Accounting in Logistics and Supply Chain Sector-V1Final

8/10/2019 Accounting in Logistics and Supply Chain Sector-V1Final

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UNIT 20:Case Study

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Accounting in Logistics and Supply Chain Secto

Course Design

Advisory Council

Chairman

Dr Parag Diwan

Members

Dr Shrihari

Dean

Dr Anirban Sengupta

Dean

Dr Ashish Bhardwaj

CIO

Dr Satya Sheet

VP Academic Affairs

Prof I M Mishra

Dean IIT Roorkee

Mr M K Goel

Management Consultant

SLM Development Team

Wg Cdr P K Gupta

Dr Joji Rao

Dr Neeraj Anand

Dr K K Pandey

Print Production

Mr Kapil Mehra Mr A N Sinha

Manager Material Sr Manager Printing

Author

N Balwani

All rights reserved. No parts of this work may be reproduced in any form, by mimeograph or any other means,

without permission in writing from Hydrocarbon Education Research & Society.

Course Code:MBAF-911D

Course Name:Accounting in Logistics and Supply Chain Sector

Version:January 2013

MPower Applied Learning Enterprise

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UNIT 20:Case Study

Contents

Block-I

Unit 1 Fundamentals of Accounting................................ ................................ ........................ 3

Unit 2 Generally Accepted Accounting Principles (GAAP)................................ ................... 17

Unit 3 Accounting Principles and Standards ................................ ................................ ........ 29

Unit 4 Accounting Equation ................................ ................................ ................................ .. 41

Unit 5 Case Studies................................ ................................................................ ................ 49

Block-II

Unit 6 Accounts................................ ................................ ................................ ...................... 55

Unit 7 Journal................................ ................................ ........................................................ 67

Unit 8 Ledger ................................ ................................................................ ......................... 79

Unit 9 Subsidiary Books ................................ ................................................................ ........ 93

Unit 10 Case Studies................................ ................................................................ .............. 113

Block-III

Unit 11 Trial Balance................................ ................................ ............................................. 119

Unit 12 Preparation of Trading, Profit & Loss Account and Balance Sheet ........................ 127

Unit 13 Depreciation Accounting................................ ................................ ........................... 141

Unit 14 Cash Flow Statements................................ .............................................................. 153


Block-IV

Unit 16 Financial Aspects of Supply Chain Management................................ .................... 169

Unit 17 Inventory Managements Techniques and Control................................ .................. 181

Unit 18 Cost Accounting ................................ ................................ ........................................193

Unit 19 EVA and Budgets................................ ................................................................ ......207


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Block-V

Unit 21 Corporate Financial Reporting................................ ................................ ................. 223

Unit 22 International Financial Reporting Standards ................................ ......................... 233

Unit 23 International Accounting Standards-I................................ ................................ ..... 241

Unit 24 International Accounting Standards-II................................ ................................ .... 251

Unit 25 Case Study................................ ................................ ................................................ 263

Glossary ................................ ................................................................ ................................ .......... 265

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UNIT 1:Fundamentals of Accounting

Notes

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BLOCK-I

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Notes

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Accounting in Logistics and Supply Chain SectoDetailed Contents

UNIT 1: FUNDAMENTALS OF ACCOUNTING

Introduction

Characteristics of Accounting

Stages of Accounting

Objectives of Accounting

Accounting Information

Functions of Accounting

Branches of Accounting

UNIT 2: GENERALLY ACCEPTED ACCOUNTINGPRINCIPLES (GAAP)

Introduction

Classification of Accounting Principles

Basic Assumptions

Basic Accounting Principles

UNIT 3: ACCOUNTING PRINCIPLES AND

STANDARDS

Introduction

Accounting Process

Uses, Advantages or Role of Accounting

Limitations of Accounting

UNIT 4: ACCOUNTING EQUATION

Introduction

Meaning of Accounting Equation

Calculation/Computation of Accounting Equation

Effect of Transactions on Accounting Equation

UNIT 5: CASE STUDIES

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Notes

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Fundamentals of Accounting

Objectives

After completion of this unit, the students will be aware of the following

topics:





Characteristics of Accounting Information



Introduction

Accounting is used as an information system by its users. The

users are of two types i.e., Internal and External. Accounting is

generally termed as the language of business. It records all the

transactions which can be expressed either in money or moneys

worth and have taken place during a particular period. It is also

termed as a science as the Transactions are recorded (which are of

economic nature) in a systematic manner and also an art of

analysing and interpreting the same i.e., the business transactions.

Accounting is defined by different authors and institutions. Some

of the most important definitions are as given below:

Accounting system is a means of collecting, summarizing,

analyzing and reporting in monitory terms, information about the

business.

Robert N. Anthony

Accounting is the process of identifying, measuring and

communicating economic information to permit informed

judgements and decisions by users of information.

The American Accounting Association (AAA), 1966

Accounting is the art of recording, classifying and summarizing in

a significant manner and in terms of money, transactions and

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Notes

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events which are, in part, at least, of a financial character, and

interpreting the results there of.

American Institute of Certified Public Accountants, 1941


The following are the characteristics of accounting:

Recording of transactions of financial nature:Transactions

or events which are of economic/financial nature are only recorded

in accounting. Events/transactions which cannot be measured in

terms of money, are not at all recorded in accounting. For example,

efficiency or honesty of the employees cannot be recorded because

it cannot be measured in terms of money though it affects the total

profits of business. Similar is the case of a quarrel between the

factory workers and the factory production Manager which affects

the production, but it is not recorded in the books as it can neither

be measured in terms of money nor has any exchange or economic

value.

