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BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)(SET UP BY AN ACT OF PARLIAMENT)
PRINCIPLES AND
PRACTICE OF
ACCOUNTING
MODULE – 1
FOUNDATION COURSE
(Modules 1 to 2)
Paper–1, Module–1
© The Institute of Chartered Accountants of India
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: Board of Studies DepartmentCommittee/
© The Institute of Chartered Accountants of India
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BEFORE WE BEGIN …
SKILL REQUIREMENTS AT FOUNDATION LEVEL
The Board of Studies, ICAI presents the study material for Foundation (Entry Level Exam to the
Chartered Accountancy Course). The contents have been designed and developed with an objective
to synchronize the syllabus with the guidelines prescribed by IAESB (International Accounting
Education Standards Board), IFAC (International Federation of Accountants), to instill and enhance
the necessary pre-requisites for becoming a well-rounded, competent and globally competitive
Accounting Professional.
The level of complexity of the study material is as per standards accorded by IAESB comprising an
ideal mix of subjective and objective examination pattern to ensure discerning students get through
and seek admission to the CA Course.
The paper of 'Principles and Practice of Accounting' at Foundation level concentrates on
conceptual understanding of fundamentals of accounting. The objective of this paper is to develop
an understanding of the basic concepts and principles of Accounting and apply the same in
preparing financial statements of Non-corporate entities, computing accounting ratios and simple
problem solving.
This Study Material endeavouring towards accounting education, is committed to provide a
framework for understanding accounting discipline and describing the fundamental accounting
concepts and conventions of the basic accounting system. An attempt has been made to provide a
solid foundation on which students can successfully build and enhance their studies.
KNOW YOUR SYLLABUS AND STUDY MATERIAL
The Study Material of Principles and Practice of Accounting has been designed having regard to
the needs of home study and distance learning students. The Study Material has been divided into
eleven chapters, each addressing to a special aspect of accounting. Chapters 1 to 5 lay emphasis on
bookkeeping aspect of accounting whereas chapter 7 deals with preparation of financial statements
of sole proprietors. Chapter 6 covers accounting for special transactions like consignment, joint
ventures, bills of exchange, sale of goods on approval basis, royalty accounts and average due date
which are useful for different business entities. Chapter 8 discusses accounting of partnership firms
and chapter 9 deals with financial statements of Not-for-profit organizations. Chapter 10 explains
basic concepts of company accounts and Chapter 11 is on basic accounting ratios which are used
as a tool used in analysing financial statements and performance of a business entity.
The study material has been bifurcated into two modules (Module I : chapters 1 to 6 and Module
II: Chapters 7 to 11) for the easy handling and convenience of students. It is important to read the
Study Material thoroughly for understanding the coverage of syllabus in the paper of Advanced
Accounting.
FRAMEWORK OF CHAPTERS – UNIFORM STRUCTURE COMPRISING OF SPECIFIC
COMPONENTS
Efforts have been made to present each topic of the syllabus in a lucid manner. Care has been
taken to present the chapters in a logical sequence to facilitate easy understanding by the students.
Sincere efforts have been taken to updated the study material so that it reflects the current position.
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The content for each chapter/unit of the study Material has been structured in the following manner
–
Components of each Chapter About the component
1 Learning Outcomes Learning outcomes which you need to demonstrate a�er learning each topic have been detailed in the first page of each chap-ter/unit. Demonstration of these learning outcomes would help you to achieve the de-sired level of technical competence
2 Chapter/Unit Overview As the name suggests, the flow chart/table/diagram given at the beginning of each chap-ter would give a broad outline of the contents covered in the chapter
3 Content of each unit/ chapter �e concepts and provisions of each topic is explained in student-friendly manner with the aid of Examples/ illustrations/ diagrams/flow charts. �ese value additions would help you develop conceptual clarity and get a good grasp of the topic. Diagrams and Flow charts would help you understand the con-cept/application of topic in a better manner.
4 Illustrations involving conceptual understanding
Illustrations would help the students to un-derstand the application of concepts. In ef-fect, it would test understanding of concepts as well as ability to apply the concepts learnt in solving problems and addressing issues.
5 Summary A summary of the chapter is given at the end to help you revise what you have learnt. It would especially facilitate quick revision of the chapter the day before the examination.
6 Test Your Knowledge �is section comprises of number of multiple choice questions, theoretical questions and practical questions which would help stu-dents to evaluate what they have understood a�er studying the chapter. �e questions giv-en in this section have also been supplement-ed with the answers to help the students in evaluating their solutions so that they can know about their grey areas.
We hope that these student-friendly features in the Study Material makes your learning process
more enjoyable, enriches your knowledge and sharpens your application skills.
Happy Reading and Best Wishes!
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PAPER – 1 : PRINCIPLES AND PRACTICE OF ACCOUNTING
(One paper – Three hours – 100 Marks)
OBJECTIVE:
To develop an understanding of the basic concepts and principles of Accounting and apply
the same in preparing financial statements, computing accounting ratios and simple problem
solving.
CONTENTS:
1. Theoretical Framework
(i) Meaning and Scope of accounting
(ii) Accounting Concepts, Principles and Conventions
(iii) Accounting terminology - Glossary
(iv) Capital and revenue expenditure, Capital and revenue receipts, Contingent assets and
contingent liabilities
(v) Accounting Policies
(vi) Accounting as a Measurement Discipline – Valuation Principles, Accounting Estimates.
(vii) Accounting Standards – Concepts and Objectives.
(viii) Indian Accounting Standards – Concepts and Objectives.
2. Accounting Process
(i) Books of Accounts
(ii) Preparation of Trial Balance
(iii) Rectification of Errors.
