DISCUSSION OF VARIOUS ACCOUNTING CONCEPTS 1. MONEY MEASUREMENT CONCEPT OR COMMON DENOMINATOR CONCEPT Meaning of Money Measurement Concept: — The money measurement concept implies that, in accounting, a record is made of only those transactions or events which can be measured and expressed in terms of money. Non-monetary events (i.¢.,events which cannot be measured and expressed in terms of money) like the retirement of the managing director of a concern, the good quality of the products produced by the concern, the team-work that is found in the concern, the poor health of the production manager of the concern, etc, are not recorded, though they arg also material events, as they cannot be measured and expressed in terms of money. This concept also implies that business transactions are recorded in the books of account in terms of the value of money at the time the transactions are recorded. Subsequent changes in the value of Money cr the purchasing power of money are ignored. In other words,business transac! thi of ie value money is always stable recorded on the presumption ne a enefits of This Coneene v7e8 NOt change from time The benefits of this co (i) An important Benen ctie Bre: : tit helps e concern to express diveraa tee, Measurement concept |$ oe tock-in- ade, furniture, machinery, bullae Such as bank balance: & mon . . in m fenominator, viz., money, and add thon so on in terms of 2 owing eee! worth of assets of a concern at Se ee But for this ces Bao adding up the diverse items, which exist in different forms. will fog ae: For instance, if a concern has bank balance of Rs. 1 0,000, iaghingwess of stock in-trade, 2 computers and 10 steel cabinets. 5 vis mon and 2 buildings, in the absence of a common denominator, ae Fale these diverse items cannot be added up to give any ee Beanies end useful figure. But if they are expressed in terms of money Rs. 38 aaa lance of Rs.10,000, stock-in-trade of Rs. 50,000, furniture of machine (computers of Rs. 20,000 + steel cabinets of Rs. 18,000), add ry of Rs. 50,000 and buildings of Rs. 4,00,000, it is possible to up the values of all these assets and to state the total worth of the assets of the business as Rs. 2,48,000. (ii) Another advantage of this concept is that, because of recording business transactions in terms of the value of money at the time the transactions are entered into on the assumption that the value of money does not change from time to time, assets acquired on different dates ar be easily added up for the purpose of knowing their total worth on any ate. Limitations of This Concept: 2 The money measurement concept suffers from certain limitations. They are: (i) As only monetary transactions are recorded in account books, and no record is kept of non-monetary events, accounting records do not give a complete picture of all the happenings in a concern. (ii) The recording of business transactions in terms of the value 0} money at the time they (i.e., the transactions) are entered into on thi assumption that the value of money remains always stable and does no} change from time to time is not realistic in these days of rising prices ang falling values of money all over the world.2. SEPARATE ENTITY CONCEPT, BUSINESS ENTITY CONCEPT, ECONOMIC ENTITY CONCEPT OR ACCOUNTING ENTITY CONCEPT eaning of This Concept: Legally, only a joint stock company is a distinct entity or unit apart from the shareholders who own it. But the business entity concept means that, in accounting, every business undertaking, whether itis ajoint stock company or a partnership firm or a sole trading concern, is regarded as a distinct unit or entity apart from the owners who own it, and So, the business and the proprietors who own the business are regarded as two separate entities capable of entering into transactions with each other. ~ ‘This concept also means that, as the business and the proprietors of the business are two separate entities, the transactions of the business are distinguished from those of the proprietors, and in the books of the business, only the transactions of the business, and not the private transactions of the proprietors, are recorded. Benefits of This Concept: This concept offers a number of benefits. They are: (@) Because of this concept, the transactions of a business are recorded in the books of the business from the point of view of the business. (b) Because of this concept, in the books of the business, only the transactions of the business are recorded. The personal affairs or transactions of the owners of the business are not recorded in the books of the business. As the business is regarded as a separate entity or party quite separate from the owners of the business as per this concept, there could be dealings between the business and the proprietor of the business, and those transactions (i.e., the transactions between the business and the proprietor of the business) are also recorded in the books of the business. It is on account of this concept that ~ the capital invested by the proprietor in the business is regarded as money borrowed by the business from the proprietor of the business, and is shown on the liabilities side of the balance sheet of the business. Again, it is on account of this concept that the drawings of the proprietor (i.e., the amounts withdrawn by the proprietor from the business) are regarded as amounts due from M ©the proprietor to the business, and are deducted from proprietor: capital on the liabilities side of the balance sheet of the busines, (d) Because of this concept, the profit or loss of the business can 5, easily and correctly ascertained. () Because of this concept, the financial position of the business c;, be ascertained easily and accurately. (f) This concept has contributed to responsibility accounting. p extending the business entity concept to the various departmen; of a concern, and by maintaining separate accounting records , the transactions of each of the departments of the concern, a cle; picture of the profit or loss of each of the departments of the conce ry can be obtained, and each department can be held responsible f, its business results. 