Recording in definite (certain) units: Only such events are

recorded which are measured in terms of money, no other unit is

used to record such transactions, for example, if the publisher sells

10 books (copies) of Accounting to a bookseller and 20 copies of

Business Studies to another bookseller, then the publisher is

required to record these transactions only in terms of money. That

in the first case 10 No. of copies is to be multiplied by the price per

copy and if any discount (trade) is to be given, is deducted. The

recording is done for the net amount in the books of the business

and not in terms of 10 or 20 or so on the number of books only.

It is an art of classifying the data:Accounting is also an art of

classifying the data systematically. After all the transactions are

recorded properly, all such data are also classified under

appropriate heads, so that as and when data is analysed or

interpreted, correct results can be drawn if data of similar nature

is available at a particular place. This also saves the time and

avoids unnecessary wastage of money.

It is a science: Accounting is a science because every business

transaction is recorded in a systematic manner. This is done first

in the Journal which is the primary book of Accounting/Business.

This may further be sub-divided into various types of subsidiary

books such as cashbook for recording cash transactions only

Activity

Write an article on thecharacteristics of accounting.

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Notes

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whereas sales day book for recording credit sales of goods.

Purchases book for recording credit purchases of goods and returns

books for recording purchase returns and sales returns and other

subsidiary books such as Bills Receivable book, Bills Payable book,

etc.

Accounting can be used for analyzing and interpreting

business transactions: As we know that the purpose of

accounting is not only recording of transactions but also of

analyzing and interpreting data for taking certain important

future decisions. This is also known as future forecasting. Thus, we

see that definition of accounting is changing rapidly because of

increase in its functions. i.e., from recording of transactions to

interpreting of economic events.


After knowing the characteristics of Accounting, one can list the

different stages of Accounting which are as follows:

Financial Transactions,

Recording of Transactions,

Classifying in different groups of transactions based as per thenature of transactions,

Summarizing of transactions, and

Analyzing and interpreting the same.

Table 1.1: Distinction between Book-keeping and Accounting

S.

No.

Basis of

Difference

Book-keeping

Accounting

Accounting

1 Objective The objective of book-

keeping is to record

the transactions ofeconomic nature.

Whereas the objective of

accounting is not only the

recording of transactions butalso analyzing and interpreting

the data.

2 Nature (Art

or science)

It is an art. It is a science.

3 Scope The scope of book-

keeping is very

limited.

The scope of accounting is very

wide.

4 Functions Most of the functions

of book-keeping are

now-a-days

performed by

machines.

Functions of accounting involve

expert human beings in the art

of analysis and interpretation.

Contd...

Activity

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Notes

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5 Accounting

Process

Book-keeping is just

one part of

accounting process.

Accounting involves the entire

process of accounting that is

why it is said that accounting

begins where book-keeping

ends.

6 Rules to be

followed

Rules of accounting

are followed for

recording.

Along with rules, assumptions

and conventions are also there

to follow.

7 Net Results

Profit or loss

Net results of the

business cannot be

known from book-

keeping.

Whereas accounting is used to

find out net results of the

business.

8 Time Transactions are

immediately

recorded.

Transactions are generally

recorded after a gap of time or

at the end of a financial year.

Check Your Progress

State whether True or False:

1. Accounting is the language of business.

2. Transactions or events which are of economic/financial

nature are only recorded in accounting.


The basic objective of Accounting is to provide necessary

information to the persons interested in the business. As we know

that persons interested in the business are of two types: (a)

Internal users and (b) External users.

(a) Internal users: These are the persons who manage the

business, i.e., management at all the levelstop, middle and

lower level.

(b) External users: External users are all persons other than

internal users such as Investors, creditors, Government. The

necessary information is supplied to the external usersthrough the following financial statements:

Profit & Loss Account/Statement and

Balance Sheet.

Whereas the internal users can obtain necessary information other

than the above statements from the records of the business. Thus,

the primary objectives of accounting are as given below:

1. Maintenance of records of business.

2. Calculation of profit or loss of the business.

Activity

Make a report on theobjectives of accounting.

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Notes

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3. Presentation of the financial position of the business.

4. To provide and make available the necessary and financial

information to the users.

The above objectives can be explained in detail:

1. Maintenance of records of business:The Primary objective

of accounting is to maintain proper records of business, i.e.,

every transaction which is of financial nature must be

recorded fully otherwise it is very difficult to remember all the

transactions because human memory is very short. Moreover,

correct and fair results of the business transactions cannot be

ascertained (calculated). So it is very much essential to keep

proper and complete records of all business transactions so

that records can be used as and when required/desired by the

persons interested in the business.

2. Calculation of Profit or Loss:As we know that one of the

most important objectives of business is to earn profit, and the

main objective of accounting is to maintain proper records of

all financial transactions in to order to calculate profit or loss

of the business. This can be done with the help of a financial

statement known as the Profit & Loss statement. This

statement is prepared for a particular period which can tell us

about the profit or loss of the business. If there is a profit, the

management can take important decisions relating to selling

price, output, etc. If two years results are known, then a

comparison can also be made. Similarly, if there is a loss, then

management can decide to discontinue the production of such

items. Thus, we see that it is a very important objective of

accounting, i.e., to provide information relating to profit or loss

of business. This statement is very useful to all the persons

interested, i.e., from management to creditors, investors,

government and society at large including employees of the

business. Thus, profit or loss statement is a measurement of

performance of the business.

3. Presentation of financial position of the business: The

financial position of the business is presented through another

financial statement known as the Balance Sheet or Position

Statement. This is a statement of assets and liabilities of the

business. It tells about the owned capital as well as borrowed

capital (liabilities) along with different assets such as fixed

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Notes

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assets and current and other assets. If total liabilities are

deducted from the total assets, then balance depicts the

owners capital (owned funds). As we know that the objective of

accounting is not only recording of financial events, make

available information relating to profit or loss of the business

but also provide full information regarding financial position of

the business. This is done through a financial statement. The

balance sheet is a mirror showing the financial solvency or

insolvency of the business. If assets are more than its

liabilities, it is a solvent otherwise in case of reverse, it is an

insolvent business.

