Unit-1

Nature and Scope of Accounting

DEFINITIONS
Definition of Accounting Definition by the American Institute of Certified
Public Accountants (Year 1961): “Accounting is 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 a financial character, and interpreting the result thereof”

Definition by the American Accounting Association (Year 1966): “The process of

identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounting”.

Accounting process:
(1) Identification: It is the process of identifying and analysing business transactions.
(2) Recording: For recording, we use ‘Journal’ or Subsidiary Books.
(3) Classification of transactions: Classification means segregation of transactions on the
basis of nature and posting them in a format known as Ledger Account.
(4) Summarisation: It includes preparation of Trial Balance and Financial Statements.
(5) Analysis & Interpretation: It includes an assessment of the financial reports and making
some meaningful conclusions.
(6) Communicating information to the users: It includes sharing the financial reports and
interprets results to the users of financial statements.

Objectives of Accounting
(i) Systematic Recording of Transaction
(ii) Ascertainment of Results of above Transactions
(iii) Ascertain the Financial Position of Business
(iv) Providing Information to the Users for Rational Decision-making
BOOK-KEEPING
As defined by Carter, ‘Book-keeping is a science and art of correctly recording in books-of
accounts all those business transactions that result in transfer of money or money’s worth’.
Book-keeping is an activity concerned with recording and classifying financial data related to
business operation in order of its occurrence
Book-keeping is a mechanical task which involves:

 Collection of basic financial information.

 Identification of events and transactions with financial character
 Measurement of economic transactions in terms of money.
 Recording financial transactions in order of its occurrence.
 Classifying effects of economic transactions.
 Preparing organized statement known as trial balance

Difference between Book Keeping and accounting

Basis Bookkeeping Accounting
It refers to the process of identifying,
It refers to identifying and
recording, classifying, summarizing,
Meaning recording monetary
interpreting and communicating
transactions.
financial transactions.
The accounting process involves the
Preparation of Preparing financial statements
preparation of financial statements
Financial does not fall under the
such as Trading, Profit and Loss A/c
Statements purview of bookkeeping.
and Balance Sheet.
It provides sufficient and accurate
Helps in It does not provide sufficient
data for helping in the decision-
Decision making data for decision making.
making process.
Bookkeeping does not require It helps in the process of analysis of
Analysis
any analysis of data. data.
Financial It does not depict the financial It clearly depicts the financial
position position of the business. position of the business.
It requires a high level of skills for
Requirement of No high level of skills is
analyzing the financial data and using
skill needed.
it for decision making.
ACCOUNTING CYCLE
When complete sequence of accounting procedure is done which happens frequently and
repeated in same directions during an accounting period, the same is called an accounting
cycle.
Steps/Phases of Accounting Cycle The steps or phases of accounting cycle can be developed
as under:
(i) Recording of Transaction: As soon as a transaction happens it is at first recorded
in subsidiary book.
(ii) Journal: The transactions are recorded in Journal chronologically.
(iii) Ledger: All journals are posted into ledger chronologically and in a classified
manner.
(iv) Trial Balance: After taking all the ledger account closing balances, a Trial Balance
is prepared at the end of the period for the preparations of financial statements.
(v) Adjustment Entries: All the adjustments entries are to be recorded properly and
adjusted accordingly before preparing financial statements.
(vi) Adjusted Trial Balance: An adjusted Trail Balance may also be prepared.
(vii) Closing Entries: All the nominal accounts are to be closed by the transferring to
Trading Account and Profit and Loss Account.
(viii) Financial Statements: Financial statement can now be easily prepared which will
exhibit the true financial position and operating results.

Advantages of Accounting

1. Maintenance of business records

It records all the financial transaction pertaining to the respective year systematically in the
books of accounts. It is not possible for management to remember each and every transaction
for a long time due to their size and complexities.
2. Preparation of financial statements
Financial statements like Trading and profit and loss account, Balance Sheet can be prepared
easily if there is a proper recording of transactions. Proper recording of all the financial
transactions is very important for the preparation of financial statements of the entity.
3.Comparison of results
It facilitates the comparison of the financial results of one year with another year easily. Also,
the management can analyze the systematic recording of all the financial transactions
according to the policies of the entity.
4. Decision making
Decision making becomes easier for management if there is a proper recording of financial
transactions. Accounting information enables management to plan its future activities, make
budgets and coordination of various activities in various departments.
5. Evidence in legal matters
The proper and systematic records of the financial transactions act as evidence in the court of
law.
6. Provides information to related parties
It makes the financial information of the organization available to stakeholders like owners,
creditors, employees, customers, government etc. easily.
7. Helps in taxation matters
Various tax authorities like income tax, indirect taxes depends on the accounts maintained by
the management for settlement of taxation matters.
8. Valuation of business
For proper valuation of an entity’s business accounting information can be utilized. Thus, it
helps in measuring the value of the entity by using the accounting information in the case of
sale of the entity.
9. Replacement of memory
Proper recording of accounting transactions replaces the need to remember transactions.

