Financial and management accounting notes @ mba bk
FINANCIAL AND MANAGEMENT ACCOUNTINGUnit - 1 Accounting – Defination – According for historical function andmanagerial function – Scope of accounting – Financial accounting andManagement accounting – Managerial uses – Differences. Financial Accounting: Accounting concepts – Convections –Principles – Accounting standards – International Accountingstandards.Unit-2 Double entry system of accounting - Accounting books –Preapartion of journal and ledger, subsidiary books - Errors andrectification – Preparation of trial balance and final accounts. Accounting from incomplete records - Statements of affairsmethods -Conversion method - Preparation of Trading, Profit & LossAccount and Balance Sheet from incomplete records.Unit - 3 Financial Statement Analysis - Financial statements - Nature offinancial statements - Limitations of financial statements - Analysis ofinterpretation -Types of analysis -- External vs Internal analysis -Horizontal vs Vertical analysis - Tools of analysis - Trend analysis -Common size statements -Comparative statements. Ratio Analysis - Types - Profitability ratios - Turnover ratios -Liquidity ratios - Proprietary ratios - Market earnings ratios - Factorsaffecting efficiency of ratios - How to make effective use of ratioanalysis - Uses and limitation of ratios - Construction of Profit andLoss Account and Balance Sheet with ratios and relevant figures -Inter-firm, Intra-firm comparisons.
Unit -4 Fund Flow Statements - Need and meaning - Preparation ofschedule of changes in working capital and the fund flow statement -Managerial uses and limitation of fund flow statement. Cash Flow Statement - Need - Meaning - Preparation of cashflow statement - Managerial uses of cash flow statement - Limitations– Differences between fund How and cash tlow analysis.Unit-5 Budgeting and Budgetary Control: Preparation of various typesof budgets - Classification of budgets - Budgetary control system -Mechanism -Master budget.Unit-6 Capital Budgeting System - Importance - Methods of capitalexpenditure appraisal - Payback period method - ARR method - DCFmethods - NPV andIRR methods - Their rationale - Capital rationing.
FINANCIAL AND MANAGEMENT ACCOUNTINGLESSON TITLE 1. Accounting an Introduction 2. Management Accounting 3. Theory Base of Accounting - Accounting Standards 4. Practical Base of Accounting - Origin and Analysis of Business Transactions 5. Financial Statements of Profit-making Entities Manufacturing-cum-Trading Organisations 6. Financial Statements of Non-Profit-making Entities 7. Errors Management 8. Accounts from Incomplete Records - Single Entry System 9. Financial Statement Analysis 10. Ratio Analysis 11. Fund Flow Analysis 12. Cash Flow Analysis 13. Budgeting and Budgetary Control 14. Capital Budgeting 15. Case Study
LESSON - 1 ACCOUNTING: AN INTRODUCTIONLearning outcomes; on completion of this chapter, you should be ableto: Explain the nature of accounting. Identify the various branches of accounting. Explain the process of creation of financial statements and their interpolation. Explain the various objectives of financial statements. Identify the various uses of accounting information.INTRODUCTION Accounting discipline deals with measurement of economicactivities affecting inflow and outflow of economic resources to developuseful information for decision making. At household level informationabout outflow and inflow of cash resources helps -.0 assess financialposition and plan household activities. At Government level,information about inflow from taxes (direct as well as indirect) andexpenditure on various activities (developmental and nondevelopmental) is needed for planning and budgeting. Althoughaccounting can be discipline has universal applicability, but itsgrowth is closely associated with the developments in the businessworld. Thus to understand accounting as a field of study for universalapplication, it is best identified with recording of business transactionand thereby creating economic information about businessenterprises to facilitate decision making.NATURE OF ACCOUNTING:1.2 Accounting i. is man-made; ii. has evolved over a period of time;
iii. is practiced in a social system; iv. is a systematic exercise; v. is judgmentat at times; vi. follows flexible, not a rigid approach; vii. is essentially a language; viii. as a language, has a very well defined syntax of its own; and ix. Communicates financial information for decision making. Accounting being a man-made system has evolved over a periodof time to provide financial information of business enterprises tousers of accounting information. A large number of groups with variedinterests in affairs of a business enterprise have emerged over a periodof time, especially after emergence of corporate forms of organizationinvolving separation of ownership management. These user groupsinclude those who; manage the activities of the enterprise( management) own the enterprise( owners/ shareholders) extend credit for supply of goods to the enterprises (creditors) buy goods from the enterprises( customers) lend money to the enterprises( banks and financial information) are employed in the enterprises (employees) intend to make investment in the enterprises(mvestors) are doing research(researchers) are engaged in collection of taxes ( sales tax and income tax authorities) formulate fiscal and monetary policies (other Government department) are members of the public at large(general public) Internal users of accounting information are inside the
enterprise and need information to control and plan the activities ofthe business to manage it effectively. These include Owners in case ofnon corporate enterprises and managers and directors in case ofcorporate business. Their information needs are satined throughvarious reports which are generally prepared internal use and remainunpublished. External users of accounting information are outside theenterprise. The information need of these user groups are met bymeasuring the desired information by following a systematic process.It results in creation of financial statements which are generallypublished to make the information available to external user group fordecision making. The need for communicating relevant and usefulinformation to that potential internal and external users is alwaysthere and accounting is intended to perform that role.Thus, accounting may be defined as: "the process of identifying, measuring and communicatinginformation to permit judgement and decision by the users"( American Accounting Association)BRANCHES OF ACCOUNTINGFinancial Accounting: It primarily concentrates on creation of financialinformation for external user groups such as creditors, investors,lenders and so on. It deals with business events which have alreadyoccurred and is, therefore, historical in nature. Traditionally, the aimwas to develop information about income and financial position on thebasis of events which had taken place during a period of time. Recenttrend in corporate form of organization is to provide information aboutcash flows and earnings per sh^e also as part of published financialstatements. Management Accounting - The information provided by
the financial accounting system is significant but not sufficient forsmooth orderly and efficient conduct of business. Management needsmore information to discharge its function of stewardship, planning,control and decision-making. As information needs of managementvary from enterprise to enterprise, the grouping and reporting ofinformation takes different forms. Trie different ways of groupinginformation and preparing reports as desired by managers fordischarging their functions are referred to a management accounting.Management accounting provides information to the management notonly about cost but also revenue, profit, investment etc., for managingbusiness more efficiently and effectively. A very important componentof management accounting is cost accounting which deals with costascertainment and cost control. Few other branches of accounting which are of recentorigin are social responsibility accounting and human resourcesaccounting. The first one involves accounting for social costs incurredby the enterprise and social benefits created by it while the seconddeals with accounting for human resources. In the present book, we are concerned with financialaccounting only. The word accounting and financial accounting areused interchangeably. Financial accounting provides information to externaluser groups in the form of published financial statements. As theseusers are involved in preparation of financial statements, it is veryessential that the published statements have credibility and regardedas reliable by external users. Therefore, accounting, as a language forcommunicating information, needs to have a strong syntax of its ownfor preparing credible financial statements. The syntax of accounting language comprises of analysis
and recording of business transactions on the basis of double Entrysystem of book keeping and the basic principles on which thepractical system is based. The theory base; of accounting consists ofGenerally Accepted Accounting Principles (GAAP), Conceptualframework and Accounting Standards (AS) issued by the professionalaccounting bodies all over the world, The credibility of the financial statements is establishedthrough analysis independent examinations by a chatteredaccountant who certifies that the information provided therein givestrue and fair view of the activities of tM business in conformity withaccepted principles and practices. This process of attestation ofaccount is known as auditing of accounts.MEANING OF FINANCIAL ACCOUNTING Measurement of accounting information involves threebasic steps as per the traditional definition of accounting by theAmerican Institute of Certified Public Accounts (AICPA) which definesaccounting as "the are of recording, classifying and summarizing in asignificant manner and in terms of money, transaction- and eventswhich are negative part atleast of financial character and interpretingthe results thereof. On this basis of above information, Accounting or moreprecise financial accounting can be basically divided into two parts", A. Creation of financial information. B. Use of financial information.A. Creation of financial information: Creation of financial information involves three steps:
