial character in order of its report financial strength of business. occurrence rs 2 Output of book-keeping is an input for Output of accounting permit informed accounting. judgments and decisions by the user of accounting information ve 3 Book-keeping is a foundation of accounting. Accounting is considered as a language of business. 4 Book-keeping is carried out by junior staff Accounting is done by senior staff with skill of analysis and interpretation. ni 5 Objects of book-keeping is to summarize Object of accounting is not only the cumulative effect of all economic bookkeeping but also analyzing and transactions of business for a given period interpreting reported financial information U by maintaining permanent record of each for informed decisions. business transaction with its evidence and financial effects on accounting variable. ity 1.8 Generally Accepted Accounting Principles A widely accepted set of rules, conventions, standards, and procedures for reporting financial information, as established by the Financial Accounting Standards Board are known as Generally Accepted Accounting Principles (GAAP). These are the m common set of accounting principles, standards and procedures that companies use to compile their financial statements. )A GAAP is a mix of standards set by the government bodies and essentially the commonly accepted methods of collecting and presenting information on accounting. Organizations are to follow GAAP so that investors have an optimal level of consistency in the financial statements they use when evaluating firms for investment purposes. GAAP covers the aspects like revenue recognition, balance sheet items classification (c and outstanding share measurements. Amity Directorate of Distance & Online Education  Accounting Fundamentals 7 1.8.1 Accounting Concepts and Conventions Notes e Accounting principles are the basic guidelines which set standards for scientific accounting practices and procedures. They guide as to how to record and report the in transaction and also guarantee uniformity and understandability. The accounting standards lay the foundations for the principles of accounting. Such principles ensure that financial facts are documented on solid foundations, nl and rational criteria. Accounting Conventions are widely accepted approaches or procedures. We follow the Conventions as transactions are registered or interpreted. The terms-principles, definitions and conventions are however used interchangeably at O times. A. Basic Assumptions ity (a) Business Entity Concept - This concept explains how distinct the business is from its owner. Thus, business transactions are to be recorded in the business books only. For example, a business should pay its debts and file its own income tax return. The owner is required to file their income tax return that is separate from the business return. The property or assets that a business owns must be recorded separately from the property that the owner of the business has. Significance rs ve The significance of business entity concept is : The concept helps in the ascertainment of the profit of business as only the business expenses and revenues are recorded and all the other private and ni personal expenses are ignored. The concept restraints the accountants from recording of the owner’s private and personal transactions. U Facilitates the recording and reporting of the business transactions from the point of view of business. It is the very basis of accounting concepts, conventions, and principles. ity (b) Going Concern Concept - When a business is started, the operations are intended to last for some time or continue. It does not intend to go into bankruptcy or instantly dissolve. It expects to be able to meet its responsibilities to its consumers or partners, to offer goods or services. The business often continues, even when the ownership changes.The concept assumes that the business has a perpetual succession or m continued existence. For example, a Company purchases a plant and machinery of Rs.2,00,000 with a life )A span of 10 years. According to the concept every year some amount will be shown as expenses and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it will not be proper to charge the amount from the revenues of the year in which the item is acquired. In the year of purchase, only a part of the value is shown as expense and the remaining balance (c is shown as an asset. Amity Directorate of Distance & Online Education  8 Accounting Fundamentals Significance Notes e The significance of the going concern concept the following: in The concept facilitates preparation of financial statements. On the basis of this concept, depreciation is charged on fixed asset. It is of great help to the investors, as it assures, that there will be a continuous nl income on their investments. The cost of a fixed asset will be treated as an expense in the year of its purchase in the absence of the concept. O A business is accurately judged for its capacity to earn profits in future. (c) Money Measurement Concept – The concept assumes that all business transactions must be in terms of money that is in the