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Generally Accepted Accounting Principles
Generally Accepted Accounting Principles refer to the standard
framework of guidelines for financial accounting used in any given
jurisdiction; generally known as accounting standards or Standard
Accounting Practice. These include the standards, conventions, and
rules that accountants follow in recording and summarizing, and in
the preparation of financial statements.
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Accounting - DefinitionA record of financial transactions for an
asset or individual, such as at a bank, brokerage, credit card
company, or retail store.. Accounting is define as an art of
recording, classifying and summarizing in a systematic manner and
in terms of money, transactions and events which are in part
atleast of a financial character and interpreting the results
thereof. American Institute of Certified Public Accountants
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Objectives of Accounting To keep systematic recordsTo protect
business propertiesTo ascertain profit or lossTo ascertain the
financial position of the businessTo facilitate rational decision
making
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Functions of Accounting Recording: Basic function of accounting.
Record all transactions that are financial characterIn an
chronological order.
Classifying: Concerned with systematic analysis of recorded
facts.Done in the book called LedgerLedger contains different pages
for individual accounts.Summarizing: Involves presenting the
classified data in a manner, which is understandable and useful to
the internal and external end-users i.e. trial balance, income
statement, balance sheet
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AnalyzingIt establish the relationship between the items of
P&L account and Balance sheet
Purpose of analyzing is to identify the financial strength and
weakness of the business
Interpreting: Final function of the accounting.
The recorded financial data is interpreted in a manner that the
end- users can make a meaningful judgement about financial
condition and profitability of the business operations.
This data is used for preparing the future plans and framing new
policies.
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Classification of Accounts
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Personal accounts
Includes the accounts of a persons with whom the business
deals.
Natural Persons Persons who are created by god. Eg. Ram, Raja
etc.
2. Artificial Persons Organizations and companies which are
created by natural persons are called artificial persons. eg. LIC,
Bank, Companies etc
3. Representative persons Amounts outstanding and prepaid
represents the person involved. Eg. Rent outstanding represents the
landlord, insurance prepaid represents the insurance company
Rules of Personal accounts Debit the receiver Credit the
giver
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Real accounts
Real accounts includes all categories of Assets. i.e Fixed
assets, current assets and fictitious assts.
Eg. Buildings, Cash and goodwill
Rules of Real accountsDebit what comes inCredit what goes
out
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Nominal accounts
Nominal accounts covers all expenses, losses, all incomes and
gains. Eg. Salary, rent, wages, bad debts etc.
Rules of Real accountsDebit all expenses and lossesCredit all
incomes and gains
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Branches of Accounting
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Financial Accounting:
It is the original form of accounting.
Concerned with the preparation of financial statements like
P&L a/c, balance sheet to show the operations of a business for
a specific period of time.
Useful for the outsiders like shareholders, debenture holders,
creditors, banks and financial institutions.
Two principal statements of Financial accounting are Income and
Expenditure statement and Balance Sheet.
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Accounting principles
Accounting principles may be defined as those rules of action or
conduct, which are adopted by the accountants universally while
recording accounting transactions.
Business entity conceptGoing concern conceptMoney measurement
conceptCost conceptDual aspect conceptAccounting period
conceptMatching conceptRealization conceptConservatismFull
disclosureConsistencyMateriality
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Accounting concepts
The term concept includes basic assumptions or conditions upon
which the science of accounting is based. The important concepts
are described as below
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Business Entity Concept
Business entity concept implies that a business unit is separate
and distinct from the person who supplies capital to it,
irrespective of the organization.
Going concern concept
Going concern concept implies that the business concern will
exist upto the foreseeable future.This concept assumes that the
business concern has perpetual life, assets and liabilities are
valued on the basis of their potential and not on their market
value.
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Money measurement Concept
Money measurement concept implies that only transactions
involving money or moneys worth will be recorded in the books of
the business. Because money is the only practical unit of
measurement.
Cost concept
The cost concepts assumes that the price to acquire an asset is
the basis for subsequent accounting for the asset.
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Dual aspect Concept
Every business transaction has two aspects: giving and
receiving: and ultimately it effects a change in the composition of
assets or liabilities or both.
Example: Ram commenced business with a cash of Rs.1,00,000
Now the business is having Rs.1,00,000 (ASSET) and the business
owes its proprietor, i.e. Ram Rs.1,00,000.
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Accounting period concept
The life of the business is divided into appropriate segments
say 12 months. Interim reports are also prepared for internal
reporting and evaluation.
