Basic concepts of finanacial accounting

MEANING OF ACCOUNTING:

Accounting is the process of recording, classifying, summarizing, analyzing and interpreting the
financial transactions of the business for the benefit of management and those parties who are
interested in business such as shareholders, creditors, bankers, customers, employees and
government. Thus, it is concerned with financial reporting and decision making aspects of the
business.

The American Institute of Certified Public Accountants Committee on Terminology proposed in

1941 that accounting may be defined as, The art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events which are, in part at least, of a
financial character and interpreting the results thereof.

FINANCIAL ACCOUNTING:

The term Accounting unless otherwise specifically stated always refers to Financial
Accounting. Financial Accounting is commonly carries on in the general offices of a business. It
is concerned with revenues, expenses, assets and liabilities of a business house. Financial
Accounting has two-fold objective, viz,

To ascertain the profitability of the business, and

To know the financial position of the concern.

NATURE AND SCOPE OF FINANCIAL ACCOUNTING:

Financial accounting is a useful tool to management and to external users such as shareholders,
potential owners, creditors, customers, employees and government. It provides information
regarding the results of its operations and the financial status of the business. The following are
the functional areas of financial accounting:-

Dealing with financial transactions: Accounting as a process deals only with those
transactions which are measurable interms of money. Anything which cannot be
expressed in monetary terms does notform part of financial accounting however
significant it is.
Recording of information: Accounting is an art of recording financial transactions of a
business concern. Thereis a limitation for human memory. It is not possible to remember
all transactions ofthe business. Therefore, the information is recorded in a set of books
called Journaland other subsidiary books and it is useful for management in its decision
making process.
 Classification of Data: The recorded data is arranged in a manner so as to group the
transactions of similar nature at one place so that full information of these items may be
collected under different heads. This is done in the book called Ledger. For example,
we may have accounts called Salaries, Rent, Interest, Advertisement, etc. To verify
the arithmetical accuracy of such accounts, trial balance is prepared.
Making Summaries: The classified information of the trial balance is used to prepare
profit and loss account and balance sheet in a manner useful to the users of accounting
information. The final accounts are prepared to find out operational efficiency and
financial strength of the business.
Analyzing: It is the process of establishing the relationship between the items of the
profit andloss account and the balance sheet. The purpose is to identify the financial
strength and weakness of the business. It also provides a basis for interpretation.
Interpreting the financial information: It is concerned with explaining the meaning
and significance of the relationshipestablished by the analysis. It should be useful to the
users, so as to enable them totake correct decisions.
Communicating the results: The profitability and financial position of the business as
interpreted above arecommunicated to the interested parties at regular intervals so as to
assist them tomake their own conclusions.

LIMITATIONS OF FINANCIAL ACCOUNTING:

Financial accounting is concerned with the preparation of final accounts. The business has
become so complex that mere final accounts are not sufficient in meeting financial needs.
Financial accounting is like a post-mortem report. At the most it can reveal what has happened
so far, but it cannot exercise any control over the past happenings. The limitations of financial
accounting are as follows:-

1. It records only quantitative information.

2. It records only the historical cost. The impact of future uncertainties has no place in
financial accounting.
3. It does not take into account price level changes.
4. It provides information about the whole concern. Product-wise, process-wise,
department-wise or information of any other line of activity cannot be obtained separately
from the financial accounting.
5. Cost figures are not known in advance. Therefore, it is not possible to fix the price in
advance. It does not provide information to increase or reduce the selling price.
6. As there is no technique for comparing the actual performance with that of the budgeted
targets, it is not possible to evaluate performance of the business.
7. It does not tell about the optimum or otherwise of the quantum of profit made and does
not provide the ways and means to increase the profits.
8. In case of loss, whether loss can be reduced or converted into profit by means of cost
control and cost reduction? Financial accounting does not answer this question.
9. It does not reveal which departments are performing well? Which ones are incurring
losses and how much is the loss in each case?
10. It does not provide the cost of products manufactured
11. There is no means provided by financial accounting to reduce the wastage.
 12. Can the expenses be reduced which results in the reduction of product cost and if so, to
what extent and how? No answer to these questions.
13. It is not helpful to the management in taking strategic decisions like replacement of
assets, introduction of new products, discontinuation of an existing line, expansion of
capacity, etc.
14. It provides ample scope for manipulation like overvaluation or undervaluation. This
possibility of manipulation reduces the reliability.
15. It is technical in nature. A person not conversant with accounting has little utility of the
financial accounts.

Role and duties of management accountant

Management Accountant is an officer who is entrusted with Management Accounting function of

an organization. He plays a significant role in the decision making process of an organization.
The organizational position of Management Accountant varies from concern to concern
depending upon the pattern of management system. He may be an executive in some concern,
while a member of Board of Directors in case of some other concern. However, he occupies a
key position in the organization. In large concerns, he is responsible for the installation,
development and efficient functioning of the management accounting system. He designs the
frame work of the financial and cost control reports that provide with the most useful data at the
most appropriate time. The Management Accountant sometimes described as Chief Intelligence
Officer because apart from top management, no one in the organization perhaps knows more
about various functions of the organization than him. Tandon has explained the position of
Management Accountant as follows:

The management accountant is exactly like the spokes in a wheel, connecting the rim of the
wheel and the hub receiving the information. He processes the information and then returns the
processed information back to where it came from.

