Basics of Financial Accounting: Chapter I: Fundamentals of Financial Accounting: The following questions contain multiple choices [ (a), (b), (c) and (d) ] in which one is correct. Indicate the correct choice in your answer booklet. I Set 1. A transaction, which increases the capital is called income. a) TRUE b) FALSE 2. Bill of exchange is drawn only when money is lent by a moneylender, banker or other financial institution a) TRUE b) FALSE 3. When the bill is dishonoured, the drawee will be debited in the books of the drawer whether the bill is retained, endorsed or discounted. a) TRUE b) FALSE 4. When the bill is endorsed or discounted, no entry is passed in the books of the drawer a) TRUE b) FALSE 5. Wages and Salaries are debited to a) Trading Account; b) Profit and Loss Account; c) Bal Balan ance ce She Sheet et;; d) The The per perso sona nall acco accoun untt of the the wage wage and and sal salar ary y earn earner er 6. Carriage Outwards are debited to: a) Balan alance ce Shee Sheet; t; b) The The per perso sona nall acc accou ount nt of the the car cartt own owner er c) Trading Account; d) Profit and Loss Account; 7. Customs duty paid on the import of a new machinery is a a) Reven evenu ue Expe xpendi nditure; ure; b) Cust ustomar omary y Expe Expend ndiiture ture;; c) Capital Expenditure; d) None of the above 8. Interest on capital is a) a personal expenditure of of the owner; b) a non-business expenditure expenditure c) a business expenditure and hence debited to P & L Account; d) none of the above 9. Insurance claim acknowledged by the insurance company but not yet paid on the closing day is treated as a) An Asset; b) A Liability; c) An Outstanding income; d) An Outstanding charge/expense. 10. The accounting principle that conforms to the tendency of accountants to resolve uncertainty and doubt in favour of understating assets and revenues and o verstating liabilities liabilities and expenses, is known as: a) conservatism b) materiality; c) industry practice; d) consistency; 11. Debit means: a) decre decrease ase in in assets assets
b) incre increase ase in in income income;;
c) incr increas ease e in expen expendit diture ure;; d) incr increas ease e in capi capital tal;;
-212. Which of the following is correct: a) PROFIT = OPENING CAPITAL + DRAWINGS – ADDITIONAL CAPITAL –CLOSING CAPTIAL b) PROFIT = CLOSING CAPITAL + ADDITIONALCAPITAL – DRAWINGS MADE – OPENING CAPITAL c) PROFIT = CLOSING CAPITAL –DRAWINGS –ADDITIONAL CAPITAL –OPENING CAPITAL d) PROFIT = CLOSING CAPITAL + DRAWINGS –ADDITIONAL CAPITAL –OPENING CAPITAL 13. The liabilities of a firm are 350000 and the Capital is Rs150000. Of these Rs2 lakh is spent on acquiring a building. What are the remaining assets? a) Rs 500000 b) Rs150000 c) Rs700000 d) Rs300000 14. An amount of Rs 2800 was incurred on the installation of a machinery. The expenses are treated as: a) Dr to Wages Account; b) Dr to Machinery Account c) Dr to Repairs account d) Dr Miscellaneous expenditure account 15. Cash book Bank column always show a a) Debit bit Balan alanc ce; b) Credit edit Bal Balance ance;; balance
c) Debi ebit or Credi reditt Bala alance; nce;
d)
a
NIL
16. Discount column in the cash book should be balanced and the balance shall be carried over to the next accounting period: a) TRUE b) FALSE 17. Bank Reconciliation Statement is a) journal b) ledger c) profit or loss statement; d) a statement showing the causes of differences between the cash book and the bank pass book. 18. Bank Reconciliation Statement starts with a) The The Ope Openi ning ng bal balan ance ce of of the the Cas Cash h Book Book;; c) The The Clo Closi sing ng bala balanc nce e of of the the Cash Cash Book Book;; cash column in a three columnar cash book
b) The The Ope Openi ning ng bal balan ance ce of of the the Pas Passb sboo ook; k; d) The The Clo Closi sing ng bala balanc nce e of the the Cash Cash boo book k in the the
19. When When the balanc balance e as per Cash Book is the startin starting g point, point, the direct direct deposit deposits s by the customers in the bank are……. ……….while preparing the Bank Reconciliation Statement. a) added b) subtracted; c) nei neither of the above 20. Which of the following are intangible assets? a) Plant and Machinery; b) Stock in Trade destroyed by fire c) Inv Investm estmen entt in in una unapp pprroved oved comp compan aniies; es; d) Trad Trade e Mar Marks ks and Pate Patent nts. s. 21. Loss on sale of a fixed asset is debited to a) Trading Account; c) Prof Profiit an and Los Loss s Acc Accou ount nt;;
b) The concerned Asset Account d) Balan alanc ce She Sheet et
22. Depreciation is an amortised expenditure a) TRUE b) FALSE 23. Depreciation is a a) Cash Cash expe expend ndit itur ure; e;
b) NonNon-Ca Cash sh expe expend ndit itur ure; e;
c) Neit Neithe herr a nor nor b
-324. Fixed assets are stated at their market value in the balance sheet a) TRUE b) FALSE 25. Bank column of the Cash book may show a) Debi Debitt Bala Balanc nce; e; b) Cred Credit it Bala Balanc nce; e;
c) Eith Either er a debi debitt bala balanc nce e or a cred credit it balanc balance. e.
26. Withdrawal of cash from the bank for office purposes is entered in the Cash Book a) only only in the the bank bank colu column mn;; b) only only in the the cash cash colu column mn;; c) as a cont contra ra entr entry y 27. If the debit as well as credit aspects of a transaction are entered in the Cash book it is called: a) Compound entry; b) An openin ning ent entry; c) Transfer Entry d) Contra Entry; 28. Petty Cash book is maintained to a) save time for the main cashier; c) save save the the lab labou ourr in in pos posti ting ng innu innume mera rabl ble e ent entri ries es;;
b) account for all the petty cash d) all all the the abov above. e.
29. Fill in the blank by choosing the a ppropriate words given in the options a, b & c Interest free loan given by the wife of the proprietor proprietor is…………… a) liability; b) asset; c) profit profit 30. Fill in the blank by choosing the a ppropriate words given in the options a, b & c A bill accepted by Mr Kumar in settlement of his accounts transactions with Mr Tulasi is a ………… a) liability b) asset; c) profit 31. For a bill drawn on August 11 for two months falls due on 14th October a) TRUE b) FALSE 32. A bill of exchange is a conditional order in writing given by a debtor to a creditor a) TRUE b) FALSE 33. In case the due date of a bill falls on 15 th August of any year, the due correct due date falls on the prece eceding working day a) TRUE b) FALSE 34. The due date of a bill drawn on 31-01-2004 for 1 month fell on a) 1st March 2004; b) 3rd March 2004; c) 28-02-2004; d)29-02-2004 35. Wages and Salaries are debited to: a) Trading Account b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the wage and salary earner 36. Carriage OUtwards are debited to: a) Trading Account b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the cart owner 37. Ms Srilakshmi started business with cash Rs25,000 on 1 st October 2002. She withdrew Rs2500 Rs2500 on 1st November 2002. As on 31st December 2002 she suffered a net loss as per P & L Account of Rs1800. Her closing capital is a)Rs 23200; b) 21700; c) 20700 38. Expenses on foreign tour for purchasing a new machinery is a : a) Revenue expenditure; b) Capital Expenditure; c) Travel and tourism expenditure; d) None of the above
-439. Interest paid on a term loan where the p roduction has already started is a a) Revenue Expenditure b) Capital Expenditure c) Both 40.The assumption that a business enterprise will not be sold or liquidated in the near future is known as the: a) economic entity; b) monetary unit; c) conservatism d) none of the above 41. The liabilities of a firm are 250000 and the Capital is Rs 125000. The total assets of the firm are: a) Rs12 Rs1250 5000 00 b) 2500 250000 00 c) 3750 375000 00 d) 1250 125000 00 42. 42. Jour Journa nall is a book book of; of; a) orig origin inal al entr entry y b) Bank Bank Recon econci cili liat atio ion n stat statem emen entt entry; d) all cash transactions;
c) seco second ndar ary y
43. Normally the following accounts are balanced: a) Personal Accounts and Nominal Accounts; b) Real accounts and Nominal Accounts c) Personal accounts and Real accounts 44. Cash Discount allowed by the trader to the purchasers is entered in a) Credit side of the Cash book; b) Debit side of the Cash book 45. Which of the following is a business credit? a) The Seller receives an accepted Bill of Exchange from the purchaser; b) The seller receives a lesser cash because of the rebate or a price crash; c) The seller receives an advance amount equal to the sales by way of a bank demand draft; d) Cash deposited and goods delivered on a subsequent date. 46. Returns Outwards is treated as a) a deduction deduction from sales; b) a deduction deduction from purchases; purchases; c) an additional additional sales; d) addition addition to the purchases 47. Bank Reconciliation Statement is prepared a) by the bank and supplied to the customer to verify the same b) by the customer to see that the transactions are properly recorded in the cash book and the pass book and the differences are reconciled. c) both (a) and (b) above 48. The causes of differences in the Bank Reconciliation statements are rectified by passing a) rectification entries on the date of the bank reconciliation statement; b) Journal entries are passed only for some causes after the BRS is prepared; c) Journal entries are passed for all the causes; d) Journal entries are passed only during the year end. 49. Which of the following are intangible assets? a) Land and Buildin Buildings; gs; b) Stock in Trade; Trade; c) Investme Investment nt in unapproved unapproved companie companies; s; d) Patents Patents 50. Which of the following are intangible assets? a) Stock in Trade destroyed by fire; b) IPRs; IPRs; c) Investment in unapproved companies d) Loss in business
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II Set: 1. Depreciation Policy is one o f the important accounting policies for any business organsation a) TRUE: b) FALSE 2. Providing depreciation in the accounts reduces the amount of profits available for dividend. a) TRUE b) FALSE 3. Reser Reserves ves and and Surp Surplus lus is: is:
a) A Liab Liabili ility; ty; b) b) An Asse Asset; t; c) A Profi Profit; t; d) Not an accou account nt at all
4. Reducing balance method of depreciation is followed to have a uniform charge for depreciation and re repairs an and ma maintenance to together: a) TR TRUE b) FA FALSE 5. Transactions entered on the debit side of the Cash book are to be posted to a) the debit side of the concerned ledger accounts in the ledger b) the credit side of the concerned ledger accounts in the ledger c) None of the ledger accounts as the cash book serves as a permanent record. 6. Subs Subsid idia iary ry Book Books s act act as a jou journ rnal al as well ell as as a ledg ledger er:: a) a) TRUE TRUE
