Unit 01

Theoretical Framework of Accounting

Introduction to Accounting

Accounting is the systematic process of recording, analyzing, and interpreting financial

transactions of a business or organization. It provides valuable information about a company's
financial performance, enabling informed decision-making by stakeholders.

Accounting, which has been called the "language of business", measures the results
of an organization's economic activities and conveys this information to a variety of users,
including investors, creditors, management, and regulators

Meaning of Accounting

Accounting is the process of identifying, measuring, recording, classifying,

summarizing, analyzing, and reporting financial transactions of a business or organization.

It involves the systematic and comprehensive recording of financial transactions

pertaining to a business, and it plays a crucial role in various aspects of management, including
financial planning, decision-making, and evaluating the financial health of an entity.

Accounting provides essential information for stakeholders, such as investors,

creditors, and government agencies, to make informed decisions about the organization

Definitions of Accounting

The American institute of certified public accountants has defined accounting as "the
art of recording, classifying and summarizing, in a significant manner and in terms of money,
transactions and events which are, in part at least, of a financial character, and interpreting the
results thereof"

In the words of Batman and Durbin "accounting maybe defined as the identifying,
measuring, recording and communicating of financial information"

Objectives of Accounting

 To maintaining proper records of business transaction

 To ascertaining the profits or loss of the business
 To knowing the sources of revenue and the items of expenses
 To ascertaining of the financial position of the business
 To ascertaining the amounts due to the business and the amounts due from the business
 To ensuring effective control over the performance of the business
 To protection of the properties of the business
 To prevention of errors and frauds
 To satisfying legal requirements
 To making financial information available to various group of persons

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Scope of accounting

The scope of accounting is vast and essential for businesses and organizations of all
sizes. Some key aspects of the scope of accounting:

Financial Accounting: Involves preparing financial statements like the balance sheet,
income statement, and cash flow statement. These statements provide an overview of a
company's financial health.

Management Accounting: Helps management make internal decisions by providing

detailed reports and analysis. It includes budgeting, cost accounting, and performance evaluation.

Auditing: Ensures the accuracy of financial records. Internal auditors work within
organizations, while external auditors provide independent assessments.

Tax Accounting: Focuses on preparing tax returns and ensuring compliance with tax
laws and regulations.

Forensic Accounting: Involves investigating financial discrepancies and fraud.

Forensic accountants analyze financial data to uncover illegal activities.

Government and Non-Profit Accounting: Encompasses accounting practices

specific to government agencies and non-profit organizations, which have different reporting
requirements than for-profit businesses.

International Accounting: Deals with accounting standards and practices across

different countries and international organizations.

Environmental Accounting: Focuses on the environmental impact of business

activities and helps companies assess their environmental costs and performance.

Social Responsibility Accounting: Involves evaluating and reporting a company's

social and ethical performance, including its efforts related to corporate social responsibility.

Accounting plays a crucial role in decision-making, resource allocation, and ensuring

the financial integrity of businesses and organizations. It continues to evolve with advancements in
technology, regulations, and global business practices.

Uses /advantages / importance of accounting information

Accounting information is crucial for various purposes in businesses and
organizations:
Maintenance of permanent records of business: When a concern keeps
accounting records of its financial transaction, it has permanent records of its transaction for
present and future reference.

Financial Reporting: Companies use accounting information to prepare financial

statements like balance sheets, income statements, and cash flow statements. These reports
provide a snapshot of the company's financial health and performance.

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 Decision Making: Managers and stakeholders use accounting data to make informed
decisions. It helps in evaluating the financial implications of different options and choosing the
most viable one.

Budgeting and Planning: Accounting information aids in budgeting, allowing

businesses to plan their expenses, investments, and revenue targets. This is vital for setting
organizational goals.

Taxation: Accurate accounting is necessary for calculating and filing taxes.

Businesses use financial data to determine their tax liabilities and ensure compliance with tax
laws.

Documentary evidence: Claims against a business by its creditors, and claims by

the business against its debtors can be easily established and proved in courts of law by producing
accounting records as evidence.

Prevention of errors and frauds: Accounting records enable a business concern to

detect errors and frauds that have take place in its business and take steps to prevent their
recurrence

Investor Relations: Investors analyze financial statements to assess the profitability

and stability of a company before investing. Publicly traded companies use accounting information
to communicate their financial health to shareholders.

