MEANING & SCOPE OF ACCOUNTING

DEFINITION OF ACCOUNTING
1) As per the American Institute of Certified Public Accountants (AICPA) – Accounting is an art of
recording, classifying and summarizing transactions and events which are in part at least of
financial character, in a significant manner and in terms of money, and interpreting the results
thereof.

TRANSACTIONS VS EVENTS, FINANCIAL VS NON – FINANCIAL

1. Transactions and Events: In a business or economic scenario (which involves monetary transaction.)
Business Activities

Transactions – Performance of business Activity Both Transaction and Event

Events – Result of Transactions.

Thumb rule: Human Effort is involved Thumb rule: Human Effort not Thumb rule: Both Human Effort
involved. & results from such effort are
2. Types of Transactions – 2 Types:
It represents results involved in aTransaction
single activity
Types Financial Transaction Non – Financial
Meaning When a business transaction includes a When a business transaction does not
transfer of money or moneys’ worth, then involve money or money’s worth
For Eg.: Purchases, Sales, Expenses paid Eg.: Profits/Closing Stock Eg.: Purchase of Fixed Assets on
the transaction is called “Financial
are results of purchases & last day of accounting year
Transaction”
Sales
Example Purchase and Sale of goods, Payment of Quarrel between 2 Managers, Death of
Expenses, Purchase of Assets, etc. an employee etc.
Types Both Cash and Credit Transactions There is “No such classification”

ACCOUNTING PROCESSES
Accounting
Analysing Interpreting Communicating
Recording Classifying Summarising

Generating Financial Using the Financial

Information Information
 OBJECTIVES AND FUNCTIONS OF ACCOUNTING
Objectives of Accounting
Providing
Systematic record Accounting of Ascertainment
ofinformation
all business results of business of Financial
transaction
to Users operation position

Book-Keeping, Trading and Profit Balance Sheet Financial

Statements
i.e. Journal, FUNCTIONS
& Loss OF ACCOUNTING and Reports
Ledger and Trial Account
Balance
APB (Accounting Principles Board) of AICPA (American Institute of Certified Public Accountants)
enumerated the following functions of accounting:
Measurement Accounting measures the performance of the business entity and depicts its current
financial position.
Forecasting Accounting helps in forecasting future performance and financial position of
enterprise using past data.
Decision- Accounting provides relevant information to the Users of accounts to aid rational
making decision-making.
Comparison Accounting assesses performance achieved in relation to targets and discloses
& Evaluation information which plays important role in comparing & evaluating financial results.
Control Accounting identifies weaknesses in the operational system and provides feedback
regarding effectiveness of measures to rectify such weaknesses.
Government Accounting provides necessary information to the Government, to exercise control
Regulation on the entity as well as in collection of direct and indirect tax revenues.

BOOK-KEEPING – MEANING AND FEATURES

Meaning It is an activity of recording and classifying the financial data relating to business
operations in a significant and orderly manner.
ObjectiveComplete recording of transactions.
Ascertainment of financial effect on the business.
FeaturesIt is an art of scientifically recording the transactions.
The recording is fine only in monetary terms.
Recording of transactions is restricted only to that of particular enterprises.
The recordings are made in a given set of books.

BOOK-KEEPING V/S ACCOUNTING

Basis Book-Keeping Accounting
Scope Book-Keeping involves In addition to book-keeping, Accounting
(a) Identifying the transactions involves-
(b) Measuring the identified (a) Summarizing the classified transactions
transactions
 (c) Recording the measured transactions (b) Analyzing the summarized results,
(d) Classifying the recorded transactions (c) Interpreting the analyzed results, and
(d) Communicating the information to
interested parties
Stage Book-Keeping is the primary stage Accounting is the secondary (summarizing)
(i.e., record-keeping phase) stage. It starts where book-keeping ends
Basic It helps to maintain systematic records of To find the net results of operations and
Objectives financial transactions financial position and to communicate
information to the interested parties.
Financial Financial position of the business may not Financial position of the business is
position be ascertained through book-keeping ascertained based on the accounting reports
Financial Financial Statements do not form a part of Financial statements are part of the
Statements the book-keeping process. accounting process. These Statements are
prepared based on book-keeping records.
Managerial Managerial decision cannot be taken with Management can take decision on the basis
decision the help of book-keeping records alone. of accounting records and statements
Sub-fields There are no-sub fields for Book-Keeping It has several sub-fields such as financial
Accounting, Management, etc.
Note: In terms of scope, Book-Keeping < Accounting

SUB FIELDS OF ACCOUNTING

Financial It covers the preparation and interpretation of financial statement (i.e. P&L Account
Accounting and Balance Sheet) and communication thereof, to the User of accounts. It is
historical as it records transaction which has already occurred. It primary helps in
determination of the net result for an accounting period and the financial position as
on a given date.
Management It is used for internal reporting to the Management of a business unit. The different
Accounting ways of grouping information and preparing reports as desired by the Managers for
discharging their functions and referred to as Management Accounting.
Cost It is the process of accounting for cost and determination of overall cost of the
Accounting product or service. The study of the behavioural pattern of cost will enable to control
cost.
Social It is concerned with accounting for social costs incurred by the enterprise and social
Responsibility benefits created.
Accounting
Human It seeks to identify, qualify and report investments made in human resources of an
Resource organization that are not presently accounted under any conventional accounting
Accounting practice.