b) FALS FALSE E
7. When a firm maintains a Three-column Cash Book, it need not maintain: a) Cash account in the ledger; b) Bank account in the ledger c) Disc Discoun ountt Acc Accou ount nt in the the led ledge ger; r; d) Both Both Cash Cash and and Ban Bank k acc accou ount nt in the the ledg ledger er.. 8. Fill in the blank by choosing the appropriate words given in the options a, b & c Income accrued due but not received is a…………………….. (a) asset, b) liability, c) profit) 9. When a Trial balance is tallied, there are no errors in accounting. a) TRUE b) FALSE 10. Mr Rajesh starts with the business with Cash Rs45000/-, Furniture Rs20,000/- and Bank Loan Rs2.5lakhs; Land and Buildings Rs4.5 lakhs. His capital is: a) Rs2.65lakhs; b) 7.70 Lakhs; c) Rs 3.00 lakhs; 11. If a firm borrows money, there will be a) increase in capital; b) decrease in capital; c) no effect on cap ital. 12 Assets are: a) Sources of Funds b) application of funds; 13 Wages of Rs1200/- incurred for installation of machinery is debited to a) Wages Account; b) Machinery Account; c) Installation Installation Charges account; 14 Debit means a) Increase in expenditure; b) Increase in income; c) an increase in liability; d) an increase in owners’ capital 15 Ledger is a book of a) original entry; b)secondary entry; c) all cash transactions; d) all non-cash transactions 16 Discount allowed is entered in the Cash Book with Bank Column on the a) Debit side; b) Credit Side; c) not entered at all;
-617. If the debit and credit aspects of a transaction are recorded in the Cash Book itself it is called: a) Compound entry;b) Double entry; c) Contra entry; d) Transfer entry 18 Returns Outwards is treated as a) a deduction deduction from sales; b) a deduction from purchases; purchases; c) an additional additional sales; d) addition addition to the purchases 19) Bank Reconciliation Statement is prepared by a) bank; b) customer; c) creditor of a business; d) none of them 20) Credit balance in the bank column of the Cash Book means: a) Bank Overdraft; b) Credit balance in the Bank pass book; c) funds available in the bank account; d) none of these 21) When the balance as per Cash book is the starting point, direct deposits by customers are: a) deducted; b) added; c) neither a nor b 22) Bank Reconciliation Statement is a) ledger account; b) journal ; c) final account; d) a statement showing the causes of difference between the cash book and the bank pass book 23) When you start preparing Bank Reconciliation Statement we may observe a) overdraft in both cash book and bank pass book; b) overdraft in cash book and credit balance in the pass book; c) overdraft in cash book and debit balance in the pass book; d) all the above 24) Bills Receivable is a) a liability; b) an Asset; c) a part of capital account; 25) A Bill of Exchange is an a) unconditional promise; b) unconditional order; c) conditional i.e, subject to satisfactory delivery of goods 26) A Bill of exchange can be a) retained till the due date; b) collected through the bank; c) discounted at a bank before the due date; d) all of these. 27) Salaries and Wages appearing in the Trial balance appears in a) Trading Account; b) Profit and Loss Account; c) Balance Sheet; d) all of these 28) Manufacturing Wages appearing in the Trial balance appear in the a) Trading Account; b) manufacturing account; c) P & L Account; d) Balance sheet 29) Discounts received appear in the Trial balance on the a) Debit side; b) Credit Side; c) Both sides; d) does not appear as it is found only in the ledger account 30) Discount on Creditors is a……….to our business a) loss; b) gain; c) both;d)none. 31) Drawings are deducted from a) Purchases; b) Sales; c) Capital; d) Returns outward
-732) The trial balance of Mr X contains the following information: Bad Debts Rs400; Provision for bad debts Rs 500; Sundry Debtors Rs2500;. It is desired to create a provision for bad debts at10% on Sundry Debtors at the end of the year. The figure of Sundry Debtors appear in the Balance sheet at a figure of a) 2250; b) 2500; c) 1600; d) 1860 33) Depreciation is a) a non cash charge; b) an amortisation expenditure; c) both a and b 34) Trading and Profit and Loss Account is a a) Real Account; b) Nominal Account; c) Personal Account; 35) Sundry Debtors, Bills Receivable, Stock in Trade are a) Current Assets; b) Fixed Asset; c) Intangible Asset 36) The amount of depreciation charged to the Asset account is more in a) Straight Line method; b) Written Down Method; 37) The real profits of a business depends on a) Depreciation Policy; b) Investment policy; c) Policy on sourcing of funds d) all of these 38. For a bill drawn on August 1 for two months falls due on 4th October a) TRUE b) FALSE 39. In case of a p ublic holiday the due date of the bill falls on the p receding working day a) TRUE b) FALSE 40. The due date of a bill drawn on 31-01-2000 for 1 month fell on a) 1st March 2000; b) 3rd March 2000; c) 28-02-2000; d)29-02-2000 41. Salaries and Wages are debited to a) Trading Account b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the wage and salary earner 42. Carriage Inwards are debited to: a) Trading Account b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the cart owner 43. Adjusted Purchases means Purchases MINUS Returns Outwards b) Purchases MINUS Returns Inwards MINUS Closing Stock c) Purchases PLUS Returns Inwards MINUS Closing Stock d) Purchases MINUS Returns Outwards MINUS Closing Stock 44. Expenses on foreign tour for purchasing a new machinery is a a) Revenue expenditure; b) Capital Expenditure; c) Travel and tourism expenditure; d) None of the above 45. Ram has total assets of Rs 580000. His outside liabilities are Rs80000 and the loan from his family members is Rs 2 lakhs. What is his capital? a) Rs28 Rs2800 0000 00 b) Rs66 Rs6600 0000 00 c) Rs30 Rs3000 0000 000 0 d)Rs d)Rs58 5800 0000 00
-846. When a cheque received is endorsed it shall be entered on a) Debit side of the Cash book; b) Credit side of the Cash Book; c) It is endorsed in the personal account of the endorsee and not in the cash book; d) both sides of the Cash book 47. The causes of differences in the Bank Reconciliation statements are rectified by passing a) rectification entries on the date of the bank reconciliation statement b) Journal entries are passed only for some causes after the BRS is prepared c) Journal entries are passed for all the causes. d) Journal entries are passed only during the year end. 48. Which of the following are intangible assets? a) Land and Buildings; Buildings; b) Stock in Trade; Trade; c) Investment Investment in unapproved unapproved companies companies;; d) Goodwill Goodwill 49. Which of the following are intangible assets? a) Stock in Trade destroyed by fire; b) Copyrights; c) Investment in unapproved companies d) Loss in business 50. A tallied Trial balance does not reveal compensating errors. a) TRUE b) FALSE 51. Bill of exchange is drawn only when money is lent b y a moneylender, banker or other financial institution a) TRUE b) FALSE 52. When the bill is dishonoured, the drawee will be debited in the books of the drawer whether the bill is retained, endorsed or discounted. a) TRUE b) FALSE 53 When the bill is endorsed or discounted, no entry is passed in the books of the drawer a) TRUE b) FALSE 54. Wages and Salaries are debited to a) Trading Account; b) Profit and Loss Account; c) Bal Balan ance ce She Sheet et;; d) The The per perso sona nall acco accoun untt of the the wage wage and and sal salar ary y earn earner er 55. Customs duty paid on the import of a new machinery is a a) Reven evenu ue Expe xpendi nditure; ure; b) Cust ustomar omary y Expe Expend ndiiture ture;; c) Capital Expenditure; d) None of the above 56. Interest on capital is a) a personal expenditure of of the owner; b) a non-business expenditure expenditure c) a business expenditure and hence debited to P & L Account; d) none of the above 57. Insurance claim acknowledged by the insurance company but not yet paid on the closing day is treated as a) An Asset; b) A Liability; c) An Outstanding income; d) An Outstanding charge/expense. 58. The accounting principle that conforms to the tendency of accountants to resolve uncertainty and doubt in favour of understating assets and revenues and o verstating liabilities liabilities and expenses, is known as: a) conservatism b) materiality; c) indu ndustry practice; d) consistency;
-9GENERAL STRUCTURE OF THE BALANCE SHEET AND PROFIT AND LOSS ACCOUNTS: Exercise No 1: Fill up the blanks: 1. The things that a business enterprise owns are called -------- ( Assets) 2. The various amounts of money owned by an enterprise are called ………(Liabilities) 3. Assets are usually listed in a Balance Sheet in 2 main groups…………….. (Fixed Assets and Current Assets) 4. Assets which are generally intended for use in the business over a relatively long period are called………………….assets. ( Fixed) 5. Assets which are not intended for long periods are called…………………. assets.( current) 6. Accounts ……………..(Receivables) are likely to be paid and therevore converted into cash. They are classified classified as…………….assets as…………….assets (current) 7. Marketable securities are generally regarded as part of………….assets because they can readily be converted into cash (current). 8. The most liquid simple assets of all is ………… (cash) 9.Current Assets are more liquid than …………..assets (fixed). 10. Accounts receivables and marketable securities can be converted into cash at short notice. Hence they can e called …………. ……………(quick assets). 11.Marketable securities are valued at……….. or lower ………..value (cost or realisable). 12. All receivables, employee accounts and other outstanding items are valued at…….. ………… less provision for…….. …………. (full value; doubtful items). 13. Stock in trade …………… are valued at cost or current market value whichever is the lower. 14. Land is valued at ………. Or……….. (cost (cost or valuation). 15.Building, Plant and Machinery, Furniture and fixtures are valued at…… Less………….. (cost, depreciation) 16.It is possible to tell how an enterprise has obtained its finance by looking at the …………..side of the balance sheet (liability). 17.The moneys put by the shareholders into the company is the money the company owes to the shareh sharehold olders ers.. Hence Hence shareh sharehold olders ers funds funds are part part of the total… total………… ………….. …..of of the compan company. y. (liabilities) 18.Excepting shareholders’ funds, other liabilities are described as …….. ……….These consists of Current Liabilities (outside liabilities; liabilities; fixed liabilities).
