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Accounting System
UNIT 2 ACCOUNTING CONCEPTS AND
STANDARDS
Structure Page Nos.
2.0 Introduction 20 2.1 Objectives 20 2.2 The Accounting Framework 20 2.3 Accounting Concepts 21 2.4 Accounting Standards 30 2.5 The Changing Nature of Generally Accepted Accounting Principles 31 2.6 Attempts towards Standardisation 31 2.7 Accounting Standards in India 32 2.8 Summary 33 2.9 Key Words 33 2.10 Self-Assessment Questions/Exercises 34 2.11 Further Readings 36
2.0 INTRODUCTION
Any activity that you perform is facilitated if you have a set of rules to guide your efforts. Further, you find that these rules are of more value to you if they are standardised. When you are driving your vehicle, you keep to the left. You are in fact following a standard traffic rule. Without the drivers of vehicles adhering to this rule, there would be much chaos on the road. A similar principle applies to accounting which has evolved over a period of several hundred years, and during this time certain rules and conventions have come to be accepted as useful. If you are to understand and use accounting reports which is the end product of an accounting system then you must be familiar with the rules and conventions behind these reports.
2.1 OBJECTIVES
After going through this unit, you should be able to:
l appreciate the need for a conceptual framework of accounting; l understand and appreciate the Generally Accepted Accounting Principles (GAAP), and l develop an understanding of the importance and necessity for uniformity in accounting practices.
2.2 THE ACCOUNTING FRAMEWORK
The rules and conventions of accounting are commonly referred to as the conceptual framework of accounting. As with any discipline or body of knowledge, some underlying theoretical structure is required if a logical and useful set of practices and procedures are to be developed for reaching the goals of the profession, and for expanding knowledge in that field. Such a body of principles is needed to help answer new questions that arise. No profession can thrive in the absence of a theoretical framework. According to Hendriksen (1977), accounting theory may be defined as logical reasoning in the form of a set of broad principles that (i) provide a general frame of reference by which accounting practice can be evaluated, and (ii) guide the
Accounting and its Functions
Accounting Concepts and Standards
development of new practices and procedures. Accounting theory may also be used to explain existing practices to obtain a better understanding of them. But the most important goal of accounting theory should be to provide a coherent set of logical principles that form the general frame of reference for the evaluation and development of sound accounting practices.
The American Institute of Certified Public Accountants (AICPA) discusses financial accounting theory and generally accepted accounting principles as follows:
Financial statements are the product of process in which a large volume of data about aspects of the economic activities of an enterprise are accumulated, analysed, and reported. This process should be carried out in accordance with generally accepted accounting principles. Generally accepted accounting principles incorporate the consensus at a particular time as to which economic resources and obligations should be recorded as assets and liabilities by financial accounting, which changes in assets and liabilities should be recorded, when these changes should be recorded, how the assets and liabilities and changes in them should be measured, what information should be disclosed and how it should be disclosed, and which financial statements should be prepared.
Generally Accepted Accounting Principles (GAAP) encompass the conventions, rules and procedures necessary to define accepted accounting practice at a particular time........generally accepted accounting principles include not only broad guidelines of general application, but also detailed practices and procedures.
( Source: AICPA. Statements of the Accounting Principles Board No.4 “Basic Concept and Accounting Principles Underlying Financial Statement of Business Enterprises”, October, 1970, pp.54-55).
The word ‘principles’ is used to mean a “general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice”. You will note that this definition describes a principle as a general law or rule that is to be used as a guide to action. This implies that accounting principles do not prescribe exactly how each detailed event occurring in business should be recorded. Consequently, there are several matters in accounting practice that may differ from one company to another.
Accounting principles are man-made. They are accepted because they are believed to be useful. The general acceptance of an accounting principle (or for that matter, any principle) usually depends on how well it meets the three criteria of relevance , objectivity , and feasibility. A principle is relevant to the extent that it results in meaningful or useful information to those who need to know about a certain business. A principle is objective to the extent that the information is not influenced by the personal bias or judgement of those who furnished it. Objectivity connotes reliability or trustworthiness which also means that the correctness of the information reported can be verified. A principle is feasible to the extent that it can be implemented without undue complexity or cost.
