Unit 1: Theoretical Framework

Q. What is accounting?
Ans: Accounting is an art of recording, classifying, summarizing, interpreting, and communicating the business
transactions in a systematic manner to the users.
Q. Define Accounting?
Ans:Accounting is a man made activity which has evolved a period of time. It is a systematic exercise carried on
for the purpose of recording, summarizing and interpreting the results for the users of the information.
According to R.N. Anthony: “Nearly every business enterprise has accounting system. It is a means of
collecting, summarising, analysing and reporting in monetary terms, information about business.”
Q. What are the various advantages and disadvantages of accounting?
Ans: Following are the various advantages of accounting:
1. Complete and Systematic Record: Accounting is a complete and systematic recording of all business
transactions. The limitations of humans, that they can not keep all transactions in mind, is overcome by
accounting because each and every business transaction can be recorded and analyzed through same.
2. Assessment of Performance of the Business: Accounting keeps a proper record of all revenues and
expenses. As a result, Trading and Profit and Loss Account for a period can be prepared and Gross Profit
and Gross Loss and Net Profit or Net Loss can be ascertained.
3.Assessment of Financial Position: Accounting keeps a proper record of all Assets, Liabilities and Capital
Accounts. Hence a Balance Sheet can be prepared at the end of a period and the financial position of the
Business can be assessed.
4.Helps in taxation matters: Various tax authorities like income tax, indirect taxes depends on the accounts
maintained by the management for settlement of taxation matters.
5.Decision making: Decision making becomes easier for management if there is a proper recording of financial
transactions. Accounting information enables management to plan its future activities, make budgets and
coordination of various activities in various departments.

Q: “Accounting as an information system”- Discuss. Discuss the different users of financial accounting
information and their needs.
Or
Q: What is Accounting Information? Discuss the users of Accounting Information.
Ans: An information system is a formal process for collecting data, processing the data into information, and
distributing that information to users. An accounting information system (AIS) is the collection, storage and
processing of financial and accounting data used by internal users to report information to investors, creditors and
tax authorities. The purpose of an accounting information system (AIS) is to collect, store, and process financial
and accounting data and produce informational reports that managers or other interested parties can use to make
business decisions.
Users of Accounting Informations:
Accounting information helps users to make better financial decisions. Users of financial information may be
both internal and external to the organization.
Internal users of accounting information include the following:
 1. Management: They use accounting for analyzing the organization's performance and position and taking
appropriate measures to improve the company results.
2. Employees: Employees of the organization use accounting data for assessing company's profitability and
its consequence on their future remuneration and job security.
3. Owners: Owners who invest capital in to the business. They are in need for the accounting information for
analyzing the viability and profitability of their investment and determining any future course of action.
External users of accounting information include the following:
1. Creditors: They need accounting for determining the credit worthiness of the organization. Terms of
credit are set by creditors according to the assessment of their customers' financial health. Creditors
include suppliers as well as lenders of finance such as banks.
2. Tax Authourities: the business organizations have to pay various kinds of taxes to the government. For
determining the credibility of the tax returns filed on behalf of the company the tax authorities required
accounting data of the companies.
3. Investors: They need accounting for analyzing the feasibility of investing in the company. Investors want
to make sure they can earn a reasonable return on their investment before they commit any financial
resources to the company.
4. Customers: customers looking for accounting information for assessing the financial position of its
suppliers which is necessary for them to maintain a stable source of supply in the long term.
5. Regulatory Authorities: They need for ensuring that the company's disclosure of accounting information
is in accordance with the rules and regulations set in order to protect the interests of the stakeholders who
rely on such information in forming their decisions.
Q: Discuss the qualitative characteristics of accounting information.
Ans: the following are the points describing the qualitative characteristics of accounting information:
1. Relevant: Relevance refers to how helpful the information is for financial decision-making processes.
Accounting information is relevant if it can provide helpful information about past events and help in
predicting future events or in taking action to deal with possible future events.