USERS OF FINANCIAL INFORMATION

Users Purpose
Management For day-to-day decision-making and performance evaluation.
Proprietor/Share To analyze performance, profitability and financial position.
holders Note: Prospective investors are interested in the track record of the company
Lenders-Banks & To determine the financial position and strength of the Company, Debt-Service
Fin. Institutions Coverage, etc
 Suppliers To determine the credit worthiness of the Company.
Customers To know general business viability before entering into long-term contracts
and
Arrangements
Employees To know the stability, continuity and growth of the enterprises, and its ability
to pay remuneration, retirement & Other benefits and to enhance career
opportunities.
Government To ensure prompt collection of Direct and Indirect Tax revenues & to evaluate
performance and contribution to social objectives
Research Scholars For study research and analyze purpose
Public at Large To see whether the enterprise is making a reasonable/ substantial contribution
to local economy, e.g. employment opportunities, patronage of local suppliers

LIMITATIONS OF ACCOUNTING
1. Accounting involves different assumptions and conventions on which it is based. These assumptions,
by themselves become a limitation for accounting. Hence, Accounting is considered only as an art
and not as pure science.
2. There are different accounting policies for the treatment of the same item, e.g. Depreciation,
Valuation of Stocks, etc. This may not ensure comparability among financial statements of various
firms.
3. Certain accounting estimates are based on the personal judgement of the accountant e.g. provision
for doubtful debts, capital vs revenue expenditure, writing off intangible assets, etc. This may lead to
the possibility of manipulation.
4. The financial position of the business as described by accounts is fixed and not dynamic i.e. it gives the
position on a particular day on which it is prepared and does not predict future position.
5. Inflation effect is not considered in the general purpose financial statements.
6. Accounting ignores the real assets which cannot be measured in terms of money, i.e., Employees.
There is no generally accepted formula for the valuation of Human Resources in terms of money.

SERVICES OF A CHARTERED ACCOUNTANT

Accounting Services Audit Services Consultancy Service Other Services
 Maintenance of Books  Statutory Audit  Taxation Consultancy  Financial Advisory
of accounts  Internal Audit (Direct & Indirect Services e.g. Investment,
 Preparation of  Limited Review Tax) Insurance, Business
Financial Statement  Due Diligence  Corporate Laws Expansion, etc
audit Consultancy  Specific Services, e.g.
 Investigation  Management Secretarial, Share
Consultancy Registration,
formation/Liquidation
of Companies etc.
 ACCOUNTING CONCEPTS, PRINCIPLES AND
CONVENTIONS
Item Descriptions
(a) ‘’Assumptions’’ refers to the Fundamental conditions based on which the
entire accounting process is carried out.
Accounting (b) In accounting there are 3 fundamental Accounting Assumptions.
1.
Assumptions (c) For e.g. when a person started a particular business, we assume that the
person started the business for continuing it to earn profits and not for closing
it.
(a) ‘’Concept’’ means any idea or notion, which has a universal application.
Accounting (b) Accounting Concepts are the basic conditions which lay down the
2.
Concepts foundation for formulating the accounting principles
(c) They are clearly defined and supported by reasoning.
(a) Accounting Principles refers to the set of doctrines associated with the
theory and procedures of accounting
(b) They serve as an explanation of currently practices and as a guide for
Accounting
3. selection of conventions or procedures where alternatives exist.
Principles
(c) Accounting Policies should be- (i) based on real assumptions, (ii) simpler and
easily understandable, (iii) consistently followed, (iv) informational to the
Users, and (v) able to reflect future predictions.
(a) Accounting Conventions are the general procedures emerging out of
usage and practice of accounting principles
(b) Conventions may not have universal application.
(c) They may contradict the basic accounting principles.
Accounting
4. (d) Further, certain conventions may be changed over a period of time, by
Conventions
Accounting Bodies like ICAI, for improving the quality of financial statement
(e) Eg: In India, pedestrians walk on the left side and the vehicles go on the right
side of the road. This is traditionally accepted practice and everybody follows
It
Concept Vs Conventions:
(a) Concepts are clearly defined & supported by reasoning while conventions may not be clearly
defined
(b) Concept support the principles whereas Conventions may contradict the principles
Note: The above terms Concepts, Principles and Conventions, are sometimes used interchangeably.

LIST OF ACCOUNTING ASSUMPTIONS / CONCEPTS/ CONVENTIONS

1. Fundamental Accounting Assumptions: Only 3- (a) Going concern, (b) Consistency and (c) Accrual.
(They are also considered as part of accounting concepts)

2. Accounting Concepts:
1. Business Entity 7. Going Concern
2. Money Measurement 8. Cost
3. Accounting Period/Periodicity 9. Realization
4. Accrual 10. Dual Aspect
5. Matching

3. Accounting Conventions: (a) Consistency (b) Full Disclosure (c) Conservatism (d) Materiality
 FUNDAMENTAL ACCOUNTING ASSUMPTIONS
1. Going Concern:
(a) The enterprise is normally viewed as Going Concern, i.e. Continuity in operation for
the foreseeable future (endlessly)
(b) It is assumed that the enterprise has neither the intention nor the necessity of liquidation or
of reducing substantially its level of operations.
(c)Exception to Assumption: Joint Venture (Which is created for specific purpose/ period)

2. Consistency:
(a) Meaning: Accounting principles followed by the entity shall be consistent. i.e., the same over a
period of time. Frequent changes in accounting policies will distort comparison.

