August 2009

Bachelor of Science in Information Technology (BScIT) – Semester 4

BT0048 – Accounting Principles & Practice – 4 Credits
(Book ID: B0429)
Assignment Set – 1 (60 Marks)

Answer all questions

Quest 1 Briefly explain the functions of accounting.

Accountancy is the art of communicating financial information about a business entity

to users such as shareholders and managers. The communication is generally in the
form of financial statements that show in money terms the economic resources under
the control of management.

Accounting is thousands of years old. The earliest accounting records were found in
the Middle East which date back more than 7,000 years. The people of that time
relied on primitive accounting methods to record the growth of crops and herds.
Accounting evolved, improving over the years and advancing as business advanced.

Early accounts served mainly to assist the memory of the businessperson and the
audience for the account was the proprietor or record keeper alone. Cruder forms of
accounting were inadequate for the problems created by a business entity involving
multiple investors, so double-entry bookkeeping first emerged in northern Italy in the
14th century, where trading ventures began to require more capital than a single
individual was able to invest. The development of joint stock companies created wider
audiences for accounts, as investors without firsthand knowledge of their operations
relied on accounts to provide the requisite information. This development resulted in
a split of accounting systems for internal (i.e. management accounting) and external
(i.e. financial accounting) purposes, and subsequently also in accounting and
disclosure regulations and a growing need for independent attestation of external
accounts by auditors.

Today, accounting is called "the language of business" because it is the vehicle for
reporting financial information about a business entity to many different groups of
people. Accounting that concentrates on reporting to people inside the business
entity is called management accounting and is used to provide information to
employees, managers, owner-managers and auditors. Management accounting is
concerned primarily with providing a basis for making management or operating
decisions. Accounting that provides information to people outside the business entity
is called financial accounting and provides information to present and potential
shareholders, creditors such as banks or vendors, financial analysts, economists, and
government agencies. Because these users have different needs, the presentation of
financial accounts is very structured and subject to many more rules than
management accounting. The body of rules that governs financial accounting is called
Generally Accepted Accounting Principles, or GAAP.

Accounting has also been defined by the AICPA as "The art of recording, classifying,
and summarizing in a significant manner and in terms of money, transactions and
events which are, in part at least, of financial character, and interpreting the results
thereof."
The functions of accounting are as follows

• Recording: This is the basic function of accounting. It is essentially concerned

with not only ensuring that all business transactions of financial character are in
fact recorded but also that they are recorded in an orderly manner. Recording is
done in the book "Journal".

• Classifying: Classification is concerned with the systematic analysis of the

recorded data, with a view to group transactions or entries of one nature at one
place. The work of classification is done in the book termed as "Ledger".

• Summarizing: This involves presenting the classified data in a manner which

is understandable and useful to the internal as well as external end-users of
accounting statements. This process leads to the preparation of the following
statements: (1) Trial Balance, (2) Income statement (3) Balance sheet.

• Analysis and Interprets: This is the final function of accounting. The

recorded financial data is analyzed and interpreted in a manner that the end-
users can make a meaningful judgment about the financial condition and
profitability of the business operations. The data is also used for preparing the
future plan and framing of policies for executing such plans.

• Communicate: The accounting information after being meaningfully analyzed

and interpreted has to be communicated in a proper form and manner to the
proper person. This is done through preparation and distribution of accounting
reports, which include besides the usual income statement and the balance
sheet, additional information in the form of accounting ratios, graphs,
diagrams, funds flow statements etc.

Quest 2 Explain the three branches of accounting.

Three branches of accounting are as follows:

• Financial Accounting: The main object of Financial Accounting is to find out

the profitability and to provide information about financial position of the
concern. It presents a general idea of the working of the business and permits
management to control in general way the major functions of a business, viz.
finance, administration, production and distribution. But Financial Accounting
does not give details.
• Cost Accounting: The main objects of Cost Accounting is to find out the cost
of goods produced or services rendered by business. It also helps the
management to detect and control all leakages, defective works, and wastage
in tools and stores.
• Management Accounting: The primary objective of Management Accounting
is to supply relevant information at appropriate time to the management to
enable it to take the decisions and effect control

Uses of Accounting

Accounting plays important and useful role by developing the information for
providing answers to many questions faced by the users of accounting information.

• How good or bad is the financial condition of the business?

• Has the business activity resulted in a profit or loss?
• How well the different departments of the business have performed in the
past?
• Which activities or products have been profitable?
• Out of the existing products which should be discontinued and the production
of which commodities should be increased.
• Whether to buy a component from the market or to manufacture the same?
• Whether the cost of production is reasonable or excessive?
• What has been the impact of existing policies on the profitability of the
business?
• What are the likely results of new policy decisions on future earning capacity of
the business?
• In the light of past performance of the business how it should plan for future to
ensure desired results?

