- The importance of accounting theory need not be over emphasized as no discipline can develop without a sound theoretical base.
- The theory base of accounting consists of principles, concepts, rules and guidelines developed over a period of time to bring uniformity and consistency to the process of accounting and enhance its utility to different users of accounting information.
- Apart from these, the Institute of Chartered Accountants of India, (ICAI), which is the regulatory body for standardization of accounting policies in the country, has issued Accounting Standards which are expected to be uniformly adhered to, in order to bring consistency in the accounting practices.
Generally Accepted Accounting Principles
- In order to maintain uniformity and consistency in accounting records, certain rules or principles have been developed which are generally accepted by the accounting profession.
- These rules are called by different names such as principles, concepts, conventions, postulates, assumptions and modifying principles.
- The term ‘principle’ has been defined by AICPA as ‘A general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice’.
- The word ‘generally’ means ‘in a general manner’, i.e. pertaining to many persons or cases or occasions.
- Thus, Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial statements.
- This brings in objectivity in the process of recording and makes the accounting statements more acceptable to various users.
- The Generally Accepted Accounting Principles have evolved over a long period of time on the basis of past experiences, usages or customs, statements by individuals and professional bodies and regulations by government agencies and have general acceptability among most accounting professionals.
- However, the principles of accounting are not static in nature. These are constantly influenced by changes in the legal, social and economic environment as well as the needs of the users.
- These principles are also referred as concepts and conventions.
- The term concept refers to the necessary assumptions and ideas which are fundamental to accounting practice, and the term convention connotes customs or traditions as a guide to the preparation of accounting statements.
Basic Accounting Concepts
Systems of Accounting
- The systems of recording transactions in the book of accounts are generally classified into two types, viz. Double entry system and Single entry system.
- Double entry system is based on the principle of “Dual Aspect” which states that every transaction has two effects, viz. receiving of a benefit and giving of a benefit. Each transaction, therefore, involves two or more accounts and is recorded at different places in the ledger. The basic principle followed is that every debit must have a corresponding credit. Thus, one account is debited and the other is credited.
- Double entry system is a complete system as both the aspects of a transaction are recorded in the book of accounts. The system is accurate and more reliable as the possibilities of frauds and misappropriations are minimized. The arithmetic inaccuracies in records can mostly be checked by preparing the trial balance. The system of double entry can be implemented by big as well as small organizations.
- Single entry system is not a complete system of maintaining records of financial transactions. It does not record two-fold effect of each and every transaction.
- Instead of maintaining all the accounts, only personal accounts and cash book are maintained under this system.
- In fact, this is not a system but a lack of system as no uniformity is maintained in the recording of transactions. For some transactions, only one aspect is recorded, for others, both the aspects are recorded.
- The accounts maintained under this system are incomplete and unsystematic and therefore, not reliable. The system is, however, followed by small business firms as it is very simple and flexible.
Basis of Accounting
- From the point of view the timing of recognition of revenue and costs, there can be two broad approaches to accounting. These are:
- Cash basis; and
- Accrual basis.
- Under the cash basis, entries in the book of accounts are made when cash is received or paid and not when the receipt or payment becomes due.
- Under the accrual basis, however, revenues and costs are recognized in the period in which they occur rather when they are paid. A distinction is made between the receipt of cash and the right to receive cash and payment of cash and legal obligation to pay cash. Thus, under this system, the monitory effect of a transaction is taken into account in the period in which they are earned rather than in the period in which cash is actually received or paid by the enterprise.
- This is a more appropriate basis for the calculation of profits as expenses are matched against revenue earned in relation thereto. For example, raw material consumed is matched against the cost of goods sold.
Accounting Standards
- Accounting standards are written statements of uniform accounting rules and guidelines or practices for preparing the uniform and consistent financial statements and for other disclosures affecting the user of accounting information.
However, the accounting standards cannot override the provision of applicable laws, customs, usages and business environment in the country.
- The Institute tries to persuade the accounting profession for adopting the accounting standards, so that uniformity can be achieved in the presentation of financial statements.
- In the initial years the standards are of recommendatory in nature. Once awareness is created about the requirements of a standard, steps are taken to enforce its compliance by making them mandatory for all companies to comply with.
- In case of non-compliance, the companies are required to disclose the reasons for deviations and the financial effect, if any, arising due to such deviation.
International Financial Reporting Standards (IFRSs)
- International Financial reporting Standards (IFRSs) are globally accepted accounting standards developed by International Accounting Standard Board (IASB).
- IFRS is a set of accounting standards for reporting different types of business transactions and events in the financial statements.
- The objective is to facilitate international comparisons for true and fair valuation of a business enterprise. The qualitative characteristics associated with the preparation of financial statements are useful to the users of accounting information in making financial decisions.
Benefits to Convergence to IFRSs
- Easy access to global or international capital markets.
- Easy comparisons and transparency.
- True and fair valuation.
- Increased trust and reliance.
- Eliminates multiple reporting.