English for Accounting and Auditing BST

BIG STEP TRAINING

No. 33, Alley 3, Le Van Hien
HOTLINE: 0972.202.138


GII THIU V KHÓA HC “TING ANH K TOÁN KIM TOÁN” TI BST

MC TIÊU KHÓA HC
Khóa hc cung cp nn tng v ting Anh trong lnh vc K toán Kim toán thông qua vic phân tích và
cung cp kin thc v nhng thut ng, nghip v cn bn theo các thông l mi nht ca Quc t
cng nh Vit Nam đ sau khi hoàn thành khóa hc:

 Hc viên có đc nn tng tt đ nghiên cu các chng trình chuyên sâu v lnh vc k toán,
kim toán nh FIA, ACCA, CIA, CPA
 Hc viên có th vt qua các bài thi tuyn dng và có th tr li phng vn v lnh vc k toán,
kim toán bng ting Anh.
 i vi hc viên là nhân viên vn phòng, hc viên có th nâng cao hiu qu công vic và làm
vic tt vi các tài liu v k toán, kim toán cng nh tham gia các hi tho đc din thuyt
bng ting Anh bi các chuyên gia nc ngoài; có th làm vic bng ting Anh đi vi các đi tác
nc ngoài trong lnh vc k toán - kim toán.

I TNG HC VIÊN
Chng trình đc thit k phù hp vi đi tng là sinh viên và nhân viên vn phòng hoc các
đi tng khác mun tìm hiu v k toán, kim toán bng ting Anh.

 Yêu cu ting Anh đu vào: có trình đ ting Anh  mc đ c bn (nn tng t cp 3).
 Yêu cu nghip v đu vào: chng trình s cung cp cho hc viên nhng kin thc c bn v
nghip v nên mi đi tng đu có th tham gia.

S LNG HC VIÊN: Khong 20 hc viên/lp.

GING VIÊN

Mr. TRNG C THNG (1988)
 Tt nghip loi Gii - Hc vin Tài chính – Hà Ni (2006-2010).
 Hin ti (2013) đã hoàn thành chng trình CAT, hoàn thành các
môn F chng trình ACCA và đang nghiên cu chng trình CIA.

 01 nm kinh nghim ging dy chng trình FIA, ACCA.
 Kinh nghim làm vic trong lnh vc kim toán đc lp, kim toán
ni b, Giám đc điu hành.


NI DUNG CHNG TRÌNH HC
 đm bo các mc tiêu đc đ ra, chng trình hc (vi thi lng khong 50 gi) đc thit k đi
sâu vào hai k nng cn thit cho công vic bao gm các bài c (Reading) và các bài
Nghe (Listening) nhm giúp hc viên có các k nng đc và dch tài liu chuyên sâu v k toán kim toán
cng nh kh nng nghe hiu khi tip xúc hoc nghe thuyt ging bi chuyên gia nc ngoài.
Bên cnh hai k nng chính là c và Nghe, hc viên còn đc đan xen thêm các hot đng làm vic
nhóm, thuyt trình, vit lun nhm nâng cao kh nng Nói (Speaking) và Vit (Writing) v vn đ

thuc lnh vc k toán, kim toán.
Hc viên s tip nhn các mng kin thc theo ni dung ca cun ―Reading Comprehension‖ di đây.
Mi thc mc v chng trình hc xin vui lòng liên h BST đ đc gii đáp!
PREFACE
English for Accounting and Auditing has been specifically developed for people studying and working
in accounting and auditing who need English to study higher programs or communicate in a variety of
situations with colleagues and business partners. In this short course, students will learn the language
related to accounting and auditing as well as ways to achieve their goals.
English for Accounting and Auditing consists of 5 parts (13 lessons), each dealing with a different area
of financial accounting, management accounting, auditing (internal and external), financial management
and taxation. Every lesson begins with a Reading which consists of vocabulary and basic knowledge

about the subject. Each lesson is followed by Listening videos and Activities (short exercise,
brainstorming, or a quiz) and they give students the opportunity to practice the target language with
partners in realistic situations, opportunity for discussion.
During the course, the lecturer plays an important role in explaining Accounting and Auditing knowledge,
providing more learning materials for student to practice as well as acts as an instructor in helping
students achieve their goals.
Please do not hesitate to contact us if you have any comments about this Reading comprehension, or
would like to see additional information or new editions.

