Financial Accounting

Study Material

This document includes some of the most important theory topics from the examination point of view.
Please note that this is not an exhaustive list and is prepared based on D.U. previous year’s questions
alone. It is only to give you a fair idea about the different relevant topics that should not be skipped
from the examination point of view.

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 Contents

Chapter-wise theory & important topics for BMS (DU) examination .................................................. 3
I. Introduction to Accounting ............................................................................................................ 3
Advantages of Accounting.................................................................................................................. 4
Limitations of Accounting .................................................................................................................. 4
Users of Accounting information: ...................................................................................................... 4
II. Accounting concepts & conventions .............................................................................................. 5
III. Important distinctions ................................................................................................................ 6
1. Capital expenditure and Revenue expenditure. ........................................................................ 6
2. Capital Receipt & Revenue Receipt............................................................................................ 6
3. U.S. GAAP Vs. Indian GAAP ........................................................................................................ 6
4. Cash book and Cash Flow Statement......................................................................................... 7
5. Indian GAAP Vs. IFRS Vs. Ind AS ................................................................................................. 7
6. Accrual Basis of Accounting & Cash Basis of Accounting .......................................................... 9
7. Horizontal analysis & vertical analysis....................................................................................... 9
IV. Meaning, Contents and Utility of Annual Report .................................................................... 10
V. Harmonization and Convergence of IFRS..................................................................................... 10
VI. Ind AS-1: Presentation of Financial Statements ...................................................................... 12
VII. Ind AS-7: Statement of Cash Flows .......................................................................................... 13

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 Chapter-wise theory & important topics for BMS (DU) examination

I. Introduction to Accounting

Accounting may be defined as the process of collecting, recording, summarising, and

communicating financial information. Accounting is an art of recording, classifying, and
summarising in a significant manner and in terms of money, transactions and events which are,
in part at least, of a financial character, and interpreting the results thereof.
The term ‘accounting’ can be classified into the following broad categories:
● Financial accounting: This deals with ascertainment of profitability and provides relevant
information about the financial position of an undertaking.
● Cost accounting: Since financial accounting is not sufficient to provide relevant details about
the cost of production of various items produced by an undertaking or the cost structure of
product, cost records are to be maintained to ascertain the cost of production of items produced
during a certain period; and this aspect of accounting is dealt with under cost accounting.
However, the information required for the maintenance of cost records is obtained from
financial accounts.
● Management accounting: Any form of accounting which enables a business unit to be
conducted more efficiently can be regarded as management accounting. Management
accounting is that part of accounting, which is concerned, mainly with internal reporting to the
managers of a business unit. It relates to planning, control and decision-making which is useful
to the management in the discharge of its functions. Thus, it emphasizes the control of decision-
making aspects of accounting, which is tailor-made to suit the needs of the management of a
specific enterprise, rather than stewardship aspects of accounting. Management accounting is
‘forward-looking’ and generally includes cost accounting and budgeting. The preparation of
management accounting is not based on generally accepted accounting principles and is
relatively free of constraints imposed by legal regulations and accounting standards
● Social Accounting: Social accounting is a branch of accounting which attempts to measure
the social benefits that an organisation provides and the social costs that an organisation
imposes. Social accounting is not a new method of keeping books of account, but a concept
based on evaluating the costs and benefits relating to socially responsible actions by business
enterprises. Both social cost and social benefit arise from externalities. Externalities are the
benefits or costs which are not received or borne by the business unit responsible for them.
Social costs as well as social benefits are a function of social perception of what is bad or good
about business activity.
●Human Resource Accounting: Human resource accounting is the accounting for the human
resource of an enterprise. It is the process of identifying and measuring data about human
resources and communicating this information to interested parties. Human resource
accounting is, therefore, accounting for people as organisational resource. It is an act of
identifying, measuring and evaluating the worth of human resources of an enterprise in a
systematic manner to the organisation and to society as a whole, and recording these in a
significant manner in the financial statement for presenting the information to the various users

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and to communicate their worth with changes over the period as also results obtained from
their utilisation to those users.
●National Accounting: National accounting is the accounting of the transactions of a national
economy, as distinct from those of entities in sectors of the economy, i.e., business enterprises
and public authorities. National accounting is not based on generally accepted accounting
principles. It has been developed by economists and statisticians and, therefore, data for
national accounting must be collected from non-accounting sources

