Basic Concepts of Accounting & Framework

1. Financial Accounting and Reporting Basic Concepts of Accounting & Framework • Course Faculty • Dr. Sangeeta Chauhan • Assistant Professor • K.R Mangalam University, Sohna, Gurugram • E-mail: rajputsangeeta47@gmail.com

2. Unit-1 Unit I: Basic Concepts of Accounting & Framework Basics of Accounting, Financial accounting principles: Meaning and need; Concepts and Conventions of Accounting, Accounting Systems, Measurement of Business income, Revenue recognition, Introduction to Generally Accepted Accounting Principles (GAAP), Accounting standards: Overview of IAS, IFRS. AS and Ind AS.

3. Accounting meaning • Accounting is the systematic process of recording, summarizing, analyzing, and reporting financial transactions of a business or organization. It provides a structured way to track financial information, enabling stakeholders to understand the financial position, performance, and cash flows of an entity.

4. Accounting importance • Provides Accurate Financial Information: Helps in assessing financial performance, profitability, and financial position. • Supports Decision-Making: Assists in making informed business decisions on operations, investments, and strategy. • Ensures Legal Compliance: Helps businesses comply with tax laws and regulatory requirements. • Facilitates Budgeting and Planning: Aids in forecasting, setting financial goals, and tracking progress. • Promotes Transparency: Provides clear, reliable financial reports for stakeholders, enhancing trust. • Monitors Business Performance: Tracks income, expenses, and profitability, highlighting areas for improvement. • Helps in Raising Capital: Attracts investors and lenders by providing accurate financial data.

5. objectives of Accounting • To provide financial information about the performance and position of a business. • To ensure compliance with financial regulations and standards. • To aid in decision-making by offering insights into profitability, liquidity, and efficiency. • To protect assets by ensuring transactions are accurately recorded and reviewed for integrity

6. ACCOUNTING CONCEPT

7. Accounting concept • In accounting, a concept is a fundamental idea or guideline that provides a foundation for the practice and interpretation of financial information. These concepts establish a framework for consistent and accurate recording, reporting, and analyzing financial transactions. Here are some key accounting concepts

8. 1. Accrual Concept This concept requires that revenues and expenses are recorded when they are earned or incurred, regardless of when cash is actually received or paid. This helps to provide a more accurate picture of a business’s financial position. 2. Going Concern Concept This assumes that a business will continue operating in the foreseeable future. It affects how assets and liabilities are valued, as it implies that the business does not need to liquidate its assets immediately.

9. 3. Consistency Concept This concept states that companies should consistently use the same accounting methods across periods unless a legitimate reason for change exists. This consistency allows for comparability over time. 4. Prudence (Conservatism) Concept This approach advises accountants to avoid overestimating income or assets and underestimating expenses or liabilities. The idea is to ensure that financial statements do not give an overly optimistic view of the company’s financial health.

10. 5. Matching Concept Expenses should be matched with the revenues they help to generate. This means that costs associated with a certain revenue are recorded in the same period as that revenue, regardless of when cash changes hands. 6. Materiality Concept Only items that would affect the decision-making of users of financial statements should be included. This concept allows for ignoring trivial details that do not have a significant impact on overall financial reporting.

11. 7. Entity Concept This concept treats the business as separate from its owner(s) or other entities. The financial records of the business are distinct from those of its owners, even in small or unincorporated businesses. 8. Money Measurement Concept Only transactions and events that can be measured in monetary terms are recorded. Non-financial factors are not recorded in the financial statements, even if they impact the business.

12. 9. Cost Concept Assets are recorded on the financial statements at their original purchase cost, not at their current market value. This provides an objective, verifiable figure for reporting.

