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CASEBOOK

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Content
    Introduction to Accounting
    The Story Income Statement Balance Sheet Statement of Cash Flow
    Accounting Principles
    Introduction to Accounting Principles Accounting Principles & Guidelines (contd..) Accounting Principles & Financial Statements
    Accounting Basics
    Double Entry System of Accounting Debits & Credits Bank's Debit & Credit Chart of Accounts
    Financial Statements
    Introduction to Financial Statements Accrual v/s Cash basis of Accounting
    Income Statement
    Income Statement: An Introduction Revenue & Expenses; Gains & Losses Income Statement Formats Operating Income; EBITDA; Net Income; EPS
    Balance Sheet
    Balance Sheet: An Introduction Assets & Liabilities; Stockholders' Equity Relation: Balance Sheet & Income Statement
    Working Capital & Liquidity
    Operating Cycle Working Capital: An Introduction Working Capital v/s Liquidity
    Statement of Cashflow
    Cashflow Statement: An Introduction Preparing Cashflow Statement Preparing Cashflow Statement (Contd ... ) Preparing Cashflow Statement: Summary Relation: Balance Sheet & Cashflow Statement
    Adjusting Entries
    Introduction to Adjusting Entries Accrual Entries Deferral Entries Reversal Entries
    Preparing Financial Statements
    Financial Statements: Quarter 1 Financial Statements: Quarter 2 Financial Statements: Quarter 3 Financial Statements: Quarter 4
    Financial Ratios
    Introduction to Financial Ratios Profitability Ratios Liquidity & Solvency Ratios Activity & Valuation Ratios
    Capital Budgeting
    Need & Business Scenario Net Present Value (NPV) Present Value (PV) of an Annuity Present Value (PV) of a Perpetuity Rate of Return (IRR) & Payback Method
    Case Study Framework
    Introduction to Case Study Frameworks Growth Strategy Merger & Acquisition International Expansion Pricing Strategy

Accounting Principles

INTRODUCTION TO ACCOUNTING PRINCIPLES

Accounting principles were created to bring in standardization in the field of accounting. They ensure that financial statements as published by various companies follow the same guidelines and are comprehensible by their investors and other stakeholders. These rules dictate the field of financial accounting and are commonly known as Generally Accepted Accounting Principles (GAAP).

ACCOUNTING PRINCIPLES & gUIDELINES

The following section captures description for a few of these principles in a highly condensed format.

1. MONEY MEASUREMENT

Transactions or economic activities that can be measured or converted in monetary terms are the only ones considered for accounting purposes. The monetary value of transactions provides a common denominator for the comparison of several heterogeneous facts as undertaken by a business entity.

Example. Consider a company that owns $50,000 of cash, 10,000 square feet of land, 2,000 pounds of inventory, 3 trucks, and so on; these units cannot be added together to provide real insight of what actually business owns. Also, these are not quite useful for comparing two or more such entities.

However, expressing these items in monetary terms makes addition possible and thus true ownership of the company can be studied and compared to an extent.

Measuring financial transactions using their monetary values often comes with a few limitations on the scope of the accounting reports. Transactions or business events captured in terms of their monetary values assume that the dollar’s purchasing power has not changed over time; thus ignoring the effect of inflation on the recorded amounts. So theoretically, a dollar from the 1980 transaction carries the same value as a dollar from the 2020 transaction.

2. ECONOMIC ENTITY ASSUMPTION

Transactions are recorded and accounting reports are prepared for business entities. These entities are considered different and distinguished from their owners, executives and persons who are associated with them for accounting purposes.

Business entities can either be incorporated (registered) or unincorporated (un-registered). For corporations, the distinction between owners and the businesses is often quite easily made as corporations themselves are registered as a separate legal entity. However, in case of un-incorporated businesses, it often becomes difficult to identify the entity for which a set of accounts is defined.

Example. consider a family who owns and operates an unincorporated clothing store. For legal purposes, the store and its owners are considered to be a single entity and a creditor of the store can sue owners in case of a default payment. But for sake of accounting, they are considered as two different entities. The non-business transactions of the owners must not be captured in the store’s set of accounts.

3. THE GOING CONCERN PRINCIPLE

The Going concern principle assumes that a business entity will continue to operate for infinitely long periods and will not liquidate in the near future. Thus, the resources currently available to the entity will be available for future use and there is no use to continually estimate an entity’s total worth for prospective buyers. This principle allows entities to spread its prepaid expenses to several future accounting periods.

