UNIT – I

Section- A

1) Closing capital + Drawings - Opening capital =

a) Profit & Loss

b) Additional Capital

c) Opening debtors

d) Closing debtors

Ans: a

2) Double entry system means

a) Entry in two Books

b) Entry in account Books

c) Entry for two aspects of the transaction

d) Entry in two accounts books

Ans: c

3) Journal proper is used to record

a) All cash & Credit transactions

b) Cash & Credit sales

c) Cash & Credit purchases

d) Adjusting & Closing entries

Ans: a

4) A List of all the balances standing in the ledger account of a concern at any given data are shown in

a) Debtors statement

b) Balance sheet

c) Trial balance

d) Capital

Ans: c

5) An example of personal account is

a) Bank account

b) Machinery account

c) Wages account

d) None of the above

Ans: a

6) Bank account is a

a) Real account

b) Personal account

c) Nominal account

d) Impersonal account

Ans: b

7) Capital account is

a) An assets

b) Liability

c) An expenses

d) None of the above

Ans: a

8) Bills Receivable is a

a) Current asset

b) Current Liability

c) Fixed assets

d) Fixed Liability

Ans: b

9) Cash book is a

a) Ledger account

b) Subsidiary Journal & Ledger account

c) Subsidiary Journal

d) All the above

Ans: d

10) The total figure of purchase book will given

a) Total purchase

b) Total cash purchase

c) Total credit purchase

d) Cash & Credit purchase

Ans: d

Section - B

1. Define accounting. What are the objectives of accounting?

Definition of Accounting:

The American Accounting Association defined accounting as:

“It is the process of identifying, measuring, recording and communicating the required

information relating to the economic events of an organisation to the interested users of such

information.

Objectives of Accounting: 

The following are the main objectives of accounting

To keep systematic records: Accounting is done to keep a systematic record of financial

transactions. In the absence of accounting there would have been terrific on human memory

which in most cases would have been impossible to bear.

To protect business properties: - Accounting provides protection to business properties form

unjustified and unwarranted use. This is possible on account of accounting supplying the

following information to the manager or the proprietor.

The amount of the proprietor’s funds invested in the business.

How much the business has to pay to others?

How much the business has to recover from others?

How much the business has in the form of (a) fixed assets, (b) cash in hand, (c) cash at bank, (d)

stock of raw materials, work in progress and finished goods?

Information about the above matters helps the proprietor in assuring that the funds of the

business are not necessarily kept idle or underutilized.

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

earned or loss suffered on account of carrying the business. This is done by keeping a proper

record of revenues and expense of a particular period. The profit and Loss accounts is prepared

at the end of a period and if the amount of revenue for the period is more that the expenditure

incurred in earning that revenue, there is said to be a profit. In case the expenditure exceeds the

revenue, there is said to be a loss.

To ascertain the financial position of the business: The profit and Loss account gives the

amount of profit or loss made by the business during a particular period. However, it is not

enough. The business man must know about his financial position i.e. where he stands? What he

owes and what he owns? This objective is served by the Balance Sheet or position Statements.

The Balance Sheet is a statement of assets and liabilities of the business on a particular date. It

serves as barometer for ascertaining the financial health of the business.

To facilitate 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

levels of authority in order to facilitate rational decision making . The American Accounting has

also stressed this point while defining the terms accounting when is says that accounting is the

process of identifying, measuring and communicating economic information to permit informed

judgments and decisions by users of the information. Of course, this is by no means as easy task.

However, the accounting bodies all over the world and particularly the International Accounting

Standards Committee have been trying to grapple with this problem and have achieved success

in laying down some basic postulates on the basis of which the accounting statements have to be

prepared.

Information system: Accounting functions as an information system for collecting and

communicating economic information about the business enterprise. This information helps the

managements is taking appropriate decisions. This function, as sated, is gaining tremendous

importance these days.

Or Equity (Proprietor Fund) = Assets – Liabilities

The whole accounting procedure is based on this equation.

2. Brief explains the methods of accounting.

Basically all methods of accounting are classified under two headings:

Single Entry System of Book Keeping

Double Entry System of Book keeping

Single Entry System of Book Keeping:

This system of recording transactions is unscientific. Trial balance cannot be prepared and hence

accuracy of books cannot be ascertained since all accounts are not kept. It is impossible to

prepare Profit and Loss Account and Balance Sheet from the books of single entry. Under such

condition the profit can be ascertained by valuing the assets and liabilities at the end of each

accounting period.

Double Entry System of Book keeping:

This system was invented by an Italian named LUCO PACIOLI in 1494 A.D. According to this

system, every transaction has got a twofold aspect. One is Benefit Receiving Aspect or

Incoming aspect and the other one, Benefit giving Aspect or Outgoing aspect. The benefit

receiving aspect is said to be a Debit and the benefit giving aspect is said to be a Credit. For

every transaction one account is to be debited and another account is to be credited in order to

have a complete record of the same. Therefore every transaction affects two accounts in

opposite direction.

3. State the rules of making entries under double entry system.

RULES OF THE DOUBLE ENTRY SYSTEM:

Double entry system recognizes that every transaction has two aspects and it records both

the aspects of a transaction. Technically speaking, it can be said that every transaction involves

two accounts out of which one account is debited and the other is credited with the same amount.

As the accounts have been classified under three categories viz., Personal, Real and nominal,

there are three rules of debit and credit for recording transactions. These rules are as follows:

1. Rule for Personal Accounts: Whenever a personal account is involved in a transaction, that

person either receives some benefit from the business or gives some benefit to the business.

Thus, the rule is:

Debit the Receiver of the benefit, Credit the Giver of the benefit.

For example, if cash is paid to Sohan is the receiver of cash and his account shall be

debited. In the same manner if goods and thus his account shall be credited.

2. Rule for Real Accounts: Whenever a real account is involved in a transaction, that thing

either comes into the business or goes out of the business. This rule for real accounts is:

Debit What Comes In

Credit What Goes Out

For example, if furniture is purchased for cash, the two accounts involved in the

transaction are Furniture A/c and Cash A/c; Furniture comes into the business and cash goes out

of the business. Hence, Furniture A/c should be debited and Cash A/c should be credited.

3. Rule For Nominal Account: Nominal accounts are related to either expenses and losses or

incomes, gains and profits. Thus, the rule for nominal accounts is:

Debit All Expenses And Losses

Credit All Incomes, Gains or Profits.

For example, when rent is paid, Rent A/c should be debited as it is an expenses for the

business. Similarly, if interest is received, Interest A/c should be credited since it is an income.

4. Explain the meaning of “Journal “and prepare format.

Journal is a book of original or prime entry where transactions are recording in the order in

which they occur, i.e., in chronological order. It is the basic book of accounting in which all

business transactions are recorded at the first instance and that is why it is called the book of

original entry. Journal is called the book of prime entry or the primary book of accounts because

after recording the transaction in the journal it is finally posted in the ledger, called the book of

final entry.

The process of recording or entering a transaction in the journal is called Journalising

and the record of each transaction in the journal is called Journal Entry.

Every page of Journal has the following format. It is a columnar book. Each column is given a

name written on its top. Format of journal is given below:

Journal Format

DATE PARTICULARS LEDGER FOLIODr. Amount

(Rs.)

Cr. Amount

(Rs.)

(1) (2) (3) (4) (5)

5) Prepare journal entries for the following transactions.

6. What is “Ledger”? How the accounts written in the ledger?

LEDGER:

All the accounts identified on the basis of transactions recorded in different journals/books such

as Cash Book, Purchase Book, Sales Book etc. will be opened and maintained in a separate book

called Ledger. So a ledger is a book of account; in which all types of accounts relating to assets,

liabilities, capital, expenses and revenues are maintained. It is a complete set of accounts of a

business enterprise.

Ledger is bound book with pages consecutively numbered. It may also be a bundle of sheets.

Thus, from the various journals/Books of a business enterprise, all transactions recorded

throughout the accounting year are placed in relevant accounts in the ledger through the process

of posting of transactions in the ledger. Thus, posting is the process of transfer of entries from

Journal/Special Journal Books to ledger.

POSTING OF JOURNAL PROPER INTO LEDGER

You know that the purpose of opening an account in the ledger is to bring all related items of this

account which might have been recorded in different books of accounts on different dates at one

place. The process involved in this exercise is called posting in the ledger. This procedure is

adopted for each account.

To take the items from the journal to the relevant account in the ledger is called posting of

journal. Following procedure is followed for posting of journal to ledger :

1. Identify both the accounts ‘debit’ and credit of the journal entry. Open the two accounts in the

ledger.

2. Post the item in the first account by writing date in the date column, name of the account to be

credited in the particulars column and the amount in the amount column of the ‘debit’ side of the

account.

3. Write the page number of the journal from which the item is taken to the ledger in Folio

column and write the page number of the ledger from which account is written in L.F. column of

the journal.

4. Now take the second Account and give the similar treatment. Write the date in the ‘date’

column, name of the account in the ‘amount’ column of the account on its credit side in the

ledger.

5. Write page number of journal in the ‘folio’ column of the ledger and page number of the

ledger in the ‘LF’ of column of the journal.

