Theory Base of Accounting, AS and IFRS

Chapter 3
Theory Base of Accounting,
Accounting Standards and
International Financial Reporting Standards
(IFRS)

Theory Base of Accounting, AS and IFRS

Learning Objectives
This chapter enables you to understand:
1. Meaning and Nature of Accounting Principles
2. Features of Accounting Principles
3. Necessity of Accounting Principles
4. Fundamental Accounting Assumptions
a. Going Concern
b. Consistency
c. Accrual

Theory Base of Accounting, AS and IFRS

Learning Objectives
5. Accounting Principles or Concepts
a. Accounting Entity b. Money Measurement
c. Accounting Period d. Full Disclosure
e. Materiality f. Prudence or Conservatism
g. Cost h. Matching
i. Dual Aspect j. Revenue Recognition
(Realisation)
k. Verifiable Objective

Theory Base of Accounting, AS and IFRS

Learning Objectives
6. Accounting Standards

a. Meaning of Accounting Standards

b. Nature of Accounting Standards
c. Utility of Accounting Standards
d. Accounting Standards issued by the Accounting
Standards Board of the Institute of Chartered
Accountants of India

7. IFRS (International Financial Reporting

Standards)

Theory Base of Accounting, AS and IFRS

MEANING AND NATURE OF ACCOUNTING PRINCIPLES

"Principles of Accounting are the general law or rule

adopted or proposed as a guide to action, a settled
ground or basis of conduct or practice."
-The American Institute of Certified Public Accountants

Accounting Principles are the rules of action or

conduct adopted by accountants universally while
recording accounting transactions. They are the
norms or rules which are followed in treating various
items of assets, liabilities, expenses, incomes, etc.

Theory Base of Accounting, AS and IFRS

MEANING AND NATURE OF ACCOUNTING PRINCIPLES

These principles are classified into two categories:

1. Accounting Concepts;
2. Accounting Conventions.

Theory Base of Accounting, AS and IFRS

Accounting Concepts
Accounting Concepts are the basic assumptions or
fundamental propositions within which accounting
operates. They are generally accepted accounting
rules based on which transactions are recorded and
financial statements are prepared. It is important to
follow the accounting concepts because it will enable
the users of financial statements to understand them
better and in the same manner

Theory Base of Accounting, AS and IFRS

Accounting Conventions
Accounting Conventions are the outcome of
accounting practices or principles being followed by
the enterprises over a period of time. Conventions
may undergo a change with time to bring about
improvement in the quality of accounting information.

Theory Base of Accounting, AS and IFRS

FEATURES OF ACCOUNTING PRINCIPLES

Accounting Principles are

Man-Made
Flexible and
Generally Accepted

Theory Base of Accounting, AS and IFRS

NECESSITY OF ACCOUNTING PRINCIPLES

Accounting information is better understood if it is

prepared following the set of uniform accounting
principles.
It means the same Accounting Principles are
followed by all entities in preparing their final
accounts.
Accounting information is meaningful and useful for
its users if the accounting records and financial
statements are prepared following generally
accepted accounting information in standard forms
which are easily understandable.

10

Theory Base of Accounting, AS and IFRS

FUNDAMENTAL ACCOUNTING ASSUMPTIONS OR
CONCEPTS

Fundamental Accounting Assumptions or Concepts

are the assumptions which are presumed to have
been followed in preparing the annual accounts.
The Fundamental Accounting Assumptions are:
1. Going Concern Assumption
2. Consistency Assumption; and
3. Accrual Assumption.

11

Theory Base of Accounting, AS and IFRS

FUNDAMENTAL ACCOUNTING ASSUMPTIONS OR CONCEPTS

Going Concern Assumption

According to the Going Concern Concept it is
assumed that business shall continue for a
foreseeable period and there is no intention to close
the business or scale down its operations
significantly.
It is because of this concept that a distinction is
made between capital expenditure, i.e., expenditure
that will render benefit for a long period and revenue
expenditure, i.e., one whose benefit will be
exhausted quickly, say, within the year.

12

Theory Base of Accounting, AS and IFRS

FUNDAMENTAL ACCOUNTING ASSUMPTIONS OR CONCEPTS

Consistency Assumption
According to the Consistency Assumption,
accounting practices once selected and adopted,
should be applied consistently year after year.
The concept helps in better understanding of
accounting information and makes it comparable (a
qualitative characteristic of accounting information)
with that of previous years.

13

Theory Base of Accounting, AS and IFRS

FUNDAMENTAL ACCOUNTING ASSUMPTIONS OR CONCEPTS

Accrual Assumption
According to the Accrual Assumption, a transaction is
recorded at the time when it takes place and not
when the settlement takes place.
The concept is particularly important because it
recognises the assets, liabilities, incomes and
expenses as and when transactions relating to it are
entered into.