13. Accounting Process

14. Process • The process of accounting is a structured sequence of steps that businesses follow to record, classify, summarize, and report financial information. This process is often referred to as the accounting cycle and ensures that financial data is accurately recorded and presented. Here’s a breakdown of the steps involved:

15. 1. Identifying Transactions The first step involves identifying all transactions or events that have a financial impact on the business. These could include sales, purchases, payments, receipts, and other financial events. 2. Recording Transactions (Journalizing) Each identified transaction is recorded in a journal using double-entry bookkeeping, where every transaction has a debit and a credit entry. This step is also known as journalizing.

16. 3. Posting to the Ledger After transactions are recorded in the journal, they are transferred, or “posted,” to the ledger accounts. Each ledger account represents a specific category, like cash, accounts receivable, or accounts payable, and is used to track changes in those accounts over time. 4. Preparing an Unadjusted Trial Balance Once transactions are posted to the ledger, a trial balance is prepared to check the accuracy of the books. This involves listing all account balances and ensuring that total debits equal total credits.

17. 5. Making Adjusting Entries Adjustments are made to account for accrued and deferred items, such as prepaid expenses, accrued revenue, or depreciation, to reflect the actual financial position at the end of the accounting period. 6. Preparing an Adjusted Trial Balance After adjusting entries are made, a second trial balance is prepared to confirm that debits still equal credits. This adjusted trial balance forms the basis for preparing financial statements.

18. 7. Preparing Financial Statements • Using the adjusted trial balance, financial statements are prepared. The main financial statements include: • Income Statement (shows revenues and expenses) • Balance Sheet (shows assets, liabilities, and equity) • Cash Flow Statement (shows cash inflows and outflows) • 8. Closing Entries • At the end of the accounting period, closing entries are made to transfer temporary account balances (revenues, expenses, and dividends) to permanent accounts like retained earnings. This resets the balances of temporary accounts to zero for the next period.

19. 9. Preparing a Post-Closing Trial Balance A final trial balance is prepared after the closing entries to ensure that total debits still equal total credits. This post-closing trial balance contains only permanent accounts and verifies that the books are ready for the new accounting period. 10. Reversing Entries (Optional) Some businesses make reversing entries at the beginning of the new accounting period to simplify the recording of future transactions, especially those related to accrued items from the previous period.

20. SCOPE OF ACCOUNTING

21. Scope of accounting The scope of accounting is broad and includes various functions, tasks, and areas of specialization within the field. It extends beyond basic bookkeeping to encompass planning, analyzing, interpreting, and communicating financial information to support decision-making. Here are some key areas that define the scope of accounting: 1. Financial Accounting Involves recording, classifying, summarizing, and reporting financial transactions to present an accurate picture of a company's financial position. It produces financial statements like the income statement, balance sheet, and cash flow statement for stakeholders, including investors, creditors, and regulatory bodies.

22. 2. Managerial Accounting Focuses on providing internal management with the information needed for decision-making, planning, and control. It includes budgeting, cost analysis, and performance evaluation, helping managers make informed business decision 4. Tax Accounting Involves preparing tax returns and planning for future tax obligations. Tax accountants ensure compliance with tax laws, help optimize tax liability, and offer advice on tax planning to maximize after-tax income for individuals or corporations.

23. 5. Auditing The examination and verification of a company’s financial records by an independent third party (external audit) or internal team (internal audit) to ensure accuracy, fairness, and compliance with accounting standards and regulations. Auditing builds trust in financial statements for stakeholders. 6. Accounting Information Systems (AIS) This field combines accounting with information technology to design, implement, and manage systems for recording and processing financial data. AIS enables accurate, efficient data handling and enhances security, improving the quality of financial information and decision-making. 7. Forensic Accounting Involves investigating financial records to detect fraud, embezzlement, or other financial irregularities. Forensic accountants analyze financial data for legal cases, disputes, or fraud investigations and provide expert testimony in court.

