ACCOUNTING CONCEPT AND CONVENTIONS

CONCEPTS AND CONVENTIONS OF ACCOUNTING

Definition of Accounting:

Accounting is the art of recording, classifying and summarizing events or transactions in terms of money and interpreting the results thereof.

Type of Accounts:

1. Nominal Account:       Dr. All Expenses and Losses

                                          Cr. All Income and Gains

2. Real Account:             Dr. What Comes in

                                          Cr. What Goes Out

3. Personal Account:      Dr. The Receiver

                                          Cr. The Giver

ACCOUNTING CONCEPTS:

Definition:

Accounting concepts are fundamental thoughts or ideas that underlines or give guidelines to the theory and practices of Accounting.

Different Concepts of Accounting:

1. Money Measurement Concept: This concept means in accounting a record is made only of those events or transactions which can be measured or expressed in terms of money.

Non monetary events which cannot be measured and expressed in monetary terms are ignored.

Eg: Retirement of managing director, quality of the goods and services of the organization.

2. Separate Entity or Business Entity Concept: This concept means that a business undertaking or unit is treated or regarded as different and distinct from its owners or contributors.

Hence under the eyes of law, the owners and the business are two separate entities. Who are capable of entering into transactions with each other.

The books of accounts show only those transactions which are in the nature of business.

3.    Going Concern Concept / Continuity Concept: This concept means that a business will continue to exist and carry on its business operations for an indefinite period in the future.

It implies that an organization has no intention of winding up in the future. The assumption is that the fixed assets are not for the purpose of resale.

4. Cost/Historical Cost Concept: This concept implies that the fixed assets are to be recorded at the price at which it was acquired i.e., cost price.

The market values of such fixed assets are ignored. This concept is based on the principle of objectivity and it prevents giving of an arbitrary value to any fixed asset.

5. Dual Aspect / Equation / Accounting Equation Concept: This concept emphasizes that every business transaction always result in the receiving of some value and the giving of some other benefit of equal value i.e., 2 aspects of a transaction. This is also known as double aspect of accounting. For eg:- When a business purchases goods for cash. It receipts goods of some value and imports cash of the equal value.

6. Accounting Period Concept: This concept means that for measuring the financial results of a business periodically the business life of a concern is divided into convenient short periods of time called accounting periods. The profit or loss and the financial position is ascertained at the end of the accounting period by preparing the financial statement.

The accounting period is generally one year. It may be Calendar year 1^st Jan to 31^st Dec. or financial year 1^st April to 31^st March.

7. Realisation Concept: This concept emphasis that profit should be considered only when it is realized. According  to sale of goods act revenue is earned only when the goods are transferred.

Profit is deemed to have accrued, when the property in good passes to the buyer i.e., when sales are affected and the customer becomes liable to pay.

8. Accrual Concept: This concept implies that when an event or transaction is entered into its consequences will certainly follows for instance, ABC company borrows loan of Rs. 10,000 at 12% P.A. from SBI on 1^st April 2002.

The consequence of this transaction is that he will have to pay an interest of Rs. 1,20,000 at the end of the year i.e., Interest becomes payable.

This concept is concerned with the expected future cash receipts and payments. Eg:- Wages, Salaries, Rent, Interest, etc.

9. Objective Evidence Concept: This concept means that all the accounting entries should be evidenced and supported by source documents such as invoices, vouchers, etc.

This leads to no bias or fraud and the accounts as well as the source documents must be subject to certification by Auditors.

10.      Matching Concept: Profit is the result of 2 factors i.e., 1) Revenue 2) Expenses.

This concept states that only expenses and revenues occurring in respect to a particular financial year is taken into account for that particular period.

This concept requires the proper recognition and allocation of revenues and expenses.

Conventions of Accounting

1. Convention of Conservatism: This convention is an convention of caution or prudence or the policy of playing sale. This convention implies that in the accounting records and the financial statements of a business the prospective losses, risk and uncertainties should be taken note of and provided for, but prospective profits should be ignored “provide for all possible losses but anticipate no profits”. Eg:- Closing stock is valued at cost price or market value which ever is lower. Reserve for bad debts, provision for discount, provision for tax, etc. are made. The nationals behind this convention is that the future is uncertain.

2. Convention of Consistency: This convention that the accounting practices and methods should be consistent from one accounting year to another. For instance, the depreciation method valuation of stock and the treatment of deafened revenue expenditure. The idea behind this convention is that there will be no difficulty in comparing the financial statements year after year. It will also enable that the financial records to show a true picture.