BIG STEP TRAINING
08/2013

BIG STEP TRAINING English for Accounting and Auditing


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Contents
LESSON 1: INTRODUCTION TO ACCOUNTING 2
LESSON 2: ASSETS, LIABILITIES AND THE ACCOUNTING EQUATION 5
LESSON 3: DOUBLE ENTRY 8
LESSON 4: BASIC ACCOUNTING CONCEPTS AND PRINCIPLES 11
LESSON 5: CASH AND CREDIT TRANSACTIONS 20
LESSON 6: TRIAL BALANCE 23
LESSON 7: FINANCIAL STATEMENTS 26

LESSON 8: EXTERNAL AUDIT 34
LESSON 9: INTERNAL AUDIT 44
LESSON 10: FINANACIAL RATIOS 51
LESSON 11: COST CLASSIFICATION 59
LESSON 12: INFORMATION FOR COMPARISON AND VARIANCES 64
LESSON 13: TAXATION 67



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LESSON 0 INTRODUCTION TO ACCOUNTING
What is accounting?
Accounting is the language of business. Companies communicate their performance to outsiders
and evaluate the performance of their employees using information generated by the accounting
system. Learning the language of accounting is essential for anyone that must make decisions
based on financial information.
Accounting is the art of recording, summarizing, reporting, and analyzing financial transactions.
Bookkeeping is the practice of recording transactions. Bookkeepers tend to focus on the details,
recording transactions in an efficient and organized manner, and they may or may not see the
overall picture.
Accountants use the work done by bookkeepers to produce and analyze financial reports.

Although accounting follows the same principles and rules as bookkeeping, an accountant can
design a system that will capture all of the details necessary to satisfy the needs of the business -
managerial, financial reporting, projection, analysis, and tax reporting. A good accountant will
create a system of financial reporting that gives a complete picture of a business. Therefore
accountants are responsible for determining an organization‘s overall wealth, profitability, and
liquidity. Without accounting, organizations would have no basis or foundation upon which daily
and long-term decisions could be made. The budgets for marketing activities, profit reinvestment,
research and development, and company growth all stem from the work of accountants.
Accounting is one of the oldest and most respected professions in the world, and accountants
can be found in every industry from entertainment to medicine.
Two main branches of accounting are financial accounting and management accounting.
Financial accounting systems ensure that the assets and liabilities of a business are properly

accounted and provide information about profits and so on to external organization: shareholders,
customers, suppliers, tax authorities, employees… Management accounting systems provide
information specifically for the use of managers within an organization.
The data used to prepare financial accounts and management accounts are the same. The
differences between the financial accounts and the management accounts arise because the
data is analysed differently.
Financial accounts versus management accounts
Financial accounts
Management accounts
Financial accounts detail the performance of
an organisation over a defined period and the
state of affairs at the end of that period.

Management accounts are used to aid
management record, plan and control the
organisation‘s activities to help the decision –
making process.
Limited liability companies must prepare
financial accounts by law.
There is no legal requirement to prepare
management accounts.
The format of published financial accounts is
determined by local law, by IAS (International
Accounting Standards) …
In principle the accounts of different

organization is the same therefore be easily
The format of management accounts is
entirely at management discretion: no strict
rules govern the way they are prepared or
presented.
Each organization can devise its own
management accounting system and format of
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compared.

reports.
Most financial accounting information is of a
monetary nature.
Management accounts incorporate non-
monetary measures. For example: miles
travelled by salesmen, monthly machine
hours…
Financial accounts present an essentially
historic picture of past operation.
Management accounts are both an historical
record and future planning tool.

GAAP & IFRS/IAS
In the world of financial accounting there are lots of principles and standards to be followed. The
IAS, for one, is known worldwide as the International Accounting Standards.
Conversely, GAAP, or the Generally Accepted Accounting Principles, is the more Americanized
term referring to the accounting standards present in any country. The GAAP basically dictates
the rules or standards, as well as the conventions to be followed when one records, summarizes,
transacts and prepares financial statements within the nation. In individual countries this is seen
primarily as a combination of national company law, national accounting standards and local
stock exchange requirements. The concept also includes the effects of non-mandatory sources
such as: International accounting standards; Statutory requirements of others countries.
In many countries, like the UK, GAAP does not have any statutory or regulatory authority of
definition, unlike other countries, such as the USA. There are different views of GAAP in different

countries.
Although the IASC is a powerful entity, it still does not directly control or set the rules for the
GAAP. Whenever the IASC forms a new accounting standard, some nations just try to
incorporate that standard into their country‘s existing set of standards. The said standards were
already set by the local accounting board of the nation. They will be the ones that influence what
will be the GAAP for their jurisdiction.
Furthermore, it was last in 2001 when IASB took the role of the IASC in setting the actual IAS. To
date, the IASB has been making and implementing new accounting standards, but is named as
the IFRS, or International Financial Reporting Standards. Nevertheless, all the other standards,
including the IAS, are still included in the IFRS.
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board (IASB).
International Accounting Standards (IASs) were issued by the antecedent International Accounting Standards Council

(IASC), and endorsed and amended by the International Accounting Standards Board (IASB). The IASB will also reissue
standards in this series where it considers it appropriate.

