BIKASH AGARWAL  9831421813 ------------- B.

COM (HONOURS) 3RD YEAR

FINANCIAL ACCOUNTING FOR 2014 EXAMINATION ONLY
THIS IS NOT A SUGESTION. STUDENT SHOULD GO THROUGH EACH AND
EVERY QUESTIONS FOR SCORING GOODS MARKS IN ACCOUNTS.
Generally Accepted Accounting Principles (GAAP)
Financial statement should be prepared on the basis of some widely accepted accounting principles. These
widely accepted accounting principles that are generally recognised by almost all the persons associated with
the accounting along with representation of accepted accounting practices are known as "Generally Accepted
Accounting Principles". It is the summation of all theories, doctrine, conventions or principles closely related
with the accounting which got the global recognition. Conceptually, it may be considered as a guideline for the
fair representation of financial statement. Consequently, GAAP makes the financial statement useful, objectful,
comparable and dependable.
At present, the accountants and the Government of different countries of the world have come forward to co-
ordinate their efforts in reducing international disparity. Consequently, to move with the globalisation, all the
leading countries of the world have to decide to use global accounting standard issued by the International
Accounting standard Committee (IASC).It has been playing a very significant role in the formation of GAAP for
implementation across the countries.

Advantages of GAAP
The following advantages may be derived from GAAP
(1) Harmonisation of Accounting Practices : GAAP helps to remove disparity in accounting practices and policies
adopted by different concerns and bring consistency in reporting information in the financial statement of all
concern. This makes the inter-firm comparison meaningful and practicable. Consequently, performance
evaluation of the concern is possible.
(2) Reduction of Fraud and Mis-representation : GAAP remove the possibility of alternative judgement in the
preparation of Financial statements. As a result, the instance of fraud and mis-representation in the financial
statement has come down considerably.
(3) Standard of Accounting : GAAP are the guidelines created with collective wisdom and experience of the
professional experts. Therefore, adherence to GAAP bring certainty about the betterment in the quality of
accounting.
(4) Faciliting quick recording of daily accounting work : GAAP provides the accountant with handy rules for their
quick recording of daily accounting work. It feels confident and can be able to eliminate the wastage of time in
the deliberation regarding the accounting treatment of complex transactions. As a result, the accountant can
bring out the financial statement in proper time.
(5) Defence against window-dressing : The accountant can neutralise the pressure of preparation of window
dressed financial statement by the management under the umbrella of GAAP
(6) Development of International Capital Market: GAAP provides the framework for the development of the
operational activities of the International Capital Market. Operational activities of a firm can be evaluated on the
basis of some Yardstick followed globally. Therefore, it can easily mobilise fund from international market.

Disadvantages of GAAP :
Following shortcomings are discovered from GAAP
(1) Inflexible Rules : GAAP is formulated on the basis of specific circumstances. Once they are set, are supposed
to be strictly followed. However, due to changing scenario in the modern dynamic business world, GAAP is
gradually losing its effectiveness.
(2) Lack of Uniformity : Industries are diversified from each other. Even firms within the same industry also vary
in their size and operation. Again it is true that all the rules and principles are not evenly applicable to all the
firms within the same industry. Hence it is quite difficult to make accounting practices standardised on the basis
of GAAP
(3) Formulation of GAAP : Formulation of GAAP is not only expensive but also bureaucratic and time consuming
factor. For its enforcement fund is also needed.
(4) Politicization in Standard Setting : Frequently no specific standard has been prescribed for better accounting
and reporting. Cases are not rare where standards are set in the interest of particular group of people, or even
rational standards are often withdrawn just to satisfy the interest of a specific group of persons.
(5) Interpretation facing problem : Selection of standards are done by keeping in view the interests of the groups
in the standard setting committee. Occasionally this will create ambiguity in the functioning of the standard
which may be difficult to interpret.

