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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), Chapter – 2, , THEORY BASE OF ACCOUNTING, , As we know, every discipline can be developed only with a sound theoretical base. The theory, base of accounting consists of principles, concepts, rules and guidelines developed to bring, uniformity and consistency to the process of accounting. Apart from these, the Institute of, Chartered Accountants of India, (ICAI), which is the regulatory body for standardisation of, accounting policies in the country, has issued Accounting Standards which are expected to be, uniformly adhered to, in order to bring consistency in the accounting practices., GAAP – In order to ensure uniformity in accounting procedures and methods, certain accounting, principles have been accepted by accountants all over the world. The rules and guidelines used in, preparing accounting reports are termed as Generally Accepted Accounting Principles (GAAP)., These principles are also referred as concepts and conventions. The term concept refers to the, necessary assumptions and ideas which are fundamental to accounting practice, and the term, convention connotes customs or traditions as a guide to the preparation of accounting statements., Basic Accounting Concepts – The basic accounting concepts are referred to as the fundamental, ideas or basic assumptions underlying the theory and practice of financial accounting which are, developed by the accounting profession. From the practicability view point, it is observed that the, various terms such as principles, conventions, modifying principles, assumptions, etc. have been, used interchangeably and are referred to as Basic Accounting Concepts., The important concepts are:, 1. Business entity, 8. Matching, 2. Money measurement, 9. Full disclosure, 3. Going concern, 10. Consistency, 4. Accounting period, 11. Conservatism (Prudence), 5. Cost, 12. Materiality, 6. Dual aspect (or Duality), 13. Objectivity, 7. Revenue recognition (Realisation), 1. Business Entity Concept – This concept assumes that the entity of business is different, from its owners. For accounting purpose, the business is treated as a unit or entity, separate from the person who controls it. Based on this concept when a person brings in, some money as capital into his business, it is treated as a liability of the business to the, owner., 2. Money Measurement Concept – According to this concept, transactions that can be, measured in terms of money only are recorded in the books of accounts. For example, an, organization is having a factory building in 2 acres of land, 100 boxes of finished goods, etc. cannot be accounted, but it should stated in monetary terms such as Land and, Building Rs. 50 lakhs, Stock of goods Rs. 50000 etc., 3. Going Concern Concept – According to this concept, it is assumed that the business will, last for a long time. Based on this concept we are charging depreciation on fixed assets, every year till the end of its life, that the cost of asset which has been used during a period, should be charged from the revenue of that period itself., Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting-11, , Chapter - 2, , Page 1

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), 4., , 5., , 6., , 7., , Accounting period – The period of interval for which accounts are prepared to know the, profit or loss and what exactly the financial position of the business is called accounting, period. For this purpose “Profit and Loss account and Balance sheet is prepared at the, end of the accounting period. Usually it is one year starting from April 1st and ends at, March 31st every year., Cost Concept – This principle assumes that all assets are to be recorded at the total, amount paid to acquire them and this cost is the basis for all subsequent accounting for, those assets. The cost of acquisition includes the cost of purchase of asset, the expenses, incurred for bringing them to the location and the installation expenses. This concept of, cost is historical in nature (historical cost concept), which has been paid on the date of, acquisition and does not change year after year. But it does not mean that the assets are, always shown at the cost, but will be reduced by the decrease in value which is called, depreciation. In other words, the current market value of those assets will not be recorded, in the books., Dual aspect principle – This is the basic principle of accounting. According to this, concept every transaction has two aspects; they are receiving aspect and giving aspect. In, other words, at least two accounts are involved in recording a transaction. Eg: Capital, introduced: Cash A/c and Capital A/c, Machinery purchased: Machinery A/c and Cash A/c., The receiving aspect is called debit aspect and giving aspect is called credit aspect. Thus, for every debit there is a corresponding credit. The system of recording transactions with, dual aspect concepts is called double entry system of accounting., Revenue recognition (Realisation) Concept – Revenue is the amount which a business, earns through sale of goods or by providing services. This principle states that revenue is, earned or recognized at the point of sale, when the title of goods passes from the seller to, the buyer (cash or credit). But in case of an income, it is recognized on time basis. Eg:, rent for the month of March 2017, even if received in April 2017, will be taken into the, profit and loss account of the financial year ending March 31, 2017 and not into financial, year beginning with April 2017., , However, there are certain exceptions to the above rule:, i., , In case of hire purchase sale, the ownership passes to the buyer only when the last, installment is paid. In this case, sales are presumed (supposed) to have been made to, the extent of installments due, whether paid or not., ii. In case of contract accounts (eg; government contracts), the full contract price will be, received on completion. But profit is calculated on the basis of work certified for each year, as per certain accounting norms., 8. Matching Concept - It states that expenses incurred in an accounting period should be, matched with revenues during that period. An expense is recognized not when cash is, paid but when an asset or service has been used to generate revenue. For example,, expenses such as salaries, rent, insurance etc. are recognized on the basis of period to, which they relate and not when these are paid. Similarly, costs like depreciation of fixed, asset are divided over the periods during which the asset is used. The matching concept,, thus, implies that all revenues earned during an accounting year, whether received during, that year, or not and all costs incurred, whether paid during the year, or not should be taken, into account while ascertaining profit or loss for that year. (Profit = Revenue – Expenses)., Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 2