currency of a country. In our ity country the transactions are in terms of rupees. Thus, according to this concept only those transactions which are expressed in money terms are to be recorded in the books of accounts. For example, sale of goods worth Rs. 2,50,000 purchase of raw materials rs Rs.1,00,000 Rent Paid is Rs.10,000 etc. are expressed in terms of money. Thus, they are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. ve For example, loyalty, sincerity and the honesty of employees are not recorded in books of accounts as they are immeasurable in terms of money, although they do affect the profits and losses of the business concern. ni Significance The following points highlight the significance of the money measurement concept: The concept guides accountants as to what to record and what not to record. U It helps in recording the business transactions uniformly. If all the transactions are represented in monetary terms, the accounts prepared by the business Company will be easy to understand. ity This enables the comparison of two different periods of business performance of the same Company or of the two different companies for the same duration. (d) The Accounting Period Concept – According to the concept, all the transactions m are recorded in the books of accounts on the assumption that profits on these transactions are to be ascertained for a specified period. Thus, the concept requires that a balance sheet and profit and loss account should be prepared at regular )A intervals. This is relevant for various purposes such as income calculation, financial position ascertainment, tax calculation etc. Furthermore, the concept assumes that infinite business life is divided into parts. These sections are called the Accounting Period. It may be of one year, six months or three months etc, but usually one year is taken as one accounting period which can be either a calendar year or a financial (c year. Amity Directorate of Distance & Online Education  Accounting Fundamentals 9 Significance Notes e It helps in the prediction of future prospects of a business. It helps in the calculation of tax on the business income that is calculated for a in particular time period. It also helps the banks, financial institutions, creditors, etc. to assess and analyze the performance of a business for a particular time period. nl It also helps the business firms to distribute their income at regular intervals as dividends. O (e) The Accrual Concept – Accrual means something which becomes due, especially an amount of money that is yet to be paid or received at the end of an accounting period. This also means that revenues are recognized when they become receivable. The accrual concept is based on the recognition of both cash and credit transactions. ity In case of a cash transaction, the owner’s equity is instantly affected as cash either is received or paid. In a credit transaction, a mere obligation towards or by the business is created. When credit transactions exist, the revenues are not the same as cash receipts and expenses are not same as cash paid during the period. Thus, rs the concept makes a distinction between the accrual receipt of cash and the right to receive cash. For example, a firm sells goods for Rs 50,000 on 20th March 2008 and the payment ve is not received until 10th April 2008, the amount is due and payable to the firm on the date of sale i.e. 20th March 2008. It must be included in the revenue for the year ending 31st March 2008. Significance ni It helps in the determination of actual expenses and actual income during a particular time period. U It helps in the calculation of the net profit of the business. B. Basic Principles (a) Realization Concept – The concept emphasizes on recording of only those ity transactions which are actually realized. For example, the sale or profit on sales will be taken into account only when money is realized, i.e., either cash is received or legal ownership is transferred. Example: m Mr. A sold goods for Rs.1,00,000 for cash in 2020 and the goods have been delivered during the same year. Thus, The revenue for Mr. A for year 2019 is Rs.1,00,000 as the goods have been delivered in the year 2019. Cash has also been )A received in the same year. Significance It makes the accounting information more objective. (c It provides that, transactions must be recorded only when goods are delivered to the buyer. Amity Directorate of Distance & Online Education  10 Accounting Fundamentals (b) Matching Concept - It is referred to as matching of expenses against incomes. Notes e The concept states that all incomes and expenses relating to the financial period to which the accounts relate should be taken in to account without regarding the date in of receipts or payment. Significance nl Guides on how to balance expenditures with revenue to calculate exact profit or loss for a given period. Helpful for the investors or the shareholders for determining the exact amount O of profit or loss of the business. (c) Full Disclosure Concept: According to the concept, all significant information must be disclosed. For the purpose of presenting the financial