Advantages of Accounting

The advantages of accounting are :

• It provides information useful for making economic decisions.
• It serves primarily those users who have limited authority, ability or resources to obtain
information and who rely on financial statements as their principal sources of
information about an enterprise’s economic activities.
• It provides information useful to investors and creditors for predicting, comparing and
evaluating potential cash flows in terms of amount, timing and related uncertainty.
• It supplies information useful in judging the management’s ability to utilise enterprise
resources effectively in achieving primary enterprise goals.
• It provides factual and interpretative information about transactions and other events
which are useful for predicting, comparing and evaluating the enterprise’s earning
power.

Limitations of Accounting

The limitations of accounting are :

• Accounting is historical in nature, it does not reflect the current financial position or
worth of a business.
• The Profit and Loss Account tends to match current revenues with historical costs
(expenses) rather than current costs.
• Accounting statements do not show the impact of inflation.
• The Profit and Loss Account does not reflect those increases in net asset values which
are not considered to be realised.
• Accounting principles are not static ----alternative accounting procedures are often
equally acceptable. Therefore, accounting statements do not always present comparable
data.

Users of Accounting information:

Accounting information is needed by two sets of people----internal and external. Internal users
are associated with management of the concern for which information is sought to be gathered
and surveyed. For example, the directors or the partners, managers and officers.

The external users consist of several explicit groups : (1) potential investors; (2) lenders; (3)
suppliers; (4) customers; (5) government agencies; (6) the public; and, (7) employees.

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 • Investors: They supply the risk capital to the business unit. Ownership is separated
from management in joint stock companies; hence, investors need to know how their
money is being spent by the managers. Financial information helps them to decide
about (a) making investments, (b) quantum of investment, and (c) holding on to the
equities they own.
• Lenders: Accounting information provides them with reasonable assurance as to the
payment of interest and repayment of the principal.
• Suppliers: They normally sell on credit and they must have reasonable assurance that
their credit will be honoured. Financial information helps them to decide about the
credibility of the firm, and whether they should continue supplying on credit.
• Customers: They are a composite group, consisting of (a) producers at every stage of
processing, (b) wholesalers and retailers and (c) the final consumers. Producer at the
next stage of processing must be assured of the input which they obtain from the
concern in question. The wholesalers and retailers must also be sure about the
uninterrupted supply of materials. Otherwise, they will be hesitant to stock it. The
ultimate consumer is interested in the continuous availability of the product. Should he
come to think that the availability may be disrupted or stopped, he will shift his
preference for another variety or brand. In all these kindred decisions, accounting
information has a significant role to play.
• Government agencies: Any economy of the day is, in a way, controlled and regulated
by the political authorities, i.e., the government. Consequently, government agencies
rely on the financial information for permitting expansion or contraction of business,
for import and export of products and/or materials, for allocation of essential resources
for regulating labour or taxation, etc.
• Public: For members of the public the financial information is of the nature of a health
examination report ---- it tells them about employment opportunities and general
growth in the individual concern and the economy as a whole.
• Employees: The employees of the concern are interested in the financial information
because both, their present and future are tied up with the company’s fortunes. Thus,
financial information serves diverse interests. Hence, the information should be
gathered and disseminated in a way that benefits each interest. Information should not
be biased and should not supress facts or suggest anything false.

II. Accounting concepts & conventions

Provided in a separate file in Folder named Chapter 1.

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III. Important distinctions

1. Capital expenditure and Revenue expenditure.

Basis of difference Capital Expenditure Revenue Expenditure
1. Purpose of the Such expenses are incurred Such expenses are incurred
expense either for acquiring a new asset either for maintaining the fixed
or for improving profit-earning asset or meeting the routine
capacity of the asset. business expenses like purchase
of raw material, goods for sale.

2. Nature of the expenses Non-recurring in nature Recurring in nature

3. Effect on final Appears in balance sheet by Appears in Income statement

accounts way of addition to assets

4. Increase in value of Result in increase in value of Such expenses are incurred to

assets asset maintain the assets in working
condition.

