ACCOUNTING

Theoretical framework

 Meaning and Scope of accounting

 Accounting Concepts, Principles and Conventions

 Capital and revenue expenditure, Capital and revenue receipts, Contingent

assets and contingent liabilities

 Accounting Policies

 Accounting as a Measurement Discipline – Valuation Principles, Accounting

Estimates.

 Accounting Standards – Concepts and Objectives.

ACCOUNTING Slide 2
ACCOUNTING Slide 3
 Chapter - 1
Unit - 1
Meaning and scope of accounting

ACCOUNTING Slide 4
ACCOUNTING Slide 5
 1.1 Introduction

ACCOUNTING Slide 6
 Introduction
 Every individual performs some kind of economic activity.

 A sports club formed by a group of individuals, a business run by an individual or a group of

individuals

 A company running a business in telecom sector, a local authority like Calcutta Municipal

Corporation, Delhi Development Authority, Governments, either Central or State, all are carrying

some kind of economic activities.

 Not necessarily all the economic activities are run for any individual benefit; such economic

activities may create social benefit i.e. benefit for the public, at large.

 Such economic activities are performed through ‘transactions and events’.

 Transaction mean ‘a business, performance of an act, an agreement’

 Event mean ‘a happening, as a consequence of transaction(s), a result.’

ACCOUNTING Slide 7
 Example 01 Question

An individual invests ₹2,00,000 for running a stationery business. On 1st January, he

purchases goods for ₹1,15,000 and sells for ₹1,47,000 during the month of January. He

pays shop rent for the month ₹5,000 and finds that still he has goods worth ₹15,000 in

hand. The individual performs an economic activity. He carries on a few transactions and

encounters with some events. Is it not logical that he will want to know the result of his

activity?

ACCOUNTING Slide 8
 Example 01 Reason

Earning of ` 42,000 surplus is an event; also having the inventories in hand is another

event, while purchase and sale of goods, investment of money and payment of rent are

transactions.
ACCOUNTING Slide 9
 Introduction Continued

 Everybody wants to keep records of all transactions and events and to have adequate information

about the economic activity as an aid to decision-making.

 Accounting discipline has been developed to serve this purpose as it deals with the measurement

of economic activities involving inflow and outflow of economic resources, which helps to develop

useful information for decision-making process.

 The growth of accounting discipline is closely associated with the development of the business

world. Thus, to understand accounting as a field of study for universal application, it is best

identified with recording of business transactions and communication of financial information about

business enterprise to facilitate decision-making.

 The aim of accounting is to meet the information needs of the rational and sound decision- makers,

and thus, called the language of business. Slide

ACCOUNTING 10
1.2 Meaning of Accounting
 Meaning

According to the American Institute of Certified Public Accountants formulated the following
definition of accounting in 1961:

“Accounting is the 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 result thereof.”

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ACCOUNTING 12
 Meaning Continued

The American Accounting Association in 1966 which treated accounting as

“The process of identifying, measuring and communicating economic information

to permit informed judgments and decisions by the users of accounts.”

In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public
Accountants (AICPA) enumerated the functions of accounting as follows:

“The function of accounting is to provide quantitative information, primarily of

financial nature, about economic entities, that is needed to be useful in making
economic decisions.”

Thus, accounting may be defined as the process of recording, classifying, summarising,

analysing and interpreting the financial transactions and communicating the results thereof
to the persons interested in such information.
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ACCOUNTING 13
1.3 Procedural aspects of Accounting
 Procedural aspects of Accounting

On the basis of the above definitions, procedure of accounting can be basically divided into
two parts:

(i) Generating financial information

a. Recording
b. Classifying
c. Summarizing
d. Analysing
e. Interpreting
f. Communicating

(ii)Using the financial information.

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ACCOUNTING 15
 Generating financial information Continued

Recording –

 This is the basic function of accounting.

 All business transactions of a financial character, as evidenced by some documents such

as sales bill, pass book, salary slip etc. are recorded in the books of account.

 Recording is done in a book called “Journal.”

 This book may further be divided into several subsidiary books according to the nature

and size of the business.

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ACCOUNTING 16
 Generating financial information Continued

Classification –

 Classification is concerned with the systematic analysis of the recorded data, with a view to

group transactions or entries of one nature at one place so as to put information in compact

and usable form.

 The book containing classified information is called “Ledger”.

 This book contains on different pages, individual account heads under which, all financial

transactions of similar nature are collected. For example, there may be separate account

heads for Salaries, Rent, Printing and Stationeries, Advertisement etc.

 All expenses under these heads, after being recorded in the Journal, will be classified under

separate heads in the Ledger. This will help in finding out the total expenditure incurred under
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ACCOUNTING 17
 Generating financial information Continued

Summarising –

 It is concerned with the preparation and presentation of the classified data in a manner

useful to the internal as well as the external users of financial statements.

 This process leads to the preparation of the financial statements

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ACCOUNTING 18
 Generating financial information Continued

Analysing –

 The term ‘Analysis’ means methodical classification of the data given in the financial

statements. The figures given in the financial statements will not help anyone unless

they are in a simplified form.

