Unit 1

ACCOUNTING CONCEPT
Introduction, Techniques and Conventions, Financial Statements- Understanding &
Interpreting Financial Statements. Company Accounts and Annual Reports- Audit
Reports and Statutory Requirements, Directors Report, Notes to Accounts, Pitfalls.
 Introduction
• Business entities and other organisations carry on activities which involve exchange of money or
money’s worth or economic resources. Where the volume of these activities are large in number it is
necessary that these are recorded for the purpose of taking important decisions as to whether the
activities are viable, gainful and are to be continued or not.
• Information about the business and other organisations is required not only to the proprietors and
managers of business and other organisations but also to various other interested users such as the
government, investors, customers, employees and researcher.
• Raising and utilizing of finance for various purposes must be recorded systematically, scientifically and
uniformly.
• It is very important because finance is the most important resource next to the human element for any
economic activity. Hence, there is a need for principles, methods and procedures to be followed to
record all these information and to derive from these information, the feasibility and benefit of the
activities carried out.
• Accountancy provides the basic theory, principles and methods to be followed to account for all
financial activities taking place in an organisation.
 •Accounting is the language of business. The most important function of a language is to facilitate
communication. The information about business entities regarding their operating performance and
financial status can be obtained from the financial information recorded in the accounting records. This
information is communicated to the interested users of business information such as proprietors,
management, investors, customers and the government.
Definition
•Accounting is the systematic process of identifying, measuring, recording, classifying, summarizing,
interpreting and communicating financial information. Accounting gives information on:
(i) the resources available
(ii) how the available resources have been employed and
(iii) the results achieved by their use.
The profit earned or loss incurred during the accounting period, value and nature of assets, liabilities and
capital can be ascertained from the information recorded in accounts.
•According to the American Institute of Certified Public Accountants “Accounting is the art of
recording, classifying and summarizing in a significant manner and in terms of money, transactions
and events which are in part, at least of a financial character and interpreting the results thereof ”.
•From the above definitions, the following attributes of accounting emerge:
i) Accounting is an art. It requires the expertise and skill of accountants to design accounting system
and policies, to decide the accounting process in order to suit the requirements of an organisation.
ii) The transactions or events of a business must be recorded in monetary terms.
iii) Accounting process involves recording, classifying and summarizing of transactions and analysis
and interpretation of the results.
iv) The results of such analysis must be communicated to the persons who are interested in such
information
Basic Accounting terminologies
• A man who is involved in the process of book keeping and accounting is called an accountant, who
does the basic job of maintaining accounts
• Since the managers would always want to know the financial performance of the business.
• An accountant prepares profit and loss account which reports the profits/losses of the business
during the accounting period, Balance Sheet, which is a statement of assets and liabilities of the
business at a point of time, is also proposed by all accountants.
• Since both statements are called financial statements, the person who prepares them is called a
financial accountant.
•An accounting information system (AIS) is a structure that a business uses to collect, store, manage, process,
retrieve, and report its financial data so it can be used by accountants, consultants, business analysts,
managers, chief financial officers (CFOs), auditors, regulators, and tax agencies.
•Accounting is the art of recording, classifying and Summarizing financial transactions in the Preparation of
Financial Statements.
•Recording refers to creating Journal entry for every financial transaction with Debit and Credit amounts.
• Classifying refers to Classifying each of the Debit / Credit Transaction to Capital or Revenue and Asset,
Liability, Revenue or Expense
• Summarizing refers to Grouping the Transactions of Asset, Liability, Revenue and Expenses and preparing the
Financial Statements (Trading, Profit and Loss Account and Balance Sheet)
• In case of Trading, Manufacturing and Customer Service oriented Organization, the sum of all income and
expenses is referred to as Profit and Loss account/Income statement
• Social Service oriented Organization like Schools, Hospitals and Government Organizations, Banks it is
referred to as Income and Expenditure account . (Non Trading organizations)
•Real World Examples of Accounting Information Systems:
•TALLY ,WorldCom
• Individuals may use accounting information to manage their routine affairs like operating and
managing their bank accounts, to evaluate the worthwhileness of a job in an organization, to
invest money, to rent a house, etc.
• Business Managers have to set goals, evaluate progress and initiate corrective action in case of
unfavourable deviation from the planned course of action. Accounting information is required for
many such decisions—purchasing equipment, maintenance of inventory, borrowing and lending,
etc.
• Investors and creditors are keen to evaluate the profitability and solvency of a company before
they decide to provide money to the organisation. Therefore, they are interested to obtain
financial information about the company in which they are contemplating an investment.
Financial statements are the principal source of information to them which are published in
annual reports of a company and various financial dailies and periodicals.
• Government and Regulatory agencies are charged with the responsibility of guiding the
socio-economic system of a country in such a way that it promotes common good. For example,
the Securities and Exchange Board of India (SEBI) makes it mandatory for a company to disclose
certain financial information to the investing public. The government’s task of managing the
industrial economy becomes simplify if the accounting information such as profits, costs, taxes,
etc. is presented in a uniform manner without any manipulation or ‘windowdressing’.
• Central and State governments levy various taxes. The taxation authorities, therefore, need to
know the income of a company to calculate the amount of tax that the company would have to
pay. The information generated by accounting helps them in such computations and also to detect
any attempts of tax evasion.
• Employees and trade unions use the accounting information to settle various issues related to
wages, bonus, profit sharing, etc.
• Consumers and general public are also interested in knowing the amount of income earned by
various business houses. Accounting information helps in finding whether or not a company is
over charging or exploiting the customers, whether or not companies are showing improved
business performance, whether or not the country is emerging from the economic recession, etc.
All such aspects draw heavily on accounting information and are closely related to our standard of
living.
Evolution
• During 1400s, accounting grew further because the needs for information of merchants in the
Venis City of Italy increased. The first known description of double entry book keeping was first
published in 1994 by Lucas Pacioli
• Accounting records can be traced back to the ancient civilizations of China, Babylonia, Greece
and Egypt. Accounting was used to keep records regarding the cost of labour and materials used
in building great structures like the Pyramids.
• The onset of the industrial revolution necessitated the development of more sophisticated
accounting system, rather than pricing the goods based on guesses about the costs. The increase
in competition and mass production of goods led to the rise of accounting as a formal branch of
study.
• With the passage of time, the corporate world grew. In the nineteenth century, companies came
up in many areas of infrastructure like the railways, steel, communication, etc. It led to a rapid
growth in accounting. As the complexities of business grew, ownership and management of
business was divorced. As such, managers had to come up with well-defined, structured systems
of accounting to report the performance of the business to its owners.
• Government also has had a lot to do with more accounting developments. The Income Tax
brought about the concept of ‘income’. Government takes a host of other decisions, relating to
education, health, economic planning, for which it needs accurate and reliable information.
• As such, the government demands stringent accountability in the corporate sector, which forces
the accounting process to be as objective and formal as possible.
Objectives of Accounting
To maintain a systematic record of business transactions
Accounting is used to maintain a systematic record of all the financial transactions in a book of accounts.
∙

For this, all the transactions are recorded in chronological order in Journal and then posted to principle book i.e.
∙

Ledger.
To ascertain profit and loss
Every businessman is keen to know the net results of business operations periodically.
∙

To check whether the business has earned profits or incurred losses, we prepare a “Profit & Loss Account”.
∙

To determine the financial position

∙Another important objective is to determine the financial position of the business to check the value of assets and
liabilities. For this purpose, we prepare a “Balance Sheet”.
•To provide information to various users
∙Providing information to the various interested parties or stakeholders is one of the most important objectives of
accounting.
∙It helps them in making good financial decisions.
•To assist the management
By analysing financial data and providing interpretations in the form of reports, accounting assists management in
∙

handling business operations effectively.