However, considering the financial situation if the accountant feels that an entity is going to be liquidated in the near future; he is required to disclose this assessment and report the entity’s resources at their liquidation value. 

Example. a shirt manufacturer might have various stages of production and at any point in time; it may have several partially completed shirts. Accounting does not attempt to value these partially completed shirts for regular reporting. The on-going principle presumes that the manufacturing of these shirts will proceed to completion, and thus the value at which these unfinished items could be sold, if the entity were liquidated today is immaterial.

4. THE COST PRINCIPLE

The cost principle states that an entity should record the value of all its assets (such as land, machinery, equipments, buildings, etc) at the cost of their purchase. This amount once captured remains unaffected by the depreciation or appreciation in the value of the asset in future. Therefore the values shown on financial statements are actually historical costs of purchase and under no circumstances reflect the true market value of these assets. (Exception to this principle is investments related to stocks, bonds and other marketable securities that are actively traded on stock markets).

Example. an entity purchases a piece of land for $500,000; this transaction would be recorded in the accounts of the entity as an asset worth $500,000. This value would remain unaltered in books even if the value of land appreciates to $600,000 or depreciates to $400,000 next year.

At the time of liquidation or acquisition; the true worth of an entity’s long term assets is mostly derived by third party appraisers and is altogether a very different activity.

5. THE DUAL ASPECT PRINCIPLE

Each entity has economic resources called assets. These assets are claimed by various parties called equities. There are two types of Equities – 1) Owner’s equity (claims by business owners) 2) Liabilities (claims by creditors). For an incorporated business; term stockholders’ equity is used instead of owners’ equity.

Basis above explanation, the financial accounting equation can be summarized as below –

Assets = Owners’ Equity + liabilities

Accounting records for all business transactions are generated considering the above equation. As an example, if an entity decides to increase one of its assets, it will be automatically followed by either a decrease in another asset or an increase in one of its equities (liability or owners’ equity) in order to bind accounting entry as per the above equation. This phenomenon is called the dual impact of accounting records.

Dual aspect principle ensures that every transaction recorded in the accounting books of an entity affects at-least two accounts and it is not possible to record a transaction resulting in change of only one account.

Example. To illustrate the dual aspect of accounting records, consider Mr. Jane has just started a business and has infused capital of $55,000 into the entity’s bank account.

The new entity now has an asset (cash) of $55,000 which is claimed by Mr. Jane (owner’s equity); thus accounting records generated would be –

Cash $55,000                                       Owner’s Equity $55,000

Table of Contents : Accounting Principles

Part 2 : Accounting Principles & Guidelines (Contd..)

Accounting Principles & guidelines

  • Time Period Assumption
  • Conservatism Principle
  • Revenue Recognition Principle
  • Full disclosure Principle
  • Matching Principle
  • Materiality
Part 3 : Effect of Accounting Principles on Financial Statements

Effect of Accounting Principles on Financial Statements

  • Income Statement
  • Balance Sheet
  • Notes to Financial Statements
Part 1: Introduction & Accounting Principles
  • Introduction
  • Accounting Principles & guidelines
    • Money Measurement
    • Economic Entity Assumption
    • The Going Concern Principle
    • The Cost Principle
    • The Dual Aspect Principle

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Accounting Basics

Some of the basic accounting terms that you will learn include revenues, expenses, assets, liabilities, income statement, balance sheet, and statement of cash flows.

Chart of accounts

A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger.

Trending Topics

Break-even Point

Depreciation

Activity Based Costing

Credits & Debits

Bank Reconciliation

Manufacturing Overheads

Non-manufacturing Overheads

Improving Profits

standard costing

A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger.

Advanced section top picks

expert's choice

Standard Costing

Financial accounting

Working Capital & Liquidity

Evaluating business investments

Inventory & Cost of goods sold

Trending Topics

Featured

Accounting Basics

Some of the basic accounting terms that you will learn include revenues, expenses, assets, liabilities, income statement, balance sheet, and statement of cash flows.

Chart of accounts

A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger.

Trending Topics

Break-even Point

Depreciation

Activity Based Costing

Credits & Debits

Bank Reconciliation

Manufacturing Overheads

Non-manufacturing Overheads

Improving Profits

standard costing

A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger.

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