'Accounting – Concepts and Conventions\r'

'NATURE OF financial description The entropy exhibited by financial biddings atomic number 18 affected by a)Recorded facts b) system of news report sup coifs, Conventions & Principles c)Personal Judgment 1)Recorded Facts: The term preserve facts rec altogethers the information used for preparing financial narratives be taken from news report record which argon facts. i. e. nones in Hand: Actual capital is put down Amount due from debtor: Actual to be recorded Amount due to creditor: Actual to be recorded consequently the financial statement do not disclose such facts which whitethorn be reality, which be not recorded. For ex. : L/Bldg. urchased ar shown at hail price in the flooring Books precisely commercialise value which in reality may be diffe necessitate is not utter because it is not recorded in Books of A/c. 2)Accounting ideals & conventions & principle: The mental lexicon meaning is â€Å"Fundamental truth implying uniformity o f applicability e rattlingwhere. ” However when applied in Financial instruction psychoanalysis, it gives different meaning in different patterns & so it is rargonly used as a aboriginal accountancy truth. Accounting Principles are those rules of Action which are adopted by the Accountant univers andy in put down motion.Different professional bodies like Australian orderliness of Account (i. e. Institute of Chartered Accountant in Australia) The Institute of Chartered Accountant in England & Wales. The American Institute of certified public accountant contract made recommendation on accounting principles in the recent year. Accounting principles buzz off been developed oer the years from experience, usage & necessity. They are judged on the world(a) Acceptability rather than Universal Acceptability to the user of financial statement hence they are c everyed as General Accepted Accounting Principles (G. A. A. P. )According principles can be broadly classified into two categories: A. Accounting apprehensions B. Accounting Conventions Accounting Principles Accounting innovationsAccounting Conventions a)Entity patterna)Disclosure b)Going tinge opinionb) corporeality c)Accounting period fancyc)Consistency d)Money meter Conceptd)conservativism e) salute Concept f)Cost Attach Concept g)Dual Aspect Concept h)Accrual judgment i)Periodic Matching of approach and R blushue Concept j)realisation Concept k)Verifi fitted documental Evidence Concept air relationship CONCEPTS: They are the demand assumptions or conditions upon which accounting is base.Accounting concepts are postulates, assumptions or conditions upon which accounting is based. They are developed to catch the same meaning to all(a) people. slightly of the principal(prenominal) concept are given as follows: 1. Entity Concept: For accounting purposes- the ‘ concern’ is treated as a separate entity from the giveor (s). It may sound to be absurd that one sell goods to himself, merely all transactions are recorded in the books of the personal credit line as per this point of view. This concept helps in tutelage private af attractives of the owner away from the military control affairs. Thus if a proprietor invests Rs. ,00,000/- in the melody, it is deemed that the proprietor has given Rs. 1,00,000/- to the ‘ occupancy’ and it is shown as a ‘indebtedness’ in the books of vexation. (because business has to ultimately repay it to the proprietor). Similarly, if the proprietor withdraws Rs. 10,000/- from the business, it is charged to him. This concept is applicable to all forms of business organizations. Although in the eyes of Law a resole trader and his business or the partner and their business are one and the same, for accounting purposes they are regarded as separate entities. It is the ‘business’ with which we are concerned. . Going Concern Concept (Continuity of Activity): It is assumed that the business concern leave continue for a fairly long cadence, unless and until it has entered into a state of liquidation. 3. Accounting Period Concept: Although the ‘ spill concern’ concept stresses the continuing genius of the business enterprise, it is customary to divide its feel into chapters know as ‘Accounting Periods. ’ An accounting period is the interval of time at the end of which the income statement and financial position statement (balance shred) are put togetherd to know the egress and resources of the business.Although shorter periods are frequently adopted for purposes of comparative studies, the rule accounting period is twelve months. This is because though the life of the business is considered to be indefinite, the measurement of income and studying the financial position of the business after a very long period would not help in taking timely corrective steps or to enable periodic distri preciselyions of inco me to proprietor (s) with reasonable safety. Therefore, it is obligatory for the concern to ‘stop’ at regular intervals and ‘ claver back’ how it is faring. 4.Money Measurement Concept : In accounting everything is recorded in wrong of spot. Events or transaction which cannot be expressed in terms of money are not recorded in the books of accounts, hitherto if they are very all big(p) or usable for the business. Purchase and sale of goods, payment of expenses and receipt of income are monetary transactions which find place in accounting and so on Death of an executive, resignation of a manager are the events which cannot be expressed in money and so are not to be recorded in Book’s of A/c. 5. Cost Concept (Objectivity Concept): As per follow concept: )an asset is ordinarily recorded at the price paying to acquire it i. e. at its be, and b)this cost is the rear end for all subsequent accounting for the asset. For example, if a dapple of land is purchased for Rs. 1,00,000/- it is recorded in the books of at Rs. 1,00,000/- and even if its market value at the time of supplying of final accounts is Rs. 2,00,000/- or Rs. 60,000/- it go forth not be considered. Thus the balance sheet on a particular date does not ordinarily demonstrate what the asset could be sold for. The cost concept does not mean that the asset will forever and a day be shown at cost.It only means that cost becomes the basis for all subsequent accounting for the asset. Thus the assets recorded by the process of depreciation. Cost concept brings objectivity in the preparation and presentation of financial statements. It implies that the figures shown in the accounting records should be based on objective evidence and not on the inwrought views of a person. 