CruxFinancial Accounting

Accounting is often called the language of business: it is how a business tells others what it owns, what it owes and what it earned. Like any information system, it has three parts.

A widely used definition (the American Institute of Certified Public Accountants) describes accounting as recording, classifying and summarising money transactions of a financial character, and interpreting the results. The first part, keeping the records, is book-keeping: routine and clerical, and now mostly done by computers. Interpreting the records is the accountant's work and needs judgement.

Users are usually split into those inside the business and those outside it. Financial accounting serves mainly the outsiders, who cannot see the books and must rely on published statements.

• Artificial intelligence means computer systems that perform tasks which normally need human judgement: reading a document, recognising a pattern, learning from past examples, or answering a question in ordinary language.
• Data analytics means examining large sets of data to describe what happened, explain why, forecast what may happen, and suggest what to do. In accounting the data are transactions, ledgers, invoices, bank feeds and similar records.

The two work together. Analytics needs clean, complete data; artificial intelligence tools help collect and sort the data and spot what a person would miss.

Benefits. Faster closing of the books, fewer clerical errors, the whole population of transactions checked, earlier warning of fraud or cash shortages, and more time for analysis.

Limits and risks.

• The output is only as good as the input data: wrong or incomplete data give wrong results.
• The tools cannot replace judgement on estimates, policies and unusual transactions; someone must still decide and answer for the accounts.
• A model's reasoning can be hard to explain, which makes review and audit harder.
• Large volumes of financial and personal data raise privacy and security concerns, so access must be controlled.
• Systems cost money to set up, and staff need training.

The accountant's changing role. Less time on entering and ticking data; more on reviewing exceptions, interpreting results, advising management and controlling the systems.

Figures are useful only if they have certain qualities. These are called qualitative characteristics, because they describe the quality of information, not its amount. The four main ones:

Two practical limits act on all four:

• Timeliness. Late information loses relevance, so there is often a trade-off between speed and full reliability.
• Cost and benefit. A piece of information should be worth more to users than it costs to produce. The DU text makes the same point when it says a principle must be feasible, that is, usable without undue cost or complexity.

Functions. Keeping records is only the first job of accounting. The full list:

1. Keeping systematic records: recording, classifying and summarising transactions into the income statement and balance sheet.
2. Communicating results: telling interested parties the profit or loss, assets and liabilities.
3. Meeting legal needs: company law and the tax laws require annual accounts and returns.
4. Protecting business assets: records of cash, stock, debtors, creditors and fixed assets let management control them.
5. Helping management plan, control and co-ordinate activities.
6. Stewardship: showing how managers have used the funds owners and lenders entrusted to them.
7. Fixing responsibility: departmental profits show how each head has performed.

Advantages. Help to management in budgeting and control; written records instead of memory; comparison of one year with earlier years; evidence in a court of law; support for tax assessments; a basis for valuing the business when it is sold.

Limitations.

• Only money facts are recorded. Skill of staff, reputation and quarrels between managers are left out.
• Fixed assets stay at original cost, so inflation is ignored and the balance sheet does not show current worth.
• Many figures rest on estimates (useful life, doubtful debts) that may prove wrong.
• One year's profit can be manipulated, for example by cutting advertising or depreciation.
• Social costs such as pollution are not counted.
• Principles can pull against each other: valuing stock at the lower of cost and market price may give cost in one year and market price in the next, which disturbs consistency.

There are two main ways to decide in which year an income or expense is counted.

• Cash basis. Income is the cash actually received and expense is the cash actually paid during the year. Credit transactions, outstanding expenses and accrued income are ignored. It is simple, and suits doctors, lawyers, other professionals and very small traders. Its result is a receipts-minus-payments figure, not the true profit.
• Accrual (mercantile) basis. Income is counted in the year it is earned and expense in the year it is incurred, whenever the cash moves: in an earlier year, this year or a later one. Accrual is one of the three fundamental accounting assumptions of AS 1, so it is the normal basis of business accounts.
• Mixed (hybrid) basis. Incomes on a cash basis and expenses on an accrual basis. The aim is extreme caution: count income only when certain, but provide for every expense.

The split decides whether an amount goes to the balance sheet or to the Profit and Loss Account, so it changes the profit directly.

