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Basics of Financial Accounting:

Chapter I: Fundamentals of Financial Accounting:

The following questions contain multiple choices [ (a), (b), (c) and (d) ] in which
one is correct. Indicate the correct choice in your answer booklet.

I Set

1. A transaction, which increases the capital is called income.


a) TRUE b) FALSE

2. Bill of exchange is drawn only when money is lent by a moneylender, banker or other financial
institution
a) TRUE b) FALSE

3. When the bill is dishonoured, the drawee will be debited in the books of the drawer whether the
bill is retained, endorsed or discounted.
a) TRUE b) FALSE

4. When the bill is endorsed or discounted, no entry is passed in the books of the drawer
a) TRUE b) FALSE

5. Wages and Salaries are debited to


a) Trading Account; b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the wage and salary earner

6. Carriage Outwards are debited to:


a) Balance Sheet; b) The personal account of the cart owner
c) Trading Account; d) Profit and Loss Account;

7. Customs duty paid on the import of a new machinery is a


a) Revenue Expenditure; b) Customary Expenditure;
c) Capital Expenditure; d) None of the above

8. Interest on capital is
a) a personal expenditure of the owner; b) a non-business expenditure
c) a business expenditure and hence debited to P & L Account; d) none of the above

9. Insurance claim acknowledged by the insurance company but not yet paid on the closing day is
treated as
a) An Asset; b) A Liability; c) An Outstanding income; d) An Outstanding charge/expense.

10. The accounting principle that conforms to the tendency of accountants to resolve uncertainty
and doubt in favour of understating assets and revenues and overstating liabilities and expenses,
is known as:
a) conservatism b) materiality; c) industry practice;
d) consistency;

11. Debit means:


a) decrease in assets b) increase in income; c) increase in expenditure; d) increase in capital;
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12. Which of the following is correct:
a) PROFIT = OPENING CAPITAL + DRAWINGS – ADDITIONAL CAPITAL –CLOSING CAPTIAL
b) PROFIT = CLOSING CAPITAL + ADDITIONALCAPITAL – DRAWINGS MADE – OPENING
CAPITAL
c) PROFIT = CLOSING CAPITAL –DRAWINGS –ADDITIONAL CAPITAL –OPENING CAPITAL
d) PROFIT = CLOSING CAPITAL + DRAWINGS –ADDITIONAL CAPITAL –OPENING CAPITAL

13. The liabilities of a firm are 350000 and the Capital is Rs150000. Of these Rs2 lakh is spent on
acquiring a building. What are the remaining assets?
a) Rs 500000 b) Rs150000 c) Rs700000 d) Rs300000

14. An amount of Rs 2800 was incurred on the installation of a machinery. The expenses are
treated as:
a) Dr to Wages Account; b) Dr to Machinery Account c) Dr to Repairs account
d) Dr Miscellaneous expenditure account

15. Cash book Bank column always show a


a) Debit Balance; b) Credit Balance; c) Debit or Credit Balance; d) a NIL
balance

16. Discount column in the cash book should be balanced and the balance shall be carried over
to the next accounting period:
a) TRUE b) FALSE

17. Bank Reconciliation Statement is


a) journal b) ledger c) profit or loss statement;
d) a statement showing the causes of differences between the cash book and the bank pass
book.

18. Bank Reconciliation Statement starts with


a) The Opening balance of the Cash Book; b) The Opening balance of the Passbook;
c) The Closing balance of the Cash Book; d) The Closing balance of the Cash book in the
cash column in a three columnar cash book

19. When the balance as per Cash Book is the starting point, the direct deposits by the
customers in the bank are……. ……….while preparing the Bank Reconciliation Statement.
a) added b) subtracted; c) neither of the above

20. Which of the following are intangible assets?


a) Plant and Machinery; b) Stock in Trade destroyed by fire
c) Investment in unapproved companies; d) Trade Marks and Patents.

21. Loss on sale of a fixed asset is debited to

a) Trading Account; b) The concerned Asset Account


c) Profit and Loss Account; d) Balance Sheet

22. Depreciation is an amortised expenditure


a) TRUE b) FALSE

23. Depreciation is a
a) Cash expenditure; b) Non-Cash expenditure; c) Neither a nor b
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24. Fixed assets are stated at their market value in the balance sheet
a) TRUE b) FALSE

25. Bank column of the Cash book may show


a) Debit Balance; b) Credit Balance; c) Either a debit balance or a credit balance.

26. Withdrawal of cash from the bank for office purposes is entered in the Cash Book
a) only in the bank column; b) only in the cash column; c) as a contra entry

27. If the debit as well as credit aspects of a transaction are entered in the Cash book it is called:
a) Compound entry; b) An opening entry; c) Transfer Entry d) Contra Entry;

28. Petty Cash book is maintained to


a) save time for the main cashier; b) account for all the petty cash
c) save the labour in posting innumerable entries; d) all the above.

29. Fill in the blank by choosing the appropriate words given in the options a, b & c

Interest free loan given by the wife of the proprietor is…………… a) liability; b) asset; c) profit

30. Fill in the blank by choosing the appropriate words given in the options a, b & c

A bill accepted by Mr Kumar in settlement of his accounts transactions with Mr Tulasi is a


…………
a) liability b) asset; c) profit

31. For a bill drawn on August 11 for two months falls due on 14th October
a) TRUE b) FALSE

32. A bill of exchange is a conditional order in writing given by a debtor to a creditor


a) TRUE b) FALSE

33. In case the due date of a bill falls on 15th August of any year, the due correct due date falls on
the preceding working day a) TRUE b) FALSE

34. The due date of a bill drawn on 31-01-2004 for 1 month fell on
a) 1st March 2004; b) 3rd March 2004; c) 28-02-2004; d)29-02-2004

35. Wages and Salaries are debited to: a) Trading Account b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the wage and salary earner

36. Carriage OUtwards are debited to: a) Trading Account b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the cart owner

37. Ms Srilakshmi started business with cash Rs25,000 on 1st October 2002. She withdrew
Rs2500 on 1st November 2002. As on 31st December 2002 she suffered a net loss as per P & L
Account of Rs1800. Her closing capital is
a)Rs 23200; b) 21700; c) 20700

38. Expenses on foreign tour for purchasing a new machinery is a : a) Revenue expenditure;
b) Capital Expenditure; c) Travel and tourism expenditure; d) None of the above
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39. Interest paid on a term loan where the production has already started is a
a) Revenue Expenditure b) Capital Expenditure c) Both

40.The assumption that a business enterprise will not be sold or liquidated in the near future is
known as the:
a) economic entity; b) monetary unit; c) conservatism d) none of the above

41. The liabilities of a firm are 250000 and the Capital is Rs 125000. The total assets of the firm
are:
a) Rs125000 b) 250000 c) 375000 d) 125000

42. Journal is a book of; a) original entry b) Bank Reconciliation statement c) secondary
entry; d) all cash transactions;

43. Normally the following accounts are balanced:


a) Personal Accounts and Nominal Accounts; b) Real accounts and Nominal Accounts
c) Personal accounts and Real accounts

44. Cash Discount allowed by the trader to the purchasers is entered in


a) Credit side of the Cash book; b) Debit side of the Cash book

45. Which of the following is a business credit?


a) The Seller receives an accepted Bill of Exchange from the purchaser;
b) The seller receives a lesser cash because of the rebate or a price crash;
c) The seller receives an advance amount equal to the sales by way of a bank demand draft;
d) Cash deposited and goods delivered on a subsequent date.

46. Returns Outwards is treated as


a) a deduction from sales; b) a deduction from purchases; c) an additional sales; d) addition to
the purchases

47. Bank Reconciliation Statement is prepared


a) by the bank and supplied to the customer to verify the same
b) by the customer to see that the transactions are properly recorded in the cash book and the
pass
book and the differences are reconciled.
c) both (a) and (b) above

48. The causes of differences in the Bank Reconciliation statements are rectified by passing
a) rectification entries on the date of the bank reconciliation statement; b) Journal entries are
passed only for some causes after the BRS is prepared; c) Journal entries are passed for all the
causes; d) Journal entries are passed only during the year end.