3. Accrual:
(a) Revenue and Costs are ‘’accrued’’. i.e, recognized as they are earned or incurred and recorded
in the financial Statement of the period to which they relate and not when money or paid.

Disclosure Requirements
If the above assumption are followed in If the above assumptions are not followed
preparing accounts
Separate disclosure is not required, since their Disclosure is necessary, specifying that the
acceptance and use are assumed general accounting assumptions are not followed.

ACCOUNTING CONCEPTS & CONVENTIONS

BUSINESS ENTITY
1. Meaning: The business enterprise is a separate identity and distinct from that of its Owners of
Managers. The Owner of the business and the business as such is treated as two different persons.
2. Impact of above concept: All transactions are classified into – (a) Business Transactions, and (b)
Personal Transactions. Business transactions are recorded in the books of accounts of the business.
Owner’s Personal transactions are recorded in his personal book of accounts and not in the books of
the business.

MONEY MEASUREMENT
1. Meaning: Accounting data must be quantified so that date can be aggregated and hence summarized;
hence, all transactions and events should be measured in terms of money. Transactions are recorded in
books of account, in the ruling currency of the country where the books of accounts are prepared.
2. Common unit: A common measuring unit in terms of money helps to (a) quantify data, and (b)
enable determination of profit/loss and financial position. For Example the Rupee is the common unit
of measurement for economic events and transactions in India. It is the legal tender used as the
medium of exchange in market transactions.
3. Impact on Accounting:
(a) As per Money Measurement Concept, only those transactions which are capable of being measured
in terms of money are recorded in the books of accounts, that too in the ruling currency of the
country. E.g. in Rupees in India, in Dollars in USA, in Pounds in UK.
(b) Transactions which are not in monetary terms, even if they affect the results of the business
materially, are not recorded in the books of accounts.
Note: Entity & Money Measurement Concepts are basic concepts on which the other procedural concepts depend.
 PERIODICITY OR ACCOUNTING PERIOD
1. Need: As per the Going Concern Assumption, the enterprise has an indefinite life. However, it is
necessary to sub-divide such indefinite period into a smaller time units for (a) measurement of
performance; (b) understanding the financial position of the enterprise and (c) control over
operations. Such smaller and usable time-frame for reporting purposed is called Accounting Period.
2. Meaning:
(a) Hence, during the life-time of an entity, financial Statement can be prepared in periodic intervals of
time. The economic life of an enterprise is split into the periodic interval (being a financial year).
(b) As per Periodicity Concept, the financial Statements should be prepared after every
accounting/ financial period, and not at the end of the life of the entity.
(c) Generally a period of 12 months (i.e. one year) is considered as the accounting period by most
enterprises. In the corporate sector, Interim Financial Reporting is also prevalent. The length of the
accounting period is also determined by the statute in certain cases.
Note: Normally the term ‘’Financial Year’’ refers to the period for which the accounts are prepared. it is usually
taken as the period from 1st April to 31st March of the next year.

ACCRUAL
1. Meaning: ‘’Accrual’’ means recognition of revenue as they are earned and the cost as they are
incurred and not when money is received or paid. This concept relates to measurement of income,
identifying assets and liabilities.
2. Method: Under Accrual Concept, all transactions and events are recognized on mercantile basis,
i.e., as they are earned or incurred, and recorded in the financial statement of the period to which they
relate, and not when cash is actually received or paid.
3. As per Accrual Concept, Profits = Revenue Less Expenses

1. Meaning: MATCHING
(a) Performance of a business entity is measured with reference to a specific accounting period.
(b) Hence, to determine the profits for a particular period, Revenue earned in that period should be
matched with the expenses incurred for earning such revenue.

2. Impact: The Accrual Concept, together with Periodicity and Matching concepts, give rise to the
recognition of (a) Prepaid Expenses (b) Outstanding Expenses (c) Income Receivable and (d) Income
Received in advance.

1. Meaning: As per Cost Concept, Value of asset COSTas shown in balance sheet must be its Historical Cost,
i.e. Acquisition Cost. This is the conventionally adopted measurement base for valuation of assets

1. Meaning: As per Realization Concept, AnREALIZATION

asset is recorded at its Historical Cost and any change in
its value should only be recognized when it is realized, i.e. at the time of its actual sale/disposal.
2. Concept : It emphasized that there is no certainty of income until a sale has been made and hence
increases in value of the assets should not be taken into account unless it is actually realized.
 DUAL ASPECT
1. Meaning: The Dual aspect concept is the core of double entry book-keeping
2. Basis: As per this concept, every transaction or event has two aspects, which have to be recorded in
the books the amounts of both the aspects are equal.
3. The possible combinations of the effect of each transaction is as under-
1st Aspect 2nd Aspect Example
Increase in one asset Decrease in another asset Purchase of Machine by paying cash
Increase in asset Increase in liability Purchase of goods on credit
Decrease in asset Decrease in liability Payment of Cash to Creditors
Increase in one liability Decrease in another liability Creditors paid from bank Overdraft

