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UNIT I FINANCIAL ACCOUNTING
Introduction to Financial, Cost and Management Accounting- Generally accepted accounting
principles, Conventions and Concepts-Balance sheet and related concepts- Profit and Loss
account and related concepts - Introduction to inflation accounting- Introduction to human
resources accounting.
S.NO
TITLE
PAGE. NO.
1.
Definition of Financial Accounting
2
1.1
Objectives of Accounting
3
1.2
Branches of Accounting
4
1.3
Basic Accounting Cycles
4-5
1.4
Accounting Concepts
5
1.5
Accounting Rules- Traditional Approach
16
1.6
Journal & Steps in Journalizing
18
1.7
Ledger & Steps in Ledger
20
1.8
Features and Objectives of Trial Balance
23
1.9
Indian and International Accounting Standards
24
2
Inflation Accounting
31
2.1
Definition and Features of Inflation Accounting
32
2.2
Methods of Inflation Accounting
32
3
Human Resource Accounting
33
3.1
Definition and Need For Human Resource Accounting
34
3.2
Objectives of HRA
35
3.3
Advantages of HRA
36
3.4
Limitations of HRA
36
3.5
HRA Accounting Methods
36
Financial accounting
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KV INSTITUTE OF MANAGEMENT AND INFORMATION STUDIES
BA7106- ACCOUNTING FOR MANAGEMENT.
Definition
A field of accounting that treats money as a means of measuring economic performance
instead of as a factor of production. It encompasses the entire system of monitoring and control
of money as it flows in and out of an organization as assets and liabilities, and revenues and
expenses.
Financial accounting gathers and summarizes financial data to prepare financial reports
such as balance sheet and income statement for the organization's management, investors,
lenders, suppliers, tax authorities, and other stakeholders.
Definition of 'Financial Accounting'
The process of recording, summarizing and reporting the myriad of transactions from a
business, so as to provide an accurate picture of its financial position and performance. The
primary objective of financial accounting is the preparation of financial statements - including
the balance sheet, income statement and cash flow statement - that encapsulates the company's
operating performance over a particular period, and financial position at a specific point in time.
These statements - which are generally prepared quarterly and annually, and in accordance with
Generally Accepted Accounting Principles (GAAP) - are aimed at external parties including
investors, creditors, regulators and tax authorities.
Definition
Accountancy or accounting is defined as the systematic recording, verifying, and
reporting of financial transactions, including the origination of the transaction, its recognition,
processing, and summarization in the Financial Statements.
It has been defined by the AICPA as “The art of recording, classifying, and summarizing
in a significant manner and in terms of money, transactions and events which are, in part at
least, of financial character, and interpreting the results thereof."
Such financial information is primarily used by lenders, managers, investors, tax
authorities and other decision makers to make resource allocation decisions between and within
companies, organizations, and public agencies.
A field of accounting that treats money as a means of measuring economic performance
instead of as a factor of production. It encompasses the entire system of monitoring and control
of money as it flows in and out of an organization as assets and liabilities, and revenues and
expenses.
Financial accounting gathers and summarizes financial data to prepare financial reports
such as balance sheet and income statement for the organization's management, investors,
lenders, suppliers, tax authorities, and other stakeholders.
Objectives of Accounting
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1. To keep systematic records:
Accounting is done to keep a systematic record of financial transactions. In the absence
of accounting there would have been terrific burden on human memory which in most cases
would have been impossible to bear.
2. To protect business properties:
Accounting provides protection to business properties from unjustified and unwarranted
us. This is possible on account of accounting supplying the information to the manager or the
proprietor.
3. To ascertain the operational profit or loss:
Accounting helps is ascertaining the net profit earned or loss suffered on account of
carrying the business. This is done by keeping a proper record of revenues and expenses of a
particular period. The profit and loss account is prepared at the end of a period and if the
amount of revenue for the period is more than the expenditure incurred in earning that
revenue, there is said to be a profit. In case the expenditure exceeds the revenue, there is said
to be a loss.
4. To ascertain the financial position of business:
The profit and loss account gives the amount of profit or loss made by the business
during a particular period. However, it is not enough. The businessman must know about his
financial position i.e., where he stands; what he owes and what he owns? This objective is
served by the balance sheet or position statement.
5. To facilitate rational decision making:
Accounting these days has taken upon itself the task of collection, analysis and reporting
of information at the required points of time to the required levels of authority in order to
facilitate rational decision making.
Definition of 'Branch Accounting'
An accounting system in which separate accounts are maintained for each branch of a
corporate entity or organization. The primary objectives of branch accounting are better
accountability and control, since profitability and efficiency can be closely tracked at the branch
level.
'Branch Accounting'
Branch accounting may involve added expenses for an organization in terms of
accounting and infrastructure. This is because it may be necessary to appoint branch accountants
to ensure accurate financial reporting and compliance with head office procedures and processes
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BRANCHES OF ACCOUNTING
The changing business scenario over the centuries gave rise to specialized branches of
accounting which could cater to the changing requirements. The branches of accounting are;
i) Financial accounting;
ii) Cost accounting; and
iii) Management accounting.
Now, let us understand these terms.
Financial Accounting
The accounting system concerned only with the financial state of affairs and financial
results of operations is known as Financial Accounting. It is the original from of accounting. It is
mainly concerned with the preparation of financial statements for the use of outsiders like
creditors, debenture holders, investors and financial institutions. The financial statements i.e., the
profit and loss account and the balance sheet, show them the manner in which operations of the
business have been conducted during a specified period.
Cost Accounting
In view of the limitations of financial accounting in respect of information relating to the
cost of individual products, cost accounting was developed. It is that branch of accounting which
is concerned with the accumulation and assignment of historical costs to units of product and
department, primarily for the purpose of valuation of stock and measurement of profits. Cost
accounting seeks to ascertain the cost of unit produced and sold or the services rendered by the
business unit with a view to exercising control over these costs to assess profitability and
efficiency of the enterprise. It generally relates to the future and involves an estimation of future
costs to be incurred. The process of cost accounting based on the data provided by the financial
accounting.
Basic Accounting Cycles
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ACCOUNTING CONCEPTS:
In the previous lesson, you have studied the meaning and nature of business transactions
and objectives of financial accounting. In order to maintain uniformity and consistency in
preparing and maintaining books of accounts, certain rules or principles have been evolved.
These rules/principles are classified as concepts and conventions. These are foundations of
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preparing and maintaining accounting records. In this lesson we shall learn about various
accounting concepts, their meaning and significance.
The main objective is to maintain uniformity and consistency in accounting records.
These concepts constitute the very basis of accounting. All the concepts have been developed
over the years from experience and thus they are universally accepted rules. Following are the
various accounting concepts that have been discussed in the following sections:
∑
∑
∑
∑
∑
∑
∑
∑
∑
Business entity concept
Money measurement concept
Going concern concept
Accounting period concept
Accounting cost concept
Duality aspect concept
Realization concept
Accrual concept
Matching concept
1. BUSSINESS ENTITY CONCEPT
This concept assumes that, for accounting purposes, the business enterprise and its
owners are two separate independent entities. Thus, the business and personal transactions of its
owner are separate. For example, when the owner invests money in the business, it is recorded as
liability of the business to the owner. Similarly, when the owner takes away from the business
cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting
records are made in the books of accounts from the point of view of the business unit and not the
person owning the business. This concept is the very basis of accounting.
Let us take an example. Suppose Mr. Sahoo started business investing Rs100000. He
purchased goods for Rs40000, Furniture for Rs20000 and plant and machinery of Rs30000.
Rs10000 remains in hand. These are the assets of the business and not of the owner. According
to the business entity concept Rs100000 will be treated by business as capital i.e. a liability of
business towards the owner of the business. Now suppose, he takes away Rs5000 cash or goods
worth Rs5000 for his domestic purposes. This withdrawal of cash/goods by the owner from the
business is his private expense and not an expense of the business. It is termed as Drawings.
