FINANCIAL AND MANAGEMENT ACCOUNTINGUnit - 1Accounting Defnation
According for historical function andmanagerial function Scope of
accounting Financial accounting andManagement accounting Managerial
uses Diferences.Financial Accounting: Accounting concepts
Convections Principles Accounting standards International
Accounting standards.Unit-2Double entry system of accounting -
Accounting books Preapartion ofjournal and ledger, subsidiary books
- Errors and rectifcation Preparation oftrial balance and fnal
accounts.Accounting from incomplete records - Statements of afairs
methods-Conversion method - Preparation of Trading, Proft &
Loss Account and BalanceSheet from incomplete records.Unit -
3Financial Statement Analysis - Financial statements - Nature of
fnancialstatements - Limitations of fnancial statements - Analysis
of interpretation-Types of analysis -- External vs Internal
analysis - Horizontal vs Verticalanalysis - Tools of analysis -
Trend analysis - Common size statements-Comparative
statements.Ratio Analysis - Types - Proftability ratios - Turnover
ratios - Liquidityratios - Proprietary ratios - Market earnings
ratios - Factors afecting efciencyof ratios - How to make efective
use of ratio analysis - Uses and limitation ofratios - Construction
of Proft and Loss Account and Balance Sheet with ratiosand relevant
fgures - Inter-frm, Intra-frm comparisons.Unit -4Fund Flow
Statements - Need and meaning - Preparation of schedule ofchanges
in working capital and the fund fow statement - Managerial uses
andlimitation of fund fow statement.Cash Flow Statement - Need -
Meaning - Preparation of cash fowstatement - Managerial uses of
cash fow statement - Limitations Diferencesbetween fund How and
cash tlow analysis.Unit-5Budgeting and Budgetary Control:
Preparation of various types of budgets- Classifcation of budgets -
Budgetary control system - Mechanism -Masterbudget.Unit-6Capital
Budgeting System - Importance - Methods of capital
expenditureappraisal - Payback period method - ARR method - DCF
methods - NPV andIRR methods - Their rationale - Capital
rationing.FINANCIAL AND MANAGEMENT ACCOUNTINGLESSONTITLE1.
Accounting an Introduction2. Management Accounting3. Theory Base of
Accounting - Accounting Standards4. Practical Base of Accounting -
Origin and Analysis of BusinessTransactions5. Financial Statements
of Proft-making Entities Manufacturing-cum-Trading Organisations6.
Financial Statements of Non-Proft-making Entities7. Errors
Management8. Accounts from Incomplete Records - Single Entry
System9. Financial Statement Analysis10. Ratio Analysis11. Fund
Flow Analysis12. Cash Flow Analysis13. Budgeting and Budgetary
Control14. Capital Budgeting15. Case StudyLESSON - 1ACCOUNTING: AN
INTRODUCTIONLearning outcomes; on completion of this chapter, you
should be able to: Explain the nature of accounting. Identify the
various branches of accounting. Explain the process of creation of
fnancial statements and theirinterpolation. Explain the various
objectives of fnancial statements. Identify the various uses of
accounting information.INTRODUCTIONAccounting discipline deals with
measurement of economic activitiesafecting infow and outfow of
economic resources to develop useful informationfor decision
making. At household level information about outfow and infow
ofcash resources helps -.0 assess fnancial position and plan
household activities.At Government level, information about infow
from taxes (direct as well asindirect) and expenditure on various
activities (developmental and nondevelopmental) is needed for
planning and budgeting. Although accounting canbe discipline has
universal applicability, but its growth is closely associated
withthe developments in the business world. Thus to understand
accounting as afeld of study for universal application, it is best
identifed with recording ofbusiness transaction and thereby
creating economic information about businessenterprises to
facilitate decision making.NATURE OF ACCOUNTING: 1.2 Accountingi.is
man-made;ii.has evolved over a period of time;iii.is practiced in a
social system;iv.is a systematic exercise;v.is judgmentat at
times;vi.follows fexible, not a rigid approach;vii.is essentially a
language;viii. as a language, has a very well defned syntax of its
own; andix.Communicates fnancial information for decision
making.Accounting being a man-made system has evolved over a period
of time toprovide fnancial information of business enterprises to
users of accountinginformation. A large number of groups with
varied interests in afairs of abusiness enterprise have emerged
over a period of time, especially afteremergence of corporate forms
of organization involving separation of ownershipmanagement. These
user groups include those who; manage the activities of the
enterprise( management) own the enterprise( owners/ shareholders)
extend credit for supply of goods to the enterprises(creditors) buy
goods from the enterprises( customers) lend money to the
enterprises( banks and fnancialinformation) are employed in the
enterprises (employees) intend to make investment in the
enterprises(ivestors) are doing research(researchers) are engaged
in collection of taxes ( sales tax and income tax authorities)
formulate fscal and monetary policies (otherGovernment department)
are members of the public at large(general public)Internal users of
accounting information are inside the enterprise andneed
information to control and plan the activities of the business to
manage itefectively. These include Owners in case of non corporate
enterprises andmanagers and directors in case of corporate
business. Their information needsare satined through various
reports which are generally prepared internal useand remain
unpublished. External users of accounting information are
outsidethe enterprise. The information need of these user groups
are met by measuringthe desired information by following a
systematic process. It results in creationof fnancial statements
which are generally published to make the informationavailable to
external user group for decision making. The need forcommunicating
relevant and useful information to that potential internal
andexternal users is always there and accounting is intended to
perform that role.Thus, accounting may be defned as:"the process of
identifying, measuring and communicating information topermit
judgement and decision by the users" ( American
AccountingAssociation)BRANCHES OF ACCOUNTING Financial
Accounting:It primarily concentrates on creation of fnancial
information forexternal user groups such as creditors, investors,
lenders and so on. It dealswith business events which have already
occurred and is, therefore, historical innature. Traditionally, the
aim was to develop information about income andfnancial position on
the basis of events which had taken place during a periodof time.
Recent trend in corporate form of organization is to provide
informationabout cash fows and earnings per sh^e also as part of
published fnancialstatements.Management Accounting - The
information provided by the fnancialaccounting system is signifcant
but not sufcient for smooth orderly andefcient conduct of business.
Management needs more information to dischargeits function of
stewardship, planning, control and decision-making. Asinformation
needs of management vary from enterprise to enterprise, thegrouping
and reporting of information takes diferent forms. Trie diferent
waysof grouping information and preparing reports as desired by
managers fordischarging their functions are referred to a
management accounting.Management accounting provides information to
the management not onlyabout cost but also revenue, proft,
investment etc., for managing business moreefciently and
efectively. A very important component of managementaccounting is
cost accounting which deals with cost ascertainment and
costcontrol.Few other branches of accounting which are of recent
origin aresocial responsibility accounting and human resources
accounting. The frst oneinvolves accounting for social costs
incurred by the enterprise and socialbenefts created by it while
the second deals with accounting for humanresources.In the present
book, we are concerned with fnancial accountingonly. The word
accounting and fnancial accounting are used
interchangeably.Financial accounting provides information to
external user groupsin the form of published fnancial statements.
As these users are involved inpreparation of fnancial statements,
it is very essential that the publishedstatements have credibility
and regarded as reliable by external users.Therefore, accounting,
as a language for communicating information, needs tohave a strong
syntax of its own for preparing credible fnancial statements.The
syntax of accounting language comprises of analysis andrecording of
business transactions on the basis of double Entry system of
bookkeeping and the basic principles on which the practical system
is based. Thetheory base; of accounting consists of Generally
Accepted Accounting Principles(GAAP), Conceptual framework and
Accounting Standards (AS) issued by theprofessional accounting
bodies all over the world,The credibility of the fnancial
statements is established throughanalysis independent examinations
by a chattered accountant who certifes thatthe information provided
therein gives true and fair view of the activities of tMbusiness in
conformity with accepted principles and practices. This process
ofattestation of account is known as auditing of accounts.MEANING
OF FINANCIAL ACCOUNTINGMeasurement of accounting information
involves three basic stepsas per the traditional defnition of
accounting by the American Institute ofCertifed Public Accounts
(AICPA) which defnes accounting as "the are ofrecording,
classifying and summarizing in a signifcant manner and in terms
ofmoney, transaction- and events which are negative part atleast of
fnancialcharacter and interpreting the results thereof.On this
basis of above information, Accounting or more precisefnancial
accounting can be basically divided into two parts",A.Creation of
fnancial information. B.Use of fnancial information.A. Creation of
fnancial information:Creation of fnancial information involves
three steps: 1. Recording:The process of creation of fnancial
information starts with the occurrenceof a business transaction
which can be Qualifed. The transaction is evidencedby some document
such as Sales bill, Pass book, Salaries slip etc., Thesystematic
record of those transactions is chronological order (i.e. the order
inwhich they occur ) is made in a book called JOURNAL BOOK. The
four basicquestions need to be addressed while recording namely,
what to record, when torecord, how to record and at what value to
record?What to record? Since-accounting is regarded as language of
the business, itshould systematically record all the transaction
and events which afect theresults of business and ignore the person
transaction of the proprietor. Beforerecording in the journal book,
all business transaction expressed in terms ofmoney. Consequently
business activities which cannot be expressed in terms ofmoney such
as strikes, changes in the composition of board of directors etc.,
arenot recorded. Thud decision makers will get information only
about moneyaspects of the business enterprise from a accounting
records.When to record? Usually business transaction is recorded
only when it hasoccurred. Thus accounting is basically historical
in nature.How to record? Usually business transaction has two
aspects and both theseare recorded by passing analysts entry in an
journal book. This system ofrecording is called double entry book
keeping system.At what value to record? To record occurrence of an
event in journal book,decision about the value of the transaction
is needed.A number of diferent valuation bases are used in
accounting invarying degrees and include historical cost, current
cost, realizable value andpresent value. These valuation based
generally assume signifcance in case ofvaluation of assets.
