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CHAPTER – 1
ACCOUNTING
A systematic record of the daily events of a business leading to presentation to financial picture is known as
Accounting or in its elementary stages, as Book keeping. Accounting organizes and summarises economic
information so that the decision-makers can use it. The information is presented in reports called financial
statements. To prepare these statements, accountants analyze, record, quantify, accumulate, summarize,
classify, report, and interpret economic events and their financial effects on the organization.

The series of steps involved in initially recording information and converting it into financial
statements is called the accounting system.

The financial picture mostly has two parts, one showing how much profits has been earned or loss
suffered, and other showing assets and liabilities and the proprietors interest in the firm. Even
institution which do not have the earning of profit as an objective must know periodically whether the
current income is sufficient to meet the current expenditure and what the financial state of affairs.

The American Institute of Certified Public accountants has defined Accounting as:-
“The art of recording, classifying and summarizing in a significant manner and in term of money
transactions and events which are, in part at least, of a financial character, and the interpreting the
result thereof.”

 ACCOUNTANCY, ACCOUNTING AND BOOK-KEEPING

ACCOUNTANCY ACCOUNTING BOOK-KEEPING


 Accountancy refers to a  Accounting refers to the actual  Book-keeping is a part of
systematic knowledge of process of preparing and accounting and is concerned
accounting. It explains ‘why presenting the accounts. It is with record keeping or
to do’ and ‘how to do’ of the art of putting the academic maintenance of books of
various aspect of accounting. knowledge of accountancy accounting, which is often
It tells us why and how to into practice. routine and clerical in nature.
prepare the books of accounts It covers the following activities:- It only covers the following four
and how to summarize the (i) Identifying the transactions activities:
accounting information and to and event. (i) Identifying the transactions
communicate it to the (ii) Measuring the identified and events.
interested parties. transactions and events in (ii) Measuring the identified
common measuring unit. transactions and events in a
(iii) Recording the identified common measuring unit.
and measured transactions (iii) Recording the identified
and events in Journal. and measured transactions
(iv) Classifying the recorded and events in Proper Books
transactions and events in Accounts.
ledger. (iv) Classifying the recorded
(v) Summarizing the classified transactions and events in
transactions and events in the ledger.
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form of Income Statement


and Position Statement.
(vi) Analysing the summarized
results.
(vii) Interpreting the analysed
results.
(viii) Communicating the
interpreted information to the
interested parties.

ACCOUNTING CYCLE
An accounting cycle is a complete sequence beginning with the recording of the transactions and ending
with the preparation of the final accounts.
 SEQUENTIAL STEPS INVOLVED IN AN ACCOUNTING CYCLE:
(1) Journalising:- Record the transactions in Journal book.
(2) Posting: - Transfer the transactions recorded in journal, in the respective accounts opened in the ledger.
(3) Balancing:- Ascertain the difference between the total of debit amount column and the total of credit
amount column of a ledger account.
(4) Trial Balance:- Prepare a list showing the balances of each and every account to verify whether the
sum of the debit balances is equal to the sum of the credit balances.
(5) Income Statement:- Prepare Trading and Profit and Loss Account to ascertain the profit or loss for the
accounting period.
(6) Position Statement (Balance Sheet):- Prepare the Balance sheet to ascertain the financial position as at
the end of the accounting period.

OBJECTIVES OF ACCOUNTING
(i) To maintain accounting records.
(ii) To calculate the results of operations.
(iii) To ascertain the financial position.
(iv) To communicate the information to the users.

ADVANTAGES OF ACCOUNTING
(1) Facilities to ascertain net result of operations.
(2) Facilities to ascertain financial position.
(3) Facilities the users to take decisions.
(4) Facilities to comply with legal requirements.
(5) Facilities the settlement of tax liability.
(6) Assists the management in planning and controlling business activities and in taking decisions.
(7) Facilities the ascertainment of value of business.
(8) Facilitates a comparative study.

 Limitations of Accounting:
⇒ Ignores the qualitative elements.
⇒ Not free from bias.
⇒ Estimated position and not real position.
⇒ Ignore the price level changes in case of financial statement prepared on historical cost.
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⇒ Danger of window dressing.


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 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

1) Understandability:- Financial Statements must be readily understandable by users. However,


information about complex matters that should be included in the financial statements because of its
relevance to the economic decision making needs of user should not be excluded merely on the grounds
that it may be too difficult for certain users to understand.
2) Relevance:- To be useful, information given in financial statement must be relevant to the decision-
making needs of users. Any materials fact or figure should not be omitted.
3) Materiality:- The relevance of information is affected by its materiality. Its provides a cut-off point
rather than being a primary qualitative characteristics which information must have if it is to be useful.
Information is material if its omission of misstatement could be influence the economic decision of the
users taken on the basis of the financial statements. Materiality depends on the size of the item or error
judged in particular circumstances of its omission or misstatements.
4) Reliability:- To be useful, information must also be reliable. Information has the quality of reliability
when it is free from material error and bias. If there is fraud or misrepresentation, the statement will not
be reliable.
5) Faithful Representation:- to be reliable, information must represent faithfully the transaction and other
events it either purports to represent or could be reasonably be expected to represent.
6) Substance over form:- If information is to represent faithfully the transactions and other events that it
purports to represent, it is necessary that they are accounted for and presented in accordance with their
substance and economic reality and not their legal form.
7) Neutrality:- To be reliable, the information contained in the financial statements must be neutral, that
is, free from bias.
8) Prudence:- Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in
making the estimates required under conditions of uncertainty, such assets or income are not overstated
and liabilities or expenses are not understated. However, the exercise of prudence does not allow, the
creation of hidden reserves or excessive provisions, the deliberate overstatement of liabilities or
expenses, because the financial statements would not be neutral and, therefore, not have the quality of
reliability.
9) Completeness:- To be reliable, the information in financial statements must be complete within the
bounds of materiality and cost. An omission can cause information to be false or misleading and thus
unreliable and deficient in the term of its relevance.
10) Comparability:- The information provided by the financial statements is compared by the management
for decision making. Therefore, uniform accounting methods and policies should be followed from year
to year.

Role of Accounts in Society:


The profession of accountant is an instrument of socio-economic change and welfare of the society. The
modern accountancy is not like the old book-keeper. He is now expected to perform multifarious duties and
play a great role than he supposed to play earlier. His area of operation now cover such fields as
productively, taxation, trade and industry, law and integrated information system. They can also act in the
fields relating to financial policies, budgetary policies and even economic principles. At present there are
not only financial accountants but highly specialized ones such as Chartered Accountants, Cost Accountants,
management Accountants and other specialist accountants who prepare special reports on the various aspect
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of expansion and new developments of the enterprise. The services rendered by them to the society include
the following:
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(i) To maintain the boos of accounts in a systematic manner.
(ii) To act as Statutory Auditor.
(iii) To act as an Internal Auditor.
(iv) To act as Taxation Advisor.
(v) To act as Financial Advisor.
(vi) To act as Company Law Advisor.
(vii) To act as Management Consultants.
(viii) To act as Liquidator, Arbitrator and Receiver.
(ix) To act as Management information System Consultants.

BRANCHES OF ACCOUNTING
⇒ Financial Accounting:- The purpose of this branch of accounting is to keep systematic record to
ascertain financial performance and financial position and to communicate the accounting information
to the interested parties.
⇒ Cost Accounting:- The purpose of this branch of accounting is to ascertain the cost, to control the cost
and communicate information for decision making.
⇒ Management Accounting:- The purpose of this branch of accounting is to supply any and all
information that management may need in taking decision and to evaluate the impact of its decisions
and actions.
⇒ Social Responsibility Accounting:- It is accounting for social responsibility aspect of a business.
Management is held responsible for what it contributes to the social well being and progress.

 USERS OF ACCOUNTING DATA


Besides the people of the concerned firm or institution, there are various other parties interested in
the financial statement who must make decisions that have economic consequences. Such decision
makers include:-

(i) Shareholder (vi) Suppliers and other trade creditors


(ii) Investors (vii) Employees.
(iii) Management (viii) Government and their agencies
(iv) Lenders (ix) Researcher
(v) Customers
For example:
 An investor considering buying stock in either General Motors Ltd. or Volvo Ltd., would consult
published accounting reports to compare the most recent financial results of the companies. The
information in the reports helps the buyer to decide which company would be the better investment
choice.
 A lender considering a loan to a company that want to expand would examine the historical
performance of the company and projections the company provided about how the borrowed funds
are to be used to produce new business.
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Accounting helps decision making by showing where and when money has been spent and commitments
have been made, but evaluating performance, and by indicating the financial implications of choosing one
plan instead of another. Accounting also helps predict the future effects of decisions, and it helps direct
attention to current problems, imperfection and in inefficiencies, as well as opportunities.

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 FUNCTIONS OF ACCOUNTING DATA
The main functions of Accounting Data are as follows:-
a) Measurement of past performance of the entity and depicting its current financial position.
b) Forecasting:- On the basis of past date we may forecast future performance as financial position of the
entity.
c) Decision-Making:- Accounting data provides relevant information to the users of accounts to aid
decision-making.
d) Evaluation:- Assessing performance achieved in relation to target.
e) Control:- On the basis of accounting data we can identify weaknesses of the operational system and
feed back the effectiveness of measures adopted to check such weaknesses.
f) Stewardship:- Accounting for the users of owner’s fund where in the management and owners are
separated.
g) Government Regulation and Taxation:- Accounting data provides necessary information for
government to exercise control on the entity as well as collection for tax revenues.

 Relationship of accounting with some other discipline:


(a) Accounting and Economics:
 Economics is viewed as a science of rational decision making about the efficient use of scarce
resources. This many be viewed either from the relative importance of situations or facts of a single
firm or of the country as a whole.
 Account is viewed as a system, which provide data to the users to permit informed judgment and
decisions. It contributed a lot in improving the management decision making process.
 But, economic theories influenced the development of the decision making tools used in accounting.
At the macro level:-
 Accounting provides the data base over which the economic decision models have been developed;
micro level data arranged by the accounting system is summed up to get macro level data base.

(b) Accounting and Statistics:


Accounting records generally take a short-term view of events and are confined to a year while
statistical analysis is more useful if a longer view is taken for the purpose. For example, to fit the
trend line a longer period will be required.
However, statistical method does use past accounting record maintained on a consistent basis.
In account, all values are important individually because they relate to business transactions, while
statistics is concerned with the typical value, behaviour or trend over a period or the degree of
variation over a series of observations. Accounting records are based on historical cost of permanent
assets, while the current assets are automatically valued at the current value. However, when prices
are not stable over a period of time, inflation accounting method are used which require the use of
price indices or price deflator which are based on statistical calculations of price changes. In
accounting, a number of financial and other ratios are based on statistical method and several
financial calculations are based on statistical framework.
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Statistical methods are helpful in developing accounting data and their interpretation. For example,
time series and cross-sectional comparisons of accounting data is based on statistical techniques,
regression analysis of budget and standard cost variances and multiple discriminant analysis are
popularly used to identify symptoms of sickness of business firm.
Therefore, the study and application of statistical method would add extra edge to the accounting
data.
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(c) Accounting and Mathematics:
Knowledge of arithmetic and algebra is a prerequisite for accounting computations and measurements.
Calculate of interest and annuity are the examples of such fundamental use. While computing
depreciation, finding out instalment in hire purchase and instalment payment transactions, calculating
amount to be set aside for repayment of loan and replacement of assets and setting lease rentals,
mathematical techniques are frequently used. Accounting data are also presented in ratio form.
With the advent of the computer, mathematics is becoming vital part of accounting. Instead of writing
accounts in traditional form, transactions and events can be recorded in the matrix from and the rules of
matrix algebra can be applied for classifying and summarizing data.
Understanding mathematics has become a must to grasp the decision models framed by the statisticians,
economists and the O.R. experts. In addition to statistical knowledge, knowledge in geometry and
trigonometry seams to be essential to have a better understanding about the accounting communications
system.

(d) Accounting and Law:


Since, the various transactions of business professions are governed by various law, the knwoeldge
of some important provision of various law is essential for recording the transactions in accounting
record. All transaction with suppliers and customers are governed by the Contact Act, the Sale of
Goods Act, and the Negotiable Instrument Act etc. The entity itself is created by law. For example,
partnership business are controlled by Partnership Act. A company is created and controlled by
Companies Act. Similarly, every country has a set of economics, fiscal and labour laws. Banking
Insurance and electricity company also have to produce financial statement as prescribed by the
respective legislation’s controlled such entities. In that way accounting influences law and are also
influenced by law.

(e) Accounting and Management:


Management is broad occupational field, which comprises many functions and application of many
disciplines. Accountants are well placed in the management and play a key role in the management
team. A large number of accounting information is prepared for management decision making.
Although management relies on the other data sources also. Accounting data are used as basic
source document. In the management team an accountant is in a better position to understand and
use such data. Accounting is an essential service function of management.