statements that are useful to accounting information users, accounting details should be adequately described, ity summarized, aggregated, and explained. In practice, this concept underlines the materiality, objectivity and accuracy of accounting data which should show a true and fair view of a firm’s state of affairs. (d) Duality Concept: According to this concept each transaction has two aspects, i.e. rs the aspect of benefit receiving and the aspect of benefit giving. Such two factors are to be identified in the account books. For example, goods purchased for cash has two aspects - ve (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded. The duality concept is expressed in terms of fundamental accounting equation as – ni Assets = Liabilities + Capital The above accounting equation states that the assets of a business are always U equal to the claims of the owner and the outsiders. The claim is also termed as capital or owners’ equity and that of outsiders, as liabilities or creditors’ equity. (e) Verifiable Objective Concept – As per this concept, the accounting data must be ity verified. It means the documentary proof of transactions that can be checked by an independent respect must be given. Without such assurance, the available data will neither be accurate nor correct, ie. Those details will be biased. Both verifiability and objectivity express dependability, reliability and the trustworthiness, which is useful for the purpose of displaying accounting data and information to the users. m Significance The concept requires assets to be shown at the price they have been )A acquired, which can be verified from the supporting documents. Helps in the calculation of depreciation on fixed assets. The effect of cost concept is that the item will not be shown in the account books if the business entity does not pay anything for an asset (c (f) Historical Cost Concept - Business transactions are always recorded at the actual cost at which they are undertaken. The main advantage is that, there is an avoidance Amity Directorate of Distance & Online Education  Accounting Fundamentals 11 of the arbitrary value being attached to the transactions. Whenever an asset is Notes e acquired, it is recorded at its actual cost, and the same is used as the basis for all subsequent accounting purposes, such as charging depreciation on asset use. in For example, if production equipment is bought for Rs.2 crores, the asset will be shown at the same value in all future periods when disclosing the original cost. It will be reduced by the amount of depreciation, which will be calculated with reference to nl the actual cost. The actual value of the equipment may increase or decrease after the purchase but this is deemed irrelevant for accounting purposes according to the concept. The limitation of this concept is that the balance sheet does not represent the market value of the business-owned assets and therefore the owner’s equity will O not reflect the real value. On an ongoing basis, however, the properties are seen as reduced by depreciation at their historical prices. (g) Balance Sheet Equation Concept – According to this concept, all that has been ity received, must be equal to that has been given. Here the receipts are clarified as debits and giving is clarified as credits. The basic equation, appears as – Debit = Credit Every debit must have a corresponding credit and vice-e-versa. Thus, we can write the above in the following form: rs Expenses + Losses + Assets = Revenues + Gains + Liabilities ve If expenses and losses, and incomes and gains are set off, the equation will be – Asset = Liabilities or, Asset = Equity + External Liabilities i.e., the Accounting Equation. ni C. Modifying Principles (a) The Concept of Materiality or Full Disclosure - Materiality can be related to information, amount, procedure and nature. According to the concept, all such U information having the chance to influence financial information including the owners is relevant and must be integrated into the accounting process. Error in the description of an asset or a misclassification between capital and profits may result in information materiality. ity For example, where at the end of the accounting period postal stamps of 300 remain unused, the same may not be considered for acknowledgment as an inventory on account of the materiality of the number. All accounting treatments rely on the accounting standards defined procedures. All transactions are by nature of material m regardless of the amount involved, e.g. an audit fee, loan to directors. (b) Consistency Concept – According to this concept, the accounting practices should not change or must remain unchanged over a period of several years. This means )A that the accounting principles, methods, practices, and procedures adopted in accounting process shall be applied consistently. Frequent changes in accounting methods is not desirable in accounting process, as it reduces third party acceptability of financial statements. (c (c) Conservatism Concept or Prudence - Conservatism concept states that when alternative valuations are possible then the alternative fairly