• Capital expenditure buys an asset, or a benefit, that lasts beyond the year, or raises the earning capacity of the business (more output, lower running cost). It is shown as an asset and written off over time through depreciation. Examples: buying machinery; repairs needed to bring a second-hand machine into use; carriage and installation of a new machine; buying the goodwill of a running business.
• Revenue expenditure gives a benefit used up within the year, or merely keeps an asset in working order. It is an expense of the year. Examples: wages, salaries, rent, routine repairs and maintenance.
• Deferred revenue expenditure is the DU text's name for a large revenue outlay whose benefit lasts a few years, such as heavy advertising to launch a product. See the Trap below on how AS 26 treats it now.
• Capital receipts are not earned in the normal course of business: capital brought in by the owner, loans raised, and the sale proceeds of fixed assets. They go to the balance sheet.
• Revenue receipts arise from normal operations: sales, fees, commission, interest and rent received. They go to the Profit and Loss Account.

When a fixed asset is sold, the whole proceeds are a capital receipt. Only the difference between the proceeds and the book value is a profit or loss on sale, taken to the Profit and Loss Account.

Accounts for the year ended 31 March are usually approved weeks later. Things that happen in that gap may change what the accounts should show.

Meaning (AS 4, para 3.2). These are significant events, good or bad, that take place between the balance sheet date and the date on which the accounts are approved. The approving body is the Board of Directors for a company, and the corresponding authority for any other entity. Ind AS 10 deals with the same subject and calls them events after the reporting period.

There are two kinds.

Two special cases:

1. Going concern. An event after the year end may show that the going concern assumption no longer fits, for example a fire that destroys the main plant. Then the accounts must be adjusted (AS 4, paras 8.6 and 13), not merely footnoted.
2. Dividends declared after the balance sheet date are not a liability at that date, unless a statute requires otherwise. They are disclosed in the notes (AS 4, para 14).

AS 5 makes every business present certain items in the statement of profit and loss the same way, so that profits can be compared over time and between firms.

Net profit. Every income and expense recognised in a period goes into its net profit or loss, unless another standard says otherwise. This includes extraordinary items and the effect of changes in estimates (AS 5, paras 5 and 6). The net profit has two parts, each shown on the face of the statement (para 7):

1. profit or loss from ordinary activities: the activities the business carries on as its business, and the related activities that further, support or arise from them (para 4.1);
2. extraordinary items.

Extraordinary items (para 4.2). Income or expenses arising from events or transactions plainly separate from the business's ordinary activities, which for that reason are not expected to happen often or regularly.

• Whether an event is distinct depends on its nature compared with the business the firm normally does, not on how often it happens (para 10). So the same event can be extraordinary for one firm and ordinary for another.
• Common examples (para 11): attachment of the firm's property, and an earthquake. Earthquake losses are extraordinary for most firms, but claims arising from an earthquake are ordinary for an insurance company that insures against it.
• They are rare, because almost all income and expense arises in ordinary activities (para 9).
• Disclosure (para 8): included in net profit, with the nature and amount of each shown separately, so that its effect on the year's profit can be seen.

Exceptional items (para 12). These lie within ordinary activities but are of such size, nature or incidence that their separate disclosure helps explain the year's performance. Their nature and amount are disclosed separately, sometimes in the notes. AS 5 does not use the word "exceptional"; it is the common name for these items. Para 14 lists typical cases:

• writing inventories down to net realisable value, and reversing such write-downs;
• restructuring of activities, and reversing provisions for its cost;
• disposals of fixed assets;
• disposals of long-term investments;
• changes in law with retrospective effect;
• settlements of litigation;
• other reversals of provisions.

Prior period items (para 4.3). Income or expenses that come up in the current period because of errors or omissions made in preparing the accounts of one or more earlier periods.

• Causes (para 17): arithmetical mistakes, mistakes in applying accounting policies, misreading the facts, or oversight.
• Not prior period items (paras 16, 18 and 21): adjustments that relate to earlier years but are determined only now (arrears of wages after a pay revision with retrospective effect), changes in accounting estimates, and income or expense on the outcome of a contingency that could not be estimated reliably before.
• Treatment (paras 15 and 19): normally included in this year's net profit, or shown after this year's net profit is struck. Either way their nature and amount are disclosed separately, so that their effect on the current profit can be seen.

Many figures cannot be measured exactly and must be estimated with judgement on the latest information: bad debts, obsolete stock, the useful life and residual value of assets (AS 5, para 20). Using sensible estimates does not make the accounts unreliable.

An estimate is revised when the circumstances behind it change, or new information or more experience arrives (para 21). Such a revision is a change in an accounting estimate. It is not an error, not a prior period item and not an extraordinary item.

Treatment (para 23). The effect goes into the profit or loss of:

1. the period of the change, if only that period is affected (a revised estimate of bad debts), or
2. the period of the change and later periods, if both are affected (a revised useful life changes depreciation for every remaining year).