FULL DISCLOSURE
1. Meaning: As per this concept all the events and transactions which are relevant shall be disclosed in
the books of accounts and the financial statement. The events may relate to the current or the
subsequent accounting periods.
2. Purpose: The users of the financial statements must be aware of all relevant events and transactions to
understand real position of the business.
3. Disclosure: The term Disclosure’’ means that a statement describing the event/ transaction
(including the amount involved) should be added to the financial statements as a note therein.
(Disclosure is not same as accounting. Accounting means Accounting Entries will be passed, whereas in disclosure
a mere statement is given Journal Entry not passed.)
Example: The legal suit filed against a company for violation of copyrights shall be disclosed as part of
the financial statements though it cannot be measured accurately.
Exception: The Conventions of Materiality and Conservatism are exceptions to the concept of full
disclosure due to following reasons:

SUBSTANCE OVER LEGAL FORM

1. Meaning: The accounting treatment and presentation in financial statements of transactions and
events, should be governed by their substance and not merely by the legal form.
2. For Example:
(a) Sale of Land & Buildings without Registration: If the Firm has sold its land and Building,
received consideration and handed over the possession to the buyer, it should be recorded as sale of
land and building this recognition cannot be postponed for mere procedural formality pending e.g
registration of sale deed.
(b) Hire Purchase-Considered as Sale: In case of an asset required on hire purchase, ownership is
not transferred till last installment is paid. However, asset is shown in the books of the hire
purchased.

CONSERVATISM
(a)Conservatism or Prudence demands that unrealized profits and gain should not be recognized in
the accounts. However provision should made for all actual and possible losses.
(b) The accountants should not anticipate income, but should provide all possible losses.

MATERIALITY
1. Meaning: As per Materiality Concept, all items having significant economic effect on the
business should be disclosed in the financial statement.
2. Material items refer to the items in the financial statements the knowledge of which might influence
the decision of the users of financial statement.
3. Factors: Materiality depends on the size and nature of the items or error, judged in the particular
circumstances of its misstatement.
 BASIS OF ACCOUNTING
1. Meaning: ‘’Basis of Accounting’’ refers to the stage at which incomes and expenses are recorded in the
books of accounts.
2. Types: There are 3 bases of Accounting- (a) Cash Basis (b) Accrual Basis and (c) Hybrid Basis.
Explained as under-
Cash Basis Accrual Basis (Otherwise called as Mercantile Basis)
Profit = Cash received in normal course of Profit = Revenue (earned) (-) Expenses (incurred)
business (-) Cash paid in normal course of
business
Cash Receipts of any year may relate to When cash and revenue flow at different times, it is
(a) previous year (b) current year or (c) treated as under (a) Cash received before revenue is
future years. No distinction is drawn for earned = Income Received in Advance = Liability.
calculating profits/surplus (a) Cash received after revenue is earned = Income
Receivable = Assets
Cash payments of any year, may relate to When cash and expense are recognized at different
– (a) previous years, (b) current year or times, it is treated as under-
(c) future years. No distinction is drawn (a) Cash paid before expenses is incurred= Prepaid
for calculating profits/surplus expenses = Assets.
(b) Cash paid after expenses is incurred = payables /
Outstanding Liabilities = liability
Companies Act, 2013 does not permit the Companies Act 2013 specifically requires the use of
use of cash basis of accounting accrual basis of accounting
Hybrid System or Modified Accrual System: In this method, the revenue are recognized on cash basis
and expenses are recognized on Accrual Basis.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

Financial Statements are prepared to ascertain the operating results and the financial position of the
business. They should have the following features
1) Relevance
2) Reliability
3) Understandability
4) Comparability
5) Materiality
6) Faithful Representation
7) Substance over form
8) Prudence
9) Disclosure
10) Completeness
 CAPITAL & REVENUE EXPENDITURE/RECEIPTS
CAPITAL EXPENDITURE VS REVENUE EXPENDITURE
Particulars Capital Expenditure Revenue Expenditure
1. Meaning It is expenditure incurred for the It is an expenditure, the benefit of
purpose of- which is immediately (normally within
(a) Purchase / Creation / Improvement of one year) exhausted in the process of
Fixed Assets earning revenue.
(b) Expenses necessary for the above
purchase / Creation
(c) Increasing the earning capacity of
business.
2. Purpose (a) Acquiring Fixed Assets, which are held (a) Actual day-to-day running of the
not for resale, but for use with a view to business,
earn profits. (b) Maintaining the capital assets in an
(b) Making additions to existing Fixed efficient manner.
Assets (c) Cost of Material & Stores
(c) Increasing earning capacity of the (d) Salary and Wages of employees,
business by improved facilities and (e) Administrative Exp. Like
equipments. Stationery, Rent, Telephone and
(d) Reducing the cost of production. Insurance.
(e) Acquiring benefit of enduring nature or
valuable right.
3. Treatment  Capital Expenditure is shown as  Expenditure is charged fully in the
in asset in Balance Sheet. Only Profit and Loss Account,
Financial depreciation portion is debited to P&L  It is fully REDUCED from income
Statement A/c.
 It is NOT directly Deducted
from Income.
4. Wrong If wrongly treated as revenue, profits will If wrongly capitalized, profits will
treatment be understated or reduced. inflated or overstated.
5. Matching Capital Expenditure is not matched with Revenue Expenditure is matched with
Capital Receipts. Revenue Receipts.
6. Recurring Normally Capital Expenditure is generally Revenue Expenditure is of recurring
Nature non-recurring in nature. However, certain /repetitive nature. It is incurred every
Capital Expenditure is required once in 2-5 year by the business.
years. E.g. Modernization of
Machinery,etc.

