GAAP

Generally Accepted Accounting Principles:-

A widely accepted set of rules, conventions, standards, and procedures for reporting financial information as established by the Financial Accounting standards Board are called Generally Accepted Accounting principles ( GAAP).  These are the common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information.

GAAP is to be followed by companies so that investors have a optimum level of consistency in the financial statements they use when analyzing companies for investment purposes.  GAAP cover such aspects like revenue recognition, balance sheet item classification and outstanding share measurements.

Accounting concepts and Conventions:

As seen earlier, the accounting information is published in the form of financial statements.  The three basic financial statements are

i.                     The profit & Loss Account that shows net business result i.e. profit or loss for a certain periods.

ii.                   The balance sheet that exhibits the financial strength of the business as on a particular dates

iii.                  The cash flow statement that describes the movement of cash from one date to the other.

As these statements are meant to be used by different stakeholders, it is necessary that the information contained therein is based on definite principles, concrete concepts and well accepted convention.

Accounting principles are basic guidelines that provide standards for scientific accounting practices and procedures.  They guide as to how the transaction are to be recorded and reported.  They assure uniformity and understandability.  Accounting concepts lay down the foundation for accounting principles.  They are ideas essentially at mental level and are self-evident.  These concepts ensure recording of financial facts on sound bases and logical considerations.  Accounting conventions are methods or procedures that are widely accepted. 

Professional Accounting Bodies have published statement of these concepts.  Over years, many of these concepts are being challenged as outlived.  Yet, no major deviations have been made as yet.  Path breaking ideas have emerged and the accounting standards of modern days do require companies to record and report transaction which may not be necessarily based on concepts that are in vogue for long.

It is essential to study accounting from the basic levels and understand these concepts in entirely.

A.      BASIC ASSUMPTIONS

1.       Business entity concept:-  As per this concept, the business is treated as distinct and separate from the individuals who own or manage it.  For example, if the owner pays his personal expenses from business cash, this transaction can be recorded in the books of business entity.  This transaction will take the cash out of business and also reduce the obligation of the business towards the owners.

The entity concept requires that all the transactions are to be viewed, interpreted and recorded from ‘business entity’ point of view.  An accountant steps into the shoes of the business entity and decides to account for the transactions.  The owner’s capital is the obligation of business and it has to be paid back to the owner in the event of business closure.  Also, the profit earned by the business will belong to the owner and hence is treated as owner’s equity.

2.       Going concern Concept:- The basic principles of this concept is that business is assumed to exist for an indefinite period and is not established with the objective of closing it down.  So unless there is good evidence to the contrary, the accountant assumes that a business entity is a ‘going concern’- that it will continue to operate as usual for a longer period of time.  It will keep getting money from its customers, pay its creditors, buy and sell goods, use assets to earn profits in future.  If this assumption is not considered, one will have to constantly value the worth of the assets and resource.  This is not practicable.  This concept enables the accountant to carry forward the values of assets and liabilities from one accounting period to the other without asking the question about usefulness and worth of the assets and recoverability of the receivables.

The going concern concept forms a sound basis for preparation of a balance sheet.

3.       Money measurement concept:- A business transaction will always be recoded if it can be expressed in terms of money.  The advantage of this concept is that different types of transactions could be recorded as homogenous entries with money as common denominator.  A business may own Rs.3 laks cash, 1500kgs of raw material,10 vehicles, 3 computers etc.  Unless each of these is expressed in terms of money, we cannot find out the assets owned by the business.  When expressed in the common measure of money, transaction could be added or subtracted to find out the combined effect.  In the above example, we could add values of different assets to find the total assets owned.

The application of this concept has a limitation.  When transactions are recorded in terms of money, we only consider the absolute value of the money.  The real value of the money may fluctuate from time to time due to inflation, exchange rate changes, etc.  This fact is not considered when recording the transaction.

