UNIT I

Accounting

1.1 Accounting – Definitions, Functions, Objectives, Nature and Scope , Limitation, Branches of Accounting

Accounting Definition

According to AW Johnson; "Accounting collects, edits, systematically records, prepares financial reports, analyses and interprets these reports, and uses these reports for management information and guidance. May be defined as. "

A technique for recording, classifying, and summarizing the terms of money, transactions, and events in a critical way, at least in part, of a monetary nature, and as a result. Interpret is called Accounting.  American Institute of Certified Public Accountants [AICPA];

A process of identifying, measuring, and communicating economic information that allows users of information to make informed decisions and decisions is known as Accounting." American Accounting Association [AAA]”

In light of the discussion above and the definition of accounting, we can thus give a comprehensive and meaningful definition of accounting.

Accounting is a field with the technology and methods to properly and systematically record, classify, and summarize all types of transactions that are measurable in terms of money or monetary value. This helps to present and explain income, expenses, loss of profits, and assets and liabilities for a particular period of time, and to provide management and investors with the information and statements they need.

So, we can say that Accounting is the art and science of tracking financial events.

Accounting systematically records business transactions from a financial perspective.

The accounting process produces financial reports and examines them to facilitate decision making.

Accounting is an ongoing process for providing information to interested users.

So, we can say. Accounting is defined as an information system that maintains the process of identifying and measuring quantitative financial activity and communicating these financial reports to decision makers or interested users of the organization.

Accounting is just a tool for measuring the financial position of any entity involved in economic activity. Accounting helps management.

It is a system that keeps a record of financial events, analyzes them, and presents a report of financial results and the location of economic agents.

The accounting process provides the governing body with the information it needs to make decisions. This information is needed by stakeholders. Inside and outside the organization.

The information that accounting provides is very important to do that. For this reason, accounting is also known as the "business language."

Accounting as a business language

Language is a medium of communication process that conveys one person to another, one person to another business, and one business to another, and takes several different forms, such as verbal, written, and non-verbal. You may.

It identifies, records, and communicates the financial events of a business organization to those users who are interested

Accounting is as old as money itself. As a child, commercial activities were based on barter systems, so record keeping was not necessary. The Industrial Revolution of the 19th century paved the way for commercial activity, mass production, and the development of credit terms, along with the rapid population growth. Therefore, the record of commerce has become an important function-

Accounting principles are expected to be feasible, predictable and applicable. It should be easy to apply to accounting systems and easy for anyone to implement.

For example, if you see fixed assets on your balance sheet, replacement costs are difficult, and fluctuations and people can cause fluctuations and market prices. It doesn't change from person to person, but it shouldn't.

2.     Recording:

Accounting has the unique function of recording all financial transactions. It provides provisions for recording transactions in a detailed way that companies can use. Recording is systematic and can be done by anyone familiar with the basics of accounting and the law.

Recording is done by similar grouping entries under a single title so that all financial transactions can be easily categorized.

3.     Classification:

Accounting provides the ability to categorize all financial transactions into different categories. These categories are grouped in one place according to their similarity. For example, all payments and receipts received will be reflected in your cashbook or memo book.

This helps to classify all similar transactions into one heading, which helps to find them and makes it easier. A book that has completed the process of opening an account is called a ledger.

4.     Usefulness:

Accounting principles have been found to be useful and provide important information to anyone trying to find them in an easy way. With different categories and headings that categorize different transactions, the finder can easily find a particular transaction.

These entries help determine and identify the nature of the transaction and analyze its impact on the overall balance sheet.

5.     Objectivity:

Principals are relevant when there are numbers and facts. Factual accounting principles that support numbers make it very relevant. There is no prejudice, as it is guaranteed that personal whims and prejudices are not included in the accounting case.

This is why accounting is said to be objective.

6.     Summary:

Accounting is known to provide a summary of the relevant complex financial statements. Cash flow, fund flow and balance sheet statements are briefly summarized and presented to investors and the general public.

These statements help investors make investment decisions. The abstract also provides a test of the organization's overall financial position without spending a lot of time.

Income statements, balance sheets, etc. are mirrors of the company, and summaries are considered to be very important statements.

7.     Verification:

All statements generated by a Certified Treasury Auditor or Bookkeeper can be audited and verified for their validity. All entries in the accounting system are related to a company's financial transactions. Therefore, financial statements give a glimpse of the mirror of the organization.

All of these entries can be validated and verified to test the validity of the statement.

8.     Interpretation:

Financial statement summaries can be read and interpreted by anyone with knowledge. The interpretation is universal and there is no difference from person to person or from auditor to auditor. It remains constant regardless of who interprets it, which gives it a characteristic of universality.

You can analyze the interpretation to find out if your organization is in good or bad financial position. Business performance can be determined with the help of accounting statements.

9.     Reproducibility:

Accounting is characterized by reproducibility due to established procedures and formulas. Accounting steps are calculated based on a fixed formula. For example, ratio analysis uses different formulas to determine different aspects of a stock. This is convenient for investors.

The results obtained from these analyzes are repeatable due to the universality of the formula and are not individual dependent or change over time.

The necessity and importance of accounting

When a person starts a business, big or small, his main purpose is to make a profit. He receives money from certain sources such as selling goods and interest on bank deposits. He has to spend money on certain items such as purchasing goods, salaries, and rent. These activities take place in the course of his normal business. He naturally wants to know the progress of his business at the end of his year. There are so many commerce that I can't remember his memory of how the money was made. At the same time, if he writes down his income and expenses, he can quickly get the information he needs. Therefore, in order to get an easy and accurate answer to the next question at any time, you need to clearly and systematically record the details of your commerce.

a)     What happened to his investment?

b)    What will happen to the results of the commercial transaction?

c)     How much are your income and expenses?

d)    How much can I receive from a customer whose goods are sold by credit?

e)     How much do you pay the supplier to buy credit?

f)       What are the nature and value of assets that business concerns have?

g)    What is the nature and value of debt of business concern?

These and some other questions can be answered with the help of accounting. The need to record commerce in a clear and systematic way is the basis for creating bookkeeping.

Accounting, one of the key aspects of an organization, has many well-defined purposes. The purpose may also vary depending on the genre of the business you belong to. Analyse your accounting objectives from a broader perspective and understand how you can achieve them.

1) Records management:

The basic role of the accounting department of an organization is to keep a systematic record of all financial transactions. Systematic records management ensures an appropriate level of analysis to reach the financial position of the organization.

It makes systematic record keeping an absolute purpose of accounting. This is a great help for systematic and accurate decision analysis. Proper recording is one of the key factors and must form the backbone of an organization before it can achieve other purposes or other sections of accounting.

2) Analysis and confirmation of financial results:

If you are in business, you will want to determine the exact state of your company's financial position at the end of a particular period. Companies typically prefer quarterly closing of operating finance.

The accounting department creates the profit and loss details of the organization based on the income statement generated using the records held during that period. This is a continuous process and will continue regardless of the specified time period.

3) Analysis of financial condition:

Accounting also aims to check the financial status of an organization. This includes liabilities, liabilities, assets, and assets. The accounting section should be able to keep up to date with the financial status of the company.

This is ideally achieved through the creation of a balance sheet. This gives you a glimpse of your organization's financial position over a specific period of time. The balance sheet helps you analyse your company's financial position and make future decisions and goals.

4) Decision-making:

Decision-making accounting has a broader purpose of supporting the decision-making of business owners and business owners. Systematic accounting is an important factor in making business decisions and setting goals for future growth and realistic goals for planning.

Here are some examples of decisions that accounting can support:

5) Liquidity status:

A complete understanding of an organization's liquidity status is also an important goal that accounting must fulfil. Lack of proper accounting often leads to financial mismanagement of the organization and can lead to major problems such as lockouts and business closures.

Appropriate accounting should help management and business owners see how much cash and other resources they have at their disposal to pay their financial commitments. Must be. Knowledge of liquidity also helps to calculate the amount of working capital and the capital that can be used to repay debt.

6) Ensuring positioning:

One of the main purposes of accounting is to support the positioning of an organization. Accounting provides a large amount of financial statements to help you reach this goal. The financial position of an organization would ideally be of great help in promoting the financial position of the company.

Financial statements that help you check your organization's financial position include:

7) Accountability:

One of the most important goals of accounting perfection is to maximize the accountability of the company. It is the accounting department of an organization that provides a solid foundation for assessing the actual performance of an organization over a period of time.

This also helps to promote organizational accountability in the long run and through multiple layers of the organizational hierarchy. Financial statements in the accounting department also help to give shareholders sufficient trust. In poor performance, the same financial statements help shareholders hold the company's directors and promoters accountable. This is also useful if you are planning to fund a new project. A reliable and accountable financial position helps to secure financing through loans or from investors.

8) Legal purpose:

Accounting also serves as legal support to support an organization's financial position. Therefore, one of the key objectives that accounting needs to deal with is to meet the legal requirements of the organization.

Accounting is a legal requirement in accordance with laws around the world. In accordance with the law, all companies are required to maintain and maintain financial records of transactions for a specified period of time and share this information with shareholders, promoters and regulators. In addition, proper accounting helps an organization to positively reach the right financial rights, obligations, and liabilities.

9) Fraud detection and prevention:

Financial mismanagement and fraud are one of the main reasons that can cause business closures or losses. One of the main purposes of accounting is to record actual transactions to prevent fraud and mismanagement.

If the records are correct and genuine, you can prevent employees of your organization from indulging in fraudulent financial activities. Accounting provides the coveted transparency of company-wide transactions and thus ensures that fraud is reduced to near zero.

Conclusion-

In essence, the main purpose of accounting is to manage and maintain good records of each financial transaction in a systematic way and analyze these records to reach the proper financial position of the organization. Once you start achieving this goal, rest on the goals outlined above.

Overview:

Accounting principles are built on some basic concepts. These concepts are so basic that most financial statement authors do not consciously consider them. As mentioned earlier, they are considered trivial. Some accounting researchers and theorists argue that some of the current accounting concepts are wrong and need to be changed.

Nevertheless, in order to understand the accounting that currently exists, it is necessary to understand the basic concepts currently in use. The basic accounting concepts described here may not be the same as those listed by other authors or groups. However, these are widely accepted and practical concepts used by financial statement authors and auditors to review financial statements.

Objects and functions of Accounting

One of the objectives is to ensure compliance with local laws related to taxation, corporate law, and other statutory requirements related to the country of business. This ensures that the business complies with such laws and that relevant provisions are complied with during the course of the business.

2.     Protecting the interests of various stakeholders

It provides relevant stakeholders, including shareholders, future investors, finance personnel, clients and creditors, with relevant and relevant information related to their business operations. They are suitable not only for those who have an existing business relationship, but also for those who are interested in collaborating with future businesses by providing meaningful information about the business. Further financial accounting standards ensure control of corporate accounting policies to protect the interests of investors.

3.     Useful for measuring business profits and losses

It measures the profitability of a business over a specific period of time and discloses the net profit or loss of the entire business. It also shows the assets and liabilities of the business.

4.     Presenting historical records

Unlike other accounting, it focuses on displaying past records rather than forecasting the future. The main reason for creating financial accounting is the confirmation of profits or losses incurred by the business during the period.

5.     Focus on external business transactions

It focuses on the transactions that a business conducts with external parties such as customers and suppliers, and based on these transactions, quantifies the business, the costs incurred, and the resulting profits or losses. An account will be created for you.

Limitations of Accounting-

2.   Fixed assets are recorded in the accounting records at the original cost, that is, the actual amount spent on them plus, of course, any incidental charges. In this way the effect of inflation (or deflation) is not taken into consideration. The direct result of this practice is that balance sheet does not represent the true financial position of the business.

3.   Accounting information is sometime based on estimates; estimates are often inaccurate. For example, it is not possible to predict with any degree of accuracy the actual useful life of an asset for the purpose of depreciation expense.

4.   Accounting information cannot be used as only test of managerial performance on the basis of more profits. Profits of a period of one year can readily be manipulated by omitting such cost of advertisement, research and development, depreciation and soon.

5.   Accounting information is not neutral or unbiased. Accountants calculate income as excess of revenue over expenses. But they consider only selected revenues and expenses. They do not, for example, include cost of such items as water or air pollution, employee’s injuries etc.