Recommended reading: Basic concepts of management accounting

Role of Management Accountant

Management Accountant, otherwise called Controller, is considered to be a part of the

management team since he has the responsibility for collecting vital information, both from
within and outside the company. The functions of the controller have been laid down by the
Controllers Institute of America. These functions are:

To establish, coordinate and administer, as an integral part of management, an adequate

plan for the control of operations. Such a plan would provide, to the extent required in the
business cost standards, expense budgets, sales forecasts, profit planning, and programme
for capital investment and financing, together with necessary procedures to effectuate the
plan.
To compare performance with operating plan and standards and to report and interpret
the results of operation to all levels of management, and to the owners of the business.
 This function includes the formulation and administration of accounting policy and the
compilations of statistical records and special reposts as required.
To consult withal segments of management responsible for policy or action conserving
any phase of the operations of business as it relates to the attainment of objective, and the
effectiveness of policies, organization strictures, procedures.
To administer tax policies and procedures.
To supervise and coordinate preparation of reports to Government agencies.
The assured fiscal protection for the assets of the business through adequate internal;
control and proper insurance coverage.
To continuously appraise economic and social forces and government influences, and
interpret their effect upon business.

Duties and Responsibilities of Management Accountant

The primary duty of Management Accountant is to help management in taking correct policy-
decisions and improving the efficiency of operations. He performs a staff function and also has
line authority over the accountants. If management accountant feels that a decision likely to be
taken by the management based on the information tendered by him shall be detrimental to the
interest of the concern, he should point out this fact to the concerned management, of course,
with tact, patience, firmness and politeness. On the other hand, if the decision taken happens to
be wrong one on account t of inaccuracy, biased and fabricated data furnished by the
management accountant, he shall be held responsible for wrong decision taken by the
management. Controllers Institute of America has defined the following duties of Management
Accountant or controller:

The installation and interpretation of all accounting records of the corporative.

The preparation and interpretation of the financial statements and reports of the
corporation.
Continuous audit of all accounts and records of the corporation wherever located.
The compilation of costs of distribution.
The compilation of production costs.
The taking and costing of all physical inventories.
The preparation and filing of tax returns and to the supervision of all matters relating to
taxes.
The preparation and interpretation of all statistical records and reports of the corporation.
The preparation as budget director, in conjunction with other officers and department
heads, of an annual budget covering all activities of the corporation of submission to the
Board of Directors prior to the beginning of the fiscal year. The authority of the
Controller, with respect to the veto of commitments of expenditures not authorized by the
budget shall, from time to time, be fixed by the board of Directors.
The ascertainment currently that the properties of the corporation are properly and
adequately insured.
The initiation, preparation and issuance of standard practices relating to all accounting,
matters and procedures and the co-ordination of system throughout the corporation
including clerical and office methods, records, reports and procedures.
 The maintenance of adequate records of authorized appropriations and the determination
that all sums expended pursuant there into are properly accounted for.
The ascertainment currently that financial transactions covered by minutes of the Board
of Directors and/ or the Executive committee are properly executed and recorded.
The maintenance of adequate records of all contracts and leases.
The approval for payment(and / or countersigning ) of all cheques, promissory notes and
other negotiable instruments of the corporation which have been signed by the treasurer
or such other officers as shall have been authorized by the by-laws of the corporation or
form time to time designated by the Board of Directors.
The examination of all warrants for the withdrawal of securities from the vaults of the
corporation and the determination that such withdrawals are made in conformity with the
by-laws and /or regulations established from time by the Board of Directors.
The preparation or approval of the regulations or standard practices, required to assure
compliance with orders of regulations issued by duly constituted governmental agencies.

Basic concepts of cost accounting

COST ACCOUNTING:

An accounting system is to make available necessary and accurate information for all those who
are interested in the welfare of the organization. The requirements of majority of them are
satisfied by means of financial accounting. However, the management requires far more detailed
information than what the conventional financial accounting can offer. The focus of the
management lies not in the past but on the future. For a businessman who manufactures goods or
renders services, cost accounting is a useful tool. It was developed on account of limitations of
financial accounting and is the extension of financial accounting. The advent of factory system
gave an impetus to the development of cost accounting.

It is a method of accounting for cost. The process of recording and accounting for all the
elements of cost is called cost accounting.

The Institute of Cost and Works Accountants, London defines costing as, the process of
accounting for cost from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units. In its wider usage it
embraces the preparation of statistical data, the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned.

The Institute of Cost and Works Accountants, India defines cost accounting as, the technique
and process of ascertainment of costs. Cost accounting is the process of accounting for costs,
which begins with recording of expenses or the bases on which they are calculated and ends with
preparation of statistical data. To put it simply, when the accounting process is applied for the
elements of costs (i.e., Materials, Labour and Other expenses), it becomes Cost Accounting.

OBJECTIVES OF COST ACCOUNTING:

Cost accounting was born to fulfill the needs of manufacturing companies. It is a mechanism of
accounting through which costs of goods or services are ascertained and controlled for different
purposes. It helps to ascertain the true cost of every operation, through a close watch, say, cost
analysis and allocation. The main objectives of cost accounting are as follows:-

Cost Ascertainment: The main objective of cost accounting is to find out the cost of
product, process, job, contract, service or any unit of production. It is done through
various methods and techniques.
Cost Control: The very basic function of cost accounting is to control costs. Comparison
of actual cost with standards reveals the discrepancies (Variances). The variances reveal
whether cost is within control or not. Remedial actions are suggested to control the costs
which are not within control.
Cost Reduction: Cost reduction refers to the real and permanent reduction in the unit
cost of goods manufactured or services rendered without affecting the use intended. It can
be done with the help of techniques called budgetary control, standard costing, material
control, labour control and overheads control.
Fixation of Selling Price: The price of any product consists of total cost and the margin
required. Cost data are useful in the determination of selling price or quotations. It
provides detailed information regarding various components of cost. It also provides
information in
terms of fixed cost and variable costs, so that the extent of price reduction can be decided.
Framing business policy: Cost accounting helps management in formulating business
policy and decision making. Break even analysis, cost volume profit relationships,
differential costing, etc are helpful in taking decisions regarding key areas of the
business.

