ACCOUNTING Evolution: Accounting can be traced back to the evolution of the number system itself.

It has been there in one form or the other, since the human beings started exchanging things. In ancient times the kings or monarchs used to maintain treasury records. They used to keep records of the incomes and expenses to the treasury. However, the real beginning can be traced to the reference to double entry system in the book published about 500 years ago. It was the great Italian Mathematician, Luca Pacioli, who authored the book and got it published in 1494. Every transaction has two aspects. The double entry system provides for recording both aspects of a transaction in such a manner as to establish an equilibrium. Barter System: A system, in which goods are exchanged for goods, is called Barter System. For example, A to A has some surplus wheat and he wants to have a goat. A to B has some goats and he wants some wheat. Now, when they meet, the wheat is exchanged for goat .This is called Barter. This system of exchange was prevailing before the invention of money. Money: In order to overcome the limitations of barter system the money was invented. Money is a medium of exchange. In ancient times a piece of leather served as money. Later, gold coins, copper coins, iron coins with the stamp of the King etc., were used as money. In the modern times, paper money is used. For example, Rupees, dollars etc., in the form of printed paper act as money. Now A to A can sell wheat to some body and get money and with this money or a part of it, he can buy goat. A to A need not go in search of a person who can exchange goat for wheat. Definitions: Business: An entity which carries on trading /manufacturing and selling of goods and services for a profit is called business. The main intention of a business is to make profit, while trading /manufacturing and selling. For example, a retail shop owner who sells a variety of goods is carrying on business. Transactions: An event in which an exchange of things takes place or a condition occurs is called a transaction. For example, the cash paid for purchasing stationery, salary paid, interest received etc. Business transactions are the transactions relating to a business such as, sale, purchase, receipt of cash etc. A machinery is subject to wear and tear due to usage, which is a condition, considered as a transaction to be recorded.

Accounting: Accounting is a body of knowledge which provides essential information about the financial activities of an entity to facilitate informed judgments and decisions .It is connected with identifying how transactions and events should be described in financial reports. Book keeping: Book keeping is the part of accounting that records transactions and other events manually or with computers. It is the writing part of accounting. It is concerned with how the transactions are recorded in the books. Double entry system: For each transaction there are two aspects. A system which provides for the recording each of the two aspects of a transaction, separately, to facilitate equilibrium is called double entry system. It is called double entry because two entries have to be made in the books for every transaction. Service Rendering: From the business point of view, rendering service refers to providing an utility to the customer for a fees or fare, for example Laundry service, Transportation, consultancy by Doctors, professionals etc. Merchandising (Trading): An activity of buying and selling of goods and services is called Merchandising/ Trading. For example, a merchant buys Shoes from the manufacturer and sells them to the ultimate customers. He is merchandising /trading the shoes. Manufacturing: The process of converting raw materials in to the finished goods ready for use is called manufacturing. The material is converted in to usable finished product with the help of labor and machines. Finally they are sold to consumers. For example manufacturing shoes in a factory. Profit: The difference in money between the selling price (being higher) and the cost of sales of goods or services in a business entity during a period is called profit. However, if cost of sales is more than the selling price, the difference is called loss. For example, if a retailer buys a pair of shoes at Rs. 80 and sells it for Rs.100, he makes a profit of Rs. 20. On the other hand, if he sells the same for Rs. 75, he incurs a loss of Rs. 5. FORMS OF BUSINESS OWNERSHIP A business can be carried on by either a single person or a small group of persons or very large group of persons. Accordingly, the main forms of business owner ship are 1) Sole proprietorship 2) Partnership firms 3) Joint stock companies /Corporations. They are discussed as below:

1.

Sole proprietorship: A business is called proprietorship business, when it has only one owner. A single Person as owner carries on the business. Only one person contributes money, called capital, to the business. However, he takes the help of others for the manufacturing, Administration, & selling activities of the business. It is also called proprietary concern. In sole proprietorship form of business, the entire profit/ loss goes to the only owner. The criterion is not the size of the business but the number of owners. A sole proprietorship business may have billions of Rs. transactions also. A small petty retail store is also a sole proprietary concern. The condition is that only one person should be the owner of the business.

2. Partnership firms: A group of two or more persons to carry on a business and to share the profit or loss, under an agreement is called a Partnership firm ". In this form of organization two or more persons combine together and contribute capital to carry on the business and the profit/loss is shared among them. Partnership agreement is the most important binding factor. The partners enter in to an agreement relating to capital contribution, ratio of profit/loss to be shared, business to be carried on, interest on loan and capital, salary to partners, nature of liability, dissolution, admission of a partner, etc. These partnership concerns are governed by the partnership acts formulated by the government. 3. Share Company or Joint Stock Company or corporation: An association of two or more persons having a separate legal entity, to carry on a business, registered under a state or federal statute with a common seal and in which ownership is divided in to shares of stock, is called corporation or Joint Stock Company or Share Company. When huge capital is required to carry on the business, this form of business ownership is formulated. The capital is contributed by a large number of persons called Share holders. Since there is a large number of share holders, the management is separated from the ownership .The business is carried on by a board of directors, elected by the share holders. These directors have to report the result of the business operations back to the share holders every year. Types of Business operations A business is carried on for the purpose of making profit. There are various types of business operations. They are: (1) Trading/Merchandising: Buying and selling of goods for profit is called Trading/Merchandising. A whole seller buys goods from manufacturers and sells them to retailers. The retailers buy goods form wholesalers and sell them to ultimate consumers. Generally, they deal with the finished goods/merchandise. In the process they make profit.

(2) Manufacturing & Selling: Conversion of Raw Materials in to finished goods ready for consumption is called manufacturing. Example: Manufacturing cycle, Cement, Shoes etc. The manufacturers sell the goods at a price which is fixed after adding a certain percentage of profit. (3) Rendering Service: This is a type of business operation where a service is rendered to the customers. Under this, physical goods are not supplied to the consumers, instead a utility-place, time, knowledge, is provided to the customer. One cannot physically see a service but only, can feel and utilize the service. For example, Transportation. Bank, Education, consultancy etc. (4) Agency/Brokering: This is a type of business operation where the buyers & sellers are brought together to exchange goods & services. For this operation a Commission/Brokerage is charged. USERS OF ACCOUNTING INFORMATION: Accounting is designed to suit the needs of many users. It is a system to provide useful information to the users to make informed judgments. Following are the users of accounting information: 1) Management: The proprietor, the partners, the board of directors is all the people concerned with the management of the business. They are required to know the financial results in the form of profit /loss, financial position and the progress made from year to year. They are also required to take managerial decisions. Accounting supplies crucial information to them. 2) Shareholders: In the joint stock form of organization, shareholders are the owners. They elect and authorize the directors to manage the affairs and report back. They wish to know how the business is managed, what is the share of profit, how is the financial position, health and wealth of the company. 3) Investors: Individuals and institutions, who want to take part in the ownership, require information about organization. Because, they want good return for their capital, the growth and safety of the investment. 4) Bank and financial institutions: Banks and financial institutions lend money to the business. They are more concerned with the return of the amount lent and the interest income. Therefore, they enquire about the financial condition of the enterprises. 5) Creditors and suppliers of goods and services: The creditors and suppliers of goods and services need to know the credit worthiness of the business i.e. the capacity to pay for the supplies within the specified time. A careful verification and analysis of financial data reveals this information.