3. Convention of Full Disclosure: This convention means that the material facts must be disclosed, in the financial statement with sufficient details.

For instance, Investments not only the various securities held by the concern, but also the more of valuation should be disclosed.

Fixed Assets – should disclose the cost of acquisition, the depreciation method and the amount of depreciation written of to date.

Contingent liabilities of the business organization should also be disclosed in the financial report.

ACCOUNTING STANDARDS

ACCOUNTING STANDARDS

Accounting Standards are the policy documents or written statements issued, from time to time, by an apex expert accounting body in relation to various aspects of measurement, treatment and disclosure of accounting transactions for ensuring uniformity in accounting practices and reporting. These standards are prepared by Accounting Standard Board (ASB).

Objectives or Purposes of Accounting Standards:

1.    The main purpose of accounting standards id to provide information to the users as to the basis on which the accounts have been prepared and the financial statements have been presented.

2.    Another important objective of accounting standards is to serve the statutory purpose of eliminating the impact of diverse accounting policies and practices and to ensure uniformity in accounting policies & practices, ie, to harmonise the diverse accounting policies & practices which are in use the preparation & presentation of financial statements.

3.    Another objective of accounting standards is to make the financial statements more meaningful and comparable and to make people place more reliance on financial statements prepared in conformity with the accounting standards.

4.    Yet another objective of accounting standards is to guide the judgment of professional accountants in dealing with those items, which are to be followed consistently from year to year.

LIST OF ACCOUNTING STANDARDS                  

AS 1	Disclosure of Accounting Policies
AS 2	Valuation of Inventories
AS 3	Cash Flow Statement
AS 4	Contingencies & Events occurring after Balance Sheet date
AS 5	Net profit or Loss for the Period, Prior period items & changes in accounting policies
AS 6	Depreciation Accounting
AS 7	Accounting for Construction Contracts
AS 8	Accounting for Research & Development
AS 9	Revenue Recognition
AS 10	Accounting for Fixed Assets
AS11	Accounting for effects in changes in Foreign Exchange Rates
AS 12	Accounting for Government Grants
AS 13	Accounting for Investments
AS 14	Accounting for Amalgamations
AS 15	Accounting for Retirement benefits in the Financial Statements of employers
AS 16	Borrowing Cost
AS 17	Segment Reporting
AS 18	Related Party Disclosure
AS 19	Leases
AS 20	Earnings Per Share
AS 21	Consolidated Financial Statements
AS 22	Accounting for taxes on income
AS 23	Accounting for Investments in Associates in consolidated financial statements
AS 24	Discontiuning Operations
AS 25	Interim Financial Reporting
AS 26	Intangible Assets
AS 27	Financial Reporting of Interests in Joint Ventures

MANAGEMENT ACCOUNTING

Introduction to ManagementAccounting

Definitions

The Institute of Chartered Accountants of England states “Any form of accounting which enables a business to be conducted more efficiently can be regarded as management accounting”.

“Management Accounting may be defined as the application of accounting techniques to the provisions of information designed to assist all levels of management in planning and controlling the activities of the firm”.

The Institute of Cost and Works Accountants of India defines Management Accounting as “a system of collection and presentation of relevant economic information relating to an enterprise for planning, controlling and decision-making”

Functions (or objectives) of Management Accounting

Main functions of Management Accounting are as follows:

1. Planning - Information and date provided by management accounting helps management to forecast and prepare short-term and long term plans for the future activities of the business and formulate corporate strategy. For this purpose management accounting techniques like budgeting, standard costing, marginal costing.

2. Coordinating: Management accounting techniques of planning also help in coordinating various business activities. For example, while preparing budgets for various departments like production, sales, purchases, etc., there should be full coordination so that there is no contradiction. By proper financial reporting, management accounting helps in achieving coordination in various business activities and accomplishing the set goals.
3. Controlling: Controlling is a very important function of management and management accounting helps in controlling performance by control techniques such as standard costing, budgetary control, control rations, internal audit, etc.

4. Communication: Management accounting system prepares reports for presentation to various levels of management which show the performance of various sections of the business. Such communication in the form of reports to various levels of management helps to exercise effective control on various business activates and successfully running the business.

5. Financial analysis and interpretation: In order to make accounting data easily understandable, the management accounting offers various techniques of analyzing, interpreting and presenting this data in non-accounting language so that every one in organization understands it. Ratio analysis, cash flow and funds flow statements trend analysis, etc., are some of the management accounting techniques which may be used for financial analysis and interpretation.