NATURE AND SCOPE OF COST ACCOUNTING:

Cost accounting is concerned with ascertainment and control of costs. The information provided
by cost accounting to the management is helpful for cost control and cost reduction through
functions of planning, decision making and control. Initially, cost accounting confined itself to
cost ascertainment and presentation of the same mainly to find out product cost. With the
introduction of large scale production, the scope of cost accounting was widened and providing
information for cost control and cost reduction has assumed equal significance along with
finding out cost of production. To start with cost accounting was applied in manufacturing
activities but now it is applied in service organizations, government organizations, local
authorities, agricultural farms, extractive industries and so on.

Cost accounting guides for ascertainment of cost of production. Cost accounting discloses
profitable and unprofitable activities. It helps management to eliminate the unprofitable
activities. It provides information for estimate and tenders. It discloses the losses occurring in the
form of idle time spoilage or scrap etc. It also provides a perpetual inventory system. It helps to
make effective control over inventory and for preparation of interim financial statements. It helps
in controlling the cost of production with the help of budgetary control and standard costing.
Cost accounting provides data for future production policies. It discloses the relative efficiencies
of different workers and for fixation of wages to workers.
LIMITATIONS OF COST ACCOUNTING:

It is based on estimation: as cost accounting relies heavily on predetermined data, it is

not reliable.
No uniform procedure in cost accounting: as there is no uniform procedure, with the
same information different results may be arrived by different cost accounts.
Large number of conventions and estimate: There are number of conventions and
estimates in preparing cost records such as materials are issued on an average (or)
standard price, overheads are charged on percentage basis, Therefore, the profits arrived
from the cost records are not true.
Formalities are more: Many formalities are to be observed to obtain the benefit of cost
accounting. Therefore, it is not applicable to small and medium firms.
Expensive: Cost accounting is expensive and requires reconciliation with financial
records.
It is unnecessary: Cost accounting is of recent origin and an enterprise can survive even
without cost accounting.
Secondary data: Cost accounting depends on financial statements for a lot of
information. Any errors or short comings in that information creep into cost accounts
also.

MANAGEMENT ACCOUNTING

Management accounting is not a specific system of accounting. It could be any form of

accounting which enables a business to be conducted more effectively and efficiently. It is
largely concerned with providing economic information to mangers for achieving organizational
goals. It is an extension of the horizon of cost accounting towards newer areas of management.
Much management accounting information is financial in nature but has been organized in a
manner relating directly to the decision on hand.

Management Accounting is comprised of two words Management and Accounting. It means

the study of managerial aspect of accounting. The emphasis of management accounting is to
redesign accounting in such a way that it is helpful to the management in formation of policy,
control of execution and appreciation of effectiveness. Management accounting is of recent
origin. This was first used in 1950 by a team of accountants visiting U. S. A under the auspices
of Anglo-American Council on Productivity.

Anglo-American Council on Productivity defines Management Accounting as, the

presentation of accounting information in such a way as to assist management to the
creation of policy and the day to day operation of an undertaking
The American Accounting Association defines Management Accounting as the methods
and concepts necessary for effective planning for choosing among alternative business
actions and for control through the evaluation and interpretation of performances.
The Institute of Chartered Accountants of India defines Management Accounting as
follows: Such of its techniques and procedures by which accounting mainly seeks to aid
the management collectively has come to be known as management accounting
From these definitions, it is very clear that financial data is recorded, analyzed and presented to
the management in such a way that it becomes useful and helpful in planning and running
business operations more systematically.

OBJECTIVES OF MANAGEMENT ACCOUNTING:

The fundamental objective of management accounting is to enable the management to maximize

profits or minimize losses. The evolution of management accounting has given a new approach
to the function of accounting. The main objectives of management accounting are as follows:

Planning and policy formulation: Planning involves forecasting on the basis of

available information, setting goals; framing polices determining the alternative courses
of action and deciding on the programme of activities. Management accounting can help
greatly in this direction. It facilitates the preparation of statements in the light of past
results and gives estimation for the future.
Interpretation process: Management accounting is to present financial information to
the management. Financial information is technical in nature. Therefore, it must be
presented in such a way that it is easily understood. It presents accounting information
with the help of statistical devices like charts, diagrams, graphs, etc.
Assists in Decision-making process: With the help of various modern techniques
management accounting makes decision-making process more scientific. Data relating to
cost, price, profit and savings for each of the available alternatives are collected and
analyzed and provides a base for taking sound decisions.
Controlling: Management accounting is a useful for managerial control. Management
accounting tools like standard costing and budgetary control are helpful in controlling
performance. Cost control is effected through the use of standard costing and
departmental control is made possible through the use of budgets. Performance of each
and every individual is controlled with the help of management accounting.
Reporting: Management accounting keeps the management fully informed about the
latest position of the concern through reporting. It helps management to take proper and
quick decisions. The performance of various departments is regularly reported to the top
management.
Facilitates Organizing: Return on Capital Employed is one of the tools of
management accounting. Since management accounting stresses more on Responsibility
Centres with a view to control costs and responsibilities, it also facilitates
decentralization to a greater extent. Thus, it is helpful in setting up effective and
efficiently organization framework.
Facilitates Coordination of Operations: Management accounting provides tools for
overall control and coordination of business operations. Budgets are important means of
coordination.