-1019.Current liabilities are usually payable in…………. period say within a year. (short) 20. Bank Overdrafts and other current liabilities represent enterprises’ ……………finance (short term) 21. Current Liabilities Liabilities are usually met from …….. assets (short term or current) current) 22. Fixed Liabilities represent companys’ …… ……. Finance (long term) 23. The main items in the shareholders’ fund are likely to be ……………….. ………………(capital issued and subscribed, capital reserve and revenue reserve) 24. Capital Reserve and Revenue Reserve figures in a Balance Sheet represent ………….that have been ………….in the company. (profits; retained) 25.An enterprise is said to be solvent if its total assets are greater than its……… ……… So the solvency of an enterprise is the ability to meet meet its…. ………(outside liabilities; liabilities; outside liabilities) liabilities)
-11CHAPTER II: Manufacturing, Trading and Profit and Loss Account
2.1 INTRO: Journal, ledger accounts and subsidiary books are written as and when transactions take place. The owner of the business expects the results of his business once in a quarter / half year or year. At the end of the financial period, a trail balance is prepared to find out the accuracy of the accounts prepared and then the final accounts are prepared to ascertain the profit or loss and also the financial status of the business. All the accounts are closed by passing closing entries by giving a separate treatment in the final accounts. The final accounts are generally a) Manufacturing account, b) Trading Account; c) Profit and Loss Account and the final Statement is called BALANCE SHEET.
2.1.1. Manufacturing Account is prepared to ascertain the cost of manufacture of the product, which in turn help the owner to fix the selling price. The cost of goods produced is calculated as: Opening stock of Work-in-progress + Raw Materials Consumed (Opening stock + Purchases+ All direct expenses- Closing stock of Raw materials) MINUS (Sale of scrap and Closing stock of work in progress). progress). PLEASE PLEASE note that opening stock and closing closing stock of finished goods do not appear in the manufacturing account as they are taken to the Trading Account. It may be observed that all the expenses directly connected with Factory land and building and Plant and Machinery are debited to the Manufacturing Account. A common guideline for preparation of manufacturing, trading and profit and loss account is that all the ledger ledger accounts are closed closed and the totals totals for the entire accounting accounting period period are taken into account as the total expenses or total income under respective heads.
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A model Manufacturing Account is shown below: Dr Manufacturing Account of….. for the period ending on………….. Particulars Amt Particulars To Opening Work in Progress To Raw Materials Consumed: Op Stock 75000 Add Purchases 35000 Add Cartage Inward 3000 Add Freight Inward 2000 Less Return Outward 2500 Less Closing Stock 65000 To Wages To Salary of Works Manager To Power, Electricity & Water To Fuel To Postage & Telephone To Depreciation Plant and Machinery 6000 Factory L & B 3000 To Repairs to Plant and Machinery 11000 Factory L & B 4500 To Insurance Plant and Machinery 3500 Factory L & B 2000 To Rent and Taxes To General Expenses To Royalty based on production
Total
5000
Cr Amt
By Sale of Scrap By Closing Work in Progress By Trading Account (Cost of goods produced)
5500 3500 138000
Total
147000
47500 21000 9000 5000 6000 3500 9000
15500
5500
12000 3000 25000
147000
2.1.2. Trading Account: Account: is prepared to ascertain the gross profit or gross loss. In case of manufacturing concerns the trading account is opened with the cost of goods manufactured (brought down from manufacturing account). Then the direct expenses relating to finished goods are debited. Then the sales of finished goods and closing stock are accounted. The result is the gross profit or gross loss. In case of trading concerns, it starts with the opening stock. Then the Net purchases and direct expenses incurred for bringing the goods are debited. On the credit side, the value of sales and the closing stock will appear. The result is the Gross profit, which is carried to Profit and Loss Account. Tradin Trading g accoun accountt is prepar prepared ed for manufa manufactu cturi ring ng concer concerns ns and also also for trader traders. s. In case case of manufacturing concerns, the cost of manufacturing is taken to the trading account. In case of trading concerns, the opening stock of goods added with the purchases (less returns) and direct expenses on the goods are debited to the trading account and sales and closing stock are credited.
-13The objective of preparing Trading account is to know the gross profit or gross loss during the accounting period. It helps matching the selling prices with the cost of goods and services produced and delivered.
A Model Trading Account is shown below: Dr
Trading Account of….. for the period ending on………….. Cr Particulars Amt Particulars To Opening Stock 125000 By Sales 375000 To Purchases 165000 Less returns 3500 Less Returns 2500 162500 By Closing Stock To Direct Expenses 3000 By Abnormal Loss of stock To Freight Inward 2500 By Gross Loss transferred to To Carriage Inward 1500 P & L Account (if any) To Cartage Inward 2000 To Wages & Salaries 8000 To Gross Profit transferred to P & L Account 119000
Total
423500
Total
Amt 371500 50000 2000
423500
2.1.3. Profit and Loss Account: Manufacturing Account shows the cost of production. The Trading account reflects gross profit—cost of goods purchased/manufactured and the cost of goods sold. Other expenses of general nature are not accounted. A Profit and Loss account is a compre comprehen hensiv sive e accoun accountt showin showing g all expens expenses es of whatev whatever er nature nature incurr incurred ed in runnin running g the business and also provisions for losses, reserves, depreciation etc. It recognizes certain incomes, which accrue in the normal course of business. The net result is the Net profit or Net Loss, which is accounted to the Capital account of the proprietor/partner/s. proprietor/partner/s. The basic objective of P & L Account is to find out the Net profit or Net loss P & L Account takes into account all indirect revenue expenses and losses on the debit side and all indirect revenue incomes
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A model of Profit and Loss Account is shown below Dr Profit and Loss Account of….. for the period ending on……….. Particulars Amt Particulars To Gross Loss b/d (if any) To Salaries and Wages To Rent, Rates and Taxes To Fire Insurance premium To Repairs and Maintenance To Depreciation To Audit fees To Bank Charges To Legal Charges To Miscellaneous Expenses To Discount allowed To Carriage Outward To Freight Outward To Commission to Salesmen To Travelling Expenses To Entertainment Expenses To Business dev Expenses To Sales Promotion Expenses To Advertising and Publicity To Bad Debts To Packing Expenses To Interest on Loans To Loss by Theft To Loss by Fire To Loss by Embezzlement To Net Profit transferred to Capital Account
NIL 11000 1500 600 1200 9000 600 250 550 350 NIL 1200 NIL NIL 1350 550 12000 14000 22000 3000 5500 3500 1250 NIL NIL
Total
187000
Cr Amt
By Gross Profit b/d By Interest earned By Commission earned By Rent Earned By Profit on sale of fixed assets By Income from investments By Sale of scrap By Miscellaneous Incomes By Net Loss transferred to Capital Account
119000 11000 12000 33000 2000 7000 1000 2000
Total
187000
98600
It is to be noted that the Manufacturing, Trading and Profit and Loss account comprises of only revenue expenses and revenue incomes. That means income of a capital nature or expenditure of a capital nature does not find a place here. For example, expenditure incurred in acquiring an asset does not find a place in P & L Account. But the Profit on the proceeds on the sale of a Fixed Asset is shown as revenue in the Profit and Loss Account. It must be noted that it is the profit or loss on the sale of an asset and not the ENTIRE PROCEEDS that go the Profit and Loss Account. Again, the revenue items in the Profit and Loss Account are referred to as indirect expenses. These indirect expenses may be classified into a) Selling and Distribution Expenses, b) Office administration expenses; c) Interest on loans and Advances; d) Depreciation on Fixed Assets; e) Reserves and Provisions. ON the income side, the income by way of interest, commission, and rent earned by the concern are recognized Another way of putting up expenditure in the P & L Account is to be classify the heads of expenditure –like Administrative Expenses, Legal Expenses, Selling and Distribution Expenses, Promotion Expenses and Provisions.