6) Government: The government is responsible for the socio-economic development of a country. Various sectors like agriculture, industry and service need proper direction. Government provides regulation and formulates policies to show the path of development. For these purposes, money is collected from the public through taxes. Accounting provides the information about the profit and financial positions of the businesses on the basis of which the tax is collected. 7) Employees: Employees need monetary and non monetary incentives to improve the productivity and relationship with the management. The data relating to profit, liquidity position and solvency status, help the employee unions to bargain with the management to get bonus and other benefits. 8) International organizations: In the wake of globalization movement, the multinational companies need accounting information for collaborations, franchises and investments. 9) Other enterprises: Accounting analysis is very useful for mergers, amalgamations collaborations inter-firm comparison and bench marking of the firms and companies. 10) Standardization: The professional bodies, academics and accountants need the accounting information for the purpose of evolving standard accounting practices, from time to time. Accounting Concepts 1) Business Entity: When a business is started, for all practical purposes, it is treated as independent of its owner. Once the owner invests capital to start a business, for accounting purpose, the business is considered as a separate unit having its own identity, distinct from its owner who created it. This is called business entity concept. Therefore, every event of the owner with the business is treated as a transaction that must be recorded in the books of the business. A business cannot be physically seen. It is run by natural persons. It is conceptually and legally, a separate entity or unit or a person. 2) Going Concern: When a business is started, it is expected to exist for a long period of time. The business is expected to be continuing even if the owner is changed due to transfer from father to son, or death. Every business is assumed to have a continued existence with profit for an indefinite period of time. This is called going concern concept (continuing business).Based on this assumption the accounting entries are made. For example, when a machine is purchased for business, the machine is expected to be with the business for an indefinite period of time and so it is recorded as an asset at purchase cost.

3) Objective evidence: In business transaction, to make an entry in the books, evidence of the expense or income is required. Examples of evidences are invoice and vouchers for purchases, bank statement for bank balance etc. Objective evidence means, the proof of a transaction that can be verified with the relevant support documents. One cannot show the purchase invoice as the evidence for payment of salary. However, individual judgments are made in some cases where estimates are involved. Any way the user of the accounts must believe the entries. Adoption of objective evidence principle will minimize the accounting errors, bias and frauds. For example, physical verification report with respect to materials acts as an evidence of material purchased and stored. 4) Unit of measurement: All business transactions are recorded on terms of money. Each country will have its own currency as common unit of measurement. For example, US dollars, Japan yen, Indian rupees, Kenyan shilling, Ethiopian birr etc. While recording and presenting accounting data, every business enterprise will express the amounts in the countrys currency. For example, if a business purchases 100 pairs of shoes at Rs. 120 each and 100 liters of oil at 20 Rs. per liter, then the recording is done as below: Sr. No. 1 2 Details Shoes purchased Oil purchased Quantity 100 pairs 100 liters Unit Price Rs. 120 20 Total Total Amount Rs. 12,000 2,000 14,000

Though, the details of other units of measurement such as number of shoes, 100 liters of oil, are stated ,it is the expression of their value in terms of Rs. that is significant. Imagine expressing the information only in terms of 100 shoes and 100 liters of oil. Does it convey any uniformity in information? Can you draw any inference out of it? Therefore, all these transactions are entered in a common unit of measurement, namely Rs. 5) Accounting period: The growth of a business has to be measured over a period of time frame. The universally accepted standard time period is ONE YEAR. This is called accounting period. For example the year from April 1, 2009 to March 31, 2010 (a period of twelve months). The business profit and financial position are expressed for one year. This helps to measure the success/failure as well as the health of the business. In modern times, business results are reported as frequently as needed, say, every month. 6) Matching revenue and expired cost: Expired cost refers to the money spent relating to an item in an accounting period. For example, salary paid, rent paid etc. In case of Assets, the usage is expressed in terms of expired cost and not the purchase cost of assets. Revenue is the regular income that is generated out of business transactions. For example, sales for the period, commission received etc. Comparing the revenue with that of expired cost during the period results in profit or loss.

If revenue is more than the expense the result is the profit and if the revenue is less than the expense, the result is loss. Matching concept, therefore, refers to the process of comparing the revenue with that of expense during an accounting period so as to determine the profit or loss for the business. 7) Adequate disclosure: Accounting is a system to provide useful information to the user. A standard practice is followed to disclose all the relevant material facts in the report. Only necessary data are reported. This is called adequate disclosure. Whenever the individual judgment is involved, the practice followed is stated to avoid any misinterpretation. For example, if the method of valuing inventory is changed, it should be disclosed. 8) Consistency: The result of one accounting period is compared with the result of the next accounting period to know the progress made. The comparison helps to know the direction in which the business is moving. Comparison of the results is meaningful to the user only when the same accounting principles are followed year after year. This is called consistency. For example, there are several methods of valuing the inventory. The value has an effect on the profit position. If the method is changed in any year, the resulting profit is the result of change in the method and not necessarily due to business operations. This will not facilitate to form an opinion about the progress of the business. Therefore, same accounting practice is followed every year. However, change made only if it could be justified. 9) Materiality: In the business records, the amounts are normally rounded off to the nearest Rs. . For example, if the amount is Rs. 198.01, it could as well be rounded off to Rs. 198, ignoring, 0.01. It does not matter much. In fact it saves labor, time and energy. Some times it provides clarity also. If the administrative and stationery expenses of recording a fraction of amount are more than the amount itself, then it is not worth the effort of recording. It is better to ignore, if it has no significant impact. This is called materiality concept. When non disclosure of an item does not affect the required information to be given, then there is no need to disclose the same. The materiality concept speaks about the feasibility of recording and reporting of an item of expense or income. 10) Conservatism: Future is most uncertain. No body can predict the future perfectly. In case of businesses, there is no 100% guarantee that there will always be profit. Therefore, while presenting the financial results, wherever individual judgments are involved, care is taken to see that only lesser profit is shown in the current year. This is to reserve the rest of the profit, if any for safeguarding the future uncertainty. This is called conservatism concept. For example, while valuing the inventory at the end of the year, the market price or the cost whichever is less, is taken. A higher value results in higher profit and lower value in lower profit. According to this concept, lower value is considered.

ACCOUNTING EQUATION A business is, normally, started with cash. Various properties are purchased to carry on the business. In the course of the business, it may have to owe money to others and may have to receive money from others. They are defined as below: Assets: The cash and other properties owned and moneys receivable by a business enterprise are called Assets. For example, cash in hand, cash at bank, bills and amount receivables stock of goods, plant and machinery, land etc. owned by the business. Equities: The rights or claims on the assets of the business are called Equities. For example, the owners have the right over the properties, the creditors and suppliers have the claim over the money or goods etc. Liabilities: That part of equities which is represented by the claims of the creditors is called Liabilities. For example, bills payable and amounts payable by the business on account purchases. Owners equity: That part of the equities which is represented by the rights of the owner/s is called owners equity. For example, capital contributed by the proprietor, partners and shareholders. Accounting Equation: According to the double entry principle each transaction has two aspects and each aspect has to be recorded separately to provide for the equilibrium. Therefore, Assets = Liabilities + Owners Equity Now, let us take an example. Assume that, 1) A started a business with cash of Rs. 10,000 and 2) the business has purchased supplies like stationeries on credit for Rs. 6,000. On credit means, cash is not paid to suppliers now but will be paid later. There are two transactions. In the first, the cash coming to business forms the asset of the business and the owner has the right over this cash contributed by him called , capital, which forms the Owners equity. As the cash contributed is equal to owners right over it, we can establish the relation between the two as below: Cash (asset) = Capital (owners equity).

In the second transaction, the supplies (stationery etc.) coming in to business becomes the asset called supplies, and the claim over this by the suppliers on this (since the money is not yet paid) becomes the liability , called account payable. As the amount of supplies is equal to the amount of the claim over the supplies, the relation between the two can be established as below: Supplies (asset) = Account payable (liabilities) The liabilities and owners equity are together called as equities. The relation among these can be stated as below: Liabilities + Owners equity

Assets = Equities

The relation between the three can be expressed in the form of equation as below: Assets = Liabilities + Owners equity This is called Accounting equation. Now, the above example can be summarized and presented in the equation form as below: Assets Cash + Supplies 10,000 + 6,000 = Liabilities + Owners equity

= Accounts Payable + As Capital = 6,000 + 10,000.

