1.

2.

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.
He should record 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 certainity. 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 unfavorable 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 are more likely to be understated than overstated, and
income is more likely to be overstated than understated. 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
8. 27 Accounting Concepts and Standards 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 ad 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
rational Y as over- conservatism may result in misrepresentation. 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. 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 benefrt 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 entire stationery would be treated as 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 carried forward as a resource to the next period. The accountant would
regard the stock lying unused as immaterial. Hence, the entire amount spent on stationery would be taken as the
expense of the period in which such expense was incurred. Where to draw the line between material and
immaterial events is a matter of judge- ment and common sense. There are no hard and fast rules in this respect.
Whether a particular item or occurrence is material or not, should be determined by considering its relationship to
other items and the surrounding circumstances. It is desirable to establish and follow uniform policies governing
such matters. Consistency Concept In practice, there are several ways to record an event or a transaction in the
books of account. For example, the trade discount on raw material purchased may be deducted from the cost of
goods and net amount entered in the books, or alternatively trade discount may be shown as the income with full
cost of raw material purchased entered in the books. Similarly, there are several methods to charge depreciation
(which is a decrease in the value of assets caused by wear and tear, and passage of time) on an asset or of
valuing inventory. The consistency concept requires that once a company has decided on one method and has
used it for some time, it should continue to follow the same method or procedure for all subsequent events of the
same character unless it has a sound reason to do otherwise. If for valid reasons the company makes any
departure from the method it has been following so far, then the effect of the change must be clearly stated in the
financial statements in the year of change. You will appreciate that much of the utility of accounting information lies
in the fact that one could draw valid conclusions from the comparison of data drawn from financial statements of
one year with data of the other year. Comparability is essential so that trends or differences may be identified and
evaluated. Inconsistency in the application of accounting methods might significantly affect the reported profit and
the financial position. Further, inconsistency also opens the door for manipulation of reported income and assets.
The comparability of financial information depends largely upon the consistency with which a given class of events
are handled in ac-counting records year after year.

Assets
Current assets
1.

Cash and cash equivalents

2.

Accounts receivable

3.

Prepaid expenses for future services that will be used within a year

Non-current assets (Fixed assets)

1.

Property, plant and equipment

2.

Investment property, such as real estate held for investment purposes

3.

Intangible assets

4.

Financial assets (excluding investments accounted for using the equity method, accounts receivables, and cash
and cash equivalents)

5.

Investments accounted for using the equity method

6.

Biological assets, which are living plants or animals. Bearer biological assets are plants or animals which bear
agricultural produce for harvest, such as apple trees grown to produce apples and sheep raised to produce wool.

Liabilities
1.

Accounts payable

2.

Provisions for warranties or court decisions (contingent liabilities that are both probable and measurable)

3.

Financial liabilities (excluding provisions and accounts payable), such as promissory notes and corporate bonds

4.

Liabilities and assets for current tax

5.

Deferred tax liabilities and deferred tax assets

6.

Unearned revenue for services paid for by customers but not yet provided

Equity / Capital
The net assets shown by the balance sheet equals the third part of the balance sheet, which is known as the shareholders'
equity. It comprises:
1.

Issued capital and reserves attributable to equity holders of the parent company (controlling interest)

2.

Non-controlling interest in equity

What is/How to make a Funds Flow Statement?

Sources/Inflow Applications/Outflow of Funds

... From Page 3

Balance Sheet- Information relating to Funds

The Fund area of the balance sheet provides us the information relating
Cost
to Funds. By Funds we mean items (Assets and Liabilities) which have a Manageme
life span of over a year.
nt
Accountin
g

A Single Balance Sheet

A single balance sheet provides the information relating to a specific

date, generally the last day of the accounting period. Where the
balance sheet has been prepared by grouping information as in the
case of "Balance Sheet in a form suitable for financial analysis", we
would be able to derive the information relating to Liquid Assets,

Process
Costing
Standard
Costing
(Variance

Current Assets, Current Liabilities/Provisions, Fixed Assets, Other Assets, Analysis)