Relation between Accounting Theory and Accounting Practices:

Accounting Theory is the set of systematic and definite directive principle and methodology as different from
practice. Truly speaking, no theory can be different from its practice which it explains, analyses and attempts to
predict. Thus only those explanation may be considered as theory which makes analysis of the facts and
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predicts accounting practices. The following relation can be established between Accounting theory and
Accounting practices:
i) Cause and Effect Relation: A cause and effect relationship can be built up between accounting theory and
accounting practice. Accounting theory is considered to be as cause while accounting practice as effect.
ii) Target and Path Relation : Accounting is accomplish in a systematic manner by following the accounting
theory. As such, accounting theory may be considered as a target, while path of Accounting practice is followed
to reach such established target.
iii) Science and Art Relation: Like other branches of science, accounting theory is based on certain specific
accounting concepts, principles, hypothesis, conventions and so on. As such, accounting theory is called a
science. On the other hand, accounting practice is an art, because practical accounting is done on the basis of
it.
iv) Changeability Relation: Sometime accounting practices are revised on the basis of prior change of accounting
theory and vice versa.

Fair Value Accounting or Current Purchasing Power of Accounting

The financial statements convey the information relating to the financial transactions occurring at various point
of time. Therefore, during the period of inflation, the different items appearing in the financial statements
acquiring at different point of time representing different purchasing power of monetary unit. The prime
objective of CPP method is to remove the absurdity in the accounting framework created by the changing price
level by restating the information contained in the conventional financial statement in terms of units of general
purchasing power. Another objective of CPP is the reporting of explanations in respect of conversion of
monetary units in term of General Purchasing Power. It expressed all the items of financial statement occurring
at different point of time having different purchasing power into current purchasing power. As such, this method
makes all the items containing in the financial statements bearing the uniform purchasing power at a particular
point of time. Change in the purchasing power of money is followed by change in the price level. Therefore, the
conventional financial accounting which earlier developed on the basis of the assumption of stability in
monetary unit fails to exhibit a true and fair view of the operating performance and financial position of the firm.
CPP method solved this problem and helps to disclose the true profit and financial position of the firm in terms
of current cost. It also helps to separate the portion of profit created by inflationary effect from the read profit.
Similarly, it also helps to indentify the holding gain resulting from holding assets for a period of time. This
method helps to increase the reliability of accounting information and it also helps to remove the absurdity of
accounting information by expressing them in terms of uniform purchasing power at the same point of time.
Needs of Financial Statement Analysis
¾ To obtain better understanding of the firms performance and position
¾ To identify the financial strength and weakness of the firm
¾ To measure interrelationship of the data of financial statement
¾ To check the movement of funds of the firm
¾ To measure operational efficiency
¾ To know the business solvency position
¾ To safeguard interested parties
¾ To know the growth potential of the firm
¾ To check the movements of cash of the firm
¾ To check the short term liquidity of the firm
¾ To have inter firm comparison
¾ To compare the strengths and weaknesses of the firm with the industrial average
¾ To have an intra firm comparison to evaluate the performance of each segments of the business
Parties interested in Financial Statement
Financial statement of a firm does not yield benefit to the firm only, but it also provides utility to many other
related and non related parties, few of them are discussed below:
¾ Owners of the business : The owners of the business are interested in the profitability ratios like Net
profit ratio, operating profit ratio, return on investment, etc. The shareholders are interested in the
ratios like Earning per share, dividend per share, price-earning ratio, yield ratio, etc.
¾ Management : The management of the business would be interested in knowing the financial strengths
and weaknesses of the enterprise for making effective the various avenues like operating, investing,
financing and strategic activities of the business
¾ Workers : The workers of the company are interested in the earning capacity, solvency position of the
business, since their remuneration depends on that.
¾ Creditors and moneylenders : Creditors and moneylenders are interested in the ratios like current ratio,
quick ratio, debt service coverage ratio, interest coverage ratio, etc. They also keen to check the cash
movement of the company.

