accounting theory and practice

561 Pages·2012·8.88 MB·English

ACCOUNTING
THEORY
AND
PRACTICE
PROFESSOR JAWAHAR LAL
Formerly Head, Department of Commerce,
Formerly Dean, Faculty of Commerce and Business,
Department of Commerce,
Delhi School of Economics,
University of Delhi,
DELHI.
Fourth Revised Edition 2017
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© AUTHOR
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means,
electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the publisher.
Third Edition : 2009
Edition : 2011, 2012, 2013, 2014, 2015, 2016
Fourth Revised Edition : 2017
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ACCOUNTING
THEORY
AND
PRACTICE
Dedicated
to the Sacred Memory
of
My Parents
PREFACE
To the Fourth Edition
It is my esteemed pleasure to place the fourth edition of the book, Accounting Theory and Practice, among the
students and other readers. The earlier edition of the book has been highly appreciated by the students and the academic
community. This fact has further inspired me to make the revised edition a highly valuable and student-friendly text.
Accounting Theory and Practice is intended to provide students with a contemporary and comprehensive course
of study in accounting theory and practice. Financial accounting and theory has been in a constant state of evolution and
many developments have taken place in this vital discipline. It is also true that without proper understanding of the subject
of accounting theory, one will have difficulty in understanding and resolving accounting issues and problems and formulating
useful accounting theory to improve financial accounting and reporting. Many efforts have been made to construct
accounting theory and to develop a single generally accepted accounting theory. But these attempts are based on
different assumptions and methodologies. A universally accepted accounting theory would contribute greatly in the
development of accounting principles and standards.
There is also a need to develop adequate knowledge about different elements of financial statements and their
recognition and measurement and emerging significant issues in the area of accounting theory and practice.
The text, Accounting Theory and Practice, discusses thoroughly principal approaches in accounting theory
construction; accounting postulates, concepts, and principles; elements of financial statements; accounting standards
setting; global convergence and international financial reporting standards; emerging issues of importance in accounting
and reporting practices; cash flow statement.
The book is divided into five parts consisting of twenty five chapters.
Part One: Fundamentals has three chapters—Accounting: An Overview; Accounting Postulates, Concepts and
Principles; Accounting Theory: Formulation and Classifications.
Part Two: Elements of Financial Statements has seven chapters and focuses on Income Concepts; Revenues,
Expenses, Gains and Losses; Assets; Liabilities and Equity; Depreciation Accounting and Policy; Inventory; Accounting
and Reporting of Intangibles.
Part Three: Accounting Standards deals with Accounting Standards Setting; Global Convergence and International
Financial Reporting Standards.
Part Four: Corporate Financial Reporting has twelve chapters and presents discussion on some financial reporting
issues. The issues covered are Financial Reporting: An Overview; Conceptual Framework; Accounting for Changing
Prices; Fair Value Measurement; Segment Reporting; Interim Reporting; Human Resource Accounting; Corporate
Social Reporting; Value Added Reporting; Environmental Accounting and Reporting Financial Reporting in Not-for-profit
Organizations and Foreign Currency Translation.
Part Five: Specialized Topics focuses on Cash Flow Statement.
The materials and discussion in the book have been presented in a highly organised and lucid manner and the book
provides a clear and detailed analysis of the concepts, approaches, issues and developments in the area of accounting
theory. Illustrations have been given about Indian Corporate Practices in some chapters of the book. ‘Corporate Insight’
and ‘Research Insight’ have been given to focus on relevant corporate news and research evidences. Thought provoking,
real life questions and multiple choice questions have been given at the end of the chapters.
The book will be very useful for M.Com., M.B.A., M. Phil and Ph.D., students of Indian Universities and Management
Institutes. The book will also be useful to those who are preparing for professional accounting examinations and who
wish to update their knowledge with current accounting issues and research.
I am grateful to my friends and colleagues who have provided useful suggestions and comments in the course of
writing this book.
I owe a special gratitude to my family for showing great patience and understanding during the entire process of
completing this project.