2.3 ACCOUNTING CONCEPTS
Earlier, in unit 1, we had described accounting as the language of business. As with language, accounting has many dialects. There are differences in terminology. In dealing with the framework of accounting theory, one is confronted with a serious problem arising from differences in terminology. A number of words and terms have been used by different writes to express and explain the same idea or notion. Thus, confusion abounds in the literature insofar as the theoretical framework is concerned.
The various terms used for describing the basic ideas are: concepts, postulates, propositions, basic assumptions, underlying principles, fundamentals, conventions,
Accounting and its Functions
Accounting Concepts and & Check Your Progress 2 Standards
The proprietor of a firm withdrew Rs. 50,000 for his personal use. This was shown as an expense of the firm and hence, profits were reduced thereby. Is this right from an accounting point of view?
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& Check Your Progress 3
The proprietor of a firm contributed Rs. 10 lakhs towards the capital of the firm. Does it means, from an accounting point of view, that the firm had a corresponding liability towards the proprietor?
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Money Measurement Concept
In accounting, only those facts which can be expressed in terms of money are recorded. As money is accepted not only as a medium of exchange but also as a measuring rod of value, it has a very important advantage since a number of widely different assets and equities can be expressed in terms of a common denominator. Without this adding heterogeneous factors like five buildings, ten machines, six trucks will not have much meaning.
While money is probably the only practical common denominator and a yardstick, we must realise that this concept imposes two sever limitations. In the first place, there are several facts which, though vital to the business, cannot be recorded in the books of account because they cannot be expressed in money terms. For example, the state of health of the Managing Director of a company, who has been the key contributor to the success of business, is not recorded in the books. Similarly, the fact that the Production Manager and the Chief Internal Auditor are not on speaking terms, or that a strike is about to begin because labour is dissatisfied with the poor working conditions in the factory, or that a competitor has recently taken over the best customer, or that it has developed a better product, and so on will not be recorded even though all these events are of great concern to the business.
From this standpoint, one could say that accounting does not give a complete account of the happenings in the business. You will appreciate that all these have a bearing on the future profitability of the company.
Second, the use of money implies that a rupee today is of equal value to a rupee ten years back or ten years later. In other words, we assume that there is a stable or constant value of the rupee. In the accounts, money is expressed in terms of its value at the time an event is recorded. Subsequent changes in the purchasing power of money do not affect this amount. You are, perhaps, aware that most economies today are in inflationary conditions with rising prices. The value of a rupee in the 80s has depreciated to an unbelievably low level in the 90s. Most accountants know fully well that the purchasing power of a rupee does change, but very few recognise this fact in
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Accounting System (^) accounting books and make an allowance for changing price level. This is so, despite the fact that the accounting profession has devoted considerable attention to this problem, and numerous suggestions have been made to account for the effects of changes in the purchasing power of money. In fact, one of the major problem of accounting today is to find means of solving the measurement problem, that is, how to extend the quality and the coverage of meaningful information. It will be desirable to present, in a supplementary analysis, the effect of price level changes on the reported income of the business and the financial position.
& Check Your Progress 4
Suppose the Managing Director of a company is killed in a plane crash. To the extent that “an organisation is the lengthened shadow of a man”, the real value of the company will change immediately, and this will be reflected in the market price of the company shares. Will this have any effect as far as the accounts of the company are concerned?
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Continuity Concept
Accounting assumes that the business (an accounting entity) will continue to operate for a long time in the future, unless there is good evidence to the contrary. The enterprise is viewed as a going concern, that is, as continuing in operation, at least in the foreseeable future. The owners have no intention, nor have they the necessity to wind up or liquidate its operations.
This assumption is of considerable importance, for it means that the business is viewed as a mechanism for adding value to the resources it uses. The success of the business can be measured by the difference between output values (sales or revenues) and input values (expenses). Therefore, all unused resources can be reported at cost rather than at market values as, according to the continuity concept, the future instead of selling them out rightly in the market.
