Introduction to

UNIT 1 INTRODUCTION TO ACCOUNTING Accounting

Objective
After studying this unit, you should be able to appreciate:

 Nature and role of accounting;

 Meaning and objectives of accounting

 Different branches of accounting

 Users of Accounting information

 The basic accounting concepts, principles and conventions

Structure
1.1 Introduction
1.2 Scope and Objectives of Accounting
1.3 Definition of Accounting
1.3.1 Steps in Accounting Cycle
1.3.2 Book Keeping vsAccounting
1.3.3 Systems of Accounting
1.3.4 Applications of Accounting
1.3.5 Qualitative Characteristics of Accounting
1.4 Accounting as an Information System of Accounting
1.4.1 Nature of Accounting Function
1.5 Emerging role of Accounting
1.6 Accounting Personnel
1.7 Accounting Framework
1.7.1 Accounting Concepts
1.8 Summary
1.9 Answers to Check Your Progress

1.1 INTRODUCTION
Accounting is often called the language of business. The basic function of
any language is to serve as a means of communication. In this context, the
purpose of ac-counting is to communicate or report the results of business
operations and its various aspects. Accounting has been defined in various
ways. According to one commonly accepted definition, "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
financial character and interpreting the results thereof'. Another definition
which is less restrictive interprets accounting as "The process of identifying,
measuring and communicating economic information to permit informed
judgements and decisions by the users of information".
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Accounting: An
Overview
1.2 OBJECTIVESAND SCOPE OF ACCOUNTING
The main objectives of accounting are:

To maintain a systematic record of business transactions

 Accounting is prepared to maintain a systematic record of all the
financial transactions or monetary transaction in a book of accounts
 For this purpose, all the transactions are recorded in chronological order
in Journal and then posted to principal book i.e. Ledger, Trial balance.
To ascertain profit and loss
 Every businessman is curious to know the net results of business
operations periodically.
 In order to find out whether the business has earned profits or incurred
losses, we prepare a “Profit & Loss Account”.
To determine the financial position
 Another important objective is to determine the financial position of the
business to check the value of assets and liabilities.
 For this purpose, we prepare a “Balance Sheet”.
To provide information to various users
 The most important objectives of accounting. Is to provide information
to the various interested parties or stakeholders
 The information provided by accounts helps them in making good
financial decisions.
To assist the management
 By analysing financial data and providing interpretations in the form of
reports, accounting assists management in handling business operations
effectively.
SCOPE OF ACCOUNTING
The scope of accounting can be presented in a diagrammatic form as shown
in Figure 1.1.

Source: Adapted from R.J. Bull, Accounting in Business, Butterworths, London, 1969,p.2.
8
Data creation and collection is the area which provides raw material for Introduction to
Accounting
accounting. The data collected is `historic' in the sense that it refers to events
which have already taken place. Earlier, accounting was largely concerned
with what had happened, rather than making any attempt to predict and
prepare for future.

After the historic data has been collected, it is recorded in accordance with
generally accepted accounting theory. A large number of transactions or
events have to be entered in the books of original entry (journals) and ledgers
in accordance with the classification scheme already decided upon. The
recording and processing of information usually accounts for a substantial
part of total accounting work. This type of activity of accounting may be
called recordative. The processing method employed for recording may be
manual, mechanical or electronic. Computers are also used widely in modern
business for doing this job.

Data evaluation is regarded as the most important activity in accounting

these days. Evaluation of data includes controlling the activities of business
with the help of budgets and standard costs (budgetary control), evaluating
the performance of business, analysing the flow of funds, and analysing the
accounting information for decision-making purposes by choosing among
alternative courses of action.

The analytical and interpretative work of counting may be for internal or

external uses and may range from snap answers to elaborate reports produced
by extensive research. Capital project analysis, financial forecasts, budgetary
projections and analysis for reorganisation, takeover or merger often lead to
research-based reports.

Data evaluation has another dimension and this can be known as the auditive
work which focuses on verification of transactions as entered in the books of
account and authentication of financial statements. This work is done by
public professional accountants. However, it has become common these days
for even medium-sized organisations to engage internal auditors to keep a
continuous watch over financial flows and review the operation of the
financial system.

Data reporting consists of two parts-external and internal. External reporting

refers to the communication of financial information (viz., earnings, financial
and funds position) about the business to outside parties, e.g., shareholders,
government agencies and regulatory bodies of the government. Internal
reporting is concerned with the communication of results of financial analysis
and evaluation to management for decision-making purposes.

You will note that accounting theory has been shown in the centre of the
diagram.

The central purpose of accounting is to make possible the periodic matching

of costs (efforts) and revenues (accomplishments). This concept is the
nucleus of accounting theory. However, accounting is moving away from its
traditional procedure-based record -keeping function to the adoption of a role
which emphasises its social importance.
9
Accounting: An
Overview
1.3 DEFINITION OF ACCOUNTING
Accounting can be defined as a process of reporting, recording, interpreting
and summarising economic data. The introduction of accounting helps the
decision-makers of a company to make effective choices, by providing
information on the financial status of the business

Accounting is a system which identify the transaction, record those

transaction of a business organisation in a way that can be compared with the
other business as well as within the business with the past performance..
Accounting is a part of our daily life a person most common use of
accounting is to check accounts, Tax forms, Pay roll any credit taken all these
experience focus on record keeping part of accounting. Now days due to
advancement of technology the recording part is done with the help of
technology still the analysis is done by human minds thus understanding the
various concept of accounting is important

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”.

As per Robert N. Anthony – “Accounting system is a means of collecting,

summarizing, analyzing and reporting, in monetary terms, information about
the business”.

To understand accounting efficiently, it is important to understand the

following aspects of accounting.

Economic Events- Economic events are those which are a result of a

consequence of a monetary transaction which company has to undergo during
its lifetime. Such as purchasing new machinery, transportation, machine
installation on-site, etc.

Identification, Measurement, Recording, and Communication- The

purpose of accounting system should be elaborated in such a way that the
right data is identified, measured, recorded and communicated to the right
individual and at the right time.

Organization-It refers to the size of business and the types of activities.

Assets –Assets are those resources owned by organization which helps the
company to earn profit. The economic value of an item which is possessed by
the enterprise is referred to as Assets. e.g. Plant and Machinery, Furniture and
Fittings, Land and Buildings, Books, Computers, Motor Vehicles, etc Assets
can Tangible which can be seen or touched and Intangible for example
Goodwill, Patent etc,

Liabilities - The economic value of an obligation or debt that is payable by

the enterprise to other establishment or individual is referred to as liability. In
other words, liabilities are the obligations or responsibility that are arise out
of previous transactions, which is payable by the enterprise, through the
10 assets possessed by the enterprise. Liabilities can be classified as Fixed and
current. For example outstanding expenses , Debentures , Loans from banks Introduction to
Accounting
and financial institutions

Owner’s Equity - Owner‟s equity is one of the 3 vital segments of a sole

proprietorship‟s balance sheet and one of the main aspects of the accounting
equation:

Assets = Liabilities + Owner’s Equity.

It represents the owner‟s investment (Capital) in the trade minus the owner‟s
withdrawal from the trade (Drawings) + the net income since the business
concern commenced.

1.3.1 Steps in Accounting Cycle

The following attributes or characteristics can be drawn from the definition of
Accounting:

Identifying financial transactions and events

 Only those transactions and events which are of financial nature.

