1

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Accounting
An Introduction

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Unit
1.1

Meaning and Scope

of Accounting

Learning
Objectives
After studying this unit, you will be able to:
Understand the meaning and signicance
of accounting.
Appreciate the evolution of accounting.
Understand the accounting process.
Know various users of accounting information.

Know the objective, function, sub-elds and

limitations of accounting.
Understand the meaning and relationship
between accountancy, accounting and
book-keeping.

Introduction
As long as there will be people, there will be business, and as long as there is business, there is accounting. Accounting is virtually involved in everything in our lives whether we know it or not.
Every individual performs some kind of economic activity, be it business activities like manufacturing
entity/trading entity or non-business activities like spending on shopping or watching a movie. In order
to record these economic or money-related activities, accounting is required. In other words, wherever
money is involved, accounting is required to record it. Accounting is the language of business. It communicates the desired information to various persons. These economic activities are performed through
transactions and events. Everybody wants to keep a record of all the transactions and events to have
adequate information about the economic activity as an aid to decision-making.
Transaction means a business, performance of an act, or an agreement. It involves transfer of money
or moneys worth. An event means a happening, as a consequence or result of a transaction(s).
Example: An individual starts a stationery business with an initial investment of ` 2,00,000. On 1st January, he
purchases goods for ` 1,10,000 and sells them for ` 1,40,000. He pays a shop rent for the month of ` 5,000
and finds that he still has goods worth ` 10,000 in hand.

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AccountingAn Introduction

Particulars
Goods sold
Goods in hand
Less: Goods purchased
Rent paid
Surplus

`
1,40,000
10,000
1,10,000
5,000

`
1,50,000
1,15,000
35,000

Events are: Earning ` 35,000 surplus, having stock in hand.

Transactions are: Purchase and sale of goods, investment of money and payment of rent.

Accounting History and Development

Accounting is as old as money itself. In India, Chanakya, in his Arthashastra, has emphasized the existence and need of proper accounting and auditing. However, the modern system of accounting owes its
origin to Luca Pacioli, who lived in Italy in the eighteenth century. Earlier, accounting was considered
simply as a process of recording business transactions and the role of an accountant was that of a recordkeeper. However, accounting is now considered to be a management tool providing vital information
concerning the organizations future. Accounting today is, thus, more of an information system rather
than a mere recording system.

Meaning and Definitions of Accounting

Accounting serves several purposes of business, such as recording of transactions, classifying, summarizing and analysing these transactions for vital decision-making by various users.

Traditional Definition
In 1961, The American Institute of Certied Public Accountants (AICPA) formulated the following
denition of accounting:
Accounting is the art of recording, classifying and summarizing in a signicant manner and in terms
of money, transactions and events which are, in part at least, of a nancial character and interpreting the
results thereof.

Modern Definition
In 1966, the American Accounting Association (AAA) dened accounting as follows:
Accounting is the process of identifying, measuring and communicating economic information
to permit informed judgements and decisions by the users of the information.

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Chapter 1

Accounting Process
Economic transactions
and events measurable
in monetary terms

Only economic activity measurable in terms of money can be accounted. This is

the input to the accounting process.

Recording

Recording is the basic function of accounting. All business transactions of

financial character, evidenced by documents such as sales bill, pass book,
salary slip, etc., are recorded in a book called the Journal in a chronological
order of its occurrence. This book may further be divided into several subsidiary
books according to the nature and size of the business. It is the primary book.

Classifying

Classification is concerned with the systematic grouping of the recorded data

of similar nature of a journal, under a single head, to put information in a compact
and usable form in a book called ledger. This process of classifying from a
journal to a ledger is called posting.

Summarising

Analysing

Interpreting

Communicating

Summarising is concerned with totalling the summarised data in the ledger,

preparing and presenting classified data in a manner useful to the users of the
financial statements. This process leads to the preparation of a trial balance,
profit and loss account, balance sheet, cash flow statement, etc.
Analysing is concerned with the establishment of a relationship between the
various items taken from the profit and loss account and the balance sheet. It
provides the basis for interpretation. Likewise, all items relating to fixed assets are
put at one place, while all items relating to current assets are put at another place.
Interpreting is the final role of accounting. It is concerned with explaining the
meaning and significance of the relationship so established by the analysis of
accounting data. It helps in understanding what has happened, why it has
happened and what is likely to happen under specified conditions and, thus,
enables the users to make reasonable decisions out of alternative courses
of actions.
Communication is concerned with the transmission of information collected
and prepared in the above accounting process to the end users. It is performed
through preparation and distribution of accounting reports, which includes profit
and loss account, balance sheet, cash flow statement, fund flow statements,
etc., along with additional information in the form of accounting ratios, graphs,
diagrams, etc. This is the output of the process.

Users of Accounting Information

Generally the users of accounting information are classied into two categories:

Internal Users or Owners



Management team/board of directors/partners/shareholders: The owner or management, as a

whole, is interested in the accounting information for various managerial decisions. Accounting helps
the management to plan and control the business in an effective and efcient manner.

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AccountingAn Introduction

External Users or Outsiders









Short-term creditors (suppliers of goods): Short-term creditors need information to determine

whether the amount owed to them will be paid on time and to x the credit policy to the customer.
Long-term creditors (loan creditors): Long-term creditors need information to determine whether
the principal and interest due to them will be paid on time.
Present and potential investors: Present and potential investors need information to judge the
prospects of the enterprise and determine whether they should invest in the shares of the company.
Employees: Employees need information to determine the stability and protability of the employer,
which enables them to assess the ability of the enterprise to pay remuneration and other retirement benets.
Government agencies: Government agencies need information to regulate the functioning of a business enterprise for public welfare and to assess the tax liability of the enterprise.
Customers: Customers need information to determine the continuation of the enterprise, especially
when they are solely dependent on the enterprise for the supply of goods.
Public: Public is interested in understanding the enterprises substantial contribution in terms of
employment opportunity and their patronage to local suppliers.

Objectives of Accounting


Systematic recording of transactions: The basic objective of accounting is to systematically record

the nancial aspects of business transactions, classify and summarize the same for the preparation of
nancial statements and their analysis, interpretation and communication. This is also called bookkeeping, which involves recording in a Journal, posting in a Ledger and preparing the Trial Balance.
Ascertain the nancial performance of the business: One of the objectives of accounting is to
measure the nancial performance of an enterprise. An entity prepares a Manufacturing, Trading and
Prot and Loss Account to know the results of the business operations for a particular period of time.
If revenues exceed expenses, then it is said that the business is running protably; but if expenses
exceed the revenue, then it can be said that the business is running under losses.
Ascertain the nancial position of the business: An entity would want to know what it owes (liability) and what it owns (asset) on a particular date to determine the nancial health of the business.
This requires preparing the position statement, that is, the Balance Sheet.
Communicate information to the users for rational decision-making: Accounting is a language
of business which communicates the nancial results of an enterprise to various internal and external
users by preparing Financial Reports on a regular basis. The communication of information helps
users in rational decision-making.

Functions of Accounting





Measurement: Accounting measures past performance and depicts its current nancial position.
Forecasting: Accounting helps in forecasting a future performance by using past data.
Decision-making: Accounting provides relevant information to the users for decision-making.
Comparison and evaluation: Accounting helps in the comparison and evaluation of business
results. It assesses performance achieved in relation to targets and discloses information regarding

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Chapter 1




accounting policies and contingent liabilities which help in prediction, evaluation and comparison
of the nancial results.
Control: Accounting helps in identifying the weaker areas of the business operation and provides
feedback regarding the effectiveness of measures adopted to check such weakness.
Government regulation and taxation: Accounting provides necessary information to the government to exercise control on the entity as well as in collecting tax revenues.

Sub-fields of Accounting
Sub-fields of accounting

Financial
accounting is
the original form
of accounting.
It is mainly
concerned
with the
preparation of
financial
statements for
the end users.
It helps in
determination
of the net result
of an accounting
period and the
financial position
of the business.

Management
accounting is
concerned with
grouping
information and
preparing reports
in different ways
desired by
managers for
discharging their
functions. Cost
accounting which
deals with cost
ascertainment
and cost control
is a very
important
component of
management
accounting.

Cost
accounting
is focused on
recording the
income and
expenditure
with the view
of preparing
periodical
statements
and reports
for ascertaining
and controlling
cost.

Human
resources
accounting is
concerned with
identifying,
quantifying and
reporting the
total investments
made in the human
resources of a
business entity.
However, such
investments are
presently not
recorded under
the conventional
accounting
practice.

Social
responsibility
accounting is
concerned with
the process of
identifying,
measuring and
communicating
the social effects
of the business
decisions. It is
accounting the
social
responsibility
aspects of a
business.