Characteristics of Accounting

The following attributes or characteristics can be drawn from the definition of Accounting:
(1) Identifying financial transactions and events- Accounting records only those transactions and events which are
of financial nature. So, first of all, such transactions and events are identified.
(2) Measuring the transactions-Accounting measures the transactions and events in terms of money which are
considered as a common unit.
(3) Recording of transactions-Accounting involves recording the financial transactions inappropriate book of
accounts such as Journal or Subsidiary Books.
(4) Classifying the transactions-Transactions recorded in the books of original entry – Journal or Subsidiary books
are classified and grouped according to nature and posted in separate accounts known as ‘Ledger Accounts’.
(5) Summarising the transactions-It involves presenting the classified data in a manner and in the form of
statements, which are understandable by the users. It includes Trial balance, Trading Account, Profit and Loss
Account and Balance Sheet.
(6) Analysing and interpreting financial data-Results of the business are analyzed and interpreted so that users of
financial statements can make a meaningful and sound judgment.
(7) Communicating the financial data or reports to the users-Communicating the financial data to the users on
time is the final step of Accounting so that they can make appropriate decisions.
Branches of Accounting
(a) Financial accounting:
•It is concerned with identification, recording, classifying and summarizing of
financial transactions and events and ends up with the preparation of financial
statements, namely, trading and profit and loss account or income statement and
balance sheet and communication of the same to the interested users.
•Trading and profit and loss account shows the profit or loss made during an
accounting period and the balance sheet shows the financial position of the
business as on a particular date.
(b)Cost Accounting
•It involves the collection, recording, classification and appropriate allocation of
expenditure for the determination of the costs of products or services and for the
presentation of data for the purposes of cost control and managerial decision
making
Branches of Accounting
(c) Management Accounting
•It is concerned with the presentation of accounting information in such a way as
to assist management in decision making and in the day-to-day operations of an
enterprise. The information collected from financial accounting, cost accounting,
etc. are grouped, modified and presented as per the requirements of
management for discharging their functions and for decision making.
(d) Social Responsibility Accounting
•It is concerned with presentation of accounting information by business entities
and other organisations from the view point of the society by showing the social
costs incurred such as environmental pollution by the enterprise and social
benefits such as infrastructure development and employment opportunities
created by them. It arises because of corporate social responsibility.
(e) Human Resources Accounting
•It is concerned with identification, quantification and reporting of investments
made in human resources of an enterprise
 Steps of the Accounting Process &
Accounting Cycle
•Accounting process is the process of collecting, recording,
classifying, summarising and communicating financial information to
the users for judgement and decision-making. The following steps are
involved in accounting process:
(1) Identification: It is the process of identifying and analysing
business transactions.
(2)Recording: For recording, we use ‘Journal’ or Subsidiary Books.
(3) Classification of transactions: Classification means segregation of
transactions on the basis of nature and posting them in a format
known as Ledger Account.
(4) Summarisation: It includes preparation of Trial Balance
and Financial statements.
(5) Analysis & Interpretation: It includes an assessment of the
financial reports and making some meaningful conclusions.
(6) Communicating information to the users: It includes sharing the
financial reports and interprets results to the users of financial
statements.
• Accounting cycle is the sequence of steps involved in the accounting process. Accounting cycle starts with
the identification and recording of financial transactions of an organization and ends with the preparation of
final accounts for the accounting year. The cycle continues for the next accounting year with the opening
balances of assets and liabilities which are the closing balances of the preceding year. The steps involved are:
(i) Identifying the transactions and journalising
• The first step in the accounting process is identifying the financial transactions of a business. All the
monetary transactions are recorded in the books of original entry called journals. Recording the transactions
in the journal is called journalising. Entries are made in the journals on the basis of source documents in the
chronological order, i.e., the order of occurrence of the transactions.
(ii) Posting and balancing
• Transferring the entries from the journal to the ledger is called posting. In the ledger, entries are made in
each account after classifying them under common heads. Finding the difference between the total of the
debit column and credit column of all the ledger accounts is called balancing.
(iii) Preparation of trial balance
• The list of ledger balances namely trial balance is prepared as the next step. On the basis of ledger balances
the financial statements are prepared.
(iv) Preparation of trading account
•Next step is preparation of trading account for a particular accounting period. All the direct revenues and direct
expenses are transferred to trading account. The balance in the trading account is the gross profit or gross loss.
•Preparation of profit and loss account
•Profit and loss account is prepared next for a particular accounting period. All the indirect revenues and indirect
expenses along with gross profit or gross loss are transferred to profit and loss account. The balance in the profit and
loss account is the net profit or net loss.
(vi) Preparation of balance sheet
•A statement showing the balances of assets and liabilities namely balance sheet is prepared as the final step in the
accounting process. It is prepared on a particular date, normally, on the last day of the accounting period.
•The closing balances of an accounting year are taken as the opening balances for the next accounting year. The
transactions identified and recorded for the next year are followed by posting and other steps.
•The results are communicated to the users of accounting information for the purpose of analysis and decision
making.
Functions of Accounting
(i) Measurement-The main function of accounting is to keep systematic record of transactions, post them to the ledger
and ultimately prepare the final accounts. Accounting works as a tool for measuring the performance of the business
enterprises. It also shows the financial position of the business enterprises.
(ii) Forecasting-With the help of the various tools of accounting, future performance and financial position of the
business enterprises can be forecasted.
(iii) Comparison-Accounting helps to compare the actual performance with the planned performance. It is also possible
to compare with the accounting policies. Through comparison of the actual financial results of the business enterprises
with projected figures and standards, effective measures can be taken to enhance the efficiency of various operations.
(iv) Decision making-Accounting provides relevant information to the management for planning, evaluation of
performance and control. This will help them to take various decisions concerning cost, price, sales, level of activity, etc.
(v) Control-As accounting works as a tool of control, the strengths and weaknesses are identified to provide feedback on
various measures adopted. It serves as a tool for evaluating compliance of business policies and programmes.
(vi) Assistance to government-Government needs full information on the financial aspects of the business for various
purposes such as taxation, grant of subsidy, etc. Accounting provides relevant information about the business to exercise
government control on business enterprises.
Importance of Accounting
• Accounting is a basic necessity for all enterprises. Importance of
accounting is enumerated as below:
Systematic records- All the transactions of an enterprise which are
financial in nature are recorded in a systematic way in the books of
accounts. The records are classified under common heads and summaries
are prepared.
Preparation of financial statements- Results of business operations and the
financial position of the concern can be ascertained from accounting
periodically through the preparation of financial statements namely,
income statement or trading and profit and loss account and balance
sheet. This helps in distribution of profits to the owners and to provide
funds for future growth of the business.
Assessment of progress- Analysis and interpretation of financial data can
be done to assess the progress made in different areas and to identify the
areas of weaknesses. Management is provided with a complete picture of
the liquidity, profitability and solvency of the business.
Aid to decision making-Management of a firm has to make routine and strategic decisions while discharging its
functions. Accounting provides the relevant data to make appropriate decisions. Future policies and programmes can
be planned by the management based on the accounting data provided.
Statisfies legal requirements-Various legal requirements like maintenance of Provident Fund (PF) for employees,
Employees State Insurance (ESI) contributions, Tax Deducted at Source (TDS), filing of tax returns are properly fulfilled
with the help of accounting. Preparation of accounts and financial statements as per the legal requirements is also
facilitated.
Information to interested groups-Accounting supplies appropriate information to different interested groups like
owners, management, creditors, employees, financial institutions, tax authorities and the government.
Legal evidence-Accounting records are generally accepted as evidence in courts of law and other legal authorities in
the settlement of disputes.
Computation of tax-Accounting records are the basic source for computation and settlement of income tax and other
taxes.
Settlement during merger-When two or more business units decide to merger, accounting records provide
information for deciding the terms of merger and any compensation payable as a consequence of merger.
Different Accounting Concepts
• Business Entity Concept
• Accrual Concept
• Accounting Cost Concept
• Dual concept
• Going concepts
• Money Measurement
• Accounting Period Concepts
• Realization Concept
• Matching Concepts
 This concept assumes that the organization and business owners are two
independent entities.
For example, when the business owner invests his money in the business, it is
recorded as a liability of the business to the owner. Similarly, when the owner
takes away from the business cash/goods for his/her personal use, it is not
treated as a business expense. Thus, the accounting transactions are recorded
in the books of accounts from the organization's point of view and not the
person owning the business.

