Basic of Financial Accounting

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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) Balance Sheet; d) The personal account of the wage and salary earner 6. Carriage Outwards are debited to: a) Balance Sheet; b) The personal account of the cart owner c) Trading Account; d) Profit and Loss Account; 7. Customs duty paid on the import of a new machinery is a a) Revenue Expenditure; b) Customary Expenditure; c) Capital Expenditure; d) None of the above 8. Interest on capital is a) a personal expenditure of the owner; b) a non-business 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

Transcript of Basic of Financial Accounting

Page 1: Basic of Financial Accounting

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 drawera) TRUE b) FALSE

5. Wages and Salaries are debited toa) Trading Account; b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the wage and salary earner

6. Carriage Outwards are debited to:a) Balance Sheet; b) The personal account of the cart owner c) Trading Account; d) Profit and Loss Account;

7. Customs duty paid on the import of a new machinery is aa) Revenue Expenditure; b) Customary Expenditure;c) Capital Expenditure; d) None of the above

8. Interest on capital isa) a personal expenditure of the owner; b) a non-business expenditurec) 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 asa) 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 overstating liabilities and expenses, is known as:a) conservatism b) materiality; c) industry practice; d) consistency;

11. Debit means:a) decrease in assets b) increase in income; c) increase in expenditure; d) increase in capital;

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-2-12. Which of the following is correct:a) PROFIT = OPENING CAPITAL + DRAWINGS – ADDITIONAL CAPITAL –CLOSING CAPTIALb) PROFIT = CLOSING CAPITAL + ADDITIONALCAPITAL – DRAWINGS MADE – OPENING CAPITALc) PROFIT = CLOSING CAPITAL –DRAWINGS –ADDITIONAL CAPITAL –OPENING CAPITALd) 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 accountd) Dr Miscellaneous expenditure account

15. Cash book Bank column always show a a) Debit Balance; b) Credit Balance; c) Debit or Credit Balance; d) a NIL balance

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 witha) The Opening balance of the Cash Book; b) The Opening balance of the Passbook;c) The Closing balance of the Cash Book; d) The Closing balance of the Cash book in the cash column in a three columnar cash book

19. When the balance as per Cash Book is the starting point, the direct deposits by the customers in the bank are……. ……….while preparing the Bank Reconciliation Statement.a) added b) subtracted; c) neither of the above

20. Which of the following are intangible assets?a) Plant and Machinery; b) Stock in Trade destroyed by firec) Investment in unapproved companies; d) Trade Marks and Patents.

21. Loss on sale of a fixed asset is debited to

a) Trading Account; b) The concerned Asset Accountc) Profit and Loss Account; d) Balance Sheet

22. Depreciation is an amortised expenditurea) TRUE b) FALSE

23. Depreciation is aa) Cash expenditure; b) Non-Cash expenditure; c) Neither a nor b

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24. Fixed assets are stated at their market value in the balance sheeta) TRUE b) FALSE

25. Bank column of the Cash book may showa) Debit Balance; b) Credit Balance; c) Either a debit balance or a credit balance.

26. Withdrawal of cash from the bank for office purposes is entered in the Cash Booka) only in the bank column; b) only in the cash column; c) as a contra entry

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 opening entry; c) Transfer Entry d) Contra Entry;

28. Petty Cash book is maintained to a) save time for the main cashier; b) account for all the petty cashc) save the labour in posting innumerable entries; d) all the above.

29. Fill in the blank by choosing the appropriate words given in the options a, b & c

Interest free loan given by the wife of the proprietor is…………… a) liability; b) asset; c) profit

30. Fill in the blank by choosing the appropriate 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 Octobera) TRUE b) FALSE

32. A bill of exchange is a conditional order in writing given by a debtor to a creditora) TRUE b) FALSE

33. In case the due date of a bill falls on 15th August of any year, the due correct due date falls on the preceding working day a) TRUE b) FALSE

34. The due date of a bill drawn on 31-01-2004 for 1 month fell ona) 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 1st October 2002. She withdrew 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 isa)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

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-4-39. Interest paid on a term loan where the production has already started is aa) 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) Rs125000 b) 250000 c) 375000 d) 125000

42. Journal is a book of; a) original entry b) Bank Reconciliation statement c) secondary entry; d) all cash transactions;