 MEASUREMENT BASE:
There are fount accepted measurement bases. These are the following:-
1. Historical Cost:- According to this base:-
 The assets are recorded at an amount of cash or cash equivalents paid or the fair value of
consideration given at the time of acquisition.
 Liabilities are recorded at the amount of the proceeds received in exchange for the obligation.
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 In Some circumstances a liabilities

2. Current Cost:- Under current cost measurement base:-


 Assets are carried at the amount cash or cash equivalents that would have to be paid if the same
or an equivalent asset was acquired currently.
 Liabilities are carried at the undiscounted amount of cash or cash equivalents that would required
to be settle the obligation currently.
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3. Realisable value :- As per realisable value:-
 Assets are carried at the amount of cash or equivalents that could currently be obtained by selling
the assets in an orderly disposal
 Liabilities are carried at their settlement values; i.e. the undiscounted amounts of cash or cash
equivalents expressed to be paid to satisfy the liabilities in the normal course of business.

4. Present Value:- As per present value:-


 An asset is carried at the present discounted value of the future net cash inflows that the item is
expected to generate in the normal course of business.
 Liabilities are carried at the present discounted value of further net cash outflows that are
expected to be required to settle the liabilities in the normal course of business.

 ACCOUNTING CONCEPT
The following are the accounting concepts:
(i) Business entity concept.
(ii) Money measurement concept
(iii) Cost concept
(iv) Going concern concept
(v) Dual aspect concept
(vi) Realization concept.
(vii) Accrual concept.

(i) Business entity concept:- Treat a business as distinct from the person who owns it.
(ii) Money measurement concept:- Accounting records only those transactions, which are expressed in
monetary term.
(iii) Cost Concept:- Transactions is entered in the books of account at the amount actually involved.
(iv) Going concern Concept:- It is assumed that business will exist for a long time and transactions are
recorded from that point of view.
(v) Dual Aspect concept:- Each transaction has two aspects; if a business has acquired assets, it must
have resulted in one of the following:-
(a) Some other assets have been given up.
(b) The obligation to pay for it has arisen; or rather,
(c) There has been a profit, leading to an increase in the amount that the business owes to the
proprietors, or
(d) The proprietor has contributed money for the acquisition of assets.
ACCOUNTING EQUATIONS
ASSETS = Liabilities + Capital or CAPITAL = Asset – Liabilities
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(vi) Realization Concept:- Accounting is a historical record of transactions; it records what has
happened. It does not anticipated events though anticipated adverse effects of events that have
already occurred are usually recorded.
This concept stops the business firms form inflating their profits by recording sales and income that
are likely to accrue. Unless the money has been realized – either cash has been received or a legal
obligation to pay has been assumed by the customers – no sale can be said to have taken place and no
profit or income can be said to have arisen.

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(vii) Accrual Concept:- If an event has occurred or a transaction has been interred into, its consequences
will follow. Normally, all transactions are settled in cash but even if cash settlement has not taken
place, it is proper to bring the transaction or the event concerned in to the books.
 FUNDAMENTAL ACCOUNTING ASSUMPTION
The following are the fundamental accounting assumptions:-
(a) Going Concern:- The enterprise is normally viewed as a going concern, that is, as continuing
in operation for the foreseeable future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing materially the scale of the
operations.
(b) Consistency:- It is assumed that accounting policies are consistent from one period to
another. A change in an accounting policy is made only in certain exceptional circumstances.
(c) Accrual:- Revenue and costs are accrued, i.e., recognized as they are earned or incurred (and
not as money is received or paid) and recorded in the financial statements of the period to
which they relate.
 ACCOUNTING CONVENTIONS REGARDING FINANCIAL STATEMENTS

In order to make the information contained in the financial statements clear and meaningful, these are drawn
up according to the following convention:-
(i) Consistency:- The accounting practices should remain the same from one year to another. If a
change become necessary, the change and its effects should be stated clearly.
(ii) Disclosure: Apart from legal requirements good accounting practices also demand that all
significant information should be disclosed.
(iii) Conservatism: Financial Statements are usually drawn up on rather a conservation basis. Window-
dressing i.e. showing a position better than what is not permitted. It is also not proper to show a
position substantially worse than what it is. In other words secret reserve are not permitted.
Question: Elucidate “accounting convention of conservatism”.
Ans.: ‘Conservatism convention’ states that the accountants should not anticipate income and should
provide for all possible losses. The underlying principle is that revenues should only be recognized when
there is reasonable certainly about their realization. At the same time television must be made for all
possible liabilities, whether the amount is known with certainly or is based on lesser value must be selected.
To illustrate, inventories are recorded at the cost or market value whichever is less or if there a possibility
that a debt may not be realized, a specific amount is charged against profits as a provision for doubtful debts.

 ACCOUNTING POLICIES
The accounting policy refer to specific accounting principles and the methods of applying those
principles adopted by the enterprise in the preparation and presentation of financial statements.
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There is no single list of accounting policies, which is applicable to all enterprise in all
circumstances. The choice of the appropriate accounting principles in specific circumstances of each
enterprise calls for considerable judgment by the management of the enterprise.

The area where in different accounting policies are frequently encountered:-


(1) Method of depreciation, depletion and amortization;
(2) Treatment of expenditure during construction;
(3) Conversion or translation of foreign currency items;
(4) Valuable of inventories;
(5) Treatment of Goodwill;
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(6) Valuation of investments;
(7) Treatment of retirement benefits;
(8) Recognition of profit on long term contracts;
(9) Valuation of fixed assets;
(10)Treatment of contingent liabilities.

 CONSIDERATION IN THE SELECTION OF ACCOUNTING POLICIES:


The primary consideration in selection of Accounting Policies by an enterprise is that the financial statement
is prepared and presented on the basis of such accounting policies should represent a true and fair view of
the state of affairs of the enterprise as the Balance Sheet date and of the profit or loss for the period ended on
that date.
The major considerations governing the selection and application of accounting policies are the following:-
(a) Prudence:- In view of uncertainty attached to future events, profits are not anticipated but
recognized only when realised through not necessarily in cash. Provision is made for all known
liabilities and losses even though the amount cannot be determined with certainty and represent only
a best estimate in the light available information.
(b) Substance over form:- The accounting treatment and presentation in financial statements of
transactions and events should be governed by their substance and not merely by the legal form. For
example:
(i) Where rights and interest in a property stands transferred while legal documentation for
the transfer is yet to be completed, the transaction should be recorded as a sale in the books of
transferor and acquisition in the books of transferee.
(c) Materiality: - Financial statement should disclose all “ material” items, i.e. items the knowledge of
which might influence the decisions of the user of the financial statements.

 Disclosure of Accounting Policy:


(a) All significant accounting policies adopted in preparation and presentations of financial
statement should be disclosed.
(b) The disclosure of the significant accounting policies as such should form a part of the financial
statements and the significant accounting policies should normally be disclosed in one place.
 Change in Accounting Policies:
The change in Accounting Policy is recommended only in the following circumstances:
(i) If it is required by statute for compliance with an accounting standard.
(ii) If it is considered that the change would result in a more appropriate presentation of the
financial statements of an enterprise.
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 Disclosure in case of change in accounting policy:


Case Disclosure Requirement
(i) If change has a material effect in current (i) The amount of change should be
period and the effect of change is disclosed . The fact should disclosed.
ascertainable.
(ii) If change has a material effect in current (ii) The fact of such change should be
period and the effect of change in not appropriately disclosed.
ascertainable, wholly or in part.
(iii) If change has no material effect in current
period but which is reasonably expected to
have a material effect in later period.
 SYSTEM FOR RECORDING THE TRANSACTIONS:
There are two systems for recording the transactions:
(i) Single Entry System.
(ii) Double Entry System.

 DOUBLE ENTRY SYSTEM


The Double Entry system of accounting is the only real system of accounting. This system recognizes that
every transaction is a double-sided affair. If one receives something then either
a) some other person has given it, or
b) Stock of something else has diminished, or
c) Some service has been rendered.
Is one losses something in the sense that either cash (or its equivalent) has to be given up (or is irretrievable
lost), then a corresponding benefit must have been received. For good and accurate results a transaction
should be recorded in both aspects.
Advantages of double entry system:
(i) The accuracy of the accounting work can be ensured, through the devices of the trial balances.
(ii) The profit earned or loss suffered during a period can be ascertained together with details.
(iii) The financial position of the firm or institution concerned can be ascertained at the end of each
period through preparation of the balance sheet.
(iv) The system permits accounts to be kept in as much details as necessary and therefore afford
significant information for the purpose of control etc.
(v) Result of one year may be compared with those of the previous years and reasons for the change
may be ascertained.

 CASH AND MERCANTILE SYSTEM OF ACCOUNTING:


Cash system:- In this system, entries are made only when cash is received or paid, no entry being
made when payment or receipt. The mercantile system is better normally since it takes into account
the amounts that become due.
Mercantile / Accrual system:- Under this system, a record is made on the basis of amounts having
become due for payment or receipt. The mercantile system is better normally since it takes into
account the amounts the become due.

 Distinguish between Accrual Basis of Accounting and Cash Basis of Accounting:


Accrual Basis Cash Basis
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(i) Under this system, there may be prepaid / (i) Under this, there is no prepaid /
outstanding expenses and accrued / outstanding expenses or accrued / unaccrued
unaccrued income in the balance sheet. income.
(ii) Income Statement will show a relatively
higher income in case of prepaid expenses (ii) Income statement will show lower
and accrued income. income.
(iii) Income statement will show a relatively
lower income in case of outstanding expenses
and unaccrued income . (iii) Income statement will show higher
(iv) The basis is recognized under the income.
Companies Act. 1956.
(iv) The basis is not recognized under the
Companies Act.1956.

 The Elements of Financial Statements:


The elements directly related to the measurement of financial position are assets, liabilities and
equity. These are defined as follows:-
a) An Assets is a resource controlled by the enterprise as a result of past events and from which future
economic benefits are expected to flow to the enterprise. These assets may be classified as follows:-
(i) Current Assets
(ii) Fixed Assets:
(a) Tangible fixed assets
(b) Intangible fixed assets.
b) A Liability is a present obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow from the enterprise or resources embodying economic benefits.
Liabilities may be broadly classified as follows:
(a) current Liabilities
(b) Long-Term Liabilities
c) Equity is the residual interest in our remaining claim against the assets of the enterprise after deducting
all its liabilities. When the business is first started, the owner’s equity is measured the total amount
invested by the owners.
Owners’ equity = Assets – Liabilities

 The rule for writing up accounts of various types are as follows:-


 Assets: Increase on the left hand or the debit side and decrease on the right hand or credit side.
Ex.: When cash is received, cash account should be debited and when it is paid, the account
should be credited.
 Liabilities: Increase on the credit side and decrease on the debit side.
 Capital: Increase on the credit side and decrease on the debit side.
 Expenses: Increase on the debit side and decrease on the credit side.
 Income or Gains: Increase on the credit side and decrease on the debit side.

 IMPORTANT TERMS USED IN FINANCIAL STATEMENTS

S.No. Terms Definitions


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1. Accrual Recognition of revenues and costs as they are earned or


incurred (and not as money is received or paid). It
includes recognition of transactions relating to assets and
liabilities as they occur irrespective of the actual receipts
or payments.
2. Accrual Basis of Accounting The method of recording the transactions by which
revenues, cost, assets and liabilities are reflected in the
accounts in the period in which they accrue.
3. Accrued Assets A developing but not yet enforceable claim against
another person which accumulates with the passage of
time or the rendering of service or otherwise. It may
arise from the rendering of services (including the use of
money) which at the date of accounting have been only
partly performed, and yet are not billable.
4. Accrued Expenses An expenses which has been incurred in an accounting
period but for which no enforceable claim has become
due in that period against the enterprise. It may also from
the purchase of services which at the date of accounting
have been partly performed, and are not yet billable.
5. Accrued Liability A developing but not yet enforceable claim by another
person which accumulates with the passage of time or the
receipt of service or otherwise. It may arise from the
purchase of services which at the date of accounting
have been only partly performed, and are not yet billable.
6. Accrued Revenue Revenue which has been earned in an accounting period
but in respect of which no enforceable claim has become
due in that period by the enterprise. It may arise from the
rendering of services which at the date of accounting
have been partly performed, and are not yet billable.
7. Accumulated Depreciation Is the cumulative sum of all depreciation recognised
since the date of acquisition of the particulars assets
described.
8. Advance Payment made on account of, but before completion of, a
contract, or before acquisition of goods or receipt of
services.
9. Amortisation The gradual and systematic writing off of an assets or an
account over an appropriate period. The amount on
which amortisation is provided is referred to as
amortizable amount. Amortisation also refers to gradual
extinction or provision for extinction of a debt by gradual
redemption or sinking fund payments or the gradual
writing off to revenue of miscellaneous expenditure
carried forward, e.g., share issue expenses, preliminary
expenses, etc.
10. Appropriation Account An account sometimes included as a separate section of
the profit and loss statement showing application of
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profits towards dividends, reserves, etc.