representing the Amity Directorate of Distance & Online Education  12 Accounting Fundamentals economic substance of transactions should be selected. However, when such Notes e choice is not clear then the alternative that is least likely to overstate net assets and net income must be selected. The concept provides the best estimate for all known in expenditures and losses if the sum is not known with certainty but on the basis of expectation it does not consider sales and profits. (d) Timeliness Concept – According to this concept, every transaction must be recorded nl in proper time. It refers to the need for accounting information to be presented to the users in time to fulfill their decision making needs. In short, transaction should be recorded date-wise in the books of accounts. A delay in providing information makes it irrelevant and less useful to the decision making needs of the users. Further, a O delay in recording such transaction may lead to manipulation, misplacement of vouchers; misappropriation etc. of both cash and assets.This concept is particularly followed during day-to-day cash balance verification. It is also followed by banks i.e. ity each bank verifies the cash balance with their cash book and must complete the same within the day. (e) Industry Practice - As there are different types of industries, each industry has its own characteristics and features. There may be some seasonal industries also. Every industry follows the accounting principles and standards for carrying out its rs own activities. Some of them follow to the values, definitions and conventions in a modified manner. For example, the electric supply companies or the insurance companies maintain their accounts in a specific manner. Insurance companies ve prepare a revenue account to ascertain the profit/loss of the Company. Similarly, non-trading organizations prepare Income and Expenditure Account to find out Surplus or Deficit. ni 1.9 International Financial Reporting Standards International Financial Reporting Standards (IFRSs) are set by the International Accounting Standards Board (IASB) that was established in 2001 to replace the U International Accounting Standards Committee (IASC). International Financial Reporting Standards (IFRS), formerly known as International Accounting Standards (IAS) are the standards, interpretations and the framework preparing and presenting the Financial Statements adopted by the International Accounting Standards Board (IASB). ity What is International Accounting Standards Board (IASB), The IASB is the independent standard setting body of the IFRS to approve the interpretations of IFRS as developed by the IFRS Interpretations Committee. m The IASB engages closely with the stakeholders globally including the investors, analysts, regulators, accounting standard setters and more. The formulation if ISB is necessary as – )A There is a recognized and growing need for the common international standards No individual setter has a monopoly over a best solution to the accounting standards. (c No national standard setter is in a position to set accounting standard that gain acceptance around the world. Amity Directorate of Distance & Online Education  Accounting Fundamentals 13 Steps taken by IASB for Global Convergence Notes e 1. Issued a conceptual framework - It had adopted the framework issued by IASC in 1989. The framework saves as guide to IASB for developing Accounting Standards. in 2. Issue of IAS – Till now IASC had Issued 41 International Accounting Standards IAS List Particulars nl IAS 1 Presentation of Financial Statements IAS 2 Inventories O IAS 7 Statement of Cash Flows IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events After the Balance Sheet Date ity IAS 1 1 Construction Contracts IAS 1 2 Income Taxes IAS 1 6 Property, Plant and Equipment rs IAS 1 7 Leases IAS 1 8 Revenue IAS 1 9 Employee Benefits ve IAS 20 Accounting for Government Grants and Disclosure of Government Assistance IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs ni IAS 24 Related Party Disclosures IAS 26 Accounting and Reporting by Retirement Benefit Plans U IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 29 Financial Reporting in Hyperinflationary Economies ity IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Presentation IAS 33 Earning Per share (EPS) m IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets )A IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property (c IAS 41 Agriculture Amity Directorate of Distance & Online Education  14 Accounting Fundamentals 3. Issue of International Financial Reporting Standards (IFRS) Notes e IAS List Particulars in IFRS 1 First-time Adoption of IFRS IFRS 2 Share-based Payment nl IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-current Assets Held for Sale and Discontinued Operations O IFRS 6 Exploration for and evaluation of Mineral Resources IFRS 7 Financial Instruments: Disclosures ity IFRS 8 Operating Segments IFRS 9 Financial Instruments IFRS 10 Consolidated Financial Statements IFRS 11 Joint Arrangements IFRS 12 IFRS 13 rs Disclosure of Interests in Other Entities Fair Value Measurement ve 4. Setting