3. Bank Reconciliation Statement
Introduction, reasons, preparation of bank reconciliation statement.
4. Inventories
Cost of inventory, Net realizable value, Basis and technique of inventory valuation and record
keeping.
5. Concept and Accounting of Depreciation
Concepts, Methods of computation and accounting treatment of depreciation, Change in
depreciation methods.
6. Accounting for Special Transactions
(i) Bills of exchange and promissory notes
Meaning of Bills of Exchange and Promissory Notes and their Accounting Treatment;
Accommodation bills.
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(ii) Sale of goods on approval or return basis
Meaning of goods sent on approval or return basis and accounting treatment.
(iii) Consignments
Meaning and Features of consignment business, Difference between sale and consignment,
Accounting treatments for consignment transactions and events in the books of consignor and
consignee.
(iv) Joint Ventures for non-corporate entities
Meaning and Features of joint venture transactions, Distinction between joint venture and
partnership, Methods of maintaining joint venture accounts.
(v) Royalty accounts
Meaning of the term “Royalty” and Accounting Treatment thereof.
(vi) Average due Date
Meaning, Calculation of average due date in various situations.
(vii) Account Current
Meaning of Account Current, Methods of preparing Account Current.
7. Final Accounts of Sole Proprietors
Elements of financial statements, Closing Adjustment Entries, Trading Account, Profit and Loss
Account and Balance Sheet of Manufacturing and Non-manufacturing entities.
8. Partnership Accounts
(i) Final Accounts of Partnership Firms
(ii) Admission, Retirement and Death of a Partner including Treatment of Goodwill
(iii) Introduction to LLPs and Distinction of LLPs from Partnership.
9. Financial Statements of Not-for-Profit Organizations
Significance of Receipt and Payment Account, Income and Expenditure Account and Balance
Sheet, Difference between Profit and Loss Account and Income and Expenditure Account.
Preparation of Receipt and Payment Account, Income and Expenditure Account and Balance
Sheet.
10. Introduction to Company Accounts
(i) Definition of shares and debentures
(ii) Issue of shares and debentures, forfeiture of shares, re-issue of forfeited shares
(iii) Statement of Profit and Loss and Balance Sheet as per Schedule III to the Companies Act,
2013.
11. Basic Accounting Ratios (profitability, solvency, liquidity and turnover)
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CONTENTS
MODULE 1
CHAPTER 1 : Theoretical Framework
CHAPTER 2 : Accounting Process
CHAPTER 3 : Bank Reconciliation Statement
CHAPTER 4 : Inventories
CHAPTER 5 : Concept and Accounting of Depreciation
CHAPTER 6 : Accounting for Special Transactions
MODULE 2
CHAPTER 7 : Preparation of Final Accounts of Sole Proprietors
CHAPTER 8 : Partnership Accounts
CHAPTER 9 : Financial Statements of Not-For-Profit Organizations
CHAPTER 10 : Company Accounts
CHAPTER 11 : Basic Accounting Ratios
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DETAILED CONTENTS : MODULE–1
Pages
CHAPTER 1: THEORETICAL FRAMEWORK .........................................................................1.1–1.96
Unit 1: Meaning And Scope Of Accounting
Learning Outcomes ...................................................................................................................................................... 1.1
Unit overview.................................................................................................................................................................. 1.2
1.1 Introduction ................................................................................................................................................ 1.2
1.2 Meaning of Accounting ........................................................................................................................... 1.3
1.3 Evolution of Accounting as a Social Science ................................................................................... 1.6
1.4 Objectives of Accounting ....................................................................................................................... 1.7
1.5 Functions of Accounting ......................................................................................................................... 1.8
1.6 Book-Keeping ............................................................................................................................................. 1.8
1.7 Distinction Between Book-Keeping and Accounting ................................................................... 1.9
1.8 Sub-Fields of Accounting......................................................................................................................1.10
1.9 Users of Accounting Information .......................................................................................................1.10
1.10 Relationship of Accounting with other Disciplines .....................................................................1.11
1.11 Limitations of Accounting ....................................................................................................................1.14
1.12 Role of Accountant in the Society .....................................................................................................1.14
Summary ........................................................................................................................................................................1.18
Test Your Knowledge ..................................................................................................................................................1.19
Unit 2 : Accounting Concepts, Principles And Conventions
Learning Outcomes ....................................................................................................................................................1.22
Unit Overview ...............................................................................................................................................................1.23
2.1 Introduction ..............................................................................................................................................1.23
2.2 Accounting Concepts .............................................................................................................................1.24
2.3 Accounting Principles ............................................................................................................................1.24
2.4 Accounting Conventions ......................................................................................................................1.24
2.5 Concepts, Principles and Conventions - An Overview ...............................................................1.25
2.6 Fundamental Accounting Assumptions..........................................................................................1.35
2.7 Financial Statements ..............................................................................................................................1.35
Summary ........................................................................................................................................................................1.39
Test Your Knowledge ..................................................................................................................................................1.39
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Unit 3 : Accounting Terminology – Glossary
Learning Outcomes ...................................................................................................................................................1.43
Accounting Terminology - Glossary ..................................................................................................................... 1.43
Test Your Knowledge ................................................................................................................................................. 1.57
Unit 4 : Capital And Revenue Expenditures And Receipts
Learning Outcomes ...................................................................................................................................................1.58
Unit Overview ...............................................................................................................................................................1.58
4.1 Introduction ............................................................................................................................................. 1.58
4.2 Considerations in Determining Capital and Revenue Expenditures ................................... 1.59
4.3 Capital Expenditures and Revenue Expenditures....................................................................... 1.59
4.4 Capital Receipts and Revenue Receipts ......................................................................................... 1.61
Summary .......................................................................................................................................................................1.64
Test Your Knowledge .................................................................................................................................................1.64
Unit 5 : Contingent Assets And Contingent Liabilities
Learning Outcomes ...................................................................................................................................................1.66
Unit Overview ..............................................................................................................................................................1.66
5.1 Contingent Asset .................................................................................................................................... 1.66
5.2 Contingent Liabilities ............................................................................................................................ 1.67
5.3 Distinction Between Contingent Liabilities and Liabilities ..................................................... 1.67
5.4 Distinction Between Contingent Liabilities and Provisions .....................................................1.67
Test Your Knowledge ..................................................................................................................................................1.68
Unit 6 : Accounting Policies
Learning Outcomes ...................................................................................................................................................1.70
Unit Overview ...............................................................................................................................................................1.70
6.1 Meaning ..................................................................................................................................................... 1.70
6.2 Selection of Accounting Policies ....................................................................................................... 1.71