11. Assets Assets are economic resources that are expected to help
generate future cash in flow or reduce or prevent future
cash outflows. Example are cash, inventories, equipment
etc.
12. Bad Debts Debts owed to an enterprise which are considered to be
an irrecoverable.
13. Book Value The amount at which an item appears in the books of an
account or financial statements. It does not refer to any
particular basis on which the amount is determined e.g.,
cost, replacement value, etc.
14 Capital Generally refers to the amount invested in an enterprise
by its owners e.g. paid up share capital in a corporate
enterprise. It is also used to refer to the interest of owners
in the assets of an enterprise.
15 Capital Assets Assets, including investments not held for sale,
conversion or consumption in the ordinary course of
business.
16 Capital Employed The finances deployed by an enterprise in its net fixed
assets, investments and working capital. Capital
employed in an operation may, however, exclude
investments made outside that operation.
17 Capital Profit and Capital Loss Excess of proceeds realised from the sale, transfer, or
exchange of the whole or a part of a capital assets over its
cost. When the result of this computation is negative, it
is referred to as capital loss.
18 Capital Reserve A reserve of a corporate enterprise which is not available
for distribution.
19 Capital Work in Progress Expenditure on capital assets which are in the process of
construction or completion.
20 Cash Basis of Accounting The method of recording transactions by which revenues
and costs and assets and liabilities are reflected in the
accounts in the period in which actual receipts or actual
payments are made.
21 Cash Discount A reduction granted by a supplier from the invoiced price
in consideration of immediate payment within a
stipulated period
22 Cash Profit The net profit as increased by non-cash costs, such as
depreciation, amotisation, etc when the result of the
computation is negative, it is termed as cash loss.
23 Security Security which is given in addition to the principal
against the same liability or obligation.
24 Contingent Assets An assets the existence, ownership or value of which may
be known or determined only on the occurance or non-
occurance of one or more uncertain future events.
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25 Contingent Liabilities An obligation relating to an existing condition or


situation which may arise in future depending on the
occurance or non-occurance of one or more uncertain
future events.
26 Cost of purchase The purchase price including duties and taxes, freight
inward and other expenditure directly attributable to
acquisition, less trade discounts, rebates duty drawbacks,
and subsidies in respect of such purchase.
27 Cost of goods sold The cost of goods and sold during an accounting period.
In manufacturing operation, it includes (a) cost of
material (b) labour and factory over heads; selling and
administrative expenses are normally excluded.
28 Cost of Sales The cost of goods sold plus selling and administrative
expenses.
29 Conversion cost Cost incurred to convert raw materials or components
into finished or semi-finished products. This normally
includes costs which are specifically attributable to units
of production, i.e., direct labour, direct expenses and sub
contracted work, and production overheads as applicable
in accordance with either the direct costing or absorption
costing method. Production overheads exclude expenses
which relate to general administration, finance, selling
and distribution.
30 Current Assets Cash and other assets that are expected to be converted
into cash or consumed in the production of goods or
rendering of services in the normal course of business.
31 Current Liability Liability including loans, deposits and bank overdraft
which fall due for payment in a relatively short period,
normally not more than twelve months.
32 Defferal Postponement of recognition of a revenue or expense
after its related receipt or payment (or incurrence of a
liability) to a subsequent period to which it applies.
Common examples of deferrals include pre-paid rent and
taxes, unearned subscriptions received in advance by
newspaper and magazine selling companies, etc.
33 Deferred expenditure Expenditure for which payment has been made or a
liability incurred but which is carried forward on the
presumption that it will be of benefit over a subsequent
period or periods. This is also referred to as deferred
revenue expenditure.
34 Deferred Revenue Revenue or income received or recorded before it is
earned and carried forward to a subsequent period or
periods to which it relates.
35 Deficiency The excess of liabilities over assets of an enterprise at a
given date. The debit balance in the profit and loss
statement.
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36 Depreciable amount The historical cost, or other amount subsituated for


historical cost of a depreciable asset in the financial
statements, less the estimated residual value.
37 Depreciable asset Asset which is expected to be used during more than one
accounting period, has a limited useful life, and is held by
an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative
purposes and not for the purpose of sale in the ordinary
course of business.
38 Depreciation A measure of the wearing out, consumption or other loss
of value of a depreciable asset arising from use, effluxion
of time or obsolescence through technology and market
changes. It is allocated so as to charge a fair proportion
in each accounting period during the useful life of the
asset. It includes amortisation of asset whose useful life is
predetermined and depletion of wasting assets.
39 Depreciation Method Any method of calculating deprecation for an accounting
period.
40 Depreciation Rate A percentage applied to the historical cost or the
substituted amount of a depreciable asset (or in case of
diminishing balance method, the historical cost or the
substituted amount less accumulated deprecation.)
41 Diminishing Balance Method A method under which the periodic charge for
depreciation of an asset is computed by applying a fixed
percentage to its historical cost or substituted amount
less accumulated depreciation (net book value). This is
also referred to as written down value method.
42 Direct Cost An item of cost that can be reasonable identified with a
specific unit of product or with a specific operation or
other cost centre.
43 Direct costing A method whereby the cost is determined so as to include
the appropriate share of variable costs only, all fixed
costs being charged against revenue in the period in
which they are incurred.
44 Discount A reduction from the list price, quoted price or invoiced
price. It also refers to the price for obtaining payment on
a bill before its maturity.
45 Expenditure Incurring a liability, disbursement of cash or transfer of
property for the purpose of obtaining assets, goods or
services.
46 Expense A cost relating to the operations of an accounting period
or to the revenue earned during the period or the benefit
of which do not extend beyond the period.
47 Expired Cost The proportion of an expenditure from which no further
benefit is expected. Also termed as expense.
48 Ordinary Item Gain or loss which arises from events or transactions that
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are distinct from ordinary activities of the enterprise and


which are both material and expected not to recur
frequently or regularly. This would also include
material adjustment necessitated by circumstances,
which, though related to previous periods, are determined
in the current period.
49 Fair Market Value The price that would be agreed to in an open and
unrestricted market between knowledge and wiling
parties dealing at arm’s length who are fully informed
and not under any compulsion to transact. Arm’s length
is a term applied to any transaction on the assumption
that the parties to the transactions would act without
being influenced by each other or by any other person.
50 Fictitious Asset Item grouped under assets in a balance sheet which has
no real value (e.g. the debit balance of the profit and loss
statement.)
51 Fixed asset Asset held for the purpose of providing or producing
goods or services and that is not held for resale in the
normal course of business.
52 Fixed cost The cost of production which by its very nature remains
relatively unaffected in a defined period of time by
variations in the volume of production.
53 Free Reserve A reserve the utilisation of which is not restricted in any
manner.
54 Franchises and Licenses: Franchises and licenses are legal contract that grant the
buyer the right to sell a product or service. An example
is a local McDonald’s name, to acquire branded products
such as cups and bags, and to share in advertising and
special promotions. In exchange, the franchisee promise
to follow McDonalds’s procedures and maintain
standards of quality, cleanliness, and pricing. The
acquisition costs of franchises and licenses are amortized
over their economic lives.
55 Gain A monitary benefit, profits or advantage resulting from a
transition or group of transations.
56 Reserve A revenue reserve which is not earmarked for a specific
purpose.
57 Goodwill An intangible asset arising from business connections or
trade name or reputation of an enterprise.
58 Intangible Asset Asset which does not have a physics identity e.g.
Goodwill, Patents, Copyright etc.
59 Investment Expenditure on assets held to earn interest, income,
profit, or other benefits.
60 Investments Assets held not for operational purposes or for rendering
services i.e. assets other than fixed assets or current
assets (e.g. securities, shares, debentures, immovable
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properties). The financial obligation of an enterprise


other than owners funds.
61 Liabilities Liabilities are economic obligations of the organization
to outsiders, or claim against its assets by outsides. An
example is debt to bank.
62 Lien Right of one person to satisfy a claim against another by
holding or retaining possession of the other’s
assets/property.
63 Long-term Liability Liability which does not fall due for payment in a
relatively short period, i.e., normally a period not more
than twelve months.
64 Materiality An accounting concept according to which all relatively
important and relivant items, ie., items the knowledge of
which might influenced the decisions of the user of the
financial statements are disclosed in the financial
statements.
65 Mortgage A transfer of interest in specific immovable property for
the purpose of securing a loan advanced or to be
advanced, an existing or further debt or the performance
of an engagement which may give rise to a pecuniary
liability. The security is redeemed when the loan is
repaid or the debt discharged or the obligations
performed.
66 Net Assets The excess of the book value of assets (other than
fictitious assets) of an enterprise over its liabilities. This
is also referred to as net worth or shareholde’s funds.
67 Operating profit The net profit arising from the normal operations and
activities of an enterprise without taking account of
extraneous transactions and expenses of a purely
financial nature.
68 Operating cycle The time span during which cash is used to acquire goods
and services, which cash is used to acquired goods and
services, which in term are sold to customers, who is tern
pay for their purchases with cash.
69 Preliminary Expenses Expenses relating to the formation of an enterprise.
These include legal, accounting and share issued
expenses incurred for formation of the enterprise.
70 Pre-paid Expenses Payment for expense in an accounting period, the benefit
for which will accrue in the subsequent accounting
period(s).
71 Prior Period Item A material charge or credit which arises in the current
period as a result of errors or omissions in the preparation
of the financial statements of one or more prior periods.
72 Provision An amount written off or retained by way of providing
for deprecation of diminution in value of assets or
retained by way of providing for any known liability the
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amount of which can’t be determined with substantial


accuracy.
73 Provision for Doubtful Debts A provision made for debts considered doubtful or
recovery.
74 Reserve The portion of earnings, receipts or other surplus of an
enterprise (whether capital or revenue) appropriated by
the management for a general or a specific purpose other
than a provision for deprecation or diminution in the
value of assets or for a known liability. The reserves are
primarily of two types: (a) capital reserves and (b)
revenue reserves.
75 Revenue The gross inflow of cash, receivables or other
consideration arising in the course of ordinary activities
of an enterprise from the sales of goods, from the
rendering of services, and from the use by others of
enterprise resources yielding interest, royalties and
dividends. Revenue is measured by the charges made to
customers or clients for goods supplied and services
rendered to them and by the charges and rewards arising
from the use of resources by them. It excludes amount
collected on behalf of third parties such as certain taxes.
In an agency relationship, the revenue is the amount of
commission and not the gross inflow of cash, receivables
or other consideration.
76 Sales turnover The aggregate for which sales are effected or services
rendered by an enterprise. The terms gross turnover and
net turnover (or gross sales and net sales) are sometimes
used to distinguish the sales aggregate before and after
deduction of returns and trade discounts.
77 Secured Loan Loan secured wholly or partially against an asset.
78 Sinking Fund A fund created for the repayment of liability or for the
replacement of an asset.
79 Straight Line Method The method under which the periodic charge for
depreciation is computed by dividing the depreciable
amount of a depreciable asset by the estimated number of
years of its useful life.
80 Sundry Creditor Amount owed by an enterprise on account of goods
purchased or services received or in respect of
contractual obligations. Also termed as Trade creditor or
account payable.
81 Sundry Debtor Person from whom amounts are due for goods sold or
services rendered or in respect of contractual obligations.
Also termed as debtor, trade debtor, or account
receivable.
82 Trade Discount The reduction granted by a supplier for the list price of
goods or services on business considerations other than
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83 Trade Mark Trademarks are distinctive identifications of a
manufactured product or of service, taking the form of a
name, a sign, a slogan, a logo, or an emblame. An
example is an emblem for Coco-Cola. Trademark, trade
names, trade brands, secret formulas, and similar items
are property rights with economic lives depending on
their length of use.
84 Transaction A transaction is any event that both affects the financial
position of an entity and can reliably recorded in money
terms. Each transaction has counterbalancing entries on
the balance sheet so that the total assets always equal the
total liabilities and owners’ equity.
85 Unexpired Cost That portion of an expenditure whose benefit has not yet
been exhausted.
86 Variable Cost That cost which varies directly, or nearly directly, with
the volume of activity.
87 Work-in-Progress Work in process includes all materials which have
undergone manufacturing or processing operations, but
upon which further operations are necessary before the
product is ready for sale.