PROFESSOR JAWAHAR LAL
BRIEF CONTENTS
Pages
Preface to the Fourth Edition
PART ONE : FUNDAMENTALS
Chapter 1 – Accounting : An Overview......................................................................................................3-17
Chapter 2 – Accounting Postulates, Concepts and Principles...................................................................18-35
Chapter 3 – Accounting Theory : Formulation and Classifications ...........................................................36-55
PART TWO : ELEMENTS OF FINANCIAL STATEMENTS
Chapter 4 – Income Concepts...................................................................................................................59-85
Chapter 5 – Revenues, Expenses, Gains and Losses..............................................................................86-100
Chapter 6 – Assets ................................................................................................................................101-132
Chapter 7 – Liabilities and Equity..........................................................................................................133-143
Chapter 8 – Depreciation Accounting and Policy .................................................................................144-159
Chapter 9 – Inventory............................................................................................................................160-189
Chapter 10 – Accounting and Reporting of Intangibles ..........................................................................190-197
PART THREE : ACCOUNTING STANDARDS
Chapter 11 – Accounting Standards Setting............................................................................................201-226
Chapter 12 – Global Convergence and International Financial Reporting Standards (IFRSs) ...............227-253
PART FOUR : CORPORATE FINANCIAL REPORTING
Chapter 13 – Financial Reporting : An Overview...................................................................................257-297
Chapter 14 – Conceptual Framework.....................................................................................................298-326
Chapter 15 – Accounting for Changing Prices........................................................................................327-374
Chapter 16 – Fair Value Measurement ...................................................................................................375-389
Chapter 17 – Segment Reporting ............................................................................................................390-419
Chapter 18 – Interim Reporting...............................................................................................................420-437
Chapter 19 – Human Resource Accounting............................................................................................438-450
Chapter 20 – Corporate Social Reporting ...............................................................................................451-464
Chapter 21 – Value Added Reporting......................................................................................................465-482
Chapter 22 – Environmental Accounting and Reporting.........................................................................483-500
Chapter 23 – Financial Reporting in Not-for-profit Organizations..........................................................501-507
Chapter 24 – Foreign Currency Translation............................................................................................508-514
PART FIVE : SPECIALIZED TOPICS
Chapter 25 – Cash Flow Statement ........................................................................................................517-563
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(1)
C 1
HAPTER
Accounting : An Overview
EVOLUTION OF ACCOUNTING one that has a high degree of freedom at the individual level and
typically evidences an effective commitment to measuring the
Accounting has evolved and emerged, as have medicine,
quality of life attained. These characteristics make it essential
law, and most other fields of human activity, in response to the
that the members of that society, be provided adequate,
social and economic needs of society. Bookkeeping and
understandable, and dependable financial information from the
Accounting appeared not as a chance phenomenon, but distinctly
major institutions that comprise it.”
in response to a world need.1 This is true not only of the days of
Paciolo2 but also important for presentday accounting survival. Profit calculation now is no longer a simple comparison of
Sieveking, one of the few historians who have paid attention to financial values at the beginning and end of a transaction or series
the subject, says that bookkeeping developed as a direct result of transactions. It is now related to a complex set of allocations
of the establishment of partnership on a large scale. and valuations pertaining to the operational activities of a business
enterprise. The concept of accountancy or accounting is now
For centuries after the system of double entry bookkeeping
broader to include the description of the recording, processing,
appeared, accounting was without methodology or any form of
classifying, evaluating, interpreting and supplying of economic
theory. It was during the nineteenth century that a move from
financial information for financial statement presentation and
bookkeeping to accounting—a move away from the relatively
decision making purposes. In its tasks, accounting has been
simple recording and analysis of transactions toward a
successful technically and methodologically.
comprehensive accounting information system—was seen. The
end of the nineteenth century was marked by the most Refinements in cost and management accounting came later
extraordinary expansion of the business. Company form of in the twentieth century along with large-scale production and
organisation, a phenomenon common in business world, grew at high capital investment. These developments created a need to
a great speed. Books about business transactions were written, allocate costs correctly over the units of production, and also to
conventions were followed and accounting was recognised as a provide a measure of productivity and efficiency. Thereafter, cost
system of analysing and maintaining record about business accounting evolved naturally to meet recognized managerial
transactions. In part, the new significance of accounting gained requirements of pricing and costing for competitive purposes,
recognition because of separation between ownership and control and to the determination and setting forth of operational
and also due to diversification in ownership. The increased information for decision making purposes.
reliance on capital as a factor of production necessitated extensive Traditionally, government accounting was linked to taxation
record keeping but, finally, in the nineteenth century, a theoretical and revenue control, and to the recording of and accountability
framework began to develop. This framework or methodology for receipts and expenditures. The twentieth century development
provided a technical means to measure, evaluate, and in budgeting gave a much larger scope to the area of government
communicate information of an economic and financial nature. accounting. The budget became a managerial and policy-making
Modern business has continuity—never-ending flow of instrument and developed into a mechanism for the forward
economic activities. Therefore, accounting has grown to meet a planning of receipts and expenditures. Budgeting nowadays has
social requirement and to guide the business and industry developed in such a manner that it forms one of the bases of, and
accordingly. Accounting is moving away from its traditional is closely associated with economic planning and programming.
