CHAPTER 2
THEORY BASE OF ACCOUNTING

Content’s

• Notes of Theory Base of Accounting Class 11th Accountancy (Commerce) Chapter 2
• NCERT Solutions of Theory Base of Accounting Class 11th Accountancy (Commerce) Chapter 2
• Extra Questions of Theory Base of Accounting Class 11th Accountancy (Commerce) Chapter 2

Page No: 38

Questions for Practice

Short Questions

1. Why is it necessary for accountants to assume that business entity will remain a going concern?

Answer

It is necessary for accountants to assume that business entity will remain a going concern because

→ It helps in recording fixed assets at their original cost and depreciation is charged on these assets without reference to their market value. For example: if a machinery is purchased which would last for next 5 years, the cost of this machinery will be spread over the next 5 years for calculating the net profit or loss of each year. The full cost machinery would not be treated as an expense in the year of its purchase itself.

→ It is also because of this concept that outside parties enter into long-term contracts with the enterprise, give loans and purchase the debentures and shares of enterprise.

2. When should revenue be recognised? Are there exceptions to the general rule?

Answer

Revenue is recognised only when it is realised i.e., when a legal right to receive it arises. Thus credit sales are treated as revenue on the day sales are made and not when cash is received from the buyers. Similarly, rent for the month of March even if received in April month will be treated as revenue of the financial year ending 31st March.
There are two exceptions to this rule:
→ In case of sales on installment basis, only the amount collected in installments is treated as revenue.
→ In case of long-term construction contracts, proportionate amount of revenue, based on part of the contracted completed by the end of the financial year is treated as realised.

3. What is the basic accounting equation?

Answer

Assets = Liabilities + Capital

4. The realisation concept determines when goods sent on credit to customers are to be included in the sales figure for the purpose of computing the profit or loss for the accounting period. Which of the following tends to be used in practice to determine when to include a transaction in the sales figure for the period. When the goods have been:
(a) dispatched
(b) invoiced
(c) delivered
(d) paid for

Answer

According to the realisation concept, revenue is recognised when a legal right to receive it arises. Therefore, when the goods are invoiced, it is treated as the transfer of ownership of goods from the seller to the buyer and hence the revenue is recognised.

5. Complete the following work sheet:

(i) If a firm believes that some of its debtors may ‘default’, it should act on this by making sure that all possible losses are recorded in the books. This is an example of the ___________ concept.
► conservatism

(ii) The fact that a business is separate and distinguishable from its owner is best exemplified by the ___________ concept.
► business entity concept

(iii) Everything a firm owns, it also owns out to somebody. This co-incidence is explained by the ___________ concept.
► dual aspect

(iv) The ___________ concept states that if straight line method of depreciation is used in one year, then it should also be used in the next year.
► consistency

(v) A firm may hold stock which is heavily in demand. Consequently, the market value of this stock may be increased. Normal accounting procedure is to ignore this because of the ___________.
► conservatism

(vi) If a firm receives an order for goods, it would not be included in the sales figure owing to the ___________.
► revenue recognition

(vii) The management of a firm is remarkably incompetent, but the firms accountants can not take this into account while preparing book of accounts because of ___________ concept.
► money measurement

Long Answers

1. ‘The accounting concepts and accounting standards are generally referred to as the essence of financial accounting’. Comment.

Answer

Financial accounting is concerned with the preparation of the financial statements and provides financial information to various accounting users. It is performed according to the basic accounting concepts like Business Entity, Money Measurement, Consistency, Conservatism, etc. These concepts allow various alternatives to treat the same transaction. For example, there are a number of methods available for calculating stock and depreciation, which can be followed by various firms. This leads to wrong interpretation of financial results by external users due to the problem of inconsistency and incomparability of financial results among different business entities. In order to mitigate inconsistency and incomparability and to bring uniformity in preparation of the financial statements, accounting standards are being issued in India by the Institute of Chartered Accountant of India. Accounting standards help in removing ambiguities and inconsistencies. Hence, accounting standards and accounting concepts are referred as the essence of financial accounting.

2. Why is it important to adopt a consistent basis for the preparation of financial statements? Explain.

Answer

It is important to adopt a consistent basis for the preparation of financial statements because it helps in comparability of financial statements. For Example: if a firm choose straight line method for showing depreciation but in the next accounting period switched over to written down method then the results of this year cannot be compared to that of the previous years. However, it does not mean that firm cannot changes its accounting policies. A better method, if available which will lead to better presentation and better understanding of the financial results, the firm may adopt but it must be stated clearly by way of footnotes to enable the users of the financial statements to be aware of the changes.

