Accounting – Concepts and Conventions

NATURE OF FINANCIAL STATEMENT The info exhibited by m unmatchabletary commands argon affected by a)Recorded facts b) chronicle judgments, conventionalitys & Principles c)Personal Judgment 1)Recorded Facts The term memorializeed facts actor the data used for preparing fiscal literary arguments be taken from invoice record which ar facts. i. e. Cash in Hand Actual hard currency is enter standard due from debtor Actual to be preserve Amount due to creditor Actual to be put down thusly the pecuniary narration do not observe much(prenominal) facts which whitethorn be reality, which atomic number 18 not save. For ex. L/Bldg. urchased argon shown at cost bell in the bill Books But food market prize which in reality whitethorn be opposite is not stated because it is not recorded in Books of A/c. 2)Accounting images & conventions & principle The Dictionary esteeming is Fundamental truth implying unanimity of Applicability everywhere. However when applied in Financial report Analysis, it gives different meaning in different ideas & so it is r atomic number 18ly used as a fundamental invoice truth. Accounting Principles be those rules of Action which are larded by the control univers entirelyy in save transaction.Different captain bodies manage Australian Society of Account (i. e. bring of Chartered Accountant in Australia) The Institute of Chartered Accountant in England & Wales. The Ameri whoremaster Institute of certified public accountant gift make recommendation on invoice principles in the recent grade. Accounting principles have been developed exclusively over the years from experience, usage & necessity. They are judged on the General Acceptability quite an than Universal Acceptability to the user of financial statement hence they are called as General Accepted Accounting Principles (G. A. A. P. ) correspond principles can be in the main classified into two categories A. Accounting concepts B. Accounting Conventio ns Accounting Principles Accounting conceptsAccounting Conventions a)Entity suppositiona) revelation b)Going forethought Conceptb)Materiality c)Accounting gunpoint conceptc)Consistency d)Money beat Conceptd)Conservatism e) toll Concept f)Cost Attach Concept g) bivalent Aspect Concept h)Accrual concept i)Periodic Matching of cost and Revenue Concept j)Realisation Concept k)Verifiable heading Evidence Concept news report CONCEPTS They are the incumbent assumptions or take aims upon which accounting is ground.Accounting concepts are postulates, assumptions or conditions upon which accounting is based. They are developed to convey the equivalent meaning to all people. Some of the crucial concept are given up as follows 1. Entity Concept For accounting purposes- the championship is treated as a separate entity from the possessor (s). It may sound to be absurd that one sell goods to himself, only if all transactions are recorded in the books of the barter as per this poin t of consume. This concept helps in keeping undercover affairs of the proprietor away from the business affairs. thence if a proprietor invests Rs. ,00,000/- in the business, it is deemed that the proprietor has given Rs. 1,00,000/- to the business and it is shown as a financial obligation in the books of business. (because business has to ultimately repay it to the proprietor). Similarly, if the proprietor withdraws Rs. 10,000/- from the business, it is charged to him. This concept is applicable to all works of business organizations. Although in the eyes of Law a Sole quite a littler and his business or the partner and their business are one and the same, for accounting purposes they are regarded as separate entities. It is the business with which we are concerned. . Going Concern Concept (Continuity of Activity) It is assumed that the business concern exit continue for a fairly presbyopic time, unless and until it has entered into a state of liquidation. 3. Accounting Per iod Concept Although the going concern concept stresses the continuing spirit of the business enterprise, it is customary to divide its life into chapters known as Accounting Periods. An accounting purpose is the interval of time at the end of which the income statement and financial position statement (balance weather stable gear of paper) are prepared to know the solvent and resources of the business.Although shorter outcomes are frequently adopted for purposes of comparative studies, the normal accounting period is twelve months. This is because though the life of the business is considered to be indefinite, the measurement of income and study the financial position of the business after a very long period would not help in taking timely disciplinal steps or to enable periodic distributions of income to proprietor (s) with reasonable safety. Therefore, it is necessary for the concern to stop at regular intervals and see back how it is faring. 4.Money Measurement Concept In accounting everything is recorded in damage of money. Events or transaction which cannot be show in terms of money are not recorded in the books of accounts, even if they are very important or useful for the business. Purchase and sale of goods, payment of expenses and receipt of income are monetary transactions which find place in accounting and so on Death of an exe apologizeive, resignation of a manager are the events which cannot be expressed in money and so are not to be recorded in Books of A/c. 5. Cost Concept (Objectivity Concept) As per cost concept )an asset is ordinarily recorded at the price paid to acquire it i. e. at its cost, and b)this cost is the understructure for all ensuant accounting for the asset. For example, if a plot of land is purchased for Rs. 1,00,000/- it is recorded in the books of at Rs. 1,00,000/- and even if its market value at the time of facility of final exam accounts is Rs. 2,00,000/- or Rs. 60,000/- it will not be considered. Thus the balance sheet on a peculiar(prenominal) duration does not ordinarily signal what the asset could be sold for. The cost concept does not mean that the asset will always be shown at cost.It moreover representation that cost becomes the fundament for all subsequent accounting for the asset. Thus the assets recorded by the process of depreciation. Cost concept brings objectivity in the preparation and presentation of financial statements. It implies that the figures shown in the accounting records should be based on fair game evidence and not on the subjective views of a person. 