49. Which of the following are intangible assets?


a) Land and Buildings; b) Stock in Trade; c) Investment in unapproved companies; d) Patents

50. Which of the following are intangible assets?


a) Stock in Trade destroyed by fire; b) IPRs; c) Investment in unapproved companies
d) Loss in business
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II Set:
1. Depreciation Policy is one of the important accounting policies for any business organsation
a) TRUE: b) FALSE

2. Providing depreciation in the accounts reduces the amount of profits available for dividend.
a) TRUE b) FALSE

3. Reserves and Surplus is: a) A Liability; b) An Asset; c) A Profit; d) Not an account at all

4. Reducing balance method of depreciation is followed to have a uniform charge for depreciation
and repairs and maintenance together: a) TRUE b) FALSE

5. Transactions entered on the debit side of the Cash book are to be posted to
a) the debit side of the concerned ledger accounts in the ledger
b) the credit side of the concerned ledger accounts in the ledger
c) None of the ledger accounts as the cash book serves as a permanent record.

6. Subsidiary Books act as a journal as well as a ledger: a) TRUE b) FALSE

7. When a firm maintains a Three-column Cash Book, it need not maintain:


a) Cash account in the ledger; b) Bank account in the ledger
c) Discount Account in the ledger; d) Both Cash and Bank account in the ledger.

8. Fill in the blank by choosing the appropriate words given in the options a, b & c
Income accrued due but not received is a…………………….. (a) asset, b) liability, c) profit)

9. When a Trial balance is tallied, there are no errors in accounting.


a) TRUE b) FALSE

10. Mr Rajesh starts with the business with Cash Rs45000/-, Furniture Rs20,000/- and Bank Loan
Rs2.5lakhs; Land and Buildings Rs4.5 lakhs. His capital is:

a) Rs2.65lakhs; b) 7.70 Lakhs; c) Rs 3.00 lakhs;

11. If a firm borrows money, there will be


a) increase in capital; b) decrease in capital; c) no effect on capital.

12 Assets are:
a) Sources of Funds b) application of funds;

13 Wages of Rs1200/- incurred for installation of machinery is debited to


a) Wages Account; b) Machinery Account; c) Installation Charges account;

14 Debit means
a) Increase in expenditure; b) Increase in income; c) an increase in liability; d) an increase in
owners’ capital

15 Ledger is a book of
a) original entry; b)secondary entry; c) all cash transactions; d) all non-cash transactions

16 Discount allowed is entered in the Cash Book with Bank Column on the
a) Debit side; b) Credit Side; c) not entered at all;
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17. If the debit and credit aspects of a transaction are recorded in the Cash Book itself it is called:
a) Compound entry;b) Double entry; c) Contra entry; d) Transfer entry

18 Returns Outwards is treated as


a) a deduction from sales; b) a deduction from purchases; c) an additional sales; d) addition to
the purchases

19) Bank Reconciliation Statement is prepared by


a) bank; b) customer; c) creditor of a business; d) none of them

20) Credit balance in the bank column of the Cash Book means:
a) Bank Overdraft; b) Credit balance in the Bank pass book; c) funds available in the bank
account; d) none of these

21) When the balance as per Cash book is the starting point, direct deposits by customers are:
a) deducted; b) added; c) neither a nor b

22) Bank Reconciliation Statement is


a) ledger account; b) journal ; c) final account; d) a statement showing the causes of difference
between the cash book and the bank pass book

23) When you start preparing Bank Reconciliation Statement we may observe
a) overdraft in both cash book and bank pass book;
b) overdraft in cash book and credit balance in the pass book;
c) overdraft in cash book and debit balance in the pass book;
d) all the above

24) Bills Receivable is


a) a liability; b) an Asset; c) a part of capital account;

25) A Bill of Exchange is an


a) unconditional promise; b) unconditional order; c) conditional i.e, subject to satisfactory delivery
of goods

26) A Bill of exchange can be


a) retained till the due date; b) collected through the bank; c) discounted at a bank before the due
date; d) all of these.

27) Salaries and Wages appearing in the Trial balance appears in


a) Trading Account; b) Profit and Loss Account; c) Balance Sheet; d) all of these

28) Manufacturing Wages appearing in the Trial balance appear in the


a) Trading Account; b) manufacturing account; c) P & L Account; d) Balance sheet

29) Discounts received appear in the Trial balance on the


a) Debit side; b) Credit Side; c) Both sides; d) does not appear as it is found only in the ledger
account

30) Discount on Creditors is a……….to our business


a) loss; b) gain; c) both;d)none.

31) Drawings are deducted from


a) Purchases; b) Sales; c) Capital; d) Returns outward
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32) The trial balance of Mr X contains the following information:


Bad Debts Rs400; Provision for bad debts Rs 500; Sundry Debtors Rs2500;. It is desired to
create a provision for bad debts at10% on Sundry Debtors at the end of the year. The figure of
Sundry Debtors appear in the Balance sheet at a figure of
a) 2250; b) 2500; c) 1600; d) 1860

33) Depreciation is
a) a non cash charge; b) an amortisation expenditure; c) both a and b

34) Trading and Profit and Loss Account is a


a) Real Account; b) Nominal Account; c) Personal Account;

35) Sundry Debtors, Bills Receivable, Stock in Trade are


a) Current Assets; b) Fixed Asset; c) Intangible Asset

36) The amount of depreciation charged to the Asset account is more in


a) Straight Line method; b) Written Down Method;

37) The real profits of a business depends on


a) Depreciation Policy; b) Investment policy; c) Policy on sourcing of funds d) all of these

38. For a bill drawn on August 1 for two months falls due on 4th October
a) TRUE b) FALSE

39. In case of a public holiday the due date of the bill falls on the preceding working day
a) TRUE b) FALSE

40. The due date of a bill drawn on 31-01-2000 for 1 month fell on
a) 1st March 2000; b) 3rd March 2000; c) 28-02-2000; d)29-02-2000

41. Salaries and Wages are debited to


a) Trading Account b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the wage and salary earner

42. Carriage Inwards are debited to:


a) Trading Account b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the cart owner

43. Adjusted Purchases means


Purchases MINUS Returns Outwards
b) Purchases MINUS Returns Inwards MINUS Closing Stock
c) Purchases PLUS Returns Inwards MINUS Closing Stock
d) Purchases MINUS Returns Outwards MINUS Closing Stock

44. Expenses on foreign tour for purchasing a new machinery is a


a) Revenue expenditure; b) Capital Expenditure;
c) Travel and tourism expenditure; d) None of the above

45. Ram has total assets of Rs 580000. His outside liabilities are Rs80000 and the loan from his
family members is Rs 2 lakhs. What is his capital?
a) Rs280000 b) Rs660000 c) Rs3000000 d)Rs580000
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46. When a cheque received is endorsed it shall be entered on
a) Debit side of the Cash book;
b) Credit side of the Cash Book;
c) It is endorsed in the personal account of the endorsee and not in the cash book;
d) both sides of the Cash book

47. The causes of differences in the Bank Reconciliation statements are rectified by passing
a) rectification entries on the date of the bank reconciliation statement
b) Journal entries are passed only for some causes after the BRS is prepared
c) Journal entries are passed for all the causes.
d) Journal entries are passed only during the year end.

48. Which of the following are intangible assets?


a) Land and Buildings; b) Stock in Trade; c) Investment in unapproved companies; d) Goodwill

49. Which of the following are intangible assets?


a) Stock in Trade destroyed by fire; b) Copyrights; c) Investment in unapproved companies d)
Loss in business

50. A tallied Trial balance does not reveal compensating errors.


a) TRUE b) FALSE

51. Bill of exchange is drawn only when money is lent by a moneylender, banker or other financial
institution
a) TRUE b) FALSE

52. When the bill is dishonoured, the drawee will be debited in the books of the drawer whether
the bill is retained, endorsed or discounted.
a) TRUE b) FALSE

53 When the bill is endorsed or discounted, no entry is passed in the books of the drawer
a) TRUE b) FALSE

54. Wages and Salaries are debited to


a) Trading Account; b) Profit and Loss Account;
c) Balance Sheet; d) The personal account of the wage and salary earner

55. Customs duty paid on the import of a new machinery is a


a) Revenue Expenditure; b) Customary Expenditure;
c) Capital Expenditure; d) None of the above

56. Interest on capital is


a) a personal expenditure of the owner; b) a non-business expenditure
c) a business expenditure and hence debited to P & L Account; d) none of the above

57. Insurance claim acknowledged by the insurance company but not yet paid on the closing day
is treated as
a) An Asset; b) A Liability; c) An Outstanding income; d) An Outstanding charge/expense.