Historical cost refers to amount paid / payable to acquire anasset.
The current cost means the amount that would have to be paid, if
theasset is to be acquired currently. The realizable value refers
to the net realizablevalue of the assets if it is to be disposed.
The present value of an asset is thepresent discounted value of the
future infows that analysis item is expected togenerate in the
normal course of business.2. Classifying:After recording monetary
transactions in the journal book, nextstep is to classify the
recorded information into related groups to putinformation in
compact and usable forms. For e.g., all transactions involvingcash
infows (receipts) and cash outfows (payments) can be grouped to
developuseful information is called ledger book. Mechanism used for
classifcation ofrecorded information is to open accounts which are
called ledger accounts.3. Summarizing:Basic aim of accounting is to
create fnancial information in a form whichwill be useful to the
decision makers. To achieve this end, accounts containingclassifed
information in the ledger book are balanced. After balancing of
theledger book, account balances are listed statement giving names
of thesesaccounts and their balance is called " TRIAL BALANCE " on
the basis of trailbalance, summaries are prepared to give useful
information about the fnancialresults during a time period and the
fnancial position at a point of time.Reporting of summarizes of the
business transaction is done in the form offnancial statements
which are known as FINAL ACCOUNTS. According tointernational
Accounting standard - 1 the term fnancial statements coversbalance
sheet, income statements or proft and loss accounts, notes and
otherstatements and explanatory material which are identifed as
being part of thefnancial statements. The process of creation of
fnancial information can besummarized as follows:Thus recording,
classifying and summarizing are three basic stepsinvolved in
creation of fnancial statement which ascertain and
communicateresult of business entity. For this is assumed that
business and its owner haveseparate existence. For accounting
purpose, even a division of the business or abranch of it may be
treated as an accounting entity.B. Use of Financial Information /
Statements:Financial statements prepared by a business enterprise
arepublished and are available to the decision makers. Sound
division makingrequires analysis and interpretation of these
fnancial statements. A verycommonly used tool for fnancial analysis
is ratio analysis. However, there areother tools which are used by
the decision makers to undertake analysis. Thewidely used tools for
carrying out analysis are : Cash fow statement Fund fow statement
Ratio analysis Comparative statement Common size statementHowever
to analyze and interpret these fnancial statements, theuser should
be aware of purpose and nature of these statements can bedescribed
as follows :"Financial statements are prepared for the purpose of
presenting aperiodical review or report on progress by management
and deal with the statusof investment in the business and the
results achieved during the period underAnalysis of business
transaction evidenced by source document Recording Journal Book
Classifcation in ledgerbookSummarization frst in trial balance and
then infnancial review. They refect a combination of recorded
facts, accounting, conventionsand personal judgements and
judgements and conventions applied after themmaterially. The
soundness of the judgement necessarily depends on thecompetence and
integrity of those who make them and on their adherence toGenerally
Accepted Accounting Principles and Conventions. (Bombay
StockExchange Ofcial Directory).OBJECTIVES OF ACCOUNTINGThe main
objective of accounting are as follows: The main records of
business: In accounting, systematic record ofmonetary aspects of
business events are maintained. The frst step inpreparation of
fnancial statements. This is referred to as book-keeping.
Calculation of proft or loss: To calculate proft earned or losses
suferedduring a period of time, a business enterprise prepares an
IncomeStatement. It is also referred to a trading and proft and
loss account. Depiction of fnancial position: In addition to proft
(or loss), sounddecision-making requires information about the
fnancial position of abusiriess enterprises. To depict fnancial
position of a business, fnancialposition statement is prepared. On
the one hand, it gives details ofresources owned by the business
enterprise. Resource owned are termedas assets. On the other hand
it contains the information about obligationsof business.
Obligation of the business towards outsiders and owner arereferred
to as liabilities and capital respectively.Financial
positionstatement is also termed as balance sheet which provide
informationabout sources of fnance (e.g. outside liability and
owners equity) and theresources (eg. assets) of the business. To
portray the liquidity position: Financial reporting should
provideinformation about how an enterprise obtains and spends cash,
about itsborrowing and repayment of borrowing about its capital
transactions,cash dividends and other distribution of resources by
the enterprise toowners and about other factors that may afect an
enterprise's liquidityand solvency. Control over the property and
asset of the frm: Accounting provides up-to-date information about
the various assets that the frm possess andthe liabilities the frm
owes so that nobody can claim a payment which isnot due to him. To
fle tax returns: This is the objective which really hardly
needsemphasis. The credible accounting records provide the best
bases forfling returns of both, direct as well as indirect taxes.
To make fnancial information available to various groups and
users:Accounting is called the language of business. It aims to
communicateinformation about fnancial results and fnancial position
of a businessenterprise to decision makers,USERS OF ACCOUNTING
INFORMATIONUsers of accounting information can be grouped as
followsOwners: Owners refers to a person or group of persons who
have suppliedcapital for running the business. It refers to
individual in case of joint stockcompanies. Information needs of
shareholders have assumed great signifcancein the corporate
business world because of separation of ownership andmanagement in
case of joint stock companies owners are interested in thefnancial
information, to know"about safety of amount invested and return
onamount invested.Managers: For managing business proftably
information aboutHnancial resultand fnancial position is needed by
management By providing this information,accounting helps managers
in efcient and smooth running of a businessenterprise.Investors:
Prospective investors would like to know about the past
performanceof the business enterprise before making investment in
that concern. Byanalyzingihistorical information provided by
accounting records, they can arriveat a decision about the expected
return and risk involved in investing inparticular business
enterprise.Creditors and Financial Institutions: Whosoever is
extending credit or loan toa business'enterprise, would like to
have information about its repayingcapacity, creditworthiness etc.,
The required information can be obtained byanalyzing and
interpreting the fnancial statements of the business
enterprise.Employees: Employees are concerned about job security
and future prospectus.Both of these are intimately related with the
performance of the businessenterprise, Thus by analyzing fnancial
statements they can draw conclusionsabout their job security and
future prospectus.Government: Government policies relating to
taxation, providing subsidies etc.,are guided by the relevance of
the industry in the economic development of thecountry and the past
performance of the industry. Information about the pastperformance
is provided by the accounting system, collection of taxes is
alsobased on accounting records.Researchers: Researchers need
fnancial information for testing hypothesis anddevelopment of
theories and models. The fnancial statement provides therecorded
information.Customers: (Customers who have developed loyalties to a
business are ceitainlyinterested in the continuance of the
business. They certainly want to knowabout the future directions of
the enterprise with which they are associatingthemselves. The way
to information about the enterprise is through theirfnancial
statements.Public: An enterprise afects the public at large in many
ways such as providerof the employment to a number of persons being
a customer to many supplier aprovider of amenities on the locality,
a cause of concern to the public due topollution etc., Hence public
at large is interested in knowing the futuredirections of the
enterprise and the only window to peep inside the enterprise
istheir fnancial statements.ACCOUNTING AND THEIR
DISCIPLINES:Accounting is the best understood when the other
relateddisciplines are conceptually clear to the user. For e.g., a
user can hardlyunderstand fnancial statements with lots of tables
and graphs in it. He is notcomfortable with the basics of
mathematics and statistics. Accounting is veryintimately connected
with many disciplines more important of which areeconomics, law,
management, statistics and mathematics.Linkage with
Economics:Accounting has strong linkages with economics. It has
acquired its mostimportant concepts of income and capital from
economics. The accountant aswell as economist agree that capital
should be maintained intact whilecalculating income and this income
can be distributed without afecting capital.However, the
interpretation of the two concepts by accountant and economistdifer
a great deal despite similarities. The capital to an economist is
like a treeand income is like a fruit on that tree. In technical
terms, a stock of wealth(Tree) or assets existing at a point of
time is called capital whereas fow ofbenefts from the wealth
through a given periodvs called income. Hence capitaland wealth are
synonyms for the economist. The methodology adopted byeconomist is
fnding income is to fnd out the excess of capital at the end of
theyear over the beginning of the year. If the capital increases,
it is more income.However as the capital decreases it is called
loss. To arrive at the value of thecapital or wealth, the present
value of the future benefts is calculated bydiscounting expected
benefts at the required rate of return. Hence to fnd outthe worth
of an asset, the economist will have to estimate the life of the
assetand the likely benefts to be desired from it. The benefts will
be discounted atthe requires rate of return of the asset has an
exceptionally long life. Henceeconomists valuation of capital and
income are highly subjective.Accountant tries to impart
practicability to the concept of capital andincome. Recognizing
that future benefts of an asset with long life of say 100years are
difcult to estimate, the accountant puts a value of the asset at
whichit was acquired. However, his attitude is quite fexible and
makes use of otherbases of measurement wherever the need arises.