4.       The accounting period concept: This period is usually one year, which could be a calendar year i.e. 1^st January to 31^st December or it could be a fiscal year in India as 1^st April to 31^st march.  The business organizations have the freedom to choose their own accounting year.  For certain organizations, reporting of financial information in public domain are compulsory.  In India, listed companies must report their quarterly unaudited financial results and year audited financial statements.  For internal control purpose, many organizations prepare monthly financial statements.  The modern computerized accounting systems enable the companies to prepare real-time online financials at the click of button.

Businesses are living, continuous organisms.  The splitting of the continuous stream of business events into time period is thus somewhat arbitrary.  There is no significant change just because one accounting period ends and a new one begins.  This results into the most difficult problem of accounting of how to measure the net income for an accounting period.  One has to be careful in recognizing revenue and expenses for a particular accounting period.  Subsequent section on accounting procedures will explain how one goes about it in practice.

5.       The accrual concept:  The accrual concept is based on recognition of both cash and credit transactions.  In case of a cash transaction, owner’s equity is instantly affected as cash either is received or paid.  In a credit transaction, however, a mere obligation towards or by the business is created.  When credit transactions exist (which is generally the case), revenues are not the same as cash receipts and expenses are not same as cash paid during the period.

When goods are sold on credit as per normally accepted trade practices, the business gets the legal right to claim the money from the customer.  Acquiring such right to claim the consideration for sale of goods or services is called accrual of revenue.  The actual collection of money from customer could be at a later date.

Similarly, when the business procures goods or services with the agreement that the payment will be made at a future date, it does not mean that the expense effect should not be recognized.  Because an obligation to pay for goods or services is created upon the procurement thereof, the expense effect also must be recognized.

Today’s accounting systems based on accrual concept are called as Accrual System or Mercantile system of Accounting.

A.      BASIC PRINCIPLES

a.       The revenue realization Concept:

It says amount should be recognized only to the tune of which it is certainly realizable.  Thus, mere getting an order from the customer won’t make it eligible to recognize as revenue.  The reasonable certainty of realizing the money will come only when the goods ordered are actually supplied to the customer and he is billed.  This concept ensures that income unearned or unrealized will not be considered as revenue and the firms will not inflate profits.

Consider that a store sales goods for Rs.25 lacs during a month on credit.  The experience and past data shows that generally 2% of the amount is not realized.  The revenue to be recognized will be Rs.24.5lacs.  Although conceptually the revenue to be recognized at this value, in practice the doubtful amount of Rs.50 thousand (2% of Rs.25 lacs) is often considered as expense.

b.      The matching concept:

As we have seen the sale of goods has two effects: (i) a revenue effect, which results in increase in owner’s equity by the sales value of the transaction and (ii) an expense affect, which reduces owner’s equity by the cost of goods sold, as the goods go out of the business.  The net effect of these two effects will reflect either profit or loss.  In order to correctly arrive at the net result, both these aspects must be recognized during the same accounting period.  One cannot recognize only the revenue effect thereby inflating the profit or only the expense effect which will deflate the profit.  Both the effects must be recognized in the same accounting period.  This is the principle of matching concept.

To generalize, when a given event has two effects – one on revenue and the other on expense, both must be recognized in the same accounting period.

c.       Full disclosure Concept:

As per this concept, all significant information must be disclosed.  Accounting data should properly be clarified, summarized, aggregated and explained for the purpose of presenting the financial statement which are useful for the user of accounting information.  Practically, this principle emphasized on the materiality, objectivity and consistency of accounting data which should disclose the true and fair view of the state of affairs of a firm.  This principle is going to be popular day by day as per companies act, 1956 major provisions for disclosure of essential information about accounting data and as such, concealment of material information, at present, is not very easy.  Thus, full disclosure must be made for such material information which are useful to the users of accounting information.

d.      Dual Aspect Concept:

The assets represent economic resources of the business, whereas the claims of various parties on business are called obligations.  The obligations could be towards owners (called as owner’s equity) and towards parties other than the owners (called as liabilities)