2. Capital Receipt & Revenue Receipt

3. U.S. GAAP Vs. Indian GAAP

Basis Indian GAAP US GAAP
Financial statement Prepared in accordance with the Not required to be prepared
presentation requirements of Schedule under any prescribed format,
VI of format, provided they comply provided they comply with the
with the disclosure the Companies disclosure requirements of the
Act, 2013. US accounting standard

Investments in own Investments in own shares is expressly Permitted,

shares prohibited but buy-back is permitted

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Assets and liabilities No mandatory disclosure of current & Mandatory disclosure of current
long-term component and long-term component.

4. Cash book and Cash Flow Statement

Criteria Cash Book Cash Flow Statement

Purpose It is a ledger that records all cash It provides a summary of how changes in
transactions, including cash receipts and balance sheet accounts and income affect
cash payments, in chronological order. The cash and cash equivalents. The primary
Cash Book helps in maintaining a record of purpose is to analyse the sources and uses
the cash position of a business. of cash over a specific period, helping
stakeholders understand the cash position
and liquidity of a business.

Scope It deals specifically with cash transactions, It covers a broader range of activities,
including those related to sales, purchases, including operating, investing, and
expenses, and other financial activities that financing activities. The Cash Flow
involve the exchange of physical currency. Statement provides a comprehensive
view of how various business activities
impact cash.

Time Frame Typically, records transactions in real-time Summarizes cash inflows and outflows
or on a daily basis, providing an up-to-date over a specified period, usually monthly,
snapshot of the company's cash position. quarterly, or annually. It provides a more
extended and comprehensive overview
of cash movements.

Components It includes columns for date, particulars, It is divided into three main sections:
cash received, cash paid, and the balance operating activities, investing activities,
of cash on hand. The Cash Book can be a and financing activities. Each section
single column, double column, or three- provides a detailed breakdown of cash
column book depending on the level of flows related to different aspects of the
detail required. business.

Users Primarily internal: used by accountants and Used by both internal and external
financial staff within the organization for stakeholders, including investors,
day-to-day cash management and creditors, management, and analysts, to
reconciliation. assess the financial health and liquidity
of the business.

5. Indian GAAP Vs. IFRS Vs. Ind AS

Basis Indian GAAP IFRS Ind AS

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Presentation of AS 1 disclosure of accounting IAS 1 presentation of Ind AS 1 presentation of
financial policies financial statements financial statements
statements

Formats of Under Schedule VI of Only illustrative formats No format prescribed

financial companies Act 1956 have have been given.
statements provided
Classification of Classification of inventories No specific Same as IFRS
inventories as per schedule VI: requirements.
- Raw material, Classification should be
- Work in progress appropriate to entity
- Finished goods
- Stock in trade
- Stores and spares
- Loose tools
- Others
Bank overdraft Financing activities Cash &cash equivalents Same as IFRS

Cash flows from to be classified as operating, Cash flow statements do Same as IFRS
extra ordinary financing and investing not reflect any items as
items activities. extraordinary
Change in method Requires retrospective It will be treated as Same as IFRS
of depreciation recomputation of change in accounting
depreciation and any excess estimates and applied
or deficit is required to be prospectively
adjusted in the period in
which such change is
affected. Such a change is
treated as a change in
accounting policy and its
effect is quantified and dis
Replacement costs closed.
Revaluation No specific requirements on Revaluations are Same as IFRS
frequency of revaluation. required to be made
with sufficient
regularity to ensure that
the carrying amount
does not differ
materially from that
which would be
determined using fair
value at the end of the
reporting period.
Government Does not deal with disclosure IAS 20 Deals with Same as IFRS
assistance of government assistance government grants as
other than in the form of well as disclosure of
government grants. government assistance.

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 disclosure in AS 20 requires disclosure of When associate degree EPS is needed to be
separate financial basic and diluted EPS entity presents each presented in Each
statements information both in the separate and consolidated as well as
separate and consolidated consolidated financial separate financial
financial statements of the statements, EPS is statements.
parent. required to be presented
only in the consolidated
financial statements. An
entity could disclose
EPS in its separate
financial statements
voluntarily.

