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Soln - Basis of Accounting

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Soln - Basis of Accounting

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peven28003
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© © All Rights Reserved
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Solution

ACCOUNTANCY - BASIS OF ACCOUNTING

Class 11 - Accountancy
1. i. GST paid (Input GST) is treated as assets till it is set off against GST collected (output GST).
ii. GST collected (output GST) is payable to the government after setting it off against GST paid. Hence, it is a liability.
iii. In case, where GST paid is not allowed to be set off against output GST, it is accounted as cost.
2. A debit is the portion of the transaction that accounts for the increase in assets and expenses, and the decrease in liabilities, equity,
and income. Every transaction is recorded twice on both the debit and credit sides depending on the nature of the transaction.
3. The steps involved in the process of accounting are as follows:
i. Identifying the financial transactions.
ii. Recording these transactions in the books of accounts.
iii. Classifying the recorded entries in separate accounts.
4. Accounting is often considered the language of business, as it communicates to others the financial position of the company. And
like every language has certain syntax and grammar rules the same is true here. These rules in the case of accounting are the

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Accounting Standards (AS). They are the framework of rules and regulations for accounting and reporting in a country. Let us see
the main objectives of forming these standards.

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i. The main aim is to improve the reliability of financial statements. Now because the financial statements have to be made
following the standards the users can rely on them. They know that not conforming to these standards can have serious

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consequences for the companies.
ii. Secondly it facilitates the comparability. Following these standards will allow for inter-firm and intra-firm comparisons. This
allows us to check the progress of the firm and its position in the market.
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iii. It also looks to provide one set of accounting policies that include the necessary disclosure requirements and the valuation
methods of various financial transactions.
5. The revenue recognition principle states that revenue should be recognized and recorded when it is realized or realizable and when
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it is earned. In other words, companies shouldn’t wait until revenue is actually collected to record it in their books. Revenue
should be recorded when the business has earned the revenue. This is a key concept in the accrual basis of accounting because
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revenue can be recorded without actually being received.


Revenues are realized or realizable when a company exchanges goods or services for cash or other assets. So if a company enters
into a transaction to sell inventory to a customer, the revenue is realizable. A specific amount of cash is identified in the
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transaction. The revenue is not recorded, however, until it is earned. In this case, the retailer would not earn the revenue until it
transfers the ownership of the inventory to the customer.
6. Dual Aspect Concept, also known as Duality Principle, is a fundamental convention of accounting that necessitates the
recognition of all aspects of an accounting transaction. Dual aspect concept is the underlying basis for double entry accounting
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system. According to this principle, every transaction has two aspects one aspect is debit and the other is credit, and both the
aspects are recorded in the accounting books. This concept is the basis of the double-entry system. To understand the double effect
of a transaction, we should also remember the business entity concept. When a person starts a business and invests capital in the
business, on the one hand, it increases the cash in hand (asset) and on the other hand, it increases the liability of the business
towards the proprietor. The following accounting equation is drawn on the basis of this principle :
Assets = Capital (or Owner's Equity) + Liabilities (Claims of Outsider).
7. Financial Statements prepared under IFRS are as follows:
i. Statement of Financial Position;
ii. Statement of Comprehensive Income;
iii. Statement of Changes in Equity;
iv. Statement of Cash Flow; and
v. Notes and Significant Accounting Policies.
8. The principle that requires a company to match expenses with related revenues in order to report a company's profitability during
a specified time interval. Ideally, the matching is based on a cause and effect relationship: sales cause the cost of goods sold
expense and the sales commissions expense. If no cause and effect relationship exists, accountants will show an expense in the
accounting period when a cost is used up or has expired. Lastly, if a cost cannot be linked to revenues or to an accounting period,

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the expense will be recorded immediately. An example of this is Advertising Expense and Research and Development Expense.
While recognizing expenses, the following points should be kept in mind:
i. Only that part of the cost should be recognized which is directly associated with revenue generated. For example, the cost of
goods sold is always associated with generating revenue, i.e., sales.
ii. Some expenses are not directly related to the revenue generated but are associated with the current accounting period. These
are recognised in the same accounting period. For example, salaries of the office staff, rent paid depreciation, etc.
iii. Costs that do not provide clear future benefits are recognised immediately. For example, loss of goods by fire, etc.
9. Materiality Principle:- The materiality principle states that an accounting standard can be ignored if the net impact of doing so
has such a small impact on the financial statements that a reader of the financial statements would not be misled. Under generally
accepted accounting principles (GAAP), you do not have to implement the provisions of an accounting standard if an item is
immaterial. This definition does not provide definitive guidance in distinguishing material information from immaterial
information, so it is necessary to exercise judgment in deciding if a transaction is material.
The Securities and Exchange Commission has suggested for presentation purposes that an item representing at least 5% of total
assets should be separately disclosed in the balance sheet. However, much smaller items may be considered material. For
example, if a minor item would have changed a net profit to a net loss, that item could be considered material, no matter how
small it might be. Similarly, a transaction would be considered material if its inclusion in the financial statements would change a

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ratio sufficiently to bring an entity out of compliance with its lender covenants.
The materiality principle is especially important when deciding whether a transaction should be recorded as part of the closing

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process, since eliminating some transactions can significantly reduce the amount of time required to issue financial statements. It
is useful to discuss with the company's auditors what constitutes a material item so that there will be no issues with these items

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when the financial statements are audited.
Material items are disclosed in the financial statement As per Accounting Standard.
10. Elements of the Statement of Financial Position are-
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i. It is because of this concept that a distinction is made between capital expenditure and revenue expenditure.
ii. It is because of this concept that full cost of an asset is not treated as an expense in the year of purchase itself and the cost is
spread over the useful life of the asset by charging depreciation on a suitable basis.
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iii. It is because of this concept that outside parties purchase shares and debentures of the enterprise.
11. An accounting standard is a common set of principles, standards and procedures that define the basis of financial accounting
policies and practices. Accounting standards improve the transparency of financial reporting in all countries. Accounting
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standards are principles that guide and standardizes the process of accounting and is notified by the Ministry of Corporate Affairs.
The advantages are:
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i. Accounting practice is standardized and hence comparison of accounts of different companies is possible.
ii. Window dressing manipulation is not possible.
12. The basic features of accounting principles are:
i. Usefulness: An accounting principle should be useful i.e., an accounting rule which does not increase the utility of the records
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is not accepted as an accounting principle.


ii. Objectivity: Accounting principle should be objective in nature. It should not be influenced by personal bias.
iii. Feasibility: Accounting principle should be practicable and feasible.
13. Underlying accounting concepts are also known as accounting assumptions. One assumption is that the business and the owners'
records be kept separate since the business is its own entity.
Basis of
Fundamental Accounting Assumptions Accounting Principles
Difference

Fundamental accounting assumptions are the basic Accounting principles or accounting concepts refer to
Meaning accounting conditions that provide a foundation for the the rules or guidelines adopted for recording and
accounting process. reporting of business transactions.

There is no option available regarding its adoption. It is There is an option to adopt or not to adopt a particular
Option
mandatory. accounting principle.

There is no need for any disclosure that the accounting


Disclosure is necessary if an accounting principle is
Disclosure assumptions have been followed. Disclosure is necessary
adopted for the first time or if there is any change.
if these are not followed.

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14. The business entity concept (also known as a separate entity and economic entity concept) states that the transactions related to a
business must be recorded separately from those of its owners and any other business.
i. For the purpose of accounting, it is assumed that the business has a separate and distinct entity from its owners and all other
entities having transactions with it.
ii. Due to this Principle, a separate record is maintained for the transactions between owner and business. A distinction should be
made between business affairs and personal affairs and in the accounting books of the business, only business transactions are
to be recorded.
iii. The amount invested by the owner is recorded in his 'Capital Account' and the amount withdrawn by the owner from the
business for his personal use is recorded in 'Drawings Account'. The Principle is followed by all organizations, irrespective of
their form, i.e., sole proprietorship, partnership, company, or cooperative organization.
15. i. According to the Convention of Full Disclosure, all significant information relating to the economic affairs of the entity
should be reported in the financial statements in an understandable manner.
ii. According to the Convention of Consistency, accounting practices once selected and adopted should be consistently applied
year after year.
iii. According to the Convention of Materiality, a transaction should be reported in the financial statements on the basis of its
materiality. An item is material if it can influence the decision of the user.