Earlier years are never re-opened: the change is applied prospectively. The effect keeps the same classification in the statement as the original estimate (para 25). A change with a material effect now or later is disclosed with its nature and amount (para 27).

AS 10 asks for the residual value, the useful life and the depreciation method to be reviewed at least at each financial year end (paras 53 and 63). A revised residual value or useful life is a change in estimate. The method is changed only if the expected pattern in which the asset's benefits are used up has changed significantly, and that change too is a change in estimate. Where it is hard to tell whether a change is one of policy or of estimate, treat it as a change in estimate and disclose it (AS 5, para 22).

Meaning. Accounting policies are the particular accounting principles a business adopts, and the methods by which it applies them, in preparing and presenting its financial statements (AS 1, para 11; AS 5, para 4.4). No single list fits every business, so management must choose with judgement (AS 1, para 12).

Areas where policies differ (AS 1, para 14; the list is not complete):

• methods of depreciation, depletion and amortisation;
• treatment of expenditure during construction;
• conversion or translation of foreign currency items;
• valuation of inventories;
• treatment of goodwill;
• valuation of investments;
• treatment of retirement benefits;
• recognition of profit on long-term contracts;
• valuation of fixed assets;
• treatment of contingent liabilities.

Considerations in selecting policies. The main test is that the statements give a true and fair view: of the position on the balance sheet date, and of the year's profit or loss (AS 1, para 16). To get there, three considerations guide the choice (para 17):

1. Prudence: because the future is uncertain, profits are not anticipated but counted only when realised (not necessarily in cash), while every known liability and loss is provided for, even if only a best estimate can be made.
2. Substance over form: transactions are accounted for and shown according to their real substance, not merely their legal form.
3. Materiality: the statements disclose every item knowledge of which could influence a user's decisions.

Disclosure (AS 1, paras 24 to 26).

• All significant accounting policies are disclosed.
• The disclosure forms part of the financial statements, normally all in one place.
• A change of policy that has a material effect now, or is expected to have one later, is disclosed. Where it has a material effect now, the amount by which items are affected is disclosed too, as far as it can be found; if it cannot be found, that fact is stated.
• Disclosing a policy cannot cure a wrong treatment (para 23).

When a policy may be changed (AS 5, para 29). Policies are normally kept the same from year to year so that users can see trends (para 28). A change is made only if:

1. a statute requires it, or
2. an accounting standard requires it, or
3. the change gives a more appropriate presentation, meaning more relevant or reliable information (para 30).

These are not changes in policy (para 31): adopting a policy for events that differ in substance from earlier ones (a formal gratuity scheme replacing occasional ex-gratia payments), and adopting a policy for events that are new or were immaterial before. A change made because a new standard is adopted follows that standard's transition rules (para 33).

Meaning. In AS 10, fair value is the price at which an asset could change hands between two parties who are well informed and willing to deal, acting independently of each other (an arm's length transaction). In short, it is the current exchange price, as against historical cost, the price actually paid. AS 19 uses the same idea for leases.

Where the standards use it.

• Revaluation model (AS 10, para 34). After first recording an asset at cost, a business may carry a whole class of assets at a revalued amount: fair value at the date of revaluation, less later depreciation and impairment. The choice between this and the cost model is a policy applied to the whole class (para 32). Revaluations must be frequent enough that the carrying amount stays close to fair value. Fair value is usually found from market evidence by professional valuers (para 35).
• Revaluation increase goes straight to owners' interests as revaluation surplus, except that it is taken to profit and loss to the extent it reverses an earlier revaluation loss on the same asset (para 42). A decrease is charged to profit and loss, except that it is first set against any revaluation surplus already held for that asset (para 43).
• Exchange of assets (AS 10, para 26). An asset received in exchange for another is measured at fair value, unless the exchange lacks commercial substance or neither asset's fair value can be measured reliably.
• Leases (AS 19). A lessee records a finance lease at the lower of the asset's fair value and the present value of the minimum lease payments (U4).

Merits and limits. Fair value shows current worth, which is more relevant to users. But it often rests on estimates, so it is less objective than cost and makes reported figures move from year to year. This is the trade-off between relevance and reliability (sub-topic 1).

AS 29 decides when a possible future payment or receipt must appear in the accounts, when it only goes in a note, and when it is left out.

Definitions (AS 29, para 10), in plain words.