6.3 Change in Accounting Policies .......................................................................................................... 1.71
Summary .......................................................................................................................................................................1.72
Test Your Knowledge .................................................................................................................................................1.72
Unit 7 : Accounting As A Measurement Discipline – Valuation Principles, Accounting Estimates
Learning Outcomes ...................................................................................................................................................1.74
Unit Overview ..............................................................................................................................................................1.74
7.1 Meaning of Measurement ................................................................................................................... 1.75
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7.2 Objects or Events to be Measured ................................................................................................... 1.75
7.3 Standard or Scale of Measurement ...................................................................................................1.75
7.4 Dimension of Measurement Scale ................................................................................................... 1.76
7.5 Accounting as a Measurement Discipline ..................................................................................... 1.76
7.6 Valuation Principles ............................................................................................................................... 1.77
7.7 Measurement and Valuation .............................................................................................................. 1.80
7.8 Accounting Estimates ........................................................................................................................... 1.80
Summary ........................................................................................................................................................................1.81
Test Your Knowledge ..................................................................................................................................................1.81
Unit 8 : Accounting Standards
Learning Outcomes ....................................................................................................................................................1.84
Unit Overview ...............................................................................................................................................................1.84
8.1 Introduction of Accounting Standards ............................................................................................1.85
8.2 Objectives of Accounting Standards ................................................................................................1.85
8.3 Benefits and Limitations of Accounting Standards .....................................................................1.85
8.4 Process of Formulation of Accounting Standards in India .......................................................1.87
8.5 List of Accounting Standards in India ..............................................................................................1.87
Test Your Knowledge ..................................................................................................................................................1.89
Unit 9 : Indian Accounting Standards
Learning Outcomes ....................................................................................................................................................1.91
Unit overview................................................................................................................................................................1.91
9.1 Need for Convergence towards Global Standards ......................................................................1.91
9.2 International Financial Reporting Standards as Global Standards ........................................1.92
9.3 Benefits of Convergence with IFRSS .................................................................................................1.93
9.4 Development in Indian Accounting Standards (Ind AS) ...........................................................1.93
9.5 List of IND AS .............................................................................................................................................1.94
Test Your Knowledge ..................................................................................................................................................1.95
CHAPTER 2 : ACCOUNTING PROCESS ............................................................................. 2.1–2.116
Unit 1 : Basic Accounting Procedures - Journal Entries
Learning Outcomes ...................................................................................................................................................... 2.1
Unit overview.................................................................................................................................................................. 2.1
1.1 Double Entry System ................................................................................................................................ 2.2
1.2 Advantages of Double Entry System .................................................................................................. 2.2
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1.3 Account ......................................................................................................................................................... 2.2
1.4 Debit and Credit ......................................................................................................................................... 2.4
1.5 Transactions ................................................................................................................................................. 2.7
1.6 Accounting Equation Approach ........................................................................................................... 2.8
1.7 Traditional Approach..............................................................................................................................2.12
1.8 Modern Classification of Accounts ....................................................................................................2.14
1.9 Journal .........................................................................................................................................................2.14
Summary ........................................................................................................................................................................2.24
Test Your Knowledge ..................................................................................................................................................2.24
Unit 2 : Ledgers
Learning Outcomes ....................................................................................................................................................2.31
Unit Overview ...............................................................................................................................................................2.31
2.1 Introduction ..............................................................................................................................................2.32
2.2 Specimen of Ledger Accounts ............................................................................................................2.32
2.3 Posting .........................................................................................................................................................2.32
2.4 Balancing an Account ............................................................................................................................2.32
Summary ........................................................................................................................................................................2.37
Test Your Knowledge ..................................................................................................................................................2.38
Unit 3 : Trial Balance
Learning Outcomes ...................................................................................................................................................2.41
Unit Overview ..............................................................................................................................................................2.41
3.1 Introduction ............................................................................................................................................. 2.41
3.2. Objectives of Preparing the Trial Balance ...................................................................................... 2.42
3.3 Limitations of Trial Balance ................................................................................................................. 2.43
3.4 Methods of Preparation of Trial Balance ........................................................................................ 2.43
3.5 Adjusted Trial Balance (Through Suspense Account) ................................................................ 2.47
3.6 Rules of Preparing the Trial Balance ................................................................................................. 2.47
Summary .......................................................................................................................................................................2.49
Test Your Knowledge ..................................................................................................................................................2.50
Unit 4 : Subsidiary Books
Learning Outcomes ...................................................................................................................................................2.53
Unit Overview ...............................................................................................................................................................2.53
4.1 Introduction ............................................................................................................................................. 2.53
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4.2 Distinction between Subsidiary Books and Principal books .................................................. 2.54
4.3 Purchases Book ....................................................................................................................................... 2.56
4.4 Sales Book ................................................................................................................................................. 2.60
4.5 Sales Returns Book or Returns Inward Book ................................................................................. 2.61