3. Discuss the concept-based on the premise ‘do not anticipate profits but provide for all losses’.

Answer

According to the Conservatism Principle, all anticipated loss should be recorded in books of accounts, but all anticipated gains should be ignored until they are recognized. For example, stock is valued at cost or market price, whichever is lower. If the market price is lower than the cost price, loss should be accounted; whereas, if the former is more than the latter, then this profit should not be recorded until unless the stock is sold. There are numerous provisions that are maintained based on the conservatism principle like, provision for discount to debtors, provision for doubtful bad debts, etc. This principle is based on the common sense and depicts pessimism. This also helps the business to deal uncertainty and unforeseen conditions.

4. What is matching concept? Why should a business concern follow this concept? Discuss?

Answer

Matching Concept states that all expenses incurred during the year, whether paid or not, and all revenues earned during the year, whether received or not, should be taken into account while determining the profit of that year. For Example: When some expense such as insurance premium is paid partly for the next year also, the part relating to next year will be shown as expense only next year not this year.
This concept is very important for correct determination of net profit. It is possible that in the same accounting period, the business may either pay or receive payments that may or may not belong to the same accounting period. This leads to either overcasting or under-casting of the profit or loss, which may not reveal the true efficiency of the business and its activities in the concerned accounting period. Similarly, there may be various expenditures like, purchase of machinery, buildings, etc. These expenditures are capital in nature and their benefits can be availed over a period of time. In such cases, only the depreciation of such assets is treated as an expense and should be taken into account for calculating profit or loss of the concerned year. Thus, it is very necessary for any business entity to follow the matching concept.

5. What is the money measurement concept? Which one factor can make it difficult to compare the monetary values of one year with the monetary values of another year?

Answer

Money Measurement Concept states that only those transactions and events are recorded in accounting which are capable of being expressed in terms of money. An event even though may very important for business, will not be recorded in the books of accounts unless its effect can be measured in terms of money. For Example:  a business have 5 machines then this thing cannot be added up unless expressed in terms of money. In order to record this item, we must have to expressed it in monetary terms say Rs. 1,00,000. Thus, money measurement concept enables consistency in maintaining accounting records.

QUESTIONS

1. Consider the following data pertaining to Ananya Ltd:

Particulars Rs.

Cost of Machinery purchased on 1st April, 2012 5,00,000 Installation charges 50,000

Market value as on 31st march, 2013 8,00,000

While preparing the annual accounts, if the company values the machinery at Rs. 8,00,000 which principle is being violated by Ananya Ltd.?

Ans. Historical cost concept.

1. Accounting to which concept, all expenses incurred to earn revenue of a particular period should be charged against that revenue to determine the net income?

Ans. Matching concept

1. A business purchased goods for Rs. 2,00,000 and sold 75% of such goods during accounting year ended 31st March, 2013. The market value of remaining goods was Rs. 48,000. He valued closing stock at cost. Name the concept being violated in this situation.

Ans. Prudence or conservatism

1. Under which concept, Owner of business is treated as creditor to the extent of his capital?

Ans. Business entity concept

1. Financial statements of an entity are prepared at regular intervals in accordance with which accounting concept?

Ans. Accounting period concept

1. According to which concept, each accounting transaction has at least two effects?

Ans. Dual aspect concept

1. According to which convention, depreciation is being charged as per one particular method year after year?

Ans. Consistency

1. Which accounting convention takes into account all prospective losses but leaves all prospective Profits?

Ans. Conservatism/prudence

1. Name the concept under which the skills or quality of the management team is not disclosed in the financial statements.

Ans. Money measurement concept

1. Name the concept under which assets are recorded in books at the cost incurred for acquisition of such assets.

Ans. Historical cost concept

1. Name the concept under which advance received from the supplier is not taken as income or Sale.

Ans. Revenue recognition concept

1. Under which basis of accounting only cash transactions are recorded in the books?

Ans. Cash basis of accounting.

Notes

THEORY BASE OF ACCOUNTING

Learning Objectives

After studying this chapter, students will be able to:

• Describe the meaning of Accounting Assumptions and Accounting Principles.
• Explain the Accounting Standard and IFRS along with their objectives.
• Describe the Bases of Accounting.
• Distinguish between Cash Basis of Accounting and Accrual Basis of Accounting

Main objective of accounting is to provide appropriate, useful and reliable information about the financial performance of the business to its various users to enable them in judicious decision-making. This objective can be achieved only when accounting records are maintained on the basis of uniform rules and principles.

Accounting principles, concepts and conventions are known as Generally Accepted Accounting Principles (GAAP). These principles are the base of Accounting. Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity and consistency in the preparation and the presentation of financial statements.

These principles have evolved over a long period of time on the basis of experiences of the accountants, customs, legal decisions etc., and which are generally accepted by the accounting professionals.

