Question 1: Explain the accounting concepts that are being followed in organizations and how they are useful

in preparing financial statements. Answer:

ACCOUNTING CONCEPTS
Introduction
Basic accounting rules group all finance related things into five fundamental types of accounts. That is, everything that accounting deals with can be placed into one of these five accounts:

Assets - things are own. Liabilities - things are owe. Equity - overall net worth. Income - increases the value in accounts. Expenses - decreases the value from accounts.

It is clear that it is possible to categorize financial world into these 5 groups. For example, the cash in the bank account is an asset, mortgage is a liability, pay check is income, and the cost of dinner last night is an expense. Net worth is calculated by subtracting liabilities from the assets: Assets - Liabilities = Equity Equity can be increased through income, and decreased through expenses. This means pay check make "richer" and expense make "poorer". This is expressed mathematically in what is known as the Accounting Equation: Assets - Liabilities = Equity + (Income - Expenses) This equation must always be balanced, a condition that can only be satisfied if values are enter to multiple accounts.

Accounting Principles
The transactions of the business enterprise are recorded in the business language, which routed through accounting. The entire accounting system is governed by the practice of accountancy. The accountancy is being practiced through the universal principles which are wholly led by the concepts and conventions. The entire principles of accounting are on the constructive accounting concepts and conventions. Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts. The main objective is to maintain uniformity and consistency in accounting records. These concepts constitute the very basis of accounting. All the concepts have been developed over the years from experience and thus they are universally accepted rules. Below are the main accounting concepts that have been discussed in details:
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1. 2. 3. 4. 5. 6. 7. 8. 9.

Business entity concept; Money measurement concept; Going concern concept; Accounting period concept; Accounting cost concept; Duality aspect concept; Realization concept; Accrual concept; Matching concept;

1. Business entity concept: This concept assumes that, for accounting purposes, the business
enterprise and its owners are two separate independent entities. The business and personal transactions of its owner are separate. The accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. This concept is the very basis of accounting. The private expense of the owner is not the expense of the business and it is termed as Drawings. Accordingly, any expenses incurred by owner for himself or his family from business will be considered as expenses and it will be shown as drawings. 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. These concept restraints accountants from recording of owners private/ personal transactions. It also facilitates the recording and reporting of business transactions from the business point of view It is the very basis of accounting concepts, conventions and principles 2. Money Measurement Concept: This concept assumes that all business transactions must be in terms of money, that is in the currency of a country. In our country such transactions are in terms of rupees. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, locality, honesty of employees is not recorded because these cannot be measured in terms of money although they do affect the profits and losses of the business concern. Another aspect of this concept is that the records of the transactions are to be kept not in the physical units but in the monetary unit. The transactions which can be expressed in terms of money is recorded in the accounts books, that too in terms of money and not in terms of the quantity. 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.

3. Going Concern Concept: This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset. 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. 4. Accounting Period Concept: All the transactions are recorded in the books of accounts on the assumption that profits on these transactions are 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 1 month to one year. But usually one year is taken as one accounting period which may be a calendar year or a financial year. 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.

5. Accounting Cost Concept: 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. 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.
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6. Dual Aspect Concept: Dual aspect is the foundation or basic principle of accounting. It
provides the very basis of recording business transactions in the books of accounts. 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. For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded. Thus, the duality concept is ommonly expressed in terms of fundamental accounting equation : Assets = Liabilities + Capital The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners equity and that of outsiders, as liabilities or creditors equity. 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. 7. Realization Concept: This concept states that revenue from any business transaction should be included in the accounting records only when it is realized. The term realization means creation of legal right to receive money. Selling goods is realization, receiving order is not. In other words: Revenue is said to have been realized when cash has been received or right to receive cash on the sale of goods or services or both has been created. In short, the realization occurs when the goods and services have been sold either for cash or on credit. It also refers to inflow of assets in the form of receivables. 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. 8. Accrual Concept: The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognized when they become receivable. Though cash is received or not received and the expenses are recognized when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate. The accrual concept under accounting assumes that revenue is realized at the time of sale of goods or services irrespective of the fact when the cash is received. Similarly, expenses are recognized at the time services provided, irrespective of the fact when actual payments for these services are made. In brief, accrual concept requires that revenue is recognized when realized and expenses are recognized when they become due and payable without regard to the time of cash receipt or cash payment. Significance
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It helps in knowing actual expenses and actual income during a particular time period. It helps in calculating the net profit of the business.

9. Matching Concept: The matching concept states that the revenue and the expenses incurred
to earn the revenues must belong to the same accounting period. So once the revenue is realized, the next step is to allocate it to the relevant accounting period. This can be done with the help of accrual concept. If the revenue is more than the expenses, it is called profit. If the expenses are more than revenue it is called loss. This is what exactly has been done by applying the matching concept. Therefore, the matching concept implies that all revenues earned during an accounting year, whether received/not received during that year and all cost incurred, whether paid/not paid during the year should be taken into account while ascertaining profit or loss for that year. 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.

Accounting Concepts for Financial Statement Preparation

The Financial Statements are found to be more useful to many people immediately after presentation only in order to study the financial status of the enterprise in the angle of their own objectives. The preparation of Final accounts the business firm involves two different stages, Preparation of Accounting and Positioning Statement of the enterprises. The preparation of accounting statement involves two different category, Trading account and Profit and Loss account. The preparation of the positional statement involves only one statement, Balance sheet. The following Financial Statement are prepared by considering the accounting concepts: 1. Trading Account 2. Profit and Loss Account 3. Balance Sheet 4. Income Statement

1. Trading Account
This is first Financial Statement prepared by the owner of the enterprise to determine the gross profit during the year through the matching Concept of Accounting. The gross profit of the enterprise is calculated through the comparison of purchase expenses, manufacturing expenses, and other direct expenses with the sales.