The assumption that the business is not expected to be liquidated in the foreseeable future, in fact, establishes the basis for many of the valuations and allocations in accounting. For example, depreciation (or amortisation) procedures rest upon this concept. It is this assumption which underlies the decision of investors to commit capital to enterprise. The concept holds that continuity of business activity is the reasonable expectation for the business unit for which the accounting function is being performed. Only on the basis of this assumption can the accounting process remain stable and achieve the objective of correctly recording and reporting on the capital invested, the efficiency of management, and the position of the enterprise as a going concern. Under this assumption neither higher current market values nor liquidation values are of particular importance in accounting. This assumption provides a basis for the application of cost in accounting for assets.
However, if the accountant has good reasons to believe that the business, or some part of it, is going to be liquidated, or that it will cease to operate (say within a year or two), then the resources could be reported at their current values (or liquidation values).
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Accounting System (^) Accrual Concept
The accrual concept makes a distinction between the receipt of cash, and the right to receive it, and the payment of cash and the legal obligation to pay it. In actual business operations, the obligation to pay and the actual movement of cash may not coincide. The accrual concept recognises this distinction. In connection with the sale of goods, revenue may be received (i)before the right to receive arises, or (ii) after the right to receive has been created. The accrual concept provides a guideline to the accountant as to how s/he should treat the cash receipt and the rights related thereto. In the former case the receipt will not be recognised as the revenue of the period for the reason that the right to receive the same has not yet arisen. In the latter case the revenue will be recognised even though the amount is received in the subsequent period.
Similar treatment would be given to expenses incurred by the firm. Cash payments for expenses may be made before or after they are due for payment. Only those sums which are due and payable would be treated as expenses. If a payment is made in advance (i.e., it does not belong to the accounting period in question) it will not be treated as an expense, and the person who received the cash will be treated as a debtor until his right to receive the cash has matured. Where an expense has been incurred during the accounting period, but no payment has been made, the expense must be recorded and the person to whom the payment should have been made is shown as a creditor.
& Check Your Progress 7
The accounting year of a firm closes on 31st December each year. The rent for business premises of Rs. 50,000 for the last quarter could not be paid to the owner on account of his being away in a foreign country. Should the rent payable be taken into account for computing the firm’s income for the accounting year?
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& Check Your Progress 8
A government contractor supplies stationery to various government offices. Some bills amounting to Rs.10,000 were still pending with various offices at the close of the accounting year on 31st March. Should the businessman take the revenue of Rs.10,000 into account for computing the net profit of the period?
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Accounting and its Functions
Accounting Concepts and Standards
The Concept of Conservatism
The concept of conservatism, also known as the concept of prudence, is often stated as “anticipate no profit, provide for all possible losses”. This means an accountant should follow a cautious approach. Facing a choice, he should record the lowest possible value for assets and revenues, and the highest possible value for liabilities and expenses. According to this concept, revenues or gains should be recognised only when they are realised in the form of cash or assets (usually legally enforceable debts) the ultimate cash realisation of which can be assessed with reasonable certainty. Further, provision must be made for all known liabilities, expenses, and losses whether the amount of these is known with certainty, or is at best an estimate in the light of the information available. Probable losses in respect of all contingencies should also be provided for. A contingency is a condition, or a situation, the ultimate outcome of which−gain or loss−cannot be determined accurately at present. It will be known only after the event has occurred (or has not occurred). For example, a customer has filed a suit for damage against the company in a court of law. Whether the judgement will be favourable or unfavourable to the company cannot be determined for sure. Hence, it will be prudent to provide for likely loss in the financial statements. As a consequence of the application of this concept, net assets and incomes are more likely to be understated than overstated. Based on this concept is the widely advocated practice of valuing inventory (stock of goods left unsold) at cost or market price, whichever is lower. You will note that this convention, in a way, modifies the earlier cost concept. It should be stated that the logic of this convention has been under stress recently; it has been challenged by many writers on the ground that it stands in the way of fair determination of profit, and the disclosure of true and fair financial position of the business enterprise. The concept is not applied as strongly today as it used to be in the past. In any case, conservatism must be applied rationally as over-conservatism may result in misrepresentation.
