MODULE I

PREPARATION OF FINANCIAL
STATEMENTS
 UNIT 1
CONCEPTUAL FRAMEWORK
ACCOUNTING : Definition

“ Accounting is a systematic process of

identifying, measuring, recording, classifying,
summarizing, interpreting and communicating
financial information”
ACCOUNTING CYCLE
(PROCESS)
● Identifying Business transactions

● Measuring Assigning monetary values

● Recording Journalizing

● Classifying Posting to ledgers

● Summarizing Final Accounts

● Interpreting Analysis of financial statements

● Communicating Strategic financial information
FINANCIAL ACCOUNTING
● The science and art of recording and classifying
business transactions and preparing summaries
of the same for determining profitability and
financial position of the concern

● 2 principal statements :-
A.Income Statement ( trading& Profit and loss A/c)
B.Position Statement (B/S)
Objectives of financial Accounting
● Recording business transactions systematically

● Calculation of profit/loss

● Depiction of financial position

● Assisting Management
● Assessing the progress of business

● Detecting and preventing errors & frauds

● To file tax returns
● Communicating accounting information
FINANCIAL STATEMENTS
● End products of business transactions, which
act as the sources of information on the basis
of which conclusions about profitability and
financial position are made

● These are the foundation for strategic decision

making by management & other stakeholders

● It mainly comprises of Income statement &

Position Statement
OBJECTIVES OF FINANCIAL STATEMENTS
● To provide reliable information about
A.economic resources & obligations of business
B.profitability of business
C.financial position of business
D.changes in Net resources arising out of business activities
● To provide information that assist in estimating earning
potentials of business
TYPES OF FINANCIAL STATEMENTS
Primarily it consists of 2 basic statements :-
Income statement & Position Statement.GAAP (Generally
Accepted Accounting Principles) specify a complete list as
follows:

● Position Statement (Balance Sheet )

● Income statement (Trading and P&L A/c)
● Statement of retained earnings (P/L appropriation A/c)
● Statement of changes in financial position (Cash flow
Statement & Funds flow statement )
CAPITAL V/S REVENUE
• WE NEED TO CATEGORIZE ITEMS INTO
CAPITAL AND REVENUE NATURE
• ALL ITEMS OF REVENUE NATURE ARE TO
BE SHOWN IN TRADING AND P&L A/C
• ALL ITEMS OF CAPITAL NATURE ARE TO
BE SHOWN IN BALANCE SHEET
I. EXPENDITURE
• ANY PAYMENTS OTHER THAN SETTLEMENT OF AN
EXISTING LIABILITY CAN BE CALLED AS
EXPENDITURE
• AND, IT IS INCURRED FOR DERIVING ANY BENEFITS
TO BUSINESS
• EXPENDITURE MAY BE OF THE FOLLOWING 3
TYPES;
1.CAPITAL EXPENDITURE
2.REVENUE EXPENDITURE
3.DEFERRED REVENUE EXPENDITURE
1.CAPITAL EXPENDITURE
• EXPENDITURE INCURRED IN ACQUIRING FIXED ASSESTS OR IMPROVING
EXISTING ASSESTS WHICH WILL INCREASE THE EARNING CAPACITY OF
BUSINESS

• THE BENEFIT DERIVED WILL BE AVAILABLE FOR MORE THAN ONE

ACCOUNTING YEAR

• EXAMPLES;
PURCHASE OF FIXED ASSESTS,INSTALLATION CHARGES ,PAYMENT
FOR GOODWILL,PATENT ETC, PAYMENT OF WAGES FOR CONSTRUCTION OF
FIXED ASSESTS, COST OF SECOND HAND ASSETS WITH
REPAIRS/OVERHAULING CHARGES

• TREATMENT :
DEBITED TO FIXED ASSETS A/C (ASSETS SIDE OF B/S)
2.REVENUE EXPENDITURE
• EXPENDITURE INCURRED FOR MAINTAINING THE PRESENT LEVEL OF
PROFIT OF BUSINESS.AND DAY-TO-DAY CONDUCT OF BUSINESS

• THE BENEFIT DERIVED WILL BE EXHAUSTED WITHIN THE ACCOUNTING

PERIOD

• EXAMPLES;
PURCHASE OF GOODS/SERVICES,OPERATING EXPENSES LIKE
WAGES,RENT,SALARIESETC., SELLING&DISTRIBUTION EXPENSES, REPAIRS &
DEPRECIATION OF FIXED ASSETS, BAD DEBTS, GENERAL EXPENSES ETC.