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16. i. Revenue Recognition (Realisation) Concept: According to this concept revenue is considered to have been realised when a
transaction has been entered into and the obligation to receive the amount has been established. For Example, an organisation

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sells goods in March 2016 and receives the amount in April, 2016. Revenue of these sales should be recognised in March,
2016 or when the goods are sold as the legal obligation has been established upon sales in March 2016.

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ii. Conservation or Prudence Principle is described using the phrase "Do not anticipate a profit, but provide for all possible
losses." In other words, it takes into consideration all prospective losses but not the prospective profits.Conservatism does not
record anticipated revenue but provides all anticipated expenses and losses, thus it may overstate liabilities. For example,
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closing stock is valued at lower of cost or net realisable value.
iii. Money Measurement Concept: is the principle in which transaction and events that can be measured in money terms are
recorded in the books of account of the enterprise.
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The value of money is considered to have static value as the transactions are recorded at the value on the transaction date. This
is the one factor which makes it difficult to compare the monetary value of one year with the monetary value of another year.
For example purchases of two trucks cannot be recorded but the money value paid for this will be recorded in the books of
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accounts.
17. i. IGST (Integrated GST) is levied on inter-state supply of goods and/or services, e.g., if the seller is located in Delhi and the
purchaser is located in Bihar, IGST will be levied.
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ii. CGST (Central GST) and SGST (State GST) is levied on intrastate (within state) supply of goods and/or services, where both
the seller and purchase are located in some state.
18. Following Financial Statements are prepared under Ind-AS:
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i. Statement of Financial Position


ii. Statement of Comprehensive Income
iii. Statement of Changes in Equity
iv. Statement of Cash Flow and
v. Notes and Significant Accounting Policies
19. In accounting, the matching principle guides firms to record expenses in the same accounting period as the related revenues. In
other words, the matching principle directs firms to match revenues and expenses in the same period to the greatest extent
possible, regardless of when subsequent events occur.
20. Accrual Basis of Accounting means the transaction is recorded at the time when it is entered into and not when the settlement
takes place.
21. IFRS (International Financial Reporting Standards) are the accounting standards issued by the IASB, recommended to be used by
enterprises globally to produce financial statements following a single set of accounting standards. IFRS are principle-based
accounting standards in comparison to rule-based Indian Accounting Standards. Also, they are based on the fair value concept.
22. The consistency principle requires accountants to be consistent from one accounting period to another in applying accounting
principles, methods, practices, and procedures. In other words, the readers of a company's financial statements can presume that
the same rules and measurements were followed in all of the years being reported. If a change is made to a more preferred
accounting method, the effects of the change must be clearly disclosed.

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The consistency principle is most frequently ignored when the managers of a business are trying to report more revenues profits
than would be allowed through a strict interpretation of the accounting standards. A telling indicator of such a situation is when
the underlying company's operational activity levels do not change, but profits suddenly increase.
23. Business is a going concern; the owners cannot wait for a long period to know the results of their business as it may not serve the
purpose of owners and other interested parties. An accounting period is an established range of times during which accounting
functions are performed, aggregated, and analyzed including a calendar year or fiscal year. Normally, the accounting period is one
year. At present accounting, the year is a financial year, i.e., from 1st April - 31st March established by law. The Companies Act
requires yearly reports to be presented to shareholders, and the Income Tax Act requires accounts for all business enterprises to be
submitted annually.
24. Cash basis refers to a major accounting method that recognizes revenues and expenses at the time cash is received or paid out.
This contrasts accrual accounting, which recognizes income at the time the revenue is earned and records expenses when
liabilities are incurred regardless of when cash is received or paid.
Cash Basis of Accounting =4,50,000-2,00,000
=Rs. 2,50,000
Under the accrual basis of accounting (or accrual method of accounting), revenues are reported on the income statement when
they are earned. When the revenues are earned but cash is not received, the asset accounts receivable will be recorded.

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Accrual Basis of Accounting=4,50,000+3,00,000-3,50,000
=Rs. 4,00,000

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25. Cash basis refers to a major accounting method that recognizes revenues and expenses at the time cash is received or paid out.
Cash Basis of Accounting =10,50,000+1,35,000-3,90,000-60,000
=Rs.7,35,000
Under the accrual basis of accounting (or accrual method of accounting), revenues are reported on the income statement when
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they are earned. When the revenues are earned but cash is not received, the asset accounts receivable will be recorded.
Accrual Basis of Accounting=12,00,000-5,10,000
=Rs.6,90,000
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26. The elements or contents of the statement are:
i. Revenue: It increases the economic benefit during the accounting period because of business operations and/or an increase in
the value of assets or a decrease in liabilities. As a result of it, the value of shareholder's equity increases.
ii. Expense: It is a decrease in economic benefits in the form of outflows during the accounting period because of business
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operations and/or decrease in the value of assets or an increase in liabilities. As a result of it, the value of shareholders' equity
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decreases.

27. In India, the convergence of IFRS with its domestic accounting standards will be made in a phased manner starting from 1st April
2011 as under: Following companies are required to converge with IFRS from April 2011 in the first phase :
i. Companies not listed but have a net worth of ₹1,000 crores or more.
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According to the Institute of Chartered Accountants of India (ICAI), IFRS was to be implemented from April 2011 but was
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put on hold and is under review. The expected date of implementation is yet to be declared.
ii. Companies listed in India or outside.
28. An accounting standard is a common set of principles, standards and procedures that define the basis of financial accounting
policies and practices. Accounting standards improve the transparency of financial reporting in all countries.
Accounting standards serve the following purposes :
i. Accounting standards provide the norms on the basis of which financial statements should be prepared.
ii. Accounting standards ensure uniformity in the preparation and presentation of financial statements by removing the effect of
diverse accounting practices.
iii. Accounting standards provide a useful system to resolve potential financial conflicts of interest between various groups.
iv. Accounting standards help auditors in the audit of accounts. Accounting standards raise standard of an audit of accounts.
29. Closing stock is the goods that remain unsold at the end of the year. It is valued at Cost price or Realisable Value, whichever is
less.
It is based on the principle of Conservatism or prudence, According to which all anticipated losses should be recorded in the
books of accounts, but all anticipated or unrealized gains should be ignored.
Following are some of the examples of conservatism:
i. Making the provision for doubtful debts and discount on the debtor.
ii. Valuing the stock in trade at market price or cost price, whichever is less.

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iii. Creating provisions against fluctuation in the price of investments.
iv. Charging of small capital items, like crockery, to revenue.
v. Adopting the written-down-value method of depreciation.
vi. Amortization of intangible assets like goodwill.
vii. Showing joint life policy at surrender value as against the amount paid.
viii. Not providing for a discount on creditors.
30. Accounting data must be comparable. Financial analysts have to analyze and compare the performance and financial position of
the various companies in the same industry. To make them comparable, it is necessary that all the companies of industry must
follow the common accounting policies and practices. Some of the industries may follow different accounting policies which may
not be in accordance with the accepted accounting principles explained above. Following are a few examples of industry practice:
i. In the agricultural industry, crops are often reported at market value because it is difficult to develop accurate cost figures on
individual crops.
ii. Banks and insurance companies in some countries report certain investment securities at market price (rather than cost or
market price whichever is less) as these securities are traded frequently.
31. Elements of the Statement of Financial Position are-
Assets: Assets are the resources controlled by the enterprise as a result of past events and operations from which the future

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economic benefits shall flow to the enterprise. Thus, assets shall include tangible and intangible assets, which an enterprise owns.
Liabilities: Liabilities are the obligations of the enterprise from past events and operations, which shall result in the outflow of

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resources, i.e., assets.
Equity: Equity is the difference between assets and liabilities.