58. The accounting principle that conforms to the tendency of accountants to resolve uncertainty
and doubt in favour of understating assets and revenues and overstating liabilities and expenses,
is known as:
a) conservatism b) materiality; c) industry practice; d) consistency;
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GENERAL STRUCTURE OF THE BALANCE SHEET AND PROFIT AND LOSS ACCOUNTS:

Exercise No 1:

Fill up the blanks:

1. The things that a business enterprise owns are called -------- ( Assets)

2. The various amounts of money owned by an enterprise are called ………(Liabilities)

3. Assets are usually listed in a Balance Sheet in 2 main groups…………….. (Fixed Assets and
Current Assets)

4. Assets which are generally intended for use in the business over a relatively long period are
called………………….assets. ( Fixed)

5. Assets which are not intended for long periods are called………………….
assets.( current)

6. Accounts ……………..(Receivables) are likely to be paid and therevore converted into cash.
They are classified as…………….assets (current)

7. Marketable securities are generally regarded as part of………….assets because they can
readily be converted into cash (current).

8. The most liquid simple assets of all is ………… (cash)

9.Current Assets are more liquid than …………..assets (fixed).

10. Accounts receivables and marketable securities can be converted into cash at short notice.
Hence they can e called …………. ……………(quick assets).

11.Marketable securities are valued at……….. or lower ………..value (cost or realisable).

12. All receivables, employee accounts and other outstanding items are valued at…….. …………
less provision for…….. …………. (full value; doubtful items).

13. Stock in trade …………… are valued at cost or current market value whichever is the lower.

14. Land is valued at ………. Or……….. (cost or valuation).

15.Building, Plant and Machinery, Furniture and fixtures are valued at……
Less………….. (cost, depreciation)

16.It is possible to tell how an enterprise has obtained its finance by looking at the …………..side
of the balance sheet (liability).

17.The moneys put by the shareholders into the company is the money the company owes to the
shareholders. Hence shareholders funds are part of the total……………..of the company.
(liabilities)

18.Excepting shareholders’ funds, other liabilities are described as …….. ……….These consists
of Current Liabilities (outside liabilities; fixed liabilities).
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19.Current liabilities are usually payable in…………. period say within a year. (short)

20. Bank Overdrafts and other current liabilities represent enterprises’ ……………finance (short
term)

21. Current Liabilities are usually met from …….. assets (short term or current)

22. Fixed Liabilities represent companys’ …… ……. Finance (long term)

23. The main items in the shareholders’ fund are likely to be ………………..
………………(capital issued and subscribed, capital reserve and revenue reserve)

24. Capital Reserve and Revenue Reserve figures in a Balance Sheet represent ………….that
have been ………….in the company. (profits; retained)

25.An enterprise is said to be solvent if its total assets are greater than its……… ……… So the
solvency of an enterprise is the ability to meet its…. ………(outside liabilities; outside liabilities)
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CHAPTER II: Manufacturing, Trading and Profit and Loss Account

2.1 INTRO:
Journal, ledger accounts and subsidiary books are written as and when transactions take place.
The owner of the business expects the results of his business once in a quarter / half year or
year. At the end of the financial period, a trail balance is prepared to find out the accuracy of the
accounts prepared and then the final accounts are prepared to ascertain the profit or loss and
also the financial status of the business. All the accounts are closed by passing closing entries by
giving a separate treatment in the final accounts.

The final accounts are generally a) Manufacturing account, b) Trading Account; c) Profit and Loss
Account and the final Statement is called BALANCE SHEET.

2.1.1. Manufacturing Account is prepared to ascertain the cost of manufacture of the


product, which in turn help the owner to fix the selling price. The cost of goods produced is
calculated as:

Opening stock of Work-in-progress + Raw Materials Consumed (Opening stock + Purchases+ All
direct expenses- Closing stock of Raw materials) MINUS (Sale of scrap and Closing stock of
work in progress). PLEASE note that opening stock and closing stock of finished goods do not
appear in the manufacturing account as they are taken to the Trading Account.

It may be observed that all the expenses directly connected with Factory land and building and
Plant and Machinery are debited to the Manufacturing Account.

A common guideline for preparation of manufacturing, trading and profit and loss account is that
all the ledger accounts are closed and the totals for the entire accounting period are taken into
account as the total expenses or total income under respective heads.
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A model Manufacturing Account is shown below:

Dr Manufacturing Account of….. for the period ending on………….. Cr


Particulars Amt Particulars Amt
To Opening Work in Progress 5000 By Sale of Scrap 5500
To Raw Materials Consumed: By Closing Work in Progress 3500
Op Stock 75000 By Trading Account
Add Purchases 35000 (Cost of goods produced) 138000
Add Cartage Inward 3000
Add Freight Inward 2000
Less Return Outward 2500
Less Closing Stock 65000 47500
To Wages 21000
To Salary of Works Manager 9000
To Power, Electricity & Water 5000
To Fuel 6000
To Postage & Telephone 3500
To Depreciation 9000
Plant and Machinery 6000
Factory L & B 3000
To Repairs to 15500
Plant and Machinery 11000
Factory L & B 4500
To Insurance 5500
Plant and Machinery 3500
Factory L & B 2000
To Rent and Taxes 12000
To General Expenses 3000
To Royalty based on production 25000

Total 147000 Total 147000

2.1.2. Trading Account: is prepared to ascertain the gross profit or gross loss. In case of
manufacturing concerns the trading account is opened with the cost of goods manufactured
(brought down from manufacturing account). Then the direct expenses relating to finished goods
are debited. Then the sales of finished goods and closing stock are accounted. The result is the
gross profit or gross loss.

In case of trading concerns, it starts with the opening stock. Then the Net purchases and direct
expenses incurred for bringing the goods are debited. On the credit side, the value of sales and
the closing stock will appear. The result is the Gross profit, which is carried to Profit and Loss
Account.

Trading account is prepared for manufacturing concerns and also for traders. In case of
manufacturing concerns, the cost of manufacturing is taken to the trading account. In case of
trading concerns, the opening stock of goods added with the purchases (less returns) and direct
expenses on the goods are debited to the trading account and sales and closing stock are
credited.
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The objective of preparing Trading account is to know the gross profit or gross loss during the
accounting period. It helps matching the selling prices with the cost of goods and services
produced and delivered.

A Model Trading Account is shown below:

Dr Trading Account of….. for the period ending on………….. Cr


Particulars Amt Particulars Amt
To Opening Stock 125000 By Sales 375000
To Purchases 165000 Less returns 3500 371500
Less Returns 2500 162500 By Closing Stock 50000
To Direct Expenses 3000 By Abnormal Loss of stock 2000
To Freight Inward 2500 By Gross Loss transferred to
To Carriage Inward 1500 P & L Account (if any)
To Cartage Inward 2000
To Wages & Salaries 8000
To Gross Profit transferred
to P & L Account 119000

Total 423500 Total 423500

2.1.3. Profit and Loss Account: Manufacturing Account shows the cost of production.
The Trading account reflects gross profit—cost of goods purchased/manufactured and the cost of
goods sold. Other expenses of general nature are not accounted. A Profit and Loss account is a
comprehensive account showing all expenses of whatever nature incurred in running the
business and also provisions for losses, reserves, depreciation etc. It recognizes certain incomes,
which accrue in the normal course of business. The net result is the Net profit or Net Loss, which
is accounted to the Capital account of the proprietor/partner/s.

The basic objective of P & L Account is to find out the Net profit or Net loss

P & L Account takes into account all indirect revenue expenses and losses on the debit side and
all indirect revenue incomes
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A model of Profit and Loss Account is shown below
Dr Profit and Loss Account of….. for the period ending on……….. Cr
Particulars Amt Particulars Amt
To Gross Loss b/d (if any) NIL By Gross Profit b/d 119000
To Salaries and Wages 11000 By Interest earned 11000
To Rent, Rates and Taxes 1500 By Commission earned 12000
To Fire Insurance premium 600 By Rent Earned 33000
To Repairs and Maintenance 1200 By Profit on sale of fixed assets 2000
To Depreciation 9000 By Income from investments 7000
To Audit fees 600 By Sale of scrap 1000
To Bank Charges 250 By Miscellaneous Incomes 2000
To Legal Charges 550 By Net Loss transferred to
To Miscellaneous Expenses 350 Capital Account
To Discount allowed NIL
To Carriage Outward 1200
To Freight Outward NIL
To Commission to Salesmen NIL
To Travelling Expenses 1350
To Entertainment Expenses 550
To Business dev Expenses 12000
To Sales Promotion Expenses 14000
To Advertising and Publicity 22000
To Bad Debts 3000
To Packing Expenses 5500
To Interest on Loans 3500
To Loss by Theft 1250
To Loss by Fire NIL
To Loss by Embezzlement NIL
To Net Profit transferred to Capital
Account 98600

Total 187000 Total 187000

It is to be noted that the Manufacturing, Trading and Profit and Loss account comprises of only
revenue expenses and revenue incomes. That means income of a capital nature or expenditure
of a capital nature does not find a place here. For example, expenditure incurred in acquiring an
asset does not find a place in P & L Account. But the Profit on the proceeds on the sale of a Fixed
Asset is shown as revenue in the Profit and Loss Account. It must be noted that it is the profit or
loss on the sale of an asset and not the ENTIRE PROCEEDS that go the Profit and Loss
Account.