CRITERIA / CONSIDERATIONS FOR CAPITAL VS REVENUE

Whether an expenditure is Capital or Revenue in nature, depends upon the following factors —
Factor Capital Expenditure if..... Revenue Expenditure if.......
Nature of Expenditure relates to purchase of a Fixed Expenditure relates to purchase of a
Business Asset (e.g. Land purchased by a Current Asset (e.g. Land purchased by
Manufacturing Firm). a Construction Company).
Recurring Expenditure is incurred infrequently, or Expenditure is incurred frequently /
Nature once in 2-5years (e.g. purchase of assets.) regularly, in the normal course of
business (e.g. Salary, Rent, etc.)
 Purpose of Expenditure is for acquiring / creating Expenditure is for maintaining the
Expenses capital assets or increasing their capital assets in an efficient manner.
productive capacity.
Period of Expenditure helps to generate revenue over Expenditure helps to generate income
Benefit more than one accounting period / revenue in the current period only.
Materially Expenditure is material / significant. Expenditure is not material, i.e.
insignificant.

EXAMPLES FOR CAPITAL AND REVENUE EXPENDITURES

Capital Expenditure Revenue Expenditure
1. Purchase of Fixed Asset (Land, Building, etc.) 1. Expenditure for replacement of worn—
2. Purchase of Second hand Asset (e.g. Vehicle, out part of an existing asset.
Furniture, etc.) 2. Regular Advertisement Expenses in
3. Overhaul Expenses to put secondhand machinery in respect of products and services.
working condition. 3. Expenditure on removal of stock to new
4. Repairing & Painting of Old Building purchased site.
recently by the Firm. 4. Legal Fees incurred to file suit against a
5. Expenditure incurred to reduce working expenses / Customer from whom money is due.
operating expenses which generate long term benefits
to the entity
6. Legal Fee paid to acquire new property.
7. Licence Fee paid by Cinema Theatre to commence its
business.
8. Cost of constructing Temporary Huts which were
necessary for Factory Building Construction, which
were demolished when the Factory was ready.

CAPITAL VS REVENUE RECEIPTS

Particulars Capital Receipt Revenue Receipt
1. Meaning Capital Receipts refer to receipts other Revenue Receipts are moneys received in
than Revenue Receipts. the course of normal business activities,
and are recurring in nature.
2. Example Capital contribution by Owner, Issue of Sales, Interest and Other Income Received,
Shares /Debentures, Sale Proceeds of Bad Debts Recovered, etc.
Fixed Assets, etc.
3. Purpose Capital Receipts relate to specific Revenue Receipts relate to general business
purpose, e.g. Capital Contribution for purpose, and are not specifically
commencing business or expanding identifiable to any purpose as such.
business, Loans taken for acquiring
Fixed Assets, etc.
4. Effect on Capital Receipts do not affect profit. Revenue Receipts have a direct impact on
Profit the profits.
5. Disclosure They are shown as Liability or They are shown on the Credit Side of the
Reduction from the Asset in the Profit and Loss Account.
Balance Sheet.
6. Matching Capital Receipts are not matched with Revenue Receipts is generally matched
Capital Expenditure, in all cases. with Revenue Expenditure.
QUESTION
State with reasons whether the following are Capital or Revenue Expenditure:
(1) Expenses incurred in connection with obtaining a license for starting the factory for Rs. 10,000.
(2) Rings and Pistons of an engine were changed at a cost of Rs. 5,000 to get fuel efficiency.
(3) A factory shed was constructed at a cost of Rs. 1,00,000. A sum of Rs. 5,000 had been incurred in the
construction of temporary huts for storing building material.

Solutions:
(1) Money paid Rs. 10,000 for obtaining license to start a factory is a capital expenditure. This is an item
of expenditure incurred to acquire the right to carry on business.
(2) Rs. 5,000 spent in changing Rings and Pistons of an engine to get fuel efficiency is capital
expenditure. This is an expenditure on improvement of a fixed asset.
(3) Cost of construction of building including cost of temporary huts is capital expenditure. Building is
fixed asset which will generate enduring benefit to the business over more than one accounting
period. Construction of temporary huts is incidental to the main construction.

QUESTION
Classify the following expenditures and receipts as capital or revenue:
(i) Rs. 10,000 spent as travelling expenses of the directors on trips abroad for purchase of capital assets.
(ii) Amount received from Trade receivables during the year.
(iii) Amount spent on demolition of building to construct a bigger building on the same site.
(iv) Insurance claim received on account of machinery damaged by fire.
(v) Travelling expenses of the directors for trips abroad for purchase of capital assets.
(vi) Amount spent to reduce working expenses.
(vii)Amount paid for removal of stock to a new site.
(viii) Cost of repairs on second-hand car purchased to bring it into working condition.