3. GOING-CONCERN CONCEPT OR CONCEPT OF CONTINUITY Meaning of This Concept: a The going-concern concept means that, in accounting, a, enterprise is regarded as a going-concern (i.e., a concern that wil continue to operate for an indefinitely long period of time). There j; neither the intention nor:the necessity to wind’ up the concern in the foreseeable future. It may be noted that this. concept does not mear permanent continuance of a business. All. that it means is that; business enterprise will continue to operate for a fairly long periog of time. EEE ; ae Benefits of This Concept: / : The benefits of this concept are as follows: ee (a) The going-concern concept is a fundamental accounting assumptior underlying the preparation of financial statements of a concer That is, it is on. the basis. of this concept or assumption that the annual financial statements of a concern are prepared. This concept, makes a distinction between revenue expenditure: and capital expenditures possible and meaningful. It is only wher this assumption is made, and accounts are prepared for a period¢ one year for a concern which is assumed to have a fairly long lite that some expenditures (i.e., those expenditures whose bene! will be exhausted within a year) can be regarded as reven expenditures, and others (i.e., those expenditures whose bene’ will last for many years) can be regarded as capital expenditures If this assumption is not made, and accounts are prepared on thé ©assumption that a concern will last just for a short period of one year, then, all expenditures have to be treated as revenue expenditures, and the question of distinction between revenue expenditures and capital expenditures will not arise. It is because of this concept that assets are classified as fixed (c) assets and current assets, and liabilities are classified as fixed liabilities and current liabilities, (@) This concept compels an accountant to give proper attention to the process of determination of expenses and incomes to be taken to the current year. (@) It is because of this concept (i.e., because it is assumed that a business enterprise will not be sold or wound up, but will continue to operate for an indefinite period) that fixed assets are valued for the purpose of balance sheet at their cost prices, and their market values or saleable values are not taken into account. () Itis because of this concept that the working life of fixed assets is estimated and is taken into account, while calculating the depreciation to be provided on the fixed assets every year. It is because of this concept that outstanding expenses and outstanding incomes, and prepaid expenses and pre-received incomes (i.e., incomes received in advance) are adjusted (i.e., taken into account), while preparing the final accounts of aconcern. Itis because of this assumption that outsiders enter into long-term contracts with the firm, say, give long-term loans to the firm and ~ = jnvest money on the debentures of that concern. (i) This concept has given birth to the accounting period concept. 4. COST CONCEPT OR HISTORICAL COST CONCEPT Meaning of This Concept: The cost concept means that an asset acquired by a concern is recorded in the books of accounts at cost (i.e., at the price actually paid for acquiring the asset). The market price of the asset is ignored, and it is its cost price that forms the basis for all subsequent accounting for that asset. The cost concept is of relevance only for fixed asset current assets, in the sense that only the fixed assets are balance sheet at cost, and the current assets are, generally, balance sheet, not at their cost price, but at cost price or mar! whichever is lower. @) (ny) s, and not for shown in the shown in the ‘ket price,It should be noted that the cost concept does not mean pie ASs. of a business should appear in its books at their cost ee aes ie as long as they are owned by the concern. What it (enti * the assets should appear in the books of a concern a’ i ct Brice: the time of their acquisition, and in subsequent years, they should app. at their cost prices less depreciation written off to date. : The recording of a fixed asset in the books of a business at its c- price (i.e., the cost concept) is justified on many grounds. First, ca price is the actual price that is agreed upon by both the parties te contract, i.e., the purchaser and the seller. So, there is some object, F as regards the cost price. Secondly, the cost concept prevents aconce. | from giving arbitrary value to an asset. Thirdly, the practice of record) assets at cost contributes to true accounting records. Lastly, the cos: an asset is stable, while its market price is variable, Benefits of Cost Concept: The benefits of cost concept are as follows: (a) Inthe absence of the cost concept, the fixed assets of a busine: have to be valued, taking into consideration their market value: every year when financial statements are prepared. This wou make the preparation of annual financial statements difficult. (b) The cost concept makes the estimation (i.e., the calculation) < depreciation on fixed assets easy.in the sense that, for th estimation of depreciation on an asset, only its cost price ar expected working life are required to be taken into account. (c) This concept supports the view that depreciation is a process ¢ allocation of the cost of an asset over its working life, and not Process of valuation (i.e., consideration of the market value of th: asset). Limitations: This concept suffers from the following limitations: 1. Both fixed assets and current assets are acquired at cost. Bu | es) under this concept, only fixed assets are shown at cost..Currer assets are shown at cost price or market price, whichever.is lowe Under this concept, market prices of fixed assets are ignored. Thé means, balance sheet indi cates the financial position only on.cos basis, P ONY ON. (5. DUAL-ASPECT CONCEPT, EQUATION CONCEPT OR ACCOUNTING EQUATION CONCEPT meaning of This Concept: Every business transaction always results in receiving of some benefit of some value and giving of some other benefit of equal value. For instance, when a business purchases goods for cash, it receives goods of some value and gives cash of equal value. Similarly, when it sells gods for cash, it receives cash of some value and gives goods of equal value. Thus, every business transaction involves dual or double aspects of equal value. So, in accounting, a record is made of the dual or two aspects of each transaction, and this is called dual-aspect concept. The dual aspect concept can also be explained in another way. Each transaction of a concern has dual or double effects, viz., (a) an increase in the assets and a corresponding increase in the liabilities or the proprietor’s capital or (b) a decrease in the assets and a corresponding decrease in the liabilities or the proprietor’s capital or (c) a decrease in some assets and a corresponding increase in some other assets without any change in the liabilities or (d) a decrease in some liability and a corresponding increase in some other liabilities without any change in the assets. For