4. To provide and make available the necessary and

financial information to the users:The major objective of

accounting is to provide and make available the necessary and

financial information to the users or the persons interested so

that, necessary and financial decisions and actions can be

initiated by the management/persons interested such as

owners, shareholders, debenture holders, creditors, investors,

government and others such as research scholars, etc.

Thus, we see that the accounting can play a very important

role in depicting the financial results (profit/loss) of the

business as well as the financial position (solvency or

insolvency) of the business.


As per Accounting Principles Board (APB), Accounting is defined

as follows:

Accounting is a service activity. Its function is to provide

qualitative information, primarily financial in nature about

economic activities that is intended to be useful in making economic

decisions.

Thus, it is clear from the above definition, that accounting

information is an important function of accounting. Accounting

information must also be of quality so that important financial

decisions can be taken by the users of accounting. Accounting

information is supplied through financial statements. Financial

statements are Profit & Loss account being income statement and

balance sheet being position statement.

Activity

Present a draft on accountinginformation.

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Notes

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The information which is provided by these statements is as

follows:

1. Information about profit or loss of the business.

2. Information about financial position of the business.

Information about Profit or Loss of the Business

The Profit & Loss account which is also known as income

statement provides accounting information about profit earned or

loss suffered (incurred) during an accounting period. This

statement provides gross profit through trading account and net

profit through Profit & Loss account.

Gross profit = Sales Cost of Sales

This information is very useful as it helps in deciding the following

questions:

1. Whether cost of sales is reasonable or not?

2. Whether it can be reduced or not?

3. Whether selling price can be increased or not?

The Accounting information, thus available through trading

account helps us to resolve the above questions.

Net profit is the profit earned after allowing all the expenses

relating to factory administration, financial, selling and

distribution. Thus, income statement makes available information

about net profit earned or net loss suffered. This also helps in

answering the following questions.

1. Whether expenses are reasonable or not?

2. Whether expenses can be reduced or not?

Net profit is used as a basis for taxation purposes.

Information about Financial Position of Business

The balance sheet also known as position statement tells about

financial health of the business. This statement tells about the

assets owned by the business including cash and bank balances.

These assets are total of liabilities owned by the business which

may be taken from the proprietor of the business or borrowed from

outsiders. The position statement helps in determining the

following questions:

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Notes

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1. Whether funds invested are safe and sound, means provides

reasonable return of income along with safety of funds?

2. Whether return of income is adequate or not?

3. It helps the investors, the creditors to arrive at a correct

decision regarding investment, lending of funds, etc.

4. It helps in restoring confidence among the employees about

their provident fund being properly deposited with the cost as

per requirements.

Characteristics of Accounting Information

Accounting information consists of the following characteristics:

1. Reliability: Whatever accounting information is supplied

must be reliable, means it must be free from all sorts of biases.

Otherwise the basic purpose of using accounting information is

defeated. Accounting information is reliable if following rules

are observed:

(a) Principle of prudence is followed:It means the principle of

prudence, i.e., conservatism is followed and all losses are

taken into account while all prospective gains are left out.

In other words, accounting information tells about thefacts and does not give any wrong information about the

business.

(b) Neutral Accounting information is free from all sorts of

biases because if information supplied is biased, it would

give misleading results.

(c) Complete: Whatever accounting information is supplied,

must be complete in all respects. Otherwise incomplete

information may give us misleading results.

2. Relevance: The accounting information should also disclose

other information which may be useful to the users of

information. This is in addition to the information which is

required by statutes under different Acts/Laws.

3. Understandability: The accounting information provided,

must be in a form which is understandable to the users of

information. However, the information which can be useful

must also be given. Whatever is the requirement of disclosure

of information, must be followed strictly.

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Notes

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4. Comparability: The users should be able to compare the

accounting information as inter firm or intra firm comparison.

It is therefore necessary to use standardized accounting

policies consistently.

Various Users of Accounting Information

Following are the users of accounting information:

1. The owners:Whosoevers money is provided to the business,

such persons are known as owners of the business. Such

persons may be either the proprietor, the partners or the

shareholders. They are very much interested in knowing about

the profit or loss of the business and also the financial health

and wealth of the business.

2. Investors: Everyone who is either willing to invest in a

business as a partner or as a shareholder is always interested

to know about the safety of funds as well as adequate return

on investments.

3. Creditors are interested to be satisfied about the credit

worthiness of the business before supplying goods or services.

Accounting information available through financial statements

thus proves useful and helpful.

4. Government is interested in having certain other financial

information on the basis of which economic and taxation

policies are decided.

5. Employees:Accounting information is useful to the employees

by telling them about their contribution which is regularly

deposited with the Government by their employers.

6. Society: Accounting information is useful to the society. It

depicts general financial state of affairs in the society, i.e.,

standard of living, per capita income, national income, etc.

Check Your Progress

Fill in the blanks:

1. The ........................ also known as position statement

tells about financial health of the business.

2. ................... is the profit earned after allowing all the

expenses relating to factory administration, financial,

selling and distribution.

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Notes

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The main function of accounting is to record the business

transactions scientifically and systematically. Apart from this,

there are other functions of accounting which are as follows:

1. It depicts the true and fair picture of the financial position of

the company.

2. It helps in ascertaining profit or loss of the business which is

the only primary aim of the business.

3. It helps in future decision-making by different persons

interested in such accounting information.

4. It depicts the earning capacity of the business.

5. It satisfies all Government rules and regulations connected

with Accounting information such as all the companies are

required to prepare their statements as per requirements of

the Indian companies Act, 1956, amended up to date.


As we know that the objectives of accounting are recording of

business transactions and also make necessary information

available to the persons interested. The accounting is broadly

classified into three main branches, in order to achieve the above

objectives. The branches are:

(a) Financial Accounting

(b) Cost Accounting

(c) Management Accounting

(a) Financial Accounting: It is mainly concerned with the

ascertainment of profit or loss made during a particular periodand also presents the financial position of the business.