Disadvantages:

Expresses Accounting information in terms of money

Non-financial transactions cannot be given effect to in books of accounts. Only transactions of
financial nature are measurable by the accountant. In fact, financial transactions are expressed
in terms of money.

Accounting information is based on estimates

There are some accounting data which are based on estimates. Thus, inaccuracy in estimates is
possible.

Accounting information based on personal judgment

Accountants personal influence affects the accounting information of the entity. Different
methods of inventory valuation, depreciation methods, treatment of revenue and capital
expenses etc can be adopted by the accountant for measurement of income of the entity.
Hence, the income arrived in certain cases might be incorrect due to the lack of objectivity.

Based on historical cost

There can be a difference between the original cost and current replacement cost of a fixed
asset due to efflux of time, change in technology etc. Thus, the balance sheet may not show
the true financial status of an entity.

Suffer from window dressing or Manipulation of Accounts

Management of business may present the financial statement to suit their own requirement by
showing more or less profit than true and fare profit.

Money as a measurement unit changes in value

Stability in the value of money is not possible. Accounting information will not show the true
financial position if changes in the price level are not considered.
Generally Accepted Accounting Principles
Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted
for recording and reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements.
Accounting Principle can be classified into two parts:
(a) Accounting concepts
(b) Accounting conventions

Accounting concepts
Accounting concepts are basic rules, assumptions and conditions that define the parameters
and constraints within which the accounting operates.
Various concepts are given below
1 Business Entity Concept: The concept of business entity assumes that business has a
distinct and separate entity from its owners. It means that for the purposes of accounting,
the business and its owners are to be treated as two separate entities. Keeping this in view,
when a person brings in some money as capital into his business, in accounting records, it is
treated as liability of the business to the owner.
2 Money Measurement Concept: The concept of money measurement states that only
those transactions and happenings in an organisation which can be expressed in terms of
money such as sale of goods or payment of expenses or receipt of income, etc., are to be
recorded in the book of accounts. All such transactions or happenings which
3 Going Concern Concept The concept of going concern assumes that a business firm would
continue to carry out its operations indefinitely, i.e. for a fairly long period of time and
would not be liquidated in the foreseeable future. This is an important assumption of
accounting as it provides the very basis for showing the value of assets in the balance sheet.
4 Accounting Period Concept Accounting period refers to the span of time at the end of
which the financial statements of an enterprise are prepared, to know whether it has
earned profits or incurred losses during that period and what exactly is the position of its
assets and liabilities at the end of that period
5 Cost Concept The cost concept requires that all assets are recorded in the book of
accounts at their purchase price, which includes cost of acquisition, transportation,
installation and making the asset ready to use. To illustrate, on June 2005, an old plant was
purchased for ` 50 lakh by Shiva Enterprise, which is into the business of manufacturing
detergent powder. An amount of ` 10,000 was spent on transporting the plant to the factory
site. In addition, ` 15,000 was spent on repairs for bringing the plant into running position
and ` 25,000 on its installation. The total amount at which the plant will be recorded in the
books of account would be the sum of all these, i.e. ` 50,50,000.
6 Dual Aspect Concept Dual aspect is the foundation or basic principle of accounting. It
provides the very basis for recording business transactions into the book of accounts. This
concept states that every transaction has a dual or two-fold effect and should therefore be
recorded at two places. In other words, at least two accounts will be involved in recording a
transaction.
7 Revenue Recognition (Realisation) Concept With this concept, accounts recognise
transactions (and any profits arising from them) at the point of sale or transfer of legal
ownership - rather than just when cash actually changes hands. For example, a company
that makes a sale to a customer can recognise that sale when the transaction is legal - at the
point of contract. The actual payment due from the customer may not arise until several
weeks (or months) later - if the customer has been granted some credit terms.

8. Accrual Concept: According to this concept Items and Events are recoded when they are
earned/expended and not received/paid. Because of this concept Outstanding/ Prepaid
items arise in the financial statement. The general concept of accrual accounting is that
economic events are recognized by matching revenues to expenses (the matching principle)
at the time when the transaction occurs rather than when payment is made or received.
9. Matching Concept: Here, it is ascertained that every cost incurred to earn the revenue
should be recognised as an expense in the accounting period when revenue is earned. In a
given accounting period, expenses are matched with the revenue earned.

