THEORETICAL

FRAMEWORK

UNIT- 1
 R
BASIC INTRODUCTION TO ACCOUNTING.

MEANING OF FRAMEWORK.

PURPOSE OF THE FRAMEWORK.

O
A
SCOPE OF THE FRAMEWORK.

APPLICATION OF FRAMEWORK.

OBJECTIVES.

UNDERLYING ASSUMPTIONS.
D
QUALITATIVE ASPECTS.
M
A
THE ELEMENTS OF FINANCIAL STATEMENTS.

RECOGNITION OF THE ELEMENTS OF FINANCIAL

STATEMENTS.
CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE
P
  It can be defined as the process of
recording, classifying,
summarizing, analysing and interpreting
financial
transactions and communicating the
results to the users
ACCOUNTI interested in such communication.
NG:  American Accounting Association
(AAA) defines accounting as ‘the
process of identifying, measuring and
communicating economic information
to permit informed judgements and
decisions by the users of accounts’.
RELATIONSHIP OF
ACCOUNTING WITH BOOK
KEEPING AND
ACCOUNTANCY
 Book Keeping- It is a part of accounting that is
concerned with the recording of transactions and
maintenance of books of accounts. It is a concept
narrower than accounting.
 Accountancy- It is a discipline that incorporates certain
principles or rules of accounting. It is a concept wider
than accounting. 
** Thus Book Keeping is a subset of accounting whereas
Accounting is a part of Accountancy.
 
Ascertaining of financial
result of an enterprise
(obtained from Income
statement or Profit and Loss OBJECTIV
Account)
ES OF
ACCOUNT
Ascertaining financial
ING
position of an Enterprise
(obtained from Balance
Sheet)
  It is a process as it involves the task of
collecting, recording, classifying,
summarising and analysing financial
information in a sequential order.

NATURE OF
 It is considered as an art because it has
certain definite techniques of performing
the various functions.
ACCOUNTI  It is an information system.

NG:  It is a ‘means to an end’ and not an ‘end

in itself’ i.e., it does not end by reporting
the results to the users but also paves the
way for their decision making.
 It deals with only monetary events.
Recording (Journal)

Classifying (Ledger)
FUNCTION
S OF
Summarising (Income Statement and
balance Sheet) ACCOUNTI
NG:
Analysis and Interpretation

Communicate
It refers to the information generated by the
accounting system of an entity related to a
particular accounting period.

ACCOUNTI
NG
They disclose the financial position of the
entity. INFORMATI
ON:

It acts as a mirror of the financial

performance of a concern.
(A) Internal Users-
Board of Directors
Owners
Managers
USERS OF
Employees
ACCOUNTI
(B) External Users- NG
Investors INFORMATI
Money lenders
ON:
Suppliers
Trade Union
Customers
Government
BRANCHES OF
ACCOUNTING:
(A) Traditional Classification:
 Financial Accounting- Financial Accounting is that branch of accounting that is
concerned with the recording of transactions in the books of accounts. The
primary objective of this is to determine the operating result of an organization
during each accounting period and to disclose the financial position at the end of
each accounting period.
 Cost Accounting- It is concerned with the collection, classification, recording,
summarisation and presentation of costing information that is used for cost
ascertainment, cost control and cost reduction.
 Management Accounting- It deals with the presentation of accounting
information in such a way so as to assist the management in day-to-day operations
of the concern, in planning, in policy formulation, in controlling and in decision
making.
BRANCHES OF
ACCOUNTING:
(B) Modern Classification:
 Human Resource Accounting- It identifies and measures data related to human
resources (employees) of an organisation.
 Environmental Accounting- It is also called green accounting. It identifies the
use of natural resources, measures and communicates costs of a company’s
economic impact on the environment.
 Social Accounting- It helps in comparing the social costs and social benefits of an
organisation.
 Forensic Accounting- It deals with the use of accounting skills to investigate
fraud and embezzlement and to analyse financial information for use in legal
proceedings.
 
FRAMEWORK FOR THE
PREPARATION AND
PRESENTATION OF
FINANCIAL STATEMENT
S IN ACCORDANCE
WITH INDIAN
ACCOUNTING
STANDARDS
MEANING OF FRAMEWORK
 The Framework describes the concepts upon which the Ind ASs are based and hence which
determines how financial statements are prepared and the information they contain.
 The Framework is not an accounting standard. It provides the general principles upon which the
accounting standards themselves will be based i.e., the framework is the standard of all standards.
However, it cannot override any specific standard.
 This Framework is prepared in the context of Indian Accounting Standards as they contain
references to this Framework. The existing Framework for the Preparation and Presentation of
Financial Statements (issued by ICAI in July 2000) will continue to remain effective for the
existing Accounting Standards as these standards contain references to it.
 There are certain minor differences in the Framework for the existing Accounting Standards and
the Framework for the Indian Accounting Standards. In near future, the ICAI proposes to integrate
both the Framework for the existing Accounting Standards and the Framework for Indian
Accounting Standards and issue one Framework for both sets of the Standards.
PURPOSE OF THE
FRAMEWORK
The purpose of the Framework is that it:

1. sets out the concepts that underlie the preparation and presentation of financial statements in accordance
with the Indian Accounting Standards for external users;
2. assist in the development of future Indian Accounting Standards and in its review of existing Indian
Accounting Standards;
3. assist in promoting harmonization of regulations, accounting standards and procedures relating to the
presentation of financial statements;
4. providing a basis for reducing the number of alternative accounting treatments permitted by Indian
Accounting Standards;
5. assist preparers of financial statements in applying Indian Accounting Standards and in dealing with topics
that have yet to form the subject of an Indian Accounting Standard;
6. assist auditors in forming an opinion as to whether financial statements conform with Indian Accounting
Standards;
7. assist users of financial statements in interpreting the information contained in financial statements prepared
inconformity with Indian Accounting Standards; and
8. provide those who are interested in Indian Accounting Standards with information about approach to their
formulation.
SCOPE OF THE FRAMEWORK

The Framework provides answers to a

The Framework deals with:
series of fundamental questions:
• the objective of financial statements; • What are financial statements?
• the qualitative characteristics that • What are they for?
determine the usefulness of information • Who are they for?
in financial statements; • What makes them useful?
• the definition, recognition and
measurement of the elements from which
financial statements are constructed;
• Concepts of capital and capital
maintenance.
APPLICATION OF
FRAMEWORK
The Framework applies to the financial statements of all commercial,
industrial and business reporting entities, whether in the public or the
private sectors. A reporting entity is an entity for which there are users
who rely on the financial statements as their major source of financial
information about the entity.
 1. The objective of financial statements
includes:
1. To provide information about the
financial position, performance and
OBJECTIV cash flows of an entity that is useful to
a wide range of users in making

ES economic decisions.
2. To show the results of the stewardship
of management (e., accountability for
the resources entrusted to it.)
UNDERLYING
ASSUMPTIONS
 Accrual Basis

• Under this basis, the effects of transactions and other events are:
• recognized when they occur (and not as cash or its equivalent is received or paid)
• recorded in the accounting records and reported in the financial statements of the
periods to which they relate.
• Financial statements prepared on the accrual basis inform users not only of past transactions
involving the payment and receipt of cash but also of obligations to pay cash in the future and
of resources that represent cash to be received in the future.
 The conceptual framework issued by the IASB in 2010 does not include the accrual basis as
underlying assumption. As per this framework there is only one underlying assumption of
‘going concern’.
 Going Concern
• The financial statements are normally prepared on the assumption that
an entity is a going concern and will continue in operation for the
foreseeable future.
• It is assumed that the entity has neither the intention nor the need to
liquidate or curtail materially the scale of its operations; if such an
intention or need exists, the financial statements may have to be
prepared on a different basis and, if so, the basis used is disclosed
  Qualitative characteristics are the attributes that
make the information provided in financial
statements useful to users. The qualitative
characteristics of financial statements basically
relate to presentation and content. The principal
qualitative characteristics are:
• Understandability

• Relevance

QUALITATI • Materiality

VE ASPECT • Reliability is dependent on:

• Faithful representation
• Substance over form
• Neutrality
• Prudence
• Completeness
• Comparability
THE ELEMENTS OF
FINANCIAL STATEMENTS
• Financial statements portray the financial effects of transactions and other events by grouping them into
broad classes according to their economic characteristics. These broad classes are termed the elements of
financial statements:
• The elements directly related to the measurement of financial position in the balance sheet are:
• Assets,
• Liabilities and
• Equity

• The elements directly related to the measurement of performance in the statement of profit and loss are:
• Income and
• Expenses
• The cash flow statement usually reflects elements of statement of profit and loss and changes in
balance sheet elements; accordingly, this Framework identifies no elements that are unique to this
statement.
 Asset
• a resource controlled by the entity
• as a result of past events and
• from which future economic benefits are
expected to be generated.

 Liability
• a present obligation of the entity
• arising from past events
• Settlement of which is expected to result
in an outflow from the entity of
resources embodying economic benefits.
 Equity: It typically referred to
as shareholders' equity (or owners'
equity for privately held companies),
represents the amount of money that
would be returned to a company’s
shareholders if all the assets were
liquidated, and all the company's debt
was paid off in the case of liquidation.
 OR
• the residual interest
• in the assets of the entity
• after deducting all its liabilities
 Defined in terms of other items in
Balance Sheet it amounts to the
‘Balancing Figure’.
 INCOME

• increases in economic benefits during the accounting period

• in the form of inflows or enhancements of assets or decreases of liabilities

• that result in increases in equity other than those relating to contributions from equity
participants (g., to purchase new shares)
 Again, this is defined in terms of items in the Balance Sheet. Income includes revenue
and gains, even though they may be included in other comprehensive income or directly
in equity rather than profit or loss (e.g., a revenue surplus).