When a business transaction happens, it will involve use of one or the other resource of the business to create or settle one or more obligations.  E.g. consider Mr.Ramesh starts a business with the investment of Rs.20 lacs.  Here, the business has got a resource of cash worth Rs.20 lacs (which is its asset), but at the same time it has created an obligation of business towards Mr.Ramesh that in the event of business closure, the money will be paid back to hime.  This could be shown as:

        Assets = Liabilities + Capital

This is the fundamental accounting equation shown as formal expression of the dual aspect concept.  This powerful concept recognizes that every business transaction has dual impact on the financial posting.  Accounting systems are set up to simultaneously record both these aspects of every transaction; that is why it is called as Double-entry system of accounting.  In its as present form the double entry system of accounting owes its existence to an Italian expert Mr.Luca Pacioli in the year 1495.

Continuing with our example Mr.Ramesh, now let us consider he borrows Rs.10 lacs from bank.  The dual aspect of this transaction  - on one hand the business cash will increase by Rs.10 lacs and a liability towards the bank will be created for Rs.10lacs.

The student must note that the dual aspect concept entails recognition of the two effect of each transaction.  These effects are of equal amount and reverse in nature.  How to decide these two aspects? After recording both aspects of the transaction, the basic accounting equation will always balance or be equal.

e.      Verifiable Objective Evidence Concept:-

Under this principle, accounting data must be verified.  In other words, documentary evidence of transaction must be made which are capable of verification by an independent respect.  In the absence of such verification, the data which will be available will neither be reliable nor dependable, i.e., these should be biased data.  Verifiability and objectivity express dependability, reliability and trustworthiness that are very useful for the purpose of displaying the accounting data and information to the users.

f.        Historical Cost Concept:

Business transactions are always recorded at the actual cost at which they are actually undertaken. The basic advantage is that it avoids an arbitrary value being attached to the transactions. Whenever an asset is bought, it is recorded at its actual cost and the same is used as the basis for all subsequent accounting purposes such as charging depreciation on the use of asset, e.g. if a production equipment is bought for Rs.1.25 crores, the asset will be shown at the same value in all future periods when disclosing the original cost.  It will obviously be reduced by the amount of depreciation, which will be calculated with reference to the actual cost.  The actual value of the equipment may rise or fall subsequent to the purchase, but that is considered irrelevant for account purpose as per historical cost concept.

g.       Balance Sheet Equation Concept:

Under this principle, all which has been received by us must be equal to that has been given by us and needless to say that receipts are clarified as debits and giving is clarified as credits.  The basic equation appears as below

Debit = Credit

Naturally every debit must have a corresponding credit and vice-e-versa.  So, we can write the above in the following form

Expenses + Losses + Assets = Revenues + Gains + Liabilities

 And if expenses and losses, and incomes and gains are set off, the equation take the following form

Assets = Liabilities

Or Assets = Equity + External Liabilities

i.e., the Accounting Equation.

B.      MODIFYING PRINCIPLES

a.       The concept of Materiality:

This is more of a convention than a concept.  It proposes that while accounting for various transactions, only those which may have material effect on profitability or financial status of the business should have special consideration for reporting.  This does not mean that the accountant should exclude transactions from recording. E.g. even Rs.10 worth conveyance paid must be recorded as expense.  The concept of materiality is subjective and accountant will have to decide on merit of each case.  Generally, the effect is said to be material, if the knowledge of an event would influence the decision of an informed stakeholder.

The materiality could be related to information, amount, procedure and nature.  Error in description of an asset or wrong classification between capital and revenue would lead to materiality of information.  Some transactions are by nature material irrespective of the amount involved. E.g. audit fees, loan to directors.

b.      The concept of Consistency

This concept advocates that once an organization decides to adopt a particular method of revenue or expense recognition in line with the other concepts, the same should be consistently applied year after year, unless there is a valid reason for change in the method.  Lack of consistency would result in the financial information becoming non-comparable between the different accounting periods.  The insistence of this concept would result in avoidance of window dressing the results by choosing the accounting method by convenience and thereby either inflating or understating net income.

