Financial Accounting - All Four Parts Sent by Paul -Precourse
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Transcript of Financial Accounting - All Four Parts Sent by Paul -Precourse
7/23/2019 Financial Accounting - All Four Parts Sent by Paul -Precourse
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FFINANCIALINANCIAL AACCOUNTINGCCOUNTING
ObjectivesObjectivesIn this lesson, you will be able to:
Appreciate the need to maintain account books Describe the double entry method of book-keeping and use it to record
transactions Create a trial balance, profit and loss account and balance sheet
Describe the method of providing depreciation Appreciate the importance of accounting standards
Financial Accounting 4.1
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4.2 Financial Accounting
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Financial accounting involves recording, classifying, and summarising financial transactionsof an organisation business entity!, and interpreting their results" #ecording involveswriting the financial transactions soon after they occur, in an orderly manner" Classifying the
data relating to transactions involves a systematic analysis of the recorded data so thatsimilar items are classified under appropriate heads such as all cash transactions being
recorded in Cash Account" $ummarising consists of presenting the classified data in amanner, which is useful to the internal and e%ternal end-users of accounting statementssuch as the &rofit and 'oss Account, which shows the profit earned or loss incurred by thebusiness in a year"
(herefore, accounting involves:
)nderstanding the standard accounting principles
Applying the accounting principles while recording all transactions
Classifying the recorded data under appropriate heads or accounts
$ummarising accounts into various accounting statements which help the owners,
managers and e%ternal users such as investors, stock e%changes, governmentauthorities such as income ta% officials to understand the financial performance andposition of the organisation" At any point of time, a properly kept record of
transactions enables the owners or management of the business to understand thefinancial state of affairs of the organisation" (his record in turn assists the owners ormanagement in steering the course of the organisation so that it is in tune with theob*ectives of the organisation and the laws governing the organisation"
Financial accounting information helps you to understand the following aspects of an entity:
+hether the entity has made a profit or incurred a loss during the accounting period
+hether the profitability of the entity is adeuate in terms of return on capital or
profit on sales
(he values of an entitys assets, which are what it owns and what is owed to it and
the entitys liabilities, which are what is owed to others
+hether the financial condition of the entity is sound in terms of the composition of
its assets and liabilities
+hether the growth of the business is reasonable or below e%pectations or targets
Concepts of Accounting
Financial Accounting is based on certain concepts of accounting" (he most important andfreuently used concepts of accounting are:
Cash basis of accounting
Accrual basis of accounting
Financial Accounting 4.3
Introducing Financial Accounting Concepts
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Cash Basis of Accounting
)nder the cash basis of accounting, the entity records a transaction of income when realisedor an e%pense when it is incurred" For e%ample, if the entity has to pay rent every monththat is payable on the last day of each month, the transaction is recorded in the books of
the entity only when rent is actually paid"
If the rent for the month of .arch is paid on April /0, 1002, then the transaction is recordedin the books only on April /0 that is, on the date of payment, and not earlier" If the financialstatements of the entity are prepared on .arch 3/, then the rent for the month of .archwill not be reflected in the financial statements for the year ended .arch 3/, 1002 becausethe rent is paid after that date"
$imilarly, only those incomes that have been actually received are recorded in the booksand reflected in the financial statements" (he books do not reflect the incomes that are yetto be received, although they might be due or might relate to the accounting period"
An income or e%pense pertaining to the period prior to or subseuent to the accounting
period will get reflected in the financial statement of the period if it has been actuallyreceived or paid, respectively"
Accrual Basis of Accounting
)nder the accrual basis of accounting, all the income and e%penditure that has become dueand is receivable or payable is recorded in the books of accounts" It is not necessarywhether the income has been received or the e%penditure has been incurred for the
transaction to be recorded in the books of account" It is enough if it is due or in other wordsaccrued" Accrual based accounting is also known as mercantile system"
For e%ample, the rent for the month of .arch, although paid in April, will be recorded in thebooks of the entity on .arch 3/, 1002, that is, the day on which it became due andpayable" (his will accordingly be reflected in the financial statements of .arch 3/"
$imilarly, all the incomes that have become due and receivable, even if not received, will berecorded in the books of account on the date they became due and receivable" (herefore,the entire income and e%penditure pertaining to a particular period will be reflected in thefinancial statements of that period irrespective of their actual receipt4payment"
$imilarly, any income received in advance or any payment made in advance that pertains tothe subseuent period will be removed from the financial statements of the period for whichthe statements are made"
#ecording of prepaid or outstanding income and e%penses are made by making provisionsfor them in the books of the entity"
Accounting Conventions
(here are certain internationally accepted conventions and principles that are strictlyfollowed while recording transactions in the books of accounts and in preparing financialstatements" (he most important accounting conventions are:
Consistency
4.4 Financial Accounting
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Conservatism
Disclosure
Consistency
5rganisations must follow consistent accounting practices and policies over variousaccounting periods" Consistency is essential to enable any financial analyst to analyse thestatements to make a meaningful comparison of the various parameters, over a series ofaccounting periods" (here are various parameters such as the profitability, growth, andfinancial position of organisations"
Freuent changes in accounting policies tend to pro*ect a distorted image of the financialposition of the concern and make historical comparisons impossible" (herefore, such ad-hoc
changes in accounting policies are not desirable"
Conservatism
It is essential that the valuation of the financial transactions as reflected in the financialstatements is done conservatively" (his ensures that the income and e%penditure as well asthe value of the assets and liabilities are neither overstated nor understated" (his alsoenvisages that all the anticipated and probable losses are provided for" A conservativevaluation, therefore presents a reasonable and fair picture of the profit or loss of thebusiness entity"
Disclosure
In the book, Financial Accounting: Concepts and Uses, $chattke and 6ensen state, 7Fulldisclosure has been long considered a vital aspect of reporting financial accountinginformation" Full disclosure means disclosure of all the important facts that is all the factsthat might affect the decisions of an informed user of the statements" Full disclosure isrelated to, and derived from a number of other ob*ectives of financial accounting,
particularly relevance, neutrality, completeness and understandability" (he reuirement offull disclosure in financial statements is influenced by many factors" .any leaders inbusiness enterprises have a highly developed sense of social responsibility" (hey feelresponsible to users of their financial statements and therefore take the initiative in fullydisclosing all facts8"
In addition to the preceding conventions, financial statements must be free from sub*ective
bias and they should be made available early enough to enable users to take timelydecisions"
Financial Accounting 4.5
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Financial transactions are recorded as they occur" (hen, they are classified in groups basedon their similarity" #ecords of transactions of similar nature are called accounts A4c!" Fore%ample all cash transactions, such as receipts and payments are recorded in the Cash A4c"
$imilarly, all transactions relating to purchase of stationery will be recorded in the$tationery A4C" (he following table shows the format of a cash account"
Format of a Cash Account
(he account of any transaction is entered in two parts as follows:
(he left side of the account is the Debit side and the right side is the Credit side" Debit andCredit are written in short as Dr" and Cr" respectively"
Double Entry Book-Keeping
(he system of double entry book-keeping is based on the fundamental principle that everytransaction involving money or moneys worth has a two-fold effect" +hile one entityreceives an amount of money, the other entity parts with an identical amount" (herecording of the two-fold effect of a transaction in the books of account is called doubleentry book-keeping"
(o understand this system, consider the following e%ample:
A bank purchases a computer from I9. for #s" /0000 on / 6une, 1002" (o record this
transaction, the bank needs to identify its two-fold effect" (he effects are:
(he bank receives a computer worth #s" /0000"
(he bank needs to pay #s" /0000 to I9., which is the supplier of the computer"
(he transaction is recorded in the Computer A4c and Cash A4c, respectively" (he entries aremade in an account on the debit side and in another account on the credit side" (heComputer A4c will be debited and Cash A4c will be credited"
$imilarly, if the bank gives a loan of #s" 0000 to $an*ay, the bank needs to record thefollowing parts of the transaction:
$an*ay gets a loan
(he bank pays cash
4.6 Financial Accounting
Dr. Cas Account Cr.