• Liability: a present obligation arising from past events, whose settlement is expected to take resources out of the business.
• Provision: a liability that can be measured only with a substantial degree of estimation. It differs from trade payables and accruals, which need little or no estimation (para 12).
• Obligating event: a past event that leaves the business no realistic alternative to settling the obligation.
• Contingent liability: either (a) a possible obligation from past events, whose existence will be confirmed only by uncertain future events not wholly within the firm's control; or (b) a present obligation that is not recognised because an outflow is not probable, or its amount cannot be estimated reliably.
• Contingent asset: a possible asset from past events, whose existence will be confirmed only by uncertain future events not wholly within the firm's control.
• Probable means more likely than not (paras 10.6 and 22).

Recognising a provision (para 14). A provision is recognised only when all three conditions hold:

1. the business has a present obligation as a result of a past event;
2. an outflow of resources to settle it is probable; and
3. a reliable estimate of the amount can be made.

If any condition fails, no provision is made. Only obligations existing at the balance sheet date are provided for, so there is no provision for future operating losses or for costs the business can avoid by its own future actions (paras 17, 18 and 55). In the rare case where no reliable estimate can be made, the obligation is disclosed as a contingent liability (para 25).

Contingent liabilities (paras 26 to 29 and 68). Never recognised in the accounts. Disclosed in the notes, unless the chance of an outflow is remote. The note gives the nature of the item and, where practicable, an estimate of its financial effect, the uncertainties, and any possible reimbursement. They are reviewed continually; once an outflow becomes probable, a provision is recognised in that period.

Contingent assets (paras 30 to 34). Never recognised, because that could record income that may never arise. Not disclosed in the financial statements either; they are usually disclosed in the report of the approving authority when an inflow is probable. When the inflow becomes virtually certain, the asset is no longer contingent: the asset and the income are recognised in that period.

Measuring a provision (paras 35 to 46).

1. The amount is the best estimate of the expenditure needed to settle the obligation at the balance sheet date.
2. It is not discounted to present value, except for decommissioning, restoration and similar liabilities that form part of the cost of property, plant and equipment.
3. It rests on management's judgement, experience of similar cases and, where needed, experts' reports, including evidence from events after the balance sheet date.
4. It is measured before tax.
5. Risks and uncertainties are taken into account, with caution, but uncertainty does not justify excessive provisions.
6. Expected future events count only where there is sufficient objective evidence that they will occur; gains from expected disposals of assets are ignored.
7. A reimbursement expected from another party is recognised only when it is virtually certain, as a separate asset.

After recognition. Provisions are reviewed at each balance sheet date and adjusted to the current best estimate; one no longer needed is reversed (para 52). A provision may be used only for the expenditure it was created for (para 53).

Disclosure. For each class of provision: the opening and closing amounts, additions, amounts used and amounts reversed; the nature of the obligation, expected timing and uncertainties; and expected reimbursements (paras 66 and 67). A small and medium-sized company, and a micro, small or medium-sized entity that is not a company, may omit paras 66 and 67.

Why principles are needed. Owners, lenders, investors and government all read the same statements. They can rely on them only if the statements follow rules that are generally accepted. Without such agreement, each accountant could define revenue and expense in his own way, and no two sets of accounts could be compared.

Meaning. An accounting principle is best seen as a rule of action or conduct adopted as a guide, not as a law of nature. Principles are man-made. They change as business practice, users' needs, laws and regulations change, and a theory becomes a principle only when it is generally accepted. The whole body of such rules is called generally accepted accounting principles (GAAP). Accounting standards put GAAP into written form (C03).

What makes a principle acceptable. The DU text names three tests:

1. Relevance: it gives information that is meaningful and useful to users.
2. Objectivity: the result does not depend on the personal bias of whoever prepares the accounts, and can be verified.
3. Feasibility: it can be applied without undue cost or complexity.

The tests can conflict. Fixed assets are kept at cost rather than market value because cost is more objective and easier to apply, even though current value would be more relevant.

Concepts and conventions. Both are part of GAAP, but they are not the same.

Business entity. For accounting, the business is a unit separate from its owner, even though in law a sole trader and his business are one. The owner's private affairs are kept out of the business books. Capital is shown as owed by the business to the owner, and drawings reduce it. The idea now extends to departments, whose results are found separately to fix responsibility.

Money measurement. Only facts that can be expressed in money are recorded. Money gives a common unit, so land, stock, debtors and labour can be added together. Two limits follow:

• Important facts that cannot be measured in money are left out: a strike, a rival's better product, the skill of staff, a quarrel between managers.
• Money is recorded at its value on the day of the transaction. Later changes in its purchasing power (inflation or deflation) are ignored, so a rupee of one year is treated as equal to a rupee of another.