& Check Your Progress 9
A company is negotiating to get an order for Rs.5 lakhs from XYZ company. It is confident to get an order and as a result, it shows this order as a part of its sales revenue. Will you approve such an accounting treatment of probable order to be obtained in future?
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Materiality Concept
There are many events in business which are trivial or insignificant in nature. The cost of recording and reporting such events will not be justified by the usefulness of the information derived. The materiality concept holds that items of small significance need not be given strict theoretically correct treatment. For example, a paper stapler costing Rs. 30 may last for three years. However, the effort involved in allocating its cost over the three-year period is not worth the benefit than can be derived from this operation. Since the item obviously is immaterial when related to overall operations, the cost incurred on it may be treated as the expense of the period in which it is acquired. Some of the stationery purchased for office use in any accounting period may remain unused at the end of that period. In accounting, the amount spent on the entire stationery would be treated as an expense of the period in which the stationery was purchased, notwithstanding the fact that a small part of it still lies in stock. The value (or cost) of the stationery lying in stock would not be treated as an asset and
Accounting and its Functions
Accounting Concepts and Standards
Periodicity Concept
Although the results of the operations of a specific enterprise can be known precisely only after the business has ceased to operate, its assets have been sold off and liabilities paid off, the knowledge of the results periodically is also necessary. Those who are interested in the operating results of a business obviously cannot wait till the end. The requirements of these parties, therefore, force the accountant to report the changes in the wealth of a firm for some time periods. These time periods in actual practice vary, though a year is the most common interval as a result of established business practice, tradition, and government requirements. Some firms adopt the calendar year, and some others the financial year of the government. But more and more firms are changing to the ‘natural’ business year, the end of which is marked by relatively lower or lowest volume of business activity in the twelve-month period. The custom of using twelve-month period is applied only for external reporting. The firms usually adopt a shorter span of interval, say one month or three months, for internal reporting purposes.
The allocation of long-term costs and the difficulties associated with this process directly stem from this concept. While matching the earnings and the cost of those earnings for any accounting period, all the revenues and all the costs relating to the year in question have to be taken into account irrespective of whether or not they have been received in cash, or paid in cash. Despite the difficulties that arise in allocations and adjustments, short-term reports (i.e., yearly reports) are of such importance to owners, management, creditors, and other interested parties that the accountant has no option but to resolve such difficulties. Obviously, the utility of the periodic financial statements outweighs the difficulties.
Some other concepts, e.g., the Matching concept, the Realisation concept and the Dual Aspect concept are discussed in units 4 and 5, and as such, they have not been taken up here.
While going through all these concepts, probably you may have developed a feeling that they sometimes conflict with each other. You are right. We illustrate this by considering some of these concepts in the context of valuation of business properties. Suppose a firm acquired a piece of land in 1985 for a price of Rs. 6,00,000. Factory premises were constructed in 1986, and operations commenced in 1987. The firm has been successful in achieving the desired profit for the past year. The Balance Sheet (a statement of assets and liabilities) for the year 2005 is being prepared and ‘Land’ is required to be valued. The estimated current market price of this land is Rs. 60,00,000.
Should you recommend that the land be valued at Rs. 60 lakhs? The answer is ‘no’, obviously. Land would be carried on the Balance Sheet at its original cost of Rs. 6,00,000 only. This decision is supported by several of the concepts discussed in this section. In the first place, the stability of purchasing power of money implied in the money measurement concept prevents us from recognising accretion in values as a result of changing price levels. Then, the realisation concept will not allow unrealised profits to be included as long as land is held by the company and not sold away. You may note that the continuity , or going concern concept , makes any possible market value of land irrelevant for the balance sheet because the firm has to continue in business, and land will be needed by it for its own use. In this connection, it could be argued that if land were shown on the balance sheet at its estimated current market value, the owner might decide to discontinue the business, sell the land and retire. The principle of objectivity is now introduced into the argument. It can be easily seen that in a situation like this the cost of acquisition of land at Rs. 6,00,000 in 1985 is the objective fact because it is based on a transaction that actually took place and this objective evidence is capable of being verified. In contrast, the estimate of current market value figure may be suspect. It raises many questions. Do you have a market quotation for an identical plot of land? Has a similar plot of land been sold recently, and can we pick it up as verifiable evidence of the current market price? It
Accounting System (^) may be said that even if market price for an identical plot of land is not available, estimates by an accredited valuer may be accepted as verifiable evidence of the market price. Further complications may be noticed if buildings and facilities have been erected on the plot of land. Is it possible to estimate the value of land without factory buildings and other facilities constructed on it? The answer is a flat ‘no’, and the conservatism concept will then deter you from accepting an estimate of market value since it cannot be ascertained with reasonable accuracy.