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 asa) a deduction from sales; b) a deduction from purchases; c) an additional sales; d) addition to the purchases 47. Bank Reconciliation Statement is prepared a) by the bank and supplied to the customer to verify the sameb) 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 passinga) 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 Buildings; b) Stock in Trade; c) Investment in unapproved companies; d) Patents

50. Which of the following are intangible assets?a) Stock in Trade destroyed by fire; b) IPRs; c) Investment in unapproved companiesd) Loss in business

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-5-II Set:

1. Depreciation Policy is one of the important accounting policies for any business organsationa) TRUE: b) FALSE

2. Providing depreciation in the accounts reduces the amount of profits available for dividend.a) TRUE b) FALSE

3. Reserves and Surplus is: a) A Liability; b) An Asset; c) A Profit; d) Not an account at all

4. Reducing balance method of depreciation is followed to have a uniform charge for depreciation and repairs and maintenance together: a) TRUE b) 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 ledgerb) the credit side of the concerned ledger accounts in the ledgerc) None of the ledger accounts as the cash book serves as a permanent record.

6. Subsidiary Books act as a journal as well as a ledger: a) TRUE b) FALSE

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 ledgerc) Discount Account in the ledger; d) Both Cash and Bank account in the ledger.

8. Fill in the blank by choosing the appropriate words given in the options a, b & cIncome 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 capital.

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 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 thea) Debit side; b) Credit Side; c) not entered at all;

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-6-17. 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 asa) a deduction from sales; b) a deduction from purchases; c) an additional sales; d) addition to the purchases

19) Bank Reconciliation Statement is prepared bya) 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 isa) 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 observea) 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 bea) 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 ina) 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 thea) 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 businessa) loss; b) gain; c) both;d)none.

31) Drawings are deducted froma) Purchases; b) Sales; c) Capital; d) Returns outward

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32) 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 aa) Real Account; b) Nominal Account; c) Personal Account;

35) Sundry Debtors, Bills Receivable, Stock in Trade area) Current Assets; b) Fixed Asset; c) Intangible Asset

36) The amount of depreciation charged to the Asset account is more ina) Straight Line method; b) Written Down Method;

37) The real profits of a business depends ona) 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 Octobera) TRUE b) FALSE

39. In case of a public holiday the due date of the bill falls on the preceding working daya) TRUE b) FALSE

40. The due date of a bill drawn on 31-01-2000 for 1 month fell ona) 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 Outwardsb) Purchases MINUS Returns Inwards MINUS Closing Stockc) Purchases PLUS Returns Inwards MINUS Closing Stockd) 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) Rs280000 b) Rs660000 c) Rs3000000 d)Rs580000

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-8-46. When a cheque received is endorsed it shall be entered ona) 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 passinga) rectification entries on the date of the bank reconciliation statementb) Journal entries are passed only for some causes after the BRS is preparedc) 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; b) Stock in Trade; c) Investment in unapproved companies; d) 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 by 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 drawera) TRUE b) FALSE

54. Wages and Salaries are debited toa) Trading Account; b) Profit and Loss Account; c) Balance Sheet; d) The personal account of the wage and salary earner

55. Customs duty paid on the import of a new machinery is aa) Revenue Expenditure; b) Customary Expenditure;c) Capital Expenditure; d) None of the above

56. Interest on capital isa) a personal expenditure of the owner; b) a non-business expenditurec) 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 asa) 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 overstating liabilities and expenses, is known as:a) conservatism b) materiality; c) industry practice; d) consistency;

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-9-GENERAL 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 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 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 shareholders. Hence shareholders funds are part of the total……………..of the company. (liabilities)

18.Excepting shareholders’ funds, other liabilities are described as …….. ……….These consists of Current Liabilities (outside liabilities; fixed liabilities).

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-10-19.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 are usually met from …….. assets (short term or 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 its…. ………(outside liabilities; outside liabilities)

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-11-CHAPTER 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). PLEASE note that opening stock and 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 accounts are closed and the totals for the entire accounting period are taken into account as the total expenses or total income under respective heads.