 Therefore, first of all, such transactions and events are identified.

Measuring the transactions

 The transactions and events are measured in terms of money which is
considered as a common unit.

Recording of transactions
 Accounting involves recording the financial transactions inappropriate
book of accounts such as Journal or Subsidiary Books.

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‟.

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.

Analysing and interpreting financial data

 Results of the business are analyzed and interpreted so that users of
financial statements can make a meaningful and sound judgment.

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. It not only
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Accounting: An record classifies and summaries the business data but also analyse and
Overview
interprets the results for the future decisions.

1.3.2 Bookkeeping Vs Accounting

Bookkeeping It is a component of accounting that involves the process of

identifying the financial transactions, measuring, recording
and classifying those transactions that have occurred in the
course of business.

Accounting Accounting begins where Book Keeping ends. It is a wider

concept and includes summarizing, interpreting and
communicating the financial data to the users of financial
statements.

Accountancy Accountancy refers to systematic knowledge of the

accounting principles and the techniques.

Parameters Bookkeeping Accounting

Scope It involves identifying, In addition to bookkeeping,

measuring, recording & Accounting also involves
classifying financial summarizing, interpreting and
transactions in the ledger communicating the financial data
accounts. to the users of financial
statements.

Objective The major objective is to Its objective is to determine the

maintain systematic profitability and financial
records of financial position of the business.
transactions.

Stage It is a primary stage of Accounting starts where book

accounting keeping ends.

Nature of It is routine and It is analytical in nature.

job repetitive in nature.

Level of Bookkeeping does not It requires specialized skill and is

skills require special skills and performed by senior staff.
is performed by Junior
Staff.

1.3.3 Systems of Accounting

There are following two systems of recording transactions in the books of
accounts:

12 I. Double Entry System

II. Single Entry System Introduction to
Accounting

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.

 Minimum two accounts are involved.

 The accounting equation should not be violated.

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 merits of the double-entry system of accounting:

i. Scientific system
 As compared to the single-entry systems, this system is more
scientific and is useful to achieve the objective of accounting.
ii. A complete record of the transaction
 Since both the aspects of transactions are considered, thus there is a
complete recording of each and every transaction.
 Using these records one can compute profit or loss easily.

iii. Checks arithmetical accuracy of accounts

 Under this system, one can check the arithmetical accuracy of the
records by preparing a Trial Balance.
iv. Determination of profit/loss and depiction of financial position
 Under this system one get to know about the profit earned or loss
incurred by preparing „Profit & Loss A/c‟ we get
 By preparing the „Balance Sheet‟ the financial position of the
business can be ascertained, i.e., position of assets and liabilities is
depicted.
v. Helpful in decision making
 Under the double-entry system of accounting, administration and
management are able to take decisions on the basis of factual
information.

1.3.4 Applications of Accounting

13
Accounting: An The following are the main applications of accounting:
Overview

Provide information about financial performance

 Accounting provides factual information about the financial performance
of an enterprise during a given time period.
 It provides information like, profit earned or loss incurred over a period
of time (through profit and loss statement) and financial position
(through balance sheet) at a particular point of time.
Provide assistance to management
 Accounting also assists the management in business planning, decision
making and in exercising control by providing financial information in
the form of reports.
Facilitates comparative study
 Accounting helps in making a comparison by keeping a systematic
records and preparation of reports at regular intervals.
Helps in settlement of tax liability
 Systematic accounting records further help in settlement of various tax
liabilities such as – Income Tax, GST, etc.
Helpful in raising loan
 On the basis of appraisal of the financial statement of the firm, banks and
Financial Institutions grant a loan to the firm.
Helpful in decision making
 Accounting also provides useful information to the management for
taking vital decisions.
Substitute of human memory:
 Since it is difficult for a human to remember all the transactions of the
business, accounting serve as a substitute of human memory by
recording all the transaction and keep all information handy as and one
require.
Helps in the valuation of business:
 In case of the shut down and dissolution of business , accounting helps
the businessman to determine the value of business otherwise it is not
possible to determine value of business

A. Limitations
Following are the limitations of accounting:

Accounting is not precise: Accounting is often subjected to personal bias or

judgment.
Accounting is done on historic values of assets: Accounting records assets
at their historical cost less depreciation and does not reflect their current
14 market value.
Ignore the effect of price level changes: Accounting statements are Introduction to
Accounting
prepared at historical cost and thus ignores the changes in the value of
money.

Ignore the qualitative information: Accounting ignores the qualitative

aspects as it records only monetary transactions.

Affected by window dressing: Window dressing means manipulation in

accounting, in order to present a more favourable position of the business
than the actual position.

1.3.5 Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information, which
enhance its understand ability and usefulness:
Reliability: Reliability means that the information must be free from material
error and personal bias. Unless the information is reliable the accounting
records cannot be prepared accurate.

Relevance: To be useful: accounting information must be relevant to the

decision-making requirements of the users.

Understand ability: 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. That is the performance of company can be
compared with its previous performance and with other companies also.

1.4 ACCOUNTING AS AN INFORMATION

SYSTEM
While discussing the scope of accounting you must have observed that
accounting involves a series of activities linked with each other, beginning
with the collecting, recording, analysing and evaluating the data, and finally
communicating information to its users. Information has no meaning unless it
is linked with a certain purpose. Accounting as a social science can be
viewed as an information system since it has all the features of a system. It
has its inputs (raw data), processes (men and equipment), and outputs (reports
and information). If we consider accounting as an information system, then
we are in a position to make some important observations. First, the goal of
the system is to provide information which meets the needs of its users. If we
can correctly identify the needs of the users, we are then able to specify the
nature and character of the outputs of the system. Secondly, it is the output
requirements that .determine the type of data which would be selected as the
inputs for processing into information output.

There are several groups of people who have a stake in a business

organisation-managers, shareholders, creditors, employees, customers, etc.
Additionally, the community at large has economic and social interest in the
activities of such organisations. This interest is expressed at the national level
by the concern of government in various aspects of the firms' activities, such
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Accounting: An as their economic well-being, their contribution to welfare, their part in the
Overview
growth of the national product, to mention only a few examples.

We shall now briefly discuss what the information needs of various users are.

Shareholders and Investors: Since shareholders and other investors have

invested their wealth in a business enterprise, they are interested in knowing
periodically about the profitability of the enterprise, the soundness of their
investment and the growth prospects of the enterprise. Historically, business
accounting was developed to supply information to those who had invested
their funds in business enterprises.

Creditors: Creditors may be short-term or long -term lenders. Short-term

creditors include suppliers of materials, goods or services. They are normally
known as trade creditors. Long-term creditors are those who' have lent money
for a long period, usually in the form of secured loans. The main concern of
the creditors is focused on the credit worthiness of the firms and its ability to
meet its financial obligations. They are therefore concerned with the liquidity
of the firms, its profitability and financial soundness. In other words, it can
also be stated that creditors are interested mainly in information which deals
with solvency, liquidity and profitability so that they could assess the
financial standing of the firms.

Employees: The view that business organisations exist to maximise the

return to shareholders has been undergoing change as a result of social
changes. A broader view is taken today of economic and social role of
management. The importance of harmonious industrial relations between
management and employees cannot be over-emphasised. That the employees
have a stake in the outcomes of several managerial decisions is recognised.
Greater emphasis on industrial democracy through employee participation in
management decisions has important implications for the supply of
information to employees. Matters like settlement of wages, bonus, and profit
sharing rest on adequate disclosure of relevant facts.