Performance Evaluation: Companies use accounting information to assess their own

performance over specific periods. Key performance indicators (KPIs) derived from financial data
help in this evaluation.

Credit Decisions: Lenders and creditors use accounting information to evaluate a

borrower's creditworthiness. They assess financial ratios and trends to determine the risk
associated with lending money.

Costing: Accounting information helps in determining the cost of products or services.

This is crucial for setting prices that cover costs and generate profits.

Auditing: External auditors use accounting records to verify the accuracy and fairness
of financial statements. Internal auditors also rely on accounting data to assess internal controls
and ensure compliance.

Forecasting: Historical accounting data can be analyzed to make future predictions.

Businesses use forecasting for financial planning and strategizing.

In essence, accounting information serves as the backbone for sound financial

management, aiding businesses in making strategic decisions, complying with regulations, and
fostering trust among stakeholders.

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Parties interested in accounting information/users of accounting

Owners are shareholders Prospective or potential investors Debenture holders

Creditors Customers General public
Management Employees Government
Consumers Stock exchange Security or investment analysts
Economist and researchers Commercial banks and other financial institutions

Accounting process
The accounting process involves a series of steps that businesses follow to record, analyze,
and report financial transactions. Here's a brief overview of the key steps in the accounting process:

1. Identifying Transactions:

The process begins with identifying and recognizing business transactions. These can include sales,
purchases, expenses, and other financial activities.

2. Recording Transactions:

Once transactions are identified, they need to be recorded in the accounting system. This typically
involves journal entries, where each transaction is recorded in the appropriate accounts using double-entry
accounting principles.

3. Classifying Transactions:

Transactions are then classified into different accounts, such as assets, liabilities, equity, revenue, and
expenses. This helps organize financial information for analysis and reporting.

4. Summarizing Transactions:

The recorded transactions are summarized periodically (usually at the end of an accounting period) to
create trial balances. Trial balances ensure that debits equal credits, helping to identify errors.

5. Adjusting Entries:

Adjusting entries are made to account for items such as accrued expenses, prepaid expenses,
depreciation, and other adjustments needed to accurately reflect the financial position of the business.

6. Preparing Financial Statements:

Based on the adjusted trial balance, financial statements such as the income statement, balance sheet,
and cash flow statement are prepared. These statements provide a snapshot of the company's financial
performance and position.

Basis of accounting

The basis of accounting refers to the underlying principles or rules that govern how
financial transactions are recognized, recorded, and reported in a company's financial statements.
There are two primary bases of accounting: cash basis and accrual basis.

A) Cash Basis of Accounting:

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 Under the cash basis, transactions are recorded when actual cash exchanges hands.
Revenue is recognized when payment is received, and expenses are recorded when payments
are made. This method is straightforward and easy to apply for small businesses but may not
provide a complete picture of a company's financial performance and position.

B) Accrual Basis of Accounting:

The accrual basis is more widely used in business and is considered generally
accepted accounting principles (GAAP) in many jurisdictions. Under this method:

a) Revenue Recognition: Revenue is recognized when it is earned, regardless of

when the payment is received. This means that sales are recorded when
products or services are delivered, and the right to receive payment is
established.
b) Expense Recognition: Expenses are recorded when they are incurred, rather
than when they are paid. This includes recognizing costs associated with goods
or services received, even if payment is deferred.

The accrual basis aims to provide a more accurate representation of a company's

financial performance and financial position, aligning with the matching principle. The matching
principle states that expenses should be matched with the revenues they help to generate in a
given accounting period.

In summary, while the cash basis focuses on actual cash transactions, the accrual
basis recognizes revenues and expenses when they are earned or incurred, providing a more
comprehensive view of a company's financial activities.

Accounting terminologies

Transaction or business transaction

The term transaction refers to any event which is measured in terms of money and
which changes the financial position of the business concern

Entity

The term entity means something or someone having a separate existence

Proprietor owner

Proprietor is the person who invests money or money’s worth into the business as
capital and bears all the risks of the business

Equity

Equity means the claims against the assets of an enterprise or rights in the assets of
an enterprise

Capital

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 Capital is the amount of money or money’s worth say, stock of goods, furniture,
machinery etc., invested or introduced by the proprietor into his business at the time of the
commencement of the business is called capital

Drawing

Drawings refers to cash, goods or any other assets withdrawn by the proprietor from
his business for his personal ,private or domestic use or purpose

Assets

The term asset is derived from latin word ‘assez’ which means enough. So literally
asset mean enough or sufficient economic resources owned by a business concern for carrying on
the business

Liability

The term liabilities derived from the French word ‘liar’ which means to ‘bind’ so literally
liability means claim of outsiders us against a business concern which bind the business concern
to others.