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-12-A model Manufacturing Account is shown below:

Dr Manufacturing Account of….. for the period ending on………….. CrParticulars Amt Particulars AmtTo Opening Work in ProgressTo Raw Materials Consumed: Op Stock 75000 Add Purchases 35000 Add Cartage Inward 3000 Add Freight Inward 2000 Less Return Outward 2500 Less Closing Stock 65000To WagesTo Salary of Works ManagerTo Power, Electricity & WaterTo FuelTo Postage & TelephoneTo Depreciation Plant and Machinery 6000 Factory L & B 3000To Repairs to Plant and Machinery 11000 Factory L & B 4500To Insurance Plant and Machinery 3500 Factory L & B 2000To Rent and TaxesTo General ExpensesTo Royalty based on production

5000

47500 21000 9000 5000 6000 3500 9000

15500

5500

12000 3000 25000

By Sale of ScrapBy Closing Work in ProgressBy Trading Account (Cost of goods produced)

5500 3500

138000

Total 147000 Total 147000

2.1.2. Trading 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.

Trading account is prepared for manufacturing concerns and also for traders. In 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.

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The 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………….. CrParticulars Amt Particulars AmtTo Opening Stock To Purchases 165000 Less Returns 2500 To Direct Expenses To Freight Inward To Carriage Inward To Cartage Inward To Wages & Salaries To Gross Profit transferred to P & L Account

125000

162500 3000 2500 1500 2000 8000

119000

By Sales 375000 Less returns 3500By Closing StockBy Abnormal Loss of stockBy Gross Loss transferred to P & L Account (if any)

371500 50000 2000

Total 423500 Total 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 comprehensive account showing all expenses of whatever nature incurred in running 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.

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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-14-A model of Profit and Loss Account is shown belowDr Profit and Loss Account of….. for the period ending on……….. CrParticulars Amt Particulars AmtTo Gross Loss b/d (if any)To Salaries and WagesTo Rent, Rates and TaxesTo Fire Insurance premiumTo Repairs and MaintenanceTo DepreciationTo Audit feesTo Bank ChargesTo Legal ChargesTo Miscellaneous ExpensesTo Discount allowedTo Carriage OutwardTo Freight OutwardTo Commission to SalesmenTo Travelling ExpensesTo Entertainment ExpensesTo Business dev ExpensesTo Sales Promotion ExpensesTo Advertising and PublicityTo Bad DebtsTo Packing ExpensesTo Interest on LoansTo Loss by TheftTo Loss by FireTo Loss by EmbezzlementTo Net Profit transferred to Capital Account

NIL11000 1500 600 1200 9000 600 250 550 350 NIL 1200 NIL NIL 1350 550 12000 14000 22000 3000 5500 3500 1250 NIL NIL

98600

By Gross Profit b/dBy Interest earnedBy Commission earnedBy Rent EarnedBy Profit on sale of fixed assetsBy Income from investmentsBy Sale of scrapBy Miscellaneous IncomesBy Net Loss transferred to Capital Account

119000 11000 12000 33000 2000 7000 1000 2000

Total 187000 Total 187000

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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-15-2.1. 5. Income and Expenditure Account of Non-Trading Organisations.

Non-trading concerns render social services-promotion of art, culture, literature, sports entertainment, education, science, charity, religion etc. They include institutions, which provide these services. Hence, we do not call the account as Profit & Loss 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 capital fund; The office bearers work out the methods of raising or utilizing the resources 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 transactions even if the item relates to previous year or future years. It is helpful 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 account1.Day to day receipts and payments 1. Abstract / summary of cash transactions.2. Written every day 2. Prepared at the end of year3. An individual item is written many times as and when transaction takes place.

3. The sum total of an individual is written at the end of year.

4. Prepared from vouchers and receipts 4. Prepared from cash book5. Trading and non trading concerns prepares cash books

5. Only non trading concerns

6. Prepared In columnar form. 6. Not in columnar form.7. Part of books of accounts 7. Part of final accounts8. Part of double entry system 8. Does not part of double entry9. Records all receipts and payments and indicates the opening and closing balances of cash on any day

9. To facilitate the preparation of income and expenditure account

INCOME AND 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 is prepared from the receipts and payments account and recognising all prepaid and outstanding income and expenditure.

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-16-Differences between Income and Expenditure account and Profit and Loss accountIncome and Expenditure account Profit and Loss account1. Revenue account of a non trading concern 1. Revenue account of trading concern2. It is prepared to find out surplus or deficit 2. To find out profit or loss3. It does not start with any balance 3. It starts with a balance of gross profits/loss4. Closing balance is called excess of income over expenditure or excess of expenditure over income

4. The closing balance is net profit or loss

5. Surplus is not distributed among members 5. The net profit is distributed among the owners

The differences between Receipts and Payments account and Income and Expenditure account is tabulated.Receipts and payment account Income and expenditure account1. Real account 1. Nominal account2. Similar to cash book 2. Similar to profit and loss account3. Summary of actual cash receipts and payments

3. Summary of income and expenses relating to an accounting period

4. Cash system of accounting 4. Accrual system of accounting5. Includes both capital and revenue items 5. It includes only revenue accounts6. Entries may relate to items of previous year or next year.

