Unit 2: Mechanics of Accounting

Accounting Standards and IFRS

Accounting standards are a set of principles and guidelines that companies must follow when preparing financial statements. These standards ensure consistency, transparency, and comparability in financial reporting, which is crucial for stakeholders such as investors, creditors, and regulators.

IFRS (International Financial Reporting Standards) is a set of accounting standards developed by the International Accounting Standards Board (IASB). These standards are intended to create a common accounting language and are used by companies in many countries around the world. They help businesses report their financial performance and position consistently, regardless of the country in which they operate.

International Accounting Principles and Standards

1. International Accounting Principles

International accounting principles are fundamental guidelines that form the foundation for preparing and presenting financial statements globally. These principles ensure uniformity, consistency, and comparability in financial reporting.

These are fundamental concepts and guidelines that form the basis for preparing financial statements worldwide.

Objectives of International Accounting Principles

• Uniformity: Ensure consistent accounting practices globally.
• Comparability: Facilitate comparison between different companies' financial statements.
• Transparency: Provide clear and understandable financial information to stakeholders.
• Accountability: Assist companies in tracking financial performance accurately.

These principles are the foundation for International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS)

2. International Accounting Standards (IAS) and IFRS

Objectives of International Standards

• Ensure transparency and comparability in financial reporting.
• Enhance global investor confidence through reliable and accurate reporting.
• Facilitate cross-border investments by adopting standardized practices.

Differences Between IAS and IFRS

Matching of Indian Accounting Standards with International Accounting Standards

Double Entry System of Accounting

The Double Entry System of Accounting is a method where every financial transaction is recorded in at least two accounts—one as a debit and the other as a credit of equal value. This system ensures that the accounting equation remains balanced:

Accounting Equation: Assets = Liabilities + Owner's Equity

Key Features of Double Entry System

1. Dual Aspect: Every transaction has two aspects—debit and credit.
2. Complete Recording: It records all types of transactions, financial assets, and liabilities.
3. Accurate and Reliable: Ensures the accuracy of accounts through trial balances.
4. Systematic maintenance provides a detailed record of financial data.
5. Prevents Errors: Helps in detecting errors and frauds through reconciliation.

Rules of Debit and Credit

Suppose a business buys office furniture worth ₹50,000 in cash.

Advantages of Double Entry System

1. Accurate Financial Position: Provides a complete view of the financial status of the business.
2. Error Detection: Errors can be identified through trial balance.
3. Facilitates Financial Statements: Helps in preparing income statements and balance sheets.
4. Legal and Tax Compliance: Ensures systematic records for legal and tax purposes.

Disadvantages of Double Entry System

1. Complexity: Requires trained personnel for maintaining accounts.
2. Time-Consuming: Recording each transaction twice takes time.
3. Costly: Suitable for larger organizations due to the associated costs.

Golden Rules of Debit and Credit

The Golden Rules of Accounting provide simple guidelines to determine when to debit and credit accounts in the double-entry accounting system. These rules are categorized based on the three types of accounts

1. Real Account (Assets)

• Debit: When assets come into the business
• Credit: When assets go out of the business

• Example: Furniture purchased for ₹50,000: Debit Furniture, Credit Cash.

2. Personal Account (Persons or Entities)

• Debit: The person/entity receiving the benefit
• Credit: The person/entity giving the benefit
• Example: Payment made to supplier for ₹30,000: Debit Supplier, Credit Cash.

3. Nominal Account (Expenses and Incomes)

• Debit: Expenses and losses
• Credit: Incomes and gains
• Example: Commission earned ₹10,000: Debit Cash, Credit Commission Income.

Mnemonic to Remember the Golden Rules

• Real: "What comes in - Debit; What goes out - Credit"
• Personal: "Receiver - Debit; Giver - Credit"
• Nominal: "Expenses - Debit; Income - Credit"

Journalizing of Transactions

The Journal is the book of original entry where all financial transactions are recorded in chronological order.

Rules for Journalizing

• Identify the type of accounts involved.
• Apply the golden rules of accounting to determine debit and credit.
• Record the transaction in the journal.

Example: A company pays rent of ₹10,000.

Ledger Posting

The ledger is the book of final entry where journal entries are classified and posted into individual accounts.

Steps for Ledger Posting

• Create separate ledger accounts for each transaction element.
• Post debits and credits from the journal to the respective ledger accounts.

Trial Balance

The Trial Balance is a statement that lists the balances of all ledger accounts to ensure that total debits equal total credits.

Steps for Preparing a Trial Balance

1. List all ledger accounts.
2. Write their respective debit or credit balances.
3. Ensure the total debit equals the total credit.

Example 

Transaction:

• Purchased Furniture ₹50,000 for cash.
• Paid Rent ₹10,000.

Journal Entry:

• Furniture A/c Dr. ₹50,000
  To Cash A/c ₹50,000
• Rent A/c Dr. ₹10,000
  To Cash A/c ₹10,000

Ledger Posting:

• Furniture Account shows a Debit of ₹50,000.
• Rent Account shows a Debit of ₹10,000.
• Cash Account shows a Credit of ₹60,000.

Trial Balance:
Debits = Credits (₹60,000).