All transactions of business are recorded, summarized and posted by accountants. The diagram
below shows how items are entered in the ledgers, ultimately to arrive at the financial statements.





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Totals
Totals
Sales
credit
notes
Purchase
invoices
Sales
invoices
Wages

document
s
Cheques
received
and paid
Petty
cash
vouchers
Journal
vouchers
Purchase
credit

notes
Sales day
book
Wages
book
Cash
book
Petty
cash
book
Journal
Purchase

day book
Receivables
ledger
(memorandum)
Payables
ledger
(memorandum)
General ledger
1 Bank account
2 Receivables ledger control account
3 Payables ledger control account
4 Sales tax control account

5 Other accounts
Income
statement
Balance
sheet
Source documents
Books
of
prime
entry
Ledger
accounts

Financial
statements
DOCUMENTING
RECORDING
SUMMARISING/
POSTING
PRESENTING
Posting of individual amounts in memorandum personal accounts
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LESSON 2: ASSETS, LIABILITIES AND THE ACCOUNTING EQUATION
The resources controlled by business are referred to its assets. For a new business, those assets
originate two possible resources:
 Investors who buy ownership in the business;
 Creditors who extend loans to business.
The total assets of business must are equal to sum of the assets contributed by investors and the
assets contributed by creditors, the following relationship holds and is referred to as the accounting
equation:

An asset is something valuable which a business owns or has the use of. Assets are items
belonging to a business and used in the running of business. They may be non-current assets or
current assets.

Examples of assets are factories, office buildings, warehouses, delivery vans, plant and machinery,
computer equipment, office furniture, investment, cash, a trade account receivable, goods held in
store awaiting sale to customers and raw materials held in store by manufacturing business for use in
production …
A liability is something which is owed to somebody else. Liabilities are sums of money owed by a
business to outsiders such as a bank or a supplier. They may be non-current liabilities or current
liabilities.
Examples of liabilities are bank loan, overdraft, salaries and wages payable, trade account payable,
interest payable and income taxes payable…
Owner’s equity represents the owner‘s investment in the business. The amount of owner‘s equity is
the amount of assets minus the amount of liabilities.
Examples of owner‘s equity are capital introduced, retained profit…

The basic of a fundamental rule of accounting is the accounting equation.

The accounting equation 1:

The accounting equation 2:

The accounting equation 3:

Assets = Capital introduced + (Earned profits – Drawing) + Liabilities
Assets = (Capital introduced + Retained profits) + Liabilities
Assets = Owner‘s equity + Liabilities
Assets = Owner‘s equity + Liabilities

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The accounting equation is the rule of accounting which is that the assets and aggregate of the
capital and the liabilities of a business must always be equal. The accounting equation holds at all
times life of business. When the transaction occurs, the total assets of business may change, but the
accounting equation will remain in balance. To better understand the accounting equation, consider
the following examples:

a. Obama starts business by paying $30,000 to business‟ bank

- Business of Obama receives cash as asset, Cash asset will be $30,000.
- Obama gives this cash in the form of capital = Owner's equity will be $30,000.
Assets
=
Owner‘s equity
+
Liabilities
Cash $30,000
=
Capital introduced $30,000
+
0

$30,000
=
$30,000

b. Obama purchased furniture for cash $10000

- When we bought furniture with cash, our cash will decrease with $10,000. It means one asset will
decrease.
- Our furniture asset will increase in business, so we add $10,000 as furniture asset. There will no
effect on liability side of accounting equation.
Assets
=

Owner‘s equity
+
Liabilities
Cash $20,000
Furniture $10,000
=
Capital introduced $30,000
+
No effect
$30,000
=
$30,000

c. Obama Purchased Goods from Sham on credit of $5,000
- With this there will no effect on cash but new goods asset will increase. This is called inventory or
stock asset. So, we will show more $5,000 in asset side of accounting equation.
- With we have to pay to sham $5,000, so he is our creditor. This will increase our liability.
Assets
=
Owner‘s equity
+
Liabilities
Cash $20,000
Furniture $10,000

Inventory $5,000
=
Capital introduced $30,000
+
Trade payable $5,000
$35,000
=
$35,000


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d. Obama sold goods (Cost $1,000) at $2,000 on credit to Bush
- Inventory asset will decrease (cost $1,000).
- We have to get money of $2,000. So, account receivable will increase with $2,000.
- By this dealing we gained $1,000. So, this will increase our initial capital.
Assets
=
Owner‘s equity
+
Liabilities
Cash $20,000