Above mentioned are few examples of the types of questions faced by the users of
accounting information. These can be satisfactorily answered with the help of suitable
and necessary information provided by accounting.
Besides, accounting is also useful in the following respects:-

• Increased volume of business results in large number of transactions and no

businessman can remember everything. Accounting records obviate the
necessity of remembering various transactions.
• Accounting record, prepared on the basis of uniform practices, will enable a
business to compare results of one period with another period.
• Taxation authorities (both income tax and sales tax) are likely to believe the
facts contained in the set of accounting books if maintained according to
generally accepted accounting principles.
• Cocooning records, backed up by proper and authenticated vouchers are good
evidence in a court of law.
• If a business is to be sold as a going concern then the values of different assets
as shown by the balance sheet helps in bargaining proper price for the
business.

Limitations of Financial Accounting

Advantages of accounting discussed in this section do not suggest that accounting is

free from limitations.

Following are the limitations:

Financial accounting permits alternative treatments Accounting is based on concepts

and it follows “generally accepted principles" but there exist more than one principle
for the treatment of any one item. This permits alternative treatments within the
framework of generally accepted principles. For example, the closing stock of a
business may be valued by anyone of the following methods: FIFO (First-in- First-out),
LIFO (Last-in-First-out), Average Price, Standard Price etc., but the results are not
comparable.

Financial accounting does not provide timely information

It is not a limitation when high powered software application like Hi-tech Financial
Accenting are used to keep online and concurrent accounts where the balance sheet
is made available almost instantaneously. However, manual accounting does have
this shortcoming.

Financial accounting is designed to supply information in the form of statements

(Balance Sheet and Profit and Loss Account) for a period normally one year. So the
information is, at best, of historical interest and only 'post-mortem' analysis of the
past can be conducted. The business requires timely information at frequent intervals
to enable the management to plan and take corrective action. For example, if a
business has budgeted that during the current year sales should be $ 12,00,000 then
it requires information whether the sales in the first month of the year amounted to $
10,00,000 or less or more?

Traditionally, financial accounting is not supposed to supply information at shorter

interval less than one year. With the advent of computerized accounting now software
like Hi-tech Financial Accounting displays monthly profit and loss account and balance
sheet to overcome this limitation. Financial accounting is influenced by personal
judgments ‘Convention of objectivity' is respected in accounting but to record certain
events estimates have to be made which requires personal judgment. It is very
difficult to expect accuracy in future estimates and objectivity suffers. For example, in
order to determine the amount of depreciation to be charged every year for the use
of fixed asset it is required estimation and the income disclosed by accounting is not
authoritative but 'approximation'.

Quest 3 What is single entry system? What are the advantages and
disadvantages of Single entry system? (10 marks)

Single-entry bookkeeping system also known as Single-entry accounting system is a

method of bookkeeping relying on a one sided accounting entry to maintain financial
information.

Overview
Most businesses maintain a record of all transactions based on the double-entry
bookkeeping system. However, many small, simple businesses maintain only a single-
entry system that records the "bare-essentials." In some cases only records of cash,
accounts receivable, accounts payable and taxes paid may be maintained. Records of
assets, inventory, expenses, revenues and other elements usually considered
essential in an accounting system may not be kept, except in memorandum form.
Single-entry systems are usually inadequate except where operations are especially
simple and the volume of activity is low.
This type of accounting system with additional information can typically be compiled
into an income statement and balance sheet by a professional accountant.

Advantages
• Single-entry systems are used in the interest of simplicity.
 • They are usually less expensive to maintain than double-entry systems
because they do not require the services of a trained person

Disadvantages
•Data may not be available to management for effectively planning and controlling
the business.
•Lack of systematic and precise bookkeeping may lead to inefficient administration
and reduced control over the affairs of the business.
•Single-entry records do not provide a check against clerical error, as does a
double-entry system. This is one of the most serious defects of single-entry
systems.
•Single-entry records seldom make provision for recording all transactions. In
addition, many internal transactions, such as adjusting entries are often not
recorded.
•Because no accounts are provided for many of the items appearing in both the
Income Statement and Balance Sheet, omission of important data is possible.
•In the absence of detailed records of all assets, lax administration of those assets
may occur.
•Theft and other losses are less likely to be detected.

Quest 4: Briefly explain the types of business transaction. (10 marks)

A business transaction is driven by well-defined business tasks and events that

directly or indirectly contribute to generating economic value, such as processing and
paying an insurance claim, and has also an associated number of parameters that
represent security and timing requirements. Business transactions always either
succeed or fail with respect to the business tasks (functions) that initiated them and
govern them throughout their execution. If a business transaction completes
successfully then each participant will have made consistent state changes, which, in
aggregate, reflect the desired outcome of the multi-party business interaction.

At structural level, a business transaction is made up of a requesting (initiating)

business activity performed by an initiating partner (party) and a responding business
activity performed by the responding business partner. The initiating business activity
sends a business document to a responding business activity that may return a
business signal (signifying the completion of an activity) and possibly a business
document as the last responding message. A transaction is associated with an SLA
that describes the agreed upon QoS requirements and usually outlines what each
party can do in the event the intended actions are not carried out (e.g., promised
services not rendered, services rendered but payment not issued).

