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Accounting and Financial Reporting

 Accounting refers to systematic recording,

classifying and summarizing of financial
transactions and interpreting the results thereof.
Thus, accounting encompasses financial
reporting.
 Accounting starts with recording and ends with
presentation of financial information in a manner
that facilitates informed judgments and decisions
by users.

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Events and Transactions

 An event is a happening of consequence to an
entity.
 An event could be an internal happening or
external happening.
 External events that involve transfer of value ( in
monetary terms) between two entities (within or
outside) are called transactions.
 Thus, a transaction is an external event that
affects the financial position of an entity.

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Recording of Transactions: The

Double Entry Principle
 Each transaction has two aspects (or side): Debit
and Credit.
 Every debit has an equal and opposite credit.
 Each transaction should be recorded in such a
way that it affects two sides- debit and credit-
equally.
 Thus, the first and foremost step in recording a
transaction is to identify the debit and credit
elements.

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Basic Accounting Concepts

 An understanding of accounting concepts is vital

to understand the process of accounting.
 Accounting concepts underlying the recording of
transactions:
 Entity Concept
 Money Measurement Concept
 Accrual Concept
 Cost Concept

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Basic Accounting Concepts

 Accounting concepts underlying financial

reporting:
 Going Concern Concept
 Periodicity Concept
 Matching Concept
 Prudence
 Substance over form
 Consistency

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Accounting Concepts: Entity and

Money Measurement
 Entity Concept:
 A business entity is an economic unit distinct from its
owner(s). Such entity owns its assets and has its own
obligations. Only those transactions and events which
affect the financial position of the business entity will be
recorded in its books of accounts.
 Money Measurement Concept:
 Only transactions and events which are measurable in
monetary terms should be recorded.

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Accounting Concepts: Accrual and

Cost
 Accrual Concept:
 Income and expenses should be recognised as and
when they are earned and incurred, irrespective of
whether money is received or paid in connection thereof.
An alternative of accrual basis of accounting is cash
basis where transactions are recorded only when cash is
received or paid.
 Cost Concept:
 Assets and liabilities should be recorded at historical
cost. The recent trends in accounting show that policy
makers favour fair value accounting in place of historical
cost accounting.

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Accounting Concepts: Going

Concern and Periodicity
 Going Concern Concept:
 An entity is said to be a going concern if it has ‘neither
the intention nor the necessity of liquidation or of
curtailing materially the scale of the operations’. The
valuation principles of assets and liabilities depend on
this concept.
 Periodicity Concept:
 Accounts are prepared for a defined accounting period.
Such period could be a quarter, half year, a year or, in
exceptional circumstances, more than one year. This
concept is essential to measure financial performance.

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Accounting Concepts: Matching and

Prudence
 Matching Concept:
 While measuring periodic financial results, revenue
earned during an accounting period is matched with
expenses incurred (to earn the revenue) in the same
accounting period. Thus, expenditure incurred during
construction phase should be withheld till the business
starts commercial activity and earns revenue.
 Prudence Concept:
 This concept suggests that all possible expenses and
losses should be estimated and recorded, but
anticipated gains should be ignored. This concept is also
called the concept of ‘conservatism’.

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Accounting Concepts: Substance
over form and Consistency
 Substance over form:
 While recording transactions more emphasis needs to be
given to the substance of the transactions and not merely to
their legal form. A transaction may appear to be an expense
when looked at from legal angle (e.g., construction of road by
a business entity on land owned by the municipality), but the
substance of the matter may demand such expense be
shown as asset (e.g., if such road is primarily used by the
business entity for its business purposes).
 Consistency:
 A business entity frames accounting policies that lay down
rules for presentation of financial statements. Accounting
policies, once framed, should be consistently followed.
However, such policies may be changed if circumstances so
warrant.

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Financial Statements: Objective

 To provide information about the financial position,

performance and cash flows of an enterprise that
is useful to a wide range of users in making
economic decisions.
 Financial statements do not necessarily provide
non-financial information.

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Financial Statements: Qualitative

Characteristics
 Understandability
 Relevance
 Reliability
 Faithful representation
 Substance over form
 Prudence
 Neutrality
 Comparability

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Financial Statements: Elements

 Elements measuring financial position:

 Assets
 Liabilities
 Equity
 Elements measuring performance
 Income (includes gains)
 Expenses (includes losses)

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Financial Elements: Definition

 Assets are economic resources controlled by the
enterprise as a result of past events from which
future economic benefits are expected to flow to
the enterprise.
 Liabilities are present obligations of the
enterprise arising from past events, the settlement
of which is expected to result in an outflow from
the enterprise of resources embodying economic
benefits.
 Equity is the residual interest in the assets of the
enterprise after deducting all its liabilities.

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Financial Elements: Definition

 Income is increase in economic benefits during the
accounting period in the form of inflows or
enhancement of assets or decreases of liabilities
that result in increases in equity, other than those
relating to contributions from equity participants.
 Expenses are decreases in economic benefits
during the accounting period in the form of outflows
or depletion of assets or incurrence of liabilities that
result in decreases in equity, other than those
relating to distributions to equity participants.

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Corporate Financial Statements

 What are the corporate financial statements?

 Balance Sheet
 Shows the financial position (position of assets,
liabilities and equity) as on the reporting date.
 Profit & Loss Account
 Shows the financial results (profit or loss) for an
accounting period.
 Cash Flow Statement
 Shows the net increase /decrease in cash and cash
equivalents during the accounting period.

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Fundamental Accounting
Assumptions
 What are the fundamental accounting
assumptions?
 Accrual
 Going concern
 Consistency.
 Why are they called “Fundamental”?

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Accounting Equation
 The relationship among three elements of the
balance sheet can be expressed through an
equation, known as fundamental accounting
equation:
Assets (A) = Liabilities (L) + Equity (E)
 The unique feature of the above equation is that
all transactions will affect the equation in such a
way that the equality will always be maintained.
 This happens due to double entry rule.

Financial Accounting: An introduction