CHAPTER – 2
JOURNALIZING, POSTING & BALANCING

 TRADITIONAL CLASSIFICATION OF ACCOUNTS:


a) Personal Accounts:- These accounts relate to natural persons, artificial persons, and representative
persons. (creditors, customers, etc)
b) Impersonal Accounts:
i) Real Accounts:- These accounts relate to the tangible or intangible real assets. (i.e. accounts
of properties and assets); and
ii) Nominal Accounts:- These accounts relate to incomes, expenses or losses.
RULES:- The following three are the basic rules for recording the transaction:-
1) Personal Accounts:- Debit the receiver and Credit the giver.
2) Real Accounts:- Debit what comes in and credits what goes out.
3) Nominal Accounts:- Debit all exp. (and loses) and credit all incomes and gains.
The left hand side of an account is called the debit side and the right-hand side of an account is called
credit side.

 ACCOUNTING EQUATION BASED CLASSIFICATION:

1. Assets Accounts These accounts relate to tangible or intangible real assets. Eg. Land A/c, Building
A/c, cash A/c, Patents, Goodwill, Trademark etc.
2. Liabilities Accounts These accounts relate to the financial obligations of an enterprise towards
outsiders. Eg Trade creditors, Bills Payable , Bank Overdraft, Loans, Outstanding
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Exp. etc.
3. Capital Accounts These accounts relate to owners of an enterprise. Eg. Capital A/c, Drawings A/c.
4. Revenue Accounts These accounts relate to the amount charged for goods sold or services rendered
or permitting others to use enterprise’s resources yielding interest, royalty or
dividend. Eg. Sales A/c, Discount Received A/c, Dividend Received A/c, Interest
Received A/c.
5. Expenses Accounts These accounts relate to the amount incurred or lost in the process of earning
revenue. Eg. Purchase A/c, Discount allowed A/c, Royalty paid A/c, Interest
payable A/c, Loss by Fire A/c etc.

 DISTINCTION BETWEEN REAL ACCOUNT AND NOMINAL ACCOUNT


Real Account Nominal Account
⇒ These accounts relate to properties of the ⇒ These accounts relate to expenses, losses,
business. income and gains.
⇒ These accounts are shown in Balance Sheet. ⇒ These accounts are shown in profit and loss
⇒ Closing balances of these accounts are carried account.
over to the next year as opening balances. ⇒ Closing balance of these accounts are closed by
⇒ These accounts indicate financial position of transfer to profit and loss account.
the business. ⇒ These accounts assist in calculating profit and
⇒ As per double entry rule, property received is loss of the business.
debited and property given is credited. ⇒ As per double entry rule, expenses and losses
are debited and income and gains are credited.

 JOURNAL
A Journal is a book in which transactions are recorded in the order in which they occur i.e., in chronological
order. A journal is the primary books of account under which all the transactions are recorded with
complete narration on the basis of the three basic rules given for recording the transactions. The process of
recording a transaction in a journal is called Journalizing. An entry made in the journal is called a ‘Journal
Entry’.
A journal entry is an analysis of all the effect of a single transaction on the various accounts, usually
accompanied by an explanation. For each transaction, this analysis identifies the accounts to be debited or
credited.
FORMAT:
Date Particulars L.F. Amount (Dr.) Amount (Cr.)

Note:- The ‘Ledger Folio column’ is filled in at the time of posting into the ledger and not at the time of
journalizing.

 ADVANTAGES OF JOURNAL
♦ Chronological record:- It records the transactions in the order in which they occur.
♦ Explanation of transaction:- Each journal entry in the journal carries narration which gives a brief
explanations of the transaction.
♦ Recording the both aspects:- Both the aspect (i.e., debit and credit) of a transaction are recorded in
the journal. Since the amounts recorded in both debit amount column and credit amount column
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must be equal, the possibility of accounting error is reduced and the detection of errors, if any,
committed becomes easy.

 LIMITATIONS OF JOURNAL:
When the number of transactions is large, it is practically impossible to record all the transactions
through one journal because of the following reasons:
(i) The system of recording all the transactions in a journal required (a) the writing down of the
name of account involved as many times as the transactions occur; and (b) an individual posting
of each account debited and credited and hence involves the repetitive journalizing and posting
labour.
(ii) Such system does not provide the information on prompt basis.
(iii) Such a system does not facilitate the installation of an internal check system since, the journal
can be handled by only one person.
(iv) The journal becomes bulky and voluminous.
To overcome and shortcomings of the use of the journal only as a book of original entry, the journal is
subdivided into special journal.

 NARRATION:
The narration is the explanation of the entry and facilitates quick understanding. The length of the
narration depends on the complexity of the transaction and whether management wants the journal itself
to contain all relevant information. Most often narration are in brief.
S.No. Particulars Amount (Dr.) Amount (Cr.)
1. On bringing of Capital in Cash:
Cash Account ...........…...........… Dr.
To Capital Account
(Being cash brought as capital in to business)
2. On brining of capital in the mode of cheque:
Bank Account ...........…...........… Dr.
To Capital Account
(Being capital brought into business)
3. On deposit of cash into bank:
Bank Account ...........…...........… Dr.
To Cash Account
(Being Cash deposited into bank)
4. On purchase of assets for cash.
Assets (name of assets) Account ...........…. Dr.
To Cash Account.
(Being assets purchase for cash)
5. On purchase of assets on credit:
Assets Account ...........…...........…. Dr.
To Supplier Account
(Being assets purchased on credit from .............)
6. On sale of goods for cash.
Cash Account ...........…...........…… Dr.
To Sales Account
(Being goods sold for cash)
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7. On sale of goods on credit.


Sundry Debtors Account ...........…… Dr.
To Sales Accounts
(Being goods sold to Mr. ............. on credit)
8. On return of goods from customer:
Sales Account ...........…...........… Dr.
To Sundry Debtors / Cash A/c
(Being goods return from Mr. ...........…)
9. On payment received from debtors:
(i) Received in cash:
Cash Account ...........…...........… Dr.
To Sundry Debtors Account
(Being cash received from .............)

(ii) Received by cheque and the same is


deposited into bank:
Bank Account ...........…...........… Dr.
To Sundry Debtors Account
(Being cheque received from customer deposited
into bank)
10. On Dishonour of cheque deposited into Bank:
Sundry Debtors A/c ...........…...........… Dr.
To Bank A/c
(Being dishonour of cheque received from customer)
11 On Payment received from debtors:
Cash / Bank Account ...........…............. Dr.
Discount Account ...........…...........…... Dr.
To Sundry Debtors Account
(Being amount received from ............. after giving a
discount @…%)
12 For bad debts:
Bad Debts Account ...........…............. Dr.
To Sundry Debtors Account
(Being amount due from Mr............. is confirmed as bad
debts)
13 For provision for bad and doubtful debt:
Profit and Loss Account ...........…............. Dr.
To Provision for doubtful debt Account
(Being prov. made for doubtful debts @ ..% of Sundry
debtors)
14 For transfer of Bad Debts of provision for doubtful debts
account (if prov. for doubtful debts account maintained)
Provision for doubtful debts account ............. Dr.
To Bad Debts Account
(Being amt. of bad dents trad. to prove for doubtful
debts account)
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15 On purchase of raw material / trading goods for cash:


Purchase/Goods Account ...........…............. Dr.
To Cash Account
(Being goods purchased for cash)
16. On purchase of raw material/trading goods on credit:
Purchase / Goods Account ...........…............. Dr.
To Sundry Creditors Account
(Being goods purchased on credit)
17. On return of purchased goods to the supplier:
Sundry Creditors Account ...........…............. Dr.
To Purchase / Goods A/c
(Being goods return to Mr. ...........…)
18. On Payment made to supplier/creditor:
Sundry Creditor Account ...........…............. Dr.
To cash/Bank account
(Being cash / cheque no......paid to Mr.............)
19 On payment made to creditors after availing cash
discount
Sundry Creditors Account ...........…............. Dr.
To cash/bank A/c
To Discount A/c
(being cash/cheque no…..paid to Mr. .... after discount
@…%)
20 On payment of expenses:
Expenses Account ...........…...........… Dr.
To cash/Bank A/c
(Being cash paid for .............)
21 On expenses due but no paid:
Expenses Account ...........…............. Dr.
To Expenses outstanding/payable account
(Being expenses for the month of .............due but not
paid)
22 On income accrue but not received:
Income Accrue/Received A/c ...........…. Dr.
To respective Income A/c
(Being Income accrues but not received during the year.)
23 On amount withdrawn from bank:
Cash Account ...........…...........…. Dr.
To Bank A/c
(Being amount withdrawn from bank for business use)
24 On amount withdrawn from bank for private use:
Capital / Drawing Account ...........… Dr.
To Bank A/c
(Being amount withdrawn from bank for personal use.)
25 On withdrew of trading gods for private use:
Capital / Drawing Account ...........…......... Dr.
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To Purchase / Goods A/c


(Being goods withdrew from business for personal use.)
26 For distribution of trading goods free as a sample:
Advertisement A/c ...........…............. Dr.
To Purchase A/c.
(Being distribution of trading goods free as a sample
debited to advertisement A/c and credited to purchases
A/c)

 COMPOUND ENTRY:
When more than two accounts are involved in a transaction and the transaction is recorded by means of
single journal entry instead of passing several journal entries, such single journal entry is termed as
‘Compound Journal Entry’. A compound journal may also be passed if there are more transactions of
the same nature, taking place on the same date. It may be recorded in the following three way:
(i) by debiting one account and crediting two or more accounts; or
(ii) by debiting two or more accounts and crediting one account; or
(iii) by debiting several accounts and crediting several accounts.
Example:-
Paid Rs. 920 to Mr. Gopal in full settlement of his account of Rs. 1,000.
Gopal A/c ...........… Dr. 1000
To Cash a/c 980
To discount received A/c 20
(Being cash paid to Gopal in full settlement of his account)

 OPENING ENTRY
A Journal entry by means of which the balances of various assets, liabilities and capital appearing in the
balance sheet of previous accounting period are brought forward in the books of current accounting
period, is known as ‘Opening Entry’.
While passing an opening entry. All those accounts which denote what the business possesses (assets)
are debited and all the accounts showing amounts due by the business (liabilities) are credited.
⇒ If Capital is not given, it can be easily found out by deducting liabilities from assets.
Opening entries are the following:
Cash Account ............. Dr.
Cash at Bank Account ............. Dr.
Sundry Debtors Account ............. Dr.
Stock Account ............. Dr.
Fixed Assets Account ............. Dr.
To Sundry Creditors Account
To Capital Account
⇒ The opening entry is made in the journal. At the end of the trading period, closing entries are made,
the object being to close the books.

 LEDGER:
A ledger is a principal book, which contains all the accounts to which the transactions recorded in the
books of original entry are transferred. As the ledger is the ultimate destination of all transactions, the
ledger is called the ‘Book of Final Entry.’
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The ledger may be kept in the form of a bound book, a loose-leaf set of pages, or some kind of electronic
storage device such as magnetic tape or floppy diskettes or CDs, but it is always kept current in a
systematic manner.
Utility of the ledger:
⇒ It provides complete information about all the accounts in one book.
⇒ It enables to ascertain what the main item of revenues are.
⇒ It enables to ascertain what the main item of expenses are.
⇒ It enables to ascertain what the assets are and of what value.
⇒ It enables to ascertain what the liabilities are and of what amounts.
⇒ It facilitate (i.e. make easy) the preparation of Final Accounts.

 DISTINCTION BETWEEN JOURNAL AND LEDGER:


Journal Ledger
⇒ It is a book of primary entry. ⇒ It is book of final or secondary entry.
⇒ It is prepared on the basis of source documents ⇒ It is prepared on the basis of journal.
of transactions.
⇒ Recording of transactions in the journal is ⇒ Recording in the Journal is second stage.
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25
CHAPTER – 3
SUBSIDIARY BOOKS
When number of transactions is numerous, it is practically impossible to record all the transactions through
one journal because of a its limitations. To overcome the shortcomings of the use of the journal entry, the
journal is divided into special journals.
The journal is subdivided in such a way, that a separate book is used for each category of transactions,
which are repetitive in nature and are sufficiently large in number.
Special journal, refer to the journals meant for specific transactions of similar nature. Special journals are
also known as subsidiary books or day-book.
In any large business organization, the following special journal (or subsidiary books) are generally used:
Name of Books Transactions to be recorded
[I] Cash Journals:
(a) Cash Book (simple) ⇒ Cash transactions
(b) Cash book with discount column ⇒ Cash and discount transactions
(c) Cash Book with bank and ⇒ Cash, Bank and discount transactions
(d) Petty Cash Book ⇒ Petty Cash transactions
[II] Goods Journals:
(a) Purchase book ⇒ Credit purchase of goods.
(b) Sales book.
⇒ Credit sales of goods
(c) Sales return book
⇒ Goods returned by those customers to whom
(d) Purchase returns book goods were sold on credit.
⇒ Goods returned to those suppliers from goods
[III] Bills of Journals: were purchased on credit
(a) Bills receivable book.
(b) Bills payable ⇒ Bills receivable Drawn
book. ⇒ Bills payable accepted.
Advantages of subsidiary Books:-
(i) Division of work.
(ii) Specialization and efficiency.
(iii) Saving the time.
(iv) Availability of information’s.
(v) Facility in checking.