4.6 Purchase Returns or Returns Outward Book ................................................................................ 2.61
4.7 Importance of Journal .......................................................................................................................... 2.63
Summary .......................................................................................................................................................................2.65
Test Your Knowledge .................................................................................................................................................2.65
Unit 5 : Cash Book
Learning Outcomes ...................................................................................................................................................2.69
Unit Overview ...............................................................................................................................................................2.69
5.1 Cash Book - A Subsidiary Book and a Principal Book ................................................................ 2.70
5.2 Kinds of Cash Book ................................................................................................................................. 2.70
5.3 Posting the Cash Book Entries ........................................................................................................... 2.76
5.4 Petty Cash Book ...................................................................................................................................... 2.76
5.5 Entries for Sale Through Credit/Debit Cards ................................................................................. 2.79
Summary .......................................................................................................................................................................2.81
Test Your Knowledge .................................................................................................................................................2.82
Unit 6: Rectification Of Errors
Learning Outcomes ...................................................................................................................................................2.85
Unit Overview ...............................................................................................................................................................2.85
6.1 Introduction ............................................................................................................................................. 2.85
6.2 Stages of Errors ........................................................................................................................................ 2.88
6.3 Types of Errors ......................................................................................................................................... 2.89
6.4 Steps to Locate Errors ........................................................................................................................... 2.90
6.5 Rectification of Errors ............................................................................................................................ 2.91
Summary .................................................................................................................................................................... 2.106
Test Your Knowledge .............................................................................................................................................. 2.107
CHAPTER 3: BANK RECONCILIATION STATEMENT ............................................................3.1–3.33
Learning Outcomes ..................................................................................................................................................... 3.1
Chapter Overview ......................................................................................................................................................... 3.1
1. Introduction ............................................................................................................................................... 3.2
2. Bank Pass Book .......................................................................................................................................... 3.2
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3. Bank Reconciliation Statement ........................................................................................................... 3.3
4. Importance of Bank Reconciliation Statement .............................................................................. 3.3
5. Procedure for Reconciling the Cash Book Balance with the Pass Book Balance.............. 3.11
6. Methods of Bank Reconciliation ....................................................................................................... 3.13
Summary .......................................................................................................................................................................3.28
Test Your Knowledge .................................................................................................................................................3.29
CHAPTER 4: INVENTORIES ..................................................................................................4.1–4.27
Learning Outcomes ..................................................................................................................................................... 4.1
Chapter Overview ......................................................................................................................................................... 4.1
1. Meaning ....................................................................................................................................................... 4.2
2. Inventory Valuation.................................................................................................................................. 4.3
3. Basis of Inventory Valuation ................................................................................................................. 4.4
4. Inventory Record Systems ..................................................................................................................... 4.5
5. Formulae/Methods to Determine Cost of Inventory .................................................................... 4.6
6. Inventories Taking .................................................................................................................................. 4.14
Summary .......................................................................................................................................................................4.18
Test Your Knowledge .................................................................................................................................................4.19
CHAPTER 5: CONCEPT AND ACCOUNTING OF DEPRECIATION .......................................5.1–5.36
Learning Outcomes ..................................................................................................................................................... 5.1
Chapter Overview ......................................................................................................................................................... 5.1
1. Introduction ............................................................................................................................................... 5.2
2. Factors in the Measurement of Depreciation ................................................................................. 5.4
3. Methods for Providing Depreciation ................................................................................................. 5.7
4. Profit or Loss on The Sale/Disposal of Property, Plant and Equipment ............................... 5.20
5. Change in the Method of Depreciation ..........................................................................................5.22
6. Revision of the Estimated Useful Life of Property, Plant and Equipment .......................... 5.24
7. Revaluation of Property, Plant and Equipment ........................................................................... 5.24
8. Provision for Repairs and Renewals ................................................................................................. 5.26
Summary .......................................................................................................................................................................5.27
Test Your Knowledge .................................................................................................................................................5.28
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CHAPTER 6: ACCOUNTING FOR SPECIAL TRANSACTIONS ............................................ 6.1–6.163
Unit 1: Bill Of Exchange And Promissory Notes
Learning Outcomes ...................................................................................................................................................... 6.1
Unit Overview ................................................................................................................................................................. 6.1
1.1 Bills of Exchange ........................................................................................................................................ 6.2
1.2 Promissory Notes ....................................................................................................................................... 6.3
1.3 Differences - Bill of Exchange and Promissory Note ..................................................................... 6.4
1.4 Record of Bills of Exchange and Promissory Notes ....................................................................... 6.5
1.5 Term of a Bill ................................................................................................................................................ 6.6
1.6 Expiry / Due Date of a Bill ....................................................................................................................... 6.6
1.7 Days of Grace .............................................................................................................................................. 6.6
1.8 Date of Maturity of Bill ............................................................................................................................. 6.6
1.9 Bill at Sight ................................................................................................................................................... 6.7
1.10 Bill after Date .............................................................................................................................................. 6.7
1.11 How to Calculate Due Date of a Bill .................................................................................................... 6.8
1.12 Noting Charges .......................................................................................................................................... 6.8