Quest 5 What do you mean by Bank reconciliation statement? (05

marks)
Bank reconciliation is the process of matching and comparing figures from accounting
records against those presented on a bank statement. Less any items which have no
relation to the bank statement, the balance of the accounting ledger should reconcile
(match) to the balance of the bank statement. Bank reconciliation allows companies
or individuals to compare their account records to the bank's records of their account
balance in order to uncover any possible discrepancies. Since there are timing
differences between when data is entered in the banks systems and when data is
entered in the individual's system, there is sometimes a normal discrepancy between
account balances. The goal of reconciliation is to determine if the discrepancy is due
to error rather than timing.

Comparing The Bank Statement To The Cashbook

When all of the receipts for a period have been written up in the cash receipts book
and all of the cheque payments, standing orders and direct debits have been entered
into the cash payments book, it is necessary to carry out any further checks possible
on the cashbook. The most obvious check is to compare the entries in the cash
receipts and cash payments book for the period, to the entries on the bank
statement, although some care does need to be taken here.

Debits and Credits One of the most obvious differences between the cashbook and
the bank statement is that the use of the terms debit and credit appear to be totally
opposed to each other.
If cash is paid into the bank by a business then for the business this is a receipt and is
entered in the cash receipts book as a debit entry. However, in the bank statement
this will be described as a credit and the balance will be a credit balance. This is due
to the fact that if a business has money in the bank, the bank effectively owes the
money back to the business and therefore the business is a creditor to the bank.
Similarly, if the business writes a cheque out of the business bank account this will be
entered in the cash payments book as a credit entry. From the bank's perspective
however, this is known as a debit entry and any overdrawn balance is a debit balance.

Method of Doing A Bank Reconciliation

Summarised, the procedure for performing a bank reconciliation, in four simple steps:
• Compare the cash receipts book to the receipts shown on the bank statement
(the credits on the bank statement) - for each receipt that agrees, tick the item
in both the cashbook and the bank statement.

• Compare the cash payments book to the payments shown on the bank
statement (the debits on the bank statement) - for each payment that agrees,
tick the item in both the cashbook and the bank statement.

• Any un-ticked items on the bank statement (other than rare errors made by the
bank) will be items that should have been entered into the cash books, but
have been omitted for some reason - these should be entered into the
cashbook and then the amended balance on the cashbook can be found. To
find the correct cashbook balance a ledger account is used for the bank with
the original cashbook balance shown as the brought forward balance and any
additional payments shown as credits and receipts as debits. This is illustrated
in the example.

• Finally, any un-ticked items in the cashbook will be the timing differences -
unpresented cheques and outstanding lodgements - these will be used to
reconcile the bank statement closing balance to the corrected cash book
closing balance.

Quest 6: What are the different classifications of error? (10

marks)
The language definition classifies errors into several different categories:
Errors that are required to be detected prior to run time by every Ada
implementation; These errors correspond to any violation of a rule given in this
International Standard, other than those listed below. In particular, violation of any
rule that uses the terms shall, allowed, permitted, legal, or illegal belongs to this
category. Any program that contains such an error is not a legal Ada program; on the
other hand, the fact that a program is legal does not mean, per se, that the program
is free from other forms of error.
The rules are further classified as either compile time rules, or post compilation rules,
depending on whether a violation has to be detected at the time a compilation unit is
submitted to the compiler, or may be postponed until the time a compilation unit is
incorporated into a partition of a program. Errors that are required to be detected at
run time by the execution of an Ada program; The corresponding error situations are
associated with the names of the predefined exceptions. Every Ada compiler is
required to generate code that raises the corresponding exception if such an error
situation arises during program execution. If such an error situation is certain to arise
in every execution of a construct, then an implementation is allowed (although not
required) to report this fact at compilation time.

Bounded errors

The language rules define certain kinds of errors that need not be detected either
prior to or during run time, but if not detected, the range of possible effects shall be
bounded. The errors of this category are called bounded errors. The possible effects
of a given bounded error are specified for each such error, but in any case one
possible effect of a bounded error is the raising of the exception Program Error.

Erroneous execution.

In addition to bounded errors, the language rules define certain kinds of errors as
leading to erroneous execution. Like bounded errors, the implementation need not
detect such errors either prior to or during run time. Unlike bounded errors, there is
no language-specified bound on the possible effect of erroneous execution; the effect
is in general not predictable.

Implementation Permissions
An implementation may provide nonstandard modes of operation. Typically these
modes would be selected by a pragma or by a command line switch when the
compiler is invoked. When operating in a nonstandard mode, the implementation may
reject compilation units that do not conform to additional requirements associated
with the mode, such as an excessive number of warnings or violation of coding style
guidelines. Similarly, in a nonstandard mode, the implementation may apply special
optimizations or alternative algorithms that are only meaningful for programs that
satisfy certain criteria specified by the implementation. In any case, an
implementation shall support a standard mode that conforms to the requirements of
this International Standard; in particular, in the standard mode, all legal compilation
units shall be accepted.

Implementation Advice
If an implementation detects a bounded error or erroneous execution, it should raise
Program Error.