1. Recording: The process of creation of financial information starts with theoccurrence of a business transaction which can be Qualified. Thetransaction is evidenced by some document such as Sales bill, Passbook, Salaries slip etc., The systematic record of those transactions ischronological order (i.e. the order in which they occur ) is made in abook called JOURNAL BOOK. The four basic questions need to beaddressed while recording namely, what to record, when to record,how to record and at what value to record?What to record? Since-accounting is regarded as language of thebusiness, it should systematically record all the transaction andevents which affect the results of business and ignore the persontransaction of the proprietor. Before recording in the journal book, allbusiness transaction expressed in terms of money. Consequentlybusiness activities which cannot be expressed in terms of money suchas strikes, changes in the composition of board of directors etc., arenot recorded. Thud decision makers will get informa^on only aboutmoney aspects of the business enterprise from a accounting records.When to record? Usually business transaction is recorded only whenit has occurred. Thus accounting is basically historical in nature.How to record? Usually business transaction has two aspects andboth these are recorded by passing analysts entry in an journal book.This system of recording is called double entry book keeping system.At what value to record? To record occurrence of an event in journalbook, decision about the value of the transaction is needed. A number of different valuation bases are used inaccounting in varying degrees and include historical cost, currentcost, realizable value and present value. These valuation based
generally assume significance in case of valuation of assets. Historicalcost refers to amount paid / payable to acquire an asset. The currentcost means the amount that would have to be paid, if the asset is tobe acquired currently. The realizable value refers to the net realizablevalue of the assets if it is to be disposed. The present value of an assetis the present discounted value of the future inflows that analysis itemis expected to generate in the normal course of business.2. Classifying: After recording monetary transactions in the journalbook, next step is to classify the recorded information into relatedgroups to put information in compact and usable forms. For e.g., alltransactions involving cash inflows (receipts) and cash outflows(payments) can be grouped to develop useful information is calledledger book. Mechanism used for classification of recordedinformation is to open accounts which are called ledger accounts.3. Summarizing: Basic aim of accounting is to create financial information in aform which will be useful to the decision makers. To achieve this end,accounts containing classified information in the ledger book arebalanced. After balancing of the ledger book, account balances arelisted statement giving names of theses accounts and their balance iscalled " TRIAL BALANCE " on the basts of trail balance, summariesare prepared to give useful information about the financial resultsduring a time period and the financial position at a point of time.Reporting of summarizes of the business transaction is done in theform of financial statements which are known as FINAL ACCOUNTS.According to international Accounting standard - 1 the term financialstatements covers balance sheet, income statements or profit and lossaccounts, notes and other statements and explanatory material whichare identified as being part of the financial statements. The process of
creation of financial information can be summarized as follows:
Analysis of Recording Classificati Summariza business Journal on in ledger tion first in transaction Book book trial evidenced balance by source and then in document financial statements Thus recording, classifying and summarizing are three basicsteps involved in creation of financial statement which ascertain andcommunicate result of business entity. For this is assumed thatbusiness and its owner have separate existence. For accountingpurpose, even a division of the business or a branch of it may betreated as an accounting entity.B. Use of Financial Information / Statements: Financial statements prepared by a business enterpriseare published and are available to the decision makers. Sounddivision making requires analysis and interpretation of these financialstatements. A very commonly used tool for financial analysis is ratioanalysis. However, there are other tools which are used by thedecision makers to undertake analysis. The widely used tools forcarrying out analysis are : • Cash flow statement • Fund flow statement Ratio analysis • Comparative statement • Common size statement However to analyze and interpret these financialstatements, the user shou/d be aware of purpose and nature of thesestatements can be described as follows : "Financial statements are prepared for the purpose ofpresenting a periodical review or report on progress by management
and deal with the status of investment in the business and the resultsachieved during the period under review. They reflect a combination ofrecorded facts, accounting, conventions and personal judgements andjudgements and conventions applied after them materially. Thesoundness of the judgement necessarily depends on the competenceand integrity of those who make them and on their adherence toGenerally Accepted Accounting Principles and Conventions. (BombayStock Exchange Official Directory).OBJECTIVES OF ACCOUNTING The main objective of accounting are as follows: The main records of business: In accounting, systematic record of monetary aspects of business events are maintained. The first step in preparation of financial statements. This is referred to as book-keeping. Calculation of profit or loss: To calculate profit earned or losses suffered during a period of time, a business enterprise prepares an Income Statement. It is also referred to a trading and profit and loss account. Depiction of financial position: In addition to profit (or loss), sound decision-making requires information about the financial position of a busiriess enterprises. To depict financial position of a business, financial position statement is prepared. On the one hand, it gives details of resources owned by the business enterprise. Resource owned are termed as assets. On the other hand it contains the information about obligations of business. Obligation of the business towards outsiders and owner are referred to as liabilities and capital respectively. Financial position statement is also termed as balance sheet which provide information about sources of finance (e.g. outside liability and owners equity) and the resources (eg. assets) of the business. To portiay the liquidity position: Financial reporting should
provide information about how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing about its capital transactions, cash dividends and other distribution of resources by the enterprise to owners and about other factors that may affect an enterprises liquidity and solvency. Control over the property and asset of the firm: Accounting provides up-to-date information about the various assets that the firm possess and the liabilities the firm owes so that nobody can claim a payment which is not due to him. To file tax returns: This is the objective which really hardly needs emphasis. The credible accounting records provide the best bases for filing returns of both, direct as well as indirect taxes. To make financial information available to various groups and users: Accounting is called the language of business. It aims to communicate information about financial results and financial position of a business enterprise to decision makers,USERS OF ACCOUNTING INFORMATION Users of accounting information can be grouped asfollowsOwners: Owners refers to a person or group of persons who havesupplied capital for running the business. It refers to individual incase of joint stock companies. Information needs of shareholders haveassumed great significance in the corporate business world because ofseparation of ownership and management in case of joint stockcompanies owners are interested in the financial information, toknow"about safety of amount invested and return on amountinvested.Managers: For managing business profitably informationaboutHnancial result and financial position is needed by management
By providing this information, accounting helps managers in efficientand smooth running of a business enterprise.Investors: Prospective investors would like to know about the pastperformance of the business enterprise before making investment inthat concern. By analyzingihistorical information provided byaccounting records, they can arrive at a decision about the expectedreturn and risk involved in investing in particular business enterprise.Creditors and Financial Institutions: Whosoever is extending creditor loan to a businessenterprise, would like to have information aboutits repaying capacity, creditworthiness etc., The required informationcan be obtained by analyzing and interpreting the financialstatements of the business enterprise.Employees: Employees are concerned about job security and futureprospectus. Both of thpse are intimately related with the performanceof the business enterprise, Thus by analyzing financial statementsthey can draw conclusions about their job security and futureprospectus.Government: Government policies relating to taxation, providingsubsidies etc., are guided by the relevance of the industry in theeconomic development of the country and the past performance of theindustry. Information about the past performance is provided by theaccounting system, collection of taxes is also based on accountingrecords.Researchers: Researchers need financial information for testinghypothesis and development of theories and models. The financialstatement provides the recorded information.Customers: (Customers who have developed loyalties to a business
are ceitainly interested in the continuance of the business. Theycertainly want to know about the future directions of the enterprisewith which they are associating themselves. The way to informationabout the enterprise is through their financial statements.Public: An enterprise affects the public at large in many ways such asprovider of the employment to a number of persons being a customerto many supplier a provider of amenities on the locality, a cause ofconcern to the public due to pollution etc., Hence public at large isinterested in knowing the future directions of the enterprise and theonly window to peep inside the enterprise is their financialstatements.ACCOUNTING AND THEIR DISCIPLINES: Accounting is the best understood when the other relateddisciplines are conceptually clear to the user. For e.g., a user canhardly understand financial statements with lots of tables and graphsin it. He is not comfortable with the basics of mathematics andstatistics. Accounting is very intimately connected with manydisciplines more important of which are economics, law, management,statistics and mathematics.Linkage with Economics: Accounting has strong linkages with economics. It has acquiredits most important concepts of income and capital from economics.The accountant as well as economist agree that capital should bemaintained intact while calculating income and this income can bedistributed without affecting capital. However, the interpretation ofthe two concepts by accountant and economist differ a great dealdespite similarities. The capital to an economist is like a tree andincome is like a fruit on that tree. In technical terms, a stock of wealth(Tree) or assets existing at a point of time is called capital whereas