The income of businessbelongs to a owner. The accountant fnds
income as a direct result of matchingof revenue and expense of the
same period. It is always calculated at the end ofa period. The
matching of revenues and expense can be done on diferent basisviz
accrual, cash and hybrid bases. The bases are discussed in detail
later:Linkage with Mathematics:Accounting is all about fgures and
operations on these fgures. Thebasic system of accounting can be
very conveniently converted in themathematical form in the form of
an accounting equation. Simple mathematicaloperations involved in
accounting are addition, subtraction, multiplication anddivision.
Besides many aspects of accounting involve calculations which
involvestrong knowledge of mathematics. For e.g., calculation of
interest, calculation ofthe annuity needed to depreciate an asset
with a defned rate of interest over itsestimated useful life,
bifurcation of a hire purchase instalment in cash pricecomponent
and interest component etc.,Linkages with Statistics:Accounting is
not only about the preparationof accounting information,it also
involves the presentation and interpretation of accounting
information.The presentation aspects involved creation of tables
and graphs etc., theknowledge of which essentially lies in the
discipline of statistics. One of the mostdebated topic of
accounting namely infation accounting involves
extensiveconversation of historical accounting information with the
help of price indices,'an important constituent of the discipline
of statistics. The interpretation ofaccounting information involves
making absolute and relative comparison withthe help of ratio
analysis. The knowledge of statistics is needed for the purpose.An
important way of calculating interest is through the concept of
average duedate, which is based on the knowledge of
averages.Linkages with Law:Accounting essentially operates within a
legal environment. Manybusiness organizations are governed by their
respective statues which prescribethe many aspects of their
accounting information including the presentation ofinformation.
For e.g., the Indian Companies Activities, 1956 prescribes the
rulesfor managerial remuneration. It also prescribes the format of
balance sheet aswell as proft and loss account, The banking,
insurance and electricitycompanies have also to prepare their
accounts as per the requirement of therespective statutes governing
them.LESSON - 2MANAGEMENT ACCOU NTINGDEFINITION OF MANAGEMENT
ACCOUNTINGThe accounting activity can be classifed into two parts.
FinancialAccounting and Management Accounting. Though both of them
are interlinked,Management accounting is future oriented, dynamic
and is made to be decisiveand control relevant.International
Federation of Accountants (IFAC) defned ManagementAccounting
process as "the process of identifcation, measurement,accumulation,
analysis, preparation, interpretation and communication
ofinformation both fnancial and operating used by management to
plan, evaluateand control within an organisation and to assure use
of and accountability forits resources".ICWAI published Glossary of
Management Accounting terms defningManagement Accounting as "a
system of collection and presentation of relevanteconomic
information relating to an enterprise for planning, coordinating
anddecision making",Management Accounting : Ofcial Terminology of
CIMA is defnedManagement Accounting as "the provision of
information required bymanagement for such purposes
as:1.Formulation of policies2.Planning and controlling the
activities of the enterprise3.Decision taking on alternative course
of action4.Disclosure to those external to the entity (shareholders
and others)5.Disclosure to employees6.Safeguarding assetsThe assets
involves participation in management to ensure that there
isefective: Formulation of plans to meet objectives (long-term
planning) Formulation of short-term operation plans (budgeting/
proftmaking)".American Accounting Association defnes Management
Accounting as "theapplication of appropriate techniques and
concepts in processing historical andprojected economic data of an
entity to assist management in establishing plansfor reasonable
economic objectives and in the making of rational decisions witha
view towards these objectives".Richard M.S. Wilson and Wai Fong
Chua defne Managerial Accounting as"Managerial Accounting
encompasses techniques and processes that areintended to provide
fnancial and non-fnancial information to people within
anorganisation to make better decisions and thereby achieve
organisational controland enhance organisational efectiveness" The
Management Accounting is used by management to plan the
activity,evaluate performance, ensure integrity of fnancial
information and toimplement the systemof reporting that is linked
to organisationalresponsibilities and contributes to the efective
performance measurement. Thedefnition of Management Accounting
embraces all functions undertaken byaccountants in an organisation.
Management Accounting needs to be dynamicand forward looking. It
also comprises the preparation of fnancial reports
fornon-management groups such as shareholders, creditors,
regulatory agenciesand tax authorities. The role of Management
Accountant is not determined byan isolated concept. It is
determined by the requirements of business asExpressed in its
structures.SCOPE OF MANAGEMENT ACCOUNTINGManagement Accounting
includes Financial Accounting and extends tothe operation of a
system of cost accounting and fnancial management. Whilemeeting the
legal and conventional requirements regarding the presentation
offnancial statements (proft and loss account, balance sheet and
funds fowstatements) it stresses upon the establishment and
operation of internalcontrols. The scope of Management Accounting,
inter alia, includes: Formation, installation and operation of
accounting, cost accounting, taxaccounting and information systems.
Management Accountant has to construct and re-construct these
systems to meet the changing needs ofmanagement functions The
compilation and preservation of vital data for management
planning.The account and document fles are respository of vast
quantities ofdetails about the past progress of the enterprise,
without which forecastsof the future is very difcult for the
enterprise. The ManagementAccountant presents the past data in such
a way as to refect the trendsof events to the management. Providing
means of communicating management plans to the variouslevels of
organisation. This, on the one hand, ensures the coordination
ofvarious segments of the enterprise plans and on the other defnes
the roleof individual segments in the whole plan and assists the
management indirecting their activities. Providing and installing
an efective system of feedback reports. Thiswould enable the
management in its controlling function. By pinpointingthe
signifcant deviations between actual and expected activities, and
byadhering to the principles of selectivity and relevance, such
reports helpin jthe installation and operation of the system of
'Management byException'. The Management Accounting is expected to
analyse thedeviation by reasons and responsibility and to suggest
appropriatecorrective measures in deserving cases. Analysing and
interpreting accounting and other data to make itunderstandable and
usable to the management. It is only through suchanalysis and
clarifcation that the management is enabled to place thevarious
data and fgures in proper perspective in the performance of
itsfunctions. Such analysis assists management- in the location
ofresponsibilities and to efect necessary changes in the
organisationalsetup to achieve the objectives of the enterprise in
a more efcientmanner. Assisting management in decision making by
(i) providing relevantaccounting and other data and (ii) analysing
the efect of alternativeproposals on the profts and position of the
enterprise. ManagementAccountant helps the management in proper
understanding and analysisof the problem in hand and presentation
of factual information obviouslyin fnancial terms. Providing
methods and techniques for evaluating the performance of
themanagement in the light of the objectives of the enterprise,
thus assistingin the jrnpiementation of the principle 'Management
by Objectives'.Improving, modifying and sharpening the efectiveness
of the existingtechniques of analysis. The Management Accountant
would always thinkof increasing the practicability of existing
techniques. He should be on thelook-out of the development of new
techniques as well.Thus, Management Accounting serves not only as a
tool in the hands ofmanagement, but also provides for a technique
evaluating the performance of itsfunctions of planning/decision
making and control, and at the same time,enabling the owners and
other interested parties to evaluate and appraise themanagement of
the enterprise.FUNCTIONS OF MANAGEMENT ACCOUNTINGManagement
Accountant is one of the best assets for management.
Hiscontribution has been growing with passage of time. He will
continue to deliverthe goods in a magnifcent manner in future with
varied experiences. Scope isexpanding and managements of various
sectors are benefting. Excerpts fromthe "Preface to Statements on
International Management Accounting" issued oythe international
Federation of Accountants in February 1987 are
reproducedbelow:"Management Accounting is used by management
to;Plan - to gain an understanding, to expected business
transactions andother economic events and their impact on the
organisation, and to usethis understanding as a basis for a course
of action to be followed by theorganisation in the future;Evaluate
- to judge the implications of various past and/or future
events;Control - to ensure the integrity of fnancial information
concerning anorganisation's activities or its resources;Assure
accountability - to implement the system of reporting that is
closelyaligned to organisational responsibilities and that
contributes to theefective measurement of management
performance"The functions of Management Accounting can be broadly
classifed into;(a) Periodic interval accounting reports, and(b) Ad
hoc analysis of data decision making.It is increasingly felt that
Management Accountants should involvethemselves more and more in
decision making and problem solving oforganisations. The areas of
decision making and problem solving are dealt inthe following
paras: Strategic Management Accounting: This function helps the
organisationprepare long-term plans, formulate corporate strategy
and forecast andevaluate the competitors. Investment Appraisal:
This activity includes the (i) appraisal of long-terminvestment
(ii) funding of accepted programmes projects, and (iii) post-audit
of accepted programmes. Financial Management: It deals with raising
of funds for investment,managing surplus funds, controlling working
capital etc, Short-term ad hoc decisions: This includes analysing
data for takingdecisions c i pricing, product introduction,
acceptance of special ordersetc. Managing the organisation of
information system: This includes not onlyorganising the
enterprise's fnancial data but fulflling the informationneeds of
all the segments of the organisation.FUNCTIONS OF MANAGEMENT
ACCOUNTANTThe term 'Management Accountant' has many Director,
Financial Director,Financial Controller, Finance Comptroller etc.,
are some of the terms used todesignate withtheworkManagement
Accounting. Depending situation,size, nature arid organisational
setup and his position in the company, theManagement Accountant may
be required to perform various and variedfunctions. The importance
and efectiveness of his function would also dependupon the
confdence reposed in him by the top management and the
functionalmanagers. His functions generally embrace each and every
activity of themanagement. The essence of Management Accountant's
functions are asfollows: The Management Accountant will establish,
coordinate and: administerplans to facilitate the forecasting of
sales, expense budgets and coststandards that will permit proft
planning, capital budgeting andfnancing. The Management Accountant
will formulate accounting policy andprocedures. Operating data and
special reports must be prepared so thatthe performance can be
compared with plans and standards, and anyvariance between actual
operations and pre-determined standards can beanalysed for
corrective actions by management Such comparisonsbetween actual and
expected activities should help the management inproper fxation of
responsibility and also in evaluation of variousfunctional and
divisional heads. The Management Accountant will be responsible for
the protection ofbusiness assets to the extent possible by external
controls and internalauditing and insurance coverage. The
Management Accountant will be responsible for tax policies
andprocedures and will supervise and coordinate the reports
required byvarious authorities. ; The Management Accountant must
continually e aware of economic andsocial forces as well as the
efect of the Government policies and actionson business activities.