Long Term Liabilities and Share Capital from the balance sheet itself.
Funds
Flow Cash
This enables us to have an understanding of the funds within that Balance Sheet.
Flow
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Balance Sheet of M/s ___ as on 31st March 2007

Liabilities

EQUITY SHARE
CAPITAL
PREFERENCE SHARE
CAPITAL
RESERVES
a) P/L Appropriation
a/c
b) Share Premium
e) General Reserve

Amou
nt

8,00,00
0
6,00,00
0
9,00,00
0

Amou
nt
15,00,
000

9,00,00
0
23,00,0
00

8,00,00
0 16,00,0
8,00,00
00
0

Assets
FIXED ASSETS
(1) Goodwill
at Cost
(2) Land and
Buildings
(3) Plant and
Machinery
(4) Furniture
and Fittings
(7)
Investments

24,00,0 CURRENT
11,00,00
LONG TERM
00 ASSETS
0
LIABILITIES
4,00,00
A. LIQUID
0
(1) Loans from Banks
ASSETS
(2) Debentures
2,50,00
0
(1) Cash
CURRENT
Balance
1,00,00
LIABILITIES/PROVISI
(2) Bills
0
ONS
Receivable
3,00,00
(3) Sundry
0
(1) Sundry Creditors
debtors
2,50,00
(2) Bills Payable
0
Less: Bad
(3) Bank Overdraft
(4) Outstanding
Expenses
(7) Provision for
Taxation
(8) Provision for
Dividends

Debt Reserve

B. OTHER
CURRENT
ASSETS
(1)
Stocks/Invent

Amou
nt

Amou
nt

8,00,00
0
13,00,0
00
14,00,0
00
6,00,00
0
4,00,00
0

45,00,0
00

78,000
8,25,00
0
12,25,0
00
(12,000)
12,00,0
00
2,84,00
0

36,00,00
0 Financial
6,00,000

Accountin
g
Basic
Accountin
g Process

Consignm
ent
Accountin
g
Bank
Reconciliat
ion
Statement

Partnershi
p Accounts
Final
Accounts
Quantitati
ve
Techniques

Permutatio
ns
Combinati

ories
(2) Prepaid
Expenses

ons

Probability

ACCUMULAT
ED LOSSES

Theory
of
Expectatio
n
(Random
Variable)

1)
Miscellaneous
Expenses
87,00,
000

87,00,0
00

We may not be able to derive the extracted information such as Working Capital,
Net Assets, Total Capital Employed, Share Holders Net Worth, Equity Share
Holders Net Worth, Non-Assets (Asset side items not to be considered as fixed
assets) straight away from the balance sheet.
If we need them, we may have to derive them using the figures available in the
Balance Sheet.

Balance Sheet with previous period figures

A balance sheet with the figures pertaining to the previous period
enables us to have an understanding on the position of the business as
on the date of preparation of the balance sheet as well as the date of
the previous balance sheet.
Balance Sheet of M/s ___ as on 31st March 2007
LIABILITIES
Amo
unt
(Prev
ious)

Particulars

12,00 EQUITY SHARE

,000 CAPITAL

7,00,0
PREFERENCE
00
SHARE CAPITAL

ASSETS
Amo Amo
Amo
Amo unt
unt Particular Amo unt
unt (Curr (Prev
s
unt (Curr
ent) ious)
ent)

8,00,0 15,00 37,00

00 ,000 ,000
6,00,0
9,00,0 28,00,
00
00
000
9,00,0
00

FIXED
ASSETS

8,00,0 45,00
00 ,000
13,00,
(1)
36,00,
000
Goodwill at
000
14,00,
Cost
000

Exam
Papers/Ans
wers
CA CPT
CA PE-II
CA PCC
CA Final
CWA
Foundatio
n
CWA
Inter
CWA
Final
CS
Foundatio
n
CS Inter
CS Final