6. Entries relates only to current year

7. It does not include outstanding accounts 7. It includes outstanding items8. Non cash items are not included 8. Non cash items like bad debts, depreciation

are included.9. Receipts on the debit side and payments on the credit side are shown

9. Income is shown on credit side and 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 bank balances

11. Closing balance represents surplus or deficit

12. Closing balance is generally a debit balance(exceptions being overdrafts)

12. Closing balance may be a credit balance or a debit balance.

13. Closing balance is brought down for the next accounting period

13. A closing balance is not brought down but transferred to capital fund

14. Does not form a part of double entry 14. It forms a part of double entry15. Does not accompany a balance sheet 15. Always accompanied by a balance sheet.

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-17-2.1.6. 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 Partnership Deed is a written agreement among the partners providing for rules 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”. It is documented to prevent possible disputes & disagreements 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 commencement; Duration/Period; The amount of capital to be brought in by each 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 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 partnership 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.

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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 paid 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 asset but not a fictitious one.

The accumulated profits and General Reserves till the date of admission of a partner 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 of the current year; b) Payment of dividends to shareholders; c) Transfer to General Reserves; d) Transfer to Sinking Funds; e) Transfer to Dividend 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 accounts) in some types of organizations. Insurance companies, Banks, Railways, Electricity Companies. Hire Purchase and Leasing Companies, Transportation companies, Government departments and companies having international (global presence) are all good examples. Bankers who go through the final accounts of these types of organizations would do well to understand the rules and regulations before using them for purposes of analysis and taking financial decisions.

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CHAPTER III: PRESENTATION OF FINAL ACCOUNTS (horizontal 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 of 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, which will incorporate all the information. The schedules form an 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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-20-3.3.2. Vertical Form of Profit and Loss Account: Particulars Rs Rs RsA. Net Sales: Sales (Gross) Less Returns

B. Cost of Goods Sold Opening Stock: Add: Purchases Less: Returns Add: Direct Expenses: 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 Result a) Interest earned Commission earned Discount earned Miscellaneous Incomes b) Non-Operating Expenses and Losses Interest allowed Loss on sale of a fixed AssetG. Net Profit

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-21-3.3.3. Vertical Form of Balance Sheet Particulars Rs Rs RsA. 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 FundsParticulars Rs RsA. Capital in the beginningB. 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 periodD. Capital at the end of the year (A-B-C)

Note: Vertical form of presentation of final accounts of joint stock 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 parties 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 transactionsb) Compliance with legal and taxation matters.c) Decision making, ascertaining the financial position,d) Facilitates comparative studies and serves as a management information systeme) Helps in raising resources and proper deployment of resources

4.1.3.Limitations of Accounting:

a) Does not recognize qualitative informationb) Even accountants are biased towards following a certain policyc) Every business is accounted as an ongoing concern basis and hence may not reveal the real picture as it would have been if the business 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 Accountingc) Social Responsibility Accountingd) Fund Based Accounting

4.1.5.GAAP: GAAP refers to Generally Accepted Accounting Principles are those rules of action or conduct, which are derived from experience and practice. These when proved 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 business unit.

b) Money Measurement Concept: Accounting refers to recording only those transactions, which are capable of expression in money terms. Hence, qualitative items like the 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) is continuing operations for a 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 over.

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 Depletionb) Treatment of expenditure during construction of building and other infrastructurec) Conversion of Foreign Currencyd) Inventory Valuatione) Treatment of Goodwillf) Valuation of Investmentg) Treatment of retirement benefitsh) Recognition of long-term contractsi) Valuation of Permanent Assetsj) Contingent 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 money or money’s worth. The basic principle of recording is that every debit has 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.