An analysis of the above list (obviously not exhaustive) o
functions,refects the status of a Management Accountant. He is the
principal ofce in-charge of the accounts of the company. He shall
be responsible to the Board ofDirectors for the maintenance of
adequate accounting procedures and recordson the operation of
business. He shall be responsible to the President or theChairman
of the Board or the Board of Directors. Thus, in his broad
functionalactivities, the Management Accountant is responsible to
the policy makinggroup of top management, whereas, in his
administrative activities he ssresponsible to the top executive
ofer.MANAGEMENT ACCOUNTING VS FINANCIAL ACCOUNTINGThe fnancial
accounting classifes and records an entity's transactionsnormally
in money terms, in accordance with established concepts,
principles,accounting standards and legal requirements. It aims to
present a 'true and fairview' jof the overall results of those
transactions. Management Accounting hasbeen described as a
continuous process of analysis, planning and control in thecontext
of providing decision support for decision makers.
ManagementAccounting is more concerned with decision making and a
key role forManagement Accountant is acting as a provider of
fnancial information tosupport these decisions, There are several
diferences between FinancialAccounting and Management Accounting as
are set out in Table 1.1.Financial Accounting and Management
Accounting both appear to be similarinasmdch as both study the
impact of business transactions and events of theenterprise,
reports and interpret the results thereof. Both provide
informationfor internals as well as external use. But Management
Accounting althoughhaving its roots in Financial Accounting difers
from the latter in followingrespects: Financial Accounting studies
the business transactions and events for theenterprise as a whole.
It does not trace the path of events with in theenterprise.
Management Accounting, in additions to the study of theevents in
relation to the enterprise as a whole, takes organisation in
itsvarious units and segments and attempts to trace the impact and
efect ofthe business transactions and events through these various
divisions andsub-divisions. Thus, while the fnancial statements
-proft and lossaccount, balance sheet and fow statements reveal the
overall performanceand position of the enterprise. Management
Accounting reports emphasison the details of operational costs,
inventories, products, processes andjobs. It traces the efect and
impact of the business transactions andevents on costs,
inventories, processes, jobs and products. Financial Accounting is
more attached with reporting the results andpositions of business
to persons and authorities other than management-Government,
Creditors, Investors, Owners, etc. At times, FinancialAccounting
follows window-dressing tactics in order to project a betterthan
actual image of the enterprise. Management Accounting isconcerned
more with generating information for the use of internalmanagement
and hence the information refects the real or really
expectedposition. Financial Accounting is necessarily historical.
It records and analysesbusiness events long after they have taken
place. Management Accountinganalyses the events as they take place
and also anticipates such eventsfor the future. Thus, it uses data
which generally has relevance to thefuture. Since Financial
Accounting data is historical in nature, it is more precisethan the
Management Accounting data, which generally refects Iheexpected
future, and hence could only be an estimation. This provides
thenecessary rapidly to Management Accounting information. The
periodicity in reporting fnancial accounts is much wider than in
caseof Management Accounting. In Financial Accounting, generally,
results arereported on year to year basis. In Management Accounting
is free toformulate its own rules, procedures and forms because the
informationgenerates is solely for internal consumption. Financial
Accounting has to governed by the 'generally acceptedprinciples'.
This is so because, it has to cater for the informational needsof
the outsiders and legal provisions. Management Accounting is free
toformulate its own rules, procedures and forms because the
information itgenerates is solely for internal consumption.
Financial Statements prepared under Financial Accounting consists
'ofmonetary information only. Management Accounting statements,
inaddition to monetary information, also consists
non-monetaryinformation viz., quantities of materials consumed,
number of workers,quantities produced and sold and so on.TABLE 1.1:
MANAGEMENT ACCOUNTING vs. FINANCIAL ACCOUNTINGNature Fianacial
Accounting ManagementAccoutning1.Governed by 2.Basic functions 3.
Users Company law etc.Transactionrecording,Publication ofexternal
fnancialstatements External Needs of managersDecision
supportProvision ofManagementinformation Internal 4.Availibility
5.Time focus 6.Period 7.Main emphasis 8.Speed ofprepartion 9.Form
ofpresentations 10. Style anddetails 11. Criteria 12.
Unitofaccount13. Nature ofdata Publicly available Past and present
Usually one year Explanation Slow but detailed andaccurate whole of
entity Standardized Objective, verifableand consistent Money
Somewhat technical Confdential Present and futureAs appropriate
Planning and control Fast but approximateSegmented to controlunits
Tailored torequirement andsummarized Relevant, useful
andunderstandableMoney physical units For use by
non-accountantsLESSON - 3THEORY BASE OF ACCOUNTING - ACCOUNTING
STANDARDSAccounting is "the process of identifying, measuring and
communicatinginformation to permit judgement and decisions by the
users of accounts"-American Accounting Association. It is
absolutely necessary that accountinginformation contained in
fnancial statements are credible and are regarded asreliable by the
diferent user groups to be consistent. Preparation of
fnancialstatements on uniform and consistent basis improves their
comparability andcredibility. It has two aspects, namely, The
fnancial statements of an enterprise for diferent accounting
yearsare based on similar accounting procedures and policies so
thatmeaningful comparisons over a period of time can be made1 about
heprogress of the enterprise. This is commonly referred to as 'Time
seriesanalysis. The fnancial statements of many enterprises at a
point of time arebased on similar accounting procedures and
policies so thatconclusions can be drawn about their relative
performance at a point oftime. It is known as 'Cross-sectional
analysis'. ,It is the function of 'Accounting Standards' -to
provide a rationalstructural framework so that credible fnancial
statements of the highest qualitycan be produced. According to T.P.
Ghosh accounting standards are defned asunder.Accounting standards
are the policy documents issued by the recognisedexpert accountancy
body relating to various aspects of measurement,treatment and
disclosure of accounting transactions and eventsIt is clear from
the above defnition that accounting standards provide aframework
for the preparation of the fnancial statements. They also draw
theboundaries within which acceptable conduct lies. In the absence
of accountingstandards, many alternatives will exist and will give
the accountant the|leverage to colour'his accounting records the
way he likes. Such 'CreativeAccounting Practices will certainly
create fnancial statements which areunreliable and lower the
confdence of user in the reported results.Hence theneed for a
coherent pet of accounting standards is imperative. The
efcientfunctioning of the fnancial system depends upon the
confdence that usergroups have in the fairness and reliability of
the fnancial statements of thebusinesses ana it is the function of
accounting standards to create this genera)sense of confdence by
providing; a structural framework within which crediblefnancial
statements can be produced.The whole idea of AccountingStandards is
centred around harmonisation in the accounting policies
andpractices followed by businesses. The basic purpose of
'Accounting Standards' isto standardize the diverse accounting
practices followed for many aspectsof accounting. The harmonisation
of accounting policies and practices is neededat national level as
well as international level.To tackle the problem at nationallevel,
the Institute of Chartered Accountants of" India issues
accountingstandards (called AS's) formulated by the Accounting
Standards Board (ASB). Atinternational level, International
Accounting Standards Committee (IASC)issuesInternational Accounting
Standards (called lAS's). The objective of theIASC in terms of
standard setting is "to work generally for the improvement
andharmonisation of regulations, accounting standards and
procedures relating tothe presentation of fnancial statements'. The
Institute of CharteredAccountants of India is a member of IASC and
has a tacit understanding withthe IASC that it would adopt the
accounting standards issued by IASC after duerecognition of the
conditions and practices prevailing in India. At theinternational
level, IASC has issued 32 international accounting standards. Atthe
national level, ICAI has issued 15 accounting standards on various
issuesof accountinganda preliminary draft of a proposed accounting
standard onborrowing costs is being made by the ASB in addition to
the revisioncontemplated in existing standards on valuation of
inventories and accountingfor construction contracts.ACCOUNTING
STANDARDS (N INDIAThe Institute of Chartered Accountants of India,
fully recognising the needcf harmonizing the diverse accounting
policies and practices established'Accounting Standards Board' on
21st April, 1977 so that accounting as alanguage could develop
along the right lines. Accounting Standard Board's(ASB) main
function is to formulate accounting standards to be issued underthe
authority of the council of the institute. Accounting standards
provide rulesand criteria of accounting measurement. However the
rules' criteria areintended lo be used if: a sociai system and
hence are never intended lo be rigidas in case of physical
sciences.Constitution of ASB :The consistitution of ASB gives
adequate representation to all interested partiesand, at present,
it consists of members of the council and representatives
toindustry, banks, Company Law Board, Central Board of Direct Taxes
and theComptroller and Auditor General of India, Security Exchange
Board of India etc,Functions of ASB :The main function of ASB is to
fomralate accounting standards. Whileformulating accounting
standards, ASB takes into consideration the applicablelaws,
customs, usage and business environment. The Institute is the
member ofInternational Accounting Standards Committee (IASC) and
has agreed tosupport the objectives of IASC. While formulating
standards, it gives dueconsideration to the International
Accounting Standards (IAS) issued by IASCand tries to integrate
them, to the extent possible, in the light of conditions
andpractices prevailing in India. It also reviews the accounting
standards atperiodical intervals.FORMULATION OF ACCOUNTING
STANDARDSThe following points need to be kept in mind while
drafting accountingstandards, namely - The accounting standards
issued are in conformity with the provisions ofthe applicable laws,
customs, usage and business environment of ourcountry; The
accounting standards are in the nature of laws but not laws.