Going concern. The business is assumed to continue operating for the foreseeable future, with no intention or need to close down or cut its operations sharply. AS 1 makes this a fundamental assumption (sub-topic 5). It explains much of accounting:

• Fixed assets are shown at cost less depreciation, not at what they would fetch in a forced sale, because they will be used, not sold.
• Depreciation and prepaid expenses make sense, because there will be future years to carry the cost to.
• The split between capital and revenue expenditure, and between current and non-current items, rests on it.

If the business is clearly about to close, the assumption fails: assets are then shown at realisable values, and the fact must be disclosed.

Accounting period (periodicity). A business lives indefinitely, but owners, managers and tax authorities cannot wait until it closes to learn the result. So its life is cut into equal periods, usually a year (the financial year), and profit is measured for each. Interim reports may be made for shorter periods. Cutting a continuous business into periods is what makes accruals, prepayments and the matching of costs with revenue necessary.

Cost (historical cost). An asset is recorded at the price paid to acquire it, and that cost is the base for all later accounting for it, such as depreciation. At the date of purchase cost is taken to equal fair value. Later rises or falls in market value are normally not recorded, which keeps the figures objective and verifiable. Two results: an asset that cost nothing (goodwill built up by the firm itself, the skill of a research team) does not appear at all; and fixed assets show cost less depreciation, not current worth. Current assets such as stock are an exception in practice: they are shown at the lower of cost and market value.

Dual aspect. Every transaction has two equal sides: something is received and something is given. So total assets always equal the claims on them, the owner's and the outsiders'. This is the basis of the double entry system (C16).

Realisation (revenue recognition). Revenue is treated as earned when goods are delivered or services rendered to a customer for a price, that is, when the buyer becomes liable to pay. It is not earned when an order is received, a contract is signed or goods are made. This stops a firm from inflating profit with sales that have not yet happened. An advance from a customer is therefore a liability, not a sale. The detailed rules are in AS 9 (U2).

Accrual. Income is counted when earned and expenses when incurred, whether or not cash has moved. Profit is an increase in the owner's equity from operations, not an increase in cash. Accrual is a fundamental assumption under AS 1.

Matching. To find the profit of a period, first decide the revenue of that period, then set against it the costs incurred in earning it. Goods bought but unsold are carried forward as closing stock, to be matched with next year's sales. Matching is treated in full under business income (U2).

Verifiable objective evidence. Every entry should be supported by a document (a voucher) that can be checked later. Non-cash entries such as depreciation and provisions are the exception: they rest on estimates.

Consistency. Once a method is chosen (of depreciation, of stock valuation), it is applied the same way year after year. Otherwise a change in reported profit might come from a change of method, not from better trading, and users would be misled. Consistency allows comparison of one year with another, and of one firm with another.

• It does not freeze a method for ever. A method may be changed after careful thought when the change gives a fairer view, and the effect of the change must then be stated (AS 5, para 29 lists the grounds; see C02).
• It applies to items of the same kind across periods. Valuing stock at the lower of cost and market value while fixed assets stay at cost is not inconsistent.

Conservatism (prudence). "Anticipate no profit, but provide for all possible losses." Where judgement is needed, the accountant prefers the figure that does not overstate assets or profit. Examples: stock valued at the lower of cost and net realisable value; a provision for doubtful debts. Overstating assets and profit harms users more than understating them. But prudence pushed too far, through excessive provisions or charging capital items to expense, misstates profit and creates secret reserves, which conflicts with full disclosure. AS 1 treats prudence as a consideration in choosing policies (C02).

Full disclosure. The statements must disclose every material fact a user needs to understand them, on their face or in notes: the accounting policies, changes in them, contingent liabilities, and values that differ widely from cost. Disclosure of trivial details is neither possible nor wanted.

Materiality. An item is material if knowing it might influence the decision of a user (AS 1, para 17). Material items are shown separately; immaterial items may be treated in the simplest way. A cheap item such as a stapler is charged as an expense in the year bought, even if it lasts several years. What is material depends on the size and nature of the item and of the firm, and on judgement.

AS 1 (Disclosure of Accounting Policies) names three assumptions that lie under every set of financial statements (paras 9 and 10).

1. Going concern. The enterprise is normally viewed as continuing in operation for the foreseeable future. It is assumed to have neither the intention nor the need to liquidate or to cut down the scale of its operations materially.
2. Consistency. Accounting policies are assumed to stay the same from one period to the next.
3. Accrual. Revenues and costs are recognised as they are earned or incurred, not as money is received or paid, and are recorded in the statements of the periods to which they relate.