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2.1. 5. Income and Expenditure Account of Non-Trading Organisations. Non-tr Non-tradi ading ng concer concerns ns render render social social servic serviceses-pro promot motion ion of art, art, cultur culture, e, litera literatur ture, e, sports sports entertainment, education, science, charity, religion etc. They include institutions, which provide these services. services. Hence, we do not call the account as Profit Profit & Loss Account. Account. Instead, we call it Income and Expenditure Account. Social services; No profit motive; Majority are cash transactions; Generally a cash book and journal are maintained; Members are not owners; Cash book contains individual receipts and payments; Volume of ledger transactions is limited; Trial balance is prepared only exceptionally; Receipts and payments account prepared at the end of year; Income and expenditure account (also called revenue account) is prepared at the end of year; The surplus/deficit is transferred to capita capitall fund; fund; The office office bearer bearers s work work out the method methods s of raisin raising g or utiliz utilizing ing the resour resources ces depending on the amount of surplus or deficit. The final accounts of non-trading concerns are 1) Receipts and Payments account; 2) Income and Expenditure account and 3) Balance Sheet
RECEIPTS AND PAYMENTS ACCOUNT: It is a summary of cash receipts and cash payments relating to the entire accounting period. It is prepared on cash system of accounting. It includes both revenue and capital items. It includes all transa transacti ctions ons even if the item item relate relates s to previ previous ous year or future future years. years. It is helpfu helpfull for the preparation of income and expenditure account and balance sheet. It resembles cash book in many respects. But there are certain differences.
Cash book
Receipts and payment account
1.Day to day receipts and payments 2. Written every day 3. An individual item is written many times as and when transaction takes place. 4. Prepare ared fr from vouc ouchers ers and and re receipts pts 5. Trading and non trading concerns prepares cash books 6. Prepared In columnar form. 7. Part of books of accounts 8. Part of double entry system 9. Reco Record rds s all all recei receipt pts s and and paym paymen ents ts and and indicates the opening and closing balances of cash on any day
1. Abstract / summary of cash transactions. 2. Prepared at the end of year 3. The sum total of an individual is written at the end of year. 4. Prepa epared fr from cash bo book 5. Only non trading concerns 6. Not in columnar form. 7. Part of final accounts 8. Does not part of double entry 9. To facilitate the preparation of income and expenditure account
INCOME AND EXPENDITURE EXPENDITURE ACCOUNT: Income and expenditure is a revenue account of non-trading concern. It is prepared on the accrual system of accounting. All items of incomes and expenditure of revenue nature pertaining to the accounting period are recorded irrespective of whether they are actually received or paid. This This is prepar prepared ed from from the receip receipts ts and paymen payments ts accoun accountt and recogni recognisin sing g all prepaid prepaid and outstanding income and expenditure.
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Diffe Differen rence ces s betwe between en Incom Income e and and Expe Expendi nditur ture e accou account nt and and Profi Profitt and and Loss Loss account Income and Expenditure account Profit and Loss account 1. Reve Revenue nue accoun accountt of a non non tradi trading ng conc concern ern 2. It is prep prepar ared ed to find find out out sur surpl plus us or defi defici citt 3. It does not start art with any any balance 4. Closing balance is called excess of income over expenditure or excess of expenditure over income 5. Surpl urplus us is not not dist distri ribu bute ted d amon among g memb member ers s
1. Revenu Revenue e accou account nt of of tradi trading ng conc concern ern 2. To find find out out pro profi fitt or or los loss s 3. It start arts with a balance of gro gross profi ofits/loss 4. The closing balance is net profit or loss
5. The The net net prof profit it is dist distri ribu butted amon among g the the owners
The diffe differen rences ces betwe between en Receip Receipts ts and and Paym Payment ents s acco account unt and and Incom Income e and Expenditure account is tabulated. Receipts an and pa payment ac account Income an and ex expenditure ac account 1. Real account 2. Similar to cash book 3. Summa ummary ry of actu actual al cash cash rece receip ipts ts and and payments 4. Cash system of accounting 5. Incl Includ udes es bot both h capi capita tall and and rev reven enue ue item items s 6. Entries may relate to items of previous year or next year. 7. It does does not not incl includ ude e out outst stan andi ding ng acco account unts s 8. Non cash items are not included
1. Nominal account 2. Similar to profit and loss account 3. Summary of income and expenses relating to an accounting period 4. Accrual system of accounting 5. It incl includ udes es onl only y rev reven enue ue acc accou ount nts s 6. Entries relates only to current year
14. 14. Does oes not not form orm a part part of doub double le ent entry 15. 15. Doe Does s not not acco accomp mpan any y a bala balanc nce e she sheet et
14. It form orms a part art of dou double ble ent entrry 15. 15. Alw Alway ays s acc accom ompa pani nied ed by a bal balan ance ce shee sheet. t.
7. It incl includ udes es outs outsta tand ndin ing g item items s 8. No Non ca cash it items lilike ba bad de debts, de depreciation are included. 9. Receipts on the debit side and payments on 9. Inc Income ome is show shown n on cre credit dit side side and and the credit side are shown expenditure on the debit side. 10. Starts with an opening balance 10. It does not begin with the opening balance. 11. Closing balance represents cash in hand or 11. 11. Clos Closin ing g bala balanc nce e repr repres esen ents ts surp surplu lus s or bank balances deficit 12. 12. Clos Closin ing g bala balanc nce e is gene genera rall lly y a debi debitt 12. Closing balance may be a credit balance or balance(exceptions being overdrafts) a debit balance. 13. Closing balance is brought down for the 13. A closing balance is not brought down but next accounting period transferred to capital fund
-172.1.6. Profit and Loss Account of PARTNERSHIP ACCOUNTS The guidelines relating to Partnership accounts are governed by the Partnership Deed or in its absence the Indian Partnership Act, 1932. Partnership Deed and its contents: A Part Partne ners rshi hip p Deed Deed is a writ writte ten n agree agreeme ment nt amon among g the the part partne ners rs prov provid idin ing g for for rule rules s and and regulations. It is accepted as an evidence in law in case of disputes. It is signed by all the partners. It is stamped as per the Stamp Act. It is also called “Articles of Partnership” or the “constitution of Pp firm”. firm”. It is documented to prevent possible possible disputes & disagreements among among the partners at a future date. The following are the contents of a Pp Deed: The name of the firm; Names and addresses of the partners; Nature of business; Date of commenceme commencement; nt; Duration/Per Duration/Period; iod; The amount amount of capital capital to be brought brought in by each partner; partner; The amount of drawings that may be permitted in anticipation of profits and the manner of withdrawal; Interest on partner’s capital and the Rate of interest; Interest on partner’s drawings and the rate of interest; The amount of salary, commission or any other remuneration payable to any partner; The ratio of sharing profits or losses; The treatment of losses arising on account of insolvency of a partner; The manner of calculation of goodwill at the time of admission, retirement retirement or death of a partner; The method of settlement of account in case of retirement of a partner; Details re: operation of the bank account; The manner of keeping books of account and audit; Sharing of managerial work/responsibilities; Dissolution and settling of accounts thereupon; Disputes and the manner of settlement. Rules in the absence of a p artnership deed: Profits/losses are to be shared equally; Interest on partner’s capital is not allowed; Interest on partner’s drawings is not to be charged; Partner is not eligible for salary, commission, or any other remuneration for any extra work done; Where partners lend loans, they are entitled for interest @ 6% p.a. only; A change in the constitution of the firm does not alter the rights and duties of the partners; Every person has a right to participate in the management; Every partner has a right to inspect the books of account; Every partner is to be indemnified in respect of all acts done in the ordinary course of business; Majority of partners has to decide all matters relating to day to day conduct of the business. Change in the nature of the business is to be decided with the consent of all the partners; Every partner has a right to protect the firm in case of an emergency; No person can be admitted as a partner without the consent of all the existing partners; Every person must compensate the firm for any loss caused to it by fraud or wilful negligence in the management of business; The benefits of the firm should not be diverted to the personal purposes. If profits are derived by using the Pp property, the partner must hand over such profits to the firm; A partner should not carry on other business which is competing with the business of the firm. The final accounts of Partnership accounts are similar to that of a sole proprietorship. However, the treatment of certain items is subject to the Partnership Deed or in accordance with the Indian Partnership Act, 1932. The Profit and Loss account is influenced on the admission, retirement, death or dissolution of a partnership. A REVALUATION ACCOUNT in case of admission, retirement or death is prepared and the partners’ accounts are settled. In case of dissolution, a REALIZATION ACCOUNT is prepared and the partners claims are settled.