Observe that the total of the left hand side of the equation (16,000) is equal to the total of the right hand side of the equation (16,000), which sets the equilibrium according to double entry concept. Statement of accounting equation: A statement prepared to know the effect of each business transaction on assets and equities and balances at the end, is called Statement of accounting Equation. Effect of transactions on the accounting equation: Each business transaction has two-fold effect on the accounting equation the effect could be as below: a) b) Increase in asset and increase in equities (liabilities or owners equity) Decrease in asset and decrease in equities (liabilities or owners equity),

c) d)

Increase in one asset and decrease in another asset, Increase in one liability and decrease in another liability or owners equity.

Such an effect will always maintain equilibrium. After the record of each transaction, the total of assets will be equal to the total of equities. Financial Statements for Sole Proprietorships The users of accounting information need to know 1) what profit the organization has made during a period, 2) what is the financial position of the organization at the end of a period, 3) what is the progress made year after year. The accounting equation is only a fundamental relation between the assets, liabilities, and owners equity. It does not indicate the financial operations. Financial statements: The accounting statements prepared for communicating essential information to the users are called financial statements. They are 1) Income statement 2) Statement of owners equity, 3) Balance Sheet and 4) Cash flow statement. 1) Income Statement: A statement prepared to show the result of operation with respect to revenues and expenses for a specific accounting period is called income statement. The excess of revenue over the expenses is called net income/ profit. The excess of expenses over the revenues is called net loss. Revenue refers to the regular income to the organization on day-today recurring transactions. The criteria are the regularity and recurring (repeating) inflow of revenue on a day-to-day basis. It includes actual receipts or accrual due to be received. For example, sale of goods, and services, professional fees earned, rent received, fares received commission received, interest received etc. Note that the income on the sale of asset and lottery are not considered as revenues. Expense refers to the regular spending by the organization on day-today recurring transactions for earning revenue. They are also called expired costs. It includes items of actual or accrued payments. For example, supplies expense, salary, rent, utilities paid etc. Note that, payments for the purchase of assets /properties are not considered as expenses.

10

Capital receipt: The money received other than the revenue is called capital receipt. For example, money received on sale of assets. Capital expenditure: The money spent other than towards the expenses are called capital expenditure. For example, money spent on purchasing assets such as, land, machinery, furniture etc. Only revenues and expenses enter the income statement directly. 2) Statement of owners equity: Finally, the owner of the business has to enjoy the result of business operations. The statement prepared to know the increase or decrease in owners equity over a period is called Statement of owners equity. The equity changes due to the revenues, expenses, additional investment to and withdrawals from the business by the owner. The ultimate effect is either a net increase or a net decrease in equity. In other words, the difference between the capital at the end and the capital at the beginning of a period is either an increase or decrease in the equity. Balance Sheet: A statement showing the position of assets, liabilities and owners equity as on the last date of the accounting period is called Balance Sheet. It contains the details of the balances of assets, liabilities and owners equity on a specific date. Cash flow statement: A statement showing the cash at the beginning of a period, actual cash receipts and payments during the period and cash balance at the end of the period is called Cash flow statement.

3)

4)

11

ACCOUNTING CYCLE FOR SERVICE RENDERING BUSINESSES Introduction: Business operations can broadly be divided in to three categories. They are 1) Service rendering 2) merchandising (trading) 3) Manufacturing and selling Service rendering businesses are the businesses, which provide specific utility to the user. Service can only be felt and cannot be seen. For example, transportation, education, consultancy, bank etc. In transportation, goods and passengers are moved from one place to another place called place utility. For example, taxi service. Banks collect deposits and lend loans; educational institutions make the students graduates. A professional Accountant solves the problems of the clients, for example, calculating the tax liability. A doctor cures the diseases, etc. We have seen in the preceding pages that, the transactions relating to revenues, expenses, assets, liabilities and owners equity are very few. Imagine, if there are hundreds and thousands of transactions with respect to each item. Probably, recording looks very clumsy and confusing. It may not help to draw any inferences. Therefore, there is a need to have a systematic approach that is uniformly acceptable. The systematic accounting approach is discussed as below: Account: When several transactions occur, relating to a specific item, then it is better to put them all in one particular place to have a complete picture about that item, of expense, revenue, asset, liability and owners equity. For example, supplies purchased on different dates can be put in one place of recording, to have an idea of the total purchases during the period. A place in the business book where all the related transactions of a specific item are recorded is called an Account. For example, supplies account, rent account, plant account, account payable, capital account etc. Nature of an account: Each transaction has two aspects. In order to provide space for recording these two aspects, an account is divided in to two sides- left hand side and right hand side. An account can be written in two forms: 1) T form, 2) Statement form(Standard form) 1) An account in T form is as below: Supplies account Account No Date Item Post Amount Date Item ref.

Post ref.

Amount

Title of the account is written on the top center. The entries are written on both the sides of the account depending on the effect of a transaction.

12

2) An account in the statement form:

Supplies account No: Date Item

Account Post.ref. Debit Credit Balance Debit Credit

Debit and Credit: The effect on an account due to a transaction is expressed in two ways for recording. Debit: This is an accounting term, which is understood in three ways: a) To debit: To debit means, to make an entry on the left hand side of an account, b) Debit side : Debit side refers to the left hand side of an account, c) Debit entry: Debit entry refers to an entry on the left hand side of an account. Credit: This is an accounting term, which is understood in three a) To Credit: To credit means make an entry on the an account, b) Credit side : Credit side refers to the right hand account, c) Credit entry: Credit entry refers to an entry on the an account. ways; right side of side of an right side of

Name of the account: The name of the account is written on the top center/left corner. Account number: Each account is given a separate number for the purpose of identification. Date: In this column, the year, month, and date on which the transaction occurred is written. Item: The name of the opposite account, which is affected in written in this column. Posting reference (post.ref.): The page number of the journal (explained later) is written in this column. Debit and Credit: The respective amounts are written in these columns. Balance: The amount remaining at the end of the period or at the end of each entry is called balance. Debit balance, refers to the amount of debit in excess over the credit. Credit balance, refers to the amount of credit in excess over the debit.

13

Balancing an account is an act of determining the excess of debit or credit in each account. In T form, the balance is determined at the end of the period and in the statement form, the balance is found out after recording each entry. Ledger : A ledger is a book in which all the accounts are written .This book will have a number of pages .Specified number of pages are earmarked(kept apart) for each account depending on the number of entries. Some times a separate book is maintained for each account. A ledger is a book of second entry. CLASSIFICATION OF ACCOUNTS Classification of accounts refers to grouping of accounts according to some common characteristics. There are two types: 1) Based on personal or impersonal:

Personal accounts are the accounts indicated by the names of persons related to the business through business transactions. For example, Ato Clintons account, As account, Account payable, debtors, creditors, ABC Company account etc. Impersonal accounts are divided in to two parts; Real or asset accounts are the accounts indicated by the names of the assets, related to the business through business transactions. For example, plant account, machinery account, land account etc. Nominal accounts are the accounts indicate d by the names of the expenses or revenues related to the business through business transactions. For example, salary account, rent account, commission received account, sales account. fares received account, etc. 2) Based on financial Statements: According to this, the accounts are classified as A) Balance Accounts, B) Income statement Accounts. A) Balance Sheet Accounts: The accounts that appear in a balance sheet are called balance sheet accounts. They are further divided in to a) Assets accounts, b) Liabilities accounts, and c) Owners Equity Accounts. a) Assets Accounts: The properties owned and accounts receivable by the business are called Assets. They can be i) Tangible Assets, or ii) Intangible. (i) Tangible Assets are the assets which can be physically seen .For example, Furniture, Land .Machinery etc.