 Cash Book:
A cash – Book is special journal which is used for recording all cash receipts and cash payments. It is a
book of original entry, since transactions are recorded for the first time from the source documents. The
Cash-Book is a ledger in the sense that it is designed in the form of a Cash Account and records cash
receipts on the debit side and cash payment on the credit side. Thus, Cash-book is both a journal and
ledger.
⇒ Single Column Cash Book has one amount column on each side.
⇒ Double Column Cash Book (i.e. Cash book with discount Column) has two amount columns. One for
cash and another fro discount. All cash receipts and cash discount allowed are recorded on the debit side
and all cash payments and cash discount received are recorded on the credit side.
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1. Three Column Cash Book has three amount columns (one for cash, one for bank and one for discount)
on each side. All cash receipts, deposits into bank and discount allowed are recorded on debit side and
all cash payments, withdrawals from bank and discount received are recorded on the credit side. A three
26
column cash book serves the purpose of Cash Account and Bank Account. Hence, there is no need to open
these two accounts in ledger.

 Petty Cash Book:


Petty cash book is the book which is used for the purposes of recording the payment of petty cash
expenses.
Features of Petty Cash Book:
(i) The amount of cash received from the main cashier is recorded on the left hand side column.
(ii) The payments of petty cash expenses are recorded on the right hand side in the respective
columns.
(iii) It can never show a credit balance because the cash payments can never exceed the cash receipts.
(iv) Its balance represents unspent petty cash in hand.
(v) All the columns of expenses are totaled periodically and such periodic totals are individually
posted to the debit side of the respective expenses accounts in the ledger by writing ‘To Sundries
as per petty Cash Book’.
Advantages:
(i) Saving of chief cashier’s time.
(ii) Saving labour in posting.
(iii) Control over mistakes
(iv) Control over petty expenses
(v) Control over fraud
(vi) Benefits of specialization

 Imprest System of Petty Cash Book


The amount which the man cashier hands over to the petty cashier in order to meet the petty cash
expenses of a given period in known as ‘IMPREST’ OR ‘FLOAT’.
Features of imprest system of petty cash:
(i) Estimation by chief cashier
(ii) Advances by chief cashier
(iii) Submission of petty cash book by petty cashier
(iv) Examination of petty cash book by chief cashier
(v) Reimbursement of amount spent
(vi) Availability of same amount of petty cash.
Advantages:
(i) Control over mistakes
(ii) Control over petty expenses
(iii) Control over fraud
TRADE DISCOUNT
It is reduction granted by a supplier from the list price of goods or services on business considerations (such
as quantity bought, trade practices, etc.) other than for prompt payment. List price is the selling price as
printed on the product or in the List/Catalogue of product.
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CASH DISCOUNT
A reduction granted by a supplier from the invoice price in consideration of immediate payment within a
stipulated period.

27
 DISTINCTION BETWEEN TRADE DISCOUNT

Trade Discount Cash Discount


⇒ It is a reduction granted by a supplier from the ⇒ A reduction granted by a supplier from the
list price of goods or services. invoice price in consideration of immediate
payment or payment within stipulated period
⇒ It is allowed to promote the sales or as a trade ⇒ It is allowed to encourage the prompt payment.
practices.
⇒ It is allowed on purchase of goods. ⇒ It is allowed on immediate payment or payment
within a specified period.
⇒ It is shown by way of deduction in the invoice ⇒ It is not shown in the invoice.
itself.
⇒ Trade discount account is not opened in the ⇒ Cash discount Account is opened in the ledger.
ledger.
⇒ It may vary with the quantity purchased ⇒ It may vary with the period within which the
payment is made

Question:
(1) What is debit note? Name the book in which entries are recorded on the basis of debit note?
Ans.: A Debit note is a document prepared by the purchases to inform the supplier that his account has
been debited with the amount mentioned and for the reasons stated therein. Debit note contains the date of
return, name of the supplier to whom the goods have been returned, details of the goods returned, reasons
for returning the goods. Each debit note is serially numbered.
The entries in the purchases returns book are usually made on the basis of debit notes issued to the
suppliers or credit notes received from the suppliers.
(2) What is credit note? Name the book in which entries are recorded on the basis of credit note?
Ans.: A Credit note is a document prepared by the seller to inform the buyer that his account has been
credited with the amount mentioned and for the reasons stated therein. Credit note contains the date of
return of goods, the name of the customer who has returned the goods, details of goods received back and
the amount of such goods. Each credit note in serially numbered.
The entries in the sales returns book are usually on the basis of credit notes issued to customers or
debit notes issued by the customers.
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CHAPTER – 4
RECTIFICATION OF ERRORS
The term ‘error’ refers to unintentional mistakes in financial information, e.g. mathematical or clerical
mistakes, oversight or misinterpretation of facts, or unintentional misapplication of accounting policies.
While recording transactions and events various errors may be committed unintentionally. When a journal
entry contains an error, the entry can be erased or crossed out and corrected – if the error is discovered
immediately. However, if the errors are detected after posting to ledger accounts, the correcting entries are
made. The correcting entry is recorded in journal and posted to the general ledger exactly as regular entries
are.
Example:

28
(i) A repair expenses was erroneously debited to plant and machinery on November 25, the error is
discovered on December 31:
Corrective Entry: 31st Dec.: Repair Expenses A/c ............. Dr.
To Plant and Machinery A/c
The corrective entry shows a credit to Plant and Machinery to cancel or offset the erroneous debit to
Plant and Machinery.
(ii) A collection on account was erroneously credited to Sales on Jan. 1. The error is discovered on
March 26.
Corrective Entry: March 26. Sales Account ...........…. Dr.
To Sundry Debtor A/c
The debit to Sales in the correcting entry offset the incorrect credit to sales in the erroneous entry. The
credit to Accounting Receivable in the correcting entry places the collected amount where it belongs.

Some Errors are Counter Balanced:


Accounting errors that are undetected can affect a variety of items, including revenues and expenses for a
given period. Some errors are counterbalanced by offsetting errors in the ordinary accounting process in the
given period. Such errors are misstate net income in both periods, but by the end of the second period the
errors counterbalance or cancel each other out, and they affect the balance sheet of only first period, not the
second period.
Example: A payment of Rs. 10,000 in March 2003 for Rent for the month April 2003. Instead of recording
it as prepaid rent, the payment was recorded as Rent Expenses.
The effect of this recording error would be to:
(1) Overstate rent expenses for the year 2002-2003 and understate year-end assets by Rs. 10,000 for the first
year end; and
(2) Understate rent expense for the second year.
The errors have no effect on the second year’s ending assets because the same total assets exist whether the
rent is recorded as used in April of that year or recorded as used in full the previous year. The total of the
incorrect pretax income for the 2 years would be same with the total of the correct pretax income for the 2
year because the first year’s understatement of pretax income by Rs. 10,000 would counterbalance the
second year’s overstatement of Rs. 10,000. The retained income balance at the end of second year would
thus be correct on a pretax basis.

Errors that are not counterbalanced in the ordinary book-keeping process will keep subsequent
balance sheets in error until specific correcting entries are made.
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A Trial Balance is very good way of giving a clear indication of some mistakes that may be there. This will
be shown immediately , if the total of the two columns of the trial balance differ. Thus, trial balance is
essential to ensure that mistakes do not remain unearthed. However, the agreement to trial balance does not
show conclusively that no mistakes have remain undetected. Some errors will not be disclosed by the trial
balance whereas some will be. An agreed trial balance, therefore, is only a reasonable proof of
arithmetic accuracy of books.

 DIFFERENCE IN TRIAL BALANCE:- ERRORS


Apart from error in totaling the two columns of trial balance, the following mistakes will be shown up by
the trial balance, because then the trial balance will not agree:
a) mistake in transferring the balance of an account to trial balance.
29
b) Omitting to write the balance of an account in the trial balance.
c) ⊥Mistake in balancing.
d) Mistake an entry on the wrong side.
e) A mistake in the casting of subsidiary books.
f) Omitting to post the discount columns of the cash book.
Inspite of the agreement of the trail balance, the following types of error will not be disclosed because
they do not upset the equation: DEBIT = CREDIT.
(i) Omitting to record a transaction entirely in subsidiary books.
(ii) A wrong entry in the subsidiary books.
(iii) Posting an entry on the correct side but in the wrong account head.
(iv) An error of principle – where by an assets is transferred as an expense or liability is treated as an
income.
(v) Compensating errors.

 CLASSIFICATION OF ERRORS
(a) Error of Omission A transaction entirely omitted to record in original
books or partially omitted while posting.
(b) Error of commission Wrong posting either of amount, or on the wrong
side, or in the wrong account.
(c) Error of Principle Wrong classification of expenditure or receipt.
(d) Compensating error One error compensated by the another error i.e. an
error which cancel themselves out.

 STEPS TO LOCATE A MISTAKES


THE FOLLOWING STEPS ARE SUGGESTED TO FIND OUT ERRORS:
1) Total the debit and credit columns of trial balance again.
2) See the balances of all accounts, including the cash and bank balances, have been written in the trial
balance.
3) Find our the difference in the trial balance. Look for such accounts as show this account. It is
possible that the balance of the particular account has been omitted from the trial balance. Account
showing equal to half the difference should also be checked; the amount may have been written on
the wrong side of the trail balance.
4) See that there are no mistakes in the balancing of the various accounts.
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5) Recheck the totals of the subsidiary books, especially if the mistake is of 1,10,100 and so on.
6) If the difference is a large one, compare the figure with the trial balance of the corresponding date of
the previous year. Any account showing rather large difference over the figure in the corresponding
trial balance of the previous year, should be rechecked.
7) Posting of all amounts corresponding to the differences or half the difference should be checked.
8) If the differences are still not traced posting of all accounts will have to be checked.

 RECTIFICATION OF ERRORS
Correction of errors, if located after some time, is always made by a proper journal entry and not by
simply crossing the wrong amount and inserting the right one. A complete explanation for the correction
made should be given so that no difficulty is experienced later when accounts are checked.
From the point of view of rectification, errors are of two type:-
(i) Error that affect the trial balance; and
30
(ii) Errors that do not affect the trial balance.
Correction of such error as affect the trial balance would not be through journal entry; only a
corrective amount placed on the proper side will suffice. Some of the examples of such types of
errors are as follows:-
1) An amount of Rs. 150 for a credit sale to Mr X correctly entered in the sales book, has been debited to
his account as Rs. 105.
In this case the amount has been correctly entered in the sales book and, therefore, the sales account has
been correctly posted. The mistakes lies only in the account of Mr. X, who should have been debited
with Rs. 150 and has been debited, instead, with Rs 105. The correcting entry is to:-
Mr. X Account Dr. Rs. 45.00
To mistakes in posting on ............. Rs. 45.00
(Being amount wrongly posted in Mr. X A/c for Rs. 105 instead of Rs. 150)
2) An amount of Rs. 150 for a credit sale to D.K.Kapoor, correctly entered in sales book, has been credited
to him.
In this case also the sales account has been correctly posted and the mistakes lies only in the account of
D.K.Kapoor, who has been credited instead of debited.
The correcting entry is to debit him with Rs. 300, Rs. 150 to remove the wrong credit and Rs. 150 for the
rightful debit. The caption will be “To mistake in posting on...........…

 SUSPENSE ACCOUNT:
If the difference in the trial balances is not quickly located, it is usual to put the difference to
suspense account in order to make the trial balance balanced.
♦ If the debit side is short, the suspense account will be debited saying “To differences in trial balance”
and
♦ Similarly, the suspense account will be credited if the credit side is short.
The difference in the trial balance is due only to type of mistakes which affect only one account such as
wrong posting of an account, mistake in totaling a subsidiary book, etc. Such types of mistakes are only
reflected in suspense account.
When the difference in trial balance is put to suspense account, the account to be corrected will be
debited or credit as the case may be, and the journal entry will be completed by crediting or debiting the
suspense account. When all the mistakes have been corrected, the suspense account will show no
balance.
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 CORRECTION IN THE NEXT TRADING PERIOD:


Since it is necessary to ascertain the profit or loss of each period separately, it would be necessary to
rectify errors in such a way as not to affect the current year’s expenses, losses or incomes.
To take an example, if an error committed in 2001-2002 is rectified in 2002-2003 by debiting purchase
account, it would mean that it would be treated as expenditure for 2002-2003. This would be wrong and
the proper way is to leave the purchase account and all other nominal account for 2002-2003 unaffected
by error in 2001-2002.
For this purpose, a separate account, profit and loss adjustment account, should be opened and all debit
and credit in respect of nominal accounts for error committed in previous trading period should be
passed through that account. The balance of this account is finally transferred to the capital account.