Government: In a mixed economy it is considered to be the responsibility of

the Government to direct the operation of the economic system in such a
manner that it sub serves the common good. Controls and regulations on the
operations of private sector enterprises are the hallmark of mixed economy.
Several government agencies collect information about various aspects of the
activities of business organisations. Much of this information is a direct
output of the accounting system, for example, levels of outputs, profits,
investments, costs, and taxes, etc. All this information is very important in
evolving policies for managing the economy. The task of the Government in
managing the industrial economy of the country is facilitated if accounting
information is presented, as far as possible, in a uniform manner. It is clear
that if accounting information is distorted due to manipulations and window-
dressing in the presentation of annual accounts, it will have ill-effects on the
measures the government intends to take and the policies it wishes to adopt.
Management: Organisations may or may not exist for the sole purpose of
profit. However, information needs of the managers of both kinds of
16 organisations are almost the same, because the managerial process i.e.,
planning, organising and controlling is the same. All these functions have one Introduction to
Accounting
thing in common and it is that they are all concerned with making decisions
which have their own specific information requirements. The emphasis on
efficient and effective management of organisations has considerably
extended the demand for accounting information. The role of accounting as
far as management is concerned was highlighted earlier when we discussed
about management accounting.

Consumers and others: Consumers' organisations, media, welfare

organisations and public at large are also interested in condensed accounting
information in order to appraise the efficiency and social role of the
enterprises in different sectors of the economy, that is, what levels of profits
and outputs are being achieved, in what way the social responsibility is being
discharged and in what manner the growth is being planned by the enterprises
in-accordance with the national priorities etc.

The above discussion perhaps has indicated to you that the information needs
of the various users may not necessarily be the same. Sometimes, they may
even conflict and compete with each other. In any case, the objective of
accounting information is to enable information users to make optimum
decisions.

1.4.1 Nature of Accounting Function

Accounting is a service function. The chief accounting executive (by
whatever name he is called) holds a staff position except within his own
department where he exerts authority. This is in contradistinction to the roles
played by production or marketing executives who hold line authority: The
role of the accountant is advisory in character. He works through the
authority of the chief executive. The accounts and or finance department(s)
don‟t exercise direct authority over line departments. In decentralised
structure with a number of units and divisions, the accounting executive
however exercises what is known as the functional authority over all the
accounting staff deployed in different segments.

There are two facets to the role of the accountant. For the top managers he
works as a watchdog and for middle and lower level managers he acts as
`
helper'. The watchdog role is usually performed through `score-keeping' task
of accounting and reporting to all levels of management. The `helper' role is
usually performed through the task of directing managers' attention to
problems and assisting them in solving problems.

Mutual understanding and rapport between the accountant and the manager,
in the tasks of attention-directing and problem-solving can be enhanced if
accountant and his staff frequently interact with the line managers and guide
them in matters concerned with preparation of budgets and control
documents with which they might not be conversant. This will instil
confidence among line managers regarding the reliability of reports.

17
Accounting: An
Overview
1.5 EMERGING ROLE OF ACCOUNTING
The history of accounting indicates the evolutionary pattern which reflects
changing socio-economic conditions and the enlarged purposes to which
accounting is applied. In the present context four phases in the evolution of
accounting can be distinguished.

Stewardship Accounting
In earlier times in history, wealthy people employed `stewards' to manage
their property. These stewards rendered an account of their stewardship to
their owners periodically. This notion lies at the root of financial reporting
even today which essentially involves the orderly recording of business
transactions, commonly known as 'book-keeping'. Indeed the accounting
concepts and procedures, in use today for systematic recording of business
transactions have their origin in the practices employed by merchants in Italy
during the 15th century. The Italian method which specifically began to be
known as `double entry book-keeping' was adopted by other European
countries during the 19th century. Stewardship accounting, in a sense, is
associated with the need of business owners to keep records of their
transactions, the property and tools they owned debts they owed, and the
debts others owed them.

Financial Accounting
Financial accounting dates from the development of large-scale business and
the advent of Joint Stock Company (a form of business which enables the
public to participate in providing capital in return for `shares' in the assets and
the profits of the company). This form of business organisation permits a
limit to the liability of their members to the nominal value of their shares.
This means that the liability of a shareholder for the financial debts of the
company is limited to the amount he had agreed to pay on the shares he
bought. He is into liable to make any further contribution in the event of the
company's failure or liquidation. As a matter of fact, the law governing the
operations (or functioning) of a company in any country (for instance the
Companies Act in India) gives a legal form to the doctrine of stewardship
which requires that information be disclosed to the shareholders in the form
of annual income statement and balance sheet.

Briefly speaking, the income statement is a statement of profit and loss made
during the year of the report; and the balance sheet indicates the assets held
by the firm and the monetary claims against the firm. The general
unwillingness of the company directors to disclose more than the minimum
information required by law and the growing public awareness have forced
the governments in various countries of the• world to extend the disclosure
(of information) requirements

The importance attached to financial accounting statements can be traced to

the need of the society to mobilise the savings and channel them into
profitable investments. Investors, whether they are large or small, must be
provided with reliable and sufficient information in order to be able to make
18
efficient investment decisions. This is the most significant social purpose of Introduction to
Accounting
financial accounting.

Cost Accounting
The industrial revolution in England presented a challenge to the
development of accounting as a tool of industrial management. Costing
techniques were developed as guides to management actions. The increasing
awareness on the part of entrepreneurs and industrial managers for using
scientific principles of management in the wake of scientific management
movement led to the development of cost accounting. Cost accounting is
concerned with the application of costing principles, methods and techniques
for ascertaining the costs with a view to controlling them and assessing the
profitability and efficiency of the enterprise.

Management Accounting
The advent of management accounting was the next logical step in the
developmental process.-The practice of using accounting information as a
direct aid to management is a phenomenon of the 20th century, particularly
the last 30-40 years. The genesis of modern management with its emphasis
on detailed information for decision- making provide a tremendous impetus
to the development of management accounting.

Management accounting is concerned with the preparation and presentation

of ac-counting and controlling information in a form which assists
management in the 'formulation of policies and in decision-making on
various matters connected with routine or non-routine operations of business
enterprise. It is through the techniques of management accounting that the
managers are supplied with information which they need for achieving
objectives for which they are accountable. Management accounting has thus
shifted the focus of accounting from recording and analysing financial;
transactions to using information for decisions affecting the future. In this
sense, management accounting has a vital role to play in extending the
horizons of modern business. While the reports emanating from financial
accounting are subject to the conceptual framework of accounting, internal
reports-routine or non-routine are free from such constraints.

Social Responsibility Accounting

Social responsibility accounting is a new phase in the development of
accounting and owes its birth to increasing social awareness which has been
particularly noticeable over the last two decades or so. Social responsibility
accounting widens the scope of accounting by considering the social effects
of business decisions; in addition to the economic effects. Several social
scientists, statesmen and social workers all over the world have been drawing
the attention of their governments and the people in their countries to the
dangers posed to environment and ecology by the unbridled industrial
growth. The role of business in society is increasingly coming under greater
scrutiny\ The management is being held responsible not only for efficient
conduct of business as expressed in profitability, but also for what it
contributes to social well being and progress. There is a growing feeling that
19
Accounting: An the concepts of growth and profit as measured in traditional balance sheets
Overview
and income statements are too narrow to reflect the social responsibility
aspects of a business.