Consider an example.  An asset of Rs.15 lacs is purchased by a business.  It is estimated to have useful life of 3 years.  It will follow that the asset will be depreciated over a period of 3 years at the rate of Rs.5 lacs every year.  The estimate of useful life and the rate of depreciation cannot be changed from period to other without a valid reason.

However, it may be difficult to be consistent if the business entities have two factories in different countries which have different statutory requirement for accounting treatment.

c.       The conservatism concept:

Accountants who prepare financial statements of business, like other human being, would like to give a favourable report on how well the business has performed during an accounting period.  However, prudent reporting based on skepticism builds confidence in the results and in the long run best serves all the divergent interest of users of financial statements this philosophy of prudence leads to the conservatism concept.

This concept underlines the prudence of under-stating than over-stating the net income of an entity for a period and the net assets as on particular date. For years, this concept was meant to “anticipate no profits but recognize all losses” this can be stated as

1.       Delay in recognizing income unless one is reasonably sure.

2.       Immediately recognize expenses when reasonably sure.

     This, of course, does not mean to overdo and create window dressing in reporting.  E.g. if the business has sold Rs.15 lacs worth goods on the last day of accounting period and also received a cheque for the same, one cannot argue that the revenue should not be recognized as it is not certain whether the cheque will be cleared by the bank.  One cannot stretch the conservatism concept too much.  But at the same time, if the business has to receive Rs. 3 lacs from a customer to whom goods were sold quite some time ago and no payments are forthcoming, then while determining the net income for the period, the accountant must judge the likelihood of the recoverability of this money and the prudence will prevail to make a provision for this amount as doubtful debtors.

d.      Timeliness Concept:

Under this principle, every transaction must be recorded in proper time.  Normally, when the transaction is made, the same must be recorded in the proper books of accounts.  In short, transaction should be recorded date-wise in the books.  Delay in recording such transaction may lead to manipulation, misplacement of vouchers, misappropriation etc. of cash and goods.  Principle of timeliness is followed by banks, i.e. every bank verifies the cash balance with their cash book and within the day, the same must be completed.

e.      Industry practice:

As there are different types of industries, each industry has its own characteristics and features.  There may be seasonal industries also.  Every industry follows the principles and assumption of accounting to perform their own activities.   Some of them follow the principles, concepts and conventions in a modified way. e.g. electric supply companies, insurance companies maintain their accounts in a specific manner.  Insurance companies prepare revenue account just to ascertain the profit/loss of the company and not profit and loss account.  Similarly, non trading organizations prepare income and expenditure account to find out surplus or Deficit.

Accounting material

ACCOUNTANCY

Introduction:

                Business is an economic activity undertaken with the motive of earning profits and to maximize the wealth for the owners.  Business cannot run in isolation.  Largely, the business activity is carried out by people coming together with a purpose to serve a common cause.  This team is often referred to as an organization, which could be indifferent forms such as sole proprietorship, partnership, body corporate etc.

                The business activities require resources primarily in terms of material, labour, machineries, factories and other services.  The success of business depends on how efficiently and effectively these resources are managed.

                As the basic purpose of business is to make profit, one must keep an ongoing track of the activities undertaken in course of business.

Definitions:-

In order to understand the subject matter with clarity, let us study some of the definitions which depict the scope, content and purpose of Accounting

a)      Book-Keeping: The most common definition of book-keeping as given by J.R.Batliboi is “ Book-Keeping is an art of recording business transaction is a set of books.”

As can be seen, it is basically a record keeping function.  One must understand that not all dealings are however, recorded.

Only transactions expressed in terms of money will find place in books of accounts.  These are the transactions which will ultimately result in transfer of economic value from one person to the other.  Book-keepings is a continuous activity, routine and repetitive work, in today’s work, it is taken over by the computer systems.  Many accounting packages are available to suit different business organizations.

b)      Financial Accounting:  it is commonly termed as Accounting.  The American institute of Certified public accountants defines Accounting as “an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at lease of a financial character, and interpreting the results thereof.”