Section – C

1. Distinguish between Book keeping and accounting.

Basis ofDifference Book-keeping Accounting

Nature

It is concerned with identifyingfinancial transactions; measuring them in monetary terms; recording and classifying them.

It is concerned with summarizing the recorded transactions, interpreting them and communicating the results.

ObjectiveIt is to maintain systematic records of financial transactions.

It aims at ascertaining business income and financial position by maintaining records of businessTransactions.

FunctionIt is to record business transactions.So its scope is limited.

It is the recoding, classifying,Summarizing, interpreting business transactions and communicating the results. Thus its scope is quite wide.

Basis

Vouchers and other supportingDocuments are necessary as evidence to record the business transactions.

Book-keeping works as the basis for accounting information.

Level ofKnowledge

It is enough to have elementary Knowledge of accounting to do bookkeeping.

For accounting, advanced and in depth knowledge and understanding Is required.

RelationBook-keeping is the first step

Accounting begins where bookkeeping ends.

to accounting.

Posting Classification and ledger posting are next stages of book-keeping.

It is again not a part of accounting.

Conclusion-Finalisation of Accounts

It is not a part of book-keeping.

Preparation of Profit & Loss a/c and Balance Sheet.

Rectification and Adjustments

Errors and omissions are not corrected.

These are corrected under accounting process.

2. Explain various accounting concepts briefly.

Accounting Concepts

 The Random House dictionary defines ‘concept’ as a general notion or idea; Kohler has

however defined the term as : A series of axioms or assumptions constituting the supposed basis

of a system of thought or an organized field of an Endeavour.

Accountants have developed various accounting concepts. These concepts are systematically

followed in western countries, especially in United States of America. The Association of

certified public accountants in the U.S.A. has suggested 14 accounting concepts while according

to Prof. R.N. Anthony some of these concepts are controversial. He assumed 10

accounting concepts as important. Most of the authors agree on these 10 concepts. Accounting is

a developing science and the number of accounting concepts cannot be fixed for ever. With

emerging social changes and research in accounting accepted accounting concepts may be given

as under:

A few of generally accepted accounted accounting concepts may be given as under:

THE ENTITY CONCEPT;

MONEY MEASUREMENT CONCEPT;

THE GOING CONCERN CONCEPT;

THE COST CONCEPT;

THE DUAL-ASPECT CONCEPT;

THE ACCRUAL CONCEPT;

THE REALISATION CONCEPT;

ACCOUNTING PERIOD CONCEPT;

MATCHING CONCEPT;

BALANCE SHEET EQUATION CONCEPT.

A detailed discussion of these concepts is undertaken as follows:

 1.    The Entity Concept: For accounting purposes, each business enterprise is considered as  an

accounting unit independent of its owners. According to this concept, the business and

businessman are two separate and distinct entities. The business entity is considered to own the

assets and liable for the liabilities to outsiders, including the claims or capital of the proprietors.

In this connection Rolland has remarked that “In one sense capital itself is regarded as  a

liability, the amount due from the business to its proprietors.

The accounting entity is not necessarily a separate legal entity. For example, a sole trader

or partner cannot legally separate his business affairs from his personal assets. It is only in the

corporate form (limited company) of business organization that the business enterprise is treated

as a separate legal entity distinct from its owners. In accounting, however, every type of business

organization, is it sole trader ship or partnership, it treated as a separate accounting entity. The

entity concept, therefore, establishes a clear distinction between the owners and the business.

Precisely the business entity concept defines the range and boundaries of the accountant’s

activity and limits the number of transactions that are to be included in the records of an

enterprise.

2.    Money Measurement Concept: In accounting, only those facts, events and transactions are

recorded and reported that can be expressed in terms of money. Since money is a common

measuring unit or common denominator, it makes possible to record and compare dissimilar

facts, events and transactions about a business.

3.    The Going Concern Concept: This concept assumes that the business entity will continue

to exist indefinitely; it will not be dissolved in near future. Continuity of activity is true of all

business organization. The business entities are, therefore, treated as going concerns. The ‘going

concern’ concept does not imply that accounting assumes permanent or immortal existence; it

simply presumes stability and continuity for a period of time sufficient to carry out present plans,

contracts and commitments. This concept has important implications for accounting procedures.

 

4.    The Cost Concept: The cost is the monetary price paid for the acquisition of assets for the

business enterprise. Cost concept implies that an asset is recorded in the account books at a price

paid to acquire it. The original or acquisition cost relates to past and, therefore, it is referred to as

historical cost. It is the basis for the valuation of the assets in the financial statements. Further,

example suppose that a building was purchased in the year 2007 at a cost price of Rs. 5, 00,000.

In the year 2007 and afterwards this asset will be shown in the balance sheet at a cost price of Rs.

5, 00,000 less depreciation.

The effect of cost concept seems to be irrelevant when the price of the asset goes on

increasing in the market. In such a case, the balance sheet does not exhibit a true financial

position of the business. It has, therefore, become a matter of dispute among the accountants as

to whether the assets should be shown in the balance sheet at historical cost or at current cost.

But the majority of the accountants are in favour of disclosing the assets in the balance sheet at

historical cost because it is very difficult to ascertain the current cost of the technology has not

developed considerably and it is difficult to ascertain the current cost of the ancient machines. If

the current cost is ascertained on the basis of price index, there are many difficulties in  getting

the relevant price index.

It is still a matter of controversy as to whether the current cost be ascertained on the basis

of price index of the country or the companies should prepare their price index for each asset

separately. In view of these difficulties, the majority of the accountants still feel that the assets

should be valued on historical cost price basis and the cost concept implies this aspect.

5.    The Dual-aspect Concept:  This concept is based on double entry system of book-keeping

which means that a record of each transaction is made in two separate accounts – Once on the

debit side of an account and second time on the credit side of another account. For example,

suppose a proprietor has introduced Rs.1,00,000 in the business. This transaction will increase

Rs.1,00,000 in cash on the assets side and will also increase Rs.1,00,000 in the capital account on

the liabilities side. In another example, it is assumed that the business had purchased goods

worth Rs.5,00,000 on credit, this transaction will increase Rs.5,00,000 in the stock on the assets

side and will also increase Rs.5,00,000 in creditors on the liabilities side. Thus, it is clear that an

increase on the liabilities side of the balance sheet. Therefore, balance sheet is just like a scale

and if weight is increased or decreased on one side, the same must be added to or removed from

the other side. This is the essence of the dual-aspect concept.

6.    The Accrual Concept: The accrual concept is concerned with the period in which the

revenues and expenses are to be related. In other words once the revenue is realized the next step

is to allocate it among the accounting periods if necessary and this is achieved with the help of

accrual concept which also relates expenses to revenue for a given accounting period. It is true to

say that matching concept finds its true expression in accrual basis.

7.    The Realisation Concept: The important aspect of the realization concept is to determine

the point of time at which the revenue is to be recognized and this is referred to as timing of

revenue recognition. For example, suppose an order was received from a customer in January,

2007 the goods were manufactured as per this order in February, 2007; and the delivery of goods

was made in March, 2007; the payment of which was received in April, 2007. According to

realization concept the revenue from this sale would be deemed to accrue in March, 2007, when

the possession and title of the goods were transferred to the customer, though its payment was

received in April, 2007.

8.    The Accounting Period Concept:  It is assumed that a business will be carried on for an

indefinite period. It is, therefore, necessary to divide this indefinite period into different

accounting periods for one year which is known as accounting year or financial year of the

business. The revenues and expenses for this year are matched and a profit or loss account it

prepared for that year which shows the net profit or net loss for that period. A balance sheet is

also prepared at the end of the accounting period which discloses the financial position of the

business on a particular date. Thus, the accounting period concept implies the period for which

the entries are make in accounting record and at the end of which the account books are closed

and financial statements prepared.

9.    The Matching Concept: The matching concept is based on the principle that the expenses

for a particular accounting period should be matched with the revenues for that period only. Such

matching of expenses with the revenues is described as matching concept. On the basis of this

concept, the outstanding expenses at the end of the year are matched with the revenues, while the

prepaid expenses are not matched.

The following difficulties arise while matching expenses with revenues :

There are some expenses which cannot be matched with the revenues of a particular accounting

period. For example, preliminary expenses, expenses relating to issue of shares and debentures,

advertisement expenses are of this nature.

Similarly, it is not easily ascertainable as to how much amount should be charge as depreciation

on particulars fixed asset.

The same difficulty arises in relation to long-term contracts.

 10.  Balance Sheet Equation Concept: The balance sheet equation concept implies that in each

transaction the amount to be debited equals the amount to be credited.

In the form of equation: Debit = Credit

3. What are accounting conventions? Explain them.

ACCOUNTING CONVENTIONS

            The Oxford Advanced Learner’s Dictionary has defined the word ‘Convention’ as

practice or custom based on general consent. Kohler has observed that conventions is  ‘a

statement or rule of practice which, by common consent, is implied in the solution of a given

class of problems or guides behavior in a certain kind of situation’. An axiom and convention

may be indistinguishable, thus, the use of straight line depreciation long regarded as a

convention, has tended to take on the character of an axiom. A convention dictates many of the

activities of the public accountant, such as measures of materiality, style and content of financial

statements, the features of audit reports etc.