1.13 Renewal of Bill ............................................................................................................................................ 6.9
1.14 Retirement of Bills of Exchange & Rebate ......................................................................................... 6.9
1.15 Insolvency ..................................................................................................................................................6.16
1.16 Accommodation Bills .............................................................................................................................6.19
1.17 Bills of Collection .....................................................................................................................................6.21
1.18 Bills Receivable and Bills Payable Books ..........................................................................................6.22
Summary ........................................................................................................................................................................6.23
Test Your Knowledge ..................................................................................................................................................6.23
Unit 2 : Sale Of Goods On Approval Or Return Basis
Learning Outcomes ....................................................................................................................................................6.30
Unit Overview ...............................................................................................................................................................6.30
2.1 Introduction ..............................................................................................................................................6.30
2.2 Accounting Records................................................................................................................................6.31
Summary ........................................................................................................................................................................6.38
Test Your Knowledge ..................................................................................................................................................6.39
Unit 3 : Consignment
Learning Outcomes ...................................................................................................................................................6.44
Unit Overview ...............................................................................................................................................................6.44
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3.1 Meaning of Consignment Account .................................................................................................. 6.45
3.2 Distinctions ................................................................................................................................................6.45
3.3 Accounting for Consignment Transactions and Events in the Books of the Consignor 6.46
3.4 Valuation of Inventories ....................................................................................................................... 6.51
3.5 Goods Invoiced above Cost ................................................................................................................ 6.51
3.6 Normal Loss ...............................................................................................................................................6.54
3.7 Abnormal Loss ......................................................................................................................................... 6.54
3.8 Commission ...............................................................................................................................................6.55
3.9 Return of Goods from the Consignee ..............................................................................................6.56
3.10 Account Sales ........................................................................................................................................... 6.56
3.11 Accounting in the Books of the Consignee ....................................................................................6.57
3.12 Advance by the Consignee Vs Security against the Consignment ........................................6.58
Summary .......................................................................................................................................................................6.65
Test Your Knowledge ................................................................................................................................................. 6.66
Unit 4: Joint Ventures
Learning Outcomes ...................................................................................................................................................6.75
Unit Overview ...............................................................................................................................................................6.75
4.1 Meaning of Joint Venture .................................................................................................................... 6.76
4.2 Features of Joint Venture ..................................................................................................................... 6.77
4.3 Distinction of Joint Venture with Partnership .............................................................................. 6.77
4.4 Distinction of Joint Venture with Consignment .......................................................................... 6.78
4.5 Methods of Maintaining Joint Venture Accounts ....................................................................... 6.78
Summary .................................................................................................................................................................... 6.103
Test Your Knowledge .............................................................................................................................................. 6.103
Unit 5: Royalty Accounts
Learning Outcomes ................................................................................................................................................ 6.110
Unit Overview ........................................................................................................................................................... 6.110
5.1 Introduction of Royalty and Related Terminologies ............................................................... 6.111
5.2 Accounting Treatment in the Books of Lessee .......................................................................... 6.113
5.3 Accounting Treatment in the Books of Lessor .......................................................................... 6.113
Summary ..................................................................................................................................................................... 6.124
Test Your Knowledge ............................................................................................................................................... 6.124
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Unit 6 : Average Due Date
Learning Outcomes ................................................................................................................................................ 6.129
Unit Overview ............................................................................................................................................................ 6.129
6.1 Introduction .......................................................................................................................................... 6.130
6.2 Concept of due date (Date of Maturity) ...................................................................................... 6.131
6.3 Types of Problems ............................................................................................................................... 6.133
Summary .................................................................................................................................................................... 6.146
Test Your Knowledge .............................................................................................................................................. 6.146
Unit 7 : Account Current
Learning Outcomes ................................................................................................................................................ 6.150
Unit Overview ........................................................................................................................................................... 6.150
7.1 Introduction .......................................................................................................................................... 6.150
7.2 Preparation of Account Current ..................................................................................................... 6.151
Summary ..................................................................................................................................................................... 6.160
Test Your Knowledge ............................................................................................................................................... 6.161
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FOUNDATION COURSE
(Modules 1 to 2)
BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)(SET UP BY AN ACT OF PARLIAMENT)
PRINCIPLES AND
PRACTICE OF
Paper–1, Module–2
© The Institute of Chartered Accountants of India
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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
This study material has been prepared by the faculty of the Board of Studies. The objective of the
study material is to provide teaching material to the students to enable them to obtain knowledge
in the subject. In case students need any clarifications or have any suggestions to make for further
improvement of the material contained herein, they may write to the Director of Studies.
All care has been taken to provide interpretations and discussions in a manner useful for the students.
However, the study material has not been specifically discussed by the Council of the Institute or any
of its Committees and the views expressed herein may not be taken to necessarily represent the
views of the Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this material.
© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or
transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without prior permission, in writing, from the publisher.
Edition : July, 2017
Website : www.icai.org
E-mail : [email protected]
Committee/ : Board of Studies
ISBN No. : 978-81-8441-871-2
Price (All Modules) : ` 500/-
Published by : The Publication Department on behalf of The Institute of Chartered
Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg,
New Delhi 110 002, India.