Matching concept
to ascertain the profit it is necessary that revenue of the
period should matched with expenses of the same period. It involves
identification of revenue and expenses for the period, adjustment
of outstanding and prepaid expenses and incomes, and sufficient
provision for depreciation.
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Realisation concept
According to realization concept revenue is recognized when a
sale is made. When sale is considered to be made at the point when
the property in goods passes to the buyer, and he becomes legally
liable to pay.
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ACCOUNTING CONVENTION
The term conventions includes those customs or traditions which
guide the accountant while preparing accounting
statements.Convention ConservatismFull
disclosureConsistencyMateriality
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ConservatismConvention of conservatism is a policy of playing
safe and it had its origin as a safeguard against possible losses
in a world of uncertainty.
It compels the businessman to wear a Risk proof jacket for the
working rule anticipate no profit for possible losses.
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Full DisclosureFull DisclosureThe accountant should attach only
those important materials details and avoid those insignificant.
Otherwise, accounting will be over burdened with minute
details.
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MaterialityAll material information should be revealed while
preparing final accounts.
All information which is of material interest to proprietors,
creditors, or investors should be disclosed in accounting
statements.
ConsistencyThe accounting practice should remain the same from
one year to another. Because the evaluation of performance by the
comparison of results of different accounting periods can be
significant. Eg. Various methods of depreciation.
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Journal:
Journal is derived from the French word Jour which means a
day.
Journal means a daily record of business transactions. Journal
is a books of original entry because transaction is first written
in the journal.
Ledger:
A book in which the monetary transactions of a business are
posted in the form of debits and credits. A book to which the
record of accounts is transferred as final entry from original
postings.
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Functions of accounting
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Keeping Systematic records
The main function of HRA is to keep a systematic record of the
events. This function embraces recording transaction in journal and
subsidiary books like cash book, sales book etc.
Communicating the results:
The second main functions of accounting is to communicate the
financial facts of the enterprise to various interested parties
like owners, investors, creditors, employees, governments etc.
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Meeting the legal requirements
accounting aims at fulfilling the legal requirements, especially
to the tax authorities and regulators of the business.
Protecting the proprietor of the business
Accounting helps protecting the property of the business.
Planning and controlling the business activities
Accounting also helps planning future activities of an
enterprise and controlling its day to day operations. This function
is done mainly to promote maximum operational efficiency.
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INFLATION ACCOUNTING
Inflation normally refers to the increasing trend in general
price levels.
In economic sense inflation refers to a state in which the
purchasing power of money goes down or conversely there is more
money in circulation.
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Meaning of inflation accounting
The accounting system adopted for converting the past financial
expenditure and receipts according to the current price level is
called inflation accounting.
Also called as Price level accounting.
It is based on the principle that the prices of products at
different periods are at different levels.
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American Institute of Certified Public Accountants defines the
inflation accounting as a system of accounting, which purports to
record as a built in mechanism, all economic events in terms of
current cost..
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Features of inflation accounting:
The inflation accounting has an inbuilt and automatic recording
procedure.
The unit of measurement is not stable like traditional or
historical accounting.
It takes into consideration all the elements of financial
statements for reporting.
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Methods of inflation accounting:
Current Purchasing Power Method (CPP)
Current Cost Accounting Method (CCA)
Hybrid Method (a mixture of CPP & CCA)
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Current Purchasing Power Method (CPP)
In this method the increase of decrease of price level in a
period should be adjusted with the items in the Profit and Loss
account and Balance Sheet.
Also called as Constant rupee methodThe method is based on
General Price Index.Accounting to the Price Index the items should
be adjusted to know the real values.
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Procedure for inflation accounting under CPP method
Calculation of conversion factor
Current Price Index (consumer Price Index)Conversion factor =
-------------------------- Previous Price Index
2. Calculation of converted value
Converted value = Historical value X Conversion Factor
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Consumer Price Index: The Consumers Price Index (CPI) is a
measure of the price change of goods and services purchased by
private Indian households
Current Cost Accounting Method
CCA was introduced during 1975 by the British Government through
a committee known as Sandilands Committee, headed by Francis C.P.
Sandilands.
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Human Resource AccountingHuman Resource Accounting (HRA) is a
new branch of accounting.
HR is the most important factor in the organization. Among 4
factors of production. Material Machine Land & Men
The effective utilization of other factors depends upon the
efficiency of human resource.
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The accounting information helps to evaluate the number of
employees and their performances and changes over a period of time
about the number and performance.
Definition:
HRA is the process of identifying and measuring data about human
resources and communicating the information to interested parties
to facilitate effective management within the organization.