            In International Accounting Standards, the conventions have been termed as accounting

policies. In practice the generally accepted accounting policies are known as accounting

conventions, which have been adopted by accountants for a long time.

            Types of Accounting Conventions:  The Accounting conventions are mainly of four

types:

CONVENTION OF DISCLOSURE;

CONVENTION OF MATERIALITY;

CONVENTION OF CONSISTENCY;

CONVENTION OF CONSERVATISM.

1.      Convention of Disclosure: Every business enterprise prepare its final accounts at the end

of each financial year. The final accounts contain income statement and balance sheet. Quite a

number of persons are interested in studying these statements. They include owners, employees,

debtors, investors, Government, and consumers. Hence, it is necessary that the financial

information as contained in these statements is reported objectively so that these statements may

present a true and fair view of an enterprise.

Generally, it is observed that the companies in order to make their new share issue a

success, conceal their negative points and present a rosy picture of their establishment to the

outsiders. Such a presentation is against the canons of accounting and is also contrary to law. On

the other hand some cautious companies create secret reserves which are used in lean times to

hide weakness. Both these situations are unjust and unethical. Hence, all the enterprise is

presented.

2.      Convention of Materiality : There may be a great deal of financial information which can

be provided for any business, but in order to make financial statements more meaningful and to

minimise costs, accountants should report only such information which is material. Materiality is

an implicit guide for the accountants in deciding what should be disclosed in the financial

statements. There is, however, some difficulty in defining materiality because this convention

lacks operational definition. Most definitions of materiality stress the role of accountants’

judgement in interpreting what is and what is not material. While at the same time should be

judged material if the essentially a matter of professional judgement. An individual item should

be judge material it the knowledge of that item could reasonable be deemed to have influence on

the users of the financial statements. For example, suppose a waste paper basket is purchased in a

business. Technically it is a fixed asset of the business as its life is likely to last for more than

one accounting period. Therefore, annual depreciation should be provided on this asset. But, the

amount spent on this purchase is so insignificant that the accountant may treat it as revenue

expenditure and charge the whole amount to profit and loss account in the year of purchase.

3.      Convention of Consistency: The consistency convention implies that same accounting

policies will be used for similar items over the year. In this way more meaningful inter-period

comparisons can be made. If the income statement for the current period shows higher earning

than the preceding period, the user is entitled to assume that business operations have been more

profitable provided there is no change in the accounting policies adopted by the enterprise. The

business entity should be consistent in the accounting practices or principles in respect of the

assets, equities, revenues and expenses.

It is only when the accounting principles are uniformly followed from year to year that the

results obtained will be comparable. The rationale for this concept is that frequent changes in

accounting treatment would make the Balance Sheet and the Income Statement unreliable for

end users.

While giving audit reports in America the certified Public Accountants have to certify that the

accounting principal in preparing financial statement for a particular year are consistent with

those of the previous year. But it should not be construed by this statement that the business

enterprise cannot make changes in its accounting policies. If it wants to introduce any change in

its accounting policies, it may do so. However, such a change should be reported in its financial

statements and its effect on income statement and balance sheet should be shown separately.

4.       Convention of Conservatism: Conservatism is a policy of playing safe in the world of

uncertainties. It is a quality of judgement to be exercised in evaluating risks and uncertainties

present in the business to ensure that reasonable provisions are made for anticipated losses in the

realization of recorded assets and settlement of obligations. The working rule is : “anticipate no

gains but provide for all possible losses, and if in doubt write it off.” When applied to business

income this convention results in the recognition of all losses that have been incurred or are

likely to occur and to admit the gains only when they have been realized. According to this

convention, care should be taken in valuing the current assets like closing stock which should be

valued at lower of the cost or market price. If the value of closing stock has gone down in the

market, it should be written shows an upward trend, unless the goods are sold and the gain is

actually realized. The convention of conservatism is based on the plea that the understatement of

earnings and assets is less dangerously misleading than the overstatement.

4. Explain the classification of JOURNAL.

Journal is a book in which transactions are recorded in chronological order/ date wise, therefore

it will be practically difficult to record if the number of transactions is large. To take the benefit

of division of labour, journal should be divided into number of journals. Journal can be classified

into various special journals and Journal proper. Special journals are also known as special

purpose books. Classification of Journal can be explained with the help of the following chart:

These journals are explained below:

I. Special Journal: Special journals are those journals which are meant for recording all the

Transactions of a repetitive nature of a particular type. For example, all cash related transactions

may be recorded in one book; all credit purchases in another book and so on. These are:

(i) Cash Journal/Cash Book: Cash Journal or Cash Book is meant for recording all cash

transactions i.e., all cash-receipts and all cash payments of the ‘business. This book he1ps us to

know the balance of Cash in hand at any point of time. It is of two types:

(a) Simple Cash Book: It records only receipts and payments of cash. It is like an ordinary Cash

Account.

(b) Bank Column Cash Book: This type of Cash Book contains one more column on each side

for the Bank transactions. This Book provides additional information about the Bank

transactions. You will learn more details about the Cash Book in the lesson on Cash Book.

(ii) Purchases Journal/Purchases Book: This journal is meant for recording all credit purchases

of goods only as Cash purchases of goods are recorded in the Cash Book. In this journal,

purchases of other things like machinery, typewriter, stationery, etc. are not recorded. Goods

means articles meant for trading or the articles in which the business deals.

(iii) Sales Journal/Sales Book: This journal is meant for recording all credit sales of goods

made by the firm. Cash Sales are recorded in the Cash Book and not in the Sales Book. Credit

Sale of items other than the goods dealt in like sale of old furniture, machinery, etc. are not

entered in the Sales Journal.

(iv) Purchase Returns or Returns Outward Journal: Whenever, the goods are not as per the

specifications, the buyer may return these goods to the supplier. These returns are entered in a

book known as Purchase Returns Book. It is also known as Returns Outward Journal Book.

(v) Sale Returns or Returns Inward Journal: Sometimes, when the goods are sold to the

customer and they are not satisfied with the goods, they may return these goods to the

businessman. Such returns are known as Sales Returns. Just like Purchase Returns, they are also

recorded in a separate Book which is known as Sales Returns or Returns Inward Journal/Book.

Note: You will learn more details about these Special journals in the Subsequent lessons.

(vi) Bill Receivables Journal/Book: When goods are sold on credit and the date and period of

payment is agreed upon between the seller and the buyer, this is duly signed by both the parties.

This written document is called a Bill of exchange. For the seller it is a bill receivable and for the

buyer it is a bill payable. Bills Receivable Journal/Book and Bills Payable journal Book are two

journals prepared by a businessman.

For example: Pranaya sells goods to Gunakshi on credit for Rs 5000 payable after three months.

A document is prepared containing these facts and is duly signed by Pranaya and Gunakshi. For

Pranaya it is a Bills Receivable and she will record this transaction in Bill Receivable Book. For

Gunakshi it is a Bill Payable and she will record the transaction in her Bill Payable Book.

(vii) Bill Payable Journal: This is a journal in which record of those bills is kept on which the

firm has given its acceptance for making payments on later dates.

Note: Bill books are not now in practice.

II. Journal Proper

This journal is meant for recording all such transactions for which no special journal has been

maintained in the business. Therefore, in this journal, all such transactions are recorded which do

not occur frequently and for these transactions no special journal is required. For example, if

Machinery is purchased on credit, it will be recorded in the journal proper, because in the Cash

Book, we will record only cash purchases of machinery. Similarly, many other transactions,

which do not find their place in the special journals, will be recorded in the General Journal such

as

(i) Outstanding expenses – Salaries outstanding, Rent outstanding, etc.

(ii) Prepaid expenses – Prepaid Rent, Salaries paid in advance

(iii) Income received in advance – Rent received in advance, interest received in advance, etc.

(iv) Accrued Incomes – Commission yet to be received, interest yet to be received.

(v) Interest on Capital

(vi) Depreciation

(vii) Credit Purchase and Credit Sale of fixed Assets – Machinery, Furniture.

(viii) Bad debts.

(ix) Goods taken by the proprietor for personal use.

5. Prepare the journal entries and ledger account for the following transaction.

6. Explain different kinds of “Cash Books “?

CASH BOOK:

Cash Book is a Book in which all cash receipts and cash payments are recorded. It is also one of

the books of original entry. It starts with the cash or bank balance at the beginning of the period.

In case of new business, there is no cash balance to start with. It is prepared by all organisations.

When a cash book is maintained, cash transactions are not recorded in the Journal, and no cash

or bank account is required to be maintained in the ledger as Cash Book serves the purpose of

Cash Account.

Cash Book: Types

Cash Books may be of the following Types:

Simple Cash Book

Bank Column Cash Book

Petty Cash Book

Simple Cash Book

A Simple Cash Book records only cash receipts and cash payments. It has two sides, namely

debit and credit. Cash receipts are recorded on the debit side i.e. left hand side and cash

payments are recorded on the credit side i.e. right hand side. In this book there is only one

amount column on its debit side and on the credit side.

BANK COLUMN CASH BOOK

When the number of bank transactions is large in an organization, it is necessary to have a

separate book to record bank transactions. Instead of having a separate book to record bank

transactions a column is added on each side of the Simple Cash Book. This type of cash book is

known as Bank column Cash Book. All payments into bank are recorded on the debit

Side and all withdrawals/payments through the bank are recorded on the credit side of the cash

book.