14

(ii) Intangible Assets are the rights obtained by the business. They are not physically seen but only felt. For example, Patent right, copy right etc. (these are explained at a later stage). For the purpose of presenting in the balance sheet, the assets are divided in to i) Current Assets and ii) Plant Assts i) Current Assets are the assets including cash, which are converted in to cash within one year. For example, cash, bills and notes receivables, ending inventory, prepaid expenses etc. ii) Plant assets, are the assets which are expected to be permanently with the business. They are not expected to be sold within one year. They are also called Fixed assets. For example, land ,furniture ,patent right, good will etc. b) Liabilities Accounts: The amounts that the business has to give to others are called Liabilities. There are two categories: i) Current Liabilities - Current liabilities are the liabilities which are to be paid within one year. They are paid out of current assets. For example, Accounts payable, notes payable, sales tax ,interest payable etc. ii) Long term Liabilities - Long term liabilities are the liabilities which are due for payment beyond an accounting period. For example, long tem loans, mortgage note payable, etc. However, such part of long term liability which falls due for payment within a year is categorized as current liability. c) Owners Equity Accounts: The Accounts that are related to the owners of the business are called owners equity Accounts. The owner of the business has the last claim over the properties. It means, the business clears the outside debt first and afterwards owners can claim the residual property. For example, Capital account, Drawings Account etc. B) Income Statement Accounts: The accounts that appear in the income statement are called income statement accounts. They are further divided in to a) Revenue Accounts b) Expenses Accounts. a) Revenue accounts are the accounts relating to the regular incomes to the business. Example, sales, interest received, fees received, discount received etc. b) Expenses accounts are the accounts relating to the moneys spent to get the revenues to the business .For example, salary, rent, interest paid, depreciation, supplies expense etc.

15

Code or Index numbers: For the purpose of easy identification, the accounts are given individual code numbers. Debit and Credit Rule: General Rule Debit the Account which receives, Credit the account which gives. Debit the receiver, credit the giver. Debit what comes in, credit what goes out. Debit All expenses and losses Credit All incomes, gains and profits.

Personal Account Real Account Nominal Account

The effect of a transaction is as below: Assets: Liabilities: Owners Equity: Owners drawing: Revenues: Expenses: Debit Debit Debit Debit Debit Debit increase decrease decrease increase decrease increase Credit Credit Credit Credit Credit Credit decrease. increase. increase. decrease. increase. decrease.

JOURNAL: Many transactions occur during a period. Every day several transactions take place. A transaction may not relate to an immediate previous transaction. It is not advisable to directly enter the transactions in to the ledger accounts situated in different places in a ledger. Therefore, there is a need for an intermediate device. The gap between a transaction and the ledger is filled by a book called Journal. A journal is a book in which the transactions are first entered in the chronological order in which the transactions take place. It is a book of Prime entry. Format of a two column journal: Journal Sl.No. Date Account Title/Description

Page No. Post.ref. Debit Credit

Sl No: In this column the serial number of the transactions are written.

16

Date: The year, month, date of the transactions are written here. Account Title/Description: The names of the account to be debited and credited are written in this column. Post.ref.: (posting reference):The account number of each account is written here. Debit and credit: The amounts are written here. Passing the entries in a journal: The process of entering the transactions in a journal in a chronological order ,that is ,in the order in which they occur, is called passing the entries. Or Journalizing. Steps: 1) Go through the transactions one by one, 2) Identify only the two relevant accounts affected by the transaction, 3) Apply the rule and decide which account to be debited and which to be credited, 4) Write the serial number, year, month and the date and in the account title column, write firstly the name of the account to be debited and below that in the next row, with a small space left, in the beginning, write the name of the account to be credited (opposite account). A small description of the transaction could be written in the next row which is called Narration. 5) Write the amount of debit and credit against the respective accounts and in their columns. Compound Journal entry: When two or more accounts are debited and credited simultaneously, then such a journal entry is called Compound Journal Entry. Posting the journal entry to ledger: After passing the entry in the journal, the next step in the accounting cycle is to transfer this entry to the respective account in the ledger. A separate space (page) is provided for each account in the ledger. The entries in an account give the complete picture about what is happening with respect to that account, that is, whether the amount in the account is increasing or decreasing. At the end of an accounting period, say, a month, or a year, the balance is shown in each account. However, if the total of debit is equal to total of credit, then there will be no balance at all, that is Nil balance at the end. The ending balance of an account becomes the opening balance of that account in the beginning of the next period. Posting: The process of transferring the entries in the journal to the respective accounts in the ledger is called Posting. This is an act of grouping the related entries. For example, all the cash related entries in the journal on different dates are posted to cash account in the ledger. A consolidated picture of cash is obtained at one place.

17

Steps: 1) Provide enough place for each account in the ledger book, 2) After passing an entry in the journal, take first, the account to be debited, go to the relevant page in the ledger enter in the debit side the name of the opposite account in the account title column, and write the amount in the amount column of debit side. 3) Next, take the account to be credited, go to the relevant page number in the ledger and enter in the credit side of that account, the name of the opposite account in the account title column and write the amount in the credit column. 4) Repeat this for all the other entries. 5) Write the year, month and date in the date column. 6) Write the page number of the journal in the post ref. column of the respective account in the ledger. 7) Finally, at the end of the period(in case of T form account) or at the end of each posting (in case of Statement form ) ,determine the balance and write this balance amount in the debit side(column) or credit side(column) as the case may be. Distinction between Journal and Ledger Particulars Purpose Nature Journal Book for recording journal entries Two columns, one for debit and another for credit Book of original or prime or first entry Chronological order of transactions in general Bridge between transactions and the ledger. Supporting documents like purchase invoice, payroll etc Ledger Book for recording ledger accounts Two sides, debit and credit or four columns debit, credit and balances. Book of second entry Order of transactions relating to respective account Bridge between the journal and the trial balance. Journal entries

Entry Order Bridge Reference

Comparison : Journal is like a general assembly of all the students in a college auditorium and ledger account is like a class for each faculty such as, Accounting class, Management class, Automotive class, construction class etc.

18

TRIAL BALANCE Every day numerous transactions are entered in the journal and posted to ledger accounts. Each task is performed by a different accounting clerk. Journalizing could be done by a clerk, posting by another and so on. In large firms, even the journalizing task is shared by several persons. While performing these tasks errors may occur. Errors could occur at the time of journalizing or posting or at the time of balancing. It becomes necessary to verify the accuracy of the entries made, for two important reasons:1) to uphold the purpose of double entry principle, 2) to get the accurate financial results. A statement prepared at the end of an accounting period to verify the arithmetical accuracy of the amounts in the books is called Trial Balance. It contains the ending balances of all the accounts. When all the transactions are correctly journalized, posted to accounts and all the accounts are balanced properly, the debit total must be equal to credit total. It is to check this that a trial balance is prepared as on the last date of the accounting period The trial balance contains the names of all the accounts and their respective debit and credit balances. Debit column total is equal to credit column total so that the equilibrium is established. If there is any error at any point of entry, the debit total will not be equal to credit total. Thus a trial balance helps to trace the error of arithmetic accuracy in the accounting. A trial balance acts as a bridge between ledger accounts and the financial statements. It is prepared as on a specific date for the period ended and not for the period. This is also called Pre-closing trial balance. Steps: 1) Draw a Trial balance providing columns for serial number, account balances, account number, debit balance and credit balance, 2) Transfer the balance in each account to the trial balance to the appropriate places, 3) Find the total of debit column and credit column. They must be equal. ACCOUNTING CYCLE Basis of reporting accounting data: During an accounting period several business transactions take place. Cash is received for revenues and cash is paid for expenses. Some times though revenues are earned, cash might not have been actually received, during an accounting period. For example, assume that the accounting period is Jan 1 to Dec31. A doctor has provided service to a patient on Dec.10, amounting Rs. 100. But the patient has requested the doctor that he would pay the money in the next month, i.e., Jan. next year. This is the case of revenue earned for the year but not actually received in that same year. Similarly the expenses are incurred in a year but paid in the next year. Under such circumstances, the question arises as to how to report the accounting data. Accordingly, there are two bases for reporting the data. They are:

19

Cash basis: Under this, revenues and expenses are reported on the basis of actual receipt and payment of cash, irrespective of whether revenue is earned or not and expenses are incurred or not. Therefore ,the actual receipt and payment of cash is important. Accrual basis: Under this, revenues and expenses are reported on the basis of revenue earned and expenses incurred in the period ,irrespective of whether cash is received or not and cash is paid or not. Therefore ,earning of revenue or incurring of expense is important and not the actual receipt or payment. This also provides for matching the revenue with the related expenses. Most of the businesses use the accrual basis for reporting accounting data. Adjustments: At the end of an accounting period, before preparing the financial statements ,it is necessary to determine the exact amount of revenue earned and expenses incurred for the period. Because, the accounting practice is to record the exact amount of cash received and paid during the period. Cash received may be more or less than the revenue earned .Similarly, cash paid may be more or less than the expense incurred. The process of bringing the amounts up to date for the accounting period is called Adjustments. They act as bridge between the trial balance and the adjusted trial balance. These adjustments are discussed as below: A) Deferrals: The cases where i) cash paid is more than the actual expense of the period and ii) cash received is more than the actual revenue earned of the period, are called deferrals. They are called deferrals because the recognition of expense or revenue is postponed (deferred) for the next period. Case (i): Prepaid expenses: the expenses which are already paid but not actually used by the end of the period are called prepaid expenses. Illustration: Assume that the supplies purchased during a period (say, January to December) amounted to Rs. 1,500. But the actual supplies consumed by the end of December, amounted to Rs. 1,200. Therefore, supplies remaining unused at the end of the period is Rs. 300 (1,500 1,200). Supplies used is called supplies expenses, shown in income statement and supplies stock unused at the end is called supplies on hand, shown in the balance sheet as current asset. Other examples are prepaid insurance, prepaid interest, depreciation etc. Depreciation: The plant assets are continuously used for the purpose of business operations to get revenues. They are subject to wear and tear due to usage. The gradual reduction in the value of an asset due to usage is called depreciation. The practice is to express this rate of reduction in the form of percentage.

20

Illustration: Assume that machinery is purchased for Rs. 30,000. Depreciation rate is 10% per year. Therefore, the depreciation for the year is 10% of Rs. 30,000 that is, Rs. 3,000. This depreciation is an expense for the period and shown in income statement. The cost of the machine at the end of the period is Rs. 27,000(30,000-3,000), called book vale .This is shown in the balance sheet as plant asset. However, the depreciation could also be credited to accumulated depreciation account and shown as current liability in the balance sheet. Case (ii): Revenue received in advance (revenue unearned): Revenue which are already received but not actually earned by the end of the period are called revenue received in advance or revenue unearned. Illustration: Assume that the rent received is Rs. 5,000, but the actual rent for the period is only Rs. 4,000. Therefore, the rent received in advance is Rs. 1,000 (5,000-4,000). Rent earned, Rs. 4,000 is shown in income statement and rent unearned, Rs. 1,000, is shown in the balance sheet as current asset. Other examples are, insurance premium received in advance, college fees received in the beginning of the year, subscriptions to magazines etc. B) Accruals: The cases where, i) cash paid towards an expense is less than the actual expense for the period and ii) cash received towards a revenue is less than the actual revenue earned for the period are called accruals. They are called accruals because they are due for payment or due to be received. They will be paid or received in the next period. Case (i): Accrued expense: the expenses which are already incurred but not actually paid at the end pf the period are called accrued expenses. Illustration: Assume that the salary for the year at Rs. 1,000 per month is Rs. 1,000 X 12 = Rs. 12,000. But actual salary paid is only Rs. 10,000 during the period. Therefore, the salary still to be paid, called salary payable is Rs. 2,000 (12,000-10,000). Salary for the period Rs. 12,000, is an expense, whether paid or not, and shown in income statement as salary. Salary accrued, that is still to be paid, Rs. 2,000, is shown as salary payable under current liabilities. Other examples are, rent payable, stationery purchased on credit, etc. Case (ii): Accrued revenue: The revenues which are already earned but not actually received at the end of the period are called accrued revenue. Illustration: Assume that the interest for the year on the note receivable amounted to Rs. 8,000 but the actual interest received is only Rs. 6,500 at the end of the period. Therefore, the interest still receivable (accrued) for the period is Rs. 1,500 (8,000-6,500).

21

Interest for the year, Rs. 8,000, is a revenue whether received or not and shown in income statement as interest. Interest receivable Rs. 1,500, is shown as current asset. Other examples receivable etc. are, commission receivable, consultancy fees, fares

WORK SHEET WITH ADJUSTMENTS Prior to the preparation of financial statements it is necessary to incorporate all the adjustments in to the trial balance. A sheet prepared to make all the adjustments is called worksheet. It is a working paper. It helps to: a) b) c) d) e) record all the adjustments , verify arithmetical accuracy , arrange the data systematically, provide a basis for preparing balance sheet and income statement, bridge the gap between the adjustments and financial statements.

A worksheet contains 10 columns, two columns each for 1) 2) 3) 4) 5) Trial Balance, Adjustments, Adjusted trial balance, Draft income statement, and Draft balance sheet.

22

Accounting Standards in India Introduction Financial statements are prepared to summarize the end-result of all the business activities by an enterprise during an accounting period in monetary terms. These business activities vary from one enterprise to other. To compare the financial statements of various reporting enterprises poses some difficulties because of the divergence in the methods and principles adopted by these enterprises in preparing their financial statements. In order to make these methods and principles uniform and comparable to the extent possible standards are evolved. Accounting is the art of recording transactions in the best manner possible, so as to enable the reader to arrive at judgments/come to conclusions, and in this regard it is utmost necessary that there are set guidelines. These guidelines are generally called accounting policies. The intricacies of accounting policies permitted Companies to alter their accounting principles for their benefit. This made it impossible to make comparisons. In order to avoid the above and to have a harmonized accounting principle, Standards needed to be set by recognized accounting bodies. This paved the way for Accounting Standards to come into existence. Accounting Standards in India are issued By the Institute of Chartered Accountants of India (ICAI). At present there are 30 Accounting Standards issued by ICAI. Written Documents issued by Government or Regulatory Body In India, issued by ICAI on 21st April,1977 Initiated by Kumar Mangalam Birla, Chairman committee of Corporate Governance for Financial Disclosures Also initiated by Chair person of NACAS What are Accounting Standards? Accounting Standards are the statements of code of practice of the regulatory accounting bodies that are to be observed in the preparation and presentation of financial statements. In layman terms, accounting standards are the written documents issued by the expert institutes or other regulatory bodies covering various aspects of measurement, treatment, presentation and disclosure of accounting transactions. What are the objectives of Accounting Standards? The basic objective of Accounting Standards is to remove variations in the treatment of several accounting aspects and to bring about standardization in presentation. They intent to harmonize the diverse accounting policies followed in the preparation and presentation of financial statements by different reporting enterprises so as to facilitate intra-firm and inter-firm comparison.