In case of death of a partner, the balance due to the deceased partner may be paid immediately to the executors or it may be p aid by instalments if the legal heirs agree on the point. The balance due to the deceased partner is ascertained so as to cover all the dues till the date of death. In case of retirement or admission, the restructuring may take place as on a predetermined date coinciding with the end of a month, quarter or half year. The partners/ firm would have also taken a joint life insurance policy. The policy amount or the deceased partner’s share is also payable to the executor. On admission of a partner/s, the incoming partners bring capital and hence, profit sharing ratios change. He also brings goodwill, which will be treated as per the agreement. Goodwill is the value that is attached to the super-profit earning capacity of an existing firm. This is in addition to the value represented by tangible or concrete assets. Goodwill arises on account of name, fame, and reputation of an existing business. Goodwill is an intangible asset but not a fictitious one. It is built or created by the efforts of the existing partnersand the new partner is likely to get a share in the future profits which is the result of the super profit earning capacity of the existing firm. Goodwill is an intangible intangible asset but not a fictitious one. The accumu accumulat lated ed profit profits s and Genera Generall Reserv Reserves es till till the date date of admiss admission ion of a partne partnerr are distributed to the old partners.
2.1.7 Profit and Loss Account of JOINT STOCK COMPANIES The Profit and Loss Account of Joint Stock Companies is similar to that of a sole proprietor or a partnership firm. However, the Net Profit is transferred to a separate account called “PROFIT AND LOSS APPROPRIATION ACCOUNT”. The Balance in the Profit and Loss Appropriation Account carried over from the last year plus the current year’s Profit & Loss account balance is apportioned for:- a) Net losses transferred from the P & L Account Account of the current year; b) Payment of dividends dividends to shareholders; shareholders; c) Transfer Transfer to General General Reserves; Reserves; d) Transfer Transfer to Sinking Sinking Funds; e) Transfer to Dividend Dividend Equalisation Equalisation Fund; f) Transfer to Insurance funds; and g) the balance is transferred to Balance Sheet.
2.1.8. Profit and Loss Account of various other types of organisations Generally, there are prescribed forms of final accounts (P & L Account and Balance Sheet and other other accoun accounts) ts) in some some types types of organi organizat zation ions. s. Insura Insurance nce compan companies ies,, Banks Banks,, Railw Railways ays,, Electrici Electricity ty Companies. Companies. Hire Hire Purchase Purchase and Leasing Leasing Companies, Companies, Transporta Transportation tion companies, companies, Government departments and companies having international (global presence) are all good examples. Bankers who go through the the final accounts of these these types of organizations would would do well to understand the rules and regulations before using them for purposes of analysis and taking financial decisions.
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CHAPTE CHAPTER R III: PRESEN PRESENTAT TATION ION OF FINAL FINAL ACCOUN ACCOUNTS TS (horizon (horizontal tal and
vertical forms) 3.1. INTRO: Final accounts may be presented in two forms—a) Horizontal form and b) Vertical form. Traditionally, the profit and loss account and the balance sheet are presented in horizontal form. In the recent past, vertical form has been made mandatory in some types o f organizations. 3.2. Horizontal Form: The forms of profit and loss account and balance sheet exhibited in the previous chapters are all horizontal. In the horizontal form, the items are presented in “T” shape. 3.3. Vertical Form: Under the vertical form of presentation, the items are presented in a single columnar form. The presentation has its own objectives, which are achieved when the items are in a particular sequence. The formats are given below. In vertical formats, separate schedules should always be maintained for each of the items in detail, detail, which will incorporate incorporate all the information. information. The schedules schedules form an integral integral part of the Balance Sheet. Contingent Liabilities, if any, should be shown separately in the foot-note of the Balance sheet and not as contra entries. 3.3.1. In India, Vertical Form of presentation of Final Accounts has been made compulsory in case of a) Banks (as per Banking Regulation Act, 1949 as amended from time to time); The final Accounts of Joint Stock Companies the vertical form is being accepted for publication of results in newspapers.
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3.3.2. Vertical Form of Profit and Loss Account: Particulars A. Net Sales: Sales (Gross) Less Returns B. Cost of Goods Sold Opening Stock: Add: Purchases Less: Returns Add: Direct Expenses: Carriage/Cartage/Freight Carriage/Cartage/Freight Inwards Wages and Salaries Cost of Goods available for sale Less Closing Stock C. Gross Profit (A – B) D. Operating Expenses: a) Selling Expenses: Carriage Outward Discount allowed Commission allowed Travelling Expenses Entertainment Expenses Sales Promotion Expenses Bad Debts b) Office and Administration Expenses Salaries and Wages Rent, Rates and Taxes Repairs Insurance Printing and Stationery Water and Electricity Postage and Telegram Staff Welfare Expenses Conveyance Charges Misc Expenses Depreciation E. Net Operating Profit/Loss: C - D F. Net Non-Operating Non-Operating Result a) Interest earned Commission earned Discount earned Miscellaneous Incomes b) Non-Operating Expenses and Losses Interest allowed Loss on sale of a fixed Asset G. Net Profit
Rs
Rs
Rs
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3.3.3. Vertical Form of Balance Sheet Particulars
Rs
Rs
Rs
Rs
Rs
A. Sources of Funds a) Proprietor’s Funds b) Long-Term Debts B. Application of Funds a) Net Working Capital: i) Current Assets: Cash in hand Cash at Bank Bills Receivable Accrued Income Debtors Stock Prepaid Expenses LESS ii) Current Liabilities: Bank Overdraft Accrued expenses Bills Payable Trade creditors Income received in Advance b) Investments c) Fixed Assets: Furniture and Fixtures Patents and Trade Marks Plant and Machinery Building Land Goodwill
Schedule of Proprietor’s Funds Particulars A. Capital in the beginning B. ADD Additional Capital introduced Interest on Capital Salary to Partner Profit for the Current Accounting Period C. LESS Drawings Interest on Drawings Loss for the current accounting period D. Capital at the end of the year (A-B-C)
Note Note:: Vert Vertic ical al form form of pres presen enta tati tion on of fina finall acco accoun unts ts of join jointt stoc stock k companies is similar to the above.
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CHAPTER IV: Fundamental concepts of Accounting, Primary books, Subsidiary books and Trial balance, 4.1. FUNDAMENTALS OF ACCOUNTING
4.1.1.Accounting refers to the following functions: a) Identifying and measuring the transactions and economic activities; b) Recording, classifying, summarizing, analyzing, interpreting and c) communicating with all the pa rties concerned. Communication refers to an information system whereby the accounts convey information to internal or external users to enable them to make a reasoned decision. Communication system refers to an accounting cycle. An accounting cycle refers to Journalising, Posting, Balancing, Preparation of Trial Balance and Final Accounts.
4.1.2.Benefits of Accounting: a) Replaces memory of large and voluminous transactions b) Compliance with legal and taxation matters. c) Decision making, ascertaining the financial position, d) Facilitates comparative studies and serves as a management information system e) Helps in raising resources and proper deployment of resources
4.1.3.Limitations of Accounting: a) Does not recognize qualitative information b) Even accountants are biased towards following a certain policy c) Every business is accounted as an ongoing concern basis and hence may not reveal the real picture as it would have been if the b usiness is forced to close down. d) Ignores the effect of price rise. However, inflation accounting has been in vogue in the recent past. e) Accounting enables the decision makers to make window dressing and door dressing
4.1.4.Classification of Accounting: a) Financial Accounting; b) Cost and Management Accounting c) Social Responsibility Accounting d) Fund Based Accounting
4.1.5.GAAP: GAAP refers to Generally Accepted Accounting Principles are those rules of action action or conduct, which are derived derived from experience experience and practice. practice. These when proved proved useful, useful, they become convention and accepted as principles of accounting. The criteria are a) Relevance, b) Objectivity and c) Feasibility.
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4.1.6. Basic Accounting Concepts: a) Accounting Entity Assumption: This means that the business is different from the persons owning it. Accounting is done for the business unit and not the person representing it. Personal transactions of the owner with the business unit are also recorded in the bu siness unit. b) Money Measurement Concept: Accounting refers to recording only those transactions, which are capabl capable e of expres expressio sion n in money money terms. terms. Hence, Hence, qualit qualitati ative ve items items like like the morale morale of the employee or the corporate image of the company cannot be recorded. c) Accounting Period Concept: (Periodicity or Time Period): The income statement and all other financial statements are prepared for determined accounting periods like a quarter, half year or a year. d) Going Concern Concept: Accounting is done for an enterprise as a going concern which means that the business unit (enterprise) (enterprise) is continuing continuing operations operations for a foreseeable foreseeable future and that it is neither the intention nor the necessity to liquidate the enterprise. e) Consistency: The accounting policies are consistent over a period of time f) Accrual Concept: Revenues and Costs once accrued are recognized and recorded in the financial statements. That means they are earned or incurred (and not money received or paid) as and when the period is o ver. g) Prudence Principle (Conservatism Concept): “Anticipate no profit but provide for all possible losses” is the prudence expected of every accountant.
4.1.7. Accounting Policies: a) Policies relating to Depreciation, Amortisation and Depletion b) Treatment of expenditure during construction of building and other infrastructure c) Conversion of Foreign Currency d) Inventory Valuation e) Treatment of Goodwill f) Valuation of Investment g) Treatment of retirement benefits h) Recognition of long-term contracts i) Valuation of Permanent Assets j) Contingent Liabilities—treatment. Liabilities—treatment. We have seen that an accounting cycle refers to Journalising, Posting, Balancing, Preparation of Trial Balance and Final Accounts. We shall study them in detail. 4.2.1.JOURNALISING: 1. Every transaction is recorded in a journal as and when the transaction takes place. This process of recording the transaction is called Journalising. Transaction refers to movement of mone money y or money money’s ’s wort worth. h. The The basic basic prin princi cipl ple e of recor recordi ding ng is that that ever every y debi debitt has has got got a corresponding credit and vice versa. The debit and credit has to be carried according to the classification of accounts and the principle underlying therein.