FUNDAMENTAL ACCOUNTING ASSUMPTIONS

1. Going Concern Assumption :This concept assumes that an enterprise has an indefinite life or existence. It is assumed that the business has neither intention to liquidate nor to scale down its operations significantly.

Relevance :

1. Distinction is made between capital expenditure and revenue expenditure.
2. Classification of assets and liabilities into current and non-current.
3. Depreciation is charged on fixed assets and fixed assets appear in the Balance Sheet at book value, without having reference to their market value.
4. Consistency Assumption : According to this assumption, accounting practices once selected and adopted, should be applied consistently year after year. This will ensure a meaningful study of the performance of the business for a number of years.

Consistency of assumption does not mean that particular practices, once adopted, cannot be changed. The only requirement is that when a change is desirable, it should be fully disclosed in the financial statements along with its effect on income statement and Balance Sheet.

Any accounting practice may be changed if the law or Accounting standard requires so, to make the financial information more meaningful and transparent.

Relevance : It helps the management in decision-making by utilizing the comparable financial information.

1. Accrual Assumption :Accrual concept applies equally to revenue and expenses. As per this assumption, all revenue and costs are recognized when they are earned or incurred.

It is immaterial, whether the cash is received or paid at the time of transaction or later date e.g., if a credit sale (Credit for two months) for Rs. 15,000 is made on 15th Feb. 2013, then the revenue earned is to be recorded on 15th Feb. 2013, not on the date of cash realized, i.e., after two months. In case of Expenses, if at the end of the year the two months salary is due but not paid, then the expenses of salary will be recorded in the current year in which salary is due, not in the next year in which it will be paid.

Relevance : Earning of a revenue and consumption of a resource (expenses) can be accurately matched to a particular accounting period.

ACCOUNTING PRINCIPLES

1. Accounting Entity : An entity has a separate existence from its owner. According to this principle, business is treated as an entity, which is separate and distinct from its owner. Therefore transactions are recorded; analyzed and financial statements are prepared from the business point of view and not of the owner.

The owner is treated as a creditor (Internal liability) for his investment in the business, as if the firm has borrowed from its owner instead of the outside parties. Interest on capital is treated as expense like any other business expense. His private expenses are treated as drawings leadings to reduction in capital.

1. Money Measurement Principle : According to this principle, only those transactions that are measured in money or can be expressed in term of money are recorded in the books of accounts of the enterprises. Non-monetary events like death of any employee/Manager, strikes, disputes etc., are not recorded at all, even though these also affect the business operations significantly.

Limitation :

1. It ignores qualitative aspect e.g., efficient human resources (Assets), satisfied customers (Assets) and dishonest employee (liabilities).
2. Value of money (currency) is not stable.

To make accounting records simple, relevant, understandable and homogeneous, facts are expressed in a common unit of measurement- money.

1. Accounting Period Principle : According to this principle, the whole indefinite life of an enterprise is divided into parts, known as accounting period.

Accounting period is defined as interval of time, at the end of which the profit and loss account and balance sheet are prepared, so that the performance is measured at regular intervals and decision can be taken at the appropriate time. Accounting period is usually a period of one year and that year may be financial year or calendar year.

Relevance :

1. This Assumption requires showing the allocation of expenses between Capital and Revenue.
2. Portion of Capital Expenditure that is consumed during the current year is charged to Income statement and rest of the portion i.e., Unconsumed portion is shown as an asset in the Balance Sheet.
3. As per income tax law, tax on income is calculated on annual basis from 1st April to 31st March (Financial Year)
4. Timely action for corrective measures can be taken by the Management.
5. Full Disclosure Principle : According to this principle, apart from legal requirements all significant and material information relating to the economic affairs of the entity should be completely disclosed in its financial statements and accompanying notes to accounts.

The financial statements should act as means of conveying and not concealing the information. Disclosure of information will result in better understanding and the parties may be able to take sound decisions on the basis of the information provided.

• 1. ., footnotes such as :
     1. Contingent liabilities in respect to a claim of a very big amount against the business are pending in a Court of Law.
     2. Change in the method of providing depreciation.
     3. Market value of investment.

1. Materiality Principle : Disclosure of all material facts is compulsory but it does not imply that even those figures which are irrelevant are to be included in financial statements. According to this principle, only those items or information should be disclosed that have material effect and relevant to the users. So, item having an insignificant effect or being irrelevant to user need not be disclosed separately, these may be merged with other item.

If the knowledge of any information may affect the user’s decision, it is termed as material information.

It should be noted that an item material for one enterprise may not be material for another enterprise. e.g., an item of expenses Rs. 50,000 is material for an enterprise having turnover of Rs. 100 crore.

