INTERNATIONAL INDIAN SCHOOL, DAMMAM.

THEORY BASE OF ACCOUNTING -2023-2024 [BSSS]

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES [GAAP]-
GAAP refers to rules or guidelines adopted for recording of business transactions, in order to bring
uniformity in the preparation and presentation of financial statements.

FUNDAMENTAL ACCOUNTING ASSUMPTIONS /CONCEPTS:

 GOING CONCERN
The concept of going concern assumes that a business firm would continue to carry out its operations
indefinitely, i.e. for a long period of time and would not be liquidated in the near future. This is an
important assumption of accounting as it provides the very basis for showing the value of assets in
the balance sheet. Eg. Machine purchased is expected to last 10 years, so it is depreciated over a
period of 10 years.

 CONSISTENCY
According to this assumption, accounting policies and practices applied by the business should be
uniform and consistent (same) year after year. This helps in better understanding of accounting
information and makes it comparable with that of previous years. It helps in comparison of
performance over a period of time, as well as comparison with other enterprises of same kind. Eg-
Two methods of charging depreciation (Written Down Value Method and Straight Line Method) are
equally acceptable. According to this assumption anyone method chosen by the company must be
consistently followed year after year. But it doesn’t mean that a practice once adopted cannot be
changed. An enterprise may switch over to the next if necessary but it must be disclosed in foot
notes.

 MONEY MEASUREMENT
The concept of money measurement states that only those transactions and happenings which can be
expressed in terms of money are recorded in the book of Accounts, such as sale of goods or
payment of expenses or receipt of income, etc.,

All other transactions/happenings which cannot be expressed in monetary terms for example: the
appointment of a manager, capability of employees, etc. do not find any place in accounting
records.

 BUSINESS/ACCOUNTING ENTITY
The concept of business entity assumes that business has a distinct and separate entity from its
owners. It means that (for the purpose of accounting) the business and its owners are to be treated
as separate entities.

Accounting records are made from the point of view of business and not that of owners.

Legally, a sole proprietor or the partners of a partnership firm are not separate from their business
units; but in Accounting the business units are assumed to have separate entity.
The personal assets and liabilities of the owner are, therefore, not considered while recording and
reporting the assets and liabilities of the business. Similarly, personal transactions of the owner are
not recorded in the books of the business, unless it involves inflow or outflow of business funds.

ACCOUNTING PERIOD
Accounting period refers to the span of time at the end of which the financial statements are
prepared, to know if business has earned profits or suffered a loss. The financial statements( Profit
and Loss A/c and Balance Sheet) are prepared at regular intervals, normally after a period of one
year. This time interval is called accounting period.

In case of sole proprietorship and partnership businesses, we can choose any date as the start of an
accounting year. Eg: January 1st, July 1st or any date, but one accounting year will consist of twelve
months. But in case of company form of a business, accounting year starts on April 1 st and ends on
March 31st next year. This is called financial year.

 FULL DISCLOSURE
The principle of full disclosure requires that all material and relevant facts concerning financial
performance of an enterprise must be understandably and completely disclosed in the financial
statements and their accompanying foot notes. This is to enable the users of accounting information
(internal and external), to make correct evaluation about the profitability and financial position of
the enterprise and help them to take correct decisions.

For eg: Reasons for low sales should be disclosed. (Corona Virus)

 MATERIALITY

This concept states that accounting should focus on material facts. Time and efforts should not be
wasted in recording and presenting facts, that are immaterial in the determination of income.

Whether an item is material or not depends upon its nature and/or amount involved. An item should
be regarded as material, if it is likely to influence the decisions of a prudent investor.

For example, money spent on creation of additional capacity for production would be a material fact
as it is going to increase the future earning capacity of the enterprise, information about any change
in the method of depreciation etc.

In certain cases, when the amount involved is very small For eg, stock of erasers, pencils, scales,
etc. are treated as expense, whether consumed or not.