instance, when the proprietor invests some capital in the business, there is an increase in the assets of the business and there is also acorresponding increase in the proprietor’s capital. When the business buys some goods on credit, there is an increase in the assets of the business, and there is also a corresponding increase in the liabilities of the business. When the proprietor withdraws some amount from the business for his private expenses, there is a decrease in the assets of the business, and there is also a corresponding decrease in the proprietor’s capital. When the business pays off one of its creditors, there is a decrease inthe assets of the business and there is also a corresponding decrease in the liabilities of the business. If the business sells goods for cash, there is a decrease in one asset, viz., goods, and there is a corresponding increase in another asset, viz., cash. When the business gives a promissory note or a bill payable to one ofits creditors, there is a decrease in one liability, viz., creditors, and there is a corresponding increase in another liability, viz., bills payable. Thus, each business transaction undertaken by aconcern has a two-fold effect, an effect on its assets on the one hand and an effect on its liabilities or the proprietor’s capital on une other; or an effect on some asset or assets and an equal effect onsome other asset or assets, or an effect on some liability or liabilities a an equal effect on some other liability or liabilities. As such us transaction will always result in equality of assets and liabilities plus capita and at any point of time, the total assets of the concern will be equal to it total liabilities plus the proprietor’s capital. In short, in the books ofan business, at any moment of time, assets = liabilities + Proprietor’, Capital. This equation is called accounting equation. The accounting equation, assets = liabilities + capital, given above can also be expressed in two other ways, They are: 1. Assets - liabilities = Capital 2. Assets - Capital = Liabilities Benefits of This Concept: The benefits of this concept are follows: (@) The dual aspect concept is very useful in accounting. It forms the very basis for recording every business transaction in the books o| _ 4 concern. Evety transaction is recorded on the basis of this concept (b) The accounting equation, Assets = Liabilities + Capital, is based on this concept. 3 : (c) The principle of double-entry system, ‘every. debit has a corresponding credit, and vice'versa’ is based on this concept (d) This concept facilitates the preparation of trial balance, which helps in detecting the errors committed by the account clerks and in having strict control over them. ‘ y i. (e) Again, the accounting equation, assets-liabilities = capital, helps a concern to determine its profit or loss. At any point of time, the capital of the proprietor of a business is its assets minus its liabilities On the basis of the above accounting equation, the capital of the proprietor can be calculated at various points of time, say, at the beginning of the accounting year and at the end of the accounting year. The capital of the proprietor calculated at two different points of time (viz., at the beginning of the accounting year and at the enc of the accounting year) can be compared and the net profit or ne . loss of the business during the accounting year can be easily . ascertained. If the proprietor's capital at the end of the accountine year is more than his capital at the beginning of the accountingtal hand: Hiker, can be taken as the profit for the year. On the year is less th ba ete capital at the end of the accounting the diffe an his capital at the beginning of accounting year, rence can be taken as the loss for the year. 6. ACCOUNTING PERIOD CONCEPT OR PERIODICITY OF ACCOUNTS Introduction: The accounting period concept or the idea of periodicity of accounts comes from the going-concern concept. According to the going-concern concept, a business is likely to continue for an indefinitely long period of time. AS such, the financial results of the business operations of a concern (i.e. the profit or loss and the financial position of a concern) can be ascertained only on the liquidation or closure of the business. It is true that such results (i.e., the financial results ascertained on the liquidation of abusiness) are quite accurate. But the ascertainment of the profit or loss and the financial position of a business only on its liquidation will not serve any useful purpose. It will not be helpful in knowing the periodical progress or performance of the concern. Further, it will not be helpful to the business in taking corrective steps at the appropriate time to improve the periodical performance of the concern. Again, such an indefinite waiting for business results and distribution of profits on liquidation will discourage investors from investing funds in the business. Moreover, income-tax law requires business undertakings to calculate their profits yearly for purposes of taxation. Above all, for the purpose of reporting to outsiders like creditors, banks and other lenders of money, profits are required to be calculated and financial position is required to be ascertained yearly and are to be reported to them annually. Thus, for various reasons, the financial results of a business are required to be ascertained at periodic intervals. This has given rise to accounting period concept. Meaning of Accounting Period Concept: The accounting period concept means that, for measuring the financial results of a business periodically, the business or working life'of an undertaking is split into convenient short periods of time called'accounting periods, and profit or loss and financial position of the business are ascertained at the end of each accounting period by preparing financial statements. The length of the accounting period depends on the nature of the business and the needs of the proprietor of the business. The accountingsix months, one year or even more than on, is regarded as the ideal accounting perig, d is also recognised by law. In fact, tp, pulsory under the Companies Act a, i: unting period is, often, referreg,, tion Law, That is why, the acco! J Sete aepeunting year. The ‘accounting year may be the elle cen * (ie., from 1st January to 31st December, of every year) or the finang, ae of the Government (i.e., from 1st April of ayear to 31st March of th, ment yest) or any other year of twelve months, say, Dassera year, Deepay,, year, etc. Benefits of Accounting Period Concept: The benefits of accounting period concept are as follows: (a) The accounting period concept is responsible for the preparation , the financial statements of a business enterprise annually. (b) It aims at disclosing the periodical financial results (i-e.; the proj, or loss and the financial position) of a business annually at the er, of every accounting period. period may be three months, ; year. But, usually, one year is The one-year accounting perio one-year accounting period is com (c) The accounting period concept is also responsible for the preparatio, Of the financial statements on accrual basis, taking into’ accoun all outstanding expenses and incomes, and prepaid expenses an; pre-received incomes. ie: (d) This concept.facilitates the comparison of profit and financie Position of one year.with those of another yéar, and such - comparison helps the management in planning and in improving the efficiency of the business. ; 7. OBJECTIVE EVIDENCE CONCEPT Meaning of This Concept: This concept means that all evidenced and su documents, accounting entries should be pported by source documents or business suchas invoices, vouchers, etc. This concept also means that i.e., must state the fact: and must be subject to verificati Iti f eee he accounting entries are Supported by objective!) Nces, which are Subject to verification by auditors, th?accounting records will be accepted by various grou f le ii in accounting information with confidence. aebeligan rao Benefits of This Concept: The benefits of this concept are: (a) This concept has contributed to objective and true accounting records and financial statements. (b) Because of this concept, the accounting records and the financial statements of business concerns.will be accepted by various groups of people interested in accounting information with confidence. (oc). This concept reduces the scope for manipulation of accounts. (@. This concept reduces the scope for the personal judgment of the accountant. 8. REVENUE REALISATION CONCEPT OR REVENUE RECOGNITION CONCEPT Meaning of This Concept: The revenue realisation concept means that revenue is earned from the sale of goods or from provision of services to customers, and revenue is to-be recognised.or considered to be realised only when. goods or,services are transferred to a customer.and the customer becomes legally liable to pay for them. So, when an orderis received froma customer, it does not mean that revenue is realised or earned. Even if an.advance payment. is received from a customer, the same cannot be treated as revenue realised or earned. Benefits of This Concept: . The benefits of this concept are as follows: 4. This concept ensures that there can be no profit without the sale of goods or provision of services. It is because of this concept that when an order is just received from a customer, revenue is not recognised, i.e., not taken as earned, until the order is executed, and the customer legally becomes liable for the goods sold to him. 2, This concept also ensures that unearned or unrealised revenue should not be taken into account in the computation of profit. It is -) because of this concept, when an advance payment for goods is received from a customer, the same Is not treated as revenue realised or earned. 3. This concept prevents the recording incomes which art management from inflating profits by e not realised (i.e., not earned).ji ‘| 4. This concept facilitates correc estimate of income of a b eines . This e : fe S his concept gives objectivity and definiteness to reven een ACCRUAL CONCEPT f This Concept: , iti f revenue: Bena ae concept is concerned with the recognition of : The acc! and expenses. ansaction has been The accrual concept means that more follow. So, alt entered into, its et ee ace whether they are settleq transactions must be brought into ntant must treat as revenues in cash or not. It suggests that an accou ; receive, although all those items for which there is the legal right to a ; A i That means, if a revenue cash might not have been received for them. 1 ), it should is earned (i.e., when there is the legal right to receive arevenus ‘This a be regarded asa revenue, even if no paymentis received for it. peso means that, if some revenue is received, but not earned (.e., there is no legal right to receive), the revenue received in advance should be treated asa liability, and not as a revenue, Similarly, an accountant must treat as expenses all those items for which there is the legal obligation to Pay, evenif cash is not Paid for them. That means, if an expense is incurred (i.e., there is the legal obligation to pay), it should be treated as an expense, even if no payment is made for it. This also means that, if some payment is made, but no expense is incurred (i.€., there is No legal obligation to pay), the payment made in advance should be treated .88 an asset, and not as an expense. Benefits of Accrual Concept: ,_ The benefits of the accrual concept are as follows : se i i i yr This Concept has led to the introduction of accrual system of cash system of accounting. ae reat help for the Preparation of financia\ (c) This Concept has given sound Tecognition of revenues angactually paid” has made the ac ‘ take into account the total revere Soca nenees congatn i accounting year (i.e., the revenues earned and received duiia ine accounting year plus the revenues earned but not received dicing the accounting year), and the total expenses accrued or incurred during the accounting year (i.e., the expenses incurred and paid during the accounting year plus the expenses incurred, but not paid during the accounting year), while preparing the financial statements for an accounting year. Again, itis the accrual concept which has suggested to the accountant ofaconcern that, in case the revenues actually received during a particular accounting year include some revenues not yet earned for the accounting year (ie. relate to the next accounting year), the revenues received, but not yet earned during the accounting year should be adjusted (i.e., deducted) from the total revenues received during the accounting year, and similarly, if the expenses actually paid during a particular accounting year include some expenses not due for the year (i.e., relate to the next year), the expenses paid, but not due for the year should be adjusted (ie., deducted) from the total expenses paid during the accounting year. (0). Itis because of the accrual concept, which has given rise to accrual system of accounting as against cash system of accounting, interest on capital, interest on drawings, depreciation, provisions and reserves, which are not paid or received in cash, are made, and are taken into