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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:
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. 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.
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.
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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
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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.
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.
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Rs.
To Opening Stock
xxxxx
Rs.
By Cash Sales
Cr
xxxxx
To Cash Purchase
xxxxx
xxxxx
By Total Sales
To Total Purchase
xxxxx
Rs.
xxxxx
By Net Sales
xxxxx
To Net Purchases
xxxxx
By Closing Stock
xxxxx
To Wages
xxxxx
xxxxx
To Carriage Inward
xxxxx
To Factory Lighting
xxxxx
xxxxx
xxxxx
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
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 .
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,
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Rs
xxxx
xxxx
xxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
xxxxx
Total liabilities
xxxxx
Total Liabilities
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
4. Income Statement
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;
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Answer:
BUDGTING
Introduction
A budget is a plan of action expressed in financial terms or non financial terms. It is prepared for
a definite period of time. It is a planned estimate of future business conditions such as the sales,
cost and profit. A budget is a tool which helps the management in planning and control of
business activities. Budgets are the common denominator of an organization and a constant in the
life of any organization.
"A budget is Financial and/or quantitative statements, prepared and approved prior to a defined
period of time, of the policy to be pursed during the period for the purpose of attaining a given
objective. - ICMA, England
"Budget is a blue print of a projected plan of action of a business for a definite period of time."
According to the definition, the essential features of a budget are:
It is prepared for a definite period well in advance.
It may be stated in terms of money or quantity or both.
It is a statement defining the objectives to be attained and the policy to be followed to
achieve them in a future period.
Typically, budgets serve three major purposes: Planning; Coordinating; and Controlling.
These three functions dictate that budgeting and the financial management process be flexible
but accountable throughout the fiscal period. At all management levels, budgets typically
represent an effective element of control, whether on a day-to-day operational basis or on a
longer term basis. Controlling and monitoring are terms often used interchangeably; as one
considers controlling/monitoring.
Types of Budgets
There are many types of budgets. They may be classified into several basic types. Most
organizations develop and make use of three different types of budgets:
1. Operating budgets;
2. Capital expenditures budgets;
3. Financial budgets; and
4. Zero-Base Budgets;
1. Operating Budgets
An operating budget is a statement that presents the financial plan for each responsibility centre
during the budget period and reflects operating activities involving revenues and expenses. The
most common types of operating budgets are: Expense Budget, Revenue Budget and Profit
budgets.
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2. Financial Budgets
Financial Budgets outline how an organization is going to acquire its cash and how it intends to
use the cash. Three important financial budgets are the cash budget, capital expenditure budget
and the balance sheet budget.
i. Cash budget : Cash budgets are forecasts of how much cash the organization has on hand
and how much it will need to meet expenses. The cash budget helps managers determine whether
they will have adequate amounts of cash to handle required disbursements when necessary, when
there will be excess cash that needs to be invested, and when cash flows deviate from budgeted
amounts.
ii. Capital Expenditure Budget: Capital Expenditure Budgets. Investment in property,
buildings and major equipment are called capital expenditure. Such capital expenditure budgets
allow management to forecast capital requirements, to on top of important capital projects, and to
ensure the adequate cash is available to meet these expenditures as they come due.
iii. The balance sheet budget: The balance sheet budget plans the amount of assets and
liabilities for the end of the time period under considerations. A balance sheet budget is also
known as a Performa balance sheet. Analysis of the balance sheet budget may suggest problems
or opportunities that will require managers to alter some of the other budgets.
3. Variable Budgets
Because of the dangers arising from inflexibility in budgets and because of maximum flexibility
consistent with efficiency underlines good planning, attention has been increasingly given to
variable or flexible budgets. To deal with this difficulty, many managers resort to a variable
budget.
Whereas fixed budgeted express that individual costs should be at one specified volume, variable
budgets are cost schedules that show how each cost should vary as the level of activity or output
varies.
There are three types of costs that must be considered when variable budgets are being
developed: fixed, variable, and semi-variable costs. The problem in devising variable budgets is
that cost variability is often difficult to determine and that they are often quite expensive to
prepare.
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4. Zero-Base Budgets
The conventional budgeting process does have one major disadvantage. Managers tend to
prepare new budget requests by adding an incremental amount to their previous year's budget
requests, rather than re-evaluating the need for things already included.
Zero-base budgeting (ZBB), in contrast, enables the organization to look at its activities and
priorities a fresh. Zero-base budgeting assumes that the previous year's budget is not a valid base
from which to work. It forces department managers to thoroughly examine their operations and
justify their departments activities based on their direct to the achievement of organizational
goals.
The specific steps used in zero-based budgeting are as follows:
1. Break down each of an organization's activities into decisions packages. The decision
package includes written statements of the department's objectives, activities, costs, and
benefits; alternative ways of achieving objectives; plus the consequences expected if the
activity is not approved. Managers then assign a rank order to the activities in their
department for the coming year.
2. Evaluate the various activities and rank them in of decreasing benefits to the organization.
Rankings for all organizational activities are reviewed and selecting by top managers.
ii. Bottom-up Budgeting: Other organizations use, a process developing budgets in which
lower-level and middle managers anticipate their departments' resource needs, which are passed
up the hierarchy and approved by top management.
The bottom-up approach builds on the specialized knowledge of operating managers about
environment and marketplace, which they have gleaned from day-to-day operations. In reality,
the budgetary process usually involves a mixture of both styles.
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Budgetary Control
Budgets are the most widely used control system, because the plan and control resources and
revenues are essential to the firm's health and survival.
"The establishment of budgets relating to the responsibilities of executives to the requirements of
a policy and the continuous comparison of actual with budgeted results, either to secure by
individual action the objectives of that policy or to provide a basis for its revision. - ICMA,
England
"Budgetary control is a system which uses budgets as a means of planning and controlling all
aspects of producing and/or selling commodities and services." - J. Batty
The main steps in budgetary control are :
Establishment of budgets for each section of the organization.
Recording of actual performance. In case there is a difference between actual and
budgeted performance taking suitable remedial action
Monitoring of the actual performance with the budget and revise budgets if necessary.
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Example:
The Sales Director of a manufacturing company reports that next year he expect to sell 50,000
units of a particular product.
The production Manager consults the Storekeeper and casts his figures as follows:
Two kinds of raw materials A and B, are required for manufacturing the product. Each unit of the
product requires 2 units of A and 3 units of B. The estimated opening balances at the
commencement of the next year are:
Finished product
:
10,000 units
Raw Materials
A: 12,000 units, B: 15,000 units
The desirable closing balances at the end of the next year are:
Finished product 14,000 units,
A: 13,000 units
B : 16,000 units
Prepare Production Budget and Materials Purchase Budget for the next year
Solution:
PRODUCTION BUDGET (Units)
Estimated sales
Add: Desired closing stock
50,000
14,000
---------64,000
10,000
----------54,000
Estimated Production
13,000
16,000
--------------------------------1,21,000
1,78,000
12,000
15,000
--------------------------------1,09000
1, 63,000
____________________________________________________________________________
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