PETTY CASH BOOK

In big business organisations, a large number of repetitive small payments such as, for

conveyance, cartage, postage, telegrams, courier and other expenses are made. These

organisations appoint an assistant to the Head Cashier. The appointed cashier is known as petty

cashier. He makes payments of these expenses and maintains a separate cash book to record

these transactions. Such a cash book is called Petty Cash Book.

The petty cashier works on the imprest system. Under this system, a definite sum, say Rs. 4000/-

is given to the petty cashier at the beginning of the period. This amount is called imprest money.

The petty cashier meets all small payments out of this imprest amount, at the end of the period

say one month he presents the account to the Head Cashier and gets reimbursed from the Head

Cashier. Suppose out of Rs.4,000 he has spent Rs.3,850 by the end of the month. He will get

Rs.3,850 from the head cashier. Thus, again he has the full imprest amount in the beginning of

the next period. The process of reimbursement can be weekly, fortnightly or monthly depending

upon the frequency of small payments. The Petty Cashier is authorized to sanction and disburse

small payments. Assignment of the task of making of petty expenses to a person and the

maintenance of petty cash book by him reduces the burden of the Head Cashier.

The petty cash book has a number of columns for the amount on the payment side. Each of the

amount columns is allotted to items of specific payments, which are common. The last column is

allotted for miscellaneous payments. At the end of the period, all amount columns are totaled.

The total of the amount paid shown in column 5 is deducted from the column 1. At the opening

of the month the total amount paid in the previous month is reimbursed by the Head Cashier.

7. Enter the following transactions in the cash books.

8. What is the meaning of subsidiary books? Explain its classification.

SUBSIDIARY BOOKS

Subsidiary books or books of prime entry or original entry are those where business

transactions are recorded in the books in the first instance and then posted to the ledger from

these books.

Classification of Subsidiary Books

Cash Book: This book deals with the transactions relating to the receipts and payments

of cash direct or through bank, discount allowed or received etc. and shows cash in hand

and at bank.

Purchases Books: This book is meant for recording all transactions of credit purchase of

all goods, dealt in or of the materials and stores required in the factory and will show the

total credit purchases of goods and materials made during a particular period.

Sales Book: This book is maintained to record all credit sales (of goods dealt in made

during a particular period and will show total credit sale made during a particular period.

Purchases Returns: (or Returns Outwards) Book: This book records all returns of

goods and materials previously purchased and will show total purchases returns during a

particular period.

Sales Returns (or Return Inwards) Book: This book is maintained to record all sales

returns made by the customers and will show the total return inwards during a particular

period.

Bills Receivable Book: This book is maintained to record all bills received from the

customers during a particular period. It will also tell the various dated on which

payments are to be received by the business.

Bills Payable Book: This book records all acceptances made by the firm and will

indicate the various dated on which payments of various bills are to be made.

Journal Proper: All those transactions which could not be recorded in any of the above

subsidiary books will be recorded in this book.

9. Prepare the Purchase & Purchase return book for the following transaction with

discount.

10. From the following particulars, prepare the sales and sales return books.

UNIT – II

Section-A

1) Trial Balance is a list of balance of

a) Ledger account

b) Cash book

c) Both (a) & (b) above

d) None of the above

Ans: a

2) Bank Reconciliation Statement is prepare by

a) Bank

b) Customer

c) Both by the customer & Bank

d) None of the above

Ans: a

3) Overdraft as per cash book means

a) Credit balance in the pass book

b) Credit balance in the bank column of the cash book

c) Debit balance in the pass book

d) Debit balance in the cash book

Ans: a

4) When purchase of furniture is recorded purchase of trading goods it is an error of

a) Commission

b) Omission

c) Principle

d) Compensation

Ans: c

5) Purchase of goods worth Rs.10, 000 from Kannan on credit was not entered in purchase book, it is error of

a) Commission

b) Omission

c) Principle

d) Compensating

Ans: b

Section- B

1. What is trial balance? Explain its objectives and features.

TRAIL BALANCE

In accounting, the trial balance is a worksheet listing the balance at a certain date, of each

ledger account in two columns, namely debit and credit. Under the double-entry system, in any

transaction the total of any debits must equal the total of any credits, so in a Trial Balance the

total of the debit side should always be equal to the total of the credit side. The trial balance thus

serves as a tool to detect errors, which can result in the totals not being equal. Often credits will

be represented as a negative, in which case the total of the trial balance should be 0.

FEATURES OF TRAIL BALANCE:

The following are the features of trail balance:

Trail balance is statement or a schedule.

It contains the debit and credit balances of various accounts.

It may also be prepared by taking the totals of debit and credit sides of all the ledger

accounts before these have been balanced.

It is usually prepared at the end of the accounting year, but it can also be prepared at

any other date, say at the end of a week, month or quarter, if so desired.

It can be prepared only after balancing all the accounts in the ledger. However, if it is

prepared on total basis, accounts have to be simply totalled up and not necessarily

balanced.

It is prepared to check the arithmetical accuracy of books of accounts. If the totals of

debit and credit columns of a trial balance agree, i.e. if they are equal, it is presumed

that accounts are arithmetically correct.

If the trial balance does not agree, it points out that there are some errors.

Trial balance is not a conclusive proof of the accuracy of books of accounts. One

cannot assume that because the trial balance agrees, the accounts are positively

correct. There may still exist certain errors which are not disclosed through the trial

balance.

OBJECTIVES OF PREPARING A TRIAL BALANCE

Following are the objectives of preparing Trial Balance

(i) To check arithmetical accuracy - Arithmetical accuracy in ledger posting means writing

correct amount, in the correct account and on its correct side while posting transactions from

various original books of accounts, such as Cash Book, Purchases Book, Sales Book, etc. It also

means not only the correct balance of ledger account but also the totals of the special purpose

Books.

(ii) To help in preparing Financial Statements- The ultimate objective of the accounting is to

prepare financial statements i.e. Trading and Profit and Loss Account, and Balance sheet of a

business enterprise at the end of an accounting year. These statements contain balances of

various ledger accounts. As Trial Balance contains balances of all ledger accounts, in financial

statements the balances of ledger accounts are carried from the Trial balance for proper analysis.

(iii) Helps in locating errors- If total of two columns of the trial balance agrees it is a proof of

arithmetical accuracy in the ledger posting. However, if the totals of the two columns do not tally

it indicates that there is some mistake in the ledger accounts. This prompts the accountant to find

out the errors.

(iv) Helps in comparison- Comparison of ledger account balances of one year with the

corresponding balances with the previous year helps the management taking some important

decisions. This is possible by using the Trial Balances of the two years.

(v) Helps in making adjustments- While making financial statements adjustments regarding

closing stock, prepaid expenses, outstanding expenses etc are to be made. Trial balance helps in

identifying the items requiring adjustments in preparing the financial statements. Trial Balance is

generally prepared at the end of the year. However it can be prepared at any time during the

accounting year to check the accuracy of the posting.

2.

3. Describe different types of errors in accounting with suitable examples.

CLASSIFICATION OF ACCOUNTING ERRORS

Various accounting errors can be classified as follows:

A. On the basis of their nature

(a) Errors of omission

(b) Errors of commission

(c) Errors of principle

B. On the basis of their impact on ledger accounts

(a) One sided errors

(b) Two sided errors.

A. On the basis of their nature

(a) Errors of omission

As a rule, a transaction is first recorded in books of accounts. However,accountant may not

record it at all or record it partially. It is called an errorof omission. For example, goods

purchased on credit are not recorded inPurchases Book or discount allowed to a customer was

not posted toDiscount A/c in the ledger.

In the first case it is a complete omission. Therefore, both debit and creditare affected by the

same amount. Therefore, it does not affect the TrialBalance.

The second example is the example of partial omission. It affects only oneaccount i.e. Discount

A/c. Therefore it affects Trial Balance.

(b) Errors of commission

When the transaction has been recorded but an error is committed in theprocess of recording, it is

called an error of commission. Error ofcommission can be of the following types:

(i) Errors committed while recording a transaction in the Special Purposebooks. It may be:

Recording in the wrong book for example purchase of goods fromRakesh on credit is recorded in

the Sales Book and not in thePurchases Book.

Recording in the book correctly but wrong amount is written. Forexample, goods sold to Shalini

of Rs.4200 was recorded in theSales Book as Rs.2400In the above two cases two accounts are

affected by the same amount,debit of one and the credit of the other. Therefore, trial balance will

notbe affected.

(ii) Wrong totalling: There may be a mistake in totalling Special PurposeBook or accounts. The

totalled amounts may be less than the actualamount or more than the actual amount. First is a

case of undercastingand the other of overcasting. For example, the total of Purchases Bookis

written as Rs.44800 while actual total is Rs. 44300, the total of SalesDay Book is written as

Rs.52500 while it is Rs.52900.It is a case of an error affecting one account hence it affects trial

balance.