account, while preparing the financial statements every year. 10. MATCHING CONCEPT OR PERIODICAL MATCHING CONCEPT Profit is the result of two factors or items, viz., (i) revenues and (ii) expenses. So, for the measurement or determination of the profit or loss, these two factors are matched (i.e., compared), and the resultant balance is taken as the net profit or the net loss. If the revenues exceed the expenses, the resultant balance is taken as the net profit. On the other hand, ifthe expenses exceed the revenues, the resultant balance is taken as the net loss. Thus, the net profit or net loss of a business is determined by matching the expenses with the revenues. aca AY be noted that the matching concept implies appropriete ieee of related revenues and expenses. That means, only Oe €d during a particular accounting period for earning the revenues Oo}the related period should be considered for the computation of profit o, loss for that period. The process of matching revenues and costs involves the following steps: (a) Identification and measurement of revenues for the accounting period. (b) Identification and measurement of the expenses incurred during the accounting period for earning the revenues. (c) Matching or comparing of appropriate revenues with the relevant expenses and ascertaining the net profit or net loss for the accounting period. Benefits of This Concept: The benefits of this concept are : (a) It ensures proper recognition of revenues and expenses required | for matching expenses with revenues. (b) It provides a sound basis, viz., the accrual basis, for the ee of the correct profit or loss of the business for’aDISCUSSION OF VARIOUS ACCOUNTING CONVENTIONS 1, CONVENTION OF MATERIALITY The convntion of materiality. means that, in accounting, a detail tecord is made only of those business transactions which are materi (i.e., significant) to the users of accounting information. No detaile record need be made of transactions which are trivial (i.e., insignificant as the work of recording the minute details of such transactions is no justified by the usefulness of the results. In the case of such trivia transactions, only a broad view is taken. Let us consider as to how z trivial transaction is recorded in the books of account.:A new penci purchased and supplied to the office is, no doubt, an asset for the concem. Every day when someone in the office writes with the pencil,a portion o the pencil is used up, and, as such, the value of the pencil decreases. Theoretically, it is possible to ascertain daily the part of the pencil used} up and the part that remains. But the cost of such an effort will be ver high. So, in accounting, a simpler, though less exact, treatmentis giver to the pencil. The pencil is taken as used up at the time it is purchased o| at the time it is issued to the office. This does not affect the amo profit or loss of the firm materially. Alternatively, the insignificant may be merged with material facts.bruiser ne rationale behind the materiality principle is that, if every business action (i.e., material as well as insignificant transaction) is recorded inthe books of account, accounting records will be unnecessarily burdened with unnecessary details. For the same reason, while showing the amounts of various items in nancial statements, the amounts can be approximated to the nearest nearest ten or nearest hundred. This does not make much trans} thefi rupee OF ! gifference for the assessment of the firm's perforrnance and financial position. itmay be noted that the convention of materiality is relative, because whatis material for a small concern may not be material for a big concern. Forinstance, costs of small items of tools are material (i.e., quite important) for a small repair workshop, but they are not material for a big steel factory. In this context, it is necessary to know the meaning of materiality- The American Accounting Association (AAA) defines materiality as follows: “An item should be regarded as material, if there is reason to believe that knowledge of it would influence the decision of informed investor”. According to Welseh and Anthony, principle of materiality must be followed without exception for each transaction when the amount involved in the transaction is material, i.e., significant in relationship to the overall financial effect.” Eric Kohler defines materiality as “the characteristic attaching to a statement, fact or item whereby its disclosure or the method of giving it expression would be likely to influence the judgement ofa reasonable person.” 2. CONVENTION OF CONSERVATISM The convention of conservatism means the convention of caution, prudence or the policy of playing safe.In other words, it means that, inthe accounting records and the financial statements ofa business, allthe prospective losses, risks and uncertainties should be taken note of and provided for, but prospective profits should be ignored. In short, "provide for all possible losses, but anticipate no profits" is the implication of this principle. It is on account of this principle that provision for doubtful debts, provision for discount on debtors, provision for fluctuations in the prices of investments, provision for taxation, provision for all contingent losses are made and the practice of not recognising “The fundamental accountingappreciation of assets as gains and not recognising revenue until a Say has resulted are followed. Again, it is because of this principle that Sto, in trade is valued at cost price or market price, whichever is lower, : intangible assets like goodwill are written off as early as possible. ; The rationale behind this principle is that future is uncertain. Thoug, an estimate may be made about future events, no one can guess futy,,, with perfect certainty. So, some arrangement or provision must be Mac, to meet future uncertainties. But items of future profits should be ignore, (i.e., should not be taken into account). The implication of this principle is that the financial statements shoul, indicate the actual position. It should not show a better picture by windoy,, dressing by not providing for future contingencies. Significance or Benefits of Convention of Conservatism: An important benefit of the convention conservatism is that it i; important for the measurement of income and for ascertaining the financia, Position of the business. Another benefit of convention of conservatism is that it will check distortion of profit or loss and the possible manipulation of profit or loss figures, Limitations of Convention of Conservatism: The convention of conservatism suffers from certain limitations. They are: () This convention brings inconsistency in the measurement oj business income. (ii) This convention results in concealing the true state of affairs of the business from external or outside users of the accounting data. (iii) This convention violates the principle of full disclosure which requires the accounting reports to be fully and fairly informative for the persons for whom they are meant. 