1.

Introduction to business and accounting theory

a. Definition and Scope of business
Business A business is an organization or enterprising entity engaged in commercial, industrial or professional activities with the object of earning profit. Scope of business Scope of business refers to the breadth (number) of activities a business is engaged in. The larger the number of activities performed by a business, the larger is the scope of the business.

b. Economic setup of business

Manufacturing The process of converting raw material, component or part into finish good that meets the customers requirement. This process can be used both to produce goods for use or for sale. Trading A process in which buying and selling of goods is done without alteration and modification. Services It is a process of providing intangible products. The supplying of utilities and activities demanded by people.

c. Organization Structure
Sole proprietorship It is an ownership in which only one individual acquires all the benefits and risks running a business. There is no legal distinction between the owner and the business. The owner receives all the profit and has unlimited responsibilities to all liabilities and losses. Partnership It is a type of business in which minimum two and maximum twenty individual pools in money, skills and other resources to share profit and loss according to the terms of the partnership agreement. For example, Joint stock company: It is a type of corporation or partnership, involving two or more individuals that own share of stock in the company.

 MERITS:

Easy to Form
The partnership, like the sole proprietorship, can be easily organized. There are no complicated legal formalities involved in the establishment of partnership business. The partners enter into a partnership agreement and start business.

Favorable Credit Standing The partnership enjoys a better credit rating in the eyes of creditors. As the liability of each partner in the organization is unlimited the financial institution can safely advance loans to the firms. Large Capital In case of sole proprietorship, the capital is limited to the savings of one owner or his borrowing capacity. Partnership can bring more capital to the business by the joint efforts of the partners. The partnership is normally in strong position to raise capital and expand the business. Greater Management Ability As there are many partners involved in the operation of a business, the firm can distribute the duties and responsibilities to each partner for which one is best qualified and suited. Division of labor and specialization, thus, can promote efficiency of the firm. Union of Business Ability There is a bid age saying that two heads are better than one. In case of partner the partner mutually consults each other about the lay out, production procedure, marketing channels, etc. and as a result, a wise course of procedure results. Profit Incentive The profits are shared by the partners as per agreement. They are encouraged to do more work to earn more profit. Higher the profits, higher will be the partners share. Advantages of Secrecy The partners can keep the business secrets to themselves. The firm is not required by law to publish its profit and loss account and balance sheet. Retention of a Skilled Worker If an employee in the partnership business is found to be a man of outstanding talent and ability, he with the mutual consultation of other partners can be given a status of a partner in the business. Brake on Hasty Decisions As liability of partners is unlimited, the partners, therefore, tend to be careful in taking

business decisions. They adopt sound practices in the conduct of business. There is a brake on hasty decisions.

Special Protection to Minor A death or lunacy of a partner may not cause dissolution of the partnership. His minor can be admitted only to the benefits of partners with the consent of other partners. Increase in The Spirit of Cooperation The success of business depends upon mutual trust and cooperation of the partners. The partners are fully aware that a sight difference can cause the end of partnership. This increases in them the spirit of working together. Tax Advantage The profits of a registered firm, after payment of super fax, are divided among the partners. They pay tax to the government on their shares of profit. Thus the partners of registered firm get the benefit of lower assessment. Ease of Dissolution The partnership can also be legally dissolved much difficult by mutual consent of the partners or in accordance with a contract by the partners. There are no formal documents required to be drawn up as in the case of a joint stock company.

DEMERITS:
Unlimited Liability of Partners One of the basic defects of partnership is that the partners are personally and jointly responsible for all the debts of the firm. In case the business suffers losses and the business assets are not sufficient to satisfy the claimants on liquidation, the personal property of one or more than one partners can be sold under the Court order for the clearance of the debts of the business. The rich and wealthy persons, therefore, avoid to be enlisted in partnership because each individual partner in liable for the firms debt. Limited Life of Firm The duration of the partnership is always uncertain. I partner dies, injured, withdraws, sells his interest, or a new partner is admitted into the business, or their arises difference, the partnership may come td an end. There are every possibilities of the dissolution of the firm due to internal differences. Frozen Investment It is very easy for a partner to invest money but it is most difficult to withdraw the from the business. A person who wishes to withdraw investment has to consult his partners, find a substitute with equal business ability. Unless the above conditions are fulfilled, the funds remain difficult to transfer and as such remain a frozen investment which creates