flow of benefits from the wealth through a given periodvs calledincome. Hence capital and wealth are synonyms for the economist.The methodology adopted by economist is finding income is to find outthe excess of capital at the end of the year over the beginning of theyear. If the capital increases, it is more income. However as the capitaldecreases it is called loss. To arrive at the value of the capital orwealth, the present value of the future benefits is calculated bydiscounting expected benefits at the required rate of return. Hence tofind out the worth of an asset, the economist will have to estimate thelife of the asset and the likely benefits to be desired from it. Thebenefits will be discounted at the requires rate of return of the assethas an exceptionally long life. Hence economists valuation of capitaland income are highly subjective. Accountant tries to impart practicability to the concept ofcapital and income. Recognizing that future benefits of an asset withlong life of say 100 years are difficult to estimate, the accountant putsa value of the asset at which it was acquired. However, his attitude isquite flexible and makes use of other bases of measurement whereverthe need arises. The income of business belongs to a owner. Theaccountant finds income as a direct result of matching of revenue andexpense of the same period. It is always calculated at the end of aperiod. The matching of revenues and expense can be done ondifferent basis viz accrual, cash and hybrid bases. The bases arediscussed in detail later:Linkage with Mathematics: Accounting is all about figures and operations on thesefigures. The basic system of accounting can be very convenientlyconverted in the mathematical form in the form of an accountingequation. Simple mathematical operations involved in accounting areaddition, subtraction, multiplication and division. Besides many
aspects of accounting involve calculations which involve strongknowledge of mathematics. For e.g., calculation of interest, calculationof the annuity needed to depreciate an asset with a defined rate ofinterest over its estimated useful life, bifurcation of a hire purchaseinstalment in cash price component and interest component etc.,Linkages with Statistics: Accounting is not only about the preparation of accountinginformation, it also involves the presentation and interpretation ofaccounting information. The presentation aspects involved creation oftables and graphs etc., the knowledge of which essentially lies in thediscipline of statistics. One of the most debated topic of accountingnamely inflation accounting involves extensive conversation ofhistorical accounting information with the help of price indices, animportant constituent of the discipline of statistics. The interpretationof accounting information involves making absolute and relativecomparison with the help of ratio analysis. The knowledge of statisticsis needed for the purpose. An important way of calculating interest isthrough the concept of average due date, which is based on theknowledge of averages.Linkages with Law: Accounting essentially operates within a legalenvironment. Many business organizations are governed by theirrespective statues which prescribe the many aspects of theiraccounting information including the presentation of information. Fore.g., the Indian Companies Activities, 1956 prescribes the rules formanagerial remuneration. It also prescribes the format of balancesheet as well as profit and loss account, The banking, insurance andelectricity companies have also to prepare their accounts as per therequirement of the respective statutes governing them.
LESSON - 2 MANAGEMENT ACCOU NTINGDEFINITION OF MANAGEMENT ACCOUNTING The accounting activity can be classified into two parts.Financial Accounting and Management Accounting. Though both ofthem are interlinked, Management accounting is future oriented,dynamic and is made to be decisive and control relevant. International Federation of Accountants (IFAC) definedManagement Accounting process as "the process of identification,measurement, accumulation, analysis, preparation, interpretation andcommunication of information both financial and operating used bymanagement to plan, evaluate and controJ within an organisation andto assure use of and accountability for its resources". ICWAI published Glossary of Management Accounting termsdefining Management Accounting as "a system of collection andpresentation of relevant economic information relating to anenterprise for planning, coordinating and decision making", Management Accounting : Official Terminology of CIMA isdefined Management Accounting as "the provision of informationrequired by management for such purposes as: 1. Formulation of policies 2. Planning and controlling the activities of the enterprise 3. Decision taking on alternative course of action 4. Disc losure to those external to the entity (shareholders and others) 5. Disclosure to employees 6. Safeguarding assetsThe assets involves participation in management to ensure that thereis effective: • Formulation of plans to meet objectives (long-term planning)
• Formulation of short-term operation plans (budgeting/ profit making)". American Accounting Association defines ManagementAccounting as "the application of appropriate techniques and conceptsin processing historical and projected economic data of an entity toassist management in establishing plans for reasonable economicobjectives and in the making of rational decisions with a view towardsthese objectives". Richard M.S. Wilson and Wai Fong Chua define ManagerialAccounting as "Managerial Accounting encompasses techniques andprocesses that are intended to provide financial and non-financialinformation to people within an organisation to make better decisionsand thereby achieve organisational control and enhanceorganisational effectiveness" The Management Accounting is used by management to planthe activity, evaluate performance, ensure integrity of financialinformation and to irnplement the system of reporting that is linked toorganisational responsibilities and contributes to the effectiveperformance measurement. The definition of Management Accountingembraces all functions undertaken by accountants in an organisation.Management Accounting needs to be dynamic and forward looking. Italso comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatoryagencies and tax authorities. The role of Management Accountant isnot determined by an isolated concept. It is determined by therequirements of business as Expressed in its structures.SCOPE OF MANAGEMENT ACCOUNTING Management Accounting includes Financial Accounting andextends to the operation of a system of cost accounting and financialmanagement. While meeting the legal and conventional requirements
regarding the presentation of financial statements (profit and lossaccount, balance sheet and funds flow statements) it stresses uponthe establishment and operation of internal controls. The scope ofManagement Accounting, inter alia, includes: Formation, installation and operation of accounting, cost accounting, tax accounting and information systems. Management Accountant has to construct and re-construct these systems to meet the changing needs of management functions The compilation and preservation of vital data for management planning. The account and document files are respository of vast quantities of details about the past progress of the enterprise, without which forecasts of the future is very difficult for the enterprise. The Management Accountant presents the past data in such a way as to reflect the trends of evbnts to the management. Providing means of communicating management plans to the various levels of organisation. This, on the one hand, ensures the coordination of various segments of the enterprise plans and on the other defines the role of individual segments in the whole plan and assists the management in directing their activities. Providing and installing an effective system of feedback reports. This would enable the management in its controlling function. By pinpointing the significant deviations between actual and expected activities, and by adhering to the principles of selectivity and relevance, such reports help in jthe installation and operation of the system of Management by Exception. The Management Accounting is expected to analyse the deviation by reasons and responsibility and to suggest appropriate corrective measures in deserving cases.
Analysing and interpreting accounting and other data to make it understandable and usable to the management. It is only through such analysis and clarification that the management is enabled to place the various data and figures in proper perspective in the performance of its functions. Such analysis assists management- in the location of responsibilities and to effect necessary changes in the organisational setup to achieve the objectives of the enterprise in a more efficient manner. Assisting management in decision making by (i) providing relevant accounting and other data and (ii) analysing the effect of alternative proposals on the profits and position of the enterprise. Management Accountant helps the management in proper understanding and analysis of the problem in hand and presentation of factual information obviously in financial terms. Providing methods and techniques for evaluating the performance of the management in the light of the objectives of the enterprise, thus assisting in the jrnpiementation of the principle Management by Objectives. Improving, modifying and sharpening the effectiveness of the existing techniques of analysis. The Management Accountant would always think of increasing the practicability of existing techniques. He should be on the look-out of the development of new techniques as well. Thus, Management Accounting serves not only as a tool in thehands of management, but also provides for a technique evaluatingthe performance of its functions of planning/decision making andcontrol, and at the same time, enabling the owners and otherinterested parties to evaluate and appraise the management of theenterprise.