Human Resource Accounting

Way back in 1964 the first attempt to include figures on human capital in the
balance sheet was made by Hermansson which later came to be known as
Human Resource Accounting. However there had been a great socio-
economic shift in the 1990's with the emergence of "Knowledge economy", a
distinctive shift towards recognition of human and intellectual capital in
contrast to physical capital. Human Resource Accounting is a branch of
accounting which seeks to report and emphasise the importance of human
resources (knowledgeable, trained, loyal and committed employees) in a
company's earning process and total assets. It is concerned with "the process
of identifying and measuring data about human resources and communicating
this information to interested parties". In simple words it involves accounting
for investment in people and replacement costs as well as accounting for the
economic values of people to an organisation. Generally the methods used for
valuing and accounting of human resources are either based on costs or on
economic value of human resources., However providing adequate and valid
information on human assets (capital), which are outside the concept of
ownership, in figures is very difficult. Nevertheless HRA is a managerial tool
providing valuable information to the top management to take decisions
regarding adequacy of human resources and thus encouraging managers to
consider investment in manpower in a more positive way.

Inflation Accounting
Inflation Accounting is concerned with the adjustment in the value of assets
(current and fixed) and of profit in the light of changes in the price level. In a
way, it is concerned with the overcoming of limitations that arise in financial
statements on account of the cost assumption (that is recording of the assets
at their historical or original cost) and the assumption of stable monetary unit
(these are discussed in detail in the next unit). It thus aims at correcting the
distortions in the reported results caused by price level changes. Generally,
rising prices during inflation have the distorting influence of overstating the
profit. Various approaches have been suggested to deal with this problem.

1.6 ACCOUNTING PERSONNEL

There is hardly any organisation which does not have an accountant. His role
is all pervasive and he is involved in a wide range of activities, particularly in
a large and complex organisation. The exact duties of an accountant might
differ in different organisations. However, a broad spectrum of
responsibilities can be identified.

The accountants can be broadly divided into two categories, those who are in
public practice and those who are in private employment. The accountants in
public practice offer their services for conducting financial and or cost audit.
As such, they are known as auditors. The auditor examines the books of
20
account and reports on the balance sheet and profit and loss account of the Introduction to
Accounting
company as to whether they give a true and fair view of the state of affairs of
the company and its profit respectively. The auditor in a company is
appointed by the shareholders to whom he reports. Public accountants are
generally members of professional bodies like the Institute of Chartered
Accountants of India or the Institute of Cost and Works Accountants of India.
In addition to conducting financial or cost audit (in accordance with the
requirements of the Companies Act), as the case may be, they may also
provide consultancy services for design Qing or improving accounting and
management control systems.

Accountants in employment may be in various business or non-business

organisations to perform a variety of accounting and management control
functions. Accountants at higher levels generally belong to professional
accounting bodies but those who are at

lower levels need not be so. Accounting chiefs in different organisations,

depending upon their nature of work, are variously designated as finance
officers or internal auditors or chiefs accounts officers, etc. The term
`controller' as the head of the accounting and finance function is not very
popular in India but of late it has been catching up. Several large
organisations, both in the public and private sectors, have now controllers.
Let us have an idea of who these people are and what they do.

Internal Auditor: Internal Auditor is an employee of the organisation in

contrast to an external auditor who is paid a fee for his services. The internal
auditor is responsible for performing monitoring activities and other services,
including designing and operating the system of internal control, auditing the
data reported to the directors of the company, and assisting external auditors.
The head of the internal audit function and reports directly either to the chief
executive or to the audit committee of the Board of Directors.

Internal audit includes continuous verification of entries appearing in the

books of account with the original vouchers and proper accounting of assets.
Further, it at-tempts to ensure that the policies and procedures regarding
financial matters are being complied with. Internal auditing is also concerned
with administering the system of internal check so that mistakes, innocent or
intentional, are prevented from taking place.

We should distinguish an internal auditor from an external auditor. While an

internal auditor devotes his entire time and energy to the needs of one
company (i.e., his employer), an external auditor serves many clients. The
primary function of the external auditor, as pointed out earlier, is to safeguard
the interests of the shareholders (by whom he is appointed) by an
independent and impartial appraisal of the financial transactions of the
company so that he could report on the net profit earned by the company and
its financial position. His role is that of an objective outsider, expressing
expert opinions to the financial condition and operating results of the client's
business.

A part from shareholders, other parties such as banks, lending institutions,

government agencies, etc. reply on the fairness of such financial reports in 21
Accounting: An making certain decision about a given company. An auditor is bound by a set
Overview
of professional regulations which include an examination on technical
competence and adherence to a code of ethical conduct.

Controller : Controller- the other name for Chief Accountant- is usually the
head of the whole area of accounting, including internal audit. He is overall
in - charge of all the activities comprising financial accounting, cost
accounting, management accounting, tax accounting etc. He exercises
authority both for accounting within the organisation and for external
reporting. The external reports include reports to government revenue
collecting and regulatory bodies, such as Company Law Board and Income
Tax. Department He may also supervise the company's internal audit and
control systems. In addition to processing historical data, he is expected to
supply a good deal of accounting information to top management concerning
future operations, in line with the management's planning and control needs.
Besides, he is also expected to supply detailed information to managers in
different functional areas ( like production, marketing, etc.) and at different
levels of the organisation.

We may enumerate the functions of the controller as follows:

a) Designing and operating the accounting system

b) Preparing financial statements and reports
c) Establishing and maintaining systems and procedures
d) Supervising internal auditing and arranging for external audit
e) Supervising computer applications
f) Overseeing cost control
g) Preparing budgets
h) Making forecasts and analytical reports
i) Reporting financial information to top management
j) Handling tax matters.

Treasurer: He is the custodian arid manager of all the cash and near-cash
resources of the firm. The treasurer handles credit reviews and sets policy for
collecting receivables (debtors of the firm to whom the firm has sold goods or
services) He also handles relationships with banks and other lending or
financial institutions.

The Financial Executive Institute (of United States of America) makes the
following distinction between controllership and treasurer ship functions:
Controllership Treasurership
Planning and Control Provision of Capital
Reporting and Interpreting Investor Relations
Evaluating and Consulting Short-term Financing
Tax Administration Banking and Custody
Government Reporting Credit and Collections
Protection of Assets Investments
22 Economic Appraisal Insurance
Finance Officer: Finance is the life blood of business. Procuring financial Introduction to
Accounting
resources and their judicious utilisation are the two important activities of
financial management. Financial management includes three major decisions:
investment decision, financing decision and dividend decision. Investment
decision is perhaps the most important decision because it involves allocation
of resources. It is concerned with future which being uncertain involves risk.
How the firm is allocating its scarce resources and is planning growth will
largely determine its value in the market place. Financing decision is
concerned with determining the optimum financing mix or capital structure.
It examines the various methods by which a firm obtains short-term and long
- term finances through various alternative sources. The dividend decision is
concerned with question like how much of the profit is to be retained and
how much is to be distributed as dividends. The finance manager has to strike
a balance between the current needs of the enterprise for cash and the needs
of the shareholders for an adequate return. The financial management of a
large company is usually the responsibility of the finance director who may
be in place of, or in addition to the controller. Often finance manager and
controller are inter-changeable terms and only one of these two positions may
be found in a company. The finance manager when there is a controller also
in the organisation, is concerned with implementing the financial policy of
the board of directors, managing liquidity, preparation of budgets and
administration of budgetary control system, managing profitability, etc.