Thus, the business entity concept states that business and the owner are two separate/distinct
persons. Accordingly, any expenses incurred by owner for he or his family from business will be
considered as expenses and it will be shown as drawings.
Significance
The following points highlight the significance of business entity concept:
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∑
∑
∑
∑
This concept helps in ascertaining the profit of the business as only the business
expenses and revenues are recorded and all the private and personal expenses are
ignored.
This concept restraints accountants from recording of owner’s private/ personal
transactions.
It also facilitates the recording and reporting of business transactions from the
business point of view
It is the very basis of accounting concepts, conventions and principles.
2. MONEY MEASUREMENT CONCEPT
This concept assumes that all business transactions must be in terms of money that is in
the currency of a country. In our country such transactions are in terms of rupees. Thus, as per
the money measurement concept, transactions which can be expressed in terms of money are
recorded in the books of accounts. For example, sale of goods worth .200000, purchase of raw
materials Rs.100000, Rent Paid Rs.10000 etc. are expressed in terms of money, and so they are
recorded in the books of accounts. But the transactions which cannot be expressed in monetary
terms are not recorded in the books of accounts. For example, sincerity, loyalty, honesty of
employees are not recorded in books of accounts because these cannot be measured in terms of
money although they do affect the profits and losses of the business concern.
Another aspect of this concept is that the records of the transactions are to be kept not in
the physical units but in the monetary unit. For example, at the end of the year 2006, an
organisation may have a factory on a piece of land measuring 10 acres, office building
containing 50 rooms, 50 personal computers, 50 office chairs and tables, 100 kg of raw materials
etc. These are expressed in different units. But for accounting purposes they are to be recorded in
money terms i.e. in rupees. In this case, the cost of factory land may be say Rs.12 crore, office
building of Rs.10 crore, computers Rs.10 lakhs, office chairs and tables Rs.2 lakhs, raw
materialRs.30 lakhs. Thus, the total assets of the organisation are valued at Rs.22 crore and Rs.42
lakhs. Therefore, the transactions which can be expressed in terms of money is recorded in the
accounts books, that too in terms of money and not in terms of the quantity.
Significance
∑
∑
∑
∑
∑
The following points highlight the significance of money measurement concept :
This concept guides accountants what to record and what not to record.
It helps in recording business transactions uniformly.
If all the business transactions are expressed in monetary terms, it will be easy to
understand the accounts prepared by the business enterprise.
It facilitates comparison of business performance of two different periods of the
same firm or of the two different firms for the same period.
3. GOING CONCERN CONCEPT
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This concept states that a business firm will continue to carry on its activities for an
indefinite period of time. Simply stated, it means that every business entity has continuity of life.
Thus, it will not be dissolved in the near future. This is an important assumption of accounting,
as it provides a basis for showing the value of assets in the balance sheet; For example, a
company purchases a plant and machinery of Rs.100000 and its life span is 10 years.
According to this concept every year some amount will be shown as expenses and the
balance amount as an asset. Thus, if an amount is spent on an item which will be used in
business for many years, it will not be proper to charge the amount from the revenues of the year
in which the item is acquired. Only a part of the value is shown as expense in the year of
purchase and the remaining balance is shown as an asset.
Significance
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The following points highlight the significance of going concern concept;
This concept facilitates preparation of financial statements.
On the basis of this concept, depreciation is charged on the fixed asset.
It is of great help to the investors, because, it assures them that they will continue
to get income on their investments.
In the absence of this concept, the cost of a fixed asset will be treated as an
expense in the year of its purchase.
A business is judged for its capacity to earn profits in future.
4. ACCOUNTING PERIOD CONCEPT
All the transactions are recorded in the books of accounts on the assumption that profits
on these transactions are to be ascertained for a specified period. This is known as accounting
period concept. Thus, this concept requires that a balance sheet and profit and loss account
should be prepared at regular intervals. This is necessary for different purposes like, calculation
of profit, ascertaining financical position, tax computation etc.
Further, this concept assumes that, indefinite life of business is divided into parts. These
parts are known as Accounting Period. It may be of one year, six months, three months, one
month, etc. But usually one year is taken as one accounting period which may be a calender year
or a financial year. Year that begins from 1st of January and ends on 31st of December, is known
as Calendar Year. The year that begins from 1st of April and ends on 31st of March of the
following year, is known as financial year.
As per accounting period concept, all the transactions are recorded in the books of
accounts for a specified period of time. Hence, goods purchased and sold during the period, rent,
salaries etc. paid for the period are accounted for and against that period only.
Significance
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BA7106- ACCOUNTING FOR MANAGEMENT.
∑
∑
∑
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It helps in predicting the future prospects of the business.
It helps in calculating tax on business income calculated for a particular time
period.
It also helps banks, financial institutions, creditors, etc to assess and analyse the
performance of business for a particular period.
It also helps the business firms to distribute their income at regular intervals as
dividends.
5. ACCOUNTING COST CONCEPT
Accounting cost concept states that all assets are recorded in the books of accounts at
their purchase price, which includes cost of acquisition, transportation and installation and not at
its market price. It means that fixed assets like building, plant and machinery, furniture, etc are
recorded in the books of accounts at a price paid for them. For example, a machine was
purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs.1,000
were spent on transporting the machine to the factory site. In addition, Rs.2000 were spent on its
installation. The total amount at which the machine will be recorded in the books of accounts
would be the sum of all these items i.e. Rs.503000. This cost is also known as historical cost.
Suppose the market price of the same is now Rs 90000 it will not be shown at this value. Further,
it may be clarified that cost means original or acquisition cost only for new assets and for the
used ones, cost means original cost less depreciation. The cost concept is also known as
historical cost concept. The effect of cost concept is that if the business entity does not pay
anything for acquiring an asset this item would not appear in the books of accounts. Thus,
goodwill appears in the accounts only if the entity has purchased this intangible asset for a price.
Significance
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∑
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This concept requires asset to be shown at the price it has been acquired, which
can be verified from the supporting documents.
It helps in calculating depreciation on fixed assets.
The effect of cost concept is that if the business entity does not pay anything for
an asset, this item will not be shown in the books of accounts.
6. DUAL ASPECT CONCEPT
Dual aspect is the foundation or basic principle of accounting. It provides the very basis
of recording business transactions in the books of accounts. This concept assumes that every
transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides.
Therefore, the transaction should be recorded at two places. It means, both the aspects of the
transaction must be recorded in the books of accounts. For example, goods purchased for cash
has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be
recorded. Thus, the duality concept is commonly expressed in terms of fundamental accounting
equation:
Assets = Liabilities + Capital
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BA7106- ACCOUNTING FOR MANAGEMENT.
The above accounting equation states that the assets of a business are always equal to the
claims of owner/owners and the outsiders. This claim is also termed as capital or owners’ equity
and that of outsiders, as liabilities or creditors’ equity. The knowledge of dual aspect helps in
identifying the two aspects of a transaction which helps in applying the rules of recording the
transactions in books of accounts. The implication of dual aspect concept is that every
transaction has an equal impact on assets and liabilities in such a way that total assets are always
equal to total liabilities.
Let us analyse some more business transactions in terms of their dual aspect :
1. Capital brought in by the owner of the business The two aspects in this transaction are:
(i) Receipt of cash
(ii) Increase in Capital (owner’s equity)
2. Purchase of machinery by cheque the two aspects in the transaction are
(i) Reduction in Bank Balance
(ii) Owning of Machinery
3. Goods sold for cash The two aspects are
(i) Receipt of cash
(ii) Delivery of goods to the customer
4. Rent paid in cash to the landlord The two aspects are
(i) Payment of cash
(ii) Rent (Expenses incurred).