23

Objectives Standardize the diverse Accounting Policies Add the reliability to the Financial Statement Eradicate baffling variation in treatment of accounting aspects Facilitate inter-firm and intra-firm comparison Objective of Accounting Standards is to standardize the diverse accounting policies and practices with a view to eliminate to the extent possible the noncomparability of financial statements and the reliability to the financial statements. The institute of Chattered Accountants of India, recognizing the need to harmonize the diverse accounting policies and practices, constituted at Accounting Standard Board (ASB) on 21st April, 1977. Who issues Accounting Standards in India? The Institute of Chartered Accountants of India (ICAI) recognizing the need to harmonize the diverse accounting policies and practices at present in use in India constituted Accounting Standards Board (ASB) on April 21, 1977. The main role of ASB is to formulate Accounting Standards from time to time. Compliance with Accounting Standards issued by ICAI Sub-section (3A) to section 211 of Companies Act, 1956 requires that every Profit/Loss Account and Balance Sheet shall comply with the Accounting Standards. 'Accounting Standards' means the standard of accounting recommended by the ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards(NACAs) constituted under section 210(1) of companies Act, 1956. Duty of Statutory Auditor for Compliance with Accounting Standards Section 211(3A) of Companies Act, 1956 provides that every profit and loss account and balance sheet of the company shall comply with the accounting standards. The statutory auditors are required to make qualification in their report in case any item is treated differently from the prescribed Accounting Standard. However, while qualifying, they should consider the materiality of the relevant item. In addition to this Section 227(3)(d) of Companies Act, 1956 requires an auditor to report whether, in his opinion, the profit and loss account and balance sheet are complied with the accounting standards referred to in Section 211(3C) of Companies Act, 1956. Accounting Standards in Different Nations : Accounting Standards in Different Nations In India, 32 Accounting Standards as IAS under NACAS As per International, there are 41 Accounting Standards called as IFRS Adopted by 8 countries in the world 70 to 80 countries planning to adhere IFRS Clause 50 added to the listing agreement mandatory.

24

Accounting Standards Issued by Accountants of India are as below: y y y y y y y y y y y y y y y y y y y y y y y y y y y y y y y

the

Institute

of

Chartered

Disclosure of accounting policies: Valuation Of Inventories: Cash Flow Statements Contingencies and events Occurring after the Balance sheet Date Net Profit or loss for the period, Prior period items and Changes in accounting Policies. Depreciation accounting. Construction Contracts. Revenue Recognition. Accounting For Fixed Assets. The Effect of Changes in Foreign Exchange Rates. Accounting For Government Grants. Accounting For Investments. Accounting For Amalgamation. Employee Benefits. Borrowing Cost. Segment Reporting. Related Party Disclosures. Accounting For Leases. Earning Per Share. Consolidated Financial Statement. Accounting For Taxes on Income. Accounting for Investment in associates in Consolidated Financial Statement. Discontinuing Operation. Interim Financial Reporting. Intangible assets. Financial Reporting on Interest in joint Ventures. Impairment Of assets. Provisions, Contingent, liabilities and Contingent assets. Financial instrument. Financial Instrument: presentation. Financial Instruments, Disclosures and Limited revision to accounting standards.

Disclosure of Accounting Policies: Accounting Policies refer to specific accounting principles and the method of applying those principles adopted by the enterprises in preparation and presentation of the financial statements. Valuation of Inventories: The objective of this standard is to formulate the method of computation of cost of inventories / stock, determine the value of closing stock / inventory at which the inventory is to be shown in balance sheet till it is not sold and recognized as revenue.

25

Cash Flow Statements: Cash flow statement is additional information to user of financial statement. This statement exhibits the flow of incoming and outgoing cash. This statement assesses the ability of the enterprise to generate cash and to utilize the cash. This statement is one of the tools for assessing the liquidity and solvency of the enterprise. Contingencies and Events occurring after the balance sheet date: In preparing financial statement of a particular enterprise, accounting is done by following accrual basis of accounting and prudent accounting policies to calculate the profit or loss for the year and to recognize assets and liabilities in balance sheet. While following the prudent accounting policies, the provision is made for all known liabilities and losses even for those liabilities / events, which are probable. Professional judgment is required to classify the like hood of the future events occurring and, therefore, the question of contingencies and their accounting arises. Objective of this standard is to prescribe the accounting of contingencies and the events, which take place after the balance sheet date but before approval of balance sheet by Board of Directors. The Accounting Standard deals with Contingencies and Events occurring after the balance sheet date. Net Profit or Loss for the Period, Prior Period Items and change in Accounting Policies: The objective of this accounting standard is to prescribe the criteria for certain items in the profit and loss account so that comparability of the financial statement can be enhanced. Profit and loss account being a period statement covers the items of the income and expenditure of the particular period. This accounting standard also deals with change in accounting policy, accounting estimates and extraordinary items. Depreciation Accounting : It is a measure of wearing out, consumption or other loss of value of a depreciable asset arising from use, passage of time. Depreciation is nothing but distribution of total cost of asset over its useful life. Construction Contracts: Accounting for long term construction contracts involves question as to when revenue should be recognized and how to measure the revenue in the books of contractor. As the period of construction contract is long, work of construction starts in one year and is completed in another year or after 4-5 years or so. Therefore question arises how the profit or loss of construction contract by contractor should be determined. There may be following two ways to determine profit or loss: On year-to-year basis based on percentage of completion or on completion of the contract.

26

Revenue Recognition: The standard explains as to when the revenue should be recognized in profit and loss account and also states the circumstances in which revenue recognition can be postponed. Revenue means gross inflow of cash, receivable or other consideration arising in the course of ordinary activities of an enterprise such as: The sale of goods, Rendering of Services, and Use of enterprises resources by other yielding interest, dividend and royalties. In other words, revenue is a charge made to customers / clients for goods supplied and services rendered. Accounting for Fixed Assets: It is an asset, which is held with intention of being used for the purpose of producing or providing goods and services. Not held for sale in the normal course of business, expected to be used for more than one accounting period. The Effects of changes in Foreign Exchange Rates: Effect of Changes in Foreign Exchange Rate shall be applicable in Respect of Accounting Period commencing on or after 01-04-2004 and is mandatory in nature. This accounting Standard applicable to accounting for transaction in Foreign currencies in translating in the Financial Statement Of foreign operation Integral as well as non- integral and also accounting for forward exchange. Effect of Changes in Foreign Exchange Rate, an enterprise should disclose following aspects: y Amount Exchange Difference included in Net profit or Loss; y Amount accumulated in foreign exchange translation reserve; y Reconciliation of opening and closing balance of Foreign Exchange translation reserve; Accounting for Government Grants: Government Grants are assistance by the Govt. in the form of cash or kind to an enterprise in return for past or future compliance with certain conditions. Government assistance, which cannot be valued reasonably, is excluded from Govt. grants. Those transactions with Government, which cannot be distinguished from the normal trading transactions of the enterprise, are not considered as Government grants. Accounting for Investments: It is the assets held for earning income by way of dividend, interest and rentals, for capital appreciation or for other benefits. Accounting for Amalgamation: This accounting standard deals with accounting to be made in books of Transferee Company in case of amalgamation. This accounting standard is not applicable to cases of acquisition of shares when one company acquires / purchases the share of another company and the acquired company is not dissolved and its separate entity continues to exist. The standard is applicable when acquired company is dissolved and separate entity ceased exists and purchasing company continues with the business of acquired company.