(b) Cost Accounting: As the name suggests, this type of

accounting is mainly related with the ascertainment of the cost

of a product, so that the management can exercise its control

in order to minimize the costs and maximize the profits.

(c) Management Accounting:This type of accounting is a tool in

the hands of management for various functions; (i) to control

costs (ii) to take important future decisions (forecasting).

Activity

Prepare an assignment on the

functions and branches ofaccounting.

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Notes

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Thus, we see that there are different branches of accounting, each

branch is assigned a different job.

Check Your Progress

Fill in the blanks:

1. ................... is mainly concerned with the ascertainment

of profit or loss made during a particular period and

also presents the financial position of the business.

2. ................... accounting is a tool in the hands of

management for various functions; (i) to control costs

(ii) to take important future decisions (forecasting).

Summary

Accounting is generally termed as the language of business. It

records all the transactions which can be expressed either in

money or moneys worth and have taken place during a particular

period. It is also termed as a science as the Transactions are

recorded (which are of economic nature) in a systematic manner

and also an art of analysing and interpreting the same i.e., the

business transactions.

Lesson End Activity

Collect more information on accounting and present it in the form

of a chart.

Keywords

Accounting: It is the process of identifying, measuring and

communicating economic information to permit informed

judgements and decisions by users of information.

Cost Accounting:As the name suggests, this type of accounting is

mainly related with the ascertainment of the cost of a product.

External Users: All persons other than internal users such as

Investors, creditors, Government.

Financial Accounting: It is mainly concerned with the

ascertainment of profit or loss made during a particular period and

also presents the financial position of the business.

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Notes

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Internal Users:These are the persons who manage the business,

i.e., management at all the levelstop, middle and lower level.

Management Accounting:This type of accounting is a tool in thehands of management for various functions; (i) to control costs (ii)

to take important future decisions (forecasting).

Questions for Discussion

1. Describe the characteristics of accounting.

2. Explain the stages of accounting.

3. Discuss the objectives of accounting.

4. What do you understand by accounting information?

5. Explain the characteristics of accounting information.

6. Describe the functions of accounting.

Further Readings

Books

Anthony R. N. and Reece J. S. Accounting Principles, 6th ed.,

Homewood, Illinois, Richard D. Irwin, 1995.

Bhattacharya S. K. and Dearden J. Accounting for Management

Text and Cases, New Delhi, Vikas, 1996.

Gupta, R.L. and Ramanathan,Advanced Accountancy, Volume I &

II, Sultan Chand and Sons.

Hingorani, N.L. and Ramanathan, A. R., Management Accounting,

5th ed. New Delhi, Sultan Chand, 1992.

Jawahar Lal, Cost Accounting, Vikas Publishing House, New

Delhi.

Maheshwari, S. N.,Advanced Accounting, Vikas Publishing House,

New Delhi.

K K Verma, Financial Accounting and Analysis, Excel Books, New

Delhi.

R.L. Gupta, M. Radhaswami, Advanced Accountancy, Sultan

Chand & Sons, New Delhi.

M.C. Shukla, T.S. Grewal, S.P. Gupta, Advanced Accounts, S.

Chand, New Delhi.

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Notes

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Web Readings

www.accountingcoach.com/online-accounting-course/60Xpg01.html

www.accsoft.ch/download/accountingconcepts.pdfwww.investopedia.com/university/accounting/

www.mca.gov.in/Ministry/notification/pdf/AS_6.pdf

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Notes

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UNIT 2:Generally Accepted Accounting Principles (GAAP)

Notes

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Generally Accepted AccountingPrinciples (GAAP)

Objectives


topics:


Basic Assumptions


Introduction

Accounting is a medium of recording the transactions made in the

business that is why; accounting is termed as the language of the

business. All the persons interested in the business, such as the

owners/shareholders, the creditors, the government and the others,

get the necessary business information through accounting

because it is properly recorded, analyzed and summarized to theextent that it can be understood by all. This is possible when all

the financial statements are prepared in accordance with generally

accepted accounting principles. If such uniform principles are not

adhered /followed, there would be a lot of difficulties and confusion

which makes comparison impossible, unreliable or dependence is

also reduced because, its acceptability is unsuitable for different

business houses, etc. The accountants, therefore, have suggested

the common concepts and conventions of accounting in order to

overcome the above mentioned difficulties and problems

enumerated earlier. Such accounting concepts and conventions areknown as basic accounting concepts and conventions as they have

been commonly accepted by the professional accounting world for

preparing financial statements and reports for external use based

on experience and practice.


All the accounting concepts and conventions are broadly classified

into three broad categories, such as:

Activity

Write an article on theclassification of accountingprinciples.

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Notes

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Accounting in Logistics and Supply Chain Sector

1. Basic assumptions are like pillars on which the structure of

accounting is based

2. Basic Principles and

3. Modifying Principles.

In this unit, we will study the basic assumptions and the basic

principles. We will study the modifying principles in the next unit.

Basic Assumptions

Assumptions provide a base for accounting process without which

no enterprise can prepare its financial statements. The following

are the basic assumptions:

(a) Accounting entity/Business entity

(b) Monetary unit/Money measurement concept

(c) Going concern

(d) Periodicity.

Accounting Entity

It is also termed as Economic entity assumption which means that

economic unit/event can be known with a specific unit. For this

purpose business is considered as a distinct and separate entity

than its owners. Recording of every transaction is done whether it

is related to the owner/s or not. The business controls each and

every activity this is possible because of its separate entity hence,

it is also accountable. For example, when a business is started by

the owners, then cash/goods come in the business which results in

an increase in the capital of business and on the other hand, it

reduces private capital of the owners. Nowadays the concept of

business entity is becoming more and more popular because offurther division of accounting in different departments, so that the

responsibility of each department can be ascertained easily. This is

done in responsibility accounting. According to this accounting

entity, a distinction should be made between (1) Private/personal

and (2) those of another business entity. If it is not done, results

would not be accurate.

