ACCOUNTS 1.

Theoretical Framework

1. THEORETICAL FRAMEWORK
UNIT 1 : MEANING AND SCOPE OF ACCOUNTING
CONCEPT 1 : INTRODUCTION
 Every individual performs some kind of economic activity.
 Not necessarily all the economic activities are run for any individual benefit; some economic activities
may create social benefit i.e. benefit for the public, at large.

Economic Activity

Transaction Event

A business, performance of an act, an agreement. A happening, as a consequence of transaction(s),

a result.
[1] An individual invests Rs.2,00,000
[2] Purchases goods for Rs.1,15,000. [1] Earning of Rs.42,000surplus is an event.
[3] Sells for Rs.1,47,000. [2] Inventories in hand.
[4] He pays shop rent for the month Rs.5,000.

 Here raising money through various sources can be termed as transaction and surplus or deficit at the
end of the accounting year can be termed as an event.
 So, everybody wants to keep records of all transactions and events as an aid to decision-making.
 Accounting has universal application for recording transactions and events and presenting suitable
information to aid decision-making.
 The growth of accounting discipline is closely associated with the development of the business world.
 The aim of accounting is to meet the information needs of the rational and sound decision-makers,
and thus, called the language of business.

CONCEPT 2 : MEANING OF ACCOUNTING [T.Q. 1]

Definition :
 "Accounting is the art of recording, classifying, and summarising
in terms of money, transactions and events
of a financial character, and
interpreting the result thereof."
Process :
[1] First identifying the events and transactions and then be recorded in the books of account. This
recording is done in Journal or subsidiary books, also known as primary books.
[2] After recording, they are transferred to secondary books i.e. Ledger. In ledger it is classified in terms of
income, expense, assets and liabilities according to their characteristics and summarised in profit &
loss account and balance sheet.
Measurement :
 Essentially the transactions and events are to be measured in terms of money.
 Measurement in terms of money means measuring at the ruling currency of a country, for example,
rupee in India, dollar in U.S.A. and like.

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PROCEDURAL ASPECTS OF ACCOUNTING
 On the basis of the above definitions, procedure of accounting can be basically divided into two parts:
[i] Generating financial information and
[ii] Using the financial information.
 The procedural aspects of accounting can be explained with the help of the following chart:

Procedure of Accounting

Generating Financial Using the Financial

Information Information

Recording Classifying Summarising Analysing Interpreting Communication

[i] Generating Financial Information

Sr No. GFI Explanation
[a] Recording  Basic function of accounting evidenced by sales bill, pass book, salary slip
etc. are recorded in the books of account.
 Recording is done in a book called "Journal."
 This book may further be divided into several subsidiary books according to
the nature and size of the business.
[b] Classifying  It is systematic analysis of the recorded data.
 The book containing classified information is called "Ledger".
 This will help in finding out the total expenditure incurred under each of
the above heads.
[c] Summarising  It is concerned with the preparation and presentation of the classified data
useful to the internal as well as the external users of financial statements.
 This process leads to the preparation of financial statements:
[a] Trial Balance
[b] Profit and Loss Account
[c] Balance Sheet
[d] Cash-flow Statement.
[d] Analysing  The term 'Analysis' means methodical classification of the data given in the
financial statements.
 The figures given in the financial statements will not help anyone unless
they are in a simplified form.
 For example, all items relating to fixed assets are put at one place while all
items relating to current assets are put at another place.
[e] Interpreting  The recorded financial data is analysed and interpreted in a manner that
will enable the end-users to make a meaningful judgement about the
financial condition and profitability of the business operations.
[f] Communicating  It is concerned with the transmission of summarised, analysed & interpreted
information to the end-users to enable them to make rational decisions.
 This is done through preparation and distribution of accounting reports.

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[ii] Using the Financial Information
 Earlier it was viewed that accounting is meant for the proprietor or owner of the business, but
changing social relationships diluted the earlier thinking.
 Besides the owner include the investors, employees, lenders, suppliers, customers, government and
other agencies and the public at large.
 Accounting provides the art of presenting information systematically to the users of accounts.
 Accounting data is more useful if it stresses economic substance rather than technical form.
 Information is useless and meaningless unless it is relevant and material to a user's decision.
 The information should also be free of any biases.

PROCESS OF ACCOUNTING
Input Identification of transaction

Economic Accounting Cycle Output

events transaction
measured
in financial
terms Communicating
Recording of Posting Preparatio Preparatio information to
transactions to n of trial n of final users
in the books Ledger balance accounts
of original
entry

Internal Users External Users

Boards of Investors
Directors Lenders
Partners Suppliers
Managers Govt. agencies
Officers Customers

CONCEPT 3 : OBJECTIVES OF ACCOUNTING (SAAP To Know)

Objectives of Accounting

Systematic Ascertainment Ascertainment Communicating To know the

Recording of of Results of Financial Information to solvency
Transactions Position Various Users position.