Suppose Mr. Birla started a business. He invested Rs 1, 00, 000. He purchased goods for Rs 50,000, furniture for Rs. 40,000,
and plant and machinery for Rs. 10,000 and Rs 2000 remained in hand. These are the assets of the business and not of the
business owner. According to the business entity concept, Rs.1,00,000 will be assumed by a business as capital i.e. a
liability of the business towards the owner of the business.
Now suppose, he takes away Rs. 5000 cash or goods for the same worth for his domestic purposes. This withdrawal of
cash/goods by the owner from the business is his private expense and not the business expense. It is termed as Drawings.
Therefore, the business entity concept states that the business and the business owner are two separate/distinct persons.
Accordingly, any expenses incurred by the owner for himself or his family from business will be considered as expenses
and it will be represented as drawings.
•The term accrual means something is due, especially an amount of money that is yet to be paid or received at
the end of the accounting period. It implies that revenue is realized at the time of sale through cash or not
whereas expenses are recognized when they become payable whether cash is paid or not. Therefore, both the
transactions are recorded in the accounting period in which they relate.

•In the accounting system, the accrual concept tells that the business revenue is realized at the time goods and
services are sold irrespective of the fact when cash is received for the same. For example, On March 5, 2021,
the firm sold goods for Rs 55000, and the payment was not received until April 5, 2021, the amount was due
and payable to the firm on the date goods and services were sold i.e. March 5, 2021. It must be included in the
revenue for the year ending March 31, 2021.

Example: consulting business that provides services, for example, in December but receives payment in
January. The revenue is recognised in December when the service is delivered, regardless of the actual cash
received.
Accounting Cost Concept
•The accounting cost concept states all the business assets should be written down in the book of accounts at the price
assets are purchased, including the cost of acquisition, and installation. The assets are not recorded at their market
price. It implies that the fixed assets like plant and machinery, building, furniture, etc are recorded at their purchase
price. For example, a machine was purchased by ABC Limited for Rs.10,00,000, for manufacturing bottles. An amount
of Rs.2,000 was spent on transporting the machine to the factory site. Also, Rs.2000 was additionally spent on its
installation. Hence, the total amount at which the machine will be recorded in the books of accounts would be the
total of all these items i.e. Rs.10, 040, 00. This cost is also termed as historical cost.
 Dual Aspect
•The dual aspect is the basic principle of accounting. It provides the basis for recording business transactions in
the books of accounts. This concept assumes that every transaction recorded in the books of accountants is
based on dual concepts. This implies that the transaction that is recorded affects two accounts on their
respective opposite sides. Hence, the transaction should be recorded at dual places. It implies that both
aspects of the transaction should be recorded in the books of account.
•For example, when Arun starts a business with cash ` 5,00,000,on the one hand, the business gets cash of `
5,00,000 and on the other hand, a liability arises, that is, the business has to pay Arun a sum of ` 5,00,000.
•This is the concept which recognises the fact that for every debit, there is a corresponding and
•equal credit. This is the basis of the entire system of double entry book-keeping.

• For example, goods purchased in exchange for cash have two aspects such as paying cash and receiving goods.
Therefore, both the aspects should be registered in the books of accounts. The duality of the transaction is
commonly expressed in the terms of the following equation given below
•Assets = Liabilities + Capital
Going Concepts
•The Going concept in accounting states that a business activities will be carried by any firm for an
unlimited duration This simply means that every business has continuity of life. Hence, it will not be
dissolved shortly. This is an important assumption of accounting as it provides a base for
representing the asset value in the balance sheet.
•For example, assets are generally valued at historical cost. Any increase or decrease in the value of assets in
the short period is ignored.