NATURE AND SCOPE OF MANAGEMENT ACCOUNTING:

Management accounting involves furnishing of accounting data to the management for basing its
decisions. It helps in improving efficiency and achieving the organizational goals. The following
paragraphs discuss about the nature of management accounting.
 Provides accounting information: Management accounting is based on accounting
information. Management accounting is a service function and it provides necessary
information to different levels of management. Management accounting involves the
presentation of information in a way it suits managerial needs. The accounting data
collected by accounting department is used for reviewing various policy decisions.
Cause and effect analysis: The role of financial accounting is limited to find out the
ultimate result, i.e., profit and loss; management accounting goes a step further.
Management accounting discusses the cause and effect relationship. The reasons for the
loss are probed and the factors directly influencing the profitability are also studied.
Profits are compared to sales, different expenditures, current assets, interest payables,
share capital, etc.
Use of special techniques and concepts: Management accounting uses special
techniques and concepts according to necessity to make accounting data more useful. The
techniques usually used include financial planning and analyses, standard costing,
budgetary control, marginal costing, project appraisal, control accounting, etc.
Taking important decisions: It supplies necessary information to the management
which may be useful for its decisions. The historical data is studied to see its possible
impact on future decisions. The implications of various decisions are also taken into
account.
Achieving of objectives: Management accounting uses the accounting information in
such a way that it helps in formatting plans and setting up objectives. Comparing actual
performance with targeted figures will give an idea to the management about the
performance of various departments. When there are deviations, corrective measures can
be taken at once with the help of budgetary control and standard costing.
No fixed norms: No specific rules are followed in management accounting as that of
financial accounting. Though the tools are the same, their use differs from concern to
concern. The deriving of conclusions also depends upon the intelligence of the
management accountant. The presentation will be in the way which suits the concern
most.
Increase in efficiency: The purpose of using accounting information is to increase
efficiency of the concern. The performance appraisal will enable the management to pin-
point efficient and inefficient spots. Effort is made to take corrective measures so that
efficiency is improved. The constant review will make the staff cost conscious.
Supplies information and not decision: Management accountant is only to guide and
not to supply decisions. The data is to be used by the management for taking various
decisions. How is the data to be utilized will depend upon the caliber and efficiency of
the management.
Concerned with forecasting: The management accounting is concerned with the future.
It helps the management in planning and forecasting. The historical information is used to
plan future course of action. The information is supplied with the object to guide
management for taking future decisions.

LIMITATIONS OF MANAGEMENT ACCOUNTING:

Management Accounting is in the process of development. Hence, it suffers from all the
limitations of a new discipline. Some of these limitations are:
 Limitations of Accounting Records: Management accounting derives its information
from financial accounting, cost accounting and other records. It is concerned with the
rearrangement or modification of data. The correctness or otherwise of the management
accounting depends upon the correctness of these basic records. The limitations of these
records are also the limitations of management accounting.
It is only a Tool: Management accounting is not an alternate or substitute for
management. It is a mere tool for management. Ultimate decisions are being taken by
management and not by management accounting.
Heavy Cost of Installation: The installation of management accounting system needs a
very elaborate organization. This results in heavy investment which can be afforded only
by big concerns.
Personal Bias: The interpretation of financial information depends upon the capacity of
interpreter as one has to make a personal judgment. Personal prejudices and bias affect
the objectivity of decisions.
Psychological Resistance: The installation of management accounting involves basic
change in organization set up. New rules and regulations are also required to be framed
which affect a number of personnel and hence there is a possibility of resistance from
some or the other.
Evolutionary stage: Management accounting is only in a developmental stage. Its
concepts and conventions are not as exact and established as that of other branches of
accounting. Therefore, its results depend to a very great extent upon the intelligent
interpretation of the data of managerial use.
Provides only Data: Management accounting provides data and not decisions. It only
informs, not prescribes. This limitation should also be kept in mind while using the
techniques of management accounting.
Broad-based Scope: The scope of management accounting is wide and this creates many
difficulties in the implementations process. Management requires information from both
accounting as well as non-accounting sources. It leads to inexactness and subjectivity in
the conclusion obtained through it.

Financial Accounting vs Management Accounting

Financial Accounting and Management Accounting are two interrelated facets of the accounting
system. They are not exclusive of each other; they are supplementary in nature. Financial
accounting provides the basic structure for collecting data. The data collection structure is
suitably modified or adjusted for accumulating information for management accounting
purposes.

In a broader sense, management accounting includes financial accounting. They differ in their
emphasis and approaches. They are as follows:

1. Financial accounting serves the interest of external users (i.e. investors etc.) while
management accounting caters to the needs of internal users (i.e. management).
2. Financial accounting is governed by the generally accepted accounting principles while
management accounting has no set principles.
 3. Financial accounting presents historical information while management accounting
represents predetermined as well as past information.
4. Financial accounting is statutory while management accounting is optional.
5. Financial accounting presents annual reports while management accounting reports are of
both shorter and longer durations.
6. Financial accounting reports cover the entire organization while management accounting
reports are prepared for the organization as well as its segments.
7. Financial accounting emphasizes accuracy of facts while management accounting
requires prompt and timely reporting of facts even if they are less precise.