Solutions:
(i) Capital expenditure. (ii) Revenue receipt. (iii) Capital expenditure. (iv) Capital receipt.
(v) Capital Expenditure (vi) Revenue Expenditure if short term benefit and Capital Expenditure if long
term benefit to entity (vii) Revenue Expenditure (viii) Capital Expenditure

QUESTION
Are the following expenditures capital in nature?
(i) M/s ABC & Co. run a restaurant. They renovate some of the old cabins. Because of this
renovation some space was made free and number of cabins was increased from 10 to 13. The total
expenditure was Rs. 20,000.
(ii) M/s New Delhi Financing Co. sold certain goods on installment payment basis. Five customers did
not pay installments. To recover such outstanding installments, the firm spent Rs. 10,000 on account
of legal expenses.
(iii) M/s Ballav & Co. of Delhi purchased a machinery from M/s Shah & Co. of Ahmedabad. M/s
Ballav & Co. spent Rs. 40,000 for transportation of such machinery. The year ending is 31st Dec,
2020.
Solutions:
(i) Renovation of cabins increased the number of cabins. This has an effect on the future revenue
generating capability of the business. Thus the renovation expense is capital expenditure in nature.
(ii) Expense incurred to recover installments due from customer do not increase the revenue generating
capability in future. It is a normal recurring expense of the business. Thus the legal expenses incurred
in this case is revenue expenditure in nature.
(iii) Expenses incurred on account of transportation of fixed asset is capital expenditure in nature.
 CONTINGENT ASSET & CONTINGENT LIABILITY
PROVISIONS
1. Meaning A Provision is "a Present Obligation, as a result of past events, which leads to probable
outflow of resources representing economic benefits and a reliable assessment of the amount
of the obligation can be made"
2. Features (a) Provision is a present liability of a certain / uncertain amount.
(b) Provision can be reasonably measured using a substantial degree of
estimation.
3. Treatment Provision should be recognized in the Books of Account.
4. Impact on Provision represents liability for expense/loss; So, Provision reduces the
Profits profit.
5. Journal Entry Debit - Profit and Loss A/c Dr.
Credit - To Provisions for Liabilities A/c
6. Balance Sheet Provision is either shown (a) on the liabilities side (or) (b) on the assets side -
as a deduction from the relevant asset.
7. Examples (a) Provision for Guarantees Given, when original debtor becomes insolvent.
(b) Provision for Warranties
(c) Provision for Discount on Debtors
(d) Provision for Bad and Doubtful Debts

CONTINGENT LIABILITY

A Possible Obligation Present Obligation

That arises from past events and the existence of which will be That
confirmed
arises only
fromby
past
theevents
occurrence
but is or
notnon—occurrence
recognized because
of one
— or more uncer
it is not probable that an outflow of resources representing economic benefi
Or

Note: Possible Obligation is always a Contingent Liability, whereas Present Obligation becomes a
Contingent Liability if the recognition criteria of Provision are not satisfied.

Elements Cases
1. Possible obligation X X X X 
2. Present obligation from past events     NA
3. Expected outflow   X X NA
4. Measurability (using substantial degree of estimation)  X  X NA
5. Whether it is Provision(P) or Contingent liability(CL) P CL CL CL CL

FEATURES OF CONTINGENT LIABILITY

1. Recognition An Enterprise should NOT RECOGNISE a Contingent Liability.
2. Disclosure A Contingent Liability should be DISCLOSED as a FOOT NOTE to the Balance
Sheet.
3. Periodical Contingent Liability should be periodically reviewed. On such review, if the
Review character of the Contingent Liability is found to be changed and there is a probable
outflow of resources, then it will be recognized as Provision and treated accordingly.
4. Impact Contingent Liability will NOT AFFECT the profits of the concern, as it is not
accounted in Books.
 Claims against the business, not acknowledged as debts
 Guarantees given, if the principal debtor is solvent
5. Examples  Uncalled Liability on Partly Paid shares
 Arrears of Fixed Cumulative dividends
 Liability on Bills Discounted

CONTINGENT ASSETS
1. Meaning A Contingent Asset is a POSSIBLE ASSET that arises from past events, existence
of which will be confirmed only by occurrence / non-occurrence of one or more
uncertain future events, not wholly within the control of the enterprise.
2. Treatment An enterprise SHOULD NOT RECOGNISE a Contingent Asset due to
CONSERVATISM Convention. Because this may result in recognition of income
that may never be realized.
3. Impact Contingent Assets will not affect the profits of the enterprise as it is not accounted in
the books.
4. Certainty If the realisation of income is certain, then it is not a Contingent Asset and the same
shall be recognized in the Financial Statements.
5. Disclosure Contingent Assets should not be disclosed in the Financial Statements but may be
disclosed in the Report of the Approving Authority.
6. Examples  Unplanned or unexpected events leading to possibility of inflow of economic
benefits
 Expected Gain from a legal suit.
 Insurance claims for damage of a property
 ACCOUNTING POLICIES
1. Accounting Policies refer to – (a) The specific accounting principles and (b) the methods of applying
those principles adopted by the enterprises inMEANING
the preparation and presentation of financial statements.
2. Example: Inventory is valued at cost or Net Realizable Value, whichever is lower. This is a
principle. Cost can be determined either by First in First Out (FIFO) method or Weighted Average
Cost (WAC) or other suitable methods.
3. Need for disclosure: Accounting Policies should be disclosed in the Financial Statements due to
the following reasons-
(a) To promote better understanding of financial Statements
(b) To provide meaningful Inter-Firm Comparison.
(c) To ensure compliance with Law, for example In case of Companies, disclosure is mandatory.