 For example, all items relating to fixed assets are put at one place while all items

relating to current assets are put at another place.

 It is concerned with the establishment of relationship between the items of the Profit and

Loss Account and Balance Sheet i.e. it provides the basis for interpretation.

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ACCOUNTING 19
 Generating financial information Continued

Interpreting –

 This is the final function of accounting.

 It is concerned with explaining the meaning and significance of the relationship as

established by the analysis of accounting data.

 The recorded financial data is analysed and interpreted in a manner that will enable the

end- users to make a meaningful judgement about the financial condition and

profitability of the business operations.

 The financial statement should explain not only what had happened but also why it

happened and what is likely to happen under specified conditions

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ACCOUNTING 20
 Generating financial information Continued

Communicating –

 It is concerned with the transmission of summarised, analysed and interpreted

information to the end-users to enable them to make rational decisions.

 This is done through preparation and distribution of accounting reports, which include

besides the usual profit and loss account and the balance sheet, additional information

in the form of accounting ratios, graphs, diagrams, fund flow statements etc.

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ACCOUNTING 21
 Using the Financial Information

 Earlier it was viewed that accounting is meant for the proprietor or owner of the business

 It is now believed that, users of accounts include the investors, employees, lenders,
suppliers, customers, government and other agencies and the public at large.

 For example, if an airlines company borrows money from a bank, buys oil from
oil companies, sells tickets to the customers, has staff to be paid salaries to, all
these group of people and entities are key stakeholders in that airlines business.
 They would like to know and understand whether the business of the company is
going well or there are challenges for the company to run the business.
 Accounting provides the art of presenting information systematically to the users of
accounts.
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ACCOUNTING 22
 Using the Financial Information Continued

 Accounting data is more useful if it stresses economic substance rather than technical

form.

 Information is useless and meaningless unless it is relevant and material to a user’s

decision.

 The information should also be free of any biases.

 The users should understand not only the financial results depicted by the accounting

figures, but also should be able to assess its reliability and compare it with information

about alternative opportunities and the past experience.

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ACCOUNTING 23
 Using the Financial Information Continued

 The owners or the management of the enterprise, commonly known as internal users

 So the information served to them is presented in a manner different to the information

presented to the external users.

 Even the small details which can affect the internal working of the business are given in

the management report while financial statements presented to the external users

contains key information regarding assets, liabilities and capital which are summarised in

a logical manner that helps them in their respective decision-making.

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ACCOUNTING 24
1.4 EVOLUTION OF ACCOUNTING
EVOLUTION OF ACCOUNTING – HISTORY

 Accounting finds its roots as early as around 4000 BC,

where Egyptians used some form of accounting for their treasuries.
The in-charge of treasuries had to send day wise reports to their
superiors known as Wazirs and monthly reports were sent to kings.
 Babylonia, known as the city of commerce, used accounting for business to identify the losses
that took place due to frauds and lack of efficiency.
 Greece used accounting to divide the revenues received among treasuries, maintaining
receipts, payments and balance of government financial transactions.
 Romans used memorandum or daybook where in receipts and payments were recorded. (700
B.C to 400 A.D).
 China used sophisticated form of government accounting as early as 2000 B.C.

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ACCOUNTING 26
EVOLUTION OF ACCOUNTING – HISTORY Continued

 Accounting practices in India could be traced back to a period where, Kautilya, a minister
in Chandragupta’s kingdom wrote a book named Arthashasthra, which also described
how accounting records had to be maintained
 Luca Pacioli’s , a Franciscan friar (merchant class), book Summa de Arithmetica,
Geometria, Proportion at Proportionality (Review of Arithmetic and Geometric
proportions) in Venice (1494) is considered as the first book on double entry
bookkeeping.
 A portion of this book contains knowledge of business and book- keeping. He used the
terms Debit (Dr.) and Credit (Cr.) in his books. These were the concepts used in Italian
terminology.
 Debit comes from the Italian debito which comes from the Latin debita and debeo which
means owed to the proprietor.
 Credit comes from the Italian credito which comes from the Latin ‘credo’ which means
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ACCOUNTING 27
EVOLUTION OF ACCOUNTING – HISTORY Continued

 In explaining double entry system, Pacioli wrote that ‘All entries… have to be double
entries, that is if you make one creditor, you must make some debtor’. He also
mentioned that a merchant’s responsibility is to give glory to God in their enterprises, to
be ethical in all business activities and to earn a profit. He discussed the details of
memorandum, journal, ledger and specialised accounting procedures.