procedural base, encompassing record keeping and such related The use of enterprise accounting for the purpose of macro
work as the preparation of budgets and final accounts, towards (economic or national) accounting is largely a development of
the adoption of a role which emphasises its social importance. this century. For purpose of economic policy and economic
Welsch and Anthony3 comment: planning, these national data—to a large extent derived from
“The growth of business organisations in size, particularly commercial data—have become of great importance. They have
publicly-held corporation, has brought pressure from given rise to a new concept of macro accounting which has
stockholders, potential investors, creditors, governmental presented the professional with a new sphere of operations and
agencies, and the public at large, for increased financial disclosure. perspective. Macro accounting has particular importance in
The public’s right to know more about organisations that directly helping to build the bridge between economics and accounting,
and indirectly affect them (whether or not they are shareholders) and thus offers accounting significant scope to make a contribution
is being increasingly recognised as essential. An open society is towards macroeconomic policy.4
(3)
4 Accounting Theory and Practice
Accounting, thus, has gone through many phases: simple Goldberg8 has looked at the purpose of accounting as to
double entry bookkeeping, enterprise, government, and cost and examine and understand the relationships which make up the
management accounting and recently towards social accounting. social environment. He explains as follow:
These phases have been largely a product of changing economic “What, ultimately, is the objective in accounting: Or, more
and social environments. As business and society have become properly perhaps, is there discernible a teleological purpose to
more complex over the years, accounting has developed new which the main recognized functions of accountants as
concepts and techniques to meet the ever increasing needs for accountants are directed, whether implicitly or explicitly ? One
financial information. Without such information, many complex possible answer is that it is control. But control of what ? Since
economic developments and social and economic programmes the subject matter of the accounting processes is the activities of
might never have been undertaken. human beings, it may seem logical to say that it is control of
human beings in some of their activities, in relation, say, to
DEFINITION OF ACCOUNTING resources of various kinds. But this may be open to
misunderstanding. Some people may, indeed, use the results of
What is accounting? This basic question has never been
the accounting processes to impose control over the activities of
answered precisely and many definitions of the term ‘accounting’
other people. But this attitude may seem unsavoury to some people
are available.
who might argue that it is a misuse of accounting rather than its
Back in 1941, The Committee on Terminology of the use to make it an instrument of control over human beings. To
American Institute of Certified Public Accountants (AICPA) such people it may be more consonant with egalitarian views to
formulated the following definition,5 which was widely quoted say that the accounting processes enable people to show others
for many years: with whom they have dealings, especially, for example, employees
and managers, how control over resources may be attained. But
“Accounting is the art of recording, classifying and
what does control over resources means if it does not mean at
summarising in a significant manner and in terms of money,
least exerting some strong influence over the activities of some
transactions and events which are, in part at least, of a financial
people who have access to or influence over the use or location
character, and interpreting the results thereof.”
or movement of the resources in question? And, since resources
In 1966, The American Accounting Association (AAA), in
of all kinds come from materials and forces of nature, would it
order to emphasise the broader perspective of accounting,
be too much to say that the ultimate object of accounting is to
provided the following definition of accounting:6
help people to control materials, or, in generalization, to help
“Accounting is the process of identifying, measuring and man to control and/or manage the physical environment in which
communicating economic information to permit informed the species is placed?
judgements and decisions by users of the information.” But it may be claimed that man has a social environment
also. The role of accounting here is not so much to enable people
More recently, in 1970, the AICPA of USA defined
to control their social environment. We should recognize that each
accounting with reference to the concept of information:7
human being has a social environment composed of people. With
“Accounting is a service activity. Its function is to provide
this in mind, we could say that the purpose of accounting here is
quantitative information primarily financial in nature about
to assist people to examine and understand the relationships which
economic activities that is intended to be useful in making
make up this social environment. Hence, we might say that the
economic decisions.”
fundamental purpose of accounting – in this broad, social sense
The term, ‘quantitative information’ used in the above – is to help all human beings to understand and live at peace with
definition is wider in scope than financial or economic their social environment.