• TREATMENT :
DEBITED TO TRADING AND P &L A/C (AS THESE ARE EXPENDITURES OF
CURRENT YEAR)
EXPENSE V/S EXPENDITURE
3.DEFERRED REVENUE EXPENDITURE
• ITS BASICALLY A REVENUE EXPENDITURE IN NATURE BUT IS WRITTEN
OFF OR CHARGED FOR MORE THAN ONE YEAR
• THESE ARE HEAVY EXPENDITURES INCURRED IN THE INITIAL STAGE BUT
ITS BENEFITS ARE ENJOYED FOR MANY YEARS.THATS THE REASON WHY
SUCH EXPENDITURES ARE WRITTEN OF OVER A PERIOD OF TIME

• EXAMPLES;
RESEARCH EXPENDITURE, ADVERTISEMENT EXPENDITURE,
PRELIMINARY EXPENSES ETC.

• TREATMENT :
A PORTION IS DEBITED TO P&L A/C AND THE BALANCE IS SHOWN ON THE
ASSET SIDE AS FICTITIOUS ASSET
II. RECEIPTS
• TOTAL AMOUNT OF MONEY RECEIVED BY A
BUSINESS FROM ALL SOURCES WITHOUT
DEDUCTING ANYTHING AS EXPENSES

• RECEIPTS ARE OF 2
1.CAPITAL RECEIPTS
2.REVENUE RECEIPTS
 1.CAPITAL RECEIPTS
• AMOUNT RECEIVED FROM SALE OF FIXED ASSETS OR ISSUE OF
SHARES/DEBENTURES OR BY RAISING LONG TERM LOANS.

• THESE ARE NON-RECURRING IN NATURE

• EXAMPLES;
CAPITAL BROUGHT IN BY THE PROPRIETOR,LOANS FROM BANK,SALE
OF FIXED ASSETS ETC

• TREATMENT :
SHOWN IN B/S (AS EITHER INCREASE IN LIABILITY / DECREASE IN ASSET)
 2.REVENUE RECEIPTS
• AMOUNT RECEIVED IN NORMAL COURSE OF BUSINESS MAINLY THROUGH
SALES

• THESE ARE RECURRING IN NATURE AND NO OBLIGATION TO REPAY THE

MONEY SO RECEIVED

• EXAMPLES;
SALE OF GOODS/SERVICES, INTEREST/COMMISION/RENT RECEIVED ETC

• TREATMENT :
SHOWN ON THE CREDIT SIDE OF TRADING AND P&L A/C (AS EITHER
INCREASE IN LIABILITY / DECREASE IN ASSET)
III. CAPITAL/REVENUE PROFITS/LOSSES
CAPITAL REVENUE PROFIT CAPITAL LOSS REVENUE LOSS
PROFIT(CAPITAL
GAINS) • IRREGULAR/NON-RE • REGULAR/RECURRI
• IRREGULAR/NON-R • REGULAR/RECURR CURRING NG
ECURRING ING • WHEN MONEY IS • EXCESS OF
• ARISED FROM • EXCESS OF LOST WITH NO REVENUE
TRANSACTIONS REVENUE BENEFITS ,IT IS EXPENDITURE
INCIDENTAL TO RECEIPTS OVER TERMED AS CAPITAL OVER REVENUE
BUSINESS REVENUE LOSS RECEIPTS
• EG ; PROFIT ON EXPENDITURE • EG ; LOSS ON SALE • LOSS FROM
SALE OF FIXED • PROFIT FROM OF FIXED OPERATING
ASSETS,PREMIUM OPERATING ASSETS,GOODS ACTIVITIES
ON ISSUE OF ACTIVITIES LOST BY THEFT,
SHARES, WINNING LOSS ARISING
A COURT CASE, FROM
APPRECIATION IN NON-RECURRING
THE VALUE OF EVENTS ETC
ASSETS ETC
ACCOUNTING PRINCIPLES (POSTULATES)
• SET OF RULES OR GUIDELINES WHICH ARE
DEVELOPED TO ENSURE UNIFORMITY AND EASY
UNDERSTANDING OF ACCOUNTING INFORMATION

GAAP
• GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
• PRINCIPLES,CONCEPTS AND CONVENTIONS USED FOR
RECORDING AND REPORTING BUSINESS
TRANSACTIONS
FEATURES OF ACCOUNTING PRINCIPLES

• MAN-MADE (practical experiences not laboratory

tested)

• FLEXIBLE (changes in Govt.policies,business

environment)

• GENERALLY ACCEPTED (relevant,objective and

feasible)
EXAMPLES :-
MARKET CONDITIONS, DISPUTES AMONG EMPLOYESS, EFFICIENCY OF
MANAGEMENT ETC ARE NOT RECORED
3.
7. REVENUE RECOGNITION
• ALSO KNOWN AS REALISATION CONCEPT
• REVENUE SHOULD BE RECORDED ONLY WHEN IT IS
REALISED

Note:- receiving cash need not be considered as revenue

realization always.