27

Employee Benefits: Accounting Standard has been revised by ICAI and is applicable in respect of accounting periods commencing on or after 1st April 2006. the scope of the accounting standard has been enlarged, to include accounting for short-term employee benefits and termination benefits. Borrowing Costs : Enterprises are borrowing the funds to acquire, build and install the fixed assets and other assets, these assets take time to make them useable or saleable, therefore the enterprises incur the interest (cost on borrowing) to acquire and build these assets. The objective of the Accounting Standard is to prescribe the treatment of borrowing cost (interest + other cost) in accounting, whether the cost of borrowing should be included in the cost of assets or not. Segment Reporting: An enterprise needs in multiple products/services and operates in different geographical areas. Multiple products / services and their operations in different geographical areas are exposed to different risks and returns. Information about multiple products / services and their operation in different geographical areas are called segment information. Such information is used to assess the risk and return of multiple products/services and their operation in different geographical areas. Disclosure of such information is called segment reporting. Related Party Disclosure: Sometimes business transactions between related parties lose the feature and character of the arms length transactions. Related party relationship affects the volume and decision of business of one enterprise for the benefit of the other enterprise. Hence disclosure of related party transaction is essential for proper understanding of financial performance and financial position of enterprise. Accounting for leases: Lease is an arrangement by which the lesser gives the right to use an asset for given period of time to the lessee on rent. It involves two parties, a lessor and a lessee and an asset which is to be leased. The lessor who owns the asset agrees to allow the lessee to use it for a specified period of time in return of periodic rent payments. Earning Per Share: Earning per share (EPS) is a financial ratio that gives the information regarding earning available to each equity share. It is very important financial ratio for assessing the state of market price of share. This accounting standard gives computational methodology for the determination and presentation of earning per share, which will improve the comparison of EPS. The statement is applicable to the enterprise whose equity shares or potential equity shares are listed in stock exchange.

28

Consolidated Financial Statements: The objective of this statement is to present financial statements of a parent and its subsidiary (ies) as a single economic entity. In other words the holding company and its subsidiary (ies) are treated as one entity for the preparation of these consolidated financial statements. Consolidated profit/loss account and consolidated balance sheet are prepared for disclosing the total profit/loss of the group and total assets and liabilities of the group. As per this accounting standard, the consolidated balance sheet if prepared should be prepared in the manner prescribed by this statement. Accounting for Taxes on Income: This accounting standard prescribes the accounting treatment for taxes on income. Traditionally, amount of tax payable is determined on the profit/loss computed as per income tax laws. According to this accounting standard, tax on income is determined on the principle of accrual concept. According to this concept, tax should be accounted in the period in which corresponding revenue and expenses are accounted. In simple words tax shall be accounted on accrual basis; not on liability to pay basis. Accounting for Investments in Associates in consolidated financial statements: The accounting standard was formulated with the objective to set out the principles and procedures for recognizing the investment in associates in the consolidated financial statements of the investor, so that the effect of investment in associates on the financial position of the group is indicated. Discontinuing Operations: The objective of this standard is to establish principles for reporting information about discontinuing operations. This standard covers "discontinuing operations" rather than "discontinued operation". The focus of the disclosure of the Information is about the operations which the enterprise plans to discontinue rather than disclosing on the operations which are already discontinued. However, the disclosure about discontinued operation is also covered by this standard. Interim Financial Reporting (IFR): Interim financial reporting is the reporting for periods of less than a year generally for a period of 3 months. As per clause 41 of listing agreement the companies are required to publish the financial results on a quarterly basis. Intangible Assets: An Intangible Asset is an Identifiable non-monetary Asset without physical substance held for use in the production or supplying of goods or services for rentals to others or for administrative purpose. Financial Reporting of Interest in joint ventures: Joint Venture is defined as a contractual arrangement whereby two or more parties carry on an economic activity under 'joint control'. Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefit from it. 'Joint control' is the contractually agreed sharing of control over economic activity.

29

Impairment of Assets: The dictionary meaning of 'impairment of asset' is weakening in value of asset. In other words when the value of asset decreases it may be called impairment of an asset. As per AS-28 asset is said to be impaired when carrying amount of asset is more than its recoverable amount. Provisions, Contingent Liabilities And Contingent Assets: Objective of this standard is to prescribe the accounting for Provisions, Contingent Liabilities, Contingent Assets, Provision for restructuring cost. Provision: It is a liability, which can be measured only by using a substantial degree of estimation. Liability: A liability is present obligation of the enterprise arising from past events the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. Financial Instrument: Recognition and Measurement, issued by The Council of the Institute of Chartered Accountants of India, comes into effect in respect of Accounting periods commencing on or after 1-4-2009 and will be recommendatory in nature for an initial period of two years. This Accounting Standard will become mandatory in respect of Accounting periods commencing on or after 1-4-2011 for all commercial, industrial and business Entities except to a Small and Medium-sized Entity. The objective of this Standard is to establish principles for recognizing and measuring Financial assets, financial liabilities and some contracts to buy or sell non-financial items. Requirements for presenting information about financial instruments are in Accounting Standard. Financial Instrument: presentation: The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset. The principles in this Standard complement the principles for recognizing and measuring financial assets and financial liabilities in Accounting Standard Financial Instruments:

30

Financial Instruments, Disclosures and Limited revision to accounting standards: The objective of this Standard is to require entities to provide disclosures in their financial statements that enable users to evaluate: y the significance of financial instruments for the entitys financial position and performance; and y the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. How many Accounting Standards have been prescribed? Are these applicable to all companies irrespective of its size? In all 29 Accounting Standards have been prescribed. However their applicability is dependent on its size Level I / II / III Company. The following table lists out the Accounting Standards and its applicability. Level I Company: Enterprises, which fall in any one or more of the following categories, at any time during the accounting period, are classified as Level I enterprises: Enterprises whose equity or debt securities are listed whether in India or outside India. ii) Enterprises, which are in the process of listing their equity or debt securities as evidenced by the board of directors resolution in this regard. iii) Banks including co-operative banks. iv) Financial Institutions v) Enterprises carrying on insurance business. vi) All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 500 million. Turnover does not include other income. vii) All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of Rs. 100 million at any time during the accounting period. viii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level II Company: Enterprises, which are, not Level I enterprises but fall in any one or more of the following categories are classified as Level II enterprises; i) All commercial, industrial and business reporting enterprises whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 4 million, but does not exceed Rs. 500 million. Turnover does not include other income. i)

31

ii) All commercial, industrial and business reporting enterprises having borrowing, including public deposits, in excess of Rs. 10 million but not in excess of Rs. 100 million at any time during the accounting period. iii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level III Company: Enterprises, which are not covered under Level I and Level II are considered as Level III enterprises. Applicability Level II and Level III enterprises are considered as SMEs Level I enterprises are required to comply fully with all the accounting standards. No relaxation is given to Level II and Level III enterprises in respect of recognition and measurement principles. Relaxations are provided with regard to disclosure requirements. Accordingly, Level II and Level III enterprises are fully exempted from certain accounting standards, which mainly lay down disclosure requirements. In respect of certain other accounting standards, which lay down recognition, measurement and disclosure requirements, relaxations from certain disclosure requirements are given. Sr.No. 1 2 3 4 5 Particulars Disclosure of Accounting Policies Valuation of Inventories Cash Flow Statements Contingencies and Events Occurring After the Balance Sheet Date Net Profit or Loss for the period, Prior period Items and Changes in Accounting Policies. Depreciation Accounting Construction Contracts Accounting for Research and Development (This standard has been withdrawn w.e.f. 01.04.2004 for all levels of enterprises and AS 26 is applicable) Revenue recognition Accounting for Fixed Assets The Effect of Changes in Foreign Exchange Rates Accounting for Government Grants Accounting for Investments Accounting for Amalgamations Accounting for Retirement Benefits in Applicability I, II, III I, II, III I I, II, III I, II, III

