The main objective of accounting is to give users accurate, trustworthy information about the financial performance of the company for them to make wise decisions. Only when accounting records are kept by uniform rules and principles will this goal be accomplished.
Generally Accepted Accounting Principles (GAAP) are a set of accounting principles, ideas, and procedures (GAAP). These principles form the basis of accounting. The term "Generally Accepted Accounting Principles" (GAAP) refers to the regulations or standards established for the recording and reporting of commercial activities to ensure consistency and uniformity in the creation and presentation of financial statements.
These rules have developed over time as a result of accountants' experiences, customs, judicial decisions, and other factors. They are now generally accepted by accountants.
FUNDAMENTAL ACCOUNTING ASSUMPTIONS
1. Going Concern Assumption: This idea makes the assumption that an enterprise has an endless life or existence. It is assumed that the company has no plans to go out of business or drastically reduce its activities.
Relevance:
(a) A distinction is drawn between revenue and capital expenditures.
(a) The difference between current and non-current assets and liabilities
(c) Fixed assets are subject to depreciation, and they are listed at book value on the balance sheet without regard to their market value.
2. Consistency Assumption: This assumption states that after accounting principles have been chosen and implemented, they should be used consistently year after year. This will guarantee a detailed analysis of the company's performance over years.
The assumption of consistency does not restrict the possibility of changing procedures after adoption. The only restriction is that any desired changes must be clearly stated in the financial statements, along with how they will affect the income statement and balance sheet.
Any accounting procedure may be altered if required to do so by law or accounting standards to improve the meaning and transparency of the financial data.
Relevance: By using comparable financial information, it helps management in making decisions.
3. Accrual Assumption: Both revenue and expenses are subject to the accrual principle. According to this assumption, all revenue and expenditures are recorded as they are received or incurred.
Whether cash is received or paid at the time of the transaction or at a later date is irrelevant. For example, if a credit sale (Credit for two months) for Rs. 15,000 is made on February 15, 2015, the revenue earned must be recorded on February 15, 2015, not on the date of cash realization, which is two months later. When it comes to expenses, if two months' worth of wages is due but unpaid at the end of the year, those costs will be recorded in the year that the wages are due, not in the previous year.
Relevance: A certain accounting period can be correctly matched to the revenue that is earned and the resources that are consumed (expenses).
ACCOUNTING PRINCIPLES
1. Accounting Entity: A separate existence from the owner exists for an entity. This notion states that a business should be viewed as a separate entity from its owner. Therefore, rather than from the owner's perspective, transactions are documented, examined, and financial statements are created.
For his investment in the company, the owner is treated as a creditor (internal responsibility), as if the company had borrowed money from its owner rather than from other people. Interest on capital is treated as a cost of doing business just like any other cost. His personal costs are viewed as draws, which results in a capital decline.
2. The money measurement principle: states that only transactions that can be stated in terms of money or that can be quantified in money are entered into an enterprise's books of accounts. Even when non-financial events like the passing of a manager or employee, strikes, disagreements, etc., have a considerable impact on business operations, they are not at all recorded.
Limitations:
1. It fails to consider qualitative factors, such as effective human resources (assets), satisfied clients (assets), and dishonest employees (liabilities).
2. Money's (currency's) value is unstable.
Facts are expressed in a consistent unit of measurement—money—to make accounting records straightforward, pertinent, intelligible, and uniform.
3. Accounting Period Principle: By this principle, an enterprise's entire, indefinite life is split into segments known as accounting periods.
To enable regular performance evaluation and timely decision-making, an accounting period is defined as a period at the end of which the profit and loss account and balance sheet are prepared. The standard accounting period is one year, which can either be the financial year or the calendar year.
Relevance:
1. The distribution of expenses between capital and revenue must be demonstrated for this assumption.
2. A portion of capital expenditures that are used up in the current financial year are charged to the income statement, while the remaining, or unconsumed, amount is reported as an asset on the balance sheet.
3. According to income tax law, income tax is determined annually from April 1 to March 31(accounting period)
4. The Management can move quickly to implement corrective measures.
4. The full disclosure concept: states that, aside from what is required by law, all significant and material documents relating to the entity's financial operations should be fully disclosed in the financial statements and related notes to the accounts.
The financial statements should serve as a vehicle for communicating information, not for hiding it. Better understanding will arise from information disclosure, and the parties may be able to make wise decisions based on the information presented.
For instance, footnotes like:
1. A lawsuit against the company for a very large sum of money is still pending and may result in contingent liabilities.
2. Modification to the way depreciation is provided.
3. The investment's market value.
5. The materiality principle: states that all material facts must be disclosed, but that does not mean that even irrelevant data must be included in financial statements. This principle states that only information or items that are relevant to and have a meaningful impact on users should be disclosed. Therefore, items with little effects or those that are irrelevant to the user do not need to be revealed separately and can be combined with other items.
Information is referred to as material information if it has the potential to influence the user's choice.
It should be remembered that an item that is necessary for one business may not be necessary for another.
6. The Prudence Principle: states that while the loss in expectation should be reported right away, profit in expectation should not be. This principle does not, in any case, seek to overestimate the enterprise's earnings. When there are alternative ways that are as acceptable, the one with the least beneficial immediate effect on earnings, such as
(1) Stock valuation at the lower cost or realizable values.
(2) Provision is made for questionable debts and debtor discounts.