Thoughevery possible care is taken while drafting standards that
they are inconformity with eh applicable laws, still the confict
between the law andan accounting standard might arise due to
amendments in the lawsubsequent to the issuance of the accounting
standard. As clarifed in the'Statements of Accounting Standards',
accounting standards cannot anddo not override the statute and in
all such cases of conficts, theprovisions of the law will prevail
and the fnancial statements should beprepared in conformity with
the relevant laws Obviously, to that extent,the accounting
standards shall not be applicable. However, "the institutewill
determine the extenl of disclosure to be made in fnancial
statementsand the related auditor's reports. Such disclosure may
beby way ofappropriate notes explaining the treatment of particular
items. Suchexplanatory notes will be only in the nature of
clarifcation and therefore,need not be treated as adverse comments
on the related fnancialstatements" The accounting standards are
intended to apply only to items which arematerial and become
applicable from the date as specifed by theinstitute. They are
applicable to all classes of enterprise unless otherwisestated. No
standard is applicable retroactively, unless otherwise stated; The
accounting standards are to address the basic mattes, to the
extentpossible. The idea is to confne them to essentials only and
not to makethem complex.The ASB has drawn an elaborate procedure
for formulating accountingstandards. However, it needs to be
emphasised that the standards are issuedunder the authority of the
council of the institute. The procedure involves thefollowing
steps:a)Firstly, the ASB determines the broad areas in which
accounting standards need to be formulated;b)Secondly, the ASB
takes the assistance of the various study groups toformulate
standards The preliminary drafts of the standards areprepared by
the Study groupswhich take 'up the specifc subjectsassigned to
them. The draft prepared by a Study Group is consideredby ASB and
sent to various outside bodies like FICCI, ASSOCHAM,SCOPE, CLB,
C&AG, ICWAI, ICSI, CBDT etc. and the representative ofthese
bodies are also invited at a meeting of ASB for discussion.
c)Thirdly, after taking into consideration their views, the draft
of thestandard is issued as exposure draft for soliciting comments
frommembers of the institute and public at large. The draft is
issued to alarge number of institutions and is published in the
journal of theinstitute. The exposure draft includes the following
basic points: A statement of concepts and fundamental accounting
principlesrelating to the standard; Defnitions of the terms used in
the standard; The manner in which the accounting principles have
been appliedfor formulating the standard; The presentation and
disclosure requirements in complying withthe standard; Class of
enterprises to which the standard will apply, Date from which the
standard will be efective.d)Fourthly, the comments on the exposure
draft are then considered by theASB and a fnal draft is prepared
and submitted to the council of theinstitute;e)Lastly, the council
of the institute considers the fnal draft of the proposedstandard,
and if found necessary, modifes the same in consultationwith ASB.
The accounting standard on the relevant subject is thenissued under
the authority of the council.NATURE OF ACCOUNTING STANDARDSThe
accounting standards issued by the ICAI-are recommendatory innature
in the initial years. During the period a standard is
recommendatory, itis expected that the accounting practices shall
be brought in line with thestandard. In other words, the
recommendatory period is allowed to smoothenthe process of
transition so that no enterprise should have difculty inconforming
to the accounting standards once they are made mandatory. Oncean
accounting standard is made mandatory, it is applicable to all
enterpriseswhose accounts are audited by the members.During the
period an accounting standard is recommendatory, tneauditors of
companies are required to recommend and persuade their cfents
tocomply with the requirements of the accounting standard even
though it isrecommendatory in nature. Regarding the mandatory
standards, it is the dutyof the auditors to ensure that the
accounting standards are followed in thepreparation and
presentation of the fnancial statements. If the mandatoryaccounting
standards have not beer, complied with, the auditor is required
tomake adequate disclosure in his report so that the users of
fnancial statementsare aware of the non-compliance on the part of
the enterprise. If a member failsto do so, the Chartered
Accountants Act explicitly provides that a charteredaccountant in
practice will be deemed to be guilty of professional misconduct
ifhe ails to invite attention to any material departure from the
generally acceptedprocedure of audit applicable to the
circumstancesIt is amply clear that standards on their own have no
legal backing andhence, are not enforceable on the public at large.
Hence the institute dependson is members for implementation of
accounting standards issued by it throughtheir attest function. To
make it efective, following steps are needed: Self-regulation on
the part of the business organisation so that I heyadhere to these
standards while fnalising their accounts; Legal backing to the
accounting standards. The standards as they areissued not have no
legal backing and institute depends on its memters fortheir
implementation through their attest function; Publicising the use
of accounting standards and making the user: ofaccounting
information more informed about their right of getting a moretrue
and fair picture of the results of business based on these
accountingstandards; To avoid duplication of authority. If more
than one authority issuesstandards, it is bound to create a
confusion in the mind of the user as towhich standard needs to be
followed.A recent development, worthy ofattention, is the
establishment of two accounting standards by thegovernment under
the Income Tax Act, 1961 which are to be followed inthe preparation
of fnancial statements in case the assessee prefersmercantile basis
accounting, (Accounting Standard I 'relating todisclosure of
accounting policies and Accounting Standard II relating
todisclosure of prior period and extraordinary items and changes
inaccounting policies).To conclude, the Institute and its members
are duty bound to formulateand implement accounting standards to
provide objective and reliableaccounting data that would satisfy
the information requirements of the users Toachieve this, problem
of duality of authority should be tackled and the system ofdual
accounting standards in view of its expertise in the feld. To
improve theirefectiveness, it is also suggested that the standards
should be given a legalbacking with strong punishment for the
erring business organisations. At thesame time, to make a genuine
case for recognition of accounting standards andto prevent abuse of
fnancial statements, more credibility should be provided tothe
process of standard setting.ACCOUNTING STANDARDS ISSUED BY THE
INSTITUTE AS-1 Disclosure of Accounting Policies :The standard
defnes 'Accounting Policies' as referring to the specifcaccounting
principles and the methods of applying those principles adopted
bythe enterprise in the preparation and presentation of fnancial
statements. Itrecommends the disclosure of signifcant accounting
policies adopted in thepreparation and presentation of fnancial
statements in a manner that shouldform part of the fnancial
statements. It also recommends that he disclosureshould normally be
at one place. Any change in the accounting policies whichhas a
material efect in the current period or which is reasonably
expected tohave material efect in later pe\jods should be
disclosed. It also emphasises thatthe disclosure of compliance with
fundamental accounting assumption of GoingConcern, Consistency and
Accrual is not needed. However, if they are notfollowed, the fact
must be disclosed.AS-2 Valuation of Inventories :The inventories
should be normally valued at 'Lower of Cost or Market'where market
value means net realizable value. The historical cost of
inventorycan be ascertained by use of 'FIFO', 'Average Cost', of
'LIFO' formulae. Whenorganization have diferent items in inventory,
each item may be dealt withseparately, or similar items may be
dealt with as a group.The historical cost of manufactured
inventories may be arrived on thebasis of either direct costing or
absorption costing. Where absorption costing isused, the fxed costs
should be based on the normal level of production.Overheads other
than production overheads should be included as part of
theinventory' cost only 10 the extent that they clearly relate to
putting theinventories in their present location and condition.The
accounting policy in respect of inventories should be
properlydisclosed and any change in it which has a material efect
in the currentaccounting period or which is reasonably expected to
have material efect inlater periods should be disclosed. The amount
by which an item in the fnancialstatements is afected by such
change should also be disclosed to the extentascertainabfe. Where
such amount is not ascertainable, wholly or in part, thefact should
be indicated.The 'Specifc Identifcation Method', 'Adjusted Selling
Price Method','Standard Cost Method' and 'Base Stock Method' are to
be used in specifccircumstances. However, if base stock method is
used, the diference betweenthe value at which it is carried and the
value by applying the method at whichstock in excess of the base
stock is valued should be disclosed. AS-3 Changes in Financial
Position :A statement of changes in fnancial position should be
published alongwith its published accounts. Such a statement should
be prepared andpresented for the period covered by the proft and
loss account and for thecorresponding period.It may be prepare on
working capital basis or cash basis.It emphasises that the funds
provided from operation and used in the operationbe shown
separately and the form of statement should be most informative
inthe circumstances. However, the standard is no longer vaJid as it
has beensuperseded by new standard AS-3 (Revised) Cash Flow
Statement issued inMarch, 1997.AS-3 (Revised) Cash Flow
Statement:The cash fow statement should report cash fows coring the
periodclassifed by operating, investing and fnancing activities. An
enterprise shouldreport cash Hows from operating activities using
either (a) direct method; or (b)indirect method. The infow and
outfow from the investing and fnancingactivities should be shown
separately. Investing and fnancing transactions thatdo not require
the use of the cash or cash equivalents and should present
areconciliation of the amounts in its cash fow statement with the
equivalentitems reported in the balance sheet.The enterprise should
also disclose theamount of signifcant cash and cash equivalents
balances that are not availablefor use by it.AS-4 (Revised)
Contingencies and Events Occurring after the Balance SheetDate :A
contingency is a condition or situation, the ultimate outcome of
which,gam or loss, will be known or determined only on the
occurrence, or non-occurrence, of one or more uncertain events. A
contingent loss should berecognised if (a) it is probable that
future events will confrm that ari asset hasbeen impaired or a
liability has been incurred on the balance sheet date^ and(b) a
reasonable estimate of the amount of the resulting loss can be
made. Acontingent gain should not be recognised. If either of the
two conditionsmentioned above are not met, a disclosure should be
made of the existence ofthe contingency specifying: the nature of
the contingency; the uncertainties which may afect the future
outcome;: an estimate of the fnancial efect, or a statement that
such ail estimatecannot be made. Assets and liabilities should be
adjusted for events occurring after balancesheet date that provide
additional evidence to assist the estimation of theamounts relating
to conditions existing at the balance sheet date (for:
example,insolvency of a debtor subsequent to fnalisation of
fnancial statements) or thatindicate that the fundamental
accounting assumption of going concern is notappropriate.