up the IFRS Interpretations Committee The IFRS Interpretations Committee ( formerly called as the IFRIC) is the interpretative body of the IASB. The objective of the committee is to review on timely ni basis within the context of IAS, IFRS and the framework, accounting issues that are debatable and provide a clarification for the same. U 1.10 IFRS Foundation On 24 May 2000, IASC members approved the first constitution of the IASC foundation, and on 5 March 2002, IASC foundation trustees amended those articles, ity effective that date. These amendments were necessary to implement some elements of the IASB’s Standing Interpretation Committee preface to IFRS. The IFRS foundation is an independent and not for profit private sector organization that works in public interest. The principal objectives of the organization as m follows – 1. The main objective of the IFRS Foundation is to establish a common set of high quality, comprehensible, enforceable and internationally agreed financial )A reporting standards based on clearly articulated principles for the public interest. 2. Development of a single set of high quality, understandable and a globally accepted IFRS through its standard setting body ISB. 3. Promote the use and a regular application of the principles. (c 4. Take into account the financial reporting needs of the emerging economies and the small and medium sized entities (SMEs) Amity Directorate of Distance & Online Education  Accounting Fundamentals 15 Key Takeaways Notes e Accounting: Accounting is treated as the language of business. It records all the transactions which can be measured in money and have occurred in a particular in period. Cost accounting: It is intended to capture an Enterprise’s production costs by assessing the input costs for each production phase, as well as fixed costs such nl as depreciation of an equipment Management accounting: It is the application of professional knowledge and skills for the preparation and presentation of accounting information O Account: An account is a record used to properly classify the activity recorded in the General Ledger. Accrual Basis - Method of accounting that recognizes revenue when earned, ity rather than when collected and expenses when incurred rather than when paid. The college uses the accrual basis for its accounting. Asset- Anything of use to future operations of business and belonging of an enterprise. An asset is what the college owns. For example- land, property, rs buildings, equipment, cash in bank accounts, other investments and accounts receivable. Credit - A credit is an entry on the right side of a double-entry accounting system ve that represents the reduction of an asset or expense or the addition to a liability or revenue. Debit - A debit is an entry on the left side of a double-entry accounting system that represents the addition of an asset or expense or the reduction to a liability or ni revenue. Double-Entry Accounting - Method of recording financial transactions in which each transaction is entered in two or more accounts and involves two-way, self- U balancing posting. Expense/Costs - It is the expenditure incurred by enterprise to earn revenue. An expense is funds paid by the college. For example-paychecks to employees, ity reimbursements to employees, payments to vendors for goods or services. Equity- It refers to total claims against enterprise. It is further dividers into Owner’s Claim (Capital) and Outside’s Claim (Liability). GAAP - GAAP stands for Generally Accepted Accounting Principles which are m conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. Liability - A liability is what the college owes. For example-loans, taxes, payables, )A long term debt from a bond issue, funds held by the college for a third party such as a student group. Revenue - Revenue is funds collected by the college; it can also be called income. It is monetary value of products/services sold to customers during the period. For (c example, tuition, fees, rentals, income from investment. Amity Directorate of Distance & Online Education  16 Accounting Fundamentals Balance Sheet - The Balance Sheet is the statement summarizing the financial Notes e position of a business on a given date. It summaries on the right hand side the assets of the business and on the left hand side the liabilities of the business. in Check your progress 1. Accounting based on the monetary transactions of the enterprise is nl a) Management Accounting b) Cost Accounting c) Financial Accounting O d) Absorption Accounting 2. Accounting aimed at identifying an accounting year’s results in terms of profits or losses and assets and liabilities. ity a) Management Accounting b) Cost Accounting c) Financial Accounting 3. d) Absorption Accounting rs __________________ is the language of business. ve a) Accounting b) Business Transaction c) Profits ni d) Financial Management 4. What is IASB? a) Indian Accounting Standards Board U b) International Accounting Standards Board c) International Asset Standards Bureau ity d) Indian Asset Standards Bureau 5. The concept explaining the distinction of business is from its owner is ? a) Going Concern Concept b) Money Measurement Concept m c) Business Entity Concept d) Prudence Concept )A Questions & Exercises 1. Define Accounting. How is it different from Accountancy and Book-keeping? 