It would be rather confusing, uncertain, ambiguous, though it is

one of the most useful assumptions. Business and the owner/s

whether sole proprietor or partner/s are one in the eyes of law, but

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Notes

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they are considered as separate entities from practical accounting

point of view. But in case of companies, the law recognizes legal

and separate entity from its owners, i.e., the shareholders.

Monetary Unit/Money Measurement Concept

Only such transactions are recorded in accounting that are of

monetary value or that can be measured in terms of money. The

transactions/events which cannot be measured in terms of money

are not at all recorded in accounting. For example, if there is

dispute between a manager and a worker which affects/does not

affect the business, it cannot be recorded unless and until it is

measured in terms of money. Likewise the health of the proprietor,

sale policy of the business, entrance of other competitors in thebusiness are such events which cannot be recorded in accounting

howsoever important it may be, because these cannot be measured

in terms of money. This is a peculiar feature of the Money

measurement concept but this can also be termed as limitation of

this concept which has attracted the attention of all the

accountants in the world. All the transactions which are recorded if

measured in money, at a present level, any increase/decrease after

recording is left out. To make accounting records relevant, simple,

understandable and of the same class or groups, they are brought

to a common unit of measurement i.e., Money. It makes possible

the preparation of financial statements. Had there been no

monetary unit assumption, it would have been difficult to record

business transactions; hence monetary unit concept is introduced.

Though it is assumed that the monetary unit is a stable unit in

value but in practice, this assumption is not correct as the money

value changes over a period of time.

Limitations of Money Measurement

There are certain limitations of this concept because of which the

scope of accounting is limited the limitations are as follows:

(i) Records only such events/transactions which can be expressed

in terms of money but as we know that there are certain

events which affect the business but cannot be measured such

as wealth of the proprietor etc. such events are responsible for

the success of the business but unable to record in the books of

accounts, the direct result is that whatever information is

gathered not correct and fair view of the either operational orposition of the business is not there.

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Notes

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(ii) There is no consideration for purchasing power of money

which is fluctuating. Again the result is that it is not a true

and fair view of the business.

Going Concern Concept

It is assumed that every business would continue for a long period

or have an indefinite life unless it is likely to be sold or wound up

in the near future. This is also known as the concept of continuity.

Keeping this in view, recording of transactions in accounting and

division of expenses is done. In other words, it is seen whether

benefit from expenses is immediate or long-term. If it is

immediate, then it is to be treated as revenue or if it is long-term,

it is to be treated as capital, depending upon the nature of

expenses. This concept of going concern is considered better as

compared to short-term or temporary business. In other words, a

businessman charges depreciation on the historical (probable) costs

as well as expected life and not on the market value. This is also a

sound and fundamental basic principle of financial statement. This

concept helps the investors in providing necessary capital to the

business because of the assurance regarding the continuation of

the business for a long time. If this type of commitment is absent,

then it would be very difficult to procure funds for the business.

Accounting Period Concept

This is also known as time period assumption, and the economic

life is divided into different periods for preparing financial

statements. As per going concern concept the financial statements

must be prepared only when either it is sold or liquidated. But

practically it is very difficult to wait for such a long period, hence it

is agreed that economic life of a business must be reported over a

reasonable time period which is normally taken as one year, eithercalendar year, financial year and or other year such as Deepawali,

Dussehra or Samvat year, etc. Though, sometimes, it may be less

than 12 months also i.e. monthly, quarterly or half yearly, etc.; but

such periods are termed as interim periods and reports for such

periods are called interim reports. Such reports are generally less

reliable than annual reports. So it is very much desired to have

relevant information, so that quick decisions can be taken. Thus,

we see that the idea of accounting period is quite helpful and

useful to all classes of users management, creditors, investors

and others.

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Notes

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Check Your Progress

Fill in the blanks:

1. ................... means that economic unit/event can be

known with a specific unit.

2. ................... is also known as time period assumption,

and the economic life is divided into different periods

for preparing financial statements.


The Accountants have agreed on some principles which tell how

the transactions should be recorded and reported in the books of

the business. Important basic accounting principles are as given

below:

1. Cost principle

2. Revenue/Realization principle

3. Matching principle

4. Full disclosure principle

5. Dual aspect principle and6. Objectivity principle.

The above principles can be explained in detail one by one.

1. The Cost Principle:Every transaction should be recorded at

its actual (historical) cost or cost of its acquisition and not its

market price. For example, if a Machine is purchased for 1 lac

and its market price is 2.50 lacs, then recording of this

transaction is done at 1 lac being its actual cost/or cost of its

acquisition. Sometimes market price may be less than even

then recording would be at its actual cost because of the cost

principle, which is the basis of charging depreciation in future.

If there is any residual value of asset and the asset is sold,

then such amount is deductible from such value. If the asset is

having no residual value, such assets are not shown in the

Balance sheet though the existence of assets is very important

to the business. Thus, we see that the Balance sheets which

are based on cost concept/principle give us very wrong/

incorrect results for those investors who are interested to know

the real values of the assets. This principle of cost is applicable

Activity

Make a report on the basicaccounting principles.

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Notes

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in case of fixed assets as well as the current assets. In the

words of Hendriksen, Expenses are using or consuming goods

and services in the process of obtaining revenues. Thus, it is

the amount that is spent with a view to produce or procures

goods or services to obtain revenue from the sale of such goods

or services. In spite of so many criticisms of this, the cost

principle is definite and reliable. So, it has an edge over other

principles. It also provides an objective and comparable data in

the financial statements.

