Accounting principles, standards and financial statements
Accounts follow GAAP concepts and conventions, and standards make them comparable. India's Ind AS are converged with IFRS; Schedule III of the Companies Act 2013 sets the format.
Accounting concepts (assumptions)
| Concept | Meaning | Example |
|---|---|---|
| Business entity | The business is separate from its owner | Owner's capital is shown as owed by the business to the owner |
| Money measurement | Only events measurable in money are recorded | Staff morale is not recorded |
| Going concern | The business will continue for the foreseeable future | Fixed assets shown at cost less depreciation, not at forced-sale value |
| Accounting period | Life is split into periods for reporting | Financial year 1 April to 31 March |
| Historical cost | Assets are recorded at what they cost | Land bought for ₹10 lakh stays at ₹10 lakh in the books |
| Dual aspect | Every transaction has two equal effects | Assets = Liabilities + Capital |
| Realisation | Revenue is recognised when earned, not when cash comes in | A credit sale is recorded on delivery |
| Accrual and matching | Expenses are set against the revenue of the same period | Outstanding wages are charged to this year's profit and loss |
Accounting conventions
| Convention | Meaning |
|---|---|
| Consistency | Use the same methods year after year; disclose any change |
| Full disclosure | Show all material information, including notes |
| Materiality | Items too small to influence users may be merged or ignored |
| Conservatism (prudence) | Anticipate no profit, provide for all possible losses; stock at the lower of cost and net realisable value |
AS versus Ind AS
Converged means aligned with IFRS, not adopted word for word.
From transaction to financial statements
A trial balance proves arithmetic accuracy, not that the accounts are free of error.
Financial statements under the Companies Act 2013
- s.2(40): financial statements include the balance sheet, the statement of profit and loss, the cash flow statement, the statement of changes in equity (where applicable) and explanatory notes.
- One person, small and dormant companies, and start-up private companies, may leave out the cash flow statement.
- Schedule III gives the format: Division I for companies following AS, Division II for Ind AS companies.
- The balance sheet shows position on a date; the profit and loss statement shows performance over a period.
- Under Ind AS, the profit and loss statement also shows other comprehensive income (OCI).
Gross and net profit
Opening stock ₹40,000; purchases ₹2,60,000; carriage inwards ₹10,000; closing stock ₹50,000; sales ₹4,00,000; office expenses ₹60,000; depreciation ₹20,000; interest on loan ₹10,000. Find gross profit and net profit.
- Cost of goods sold = opening stock + purchases + direct expenses − closing stock
- = 40,000 + 2,60,000 + 10,000 − 50,000 = ₹2,60,000
- Gross profit = sales − cost of goods sold = 4,00,000 − 2,60,000 = ₹1,40,000
- Indirect expenses = 60,000 + 20,000 + 10,000 = ₹90,000
- Net profit = 1,40,000 − 90,000 = ₹50,000
- Check: GP ratio = 1,40,000 ÷ 4,00,000 = 35%; NP ratio = 50,000 ÷ 4,00,000 = 12.5%
Gross profit ₹1,40,000; net profit ₹50,000.
NET gives a situation and asks which concept or convention applies (conservatism, matching, going concern), asks what Ind AS convergence means, or sets a one-step sum from the accounting equation or a trading account.
Typical MCQ: “Stock is valued at cost or net realisable value, whichever is lower. Which convention is this?” Conservatism (prudence). Trap: it is not consistency, which is about using the same method every year.
Typical MCQ: “Assets are ₹8,00,000 and outside liabilities ₹3,50,000. What is capital?” ₹4,50,000, from Assets = Liabilities + Capital. Trap: adding the two figures.
Typical MCQ: “Does convergence with IFRS mean India adopted IFRS word for word?” No. Ind AS are aligned with IFRS, but India kept some carve-outs.
Concepts are assumptions; conventions are customs. AS 1's three pillars are G-C-A: Going concern, Consistency, Accrual.