The first step in the cycle of accounting is to identify transactions that will find place in books of accounts.  Transactions having financial impact only are to be recorded.  E.g. if a businessman negotiates with the customer regarding supply of products, this will not be recorded.  The negotiation is a deal which will potentially create a transaction and will have exchange of money or money’s worth.  But unless this transaction is finally entered into, it will not be recorded in the books of accounts.

Secondly, the recording of the business transactions is done based on the Golden Rules of Accounting (which are explained later) in a systematic manner.  Transactions of similar nature are grouped together and recorded accordingly.  E.g. Sales Transactions, Purchase Transactions, Cash Transactions etc.

Thirdly, as the transactions increase in number, it will be difficult to understand the combined effect of the same by referring to individual records.  Hence, the art of accounting also involves the step of summarizing them.  With the aid of computers, this task is simplified in today’s accounting world.  The summarization will help users of the business information to understand and interpret business results.

Lastly, the accounting process provides the users with statements which will describe what has happened to the business.  Remember the two basic questions we talked about, one to know whether business has made profit or loss and the other to know the position of resources that are used by business.

It can be noted that although accounting is often referred to as an art, it is a science also.  This is because it is based on universally applicable set of rules.  However, it is not a pure science as there is possibility of different interpretation.

Difference between Book-Keeping and Accountancy:-

Sl.No.	Points of difference	Book- Keeping	Accountancy
1	Meaning	Book-keeping is considered as end.	Accountancy is considered as beginning
2	Functions	The primary stage of accounting function is called Book-Keeping	The overall accounting functions are guided by accountancy.
3	Depends	Book-keeping can provide the base of accounting	Accountancy depends on Book-keeping for its complete functions.
4	Data	the necessary data about financial performances and financial positions are taken from Book-keeping	Accountancy can take its decisions, prepare reports and statements from the data taken from Book-Keeping.
5	Recording of Transactions	Financial transaction are recorded on the basis of accounting principles, concepts and conventions.	Accountancy does not take any principles, concepts and conventions from Book-keeping.

ACCOUNTING CYCLE

When complete sequence of accounting procedure is done, which happens frequently and repeated in same directions during an accounting period, the same is called an accounting cycle.

Steps/ phases of Accounting Cycle

The steps or phases of accounting cycle can be developed as under:

a)      Recording of Transaction:- As soon as a transaction happens it is at first recorded in subsidiary book.

b)      Journal: The transactions are recorded in journal chronologically.

c)       Ledger: All journals are posted into ledger chronologically and in a classified manner.

d)      Trial Balance: After taking all the ledger account’s closing balances, a Trial balance is prepared at the end of the period for the preparations of financial statements.

e)      Adjustment Entries: All the adjustments entries are to be recorded properly and adjusted accordingly before preparing financial statements.

f)       Adjusted Trial Balance: An adjusted Trial balance may also be prepared

g)      Closing entries: All the nominal accounts are to be closed by the transferring to Trading account and Profit and Loss account.                                                                                                            

h)      Financial Statements: Financial Statement can now be easily prepared which will exhibit the true financial position and operation results.

Objectives of Accounting:-

The main objective of Accounting is to provide financial information to stakeholders.  This financial information is normally given via financial statements, which are prepared on the basis of Generally Accepted Accounting Principles (GAAP).  There are various accounting standards developed by professional accounting bodies all over the world.  In India, these are governed by the Institute of Chartered Accountants of India, (ICAI).  In th US, the American Institute of Certified Public Accountants (AICPA) is responsible to lay down the standards.  The financial Accounting Standards Board (FASB) is the body that sets up the International Accounting Standards.  These standards basically deal with the accounting treatment of business transactions and disclosing the same in financial statements.

The following objectives of accounting will explain the width of the application of this knowledge stream:

a)      To ascertain the amount of profit or loss made by the business i.e. to compare the income earned versus the expenses incurred and the net result thereof.

b)      To know the financial position of the business i.e. to assess what the business owns and what it owes.

c)       To provide a record for compliance with statutes and laws applicable.

d)      To enable the readers to assess progress made by the business over a period of time.

e)      To disclose information needed by different stake holders.