Printed by : Nova Publications, Daryaganj
July/2017/P2107 (New)
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CONTENTS
MODULE 1
CHAPTER 1 : Theoretical Framework
CHAPTER 2 : Accounting Process
CHAPTER 3 : Bank Reconciliation Statement
CHAPTER 4 : Inventories
CHAPTER 5 : Concept and Accounting of Depreciation
CHAPTER 6 : Accounting for Special Transactions
MODULE 2
CHAPTER 7 : Preparation of Final Accounts of Sole Proprietors
CHAPTER 8 : Partnership Accounts
CHAPTER 9 : Financial Statements of Not-For-Profit Organizations
CHAPTER 10 : Company Accounts
CHAPTER 11 : Basic Accounting Ratios
© The Institute of Chartered Accountants of India
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© The Institute of Chartered Accountants of India
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DETAILED CONTENTS : MODULE–2
Pages
CHAPTER 7 PREPARATION OF FINAL ACCOUNTS OF SOLE PROPRIETORS ....................7.1–7.73
Unit 1 : Final Accounts of Non-Manufacturing Entities
Learning Outcomes ...................................................................................................................................................... 7.1
Unit overview.................................................................................................................................................................. 7.1
1.1 Introduction ................................................................................................................................................ 7.2
1.2 Preparation of Final Accounts ............................................................................................................... 7.3
1.3 Trading Account ......................................................................................................................................... 7.6
1.4 Profit and Loss Account .........................................................................................................................7.14
1.5 Certain Adjustments and their Treatments ....................................................................................7.27
1.6 Balance Sheet ............................................................................................................................................7.32
1.7 Sequence of Accounting Procedure or the Accounting Cycle ................................................7.38
1.8 Opening Entry ..........................................................................................................................................7.39
1.9 Provisions and Reserves ........................................................................................................................7.48
1.10 Limitations of Financial Statements .................................................................................................7.52
Summary ........................................................................................................................................................................7.53
Test Your Knowledge ..................................................................................................................................................7.53
Unit 2 : Final Accounts of Manufacturing Entities
Learning Outcomes ....................................................................................................................................................7.63
Unit Overview ...............................................................................................................................................................7.63
2.1 Introduction ..............................................................................................................................................7.63
2.2 Purpose .......................................................................................................................................................7.63
2.3 Manufacturing Costs ..............................................................................................................................7.64
2.4 Design of A Manufacturing Account ................................................................................................7.66
Summary ........................................................................................................................................................................7.68
Test Your Knowledge ..................................................................................................................................................7.69
CHAPTER 8: PARTNERSHIP ACCOUNTS .......................................................................... 8.1–8.135
Unit 1 : Introduction to Partnership Accounts
Learning Outcomes ..................................................................................................................................................... 8.1
Unit Overview ................................................................................................................................................................. 8.1
1.1 Introduction: Why Partnership? .......................................................................................................... 8.2
1.2 Definition and Features of Partnership............................................................................................. 8.2
1.3 Limited Liability Partnership ................................................................................................................ 8.3
1.4 Distinction Between an Ordinary Partnership Firm and An LLP ............................................. 8.4
1.5 Main Clauses in A Partnership Deed .................................................................................................. 8.5
1.6 Powers of Partners.................................................................................................................................... 8.7
1.7 Accounts ...................................................................................................................................................... 8.7
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1.8 Profit and Loss Appropriation .............................................................................................................. 8.8
1.9 Fixed and Fluctuating Capital ............................................................................................................ 8.11
Summary .......................................................................................................................................................................8.19
Test Your Knowledge ................................................................................................................................................. 8.20
Unit 2: Treatment of Goodwill In Partnership Accounts
Learning Outcomes ...................................................................................................................................................8.27
Unit Overview ...............................................................................................................................................................8.27
2.1 Goodwill ..................................................................................................................................................... 8.28
2.2 Methods for Goodwill Valuation ....................................................................................................... 8.29
2.3 Need for Valuation of Goodwill ......................................................................................................... 8.36
2.4 Valuation of Goodwill in Case of Admission of a Partner ......................................................... 8.36
2.5 Accounting Treatment of Goodwill in Case of Admission of a New Partner ...…………8.37
2.6 Accounting Treatment of Goodwill in Case of Change in Profit Sharing Ratio ................ 8.42
2.7 Accounting Treatment Of Goodwill in Case of Retirement or Death of a Partner ......... 8.44
Summary .......................................................................................................................................................................8.44
Test Your Knowledge .................................................................................................................................................8.45
Unit 3 : Admission of A New Partner
Learning Outcomes ...................................................................................................................................................8.49
Unit Overview ...............................................................................................................................................................8.49
3.1 Introduction ............................................................................................................................................. 8.50
3.2 Revaluation Account or Profit and Loss Adjustment Account ............................................... 8.50
3.3 Reserves in the Balance Sheet ........................................................................................................... 8.58
3.4 Computation of New Profit Sharing Ratio ......................................................................................8.60
3.5 Hidden Goodwill ..................................................................................................................................... 8.69
Summary ........................................................................................................................................................................8.71
Test Your Knowledge ..................................................................................................................................................8.71
Unit 4 : Retirement of A Partner
Learning Outcomes ...................................................................................................................................................8.81
Unit Overview ...............................................................................................................................................................8.81
4.1 Introduction ............................................................................................................................................. 8.82
4.2 Calculation of Gaining Ratio ............................................................................................................... 8.82
4.3 Revaluation of Assets and Liabilities on Retirement of a Partner ......................................... 8.85
4.4 Reserve ....................................................................................................................................................... 8.86
4.5 Final Payment to a Retiring Partner ..................................................................................................8.88
4.6 Paying a Partner’s Loan in Instalment ............................................................................................. 8.99
4.7 Joint Life Policy ..................................................................................................................................... 8.102
4.8 Separate Life Policy ............................................................................................................................. 8.106
Summary .................................................................................................................................................................... 8.107
Test Your Knowledge .............................................................................................................................................. 8.107
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Unit 5 : Death of A Partner
Learning Outcomes ................................................................................................................................................ 8.116