Quest 7 How do you rectify the error? (05

marks)
 Accountants prepare trial balance to check the correctness of accounts. If total of
debit balances does not agree with the total of credit balances, it is a clear-cut
indication that certain errors have been committed while recording the transactions in
the books of original entry or subsidiary books. It is our utmost duty to locate these
errors and rectify them, only then we should proceed for preparing final accounts. We
also know that all types of errors are not revealed by trial balance as some of the
errors do not affect the total of trial balance. So these cannot be located with the help
of trial balance. An accountant should invest his energy to locate both types of errors
and rectify them before preparing trading, profit and loss account and balance sheet.
Because if these are prepared before rectification these will not give us the correct
result and profit and loss disclosed by them, shall not be the actual profit or loss.

All errors of accounting procedure can be classified as follows:

1. Errors of Principle
When a transaction is recorded against the fundamental principles of accounting, it is
an error of principle. For example, if revenue expenditure is treated as capital
expenditure or vice versa.

2. Clerical Errors
These errors can again be sub-divided as follows:

• Errors of omission
When a transaction is either wholly or partially not recorded in the books, it is
an error of omission. It may be with regard to omission to enter a transaction in
the books of original entry or with regard to omission to post a transaction from
the books of original entry to the account concerned in the ledger.

• Errors of commission
When an entry is incorrectly recorded either wholly or partially-incorrect
posting, calculation, casting or balancing. Some of the errors of commission
effect the trial balance whereas others do not. Errors effecting the trial balance
can be revealed by preparing a trial balance.

• Compensating errors
Sometimes an error is counter-balanced by another error in such a way that it
is not disclosed by the trial balance. Such errors are called compensating
errors.
From the point of view of rectification of the errors, these can be divided into
two groups :
o Errors affecting one account only, and
o Errors affecting two or more accounts.
 • Errors affecting one account

Errors which affect can be :

• Casting errors;
• error of posting;
• carry forward;
• balancing; and
• omission from trial balance.

Such errors should, first of all, be located and rectified. These are rectified either with
the help of journal entry or by giving an explanatory note in the account concerned.

Rectification
Stages of correction of accounting errors

All types of errors in accounts can be rectified at two stages:

• before the preparation of the final accounts; and
• after the preparation of final accounts.

Errors rectified within the accounting period

The proper method of correction of an error is to pass journal entry in such a way that
it corrects the mistake that has been committed and also gives effect to the entry
that should have been passed. But while errors are being rectified before the
preparation of final accounts, in certain cases the correction can't be done with the
help of journal entry because the errors have been such. Normally, the procedure of
rectification, if being done, before the preparation of final accounts is as follows:

(a) Correction of errors affecting one side of one account Such errors do not let the
trial balance agree as they effect only one side of one account so these can't be
corrected with the help of journal entry, if correction is required before the
preparation of final accounts. So required amount is put on debit or credit side of the
concerned account, as the case maybe.
For example:

• Sales book under cast by Rs. 500 in the month of January. The error is only in
sales account, in order to correct the sales account, we should record on the
credit side of sales account 'By under casting of. sales book for the month of
January Rs. 500".I'Explanation:As sales book was under cast by Rs. 500, it
 means all accounts other than sales account are correct, only credit balance of
sales account is less by Rs. 500. So Rs. 500 have been credited in sales
account.
• Discount allowed to Marshall Rs. 50, not posted to discount account. It means
that the amount of Rs. 50 which should have been debited in discount account
has not been debited, so the debit side of discount account has been reduced
by the same amount. We should debit Rs. 50 in discount account now, which
was omitted previously and the discount account shall be corrected.
• Goods sold to X wrongly debited in sales account. This error is effecting only
sales account as the amount which should have been posted on the credit side
has been wrongly placed on debit side of the same account. For rectifying it,
we should put double the amount of transaction on the credit side of sales
account by writing "By sales to X wrongly debited previously."
• Amount of Rs. 500 paid to Y, not debited to his personal account. This error of
effecting the personal account of Y only and its debit side is less by Rs. 500
because of omission to post the amount paid. We shall now write on its debit
side. "To cash (omitted to be posted) Rs. 500.

Correction of errors affecting two sides of two or more accounts

As these errors affect two or more accounts, rectification of such errors, if being done
before the preparation of final accounts can often be done with the help of a journal
entry. While correcting these errors the amount is debited in one account/accounts
whereas similar amount is credited to some other account/ accounts.

Quest 8: Briefly explain the characteristics of Bill of exchange. (10

marks)
Written, unconditional order by one party (the drawer) to another (the drawee) to pay
a certain sum, either immediately (the sight bill) or on a fixed date (the term bill), for
payment of goods and/or services received. The drawee accepts the bill by signing it,
thus converting it into a post-dated check and a binding contract. It is also called a
draft but, while all drafts are negotiable instruments, only 'to order' bills of exchange
can be negotiated. According to the 1930 'Convention Providing A Uniform Law For
Bills of Exchange and Promissory Notes' held in Geneva (also called Geneva
Convention) a BOE contains: (1) The term 'bill of exchange' inserted in the body of the
instrument and expressed in the language employed in drawing up the instrument.
(2) An unconditional order to pay a determinate sum of money. (3) The name of the
person who is to pay (drawee). (4) A statement of the time of payment. (5) A
statement of the place where payment is to be made. (6) The name of the person to
whom or to whose order payment is to be made. (7) A statement of the date and of
the place where the bill is issued. (8) The signature of the person who issues the bill
(drawer). BOE is the most often used form of payment in local and international trade,
and has a long history-as long as that of writing (which was invented by accountants
for recording trade transactions) going back over 5,000 years.