information. Both the definitions, AAA (1966), and AICPA (1970) In recent years, however, it has become clear to many people
emphasise on using the information for the purposes of decision that some parts of our natural environment cannot endure
making. The modern accounting, therefore, is not merely concerned prolonged ‘control’ and continued exploitation without becoming
with record keeping but also with a whole range of activities impaired, that is, without undergoing reactions which are
involving planning, control, decision making, problem solving, inhospitable to humans, and indeed, to other species of life. Hence,
performance measurement and evaluation, coordinating and it might be even more appropriate to say that the purpose of
directing, auditing, tax determination and planning, cost and accounting in carrying out their accounting functions should be
management accounting. to help people to examine and understand both their natural and
their social environment so that they may live in peace with both.
Both, managers within an organisation and interested outside
Perhaps another way of putting it is this: By communicating
parties use accounting information in making decisions that affect
to others information resulting from an honest ‘dealing with’,
the organisation. The today’s accounting focuses on the ultimate
accountants seek to elicit the cooperation of all recognizable
needs of those, who use accounting information, whether these
parties within the community concerned with or affected by the
users are inside or outside the business itself.
control of resources, in attaining a consensually acceptable
allocation and use of those resources.9”
Accounting : An Overview 5
Others have also given their definitions of accounting, but consist of random sets of elements but elements which may be
none has succeeded in clearly establishing the nature and scope identified as belonging together because of a common goal. A
of accounting. Each definition has merit in that it describes system contains three activities: (i) input, (ii) processing of input,
essentially what accountants do, but the boundaries are fuzzy.* and (iii) output. A business organisation is regarded as an open
Of the several available definitions of accounting, the one system which has a dynamic interplay with its environment from
developed by American Accounting Association Committee is which it draws resources and to which it consigns its product
perhaps the best because of its focus on accounting as an aid to and services.
decision making.10
Accounting comprises a series of activities linked together
among themselves. The accounting activities form a progression
ACCOUNTING AND BOOKKEEPING
of steps, beginning with observing, then collecting, recording,
Bookkeeping should be distinguished from accounting which analysing and finally communicating information to its users. In
has been defined clearly above. Bookkeeping is a process of other words, accounting process involves the accumulation,
accounting concerned merely with recording transactions and analysis, measurement, interpretation, classification, and
keeping records. Bookkeeping is a small and simple part of summarisation of the results of each of the many business
accounting. Bookkeeping is mechanical and repetitive while transaction that affected the entity during the year. After this
dealing with business transactions. processing, accounting then transmits or projects messages to
potential decision makers. The messages are in the form of financial
Accounting, on the other hand, aims at designing a
statements, and the decision makers are the users. Accounting
satisfactory information system which may fulfill informational
generally does not generate the basic information (raw financial
needs of different users and decision makers. It primarily focuses
data) rather the raw financial data result from the day to day
on measurement, analysis, interpretation and use of information.
transactions of the enterprise.
It highlights the relevance and relationship of the information
produced by the accounting process and effects of different As an information system, accounting links an information
accounting alternatives. It includes budgeting, strategic planning, source or transmitter (generally the accountant), a channel of
cost analysis, auditing, income tax preparation, performance communication (generally the financial statements) and a set of
measurement, evaluation, control, preparing managerial reports receivers (external users). When accounting is looked upon as a
for decision making, etc. process of communication, it is defined as “the process’ of
encoding observations in the language of the accounting system,
ACCOUNTING AS AN INFORMATION of manipulating the signs and statements of the systems and
decoding and transmitting the result.”11
SYSTEM
Figure 1.1 displays how accounting as an information system
The term ‘system’ may be defined as a set of elements which
helps in business and economic decisions made by userdecision
operate together in order to attain a goal. A system does not
makers. In this service activity, as shown in Fig. 1.1, accounting
Accounting Decision Makers
s
d
e
e n
N o
n ati
o m
mati for
or In
f
n
I
Business Recording of Processing of Communication
Activities and Data Measuring Data (Preparation (As Financial Statements,
Transactions Business and Storage Other Statements
Transactions of Data) and Reports)
Fig. 1.1: Accounting as an Information System in Business and Economic Decisions.
*“A good definition, besides providing a description so that people have an understanding of what the object is, should establish clear cut
boundaries. Any object that falls within the boundaries of the set is identified as a member of the set and any object that falls outside is then
not a member of the set”— Vernon Kam, Accounting Theory, John Wiley and Sons, 1990, p. 33