Unit Overview ........................................................................................................................................................... 8.116
5.1 Introduction .......................................................................................................................................... 8.117
5.2 Right of Outgoing Partner in Certain Cases to Share Subsequent Profits……………8.117
5.3 Amount Payable to Legal Representatives of Dead Partner ................................................ 8.118
5.4 Special Transactions in Case of Death: Joint Life Policy .......................................................... 8.119
5.5 Special Transactions in Case of Death: Separate Life Policy ................................................. 8.121
5.6 Special Transactions in Case of Death: Payment of Deceased
Partner’s Share ...................................................................................................................................... 8.121
Summary ..................................................................................................................................................................... 8.129
Test Your Knowledge ............................................................................................................................................... 8.130
CHAPTER 9: FINANCIAL STATEMENTS OF NOT-FOR-PROFIT ORGANIZATIONS ..............91–9.38
Learning Outcomes ...................................................................................................................................................... 9.1
Chapter Overview ......................................................................................................................................................... 9.1
1. Introduction ................................................................................................................................................ 9.2
2. Nature of Receipts and Payments Account ...................................................................................... 9.2
3. Income and Expenditure Account ....................................................................................................... 9.3
4. Balance Sheet .............................................................................................................................................. 9.8
5. Educational Institution ..........................................................................................................................9.23
Summary ........................................................................................................................................................................9.29
Test Your Knowledge ..................................................................................................................................................9.30
CHAPTER 10 : COMPANY ACCOUNTS ........................................................................... 10.1–10.90
Unit 1: Introduction to Company Accounts
Learning Outcomes ....................................................................................................................................................10.1
Unit Overview ...............................................................................................................................................................10.1
1.1 Introduction ..............................................................................................................................................10.2
1.2 Meaning of Company ............................................................................................................................10.2
1.3 Salient Features of a Company ...........................................................................................................10.3
1.4 Types of Companies ...............................................................................................................................10.4
1.5 Maintenance of Books of Account ....................................................................................................10.6
1.6 Preparation of Financial Statements ................................................................................................10.6
Summary ..................................................................................................................................................................... 10.14
Test Your Knowledge ............................................................................................................................................... 10.14
Unit 2 : Issue, Forfeiture and Re-Issue of Shares
Learning Outcomes ................................................................................................................................................. 10.17
Unit Overview ............................................................................................................................................................ 10.17
2.1 Introduction ........................................................................................................................................... 10.18
2.2 Share Capital .......................................................................................................................................... 10.18
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2.3 Types of Shares ...................................................................................................................................... 10.21
2.4 Issue of Shares for Cash ...................................................................................................................... 10.22
2.5 Subscription of Shares ........................................................................................................................ 10.25
2.6 Shares Issued at Discount .................................................................................................................. 10.30
2.7 Shares Issued at Premium ................................................................................................................. 10.31
2.8 Over Subscription and Pro-Rata Allotment ................................................................................. 10.34
2.9 Calls-In-Arrears and Calls-In-Advance ........................................................................................... 10.36
2.10 Interest on Calls-in-Arrears and Calls-in-Advance .................................................................... 10.38
2.11 Forfeiture of Shares .............................................................................................................................. 10.41
2.12 Re-issue of Forfeited Shares ............................................................................................................. 10.45
2.13 Issue of Shares for Consideration other than Cash................................................................... 10.50
Summary ..................................................................................................................................................................... 10.52
Test Your Knowledge ............................................................................................................................................... 10.53
Unit 3 : Issue of Debentures
Learning Outcomes ................................................................................................................................................. 10.61
Unit Overview ............................................................................................................................................................ 10.61
3.1 Introduction ........................................................................................................................................... 10.62
3.2 Meaning ................................................................................................................................................... 10.62
3.3 Features of Debentures ...................................................................................................................... 10.62
3.4 Distinction Between Debentures and Shares ............................................................................ 10.63
3.5 Types of Debentures ........................................................................................................................... 10.63
3.6 Issue of Debentures ............................................................................................................................. 10.64
3.7 Issue of Debentures as Collateral Security .................................................................................. 10.77
3.8 Issue of Debentures in Consideration other than for Cash ….. …. ..................................... 10.79
3.9 Treatment of Discount/Loss on Issue of Debentures .............................................................. 10.81
3.10 Interest on Debentures ...................................................................................................................... 10.82
Summary ..................................................................................................................................................................... 10.84
Test Your Knowledge ............................................................................................................................................... 10.85
CHAPTER 11 : BASIC ACCOUNTING RATIOS ................................................................ 11.1–11.49
Learning Outcomes ....................................................................................................................................................11.1
Chapter Overview .......................................................................................................................................................11.1
1. Introduction ..............................................................................................................................................11.2
2. Ratio and Ratio Analysis ........................................................................................................................11.2
3. Objectives of Ratio Analysis .................................................................................................................11.3
4. Advantages of Ratio Analysis ..............................................................................................................11.3
5. Limitations of Ratio Analysis ................................................................................................................11.4
6. Limitations of the Ratios .......................................................................................................................11.5
7. Types of Ratios ..........................................................................................................................................11.5
Summary ..................................................................................................................................................................... 11.38
Test Your Knowledge ............................................................................................................................................... 11.42
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After studying this unit, you will be able to:
w Understand the meaning and significance of accounting.
w Understand the meaning of book-keeping and the distinction of accounting with book-keeping.
w Appreciate the evolutionary process of accounting as a social science.
w Explain sub-fields of accounting.
w Identify the various user groups for whom accounting information is to be generated.
w Understand the relationship of accounting with Economics, Statistics, Mathematics, Law and
Management.
w Explain the limitations of accounting.
w Appreciate the enlarged boundary of accounting profession and the areas where in a chartered
accountant plays an important role of rendering useful services to the society.