1. Prudence Principle : According to this principle, profit in anticipation should not be recorded but loss in anticipation should immediately be recorded. The objective of this principle is not to overstate the profit of the enterprise in any case. When different equally acceptable alternative methods are available, the method which having least favourable immediate effect on profit should be adopted, e.g.,
   1. Valuation of stock at cost or realizable values, whichever is lower.
   2. Provision for doubtful debts and provision for discount on debtors is made.
2. Cost Principle : According to this Principle, an asset is recorded in the books of accounts at its original cost comprising cost of acquisition and all expenditure incurred for making the assets ready to use.

This cost becomes the basis of all subsequent accounting transactions for the asset, since the acquisition cost relates to the past, it is referred to as Historical cost. Example: Machinery purchased for Rs. 1,50,000 in cash and Rs. 20,000 was spent on installation of machine then Rs. 1,70,000 be recorded as cost of machine in the books and depreciation will be charged on this cost. If market value of machine due to inflation has gone upto Rs. 2,00,000 then the increased value will not be recorded. This cost is systematically reduced from year after year by charging depreciation and the assets are shown in the balance sheet at book value (cost-depreciation).

1. Matching Principle : According to this principle, all expenses incurred by any enterprises during an accounting period are matched with the revenue recognized during the same period.

The matching principle facilitates to ascertain the amount of profit or loss incurred in a particular period by deducting the related expenses from the revenue recognized that period.

The following treatment of expenses and revenue are done due to matching principle:

• 1. Ascertainment of Prepaid Expenses.
  2. Ascertainment of Income received in advance.
  3. Accounting of closing stock.
  4. Depreciation charged on fixed assets.

1. Dual Aspect Principle : According to this principle, every business transaction has two aspects–a debit and a credit of equal amount. In other words, for every debit there is a credit of equal amount in one or more accounts and vice-versa.

The system of recording transaction based on this principles is called as ‘‘Double Entry System’’.

Due to this principle, the two sides of Balance Sheet are always equal and the following accounting equation will always hold good at any point of time.

Assets = Liabilities + Capital

Example : Ram started business with cash Rs. 1,00,000. It increases cash in assets side and capital in liabilities side by Rs. 1,00,000.

Assets Rs. 1,00,000 = Liabilities + Capital Rs. 1,00,000

BASES OF ACCOUNTING

There are two bases of ascertaining profit or loss, namely (1) Cash Basis, and (2) Accrual Basis.

1. Cash Basis of Accounting : Under this system of accounting transactions are recorded in the books of accounts only on the receipt/ payment of cash. The income is calculated as the excess of actual cash receipts (in respect of sale of goods, service, properties etc.) over actual cash payments (regarding purchase of goods, expenses, rent, electricity, salaries etc.)

Entry is not recorded when a payment or receipt merely due i.e.,

outstanding expenses, Accrued income are not treated. This method is contrary to the matching principle.

1. Accrual Basis of Accounting :Under this system of accounting, revenue and expenses are recorded when they are recognized i.e., Income is recorded as Income when it is accrued (when transaction takes place) irrespective of fact whether cash is received or not. Similarly expenses are recorded when they are incurred or become due and not when the cash is paid for them.

Under this system, expenses such as outstanding expenses, prepaid expenses, accrued income and received in advance are identified and taken into account.

Under the companies Act 1956, all companies are required to maintain their accounts according to accrual basis of accounting.

Difference between accrual basis of accounting and cash basis of accounting

Basis Accrual Basis of Accounting Cash Basis of Accounting

1. Recording Both cash and credit trans- Only cash transactions are recorded. of transactions actions are recorded.
2. Profit or Loss Profit or Loss is ascertained Correct profit/loss is not ascertained

correctly due to complete because it records only cash record of transactions. transactions

1. Distinction This method makes a dis- This method does not make a between Capital tinction between capital and distinction between capital and and Revenue and revenue items. revenue nature items.
2. Legal position This basis is recognized This basis is not recognized under under the companies Act the companies Act. 1956.

1956

ACCOUNTING STANDARDS : CONCEPT AND OBJECTIONS

The accounting principles or GAAP in the form of concepts and conventions have been developed to bring comparability and uniformity in the financial statements. But GAAP also allow a large number of alternative treatments for the same item. Different organizations may adopt different accounting policies for the same transaction or an organization may follow different accounting policies for the same item over different accounting periods. As a result, the financial statements become inconsistence and incomparable.

So it was felt that certain minimum standards should be universally applicable, so that the accounting statements have the qualitative characteristics of realiability, relevance, understandability and comparability.

