Theory Base Accounting Notes | CBSE Class 11 Accountancy Chapter 2

CBSE Class 11 Accountancy : Chapter 2 Theory Base of Accounting Notes

CBSE Class 11 Accountancy Notes : Chapter 2 Theory Base of Accounting Notes covers a few of the key foundational ideas in accounting. Accounting traditions, standards, IFRS, GST, and other related topics are addressed in Class 11 Chapter 2 Theory Base of Accounting Notes. To fully understand the chapter and its explanations, students are recommended to consult the CHK CBSE revision notes of Class 11 Accountancy Chapter 2 Theory Base of Accounting.

REVISION NOTES

THEORY BASE OF ACCOUNTING

The principles are generally accepted by the accountants as general guidelines for preparing accounting records. These are classified as:

(i) Basic Assumptions/Concepts

(ii) Basic Principles

(iii) Modifying Principles/Conventions

BASIC ASSUMPTION/CONCEPTS

In order to make the accounting statements convey the same meaning to all people and to make them more meaningful, accountants have agreed on a number of assumptions/concepts, which are usually followed in preparing accounting records. These are following:

Going Concern Assumption: According to this assumption, it is assumed that business will continue to exist for a long period in future. All transactions are recorded assuming that enterprise will continue in future for a long time. That is why fixed assets are recorded at their cost price and depreciated during its useful life, irrespective of its market value, because fixed asset are not meant for resale in business. Also without this assumption, the classification of fixed and current assets, current and long term liabilities is impossible.
Accrual Concept: Accrual concept holds the recognition of transactions as they occur, whether receipt or payment for the same is made or not. The accrual concept recognizes revenue when it earned rather than when it is collected and recognizes expense when they occur rather than when these are paid.
Concept of Consistency: This principle states that accounting principles and methods followed for preparing accounting statements should remain consistent year after year. If this concept is not followed, different results can be drawn from the same accounting data. E.g. if method of calculation of depreciation is changed, the profit figure will distort and no longer comparable.

BASIC PRINCIPLES:

On the basis of accounting assumptions, certain principles have been developed that guide how transactions should be recorded and reported. Following are some of basic principles:

Accounting Entity Concept: According to this concept, a business is treated as an entity distinct from its owners. Business has its separate books of accounts and all business transactions are recorded from firm’s point of view and not from owner’s point of view. It this assumption is not followed, the operating results and financial position of the business entity can’t be ascertained correctly.
Money Measurement Principle: According to this principle, only those transactions and events are recorded in books of accounts, which can be measured and expressed in terms of money. Also, accounting records are made simple, understandable and homogeneous by expressing all the items in a common unit of measurement i.e. money.
Accounting Period Principle: According to this principle, the entire life of the business is divided into small time intervals for calculation of profits and losses of the business and for ascertaining its financial position. Each time interval, for which results are calculated, is known as an Accounting Period. Twelve months is usually adopted for this purpose. This accounting period can be of two types i.e. calendar year (from 1st Jan. – 31st Dec.) or financial year (from 1st Apr. – 31st Mar.). In India, financial year is adopted as accounting year.
Dual Aspect Principle: According to this principle, every transaction has two aspects i.e. debit and credit, and both are recorded at the time of occurrence of a transaction. Each transaction affects at least two accounts, one is debited and other is credited. This system is based on dual aspect and is called Double Entry System of Book Keeping.
Historical Cost Principle: According to this principle, an asset is recorded in the books of accounts at the price at which it is acquired. Market value of assets and price level changes (inflation and deflation) are ignored and not recorded. The cost of the asset relates to the past, it is referred to as Historical Cost. If nothing is paid to acquire assets of company, it is not recorded as an asset like increasing goodwill.
Principle of Full Disclosure: According to this principle, all significant financial information of an entity should be completely disclosed in financial statements. It means disclosing sufficient information, which is material to the interests of users of financial statements e.g. while reporting sales during the year, sales returns should be disclosed separately as deduction from the amount of sales, rather than showing the net sales for the year. As the huge amount of sales return can raise the inquiry and may lead to corrective action.
The Revenue Recognition Concept: This concept holds that revenue is considered to have been realized when a transaction has been entered into and the obligation to receive the amount has been established. In other words, revenue is considered as being earned when goods are sold or services rendered and not when cash is received.
The Matching Concept: This principle holds that the cost incurred to earn the revenue should be set out against the revenue in the period during which it is recognized as earned. For matching expenses with revenue, first revenue is recognized and the costs associated with this revenue are recognized.
Verifiable Objective Evidence/Objectivity Concept: All transactions, which are recorded in books of accounts, must be supported by relevant vouchers e.g. invoices, bills, passbook etc. Personal bias has no place in preparation and presentation of financial records.

MODIFYING PRINCIPLES/CONVENTIONS:

These are certain accounting principles, which can be modified by different accountants according to the situations and requirements of business. Some of these are following: 1. Principle of Conservatism/Prudence: This principle tells us that all anticipated losses should be recorded in books of accounts, but all anticipated and unrealized gains should be ignored. Provision is made for all known liabilities and losses even though the amount can’t be determined with certainty. It is the policy of playing safe. E.g. closing stock is valued at cost or market price whichever lower and making provision for doubtful debts etc. 2. Principle of Materiality: According to this principle, only those items are to be disclosed separately in financial statements which are material for decision making for the users of financial statements of the business. Insignificant items or items which are not relevant to the users need not to be disclosed separately in books of accounts. These can be merged with other items. Here materiality based on both information and amount.