7. Cost Principle: By this Principle, the initial cost of an asset, which includes the cost of acquisition as well as all expenses incurred to prepare the asset for use, is recorded in the books of accounts.
Since the acquisition cost pertains to the past, it is known as the Historical cost. This cost serves as the foundation for all subsequent accounting transactions for the asset. A machine cost of Rs. 1,70,000 will be recorded in the books and depreciation will be applied to it. For instance, if the machinery was purchased for Rs. 1,50,000 in cash and Rs. 20,000 was spent on installation, then the cost of the machine will be Rs. 1,70,000. If the machine's market worth has increased by Rs. 2,00000 as a result of inflation, the increase in value won't be noted. Depreciation is routinely applied year after year to lower this cost, and assets are reported on the balance sheet at book value (cost – depreciation).
8. The matching principle: this states that all costs incurred by any enterprise during a given accounting period must be equal to or greater than any revenue recognized during that same period.
By subtracting the associated costs from the revenue recognized during that time, the matching principle makes it easier to calculate the amount of profit or loss made during that period.
Due to the matching principle, the following handling of expenses and revenue is carried out:
(1) Determination of Prepaid Costs!
(2) Determining the amount of advance income.
(3) Closing stock accounting.
(4) Charges for fixed asset depreciation.
9. The Dual Aspect Principle: this states that every business transaction has an equal amount of a debit and a credit as its two aspects. In other words, there is a credit of the same amount in one or more accounts for every debit, and vice versa.
Based on this idea, a system of transaction logging is known as the "Double Entry system
Due to this principle, the balance sheet's two sides are always equal, and the following accounting equation is always valid.
Liabilities + Capital = Assets
Example: Ram invested Rs. 1,000,000 in his firm. It adds Rs. 1,000,000 to the capital on the liabilities side and cash on the assets side.
Liabilities Rs. 1,00,000 + Capital Rs. 1,00,000 = Assets
BASES OF ACCOUNTING
There are two ways to calculate profit or loss: (1) using the cash basis, and (2) using the accrual basis.
1. Cash Basis of Accounting: Transactions are only recorded in the books of accounts when cash is received or paid under this method of accounting. The difference between actual cash revenues (from the sale of goods, services, properties, etc.) and actual cash payments are used to compute the income (regarding the purchase of goods, expenses, rent, electricity, salaries, etc.)
When a payment or receipt is only past dues, such as with unpaid bills or accrued income, no entry is made. The matching principle is violated by this approach.
2. Accrual Basis of Accounting: This method of accounting records income and expenses as they are incurred, i.e., income is recorded as income when it is accrued (when a transaction occurs), regardless of whether cash is received or not when the money is paid for them, but when they are incurred or become due, expenses are documented.
This method identifies and takes into account expenses such as accumulated income, prepaid expenses, ongoing expenses, and expenses received in advance.
All corporations are required to maintain their accounts using the accrual approach of accounting under the 2013 Companies Amendments Act.
ACCOUNTING STANDARDS: CONCEPT AND OBJECTIONS
To make the financial statements comparable and standard, the accounting principles, or GAAP, have been developed in the form of concepts and conventions. The same item can, however, be treated in a variety of ways under GAAP. For the same transaction, many organizations may use different accounting policies, or one organization may use various accounting policies for the same item during various accounting periods. The financial statements consequently lose their consistency and comparability.
To ensure that the accounting statements have the qualitative traits of dependability, relevance, understandability, and comparability, it was felt that a set of minimal requirements should be universally applicable.
IASC, or the International Accounting Standards Committee, was founded in 1973. International Financial Reporting Committee (now known as IFRC) Members of this committee include the Institute of Cost and Works Accountants of India (ICWAI) and the Institute of Chartered Accountants of India (ICAI). To determine the areas where uniformity in accounting was necessary, the ICAI established the Accounting Standard Board (ASB) in 1977. The Council of ICAI receives a draught accounting standard from ASB. The ICAI Council presents a draught for the government, businesses, and professionals to comment on. After giving the opinions received fair attention, the ICAI Council notifies it for inclusion in financial statements.
Accounting Standards Concept
Accounting standards are written guidelines that institutions of accounting professionals periodically publish. They provide standard procedures or processes for creating financial statements.
Objectives of Accounting Standards
1.By recommending standard treatment in the preparation of financial statements, accounting standards are necessary to promote uniformity in accounting practices and policies.
2. To increase the financial statement's reliability: Because accounting standards create trust in their users, accounts prepared by them are trusted by a wide range of users.
3. To stop fraud and manipulation by putting accounting procedures into writing.
4. To Assist Auditors: Accounting standards provide consistency in accounting procedures, which facilitates the auditing of the books of accounts by auditors.
IFRS International Financial Reporting Standards
The financial standard released by the International Accounting Standards Board is referred to by this title (IASB). It is the process of enhancing financial reporting on a global scale to benefit users and participants in various capital markets throughout the globe.
Financial Statements Based on IFRS
Under IFRS, the following financial statements are generated:
1. Statement of financial position: This statement's components include assets, liabilities, and equity.
2. A thorough income statement: This statement's components are (a) Revenue and (b) Expense.
3. Statement of changes in equity.
4. Statement of changes in Cash Flow.
5. Notes and key accounting principles.
The primary distinction between IFRS and IAS (Indian Accounting Standards)
1. IFRS is based on principles, whereas IAS is based on rules.
2. IAS is based on fair value but IFRS is based on historical value.
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