2. Accounting Principles
Accounting Concepts
• Reporting Entity
• Going Concern
• Periodicity
• Money Measurement
• Accrual
• Dual aspect or Double Entry
• Matching concept
• Cost concept
Accounting Conventions
• Convention of Disclosure
• Convention of Materiality
• Convention of Consistency
• Convention of Conservatism
2
3. Cash v. Accrual – Important
Distinction- An Example
• Year 2010: Buys Inventory for Rs500, none
paid for in cash. Sells Rs 400 worth of this
inventory for Rs600, none received in cash.
• Year 2011: Collected the Rs600 from
customers and paid the Rs500 for the
inventory bought in 2010.
• Year 2012: Sold the remaining Rs100
inventory at cost for Rs100 cash
3
4. Cash v. Accrual Example: Cash
Profits
• On a cash basis, your surplus for 2010 was zero-
no cash paid for purchases and no cash collected
on sales.
• Your surplus for 2011 is Rs100 (Rs600 sales
collected -Rs500 paid for purchases)
• Your surplus is 2012 is Rs100 (cash collected on
the sale of remaining inventory)
4
5. Cash v. Accrual Example: Accrual
Profits-2010
• Under accrual accounting (GAAP), your
2010 profits are as follows:
Credit Sales Rs 600
*Cost of goods sold Rs(400)
Profits Rs 200
At the end of 2010, you have two assets:
customer receivables Rs600, and Inventory
Rs100. You have one liability: Accounts Payable
Rs500 and your Owner’s Equity is Rs200 (profits
on the transaction).
5
6. Inventory Comment
• Note that cost of goods sold can be
computed as:
Beg. Inventory + Inventory Purchases –
Ending Inventory
= 0 + Rs500 - Rs100 = Rs400
6
7. Accrual Accounting-2011
• Assuming no other transactions is 2010, your
profits for 2011 is zero – no sales, no cost of
goods sold.
• Your assets at the end of 2011 are Cash Rs100
(Rs600 collected from customers less Rs500 paid
for purchases) and Inventory Rs100 (continues
from the previous year).
• There are no liabilities
• Your owner’s equity remains at Rs200 (continues
from the previous year)
7
8. Accrual Accounting – 2012
• Now Revenues are Rs100 and cost of goods sold
are also Rs100.
• Zero profits
• Assets are now Cash (only) at Rs200 and Owner’s
Equity stays at Rs200
• Again, no liabilities
8
9. Profit comparison over three
periods
Year
Basis 2010 2011 2012
• Cash: Rs0, Rs100, Rs100
• Accrual: Rs200, Rs0*, Rs0**
• * No Revenues and Expenses
• ** Revenues equal Expenses
9
10. Key Message of Accrual
Accounting
• Profits are not determined when cash changes
hands, but by the “economic” nature of the
transaction.
• Since GAAP rests on accrual accounting (implying
that profits do not necessarily represent cash
flows), we need an important financial statement
other than the balance sheet and the income
statement – the statement of cash flows.
10
11. What is double entry?
• Every transaction has two aspects – debit and a
credit
• Assets = Liabilities + Owners Equity
• Owners Equity = Revenues – Expenses +/- direct
changes
• For example if an asset is increased by a
transaction, it is accompanied by a decrease in
another asset, an increase in a liability or an
increase in owners’ equity or a combination
11
12. Simple example of double entry
• Buy a machine for Rs15,000, paying cash.
• Asset account called “Machine A/C” increases by
Rs15,000
• Asset account called “Cash A/C” decreases by
Rs15,000
• We “debit” Machine A/C and “credit” Cash A/C
(more on this later)
• Buy inventory on account Rs5,000
• “Inventory A/C”, an asset, increases by Rs5,000
and a liability called “Accounts Payable A/C” also
increases by Rs5,000
12
15. The Accounting Information
System
15
Inputs
• Business transactions-(e.g.
Purchases, sales and Cash
receipts and payments
• Events- (external events e.g.
Fire, earthquake and Changes in
tax law and internal events like
Depriciation and Interest Due
Processing
•Accounting principles
•Accounting standards
•Management Estimates
•Laws and regulations
•Transaction processing
conventions
•Accounting records
Output
• P/L A/C, B/S, CFS
•Explanatory Notes
•Management Commentary
•Special Reports and analysis
•Tax Returns
Users
• Shareholders
•Banks, Managers, Employees
•Suppliers, Customers, Govt.
•Television Channels and News
papers, Rating agencies
16. • Is Accounting an art?
• Is accounting a science?
• How is accounting the language of the
business?
16
17. Accounting Cycle
• Journalize regular transactions
• Post in ledgers
• Journalize and post adjusting transactions
• Prepare the adjusted trial balance
• Prepare the financial statements
– Income Statement
– Balance Sheet
– Statement of Owner’s Equity
– Statement of cash flows
• Prepare the closing entries
17