Dividends, proposed (or declared) by the enterprise: after
thebalance sheet date but before approval of the fnancial
statements, andpertaining to the period covered by fnancial
statement, should be adjusted.Adjustments to assets and liabilities
are not appropriate for events occurringafter the balance sheet
date, if such events do not relate to conditions existing atthe
balance sheet date (for example, decline in market value of the
investment).Disclosure should be made in the report of the
approving authority of thoseevents occurring after the balance
sheet date that represent material changesand commitments afecting
the fnancial position of the enterprise specifying: the nature of
the event; I an estimate of the fnancial efect, or a statement that
such an estimatecannot be made.AS-5 (Revised) Net Proft or Loss for
the Period, Prior hems and Changes inAccounting Policies :The
objective of this standard is to prescribe the classifcation and
disclosure ofcertain items in the statement of proft and loss so
that all enterprises prepareand present their fnancial statements
on a uniform basis to improve 'theircomparability. It explains that
proft or loss of a period comprises of ordinaryactivities,
extraordinary activities and prior period items and all three need
tobe disclosed separately. It also includes the impact of change in
accountingestimates and change in accounting policies.Ordinary
activities are any activities which are undertaken by anenterprise
as part of its business and such related activities in which
theenterprise engages in furtherance of, incidental to, or arising
from, theseactivities. Extraordinary items are incomes or expenses
that arise from eventsor transactions that are clearly distinct
from the ordinary activities of theenterprise and, therefore, are
not expected to recur frequently or regularly. Priorperiod items
are'income or expenses which arise in the current period as aresult
of errors or omissions in the preparation of the fnancial
statements ofthe one or more prior periods. The net proft or loss
for the period comprises thefollowing components, each of which
should be disclosed on the face of thestatement of proft and loss;
proft or loss from ordinary activities; and extraordinary
items.Prior period items are normally included in the determination
of net proftor loss for the current period. An alternative approach
is to how such items inthe statement of proft and loss after
determination of current net proft or loss.The second approach
seems better because that will help ascertain the result ofcurrent
period unafected by the mistakes of the past, in either case,
theobjective is to indicate the efect of such items on the current
proft or loss.Change in Accounting Estimates Vs. Change in
Accounting Policies:A distinction should always be made between
change in accounting estimatesand changes in accounting policies.
When it is difcult to distinguish betweenthe change in accounting
estimate and change in accounting policies, it shouldbe regarded as
change in accounting estimate, with appropriate disclosure inthe
periods of change, which may be current period only or current
period aswell as future periods. The efect of change in an
accounting estimate should beclassifed as ordinary or extraordinary
depending upon whether the originalestimate was regarded as
ordinary or extraordinary item. However, the revisionof estimate,
by its nature, cannot be called extraordinary or prior period
item.When change in accounting estimate/ change in accounting
policy takes placewhich has a material efect, its nature and amount
should be disclosed. If theefect is not ascertainable, the fact
should be disclosed in the fnancialstatement.AS-6 (Revised)
Depreciation Accounting :The depreciable amount of an asset
comprising of its historical cost, orother amount substituted for
historical cost in the fnancial statements, less theestimated
realizable value should be allocated on a systematic basis to
eachaccounting period during the useful life of the asset. The
historical cost mayundergo revision arising as a result of increase
or decrease in long term liabilityon account of exchange rate
fuctuations, price adjustments, changes in dutiesor similar
factors. The useful life of the asset may itself be subjected to
revision,in which case, the unamortised balance of the asset be
depreciated over itsremaining life. Any addition or extension to an
existing asset should bedepreciated along with the original asset,
unless the extension has a separateidentity, in which case it
should be depreciated on the basis of an estimate of itsown life.
Where depreciable asses are disposed of, discarded, demolished
ordestroyed, the net surplus or defciency, if material, is
disclosed separately. Thechange of method, if warranted, should be
done with retrospective efect fromthe date of asset coming to use.
In case of revaluation of asset, the revaluedamount should be
amortised over the remaining useful life of the asset.
Theinformation to be included in the fnancial statements should
comprise ofhistorical cost or any substituted amount, total
depreciation for the period inrespect of each class of asset and
related accumulated depreciation. Thefollowing information should
be disclosed in the fnancial statements along withdisclosure of
other accounting policies: depreciation methods used; and
depreciation rates or the useful lives of the asset, if they are
diferent fromthe principal rates specifed in the statute governing
the enterprise.AS-7 Accounting for Construction Contracts :The
standard deals with the problem of allocation of revenues and
relatedcosts to the accounting periods over the duration of the
contract. The long termconstruction contracts could be fxed price
contracts where contractor agrees toa fxed contract price or cost
plus contracts where the contractor is reimbursedfor allowable or
otherwise defned costs, and is also allowed a percentage ofthese
costs or a fxed fees. Both these contracts can be accounted by
eitherpercentage of completion method or completed contract method.
Underpercentage of completion method, the amount of revenue
recognised isdetermined with reference to the stage of completion
of the contract activity atthe end of each accounting period. The
completed contract method is based onresults as determined when the
contract is completed or substantiallycompleted.Proft in the case
of fxed price contract should be recognised when thework has
progressed to a reasonable extent- say 25 or 30%. While
recognisingproft under percentage of completion method, the
appropriate allowance forfuture unforeseeable facts should be made
on either a specifc or percentagebasis. A foreseeable loss on
entire contract should always be provided for in thefnancial
statements irrespective of the amount of work done and the method
ofaccounting followed. Disclosure of changes in accounting policy
used forconstruction contracts should be made in the fnancial
statements giving theefect of the change and its amount.AS-8
Accounting for Research and Development:The prescribed research and
development costs outlined in para 7 of Hiestandard relating to a
business should be charged to the revenues of the periodin which
they are incurred unless the criteria mentioned in para 9 of
thestandard are met, in which case, the charging of these expenses
can be deferredto future accounting periods. The research and
development costs, once writtenof, arc never reinstated in
accounts. The deferred research and developmentcost should be
allocated on a systematic basis to future accounting periods
byreference to either to the sale or use of the product or process
or to the timeperiod over which the product or process is expected
to be sold or unused. If atany point of time, criteria for deferral
as detailed in para 9 are not met, theunamortised balance of
research and development expenditure should becharged to the proft
and loss account. When the criteria for deferral continue tobe met
but the amount of the deferred research and development costs
andother relevant costs exceed the expected flture revenues/
benefts relatedthereto, such expenses should be charged as an
expense immediately. Theamount charged to proft and loss account
should be explicitly disclosed andunamortised research and
development costs should be shown in the balancesheet under the
head "Miscellaneous Expenditure". ,AS-9 Revenue Recognition :The
standard mainly deals with the timing of revenue. Revenue is
defnedas "gross infow of cash, receivable or other consideration
arising in the courseof ordinary activities of an enterprise from
the sale of goods, from the renderingof services, and from the use
by others of enterprise resources yielding interest,royalties and
dividends. The revenue is recognised in case of sale when: the
seller of goods has transferred the property in goods tci the
buyeralong with signifcant risks and rewards of the ownership and
seller hasno efective control over goods transferred; ;no
signifcant uncertainty exists regarding the amount of
theconsideration that will be derived from the sale.The revenue
from rendering of services is recognised either undercompleted
service method or proportionate completion method. Completedservice
method is a method of accounting which recognises revenue in
thestatement of proft and loss only when the rendering of services
under acontract is completed or substantially completed.