6. Cost- tie up Concept: This concept is also known as ‘cost-merge’ concept. In order to produce an name it is incumbent to purchase raw-material, process it and convert into ruin ed article.This calls for the go of other(a) factors of production and thitherfore, on that point are several other costs like labor party cost, power and other overhead expenses. These cost have a capacity to ‘merge’ or ‘attach’ when they are brought together. Thus the proportionate raw-material costs, labour costs, and other overheads are added together to obtain product cost so as to increase the utility of cost data. 7. Dual Aspect Concept: This is the basic concept of accounting. As per this concept, every business transaction has a dual effect. 8.Accrual Concept: The accrual concept implies recording of revenues and expenses of a particular accounting period, whether they are genuine / paid in cash or not. downstairs cash system of accounting, the revenues and expenses are recorded only if they are actually trustworthy / paid in cash irrespective of the accounting period to which they belong. just under accrual method, the revenues and expens es relating to that particular accounting period only are considered. 9. Periodic Matching of Cost and Revenue Concept : This concept is based on the accounting period concept.Making wampum is the most important objective that keeps the proprietor engaged in business activities. That is why most of the accountant’s time is spent in evolving techniques for measuring the return/ profitability of the concern. To ascertain the profit made during a period, it is necessary to match ‘revenues’ of the period with the ‘expenses’ of that period. Income (profit) earned by the business during a period can be heedful only when the revenue earned during the period is compared with the uptake incurred to earn that revenue. The question when the payment was made / received is irrelevant.Therefore, as per this concept adjustments are made for all outstanding expenses, prepaid expenses, accrued incomes, unearned incomes etc.tera 10. Realisation Concept : Accordi ng to this concept profit should be accounted for only when it is actually realized. Revenue is recognize only when sale is effected or the services are rendered. Sale is considered to be made when the property in goods passes to the buyer and he is legally presumable to pay. However, in order to recognize revenue, receipt of cash is not essential. Even credit sale results in realization as it creates a efinite asset called ‘Account Receivable’. However, in that location are certain exceptions to the concept: like in nerve of contract accounts, necessitate purchase etc. Similarly incomes like commission, interest, rent etc. are shown in Profit and passage Account on accrual basis though they may not be realised in cash on the date of preparing accounts. 11. Verifiable Objective Evidence Concept : According to this concept all accounting transactions should be evidenced and back up by objective documents. These documents include invoices, contracts, correspondence , vouchers, bill, pass books, bank check books etc. uch supporting documents render the basis for making accounting entries and for verification by the auditors later on. This concept also has its limitations. for example, it is difficult to verify internal parceling of costs to accounting periods. 2. ACCOUNTING CONVENTIONS: Conventions are the tradition or traditions or usage which guide of accounting statements. They are adapted to make financial statements exhaust and meaningful. 1. Convention of Disclosure: This means that the accounts must be honestly ready and they must disclose all material breeding.The accounting reports should disclose full and fair reading to the proprietors, creditors, investors and others. This conventions is specially significant in case of big business like Joint breed Company where there is divorce between the owners and the managers. However, it does not mean that all information or information of any kind is to be included in accounting sta tements. The term ‘ revelation’ only implies that there must be a sufficient disclosure of informations which is of material interest to proprietors, present and potential creditors and investors. 2.Conventions of Materiality: The accountant should attach importance to material elaborate and ignore insignificant details. If this is not done accounts will be overburdened with minute details. As per the American Accounting Association, â€Å"an item should be regarded as material, if there is a reason to believe that knowledge of it would operate the decision of informed investor. ” Therefore, keeping the convention of materiality in view, unimportant items are either odd out or merged with other items. about items are shown as foot notes like, contingent liabilities, market value of investment etc.However, an item may be material for one purpose but so-so(p) for another, material for one concern but orthogonal for another, or material for one year but immat erial for next year. 3. Convention of Consistency: The likeness of one accounting period with the other is doable only when the convention of consistency is followed. It means accounting from one accounting period to another. For example, a go with may adopt straight line method, write down value method, or any other method of providing depreciation on fixed assets. except it is expected that the company follows a particular method of depreciation consistently.Similarly, if stock is valued at ‘cost or market price whichever is less,’ this principle should be followed every year. Any change from one method to another would lead to inconsistency. However, consistency does not mean non-flexibility. It should permit introduction of improved techniques of accounting. 