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32. Accounting Standards are a set of guidelines, i.e., Generally Accepted Accounting Principles (GAAP), issued by the accounting
body of the country, i.e., The Institute of Chartered Accountants of India (ICAI), that are followed for preparation and presentation
of financial statements. The objective of setting Accounting Standards is to bring uniformity in accounting practices and to ensure
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transparency, consistency and comparability in business.
33. The cash basis of accounting is the system of accounting under which revenues and expenses are recorded when they are received
or paid in cash. Cash basis of accounting is not popular due to the following reasons :
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i. It does not make a clear cut distinction between revenue items and capital items.
ii. It is not recognized under the Companies Act.
iii. It is not in line with matching principle because revenues and costs are recognized not on the basis of incurrence but on the
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basis of receipt and payment. As a result, incomes include unearned incomes and exclude accrued incomes. Similarly,
expenses include expense, paid in advance but does not include outstanding expenses.
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34. The company is not a going concern because it has not commenced any business post-acquisition. The company is only seeking
higher compensation and not quashing the acquisition order of the Government. It has invested the compensation received in the
fixed deposit which remains deposited as on date also. Thus, the company does not have intentions to conduct the business. Going
concern means business should continue in future and there is no intention to close business.
Ed

35. An accounting standard is a common set of principles, standards and procedures that define the basis of financial accounting
policies and practices. Accounting standards improve the transparency of financial reporting in all countries.
According to Kohler, "Accounting Standard is a code of conduct imposed on the accountants by custom, law, and a professional
body." Following points highlight the nature of accounting standards:
i. Accounting standards are the norms of accounting policies and practices to be adopted by the accountants.
ii. Accounting standards make accounting procedures universally acceptable by removing the diverse accounting practices and
policies.
iii. Accounting standards serve as a guide for solving one or more accounting problems.
iv. Accounting standards provide the basis upon which financial statements are prepared.
v. Accounting standards are codified principles to be followed by public accountants.
36. In an environment where financial statements are presented to external stakeholders such as investors, banks, stock exchanges,
revenue departments, government, etc., there arises a need for an accounting framework on the basis of which the financial
transactions should be recorded so as to make the resulting financial statements comparable. This need led to the framing of the
Generally Accepted Accounting Principles (GAAP). The American Institute of Certified Public Accountants (AICPA) has defined
the accounting principles as "a general law, or a rule adopted or professed as a guide to action, a settled ground or basis of conduct
or practice."

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In simple words, Generally Accepted Accounting Principles are the set of rules and practices that are followed by accounting
professionals while recording transactions, preparing financial statements, and reporting financial information.
37. i. Principle of full disclosure: The full disclosure principle states that you have to include in or together with the business
financial statements all of the details that will influence a reader’s perception of the financial statements. The significance of
the principle is that there is a sufficient disclosure of information which is of material interest to the proprietor, creditors,
investors, etc. For this purpose, facts or items which do not find a place in financial statements are shown as footnotes,
schedules, etc. Examples are :
a. Contingent liabilities appearing as a footnote.
b. The market value of investments appearing as a footnote.
ii. Principle of Materiality: This accounting concept supports that you need to record the transactions in your accounting
records. In particular, when not doing this could have changed the process of making decisions by someone looking through
the business’ financial statements.
Even then, this concept can be quite vague and rather hard to quantify. Due to this, this concept has led to a few of the very
picayune controllers ending up including even the tiny transactions in their company records. For Example Cost of loose tools
may be material for a small repair workshop but may not material for a big company like L&T.
38. According to this principle, there should be reporting of all the significant information relating to the economic affairs of the

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business and it should be complete and understandable.
The information disclosed should be material and significant, which in turn results in better understanding. Since one of the

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objectives of accounting information is to communicate accounting information to various users, it is important to provide
complete information to them, so that they can take right decisions at the right time on the basis of the financial statements of the
business. Whether information should be disclosed or not depends upon whether such information will affect the decision making
of the users of accounting information or not.
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The Companies Act, 2013 provides disclosures, yet there may be many material information which if disclosed, will make the
financial statements more meaningful. Various items which do not find a place in an accounting statement are shown in the
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balance sheet by way of footnotes. Such as:-
i. Contingent Liabilities:- For instance, a claim of a very big sum pending in a court of law against the enterprise should be
brought to the notice of the users of the financial statements, otherwise the statement should be misleading.
ii. If there is a change in the method of valuation of the stock, or for providing depreciation or in making provision for doubtful
debts, it should be disclosed in the Balance sheet by way of a footnote.
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iii. The market value of Investments should be given by way of a footnote.


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Disclosing of material facts does not mean leaking out the secrets of the business but disclosing sufficient information which is of
material interest to the users of the financial statements.
39. The accounting concept/convention involved in each of the following situations are as follows :
i. Money Measurement Concept
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ii. Revenue Recognition Concept


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iii. Cost Concept


iv. Accrual Concept
v. Business Entity Concept
vi. Going Concern Concept
vii. Business Entity Concept
viii. Accounting Period Concept
ix. Dual Aspect Concept
x. Revenue Recognition Concept
xi. Verifiable Evidence Objective
xii. Prudence Concept
xiii. Revenue Recognition
xiv. Materiality Concept
40. According to this principle, business is treated as a unit separate and distinct from its owners. In other words, the owner of a
business is always considered as distinct and separate from the business he owns. Business unit should have a separate set of
books and we have to record business transactions from the firm's point of view and not from the point of view of the proprietor.
The proprietor is treated as a creditor of the business to the extent of the capital invested by him in the business. The capital is
treated as a liability of the firm because it is assumed that the firm has borrowed funds from its own proprietors instead of

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borrowing it from the outside parties.It is for this reason, that interest on capital is treated as a business expense. Interest on capital
will reduce the profit (being an expense) and will increase the owner’s money (capital) in the business.
Also, because of this principle, owner’s personal property, investments, expenditures are kept separate from the recording of
business transactions in the books.

41. Financial statements of one accounting period must be comparable to another in order for the users to derive meaningful
conclusions about the trends in an entity's financial performance and position over time. Comparability of financial statements
over different accounting periods can be ensured by the application of similar accountancy policies over a period of time. A
change in the accounting policies of an entity may be required in order to improve the reliability and relevance of financial
statements. A change in the accounting policy may also be imposed by changes in accountancy standards. In these circumstances,
nature and circumstances leading to the change must be disclosed in the financial statements. Financial statements of one entity
must also be consistent with other entities within the same line of business. This should aid users in analyzing the performance

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and position of one company relative to the industry standards. It is, therefore, necessary for entities to adopt accounting policies
that best reflect the existing industry practice. For example, the method of depreciation once applies to follow each year.