THEORETICAL FRAMEWORK
UNIT 1: MEANING AND SCOPE OF ACCOUNTING
LEARNING OUTCOMES
1CHAPTER
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1.2 PRINCIPLES AND PRACTICE OF ACCOUNTING
1.1 INTRODUCTION
Every individual performs some kind of economic activity. A salaried person gets salary and spends to
buy provisions and clothing, for children’s education, construction of house, etc. A sports club formed
by a group of individuals, a business run by an individual or a group of individuals, a local authority like
Calcutta Municipal Corporation, Delhi Development Authority, Governments, either Central or State, all
are carrying some kind of economic activities. Not necessarily all the economic activities are run for any
individual benefit; such economic activities may create social benefit i.e. benefit for the public, at large.
Anyway such economic activities are performed through ‘transactions and events’. Transaction is used
to mean ‘a business, performance of an act, an agreement’ while event is used to mean ‘a happening, as a
consequence of transaction(s), a result.’
An individual invests `2,00,000 for running a stationery business. On 1st January, he purchases goods for
` 1,15,000 and sells for ` 1,47,000 during the month of January. He pays shop rent for the month ` 5,000
and finds that still he has goods worth ` 15,000 in hand. The individual performs an economic activity.
He carries on a few transactions and encounters with some events. Is it not logical that he will want to
know the result of his activity?
UNIT
OVERVIEW
Procedure of Accounting
Using the financial Information
Generating Financial Information
Recording
Input
Posting to
ledger
Preparation
of trial
balance
Preparation
of final
accounts
Internal users
• Board of
Directors
• Partners
• Managers
• Officers
External users
• Investors
• Lenders
• Suppliers
• Govt. agencies
• Customers
Communicating
Information to
users
Economic events and
transactions measured
in financial terms
Accounting Cycle Output
Identification of
transaction
Classifying Summarising Analyzing Interpreting Communicating
Recording of transactions in the books
of original entry
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1.3THEORETICAL FRAMEWORK
We see that the individual, who runs the stationery business, earns a surplus of ` 42,000.
`
Goods sold 1,47,000
Goods in hand 15,000
1,62,000
Less : Goods purchased 1,15,000
Shop rent paid 5,000 (1,20,000)
Surplus 42,000
Earning of ` 42,000 surplus is an event; also having the inventories in hand is another event, while purchase
and sale of goods, investment of money and payment of rent are transactions.
Similarly, a municipal corporation got government grant ̀ 500 lakhs for adult education; it spent ̀ 250 lakhs
for purchasing literacy kits, paid ` 200 lakhs to the tutors and is left with a balance of ` 50 lakhs. These are
also transactions and events.
Similarly, the Central Government raised money through taxes, paid salaries to the employees, and spent
on various developmental activities. Whenever receipts of the Government are more than expenses it has
surplus, but if expenses are more than receipts it runs in deficit. Here raising money through various sources
can be termed as transaction and surplus or deficit at the end of the accounting year can be termed as an
event.
So, everybody wants to keep records of all transactions and events and to have adequate information about
the economic activity as an aid to decision-making. Accounting discipline has been developed to serve this
purpose as it deals with the measurement of economic activities involving inflow and outflow of economic
resources, which helps to develop useful information for decision-making process.
Accounting has universal application for recording transactions and events and presenting suitable
information to aid decision-making regarding any type of economic activity ranging from a family function
to functions of the national government. But hereinafter we shall concentrate only on business activities
and their accounting because the objective of this study material is to provide a basic understanding on
accounting for business activities. Nevertheless, it will give adequate knowledge to think coherently of
accounting as a field of study for universal application.
The growth of accounting discipline is closely associated with the development of the business world. Thus,
to understand accounting as a field of study for universal application, it is best identified with recording of
business transactions and communication of financial information about business enterprise to facilitate
decision-making. The aim of accounting is to meet the information needs of the rational and sound decision-
makers, and thus, called the language of business.
1.2 MEANING OF ACCOUNTING
The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated
the following definition of accounting in 1961:
“Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of
money, transactions and events which are, in part at least, of a financial character, and interpreting the result
thereof.”
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1.4 PRINCIPLES AND PRACTICE OF ACCOUNTING
As per this definition, accounting is simply an art of record keeping. The process of accounting starts by
first identifying the events and transactions which are of financial character and then be recorded in the
books of account. This recording is done in Journal or subsidiary books, also known as primary books. Every
good record keeping system includes suitable classification of transactions and events as well as their
summarisation for ready reference. After the transactions and events are recorded, they are transferred to
secondary books i.e. Ledger. In ledger, transactions and events are classified in terms of income, expense,
assets and liabilities according to their characteristics and summarised in profit and loss account and balance
sheet. Essentially the transactions and events are to be measured in terms of money. Measurement in terms
of money means measuring at the ruling currency of a country, for example, rupee in India, dollar in U.S.A.
and like. The transactions and events must have at least in part, financial characteristics. The inauguration
of a new branch of a bank is an event without having financial character, while the business disposed of by
the branch is an event having financial character. Accounting also interprets the recorded, classified and
summarised transactions and events.
However, the above-mentioned definition does not reflect the present day accounting function. The
dimension of accounting is much broader than that described in the above definition. According to the
above definition, accounting ends with interpretation of the results of the financial transactions and events
but in the modern world with the diversification of management and ownership, globalisation of business
and society gaining more interest in the functioning of the enterprises, the importance of communicating
the accounting results has increased and therefore, this requirement of communicating and motivating
informed judgement has also become the part of accounting as defined in the widely accepted definition
of accounting, given by the American Accounting Association in 1966 which treated accounting as
“The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounts.”
In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public Accountants (AICPA)
enumerated the functions of accounting as follows:
“The function of accounting is to provide quantitative information, primarily of financial nature, about
economic entities, that is needed to be u