4. Convention of Conservatism: It refers to the policy of ‘playing safe. ’ As per this convention all prospective tone endinges are taken into rumination but not all prospective profits. In other words ‘anticipate no profit but provide for all possible losses’.However, this convention is beingness criticized on the ground that it goes not only against the convention of full disclosure but also against the concept of matching costs and revenues. It encourages presentation of secret reserves by making spare supply for depreciation, bad and doubtful debts etc. The Income statement shows a lower net income and the Balance sheet overstates the liabilities and understates the assets. The convention of conservatism should be applied carefully so that the results reported are not distorted. Some degree of conservatism is inevitable where objective data is not available.Following are the examples of application of conservatism: a)Making provision for doubtful debts and discount on debtors. b)Not providing for discount on creditors. c)Valuing stock in trade at cost or market price whichever is less. d)Creating provision against fluctuations in the price of inves tments. e)Showing Joint Life Policy at surrender value and not at the paid up amount. f)Amortization of intangible asset like grace which has indefinite life. ESSENTIAL QUALITIES OF FINANCIAL STATMENTS As stated earlier, the basic objective of financial statement is to provide information useful to the users of these statements.Different users like shareholders, investors, financial institutions, workers etc. are interested in financial statements with variable objectives. Generally, it is not possible for a pissed to prepare these statements in such a form that may suit every interested user. However, such statements should possess at least the following essential qualities. 1. relevance : Only these information should be disclosed in financial statements which are relevant to the objectives of the firm. The information is tell to be relevant only when it influences decision of the users, epoch evaluating any event or correcting past evaluation.The conclusions wasted on the basis of irrelevant information would be conducting of no use. Therefore, the information irrelevant to the statements be avoided, otherwise it would be difficult to make a distinction between relevant and irrelevant information. 2. understandability : The main objective of financial statements is to provide necessary information about the firm’s resources and performance. To effect this objectives, the information contained in these statements should be clear, simple and straightforward so that a person who is not soundly versed with the accounting terminology shall be able to understand without much difficulty.Hence, as far as possible, the form of financial statements should not be complex, and the terms used in these statements should be simple, in mutual language and non-technical. 3. dependableness and Accuracy : The information structured in financial statements should be reliable. Information has the feel of reliability when it is free from material error and stoop and can be depended upon by users. Reliability charges with the nature of information contained in the subject matter. Therefore, such information should be provided whose reliability can be verified. Reliability of financial statements also depends on the accuracy of accounts.Hence, to arrest at right conclusions, accuracy of the accounts is an essential quality. To be reliable*, information must (i) carry stuffy representation of transactions, (ii) should be presented in accordance with the magnetic core and economic reality, and (iii) must be neutral, prudent and consummate(a). 4. comparing : Comparison is the essence of financial statement analysis. comparable with(predicate) information will reveal relatively grueling and weak point. Financial statement should be fain in such a way that authoritative year’s do can be compared with that of previous year and inter-firm comparison is possible.To facilitate comparison, it would be more useful to provide wit h the financial statement of 5 to 10 years compact of important terms such as production in quantity, net sales, net profits, dividend paid, working capital etc. 5. Completeness : The information contained in the financial statements should be complete in al respects. It must be ensured that there is no possibility of any information being incomplete or doubtful. Therefore, full disclosure should be made of all significant information in a manner that is understandable and does not mislead creditors, investors and others users. . Timeliness : Financial statements are on the watch for a definite period of time. At the end of this period, they should be ready and submit to the parties concerned. If the statements are not prepared in time, they can not be right used and the firm cannot formulate plans for future developments. In addition to the aforesaid qualities, financial statements be prepared easily, attention of the reader is automatically drawn and order to most significant items and required data for the slowness of different ratios are also essential qualities.As American Accounting Association, has described, â€Å"every corporate statement should be based on accounting principles which are sufficiently uniform, objective and understood to justify opinions to the condition and progress of the business enterprise behind it. ” LIMITATIONS OF FINANCIAL STATEMENTS The summary of accounts maintained by a business firm is presented in the form of financial statements. The amounts expressed in these statements are based on vouchers and accounting records.Hence, decisions based on these information are more neat and logical. However, the conclusions drawn on the basis of these information cannot be treated as final and accurate, because there are certain limitations to the financial statements. One must, therefore, keep in view these limitations while studying the profit and loss account and balance sheet of the firm. Important and clashing bearin g limitations of financial statements are identified as below : 1. inadequacy of Precision 2. Lack of exactness 3. Incomplete Information 4. Interim Reports . Hiding of Real Position or Window Dressing 6. Lack of Comparability 7. Historical Costs Analysis †To learn †to cut into pieces But only analyse †No †It means also Interpretation. Thus Financial dictation Analysis means â€Å"Analysis, comparisons and interpretation of Financial data to achieve the desired result” TOOLS OF FINANCIAL STATEMENT ANALYSIS 1. Comparative Statements 2. Common Size Statements The inwrought Requirement is 3. Trend AnalysisVertical Financial Statement. 4. Ratio Analysis 5. Fund precipitate Statement 6. Cash Flow Statement\r\n'