lack of interest. Disputes Among The Partners The partners should be like minded, have a common objective, be large hearted, have a cool temperament, should not unnecessarily cause friction and confusion among the partners. The choosing of partner is in fact like choosing a wife. Marry in haste and repent in leisure. In case of dispute among the partners, quick action should be taken by all the partners for the remedial measures. Possibility of Misuse of Resources It is known to each and every partner that the resources of the firm are owned jointly. There can and does arise the misuse of resources by a partner/partners. Loss of Business Opportunities In case of differences among the partners, a delay may take place in decision-making. This can cause loss to the firm. Divided Control In a partnership, the work of the business is divided among the partners according to their ability, choice and taste. Divided control - and responsibility sometimes creates confusion and delay in making decisions. The lack of efficiency on the part of one partner can upset the whole structure of the business and ultimately lead to dissolution of the firm. Lack of Public Confidence Partnership form of organization may not enjoy public confidence due to lack of publicity and absence of regulations. Implied Authority Implied authority is the authority vested in a partner to bind the firm with any of his acts done in connection with the business of the firms. In partnership form of organization, each partner binds other partners by his acts done on behalf of the firm: Thus the other partners may have to pay for the follies and dishonesty of a fellow partner. Conclusion Partnership form of ownership is suitable where business is of medium size, the partners are of equal status, ability and resources.

Limited Companies I. Private Limited Companies A type of company that offers limited liability to its shareholders but that places certain restrictions on its ownership. It is written as Pvt ltd. Minimum two partners and maximum 50 partners. MERITS: The shareholders have limited liability towards the company's debts. The point is that if you are one of the shareholders and the company happens to have a debt, you are only liable for capital that you deposited, but nothing more. Continuity of the company as a legal entity more secure, because it does not depend on the number of owners. The owner can alternately. Easy to transfer ownership by selling shares to others. Easy to obtain additional capital to expand its business volume, for example by issuing new shares. Management and the specialization allow the management of capital resources to it efficiently. So if you have an incompetent manager, you can replace with a more competent.

DEMERITS: Private Limited Company is the subject of a separate tax. So its not only companies that are taxable. Dividends or net profits distributed to shareholders taxed again as income tax. Surely the shareholders concerned. If you would establish a limited liability company, its establishment is much more difficult than other forms of business ownership. In its founding, notary public and Limited Liability require special permits for certain business. Relatively high costs of establishment. For most people, private limited company is considered less "secret" in the companys kitchen. This is because all activities of the company should be reported to shareholders. Especially concerning the firm's profits.

II. Public Limited Companies A company whose securities are traded on stock exchange and can be brought or sold by anyone. It is written as (plc). It can have a minimum of seven partners and maximum of unlimited partners. Plc companies are strictly regulated and they required by law to publish there complete and true financial position so that the investors can determine the true worth of their stock (shares). MERITS:

There is limited liability for the shareholders. The business has separate legal entity. There is continuity even if any of the shareholders die. These businesses can raise large capital sum as there is no limit to the number of shareholders. The shares of the business are freely transferable providing more liquidity to its shareholders.

DEMERITS:

There are lots of legal formalities required for forming a public limited company. It is costly and time consuming. In order to protect the interest of the ordinary investor there are strict controls and regulations to comply. These companies have to publish their accounts. The original owners may lose control. Public Limited companies are huge in size and may face management problems such as slow decision making and industrial relations problems.

d. Types of finance
Long term finance
Long term financing is a form of financing that is provided for a period of more than a year. Long term financing services are provided to those business entities that face a shortage of capital. It is different from short term financing. Short term financing is normally used to provide money that has to be paid back within a year. The period may be shorter than one year as well. Examples of long-term financing include a 30 year mortgage or a 10-year Treasury note. Equity is another form of long-term financing, such as when a company issues stock to raise capital for a new project. Purpose of long term finance

To Finance fixed assets To finance the permanent part of working capital Expansion of Companies Increasing Facilities Construction Projects on a big Scale Provide Capital for funding the Operations. This helps in adjusting the cash flow.