Date !articulars LedgerFolio
A"ount#$s.%
Date !articulars LedgerFolio
A"ount#$s.%
Double Entry Book – Keeping Syste
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(he transaction will be recorded in $an*ays A4c and Cash A4c as follows:
Dr. &anja'(s A)c $s. *++++ #i.e. Debit &anja'(s Account%
Cr. Cas A)c $s. *++++ #i.e. Credit Cas Account%
(herefore, every transaction results in a debit entry in an account and a corresponding
credit entry in another account" ;very debit entry has a corresponding credit entry andevery credit entry has a corresponding debit entry" An account is to be debited and creditedby applying the principles of double entry book-keeping to the transaction"
!ypes of Accounts
)nder the double entry book-keeping system, accounts are classified into two types" (hefollowing figure shows the types of accounts"
Types of Accounts
!ersonal Accounts: All accounts that e%ist in the name of a person, a firm or acompany or corporate or any other organisation such as clubs, associations,
government departments etc fall under this type" ;very entity, for e%ample, a smallfirm or a large organisation, a government department or a private club or associationis treated as a person" A human being is a <natural person and the other entities arelegal persons" =owever, they are both considered persons because they can ownproperties or a business, lend money or borrow money"
Financial Accounting 4.7
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$eal Accounts: As the name itself suggests, these are tangible or real in nature and
include assets, such as land, building, plant and machinery, fi%tures, fittings,furniture, and vehicles of an entity"
No"inal Accounts: (hese are accounts in which all the incomes and e%penses such
as interest earned, commission received, rent, wages, salaries, ta%es, travelling
e%penses, depreciation, postages, and telegrams of an entity are recorded"
"olden #ules
(he type of account that has to be debited or credited for recording an entry depends onthe nature of accounts involved and the applicable rules" (hese rules are called the >olden
#ules" (he nature of accounts and their rules are:
!ersonal Accounts: Debit the receiver and credit the giver"
$eal Accounts: Debit what comes in and credit what goes out"
No"inal Accounts: Debit all e%penses and losses and credit all incomes and gains"
Accounting $rocess
As stated in the definition of accounting, the process of accounting involves:
#ecording a transaction as and when it occurs
Classifying the transaction so that a similar transaction is recorded
$ummarising or preparation of an accounting statement
As and when transactions occur, they are recorded in a book called *ournal" (hereafter, thetransactions are classified and recorded in Accounts" (he process of recording the
transactions in accounts is called posting in accounts"
%ournal
(he *ournal constitutes the basic record in which a transaction is recorded" (he process ofrecording the transactions in the *ournal is called journalising"
For e%ample, on /-2-1002 an organisation purchased a computer worth #s" /0000 from
I9."
A *ournal entry is recorded as follows"
Date !articulars LedgerFolio
Debit#$s.%
Credit#$s.%
1002
6une / Computer A4c Dr"
(o I9. A4c
/
?
/0000
/0000
4.8 Financial Accounting
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Date !articulars LedgerFolio
Debit#$s.%
Credit#$s.%
9eing the cost ofcomputer purchasedvide invoice number@!
Consider the following e%ample:
/" $even persons, A, 9, C, D, ;, F and > started a bank by bringing in capital of #s" /lakh each" (he total capital is #s" lakhs"
(he accounts involved are:
Cash account, which is a real account
Accounts of A to >, all of which are personal accounts as they are persons
$ince cash comes in, the cash account has to be debited"
$ince A to > are the givers of the amount, their account should be credited"
$ince A to > are the owners of the bank, to distinguish their account from theaccounts of other persons, their accounts will be prefi%ed with Capital"
(he *ournal entry will be as follows:
Dr. Cas A)c $s. ,+++++
To Capital A)c #A to G% $s. ,+++++
9eing capital of #s" / lakh each brought in by A to >!
Financial Accounting 4.9
While recording a transaction in a journal, the golden rules for
debit and credit should be followed.
Begin writing the debit entry in a transaction close to the margin
under the particulars column and end it with an abbreviation
represented by !r".
#nter the amount of the transaction under the debit column.
The ne$t entry %credit entry& begins indented towards the rightfrom the margin and begins with To" followed by the account towhich it is to be credited.
#nter the amount under the credit column.
'ive brief details about the nature of the transaction. This is
called (arration. #very journal entry should have a narration toma)e it comprehensible to a person loo)ing at the entry.
All journal entries are made in a chronological order of as it
ta)es place.
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1" (he bank purchased an office building for #s" 1 lakhs from .r" =immatlal"
(he accounts involved are:
9uilding A4c, which is a real account
Cash A4c, which also is a real account
$ince the bank purchases a building or building comes in and cash goes out, the *ournal entry will be:
Dr. -uilding A)c $s. +++++
To Cas A)c $s. +++++
9eing building purchased for cash from .r" =immatlal for housing the head officeand first branch of the bank"!
Although the amount was paid to .r" =immatlal, his personal account will not bedebited because he has sold the building in return for the cash paid to him" (hepersonal account of the receiver will be debited only when the receiver does not
give any thing in return for the cash paid" In other words, a persons account will bedebited when he becomes indebted to the bank" In short he becomes a debtor"
3" &urchased a computer for #s" 10000 from I9.
(he two accounts involved are:
Computer account, which is a real account
Cash account, which also is a real account
(he personal account of I9. is not involved because the bank has paid cash to I9."
(he *ournal entry will be:
Dr. Co"puter A)c $s. ++++ #Co"puter co"es in%
To Cas A)c $s. ++++ #Cas goes out%
9eing computer purchased for cash from I9.!
?" .r" #am opened a savings account and deposited #s" /0000 in cash"
(he accounts involved are:
Cash account, which is a real account
.r" #ams account, which is a personal account
#ams account is involved because in return for the cash paid by him the bank hasnot given him anything in return" (herefore he has a claim on the bank" (he bankowes him the amount or the bank is his creditor"
(he *ournal entry will be:
Dr. Cas A)c $s. /++++ #Cas co"es in%
To $a"0&avings A)c $s. /+++ #$a" is te giver%
" .r" 'allu opens a fi%ed deposit account and deposits #s" 0000 in cash"
(he accounts involved are:
4.10 Financial Accounting
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Cash account, which is a real account
'allus account, which is a personal account
(he *ournal entry will be:
Dr. Cas A)c $s. *++++ #Cas co"es in%
To Lallu0FD A)c $s. *++++ #Lallu is te giver%
2" 5pened a current account of the bank with the #eserve 9ank of India and deposited#s" 00000"
(he two accounts involved are:
Cash account, which is a real account
#eserve 9ank of Indias account, which is a personal account
(he *ournal entry will be:
Dr. $-I A)c $s. *+++++ #$-I is te receiver o1
cas%
To Cas A)c $s. *+++++ #Cas goes out%
" (he bank borrowed #s" 200000 from Bational =ousing 9ank B=9! and the amountwas credited by B=9 to the banks current account with #9I"
(he two accounts involved are:
B=9s account, which is a personal account
#9Is account, which also is a personal account
(he *ournal entry will be:
Dr. $-I A)c $s. 2+++++ #$-I is te receiver%
To N3- A)c $s. 2+++++ #N3- is te giver%
9oth of them receive or give cash on behalf of the bank" (he bank has a claim on#9I debtor! and owes the amount to B=9 creditor!"