Why they are not stated. Their acceptance is taken for granted, so the statements do not mention them. If they are followed, no specific disclosure is needed. If any one of them is not followed, that fact must be disclosed (AS 1, paras 9 and 27). This is the reverse of accounting policies, which must always be disclosed.

DU often gives a short statement and asks which principle it shows. Look for the key idea in each.

Meaning. Accounting standards are written policy documents that codify GAAP. They lay down how particular items are to be recognised, measured, presented and disclosed, both in the books and in the published statements. They state general principles, which are applied with professional judgement.

Need and benefits.

1. Uniformity: the same assumptions, rules and policies are followed by all, instead of each firm choosing freely.
2. Comparability: statements of different firms, and of the same firm over years, can be compared; without standards a comparison may mislead.
3. Reliability: a good standard sharply reduces the room to manipulate reported figures, so users can trust the data.
4. Better decisions: investors, lenders, government and researchers can use the figures with more confidence.
5. Resolving conflicts: groups with opposite interests (existing and prospective shareholders, for example) accept statements prepared on standards as neutral.
6. Support for auditors: an auditor can refuse a client's demand to show figures that break a standard.

Limits.

• Standards cannot override the law. If a law differs from a standard, the law prevails (Preface to the Statements of Accounting Standards, paras 4.1 and 4.2).
• They apply only to material items (Preface, para 4.3).
• They narrow the choice of methods but do not remove it: alternatives remain because firms differ (AS 1, para 13).
• A standard needs judgement to apply, and it may lag behind new kinds of transactions until it is revised.

The Institute of Chartered Accountants of India (ICAI) set up the Accounting Standards Board (ASB) on 21 April 1977, to bring the varied accounting practices in use in India into line. The Preface to the Statements of Accounting Standards (issued January 1979) sets out its scope and procedure. The ASB includes representatives of industry and government bodies, and takes account of Indian law, customs, usage and the business environment. As a member of the International Accounting Standards Committee (IASC), the predecessor of the IASB, the ICAI agreed to give due weight to international standards and to fit them to Indian conditions as far as possible.

Steps in formulating a standard (Preface, paras 5.1 to 5.7):

1. The ASB picks the broad areas that need standards and fixes their priority.
2. Study groups prepare each subject, with wide participation by members of the Institute and others.
3. The ASB holds talks with the government, public sector undertakings, industry and other bodies to learn their views.
4. An exposure draft is issued for public comment. It sets out the concepts and principles, definitions, how the principles are applied, presentation and disclosure, the class of enterprises covered and the effective date.
5. The ASB considers the comments and finalises the draft.
6. The ICAI Council considers it, modifies it with the ASB if needed, and issues the standard under its authority.

At first a standard is recommendatory; later it is made mandatory. Members of the ICAI who audit statements must see that the standards are applied and must disclose in their reports any departure, so that users know of it (Preface, para 6.1). Because standards apply only to material items, it is a material departure that is reported. For companies, the AS are now notified by the government as the Companies (Accounting Standards) Rules, 2021, under the Companies Act, 2013 (AS 1, footnote).

Ind AS (Indian Accounting Standards) are India's standards converged with IFRS. They follow IFRS closely but are issued as Indian standards and notified by the government. Ind AS 2, for example, was notified on 16 February 2015 and carries an appendix that lists where it departs from the corresponding IAS 2 of the IASB. Ind AS 116 on leases, in force for periods beginning on or after 1 April 2019, is based on IFRS 16.

AS and Ind AS compared.

India runs two sets of standards side by side.

• Ind AS are compulsory for the classes of companies that the government's Ind AS rules specify. Which companies fall in is decided by tests such as listing on a stock exchange and net worth, and the related companies of a covered company follow too. Other companies may choose Ind AS voluntarily.
• AS (notified as the Companies (Accounting Standards) Rules, 2021) apply to companies not covered by Ind AS. ICAI's AS also apply to entities other than companies, such as sole proprietors, firms and societies.
• Within AS, smaller entities get relief from some requirements. For example, small and medium-sized companies, and micro, small and medium-sized entities that are not companies, may omit certain disclosures for provisions (AS 29, paras 66 and 67).

Meaning. International Financial Reporting Standards (IFRS) are a single set of global accounting standards issued by the International Accounting Standards Board (IASB) of the IFRS Foundation. The IASB took over from the IASC, whose older standards are called International Accounting Standards (IAS); many IAS are still in force, such as IAS 2 on inventories. Like any standards, IFRS codify accounting principles and lay down how transactions are recognised, measured, presented and disclosed.