24. 8. Fiduciary Accounting Used in situations where someone is entrusted with managing another's assets, such as in trusts, estates, and legal guardianships. Fiduciary accounting ensures that assets are managed and accounted for in the best interests of the beneficiaries. 9. Governmental and Not-for-Profit Accounting Specialized accounting practices for government agencies and non-profit organizations that differ from standard corporate accounting due to a focus on accountability, fund management, and compliance with specific reporting standards. 10. Environmental and Social Accounting Focuses on accounting for the environmental and social impacts of business activities. This area includes tracking costs related to environmental sustainability and social responsibility to provide stakeholders with a broader perspective on the business’s impact.

25. Users Of ACCOUNTING

26. Users of accounting • The users of accounting information are diverse groups who rely on financial data to make decisions, assess performance, or meet legal requirements. These users can be broadly categorized into internal and external users, each with specific needs. Here’s a closer look at the main users of accounting:

27. Internal Users • These are individuals within the organization who use accounting information to guide day-to-day and strategic decisions. • Management • Managers use accounting information for planning, budgeting, and controlling resources. Financial data helps them set goals, allocate resources, measure performance, and make informed decisions for future growth and efficiency.

28. 2. Employees Employees may look at financial information to assess the company’s stability and profitability, which can impact job security, potential for bonuses, or future pay raises. They may also rely on financial information when negotiating contracts or benefits. 3. Owners and Shareholders In small businesses, owners use accounting data to evaluate profitability and business health. In corporations, shareholders review financial information (such as earnings reports) to determine the company's financial performance and to assess whether their investments are providing expected returns.

29. External Users • These are individuals or entities outside of the organization who use accounting information for various purposes, typically related to financial decision-making or compliance. • Investors and Potential Investors • Investors and analysts examine financial statements to assess the company’s profitability, risk, and growth potential. They rely on this information to decide whether to buy, hold, or sell their investments in the company. • 2. Creditors and Lenders • Banks and other lenders use financial information to evaluate the creditworthiness of a business. They assess a company’s ability to repay loans and its stability by reviewing cash flow statements, debt levels, and overall financial health.

30. 3. Suppliers and Trade Creditors Suppliers and vendors assess financial statements to determine whether a business is financially stable enough to pay for goods and services on credit, affecting their willingness to extend credit terms or negotiate payment schedules. 4. Customers Key customers, especially those dependent on a single supplier, may review financial information to assess the stability and longevity of their suppliers. Financial health indicators can impact whether customers maintain a relationship with the business.

31. 5. Auditors External auditors examine financial records to verify their accuracy and compliance with accounting standards. They assess financial statements to provide independent assurance to stakeholders about the reliability of reported information. 6. Financial Analysts and Advisors Analysts and financial consultants use accounting information to provide insights and guidance on financial markets, investments, and economic trends. They analyze financial reports to evaluate the broader market, economic conditions, or specific industries.

32. PRINCIPLES OF ACCOUNTING

33. Principle of accounting 1. Revenue Recognition Principle Revenue should be recognized when it is earned, not necessarily when cash is received. This means that revenue is recorded in the period in which the goods or services are delivered, which aligns with the accrual basis of accounting. 2. Expense Recognition (Matching) Principle Expenses should be matched with the revenues they help generate, ensuring that income statements show the net result of revenues and the related expenses in the same period. This helps in accurately assessing profitability.

34. 3. Historical Cost Principle Assets should be recorded at their original purchase cost, not at current market value. This provides objective and verifiable data, though it may not reflect the current fair market value of the assets. 4. Full Disclosure Principle Financial statements should disclose all relevant and material information that affects users’ understanding of those statements. This ensures transparency and helps stakeholders make informed decisions. MCMA707 MBA Financial Accounting Dr. Sangeeta (KRMU)

35. 5. Objectivity Principle Financial information must be based on objective evidence and be free from personal bias. This requires that financial data is supported by verifiable documentation, ensuring that reports are reliable and accurate. 6. Consistency Principle Once a company chooses an accounting method, it should consistently use it across accounting periods unless there is a valid reason for a change. This allows stakeholders to compare financial statements over time.

