FINANCINIAL ACCOUNTING I UNIT I 1. Define Accounting.

According to the American institute of certified public accountants (AICPA) Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money transaction and events which are financial character and interpreting the result thereof. 2. List out the steps/ Functions in Accounting. The following are the steps in accounting: 1. Recording 2. Classification 3. Summarizing in significant manner 4. In terms of money 5. transaction and events of financial character, 6. Interpreting the results 3. List out the objectives of accounting The following are the objectives of accounting: 1. Maintenance of accounting records, 2 .Ascertainment of profit or loss, 3. Depiction of financial position and 4. Providing information. 4. What are the advantages of accounting? The advantages of accounting are 1. Preparation of Systematic records 2. Preparation of financial statements, 3. Assessment of progress, 4. Aid to decision making, 5. Compliance to Statutory requirements, 6 .Providing .information to interested groups, 7. Evidence in courts, 8. Basic sources of computation of Taxation and 9. Merger of firms. 5. What ate the Limitations of Accounting? The disadvantages of Limitations of accounting are

1. It ignores transaction which cannot be expressed in terms of money. 2. Accounting realizes on estimate and forecast in several important matters like useful life machinery, market value of investments. 3. Accounting result may not be accurate and reliable due to such estimate. 4. Accountants rely on historical cost for recording the fixed asset. 5. Accounting also ignores the price level changes which drastically alter the values of assets and liabilities. 6. Who are the groups interested in accounting information? The groups interested in accounting information are (i) Internal users like (a) owners (b) management and (c) employee. (ii) External users comprising of (a) creditors of financiers (b) potential investors (c) consumers (d) tax authorities (e)government and (f)research scholars. 7. What do you mean by double entry system of book keeping? There are numerous transactions in a business concern. Each transaction, when closely analysed, reveals two aspects. One aspect will be receiving aspect or incoming aspect or expenses/loss aspect. This is termed as the Debit aspect. The other aspect will be giving aspect or outgoing aspect or income/gain aspect. This is termed as the Credit aspect. These two aspects namely Debit aspect and Credit aspect form the basis of Double Entry System. The double entry system is so named since it records both the aspectsof a transaction. In short, the basic principle of this system is, for every debit, there must be a corresponding credit of equal amount and for every credit, there must be a corresponding debit of equal amount. 8. What is Book keeping? Book-keeping is that branch of knowledge which tells us how to keep a record of business transactions. It is often routine and clerical in nature. It is important to note that only those transactions related to business which can be expressed in terms of money are recorded. The activities of book-keeping include recording in the journal, posting to the ledger and balancing of accounts. 10. What is Accounting Equation? Accounting equation is based on dual aspect concept (Debit and Credit). It emphasizes on the fact that every transaction has a two sided effect i.e., on the assets and claims on assets. Always the total claims (those of outsiders and of the proprietors) will be equal to the total assets of the business concern. The claims are also known as equities, are of two types: i.) Owners equity (Capital); ii.) Outsiders equity (Liabilities).

Assets = Equities Assets = Capital + Liabilities (A = C+L) Capital = Assets Liabilities (C = AL) Liabilities = Assets Capital (L = AC) 11. Classify Accounts. Accounts

Personal

Impersonal

Natural

Artificial

Representative

Real

Nominal

Tangible

Intangible

12.

What are the accounting rules?

12. What is Journal? Journal is one of the books of original entry in which transactions are originally recorded in a chronological (day-to-day) order according to the principles of Double Entry System. Format of Journal :

Advantages 1. It reduces the possibility of errors. 2. It provides an explanation of the transaction. 3. It provides a chronological record of all transactions. Limitations 1. It will be too long if all transactions are recorded here. 2. It is difficult to ascertain the balance of each account. a. What is Ledger? Ledger is a principal or main book which contains all the accounts in which the transactions recorded in the books of original entry (Journal) are transferred. Ledger is also called the Book of Final Entry or Book of Secondary Entry, because the transactions are finally incorporated in the Ledger. 15. What is Loose Leaf Ledger? Loose-leaf ledger takes the place of a bound note book. In a loose-leaf ledger, appropriate ruled sheets of thick paper are introduced and fixed up with the help of a binder. Whenever necessary additional pages may be inserted, completed accounts can be removed and the accounts may be arranged and rearranged in the desired order. Therefore, this type of ledger is known as Loose-leaf Ledger. 16. What are subsidiary books? What are its types? The subdivisions of journal into various books are called Subsidiary books.

17. What is Cash Book? What are the kinds of Cash Book? The first and most important subsidiary book of the business is cash book. All the cash transactions generally relating to receipts and payments in the business concern are recorded seperately in a book known as Cash Book.