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2. PERSONAL 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 accountThe 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 serving specific purposes. Besides, there may be a separate cash book for petty 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 Subsidiary Books are Cash Book, Purchases Book, Sales Book, Purchases 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 skills—eg. Cash book is written by an expert in cash transactions; 4. It saves time and energy in journalizing and ledger posting of innumerable entries; 5. The figures of Sales, Purchases, Returns, Cash Balance, Bank balance can be easily obtained by looking to the subsidiary books; 6. They serve as documents evidencing transactions and even when necessary by competent authorities (courts, tax authorities can scrutinise the respective subsidiary book)

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-25-4.2.4. 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 correct.

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 may not disclose the following errors: a) Error of Principle; b) Compensating 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 tally1. 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 amounts 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 whether the cash and bank balances have been correctly ascertained. Whether 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. Sometimes two wrong entries may compensate. In such cases, a thorough scrutiny 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.

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-26-4.3. 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 omissionError 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 AND MANAGEMENT ACCOUNTING FUNDAMENTALS

11.1. Intro: Cost Accounting aims at ascertainment of costs and at analysis of savings. It is the application of accounting, costing techniques, methods, and principles. It concerns with the comparison of costs with previous figures or with standards. It helps in interpretation 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 service sector organizations as well. Cost Accounting can be for specific product, 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 of the profitability of individual products, service, departments can be possible and steps can be taken for improvementb) Analysis of the cost behaviour which may point out to the corrections of some items of expenditurec) 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 profitse) 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 establishedg) Cost records serve as the base for the management information systemh) It helps interdepartmental, with adequate comparisoni) It helps in setting up standards in tune with the general industry performance.

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-27-11.3. Comparison between Cost Accounting and Financial Accounting

Cost Accounting Financial Accounting1. An internal reporting system for the management decision making

1. An external reporting system whereby all those interested in the system comes to know about the organisation

2. Emphasises on functions, activities, product, process, planning and control

2. Aims at presenting “true and fair” view of the overall results

3. Concerned with Short term planning and its reporting period is shorter

3. Financial period is generally longer and follows established concepts, principles, accounting standards and legal requirements

4. Not only deals with historical data but also futuristic in approach.

4. Historical in nature and reporting is wide

5. Cost Accounting system cannot 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 CostNon-Financial Costs

Element-wiseDirect Costs and Indirect Costs

Functional CostsProduction Cost, Administration Costs, Selling & Distribution Cost and R & D Costs

Behavioural Costs: Fixed Cost, Variable Cost, Semi-variable Cost.

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-28-11.6. 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) Policy formulation; b) Planning and Control functions of management; c) decision making/taking –deciding on alternate courses of action; d) disclosure to internal and external stake holders; e) safeguarding the assets; In short, the management accounting 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 Accounting and extends itself to a system of cost and financial management. Besides conventional financial accounts, it establishes better methods of internal control.

The scope of management, therefore, lies in the following activitiesa) Establishing and strengthening the systems relating to cost accounting, tax accounting and management informationb) Compilation and preservation of data required for management planningc) Ensuring proper means of communication to the various levels of the enterprise including feedbackd) Assess and analyse the deviations from the expected planse) Analysis and interpretation of accounting information to make it understandable to the management.f) Providing alternative proposals on the profits and position of the enterpriseg) 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 Reportsb) 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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-29-11.9. Comparison between Management Accounting and Financial Accounting

Management Accounting Financial AccountingStudies various divisions and sub-divisions of an enterprise

Studies the enterprise as a whole

Reports to the management on details of operational costs, inventories, products, processes and jobs.

Reports results to all those other than the management. Hence, there is a possibility of window dressing

Analyses business events as and when they take place i.e, Running

Mainly Historical

The historical data of financial data provides inputs giving rapidity to the management accounting practices.

Reflects the possible future based on the past information. At best it could be an estimate

Periodicity is shorter—weekly, fortnightly etc The periodicity is wider--quarterly, half yearly or yearly

Based on independent judgement of management accountants

Based on Generally Accepted Principles

Management Accounting provides both Monetary and non-monetary informations

Consists of Monetary information only

11.10. Comparison between Management Accounting and Cost Accounting

Management Accounting Cost AccountingImpact of Costs Ascertainment of CostsDerived from cost and financial accounting Serves as a base for tools and techniques of

management Wider perspective as cost data are used for decision making and problem solving

Confined to analysis of costs

Management Accounting is placed at a higher level of management

Cost Accounting is placed in a lower level of management

Management accounting uses cost data along with economic and statistical data

Cost accounting is narrower

Management Accounting in addition to using cost accounting techniques, uses funds flow, cash flow and ratio analysis