" (he bank gives a =ousing 'oan of #s" ?00000 to #am and credits the amount to his$avings account"
(he two accounts involved are:
#ams =ousing 'oan account, which is a personal account
#ams savings account, which is a personal account
(he *ournal entry will be:
Dr. $a"0Loan A)c $s. 4+++++ #$a" is te receiver o1 te loan%
To $a"0&avings A)c $s. 4+++++ #$a" is te giver o1 te deposit%
=ad the bank disbursed the loan in cash to #am, his loan account would have beendebited and cash account would have been credited" 'ater, had he deposited the
entire amount into his savings account, cash account would have been debited and
Financial Accounting 4.11
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savings account would have been credited" Combining the two entries, the loanaccount has been debited and savings account has been credited"
" (he bank buys invests! >overnment 9onds #s" 00000 from #9I, which takes theamount from the banks current account"
(he two accounts involved are:
Investment A4c, which is a real account
#9Is account, which is a personal account
(he *ournal entry will be:
Dr. Invest"ent A)c $s. ,+++++ #-ond co"es in%
To $-I A)c $s. ,+++++ #$-I is te giver. $-Igave te a"ount on beal1 o1 te ban5%
/0" (he bank receives cash of #s" 0000 from #am #s" /0000 is towards the firstinstalment and #s" ?0000 towards interest"
(he accounts involved are:
Cash account, which is a real account
#ams =ousing 'oan account which is a personal account and
Interest account, which is a nominal account
(he *ournal entry will be:
Dr. Cas A)c $s. *++++ #Cas co"es in%
To $a"0 3ousing Loan A)c $s. /++++ #$a" is te giver%
To Interest Account A)c $s. 4++++ #Inco"e%
(he preceding entry is a combination of two *ournal entries"
Dr" Cash 4 Cr" =ousing 'oan for #s" /0000 and Dr" Cash 4 Cr" Interest for #s" ?0000"Instead of debiting cash twice, consolidated amount is debited"
//" (he bank receives interest of #s" 2000 on the >overnment 9onds" (he amount iscredited by #9I to the banks current account"
(he two accounts involved are:
Interest account, which is a nominal account
#9I <s account, which is a personal account
(he *ournal entry will be:
Dr. $-I A)c $s. *2+++ #$-I is te receiver. $-I as received on beal1 o1
te ban5%
To Interest $s. *2+++ #Inco"e%
/1" (he bank pays #s" 30000 to B=9 towards interest on the loan by issuing a cheueon the banks account with #9I"
4.12 Financial Accounting
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(he accounts involved are:
Interest account, which is a nominal account
#9Is account, which is a personal account
(he *ournal entry will be:
Dr. Interest A)c $s. 6++++ #78penses%
To $-I $s. 6++++ #$-I is te giver. 9en te ceue
is presented b' N3-; $-I <ill pa'on beal1 o1 te ban5%
/3" (he bank pays interest of #s" 3000 on the fi%ed deposit of .r" 'allu, in cash"
(he accounts involved are:
Interest account which is a nominal account
Cash account, which is a real account
(he *ournal entry will be:
Dr. Interest A)c $s. 6+++ #78pense%To Cas $s. 6+++ #Cas goes out%
/?" $alary of #s" /00 is paid to .r" #amlal, the cleaner boy, in cash"
(he two accounts involved are:
$alary account, which is a nominal account
Cash account, which is a real account
(he *ournal entry will be:
Dr. &alar' A)c $s. /*++ #78pense%
To Cas $s. /*++ #Goes out%
#amlals account is not involved because he does not owe the amount to the bank"=e has already given value to the bank by way of service" For the bank it is an
e%pense"
/" $alary of #s" ?000 is paid to .r" Erishnan, the cashier" It is credited to his savingsaccount with the bank"
(he two accounts involved are:
$alary account which is a nominal account and
Erishnans savings account, which is a personal account
(he *ournal entry will be:
Dr. &alar' A)c $s. 4+++ #78pense%
To =risnan0 &avings A)c $s. 4+++ #Giver%
Financial Accounting 4.13
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(his is a combination of two *ournal entries" If salary was paid to Erishnan in cashand he had then deposited it into his savings account, the entries would have beenas follows:
Dr. &alar' #78pense%
To Cas #Goes out%
Dr. Cas #Co"es in%
To =risnan0&avings A)c #Giver%
(he debit and credit entries to Cash account is set off and the remaining two debit
and credit entries are made"
/2" (he bank buys computer paper and other stationery items worth #s" /10 from$upreme $tationery Co" Immediate payment was not made because the bankwanted to verify the uantities of items received"
(he two accounts involved are:
$tationery account which is a nominal account and
$upreme $tationery Cos account, which is a personal account
(he *ournal entry will be:
Dr. &tationer' A)c $s. />+ #78pense%
To &upre"e &tationer' Co $s. />+ #Giver. Te ban5 o<es te" te
a"ount%
+hen writing the preceding *ournal entries, the dates have been omitted for the sake ofconvenience" In *ournal entries, dates and narrations have to be written" Further, the entries
should be in chronological order"
It needs to be reiterated that applying the rules of debit4credit and correctly recording thetransaction as a *ournal entry is the most important step in financial accounting" If the *ournal entry is incorrect, the accounts and ultimately the financial statements will notreflect the correct financial position" (herefore utmost care has to be e%ercised whenrecording transactions as *ournal entries"
In a computerised environment, it is only the *ournal entries that are input in to the system"(he accounts and financial statements will be automatically generated by the system"(hough computerised accounting systems do have validations to ensure that the *ournalentries are correct, the system can help in the case of only routine entries such as cashpayments, cash deposits, and interest payment" For most of the non-routine transactionsand for correction of errors human intervention cannot be avoided"
(herefore, those processing transactions must have a clear understanding of the rules ofdebit and credit and how each entry will impact the accounts" $ince banking is transactionintensive and all that happens in a bank is financial transactions it is imperative that bankemployees are well versed in the golden rules of accounting"
(he *ournal entries summarise the transactions and indicate the accounts affected by thetransactions" (he transactions have to be classified by posting them in to the relevant
accounts"
4.14 Financial Accounting
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$osting Entries in Accounts
&ostings are made by entering the transactions on the debit side left side! or the creditside right side! of the accounts"
After the entries are posted, the balance in the account is arrived at by taking the total ofboth sides and finding out the difference between the totals of the two sides" If the total of
the debit entries are more than that of the credit entries the account is said to have a debitbalance" If the credit side total is more than the debit side total the account is said to have
a credit balance"
Financial Accounting 4.15
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For e%ample, when the preceding *ournal entries are posted, the accounts will appear asfollows"
Dr Cas A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o CapitalA4c
00000 9y 9uilding A4c 100000
(o #am
$avings A4c
/0000 9y Computer
A4c
10000
(o 'allu FDA4c
0000 9y #9I A4c 00000
(o #am'oan A4c
/0000 9y Interest A4cFD 'allu!
3000
(o InterestA4c
?0000 9y #amlal$alary A4c
/00
9y 9alance c4d 00
>/++++ >/++++
Dr Capital A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o 9alance
c4d
00000 9y Cash 00000
,+++++ ,+++++
Dr -uilding A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o Cash A4c 100000 9y 9alance c4d 100000
+++++ +++++
4.16 Financial Accounting
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Dr Co"puter A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o Cash A4c 10000 9y 9alance c4d 10000
++++ ++++
Dr $a"(s &avings A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o 9alance
c4d
?/0000 9y Cash A4c /0000
9y #am 'oan A4c ?00000
4/++++ 4/++++
Dr Lallu(s Fi8ed Deposit A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o 9alancec4d
0000 9y Cash A4c 0000
*++++ *++++
Dr $-I A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o CashA4c
00000 9y InvestmentsA4c
00000
(o B=9A4c
200000 9y Interest A4cB=9!