18. What is Contra Entry? In triple column cash book, when an entry affects both cash and bank accounts it is called a contra entry. Contra in Latin means opposite. In contra entries both the debit and credit aspects of a transaction are recorded in the cash book itself. Example entries are 1. Cash paid into bank and 2. Cash withdrawn from bank for office use

Such contra entries are denoted by writing the letter C in the L.F. column, on both sides of the cash book. They indicate that no posting in respect thereof is necessary in the ledger. 19. What is Imprest system in Petty Cash Book? Imprest means money advanced on loan. Under this system the amount required to meet out various petty expenses is estimated and given to the petty cashier at the beginning of the specified period, usually a month. All the payments are supported by vouchers. At the end of the given period or earlier, when the petty cashier has spent the petty cash amount, he closes the petty cash book for the period and balances it. Then he submits the accounts to the cashier. He verifies the petty cash book with the vouchers. After satisfying himself as to the correctness and genuineness of the payments an amount equal to the cash spent is given to the petty cashier. This amount together with the unspent amount will bring up the cash in hand to the amount with which he originally started i.e., the imprest amount. Thus the system of reimbursing the amount spent by the petty cashier at fixed period, is known as the imprest system of petty cash. For example, On June 1, 2002, Rs.1,000 was given to the petty cashier. He had spent Rs.940 during the month. He will be paid Rs.940on 30th June by the cashier so that he may again have Rs.1,000 for the next month i.e., July. 20. Explain Accounting Concepts: The Generally Accepted Accounting Principles (GAAP) are all termed concepts by some experts. Accounting concepts are the assumptions or postulates or ideas which are essential to the practice of accounting and preparation of financial statements. 1. Business Entity Concept: According to the entity concept the entity that represents the association of persons is considered distinct and separate from the owners, managers and employees of the enterprise. The accounting entity may be the business unit itself (sole proprietorship, partnership firm, joint stock company, co-operative societies or a government enterprises) or a defined part of business (i.e.,a department),or an amalgamation of related business (i.e.., a holding company),depending on the users needs .It can be a non-business group like a club, religious body which engages in economic activities. All the financial transactions are recorded from the point of view of the entity itself and not from the point of view of the other parties such as customers, suppliers, partners, owners etc, for example: when a firm sells goods to a customer. 2 Money Measurement Concept: In accounting, only those business transactions and events which are of financial nature are recorded. Money provides a common denominator or unit of measurement by means of which heterogeneous facts about a business can be expressed in terms of quantities which can be added or subtracted and summarized. Thus, quality of the production, value

of the skilled labour force, working conditions, production policies, disputes etc are not to be recorded in accounts in spite of their importance to business. 3. Going Concern Concept: This concept assumes that a business entity has continuity of life. It will continue for an indefinite period of time. It has no need or intention to close down .Creditors supply goods on credit, Customers buy goods on credit. Similarly, prepaid expenses and accrued income are treated as assets on the presumption of continuation of the business. 4. Dual Aspect Concept: Every business transaction recorded in the book of accounts of a business has two aspects receiving of benefits and giving of benefit. Both the aspects of each transaction must be recorded in appropriate accounts of the business .Assets represents all properties acquired by business for generating in short run (Current Assets) or long run (Fixed Assets). Equities represents claims of different claimants The equities are subdivided into Capital (claim from owners) and liabilities (Claim from outsiders). Thus the equation can be structured as Capital + liabilities = assets Capital = assets -liabilities 5. Matching Concept: Matching the revenues earned during an accounting period with the cost associated with the period to ascertain the result of the business concern is called the matching concept. It is the basis for finding accurate profit for a period which can be safely distributed to the owners. 6. Objective Evidence Concept All accounting entries must be based on objective evidence. Objective refers to verifiability, reliability and absence of bias. No transactions are recorded without documentary evidence. Examples are cash receipts for payments made, bank pay-in counterfoil, invoice copies for purchases, correspondence, agreements and so on. Generally, the auditor checks the accounts on basis of these documents. 7. Accounting Period Concept: The users of financial statements need periodical reports to know the operational result and the financial position of the business concern. Hence it becomes necessary to close the accounts at regular intervals. Usually a period of 365 days or 52 weeks or 1 year is considered as the accounting period. 8. Cost Concept: 7