Limitations of Accounting




Ignores the qualitative element: Since accounting is concerned with monetary matters only, the
qualitative factors like loyalty and skills of the personnel, public relations, etc., are ignored.
Estimation: Accounting only reports the estimated periodic results and not the true results, since the
true results can only be depicted on winding up the enterprise.
Not free from bias: Certain accounting estimates depend upon the personal judgment of the enterprise.
Example: One can be biased while choosing a method of depreciation or valuation of inventory to
manipulate the financial statements.

Ignores price level changes: Fixed assets are recorded at a historical cost and not at the replacement
value which is often higher than the value stated in the balance sheet. This cannot be compared unless
price level changes are taken into account.

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8


AccountingAn Introduction

Window dressing: When the management decides to enter wrong gures to articially inate or
deate the nancial results, then such income statements fail to provide a true and fair view of the
nancial position of the enterprise.
Conicting accounting principles: There are circumstance when accounting principles conict with
each other, and hence it becomes difcult in preparing nancial statements.

Meaning and Relation between Accountancy, Accounting and Book-keeping

Accountancy

Accounting

Book-keeping

Accountancy is a broader term. It includes accounting which in turn includes book-keeping.

Accountancy
Accountancy refers to a systematic knowledge of accounting. It explains how to prepare the books of
accounts and how to summarize the accounting information and communicate it to the end users.

Accounting
It serves several purposes of business such as recording of transactions, classication of transactions,
summarizing of transactions and analysing them. Accounting starts where book-keeping ends.

Book-keeping
Book-keeping is a part of accounting and is concerned with recording or maintaining the books of
accounts, which is a routine activity. It covers the activities of identifying the transactions and events,
measuring, classifying and summarizing the accounting data.

Objectives


Complete recording of transactions: It is concerned with a complete and permanent record of all
transactions in a systematic and logical manner.

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Chapter 1

Ascertainment of nancial effect of the business: It helps in the ascertainment of the nancial
effect of all the transactions of the business made during the period upon the nancial position of
the business.

Distinction between Book-keeping and Accounting

Book-keeping and accounting appear to be synonymous terms, but they are different from each other.
Book-keeping and accounting differ from each other in the following respects.
Book-keeping
It is a process concerned with the recording of
transactions.
It is a primary stage.
The basic objective is to maintain systematic
records of nancial statements.
Financial statements do not form a part of this
process.
Managerial decisions cannot be taken with the
help of these records.
There is no sub-eld under book-keeping.
Financial position of the business cannot be
ascertained through book-keeping records.







Accounting
It is a process concerned with summarizing the
recorded transactions.
It is a secondary stage. It starts where
book-keeping ends.
The basic objective is to ascertain the net results
of a business operation and the nancial position.
Financial statements are prepared in this process
on the basis of the records maintained under
book-keeping.
Managerial decisions are taken on the basis of
these records.
It has several sub-elds.
Financial position of the business is ascertained
through accounting.

Economic activities are performed through transactions and events.

The accounting process involves recording, classifying, summarizing, analysing,
interpreting and communicating the same to the users.
Management accounting and cost accounting are the two main sub-fields of accounting
apart from financial accounting.
Ignorance of a qualitative element, price level changes, subjectivity and window dressing
the financial statements are some of the limitations of accounting.
Accountancy is a broader term. It includes accounting which in turn includes book-keeping.
Book-keeping is the primary stage and accounting starts where book-keeping ends.

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10

AccountingAn Introduction

MULTIPLE CHOICE QUESTIONS

1.

2.

3.

4.

5.

6.

7.

Which of the following is not a function of

accounting?
(a) Keeping systematic record
(b) Protecting properties of the business
(c) Maximising the results
(d) Meeting legal requirements
Accounting in modern age is regarded as
(a) The art of recording, classifying and
summarizing the business transactions in
monetary units
(b) The language of business
(c) The source of business information
(d) All the above
Negotiating with the seller is a
(a) Transaction
(b) Event
(c) Both event and transaction
(d) Neither event nor transaction
The basic objective of book-keeping is
(a) To maintain systematic records of nancial
transactions
(b) To ascertain nancial performance
(c) To ascertain nancial position
(d) All the above
The basic objectives of accounting is
(a) To maintain systematic records of nancial
transactions
(b) To ascertain nancial performance
(c) To ascertain nancial position
(d) All the above
Internal users of accounting information include
(a) Short-term creditors
(b) Customers
(c) Long-term lenders
(d) Shareholders
External users of accounting information include
(a) Shareholders

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(b) Customers
(c) Management
(d) None of these
8.

Limitations of accounting are that it

(a) Ignores qualitative elements
(b) Ignores price level changes
(c) Involves subjectivity
(d) All the above

9.

Which of the following is not a sub eld/branch

of accounting?
(a) Cost accounting
(b) Management accounting
(c) Social responsibility accounting
(d) Book-keeping

10. An economic event that involves transfer of

money or moneys worth is
(a) Financial transaction
(b) Barter
(c) Settlement
(d) Receipt/payment
11. A person who owes money to the rm is
(a) A creditor
(b) A debtor
(c) An investor
(d) A lender
12. All of the following are functions of Accounting
except
(a) Decision making
(b) Measurement
(c) Forecasting
(d) Ledger posting
13. On January 1, Ram paid rent of ` 10,000. This
can be classied as
(a) An event
(b) A transaction
(c) A transaction as well as an event
(d) Neither a transaction nor an event

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14. Financial statements only consider

(a) Assets expressed in monetary terms
(b) Liabilities expressed in monetary terms
(c) Assets expressed in non-monetary terms
(d) Assets and liabilities expressed in
monetary terms
15. Users of accounting information include
(a) Creditors
(b) Lenders
(c) Customers
(d) All of the above
16. Who is the founder of book keeping?
(a) Lucas Pacioli
(b) Adam Smith
(c) Kesal
(d) None of these
17. Window dressing in accounts means
(a) Presenting accounts in beautiful manner
(b) Showing more losses to avoid income tax

11

(c) Showing more prots to attract investment

(d) Both (b) & (c)
18. _________ is called the language of business
(a) Accounting
(b) Statistics
(c) Economics
(d) None of these
19. Financial statements are a part of _________
(a) Book keeping
(b) Transaction
(c) Accounting
(d) Management accounting
20. A person to whom money is owed by the business is
(a) A creditor
(b) A debtor
(c) A borrower
(d) A customer

ANSWERS KEY
1. (c)
11. (b)

2. (d)
12. (d)

3. (d)
13. (b)

4. (a)
14. (d)

5. (d)
15. (d)

6. (d)
16. (a)

7. (b)
17. (d)

8. (d)
18. (a)

9. (d)
19. (c)

10. (a)
20. (a)

EXPLANATION
1.

2.

Accounting only records the past transaction

and events. It does not provide ways and means
to maximise business results.
Accounting in modern age considered to be a
tool of management providing vital information concerning the organisations future. Thus,
it is more of an information system rather than
a mere recording system. So, we can say that
accounting includes all activities like recording, classifying, summarizing etc. to provide
vital information to its decision maker.

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3.

4.

Economic activity (involving money or

moneys worth) can be inform of event or
transactions. Negotiation is merely bargaining,
which does not involve any economic activity,
therefore neither event nor transaction.
Basic objective of book keeping are complete recording of transactions and Ascertainment of financial effect of the business.
Ascertainment of financial performance and
position of the business are the objective of
accounting.

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AccountingAn Introduction

5.

Basic objective of accounting are Systematic

recording of transactions, ascertainment
of financial performance and position and
Communicate information to the users for
rational decision making.
6. Internal users of accounting information
include management team/board of directors/
partners/shareholders.
7. External users of accounting information
include short term creditors, long term creditors, present and potential investors, employees,
government agencies, customers and public.
8. Ignores qualitative element, estimation, not
free from bias, ignores price level changes,
window dressing, conicting accounting principles are various limitation of accounting.
9. Sub eld of accounting means various branches
of accounting like nancial accounting, management accounting, cost accounting, social responsibility accounting, human resource accounting
etc. Book-keeping is a part of accounting and
is concerned with recording or maintaining the
books of accounts, which is a routine activity.
10. Transaction means a business, performance of
an act, or an agreement. It involves transfer
of money or moneys worth.
11. A person who owes money to rm, in other
words, one who has to pay to rm is called debtor.

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12. Ledger posting is process of accounting and

objective of book-keeping and not accounting.
13. Payment of rent involves transfer of money or
moneys worth which means its a transaction.
14. Financial statements reveals all expenses,
losses, income, gain, assets and liabilities
expressed in monetary terms only.
15 External and internal users of accounting informations are like management team, shareholders, board of directors, partners and creditors,
lenders, customers, employees, government
agencies, public etc.
16. Luca pacioli is founder of book-keeping, who
lived in Italy in the 18th century.
17. Window dressing means, when the management decides to enter wrong gures to articially inate or deate the nancial results,
then such income statements fail to provide a
true and fair view of the nancial position of
the enterprise.
18. Accounting is called the language of business as its help in communicating business
information.
19. Preparing nancial statements are a part of
accounting.
20. A person to whom money is owed by the business is a creditor.