International Accounting Standard Committee (IASC) was set up in 1973. (Now renamed as International financial Reporting Committee IFRC). The Institute of Chartered Accountants of India (ICAI) and the Institute of Cost and Works Accountants of India (ICWAI) are members of this committee. ICAI set up the Accounting Standard Board (ASB) in 1977 to identify the areas in which uniformity in accounting required. ASB prepares and submits a draft accounting standard to the Council of ICAI. The Council of ICAI issues the draft for the comments to the Govt., industry and professionals etc. After due

consideration on comments received, the Council of ICAI notifies it for its use in financial statements.

Concept of Accounting Standards

Accounting standards are written statements, issued from time-to- time by institutions of accounting professionals, specifying uniform rules or practices for drawing the financial statements.

Objectives of Accounting Standards

• 1. Accounting standards are required to bring uniformity in accounting practices and policies by proposing standard treatment in preparation of financial statements.
  2. To improve realiability of the financial statement :Accounts prepared by using accounting standards are reliable for various users, because these standards create a sense of confidence among the users.
  3. To prevent frauds and manipulation by codifying the accounting methods and practices.
  4. To Help Auditors : Accounting standards provide uniformity in accounting practices, so it helps auditors to audit the books of accounts.

IFRS International Financial Reporting Standards

This term refers to the financial standard issued by International Accounting standards Board (IASB). It is the process of improving the financial reporting Internationally to help participants in the various capital markets of the world and other users. Numbers of IFRS issued so far is 9.

IFRS Based financial Statements

Following financial statements are produced under IFRS:

1. Statement of financial position: The elements of this statement are
   1. Assets (b) Liability C. Equity
2. Comprehensive Income statement: The elements of this statement are
   1. Revenue (b) Expense
3. Statement of changes in Equity
4. Statement of Cash flow
5. Notes and significant accounting policies

Main difference between IFRS and IAS (Indian Accounting Standards)

1. IFRS are principle based while IAS are rule based.
2. IFRS are based on Fair Value while IAS are based on Historical Cost.

Chapter 1 – Introduction to Accounting Class 11th Accountancy (Commerce)
Chapter 2 – Theory Base of Accounting Class 11th Accountancy (Commerce)
Chapter 3 – Recording of Transactions – I Class 11th Accountancy (Commerce)
Chapter 4 – Recording of Transactions – II Class 11th Accountancy (Commerce)
Chapter 5 – Bank Reconciliation Statement Class 11th Accountancy (Commerce)
Chapter 6 – Trial Balance and Rectification of Errors Class 11th Accountancy (Commerce)
Chapter 7 – Depreciation, Provisions and Reserves Class 11th Accountancy (Commerce)
Chapter 8 – Bills of Exchange Class 11th Accountancy (Commerce)

Financial Accounting Part II
Chapter 1- Financial Statements – I Class 11th Accountancy (Commerce)
Chapter 2- Financial Statements Class 11th Accountancy (Commerce)
Chapter 3- Accounts from Incomplete Records Class 11th Accountancy (Commerce)
Chapter 4- Accounting for Not-for-Profit Organisation Class 11th Accountancy (Commerce)
Chapter 5- Applications of Computers in Accounting Class 11th Accountancy (Commerce)
Chapter 6- Computerized Accounting System Class 11th Accountancy (Commerce)
Chapter 7- Structuring Database for Accounting Class 11th Accountancy (Commerce)
Chapter 8- Accounting System Using Database Management System Class 11th Accountancy (Commerce)

CHAPTER-1
INTRODUCTION TO ACCOUNTING

Content’s 

• Notes Of Introduction to Accounting Class 11th Accountancy (Commerce)
• NCERT Solution of Introduction to Accounting Class 11th Accountancy (Commerce)
• Extra Questions of Introduction to Accounting Class 11th Accountancy (Commerce)

Page No: 19

Questions for Practice

Short Answers

1. Define Accounting.

Answer

Accounting is the art of recording, classifying, summarising and communicating financial information to users for correct decision making.

2. State what is end product of financial accounting?

Answer

The end product of financial accounting are Trading account, Profit and loss account and Balance sheet.

3. Enumerate main objectives of accounting.

Answer

The main objectives of accounting are:
→ To keep a systematic record of all business transactions
→ To determine the profit earned or loss incurred during an accounting period by preparing profit and loss account
→ To ascertain the financial position of the business at the end of each accounting period by preparing balance sheet
→ To assist management for decision making, effective control, forecasting, etc.
→ To assess the progress and growth of business from year to year
→ To detect and prevent errors and frauds
→ To communicate information to various users

4. List any five users who have indirect interest in accounting.

Answer

The five users who have indirect interest in accounting are:
• Trade associations
• Labour unions
• Customers
• Lenders and Financial Institutions
• Tax authorities

5. State the nature of accounting information required by long-term lenders.

Answer

Long term lenders are interested in repaying capacity of the business, profitability, liquidity, operational efficiency, potential growth of business.