30000
(o InterestA4c #9IInvestments!
2000 9y 9alance c4d ?12000
//*2+++ //*2+++
Financial Accounting 4.17
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Dr N3- A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o 9alance
c4d
200000 9y #9I A4c 200000
2+++++ 2+++++
Dr $a"(s Loan A)c Cr
Date !articulars A"ount
#$s.%
Date !articulars A"ount
#$s.%
(o #am$avingsA4c
?00000 9y Cash A4cInstallment!
/0000
9y 9alancec4d
30000
4+++++ 4+++++
Dr Invest"ents A)c Cr
Date !articulars A"ount
#$s.%
Date !articulars A"ount
#$s.%
(o #9I A4c 00000 9y 9alance c4d 00000
,+++++ ,+++++
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Dr Interest A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o #9I A4cB=9!
30000 9y Cash A4c ?0000
(o CashA4c FD-'allu!
3000 9y #9I A4cInterest onInvestments!
2000
(o 9alance
c4d
23000
?2+++ ?2+++
Dr &alar' A)c Cr
Date !articular
s
A"ount
#$s.%
Date !articulars A"ount
#$s.%
(o Cash A4c#amlalsalary!
/00 9y 9alancec4d
00
(o Erishnan$avings A4c
?000
**++ **++
Dr =risnan(s &avings A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o 9alance
c4d
?000 9y $alary A4c ?000
4+++ 4+++
Financial Accounting 4.19
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Dr &tationar' A)c Cr
Date !articulars A"ount#$s.%
Date !articulars A"ount#$s.%
(o $upreme$tationary
A4c
/10 9y 9alancec4d
/10
/>+ />+
Dr &upre"e &tationar' A)c Cr
Date !articulars A"ount
#$s.%
Date !articulars A"ount
#$s.%
(o 9alancec4d /10 9y $tationaryA4c /10
/>+ />+
It will be observed that when the postings are over, the accounts are balanced by writingthe difference between the totals of the debit side and credit side on the appropriate side tomake the total of both sides eual" +hen the total of the debit side is more, the account issaid to have a debit balance, which is written on the credit side with narration, -alancec)d" C4D means carried down from one side to the other" $imilarly, if the credit side total ismore, the balance will be carried down from the credit side and written on the debit side tobalance the account"
Ledger
'edgers are books in which the accounts are maintained" (he word 7Folio8 is used to refer tothe page of the ledger in which an account is written" 7'F8 or ledger folio of each of theaccount is indicated in the 6ournal when the transaction is posted into the account" (hisserves as an indication that the transaction has been posted and also makes checking of theposting easy"
In the e%amples above, the ledger folios have been omitted for the sake of convenience"
In a computeriGed environment, 7'F8 has no relevance"
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!ass te journal entries necessar' 1or correcting te 1ollo<ing errors; <icoccurred in a ban5.
/" A cheue for #s" 00 drawn on A4c no" 2 was posted to A4c no" 22"
1" A cash deposit of #s" /000 was posted as #s" /0000 in A4c no" 1?1"
3" ;%cess interest of #s" /00 was debited to loan A4c of #amvilas"
?" A customer deposited cash of #s" 200 in his account but wrote in the payingin slip #s" 2000 only" (he cashier, unfortunately, did not notice this discrepancy andposted #s" 2000 only"
" A cash deposit of #s" /00 in account 33? was posted twice in the account
2" In fi%ed deposit account no" //3?1 interest of #s" 2 was credited at the end ofthe uarter" 'ater the customer took premature payment of the deposit" (hereforean amount of #s" 1?2 had to be recovered from him"
" +hen settling the travel claim of an employee an e%cess payment of #s" /00 wasmade
" A customer reuested that an electronic funds transfer of #s" /000 be made toaccount no" ? with &une branch" 9y mistake the ;F( was effected twice from hisaccount no" 0
" A customer deposited #s" 000 for purchase of mutual funds from &rudential ICICI"
(he amount was erroneously credited to the customers account no" ?/
/0" A cheue for #s" 00 deposited by a customer A4c no" 13! was returned unpaid"It was debited to A4c no" 31"
Financial Accounting 4.21
C&eck 'our (nderstanding
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4.22 Financial Accounting
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!rial Balance
In double entry accounting system, for every transaction, the amount involved is entered onthe debit side of one account and the same amount is entered on the credit side of another
account" ;very debit is matched by an euivalent credit" (herefore, when the debit andcredit balances in various accounts are listed and totaled, the totals will tally"
(rial 9alance is a list of closing balances in all accounts with the debit and credit balanceswritten separately" (he total of the debit balances must tally with the total of the creditbalances" +hen the balances do not tally, it indicates there is some error in posting, incalculating the balances in the account, or in totaling the two sides of the (rial 9alance"
(rial 9alance is a list of the closing balances in all accounts as on a particular date"(herefore, the following table shows the title and entries in a (rial 9alance"
Trial -alance As on #Date% Dr Cr
!articulars A"ount#$s.%
A"ount#$s.%
Cash 00
Capital 00000
9uilding 100000
Computer 10000
#am $avings A4c ?/0000
'allu FD A4c 0000
#9I ?12000
B=9 200000
#am 'oan A4c 30000
Investments 00000
Interest 23000
$alary 00
Erishnan $avings A4c ?000
$tationary /10
Financial Accounting 4.23
Financial Stateents
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Trial -alance As on #Date% Dr Cr
!articulars A"ount
#$s.%
A"ount
#$s.%
$upreme $tationary A4c /10
(otal />>>+ />>>+
5nce the (rial 9alance is balanced the ne%t step is creating financial statements to
ascertain whether the business has made a profit or not after a certain period of operation,which usually is one year" It is customary to ascertain the profit or loss at least uarterly ifnot monthly to help the management of an organisation to monitor the effectiveness oftheir strategies and make mid course corrections"
!rading and $ro)t and *oss Account
All entities prepare a (rading and profit and loss account and the related balance sheetusually once a year or earlier depending upon the accounting practices adopted or tocomply with certain statutory needs" +hatever be the period of their publication, themethod of preparation that is followed is uniform"
A trading account is related to the trading activity that is primarily concerned with thebuying and selling of goods by an entity" (his account is constructed for finding out the
gross profit" (he debit side will consist of the opening stock, the purchases made during theyear, and all direct e%penses related to the (rading activity" (he credit side will have thesales affected during the year and the closing stock"
(he difference between the two sides could result in either gross loss or gross profit that is
carried down to the profit and loss account"
$ro)t and *oss Account
(he profit or loss is ascertained by listing the balances in all the nominal accounts, thee%penses on the debit side and income on the credit side, and finding out the net balance"(he consolidated listing of all nominal accounts is called the &rofit and 'oss Account" $inceprofit earned or loss incurred over a period is ascertained, the title of the & H ' A4c iswritten as follows:
!ro1it and Loss Account 1or te !eriod 7nded 0000#date%00000
If the credit side income! total is more, the business would have made a profit and if thedebit side total is more it will indicate a loss"
$ince the & H ' A4c is an account in its own right, the balances in the nominal accounts aretransferred to the & H ' A4c, which also is a nominal account, by passing the necessary *ournal entries"
In the e%ample worked out earlier there are three nominal accounts, namely, Interest A4c,$alary A4c and $tationery A4c" 5nce the period of operation the financial year! is over, the
balances in the nominal accounts cannot be carried forward to the ne%t year as the incomeand e%penses of a new year have to be recorded afresh" (herefore, the balances in the
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nominal accounts are transferred to the & H ' A4c and the nominal accounts are closed sothat they start with Gero balance in the new year"
(o prepare the & H ' A4c of the bank in the preceding e%ample, the following *ournal entrieswill have to be passed:
Dr. Interest A)c $s. 26+++
To !@L $s. 26+++
Dr. ! @L A)c $s. **++
To &alar' $s. **++
Dr. ! @L A)c $s. />+
To &tationer' $s. />+
(he preceding *ournal entries will close the three nominal accounts and create theconsolidated nominal account, i"e" & H ' A4c which will reflect the profit or loss of the entity"
(he following table shows the & H ' A4c of the bank of the preceding e%ample"
!ro1it and Loss A)c 1or te period ended #Date%
78penses A"ount#$s.%
Inco"e A"ount #$s.%
(o $alary 00 9y Interest 23000
(o $tationary /10
(o &rofit 2110
26+++ 26+++
It will be observed that the bank has made a profit of #s" 2110 during the period ofassessment" (his credit balance in the & H ' A4c will be transferred to the Capital A4c in thecase of proprietorship and partnership entities" In the case of organisations, the balance inthe & H ' A4c may be carried forward as it is or may be transferred to the #eserves A4c"
#eserves is nothing but the accumulated profits of the organisation and it rightfully belongs
to the shareholders or owners" (herefore, the net-worth of an organisation is the total of itscapital and reserves" (echnically, net-worth is the amount the business owes the owners orshare holders" In case the business is wound up, this is the amount the owners should getfrom the business"
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Balance S&eet
+hen the & H ' A4c is prepared, all the nominal accounts would have been closed and onlythe real and personal accounts will be left" 9alances in #eal Accounts represent assets ofthe business such as cash, furniture, computer, and building" 9alances in &ersonal Accountsrepresent amounts owed to the business by debtors assets! and amounts owed by the
business to its creditors #liabilities%"
(herefore, the balances in real and personal accounts represent the assets and liabilities ofthe business" (he debit balances represent the assets and the credit balances the liabilities"(hese balances feature in balance sheet" (he liabilities appear on the left and assets on theright" 5n the other hand, debit balances are listed on the right of the 9alance $heet"
If you list the balances in the real and personal accounts in the preceding e%ample, thefollowing balance sheet will emerge"
-alance &eet As on #Date%
Liabilities A"ount#$s.%
Assets A"ount#$s.%
Capital 00000 Cash 00
&rofit and 'ossA4c
2110 9uilding 100000
$avings A4c
for e"g" #amand Erishnan!