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Unit
1.2

Accounting Concepts,
Principles and Conventions

Learning
Objectives
After studying this unit, you will be able to:
Understand the reason for existence of
Generally Accepted Accounting Principles.
Get a grip on the basic accounting principles, concepts and conventions and observe

the impact while recording transactions

and events.
Know the qualitative characteristics of
accounting information.

Introduction
Business uses accounting as its language and communicates its nancial information to the various users
for decision-making. So, the nancial statements have to be prepared on a uniform basis. To maintain
uniformity, the nancial statements have to be prepared within the framework of Generally Accepted
Accounting Principles (GAAPs). Generally Accepted Accounting Principles may be dened as those
rules of action or conduct which are derived from experience and practice, and when they prove useful,
they become accepted as the principles of accounting. All those accounting principles or practices which
have substantial authoritative support and meet the criteria of relevance, objectivity and feasibility will
become a part of the Generally Accepted Accounting Principles.

Accounting Principles
The standards which are laid down in order to follow uniformity are termed accounting principles.
Accounting principles may be dened as those rules of action or conduct which are universally adopted
by the accountants to record accounting transactions.

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AccountingAn Introduction

14

Accounting principles must satisfy the following conditions:






They should be based on real assumptions.

They must be simple, understandable and explanatory.
They must be followed consistently.
They should be informational for the users.
These principles can be classied into two categories:

1.
2.

Accounting concepts
Accounting conventions

Accounting Concepts
Accounting concepts dene the assumptions on the basis of which the nancial statements of a business
entity are prepared.
The following are the important accounting concepts:


Separate entity concept: According to this concept, a business is treated as a separate entity and is distinct from its owner(s). The concept of separate entity is applicable to all forms of business organizations.
This concept keeps the business affairs strictly free from the effect of private affairs of the proprietor(s).
Hence, a distinction has to be made between personal transactions and business transactions.

In case of a proprietary concern, though the sole proprietor is not considered

separate from his own entity in the eyes of law, for the purpose of accounting,
they are to be treated as separate from each other.

Example: If Rajesh withdrew cash from the business to pay ` 5,000 towards his life insurance premium, then
this expense should not be considered as a business expense as per the separate entity concept, because
it is his personal expense and must be deducted from the capital.

Money measurement concept: According to this concept, only those transactions which are capable
of being expressed in terms of money are included in the accounting records. In other words, the
information which cannot be expressed in terms of money is not included in the books of accounts
though they may be very useful to the business. By expressing all the transactions in terms of money,
the different transactions expressed in different units are brought to a common unit of measurement,
that is, money.
This assumption ignores:

Changes in the purchasing power of monetary unit.

Example: The value of ` 100 in 1950 is not same as in 2012.

Material transactions that cannot be measured in terms of money.

Example: Furniture and employees of the organization are the assets of the organization. Furniture
can be measured in monetary terms and hence included in the books of accounts, but measurement of

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15

employees in monetary terms is not possible. Therefore, they are not included in the books of accounts
of the organization.

Separate entity and money measurement concepts are considered as basic

concepts.


Periodicity concept: According to this concept, the economic life of an enterprise is articially split
into periodical intervals which are termed accounting periods. At the end of each accounting period,
nancial statements are prepared to show the performance and the position of the business. Usually,
an accounting period will be of 12 months, of either a calendar year ending 31st December every year
or a nancial year ending 31st March every year. However, it may also be of 3 months, 6 months or
9 months. This is also known as periodicity assumption or time period assumption.
This assumption helps in
Comparing the nancial statements of different periods
Uniform and consistent accounting treatment for ascertaining the prot and net assets of the
business
Matching periodic revenues with expenses for getting the correct results of the business operations

Accrued expenses or accrued revenue is only with reference to a nite time

frame which is called an accounting period.


Accrual concept: According to an accrual concept, all revenues and costs are recognized as they
are earned or incurred and not as money is received or paid. Revenue is the gross inow of cash,
receivables and other considerations arising in the course of ordinary activities of the enterprise.
Expenses are a cost relating to the operations of an accounting period or to the revenue earned during the period, or the benets of which do not extend beyond that period. As per this concept, any
expense incurred but not paid in the particular period or income earned but received in the particular
period should be recorded as expenses and income for that period only. Also, any income received
but not earned in the current period, that is, payment towards product or services to be rendered in
next accounting period or expenses paid in advance for product or services to be received in next
accounting period, should not be included in the current period.
Examples of income or expenses which should not be included in the calculation of current
years prot or loss are as follows:

Expenses incurred but not paid: In many companies, salaries are paid in beginning of the subsequent month. So, at the year end, the salary for the last month (March or December), though
not paid on or before the last day of the month, should be recorded as expenses.
Income earned but received: On 25th March, a trader sells goods worth ` 1,00,000 on credit for a
period of 30 days. So as on 31st March, the last day of the nancial year, though the amount has not
been received in the current period, the trader will have to record it as income for the current period.

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AccountingAn Introduction

Income received but not earned in the current period: An airline company sells its tickets
days or even weeks before the ight is made, but it does not record the payments as revenue
because the ight, on which the revenue is based, has not yet occurred. So, if the airline company
receives ` 2,00,000 on 31st March as booking amount for a ight on 14th April, on the close of
the nancial year it will not record this amount as income for the current year and the same will
be accounted for in the next nancial year.
Expenses paid in advance for products or services to be received in next accounting period:
` 5,000 spent on 28th March for booking a room in the hotel for a business trip planned in April
should not be recorded as expenses of the current period.

Matching concept: The term matching means appropriate association of related revenues and
expenses. According to this concept, the expenses incurred in one accounting period should be
matched with the revenues recognized in that same period. This concept is fundamentally based on
the accrual concept since it disregards the timing and amount of actual cash inow and concentrates
on the occurrence of revenues and expenses.
Example: A hospital pays ` 30,000 per month to three of its doctors. Monthly sales are of ` 4,00,000.
` 90,000 worth of monthly salaries should be matched with ` 4,00,000 of the revenue generated.

Accrual, matching and periodicity concepts work together for income measurement and recognition of assets and liabilities.


Going concern concept: The nancial statements are normally prepared on the assumption that an
enterprise will continue to operate for the foreseeable future. It is also known as assumption of continuity. It is assumed that the enterprise has neither the intention nor the necessity to liquidate or to
materially curtail the scale of its operations. The valuation of assets of a business entity is dependent
on this assumption. The concept applies to the business as a whole. When an enterprise liquidates a
branch, the ability of the enterprise to continue as a going concern is normally not impaired.
Cost concept: According to this concept, the value of an asset is to be determined on the basis of
historical cost, that is, acquisition cost. The cost concept does not mean that the assets will always
be shown at cost, but cost becomes the basis for all future accounting for the asset. The cost of an
asset is systematically reduced from year to year by charging depreciation on account of its wear
and tear or passage of time.
Realization concept: According to this concept, revenue is recognized only when a sale is made.
Sale is considered to be complete only when the property of the goods is passed on to the buyer and
he becomes legally liable to pay for the same. Any change in the value of an asset is to be recorded
only when the business realizes it.
Example: A house or a vehicle is bought, though the exchange of money has taken place before the transfer
of the title. Sale is considered only when the title is registered.

Dual aspect concept: This is the basic concept of accounting according to which every business
transaction has a dual effect. As the name implies, the entry made for each transaction is composed of

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Chapter 1

17

two partsone for the debit and the other for the credit. Every debit has an equal amount of credit. So
the total of all debits must be equal to the total of all credits. This gives the basic accounting equation:
Equity (E) + Liabilities (L) = Assets (A)

Hence, we can compute the following:

Increase in an asset is accompanied by decrease in another asset or increase in liability.
Decrease in an asset is accompanied by increase in another asset or decrease in liability.
Increase in liability is accompanied by decrease in another liability or increase in asset.
Decrease in liability is accompanied by increase in another liability or decrease in asset.
Example: Mr Vincent sold goods worth ` 2,000 in cash. The two aspects will be (1) receipt of ` 2,000 in
cash and (2) decrease of goods worth ` 2,000.

Going concern, consistency and accrual concepts are the fundamental concepts
and these are followed in the preparation of nancial statements. If any of these
assumptions are not followed, then this fact should be specically disclosed.

Accounting Conventions
Accounting conventions emerge out of accounting practices adopted by various entities over a period
of time. These conventions are derived by usage and practice and do not have a universal application.
The following are the important accounting conventions:


Convention of conservatism: The principle of provide for all expected losses but never for anticipated prots applies here. This is also known as prudence principle, that is, judgement about the
possible future losses which are to be guarded. This principle requires that in the situation of uncertainty and doubt, business transactions should be recorded in such a manner that the prots and assets
are not overstated and the losses and liabilities are not understated.
Example: Valuation of inventories is done at cost or market price, whichever is lower, by following the
convention of conservatism.