2.4 ACCOUNTING STANDARDS
The basic concepts, discussed in the foregoing paragraphs, are the core elements in the theory of accounting. These concepts (postulates or conventions), however, permit a variety of alternative practices to co-exist. As a result, the financial results of different companies cannot be compared and evaluated unless full information is available about the accounting methods which have been used. The variety of accounting practices have made it difficult to compare the financial results of different companies. Further, the alternative accounting methods have also enabled, the reporting of different results, even by the same company.
Need for Standards: The information contained in published financial statements is of particular importance to external users, such as shareholders and investors. Without such information they would not be able to take the right decisions about their investments. As in several other countries, Parliament in India specified in the Companies Act, the type and minimum level of information which companies should disclose in financial statements. It is the responsibility of the accounting profession to ensure that the required information is properly presented. It is evident that there should not be too much discretion to companies and their accountants to present financial information the way they like. In other words, the information contained in financial statements should conform to carefully considered standards. Public confidence in accounting information contained in financial statements will grow if they are satisfied as to the logic, consistency and fairness of the figures shown therein. For instance, a company could incur a loss and still pay dividends by manipulating the loss into a profit. In the long run, this course may have a disastrous effect on the company and its investors.
You would be better able to appreciate the function of accounting standards by relating them to the basic purpose of financial statements, which is the communication of information affecting the allocation of resources. Ideally, such information should make it possible for investors to evaluate the investment opportunities offered by different firms and to allocate scarce resource to the most efficient ones. In theory, this process should result in the capital distribution of resources within the economy, and should maximise the potential benefit to society.
In this context, unless there are reasonably appropriate standards, neither the purpose of the individual investor, nor that of the nation as a whole, can be served. The purpose is likely to be served if the accounting methods used by different firms for presenting information to investors allow correct comparisons to be made. For example, they should not permit a company to report profits which result simply from a change in accounting methods rather than from increase in efficiency. If companies were free to choose their accounting methods in this way, the consequences might be that deliberate distortions are introduced, leading eventually to misapplication of resources in the economy. The relatively less efficient companies will be able to report fictitious profits, and as a result scarce capital of society will be diverted away from the more efficient companies which have adopted more strict and consistent accounting methods.
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Accounting System (^) issued five statements of concepts and eighty-eight statements of financial accounting standards.
Standards at International Level: In view of the growth of international trade and multinational enterprises, the need for standardisation at the international level was felt. An International Congress of Accountants was organised in Sydney. Australia in 1972 to ensure the desired level of uniformity in accounting practices. Keeping this in view, the International Accounting Standards Committee (IASC) was formed and was entrusted with the responsibility of formulating international standards. All the member countries of IASC resolved to conform to the standards developed by IASC, or at least to disclose variations from recommended standards. After its formation in 1973, the IASC has issued 40 international accounting statement to date. Another professional body, the International Federation of Accountants (IFAC) was established in 1978.
Attempts have also been made in countries in the European Economic Community (EEC), and in Canada for standardisation of accounting practices regarding disclosure and consistency of procedures.
2.7 ACCOUNTING STANDARDS IN INDIA
With a view to harmonise varying accounting policies and practices currently in use in India, the Institute of Chartered Accountants of India (ICAI) formed the Accounting Standards Board (ASB) in April 1977 which includes representatives from industry and government. In line with the procedure followed in other countries, the preliminary drafts prepared by the study groups and approved by ASB are circulated amongst various external agencies, including the representative bodies of trade, commerce, and industry. So far, twenty eight standards have been issued by ASB, a brief description of which is provided in Appendix I to this unit.