 EXPENSES

• decreases in economic benefits during the accounting period

• in the form of outflows or depletions of assets or incurrences of liabilities

• that result in decreases in equity other than those relating to distributions to equity
participants.
 The framework defines ‘Balance Sheet’ oriented view of financial reporting – this is
fundamental to understanding Ind ASs. Expenses include losses- most of which will be
recognized in profit or loss though some may be included in other comprehensive income
(e.g., a revaluation deficit on an asset with a previously reported surplus) or directly in
equity.
RECOGNITION OF THE
ELEMENTS OF FINANCIAL
STATEMENTS.
 Recognition is the process of incorporating in the balance sheet or
statement of profit and loss an item that meets the definition of an
element and satisfies the criteria for recognition. An item that meets
the definition of an element should be recognized if:
• It is probable that any future economic benefit associated with the
item will flow to or from the entity; and
• The item has a cost or value that can be measured with reliability.
 Recognition of assets
• An asset is recognized in the balance sheet when it is probable that
the future economic benefits will flow to the entity and the asset has a
cost or value that can be measured reliably.
• An asset is not recognized in the balance sheet when expenditure has
been incurred for which it is considered improbable that economic
benefits will flow to the entity beyond the current accounting period.
Instead, such a transaction results in the recognition of an expense in
the statement of profit and loss.
 Recognition of Liabilities

• A liability is recognized in the balance sheet when it is probable that an

outflow of resources embodying economic benefits will result from the
settlement of a present obligation and the amount at which the settlement
will take place can be measured reliably.
• In practice, obligations under contracts that are equally proportionately
unperformed (for example, liabilities for inventory ordered but not yet
received) are generally not recognized as liabilities in the financial
statements. However, such obligations may meet the definition of liabilities
and, provided the recognition criteria are met in the circumstances, may
qualify for recognition. In such circumstances, recognition of liabilities
entails recognition of related assets or expenses.
 Recognition of Income

Income is recognized in the statement of profit

and loss a when increase in future economic
benefits related to an increase in an asset or a
decrease of a liability has arisen that can be
measured reliably. This means, in effect, that
recognition of income occurs simultaneously
with the recognition of increases in assets or
decreases in liabilities.
 Recognition of Expenses
• Expenses are recognized in the statement of profit and loss when a
decrease in future economic benefit related to a decrease in an asset or
an increase of a liability has arisen that can be measured reliably. This
means, in effect, that recognition of expenses occurs simultaneously
with the recognition of an increase in liabilities or a decrease in
assets.
• Expenses are recognized in the statement of profit and loss based on a
direct association between the costs incurred and the earning of
specific items of income. This process, commonly referred to as the
matching of costs with revenues.
When economic benefits are expected to arise over several
accounting periods and the association with income can only
be broadly or indirectly determined, expenses are recognized
in the statement of profit and loss based on systematic and
rational allocation procedures. This is often necessary in
recognizing the expenses associated with the using up of
assets such as property, plant, equipment, goodwill, patents
and trademarks.

An expense is recognized immediately in the statement of

profit and loss when expenditure produces no future
economic benefits or when, and to the extent that future
economic benefits do not qualify, or cease to qualify, for
recognition in the balance sheet as an asset.

An expense is also recognized in the statement of profit and

loss in those cases when a liability is incurred without the
recognition of an asset, as when a liability under a product
warranty arises.
CONCEPTS OF CAPITAL AND
CAPITAL MAINTENANCE

Financial Concept –Capital

(i.e., money invested) is
synonymous with the net assets
or equity of the entity.

Capital
Physical Concept – Capital is
regarded as the productive
capacity of the entity based on,
for example, units of output per
These two concept’s give rise to day.
the concepts of capital
maintenance.
 CONCEPTS OF CAPITAL
MAINTENANCE AND THE
DETERMINATION OF PROFIT.
• Financial capital maintenance: Profit is earned only if the financial (or money) amount
of the net assets at the end of the period exceeds the financial (or money) amount of net
assets at the beginning of the period, after excluding any distributions to, and
contributions from, owners during the period.
• Historical cost accounting uses financial capital maintenance in money terms.

• Physical capital maintenance: Profit is earned only if the physical productive capacity
(or operating capability) of the entity (or the resources or funds needed to achieve that
capacity) at the end of the period exceeds the physical productive capacity at the
beginning of the period, after excluding any distributions to, and contributions from,
owners during the period.
NOTE: Both concepts can be measured in either nominal monetary units or units of
constant purchasing power. Physical capital maintenance requires that current cost be
adopted as the basis of measurement, whereas financial capital maintenance does not call
for any particular measurement basis