6. Qualitative information: Apart from monetary and quantitative data, management accounting provides qualitative information which helps in taking better decisions. Quality of goods, customers and employees, legal judgments, opinion polls, logic, et, are some of the expels of qualitative information supplied and used by the management accounting system for better management.

7. Tax policies: Management accounting system is responsible for tax policies and procedures and supervises and coordinates the reports prepared by various authorities.

8. Decision – making: Correct decision making is crucial to the success of a business. Management accounting has certain special techniques which help management in short team and long term decisions. For example, techniques like marginal costing, differential costing, discounted cash flow, et., help in decisions such as pricing of products, make or buy, discontinuance of a product line, capital expenditure, etc.

Characteristics or Nature of Management Accounting

The task of management accounting involves furnishing of accounting data to the management for basing its decisions on it. It also helps, in improving efficiency and achieving organizational goals. The following are the main characteristics of management accounting:

1. Providing Accounting Information: Management according is based on accounting information. The collection and classification of data is the primary function of accounting department. The information so collected is used by the management for taking policy decisions. Management accounting involves the presentation of information in away it suits managerial needs. The accounting data is used for reviewing various policy decisions. Management accounting is a service function and it provides necessary information to different levels of management.

2. Cause and effect analysis: Financial accounting is limited to the preparation of profit and loss account and finding out the ultimate result, i.e., profit or loss management accounting goes a step further. The ‘cause and effect’ relationship is discussed in management accounting. If there is a loss, the reasons for the loss are probed. If there is a profit, the factors different expenditures, current assets, interest payables, share capital, etc. So the study of cause and effect relationship is possible in management accounting.

3. Use of Special Techniques and concepts: management accounting uses special techniques and concepts to make accounting data more useful. The techniques usually used include financial planning and analysis, standard costing, budgetary control, marginal costing, project appraisal, control accounting, etc. The type of technique to be used will be determined according to the situation and necessity.

4. Taking Important Decisions: Management accounting helps in taking various important decisions. It supplies necessary information to the management which may base its decisions on it. The historical data is studied to see its possible impact on future decisions. The implications of various alternative decisions are also taken into account while taking important decisions.

5. Achieving of Objectives: In management accounting, the accounting information is used in such a way that it helps in achieving organizational objectives. Historical data is used for formulating plans and setting up objectives. The recording of actual performance and comparing it with targeted figures will give an idea to the management about the performance of various departments. In case there are deviations between the standards set and actual performance of various departments corrective measures can be take at one. All this is possible with the help of budgetary control and standard costing.

6. Increase in Efficiency: The purpose of using accounting information is to increase efficiency of the concern. The efficiency can be achieved by setting up goals for each department. The performance appraisal will enable the management to pin point efficient and inefficient spots. An effort is made to take corrective measures so that efficiency is improved. The constant review of working will make the staff cost – conscious. Every one will try to control cost on one’s own part.

7. Supplies Information and not decision: The management accountant supplies information to the management. The decisions are to be taken by the top management. The information is classified in the manner in which it is required by the management. management accountant is only to guide and not to supply decisions. ‘How is the data to be utilized’ will depend upon the caliber and efficiency of the management.

8. Concerned with forecasting: The management accounting is concerned with the future. It helps the management in planning and forecasting. The historical information is used to plan future course of action.

Scope Of Management Accounting

1. Financial Accounting: Financial Accounting deals with the historical data. The recorded facts about an organization are useful for planning the future course of action. Though planning is always for the future but still it has to be based on past and present data. The control aspect too is based on financial data. The performance appraisal is based on recorded facts and figures. So management accounting is closely related to financial accounting.

2. Cost Accounting: Cost Accounting provides various techniques for determining cost of manufacturing products or cost of providing service. It uses financial data for finding out cost of various jobs, products or processes. The systems of standard costing, marginal costing, differential costing and opportunity costing are all helpful to the management for planning various business activities.

3. Financial Management: Financial Management is concerned with the planning and controlling of the financial resources of the firm. It deals with raising of funds and their effective utilization so to maxmise earnings. Finance has become so important for every business that all managerial activities are connected with it. Financial viability of various propositions influence decisions on them. Therefore management accounting includes and extends to the operation of financial management also.

4. Budgeting and Forecasting: Budgeting means expressing the plans, policies and goals of the enterprise for a definite period in future. The targets are set for different departments and responsibility is fixed for achieving these targets. The comparison of actual performance with budgeted figures will give an idea to the management about the performance of different departments. Forecasting, on the other hand, is a prediction of what will happen as a result of a given set of circumstances. Both budgeting and forecasting are useful for management accountant in planning various activities.