Under this concept, assets are recorded at the price paid to acquire them and this cost is the basis for all subsequent accounting for the asset. For example, if a piece of land is purchased for Rs.5,00,000 and its market value is Rs.8,00,000 at the time of preparing final accounts the land value is recorded only for Rs.5,00,000. Thus, the balance sheet does not indicate the price at which the asset could be sold for. Market value cannot be accurately ascertained. They are subject to market fluctuations. Historical concept is critisised for three reasons. Firstly, historical cost does not reflect true value of asset, secondly, it does not reflect true and fair value financial position of business unit.Thirdly cost concept ignores inflation which erodes the value of money and the true worth of assets. 9. Revenue Realisation Concept According to this concept, revenue is considered as the income earned on the date when it is realised. Unearned or unrealized revenue should not be taken into account. The realisation concept is vital for determining income pertaining to an accounting period. It avoids the possibility of inflating incomes and profit 10. Accrual Concept: According to this concept, the revenues and expenses are recognized by the companies when they are earned or incurred and not when the actual money was received or paid. n example of accrual principle is a transaction of credit sales. If a company makes sale on credit then it will enter the revenue on the income statement regardless the company has received or not received the cash. 21. Explain Accounting Conventions Full Disclosure Accounting statements should disclose fully and completely all the significant information. Based on this, decisions can be taken by various interested parties. It involves proper classification and explanations of accounting information which are published in the financial statements Consistency The aim of consistency principle is to preserve the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously observed and applied year after year. Comparisons of financial results of the business among different accounting period can be significant and meaningful only when consistent practices were followed in ascertaining them. For example, depreciation of assets can be provided under different methods, whichever method is followed, it should be followed regularly Materiality The materiality principle requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information are either left out or merged with other items

Prudence (Conservatism) Prudence principle takes into consideration all prospective losses but leaves all prospective profits. The essence of this principle is anticipate no profit and provide for all possible losses. For example, while valuing stock in trade, market price or cost price whichever is less is considered. UNIT II 1. What is Trading Account? Trading account shows the result of buying and selling goods. This account is prepared to find out difference between cost price (i.e, direct cost) and selling price of products. The net result may be gross profit (or ) gross loss. 2. Write a note on Gross Profit Ratio. This ratio indicates the efficiency of trading activities. The relationship of Gross profit to Sales is known as gross profit ratio. The ratio is calculated as: Gross Profit Gross Profit Ratio = x 100 Sales Gross profit is taken from the Trading Account of a business concern. Otherwise Gross profit can be calculated by deducting cost of goods sold from sales. Sales means Net sales (Sales Net Sales) Gross Profit = Sales Cost of goods sold Cost of goods sold = Opening Stock + Purchases Closing Stock (or) Sales Gross Profit 3. What is Profit and Loss Account? The profit and loss a/c shows the net profit (or) net loss for a particular period after charging the indirect expense and income. 4. What is a Balance Sheet? What are its objectives. Balance Sheet is a statement which set out the assets and liabilities of a business firm and which serves to ascertain the financial position of the business of the same on any particular date. OBJECTIVES OF BALANCE SHEET:

1. It shows accurate financial position of a firm. 2. It is a gist of various transactions at a given period. 3. It clearly indicates, whether the firm has sufficient assents to repay its liabilities. 4. The accuracy of final accounts is verified by this statement 5. It shows the profit or Loss arrived through Profit & Loss A/c. 4. What is the difference between Gross Profit and Net Profit? Gross Profit: Goss profit is net sales, less cost o goods sold but before consideration general and selling expense, incidental income and income deduction. Net Profit: The net profit is gross profit less general and selling expenses incidental income and income deduction 5. What is Manufacturing Account? Those concerns which convert raw materials in to finished goods and then sell the finished goods, are required to prepare manufacturing account besides preparing trading and profit and loss account. This account is prepared to calculate the cost of goods manufactured, which is transferred to the trading account. The expenses relating to the factory are transferred to manufacturing account. The main object of manufacturing account is to show: cost of finished goods produced and Cost of material consumed, productive wages, direct and indirect expenses. 6. Write a short note on (a) Capital Expenditure (b) Revenue Expenditure (c) Capital Receipt (d) Revenue Receipt (a) Capital Expenditure: Capital expenditure consists of those expenditures, the benefit of which is carried over to several accounting periods. In other words the benefit of which is not consumed within one accounting period. It is non-recurring in nature. Characteristics: i. Purchase of a fixed asset. ii. Not acquired for sale. iii. It is non-recurring in nature. iv. Incurred to increase the operational efficiency of the business concern. Examples Expenses incurred in the acquisition of Land, Building, Machinery, Furniture, Car, Goodwill, Copyright, Trade Mark, Patent Right, etc. (b) Revenue Expenditure: Revenue expenditures consist of those expenditures, which are incurred in the normal course of business. They are incurred in order to maintain the existing earning capacity of the business. It helps in the upkeep of fixed assets. Generally it is recurring in nature. Characteristics:

10

i. It helps in maintaining the earning capacity of the business concern. ii. It is recurring in nature. Examples: i. Cost of goods purchased for resale. ii. Office and administrative expense ( c ) Deferred Revenue Expenditure: A heavy revenue expenditure, the benefit of which may be extended over a number of years, and not for the current year alone is called deferred revenue expenditure. For example, a new firm may advertise very heavily in the beginning to capture a position in the market. The benefit of this advertisement campaign will last for quite a few years. It will be better to write off the expenditure in three or four years and not only in the first year. (d) Capital Receipt: Capital receipt is one which is invested in the business for a long period. It includes long term loans obtained from others and any amount realized on sale of fixed assets. It is generally non-recurring in nature. Characteristics: i. Amount is not received in the normal course of business. ii. It is non-recurring in nature. Examples: i. Capital introduced by the owner, ii. Borrowed loans. iii. Sale of fixed asset. (e) Revenue Receipt: Revenue receipt is the receipt of income which is earned during the normal course of business. It is recurring in nature. Characteristics: i. It is received in the normal course of business. ii. It is recurring in nature. Examples: i. Sale of goods or services. ii. Commission and Discount received. iii. Dividend and interest received on investments etc. 7. What do you mean by Non- trading Organisations? Charitable Institutions, Educational Institutions, Cultural Societies, Sports and recreation clubs, Libraries and Hospitals are Non-Trading organizations. The object of non-trading organizations is to render services to the members or beneficiaries. These Institutions are created for the promotion of Arts, Culture, Games, Sports, Fine Arts, Health Service etc. 11

These institutions do not aim at making profit. Hence they are known as Non-Profit Organisations or Non-trading Organisations. 8. What is Receipt and Payment accounts? It is summary of cash transactions of a non trading concern. It shows all receipts and payments during a year and the final balance of cash in hand or at bank or balance of bank overdraft. It is the cashbook prepared by a non trading concern. 9. What do you mean by Income and Expenditure Account? This is similar to the profit and loss account prepared by a trading concern. It lists all the incomes and expenses of the non trading organization for a year. The result of this account is referred to as surplus or excess of income over expenditure or deficit or excess of expenditure over income. When the income is more than the expenditure the result is known as surplus. When the expenditure is more than the income, the result is known as deficit. It is prepared by considering all expenditures and incomes relating to the current year whether it is paid or not. 9. Differentiate between Income and Expenditure account and Receipts and Payments Account. Basis of Difference Income and Expenditure Account 1. Nature of It is like Profit and Loss Account Account or a Nominal Account. 2. Nature of Items Only revenue receipts and payments are taken 3. Period Only items connected with current year are taken 4. Method of Accounting System 5. Structure of Account 6. Time of preparing Trial Balance 7. Availability of opening balance 8. Adjustments 9. Type of balance Receipts and Payments Account It is like cash book or a real account

Both capital and revenue items are shown. Period is immaterial. It may be related with the present, future or past, all are recorded. Similar to profit and loss Similar to cash book, cannot be a account, hence it is a part of part of double entry system double entry system Debit is Expenditure and Debit is receipts and credit is Credit is income Payments After preparing income and Trial Balance can be prepared expenditure account, trial only after preparing cash book balance can also be prepared There is no opening balance There are opening balances of cash in hand and at bank Adjustments for outstanding No need for any adjustment expenses/accrued incomes is a must Difference of income and Difference of receipts and

12

expenditure is either surplus or payments account is cash in deficit. hand/bank .In reverse case, it is overdraft. 43. Write a note on (a) Donations (b) Legacy (c) Life Membership fees (d) Subscription (e) Entrance Fees (a) Donations: Donations are received by non-profit organization as a gift. It is a capital receipts. Some times according to instruction, part of donation received is treated as revenue receipt and balance part is capital receipt. (b) Legacy: It is the amount given to non-profit organization as per the will of a deceased person. It is added to the capital fund on the liability side of balance sheet. (c) Life Membership Fees: The subscription from ordinary members of non-profit organization is usually collected on every months. The other category of members called LIFE MEMBERS from whom subscription is collected only once at the time of admission as a lump.it is called LIFE MEMBERSHIP FEES It is a capital receipt. (d) Subscription: It is usually collected every month from all the ordinary members. in addition to this, some special subscription like subscription for billiards, tennis are collected from relevant members playing that game. These subscriptions are alwaysREVENUE RECEIPTS. (e) Entrance Fees or Admission Fees: It is a fee collected every member only once at the time of their admission in to organization. It is treated as capital or revenue receipt according to information. UNIT III 1. What is Average Due Date? How it is calculated? Average due date is the date on which a single payment may be made in one single amount in the place of several amounts due on different dates, without loss of interest to either persons. Calculation of average due date: (a) Take any one date as a base year. It is better to take the first transaction due date as a base date. (b) Compute number of days from the base date to the due date of each transaction. (c) Compute product amount by multiply the number of days so calculated by the corresponding amount of transaction. (d) Calculate total product amount and the total transaction amount. (e) Divide the total product amount by total of the amount. The results number of days.