6. Accrual Basis of Accounting & Cash Basis of Accounting

7. Horizontal analysis & vertical analysis

Horizontal analysis and vertical analysis are both techniques used in financial statement
analysis to assess trends and relationships within financial statements. Here's a comparison of
the two:

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 Criteria Horizontal Analysis Vertical Analysis

Definition Also known as trend analysis, It involves the comparison of different

horizontal analysis compares financial components of financial statements
data over multiple periods to identify within the same period. It expresses
trends, changes, and growth rates. It each item as a percentage of a base
helps to analyse the performance and item within the same statement.
direction of a company over time.

Focus Focuses on changes in line items or Focuses on the relative proportion of

financial indicators over consecutive each line item to a base item within the
periods. It helps identify whether same period. It helps assess the
specific items are increasing or composition of various components in
decreasing over time. a financial statement.

Time Involves comparing financial data Takes place within a single period,
Frame over multiple periods, typically across comparing each line item to the total
years or quarters. or a base item in the same financial
statement.

Calculation Calculated by comparing the absolute Calculated by expressing each line

or percentage change in a line item item as a percentage of another item
from one period to another. within the same financial statement.

Example If you compare a company's revenue If you assess a company's income

from 2020 to 2021, you might find that statement and express each expense as
it increased by 10%, indicating a a percentage of total revenue, you can
positive trend. see the proportion of each expense
relative to the total revenue.

Objective Aims to identify trends and patterns, Aims to assess the relative importance
providing insights into the financial of each component within a single
performance and growth trajectory of financial statement, helping to
a company. understand the composition and
structure of financial data.

IV. Meaning, Contents and Utility of Annual Report

Refer to SN Maheshwari Book (old version), Unit 10 (Page 207)

V. Harmonization and Convergence of IFRS

With the increasing trend towards the internationalisation of business and integration of
financial markets, the need for international harmonisation of accounting rules is strengthened

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Uniform set of international standards for financial reporting through various countries are
necessary for improved comparability of the financial statements. However complete adoption
of global accounting standards is not feasible owing to the differences in the economic, legal,
cultural, social, and political environment in different nations. The quantifiable differences can
be eliminated through the standardization of accounting policies and internationally accepted
accounting standards play a major role in this entire process. By adopting International
Financial Reporting Standards (IFRS), financial statements are presented on the same basis as
that of the foreign countries.
IFRS are accounting rules and guidelines governing the reporting of different types of
accounting transactions and events in financial statements. The main objective of IFRS
development is harmonization in financial reporting to augment the utility of accounting
information across various countries. Harmonization narrows the differences in various
accounting systems and reduces the undesirable alternative practices in financial reporting.
IFRS simplifies and provides uniform accounting procedures for companies having
subsidiaries in different countries with one reporting language.
Rationale behind convergence towards IFRS
IFRS is becoming the global language of financial reporting extensively being used across the
developed and developing nations. In the market globalization, countries have opened up their
economies by integrating with other countries through trade and business in international
markets in the form of foreign direct investments, merger and acquisition, joint ventures,
franchising etc. The business entities have seen a swift shift and are being required to review,
redefine and reassess their business strategies, organisation structures and accounting processes
in the fast-changing business world.
The global companies have subsidiaries in various countries and they raise capital for various
investment opportunities and for the diversification of their business throughout the world.
With different countries having their sets of accounting standards, results of reporting becomes
complex with different basis in the financial statements. Accepting a single set of standards
allows company to use common reporting language and thereby helping the large companies
to provide the investors and auditors with a cohesive view of the financial statements. Global
standards are desirable for the global markets and multinational companies transacting across
borders.
The usage of IFRS continues to grow for better transparency, efficiency and accountability
around the expanding financial markets thereby leading to long-term financial growth in the
global economy. The benefits from adoption of IFRS to the global economies can be
summarised as follows:
• Improved transparency,
• Ease of regulation of securities markets,
• Better access to global capital markets to procure capital from abroad,
• Better cross border listing and more investment in those countries which have adopted IFRS
Standards,
• Elimination of the multiple reporting practices and following a single set of global practice,
• quality of financial reporting improves and thereby improves the reliability onthe financial
statements,