Once the two aspects of a transaction are known, it becomes easy to apply the rules of
accounting and maintain the records in the books of accounts properly. The interpretation of the
Dual aspect concept is that every transaction has an equal effect on assets and liabilities in such a
way that total assets are always equal to total liabilities of the business.
Significance
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∑
This concept helps accountant in detecting error.
It encourages the accountant to post each entry in opposite sides of two affected
accounts.
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7. REALISATION CONCEPTS
This concept states that revenue from any business transaction should be included in the
accounting records only when it is realised. The term realisation means creation of legal right to
receive money. Selling goods is realisation, receiving order is not. In other words, it can be said
that : Revenue is said to have been realised when cash has been received or right to receive cash
on the sale of goods or services or both has been created.
Let us study the following examples:
(i) N.P. Jeweller received an order to supply gold ornaments worth Rs.500000. They
supplied ornaments worth Rs.200000 up to the year ending 31st December 2005 and rests of the
ornaments were supplied in January 2006.
(ii) Bansal sold goods for Rs.1,00,000 for cash in 2006 and the goods have been delivered
during the same year.
(iii) Akshay sold goods on credit for Rs.50,000 during the year ending 31st December
2005. The goods have been delivered in 2005 but the payment was received in March 2006.
Now, let us analyse the above examples to ascertain the correct amount of revenue realised for
the year ending 31st December 2005.
(i) The revenue for the year 2005 for N.P. Jeweller is Rs.200000. Mere getting an order is
not considered as revenue until the goods have been delivered.
(ii) The revenue for Bansal for year 2005 is Rs.1,00,000 as the goods have been delivered
in the year 2005. Cash has also been received in the same year.
(iii) Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been
delivered to the customer in the year 2005. Revenue became due in the year 2005 itself. In the
above examples, revenue is realized when the goods are delivered to the customers.
The concept of realisation states that revenue is realized at the time when goods or
services are actually delivered.
In short, the realisation occurs when the goods and services have been sold either for cash
or on credit. It also refers to inflow of assets in the form of receivables.
Significance
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It helps in making the accounting information more objective.
It provides that the transactions should be recorded only when goods are delivered
to the buyer.
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BA7106- ACCOUNTING FOR MANAGEMENT.
8. ACCRUAL CONCEPT
The meaning of accrual is something that becomes due especially an amount of money
that is yet to be paid or received at the end of the accounting period. It means that revenues are
recognised when they become receivable. Though cash is received or not received and the
expenses are recognized when they become payable though cash is paid or not paid. Both
transactions will be recorded in the accounting period to which they relate. Therefore, the accrual
concept makes a distinction between the accrual receipt of cash and the right to receive cash as
regards revenue and actual payment of cash and obligation to pay cash as regards expenses.
The accrual concept under accounting assumes that revenue is realised at the time of sale
of goods or services irrespective of the fact when the cash is received. For example, a firm sells
goods for Rs 55000 on 25th March 2005 and the payment is not received until 10th April 2005,
the amount is due and payable to the firm on the date of sale i.e. 25th March 2005. It must be
included in the revenue for the year ending 31st March 2005.
Similarly, expenses are recognised at the time services provided, irrespective of the fact
when actual payment for these services is made. For example, if the firm received goods costing
Rs.20000 on 29th March 2005 but the payment is made on 2nd April 2005 the accrual concept
requires that expenses must be recorded for the year ending 31st March 2005 although no
payment has been made until 31st March 2005 though the service has been received and the
person to whom the payment should have been made is shown as creditor. In brief, accrual
concept requires that revenue is recognised when realised and expenses are recognised when
they become due and payable without regard to the time of cash receipt or cash payment.
Significance
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It helps in knowing actual expenses and actual income during a particular time
period.
l It helps in calculating the net profit of the business.
9. MATCHING CONCEPT
The matching concept states that the revenue and the expenses incurred to earn the
revenues must belong to the same accounting period. So once the revenue is realised, the next
step is to allocate it to the relevant accounting period. This can be done with the help of accrual
concept.
ACCOUNTING CONVENTIONS
Conventions are the customs and traditions that act as a guide to the preparation of the
financial statements. Following these conventions leads to clear and meaningful financial
statements. The conventions followed to prepare accounting statements are the:
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Convention of Full Disclosure
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BA7106- ACCOUNTING FOR MANAGEMENT.
∑
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Convention of Materiality
Convention of Consistency
Convention of Conservatism
Convention of Full Disclosure
The accounting convention of full disclosure implies that accounts should make a full
disclosure of all monetary or financial information that can impact decision making of different
parties. This accounting information is of interest to the management, current and potential
investors and current and potential creditors of the business.
Convention of Materiality
The convention of materiality proposes that while accounting for various transactions,
only those transactions should be considered which have material impact on the profitability or
the financial status of the organization. For example, for a business that buys and sells stationery
items, the pens lying unsold at the end of the accounting period are material items for the
business. These will be recorded in the books of account. On the other hand, for a business that
manufactures cars, the unused pens are not material items and will not be recorded in the books
of account. Similarly, insignificant transactions or items, such as postage stamps lying unused, at
the end of the accounting period will be ignored. Material information is the information that
enables any prudent person to arrive at a decision.
Convention of Consistency
To build business strategies the management of a company needs to arrive at important
conclusions and take important decisions from the financial statements over a period of years.
The convention of consistency specifies that the accounting practices and methods used by an
organization should remain consistent over the years.
Consistency should be maintained within the inter-related financial statement for the
same date. The performance of the company in one year with the performance in the next year or
another year should be such that it can be compared. This is referred to as Horizontal
Consistency.
The comparison of the performance of one company with that of another company in the
same industry can also be done. This is often referred to as Third Dimensional.
Convention of Conservatism
The convention of conservatism follows the policy of cautiously creating financial
statements in a conservative manner. This principle considers all prospective losses and ignores
all perspective gains. It is defined as a guideline that chooses between acceptable accounting
alternatives for recording events or transactions so that the least favorable immediate effect on
assets, income and owners equity is reported in the accounting period.
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Fundamental Concepts
Debit and Credit
An account is a standardized arrangement for recording financial information. In a typical
accounting system, there exists a separate account for each asset, each liability, and each
category of owners' equity, each item of revenue, and each item of expense.
Any account has two sides, namely, debit side and credit side. In the ‘T-account format’ the left
side is the debit side and the right side is the credit side. In accounting the terms ‘debit’ and
‘credit’ are merely two different sounds and do not have the same implications as they have in
English language.
A ‘debit’ in accounting means:
∑ The left side of any T account.
∑ A number entered on the left side of any account is said to be debited to an account.
A ‘credit’ in accounting means:
∑ The right side of any T account.
∑ A number entered on the right side of any account is said to be credited to an account.
The symbol Dr. is used to indicate Debit and the symbol Cr. is used to indicate Credit
Although the T- account format is used for convenience it is normally not used by the
companies. Every business transaction has two fold effect and recording of both aspects of a
transaction is called ‘double entry book keeping system. There are two approaches to analyze the
dual aspect of the transaction and to find out the accounts to be debited or credited. They are as
under:
1. Accounting equation approach
2. Traditional approach
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Accounting Equation
1. Accounting Equation approach:
Assets =
Debit Credit
+
–
Liabilities
Debit Credit
–
+
+
Owners’ equities
Debit Credit
–
+
In addition to the accounting principle we have the following rules:
∑
∑
Debits are always equal to credits
Assets are always equal to liabilities and owners equity
Accounting Approaches
The system used for recording increases and decreases in accounts can be stated as follows:
Increases Deceases
Assets
Debit
Credit
Liabilities
Credit
Debit
Owners’ equity
Credit
Debit
From the above statement it is clear that the owners’ equity is increased by credits and decreased
by debits. Since revenues increase owners’ equity and expenses decrease it, we get the following
rules:
Accounting Equation Approach
Increases
Debit
Debit
Credit
Expense
Drawings
Revenue
Deceases
Credit
Credit
Debit
i.
revenues are recorded as credits
ii.
expenses are recorded as debits
An Analysis of Business Transaction under the Accounting Equation Approach
Example of an Analysis of Business Transaction under the Accounting Equation Approach
Transaction
Analysis
Account affected Rule
& nature of
Account
Entry
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Introduction of
Cash Received
Cash – Asset
Rs. 80,000 by the Investment by Capital – Capital
Proprietor
the owner
Cash Deposited in Bank
balance
bank Rs. 10,000
increase
Cash
balance
decrease
Loan from Suresh Cash
balance
Rs.40,000
increases
An obligation to
Repay Suresh is
created
Salaries paid
Salaries for
Rs.3,500 and
services
outstanding
received Rs.