13

(f) Calculate the date by adding the number of days from base date. This is an average date.

FORMULA: = Base date + total product amount Total of the amount 2. What are the methods of calculating Average Due Date?

The following are the two methods of calculating Average Due Date: 1. Lending in Instalments but repayment in Lumpsum 2. Lending in Lumpsum but repayment in Instalment 3. What is Account Current? Account current is a statement in debit and credit form recording the transaction between two periods in chronological order. The account current is the copy of account available in the books of sender with the extra column for interest. It consists of records of all purchases, sales, receipts and payments. The account current statement is sent by agent of principal (or) banker to customer (or) from one trader to another trader. In account current statement, the name of the party to whom is sent appears first. For example: Govindan in account current with Ravi. 4. What are the methods of Calculation of interest in account current problems? There are three methods of calculating interest in account current. They are: (a) Forward Method or Interest Table method: Interest is calculated for each transaction by simple interest method by counting the number of days from the date of transaction to the settlement date. (b) Product Method: Under this method, interest is calculated for one day on the balance of product amount. The product amount is calculated by multiplying the amount of transaction and number of days up to settlement date. Formula: Balance of product amount x rate of interest x 1 100 365 (c) Periodical balance Method: Under this method interest is calculated on the balance of account after every transaction. This method is usually followed by banks. 5. What is Red Ink Interest?

14

If the due date of the bill occurs after the date of closing the account, no interest is paid for the period. But, the interest from the date of closing to this due date is entered in red ink on the proper side of the account current. The interest is known as Red Interest. It is negative interest. In practice, the product of such bill i.e., (value of bill x(due date-closing date) is entered in ordinary ink in the opposite side of the account on which the bill is entered. 6. What do you mean by Bank Reconciliation Statement? Bank reconciliation statement is the comparison of a bank statement (sent by bank) with the cash book (prepared by business) in order to explore, identify, explain and to account for the difference between the cash book and bank statement balances 67 Why Bank Reconciliation Statement is prepared? The need and importance of the bank reconciliation statement may be given as follows: It prevents cash embezzlement and frauds It is helpful in identifying errors and mistakes in a cashbook and bank statement Bank reconciliation statement explains the reasons for the disagreement between cashbook and bank statement balances 8. What are the causes of differences between Cash Book and Pass Book? A transaction relating to bank has to be recorded in both the books i.e. Cash Book and Pass Book but sometimes it happens that a bank transaction is recorded only in one book and not recorded simultaneously in other book this causes difference in the two balances. These differences may arise due to errors or mistakes and omissions in cash book and time difference between business and bank in recordintg the transactions. The causes for difference may be illustrated as follows: 1. Cheques issued but not yet presented for payment 2. Cheques paid into the bank but not yet cleared. 3. Interest allowed by the Bank 4. Interest and Expenses Charged by the Bank 5. Interest and dividends collected by Bank 6. Direct payments by the bank 7. Direct payments into the bank by a customer 8. Dishonor of a bill discounted with the bank 9. Bills collected by the bank on behalf of the customer 10. Errors committed either in Cash Back or Pass Book 9. What is Trial Balance? What are its advantages ? According to J.R. Batliboi Trial balance is a statement, prepared with the debit and credit balances of ledger accounts to test the arithmetical accuracy of the books Advantages:

15

1. It is the shortest method of verifying the arithmetical accuracy of entries made in the Ledger. If the Trial balances agree, it is an indication that the Accounts are correctly written up; but it is not a conclusive proof. 2. It helps to prepare the Trading A/c, Profit & Loss a/c and Balance Sheet. 3. It presents to the businessman consolidated lists of all Ledger Balances. 10.Explain different types of errors in accounting Classification of Accounting errors Accounting errors are classified in to four types on the basis of nature of Errors. They are (1) Errors of Omission, (2) Errors of Commission, (3) Errors of Principles and (4) Compensating Errors. (1) Errors of Omission The Errors of Omission will occur when a transaction is not recorded in the books of accounts or omitted by mistake. The Errors of Omission may happen as partial or complete. The partial errors may happen in relation to any subsidiary books. This is the result of when a transaction is entered in the subsidiary book but not posted to the ledger. For example, cash paid to the suppliers has been entered in the payment side of the cash book but it will not be entered in the debit side of the suppliers account. The complete omission may happen the transaction is completely omitted from the books of accounts. For example, an accountant fails to enter a specific invoice from the sales day book. (2) Errors of Commission When a transaction is entered in the books of accounts in wrongly, this may be entered as partially or incorrectly. This kind of errors are known as Errors of Commission. The Errors of Commission may happen because of ignorance or negligence of the accountant. This may be of different types, the main reasons are Errors relating to subsidiary books and Errors relating to ledger. (3) Errors of Principles This kind of errors are occurs when the entries are made against the principle of accounting. These Errors are made because of the following reasons:1. Errors happens due to the inability to make a distinction between the revenue and capital items. 2. Errors happens due to the inability to make a difference between the business expenses and personal expenses. 3. Errors happens because of the inability to make a distinction between the productive expense and nonproductive expenses. (4) Compensating Errors Compensating Errors are those errors which compensates themselves in the net results of the business. This means, if there are over debit in one account which will be compensated by the over credit in some account in the same extent of the business. Like

16

that, if there is a wrong debit in one account which will be neutralized by some wrong credit in the same extent of the business. 11. What is Suspense Account? When the trial balance totals do not agree and the errors cannot be found immediately the difference is put to an interim account until the errors are located. Since the errors are put to suspense, the account is refereed to as a Suspense Account. If debits are short and credit are in excess in the trial balance, the difference is placed to suspense account as a debit balance. It appears on the asset side of the balance sheet. Similarly, if credit is short and debit is in excess in the trial balance suspense account will be a credit balance and will be shown on the liabilities side of the balance sheet. Thus suspense account helps in tallying the balance sheet. If the errors are not located by the end of the financial period, then the suspense account will be entered in the Balance Sheet. Whenever the errors are located they are taken from the Suspense Accounts and corrected in the account containing the error.

12 What are the various types of Errors disclosed and not disclosed by Trial Balance.

Types of Errors

Errors disclosed by Trial balance 1. Error of Commission 2. Error of Partial omission 3.Error of Casting 4.Error in Carrying or bringing forward 5.Error in balancing

Errors not disclosed by Trial Balance 1. Error of Principle 2. Error of complete omission 3. Compensating errors 4. Error of duplication 5.Error of amounts in original entries 6.Posting to correct side but wrong account UNIT IV

1. Define Depreciation

17

According to ICMA (Institute of Cost and ManagementAccountants - London) Terminology Depreciation is the diminution in intrinsic value of asset due to use and / lapse of time. 2. What are the causes of depreciation? The following are the causes of depreciation: I. Internal Causes 1. Wear and tear: Wear and tear is an important cause of depreciation in case of tangible fixed asset. It is due to use of the asset. 2. Disuse: When a machine is kept continuously idle, it becomes potentially less useful. 3. Maintenance: The value of machine deteriorates rapidly because of lack of proper maintenance. 4. Depletion: It refers to the physical deterioration by the exhaustion of natural resources eg., mines, II. External Causes 1. Obsolescence: The old asset will become obsolete (useless) due to new inventions, improved techniques and technological advancement. 2. Effluxion of time: When assets are exposed to forces of nature, like weather, wind, rain, etc., the value of such assets may decrease even if they are not put into any use. 3. Time Factor: Lease, copy-right, patents are acquired for a fixed period of time. On the expiry of the fixed period of time, the assets cease to exist.quarries, oil wells etc. 3. What are the factors determining the amount of Depreciation? 1. Original cost of the asset: It implies the cost incurred on its acquisition, installation, commissioning and for additions or improvements thereof which are of capital nature 2. Estimated life: It implies the period over which an asset is expected to be used. 3. Residual value: It implies the value expected to be realised on its sale on the expiry of its useful life. This is otherwise known as scrap value or turn-in value. 4. Explain the methods of calculating Depreciation? 1. Straight line method or fixed instalment method or Original Cost Method Under this method, the same amount of depreciation is charged every year through out the life of the asset. The amount and rate of depreciation is calculated as under 1) Amount of depreciation Total cost Scrap value = Estimated Life 2) Rate of depreciation