Convention of consistency: According to this principle, the accounting policies adopted by the
enterprise should be followed consistently from one period to another. A change in an accounting
policy should only be made in certain exceptional circumstances and the same has to be disclosed in
the notes. This principle is applied when alternative methods of accounting are equally acceptable.
This helps in comparing the nancial statements from one period to another.
Convention of materiality: According to the convention of materiality, all relevant items, the
knowledge of which might inuence the decision of the users of the nancial statements, should be
disclosed in the nancial statement. The materiality principle requires that the items or events having
an insignicant economic effect or not being relevant to the users need not be disclosed. What constitutes materiality will vary from situation to situation; it is a matter of judgement.

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18


AccountingAn Introduction

Convention of full disclosure: According to this principle, the nancial statements should disclose
all reliable and relevant information which are necessary for the users. The disclosure should be full
and adequate so that the users of the nancial statements can make a correct assessment about the
nancial performance and position of the enterprise.
The convention of materiality is an exception to the principle of full disclosure.
As per materiality, only relevant items which inuence users decisions have to
be disclosed, whereas the principle of full disclosure requires the disclosure of
all information.

AQ1

Convention of conservatism is an exception of convention of consistency.

Example: As per the principle of conservatism, stock should be valued at cost or market price, whichever
is lower. This principle may lead to change in accounting policy year by year.

Financial Statements
Financial statements are structured representations of the nancial position and the performance of an
enterprise. To have a record of all business transactions and to determine prot and loss and the nancial
position (asset and liability on a particular day) of an enterprise, entities prepare nancial statements,
namely, prot and loss account, balance sheet, cash ow statement, etc.

Qualitative Characteristics of Financial Statements







Understandability: An essential quality of the information provided in the nancial statement is

that it must be understandable by the users. For this purpose, users are assumed to have a reasonable
knowledge of business and economic activities.
Reliability: The information is said to be reliable when it is free from material error. Reliability of
nancial information depends on faithful representation, substance over form, neutrality, prudence,
completeness, etc.
Relevance: Information is said to be relevant when it inuences the economic decisions of the users
by helping them evaluate the performance of the business.
Comparability: Users must be able to compare the nancial statements of an enterprise through a
different time period in order to identify the trends in the nancial position, performance, cash ow, etc.
Materiality: The information is material if its misstatement could inuence the economic decisions
of users taken on the basis of the nancial statements. Materiality depends on the size and nature
of the rm.
Full, fair and adequate disclosure: The nancial statements must disclose all the reliable and
relevant information about the business enterprise to the management and also to the external users
enabling them to take reasonable and rational decisions.
Prudence: Prudence means conservatorium, which states: provide for all expected losses but never
for anticipated prots. All the uncertainties and their nature should be disclosed so that it helps in
proper decision-making.

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Chapter 1

19

Completeness: To be reliable, the information in the nancial statements must be complete within
the bounds of materiality and cost. An omission can cause the information to be false or misleading.






Financial statements are prepared within the framework of accounting principles, concepts and conventions.
Separate entity concept and money measurement concept are the basic concepts on
which the other procedural concepts hinge.
Accrual, matching and periodicity concepts work together for income measurement and
recognition of assets and liabilities.
Going concern, consistency and accrual concepts are the fundamental concepts, and
these are followed in the preparation of financial statements. If any of these assumptions
are not followed, then this fact should be specifically disclosed.
To have a record of all business transactions and to determine the financial position of
an enterprise, entities prepare financial statements, namely, profit and loss account, balance sheet, cash flow statement, etc.
Relevance and reliability are the most important qualitative characteristics of financial
statements.

MULTIPLE CHOICE QUESTIONS

1.

Valuation of the crops at market value is in

accordance with the
(a) Principle of matching
(b) Principle of revenue recognition
(c) Principle of cost
(d) None of the above

2.

An example of an increase in one liability and

a decrease in another liability is
(a) Accrued interest
(b) Outstanding rent
(c) Bills payable accepted
(d) Conversion of partners loan into capital

4.

When applied to the Balance-Sheet, the convention of conservatism results in

(a) Understatement of assets
(b) Understatement of liabilities and provisions
(c) Overstatement of capital
(d) All of these

Theory
3.

Accounting principles are generally based

on
(a) Practicability
(b) Subjectivity
(c) Convenience in recording
(d) None of these

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20
5.

6.

AccountingAn Introduction

Which of the following items is not a fundamental accounting assumptions?

(a) Consistency
(b) Business entity
(c) Going concern
(d) Accrual
Fundamental accounting assumptions as per
AS-1 are
(a) Going concern, consistency, conservatism
(b) Going concern, consistency, accrual

(c) Going concern, money measurement,

conservatism
(d) Going concern, accounting period, accrual
7.

As per AS-I, a fact need not be disclosed in

the nancial statements according to which
concept
(a) Principle of money measurement
(b) Principle of periodicity
(c) Principle of consistency
(d) Principle of accounting entity

Concept
8.

9.

According to money measurement concept,

the following will be recorded in the books of
account.
(a) Health of the chairman of the company
(b) Quality control in the business
(c) Value of the building
(d) All of these
Cost concept envisages the recording of the
following in the books of accounts.
(a) An asset at its cost
(b) Knowledge and will acquired by the business executive
(c) Changes effected because of some political events
(d) All of these

10. The proprietor is treated as a creditor to the

extent of his capital according to the
(a) Cost concept
(b) Business entity concept
(c) Going concern concept
(d) All of these
11. The accounting equation is based on the
(a) Going concern concept
(b) Dual aspect concept
(c) Money measurement concept
(d) All of these
12. The entity concept of accounting is applicable to
(a) Sole Proprietary Concern

M01_CA-CPT_C01.indd 20

(b) Partnership Firm

(c) Joint Stock Company
(d) All of the aforesaid
13. Fixed assets are reported in the balance sheet
at historical cost basis. This is done in order to
comply with the accounting principle of
(a) Going concern principle
(b) Conservatism principle
(c) Cost concept
(d) Realization principle
14. The Accounting convention of matching means
(a) Prot for the period to be matched with
the sales revenue
(b) Prot for the period to be matched with
the investment
(c) Expenses of one period to be matched
against the expenses of another period
(d) Expenses of a period to be matched against
the revenue of the same period
15. Which of the following is the accounting
equation?
(a) Capital = Assets + Liabilities
(b) Capital = Assets Liabilities
(c) Assets = Liabilities Capital
(d) Liabilities = Assets + Capital
16. Recording of capital contributed by the owner
as liability ensures the adherence of the principle of

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Chapter 1

(a)
(b)
(c)
(d)

Double entry
Going concern
Separate entity of business
Materiality

17. The assumption that a business enterprise will

not be sold or liquidated in the near future is
known as the
(a) Business entity concept
(b) Principle of conservatism
(c) Accounting period concept
(d) Going concern concept

(a)
(b)
(c)
(d)

21

` 4,00,000
` 2,00,000
` 1,00,000
None of the above

23. Withdrawals by the proprietor would

(a) Reduce both, assets and owners equity
(b) Reduce assets and increase liabilities
(c) Reduce owners equity and increase
liability
(d) No change

18. The qualitative aspect of the business is not

recorded in the books of accounts according
to the basic concept of
(a) Money measurement
(b) Business entity
(c) Going concern
(d) Accounting period

24. During the life-time of an entity, accountants

prepare nancial statements at a point of time
in accordance with which basic accounting
principle?
(a) Cost-benet
(b) Periodicity
(c) Conservatism
(d) Matching

19. According to which of the following principles

should all costs which are applicable to revenue
of the period be charged against that revenue?
(a) Materiality
(b) Full disclosure
(c) Conservatism
(d) Matching

25. The assumption that a business enterprise will

not be sold or liquidated in the near future is
known as the principle of
(a) Economic entity
(b) Conservatism
(c) Periodicity
(d) Going concern

20. According to the going concern concept, a

business entity is assumed to have?
(a) A long life
(b) A very short life
(c) An indenite life
(d) All of these

26. Purchase of ofce equipment on credit results

in
(a) Decrease in liability
(b) Decrease in capital
(c) Increase in capital
(d) Increase in assets

21. The outside liabilities of a business are

` 20,000. The proprietors capital is ` 50,000.
Total assets of the rm are
(a) ` 50,000
(b) ` 30,000
(c) ` 70,000
(d) ` 20,000

27. Payment of a liability results in

(a) Increase in total assets
(b) Decrease in total assets
(c) No change in total assets
(d) None of the above

22. On 31 December 2006 assets of the business

are ` 3,00,000 and its capital is ` 1,00,000. Its
liabilities on that date will be

M01_CA-CPT_C01.indd 21

28. Purchase of machinery for cash

(a) Decrease total assets
(b) Increases total assets
(c) No change in the total assets
(d) Decreases total liabilities

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22

AccountingAn Introduction

29. Capital brought in by the proprietor will result

(a) Increase in assets and increase in liabilities
(b) Increase in liabilities and decrease in assets
(c) Increase in assets and decrease in liabilities
(d) Increase in one asset and decrease in
another assets

of A Ltd. Values machines for ` 1,20,000 while

nalizing the accounts. He has violated the
(a) Realisation
(b) Prudence
(c) Consistency
(d) None of the above