•For example, the plant and machinery was purchased by a company of Rs. 10 lakhs and its life span
is 10 years. According to the Going concept, every year some amount of assets purchased by the
business will be represented as an expense and the balance amount will be shown as an asset in the
books of accounts. Thus, if an amount is incurred on an item that will be used in business for several
years ahead, it will not be proper to charge the amount from the revenues of that particular year in
which the item was purchased Only a part of the purchase value is shown as an expense in the year
of purchase and the remaining balance is shown as an asset in the balance sheet.
•Money Measurement Concept
•The money measurement concept assumes that the business transactions are made in terms of
money i.e. in the currency of a country. In India, such transactions are made in terms of the rupee.
Hence, as per the money measurement concept, transactions that can be expressed in terms of money
should be recorded in books of accounts. For example, the sale of goods worth Rs. 10000, purchase of
raw material Rs. 5000, rent paid Rs.2000 are expressed in terms of money, hence these transactions can
be recorded in the books of accounts.
•Transactions which do not involve money will not be recorded in the books of accounts. For example,
working conditions in the work place, strike by employees, efficiency of the management, etc. will not be
recorded in the books, as they cannot be expressed in terms of money.
•For example, if a business has 5 computers, 2 tables and 3 chairs, the assets cannot be added to give useful
information, unless, they are expressed in monetary terms ` 1,00,000 for computers, ` 10,000 for tables and `
1,500 for chairs.
•Accounting Period Concepts
•Accounting period concepts state that all the transactions recorded in the books of account should
be based on the assumption that profit on these transactions is to be ascertained for a specific
period. Hence this concept says that the balance sheet and profit and loss account of a business
should be prepared at regular intervals. This is important for different purposes like calculation of
profit and loss, tax calculation, ascertaining financial position, etc. Also, this concept assumes that
business indefinite life is divided into two parts. These parts are termed accounting periods. It can
be one month, three months, six months, etc. Usually, one year is considered as one accounting
period which may be a calendar year or financial year.
•The year that begins on January 1 and ends on January 31 is termed as calendar year whereas the
year that begins on April 1 and ends on March 31 is termed as financial year.
•Realization Concept
•The term realization concept states that revenue earned from any business transaction should be included in the
accounting records only when it is realized. The term realization implies the creation of a legal right to receive
money. Hence, it should be noted that selling goods is considered as realization whereas receiving order is not
considered as realization.
•In other words, the revenue concept states that revenue is realized when cash is received or the right to receive
cash on the sale of goods or services or both have been created.

•Matching Concepts
•The Matching concept states that revenue and expenses incurred to earn the revenue must belong to the same
accounting period. Hence, once revenue is realized, the next step is to assign the relevant accounting period. For
example, if you pay a commission to a salesperson for the sale that you record in March. The commission should
also be recorded in the same month.
•The matching concept implies that all the revenue earned during an accounting year whether received or not
during that year or all the expenses incurred whether paid or not during that year should be considered while
determining the profit and loss of the business for that year. This enables the investors or shareholders to know the
exact profit and loss of the business.

• This concept is based on accrual concept and periodicity concept. Periodicity concept fixes the time frame for measuring
performance and determining financial status. All expenses paid during the period are not considered, but only the expenses
related to the accounting period are considered.
 Bases of Accounting