Rs.1500
5,000
Paid Rs.3,500
Obligation to
pay Rs.1500
Bank – Asset
Cash – Asset
Cash – Asset
Suresh’s loan –
Liability
Salary – Expense
Cash – Asset
Salaries
Outstanding –
Liability
Debit increase in
asset
Credit increase in
capital
Debit increase in
asset
Credit increase in
liability
Debit increase in
assets
Credit increase in
liabilities
Debit ‘Cash’
Credit ‘Capital
Debit Increase in
expenses
Credit decrease
in asset
Credit increase in
liability
Debit
‘salary’(5,000)
Credit ‘cash’
(3,500)
Credit salaries
outstanding
(1,500)
Debit ‘Bank’
Credit ‘Cash’
Debit cash
Credit ‘Suresh’s
Loan
Traditional Approach
Traditional Approach: Traditionally all accounts are divided as follows:
Personal Accounts:
Transactions with a person or group of persons are called personal accounts. Personal
accounts include the following:
∑
Natural person accounts such as Ram Account, Umesh Capital Account, Sunitha Account
etc.
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∑
Artificial or legal person account such as Zee Telefilms Limited Account, Syndicate
Bank Account etc.
∑ Group Account such as debtors account, creditors account, share capital account, etc.,
∑ Representative personal accounts such as commission outstanding account, salaries
outstanding account. These represent the person to whom the commission or salary is
payable.
Real Accounts: Real accounts relate to properties of a business enterprise. Such properties can
be tangible or intangible.
Tangible real accounts: Accounts of properties having physical existence such as, cash, Stock
of goods, Land and buildings etc.
Intangible real accounts: Accounts of properties which are not having physical existence but
are capable of Monitory measurement. Patent rights, copy rights trade marks are some of the
examples.
Nominal Accounts: Accounts relating to income, revenue, gain, expenses and losses are termed
as nominal accounts. Salaries, commission, rent, interest paid, interest received etc. are some of
the examples of nominal accounts.
Classification of Accounts
Classification of assets under traditional and accounting equation approach
Title of account
Traditional Approach
Accounting Equation Approach
Building
Real
Asset
Sales
Nominal
Revenue
Debtors
Personal
Asset
Rent
Nominal
Expense
Prepaid salary
Personal
Asset
Rent outstanding
Personal
Liability
Cash
Real
Asset
Bad Debts
Nominal
Expense
Capital
Personal
Capital
Closing Stock
Real
Asset
Depreciation
Nominal
Expense
Traditional Approach: Accounting Rules
The rules for recording changes in personal, real and nominal accounts are as follow
1. Accounting rule for personal accounts:
‘Debit the receiver and credit the giver’
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2. Accounting rule for real accounts:
‘Debit what comes in and credit what goes out’
3. Accounting rule for nominal accounts:
‘Debit expenses and losses and credit all revenue, gains and incomes’
Analysis of Business Transaction under the Traditional Approach
Example of an business Transaction under the Traditional Approach
Transaction
Analysis
Account affected Rule
& nature of
account
Introduction of Cash is received Cash – Real
Debit what
Rs. 80,000 by the by the business
Capital–Personal comes in
Proprietor
Owner has given
Credit what goes
cash
out
Cash Deposited
Bank Receives
Bank – Personal Debit the
in bank
Cash
Cash – Real
receiver
Rs.10,000
Cash Goes out of
Credit what goes
Business
out
Loan from
Business gets
Cash – Real
Debit what
Suresh
cash
Suresh’s loan –
comes in
Rs.40,000
Suresh pays
Personal
Credit the giver
Cash
Cost of services Salary –
Debit all
Salaries paid Rs. used Rs. 5,000
Nominal
expenses
3,500 and
Cash goes out Cash – Real
Credit what goes
outstanding
Rs. 3,500
Salary
out
Rs.1500
Outstanding for Outstanding –
Credit the giver
services received Personal
Rs.1500
Entry
Debit ‘Cash’
Credit ‘Capital
Debit ‘Bank’
Credit ‘Cash’
Debit cash
Credit ‘Suresh’s
Loan
Debit
‘salary’(Rs.5,000)
Credit ‘cash’
(Rs.3,500)
Credit salaries
outstanding
(Rs.1,500)
Journal
Accounting for business transactions starts with their recording in the journal. Journal Book
systematically records business transactions on a chronological order for the first time in the
order of their occurrence. Therefore, it is also called the book of original entry.
Format of a journal:
Date
Particulars
L.F
Debit (Rs.)
Credit (Rs.)
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∑
∑
∑
∑
The date indicates the date on which transactions have been entered in the date column
Two aspects of the transactions are entered in the particulars column. A brief description
of the transaction is also given in the particulars column.
The Ledger folio column is meant for writing the page number of the page in the ledger
on which the transaction is entered.
The amount to be debited is entered in the debit column and the amount to be credited is
entered in the credit column.
Steps in Journalizing:
∑
Analyze the transaction and identify the two accounts that are being affected by the
transaction
∑ Ascertain the nature of accounts involved as real, personal or nominal
∑ Determine which rule of debit or credit is applicable for each account involved
∑ Ascertain the account to be debited and the account to be credited
∑ Write the name of the account to be debited along with the abbreviation “Dr.’ on the
same line against the name of the account in the particulars column and the amount to be
debited in the debit amount column against the name of the account.
∑ Write narration (A brief description of the transaction) within the brackets in the next line
in the particulars column.
Examples of Journal Entries
1. I start business with Rs. 4,00,000 as my capital. The entry is:
Cash account
Dr.
4,00,000
To Capital account
4,00,000
2.Out of Rs.4,00,000, Rs. 2,50,000 is deposited in the bank. The entry is:
Bank Account
Dr.
2,50,000
To Cash Account
2,50,000
3.Goods are purchased on credit from M/s. Raman and Sons for Rs. 60,000. The entry is:
Goods Account
Dr.
60,000
To M/s. Raman and Sons
60,000
4.A computer is purchased for cash for Rs.50,000. The entry is
Computer Account Dr.
50,000
To Cash Account
50,000
5.Good worth Rs.10,000 are sold on credit to M/s. Chandhana Brothers. The entry is:
Chandhana Brothers Dr.
10,000
To Goods Account
10,000
6.Cash of Rs.9,000 is received for sale of goods to Mr. Reddy and Brothers. The entry is:
Cash Account
Dr.
9000
To Goods Account
9,000
7. Rent paid to the landlord is Rs.5,000. The entry is:
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Rent Account
Dr .
5,000
To Cash account
5,000
8.A machine is received and payment is made by cheques, the Rs. 1,00,000. The entry is:
Machinery Account Dr.
1,00,000
To Bank Account
1,00,000
9.Borrowed Rs. 20,000 from a friend, Mr. S. Sundar. The entry is:
Cash account
Dr.
20,000
To S. Sundar Account
20,000
10.Interest paid to Mr. S. Sundar is Rs.1,800. The entry is:
Interest account
Dr.
