 Hello class, last class we were talking about accounting as a subject of study, we define the system of accounting and then ended the class with an understanding that the practices that are generally followed by accounting professionals actually is based on some principles that are commonly followed. And those principles were the generally accepted accounting principles and I said that in this class we would start understanding each one of those principles. Now accounting principles are built on a foundation of a few basic concepts. Now these basic concepts are self evident for a practicing accountant that they actually do not have to worry about this concept because they actually know about them. But for non-accountance like you you need to understand what these basic concepts are and why principles of accounting actually rely on these basic concepts. And I already told you that these accounting principles are man made and anything that is man made there is not a consensus. So still you have accounting theorists arguing that some of the existing principles and concepts are actually wrong and they need to be changed. But that argument will continue, you never know principles will also change. But let us understand the currently practiced principles of accounting and why that these principles are important. And as I told you as non-accountance you should understand the underlying logic behind these accounting principles. So I am going to explain briefly on these principles and as and when applicable try to give you some examples so that you can better understand these accounting principles. Let us begin with the first principle of money measurement. All of you know that any event that is significant has to be recorded as a transaction because it needs to be reported. So a transaction that needs to be reported can be reported only if it can be expressed in monetary terms. So only if you are able to monetize this transaction which you think is significant that it has to be measured and communicated then it is possible. In the absence of a monetary equivalence not even equivalence in the absence of a monetary expression no transaction can be recorded. Because I told you in the first class that the currency of business is money and unless and otherwise you tell to the world that you have made so much money you cannot tell that you are successful. So you need to understand that the common denominator that links all these transactions is money and if and only if all the activities the events or the transactions that happen in a business organization are being able to be expressed in monetary terms then that transaction is significant or other that transaction can be captured as accounting information. So principle number one is money measurement which clearly says only if you are able to capture transactions in monetary terms it becomes relevant in the language of accounting. I will just give you a small example for you to understand I told you that accounting is capturing information. So I give you the following information about a business entity. So information on a business let us say I run a business in an office which is 50,000 square feet and then to run the business I have a fleet of 5 cars and then in my savings bank I have 50 lakh rupees and then let us say I am in the business of buying and selling goods or trading. So the current inventory of the stocks that I have on hand I have around let us say the business is about selling groceries. So I have 100 kgs of rice, 20 kgs of dal and all of this is quantitative information and all of this to the business is information that needs to be measured because this is identified information this is the information that I have with me and it is also measured but in different ways but the challenges I will have to communicate it in only one particular way. So we have a heterogeneous set of information but money measurement tells me that there is only one way of expressing this information. So money measurement in essence is giving a homogeneous identity to this heterogeneous set of quantitative information. You can recall this cliche you know compare apples to apples not apples to oranges. In accounting you can have apples you can have oranges but as long as you are able to express apples and oranges in monetary terms then you can club both of them together to present an information in monetary terms. Likewise you have 50,000 square feet of building you have 5 cars you have cash of 50,000 and inventory of this all of them in different units of expression. So using money measurement how can I record and report this information I have to necessarily convert this 50,000 square feet of building into let us say I purchase this building for 2 crores and that is monetary terminology and the 5 cars that I have was purchased at a cost of 10 lakhs each. So 50 lakhs is the monetary equivalence to the 5 cars that I have 50,000 50 lakhs of rupees is in my bank account is by default per say monetary information 100 kgs of price and 20 kgs of doll multiplied by the current price levels is expressing 100 kgs of price and 20 kgs of doll in monetary terms. So you can understand that money measurement essentially means that you can have a heterogeneous set of information quantitative in nature and essential to be measured and communicated it is possible if all of these heterogeneous information is expressed in monetary terms that is money measurement. But there might be some limitations to it as well see accounting the financial statements that come out of accounting does not talk about the entire gamut of activities happening in an organization. It does not report the health of the CEO of a firm it cannot report that the sales manager and the production manager are not in talking term it cannot report that a competitor product is priced lower that there is going to be a strike in the organization. Now all these type of information cannot be reported in the financial statement because it is bound by the scope of the accounting report which necessitates that all of those transactions that can be monetized or that can be expressed in monetary term are the ones that are relevant for the purpose of accounting that is one broad limitation. The second limitation when you actually use money measurement is that when you record let us say you purchase an asset sometime back. Now that the money that you use to purchase is recorded at it is value during the time of acquisition of that particular asset and let us say 10 years have gone after you purchase the asset and still that asset is in your balance sheet and you report that as well. Money measurement does not capture the purchasing power of money itself the limitation is the first one I said was the scope the second one is fails to capture changes in purchasing power of money itself and this is interlinked with the cost concept as well we will talk about it later. Let us say you purchase a machine in let us say 1988 for 200,000 and then you purchase land in 1980 let us say for the same 200,000 and in 1988 balance sheet you report the cost of acquisition of the machine at 200,000 and also report the cost of acquisition of the land that you actually made in 1980 the same 200,000 though the value of 200,000 between these two periods have changed. So, 200,000 in 1980 does not have the same value in 1988 I hope you are able to appreciate this and we are going to talk about this also in detail a little later. I will just give you a classic example suppose you have a house in P. Nagar that you purchase it for 50,000,000 20 years back today the value of that house is let us say 5 crores see the houses remained the houses not changed it is actually the value of the money that has actually changed which means today with the same 50,000,000 you cannot buy that house. So, the 50,000,000 that you spent 20 years back to buy a house in T. Nagar cannot buy the same house in the same place today, but you are accounting your money measurement does not capture this change in purchasing power of money, but only records that 3 crores was the amount that you spend in buying the same an identical asset in T. Nagar today. So, the second limitation hence is that you fail to capture the purchasing power of money, but let us get back to the concept you should understand that the concept of money measurement is that all transactions that need to be recorded has to be expressed in monetary terms only then heterogeneous transactions. Transactions can be of different types only then you would be able to have a uniform way of expressing this heterogeneous transactions because you are capturing them in monetary terms that is concept number 1 concept number 2 or principle number 2 the underlying concept is entity concept. Now entity concept you will have to understand it from a different level people who can appreciate philosophy can also appreciate this concept better the question of I, me, individual the owner of a business versus the business itself you see there might be a lot of events that happen in a business that affects the business and there will also be a lot of events that can affect the owners of the business as well, but accounting the entity concept of accounting must ensure that there is a clear distinction between the entity which is the business and the owners of the entity. Let me just give you a very simple example for you to understand let us say you started a canteen you put your money and you started a canteen on your own and then it was good sales you get money you put it in the cash register and one fine day your son comes to the canteen and you want to give him get him an ice cream. So, you just take 20 rupees from the cash register buy an ice cream and when then your accountant comes and says sir today you took 20 rupees from the cash register how am I going to record this in the books of the business you cannot tell him that this is my business I put money in this canteen it is not necessary that you have to record it in the business because it is my money I just took it whether it is in the cash register or whether it is with me and that I spent it makes no difference it makes a difference because the entity concept very clearly says that the business is different from the owner himself or herself. So, the question is how will you record this transaction of taking 20 rupees from the cash register. So, if I take 20 rupees from the cash register either I have to say that the business has loaned 20 rupees to me though I am the owner and that I have to give back 20 rupees later or from my owners equity or from the initial money that I deposit a let us say I put in 1000 rupees in this business I will have to reduce 20 rupees because now my the capital that I have put into the business is 980 and not 1000 rupees. So, in either of these ways you can record this transaction, but you cannot dismiss this transaction saying that I am the owner I took the money from the business and hence this transaction need not be reported that is the principle that you will have to understand this is entity concept and you can complicate this further as well. Let us say you are in a business and the ground floor is your office and the first floor is where you are staying, but the property tax the electricity expense the other shared expenses you are incurring. Now, to what extent should it be to should it be charged to the business and to what extent it should be charged to the owners of the business who are living in the first floor. There must be some basis on which you have to do this because you have to necessarily separate the business from the owner and if you are doing it based on some reasonable basis then yes it is an accepted way. If you are doing it arbitrarily then it becomes questionable there are various this is just a very simple example, but at a very big level such arbitrary decision making are the ones that have resulted in big scams where you know the owner is not able to actually disassociate himself from the business individual decisions are merged with individual own decisions are merged with business decisions as a result of which you see a lot of malpractices in accounting. So, but you have to understand that an entity is an organization where a lot of activities happen and some may or may not affect the owners of the organization and if they affect the owners of the organization you have to necessarily capture that information in proper format. And by entity I mean anything I told you before that it can be a single proprietorship firm it could be an incorporated firm run you know owned by shareholders it could be not for profit also it could be universities and all of these entities will definitely have a lot of activities and when you are recording these activities that also affect the owners of these entities you will have to necessarily make a clear distinction between the owner and the entity that is the principle of entity concept that clearly says that the individual or a group of individuals who are the owners versus the business you need to have a very clear distinction between these two. The third concept is going concern concept of going concern concept is pretty simple and straight forward for you to understand the concept is unless there is evidence to the contrary accounting always assumes that an entity or a firm is a going concern what is this mean let us say for example you are recording transactions and you are recording values of some of the assets that you have let us say you are running a business. And let us say you are in the business of selling sportswear so you make t-shirts you make you know let us say