Again, the revenue items in the Profit and Loss Account are referred to as indirect expenses.
These indirect expenses may be classified into a) Selling and Distribution Expenses, b) Office
administration expenses; c) Interest on loans and Advances; d) Depreciation on Fixed Assets; e)
Reserves and Provisions.

ON the income side, the income by way of interest, commission, and rent earned by the concern
are recognized

Another way of putting up expenditure in the P & L Account is to be classify the heads of
expenditure –like Administrative Expenses, Legal Expenses, Selling and Distribution Expenses,
Promotion Expenses and Provisions.
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2.1. 5. Income and Expenditure Account of Non-Trading Organisations.

Non-trading concerns render social services-promotion of art, culture, literature, sports


entertainment, education, science, charity, religion etc. They include institutions, which provide
these services. Hence, we do not call the account as Profit & Loss Account. Instead, we call it
Income and Expenditure Account.

Social services; No profit motive; Majority are cash transactions; Generally a cash book and
journal are maintained; Members are not owners; Cash book contains individual receipts and
payments; Volume of ledger transactions is limited; Trial balance is prepared only exceptionally;
Receipts and payments account prepared at the end of year; Income and expenditure account
(also called revenue account) is prepared at the end of year; The surplus/deficit is transferred to
capital fund; The office bearers work out the methods of raising or utilizing the resources
depending on the amount of surplus or deficit.

The final accounts of non-trading concerns are


1) Receipts and Payments account; 2) Income and Expenditure account and 3) Balance Sheet

RECEIPTS AND PAYMENTS ACCOUNT:


It is a summary of cash receipts and cash payments relating to the entire accounting period. It is
prepared on cash system of accounting. It includes both revenue and capital items. It includes all
transactions even if the item relates to previous year or future years. It is helpful for the
preparation of income and expenditure account and balance sheet. It resembles cash book in
many respects. But there are certain differences.

Cash book Receipts and payment account


1.Day to day receipts and payments 1. Abstract / summary of cash transactions.
2. Written every day 2. Prepared at the end of year
3. An individual item is written many times as 3. The sum total of an individual is written at
and when transaction takes place. the end of year.
4. Prepared from vouchers and receipts 4. Prepared from cash book
5. Trading and non trading concerns prepares 5. Only non trading concerns
cash books
6. Prepared In columnar form. 6. Not in columnar form.
7. Part of books of accounts 7. Part of final accounts
8. Part of double entry system 8. Does not part of double entry
9. Records all receipts and payments and 9. To facilitate the preparation of income and
indicates the opening and closing balances of expenditure account
cash on any day

INCOME AND EXPENDITURE ACCOUNT:

Income and expenditure is a revenue account of non-trading concern. It is prepared on the


accrual system of accounting. All items of incomes and expenditure of revenue nature pertaining
to the accounting period are recorded irrespective of whether they are actually received or paid.
This is prepared from the receipts and payments account and recognising all prepaid and
outstanding income and expenditure.
-16-
Differences between Income and Expenditure account and Profit and Loss
account
Income and Expenditure account Profit and Loss account
1. Revenue account of a non trading concern 1. Revenue account of trading concern
2. It is prepared to find out surplus or deficit 2. To find out profit or loss
3. It does not start with any balance 3. It starts with a balance of gross profits/loss
4. Closing balance is called excess of income 4. The closing balance is net profit or loss
over expenditure or excess of expenditure over
income
5. Surplus is not distributed among members 5. The net profit is distributed among the
owners

The differences between Receipts and Payments account and Income and
Expenditure account is tabulated.
Receipts and payment account Income and expenditure account
1. Real account 1. Nominal account
2. Similar to cash book 2. Similar to profit and loss account
3. Summary of actual cash receipts and 3. Summary of income and expenses relating
payments to an accounting period
4. Cash system of accounting 4. Accrual system of accounting
5. Includes both capital and revenue items 5. It includes only revenue accounts
6. Entries may relate to items of previous year 6. Entries relates only to current year
or next year.
7. It does not include outstanding accounts 7. It includes outstanding items
8. Non cash items are not included 8. Non cash items like bad debts, depreciation
are included.
9. Receipts on the debit side and payments on 9. Income is shown on credit side and
the credit side are shown expenditure on the debit side.
10. Starts with an opening balance 10. It does not begin with the opening balance.
11. Closing balance represents cash in hand or 11. Closing balance represents surplus or
bank balances deficit
12. Closing balance is generally a debit 12. Closing balance may be a credit balance or
balance(exceptions being overdrafts) a debit balance.
13. Closing balance is brought down for the 13. A closing balance is not brought down but
next accounting period transferred to capital fund

14. Does not form a part of double entry 14. It forms a part of double entry
15. Does not accompany a balance sheet 15. Always accompanied by a balance sheet.
-17-
2.1.6. Profit and Loss Account of PARTNERSHIP ACCOUNTS

The guidelines relating to Partnership accounts are governed by the Partnership Deed or in its
absence the Indian Partnership Act, 1932.

Partnership Deed and its contents:


A Partnership Deed is a written agreement among the partners providing for rules and
regulations. It is accepted as an evidence in law in case of disputes. It is signed by all the
partners. It is stamped as per the Stamp Act. It is also called “Articles of Partnership” or the
“constitution of Pp firm”. It is documented to prevent possible disputes & disagreements among
the partners at a future date.

The following are the contents of a Pp Deed:

The name of the firm; Names and addresses of the partners; Nature of business; Date of
commencement; Duration/Period; The amount of capital to be brought in by each partner; The
amount of drawings that may be permitted in anticipation of profits and the manner of withdrawal;
Interest on partner’s capital and the Rate of interest; Interest on partner’s drawings and the rate of
interest; The amount of salary, commission or any other remuneration payable to any partner;
The ratio of sharing profits or losses; The treatment of losses arising on account of insolvency of
a partner; The manner of calculation of goodwill at the time of admission, retirement or death of a
partner; The method of settlement of account in case of retirement of a partner; Details re:
operation of the bank account; The manner of keeping books of account and audit; Sharing of
managerial work/responsibilities; Dissolution and settling of accounts thereupon; Disputes and
the manner of settlement.

Rules in the absence of a partnership deed:

Profits/losses are to be shared equally; Interest on partner’s capital is not allowed; Interest on
partner’s drawings is not to be charged; Partner is not eligible for salary, commission, or any
other remuneration for any extra work done; Where partners lend loans, they are entitled for
interest @ 6% p.a. only; A change in the constitution of the firm does not alter the rights and
duties of the partners; Every person has a right to participate in the management; Every partner
has a right to inspect the books of account; Every partner is to be indemnified in respect of all
acts done in the ordinary course of business; Majority of partners has to decide all matters
relating to day to day conduct of the business. Change in the nature of the business is to be
decided with the consent of all the partners; Every partner has a right to protect the firm in case of
an emergency; No person can be admitted as a partner without the consent of all the existing
partners; Every person must compensate the firm for any loss caused to it by fraud or wilful
negligence in the management of business; The benefits of the firm should not be diverted to the
personal purposes. If profits are derived by using the Pp property, the partner must hand over
such profits to the firm; A partner should not carry on other business which is competing with the
business of the firm.

The final accounts of Partnership accounts are similar to that of a sole proprietorship. However,
the treatment of certain items is subject to the Partnership Deed or in accordance with the Indian
Partnership Act, 1932.