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42. 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,

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presented, and disclosed in financial statements. Their objective is to provide financial information to investors, lenders, creditors,
contributors, and others that are useful in making decisions about providing resources to the entity. In Canada, accounting
standards for all entities outside the public sector are issued by the Accounting Standards Board (AcSB). The AcSB adopted
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IFRS® Standards as the accounting standards used by publicly accountable enterprises. Private enterprises and not-for-profit
organizations can choose to use separately developed standards for those entities or IFRS Standards. Separate accounting
standards exist for pension plans. Accounting standards adopted by the AcSB (including IFRS Standards) are published in the
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CPA Canada Handbook – Accounting. The Canada Business Corporations Act and provincial corporations and securities
legislation generally require companies to prepare financial statements for their shareholders in accordance with GAAP as set out
in the CPA Canada Handbook – Accounting. Other legislation applies to financial institutions and certain other types of reporting
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entities.
Accounting standards are-
1. AS-2 Accounting for inventory
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2. AS-3 Cash flow statement


43. Accounting standards are the written statements consisting of rules and guidelines, issued by the accounting institutions, for the
preparation of uniform and consistent financial statements and also for other disclosures affecting the different users of accounting
information.
Ed

Objectives:
i. Accounting standards are needed to ensure uniformity in the preparation and presentation of financial statements.
ii. Accounting standards provide a basis to resolve potential financial conflicts, if any, among various groups.
iii. They ensure the comparability of the data published in the financial statement and are needed to harmonize the different and
diverse accounting policies and practices to make the financial statements meaningful.
44. Offering transparency, accountability, and efficiency, IFRS provides an internationally recognised set of accounting standards.
Following points highlight the importance or usefulness of IFRS :
i. Growth in International Business: IFRS will facilitate enormous expansion in world trade and international investment.
IFRS will make accounting reports as a universal means of communication among businessmen, entrepreneurs, and investors.
ii. Investors: With the use of IFRS, it will be convenient for investors to assess the relative merits of alternative investment
opportunities by making a comparison of the financial performance of companies in different countries.
iii. Multinational Companies: Multinational companies will find raising funds from global markets easy. The consolidation of
overseas subsidiaries would be easier due to IFRS.
iv. International Audit Firms: The adoption of IFRS is in the interest of international audit firms as it would facilitate the sale
of their services in different parts of the world.
v. Developing Countries: Many countries do not have their domestic accounting standards. IFRS would enable them to adopt a
ready-made system without spending any time, money, or efforts. The adoption of IFRS would promote foreign investors to

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invest in developing countries.
45. Accounting Standards: Accounting standards may be defined as written statements, issued from time to time by institutions of
accounting professionals, specifying uniform rules or practices for drawing the financial statements.
Kohler defines accounting standard as "a code of conduct imposed on accountants by custom, law or professional body."
Nature of Accounting Standards: Following points highlight the nature of accounting standards.
i. Accounting standards are a framework of practices and guidelines which facilitates reliability and comparability to financial
statements.
ii. Accounting standards bring uniformity in accounting practices of various businesses.
iii. Accounting standards design and mould the business environment by prescribing and recommending accounting practices.
46. i. Matching Concept: The matching principle states that expenses should be recognized and recorded when those expenses can
be matched with the revenues those expenses helped to generate. In other words, expenses shouldn’t be recorded when they
are paid. Expenses should be recorded as the corresponding revenues are recorded. This matches the revenues and expenses in
a period. In this sense, the matching principle recognizes expenses as the revenue recognition principle recognizes income.
This requires various adjustments to be made for outstanding expenses, accrued incomes, prepaid expenses, unearned
incomes, etc. The accountant must estimate the life span of the asset and allocate a part of the expired cost over accounting
periods until its useful life is ended. It is often impossible to determine what benefits have been or remain to be derived from

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certain cost outlays. The matching concept also requires the application of personal judgments in making the estimates for
doubtful debts, discounts, etc.

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ii. Duality (Dual Aspect) Concept: The principle of duality or dual aspect concept means that every transaction affects two
accounts. That is why the Double Entry System of Book-Keeping came into existence. All business transactions are recorded

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on the basis of this concept. No transaction is complete without dual aspects. This concept is the foundation on which the
whole of book-keeping and accountancy is based. This principle has given us the fundamental rule "for every debit there is
equivalent credit". According to this, there is following accounting equation: Assets = Owners' Equity (Capital) + Outsiders'
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Equity (Liabilities)
47. An accounting period is an established range of times during which accounting functions are performed, aggregated, and analyzed
including a calendar year or fiscal year. The accounting period is useful in investing because potential shareholders analyze a
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company’s performance through its financial statements that are based on a fixed accounting period.
i. According to the Accounting Period Concept, the economic life of an enterprise is divided into some shorter and convenient
periods for the measurement of income.
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ii. An accounting period is the interval of time at the end of which financial statements are prepared in order to show the results
of the business.
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iii. Since the life of the business is considered to be indefinite, the measurement of income in studying the financial position of
the business after a very long period will not be helpful to various groups interested in the business. Therefore, accountants
choose some shorter and convenient time for the accounting period.
iv. Various tax laws like Companies Act, Income Tax Act., Sales Tax, etc., recognize one year as an accounting period. This
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concept facilitates the preparation of financial statements.


48. The concept substance over form means that the transactions recorded in the financial statements must reflect their economic
substance rather than their legal form. The legal form may be different from the substance or commercial reality. According to this
principle, accounting treatment and presentation of business transactions in financial statements should be governed by their
substance and not by their legal form. For example, under hire purchase system, the hire purchaser becomes the owner of the
goods only when he pays the last instalment. This is a legal form. The substance of the hire purchase transaction is that it is a
credit transaction and the goods sold are immediately delivered to the hire purchaser and for all practical purposes he is
considered the owner of the goods from the date of acquisition. Accounting books are prepared on the basis of substance. Thus,
the substance should always be preferred to the form.
49. Following are the benefits of accounting standards:
i. Creditability and Reliability of Financial Statement: Accounting standards provide a structured framework within which
credible financial statements can be produced. Accounting standards standardize diverse accounting policies and practices and
eliminate the non-comparability of financial statements. Utilizing one common framework makes it easy to read statements
from various entities. This familiarity instils confidence that the information being represented is accurate.
ii. Beneficial to Accountants and Auditors: Accounting standards provide the norms on the basis of which business
transactions are recorded and financial statements are prepared. Accountants are not required to use personal judgment and
discretion while recording business transactions. Accounting standards helps the auditors in the audit of accounts.

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iii. Managerial Accountability: Accounting standards help in assessing managerial skills in ensuring the profitability of the
enterprise and in measuring the effectiveness of management's stewardship. It will be difficult for management to manipulate
financial data.
iv. Development of Accounting Theory: Accounting standards provide a coherent, logical, conceptual framework, and structure
for accounting measurements, financial reporting, and usefulness of accounting data. This has facilitated the making of
accounting theory which commands universal acceptance.
50. Periodicity Concept: Periodicity Concept means dividing the life of the enterprise into smaller periods(normally one year), which
is called 'Accounting Period'. Each accounting period is associated with economic activity. That economic activity must be
recorded, classified, summarised and presented in the financial statements of the enterprise within the Accounting Period only.
Thus, Periodicity concept refers to completing the Accounting Cycle of the firm in an Accounting Period.
For example, management is considering to invest the new projects which is similar to the existing one. In order to make correct
decision, management need to assess and predict the expect gain on the new investment. Normally, they use the two year period
financial performance.
In this case, we can use the periodicity assumption to produce the financial report for management. So that they could make the
correct and accurate decision making.
Dual Aspect Concept: Dual aspect concept means each business transaction is recorded as having a dual aspect. It means each

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transaction affects two accounts. If one account is debited, then the other account must be credited. This system of recording is
also known as 'double entry system'. It is because of the dual aspect concept the two sides of the Balance Sheet are always equal

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and the Accounting Equation(Assets = Liabilities + Capital)stands always true.
51. Accounting principles are the general rules and guidelines that companies are required to follow when reporting all accounts and

