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Commerce Practical Chapter i

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kannanvikas6633
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CHAPTER I

ACCOUNTING STANDARD PRACTICES


Concept and Application

Introduction
Definition of Accounting Standards
Accounting Standards (AS) are formalized rules and guidelines set by recognized accounting
bodies, such as the Institute of Chartered Accountants of India (ICAI), to standardize
financial reporting. These standards ensure transparency, comparability, and reliability in the
preparation of financial statements.
Objectives of Accounting Standards
1. To bring uniformity in accounting practices across entities.
2. To improve comparability of financial information.
3. To enhance reliability for stakeholders, including investors and creditors.
4. To comply with legal and regulatory requirements.
Advantages of Accounting Standards
 Facilitates the auditing process.
 Reduces ambiguity in accounting methods.
 Helps in global integration of accounting practices.
 Prevents manipulation of financial statements.

DETAILED STUDY OF ACCOUNTING STANDARDS

1. Accounting Standard I (AS-1): Disclosure of Accounting Policies


Concept
AS-1 mandates the disclosure of all significant accounting policies adopted in the preparation
and presentation of financial statements. This disclosure is necessary to ensure consistency,
clarity, and fairness.
Key Features
1. Clarity: Accounting policies must be clearly stated and understandable.
2. Consistency: Policies should remain consistent over time.
3. Disclosure of Changes: Any change in policy must be justified, and its impact
disclosed.
4. Relevance and Materiality: Only significant policies affecting financial statements
need disclosure.
Examples of Accounting Policies
 Depreciation Methods: Straight-Line Method (SLM) or Written-Down Value
(WDV).
 Inventory Valuation: First-In-First-Out (FIFO) or Weighted Average Method.
 Revenue Recognition: Income recognized on an accrual basis.
Practical Application
1. A company using the SLM for depreciation must mention this in its financial
statement notes.
2. If a business switches from FIFO to Weighted Average Method for inventory, the
change and its financial impact must be disclosed.

2. Accounting Standard II (AS-2): Valuation of Inventories


Concept
AS-2 provides guidelines for determining the value of inventories for inclusion in financial
statements. Inventories represent a significant portion of current assets in most businesses,
and their valuation impacts both the balance sheet and the income statement.
Key Principles
 Inventories are valued at the lower of cost or net realizable value (NRV).
 Cost includes purchase price, conversion costs, and other expenses incurred to bring
the inventory to its present condition.
 NRV is the estimated selling price in the ordinary course of business, minus costs to
complete and sell the product.
Exclusions
1. Administrative overheads not directly related to production.
2. Selling and distribution costs.
Examples
1. A retailer has 100 units of stock costing ₹500 each. However, due to market
conditions, the selling price per unit falls to ₹450. The inventory must be valued at
₹450 × 100 = ₹45,000, as it is the lower value.
2. A bakery includes the cost of flour and baking but excludes delivery charges in
inventory valuation.
Practical Application
 Ensures accurate representation of the value of closing stock.
 Avoids overstatement or understatement of profit in the income statement.

3. Accounting Standard III (AS-3): Cash Flow Statements


Concept
AS-3 specifies the preparation of a Cash Flow Statement to provide information about the
cash inflows and outflows of a business. It categorizes cash flows into three main activities:
operating, investing, and financing.
Key Features
1. Operating Activities: Cash flows from primary business operations like sales and
purchases.
2. Investing Activities: Cash spent on acquiring assets or cash received from selling
investments.
3. Financing Activities: Cash flows related to borrowings, repayments, or equity
funding.
Importance
 Provides insight into the liquidity and financial health of a business.
 Helps identify trends in cash generation and usage.
Example of a Cash Flow Statement

Particulars Details Cash Flow (₹)

Operating Activities Cash from sales, wages, etc. ₹1,00,000

Investing Activities Purchase of machinery ₹(40,000)

Financing Activities Loan repayment ₹(20,000)

Net Cash Flow ₹40,000

Practical Application
 Assesses if a business has sufficient cash to cover operational expenses.
 Helps in evaluating cash management efficiency.

COMPARISON TABLE
Aspect AS-1 AS-2 AS-3

Disclosure of accounting Valuation of Preparation of cash flow


Purpose
policies. inventories. statement.

Cost vs NRV for


Focus Principles and methods. Inflows/outflows of cash.
stock.

Closing stock Tracking cash from


Key Example Depreciation methods.
valuation. operations.

Practical Consistency in financial Accurate inventory


Understanding liquidity.
Utility reports. valuation.

Practical Significance for Students


1. Clarity in Financial Reporting: Helps students understand why businesses follow
standardized rules.
2. Foundation for Accounting Careers: Prepares students for professional roles in
accounting and auditing.
3. Decision-Making Skills: Provides insights into analyzing real-world financial
scenarios.
4. Legal Awareness: Emphasizes the necessity of compliance with statutory
requirements.

Conclusion
Accounting Standards I, II, and III provide a strong foundation for financial reporting. While
AS-1 ensures clarity and consistency, AS-2 focuses on accurate stock valuation, and AS-3
emphasizes tracking cash flow. Together, they enable businesses to present transparent and
reliable financial statements, ensuring stakeholders' confidence and compliance with legal
norms.

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