The Profit and Loss account is influenced on the admission, retirement, death or dissolution of a
partnership. A REVALUATION ACCOUNT in case of admission, retirement or death is prepared
and the partners’ accounts are settled. In case of dissolution, a REALIZATION ACCOUNT is
prepared and the partners claims are settled.
In case of death of a partner, the balance due to the deceased partner may be paid immediately
to the executors or it may be paid by instalments if the legal heirs agree on the point. The balance
due to the deceased partner is ascertained so as to cover all the dues till the date of death. In
case of retirement or admission, the restructuring may take place as on a predetermined date
coinciding with the end of a month, quarter or half year. The partners/ firm would have also taken
a joint life insurance policy. The policy amount or the deceased partner’s share is also payable to
the executor.

On admission of a partner/s, the incoming partners bring capital and hence, profit sharing ratios
change. He also brings goodwill, which will be treated as per the agreement.

Goodwill is the value that is attached to the super-profit earning capacity of an existing firm. This
is in addition to the value represented by tangible or concrete assets. Goodwill arises on account
of name, fame, and reputation of an existing business. Goodwill is an intangible asset but not a
fictitious one. It is built or created by the efforts of the existing partnersand the new partner is
likely to get a share in the future profits which is the result of the super profit earning capacity of
the existing firm. Goodwill is an intangible asset but not a fictitious one.

The accumulated profits and General Reserves till the date of admission of a partner are
distributed to the old partners.

2.1.7 Profit and Loss Account of JOINT STOCK COMPANIES


The Profit and Loss Account of Joint Stock Companies is similar to that of a sole proprietor or a
partnership firm. However, the Net Profit is transferred to a separate account called “PROFIT
AND LOSS APPROPRIATION ACCOUNT”.

The Balance in the Profit and Loss Appropriation Account carried over from the last year plus the
current year’s Profit & Loss account balance is apportioned for:- a) Net losses transferred from
the P & L Account of the current year; b) Payment of dividends to shareholders; c) Transfer to
General Reserves; d) Transfer to Sinking Funds; e) Transfer to Dividend Equalisation Fund; f)
Transfer to Insurance funds; and g) the balance is transferred to Balance Sheet.

2.1.8. Profit and Loss Account of various other types of organisations


Generally, there are prescribed forms of final accounts (P & L Account and Balance Sheet and
other accounts) in some types of organizations. Insurance companies, Banks, Railways,
Electricity Companies. Hire Purchase and Leasing Companies, Transportation companies,
Government departments and companies having international (global presence) are all good
examples. Bankers who go through the final accounts of these types of organizations would do
well to understand the rules and regulations before using them for purposes of analysis and
taking financial decisions.
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CHAPTER III: PRESENTATION OF FINAL ACCOUNTS (horizontal and
vertical forms)

3.1. INTRO: Final accounts may be presented in two forms—a) Horizontal form and b) Vertical
form. Traditionally, the profit and loss account and the balance sheet are presented in horizontal
form. In the recent past, vertical form has been made mandatory in some types of organizations.

3.2. Horizontal Form: The forms of profit and loss account and balance sheet exhibited in the
previous chapters are all horizontal. In the horizontal form, the items are presented in “T” shape.

3.3. Vertical Form: Under the vertical form of presentation, the items are presented in a single
columnar form. The presentation has its own objectives, which are achieved when the items are
in a particular sequence. The formats are given below.

In vertical formats, separate schedules should always be maintained for each of the items in
detail, which will incorporate all the information. The schedules form an integral part of the
Balance Sheet. Contingent Liabilities, if any, should be shown separately in the foot-note of the
Balance sheet and not as contra entries.

3.3.1. In India, Vertical Form of presentation of Final Accounts has been made compulsory in
case of a) Banks (as per Banking Regulation Act, 1949 as amended from time to time);
The final Accounts of Joint Stock Companies the vertical form is being accepted for publication of
results in newspapers.
-20-
3.3.2. Vertical Form of Profit and Loss Account:
Particulars Rs Rs Rs
A. Net Sales:
Sales (Gross)
Less Returns

B. Cost of Goods Sold


Opening Stock:
Add: Purchases
Less: Returns
Add: Direct Expenses:
Carriage/Cartage/Freight Inwards
Wages and Salaries

Cost of Goods available for sale


Less Closing Stock

C. Gross Profit (A – B)

D. Operating Expenses:
a) Selling Expenses:
Carriage Outward
Discount allowed
Commission allowed
Travelling Expenses
Entertainment Expenses
Sales Promotion Expenses
Bad Debts
b) Office and Administration Expenses
Salaries and Wages
Rent, Rates and Taxes
Repairs
Insurance
Printing and Stationery
Water and Electricity
Postage and Telegram
Staff Welfare Expenses
Conveyance Charges
Misc Expenses
Depreciation

E. Net Operating Profit/Loss: C - D

F. Net Non-Operating Result


a) Interest earned
Commission earned
Discount earned
Miscellaneous Incomes
b) Non-Operating Expenses and Losses
Interest allowed
Loss on sale of a fixed Asset
G. Net Profit
-21-
3.3.3. Vertical Form of Balance Sheet
Particulars Rs Rs Rs
A. Sources of Funds
a) Proprietor’s Funds
b) Long-Term Debts

B. Application of Funds
a) Net Working Capital:
i) Current Assets:
Cash in hand
Cash at Bank
Bills Receivable
Accrued Income
Debtors
Stock
Prepaid Expenses
LESS ii) Current Liabilities:
Bank Overdraft
Accrued expenses
Bills Payable
Trade creditors
Income received in Advance

b) Investments
c) Fixed Assets:
Furniture and Fixtures
Patents and Trade Marks
Plant and Machinery
Building
Land
Goodwill

Schedule of Proprietor’s Funds


Particulars Rs Rs
A. Capital in the beginning
B. ADD Additional Capital introduced
Interest on Capital
Salary to Partner
Profit for the Current Accounting Period

C. LESS Drawings
Interest on Drawings
Loss for the current accounting period
D. Capital at the end of the year (A-B-C)

Note: Vertical form of presentation of final accounts of joint stock


companies is similar to the above.
-22-
CHAPTER IV: Fundamental concepts of Accounting, Primary books,
Subsidiary books and Trial balance,

4.1. FUNDAMENTALS OF ACCOUNTING

4.1.1.Accounting refers to the following functions:

a) Identifying and measuring the transactions and economic activities; b) Recording, classifying,
summarizing, analyzing, interpreting and c) communicating with all the parties concerned.

Communication refers to an information system whereby the accounts convey information to


internal or external users to enable them to make a reasoned decision. Communication system
refers to an accounting cycle. An accounting cycle refers to Journalising, Posting, Balancing,
Preparation of Trial Balance and Final Accounts.

4.1.2.Benefits of Accounting:

a) Replaces memory of large and voluminous transactions


b) Compliance with legal and taxation matters.
c) Decision making, ascertaining the financial position,
d) Facilitates comparative studies and serves as a management information system
e) Helps in raising resources and proper deployment of resources

4.1.3.Limitations of Accounting:

a) Does not recognize qualitative information


b) Even accountants are biased towards following a certain policy
c) Every business is accounted as an ongoing concern basis and hence may not reveal the real
picture as it would have been if the business is forced to close down.
d) Ignores the effect of price rise. However, inflation accounting has been in vogue in the recent
past.
e) Accounting enables the decision makers to make window dressing and door dressing

4.1.4.Classification of Accounting:

a) Financial Accounting;
b) Cost and Management Accounting
c) Social Responsibility Accounting
d) Fund Based Accounting

4.1.5.GAAP: GAAP refers to Generally Accepted Accounting Principles are those rules of
action or conduct, which are derived from experience and practice. These when proved useful,
they become convention and accepted as principles of accounting. The criteria are a) Relevance,
b) Objectivity and c) Feasibility.
-23-

4.1.6. Basic Accounting Concepts:

a) Accounting Entity Assumption: This means that the business is different from the persons
owning it. Accounting is done for the business unit and not the person representing it. Personal
transactions of the owner with the business unit are also recorded in the business unit.

b) Money Measurement Concept: Accounting refers to recording only those transactions, which
are capable of expression in money terms. Hence, qualitative items like the morale of the
employee or the corporate image of the company cannot be recorded.

c) Accounting Period Concept: (Periodicity or Time Period): The income statement and all other
financial statements are prepared for determined accounting periods like a quarter, half year or a
year.

d) Going Concern Concept: Accounting is done for an enterprise as a going concern which
means that the business unit (enterprise) is continuing operations for a foreseeable future and
that it is neither the intention nor the necessity to liquidate the enterprise.

e) Consistency: The accounting policies are consistent over a period of time

f) Accrual Concept: Revenues and Costs once accrued are recognized and recorded in the
financial statements. That means they are earned or incurred (and not money received or paid)
as and when the period is over.

g) Prudence Principle (Conservatism Concept): “Anticipate no profit but provide for all possible
losses” is the prudence expected of every accountant.