The important characteristics of a bill of exchange are:

•It must be in writing.
•It must be an order to pay, and not a request to pay.
•The order must be unconditional.
•The order must be signed by the maker, i.e. the drawer.
•The order must be directed to a certain person.
•The order must be for the payment of money only.
•The money payable must be certain, and not vague.
•The money must be payable to a certain person mentioned in the instrument or
to his order or to the bearer of the instrument.
•It must bear the required revenue stamp.

A bill of exchange is playing an important part in the commercial life of the country.
The need for it arises where the buyer of goods needs a period of credit before paying
it, it is drawn by the creditor and is accepted by the debtor. According to F.W Muller a
bill of exchange is an unconditional order in writing addressed by one person to
another, signed by the person giving it, requiring the person to whom it is to pay on
demand or at a fixed or determinable future time a sum certain in money to or the
order of a certain person or to bearer. There are certain characteristics of the bill of
exchange. A bill of exchange must be in writing. It must contain an order to pay. The
order to pay must be unconditional. If it is subject to the happening of some events, it
will not be a bill of exchange. It must be signed by the drawer and properly stamped.
The parties to the bill, the drawer and the drawee and payee must be certain and
definite individuals. The amount payable must be certain. The payment must be
made in money and not in kind.
 August 2009
Bachelor of Science in Information Technology (BScIT) – Semester 4
BT0048 – Accounting Principles & Practice – 4 Credits
(Book ID: B0429)
Assignment Set – 2 (60 Marks)

Answer all questions

nd
Ques 1 On 2 April, 2008, Mr Rajesh sold goods to Mr. Suresh for Rs. 10000 and drew
a 3 months’ bill on him for the amount. Mr. Suresh accepts it and returns it to Mr.
Rajesh. Pass Journal entries in the books of both the parties.
( 10 marks)
Account Name and
Date Explaination Debit Credit
Opening Balance A B

April 2 2008 Suresh's A/C 15000

To Sales A/C 15000
(Being Sale of goods on
Credit)

A+150 B+150
Closing Balance 00 00

July 2 2008 Opening Balance C D

Good returned from

Suresh 15000
Purchase Return 15000
 C- D-
Closing Balance 15000 15000

Suresh’s Books

Account Name and

Date Explaination Debit Credit
Opening Balance X Y

April 2
2008 Rajesh A/C 15000
To Creditors A/C 15000

X+150 Y+150
Closing Balance 00 00

July 2 2008 Opening Balance P Q

Cash from Good Returned

to Rajesh 15000
Credit Reverted again
Rajesh A/c 15000

P- Q-
Closing Balance 15000 15000

Quest 2 What is trading account? (05

marks)
History
The first stock exchange was founded in Philadelphia sometime around 1790.
However, since the 1820s New York and Wall Street have become the focal point for
America's financial systems. Companies such as JP Morgan, Goldman Sachs and
Morgan Stanley came to represent and dominate the world of investing. For decades
these companies ruled the stock markets acting both as financial advisers and stock
brokers to the general public. Since the late 1990s, though, with the advent of online
investing via the Internet, popular discount brokers like E-Trade, Ameritrade, Scott
Trade and Interactive Brokers have largely taken over the landscape with their lower
fees and customer-friendly online investment tools.

Definition
Trading account and brokerage accounts are the same thing. A broker is a middleman
between the investor and the exchanges, such as the Nasdaq and the NYSE. These
brokers service people or institutions that want to buy and sell stocks, commodities or
options. In exchange they charge a fee for every transaction. Some full-service
brokers will also act as a financial adviser and help you set up an investment plan and
give you advice about buying and selling stocks. Keep in mind, however, that these
brokers do not make money if your stocks gain or lose value. They make money when
you buy or sell a stock, so they have no vested interest in whether the stock does well
or not.

"Trader" vs. "Investor"

The main difference between a trader and an investor is the time frame during which
they are willing to hold a position in their investment. Typically a trader moves in and
out of a transaction quickly. This can be anywhere from a few minutes to a few
months. On the other hand, an investor usually holds positions for several years.

Types of Trading Accounts

Regardless of the type, all trading accounts serve the same basic function: to allow
the investor or trader to buy and sell an investment instrument. These include stocks,
foreign exchange, commodities and stock options. Some brokerages specialize in
stocks and will only allow stocks or stock options to be traded from a customer
account. Other brokers only deal in foreign exchange.