FUNCTIONS OF MANAGEMENT ACCOUNTING Management Accountant is one of the best assets formanagement. His contribution has been growing with passage of time.He will continue to deliver the goods in a magnificent manner infuture with varied experiences. Scope is expanding and managementsof various sectors are benefiting. Excerpts from the "Preface toStatements on International Management Accounting" issued oy theinternational Federation of Accountants in February 1987 arereproduced below: "Management Accounting is used by management to; Plan - to gain an understanding, to expected business transactions and other economic events and their impact on the organisation, and to use this understanding as a basis for a course of action to be followed by the organisation in the future; Evaluate - to judge the implications of various past and/orfuture events; Control - to ensure the integrity of financial information concerning an organisations activities or its resources; Assure accountability - to implement the system of reporting that is closely aligned to organisational responsibilities and that contributes to the effective measurement of management performance"The functions of Management Accounting can be broadly classifiedinto; (a) Periodic interval accounting reports, and (b) Ad hoc analysis of data decision making. It is increasingly felt that Management Accountants should
involve themselves more and more in decision making and problemsolving of organisations. The areas of decision making and problemsolving are dealt in the following paras: Strategic Management Accounting: This function helps the organisation prepare long-term plans, formulate corporate strategy and forecast and evaluate the competitors. Investment Appraisal: This activity includes the (i) appraisal of long-term investment (ii) funding of accepted programmes projects, and (iii) post-audit of accepted programmes. Financial Management: It deals with raising of funds for investment, managing surplus funds, controlling working capital etc, Short-term ad hoc decisions: This includes analysing data for taking decisions c i pricing, product introduction, acceptance of special orders etc. Managing the organisation of information system: This includes not only organising the enterprises financial data but fulfilling the information needs of all the segments of the organisation.FUNCTIONS OF MANAGEMENT ACCOUNTANT The term Management Accountant has many Director,Financial Director, Financial Controller, Finance Comptroller etc., aresome of the terms used to designate with the work ManagementAccounting. Depending situation, size, nature arid organisationalsetup and his position in the company, the Management Accountantmay be required to perform various and varied functions. Theimportance and effectiveness of his function would also depend uponthe confidence reposed in him by the top management and thefunctional managers. His functions generally embrace each and everyactivity of the management. The essence of Management Accountantsfunctions are as follows: The Management Accountant will establish, coordinate and:
administer plans to facilitate the forecasting of sales, expense budgets and cost standards that will permit profit planning, capital budgeting and financing. The Management Accountant will formulate accounting policy and procedures. Operating data and special reports must be prepared so that the performance can be compared with plans and standards, and any variance between actual operations and pre-determined standards can be analysed for corrective actions by management Such comparisons between actual and expected activities should help the management in proper fixation of responsibility and also in evaluation of various functional and divisional heads. The Management Accountant will be responsible for the protection of business assets to the extent possible by external controls and internal auditing and insurance coverage. The Management Accountant will be responsible for tax policies and procedures and will supervise and coordinate the reports required by various authorities. ; The Management Accountant must continually £e aware of economic and social forces as well as the effect of the Government policies and actions on business activities. An analysis of the above list (obviously not exhaustive) ofunctions, reflects the status of a Management Accountant. He is theprincipal office in-charge of the accounts of the company. He shall beresponsible to the Board of Directors for the maintenance of adequateaccounting procedures and records on the operation of business. Heshall be responsible to the President or the Chairman of the Board orthe Board of Directors. Thus, in his broad functional activities, theManagement Accountant is responsible to the policy making group oftop management, whereas, in his administrative activities he ssresponsible to the top executive offer.
MANAGEMENT ACCOUNTING VS FINANCIAL ACCOUNTING The financial accounting classifies and records an entitystransactions normally in money terms, in accordance with establishedconcepts, principles, accounting standards and legal requirements. Itaims to present a true and fair view jof the overall results of thosetransactions. Management Accounting has been described as acontinuous process of analysis, planning and control in the context ofproviding decision support for decision makers. ManagementAccounting is more concerned with decision making and a key role forManagement Accountant is acting as a provider of financialinformation to support these decisions, There are several differencesbetween Financial Accounting and Management Accounting as are setout in Table 1.1.Financial Accounting and Management Accounting both appear to besimilar inasmdch as both study the impact of business transactionsand events of the enterprise, reports and interpret the results thereof.Both provide information for internals as well as external use. ButManagement Accounting although having its roots in FinancialAccounting differs from the latter in following respects: Financial Accounting studies the business transactions and events for the enterprise as a whole. It does not trace the path of events with in the enterprise. Management Accounting, in additions to the study of the events in relation to the enterprise as a whole, takes organisation in its various units and segments and attempts to trace the impact and effect of the business transactions and events through these various divisions and sub-divisions. Thus, while the financial statements -profit and loss account, balance sheet and flow statements reveal the overall performance and position of the enterprise. Management Accounting reports emphasis on the details of operational costs,
inventories, products, processes and jobs. It traces the effect and impact of the business transactions and events on costs, inventories, processes, jobs and products. Financial Accounting is more attached with reporting the results and positions of business to persons and authorities other than management-Government, Creditors, Investors, Owners, etc. At times, Financial Accounting follows window- dressing tactics in order to project a better than actual image of the enterprise. Management Accounting is concerned more with generating information for the use of internal management and hence the information reflects the real or really expected position. Financial Accounting is necessarily historical. It records and analyses business events long after they have taken place. Management Accounting analyses the events as they take place and also anticipates such events for the future. Thus, it uses data which generally has relevance to the future. Since Financial Accounting data is historical in nature, it is more precise than the Management Accounting data, which generally reflects Ihe expected future, and hence could only be an estimation. This provides the necessary rapidly to Management Accounting information. The periodicity in reporting financial accounts is much wider than in case of Management Accounting. In Financial Accounting, generally, results are reported on year to year basis. In Management Accounting is free to formulate its own rules, procedures and forms because the information generates is solely for internal consumption. Financial Accounting has to governed by the generally accepted
principles. This is so because, it has to cater for the informational needs of the outsiders and legal provisions. Management Accounting is free to formulate its own rules, procedures and forms because the information it generates is solely for internal consumption. Financial Statements prepared under Financial Accounting consists of monetary information only. Management Accounting statements, in addition to monetary information, also consists non-monetary information viz., quantities of materials consumed, number of workers, quantities produced and sold and so on.TABLE 1.1: MANAGEMENT ACCOUNTING vs. FINANCIALACCOUNTING Nature Fianacial Accounting Management Accoutning 1. Governed by Company law etc. Needs of managers 2. Basic functions Transaction Decision support recording, Provision of Publication of Management 3. Users external financial information statements Internal External
4. Availibility Publicly available Confidential5. Time focus Past and present Present and future6. Period Usually one year As appropriate7. Main emphasis Explanation Planning and control8. Speed of Slow but detailed and Fast but approximate prepartion accurate9. Form of whole of entity Segmented to control presentations units10.Style and Standardized Tailored to details requirement and Objective, verifiable summarized11.Criteria and consistent Relevant, useful and Money understandable12.Unit of account Somewhat technical Money physical units13.Nature of data For use by non- accountants
LESSON - 3 THEORY BASE OF ACCOUNTING - ACCOUNTING STANDARDS Accounting is "the process of identifying, measuring andcommunicating information to permit judgement and decisions by theusers of accounts" -American Accounting Association. It is absolutelynecessary that accounting information contained in financialstatements are credible and are regarded as reliable by the differentuser groups to be consistent. Preparation of financial statements onuniform and consistent basis improves their comparability andcredibility. It has two aspects, namely, • The financial statements of an enterprise for different accounting years are based on similar accounting procedures and policies so that meaningful comparisons over a period of time can be made1 about he progress of the enterprise. This is commonly referred to as Time series analysis’. • The financial statements of many enterprises at a point of time are based on similar accounting procedures and policies so that conclusions can be drawn about their relative performance at a point of time. It is known as Cross-sectional analysis. , It is the function of Accounting Standards -to provide a rationalstructural framework so that credible financial statements of thehighest quality can be produced. According to T.P. Ghosh accountingstandards are defined as under’. “Accounting standards are the policy documents issued by the recognised expert accountancy body relating to various aspects of measurement, treatment and disclosure of accounting transactions and