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ACCOUNTING 28
EVOLUTION OF ACCOUNTING - DEVELOPMENT

 In its oldest form, accounting aided the stewards to discharge their stewardship
function. The wealthy men employed stewards to manage their property; the stewards in
turn rendered an account periodically of their stewardship. This ‘Stewardship Accounting’
was the root of financial accounting system. Although double-entry system was followed,
‘stewardship accounting’ served the purpose of businessmen and wealthy persons at
that time. In most of the countries, stewardship accounting was prevalent till the
emergence of large-scale enterprises in the form of public limited companies.
 In the second phase, the idea of financial accounting emerged with the concept of
joint stock company and divorce of ownership from the management. To safeguard the
interest of the shareholders and investors, disclosure of financial statements (mainly,
profit and loss account and balance sheet) and other accounting information was
moulded by law.
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ACCOUNTING 29
EVOLUTION OF ACCOUNTING - DEVELOPMENT Continued

 Financial statements give periodic performance report by way of profit and loss account
and financial position at the end of the period by way of Balance Sheet. It got the legal
status due to changing relationships between the owners, economic entity and the
managers.
 With the democratisation of society, the relationships between the enterprise on the one
hand, the investors, employees, managers and governments on the other, have also
undergone a sea-change.
 Thus, financial accounting emerged as an information system to identify, measure and
communicate useful information for informed judgements and decisions by a broad
group of users.
 In the third phase, accounting information was generated to aid management
decision- making in particular. It contributed a lot to improve the quality of management
decisions. This new dimension of accounting is called Management Accounting andSlide
ACCOUNTING it is
30
EVOLUTION OF ACCOUNTING - DEVELOPMENT Continued

 Lastly, Social Responsibility Accounting is in the formative process, which aims at

accounting for the social cost incurred by business as well as the social benefit, created
by it. It emerges from the growing social awareness about the undesirable by- products
of economic activities.
 While earning profit, an enterprise incurs numerous social costs like pollution, using the
resources of society like materials, land, labour etc.
 To compensate for this social cost, in today’s world, an enterprise is expected to
generate some social benefits also like employment opportunities, recreation activities,
more choice to customers at reasonable price, better quality products etc.
 Therefore, it is demanded that the accounting system should produce a report
measuring the social cost incurred and social benefits generated.

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ACCOUNTING 31
EVOLUTION OF ACCOUNTING - DEVELOPMENT Continued

 Social Science study man as a member of society; they concern about social processes
and the results and consequences of social relationships.
 The usefulness of accounting to society as a whole is the fundamental criterion to treat it
as a social science.
 Although individuals may benefit from the availability of accounting information, the
accounting system generates information for social good. So, accounting is treated as a
social science.

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ACCOUNTING 32
1.5 OBJECTIVES OF ACCOUNTING
 OBJECTIVES OF ACCOUNTING

 Systematic recording of transactions – Basic objective of accounting is to

systematically record the financial aspects of business transactions, i.e., book-keeping.

These recorded transactions are later on classified and summarized logically for the

preparation of financial statements and for their analysis and interpretation.

 Ascertainment of results of above recorded transactions – Accountant prepares

profit and loss account to know the results of business operations for a particular period of

time. If revenue (Sales) exceeds expenses then it is said that business is running profitably

but if expenses exceed revenue, then it can be said that business is running under loss.

The profit and loss account helps the management and different stakeholders in taking

rational decisions. Slide

ACCOUNTING 34
 OBJECTIVES OF ACCOUNTING
Continued

 Ascertainment of the financial position of the business – A businessman is not only

interested in knowing the results of the business in terms of profits or loss for a particular

period but is also anxious to know that what he owes (liability) to the outsiders and what

he owns (assets) on a certain date. To know this, accountant prepares a financial position

statement popularly known as Balance Sheet. The balance sheet is a statement of assets

and liabilities of the business at a particular point of time and helps in ascertaining the

financial health of the business.

 Providing information to the users for rational decision-making – Accounting as a

‘language of business’ communicates the financial results of an enterprise to various

stakeholders by means of financial statements. Accounting aims to meet the information

Slide
ACCOUNTING 35
 OBJECTIVES OF ACCOUNTING
Continued

 To know the solvency position – By preparing the balance sheet, management not

only reveals what is owned and owed by the enterprise, but also it gives the

information regarding concern’s ability to meet its liabilities in the short run (liquidity

position) and also in the long-run (solvency position) as and when they fall due.

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ACCOUNTING 36
 OBJECTIVES OF ACCOUNTING Continued

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ACCOUNTING 37
1.6 FUNCTIONS OF ACCOUNTING
 FUNCTIONS OF ACCOUNTING

The main functions of accounting are as follows:

 Measurement: Accounting measures past performance of the business entity and

depicts its current financial position.

 Forecasting: Accounting helps in forecasting future performance and financial position

of the enterprise using past data and analysing trends.

 Decision-making: Accounting provides relevant information to the users of accounts to

aid rational decision-making.

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ACCOUNTING 39
 FUNCTIONS OF ACCOUNTING Continued

 Comparison & Evaluation: Accounting assesses performance achieved in relation to

targets and discloses information regarding accounting policies and contingent liabilities

which play an important role in predicting, comparing and evaluating the financial

results.

 Control: Accounting also identifies weaknesses of the operational system and provides

feedbacks regarding effectiveness of measures adopted to check such weaknesses.

 Government Regulation and Taxation: Accounting provides necessary information

to the government to exercise control on the entity as well as in collection of tax

revenues.
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ACCOUNTING 40
1.7 BOOK - KEEPING
 BOOK-KEEPING

 Book-keeping is an activity concerned with the recording of financial data relating to

business operations in a significant and orderly manner.