?/?000 Computers 10000
FD A4c 0000 #9I ?12000
B=9 200000 'oan A4cfor e"g"#am!
30000
Creditors A4cfor e"g"$upreme
$tationary!
/10 Investments 00000
/>/*++ />/*++
(here are regulatory reuirements for presentation of 9alance $heets" 9anks have topresent their balance sheets in the format prescribed in the 9anking #egulations Act"5rganisations other than banks have to follow the formats given in the Companies Act"
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(he balance sheet of the bank in the e%ample, if presented in the format specified in the9anking #egulations Act, will appear as shown in the following table"
-alance &eet As on #Date%
Liabilities A"ount
#$s.%
Assets A"ount #$s.%
Capital 00000 Cash and9alancewith#eserve9ank of
India
//00
#eserves and
$urplus
2110 9alance
with other9anks
00000
Deposits ?2?000 .oney atCall
------
9orrowings 200000 Investments 00000
5ther 'iabilities /10 Advances 30000
Fi%ed Assets 110000
5therAssets
0000000
/>/*++ />/*++
Balance *heet
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A. 9rite te journal entries 1or te 1ollo<ing transactions:
/" Burul =assan starts a fresh paneer shop with #s" 000 as capital"
1" =e borrows #s" 1000 from his father-in-law .r" Ahmed"
3" =e opens a current account with &un*ab Bational 9ank &B9! and deposits #s" 000"
?" =e buys a fridge from i*ay $ales Co for #s" //000 with a loan of #s" /0000 fromCiti Financials" For the margin money, he issues a cheue to i*ay $ales Co"
" =e buys furniture for #s" ?000 from a carpenter, #amvilas and pays cash to him"
2" =e buys a weighing machine for #s" 1000 from Eirloskar and issues a cheue for it"
" During the first month, he:
a" &urchases a total of 20 kilos of paneer for #s" 2000"
b" $ells it for #s" 210"
Although purchase and sales happens daily, Burul maintains only one set of entriesfor convenience sake" (here is no closing stock at the end of the first month"
" =e pays cash of #s" 00 for electricity"
" =e pays #s" /00 to incent, a helper as salary in cash
/0" =e deposits #s" /0000 in the bank"
//" =e issues a cheue for #s" 1100 in favour of Citi Financials of which #s" 1000 is
towards instalment and #s" 100 is towards interest"
/1" =e issues a cheue for #s" 1000 to Bagara*an towards rent"
/3" =e gives a loan of #s" /000 to &rabhu, a friend in cash"
/?" =e gives a donation of #s" /00 to $ai 5rphanage in cash"
/" =e pays cash of #s" 1000 to his wife, Boor for household e%penses"
-. -ased on te preceding transactions; open all te accounts; post te" andprepare a Trial -alance.
4.28 Financial Accounting
Activity+ %ournalise and $repare Financial Stateents
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C. !repare te !ro1it and Loss A)c and -alance &eet.
Ad,ustent Entries
5n working out the preceding e%ercise, the 9alance $heet will appear, as shown in thefollowing table"
-alance &eet As on #Date%
Liabilities A"ount#$s.%
Assets A"ount #$s.%
Capital 2000 Cash 0
&rofit and 'oss /120 9ank 00
'oan CityFinancials
000 Fridge //000
Furniture ?000
+eighing.achine
1000
'oan &rabhu /000
22*+ 22*+
Closing &toc5
In the above e%ample it was assumed that all the stocks purchased were sold" At the end of the period for which the profit and loss account was prepared there were no stocks on hand"In a running account this does not happen and invariably there will be some closing stock"
)nless the value of the closing stock is taken in to account, the profit or loss figure arrivedat will not be accurate"
For e%ample, assume that of the 20 kilos of paneer purchased for #s" 2000, i"e" #s" /00per kilo, he sold 220 kilos for #s" 210 and he had in stock 30 kilos worth #s" 3000 at thepurchase price of #s" /00 per kilo" (o arrive at the correct profit, he has to add this #s"3000 to the profit as in addition to the cash inflow of #s" 210, he has 30 kilos of paneerwhich he can sell for at least #s" 3000 if not more" (o bring the #s" 3000 into the profit andloss account, the following entry has to be passed:
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A. Dr. Closing &toc5 $s. 6+++ #Asset%
To !ro1it and Loss Account $s. 6+++ #Notional Inco"e%
+hen this entry is passed, #s" 3000 will be reflected on the credit side of the &rofit and 'ossaccount after 7$ales8 and the gross profit will increase by #s" 3000" Correspondingly the Bet&rofit will also increase by #s" 3000"
(he impact of this in the 9alance $heet will be:
//" 5n the Asset $ide, Closing $tock of #s" 3000 will be added
/1" 5n the 'iability $ide, the &rofit figure will increase by #s" 3000
(herefore, the 9alance $heet will tally but the total will be more by #s" 3000 on both sides"
(he uantity of closing stock is verified and the value calculated manually" (he method ofvaluation of the closing stock can alter the profit and so the financial position of thebusiness" For e%ample, if Burul =assan had chosen to value the closing stock of 30 kilos at#s" /30 saying that he can easily sell it at #s" /30, the profit would have increased by #s"300 instead of #s" 3000 when it was valued at the purchase price" >oing by the principle
of 7Conservatism8, it is customary to value the closing stock at the cost price purchaseprice! or market price possible selling price! <icever is lo<er. If the paneer hadbecome a bit stale and Burul would have had to sell it at a discount and may not have beenable to get more than, say #s" 0 per kilo, the closing stock should have been valued at #s"1/00 and not the cost price of #s" 3000"
etod o1 Baluation o1 Closing &toc5 I"pacts te !ro1it
(he closing stock of one year becomes the opening stock of the ne%t year and has to betaken on the Debit side of the &rofit and 'oss Account before &urchases" (herefore, a typical&rofit and 'oss Account will appear, as shown in the following table"
!ro1it and Loss A)c 1or te ear ended
78penses A"ount#$s.%
Inco"e A"ount #$s.%
5pening $tock -------- $ales --------
&urchases -------- Closing $tock --------
>ross &rofit --------
-------- --------+rofit and oss Account
>enerally, instead of recording 5pening $tock, &urchases and Closing $tock in the &rofit H
'oss Account, the Cost of >oods sold is recorded on the Debit $ide and $ales is recordedon the Credit side" (he Cost of >oods $old is arrived at as followsJ
5pening $tockAdd &urchases'ess Closing $tock
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K Cost of >oods $old"(he effect is the same and the >ross &rofit will be the difference between $ales and theCost of >oods $old"
Outstanding and !repaid 78penses and Inco"es
)nder the commonly accepted 7Accrual .ethod8 of accounting, all incomes and e%pensesrelating to the period, whether paid or not, have to be included in the &rofit and 'ossAccount"
It is very unlikely that all e%penses and incomes relating to the period has been paid orreceived during the period itself"
Assume that Burul =assan had the following outstanding and prepaid e%penses andincomes:
9" Interest of #s" 00 due on the loan taken from .r" Ahmed had not been paid"5utstanding ;%penses!