30. If a radio seller-proprietor buys a radio for his

personal use from out of business funds, the
amount paid for the radio will be treated as
drawings of the proprietor because of the
(a) Dual aspect concept
(b) Going concern concept
(c) Business entity concept
(d) Matching concept

35. Personal transactions are distinguished from

business transactions of an accounting period
in accordance with the principle of
(a) Periodic
(b) Entity
(c) Money measurement
(d) None of these

31. The valuation of a promise to receive cash

in the future at present value on the nancial
statements of a business entity is valid by virtue
of which accounting postulate or principle?
(a) Entity
(b) Materiality
(c) Matching
(d) Going concern
32. A sole proprietor decided to use the same
bank account for his personal affairs as for his
business. Which of the following accounting
principle is violated?
(a) Going concern
(b) Entity
(c) Measuring unit
(d) Objectivity
33. The assets are classied as current assets and
xed assets in accordance with the
(a) Accounting period assumption
(b) Matching principle
(c) Consistency principle
(d) Going concern principle
34. A Ltd. purchased a machine of ` 1,00,000 on
1st January. The market price of the machine was
` 1,20,000 on 31st December. The accountant

M01_CA-CPT_C01.indd 22

36. Mr. X purchased a motorcycle for his son on

credit and recorded it as a purchase of asset in
the book of the business. He has violated the
principle of
(a) Money measurement
(b) Periodicity
(c) Consistency
(d) Separate entity
37. The concept which calls for an adjustment to
be made in respect of prepaid and outstanding
expenses and accrued and unaccrued revenues
is the principle of
(a) Prudence
(b) Accrual
(c) Cost
(d) Consistency
38. The determination of expenses for an accounting period is based on the principle of
(a) Objectivity
(b) Materiality
(c) Matching
(d) Periodicity
39. Capital is the
(a) Excess of external liabilities over the
assets
(b) Excess of assets over the external liabilities

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Chapter 1

(c) Excess of external liabilities over xed assets

(d) Excess of assets of over internal liabilities
40. Which of the following is correct?
(a) Assets = Liabilities Capital
(b) Assets = Capital Liabilities
(c) Assets = Liabilities + Capital
(d) Assets = External equities
41. If a rm borrows a sum of money, there will be
(a) An increase in capital

23

(b) A decrease in capital

(c) No effect on capital
(d) None of these
42. Fundamental accounting concepts include all
except __________
(a) Going concern concept
(b) Social concept
(c) Accrual concept
(d) Consistency concept

Convention
43. The practice of appending a note regarding
contingent liabilities in the accounting statements is in accordance with the
(a) Convention of consistency
(b) Money measurement concept
(c) Convention of disclosure
(d) None of these
44. The convention of conservation is applicable
(a) In providing for discount on creditors
(b) In adopting straight line method as the
basis for providing depreciation
(c) For showing joint life policy at surrender
value as against the amount paid
(d) None of these
45. Market value of investments is shown as a
footnote according to the
(a) Convention of disclosure
(b) Convention of consistency
(c) Convention of conservatism
(d) All of these
46. Making the provision for doubtful debts in
anticipation of actual bad debts is on the basis
of the
(a) Convention of disclosure
(b) Convention of consistency
(c) Convention of conservatism
(d) None of these

M01_CA-CPT_C01.indd 23

47. Accounting rules, procedures and methods

should be observed alike and should not be
changed from year to year. This is called the
accounting convention of
(a) Consistency
(b) Full disclosure
(c) Conservatism
(d) Going concern
48. The principle to anticipate no prot and provide
for all possible losses emanates from
(a) The convention of relevance
(b) The consistency concept
(c) The materiality concept
(d) The conservatism concept
49. Which is the convention of accounting
wherein there is no over valuation of assets
and incomes?
(a) Uniformity
(b) Materiality
(c) Conservatism
(d) Continuity
50. Only the signicant events which affect the
business must be recorded as per the concept of
(a) Separate entity
(b) Accrual
(c) Materiality
(d) Going concern

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24

AccountingAn Introduction

51. Disclosing essential information in accounting

observes the principle of
(a) Matching
(b) Consistency
(c) Full disclosure
(d) Conservatism
52. A contingent liability is shown in the balance
sheet because of the
(a) Convention of consistency
(b) Convention of materiality
(c) Convention of disclosure
(d) All of these
53. If a company follows the written down value
method of depreciating machinery year after
year, it in accordance with the principle of
(a) Comparability
(b) Convenience
(c) Consistency
(d) All of the above
54. Materiality principle is an exception to the
(a) Principle of consistency
(b) Accounting period assumption
(c) Principle of prudence
(d) Principle of full disclosure
55. Prudence principle is an exception to the
(a) Principle of matching
(b) Going concern assumption
(c) Principle of conservatism
(d) Principle of consistency
56. Prudence is a concept to recognise
(a) All losses and not prots
(b) Unrealized prots and not losses

(c) Realized losses and not prots

(d) None of the above
57. Mr. X valued the inventory on FIFO basis and
LIFO basis during 2010 and 2011 respectively.
He has not followed the principle of
(a) Conservatism
(b) Materiality
(c) Cost
(d) Consistency
58. Mr. X followed WDV method and SLM
method of depreciation during 2010 and 2011
respectively. He has violated the principle of
(a) Conservatism
(b) Materiality
(c) Cost
(d) Consistency
59. Mr. X has sundry debtors of ` 1,00,000.
Creating a provision for bad debts @ 2% on
sundry debtors is in accordance with the principle of
(a) Conservatism
(b) Materiality
(c) Cost
(d) Consistency
60. Mr. X has sundry creditors of ` 1,00,000 creating a reserve for discount @ 2% on sundry
creditors is a violation of the principle of
(a) Conservatism
(b) Materiality
(c) Cost
(d) Consistency

ANSWERS KEY
1. (d)
11. (b)
21. (c)
31. (d)
41. (c)
51. (c)

2. (c)
12. (d)
22. (b)
32. (b)
42. (b)
52. (c)

M01_CA-CPT_C01.indd 24

3. (a)
13. (c)
23. (a)
33. (d)
43. (c)
53. (c)

4. (a)
14. (d)
24. (b)
34. (d)
44. (c)
54. (d)

5. (b)
15. (b)
25. (d)
35. (b)
45. (a)
55. (d)

6. (b)
16. (c)
26. (d)
36. (d)
46. (c)
56. (d)

7. (c)
17. (d)
27. (b)
37. (b)
47. (a)
57. (d)

8. (c)
18. (a)
28. (c)
38. (c)
48. (d)
58. (d)

9. (a)
19. (d)
29. (a)
39. (b)
49. (c)
59. (a)

10. (b)
20. (a)
30. (c)
40. (c)
50. (c)
60. (a)

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Chapter 1

25

EXPLANATION
AQ2 1.
2.

3.

4.

5.

6.

7.

Bills payable accepted results in reduction in

liability towards creditors and also increases
liability towards bills accepted.
Accounting principles are those rules of action
or conduct which are derived from experience
and practice and when they prove useful, they
become accepted as the principles of accounting. They should be based on real assumptions
or practicability. There is no scope for.
Principle of conservatism results in understatement of assets as this principle provides
for provision of anticipated losses and not for
anticipated prots.
Fundamental accounting assumptions are:
i. Going concern
ii. Accrual
iii. Consistency.
Going concern, Consistency and Accrual concepts are the fundamental concepts and these
are followed in the preparation of nancial
statements.
As per AS-1,if the same accounting concepts
are followed year on year (consistency) then
there is no need for their disclosure.

8.

According to money measurement concept, all

those transactions which can be measured in
terms of money should be recorded in books
of account. Therefore, as health of chairman
and quality control in the business cannot be
measured in terms of money, these should not
be recorded in books.

9.

According to this concept, the value of an asset

is to be determined on the basis of historical
cost i.e. acquisition cost.

10. The proprietor is treated as creditor to the

extent his share in capital as per separate entity
concept because as per this concept, owner is
treated as separate from the business.

M01_CA-CPT_C01.indd 25

11. The accounting equation Assets = Liabilities +

Equity is based on concept of dual aspect which
says that for every debit there is equal and corresponding credit.
12. According to this concept, a business is
treated as a separate entity and is distinct
from its owner(s). The concept of separate
entity is applicable to all forms of business
organizations.
13. Fixed assets are recorded in balance sheet as
per cost concept.
14. Matching convention of accounting means
expenses of current period should be matched
against revenue of same period.
15. Accounting equation is Capital + Liabilities =
Assets. Therefore, Capital = Assets Liabilities.
16. Capital is recorded as liability of business as
per concept of separate entity where the owner
is treated separate from business.
17. It is assumed that the enterprise has neither
the intention nor the necessity to liquidate or
to materially curtail the scale of its operations.
The valuation of assets of a business entity is
dependent on going concern concept.
18. According to money measurement concept,
only those transactions which are capable of
being expressed in terms of money are included
in the accounting records. The information
which cannot be expressed in terms of money
is not included in the books of accounts though
they may be very useful to the business.
19. As per matching concept, all the expenses
of current period should be matched\against
revenue of same period.
20. The nancial statements are normally prepared
on the assumption that an enterprise will
continue to operate for the foreseeable future,
which, means for a projected or anticipated
period which is long.