1,800
To Cash Account
1,800
Ledger
In journal, each transaction is dealt with separately. By looking at the journal one cannot make
out an idea of the net effect of the transactions. The record is made date wise. Transactions
which occur on different dates but are similar in nature are recorded in different places. In order
to get an idea about the net effect of the transactions the entries recorded on the journal have to
be processed further.
In the ledger, all transactions which are similar in nature are brought together. For example, all
transactions relating to cash are grouped in one place. A ledger is maintained account wise. The
statement relating to a particular subject for a particular period of time and in which the
transactions are arranged in a systematic manner is called an account.
A separate account is opened for each account and different folios are attached to different
accounts. Entries in the Ledger are posted from the Journal. The process of transferring entries
from the Journal to the ledger is called ledger posting. The opening entry for various assets
should be posted by writing ‘To Balance b/d’ on the debit side of the relevant account. Similarly,
liabilities accounts should be posted by writing ‘By Balance b/d’ on the credit side of the
relevant account.
Steps in ledger posting:
1. Enter the date of transaction on the debit side of the relevant account
2. The titles of the accounts to be credited and debited are entered in the particulars column.
The account to be credited is preceded by the word ‘To’ and the account to be debited is
preceded by the word ‘By’.
3. In Journal Folio (J.F.) Column is meant for writing the page number of the journal on
which the journal entry is passed.
4. Amount column represents the amount mentioned in the journal against the title of the
account under consideration.
The Ledger accounts are balanced at the time of extracting the Trial Balance.
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The format of ledger used in the recent days is as under:
Account Title
Dr.
Date
Particulars
J.F.
Amount (Rs.)
Date
Particulars J.F.
Cr
Amount (Rs.)
Illustration: Transfer the following Journal entries to the Ledger.
Journal
Date
2001
April
4
6
8
9
Particulars
L.F.
GoodsAccount
Dr.
To Cash Account
(Being goods purchased for cash)
CashAccount
Dr.
To Ali & Co
(Being cash received from Ali & Co)
CashAccount
Dr.
ToGoods Account
( Being cash sales made)
Praveen
Dr
To Bank Account
ToDiscountAccount
(Being cheque issued for Rs. 1900 to
Praveen and discount allowed by him
Rs.100)
8
8
Dr.
Amount Rs.)
5000
Cr.
Amount Rs.)
5000
8
8
3000
8
8
4000
9
9
9
2000
3000
4000
1900
100
Solution:
Goods Account
Date
2001
Apr.4
Dr.
Particulars
J.F.
To
Cash 20
Account
Amount (Rs.)
5000
Date
2001
Apr.8
Particulars J.F.
By Cash 20
Account
Cr
Amount (Rs.)
4000
Cash Account
Date
2001
Apr.6
8
Dr.
Particulars
J.F. Amount Rs.)
To Ali & Co
20
To Goods A/c 20
3000
4000
Date
2001
Apr.8
Particulars
Cr
J.F. Amount (Rs.)
By Goods A/c 20
5000
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Ali & Co
Dr.
Date
Particulars
J.F.
Amount (Rs.)
Date
2001
Apr.6
Particulars J.F.
By Cash 20
Account
Cr
Amount (Rs.)
3000
Praveen
Dr.
Date
2001
Apr.9
9
Particulars
J.F.
Amount (Rs.)
To Bank
To Discount
20
20
1900
100
Date
Particulars J.F.
Cr
Amount (Rs.)
Discount
Dr.
Date
Particulars
J.F. Amount (Rs.)
Date
2001
Apr.9
Particulars
By Praveen
Cr
J.F. Amount (Rs.)
20
100
Bank Account
Dr.
Date
Particulars J.F.
Amount Rs.)
Date
2001
Apr.9
Particulars
By Praveen
J.F.
20
Cr
Amount (Rs.)
1900
Cash Book
In any business, there will be numerous transactions relating to cash i.e. receipts and payments
of cash. On receipt of cash, the cash account is debited and on payment the cash account is
credited. Cash Account can be prepared straightaway without journalizing the transactions. By
doing so, much of clerical labor involved in making the journal is saved. Since cash transactions
will be numerous, it is better to keep a separate book to contain only the cash account. This book
is known as Cash Book.
Trial Balance
In a double entry book keeping every transaction has two effects i.e. very debit has a
corresponding credit. The excess of debits over credits is called as the Debit Balance and the
Excess of credit over debit is called Credit Balance. A trial balance is a summary of all the
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balances of accounts in a general ledger prepared for testing the arithmetic accuracy of the
accounts.
Features of a Trial Balance
1. It is a list of balances of all ledger accounts and cash book
2. It is not a part of the double-entry system of bookkeeping; its just a working paper
3. It can be prepared anytime during the accounting period
4. It serves as an instrument for carrying out the job of checking and testing
5. Arithmetical accuracy of posting of entries from journal to ledger can be ensured.
6. Some errors are not revealed by trial balance
Objectives of preparing a trial balance
1. It ensures that all transactions have been recorded with identical debit and credit amounts
and the balance of each account has been computed correctly
2. It facilitates the preparation of the trading account, profit and loss and balance sheet by
making available the balances of all the accounts at one place
3. It also ensures that the balance of each account, whether a debit or credit, has been
transferred properly to the respective columns of the trial balance and that the trial
balance has been correctly added.
4. Some of the errors in the books of accounts can be detected by the trial balance and they
can be rectified before the preparation of the final accounts.
Defects of a Trial Balance:
An agreed Trial Balance does not prove that:
1. All the transactions have been correctly analyzed and recorded in the proper accounts. If,
for example the wages paid for the installation of Plant had been erroneously recorded by
debiting the wages account in the place of the plant account, the trial balance would agree
2. All the transactions have been recorded in the books of original entry. If, for example, a
sales invoice were to be completely omitted from being recorded in the sales day book,
the error would not be disclosed in the trial balance.
Construction of a Trial Balance
There are three methods of constructing a Trial Balance:
a) Trial Balance with balances: In this method, the trial Balance is prepared by taking the
balance of each account. This is a widely used method as it helps in preparation of
trading, profit and loss account and balance sheet.
Specimen of the Trial Balance drawn with balances
S.No
1
2
Head of Account
Capital
Cash
LF
1
2
Debit
Credit
1,50,000
1,50,000
b) Trial Balance with totals: In this method, the trial Balance is prepared by taking the totals
of each side of the accounts without balancing it
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c) Trial Balance with balance and totals: In this method, the trial Balance is prepared by
taking the totals of each side of the accounts without balancing it in one column but
balances in other column .
Format of Standards
The format of each standard contains:
∑
∑
∑
A statement of concepts and fundamental accounting principles relating to the standard.
Definition of the terms used in the standard.
The manner in which the accounting principles have been applied for formulating the
standard.
∑ Presentation and disclosure requirements.
∑ Class of enterprise to which it applies.
∑ Effective date.
Accounting standards apply only to material items.
The Accounting Standard Board (ASB) of the Institute of Chartered Accountants of India has
issued the following Accounting Standards that are to be followed by its members.
International Accounting Standards
Accounting Standards are a collection of generally followed accounting principles, policies and
practices. These help to ensure a common basis for financial statements of different
organizations. This means that people can understand these more easily and make useful
comparisons.
Financial statements are at the centre of business reporting. Financial statements usually provide
users with essential information that heavily influences their decisions. The US is the leader in
financial reporting, and the US Securities and Exchange Commission is respected for its role in
formulating and implementing US GAAP despite the general vote of confidence. In India, the
Statements on Accounting Standards are issued by the Institute of Chartered Accountants of
India (ICAI) to establish standards that have to be complied with to ensure that financial
statements are prepared in accordance with generally accepted accounting standards in India
(India GAAP)
Indian Accounting Standards
The Council of ICAI constituted the Accounting Standards Board (ASB) in April, 1977 to
formulate Accounting Standards. While formulating the Accounting Standards, ASB takes into
consideration the applicable laws, customs, usages and business environment.