soccer balls then you make cricket bats what not I mean you have a lot of items to sell now suppose I want to record the value of the items that you have on hand let us say we are going to close this financial year now you might have in your inventory you know a bat a cricket bat where you have just worked with the wood and it is not fully complete and you know pretty sure that you cannot sell this just like that so you are not going to value this wood piece of wood at its immediate purchase value you pretty well know that this needs to undergo a lot of manufacturing processes and one fine day it will be sold in a good finished form and then the company is going to make money now when will that one fine day come that one fine day will never come if you are working under the impression that tomorrow I am going to close business I am going to liquidate but that is not the way in which we are conducting business so now you will understand that you record the value of an asset at various such intermediary stages assuming that this business is going to exist for perpetuity that is it is a going concern but if you have enough good reasons to believe yes I am going to close business then you have a case suppose you very clearly know that tomorrow the business is not going to exist then you are going to record the value of the assets where is basis the potential that it can be sold whatever for whatever value that is the basis on which you are going to add economic value to this asset now unless you do not have enough evidence unless there is a belief that you are going to close you never record the value of an assets at liquidation value it is always an accepted practice and always a practice that is followed where assets value are recorded under the assumption that the business is a going concern and will exist for a perpetual period of time going concern concept in essence means that the business will stay forever liquidation value is only if the business is going to be closed so if you feel that we are going to close then you take liquidation value otherwise you assume that the business is a going concern the fourth concept is cost concept this is an interesting concept what do you mean by asset of a firm or an entity the economic resource of an entity is its asset the economic resource of an entity is its asset it could be land building machine equipment inventories whatever they are there is some economic value to it now the cost concept is on the basis that you record let us say you purchase an asset land building or machine now the fact that you have purchased an asset is critical information and it is quantitative because you would have purchased it for a certain value and it has to be reported so an asset which is purchased has to be reported recorded at the cost of its acquisition cost of acquisition this is very important the reason that this is important is because the value of the asset may change over a period of time suppose you bought land for 10 lakh and you 10 years back today your balance sheet would say land value 10 lakhs but the market value of the land could be 1 crore or 2 crore rupees that is a different issue but when you record asset transactions it always has to be at the cost of its acquisition the market value can be different and that is why if you have the question now suppose I buy an equipment for 5 lakh rupees 2 years later you will ask me the question that equipment definitely cannot be valued more than 5 lakhs I can understand that market value for land will increase but the market value for an equipment will not increase then there is another concept called depreciation where the cost of using the equipment over its lifetime will be removed through the period of its life and every year we remove certain cost of acquisition of that particular equipment by way of depreciation that is a different concept I will be talking about that later but you should understand that the cost concept rests on the fundamental assumption that when you purchase an economic resource or an asset you have to record that purchase and report that purchase at the cost of its acquisition. Now this cost concept in my opinion is an excellent illustration to get back to our three criteria that we were talking about cost concept versus relevance versus objectivity and feasibility say I said I am not concerned about the market value because cost concept tells me that it is the cost of acquisition that is more important but relevance the principle of relevance the criteria of relevance is that you know investors or others who use this information are more interested in knowing what is the actual value that is worth today that historical cost because the accounting principle fundamental criteria is it should be relevant now as an investor or a creditor or somebody who is using this information today I would be interested in knowing what is the current worth of the asset not the historical cost so question of relevance becomes very critical here but how do I know the real current worth of the asset today can it be objectively measured suppose let us say the share price shares are being purchased and sold why is that I buy a share because I think that the value of the share will increase and hence I can sell it at that point of time and make money now why is the other person selling the share he thinks that the value of the share has hit the maximum and it is better that I sell it now same share subjective I think it will increase the other fellow thinks this is the maximum it is better I sell and hence the share is being bought and sold so whose right whose current worth is right is it objective very difficult or let us say the management or the board of a firm is the one that is going to measure the current worth can we assume is it safe to assume that the management's own estimate is objective that is free from any bias definitely not so will you accept that as the real current worth on the principles of objectivity definitely not now let us assume that you know it is possible then you an accountant will sit and all assets today's value this is this is the value of the asset today and today's later this is the value of the same asset I can understand if it is only one asset it is possible to do this activity but we are talking about a firm which has so many assets so many transactions and it is definitely not feasible to record the market value the ups and downs of the asset assuming at the first place that it is objectively measurable so in the absence of a better alternative cost concept clearly says wherever you go whether it is relevance or objectivity or feasibility there is definitely some limitation and because of that and because there is no better alternative you record the cost of acquisition and not be guided by the market value of the asset that you purchase that in essence is the cost concept the fifth concept is the dual aspect concept I told you before that assets are the economic resources of an entity assets are the economic resources of an entity and how are we getting these assets because the owner of the business put his money or the banks lent money and hence we purchase these assets so to every such economic resource that is been generated to every such asset there is a claim against these assets so the assets have a claim against them now that is your equity so every asset has a claim against it which means your assets will be equal to your equity or equities I told you that this equity could be owner's equity or somebody else's money as well so the equity could be from liabilities which is your creditors your banks or claim of the owner itself owner's equity as a result of which the equation just gets a little modified to the extent that assets is equal to liabilities plus owner's equity so what is the principle of dual concept in this I am going to rewrite this equation dual concept says when you record a transaction it necessarily has to have a dual impact and also in such a way that assets equal to liabilities plus owner's equity the fundamental accounting equation does not get unaltered we are going to talk about that later why it is not getting unaltered but the principle of duality is that definitely when you are recording an accounting transaction when you are recording a transaction in an accounting system that transaction will have a dual impact in the accounting system let us for example I will give an example so that you will understand this better you start a business let us say you put your money okay you start a business and how did you start your business you put your money Rs. 50,000 this is the transaction what is the dual impact dual impact are these one that you have invested Rs. 50,000 in the business that is the business capital and the business has received 50,000 which sits as cash for the business so you have cash 50,000 and this is for the business and this is an asset to the business and the dual impact where will this 50,000 where will this 50,000 sit as the dual entry it is my money the owner's equity I gave that 50,000 that is my capital in the business that is another 50,000 that I gave just to make the understanding simple let us say a bank approaches and says I am ready to also give you another 50,000 so what happens the cash through the company gets increased by 50,000 but it is not your money in the business you have not given that 50,000 it is a bank that has given that 50,000 so that is also an entry which has a dual impact so what is the total 100,000 100,000 cash is the asset to the business it will balance definitely balance so the principle of dual aspect the concept of dual aspect is that such transactions or any transaction for that matter that is going to be captured into the accounting system will necessarily affect the assets equal to liabilities plus owners equity will have a double impact and also the way in which you are going to record this transaction will ensure that the asset equal to liabilities plus owners equity equation is not compromised whether both the impact will be on the asset side one impact on the asset side on the other impact on the liability side or both the impact on the liability side that is a different issue which we will be talking about when we are actually spending a lot of time on this double entry bookkeeping where I will tell you how this dual impact is recorded by way of entries they weight credit and all that then you will understand actually this concept more forcefully but for the time being you should understand that this dual aspect is a concept which mandates that any transaction that you are capturing in the accounting system will necessarily will have a twin impact will have a dual impact assets liabilities plus owners equity you can impact any of these this is the fifth accounting principle now with these five accounting principles I can also make an attempt to give you a quick overview of what a balance sheet is because I feel that these principles are balance sheet related accounting principles the remaining six will be principles related to income statement and then when you look at the overall picture you will find how these eleven principles are interwoven as a result of which how your income statement and balance sheet are interwoven and you will appreciate that the balance sheet is balanced the income statement is linked with your balance sheet and why did all of this happen because all of your eleven principles tell you that this is the way in which you have to record these transactions and report them but I do not want to start with balance sheet leaving these principles five principles and then revisit them later what I will do is the next class I will talk to you about the remaining six principles then give you a brief overview on what a balance sheet and income statement is all about and if time permits we will get into another and the most important concept of the double entry book keeping that will teach you on the ways by which you record these transactions the debate and credit. But before I end the class the fundamental equation that governs all your system of accounting is this you must necessarily have this in mind this must be integrated embedded when I wake you up and ask you what is the fundamental equation you must spontaneously tell me assets is equal to liabilities plus owners equity this actually is the fundamental equation that can never be compromised and if you find that your assets is equal to liabilities plus owners equity this equation is not matching there is nothing wrong in what is happening in the business there is something wrong the way in which you have captured the transactions and recorded and reported them so that is the quick asset test for you to realize that you have made a mistake and this you can do at every stage because the dual impact is that every time you make a transaction it affects and then it affects in such a way that your assets is equal to liabilities plus owners equity so every transaction you can make this check and this necessarily will hold true this is the fundamental equation that will form the basis on which we will be recording all these transactions and then the process create a balance sheet and income statement and a cash flow statement. So have this in your mind next time when we visit the next class I will give you a quick overview of the remaining six principles and then make the class understand what a balance sheet is income statement is what are all the parts of a balance sheet what are all the parts of an income statement and then the time permits we will start the double entry bookkeeping thank you very much.