Factors determining long-term financial requirements

Nature of Business Nature of goods produced Technology used

Types of Long Term Finance The kind of long term financing that is provided to a particular company depends on its type. For example, the long term financing that is provided to a solo proprietorship is different from the long term financing that a partnership would receive. Uses of Long Term Finance Long term financing is used in separate ways by different types of business entities. The business entities that are not corporations are only supposed to use long term financing for the purposes of debt. However, the corporations can use long term financing for both debt and equity purposes. Sources of Long Term Financing a. Shares: These are issued to the general public. The holders of shares are the owners of the business. These may be of two types: (i) Equity and (ii) Preference.

b. Debentures: These are also issued to the general public. The holders of debentures are the creditors of the company. c. Public Deposits: General public also like to deposit their savings with a popular and well established company which can pay interest periodically and pay-back the deposit when due. d. Retained earnings: The Company may not distribute the whole of its profits among its shareholders. It may retain a part of the profits and utilize it as capital. e. Term loans from banks: Many industrial development banks, cooperative banks and commercial banks grant medium term loans for a period of three to five years. f. Loan from financial institutions: There are many specialized financial institutions established by the Central and State governments which give long term loans at reasonable rate of interest.

Short term finance

Short term financing is normally used to provide money that has to be paid back within a year. The period may be shorter than one year as well. In general it is a loan or credit facility with a maturity of one year or less. Purpose of Short-term Finance After establishment of a business, funds are required to meet its day to day expenses. Thus there is a continuous necessity of liquid cash to be available for meeting these expenses. For financing such requirements short-term funds are needed. The availability of short-term funds is essential. Inadequacy of short-term funds may even lead to closure of business. Short-term finance serves following purposes 1. It facilitates the smooth running of business operations by meeting day to day financial requirements. 2. It enables firms to hold stock of raw materials and finished product. 3. With the availability of short-term finance goods can be sold on credit. Sales are for a certain period and collection of money from debtors takes time. During this time gap, production continues and money will be needed to finance various operations of the business. 4. Short-term finance becomes more essential when it is necessary to increase the volume of production at a short notice. 5. Short-term funds are also required to allow flow of cash during the operating cycle. Operating cycle refers to the time gap between commencement of production and realization of sales. Need of Short term finance 1. Cash flow from operations may not be sufficient to keep up with growth-related financing needs. 2. Firms may prefer to borrow now for their inventory or other short term asset needs rather than wait until they have saved enough. 3. Firms prefer short-term financing instead of long-term sources of financing due to: a. easier availability b. usually has lower cost (remember yield curve) c. matches need for short term assets, like inventory etc. Sources of Short-term Finance There are a number of sources of short-term finance which are listed below:

1. Trade Credit Trade credit refers to credit granted to manufactures and traders by the suppliers of raw material, finished goods, components, etc. the goods are delivered but payments are not made until the expiry of period of credit. This type of credit does not make the funds available in cash but it facilitates purchases without making immediate payment. This is quite a popular source of finance. 2 . Bank Credit Commercial banks grant short-term finance to business firms which is known as bank credit. When bank credit is granted, the borrower gets a right to draw the amount of credit at one time or in instalments as and when needed. Bank credit may be granted by way of loans, cash credit, overdraft and discounted bills. 3. Customers Advances Sometimes businessmen insist on their customers to make some advance payment. It is generally asked when the value of order is quite large or things ordered are very costly. Customers advance represents a part of the payment towards price on the product(s) which will be delivered at a later date. Customers generally agree to make advances when such goods are not easily available in the market or there is an urgent need of goods. A firm can meet its short-term requirements with the help of customers advances. 4. Installment credit Installment credit is now-a-days a popular source of finance for consumer goods like television, refrigerators as well as for industrial goods. You might be aware of this system. Only a small amount of money is paid at the time of delivery of such articles. The balance is paid in a number of installments. The supplier charges interest for extending credit. The amount of interest is included while deciding on the amount of installment. Another comparable system is the hire purchase system under which the purchaser becomes owner of the goods after the payment of last installment. Sometimes commercial banks also grant installment credit if they have suitable arrangements with the suppliers. 5. Loans from Co-operative Banks Co-operative banks are a good source to procure short-term finance. Such banks have been established at local, district and state levels These banks grant loans for personal as well as business purposes. Membership is the primary condition for securing loan. The functions of these banks are largely comparable to the functions of commercial banks.