There are three bases of accounting in common usage, namely

i. Cash basis
ii. Accrual or mercantile basis
iii. Mixed or hybrid basis.
(i) Cash basis
Under cash basis of accounting, actual cash receipts and actual cash payments are recorded. In this basis,
revenue is recognised when cash is received and expenses are recognised when cash is paid. Credit transactions
are not recorded till cash is actually received or paid. Under this basis,
a. Any income received
b. Any expenditure paid
c. Any asset purchased for which cash is paid
d. Any liability paid during the accounting period whether related to the past, present or future is taken into
account.
Cash-basis accounting is also known as cash receipts and disbursements or the cash method of accounting. Sole
proprietors and small businesses: These businesses are more likely to use cash-basis accounting, as it is
straightforward and easy to use.
• Features of Cash Basis Accounting
• Simple, clear, and straightforward as accounting adjustments at the end of the year are
not to be made.
• This method is flexible as one has the option of switching from Cash to an Accrual basis
of accounting and vice versa.
• It follows the Single Entry System of Accounting.
• Not as efficient, accurate, and reliable as Accrual Basis of Accounting.
• No concept of matching revenues and expenses.
• It is not a good management tool as there is a time gap between the actual happening
of the transaction and its actual receipt or payment (results).
• It doesn’t conform to the GAAP Provisions.
Example of Cash Basis Accounting
• Donald follows the cash system of accounting. He is a small businessman dealing in the
trade of Plastics. He has sold plastic containers to a customer and made an Invoice of
$2000 on 26/10/18 (Friday). But, he has not received the payment on the same day. He
received the payment of it on 29/10/18 (Monday). So, since he follows cash basis
accounting, the invoice date is irrelevant. Hence, he recognizes this revenue in his
books of accounts on 29/10/18.
(ii) Accrual or mercantile basis
Under accrual basis of accounting, the revenue whether received or not, but has been earned or accrued during
the accounting period and expenses incurred whether paid or not are recorded. In other words, revenue is
recognised when it is earned or accrued and expenses are recognised when these are incurred. Under this basis,
a. Any income earned whether received or not
b. Any expenditure incurred whether paid or not
c. Any asset purchased whether cash is paid or not
d. Any liability incurred whether paid or not during the accounting period is recorded.
Under section 128(3) of the Indian Companies Act, 2013, all the companies are required to maintain the books of
accounts according to the accrual basis of accounting.
(iii) Hybrid or mixed basis
•This basis is a combination of cash basis and accrual basis of accounting. Under mixed basis of
accounting, both cash basis and accrual basis are followed. Revenues and assets are generally
recorded on cash basis whereas expenses and liabilities are generally taken on accrual basis.
•In this method, entries are recorded with a blend of two cash basis and accrual basis. Generally,
income is recorded when it is earned and the expenses are recorded when it is paid. For example, A
business firm sold goods worth $1,000 in June and purchase goods worth $500. The payment has to
be paid in December.
Accounting conventions
• The word convention refers to traditions or usage. The accounting conventions are the usage or practices
which are followed as a guide to the preparation of accounting statements.
• The utility of these accounting conventions have been recognised by regulatory authorities of accountancy in
making financial statements more realistic, reliable, and useful to all concerned parties.
• Sometimes, there is not a definitive guideline in the accounting standards that govern a specific situation. In
such cases, accounting conventions can be referred to.
• Accounting is full of assumptions, concepts, standards, and conventions. Concepts such as relevance,
reliability, materiality, and comparability are often supported by accounting conventions that help to
standardize the financial reporting process.
• In short, accounting conventions serve to fill in the gaps not yet addressed by accounting standards. If an
oversight organization, such as the Securities and Exchange Commission (SEC) or the Financial Accounting
Standards Board (FASB) sets forth a guideline that addresses the same topic as the accounting convention,
the accounting convention is no longer applicable.
• Accounting conventions are important because they ensure that multiple different companies record
transactions in the same way. Providing a standardized methodology makes it easier for investors to compare
the financial results of different firms, such as competing ones operating in the same sector.
Types of Accounting Convention
Four important types of accounting conventions are:
•Conservatism
•Consistency
•Materiality
•Full Disclosure
•CONVENTION OF CONSERVATISM
•This convention is based on the principle that “Anticipate no profit, but provide for all
possible losses”. It provides guidance for recording transactions in the books of accounts. It
is based on the policy of playing safe in regard to showing profit .
•The main objective of this convention is to show minimum profit. Profit should not be
overstated. If profit shows more than actual, it may lead to distribution of dividend out of
capital. This is not a fair policy and it will lead to the reduction in the capital of the
enterprise.
•Playing it safe is both an accounting principle and convention. It tells accountants to be
cautious on the side of caution when providing estimates for assets and liabilities. That
means that when two values of a transaction are available, the lower one should be
favored. The general concept is to factor in the worst-case scenario of a firm’s financial
future.
•CONVENTION OF CONSISTENCY
•The convention of consistency means that same accounting principles should be used for preparing financial
statements year after year. A meaningful conclusion can be drawn from financial statements of the same
enterprise when there is comparison between them over a period of time. But this can be possible only when
accounting policies and practices followed by the enterprise are uniform and consistent over a period of time. If
different accounting procedures and practices are used for preparing financial statements of different years,
then the result will not be comparable.
•A company should apply the same accounting principles across different accounting cycles. Once it chooses a
method it is urged to stick with it in the future, unless it has a good reason to do otherwise. Without this
convention, investors' ability to compare and assess how the company performs from one period to the next is
made much more challenging.
 •CONVENTION OF MATERIALITY
• The convention of materiality states that, to make financial statements meaningful, only material fact i.e.
important and relevant information should be supplied to the users of accounting information. The question
that arises here is what is a material fact. The materiality of a fact depends on its nature and the amount
involved. Material fact means the information of which will influence the decision of its users.
•This convention urges companies to lay all their cards on the table. If an item or event is material, in other
words important, it should be disclosed. The idea here is that any information that could influence the decision
of a person looking at the financial statement must be included.
•Materiality concept includes the impact of an event or item and its relevance in financial statements. It means
materiality allows an accountant to ignore certain principles when items are not material. The accountant must
report all such events and items that might influence the decision of investors or analysts. However, the
information should be worthy of investigation and should have a higher value than the cost of preparation of
statements. E.g., Low-cost assets like stationery and cleaning supplies are charged under expense account
instead of regular depreciating assets. Such issues have very little importance.
 •CONVENTION OF FULL DISCLOSURE
•Convention of full disclosure requires that all material and relevant facts concerning financial statements
should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of
accounting information. Adequate means sufficient set of information to be disclosed. Fair indicates an
equitable treatment of users. Full refers to complete and detailed presentation of information. Thus, the
convention of full disclosure suggests that every financial statement should fully disclose all relevant
information. Let us relate it to the business.
•The business provides financial information to all interested parties like investors, lenders, creditors,
shareholders etc. The shareholder would like to know profitability of the firm while the creditor would like to
know the solvency of the business. In the same way, other parties would be interested in the financial
information according to their requirements. This is possible if financial statement discloses all relevant
information in full, fair and adequate manner.
•Relevant and important information regarding the company’s financial status must be revealed in financial
statements even after applying the accounting convention. E.g. Contingent Liabilities , and Law Suits against a
business should be reported in adjoined notes in the company’s financial statements.
 Users of Accounting information
There are several persons who need the accounting information for various
purposes. They can be classified into two:
A) Internal Users
•The internal users are owners, management and employees who are within
the organisation.
(i) Owners
•The owners of a business provide capital to be used in the business. They are
interested to know whether the business has earned profit or not during a
particular period and also its financial position on a particular date. They
want accounting reports in order to have an appraisal of performance and
also for an assessment of future prospects to ensure that they will get their
expected returns from the business and get back their capital safely.
(ii) Management
•Accounting data are the basis for most of the decisions made by the
management. The trends in sales and purchases, relationship of expenses to
the sales, efficiency of employees, comparative profitability of different
departments, capital structure and solvency position are some of the vital
data required by management for planning and controlling the business
operations. Financial statements and other reports prepared under financial
accounting provide this information to the management.
(iii) Employees
•The employees are interested in the profit earning capacity of the business which will affect their remuneration,
working conditions and retirement benefits and stability and growth of the enterprise.
B) External users
•External users are the persons who are outside the organisation but make use of accounting information for their
purposes. They are:
(i) Creditors and financial institutions
•Suppliers of goods and services, commercial banks, public deposit holders and debentureholders are included in this
category. They are interested in knowing the liquidity position and repaying capacity of the business to ensure the
safety of getting the amount due to them or interest and the principal amount.
(ii) Investors
•Persons who are interested in investing their funds in an organisation should know about the financial condition of a
business unit while making their investment decisions. They are more concerned about future earnings and risk
bearing capacity of the organisation which will affect the return to the investors.
(iii) Customers-Customers who buy and use the products and services of business enterprises are interested in
knowing the details of the products and the prices charged to them. They are interested in knowing the stability
and profitability of an enterprise to ensure continued supply of the products or services by the enterprise.
(iv) Tax authorities and other regulatory bodies-Accounting information helps the tax authorities in computing
income tax and taxes on goods and services and other taxes to be collected from business units. Other regulatory
bodies also require information about revenues, expenses and other financial aspects of business to ensure that
the enterprises comply with statutory requirements.
(v) Government-The scarce resources of the country are used by business enterprises. Information about
performance of business units in different industries helps the government in policy formulation for development
of trade and industry, allocation of scarce resources, grant of subsidy, etc. Government also administers prices of
certain commodities. In such cases, government agencies have to ensure that the guidelines for pricing are
followed.
(vi) Researchers-Researchers to carry out their research can use accounting information and make use of the
published financial statements for analysis and evaluation.
(vii) General public-From accounting information, the general public at large can get a view of the earning capacity
and stability of the enterprise as well as the social responsibility measures undertaken by the enterprise
particularly in its area of operation and also the employment opportunities provided to the local people.
 Role of an accountant