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• Global comparability of financial statements and making comparisons easier for businesses
with subsidiaries in different countries.
• Better financial information for the stakeholders,
• Increased business efficiency,
• Better communications with international investors,
• Improved credibility of domestic markets in the foreign markets

Convergence with IFRS

• Convergence is the process of bringing accounting standards closer together, often with
the aim of adopting a single, high-quality set of global accounting standards. It involves
modifying or aligning existing national standards with international standards to
achieve a uniform global financial reporting framework.
• Application to Ind AS: For Ind AS, convergence typically refers to the process of
aligning Indian Accounting Standards with International Financial Reporting Standards
(IFRS), which are developed by the International Accounting Standards Board (IASB).
The intent is to converge Ind AS with IFRS to the extent possible, ensuring that the
financial reporting in India is consistent with global standards. This facilitates cross-
border investments, improves transparency, and enhances the credibility of financial
statements.

VI. Ind AS-1: Presentation of Financial Statements

Ind AS 1 is an Indian Accounting Standard that provides guidelines for the presentation of
financial statements to ensure comparability with previous periods and other entities. The
standard sets out overall requirements for the presentation of financial statements, guidelines
for their structure, and minimum requirements for their content.
Ind AS 1 applies to all general-purpose financial statements and requires entities to present a
balance sheet, statement of profit and loss, statement of changes in equity, statement of cash
flows, and notes to the financial statements. The standard aims to ensure that financial
statements are presented in a clear and understandable manner to enable users to make
informed decisions.
The key takeaways from Ind AS 1 are:
1. The standard provides guidelines for the presentation of financial statements to ensure
comparability with previous periods and other entities.
2. Entities are required to present a balance sheet, statement of profit and loss, statement of
changes in equity, statement of cash flows, and notes to the financial statements.
3. The notes should be presented in a systematic order, including a statement of compliance
with Ind ASs, summary of significant accounting policies, supporting information for items
presented in the balance sheet and statement of profit and loss, and other disclosures.
4. The balance sheet should include line items for property, plant and equipment, investment
property, intangible assets, financial assets, investments accounted for using the equity method,
biological assets, inventories, trade and other receivables, and cash and cash equivalents.

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 5. The statement of profit and loss should present profit or loss and other comprehensive
income in two sections.
6. Entities are required to provide comparative information for the preceding period and a
balance sheet as at the beginning of the preceding period when an entity applies an accounting
policy retrospectively or makes a retrospective restatement of items in its financial statements.
7. The standard aims to ensure that financial statements are presented in a clear and
understandable manner to enable users to make informed decisions.

VII. Ind AS-7: Statement of Cash Flows

Ind AS 7 is the Indian Accounting Standard that provides guidance on the preparation and
presentation of the statement of cash flows. The standard requires entities to prepare a statement
of cash flows that classifies cash flows during the period from operating, investing, and
financing activities. The objective of Ind AS 7 is to provide users of financial statements with
information about an entity's ability to generate cash and cash equivalents and the needs of the
entity to utilize those cash flows.
Some significant takeaways from this standard are:
1. All entities are required to present a statement of cash flows as an integral part of their
financial statements.
2. The statement of cash flows provides information that enables users to evaluate the changes
in net assets of an entity, its financial structure, and its ability to affect the amounts and timing
of cash flows.
3. Cash flow information is useful in assessing the ability of the entity to generate cash and
cash equivalents and enables users to develop models to assess and compare the present value
of the future cash flows of different entities.
4. The standard defines cash, cash equivalents, and cash flows to ensure consistency in
reporting.
5. Historical cash flow information is often used as an indicator of the amount, timing, and
certainty of future cash flows.
6. The statement of cash flows enhances the comparability of the reporting of operating
performance by different entities because it eliminates the effects of using different accounting
treatments for the same transactions and events.