14

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Accounting Entity or Business Entity Principle:
According to the Business Entity principle, business
is considered to be separate and distinct from its
owners.
Business transactions, therefore, are recorded in the
books of accounts from the business point of view
and not that of its owners.
Owners being considered separate and distinct from
business, are creditors of the business to the extent
of their capital.

15

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Money Measurement Principle:
According to the Money Measurement Principle,
transactions and events that can be measured in
money terms are recorded in the books of accounts
of the enterprise.
Consider that an enterprise has 6 trucks and 10,000
sq. yards land. These assets cannot be added and
shown in the Financial Statements unless their
monetary value is ascertained.

16

Theory Base of Accounting, AS and IFRS

Money Measurement Principle
The principle suffers from two major limitations:
1. Transactions and events that cannot be
measured in money terms are not recorded,
howsoever important they may be to the
enterprise.
2. The yardstick of measurement, i.e., money is
considered as having static value as the
transactions are recorded at the value on the
transaction date.

17

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Accounting Period Principle:
According to the Accounting Period Principle, the life
of an enterprise is broken into smaller periods so that
its performance is measured at regular intervals.
The periodical information is important and is
required by the Management, Shareholders,
Creditors, Bank and Government.

18

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Full Disclosure Principle:
According to the Principle of Full Disclosure, there
should be complete and understandable reporting on
the financial statements of all significant information
relating to the economic affairs of the entity.
Whether information should be disclosed or not
always depends on the materiality of the information.
The Companies Act, 1956 provides for disclosures
(termed as legally required disclosures) yet there
may be many material information which if disclosed
will make the financial statements more meaningful.

19

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Materiality Principle:
The Materiality Principle refers to the relative
importance of an item or an event.
According to the American Accounting Association,
"an item should be regarded as material if there is a
reason to believe that knowledge of it would
influence the decision of an informed investor.
Thus, whether an item is material or not shall depend
on its nature and/or amount.

20

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Prudence or Conservatism Principle:
The Prudence Principle is many a times described
using the phrase "Do not anticipate profits, but
provide for all possible losses."
In other words, it takes into consideration all
prospective losses but not the prospective profits.
The application of this concept ensures that the
financial statements present a realistic picture of the
state of affairs of the enterprise and do not paint a
better picture than what actually is.

21

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES

Cost Concept or Historical Cost Principle:

According to the Cost Concept, an asset is recorded in
the books of accounts at the price paid to acquire it and
the cost is the basis for all subsequent accounting of the
asset.
Asset is recorded at cost at the time of its purchase but is
systematically reduced in value by charging depreciation.
The market value of an asset may change with the
passage of time but for accounting purposes it continues
to be shown in the books of accounts at its book value
(i.e., cost at which it was purchased minus depreciation
provided up-to-date).

22

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Matching Concept or Principle:
According to the Matching Concept, cost incurred to
earn revenue is recognised as expense in the period
in which related revenue is recognised as earned.
Since the accounts are usually prepared on accrual
basis, the expenses incurred in an accounting period
are matched with the revenues recognised in that
period.

23

Theory Base of Accounting, AS and IFRS

Matching Concept or Principles

The Matching Concept operates as follows:

1. When an item of revenue is recognised as income all related
expenses incurred (whether paid or not) are also recognised as
expense.
2. If an expense is incurred against which the revenue will be
earned in the next period, the amount is carried to the next
period (and shown in the Balance Sheet as an asset) and then
in next year, it is treated as an expense.
3. If an amount of revenue is received during the year but against
it a service is to be rendered or goods are to be sold in the next
year, the amount received will be treated as revenue in the next
year after the services have been rendered or the goods have
been sold. In current year it will be shown as a liability.

24

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Dual Aspect or Duality Principle:
According to the Dual Aspect Concept, every
transaction entered into by an enterprise has two
aspects, a debit and a credit of equal amount. Simply
stated, for every debit there is a credit of equal
amount in one or more accounts. It is also true vice
versa.
Thus we can say
Capital + Claim of Outsiders = Assets

25

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Revenue Recognition Concept:
According to the Revenue Recognition Concept,
revenue is considered to have been realised when a
transaction has been entered into and the obligation
to receive the amount has been established.

26

Theory Base of Accounting, AS and IFRS

ACCOUNTING PRINCIPLES
Verifiable Objective Concept:
The Verifiable Objective Concept holds that
accounting should be free from personal bias.
Measurements that are based on verifiable
evidences are regarded as objective. It means all
accounting transactions should be evidenced and
supported by business documents. These supporting
documents are cash memo, invoices, sales bills,
etc., and they provide the basis for accounting and
audit.

27

Theory Base of Accounting, AS and IFRS

Accounting Standards
The Accounting Standards are a set of guidelines,
known as Generally Accepted Accounting Principles
(GAAP), issued by the accounting body of the
country such as The Institute of Chartered
Accountants of India. These principles i.e. GAAP are
followed for preparation and presentation of
Financial Statements.
They are accounting rules and procedures relating to
measurement, valuation and disclosure issued by
the Council of the Institute of Chartered Accountants
of India.