e. Commercial Banks Privately owned financial institution which 1. accepts demand and time deposits, 2. Makes loans to individuals and organizations. 3. provides services such as documentary collections, international banking, trade financing. Since a large proportion of a commercial banks deposits is payable on demand, it prefers to make short-term loans instead of the long-term ones (which are handled by organizations such development finance companies and home mortgage companies). f. Stock Exchange Organized and regulated financial market where securities(bonds, notes, shares) are bought and sold at prices governed by the forces of demand and supply. Stock exchanges basically serve as 1. Primary markets where corporations, governments, municipalities, and other incorporated bodies can raise capital by channeling savings of the investors into productive ventures; and 2. Secondary markets where investors can sell their securities to other investors for cash, thus reducing the risk of investment and maintaining liquidity in the system. g. Insurance Companies A company that offers insurance policies to the public, either by selling directly to an individual or through another source such as an employee's benefit plan. An insurance company is usually comprised of multiple insurance agents. An insurance company can specialize in one type of insurance, such as life insurance, health insurance, or auto insurance, or offer multiple types of insurance. h. Procurement The process of obtaining goods and services from preparation and processing of a requisition through to receipt and approval of the invoice for payment. It commonly involves: purchase planning, standards determination, specifications development, supplier research and selection, value analysis, financing, price negotiation, making the purchase, supply contract administration,

inventory control and stores, disposals and other related functions.

i. Production The processes and methods employed to transform tangible inputs (raw materials, semi finished goods, or subassemblies) and intangible inputs (ideas, information, knowledge) into goods or services. j. Marketing The management process through which goods and services move from concept to the customer. As a practice, it consists in coordination of four elements called 4P's: identification, selection, and development of a product, determination of its price, selection of a distribution channel to reach the customer's place, and Development and implementation of a promotional strategy. k. Sales It is an activity or a business of selling products or services. It is a contract involving transfer of the possession and ownership (title) of a good or property, or the entitlement to a service, in exchange for money or value. Essential elements that must be present in a valid sale are competence of both the buyer and seller to enter into a contract, mutual agreement on the terms of exchange, a thing capable of being transferred, and a consideration in money (or its equivalent) paid or promised. l. Marketing channels It is a way of communication through which manufacturers send their product to end users/customers/consumers. Manufacturer - A person or a company that manufactures goods.

Distributor - An entity engaged in general distribution of goods.

Agent - It also plays a role of a distributor.

Wholesaler - Person or firm that buys a large quantity of goods from various producers and sells it to retailers. Retailer - A person or a firm that sells goods to the consumer as opposed to the wholesaler and supplier. End user - He is the consumer of goods and services.

2. Accounting Theory
a. Fundamental accounting concepts including:
1. Accrual basis In the accrual basis accounting system: Income is recorded when it is earned even if monies have not yet been received; and Expenses are recorded when they occur - not necessarily when they are actually paid.

Total revenues and expenses are shown in financial statements whether or not cash was received or paid out in a particular accounting period. 2. Cash basis Under the cash basis accounting, revenues and expenses are recognized as follows: Revenue recognition: Revenue is recognized when cash is received. Expense recognition: Expense is recognized when cash is paid.

There are potential timing differences in recognizing revenues and expenses between accrual basis and cash basis accounting. a. b. c. d. Accrued Revenue: Revenue is recognized before cash is received. Accrued Expense: Expense is recognized before cash is paid. Deferred Revenue: Revenue is recognized after cash is received. Deferred Expense: Expense is recognized after cash is paid.