-242. PERSONAL ACCOUNTS: ACCOUNTS: Debit the receiver and credit the giver. 3. REAL ACCOUNTS: Debit what comes in and credit what goes out. 4. NOMINAL ACCOUNTS: Debit all expenses and losses and credit all gains and profits. Once a particular debit or credit is identified the other is naturally the contra. 4.2.2. Posting in ledgers: Every journal entry is entered in the respective head of account called the ledger account, which is also called Account. All the transactions in a particular head of account are available at a glance of the account The ledger being the destination of all transactions it is called the Book of Final Entry. The ledger may be in book form, loose sheet, punched card, electronic form or any other device. Balancing of a ledger account reflects the debit or credit position of that head of account on a given date. Special journals are in the form of ledger accounts and hence separate journal and ledger are not necessary--for example Cash book, Purchases and Sales register, Purchases Returns Book, Sales Returns Book, Bills Receivable Book and Bills Payable Book and Journal Proper. These serve the purposes of journal as well as ledger. Discounts, Rebates and Concessions, are to be properly accounted. Cash Book may contain a) only cash column—single columnar cash book; b) Cash book with cash and bank column—called two column cash book; or c) Cash book with cash, bank and discount columns—called three column cash book each servi serving ng spec specif ific ic purp purpos oses es.. Besi Besides des,, ther there e may may be a sepa separa rate te cash cash book book for for pett petty y cash cash transactions.
4.2.3.Subsidiary Books and their importance: Journal is book of the original entry. In the modern day business world, the number and volume of transactions being high, it is not possible to pass every transaction through the journals. Hence, it became necessary to evolve certain journals-cum-ledgers in which the voluminous transactions of identical nature are passed. These are called special journals. They are also called subsidiary books because they satisfy the requirements of Journal and Ledger. Those transactions, which cannot be classified in any of these subsidiary books can be entered in Journal Proper. Important Important Subsidiary Subsidiary Books are Cash Book, Purchases Purchases Book, Sales Book, Purchases Purchases Returns Returns Book, Sales Returns Book, Bills receivable Book and Bills Payable Book Objectives of preparing the subsidiaries:: 1. It facilitates division of work; 2. Internal checking system is strengthened. 3. Permits the use of special special skills—eg. skills—eg. Cash book is written written by an expert in cash transaction transactions; s; 4. It saves time and energy energy in journ journali alizin zing g and ledger ledger postin posting g of innum innumera erable ble entri entries; es; 5. The figure figures s of Sales, Sales, Purchases, Purchases, Returns, Returns, Cash Balance, Bank balance can be easily obtained by looking looking to the subsidiary books; 6. They serve as documents evidencing transactions and even when n ecessary by competent authorities (courts, tax authorities can scrutinise the respective subsidiary book)
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4.2.4. Trial Balance: Trial Balance is a statement as on a particular day reflecting either the balances of various ledger accounts or the totals of such accounts. It shows debit and credit balances in a columnar form. The total of debit and credit should tally. However, a trial balance is a trial as there is no guarantee that once the trial balance tallies, the balances of all the accounts are co rrect. The Trial balance is prepared a) to ascertain the arithmetical accuracy, b) to help in locating errors and c) to facilitate in the preparation of the final accounts. The Trial balance balance may not disclose the following following errors: errors: a) Error Error of Principle; Principle; b) Compensati Compensating ng Errors; c) Error of Complete Omission; d) Error of recording in the books of original entry and e) Posting a correct amount in the wrong account but on the correct side. Sometimes, trial balance does not tally. Some errors affect the trial balance. A thorough scrutiny becomes necessary. Though it may not be possible to check all the entries passed during the accounting period, there are certain steps to locate the errors. When the errors are spotted check the concerned entry/account thoroughly. Steps to be taken when the trial balance does not tally 1. Check the totals of both sides of the Trial Balance; 2. Apply trial and error techniques—ie., sample checking of some entries which indicate the entries of amount equivalent to the value of difference, double the difference or 50% of the difference. Check those entries thoroughly. These may happen on account of posting the original entries on the wrong side of the accounts; 3. Check each and every entry of the trial balance with reference to the closing balances as shown in the various ledger accounts. This is to ensure that the correct a mounts are mentioned in the trial balance; 4. Check the totals of sundry debtors and sundry creditors are correct with reference to the personal accounts maintained in the ledger; 5. Check Check whethe whetherr the cash cash and bank bank balanc balances es have have been been correc correctly tly ascert ascertain ained. ed. Whethe Whether r overdraft balances are properly taken in the trial balance; 6. Check whether the opening entries of all the ledger entries have been properly brought down; 7.Check the balancing of all the accounts as to their arithmetical accuracy; 8.Check the postings in the original ledger accounts; 9.Check the casting and carry forward of books of original entry; 10. Check the omissions and commissions; 11) Check the revenue and capital items to ensure that they are not interchanged; 12. Someti Sometimes mes two two wrong wrong entrie entries s may compen compensat sate. e. In such such cases, cases, a thoro thorough ugh scruti scrutiny ny is necessary. The trial balance can be prepared as on any date by arriving at the balance in various ledger accounts. However, generally preparation of trial balance is a preparatory step to preparation of final accounts. It is therefore necessary for us to find out the balance in the various accounts and subsidiaries and how the entries are made. Accounting or Book-keeping is both an art and a science. There are cardinal principles, which are generally applied in all types of organizations right from a small concern right to the topmost multinational companies. An accountant and his team will effectively complete an accounting cycle and provide all the relevant information to all the users through proper accounting records.
-264.3. Rectification of Entries: There is bound to be errors in accounting entries as human beings make them. Errors can be rectified as soon as they are located. Errors are located as and when the accounting supervisors are checking the entries for the transactions or it may escape their attention. Errors may be traced at the time of preparing the Trial Balance or after preparing the Trial Balance. Sometimes errors are being traced after the final accounts are prepared. The type of rectification entries depends on the time of location of errors and the type of errors committed. Errors may be of the following types: Error of Omission—Partial Omission or Complete omission Error of Commission—Error of Casting, Error in carrying forward, Error in totaling or balancing of an account, Error in Posting (other than to a wrong head of account in the correct side), Entering on the wrong side of trial balance and wrong totaling of the trial balance. Error of Principle—posting revenue expenses to capital accounts & vice versa, wrong entries in different categories of accounts etc. Compensating Errors Suspense Account: A Suspense account is an account in which the amount of difference in the trial balance is put till such time the errors are located and rectified.
CHAPTER V: COST FUNDAMENTALS
AND
MANAGEMENT
ACCOUNTING
11.1. Intro: Cost Accounting aims at ascertainment of costs and at analysis of savings. It is the applicatio application n of accounting accounting,, costing costing techniques techniques,, methods, methods, and principle principles. s. It concerns with with the compar compariso ison n of costs costs with with previo previous us figur figures es or with with standa standards rds.. It helps helps in interp interpre retat tation ion of management problems. Cost Accounting is concerned with a product, service or an operation. Actual cost incurred with reference to future cost estimation is compared. Hence, Cost Accounting is applicable in Banks and the servic service e sector sector organi organizat zation ions s as well. well. Cost Cost Accoun Accountin ting g can be for specif specific ic produc product, t, identified departments etc. Cost Accounting by itself is a management information system
11.2 Benefits of Cost Accounting to the management of an organization: a) Analysis Analysis of the profitability profitability of individua individuall products, products, service, departments departments can be possible possible and steps can be taken for improvement b) Analysis of the cost behaviour which may point out to the corrections of some items of expenditure c) Establishment of Cost centers and Profit Centres is possible, which in turn may help increasing profitability per unit or for turning around. d) Pricing Policy can be structured to cover costs and reasonable levels of profits e) The functioning of a department—increase or decrease in production for whatever reason is reflected. f) Cost records help in analyzing the final accounts like Manufacturing Account, Trading and P & L Account such that the sources of profit/loss can be established g) Cost records serve as the base for the management information system h) It helps interdepartmental, with with adequate comparison i) It helps in setting up standards in tune with the g eneral industry performance.
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11.3. Comparison between Cost Accounting and Financial Accounting Cost Accounting
Financial Accounting
1. An inte intern rnal al repo report rtin ing g syst system em for for the the management decision making
1. An external reporting system whereby all thos those e inte intere rest sted ed in the the syst system em come comes s to know about the organisation 2. Aims at presenting “true and fair” view of the overall results 3. Financ Financial ial period period is genera generally lly longer longer and follow follows s establ establish ished ed concep concepts, ts, princi principle ples, s, accounting standards and legal requirements 4. Historical in nature and reporting is wide
2. Emph Emphas asis ises es on func functi tion ons, s, acti activi viti ties es,, product, process, planning and control 3. Concerned with Short term planning and its reporting period is shorter 4. Not only deals with historical data but also futuristic in approach. 5. Cost ost Acco Accoun untting ing syst ystem cann cannot ot be established without a proper financial system.