6. Who are the external users of information?

Answer

External users of information are the individual or the organisations that have direct or indirect interest in the business firm, however, are not a part of management. They do not have direct access to the internal data of the firm and uses published data or reports like profit and loss accounts, balance sheets, annual reports, press releases, etc. Some examples of external users are government, tax authorities, labour unions, etc.

Answer

Three examples of revenue are given below.
• Sales revenue
• Interest received
• Dividends

9. Distinguish between debtors and creditors.

Answer

10. ‘Accounting information should be comparable’. Do you agree with this statement? Give two reasons.

Answer

Yes, accounting information should be comparable because:

→ Comparability is needed to make inter-firm comparisons, i.e., to find out how a firm has performed as compared to the other firms.

→ Comparability is needed to make inter-period comparisons, i.e., to find out how it has performed as compared to the previous years.

11. If the accounting information is not clearly presented, which of the qualitative characteristic of the accounting information is violated?

Answer

If the accounting information is not clearly presented, then it will violate the ‘Reliability and Understandability’ qualitative characteristics of accounting because if accounting information is not clearly presented then it will not be reliable and also cannot be understood easily.

12. The role of accounting has changed over the period of time”- Do you agree? Explain.

Answer

The role of accounting has now shifted from that of a mere recording of business transactions to that of providing information to managers and other various interested parties in order to help them in making appropriate decisions. It now becomes an information system.

13. Giving examples, explain each of the following accounting terms:
• Fixed assets
• Revenue
• Expenses
• Short-term liability
• Capital

Answer

• Fixed Assets: Fixed Assets refers to those assets which are held for continued use in the business for the purpose of producing goods and services and not meant for resale. Examples: Plant and Machinery, Land and Building etc.

• Revenue: Revenues refer to the amount received from day to day activities of the business, likesale proceeds of goods and rendering services to the customers. Example: Commission received, dividend, royalty etc.

• Expenses: Expense is the cost incurred in producing and selling the goods and services. Example: wages, depreciation, salaries etc.

• Short-term liability: Those liabilities which are to be paid in near future (normally within one year). Example: Bank Overdraft, Bills payable etc.

• Capital: It refers to the amount invested by the proprietor in a business enterprise. It is the amount with the help of which goods and assets are purchased in the business.

14. Define revenues and expenses?

Answer

Revenues is the income of a regular nature such as receipts from sale of goods, rent, commission etc.
Expense is the cost incurred in producing and selling the goods and services.

15. What is the primary reason for the business students and others to familiarise themselves with the accounting discipline?

Answer

Every monetary transaction must be recorded in such a manner that various accounting users must understand and interpret these results in the same manner without any ambiguity. The primary reason to study accounting discipline because it helps in the learning:
• the various aspects of accounting.
• how to maintain books of accounts.
• how to summarise accounting information.
• how to interpret the accounting information with relative accuracy.

Long Answers

1. What is accounting? Define its objectives.

Answer

Accounting is the art of recording, classifying , and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof.
Objectives of Accounting are:

→ To keep systematic record of business transactions: The main objective of accounting is to keep complete record of business transaction according to specified rules. It helps to avoid the possibility of errors and fraud.

→ To calculate Profit and loss: Accounting helps in ascertaining the net profit or loss suffered on account of business transaction during a particular period. For this purpose trading and profit and loss account are prepared. It gives information regarding how much of goods have been purchased and sold, expenses incurred and amount earned during a year.

→ To ascertain the financial position of the business: Ascertaining profit or loss is not sufficient for a businessman. The businessman must also know the financial health of the business. This purpose is served by preparing the balance sheet that facilitates in ascertaining the true financial position of the business.

→ To ascertain the progress of business from year to year: Accounting helps in assessing the progress of business from year to year, as accounting facilitates the comparison both inter-firm as well as intra-firm.

→ To prevent and detects errors and frauds.

→ To Provide informations to various parties: Another main objective accounting is to communicate financial and accounting information to various users including both internal and external users like owners, management, government, labour, tax authorities, etc. The information helps them in taking sound and judicious decisions about the business entity.

2. Explain the factors, which necessitated systematic accounting.

→ Recording in terms of money only: Each business transactions are recorded in terms of money only. For example, if a business possess 300 chairs and 100 tables, then their monetary values is recorded in the books, i.e. 300 chairs costing Rs 60,000, 100 tables costing Rs 50,000. Thus the total value of assets is Rs 1,10,000.

→ Recording: Accounting is the art of recording business transactions according to some specified rules. In a small business, all transaction are recorded in a book called ‘Journal’ but when the transactions becomes large the journal is further subdivided into various subsidiary books.