28

Theory Base of Accounting, AS and IFRS

Accounting Standards

Nature
1. Accounting Standards are guidelines providing the framework so
that credible Financial Statements can be produced/prepared.
2. The objective of Accounting Standards is to bring uniformity in
accounting practices and to ensure transparency, consistency
and comparability.
3. Accounting Standards are prepared keeping in view the
business environment and laws of the country.
4. Accounting Standards are mandatory in nature.
5. Accounting Standards have also been made flexible, that is to
say, where alternative accounting practices are acceptable, an
enterprise is free to adopt any of the practices with a suitable
disclosure

29

Theory Base of Accounting, AS and IFRS

Utility
1. Accounting Standards provide the norms on the basis
of which financial statements should be prepared.
2. Accounting Standards ensure uniformity in the
preparation and presentation of financial statements by
removing the effect of diverse accounting practices.
3. Accounting Standards create a sense of confidence
among the users of accounting information.
4. Accounting Standards help auditors in auditing the
accounts.

30

Theory Base of Accounting, AS and IFRS

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Globalisation integrates the national economies into the international

economy through trade, foreign direct investments, capital flow etc. In
this age of globalisation and technology, enterprises carry businesses
globally.
It is difficult to understand and compare global financial information
without a common set of accounting and financial reporting standards.
The use of a single set of high quality accounting standards would
facilitate investment and other economic decisions across borders,
increase market efficiency and reduce the cost of capital. Thus,
International Accounting Standards (lAS) were developed, which are
being withdrawn or superseded by International Financial Reporting
Standards (IFRS).

31

Theory Base of Accounting, AS and IFRS

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Objectives of ISB
(i) To develop, in the public interest, a single set of high-quality,
understandable, and enforceable global accounting .
(ii) To promote the use and rigorous application of those
standards; and
(iii) In fulfilling the objectives associated with (i) and (ii), to take
account of, as appropriate, the special needs of small and
medium-sized entities and emerging economies; and
(iv) To bring about convergence of national accounting
standards and International Financial Reporting Standards to
high-quality solutions.

32

Theory Base of Accounting, AS and IFRS

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Meaning
IFRS are a set of accounting standards developed by the
International Accounting Standards Board (IASB), the international
accounting standardsetting body.
IASB places emphasis on developing standards based on sound
and clearly stated principles, interpretation of which is essential.
Therefore, IFRS are referred to as principles-based accounting
standards.
This contrasts with sets of standards, like Indian Accounting
Standards, which significantly contains more of application guidance.
These standards are often referred to as rule-based accounting
standards.

33

Theory Base of Accounting, AS and IFRS

Assumptions in IFRS
1. Accrual Assumption: The transactions are
recorded in the books of accounts on accrual basis .

2. Going Concern Assumption: It is assumed that the

life of the business is infinite.
3. Measuring Unit Assumption: Measuring unit for
valuation of capital is the current purchasing power. 4.
Constant Purchasing Power Assumption: Constant
Purchasing Power means value of capital be adjusted
to inflation in the economy at the end of the financial
year.

34

Theory Base of Accounting, AS and IFRS

IFRS Based Financial Statement

The financial Statements prepared under IFRS
are:
1. Statement of Financial Position
2. Statement of Comprehensive Income
3. Statement of Changes in Equity
4. Statement of Cash Flow
5. Notes and Significant Accounting Policies

35

Theory Base of Accounting, AS and IFRS

Benefits of IFRS
IFRS are important for entities that have global
network of businesses, investors and lenders. A
single accounting standard provides all stakeholders
a cohesive view of finances. IFRS shall be helpful to
the economy at large,
investors,
industry, and
accounting professionals.

36

Theory Base of Accounting, AS and IFRS

Difference Between IFRS and Indian GAAP

1. IFRS are Principle based while Indian GAAP or

Accounting Standards are Rule Based
2. IFRS are based on Fair Value Concept while
Indian GAAP or Accounting Standards are based
on Historical Cost Concept.
3. Apart from the above two principal differences
there are differences in a number of areas like,
Revenue Recognition, Inventory Valuation in
Service Sector, Accounting for Taxes on Income
etc.

37

Theory Base of Accounting, AS and IFRS

Indian IFRS

India had two options, i.e. either to adopt IFRS as they

are or converge the Indian Accounting Standards in line
with the IFRS. It decided to converge its existing
accounting standards with IFRS.
The converged accounting standards titled Ind - AS have
been issued and notified.
It should be understood that the existing Indian
Accounting Standards shall not cease to be applicable
standards. They will continue to apply on entities that are
not required to migrate to Ind - AS. However, if the
entities that are not required to migrate to Ind AS, may
adopt them voluntarily.

38

Basic Accounting Terms

39