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financial data.
i. Under the Accounting Entity Principle, an accounting entity is held to be "Separate and distinct from its owners". Following
this Principle, we, therefore, record all the transactions of the business from the point of view of the business and not from the
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point of view of the proprietor.
ii. As we consider the owner to be distinct from the business, he is treated as a creditor to the extent of the capital. It is important
to understand that without such a distinction, the affairs of the business will be all mixed up with the private affairs of the
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proprietor and the true picture of the firm will not be available.
iii. The principle of accounting entity is applicable to all types of business. In the case of sole proprietorship and partnership firm,
though the sole proprietor or the partners are not considered as separate entities in the eyes of law, for accounting purposes
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they will be considered as separate entities. In the case of companies, the law recognizes the legal entity of the business
separate from its owners, i.e., shareholders. The accountant will record transactions between the owner and the firm. For
instance, when capital is provided by the owner, the record will be shown by the firm as having received money and the same
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being owed to the proprietor. In case, the proprietor withdraws money from the business, it will be charged to him. An account
is maintained for the owner in the name of capital like other parties.
52. i. Double Entry System: True to its name, double-entry accounting is a standard accounting method that involves recording
each transaction in at least two accounts, resulting in a debit to one or more accounts and a credit to one or more accounts.
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There cannot be a business transaction with one aspect. A transaction is just like a scale that must have equal weight on each
of the two sides in order to be balanced. Following are some examples which emphasize the two aspects of a transaction:
a. If a business firm acquires an asset for cash, it has to give up some other asset say cash, or the obligation to pay for it in
the future. Thus, a giver necessarily implies a receiver and a receiver necessarily implies a giver.
b. If goods of ₹30,000 are sold to Rajendra on credit, the business firm gives goods and acquires a right to receive payment
in the future. Thus, goods and Rajendra are two aspects of this transaction.
ii. Cash Basis of Revenue and Cost Recognition: Cash basis of revenue and cost recognition means that revenues and expenses
are recorded when they are received or paid in cash. For example, if total sales of the firm are ₹ 5,00,000 including credit sales
of ₹ 2,00,000, the revenue from sales will be recorded as ₹3,00,000 (₹5,00,000 - ₹2,00,000). If total expenses of the firm are ₹
60,000, including ₹ 20,000 as outstanding expenses, the expenses would be recorded as ₹40,000 60,000 - ₹20,000).
53. i. Business Entity Concept or Accounting Entity Principle: A business is treated as a separate and distinct entity from its
owners. Business transactions therefore are recorded in the books of accounts from the business point of view and not from
that of the owners. Owners being regarded as separate and distinct from a business. They are considered creditors of the
business to the extent of their capital. Their account with the business is credited with the capital introduced and profit earned
during the year, etc., and debited by the drawings made. The investment in another company's share is by a shareholder who is
distinct from the business. The proprietor is totally different from its business.

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ii. Matching Concept or Matching Principle: This concept is based on the accounting period concept. According to this
concept, the expenses for an accounting period are matched against related revenues, rather than cash received and cash paid
to find out the profit earned or loss suffered during that accounting period. A business concern should follow this concept to
find out profit earned or loss suffered during the particular accounting period. It is definitely required to adjust for all
outstanding expenses, prepaid expenses, accrued income, unearned income, etc. According to this concept, the expenses for an
accounting period are matched against related revenues, rather than cash received and cash paid relating to particular
accounting year. This concept should be followed while preparing financial statements to have a true and fair view of the
profitability and financial position of a business firm.
iii. Consistency Concept or Consistency Assumption: According to this concept accounting practices once selected and
adopted, should be applied consistently year after year. This concept helps in better understanding accounting information and
makes it comparable with that of previous years. Consistency eliminates personal bias and helps in achieving a result that is
comparable. The concept particularly important when alternative accounting practices are equally acceptable. Under this
assumption, the method once chosen and applied should be applied consistently year after year. But it does not mean that
practice once adopted cannot be changed. The accounting practice may be changed if the law or accounting standard requires
it or the change will result in a more meaningful presentation. If an enterprise to adopt an alternative practice, it must disclose
the change and its impact on the profit or loss. The method of accounting once applies consistently followed every year.
iv. Dual Aspect Concept or Duality Principle: According to this concept, every transaction entered into by an enterprise has

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two aspects, a debit and accredit of an equal amount. That is for every debit there is a credit of equal amount in one or more

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accounts. It is also true vice versa. As a matter of fact, the entire system of double-entry book-keeping is based on this
concept. When a transaction occurred one account is debited and other is credited.

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54. i. Business Entity Concept: According to this concept, the business is treated as a unit separate and distinct from the proprietor.
All the transactions of the business are recorded in the books of the business (though they belong to the proprietor) from the
point of view of the business as an entity. Even the proprietor is treated as a creditor to the extent of his capital. Capital is,
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thus, a liability like any other liability although the amount is not owing to any outsider. Therefore, whenever the business
receives cash from the proprietor, the following journal entry is passed:
Cash A/c ... Dr.
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To Capital A/c
Similarly, whenever proprietor withdraws some cash (or goods) from the business, following journal entry is passed to
decrease the claims of the proprietor:
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Drawings/Capital A/c ... Dr.


To Cash/Purchases A/c
ii. Principle of Consistency: The consistency principle of accounting states that a company should use the same accounting
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policies and methods for recording similar events or transactions from one financial period to another. It is necessary that a
company consistently apply its accounting methods and policies from one financial year to another.
A company can change its accounting methods and policies only and only if there are one or more reasonable grounds to do so
and the change reflects a more accurate picture of financial performance and position of the business in company’s financial
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statements.
55. i. Dual Aspect: According to Dual Aspect principle every business transaction has two aspects, i.e., debit and credit with the
same amount, e.g., Rent paid ₹1,000. So this transaction has two aspects one is debit as rent and the other is cash which will
be credit. Trial Balance is also prepared as per the Dual Aspect principle.
ii. Accrual: According to this principle, all anticipated losses and expenses should be recorded in the books of accounts, but all
anticipated gains should be ignored.
iii. Conservatism: It is also called Prudence Principle. Conservatism principle says that provide for all possible anticipated losses
but not for profits. But the biggest drawback of this principle is the creation of a secret reserve. For example, the creation of
Provision for doubtful debts.
56. Two objectives of IFRS are given below:
i. Helpful to Global Enterprises: IFRS unifies accounting practices worldwide which helps enterprises operating in different
countries facing problems in the consolidation of financial statements of their different units of different countries.
ii. Helpful to Industry: Following IFRS makes it easier for businesses to obtain funds globally.
iii. Helpful to Accounting Professionals: Accounting professionals will be able to provide better services to global business
enterprises following IFRS.
57. According to this principle, only those transactions and events are recorded in accounting which are capable of being expressed in
terms of money are recorded in the books of accounts, such as the sale of goods or payment of expenses or receipt of income, etc.

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An event may be important for the business (such as dispute among the owners or managers, the appointment of a manager, etc.),
but it will not be recorded in the books of accounts simply because it can not be converted or recorded in terms of money. For
instance, strike by workers may adversely affect the business but it cannot be recorded in the books of accounts unless its effect
can be measured in terms of money with a fair degree of accuracy.
Another aspect of this principle is that the transactions that can be expressed in terms of money have to be converted in terms of
money before being recorded.
It should be remembered that money is the only measurement which enables various things of diverse nature to be added up
together and dealt with. The money measurement assumption is not free from limitations. Due to the changes in price, the value of
money does not remain the same over a period of time. The value of rupee today on account of rising in price is much less than
what it was, say ten years back. As the change in the value of money is not reflected in the book of accounts, the accounting data
does not reflect the true and fair view of the affairs of an enterprise. As, such, to make accounting records relevant, simple,
understandable and homogeneous, they are expressed in a common unit of measurement,i.e., money.
58. The following Assumptions/Principles of Accounting are :
i. Going Concern Assumption: The going concern principle assumes that any organization will continue to operate its business
for the foreseeable future. The principle purports that every decision in a company is taken with the objective in mind of
running the business rather than that of liquidating it. However, it does not mean that trade is immortal and permanent. In the

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absence of liquidation, it is assumed that the trade will continue for a long period. The accounts are not affected easily by the
fear of changes or by the dissolution of trade.