6. Cost-attach Concept This concept is as well as known as cost-merge concept. In order to crap an article it is necessary to purchase raw- framework, process it and convert into finished article.This calls for the work of other factors of ingatheringion and in that respectfore, there are several other be worry labour cost, power and other overhead expenses. These cost have a capacity to merge or a ttach when they are brought together. Thus the proportionate raw-material costs, labour costs, and other overheads are added together to obtain product cost so as to increase the utility of cost data. 7. Dual Aspect Concept This is the underlying concept of accounting. As per this concept, every business transaction has a dual effect. 8.Accrual Concept The accrual concept implies recording of taxations and expenses of a particular accounting period, whether they are received / paid in cash or not. Under cash system of accounting, the revenues and expenses are recorded only if they are actually received / paid in cash irrespective of the accounting period to which they belong. But under accrual method, the revenues and expenses relating to that particular accounting period only are considered. 9. Periodic Matching of Cost and Revenue Concept This concept is based on the accounting period concept.Making pull in is the most important objective that keeps the proprietor engaged in b usiness activities. That is why most of the accountants time is dog-tired in evolving techniques for measuring the profit/profitability of the concern. To ascertain the profit do during a period, it is necessary to match revenues of the period with the expenses of that period. Income (profit) earned by the business during a period can be measured only when the revenue earned during the period is compared with the expenditure incurred to earn that revenue. The question when the payment was made / received is ir applicable.Therefore, as per this concept adjustments are made for all great expenses, prepaid expenses, accrued incomes, unearned incomes and so on 10. Realisation Concept According to this concept profit should be accounted for only when it is actually realized. Revenue is recognized only when sale is effected or the services are rendered. trade is considered to be made when the property in goods passes to the buyer and he is lawfully liable to pay. However, in order to recognize revenue, receipt of cash is not essential. Even credit sale results in realization as it creates a efinite asset called Account Receivable. However, there are certain exceptions to the concept want in case of contract accounts, hire purchase etc. Similarly incomes like commission, interest, rent etc. are shown in pay and Loss Account on accrual basis though they may not be realised in cash on the date of preparing accounts. 11. Verifiable Objective Evidence Concept According to this concept all accounting transactions should be evidenced and supported by objective documents. These documents include invoices, contracts, correspondence, vouchers, bill, pass books, cheque books etc. uch supporting documents provide the basis for making accounting entries and for verification by the auditors later on. This concept also has its limitations. for example, it is difficult to verify internal allocation of costs to accounting periods. 2. ACCOUNTING CONVENTIONS Conventions are the customs or traditions or usage which guide of accounting statements. They are adapted to make financial statements clear and meaningful. 1. Convention of Disclosure This means that the accounts must be honestly prepared and they must disclose all material randomness.The accounting reports should disclose full and fair schooling to the proprietors, creditors, investors and others. This conventions is specially significant in case of big business like Joint Stock Compevery where there is divorce between the owners and the managers. However, it does not mean that all information or information of any frame is to be included in accounting statements. The term apocalypse only implies that there must be a sufficient manifestation of informations which is of material interest to proprietors, present and potential creditors and investors. 2.Conventions of Materiality The accountant should attach wideness to material details and ignore insignificant details. If this is not done ac counts will be overburdened with minute details. As per the American Accounting Association, an full point should be regarded as material, if there is a reason to believe that companionship of it would influence the decision of informed investor. Therefore, keeping the convention of materiality in view, unimportant items are either left out or coordinated with other items. Some items are shown as foot notes like, contingent liabilities, market value of investment etc.However, an item may be material for one purpose but immaterial for another, material for one concern but immaterial for another, or material for one year but immaterial for next year. 3. Convention of Consistency The comparison of one accounting period with the other is possible only when the convention of consistency is followed. It means accounting from one accounting period to another. For example, a company may adopt straight line method, written down value method, or any other method of providing depreciation on fixed assets. But it is anticipate that the company follows a particular method of depreciation consistently.Similarly, if stock is cute at cost or market price whichever is less, this principle should be followed every year. Any change from one method to another would lease to inconsistency. However, consistency does not mean non-flexibility. It should permit introduction of improved techniques of accounting. 