Books Keeping Manufacturing, Balance Sheet Financial

Journal, Ledger Trading,
P&L A/c Reports
& Trial Balance

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CONCEPT 4 : FUNCTIONS OF ACCOUNTING
(Memory technique : MF DC ko Control karta hai & Taxes pay karta hai)
Sr. no. Functions Explanation
[1] Measurement :  It measures past performance and depicts its current financial position.
[2] Forecasting :  It helps in forecasting future performance and financial position.
[3] Decision-making :  It provides relevant information to the users of accounts to aid rational
decision-making.
[4] Comparison &  Accounting assesses performance achieved in relation to targets
Evaluation : &discloses information regarding accounting policies & contingent
liabilities which play role in predicting, comparing & evaluating the
financial results.
[5] Control :  Accounting identifies weaknesses of the operational system and
provides feedbacks to check weaknesses.
[6] Government  Accounting provides necessary information to the government to
Regulation & exercise control on the entity as well as in collection of tax revenues.
Taxation :

CONCEPT 5 : BOOK – KEEPING& ITS OBJECTIVES

 Book-keeping is an activity concerned with the recording of financial data relating to business
operations in a significant and orderly manner.
 OBJECTIVES OF BOOK-KEEPING
[a] Complete Recording of Transactions :
 It is concerned with complete and permanent record of all transactions in a systematic and logical
manner to show its financial effect on the business.
[b] Ascertainment of Financial Effect on the Business :
 It is concerned with the combined effect of all the transactions made during the accounting period
upon the financial position of the business as a whole.

CONCEPT 6 : DISTINCTION BETWEEN BOOK – KEEPING AND ACCOUNTING

 Accounting is a broad subject. It calls for a greater understanding of records obtained from book-
keeping and an ability to analyse and interpret the information provided by book-keeping records.
Sr. no. Point of Distinction Book – Keeping Accounting
1] Meaning It is a process concerned with Process concerned with
recording of transactions. summarising of the recorded
transactions.
2] Constitutes It constitutes as a base for accounting It is considered as a language of the
business.
3] Financial It does not form part of this process. It is prepared in this process.
Statements
4] Managerial Cannot be taken. Taken.
Decisions
5] Subfield No sub-field. Several sub-fields like financial
accounting, management
accounting.
6] Financial Position Cannot be ascertained through book- Ascertained on the basis of the
keeping records. accounting reports.

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CONCEPT 7 : SUB – FIELDS OF ACCOUNITNG [T.Q. 1]

Sr. no. Functions Explanation

[1] Financial  It covers the preparation and interpretation of financial statements and
Accounting communication to the users of accounts.
 It is historical in nature as it records transactions which had already
been occurred.
 The final step of financial accounting is the preparation of Profit and
Loss Account and the Balance Sheet.
[2] Management  It is concerned with internal reporting to the managers of a business
Accounting : unit.
 To discharge the functions of stewardship, planning, control and
decision making, the management needs variety of information.
 The different ways of grouping information and preparing reports as
desired by managers for discharging their functions are referred to as
management accounting.
[3] Cost Accounting :  "The process of accounting for cost which begins with the recording of
income and expenditure or the bases on which they are calculated and
ends with the preparation of periodical statements and reports for
ascertaining and controlling costs."
[4] Social Responsibility  Social responsibility accounting is concerned with accounting for social
Accounting : costs incurred by the enterprise and social benefits created.
[5] Human Resource  Human resource accounting is an attempt to identify, quantify and
Accounting : report investments made in human resources of an organisation that
are not presently accounted under conventional accounting practice.

CONCEPT 8 : USERS OF ACCOUNTING INFORMATION [T.Q. 2]

 Generally users of accounts are classified into two categories,
[a] Internal management and owners; and
[b] External users or outsiders.
Sr. no. Users Explanation
[1] Investors :  They provide risk capital to the business.
 They need information to assess whether to buy, hold or sell their
investment.
 Also they are interested to know the ability of the business to survive,
prosper and to pay dividend.
[2] Employees :  Growth of the employees is directly related to the growth of the
organisation and therefore, they are interested to know the stability,
continuity and growth of the enterprise.
[3] Lenders :  They are interested to know whether their loan-principal and interest
will be paid when due.
[4] Suppliers and  They are also interested to know the ability of the enterprise to pay the
Creditors : dues, that helps them to decide the credit policy for the relevant
concern, rates to be charged and so on.
[5] Customers :  Customers are also concerned with the stability and profitability of the
enterprise because their functioning is more or less dependent on the
supply of goods.

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[6] Government & their  They regulate the functioning of business enterprises for public good,
agencies : allocate scarce resources among competing enterprises, control prices,
charge excise duties and taxes, and so they have continued interest in
the business enterprise.
[7] Public :  The public at large is interested in the functioning of the enterprise
because it may make a substantial contribution to the local economy in
many ways including the number of people employed.