VIII. Earnings Management

You have probably heard this one. In a job interview for a company’s accountant, everyone
was given financial information and asked, “What is the net profit?” All candidates except

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one provided the correct answer but none of them got the job. The one who was selected
wrote, “What do you want the net profit to be?”
Earnings management (or creative accounting) is using judgment and discretion available in
generally accepted accounting principles or making operating decisions in order to produce a
pre-determined effect on the financial statements.
In simple words, Earnings management is the process by which management can potentially
manipulate the financial statements to represent what they wish to have happened during the
period rather than what actually happened.
The spectrum of eranings management is very wide from deferring advertisement spending to
the following quarter (not a crime) to showing phony sales (a crime), and the causes vary from
subconscious hopefulness or doubt without any intention to mislead to outright fraud motivated
by fear or greed. We use the term ‘earnings management’ here to refer to managing items in
any of the financial statements, and not only the statement of profit and loss. Earnings
management is an academic euphemism for financial reporting manipulation.
While there are legitimate reasons for managing earnings, such as tax planning or smoothing
out fluctuations in business performance, there are also motivations that are considered
unethical or misleading. Some of the motivations behind earnings management include:
1. Meeting Expectations:
Companies may be motivated to manage earnings to meet or beat analysts'
earnings expectations. Meeting these expectations can positively influence
stock prices and may prevent negative reactions from investors and
stakeholders.
2. Incentive Compensation:
Executives and employees often receive performance-based bonuses and stock
options tied to the company's financial performance. Earnings management may
be used to artificially boost reported profits, leading to higher bonuses and stock
prices.
3. Avoiding Covenant Violations:
Companies may engage in earnings management to avoid violating debt
covenants or contractual agreements with lenders. Maintaining certain financial
ratios is crucial for compliance, and manipulating earnings can help meet these
requirements.
4. Maintaining Stock Prices:
Companies may manage earnings to maintain or increase their stock prices.
Higher stock prices can be advantageous for various reasons, such as facilitating
equity financing or acquisition activities.
5. Influencing Stakeholder Perceptions:

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 Earnings management can be driven by the desire to present a more favorable
image of the company to investors, analysts, and other stakeholders. This can
impact the company's reputation and borrowing costs.
6. Smoothed Income Trends:
Some companies engage in earnings management to present a more consistent
and predictable pattern of earnings over time. This can create the impression of
stability and reliability, potentially attracting investors.
7. Tax Planning:
Earnings management may be used for tax planning purposes. By manipulating
earnings, companies can reduce taxable income, leading to lower tax liabilities.
8. Market Reactions:
Companies might engage in earnings management to influence market reactions
to specific events, such as initial public offerings (IPOs), mergers, or debt
issuances. Managing earnings can create a more favorable environment for
these activities.
Techniques of earnings management:
1. Income Smoothing:
Spreading out fluctuations in earnings over multiple periods to create a more
stable and consistent earnings trend.
Technique: Understate or overstate income in certain periods to offset
fluctuations, making the company's financial performance appear more stable.
2. Cookie Jar Reserves:
Building and using reserves to artificially boost or decrease earnings in specific
periods.
Technique: Establishing reserves in good years and using them in challenging
years to either increase or decrease reported profits.
3. Big Bath Accounting:
Taking a significant one-time charge in a particular period to intentionally
reduce reported earnings.
Technique: Recognizing all anticipated future losses or write-offs in a single
period, even if they could be spread out over several periods.
4. Revenue Recognition Timing:
Manipulating the timing of recognizing revenues from sales.
Technique: Recognizing revenue prematurely or delaying revenue recognition
to shift profits between periods.
5. Expense Manipulation:

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 Adjusting the timing or amount of expenses recorded in financial statements.
Technique: Delaying the recognition of expenses to future periods or
accelerating the recognition of expenses to the current period.
6. Changing Depreciation Methods:
Altering the method used to depreciate assets to influence reported earnings.
Technique: Choosing a depreciation method that either accelerates or delays
the recognition of depreciation expenses.
7. Off-Balance-Sheet Financing:
Keeping certain liabilities off the balance sheet to present a healthier financial
position.
Technique: Engaging in transactions such as operating leases, special purpose
entities, or other arrangements to keep certain obligations off the company's
balance sheet.
8. Sales of Assets:
Selling assets to generate immediate cash flow and influence reported profits.
Technique: Selling assets that are not essential to operations or selling assets at
inflated prices to boost profits.
9. Pro forma Earnings Reporting:
Providing non-standard, adjusted earnings figures to present a more positive
view of the company's financial performance.
Technique: Excluding certain expenses or losses to present an adjusted
earnings figure that may differ from the generally accepted accounting
principles (GAAP).

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