It is prepared normally for one year in accordance with Accounting Period Concept i.e., operating cycle of the enterprise which should not exceed 15 months with reference to the Companies Act 1956.

Trading Account for the year ended

DR To Opening Stock To Cash Purchase Add Credit Purchase To Total Purchase To Net Purchases To Wages To Carriage Inward To Factory Lighting To Fuel, Coal, Oil To Duty on Import of Materials To Gross Profit C/d xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx Rs. xxxxx By Cash Sales By Total Sales By Net Sales By Closing Stock By Gross Loss C/d Rs. xxxxx xxxxx xxxxx xxxxx xxxxx Add Credit Sales xxxxx Less Sales return xxxxx Rs. Cr

Less Purchase Return xxxxx

Balancing Process: Gross profit is the resultant of an excess of the credit side total over the total
of debit side. It means that the gross profit is the excess of incomes in the credit side over the expenses in the debit side. Gross Loss is the outcome of an excess of the debit side total over the total of credit side. It means that the gross loss is the excess of expenses in the debit side over the incomes in the credit side. The purpose of crediting the closing stock in the trading account is to find out the materials or goods consumed for trading purposes. Material consumed could be calculated Material consumption = Opening stock + Purchases - Closing stock

2. Profit & Loss Account

It is a second statement of accounting in connection with the earlier to determine the Net profit/loss of the enterprise out of the early found Gross profit/loss. This is an accounting statement matches the administrative, selling and distribution expenses with the gross profit and other incomes of the enterprise.

This is an account prepared for one Operating Cycle of the firm i.e. 12 months in period. The transactions are recorded in accordance with golden rules of nominal account. In the profit & loss account, the expenses and losses are debited and incomes and gains are credited. The expenses which are matched with the credit total of the profit and loss account. Classified into various categories i. Administrative Expense ii. Selling & Distribution Expenses iii. Financial Expenses iv. Legal Expense.

Performa Profit and Loss account for the year ended.

Dr To Gross Loss B/d Balancing figure Office and Administrative Expenses To Salaries To Rent, Rates and Taxes To Office Expenses To general Expenses To Miscellaneous Expenses Selling and Distribution Expenses To Salary to Sales staff To Commission charges To Advertising expenses To Carriage outwards To Bad debts Packing Expenses Financial Expenses To Interest on capitol To Interest on Loan To trade discount allowed Maintenance Expenses To Depreciation of Fixed assets To loss on sale of assets Other Expenses To provision for debts To Net profit c/d Rs xxxxx By Gross Profit RS xxxxx Cr

By Rent Received

By Commission received

By Increase on drawing By interest on investment By trade discount received To profit on sale of assets By Net loss c/d

Balancing process of the profit and loss account leads to two different categories: Net profit is the resultant of excess of income in the credit side over the expenses in the debit side of the Profit and Loss account. Net Loss is an outcome of excess of expenses in the debit side over the incomes in the credit side .
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3. Balance Sheet
Balance sheet is the third Financial Statement which reveals the financial status of the enterprise through the total amount of resources raised and applied in the form of assets. This is the fundamental statement of the firm which explores the firm financial stature through the resources mobilized and investments applied i.e. Liabilities and Assets respectively. From the early, according to Double Entry Concept or Duality Concept, the balance sheet can be divided into two distinct sides, known as liabilities and assets. The balance sheet can be disclosed in two different orders: (i) In the order of long lastingness permanence. (ii) In the order of liquidity.

Performa Balance Sheet as on dated

Liabilities Capital Less: Drawings Add: Net Profit Rs xxxx xxxx xxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx Assets Land & Building Plant & Material Furniture & fittings Fixtures & tools Marketable securities Closing stock Sundry debtors Bills receivable Pre paid expenses Cash at Bank Cash in hand Total Assets Cash in hand Total Assets Rs xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx

Long Term Borrowing Sundrey Creditors Bills Payable Bank Overdraft Outstanding expenses Pre received income Total liabilities Total Liabilities

Methods of determining the accounting income includes: Cash Method of Accounting : Under this method, cash receipts are matched with the cash payments irrespective of the time period in order to determine the income. Mercantile Method of Accounting: Under this method, time period is given greater importance than the
actual receipts and payments. It records the receipts and expenses pertaining to the specified period whether them are actually received /paid or not. The receipts as well as payments of the other periods should be ignored /eliminated in determining the income of the stipulated duration. It is popularly known in other words as "Accrual Accounting System".

4. Income Statement
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To determine income of the business, what should be in character either in accounting income or taxable income.
Taxable income can be computed from the transactions of the enterprise but they are subject to frequent modifications on the tax provisions from one year to another year. This cannot be uniquely found out unlike the accounting income. The accounting income should have to be found out only to the tune of accounting principles and concepts.

Conclusion
Trading Account is first financial statement prepared by the owner of the enterprise to determine the gross profit during the year through the matching concept of accounting. In order to find out the total amount of goods or materials consumed during a year, three different components to be separately considered i.e. Opening stock, Purchases and Closing Stock; Profit & Loss Account is a second statement of accounting in connection with the earlier to determine the Net profit/loss of the enterprise out of the early found Gross profit/loss. Balance sheet is the third financial statement based on Duality Concept; which reveals the financial status of the enterprise through the total amount of resources raised and applied in the form of assets.