 Book-keeping procedures are governed by the end product, i.e, the financial statements.

 The term ‘financial statements’ means Profit and Loss Account Balance Sheet and cash

flow statements including Schedules and Notes forming part of Accounts.

 A book-keeper may be responsible for keeping all the records of a business or only of a

minor segment, such as position of the customers’ accounts in a departmental store.

 Accounting is based on a careful and efficient book-keeping system.

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ACCOUNTING 42
 BOOK-KEEPING
Continued

 The essential idea behind maintaining book-keeping records is to show correct position

regarding each head of income and expenditure. A business may purchase goods on

credit as well as in cash.

 Therefore, in book-keeping, the proper maintenance of books of account is indispensable

for any business.

 Maintenance of books of accounts and the preparation of financial statements of a

company are guided by the Companies Act, banks and insurance companies by special

Acts governing these institutions and so on.

 However, for sole-proprietorship and partnership business, there is no specific legislation

Slide
ACCOUNTING
regarding maintenance of books of accounts and preparation of financial statements.43
 BOOK-KEEPING
Continued

Objectives of Book-keeping

1. Complete Recording of Transactions – It is concerned with complete and permanent

record of all transactions in a systematic and logical manner to show its financial effect

on the business.

2. Ascertainment of financial Effect on the Business – It is concerned with the

combined effect of all the transactions made during the accounting period upon the

financial position of the business as a whole.

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ACCOUNTING 44
1.8 DISTINCTION BETWEEN BOOK-
KEEPING AND ACCOUNTING
 DISTINCTION BETWEEN BOOK-KEEPING AND
ACCOUNTING

Slide
ACCOUNTING 46
1.9 SUB - FIELDS OF ACCOUNTING
 SUB-FIELDS OF ACCOUNTING

Financial Accounting –

I. It covers the preparation and interpretation of financial statements and

communication to the users of accounts.

II. It is historical in nature as it records transactions which had already been occurred.

III. The final step of financial accounting is the preparation of Profit and Loss Account

and the Balance Sheet.

IV. It primarily helps in determination of the net result for an accounting period and the

financial position as on the given date.

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ACCOUNTING 48
 SUB-FIELDS OF ACCOUNTING
Continued

Management Accounting –

I. It is concerned with internal reporting to the managers

of a business unit.

II. To discharge the functions of stewardship*, planning, control and decision- making, the

management needs variety of information. The different ways of grouping information

and preparing reports as desired by managers for discharging their functions are

referred to as management accounting.

III. A very important component of the management accounting is cost accounting which

Stewardship*
deals with cost ascertainment and : Job of supervising or taking care of something such as an
cost control.
organization
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ACCOUNTING 49
 SUB-FIELDS OF ACCOUNTING
Continued

Cost Accounting –

The terminology of Cost Accounting published by the Institute of Cost

and Management Accountants of England defines cost accounting as:

“the process of accounting for cost which begins with the recording of income and

expenditure or the bases on which they are calculated and ends with the preparation of

periodical statements and reports for ascertaining and controlling costs.”

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ACCOUNTING 50
 SUB-FIELDS OF ACCOUNTING
Continued

Social Responsibility Accounting –

i. The demand for social responsibility

accounting stems from increasing social

awareness about the undesirable by-

products of economic activities.

ii. Social responsibility accounting is

concerned with accounting for social

costs incurred by the enterprise and

social benefits created.

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ACCOUNTING 51
 SUB-FIELDS OF ACCOUNTING
Continued

Human Resource

Accounting:

Human resource accounting

is an attempt to identify,

quantify and report

investments made in

human resources of an

organisation that are not

presently accounted for

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ACCOUNTING
under conventional 52
1.10 USERS OF ACCOUNTING
INFORMATION
 USERS OF ACCOUNTING INFORMATION

1. Investors:
a) They provide risk capital to the business. They need information to assess whether
to buy, hold or sell their investment. Also they are interested to know the ability of
the business to survive, prosper and to pay dividend.
b) In non-corporate sector, where ownership and management are not essentially
separated, the owners still need information about performance of the business and
its financial position to decide whether to continue or shut down.
2. Employees:
Growth of the employees is directly related to the growth of the organisation and
therefore, they are interested to know the stability, continuity and growth of the
enterprise and its ability to provide remuneration, retirement and other benefits and to
enhance employment opportunities.
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ACCOUNTING 54
 USERS OF ACCOUNTING INFORMATION Continued

3. Lenders:
They are interested to know whether their loan-principal and interest will be paid back
when due.

4. Suppliers and Creditors:

They are also interested to know the ability of the enterprise to pay their dues, that
helps them to decide the credit policy for the relevant concern, rates to be charged and
so on. Sometimes, they also become interested in long-term continuation of the
enterprise if their existence becomes dependent on the survival of that business.

5. Customers:
Customers are also concerned with the stability and profitability of the enterprise
because their functioning is more or less dependent on the supply of goods,

“suppose, a company produces some chemicals used by pharmaceutical companies and

supplies chemicals on three month’s credit. If all of a sudden it faces some trouble and is unable to
supply the chemical, the customers will also be in trouble”. Slide
ACCOUNTING 55
 USERS OF ACCOUNTING INFORMATION Continued

6. Government and their agencies:

They regulate the functioning of business enterprises for public good, allocate scarce
resources among competing enterprises, control prices, charge excise duties and taxes,
and so they have continued interest in the business enterprise.