An information is considered material if this could change the decisions of a person to whom this information is communicated. This principle is an exception to the principle of full disclosure.

ACCOUNTING STANDARDS

Accounting standards may be defined as written statements issued from time to time by institutions of accounting professionals e.g ICAI, specifying uniform rules or practices for preparing ad presenting financial statements. Some of accounting standards are as follows:

(i) AS-1: Disclosure of Accounting Policies

(ii) AS-2: Valuation of Inventories

(iii) AS-3: Cash Flow Statement

Need or Utility or Advantages of Accounting Standards:

(i) Accounting standards bring uniformity in preparation and presentation of financial statements.

(ii) They ensure the consistency and comparability of different financial statements.

(iii) They significantly reduce the chances of manipulations and frauds.

(iv) To improve the reliability and credibility of financial statements.

Nature of accounting standards:

(i) These are based on applicable law, customs and business environment.

(ii) These are intended to apply only on material items.

(iii) Mostly accounting standards are mandatory in nature.

Limitations of Accounting Standards

Accounting standard makes choice between different alternate accounting treatments difficult to apply.
It is rigidly followed and fails to extend flexibility in applying accounting standards.
Accounting standard cannot override the statue. The standards are required to be farmed within the ambit of prevailing status.

Meaning of IFRS: IFRS is a principle-based accounting standard. IFRS are a single set of high-quality accounting Standards developed by IASB, recommended to be used by the enterprises globally to produce financial statements.

Benefits of IFRS:

(1) Global comparison of financial statements of any companies is possible

(2) Financial statements prepared by using IFRS shall be better understood with financial statements prepared by the country specific accounting standards. So the investors can make better decision about their investments.

(3) Industry can raise or invest their funds by better understanding if financial statements are there with IFRS.

(4) Accountants and auditors are in a position to render their services in countries adopting IFRS.

(5) By implementation of IFRS accountants and auditors can save the time and money.

(6) Firm using IFRS can have better planning and execution. It will help the management to execute their plans globally.

Basis of Accounting:

(1) Cash basis

Under this entry in the books of accounts are made when cash received or paid and not when the receipt or payment becomes due. For example, if salary Rs. 7,000 of January 2010 paid in February 2010 it would be recorded in the books of accounts only in February, 2010.

(2) Accrual basis

Under this however, revenues and costs are recognized in the period in which they occur rather when they are paid. It means it record the effect of transaction is taken into book when they are earned rather than in the period in which cash is actually received or paid by the enterprise. It is more appropriate basis for calculation of profits as expenses are matched against revenue earned in the relation thereto. For example, raw materials consumed are matched against the cost of goods sold for the accounting period.

Goods and Services Tax

(One Country One Tax)

GST is a destination-based tax on consumption of goods and services. It is proposed to be levied at all stages right from manufacture up to final consumption with credit of taxes paid at previous stages available as setoff.

GST has a dual aspect with the Centre and States simultaneously levying on a common tax base. There are three main components of GST which are CGST, SGST, IGST CGST means Central Goods and Services Tax. Taxes collected under CGST will constitute the revenues of the Central Government.

SGST means State Good and Services Tax. A collection of SGST is the revenue of the State Government.

For example, Ramesh a dealer in Punjab sell goods to Seema in Punjab worth ` 10,000. If the GST rate is 18%, i.e., 9% CGST and 9% SGST, ` 900 will go to Central Government and 900 will go to Punjab Government.

IGST means Integrated Goods and Services Tax. Revenue collected under IGST is divided between Central and State Government as per the rates specified by the Government. IGST is charged on transfer of goods and services from one state to another. Import of goods and services are also covered under IGST.

Characteristics of Goods and Services Tax

GST is a common law and procedure throughout the country under single administration.
GST is a destination-based tax and levied at a single point at the time of consumption of goods and services by the end consumer.
GST is a comprehensive levy and collection on both goods and services at the same rate with benefit of input tax credit or subtraction of value.
Minimum number of rates of tax does not exceed two.
There is no scope for levy of cess, resale tax, additional tax, turnover tax etc.
There is no multiple levy of tax on goods and services, such as sales tax, entry tax, octroi, entertainment tax or luxury tax etc.

Advantages

Introduction of GST has resulted in the abolition of multiple types of taxes in goods and services.
GST widens the tax base and increased revenue to Centre and State thereby reducing administrative cost for the Government.
GST has reduced compliance cost and increases voluntary compliance.
GST has affected rates of tax to the maximum of two floor rates.
GST has removed the cascading effect on taxation.
GST will result in enhancing manufacturing and distribution system affecting the cost of production of goods and services and consequently the demand and production of goods and services will increase.
It will eventually promote economic efficiency and sustainable long-term economic growth as GST is neutral to business processes, business models, organisational structure and geographical location.
GST would help to extend competitive edge in international market for goods and services produced in the country leading to increased exports.

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