4. Convention of Conservatism It refers to the policy of playing safe. As per this convention all likely losses are taken into consideration but not all prospective profits. In other words anticipate no profit but provide for all possible losses.However, this convention is existence criticized on the ground that it goes not only against the convention of full disclosure but also against the concept of matching costs and revenues. It encourages creation of underground reserves by making excess provision for depreciation, bad and questionable debts etc. The Income st atement shows a lower net income and the Balance sheet overstates the liabilities and understates the assets. The convention of conservatism should be applied cautiously so that the results report are not distorted. Some degree of conservatism is inevitable where objective data is not available.Following are the examples of application of conservatism a)Making provision for in question(p) debts and discount on debtors. b)Not providing for discount on creditors. c)Valuing stock in trade at cost or market price whichever is less. d)Creating provision against fluctuations in the price of investments. e)Showing Joint Life Policy at surrender value and not at the paid up amount. f)Amortization of intangible asset like goodwill which has indefinite life. ESSENTIAL QUALITIES OF FINANCIAL STATMENTS As stated earlier, the basic objective of financial statement is to provide information useful to the users of these statements.Different users like shareholders, investors, financial institutio ns, workers etc. are interested in financial statements with variable objectives. Generally, it is not possible for a firm to prepare these statements in such a form that may suit every interested user. However, such statements should possess at least the following essential qualities. 1. Relevance provided these information should be disclosed in financial statements which are relevant to the objectives of the firm. The information is said to be relevant only when it influences decision of the users, tour evaluating any event or correcting past evaluation.The conclusions drawn on the basis of orthogonal information would be misleading of no use. Therefore, the information irrelevant to the statements be avoided, otherwise it would be difficult to make a specialization between relevant and irrelevant information. 2. Understandability The main objective of financial statements is to provide necessary information about the firms resources and performance. To run into this obje ctives, the information contained in these statements should be clear, simple and lucid so that a person who is not well versed with the accounting terminology shall be able to understand without much difficulty.Hence, as far as possible, the form of financial statements should not be complex, and the terms used in these statements should be simple, in common language and non-technical. 3. dependability and Accuracy The information corporate in financial statements should be reliable. selective information has the quality of reliability when it is take over from material error and bias and can be depended upon by users. Reliability charges with the nature of information contained in the subject matter. Therefore, such information should be provided whose reliability can be verified. Reliability of financial statements also depends on the accuracy of accounts.Hence, to arrive at right conclusions, accuracy of the accounts is an essential quality. To be reliable*, information mus t (i) carry faithful representation of transactions, (ii) should be presented in accordance with the substance and economic reality, and (iii) must be neutral, heady and have it away. 4. Comparability Comparison is the essence of financial statement analysis. Comparable information will reveal relatively strong and weak point. Financial statement should be prepared in such a way that true years progress can be compared with that of previous year and inter-firm comparison is possible.To facilitate comparison, it would be more useful to provide with the financial statement of 5 to 10 years summary of important terms such as production in quantity, net sales, net profits, dividend paid, work capital etc. 5. Completeness The information contained in the financial statements should be complete in al respects. It must be ensured that there is no chance of any information being incomplete or doubtful. Therefore, full disclosure should be made of all significant information in a mann er that is understandable and does not mislead creditors, investors and others users. . Timeliness Financial statements are prepared for a definite period of time. At the end of this period, they should be ready and submit to the parties concerned. If the statements are not prepared in time, they can not be properly used and the firm cannot formulate plans for next developments. In addition to the aforesaid qualities, financial statements be prepared easily, attending of the reader is automatically drawn and directed to most significant items and involve data for the calculation of different ratios are also essential qualities.As American Accounting Association, has described, every corporate statement should be based on accounting principles which are sufficiently uniform, objective and understood to justify opinions to the condition and progress of the business enterprise behind it. LIMITATIONS OF FINANCIAL STATEMENTS The summary of accounts retained by a business firm is pr esented in the form of financial statements. The amounts expressed in these statements are based on vouchers and accounting records.Hence, decisions based on these information are more true and logical. However, the conclusions drawn on the basis of these information cannot be treated as final and accurate, because there are certain limitations to the financial statements. One must, therefore, keep in view these limitations while studying the profit and loss account and balance sheet of the firm. Important and impact bearing limitations of financial statements are identified as below 1. Lack of Precision 2. Lack of Exactness 3. Incomplete Information 4. Interim Reports . Hiding of Real Position or Window cover 6. Lack of Comparability 7. Historical Costs Analysis To Analyse to cut into pieces But only analyse No It means also Interpretation. Thus Financial Statement Analysis means Analysis, comparisons and interpretation of Financial data to achieve the desired result TOOLS OF FINANCIAL STATEMENT ANALYSIS 1. proportional Statements 2. Common Size Statements The Essential Requirement is 3. Trend AnalysisVertical Financial Statement. 4. dimension Analysis 5. Fund Flow Statement 6. Cash Flow Statement