2. Revenue Principle (Realization Principle): Only such

transactions are recorded in accounting which have actually

taken place not the ones which would take place in future.

This is based on revenue realization principle. For example, if

goods are sold or purchased by a trader, transaction is

recorded but if there is a contract or an agreement has taken

place, it would not be recorded unless and until the contract is

executed/complete/obligations/duties are performed as per

contract. However, there are certain exceptions to the sales

basis for revenue realization. In case of construction projects,

revenue is generally realized before the contract is complete.

Similarly in other cases, such as in case of sale by Instalment

method revenue is realized later though sale has taken placeearlier. Revenue is realized when cash is received. Sometimes

there may be defaults in payment of some instalments. Apart

from these exceptions, revenue is generally realized at the

time of sale when actually the title of ownership passes from

the seller to the buyer. This assumption is especially

important because it recognizes the assets, liabilities, incomes

and expenses as and when the transactions relating to these

take place. We can find out from the books of account how

much is due to creditors (liabilities) and how much the firm

owns (assets). Apart from this, one can also know about the

profit earned or loss suffered.

3. Matching Principle:As we all know that the business is a

going concern, so it is even more necessary to know its

operational results for a particular/fixed period. This period

may be of six months or one year. Profit or loss during this

period indicates the financial operational results of the

business, so it is necessary to put all financial records of the

expenses, revenues or incomes relating to a particular period,

so that matching between revenues and expenses can be

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Notes

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facilitated. This matching is termed as matching principle of

accounting. The equation can be written as:

Profit = Revenues ExpensesThis principle of Matching is very much important for

ascertainment of correct amount of profit (income) which is a

measurement of performance. All expenses which can generate

revenues in the current accounting period are taken as

expenses. The matching of expenses with revenue is based on

accrual system of accounting. In accrual system, revenue is

recognized when sale is complete or services are rendered

rather than when cash is received. Similar rule is applicable in

the case of expenses, i.e., expenses are recognized, when assetsand services are put to generate revenues and not when cash

is paid.

The matching principle makes the following points clear:

(a) When an item of expense is spent against revenue it will

be entered in the following period, result would be to show

it in the Balance sheet and in the following period, to be

treated as an expense.

(b) When an item of revenue is recorded in the Profit & Loss

account, all the expenses incurred whether paid for cash

on not should be recorded as the expenses.

(c) If any amount of revenue is received but either goods are

to be supplied in future or services are rendered in future,

the amount is not recognized as revenue in the current

year, the result is to be shown as liability in the balance

sheet but if any loss is there for which no revenue is

earned it is to be charged from the current Profit & Loss

account, for example in fire insurance premium. If goods

are lost, whatever is recovered from insurance company is

deducted from the cost of goods lost and the balance of loss

is charged from Profit & Loss account.

4. Full Disclosure Principle:The objective of accounting is to

provide true and accurate information. This may be because of

law or social customs. All facts of assets must be disclosed

along with their valuations. Principle of disclosure means to

supply all information relating to economic activity of the

business completely to the owners, creditors and Investors

which can protect their interests. Disclosure does not mean

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Notes

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only that information which is required up to the stage when

the Balance Sheet is prepared but after the preparation of

Balance Sheet also. For example, bad debts, destruction of any

machinery/building because of natural calamity, loan taken

within a week or so, after the Balance Sheet is prepared,

method of providing depreciation and Valuation of stock. All

such events affect the investors decisions. So such events must

be given compulsorily. The purpose of this principle is to

convey all material and relevant facts relating to the

operational result and the financial positions to the parties

using the financial statements.

Financial Statement must be duly supported by footnotes. A

good accounting principle requires that all significant and

important information must be disclosed, apart from legal

requirements.

5. Dual Aspect Principle: Every transaction of a business is

recorded at two places. That is why it is termed as Double

entry system of accounting. Every debit has a credit. For

example, when a business is started by a proprietor for cash,

then whatever comes in the business is debited and whosever

gives loan as giver is credited. Thus the following entry in the

Journal is passed:

Cash a/c Dr.

Or

Goods a/c Dr.

To Proprietor's a/c

Or

To Capital a/c

Cash or Goods brought in as capital by the proprietor or partners.

As we know that only such events are recorded in financial

accounting which are related to economic activities or can be

expressed in money. These events may be either purchase or

sale of goods on cash or on credit, receipts or payments, etc.

Every transaction is recorded at two places that are why

double entry system is in vogue. In America, this system is

used in the form of equation. In the above example the owners

can bring cash or goods or both as capital. The Following

would be the equations:

Capital = Cash/Stock/Cash + Stock

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Notes

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If any loan is taken then

Capital + Loan = Cash + Stock

OR

Total Liabilities = Total Assets

OR

Internal + External Liabilities = Fixed Assets + Current

Assets

In other words, we can say that

Equity or owners equity = All Assets Loans or

liabilities of outsiders

Thus, we see that the Principle of Dual aspect would provide

us all the rules required for recording all the transactions of a

business.

6. Principle of Objectivity:All transactions which are recorded

must be duly supported, by documents as far as possible. Then

only the auditor would be able to verify the accounts: if it is

not, transactions must have substantial evidence which is free

from personal bias and is based on rational approach. As we

know that the cash is definite and verifiable while value is not.

The principles of Objectivity require that accounting data

should be verifiable and free from bias.

Check Your Progress

Fill in the blanks:

1. ................... principle of Matching is very much

important for ascertainment of correct amount of profit

(income) which is a measurement of performance.

2. ................... is based on revenue realization principle.

3. Principle of ................... means to supply all information

relating to economic activity of the business completely

to the owners, creditors and Investors which can protect

their interests.