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), While ascertaining the profit or loss of an accounting year, we should not take the cost of, all the goods produced or purchased during that period but consider only the cost of goods, that have been sold during that year. For this purpose, the cost of unsold goods should be, deducted from the cost of the goods produced or purchased., 9. Full Disclosure Concept – Accounting statements must be prepared honestly and should, contain all relevant material information and their accompanying footnotes regarding the, financial position of the business. Eg: Loss due to accident of an employee in a particular, year may be disclosed through footnotes, method of valuation of inventory like FIFO or, LIFO may be disclosed. This is to enable the users to make correct assessment about the, profitability and financial soundness of the enterprise and help them to take appropriate, decisions., 10. Consistency Concept – Consistency means continuity or steadiness. The accounting, information provided by the financial statements would be useful only when it allows, comparison over a period of time as well as with the working of other enterprises. This can, be possible only when accounting policies and practices followed are uniform and, consistent. It means that once an accounting method is adopted, it should not be changed, from one accounting period to another. If a change is adopted, the business enterprise is, required to record the fact as a foot note and to show the impact of such change on, financial affairs. For example, method of valuation of inventory, method of charging, depreciation etc., 11. Conservatism Concept – This principle is also called prudence, which states that, anticipated profits are not to be considered but only possible losses, while recording, business transactions. This is the policy of ‘playing safe’. Eg: Inventory is valued at ‘cost or, market price, whichever is lower’; creating provision for doubtful debt, discount on debtors, etc., 12. Materiality Concept – It implies that disclosing of items in financial statements in, accordance with the relative importance they have. Certain items are materially relevant, while others are not. An item of fact is considered to be material if it influences the decision, making. According to this principle, insignificant and immaterial facts need not be, disclosed in detail. For example, stock of pens, pencils, paper, scales etc. are not shown, as assets, but it is treated as expense whether consumed or not., 13. Objectivity Concept – This principle states that the accounting data provided in the books of, accounts should be verifiable and dependable. The figures shown in the financial statements, should have supportive evidence such as bills, vouchers etc., which constitute the source, documents. In other words, the financial information should be neutral and free from bias., , Systems of Accounting, a. Double entry system – This is a complete, accurate and reliable system of accounting, as it records both the aspects of transactions in the books of accounts. The principles, of double entry are as follows:, i. There are two aspects for every transaction, namely debit and credit (receiving, aspect and giving aspect)., ii. Both the aspects should be recorded in the books of accounts., iii. For every debit there must be a corresponding credit and vice versa., , Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 3

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), b. Single entry system – It is not a complete system of accounting, under this system, in, some transactions both the aspects may be recorded and for some others, only one, aspect may be recorded. Thus it is a mixture of double entry, one entry and no entry., Even though it is an unscientific method of accounting, it is followed by small firms since, it is very simple, convenient and flexible., Basis of accounting – On the basis of timing of recognition of revenue and costs, there can, be two approaches to accounting, they are:, i), , i), , Cash Basis – in this method, entries in books of accounts are made when cash is, received or paid and not when the receipt or payment becomes due. E.g., If office, rent for the month of December 2016 is paid in January 2017, it would be recorded, in the books of account only January 2017. This system is incompatible with the, matching principle, which states that costs or expenses of a period are matched with, the revenues of the same period., Accrual Basis – In this method, costs and revenues are recognized in the period in, which they occur rather than they are paid or received. This is more appropriate for, the ascertainment of profit or loss as expanses are matched against revenue., , Accounting Standards, Accounting standards are written statements of uniform accounting rules and guidelines or, practices for preparing uniform financial statements. However, it cannot override the, provisions of applicable laws, customs, usages and business environment in the country., The objective of accounting standard is to bring uniformity in different accounting policies in, order to eliminate non comparability of financial statements for enhancing reliability of financial, statements., Accounting Standards in India are formulated and governed by Accounting Standards Board, (ASB) which was set up in 1977 by the Institute of Charted Accountants of India. This Board is, formed with representatives of ICAI, Company Low boards, Central Board of Direct Taxes,, Controller and Auditor General of India, Securities Exchange Board of India, Banks etc., Benefits of Accounting Standards, 1. Accounting standard helps in eliminating variations in accounting treatment to prepare, financial statements., 2. Accounting standard may call for disclosures of certain information which may not be, required by law, but such information might be useful for general public, investors and, creditors., 3. Accounting standard facilitate comparability between financial statements of inter and, intra companies., Limitations of Accounting Standards, 1. Accounting standard makes choice between different alternate accounting treatments, for the same item, this may cause the information incomparable., 2. It is rigidly followed and fails to extend flexibility in applying accounting standards., 3. Accounting standard cannot override the statute. The standards are required to be, framed within the ambit of prevailing laws., Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 4