6.   Accounting like any other discipline has to follow certain principles which in certain cases are contradictory. For example: current assets (e.g., stock of goods) are valued on the basis of cost or market price whichever is less following the principle of conservatism. Accordingly, the current assets may be valued on cost basis in some year and at market price in other year. In this manner, the rule of consistency is not followed regularly.

Branches of Accounting-

As a result of economic, industrial and technological developments, various accounting disciplines have emerged.

Well-known departments or accounting types include financial accounting, management accounting, accountancy, auditing, taxation, AIS, base accounting, and forensic accounting.

1. Financial accounting:

Financial accounting records and classifies business transactions and prepare financial statements which is applies by internal and external users.

In preparing financial statements, we adhere to generally accepted accounting principles or strict adherence to GAAP. Financial accounting is primarily concerned with the processing of historical data.

2. Management accounting:

Controlling or Controlling focuses on providing information to be used by administrators who are internal users. This branch addresses the requirements of management instead of strictly adhering to generally accepted accounting principles.

Management accounting includes financial analysis, budgeting and forecasting, analysis, evaluation of business decisions, and similar areas.

3. Accountancy :

Often considered a subset of management accounting, costing refers to the recording, presentation, and analysis of producing costs. Costing is extremely useful within the manufacturing industry because it's the foremost complex costing process.

Cost calculators also can compare actual costs to budgets or standards to assist determine future course of action regarding company cost control.

4. Audit:

An external audit is an independent party review of monetary statements aimed toward expressing an opinion on fairness of presentation and compliance with GAAP. Internal audit focuses on assessing the adequacy of a company's control structure by testing segregation of duties, policies and procedures, degree of approval, and other controls enforced by management.

5. Tax accounting:

Tax accounting helps clients follow the principles set by the tax authorities. This includes preparing tax plans and tax returns. It also includes tax advisory services like tax and other tax decisions, the way to legally minimize taxes, assessing the result of tax decisions, and other tax matters.

6. Accounting data system :

Accounting Information Systems (AIS) includes the event, installation, implementation, and monitoring of systems utilized in accounting procedures and processes. This includes hiring business forms, directing accountants, and managing software.

7. Trustee accounting:

Trustee accounting includes the management of the property of others and therefore the handling of accounts managed by the person entrusted with the management. Samples of trustee accounting include trust accounting, trustees, and land accounting.

8. Forensic accounting:

Forensic accounting includes court and proceedings, fraud investigations, claims and dispute reA, and other areas including legal matters. This is often one among the foremost popular trends in accounting today.

Focus on your area of experience

If you would like to specialise in your area of experience, we recommend that you simply consider obtaining an accounting qualification in your area of choice. It'll offer you a foothold over those that aren't certified. Thanks to the growing population and therefore the demand for competitive professionals, it'll take a touch intensify to be recognized.

The most well-known accreditations include Certified Public Accountant (CPA), Certified Management Accountant (CMA), Certified auditor (CIA), Certified Financial Planner (CFP), and authorized Information Systems Auditor (CISA).

Key takeaways:

General-purpose financial statements provide much of the knowledge needed by external users of monetary accounting.

1.2 Accounting as an information system

The users of financial accounting information and their needs.

Another definition of the American Institute of Certified Public Accountants (AICPA) is: Interpret the result. "

Accounting includes recording, classifying, and summarizing business transactions. This is the process of identifying, measuring, and communicating economic information, including four interrelated phases. They are outlined here:

First, the first phase is intended to record economic events or transactions called journals-recording them in chronological books in chronological order as they occur. This process is known as journaling. Next is the ledger posting phase. This is the process by which all transactions are synthesized for each account and the cumulative balance for each of those accounts can be determined. The ledger posting process is very important because it helps you see the net effect of various transactions over a particular time period. The next step is to prepare a trial balance that includes aggregating all ledger accounts into debit and credit balances. This activity allows you to see if the total debit is equal to the total credit. Finally, there is the stage of preparing financial statements. This phase aims to close the account by measuring the profit and loss account at the end of the accounting period and creating a balance sheet.

Accounting information has different users, who can be inside or outside your organization. Accounting information is economic information because it relates to the financial or economic activity of a corporate organization. Because numerous people use accounting information for therefore many diverse purposes, the aim of monetary statements is that the needs of users who may lead them to form better financial decisions. Is to respond to. Users can be categorized as internal users and external users.

The internal or primary users of accounting information are:

a)     Management - Accounting information is very useful for managing planning, management, and decision-making processes. In addition, management needs accounting information to assess an organization's performance and status and can take the necessary steps to improve performance. What's more, accounting information helps managers make their jobs better.

b)    Employees - Employees use accounting information to study the financial position, sales, and profitability of their business to determine employment stability, future compensation potential, severance pay, and employment opportunities.

c)     Owner – The owner uses accounting information to analyze the feasibility and profitability of an investment. Accounting information allows owners to assess the ability of a business organization to pay dividends. It also guides you in deciding on future course of action.

The external or secondary users of accounting information are:

a)     Creditors – Creditors are interested in accounting information because they can determine the creditworthiness of their business. Credit terms and standards are set based on the financial position of the business, which helps you analyse with accurate information. Creditors include financial suppliers and lenders such as banks. Trade creditors are generally more interested in accounting information in a shorter period of time than lenders.

b)    Investor – We need information because we are interested in the risks and returns inherent in our investment. It is important to assess the feasibility of investing in a company and should be analysed before funding the company.

c)     Customers – Customers are interested in accounting information to assess the financial position of their business. This is because you can maintain a stable business source, especially if you are involved in the long term.

d)    Regulators – Accounting information is needed to ensure that it complies with rules and regulations and protects the interests of stakeholders who depend on such information.

General-purpose financial statements provide much of the knowledge needed by external users of monetary accounting. These financial statements are formal reports that provide information about the company's financial position, cash inflows and outflows, and operating results. Many companies publish these statements in their annual reports, also known as 10-K or 10-Q (quarterly reports). The annual report contains the opinion of the independent auditor on the fairness of the financial statements and information on the company's activities, products and plans. The best place to find these reports for public companies is usually the investor public relations section of your website. Financial statements used by external entities are prepared using generally accepted accounting principles (GAAP). The GAAP language will be discussed in more detail in a later section.

a)     Government / IRS

Government agencies that track and use taxes are interested in a company's financial story. They want to know if a company pays taxes according to current tax law. The language in which tax-related financial statements are produced is called the IRC or the Internal Revenue Service. Tax preparation is outside the scope of this ours.

Qualitative characteristics of Accounting Information

The qualitative characteristics or quality required for information play a major supporting role in the usefulness of decision making in accounting theory, the approach of decision-making models. A qualitative feature is a compliment that makes the information provided in the financial statements useful to the user.

The accounting information reported to facilitate financial decisions must have certain characteristics or normative standards. Table 1 shows the quality of information recognized in FASB (US) Concept No. 2 “Quality Characteristics of Accounting Information”.

Fig 1

The International Accounting Standards Board (1ASB) comprises four key features:

1. Easy to understand.

2. Relevance.

3. Reliability.

4. Comparability.

Other qualities proposed by the IASB are importance, faithful expression, substance to form, neutrality, prudence, completeness, and timeliness.

The qualitative features that have been found to be widely accepted and recognized in the accounting literature are:

1. Relevance:

Relevance is closely and directly associated with the concept of useful information. Relevance means that you need to report all information items that may help users make decisions and forecasts. In general, the more important information in decision making is more relevant.

In particular, it is the ability of information to make a difference that identifies it as relevant to decision making. The Commission, which prepares a statement on the basic accounting theory of the American Accounting Society, describes relevance as "a primary standard and influences actions designed to facilitate information or outcomes that are desired to be generated. Or need to be usefully associated. "

2. Reliability:

Confidence is described as one of the two main qualities (relevance and credibility) that make accounting information useful for decision making. Reliable information is needed to make decisions about a company's profitability and financial position. Reliability varies from item to item.

Some of the information contained in the annual report is more reliable than the others. For example, information about plants and machinery may be less reliable than certain information about current assets due to differences in realization uncertainty. Reliability is the quality that allows users of data to rely on it with confidence as a representative of what the data is trying to represent.

The FASB Concept No. 2 concludes that:

To be useful information, it can only be trusted. There must be no relevance. You need to be aware of the degree of reliability. There are few black or white issues, but it is a high or low reliability issue. Reliability is verified by accounting explanations or measurements. It is possible, expressively faithful and dependent to some extent. Information neutrality also interacts with these two elements of reliability and affects the usefulness of information. "

3. Intelligibility:

Intelligibility is the quality of information that enables users to recognize its importance. You can increase the benefits of information by making it easier to understand and helping more users.

Presenting information that only sophisticated users can understand and others cannot understand creates a bias that contradicts proper disclosure standards. The presentation of information should not only facilitate understanding, but also avoid misinterpretation of financial statements. Therefore, easy-to-understand financial accounting information presents data that is understandable to the user of the information and is expressed in a format and terminology that fits the user's understanding.

4. Comparability:

To make an economic decision, you need to choose from possible course of action. When making a decision, the decision maker makes a comparison between the alternatives. This is facilitated by financial information. Comparability means that they are reported in the same way and in different ways.

FASB (USA) Concept No. 2 defines comparability as follows: Obviously, a valid comparison is only possible if the measurements (quantities or ratios) used are certain to represent the characteristics to be compared.

Comparable financial accounting information shows similarities and differences that result from the fundamental similarities and differences of a company or its transactions, as well as differences in the treatment of financial accounting.

The information, when comparable, helps decision makers determine relative financial strengths and weaknesses, as well as future prospects, between two or more companies, or between periods of one company.

5. Consistency:

Consistency of the method over a period of time is a valuable quality that makes accounting numbers more useful.

If the investor knows which method is being followed and it is guaranteed that it is being followed consistently each year, then what exact rules and practices are used by the investor to report their earnings. It doesn't really matter if you adopt. Inconsistency creates a lack of comparability. The value of business-to-business comparisons is significantly reduced if significant differences in revenue are caused by fluctuations in accounting practices.

6. Neutrality:

Neutrality is also known as "freedom from prejudice" or the quality of objectivity. Neutrality means that the main concern in developing or implementing a standard should be the relevance and credibility of the resulting information, not the impact of the new rules on a particular interest or user. Means neutral choices between accounting options are not biased towards given results. The purpose of (general purpose) financial reporting serves many different information users with different interests, and one given result may not fit the interests and purposes of all users.

Therefore, accounting facts and practices should be fairly determined and reported without the purpose of intentionally biasing users or groups of users. If there is no bias in the choice of reported accounting information, then one set of profits cannot be said to have an advantage over another. In fact, it may support a particular interest, because the information points to it that way.

7. Importance:

The concept of materiality pervades the entire field of accounting and auditing. The concept of materiality means that all financial information needs to or should not be communicated in accounting reports-only important information should be reported. Information that is not important may be omitted and should probably be omitted. Information that may affect your financial decisions should be disclosed in your annual report. Information that meets this requirement is important.

8. Timeliness:

Timeliness means making information available to decision makers before they lose their ability to influence decisions. Timeliness is an auxiliary aspect of relevance. Future action, if information is not available when needed or becomes available long after the reported event and is not worth it, is irrelevant and of little or no use. Timeliness alone cannot make information relevant, but lack of timeliness can rob you of relevant information that you might otherwise have.

Obviously, there is a degree of timeliness, and some reports need to be produced quickly, such as in the case of takeover bids or strikes. In other situations, such as regular reporting of annual performance by operators, long delays in reporting information can have a significant impact on relevance and thus the usefulness of the information. However, to achieve the increased relevance that accompanies the increased timeliness, other desirable properties of the information must be sacrificed, which can result in an overall increase or decrease in usefulness.

For example, it may be desirable to sacrifice accuracy for timeliness. This is because quickly-produced estimates are often more useful than accurate information reported after longer delays.

9. Verifiability:

Verification does not guarantee the suitability of the method used and does not guarantee the accuracy of the resulting measurements. It conveys some assurance that the measurement rules used, whatever they are, have been carefully applied to the measurer's side with personal prejudice.

It is a means to deal with some measurement problems more than other measurement problems.

Verification of accounting information does not guarantee that the information has a high degree of representational fidelity, and a highly verifiable measurement is a decision that is intended to be useful. Not necessarily related. "

10. Conservatism:

There are places of custom such as conservatism. This is a scrutiny of financial accounting and reporting as business and economic activity is surrounded by uncertainty, but it should be applied with caution.