Advantages and Disadvantages of Cash and Accrual Systems A business that records revenue only when cash is received, and expenses only when they are paid is said to be on the cash basis of accounting. An obvious advantage of the cash basis over the accrual basis is that it is much simpler. An accrual system requires more accounts, including accounts receivable, accounts payable, inventory, prepaid expenses, and deferred revenue. Each of these accrual accounts requires making estimates and sometimes complex computations. As in machinery, the more moving parts the more potential problems. The cash basis accounting approach requires no complete measurements or estimates. An expense is recognized only when a vendor is paid for a product or service. Revenue is recorded only when a customer or client pays for products sold or services rendered. The disadvantage of the cash basis system is that for any particular short period of time operating results can be greatly distorted (misinterpreted) from economic reality. The distortions usually result from transactions occurring near the end of accounting periods. The primary advantage of the cash basis is that it is quick and easy. For a business that does not sell on credit, and pays bills as they are incurred, it may be all that is necessary. The cash

basis records only cash transactions, making the cash account a crude measure of how well the business is performing. However, when a business makes sales or purchases on credit, the cash basis does not accurately reflect the results of operations. The cash basis does not provide a system for managing unpaid bills or for tracking customer receivables. When a business makes sales on account i.e., on credit the accrual basis of accounting will not only record the revenue in the proper time period, it will also keep track of accounts receivable: amounts due from customers on completed sales. The accrual basis matches revenue to the time period in which it was earned, making your financial reports more meaningful. Expenses recorded on the accrual basis may be coded to the proper time period by entering bills in the accounts payable account. Using accounts payable also provides reports showing amounts owed to vendors, making it easier to organize and prioritize bills and manage your cash flow. The accrual basis gives a more accurate picture of profit or loss because it includes all revenues and expenses, paid or unpaid.

Does Cash Basis Accounting Always Provide Different Operating Results? The answer is no. If most of a firms sales are cash sales and most expenses are paid immediately, there is little difference between the measured operating results using a cash basis versus an accrual basis of accounting. However, if a business extends credit to customers, has credit extended to it, or carries significant amounts of inventory, the differences in reported operating results using the two approaches can be significant. For many businesses, cash collections may lag behind earnings by two to three months. Payments on expenses may also lag as much as sixty days from the receipt of goods and services. In these cases, cash basis earnings may greatly differ from accrual basis earnings. Over the entire life cycle of a business, cumulative operating results are the same under both bases of accounting. In fact, year to year the differences may not be that great if the levels of revenue and expense remain stable and the collection and payment cycles do not fluctuate. The greatest variation between accrual and cash basis accounting tends to occur in the initial and ending periods of a firms life cycle, or during periods of significant growth or decline. Short term monthly and quarterly reporting also can be greatly different. As our friend Jim indicated, accurate short term reporting is very important in managing a business.

 Comparing Cash basis and Accrual basis CASH BASIS Revenues are recorded when they are received, which may be before or after they are earned. Expenses are recorded when they are paid, which may be before or after they are incurred. Financial statements reflect revenues and expenses based on when transactions were entered rather than when revenues were earned or expenses incurred. No receivables are recorded. No payables are recorded. No method of tracking partial payments is available. ACCRUAL BASIS Revenues are recorded when they are earned, which may be before or after they are received. Expenses are recorded when they are incurred, which may be before or after they are paid. Financial statements match revenues to the expenses incurred in earning them, and more accurately reflect the results of operations. A receivable is recorded when payment is not received at the point of sale. Payables are recorded when payment is not made at the time of purchase. Revenues and expenses are recorded in full, even though partial payments may be made over extended time periods.

3. Matching Principle Under the matching principle, when you record revenue, you should also record at the same time any expenses directly related to the revenue. Thus, if there is a cause-and-effect relationship between revenue and the expenses, record them in the same accounting period. Significance It guides how the expenses should be matched with revenue for determining exact profit or loss for a particular period. It is very helpful for the investors/shareholders to know the exact amount of profit or loss of the business.

4. Consistency Principle The consistency principle states that, once you adopt an accounting principle or method, you should continue to follow it consistently in future accounting periods. You should only change in accounting principle or method if the new version in some way improves reported financial results. If you make such a change, you should fully document its effects, and include this documentation in the notes accompanying the financial statements. 5. True and Fair View It is a responsibility to produce reports which give a true and fair view of the financial affairs of the entity. A true and fair view implies: Disclosure: All material items should be disclosed and shown separately. Similar items should be appropriately grouped and subtotaled. Unusual items should be clearly shown.