31
 DISTINCTION BETWEEN ERROR OF PRINCIPAL AND ERROR OF OMISSION
Errors of Principal Errors of Omission
⇒ This error does not affect Trial Balance ⇒ This error may affect Trial Balance.
⇒ This error is due to wrong classification of ⇒ This error is due to complete omission of a
Capital and Revenue expenditure or personal and transaction or partial omission.
nominal account.
⇒ This is not a clerical error. ⇒ This is a error may or may not affect profit of the
⇒ This error affects profit of the business. business.
⇒ This error will affect value of asset or liability. ⇒ This error may or may not affect value of assets
or liability.

CHAPTER – 6
BILLS OF EXCHANGE / PROMISSORY NOTE

BILL OF EXCHANGE:-
“A Bill of exchange is an instrument in writing containing an unconditional order signed by the maker,
directed a certain person to pay a certain sum of money only to or to the order of, a certain person or to the
bearer of the instrument.”
When such an order is accepted by writing on the face of the order itself, it becomes a valid Bill of
Exchange.
The essentials are:
1. A bill of exchange must be in writing .
2. It must be dated.
3. The bill must be signed by the drawer.
4. The drawer, the drawee, and the payee must be certain.
5. It must contain an order to pay a certain sum of money.
6. The money must be payable to a definite person or to his order to the bearer.
7. The draft must be accepted for payment by the party or whom the order is made.
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⇒ The party who make the order (i.e. who makes the bill) is known as drawer; the party who accept
the order is known as acceptor and the party to whom the amount has to be paid is known as the
payee. The drawer and payee can be the same.
Specimen of Bill of Exchange.
Rs. 10000 Delhi
October 25, 2004
Stamp
Three months after the date pay M/s X Brothers to order the sum of Rs. 10,000 for value received.
P.K.Singh
To
M/s Nanda Brothers.
Laxmi Nagar, Delhi 110092.

PROMISSORY NOTE:
“A Promissory Note is an instrument in writing, not being a bank note or currency note, containing an
unconditional undertaking, signed by, the maker, to pay a certain sum of money only to, or to the order of a
certain person or to the bearer of the instrument.”
A Promissory Note has the following characteristics:-
1. It must be in writing.
2. It must contain a clear promise to pay, mere acknowledgement of a debt is not a promissory note.
3. The promise to pay must be unconditional. “I promise to pay Rs. 5000/- as soon as I can” is not an
unconditional promise.
4. The promisor or maker must sign the promissory note.
5. The maker must be a certain person.
6. The payee must also be a certain.
7. The sum payable must be certain and must not be capable of contingent addition or subtractions. “I
promise to pay Rs. 5000/- plus all fines” is not certain.
8. Payment must be in legal money of the country.
9. It should not be made payable to bearer.
10. It should be properly stamped.
Specimen of Promissory Note:
Rs. 10000 Delhi
October 25, 2004
Stamp
Three months after the date we promise to pay M/s Alfa & Co. or order the sum of Rs. 10,000
with interest at 6% for value received.
Gopal & Sons.

DISTINGUISH BETWEEN BILLS OF EXCHANGE AND PROMISSORY NOTE:

Bill of Exchange Promissory Note


⇒ It is an unconditional order directing a certain ⇒ It is an unconditional promise to pay a certain
person to pay a certain sum of money. sum of money.
⇒ Generally, there are three parties in the bill of ⇒ There are two parties in a promissory note – the
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exchange – the drawer, the drawee and the promisor or maker and the payee.
payee.
⇒ A bill of exchange requires acceptance by the ⇒ This does not require acceptance. It is written by
drawee after if is drawn by the drawer. the person who will pay the amount.
⇒ Bill of exhange may be payable either on order ⇒ Promissory note can not be payable to bearer.
or to the bearer.
⇒ In case of Bills of Exchange notice of dishonour ⇒ In case of promissory note, notice of dishonour
is given to all parties concerned. is not required.
⇒ The maker (Drawer) of the Bill is liable only ⇒ The maker is primarily liable to pay the amount.
when drawee does not make payment.
⇒ In case of foreign bills protest is necessary if it is ⇒ Protest is not required for promissory note.
required as per law of the country where bill has
been drawn.

CHEQUE:
A cheque is a bill of exchange drawn on a specified banker and payable on demand. It includes the
electronic image of a truncated cheque and a cheque in the electronic form.
A cheque is a bill of exchange with two additional qualifications:
⇒ It is always drawn on a specified bank, and
⇒ It is always payable on demand.

DISTINGUISH BETWEEN BILLS OF EXCHANGE AND CHEQUE:

Bill of Exchange Cheque


⇒ This requires acceptance by the drawee. ⇒ This does not require acceptance.
⇒ This can be drawn on any person including bank. ⇒ This can be drawn on Bank only.
⇒ Notice of dishonour is necessary. ⇒ Notice of dishonour is not necessary.
⇒ A bill of exchange may be payable either on ⇒ Cheque is always payable on demand.
demand or after a specified period.
⇒ A bill of exchange generally requires stamping. ⇒ This does not require stamping.
⇒ Bills of exchange can not be crossed ⇒ A cheque may be crossed.
⇒ A time bill should be presented on the due date. ⇒ A cheque can be presented at any time within six
months from the date of cheque.

NEGOTIABILITY:-
Promissory Notes, Bill of Exchange and Cheque all are negotiable instrument. The holder can claim
payment on them subject to conditions that the holder takes them:-
i) without notice of defect in the title of the transferor, i.e. in good faith,
ii) for consideration and
iii) Before maturity.
Example:
If a steals a bill of exchange and passes it on to B who is not aware of A’s mode of acquiring the bill and
who takes it for the value and before the due date of the bill, B will be entitled to get payment on the bill.
Here B is a holder in due course. A holder in due course always gets a good title in case of forgery.
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Moreover, who ever gets the bill after the holder in due course will also get a good title to it; it has been
purged of all defects.
The instrument may passed on from one person to another by endorsement and delivery. The liability of the
endorser or subsequent parties is same as in the case of endorsement of cheque. Thus, if a bill of exchange
is dishonoured, i.e. if payment is not made on the due date by the promisor (drawee in case of bill of
exhange), money can be claimed form any of the previous endorsers, the payee and the maker of the
instrument.

DISCOUNTING OF BILLS:
When the bill is taken to a bank and the necessary cash if received, the act is known as discounting. The
bank will always deduct a small sum depending upon the rate of interest and the period of maturity.

MATURITY OF A PROMISSORY NOTE OR BILL OF EXCHANGE:


“The maturity of a promissory note or bill of exchange is the date at which it falls due.”
A promissory note or bill of exchange may be payable:-
(i) on demand; or
(ii) on a specified date, or
(iii) after a specified period.
In the first case, the amount is payable on the instrument, when the demand is made. In the second case,
payment can be claimed on a specified date. In the third case, date of maturity has to be calculated. Every
instrument, payable otherwise than ‘on demand’, is entitle to three days of grace.
The following instruments are not entitled to ‘days of grace’:
(a) A cheque,
(b) A bill or note payable ‘at sight’ or ‘on presentment’ or ‘on demand’.
(c) A bill or note in which no time is mentioned
The following instruments are entitled to ‘days of grace;”
(a) a bill or note payable on a specified day,
(b) a bill or note payable ‘after sight’,
(c) a bill or note payable at a certain period after date,
(d) a bill or note payable at a certain period after the happening of a certain event.

Calculation Of date of maturity:


(1) If a promissory note or bill of exchange is made payable a stated number of months after date or after
sight or after a certain event, it becomes payable three days after the corresponding date of the months
after the stated number of months. If the month in which the period would terminate has no
corresponding day, the period shall be held to terminate on the last day of such month.
(2) In the above case, the day on which the instrument is drawn, or presented for acceptance or sight or the
day on which the event happens is to be excluded.
(3) When the day on which a promissory note or bill of exchange is at maturity is a public holiday, the
instrument shall be deemed to be due on the preceding day. E.g.: A bill falling due for payment on
August 15 will have to be paid on August 14.

Dishonour:
A bill may be dishonoured either by non-acceptance or by non-payment. When an instrument is
dishonoured, the holder must give notice of dishonour to the drawer or his previous holders if he wants to
make them liable.
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Dishonoured by non acceptance:


A bill is said to be dishonoured by non acceptance:-
1. When the drawee does not accept it within 48 hours from the time of presentation for acceptance.
2. When presentation for acceptance is excused and the bill remained unaccepted.
3. When the drawee is incompetent to contract.
4. When the drawee is fictitious person or after reasonable search, can not be found.

Dishonoured by non payment:


A promissory note, a bill of exchange or cheque is said to be dishounoured by non payment:-
 When the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon
being duly required to pay the same; and
 When presentation for payment is excused and the instrument when overdue remains unpaid.
Record of bills of exchange or promissory notes:
 A person who receives a promissory note or receives an accepted bill of exchange will treat it as new
assets under the name of Bills Receivable.
 A party who issues a promissory note or accept a Bill of Exchange will treat it as liability under the
heading of Bills Payable.

Noting Charges:-
“Noting” must be recorded with Notary Public within a reasonable time after the dishonour and must contain
the fact of dishonour, the date of dishonour, the reason if any, given for such dishonour and the noting
charges. For this service they charge a small fee. This fee is known as noting charges. Noting charges have
to be born by the person responsible for dishonour. Hence, when a bill is disonoured, the amount due is the
amount of the bill plus the noting charges. However, if the acceptor prove that the bill was not properly
presented to him for payment, he may escape his liability.

Renewal of a Bill:
Some time the acceptor is unable to pay the amount and he himself moves that he should be given an
extension of time. In such a case, a new bill will be drawn and the old bill will be cancelled. If this happens
entries should be passed for cancellation of the bill as in case of dishonour of bill. When the new will is
received, entries for receipt of bill will be repeated.

Accommodation of Bills:-
Bills of exchange are usually drawn to facilitate trade transaction, finance actual purchase and sale of goods.
But apart from, financing transaction in goods, bills may also be used for raising fund temporarily.

Suppose A need finance to the extent of Rs. 10000/- for 3 months. In this case he may induce his friend B
to accept a Bill of Exchange drawn on him for Rs. 10000/- for 3 months. A can, then get the bill discounted
with his bank, paying a small sum of discount.
Thus he can use the funds for 3 months and just before maturity, he will remit the amount to B to whom the
bill will be presented by the bank for payment.
If both A and B need money, the same device can be used. Either A accept a bill of exchange or B does. In
either case the bill will be discounted with the bank and proceeds divided between the two parties according
to mutual agreement. The discounting charges must also be born by two parties in the same ratio in which
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the proceeds are divided on the due date the acceptor will receive from the other party his share. The bill
will then be met. When bills are used for such purpose, they are known as accommodation bills.

 In case of accommodation of bills, all the journal entries are passed in the books of two parties as same
in the ordinary bills.
 The only additional entries to be passed are for sending the remittance to the other parties and also
debating the other parties with the requisite amount of discount.

Bankruptcy:
Bankruptcy/ Insolvency of a person means person who has accepted the bill is unable to pay his liabilities
and
 When it is known, the acceptor of the bill has become insolvent, entry for dishonour of his acceptance
must be passed.
 When and if an amount is received, cash amount will be debited and personal account of debtor will be
credited.
 The remaining amount will be irrecoverable and should be WRITTEN OFF AS BAD DEBT.

Bills receivable and Bills payable books:


Where the number of bills received or bills issued is large, Bill receivable and bills payable registers are
maintained.
 The bills receivable register is maintained to record the bills received; and
 The bills payable register is maintained to record the bills issued.

CHAPTER – 7
CONSIGNMENT

 Consignment Sale
⇒ Where one person in firm send goods to another person or firm on the basis that the goods will be sold
on and the risk of former, it is called consignment sale.
⇒ The party which send the goods is called consignor and the party to whom goods are sent is called
consignee or agent.
⇒ The consignee does not buy these goods but merely undertake to sell them on behalf of the consignor.
The sale proceeds belong to the consignor and the consignee merely get the agreed commission for his
service in addition to any expenses he might have incurred.
⇒ The relationship between the consignor and the consignee is that of principal and agent.