The standards are recommendatory in nature in the initial years. They are recommended for use by companies listed on a recognised stock exchange and other large commercial, industrial, and business enterprises in the public and private sectors. We advise that you read all or at least some of these standards in order to get a feel of what these standards are all about. What are the policies and procedures of accounting that these standards aim to standardise and why? Do not worry if you are unable to understand some of the ideas or expressions contained in the standards. You may like to come back to these standards after you have been through all the blocks of this course, in order to have a better grasp of them.
Regarding the position in India, it has been stated that the standards have been developed without first establishing the essential theoretical framework. Without such a framework, it has been contended, any accounting standards and principles developed are likely to lack direction and coherence. This type of shortcoming also existed in the UK and USA, but then it was recognised and remedied a long time ago. In the United States, the first task which the FASB undertook was to develop a conceptual framework project which aimed at defining the objectives of financial reporting (a sample of which is presented in Appendix II). This was to be followed by the spelling out of concepts and standards establishing what have been frequently referred to as generally accepted accounting principles (GAAP). Any attempt to develop a conceptual framework regarding the objectives of reporting will have to take into consideration the answers to the following questions:
i) Who are the users of financial reports? ii) What decisions do these user groups have to take? iii) What information can be provided that would assist them to take such decisions?
Accounting and its Functions
Accounting Concepts and Standards
The objectives, as you have already noted, depend upon the economic, social, legal and political environment of the country.
At this point it will be useful for you to watch the video programme: Understanding Financial Statement-Part I.
2.8 SUMMARY
Accounting as a field of study in its developmental process has evolved a theoretical framework consisting of principles or concepts over period of time. These concepts enjoy a wide measure of support from the accounting profession. That is why they are known as Generally Accepted Accounting Principles (GAAP). Several concepts, and their implications for business and information users, were discussed in this unit.
Since the accounting principles are broad guidelines for general application, they permit a wide variety of methods and practices. The lack of uniformity in accounting practice makes it difficult to compare the financial reports of different companies. Moreover, the multiplicity of accounting practices makes it possible for management to conceal economic realities by selecting those alternative presentations of financial result which allow earnings to be manipulated. The financial statements prepared under such conditions, therefore, may have limited usefulness for several users of information. This problem has been recognised all over the world and various professional bodies are engaged in the task of standardising accounting practices. There is a movement towards consensus building even at the international level. Such professional bodies, in fact, first look at the practices used by practising accountants They then try to obtain a refinement of those practices by a process of consensus. It is in this manner that the theory of accounting is built. In India also, some headway has been made by establishing twenty eight standards for accounting practice.
2.9 KEY WORDS
Accounting framework includes generally accepted accounting principles (GAAP) on the basis of which accounting data is processed, analysed, and reported.
Accounting theory is a set of inter-related principles and propositions, which provide a general framework for accounting practice, and deal with new developments in the area.
Accrual concept says that an accountant should recognise incomes and expenses when they have actually accrued, irrespective of whether cash is received or paid. Consistency concept envisages that accounting information should be prepared on a consistent basis from period to period, and within periods there should be consistent treatment of similar items.
Conservatism concept forbids the inclusion of unrealised gains but advocates provision for possible losses.
Cost Concept states that an asset is to be recorded in books of accounts at a price for, or at a cost incurred to acquire it.
Entity concept separates the business from owner(s), from the standpoint of accounting.
Going concern concept refers to the expectation that the organisation will have an indefinite life. This assumption has an important bearing on how the assets are to be valued.
Accounting and its Functions
Accounting Concepts and Standards
- Accounting Standards are statements prescribed by:
i) Law ii) Government regulatory bodies iii) Bodies of shareholders iv) Professional accounting bodies v) None of the above.
- Accounting concepts are:
i) Broad assumptions ii) Methods of presenting financial accounts iii) Bases selected to prepare a specific set of accounts iv) None of the above.