 PRUDENCE/CONSERVATISM
“Do not anticipate a profit, but provide for all possible losses”
The concept of conservatism requires that profits should not to be recorded until realised but all
losses, even those which may have a remote possibility, are to be provided for in the books of
accounts.
This concept requires that business transactions should be recorded in such a manner that profits are
not overstated. All likely losses should be accounted for but all unrealized gains should be ignored.
For eg. Closing stock is valued at cost or market price whichever is lower, making provision for
doubtful debts or discount on debtors in anticipation of bad debts and discounts
 COST CONCEPT
This is also known as historical cost concept. This concept requires that all assets are recorded in the
book of accounts at their cost, which includes cost of acquisition, transportation, installation and
making the asset ready for use.

The concept of cost is historical in nature as it is something, which has been paid on the date of
purchase and does not change year after year.

Example: Machinery purchased for Rs. 1,50,000 in cash and Rs. 20,000 was spent on installation of
machine then Rs. 1,70,000 be recorded as cost of machine in the books and depreciation will be
charged on this cost. If market value of machine due to inflation has gone upto Rs. 2,00,000 then the
increased value will not be recorded. This cost is systematically reduced from year after year by
charging depreciation and the assets are shown in the balance sheet at book value (cost-depreciation).

 MATCHING CONCEPT/ MATCHING COST CONCEPT

This concept states that the revenues of one accounting period should match with the
expenses of the same accounting period to determine the correct profit or loss of that year. In
other words, expenses incurred in a period should be set off against its revenues earned in the
same period to determine true profit or loss.
For example- Insurance premium paid for a year is Rs. 1200 on July 1 and if accounts are
closed on March 31st every year, then the cost of insurance for the current year will be
calculated for 9 months only (ie. from July 1 to March 31 st) which is Rs. 900; will be taken in
to account and not Rs. 1200 for determining profit as the benefit of Rs. 900 only has been
availed during the current accounting period.

 DUAL ASPECT
This concept states that every transaction has a dual /two - fold effect on various accounts and
should therefore be recorded at two places. The Duality principle is commonly expressed in
terms of fundamental accounting equation which is:

ASSETS = LIABILITIES + CAPITAL

This equation demonstrates the fact that for every debit there is an equivalent credit. As a
matter of fact the entire system of Double Entry Book Keeping is based on this concept.

 Revenue Recognition ( Realisation) Concept:

The concept of accrual requires that Revenue should be recorded at the time when it is
realised. Revenue is recognized when the legal right to receive it arises ie. Revenue is
assumed to be realized when the sale is completed or service is rendered and it is immaterial
whether cash is received or not.
e.g., if a credit sale (Credit for two months) for Rs. 15,000 is made on 15th Feb. 2020, then
the revenue earned is to be recorded on 15th Feb. 2020, not on the date of cash realized, i.e.,
after two months. The transaction has been recorded /because the revenue has been earned.
  Objectivity Concept
This concept holds that accounting should be recorded in an objective manner, free from
personal bias of accountant and others. This can be possible when each transaction is
supported by verifiable documents, vouchers or evidences. Ex, purchase of material may be
supported by copy of invoice, delivery challan, etc.

SYSTEMS OF ACCOUNTING

1. DOUBLE ENTRY SYSTEM OF ACCOUNTING

It is a complete system as both debit and credit aspects of a transaction are recorded. The system is
accurate and more reliable as the possibilities of frauds and misappropriations are minimized. The
arithmetic inaccuracies in records can mostly be checked by preparing the trial balance. The system
of double entry can be implemented by big as well as small organisations. It records both cash and
credit transactions.
2. SINGLE ENTRY SYSTEM
It is not a complete system of maintaining records of financial transactions. It does not record two –
fold effect of each and every transaction. Instead of maintaining all accounts, only personal
accounts and cashbook are maintained under this system. In fact, this is not a system but a lack of
system as no uniformity is maintained in recording the transactions. However, this system is
followed by small business firms as it is very simple and flexible.
BASIS OF ACCOUNTING
1. Cash Basis
Under cash basis entries are recorded when cash is received or paid and not when the receipts or
payment becomes due. Eg: If office rent for the month of December 2019 is paid in January 2020, it
would be recorded in the books in the month of January 2020 and not in December 2019.

Similarly, sale of goods on credit in the month of January 2020 would not be recorded in January
but it will be recorded when the payment is received.

2. Accrual Basis
Under the revenues and costs are recognized in the period in which they occur rather than when they
are paid. Under this system the effect of a transaction is taken into account in the period in which
they are earned rather than in the period in which cash is actually paid/ received. This is a more
appropriate basis for the calculation of profits, as expenses are matched with the revenue earned in
relation thereto.

ACCOUNTING STANDARDS
Accounting standards are written statements of uniform accounting rules and guidelines developed
by IASC (International Accounting Standard Committee) for preparing the uniform and consistent
financial statements.

Need for Accounting Standards

Accounting extends information to various users. Accounting information can serve the interest of
different users only if it possesses uniformity and full disclosure of relevant information. There can
be alternate accounting treatments and valuation rules which may be used by any business entity.
Accounting standard facilitates the scope of alternatives which fulfil the characteristics of being true
and fair.

BENEFITS/ OBJECTIVES OF ACCOUNTING STANDARDS

1. Accounting standard helps in eliminating variations in accounting treatment to prepare

financial statements.

2. Accounting standard may call for disclosures of certain information which may not be
required by law, but such information might be useful for general public, investors and
creditors.

3. Accounting standard facilitate comparability between financial statements of inter and intra
companies

LIMITATIONS OF ACCOUNTING STANDARDS

1. Accounting standard makes choice between different alternate accounting treatments difficult to
apply.

2. It is rigidly followed and fails to extend flexibility in applying accounting standards.

3. Accounting standard cannot override the statue. The standards are required to be farmed within the
ambit of prevailing status.

APPLICABILITY OF ACCOUNTING STANDARDS

Accounting standards are applicable to sole proprietorship, partnership, societies, trusts, Hindu
undivided family, Association of persons, Co-operative societies and companies

To make accounting policies and procedures uniform almost all countries have agreed to apply
IFRS. But the name of this IFRS has been converged (joined) as “Ind AS”.

In substance, Ind AS is not different from IFRS. Ind AS is accounting standard notified by
ministry of corporate affairs and has wide range of convergence to existing Accounting
Standards.

APLICABILITY OF IND-AS

Ind-AS applies to the following companies:

(a) Companies that are listed on the stock Exchange, in India and
(b) Companies having networth of Rs 250 crores or more.

Other companies may follow Ind-AS voluntarily.

Ind-AS will also apply on the Holding, Subsidiary, Associate and Joint Venture Companies on
which Ins-AS applies or is voluntarily adopted.

GOODS AND SERVICES TAX (ONE COUNTRY ONE TAX)

GST is a destination tax on consumption of goods and services. It is a comprehensive indirect
tax levied at the prescribed rate on sale of goods and services.

It has dual aspect with center and states simultaneously levying on a common tax base. The 3
main components of GST are CGST, SGST and IGST.

CGST- CENTRAL GOODS AND SERVICE TAX

Taxes collected under CGST will constitute the revenues of the central government.
SGST- STATE GOODS AND SERVICE TAX
Collection of SGST is the revenue of state government.
IGST- ITEGRATED GOODS AND SERVICE TAX
Revenues collected under IGST is divided between central and state government as per the rates
specified by the government. IGST is charged on transfer of goods and services from one state
to another.
CHARACTERISTICS OF GST

1. GST is a destination based tax and levied at a single point at the time of
consumption of goods and services by the end consumer.
2. GST is comprehensive levy and collection on both goods and services at the
same rate with the benefit of input tax credit.
3. Minimum number of rates for tax does not exceed two.
4. There is no multiple levy of tax on goods and services such as sales tax, octroi,
entertainment tax etc.
ADVANTAGES / OBJECTIVES OF GST

1. Introduction of GST has resulted in the abolition of multiple types of taxes on goods and
services.
2. GST widens the tax base and increases the revenue to center and state thereby reducing
administrative cost for the government.
3. GST has removed the cascading effect on taxation.
4. GST will result in reducing the cost of production of goods and services and consequently the
demand of goods and services will increase.
5. It will eventually promote economic efficiency and growth in the country.