Conservatism in financial reporting should no longer mean a deliberate, consistent and unobtrusive representation of net worth and profits.

Therefore, conservatism dictates the use of non-optimistic estimates when two estimates of the amount to be received or paid in the future can occur in much the same way. However, if the two amounts are not equal, conservatism is not necessarily the most likely amount and does not dictate the use of a more pessimistic amount.

Difference between cash and anticipation

The difference between cash accounting and accrual accounting lies in the timing at which sales and purchases are recorded in your account. Cash accounting recognizes revenues and expenses only when money changes, while accrual accounting recognizes revenues when revenues are earned and expenses when billed (but pays).

Key takeaways:

1.3 Accounting Principles- concepts and conventions

Overview:

Accounting concepts defines the assumption on the basis of which financial statement of a business entity is prepared. Concepts are those basic assumption and condition which form the basis upon which the accountancy has been laid.

Accounting principles

a)     They should be based on real assumption.

b)    They must be simple, understandable and explanatory.

c)     They must be followed consistently.

d)    They should be able to reflect future predictions.

e)     They should be informational to users.

Accounting convention emerges out of accounting practices, commonly known as accounting principle, adopted by various organizations over a period of time. Accounting bodies may change any of the convention to improve the quality of accounting information.

The basic accounting concept is as follows:

The concept of an entity assumes that its financial statements and other accounting information belong to a particular company that is different from its owner. Therefore, an analysis of business transactions, including costs and revenues, is expressed in terms of changes in the company's financial position.

Similarly, the assets and liabilities devoted to business activities are the assets and liabilities of the entity. The company's transaction is reported, not the company's owner's transaction. Therefore, this concept allows accountants to distinguish between personal and commercial transactions. This concept applies to sole proprietorships, partnerships, businesses, and small businesses. It may also apply to multiple companies, such as when a segment of a company, such as a department, or an interrelated company is merged.

2.     Going Concern Concept:

An entity is considered to be in business unless there is evidence of opposition. Because companies are relatively permanent, financial accounting is designed with the assumption that the business will survive indefinitely in the future.

The Going Concern concept justifies the valuation of assets on a non-clearing basis and requires the use of acquisition costs for many valuations. In addition, fixed and intangible assets are amortized over their useful lives, rather than in shorter periods, in the hope of early liquidation.

This further means that the data transmitted is tentative and that the current statement should disclose adjustments to the statement over the past year revealed by more recent developments.

3.     Money measurement concept:

A unit of exchange and measurement is required to uniformly account for a company's transactions. The common denominator chosen in accounting is the currency unit. Money is the lowest common denominator for measuring the exchangeability of goods and services such as labor, natural resources and capital.

The concept of monetary measurement considers accounting to be a process of measuring and communicating financially measurable company activity. Obviously, the financial statements should show the money spent.

The concept of measuring money means two limitations of accounting. First, accounting is limited to the generation of information expressed in monetary units. It does not record and convey other relevant but non-monetary information. Second, the concept of monetary measurement concerns the limitation of the monetary unit itself as a unit of measurement.

There are concerns about purchasing power, which is the main characteristic of currency units, or the amount of goods and services that money can obtain. Traditionally, financial accounting has addressed this issue by stating that the concept assumes that the purchasing power of a currency unit is stable over the long term or that price changes are not significant. Although still accepted in current financial reporting, the concept of stable monetary units is subject to continuous and permanent criticism.

4.     Accounting period concept:

Financial accounting provides information about a company's economic activity over a specific period of time that is shorter than the company's lifespan. The periods are usually the same length for ease of comparison.

The period is specified in the financial statements. The period is usually 12 months. Quarterly or semi-annual statements may also be issued. These are considered provisional and differ from the annual report. Statements that cover shorter periods of time, such as months or weeks, may also be created for administrative use.

5.     Cost concept:

The concept of cost is that the asset should be recorded at the exchange price, that is, the acquisition cost or the acquisition cost. Acquisition costs are recognized as an appropriate valuation criterion for recognizing the acquisition of all goods and services, costs, expenses and capital.

For accounting purposes, business transactions are usually measured in terms of the particular price or cost at which the transaction occurred. That is, financial accounting measurements are based on exchange prices, where economic resources and obligations are exchanged. Therefore, the quantity of an asset listed during a company's account doesn't indicate what the asset could also be sold for.

The concept of acquisition cost means there's little point in revaluing an asset to reflect its current value, because the company has no plans to sell its asset. Additionally, for practical reasons, accountants like better to report actual costs over market values that are difficult to verify.

6.     Dual aspect concept:

This concept is at the guts of the whole accounting process. Accountants record events that affect the wealth of a specific entity. The question is which aspect of this wealth is vital. Accounting entities are artificial creations, so it's essential to understand who their resources belong to or what purpose they serve.

It's also important to understand what sorts of resources you manage, like cash, buildings, and land. Therefore, the accounting record system was developed to point out two main things: (a) the source of wealth and (b) the shape it takes. Suppose Mr. X decides to line up a business and transfers Rs. 100,000 from his personal checking account to a different business account.

He may record this event as follows:

Obviously, the source of wealth must be numerically adequate to the shape of wealth. S (source) must be adequate to F (form) because they're simply different aspects of an equivalent thing, that is, within the sort of equations.

In addition, transactions or events that affect a company's wealth got to record two aspects so as to take care of equality on each side of the accounting equation.

If a corporation acquires an asset, it must be one among the following:

b)    Other assets are abandoned.

c)     There was an obligation to pay it.

d)    Profitable and increased amount of cash the operator has got to pay to the owner.

e)     The owner funded the acquisition of the asset.

This doesn't mean that the transaction affects both the source and sort of wealth.

There are four categories of events that affect accounting equations:

a)     Both the source and sort of wealth are increased by an equivalent amount.

b)    Both the source and sort of wealth are reduced by an equivalent amount.

c)     Some increase without changing the source of wealth, others decrease.

d)    Some sources of wealth increase and a few decreases without changing the shape of wealth retention.

The above example shows category (a) because once you start a transaction for an entity, the source of wealth and therefore the sort of wealth, cash, increases from zero to rupees. 1,00,000. In contrast, X may plan to withdraw Rs. 20,000 cash from business.

In that case, the financial position of the entity would be:

It is essential to know why each side of the equation are reduced. By withdrawing cash, X automatically reduces the availability of personal funds to the business by an equivalent amount. Now suppose Mr. X buys a listing of products for Rs. 30,000 in cash available. His capital supply remains an equivalent, but the composition of his business assets does.

The two aspects of this transaction aren't within the same direction, but are compensatory and are increasing stocks that set a cash reduction. Similarly, sources of wealth are often suffering from transactions. So, if X gives his son Y, it becomes Rs. 20,000 shares of the business by transferring some of his own profits, the consequences are:

However, if X gives YR. He personally receives $ 20,000 in cash, and when Y puts it into the business, each side of the equation are affected. Y capital Rs. 20,000 is balanced by additional Rs. 20,000 in cash, X capital remains rupees. 80,000.

7.     The concept of accrual accounting:

According to the Financial Accounting Standards Board (USA):

"Accrual accounting is that the financial impact of transactions and other events and situations that affect a corporation on cash, not only during the amount during which it had been received, but also during the amount during which those transactions, events and situations occur. Accrual accounting is paid to the corporate as more (or perhaps less) cash spent on resources and activities, also because the start and end of the method. it's associated with the method of being returned. We recognize that purchases, production, sales, other operations, and other events that affect a company's performance during a period often do not match the receipt or payment of cash for that period. "

Realization and matching concepts are central to accrual accounting. Accrual accounting measures revenue for a period of time as the difference between the revenues recognized during that period and the costs that match those incomes. In accrual accounting, the period revenue is usually not the same as the period cash receipt from the customer, and the period cost is usually not the same as the period cash payment.

8.     Cash Basis Accounting:

In cash-basis accounting, sales are not recorded until the period in which they are received in cash. Similarly, costs are deducted from sales during the period in which the cash payment was made. Therefore, neither realization nor matching concepts apply to cash basis accounting.

In reality, "pure" cash-basis accounting is rare. This is because the pure cash basis approach requires the acquisition of inventory to be treated as a reduction in profit when paying the acquisition cost, not when selling the inventory. Similarly, the cost of acquiring plant and equipment items is treated as a reduction in profit if these long-lived items are paid in cash rather than after they have been used.

Obviously, such a pure cash basis approach would result in a balance sheet and income statement with limited usefulness. Therefore, what is commonly referred to as cash-basis accounting is actually a mixture of cash-basis for some items (especially cost of goods sold and period costs) and accrual-based for others (especially product costs and long-term assets). This mix is   sometimes referred to as modified cash-basis accounting to distinguish it from the pure cash-basis method.

Cash-basis accounting is most often seen in small businesses that do not have large inventories because they provide services. Examples include restaurants, hairdressers, hairdressers, and income tax filing companies.

Most of these establishments do not provide credit to their customers, so cash-basis profits may not differ dramatically from accrual income. Nevertheless, cash basis accounting is not permitted by GAAP for any type of entity.

9.     Conservatism concept:

 This trait can be considered a reactive version of the Minimax management philosophy. That is, it minimizes the potential for maximum loss.

The concept of accounting conservatism suggests that accounting should be cautious and cautious until the opposite evidence emerges, where and when uncertainty and risk exposure are legitimate. Accounting conservatism does not mean intentionally underestimating income and assets. It applies only to situations where there is reasonable doubt. For example, inventories are valued at the lower end of cost or market value.

In its application to the income statement, conservatism encourages recognition of all losses incurred or may occur, but does not recognize profits until they are actually realized. Early depreciation of intangible assets and restrictions on recording asset valuations have also been motivated, at least to some extent, by conservatism. Not recognizing revenue until the sale is made is another sign of conservatism.

10. Matching concept:

The concept of matching in financial accounting is the process of matching (associating) performance or revenue (measured at the selling price of goods and services offered) with labour or expense (measured at the cost of goods and services used) over a specific period of time. is. Targets for which income has been determined.

This concept emphasizes which item of expense in a particular accounting period is expense. That is, expenses are reported as expenses for the accounting period in which revenue related to those expenses is reported. For example, if the sales of some products are reported as revenue for one year, the costs for those products are reported as expenses for the same year.

The concept of matching only needs to be met after the accountant has completed the concept of realization. First measure the revenue according to the concept of realization, then associate the costs with these revenues. Cost matches revenue, but not the other way around.

Therefore, the reconciliation process requires significant cost allocation in acquisition cost accounting. Past (history) costs are investigated and steps are taken to assign a cost element that is considered to have expired service potential or to match it with the associated revenue.

The remaining component of the cost, which is considered to have continued potential for future services, is carried over to the past balance sheet and is called an asset. Therefore, the balance sheet is just a report of unallocated past costs waiting for the estimated future service potential to expire before it matches the appropriate revenue.

11. Realization or Cognitive concept:

The concept of realization or recognition indicates the amount of revenue that should be recognized from a particular sale. Realization rules help accountants determine if revenues or expenses have been incurred. This allows accountants to measure, record, and report on financial reports.

Realization refers to the inflow of cash or cash charges (accounts receivable, accounts receivable, etc.) resulting from the sale of goods or services. Therefore, if the customer purchases Rs. If you pay 500 worth of goods in cash at a grocery store, the store will realize Rs. 500 from the sale.

If the clothing store sells Rs suits. 3,000, if the buyer agrees to pay within 30 days, the store will realize Rs. From sale to 3,000 (accounts receivable) (conservative concept), provided the buyer has a good credit record and the payment is reasonably secure.

The concept of realization states that the amount perceived as revenue is reasonably certain to be realized, that is, reasonably certain to be paid by the customer. Of course, there is room for difference in judgment as to whether or not it is "reasonably certain."

However, this concept explicitly acknowledges that the perceived revenue amount is lower than the selling price of the goods and services sold. The obvious situation is the discounted sale of goods at a price lower than the normal selling price. In such cases, the revenue will be recorded at a lower price rather than the normal price.

12. Consistency concept:

In this concept, once an organization has decided on one method, it should be used for all subsequent transactions and events of the same nature unless there is a good reason to change it. Frequent changes in accounting methods make it difficult to compare financial statements for one period with financial statements for another period.