However, users were strongly critical about certain aspects of financial statements and they
offered or supported many substantive ideas for improvement. Standard setters, regulators, and
many others devote considerable resources in maintaining and improving the standards.
The new accounting norms are aimed at protecting shareholders’ interest and recommending
ways of improving corporate governance.
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Accounting Standard - 1 : Disclosure of Accounting Policies
It deals with the disclosure in the financial statements of significant accounting policies followed
in the preparation and presentation of such statements. The purpose of this standard is to promote
better understanding of financial statements by such disclosure. The major considerations to be
followed during the selection of accounting policies by management are prudence, substance
over form, and materiality. Certain fundamental assumptions in the preparation of financial
statements are going concern concept, consistency and Accrual concept. Compliance of this
standard helps in facilitating a more meaningful comparison between financial statements of two
different enterprises.
Accounting Standard - 2 : Valuation of Inventories (Revised w.e.f. 1-4-1999)
The standard has been made mandatory for accounting periods commencing from 1-4-1999. The
standard deals with the determination of value at which inventories are carried in the financial
statements until the related revenues are recognized. The standard also deals with determination
of such value, including ascertainment of cost of inventories and any write-down thereof to net
realizable value (net realizable value is explained in detail in the standard). It states that
inventories are to be valued at lower of cost or net realizable value. Weighed Average Cost or
First in First Out (FIFO) methods are permitted in cases where goods are ordinarily
interchangeable. Specific identification method is permitted only when goods are not ordinarily
interchangeable. The standard does not permit use of direct costing method and states that
absorption costing is to be applied to manufactured goods.
Accounting Standard - 3 : Cash Flow Statements (Revised)
The standard deals with preparation of a cash flow statement and its presentation along with
financial statements. It states that the cash flow statement should report cash flows during the
period of financial statements classified by operating, investing and financing activities. It
prescribes a direct and indirect method of reporting cash flows. The Standard requires that a cash
flow statement should disclose the components of cash and cash equivalents and should also
present a reconciliation of the amounts in the cash flow statement with the equivalent items
reported in the balance sheet.
Accounting Standard - 4 : Contingencies and events occurring after the Balance Sheet Date
The standard deals with the treatment in financial statements of contingencies and events
occurring after the balance sheet date. Contingencies are events whose outcome will be known
only on their occurrence, e.g., a case in High Court, Penalty proceedings under law, etc., are
events whose outcome will be known only on their occurrence. Events occurring after the
balance sheet date are those significant events that occur between the balance sheet date and the
date on which the financial statements are approved at a later date by the Board of Directors of
the Company. Let us say, insolvency of a debtor, recovery from whom was considered as
doubtful as on the date of balance sheet. The Standard lays down that contingencies must be
provided if the loss due to these can be reasonably estimated. The standard also states that assets
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and liabilities should be adjusted for events occurring after the balance sheet date if they
establish the conditions existing on the balance sheet date.
Accounting Standard - 5 : Net Profit or Loss for the period, Prior Period Items and
changes in Accounting Policies
The standard deals with the treatment in the financial statements of prior period and
extraordinary items and changes in accounting policies. Prior period items are debits or credits
which arise in the accounts of current year as a result of a mistake or omission in the preparation
of financial statement of one or more earlier years. Extraordinary items are unusual items distinct
from the day-to-day activities of an entity. Nature and significant amount of such items need to
be provided in the financial statements. A change in Accounting Policy shall be made only if the
change is required by statute, or standard or for appropriate presentation and any such change
should be reported and quantified with respect to its impact on the profit or loss of the entity for
the period of change/future period.
Accounting Standard - 6: Depreciation Accounting
The standard deals with the accounting for depreciation and the disclosure requirements in
connection therewith. It suggests various methods of depreciation in respect of various types of
fixed assets. It states that the depreciation method should be selected carefully, systematically
and consistently applied from year to year. It also lists the factors which affect depreciation and
the treatment to be given if a method of depreciation is changed. The standard also lays down
treatment in case of revaluation of assets.
Accounting Standard - 7
It deals with the accounting for construction contracts. Contract accounting is complicated
because the contract period exceeds a single year in most cases. This poses serious accounting
problems relating to revenue, treatment of advances received, work-in-progress etc., in the
financial statements. The standard recognizes two methods of accounting for construction
contract, namely, the percentage of completion method and the completed contract method. The
standard explains the relevance of both the methods of accounting and the method which is more
appropriate under a given set of circumstances. It states the essential ingredients of these two
methods and also deals with the disclosures to be made in this regard.
Accounting Standard - 8
Research and Development has been withdrawn.
Accounting Standard - 9 : Revenue Recognition
It deals with the basis for recognition of revenue, i.e., income and the time when income can be
said to have arisen. It also states the quantum of income to be credited to profit and loss account.
The statement shows how revenue is to be recognized from the various activities carried on by
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the enterprise. Let us say, from sale of goods, rendering of services, use by others of enterprise
resources yielding interest, royalties, and dividends, etc.
Accounting Standard -10 : Accounting for Fixed Assets
The standard deals with the accounting for fixed assets and specifies the disclosures to be made
in the financial statement in relation thereto. It lays down the elements of cost that should form a
part of the book value in respect of a particular asset purchased and used by an enterprise. It also
states when the fixed assets should be written off and treatment, if any, on revaluation of fixed
assets.
Accounting Standard -11 : The effects of changes in Foreign Exchange Rate (Revised 2003)
The Standard deals with accounting for transactions in foreign currencies in the financial
statements prepared by an enterprise and with translation of the financial statements of foreign
branches prepared in foreign currency into India rupees for the purpose of including them in the
financial statements of the Head Office in India. Rule with respect to foreign currency translation
(conversion) and difference arising, if an from conversion of foreign currency into Indian rupees
is also dealt with by the standard.
Accounting Standard-12: Accounting for Government Grants
The standard deals with accounting for Government grants received by entity and how such
grants should be presented in the financial statement. Such grant may be in the form of subsidies,
cash incentives or duty drawbacks, etc. the varied approaches to the grant as suggested by the
Standard would depend upon the purpose which the grant is received and conditions that have to
be fulfilled to obtained and enjoy grant. Treatment of withdrawal of grants is also laid down in
the Standard.
Accounting Standard-13: Accounting for Investments
It deals with accounting for investments made by an entity and its presentation in the financial
statement. The Standard defines current and long term investments and their basis of
classification. To the extent the Standard relates to current investments, it is also applicable to
shares, debentures and other securities held as stock-in-trade, with suitable modification as
specified in the Standard itself. It lays down the criteria for bifurcation between current and long
term investments and how they are to be classified as such.
Accounting Standard-14: Accounting for Amalgamations
It deals with accounting for amalgamation and the treatment of any result goodwill or reserve in
the books of account, arising out of such amalgamation transaction. Amalgamation means
formation of a new company to take over the existing business of two or more companies. The
Standard does not deal with cases of acquisitions whereby the acquired company is not dissolved
and its separate entity continues to exist. The standard lays down the methods of amalgamation
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and the accounting adjustment under each method. The two methods of accounting for
Amalgamations are Pooling of interest method and Purchase Method.
Accounting Standard - 15 : Accounting for retirement benefits in the Financial Statement
of Employers
It deals with accounting for retirement benefits provided to employees in the financial
statements of employers. Retirement benefits would include provident fund,
superannuation/pension, gratuity, leave encashment, post retirement health and welfare schemes.
This statement does not apply to those retirement benefits for which the employer's obligations
cannot be reasonably estimated.