Proportionate completionmethod is a method of accounting which
recognises revenues in the statementof proft and loss
proportionately with the degree of completion of services undera
pontract.Revenue arising from interest is recognised on a time
proportion basis, royaltieson an accrual basis and dividends from
investments in shares when the owner'sright to receive payment is
established.AS-10 Recounting for Fixed Assets :Fixed asset is an
asset held with the intention of being used for thepurpose of
producing or providing goods or services and is not he!d for :he
saisin the notarial course of business. The gross book vaiue of a
fxed asset shoulobe either historical cost or a revalued amount.The
cost of a fxed asset shouldnormally comprise of its purchase price
and other attributable cost of bringingthe asset to its working
condition for its intended use. Financing costs relatingto deferred
credits or to borrowed funds attributable to construction
oracquisition of fxed assets for the period up to the completion of
construction oracquisition of fxed assets should also be included
in the gross book value of theasset to which it relates.When a fxed
asset is acquired in exchange or in partexchange for another asset,
the cost of the asset required should be recordedeither at fair
market value or at the net book value of the asset given
up,adjusted for any balancing; payment or receipt of cash or other
consideration.Subsequent expenditures related to an item of fxed
asset should be added to itsbook value only if they increase the
future benefts from the existing assetbeyond its previously
assessed standards of performance. Material items retiredfrom
active use and held for disposal should be stated at the lower of
their netbook value and; net 44haracteri value. Losses arising from
the disposal of fxedasset carried at cost should be 44haracteri in
the proft and loss account.Normally the entire class of asset
should be revalued and revaluationshould never result in the net
book value of the class of asset being greater thanthe recoverable
amount of assets of that class. Gain on revaluation shouldnormally
be taken to the owners interest in the form of Revaluation
ReserveAlternatively it could be taken to proft and loss account.
Loss on revaluationshould normally be taken to proft and loss
account except that such a decreaseis related to; an increase which
was previously recorded as a credit to therevaluation reserve and
which has not been subsequently reversed or44haracte, it may be
charged directly to that account. On disposal of apreviously
revalued item of fxed asset, the diference between net
disposalproceeds and the net book value should be charged or
credited to the proft andloss statement except that to the extent
that such a loss is related to anincrease which was previously
recorded as a credit to revaluation reserve andwhich has not been
subsequently reversed or 44haracte, it may be chargeddirectly to
that account. Goodwill should he recorded in the books only
whensome consideration in money or moneys worth has been paid for
it.A properdisclosure of the gross and net book value of the asset
as well as relevantamount, if the assets are stated at revalued
amounts should be made.AS-H (Revised) Accounting for tbc Efects of
Changes in Foreign ExchangeRates :The standard deais with (a)
accounting for transactions in foreigncurrencies; and (b)
translating the fnancial statements of foreign branches
forinclusion in the fnancial statements of the enterprise. The
standard details themethods to be adopted for converting foreign
transactions denominated inforeign currency in the reporting
currency defned as currency used inpresenting the fnancial
statements of the enterprise. The standard recommendsproper
disclosure of the exchange diferences arising on foreign
currencytransaction. Disclosure is also encouraged of an
enterprises foreign currencyrisk management policy.AS-12 Accounting
for Government Grants :Government grants are assistance by
government in cash or kind to anenterprise for past or future
compliance with certain conditions. Governmentgrants can be
45haracteri in accounts on the basis of capital approach orIncome
approach, based on nature of relevant grant. However, the
governmentgrant should not be 45haracteri until there is reasonable
assurance that (i) theenterprise will comply with the conditions
attached to them; and (ii) the grantwill be received. A proper
disclosure should be made of the accounting policyadopted for
government grants, including the methods of presentation in
thefnancial statements including the nature and extent of
government grant45haracteri in the fnancial statements, including
grants of non-monetaryassets given at a concessional rate or free
of cost.AS-13 Accounting for Investments :The standard deals with
accounting for investment in fnancial statementsof enterprises and
related disclosure requirements. An enterprise shoulddisclose
current investments and long-term investments distinctly in
thefnancial statements. A current investment is an investment that
by its naturereadily realizable and is intended to be used for not
more than one year from thedate on which such investment is made. A
long-tern investment is aninvestment other than a current
investment. The cost of acquisition shouldinclude charges such as
brokerage, fees and duties. If an investment is acquiredby issue of
share or other security, the acquisition cost should be fair value
ofthe security issued. IF an investment is acquired in exchange for
another asset,the acquisition cost should be the determined cost
with reference to the fairvalue of the asset given up. Investment
properties should be treated as long-term investments.Current
investments should be carried in the fnancial statements at
thelower of cost and fair market value determined either on an
individualinvestment basis or by category of investments, but not
on an overall (or global)basis. Long-term investments should be
carried at their cost, although aprovision for diminution in their
value, other than temporary, should be made.Any change in the
carried value of the investment should be carried to the proftand
loss account. Proft or loss on disposal of investments should
be46haracteri and shown in the proft and loss account. Signifcant
disclosurerequirements are also inserted in the standard and
include among other things,the disclosure of accounting policy for
determination of carrying amount ofinvestments, classifcation of
investments, proft and loss on disposal ofinvestments and changes
in carrying amounts of these investments, for currentand long-term
investment separately and aggregate amount of quoted andunquoted
investments.AS-14 Accounting for Amalgamation :The standard deals
with the accounting for amalgamation and thetreatment of any
resultant goodwill or reserves. Amalgamation is 46haracterizedas
either in the nature of merger or purchase depending upon fve
conditionsenumerated. Amalgamation in the nature of merger is
accounted for by Poolingof interest method and amalgamation in the
nature of purchase is accounted byPurchase method. The
consideration for the amalgamation means ihe aggregateof the shares
and other securities issued and the payment made in the form ofcash
or other assets by the transferee company to the shareholders of
thetransferor company.The identity of all the reserves in
amalgamation in the nature of merger ispreserved. However, in the
case of amalgamation in the nature of purchase, onlystatutory
reserves are preserved by giving debit to a new account
calledAmalgamation Adjustment Account. Goodwill only arise in case
of Purchasemethod. Goodwill arising on amalgamation is amortised
over a period notexceeding fve years unless a somewhat longer
period can be justifed. When anamalgamation is efected after the
balance sheet date but before the issuance ofthe fnancial
statements of either party to the amalgamation, disclosure shouldbe
made in accordance with AS-4 but the amalgamation should not
beincorporated in the fnancial statements.AS-15 Accounting for
Retirement Benefts in the Financial Statements ofEmployers:The
standard deals with the accounting of retirement benefts
consistingof (a) Provident funds; (b) Superannuation/ pension; (c)
Gratuity; (d) Leaveencashment beneft on retirement; (e) Post
retirement health and welfareschemes; and (f) Other retirement
benefts in the fnancial statements ofemployers. The contribution of
the employer towards the provident fund andother contribution
schemes should be charged to the statement of proft andloss for the
period. The accounting treatment of gratuity and other
beneftschemes will depend on the type of arrangement which the
employer has chosento make. Any alterations in the retirement
beneft costs should be charged orcredited to the statement of proft
and loss as they arise in accordance with AS-5.LESSON-4PRACTICAL
BASE OF ACCOUNTING ORIGIN AND ANALYSIS OF
BUSINESSTRANSACTIONSAccounting process begins with the origin of
business transactions and isfollowed by analyses of these
transactions. After origin and analysis oftransactions comes
recording, classifcation and summarization of businesstransactions
culminating in preparation of fnancial statements,Origin of
Business TransactionsAccounting deals with business transactions
which have already takenplace, As fnancial accounting concentrates
on monetary transactions of thepast it is basically historical in
nature. Since it amounts to making recordingand analysis of
historical information only, it is also known as
post-mortemaccounting. For recording business transactions, it is
necessary that thesetransactions are evidenced by an appropriate
document such as cash memo purchase bill, sales bill, cheque book,
pass book, salary slip, etc., Documentwhich provides evidence cf
the transaction is called the Source Document. Analysis of Business
TransactionsIn accounting record is made of monetary transactions
which areevidenced by a source document and double entry system is
applied forrecording. According to J.R Batliboi every business
transaction has a two-foidefect and that it afects two accounts in
opposite directions and if a completerecord were to be made of such
transaction, it would be necessary to debit oneaccount and credit
another account. It is this recording of the two-fold efect ofevery
transaction that has given rise to the term Double Entry SystemTo
analyze the dual aspect of each transactions and to fnd out
theaccounts to be debited and credited following two approached can
be followed.7.Accounting Equation Approach8.Traditional
Approach.9.Accounting Equation Approach:Equality of assets on one
hand and liabilities and capital on the otherhand is called basic
accounting equation and is written asASSETS = LIABILITIES +
CAPITALexpected Where assets refer to resources which are owned by
businessenterprise and are to beneft future operations, liabilities
are debts payable toparties external to business and capital means
the amount payable to owners ofthe business enterprise (also called
owners equity )The dual aspect of some business transactions is
analyzed as follows:10. Introduction of resources by the owner:Rs.