Furniture $10,000
Inventory $4,000
Trade receivables $2,000
=
Capital introduced $30,000
Retained profits $1,000
+
Trade payables $5,000
$36,000
=
$36,000

e. Obama purchased Computer of $3,000 with business cash for personal use.
- Cash will decrease $3,000 for payment for buying computer.
- Capital will decrease because he withdraws money for personal use. No, business will get power
for not paying $3,000 capital in future to businessman Obama.
Assets
=
Owner‘s equity
+
Liabilities
Cash (20,000 -3,000) $17,000
Furniture $10,000
Inventory $4,000

Trade receivable $2,000
=
Capital introduce $30,000
Retained profits $1,000
Drawing $(3,000)
+
Trade payables $5,000
$33,000
=
$33,000

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LESSON 3 DOUBLE ENTRY
Earlier transactions in the books of accounts were recorded under single entry system. But this
system had some shortcomings as there was not a complete record of all the transactions. Also
problems were faced while preparing final accounts. Problems were also faced as there was no self
balancing system of accounting which could guarantee, to some extent, the accuracy of the books of
accounts. So a need was felt for some uniformly accepted system of accounting which could help in
the verification of the accuracy of books to some extent. These problems were solved by the Double
Entry System of accounting. This system has totally replaced the single entry system. This system is

now followed universally.
We know that, since the total of liabilities plus capital is always equal to total assets, any transaction
has a dual effect – if it changes the amount of total assets, it also changes the total liabilities plus
capital, vice versa. Alternatively, a transaction might use up assets of a certain value to obtain other
assets of the same value.
We can say then that there are two sides to every business transaction. Out of this concept has
developed the system of accounting known as the ―double entry‖ system of bookkeeping, so called
because every transaction is recorded twice in the accounts.
Double entry bookkeeping is the system of accounting which reflects the fact that:
- Every financial transaction gives rise to two accounting entries, one a debit and the other a credit,
and so.
- The total value of debit entries is therefore always at any time to the total value of credit entries.

Each asset, liability, item of expense or item of income has a ledger account in which debits and
credits are made. Which account receives the credit entry and which the debit depends on the nature
of the transaction.
Debit entries are ones that account for the following effects:
 Increase in assets
 Increase in expense
 Decrease in liability
 Decrease in equity
 Decrease in income
Credit entries are ones that account for the following effects:
 Decrease in assets
 Decrease in expense

 Increase in liability
 Increase in equity
 Increase in income
Double entry bookkeeping allows us to keep the accounting equation always in balance, because
every financial transaction gives rise to two accounting entries, one a debit and the other a credit.
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Double-entry accounting has the following advantages over single-entry:
- Accurate calculation of profit and loss in complex organisations.
- Inclusion of assets and liabilities in the bookkeeping accounts.

- Preparation of financial statements directly from the accounts.
- Easier detection of errors and fraud.

T-Accounts
Transactions are recorded in ledger accounts, also known as ―T‖ accounts because how they are
normally drawn up on the page. Each ledger account has a debit side on the left and a credit side on
the right. The typical layout of a ledger account is as follows:
Name of ledger account
Debit side

Credit side

Examples of Double Entry
a. Purchase of machine by cash
Debit
Machine (Increase in Asset)
Credit
Cash (Decrease in Asset)

b. Payment of utility bills
Debit
Utility Expense (Increase in Expense)
Credit
Cash (Decrease in Asset)

c. Interest received on bank deposit account
Debit
Cash (Increase in Asset)
Credit
Finance Income (Increase in Income)

d. Receipt of bank loan principal
Debit
Cash (Increase in Asset)
Credit
Bank Loan (Increase in Liability)

e. Issue of ordinary shares for cash
Debit
Cash (Increase in Asset)
Credit
Share Capital (Increase in Equity)

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Balancing ledger accounts

Once all the transactions for an accounting period have been posted to the ledger accounts, the
balance on each account can be determined. At the end of an accounting period, a balance is struck
on each account in turn. This means that all the debits on the account are totalled and so are all the
credits.
- If the total debits exceed the total credits there is a debit balance on the account.
- If the total credits exceed the total debits then the account has a credit balance.
Action:
Step 1. Calculate a total for both sides of each ledger account.
Step 2. Deduct the lower total from the higher total.
Step 3. Insert the result of Step 2 as the balance c/d on the side of the account with the lower
total.
Step 4. Check that the totals on both sides of the account are now the same.

Step 5. Insert the amount of the balance c/d as the new balance b/d on the other side of the
account. The new balance b/d is the balance on the account.

Example: balance this ledger account:
Receivables account

Balance b/d 10,000
Transaction A 15,000
Transaction B 5,000

Transaction C 2,000
Transaction D 4,000
Transaction E 5,000
Transaction F 5,000




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LESSON 4 BASIC ACCOUNTING CONCEPTS AND PRINCIPLES
Accounting follows a certain framework of core principles which makes the information generated
through an accounting system valuable. Without these core principles accounting would be irrelevant
and unreliable. These principles are the building blocks that form the basis of more complex and
specialized principles called GAAP or generally accepted accounting principles such as the
International Financial Reporting Standards, US GAAP, etc. They deal with matters like accounting
for revenue, accounting for income taxes, accounting for business combinations, etc.
These principals include:
Accrual concept
Business transactions are recorded when they occur and not when the related payments are
received or made. This concept is called accrual basis of accounting and it is fundamental to the
usefulness of financial accounting information.