2. Reliability: Accounting information must be reliable, so that the users can be reasonably assured that
accounting information presents an accurate picture of the company’s financial health. Information that is
not reliable or inaccurate may mislead the users and the decisions taken by them going to be wrong.
3. Comparable: Comparability allows users to review their companies' accounting information against that
of other companies. Non-comparable accounting information can make this a difficult process. When
accountant consider preparing financial statements according to standard accounting principles. The
statements can then be compared to other company’s financial standard prepared in a similar manner.
 4. Consistent: Consistency refers to how accountants record financial information in a company’s general
books of accounts. The accountants need to ensure financial transactions are handled the same way.
Inventory purchases should be recorded the same way as yesterday, today and tomorrow. This helps
companies create accurate historical records and limit the amount of financial accounts.
Q: Discuss the Functions of Accounting.
Ans: The following are the major functions of accounting:
(a) Keeping Systematic Records: As a language of business, accounting is to report the results of most business
events. Hence, its main function is to keep a systematic record of these events. This function embraces recording
transactions in journal and subsidiary books like cashbook, sales book etc., posting them to ledger accounts and
ultimately preparing the financial statements [final accounts].
(b) Communicating the Results: The second main function of accounting is to communicate the financial facts
of the enterprise to the various interested parties like owners, investors, creditors, employees, government, and
research scholars, etc.
(c) Meeting the Legal Requirements: Accounting aims at fulfilling the legal requirements, especially of the tax
authorities and regulators of the business. It discharges this function in accordance with certain fundamental truths
and uniform enforcement of generally accepted accounting principles.
(d) Protecting the Properties of the Business: Accounting helps protecting the property of the business. It keep
records of all the assets of the business properly.
(e) Planning and Controlling the Business Activities: Accounting also helps planning future activities of an
enterprise and controlling its day-to-day operations. This function is done mainly to promote maximum
operational efficiency.

Q: Discuss the advantage and limitations of accounting.

Advantages of accounting:
1. Maintenance of business records: It records all the financial transaction pertaining to the respective year
systematically in the books of accounts. It is not possible for management to remember each and every
transaction for a long time due to their size and complexities.
2. Preparation of financial statements: Financial statements like Trading and profit and loss
account, Balance Sheet can be prepared easily if there is a proper recording of transactions. Proper recording
of all the financial transactions is very important for the preparation of financial statements of the entity.
3. Comparison of results: It facilitates the comparison of the financial results of one year with another year
easily. Also, the management can analyze the systematic recording of all the financial transactions according
to the policies of the entity.
4. Decision making: Decision making becomes easier for management if there is a proper recording of
financial transactions. Accounting information enables management to plan its future activities, make budgets
and coordination of various activities in various departments.
5. Evidence in legal matters: The proper and systematic records of the financial transactions act as evidence
in the court of law.
6. Provides information to related parties: It makes the financial information of the organization available
to stakeholders like owners, creditors, employees, customers, government etc. easily.
7. Helps in taxation matters: Various tax authorities like income tax, indirect taxes depends on the accounts
maintained by the management for settlement of taxation matters.
8. Valuation of business: For proper valuation of an entity’s business accounting information can be utilized.
Thus, it helps in measuring the value of the entity by using the accounting information in the case of sale of
the entity.
Limitations of accounting:
 1. Expresses Accounting information in terms of money: Non-financial transactions cannot be given effect
to in books of accounts. Only transactions of financial nature are measurable by the accountant. In fact,
financial transactions are expressed in terms of money.
2. Accounting information is based on estimates: There are some accounting data which are based on
estimates. Thus, inaccuracy in estimates is possible.
3. Accounting information may be biased: Accountants personal influence affects the accounting
information of the entity. Different methods of inventory valuation, depreciation methods, treatment of
revenue and capital expenses etc can be adopted by the accountant for measurement of income of the entity.
Hence, the income arrived in certain cases might be incorrect due to the lack of objectivity.
4. Recording of Fixed assets at the original cost: There can be a difference between the original cost and
current replacement cost of a fixed asset due to efflux of time, change in technology etc. Thus, the balance
sheet may not show the true financial status of an entity.
5. Manipulation of Accounts: The accountant or management can manipulate or misrepresent the profits of
an entity.
6. Money as a measurement unit changes in value: Stability in the value of money is not possible.
Accounting information will not show the true financial position if changes in the price level are not
considered.
Q: Discuss the qualitative characteristics of accounting information.