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ii. Consistency Assumption: The accounting information provided by the financial statements would be useful in drawing
conclusions regarding the working of an enterprise only when it allows comparisons over a period of time as well as with the

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working of other enterprises. Thus, both interfirm and inter-period comparisons are required to be made. This can be possible
only when accounting policies and practices followed by enterprises are uniform and are consistent over the period of time.
iii. Matching Principle: The process of ascertaining the amount of profit earned or the loss incurred during a particular period
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involves the deduction of related expenses from the revenue earned during that period. The matching concept emphasizes
exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that
period. It follows from this that the revenue and expenses incurred to earn these revenues must belong to the same accounting
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period.
59. i. Accounting Standards: Accounting Standards are the written statements consisting of uniform accounting rules and
guidelines issued by the accounting body of the country (Such as Institute of Chartered Accountants of India) that are to be
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followed while preparation and presentation of financial statements. The main purpose of accounting standards is to promote a
better understanding of financial statements.
ii. Matching Concept: The matching principle is one of the basic underlying guidelines in accounting. The main purpose of the
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principle is to direct a company to report an expense on its income statement in the same period as the related revenues. The
matching concept also requires the application of Personal Judgments in making the estimates for Doubtful debts, discount,
etc.
iii. Going Concern Assumption: This concept assumes that every business has a long and indefinite life. Since financial
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statements are prepared on the basis of this concept, all fixed assets are shown in the books at their cost ignoring their market
value.
60. The basic accounting concepts are referred to as the fundamental ideas or basic assumptions underlying the theory and practice of
financial accounting and are broad working rules for all accounting activities and developed by the accounting profession.
On the other hand, accounting standards are written statements of uniform accounting rules and guidelines or practices for
preparing the uniform and consistent financial statements and for other disclosure affecting the user of accounting information.
However, it is to be remembered that the accounting standards cannot override the provisions of applicable laws, customs, usages
and business environment in the country.Financial statements prepared and presented by a company typically follow an external
standard that specifically guides their preparation. These standards vary across the globe and are typically overseen by some
combination of the private accounting profession in that specific nation and the various government regulators. Variations across
countries may be considerable, making cross-country evaluation of financial data challenging.
Financial accounting is concerned with the preparation of financial statements and provides financial information to various
accounting users. It is performed according to the basic accounting concepts like business entity, money measurement,
consistency, conservatism, etc.For example, there are a number of methods available for calculating stock and depreciation, which
can be followed by various firms.
These concepts allow various alternatives to treat the same transaction. This leads to wrong interpretation of financial results by
external users due to the problem of inconsistency and incomparability of financial results among different business entities. In

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order to remove inconsistency and incomparability and to bring uniformity in preparation of the financial statements, accounting
standards are being issued in India by the Institute of Chartered Accountants of India. Accounting standards keep investors,
business owners and regulators on the same page. When all businesses follow the same accounting practices, it easy to evaluate
performance. The rules also discourage businesses from interpreting gray areas of accounting to their own advantage. Hence,
accounting standards and accounting concepts are referred as the essence of financial accounting.
61. Advantages of Cash Basis of Accounting
Following are the advantages of cash basis of accounting
i. It is very simple because no adjustments are required for advance and outstanding incomes and expenses.
ii. It is an objective approach which requires less chances of subjective judgements.
iii. This approach suits the organisations which have mostly cash transactions.
Disadvantages of Cash Basis of Accounting
Following are the disadvantages of cash basis of accounting
i. It does not provide true and fair view of the financial position of the enterprise because it does not record advance and
outstanding incomes and gains.
ii. It ignores matching principle, accrual concept and revenue recognition principles of accounting.
iii. This system does not differentiate between capital and revenue items.

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iv. Companies Act, 2013 does not recognise this basis of accounting.
Advantages of Accrual Basis of Accounting

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Following are the advantages of the Accrual basis of Accounting
1. It discloses true profit or loss for a particular period and also depicts the true financial position of the business at the end of a

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particular period.
2. It follows the matching principle of accounting.
Disadvantages of Accrual Basis of Accounting
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Following are the disadvantages of the Accrual basis of Accounting
1. It is not as simple as cash basis of accounting.
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2. It requires the use of estimates and personal judgements.
62. i. Money measurement concept: Money Measurement Concept states that only those events that can be expressed in monetary
terms are recorded in the books of accounts. It says only the transactions measurable in terms of money are to be recorded.
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While we can record the values of various assets and liabilities, we cannot record the level of satisfaction of our customers and
the loyalty of our employees. We can say our customers are 'happy' or 'very happy', but we cannot write in our accounts how
much our customers are happy, simply because 'happiness' cannot be measured in terms of money.
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ii. Principle of Full Disclosure: This principle implies that the accounting report should be full and accurate. If there is any
material fact which can affect the profitability of the business in the future, it must disclose it to the users whether it is legally
required or not. These material facts should be disclosed either within the main body or notes section of financial statements.
There are standard forms for Balance Sheet, Notes to Accounts for Balance Sheet, and Profit & Loss Account. It is a legal
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requirement for joint-stock companies to present information in the standardized form.


iii. Accounting Standards: Accounting Standards are the guidelines for financial accounting, such as, how a firm prepares and
presents its business income, expenses, assets, and liabilities. The main purpose of accounting standards is to promote a better
understanding of financial statements.
iv. Dual Aspect Principle: This principle is the backbone of accounting. Every business transaction affects at least two aspects
of a business, two-fold uses like every transaction have a double effect. When we buy goods, we get goods and pay cash.
When we sell goods we give goods and get cash. Accounting is much more than just buying and selling. Dual aspects are
involved in every transaction and event which gives rise to the basic accounting equation,
Equity + Liabilities = Assets.
63. For making the accounting information meaningful to its internal and external users, it is important that such information is
reliable as well as comparable. The comparability of information is required both to make inter-firm comparisons i.e., to see how a
firm has performed as compared to the other firms, as well as to make inter-period comparison i.e., how it has performed as
compared to the previous years.
This becomes possible only if the information provided by the financial statements is based on consistent accounting policies,
principles and practices. Such consistency is required throughout the process of identifying the events and transactions to be
accounted for measuring them, communicating them in the books of accounts, summarising the results thereof and reporting them
to the interested parties. For example, a firm can choose any one of the several methods of depreciation,i.e., straight line method

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,written down method or any other method. But it is expected that the method once chosen will be followed consistently year after
year. Likewise, the method of stock valuation or making provision for likely bad debts should remain consistent with the previous
years otherwise the decision taken on the basis of accounts will be misleading.
However, consistency does not prohibit a change in accounting policies. Necessary required changes are fully disclosed by
presenting them in the financial statements indicating their probable effects on the results of the business.
Hence, it is important to adopt a consistent basis for the preparation of financial statements.
64. International Financial Reporting Standards (IFRS):-
Globalisation has unified different economies of the world. Enterprises are carrying on business worldwide. As accounting is the
language of business, different enterprises around the world should not be speaking different languages in their financial
statements. It will be very difficult to understand and compare these statements.
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standard Board (IASB). IASB
replaced International Accounting.Standard Committee (LASC) in 2001.LASC was formed in 1973 to develop accounting
standards which have global acceptance and makes different accounting statements of different countries similar and comparable.
Assumptions in IFRS:-
The underlying assumptions in IFRS are as follows:
i. Measuring Unit Assumption:- Current purchasing power is the measuring unit which means that assets in the balance sheet

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are shown at current or fair value and not at historical cost.
ii. Constant Purchasing Power Assumption:- It means that the value of capital is to be adjusted for inflation at the end of the

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financial year.
iii. Accrual Assumption:- Transactions are recorded as and when they occur and the date of settlement is irrelevant.