3. CONVENTION OF CONSISTENCY The convention of consistency signifies that the accounting practices and methods should remain consistent (i.e., unchanged) from one accounting year to another. For instance, when once 2 Particular method of depreciaion is adopted for a particular fixed ass¢’ ie same method should be followed for that asset year after year. Similar’: w Key once Stock-in-trade is valued at cost price or market Price, whicheve 'S lower, the same practice should be continued for all the years.he idea behind the consis i P accounting practices and methogs ‘are followee Wom sae rte ‘year compatison of the accounting figures of one year with those of another year would be difficult, and consequently, drawing of conclusions about the progress of the concern over a number of years becomes difficult. It may be noted that, according to Eric Kohler, there are three es of consistency. They are (i) vertical consistency, (ji) horizontal consistency and (iii) third- dimensional consistency or external consistency. Vertical consistency implies that the same accounting rules, policies and practices are adopted while preparing the inter-related financial statements of the same year. For instance, ifa particular method of depreciation is adopted, while preparing the profit and loss account of the year, and the same method of depreciation is used, while preparing the balance sheet of that year, there is said to be vertical consistency. Vertical consistency facilitates the comparison of inter-related financial statements of the same year. Horizontal consistency implies that the same accounting rules, policies and practices are followed by a firm while preparing the financial statements from year to year. Horizontal consitency facilitates inter-period comparison (i.e., comparison of the performance of a firm of one year with its performance of other years). Third-dimensional consistency or external consistency implies that the same accounting rules, policies and practices are followed by all the firms engaged in the same industry (i.e., doing the same kind of business), while preparing their financial statements. Third- dimensional consistency facilitates inter-firm comparison (i.e., comparison of the performance of one firm with the performance of the other firms engaged in the same industry). It should be noted that the principle of consistency does not mean that the accounting treatment of various categories of assets should be consistent with one another. For instance, this principle does not mean that the same method of valuation should be followed for both current assets and fixed assets. What it really means is that, whatever accounting Practice is followed for a particular asset, the same practice should be followed for that asset from year to year.Itmay also be noted that the principle of consistency does NOt pro, iain ae (i e., it does not prohibit a firm from introducing impr, ; Sicbouniing techniailes). This has been rightly pointed out by Yorsy, Smyth and Brown. In the words of Yorston, Smyth and Bro, Consistency serves to eliminate personal bias and evenout pers, d judgement but it must not become a fetish so as to ignore Chang, conditions or need for improvements in techniques". The consistency principle is, generally, followed in the following cag, (i) Methods of depreciation (ii) Valuation of stocks s (iii) Treatment of deferred revenue expenditure ; There are certain exceptions to the consistency principle. The exceptions are: i (i) For valuation of stock (li) For valuation of investments. Advantage of Convention of Consistency: ne The main advantage of this convention is that the scope for manipula; accounting figures is reduced. Limitations : The limitations of this convention are: () This convention means deliberate under-statement of revenues. ‘+>: pessimistic picture of financial position. **(i) Because of this convention. financial statements do not depict “"" true and fair view of the state of affairs of the concern. . (ii) This convention goes against the principle of full disclosure (iv) This convention encourages accountants to create secret rese’ by making excessive Provision for future contingencies. 4. CONVENTION OF FULL DISCLOSURE The convention of full disclosure means that the material facts be disclosed in the financial statements with sufficient details. ’ instance, as regards the investments, not only the various securities by a concern should be disclosed, but also the mode of their valu should be stated, In the case of sun of sundry debtors should be disclo: secured debtors, the amount of Good, but unsecured debtors anc amount of doubtful debts should bi © mentioned. In the case of fixed astheir, cost prices, the depreciation written off to date and their written down value should be disclosed. If there are any contingent liabilities, a rence should be made to them in the balance sheet. Similarly, in the refel profit and loss account, all the expenses and incomes should be clearly stated. ; The idea behind this convention is that the financial statements are lly meant for external users. It is on the basis of the information conveyed by the financial statements that the external users make decisions. As such, the financial statements should disclose all the material facts with as much details as possible. Exclusion of material facts makes the financial statements incomplete and unreliable. The convention of full disclosure has been given recognition by the Companies Act. To ensure that all material facts are disclosed to the shareholders, the Companies Act has prescribed the form of the financial statements to be presented by companies to their shareholders. Apart from legal requirements, good accounting practice also demands that all significant facts should be disclosed in the financial statements. ACCOUNTING STANDARDS Need for Accounting Standards: Accounting is the language of business which communicates, through financial statements, the financial results and performance of an enterprise to various usets of the financial statements. To make accounting, i.e., the language of business, convey the same meaning to all the users of financial statements, and to make the financial statements exhibit a true