Consistent use of accounting methods and procedures over the long term checks income statement and balance sheet distortions, and possible operations on these statements. Consistency is needed to help external users compare the financial statements of a particular company over time and make sound economic decisions.

13. Materiality concept:

The law has a doctrine called de minimis non curat lex. This means that the court does not consider trivial issues. Similarly, accountants do not attempt to record events that are not so important that the task of recording them is not justified by the usefulness of the results.

The concept of materiality means that transactions and events that have a non-significant or non-significant impact must not be recorded and reported in the financial statements. Recording of non-essential events is claimed to be unjustifiable in terms of their low usefulness to subsequent users.

For example, conceptually, a brand-new paper pad is an asset of an entity. Each time someone writes on the pad's page, some of this asset is exhausted and retained earnings are reduced accordingly. Theoretically, it is possible to see how many partially used pads the company owns at the end of the accounting period and display this amount as an asset.

However, the cost of such efforts is clearly unreasonable, and accountants are not willing to do this. The accountant took a simpler action, albeit inaccurate, that the asset was exhausted (expenditure) when the pad was purchased or when the pad was issued to the user from the consumable inventory. Treat as.

Unfortunately, there is no consensus on what it means to be important and the exact line that distinguishes between important and non-important events. Decisions depend on judgment and common sense. The accounting creator is meant to interpret what is important and what is not.

Perhaps the importance of an event or transaction can be determined in terms of financial position, performance, changes in an organization's financial position, and its impact on user evaluations or decisions.

14. Full disclosure concept:

The concept of full disclosure requires companies to provide all relevant information to external users for the purpose of sound economic decisions. This concept means that information that is substantive or of interest to the average investor is not omitted or hidden from a company's financial statements.

Accounting Principles-

The basic assumptions and concepts mentioned above have been modified to make accounting information useful to a variety of stakeholders. The principles of these changes are as follows:

Principles are:

1. Cost-benefit.

2. Importance.

3. Consistency.

4. Be cautious.

This amended principle states that the cost of applying the principle must not exceed the benefits obtained from it. If the cost is greater than the profit, then the principle needs to be changed.

2.     Materiality principle:

The principle of materiality requires that all relatively relevant information be disclosed in the financial statements. Important non-essential information is omitted or merged with other items.

3.     Principle of consistency:

The purpose of the principle of consistency is to maintain the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously adhered to and applied annually. Comparing the financial results of a business between different accounting periods is important and meaningful only if you follow consistent practices in reviewing them. For example, asset depreciation can be provided in a variety of ways, but whichever method you choose, you must do it on a regular basis.

4.     Principle of prudence (conservatism):

The principle of prudence takes into account all expected losses, but leaves all expected benefits.  For example, when valuing a stock in trade, the lower of the market price and cost is taken into account.

Key takeaways:

1.4 Accounting standards- Indian and International Context

Accounting Standards: Concept, Meaning, Nature and Purpose

Accounting Standard Concept:

We know that generally accepted accounting principles (GAAP) aim to bring uniformity and comparability to financial statements. In many places, you can see that GAAP allows different alternative accounting treatments for the same item. For example, different stock valuations result in different financial statements.

Such practices can lead the intended user in the wrong direction when making decisions related to his or her field. Given the problems faced by many accounting users, the need to develop common accounting standards has increased.

To this end, the Institute of Chartered Accountants of India (ICAI), which is also a member of the International Accounting Standards Committee (IASC), formed the Accounting Standards Committee (ASB) in 1977. ASB needed accounting. After detailed investigation and discussion, a draft was prepared and submitted to ICAI. After proper review, ICAI finalized them and notified them of their use in the financial statements.

Meaning of accounting standards:

Accounting standards are written statements consisting of rules and guidelines issued by accounting institutions for the preparation of unified and consistent financial statements and other disclosures that affect different users of accounting information. is.

Accounting standards set the conditions for accounting policies and practices with codes, guidelines, and adjustments that facilitate the interpretation of items contained in financial statements and even their handling in the books.

Nature of accounting standards:

Based on the discussion above, accounting standards can be said to be guides, dictators, service providers, and harmonizers in the field of accounting processes.

Accounting standards serve accountants as a guide to the accounting process. They provide the basis for the account to be prepared. For example, they provide a way to value inventory.

2.       Act as a dictator:

Accounting standards act as a dictator in the field of accounting. In some areas, like dictators, accountants have no choice but to choose practices other than those listed in accounting standards. For example, the cash flow statement must be prepared in the format specified by accounting standards.

3.       Act as a service provider:

Accounting standards constitute the scope of accounting by defining specific terms, presenting accounting issues, specifying standards, and explaining numerous disclosures and implementation dates. Therefore, accounting standards are descriptive in nature and act as a service provider.

4.       Functions as a harmonizer:

There is no bias in accounting standards and there is uniformity in accounting methods. They remove the effects of various accounting practices and policies. Accounting standards often develop and provide solutions to specific accounting problems. Therefore, whenever there is a contradiction in the accounting problem, it is clear that the accounting standard acts as a harmonizer and facilitates the accountant's solution.

Purpose of Accounting Standards

Previously, accounting was used to record business transactions of a financial nature. Currently, its main focus is on providing accounting information during the decision-making process.

Accounting standards are required for the following purposes:

Accounting standards brings equality to accounting methods by proposing standard treatments for accounting issues. For example, AS-6 (revised edition) describes depreciation accounting methods.

2.     To improve the reliability of financial statements:

Accounting is the language of business. The information provided by accountants is often based solely on the information contained in the financial statements, and many users make various decisions about their field. In this regard, financial statements need to provide a true and fair view of business concerns. Accounting standards bring credibility and credibility to different users.

They also help potential users of the information contained in financial statements with disclosure standards that make it easier for even the layperson to interpret the data. Accounting standards provide a concrete theoretical basis for the accounting process. They provide accounting uniformity, make financial statements for different business units comparable in different years, and again facilitate decision making.

3.     Simplify accounting information:

Accounting standards prevent users from reaching misleading conclusions and make financial data easy for everyone. For example, AS-3 (revised edition) clearly classifies cash flows in terms of "sales activities," "investment activities," and "finance activities."

4.     Prevent fraud and manipulation:

Accounting standards prevent management from manipulating data. By systematizing accounting methods, fraud and operations can be minimized.

5.     Assist auditors:

Accounting standards set the conditions for accounting policies and practices with codes, guidelines, and adjustments for creating and interpreting the items that appear in financial statements. Therefore, these terms, policies, guidelines, etc. are the basis for auditing the books.

Accounting standard formulation procedure

Let's take a quick look at the procedure setup process that ASB follows:

Salient features of Accounting Standard (AS): 1 (ICAI)

The characteristics of accounting standards:

1. Recognize financial events.

2. Measure financial transactions.

3. Presentation of financial statements in a fair manner.

4. Corporate disclosure requirements to prevent erroneous information from being provided to stakeholders.

5. Improve the reliability of financial statements.

6. Check your company's progress and market position with comparability.

7. Required disclosure requirements and valuation methods for various financial transactions.

International Financial Reporting Standards (IFRS): - Need and Procedures

Need of IFRS range-

Proper procedure of IFRS

Proper procedures for standards typically include: (* The following means required by the IFRS Foundation's Constitution):

The IASB deliberates at publicly open meetings.

Effective date

Each IFRS and interpretation sets its own effective date and transition policy.

Language

English is the official language of the IASB's discussion documents, exposure drafts, IFRS, and interpretation. If the process guarantees the quality of a translation, the IASB may approve the translation and the IASB may license other translations.

AS 5- Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

Introduction

The objective of AS 5 is to prescribe the classification and disclosure of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis. This enhances the comparability of the financial statements of an enterprise over time and with the financial statements of other enterprises. Accordingly, AS 5 requires the classification and disclosure of extraordinary and prior period items, and the disclosure of certain items within profit or loss from ordinary activities. It also specifies the accounting treatment for changes in accounting estimates and the disclosures to be made in the financial statements regarding changes in accounting policies.

This Statement does not deal with the tax implications of extraordinary items, prior period items, changes in accounting estimates, and changes in accounting policies for which appropriate adjustments will have to be made depending on the circumstances.

Net Profit or Loss for the Period

All items of income and expense which are recognised in a period should be included in the determination of net profit or loss for the period unless an Accounting Standard requires or permits otherwise.

The net profit or loss for the period comprises the following components, each of which should be disclosed on the face of the statement of profit and loss:

2.     Extraordinary items: Income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.

Extraordinary items should be disclosed in the statement of profit and loss as a part of net profit or loss for the period.

The nature and the amount of each extraordinary item should be separately disclosed in the statement of profit and loss in a manner that its impact on current profit or loss can be perceived. Whether an event or transaction is clearly distinct from the ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than by the frequency with which such events are expected to occur. Therefore, an event or transaction may be extraordinary for one enterprise but not so for another enterprise because of the differences between their respective ordinary activities. For example, losses sustained as a result of an earthquake may qualify as an extraordinary item for many enterprises. However, claims from policyholders arising from an earthquake do not qualify as an extraordinary item for an insurance enterprise that insures against such risks.

Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:

3.     Exceptional items: When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

Circumstances which may give rise to the separate disclosure of items of income and expense include:

a)     The write-down of inventories to net realisable value as well as the reversal  of such write-downs.

b)    A restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring.

c)     Disposals of items of fixed assets.

d)    Disposals of long-term investments.

e)     Legislative changes having retrospective application.

f)       Litigation settlements.

g)    Other reversals of provisions.

Prior Period Items

Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one  or more prior periods.

Errors in the preparation of the financial statements of one or more prior periods may be discovered in the current period. Errors may occur as a result of mathematical mistakes, mistakes in applying accounting policies, mis- interpretation of facts, or oversight.

The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived.

Changes in Accounting Estimates

An estimate may have to be revised if changes occur in the circumstances based on which the estimate was made, or as a result of new information, more experience or subsequent developments. The revision of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item.

Accounting estimates by their nature are approximations that may need revision as additional information becomes known. For example, income or expense recognised on the outcome of a contingency which previously could not be estimated reliably does not constitute a prior period item.

For example, Sachin purchased a new machine costing Rs 10 lakhs. Useful life was taken to be for 10 years, therefore, depreciation was charged at 10% on original cost each year. After 5 years when carrying amount was Rs 5 lakhs for the machine, management realises that machine can work for another 2 years only and they decide to write off Rs 2.5 lakhs each year. This is not an example of prior period item but change in accounting estimate. In the same example management by mistake calculates the depreciation in the fifth year as 10% of Rs 6,00,000 i.e. Rs 60,000 instead of Rs 1,00,000 and in the next year decides to write off Rs 1,40,000. In such a case, Rs 1,00,000 current year’s depreciation and Rs 40,000 will be considered as prior period item.

As per AS 10 (Revised), Property, Plant and Equipment, residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change should be accounted for as a change in an accounting estimate in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.

The effect of a change in an accounting estimate should be included in the determination of net profit or loss in:

a)     The period of the change, if the change affects the period only; or

b)    The period of the change and future periods, if the change affects both.

For example, a change in the estimate of the amount of bad debts is recognised immediately and therefore affects only the current period. However, a change in the estimated useful life of a depreciable asset affects the depreciation in the current period and in each period during the remaining useful life of the asset.

The effect of a change in an accounting estimate should be classified using the same classification in the statement of profit and loss as was used previously for  the estimate.

To ensure the comparability of financial statements of different periods, the effect of a change in an accounting estimate which was previously included in the profit or loss from ordinary activities is included in that component of net profit or loss

The effect of a change in an accounting estimate that was previously included as  an extraordinary item is reported as an extraordinary item.

The nature and amount of a change in an accounting estimate which has a material effect in the current period, or which is expected to have a material effect in subsequent periods, should be disclosed. If it is impracticable to quantify the amount, this fact should be disclosed.

Changes in Accounting Policies

Accounting policies are the specific accounting principles and the methods of applying those principles adopted by an enterprise in the preparation and presentation of financial statements.

Accounting Policies can be changed only:

a)     When the adoption of a different accounting policy is required by statute; or

b)    For compliance with an Accounting Standard; or

c)     When it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise.

The following are not changing in accounting policies:

a)     The adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, e.g., introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex- gratia payments to employees on retirement;

b)    The adoption of a new accounting policy for events or transactions which did not occur previously or that were immaterial.

Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made, to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.

AS 6- Depreciation Accounting

Introduction

This Statement deals with depreciation accounting and applies to all depreciable assets, except the following items to which special considerations apply:—
 

Different accounting policies for depreciation are adopted by different enterprises. Disclosure of accounting policies for depreciation followed by an enterprise is necessary to appreciate the view presented in the financial statements of the enterprise.

Definitions

The following terms are used in this Statement with the meanings specified:

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined.

Depreciable assets are assets which-

1. Are expected to be used during more than one accounting period; and

2. Have a limited useful life; and
3. Are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of
business.
 

 Useful life is either

Depreciable amount of a depreciable asset is its historical cost, or other amount substituted for historical cost in the financial statements, less the estimated residual value.

Explanation
Depreciation has a significant effect in determining and presenting the financial position and results of operations of an enterprise. Depreciation is charge din each accounting period by reference to the extent of the depreciable amount, irrespective of an increase in the market value of the assets.

Assessment of depreciation and the amount to be charged in respect thereof in an accounting period are usually based on the following three factors:

a)     historical cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued;

b)    expected useful life of the depreciable asset; and

c)     estimated residual value of the depreciable asset. Historical cost of a depreciable asset represents its money outlay or its equivalent in connection with its acquisition, installation and commissioning as well as for additions to or improvement thereof. The historical cost of a depreciable asset may undergo subsequent changes arising as a result of increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors.

The useful life of a depreciable asset is shorter than its physical life and is:

d)    pre-determined by legal or contractual limits, such as the expiry dates of related leases;

e)     directly governed by extraction or consumption;

f)       dependent on the extent of use and physical deterioration on account of wear and tear which again depends on operational factors, such as, the number of shifts for which the asset is to be
used, repair and maintenance policy of the enterprise etc.; and

g)    reduced by obsolescence arising from such factors as:

Determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors including experience with similar types of assets. Such estimation is more difficult for an asset using new technology or used in the production of a new product or in the
provision of a new service but is nevertheless required on some reasonable basis.

Any addition or extension to an existing asset which is of a capital nature and which becomes an integral part of the existing asset is depreciated over the remaining useful life of that asset. As a practical measure, however, depreciation is sometimes provided on such addition or extension at the rate which is applied to an existing asset. Any addition or extension which retains a separate identity and is capable of being used after the existing asset is disposed of, is depreciated independently on the basis of an estimate of its own useful life.

Determination of residual value of an asset is normally a difficult matter. If such value is considered as insignificant, it is normally regarded as nil. On the contrary, if the residual value is likely to be significant, it is estimated at the time of acquisition/installation, or at the time of subsequent revaluation of the asset. One of the bases for determining the residual value would be the realisable value of similar assets which have reached the end of their useful lives and have operated under conditions similar to those in which the asset will be used.

The quantum of depreciation to be provided in an accounting period involves the exercise of judgement by management in the light of technical, commercial, accounting and legal requirements and accordingly may need periodical review. If it is considered that the original estimate of useful life of an asset requires any revision, the unamortised depreciable amount of the asset is charged to revenue over the revised remaining useful life.

There are several methods of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the straight line method and the reducing balance method. The management of a business selects the most appropriate method(s) based on various important factors e.g.

a)       Type of asset,

b)      The nature of the use of such asset and,

c)       Circumstances prevailing in the business.

A combination of more than one method is sometimes used. In respect of depreciable assets which do not have material value, depreciation is often allocated fully in the accounting period in which they are acquired.

The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 2013 lays down the rates of depreciation in respect of various assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with requirements of the statute.

Where depreciable assets are disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, is disclosed separately.

The method of depreciation is applied consistently to provide comparability of the results of the operations of the enterprise from period to period. A change from one method of providing depreciation to another is made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When  such a change in the method of depreciation is made, depreciation is recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from retrospective recompilation of depreciation in accordance with the new method is adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency is charged in the statement of profit and loss. In case the change in the method results in surplus, the surplus is credited to the statement of profit and loss. Such a change is treated as a change in accounting policy and its effect is quantified and disclosed.
 

Where the historical cost of an asset has undergone a change due to circumstances specified above, the depreciation on the revised unamortised depreciable amount is provided prospectively over the residual useful life of the asset.

Disclosures Required

The depreciation methods used, the total depreciation for the period for each class of assets, the gross amount of each class of depreciable assets and the related accumulated depreciation are disclosed in the financial statements along with the disclosure of other accounting policies. The depreciation rates or the useful lives of the assets are disclosed only if they are different from the principal rates specified in the statute governing the enterprise.

In case the depreciable assets are revalued, the provision for depreciation is based on the revalued amount on the estimate of the remaining useful life of such assets. In case the revaluation has a material effect on the amount of depreciation, the same is disclosed separately in the year in which revaluation is carried out.

A change in the method of depreciation is treated as a change in an accounting policy and is disclosed accordingly.

The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.

The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When such a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the new method should be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged in the statement of profit and loss. In case the change in the method results in surplus, the surplus should be credited to the statement of profit and loss. Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed.

The useful life of a depreciable asset should be estimated after considering the following factors:

a)     expected physical wear and tear;

b)    obsolescence;

c)     legal or other limits on the use of the asset.

The useful lives of major depreciable assets or classes of depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life of an asset, the unamortised depreciable amount should be charged over the revised remaining useful life.

Any addition or extension which becomes an integral part of the existing asset should be depreciated over the remaining useful life of that asset. The depreciation on such addition or extension may also be provided at the rate applied to the existing asset. Where an addition or extension retains a separate identity and is capable of being used after the existing asset is disposed of, depreciation should be provided independently on the basis of an estimate of its own useful life.

Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortized depreciable amount should be provided prospectively over the residual useful life of the asset.

Where the depreciable assets are revalued, the provision for depreciation should be based on the revalued amount and on the estimate of the remaining useful lives of such assets. In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed separately in the year in which revaluation is carried out.

If any depreciable asset is disposed of, discarded, demolished or destroyed, the net surplus or deficiency, if material, should be disclosed separately.

The following information should be disclosed in the financial statements:

a)     the historical cost or other amount substituted for historical cost of each class of depreciable assets;

b)    total depreciation for the period for each class of assets; and

c)     the related accumulated depreciation.

The following information should also be disclosed in the financial statements along with the disclosure of other accounting policies:

a)     depreciation methods used; and

b)    depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the statute governing the enterprise.

Accounting for moulds and dies used in the manufacture of components

Facts of the Case

1. A company (hereinafter referred to as ‘the ancillary’) manufactures and supplies certain components to a manufacturer of motor cars (hereinafter referred to as ‘the principal manufacturer’).

2. The manufacture of these components entails the use of moulds/dies. Some of the moulds/dies are supplied by the principal manufacturer while others are arranged by the ancillary.

3. In respect of moulds/dies arranged by the ancillary, the two parties agree on what is termed as ‘tool cost’. The tool cost is agreed to be spread over a certain number of units of the component. For example, the parties may agree that the tool cost of, say, Rs.7,35,000 will be amortised over 1,50,000 units. The amortisation rate in this case works out to Rs. 4.90 per unit.

4. In some cases, a part of the agreed tool cost is paid by the principal manufacturer in lumpsum and the balance is amortised in the above manner.

5. While working out the cost of a component, the ancillary includes amortisation of the agreed tool cost as one of the elements of cost. In respect of moulds/dies supplied by the principal manufacturer, no tool cost is included in the cost of the components.

Query

The querist has sought the opinion of the Expert Advisory Committee as to whether the procedure followed by the ancillary in relation to costing of the components is proper.

Opinion

Based on the above, the Committee is of the opinion that from accounting angle, the tool cost relating to moulds/dies to be included in the cost of components manufactured by the ancillary manufacturer is represented by the depreciation charge in respect of the relevant moulds/dies, computed in accordance with the requirements of AS 6. The Committee recognises that the amount agreed to be paid by the principal manufacturer towards tool cost relating to moulds/dies may be different from the amount of depreciation computed in accordance with AS 6

Opinion finalised by the Committee on 22.4.2000.

Property, Plant & Equipment

AS 10 Property, Plant and Equipment prescribe the accounting treatment for properties, P&E (Plant and Equipment) so that the users of financial statements could recognize and appreciate the information about the investment made by any enterprise in property, P&E and the also understand the changes made in such investments.

It is also important to note that AS 6 – Accounting for Depreciation stands withdrawn and such matters related to depreciation is included in AS 10.

Applicability of AS 10

AS 10 is to be applied in accounting for property, P&E (Plant and Equipment) and this standard are not applicable to:

a)     biological assets which are related to agricultural activities except for bearer plants. The Standard is applicable to bearer plants, however, it doesn’t apply to the produce on bearer plants; and

b)    wasting assets which include mineral rights, expenses related to exploration for and extraction of oil, minerals, natural gas and other non-regenerative resources.

Recognition of Asset under AS 10

The cost of property and P&E should be recognized as an asset only if:

a)     it is apparent that the future economic benefits related to such asset would flow to the business; and

b)    the cost of such asset could be reliably measured.

Measurement of cost of the asset

An enterprise can select the revaluation model or the cost model as the accounting policy and employ the same to the entire class of its properties and P&E. According to the cost model, after recognizing the asset as an item of property or plant and equipment, it should be carried at the cost less the accumulated depreciation and the accumulated impairment losses (if any). As per revaluation model, once the asset is recognized and its fair value could be measured reliably, then it must be carried at the revalued amount, which is the fair value of such asset at the date of the revaluation as reduced any following accumulated depreciation and accumulated impairment losses (if any). Revaluations must be done at regular intervals for ensuring that the carrying amount doesn’t differ much from that which would be determined using the fair value at balance sheet date.

Depreciation under AS 10

As per the standard, depreciation charge for every period must be recognized in the P/L Statement unless it’s included in carrying the amount of any another asset. Depreciable amount of any asset should be allocated on a methodical basis over the useful life of the asset.

Every part of property or P&E (Plant and Equipment) whose cost is substantial with respect to the overall cost of the item must be depreciated separately.

The standard also prescribes, that the residual value and useful life of an asset must be reviewed at the end of each financial year and, in case the expectations vary from the previous estimates, changes must be accounted for as changes in accounting estimate as per Accounting Standard 5 – Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.

The method of depreciation employed must reflect the pattern of future economic benefits of the asset consumed by an enterprise. Various depreciation methods could be used for allocating the depreciable amount of an asset on a methodical basis over the useful life of the asset. The methods include SLM (Straight-line Method), diminishing balance method or units of production method.

Major Differences Between AS 10 and Ind AS 16

Ind AS 16 Property, Plant, and Equipment deal with accounting for fixed assets which are covered by AS 10. This Ind AS also deals with the depreciation of property, plant, and equipment that covered by AS 6. The key differences between the existing AS 10 and Ind AS 10 are mentioned below:

ICDS 5 v/s AS 10

AS 14- Accounting for Amalgamation

Introduction

AS 14 (Revised) deals with the accounting to be made in the books of Transferee company in the case of amalgamation and the treatment of any resultant goodwill or reserve.

An amalgamation may be either in the nature of merger or purchase. The standard specifies the conditions to be satisfied by an amalgamation to be considered as amalgamation in nature of merger or purchase.

An amalgamation in nature of merger is accounted for as per pooling of interests method and in nature of purchase is dealt under purchase method.

The standard describes the disclosure requirements for both types of amalgamations in the first financial statements. We will discuss the other amalgamation aspects in detail in subsequent paragraphs of this unit.

AS 14 (Revised) does not deal with cases of acquisitions. The distinguishing feature of an acquisition is that the acquired company is not dissolved and its separate entity continues to exist.

Definition of the Terms used in the Standard

a)             Amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 2013 or any other statute which may be applicable to companies and includes ‘merger’.

b)            Transferor company means the company which is amalgamated into another company.

c)             Transferee company means the company into which a transferor company is amalgamated.

Types of Amalgamations

Amalgamations fall into two broad categories. In the first category are those amalgamations where there is a genuine pooling not merely of the assets and liabilities of the amalgamating companies but also of the shareholders’ interests and of the businesses of these companies. These are known as Amalgamation in nature of merger. In the second category are those amalgamations which are in effect a mode by which one company acquires another company and, as a consequence, the shareholders of the company which is acquired normally do not continue to have a proportionate share in the equity of the combined company, or the business of the company which is acquired is not intended to be continued. Such amalgamations are amalgamations in the nature of 'purchase'.