(i) Record keeper-The accountant maintains a systematic record of financial

transactions. He also prepares the financial statements and other financial reports.
(ii) Provider of information to the management- The accountant assists the
management by providing financial information required for decision making and for
exercising control.
(iii) Protector of business assets-The accountant maintains records of assets owned
by the business which enables the management to protect and exercise control over
these assets. He advises the management about insurance of various assets and the
maintenance of the same.
(iv) Financial advisor-The accountant analyses financial information and advises the
business managers regarding investment opportunities, strategies for cost savings,
capital budgeting, provision for future growth and development, expansion of
enterprise, etc.
(v) Tax manager-The accountant ensures that tax returns are prepared and filed
correctly on time and payment of tax is made on time. The accountant can advise
the managers regarding tax management, reducing tax burden, availing tax
exemptions, etc.
(vi)Public relation officer-The accountant provides accounting information to various
interested users for analysis as per their requirements.
 FINANCIAL STATEMENTS
•Financial statements are written reports created by a company’s management to summarize the business’s
financial condition over a certain period (quarter, six-monthly, or yearly). These statements, which comprise the
balance sheet, income statement, cash flow statement, and statement of shareholders’ equity, must be
prepared by specified and standardized accounting standards to ensure that reporting is consistent.
•Financial Statements are prepared as per GAAP( Generally Accepted Accounting Principles).
Features of financial statements
(i) Financial statements are generally prepared at the end of an accounting period based on
transactions recorded in the books of accounts.
(ii) These statements are prepared for the organisation as a whole.
(iii) Information is presented in a meaningful way by grouping items of similar nature such as fixed
assets and current assets.
(iv) Financial statements are prepared based on historical cost.
(v) Financial statements are prepared based on accounting principles and Accounting Standards,
which make financial statements comparable and realistic.
(vi) Financial statements involve personal judgement in certain cases. For example, selection of
method of depreciation, percentage of reserve, etc.
Significance of financial statements
(i) To management: Financial statements provide information to the management to take decision and to have
control over business activities, in various areas.
(ii) To shareholders: Financial statements help the shareholders to know whether the business has potential for
growth and to decide to continue their shareholding.
(iii) To potential investors: Financial statements help to value the securities and compare it with those of other
business concerns before making their investment decisions.
(iv) To creditors: Creditors can get information about the ability of the business to repay the debts from financial
statements.
(v) To bankers: Information given in the financial statements is significant to the bankers to assess whether there
is adequate security to cover the amount of the loan or overdraft.
(vi) To government: Financial statements are significant to government to assess the tax liability of business
concerns and to frame and amend industrial polices.
(vii) To employees: Through the financial statements, the employees can assess the ability of the business to pay
salaries and whether they have future growth in the concern.
 Techniques or Tools of financial statement analysis

(i) Ratio analysis

•An analysis of financial statements based on ratio is known as ratio analysis. A ratio is a mathematical
relationship between two or more items taken from the financial statements. Ratio analysis is the
process of computing, determining and presenting the relationship of items. Ratio analysis is helpful to
management and outsiders to diagnose the financial health of a business concern. It helps in measuring
the profitability, solvency and activity of a firm.
(ii) Cash flow analysis
•Cash flow analysis is concerned with preparation of cash flow statement which shows the inflow and
outflow of cash and cash equivalents in a given period of time. Cash includes cash in hand and demand
deposits with banks. Cash equivalents denote short term investments which can be realised easily
within a short period of time, without much loss in value. Cash flow analysis helps in assessing the
liquidity and solvency of a business concern.
(iii) Funds flow analysis
•The term ‘fund’ refers to working capital. Working capital refers to the excess of current assets over
current liabilities. The term ‘flow’ means movement and includes both ‘inflow’ and ‘outflow’. Funds flow
analysis is concerned with preparation of funds flow statement which shows the inflow (sources) and
outflow (applications) of funds in a given period of time. Funds flow analysis is useful in judging the
credit worthiness, financial planning and preparation of budgets.
(iv) Comparative financial statement
•A statement giving comparison of net increase or decrease in the individual items of financial statements of two or
more years of a business concern is called comparative statement. It shows the actual figures at different periods of
time, the increase or decrease in these figures in absolute terms and the percentages of such increase or decrease.
The two basic comparative statements prepared are comparative income statement and comparative balance sheet.
(v) Common-size statements
•The common-size statements can be compared with those of previous years. They can also be compared with those
of other similar businesses with similar accounting policies.
(vi) Networking capital analysis
•Networking capital statement or schedule of changes in working capital is prepared to disclose net changes in
working capitals on two specific dates (generally two balance sheet dates). It is prepared from current assets and
current liabilities on the specified dates to show net increase or decrease in working capital.
(vii) Trend analysis
•Trend refers to the tendency of movement. Trend analysis refers to the study of movement of figures over a period.
The trend may be increasing trend or decreasing trend or irregular. When data for more than two years are to be
analysed, it may be difficult to use comparative statement. For this purpose, trend analysis may be used. One year,
generally, the first year is taken as the base year. The figures of the base year are taken as 100. The figures for the
other years are expressed as a percentage to the base year and the trend is determined.
 Meaning and definition of a company

• Company is a voluntary association of persons which has separate legal entity.