7. Public:
The public at large is interested in the functioning of the enterprise because it may
make a substantial contribution to the local economy in many ways including the
number of people employed and their patronage to local suppliers.

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ACCOUNTING 56
 USERS OF ACCOUNTING INFORMATION Continued

8. Management:
Management as whole is also interested in the accounts for various managerial
decisions. On the basis of the accounts, management determines the effects of their
various decisions on the functioning of the organisation. This helps them to make
further managerial decisions.

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ACCOUNTING 57
1.11 RELATIONSHIP OF ACCOUNTING
WITH OTHER DISCIPLINES
 1. ACCOUNTING AND ECONOMICS

1. Economics, broadly speaking, is a field of study concerned with the distribution of

resources among people. Outside academia, economists are involved in analyzing and
understanding the way that goods and services are produced and distributed.
2. Economists have a critical role in developing economic policies for governments and
projecting the impact of policy and regulatory changes. They are increasingly in demand
in financial services and industry, where they interpret and forecast market trends.
Economics is broadly divided into two areas of study:
Macroeconomics is concerned with the distribution of resources within an ecosystem,
such as a nation. It includes the tracking and study of the many factors that affect how
efficiently the economy works, such as the inflation rate and the productivity rate.
Microeconomics is the study of the behavior of the individual within an economic
ecosystem, or of any other single entity such as a business. It is concerned with the
impact of individual decisions on the distribution of resources.
ACCOUNTING Slide
59
 1. ACCOUNTING AND ECONOMICS Continued

3. Economics is viewed as a science of rational decision-making about the use of scarce

resources. It is concerned with the analysis of efficient use of scarce resources for
satisfying human wants. This may be viewed either from the perspective of a single firm
or of the country as a whole.
4. Accounting overlaps economics in many respects. It contributed a lot in improving the
management decision-making process. But, economic theories influenced the
development of the decision-making tools used in accounting.
5. However, there exists a wide gulf between economists’ and accountants’ concepts of
income and capital. Accountants got the ideas of value, income and capital maintenance
from economists, but brushed suitably to make them usable in practical circumstances.
Accountants developed the valuation, measurement and decision-making techniques
which may owe to the economic theorems for origin but these are moulded in the work
environment and suitably tempered with reference to relevance, verifiability, freedom
ACCOUNTING Slide
60
 2. ACCOUNTING AND STATISTICS

1. In accounts, all values are important individually because they relate to business
transactions. As against this, statistics is concerned with the typical value,
behaviour or trend over a period of time or the degree of variation over a series of
observations. Therefore, wherever a need arises for only broad generalisations or
the average of relationships, statistical methods have to be applied in accounting
data.
2. Accounting records generally take a short-term view of events and are confined to
a year while statistical analysis is more useful if a longer view is taken for the
purpose. For example, to fit the trend line a longer period will be required.
However, statistical methods do use past accounting records maintained on a
consistent basis.

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ACCOUNTING 61
 2. ACCOUNTING AND STATISTICS Continued

3. The functional relations showing mathematical relations of one variable with one or
more other variables are based on statistical work. These relations are used widely in
making cost or price estimates for some estimated future values assigned to the given
independent variables. For example, given the functional relation of total cost to the
price of an input, the effect of changes in future prices on the cost of production can be
calculated.
4. In accountancy, a number of financial and other ratios are based on statistical methods,
which help in averaging them over a period of time. Several accounting and financial
calculations are based on statistical formulae.
5. Statistical methods are helpful in developing accounting data and in their interpretation.
For example, time series and cross-sectional comparison of accounting data is based on
statistical techniques.
6. Therefore, the study and application of statistical methods would add extra edge to the
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ACCOUNTING
accounting data. 62
 3. ACCOUNTING AND MATHEMATICS

1. Knowledge of arithmetic and algebra is a pre-requisite for accounting computations and

measurements such as calculations of interest, annuity etc,.
2. While computing depreciation, finding out instalments in hire-purchase and instalments
payment transactions, calculating amount to be set aside for repayment of loan and
replacement of assets and calculating lease rentals, mathematical techniques are
frequently used.
3. With the advent of the computer, mathematics is becoming a vital part of accounting.
Instead of writing accounts in traditional fashion, the transactions and events can be
recorded in the matrix form and the rules of matrix algebra can be applied for
classifying and summarising data.

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ACCOUNTING 63
 3. ACCOUNTING AND MATHEMATICS Continued

4. Statistics and econometric models are largely used for developing decision models for
the users of accounts. Also, Operations Research Techniques provide lot of decision
models. Since accounting is meant for providing information to the users, to be
effective, accounting data should feed the information requirements of such statistical,
econometric and operations research models.
5. Understanding mathematics has become a must to grasp the decision models framed
by statisticians, econometricians and the O.R. experts.
6. Presently graphs and charts are being extensively used for communicating accounting
information. In addition to statistical knowledge, knowledge in geometry and
trigonometry seems to be essential to have a better understanding about the
accounting communications system.