Methods of Accounting for Amalgamation

Amalgamation in the nature of Merger (Pooling of Interest Method)

Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.

Amalgamation in the nature of Purchase

Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified above.

Methods of Accounting for Amalgamations

There are two main methods of accounting for amalgamations.

a)             The pooling of interest’s method and

b)            The purchase method.

Pooling of Interests Method

Pooling of interests is a method of accounting for amalgamations the object of which is to account for the amalgamation as if the separate businesses of the amalgamating companies were intended to be continued by the transferee company. Accordingly, only minimal changes are made in aggregating the individual financial statements of the amalgamating companies.

Under this method, the assets, liabilities and reserves of the transferor company are recorded by the transferee company at their existing carrying amounts (after making adjustment required in next paragraph).

If, at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform set of accounting policies is adopted following the amalgamation. The effects on the financial statements of any changes in accounting policies are reported in accordance with AS 5.

Purchase Method

Under the purchase method, the transferee company accounts for the amalgamation either

a)             By incorporating the assets and liabilities at their existing carrying amounts  or

b)            By allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company.

Consideration

Consideration for the amalgamation means the aggregate of the shares and other securities issued and the payment made in the form of cash or other assets by the transferee company to the shareholders of the transferor company. In determining the value of the consideration, an assessment is made of the fair value of its elements.

Many amalgamations recognise that adjustments may have to be made to the consideration in the light of one or more future events. When the additional payment is probable and can reasonably be estimated at the date of amalgamation, it is included in the calculation of the consideration. In all other cases, the adjustment is recognised as soon as the amount is determinable [AS 4].

Treatment of Reserves of the Transferor Company on Amalgamation

If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the reserves is preserved and they appear in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company. Thus, for example, the General Reserve of the transferor company becomes the General Reserve of the transferee company, the Capital Reserve of the transferor company becomes the Capital Reserve of the transferee company and the Revaluation Reserve of the transferor company becomes the Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves which are available for distribution as dividend before the amalgamation would also be available for distribution as dividend after the amalgamation.

Adjustments to reserves - Amalgamation in the Nature of Merger

When an amalgamation is accounted for using the pooling of interest’s method, the reserves of the transferee company are adjusted to give effect to the following:

a)        Conflicting accounting policies of the transferor and the transferee. A uniform set of accounting policies should be adopted following the amalgamation and, hence, the policies of the transferor and the transferee are aligned. The effects on the financial statements of this change in  the accounting policies  is reported in accordance with AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’

b)       Difference between the amount recorded as share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of the transferor company.

Adjustments to reserves - Amalgamation in the Nature of Purchase

If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of the reserves, other than the statutory reserves is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and if the result of the computation is positive, the difference is credited to Capital Reserve.

Certain reserves may have been created by the transferor company pursuant to the requirements of, or to avail of the benefits under, the Income-tax Act, 1961; for example, Development Allowance Reserve, or Investment Allowance Reserve. The Act requires that the identity of the reserves should be preserved for a specified period. Likewise, certain other reserves may have been created in the financial statements of the transferor company in terms of the requirements of other statutes. Though normally, in an amalgamation in the nature of purchase, the identity of reserves is not preserved, an exception is made in respect of reserves of the aforesaid nature (referred to hereinafter as ‘statutory reserves’) and such reserves retain their identity in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company, so long as their identity is required to be maintained to comply with the relevant statute. This exception is made only in those amalgamations where the requirements of the relevant statute for recording the statutory reserves in the books of the transferee company are complied with. In such cases the statutory reserves are recorded in the financial statements of the transferee company by a corresponding debit to a suitable account head (e.g., ‘Amalgamation Adjustment Reserve’) which is presented as a separate line item. When the identity of the statutory reserves is no longer required to be maintained, both the reserves and the aforesaid account are reversed.

The Standard gives a title, which reads as "Reserve". This gives rise to following requirements.

But it has to be shown as a separate line item - Which implies, that this debit "cannot be set off against Statutory reserve taken over"

Treatment of Goodwill Arising on Amalgamation

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with reasonable certainty. Such estimation is, therefore, made on a prudent basis. Accordingly, it is considered appropriate to amortise goodwill over a period not exceeding five years unless a somewhat longer period can be justified.

Factors which may be considered in estimating the useful life of goodwill arising on amalgamation include:

Balance of Profit and Loss Account

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company is aggregated with the corresponding balance appearing in the financial statements of the transferee company. Alternatively, it is transferred to the General Reserve, if any.

In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit and Loss Account appearing in the financial statements of the transferor company, whether debit or credit, loses its identity.

Disclosures

For all amalgamations, the following disclosures are considered appropriate in the first financial statements following the amalgamation:

For amalgamations accounted for under the pooling of interests method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

1. Description and number of shares issued, together with the percentage of each company’s equity shares exchanged to effect the amalgamation;

2. The amount of any difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof.

For amalgamations accounted for under the purchase method, the following additional disclosures are considered appropriate in the first financial statements following the amalgamation:

Amalgamation after the Balance Sheet Date

When an amalgamation is affected after the balance sheet date but before the issuance of the financial statements of either party to the amalgamation, disclosure is made in accordance with AS 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, but the amalgamation is not incorporated in the financial statements. In certain circumstances, the amalgamation may also provide additional information affecting the financial statements themselves, for instance, by allowing the going concern assumption to be maintained.

AS 21- Consolidated Financial Statements

AS 21- Consolidated Financial Statements should be applied in preparing and presenting consolidated financial statements for a group of enterprises under the sole control of a parent enterprise.

Applicability of AS 21

 This standard must be applied when accounting for investment in subsidiaries in a separate financial statement of the parent.

It is to be noted that while preparing a consolidated financial statement, other standards also stay relevant in a similar manner as for standalone statements.

This accounting standard doesn’t deal with:

Presentation of Consolidated Financial Statements

A parent company presenting its consolidated financial statements must present these statements along with its standalone financial statements.

The users of financial statements of a parent company are typically concerned with and are required to be educated about, the results of operations and financial position of not only the company itself but also of that group together.

This requirement is served by offering the users of financial statements –

1. standalone financial statements of a parent; and

2. consolidated financial statements that provide financial information about the business group as that of a lone enterprise without respect to the legal restrictions of the distinct legal entities

Scope of Consolidated Financial Statements

A parent company which presents its consolidated financial statements must consolidate all of its subsidiaries, foreign as well as domestic. Where a company doesn’t have any subsidiary, however, has associates and/or joint ventures such company also needs to prepare consolidated financial statements as per Accounting Standard 23 – Accounting for Associates in Consolidated Financial Statements and Accounting Standard 27 – Financial Reporting of Interests in jvs respectively.

Exclusion of Subsidiaries

A Subsidiary must be excluded from the consolidation when:

a)     Control is planned to be temporary since the subsidiary was taken over and was held exclusively for disposal in the near future; or

b)    The subsidiary is operating under severe long-standing restrictions that considerably impair the subsidiary’s ability to transfer funds to its parent

In a consolidated financial statement, investments in such subsidiaries must be accounted for as per AS 13 – Accounting for Investments. Reasons for which a subsidiary isn’t included in the consolidation must be disclosed in such consolidated financial statements.

Consolidation Procedures

While preparing a consolidated financial statement, the parent company’s financial statements and its subsidiaries must be combined line by line by totalling together similar items such as assets, liabilities, income, and expenses.

For consolidating financial statements in a way to present financial information about a group as that of a lone enterprise, the below-motioned steps must be taken:

(i) amount of equity which is attributable to the minorities at the date on which such investment in the subsidiary is done; and

(ii) minorities’ share of the movements in equity from the date the relationship of parent-subsidiary came in to force

Where carrying investment amount in a subsidiary is different from the cost, such carrying amount is to be considered for the above calculations.

Accounting for Investments in the Subsidiaries in Separate Financial Statement of the Parent

In a parent company’s separate financial statements, the investments made in subsidiaries must be accounted for as per AS 13 – Accounting for Investments.

Disclosures in the Financial Statements

Following disclosures must be made w.r.t. AS 21 Consolidated Financial Statements:

1. in the consolidated financial statements the list of all the subsidiaries of the parent company which includes the name, country of residence or incorporation, the share of ownership interest and, in case different, the share of voting power held

2. In case the consolidation of particular subsidiary hasn’t been made according to the grounds permissible in the accounting standard, reasons for which such subsidiary isn’t included in the consolidation must be disclosed in such consolidated financial statements

3. in the consolidated financial statements, where valid:

a)     type of relationship between a parent and its subsidiary, whether direct control or indirect control through the subsidiaries

b)    effect of acquisition and disposal of the subsidiaries on financial position at the date of reporting results for the reporting period and on corresponding amounts for preceding period; and

c)     Name of the subsidiary(s) of which reporting date(s) is different

Major Differences between AS 21 and Ind AS 110

Key takeaways:

Solved Examples 

Q1) (AS 5)

Fuel surcharge is billed by the State Electricity Board at provisional rates. Final bill for fuel surcharge of Rs 5.30 lakhs for the period October, 2008 to September, 2015 has been received and paid in February, 2016. However, the same was accounted in the year 2016-17. Comment on the accounting treatment done in the said case.

A1)

The final bill having been paid in February, 2016 should have been accounted for in the annual accounts of the company for the year ended 31st March, 2016. However, it seems that as a result of error or omission in the preparation of the financial statements of prior period i.e., for the year ended 31st March 2016, this material charge has arisen in the current period i.e., year ended 31st March, 2017. Therefore, it should be treated as 'Prior period item' as per AS 5. As per AS 5, prior period items are normally included in the determination of net profit or loss for the current period. An alternative approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss.

It may be mentioned that it is an expense arising from the ordinary course of business. Although abnormal in amount or infrequent in occurrence, such an expense does not qualify an extraordinary item as per AS 5. For better understanding, the fact that power bill is accounted for at provisional rates billed by the state electricity board and final adjustment thereof is made as and when final bill is received may be mentioned as an accounting policy.

Q2) (AS 5)

a)             During the year 2016-2017, a medium size manufacturing company wrote down its inventories to net realisable value by Rs 5,00,000. Is a separate disclosure necessary?

b)            A company signed an agreement with the Employees Union on 1.9.2016 for revision of wages with retrospective effect from 30.9.2015. This would cost the company an additional liability of Rs 5,00,000 per annum. Is a disclosure necessary for the amount paid in 2016-17?

A2)

“When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.”

Circumstances which may give to separate disclosure of items of income and expense in accordance with AS 5 include the write-down of inventories to net realisable value as well as the reversal of such write-downs.

2.     It is given that revision of wages took place on 1st September, 2016 with retrospective effect from 30.9.2015. Therefore wages payable for the half year from 1.10.2016 to 31.3.2017 cannot be taken as an error or omission in the preparation of financial statements and hence this expenditure cannot be taken as a prior period item.

Additional wages liability of Rs 7,50,000 (for 1½ years @ Rs 5,00,000 per annum) should be included in current year’s wages.

It may be mentioned that additional wages is an expense arising from the ordinary activities of the company. Such an expense does not qualify as an extraordinary item. However, as per AS 5, when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

Q3) (AS 5)

The company finds that the inventory sheets of 31.3.2016 did not include two pages containing details of inventory worth Rs 14.5 lakhs. State, how you will deal with the following matters in the accounts of Omega Ltd. For the year ended 31st March, 2017.

A3)

AS 5 on ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, defines Prior Period items as "income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods”.

Rectification of error in inventory valuation is a prior period item vide AS 5. Separate disclosure of this item as a prior period item is required as per AS 5.

Q4) (AS 5)

Explain whether the following will constitute a change in accounting policy or not as per AS 5.

a)             Introduction of a formal retirement gratuity scheme by an employer in place of ad hoc ex-gratia payments to employees on retirement.

b)            Management decided to pay pension to those employees who have retired after completing 5 years of service in the organisation. Such employees will get pension of Rs 20,000 per month. Earlier there was no such scheme of pension in the organisation.

A4)

As per AS 5 ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, the adoption of an accounting policy for events or transactions that differ in substance from previously occurring events or transactions, will not be considered as a change in accounting policy.

Q5) (AS 6)

A Ltd. Engaged in production of steel, wants to provide for deprecation based on unit of production instead of straight line or written down value method. Can A Ltd do so?