• According to Lord Justice Lindley, “A company is an association of many persons who contribute money or
money’s worth to a common stock and employ it in some trade or business and who share the profit and loss
arising there from.
• Characteristics of a company
• Following are the characteristics of a company:
• Voluntary association: A company is a voluntary association of persons. No law can compel persons to form a
company.
• Separate legal entity: Company is an artificial person. It has a separate legal entity which is separate and
distinct from its members.
• Common seal: A company may have a common seal which can be affixed on the documents.
• Perpetual succession: A company continues for ever. Its continuity is not affected by the changes in its
members. It can be wound up only by law.
• Limited liability: The liability of the shareholders of the company is limited to the extent of face value of the
shares held by them.
• Transferability of shares: The shares of a company are freely transferable except incase of a private company.
Meaning and types of shares
The capital of a company is divided into small units of fixed amount. These units are called shares. The shares
which can be issued by a company are of two types (i) preference shares and (ii) equity shares.
Preference shares- Preference shares are the shares which have the following two preferential rights over the
equity shares:
• Preference towards the payment of dividend at a fixed rate during the life time of the company and
• Preference towards the repayment of capital on winding up of the company.
•Equity shares -are those shares which are not preference shares. These shares do not enjoy any preferential
rights. Rate of dividend is not fixed on equity shares and it depends upon the profits earned by the company. In
case of winding up of a company equity shareholders are paid after the payments are made to preference
shareholders. Equity shares are also known as ordinary shares.
• Annual Report
• An annual report is a comprehensive report detailing a company’s activities throughout the
preceding year.
• Its purpose is to provide users, such as shareholders or potential investors, with information
about the company’s operations and financial performance.
• Annual reports are comprehensive documents designed to provide readers with information
about a company’s performance in the preceding year.
• The reports contain information, such as performance highlights, a letter from the CEO, financial
information, and objectives and goals for future years.
 ANNUAL REPORTS
COMPONENTS
∙Director’s message to shareholders & Letter to the
shareholders from the CEO
∙General corporate information
∙Information on corporate governance
∙Operating and Financial highlights
∙Management discussion and analysis
∙Auditor’s Reports
∙Shareholding pattern, management/board of
directors’ information
∙Detailed and audited financial statements
∙Financial statements, including the balance sheet
(statement of financial position), income
statement, and cash flow statement
∙Statement of Changes in Equity
∙Notes to financial statements
∙Usage of accounting policies and changes, if any
∙Other information or disclosure.
Letter from the CEO
•The letter from the CEO is addressed to shareholders and provides a summary of the company’s performance in the previous
year. CEOs typically spend a lot of time on their letters to highlight the company’s achievements, as its performance is relative to
the industry it operates in. The letter would likely mention the information of interest to shareholders since they are the primary
readers of the report.
•A letter from a Chairman, Board of Directors, or CEO of a company usually kick-starts the drafting of annual reports. This letter
not only sets the tone but also establishes a theme by providing a summary of business operations.
•A Chairman’s letter also provides an in-depth analysis of the overall business performance and offers insights into the capital
market in which a company is currently looking forward to incorporating commercial growth.
•The authority drafting this letter also indicates the challenges and risks faced by a company, such as alterations in market
conditions, changes in consumer trends, corporate scandals, etc. This section is usually concluded with the financial plans and
business directions for the upcoming fiscal year.
BUSINESS PROFILE
•A section dedicated to the discussion of a company’s business profile is usually followed by the Chairman’s letter. The business
profile is a significant part of the annual report; it describes an organization by tabulating the following information.
1.Revenue generated for a particular financial year
2.Detailed information about the product and services provided
3. Business operations
Performance Highlights
•Annual reports usually dedicate a section to highlighting some of the company’s key achievements, such as special
initiatives, goals reached, or awards received by the company or its employees. The main goal of the section is to
ensure that shareholders are satisfied with their investment in the company and persuade potential investors to do
the same.
MANAGEMEN DISCUSSIN AND ANALYSIS(MD&A)
•MD&A section emphasizes management commentary on the business.
•The final section of every annual report of a company generally comprises a discussion along with a business analysis
conducted by the organisation’s management.
•Info-graphics, flow charts, graphs of different metrics, etc. are some of the most common representations in this
section, which help to highlight data essential for business growth. Such analysis concluded showcases the financial
expectations and plans for the commercial growth of a company in the near future.
Financial Statements
•Financial statements are a key component of the annual report and provide its users with quantitative data regarding specific aspects of
its financial performance in the previous fiscal year. The next section of most company annual reports usually comprises Financial
Statements, and associated notes, primarily including the following.
∙Balance sheet
∙Income Statement
∙Cash Flow Statement
∙Statement of changes in Equity
•Financial statements give financial details of the current year and the past year; this makes year-on-year comparisons easier for a
shareholder. In addition, the notes to financial statements describe the technical anomalies and assumptions taken in preparing the
financial statements.
NOTE TO FINANCIAL STATEMENTS
•Right after the Financial Statements comes their notes in most annual reports of Indian companies. Here, additional elucidation
regarding various components of these statements is provided to offer a detailed explanation of company debts, capitalized leases,
taxations, etc.
•The later sections of this accounting report present changes in accounting policies, financial disclosure, capital projects, and other
information relevant to shareholders.
Outlook for Future Years
•Annual reports typically include information regarding its future performance in order to provide shareholders
with information on the company’s future goals and objectives. Investors are able to get a thorough
understanding of the company’s current position in its respective industry and the company’s plans for future
growth.
• The reports also include information regarding a company’s strategy and how it plans to implement that
strategy in the coming years.
Format
•While hardcopy annual reports are still common, electronic versions are increasingly popular and can be found
on the websites of many companies. Electronic versions allow the reports to be made accessible to a larger
audience in PDF or other formats.
•Increasingly common are interactive online reports, which allow users to virtually flip through the report and
expand graphics, among other things.
Audit report

•The auditing of the accounts of a company is usually done by an independent external auditor. An audit report is a
letter from the auditor of a company that is the end result of the audit process. It states the auditor’s opinion on
whether the company’s financial statements such as the balance sheet are in compliance with the generally
accepted accounting principles (GAAP) and if they are free from material misstatement.

•The audit report is generally accompanied by the company’s annual report. The audit report is required by banks,
financial institutions, investors, creditors, and regulators. When the auditor issues a clean report, it means that the
company’s financial statements have been found to be fully compliant with accounting standards. An unqualified
report will tell you that the financial statement could have some errors.