10. The verifiable objective concept: The verifiable objective concept states that accounting
should be free from personal bias.

Accounting Conventions
Four important types of accounting conventions are:
1. Conservatism: It tells the accountants to err on the side of caution when providing
the estimates for the assets and liabilities, which means that when there are two
values of a transaction available, then the always lower one should be referred to.
2. Consistency: A company is forced to apply the similar accounting principles across
the different accounting cycles. Once this chooses a method it is urged to stick with
it in the future also, unless it finds a good reason to perform it in another way. In the
absence of these accounting conventions, the ability of investors to compare and
assess how the company performs becomes more challenging.
3. Full Disclosure: Information that is considered potentially significant and relevant is
to be completely disclosed, regardless of whether it is detrimental to the company.
4. Materiality: Similar to full disclosure, this convention also bound organizations to
put down their cards on the table, meaning they need to totally disclose all the
material facts about the company. The aim behind this materiality convention is that
any information that could influence the person’s decision by considering the
financial statement must be included.
Accounting Standards (AS)

Accounting Standards (AS) are basic policy documents. Their main aim is to ensure
transparency, reliability, consistency, and comparability of the financial statements. They do so
by standardizing accounting policies and principles of a nation/economy. So the transactions of
all companies will be recorded in a similar manner if they follow these accounting standards.
These Accounting Standards (AS) are issued by an accounting body or a regulatory board or
sometimes by the government directly. In India, the Indian Accounting Standards are issued by
the Institute of Chartered Accountants of India (ICAI).
Accounting Standards mainly deal with four major issues of accounting, namely

i. Recognition of financial events

ii. Measurement of financial transactions
iii. Presentation of financial statements in a fair manner
iv. Disclosure requirement of companies to ensure stakeholders are not
misinformed

Objectives of Accounting Standards

1. Transparency,
2. Reliability,
3. Consistency, and
4. Comparability

Benefits of Accounting Standards

Accounting Standards are the ruling authority in the world of accounting. It makes sure that the
information provided to potential investors is not misleading in any way. Let us take a look at
the benefits of AS.
1] Attains Uniformity in Accounting
Accounting Standards provides rules for standard treatment and recording of transactions.
They even have a standard format for financial statements. These are steps in achieving
uniformity in accounting methods.
2] Improves Reliability of Financial Statements
There are many stakeholders of a company and they rely on the financial statements for their
information. Many of these stakeholders base their decisions on the data provided by these
financial statements. Then there are also potential investors who make their investment
decisions based on such financial statements.
So it is essential these statements present a true and fair picture of the financial situation of
the company. The Accounting Standards (AS) ensure this. They make sure the statements are
reliable and trustworthy.
3] Prevents Frauds and Accounting Manipulations
Accounting Standards (AS) lay down the accounting principles and methodologies that all
entities must follow. One outcome of this is that the management of an entity cannot
manipulate with financial data. Following these standards is not optional, it is compulsory.
So these standards make it difficult for the management to misrepresent any financial
information. It even makes it harder for them to commit any frauds.
4] Assists Auditors
Now the accounting standards lay down all the accounting policies, rules, regulations, etc in a
written format. These policies have to be followed. So if an auditor checks that the policies
have been correctly followed he can be assured that the financial statements are true and fair.
5] Comparability
This is another major objective of accounting standards. Since all entities of the country follow
the same set of standards their financial accounts become comparable to some extent. The
users of the financial statements can analyze and compare the financial performances of
various companies before taking any decisions.
Also, two statements of the same company from different years can be compared. This will
show the growth curve of the company to the users.
6] Determining Managerial Accountability
The accounting standards help measure the performance of the management of an entity. It
can help measure the management’s ability to increase profitability, maintain the solvency of
the firm, and other such important financial duties of the management.
Management also must wisely choose their accounting policies. Constant changes in the
accounting policies lead to confusion for the user of these financial statements. Also, the
principle of consistency and comparability are lost.

Limitations of Accounting Standards

There are a few limitations of Accounting Standards as well. The regulatory bodies keep
updating the standards to restrict these limitations.
1] Difficulty between Choosing Alternatives
There are alternatives for certain accounting treatments or valuations. Like for example, stocks
can be valued by LIFO, FIFO, weighted average method, etc. So choosing between these
alternatives is a tough decision for the management. The AS does not provide guidelines for
the appropriate choice.
2] Restricted Scope
Accounting Standards cannot override the laws or the statutes. They have to be framed within
the confines of the laws prevailing at the time. That can limit their scope to provide the best
policies for the situation.