A5) AS 6, on Depreciation accounting stipulates that minimum depreciation should be provided as made under statute i.e. The Companies Act, 2013. Schedule XIV to the Companies Act, 2013 prescribes various rates to be provided for different assets under straight line and written-down value method. However, where management estimates useful life of an asset shorter than as envisaged under the provisions of statute i.e. Schedule XIV, than the depreciation is provided applying a higher rate.

Thus, if A Ltd. Contemplates to provide deprecation on production basis and such depreciation happens to be lower than the depreciation worked out under schedule XIV, than A Ltd. Would not be complying with the provisions of AS 6. Since, under the Indian Accounting Standard, reference is made to statute, companies in India will be required to provide minimum depreciation at the rates prescribed in schedule XIV. Based on the estimated useful life, if the depreciation rate is lower than the rate prescribed in Schedule XIV, companies will be required to approach central government in this regards.

Note: Under the International accounting standard or for that purpose US GAAP, depreciation is provided considering the best estimate of useful life of the asset. The following abstract from the financial statement of Cathay Pacific Airways will show that enterprise is at liberty to evaluate the estimate useful life of Fixed Asset.

Annual depreciation charges to write down the original cost of aircraft to estimated residual values are based on actual operational usage of the relevant aircraft as a proportion of its total estimated operational life. The useful operational life of an aircraft is determined by reference to its anticipated aircraft flight cycle while in service of the company. However, if the aircraft is held under a finance lease, the depreciable life of the aircraft is limited to the lease term unless a purchase option is held. A flight cycle is defined as one take-off and one landing. The residual value of aircraft and related equipment are 10% of original cost or values guaranteed under forward sales agreements.

Q6) (AS 6)

R. Ltd. A newly incorporated company wants to provide depreciation on Plant and Machinery on straight line method whereas written down value method for the remaining fixed assets? Can R Ltd. Do so?

A6) Depreciation method is selected based on various important factors e.g.

AS 6, mentions, a combination of more than one method is some times used, meaning thereby that for few fixed assets straight line method can be adopted whereas for other fixed assets written down value method can also be adopted.

Accordingly R Ltd. Can choose straight line method for plant and machinery and written down value method for other fixed assets.

Q7) (AS 6)

P Ltd. Is providing deprecation on straight line method. Due to technical evaluation, the estimated useful life of certain fixed assets is less as compared to life of assets as indicated by rates prescribed under Companies Act, 2013. Is P Ltd. Required to provide depreciation considering the estimated useful life of asset which is higher than the rates prescribed in the Companies Act, 2013. Is P Ltd. Required to recompute depreciation from inception i.e. From the date when such fixed assets were purchased?

A7) AS 6 stipulates that where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. Hence, P Ltd. Will be required to provide depreciation at higher rates than rates prescribed under the act.

Second and important issue that arises is how P Ltd. Should compute the depreciation. This gives rise to a change in estimate and not a change in method, so enhanced depreciation should be provided prospectively i.e. Over the remaining useful life of the asset.

P. Ltd. Will have to provide enhanced depreciation over the residual useful life of the asset.

Q8) (AS 6)

P Ltd. Was providing depreciation on Plant and Machinery on written down value method. With effect from 1-4-03, in respect of additions to, plant and machinery, P Ltd. Wants to provide depreciation on straight line method, whereas for plant and machinery upto 31-3-03, it will continue to provide depreciation on written down value method. Is contention of P Ltd justified?

A8) As per AS 6, the method of depreciation is applied consistently to provide comparability of the results of the operation of the enterprise from period to period. A change from one method of providing depreciation to another is made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When such a change in method of depreciation is made, depreciation is recalculated in accordance with the new method from the date of the asset coming into use.

Accordingly, P Ltd. Would not be justified in providing depreciation on straight line method in respect of additions to plant and machinery with effect from 1-4-03. P Ltd. Can change method of providing depreciation from written down value to straight line method and this in compliance to Accounting Standard has to be done retrospectively from the date of the asset coming into use.

Q9) (AS 10)

A company has purchased plant and machinery in the year 2001-2002 for Rs 45 lakhs. A balance of Rs5 lakhs is still payable to the suppliers for the same. The supplier waived off the balance amount during the financial year 2004-2005. The company treated it as income and credited to profit and loss account during 2004-2005.

Whether accounting treatment of the company is correct. If not, state with reasons.

A9) As per AS 10 the cost of fixed assets may undergo changes subsequent to its acquisition or construction on account of exchange fluctuation, price adjustments, changes in duties or similar factors. The treatment done by the company is not correct. Rs5 lakhs should be deducted from the cost of fixed assets.

Q10) (AS 10)

ABC Ltd. Gave 50,000 equity shares of Rs 10 each (fully paid up) in consideration for supply of certain machinery by X & Co. The shares exchanged for machinery are quoted on Bombay Stock Exchange (BSE) at Rs 15 per share, at the time of transaction. In the absence of fair market value of the machinery acquired, how the value of machinery would be recorded in the books of the company?

A10)

As per AS-10, fixed asset acquired in exchange for shares or other securities should be recorded at its fair market value or the fair market value of the securities issued, whichever is more clearly evident. Since, the market value of the shares exchanged for the asset is more clearly evident, the company should record the value of machinery at Rs 7,50,000. (i.e., 50,000 shares x 15 per share being the market price)

Q11) (AS 10)

Jadu Ltd. Purchased certain plant and machinery for Rs 40 lakhs. 20% of the cost net of Cenvat credit is the subsidy component to be realized from a State Government for establishing industry in a backward district. Cost Rs 40 lakhs include excise Rs 5 lakhs against which Cenvat credit can be claimed. Compute depreciable amount.

A11) In this case, it is first necessary to determine the historical cost of the plant and machinery. This is shown in the following table.

Q12) (AS 10)

On March 01, 2007, X Ltd. Purchased Rs 5 lakhs worth of land for a factory site. Company demolished an old building on the property and sold the material for Rs 10,000. Company incurred additional cost and realized salvaged proceeds during the March 2007 as follows:

Compute the balance to be shown in the land account on March 31, 2007 balance sheet.

A12)

Q13) (AS 10)

Mr. X set up a new factory in the backward area and purchased plant for Rs 500 lakhs for the purpose of his business. Purchases were entitled for the CENVAT credit of Rs 10 lakhs and also Government agreed to extend the 20% subsidy for backward area development. Determine the depreciable value for the asset.

A13)

1.5 Basic Accounting Process-Journal, Ledger Trial Balance, Double Entry System, Systems of Accounting.

ACCOUNTING CYCLE

When complete sequence of accounting procedure is done which happens frequently and repeated in same directions during an accounting period, the same is called an accounting cycle.

Steps/Phases of Accounting Cycle

The steps or phases of accounting cycle can be developed as under:

Financial Statements: Financial statement can now be easily prepared which will exhibit the true financial position and operating results.

Journal

Original entry book

The book in which the transaction is recorded for the first time from the source document is called the Books of Original Entry or Prime Entry. The journal is one of the original entry books in which transactions were originally recorded in chronological order (daily) according to the principle of double-entry bookkeeping.

 Journal 

The journal is a dated record of all transactions, including debited and credited account details and the amount of each transaction.

Proforma of a Journal

Description:

1. Date: The date of the transaction is entered in the first column. The year and month are written only once until they change. The date and month order must be strictly maintained.

2. Details: Each transaction affects two accounts, one of which is debited and the other of which is credited. The name of the account to be debited is first written in the immediate vicinity of the row of details column, Dr. Is also written at the end of a particular column. On the second line, the name of the credited account begins with the word "To", a few spaces away from the margins of the detail column to distinguish it from a debit account.

3. Narration: After each entry, a brief description of the transaction and the required details are displayed in a detail column in parentheses called narration. The words "For" or "Being" are used before you start writing the narration. Currently, you don't have to use the word "For" or "Being".

4. Ledger Folio (L.F): All entries in the journal are later posted to the ledger account. The ledger page numbers or folio numbers posted from the journal are recorded in the L.F column of the journal. Until such time, this column remains blank.

5. Debit Amount: This column contains the amount of the account to be debited.

6. Credit Amount: This column will contain the amount of the account to be credited.

Journalizing steps

The process of analysing and journalizing business transactions under the head of debits and credits is called journalizing. The entries created in the journal are called "journal entries".

Step 1-

Determine the two accounts involved in the transaction.

Step 2 -

Classify the above two accounts by personal, genuine, or nominal.

Step 3 -

Review the debit and credit rules for the two accounts above.

Step 4 -

Identify which account to debit and which account to credit.

Step 5 -

Record the trading date in the date column. The year and month are written only once until they change. The date and month order must be strictly maintained.

Step 6 -

Enter the name of the account you want to debit in the detail’s column very close to the left of the detail’s column, followed by the abbreviation Dr. in the same row. In contrast, the amount debited is written in the debit amount column on the same row.

Step 7 -

Enter the name of the account to be credited on the second row, starting with the word "To", a few spaces away from the margins in the "Details" column. In contrast, the amount to be credited is written to the credit amount column in the same row.

Step 8 -

Write the narration in parentheses in the next row of the detail column.

Step 9-

Draw a line across the detail column to separate one journal entry from the other.

Example:

March 18, 2004 – Purchased from James with credit Rs.1,50,000

SOME IMPORTANT POINTS:

2.     Owner and business are considered as separate persons, hence there can be transaction between them.

3.     Our own name cannot appear in our books of accounts (i.e. the name of the business cannot appear in the books of accounts of business).

4.     Look at all the transactions from the point of view of business only.

5.     Owner giver - Capital A/c Credit.

 Owner receiver - Drawings A/c Debit.

 Hence Capital A/c and Drawing A/c represents the owner, hence these two are personal a/c’s.

6.     Capital: Amount invested by owner into the business.

7.     Drawings: Amount withdrawn by owner from the business for personal use.

8.     Goods: Items bought for re-sale and to make profit.

9.     Assets: Items bought for use in the business.

10.       

11. 

a)             Cash purchase: Goods are purchased and cash is paid on the spot.

b)            Credit purchase: Goods are purchased and cash will be paid in future.

c)             Creditor: Party to whom cash will be paid in the future is known as Creditor OR Supplier.

12. 

a)             Cash sales: Goods are sold and cash is received on the spot.

b)            Credit sales: Goods are sold and cash will be received in the future.

c)             Debtor: Party from whom cash will be received in the future is known as Debtor OR Customer.

13. Stock A/c Dr. ONLY WHEN owner introduces goods to start the business.

14. 

a)             Cash received - Cash A/c Debit

b)            Cheque received - Bank A/c Debit (because bank is the receiver of money).

15.

a)             Cash paid - Cash A/c Credit.

b)            Cheque issued - Bank A/c credit (because bank is the giver of money).

16. If Nominal A/c is our income we should write the word ‘RECEIVED’.

 For e.g.

•                 If Rent is our expense Rent A/c DEBIT

•                 If Rent is our Income Rent Received A/c CREDIT

17. 

 For e.g. Goods purchased from Amit Rs. 1,000, means goods are purchased on credit.

For e.g. Goods purchased for Rs. 2,000, means goods are purchased for cash.

18.  

19. OUTGOING OF GOODS AT COST  

-  Purchase A/c       CREDIT

e.g. Goods distributed as free samples, Goods lost by theft, Goods destroyed by fire, Goods given as donation.

20. 

NOTE: BOTH ARE EXPENSES and SHOULD BE DEBITED.

21. 

a)             Our expenses paid by us:

Expense A/c Dr.

  To Cash A/c

b)            We pay expenses of Mr. X: (It is as good as paying cash to Mr.  X).

Mr. X. A/c Dr.

  To Cash A/c.

c)             Mr. Y pays our expense: (It means Mr. Y is the giver of money for our expenses)

Expenses A/c Dr.

  To Mr. Y. A/c.

22. 

a)             Paid cash to Mr. X on advice of Mr. Y (It is as good as paying cash to Mr. Y).

Mr. Y.  A/c Dr.

  To Cash A/c

b)            Mr. X paid cash to Mr. Y on our behalf. (It is as good as: Cash received from Mr. X and then cash paid to Mr. Y)

23. Different ways of recording Personal A/cs.

OWNER   - Capital A/c / Drawings A/c

 Party for goods   - Party A/c

 Party for borrowings - Loan A/c / Advances A/c

 Party for Deposits  - Deposit A/c

24.