18

Amount of Depreciation = x 100 Original Cost Merits: 1. It is very simple and easy to understand. 2. It is easy to calculate the amount and rate of depreciation. 3. Under this method, the book value of the asset becomes zero or equal to its scrap value at the expiry of its useful life. Demerits: The amount of depreciation is same in all the years, although the usefulness of the machine to the business is more in the initial years than in the later years. 2. Written down value method or diminishing balance method Under this method, depreciation is charged at a fixed percentage each year on the reducing balance (i.e., cost less depreciation) of asset. The amount of depreciation goes on decreasing every year. For example, if the asset is purchased for Rs.1,00,000 and depreciation is to be charged at 10% p.a. on reducing balance method, then Depreciation for the 1st year = 10% on Rs.1,00,000, ie., Rs.10,000 Depreciation for the 2nd year = 10% on Rs.90,000(Rs.1,00,000 Rs.10,000) = Rs. 9,000 Depreciation for the 3rd year = 10% on Rs.81,000(Rs.90,000 - Rs.9,000) = Rs.8,100 and so on. Merits 1. This method is recognised by the Income Tax authorities 2. It is a logical method as the depreciation is calculated on the diminished balance every year. Demerits: It is very difficult to determine the rate by which the value of asset could be written down to zero. 3. Depletion Method: Depletion is a periodic charge to expense for the use of natural resources. Thus, it is used in situations where a company has recorded an asset for such items as oil reserves, coal deposits, or gravel pits. The calculation of depletion involves these steps: a. Compute a depletion base b. Compute a unit depletion rate c. Charge depletion based on units of usage 6. Annuity method: The annuity method considers that the business besides loosing the original cost of the asset in terms of depreciation and also looses. The total charge is more or less equal

19

interest on the amount used for buying the asset. This is based on the assumption that the amount invested in the asset would have earned in case the same amount would have been invested in some other form of investment. The annual amount of depreciation is determined with the help of annuity table. This method is used to calculate depreciation amount on lease. 7. Depreciation Fund Method or Sinking Fund Method : Under this method, funds are made available for the replacement of asset at the end of its useful life. The depreciation remains the same year after year and is charged to Profit and Loss account every year through the creation of depreciation fund. The amount of annual depreciation is invested in good securities bearing interest at a specified rate. The aggregate amount of interest and annual provision is invested every year. When the asset is completely written off or is to be replaced, the securities are sold and the amount so realised by selling securities is used to replace the old asset. 8. Insurance Policy Method: According to this method, an Insurance policy is taken for the amount of the asset to be replaced. The amount of the policy is such that it is sufficient to replace the asset when it is worn out. A sum equal to the amount of depreciation is paid as premium every year. The amount goes on accumulating at a certain rate of interest and is received on maturity. The amount so received is used for the purchase of new asset, replacing the old one. 7. Revaluation Method: Under this method, the assets like loose tools are revalued at the end of the accounting period and the same is compared with the value of the asset at the beginning of the year. The difference is considered as depreciation. 8. Machine hour Rate Method: The machine-hour method of depreciation estimates the useful life of an asset in machine hours, so, it is commonly applied on a machine. The useful life is based on the numbers of hours of a machine that can be utilized. The machine-hour method of depreciation is calculated using the following formula: D = (C R) / T Where D is the hourly depreciation charge, C is the original cost or cost of acquisition, R is the residual value, and T is the machines useful life measured in hours. 5. Why there is a need for Fire Insurance Claims

20

Fire, in the business premises of any firm can damage a number of assets like stock, building, furniture etc., in addition, the normal working of a firm is affected for a number of a numbers of days or months, resulting in loss of sales and loss of profits. The following are the the needs for fire insurance: a) To renew the damage property b) To overcome the loss due to short sales and loss of profit occurring out of fire c) To replace the destroyed asset d) To purchase the destroyed stock 5. Write a note on (a) Standing Charges (b) Short Sales (c) Special Circumstances clause (d) Indemnity Period (e) Salvage Value (f) Turnovers (a) Standing Charges: These are the fixed expense which have to be paid whether work is carried on or not like salaries, rent, postage. (b) Short Sales: This is the difference between standard turnover and affected period turnover. ( c) Special Circumstances Clause : : If any increasing or decreasing trend is observed in sales, adjustment has to be made. (d) Indemnity Period: This is the period for which the insurance policy is taken against the risk of fire. the insurance policy is always taken for a period of one year. (e) Salvage Value: The demand stock and undamaged stock are separately valued and are called salvage value or stock salvaged. (f) Turnovers: Turnovers means the money paid or payable to the insured for goods sold and delivered and the course of the business at the premises. The following are the types of turnovers Affected period Turnover: This is the actual sales made during the period in which work is affected. Standard Turnover: The turnover effected in the last accounting period corresponding to the indemnity period. Actual Turnover or Annual Turnover: The turnover during the twelve months exactly before fire. Accounting year Turnover: This is the turnover of the last accounting year. Saved Turnover: This is the sales achieved due to spending additional amounts during the affected period.