Ans: QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

Financial information should possess the following qualitative characteristics.

1. Reliability: The most important Qualitative Characteristics of Accounting information is that the information
furnished must be reliable. The information is considered reliable if it is free from any error or biasness
2. Relevance: Accounting information recorded in the books of accounts and disclosed in the financial statements
should be relevant to the business. Unnecessary and irrelevant information should be avoided.
3. Understandability: Accounting information should be presented in such a manner that they are understood easily
by their users such as investors, lenders, creditors, employees and other user group.
3. Comparability: Comparability is another important qualitative characteristics of accounting information. The
financial statements should be prepared in such a way that the profitability and financial position of a concern may
be used for making :
(a) Intra firm comparison, i.e. comparison with the similar information of the same enterprise over different
periods; and
(b) Inter-firm comparison, i.e. comparison with the information of other similar enterprise over different
periods,
Such comparison reveals the strength and weaknesses of the business entity.

Q: Discuss the different basis of accounting.

Ans: CASH BASIS OF ACCOUNTING – The basis of accounting actual cash receipts & actual cash payment are
recorded. Credit transaction are not recorded at all and are ignored any amount which is due or accrued. Under this
method the profit ascertained is called ‘Cash Profit’, it is the difference between the cash receipts & cash payment
relating to particular period. The receipts and payment account prepared in case of non-trading concern such as
charitable institution, a club, a school, a college, etc. and professional men and lawyer, doctors or chartered accountant
etc.

Advantages –
i) Cash basis of accounting has considerable to appeal to many people because it is so simple appears to be
realistic.
ii) This approach is more objective as very few estimate and judgment is required.
Disadvantages –

i) Cash basis of accounting does not give a true and fair view of profit and loss and financial position of the
enterprise because it ignores outstanding and prepaid expenses and accrued income.
ii) This approach does not follow matching principle of accounting.
B) ACCRUAL BASIS – Accrual basis of accounting is a method of accounting under which all transactions whether
cash or credit effecting during the year are recorded in the books of account. The income whether received or not
but has been earned or accrued during the period is the part of total income of that period. e.g – Sales made of credit
will be included in the total sales of the period irrespective of the fact when cash is actually realized.

Similarly, if the firm has taken benefit of a particular service but has not paid within that period, the expense
will relate to the period in which the service has been utilized and rent due to the landlord but not paid will be taken
as an expense for the period.

Advantages –

i) Accrual basis of accounting is preferred by accountants as it is more scientific as compared to cash basis of
accounting.
ii) This system disclosed correct profit and loss for a particular period and also exhibit through financial position
of the business of a particular day.
Disadvantages –

i) This system is not as simple as cash basis of accounting.

ii) A quick appraisal or the P/L is not possible as a lot of adjustments are required for finding the true financial
position of the business.

Q: Write a detail note on GAAP. Or Discuss the different concepts and conventions of accounting.

Ans: Generally accepted accounting principles (GAAP): Generally Accepted Accounting Principles (GAAP)
mean certain accounting principles that are followed while recording transactions and preparing the financial
statements. They are the accounting principles generally accepted by accounting professions to make the accounting
information reliable and understandable.

GAAP

Operating Guidelines Accounting Standards

1.Basic Assumptions 2. Principles 3. Modifying principles

a) Accounting Entity a) Duality a) Cost benefit.

b) Money Measurement b) Revenue recognition b) Materiality.

c) Going Concern c) Historical cost c) Prudence

d) Accounting Period d) matching of cost and d) Consistency.

Revenue. e) Timeliness.

e) Full Disclosure f) Substance over

f) Objectivity and legal form

Verifiability g) Industry Practice.

Accounting Concept: The work concept means “An abstract idea serving a systematised function”. Accounting
concepts are certain rules of general application. They are basic to the subject of accounting and provide guidelines
in selecting accounting methods in certain situations. Its object is to make accounting uniform, objective and
understandable. Examples – Dual Aspect Concept, Realisation Concept, etc.