25. 

a)             Bad debts: Amount which cannot be recovered from the party. (Insolvent).

b)            Solvent: Person whose Assets > Liabilities.

c)             Insolvent: Person whose Liabilities > Assets.

26. 

a)             Insurance premium paid  - Expense of business.

b)            Life Insurance premium paid - Personal expense of the owner.

c)             Income tax paid   - Personal expense of the owner.

27. 

a)             Goods distributed (given) as free samples

Advertisement A/c Dr. (AT COST)

  To Purchase A/c

b)            Goods received as free samples

NO ENTRY - because for us the cost is ZERO

c)             Free Samples sold:

Cash A/c   Dr (AT S.P.)

  To Sundry Income A/c

28. 

a)             Bad debts Recovery: Amount recorded as bad debts in the past now received. It is our income, hence Bad Debts Recovery A/c is a nominal A/c.

Other Important Points of Journal:

(6)  lf in the transaction of purchase or sale It is not given clearly whether it is for cash or on credit, then

a)             lf the name of party is given then It is credit transaction (ignore % of C.D. given in the transaction).

b)            lf the name of the party is not given then it is a cash transaction.

(7)   ln case of purchase and sale of goods party on cash and on credit with cash discount.

a)            If Goods A/c debited then all other A/cs will be credited.

b)            lf Goods A/c is credited then all other A/cs will be debited.

(8)  Entries are not passed for the following:

a)            Placing and receiving of order.

b)           Giving Change

c)            Appointing a person »

d)            Deciding for buying and selling of any asset etc.

(9)  Entry is passed on the day on which order is executed. (Completed)

(10)  Any amount brought in business by Owner is credit to capital A/c.

a)            Private (Personal) Car sold any money invested in the business or for business purpose.

b)           Gift received or Lottery price received and invested in business etc.

(11) Whenever goods are sold, entry should be passed with the selling price of goods. Profit or sale of goods not recorded separately.

Eg: Goods costing Rs. 10,000 sold at a loss of Rs. 1,000.,

Entry: Cash A/c Dr.    9,000

               To Sales A/c -        9,000

(12) Cash discount is calculated only for cash transactions and not on credit transaction. Cash transaction means cash and cheque received or given.

(13) Bad debts recovered:

Eg: Received Rs. 3,000 cash from Amar which was earlier written off as bad.

Entry: Cash A/c   Dr.        3,000

               To Bad Debts recovered A/c - 3,000

Note: Amar A/c is not credited because bad debts recovered is gain (Profit). It is an income.

Ledger

In the journal, each transaction is processed individually. Therefore, the ultimate results of many transactions can't be seen at a look. Therefore, it's collected in one place in your ledger to ascertain internet effect of all transactions associated with a specific account.

A ledger may be a book that contains all the accounts that are initially entered into the journal or special purpose auxiliary books, whether personal, genuine, or nominal. consistent with L.C., Cropper, "A book that contains a categorized and protracted record of all transactions during a business is named a ledger."

 The foremost commonly used ledger for many business concerns is bound notebooks. It is often stored for an extended time. As a result, the page is numbered. Each ledger account should open on a separate page, if possible. When one page is complete, your account will proceed to subsequent page or another page. But with greater concern, keeping the ledger as a bound notebook is impractical. The loose-leaf ledger has replaced the bound notebook. The loose-leaf ledger introduces an appropriate cardboard border sheet and secures it with the assistance of a binder. you'll delete the finished accounts and relocate and relocate the accounts in any order, whenever the specified additional pages could also be inserted. Therefore, this sort of ledger is understood as a loose-leaf ledger.

Utility

A utility ledger may be a principal or main ledger that contains all accounts to which transactions recorded within the original entry's books are transferred. Ledgers also are referred to as "final entry books" or "secondary entry books" because transactions are eventually incorporated into the ledger. the benefits of the ledger are:

All transactions associated with your account are collected in one place in your ledger. By watching the balance of that account, you'll see at a look the collective effect of all such transactions.

2.     Arithmetic Accuracy

 With the assistance of your ledger balance, you'll prepare an attempt balance to understand the arithmetic accuracy of your account.

3.     Business Performance

Makes it easy to make a final accounting to know business performance and therefore the financial position of the business.

4.     Accounting Information

Data provided by various ledger accounts is summarized, analyzed, and interpreted to get various accounting information.

 Description

In other words, posting means grouping all transactions associated with a specific account in one place. All journals must be posted to different accounts in your ledger because postings assist you understand internet impact of various transactions over a specific period on a specific account.

Posting procedure

Step 1 -

Find the account you would like to debit in your ledger and enter the date of the transaction within the debit date column.

Step 2 -

Record the name of the account credited within the journal as a "destination" within the debit details column. (The name of the credited account) ".

Step 3 -

Record the pagination of the journal within the debit J.F column and write the pagination of the ledger during which the actual account appears within the journal within the L.F. column.

Step 4 -

Enter the quantity related to the accounting amount column.

2.     Procedure for posting an account credited to a journal.

Step 1 -

Find the account to be credited in your ledger and enter the date of the transaction within the credit date column.

Step 2 -

Record the name of the debited account within the journal as "By (the name of the debited account)" within the detail’s column on the accounting.

Step 3 -

Record the journal page number in column J.F on the credit side and enter the page number of the ledger for which a particular account appears in the journal.

L.F. column.

Step 4 -

Enter the amount associated with the amount column on the credit side.

Ledger: A book in which all accounts are kept is called a ledger. In other words, a ledger is a set of all the different type of accounts. It is a bound book of all the transactions. It includes all the different accounts of persons, assets, liability, incomes, expenses, etc. Transactions cannot be directly recorded in ledger. Every entry in the ledger accounts comes from the books of prime entry.

Important points:

Dr.                                                            Ledger A/c                                             Cr.

5.  Process of transferring Journal entry into the ledger Account is known as posting.

6.  Posting Rule:

•                 Name of opposite Account.

•                 Amount of same Account.

7.  Ledger Account are closed and re-opened at regular intervals, mostly after every month.

8.  Balance at the end - Closing balance (Balance c/d)

Balance at the beginning - Opening balance (Balance b/d)

9.  In an Account:

   If Dr. Side is heavy - A/c shows Dr. balance

   If Cr. Side is heavy - A/c shows Cr. Balance

10.             Closing balance - Recorded on opposite side. Opening balance – recorded on same side.

11.             Personal Accounts:

12.             Real A/cs - Always Dr. balance.

13.             Nominal A/cs

14.              

   -  Overdraft- Cr. balance.

15.              

a)             Capital A/c  - Cr. balance.

b)            Drawings A/c - Dr. balance.

16.              

a)             Purchase A/c                      Dr. balance

b)            Sales A/c                       Cr. balance

c)             Purchase Return A/c          Cr. balance

d)            Sales Return A/c                  Dr. balance

e)             Stock A/c                                 Dr. balance

Trial balance

Definition

“Trial balance is a statement, prepared with debit and credit balances of ledger accounts to test the arithmetical accuracy of the books”.                          

J.R. Batliboi

a)             It is the statement from which final accounts are prepared

b)            It is the list of balances of all the ledger accounts

c)             The total of debit and credit column of trial balance must tally

d)           

How does trial balance work?

The trial balance is the statement of all debits and credits. Business man prepares trial balance at the end of the reporting period regularly to ensure that the entries are mathematically correct in the books of account. The total of trial balance should be equal. In case the debit and credit does not match it means there is an error. For example, the accountant may have recorded an account or classified a transaction incorrectly.

Preparation of trial balance

A trial balance looks like

All the account title are the closing balance of ledger account

Double Entry System

For management to take future decision requires financial information. This is where accounting steps in that record, summaries, analyze all the business transaction.

Accounting is the process of recording, classifying, summarizing, analysing, and interpreting the financial transactions and communicating the results to the persons interested in such information. Two methods for accounting are Single Entry System and Double Entry System. Mostly, we use Double Entry for better accounting purposes.

Double entry system

Double entry system of accounting deals with two aspects of every business transaction. In other words, every transaction has two effects. For ex, a person buys a cold drink from a store and in return pays the money to shopkeeper for the cold drink. This transaction has two effects in terms of both buyer and seller. Buyer cash balance will decrease by the cost of purchase on the other hand he will acquire a cold drink. Seller will have one drink short but his cash balance will increase.

Accounting attempts to record both effect of transaction in the financial statement.  This refers to double entry concept. Under this every transaction involves two parties, one party gives the benefit and other party receives it. It is also called dual entity of transaction.

Accounting records the two affects which are known as Debit (Dr) and Credit (Cr). Accounting system is based on the duality principal that for every Debit entry, there will always be an equal Credit entry.

Debit entries are ones that account for the following effects:

Credit entries are ones that account for the following effects:

Accounting equation recorded in double entry are

Assets – Liabilities = Capital

Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or increase in liability or equity (Cr) and vice-versa. The accounting equation will still be in equilibrium.

Examples of double entry

Machine account debited (increase in assets)

Cash account credited (decrease in assets)

2.     Payment of utility bills

Utility expenses account debited (increase in expenses)

Cash account credited (decrease in assets)

3.     Receipt of bank loans

Cash account credited (increase in assets)

Bank loan account credited (increase in liability)

Characteristic of double entry system

The process of keeping accounts under the double-entry system;

Advantages of double entry system

Account classification-

Transactions can be divided into three categories.

Therefore, accounts can also be categorized as personal, genuine, or nominal. The classification can be explained as follows.

I. Personal Account: An account related to an individual. Personal accounts include:

1. Natural person: An account related to an individual.

2. Artificial person: An account associated with an individual or a group of businesses or institutions. For example, HMT Ltd., Indian Overseas Bank, life assurance Corporation of India, Cosmopolitan club.

3. Representative: An account that represents a particular individual or group of individuals. For example, unpaid payroll accounts, prepaid insurance accounts, and so on.

A business concern may be to maintain business relationships with all of the above personal accounts in order to purchase, sell, rent, or rent goods from them. Therefore, they are either debtors or creditors.

The capital and drawing accounts of the individual owner are also personal accounts.

II. Non-personal accounts: All accounts that are not personal accounts. This can be further divided into two types. Real and nominal accounts.

Key takeaways:

1)     A journal is a detailed record of all transactions made by a company.

2)     Account collation and transfer of information to other accounting records is done using the information recorded in the journal.

3)     When a transaction is recorded in a company's journal, it is usually recorded using double-entry bookkeeping, but it can also be recorded using single-entry bookkeeping.

4)     Double-entry bookkeeping reflects changes in the two accounts after the transaction occurs. One increase and corresponding decrease in accounts.

5)     Single-entry bookkeeping is rarely used and records only one account change.

6)     Journals are also used in the financial industry to refer to trading journals that detail the transactions made by investors and why.

7)     The general ledger is the foundation of a company's double-entry bookkeeping system.

8)     The general ledger contains all the transaction data needed to create income statements, balance sheets, and other financial reports.

9)     A general ledger transaction is a summary of transactions made as a journal entry to a subledger account.

10) A trial balance is a report that lists all general ledger accounts and their balances, making adjustments easier to see and errors easier to find.

11) Reconciliation journals are used to record transactions that have occurred but have not yet been properly recorded according to accrual accounting methods.

12) Reconciliation journals are recorded in the company's general ledger at the end of the accounting period and adhere to the principles of matching and revenue recognition.

13) The accounting cycle is a process designed by business owners to facilitate financial accounting of their business activities.

14) The end of the accounting cycle provides business owners with a comprehensive financial performance report used to analyze their business.

15) The eight steps of the accounting cycle are identifying transactions, recording transactions in journals, posting, unadjusted trial balances, worksheets, adjusting journal entries, financial statements, and closing books.

16) The advent of double-entry bookkeeping is associated with the birth of capitalism.

17) Giver and receiver – every transaction must have giver and receiver. For ex, purchase a car, the buyer purchases a car from seller in return of cash – hence the buyer is the receiver and seller are the giver. When the seller receives the cash for the purchase made by buyer – the seller is the receiver of cash and buyer is the giver.

18) The company keep accounting records which helps in controlling

19) Using double entry system of accounting, current year can be compared with previous year to formulate the future course of action

20) Under double entry system, the total amount of assets and liabilities can be ascertained

References:

   Text Books: