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Q.1 Define accounting and explain its objective

Individuals and business houses should keep a systematic record of all their financial
transactions. This will help them keep track of all their dealings. In addition, it is
mandatory under various fiscal laws, for individuals and business houses to maintain

The systematic recording of transactions to give a true financial picture is accounting.

Accounting has gone through radical changes from its earliest form as a recording
activity to its present importance which stems from the objective of providing socio-
economic information for decision making.

According to The New Encyclopedia Britannica (1990) the purpose of accounting is to

provide information about the economic affairs of an organization. Every business,
organization and nation is continually engaged in transactions involving money and
goods. Interested and responsible parties must have access to the information necessary
for assessing the economic status and performance of the organization.

Accounting is concerned with the processes of recording, sorting, and summarizing data
resulting from business operations and events.

The Committee on terminology setup by American Institute of Certified Public

Accountants (AICPA) has defined the term accounting in 1961 as follows :

“ Accounting is an art of recording, classifying and summarizing in a significant

manner and in terms of money, transactions and events which are, in part at least, of a
financial character and interpreting the result thereof”.

The above definition does not clearly reflect the present role performed by accounting.
A widely accepted definition of the term accounting is given by American Accounting
Association, which is as follows:

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“ Accounting is the process of identifying, measuring and communicating information

to permit judgment and decision by the users of accounts”.

Objectives of Accounting

The following are the main objectives of the accounting :

Q1.To keep systematic records : Accounting is done to keep systematic records of

financial transactions. In absence of a scientific method of accounting,
there would have been tremendous burden on the human memory, which
in most cases would have been impossible to bear.

• To protect business properties : Accounting provides protection to business

properties from unjustified and unwanted use. This is possible by providing
the following information to the management :

(i) The amount of owner’s fund invested in the business;

(ii) How much the business owes to others;
(iii)How much the business has to recover from others;
(iv)How much business owns the assets;

This information helps the management in ensuring that the assets do not
remain idle or under-utilized.

• To ascertain the operational profit or loss : Accounting helps in ascertaining

the net profit or loss upon carrying on the business. This is done by
maintaining the proper record of revenues and expenses for a particular period.

• To ascertain the financial position of the business : The profit and loss accounts
reflects the performance of the business during a particular period. How ever, it
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is also necessary to know the financial position i.e. where do we stand. What we
owe and what we own. The objective is met by Balance Sheet, which shows the
state of affairs of assets and liabilities as on a given date. It serves as barometer
for ascertaining the financial health of the business.

• To help rational decision – making : Accounting these days has taken upon itself
the task of collection, analysis and reporting of information at the required
points of time to the required level of authority in order to facilitate rational
decision making.

Q2.Explain the meaning & significance of the following (i) Dual aspect (ii) Consistency
(iii) Materiality (iv) Full disclosure (v) Cost Concept

(i) Dual aspect :

This principle is the core of accountancy. All business transactions are recorded
having a dual aspect.
Let’s understand the three concepts, which are part of dual concept
Assets: It is expenditure for acquiring valuable resources, which benefit the future
activity of the business. E.g. building, land, machinery, furniture, debtors, bills
receivable, cash in hand etc.
Capital: The proprietor brings capital in to the business out of which the business
purchases assets for its use.
Creditors: In case the capital introduced by the proprietor is not sufficient the
business takes to borrowings from other parties. And now since total assets of the
business are acquired out of the money contributed by the proprietors and creditors of
the business.

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Each transaction has two aspects. With every increase in the money owed to others,
there must be an increase in Assets or loss. Thus at any time the accounting equation
is :
Assets = Liabilities + Capital or alternatively;
Capital = Assets – Liabilities

For example, a proprietor brings in Rs. 1,00,000 in cash as capital to start a small
business. Rs 1,00,000 is the Capital and corresponding amount of Rs.1,00,000 will
appear as cash on hand (Assets).

(ii) Consistency :

In order to enable the management to draw important conclusions regarding the

working of a company over a number of years, it is essential that accounting practices
and methods remain unchanged from one accounting period to another. For example,
consistency in valuation of stock in trade or method of charging depreciation. If the
stock has been valued by adopting the principle of cost or market value, whichever is
less, the same principle has to be consistently followed year after year. Similarly
method of charging depreciation either straight line or written down value method,
has to be consistently followed.

(iii) Materiality:

The role of this concept cannot be over-emphasized in as much as accounting will be

unnecessarily over with minute details in case an accountant is not able to make an
objective distinction between material and immaterial matters. So according to this
convention the accountant should attach importance to material details and ignore
insignificant details. American Accounting Association defines the term materiality as
“An item should be regarded as material if there is reason to believe that knowledge
of it would influence the decision of informed investor.”
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It should be noted that an item material for one concern might be immaterial for
another. And similarly, an item material in one year may not be material in the next
(iv) Full disclosure:

The disclosure concept implies that accounts must be honestly prepared and all
material information must be disclosed therein. The notion is so important that
Companies Act makes ample provisions for the disclosure of essential information in
company accounts.
The term disclosure does not imply that all information that anyone could conceivably
desire to be included in accounting statements. The term only implies that there is to
be a sufficient disclosure of information, which is of material interest to the
proprietors, present and potential creditors and investors. The practice of appending
notes relative to various facts or items which do not find place in accounting
statements is in pursuance to the concept of full disclosure of material facts. Examples
(a) Contingent liabilities appearing as a note.
(b) Market value of investment appearing as a note.

(v) Cost Concept:

The underlying idea of cost concept is that:

(i) Asset is recorded at the price paid to acquire it – that is, at cost; and
(ii) This cost is the basis for all the subsequent accounting for the asset.
When asset is recorded at cost price the change in real worth of an asset (for variety of
reasons) with the passage of time is not ordinarily recorded in the accounts book. For
example, if a piece of land has been purchased for Rs. 80000, its market price
(whether Rs. 1,70,000 or 50,000) at the time of preparation of final statements will not
be considered. Thus the balance sheet on a particular date, prepared on the basis of
cost concept, does not, ordinarily indicate what the assets could be sold for.

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The cost concept does not mean that assets are always shown year after year for an
indefinite period at the cost price. The assets recorded at cost price at the time of
purchase are systematically reduced by the process called depreciation.

Q3.“Trial Balance is a conclusive proof of accuracy of Account’s” – Comments

When all the accounts of a concern are thus balanced off they are put in a lost, debit
balances on one side and credit balances on the other side. The list so prepared is
called trial balance. The total of the debit side of trial balance must be equal to that of
its credit side. This is based on the principle that in double entry system, for every
debit there must be a corresponding credit. The preparation of a trial balance is an
essential part of the process because if totals of both the sides are the same then it is a
conclusive proof of arithmetical accuracy. It must be noted that equalizing the two
sides of a trial balance is not the sole conclusive proof of accuracy of accounts. If
the trial balance agrees, it does not mean that now there are no errors in accounts.
Even if the trial balance agrees, some errors may remain undetected and will not be
disclosed by the trial balance. That is the limitation of trial balance. The errors, which
are not disclosed by a trial balance, are as follows:

(i) Omission of an entry in the original book: if an entry has not been recorded in the
original or subsidiary book at all, then both the aspects of the transaction will be
omitted and the trial balance will not be affected. For example, if goods are sold to
A on credit and this fact is omitted to be recorded in Sales Journal, then it will
neither appear on the debit side of A’s A/c, nor on the credit side of Sales A/c in
the ledger. In spite of this omission the trial balance will agree.
(ii) Posting an item on the correct side but to the wrong account: If, suppose, cash
has been received on account from Mohan but this amount has been credited to
Sohan’s A/c instead of Mohan’s A/c, the amount being correct, the trial balance
will agree and it will not reveal this error.

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(iii) Wrong amount entered in the Subsidiary Book: If a credit purchase of Rs. 15000
is wrongly entered in the Purchases Journal as Rs. 1,500 then such error will not
be revealed by the trial balance.
(iv) Compensating error: These are the errors arising from the excess debits or under
debits of accounts being neutralized by the excess credit or under credit to the
same extent of some other accounts. It is very rare that such an error of equal
amounts arise on the debit side as well as on the credit sides of the ledger accounts
but the trial balance will not be affected in spite of this error.
(v) Error of principle: Whenever any amount is not properly allocated between
capital and revenue or some double entry principle is violated, the error so made is
known as error of principle. If wages paid for erection of machinery are debited to
wages account, then this is an error of principle. Wages paid for installation or
erection of machinery is a capital expenditure and should be debited to Machinery
account instead of wages account.

Where a trial balance disagrees and the differences between debit and credit
balances are quite large, it would never be safe to allow these errors to remain
undetected. All possible efforts should be made to localize the cause of the
differences. Final accounts must not be prepared unless and until trial balance
agrees, otherwise final accounts will not present true picture of financial state of
affairs. So in spite of all the limitations, the preparation of trial balance is an
important step, before preparation of final accounts.

Q4. The Trial Balance of “A” traders did not agree. The difference was put in the
Suspense Account & the following Trial Balance was drafted.

Trial Balance as on 31.3.2001

Particulars Debit Credit

Capital 45000
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Drawings 6500
Purchases 92750
Sales 107200
Salaries & Wages 12250
Furniture & Fittings 17500
Sundry Debtors 30250
Sundry Creditors
Stationery 1250 21250
Cash at Bank 5700
Cash at Hand 2300
Bills Receivable 15750
Bills Payable 9000
Rent & Rates 3200
Suspense Account 5000
Total 187450 187450

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On scrutiny, following errors were detected

a) Goods drawn by Mr A for his personal consumption of Rs 1500 have not been
b) Good sold to Mr R of Rs 1250 on credit was debited to H’s a/c for Rs 250 only
c) Wages paid for fittings Rs 500 was debited to Salaries & Wages account
d) Goods purchased from Atul for Rs 2500 on credit was wrongly debited to his
e) Bills received from Arun, a customer, for Rs 500 was debited to Ajay’s a/c
f) A credit sale of Rs 1500 was recorded in pirchase Day Books & a Credit
Purchase Rs 2000 was entered in sales Day Book

You are required to pass the rectification entries & redraft the Trial Balance

Suspense Account

Particulars Amount Particulars Amount

To Atul account 5000 By balance 5000
To Arun account 500 By “R” account 1000
To Ajay’s account 500
Total 6000 Total 6000

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Journal Entires

Particulars Debit
Drawings a/c to purchase account 1500
Dr 1500
(Being goods withdrawn for personal
consumption by proprietor)
R (Debtors) a/c 1250
Dr 250
To H’s a/c 1000
To Suspense A/c
(Being goods sold to R for Rs 1200
wrongly debited to H’s A/c for Rs 250,
now rectified)
Furniture & Fittings a/c Dr 500
To Salaries Wages a/c 500
(Being wages paid for fittings wrongly
debited to salary & wages now

Suspense Account Dr 5000

To Atul’s account 5000
(Being goods bought on credit from
Atul’s wrongly debited to his a/c, now
Suspense Account Dr 1000
To Arun;s a/c 500
To Ajay’s a/c 1000
(Being bill received from arun wrongly
debited to ajay a/c, now rectified)
Purchases a/c Dr 500
Sales a/c Dr 500
To debtors
To Creditors 500
(Being a credit sale and credit purchase 500
wrongly entered in the purchase day
book and sales day book respectively,
now rectified)

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Trial balance as on 31.03.2001
Particulars Debit Credit
Capital 45000
Drawings 8000
Purchases 91750
Sales 106700
Salaries & Wages 11750
Furniture & Fittings 18000
Sundry Debtors 29750
Sundry Creditors 26750
Stationery 1250
Cash at Bank 5700
Cash at Hand 2300
Bills Receivable 15750
Bills Payable 9000
Rent & Rates 3200

Total 187450 187450

Q.5 What are the causes of difference in the bank balance as shown by the cash book
and the pass book.

Following are the causes of differences in the balances as shown by the cashbook and
the bank passbook on any particular date:
1. Cheques deposited into the bank but not yet collected and credited: When cheques
are deposited, in the books of the concern bank account is immediately debited but in
the books of bank, the concern’s account is not credited until they are actually
collected by the bank. It is quite usual that some of the cheques deposited by the
concern may remain uncollected at the time the passbook is sent for comparison.
2. Cheques issued but not yet presented for payment: Similarly, the entry for the issue
of cheque is made in the books of the concern immediately and the bank account is
credited. But in the books of bank entry for payment can be made only when cheque
is presented for payment. At the time of comparison it is quite possible to find out
some cases where cheques were issued and recorded in the cashbook but not
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presented for payment and remained unrecorded in the bankbooks and thus causing a
3. Bank charges: Bank renders many services to its clients and for that it levies
charges. The bank makes entry for such charges but corresponding entry for it does
not appear in the cashbook of the concern because it is not known to the client until he
receives a statement. This causes a difference.
4. Amount collected or credited by the bank on standing instructions: Often, a
concern issues standing instructions to the bank to collect on its behalf dividends,
interest etc. on investments. When the bank collects such amounts, it immediately
credits the concern’s account with it. The necessary intimation and advice is sent to
the concerned party after this is done. The concern will debit the bank account in the
cashbook only when it receives such intimation of when it gets the pass book duly
completed from the bank.
5. Amounts paid or debited by the bank on standing instructions: The concern may
also issue standby instructions to the bank for making some payments on its behalf
and debit the concern’s account with it, i.e. life insurance premium, rent payment of
installments, payment of bills payable etc. whenever such payments are made by the
bank, the concern’s account is immediately debited, thus, the pass book balance is
reduced. The concern will credit the bank account in the cashbook only when it gets
intimation of such payment or the passbook from the bank.
6. Interest credited by the bank: Banks, normally do not allow any interest on the
current accounts. But if it is allowed, the concern’s account is credited by the bank,
which will enhance the firm’s balance with the bank. On the other hand, the firm will
record it on the debit side of the bank account in the cashbook only when the
passbook is received.
7. Interest debited by the bank on overdraft: If the firm withdraws more money from
the bank than the available deposits with it, it is called an overdraft. Overdraft facility
is permitted to the party by the bank only when it fulfils certain conditions. The bank
charges interest on overdrawn balances. It debits the customer’s account periodically
with such amount of interest. The firm will record the interest on the credit side of the

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cashbook only when it gets the passbook duly completed. Till then, the two books will
show differences.
8. Direct payment by customers into the bank account: Sometimes customers may
deposit money direct into the firm’s account in the bank. The bank will immediately
record the entry on the credit side of the firm’s account and thus in the pass book and
enhance the balance. But, the firm will debit the bank account in the cashbook only
when it gets the intimation or the passbook. In the mean time if the two balances will
be differing.
9. Dishonour of cheques or bills: When cheques are deposited in the bank for
collection, the firm debits the bank account in the cashbook. It increases the balance
immediately. But the bank will credit the proceeds of cheques only when they are
collected. If due to some reason, some cheques are dishonoured, i.e. not collected, the
bank will not credit the firm’s account. The firm with the bank thus, will be lower
than that in the cashbook.
10. Errors: Differences in the two balances may also be due to some errors in
recording of the transactions by either the firm or the bank. For example, the cheque
deposited in the bank for collection may not be recorded at all; or the cheque may be
forgotten to be sent to the bank though necessary entry has been recorded in the

Q6 From the following particulars, prepare a Bank Reconciliation statement as on the

31st Dec 2000

i. On 31st Dec,2000 the cash book showed a bank balance of Rs 6000(Debit)

ii. Cheque had been issued for Rs.5,000, out of which cheques worth Rs. 4000/-
only were presented for payment.
iii. Cheques worth Rs. 1400/- which were deposited in the bank on 28/12/2000
were not credited by the bank.
iv. A Cheque for Rs. 400 deposited on 26/12/2000 was dishonored and advice was
received on 02/01/2001
v. Pass book showed bank charges of Rs. 20 debited by the bank
vi. One customer had deposited Rs. 500 directly in the Bank Account intimation
for which was received from Bank as 2/1/2001
vii. Bank pass book showed a credit balance of Rs. 5180 as on 31/12/2000
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Bank Reconciliation Statement

Particulars Amount

Balance as per cash book 6000

Add : Cheque issued for Rs. 5000 but not
presented for payment 1000
(5000 – 4000)
Add : Balance (500- 400) 100

(1) 7100

Less: Cheques deposited not credited 1400

Less : Bank charges debited 20

Less : Cheque deposited but intimation from
bank on 02/01/2001
(2) 1920
Balance as per pass book
(1) – (2)

Q.7 A Company depreciates its machinery @ 10% on WDV on 01/01/1999 machinery

account showed a balance of Rs. 972000/- . On 01/07/1999 a part of machinery

purchased on 01/01/1997 for Rs. 80000 was sold for Rs. 45000 and new

machinery costing Rs. 150000 was installed at a cost of Rs. 8000. The company

decided to change its method of depreciation from WDV to SLM with effect from

01/01/1997 and adjust the difference on 01/01/1999. Prepare machinery account

for the year 1999.

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Machinery Account

Date Particulars Amount Date Particulars Amount

1/1/1999 To Balance b/d 972000 1/7/1999 By Bank a/c 45000

1/7/1999 3240
(on machinery
To bank a/c By Loss on
1/7/1999 (Machinery 150000 1/7/1999 Sale of 16560
purchased) machinery
To bank a/c By P/L a/c
1/7/1999 8000 11200
(Installation) adjustment
By Balance c/d 934100

1130000 1130000

Working Notes 1

1) Calculation of the Profit and Loss on sale of machinery on 1/7/1999

Particulars Amount
Value on 1/1/1997 80000
Less: Depreciation for the year (10% on 80000) 8000
Value as on 1/1/1998 72000
Less: Depreciation for 98 (10% on 72000) 7200
Value as on 1/1/1999 64800
Less: Depreciation for (1/2 year)
(64800 x 10/100 x 6/12)
Less: Sale value on 1/7/1999 45000
Loss on sale of machinery 16560

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Working Notes 2

Calculation of Book value of Machinery after selling a part of it on 1/1/1997

Particulars Amount
Let the book value on 1/1/1997 100
Less: Depreciation for 1997 10
Less: Depreciation for 98 9
Value of machinery on 1/1/1997
(972000-64800)/81% = 907200/0.81

Working Notes 3

Depreciation on WDV(10%) Amount(Rs.)

Value of machinery on 1/1/1997 1120000
Less: Depreciation 10% of WDV 97 112000
Less: Depreciation of 10% for 98 1008000

Depreciation on SLM(10%) Amount(Rs.)

Value of machinery on 1/1/1997 1120000
Less: Depreciation 10% of WDV 97 112000

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Less: Depreciation of 10% for 98 112000

Total Additional depreciation for 98 = (112000+112000) – (112000+100800)

= (224000 – 212800)
= 112000

Working Note 4

Depreciation for 1999:

On 1120000 for 1 year = 112000

On 15800 for ½ year = 7900

Q.8 Distinguish between –

(a) Capital Expenditure & Revenue Expenditure

Capital expenditure: The capital expenditure is incurred for acquiring long-term advantage
for the business. For example it can be incurred on acquiring an asset which can be sold or
converted into cash or which results in increasing the earning capacity of the business or by
which some other advantage can be brought to business. Following are the examples of such
expenditure –
1. Any asset purchase like Plant, Machinery, Furniture etc.
2. Expenditure incurred on improving the usefulness of the asset.
3. If an existing asset is replaced by a new asset. The expenses on that will be considered as
capital expenditure.
4. Expenses carried on buying copyrights or goodwill.
The criterion to be applied to qualify for capital expenditure to see if the benefit of such
expenditure is derived over number of years or not.

Revenue expenditure: Revenue expenditure is incurred either for maintaining the existing
fixed assets or for meeting the routine expenses of the business.

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Following are the examples of revenue expenditure:
1. Normal routine expenses like cost of administration, cost of manufacturing and selling
2. Maintenance of business e.g. repairs and maintenance of fixed assets etc.
3. Cost of goods purchased for resale.
4. Depreciation of fixed assets, interest on loans for the business.

Differences between Capital and Revenue Expenditure:

Following are the differences between Capital and Revenue expenditure

1. The Capital Expenditure is incurred either for acquiring a new asset or for improving the
existing assets, while revenue expenditure is incurred either for maintaining the existing
fixed assets or for meeting the routine, expenses of the business.
2. Capital Expenditure increases the earning capacity of the business, while revenue
expenditure does not do so. It generally helps in maintaining the existing capacity of the
3. The benefits of capital expenditure are available over a period of time, while benefit of
revenue expenditure is restricted only to accounting period in question.
4. Capital expenditure is recorded (subject to depreciation) in the Balance sheet whereas the
revenue expenditure (subject to adjustment for outstanding and prepaid amount) is
transferred either to Trading account or Profit and Loss account.

(b) Capital Receipts and Revenue Receipts:

Capital Receipts: Capital Receipts consist of additional payments made to the business
either by the shareholders of the company or by the proprietors of the business or receipts
from sale of fixed assets of the business. The capital receipts are different from capital
profits. Receipts denote the entire amount received in cash.

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Revenue Receipts: Any receipt, which is not a capital receipt, is a revenue receipt. Usually
all receipts are revenue receipts. Revenue receipts are different from revenue income.

Differences between Revenue Receipts and Capital Receipts:

Following points will clarify the differences between capital receipt and revenue receipt.

(a) Capital Receipts are normally of non recurring nature whereas revenue receipts are
normally of recurring nature.
(b) Revenue receipts are obtained in the course of normal trading operations. The receipts,
which are not revenue receipts are regarded as capital receipts.
(c) Revenue receipts are directly credited to the income statement whereas capital receipts
are not directly credited to the income statement.
(d) Capital receipts are normally not available for payment as profit to the owner of the
business where as the revenue receipts net of revenue expenses and expired portions of
capital expenditure/deferred revenue expenditure are available for distribution to the owners
of the business.

Q. 9. Prepare Manufacturing Trading & Profit & Loss A/c for the year ended 31st
March, 1998 & Balance Sheet as at the end of the year.

Particulars Debit Credit

Opening Stock of Raw Materials 30000
Opening Stock of Finished Goods 16000
Opening Stock of Work in Progress 5000
Capital Account 72000
Purchases of Raw Materials 250000
Sales 400000
Purchases of Finished Goods 8000
Carriage Inwards 4000
Provision of doubtful debts 3500
Wages 50000
Salaries(75% Factory) 26000
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Commission 3000
Bad Debts 2000
Insurance 4000
Rent, Rates & Taxes(50% Factory) 12000
Communication 2800
Tea & Tiffin 1600
Traveling & Conveyance (25% Factory) 3500
Carriage Outwards 2600
Machinery 40000
Furniture ( 40% Factory) 5000
Debtors 60000
Creditors 50000
525500 525500

1. Provide 10% depreciation on Machinery & Furniture

2. Closing Stock :
a) Raw Material Rs. 40000
b) Work In Progress Rs. 12000
c) Finished Goods Rs. 8000
3. Provide 5% reserve for doubtful debts
4. Salary outstanding Rs. 2400
5. Insurance prepaid Rs. 600

Manufacturing account for the year ended 31 march 1998

Particulars Amount Particulars Amount

By Work in
To Work in Progress 5000 12000
To materials
Opening stock:
Add: Purchases
250000 By Cost of
------ Manufacturing
28 2400000
Less: C.S
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To Wages 50000
To carriage Inwards 4000
To Salaries(75%) 19500
To Rent, Rates &
To traveling &
To furniture 2000
To depreciation of
331375 331375

Trading and Profit & loss account for the year ended 31 march 1998

Particulars Amount Particulars Amount

To opening stock of
finished goods
16000 By sales 400000
Add: Purchases 240000
To cost of goods By closing stock of
319375 8000
manufactured finished goods
To gross profit c/d 64625
408000 408000
To salaries (25%) 6500 By gross Profit b/d 64625
To commission 3000
To Insurance
Less: Pre paid Ins 3400
To outstanding
To Rent, Rates &
To Communication 2800
To Tea & Tiffin 1600
To Traveling &
To carriage

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To depreciation on
To NET pProfit 33700
64625 64625

Balance Sheet as on 31 march 1998

Liabilities & Assets &
Amount Amount
Capital Properties
Capital A/c 72000
Less: Depn 36000
S. Creditors 50000
expenses: 2400
Less: Depn 4500
P/L a/c 33700 Less: Provision
For db.debts 57000
Closing Stock 60000
Pre paid Insurance 600
158100 158100

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