Examples:
1. An airline sells its tickets days or even weeks before the flight is made, but it does not record
the payments as revenue because the flight, the event on which the revenue is based has
not occurred yet.
2. An accounting firm obtained its office on rent and paid $120,000 on January 1. It does not
record the payment as an expense because the building is not yet used. While preparing its
quarterly report on March 31, the firm expensed out three months' rent i.e. 30.00
[$120,000/12*3] because 3 months equivalent of time has expired.
3. A business records its utility bills as soon as it receives them and not when they are paid,
because the service has already been used. The company ignored the date when the
payment will be made.
Accounting standards strictly require accounting on accrual basis. However, there is an alternative

called cash basis of accounting. Under the cash basis events are recorded based on their underlying
cash inflows or outflows. Cash basis is normally used while preparing financial statements for tax
purposes, etc.

Going Concern Concept
Financial statements are prepared assuming that the company is a going concern which means that
the business will continue in operation for the foreseeable future, and that there is no intention to put
the company into liquidation or to make drastic cutbacks to the scale of operations.
The status of going concern is important because if the company is a going concern it has to follow
the generally accepted accounting standards.
Examples
1. An oil and gas firm operating in Nigeria is stopped by a Nigerian court from carrying out

operations in Nigeria. The firm is not a going concern in Nigeria, because it has to shut down.
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2. A nationalized refinery is in cash flows problems but the government of the country provided
a guarantee to the refinery to help it out with all payments, the refinery is a going concern
despite poor financial position.
3. A bank is in serious financial troubles and the government is not willing to bail it out. The
Board of Directors has passed a resolution to liquidate the business. The bank is not a going
concern.
4. A merchandising company has a current ratio below 0.5. A creditor $1,000,000 demanded

payment which the company could not make. The creditor requested the court to liquidate the
business and recover his debts and the court grants the order. The company is no longer a
going concern.

Business Entity Concept
In accounting we treat a business or an organization and its owners as two separately identifiable
parties. This concept is called business entity concept. It means that personal transactions of owners
are treated separately from those of the business.
Businesses are organized either as a proprietorship, a partnership or a company. They differ on the
level of control the ultimate owners exercise on the business, but in all forms the personal
transactions of the owners are not mixed up with the transactions and accounts of the business.
Examples

1. A CPA has 3 rooms in a house he has rented for $3,000 per month. He has setup a single-
member accounting practice and uses one room for the purpose. Under the business entity
concept, only 1/3rd of the rent or $1,000 should be charged to business, because the other 2
rooms or $2,000 worth of rent is expended for personal purposes.
2. The CPA received $900 bill for utilities. He paid the whole amount using his business
account. $600 is to be considered a withdrawal because only $300 (1/3rd) related to
business and the other $600 was for domestic purpose.
3. Assuming each public accounting business is required to pay $100 to a local association of
CPAs each month. If the CPA pays that amount from a personal bank account the amount
shall be considered additional capital.

Monetary Unit Assumption

In accounting we can communicate only those business transactions and other events which can be
expressed in monetary units. This is called monetary unit assumption.
There are certain other frameworks for reporting business performance such as triple bottom line
which focuses on "people, planet profit" the three pillars; corporate social responsibility reporting, etc.
Accounting focuses on the financial aspects of the business and that too for matters which can be
expressed in terms of currencies.
One aspect of the monetary unit assumption is that currencies lose their purchasing power over time
due to inflation, but in accounting we assume that the currency units are stable in value. This is
alternatively called stable dollar assumption.
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However, there are exceptional circumstances called hyperinflation when the accounting standards
require adjustment of prior period figures.
Examples
1. The company's property, plant and equipment on 2009 balance sheet amounted to $2 billion.
During 2010 inflation was 10%. The monetary unit and stable dollar assumption prohibits any
adjustment to current or prior period figures to account for the inflation.
2. The BP oil spill in Gulf of Mexico was a natural disaster but accounting only reports the
financial impact in the form of claims paid, damages paid, cleanup costs, etc. This is due to
the limitation imposed by the monetary unit assumption.