C" incent was paid by cheue #s" /00 to be ad*usted against salary of ne%t month"&repaid ;%penses!
D" &rabhu had not paid #s" /00 due as interest on the loan given to him" 5utstandingIncome!
;" Issued a cheue for #s" 1000 in favour of Eamal as a loan to him on the last day of thefinancial year" Bew 'oan >iven!
F" Eamal paid #s" ?00 in cash towards interest for two months due after the close of thefinancial year" &repaid Income!
(he *ournal entries for the above transactions will be:
-. Dr. Interest A)c $s. *++ #78pense%
To !rovision 1or 78penses 0 Interest $s. *++ #Liabilit'%
-eing provision "ade 1or outstanding e8penses
C. Dr. !repaid 78penses &alar' $s. /*++ #Asset%
To -an5 $s. /*++
-eing salar' paid in advance
D. Dr. Outstanding Inco"e Interest $s. /++ #Asset% To Interest $s. /++ #Inco"e%
-eing interest due 1ro" !rabu
7. Dr. Loan A)c =a"al $s. +++
To -an5 $s. +++
-eing Loan given to =a"al
F. Dr. Cas $s. 4++
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To !repaid Inco"e 0 Interest $s. 4++ #Liabilit'%
-eing interest paid in advance b' =a"al
!rovision 1or -ad Debts
.ost businesses sell on credit and lose a small portion of it due to default by the debtors" (otake care of such losses businesses set aside a portion of the profit as provision for 9adDebts" (he entries passed for the same are
Dr" &rofit H 'oss a4c
(o &rovision for 9ad Debts"
$uch provision made will reduce the profits and the amount of provision will appear on the'iability side Debit side! of the 9alance $heet"
&rovisions may be made for meeting any anticipated or unanticipated e%penses such asIncome (a% or >ratuity &ayments, &ension &ayments etc that may arise in future" All ofthem will result in a debit to the &rofit H 'oss account and will appear on the Debit side ofthe 9alance $heet"
9riting o11 -ad Debts
+hen a debt becomes irrecoverable and has to be written off, the &rovision for 9ad Debts is
utiliGed for the purpose" (he *ournal entry passed isJ
Dr" &rovision for 9ad Debts
(o Debtors a4c
$imilarly, e%penses for which a &rovision has been made, will be debited to the &rovision
account" If the provision is not adeuate to meet the e%penses only will it be debited to the&rofit H 'oss account" For instance if the 9ad Debts to be written off is #s" 000 and the
&rovision already made is only #s" 000, the balance #s" 3000 will be debited to the &rofit H 'oss account"
Depreciation
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Consider an e%ample where the cost of a new car is #s" lakhs" If the car is sold after twoyears, the car will fetch a lower price of, say, #s" 2 lakhs" As the car becomes older, theprice for which it can be sold will decrease" (here is an inverse relationship between the ageof the car and its value" (his is true of all things e%cept articles of antiue value" (he valueof assets such as vehicles, euipments, and machines depreciate over time" (he faster itwears out, the greater is the depreciation" (he rate of depreciation is dependent on the
useful life of the asset"
For e%ample, if a computer is e%pected to last three years, its value will depreciate by 33Levery year" If it is sold after three years it may fetch a scrap value only" #ate ofdepreciation will depend upon the usage also" A car that is used as a ta%i will depreciatefaster than a self-driven car because the latter would have been used sparingly and will alsobe better maintained"
$ince the value of fi%ed assets depreciates over time, business entities have to provide forthe depreciation in their books" If a car is purchased for #s" lakhs and its useful life isconsidered to be years, its value in the books should be reduced by 10L or #s" /" lakhsevery year" (he amount of depreciation will be shown as an e%pense and will reduce theprofit" At the end of five years, the book value of the car will be Gero, though the car may
continue to e%ist"
&roviding for depreciation of fi%ed assets is necessary as otherwise the assets of thebusiness entity will appear in their books at an inflated value and this will give a wrongimpression about the financial strength of the business entity" Te Co"panies Act andInco"e Ta8 Act prescribe te rates at <ic various t'pes o1 1i8ed assets souldbe depreciated.
In the e%ample, Burul =assan has the following items of fi%ed assets:
Fridge #s" //000
Furniture #s" ?000
+eighing .achine #s" 1000
'et us assume that if the above items are sold at the end of the year they will fetch 10Lless than the cost price" In other words, we assume that the assets have depreciated by10L" (o know the profit of the business correctly, the amount of depreciation has to bereduced from the profit already calculated" In other words, the amount of depreciation hasto be recorded as an e%pense, even though no cash has gone out of the business" (he
amounts of depreciation to be recoded on the Debit side of the &rofit and 'oss account is asfollows:
Fridge #s" //000 Depreciation at 10L #s" 1100
Furniture #s" ?000 Depreciation at /0L #s" ?00
+eighing .achine #s" 1000 Depreciation at 10L #s" ?00
Total $s. 6+++
(o bring this amount into the &rofit and 'oss account, the following *ournal entries have tobe passed:
G. Dr. Depreciation A)c $s. 6+++ #78pense%
To Fridge A)c $s ++
To Furniture A)c $s 4++
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To 9eiging acine A)c $s 4++
-eing depreciation provided on 1i8ed assets.
(he above entry will result in reduction of profit by 3000 and reduction of value of fi%edassets by #s" 3000"
4.34 Financial Accounting
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&ost the ad*ustment *ournal entries A to G on page 4.6 to 4.6* in to the accounts ofBurul =assan, prepared already, and draw up the revised:
/" (rial 9alance
1" &rofit and 'oss Account
3" 9alance $heet
Financial Accounting 4.35
Activity+ $repare Financial Stateents
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(here are two methods of depreciation:
+ritten down value method
Fi%ed instalment method or $traight line method
ritten Do.n /alue 0et&od
Consider an e%ample where an entity had purchased machinery for #s" /000000 on 6anuary/, 1000" (he useful life of the machinery is estimated to be /0 years" It is decided to
provide depreciation at the rate of /0L per annum" In this case, the depreciation accountand the asset account would appear"
(his e%ample shows working for only three years" (he following table shows the *ournalentry to bring the depreciation on record"
Date !articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
/st
year
3/Dec,1000
Depreciation A4c
(o .achinery A4c
9eing the depreciationM /0L on the value ofmachinery written off!