Cost accounting uses techniques like marginal costing, break even analysis, budgetary control, standard costing etc

Management Accounting includes Cost Accounting and Financial Accounting

Cost Accounting has nothing to do with financial accounting

Management Accounting in addition to assisting management provides for evaluation and performance of management

Cost Accounting assists the management but does not evaluate management

Management Accounting is futuristic Cost Accounting is historicalManagement Accounting cannot be installed without cost accounting

Cost Accounting can be installed independently

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-30-CHAPTER VI: TERMINOLOGIES USED IN ACCOUNTANCY and ACCOUNTING CONCEPTS

Every subject of study involves certain words phrases, which are used in a special sense. So is the case with accountancy. We have given the terminologies used in accountancy 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

Classification: Accounts are classified into PERSONAL and IMPERSONAL. IMPERSONAL ACCOUNTS are again classified into Real and Nominal Accounts.

Personal Accounts: Accounts relating to natural persons, artificial persons and representative 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 information: Proprietor, Partner, Shareholders, Directors, 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 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.

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-31-Drawings: 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 progress or work in process) and finished goods. The quantity and/or value is 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 other 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 needs. 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 to Manufacturing/Trading Account. The transportation 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: The charges for transportation of goods through transporters is called 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.

Apprentice Premium received. If the company / business receives the premium 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 business. Whatever be the cause of depreciation, an amount is 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: Just because the word Trade is there, it should not be debited to Trading Account. Trade expenses are debited to P & L Account.

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-32-Bad 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 be recovered is called BAD 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.

Embezzlement: When the employee misuses, misappropriates or commits fraud, it is called embezzlement of funds. This is a loss caused on account of honesty/integrity 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 expenses till the last date of the accounting period whether paid or not. The outstanding 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.

Abnormal loss of stock: (flood, fire or any reason). It is shown as a credit in 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, then besides showing a credit in the Manufacturing/Trading 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.

Capital expenditure is that expenditure which is incurred for permanent investment 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 business or for earning capacity of the business. This includes Office and Administration expenses, Selling and distribution Expenses, and Non-operating Expenses and 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.

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Capital 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 during a particular period.

ACID TEST: A measure of a firm’s liquidity using the formula—Realisable Current 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: 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 RESERVES: Reserves, which are not available for distribution as dividends as they have not arisen out of trading operations. Eg. Surplus on account of revaluation of assets.

CURRENT ASSETS: Resources that are readily convertible to cash within a year.

CURRENT LIABILITIES: Debts that are expected to be paid within a year.

CURRENT RATIO: Measure of Liquidity—CA/CL

GOODWILL: The premium recorded on the books of the company as an intangible 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: Total share holder’s equity.(Total equity minus intangible assets).

RETAINED EARNINGS: That portion of annual income after tax less dividend that is held cumulatively and is part of common stock holder’s equity.

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.

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-34-SOURCES OF FUNDS: Decrease in Assets, Increase in Liability and equity.

WORKING CAPITAL: Current Assets minus current Liabilities.

AMORTISATION: Making provision for periodic retirement of long term debts.

Accounting Concepts:

Business Entity Concept Money Measurement Concept:Accounting Period concept Accrual Concept Realisation Concept Gong Concern Historical Cost Matching ConceptConservatism (Prudential norms)

Accounting Policies:Depreciation, Depletion and Amortisation; Treatment of preliminary expenditureConversions of foreign currency items; Valuation of InventoryTreatment of goodwill; Valuation of InvestmentTreatment of retirement benefits; Recognition of profits on ongoing projectsValuation of fixed assets Treatment and provision for contingent liabilitiesCapital Adequacy on an on going basis keeping in mind the business risks

ACCOUNTING EQUATIONS:Resources = Sources of financeAssets = Capital + LiabilitiesCapital =Assets - External Liabilities

Sources of Funds:

Capital -- Own capital and borrowed capitalReserves and Surplus--Retained profits of a businessBorrowed Capital: Short term or Long term Loans from family/friends, loans from 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, GoodwillCurrent Assets: Cash and Bank balances, Stock in Trade, Bills Receivable, Sundry DebtorsInvestments--in government and non-government securitiesMiscellaneous Assets--Prepaid Expenses, Income due but not receivedIntangible Assets--Goodwill, Patents, Trade Marks, Copyrights, Intellectual Property rights, Carried forward losses