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ACCOUNTING 64
 4. ACCOUNTING AND LAW

1. An economic entity operates within a legal environment. All transactions with suppliers
and customers are governed by the Contract Act, the Sale of Goods Act, the Negotiable
Instruments Act, etc. The entity itself is created and controlled by laws. For example, a
company is created by the Companies Act and also controlled by Companies Act.
2. Similarly, every country has a set of economic, fiscal and labour laws. Transactions and
events are always guided by laws of the land. Accounting system to be followed has
been prescribed by the law. For example, the Companies Act has prescribed the format
of financial statements for companies.
3. Banking, insurance and electric supply undertakings may also have to produce financial
statements as prescribed by the respective legislations controlling such entities.
4. However, legal prescription about the accounting system is the product of developments
in accounting knowledge. That is to say, legislation about accounting system cannot be
enacted unless there is a corresponding development in the accounting discipline. In
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ACCOUNTING
that way accounting influences law and is also influenced by law. 65
 5. ACCOUNTING AND MANAGEMENT

1. Management is a broad occupational field, which comprises many functions and

encompasses application of many disciplines including those mentioned above.
2. Accountants are well placed in the management and play a key role in the management
team. A large portion of accounting information is prepared for management decision-
making.
3. Although management relies on other data sources, accounting data are used as basic
source documents.
4. In the management team, an accountant is in a better position to understand and use
such data that is since an accountant plays an active role in management, he
understands the data requirements.
5. So the accounting system can be moulded to serve the management purpose.

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ACCOUNTING 66
1.12 LIMITATIONS OF ACCOUNTING
 LIMITATIONS OF ACCOUNTING

The assumptions and conventions, on which the accounting is based, become the
limitations of accounting. The financial statements are never free from subjectivity factor
as these are largely the outcome of personal judgement of the accountant with regard to
the adoption of the accounting policies.

Following are certain instances:

1. The factors which may be relevant in assessing the worth of the enterprise don’t find
place in the accounts as they cannot be measured in terms of money. The Balance sheet
cannot reflect the value of certain factors like loyalty and skill of the personnel which
may be the most valuable asset of an enterprise these days.

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ACCOUNTING 68
 LIMITATIONS OF ACCOUNTING
Continued

2. Balance Sheet shows the position of the business on the day of its preparation and not

on the future date while the users of the accounts are interested in knowing the position

of the business in the near future and also in long run and not for the past date.

3. Accounting ignores changes in some money factors like inflation etc.

4. There are occasions when accounting principles conflict with each other.

5. Certain accounting estimates depend on the sheer personal judgement of the

accountant, e.g., provision for doubtful debts, method of depreciation adopted,

recording certain expenditure as revenue expenditure or capital expenditure, selection

of method of valuation of inventories and the list is quite long.

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ACCOUNTING 69
 LIMITATIONS OF ACCOUNTING
Continued

6. Financial statements consider those assets which can be expressed in monetary terms.

Human resources although the very important asset of the enterprise are not shown in

the balance sheet. There is no generally accepted formula for the valuation of human

resources in money terms.

7. Different accounting policies for the treatment of same item adds to the probability of

manipulations. Though through various laws and Accounting Standards, efforts are

made to reduce these options to minimum but certainly could not be reduced to one.

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ACCOUNTING 70
1.13 ROLE OF ACCOUNTANT IN THE
SOCIETY
 There are only a few types of profession in the world which are held in high esteem in

public eyes and there is no denying the fact that the accounting profession is one of

them.

 Goethe had called the accountant’s profession as ‘the fairest invention of the human

mind’.

 At the core of all types of learned profession, there is the desire of public good and of

finding the best way to serve society.

 By the use of the science of accountancy and under the spell of its art, a dynamic

pattern which assists business in planning its future is woven by accountants. This is

what makes their profession an instrument of socio-economic change and welfare of theSlide
ACCOUNTING 72
 An accountant with his education, training, analytical mind and experience is best

qualified to provide multiple need- based services to the ever growing society.

 The accountants of today can do full justice not only to matters relating to taxation,

costing, management accounting, financial layout, company legislation and procedures

but they can develop deep into the fields relating to financial policies, budgetary policies

and even economic principles. The area of activities which can be undertaken by the

accountants is not limited.

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ACCOUNTING 73
 AREAS OF SERVICE

Maintenance of Books of Accounts:

An accountant is able to maintain a systematic record of financial transactions in order to

establish the net result of the transactions entered into during a period and to state the

financial position of the concern as at a particular date.

For the fulfilment of the twin objective of ascertaining the profit earned or loss

suffered and the financial position, it is necessary that all transactions be recorded in a

systematic manner, which can be done only by an accountant. Proper maintenance of

books of accounts assists management in planning, decision-making, controlling functions.

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ACCOUNTING 74
 AREAS OF SERVICE Continued

Statutory Audit:

Every limited company is required to appoint a chartered accountant or a firm of chartered

accountants as their auditor who are statutorily required to report each year whether in

their opinion the balance sheet shows a true and fair view of the state of affairs on the

balance sheet date, and the profit and loss account shows a true and fair view of the profit

or loss for the year.

Auditing is not confined to the accounts of companies; other organisations may also have

their accounts audited, either because the law so requires (for example, the Co-operative

Societies Act, the Income-tax Act, etc.) or because the proprietors wisely decided so (for
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ACCOUNTING
example, a partnership firm or an individual trader). 75
 AREAS OF SERVICE Continued

Internal Audit:

It is a management tool whereby an internal auditor thoroughly examines the accounting

transactions and also the system, according to which these have been recorded with a view

to ensure the management that the accounts are being properly maintained and the

system contains adequate safeguards to check any leakage of revenue or misappropriation

of property or assets and the operations have been carried out in conformity with the plans

of management.

Now-a-days internal auditing has developed as a service to management. The internal

auditor constructively contributes in improving the operational efficiency of the business

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through an independent review and appraisal of all business operations.
ACCOUNTING 76
 AREAS OF SERVICE Continued

Taxation:

An accountant can handle taxation matters of a business or a person and he can represent

that business or person before the tax authorities and settle the tax liability under the

statute prevailing.

He can also assist in avoiding or reducing tax burden by proper planning of tax affairs.

Accountants also have a social obligation to express their views on broad tax policy, on the

effect of tax rate on business and the economy in general and on all other aspects of

taxation in which they have knowledge superior to that of the general public.

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ACCOUNTING 77
 AREAS OF SERVICE Continued

Management Accounting and Consultancy Services:

Management accountant performs an advisory function.

He is largely responsible for internal reporting to the management for planning and

controlling current operations, decision-making on special matters and for formulating long-

range plans.

His job is to collect, analyse, interpret and present all accounting information which is

useful to the management.

Accountant provides management consultancy services in the areas of management

information system, expenditure control and evaluation of appraisal techniques for new

investments and disinvestments, working capital management, corporate planning etc.Slide

ACCOUNTING 78
 AREAS OF SERVICE Continued

Financial Advice: Some of the areas in which an accountant can render financial advice are:

• Investments: An accountant can explain the significance of the formidable documents which

shareholders receive from companies and help in making decisions relating to their

investments.

• Insurance: An accountant can provide information to his clients on various insurance policies

and helps in choosing appropriate policy.

• Business Expansion: As businesses grow in size and complexity and mergers are being

considered, accountants are in the forefront in interpreting accounts, making suggestions as to

the form of schemes and the fairness of proposals considering cost and financial consequences

and generally advising their clients. They also advise on how to set about the problem of
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ACCOUNTING 79
 AREAS OF SERVICE Continued

• Investigations: Financial investigations are required for a variety of purposes. Examples

are:

 To ascertain the financial position of a business, for the information of interested parties

in connection with an issue of capital, the purchase or sale of the business or a

reconstruction or amalgamation.

 To help the management to decide whether it is cheaper to manufacture an article or to

buy out.

 To ascertain why profits have fallen.

 To achieve greater efficiency in management.

 To ascertain whether fraud has occurred and if so, its nature and extent and to make
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ACCOUNTING 80
 AREAS OF SERVICE Continued

• Pension schemes:

Specialist advice from actuaries, insurance agents or insurance company is needed before

launching or amending a provident fund or pension scheme in a business. But before making

a final decision, an accountant has to be consulted. Later on, his help may be needed for

managing the scheme or obtaining tax relief.

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ACCOUNTING 81
 AREAS OF SERVICE Continued

Other Services

 Secretarial Work: Companies, clubs, and associations indeed, virtually all organisations

involve secretarial work. Accountants frequently do this work.

 Share Registration Work: Accountants are often used by many companies to

undertake the work involved in registering share transfers and new issues.

 Company Formation: In conjunction with legal advisers, accountants help in the

formation of a company or advise against doing so.

 Arbitrations: At times, accountants are invited by parties to act as arbitrators in a

dispute or settle disputes of various kinds.

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ACCOUNTING 82
 AREAS OF SERVICE Continued

 Receiverships, Liquidations, etc.: An accountant has to sometimes take on the duties of

liquidator when a company is being wound up or receiver when a debenture holder exercises a

right to recover a loan on which the borrower has defaulted. Accountant is just the man for the

job. He is also just the man to help you to keep insolvency away if you consult him in time.

 As regards the Cost Accounts: A cost accountant’s job is to continuously report cost data

and related information at frequent intervals to the management.

 Accountant and Information Services: An accountant will be effective in his role if he supplies

the information promptly and in an unambiguous language. He should develop a system by

which there is a regular flow of information both horizontally and vertically.

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ACCOUNTING 83
 CHARTERED ACCOUNTANT IN INDUSTRY

 An accountant, though he is a part of the highest planning team is not a planner in an

industry.

 He works with the functional departments and translates the organisation’s aims in

terms of financial expectations.

 Therefore, he has to make a thorough study of the business and of individuals in the

functional departments, whether they are engineers or salesmen.

