accountng theory

8/6/2019 Accountng Theory

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Double Entry Systemy In a double-entry system, two entries are made for

each transaction - one entry as a debit in one account

and the other entry as a credit in another account. Thetwo entries keep the accounting equation in balance so

that:

y Assets = Liabilities + Owners' Equity


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Limitations of financial

statementsy Financial statements are based on historical costs and as

such the impact of price level changes is completely

ignored.

y They are interim reports. The basic nature of financial

statements is historic.

y These statements are neither complete nor exact. They

reflect only monetary transactions of a business.

y The following limitations may be noted:


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y The financial position of a business concern is affected by

several factors-economic, social and financial, but

financial factors are being recorded in these financialstatements. Economic and social factors are left out. Thus

the financial position disclosed by these statements is not

correct and accurate.


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y Facts which have not been recorded in the financial books

are not depicted in the financial statement.

y Only quantitative factors are taken into account.y But qualitative factors such as reputation and prestige of

the business with the public, the efficiency and loyalty of

its employees, integrity of management etc. do not appear

in the financial statement.


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Many items are left to the personal judgement of theaccountant. For example; provision of depreciation, stockvaluation, bad debts provision etc. depend on the personal

judgement of accountant.

On account of convention of conservation the incomestatement may not disclose true income of the business

since probable losses are considered while probableincomes are ignored.


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y The data contained in the financial statements are dumb;

they do not speak themselves.

y

The human judgment is always involved in the

interpretation of statement. It is the analyst or user who

provides tongue to those data and make them to speak.


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HRAy Human Resource Accounting involves the dimension of

cost incurred by the organization for all the personnel

function.y It deals with how to measure the economic value of the

people to the organization .

y The two main components ofHuman Resources

Accounting were investment related to employees and thevalue generated by them.


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y Investment in human capital included all costs incurred inincreasing and upgrading the employees skill sets andknowledge of human resources.

y The output that an organization generated from humanresources was regarded as the value of its humanresources.

y Human Resources accounting is used to measure the

performance of all the people in the organization, andwhen this was made available to the stakeholders in theform of a report, it helped them to take critical investmentdecisions.


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Cash Flow Vs Profity cash flow and profit are different. Cash flow is the money

that flows in and out of the firm from operations, like

financing activities, and investing activities. Profit, alsocalled net income, is what remains from sales revenue

after all the firm's expenses are subtracted.

y Cash flow is actually more important for the small

business owner to focus on than profit. Companies canmake a profit but still have a negative cash flow and not

be able to pay their bills.


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y Cash flow is the movement of money in and out of the

business. It is taken into consideration whenplanning the

funding requirements of a business, either on a short orlong-term basis, by forecasting the cash that is expected to

come in and go out of the business.

y Profit is basically defined as revenue minus costs. In other

words, it is the difference between the amount of moneythat the business gets from selling a certain product and

the amount spent in selling it.


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Inventory TurnoverRatioy A ratio showing how many times a company's inventory is

sold and replaced over a period. the


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y A low turnover implies poor sales and, therefore, excess

inventory. A high ratio implies either strong sales . A low

turnover rate may point to overstocking, obsolescence, ordeficiencies in the product line or marketing effort.

y High inventory levels are unhealthy because they

represent an investment with a rate of return of zero. It

also opens the company up to trouble should prices beginto fall.


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y An item whose inventory is sold (turns over) once a year has

higher holding cost than one that turns over twice, or three

times, or more in that time. Stock turnover also indicates the

briskness of the business. The purpose of increasing inventory

turns is to reduce inventory for three reasons.

y Increasing inventory turns reduces holding cost. The

organization spends less money on rent, utilities, insurance,

theft and other costs of maintaining a stock of good to be sold.y Reducing holding cost increases net income and profitability as

long as the revenue from selling the item remains constant.


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y Items that turn over more quickly increase responsiveness

to changes in customer requirements while allowing the

replacement of obsolete items. This is a major concern infashion industries.

y However high turns may indicate that the inventory is too

low. This often can result in stock shortages.


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Inflation accountingy Inflation accounting is a term describing a range of

accounting systems designed to correct problems arising

from historical cost accounting in the presence ofinflation.


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Significancey Historical accounts do not consider the unrealised holding

gains arising from the rise in the monetary value of the assetsdue to inflation.

y The objective of charging depreciation is to spread the cost ofthe asset over its useful life and make reserve for itsreplacement in the future. But it does not take into account theimpact of inflation over the replacement cost which may resultinto the inadequate charge of depreciation.

y Under historical accounting, inventories acquired at old pricesare matched against revenues expressed at current prices. In the

period of inflation, this may lead to the overstatement of profitsdue mixing up of holding gains and operating gains.


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Limitations of Inflation Accounting

y Though Inflation Accounting is more practical approach

for the true reflection of financial status of the company,

there are certain limitations which are not allowing this tobe a popular system of accounting. Following are the

limitations:

y Change in the price level is a continuous process.

yThis system makes the calculations a tedious task becauseof too many conversions and calculations.

y This system has not been given preference by tax

authorities.


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Profit Prior to Incorporationy sometimes a company purchases a running business from

a date prior to its incorporation. If the company has earned

any profit from the date of purchase to the date ofincorporation such profit is called as profit prior to

incorporation.


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Such profit cannot be said to have been earned by the

company as it is not available for distribution asdividend to the shareholders. Such profit is treated as

capital profit and is transferred to Capital Reserve

Account.

If there is any loss prior to incorporation such loss isin the nature of capital loss and is debited to Goodwill

Account. It should be noted that, the date of

incorporation and not the date of commencement

should be taken into consideration for calculating profitor loss prior to incorporation.


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A TERATION OF SHARE CAPITA

y Alteration of share capital is a business term

describing an increase, reduction, or any other change

in the authorized capital of a company. If permitted by

the articles of association, a limited company can

increase its authorized capital as appropriate. It can

also rearrange its existing authorized capital (e.g. by

consolidating 100 shares of Re.1 into 25 shares of

Re.4 or by subdividing 100 shares of Re.1 into 200 of

50p) and cancel un-issued shares. These are reserved

powers, passed - unless the articles of association

provide otherwise - by an ordinary resolution.


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Preferential Allotmenty

preferential issue means allotment of equity to someselected people by a company which has its share alreadylisted.

y When a listed company doesn't want to go for furtherpublic issue and the objective is to raise huge capital by

issuing bulk of shares to selected group of people,preferential allotment is a good option.

y A private placement is an issue of shares or of convertiblesecurities by a company to a select group of persons under

Section 81 of the Companies Act, 1956, which is neither arights issue nor a public issue. This is a faster way for acompany to raise equity capital.

y


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A private placement of shares or of convertiblesecurities by a listed company is generally known

by name of preferential allotment.


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BUYBACK OF SECURITIES

y certain provisions in the companies act which allow

the shareholders to sell their shares directly to the

company and such provisions are termed as buy backof shares. Buy back of shares can be understood as the

process by which a company buys its share back from

its shareholder or a resort a shareholder can take in

order to sell the share back to the company.

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