1. Alternative accounting policies: The different circumstances in which enterprises operate and the
CHOICE
situation of diverse and complex OF ACCOUNTING
economic POLICIES
activities of the company has given rise to acceptability of
alternative accounting principles and methods of applying those principles.
2. Decision Making: The choice of the alternatives principles and methods calls for
considerable judgment by the management of the enterprises.
3. Reduction in alternatives: Various statements issued by ICAI, together with the measures of
Governments, other regulatory agencies, etc. has reduced the number of acceptable policies can at best
be reduced, not eliminated, as different enterprises operate in differing circumstances.
4. Illustration List of areas of alternative accounting policies.
(a) Conversion or translation of foreign Currency items.
(b) Treatment of – (i) Expenditure during construction.
(c) Valuation of – (i) Inventories, (ii) Investments.
Note: Generally Companies disclose these accounting policies in the Notes of Accounting

1. True and Fair View: The Primary consideration in the selection of Accounting Policies by an
PRINCIPLES FOR SELECTION OF ACCOUNTING
enterprise is that the Financial statements prepared and presented should represent a true and fair
view as under-
Balance sheet Of the State of Affairs of the enterprises as on a certain date.
Profit & Loss Account Of the Profit or Loss for the period ended on that date.
2. Factors: To select and apply an accounting policy, the following points are considered –
(Secondary Consideration)
(a) Prudence (b) Substance over form (c) Materiality
3. Change in Accounting Policies: Accounting policies have to be consistent from year to year.
However, change in accounting policies can be made in the following situations-
(a) If the adoption of a different accounting policy is required by Statute, or
(b) For compliance with an Accounting Standard, or
(c) If it is considered that the change would result in a more appropriate presentation of the financial
Statements.
 DISCLOSURE OF ACCOUNTING POLICIES
1. Disclosure of Accounting Policies: All significant accounting policies adopted in the preparation and
presentation of financial statement should be disclosed to facilitate better understanding of the
financial statements.
2. Place of Disclosure: Disclosures should from part of the financial Statements. It should be disclosed at
one place, instead of being scattered over several statements.
3. Change in Accounting Policies: Change in an accounting policy should be disclosed-
(a) When such change has a material effect in the current period and
(b) When such change is reasonably expected to have a material effect in later periods.
4. Manner of Disclosure of change in accounting policies:
Effect in Current Period Expected Effect in later periods
 The impact of change on the Profit/Loss and  The fact of such change, and
Balance Sheet items in current period should  The fact that it is likely to have effect in later
be quantified, to the extent ascertainable. periods.
 Where quantification is not possible, either Should be appropriately disclosed in the period
wholly or in part, the fact of such change in which the change is adopted
having a material effect should be disclosed

ACCOUNTING ESTIMATES
(a) Meaning: “Accounting Estimate” means an approximation of the amount of an item in the absence
of a precise means of measurement.
As a result of uncertainties inherent in business activities, many financial statement items cannot be
measured with precisions but can only be estimated. The use of reasonable estimates is an essential
part of the preparation of financial statements and does not undermine their reliability.
(b) Example:
 Estimate of bad debts
 Useful life and Residual value of depreciable assets
 Estimates of inventory obsolescence
(c) Change in Accounting Estimate: Change can occur in the following scenarios:
 As a result of new information
 As a result of more experience
 As a result of subsequent development
 ACCOUNTING AS MEASUREMENT DISCIPLINE
ELEMENTS OF MEASUREMENT DISCIPLINE
The three elements of Measurement discipline and how accounting satisfies these elements are as under-
Elements / Conditions Does Accounting satisfy the condition?
1. Identification of objects or Financial transactions and events are measured in accounting
events to be measured Non-financial transactions, however significant are not
considered
2. Selection of Standard or The ruling currency of the country is used as the basis of money
Scale to be used. measurement, in accounting, however:
(a) Money is not a stable scale having universal applicability.
(b) Exchange rates between different currencies are not constant.
3. Evaluation of dimension of Money as a valuation base loses its value over period time.
measurement standard Hence, it is not stable in the dimension.
Conclusion: However, Accounting is not an exact measurement discipline because accounting measures
information mostly in money terms which is (a) not a stable scale. (b) Not having applicability and (c)
not stable in dimension for comparison over time

MEASUREMENT BASES IN ACCOUNTING

The measurement bases or valuation principles used in accounting are-
Base Valuation Rule for
Assets Liabilities
1. Historical Cash or Cash equivalent paid or fair Proceeds received in exchange for the
cost value of the asset at the time of obligation or the amount of cash/ cash
acquisition equivalent expected to be paid to satisfy it
in the normal course of business
2. Current Cost Cash and cash equivalent which is Undiscounted amounts of cash and cash
(PURCHASE to be paid if same or an equivalent equivalent that would be required to settle
ANGLE) asset was acquired currently the obligation currently
3. Realizable Cash or cash equivalent that could Undiscounted amounts of cash & cash
Value (SALE currently be obtained by selling the equivalent that would be required to settle
ANGLE) assets in an orderly disposal obligation in normal course of business
4. Present Present Discounted Value of cash Present Discounted value of cash
Value inflows expected to be derived from outflows expected to be required to settle
such assets over its useful life the liabilities in normal course of business
Note: Different measurement bases, are used according to suitability (i.e. the situational need) to depict
true and fair view of the financial position of the reporting entity.
 ACCOUNTING STANDARDS
Meaning Accounting standards are written policy documents issued by expert accounting
body or by government or other regulatory body (e.g. MCA issuing AS for
corporates in consultation with NACAS) covering the aspects of recognition,
measurement, presentation and disclosure of accounting transactions in the
financial statements.

