Financial Statements & Accounting Principles
Summary
• Balance Sheet has two sides, namely, Assets and Liabilities. Assets are valuable resources owned by the firm and Liabilities are obligations payable by it.
• Liabilities are sources of financing assets.
• Liabilities are broadly classified into two categories, namely, External Liabilities (consisting of creditors and lenders) and Internal Liabilities (consisting of owners' contribution/equity).
• Owners' equity consists of
1. initial capital provided by them and
2. Retained earnings accumulated over the years from the firm's profitable operations.
• External liability-holders have first claim on the assets of the firm and owners have a residual claim. It is for this reason owners' capital is known as Risky Capital.
• Profits, since payable to owners, are liabilities from the perspective of the firm and losses, since recoverable from them are its assets. This is as per Separate Entity concept.
• Total Assets are always equal to total Liabilities. This is as per the Principle of Duality. Therefore the fundamental accounting equation, is:
Owners' equity + Liabilities (external) = Assets
• Balance Sheet is always with reference to a point of time (say 31st March). Therefore, it is a snapshot of financial position of a firm at a specific date in terms of Assets owned and Liabilities owed. Whereas income statement indicates profits earned (or losses suffered) during the accounting period.
• Financial statements record only those facts, which are possible to be expressed in financial terms. Non-monetary events, howsoever important they may be, are not recorded. Therefore, financial statements do not provide all the information about the firm. This is according to the Money Measurement concept.
• Going Concern concept implies that the firm will continue to operate in a foreseeable future and, therefore, Assets should be valued at historical cost (Cost concept) less depreciation (if any) and not at liquidation value. Assets shown in a Balance Sheet do not show their market valuation.
• Accounting Period concept normally covers time span of twelve months. Most of the companies follow financial year (April-March) or calendar year (January-December) to determine income.
• According to the Accrual concept, revenues are recognized when they are earned and not when they are received. Likewise, expenses are recognized when they are incurred and not when they are paid.
• As per matching principle, expenses reckoned in an accounting period are matched with revenues earned in that period.
• Revenue expenses can be apportioned between two or more accounting periods (on the basis of time) to conform to accrual principle.
• Capital expenditure is amortised during several accounting years on the basis of some logical, objective and scientific criterion.
• As losses, do not have potentials to contribute to further revenues, they are normally written off in the same accounting year in which they occur.
• Where there exists more than one alternative method of dealing with an item, whatever method has once been adopted, the same should be consistently followed year after year as per the principle of consistency. This concept facilitates valid comparison of accounting data over a period of time.
• The Conservative principle is based on the premise of playing safe. Its' basic tenet is "provide for all possible losses but anticipate no profits till they are realised".
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