events” It is clear from the above definition that accounting standardsprovide aframework for the preparation of the financial statements. They alsodraw the boundaries within which acceptable conduct lies. In theabsence of accounting standards, many alternatives will exist and willgive the accountant the| leverage to colourhis accounting records theway he likes. Such Creative Accounting Practices’ will certainlycreate financial statements which are unreliable and lower theconfidence of user in the reported results. Hence the need for acoherent pet of accounting standards is imperative. The efficientfunctioning of the financial system depends upon the confidence thatuser groups have in the fairness and reliability of the financialstatements of the businesses ana it is the function of accountingstandards to create this genera) sense of confidence by providing; astructural framework within which credible financial statements canbe produced. The whole idea of ‘Accounting Standards’ is centredaround harmonisation in the accounting policies and practicesfollowed by businesses. The basic purpose of Accounting Standardsis to standardize the diverse accounting practices followed formany aspects of accounting. The harmonisation of accountingpolicies and practices is needed at national level as well asinternational level. To tackle the problem at national level, theInstitute of Chartered Accountants of" India issues accountingstandards (called ASs) formulated by the Accounting Standards Board(ASB). At international level, International Accounting StandardsCommittee (IASC) issues International Accounting Standards (calledlASs). The objective of the IASC in terms of standard setting is "towork generally for the improvement and harmonisation of regulations,accounting standards and procedures relating to the presentation offinancial statements. The Institute of Chartered Accountants of Indiais a member of IASC and has a tacit understanding with the IASC that
it would adopt the accounting standards issued by IASC after duerecognition of the conditions and practices prevailing in India. At theinternational level, IASC has issued 32 international accountingstandards. At the national level, ICAI has issued 15 accountingstandards on various issues of accounting and a preliminary draftof a proposed accounting standard on borrowing costs is being madeby the ASB in addition to the revision contemplated in existingstandards on valuation of inventories and accounting for constructioncontracts.ACCOUNTING STANDARDS (N INDIA The Institute of Chartered Accountants of India, fullyrecognising the need cf harmonizing the diverse accounting policiesand practices established Accounting Standards Board on 21 st April,1977 so that accounting as a language could develop along the rightlines. Accounting Standard Boards (ASB) main function is toformulate accounting standards to be issued under the authority ofthe council of the institute. Accounting standards provide rules andcriteria of accounting measurement. However the rules criteria areintended lo be used if: a sociai system and hence are never intended lobe rigid as in case of physical sciences.Constitution of ASB :The consistitution of ASB gives adequate representation to allinterested parties and, at present, it consists of members of thecouncil and representatives to industry, banks, Company Law Board,Central Board of Direct Taxes and the Comptroller and AuditorGeneral of India, Security Exchange Board of India etc,Functions of ASB :The main function of ASB is to fomralate accounting standards. Whileformulating accounting standards, ASB takes into consideration theapplicable laws, customs, usage and business environment. The
Institute is the member of International Accounting StandardsCommittee (IASC) and has agreed to support the objectives of IASC.While formulating standards, it gives due consideration to theInternational Accounting Standards (IAS) issued by IASC and tries tointegrate them, to the extent possible, in the light of conditions andpractices prevailing in India. It also reviews the accounting standardsat periodical intervals.FORMULATION OF ACCOUNTING STANDARDSThe following points need to be kept in mind while drafting accountingstandards, namely - • The accounting standards issued are in conformity with the provisions of the applicable laws, customs, usage and business environment of our country; • The accounting standards are in the nature of laws but not laws. Though every possible care is taken while drafting standards that they are in conformity with eh applicable laws, still the conflict between the law and an accounting standard might arise due to amendments in the law subsequent to the issuance of the accounting standard. As clarified in the Statements of Accounting Standards, accounting standards cannot and do not override the statute and in all such cases of conflicts, the provisions of the law will prevail and the financial statements should be prepared in conformity with the relevant laws Obviously, to that extent, the accounting standards shall not be applicable. However, "the institute will determine the extenl of disclosure to be made in financial statements and the related auditors reports. Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore, need not be treated as adverse comments on the related financial statements"
• The accounting standards are intended to apply only to items which are material and become applicable from the date as specified by the institute. They are applicable to all classes of enterprise unless otherwise stated. No standard is applicable retroactively, unless otherwise stated; • The accounting standards are to address the basic mattes, to the extent possible. The idea is to confine them to essentials only and not to make them complex. The ASB has drawn an elaborate procedure for formulatingaccounting standards. However, it needs to be emphasised that thestandards are issued under the authority of the council of theinstitute. The procedure involves the following steps: a) Firstly, the ASB determines the broad areas in which accounting standards need to be formulated; b) Secondly, the ASB takes the assistance of the various study groups to formulate standards The preliminary drafts of the standards are prepared by the Study groups which take up the specific subjects assigned to them. The draft prepared by a Study Group is considered by ASB and sent to various outside bodies like FICCI, ASSOCHAM, SCOPE, CLB, C&AG, ICWAI, ICSI, CBDT etc. and the representative of these bodies are also invited at a meeting of ASB for discussion. c) Thirdly, after taking into consideration their views, the draft of the standard is issued as exposure draft for soliciting comments from members of the institute and public at large. The draft is issued to a large number of institutions and is published in the journal of the institute. The exposure draft includes the
following basic points: • A statement of concepts and fundamental accounting principles relating to the standard; • Definitions of the terms used in the standard; • The manner in which the accounting principles have been applied for formulating the standard; • The presentation and disclosure requirements in complying with the standard; • Class of enterprises to which the standard will apply, • Date from which the standard will be effective. d) Fourthly, the comments on the exposure draft are then considered by the ASB and a final draft is prepared and submitted to the council of the institute; e) Lastly, the council of the institute considers the final draft of the proposed standard, and if found necessary, modifies the same in consultation with ASB. The accounting standard on the relevant subject is then issued under the authority of the council.NATURE OF ACCOUNTING STANDARDS The accounting standards issued by the ICAI-arerecommendatory in nature in the initial years. During the period astandard is recommendatory, it is expected that the accountingpractices shall be brought in line with the standard. In other words,the recommendatory period is allowed to smoothen the process oftransition so that no enterprise should have difficulty in conforming tothe accounting standards once they are made mandatory. Once anaccounting standard is made mandatory, it is applicable to allenterprises whose accounts are audited by the members.
During the period an accounting standard is recommendatory,tne auditors of companies are required to recommend and persuadetheir cfients to comply with the requirements of the accountingstandard even though it is recommendatory in nature. Regarding themandatory standards, it is the duty of the auditors to ensure that theaccounting standards are followed in the preparation andpresentation of the financial statements. If the mandatory accountingstandards have not beer, complied with, the auditor is required tomake adequate disclosure in his report so that the users of financialstatements are aware of the non-compliance on the part of theenterprise. If a member fails to do so, the Chartered Accountants Actexplicitly provides that “a chartered accountant in practice will bedeemed to be guilty of professional misconduct if he ails to inviteattention to any material departure from the generally acceptedprocedure of audit applicable to the circumstances” It is amply clear that standards on their own have no legalbacking and hence, are not enforceable on the public at large. Hencethe institute depends on is members for implementation of accountingstandards issued by it through their attest function. To make iteffective, following steps are needed: • Self-regulation on the part of the business organisation so that I hey adhere to these standards while finalising their accounts; • Legal backing to the accounting standards. The standards as they are issued not have no legal backing and institute depends on its memters for their implementation through their attest function; • Publicising the use of accounting standards and making the user: of accounting information more informed about their right of getting a more true and fair picture of the results of business
based on these accounting standards; • To avoid duplication of authority. If more than one authority issues standards, it is bound to create a confusion in the mind of the user as to which standard needs to be followed. A recent development, worthy of attention, is the establishment of two accounting standards by the government under the Income Tax Act, 1961 which are to be followed in the preparation of financial statements in case the assessee prefers mercantile basis accounting, (Accounting Standard I relating to disclosure of accounting policies and Accounting Standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies). To conclude, the Institute and its members are duty bound toformulate and implement accounting standards to provide objectiveand reliable accounting data that would satisfy the informationrequirements of the users To achieve this, problem of duality ofauthority should be tackled and the system of dual accountingstandards in view of its expertise in the field. To improve theireffectiveness, it is also suggested that the standards should be given alegal backing with strong punishment for the erring businessorganisations. At the same time, to make a genuine case forrecognition of accounting standards and to prevent abuse of financialstatements, more credibility should be provided to the process ofstandard setting.ACCOUNTING STANDARDS ISSUED BY THE INSTITUTEAS-1 Disclosure of Accounting Policies : The standard defines Accounting Policies as referring to thespecific accounting principles and the methods of applying those
principles adopted by the enterprise in the preparation andpresentation of financial statements. It recommends the disclosure ofsignificant accounting policies adopted in the preparation andpresentation of financial statements in a manner that should formpart of the financial statements. It also recommends that hedisclosure should normally be at one place. Any change in theaccounting policies which has a material effect in the current periodor which is reasonably expected to have material effect in laterpejods should be disclosed. It also emphasises that the disclosure ofcompliance with fundamental accounting assumption of GoingConcern, Consistency and Accrual is not needed. However, if they arenot followed, the fact must be disclosed.AS-2 Valuation of Inventories : The inventories should be normally valued at Lower of Cost orMarket where market value means net realizable value. The historicalcost of inventory can be ascertained by use of FIFO, Average Cost, ofLIFO formulae. When organization have different items in inventory,each item may be dealt with separately, or similar items may be dealtwith as a group. The historical cost of manufactured inventories may be arrivedon the basis of either direct costing or absorption costing. Whereabsorption costing is used, the fixed costs should be based on thenormal level of production. Overheads other than productionoverheads should be included as part of the inventory cost only 10the extent that they clearly relate to putting the inventories in theirpresent location and condition.