Focus Financial accounting emphasized the external use of accounting data. Management
accounting, on the other hand, utilizes accounting data for internal uses. The major objective of
financial accounting is to prepare balance sheet and profit and loss account to inform
shareholders and others about the firms profitability and the state of its resources and
obligations. The purpose for which management accounting collects and reports relevant
information is to make decisions to ensure optimum use of the firms resources.

Principles The accounting profession has developed certain principles for preparing and
presenting financial reports for external uses. Financial accounting adheres to these generally
accepted accounting principles. This introduces consistency and meaningfulness of data from the
investors point of view. They can make inter firm comparisons of performance and analyze
performance trend over years when some set of generally accepted principles are followed by all
firms. Management accounting, in contrast, is not based on any set of accepted rules of
principles. Every enterprise, depending on its requirements for facts, evolves its own procedures
and principles for preparing reports for internal uses. The information should be relevant and aid
management in making decisions.

Information Financial accounting accumulates and reports historical information to investors.

Financial accounting reports tell what has happened in the past. Through balance sheet and
profit and loss account, to the investors is revealed the manner in which the resources entrusted
by them to the firm have been utilized. Management accounting being a decision-making
process focuses on the future. It analyses past data and adjusts them in the light of future
expectations to make plans.

Need Financial accounting is an outcome of statute. For example, in India, it is required under
the Companies Act, 1956 to prepare balance sheet and profit and loss account for submission to
shareholders and others. The financial statements are generally required to be prepared in the
formats prescribed by the law. Management accounting is the result of the managements need of
information for making decisions. It is, therefore, optional. Management accounting functions
would differ from firm to firm. A firm may have a sophisticated, elaborate and comprehensive
system while another may have a partial system only.

Timing Financial accounting adopts twelve months (one Year) period for reporting financial
performance to shareholders and other investors. In contrast, management accounting reports are
for shorter durations. Some companies in India prepare daily budgets. Monthly and quarterly
reports are quite common. Management accounting information is also collect ed for preparing
long term plans for five or more years. Capital expenditure plans, for example, cover a longer
duration.

Coverage While reporting the state of affairs of a company, financial accounting covers the
entire organization. Financial statements show revenues, expenses, assets and equities of the
firm as whole. For management accounting purposes, however, organization is divided into
smaller units, or centers. These centers may be headed by responsible persons. Cost date and
other information are collected and reported by these centers. Thus, data requirements of
management accounting are more specific.

Reporting Financial statements-balance sheet and profit and loss account are subject to the
verification of statutory audit. Therefore, financial accounting stresses accuracy and precision of
accounting data. Management accounting requires information promptly for decision-
making. Continuous and speedy flow of approximate information is more useful than the
precise, but delayed information.

ACCOUNTING CONCEPT
Accounting Concept defines the assumptions on the basis of which Financial Statements of
a business entity are prepared. Certain concepts are received assumed and accepted in accounting
to provide a unifying structure and internal logic to accounting process. The word concept means
idea or nation, which has universal application. Financial transactions are interpreted in the light
of the concepts, which govern accounting methods. Concepts are those basis assumption and
conditions, which form the basis upon which the accountancy has been laid. Unlike physical
science, Accounting concepts are only results of broad consensus. These accounting concepts lay
the foundation on the basis of which the accounting principals are formulated.
Now we shall study in detail the various concept on which accounting is based. The
following are the widely accepted accounting concepts.

1.) Entity Concept:- Entity Concept says that business enterprises is a separate identity apart
from its owner. Business transactions are recorded in the business books of accounts and owners
transactions in this personal back of accounts. The concept of accounting entity for every
business or what is to be excluded from the business books. Therefore, whenever business
received cash from the proprietor, cash a/c is debited as business received cash and capital/c is
credited. So the concept of separate entity is applicable to all forms of business organization.

2.) Money Measurement Concept:- As per this concept, only those transactions, which can
be measured in terms of money are recorded. Since money in the medium of exchange and the
standard of economic value, this concept requires that these transactions alone that are capable of
being measured in terms of money be only to be recorded in the books of accounts. For example,
health condition of the chairman of the company, working conditions of the workers, sale policy
ect. do not find place in accounting because it is not measured in terms of money.
3.) Cost Concept:- By this concept, the value of assets is to be determined on the basic of
historical cost. Transaction are entered in the books of accounts at the amount actually involved.
For example a machine purchased for Rs. 80000 and may consider it worth Rs. 100000, But the
entry in the books of account will be made with Rs. 80000 or the amount actually paid. The cost
concept does not mean that the assets will always be shown at cost. The assets may be recorded
at the time of purchase but it may be reduced its value be charging depreciation.
Many assets de not have acquisition cost. Human assets of an enterprises are an example.
The cost concept fails to recognize such assets although it is a very important assets of any
organization.

4.) Going Concern Concept:- According to this concept the financial statements are normally
prepared on the assumption that an enterprises is a going concern and will continue in operation
for the foreseeable future. Transaction are therefore recorded in such a manner that the benefits
likely to accrue in future from money spent. It is because of this concept that fixed assets are
recorded at their original cost and depreciation in a systematic manner without reference to their
current realizable value.