Scope. IFRS cover general-purpose financial statements as a whole: the statement of financial position, the statement of profit or loss, cash flows, changes in equity and notes, and individual subjects such as inventories, property, plant and equipment, revenue and leases. Each country decides whether, and for which entities, to adopt or converge with them.

Need for IFRS and for convergence.

1. Cross-border comparability. Investors and lenders work across countries. If each country uses its own GAAP, statements of firms in different countries cannot be compared.
2. Access to global capital. Investors abroad understand statements prepared on a framework they know, which can lower the cost of raising funds.
3. One set of accounts for multinational groups, instead of costly reconciliation between several national GAAPs.
4. Reliability and trust. Widely accepted standards leave less room to manipulate figures and raise investor confidence.
5. Better quality reporting through standards developed with worldwide consultation.

1. Transaction and source document. A transaction measurable in money takes place and is evidenced by a document: bill, cash memo, receipt, cheque counterfoil, debit or credit note. Each entry should rest on such a voucher.
2. Recording. The transaction is entered, in date order, in a book of original entry: the journal or a subsidiary book.
3. Classifying. Each entry is posted to the accounts concerned in the ledger.
4. Balancing each ledger account at the end of the period.
5. Trial balance: a list of the balances, to check that debits equal credits.
6. Adjusting entries for outstanding, prepaid and accrued items, depreciation and provisions.
7. Final accounts: Trading and Profit and Loss Account, and Balance Sheet.
8. Closing entries that transfer the revenue and expense accounts to the Trading and Profit and Loss Account; the asset, liability and capital balances are carried to the next period.

Double entry. Every transaction has two sides: one account receives a benefit and another gives it. Both are recorded, one as a debit (left side of the account) and one as a credit (right side), for the same amount. So the total of debits always equals the total of credits. The system records both cash and credit transactions and gives a complete record.

Classes of accounts (the traditional approach).

Receiving and giving are judged from the point of view of the business, not the owner.

Representative personal accounts stand for persons even though they carry an expense or income name: outstanding expenses (salary outstanding, rent outstanding), prepaid expenses, accrued income and income received in advance. Salary outstanding is owed to the staff, so it is a personal account and a liability; the Salary Account itself is nominal.

The equation approach. The same rules follow from the accounting equation, Assets = Capital + Liabilities, with profit adding to capital:

Drawings reduce capital, so they are debited.

Journal. A book in which transactions are first entered in date order, each showing the account debited, the account credited, the amounts and a short narration. The ledger folio column shows the page of the ledger to which it was posted. A business with many transactions splits the journal into subsidiary books, one for each type of recurring transaction:

The journal proper is still used for opening entries, closing entries, writing off bad debts and depreciation, correcting errors, adjustment entries, transfer entries, and credit purchases or sales of things other than goods (such as a machine bought on credit).

Advantages of subsidiary books. Division of work among clerks, so errors and frauds are caught sooner; entries backed by vouchers and better as legal evidence; similar transactions in one place for easy reference; and less posting, since only periodic totals go to the ledger.

Cash book. It is both a book of original entry and the Cash (and Bank) Account of the ledger, kept separately for convenience; its balances go straight to the trial balance.

• Single column: cash only.
• Two column: cash and discount columns, or cash and bank columns.
• Three column: discount, cash and bank. The discount columns are memorandum totals: discount allowed (debit side) and discount received (credit side) are posted to the Discount Accounts at the end of the period.
• Contra entry: a transaction between cash and bank, such as cash deposited in the bank, appears on both sides and is marked "C"; no further posting is needed.
• Petty cash book: small expenses paid by a petty cashier from a fixed advance, often under the imprest system, with analysis columns for postage, stationery, carriage and the like.

The ledger is the main book of account: it collects all entries for one person, asset, liability, expense or income in one account. It is not a book of original entry; every entry reaches it through the journal or a subsidiary book.

Posting copies each debit in a book of original entry to the debit side of the account named, and each credit to the credit side. In the particulars column, each account names the other account of the entry ("To" on the debit side, "By" on the credit side).

Balancing. At the end of the period each side is totalled. The difference is the balance: written on the shorter side as "By balance c/d" (or "To balance c/d") so both sides agree, and brought down on the opposite side as the opening balance of the next period. A debit balance is an asset, expense or loss; a credit balance is a liability, capital, income or gain. Nominal accounts are not carried down: they are closed to the Trading or Profit and Loss Account.

The ledger may be divided into a debtors' (sales) ledger, a creditors' (bought) ledger and a general ledger for all other accounts.

Meaning. A trial balance is a statement of the debit and credit balances extracted from the ledger, including the cash and bank balances of the cash book, on a given date.