36. 7. Materiality Principle Only information that would influence a reasonable person's judgment or decision should be included in financial reports. Small and insignificant items may be omitted if they do not impact the decision-making of users. 8. Conservatism (Prudence) Principle Accountants should take a cautious approach to avoid overstating assets or income. When choosing between alternatives, the method that results in lower profits or asset valuations is often preferred, ensuring a realistic and conservative representation of financial health.

37. 9. Monetary Unit Principle Only transactions that can be measured in monetary terms are recorded in the financial statements. This principle also assumes a stable currency, disregarding inflation or deflation effects over time. 10. Going Concern Principle This principle assumes that the business will continue operating for the foreseeable future. This affects asset valuation and financial planning, as it implies the business won’t need to liquidate assets immediately.

38. 11. Economic Entity Principle The business is treated as a separate entity from its owners or other businesses. This ensures that the company’s financial records are distinct from those of its owners or affiliates, providing a clear picture of its financial performance. 12. Time Period Principle Financial reporting should be done for specific periods (monthly, quarterly, annually) to provide timely and consistent financial information, which enables performance analysis and comparisons across periods.

39. 13. Reliability Principle Financial statements should be accurate and verifiable, ensuring that all reported information is trustworthy. Users of financial data need to feel confident that the information is free from significant errors.

40. Accounting standards in financial accounting

41. Meaning :- • Accounting standards are the formal guidelines, principles, and rules that govern financial accounting practices. They ensure consistency, transparency, and accuracy in financial reporting across different companies and industries, enabling stakeholders to make informed decisions. Here are some key accounting standards in financial accounting:

42. Generally Accepted Accounting Principles (GAAP) • Purpose: Primarily used in the United States, GAAP is a collection of commonly-followed accounting principles and standards for financial reporting. • Key Features: • Ensures uniformity in financial statements • Includes principles like revenue recognition, matching, full disclosure, and materiality • Governing Body: The Financial Accounting Standards Board (FASB) establishes GAAP in the U.S. • Scope: Mandatory for publicly traded companies in the U.S.; widely followed by private companies as well.

43. Generally Accepted Accounting Principles (GAAP)

44. International Financial Reporting Standards (IFRS) • Purpose: IFRS is an international framework for accounting standards that aims to standardize accounting practices globally. • Key Features: • Promotes comparability and transparency across global markets • Based on principles rather than strict rules, allowing flexibility in certain areas • Governing Body: The International Accounting Standards Board (IASB) sets IFRS standards. • Scope: Mandatory for public companies in over 140 countries, including the EU, and widely adopted in other countries.

45. International Financial Reporting Standards (IFRS)

46. Other Country-Specific Standards • Purpose: Some countries have their own standards, which may align with or differ from GAAP or IFRS. • Examples: • Canadian GAAP: Canada adopted IFRS for publicly traded companies but still uses Canadian GAAP for private enterprises. • Indian Accounting Standards (Ind AS): India has its own set of standards based on IFRS. • Chinese GAAP (ASBE): China follows Accounting Standards for Business Enterprises (ASBE), which align with IFRS but have specific national adjustments.

47. Public Accounting Standards (IPSAS) • Purpose: IPSAS (International Public Sector Accounting Standards) are designed for government and public sector organizations. • Key Features: • Focuses on accountability and transparency in public sector financial statements • Governing Body: IPSAS Board, a division of the International Federation of Accountants (IFAC).

48. U.S. Governmental Accounting Standards (GASB Standards) • Purpose: Specifically for U.S. state and local governments to ensure accountability in the public sector. • Governing Body: The Governmental Accounting Standards Board (GASB) issues these standards.

49. Importance of Accounting Standards • Consistency: Allows for consistent reporting practices across companies. • Comparability: Helps investors and stakeholders compare financial information. • Transparency: Enhances the reliability of financial statements. • Decision-Making: Facilitates informed decision-making by stakeholders, investors, and regulators.

50. OBJECTIVE AND RELEVANCE OF GAAP