2. Explain various steps in the process of Accounting. (c 3. What do you understand by Accounting Principles? Explain some of them. Amity Directorate of Distance & Online Education  Accounting Fundamentals 17 4. Differentiate between management and financial accounting? Notes e 5. Explain in brief the various branches of accounting. in Check your progress: 1. c) Financial Accounting 2. c) Financial Accounting nl 3. a) Accounting 4. b) International Accounting Standards Board O 5. c) Business Entity Concept Further Readings ity 1. Accounting for Managers. Maheshwari and Maheshwari. Vikas publication. 2. Financial Accounting. Meigs and Meigs. Mcgraw Hills Inc. 3. Introduction to Accountancy. T S Grewal. S Chamd & Co Ltd 4. Advanced Accounting, Sehgal Ashok, Sehgal Deepak.Taxman Allied Services 5. (P) Ltd., New Delhi rs Advanced Accountancy, Jain S.P., Narang K.L..Kalyani Publishers, Ludhiana. ve 6. Advanced Accounts, Shukla M.C., Grewal T.S.: S. Chand & Company Ltd., New Delhi. 7. Advanced Accountancy, Gupta R.L., M. Radhaswamy: Sultan Chand & Sons, New Delhi. ni 8. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi. U ity m )A (c Amity Directorate of Distance & Online Education  18 Accounting Fundamentals Module–2: Recording of Transactions Notes e Objective in The module is intended to introduce the basic concept of double entry, accounting cycle and preparation of voucher, journal, ledger and trial balance. It includes the nl recording of transaction in primary and subsidiary books of accounts. Outcome O At the end of this module, learner will be able to: Understand the meaning and significance of Double Entry System. Record transactions in the appropriate ledger accounts using the double-entry ity book-keeping system. Understand how debits and credits are determined from transactions and events. Observe the points to be taken care of while recording a transaction in the journal. rs “Accounting is the art of recording, classifying and summarizing in a significant manner and terms of money, transactions and events, which are, in part at least, of a financial character and interpreting the result thereof” ve According to the American Institute of Certified Public Accountants [AICPA]– Introduction ni Accounting is the analysis & interpretation of book keeping records. It includes not only the maintenance of accounting records but also the preparation of financial & economic information which involves the measurement of transactions & other events U relating to entry. The main object of keeping the books of accounts is to ascertain the profit or loss of business and to assess the financial position of the business at the end of the year. The object is better served if the businessman first satisfies himself that the accounts ity written up during the year are correct or at least arithmetically accurate. When the transactions are recorded under double entry system, there is a credit for every debit, when on a/c is debited; another a/c is credited with equal amount. m 2.1.1 Concept of Double Entry System Double Entry System It was in 1494 that Luca Pacioli the Italian mathematician first published his comprehensive treatise on the principles of Double Entry System. The )A use of principles of double entry system made it possible to record not only cash but also all sorts of mercantile transactions. It had created a profound impact on auditing too, because it enhanced the duties of an auditor to a considerable extent. Features of Double Entry System (c Every transaction has two fold aspects, i.e., one party giving the benefit and the other receiving the benefit. Amity Directorate of Distance & Online Education  Accounting Fundamentals 19 Every transaction is divided into two aspects, Debit and Credit. One account is Notes e to be debited and the other account is to be credited. Every debit must have its corresponding and equal credit. in 2.1.2 Advantages of Double Entry System Since personal and impersonal accounts are maintained under the double entry nl system, both the effects of the transactions are recorded. Ensures an arithmetical accuracy of the books of accounts, for every debit, there is a corresponding and equal credit. This is ascertained by preparing a trial balance O periodically or at the end of the financial year. Prevents and minimizes frauds. Moreover frauds can be detected early. Errors can be checked and rectified easily. ity Balances of receivables and payables are determined easily, since the personal accounts are maintained. Businesses can compare the financial position of the current year with that of the rs past years The net operating results can be calculated by preparing the Trading and Profit and Loss A/c for the year ended and the financial position can be ascertained by ve the preparation of the Balance Sheet. It becomes easy for the Government to decide the tax and also helps the Government to decide sickness of business units and extend help accordingly. Other stakeholders like suppliers, banks, etc take a proper decision regarding ni grant of credit or loans. 