Accounting Systems, Standards and GST

Systems Of Accounting

Accounting is a systematic process of recording financial transactions. Over time, different systems of maintaining accounting records have evolved. The choice of system depends on the size and complexity of the business and the information requirements. The two main systems are the Double Entry System and the Single Entry System.

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1. Double Entry System:

This is the most scientific and widely used system of accounting. It is based on the Dual Aspect Concept, which states that every transaction has two effects, and both effects must be recorded. For every debit entry, there must be a corresponding credit entry of an equal amount.

Characteristics:

• Records both aspects of every transaction (Debit and Credit).
• Follows specific rules for debiting and crediting accounts based on the nature of the transaction and the account type (e.g., Debit the Receiver, Credit the Giver; Debit what comes in, Credit what goes out; Debit all expenses and losses, Credit all incomes and gains).
• Maintains balances in various accounts (Assets, Liabilities, Capital, Revenues, Expenses).
• Enables the preparation of a Trial Balance to check the arithmetical accuracy of the records (Total Debits must equal Total Credits).
• Allows for the preparation of complete financial statements (Profit and Loss Account and Balance Sheet), which accurately reveal the profitability and financial position of the business.
• Provides comprehensive and reliable information for decision-making.

Answer:

The Double Entry System is mandatory for companies and is generally preferred by larger businesses and professionals like Chartered Accountants.

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2. Single Entry System:

This is an incomplete system of recording transactions. It does not record both aspects of every transaction. Some transactions might be recorded with one aspect, some with two, and some might not be recorded at all. It is often based on recording only cash receipts and payments and the personal accounts of debtors and creditors.

Characteristics:

• Incomplete record of transactions.
• Does not follow the rules of debit and credit systematically for all accounts.
• Usually maintains only Cash Book and personal accounts (Debtors and Creditors).
• Cannot prepare a Trial Balance to check accuracy.
• It is difficult to prepare accurate Profit and Loss Account and Balance Sheet. Profit is usually estimated by comparing capital at the beginning and end of the period after considering drawings and fresh capital.

Profit = (Capital at end + Drawings) - (Capital at beginning + Fresh Capital)

Suitability:

Generally used by very small businesses or sole proprietors who do not require detailed or highly accurate financial information. It is simpler and requires less effort than the Double Entry System.

The Single Entry System is not a systematic or reliable accounting system and is generally not accepted for statutory purposes (like company accounts or for large businesses seeking audits).

Basis Of Accounting

The Basis of Accounting refers to the timing of recognising revenues and expenses in the accounting records. There are primarily two bases: the Cash Basis and the Accrual Basis.

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1. Cash Basis Of Accounting:

Under this basis, revenues are recognised only when cash is actually received, and expenses are recognised only when cash is actually paid, regardless of when the revenue was earned or the expense was incurred.

Characteristics:

• Recognises cash inflows as revenue and cash outflows as expenses.
• Simple to maintain, as it only requires tracking cash movements.
• Does not recognise outstanding (accrued) income/expenses or prepaid income/expenses.
• Does not provide a true and fair view of the profitability or financial position of a business that involves credit transactions.

Suitability:

Mainly used by non-profit organisations, professionals (like doctors, lawyers, accountants) who primarily deal with cash transactions, or very small businesses. It is not suitable for businesses with significant credit sales or purchases.

Answer:

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2. Accrual Basis Of Accounting:

Under this basis, revenues are recognised when they are earned, regardless of when cash is received, and expenses are recognised when they are incurred, regardless of when cash is paid. This basis follows the Revenue Recognition Concept and the Matching Concept.

Characteristics:

• Recognises revenues when earned (goods delivered, services rendered), even if cash is received later (creating a Debtor).
• Recognises expenses when incurred (benefit consumed), even if cash is paid later (creating a Creditor/Outstanding Expense).
• Requires making adjustments for outstanding expenses, prepaid expenses, accrued income, and unearned income at the end of the accounting period.
• Provides a more accurate picture of the business's profitability and financial position for a period, as it matches revenues earned with expenses incurred in the same period.

Suitability:

This is the most commonly used and required basis of accounting for businesses, especially for compliance with Accounting Standards and laws like the Companies Act, 2013. It provides a true and fair view of financial performance.

Answer:

The Accrual Basis is considered superior as it provides a more realistic view of the business's performance over a period.

Accounting Standards

Accounting Standards (AS) are written policy documents issued by expert accounting bodies or government authorities or other regulatory agencies covering aspects of recognition, measurement, presentation, and disclosure of accounting transactions and events in the financial statements. They are part of the broader GAAP framework.

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Need For Accounting Standards

Accounting standards are necessary for several reasons:

1. To Bring Uniformity:

In the absence of standards, businesses might use different accounting policies or methods (e.g., different methods for valuing inventory or calculating depreciation). Standards reduce such variations, promoting uniformity in accounting practices.

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2. To Enhance Reliability:

Standards provide clear guidelines, reducing the scope for personal bias and manipulation in financial reporting, thus increasing the reliability of financial statements.

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3. To Improve Comparability:

By ensuring uniformity and consistency in accounting practices (as required by the Consistency Concept), standards make it easier for users to compare financial statements of different companies (inter-firm comparison) and the same company over different periods (intra-firm comparison).

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4. To Ensure Transparency and Full Disclosure:

Standards often mandate specific disclosures in financial statements, ensuring that all material information is presented to users, adhering to the Full Disclosure Concept.

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5. To Facilitate Auditing:

Auditors use accounting standards as a benchmark to verify whether financial statements present a true and fair view. Compliance with standards simplifies the audit process.

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6. To Address Complex Transactions:

Standards provide guidance on how to account for complex or unique transactions (like leases, intangible assets, mergers), ensuring consistent treatment across entities.

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Benefits Of Accounting Standards

• Increased confidence of users in financial statements due to improved reliability and transparency.
• Facilitates easy understanding of financial statements across different companies and periods.
• Aids in making informed economic decisions by investors, creditors, and others.
• Reduces instances of accounting frauds or manipulation.
• Helps regulators and tax authorities in assessing compliance.
• Promotes professional judgment within a structured framework.

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Limitations Of Accounting Standards

• Difficulties in Preparation: Setting accounting standards can be challenging due to diverse business practices and conflicting interests of stakeholders.
• Rigidity: Standards can sometimes be too rigid, not allowing for flexibility needed in specific or unique circumstances.
• Based on Judgement: Despite standards, professional judgment is still required in applying them, which can introduce some degree of variation.
• Choice Among Alternatives: In some cases, standards might permit a choice among different accounting treatments for the same item, impacting comparability (though ideally, this is minimised).
• Limited Scope: Accounting standards only address financial reporting and do not cover all aspects of management accounting or internal reporting.

Despite limitations, the benefits of accounting standards in bringing credibility and comparability to financial reporting outweigh the drawbacks.

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Applicability Of Accounting Standards

In India, accounting standards are mandatory for entities based on their size and nature.

• Companies registered under the Companies Act, 2013, must comply with the Accounting Standards or Indian Accounting Standards (Ind AS) issued by ICAI, as notified by the Ministry of Corporate Affairs (MCA).
• Other entities (like sole proprietorships, partnerships, Trusts) may also be required to follow standards based on certain criteria (e.g., turnover) as specified by ICAI.
• Compliance with standards is often required for obtaining bank loans or for specific regulatory filings.

Statutory auditors in India are responsible for reporting whether the financial statements comply with the applicable accounting standards.

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International Financial Reporting System (IFRS)

IFRS are a single set of high-quality, global accounting standards developed and maintained by the International Accounting Standards Board (IASB). They are designed to provide transparent, comparable, and understandable financial information across the world.

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Need For IFRS

The need for a globally accepted set of accounting standards arises from:

• Globalisation of Business: Companies operate in multiple countries, requiring consistent financial reporting across borders.
• International Investment: Investors invest in companies worldwide and need comparable financial information to make decisions.
• Comparability: IFRS allows for easy comparison of financial statements of companies located in different countries.
• Transparency: IFRS aims for comprehensive disclosure and transparent reporting.
• Reduced Reporting Costs: Multinational companies can save costs by using a single set of standards globally.

Many countries, including India (through Ind AS), have either adopted IFRS or converged their national standards with IFRS.

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Ind AS (Indian Accounting Standards):

These are the converged IFRS in India. Ind AS are substantially similar to IFRS but with certain carve-outs (modifications) to suit the Indian economic environment and legal framework. Ind AS has been made applicable in a phased manner to specified classes of companies in India.

The move towards Ind AS/IFRS represents a significant step in harmonising Indian accounting practices with global standards.

Goods And Services Tax (GST)

Goods and Services Tax (GST) is a comprehensive, multi-stage, destination-based tax levied on every value addition. It is an indirect tax that has largely replaced many indirect taxes in India, such as excise duty, VAT, service tax, etc. GST was implemented in India from 1st July 2017.

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Characteristics Of Goods And Services Tax

1. Indirect Tax:

The burden of the tax is ultimately borne by the final consumer, although it is collected at various stages of the supply chain.

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2. Comprehensive:

It covers almost all goods and services, with few exceptions.

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3. Multi-Stage:

It is levied at each stage of the supply chain, from manufacturing to final consumption (e.g., at the time of purchase of raw materials, production, sale to wholesaler, sale to retailer, sale to consumer).

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4. Destination-Based:

The tax is collected by the state or union territory where the goods or services are finally consumed, not where they are produced or sold along the way.

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5. Value Addition:

Tax is levied only on the value addition at each stage of the supply chain. This is facilitated by the concept of Input Tax Credit (ITC). A business can claim credit for the GST paid on inputs (purchases) when paying the GST on outputs (sales). This avoids the cascading effect of taxes.

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6. Dual GST Model in India:

India follows a dual GST model, where both the Central Government and the State Governments levy GST on a single transaction.

• Intra-state supply (within the same state): CGST (Central GST, levied by Central Government) + SGST (State GST, levied by State Government).
• Inter-state supply (between states): IGST (Integrated GST, levied by Central Government). IGST is the sum of CGST and SGST, and is later apportioned between the Centre and the destination State.
• Supply within Union Territories: CGST + UTGST (Union Territory GST).

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Advantages

1. Elimination of Cascading Effect:

ITC mechanism ensures tax is paid only on the value addition at each stage, removing the "tax on tax" effect that was present in the old indirect tax regime. This often leads to lower final prices for consumers.

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2. Simplification of Indirect Tax Structure:

Replaced multiple taxes (like Excise Duty, Service Tax, VAT, CST, Entry Tax) with a single tax, making the system less complex and easier to understand and comply with.

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3. Increased Tax Base:

A simplified system and better compliance mechanisms are expected to bring more businesses under the tax net.

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4. Promotion of Make in India:

By removing the cascading effect, manufacturing costs can potentially decrease, making domestically produced goods more competitive.

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5. Easier Compliance:

Online procedures for registration, return filing, and payment are intended to make compliance easier for businesses (though initially, there were challenges).

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6. Benefit to Consumers:

Reduced prices of goods and services due to the elimination of the cascading effect (though the actual impact on prices can vary depending on the product and tax rates).

From an accounting perspective, GST requires businesses to adapt their accounting systems and processes to handle GST calculations, ITC tracking, and filing of various GST returns (GSTR-1, GSTR-3B, etc.). It necessitates accurate recording of GST paid on purchases (Input GST) and GST collected on sales (Output GST).

Answer:

GST has brought about significant changes in the Indian tax and accounting landscape, aiming for greater transparency and efficiency.