Similarities to a Bank Account

Trading accounts can be very similar to a bank account in that they hold a reserve of
currency for an institution or an individual. You can even get a debit card, or use
checks to withdraw the cash in the account just as you would with a regular checking
or savings account.

Quest 3: Explain balance sheet and profit & loss account.

(10 marks)
BALANCE SHEET
Balance sheet is a summary of a person's or organization's balances. Assets, liabilities
and ownership equity are listed as of a specific date, such as the end of its financial
year. A balance sheet is often described as a snapshot of a company's financial
condition. Of the four basic financial statements, the balance sheet is the only
statement which applies to a single point in time.A company balance sheet has three
parts: assets, liabilities and ownership equity. The main categories of assets are
usually listed first, and typically in order of liquidity. Assets are followed by the
liabilities. The difference between the assets and the liabilities is known as equity or
the net assets or the net worth or capital of the company and according to the
accounting equation, net worth must equal assets minus liabilities.

Another way to look at the same equation is that assets equals liabilities plus owner's
equity. Looking at the equation in this way shows how assets were financed: either by
borrowing money (liability) or by using the owner's money (owner's equity). Balance
sheets are usually presented with assets in one section and liabilities and net worth in
the other section with the two sections "balancing."

Records of the values of each account or line in the balance sheet are usually
maintained using a system of accounting known as the double-entry bookkeeping
system.A business operating entirely in cash can measure its profits by withdrawing
the entire bank balance at the end of the period, plus any cash in hand. However,
many businesses are not paid immediately; they build up inventories of goods and
they acquire buildings and equipment. In other words: businesses have assets and so
they cannot, even if they want to, immediately turn these into cash at the end of each
period. Often, these businesses owe money to suppliers and to tax authorities, and
the proprietors do not withdraw all their original capital and profits at the end of each
period. In other words businesses also have liabilities.

Types
A balance sheet summarizes an organization or individual's assets, equity and
liabilities at a specific point in time. Individuals and small businesses tend to have
simple balance sheets. Larger businesses tend to have more complex balance sheets,
and these are presented in the organization's annual report. Large businesses also
may prepare balance sheets for segments of their businesses. A balance sheet is
often presented alongside one for a different point in time (typically the previous
year) for comparison.
Personal balance sheet
A personal balance sheet lists current assets such as cash in checking accounts and
savings accounts, long-term assets such as common stock and real estate, current
liabilities such as loan debt and mortgage debt due, or overdue, long-term liabilities
such as mortgage and other loan debt. Securities and real estate values are listed at
market value rather than at historical cost or cost basis. Personal net worth is the
difference between an individual's total assets and total liabilities.
US small business balance sheet
Sample Small Business Balance Sheet
AssetsLiabilities and Owners' Equity

Liabilities and Owners'

Assets
Equity
$6,60
Cash Liabilities
0
Accounts $6,20 $30,0
Notes Payable
Receivable 0 00
Accounts Payable
$30,0
Total liabilities
00
Tools and $25,0
Owners' equity
equipment 00
$7,00
Capital Stock
0
Retained
$800
Earnings
$7,80
Total owners' equity
0
$37,8 $37,8
Total Total
00 00

A small business balance sheet lists current assets such as cash, accounts receivable,
and inventory, fixed assets such as land, buildings, and equipment, intangible assets
such as patents, and liabilities such as accounts payable, accrued expenses, and
long-term debt. Contingent liabilities such as warranties are noted in the footnotes to
the balance sheet. The small business's equity is the difference between total assets
and total liabilities.

PROFIT AND LOSS ACCOUNT

Company’s financial statement that indicates how the revenue (money received from
the sale of products and services before expenses are taken out, also known as the
"top line") is transformed into the net income (the result after all revenues and
expenses have been accounted for, also known as the "bottom line"). It displays the
revenues recognized for a specific period, and the cost and expenses charged against
these revenues, including write-offs (e.g., depreciation and amortization of various
assets) and taxes.[1] The purpose of the income statement is to show managers and
investors whether the company made or lost money during the period being reported.
The important thing to remember about an income statement is that it represents a
period of time. This contrasts with the balance sheet, which represents a single
moment in time.Charitable organizations that are required to publish financial
statements do not produce an income statement. Instead, they produce a similar
statement that reflects funding sources compared against program expenses,
administrative costs, and other operating commitments. This statement is commonly
referred to as the statements of activities. Revenues and expenses are further
categorized in the statement of activities by the donor restrictions on the funds
received and expended.

The income statement can be prepared in one of two methods. The Single Step
income statement takes a simpler approach, totaling revenues and subtracting
expenses to find the bottom line. The more complex Multi-Step income statement (as
the name implies) takes several steps to find the bottom line, starting with the gross
profit. It then calculates operating expenses and, when deducted from the gross
profit, yields income from operations. Adding to income from operations is the
difference of other revenues and other expenses. When combined with income from
operations, this yields income before taxes. The final step is to deduct taxes, which
finally produces the net income for the period measured.