Time Period Principle

Although businesses intend to continue in long-term, it is always helpful to account for their
performance and position based on certain time periods because it provides timely feedback and
helps in making timely decisions.
Under time period assumption, we prepare financial statements quarterly, half-yearly or annually.
The income statement provides us an insight into the performance of the company for a period of
time. The balance sheet (also known as the statement of financial position) provides us a snapshot of
the business' financial position (assets, liabilities and equity) at the end of the time period. The
statement of cash flows and the statement of changes in equity provide detail of how the company's
financial position changed during the time period.
One implication of the time period assumption is that we have to make estimates and judgments at
the end of the time period to correctly decide which events need to be reported in the current time
period and which ones in the next.

Revenue recognition and matching principles are relevant to time period assumption. Revenue
recognition principle provides guidance on when to record revenue while matching concept tells us
how to reach an accurate net income figure by creating 1-1 correspondence between revenues and
expenses.

Revenue Recognition Principle
Revenue recognition principle tells that revenue is to be recognized only when the rewards and
benefits associated with the items sold or service provided is transferred, where the amount can be
estimated reliability and when the amount is recoverable.
Accrual basis of accounting is used in recognizing revenue which tells that revenue is to be
recognized ignoring when the cash inflows occur.
Examples

1. A telecommunication company sells talk time through scratch cards. No revenue is
recognized when the scratch card is sold, but it is recognized when the subscriber makes a
call and consumes the talk time.
2. A monthly magazine receives 1,000 subscriptions of $240 to be paid at the beginning of the
year. Each month it recognizes revenue worth $20,000 [($240 ’ 12) × 1,000].
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3. A media company recognizes revenue when the ads are aired even if the payment is not
received or where payment is received in advance.
In case where payment is received before the event triggering recognition of revenue happens, the

debit goes to cash and credit to unearned revenue. In case the event triggering revenue recognition
occurs before payment is received, the debit goes to accounts receivable and credit to revenue.
Revenue is the item which is the easiest to misstate, hence more stringent rules and guidance is
required in this area. IAS 18 Revenue deals with recognition of revenue.

Full Disclosure Principle
Full disclosure principle is relevant to materiality concept. It requires that all material information has
to be disclosed in the financial statements either on the face of the financial statements or in the
notes to the financial statements.
Examples
1. Accounting policies need to be disclosed because they help understand the basis of
accounting.

2. Details of contingent liabilities, contingent assets, legal proceedings, etc. are also relevant to
the decision making of users and hence need to be disclosed.
3. Significant events occurring after the date of the financial statements but before the issue of
financial statements (i.e. events after the balance sheet date) need to be disclosed.
4. Details of property, plant and equipment cannot be presented on the face of the balance
sheet, but a detailed schedule outlining movement in cost and accumulated depreciation
should be presented in the notes.
5. Tax rate is expected to change in near future. This information needs to be disclosed.
6. The draft for a new legislation is presented in the legislative of the country in which the
company operates. If passed, the law would subject the company to significant cleanup
costs. The company has to disclose the information in the notes.
7. The company sold one of its subsidiaries to the spouse of one of its directors. The

information is material and needs disclosure.

Historical Cost Concept
Accounting is concerned with past events and it requires consistency and comparability that is why it
requires the accounting transactions to be recorded at their historical costs. This is called historical
cost concept.
Historical cost is the value of a resource given up or a liability incurred to acquire an asset/service at
the time when the resource was given up or the liability incurred.
In subsequent periods when there is appreciation is value, the value is not recognized as an increase
in assets value except where allowed or required by accounting standards.

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Examples
1. 100 units of an item were purchased one month back for $10 per unit. The price today is $11
per unit. The inventory shall appear on balance sheet at $1,000 and not at $1,100.
2. The company built its ERP in 2008 at a cost of $40 million. In 2010 it is estimated that the
present value of the future benefits attributable to the ERP is $1 billion. The ERP shall stand
on balance sheet at its historical costs less accumulated depreciation.
The concept of historical cost is important because market values change so often that allowing
reporting of assets and liabilities at current values would distort the whole fabric of accounting, impair
comparability and makes accounting information unreliable.

Matching Principle
In order to reach accurate net income figure, the expenses incurred to earn the revenues recognized
during the accounting period should be recognized in that time period and not in the next or previous.
This is called matching principle of accounting.
Examples
1. $2,000,000 worth of sales is made in 2010. Total purchases of inventory were $1,000,000 of
which $100,000 remained on hand at the end of 2010. The cost of earnings is $2,000,000
revenue is $900,000 [$1,000,000 minus $100,000] and this should be recognized in 2010
thereby yielding a gross profit of $1,100,000.
2. A hospital pays $20,000 per month to 5 of its doctors. Monthly sales are $500,000. $100,000
worth of monthly salaries should be matched with $500,000 of revenue generated.

