Chapter 2.
Theory Base Of AccountingQ1. What do you understand by Generally Accepted Accounting Principles [GAAP]?
Ans. GAAP stand for Generally Accepted Accounting Principles. It refers to the rules and guidelines adopted for recording and reporting of business transaction, in order to bring uni formality in the preparation and the presentation of financial statements.
Basic Accounting Concept:
• Business entity;
• Money measurement;
• Going concern;
• Accounting period;
• Cost
• Dual aspect (or Duality);
• Revenue recognition (Realization);
• Matching;
• Full disclosure;
• Consistency;
• Conservatism (Prudence);
• Materiality;
• Objectivity.
[1] Business Entity Concept:
The concept of business entity assumes that business has a distinct and separate entity from its owners. Keeping this in view, when a person brings in some money as capital into his business, in accounting records, it is treated as liability of the business to the owner. Similarly, when the owner withdraws any money from the business for his personal expenses(drawings), it is treated as reduction of the owner’s capital.
[2] Money Measurement Concept:
The concept of money measurement states that only those transactions and happenings in an organisation which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts. All such transactions or happenings which can not be expressed in monetary terms do not find a place in the accounting records of a firm.
[3] Going Concern Concept:
The concept of going concern assumes that a business firm would continue to carry out its operations indefinitely, i.e. for a fairly long period of time. This is an important assumption of accounting as it provides the very basis for showing the value of assets in the balance sheet.
[4] Accounting Period Concept:
Accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and what exactly is the position of its assets and liabilities at the end of that period.
[5] Cost Concept:
The cost concept requires that all assets are recorded in the book of accounts at their purchase price, which includes cost of acquisition, transportation, installation and making the asset ready to use.
For example: A Machinery was purchased for Rs. 100,000 and in addition Rs. 5,000 was spent on its transportation, Rs. 15,000 spent on its installation. The total amount at which the plant will be recorded in the books of account would be the sum of all these, i.e. Rs. 1,20,000.
[6] Dual Aspect Concept:
This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction. If one a/c is debited other must be credited and visa-versa.
[7] Revenue Recognition (Realization) Concept:
The concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realised.
For example: [a] Credit sale are treated as revenue.,
[b] Income such as rent, commission, interest, etc.
[8] Matching Concept:
The process of ascertaining the amount of profit earned or the loss incurred during a particular period involves deduction of related expenses from the revenue earned during that period. The matching concept emphasizes exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that period.
[9] Full Disclosure Concept:
Information provided by financial statements are used by different groups of people such as investors, lenders, suppliers and others in taking various financial decisions. Contingent liability are shown as foot note under balance sheet.
The principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes.
[10] Consistency Concept:
The accounting information provided by the financial statements would be useful in drawing conclusions regarding the working of an enterprise only when it allows comparisons over a period of time as well as with the working of other enterprises. Thus, both inter-firm and inter-period comparisons are required to be made.
[11] Conservatism Concept:
The concept of conservatism (also called ‘prudence’) provides guidance for recording transactions in the book of accounts and is based on the policy of playing safe. All anticipated losses should be recorded but all anticipated profit should be ignored.
[12] Materiality Concept:
The concept of materiality requires that accounting should focus on material facts. Efforts should not be wasted in recording and presenting facts, which are immaterial in the determination of income. Any fact would be considered as material if it is reasonably believed that its knowledge would influence the decision of informed user of financial statements.
Q. What are the Basis of Accounting?
Ans. There are two Basis of Accounting:
(i) Cash basis; and
(ii) Accrual basis.
[i]Cash basis: Under the cash basis, entries in the book of accounts are made when cash is received or paid and not when the receipt or payment becomes due.
[ii]Accrual basis: Under the accrual basis, however, revenues and costs are recognised in the period in which they occur rather when they are paid.
Q. What is International Financial Reporting Standards (IFRSs)? Gives its benefits.
Ans. International Financial reporting Standards (IFRSs) are globally accepted accounting standards developed by International Accounting Standard Board (IASB).
Benefits to Convergence to IFRSs
1. Easy access to global or international capital markets.
2. Easy comparisons and transparency.
3. True and fair valuation.
4. Increased trust and reliance.
5. Eliminates multiple reporting.
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