- American Accounting Association Committee
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Definition:
HRA is an attempt to identify and report about investment made
in human resources of an organization that are presently not
accounted for under conventional accounting practice. Basically, it
is information system that tells the management what changes over
time are occurring to the human resources of the business.-
Woodraff Jr.
The accounting about cost and value factors of human resources
is the purpose of Human Resource Accounting.
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Objectives of HR Accounting The objective of HRA is not merely
the recognition of the value of all resources used by the
organisation, but it also includes the management of human resource
which will ultimately enhance the quantity and quality of goods and
services. The main objectives of HR Accounting system are as
follows:
To furnish cost value information for making proper and
effective management decisions about acquiring, allocating,
developing and maintaining human resources in order to achieve cost
effective organisational objectives.
To monitor effectively the use of human resources by the
management.
To have an analysis of the human assets i.e. whether such assets
are conserved, depleted or appreciated.
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To aid in the development of management principles. and proper
decision making for the future by classifying financial
consequences of various practices.
In all, it facilitates valuation of human resources recording
the valuation in the books of account and disclosure of the
information in the financial statement.
It helps the organisation in decision making in the following
areas:
Direct Recruitment vs. promotion, transfer vs. retention,
retrenchment vs. retention, impact on budgetary controls of human
relations and organisational behaviour, decision on reallocation of
plants closing down existing units and developing overseas
subsidiaries etc.
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Methods of HR Accounting
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Human Resources Cost Accounting
HRCA is concerned with the cost aspect involved in recruitment
and maintaining of human resources.
It is the process of the costs incurred for the recruitment,
training and replacement of employees in an organisation.
It is like ascertainment of cost of any other fixed assets of a
concern.
Three kinds of HRA are
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1. Historical cost method
This approach was developed by William C. Pyle and R.G. Barry
corporation, Ohio (USA) in 1967.
According to this method, the cost of human resources is
measured on the basis of actual cost incurred for it.
It is the cost for recruitment, training and developing the
human resources of the organisation.
The present cost for recruitment and training of human resources
who are already employed will not be considered by this method.
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2. Replacement Method
In this method, the cost of HR is ascertained on the basis of
the cost required to replace the entire employees of a concern.
This cost will be definitely high when compared to the actual
cost of recruitment, training and development.
This method was suggested by Rensis Likert.
According to him, there may be situation where all employees may
leave the and only chairman of the concern may exist. In such a
situation there is a need for the concern to recruit all new
employees.
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3. Opportunity cost method
Also known as Market value method.
Hekimian and Jones suggested the concept of opportunity cost for
valuing human resources in a company.
Opportunity cost means the most profitable opportunity cost that
was foregone due to the adoption of this method..
Or the next probable alternative with low cost.
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Opportunity cost for valuing human resources is based on the
chance for the selection of the employees in other departments of
the same organisations or in other organizations.
If the employees have the chance of being selected in other
places, the remuneration of those better place has been foregone by
them due to the present employment.
According to this method the value of the employees are assessed
on the basis of the foregone better remuneration.
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The opportunity cost method is possible only when there is
scarcity of qualified people.
Happens only in rare situations.
This method is not a popular one for valuing the human resources
of a company.
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II. Human Resource Value Accounting
This method of accounting of HR is based on the Discounting
factor of cost and revenue related to HR in future.
The value of HR depends upon the excess of revenue generated due
to it, over the cost incurred for it.
i.e. the cost and the revenue aspects include the present and
future cost and revenue.
Cost = cost of recruitment, training and development
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For calculating the cost ,
The present cost should be taken as its is, and
The future expected cost should be converted into present cost
by discounting factor.
Like this the revenue should be determined.
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Different valuation models developed by scholars.
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Present value of future earnings model
Lev and Schwartz (1971) proposed an economic valuation of
employees based on the present value of future earnings.
According to this model, like any other investment of capital
the capital invested in human resource will give return in
future.
The basis of ascertainment of the human value is the
remuneration given to them.
The present value of it should be determined through discounting
factor of the revenue (remuneration) for the employees.
This concept of valuation should be adopted for each individual
(employees) of the organisation
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Flamholtz Stochastic Rewards Valuation Model
This model states that the individuals value in an organisation
is the expected realizable value.
i.e. Present value of the expected service provided by the
individual to the organisation during his employment.
Based on the revenue aspect of the concern.
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Prof. S.K.Chakraborthys Model
According to this model the value of human resources is
Determined on Aggregate basis and not on individual basis.
In this method, the cost involved for recruitment, replacement,
training and development should be shown separately in Deferred
Revenue Expenditure Account.