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26

AccountingAn Introduction

21. Assets = Capital + Liabilities.

Therefore, Assets = ` 50,00 + ` 20,000
= ` 70,000.
22. Assets = Capital + Liabilities.
Therefore, ` 3,00,000 = ` 1,00,000 + x.
So x = ` 2,00,000.
23. Withdrawal will result in decrease in capital
and also decrease in cash (current assets)
withdrawn . As per dual aspect concept, every
debit has an equal amount of credit.
24. According to periodicity concept, the economic
life of an enterprise is articially split into periodical intervals which are termed as accounting
periods. At the end of each accounting period,
nancial statements are prepared to show the
performance and the position of the business.
25. As per going concern concept, the nancial
statements are normally prepared on the
assumption that an enterprise will continue
to operate for the foreseeable future. It is also
known as assumption of continuity.
26. Purchase of ofce equipment on credit results
in increase in asset and increase in liability.
27. Payment of a liability results in decrease in
cash on asset side and decrease of liability.
28. Purchase of machinery for cash results in no
change in total assets as there is increase in one
asset (machinery) and decrease in other asset
(cash).
29. Capital brought in by the proprietor will
result in increase in asset as cash is added and
increase in liabilities capital is categorised as
liability as per separate entity concept.
30. The personal expenses of the owner should not
be charged to business and should be treated
as drawings as per the concept of separate
entity.
31. To receive cash in future takes into account
the future operating possibility of the business
which is depicted by going concern concept.

M01_CA-CPT_C01.indd 26

32. By using the same bank account for his personal affairs and for his business he will be
violating Entity concept as according to this
concept, a business is treated as a separate
entity and is distinct from its owner(s).
33. The assets are classied as current assets and
xed assets in accordance with the periodic
concept.
34. The accountant should have recorded machinery at cost as per cost concept.
35. According to entity concept, a business is
treated as a separate entity and is distinct from
its owner(s). So all personal transactions are
distinguished from business transaction.
36. As per the principle of separate entity personal
assets of the owner should not be treated as
business assets.
37. Accrual concept states that all revenues and
costs are recognised as they are earned or
incurred and not as money is received or paid.
38. According to matching concept, the expenses
incurred in one accounting period should be
matched with the revenues recognized in that
same period.
39. Capital = Assets External liabilities.
40. Basic accounting equation:
Equity (E) + Liabilities (L) = Assets (A).
41. If rm borrows money, then there is increases
in asset i.e., cash and increase in liability. There
is no effect on capital.
42. Going concern, Consistency and Accrual concepts are the fundamental concepts and these
are followed in the preparation of nancial
statements.
43. The practice of appending a note regarding
contingent liabilities in the accounting statements is in accordance with the convention
of disclosure as this convention requires
full disclosure of all important accounting
information.

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Chapter 1

44. Convention of conservatism requires provision

for all the anticipated expenses and therefore
joint policy is shown at surrender value and
not at policy value.
45. Market value of investments is shown as a
footnote is in accordance with the convention of disclosure as this convention requires
full disclosure of all important accounting
information.
46. Convention of conservatism requires provision for all the anticipated expenses and not
for anticipated prots therefore provision for
doubtful debts is provided.

53.

54.

55.

47. According to this principle, the accounting

policies adopted by the enterprise should
be followed consistently from one period to
another.
48. The principle to anticipate no prot and provide for all possible losses emanates from the
conservatism concept.
49. Conservatism principle does not lead to over
valuation of assets as it provides for provision for anticipated losses and not anticipated
prots.
50. According to the convention of materiality,
all relevant items, the knowledge of which
might inuence the decision of the users of
the nancial statements, should be disclosed
in the nancial statement.

56.

57.

58.

59.

51. Principle of full disclosure requires disclosure

of all the essential information affecting the
business.
52. According to convention of full disclosure
principle, the financial statements should
disclose all reliable and relevant information
which are necessary for the users. So any

M01_CA-CPT_C01.indd 27

60.

27

contingent liability should be disclosed as per

this convention.
According to convention of consistency principle, the accounting policies adopted by the
enterprise should be followed consistently
from one period to another.
Materiality principle is an exception to principle of disclosure, because as per principle
of full disclosure all the business information
should be disclosed in accounting, but materiality concept provides that only material and
signicant information should be disclosed.
Prudence principle is exception to principle
of consistency. For example, as per consistency principle accounting policies should
be followed consistently. Whereas, prudence
principle provides that stock should be valued
at lower of cost or market price. Therefore,
there can be change in accounting polices due
to prudence principle.
As per prudence (conservatism convention)
provide for all expected losses but never for
anticipated prots.
Mr. X has violated the principle of consistency,
which requires that the accounting policies
should be followed consistently.
Mr. X has violated the principle of consistency,
which requires that the accounting policies
should be followed consistently.
Creation of provision for sundry debtor is as per
principle of conservatism which states provide
for all expected losses but never for anticipated
prots.
Creation of reserve for sundry creditors is
against principle of conservatism because as
per this principle there should be no provision
for anticipates prots.

2/19/2013 11:18:04 AM

Unit
1.3

Accounting Standards

Learning
Objectives
After studying this unit, you will be able to:
Accustom with the concept of Accounting
Standards.

Know the objectives, benets and limitations of Accounting Standards.

Introduction
Accounting is the language of a business which communicates the nancial performance of the business
to various users. It has to exhibit a true and fair view. If the nancial accounting process is not properly
regulated, then the nancial statements may be misleading and may provide a distorted picture of the
business. In order to ensure a true and fair view, transparency, consistency, comparability and reliability of
nancial reports, a standardized set of rules and accounting principles are required. Accounting Standards
provide a framework and standard accounting policies so as to ensure true and fair view, transparency,
consistency, comparability and reliability of the nancial reports.

Meaning of Accounting Standards

Accounting Standards are written policy documents issued by an expert accounting body or by the
government or any other regulatory body. It covers the aspects of recognition, treatment, measurement,
presentation and disclosure of accounting transactions and events in the nancial statements.

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29

Objectives of Accounting Standards

The main objective of Accounting Standards is to harmonize the diverse accounting policies and practices
followed by different business entities so as to ensure standardization. Accounting Standards harmonize
accounting policies with a view to



Enable the comparability of nancial statements and thereby improve the reliability and usefulness
of the nancial statements.
Provide a standard set of accounting policies, valuation norms and disclosure requirements.

Advantages of Accounting Standards






By adopting the Accounting Standards, confusing variations in the accounting treatment used to AQ3
prepare nancial statements are reduced.
Accounting Standards describe the accounting principles, the valuation techniques and the method
of applying accounting principle so as to ensure true and fair view.
Where important information is not statutorily required, it calls for disclosure.
Accounting Standards facilitate the comparison of nancial statements of companies in the same
industry situated in different parts of the world.

Limitations of Accounting Standards





Alternative solutions to certain accounting policies may each have arguments to them. So, the choice
between different alternative accounting treatments becomes difcult.
Generally, there is rigidity in applying the Accounting Standards.
The standards are required to be framed within the ambit of prevailing statutes. Accounting Standards
cannot override the statute.

Overview of Accounting Standards in India

In India, the Institute of Chartered Accountants of India (ICAI), being a premier accounting body in the
country, took upon itself the leadership role by constituting the Accounting Standard Board (ASB) on 21st
April 1977. The main function of ASB is to formulate Accounting Standards so that such standards may
be established in India by the council of the ICAI. The council of the Institute of Chartered Accountants
of India has, so far, issued 32 Accounting Standards. However, AS 8 on Accounting for Research and
Development has been withdrawn consequent to the issuance of AS 26 on Intangible Assets. Thus
effectively, there are 31 Accounting Standards at present. The Accounting Standards issued by the
Accounting Standard Board establish standards which have to be complied by the business entities so
that the nancial statements are prepared in accordance with Generally Accepted Accounting Principles.
A list of Accounting Standards is given in the following page.

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30






AccountingAn Introduction

Accounting Standards are written policy documents.

The main objective of Accounting Standards is to ensure standardization.
The Accounting Standards Board (ASB) had formulated 32 Accounting Standards. At
present, there are 31 Accounting Standards.
Rigidity is a major limitation of Accounting Standards.