The accounting policy in respect of inventories should beproperly disclosed and any change in it which has a material effect inthe current accounting period or which is reasonably expected to havematerial effect in later periods should be disclosed. The amount bywhich an item in the financial statements is affected by such changeshould also be disclosed to the extent ascertainabfe. Where suchamount is not ascertainable, wholly or in part, the fact should beindicated. The Specific Identification Method, Adjusted Selling PriceMethod, Standard Cost Method and Base Stock Method are to beused in specific circumstances. However, if base stock method isused, the difference between the value at which it is carried and thevalue by applying the method at which stock in excess of the basestock is valued should be disclosed.AS-3 Changes in Financial Position : A statement of changes in financial position should bepublished along with its published accounts. Such a statement shouldbe prepared and presented for the period covered by the profit andloss account and for the corresponding period. It may be prepare onworking capital basis or cash basis. It emphasises that the fundsprovided from operation and used in the operation be shownseparately and the form of statement should be most informative inthe circumstances. However, the standard is no longer vaJid as it hasbeen superseded by new standard AS-3 (Revised) ‘Cash FlowStatement’ issued in March, 1997.AS-3 (Revised) Cash Flow Statement:
The cash flow statement should report cash flows coring theperiod classified by operating, investing and financing activities. Anenterprise should report cash Hows from operating activities usingeither (a) direct method; or (b) indirect method. The inflow and outflowfrom the investing and financing activities should be shownseparately. Investing and financing transactions that do not requirethe use of the cash or cash equivalents and should present areconciliation of the amounts in its cash flow statement with theequivalent items reported in the balance sheet. The enterprise shouldalso disclose the amount of significant cash and cash equivalentsbalances that are not available for use by it.AS-4 (Revised) Contingencies and Events Occurring after theBalance Sheet Date : A contingency is a condition or situation, the ultimate outcomeof which, gam or loss, will be known or determined only on theoccurrence, or non-occurrence, of one or more uncertain events. Acontingent loss should be recognised if (a) it is probable that futureevents will confirm that ari asset has been impaired or a liability hasbeen incurred on the balance sheet date^ and (b) a reasonableestimate of the amount of the resulting loss can be made. Acontingent gain should not be recognised. If either of the twoconditions mentioned above are not met, a disclosure should be madeof the existence of the contingency specifying: • the nature of the contingency; • the uncertainties which may affect the future outcome; : • an estimate of the financial effect, or a statement that such ail estimate cannot be made. Assets and liabilities should be adjusted for events occurringafter balance sheet date that provide additional evidence to assist theestimation of the amounts relating to conditions existing at thebalance sheet date (for: example, insolvency of a debtor subsequent to
finalisation of financial statements) or that indicate that thefundamental accounting assumption of going concern is notappropriate. Dividends, proposed (or declared) by the enterprise: afterthe balance sheet date but before approval of the financial statements,and pertaining to the period covered by financial statement, should beadjusted. Adjustments to assets and liabilities are not appropriate forevents occurring after the balance sheet date, if such events do notrelate to conditions existing at the balance sheet date (for example,decline in market value of the investment). Disclosure should be madein the report of the approving authority of those events occurring afterthe balance sheet date that represent material changes andcommitments affecting the financial position of the enterprisespecifying: • the nature of the event; I • an estimate of the financial effect, or a statement that such an estimate cannot be made.AS-5 (Revised) Net Profit or Loss for the Period, Prior hems andChanges in Accounting Policies :The objective of this standard is to prescribe the classification anddisclosure of certain items in the statement of profit and loss so thatall enterprises prepare and present their financial statements on auniform basis to improve their comparability. It explains that profit orloss of a period comprises of ordinary activities, extraordinaryactivities and prior period items and all three need to be disclosedseparately. It also includes the impact of change in accountingestimates and change in accounting policies. Ordinary activities are any activities which are undertaken by
an enterprise as part of its business and such related activities inwhich the enterprise engages in furtherance of, incidental to, orarising from, these activities. Extraordinary items are incomes orexpenses that arise from events or transactions that are clearlydistinct from the ordinary activities of the enterprise and, therefore,are not expected to recur frequently or regularly. Prior period itemsareincome or expenses which arise in the current period as a result oferrors or omissions in the preparation of the financial statements ofthe one or more prior periods. The net profit or loss for the periodcomprises the following components, each of which should bedisclosed on the face of the statement of profit and loss; • profit or loss from ordinary activities; and • extraordinary items. Prior period items are normally included in the determination ofnet profit or loss for the current period. An alternative approach is tohow such items in the statement of profit and loss after determinationof current net profit or loss. The second approach seems betterbecause that will help ascertain the result of current period unaffectedby the mistakes of the past, in either case, the objective is to indicatethe effect of such items on the current profit or loss. Change in Accounting Estimates Vs. Change in AccountingPolicies:A distinction should always be made between change in accountingestimates and changes in accounting policies. When it is difficult todistinguish between the change in accounting estimate and change inaccounting policies, it should be regarded as change in accountingestimate, with appropriate disclosure in the periods of change, whichmay be current period only or current period as well as future periods.The effect of change in an accounting estimate should be classified asordinary or extraordinary depending upon whether the originalestimate was regarded as ordinary or extraordinary item. However, the
revision of estimate, by its nature, cannot be called extraordinary orprior period item. When change in accounting estimate/ change inaccounting policy takes place which has a material effect, its natureand amount should be disclosed. If the effect is not ascertainable, thefact should be disclosed in the financial statement.AS-6 (Revised) Depreciation Accounting : The depreciable amount of an asset comprising of its historicalcost, or other amount substituted for historical cost in the financialstatements, less the estimated realizable value should be allocated ona systematic basis to each accounting period during the useful life ofthe asset. The historical cost may undergo revision arising as a resultof increase or decrease in long term liability on account of exchangerate fluctuations, price adjustments, changes in duties or similarfactors. The useful life of the asset may itself be subjected to revision,in which case, the unamortised balance of the asset be depreciatedover its remaining life. Any addition or extension to an existing assetshould be depreciated along with the original asset, unless theextension has a separate identity, in which case it should bedepreciated on the basis of an estimate of its own life. Wheredepreciable asses are disposed of, discarded, demolished or destroyed,the net surplus or deficiency, if material, is disclosed separately. Thechange of method, if warranted, should be done with retrospectiveeffect from the date of asset coming to use. In case of revaluation ofasset, the revalued amount should be amortised over the remaininguseful life of the asset. The information to be included in the financialstatements should comprise of historical cost or any substitutedamount, total depreciation for the period in respect of each class ofasset and related accumulated depreciation. The following informationshould be disclosed in the financial statements along with disclosureof other accounting policies:
• depreciation methods used; and • depreciation rates or the useful lives of the asset, if they are different from the principal rates specified in the statute governing the enterprise.AS-7 Accounting for Construction Contracts : The standard deals with the problem of allocation of revenuesand related costs to the accounting periods over the duration of thecontract. The long term construction contracts could be fixed pricecontracts where contractor agrees to a fixed contract price or cost pluscontracts where the contractor is reimbursed for allowable orotherwise defined costs, and is also allowed a percentage of thesecosts or a fixed fees. Both these contracts can be accounted by eitherpercentage of completion method or completed contract method.Under percentage of completion method, the amount of revenuerecognised is determined with reference to the stage of completion ofthe contract activity at the end of each accounting period. Thecompleted contract method is based on results as determined whenthe contract is completed or substantially completed. Profit in the case of fixed price contract should be recognisedwhen the work has progressed to a reasonable extent- say 25 or 30%.While recognising profit under percentage of completion method, theappropriate allowance for future unforeseeable facts should be madeon either a specific or percentage basis. A foreseeable loss on entirecontract should always be provided for in the financial statementsirrespective of the amount of work done and the method of accountingfollowed. Disclosure of changes in accounting policy used forconstruction contracts should be made in the financial statementsgiving the effect of the change and its amount.AS-8 Accounting for Research and Development:
The prescribed research and development costs outlined in para7 of Hie standard relating to a business should be charged to therevenues of the period in which they are incurred unless the criteriamentioned in para 9 of the standard are met, in which case, thecharging of these expenses can be deferred to future accountingperiods. The research and development costs, once written off, arcnever reinstated in accounts. The deferred research and developmentcost should be allocated on a systematic basis to future accountingperiods by reference to either to the sale or use of the product orprocess or to the time period over which the product or process isexpected to be sold or unused. If at any point of time, criteria fordeferral as detailed in para 9 are not met, the unamortised balance ofresearch and development expenditure should be charged to the profitand loss account. When the criteria for deferral continue to be metbut the amount of the deferred research and development costs andother relevant costs exceed the expected filture revenues/ benefitsrelated thereto, such expenses should be charged as an expenseimmediately. The amount charged to profit and loss account shouldbe explicitly disclosed and unamortised research and developmentcosts should be shown in the balance sheet under the head"Miscellaneous Expenditure". ,AS-9 Revenue Recognition : The standard mainly deals with the timing of revenue. Revenueis defined as "gross inflow of cash, receivable or other considerationarising in the course of ordinary activities of an enterprise from thesale of goods, from the rendering of services, and from the use byothers of enterprise resources yielding interest, royalties anddividends. The revenue is recognised in case of sale when: • the seller of goods has transferred the property in goods tci the
buyer along with significant risks and rewards of the ownership ; and seller has no effective control over goods transferred; • no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale. The revenue from rendering of services is recognised eitherunder completed service method or proportionate completion method.Completed service method is a method of accounting which recognisesrevenue in the statement of profit and loss only when the rendering ofservices under a contract is completed or substantially completed.Proportionate completion method is a method of accounting whichrecognises revenues in the statement of profit and loss proportionatelywith the degree of completion of services under a pontract.Revenue arising from interest is recognised on a time proportionbasis, royalties on an accrual basis and dividends from investments inshares when the owners right to receive payment is established.AS-10 Recounting for Fixed Assets : Fixed asset is an asset held with the intention of being used forthe purpose of producing or providing goods or services and is not he!d for :he sais in the notarial course of business. The gross bookvaiue of a fixed asset shoulo be either historical cost or a revaluedamount. The cost of a fixed asset should normally comprise of itspurchase price and other attributable cost of bringing the asset to itsworking condition for its intended use. Financing costs relating todeferred credits or to borrowed funds attributable to construction oracquisition of fixed assets for the period up to the completion ofconstruction or acquisition of fixed assets should also be included inthe gross book value of the asset to which it relates. When a fixedasset is acquired in exchange or in part exchange for another asset,the cost of the asset required should be recorded either at fair market
value or at the net book value of the asset given up, adjusted for anybalancing; payment or receipt of cash or other consideration.Subsequent expenditures related to an item of fixed asset should beadded to its book value only if they increase the future benefits fromthe existing asset beyond its previously assessed standards ofperformance. Material items retired from active use and held fordisposal should be stated at the lower of their net book value and; net47haracteri value. Losses arising from the disposal of fixed assetcarried at cost should be 47haracteri in the profit and loss account. Normally the entire class of asset should be revalued andrevaluation should never result in the net book value of the class ofasset being greater than the recoverable amount of assets of thatclass. Gain on revaluation should normally be taken to the owner’sinterest in the form of ‘Revaluation Reserve’ Alternatively it could betaken to profit and loss account. Loss on revaluation should normallybe taken to profit and loss account except that such a decrease isrelated to; an increase which was previously recorded as a credit tothe revaluation reserve and which has not been subsequently reversedor 47haracte, it may be charged directly to that account. On disposalof a previously revalued item of fixed asset, the difference between netdisposal proceeds and the net book value should be charged orcredited to the profit and loss statement except that to the extent thatsuch a loss is related to an increase which was previously recorded asa credit to revaluation reserve and which has not been subsequentlyreversed or 47haracte, it may be charged directly to that account.Goodwill should he recorded in the books only when someconsideration in money or money’s worth has been paid for it. A properdisclosure of the gross and net book value of the asset as well asrelevant amount, if the assets are stated at revalued amounts shouldbe made.AS-H (Revised) Accounting for tbc Effects of Changes in Foreign
Exchange Rates : The standard deais with (a) accounting for transactions inforeign currencies; and (b) translating the financial statements offoreign branches for inclusion in the financial statements of theenterprise. The standard details the methods to be adopted forconverting foreign transactions denominated in foreign currency inthe reporting currency defined as currency used in presenting thefinancial statements of the enterprise. The standard recommendsproper disclosure of the exchange differences arising on foreigncurrency transaction. Disclosure is also encouraged of an enterprise’sforeign currency risk management policy.AS-12 Accounting for Government Grants : Government grants are assistance by government in cash orkind to an enterprise for past or future compliance with certainconditions. Government grants can be 48haracteri in accounts on thebasis of capital approach or Income approach, based on nature ofrelevant grant. However, the government grant should not be48haracteri until there is reasonable assurance that (i) the enterprisewill comply with the conditions attached to them; and (ii) the grantwill be received. A proper disclosure should be made of the accountingpolicy adopted for government grants, including the methods ofpresentation in the financial statements including the nature andextent of government grant 48haracteri in the financial statements,including grants of non-monetary assets given at a concessional rateor free of cost.AS-13 Accounting for Investments : The standard deals with accounting for investment in financialstatements of enterprises and related disclosure requirements. An
enterprise should disclose current investments and long-terminvestments distinctly in the financial statements. A currentinvestment is an investment that by its nature readily realizable andis intended to be used for not more than one year from the date onwhich such investment is made. A long-tern investment is aninvestment other than a current investment. The cost of acquisitionshould include charges such as brokerage, fees and duties. If aninvestment is acquired by issue of share or other security, theacquisition cost should be fair value of the security issued. IF aninvestment is acquired in exchange for another asset, the acquisitioncost should be the determined cost with reference to the fair value ofthe asset given up. Investment properties should be treated as long-term investments. Current investments should be carried in the financialstatements at the lower of cost and fair market value determinedeither on an individual investment basis or by category ofinvestments, but not on an overall (or global) basis. Long-terminvestments should be carried at their cost, although a provision fordiminution in their value, other than temporary, should be made. Anychange in the carried value of the investment should be carried to theprofit and loss account. Profit or loss on disposal of investmentsshould be 49haracteri and shown in the profit and loss account.Significant disclosure requirements are also inserted in the standardand include among other things, the disclosure of accounting policyfor determination of carrying amount of investments, classification ofinvestments, profit and loss on disposal of investments and changesin carrying amounts of these investments, for current and long-terminvestment separately and aggregate amount of quoted and unquotedinvestments.AS-14 Accounting for Amalgamation :
The standard deals with the accounting for amalgamation andthe treatment of any resultant goodwill or reserves. Amalgamation is50haracterized as either in the nature of merger or purchasedepending upon five conditions enumerated. Amalgamation in thenature of merger is accounted for by ‘Pooling of interest method’ andamalgamation in the nature of purchase is accounted by ‘Purchasemethod’. The consideration for the amalgamation means ihe aggregateof the shares and other securities issued and the payment made inthe form of cash or other assets by the transferee company to theshareholders of the transferor company. The identity of all the reserves in amalgamation in the nature ofmerger is preserved. However, in the case of amalgamation in thenature of purchase, only statutory reserves are preserved by givingdebit to a new account called ‘Amalgamation Adjustment Account’.Goodwill only arise in case of ‘Purchase method’. Goodwill arising onamalgamation is amortised over a period not exceeding five yearsunless a somewhat longer period can be justified. When anamalgamation is effected after the balance sheet date but before theissuance of the financial statements of either party to theamalgamation, disclosure should be made in accordance with AS-4but the amalgamation should not be incorporated in the financialstatements.AS-15 Accounting for Retirement Benefits in the FinancialStatements of Employers: The standard deals with the accounting of retirement benefitsconsisting of (a) Provident funds; (b) Superannuation/ pension; (c)Gratuity; (d) Leave encashment benefit on retirement; (e) Postretirement health and welfare schemes; and (f) Other retirementbenefits in the financial statements of employers. The contribution ofthe employer towards the provident fund and other contribution
schemes should be charged to the statement of profit and loss for theperiod. The accounting treatment of gratuity and other benefitschemes will depend on the type of arrangement which the employerhas chosen to make. Any alterations in the retirement benefit costsshould be charged or credited to the statement of profit and loss asthey arise in accordance with AS-5.
