Theory Base of Accounting – Class 11 Accountancy Chapter 2 Notes & NCERT PDF

Introduction

For accounting information to be useful it must be reliable and comparable – both across firms (inter-firm) and across years (inter-period). This is possible only when financial statements are prepared using consistent principles, concepts and rules. This body of principles, concepts, rules and guidelines is the theory base of accounting. In India, the Institute of Chartered Accountants of India (ICAI) also issues Accounting Standards to bring uniformity.

2.1 Generally Accepted Accounting Principles (GAAP)

The AICPA defines a principle as "a general law or rule adopted or professed as a guide to action, a settled ground or basis of conduct or practice."

GAAP are the rules or guidelines adopted for recording and reporting business transactions in order to bring uniformity in the preparation and presentation of financial statements.

Example: recording all transactions at historical cost, verifiable from documents such as a cash receipt, brings objectivity. GAAP have evolved from experience, customs, statements of professional bodies and government regulation, and they change with the legal, social and economic environment. Terms such as principles, concepts, conventions, postulates and assumptions are used interchangeably; the chapter calls them basic accounting concepts.

2.2 Basic Accounting Concepts

Thirteen concepts are listed: business entity, money measurement, going concern, accounting period, cost, dual aspect, revenue recognition (realisation), matching, full disclosure, consistency, conservatism (prudence), materiality and objectivity.

2.2.1 Business Entity

The business is separate from its owner. Capital brought in by the owner is a liability of the business to the owner; drawings reduce capital. Personal transactions of the owner are not recorded unless business funds flow in or out.

2.2.2 Money Measurement

Only transactions expressible in money are recorded, and records are kept in money, not physical units. 2 acres of land, 30 computers and 20 tons of raw material cannot be added – their rupee values can. Limitation: the value of money changes over time, so adding a building bought in 1995 with a plant bought in 2005 adds heterogeneous values.

2.2.3 Going Concern

The firm is assumed to continue operating for a long time and not to be liquidated in the foreseeable future. An asset is a "bundle of services": a computer costing ₹50,000 with a 5-year life is charged at ₹10,000 a year instead of the full ₹50,000 in the year of purchase.

2.2.4 Accounting Period

Financial statements are prepared at regular intervals, normally one year, so users get timely information. The Companies Act 2013 and the Income Tax Act require annual statements; listed companies also publish quarterly results.

2.2.5 Cost Concept

Assets are recorded at purchase price, including acquisition, transport, installation and making ready for use. Book example: an old plant bought by Shiva Enterprise for ₹50 lakh + ₹10,000 transport + ₹15,000 repairs + ₹25,000 installation is recorded at ₹50,50,000. Historical cost is objective and verifiable, but may not show true worth and can lead to hidden profits when prices rise.

2.2.6 Dual Aspect

Every transaction has a two-fold effect and is recorded in at least two accounts. It gives the accounting equation:

Assets = Liabilities + Capital

Ram starting business with ₹50,00,000 increases cash (asset) and capital equally. Buying a machine on credit for ₹30,00,000 increases machinery and creditors. This is the core of the double entry system.

2.2.7 Revenue Recognition (Realisation)

Revenue is recognised when it is realised, i.e. when a legal right to receive it arises – when goods are sold or services rendered, not when cash is received. Credit sales are revenue on the day of sale. Rent, commission and interest are recognised on a time basis. Exceptions: long construction contracts (proportionate revenue), hire purchase (instalments collected).

2.2.8 Matching

Expenses of a period should be matched with revenues of the same period. Salaries, rent and insurance are recognised for the period they relate to; depreciation spreads an asset's cost over its useful life; only the cost of goods sold (not all goods bought) is matched with sales.

2.2.9 Full Disclosure

All material and relevant facts about financial performance must be fully disclosed in the statements and notes. Formats prescribed by law and SEBI's disclosure rules support this.

2.2.10 Consistency

The same accounting policies (e.g. depreciation method, stock valuation) should be followed year after year so that results are comparable. Consistency does not forbid change, but necessary changes and their effects must be disclosed.

2.2.11 Conservatism (Prudence)

"Play safe": do not anticipate profits, but provide for all possible losses. Examples: valuing closing stock at cost or market value, whichever is lower; provision for doubtful debts; writing off intangible assets. Deliberate understatement is discouraged because it creates secret reserves.

2.2.12 Materiality

Focus on facts that would influence an informed user's decision. Small items such as erasers and pencils are treated as expenses of the year even if unused.

2.2.13 Objectivity

Transactions should be recorded free from bias, supported by verifiable documents (cash receipt, invoice, delivery challan). This is one reason for using historical cost rather than market value.

2.3 Systems of Accounting

2.4 Basis of Accounting

2.5 Accounting Standards

Written policy documents issued by the ICAI covering recognition, measurement, treatment, presentation and disclosure of transactions.

Goods and Services Tax (GST)

GST is a destination-based tax on consumption of goods and services, with credit for taxes paid at earlier stages, so only value addition is taxed and the burden falls on the final consumer.

Exam Focus

Key Terms

GAAP (सामान्यतः स्वीकृत लेखांकन सिद्धांत), Business entity (व्यावसायिक इकाई), Going concern (चालू व्यवसाय), Accounting period (लेखांकन अवधि), Dual aspect (द्विपक्षीय अवधारणा), Matching (मिलान), Conservatism (रूढ़िवादिता), Materiality (सारता), Consistency (एकरूपता), Objectivity (वस्तुनिष्ठता), Accrual basis (उपार्जन आधार), Accounting standards (लेखांकन मानक), GST (वस्तु एवं सेवा कर).

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