List of Accounting Standards

Number of the Accounting
Standard (AS)
AS 1
AS 2 (Revised)
AS 3 (Revised)
AS 4 (Revised)
AS 5 (Revised)
AS 6 (Revised)
AS 7 (Revised)
AS 8 (withdrawn pursuant to
AS 26 becoming mandatory)
AS 9
AS 10
AS 11 (Revised)
AS 12
AS 13
AS 14
AS 15 (Revised)
AS 16
AS 17
AS 18
AS 19
AS 20

M01_CA-CPT_C01.indd 30

Title of the Accounting Standard

Disclosure of Accounting Policies
Valuation of Inventories
Cash Flow Statements
Contingencies and Events Occurring after
the Balance Sheet Date
Net Prot or Loss for the Period, Prior Period Items
and Changes in Accounting Policies
Depreciation Accounting
Accounting for Construction Contracts
Accounting for Research and Development
Revenue Recognition
Accounting for Fixed Assets
The Effects of Changes in Foreign Exchange Rates
Accounting for Government Grants
Accounting for Investments
Accounting for Amalgamations
Employee Benets
Borrowing Costs
Segment Reporting
Related Party Disclosures
Leases
Earnings Per Share

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Chapter 1

Number of the Accounting

Standard (AS)
AS 21
AS 22
AS 23
AS 24
AS 25
AS 26
AS 27
AS 28
AS 29
AS 30
AS 31
AS 32

31

Title of the Accounting Standard

Consolidated Financial Statements
Accounting for Taxes on Income
Accounting for Investments in Associates in Consolidated
Financial Statements
Discontinuing Operations
Interim Financial Reporting
Intangible Assets
Financial Reporting of Interest in Joint Ventures
Impairment of Assets
Provisions, Contingent Liabilities and Contingent Assets
Financial Instruments: Recognition and Measurement
Financial Instruments: Presentation
Financial Instruments: Disclosure

For CPT level, the candidate is not required to remember the Accounting Standards by heart.

MULTIPLE CHOICE QUESTIONS

1.

2.

3.

4.

(c) Companies
(d) Small enterprises

Accounting Standards in India are issued by

(a) The International Accounting Standards
Board
(b) The Central Government
(c) Accounting Standards Board of ICAI
(d) Institute of Standards of India

5.

The generally accepted accounting principles

are codied by the
(a) Accounting concepts
(b) Accounting theories
(c) Accounting policies
(d) Accounting standards

Accounting Standard Board was set up by

(a) ICSI
(b) ICAI
(c) ICWAI
(d) None of these

AS 6 relates with
(a) Valuation of inventories
(b) Accounting for xed assets
(c) Depreciation accounting
(d) Accounting for investments

7.

AS 2 relates with
(a) Valuation of inventories
(b) Accounting for xed assets
(c) Depreciation accounting
(d) Accounting for investments

There are _____ Accounting Standards in India

(a) 35
(b) 28
(c) 33
(d) 32
The Accounting Standards are compulsory for
(a) Hospital
(b) Electricity department

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AccountingAn Introduction

32

ANSWERS KEY
1. (c)

2. (d)

3. (d)

4. (c)

5. (b)

6. (c)

7. (a)

EXPLANATION
1.

Accounting Standards in India are issued by

Accounting Standards Board of ICAI.

2.

The generally accepted accounting principles

are codied by the accounting standards.

3.

Accounting Standards Board (ASB) had formulated 32 Accounting Standards. At present,

there are 31 Accounting Standards.

4.

The Accounting Standards issued by the

Accounting Standard Board establish standards

M01_CA-CPT_C01.indd 32

which have to be complied by the business

entities so that the nancial statements are prepared in accordance with Generally Accepted
Accounting Principles.
5.

Accounting Standard Board was set up by

ICAI.

6.

AS 6 relates with depreciation accounting.

7.

AS 2 relates with valuation of inventories.

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Unit
1.4

Accounting Policies

Learning
Objectives
After studying this unit, you will be able to:
Understand the meaning of accounting
policies.

Learn the basis for the selection of an

accounting policy and the criteria for the
change in the accounting policy.

Meaning
Accounting policies refer to specic accounting principles and methods of applying these principles
adopted by the enterprise in the preparation and presentation of nancial statements.
The areas in which different accounting policies are frequently encountered are






Methods of depreciation, depletion, amortization

Valuation of inventories
Treatment of goodwill
Valuation of investments
Valuation of xed assets, etc.

Considerations in the Selection of Accounting Policies

Selection of accounting policies is based on

Prudence

M01_CA-CPT_C01.indd 33

Substance over form

Materiality

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34
1.

AccountingAn Introduction

Prudence: Prudence means conservatorium, which states, provide for all expected losses but never
for anticipated prots. As per this, assets and income should not be overstated and liabilities and
expenses should not be understated. All the uncertainties and their nature should be disclosed so
that it helps in proper decision-making.
Substance over form: Transactions and events should be accounted for and presented in accordance
with their substance and nancial reality and not merely with their legal form.

2.

Example: A lease might not transfer the ownership to the leasee but the leasee has to record the leased
items as an asset if it intends to use it for a major portion of its useful life or where the present value of
lease payment is fairly equal to the fair value of the asset, etc. Although legally the leasee is not the owner,
so the leased item is not his asset, from the perspective of the underlying economics the leasee is entitled to
the benefits embedded in the use of the item and hence it has to be recorded as an asset.

3.

Materiality: Financial statements should disclose all the material items which inuence the decision
of the users of the nancial statements.

Change in Accounting Policy

Change in the accounting policy should be made under the following conditions:




If it is required by some statute.

If it is required by compliance with an Accounting Standard.
If the change would result in a more appropriate presentation of nancial statements.
Example: If the depreciation method is changed from a straight line method to a written down value
method, then it amounts to a change in accounting policy.





Accounting policies refer to specific accounting principles adopted by the enterprise in

the preparation and presentation of financial statements
Selection and application of accounting policies are based on three characteristics:
prudence, substance over form and materiality
A change in the accounting policy can happen if:
Required by statute.
Required by compliance.
Change results in a more appropriate presentation of financial statement.

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Chapter 1

35

MULTIPLE CHOICE QUESTIONS

1.

Accounting policies refer to specic accounting

(a) Principles
(b) Methods of applying those principles
(c) Both (a) & (b)
(d) None of the above

2.

Accounting policies are based on various

(a) Accounting concepts
(b) Accounting principles
(c) Accounting conventions
(d) All of these

3.

4.

Selection of appropriate ________ is an

important policy decision which affects the
measurement of performance, as well as the
nancial position of the business entity
(a) Accounting policies
(b) Accounting principles
(c) Accounting conventions
(d) Accounting concepts
A change in accounting policy is permissible
(a) When it is required by some statue
(b) For compliance with an Accounting
Standard
(c) When change would result in more appropriate presentation of nancial statement
(d) All of these

5.

Which of these is an example of accounting

policy?
(a) Accrual
(b) Consistency
(c) Going concern
(d) Depreciation

6.

Accounting policies
(a) Are same for all concerns
(b) Are laid down by law
(c) Change from concern to concern
(d) Are prescribed by AS1

7.

In which of the following areas may different

accounting policies be adopted by different
enterprises?
(a) Valuation of inventory
(b) Method of depreciation
(c) Treatment of goodwill
(d) All of these

8.

Selection of appropriate accounting policies is

based on
(a) Prudence
(b) Substance over form
(c) Materiality
(d) All of the above

ANSWERS KEY
1. (c)

2. (d)

3. (a)

4. (d)

5. (d)

6. (c)

7. (d)

8. (d)

EXPLANATION
1.

Accounting policies refer to specic accounting principles and methods of applying those
principles.

M01_CA-CPT_C01.indd 35

2.

Accounting policies are based on various accounting concepts, principles and

conventions.

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36
3.

4.

5.

AccountingAn Introduction

Selection of appropriate accounting policies

is an important policy decision which affects
the measurement of performance, as well as
the nancial position of the business entity.

6.

Change in the accounting policy should be

made under the following conditions:
i. If it is required by some statute.
ii. If required by compliance with an Accounting Standard.
iii. If the change would result in a more appropriate presentation of nancial statements.

7.

Accounting policies refer to specic accounting principles and methods of applying these
principles adopted by the enterprise. The
areas in which different accounting policies
are frequently encountered are methods of

8.

M01_CA-CPT_C01.indd 36

depreciation, depletion, amortisation, valuation

of inventories, etc.
Accounting policies refer to specic accounting principles and methods of applying these
principles adopted by the enterprise. One concern can use FIFO for valuation of inventory
and other can use LIFO.
The areas in which different accounting policies are frequently encountered are methods
of depreciation, depletion, amortisation, valuation of inventories, treatment of goodwill,
valuation of investments, valuation of xed
assets etc.
Selection of appropriate accounting policies is
based on prudence, substance over form and
materiality.

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Unit
1.5

Accounting as a
Measurement Discipline,
Valuation Principles,
Accounting Estimates

Learning
Objectives
After studying this unit, you will be able to:
Know the meaning of measurement and
its elements.
Know how far accounting is a measurement
discipline if considered from the standpoint
of the basic elements of measurement.