LESSON-4 PRACTICAL BASE OF ACCOUNTING – ORIGIN AND ANALYSIS OF BUSINESS TRANSACTIONS Accounting process begins with the origin of businesstransactions and is followed by analyses of these transactions. Afterorigin and analysis of transactions comes recording, classification andsummarization of business transactions culminating in preparation offinancial statements,Origin of Business Transactions Accounting deals with business transactions which havealready taken place, As financial accounting concentrates on monetarytransactions of the past it is basically historical in nature. Since itamounts to making recording and analysis of historical informationonly, it is also known as post-mortem accounting. For recordingbusiness transactions, it is necessary that these transactions areevidenced by an appropriate document such as cash memopurchase bill, sales bill, cheque book, pass book, salary slip, etc.,Documentwhich provides evide nce cf the transaction is called the SourceDocument.Analysis of Business Transactions In accounting record is made of monetary transactions whichare evidenced by a source document and double entry system isapplied for recording. According to J.R Batliboi “every businesstransaction has a two-foid effect and that it affects two accounts inopposite directions and if a complete record were to be made of suchtransaction, it would be necessary to debit one account and credit
another account. It is this recording of the two-fold effect of everytransaction that has given rise to the term Double Entry System” To analyze the dual aspect of each transactions and to find outthe accounts to be debited and credited following two approached canbe followed. 7. Accounting Equation Approach 8. Traditional Approach. 9. Accounting Equation Approach: Equality of assets on one hand and liabilities and capital on theother hand is called basic accounting equation and is written as ASSETS = LIABILITIES + CAPITAL expected Where assets refer to resources which are owned bybusiness enterprise and are to benefit future operations, liabilities aredebts payable to parties external to business and capital means theamount payable to owners of the business enterprise (also calledowner’s equity ) The dual aspect of some business transactions is analyzed asfollows: 10.Introduction of resources by the owner: Rs. 5,00,000 cash and furniture worth Rs. 20, 000 invested bythe owner in the business. Introduction of Rs.5,00,000 cash increases business cash byRs. 5,00,000 and it creates analysis obligation to pay Rs. 5,00,000 tothe owner which is recorded as capital. In terms of accountingequation its effect is asfollows:
ASSETS = LIABILITIES + CAPITAL Cash (Rs.5,00,000) =__ + capital (Rs.5,00,000)Further, if furniture worth Rs.20,000 is provided by theproprietor, the accounting equation appears as under:Cash + Furniture = Capital(Rs.5,00,000) (Rs.20,000) - +(5,00,000 + 20,000 ) Rs. 5,20,000 Rs.5,20,000 11.Purchase of assets for cash and / or credit : Purchased building for Rs,2,00,000 and paid Rs. 10,000 cashimmediately. It increases business assets or resources by Rs,1,90,000 as cash decreases by Rs. 10,000 and building increases byRs.2,00,000. It also creates an obligation to pay Rs. 1,90,000 infuture. The accounting equation now appears as follows; Cash + Furniture = Creditors for building + Capital(Rs.5,00,000 (Rs.20,000) (Rs.1,90,000)(Rs.5,20,000) –Rs. 10,000)+ Building(Rs. 2,00,000) -7,10,000 = Rs.7,10,000 12.Paid into bank Rs.3,00,000 It decreases cash balance and increase bank balance and thus,have no net effect on total assets as shown below: Cash + Bank = Creditors for building + Capital(Rs.4,90,000 (Rs.1,90,000) (Rs.5,20,000) 13.(Rs. 3,00,000)
+ Furniture + Building(Rs. 20,000) (Rs. 2,00,000) -7,10,000 = Rs.7,10,000 14.Payment of Rs. 1,90,000 by cheque to creditors for building : It decreases bank balance by Rs.1,90,000 and creditors forbuilding by Rs. 1,90,000 as shown below: Cash + Bank = Creditors for building +Capital(Rs.1,90,000 (Rs. 3,00,000) (Rs.1,90,000)(Rs.5,20,000) - Rs. 1,90,000) - Rs. 1,90,000)+ Furniture + Building(Rs. 20,000) (Rs. 2,00,000) Rs. 5,20,000 = Rs. 5,20,000 15.Purchase of goods for Cash/Credit: Business enterprise purchase goods worth Rs. 50,000 for cashand Rs.20,000 on credit. It increases stock of goods by Rs. 70,000, decreases cash byRs.50,000 and creates analysis obligation to pay. Rs.20,000 to thesupplier of goods. After this accounting equation appears as follows:Cash + Bank + Stock of goods = Creditors + Capital
(Rs.1,90,000 (Rs. 1,10,000) (Rs.70,000) (Rs.20,000)(Rs.5,20,000) 16.50,000)+ Furniture + Building(Rs. 20,000) (Rs.2,00,000) Rs. 5,40,000 = Rs.5,40,000 17.Rs. 40,000 cash and Rs.20,000 goods withdrawn for personal use:It decreases cash by Rs.40,000 and goods by Rs.20,000. At the sametime, it decreases capital by Rs.60,000 as shown below:Cash + Bank + Stock of goods = Creditors +Capital(Rs. 1,40,000 (Rs. 1,10,000) (Rs.70,000 (Rs.20,000)(Rs.5,20,000- 50,000) -Rs,20,000) -Rs.60,000) + Furniture + Building(Rs. 20,000) (Rs.2,00,000) Rs. 4,80,000 = Rs.4,80,000if accounting equation after above transactions is to be presented inthe form of balance sheet, it will appear as follows :
Balance Sheet Liabilities Amount Assets amountCapital 4,65,000 Cash 1,25,000Creditors 20,000 Bank 1,10,000 Stock 30,000 Furniture 20,000 Building 2,00,000 4,85,000 4,85,000Classification of Accounts and rules for Recording Transactions : For recording business transaction all accounts are divided intothree categories, 1) Assets Account 2) Liability Account 3) Capital Account For recording changes in assets, liabilities and capital two basic rules are followed :Rule No. 1 for recording changes in assets : Increase in asset is debited and decrease in asset in credited.Rule No. 2 for recording changes in liabilities and capital : Increase in liabilities and capital are credited and decrease inliabilities and capital are debited.
Transactio n Assets = No. Creditor Trade Furniture s for Cash + Bank + Stock+ Building = Creditor Capital + Building s+ + 1. 5,00,000 - - 20,000 - = - - 5,20,000 2. 5,00,000 - - 20,000 - = - - 5,20,000 - 10,000 - - - +2,00,00 + - - 0 1,90,000 3. 4,90,000 - - 20,000 2,00,000 = 1,90,000 - 5,20,000 -3,00,00 +3,00,00 - - - - - - 0 0 4. 1,90,000 3,00,000 - 20,000 20,000 = 1,90,000 - 5,20,000 - -1,90,000 - - - - - - 1,90,000 5. 1,90,000 1,10,000 - 20,000 20,000 = - - 5,20,000 - 50,000 - +70,00 - - - + 20,000 - 0 6. 1,40,000 1,10,000 70,000 20,000 20,000 = - 20,000 5,20,000 - 40,000 - -20,000 - - - - - 60,000 7. 1,00,000 1,10,000 50,000 20,000 20,000 = - 20,000 4,60,000 + 25,000 - -20,000 - - - - + 50,000 8. 1,25,000 1,10,000 30,000 20,000 20,000 = - 20,000 4,65,000 Analysis of Changes in Capital Account Increases and decreases in capital account can take place due to introduction of capital, withdrawal of cash, goods and other assets for personal use ( called drawings ), revenue and income earned ( resulting in increase in capital) and expenses incurred ( resulting in decrease in capital). Recording the effect of all these transactions directly in the capital account will make it unwieldy. In actual practice, net effect of revenue and expense transaction during an accounting period as shown by profit and loss account is transferred