Accounting Standard - 16 : Borrowing Costs (w.e.f. 1-4-2000)
The standard is mandatory for accounting periods commencing from 1-4-2000. It deals with
accounting for borrowing cost and not with the actual cost of owners equity/preference capital. It
states that borrowing costs like interest and other costs that are directly attributable to the
acquisition, construction or production of any qualifying asset (assets that take a substantial
period of time to get ready for its intended use or sale) should be capitalized. It states the income
on the temporary investment of the borrowed funds be deducted from the borrowing costs. It
states that capitalization of borrowing cost should be suspended during extended periods in
which development is interrupted. Capitalisations should cease when asset is completed
substantially or if completed in parts, in respect of that part, all the activities for its intended use
or sale are complete. Policy with regard to borrowing cost needs to be disclosed in the financial
statements.
Accounting Standard - 17 : Segment Reporting (w.e.f. 1-4-2001)
The standard is mandatory for accounting periods commencing from 1-4-2001. it deals with
reporting of information about different types of products and services of a n enterprise and its
operations in different geographical areas for assessing risk and returns of a diversified or multilocational enterprise that is not determinable from the aggregated data. The statement is
applicable to general purposes financial statements and consolidated financial statements (a
separate accounting standard is presently being formulated on consolidated financial statements)
it lays down criteria for identifying a ‘business segment' and ‘geographical segment' and requires
reporting of the segments subject to fulfillment of certain criteria specified in the statement. It
states that segment information should be prepared in conformity with the accounting policies
adopted for preparing and presenting financial statements of the enterprise as a whole.
Accounting Standard -18 : Related Party Disclosures (w.e.f. 1-4-2001)
The standard is mandatory for accounting periods commencing from 1-4-2001. it deals with
reporting of related party relationships and transactions between a reporting enterprise and its
related parties. The statement is applicable to general purposes financial statements and
consolidated financial statements (a separate accounting standard is presently being formulated
on consolidated financial statements). The statement applies to related party relationship as
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described in the statement. It states that the requirement of statement shall not apply in
circumstances where providing such disclosures would conflict with the reporting enterprise's
duties of confidentiality as specifically required in terms of a statute or by any regulator or
similar competent authority. It states that name of the related party and nature of the related party
relationship where control exists should be disclosed irrespective of whether or not there have
been transactions between the related parties.
Accounting Standard - 19 : Leases (w.e.f. 1-4-2001)
The objective of this standard is to prescribe, for lessors and lessees, the appropriate accounting
policies and disclosure in financial statements in relation to finance lease and operating leases. It
lays down guidelines for classification of a lease between finance and operating lease. It lays
down the treatments to be given to finance and operating leases in the financial statements of the
lessor and lessee. It also states that the disclosure requirements apply equally to sale and
leaseback transaction.
Accounting Standard - 20 : Earnings per Share (w.e.f. 1-4-2001)
This standard is relevant only for companies with equity share capital. The objective of this
statement is to prescribe principles for the determination and presentation of earnings per share,
which will improve comparison of performance among different enterprises for the same period
and among different accounting periods for the same enterprise. The focus of this statement is on
the denominator of eth earnings per share calculation. Even though earnings per share data has
limitations because of different accounting policies used for determining ‘earnings', a
consistently determined denominator enhances the quality of financial reporting.
Accounting Standard - 21 : Consolidated Financial Statements
The standard is designed for holding companies and group companies and applies only if
consolidated statements are prepared by the group or parent company. Some concepts are
relevant to consolidation of accounts of NGOs. Consolidated Financial statements are presented
by the parent of a group to provide financial details about the economic activities of its groups.
This standard lays down principles and procedures for the preparation and presentation of
consolidated financial statements.
Accounting Standard - 22 : Accounting for Taxes on Income
The objective of the statement is to prescribe accounting treatment for taxes on income. Taxes on
income is one of the significant items in the statement of profit and loss of an enterprise. The
standard explains the reasons for divergence between taxable income and accounting income. It
states that tax expenses for the period should comprise of current tax and deferred tax, in the
determination of net profit for the period. Deferred tax should be recognized for all the timing
differences subject to the consideration of prudence in respect of deferred tax assets.
Accounting Standard - 23 : Accounting for Investments in Associates in Consolidated
Financial Statements
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Accounting Standard 24: Discontinuing Operations
Accounting Standard 25: Interim Financial Reporting
Accounting Standard 26: Intangible Assets
Accounting Standard 27: Financial Reporting of Interests in Joint Ventures
Accounting Standard 28: Impairment of Assets
Accounting Standard 29: Provisions, Contingent Liabilities and Contingent Assets
Difference between the International Accounting Standards and Indian Accounting
Standards
The following are the differences
Reporting Vs. Disclosure: Firstly the accent of the Indian accounting standards is on reporting
where as the accent of the US GAAP is on disclosure and transparency.
For example in India it is not necessary to disclose the portion of long-term debt which has an
unexpired term of maturity of less than one year. This gives an erroneous picture of the potential
short-term liabilities of the company and the liquidity risk that the company could face in such an
eventuality. The US GAAP on the contrary insists on the disclosing the portion of long-term debt
separately which has an un expired term to maturity of less than one year.
Form vs. Substance: The accent of the Indian Accounting standards is on form where as the
accent of the US GAAP is on the substance of the transaction. For example, while accounting of
a lease in India the depreciation benefit is available to the lessor because in structure or form a
lease deal is not a sale. On the contrary, in the US GAAP a lease deal confers the depreciation
benefit on the lessee since the benefits of the productive use of the asset rests with the lessee
Accounting vs. Analysis The accent of the Indian accounting standards is on abiding by
accounting principles whereas the accent on the US GAAP is on presenting a true and fair
picture of the financial position of the company to the analysts. For example, under the US
GAAP the companies are required to disclose the sales, operating profits and the assets that can
be identified with each product division enabling analysts to get a true and unbiased picture of
the performance and profitability of each division. According to the Indian accounting standards
it is not necessary.
Globalization vs. Localization The other difference between the Indian Accounting Standards
and the US GAAP is that the accent of Indian accounting standards is on localization of the
business while the accent of the US GAAP is on globalization of the business. The US GAAP
stipulates that companies consolidate their subsidiary accounts and show the results as a part of
the parent company accounts. This has provided an incentive to US corporates to expand
offshore through subsidiaries and ensure its good performance.
Changes in Indian Accounting standards and their impact:
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Like any other listed firms, Satyam Computers is now required to consolidate its accounts of its
subsidiaries into its balance sheet. Satyam reported a net profit of around 119 crore in the quarter
ending December 2001. But, its 52.5 subsidiary, Satyam Infoway, reported a net loss of around
Rs.391.96 crore as per US GAAP. Under the new norms, Satyam Computers would be required
to add the losses of its subsidiary as it’s bottom-line after subtracting the minority interest i.e.
after subtracting 47.5 percent of net losses.
If Satyam Infoway’s losses are not taken into account, the situation is very bright. However, one
cannot be happy once Satyam Infoway’s losses are taken into account.
How ever, new accounting norms do not necessarily mean losses to the companies. Some
companies are going to see a jump in their net profits. For example, Reliance is likely to see a
jump in net profit after consolidating the accounts of Reliance Petroleum. Similarly, there is
going to be a jump in the profits of State Bank of India by 20 percent after it consolidates the
accounts of its subsidiaries.
Criticism of US Accounting Standards
∑ The current standard setting process is too cumbersome and slow
∑ Much of the recent FASB guidance is rule based and inhibits transparency
∑ Much of the recent FASB guidance is too complex
Accounting Standards Should Change
It is widely believed that rather than enforcing standards based on specific rules, if it were on
intent, there is a possibility of avoiding the loopholes exploited by many companies. The
International Accounting bodies like the International Accounting Standards Board and the
Financial Accounting Standards Boards are trying their best to change the accounting rules to
benefit both the companies and the investing companies and the investing community by way of
better and informed financial statements.
Capital markets all over the world, particularly the US capital markets are plagued by murky
accounting standards. Enron is the best example for this. All this has resulted in the lack of
confidence in the US financial reporting standards. It may result in deterring the foreign
investors’ trust on the most revered and feared US GAAP.