Accounting Conventions: Accounting Convention means the recognised methods and procedures for recording
and presenting financial data to make the financial statements clear and meaningful to the users. These methods and
procedures are based on customs and usages. Now a days, Accounting Conventions are termed as Modifying
Principles.

Example: Consistency, Full disclosure, etc.

Assumptions: Accounting assumptions are generally accepted self evident truths. They do not need any evidence
to prove themselves. They provide a foundation on which the accounting system stands. Certain accounting
assumptions are fundamental for the preparation and presentation of financial statements.

Example: Business Entity, Going Concern, Accrual and Consistency Assumptions.

Accounting Principles: Accounting principles are the general guidelines for sound accounting practices. They
provide a broad frame work within which the accountants may differ while recording, classifying, summarising the
economic events. They are general decisions and rules derived from accounting concepts and are adopted by
accounting professions. They are man-made and subject to evolution.

BASIC ASSUMPTION

a) Accounting Entity Assumption: According to this assumption, the owner of a business is always considered as
distinct and separate from the business he owns. Business unit should have a completely separate set of books and
the business transactions are recorded from the point of view of the firm and not from the point of view of the
proprietor

b) Money Measurement Assumption: According to Money measurement assumption, only those events which
are capable of being expressed in terms of money are recorded in the books of account. The accounting system uses
money are recorded in the books of account. The accounting system uses money as its basic unit measurement.
c) Going Concern Assumption: Accounting system assumes that a business entity will continue to exit indefinitely.
It means that it will continue for a long period and will not be dissolved. So the business entity will be considered as
a going concern and its resources will be utilised to fulfil the long term objectives of the concern.

d) Periodicity Assumption of Accounting Period Assumption: Business is biased on going concern assumption,
thus for the reporting purpose, the entire life of the business is divided into small periods which are called accounting
periods. An accounting period is usually of one year

BASIC PRINCIPLES

• Duality or Dual Aspect Principle: According to this principle, every business transaction has a double
effect, i.e., it has two sides. This principle expresses the relationship between assets, liabilities and capital and is
expressed in the form of equation as under:
Capital + Liability = Asset
▪ Revenue Recognition: Revenue recognition principle tells us the procedure of determining the income and
expense for incorporation in profit and loss account. The determination of the point of time when revenue is
recognised is to be explained by the following examples:
i) If a business sells goods in December and receives cash in March, the revenue is considered as earned in
December as goods are legally transferred in December.
ii) If a business receives as advance of Rs. 5000 in December for supping goods in March, the amount of Rs.
5000 will be recognized as revenue in the month of March and not in the month of December as the transfer
of goods takes place in the month of March.
• Historical Cost Principle: Historical cost principle implies that an asset is ordinarily recorded in accounting
records at a price which is paid or to be paid to acquire it. As it refers to the past, it is called historical cost. It is the
basis for the valuation of an asset in the financial statements.
Matching Principle : Cost and revenue of a specified period is matched under this concept. To ascertain the earning of the
entity cost and revenue of the same accounting period are matched with each other. The cost that is so matched against the
revenue in the same accounting year, it becomes an expense of the same year.
• Full Disclosure Principles or Full Disclosure: Under this principles, all accounting statements should be
honestly prepared and all information of material interest to proprietors, creditors, investors, etc. should be disclosed
in the accounting statements. Moreover, books of account should be prepared in such a way that they become
reliable, informative and transparent.
• Objectivity and Verifiability Principle: It means that there must be some evidence in ascertaining the
correctness of information reported in a statement. Verifiability means that accounting information is supported
by a proper documentary evidence e.g. cash memos etc.
Modifying Principles

• Cost Benefit Principle: Modifying Cost- benefit Principle states that the cost of generating an information should
not exceed the benefit to be derived from it.
Example: A registered company provides to its shareholders an abridged Annual Report instead of a detailed annual
report in order to save cost and labour.