Ques 4 Which are the expenses shown under profit & loss account?
(10 marks)
Profit is the incentive for business; without profit people wouldn’t bother. Profit is
the reward for taking risk; generally speaking high risk = high reward (or loss if it
goes wrong) and low risk = low reward. People won’t take risks without reward. All
business is risky (some more than others) so no reward means no business. No
business means no jobs, no salaries and no goods and services.

This is an important but simple point. It is often forgotten when people complain
about excessive profits and rewards, or when there are appeals for more taxes to pay
for e.g. more policemen on the streets.
Profit also has an important role in allocating resources (land, labor, capital and
enterprise). Put simply, falling profits (as in a business coming to an end eg black-
and-white TVs) signal that resources should be taken out of that business and put into
another one; rising profits signal that resources should be moved into this business.
Without these signals we are left to guess as to what is the best use of society’s
scarce resources.
People sometimes say that government should decide (or at least decide more often)
how much of this or that to make, but the evidence is that government usually do a
bad job of this e.g. the Dome.

The Task of Accounting - Measuring Profit

The main task of accounts, therefore, is to monitor and measure profits.
Profit = Revenue less Costs
So monitoring profit also means monitoring and measuring revenue and costs. There
are two parts to this:-
1) Recording financial data. This is the ‘book-keeping’ part of accounting.
2) Measuring the result. This is the ‘financial’ part of accounting. If we say ‘profits
are high’ this begs the question ‘high compared to what?’ (You can look at this idea in
more detail when covering Ratio Analysis)
Profits are ‘spent’ in three ways.
1) Retained for future investment and growth.
2) Returned to owners eg a ‘dividend’.
3) Paid as tax.

Parts of the Profit and Loss Account

The Profit & Loss Account aims to monitor profit. It has three parts.
1) The Trading Account.
This records the money in (revenue) and out (costs) of the business as a result of the
business’ ‘trading’ ie buying and selling. This might be buying raw materials and
selling finished goods; it might be buying goods wholesale and selling them retail. The
figure at the end of this section is the Gross Profit.

2) The Profit and Loss Account proper

This starts with the Gross Profit and adds to it any further costs and revenues,
including overheads. These further costs and revenues are from any other activities
not directly related to trading. An example is income received from investments.

3) The Appropriation Account. This shows how the profit is ‘appropriated’ or

divided between the three uses mentioned above.

Uses of the Profit and Loss Account.

 The main use is to monitor and measure profit, as discussed above. This
assumes that the information recording is accurate. Significant problems can
arise if the information is inaccurate, either through incompetence or
deliberate fraud.
  Once the profit(loss) has been accurately calculated, this can then be used for
comparison ie judging how well the business is doing compared to itself in the
past, compared to the managers’ plans and compared to other businesses.

 There are ways to ‘fix’ accounts. Internal accounts are rarely ‘fixed’, because
there is little point in the managers fooling themselves (unless fraud is going
on) but public accounts are routinely ‘fixed’ to create a good impression out to
the outside world. If you understand accounts, you can usually (not always)
spot these ‘fixes’ and take them out to get a true picture.

Example Profit and Loss Account:

An example profit and loss account is provided below:
£'000 £'000
Revenue 12,500 10,000
Cost of Sales 7,500 6,000

Gross Profit 5,000 4,000

Gross profit margin (gross profit / revenue) 40% 40%

Operating Costs
Sales and distribution 1,260 1,010
Finance and administration 570 555
Other overheads 970 895
Depreciation 235 210
Total Operating Costs 3,035 2,670

Operating Profit (gross profit less operating costs) 1,965 1,330

Operating profit margin (operating profit / revenue) 15.7% 13.3%

Interest (450) (475)

Profit before Tax 1,515 855

Taxation (455) (255)

Profit after Tax 1,060 600

Dividends 650 400

Retained Profits 410 200

Quest 5: Briefly explain the structure of GAAP along with the pictorial representation.

In the U.S., generally accepted accounting principles, commonly abbreviated as US

GAAP or simply GAAP, are accounting rules used to prepare, present, and report
financial statements for a wide variety of entities, including publicly-traded and
privately-held companies, non-profit organizations, and governments. Generally GAAP
includes local applicable Accounting Framework, related accounting law, rules and
Accounting Standard.Similar to many other countries practicing under the common
law system, the United States government does not directly set accounting
standards, in the belief that the private sector has better knowledge and resources.
US GAAP is not written in law, although the U.S. Securities and Exchange Commission
(SEC) requires that it be followed in financial reporting by publicly-traded companies.
Currently, the Financial Accounting Standards Board (FASB) is the highest authority in
establishing generally accepted accounting principles for public and private
companies, as well as non-profit entities.
For local and state governments, GAAP is determined by the Governmental
Accounting Standards Board (GASB), which operates under a set of assumptions,
principles, and constraints, different from those of standard private-sector GAAP.
Financial reporting in federal government entities is regulated by the Federal
Accounting Standards Advisory Board (FASAB). The US GAAP provisions differ
somewhat from International Financial Reporting Standards, though former SEC
Chairman Chris Cox set out a timetable for all U.S. companies to drop GAAP by 2016,
with the largest companies switching to IFRS as early as next year.