/00000
/00000
/styear
3/Dec,1000
&rofit and 'oss A4c
(o Depreciation
A4c
9eing the transfer ofdepreciation to the&rofit and 'oss
Account!
/00000
/00000
4.36 Financial Accounting
0et&ods of Depreciation
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Date !articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
1ndyear
3/
Dec,100/
Depreciation A4c
(o .achinery A4c
9eing the depreciationM/0L on the value ofmachinery written off!
Bote: - (hedepreciation is worked
out on the book valueof the asset at thebeginning of the secondyear
0000
0000
1nd
year3/Dec,100/
&rofit and 'oss A4c
(o Depreciation A4c
9eing the transfer ofdepreciation to theprofit and loss account!
0000
0000
3rd
year
3/Dec,1001
Depreciation A4c
(o .achinery A4c
9eing the depreciation
M/0L written off!
/000
/000
3rdyear
3/Dec,1001
&rofit and 'oss A4c
(o Depreciation A4c
9eing the transfer ofdepreciation to theprofit and 'ossaccount!
/000
/000
Financial Accounting 4.37
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(herefore, every year, /0L on the reducing balance of the machinery account book value!is written off during the useful life of the asset concerned" Further, the amount written offby way of depreciation will be shown as deduction from the asset concerned in the balancesheet of each year to reflect the true value of the asset, as shown in the following table"
Liabilities A"ount
#$s.%
Assets A"ount
#$s.%
-alance &eet as at 6/ Dece"ber; +++
.achinery A4c /000000
'ess Depreciation
/00000
00000
-alance &eet as at 6/ Dece"ber; ++/
.achinery A4c 00000
'ess Depreciation0000
/0000
-alance &eet as at 6/ Dece"ber; ++
.achinery A4c /0000
'ess Depreciation/000
1000
4.38 Financial Accounting
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(he following table shows table shows the depreciation account"
Date !articulars Dr.A"t.#$s.%
Date !articulars Cr.A"t.#$s.%
1000,
December3/
(o.achineryA4c
/00000 1000,
December3/
9y & H 'A4c
/00000
Total /+++++ Total /+++++
100/,
December
3/
(o.achinery
A4c
0000 100/,
December
3/
9y & H 'A4c
0000
Total ?+++++ Total ?++++
1001,
December
3/
(o.achinery
A4c
/000 1001,
December
3/
9y & H 'A4c
/000
Total >/++++ Total >/+++
Financial Accounting 4.39
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(he following table shows the machinery account"
Date !articulars Dr. A"t.#$s.%
Date !articulars Cr. A"t.#$s.%
1000,
6anuary/
(o 9ank A4c /000000 1000,
December3/
9yDepreciation A4c
9y 9al c4d
/00000
00000
Total /++++++ Total /++++++
100/,
6anuary
/
(o 9al b4f 00000 100/,
December
3/
9yDepreciation A4c
9y 9al c4d
0000
/0000
Total ?+++++ Total ?+++++
1001,
6anuary/
(o 9al b4f /0000 1001,
December3/
9y
Depreciation A4c
9y 9al c4d
/000
1000
Total >/++++ Total >/++++
1003,
6anuary/
(o 9al b4f 1000
Fi1ed Instalent 0et&od
)nder this method, a percentage on the original value of an asset is provided asdepreciation year after year during the life of the asset" (his method is also known as the
straight-line method" Consider the following e%ample" (he original cost of the asset is #s"/000000 and if the entity decides to provide a depreciation of /0L per annum, the
depreciation and the machinery account would appear as follows:
4.40 Financial Accounting
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(his e%ample shows working for only two years" (he following table shows the depreciationaccount"
Date !articulars Dr.A"t.
#$s.%
Date !articulars Cr.A"t.
#$s.%
1000,
December3/
(o.achineryA4c
/00000 1000,
December3/
9y & H ' A4c /00000
Total /+++++ Total /+++++
100/,
December
3/
(o
.achinery
A4c
/00000 100/,
December
3/
9y & H' A4c /00000
Total /+++++ Total /+++++
!epreciation Account
(he following table shows the machinery account"
Date !articulars Dr. A"t.#$s.%
Date !articulars Cr. A"t.#$s.%
1000,
6anuary/
(o 9ank A4c /000000 1000,
December3/
9yDepreciationA4c
9y 9al c4d
/00000
00000
Total /++++++ Total /++++++
100/,
6anuary
/
(o 9al b4f
00000 100/,
December
3/
9yDepreciationA4c
9y 9al c4d
/00000
00000
Total ?+++++ Total ?+++++
1001,
6anuary/
(o 9al b4f 00000
Financial Accounting 4.41
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/" A 'td" had purchased a computer system valued at #s" 00000 on 6anuary /, 100"It is proposed to write off 10L as depreciation on the original cost every year" +ritethe *ournal entries to give effect to the above decision, and show the entries in the
computer account for two years"
1" 9 'td" had purchased some machinery worth #s" /000000 on 6anuary /, 1003" It
was decided to write off /0L as depreciation on the reducing balance method"Further, machinery worth #s" ?00000 was added on 6uly /, 100?" $how the workingof the depreciation account for three years along with the *ournal entries"
4.42 Financial Accounting
C&eck 'our (nderstanding
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If entities were permitted absolute freedom to draw up their books of accounts without anymethods and standards, it will become difficult to compare the results" For e%ample, an
entity may follow the straight-line method for providing /0L as depreciation on the original
cost of the machinery" (he amount written off after three years would amount to 30L ofthe cost of machinery"
=owever, under the reducing balance method, this amount would vary as the depreciation isprovided on the balance amount at the beginning of each year" $imilarly, in valuing stock,different entities may adopt different standards like First in First 5ut, 'ast in First 5ut"
(herefore, there arises a need to adopt certain standard accounting practices, which areuniform and prevent ambiguity in reporting" +ith this end in view, the InternationalAccounting $tandards Committee has evolved certain norms, which are adopted by theInstitute of Chartered Accountants of India ICAI!" #ules that are decided for uniformapplication for reporting transactions in published accounts are made mandatory for allentities"
(he Accounting $tandards 9oard A$9! was formed in / for formulating accountingstandards that are published by the council of ICAI" (he >overnment of India has alsoconstituted a national body called the Bational Advisory Committee on Accounting$tandards in the year 100/" (his committee advises the >overnment about certainstandards that are to be followed by all corporate bodies in India"
At present, there are 1 issues on which accounting standards have been evolved" (heseare mandatory for all organisations, which are listed on the $tock ;%changes $;! in India"Further, these are also applicable for the entities whose annual turnover e%ceeds #s" 0crores" (he emergence of accounting standards provides for uniform disclosure norms" (heauditors of the entities are en*oined to ensure compliance with all reporting reuirements
under these standards and report deviations from the standards laid down" In addition,these also cast an obligation on the 9oard of Directors of the organisation to ensureadherence to these standards"
For a better appreciation of these standards, look at a few of the directives, which are
issued:
Accounting 1or depreciation: (he accounting standard Bo" 2 deals with the
disclosure relating to the depreciation method, total depreciation and the grossamount of depreciation provided" It also mandates that if a particular method ischosen to provide depreciation, it should be followed consistently year after year andwhat needs to be done if the method is changed"
7nterprise and related part': (he reporting reuirement for transactions betweenthe reporting enterprise and related party is covered by accounting standards Bo"/"It applies to all transactions with the related party and calls for disclosure of name ofthe related party, nature of relationship, volume of transactions, and amount of writeoff, if any"
$eporting reuire"ents on econo"ic activit' controlled b' parent bod' and
an outsider group: (his issue is covered by the accounting standards Bo" 1" Itdeals with disclosure of information where an activity is *ointly organised and sub*ectto *oint control in the matter of operations and policy decisions" It provides for
Financial Accounting 4.43
Accounting Standards