8,00,0 23,00, 7,00,0 (2) Land

00
000
00 and
Buildings
a) P/L
8,00,0
(3) Plant
Appropriation a/c
00 16,00,
and
b) Share
000
Machinery
Premium
11,00,
(4)
e) General
000 24,00,
Furniture
Reserve
4,00,0 000
and
00
LONG TERM
Fittings
2,50,0
LIABILITIES
(7)
00
Investment
1,00,0
(1) Loans from
s
Banks
00
CURRENT
(2) Debentures
3,00,0
ASSETS
00
CURRENT
2,50,0
LIABILITIES/PRO
A. LIQUID
00
VISIONS
ASSETS

20,00, RESERVES
000
15,00,
000
18,00,
000

(1) Sundry
Creditors
(2) Bills Payable
(3) Bank
Overdraft
(4) Outstanding
Expenses
(7) Provision for
Taxation
(8) Provision for
Dividends

(1) Cash
Balance
(2) Bills
Receivable
(3) Sundry
debtors
Less: Bad
Debt
Reserve

B. OTHER
CURRENT
ASSETS
(1)
Stocks/Inve
ntories
(2) Prepaid
Expenses

ACCUMUL
ATED

6,00,0 6,00,0
00
00
4,00,0
00
78,000
8,25,0
00
12,25,
000
(12,00
0)
12,00,
000
2,84,0
00

LOSSES
1)
Miscellane
ous
Expenses
72,00
,000

87,00 72,00
,000 ,000

87,00
,000

In addition to providing all the information pertaining to the current period, this
would also enable us to compare the current period figures to the previous period
figures and have a comparative evaluation with respect to all the information that
we can derive from the Balance Sheet.
This also gives rise to a possibility to compare the extracted information such as
Working Capital, Net Assets, Total Capital Employed, Share Holders Net Worth,
Equity Share Holders Net Worth, Non-Assets (Asset side items not to be
considered as fixed assets) pertaining to the two periods.

Limitation - Absence of information relating to

Flow
The data relating to two different balance sheets, enables us to assess
the quantum (amount) of change over the two periods (as shown in the
following statement).

Item

Equity Share
Capital
Preference Share
Capital
Reserves
Long Term
Liabilities
Fixed Assets
Accumulated
Losses

Natu
re

Liabili
ty
Liabili
ty
Liabili
ty
Liabili
ty
Asset
s
Asset

Amount
Previous
Period
12,00,000
7,00,000
20,00,000
15,00,000
37,00,000
7,00,000

Amount
Current
Period
15,00,000
9,00,000
23,00,000
16,00,000
45,00,000
6,00,000

Chang Natur
e
e

3,00,0
00
2,00,0
00
3,00,0
00
1,00,0
00
8,00,0
00
1,00,0

Increas
e
Increas
e
Increas
e
Increas
e
Increas
e
Decrea

00

se

The above information on its own is useful to a limited extent. It helps in

understanding what changes have occurred over the two balance sheets and to what
quantum.
There is one another important information that can be derived from this
information and that is relating to Flow of Funds.

What is Funds Flow?

Flow
Meaning
i.

To move or run smoothly with unbroken continuity like in the case

of a fluid.

ii.

Something that resembles a flowing stream in moving

continuously

Synonyms = Stream, Gush, Course

Funds Flow
By Funds flow (in accounting and financial management) we mean the
flow in relation to the various items that form part of the Fund Area in a
Balance Sheet. The Funds Flow explains how the values changed from
the initial figure to the final figure between the two balance sheet dates.
Flow is between two points and the two points in a Funds Flow Analysis
are the beginning and the ending dates as indicated by the two balance
sheets.

The flow (changes) is interpreted in two directions/ways. Funds flowing in and

flowing out of the organisation

Inflow (Or) Source of Fund

Where the change in the value of a Fund Account (Asset or Liability)
results in the availability of additional funds we say there is an inflow of

fund and the change forms the source of fund. The source of fund is an
explanation for how we are getting the funds.

Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits

A Decrease in the value of a Fund Asset

Fixed Assets

Accumulated Losses

Outflow (Or) Application of Fund

Where the change in the value of a Fund Account (Asset or Liability)
results in the reduction of available funds, we say there is an outflow of
fund and the change forms the application of fund. The application of
fund is an explanation for how we are utilising the funds.

Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Asset

Fixed Assets

Accumulated Losses

A Decrease in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits

The changes as revealed by the balance sheets of the two periods would be

Item

Equity Share
Capital
Preference
Share Capital
Reserves
Long Term
Liabilities
Fixed Assets
Accumulated
Losses

Amount
Previous
Period

Amount
Current
Period

12,00,000
7,00,000
20,00,000
15,00,000
37,00,000
7,00,000

15,00,000
9,00,000
23,00,000
16,00,000
45,00,000
6,00,000

Chang
e

3,00,0
00
2,00,0
00
3,00,0
00
1,00,0
00
8,00,0
00
1,00,0
00

Nature

Liability Increase
Liability Increase
Liability Increase
Liability Increase
Asset Increase
Asset Decrease

Resul
t

Inflow
Inflow
Inflow
Inflow
Outflo
w
Inflow

Decrease in Accumulated Losses - Inflow !!

Consider this explanation based on the logic that a decrease in fund
assets would result in an inflow of funds. This results in an inflow of
funds which are a part of Funds From Operations about which we will
learn in the subsequent notes.

Funds Flow Statement

A statement presenting the information relating to the inflow and

outflow of funds or the sources and applications of funds is what is
called a Funds Flow Statement.

The Funds flow statement is presented in two different forms (a) As a Statement
and (b) in 'T' form.

As a Statement
Funds Flow Statement for the period from __ to __
Particulars

Amount

Amount

3,00,000
2,00,000
3,00,000
1,00,000
1,00,000

10,00,000

8,00,000

8,00,000

SOURCES (INFLOW) of FUNDS :

1)
2)
3)
4)
5)

Equity Share Capital

Preference Share Capital
Reserves
Long Term Liabilities
Accumulated Losses

Less: APPLICATIONS (OUTFLOW) of FUNDS

1) Fixed Assets
Change in Working Capital

+ 2,00,000

Since the Change is positive, there is a Net increase in Working Capital

In a T Form
Statement of Sources and Applications of Funds for the period
from __ to __

Sources of Funds
(Inflow)

Equity Share Capital

Preference Share Capital
Reserves

Amount

3,00,000
2,00,000
3,00,000

Applications of
Funds
(Outflow)
Fixed Assets

Amount

8,00,000

Long Term Liabilities

Accumulated Losses

1,00,000
1,00,000
10,00,00
0

Change in Working
Capital

8,00,000

2,00,000

Since the Sources/Inflows are more, there is a Net increase in Working Capital
This statement is identified using different titles as

Funds Flow Statement

Statement of Sources and Applications of Funds

Note
Sources/Inflow Applications/Outflow = Change in Working Capital How?. Please read the following page.
Author Credit : The Edifier

... Continued Page 5

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Funds Flow
By Funds flow (in accounting and financial management) we mean the flow in relation to the
various items that form part of the Fund Area in a Balance Sheet. The Funds Flow explains how
the values changed from the initial figure to the final figure between the two balance sheet dates.
Flow is between two points and the two points in a Funds Flow Analysis are the beginning and
the ending dates as indicated by the two balance sheets.
The flow (changes) is interpreted in two directions/ways. Funds flowing in and flowing out of
the organization.

1. Inflow (Or) Source of Fund

Where the change in the value of a Fund Account (Asset or Liability) results in the availability of
additional funds we say there is an inflow of fund and the change forms the source of fund. The
source of fund is an explanation for how we are getting the funds.

Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits

A Decrease in the value of a Fund Asset

Fixed Assets

Accumulated Losses

2. Outflow (Or) Application of Fund

Where the change in the value of a Fund Account (Asset or Liability) results in the reduction of
available funds, we say there is an outflow of fund and the change forms the application of fund.
The application of fund is an explanation for how we are utilising the funds.
Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Asset

Fixed Assets

Accumulated Losses

A Decrease in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits