Theory Base of Accounting H.S. 1ST YEAR ACCOUNTANCY NOTES AHSEC ASSAM Higher Secondary Unit – 2


Unit – 2

Theory Base of Accounting

Q1. What is Generally Accepted Accounting Principle (GAAP)?
Ans: Accounting is the language of business. To make the language convey, the same meaning to all people, accountants all over the world have developed certain rules, regulations, procedures and conventions which represent a consensus view by the profession of good accounting practices and procedures are generally referred to as Generally Accepted Accounting Principle.

Q2. What are the features of Accounting Principles?
Ans: Following are the features of Accounting Principles:
a. Man made: Accounting principles are manmade. They are not tested in a laboratory; therefore, they do not have authoritativeness, as universal principles like other natural sciences viz., Physics, chemistry, botany etc.

b. Objectivity: It means accounting principles must be based on facts and free from personal bias or judgement of the individual who prepares the statements.

c. Relevance: Accounting principles must be relevant and useful to the person who is using financial statements.

d. Feasibility: The accounting principles should be practicable or feasible. In case principle is sound theoretically but its application is difficult, then the principle does not have much value.

Q3. Write short notes on:
1. Accounting Principle
The term principle refers to fundamental believe or a general truth which once established does not change. The accounting principles are usually the concept of conventions which have been adopted as a general guide by the accounting profession. Some accountants prefer to use the term standard instead of using the word principle. Accounting principle can be classified into two categories:
a. Accounting concept.
b. Accounting convention.

Accounting concept: Accounting concept may be considered as postulates i.e., basic assumption or condition upon which the science of accounting is based. Any abstract ideas surviving a systematized function are regarded as concept.

Accounting convention: The term convention denotes circumstances or traditions which guide the accountants while preparing the accounting statement. It refers to a statements or a rule of practice which, by common consent, express or implied is employed in the solution of a given class of problem or guide behavior of a certain kind of situation.

Accounting concept
a. Business entity concept:  This concept implies that a business unit is separate and distinct from the person who supplies capital to it. Irrespective of the form of organization a business unit has got its own individuality as distinguished from the person who own or control it.

b. Money measurement concept: Money is the only practical unit of measurement that can be employed to achieve homogeneity of financial data, so accounting records only those transactions which can be expressed in terms of money.

c. Going concern: It is assumed that a business unit has a reasonable expectation of continuing business at a profit for an indefinite period of time. A business unit is deemed to be a going concern not a gone concern.

d. Cost concept: The cost principle provides a relatively objective foundation for accounting. Cost principle in accounting states that all accounting entries shall be made at cost as and when the transactions take place. Cost is the amount of money paid or payable for goods and assets acquired or services received.

e. Dual aspect concept: Dual aspect is another important concept applied in recording and presenting accounting information. According to this concept every business transaction has a double effect i.e., it has two sides debit and credit.

f. Accounting period concept: Accounting period refers to the period of time at the end of which books of accounts of business entity are to be closed and financial statements are to be prepared.

g. Matching concept: This concept is based on the accounting period concept. The determination of profit of a particular accounting period is essentially a process of matching the revenue recognized during the period and the cost to be allocated to that period to obtain the revenue.

h. Realization concept: According to this concept revenue is considered as being earned on the date at which it is realized i.e., on the date when the property in goods passes to the buyer and he becomes legally liable to pay.

i. Accrual concept: The essence of the accrual concept is that revenue is recognized when it is realized i.e., when sale is complete or services are given and it is immaterial whether cash is received or not. 

j. Objective evidence concept: The objectivity principle states that accounting should be definite, verifiable, reliable and free from manipulation and personal bias of the persons engaged in the process of recording and presenting accounting data.

Accounting conventions
a. Convention of consistency: The principle of consistency requires that the accounting policies which are followed from period to period should not be changed.

b. Convention of full disclosure: Accounting information are required for decision making purpose by various users. Therefore to be useful as the basis of decision making process, there should be full disclosure in the financial statements of all significant information.

c. Convention of conservatism (prudence): The term conservatism implies that all probable or anticipated losses should be provided for and all anticipated or unrealized gains should be ignored and the profit should not be overstated.

d. Convention of materiality: The term materiality refers to the relative importance of an item. What is material for one firm may be immaterial for another firm. Materiality depends on the amount involved in the transactions.

Q4. What is Accounting Standard?
Ans: Accounting standards are authoritative standards for financial reporting and are the primary source of generally accepted accounting principles (GAAP). Accounting standards specify how transactions and other events are to be recognized, measured, presented, and disclosed in financial statements. The objective of such standards is to provide financial information to investors, lenders, creditors, contributors and others that is useful in making decisions about providing resources to the entity. Accounting standard is a selected set of accounting policies or broad guidelines issued by an accounting body, regarding the principles and methods to be chosen out of several alternatives that are followed for the preparation of financial statements.

Q5. What are the needs for Accounting Standard/ objectives of Accounting Standard/ Purposes of Accounting Standard?
Ans: Following are the needs for Accounting Standard/ objectives of Accounting Standard/ Purposes of Accounting Standard:

a. Uniform presentation of accounts: The users of financial statements require the accounting information which is comparable. The presence of wide variety of concepts, conventions and principles created confusion among them, rather than providing a solid and logical treatment of the transactions. The necessity to present uniform accounting information resulted in the emergence of accounting standards.

b. Avoidance of manipulation: Misusing the vagueness of accounting concepts, conventions and principles generates scandals resulting into failure of the business. Accounting Standards are needed to avoid such manipulation of accounting results.

c. Globalised business: Globalization of business has resulted in the emergence of multinational corporations in different countries with different principles, customs and currency. The global business needs standardization of accounting system for its smooth and fair flow.

d. Disclosure beyond law: There are certain areas of accounting where law does not require important information to be disclosed. Accounting standard may call for disclosure of such information beyond that required by law.

e. Simplify the accounting information: Accounting standards prevent the users from reaching any misleading conclusions and make the financial data simpler for everyone. For example, AS-3(Revised) clearly classifies the flows of cash in terms of ‘operating activities’, ‘investing activities’ and ‘financing activities’.

Q6. Write short notes on: ACCOUNTING STANDARD BOARD (ASB):
Ans: It was constituted by the ICAI on April 21, 1977 to formulate accounting standards. While formulating accounting standards, the ASB takes into consideration the applicable laws, customs and business environment prevailing in the country. The ASB also gives due consideration to IASs/IFRSs is issued by the International Accounting Standard Board (IASB) and tries to integrate them, to the extent possible, in the light of conditions prevailing in India.

Q7. What are the distinction between Accounting Standard and Accounting Principles?
Ans: Following are the distinction between Accounting Standard and Accounting Principles:

Q8. What are the Advantages or Benefits of Accounting Standards?
Ans: Following are the Advantages or Benefits of Accounting Standards:
a. Accounting Standards sets the tone of accounting: Accounting as a language of business communicates the financial results and health of an enterprise to various interested parties by means of periodical financial statements.

b. Standardization of different accounting treatments: Standards reduce to a reasonable extent or eliminate altogether confusing variations in the accounting treatments used to prepare financial statements.

c. Improve the credibility and reliability of financial statements: Financial Statements of business enterprises are used by a diverse group of users for making sound economic decisions. It is necessary, therefore, that the financial statements present a fair picture of the position and progress of the enterprise.

d. Fulfill requirements for additional disclosures: There are certain areas where important information are not statutorily required to be disclosed. Standards may call for disclosure beyond that required by law.

Q9. What are the limitations of Accounting Standards?
Ans: Following are the limitations of Accounting Standards:
a. Difficulties in making choice between different treatments: Alternative solutions to certain accounting problems may each have arguments to recommend them. Therefore, the choice between different alternative accounting treatments may become difficult.

b. Lack of flexibility: There may be a trend towards rigidity and away from flexibility in applying the accounting standards.

c. Restricted scope: Accounting standards cannot override the statute. The standards are required to be framed within the ambit of prevailing statutes.

d. Involves Cost: The Company needs to comply with accounting standards which requires a financial investment that includes employee labor costs, system upgrades and employee training.

Q10. Write short notes on International Financial Reporting Standards (IFRS)
Ans: International Financial Reporting Standards constitute a globally recognized set of standards for the preparation of financial statements by business entities used in multiple countries. The IASB, or International Accounting Standards Board, work to develop these standards, creating a consistent approach to financial reporting globally. The IASB works with investors, auditors and regulators in different countries to determine the needs of each user and incorporate those needs in the standards.

Q11. What are the need and Importance of IFRS?
Ans: International Financial Reporting Standards (IFRS) convergence, in recent years, has gained momentum all over the world. As the capital markets become increasingly global in nature, more and more investors see the need for a common set of accounting standards. It will lower the cost of raising funds, reduce accountants’ fees and enable faster access to all major capital markets. It will facilitate companies to set targets and milestones based on global business environment rather than an inward perspective. This will eliminate the need for multiple reports and significant adjustment for preparing consolidated financial statements or filling financial statements in different stock exchanges.