Distinguish measurement with valuation.

Learn various valuation principles.
Understand accounting estimates.

Measurement
Prof. R.J. Chambers dened measurement as an assignment of numbers to objects and events according to rules specifying the property to be measured, the scale to be used and the dimension of the unit.
Thus, three elements of measurement are as follows:


Identication of objects and events to be measured: Every enterprise will need to measure its
performance. Future transactions or events are only predicted but not measured. Past and present
transactions or events can be measured with some degree of accuracy.
Selection of standard or scale to be used: Money is the scale of measuring a business performance.
It takes the shape of the currency ruling in a country. Also, there is no constant exchange relationship
among the currencies: the scale of measurement in India is the Rupee, in U.K. the Pound-sterling,
in US the dollar, etc.
Evaluation of dimension of measurement standard or scale: Business performance is measured in
terms of money earned. An ideal measurement scale should be stable over time. Money is not stable
in the dimension for comparison over time as the same amount of money may not be able to buy the
same quantities of identical goods at different periods. Thus, the information of one year measured
in terms of money may not be comparable with that of another year.

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38

AccountingAn Introduction

Accounting as a Measurement Discipline

Accounting information measures the performance of a business entity by way of prot or loss and
shows its nancial position. Thus, measurement is an important part of accounting discipline. Accounting
is not an exact measurement discipline because accounting measures information mostly in terms of
money which is not a stable scale, does not have universal applicability and is not stable in dimension
for comparison over time.
As measurement is an important part of the accounting discipline, a set of theorems which govern
the measurement system, such as going concern, consistency and accrual concept, should be carefully
understood.

Valuation
Value relates to the benets to be derived from objects, abilities or ideas.
Valuation principles

Historical cost

Current cost

Realisable value

Present value

Historical cost
All xed assets are recorded at the actual purchase price or acquisition price by following the
principle of historical cost.
Example: Mr Manoharlal purchased a machinery by paying ` 8,00,000 when the actual price of
the machinery is ` 10,00,000. Here, the historical cost is only ` 8,00,000 which is the price paid for
acquiring the machine.

Liabilities are recorded at an amount payable of proceeds received in exchange of the obligation.
Example: When Mr Manoharlal, a businessman, takes ` 1,00,000 loan from a bank at 12 per cent
interest p.a., it is to be recorded at the amount of proceeds received in exchange for the obligation being
repayment of loan and payment of interest at an agreed rate. Proceeds received are ` 1,00,000it is
the historical cost of the transactions.

Current cost
Assets are carried out at the amount of cash or cash equivalent that would have to be paid if the
similar asset was acquired currently.
Example: Raj purchased a machine at ` 8,00,000 on 1st January 2009. The similar machine if
purchased now, that is, in 2013, would cost ` 15,00,000. So as per current cost basis, the machines
value is ` 15,00,000.

Liabilities are carried out at the undiscounted amount of cash or cash equivalent that would be
required to settle the obligation currently.

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Chapter 1

39

Realizable value
A realizable value is the amount of cash or cash equivalent that could currently be obtained by
selling the asset in an orderly disposal.
Example: Rachna purchased a machine at ` 8,00,000 on 1st January 2009. If she sells the machine
now, that is, in 2012, she will be get ` 2,00,000. So, the machine has to be recorded at ` 2,00,000
being the realizable value.

Liabilities are carried at settlement values, that is, the undiscounted amount of cash or cash
equivalent to be paid.
Present value
Present value is the present discounted value of the future net cash inows that the asset is expected
to generate in the normal course of business.
Liabilities are carried at the present discounted value of future net cash outows expected to settle
the liabilities in the normal course of business.
Example: Shahid purchased a machine on 1st April 2002, and it is supposed to generate cash at
` 50,000 p.a. for the next 10 years at the rate of 10 per cent p.a. The present value of future cash
flows will be calculated as follows:
PV =

A
(1+ I )n

PV =

50, 000
(1+ 0.10)n

Solution

= ` 45,455
Similarly,
Where PV = Present value
n = Number of years
I = Rate of interest
A = Amount

Time of receipt
31-03-2004
31-03-2005
31-03-2006
31-03-2007
31-03-2008
31-03-2009
31-03-2010
31-03-2011
31-03-2012
Total

M01_CA-CPT_C01.indd 39

Money value (`)

50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000
50,000

Present value (`)

41,322
37,565
34,151
31,046
28,224
25,658
23,325
21,205
19,277
3,07,228

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40

AccountingAn Introduction

The total of all these present values is ` 3,07,228.

The machine purchased by Mr X has to be valued at its present value of ` 3,07,228.

Illustration 1
A Ltd purchased a machine for ` 50,000 on 1st April 2001
1.
2.
3.

A similar machine could be purchased for ` 60,000.

The same machine could be disposed of for ` 40,000.
The present discounted value of the future net cash inows that the machinery was expected to
generate in the normal course of business is calculated at ` 75,000.
It signies the following:

1.
2.
3.
4.

Historical cost is ` 50,000

Current cost is ` 60,000
Realizable value is ` 40,000
Present value is ` 75,000

Measurement and Valuation

Value relates to the benets to be derived from objects, abilities or ideas. In economics, the value of
an object, ability or idea is the utility of an economic resource to the person contemplating or enjoying
its use. Economists use an ordinal scale to indicate the level of satisfaction. In accounting, the value of
an object, ability or idea is always measured in terms of money. Accountants use only cardinal scales.
Example: The statement the value of one pizza is ` 100 follows a cardinal approach while the statement
I give first preference to pizzas and second to burgers follows a ordinal approach.

Accounting Estimates
AQ4 Valuation principles help in the evaluation of those transactions or events which have occurred. Items
which have not occurred cannot be measured using valuation principles. However, it is necessary to
record them too, for example, the provision for doubtful debts on debtors. Accounting estimates are
usually made in respect of doubtful debts, inventory obsolescence, residual value, etc. If changes
occur in the circumstances on which the estimates were based, the accounting estimate may require
revision. A change in accounting estimates means the differences arising between certain parameters
estimated earlier and re-estimated during the current period, or actual results achieved during the
current period.
Example: On 30th September 2011, the provision for doubtful debts was ` 10,000. By the end of the current
year, that is, 31st March 2012, a debt of ` 5,000 which was considered doubtful was realized, and hence
there was a revision in the provision for doubtful debts. On 31st March 2012, the provision for doubtful debts
was ` 5,000.

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Chapter 1





41

Though unstable, money is the scale of measurement in accounting.

The elements of measurement are: identification of events, selection of a scale and evaluation of the dimension of scale.
Four valuation principles are
Historical cost
Current cost
Realizable value
Present value
Accounting estimates are made for doubtful debts, inventory obsolescence, residual
value, etc.

MULTIPLE CHOICE QUESTIONS

1.

2.

3.

Measurement is a vital aspect of accounting.

________ are measured in terms of money.
(a) Primary transactions
(b) Events
(c) Both (a) & (b)
(d) None of these
Any measurement discipline deals with ______
basic elements of measurement.
(a) 2
(b) 3
(c) 4
(d) 5
Ordinal numbers or ordinals are numbers used
to denote the
(a) The situation of number in an equation
(b) Position in an ordered sequence

(c) Position in progressive numbers

(d) None of these
4.

Accounting can be treated as a measurement

discipline only if there is/are
(a) Identication of objects and events
(b) Selection of standards or scale
(c) Evaluation of dimension of measurement
standards or scale
(d) All of these

5.

Which of the following is not a valuation

principle?
(a) Historical cost
(b) Present value
(c) Current cost
(d) Future value

ANSWERS KEY
1. (c)

M01_CA-CPT_C01.indd 41

2. (b)

3. (b)

4. (d)

5. (d)

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42

AccountingAn Introduction

EXPLANATION
1.

2.

3.

Measurement is a vital aspect of accounting.

Primary transactions and Events are measured
in terms of money.
Three elements of measurement are:
i. Identication of objects and events to be
measured
ii. Selection of standard or scale to be used
iii. Evaluation of dimension of measurement
standard or scale
Ordinal numbers are used to denote the position
in an ordered sequence. Example: The statement the value of one pizza is ` 100 follows
cardinal approach while the statement I give

M01_CA-CPT_C01.indd 42

4.

5.

rst preference to pizzas and 2nd to burgers

follows ordinal approach.
Accounting can be treated as a measurement
discipline only if there are identication of
objects and events, selection of standards or
scale and evaluation of dimension of measurement standards or scale.
Four valuation principles are
i. Historical cost
ii. Current cost
iii. Realisable value
iv. Present value
Future value is not a valuation principle.

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Author Queries:
AQ1: Please check if edit to the sentence starting As per materiality is okay.
AQ2: Please provide explanation text.
AQ3: Please check if edit to the sentence starting By adopting the is okay.
AQ4: Please check if edit to the sentence starting Valuation principles help is okay.

M01_CA-CPT_C01.indd 43

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