2.1.3 Limitations of Double Entry System U The system does not disclose all the errors committed in the books accounts. The trial balance prepared under this system does not disclose certain types of errors. ity It is expensive as it involves the maintenance of numbers of books of accounts. 2.2 The Concepts of ‘Account’, ‘Debit’ and ‘Credit’ m The concept of Account An account is defined as a summarized record of transactions related to a person or a thing, for example when the business deals with customers and suppliers, each of )A the customers and supplier will be a separate account. The account is also related to things – both tangible and intangible. e.g. land, building, equipment, brand value, trademarks etc are some of the things. When a business transaction happens, one has to identify the ‘account’ that will be affected by it (c and then apply the rules to decide the accounting treatment Amity Directorate of Distance & Online Education  20 Accounting Fundamentals Typically, an account has two sides. The left hand side is called as “Debit’ side and Notes e the right hand side is called as “Credit’ side. The debit is denoted as ‘Dr’ and the credit by ‘Cr’. The convention is to write the Dr and Cr labels on both sides as shown below. in Dr. Cash Account Cr. Debit Side Credit Side nl 2.3 Accounting Cycle When a complete sequence of accounting procedure is done which happens O frequently and repeated in same directions during an accounting period, the same is called an accounting cycle. ity Collect and Analyze Cash and every Transactions rs Take action for investment, credit and Posting into similar decisions Journals ve Interpretation Posting Transactions to ledger accounts ni Prepare financial Prepare U statements Trial Balance (i) Recording of Transaction: As soon as a transaction happens it is at first recorded ity in subsidiary book. (ii) Journal: The transactions are recorded in Journal chronologically. (iii) Ledger: All journals are posted into ledger chronologically and in a classified manner. m (iv) Trial Balance: After taking all the ledger account closing balances, a Trial Balance is prepared at the end of the period for the preparations of financial statements. )A (v) Adjustment Entries: All the adjustments entries are to be recorded properly and adjusted accordingly before preparing financial statements. (vi) Adjusted Trial Balance: An adjusted Trail Balance may also be prepared. (c (vii) Closing Entries: All the nominal accounts are to be closed by the transferring to Trading Account and Profit and Loss Account. Amity Directorate of Distance & Online Education  Accounting Fundamentals 21 (viii) Financial Statements: Financial statement can now be easily prepared which Notes e will exhibit the true financial position and operating results. in 2.4 Types of Accounts The classification of accounts and rules of debit and credit based on such classification are given below: nl a) Personal Accounts: Accounts recording transactions relating to individuals or firms or Company are known as personal accounts. Personal accounts may further be classified as: O (i) Natural Person’s personal accounts: The accounts recording transactions relating to individual human beings e.g., Ajay’s a/c, Ram’s a/c, John’s a/c are classified as natural persons personal accounts. ity (ii) Artificial Person’s personal accounts: The accounts recording transactions relating to limited companies, bank, firm, institution, club, etc., Delhi Cloth Mill; M/s Singh & Singh; Ramjas College; Gymkhana Club are classified as artificial persons’ personal accounts. rs (iii) Representative Personal Accounts: The accounts recording the expenditure and income related transactions are listed as nominal accounts. But in some situations (due to the matching accounting concept) the sum is payable to the ve individuals on a particular date or recoverable from individuals. Such amount -  Relates to the particular head of expenditure or income and  Represents people to whom it is payable or from whom it is recoverable. Such accounts are classified as representative personal accounts , for ni example “wages outstanding account”, pre-paid Insurance account, etc. b) Real Accounts: The accounts recording transactions relating to tangible things (that can be touched, purchased and sold) like the cash, goods, building & machinery U etc. are classified as tangible real accounts. Whereas the accounts recording transactions relating to intangible things (which do not have a physical form ) like the goodwill, patents and copy rights, trade marks etc. are classified as intangible real accounts. ity c) Nominal Accounts: The account recording transactions relating to the losses, gains, expenses and incomes, for example salaries, wages, rent, commission, interest, bad debts etc. are classified as nominal accounts. m Rules of debit and credit (classification based) 1. Personal accounts: Debit the receiver Credit the giver (supplier) 2. Real accounts: Debit what comes in Credit what goes out )A 3. Nominal accounts: Debit expenses and