 A qualified accountant will be able to play an important role in performing important

functions of a business relating to accounting, costing and budgetary control, estimating

and treasury.
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ACCOUNTING 84
 CHARTERED ACCOUNTANT IN PUBLIC SECTOR ENTERPRISES

 Both in the developed and developing countries, public sector enterprises have become a
special feature of the national economy.
 The system of financial and budgetary control and of accounting, auditing and reporting has,
therefore, become a matter of interest and concern to the nation, and does not remain
confined merely to a limited number of shareholders.
 The form of accounting followed by these corporations or companies is different from that of
ordinary government accounting.
 It is the duty of the accountants to prepare the accounts and reports of these public
corporations in such a way that they enable the general public to know how far the items
appearing in the various types of records and financial statements justify their existence.

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ACCOUNTING 85
 CHARTERED ACCOUNTANT IN FRAMING FISCAL POLICIES

 Accountants have a positive role to play in the determination of proper fiscal policies and

advancement of trade, commerce and industry.

 They should develop new techniques and prepare themselves for new fields of service

towards their commitment to the concept of the public goods and services.

 A business enterprise can be successful in the commercial sense only if accounting and

business knowledge are pooled together.

 It is a social obligation for both accountants in industry and in practice to disclose greater

information regarding the corporate results. The state of affairs of the economy can be

ascertained only when such consolidated corporate information is disclosed.

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ACCOUNTING 86
 CHARTERED ACCOUNTANT AND ECONOMIC GROWTH

 In the present times accountants should conceive their duties as broadly as the

conditions might require and do not restrict them to only literal compliance of the

law.

 Their aim should be not to allow any individual to gain at the cost of the nation.

 Accountants have to accept a positive role and do their best to encourage efficiency

in individual business units and encourage those social objectives which form the

main foundation of a welfare state.

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ACCOUNTING 87
TEST YOUR KNOWLEDGE
 TEST YOUR KNOWLEDGE

True and False

1) There is no difference between book keeping and accounting, both are same.

2) Management Accounting covers the preparation and interpretation of financial

statements and communication to the users of accounts.

3) Financial accounting is concerned with internal reporting to the managers of a business

unit.

4) Customers of business should not be considered as users of accounts prepared by

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ACCOUNTING
business. They are not interested to know performance of the business 89
 TEST YOUR KNOWLEDGE Continued

5) Summarising is the basic function of accounting. All business transactions of a financial

characters evidenced by some documents such as sales bill, pass book, salary slip etc.

are recorded in the books of account.

6) Balance sheet shows the position of the business on the day of its preparation and not

on the future date.

7) Objectives of book-keeping are complete recording of transactions & ascertainment of

financial effect on the business.

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ACCOUNTING 90
 TEST YOUR KNOWLEDGE Continued

Multiple Choice Questions

1. Which of the following is not a subfield of accounting?

(a) Management accounting.

(b) Cost accounting.

(c) Book-keeping

2. Purposes of an accounting system include all the following except

(a) Interpret and record the effects of business transaction.

(b) Classify the effects of transactions to facilitate the preparation of reports.

(c) Dictate the specific types of business enterprise transactions that the enterprises

may engage in.

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ACCOUNTING 91
 TEST YOUR KNOWLEDGE Continued

3. Book-keeping is mainly concerned with

(a) Recording of financial data.

(b) Designing the systems in recording, classifying and summarizing the recorded data.

(c) Interpreting the data for internal and external users.

4. All of the following are functions of Accounting except

(a) Decision making.

(b) Ledger posting.

(c) Forecasting.

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ACCOUNTING 92
 TEST YOUR KNOWLEDGE Continued

5. Financial statements are part of

(a) Accounting.

(b) Book-keeping.

(c) Management Accounting.

6. Financial position of the business is ascertained on the basis of

(a) Records prepared under book-keeping process.

(b) Trial balance.

(c) Balance Sheet.

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ACCOUNTING 93
 TEST YOUR KNOWLEDGE Continued

7. Users of accounting information include

(a) Creditors/Suppliers

(b) Lenders/ Customers

(c) Both (a) and (b)

8. Financial statements do not consider

(a) Assets expressed in monetary terms.

(b) Liabilities expressed in monetary terms.

(c) Assets and liabilities expressed in non-monetary terms

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ACCOUNTING 94
 TEST YOUR KNOWLEDGE Continued

9. On January 1, Sohan paid rent of ₹5,000. This can be classified as

(a) An event.

(b) A transaction.

(c) A transaction as well as an event.

10. On March 31, 2022 after sale of goods worth ₹2,000, he is left with the closing

inventory of ₹10,000. This is

(a) An event.

(b) A transaction.

(c) A transaction as well as an event.

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ACCOUNTING 95
 TEST YOUR KNOWLEDGE Continued

11. Which of the following is not a business transaction?

(a) Bought a machine of ₹10,000 for business

(b) Paid towards salaries of employees ₹5,000

(c) Paid son’s fees from her personal bank account ₹8,000

12. Which qualitative characteristics of accounting information is reflected when

accounting information is clearly presented?

(a) Understandability

(b) Relevance

(c) Comparability

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ACCOUNTING 96
Thank You
Happy Learning