Debtor

Debtor is a person who owes money to the business. He owes money to the business
because he has received some benefit from business.

Creditor

Creditor is a person to whom the business owes money. the business owes money to
him, because he has given some benefit to the business

Solvent

A businessman is said to be solvent when he is able to pay his liabilities in full

Insolvent

A businessman is said to be insolvent when he is not able to pay his liabilities in full

Goods

Goods refers to merchandise ,commodities, products, articles are things in which a

trader deals. In other words they refer to commodities or thing meant for resale.

Expenses

Expenses are the costs incurred in connection with the earnings of revenue.

Loss:Loss refers to money or money's worth giving up without getting any benefit in return.

Branches of Accounting

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 Accounting is a broad field with various branches, each serving specific purposes in
financial management and reporting. Here are some key branches of accounting:

Financial Accounting:

Purpose: To prepare financial statements for external users, such as investors, creditors, and
regulators.

Key Activities: Recording financial transactions, preparing income statements, balance sheets, and
cash flow statements.

Managerial Accounting:

Purpose: To provide information for internal management decision-making.

Key Activities: Cost accounting, budgeting, performance analysis, and forecasting to assist
managers in planning and control.

Cost Accounting:

Purpose: To track and analyze the costs associated with producing goods or services.

Key Activities: Identifying, measuring, and allocating costs to products or services to facilitate
better pricing and cost control.

Tax Accounting:

Purpose: To ensure compliance with tax regulations and optimize tax liabilities.

Key Activities: Calculating income tax, preparing tax returns, and advising on tax planning
strategies.

Auditing:

Purpose: To independently examine and verify financial information to ensure accuracy and
compliance.

Key Activities: External auditors review financial statements, internal auditors assess internal
controls and risk management.

Forensic Accounting:

Purpose: To investigate financial discrepancies and fraud.

Key Activities: Tracing funds, analyzing financial records, and providing evidence in legal
proceedings.

Governmental Accounting:

Purpose: To account for public funds and ensure transparency in government financial activities.

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Key Activities: Budgeting, financial reporting, and compliance with government accounting
standards.

Nonprofit Accounting:

Purpose: To track and report financial information for nonprofit organizations.

Key Activities: Fund accounting, compliance with accounting standards for nonprofits, and
reporting to donors and regulatory bodies.

International Accounting:

Purpose: To address accounting issues in the global business environment.

Key Activities: Adhering to international accounting standards (IFRS), managing currency

exchange, and dealing with cross-border transactions.

Social Accounting:

Purpose: To assess and communicate an organization's social and environmental impact.

Key Activities: Measuring and reporting on social responsibility, sustainability, and ethical
practices.

These branches collectively contribute to the overall financial health and management
of organizations, catering to the diverse needs of stakeholders and regulatory requirements.

ACCOUNTING PRINCIPLES

A principal is rule of action or guide to action. So accounting principles are broad

guidelines or rules of action to be adopted for the preparation of accounts and for the presentation
of financial statements.

Traditionally Accounting principles have been classified as accounting concepts and

accounting conventions

A.Accounting concepts

The term concept means an idea or thought. So accounting concepts are the
fundamental ideas are basic assumptions underlying the theory and practice of accounting.

Important accounting concepts are as follows

 Money measurement concept

 Separate entity concept
 Going concern concept
 Cost concept
 Dual aspect concept
 Accounting period concept
 Objective evidence concept
 Realisation concept
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  Accrual concept
 Matching concept

Money measurement concept

Money measurement concept means that in accounting a record is made only of those
transaction or events which can be measured and expressed in terms of money

Separate entity concept/business entity concept

Every business undertaking whether it is jointstock company or partnership firm or a sole

trading concern is regarded as a distinct unit or entity apart from the owners who won it and so the
business and the proprietors who won the business are regarded as two separate entities capable
of entering into transactions with each other.