Summary

All the persons interested in the business, such as the

owners/shareholders, the creditors, the government and the others,

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Notes

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get the necessary business information through accounting

because it is properly recorded, analysed and summarized to the

extent that it can be understood by all. This is possible when all

the financial statements are prepared in accordance with generally

accepted accounting principles. If such uniform principles are not

adhered /followed, there would be a lot of difficulties and confusion

which makes comparison impossible, unreliable or dependence is

also reduced because, its acceptability is unsuitable for different

business houses, etc.

Lesson End Activity

Gather information about the GAAP. Present the informationcollected in the form of a collage.

Keywords

Accounting Entity: It is also termed as Economic entity

assumption which means that economic unit/event can be known

with a specific unit.

Accounting Period Concept: This is also known as time period

assumption, and the economic life is divided into different periods

for preparing financial statements.

Going Concern Concept: It is assumed that every business would

continue for a long period or have an indefinite life unless it is

likely to be sold or wound up in the near future. This is also known

as the concept of continuity.

Monetary Unit Concept: Only such transactions are recorded in

accounting that are of monetary value or that can be measured in

terms of money.

The Cost Principle:Every transaction should be recorded at its

actual (historical) cost or cost of its acquisition and not its market

price.

Questions for Discussion

1. Describe the classification of accounting principles.

2. Explain the basic assumptions of GAAP.

3. Discuss the basic accounting principles.

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Notes

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Further Readings

Books

Anthony R. N. and Reece J. S. Accounting Principles, 6th ed.,

Homewood, Illinois, Richard D. Irwin, 1995.

Bhattacharya S. K. and Dearden J. Accounting for Management

Text and Cases, New Delhi, Vikas, 1996.

Gupta, R.L. and Ramanathan,Advanced Accountancy, Volume I &

II, Sultan Chand and Sons.

Hingorani, N.L. and Ramanathan, A. R., Management Accounting,

5th ed. New Delhi, Sultan Chand, 1992.

Jawahar Lal, Cost Accounting, Vikas Publishing House, New

Delhi.

Maheshwari, S. N.,Advanced Accounting, Vikas Publishing House,

New Delhi.

K K Verma, Financial Accounting and Analysis, Excel Books, New

Delhi.

R.L. Gupta, M. Radhaswami, Advanced Accountancy, Sultan

Chand & Sons, New Delhi.

M.C. Shukla, T.S. Grewal, S.P. Gupta, Advanced Accounts, S.Chand, New Delhi.

Web Readings

www.accountingcoach.com/online-accounting-course/60Xpg01.html

www.accsoft.ch/download/accountingconcepts.pdf

www.investopedia.com/university/accounting/

www.mca.gov.in/Ministry/notification/pdf/AS_6.pdf

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Notes

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UNIT 3:Accounting Principles and Standards

Notes

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Accounting Principles andStandards

Objectives


topics:

Modifying Accounting Principles

Accounting Standards in India

Accounting Process

Uses, Advantages or Role of Accounting

Limitations of Accounting

Introduction

Basic accounting assumptions and principles provide different

rules for preparing certain financial statements which can provide

useful information to different interested persons.

In the previous unit, we studied the basic assumptions and the

basic accounting principles of accounting. In this unit, we will

study the modifying accounting principles.

Modifying Accounting Principles

The information is useful if it is relevant and reliable. Information

is relevant if it can provide a basis for future forecasting and is free

from bias and errors. In order to prepare correct financial

statements, it is necessary, to modify certain assumptions andprinciples. Cost benefits relationship, materiality, consistency,

conservatism. Timeliness and industry practice, etc., have to be

taken into account for making the information more useful. The

following are the important modifying principles;

1. Consistency:One thing must be kept in view, while recording

in the books of account i.e., whatever principle or method is

adopted in a year, must be adopted for the subsequent years

then only comparison of results is possible. For example, if

stock is valued using LIFO (Last In First Out) or FIFO (First

Activity

Write an article on themodifying accountingprinciples.

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Notes

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In First Out) or any other method, the same method must be

followed in subsequent years likewise is in case of depreciation

and if there is any change in the method of charging

depreciation it must be reported. Because of this, convention of

consistency occupies an important place in the field of

accounting. Consistent use of accounting principle and

conventions is necessary in achieving comparability. Though

the principle of consistency requires that a particular method

used, generally should not be changed unless otherwise

required and the user is informed accordingly. The Generally

Accepted Accounting Principles (GAAP) allow more than one

method of explaining similar operational results but in such

situations, financial statements are not comparable. This iswhy the principle of consistency requires that the basis should

remain consistent with the previous accounting year. One can

conclude from the above that the principle of consistency does

not allow a firm to change its method under any situation. It

allows the firm to change its method if it is more useful or can

supply better information or results. This change must be

reported/disclosed in the financial statements by way of a foot

note with a view to inform the users about the lack of

consistency.

2. Conservatism [Prudence]: All financial statements are

prepared and presented as per law or conservatism and not for

a specific purpose. That is why it is termed as convention of

conservatism. This is a good and the safest policy. Accordingly

all possible losses are taken into account and all (probable)

(unrealized) profits/gains are left out. Likewise stock can be

valued either at cost or market price whichever is lower.

Similarly, provision for doubtful debts or provision for

depreciation can also be arranged as per the conservatism. It

can be a useful tool in such situations but if it is not used

properly, it may lead to unpleasant and unforeseen results.

For example, if a machine is purchased and the cost of

machine is charged as an expense, then profit as well as assets

would be underestimated.

Nowadays conservatism has been replaced by prudence which

means the principle of conservatism is applied by the

accountants only in case of doubts or uncertainties with

prudence. The theme of the principle of conservatism is under-

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Notes

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statement of profit or assets rather than over-statement of

profit or assets.

3. Principle of Materiality: The American Accounting

Association defines the term materiality as, an item should be

regarded as material if there is reason to believe that

knowledge of it would influence the decision of informed

investor. In other words, materiality means only that

information should be used which influences the decision of

the investors, creditors, shareholders, etc. Though there may

be so much financial information, but only relevant must be

taken into account. This is very subjective. Likewise the

problem may be in case of allocation of costs/other expenses.