5. Inventory Control: Inventory is used to denote stock of raw materials, goods in the process of manufacture and finished products. Inventory has a special significance in accounting for determining correct income for a given period. Inventory control is significant as it involves large sums. The management should determine different levels of stocks, ie. minimum level, maximum level, re- ordering level for inventory control. The control of inventory will help in controlling costs of products. Management accountant will guide management as to when and from where to purchase and how much to purchase. So the study of inventory control will be helpful for taking managerial decisions.

6. Reporting to Management: One of the functions of management accountant is to keep the management informed of various activities of the concern so as to assist it in controlling the enterprise. The reports are presented in the form of graphs, diagrams, index numbers or other statistical techniques so as to make them easily understandable. The management accountant sends interim reports to the management and these reports may be monthly, quarterly, half – yearly. The reports may cover profit and loss statement, cash and found flow statements, stock reports, absentee reports and reports on orders in hand, etc. These reports are helpful in giving a constant review of working of the business.

7. Interpretation of Data: The management accountant interprets various financial statements to the management. These statements give an idea about the financial and earning position of the concern. These statements may be studied in comparison to statements of earlier periods or in comparison with the statements of similar other concerns. The significance of these report is explained to the management in a simple language. If the statements are not properly interpreted then wrong conclusions may be drawn. So interpretation is also important as compiling of financial statements.

8. Control procedures and Method: Control procedures and methods are needed to use various factors of production in a most economical way. The studies about cost, relationship of cost and profits are useful for using economic resources efficiently and economically.

9. Internal Audit: Internal audit system is necessary to judge the performance of every department. The actual performance of every department and individual is compared with the pre-determined standards. Management is able to know deviations in performance. Internal audit helps management in fixing responsibility of different individuals.

10. Tax Accounting: In the present complex tax systems, tax planning is an important part of management accounting. Income statements are prepared and tax liabilities are calculated. The management is informed about the tax burden from central government, state government and local authorities. Various tax returns are to be filed with different departments and tax payments are to be made in time. Tax accounting comes under the purview of management accountant’s duties.

11. Office services: Management accountant may be required to control an office. He will be expected to deal with data processing, filing, copying, duplicating, communicating etc. He will also be reporting about the utility of different office machines.

Relationship between Financial Accounting and Management Accounting

Financial accounting and management accounting are two major sub-systems of accounting information system. Both are concerned with revenues and expenses, assets and liabilities and cash flows. Both therefore involve financial statements. But the major differences between the two arise because they serve different audiences. The main points of difference between the two are as follows:

Basis	Financial Accounting	Management Accounting
1. External and  Internal users	Financial accounting information is mainly intended for external users like investors, shareholder, creditors, Govt. authorities etc.	Management accounting information is mainly meant for internal user, i.e., management
2. Statutory requirements	Under company law and tax law, financial accounting is obligatory to satisfy various statutory provisions.	Management accounting is optional though its utility makes it highly desirable to adopt it.
3. Analysis of cost and profit	Financial accounting shows the profit / loss of the business as a whole. It does not show the cost and profit for individual products, processes or departments, etc.	Management accounting provides detailed information about individual products, plants, departments or any other responsibility centre.
4.Past and future data	It is concerned with recording transactions, which have already taken place, i.e., it represents past or historical records.	It is future oriented and concentrates on what is likely to happen in future though it may use past data for future projections.
5. Periodic and continuous reporting	Financial reports, i.e., Profit and Loss account and Balance Sheet are prepared usually on a year to year basis.	Management accounting reports are prepared frequently, i.e, these may be monthly, weekly or even daily depending on managerial requirements
6. Accounting standards	Companies are required to prepare financial accounts according to accounting standards issued by the Institute of chartered accountants of India.	Management accounting is not bound by accountings standards. It may use any practice which generates useful information to management.
7.Types of statements prepared	Financial accounting prepares general purpose statements Profit & Loss account and Balance sheet which are used by external users.	In Management accounting special purpose reports are prepared, eg,, performance report of sales manager or any other department manager which are used by top level Management.
8.Pubilcation and audit	Financial statements, i.e., P&L A/c and Balance sheet are published for general public use and also sent to share holders. These are required to be audited by the chartered Accountants.	Management accounting statements are for internal use and thus neither published for general public use nor these are required to be audited by chartered accountants.
9 Monetary and non monetary measurements.	Financial accounting provides information in terms of money only.	Management accounting may apply monetary or non monetary units of measurements for example information may be expressed in terms of Rs. or units of quantity, machine hours, labour hours, etc.