Going concern concept or concept of continuity

Enterprise is regarded as going concer(concern that will continue to operate for a indefinitely
long period of time). It means that a business enterprise will continue to operate for a fairly long
period of time

Cost concept

An asset acquired by a concern is recorded in the books of accounts at cost (that is at the price
actually paid for acquiring the asset).The market price of the asset is ignored.

Dual aspect concept

Every business transaction always results in receiving of some benefit of some value and
giving of some other benefit of equal value. 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

Assets=liability+capital

Accounting period concept/periodicity concept

Accounting period concept means 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 period and profit or loss and financial position of the business are
ascertained at the end of the accounting period by preparing financial statement.

Objective evidence concept

This concept means that all accounting entries should be evidenced and supported by
source document or business documents or business documents such as invoices , voucher etc

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Revenue realisation concept or revenue recognition concept 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 consider to be realised only when goods or services are transferred
to a customer and the customer becomes leglly liable to pay for them.

Accrual concept

The accrual concert means that when a transaction has been entered into, its
consequences will certainly fallow, so all transactions must be brought into record whether they
are settled in cash or not.

Matching concept

Profit is a result of two factors revenue and expenses. so for the measurement of
determination of the profit oloss these two factors are matched or compared and the resultant
balance is taken as the net profit or net loss.

B.Accounting convention

Accounting conventions are the customs or practices which have been in force for a
long period and which guide the accountant while preparing financial statement like profit and loss
and the balance sheet. AcCounting conventions are as follows

 Convention of materiallity
 Convention of conservatism
 Convention of consistency
 Convention of full disclosure

Convention of materiality

The convention of materiality means that in accounting a detailed record is made only
of those business transactions which are material that is significant to the users of accounting
information .

Convention of conservatism

The convention of conservatism means the convention of caution prudence or the

policy of playing safe. In the accounting records and the financial statements of a business all the
prospective losses, risk and uncertainty should be taken note of and provided for but prospective
profit should be ignore.

Convention of consistency

The convention of consistency means that the accounting practice and methods
should remain consistent from one accounting year to another

Convention of full disclosure

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The convention of full disclosure means that the material facts must be disclosed in the financial statements with
sufficient details

TYPES OF ACCOUNTS

1. Personal accounts

Personal accounts are accounts of persons with whom a concern carries on business.
Personal accounts may be:

 Natural Personal Accounts, i.e., accounts of human beings, e.g., Ram’s accounts, Sitaram’s
Account, Janakiram’s Account, Balaram’s Account etc.
 Artificial Personal Accounts, i.e., accounts of artificial or legal persons, i.e., accounts of
partnership firms, companies, clubs, associations, banks, schools and colleges etc.
 Representative Personal accounts, i.e., accrued expenses account, outstanding expenses
account, prepaid expense account, accrued incomes, outstanding incomes account

Debit the receiver And Credit the giver

2. Real, Asset or Property Accounts

Real accounts are accounts of properties, assets or things owned by a concern and in
and with which the business is carried on. Real or assets accounts may be:

 Accounts of tangible assets

Such as goods account, cash account, furniture account, vehicles account, machinery
account, buildings account, land account etc.

 Accounts of Intangible assets

Such as goodwill account, patent rights account, copyrights account and trademarks
account.

Debit what comes in And Credit what goes out

3. Nominal or Fictitious Accounts

Nominal or fictitious accounts are accounts of the expenses and losses which a
concern incurs and incomes and gains which a concern earns in the course of its business. These
accounts are called nominal accounts, because they do not really exist and they cannot be seen or
touched. Nominal accounts may be:

 Revenue or income accounts, i.e., accounts of revenues, incomes, gains or

profits, such as commission earned, interest received, discount received etc.
 Expenses accounts, i.e., accounts of expenses or losses such as salaries paid,
rent paid, discount allowed, bad debts etc.

Debit all expenses and losses And Credit all incomes and gains
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ACCOUNTING STANDARDSs

Accounting standards are in the form of authoritative statements issued by the

competent authorities showing how particular types of transactions should be accounted for in the
financial statements. Consequently, compliance with these accounting standards is mandatory to
ensure that the financial statements present a true and fair view.

Definition

According to accounting standard committee of United Kingdom, the Generally

Accepted Accounting Principles (GAAPs) are a group of accounting standards that are widely
accepted as appropriate to the field of accounting. Accounting standards are necessary so that
financial statements are meaningful across a wide variety of businesses; otherwise the accounting
rules of different companies would make comparative analysis almost impossible.