Matching principle is relevant to the time period assumption, the revenue recognition principle and it
is at the heart of accrual basis of accounting.
Matching Vs Accruals Vs Cash Basis

In the accounting community, the expressions 'matching principle' and 'accruals basis of accounting'
are often used interchangeably. Accruals basis of accounting requires recognition of income and
expenses in the accounting periods to which they relate rather than on cash basis. Accruals basis of
accounting is therefore similar to the matching principle in that both tend to dissolve the use of cash
basis of accounting.
However, the matching principle is a further refinement of the accruals concept. For example,
accruals basis of accounting requires the recognition of the estimated tax expense in the current
accounting period even though the actual settlement of the provision may occur in the subsequent

period. However, matching principle would also necessitate the recognition of deferred tax in the
accounting periods in which the temporary differences arise so as to 'match' the accounting profits
with the tax charge recognized in the accounting period to the extent of the temporary differences.

Relevance and Reliability
Relevance and reliability are two of the four key qualitative characteristics of financial accounting
information. The others being understandability and comparability.
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Relevance requires that the financial accounting information should be such that the users need it

and it is expected to affect their decisions.
Reliability requires that the information should be accurate and true and fair.
Relevance and reliability are both critical for the quality of the financial information, but both are
related such that an emphasis on one will hurt the other and vice versa. Hence, we have to trade-off
between them. Accounting information is relevant when it is provided in time, but at early stages
information is uncertain and hence less reliable. But if we wait to gain while the information gains
reliability, its relevance is lost.
Examples
1. After the balance sheet date but before the date of issue a company wants to dispose of one
of its subsidiaries and is in final stages of reaching a deal but the outcome is still uncertain. If
the company waits they are expected to find more reliable information but that would cost
them relevance. The information would be outdated and no longer very relevant.

2. After the balance sheet date during the time when audit is carried out, it becomes clear which
debts were realized and where were not hence it improves the reliability of allowance for bad
debts estimate but the information loses its relevance due to too much time being taken.
Timeliness is the key to relevance.

Materiality Concept
Financial statements are prepared to help the users with their decisions. Hence, all such information
which has the ability to affect the decisions of the users of financial statements is material and this
property of information is called materiality. Items are material if their omission or misstatement
would influence the economic decisions of users based on the financial statements.
Examples
1. The government of the country in which the company operates in working on a new

legislation which would seriously impair the company's operations in future. Although there
are no figures involved but the impact is so large that disclosure is imminent.
2. The remuneration paid to the executives and the directors is material.
3. The accounting policies are material because they help the users understand the figures.
Materiality might be based on a percentage of sales such as 0.5% of sales or on total assets.
Materiality is helpful in determining which figures are to be reported on income statement and
balance sheet and which one in the notes. It is also helpful in helping decide which items should
appear as line items and which ones are aggregated with others.

Substance Over Form
While accounting for business transactions and other events, we measure and report the economic
impact of an event instead of its legal form. This is called substance over form principle. Substance

over form is critical for reliable financial reporting. It is particularly relevant in case of revenue
recognition, sale and purchase agreements, etc.

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Examples
1. A lease might not transfer ownership to the leasee but the leasee has to record the leased
items as an asset if it intends to use it for major portion of its useful life or where the present
value of lease payment is fairly equal to the fair value of the asset, etc. Although legally the
leasee is not the owner, so the leased item is not his asset, but from the perspective of the

underlying economics the leasee is entitled to the benefits embedded in the use of the item
and hence it has to be recorded as an asset.
2. A company is short of cash, so it sells its machinery to the bank and obtains it back on a
lease. It is called sale and leaseback. Although the legal ownership has transferred but the
underlying economics remain the same and hence under the substance over form principle
the sale and subsequent leaseback are considered one transaction.
3. If two companies swap their inventories they will not be allowed to record sales because not
sales has occurred even if they have entered into valid enforceable contracts.

Prudence Concept
Accounting transactions and other events are sometimes uncertain but in order to be relevant we
have to report them in time. We have to make estimates requiring judgment to counter the

uncertainty. While making judgment we need to be cautious and prudent. Prudence is a key
accounting principle which makes sure that assets and income are not overstated and liabilities and
expenses are not understated.
Examples
1. Bad debts are probable in many businesses, so they create a special contra-account to
accounts receivable called allowance for bad debts which brings the accounts receivable
balance to the amount which is expected to be realized and hence prevents overstatement of
assets. An expense called bad debts expense is also booked to stop net income from being
overstated.
2. Some liabilities are contingent upon future occurrence or non-occurrence of an event such a
law suit, etc. We judge the probability of occurrence of that event and if it is more than 50%
we record a liability and corresponding expense at the most likely amount. Hence, we stop

liability and expense from being understated.
3. Periodic evaluations of assets are made to make sure their carrying value does not exceed
the benefits expected to be derived from the asset, and if it does exceed, the impairment of
fixed asset is recorded by reducing its carrying amount.