(iii) Wrong balancing: While closing the books of accounts at the end ofthe accounting period,

the ledger accounts are balanced. Balance iscalculated of the totals of the two sides of the

account. It may be wronglycalculated. For example, the total of the debit column of Mohan’sA/c

is Rs.8600 and that of credit column is Rs.6800. The balancecalculated is as Rs.1600 while the

actual balance is Rs.1800.It has affected one account only; therefore, the Trial Balance

getsaffected.

(iv) Wrong carry forward of balances or totals: Totals or balances are carriedforward to the next

page. These may be carried forward incorrectly. Forexample, the total of one page of the

Purchases Book. of Rs.35,600is carried to next page as Rs.36500.Again the error affects one

account only. Therefore, Trial Balance getsaffected.

(v) Wrong Posting: Transactions from the journal or special purpose booksare posted to the

respective accounts in the ledger. Error may becommitted while carrying out posting. It may take

various forms suchas, posting to wrong account, to the wrong side of the account or postedtwice

to the same account. For example goods purchased of Rs.5400from Rajesh Mohanti was posted

to the debit of Rajesh Mohanti orposted twice to his account or posted to the credit of Rakesh

Mohanti.In the above examples, only one account is affected because of the errortherefore, Trial

Balance is also affected.

Compensating Errors

Two or more errors when committed in such a way that there is increaseor decrease in the debit

side due to an error, also there is correspondingdecrease or increase in the credit side due to

another error by the sameamount. Thus, the effect on the account is cancelled out. Such errors

arecalled compensating errors. For example, Sohan’s A/c is debited byRs 2500 while it was to be

debited by Rs 3500 and Mohan’s A/c is debitedby Rs 3500 while the same was to be debited by

Rs 2500. Thus excess debitof Mohan’s A/c by Rs.1000 is compensated by short credit of

Sohan’sA/c by Rs.1000.As the debit amount and the credit amount are equalized, such errors

donot affect the agreement of Trial Balance, but the fact remains that thereis still an error.

(c) Error of Principle

Items of income and expenditure are divided into capital and revenuecategories. This is the basic

principle of accounting that the capital incomeand capital expenditure should be recorded as

capital item and revenueincome and revenue expenditure should be recorded as revenue item.

Iftransactions are recorded in violation of this principle, it is called error ofprinciple i.e. the

capital item has been recorded as revenue item and revenueitem is recorded as capital item. For

example, Rs. 5000 spent on the repairsof building is debited to Building A/c while it should have

been debitedto Repair to Building A/c. It is a case of error of principle becauseexpenditure on

repairs of building is revenue expenditure, while it hasbeen debited to Building A/c taking it as

an item of capital expenditure.As both the sides i.e. credit as well as debits remain affected, the

trial Balancealso is not affected by such errors.

B. On the basis of impact on ledger accounts

Errors may affect one side i.e. either debit or credit side of an account orits two sides i.e. both

debit and credit thus errors may be divided as:

(a) One sided errors

(b) Two sided errors

(a) One sided errors

Accounting errors that affect only one side of an account which may beeither its debit side or

credit side, is called one sided error. The reason ofsuch error is that while posting a recorded

transaction one account iscorrectly posted while the corresponding account is not correctly

posted.

For example, Sales Book is overcast by Rs.1000. In this case only SalesA/c is wrongly credited

by excess amount of Rs.1000 while the correspondingaccount of the various debtors have been

correctly debited. Anotherexample of one sided error is Rs 2500 received from Ishita is

wronglydebited to her account. In this case, only Ishita’s account is affected, amountin the cash-

book is correctly written. This type of mistake does affect thetrial balance.

(b) Two sided errors

The error that affects two separate accounts, debit side of the one and creditside of the other is

called two sided error. Example of such error is purchaseof machinery for Rs.1000 has been

entered in the Purchases Book. In thiscase, Purchases A/c is wrongly debited while Machinery

A/c has beenomitted to be debited. So two accounts i.e. Purchases A/c and the MachineryA/c is

affected.

4)

5. What is B.R.S? Explain preparation of BRS?

BANK RECONCILIATION STATEMENT

Bank Reconciliation Statement is a statement prepared to reconcilethe difference between the

balances as per the bank column of thecash book and pass book on any given date.

PREPARATION OF BANK RECONCILIATION STATEMENT

To reconcile the bank balance as shown in the pass book with the balanceshown by the cash

book, Bank Reconciliation Statement is prepared. Afteridentifying the reasons of difference, the

Bank Reconciliation statement isprepared without making change in the cash book balance.

We may have the following different situations with regard to balanceswhile preparing the Bank

Reconciliation statement. These are:

1. Favourable balances

(a) Debit balance as per cash book is given and the balance as per pass bookis to be ascertained.

(b) Credit balance as per pass book is given and the balance as per cashbook is to be ascertained.

2. Unfavourable balance/overdraft balance

(a) Credit balance as per cash book (i.e. overdraft) is given and the balanceas per pass book is to

be ascertained.

(b) Debit balance as per pass book (i.e. overdraft) is given and the balanceas per cash book is to

be ascertained.

The following steps are taken to prepare the bank reconciliation statement:

(i) Favourable balances:When debit balance as per cash book or creditbalance as per pass book

is given:

(a) Take balance as a starting point say Balance as per Cash Book.

(b) Add all transactions that have resulted in increasing the balanceof the pass book.

(c) Deduct all transactions that have resulted in decreasing thebalance of pass book.

(d) Extract the net balance shown by the statement which should bethe same as shown in the pass

book.

In case balance as per pass book is taken as starting point all transactionsthat have resulted in

increasing the balance of the Cash book will be addedand all transactions that have resulted in

decreasing the balance of Cashbook will be deducted. Now extract the net balance shown by the

statementwhich should be the same as per the Cash book.The following illustration helps to

understand dealing with the favourablebalance as per cash book or pass book.

6)

Section – C

1. Define trial balance. How is it prepared?

TRIAL BALANCE:

According to Pickles, “the statement prepared with the help of ledger balances, at the end of

financial year or at any other date to find out whether debit total agrees with credit total is called

trial balance.”

PREPARATION OF TRIAL BALANCE

Trial Balance is not an account. It is only a list or schedule of balances ofledger

accountsincluding cash and bank balances. It is prepared on aparticular date. The accounts

having a debit balance are entered in the debitamount column and credit balance accounts are

entered in the credit amountcolumn. The totals of the two sides of the accounts may also be used

toprepare trial balance. The sum of each column should be equal. The standardformat of a trial

blance is given below:

Trial Balance of .................

As at .................(closing date)

Name of the a/c LF Dr.

Amount

Cr.

Amount

The name of the business firm is written on the top of the statement withTrial Balance. Under

this we write the date on which Trial Balance isprepared.Trial Balance has three columns: Name

of the Ledger Account, DebitAmount and Credit Amount.In the ledger account column we write

the name of the account. In the Debitamount column we write the amount of debit balance of the

account (orthe total of the debit side of the account). Similarly in the credit amount column we

write the amount of credit balance of the account (or the total

Of the credit side of the account.Finally, columnar total is done and compared.

Steps to prepare Trial Balance

(i) At first ascertain the balance account wise of all the ledger accounts.

(ii) Write the name of the ledger account in the ledger account column.

(iii) Write against the name of the ledger account, the balance amount/totalamount, debit

balance/total in the debit column; and credit balance/total in the credit column.

(iv) Add the debit balance/total amount column and credit balance/totalamount column.

There are three methods of preparing Trial Balance

(i) Balance Method

(ii) Total Method

(ii) Balance Totals Method

(i) Balance Method

In this Balance method, the balance of each account (which may be debitbalance or credit

balance) is extracted and written against each account;we write debit balance in the debit column

and credit balance in thecredit column.

(ii) Total Method

In this method the total of both sides of every account in the ledgeris written against the name of

the respective account without balancingthem in the form of debit and credit balances

respectively.

(iii) Balance totals Method

Trial Balance is prepared by combining the first and second methods.However, in practice the

trial balance is prepared with debit and creditbalances of various accounts in the ledger.

Normally balance method isused.

2)

3. Explain methods of rectification of accounting errors?

By now you must have understood well that every business enterpriseprepares its financial

statements to provide information of profit earned orloss incurred by it during an accounting

period and its financial positionon the relevant date. This information will be most useful only if

theinformation is accurate. How can the business concern achieve thisobjective if there are

number of errors in the accounting? Your immediateresponse will be that errors in accounts

should be detected at the earliestand be corrected before preparing the financial statements.It

should be clear in your mind that the errors should never be rectified byerasing or overwriting

because it will encourage manipulations and fraudsin accounts.In accounting practice there are

some definite methods to rectify theaccounting errors. These are based on accounting practices

and procedures.Rectification of errors using these methods is called rectification ofaccounting

errors. So it is a process of rectification. It is generally done bypassing an entry to nullify the

effect of error.

Methods of rectification of accounting errors

Before preparing Trial Balance

(i) Instant correction

(ii) Correction in the affected account

After preparing Trial Balance

Before preparing Trial Balance

(i) Instant correction

If the error is detected immediately after making an accounting entry,it may be corrected by

neatly crossing out the wrong entry and makingthe correct entry and the accountant should put

his initials. For example,an amount of Rs. 3500 is written as Rs. 5300. This can be corrected

as 3500.

(ii) Correction in the affected accounts.