Relationship between Cost Accounting and Management Accounting

 The distinction between cost accounting and management accounting may be made on the following points:

Basis	Cost Accounting	Management Accounting
1. Scope	Scope of cost accounting is limited to providing cost information for managerial uses.	Scope of management accounting is broader than that of cost accounting as it provides all types of information, i.e., cost accounting as well as financial accounting information for managerial uses.
2. Emphasis	Main emphasis is on cost ascertainment and cost control to ensure maximum profit.	Main emphasis is on planning, controlling and decision – making to maximize profit.
3.Techniques employed	Various techniques used by cost accounting include standard costing and variance analysis, marginal costing and cost volume profit analysis, budgetary control, uniform costing and inter-firm comparison, etc.	Management accounting also uses all these techniques used in cost accounting but in addition it also uses techniques like ratio analysis, funds flow statement, statistical analysis operations research and certain techniques from various branches of knowledge like mathematics, economics, etc. which so ever can help management in its tasks
4. Evolution	Evolution  of cost accounting is mainly due to the limitations of financial accounting	Evolution management accounting is due to the limitations of cost accounting. In fact, management accounting is an extension of the managerial aspects of cost accounting.
5. Statutory requirements	Maintenance of cost records has been made compulsory in selected industries as notified by the Govt. from time to time.	Management accounting is purely voluntary and its use depends upon its utility to management.
6.Data base	It is based on data derived from financial accounts	It is based on data derived from cost accounting, financial accounting and other sources.
7.Status in  organization	In the organizational set up, cost accountant is placed at a lower level in hierarchy than the management accounting	Management accounting is generally placed at a higher level of hierarchy than the cost accounting
8.Installation	Cost accounting system can be installed without management accounting	Management accounting cannot be installed without a proper system of cost accounting.

The Management Accountant

Management accounting provides significant economic and financial data to the Management and the Management Accountant is the channel through which this information efficiently and effectively flows to the Management.

            The Management Accountant has a very significant role to perform in the installation, development and functioning of an efficient and effective management accounting system. He designs the frame work of the financial and cost control reports that provide each managerial level with the most useful data at the most appropriate time. He educates executives in the need from control information and ways of using it. His position is unique with respect to information about the organization. Apart from top management no one in the organization perhaps knows more about the various functions of the organization than him. He is as the chief intelligence officer or financial advisor or financial controller of the management. He gathers information, breaks it down, sifts it out and organizes it into meaningful categories. He separates relevant and irrelevant information and then ranks relevant information according to degree of importance to management. He reports relevant information in an intelligible form to the management and sometimes also to those who are interested in the information outside the company. He also compares the actual performance with the planned one and reports and interprets the results of operations to all levels of management and to the owners of the business.

 

Functions of the Management Accountant

It is the duty of the management accountant to keep all levels of management informed of their real position. He has, therefore, varied functions to perform. His important functions can be summarized as follows:

1. Planning: He has to establish, coordinate and administer as an integral part of management, an adequate plan for the control of the operations. Such a plan would include profit planning, programmes of capital investment and financing sales forecasts, expense budgets and cost standards.
2. Controlling: he has to compare actual performance with operating plans and standards and to report and interpret the results of operations to all levels of management and the owners of the business. This is done through the compilation of appropriate accounting and statistical records and reports.
3. Coordinating: He consults all segments of management responsible for policy or action. Such consultation might concern any phases of the operation of the business having to do with attainment of objectives and the effectiveness of the organization structures and policies.
4. Other Functions:
1. He administers tax policies and procedures.
2. He supervises and coordinates the preparation of reports to government agencies.
3. He ensures fiscal protection for the assets of the business through adequate internal control and proper insurance coverage.
4. He carries out continuous appraisal of economic and social forces, and the government influences, and interprets their effect on the business.

Questions

(2 marks)

1)    Define Management Accounting

2)    List few functions of Management accounting

3)    State two differences between Management accounting & financial accounting

4)    State two differences between Management accounting and cost accounting

5)    What are the duties of a management accountant?

6)    Name any 5 techniques of management accounting.

7)    State any 3 objectives of management accounting

(8 & 15 marks)

1)    Define management accounting & explain its objectives.

2)    Discuss in detail the nature & scope of management accounting

3)    Management accounting is nothing more than the use of financial information for management purposes. Explain this statement & clearly distinguish between management accounting and financial accounting.

4)    Who is a management accountant? Explain his role & functions in an organisation.