4.1.7. Accounting Policies:

a) Policies relating to Depreciation, Amortisation and Depletion


b) Treatment of expenditure during construction of building and other infrastructure
c) Conversion of Foreign Currency
d) Inventory Valuation
e) Treatment of Goodwill
f) Valuation of Investment
g) Treatment of retirement benefits
h) Recognition of long-term contracts
i) Valuation of Permanent Assets
j) Contingent Liabilities—treatment.

We have seen that an accounting cycle refers to Journalising, Posting, Balancing, Preparation of
Trial Balance and Final Accounts. We shall study them in detail.

4.2.1.JOURNALISING:
1. Every transaction is recorded in a journal as and when the transaction takes place. This
process of recording the transaction is called Journalising. Transaction refers to movement of
money or money’s worth. The basic principle of recording is that every debit has got a
corresponding credit and vice versa. The debit and credit has to be carried according to the
classification of accounts and the principle underlying therein.
-24-
2. PERSONAL ACCOUNTS: Debit the receiver and credit the giver.
3. REAL ACCOUNTS: Debit what comes in and credit what goes out.
4. NOMINAL ACCOUNTS: Debit all expenses and losses and credit all gains and profits.

Once a particular debit or credit is identified the other is naturally the contra.

4.2.2. Posting in ledgers:

Every journal entry is entered in the respective head of account called the ledger account, which
is also called Account.
All the transactions in a particular head of account are available at a glance of the account
The ledger being the destination of all transactions it is called the Book of Final Entry.
The ledger may be in book form, loose sheet, punched card, electronic form or any other device.
Balancing of a ledger account reflects the debit or credit position of that head of account on a
given date.
Special journals are in the form of ledger accounts and hence separate journal and ledger are not
necessary--for example Cash book, Purchases and Sales register,
Purchases Returns Book, Sales Returns Book, Bills Receivable Book and Bills Payable Book and
Journal Proper. These serve the purposes of journal as well as ledger. Discounts, Rebates and
Concessions, are to be properly accounted. Cash Book may contain a) only cash column—single
columnar cash book; b) Cash book with cash and bank column—called two column cash book; or
c) Cash book with cash, bank and discount columns—called three column cash book each
serving specific purposes. Besides, there may be a separate cash book for petty cash
transactions.

4.2.3.Subsidiary Books and their importance:

Journal is book of the original entry. In the modern day business world, the number and volume of
transactions being high, it is not possible to pass every transaction through the journals. Hence, it
became necessary to evolve certain journals-cum-ledgers in which the voluminous transactions
of identical nature are passed. These are called special journals. They are also called subsidiary
books because they satisfy the requirements of Journal and Ledger. Those transactions, which
cannot be classified in any of these subsidiary books can be entered in Journal Proper.

Important Subsidiary Books are Cash Book, Purchases Book, Sales Book, Purchases Returns
Book, Sales Returns Book, Bills receivable Book and Bills Payable Book

Objectives of preparing the subsidiaries::


1. It facilitates division of work; 2. Internal checking system is strengthened. 3. Permits the use of
special skills—eg. Cash book is written by an expert in cash transactions; 4. It saves time and
energy in journalizing and ledger posting of innumerable entries; 5. The figures of Sales,
Purchases, Returns, Cash Balance, Bank balance can be easily obtained by looking to the
subsidiary books; 6. They serve as documents evidencing transactions and even when necessary
by competent authorities (courts, tax authorities can scrutinise the respective subsidiary book)
-25-
4.2.4. Trial Balance:

Trial Balance is a statement as on a particular day reflecting either the balances of various ledger
accounts or the totals of such accounts. It shows debit and credit balances in a columnar form.
The total of debit and credit should tally. However, a trial balance is a trial as there is no
guarantee that once the trial balance tallies, the balances of all the accounts are correct.

The Trial balance is prepared a) to ascertain the arithmetical accuracy, b) to help in locating
errors and c) to facilitate in the preparation of the final accounts.

The Trial balance may not disclose the following errors: a) Error of Principle; b) Compensating
Errors; c) Error of Complete Omission; d) Error of recording in the books of original entry and e)
Posting a correct amount in the wrong account but on the correct side.

Sometimes, trial balance does not tally. Some errors affect the trial balance. A thorough scrutiny
becomes necessary. Though it may not be possible to check all the entries passed during the
accounting period, there are certain steps to locate the errors. When the errors are spotted check
the concerned entry/account thoroughly.

Steps to be taken when the trial balance does not tally


1. Check the totals of both sides of the Trial Balance;
2. Apply trial and error techniques—ie., sample checking of some entries which indicate the
entries of amount equivalent to the value of difference, double the difference or 50% of the
difference. Check those entries thoroughly. These may happen on account of posting the original
entries on the wrong side of the accounts;
3. Check each and every entry of the trial balance with reference to the closing balances as
shown in the various ledger accounts. This is to ensure that the correct amounts are mentioned in
the trial balance;
4. Check the totals of sundry debtors and sundry creditors are correct with reference to the
personal accounts maintained in the ledger;
5. Check whether the cash and bank balances have been correctly ascertained. Whether
overdraft balances are properly taken in the trial balance;
6. Check whether the opening entries of all the ledger entries have been properly brought down;
7.Check the balancing of all the accounts as to their arithmetical accuracy;
8.Check the postings in the original ledger accounts;
9.Check the casting and carry forward of books of original entry;
10. Check the omissions and commissions;
11) Check the revenue and capital items to ensure that they are not interchanged;
12. Sometimes two wrong entries may compensate. In such cases, a thorough scrutiny is
necessary.

The trial balance can be prepared as on any date by arriving at the balance in various ledger
accounts. However, generally preparation of trial balance is a preparatory step to preparation of
final accounts. It is therefore necessary for us to find out the balance in the various accounts and
subsidiaries and how the entries are made.

Accounting or Book-keeping is both an art and a science. There are cardinal principles, which are
generally applied in all types of organizations right from a small concern right to the topmost
multinational companies. An accountant and his team will effectively complete an accounting
cycle and provide all the relevant information to all the users through proper accounting records.
-26-
4.3. Rectification of Entries: There is bound to be errors in accounting entries as human
beings make them. Errors can be rectified as soon as they are located. Errors are located as and
when the accounting supervisors are checking the entries for the transactions or it may escape
their attention. Errors may be traced at the time of preparing the Trial Balance or after preparing
the Trial Balance. Sometimes errors are being traced after the final accounts are prepared.

The type of rectification entries depends on the time of location of errors and the type of errors
committed.

Errors may be of the following types:


Error of Omission—Partial Omission or Complete omission
Error of Commission—Error of Casting, Error in carrying forward, Error in totaling or balancing of
an account, Error in Posting (other than to a wrong head of account in the correct side), Entering
on the wrong side of trial balance and wrong totaling of the trial balance.
Error of Principle—posting revenue expenses to capital accounts & vice versa, wrong entries in
different categories of accounts etc.
Compensating Errors

Suspense Account: A Suspense account is an account in which the amount of difference in the
trial balance is put till such time the errors are located and rectified.

CHAPTER V: COST AND MANAGEMENT ACCOUNTING


FUNDAMENTALS

11.1. Intro: Cost Accounting aims at ascertainment of costs and at analysis of savings. It is the
application of accounting, costing techniques, methods, and principles. It concerns with the
comparison of costs with previous figures or with standards. It helps in interpretation of
management problems.

Cost Accounting is concerned with a product, service or an operation. Actual cost incurred with
reference to future cost estimation is compared. Hence, Cost Accounting is applicable in Banks
and the service sector organizations as well. Cost Accounting can be for specific product,
identified departments etc. Cost Accounting by itself is a management information system

11.2 Benefits of Cost Accounting to the management of an organization:


a) Analysis of the profitability of individual products, service, departments can be possible and
steps can be taken for improvement
b) Analysis of the cost behaviour which may point out to the corrections of some items of
expenditure
c) Establishment of Cost centers and Profit Centres is possible, which in turn may help increasing
profitability per unit or for turning around.
d) Pricing Policy can be structured to cover costs and reasonable levels of profits
e) The functioning of a department—increase or decrease in production for whatever reason is
reflected.
f) Cost records help in analyzing the final accounts like Manufacturing Account, Trading and P &
L Account such that the sources of profit/loss can be established
g) Cost records serve as the base for the management information system
h) It helps interdepartmental, with adequate comparison
i) It helps in setting up standards in tune with the general industry performance.
-27-
11.3. Comparison between Cost Accounting and Financial Accounting

Cost Accounting Financial Accounting


1. An internal reporting system for the 1. An external reporting system whereby all
management decision making those interested in the system comes to
know about the organisation
2. Emphasises on functions, activities, 2. Aims at presenting “true and fair” view of
product, process, planning and control the overall results
3. Concerned with Short term planning and its 3. Financial period is generally longer and
reporting period is shorter follows established concepts, principles,
accounting standards and legal requirements
4. Not only deals with historical data but also 4. Historical in nature and reporting is wide
futuristic in approach.
5. Cost Accounting system cannot be 5. Concerned about the type of transaction.
established without a proper financial system.