List of Indian Accounting Standards

  Indian Accounting Standard (Ind AS) 1: Disclosure of Accounting Policies
 Indian Accounting Standard (Ind AS) 2: Inventories
 Indian Accounting Standard (Ind AS) 3: Cash Flow Statements
 Indian Accounting Standard (Ind AS) 4: Contingencies and Events Occurring
after the Balance Sheet Date
 Indian Accounting Standard (Ind AS) 5: Net Profit or Loss for the Period, Prior
Period Items and Changes in Accounting Policies
 Indian Accounting Standard (Ind AS) 6: Depreciation Accounting
 Indian Accounting Standard (Ind AS) 7: Statement of Cash Flows
 Indian Accounting Standard (Ind AS) 8: Accounting for Government Grants
and Disclosure of Government Assistance
 Indian Accounting Standard (Ind AS) 9: Revenue Recognition
 Indian Accounting Standard (Ind AS) 10: Accounting for Fixed Assets
 Indian Accounting Standard (Ind AS) 11: Construction Contracts
 Indian Accounting Standard (Ind AS) 12: Income Taxes
 Indian Accounting Standard (Ind AS) 13: Accounting for Investments
 Indian Accounting Standard (Ind AS) 14: Segment Reporting
 Indian Accounting Standard (Ind AS) 15: Employee Benefits
 Indian Accounting Standard (Ind AS) 16: Borrowing Costs
 Indian Accounting Standard (Ind AS) 17: Leases
 Indian Accounting Standard (Ind AS) 18: Related Party Disclosures
 Indian Accounting Standard (Ind AS) 19: Leases
 Indian Accounting Standard (Ind AS) 20: Provisions, Contingent Liabilities and
Contingent Assets
Recent Updates to Indian Accounting Standards

 AS 18 – The revised version of the Indian Accounting standard AS 18 has been

published. It deals with the recognition and measurement of related party
transactions.
 AS 15 (revised) – In accordance with the Companies Act, 2013, a revised
version of the Indian Accounting standard AS 15 has been published. It deals
with Employee Benefits, which includes both short and long-term benefits.
 AS 31 – The Indian Accounting standard AS 31 has been revised to align with
the requirements of the Companies Act, 2013. It deals with the disclosure of
associated entities.
 AS 19 – The revised version of the Indian Accounting standard AS 19 has been
published. It deals with leasing arrangements, and provides greater clarity on
how to account for such transactions.
 AS 25 – The Indian Accounting standard AS 25 has been revised to provide
greater clarity on the disclosure of contingent liabilities.
 AS 20 – The revised version of the Indian Accounting standard AS 20 has been
published. It deals with the recognition, measurement and disclosures of
government grants and other incentives.

Management Accounting
Definition of Management Accounting

The Institute of cost and Management Accountants, London, has defined Management Accounting
as, "the application of professional knowledge and skill in the preparation of accounting information
in such a way as to assist management in the formulation of policies and in planning and control of
the operation of the undertaking."

According to R.N Anthony, " Management Accounting is concerned with accounting information
that is useful to management

OBJECTIVE OF MANAGEMENT ACCOUNTING

The main objectives of management accounting are as follows:

1. To formulate Planning and policy Planning involves forecasting on the basis of available
information, setting goals; framing polices determining the alternative courses of action and
deciding on the program of activities. It facilitate the preparation of statements in the light of past
results and gives estimation for the future.

2. To interpretation of financial documents Management accounting is to present financial

information to the management. Financial information must be presented in such away that it is
easily understood. It presents accounting information with the help of statistical devices like charts,
diagrams, graphs, etc.

3. To assist in Decision-making process Management accounting makes decision-making process

more scientific with the help of various modern techniques. Information/figure relating to cost,
price, profit and savings for each of the available alternatives are collected and analyzed accordingly
which will provide a base for taking sound decisions.

4. To help in control Management accounting is a helpful for managerial control. Management

accounting tools e.g. standard costing and budgetary control are helpful in controlling performance.
Cost control is affected through the use of standard costing and departmental control is made
possible through the use of budgets. Performance of each and every individual is controlled with the
help of management accounting.

5. To provide report Management accounting keeps the management fully informed about the
latest position of the concern through reporting. It helps management to take proper and quick
decisions. It informs the performance of various departments regularly to the top management.