Though financial management is regarded as a separate area, this function is

per-formed in several countries, including India, by the Accountant ( or the
Financial Controller) several large organisations however have a financial
executive besides the chief accountant. Often, finance and accounting
functions are clubbed together in one person in small organisations.

1.7 ACCOUNTING FRAMEWORK

The rules and conventions of accounting are commonly referred to as the
conceptual framework of accounting. As with any discipline or body of
knowledge, some underlying theoretical structure is required if a logical and
useful set off practices and procedures are to be developed for reaching the
goals of the profession and for expanding knowledge in that field. Such a
body of principles is needed to help answer new questions that arise. No
profession can thrive in the absence of a theoretical frame-work. According
to Hendriksen (1977), Accounting theory may be defined as logical reasoning
in the form of a set of broad principles that

(i) provide a general frame of reference by which accounting practice

can be evaluated, and

(ii) guide the development of new practices and procedures. Accounting

theory may also be used to explain existing practices to obtain a
better understanding of them. But the most important goal of
accounting theory should be to provide a coherent set of logical
principles that form the general frame of reference for the evaluation
and development of sound accounting practices.
23
Accounting: An The American Institute of Certified Public Accountants (AICPA) discusses
Overview
financial accounting theory and generally accepted accounting principles as
follows.

Financial statements are the product of process in which a large volume of

data about aspects of the economic activities of an enterprise are
accumulated, analysed, and reported. This process should be carried out in
accordance with generally accepted accounting principles. Generally
accepted accounting principle incorporate the consensus at a particular time
as to which economic resources and obligations should be recorded as assets
and liabilities by financial accounting, which changes in assets and liabilities
should be recorded, when these changes should be recorded, how the assets
and liabilities and changes in them should be measured, what information
should be disclosed and how it should be disclosed, and which financial
statements should be prepared.

Generally accepted accounting principles encompass the conventions, rules

and procedures necessary to define accepted accounting practice at a
particular time generally accepted accounting principles include not only
broad guidelines of general application, but also detailed practices and
procedures.

(Source: AICPA Statements of the Accounting Principles Board No.4 "Basic

Concept and Accounting Principles Underlying Financial Statement of
Business Enterprises", October, 1970, pp.54-55)

The word `principles' is used to mean a "general law or rule adopted or

professed as a guide to action, a settled ground or basis of conduct or
practice". You will note that this definition describes a principle as a general
law or rule that is to be used as a guide to action. This implies that
accounting principles do not prescribe exactly how each detailed event
occurring in business should be recorded. Consequently, there are several
matters in accounting practice that may differ from one company to another.

Accounting principles are man-made. They are accepted because they are
believed to be useful. The general acceptance of an accounting principle (or
for that matter any principle) usually depends on how well it meets the three
criteria of relevance, objectivity, and feasibility. A principle is relevant to
the extent that it results in meaningful or useful information to those who
need to know about a certain business. A principle is objective to the extent
that the information is not influenced by the personal bias or judgment of
those who furnished it. Objectivity connotes reliability or trustworthiness
which also means that the correctness of-the information reported can be
verified. A principle is feasible to the extent that it can be implemented
without undue complexity or cost.

1.7.1 Accounting Concepts

Earlier, we had described accounting as the language of business. As with
language, accounting has many dialects. There are differences in
24
terminology. In dealing with the framework of accounting theory, one is Introduction to
Accounting
confronted with a serious problem arising from differences in terminology. A
number of words and terms have been used by different writers to express
and explain the same idea or notion. Thus, confusion abounds in the literature
in so far as the theoretical framework is concerned. The various terms used
for describing the basic ideas are: concepts, postulates, propositions, basic
assumptions, underlying principles, fundamentals, conventions, doctrines,
rules, etc. Although each of these terms is capable of precise definition,
general usage by the profession of accounting has served to give them loose
and overlapping meanings. The same idea has been described by one author
as a concept and by another as a convention. To take another instance, the
idea implied in Conservatism has been labelled by one author as a
(modifying) convention, by another as a principle and yet by another as a
doctrine. The wide diversity in terminology to express the basic framework
can only serve to confuse the learner

Without falling into the trap of this terminological maze, we are explaining
below some widely recognised ideas and we call all of these concepts. We do
feel, however, that some of these ideas have a better claim to be called
`concepts', while the rest should be called `conventions'. Fundamental
accounting concepts are broad general assumptions with underlie the periodic
financial accounts of business enterprises. The reason why some of these
ideas should be called concepts is that they are basic assumptions and have a
direct bearing on the quality of financial accounting information. The
alteration of any of the basic concepts (or postulates) would change the entire
nature of financial accounting.

Business Entity Concept

In accounting we make a distinction between business and the owner. All the
records are kept from the viewpoint of the business rather than from that of
the owner. An enterprise is an economic unit separate and apart from the
owner or owners. As such, transactions of the business and those of the
owners should be accounted for and reported separately. In recording a
transaction the important question is how does it affect the business? For
example, if the owner of a shop were to take cash from the cash box for
meeting certain personal expenditure, the accounts would show that cash had
been reduced even though it does not make any difference to the owner
himself. Similarly, if the owner puts cash into the business, he has a claim
against the business for capital brought in.

This distinction can be easily maintained in the case of a limited company

because a company has a legal entity (or personality) of its own. Like a
natural person it can engage itself in economic activities of producing,
owning, managing, storing, transferring, lending, borrowing and consuming
commodities and services. Distinction, however, is difficult in the case of
partnership, and even more so in the case of one-man business, accounting
still maintains separation of business and owner. This implies that owner's
personal and household expenses or obligations (e.g., expenditure on food,
clothing, entertainment, debts, mortgages, etc.) will not appear in the books
of account. It may be clarified that it is only for accounting purposes that
25
Accounting: An partnerships and sole proprietorships are treated as separate and apart from
Overview
the owners though law does not make such distinction. A creditor would be
justified in looking to both the business assets and the private estate of the
owner for satisfaction of his claim. One reason for this distinction is to make
it possible for the owners to have an account of the performance from those
who manage the enterprise. The managers are entrusted with funds supplied
by owners, banks and others; they are responsible for the proper use of the
funds. The financial accounting reports are designed to show how well this
responsibility has been discharged.

Activity 1.1
Apart from the reason mentioned above, can you think of any other reason
for justification of Business Entity Concept?

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Activity 1.2
The proprietor of a firm withdrew Rs. 50,000 for his personal use. This was
shown as an expense of the firm. Profits were reduced to pay a lower tax. Is
this right from accounting point of view?

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Money Measurement Concepts

In accounting, only those facts which can be expressed in terms of money are
recorded. As money is accepted not only as a medium of exchange but also as
a store of value, it has a very important advantage since a number of widely
different assets and equities can be expressed in terms of a common
denominator. Without these adding heterogeneous factors like five buildings,
ten machines, six trucks will not have much meaning.

While money is probably the only practical common denominator and a

yardstick, we must realise that this concept imposes two sever limitations. In
the first place, there are several facts which, though vital to the business,
cannot be recorded in the books of account because they cannot be expressed
26
in money terms. For example, the state of health of the Managing Director of Introduction to
Accounting
a company who has been the key contributor to the success of business is not
recorded in the books. Similarly, the fact that the Production Manager and the
Chief Internal Auditor are not on speaking terms, or that a strike is about to
begin because labour is dissatisfied with the poor working conditions in the
factory, or that a competitor has recently taken over the best customer, or that
it has developed a better product and so on will not be recorded even though
all these events are of great concern to the business.