→ Classifying: After recording the transaction is Journal and subsidiary books, the transactions are classified and posted under their respective accounts. The books in which various accounts are opened is called ‘Ledger’.

→ Summarising: All business transactions are summarised in the form of Trial Balance, Trading Account, Profit and Loss Account and Balance Sheet that provides necessary information to various users.

→ Interpretation of the results: The results of the business are presented in form of graphs, statements, charts so that interested parties such as proprietors, managers, creditors etc. can have full information about the profitability and the financial position of the business.

Answer

Profit is the excess of total revenues over total expenses of a business enterprise for an accounting period whereas Gain is the monetary benefit, profit or advantage resulting from events or transactions which are incidental to business such as sale of fixed assets.

6. Explain the qualitative characteristics of accounting information.

Answer

The qualitative characteristics of accounting information are:

→ Reliability: Accounting information must be reliable, so that business owners can be reasonably assured that accounting information presents an accurate picture of the company. All accounting information is verifiable and can be verified from the source document (voucher), via cash memos, bills, etc. Hence, the available information should be free from any errors and unbiased.

→ Relevance: It means that essential and appropriate information should be easily and timely available and any irrelevant information should be avoided. The users of accounting information need relevant information for decision making, planning and predicting the future conditions.

→ Understandability: Accounting information should be presented in such a way that every user is able to interpret the information without any difficulty in a meaningful and appropriate manner.

→ Comparability: It allows business owners to compare accounting information of a current year with that of the previous years. Comparability enables intra-firm and inter-firm comparison. This assists in assessing the outcomes of various policies and programmes adopted in different time horizons by the same or different businesses. Further, it helps to ascertain the growth and progress of the business over time and in comparison to other businesses.

7. Describe the role of accounting in the modern world.

Answer

The role of accounting has been changing over the period of time. In the modern world, the role of accounting is not only limited to record financial transactions but also to provide a basic framework for various decision making, providing relevant information to various users and assists in both short run and long run planning. The role of accounting in the modern world are given below.

→ Assisting management- Management uses accounting information for short term and long term planning of business activities, to predict the future conditions, prepare budgets and various control measures.

→ Comparative study- In the modern world, accounting information helps us to know the performance of the business by comparing current year’s profit with that of the previous years and also with other firms in the same industry.

→ Substitute of memory- In the modern world, every business incurs large number of transactions and it is beyond human capability to memorise each and every transaction. Hence, it is very necessary to record transactions in the books of accounts.

→ Information to end user- Accounting plays an important role in recording, summarising and providing relevant and reliable information to its users, in form of financial data that helps in decision making.

Introduction

Accounting is the essential part of business, as it keeps the proper records of business transactions.

Learning Objectives

After studying the chapter, you will be able to:  Explain the Accounting alongwith its objectives.

 Explain the advantages & limitations of accounting.

 Explain the users of accounting information and their needs.

 Explain the basic accounting terms.

Suggested Teaching Method:

Discussion Method

Meaning of Accounting

Accounting is an information system that provides accounting information to the users for correct decision-making.

“Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof..” Objectives of Accounting

1. To maintain systematic and complete record of business transactions.

2. To know profitabilities of business by calculating profit or loss.

3. To ascertain the Financial position of business.

4. To provide useful information to various users.

Interested users/parties of Accountings informations and their Needs There are number of users interested in knowing about the financial soundness and the profitability of the business.

Users Classification Information the user want Internal

1. Owner Return on their investment, financial health of their company/business.

2. Management To evaluate the performance to take various decisions.

External 1. Investors and Safety and growth of their investments, potential investors future of the business.

2. Creditors Assessing the financial capability, ability of the business to pay its debts.

3. Lenders Repaying capacity, credit worthiness.

4. Tax Authorities Assessment of due taxes, true and fair disclosure of accounting information,

5. Employees Profitability to claim higher wages and bonus, whether their dues (PF, ESI, etc.) deposited regularly.

6. Others Customers, Researchers etc., may seek different information for different

reasons.

Qualitative Characteristics of Accounting Information Accounting information is useful for interested users only if it posses the following characteristics:

1. Realiability : Means the information must be based on facts and be verified through source documents by anyone. It must be free from bias.

2. Relevance : To be relevant, information must be available in time and must influence the decisions of users by helping them form prediction about the outcomes.

3. Understandability: The information should be presented in such a manner that users can understand it well.

4. Comparability: The information should be disclosed in such a manner that it can be compared with previous years figures of business itself and other firm’s data.

Limitations of Accounting

The accounting information suffers from the following limitations: 1. Based on historical data

2. Not free from bias

3. Qualitative information not shown

4. Ignores price level changes

5. Window Dressing

BASIC ACCOUNTING TERMS

Business Transaction

An economic activity that affects financial position of the business and can be measured in terms of money e.g., sale of goods, paying for expenses etc.