11.4. Cost Concepts:


--Product and Period Costs
--Common and Joint Costs
--Short Run and Long Run Costs
--Past and Future Costs
--Controllable and Non-controllable costs
--Replacement and historical costs
--Imputed and Sunk Costs
--Relevant and Irrelevant Costs
--Opportunity and Incremental Cost
--Conversion Csot
--Committed cost
--Marginal Cost and Notional Cost

11.5.Classification of Costs:
Financial---Cash Cost Versus Non Cash Cost
Non-Financial Costs

Element-wise
Direct Costs and Indirect Costs

Functional Costs
Production Cost, Administration Costs, Selling & Distribution Cost and R & D Costs

Behavioural Costs: Fixed Cost, Variable Cost, Semi-variable Cost.


-28-
11.6. Management Accounting: Management Accounting is the process of identification,
measurement, accumulation, analysis, interpretation and communication of both financial and
operating used by management to plan, evaluate, and control within an organization and also to
fix up accountability for its resources.

It is a system of collection and presentation of relevant economic information of an enterprise for


planning, controlling and decision making.

The information provided by the management accountants shall facilitate the following purposes:
a) Policy formulation; b) Planning and Control functions of management; c) decision
making/taking –deciding on alternate courses of action; d) disclosure to internal and external
stake holders; e) safeguarding the assets; In short, the management accounting helps the
enterprise draw out long term plans and also short term plans and decide about the budget
allocation and operation plans

11.7. Scope of Management Accounting: Management accounting includes Financial


Accounting and extends itself to a system of cost and financial management. Besides
conventional financial accounts, it establishes better methods of internal control.

The scope of management, therefore, lies in the following activities


a) Establishing and strengthening the systems relating to cost accounting, tax accounting and
management information
b) Compilation and preservation of data required for management planning
c) Ensuring proper means of communication to the various levels of the enterprise including
feedback
d) Assess and analyse the deviations from the expected plans
e) Analysis and interpretation of accounting information to make it understandable to the
management.
f) Providing alternative proposals on the profits and position of the enterprise
g) Providing methods and techniques for evaluation of the performance of the organization with
reference to the objectives (MBO)
h) Improving and sharpening existing techniques of analysis.

Management Accounting serves as a technique for evaluating the performance of management


itself.

11.8. Functions of Management Accounting:


a) Periodic Internal Accounting Reports
b) Analysis of data for decision making

The management accountants shall involve themselves in the areas of decision making and
problem solving particularly in the following areas:
a) Strategic Management Accounting; b) Investment Appraisals; c) Financial Management; d)
Short-term and Ad-hoc decision and e) managing the management information systems
-29-
11.9. Comparison between Management Accounting and Financial
Accounting

Management Accounting Financial Accounting


Studies various divisions and sub-divisions of Studies the enterprise as a whole
an enterprise
Reports to the management on details of Reports results to all those other than the
operational costs, inventories, products, management. Hence, there is a possibility of
processes and jobs. window dressing
Analyses business events as and when they Mainly Historical
take place i.e, Running
The historical data of financial data provides Reflects the possible future based on the
inputs giving rapidity to the management past information. At best it could be an
accounting practices. estimate
Periodicity is shorter—weekly, fortnightly etc The periodicity is wider--quarterly, half yearly
or yearly
Based on independent judgement of Based on Generally Accepted Principles
management accountants
Management Accounting provides both Consists of Monetary information only
Monetary and non-monetary informations

11.10. Comparison between Management Accounting and Cost Accounting

Management Accounting Cost Accounting


Impact of Costs Ascertainment of Costs
Derived from cost and financial accounting Serves as a base for tools and techniques of
management
Wider perspective as cost data are used for Confined to analysis of costs
decision making and problem solving
Management Accounting is placed at a higher Cost Accounting is placed in a lower level of
level of management management
Management accounting uses cost data along Cost accounting is narrower
with economic and statistical data
Management Accounting in addition to using Cost accounting uses techniques like
cost accounting techniques, uses funds flow, marginal costing, break even analysis,
cash flow and ratio analysis budgetary control, standard costing etc
Management Accounting includes Cost Cost Accounting has nothing to do with
Accounting and Financial Accounting financial accounting
Management Accounting in addition to Cost Accounting assists the management but
assisting management provides for does not evaluate management
evaluation and performance of management
Management Accounting is futuristic Cost Accounting is historical
Management Accounting cannot be installed Cost Accounting can be installed
without cost accounting independently
-30-
CHAPTER VI: TERMINOLOGIES USED IN ACCOUNTANCY and
ACCOUNTING CONCEPTS
Every subject of study involves certain words phrases, which are used in a special sense. So is
the case with accountancy. We have given the terminologies used in accountancy and
accounting concepts at one place. This enables the reader to get at one place the meaning of the
words or phrases and serves as an immediate reference.

Transaction: Transaction means movement of money or money’s worth

Recording: Recording of identified and measured financial transactions

Classification: Accounts are classified into PERSONAL and IMPERSONAL. IMPERSONAL


ACCOUNTS are again classified into Real and Nominal Accounts.

Personal Accounts: Accounts relating to natural persons, artificial persons and representative
persons

Real Accounts: Accounts relating to Tangible or intangible real assets

Nominal Accounts: Accounts relating to income, expenses, losses and gains.

Accounting Cycle: Journalising, Posting the Ledgers, Balancing, Preparing Trial Balance, Income
Statement and Position Statement (Balance Sheet)

Advanced accounting functions are analysis, interpretation, communication and decision making.

Users of accounting information: Proprietor, Partner, Shareholders, Directors, Investors,


Creditors, Employee-groups, Government (incl. tax authorities) and the General Public

Branches of Accounting: Financial Accounting, Cost Accounting, Management Accounting and


Social Responsibility Accounting

Limitations of Accounting: Does not recognise qualitative elements; Not free from bias; Estimates
and not real positions; Ignores changes in the prices; Danger of manipulations and window
dressing

Entity: Owner is different from the business for accounting purposes

Voucher: Document evidencing a transaction

Entry: A record made in the books of account

Assets: Assets refer to tangible or intangible assets, which are the uses of the funds in the
business. These assets are in the form of Fixed Assets (Permanent Assets), Current Assets,
Investments, Miscellaneous Assets and Intangible Assets

Liabilities: Liabilities means financial obligations of the business unit to others. Capital is a liability
to the owners because the business owes that amount to the owner. However owner takes the
risk of loss which he has to set off. Again, this depends on the constitution of the business.

Capital: Capital is the excess of assets over external liabilities.


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Drawings: The owner of the business (proprietor or partner) cannot afford to wait indefinitely. So,
in anticipation of profits, they draw a certain sum of money, take some assets or utilise some of
the business purchases for personal purposes. This is called Drawings. Sometimes, interest is
charged on the amount of drawings. Drawings are shown in the accounts as a deduction from the
capital.

Inventory: Stock of goods may be in the form of raw materials, semi-finished goods (work in
progress or work in process) and finished goods. The quantity and/or value is known as
inventory.

Debtors:The persons who owe amounts to a business unit. When the goods are sold on credit,
the purchaser owes the amount to the business, in which case he is called Trade Debtor. Trade
Debtors, Sundry Debtors, Book Debts are different names for this item.

Creditors: The persons to whom the business unit owe amounts. When the goods are purchased
on credit, the business owes the amount to the seller, in which case he is called Trade Creditor.
Trade Creditor, Sundry Creditors are the other names for this item.

Capital and Revenue Items: Permanent items are called Capital items and recurring items and
items where the period is generally an year are called Revenue items. There are both debits and
credits in both the items. Sometimes, large revenue items are deferred to be absorbed in future.