 Materiality: Implies relative importance and what is material will depend on the size and circumstances of the particular entity. Consistency. Once selected, accounting principles should be consistently adhered to. When a change becomes necessary in order to adopt a more suitable principle, the fact that the changes have been made and the effects of the change should be adequately disclosed. Understandable, Objective and Significant Accounting Principles. Principles will be understandable if they are those customarily employed or if they are clearly explained in the accounts, objective if the results obtained by their use will not be unduly affected by the personal opinions of those applying them, and significant if they result in producing financial information suitable for the purpose for which the accounts are normally required. 5. Materiality Financial statements are prepared to help the users with their decisions. Hence, all such information which has the ability to affect the decisions of the users of financial statements is material and this property of information is called materiality. In deciding whether a piece of information is material or not requires considerable judgment. Information is material either due to the amount involved or due to the importance of the event. The materiality concept proposes paying attention to important events and ignoring insignificant accounting items. The extra effort required to process insignificant items is not cost effective. The concept of materiality also suggests that small asset purchases or improvements should be initially written off as an expense. Definitive rules exist on whether an accounting element is significant or insignificant. Therefore decisions are based on both objective and subjective criteria.

Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.

6. Prudence/Conservatism An accounting principle that requires recording expensesand liabilities as soon as possible, but the revenues only when they are realized or assured. Under the prudence concept, you should not overestimate the amount of revenues that you record, nor underestimate the expenses. You should also be conservative in recording the amount of assets, and not underestimate liabilities.

7. Completeness This is assertions (confirmation) by management about the accuracy of the financial statement components that are: Relating to Transactions Completeness relates to whether all transactions that occurred during the period have been recorded. For example, if a client fails to record a valid revenue transaction, the revenue account will be understated. The completeness assertion is more focused on expense and liability accounts. Relating to Account Balances Completeness addresses whether all assets, liabilities, and equity interests that should have been included as ending balances on the financial statements have been included. Relating to Presentation and Disclosure This assertion relates to whether all disclosures that should have been included in the financial statements have been included. 8. Going Concern The going concern principle is the assumption that an entity will remain in business for the foreseeable future. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term. For this to happen, the company must be able to generate and/or raise enough resources to stay operational. By making this assumption, the accountant is justified in deferring the recognition of some expenses until a later period, when the entity will presumably still be in business and using its assets. If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of whether its assets are impaired, (Impairment is a permanent decline in the value of an asset. If there is impairment, then you write off the difference between the fair value of the asset and its carrying amount.), which may call for the write-down of their carrying amount to their liquidation value. Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value, since a going concern can potentially continue to earn profits. Significance This concept facilitates preparation of financial statements. On the basis of this concept, depreciation is charged on the fixed asset. It is of great help to the investors, because, it assures them that they will continue to get income on their investments. In the absence of this concept, the cost of a fixed asset will be treated as an expense in the year of its purchase.

A business is judged for its capacity to earn profits in future.

9. Substance Over Form Substance over form is an accounting principle used to ensure that financial statements give a complete, relevant and accurate picture of transactions and events. If an entity practices the 'substance over form' concept, the financial statements will show the financial reality of the entity (economic substance), rather than the legal form of transactions (form). 10. Separate/business entity concept In accounting, a business entity is treated as a separate entity from the owner(s). Therefore, any capital injections made by the owner(s) are recorded as capital contribution from owners in the books of the business entity. The owner(s) private expenditure/spending are not recorded in the books of the business entity. The direct consequence is the recording of private/personal expenditure in the books of the business entities and therefore the financial position and results of the business entities do not show a true picture of the business entities. The business entities may face the following problems: Private/personal expenses not adjusted from the profit/income reported for income tax purposes and therefore understating the income subject to tax. Unnecessary penalty and more seriously, jail terms are possible outcome. It may cause the application for banking facility unsuccessful should the assessor of the application notice that the owner(s) private expenditure is included in the financial statements of the business entities. In general, this does not do good to the application submitted by the business entities whereby financial statements are to be included in the application (e.g. project tender, grant application & etc.)