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iv. Going Concern Assumption:- It is assumed that the life of the business is infinite.
65. Double Entry System:-
Double entry system is based on the principle of ‘dual aspect’ which states that every transaction has two aspects i.e. debit and
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credit.
The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and the other is
credited.
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It is a complete system as both the aspects of a transaction are recorded in the books of accounts. The system is accurate and more
reliable as the possibilities of frauds and misappropriations are minimised.
The system of double entry can be implemented by big as well as small organisations.
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Features of the Double Entry System:-


Features of the double entry system are as follow
i. It maintains a complete record of each transaction.
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ii. In this system, one aspect is debited and another aspect is credited as per the rules of debit and credit .
iii. It recognises the two side aspects of every transaction i.e.debit and credit.
iv. The total of all debits is always equal to the total of all credits. It also helps in establishing the arithmetical accuracy of
accounting records by preparing the trial balance.
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Advantages of the Double Entry System


The main advantages of the double entry system are:-
i. Complete Record of Transaction:- Under the double entry system both sides of a transaction are recorded, which results in
presenting correct income or loss, assets and liabilities.
ii. Scientific System:- Double entry system is a scientific system of recording business transactions. Two sides of a transaction
are recorded on the basis of scientific and logical rules which leave little room for errors.
iii. Calculation of Profit or Loss:- The profit earned or loss suffered during a period can be found out by preparing the profit and
loss account .
iv. Check on the Accuracy of Accounts:- The accuracy of the accounting work can be established by the use of this system, by
preparing the trial balance.
v. Ascertainment of Financial Position:- The financial position of the business can be ascertained at the end of the accounting
period by preparing the balance sheet.
66. i. Principle of Full Disclosure: The full disclosure principle, as adopted by the accounting profession, is best described by
which of the following:
a. All information related to an entity's business and operating objectives are required to be disclosed in the financial
statements.

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b. Information about each account balance appearing in the financial statements is to be included in the notes to the financial
statements.
c. Enough information should be disclosed in the financial statements so a person wishing to invest in the stock of the
company can make a profitable decision.
d. Disclosure of any financial facts significant enough to influence the judgment of an informed.
ii. Money measurement concept: Restricts the scope of accounting to factors that are measurable in terms of money. It says
only the transactions measurable in terms of money are to be recorded. While we can record the values of various assets and
liabilities, Transactions, even if, they affect the results of the business materially, are not recorded if they are not convertible in
monetary terms. Transactions and events that cannot be expressed in terms of money are not recorded in the business books.
For example; employees of the organization are, no doubt, the assets of the organizations but their measurement in monetary
terms is not possible, therefore, not included in the books of account of the organization.
iii. Materiality: This is a reception to the full disclosure principle. Financial statements should disclose all items that are material
enough to influence decision making. Items are accounted on the basis of significance rather than accurate adherence to
principles. We do classify expenses into revenue expenses and capital expenses (assets) on the basis of this principle. The
purchase of a pen is treated as an expense, not as an asset, but the purchase of a machine is treated as a purchase of assets not
as an expense.

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iv. Accounting Period Principle: As per the going concern assumption the life of the business is indefinite. To assess the
performance of a business, it is illogical to wait for the life of the business to come to an end and then calculate the profit or

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loss. To overcome this problem and for the purpose of calculation of profits, the life of the business is divided into smaller
parts called the 'accounting period'. An Accounting period is a segment of one year in the indefinite life of a business. This

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assumption helps us to :
a. Measure the progress of business accurately and on a consistent basis;
b. Facilitates comparison;
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c. Match periodic revenues with expenses for getting correct business results;
d. Calculate income tax and other government dues. In India we practice two types of accounting years:
I. Calendar Year (1 Jan. - 31 Dec.)
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II. Fiscal or Financial Year (1 Apr. - 31 Mar.)
67. i. Accrual Concept According to this concept, a transaction is recorded at the time, it takes place and not at the time when
settlement is done. In other words, revenue is recorded when sales are made or services are rendered and it is irrelevant as to
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when cash is received against such sales. Similarly, expenses are recorded at the time they are incurred and it is irrelevant as to
when payment is made in cash for such expenses. Thus, to find out correct profit and to show true financial position of an
enterprise at the end of accounting period, all expenses and income belonging to that particular accounting period are shown
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whether cash has been paid or received or not. For example, let's assume Company XYZ must insure one of its buildings. The
insurance company bills Company XYZ Rs 600 every six months (one bill in January, the next in July). If each bill is for six
months of coverage, then under the accrual method, Company XYZ would not record a Rs 600 expense in January and a
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Rs600 expense in July (doing so would mean company XYZ was using the cash method); it would instead record a Rs100
expense each month for the whole year. That is, Company XYZ would match the expense to the period in which it was
incurred: Rs100 for January, Rs100 for February, Rs100 for March, and so on.
ii. Prudence Principle The concept of conservatism (also called ‘prudence’) provides guidance for recording transactions in the
books of accounts and is based on the policy of playing safe. This principle states that ‘Do not anticipate profits but provide
for all possible losses’.
In other words, we should make provisions for probable future expenses and ignore any future probable gain, until it actually
happens. It is the prudence principle which ensures that the financial statements present a realistic picture of the working
affairs of the business and does not present a picture which will mislead the users of accounting information. For example,
Closing stock is valued at lower of cost or net realisable value, making provisions for doubtful debts or making provisions for
any future likely obligation or liability. This principle ignores anticipated future profits or revenue until they actually
materialise. This approach of providing for the losses but not recognising the gains until realised is called conservation
approach.
However, excess use of this concept will lead to creation of secret reserves because liabilities get overstated and assets get
understated. for example- Bad debts are probable in many businesses, so they create a special contra account o accounts
receivable called allowance for bad debts which brings the accounts receivable balance to the amount which is expected to be
realized and hence prevents overstatement of assets. An expense called bad debts expense is also booked to stop net income
from being overstated.

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iii. Historical Cost Concept According to this principle, assets are recorded in the books at the price paid to acquire it. Assets are
recorded in the books of accounts at their cost price, which includes cost of acquisition, transportation, installation and making
the asset ready for use and this cost is the basis for all subsequent accounting of such assets. Depreciation to be charged on
assets is calculated on the basis of cost of asset and market value of such asset is irrelevant for accounting of such assets. Book
value of the asset in the books of accounts is decided on the basis of cost less depreciation without giving consideration to its
market price. If this principle is not followed, information contained in the financial statements may be affected by personal
judgement and bias as market value of an asset may be a subjective calculation. Adoption of historical cost brings in
objectivity in recording as the cost of acquisition is easily verifiable from the purchase documents. However, an important
limitation of the historical cost basis is that it does not show the true worth of the business and may lead to hidden profits. For
example - The Washington Company constructed a building at a cost of Rs 45,000 in 2005. On December 31, 2017, the fair
market value of the building is Rs 65,000 but still stands on the balance sheet at its original cost of Rs 45,000.
68. Difference between Accrual and Cash Basis of Accounting
Basis Accrual Basis of Accounting Cash Basis of Accounting

Recording of Cash
and Credit This basis makes a complete record of all cash as well as This basis records only cash transactions in
Transactions in the credit transactions in the books. the books.

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books

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This basis does not take into consideration
Treatment of This basis takes into consideration all such items.
outstanding expenses, prepaid expenses,
Advance/Outstanding Adjustment is made for Outstanding, Advances, Prepaid

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accrued incomes and incomes received in
Incomes & Expenses or income received in advance etc.
advance.

Correct profit or loss is not ascertained


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Correct profit or loss is ascertained because it records
Reliability of Profits because it records only cash transaction.
both cash and credit transactions. Hence it is Reliable.
Hence it is not Reliable.
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The accrual basis of accounting requires accounting It does not require much of accounting
Accounting knowledge as many adjustments of advance, outstanding, knowledge as only cash receipt and cash
Knowledge capital and revenue are to be carried out in a financial payments are considered for financial
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statement. statement.

This basis is suitable for a not-for-profit


Suitability This basis is suitable for All businesses. organisation and professionals like, doctor,
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lawyer, chartered accountants, etc.

Accrual basis of accounting is more acceptable in Cash basis of accounting is not acceptable in
Acceptability business, as it reveals correct income and expense besides business as it does not reveal the required
Ed

assets and liabilities. information.