21

9. What is Average Clause? The insurance company applies the average clause in case of under insurance. If the value of insurance policy is less than the value of average stock in the godown it is known as under insurance. In order to discourage the under insurance the average clause is inserted by the insurance company Amount of claim = Value of the policy __________________________ x Value of stock on the date of fire Actual loss of stock

UNIT V 1. What is Single Entry System ? What are its Features. Accounting records which are not maintained according to double entry principles is known as Single Entry System. Single Entry System is an incomplete, inaccurate, unscientific and unsystematic system of book keeping. According to Kohler Single Entry System is a system of bookkeeping in which as a rule, only records of cash and personal accounts are maintained. It is always incomplete double entry varying with circumstances. Salient Features of Single Entry System 1. Suitable for sole traders and partnership firms 2. Only personal accounts and cash accounts are kept 3. All transactions are not recorded 4. This system lacks uniformity as it is prepared according to the convenience of the individual. 5. It is quite often seen that for information one has to depend on original vouchers. 6. Profit under this system is only an estimate. 7. True financial position can not be ascertained: 8. Not accepted by Tax Authorities 2. What are the different methods of ascertaining profit under Sigle Entry System? : When accounts are kept under single entry system, the following methods are adopted to find out profit or loss of the business. 1. Statement of affairs method or Net worth method or Capital comparison method 2. Conversion method

22

3. Distinction between Statement of Affairs and Balance Sheet: Statement of affairs which looks like a balance sheet differs from the balance sheet in the following respects. BASIS OF DISTINCTION (1)BASIS OF PREPARATION: (2)SYSTEM: (3)TRIAL BALANCE: BALANCE SHEET Balance sheet is based on ledger. Balance sheet is prepared on the basis of double entry system. Trial balance is prepared before a balance sheet is drawn which ensures its arithmetic accuracy. Omission of any asset or liabilities is automatically found in balance sheet because the debit and credit will not tally. Capital is shown in the balance sheet from the capital account in the ledger. STATEMENT OF AFFAIRS Statement of affairs is prepared from balance, valuation, information from inquiry. Statement of affairs is out of incomplete records. Statement of affairs has no foundation like trial balance. Statement of affairs cannot reveal any omissions and commissions in asset and liabilities. Capital in the statement of affairs, is only a balancing figure in the statement itself.

(4)OMISSION OF ASSET AND LIABILITIES:

(5)CAPITAL:

3. . Difference between Double Entry System and Single Entry System: BASIC OF DIFFERENCE RECORDING OF TRANSACTION: OPENING OF ACCOUNTS: PREPARATION OF TRIAL BALANCE: ASCERTAINING PROFIT OR LOSS: REVEALING FINANCIAL POSITION: DOUBLE ENTRY SYSTEM SINGLE ENTRY SYSTEM Both aspects of all transaction are recorded. All personal, real, nominal accounts are opened. Trial balance are prepared. Accurate profit or loss can be found ,through trading and profit or loss a/c. Reliable financial position can be found through balance sheet. In some case, both aspects, in some others a single aspects or no aspects is recorded. Only personal accounts and cash accounts are opened. Trial balance cannot be prepared. Profit or loss cannot be found normally ,in the absence of trading and profit or loss a/c. Balance sheet cannot be prepared. so finally position is difficult to ascertain. 23

ACCEPTABILITY: ACCEPTABLE EVIDENCE: UTILITY:

Acceptable for income tax and other tax puposes, for raising of bank loan etc., Incase of disputes accounting records can be produced in courts of law. Suitable for any type of business of any size. Internal check is possible.

Not acceptable for taxation, claims, raising of loans. etc.., The accounting records are not acceptable as evidence. It can be followed by small business men who can exercise personal control over the business. Internal check is not possible.

INTERNAL CHECK:

4. List out the limitations of Single Entry System (i) Insufficient records. (ii) Absence of trial balance. (iii) Difficulty in ascertaining profit. (iv) Difficulty in ascertaining financial position. (v) Lack of statistical data. (vi ) Encouragement of fraud. (vii) Rectification of errors is difficult. (viii) Value of business cannot be ascertained. (ix) Planning of decision making are difficult. (x) Difficulty in getting institutional loans. (xi) Filing tax returns, preparing claims etc..,

24

FINAL ACCCOUNTS ADJUSTMENT ENTRIES:

25

26