ACCOUNTANCY CHAPTER 2 (class 11)

ACCOUNTANCY CLASS 11

CHAPTER 2

THEORY BASE OF ACCOUNTING

 THE NEED FOR A THEORY BASE

Information about financial status of the firm is required for various users like owners, managers, employees, investors, creditors, suppliers of goods and services and tax authorities to help them in making decisions. The information available should be reliable as well as comparable. This becomes possible only if the information provided by the financial statements is based on consistent accounting policies, principles and practices. Such consistency is required in accounting the transactions, measuring the communicating them in the books of accounts summarising the results thereof and reporting them to interested parties. This calls for developing a proper theory base of accounting.

GAAP – generally accepted accounting principles refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and presentation of financial statements. However, the GAAP are not static in nature. These are constantly influenced by changes in the legal, social and economic environment as well as the need of the users.

MEANING AND PURPOSE OF BASIC ACCOOUNTING CONCEPTS.

According is a team that describes the process of consolidating financial information to make it clear and understandable for all stakeholders and shareholders. The main goal of accounting is to record and report company’s financial transaction, financial performance and cash flows.

LIST THE ACCOUNTING STANDARDS ISSUED BY INSTITUTE OF CHARTERED ACCOUNTANT OF INIDA.

Business entity concept: For the purpose of accounting the business and its owners are to be treated as two separate entities. The accounting records are made in the books of accounts from the point of business unit and not of the owner.

Money measurement concept: The concept of money says that only these transactions and happenings in an organisation which can be expressed in terms of money such as sale of goods or payments of expenses or receipts of income etc are to be recorded in the books of accounts. All such transactions that cannot be expressed in monetary terms do not find in accounting records.

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 would not be liquidated in the foreseeable future. An asset may be defined as a bundle of services when we purchase an asset. When we purchase a machinery, we are actually buying its services that we shall be getting over an estimated life span of say 5 years.

ACCOUNTING PERIOD CONCEPT: The financial statements are prepared at regular intervals normally after a period of one year, so that timely information is made available to the users. The interval time is called accounting period. The companies act 2013 and the income tax act require that the income statement should be prepared annually.

COST CONCEPT: The cost concept requires that all assets are recorded in the books of accounts at the purchase price which includes cost of acquisition, transportation, installation and making the asset ready to use. The cost concept is historical in nature.

DUAL ASPECT CONCEPT: Dual aspect is the foundation or basic principle of accounting. The duality concept is commonly expressed in terms of fundamental accounting equation which is as follows:

ASSETS = LIABILITIES + CAPITAL 

REVENUE RECOGNITION CONCEPT: The concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realised. Revenue is the gross inflow of cash arising from the sale of goods and services by an enterprise. Revenue is assumed to be realised when a legal right to receive it arises, the point of time when goods have been sold or service has been rendered. Thus, credit sales are treated as revenue or the day sales are made not when money is received but when the goods are delivered to the customers. 

MATCHING CONCEPT: An expense is recognised not when cash is paid but when an asset or service has been used to generate revenue. For example expenses such as rent, salary is recognised on the basis of period to which they relate and when these are paid. Similarly costs like depreciation of fixed assets is divided over the periods during which the assets are used.

FULL DISCLOSURE CONCEPT:  Financial statements however are the only or basic means of communicating financial information to all interested parties. It is very important that the financial statements make a full and fair disclosure of all information which is relevant for taking financial decisions.

CONSISTENCY CONCEPT: Comparison between the financial results of two enterprises would be meaningful only if some kind of accounting methods and policies are adopted in the preparation of financial statements. Consistency eliminates personal bias and helps in achieving results that are comparable.

CONSERVATION CONCEPT: The concept of conservatism also called prudence provides guidance for recording transactions in the books of accounts and is based on the policy of playing safe. The concept of conservatism requires that profits should not be recorded until realised but all losses even those which may have a remote possibility are to be provided for in the books of accounts. Thus,if market value of goods purchased has fallen down the stock will be shown at cost price in the books but if the market value has gone up the gain is not to be recorded until the stock is sold.

MATERIALITY CONCEPT: Accounting should focus on material fact. What is material fact? Material facts refer to the knowledge that would influence decision of the informed users of financial statements. The money spent to enhance the business will increase the future earning capacity of business, all this should be disclosed in books of accounts and to be kept to the knowledge of the users.

OBJECTIVITY CONCEPT: The concept of objectivity requires that accounting transaction should be recorded in an objective manner free from bias. This is possible when each of the transaction is supported by verifiable documents or vouchers. The reason for the adoption of historical cost is the basis of recording accounting transaction is to adhere to the principle of objectivity.