Let us now see which are different stakeholders of the business and what do they seek from the accounting information.  This is shown in the following table.

Stakeholder	Interest in business	Accounting Information
Owners/Investors/Existing and potential	Profit or losses	Financial statements, Cost Accounting records, management Accounting reports.
Lenders	Assessment of capability of the business to pay interest and principal of money lent.  Basically, they monitor the solvency of business	Financial statement and analysis thereof, reports forming part of accounts, valuation of assets given as security.
Customers and Suppliers	Stability and growth of the business	Financial and cash flow statements to assess ability of the business to offer better business terms and ability to supply the products and services.
Government	Whether the business is complying with various legal requirements	Accounting documents such as vouchers, extracts of books, information of purchase, sales, employee obligations etc. and financial statements.
Employees and Trader unions	Growth and profitability	Financial statements for negotiating pay packages.
Competitors	Performance and possible tie-ups in the era of mergers and acquisitions.	Accounting information to find out possible synergies.

Users of Accounting Information:-

Accounting provides information both to internal users and the external users. The internal users are all the organizational participants at all levels of the management (i.e. top, middle and lower).  Generally top level management requires information for planning, middle level management which requires information for controlling the operations.  For internal use, the information is usually provided in the form of reports, for insance Cash Budget Reports, Production Reports, Idle Time Reports, Feedback Reports, Whether to retain or replace an equipment decision reports, project appraisal report, and the like. 

There are also the external users (e.g. Banks, Creditors).  They do not have direct access to all the recors of an enterprise, they have to rely on financial statements as the source of information.  External users are basically, interested in the solvency and profitability of an enterprise.

Types of Accounting Information:-

Accounting information may be categorized in number of ways on the basis of purpose of accounting information, on the basis of measurement criteria and so on.  The various types of accounting information are given below.

I.                    Accounting information relating to financial transaction and events.

a)      Financial position: information about financial position is primarily provided in a Balance sheet

b)      Financial Performance: information about financial performance is primarily provided in a statement of profit and loss which is also known as income statement.

c)       Cash Flows: information about cash flows is provided in the financial statements by means of a cash flow statement.

II.                  Accounting information relating to cost of a product, operation or function.

III.                Accounting information relating to planning and controlling the activities of an enterprise for internal reporting.

IV.                Accounting information relating to Social Effects of business decisions.

V.                  Accounting information relating to Environment Ecology.

VI.                Accounting information relating to Human Resources.

Basic Accounting Terms:-

In order to understand the subject matter clearly, one must grasp the following common expressions always used in business accounting.

i.                     Transaction: It means an event or a business activity which involves exchange of money or money’s worth between parties.  The event can be measured in terms of money and changes the financial position of a person e.g. purchase of goods would involve receiving material and making payment or creating an obligation to pay to the supplier at a future date.  Transaction could be a cash transaction or credit.  When the parties settle the transaction immediately by making payment in cash or by cheque, it is called a cash transaction.  In credit transaction, the payment is settled at a future date as per agreement between the parties.

ii.                   Goods / Services:  These are tangible article or commodity in which a business deals.  These articles or commodities are either bought and sold or produced and sold.  At times, what may be classified as ‘goods’ to one business firm may not be ‘goods’ to the other firm.  E.g. for a machine manufacturing company, the machines are ‘goods’ as they are frequently made and sold.  But for the buying firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell it.  Services are intangible in nature which is rendered with or without the object of earning profits.

iii.                  Profit: The excess of Revenue Income over expenses is called profit.  It could be calculated for each transaction or for business as a whole.

iv.                 Loss: The excess of expense over income is called loss.  It could be calculated for each transaction or for business as a whole.

v.                   Asset: Asset is a resource owned by the business with the purpose of using it for generating future profits.  Assets can be tangible and intangible.  Tangible assets are the capital assets which have some physical existence.  They can, therefore, be seen, touched and felt, e.g. Plant and machinery, furniture and fittings, land and buildings, books, computers, vehicles, etc.  The capital assets which have no physical existence and whose value is limited by the rights and anticipated benefits that possession confers upon the owner are known as intangible assets.  They cannot be seen or felt although they help to generate revenue in future, e.g. Goodwill, Patents, trade-marks, copyrights, brand equity, design, intellectual property, etc.