From this standpoint, one could say that accounting does not give a complete
account of the happenings in the business. You will appreciate that all these
have a bearing on the future profitability of the company.

Secondly, use of money implies that a rupee today is of equal value to a

rupee ten years back or ten years later. In other words, we assume stable or
constant value of rupee. In the accounts, money is expressed in terms of its
value at the time an event is recorded. Subsequent changes in the purchasing
power of money do not affect this amount. You are perhaps aware that most
economies today are in inflationary conditions with rising prices. The value
of a rupee of 1980's has depreciated to an unbelievably low level in the 90s.
Most accountants know fully well that purchasing power of rupee does
change but very few recognise this fact in accounting books and make
allowance for changing price level. This is so despite the fact that accounting
profession has devoted considerable attention to this problem and numerous
suggestions have been made to account for the effects of changes in the
purchasing power of money. In fact, one of the major problems of accounting
today is to find means of solving the measurement problem, that is, how to
extend the quality and the coverage of meaningful information. It will be
desirable to present in a supplementary analysis the effect of price level
changes on the reported income of the business and the financial position.

Activity 1.3
Suppose the Managing Director of a company is killed in a plane crash. To
the extent "an organisation is the lengthened shadow of a man", the real value
of the company will change immediately and this will be reflected in the
market price of the company shares. Will this have any effect as far as the
accounts of the company are concerned?

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27
Accounting: An ............................................................................................................................
Overview
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Continuity Concept
Accounting assumes that the business (an accounting entity) will continue to
operate for a long time in the future unless there is good evidence to the
contrary. The enterprise is viewed as a going concern, that is, as continuing
in operation, at least in the foreseeable future. The owners have no intention
nor have they the necessity to windup or liquidate its operations.

This assumption is of considerable importance for it means that the business

is viewed as a mechanism for adding value to resources it uses. The success
of the business can be measured by the difference between output values
(sales or revenues) and input values (expenses). Therefore, all unused
resources can be reported at cost rather than at market values.

The assumption that the business is not expected to be liquidated in the

foreseeable future, in fact, establishes the basis for many of the valuations
and allocations in accounting. For example, depreciation (or amortisation)
procedures rest upon this concept. It is this assumption which underlies the
decision of investors to commit capital to enterprise. The concept holds that
continuity of business activity is the reasonable expectation for the business
unit for which the accounting function is being performed. Only on the basis
of this assumption can the accounting process remain stable and achieve the
objective of correctly recording and reporting on the capital invested, the
efficiency of management, and the position of the enterprise as a going
concern. Under this assumption neither higher current market values nor
liquidation values are of particular importance in accounting. This
assumption provides a basis for the application of cost in accounting for
assets.

However, if the accountant has good reasons to believe that the business, or
some part of it, is going to be liquidated or that it will cease to operate (say
within a year or two), then the resources could be reported at their current
values (or liquidation values).

Activity 1.4
A company revalue‟s its buildings which were purchased at a cost of Rs.
5,00,000 in 2005 to Rs. 50,00,000 in 2021 and records the difference of Rs.
45,00,000 as profit for the year 2021. Is this practice right?

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28 ............................................................................................................................
............................................................................................................................ Introduction to
Accounting
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Cost Concept
The resources (land, buildings, machinery, property rights, etc.) that a
business owns are called assets. The money values that are assigned to assets
are derived from the cost concept. This concept states that an asset is worth
the price paid for or cost incurred to acquire it. Thus, assets are recorded at
their original purchase price and this cost is the basis for all subsequent
accounting for the assets. The assets shown on the financial statements do not
necessarily indicate their present market worth (or market values). This is
contrary to what is often believed by an uninformed person reading the
statement or report. The term `book value' is used for amount shown in the
accounting records.

In case of certain assets the accounting values and market values may be
similar; cash is an obvious example. In general, the longer an asset has been
owned by the company the lesser, are the chances that the accounting value
will correspond to the market value.

The cost concept does not mean that all assets remain on the accounting
records at their original cost for all time to come. The cost of an asset that has
a long but limited life is systematically reduced during its life by a process
called `depreciation' which will be discussed at some length in a subsequent
unit. Suffice it to say at this point that deprecation is a process by which the
cost of the asset is gradually reduced (or written off) by allocating a part of it
to expense in each accounting period. This will have the effect of reducing
the profit of each period. In charging depreciation the intention is not to
change depreciation equal to the fall in the market value of the asset. As such,
there is no relationship between depreciation and changes in market value of
the assets. The purpose of depreciation is to allocate the cost of an asset over
its useful life and not to adjust its cost so as to bring it closer to the market
value.

You must be wondering as to why assets are shown at cost even when there
are wide differences between their costs and market values. The main
argument is that the cost concept meets all the three basic criteria of
relevance, objectivity and feasibility.

Accrual Concept
The accrual concept makes a distinction between the receipt of cash and the
right to receive it, and the payment of cash and the legal obligation to pay it.
In actual business operations, the obligation to pay and the actual movement
of cash may not coincide. The accrual concept recognises this distinction. In
connection with the sale of goods, revenue may be received
(i)before the right to receive arises, or

(ii) after the right to receive has been created.

The accrual concept provides a guideline to the accountant as to how he 29

Accounting: An should treat the cash receipt and the rights related thereto. In the former case
Overview
the receipt will not be recognised as the revenue of the period for the reason
that the right to receive the same has not yet arisen. In the latter case the
revenue will be recognised even though the amount is received in the
subsequent period.

Similar treatment would be given to expenses incurred by the firm. Cash

payments for expenses may be made before or after they are due for payment.
Only those sums which are due and, payable would be treated as expenses. If
a payment is made in advance (i.e. it does not belong to the accounting period
in question) it will not be treated as an expense, and the person who received
the cash will be treated as a debtor until his right to receive the cash has
matured. Where an expense has been incurred during the accounting period
but no payment has been made, the expense must be recorded and the person
to whom the payment should have-been made is shown as a creditor.

Activity 1.5
The accounting year of a firm closes on 31st December each year. The rent
for business premises of Rs 50,000 for the last quarter could not be paid to
the owner on account of his being away in a foreign country. Should the rent
payable be taken into account for computing the firm's income for the
accounting year?

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Activity 1.6
A government contractor supplies stationery to various government offices.
Some bills amounting to Rs. 10,000 were still pending with various offices at
the close of the accounting year on 31st March. Should the businessman take
the revenue of Rs.10,000 into account for computing the net profit of the
period?