and fair view of the state of affairs of an enterprise, there arises the need for the adoption of certain accounting standards in the preparation of accounts and in the presentation of financial statements. Meaning of Accounting Standards: Accounting standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions or events for ensuring uniformity in accounting practices and reporting. In other words, accounting standards are the guidelines laid down by an apex expert accounting body as to how business transactions or events are to be recorded in books of account, and the manner in which the business transactions are to be exhibited in the financial statements. Inshort, accounting standards are the norms of accounting policies and practices, by way of codes or guidelines, to direct as to how the essentiali the financial statements shoy ious items which go to make up t i Ba tionted in accounts and disclosed in the financial statements, Objectives or Purposes of Accounting Standards: | F The main objectives of accounting standards are: w) (ii) (iii) (iv) The main purpose of accounting standards is to provide informatio, to the users as to the basis on which the accounts have bee, prepared and the financial statements have been presented. important objective of accounting standards is to Serv fhe ETON purpobe i eliminating the impact of diverse accountin policies and practices and to ensure uniformity in accountin policies and practices, i.e., to harmonise the diverse accounting policies and practices which are in use in the preparation ang Presentation of financial statements. Another objective of accounting standards is to make financig, Statements more meaningful and comparable and to make People Place more reliance on financial statements prepared in conformity with the accounting standards. Yet another objective of accounting standards jis to guide the judgement of professional accountants in dealing with those items which are to be followed consistently from year to year. Importance and Advantages of Accounting Standards: Accour ting standards are of immense help. They have the following advantaces: @ (b) (c) (d) Acc ,unting standards lay down uniform accounting policies ang Practices which are to be followed by all business enterprises in respect of particular transactions or events. If uniform accounting standards are followed by all business concerns in the preparation of accounts and in the presentation of financial statements, the financial statements of various business concerns become comparable. When financial statements are Prepared in accordance with the accounting standards, which are more accurate as compared to customs-based Practices, the financial statements would become more reliable. As accounting standards are formulated and issued by the apex’ expert accounting body in the country, they (i.e., the accounting standards) are more Scientific and rational.As accounting standards in a country are formulated i . ‘i ‘ 1 after taki into consideration the international accounting standards, they (les the accounting standards) ensure the incorporation of the latest trends in accounting in the preparation of financial statements. () Accounting standards would improve the credibility and reliability of accounting information. @) Accounting standards would raise the standards of auditing in its task of reporting on the financial statements and make the chartered accountants ensure commitment and integrity in their profession. (h) Accounting reports produced in accordance with established accounting standards are regarded by Government officials, tax authorities, etc. as quite reliable and acceptable. @) Financial statements, produced on the basis of established accounting standards, will be reliable documents for the purpose of analysis and interpretation by analysts, researchers and consultants for economic forecasting and planning. @) Financial statefments, prepared in accordance with established accounting standards, would be useful to investors in judging the yield and risk involved ‘in alternative investments in different companies and in different countries. (kK) Accounting ‘standards would ¢urb the unlimited flexibility in the adoption of accounting policies and practices. 7 Nature of Accounting Standards: The accounting standards may be recommendatory or mandatory in nature. Generally, the accounting standards are recommendatory in the initial years of their issue, and become mandatory after a certain period of time of their issue, i.e., after they had created requisite awareness amongst the business houses. INTERNATIONAL ACCOUNTING STANDARDS With the objective of formulating international accounting standards for the preparation of accounts and for the presentation of financial statements, the International Accounting Standards Committee (IASC), came into existence on 29th June, 1973 with headquarters at London, when 16 accounting bodies of nine countries, viz., U.S.A, Canada, U.K., France, Germany, Netherlands, Japan, Australia and Mexico, signed the Agreement and Constitution for its formation. In 2001, the IASC was restructured and now it is known as the International AccountingStandards Board (IASB). The accounting standards issued by IASB are called International Financial Reporting Standards (IFRS). The International Accounting Standards Board has more than 140 professional member bodies from more than 100 countries as members at present. (It may be noted that the Institute of Chartered Accountants of India and the Institute of Cost and Works Accountants of India are members of the International Accounting Standards Board.) The International Accounting Standards Board has, so far, issued 41 international accounting standards. Some of these standards are revised. A few of these standards are withdrawn, and new standards on the same are issued. Today, there are 34 international accounting standards in | existence. The International Accounting Standards are intended to harmonise, as far as possible, the diverse accounting policies and standards formulated by the different regulatory bodies of different countries. Of course, within each country, local regulations govern the presentation of financial statements.Financial Accounting, Itis commonly connoted as Accounting. The American Institute of Certified Public Accountants defines Accounting as “an art of recoding, classifying and summarizing in significant manner and in terms of money, SS and events which are of financial character, and interpreting the results thereof.” The first step in the cycle of accounting is to identify transactions that will find place in books of