Objectives of Accounting Standards

 To standardize accounting methods and procedures for all different and major accounting
issues.
 To lay down principles for the preparation and presentation of financial statements.
 To establish benchmark for evaluating the quality of financial statements prepared by the
enterprises.
 To ensure that the users of financial statements receive reliable and comparable financial
information.
 To ensure uniformity in the preparation and presentation of financial reports across the
countries.

Importance of Accounting Standards

 Essentials of accounting standard

Accounting standards are generally accepted principles for recording and reporting business
transactions. Authorities which issue these standards require the companies to adhere to all
provisions of all applicable accounting standards. Besides the accounts prepared by the
organizations should be certified by the qualified and independent auditors to the effect that all
accounting standards have been complied with by the organizations.

 Comparability

Supreme to the role of accounting standards is the universality that is brings to financial record
keeping. Governmental organizations must follow accounting procedures that are the same as
their counterparts, and non governmental organizations must do the same. The result is that it is
easy to compare the financial standing of similar entities.

 Transparency

Accounting standards are designed to enforce transparency in the organizations. The principles,
procedures and standards that make up the Generally Accepted Accounting Principles were

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chosen with the objective ensuring that organizations lean in the direction of openness when
deciding how to provide information to users.

 Relevance

Standards help entities the relevant information in the most reasonable was possible. In this way,
an organization, guided by accounting standards, generates the kind of financial information that
users are most interested in examining. Entities ultimately should provide information in a way that
most fairly and clearly represents the current financial standing of the information.

 Investor Protection

Accounting standards protect the interest of investors and ensure that the financial documents
investors receive and review are accurate and authentic. Investors usually want to know that the
money they put into a company results in a return on investment and build shareholder value.

 Regulatory compliance

In many cases, business concerns must adhere to Accounting standards set by the regulators.
These standards protect both consumers and investors from the risk of fraud by the business
enterprises. They also ensure transparency in transactions which improves the efficiency of
markets.

 Assessing business performance

Using consistent Accounting standards is one way to provide business managers with the ability to
reasonably and accurately assess their performance. Further, as different companies use the
same Accounting standards, the business that opt to do so are able to contrast their froth with that
of competitors.

 Stakeholders

Ultimately, the importance of accounting standards lies in the value that it brings of financial
documents for different stakeholders who review and make critical decisions based on the financial
statements and reports.

List of Indian Accounting Standard

IND AS NO. NAME OF THE INDIAN ACCOUNTING STANDARD

Ind AS 1 Presentation of Financial Statements
Ind AS 2 Inventories
Ind AS 7 Statement of Cash Flows
Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors
Ind AS 10 Events occurring after Reporting Period
Ind AS 11 Construction Contracts
Ind AS 12 Income Taxes
Ind AS 16 Property, Plant and Equipment
Ind AS 19 Employee Benefits
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Ind AS 20 Accounting for Government Grants and Disclosure of Government Assistance
Ind AS 21 The Effects of Changes in Foreign Exchange Rates
Ind AS 23 Borrowing Costs
Ind AS 24 Related Party Disclosures
Ind AS 27 Separate Financial Statements
Ind AS 28 Investments in Associates and Joint Ventures
Ind AS 29 Financial Reporting in Hyper inflationary Economies
Ind AS 32 Financial Instruments: Presentation
Ind AS 33 Earnings per Share
Ind AS 34 Interim Financial Reporting
Ind AS 36 Impairment of Assets
Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets
Ind AS 38 Intangible Assets
Ind AS 40 Investment Property
Ind AS 41 Agriculture
Ind AS 101 First time adoption of Ind AS
Ind AS 102 Share Based Payment
Ind AS 103 Business Combination
Ind AS 104 Insurance Contracts
Ind AS 105 Non-Current Assets Held for Sale and Discontinued Operations
Ind AS 106 Exploration for and Evaluation of Mineral Resources
Ind AS 107 Financial Instruments: Disclosures
Ind AS 108 Operating Segments
Ind AS 109 Financial Instruments
Ind AS 110 Consolidated Financial Statements
Ind AS 111 Joint Arrangements
Ind AS 112 Disclosure of Interests in Other Entities
Ind AS 113 Fair Value Measurement
Ind AS 114 Regulatory Deferral Accounts
Ind AS 115 Revenue from Contracts with Customers
Ind AS 116 Leases

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