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30
Concept of Conservatism Introduction to
Accounting
The concept of conservatism, also known as the concept of prudence, is often
stated as" anticipate no profit, provide for all possible losses". This means an
accountant should follow a cautious approach. He should record lowest
possible value for assets and revenues, and the highest possible value for
liabilities and expenses. According to this concept, revenues or gains should
be recognised only when they are realised in the form of cash or assets
(usually legally enforceable debts)the ultimate cash realisation of which can
be assessed with reasonable certainty. Further, provision must be made for all
known liabilities, expenses and losses whether the amount of these is known
with certainty or is at best an estimate in the light of the information
available. Probable losses in respect of all contingencies should also be
provided for. A contingency is a condition or a situation, the ultimate
outcome of which –gain or loss-cannot be determined accurately at present. It
will be known only after the event has occurred (or has not occurred). For
example, a customer has filed a suit for damage against the company in a
court of law. Whether the judgment will be favourable or unfavourable to the
company cannot be determined for sure. Hence, it will be prudent to provide
for likely loss in the financial statements. As a consequence of the application
of this concept, net assets are more likely to be understated than overstated,
and income is more likely to be overstated than understated. Based on this
concept is the widely advocated practice of valuing inventory (stock of goods
left unsold) at cost or market price whichever is lower? You will note that
this convention, in a way, modifies the earlier cost concept. It should be
stated that the logic of this convention has been under stress recently; it has
been challenged by many writers on the ground that it stands in the way of
fair determination of profit and the disclosure of true ad fair financial position
of the business enterprise. The concept is not applied as strongly today as .it
used to be in the past. In any case, conservatism must be applied rational Y as
over-conservatism may result in misrepresentation.

Materiality Concept
There are many events in business which are trivial or insignificant in nature.
The cost of recording and reporting such events will not be justified by the
usefulness of the information derived. Materiality concept holds that items of
small significance need not be given strict theoretically correct treatment. For
example, a paper stapler costing Rs. 30 may last for three years. However, the
effort involved in allocating its cost over the three-year period is not worth
the benefit than can be derived from this operation. Since the item obviously
is immaterial when related to overall operations, the cost incurred on it may
be treated as the expense of the period in which it is acquired. Some of the
stationery purchased for office use in any accounting period may remain
unused at the end of that period. In accounting, the amount spent on entire
stationery would be treated as expense of the period in which the stationery
was purchased, notwithstanding the fact that a small part of it still lies in
stock. The value (or cost) of the stationery lying in stock would not be treated
as an asset and carried forward as a resource to the next period. The
accountant would regard the stock lying unused as immaterial. Hence, the
31
Accounting: An entire amount spent on stationery would be taken as the expense of the period
Overview
in which such expense was incurred.

Where to draw the line between material and immaterial events is a matter of
judgment and common sense. There are no hard and fast rules in this respect.
Whether a particular item or occurrence is material or not, should be
determined by considering its relationship to other items and the surrounding
circumstances. It is desirable to establish and follow uniform policies
governing such matters.

Consistency Concept
In practice, there are several ways to record an event or a transaction in the
books of account. For example, the trade discount on raw material purchased
may be deducted from the cost of goods and net amount entered in the books,
or alternatively trade discount maybe shown as the income with full cost of
raw material purchased entered in the books. Similarly, there are several
methods to charge depreciation (which is a decrease in the value of assets
caused by wear and tear, and passage of time) on an asset or of valuing
inventory. The consistency concept requires that once a company has decided
on one method and has used it for some time, it should continue to follow the
same method or procedure for all subsequent events of the same character
unless it has a sound reason to do otherwise. If for valid reasons the company
makes any departure from the method it has been following so far, then the
effect of the change must be clearly stated in the financial statements in the
year of change.

You will appreciate that much of the utility of accounting information lies in
the fact that one could draw valid conclusions from the comparison of data
drawn
fromfinancialstatementsofoneyearwithdataoftheotheryear.Comparabilityisess
ential so that trends or differences may be identified and evaluated.
Inconsistency in the application of accounting methods might significantly
affect the reported profit and the financial position. Further, inconsistency
also opens the door for manipulation of reported income and assets. The
comparability of financial information depends largely upon the consistency
with which a given class of events are handled in ac-counting records year
after year.

Activity 1.7
A company had been charging depreciation on a machine at Rs. 10,000 per
year for the first 3 years. Then it began charging Rs. 9,000 for 4th year and
Rs. 7,800 for 5thyearand so on. Is this practice justified? Give reasons for
your answer.

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32
............................................................................................................................ Introduction to
Accounting
Periodicity Concept
Although the results of operations of a specific enterprise can be known
precisely only after the business has ceased to operate, its assets have been
sold off and liabilities paid off, the knowledge of the results periodically is
also necessary. Those who are interested in the operating results of business
obviously cannot wait till the end. The requirements of these parties therefore
force the accountant to report for the changes in the wealth of a firm for short
time periods. These time periods in actual, practice vary, though a year is the
most common interval as a result of established business practice, tradition
and government requirements. Some firms adopt calendar year, some others
financial year of the government. But more and more firms are changing to
the `natural' business year the end of which is marked by relatively lower or
lowest volume of business activity in the twelve-month period. The custom
of using twelve-month period is applied only for external reporting. The
firms usually adopt a shorter span of interval, say one month or three months,
for internal reporting purposes.

The allocation of long-term costs and the difficulties associated with this
process directly stem from this concept. While matching the earnings and the
cost of those earnings for any accounting period, all the revenues and all the
costs relating to the year in question have to be taken into account
irrespective of whether or not they have been
receivedincashorpaidcash.Despitethedifficultiesthatariseinallocationsand
adjustments, short-term reports (i.e., yearly reports) are of such importance to
owners, management, creditors, and other interested parties that the
accountant has no option but to resolve such difficulties. Obviously, the
utility of the periodic financial statements outweighs the difficulties.

While going through all these concepts, probably you have developed a
feeling that they come in conflict with each other. You are right. We illustrate
this by considering some of these concepts in the context of valuation of
business properties. Suppose, a firm acquired a piece of land in 2017 for a
price of Rs.6,00,000. Factory premises were constructed in 2018 and
operations commenced in2019. The firm has been successful in achieving
desired profit for the past year. The Balance Sheet (a statement of assets and
liabilities) for the year 2019 is being prepared and `Land' is required to be
valued. The estimated current market price of this land is Rs. 60,00,000.

Should you recommend that the land be valued at Rs. 60 lakhs? The answer
is `no' obviously. Land would be carried on the Balance Sheet at its original
cost of Rs,6,00,000 only. This decision is supported by several of the
concepts discussed in this section. In the first place, the stability of
purchasing power of money implied in the money measurement concept
prevents us from recognising accretion in values as
aresultofchangingpricelevels.Then,therealisationconceptwillnotallowunreali
sed profits to be included as long as land is held by the company and not
soldaway.Youmaynotethatthecontinuityorgoingconcernconceptmakesanypo
ssible market value of land irrelevant for balance sheet because the firm has
33
Accounting: An to continue in business and land will be needed by it for its own use. In this
Overview
connection,itcouldbearguedthatiflandwereshownonthebalancesheetatitsestima
tedcurrentmarketvalue,theownermightdecidetodiscontinuethebusiness,sellthel
and and retire. The principle of objectivity is now introduced into the
argument. It can be easily seen that in a situation like this the cost of
acquisition of land at Rs.6,00,000 in 2000 is the objective fact because it is
based on a transaction that actually took place and this objective evidence is
capable of being verified. In contrast, the estimate of current market value
figure may be suspect. It raises many questions. Do you have a market
quotation for an identical plot of land? Has a similar plot of land been sold
recently and can we pick it up as verifiable evidence of the current market
price? It may be said that even if market price for an identical plot of land is
not available, estimates by an accredited valuer may be accepted as verifiable
evidence of the market price. Further complications may be noticed if
buildings and facilities have been erected on the plot of land. Is it possible to
estimate the value of land without factory buildings and other facilities
constructed on it? The answer is a flat `no' and the conservatism concept will
then deter you from accepting an estimate of market value since it cannot be
ascertained with reasonable accuracy.