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), Applicability of Accounting Standards, , Except the purely charitable organisation which does not have any commercial, industrial and, business activity, accounting standard is applicable to:, 1. Sole proprietorship unit, 2. Partnership firm, 3. Societies, 4. Trusts, , 5., 6., 7., 8., , Hindu undivided family, Association of persons, Cooperative societies, Companies, , International Financial Reporting Standards (IFRS), IFRSs are globally accepted accounting standards developed by International Accounting, Standard Board (IASB). It is a set of accounting standards for reporting different types of, business transactions and events in the financial statements. The objective is to facilitate, international comparison for true and fair valuation of business enterprise., Need for IFRS, 1. IFRS helps to prevent material manipulation or errors in financial statements., 2. It brings uniformity and comparability of accounting information on a global basis., 3. It facilitates global investment because of increased trust and reliability., To uniform accounting policies and procedures almost all countries have agreed to apply, IFRS. Some of the items in the list of IFRS which are accepted by India (also called Ind AS), and the previous Accounting Standards are given below for a comparative study., IFRS, (Ind AS), , 1, 2, 7, 10, 12, 16, 38, , Title, , AS, , Presentation of financial, statements, Inventories, Cash flow statement, Events after Balance Sheet, date, Income Taxes, Property, Plant and, Equipment, Intangible assets, , 1, 2, 3, 4, 22, 10, 6, 30, , Title, , Disclosure of accounting policies Framework for preparation and, presentation of financial statements, Valuation of inventories, Cash flow statement, Contingencies and events occurring, after the balance sheet date, Accounting for taxes on income, Accounting for fixed assets, Depreciation accounting, Intangible assets, , Goods and Service Tax, GST is a destination based tax on consumption of goods and services. It is proposed to be, levied at all stages from manufacture to final consumption with credit of taxes paid at previous, stages available as setoff. That means only value addition will be taxed and burden of tax is to, be borne by the final consumer. The concept of destination based tax on consumption implies, that the tax would accrue to the taxing authority which has jurisdiction over the place of, consumption. GST implemented in India on July 1, 2017., , Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 5

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), Components of GST – There are three main components of GST which are CGST, SGST, and IGST., CGST means Central Goods and Services Tax. Taxes collected under CGST will constitute, the revenues of the Central Government. The present central taxes like central excise duty,, additional excise duty, special excise duty, central sales tax etc., will be subsumed under, CGST., SGST means State Good and Services Tax. SGST is the revenue of State Government. With, GST all state taxes like VAT, entertainment tax, luxury tax, entry tax etc. are merged with GST., For example, Sunitha a dealer in Kerala sells goods to Ajith in Kerala worth Rs. 10,000. If the, GST rate is 18%, i.e., 9% CGST and 9% SGST, Rs. 900 will go to Central Government and, 900 will go to Kerala Government., IGST means Integrated Goods and Services Tax. Revenue collected under IGST is divided, between Central and State Government as per the rates specified by the Government. IGST is, charged on transfer of goods and services from one state to another. Import of goods and, services are also covered under IGST. For example, if the goods are transferred from Madhya, Pradesh to Rajasthan then this transaction will attract IGST. If Beena in Kerala sells goods to, Shaji in Rajasthan worth Rs. 100,000. Applicable GST rate is 18%. In this case, the dealer will, charge 18,000 as IGST and will go the Central Government, but later Rs.9000 (50% of 18000), will be allotted to the State Govts., Characteristics of Goods and Services Tax, 1. GST is a common law and procedure throughout the country under single, administration (One Nation One Tax)., 2. GST is a destination based tax and levied at a single point at the time of consumption of, goods and services by the end consumer., 3. GST is charged on both goods and services with the benefit of input tax credit., 4. There is no scope for levy of cess, resale tax, additional tax, turnover tax etc., 5. There is no multiple levy of tax on goods and services, such as sales tax, entry tax,, octroi, entertainment tax or luxury tax etc., , Advantages, 1. Introduction of GST has resulted in the abolition of multiple types of taxes in goods and, services., 2. GST widens the tax base and increased revenue to Centre and State Governments., 3. GST has removed the cascading effect on taxation (tax on tax)., 4. It reduces the cost of production., 5. It will promote the economic efficiency of the nation., 6. GST would help to extend competitive edge in international market for goods and, services produced in the country leading to increased exports., Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 6