Accrual basis of accounting is recognised by the Cash basis of accounting is not recognised
Legal Position
Companies Act, 2013. by the Companies Act, 2013.
69. This concept is very important for the correct determination of net profit. According to this principle, expenses incurred in an
accounting period should be matched with revenues during that period i.e., when revenue is recognised in a period, then the cost
related to that revenue also needs to be recognised in that period to enable calculation of correct profits of the business.
The matching concept thus, states that all revenues earned during an accounting year, whether received during that year or not and
all costs incurred, whether paid during the year or not should be taken into account while ascertaining profit or loss for that year.
When some expense, say insurance premium is paid partly for the next year also, the part relating to the next year will be shown
as an expense only next year and not this year. This means that that part of the insurance premium against which benefit will be
derived or revenue will be earned in future should be shown in the balance sheet as an asset and the rest is treated as an expense
during the current year.
For example, If there is unsold stock at the end of accounting period, then its cost needs to be carried over to next year, so that
such cost can be recognised or adjusted with the revenue earned with the sale of such stock.
Similarly, if a machinery is purchased with useful life of 10 years, then its cost needs to be spread over these 10 years, so that it
gets adjusted with the revenue earned in those 10 years. If revenue is received for which expenses are to be incurred in next year,
then such revenue is also carried over to next year to be matched with its cost only.

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A business concern should follow this concept otherwise it will be very much difficult to ascertain the profit or loss of a given
period of time.
70. The concept of conservatism (also called ‘prudence’) provides guidance for recording transactions in the books of accounts and is
based on the policy of playing safe.
This principle states that ‘Do not anticipate profits but provide for all possible losses’.
In other words, we should make provisions for probable future expenses and ignore any future probable gain, until it actually
happens. It is the prudence principle which ensures that the financial statements present a realistic picture of the working affairs of
the business and does not present a picture which will mislead the users of accounting information.
For example, Closing stock is valued at lower of cost or net realisable value, making provisions for doubtful debts or making
provisions for any future likely obligation or liability,Joint life policy is shown at surrender value as against the amount paid,
Provision for pending suit against the firm, which may either be decided in its favour .
This principle ignores anticipated future profits or revenue until they actually materialise.
This approach of providing for the losses but not recognising the gains until realised is called conservation approach.
However, excess use of this concept may have two effects i.e. Profit and loss account will disclose lower profits in comparison to
the actual profits and Balance sheet will disclose understatement of assets and overstatement of liabilities in comparison to the
actual values.
The above mentioned effects will result in creation of secret reserves which is in direct conflict with the convention of full

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disclosure.

in
71. According to this principle, only those transactions which can be expressed in terms of money are recorded in the books of
accounts. Such as the sale of goods or payment of expenses or receipt of income, etc. Another aspect of this principle is that the
transactions that can be expressed in terms of money have to be converted in terms of money before being recorded.

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An event may be important for the business but it will not be recorded in the books of accounts simply because it can not be
converted or recorded in terms of money. For instance, a strike by workers may adversely affect the business but it cannot be
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recorded in the books of accounts or dispute among the owners or managers, the appointment of a manager, death of an employee
etc.simply because of they are not a monetary transaction, only transactions which can be measured in monetary terms will be
recorded in the books of accounts.
C
The money measurement assumption has many limitations too, Due to the changes in price, the value of money does not remain
the same over a period of time. The value of rupee today on account of rising in price is much less than what it was, say ten years
back.
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As the change in the value of money is not reflected in the book of accounts, the accounting data does not reflect the true and fair
view of the affairs of an enterprise.
Inflation is the factor which can make it difficult to compare the monetary values of one year with the monetary values of another
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year. Due to the changes in price, the value of money does not remain the same over a period of time. The value of rupee today on
account of rising in price is much less than what it was, say ten years back.
72. This concept is known as 'Going Concern Concept'. According to this concept, it is assumed that the business firm would
continue its operations indefinitely i.e., for a fairly long period of time and would not be liquidated in the foreseeable future. All
Ed

the transactions are recorded in the books on the assumption that it is a continuing enterprise.
It is the concept, which facilitates recording of fixed assets on the basis of their book value and maximum life. Market value of
these assets is irrelevant for accounting of these assets.
It is because of this concept that the Revenue & Capital expenditures are distinguished. The expenditure that will give benefit for
a longer duration are termed as Capital Expenditure whereas the expenditure that gives short term benefits are called Revenue
Expenses.
An example of the application of going concern concept of accounting is the computation of depreciation on the basis of expected
economic life of fixed assets rather than their current market value. Companies assume that their business will continue for an
indefinite period of time and the assets will be used in the business until fully depreciated. Another example of the going concern
assumption is the prepayment and accrual of expenses. Companies prepay and accrue expenses because they believe that they will
continue operations in future.
The going concern concept is applicable to the company’s business as a whole. If, for example, a company closes a small business
segment or discontinues one of its product and continues with others, it does not mean that the company is no longer a going
concern because the going concern concept is applicable to the entity as a whole not to the particular segment of business or
product.
73. Statement of Financial Position: It is referred to as a balance sheet, it reports on the company’s assets, liability.
The elements or contents of the statement are

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a. Equity The residual interest in the assets of the enterprise after deducting liabilities is equity. It is the real value of
shareholders equity.
b. Assets The resources controlled by the enterprise as a result of past events and operations from which the future economic
benefits shall flow to the enterprise are assets.
c. Liability The obligations of the enterprise from the past events and operations, which shall result in an outflow of resources
i.e., assets are liabilities.
Comprehensive Income: It is referred to as a profit and loss statement. It reports on the company’s income, expenses and profits
over a period of time. It includes two separate statements i.e ., income statement and a statement of comprehensive income.
The statement of comprehensive income reconciles the income or loss as per income statement with total comprehensive income.
The elements or contents of the statement are
a. Expense It is a decrease in economic benefits in the form of outflows during the accounting period as a result of business
operations or a decrease in value of assets or an increase in liabilities.
b. Revenue It increases the economic benefit during the accounting period as a result of business operations or increases in the
value of assets or decrease in the value liabilities.
74. Single Entry System
This system is not a complete system of maintaining records of financial transactions. It does not record two-fold effect of each

g
and every transaction.
Only personal accounts and cash book are maintained under this system instead of maintaining all the accounts. No uniformity is

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maintained under this system while recording transactions.
The single entry system is also known as accounts from incomplete records. The accounts maintained under this system are
incomplete and unsystematic and therefore, not reliable. The system is however, followed by small business firms as it is very
simple and flexible.
Double Entry System ac
Double entry system is based on the principle of ‘dual aspect’ which states that every transaction has two aspects i.e. debit and
Co
credit. The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and the
other is credited. It is a complete system as both the aspects of a transaction are recorded in the books of accounts. The system is
accurate and more reliable as the possibilities of frauds and misappropriations are minimised. The system of double entry can be
implemented by big as well as small organisations.
75. i. Dual Aspect Concept: Every transaction of a firm is recorded in two different accounts. That means the dual aspects concept
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tells every transaction affects the business in at least two aspects which are equal and opposite in nature.
ii. Accrual concept is the most fundamental principle of accounting which requires recording revenues when they are earned
and not when they are received in cash, and recording expenses when they are incurred and not when they are paid in
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business.
iii. Going Concern Concept: The concept of going concerned is an underlying assumption in the preparation of financial
statements, hence it is assumed that the entity has neither the intention nor the need, to liquidate or curtail materially the scale
Ed

of its operations.It is assumed that business will last longer in future.


iv. Cost concept of accounting states that all acquisition of items (such as assets or things needed for expending) should be
recorded and retained in books at cost. Thus, if a balance sheet shows an asset at a certain value it should be assumed that this
is its cost unless it is categorically stated otherwise.
v. Accounting Period Concept: An accounting period is the span of time covered by a set of financial statements. This period
defines the time range over which business transactions are accumulated into financial statements, and is needed by investors
so that they can compare the results of successive time periods in business .

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