This problem of keeping the books/accounts of business entities clean from owner(s) private expenditure can be further compounded if the transactions record keeping of the business entities is poor, making any effort to identify these private expenditure recorded in the books of the business entities for adjustment purposes difficult. Significance This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored. This concept restraints accountant from recording of owners private/personal transactions.

It also facilitates the recording and reporting of business transactions from the business point of view l It is the very basis of accounting concepts, conventions and principles.

11. Accounting period Concept All the transactions are recorded in the books of accounts on the assumption that profit on these transactions is to be ascertained for a specified period. This is known as accounting period concept. Thus, this concept requires that a balance sheet and profit and loss account should be prepared at regular intervals. This is necessary for different purposes like, calculation of profit, ascertaining financial position, tax computation etc. Further, this concept assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be of one year, six months, three months, one month, etc. But usually one year is taken as one accounting period which may be a calendar year or a financial year. As per accounting period concept, all the transactions are recorded in the books of accounts for a specified period of time. Significance It helps in predicting the future prospects of the business. It helps in calculating tax on business income calculated for a particular time period. It also helps banks, financial institutions, creditors, etc to assess and analyze the performance of business for a particular period. It also helps the business firms to distribute their income at regular intervals as dividends.

12. Monetary Concept This concept assumes that all business transactions must be in terms of money that is in the currency of a country. Significance This concept guides accountants what to record and what not to record. It helps in recording business transactions uniformly. If all the business transactions are expressed in monetary terms, it will be easy to understand the accounts prepared by the business enterprise. It facilitates comparison of business performance of two different periods of the same firm or of the two different firms for the same period.

13. Dual Aspects This concept is the basis of the fundamental accounting equation:

Assets = Liabilities + Equity I. Assets are what the company owns. II. Liabilities are what the company owes to creditors against those assets III. Equity is the difference between the two and represents what the company owes to its investors/owners. All accounting transactions must keep this equation balanced so when there is an increase on one side there must be an equal increase on the other side or an equal decrease on the same side. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. The interpretation of the Dual aspect concept is that every transaction has an equal effect on assets and liabilities in such a way that total assets are always equal to total liabilities of the business. Significance This concept helps accountant in detecting error. It encourages the accountant to post each entry in opposite sides of two affected accounts.

14. Realization Concept The concept of realization states that revenue is realized at the time when goods or services are actually delivered. Significance It helps in making the accounting information more objective. It provides that the transactions should be recorded only when goods are delivered to the buyer.

15. Objectivity The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices, receipts, bank statement, etc). This means that accounting records will initiate from a source document and that the information recorded is based on fact and not personal opinion. 16. Disclosure Disclosure is providing information that will enable a proper appraisal of the situation to be made and appropriate decisions taken. Relevant facts must be stated fully and clearly, unusual circumstances noted and additional notes given to achieve this.

17. Cautious An accountant tends to be cautious in the judgments and estimates that are necessary to prepare accounts. For instance, he makes provision for possible losses that may occur but he would refrain from taking into account profits that have not been actually realized. He considers that it is better to guard against overstating profit.

b. Financial Statements
1. Components Financial statements consist of three different statements: income statement, balance sheet and cash flow statement. All three are necessary to provide an accurate overview of the financial stability and viability of a business. At the least, firms prepare annual financial statements, and most businesses compile them monthly or quarterly as well.

Balance Sheet The balance sheet of a business reveals its net worth. This is the difference between all assets and all liabilities. Some businesses are generic in this statement and simply list generalized categories of assets and liabilities, with the asset category being first on the statement. Assets minus liabilities equal the company's net worth. Income Statement The income statement details income sources and expenses and shows the net income. The first section of the statement lists all income of the business. This usually breaks down into categories to show sources of income, which add up to a total income figure. The next section shows a total of all expenses associated with the business. The final category shows net income, derived by subtracting total expenses from total income.
Statement of changes in equity

Cash Flow Statement The cash flow statement shows the cash that flows in and out of the business. This is actual cash and does not include credit, loans, payables or receivables not yet received or paid out. Cash inflows list first followed by cash outflows. The difference between the two should correspond to the bank account balances of the business. Notes, comprising a summary of accounting policies and other explanatory notes.