5.) Dual aspect Concept:- This concept is the care of double entry book-keeping. Every
transaction or event has two aspect. If any event occurs, it is bound to have two effect. For
Rs.50000, on the other hand stock will increase by Rs.50000 and other liability will increase by
Rs.50000. similarly is X starts a business with a capital of Rs. 50000, while on the other hand the
business has to pay Rs. 50000 to the proprietor which is taken as proprietors Capital.

6.) Realization Concept: - It closely follows the cost concept any change in value of assets is
to be recorded only when the business realize it. i.e. either cash has been received or a legal
obligation to pay has been assumed by the customer. No Sale can be said to have taken place and
no profit can be said to have arisen. It prevents business firm from inflating their profit by
recording sale and income that are likely to accrue, i.e. expected income or gain are not recorded.

7.) Accrual Concept:- Under accrual concept the effect of transaction and other events are
recognized on mercantile basic. When they accrue and not as cash or a cash equivalent is
received or paid and they are recorded in the accounting record and reported in the financial
statements of the periods to which they relate financial statement prepared on the accrual basic
inform users not only of past events involving the payment and receipt of cash but also of
obligation to pay cash in the future and of resources that represent cash to be received in the
future. For Example:- Mr. Raj buy clothing of Rs. 50000,a paying cash Rs. 20000 and sells at Rs.
60000 of which customer paid only Rs. 40000. So his revenue is Rs. 60000, not Rs. 40000 cash
received. Exp. Or Cash is Rs. 50000, not Rs. 20000 cash paid. So the accrual concept based
profit is Rs. 10000 (Revenue- Exp.)
8.) Accounting Period Concept:- This is also called the concept of definite periodicity
concept as per going concept on indefinite life of the entity is assumed for a business entity it
causes inconvenience to measure performance achieved by the entity in the ordinary causes of
business. Therefore, a small but workable fraction of time is chosen out of infinite life cycle of
the business entity for measure the performance and loading at the financial position 12 months
period is normally adopted for this purpose accounting to this concept accounts should be
prepared after every period & not t the end of the life of the entity. Usually this period is one
calendar year. In India we follow from 1st April of a year to 31st March of the immediately
following years. Now a day because of the need of management, final accounts are prepared at
shoter intervals of quarter year or in some cases a month such accounts are know a interim
account.

9.) Matching Concept:- In this concept, all exp. Matched with the revenue of that period
should only be taken into consideration. In the financial statements of the organization. If any
revenue is recognized that exp. Related to earn that revenue should also be recognized. This
concept as it considers the occurrence of exp. And income and do not concentrate on actual
inflow or outflow of cash. This leads to adjustment of certain items like prepaid and outstanding
expenses, unearned or accrued income.
It is not necessary that every exp. Identity every income. Some exp. Are directly related to
the revenue and some are directly related to sale but rent, salaries etc. are recorded on accrual
basis for a particular accounting period. In other words periodicity concept has also been
followed while applying matching concept.

10.) Objective Concept:- As per this concept, all accounting must be based on objective
evidence. In other words, the transactions recorded should be supported by verifiable documents.
Only than auditors can verify information record as true or otherwise. The evidence should not
be biased. It is for this reasons that assets are recorded at historical cost and shown thereafter at
historical lass depreciation. If the assets are shown on replacement cost basis, the objectivity is
lost and it become difficult for auditors to verify such value, however, in resent year replacement
cost are used for specific purpose as only they represent relevant costs. For example, to find out
intrinsic value of share, we need replacement cost of assets and not the historical cost of the
assets.
 ACCOUNTING CONVENTIONS
The term Accounting Conventions refers to the customs or traditions which are used as a
guide in the preparation of accounting reports and statements. The conventions are derived by
usage and practice. The accountancy bodies of the world may charge any of the convention to
improve the quality of accounting information accounting conventions need not have universal
application. Following are important accounting conventions in use:

1.) Convention of consistency:- According to this convention the accounting practices should
remain unchanged from one period to another. It requires that working rules once chosen should
not be changed arbitrarily and without notice of the effect of change to those who use the
accounts. For example, stock should be valued in the same manner every year. Similarly
depreciation is charged on fixed assets on the same method year after year. If this assumption is
not followed, the fact should be disclosed together with reasons.
The principle of consistency plays its role particularly when alternative accounting methods
is equally acceptable. Any change from one method to another method would result in
inconsistency; they may seem to be inconsistent apparently. In case of valuation of stocks if the
company applies the principle at cost or market price whichever is less and if this principle
accordingly result in the valuation of stock in one year at cost and the market price in the other
year, there is no inconsistency here. It is only an application of the principle.
An Enterprise should change its accounting policy in any of the following circumstances
only.
(i) To bring the books of accounts in accordance with the issued accounting standard.
(ii) To compliance with the provision of law.
(iii) When under changed circumstances it is felt that new method will reflect more true and
fair picture in the financial statement.

2.) Convention of Conservatism:- This is the policy of playing sale game. It takes into
consideration all prospective losses but leaves all prospective profits financial statements are
usually drawn up on a conservative basis anticipated profit are ignored but anticipated losses are
taken into account while drawing the statements following are the examples of the application of
the convention of conservatism.
(i) Making the provision for doubtful debts and discount on debtors.
(ii) Valuation of the stock at cost price or market price which ever is less.
(iii)Charging of small capital items, like crockery to revenue.
(iv) Showing joint life policy at surrender value as against the actual amount paid.
(v) Not providing for discount on creditors.