5. Concerned about the type of transaction.
11.4. Cost Concepts: --Product and Period Costs --Common and Joint Costs --Short Run and Long Run Costs --Past and Future Costs --Controllable and Non-controllable costs --Replacement and historical costs --Imputed and Sunk Costs --Relevant and Irrelevant Costs --Opportunity and Incremental Cost --Conversion Csot --Committed cost --Marginal Cost and Notional Cost
11.5.Classification of Costs: Financial---Cash Cost Versus Non Cash Cost Non-Financial Costs Element-wise Direct Costs and Indirect Costs Functional Costs Production Cost, Administration Costs, Selling & Distribution Cost and R & D Costs Behavioural Costs: Fixed Cost, Variable Cost, Semi-variable Cost.
-2811.6. Management Accounting: Management Accounting is the process of identification, measurement, accumulation, analysis, interpretation and communication of both financial and operating used by management to plan, evaluate, and control within an organization and also to fix up accountability for its resources. It is a system of collection and presentation of relevant economic information of an enterprise for planning, controlling and decision making. The information provided by the management accountants shall facilitate the following purposes: a) Poli Policy cy form formul ulat atio ion; n; b) Plan Planni ning ng and and Cont Contro roll func functi tion ons s of mana manage geme ment nt;; c) deci decisi sion on making/taking –deciding on alternate courses of action; d) disclosure to internal and external stake stake holder holders; s; e) safegu safeguard ardin ing g the assets assets;; In short, short, the managem management ent accoun accountin ting g helps helps the enterprise draw out long term plans and also short term plans and decide about the budget allocation and operation plans
11.7. Scope of Management Accounting : Management accounting includes Financial Acco Accoun unti ting ng and and exte extend nds s itsel itselff to a syst system em of cost cost and and fina financ ncia iall mana manage geme ment nt.. Besi Beside des s conventional financial accounts, it establishes better methods of internal control. The scope of management, therefore, lies in the following activities a) Establishing and strengthening the systems relating to cost accounting, tax accounting and management information b) Compilation and preservation of data required for management planning c) Ensuring proper means of communication to the various levels of the enterprise including feedback d) Assess and analyse the deviations from the expected plans e) Analys Analysis is and inter interpre pretat tation ion of accoun accountin ting g inform informati ation on to make make it unders understan tandab dable le to the management. f) Providing alternative proposals on the profits and position of the enterprise g) Providing methods and techniques for evaluation of the performance of the organization with reference to the objectives (MBO) h) Improving and sharpening existing techniques of analysis. Management Accounting serves as a technique for evaluating the performance of management itself.
11.8. Functions of Management Accounting: a) Periodic Internal Accounting Reports b) Analysis of data for decision making The management accountants shall involve themselves in the areas of decision making and problem solving particularly in the following areas: a) Strategic Management Accounting; b) Investment Appraisals; c) Financial Management; d) Short-term and Ad-hoc decision and e) managing the management information systems
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11.9 11.9.. Comp Compar aris ison on Accounting
betw betwee een n
Mana Manage geme ment nt
Management Accounting Studies various divisions and sub-divisions of an enterprise Repo Report rts s to the the mana manage geme ment nt on deta detail ils s of oper operat atio iona nall cost costs, s, inve invent ntor orie ies, s, prod produc ucts ts,, processes and jobs. Analyses business events as and when they take place i.e, Running The historical data of financial data provides inpu inputs ts givi giving ng rapi rapidi dity ty to the the mana managem gemen entt accounting practices. Period Periodici icity ty is shor shorter ter—we —weekl ekly, y, fort fortnig nightl htly y etc
Acco Accoun unti ting ng
and and
Fina Financ ncia iall
Financial Accounting Studies the enterprise as a whole Repor Reports ts result results s to all those other other than than the management. Hence, there is a possibility of window dressing Mainly Historical
Refle Reflects cts the possib possible le future future based based on the past past info inform rmat atio ion. n. At best best it coul could d be an estimate The periodi periodicit city y is wider-wider--qua quart rterl erly, y, half yearly yearly or yearly of Based on Generally Accepted Principles
Based on independent judgement management accountants Mana Manage geme ment nt Acco Accoun unti ting ng prov provid ides es both both Monetary and non-monetary informations
Consists of Monetary information only
11.10. Comparison between Management Accounting and Cost Accounting Management Accounting Impact of Costs Deri Derive ved d fro from m cos costt and and fina financ ncia iall acc accou ount ntin ing g
Cost Accounting Ascertainment of Costs Serv Serves es as a bas base e for for tool tools s and tec techn hniq ique ues s of management Wider perspective as cost data are used for Confined to analysis of costs decision making and problem solving Management Accounting is placed at a higher Cost Accounting is placed in a lower level of level of management management Management accounting uses cost data along Cost accounting is narrower with economic and statistical data Management Accounting in addition to using Cost Cost accou account ntin ing g uses tech techni niqu ques es like like cost accounting techniques, uses funds flow, marg margin inal al cost costin ing, g, brea break k even even anal analys ysis is,, cash flow flow and ratio analysis budgetary control, standard costing etc Mana Manage geme ment nt Acco Accoun unti ting ng incl includ udes es Cost Cost Cost Cost Acco Accoun unti ting ng has has noth nothin ing g to do with with Accounting and Financial Accounting financial accounting Mana Manage geme ment nt Acco Accoun unti ting ng in addi additi tion on to Cost Accounting assists the management but assisting manageme ement provides for does not evaluate management evaluation and performance of management Management Accounting is fu futuristic Cost Ac Accounting is hi historical Management Accounting cannot be installed Cost Accounting can be installed without cost accounting independently
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CHAPTER VI: TERMINOLOGIES ACCOUNTING CONCEPTS
USED
IN
ACCOUNTANCY
and
Every subject of study involves certain words phrases, which are used in a special sense. So is the case with account accountancy ancy.. We have given the terminol terminologi ogies es used in accounta accountancy ncy and accounting concepts at one place. This enables the reader to get at one place the meaning of the words or phrases and serves as an immediate reference. Transaction: Transaction means movement of money or money’s worth Recording: Recording of identified and measured financial transactions Classific Classificatio ation: n: Accounts Accounts are classifie classified d into PERSONA PERSONAL L and IMPERSO IMPERSONAL. NAL. IMPERSON IMPERSONAL AL ACCOUNTS are again classified into Real and Nominal Accounts. Personal Personal Accounts: Accounts: Accounts Accounts relating relating to natural natural persons, persons, artifici artificial al persons persons and representat representative ive persons Real Accounts: Accounts relating to Tangible or intangible real assets Nominal Accounts: Accounts relating to income, expenses, losses and gains. Accounting Cycle: Journalising, Posting the Ledgers, Balancing, Preparing Trial Balance, Income Statement and Position Statement (Balance Sheet) Advanced accounting functions are analysis, interpretation, communication and decision making. Users of accounting accounting informati information: on: Proprieto Proprietor, r, Partner, Partner, Shareholder Shareholders, s, Directors Directors,, Investors, Investors, Creditors, Employee-groups, Government (incl. tax authorities) and the General Public Branches of Accounting: Financial Accounting, Cost Accounting, Management Accounting and Social Responsibility Accounting Limitations of Accounting: Does not recognise qualitative elements; Not free from bias; Estimates and not real positions; Ignores changes in the prices; Danger of manipulations and window dressing Entity: Owner is different from the business for accounting purposes Voucher: Document evidencing a transaction Entry: A record made in the books of account Assets: Assets refer to tangible or intangible assets, which are the uses of the funds in the business. These assets are in the form of Fixed Assets (Permanent Assets), Current Assets, Investments, Miscellaneous Assets and Intangible Assets Liabilities: Liabilities Liabilities means financial obligations of the business unit to others. Capital is a liability to the owners because the business owes that amount to the owner. However owner takes the risk of loss which he has to set off. Again, this depends on the constitution of the business. Capital: Capital is the excess of assets over external liabilities.