Net Profit: Net profit is the excess of revenue over expenses. If expenses exceed the revenue it is
Net loss.

Retained Profits: IN a business a portion of profits is transferred to Reserves to offset future


exigencies or for meeting specific needs. This is called Retained profits.

Carriage Inwards & Carriage Outwards: The expenses on transportation for goods purchased
(raw-materials or finished goods) is called Carriage Inwards which adds to the cost of the goods
and is debited to Manufacturing/Trading Account. The transportation expenses incurred on
outgoing goods (sales) is called Carriage Outwards which find a place in P & L Account.

Cartage Inwards & Cartage Outwards: If the transportation is by way of a cart, it is called Cartage
charges. Same treatment in Mfg/Trading & P & L A/c

Freight: The charges for transportation of goods through transporters is called Freight. Freight
can be paid by the seller or by the buyer. Freight Inwards is debited to Mfg / Trading Account and
Freight Outwards is debited to P & L Account.

Apprentice Premium received. If the company / business receives the premium from the
apprentice pupils joining the company is a business income and credited to P & L Account.

Discounts allowed and received: Discount allowed is a expenditure and discount earned is an
income.

Depreciation: A non-cash provision for depreciation in the value of the various assets used in the
business. Whatever be the cause of depreciation, an amount is debited to P & L A/c as
depreciation as per the policy of the business and shown as a deduction from the value of the
asset concerned.

Trade Expenses: Just because the word Trade is there, it should not be debited to Trading
Account. Trade expenses are debited to P & L Account.
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Bad Debts, Doubtful Debts, Discount on Debtors and Creditors: Debtors means the amount due
from others. Generally this is on account of sales. There is a business risk. A part of the amount
which cannot be recovered is called BAD DEBTS. A part of the amount may be doubtful of
recovery but may come. They are called DOUBTFUL DEBTS. P & L Account shall provide for all
such possible losses. Besides, there are some debtors who pay the money in advance or before
the due dates agreed to. In such cases, a discount may be offered for prompt/advance payment.
It is called DISCOUNT ON DEBTORS. A provision for this is also made. All the above are debited
to the P & L Account and are deducted from the value of the Debtors in the Assets side of the
Balance sheet. Similarly a discount may also be received from our creditors,which is an income
for us.

Embezzlement: When the employee misuses, misappropriates or commits fraud, it is called


embezzlement of funds. This is a loss caused on account of honesty/integrity of the workers in
the business and should be treated as a loss. So, it is debited to P & L Account.

Goodwill, Trade Marks, Copyrights, Patents, Intellectual Property Rights (IPRs) are all intangible
assets.

Outstanding Expenses/Charges. When we prepare the final accounts, we have to account for all
expenses till the last date of the accounting period whether paid or not. The outstanding
expenses are added to the concerned head of account in the P & L account and also shown as a
liability in the Balance Sheet.

Outstanding Income: This is added to the concerned head of account and shown as an asset in
the Balance Sheet.

Prepaid Expenses: Some expenses are paid in advance. These are deducted from the concerned
head of expenses in the P & L Account and shown as an Asset in the Balance Sheet.

Abnormal loss of stock: (flood, fire or any reason). It is shown as a credit in the
Manufacturing/Trading loss and the insurance claim is made. Insurance company will admit the
claim or reject the claim for a value. If the actual value of loss is more than the claim admitted the
difference is a loss, which has to be accounted in the P & L Account. If the full value is admitted
as a claim, then besides showing a credit in the Manufacturing/Trading account, it is shown on
the Assets side of the Balance Sheet.

The going concern assumption allows the accountant to classify the expenditure and receipts as
Capital Expenditure, Revenue Expenditure, Deferred Revenue Expenditure, Capital Receipts and
Revenue Receipts.

Capital expenditure is that expenditure which is incurred for permanent investment in the
business in the form of plant & machinery, land & building, Furniture & Fixtures or for expansion,
modernization or technology upgradation or replacement.

Revenue Expenditure is that expenditure which is incurred for maintaining productivity of the
business or for earning capacity of the business. This includes Office and Administration
expenses, Selling and distribution Expenses, and Non-operating Expenses and Losses.

Deferred Revenue Expenditure is that expenditure which yields benefits which extend beyond a
current accounting period but the amount of expenditure is fairly big to absorb in the current
accounting period. Expenses such as Advertising, Campaigning, Research and Development and
all other amortizations fall in this category.
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Capital Receipts and Revenue Receipts. Though no clear-cut formula for distinction could be
found, receipts in the form of sale of fixed asset, amount of loan received capital contributed by
the proprietor/partner/owner are all capital receipts. Revenue receipts are sales, revenue from
services rendered in the normal course of business, interests, rents, royalty etc. However, the
proceeds of sale of a car is a revenue receipt for one who is dealing in sale of cars as a
commodity whereas the same is treated as a capital receipt for other businesses.

All expenditure incurred till erection, installation and normal functioning of machinery etc is a
capital expenditure.

Interest on Capital: Sometimes interest is allowed on the capital contributed by the proprietor or
partner/s. This is an item of business expenditure and debited to P & L account.

ACCRUALS: Costs that were incurred although not paid during a particular period.

ACID TEST: A measure of a firm’s liquidity using the formula—Realisable Current Assets MINUS
Current Liabilities (also called Quick Ratio)

RATE OF RETURN: Percentage of gain from the annual Income in relation to total Capital
Investment.

CAPITAL BUDGETING: An exercise by which funds are allocated for particular projects/uses.

CAPITAL GAIN: Profit earned by selling long or short term assets.

CASH FLOW: Inflow and outflow of Cash items in the operations of cash nature.

CAPITAL RESERVES: Reserves, which are not available for distribution as dividends as they
have not arisen out of trading operations. Eg. Surplus on account of revaluation of assets.

CURRENT ASSETS: Resources that are readily convertible to cash within a year.

CURRENT LIABILITIES: Debts that are expected to be paid within a year.

CURRENT RATIO: Measure of Liquidity—CA/CL

GOODWILL: The premium recorded on the books of the company as an intangible asset
whenever payment for any assets exceeds its book value.

NET SALES: Sales less of rebate, discount, excise duty and cess.

N A T: Net after tax.

TANGIBLE NETWORTH: Total share holder’s equity.(Total equity minus intangible assets).

RETAINED EARNINGS: That portion of annual income after tax less dividend that is held
cumulatively and is part of common stock holder’s equity.

REDEMPTION: Use of funds for repayment of specific liabilities.

SINKING FUND: Annual sum set apart from income after tax for the purpose of redeeming any
bonds or preferred stock.
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SOURCES OF FUNDS: Decrease in Assets, Increase in Liability and equity.

WORKING CAPITAL: Current Assets minus current Liabilities.

AMORTISATION: Making provision for periodic retirement of long term debts.

Accounting Concepts:

Business Entity Concept Money Measurement Concept:


Accounting Period concept Accrual Concept
Realisation Concept Gong Concern
Historical Cost Matching Concept
Conservatism (Prudential norms)

Accounting Policies:
Depreciation, Depletion and Amortisation; Treatment of preliminary expenditure
Conversions of foreign currency items; Valuation of Inventory
Treatment of goodwill; Valuation of Investment
Treatment of retirement benefits; Recognition of profits on ongoing projects
Valuation of fixed assets Treatment and provision for contingent liabilities
Capital Adequacy on an on going basis keeping in mind the business risks

ACCOUNTING EQUATIONS:
Resources = Sources of finance
Assets = Capital + Liabilities
Capital =Assets - External Liabilities

Sources of Funds:

Capital -- Own capital and borrowed capital


Reserves and Surplus--Retained profits of a business
Borrowed Capital: Short term or Long term Loans from family/friends, loans from outsiders
including banks and financial institutions.
Creditors:
Bills Payable:(including outstanding expenses)
Deposits of money by subsidiaries/ancillaries

Application of funds: Use of Funds- Increase in Assets,


-Decrease in Liabilities,
-Decrease in Stock holder’s equity.

Uses of Funds or Application of funds

Fixed or Long Term Assets--Land and Building, Plant and Machinery,


Goodwill
Current Assets: Cash and Bank balances, Stock in Trade, Bills Receivable, Sundry Debtors
Investments--in government and non-government securities
Miscellaneous Assets--Prepaid Expenses, Income due but not received
Intangible Assets--Goodwill, Patents, Trade Marks, Copyrights, Intellectual Property rights,
Carried forward losses