In case error is detected on a date later than the date on which thetransaction was recorded but

before the Trial Balance, the rectificationwill be made by making a correction in the affected

account.

4.Explain the Rectification of errors through suspense Account.

You have learnt that the Trial Balance prepared at the end of a period bythe business concern

must agree. It means the sum of its debit column andsum of credit column should agree. But if

the totals do not agree thedifference amount is written in a new account. This account is

calledSuspense Account.

If the total of the debit side of the Trial Balance is morethan the total of its credit side, the

difference amount will be written inSuspense A/c on its credit side i.e. Suspense A/c is credited

and vice-versa.You have also learnt that the two sides of the Trial Balance do notagree because

there is some error or errors in the accounts, which is reflectedin the Suspense Account. Thus,

Suspense A/c is a summarised account oferrors.Opening of a Suspense Account is a temporary

arrangement. As soon asthe error that has led to Suspense Account is rectified, this account

willdisappear. One point needs to be noted that Suspense A/c is the result ofone sided errors. So

one sided errors are corrected through Suspense A/c.completing the double entry when an error

is corrected by placing thecorrect amount on the debit of the proper account, the credit is placed

inSuspense Account or vice-a-versa.

For example, Gopal’s Account wasdebited short by Rs.100. The error will be rectified through

Suspense A/c by debiting Gopal A/c and crediting Suspense A/c by Rs.100.

Journal entry for the same is as follows:

Gopal A/c Dr. 100

To Suspense A/c 100

(Gopal’s A/c debited shortis now corrected)

Similarly, while correcting as one sided error the proper account is creditedwith the correct

amount, the debit is placed in the Suspense A/c.

Forexample, Sales Book for December, 2006 is under cast by Rs. 500. The errorwill be rectified

by debiting Suspense A/c and crediting Sales A/c.

Journal Entry for the same will be as follows:

Suspense A/c Dr 500

To Sales A/c 500

(Sales Book under cast is rectified)

5)

6. What is the need for preparation of B.R.S?

Business concern maintains the cash book for recording cash and banktransactions. The Cash

book serves the purpose of both the cash accountand the bank account. It shows the balance of

both at the end of a period.Bank also maintains an account for each customer in its book. All

depositsby the customer are recorded on the credit side of his/her account and allwithdrawals are

recorded on the debit side of his/her account. A copy ofthis account is regularly sent to the

customer by the bank. This is called‘Pass Book’ or Bank statement.

It is usual to tally the firm’s banktransactions as recorded by the bank with the cash book. But

sometimesthe bank balances as shown by the cash book and that shown by the passbook/bank

statement do not match. If the balance shown by the pass bookis different from the balance

shown by bank column of cash book, thebusiness firm will identify the causes for such

difference. It becomesnecessary to reconcile them. To reconcile the balances of Cash Book

andPass Book a statement is prepared. This statement is called the ‘BankReconciliation

Statement

Need of preparing Bank Reconciliation Statement

It is neither compulsory to prepare Bank Reconciliation Statement nor a dateis fixed on which it

is to be prepared. It is prepared from time to time tocheck that all transactions relating to bank

are properly recorded by thebusinessman in the bank column of the cash book and by the bank in

itsledger account. Thus, it is prepared to reconcile the bank balances shownby the cash book and

by the bank statement. It helps in detecting, if thereis any error in recording the transactions and

ascertaining the correct bankbalance on a particular date.

7)

UNIT – IIISection- A

1) The manufacturing account is prepared

a) To ascertain profit & loss on the goods sold

b) To show the sale proceeds from the goods produced

c) To ascertain the cost of goods manufactured

d) To ascertain gross profit

Ans: a

2) Balance Sheet is a

a) Journal

b) Ledger

c) Statement

d) Report

Ans: d

3) An example for fixed asset is

a) Buildings

b) Closing Stock

c) Net Profit

d) Wages

Ans: a

4) Prepaid insurance is

a) An assets

b) Liability

c) An expenses

d) Outstanding liability

Ans: a

5) Holding of Fixed assets in a business for purpose of

a) Resale after use

b) Earning revenue

c) Converting into cash

d) Writing depreciation

Ans: b

Section – B

1. What is trading account? Explain its needs.

Trading account:

Income statement consists of Trading and Profit and Loss Account. Let us first study the Trading

Account. A business firm either purchases goods from others and sells them or manufactures and

sells them to earn profit. This is known as trading activities. A statement is prepared to know the

results in terms of profit or loss of these activities. This statement is called Trading Account.

Need of Trading Account

Trading Account serves the following purposes:

1. Knowledge of Gross Profit

Trading Account gives information about Gross Profit. It is the profit earned by a business

enterprise from its trading activities. The percentage of gross profit on sales reflects the degree of

success of business.

2. Knowledge of All Direct expenses

All direct expenses are taken to trading Account. Direct expenses are the expenses that can be

directly attributed to purchase or manufacturing of goods for sale. Percentage of Direct expenses

on sales of current year when compared with the same of previous years, helps the manager to

exercise control over direct expenses.

3. Precaution against future losses

Trading Account, if shows gross loss, reasons for this loss can be found out and necessary

corrective steps can be taken.

2)

3)

4. Prepare the format of Trading Account.

5. Explain the Profit & Loss a/c and Balance sheet.

PROFIT & LOSS ACCOUNT :

As stated earlier, income statement consists of two accounts:

Trading Account and Profit & Loss Account.

You have seen that Trading account is prepared to ascertain the Gross profit or Gross loss of the

trading activities of the business. But these are not the final results of business operations of an

enterprise. Apart from direct expenses, there are indirect expenses also. These may be

conveniently divided into office and administrative expenses, selling and distribution expenses,

financial expenses, depreciation and maintenance charges etc. Similarly, there can be income

from sources other than sales revenue. These may be interest on investments, discount received

from creditors, commission received, etc. Another account is prepared in which all indirect

expenses and revenues from sources other than sales are written. This account when balanced

shows profit (or loss). This account is termed as Profit and Loss Account. The profit shown by

this account is called ‘net profit’ and if it shows loss it is known as ‘net loss’.

Position Statement/Balance Sheet

Position Statement or Balance Sheet is another basis of financial statement. Balance Sheet is a

statement prepared on a particular date, generally at the end of accounting year to ascertain the

financial position of the entity. It consists of assets on the one hand and liabilities on the other.

In the words of Francis R Steal, “Balance Sheet is a screen picture of the financial position of a

going business at a certain moment.” In the words of Freeman, “A Balance Sheet is an item wise

list of assets, liabilities and proprietorship of a business at a certain date.” Financial position of a

business is the list of assets owned by the business and the claims of various parties against these

assets. The statement prepared to show the financial position is termed as Balance Sheet.

6) Prepare the format of Profit & Loss account.

7)

8) What is Balance sheet? Explain its needs and format.

Apart from Trading Account and Profit and Loss Account, Balance Sheet is another financial

statement that is prepared by the every business firm. Balance sheet is a statement which shows

the financial position of a business organisation on a particular date which is generally the last

date of the accounting period. Financial position of a business unit is the amount of claims

against the resources of business. These resources are cash, stock of goods, furniture, machinery,

etc. The claims include the claims of the owner capital and the claims of outsiders such as

creditors, bankers, etc. Therefore, it can be stated that Balance Sheet is the statement which

shows assets owned by the business and liabilities owed by it on a particular date.

Balance Sheet is not an account.

It has two sides. (i) Assets side and (ii) the Liabilities side.

The Asset side has a list of fixed as well current assets.

The liabilities side has a list of items of capital, long term as well as short term liabilities.

Need

1. Balance Sheet is prepared to measure the true financial position of a business entity at a

particular point of time.

2. It is a systematic presentation of what a business unit owns and what it owes.

3. Balance Sheet shows the financial position of the concern at a glance.

4. Creditors, financiers are particularly interested in the Balance Sheet of a concern so that they

can decide whether to deal with the concern or not.

Marshalling of Assets and Liabilities

As stated above Balance sheet has two sides i.e. Assets side, which has various items of assets of

the concern and liabilities side which has the liability or claim of the owner as well as of the

outside parties.

Assets refer to the financial resources of the business and can broadly be divided into Current

Assets and Fixed Assets, Liabilities denote claims against the assets of the business. Liabilities

can be of two types’ owners’ liability or capital and outsiders liabilities such as creditors, bills

payable, Bank Loan etc.

There is no prescribed form of a Balance Sheet in which it should be prepared by a sole

proprietary business or a partnership firm. However, an order is generally maintained in which

assets and liabilities are written. This is to maintain uniformity/consistency which facilitates

comparative analysis for decision making. Balance sheet may be prepared in any of the

following orders:

(a) Liquidity order

(b) Permanency order

(a) Liquidity order

Liquidity means convertibility of assets into cash. Every asset cannot be converted into cash at

the same degree of ease and convenience. Assets are written in the order of their liquidity, Assets

of highest liquidity is written first and next highest follows and so on. Similarly, liabilities are

also written in this very order. Short term liabilities are written first and then long term liabilities

and lastly the capital.

A specimen of the balance sheet prepared on the basis of liquidity order

is given below :

Permanency order

While following the order of permanency, assets, which are to be used permanently i.e. for a

long time and not meant for resale, are written first.