3.) Convention of Disclosure:- Apart from statutory requirement, good accounting practice
also demands that significant information should be disclosed in financial statements. Such
disclosures can also be made through footnotes. The purpose of this convention is to
communicate all material and relevant facts concerning financial position and results of
operations to the users. The contents of balance sheet and profit and loss account are prescribed
by law. These are designed to make disclosures of all materials facts compulsory. The practice of
appending notes relative to various facts and items which do not find place in accounting
statements is in pursuance to the convention of full disclosure of material facts. For example;
(a) Contingent liability appearing as a note.
(b) Market value of investments appearing as a note.
The convention of disclosure also applies to events occurring after the balance sheet date
and the date on which the financial statement are authorized for issue. Such events include bad
debts, destruction of plant and equipment due to natural calamities, major acquisition of another
enterprises, etc. such events are likely to have a substantial influence on the earnings and
financial position of the enterprises. Their not-disclosure would affect the ability of the users for
evaluations and decisions.

4.) Convention of Materiality:- According to this conventions, the accountant should attach
importance to material detail and ignore insignificant details in the financial statement. In
materiality principle, all the items having significant economics effect on the business of the
enterprises should be disclosed in the financial statement.
The term materiality is the subjective term. It is on the judgment, common sense and
discretion of the accountant that which item is material and which is not. For example stationery
purchased by the organization though not used fully in the concept. Similarly depreciation small
items like books, calculator is taken as 100% in the year if purchase through used by company
for more than one year. This is because the amount of books or calculator is very small to be
shown in the balance sheet. It is the assets of the company.

JOURNAL
Introduction:- The word Journal means a daily record. Journal is derived from French word
Jour which means a day. It is a book of original or prime entry written up from the various
sources documents. Every transaction is recorded in the first instance and than it is posted to the
ledger. The form in which it is recorded is called journal entry and recording or entering a
transaction in the journal is known as Journalizing.

Rules of Journalizing:- The process of passing an entry in a journal is called Journalizing. The
rule for Journalizing is same as that of rules of debit and credit. It is based on two facts. First is
accounting equation and other is accounting approach.
1.) Based on Accounting Equation:-
a) Increases in assets are debits, decreases are credit.
b) Increased in liability are credit, decreases are debits.
c) Increases in capital are credits, decreases are debits.
d) Increases in profits are credits, decreases are debits.
 e) Increases in expenses are debits, decreases are credits.

2.) Based on Traditional Approach:-

a) Debit the receiver, credit the giver
b) Debit what comes in, credit what goes out.
c) Debit all expenses and losses, credit all income and gains.

TRIAL BALANCE

We know that the fundamental principle of Double Entry System id

accounting is that for every debit, there must be a corresponding credit, thus, for
every debit or a series of debits given to one or several accounts, there is a
corresponding credit or a series of credit of n equal amount given to some other
account or accounts and vice versa. It follows, therefore, that the sum total of debit
accounts should equal the credit amounts of the ledger at any date. But if the
various accounts in the ledger are balanced, then the total of all debit balance must
be equal to the total of all credit balances if the books of accounts are
arithmetically accurate.
Thus, at the end of the financial year o at any other time, the balances of all
the ledger accounts are extracted and are written up in a statement known as Trial
Balance and finally totaled up to see if the total of debit balances is equal to the
total of credit balances. A Trail Balance may thus be defined as a statement of
debit and credit totals or balance extracted from the various accounts in the ledger
with a view to test the arithmetical accuracy of the books.
The agreement of the Trial Balance reveals that both the aspects of each
transaction have been recorded and that the books are arithmetically accurate. If
the Trial Balance does not agree, it shows that there are some errors which must be
detected and rectified link between the ledger accounts and the final accounts.
OBJECTIVES OF TRIAL BALANCE
The following are the main objectives of preparing the trial balance:
(i) To have balances of all the accounts of the ledger in order to avoid the
necessity of going through the pages of the ledger to find it out.
(ii) To have a proof that the double entry of each transaction has been recorded
because of its agreement.
(iii) To have arithmetic accuracy of the books of accounts because of the
agreement of the trial balance.
 (iv) To have material for preparing the profit and loss account and balance sheet
of the business.

LIMITATIONS OF TRIAL BALANCE

The following are the main limitations of the trial balance:
(i) Trial balance can be prepared only in those concerns where double entry
system of accounting is adopted. This system is very costly and cannot be
adopted by the small concerns.
(ii) Through trial balance gives arithmetic accuracy of the books of accounts but
there are certain errors which are not disclosed by the trial balance. That is
why it is said that trial balance is not a conclusive proof of the accuracy of
the books of accounts.
(iii) If Trial Balance is not prepared correctly then the final accounts prepared will
not reflect the true and fair view of the state of affairs of the business.
Whatever conclusions and decisions are made by the various groups of
persons will not be correct and will mislead such persons.