Voucher

The documentary evidence in support of a transaction is known as voucher.

For example, if we buy goods for cash we get cash memo, if we buy on credit, we get an invoice, when we make a payment, we get a receipt and so on.

Capital

Amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or assets by the owner.

Drawings

The money or goods or both withdrawn by owner from business for personal use, is known as drawings. Example: Purchase of car for wife by withdrawing money from business.

Assets

Assets are valuable and economic resources of an enterprise useful in its operations. Assets can be broadly classified as :

1. Current Assets : Current Assets are those assets which are held for short period and can be converted into cash within one year. For example: Debtors, stock etc.

2. Non-Current Assets : Non-Current Assets are those assets which are hold for long period and used for normal business operation. For example: Land, Building, Machinery etc.

3. Tangible Assets : Tangible Assets are those assets which have physical existence and can be seen and touched. For Example: Furniture, Machinery etc.

4. Intangible Assets : Intangible Assets are those assets which have no physical existence and can be feel by operation. For example: Goodwill, Patent, Trade mark etc.

Liabilities :

Liabilities are obligations or debts that an enterprise has to pay after some time in the future.

Liabilities can be classified as :

1. Current Liabilities : Current Liabilities are obligations or debts that are payable within a period of one year. For Example: Creditors, Bill Payable etc.

2. Non-Current Liabilities : Non-Current Liabilities are those obligations or debts that are payable after a period of one year. Example: Bank Loan, Debentures etc.

RECEIPTS

1. Revenue Receipts : Revenue Receipts are those receipts which are occurred by normal operation of business like money received by sale of business products.

2. Capital Receipts : Capital Receipts are those receipts which are occurred by other than business operations like money received by sale of fixed assets.

Expenses

Costs incurred by a business for earning revenue are known as expenses.

For example: Rent, Wages, Salaries, Interest etc.

Expenditure

Spending money or incurring a liability for acquiring assets, goods or services is called expenditure. The expenditure is classified as :

1. Revenue Expenditure : If the benefit of expenditure is received within a year, it is called revenue expenditure. For Example: Rent, Interest etc.

2. Capital Expenditure : If benefit of expenditure is received for more than one year, it is called capital expenditure. Example: Purchase of Machinery.

3. Deferred Revenue Expenditure : There are certain expenditures which are revenue in nature but benefit of which is derived over number of years. For Example: Huge Advertisement Expenditure.

Profit

The excess of revenues over its related expenses during an accounting year is profit.

Profit = Revenue – Expenses

Gain

A non-recurring profit from events or transactions incidental to business such as sale of fixed assets, appreciation in the value of an asset etc.

Loss

The excess of expenses of a period over its related revenues is termed as loss.

Loss = Expenses – Revenue

Goods

The products in which the business deal in. The items that are purchased for the purpose of resale and not for use in the business are called goods.

Purchases

The term purchases is used only for the goods procured by a business for resale. In case of trading concerns it is purchase of final goods and in manufacturing concern it is purchase of raw materials. Purchases may be cash purchases or credit purchases.

Purchase Return

When purchased goods are returned to the suppliers, these are known as purchase return.

Sales

Sales are total revenues from goods sold or services provided to customers.

Sales may be cash sales or credit sales.

Sales Return

When sold goods are returned from customer due to any reason is known as sales return.

Debtors

Debtors are persons and/or other entities to whom business has sold goods and services on credit and amount has not received yet. These are assets of the business.

Creditors

If the business buys goods/services on credit and amount is still to be paid to the persons and/or other entities, these are called creditors. These are liabilities for the business.

Bill Receivable

Bill Receivable is an accounting term of Bill of Exchange. A Bill of Exchange is Bill Receivable for seller at time of credit sale.

Bill Payable

Bill Payable is also an accounting term of Bill of Exchange. A Bill of Exchange is Bill Payable for purchaser at time of credit purchase.

Discount

Discount is the rebate given by the seller to the buyer. It can be classified as :

1. Trade Discount : The purpose of this discount is to persuade the buyer to buy more goods. It is offered at an agreed percentage of list price at the time of selling goods. This discount is not recorded in the accounting books as it is deducted in the invoice/cash memo.

2. Cash Discount : The objective of providing cash discount is to encourage the debtors to pay the dues promptly. This discount is recorded in the accounting books.

Account

Account refers to a summarised record of relevant transactions of particular head at one place.

Income

Income is a wider term, which includes profit also. Income means increase in the wealth of the enterprise over a period of time.

Stock

The goods available with the business for sale on a particular date is known as stock.

Cost

Cost refers to expenditures incurred in acquiring manufacturing and processing goods to make it saleable.