Ques 6 Explain the Debit and Credit rules with real life examples. (10
marks)

The Rules of Debit & Credit with example

In the world of accounting, debit and credit are two of the major players. It's
important to understand that debit and credit work against each other on the balance
sheet and that both the debit and credit processes are required to make accounting
function like it is supposed to. It is equivalent to how addition and subtraction make
the world of mathematics go round.

Real Accounts
A real account is an account that is reported on the balance sheet, which is where the
assets, liabilities and equities of the business owner are recorded. The reasons these
types of accounts are labeled as "real" is because they exist on a continuous and
permanent basis.

So if you buy office furniture for your business, the debit rule states that the furniture
coming into the business affects the real accounts on the balance sheet. In this case,
the furniture account of the company is debited because the rule states that you
"debit what comes in."

In another example, if you were the company selling the furniture to Ms. Smith, then
your balance sheet would look different. In this case, you as the furniture seller would
credit your real accounts area of the balance sheet because the credit rule states that
you credit "what goes out."

To determine whether a real account is a debit or credit, you have to stop and think
about whether the item is coming into the company (debit) or going out of the
company (credit).

Personal Accounts
Personal accounts are related to natural persons or representatives of the company or
organization. To determine whether a personal account is debited or credited, you
have to first determine whether the "person" is giving money to the organization or
receiving (or benefiting) from the organization.

The rule states that you debit the receiver and credit the giver.

So if the business pays Mr. Smith $1,000 in cash, then the Mr. Smith account is
debited and so is the cash account because that is where the cash was taken from to
pay Mr. Smith.

If the business were buying furniture on credit from the ABC Furniture company, you
would credit the ABC Furniture account because it is "giving" the furniture to the
business.

Nominal Accounts
A nominal account is registered on the income sheet of the business, which is where
the income and expenses of the business are recorded for a specific period of time.

There are two rules for nominal accounts. The first rule states that all expenses and
losses to the company are recorded on the income sheet as debits. The second rule
states that all income and gains to the business are recorded as credits on the income
sheet. Using these rules, if the company pays its employees for work performed, the
cash account, which is the real account, and the wages account, which is the nominal
account, are both debited as losses or expenses to the company.

On the other hand, if the company receives a commission payment from a company
for selling its goods, then the payment is recorded as a credit to the bank account,
which is the personal account of the business, and to the commission account, which
is the nominal account of the business.

Two Effects
Another primary rule of accounting is that there are always two accounts effected by
a transaction. This means that if one account is credited then another account has to
be debited. This is what has to happen to keep the numbers balanced.

So let's say that your company is purchasing office furniture from the ABC Furniture
Company on credit (rather than paying in cash). Since you are buying furniture for the
company, it is coming into the company and therefore is treated as a debit to the
goods account. A credit is recorded to the ABC Furniture Company account because
you credit the giver.

Debited and Credited Accounts

There are some cases where an account is credited but then in another scenario the
account would be debited. For example, a cash account would be credited when a
cash purchase is made, but the same cash account would be debited if a cash sale is
made.

Quest 7: Explain the statement of changes in financial position.

(05 marks)
Statement of Changes in Position
The statement of changes in financial position provides data that are not explicitly
present in the balance sheet or the income statement. This statement helps to
explain how your company acquired its money and how it was spent. This statement
can also help to identify financing needs, to identify cash drains, and to identify holes
in the cash budgeting process. Use the statement of changes in financial position as a
tool to analyze cash inflows and outflows. Also, use it as a starting point to forecast
future cash flows and financing requirements.

Accounting standards give preparers of this statement quite a bit of flexibility in how
they arrange and format the information. However, the Financial Accounting
Standards Board has stated its intention that this statement should evolve into one
whose focus is on cash and changes in cash. This position has been strongly endorsed
by the Financial Executives Institute (FEI). As might be expected, more and more
companies are using a cash focus for the statement of changes in financial position.
In fact, the statement is often called the "Sources and Uses of Cash Statement."

An example of a cash-focus statement of changes in financial position appears below.

Jones Tool Company

Statement of Changes in Financial Position for
the
Years Ended December 31, 200Z, 200Y, and 200X
200 200 200
Z Y X
Sources of cash
Net income $X $X $X
Add back non-cash deductions from
net income:
Depreciation $X $X
Deferred taxes $X $X $X
Cash provided by operations $X $X $X
Issuance of stock $X $X $X
Sale of fixed assets $X $X $X
$ $
Total sources of cash $ XX
XX XX
Uses of cash
Purchases of equipment ($ ($ ($ X)
 X) X)
($ ($
Purchase of company debt ($ X)
X) X)
$ $
Total uses of cash $ XX
XX XX
Net increase in cash $X $X $X
Cash, beginning of year $X $X $X
$ $ $
Cash, end of year
XX XX XX
(The notes are an integral part of this statement.)

The statement of changes in financial position should also include a supplement

detailing the net changes in working capital. Specifically, this would include increases
(or decreases) in accounts receivable, inventory, and accounts payable