Purpose.

1. To check the arithmetical accuracy of the ledger: total debits should equal total credits.
2. To check that both sides of each transaction have been recorded.
3. To provide a summary of balances from which the final accounts are prepared.

Methods. By totals (the total of each side of every account), by balances (the usual method), or both side by side.

Errors a trial balance does not reveal. Agreement proves arithmetic, not correctness. The totals still agree when:

• a transaction is omitted entirely (error of complete omission);
• an amount is posted to the wrong account but on the correct side, such as to Mohan instead of Sohan;
• a capital item is treated as revenue or the reverse, such as machinery debited to Purchases (error of principle);
• two errors of the same amount cancel each other (compensating errors);
• the wrong amount is entered in the book of original entry, so both sides carry it.

Errors it does reveal. Posting only one side of an entry, posting to the wrong side, a wrong total of a subsidiary book, a wrong balance, or a balance left out of the trial balance.

Suspense account. When the trial balance does not agree and the errors cannot be found at once, the difference is placed in a suspense account so the final accounts can be drafted. As each error is found, it is corrected through the suspense account until its balance disappears. Errors that do not affect agreement, such as errors of principle or of complete omission, are corrected directly, without the suspense account.

Adjusting entries at the year end bring the accounts into line with the accrual and matching ideas (C01), so that the profit and loss shows all the income and expense of the year and only that. Without them profit is over- or understated. The usual groups:

Transfer entries move an amount from one account to another, such as goods withdrawn by the owner (Drawings A/c Dr, to Purchases A/c) or a balance moved to capital.

Closing entries close the nominal accounts at the year end:

1. Trading A/c Dr, to Opening Stock, Purchases, Sales Returns, Wages, Carriage Inwards and other direct expenses.
2. Sales A/c and Purchases Returns A/c Dr, to Trading A/c.
3. Trading A/c Dr, to Profit and Loss A/c, for gross profit (reversed for a gross loss).
4. Incomes and gains (discount received, commission received) Dr, to Profit and Loss A/c.
5. Profit and Loss A/c Dr, to indirect expenses and losses (rent, salaries, discount allowed, carriage outwards, depreciation).
6. Profit and Loss A/c Dr, to Capital A/c, for net profit (reversed for a net loss); Capital A/c Dr, to Drawings A/c.

GAAP in recording. The concepts of C01 govern each step: the entity concept keeps the owner's private items in drawings; cost fixes the amount at which assets are recorded; realisation decides when a sale is recorded; accrual and matching drive the adjusting entries; materiality allows small items to be expensed; conservatism calls for provisions. The final accounts themselves are prepared in U3.

The taxes. Goods and Services Tax (GST) is charged on supplies of goods and services. It has four parts, and the law keeps a separate account of each: central tax (CGST), State tax (SGST), Union territory tax (UTGST) and integrated tax (IGST). A supply within one State normally carries CGST and SGST together; a supply from one State to another carries IGST.

Input and output tax. GST paid on purchases and expenses is input tax. GST charged on sales is output tax. A registered business may use the input tax as input tax credit (ITC) to pay its output tax, so it bears tax only on the value it adds. The credit taken is held in the electronic credit ledger; the tax still due is paid in cash through the electronic cash ledger (CGST Act, s. 49(1) to (4)). GST is therefore not a cost or an income of a registered business: it is collected for the government.

Accounts kept. Input CGST, Input SGST and Input IGST (assets); Output CGST, Output SGST and Output IGST (liabilities). Purchases and sales are recorded net of GST.

The order of set-off (CGST Act, s. 49(5); CGST Rules, r. 88A).

Two further rules:

1. IGST credit goes first. Credit of CGST, SGST or UTGST may be used only after the IGST credit has been used in full (r. 88A). Section 49(5)(a) lists central tax before State tax for the IGST balance, but r. 88A allows that balance to go to the two in any order.
2. Unused credit stays in the electronic credit ledger and is carried forward; a refund of a balance is possible only under the refund provisions (s. 49(6)).

Because CGST credit can never pay SGST, and SGST credit never CGST, the way the IGST balance is split between CGST and SGST matters. Split it so that no CGST or SGST credit is left stranded.

Blocked credit (s. 17(5)). No ITC is allowed, among other cases, on goods or services used for personal consumption (clause (g)), or on goods lost, stolen, destroyed, written off, or given away as gifts or free samples (clause (h)). If credit was taken when the goods were bought, it is reversed.

In the balance sheet. After set-off, any output tax still payable is a current liability (GST payable); any unused input credit is a current asset. Final accounts with GST are worked in U3.