- Name the accounting concept violated, in any of the following situations:
a) The Rs, 1,00,000 figure for inventory on a Balance Sheet is the amount for which it could be sold on the balance sheet date. b) The Balance Sheet of a retail store which has experienced a gross profit of 40% on sales contains an item of merchandise inventory of Rs. 1,15,00,000: Merchandise inventory (at cost) Rs. 69,00,000. c) Company M does not charge annual depreciation, preferring instead to show the entire difference between original cost and proceeds of sale as a gain or loss in the period when the asset is sold. It has followed this practice for many years.
Answers to Activities
- If the ‘separate entity concept’ is not observed, it becomes difficult to calculate the profitability of business and ascertain its financial position. It would be particularly difficult if the owner has several distinct businesses.
- Proprietary withdrawals reduce the capital of the enterprise unless they are in lieu of anticipated profits. It is not proper to show them as operating expense. They are also not admissible as deductions from profits for tax purposes.
- Yes, because as per the entity concept the business and the proprietor are two separate entities. If the proprietor contributes some amount towards capital, it means that the business has a liability to return it to the proprietor.
- No, the money measurement concept does not permit the recording of such events. What effect this event will have on the business cannot be objectively determined.
- Revaluation violates several concepts like, cost concept, conservatism concept, and continuity concept. To take credit for an extraordinary gain like this is normally not considered justified. However, were a substantial gap exists between the historical cost of a fixed asset and its market value, it has been observed that the accounting profession has been supporting such revaluations so that the balance sheet could show a realistic position of the enterprise.
- As per the cost concept, the company should show the value of machinery in books of accounts at Rs. 40,000 the price, which is being actually paid.
- It should be taken into account, otherwise profit will be overstated.
- It should be taken into account, otherwise profit will be understated.
Accounting System (^) 9. No. Since the order is not actually obtained, the probable sales revenue could not be recognised as per the conservatism concept.
- Though the table has a long-term life and as such can be shown as an asset, yet the materiality concept requires it to be treated as an expense.
- It violates the consistency concept, unless there is a solid reason for departing from the earlier practice.
Answer to Self-assessment Questions Exercises
- a) True b) True c) True d) False e) True.
- (iii)
- (iv)
- (i)
- (a) Conservatism concept, (b) Cost concept, (c) Periodicity concept.
2.11 FURTHER READINGS
Financial Accounting, Maheshwari, S.N. and S.K. Maheshwari, 2000, Vikas Publishing House: New Delhi (Chapter 2).
Accounting Principles, Anthony, Robert, N. and James Reece, 1987 , All India Traveller Book Seller: New Delhi ( Chapters 1-3).
Accounting, The Basis for Business Decisions, Meigs, Walter, B.and Robert F. Meigs, 1987, McGraw Hill: New York (Chapter 1).
Accounting Theory, Hendriksen, E. S., 1984, Khosla Publishing House, Delhi (Chapters 2,3 and 6).
Accounting System (^) (AS 19) Leases
(AS 20) Earnings Per Share
(AS 21) Consolidated Financial Statements
(AS 22) Accounting for Taxes on Income Clarification on Accounting Standards (AS) 22, Accounting for Taxes on Income
(AS 23) Accounting for Investments in Associates in Consolidated Financial Statements
(AS 24) Discontinuing Operations Announcement — Accounting Standards (AS) 24, Discontinuing Operations
(AS 25) Interim Financial Reporting
(AS 26) Intangible Assets
(AS 27) Financial Reporting of Interests in Joint Ventures
(AS 28) Impairment of Assets 30-05-
For further details, please visit: http://www.icai.org/resource/o_ac_standard.html
Accounting and its Functions
Accounting Concepts and Standards
Appendix II
Financial Accounting Standards Board (FASB )
Concepts No. 1: ‘ Objectives of financial reporting by business enterprises’.
The three objectives which are included in concept No. 1 are reproduced below:
Financial reporting should provide information that is useful to the present and potential investors and creditors and other users in making rational investment, credit and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.
Financial reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors’ and creditors’ cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors and others, assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.
Financial reporting should provide information about the economic resources of an enterprise, the claim to those resources (obligations of the enterprise to transfer resources to other entities and owners’ equity), and the effects of transaction, events, and circumstances that change its resources and claims to those resources.