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), , Taxes, , Accounting Concepts – Some Examples, No., 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, , Description, Anticipate no profit and provide for all possible losses, Provision for doubtful debt, Capital is treated as liability of the business, Method of charging depreciation should not be changed year after, year, Policy of playing safe, Increase / Decrease in the market value of an asset is not, accounted, A business owns 2 buildings, it cannot be accounted, There must be a source document for every transaction, Rent outstanding is added to Rent A/c, Stock of stationery items are not treated as asset, but it is an, expense, Businessman and the firm are separate entities, For every debit there is a corresponding credit, Transactions which are measurable in terms of money only be, recorded, Business will last for a long period, Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Accounting Concept, Conservatism, Conservatism, Business Entity, Consistency, Conservatism, Cost concept, Money measurement, Objectivity / Verifiability, Matching, Materiality, Business Entity, Dual Aspect, Money Measurement, Going Concern, Chapter - 2, , Page 7

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Ranker’s Academy, (A Leading Institute of Accountancy, Business Studies and Economics for XI & XII), 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46, 47, 48, 49, 50, , Stock is valued at cost price or market price (net realizable value), whichever is lower, Provision should be given for all possible losses, 100 Kg rice @ Rs.20 purchased by a grocery shop, recorded it as, Rs.2000, Transaction between owner and business are recorded separately, Charging depreciation on fixed assets every year till the end of its, life., Depreciation of fixed debited in P/L Acccount, Depreciation deducted from concerned asset in the Balance Sheet, every year, Profit and Loss account and Balance sheet is prepared at the end, of every year., A machinery purchased for Rs.5000, transportation charges, Rs.1000 and installation cost Rs.2000. The amount of transaction, recorded is Rs.8000, Every transaction has two aspects, In case of a contract work the profit is calculated on the basis of, work certified for each year., Revenue is earned or recognized at the point of sale, Sales is recorded when the title of goods passes from the seller to, the buyer (cash or credit)., In case of hire purchase system, sales are assumed to the extent, of installments due, whether paid or not., Profit = Revenue – Expenses, Accounting statements should contain all relevant material, information and their accompanying footnotes, Assets = Liabilities + Capital, Total Debits = Total Credits, Sales revenue is recorded when goods are delivered to the, customers, Paise column is eliminated in the books of accounts, Contingent liabilities are shown as a footnote in Balance Sheet, Expenses are incurred for earning revenue, Owner is treated as a creditor to the business, The owner of a business cannot wait till the closure of the business, to know the financial position, Account books should not be overloaded with irrelevant facts, Vouchers are the basis for recording a transaction, Personal transactions of the owner should not be included in the, books of accounts of the business, All business events may not be recorded in books of accounts, Accounting information should be free from bias, Qualities of a manager cannot be accounted, Business has indefinite life, Following same accounting practices year after year, Compare expenses with revenues of an accounting period, ABC Ltd. sold goods to XYZ Ltd on credit assuming that they can, realize the amount in future, Closing stock is credited to Trading A/c, Assets and Liabilities shown in Balance sheet, , Conservatism, Conservatism, Money Measurement, Business Entity, Going Concern &, Matching Concept, Matching Concept, Going Concern, Accounting Period, Cost Concept, Dual Aspect, Revenue Recognition, Revenue Recognition, Revenue Recognition, Revenue Recognition, Matching Concept, Full Disclosure, Dual Aspect, Dual Aspect, Revenue Recognition, Materiality, Full Disclosure, Matching, Business Entity, Accounting Period, Materiality, Objectivity, Business Entity, Money Measurement, Objectivity, Money Measurement, Going Concern, Consistency, Matching, Going Concern, Matching Concept, Full Disclosure, , ******************************************************************************************************************************************************************************, , Add. 14-A, Anupam Nagar, Govindpuri-Gwl., , Accounting -11, , Chapter - 2, , Page 8