Eg:- a firm sells goods in june 2020 and receives payment only
in november 2020. Here the date of revenue recognition is the
date of sales (june,2020) .As ownership and legal obligation is
transferred at the time of sales and not at the time of payment
(to avoid misstatement of earnings)
10. Objective evidence concept :
o Also known as OBJECTIVITY Principle
o Accounting information should be verifiable and free from bias
o Each recorded transaction should be supported by source documents
ACCOUNTING CONVENTIONS
The disclosures can be in the way of footnotes.to the
financial statemnts
Eg:- contingent liabilities, market value of investments etc.
o Also known as PRUDENCE PRINCIPLE
o EXAMPLES :- PROVISION FOR DOUBTFUL
DEBTS,CLOSING STOCK
o There are no hard and fast rules in order to
differentiate between material and immaterial item. It
is just a matter of judgement and some common
sense
o EXAMPLE :- Suppose a calculator used in business costing Rs 100
can be utilize for say next 8 years. However the effort in order to
allocate its cost over the eight year period is not worth the benefit in
comparison to the benefit derive from its operation. So treat the
expense of calculator in the year it was purchased.
TIPS TO REMEMBER
• ACCOUNTING PRINCIPLES RELATING TO P&L A/C :-
ACCOUNTING PERIOD CONCEPT, ACCRUAL CONCEPT,REALISATION
CONCEPT,MATERIALITY CONCEPT AND MATCHING CONCEPT

• ACCOUNTING PRINCIPLES RELATING TO B/S :-

BUSINESS ENTITY CONCEPT,GOING CONCERN CONCEPT,HISTORIC COST
CONCEPT,MONEY MEASUREMENT CONCEPT ,DUAL ASPECT CONCEPT & CONCEPT OF
CONSERVATISM

• FUNDAMENTAL ACCOUNTING ASSUMPTIONS :-GOING CONCERN

CONCEPT,CONSISTENCY CONCEPT AND ACCRUAL CONCEPT

• GAAP ARE THE PILLARS UPON WHICH STRUCTURE OF ACCOUNTING BUILT

LIMITATIONS OF GAAP

• DIFFICULT TO USE ALTERNATIVE POLICIES AND PRACTICES

• IT IS BASED ON HISTORICAL ACCOUNTING (VALUATION OF

ASSETS)

• ALLOW USE OF PERSONAL JUDGEMENT .(MISLEADING)

• THERE IS NO INDEX OF CONCEPTS ON WHICH ALL THE

ACCOUNTANTS HAVE AGREED

• CONFLICTING PRINCIPLES (going concern vs cost concepts)

MEANING OF ACCOUNTING
STANDARDS

• WRITTEN STATEMENTS CONSISTING OF

UNIFORM ACCOUNTING RULES AND
GUIDELINES ISSUED BY ACCOUNTING
BODY(ICAI)
• ACCOUNTING STANDARDS WILL NEVER
OVERRIDE LAWS OF LAND
ACCOUNTING STANDARDS IN INDIA
NEED FOR ACCOUNTING STANDARDS
(OBJECTIVES)

• TRANSPARENT & MEANINGFUL FINANCIAL REPORTING

• REDUCES ALTERNATIVES IN ACCOUNTING
• UNIFORMITY IN PREPARING FINANCIAL STATEMENTS
• CONSISTENT ACCOUNTING PRACTICES
• TO OFFER SET OF NORMS ON ACCOUNTING
• SETS BOUNDARIES WITHIN WHICH AN ACCOUNTANT CAN
FUNCTION BUT NOT RIGID
NATURE OF ACCOUNTING STANDARDS

• FRAMEWORK OF ACCOUNTING GUIDELINES

• FACILITATES RELIABILITY AND COMPARABILITY
• FLEXIBLE
• CANNOT VIOLATE LAWS OF LAND
• UNIFORMITY
• DESIGN A STANDARD BUSINESS ENVIRONMENT
UTILITY OF ACCOUNTING STANDARDS(BENEFITS)

• IMPROVES RELIABILITY AND CREDIBILITY OF FINANCIAL

STATEMENTS
• UNIFORM GUIDELINES
• ENSURES CONSISTENCY
• COMPARABILITY
• RESOLVES CONFLICTS OF FINANCIAL INTERESTS (ACCEPTABLE
TO ALL PARTIES)
• REDUCES CHANCE OF ERRORS,MANIPULATIONS ETC
• ASSIST AUDITORS
• SIMPLIFIES ACCOUNTING INFORMATION
*********END OF UNIT 1,MODULE 1*************