Issues dealt  Recognition of events and transactions in the financial statements.

by AS  Measurement of these transactions and events.
 Presentation of these transactions and events in the financial statements in a
manner that is meaningful and understandable to the reader.
 The disclosure requirements which should be there to enable public at large,
the stakeholders and potential investors in particular, to get an insight in to
what these financial statements are trying to reflect and thereby facilitating
them to take prudent and informed business decisions.

Objectives  The primary objective is to establish standards which have to be complied with
to ensure that the financial statements are prepared in accordance with
generally accepted accounting principles.
 To provide a standard for the diverse accounting policies and principles.
 To eliminate the non-comparability of financial statements.
 To increase/improve the reliability of the financial statements.
 To provide standards which are transparent for users.

Benefits  Standardization of alternative accounting treatment (Reduce/eliminate the

confusing variations in the accounting treatments used to prepare the financial
statements)
 Requirement for additional disclosures. (disclosures which are not statutorily
required)
 Comparability of financial statements.

Limitations  Difficulties in making choice between different treatments.

 Lack of flexibilities
 Restricted scope (accounting standards cannot override the statute)

Standards ICAI has constituted the Accounting Standard Board (ASB) in 1977. ASB is
setting process responsible for setting accounting standards. Although ASB is a body constituted
by council of ICAI, it is independent in the formulation of accounting standards
and council of ICAI is not empowered to make any modifications in the draft AS
formulated by ASB without consulting with the ASB.

Process  Identification of area (where standardization is required)

 Constitution of study groups (for research)
 Preparation of draft and its circulation
 Ascertainment of views of different bodies on draft (like SEBI, CBDT, C&AG)
 Finalization of exposure draft
 Comments reviewed on exposure draft (public comments)
 Modification of the draft
 Issue of AS
 For Non Corporate Entities by ICAI
 For Corporate Entities by Central Government of India

The Copyright of these notes is with CA. Nitin Goel

 OVERVIEW OF ACCOUNTING STANDARDS (AS) IN INDIA
AS AS TITLE AS AS TITLE
1 Disclosure of Accounting Policies 16 Borrowing Costs
2 Valuation of Inventories 17 Segment Reporting
3 Cash Flow Statements 18 Related Party Disclosures
4 Events Occurring after Balance Sheet Date 19 Leases
5 Net Profit or Loss for the period, Prior 20 Earnings Per Share
Period Items and Changes in Accounting
Policies
6 Depreciation Accounting -Withdrawn- 21 Consolidated Financial Statements
(CFS)
7 Construction Contracts 22 Accounting for Taxes on Income
8 -Withdrawn- 23 Accounting for Investment in Associates
in CFS
9 Revenue Recognition 24 Discontinuing Operations
10 Accounting for fixed assets 25 Interims Financial Reporting
Property, Plant & Equipment
11 Effects of changes in Foreign Exchange Rates 26 Intangible assets
12 Accounting for Government Grants 27 Financial Reporting of Interest in Joint
Ventures
13 Accounting for Investments 28 Impairment of assets
14 Accounting for Amalgamation 29 Provisions, Contingent Liabilities and
Contingent Assets
15 Employee Benefits

The Copyright of these notes is with CA. Nitin Goel

 INDIAN ACCOUNTING STANDARDS
Indian Accounting Standards (Ind-AS) are the International Financial Reporting
Standards (IFRS) converged standards issued by the Central Government of India
Ind AS under the supervision and control of Accounting Standards Board (ASB) of ICAI
and in consultation with National Advisory Committee on Accounting Standards
(NACAS).

 The Government of India in consultation with the ICAI decided to converge

and not to adopt IFRSs issued by the IASB.
Need of  The decision of convergence rather than adoption was taken after the detailed
convergence analysis of IFRSs requirements and extensive discussion with various
rather stakeholders.
adoption of
 Accordingly, while formulating IFRS-converged Indian Accounting Standards
IFRS
(Ind AS), efforts have been made to keep these Standards, as far as possible, in
line with the corresponding IAS/IFRS and departures have been made where
considered absolutely essential.

 Global Standards facilitate cross border flow of money, global listing in

different bourses and comparability of financial statements. The convergence of
financial reporting and accounting standards is a valuable process that
Significance of contributes to the free flow of global investment and achieves substantial
benefits for all capital market stakeholders.
issue of Indian
Accounting  It improves the ability of investors to compare investments on a global basis
Standards and thus lowers their risk of errors of judgment.

 It facilitates accounting and reporting for companies with global operations and
eliminates some costly requirements say reinstatement of financial statements

The Copyright of these notes is with CA. Nitin Goel