6 7 8

I, II, III I, II, III AS WITHDRAWN

9 10 11 12 13 14 15

I, II, III I, II, III I, II, III I, I, I, I, II, II, II, II, III III III III

32

16 17

the Financial Statements of Employers Borrowing Costs Segment Reporting

18

Related Party Disclosures

19

Leases

20

Earning Per Share

21 22 23

24 25 26 27

Consolidated Financial Statements Accounting for Taxes on Income Accounting for Investments in Associates in Consolidated Financial Statements Discontinuing Operations Interim Financial Reporting Intangible Assets Financial Reporting of Interests in Joint Ventures Impairment of Assets

I, II, III I II-with modification III- with modification I II-with modification III-with modification I II-with modification III- with modification I II-with modification III- with modification I I, II, III I

28

29

Provisions, Contingent Contingent Asset

Liabilities

and

I I I, II, III I-with clarification II-with clarification III-with clarification I-with clarification II-with clarification III-with clarification I

Evolution and Types of AS : Evolution and Types of AS AS 1-Disclosure of Accounting Policies: AS 1-Disclosure of Accounting Policies Specific policies adapted to prepare FS Should be disclosed at one place Purpose :- Better understanding of FS Better comparison analysis Mostly needed w.r.t Depreciation AS 2- Accounting for Inventories: AS 2- Accounting for Inventories Used for computation of Cost of inventories and to show in BS till it is sold Consists of:- Raw Materials Work in progress Finished goods Spares, etc Measurements of Inventories :Measurements of Inventories Determination of Cost of Inventories Cost of purchase (Purchase price, duties & taxes, freight inwards) Cost of conversion Determination of Net realizable value Comparison of cost and net realizable

33

AS 3- Cash Flow Statements :AS 3- Cash Flow Statements Incoming and outgoing of cash Act as barometer to judge surplus and deficit Explain Cash flow under 3 heads :- Cash flow from operating activities Cash flow from financing activities Cash flow from investing activities AS 4- Contingencies and events occurring after BS date :AS 4Contingencies and events occurring after BS date For maintaining Provision of Bad debts Generally uses Conservative concepts of Accounting like Bankruptcy, frauds & errors. AS 5- Net profit or loss for the period, prior period items and change in Accounting policies: AS 5- Net profit or loss for the period, prior period items and change in Accounting policies Ascertain certain criteria for certain items Include income and expenditures of Financial year Consists of 2 component Profit and loss of ordinary activities Profit and loss of extra ordinary activities AS 6- Accounting for Depreciation :AS 6- Accounting for Depreciation A non-cash expenditure Distribution of total cost to its useful life Occurs due to obsolescence Different methods of computation Straight line method ( SLM ) Written-down value or diminishing value (WDV) AS 7- Construction Contract: AS 7- Construction Contract specifically negotiated for construction of Asset or combination of Assets closely interrelated AS 8- Accounting for R&D :AS 8- Accounting for R&D To deal with treatment of Cost of research and development in the financial statements, identify items of cost which comprise R&D costs lays down condition R&D cost may be deferred and requires specific disclosures to be made regarding R&D costs. AS 9- Revenue Recognition: AS 9- Revenue Recognition Means gross inflow of cash and other consideration like arising out of :- Sale of goods Rendering services Use of enterprise resources by other yielding interest, dividend and royalties. AS 10- Accounting for Fixed Assets :AS 10- Accounting for Fixed Assets Called as Cash generating Assets Expected to used for more than a Accounting period like land, building, P/M, etc Shown at either Historical or Revalued value AS 11- Effect of change in FOREX Rates :AS 11- Effect of change in FOREX Rates Classification for Accounting treatment:- Category I: Foreign currency transactions: a) buying and selling of goods or services b) lending and borrowing in foreign currency c) Acquisition and disposition of assets Category II: Foreign operations: a) Foreign branch b) Joint venture c) Foreign Subsidiary Category III: Foreign Exchange contracts: a) For managing Risk/hedging b) For trading and Speculation

34

AS 12- Accounting for Govt. Grants :AS 12- Accounting for Govt. Grants Assistance provided by Govt. in cash or in kind like Grants of Assets like P/M, Land, etc Grants related to depreciable FA Tax exemptions in notified area

AS 13- Accounting for Investments :AS 13- Accounting for Investments Assets held for earning incomes like dividend, interest, rental for capital appreciation, etc It involves:- Classification of Investment Cost of Investment Valuation of Investment Reclassification of Investment Disposal of Investment Disclosure of Investment in FS AS 14- Accounting for Amalgamation: AS 14- Accounting for Amalgamation Section 391 to 394 of Companies Act, 1956 governs the provision of amalgamation. Disclosures: Names and nature of amalgamating companies Effective date of amalgamation Method of Accounting used Particulars of scheme sanctioned under a statute AS 15- Employees Benefits :AS 15- Employees Benefits All forms of consideration given by enterprise directly to the employees or their spouses, children or other dependants, to other such as trust, insurance companies in exchange of services rendered. AS 16- Borrowing Costs :AS 16- Borrowing Costs Interest and cost incurred by an enterprise in connection to the borrowed funds. Availed for acquiring building, installed FA to make it useable and saleable. AS 17- Segment Reporting :AS 17- Segment Reporting It consists of 2 segment:- Business segment Geographical segment Information and different risk and return reporting. AS 18- Related party disclosure :AS 18- Related party disclosure Related party are those party that controls or significantly influence the management or operating policies of the company during reporting period Disclosure: Related party relationship Transactions between a reporting enterprises and its related parties. Volume of transactions Amt written off in the period in respect of debts AS 19- Accounting for Leases :AS 19- Accounting for Leases Agreement between Lessor And Lessee Two types of leases: Operating lease Finance lease Different from Sale Classification to be made at the inception AS 20- Earning per share :AS 20- Earning per share Earning capacity of the firm Assessing market price for share AS gives computational methodology for determination and presentation of EPS 2 types of EPS AS 21- Consolidated Balance Sheet :AS 21- Consolidated Balance Sheet Accounting for Parent and Subsidiary company in single entity Disclosure:List of all subsidiaries Proportion of ownership interest Nature of relation whether direct or indirect

35

AS 22- Accounting for taxes and income :AS 22- Accounting for taxes and income Tax accounted for period in which are accounted It should be accrued and not liability to pay Deals in 2 measurements:- Current tax Deferred tax

AS 23- Accounting for investments in Associates in CFS :AS 23Accounting for investments in Associates in CFS Objectives to set out principles and procedures for recognizing the investment associates in CFS of the investors, so that effect of investments in associates on financial position of group is indicated. AS 24- Discontinuing operations :AS 24- Discontinuing operations Establishes principles for reporting information about discontinuing operations Covers discontinuing operations rather than discontinued operation AS 25-Interim Financial Reporting (IFR) :AS 25-Interim Financial Reporting (IFR) Reporting for less than a year, i.e., 3 months Clause 41 says publish financial results on quarterly basis Objective is to provide frequently and timely assessment AS 26- Intangible Assets :AS 26- Intangible Assets No physical existence Can not be seen or even touched 3 featured as per AS Identifiable Nonmonetary assets Without physical substance AS 27- Financial Reporting of interest in Joint Venture :AS 27Financial Reporting of interest in Joint Venture What is joint venture? Three types of JV in case of Financial reporting AS 28- Impairment of Assets :AS 28- Impairment of Assets Weakening of Assets value Occurs when carrying cost more than recoverable amt Carrying cost = Cost of assets Accumulated Depreciation AS 29- Provision, contingent liabilities and assets :AS 29- Provision, contingent liabilities and assets Provisions:- It is a Liability Settlement should result in outflow Liability is result of obligating event Contingent liabilities:Obligation arises of past event Existence confirmed when actually occurred of uncertain future Contingent Asset Same as Contingent liability Financial Instruments :Financial Instruments AS 30 Recognition and Measurement AS 31 Presentation AS 32 Disclosures Has not been made mandatory (expected in 2009)

36