 Account Sales
⇒ After sale of goods, consignee sends a statement to consignor. This statement is called account sales.
⇒ In this statement gross sales value, expenses and commission of consignee, advance paid by consignee
and net amount due by consignee are shown.

 Del-Credere Commission
⇒ The additional commission for which the consignee guarantee debt is called del-credere commission.
⇒ This commission save consignor from loss of bad debts only.
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⇒ The agent is responsible for bad debts due but not for loss due to a dispute between the buyer and the
seller.
⇒ The del-credere commission is payable on total sales and not merely on credit sales.

 Ordinary Commission
⇒ Ordinary commission is a commission which consignee gets as his remuneration from the consignor for
the sales made in behalf of the consignor.
⇒ In this case the consignee does not guarantee that all those who buy on credit will pay up. The
consignee is not responsible for bad dents.

 Discount paid on bills receivable discounted by Consignor


There are two alternative treatments for the aforesaid discount:-
a) If discount is treated as “consignment expenses” it is debited to consignment account.
b) If discount is treated as “financial charges”, it is debited to profit and loss account.

 Books of consignor
⇒ To know the profit and the loss made on a consignment separately a consignment account is opened.
⇒ A consignment account is not a personal account but is in the nature of a special type of a trading and
profit and loss account which show profit or loss made on the particular consignment.
⇒ If goods are consigned to a number of parties, the profit and loss on consignment to each consignee may
be ascertained separately.

 Journal Entries in the Books of Consignor


1. On dispatch of goods to Consignee:-
Consignment account ...........…...........… Dr. (with the cost of goods)
To goods sent to consignment A/c
(being goods sent to M/S ...... at ...... on consignment basis and invoiced at the rate of ...... each)
2. For payment of expenses by consignor on dispatching the goods:-
Consignment account ...........…............. Dr.
To Bank Account (with the amount spent)
(Being expenses incurred on dispatching the goods on consignment)
3. On receipt of advance from consignee:-
Cash / Bank a/c ...........…...........…… Dr.
To consignee A/c
(Being advance received from consignee)
4. On the consignee accepting a bill of exchange:-
Bill receivable account ...........…............. Dr,
To consignee’s personal A/c
(The bill of exchange accepted by the consignee M/S.............)
5. On discounting of bill of exchange:-
Bank a/c ...........…...........… Dr.
Discount a/c ...........………. Dr.
To Bills Receivable Account
(Being bill for Rs. … discounted with bank for Rs. … ie at a discount of Rs. .............)
6. On the consignee reporting sale (As per account sale):- (with gross proceed of sale)
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Consignee’s personal account ...........…............. Dr.


To consignment account
(Being sale proceed of ..... at Rs. ...... each as per account sales rendered by consignee M/S….)
7. For goods taken over by consignee:-
Consignee A/c ...........…...........… Dr.
To consignment A/c
(Being goods taken over by agent consignee)
8. For expenses incurred by the consignee (according to Account Sales):-
Consignment Account ...........…............. Dr.
To consignees personal account
(Being expenses incurred by M/s or M/r …. on …. As per account sales)
9. For commission payable to the consignee:-
Consignment account ...........…...........… Dr.
To consignee’s personal account
(commission due to Mr./Ms ............. at the rate of .............% on Rs. .............)
10. For stock remaining unsold at the end of period (i.e. goods lying with consignee)
Stock on consignment A/c ...........…............. Dr.
To consignment A/c
(Being goods sent on consignment have not yet been sold by the consignee and still lying with
consignee value at cost.)
11. (a) For abnormal loss of goods:
Abnormal loss A/c ...........…............. Dr.
To consignment A/c
(Being loss occurred due to .............)
(b) On recovery of abnormal loss (fully or partly) from insurance company:
Bank Account / Insurance Co. ............. Dr.
To Abnormal loss A/c
(Being amount recovered from Insurance company against loss occurred due to .............)
(c) For sale proceed of damaged goods:
Consignee A/c ...........…...........… Dr.
To Abnormal loss A/c
(Being damaged goods sold by an agent)
Note:- If damaged goods have not been sold, Net realized value of such goods will be include in closing
stock on Consignment.
(d) For net abnormal loss:
Profit & Loss A/c ...........…...........… Dr.
To Abnormal loss A/c
(Being net abnormal loss transferred to Profit & Loss A/c)
12. For Normal loss (i.e. loss which is inherent and unavoidable):
No entry in the books
13. For profit earn on consignment:
Consignment Account ...........…...........… Dr.
To Profit & Loss A/c
(Being Profit earn on consignment transferred to Profit & Loss account)
14. For Loss incurred on Consignment:
Profit & Loss Account ...........…........... Dr.
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To Consignment A/c
(Being loss incurred on consignment transferred to Profit & Loss A/c)
Note: the goods sent on Consignment account is transferred to the purchase Account in case the
consignor carries in a trading business and to Trading account if the consignor carries on a
manufacturing business.

 Valuation of closing Stock


The goods lying unsold with the Consignee at the end of the accounting year is usually valued at cost.
⇒ In this case cost means, cost at which goods sent on Consignment plus all expenses incurred till the
goods reach the premises of the consignee.
⇒ Such expenses include packing, freight, cartage, insurance in transit, octroi, import duty, customs
charges, packing, loading & unloading charges etc.
But expenses incurred after the goods have reached the consignee godown are not treated as part of the cost
of purchase for valuing stock on hand, i.e. expenses like godown rent, godown insurance, sales expenses etc
are not included in the value of stock.
The main principal of valuing closing stock at cost or market price whichever is less, is also applicable here.

 Abnormal Loss:
Abnormal loss of goods occurs due to accidental, mischief or carelessness. e.g. loss occurred due to fire,
theft, flood, earthquake, etc.
⇒ Abnormal loss should be debited to abnormal loss account and credited to consignment account.
⇒ The amount of loss is ascertained like the value of closing stock at cost; except that
⇒ The expenses incurred on the remaining goods after the loss have to be ignored while calculating the
amount of loss because no part of such expenses can be said to have been incurred on the goods lost.
⇒ If abnormal loss is fully or partly covered by insurance, abnormal loss account may be debited and
consignment account credit with full cost of the goods involved in the loss.
⇒ The amount recovered (if any) from the insurance company will be credited to abnormal loss account
and, the balance, if any left in abnormal loss account will be transferred to Profit & Loss Account.

 Normal Loss:
Any loss which occurs due to natural causes e.g. normal leakage, loss in weight due to nature of goods,
etc. is termed as ‘normal loss’. In certain cases, some loss is inherent and unavoidable. For instance, if a
certain quantity of cement is consigned, some of it is bound to be lost because of loading and unloading.
Such inherent and unavoidable loss is known as normal loss and should be allowed while calculating the
cost of the stock on hand. Such loss inflates the value of closing stock.
Ex. 200 tones of cement are consigned at Rs. 1,000 per tones, freight being Rs. 10,000. By the end of
the year, the consignee has sold 130 tones of cement and is left with 65 tones of cement, the remaining 5
tones of cement having been lost due to normal wastage. The closing stock of 65 tones will be valued at
Rs. 70,000.

CHAPTER - 9
CAPITAL AND REVENUE
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It is necessary to make a distinction between Revenue and capital expenditure and income to determine the
correct income of the business. To calculate net profit of the business, only revenue income and expenditure
will be taken into consideration, however business may incur some expenditure of capital nature.
The following facts will not be taken in to consideration to decide, whether an expenditure incurred or
income earned is capital or Revenue in nature:-
(i) Source of payment (ii) Quantum of Amount
(iii) Nature of recipient (iv) Manner of payment
Classification of Expenditure Classification of Income Classification of Receipt
[1] Capital Expenditure [1] Capital Income [1] Capital Receipt
[2] Revenue Expenditure [2] Revenue Income [2] Revenue Receipt
[3] Deferred Revenue Expenditure

• Capital Expenditure:
Capital expenditure is that expenditure which result in the acquisition of an assets, tangible or intangible,
which can be later sold and converted in to cash or which result in an increase in the earning capacity of a
business or which afford some other benefits to the firm. Such expenditure is incurred with a view to
brining in improvements in productivity of earning capacity for getting long-term advantages for the
business. It is not incurred for day-to-day working of the business. The following types of expenditure are
treated as – ‘Capital expenditure’.
(i) Acquisition of an asset.
(ii) Improvement of fixed assets.
(iii) Extension of an asset.
(iv) Putting the new assets into working condition.
(v) Expenditure in acquiring the asset.
(vi) Acquisition of a right to carry on business.
Other example are- money paid for goodwill since it will attract the old firm’s customer and thus result in
higher sales and profit. Money spent to reduce the working expenses, for example, conversation of hand
driven machinery to power driven machinery and expenditure which enable a firm to produce a large
quantity of goods.
It is important to note that all amount spent up to the point an assets is ready for use should be treated as
capital expenditure. The examples are − fees paid to lawyer for drawing up the purchase deed of land,
overhaul expenses of second hand machinery etc. Interest paid on loans raised to acquire a fixed asset is
particularly noteworthy. Such interest can be capitalized; i.e. added to the cost of the assets but only for the
period before the assets is ready for use.
It is not necessary that capita expenditure always generate profit. Even if there is a loss or asset has
not been used, such expenditure will be treated as capital expenditure.

• Revenue Expenditure:
Revenue Expenditure is that expenditure which is incurred for maintaining productivity or earning capacity
of a business. An item of expenditure whose benefit express within the year or expenditure which merely
seeks to maintain the business or keep assets in good working condition is revenue expenditure. Expenses
of following nature are treated as revenue expenses:-
(i) Expenses for running the business.
(ii) Expenses incurred to maintained the fixed assets.
(iii) Purchase of material and goods.
(iv) Depreciation.
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Such expenditure does not increase the efficiency of the firm, nor does it result in the organization of some
thing permanent.

• Deferred Revenue Expenditure


When the benefit of revenue expenditure is available for a period or three more years, such expenditure
is then known as ‘deferred revenue expenditure’ and is written off over a period of few years and not
wholly in the year in which it is incurred.
Ex: If a new firm advertise very heavily in the beginning of the year to capture a position in the market,
the benefit of this advertising campaign will last 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.
When loss of a specially heavy and exceptional nature is sustained, it can also be treated as deferred
revenue expenditure. If fire or earthquake destroys a building, the loss may be written off in three or
four years. The amount net yet written off appears in the balance sheet. Only loss arising from
circumstances beyond one’s control can be deferred revenue expenditure.

• Capital Income:
If any income is derived not by running the business, it is treated as Capital Income. For example, profit
on sale of fixed assets over its cost is treated as Capital Income. However any profit upto the cost of the
asset is treated as Revenue Profit.
Example:- A Building had originally cost Rs. 60,000. Its present written down value in the books is
45,0000. It is sold for Rs. 65,000. In this case total profit on sale is Rs. 20,000 (65,000 – 45,000). Out of
this Rs. 5,000 being excess of sale price over cost [65,000 – 60,000] is capital profit and Rs. 15,000
[60,000 – 45,000] is revenue profit.

• Revenue Income:
Any income or profit derived by carrying on the business or during the course operations is treated as
revenue income. Ex. profit on sale of goods, dividend or interest received, commission or discount
received. Such income is shown in profit and loss A/c.

• Capital Receipt
Amount received from the proprietors as capital or loan receipt is treated as capital receipt. Similarly
sale proceeds of permanent or fixed assets are also treated as capital receipt. In order to ascertain the
profit made by a business, only revenue receipt should be taken in to account. Capital receipts have no
bearing on the profit made or loss incurred during a particular year.

• Revenue Receipt
Amount received in the course of normal business transaction is treated as revenue receipt. Total receipt
is not necessarily income. For example, sale proceeds of goods are revenue receipt but surplus of sale
proceeds after deducting cost of goods sold will be treated revenue income.