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disclosure by way of statement regarding the share of assets, incomes, liabilities, ande%penses" (he disclosure norms stipulated are uite elaborate and cover a widevariety of issues that form the basis of a relationship between the parent organisationand the outside organisation *ointly controlling the activities of a organisation"
(he accounting standards introduce an element of uniformity in reporting on numerousissues so that all parties - regulators, public, investors, and shareholders are served by the
transparency it seeks to achieve"
4.44 Financial Accounting
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Financial Accounting 4.45
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I. Fill in te blan5s:
/3" A (rial 9alance is the summary of both the NNNNNN"
/?" (rial 9alance tells us that the books are NNNNNNNN"
/" Agreement of (rial 9alance is a forerunner for preparation of NNNNNN"
/2" A profit and loss account relates to NNNNNNNN"
/" If e%penses e%ceed income in a &rofit and 'oss account, it is termed as
NNNNNNNNNN"
/" Depreciation should be charged at a percentage such that the asset is NNNNNNNNwithin its useful life"
II. ultiple Coice Euestions:
/" (o debit an account is to post the transaction on the
a" #ight sideb" 9oth the sidesc" 'eft sided" Bone of the above
1" (he double entry book- keeping is represented by which of the followingO
a" #ecord the cash receivedb" #ecord both the debit and credit aspects of the same transaction
c" #ecord receipts and payments at one and the same sided" #ecord only credit entries
3" +hich one of the following is not a personal accountO
a" Depreciationb" (elco 'tdc" Arun H Co"d" .ahnagar >as 'td
?" +hich one of the following is not a nominal accountO
a" (a%esb" Car
c" &ostagesd" (ravelling e%penses
" A (rial 9alance is @
a" A list of balances in the ledger accounts of an entity on any given date
b" An activity undertaken to balance an accountc" A trial activity to mask a mistaked" Bone of the above
2" (he agreement of a (rial 9alance is a conclusive proof of:
a" (he fact that all entries are posted
4.46 Financial Accounting
$ractice 2uestions
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b" (he arithmetic accuracy of the recorded transactionsc" (he intelligence of the book-keeperd" Bone of the above
" A &rofit and 'oss account is a:
a" #evenue account
b" #eal accountc" &ersonal accountd" Fictitious account
" +hich of the following correctly describes the concept accrual basis in preparation of the accountsO
a" (o record cash as and when receivedb" (o record only lossesc" (o record all e%penses and incomes relating to a period irrespective of the dated" (o take stock of stock
Financial Accounting 4.47
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In this lesson, you learned that:
Financial accounting involves recording, classifying, and summarising financial
transactions of an organisation business entity!, and interpreting their results"
#ecording involves writing the financial transactions soon after they occur, in an
orderly manner"
#ecord keeping involves an application of the principles of accountancy at every
stage"
Accounting involves:
• )nderstanding the standard accounting principles"
• Applying the accounting principles while recording all transactions"
•
Classifying the accounts of transactions under appropriate heads of accounts"• $ummarising these transactions into various accounting statements, such as (rial
9alance, &rofit And 'oss Account and the 9alance $heet"
(he most important and freuently used concepts of accounting are:
• Cash basis of accounting
• Accrual basis of accounting
(he most important internationally accepted conventions and principles, which are
strictly followed in the recording of transactions in the books of accounts and inpreparing the financial statements are:
• Consistency
• Conservatism
• Disclosure
(he left side of the account is the Debit side and the right side is the Credit side" Debit
and Credit are written in short as Dr" and Cr" respectively"
(he system of double entry book- keeping which is universally followed! is based on
the fundamental premise that every transaction involving money or moneys worthhas a two-fold effect"
)nder the double entry book-keeping system, accounts are classified into two types:
• &ersonal account
• Impersonal account
(he accounting process involves:
• #ecording a transaction as and when it occurs
• Classifying the transaction so that a similar transaction is recorded
4.48 Financial Accounting
Suary
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• $ummarising or preparation of an accounting statement
(he process of recording the transactions in the *ournal is called *ournalising"
&ostings are made by entering the transactions on the debit side left side! or the
credit side right side! of the accounts"
(rial 9alance is a list of closing balances in all accounts with the debit and credit
balances written separately"
(he consolidated listing of all nominal accounts is called the &rofit and 'oss Account"
A balance sheet is a statement drawn up at the end of each financial period, setting
forth the various assets and liabilities of the concern as on that date"
Depreciation represents the diminution in the value of an asset due to its normal use
by the entity and may become worthless after some time"
(here are two methods of depreciation:
• +ritten down value method
• Fi%ed instalment method or $traight line method
At present, there are 1 issues on which accounting standards have been evolved"
(hese are mandatory for all companies, which are listed on the $tock ;%changes $;!in India"
(he accounting standards introduce an element of uniformity in reporting on
numerous issues so that all parties - regulators, public, investors, and shareholdersare served by the transparency it seeks to achieve"
Financial Accounting 4.49
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/" &repare a (rading and &rofit and 'oss account for the year ended 3/st .arch 1002based on the following"
Trial balance on 6/st arc ++2
!articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
Capital 1?0000
5pening stock as on/"?" 100
10000
$ales 300000
&urchases 110000
$ales returns 000
#ent 2000
$alaries and wages 000
Carriage inward /000
(raveling e%penses onsalesmen
2000
>eneral e%penses /000
Interest recd oninvestment
?000
$undry creditors /000
Insurance /100
'aw charges 00
Discount recd 1000
Discount paid 200
Furniture H fittings 3000
&ostage H (elegrams ?0
Cash in hand 0
Cash at bank 10000
4.50 Financial Accounting
E1ercises
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!articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
&lant H .achinery /0000
.otor car 20000
Total *2/+++ *2/+++
(he following ad*ustments are to be made:
a" (he closing stock is valued at #s" 30000"b" #ent to the e%tent of #s" 00 and $alary and wages to the e%tent of #s"/000
remain to be paid"
c" &repaid insurance amounted to #s" 300"d" Depreciate machinery M/0L, motor car M 10L and furniture M L"
1" (he following is the (rial 9alance of .4$ $ahakar +ire #opes H Co as on the 3/st.arch 1002" Pou are reuired to prepare a (rading and &rofit and loss account for
the year ended 3/st .arch 1002 and a 9alance sheet as on that date after makingnecessary ad*ustments"
!articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
'and and 9uilding 20000
&lant H .achinery ?0000
Carriage inwards ?000
+ages manufacturing! ?0000
$undry creditors 1?000
$ahakars capital /2?000
$alaries 20
9ank interest 300
&urchases 000
&urchase returns /110
9ills receivables 1300
(rade e%penses ?000
$undry debtors 2000
$tock as on /"?"100 0000
Financial Accounting 4.51
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!articulars Dr. A"t. #$s.% Cr. A"t. #$s.%
Insurance /100
$ales 103000
Cash in hand 1/20
Cash at bank /000
Furniture H Fi%tures 2000
&ower and fuel 1000
Total 4+6?+ 4+6?+
Additional in1or"ation:
i" (he value of closing stock as on 3/"3"1002 was #s" 3000"
ii" Depreciation on land H building to be provided M L"
iii" Depreciation on &lant H .achinery and furniture 4 fi%tures M /0L"
iv" $alaries to the e%tent of #s" 1000 was outstanding on date"
v" Insurance to the e%tent of #s" 300 is prepaid"
Create a reserve of 1"L on sundry debtors"
4.52 Financial Accounting
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