Assets can also be classified into current assets and non-current assets.

Currents assets- an asset shall be classified as current when it satisfies any of the following:

a)      It is expected to be realized in, or is intended for sale or consumption in the company’s normal operating cycle.

b)      It is held primarily for the purpose of being traded.

c)       It is due to be realized within 12 months after the reporting date, or

d)      It is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after the reporting date.

Non-Current assets- All other assets shall be classified as Non-current assets, e.g. Machinery held for long term etc.

vi.                 Liability: It is an obligation of financial nature to be settled at a future date.  It represents amount of money that the business owes to the other parties.  E.g. when goods are bought on credit, the firm will create an obligation to pay to the supplier the price of goods on an agreed future date or when a loan is taken from bank, an obligation to pay interest and principal amount is created.  Depending upon the period of holding, these obligations could be further classified into long term on non-current liabilities and short term or current liabilities. 

Current liabilities- a liability shall be classified as current when it satisfies any of the following:

a)      It is expected to be settled in the company’s normal operating cycle.

b)      It is held primarily for the purpose of being traded,

c)       It is due to be settled within 12 months after the reporting Date, or

d)      The company does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date (Terms of a liability that could at the option of the counterparty, result in its settlement by the issue of Equity instruments do not affect its classification)

Non-current liabilities:- All other liabilities shall be classified as Non-current liabilities.  E.g. loan taken for 5 years, Debentures issued etc.

vii.               Internal Liability: These represent proprietor’s equity, i.e. all those amount which are entitle to the proprietor, e.g., Capital, Reserves, Undistributed profits, etc.

viii.             Working Capital:- In  order to maintain flows of revenue from operation, every firm needs certain amount of current assets.  For example, cash is required either to pay for expenses or to meet obligation for service received or goods purchased, etc. by a firm.  On identical reason, inventories are required to provide the link between production and sale.   Similarly, accounts receivable generate when goods are sold on credit.  Cash, bank, Debtors, Bills Receivables, closing stock, prepayments etc. represent current assets of firm.  The whole of these current assets form the working capital of a firm which is termed as Gross working capital.

Gross working capital            = Total Current Assets

= Long term internal liabilities plus long term debits plus the          current liabilities minus the amount blocked in the fixed assets.

There is another concept of working capital.  Working capital is the excess of current assets over current liabilities.  That is the amount of current assets that remain in a firm if all its current liabilities are paid.  This concept of working capital is known as net working capital which is a more realistic concept.

Working capital (Net) = Current Assets – Current Liabilities.

ix.                 Contingent Liability:  it represents a potential obligation that could be created depending on the outcome of an event. E.g. if supplier of the business files a legal suit, it will not be treated as a liability because no obligation is created immediately.  If the verdict of the case is given in favour of the supply then only the obligation is created.  Till that it is treated as a contingent liability.  Please note that contingent liability is not recorded in books of account, but disclosed by way of a note to the financial statements.

x.                   Capital: It is amount invested in the business by its owners.  It may be in the form of cash, goods or any other asset which the proprietor or partners of business invest in the business activity.  From the business point of view, capital of owners is a liability which is to be settled only in the event of closure or transfer of the business.  Hence it is not classified as a normal liability.  For corporate bodies, capital is normally represented as share capital.

xi.                 Drawings: It represents an amount of cash, goods or any other assets which the owner withdraws from business for his or her personal use. E.g. if the life insurance premium of proprietor or a partner of business is paid from the business cash, it is called drawings.  Drawings will result in reduction in the owner’s capital.  The concept of drawing is not applicable to the corporate bodies like limited companies.