•Audit reports are very important to a company. Investors rely on the audit report to assess the financial health of
the company and they base many important decisions on the audit report. Regulatory bodies also read the audit
report as it tells them how accurate the financial information reported is. When an audit report is adverse it can
seriously affect the company’s status and reputation. It is essential to have good accounting practices so that the
audit of accounts goes well.
1. Title of the report
The title of audit report should help the reader to identify the report. It should
disclose the name of the client. The title distinguishes the audit report from other
reports.
2. Name of the Addressee
The addressee normally refers to the person who appoints the auditor. If a
company appoints the auditor, the addressee should be shareholders. As per law,
the complete address of the addressee is required. Addressee for the statutory
audit shall be shareholders and in case of Special Audit, it is Central Government.
3. Introductory Paragraph
The introductory paragraph should specify that it is the auditor’s opinion on
financial statements audited by him. The period covered by financial statements
should be stated with exact dates.
4. Scope
This part should include the matter-of-fact relating to the manner in which audit
examination was made. The audit examination should cover company’s accounts,
Profit and Loss Account, Balance Sheet and Cash Flow Statements. The
examination should be as per the relevant law. The auditor should not curtail or
limit any examination task.
5. Opinion
The auditor’s opinion on the books of account and financial statements examined
by him is based on the information and free from bias. The auditor has to give his
opinion as follows:
· Whether the financial statements are arithmetically correct and correspond
to the figures recorded in the books of accounts.
· In case of unqualified opinion, whether the financial statements represent a
true and fair view of the state of affairs and the results of operations.
· In case of qualified opinion, if the Balance Sheet and Profit and Loss account
do not present a true and fair view, the reasons for what and where is wrong.
6. Signature
The signature part should include the manual signature of the auditor.The personal
name and signature of the auditor should be given. If the auditor is a firm, the
signature in the personal name and firm name should be given.
7. Place of Signature
This should include the location of the auditor or the auditor firm, which is
ordinarily their city.
8. Date of the Report
The date of completion of the audit work should be mentioned in this section.
Statutory Requirements
means all approvals, consents, permits, or licences necessary for the purposes of the Redevelopment
from the State, any government department, authority, instrumentality or local government authority,
and includes, without limiting the generality of the foregoing, all approvals, consents, permits, and
licences, for engineering drawings, construction plans, earthworks and structures necessary for the
purposes of the Redevelopment; “subsidiary legislation” includes any proclamation, regulation, rule,
by‑law, order, notice, rule of court, town planning scheme, resolution, or other instrument, made
under any Act of the State or of the Commonwealth of Australia or subsidiary legislation for the time
being in force and having legislative effect
• Director’s report
• Director’s report is a financial disclosure made by director to the shareholders of the company. It
is envisaged to disclose financial status of the company by disclosing company’s affairs and scope
of work along with its subsidiaries. It is basically financial summary of the company for the whole
financial year and future vision too.
• The objective of Directors’ report
• A director of the company needs to prepare and submit a said report to shareholders of the
company at every annual general meeting every year in order to maintain transparency in the
company. It helps stakeholders of the company understand the current financial status of the
company and future scope and understand:
• The current financial health of the company
• Company’s capability to diversify and grow
• Company’s status and position in the current market and future scope and growth
• Whether company is following current regulations, standards, and social responsibility as required
by various regulators like ROC, RBI, SEBI, etc.
• Director’s report covers
• Company’s description and details of current shareholders and other key managerial personnel’s
• Directors description submitting director’s report
• Description of companies trading activity
• Future vision and prospectus of the company
• Submission and description of financial records and statement of the company before members
• Current Balance sheet, profit and loss, and cash flow description along with auditor’s report
• Dividend recommendation for current financial year
• Any financial incidence that may affect company’s financial position in the future
 Notes to account
• Also known notes to financial statements, footnotes, notes to accounts are supporting information that is
usually provided along with a company’s final accountsAlso known notes to financial statements, footnotes,
notes to accounts are supporting information that is usually provided along with a company’s final
accounts or financial statements. Many such notes are required to be provided by law, including details
related to provisions, reserves, depreciation, investments, inventory, share capital, employee benefits,
contingencies, etc.
• They provide more details and clarity about the items, amounts, and transactions reported in the balance
sheet, income statement, statement of changes in equity, and cash flow statement.
• Notes to the accounts reflect the accounting principles and the facts that can have a significant impact on the
judgment of the reader of accounting information.
• The notes are used to explain the assumptions used to prepare the numbers in the financial statements as
well as the accounting policies adopted by the company. Footnotes are used by both analysts and auditors to
better understand the company's financial position.
• Notes to accounts help users of accounting information to understand the current financial position of a
company and act as a support for its estimated future performance.
• These notes (or footnotes) inform of important accounting policies, company’s commitments,
breakdown of sales, breakdown of purchases, details of assets and liabilities, potential profits and
losses, etc. The information provided by notes to accounts is critical for concisely understanding
and evaluating the financial statements of the company.
• Investors who only focus on the main body of financial statements and oversee the notes commit
a grave blunder as they can be easily misled that way. The notes may be several pages long but
they are not to be undervalued while analyzing the financial statements of a business. Therefore,
a good way to read financial statements is from bottom to up and from back to front.
 Pitfalls
• They include data entry errors, such as typos; errors of commission, such as using the wrong general ledger account
number; errors of omission, such as neglecting to record a transaction; and errors in principle, such as recording a
purchase as an expense rather than an asset.
• Accounting errors are broadly described as those that either cause a clear imbalance in the sum totals of debit and
credit balances and errors that don't. The most obvious errors impact the trial balance, causing debits to be out of
balance with credits. Errors that don't impact the trial balance can be more difficult to detect.
1. Recording only monetary items
• As per accounting principles, only the events measurable in terms of money are recorded in the books of accounts.
But events of great importance, if not measurable in terms of money, are not accounted for. For that reason,
recorded accounting information fails to exhibit the exact financial position of a business concern.
2. Time Value of Money
• Under the accounting system, money value is treated constantly. But the value of money always changes due to
inflation. Under existing accounting systems, accounts are maintained considering historical cost ignoring current
changed value. As a result, the accounts maintained fail to exhibit the exact financial position of a business concern.
3. Recommendation of alternative methods
• There exists an application of alternative methods in determining depreciation of assets and valuation of stock etc.
Information regarding the activities of the business is expressed in a misleading way if an alternative method is used
to achieve a particular object.
4. Restrain of Accounting Principles
•Exhibited accounting information cannot always exhibit a true and fair picture of a business concern owing to
limitations of the accounting principles used.
5. Recording of past events
•Accounting past events are accounted for. But naturally, there is no system of recording events that may occur in the
future.
6. Allocation of problem
•The allocation process is an important problem in the accounting system. The value of fixed assets is exhausted,
charging depreciation for the allocated period. The useful life of fixed assets is fixed up hypothetically, which does not
stand accurately in most cases.
7. Maintaining secrecy
•Secrecy cannot be ensured for the involvement of many employees in accounting work, although maintaining secrecy
is very important.
8. The tendency for secret reserves
•Often management creates secret reserves intentionally by increasing or decreasing assets and liabilities for which the
total financial picture of an organization is not reflected.
9. Importance of form over substance
•At the time of preparing accounts for a particular period, the emphasis is laid on the form, table, etc. instead of giving
importance to an exhibition of substantial information.
• Accounting Principles
• Accounting principles are the basic norms and assumptions developed and established as the basis for
accounting system. These principles are adopted by the accountants universally. These accounting principles
provide uniformity and consistency in the accounting methods and process. Such accounting principles are
known as Generally Accepted Accounting Principles (GAAP).
• Accounting principles provide the basic framework within which the accounting records and accounting
reports are to be prepared. Accounting standards have been issued by national and international regulatory
authorities to ensure uniformity of accounting procedure and accounting results. These accounting
standards and GAAPs provide the theoretical base of accounting. Accounting principles may be accounting
concepts or accounting conventions.
• Accounting concepts are the basic assumptions whereas conventions are the guidelines based upon practice
or usage. Accounting concepts are the basic assumptions or conditions upon which accounting has been laid.
Accounting concepts are the results of broad consensus. The word concept means a notion or abstraction
which is generally accepted. Accounting concepts provide unifying structure to the accounting process and
accounting reports.
 Accounting Standards (AS)

• Accounting Standards provide the framework and norms to be followed in accounting so that the financial
statements of different enterprises become comparable. It is necessary to standardise the accounting
principles to ensure consistency, comparability, adequacy and reliability of financial reporting.
• In the words of Kohler, “Accounting standards are codes of conduct imposed by customs, law or professional
bodies for the benefit of public accountants and accountants generally” Thus, Accounting Standards are
written policy documents issued by the expert accounting body or by government or other regulatory body
covering the aspects of recognition, measurement, treatment, presentation and disclosure of accounting
transactions and events in the financial statements.
The need for accounting standards is as follows:
i. To promote better understanding of financial statements
ii. To help accountants to follow uniform procedures and practices
iii. To facilitate meaningful comparison of financial statements of two or more entities.
iv. To enhance reliability of financial statements
v. To meet the legal requirements effectively
International Financial Reporting Standards (IFRS)
•International Financial Reporting Standards (IFRS) are issued by the International Accounting Standard Board
(IASB). IFRS is a set of International Accounting Standards stating how particular types of transactions and other
events should be reported in financial statements. IFRS are issued to develop Accounting Standards that would
be acceptable worldwide and to improve financial reporting internationally.
Accounting Standards in India
•In India, Standards of Accounting is issued by the Institute of Chartered Accountants of India (ICAI). The Council
of the Institute of Chartered Accountants of India constituted Accounting Standards Board (ASB) on 21st April,
1977 recognising the need for Accounting Standards in India.
•Due to globalisation, the accounts prepared in India must be compatible with accounts prepared in other
countries. This has resulted in the existing AS being converged with the IFRS. This convergence has resulted in
what is known as Ind AS.