accounts. Transactions having financial impact only are to be recorded. E.g. ifa businessman negotiates with the customer regarding supply of products, this will not be recorded. The negotiation is a deal which will potentially create a transaction which will have exchange of money or money’s worth. But unless this transaction is finally entered into, it will notbe recorded in the books of accounts. Secondly, the recording of the business transactions is done based ‘on the golden rules of accounting (which are explained later) in a systematic manner. Transaction of similar nature are grouped together and recorded accordingly. E.g. Sales transactions, Purchase transactions, cash transactions etc. Orie has to interpret the transaction and then apply the relevant golden rule to'make a correct entry oe Thirdly, as the transactions grow in number, it will be difficult to understand the combined effect of the same by referring to individual records. Hence, the art of accounting also involves the step of summarizing them. With the aid of computers, this task is simplified in today’s accounting though. The summarization will help users of the business information to understand and interpret business results.(BASied OF HooIeKeepingand Kee Q) cos Lastly, the accounting process provides the users with statements which will describe has happened to the business. Remember the two basic questions we talked about, ott know whether business has made profit or loss and the other {o know the position of reson? that are used by the business. —— It can be noted that although accounting is often referred to as an art, itis a science also. This is because it is based on universally applicable set of rules. However, it is not a pure science as there is a possibility of different interpretation. Cost Accounting According to the Chartered Institute of Management Accountants (CIMA), Cost Accountancy is defined as “application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability as well as the presentation of information for the purpose of managerial decision-making.” It isa branch of accounting dealing with the classification, recording, allocation, summarization and reporting of current and prospective costs and analyzing their behaviours. Cost accounting is frequently used to facilitate internal decision making and provides tools with which managementcan appraise performance and control costs of doing business. It primarily involves relating the costs to the different products produced and sold or services rendered by the business. While financial accounting deals with business transactions at a broader level, cost accounting aims at further breaking it up to the last possible level to indentify costs with products and services. It uses the same financial accounting documents and records. Modern computerized accounting packages like ERP systems provide for processing financial as well as cost accounting records simultaneously. We will study this at length later in this study material. This branch of accounting deals with the process of ascertainment of costs. The concept of cost is always applied with reference to a context. Knowledge of cost concepts and their application provide a very sound platform for decision support systems. Cost Accounting aims at equipping management with information that can be used for control on business activities. We will cover these concepts in depth later in this study material. Management Accounting, Management accounting is concerned with the use of financial and cost accounting information to managers within organizations, to provide them with the basis in making informed business decisions that would allow them to be better equipped :in.their management and control functions. Unlike financial accounting information (which, for public companies, is public information), management accounting information is used within an organization (typically for decision-making) and is usually confidential and its access available only to a select few. According to the Chartered Institute of Management Accountants (CIMA), Management Accounting is “the process of identification, measurement, accumulation, analysis, preparation,ation used by management to plan, evaluate and nd accountability for its resources, ancial reports for non management and tax authorities” interpretation and communication of inform: control within an entity and to assure appropriate use of al Management accounting also comprises the preparation of fir groups such as shareholders, creditors, regulatory agencies aims at helping management in formulating, strategies, Basically, management accountin, aa : aking decisions, optimal use of resources, and planning and constructing business activities, m safeguarding assets of business. over years of: research and are basically synchronized tions and.all entities associated with them. We will tisfies various needs of different stakeholders. These branches of accounting have evolved with the requirements of business organizal now see what are they and how accounting sal jek Accounting) The main objective of Accounting is to provide financial information to various interested parties. This financial information is normally given via financial statements, which are prepared on the basis of Generally Accepted Accounting Principles (GAAP). There are various accounting standards developed by professional accounting bodies all over the world. In India, these are governed by The Institute of Chartered Accountants of India, (ICA). In the US, the American Institute of Certified Public Accountants (AICPA) is responsible to lay down the standards. The Financial Accounting Standards Board (FASB) is the body that sets up the International Accounting Standards. These standards basically deal with accounting treatment of business transactions and disclosing the same in financial statements, The following objectives of accounting will explain the width of the application of this knowledge stream: (a) Toascertain the amount of profit or loss made by the business i.e. to compare the income earned versus the expenses incurred and the net result thereof. (b) To know the financial position of the business i.e. to assess what the business owns and what it owes. ( 5 tolls (0) To provide a record for compliance with statutes and laws applicable. (d) To enable the readers to assess progress made by the business over a period of time. (e) To disclose information needed by different stakeholders Let us now see which are different stakeholders of the business and what do they seek from the accounting information. This is shown in the following table,