1.7.2 Accounting Standards

The basic concepts discussed in the foregoing paragraphs are the core
elements in the theory of accounting. These concepts (postulates or
conventions), however, permit a variety of alternative practices to co-exist.
As a result, the financial results of different companies cannot be compared
and evaluated unless full information is available about the accounting
methods which have been used. The varieties of accounting practices have
made it difficult to compare the financial results of different companies.
Further, the alternative accounting methods have also enabled the reporting
of different results, even by the same company.

Need for Standards: The information contained in published financial

statements is of particular importance to external users, such as shareholders
and investors. Without such information they would not be able to take right
decisions about their investments. As in several other countries, Parliament in
India has specified in the Companies Act the type and minimum level of
information which companies should disclose in financial statements. It is the
responsibility of the accounting profession to ensure that the required
information is properly presented. It is evident that there should not be too
much discretion to companies and their accountants to present financial
information the way they like. In other words, the information contained in
financial statements should conform to carefully considered standards. Public
confidence in accounting information contained in financial statements will
grow if they are satisfied as to the logic, consistency and fairness of the
figures shown there in. For instance, a company could incur a loss and still
pay dividends by manipulating the loss into a profit. In the long run this
course may have a disastrous effect on the company and its investors. You
would be better able to appreciate the function of accounting standards by
relating them to the basic purpose of financial statements which is the
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communication of information affecting the allocation of resources. Ideally, Introduction to
Accounting
such information should make it possible for investors to evaluate the
investment opportunities offered by different firms and allocate scarce
resource to the most efficient ones. In theory, this process should result in the
capital distribution of resources within the economy and should maximise the
potential benefit to society

In this context unless there are reasonably appropriate standards, neither the
purpose of the individual investor nor that of the nation as a whole can be
served. The purpose is likely to be served if the accounting methods used by
different firms for presenting information to investors allow correct
comparisons to be made. For example, they should not permit a company to
report profits which result simply from a change in accounting methods
rather than from increase in efficiency. If companies were free to choose their
accounting methods in this way, the consequences might be that deliberate
distortions are introduced, leading eventually to misapplication of resources
in the economy. The relatively less efficient companies will be able to report
fictitious profits, and as a result scarce capital of society will be diverted
away from the more efficient companies which have adopted stricter and
consistent accounting methods.

1.7.3 Changing Nature of Generally Accepted Accounting

Principles (GAAP)
Generally accepted accounting principles are usually developed by
professional accounting bodies like American Institute of Certified Public
Accountants (AICPA)and Institute of Chartered Accountants of India (ICAI).
In developing such principles, however, the accounting profession has to
reflect the realities of social, economic, legal and political environment in
which it operates. Besides academic research, regulatory and tax laws of the
government e.g., Companies Act, 1956, income Tax Act, 1961 etc., in a large
measure, influence the formulation of acceptable accounting principles. Stock
exchanges and other regulatory agencies like Securities and Exchange Board
of India (SEBI) have laid down rules for disclosure and extent of accounting
information.

Since the environment in which business operates, undergoes constant

changes as result of changes in economic and financial policies of the
Government and changes in the structure of business, continued evaluation of
the relevance of generally accepted accounting principles is required. In this
sense, the principles of accounting are not ever-lasting truths. You will
appreciate that it is the development of relevant accounting principles in tune
with the present day needs of the society that would make it possible for the
business enterprises to develop financial statements which would be
acceptable and of value to the end users.

1.8 SUMMARY
 Accounting can be defined as a process of reporting, recording,
interpreting and summarising economic data.

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Accounting: An  Assets are those resources owned by organization which helps the
Overview
company to earn profit.
 The economic value of an obligation or debt that is payable by the
enterprise to other establishment or individual is referred to as liability.
 Capital represents the owner‟s investment (Capital) in the trade minus
the owner‟s withdrawal from the trade (Drawings) + the net income since
the business concern commenced.
 The major objectives of accounting are –
o To maintain a systematic record of business transactions
o To ascertain profit and loss
o To determine the financial position
o To provide information to various users assist the management
 The major characteristics of accounting are –
o Identifying financial transactions and events
o Measuring the transactions
o Recording of transactions
o Classifying the transactions
o Summarising the transactions
o Analysing and interpreting financial data
o Communicating the financial data or reports to the users
 Financial, Cost and management accounting are the major branches of
accounting
 The Accounting process is the process of collecting, recording,
classifying, summarising and communicating financial information to the
users which help them in taking decisions.
 Book keeping is a component of accounting that involves the process of
identifying the financial transactions, measuring, recording and
classifying those transactions that have occurred in the course of
business.
 Accounting begins where Book Keeping ends. It is a wider concept and
includes summarizing, interpreting and communicating the financial data
to the users of financial statements.
 Accountancy refers to systematic knowledge of the accounting principles
and the techniques
 The major benefits of accounting are –
o Provide assistance to management
o Facilitates comparative study
o Helps in settlement of tax liability
o Helpful in raising loan
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 o Helpful in decision making Introduction to
Accounting
o Substitute of human memory
o Helps in the valuation of business
 Accounting is also criticized for not being precise, uses historical
information, ignores the effect of price level changes and qualitative
information and is often affected by window dressing.
 Users of accounting information include owners, management,
employees, trade union, customer, suppliers, bank, creditors, investors
and researchers.
 Qualitative characteristics are the attributes of accounting information,
which enhance it‟s understand ability and usefulness. It includes
reliability, relevance, and comparability and understand ability.
 There are two systems of recording transactions in the books of accounts
namely single entry and double entry system.
 In order to maintain uniformity and consistency in preparing and
maintaining books of accounts, certain rules or principles have been
evolved. These rules/principles are known as concepts and conventions.

1.9 SELF-ASSESSMENT QUESTIONS

1. Confidence and trust that the reported information is a reasonable
representation of the actual items and events, that have occurred, indicate
which qualitative characteristic of accounting information.
2. State whether a large order of supply of goods received by the firm be
recorded in books.
3. Appointment of a new managing director is not recorded in the books of
accounts. Why?
4. What is a person to whom money is owed by a firm called?
5. Mr Raj, an electronic goods dealer, gifted a microwave of value Rs.
30,000 to his friend Rohan and recorded it in books as drawing. Is he
correct?
6. Distinguish between financial accounting, cost accounting, and
management accounting.
7. Distinguish between book-keeping, accounting, and accountancy.
8. Basic objective of accounting is to provide useful information to various
users. Besides these, there are many other objectives of accounting.
Explain any four of them.
9. Select an appropriate option
I. That a business may only report activities on financial statements
that are specifically related to company operations, not those
activities that affect the owner personally, is known as which of the
following?
a. separate entity concept
37
Accounting: An b. monetary measurement concept
Overview
c. going concern assumption
d. time period assumption
II. That companies can present useful information in shorter time
periods such as years, quarters, or months is known as which of the
following?
a. separate entity concept
b. monetary measurement concept
c. going concern assumption
d. time period assumption
III. The system of using a monetary unit, such as the US dollar, to value
the transaction is known as which of the following?
a. separate entity concept
b. monetary measurement concept
c. going concern assumption
d. time period assumption
IV. Which of the following terms is used when assuming a business will
continue to operate in the foreseeable future?
a. separate entity concept
b. monetary measurement concept
c. going concern assumption
d. time period assumption

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