Unit -1

Introduction to Accounting and Financial Statements

Q1) Define Basic Accounting Concepts/Accounting Principles/Accounting Conventions.

A1)

Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared.

The three basic assumptions are:

• Going Concern
• Consistency
• Accrual basis

Besides these three, Business Entity, Conservatism, Consistency, Dual Aspect, Materiality are other basic assumptions on which accounting concepts are based on.

Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternative exists.

Accounting principles are the guidelines and procedures that should be adhered to while recording financial data.

The ultimate goal of accounting principles is to guarantee a company's financial statements to be complete and comparable. This makes it easier for investors to analyse the company's financial statements.

Accounting conventions emerge out of accounting practices, commonly known as accounting principles, adopted by various organizations, over a period of time. Accounting conventions need not have universal application.

This helps the organisations to address such transactions while recording in the books of accounts, on which Accounting Standards are not definite or there is scope for the improvement in the guidelines.

Accounting is full of assumptions, concepts and conventions. They collectively standardize not only the process of accounting but also the process of financial reporting.

Q2) Explain Basic Accounting Concepts.

A2)

These basic accounting concepts are as follows:

a) Entity Concept:

Entity concept states that business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner.

b) Money Measurement Concept:

As per this concept, only those transactions which can be measured in terms of money are recorded. Transactions and events that cannot be expressed in terms of money are not recorded in the business books.

c) Accrual Concept:

Under accrual concept, the effects of transactions are recognised on Mercantile basis i.e., when they occur and not when cash is received or paid and they are recorded in the accounting records of the periods to which they relate.

d) Matching Concept:

In this concept, all expenses matched with the revenue of that period should only be taken into consideration. In the financial statements of the organisation, if any revenue is recognised, then expenses related to earn that revenue should also be recognised.

e) Going Concern Concept:

The financial statements are normally prepared on the assumption that an enterprise is a Going Concern and will continue its operations for the foreseeable future.

f) Cost Concept:

By this concept, the value of an asset is to be determined on the basis of Historical cost, in other words, Acquisition cost.

g) Dual Aspect Concept:

This concept is the core of double entry book keeping. Every transaction or event has two aspects that is, one Debit effect and another one as Credit.

h) Conservatism:

Conservatism states that the accountant should not anticipate an income and should provide for all possible losses. It is not prudent to count unrealized gain but it is desirable to guard against all possible losses.

i)     Consistency:

In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another and a change in an accounting policy is made only in certain exceptional circumstances.

j) Materiality:

Materiality principle permits other concepts to be ignored if the effect is not considered material. The term material is a subjective term; it is on the judgement, common sense and discretion of the accountant that which item is material and which is not.

Q3) What are various types of Accounting?

A3)

Financial Accounting:Financial Accounting is a field of accounting that is concerned with summarizing, analysing and reporting of financial transactions of a business. It is historical in nature because the transactions which had already been occurred, are recorded.

Management Accounting:In simple terms, Management Accounting is defined as providing of financial as well as non-financial decision-making information to the managers of the business. Generally, it is not released publically as it is concerned with only the internal reporting to the managers of a business unit.

Cost Accounting:According to Harold Wheldon, "Costing is the classifying, recording and appropriate allocation of expenditure for the determination of cost". It can be understood from the definition that cost accounting relates to the classification and ascertainment of the cost of a product.

Social Responsibility Accounting:Social accounting is defined as the reporting of the costs incurred in various societal beneficial requirements and more generally, the impact that the business entity created on the society and the environment. Thus, it is concerned with the accounting of social costs incurred and social benefits created.

Human Resource Accounting:Human resource accounting is a process to identify the investments incurred to develop human resources of an organisation. Various costs are incurred by a business entity to recruit, select, train and develop the personnel so that they work effectively.

Besides, there are other various types of accounting. Public Accounting, Government Accounting, Forensic Accounting, Tax Accounting are some of them.

Q4) Explain the framework for the preparation and presentation of Financial Statements.

A4)

    The text of ‘Framework for the Preparation and Presentation of Financial Statements’ is issued by the Accounting Standards Board of The Institute of Chartered Accountants of India.

    This framework sets out the concepts that underline the preparation and presentation of financial statements for external users.

    The users of financial statements include the present and potential investors, lenders, trade creditors, Government and its agencies and the public.

    They use financial statements to get some information. For example, the providers of the capital, i.e., the Investors are concerned with the risk inherent and the return provided. Lenders and Creditors are interested in information which enables them to determine the amounts owing to them, will be paid when due.

    The management of the business entity has the responsibility for the preparation and presentation of the financial statements.

    The objective of the financial statements is to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of uses and making economic decisions.

    Information about financial position is primarily provided in a balance sheet. Information about performance is primarily provided in a statement of profit and loss. Information about cash flows is provided in the financial statements by means of a cash flow statement.

Q5) What are the assumptions of Accounting?

A4)

The underlying Assumptions of Accounting are:

Accrual Basis - Under this basis, the effects of transactions are recognised when they occur and not when cash is received or paid and they are recorded in the accounting records of the periods to which they relate.

Going Concern - The financial statements are normally prepared on the assumption that an enterprise is a Going Concern and will continue its operations for the foreseeable future. Hence it is assumed that the enterprise has neither the intention nor the need to liquidate the business.

Consistency - In order to achieve comparability of the financial statements of an enterprise through time, the accounting policies are followed consistently from one period to another. A change in an accounting policy is made only in certain exceptional circumstances.

Q6) What are the limitations of Financial Statements?

A5)

The limitations of financial statements are those factors that a user should be aware of before relying on them to an excessive extent.

a) Dependence on Historical Costs:

Transactions are initially recorded at their cost. The balance sheet could be misleading if a large part of the amount presented is based on historical costs.

b) Inflationary effects:

If the inflation rate is relatively high, the amounts associated with assets and liabilities in the balance sheet will appear inordinately low, since they are not being adjusted for inflation.

c) Not always comparable across companies:

If a user wants to compare the results of different companies, their financial statements are not always comparable, because the entities use different accounting practices.

d) Subject to Fraud:

The management team of a company may deliberately skew the results presented. This situation can arise when there is undue pressure to report excellent results

e) No predictive Value:

The information in a set of financial statements provides information about either historical results or the financial status of a business as of a specific date. The statements do not necessarily provide any value in predicting what will happen in the future.

f) Impact of Non-Monetary factors ignored:

There are certain factors which have a bearing on the financial position and operating results of the business but they do not become a part of these statements because they cannot be measured in monetary terms. Such factors may include the reputation of the management, credit worthiness of the concern, etc.

g) Assets may not realise:

Accounting is performed on the ground of a few definite conventions. Some of the assets might not realise the declared values if the liquidation is enforced on the enterprise. Assets shown in the balance sheet reflect slightly at an unexpired cost.