5,00,000 cash and furniture worth Rs. 20, 000 invested by the
ownerin the business.Introduction of Rs.5,00,000 cash increases
business cash by Rs. 5,00,000and it creates analysis obligation to
pay Rs. 5,00,000 to the owner which isrecorded as capital. In terms
of accounting equation its efect is asfollows:ASSETS = LIABILITIES
+ CAPITALCash (Rs.5,00,000) =__ + capital (Rs.5,00,000)Further, if
furnitureworthRs.20,000 isprovidedbythe proprietor,theaccounting
equation appears as under:Cash +Furniture = Capital(Rs.5,00,000)
(Rs.20,000) - +(5,00,000 +20,000 )Rs. 5,20,000 Rs.5,20,00011.
Purchase of assets for cash and / or credit : Purchased building
for Rs,2,00,000 and paid Rs. 10,000 cashimmediately. It increases
business assets or resources by Rs, 1,90,000 as cashdecreases by
Rs. 10,000 and building increases by Rs.2,00,000. It also createsan
obligation to pay Rs. 1,90,000 in future. The accounting equation
nowappears as follows;Cash+Furniture =Creditors for building +
Capital (Rs.5,00,000 (Rs.20,000) (Rs.1,90,000)(Rs.5,20,000) Rs.
10,000)+ Building (Rs. 2,00,000)-7,10,000 =Rs.7,10,000 12. Paid
into bank Rs.3,00,000It decreases cash balance and increase bank
balance and thus, have nonet efect on total assets as shown
below:Cash+Bank =Creditors for building +Capital
(Rs.4,90,000(Rs.1,90,000)(Rs.5,20,000)13. (Rs. 3,00,000)+
Furniture+ Building (Rs. 20,000) (Rs. 2,00,000) -7,10,000
=Rs.7,10,000 14. Payment of Rs. 1,90,000 by cheque to creditors for
building :It decreases bank balance by Rs.1,90,000 and creditors
for building byRs. 1,90,000 as shown below:Cash+Bank=Creditors for
building +Capital (Rs.1,90,000 (Rs. 3,00,000) (Rs.1,90,000)
(Rs.5,20,000) - Rs. 1,90,000) - Rs. 1,90,000)+ Furniture+ Building
(Rs. 20,000) (Rs. 2,00,000) Rs. 5,20,000 =Rs. 5,20,00015. Purchase
of goods for Cash/Credit:Business enterprise purchase goods worth
Rs. 50,000 for cash andRs.20,000 on credit.It increases stock of
goods by Rs. 70,000, decreases cash by Rs.50,000and creates
analysis obligation to pay. Rs.20,000 to the supplier of goods.
Afterthis accounting equation appears as follows:Cash+Bank +Stock
of goods = Creditors + Capital (Rs.1,90,000(Rs. 1,10,000)
(Rs.70,000) (Rs.20,000)(Rs.5,20,000) 16. 50,000)+ Furniture+
Building (Rs. 20,000) (Rs.2,00,000) Rs. 5,40,000 = Rs.5,40,00017.
Rs. 40,000 cash and Rs.20,000 goods withdrawn for personaluse:It
decreases cash by Rs.40,000 and goods by Rs.20,000. At the same
time, itdecreases capital by Rs.60,000 as shown below:Cash + Bank+
Stock of goods =Creditors + Capital (Rs. 1,40,000 (Rs. 1,10,000)
(Rs.70,000(Rs.20,000)(Rs.5,20,000- 50,000)-Rs,20,000) - Rs.60,000)
+Furniture+ Building (Rs. 20,000) (Rs.2,00,000) Rs. 4,80,000
=Rs.4,80,000ifaccounting equation after above transactions is to be
presented in the form ofbalance sheet, it will appear as follows
:Balance SheetLiabilities Amount Assets amountCapital4,65,000 Cash
1,25,000Creditors20,000 Bank 1,10,000Stock 30,000Furniture
20,000Building2,00,0004,85,000 4,85,000Classifcation of Accounts
and rules for Recording Transactions :For recording business
transaction all accounts are divided into threecategories,1) Assets
Account2) Liability Account3) Capital AccountFor recording changes
in assets, liabilities and capital two basicrules are followed
:Rule No. 1 for recording changes in assets : Increase in asset is
debited and decrease in asset in credited.Rule No. 2 for recording
changes in liabilities and capital : Increase in liabilities and
capital are credited and decrease in liabilitiesand capital are
debited.TransactionNo.Assets =Cash + Bank +
Stock+Furniture+Building =Creditors forBuilding+TradeCreditors
+Capital1. 5,00,000- - 20,000 - = - - 5,20,0002. 5,00,000-
10,000----20,000--+2,00,000= -+1,90,000--5,20,000-3.
4,90,000-3,00,000-+3,00,000--20,000-2,00,000-=
1,90,000---5,20,000-4. 1,90,000-3,00,000-1,90,000--20,000-20,000-=
1,90,000-1,90,000--5,20,000-5. 1,90,000-
50,0001,10,000--+70,00020,000-20,000-= ---+ 20,0005,20,000-6.
1,40,000- 40,0001,10,000-70,000-20,00020,000-20,000-=
--20,000-5,20,000- 60,0007. 1,00,000+
25,0001,10,000-50,000-20,00020,000-20,000-= --20,000-4,60,000+
50,0008. 1,25,0001,10,000 30,000 20,000 20,000 = - 20,000
4,65,000Analysis of Changes in Capital AccountIncreases and
decreases in capital account can take place due tointroduction of
capital, withdrawal of cash, goods and other assets for personaluse
( called drawings ), revenue and income earned ( resulting in
increase incapital) and expenses incurred ( resulting in decrease
in capital). Recording theefect of all these transactions directly
in the capital account will make itunwieldy. In actual practice,
net efect of revenue and expense transactionduring an accounting
period as shown by proft and loss account is transferredto capital
account. Similarly cumulative efect of drawings during an
accountingperiod is recorded in the capital account at the end of
the accounting period.For this purpose, temporary capital accounts
are opened. These are calledtemporary accounts because these
accounts start with zero balance in thebeginning of the accounting
period and at the end of the accounting period,these account are
closed and their net efect it transferred to capital account.These
include:a) Revenue Account(mcluding other incomes and gains)b)
Expense Account(mcludmg losses)c) Drawing Account.As these accounts
record changes which afect capital account only, no separaterule is
required for recording changes in temporary accounts. For
example:i. Revenue increases capital and decrease in capital is
credited, thereforerevenue earned is credited to revenue
account.ii. Expense decreases capital and decrease in capital is
debited, therefore,expenses are debited to expense account.iii.
Drawings decrease capital and decrease in 'capital is
debited,therefore, the value of assets withdrawn for personal use
is debited todrawings account.Thus capital at the end of the period
may be calculated as follows:Closing capital = Opening capital +
Additional capital- Drawings +Revenue and Gains- ExpensesTo sum up,
under accounting equation approach all accounts aredivided into
three, categories namely, assets, liabilities and capital.
Capitalaccount is further sub-divided into permanent and temporary
account Forrecording changes in assets Rule NO. 1 is applied and to
record increases anddecreases in liabilities and capital Rule N0.2
is followed.Illustration:Prepare a statement showing analysis of
transactions, title andnature of afected accounts, relevant rule of
recording and the account to bedebited and credited on the basis of
transactions of Mr. X for the month ofDecember,1998. Transactions
for the month of December, 1998, were asfollowsRs.1. Received cash
form debtors 20,0002. Deposited cash in bank 4,0003. Payment to
creditors bycheque4,0004. Machine purchased for10,0005. Traveling
Expenses 5,000Statement Showing Analysis of
TransactionsTransactions Analysis Title andNature ofAccountRule
EntryReceived cashfrom debtorsRs. 20,000Increase cash Decrease the
amount Cash Asset Debtor AssetDebit increase in assets Credit Debit
cashCredit Debtorsdue from debtors decrease in asset Depositedcash
in bankRs. 4000Increase bank balance Decreases cash in hand Bank
assetCash - assetDebit increase in asset Credit decrease increase
asset Debit bank Credit cashPayment tocreditors
bychequeRs.4,000Decreases amount payable to creditors decreases
bank balance Creditors Liability Bank Asset Debit decrease in
liability Credit decrease in asset Debit creditors Credit
BankMachinerypurchasedRs.10,000Increases machinery Decreases cash
in handMachinery assetCash - assetDebit increase in assetCredit
decrease in asset Debit machinery Credit cashTravelingExpenses
incurred on Traveling expense-Debit Debit traveling
expensesRs.5000travel increases cash in hand decreases Temporary
capital (Expense) Cash - Assetincrease in expensesCredit decrease
in asset ExpensesCredit cash
Analysis of Valuation of Assets and LiabilitiesFinancial
accounting is basically historical in nature and
businesstransactions are accounted at their value on the date of
the transactions. As aresult asset and liabilities also appear at
historical value. To portray true andfair fanancial position in
balance sheet some of the assets and liabilities needrevaluation to
show these items at realistic, and not historical, level in
thebalance sheet. To achieve this objective without changing asset
and liabilitiesbalances in accounting records, valuation records,
valuation accounts areopened to account for increase or decrease in
historical value of these items. Rules relating to analyze to
assets and liabilities can be extended toaccommodate analysis of
valuation accounts as follows: 1. Valuation of Assets:Various
valuation accounts generally opened to account for decreae in
thevalue of assets are provision for discount on debtors account,
provision fordoubtful debts account, stock reserve account,
investment fuctuation reserveaccount, provision for (or
accumulated) depreciation account and so on. Theaccounts are opened
to bring and report assets at their reduced level. As decrease in
as