• Materiality Principle: The term materiality refers to the relative importance of an item. What is material for one
firm may be immaterial for another firm. Accounting standard 1, states that financial statements should disclosed
all “material’ items i.e., the items, the knowledge of which might influence the decisions of the users of the financial
statements.
• Prudence: The principle of prudence means that all unfavorable events should be recognized at the earliest and
favourable events should be recorded only when they actually take place. As for example, inventories are valued at
cost price or market price whichever is lower.
• Consistency Principle: Consistency implies that the same accounting procedure should be used for similar
items over periods. It is essential for clear and correct understanding and interpretation of the financial statements.
• Timeliness:. The principle of timeliness states that information should be disclosed timely. The Companies Act,1956
requires that the annual reports must be submitted to the Registrar of Companies and made available to the users within a
specified period of time after the closure of accounting year.
• Substance Over Legal form Principle: The modifying principle of substance over legal form implies that the accountant
should record and present in financial statements, transactions and events in such away that the substance of the transactions
and not their legality is communicated to the users.
• Industry- Practice Principle: GAAP are generally followed by all enterprise but sometimes certain practical considerations
require that the entries in the given industry should depart from GAAP.
Q: What is Accounting Standards? Discuss the needs for accounting standards.

Ans: Accounting standards are the established and accepted models which aim at providing excellent, adequate and
unbiased treatment of accounting transaction/ information and reporting the same in the financial statements to
facilities their users in forming rational and judicious decision.

Thus accounting standard is a standardized practice of accounting; formulated and established by a recognized
professional body.

Need for Accounting Standard

a) To ensure consistency and comparability: The main necessity of prescribe accounting standard is to bring
uniformity in financial reporting and to ensure consistency and comparability of data contained in the financial
statements.
b) To develop accounting as a language of business: Accounting as a language communicates the information about
an entity to its users. Accounting as a language of business can be developed if the grammar of this language in
the form of accounting standard is followed.
c) To harmonise accounting policies and practices: the objective of accounting is to harmonise the diverse
accounting policies and practices followed by different entities.
d) To provide tool to enhance corporate governance and responsibility.
Q: Discuss the different branches of accounting.

Ans:

1. Financial Accounting: It is that branch of accounting, which involves the recording of the transactions,
inclined towards the preparation of trial balance and final accounts.
2. Cost Accounting: Cost account is the accounting discipline, which deals with costs, i.e. the unit costs of
the goods produced and services provided. It helps the management of the organization in fixing the price,
controlling costs and providing relevant information for the purpose of decision making.
3. Management Accounting: The accounting system which supplies the necessary information to the
management, for rational decision making. The information may be concerned with funds, costs, profits
and losses and so forth. This information is helpful in determining the effect of the decisions and analysing
the performance of the entity.
4. Tax Accounting: The accounting system that deals with the tax return and its payment, instead of
preparation of final accounts of the enterprise, is called tax accounting.
5. Social Accounting: This branch of accounting is commonly termed as social responsibility accounting. It
aims at unveiling the facilities provided by the entity to the society, in terms of medical, housing,
education, and so forth.
Q: Discuss the procedure for issuing accounting standards in India.
Ans: following are the procedure is to be followed while issuing AS in India:

• First, the ASB will identify areas where the formulation of accounting standards may be needed
• Then the ASB will constitute study groups and panels to discuss and study the topic at hand. Such panels will
prepare a draft of the standards. The draft normally includes the definition of important terms, the objective
of the standard, its scope, measurement principles and the representation of said data in
the financial statements.

• The ASB then carries out deliberations of the said draft of the standard. If necessary changes and revisions
are made.

• Then this preliminary draft is circulated to all concerned authorities. This will generally include the members
of the ICAI, and any other concerned authority like the Department of Company Affairs (DCA), the SEBI,
the CBDT, Standing Conference of Public Enterprises (SCPE), Comptroller and Auditor General of India etc.
These members and departments are invited to give their comments.

• Then the ASB arranges meetings with these representatives to discuss their views and concerns about the draft
and its provisions

• The exposure draft is then finalized and presented to the public for their review and comments

• The comments by the public on the exposure draft will be reviewed. Then a final draft will be prepared for
the review and consideration of the ICAI

• The Council of the ICAI will then review and consider the final draft of the standard. If necessary they may
suggest a few modifications.

• Finally, the Accounting Standard is issued. In the case of standard for non-corporate entities, the ICAI will
issue the standard. And if the relevant subject relates to a corporate entity the Central Government will issue
the standard.