Understandability Concept
Understandability is one of the four qualitative characteristics of financial accounting information.
Understandability refers to the quality of financial information which makes it understandable by
people with reasonable background knowledge of business and economic activities.
Understandability requires the information presented in financial reports to be concise, complete and
clear in presentation. The information should be presented so as to facilitate the user of the
information.

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However, understandability never prescribes any complex information to be omitted altogether due to
its underlying difficulty in understanding. It just requires us to disclose the information systematically
instead of presenting it haphazardly.
Examples
1. Understandability would require the financial statements to be identified by presenting the
name of the financial statement, the name of the entity and the period covered by the
statement.
2. Understandability also requires the notes to be properly numbered and cross-referred to the

original balance sheet and income statement items. For example the note number of
disclosure on leases should be mentioned in front of the lease payable line item appearing on
the face of a balance sheet.
3. Financial instruments and derivatives are specialized instruments which require rigorous
understanding of finance to properly understand the underlying economics. In such
complexity we cannot omit the disclosure because it is not easily understandable.

Comparability Principle
Comparability is one of the key qualities which accounting information must possess. Accounting
information is comparable when accounting standards and policies are applied consistently from one
period to another and from one region to another. The characteristic of comparability of financial
statements is important because it allows us to compare a set of financial statements with those of

prior periods and those of other companies. Comparability can usually be achieved through a
combination of consistency and disclosure.
Examples
1. We can compare 20X2 financial statements of ExxonMobil with its 20X1 financial statements
to know whether performance and position improved or deteriorated.
2. We can compare the ExxonMobil financial statements with that of BP if both are prepared in
accordance with same set of accounting standards, such as IFRS or US GAAP, etc.
3. When preparing 20X3 financial statements we are required to present with each of the 20X3
figure the corresponding 20X2 figures. This is done to add the characteristic of comparability
to the financial statements.

Consistency Concept

The concept of consistency means that accounting methods once adopted must be applied
consistently in future. Also same methods and techniques must be used for similar situations.
It implies that a business must refrain from changing its accounting policy unless on reasonable
grounds. If for any valid reasons the accounting policy is changed, a business must disclose the
nature of change, the reasons for the change and its effects on the items of financial statements.
Consistency concept is important because of the need for comparability, that is, it enables investors
and other users of financial statements to easily and correctly compare the financial statements of a
company.
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Examples
1. Company A has been using declining balance depreciation method for its IT equipment.
According to consistency concept it should continue to use declining balance depreciation
method in respect of its IT equipment in the following periods. If the company wants to
change it to another depreciation method, say for example the straight line method, it must
provide in its financial report, the reason(s) for the change, the nature of the change and the
effects of the change on items such as accumulated depreciation.
2. Company B is a retailer dealing in shoes. It used first-in-first-out method of inventory
valuation in respect of shoes at Branch X and weighted average inventory valuation method
in respect of similar shoes at Branch Y. Here, the auditors must investigate whether there are
any valid reasons for the different treatment of similar inventory located at different locations.
If not, they must direct the company to use any one of the valuation method uniformly for the

whole class of inventory.


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LESSON 5 CASH AND CREDIT TRANSACTIONS
Business transactions are the interactions between businesses and their customers, suppliers and
others with whom they do business. Transactions can be very simple, like buying a newspaper, or
extremely complex, taking a long time and involving many companies or agencies. New technologies
and management approaches are developing around the management of business transactions. The

main types of business transaction are sale and purchase.
Sales and purchases occur in two different ways, by cash or on credit.
Cash transaction is one where the buyer pays cash to the seller at the time the goods or services
are transferred. Cash book is a book of prime entry which records the receipts and payments of
cash. With the help of cash book and bank statement can be checked at a point of time.
A simple cash book is prepared like any ordinary account. The receipts are recorded in the debit side
and the payments are recorded in the credit side of the cash book.
Simple Cash book
Receipts
Payments
Date
Narrative

Amount $
Date
Narrative
Amount $







Example1:

Enter the following transaction in a simple cash book
201X

$
May-01
Cash in hand
10,000
May-05
Received from Ram
5,000
May-15
Cash sales

8,000
May-28
Paid Susan
2,000

Solution
Simple Cash Book
Receipts
Payments
Date
Narrative
Amount

Date
Narrative
Amount
20X1

$
201X

$
May -01
May -05
May-15

Balance b/d
Received from Ram
Cash sales
10,000
5,000
8,000
May -28
Paid Susan
Balance c/f
2,000
21,000

23,000


23,000

Petty cash
In every business, there will be a number of small expenses that have to be paid for in notes and
coins, instead of by cheque or by other methods of payment. To make these payments, a supply of
cash has to be kept on the business premises. This cash is called petty cash.
The petty cash book is the book of prime entry which keeps a cumulative record of the small amount
of cash received into and paid out of the cash float. There is usually an imprest system for petty