-31Drawings: The owner of the business (proprietor or partner) cannot afford to wait indefinitely. So, in anticipation of profits, they draw a certain sum of money, take some assets or utilise some of the business purchases for personal purposes. This is called Drawings. Sometimes, interest is charged on the amount of drawings. Drawings are shown in the accounts as a deduction from the capital. Inventory: Stock of goods may be in the form of raw materials, semi-finished goods (work in progre progress ss or work work in proces process) s) and finis finished hed goods. goods. The quanti quantity ty and/or and/or value is known known as inventory. Debtors:The persons who owe amounts to a business unit. When the goods are sold on credit, the purchaser owes the amount to the business, in which case he is called Trade Debtor. Trade Debtors, Sundry Debtors, Book Debts are different names for this item. Creditors: The persons to whom the business unit owe amounts. When the goods are purchased on credit, the business owes the amount to the seller, in which case he is called Trade Creditor. Trade Creditor, Sundry Creditors are the o ther names for this item. Capital and Revenue Items: Permanent items are called Capital items and recurring items and items where the period is generally an year are called Revenue items. There are both debits and credits in both the items. Sometimes, large revenue items are deferred to be absorbed in future. Net Profit: Net profit is the excess of revenue over expenses. If expenses exceed the revenue it is Net loss. Retained Profits: IN a business a portion of profits is transferred to Reserves to offset future exigencies or for meeting specific n eeds. This is called Retained profits. Carriage Inwards & Carriage Outwards: The expenses on transportation for goods purchased (raw-materials or finished goods) is called Carriage Inwards which adds to the cost of the goods and is debited debited to Manufactu Manufacturing/ ring/Tradi Trading ng Account. Account. The transporta transportation tion expenses incurred on outgoing goods (sales) is called Carriage Outwards which find a place in P & L Account. Cartage Inwards & Cartage Outwards: If the transportation is by way of a cart, it is called Cartage charges. Same treatment in Mfg/Trading & P & L A/c Freight: Freight: The charges charges for transportatio transportation n of goods through through transport transporters ers is called Freight. Freight. Freight can be paid by the seller or by the buyer. Freight Inwards is debited to Mfg / Trading Account and Freight Outwards is debited to P & L Account. Appren Apprentic tice e Premi Premium um receiv received. ed. If the compan company y / busine business ss receiv receives es the premi premium um from from the apprentice pupils joining the company is a business income and credited to P & L Account. Discounts allowed and received: Discount allowed is a expenditure and discount earned is an income. Depreciation: A non-cash provision for depreciation in the value of the various assets used in the busine business. ss. Whateve Whateverr be the cause cause of deprecia depreciatio tion, n, an amount amount is debited debited to P & L A/c as depreciation as per the policy of the business and shown as a deduction from the value of the asset concerned. Trade Expenses: Expenses: Just because the word Trade is there, it should should not be debited debited to Trading Trading Account. Trade expenses are debited to P & L Account.
-32Bad Debts, Doubtful Debts, Discount on Debtors and Creditors: Debtors means the amount due from others. Generally this is on account of sales. There is a business risk. A part of the amount which cannot cannot be recovered is called called BAD DEBTS. DEBTS. A part of the amount may be doubtful of recovery but may come. They are called DOUBTFUL DEBTS. P & L Account shall provide for all such possible losses. Besides, there are some debtors who pay the money in advance or before the due dates agreed to. In such cases, a discount may be offered for prompt/advance payment. It is called DISCOUNT ON DEBTORS. A provision for this is also made. All the above are debited to the P & L Account and are deducted from the value of the Debtors in the Assets side of the Balance sheet. Similarly a discount may also be received from our creditors,which is an income for us. Embezzlem Embezzlement: ent: When the employee employee misuses, misuses, misappropriates misappropriates or commits commits fraud, fraud, it is called called embezzlemen embezzlementt of funds. This is a loss caused on account account of honesty/integr honesty/integrity ity of the workers in the business and should be treated as a loss. So, it is debited to P & L Account. Goodwill, Trade Marks, Copyrights, Patents, Intellectual Property Rights (IPRs) are all intangible assets. Outstanding Expenses/Charges. When we prepare the final accounts, we have to account for all expens expenses es till till the last last date date of the accoun accountin ting g period period whethe whetherr paid paid or not. not. The outsta outstandi nding ng expenses are added to the concerned head of account in the P & L account and also shown as a liability in the Balance Sheet. Outstanding Income: This is added to the concerned head of account and shown as an asset in the Balance Sheet. Prepaid Expenses: Some expenses are paid in advance. These are deducted from the concerned head of expenses in the P & L Account and shown as an Asset in the Balance Sheet. Abno Abnorm rmal al loss loss of stoc stock: k: (flo (flood od,, fire fire or any any reas reason on). ). It is show shown n as a cred credit it in the the Manufacturing/Trading loss and the insurance claim is made. Insurance company will admit the claim or reject the claim for a value. If the actual value of loss is more than the claim admitted the difference is a loss, which has to be accounted in the P & L Account. If the full value is admitted as a claim, claim, then besides besides showing a credit credit in the Manufacturi Manufacturing/Tr ng/Trading ading account, account, it is shown on the Assets side of the Balance Sheet. The going concern assumption allows the accountant to classify the expenditure and receipts as Capital Expenditure, Revenue Expenditure, Deferred Revenue Expenditure, Capital Receipts and Revenue Receipts. Capit Capital al expend expenditu iture re is that that expend expendit iture ure which which is incur incurred red for perman permanent ent inves investme tment nt in the business in the form of plant & machinery, land & building, Furniture & Fixtures or for expansion, modernization or technology upgradation or replacement. Revenue Expenditure is that expenditure which is incurred for maintaining productivity of the busine business ss or for earning earning capaci capacity ty of the business business.. This This includ includes es Offic Office e and Administ Administrat ration ion expenses, Selling and distribution Expenses, and Non-operating Expenses a nd Losses. Deferred Revenue Expenditure is that expenditure which yields benefits which extend beyond a current accounting period but the amount of expenditure is fairly big to absorb in the current accounting period. Expenses such as Advertising, Campaigning, Research and Development and all other amortizations fall in this category.
-33Capital Receipts and Revenue Receipts. Though no clear-cut formula for distinction could be found, receipts in the form of sale of fixed asset, amount of loan received capital contributed by the proprietor/partner/owner are all capital receipts. Revenue receipts are sales, revenue from services rendered in the normal course of business, interests, rents, royalty etc. However, the proceeds of sale of a car is a revenue receipt for one who is dealing in sale of cars as a commodity whereas the same is treated as a capital receipt for other businesses. All expenditure incurred till erection, installation and normal functioning of machinery etc is a capital expenditure. Interest on Capital: Sometimes interest is allowed on the capital contributed by the proprietor or partner/s. This is an item of business expenditure and debited to P & L account. ACCRUALS: Costs that were incurred although not paid du ring a particular period. ACID TEST: A measure of a firm’s liquidity using the formula—Realisable formula—Realisable Current Assets Assets MINUS Current Liabilities (also called Quick Ratio) RATE OF RETURN: Percentage of gain from the annual Income in relation to total Capital Investment. CAPITAL BUDGETING: BUDGETING: An exercise by which funds are allocated for particular projects/uses. CAPITAL GAIN: Profit earned by selling long or short term assets. CASH FLOW: Inflow and outflow of Cash items in the operations of cash nature. CAPITAL CAPITAL RESERVES: RESERVES: Reserves, Reserves, which are not available available for distributi distribution on as dividends dividends as they have not arisen out of trading operations. Eg. Surplus on account of revaluation of assets. CURRENT ASSETS: ASSETS: Resources that are readily convertible convertible to cash within a year. CURRENT LIABILITIES: LIABILITIES: Debts that are expected to be paid within a year. CURRENT RATIO: Measure of Liquidity—CA/CL Liquidity—CA/CL GOODWILL: GOODWILL: The premium premium recorded recorded on the the books of of the company company as as an intangibl intangible e asset whenever payment for any assets exceeds its book value. NET SALES: Sales less of rebate, discount, excise duty and cess. N A T: Net after tax. TANGIBLE NETWORTH: NETWORTH: Total share holder’s equity.(Total equity minus intangible assets). RETAINED RETAINED EARNIN EARNINGS: GS: That portion portion of annual income after tax less dividend dividend that is held cumulatively and is part of common stock holder’s equity. REDEMPTION: REDEMPTION: Use of funds for repayment of specific liabilities. SINKING FUND: Annual sum set apart from income after tax for the purpose of redeeming any bonds or preferred stock.
-34SOURCES OF FUNDS: FUNDS: Decrease in Assets, Increase Increase in Liability and equity. WORKING CAPITAL: Current Assets minus current Liabilities. AMORTISATION: AMORTISATION: Making provision for periodic retirement of long term debts. Accounting Concepts: Business Entity Concept Money Measurement Concept: Acco Accoun unti ting ng Peri eriod conc concep eptt Accr ccrual ual Con Conc cept ept Realisation Concept Gong Concern Historical Cost Matching Concept Conservatism (Prudential norms) Accounting Policies: Depr Depreci eciat atio ion, n, Depl Deplet etio ion n and and Amor Amorti tisa sati tion on;; Trea Treatm tmen entt of of prel prelim imin inar ary y expe expend ndit itur ure e Conversions of foreign currency items; Valuat uation of Inventory ory Treatment of goodwill; Valuation of Investment Treatment of of re retirement be benefits; Recognition of of pr profits on on on ongoing pr projects Valuation of fixed assets Treatment and provision for contingent liabilities Capital Adequacy on an on going basis keeping in mind the business risks ACCOUNTING EQUATIONS: Resources = Sources of finance Assets = Capital + Liabilities Capital =Assets - External Liabilities Sources of Funds: Capital -- Own capital and borrowed capital Reserves and Surplus--Retained profits of a business Borrowed Borrowed Capital: Short term or Long term Loans from family/f family/frien riends, ds, loans from outsiders outsiders including banks and financial institutions. Creditors: Bills Payable:(including outstanding expenses) Deposits of money by subsidiaries/ancillaries Application of funds: Use of Funds- Increase in Assets, -Decrease in Liabilities, -Decrease in Stock holder’s equity. Uses of Funds or Application of funds Fixed or Long Term Assets--Land and Building, Plant and Machinery, Goodwill Current Assets: Cash and Bank balances, Stock in Trade, Bills Receivable, Sundry Debtors Investments--in government and non-government securities Miscellaneous Assets--Prepaid Expenses, Income due but not received Intangible Intangible Assets--G Assets--Goodwi oodwill, ll, Patents, Patents, Trade Marks, Marks, Copyright Copyrights, s, Intellect Intellectual ual Property Property rights, rights, Carried forward losses