2. Responsibility/ Importance a. Holding Of Share Shareholders are the owners of the company. Time and again, they may have to take decisions whether they have to continue with the holdings of the company's share or sell them out. The financial statement analysis is important as it provides meaningful information to the shareholders in taking such decisions.

b. Decisions and Plans The management of the company is responsible for taking decisions and formulating plans and policies for the future. They, therefore, always need to evaluate its performance and effectiveness of their action to realize the company's goal in the past. For that purpose, financial statement analysis is important to the company's management. c. Extension of Credit The creditors are the providers of loan capital to the company. Therefore they may have to take decisions as to whether they have to extend their loans to the company and demand for higher interest rates. The financial statement analysis provides important information to them for their purpose. d. Investment Decision The prospective investors are those who have surplus capital to invest in some profitable opportunities. Therefore, they often have to decide whether to invest their capital in the company's share. The financial statement analysis is important to them because they can obtain useful information for their investment decision making purpose. 3. Presentation 4. User of financial Statement

Existing equity investors and lenders, to monitor their investments and to evaluate the performance of management. Prospective equity investors and lenders, to decide whether or not to invest. Investment analysts, money managers, and stockbrokers, to make buy/sell/hold recommendations to their clients. Rating agencies to assign credit ratings. Major customers and suppliers, to evaluate the financial strength and staying power of the company as a dependable resource for their business. Labor unions, to gauge how much of a pay increase a company is able to afford in upcoming labor negotiations. Boards of directors, to review the performance of management. Management, to assess its own performance. Corporate raiders, to seek hidden value in companies with under priced stock. Competitors, to benchmark their own financial results.

Potential competitors, to assess how profitable it may be to enter an industry. Government agencies responsible for taxing, regulating, or investigating the company. Politicians, lobbyists, issue groups, consumer advocates, environmentalists, think tanks, foundations, media reporters, and others who are supporting or opposing any particular public issue the company's actions affect. Actual or potential joint venture partners, franchisors or franchisees, and other business interests who need to know about the company and its financial situation.

c. Asset valuation alternatives

1. Historical Cost/Cost concept The cost principle or historical cost principle states that an asset should be reported at its cost (cash or cash equivalent amount) at the time of the exchange transaction and should include all costs necessary to get the asset in place and ready for use. For example, land purchased in 1992 at cost of $80,000 and still owned by the buyer will be reported on the buyers balance sheet at its cost or historical cost of $80,000 even though its current cost, replacement cost, and inflation-adjusted cost is much higher today. Accounting cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc are recorded in the books of accounts at a price paid for them. Further, it may be clarified that cost means original or acquisition cost only for new assets and for the used ones, cost means original cost less depreciation. The cost concept is also known as historical cost concept. The effect of cost concept is that if the business entity does not pay anything for acquiring an asset this item would not appear in the books of accounts. Thus, goodwill appears in the accounts only if the entity has purchased this intangible asset for a price. Significance This concept requires asset to be shown at the price it has been acquired, which can be verified from the supporting documents. It helps in calculating depreciation on fixed assets. The effect of cost concept is that if the business entity does not pay anything for an asset, this item will not be shown in the books of accounts.

2. Fair Value Fair value is the price that two willing parties are will to pay for an asset or liability, preferably in an active market. A less accurate measure of fair value is when there is an active market for a similar item, while the least accurate measurement method is to use discounted cash flows associated with the future performance of the item.

3. Net realizable value Net realizable value is the estimated selling price of inventory, minus its estimated cost of completion and any estimated cost to complete its sale. Thus, it is the net amount realized from the sale of inventory. Net realizable value does not necessarily equal fair value. 4. Replacement Cost Replacement cost is the cost that would be incurred to replace an existing asset with one having the same utility. Current cost of replacing an existing asset or property with the same quality of construction and operational utility, without taking depreciation into account. Replacement cost is usually higher that the item's book value. It is also called replacement value.