Moreover information material for one concern may not bematerial for others so, an alert is required and care has to be

exercised while selecting or rejecting information. As per

principle of disclosure, all relevant and necessary information

(facts) must be disclosed whereas the Principle of Materiality

is an exception or modifying principle. It is because of this,

that the events or items not relevant or having an insignificant

effect, need not be given. The concept of Materiality is relative.

It is different for different enterprises. For example, the cost of

a component is very significant to a small company whereas it

is insignificant for a big company. Similarly nature of

transaction also affects the decision of the user of information.

Thus, it is clear from the above that the principle of

materiality is very much useful in the day-to-day working of

an organization.

4. Cost Benefit Principle:This principle says that the cost of

applying an accounting principle should not exceed its benefit.

It does not mean that to save cost, no information or very little

information should be given to the users. Certain minimum

levels of relevance and reliability must be reached for

information to be useful.

For example, it is required under the Companies Act, 1956

that information regarding managerial remuneration

satisfying the overall ceiling of 11% of Net Profits should be

given. This increases the cost of providing information.

5. Timeliness:Information given must be relevant and reliable.

In order to be relevant the information must also be timely. If

information is not available or is provided after a long gap, it is

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of no use. It is therefore desired that information must be

available for decision-making before it becomes redundant. Old

and late information hampers the ability of users on

application of different accounting principles.

6. Substance over form: Means accounting treatment and its

presentation in financial statement should be as per substance

of the Transaction and not by its legal form alone. For

example, in case of a lease the lessor is funding the

transactions, hence he recognized the assets so financed as his

assets whereas the lessee recognized lease payments as hire

charges paid. In the First case, it is the legal form whereas in

the second case, it is the substance of the transaction.

7. Variations in Accounting Practices: It means different

accounting practices, which are equally acceptable. As such

there is no single accounting practice which is applicable in all

cases. For example valuation of inventories, method of

charging depreciation, treatment of contingent liabilities etc.

In the above such cases, the Management is required to use

considerable judgment to select an appropriate/just practice.

8. Industry Practice: Sometimes different industries use

different accounting principles and approaches to producerealistic financial reporting. For example, it is a practice to

show investment at cost or market price whichever is lower.

Similarly, agricultural produce is shown at market price

because of certain practical difficulties. Thus, it is very much

clear from the above that Industry practice also plays a very

important role while applying certain accounting principles.

Check Your Progress

Fill in the blanks:

1. ................... is defined as an item should be regarded as

material if there is reason to believe that knowledge of

it would influence the decision of informed investor

2. ................... principle says that the cost of applying an

accounting principle should not exceed its benefit.

Accounting Standards in India

Indias accounting standards are explained in the following sub-

sections:

Activity

Present a report on theaccounting standards of India.

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Meaning of Accounting Standards

It is a set of certain generally accepted rules, principles, concepts

and conventions issued by the Institute of Chartered Accountants

of India in consultation with other International Accounting

Bodies. The purpose of making uniform rules and principles is to

make the preparation and presentation of financial statement

easy, relevant, reliable, understandable and finally comparable. In

other words, Accounting standards are the basis of accounting

policies and practices to facilitate the recording of transactions and

events in such a way which can change them into financial

statements, to be used by the persons interested in getting the

correct and reliable information with a view to take future

decisions.

Need for Accounting Standards

Different business enterprises were having different modes of

recording the transactions and events and lack of uniform set of

rules created a lot of problems, such as comparison was not truly

possible but difficult also this was because of the nature of

business, diversified and complex economic situations. This also

made accounting information incomparable and less meaningful.

Therefore a need was felt to have certain minimum standardswhich can are universally applicable, so that the financial

statements thus made, can be more reliable, comparable, relevant

and understandable. Keeping this in view, International

Accounting Standard Committee (IASC) was set up in 1973. The

objectives of this Committee were:

(i) To formulate and publish in the public interest, accounting

standards to be observed in the presentation of financial

statements and also its world-wide acceptance, and

(ii) To work for improvement and harmonization of regulation of

accounting standards and procedure relating to the

presentation of financial transactions.

Nature

The Institute of Chartered Accountants of India had set up

Accounting Standards Board on 22nd April, 1977 to formulate

accounting standards on a number of accounting issues, taking

into account the accounting standards developed by the

International Accounting Standard Committee, prevailing laws in

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India, business customs usages and conventions, etc. The

Accounting Standards made were not mandatory in the beginning

but after the amendment in the Sec 211(3C) of Companies Act,

1956 Accounting Standards out of 28 have been made mandatory.

The Auditor is required to give in his report to the shareholders

that accounts are prepared (drawn) in accordance with the

provisions relating to Accounting Standards in India.

Accounting Process

The basic accounting process is shown in the Figure 3.1.

The first thing that the accounting system takes on is the financial

transactions. A transaction is defined as an external event or

internal event which gives rise to a change affecting the operations

or finances of an organisation. Now there should be evidence that a

transaction has taken place. This evidence comes from the

documents that are used to support a transaction, like invoices,

receipts, cheques, bank statements, etc. For recording a

transaction, it must be analysed to determine its effects on the two

(or more) accounts and the reason why it affects those accounts. As

the original document cannot be used to write these details, a

standard document known as a voucher is used to accompany theoriginal document.

Figure 3.1: Basic Accounting Process

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Voucher is therefore the basic document of an accounting

transaction. Every voucher mentions the two (or more) accounts

that are being affected, the amount with which each account is

affected and the reason for the transaction (known as narration).

Each voucher is numbered and dated, so as to make referencing

easier.

Once the vouchers are made for the day, they are entered into an

intermediate book known as Journal. Vouchers are normally

recorded in the order in which they occu

Documents

Accounting in Logistics and Supply Chain Sector-V1Final