CONCEPT 9 : RELATIONSHIP OF ACCOUNTING WITH OTHER DISCIPLINES [T.Q. 3]

 Accounting is closely related with several other disciplines and the Accountant should have a working
knowledge of the related disciplines so that he can understand such overlapping areas.
[a] Accounting and Economics :
Similarities Difference Nexus
 Economics :  In concepts of income and  Accountants got the ideas of value,
 It is a science of rational capital. income and capital maintenance
decision-making about the from economists.
use of scarce resources.  Economists think that value of an
 This may be viewed either asset is the present value of all
from the perspective of a future earnings which can be
single firm or of the derived from such assets.
country as a whole.  How can you estimate future
 Accounting stream of earnings? So
 It provides data to the users accountants developed the
to permit informed workable valuation base - the
judgement and decisions. acquisition cost i.e., the price paid
to acquire the assets.
 At the macro-level, accounting
provides the database over which
the economic decision models
have been developed; micro-level
data arranged by the accounting
system is summed up to get
macro-level database.
[b] Accounting and Statistics :
 In accountancy, a number [1] In accounts, all values are  Accounting records are based on
of financial and outer important individually historical costs of fixed assets,
ratios are based on because they relate to while the current assets are valued
statistical methods, which business transactions. at the current values. The new
help in averaging them [2] Statistics is concerned with methods of inflation accounting
over a period of time. typical value over a period of are an attempt to correct this
 Statistical methods are time or degree of variation situation.
helpful in developing over a series of observations.  The correction of values is made
accounting data and in [3] Accounting records on the basis of the current
their interpretation. generally take a short-term purchasing power of money.
view of events (a year) while  All this would require the use of
statistical analysis is more price indices or the price deflators
useful if a longer view is based on statistical data.
taken for the purpose.

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[c] Accounting and Mathematics :
 Double Entry book-keeping can be converted in algebraic form.
 Knowledge of arithmetic and algebra is a pre-requisite for accounting computations and
measurements. Calculations of interest and annuity are the examples of such fundamental uses.
 With the advent of the computer, mathematics is becoming a vital part of accounting. Instead of
writing accounts in traditional fashion, the transactions and events can be recorded in the matrix form
for classifying and summarising data.
 Presently graphs and charts are being extensively used for communicating accounting information.
[d] Accounting and Law :
 All transactions with suppliers and customers are governed by the Contract Act, the Sale of Goods Act,
the Negotiable Instruments Act, etc. The entity itself is created and controlled by laws. Every country
has a set of economic, fiscal and labour laws.
 Transactions and events are always guided by laws.
 Very often the accounting system to be followed has been prescribed by the law. For example, the
Companies Act has prescribed the format of financial statements. Banking, insurance and electric
supply undertakings also have to produce financial statements as prescribed by the respective
legislations.
[e] Accounting and Management :
 Management is a broad occupational field.
 Accountants are well placed in the management and play a key role in the management team. A large
portion of accounting information is prepared for management decision-making.
 So the accounting system can be moulded to serve the management purpose.

CONCEPT 10 : LIMITATIONS OF ACCOUNTING [T.Q. 4]

 The assumptions and conventions, on which the accounting is based, become the limitations of
accounting.
[a] The Balance sheet cannot reflect the value of certain factors like loyalty and skill of the personnel.
[b] Balance Sheet shows the position on the day of its preparation and not on the future date. Users are
interested in knowing the position in the near future and not for the past date.
[c] Accounting ignores changes in some money factors like inflation etc.
[d] There are occasions when accounting principles conflict with each other.
[e] Certain accounting estimates depend on the personal judgement of the accountant, e.g., provision for
doubtful debts, method of depreciation adopted.
[f] Financial statements only consider those assets which can be expressed in monetary terms. Human
resources although very important are not shown in the balance sheet.
[g] Different accounting policies for the treatment of same item add to the probability of manipulations.
 It can be said that the language of accounting has certain practical limitations and, therefore, the
financial statements should be interpreted carefully keeping in mind all various factors influencing the
true picture.

CONCEPT 11 : ROLE OF CHARTERED ACCOUNTANT IN THE SOCIETY [T.Q. 5]

[A] AREAS OF SERVICE

[1] Maintenance of Books of Accounts
[2] Statutory Audit
[3] Internal Audit
[4] Taxation
[5] Management Accounting and Consultancy Services

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[6] Financial Advice
[a] Investments
[b] Insurance
[c] Business Expansion
[d] Investigations
[e] Pension schemes
[7] Other Services
[a] Secretarial Work
[b] Share Registration Work
[c] Company Formation
[d] Receiverships, Liquidations, etc.
[e] Arbitrations
[f] As Regards the Cost Accounts
[g] Accountant and Information Services

[B] CHARTERED ACCOUNTANT IN INDUSTRY

[C] CHARTERED ACCOUNTANT IN PUBLIC SECTOR ENTERPRISES
[D] CHARTERED ACCOUNTANT IN FRAMING FISCAL POLICIES
[E] CHARTERED ACCOUNTANT AND ECONOMIC GROWTH
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