Financial Systems

Unit 1

Financial Statements

Parties Interested in Financial Statements

Shareholders Investors Creditors Labour Government Researchers

Accounting Concepts
Business entity concept Money measurement concept Going concern concept Accounting period concept Accounting cost concept Duality aspect concept Realisation concept Accrual concept Matching concept

Business entity concept

Business enterprise and its owners are two separate independent entities. Business and personal transactions of its owner are separate

Significance
This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored. This concept restraints accountants from recording of owners private/ personal transactions. It also facilitates the recording and reporting of business transactions from the business point of view It is the very basis of accounting concepts, conventions and principles

Money measurement concept

All business transactions must be in terms of money, that is in the currency of a country.

Significance
This concept guides accountants what to record and what not to record. It helps in recording business transactions uniformly. If all the business transactions are expressed in monetary terms, it will be easy to understand the accounts prepared by the business enterprise. It facilitates comparison of business performance of two different periods of the same firm or of the two different firms for the same period.

Going concern concept

Business firm will continue to carry on its activities for an indefinite period of time.

Significance
This concept facilitates preparation of financial statements. On the basis of this concept, depreciation is charged on the fixed asset. It is of great help to the investors, because, it assures them that they will continue to get income on their investments. In the absence of this concept, the cost of a fixed asset will be treated as an expense in the year of its purchase. A business is judged for its capacity to earn profits in future.

Accounting period concept

All the transactions are recorded in the books of accounts for a specified period of time.

Significance
It helps in predicting the future prospects of the business. It helps in calculating tax on business income calculated for a particular time period. It also helps banks, financial institutions, creditors, etc to assess and analyse the performance of business for a particular period. It also helps the business firms to distribute their income at regular intervals as dividends.

Accounting cost concept

All assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price.

Significance
This concept requires asset to be shown at the price it has been acquired, which can be verified from the supporting documents. It helps in calculating depreciation on fixed assets. The effect of cost concept is that if the business entity does not pay anything for an asset, this item will not be shown in the books of accounts.

Duality aspect concept

Assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places.
Assets = Liabilities + Capital

Significance
This concept helps accountant in detecting error. It encourages the accountant to post each entry in opposite sides of two affected accounts.

Realisation concept
This concept states that revenue from any business transaction should be included in the accounting records only when it is realised. The term realisation means creation of legal right to receive money. Selling goods is realisation, receiving order is not.

Significance
It helps in making the accounting information more objective. It provides that the transactions should be recorded only when goods are delivered to the buyer.

Accrual concept
Accrual concept requires that revenue is recognised when realised and expenses are recognised when they become due and payable without regard to the time of cash receipt or cash payment.

Significance
It helps in knowing actual expenses and actual income during a particular time period. It helps in calculating the net profit of the business.

Matching concept
The matching concept states that the revenue and the expenses incurred to earn the revenues must belong to the same accounting period.

Significance
It guides how the expenses should be matched with revenue for determining exact profit or loss for a particular period. It is very helpful for the investors/shareholders to know the exact amount of profit or loss of the business.

Accounting Conventions
Consistency Disclosure Conservation Materiality

Consistency
The convention of consistency means that same accounting principles should be used for preparing financial statements year after year.

Significance

It facilitates comparative analysis of the financial statements. It ensures uniformity in charging depreciation on fixed assets and valuation of closing stock.

Disclosure
All material and relevant facts concerning financial statements should be fully disclosed.

Significance
It helps in meaningful comparison of financial statements of the different business units. This convention is of great help to investor and shareholder for making investment decisions. The convention of full disclosure presents reliable information.

Conservation
This convention is based on the principle that Anticipate no profit, but provide for all possible losses Profit should not be recorded until it is realised. But if the business anticipates any loss in the near future, provision should be made in the books of accounts for the same.

Significance
It helps in ascertaining actual profit. It is useful in the situation of uncertainties and doubts. It helps in maintaining the capital of the enterprise

Materiality
Only material fact i.e. important and relevant information should be supplied to the users of accounting information.

Significance
It helps in minimizing errors in calculation. It helps in making financial statements more meaningful. It saves time and resources.

Branches of Accounting
Financial Accounting Cost Accounting Management Accounting or Managerial Accounting

Financial Accounting
Mainly confined to the preparation of financial statements for the use of outsiders like creditors, banks and financial institutions etc. Purpose is to calculate profit or loss made by the business during the year and exhibit financial position of the business as on a particular date.

Cost Accounting
Function of cost accounting is to ascertain the cost of the product and to help the management in the control of cost.

Management Accounting
It is accounting for management. i.e., accounting which provides necessary information to the management for discharging its functions. It is the reproduction of financial accounts in such a way as will enable the management to take decisions and to control various business activities.

Systems of Record Keeping

Double Entry Cash System Mercantile System( Accrual Concept)

Accounting Standard
Accounting standard provides uniform practices and common techniques of accounting. Accounting standards are applicable to all corporate enterprises.

Accounting Standard Board

The Institute of Chartered Accountants of India (ICAI) constituted the Accounting Standards Board (ASB) on 21 st April, 1977.

Objectives and Functions of the Accounting Standards Board

To conceive of and suggest areas in which Accounting Standards need to be developed. To formulate Accounting Standards with a view to assisting the Council of the ICAI in evolving and establishing Accounting Standards in India. To examine how far the relevant International Accounting Standard/International Financial Reporting Standard can be adapted while formulating the Accounting Standard and to adapt the same. To review, at regular intervals, the Accounting Standards from the point of view of acceptance or changed conditions, and, if necessary, revise the same. To provide, from time to time, interpretations and guidance on Accounting Standards. To carry out such other functions relating to Accounting Standards.