6. To Facilitate Coordination of Operations Management accounting provides tools for overall

control and coordination of business operations. Budgets are important means of coordination.

Nature of Management Accounting

(i) Mainly concerned with future : Planning is the process of looking ahead by taking the
reference of the past. The process of management accounting is driven towards the
future course of action with proper planning based on the analytical financial details
other past. It considers the budgets to forecast the future revenue and expenditure and
inflow and out follow of funds.
(ii) Recent origin: Management accounting has been well recognized in the modern
business houses due to increasing customer base and market complexity. Modern
 managerial decisions need much quantitative organized information rather traditional
form of financial statements for making effective decisions.
(iii) Management need oriented: Management Accounting is highly personalized service
and Subjective in nature. It is basically intended for the use of internal managerial
decisions. It provides necessary information as per the need of the management in the
required format and ensures that the information’s are sufficient to make effective
decisions.
(iv) Information as per Management need: There is no hard and fast rule in the preparation
of management reports and statement, it always as per the situational requirement of
the management and based on the availability of the data for analysis and
interpretation.
(v) Provides data and not the decisions: Management accounting discipline is not an
replacement of management. It provides just information to the managerial decisions. It
facilitates decisions since majority of the decisions are made considering the facts and
figures provided by the management accountants. But at the same time these data itself
cannot form the decisions of the management.
(vi) Objective oriented: Management accounting present data in such a way that it enables
the management to formulate policies and programme so as to achieve the managerial
or organizational goals in most efficient and effective manner.
(vii) Financial and cost accounting information: Management accounting is all about the
analysis and interpretation of financial and cost accounting data, to generate such
reports and statements which can prove useful to management in decision making.
(viii) Increases efficiency: Management accounting is concerned with providing, the needed
information to the Management in the proper manner and assisting in the policy
formulation and managerial control. This enables the management to increase efficiency
of its operation and ensures the optimum profits with minimum operational risk

Limitations of Management Accounting

1. Data Dependency Management accounting derives information from Financial accounting, Cost
accounting and other sources. So, the conclusions arrived at by management accountants depend to
a large extent on the accuracy of these two (Financial accounting and Cost accounting) records.
Therefore, if the past data which are collected from the financial and cost records are found
inaccurate, the decisions suggested by the management accountants, on the basis of the above, also
will be inaccurate.

2.Does not give the decision Management accounting cannot replace the decisions. It can just assist
the management in its operations through providing necessary analytical statements and advises
management for better and efficient managerial functions.

3. Costly affair Installation and maintenance of Management accounting system is suitable for
those concerns which has significant amount of transactions generally large establishments. before,
small concerns cannot afford to adopt this system.

4. No standardization as other disciplines Management accounting is still in the development stage.

So it has to face the problems fluidity of concepts, improvement of techniques etc. It does not have
any strong principles like financial accounting and cost accounting. It does not follow any set rule
and hence differs in its practices.
 5. Danger of misleading The information Provided by Management accountants cannot be taken as
full proof information for making any managerial decisions. Because the data used by
managementaccountants itself may have window dressed data due to which the management
accounts may mislead the management

6. Needs human involvement for interpretation Management accounting involves people to make
final reports or interpretations, due to which the interpretation may be of the personal opinion of
the person Who has prepared it. It creates differences in the interpretations and becomes more
subjective rather than objective in the analysis

Difference between Financial Accounting and Management Accounting

Basis Financial Accounting Management Accounting

1 Users Mainly intended to serve external
users like shareholders, bankers,
creditors and government
Legality Statutorily compulsory as per
different acts such as companies
act of 1956 income tax act of
1961etc
Development It is well developed and very old
system in practice
Subject matter It deals with preparation of
financial statements through
systematic recording and
determines the financial position
of a concern.
Standard There is specific standard for
Preparation as per the act and
reports are practice.
Dependency It is an independent discipline.
Publications It is compulsory to publish the
financial reports of the concern.
Statement and Generally Trading and profit and
report prepared loss account and balance sheet
are prepared
Consideration It considers only monetary
transactions.
Auditing Audit of books of accounts by a
qualified charted accountant is
compulsory
Mainly intended to serve internal
users like management
Not compulsory
It is of recent development
It deals with presentation of
needed information for
management for effective
decisions.
Preparation of statements and
reports are not standardized
It is an inter dependent.
It is not compulsory.
It prepares the funds and cash
flow statement, budgetary
reports, ratio statements etc,
It sometime considers non
monetary aspect also like quality,
machine hours, number of people
working etc
It is not necessary to get audited
the records of management
accounting,