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BIKASH AGARWAL  9831421813 ------------- B. COM (HONOURS) 3RD YEAR
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¾ Investors : Investors analyses the financial statements to check safety and profitability of their
investments. They are needed to be assured that their investment will be mobilized in safe channels.
¾ Government : The financial statements help the government to know the profit, wealth, production, etc.
of the concern and to determine the income tax liability, wealth tax liability, excise duty, etc. of the
business.
¾ Research Association : Financial statements of the various concerns are gathered and analysed by the
accounting researchers. If any defect is found in the existing system, research is done and new
accounting system and techniques are evolved.
¾ Other users : Financial statement is the source of information regarding an organisation. Various groups
of the society like Chamber of Commerce, Stock Exchange, etc. are immensely benefited by studying
and analyzing this information.
Techniques of Financial Statement Analysis
The following techniques of analysis are generally used:
¾ Comparative Statements
¾ Common-Size Statements
¾ Index Number Trend Analysis
¾ Ratio Analysis
¾ Fund Flow Analysis
¾ Cash Flow Analysis
¾ Cost Volume Profit Analysis
¾ Balanced Scorecard
¾ Multivariate Analysis – Z Scores
¾ A – Scores
¾ H – Scores
Difference between Comparative Statement and Common – size statement
Comparative Statement Common – size Statement
This technique is popularly applied by all the financial This technique is not so popularly applied by
organisation all the financial organisation
Data of two or more years are used Data of one financial year are used
Data are compared horizontally, therefore it is also Data are compared vertically, therefore it is
called horizontal analysis also called vertical analysis
Data are presented in absolute form Data are presented in % form
Data of one year to another year is compared Data of the same financial year is compared
with the data of same year
Importance of Ratio Analysis
The importance of ratio analysis are :
¾ Forecasting and Planning : The trend in costs, sales, profits and other facts can be known by
constructing ratios of relevant accounting figures of last few years.
¾ Budgeting : While preparing budgets of different functions past ratios can be used as guide for
harmonisation among them
¾ Evaluation of Departmental activities : Activities of various departments can be evaluated with the help
of ratios.
¾ Communication : Pertinent informations of the organisation can be more meaningfully communicated to
outsiders with the help of ratios
¾ Measurement of efficiency in utilisation of Assets : The technique of ratio analysis throws light on the
degree of managerial efficiency in utilisation of various assets
¾ Indication of Liquidity position : With the help of ratio analysis, conclusion can be drawn regarding
liquidity position i.e. short term debt paying ability of the firm
¾ Indication of Long Term Solvency position : It is also helpful in assessing the long term solvency position
i.e. long term debt paying capacity of a firm.
¾ Signal of Corporate Sickness : Proper ratio analysis can give signal to corporate sickness in advance.
¾ Formulation of Governmental Plans and Policies : The government takes various plans and policies based
on industrial performance of the country. Ratio are generally used as indicators of performance of
various industries
Limitations of Ratio Analysis
The limitations of ratio analysis are as follows:
¾ Dependence on correct data : The efficiency of ratio analysis depends upon the correctness of
accounting data.

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¾ Incomparability : Inter firm comparison with the help of ratios becomes meaningful only when firms in
question adopt uniform accounting principles and procedures.
¾ Price level changes : The price level changes very often distort trend analysis done with the help of
ratios.
¾ Historical : Ratios are generally computed from past financial statements and are not true indicators of
the future.
¾ Lack of standards : One of the ways of ratio analysis is comparison of actual ratios with the standard
ratios. But fixation of standard ratios is not an easy task.
¾ Solution of real problem not possible : Ratio analysis may only identify the problem but cannot solve the
same.
Concept of Fund
Accountants are not unanimous about the meaning of the term fund. They have interpreted the term in several
ways:
1.) Literal Cash : Some think that fund simply refers to cash available with the firm and demand deposit with
bank.
2.) Net Working Capital : The most popular concept of fund is net working capital. It refers to excess of current
assets over current liabilities. The fund flow statement under this concept depicts the various sources and
uses of working capital and the resulting impact on net working capital during the period.
3.) All Financial Resources : Modern view is to treat “all financial resources” employed in the firm as fund. “All
financial resources” refer to money value of all resources used in the business whether in the form of men,
material, machinery and others.
Difference between Fund Flow Statement and Cash Flow Statement
Fund Flow Statement Cash Flow Statement
It is prepared on accrual basis It is prepared on cash basis
It shows sources of fund and application of fund It shows the inflows and outflows of cash
separately
It deals with all the items of current assets and It deals with only one item of current asset i.e. cash
current liabilities
The statement shows separately cash from The statement shows separately cash from operation,
operation cash from investing activity and cash from financing
activity
It is not governed by any Accounting standard It is governed by Accounting standard – 3 issued by
issued by “The Institute of Chartered Accountants “The Institute of Chartered Accountants of India”
of India”
It is not compulsory but advisory Every listed company and organization having
turnover of 50 crores or more is required to present
Cash Flow statement.

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