Question:
(1) State with reason whether the following are capital or Revenue Expenditure:
(i) Expenses incurred in connected with obtaining a licence for staring the factory were 10,000
(ii) Rs. 2,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged to
the plaintiff the suit was not successful.
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(iii) Rs. 12,000 interest had accrued during the year on term loan and utilised for the construction of
factory building and purchase of machineries, however, the production had not commenced till
the last date of the accounting year.
(iv) Cost of making more exists in a cinema hall.
(v) Expenditure on acquisition of Export Rights, when payment is made in instalments.
(vi) Interest on arrears of sales tax.
(vii) Less due to devaluation of currency on loan taken in foreign currency.
(viii) Cost of project Report – Project did not materialized.
Ans.: (1)
(i) Money paid Rs. 10,000 for obtaining a license to start a factory is a capital expenditure. This is
an item of expenditure incurred to acquire the right to carry on business. The expenses necessary
for either establishing the business, like expenses for obtaining the necessary license will be
capital expenditure. Only the initial expenditure is capital; renewal fees are recenue.
(ii) Rs. 2,000 spent as lawyer’s fee in defending the title to the firm’s assets is a revenue expenditure.
This is an expenditure incurred for upkeep of a fixed assets. If there is a dispute about the
ownership, legal expenses incurred for defending the title will be a revenue expense.
(iii) Interest accrued Rs. 12,000 on term loan obtained and utilised for the construction of factory
building and purchase of machinery should be treated as capital expenditure since commercial
production has not begun till the last day of accounting year.
(iv) Making more exist in a cinema hall does not increase the capacity of the hall and, therefore, it
should be treated as revenue expenditure.
(v) This is an expenditure of an enduring nature and will benefit the business for a long period. This
a kind of intangible assets which will help business to earn income. Whether payment is made
lump sum or in instalments. the nature of expenditure being capital will not change.
(vi) When sales tax is payable in instalements, any interest paid with amount of sales tax is similar to
tax for the business. Further, this expenditure has direct relationship with the income earned
during the current year. Hence, treated Revenue Expenditure.
(vii) Treatment for such loss will depend on the fact whether loan amount has been used for acquiring
a fixed asset or it was being used as circulating capital or trading assets. If loan was used for
acquitting fixed assets, any loss arising on account of devaluation of currency will be capital loss.
But if loan was being used in circulating capital or trading asset, such loss will be treated as
Revenue Loss.
(viii) The expenditure is not giving any enduring benefit of the business. However, if amount is heavy
it will be treated as deferred Revenue Expenditure.

VALUATION OF INVENTORIES
The revised standard came in to effect in respect of accounting period commencing on or after 1.4.99 and is
mandatory in nature. However, this statement does not apply in valuation of the following:-
(a) work- in-progress arising under construction contract, including directly related service contact.
(b) Work-in-progress arising in the ordinary course of business of service providers;
(c) Shares, debentures and other financial instrument held as stock-in –trade.
(d) Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to
the extent that they are measured at net realizable value in accordance with well established practices in
those industries.
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• Valuation:
The principle for valuation is that inventories should be valued at the lower of cost and net realised value.

• Cost of Inventories:
The cost of inventories should comprise all costs of purchase, costs of conversion and other cost incurred in
bringing the inventories to their present location and condition.
a) Cost of Purchase:- The costs of purchase, consist of the purchase price including duties and taxes
(other than those subsequently recoverable from taxing authorities), freight inwards and other
expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other
similar items are deducted in determining the cost of purchase.
Note: Cash discount should not be treated as adjustment to the cost of purchase. Such rebate should be
treated as separate revenue items and accounted for accordingly. Any discretionary discounts given on ad-
hoc basis are also not deductible from the cost of inventory.
b) The cost of conversion:- The costs of conversion of inventories include costs directly related to the
units of production , such as direct labour. They also include a systematic allocation of fixed and
variable production overheads that are incurred in converting materials into finished goods.
⇒ Fixed production overheads are those indirect costs of production that remain relatively constant
regardless of the volume of production, such as depreciation and maintenance of factor buildings and the
cost of factory management and administration.
⇒ Variable overhead are those indirect costs of production that vary directly, or nearly directly, with the
volume of production, such as indirect materials and indirect labour. The inclusion of cost of conversion
as part of inventory cost follows the principle that all costs incurred to bring the inventory to its present
location and condition should form part of the inventory costs.

Valuation of Joint Products / By-Products:


A production process may result in more than one product being produced simultaneously.
⇒ This is the case, for example, when joint products are produced or when there is a main product and a
by-product.
⇒ When the cost of conversion of each product are not separately identifiable, they are allocated between
the products on a rational and consistent basis.
⇒ The allocation may be based, for example, on the relative sales value of each product either at the stage
in the production process when the product become separately identifiable, or at the completion of
production.
⇒ Allocation of costs may also be done on the basis of physical measures of the products or on the basis of
technical evaluation.
⇒ Most by-products as well as scrap or waste materials, by their nature, are immaterial. When this is the
case, they are often measured at net realizable value and this value is deducted from the cost of the main
product.
As a result, the carrying amount of the main product is nor materially different from its cost.

Costs not included in the valuation of Inventories:


Overhead costs are included in the cost of inventories only to the extent that they are incurred in bringing the
inventories to their present location and condition. For example, it may be appropriate to include overheads
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other than production overheads such as the costs of t\designing products for specific customers in the costs
of inventories.
In determining the cost of inventories the following costs are excluded and recognize such costs as expenses
in the period in which they are incurred.
(a) Abnormal amount of wasted material, labour, or other production costs;
(b) Storage costs, unless those costs are necessary in the production process prior to the further
production stage;
(c) Administrative overhead that do not contribute to bringing the inventories to their present location
and condition.
(d) Selling and distribution costs.

Warranty expenses incurred after completion of the sale will not form part of cost of inventory because it is
not a cost incurred to bring the inventory to its present location and condition. Warranty expenses should
not be included in cost of inventory even if the warranty is in relation to a manufacturing defect. If a
particulars item of inventory has a defect, then the cost of inventory would be the cost of the defective
inventory (present condition) and not what the cost of inventory would be if the defect was rectified.

Cost Formulae:
⇒ The cost of inventories of items that are not ordinarily interchangeable and goods or services products
and segregated for specific projects should be assigned by specific identification of their individual
costs.
⇒ The cost of inventories, other than those dealt with in the specific identification method, should be
assigned by using the first-in, first –out (FIFO), or weighted averaged cost formula.
⇒ Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail
method, may be used for convenience if the results approximate the actual cost.

Determination of Net Realisable Value:


⇒ Net realisable value is the estimated selling price in the ordinary course of business less the estimated
cost of completion and the estimated costs necessary to make the sale.
⇒ An assessment is made of net realizable value as at each balance sheet date.
⇒ Estimates of net realisabel value are based on the most reliable evidence available at the time, the
estimates are made as to the amount the inventories are expected to realise.
⇒ These estimates takes into consideration fluctuations of price or cost directly relating to events occurring
after the balance sheet date to the extent that such events confirm the conditions existing at the balance
sheet date.
⇒ Estimates of net realisable value also take into consideration the purpose for which the inventory is held.

Inventories are usually written down to net realizable value on an item-by-item basis. In some
circumstances, however, it may be appropriate to group similar or related item.

Net Realisabel Value of Raw Materials:


⇒ Material and other supplies held for use in the production of inventories are not written down below cost
if the finished products in which they will be incorporated are expected to be sold at or above cost.
However,
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⇒ When there has been a decline in the price of materials and it is estimated that the cost of finished
products will exceed net realizable value, the raw materials are written down to net realisable value.
In such case the replacement cost of the raw material may be the best available measure of their net
realisable value.

Disclosure Requirements:
The financial statements should disclose:
⇒ The accounting policies adopted in measuring inventories, including the cost formula used; and
⇒ The total carrying amount of inventories and its classification appropriate to the enterprise.

Wear and Tear DEPRECIATION


Meaning:- Depreciation means a fall in the quality, quantity or value of assets. The net result of an assets
depreciation is that sooner or latter the assets will become useless. It is the permanent and continuous
decrease in the book value of fixed assets due to use, effluxion of time obsolescence, expiration of legal
right or any other cause.
Depreciation is not the result of fluctuation in the value of fixed asset since, the fluctuation is concerned
with the market price of the fixed asset whereas the depreciation is concerted with the historical cost.

Characteristics of depreciation:
(a) It is related to depreciable fixed assets only.
(b) It is fall in the book value of depreciable fixed assets.
(c) The fall in the book value of an asset is due to the use of the asset in business operations, effluxion of
time, obsolescence, expiration of legal rights or any other cause.
(d) It is a permanent decrease in the book value of an asset.
(e) It is continuous decrease in the book value of an asset.

Main causes of Depreciation:


1. due to actual use;
2. Efflux of time – more passage of time will cause a fall in the value of assets even if it is not used.
3. Obsolescence – a new invention or a permanent change in demand may render the assets unless.
4. Accidents;
5. Depletion – Value of assets decreases due to consumption i.e. coal mine, stone quarries etc.
6. Expiration of legal rights – When the use of asset (e.g. Patents, leases) is governed by the time bound
arrangement, the value of such assets may decrease with the passage of time.

Objective for providing Depreciation:


The following are the prime objectives for providing depreciation:
1. Presentation of correct financial position.
2. Calculation of correct profit.
3. Retaining enough funds for replacement of assets at the end of its commercial life.
4. Ascertainment of correct cost of production.
5. Correct information about value of assets to financial institution.
6. Comply with legal requirements.

The Basic Factors:


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For Calculation of depreciation, the basic factors are


(i) The cost of the assets;
(ii) The estimated residual or scrap value at the end of its life; and
(iii) The estimated number of years of its commercial life.

Different Approach:
Type of Rate of Depreciation given Period for which Depreciation is to be charged
 When the rate of Depreciation with the words
‘per annum’ is given. (e.g. 15% p.a.)
(a) If the date of acquisition is given. ⇒ Charge depreciation for the period beginning
with the date of acquisition and ending with the
date of closing accounting period.
(b) If the date if acquisition is snot given. ⇒ Charge depreciation for the full year assuming
that the assets was purchased / acquired in the
beginning of the year; OR
⇒ Charges depreciation for half year assuming that
assets was purchased in the middle of the year;
OR
⇒ Charge no depreciation assuming that the asset
was acquired at the end of the year.
 When the Flat Rate of Depreciation without the ⇒ Charge depreciation for the full year irrespective
words, ‘per annum’ is given (e.g. 15%) of the date of acquisition of assets
METHODS OF PROVIDING DEPRECIATION:
(1) Straight line method;
(2) Written down value method or Reducing balance method;
(3) Annuity method;
(4) Depreciation fund method;
(5) Insurance fund method;
(6) Sum of digit method;
(7) Revaluation method;
(8) Depletion method;
(9) Machine hour rate method; and
(10) Repairs provision method.

Straight line Method


Under this method, a suitable percentage of original cost is written off the assets every year. This method is
useful when the service rendered by the assets is uniform from year to year.
Depreciation = Cost of Assets – Scrape Value
Useful Life
Depreciation Rate = Straight line Dep. × 100
Cost of assets – Scrap Value
The period for which the assets is used in a particular year (i.e in the year of acquisition) should also taken
into account.

Written Down Value Method


SPECTRUM STUDY CIRCLE
(The Acme of Excellence)
+ 15/22 IInd Floor Ashok Nagar, New Delhi-110018.
Ph.: 25499279, 55711031(O), 9810378235(M)

Under this method, the rate of depreciation is fixed, but it applied to the value at which the assets stands in
the books in the beginning of the year. Under this method the amount of depreciation will reduce every year.
The rate of depreciation under this method may be determined by the following formula:-
Dep. Rate = 1 – n √(Residual Value) × 100
Cost of assets
Note: If instead of scrap value some amount will have to be spent at the end of the life of the assets, such as
on pulling down the building on a leasehold land, such an amount should be added.

AVERAGE DUE DATE


If a person owes a number of sums to a person on different dates, he may like to pay the whole amount on
such a day as will involve neither party in loss of interest. Such a day is known as Average Due Date. It is
calculated in the following way:-
(i) Take one of the due date as the base date.
(ii) Calculate the number of days between the base date and the due date of every transaction. The base
date is not to be taken into account.
(iii) Multiply each amount by its respective number of days as calculated in the second step.
(iv) Add the amounts and the products separately.
(v) Divide the sum of the products by the total of the amounts. This give the number of days the average
due date is away from the base date.
(vi) Add the number of days to the base date and thus arrive at the average due date.

Calculation of Interest with the help of Average Due Date:


⇒ The average due date determines the day on which various amounts can be settled without loss or gain
of interest to either party.
⇒ If full payment is made on the average due date, no interest is payable.
⇒ If payment is made after the average due date, Interest will be calculated for the number of days from
the average due date to the actual date of payment / settlement.

Days of Grace and date of Maturity:


A bill of exchange or promissory notes matures on the due date on which it falls due and it falls due and it
falls due on the third day after the day on which it is expressed to be payable. These extra three days are
known as “Days of Grace”. When it is an ‘after date bill’, the period is counted from the date drawing the
bill but when there is ‘after sight bill’, the period is counted from the date of acceptance of bill. However,
when bill is payable on demand or on presentation, it becomes due immediately on presentation for
payment.
When the day on which bill or promissory note is at maturity after including three days of grace is a public
holiday or Sunday, the due date will be preceding business day. If holiday is emergency or unforeseen
holiday then the due date shall be the next following day.
SPECTRUM STUDY CIRCLE
(The Acme of Excellence)
+ 15/22 IInd Floor Ashok Nagar, New Delhi-110018.
Ph.: 25499279, 55711031(O), 9810378235(M)