xii.                Net worth: It represents excess of total assets over total liabilities of the business.  Technically, this amount is available to be distributed to owners in the event of closure of the business after payment of all liabilities.  That is why it is also termed as owner’s Equity.  A profit making business will result in increase in the owner’s equity where as losses will reduce it.

xiii.              Non- current Investments: Non-current Investments are investments which are held beyond the current period as to sale or disposal.  E.g. fixed deposit for 5 years.

xiv.              Current Investments: Current investments are investments that are by their nature readily realizable and are intended to be held for not more than one year from the date on which such investment is made. E.g. 11 months commercial paper

xv.               Debtor:  The sum of total or aggregate of the amount which the customer owe to the business for purchasing goods on credit or services rendered or in respect of other contractual obligations, is known as sundry debtors or trader debtors, or trade receivable, or book-debts or debtors.  In other words, debtors are those persons from whom a business has to recover money on account of goods sold or service rendered on credit.  These debtors may again be classified as under:

1.       Good debts: The debts which are sure to be realized are called good debts.

2.       Doubtful debts: The debts which may or may not be realized are called doubtful debts.

3.       Bad debts: The debts which cannot be realized at all are called bad debts.

It must be remembered that while ascertaining the debtors balance at the end of the period certain adjustments may have to made e.g. Bad debts, discount allowed, returns inwards, etc.

xvi.              Creditor: A creditor is a person to whom the business owes money or money’s worth. E.g. money payable to supplier of goods or provider of service.  Creditors are generally classified as current liabilities.

xvii.            Capital expenditure: This represents expenditure incurred for the purpose of acquiring a fixed asset which is intended to be used over long term for earning profits there from. E.g. amount paid to buy a computer for office use is a capital expenditure.  At times expenditure may be incurred for enhancing the production capacity of the machine.  This also will be a capital expenditure.  Capital expenditure forms part of the balance sheet.

xviii.           Revenue expenditure: This represents expenditure incurred to earn revenue of the current period.  The benefits of revenue expense get exhausted in the year of the incurrence.  E.g. repairs, insurance, salary & wages to employees, travel etc.  The revenue expenditure results in reduction in profit or surplus.  It forms part of the income statement.

xix.              Balance sheet: It is the statement of financial position of the business entity on a particular date.  It lists all assets, liabilities and capital.  It is important to note that this statement exhibits the state of affairs of the business owes to outsiders (this denotes liabilities) and to the owners (this denote capital).  It is prepared after incorporating the resulting profit/losses of income statement.

xx.               Profit and loss account or income statement: This account shows the revenue earned by the business and the expenses incurred by the business to earn that revenue.  This is prepared usually for a particular accounting period, which could be a month, quarter, a half year or a year.  The net result of the profit and loss account will show profit earned or loss suffered by the business entity.

xxi.              Trade discount: It is the discount usually allowed by the wholesaler to the retailer computed on the list price or invoice price. E.g. the list price of a TV set could be Rs.15,000.  The wholesaler may allow 20% discount thereof to the retailer.  This means the retailer will get it for Rs.12,000/- and is expected to sale it to the final customer at the list price.  Thus the trade discount enables the retailer to make profit by selling at the list price.  Trade discount is not recorded in the books of accounts.  The transactions are recorded at net values only.  In above example, the transaction will be recorded at Rs.12000/- only.

xxii.            Cash discount: This is allowed to encourage prompt payment by the debtor.  This has to be recorded in the books of accounts. This is calculated after deducting the trade discount. E.g. if list price is Rs.15,000/- on which a trade discount of 20% and cash discount of 2% apply, then first trade discount of Rs.3000/- (20% of Rs.15000/-) will be deducted and the cash discount of 2% will be calculated on Rs.12000/- (Rs.15000-Rs.3000).  Hence the cash discount will be Rs.240/- (2% of Rs.12000) and net payment will be Rs.11,760/- (Rs.12000-240).