losses Credit incomes and gains Modern Approach to Accounting Under the Modern Approach, the accounts are not debited and credited. Hence, (c the Accounting Equation is used to debit or credit an account. Thus, it is also known as the Accounting Equation Approach. Amity Directorate of Distance & Online Education  22 Accounting Fundamentals Modern Classification of Accounts Notes e Types of accountq Normal balance Account to be Account to be of account debited when credited when in there is; there is: Asset account Debit Increase Decrease nl Liabilities account Credit Decrease Increase Capital account Credit Decrease Increase O Revenue account Credit Decrease Increase Expenditure account Debit Increase Decrease Drawing account Debit Increase Decrease ity Debit Amount (Debit): The debit amount is recorded in the debit amount column opposite to the title of the account that is being debited. Credit Amount (Credit): The credit amount is recorded in the credit amount rs column opposite to the title of the account that is being credited. The Basic Accounting Equation is: Assets = Liabilities + Capital (Owner’s Equity) Furthermore, it can be expanded as Assets = Liabilities + Capital + Revenues – ve Expenses Also, Profit = Revenues – Expenses a. Assets Accounts: Assets are a business’s properties, possessions or ni economic resources. They assist in company activities and help to raise money. It is possible to calculate them in terms of revenue. Resources may be either intangible or tangible. You may also identify assets as fixed assets and current U assets. For the long-term, fixed assets are retained. b. Liabilities Accounts: Liabilities are the amounts that an entity owes to the outsiders. These are the obligations or the debts payable by the business. Liabilities can also be classified as Long-term and Current. ity Long-term Liabilities are payable after a period of one year. For example, debentures, bank loans, etc. Current liabilities are payable within one year. For example, creditors, bills payable, rent outstanding, bank overdraft, etc. m c. Capital Accounts: The cash brought by the investor into the corporation is called Capital or Owner’s Equity. The capital may be transported by the owner in cash or properties. Capital is a corporation responsibility that needs to be paid back to the owner. Therefore, capital is shown on the liabilities side of )A the Balance Sheet. The capital account is shown after deducting the Drawings by the owner. Drawings are the amount of cash, goods or assets taken by the owner for personal use from the business. d. Revenue Accounts: Revenue is the amount earned by an enterprise by selling (c goods or rendering of services. Also, it includes other incomes such as rent Amity Directorate of Distance & Online Education  Accounting Fundamentals 23 and commission received, interest received, dividend earned, etc. All items of Notes e revenue are also clubbed together under the Modern Approach. e. Expenses Accounts: All costs incurred or money invested by a corporation in in order to raise income are called costs. It is interesting here that it is considered an expenditure when the advantages of the money invested are exhausted within a span of one year. If the advantage lasts for more than a year, it is called nl investment. Therefore, the purchase of goods is expenditure while the cost of goods sold is an expense. For example, rent paid, salary paid, electricity charges, interest O paid, etc. are expenses. While the purchase of assets, purchase of short-term investments, etc. fall under the category of expenditure. 2.5 Accounting Equation ity The recording of business transaction in books of accounts is based on a fundamental equation called accounting equation. Whatever business possesses in the form of assets is financed by proprietor or by outsiders. This equation expresses the equality of assets on one side and the claims of outsiders (liabilities) and owners or rs proprietors on the other side. In Mathematical form = Assets = Liabilities + Capital ve Or A = L + P or P=A–L or L = A – P ni Where A = Assets, L = Liabilities, P = Capital Example: U XYZ Ltd. is a company incorporated to carry on the business of selling juices. XYZ Ltd.’s transactions for the month of January were as follows: Jan. 1 Issued equity shares of 20,00,000 (cash received in full). ity Jan. 5 Purchased land for 5,75,000. Jan. 8 Purchased a building for 4,40,000, paying 1,40,000 in cash and the balance payable in three monthly installments. Jan. 15 Purchased machinery worth 2,20,000. m Jan. 20 Purchased syrup (raw material) for making soft drinks worth 5,75,000, paying 1,75,000 in cash and accepting a bill drawn by the supplier for the balance. )A Jan. 25 Purchased further machinery worth 50,000. Jan. 31 Sold cold drinks worth 50,000 (consuming 30,000 of syrup). Show the effects of the above transactions upon the accounting equation. (c Amity Directorate of Distance & Online Education  24 (c Notes )A m (Figures are in `) ity Solution: 2.6 Journal Amity Directorate of Distance & Online Education Assets Liabilities +Capital Cash U Inventory Land Building Machinery Creditors Bills