Many fear that the situation in US may result in many mangers around the world withdrawing
their investments from US. The reason for US not to ensue with accounting standards is its
negative networth against the world. Consider these figures: World assets in the US amount to
$7.3 tn, Us investment outside its borders is $5.2 tn.
To understand the amusing aspect of the US accounting standards, consider this example. A
company that owns an asset, say an aircraft, and finances this asset with debt, reports it as an
asset and liability. Under the existing accounting standards, if the company acquires the asset
under a lease structured as an operating lease, it will neither report the asset nor the liability. So
this makes the situation where it is possible for a company to operate an airline without reporting
any of its principle assets on the balance sheet. Thus a Balance Sheet that presents an airline
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without showing it on the sheet is not a faithful representation of economic reality. All these
make a case to harmonize global accounting standards for the benefit of both global and US
investors.
INFLATION ACCOUNTING
Inflation normally refers to the increasing trend in general price levels. In economic
sense inflation refers to a state in which the purchasing power of money goes down or
conversely there is more money in circulation.
Meaning of inflation accounting
The accounting system adopted for converting the past financial expenditure and receipts
according to the current price level are called inflation accounting.
Also called as Price level accounting.It is based on the principle that the prices of products at
different periods are at different levels.
Inflation Accounting – Definition
According to American Institute of Certified Public Accountants defines “the
inflation accounting as a system of accounting, which purports to record as a built in mechanism,
all economic events in terms of current cost”.
Features of inflation accounting:
∑
The inflation accounting has an inbuilt and automatic recording procedure.
∑
The unit of measurement is not stable like traditional or historical accounting.
∑
It takes into consideration all the elements of financial statements for reporting.
Methods of inflation accounting:
Current Purchasing Power Method (CPP)
Current Cost Accounting Method (CCA)
Hybrid Method (a mixture of CPP & CCA)
Current Purchasing Power Method (CPP)
In this method the increase of decrease of price level in a period should be adjusted
with the items in the Profit and Loss account and Balance Sheet.
Also called as Constant rupee method
The method is based on General Price Index.
Accounting to the Price Index the items should be adjusted to know the real values.
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Consumer Price Index: The Consumers Price Index (CPI) is a measure of the price change of
goods and services purchased by private Indian households
Current Cost Accounting Method
CCA was introduced during 1975 by the British Government through a committee known as
Sandilands Committee, headed by Francis C.P. Sandilands.
Hybrid Method:
The Combination of the Current Purchasing Power Method (CPP) and Current Cost Accounting
Method (CCA) is called as hybrid method.
HUMAN RESOURCE ACCOUNTING
Introduction
∑
∑
Human Resource Accounting (HRA) is a new branch of accounting.
HR is the most important factor in the organization. Among 4 factors of production.
o
Material
o
Machine
o
Land &
o
Men
The effective utilization of other factors depends upon the efficiency of human
resource.
Meaning
Human Resource Accounting (HRA) means to measure the cost and value of the people (i.e. of
employees and managers) in the organization. It measures the cost incurred to recruit, hire, train
and develop employees and managers.
HRA also finds out the present economic value of its employees and managers. After measuring
the cost and value of its employees and managers, the organization prepares a report. This report
is called HRA Report. It is shown to the top level management. It can also be shown to the
employees, managers and outside investors.
Definition of HRA
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According to American Accounting Association, "HRA is the process of identifying and
measuring data about human resources and communicating this information to interested
parties."
Objectives of HRA
The objective of HRA is not merely the recognition of the value of all resources used by the
organisation, but it also includes the management of human resource which will ultimately
enhance the quantity and quality of goods and services.
The main objectives of HR Accounting system are as follows:
To furnish cost value information for making proper and effective management
decisions about acquiring, allocating, developing and maintaining human resources in
order to achieve cost effective organisational objectives.
To monitor effectively the use of human resources by the management.
To have an analysis of the human assets i.e. whether such assets are conserved,
depleted or appreciated.
To aid in the development of management principles. and proper decision making for
the future by classifying financial consequences of various practices.
In all, it facilitates valuation of human resources recording the valuation in the books
of account and disclosure of the information in the financial statement.
It helps the organization in decision making in the following areas:
Advantages of HRA
1. Information for manpower planning
HRA provides useful information about the cost and value of human resources. It shows
the strengths and weakness of the human resources. All this information helps the
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managers in planning and making the right decisions about human resources. Thus HRA
provides useful information for Manpower Planning and Decision Making.
2. Information for making personnel policies
HRA provides useful information for making suitable personnel policies about
promotion, favorable working environment, job satisfaction of employees, etc.
3. Utilization of human resources
HRA helps the organization to make the best utilization of human resources.
4. Proper placements
HRA helps the organization to place the right man in the right post depending on his
skills and abilities.
5. Increases morale and motivation
HRA shows that the organization cares about the employees and their welfare. This
increases their morale and it motivates them to work hard and achieve the objectives of
the organization.
6. Attracts best human resources
Only reputed organizations conduct HRA. So, competent and capable people want to join
these organizations. Therefore, HRA attracts the best employees and managers to the
organization.
7. Designing training and development programmes
HRA helps the organization to design (make) a suitable training and development
programme for its employees and managers.
8. Valuable information to investors
HRA provides valuable information to present and future investors. They can use this
information to select the best company for investing their money.
Limitations of HRA
1. Employee Mobility is Very High
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The valuation of human assets is based on the assumption that the employees are going to
remain with the organization for a specified period. However, this assumption is wrong
because employee mobility is very high.
Valuations is Not Done Correctly
The human resource accounting may lead to the dehumanization in the organization. If
the valuation is not done correctly or the results of the valuation are not used properly.
No uniform standards for HRA
In the case of financial accounting, there are certain specified accounting standards which
every organization must follow. However, there are no standards for HRA. Each
organization has its own standards for HRA. So, there are no uniform standards for
HRA. Therefore, the HRA of two organizations cannot be compared.
No Specific Guidelines
There are no specific and clear cut guidelines for 'cost' and 'value' of human
resources of an organization. The present valuation systems have many limitations.
Value is Uncertain
The life of a human being is uncertain. So its value is also uncertain.
Position of HRA in India
In India, very few companies use HRA. HRA is not compulsory in India. Infosys
Technologies and BPL are the leading companies in India, which use HRA. HRA reports
give useful information to the company management, employees and investors.
Methods of HRA Accounting
1. Historical cost method:
This approach was developed by William C. Pyle and R.G. Barry corporation, Ohio (USA) in
1967.
o
According to this method, the cost of human resources is measured on the basis of
actual cost incurred for it.
o
It is the cost for recruitment, training and developing the human resources of the
organization. The present cost for recruitment and training of human resources
who are already employed will not be considered by this method.
2. Replacement Method
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o
In this method, the cost of HR is ascertained on the basis of the cost required to
replace the entire employees of a concern.
o
This cost will be definitely high when compared to the actual cost of recruitment,
training and development.
This method was suggested by Rensis Likert.
o
o
According to him, there may be situation where all employees may leave the and
only chairman of the concern may exist. In such a situation there is a need for the
concern to recruit all new employees.
3. Opportunity cost method
o
Also known as Market value method.
o
Hekimian and Jones suggested the concept of opportunity cost for valuing human
resources in a company. Opportunity cost means the most profitable opportunity
cost that was foregone due to the adoption of this method. Or the next probable
alternative with low cost.
o Opportunity cost for valuing human resources is based on the chance for the
selection of the employees in other departments of the same organisations or in
other organizations. If the employees have the chance of being selected in other
places, the remuneration of that better place has been foregone by them due to the
present employment. According to this method the value of the employees are
assessed on the basis of the foregone better remuneration.
o
The opportunity cost method is possible only when there is scarcity of qualified
people. This method is not a popular one for valuing the human resources of a
company.
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