ERROR DISCLOSED BY TRIAL BALANCE

It the two sides of a trial balance are not equal, it is the proof of the existence
of error. There may, of course, be more than one error.
The main reasons of such errors are given below;
1.) An item omitted to be posted from a subsidiary book into the ledger i.e., A
purchase of Rs.1000 from Navin omitted to be credited to his account. As a
result of this error, the figure of sundry creditors to be shown in the Trial
Balance will reduce by Rs.1000 and the total of the credit side of the Trial
Balance will b Rs.1000 less as compared to the debit side of the Trial Balance.
2.) Posting of wrong amount to a ledger account i.e., A Credit sale of Rs. 2000 to
Aarti wrongly posted to her account as Rs.200. the effect of this error will be
that the figure of sundry debtors will be reduced by Rs.1800 and the total of
the debit side of the Trial Balance will be Rs.1800 Less than the total of the
credit side of the Trial Balance.
3.) Posting an amount to the wrong side of the ledger account i.e., Rs.50 Discount
allowed to a Customer wrongly posted to the credit instead of the debit side of
the discount account. As a result to this error, the credit side of the Trial
Balance will exceed by Rs.100 (double the amount of the error).
4.) Wrong additions or balancing of ledger accounts i.e., while Balancing Capital
account at the end of the financial year, credit balance of Rs.89000 wrongly
taken as Rs.79000. as a result of this error, the credit total of the Trial Balance
will Rs.10000 too short.
5.) Wrong totaling of subsidiary books i.e., Sales Book is overcast by Rs.10 as
result of this error, credit side of the Trial balance will be Rs.10 too much
because sales account will appear at a higher figure on the credit side of the
Trial Balance.
6.) An item in the subsidiary book posted twice to a ledger account i.e., Payment
of Rs.1000 to a creditor posted twice to his account.
7.) Omission of Balance of an account in the Trial Balance Cash and Bank
Balance may have been omitted to be included in the Trial Balance.
8.) Balance of Some account wrongly entered in the Trial Balance i.e., A Balance
of Rs. 513 in Stationery Account wrong entered as Rs.315in the Trial balance.
9.) Balance of some account written to the wrong side of the Trial Balance i.e.,
Balance of Commission earned account wrongly shown to the side instead of
the credit side of the Trial Balance.
10.) An error in the Totaling of the Trial Balance will bring the disagreement of
the Trial Balance.

ERROR NOT DISCLOSED BY A TRIAL BALANCE

It is certain that the error exists of the debits of trial balance are not equal to
its credits. But the fact that trial balance is in balance does not prove the
accuracy of accounts. There is a possibility of mistakes which will not upset
the equilibrium of the equality of debits and credits and thus is a proof only of
arithmetic accuracy of posting.
The following are the cases of such error which are not disclosed by a trail
balance:
1.) Omission of an entry in a subsidiary book:- if an entry has not been
recorded in a subsidiary book both the debit and credit of that transaction
would be omitted and the agreement of the trial balance will not be affected in
any way.
2.) A wrong entry in a subsidiary book:- If a Credit purchase of Rs.465 from
Annu is Wrongly written as Rs.564 in the Purchase book, such an error will
not be disclosed by the trial balance. As the posting on both the debit side of
 purchases account and credit side annus account will be with the wrong
amount of Rs.564, so the trial balance will agree.
3.) Posting an item to the correct side but in the wrong account:- If a purchase
of Rs.500 from Vasant Desai has been credited to Himanshu Desai in stead of
Vasant Desai, it will not affect the agreement of the Trial Balance, so the Trial
Balance will not detect such an error.
4.) Compensating error:- These are errors which compensate themselves in the
net result, i.e., over-debits or under-debits of various accounts being
neutralized by the over-credits or under-credits to the same extent of some
other accounts. For example under-posting of Rs.500 on the debit side of a
certain account would be compensated by under-posting of Rs.100 on the
credit side of another account and an omission of credit posting of Rs.400 to a
third account. It is quite possible that this error may also be neutralized by
over-posting of Rs.500 on the debit side in some other account or accounts or
accounts.
5.) Errors of Principle:- These errors will not affect the agreement of the trial
balance as they arise from the debiting or crediting of wrong heads of
accounts as would be inconsistent with the fundamental principles of double
entry accounting. For Example Rs.6550 spent in extension of building
wrongly debited to repairs account instead of building account will not affect
the agreement of the Trial balance. Thus, such errors arise whenever an asset
is treated as an expense or vise versa or a liability is treated as an income or
vise versa.

METHOD OF PREPARATION OF TRIAL BALANCE

Preparation of Trial Balance is the third step in accounting process. It is
preceded by recording of transaction in subsidiary nooks and posting of the
accounts in the ledger, and succeeded by preparation of final accounts.
A Trial Balance can be prepared at ant time as and when desired, but it must
be prepared at the end of each financial year after the accounts have been
closed. There are three methods of preparing the Trial balance.

1. TOTAL METHOD:-Under this method, every ledger account is totaled and

that total amount (both of debit side and credit side) is transferred to trial
balance. In this method, trial balance can be prepared as soon as ledger
 account is totaled. Time taken to balance the ledger accounts is saved under
this method as balance can be found out in the trial balance itself. The
difference of totals of each ledger account is the balance of that particular
account. This method is no commonly used as it cannot help in the preparation
of the financial statements.
2. BALANCE METHOD:- Under this method every ledger account is balanced
and those balances only are carry forward to the trial balance. This method is
used commonly by the accountants and helps in the preparation of the
financial statements. Financial statements are prepared on the basis of the
balance of the ledger accounts.
3. TOTAL AND BALANCE METHOD:- Under this method, the above two
explained methods are combined. Under this method statement of trial balance
contains seven columns instead of five columns. This has been explained with
the help of the following example:
S.No. Heads of Account Debit Total Credit Total
1. Cash Account 30000 19800
2. Furniture Account 3000
3. Salaries Account 2500
4. Shyams Account 21500 25000
5. Purchase Account 26000
6. Purchase Return Account 500
7. Rams Account 30000 25100
8. Sales Account 30500
9. Sale Return Account 100
10. Capital Account 500 1000
11. Bank Account 5000 8200
TOTAL

119100 191100