For example, Land and Building, Plant and Machinery, furniture etc. is written first.

Assets which are most liquid such as cash in hand is written in the last. Order of liabilities is

similarly changed. Capital is written first, then the long term liabilities and lastly the short term

liabilities and provisions and Specimen of a Balance Sheet that can be prepared in the order of

permanency is as follows:

9)

Section - C

1. What is mean by FINANCIAL STATEMENT? Explain its OBJECTIVES.

FINANCIAL STATEMENT

When a student has studied for a year, he/she wants to know how much he/she has learnt during

that period. Similarly, every business enterprise wants to know the result of its activities of a

particular period which is generally one year and what is its financial position on a particular

date which is at the end of this period. For this, it prepares various statements which are called

the financial statements.

Financial statements are the statements that are prepared at the end of the accounting period,

which is generally one year. These include income statement i.e. Trading and Profit & Loss

Account and Position statement i.e. Balance Sheet.

Objectives of financial statements

Financial statements are prepared to ascertain the profits earned or losses incurred by a business

concern during a specified period and also to ascertain its financial position at the end of that

specified period. Financial statements are generally of two types (a) Income statement which

comprises of Trading Account and Profit & Loss Account, and (b) Position Statement i.e., the

Balance Sheet.

Following are the objectives of preparing financial statements: -

1. Ascertaining the results of business operations

Every businessman wants to know the results of the business operations of his enterprise during

a particular period in terms of profits earned or losses incurred. Income statement serves this

purpose.

2. Ascertaining the financial position

Financial statements show the financial position of the business concern on a particular date

which is generally the last date of the accounting period. Position statement i.e. Balance Sheet is

prepared for this purpose.

3. Source of information

Financial statements constitute an important source of information regarding finance of a

business unit which helps the finance manager to plan the financial activities of the business and

making proper utilisation of the funds.

4. Helps in managerial decision making

The Manager can make comparative study of the profitability of the concern by comparing the

results of the current year with the results of the previous years and make his/her managerial

decisions accordingly.

5. An index of solvency of the concern

Financial statements also show the short term as well as long term solvency of the concern. This

helps the business enterprise in borrowing money from bank and other financial institutions

and/or buying goods on credit.

2.

3. Briefly explain different adjustments for preparation of final accounts.

The number and nature of adjustments differ from organisation to organisation. It depends upon

the volume and nature of activities in the organisation; however, certain adjustments are common

in all types of organisations. Moreover, while making adjustments you will have to follow the

general principle of double entry i.e. the amount is to be debited to one account and credited to

another account. Thus in the financial statements the item to be adjusted should appear at two

places one representing the debit and the other representing the credit.

Let us now discuss some of the items of adjustment and its accounting treatment in financial

statements.

These are as under:

1. Closing Stock

2. Outstanding Expenses.

3. Prepaid Expenses

4. Accrued Income.

5. Income received in advance

6. Interest on Capital

7. Interests on Drawings

8. Depreciation.

9. Further Bad Debts.

10. Provision for Bad and Doubtful Debts.

Adjustment Adjustment entry

Treatment in

Trading

and Profit & Loss

A/c

Treatment in

Balance Sheet

Closing stock

Outstanding

expenses

Closing stock A/c Dr

To Trading A/c

Expenses A/c Dr

To Outstanding expenses A/c

Shown on the

credit side of

Profit & Loss A/c

Added to

respective

Shown on the

Assets side

Shown on the

the liabilities side

Prepaid

Accrued income

Income

received in

advance

Interest on capital

Interest on

drawings

Prepaid expenses A/c Dr

To Expenses A/c

Accrued income A/c Dr

To Income A/c

Income A/c Dr

To income received in advance

A/c

Interest on capital A/c Dr To

capital A/c

Capital A/c Dr

To interest on drawing A/c

expenses on debit

side

Deducted from the

respective

expenses on the

debit side

Added to the

respective income

on the credit side

Deducted from the

respective income

on the credit side

Shown on the

debit side

Shown on the

credit side

Shown on the

expenses Assets

side

Shown on the

Assets side

Shown on the

liabilities side

Shown as

addition to

capital on

liabilities side

Shown as

deduction to

capital on

liabilities side

Depreciation

Further

bad debts

Provision for the

bad and doubtful

debts

Depreciation A/c Dr

To Assets A/c

Bad Debts A/c Dr

To Debtors A/c

Profit & Loss A/c Dr To

Provision for bad and doubtful

debts

Shown on the

debit side

Shown on the

debit side

Shown on debit

side

Deducted from

the value of

Assets

Deducted from

debtors, shown on

Assets side

Shown as

deduction from

debtors on

Asset side.

4.

UNIT – IV

Section – A

1) Income & Expenditure account is prepared by

a) Trading concerns

b) Non-Trading concerns

c) Manufacturing concerns

d) None of the above

Ans: b

2) Special Donation is a

a) Capital Receipt

b) Revenue Receipt

c) An Expense

d) Revenue income

Ans: b

3) Depreciation is provided on

a) Stock of goods

b) Intangible assets

c) Tangible assets

d) Tangible & Intangible assets

Ans: c

4) In Straight line method of depreciation, the depreciation amount will be

a) Uniform every year

b) Different every year

c) Decrease every year

d) Increase every year

Ans: a

5) Under diminishing balance method, depreciation is calculated on

a) Original cost

b) Written down value

c) The scrap value

d) None of the above

Ans: b

Section - B

1. Difference between Capital Expenditure and Revenue Expenditure.

CAPITAL EXPENDITURE AND REVENUE EXPENDITURE

Sl.No Capital Expenditure Revenue Expenditure

1. It results in acquisition of fixed assets It does not result in acquisition of any fixed

which are meant for use and not for resale. asset. This expenditure is incurred for

the assets acquired are used for earning meeting the day-to-day expenses of

profit as long as they can serve the purpose carrying on operation of business.

of the business and sold only when they

become unfit or obsolete for business.

2. It results in improving the earning capacity It results in maintenance of business assets such

of the fixed assets, e.g., overhauling the as repairs and maintenance of machinery. It is

machinery for improving the business by helpful in maintaining the existing capacity of

increasing the earning capacity of the the asset.

machinery.

3. It represents unexpired cost i.e., cost of It represents expired cost i.e., benefit of cost has

benefit to be taken in future. been taken.

4. It is a non-recurring expenditure. It is a recurring expenditure.

5. The benefit of such expenditure will be The benefit of such expenditure expires during

for more then one year. Only a portion of the year and the amount is charged to Revenue

such expenditure known as depreciation is Account, (i.e., Trading and Profit and Loss

charged to Profit and Loss Account and Account) of the same year.

balance amount of such expenditure unless

it is Balance Sheet as an asset.

6. All items of capital expenditure which are All items of revenue expenditure the benefit of

not written off are shown in the Balance which has exhausted during the year are

Sheet as assets and are carried forward to transferred to Trading and Profit and Loss S

the next year. Account and the accounts representing such

items are closed by transferring them to

Trading and Profit and Loss. Such items are

Carried forward to the next year because their

Benefit has been taken during the year. Only a

Portion of the deferred revenue expenditure,

(i.e., heavy advertisement) the benefit of which

has not expired during the year is carried

forward to the next year.

2. What do you mean by income and expenditure account and define the format?

It is the summary of incomes and expenditures of the organisation of a particular year and is

prepared at the end of the year. This account is similar to the Profit and Loss Account of the

Business Organisations. In this account revenue expenditure and revenue income of the year for

which Income and Expenditure A/c is prepared are taken. That means any amount of these

items pertaining to either previous year or next year are not considered. The balance amount of

this account is either surplus or deficit. If the income side of this account exceeds the expenditure

side, the difference is ‘surplus’. In case the expenditure side exceeds the income side, the

difference is ‘deficit’.

Need of preparing Income and Expenditure Account

Even the Not for Profit Organisations would like to know the net result of their activities of a

particular period which generally is one year. Though such organisations do not engage in

trading activities and their objective is not earning profits, yet they would like to know whether

income exceeds expenditure or vice a versa. The amount of the such difference is not termed as

Net Profit or Net Loss as it is so termed in case of business organisations. In case of Not for

Profit organisations the net result is termed as ‘surplus’ or ‘deficit’ as the case may be. Moreover

of a preparation of Income and Expenditure Account is a legal requirement. It helps the

organisations to control their expenditure.

3.

4.

5. Define and explain the terms "depreciation" or "accounting depreciation".

The value of assets gradually reduces on account of use. Such reduction in value is known as

depreciation. Different authors have given different definitions of depreciation, such as:

"Depreciation may be defined as the permanent continuous diminution in the quality, quantity or

value on an asset."  (By Pickles)

"Depreciation is the gradual permanent decrease in the value of an asset from any cause."  (By

Carter)

"Depreciation may be defined as a measure of the exhaustion of the effective life of an asset

from any cause during a given period." (By Spicer & Pegler)

Depreciation is the diminution in intrinsic value of an asset due to use and/or the lapse of time." 

(By Institute of Cost and Management Accountants, England)

"Depreciation is the reduction in the value of a fixed asset occasioned by physical wear and tear,

obsolescence or the passage of time."  (Northcott & Forsyth)

"Depreciation is the diminution in the value of assets owing to wear and tear, effusion of time,

obsolescence or similar causes."  (Cropper)

From the above definitions, it follows that an asset gradually declines on account of use and

passage of time and this causes permanent reduction in the value and utility of asset. Such

reduction in the value or utility of asset is called depreciation. In other words, expired cost or

utility of asset is depreciation.

6. Explain the characteristics of depreciation.

Depreciation has the following characteristics:

Depreciation is charged in case of fixed assets only. e.g., building, plant and machinery,

furniture etc. There is no question of depreciation in case of current assets - such as stock,

debtors, bills receivable etc.

Depreciation causes perpetual, gradual and continual fall in the value of assets.

Depreciation occurs till the last day of the estimated working life of the asset.

Depreciation occurs on account of use of asset. In certain cases, however, depreciation

may occur even if the assets are not used, e.g., leasehold, property, patent, copyright etc.

Depreciation is a charge against revenue of an accounting period.

Depreciation does not depend on fluctuations in market value of assets (see difference

between depreciation and fluctuation page).

The amount of depreciation of an accounting year cannot be determined precisely - it has

to be estimated. In certain cases, however, it may be ascertained exactly, e.g., leasehold

property, patent right, copyright etc.

Total depreciation of an asset cannot exceed its depreciable value (cost less scrap value).

7. Brief about the needs of depreciation.

The Need for depreciation arises for the following reasons:

Ascertainment of True Profit or Loss:

Depreciation is a loss. So unless it is considered like all other expenses and losses, true profit or

loss cannot be ascertained. In other words, depreciation must be considered in order to into out

true profit or loss of a business.

Ascertainment of True Cost of Production:

Goods are produced with the help of plant and machinery which incurs depreciation in the

process of production. This depreciation must be considered as a part of the cost of production of

goods. Otherwise, the cost f production would be shown less than the true cost. Sales price is

fixed normally on the basis of cost of production. So, if the cost of production is shown less by

ignoring depreciation, the sale price will also be fixed at low level resulting in a loss to the

business.

True Valuation of Assets:

Value of assets gradually decreases on account of depreciation, if depreciation is not taken into

account, the value of asset will be shown in the books at a figure higher than its true value and

hence the true financial position of the business will not be disclosed through balance sheet.

Replacement of Assets:

After sometime an asset will be completely exhausted on account of use. A new asset must then

be purchased requiring a large sum of money. If the whole amount of profit is with drawal from

business each year without considering the loss on account of depreciation, necessary sum may

not be available for buying the new asset. In such a case the required money is to be collected by

introducing fresh capital or by obtaining loan or by selling some other assets. This is contrary to

sound commerce policy.

Keeping Capital Intact:

Capital invested in buying an asset, gradually diminishes on account of depreciation. If loss on

account of depreciation is not considered in determining profit or loss at the year end, profit will

be shown more. If the excess profit is withdrawal, the working capital will gradually reduce, the

business will become weak and its profit earning capacity will also fall.

8. Describe the causes for depreciation.

Depreciation:

Depreciation is a permanent, continuing and gradual shrinkage in the book value of a

fixed asset. Depreciation is charged on the fixed assets only. Current assets are never

depreciated rather these are valued. Depreciation is charged on the book value (as shown in the

books after charge of depreciation) only. It has nothing to do with the market value of the fixed

asset. Depreciation is charged on permanent basis. Once the depreciation is charged it reduces

the value of the asset permanently. Depreciation is charged on continuous basis. Once the

depreciation is charged it must be charged on regular basis in the succeeding period also. The

charge of depreciation will decrease the value of asset gradually. There should not be abrupt

changes in the value of fixed assets due to depreciation. It must reduce the value of asset slowly

and steadily.

Causes of Depreciation:

The following are the main causes of depreciation:

Physical Deterioration: It is caused mainly from wear and tear when the asset is in use

and from erosion, rust, rot and decay from being exposed to wind, rain, sun and other elements

of nature.

Economic Factors: These may be said to be those that cause the asset to be put out of

use even though it is in good physical condition. These arise due to obsolescence and

inadequately. Obsolescence means the process of becoming obsolete or out of date. An old

machinery though in good physical condition may be rendered obsolete by the introduction of a

new model which produces more than the old machinery. Inadequacy refers to the termination

of the use of an asset because of growth and changes in the size of the firm. But obsolescence

and inadequacy do not necessary mean that the asset is scrapped. It is merely put out of use by

the firm. Another firm will often buy it.

Time factors: There are certain assets with a fixed period of legal life such as lease,

patents and copyrights. For instance, a lease can be entered into for any period while a patent’s

legal life is for some years but on certain grounds this can be extended. Provision for the

consumption of these assets is called amortization rather than depreciation.

Depletion: Some assets are of a wasting character perhaps due to the extraction of

raw materials from them. These materials are then either used by the firm to make something

else or are sold in their raw state to other firms. Natural resources such as mines, quarries and oil

wells come under this heading. To provide for the consumption of an asset of a wasting

character is called provision for depletion.

Accident: An asset may reduce in value because of meeting of an accident.

Section- c

1. What do you mean by “Non Trading Organisation”? Brief about its characteristics.

Non Trading Organisation:

You must have come across organisations which are not engaged in business activities. Their

objective is not to make profits but to serve. Examples of such organisations are: schools,

hospitals, charitable institutions, welfare societies, clubs, public libraries, resident welfare

association, sports club etc. These are called Not-for-Profit Organisations (NPOs).

Characteristics of Not-for-profit organisations (NPOs)

Following are the main characteristics or the salient features of Not for Profit organisations

(NPOs):

1. The objective of such organisations is not to make profit but to provide service to its members

and to the society in general.

2. The main source of income of these organisations is not the profit earned from purchase and

sale of goods and services but is admissions fees, subscriptions, donations, grant-in-aid, etc.

3. These organisations are managed by a group of persons elected by the members from among

themselves. This group is called managing committee.

4. They also prepare their accounts following the same accounting principles and systems that

are followed by business for profit organisations that are run with an objective to earn profits.

2. Distinguish between Receipts & payments a/c and Income & Expenditure a/c.

Receipts and Payments Account:

Receipts and Payments Account is a real account. Debit what comes in and credit what goes out

(or Increase in an asset is debited and decrease in an asset is credited) is the basic rule of double

entry which is followed while preparing this account. It is a summary of cash book and is

different from the cash book as an item of expense is written in the cash book as many times as it

is paid (say rent, if paid monthly will be written twelve times) but it Receipts and Payments

Account, it is written only once i.e., in summary form. It is maintained on cash system of

accountancy and is prepared in non-trading concerns in lieu of cash book. Like cash book,

receipts of cash are written on the debit side and payments on the credit side. All receipts and

payments, whether these are relating to the current, preceding or succeeding period or are of

capital or revenue nature, are written in this account. Opening balance in this account shows

cash in hand or at bank at the beginning of the accounting period and closing balance shows cash

in hand or at bank at the end of the accounting period. As all types of accounts i.e., personal,

real and nominal are written in this account, so it is not necessary to prepare a Balance Sheet

along with this account. No adjustments for outstanding expenses, prepaid expenses, provision

for doubtful debts or depreciation are made in this account as it is prepared on cash system of

accountancy. It is prepared only for a specific period say for a month or a year.

Income and Expenditure Account:

Income and Expenditure Account is a nominal account. Debit all losses or expenses and credit

all incomes and gains (or expenses decrease the equity and incomes increase the equity) will be

followed while preparing this account. It is prepared in non-trading concerns in lieu of Profit

and Loss Account. Incomes are shown on the credit side and expenses on the debit side. There

is no opening balance but closing balance will show either surplus i.e., excess of income over

expenditure or deficit i.e. excess of expenditure over income. Only revenue items are taken into

consideration i.e. capital items are totally excluded and incomes and expenditures of the current

year are taken into consideration and incomes and expenditures relating to the preceding or

succeeding periods are excluded while preparing this account. This account is prepared on

mercantile system of accountancy and thus all adjustments relating to prepaid to prepaid or

outstanding expenses and incomes, provision for depreciation or doubtful debts will be made.

BASIS OF DISTINCTIONRECEIPTS AND

PAYMENTS ACCOUNTINCOME AND

EXPENDITURE ACCOUNT

Type of Account It is a real account It is a nominal account

In lieu ofIt is prepared in non-trading concerns in lieu of cash book

It is prepared in non-trading concerns in lieu of profit and loss account.

Sides

Receipts are shown on the debit side and payments on the credit side

Incomes (receipts) are shown on the credit side and expenditures (payments) on the debit side.

Opening BalanceThere can be opening balance, which represents cash in hand or at bank.

There is no opening balance.

Closing Balance

This shows cash in cash in hand or at bank at the end of the accounting year.

There is no closing balance but the difference between the two sides shows either surplus of deficit.

Capital and revenue items

All items whether of capital or revenue nature are shown in this account.

Only revenue items are taken into consideration while preparing this account i.e. capital items are totally excluded.

Period

All receipts and payments whether relating to the current period, succeeding or preceding periods are taken into consideration.

Only current period’s incomes and expenditures are taken into consideration while preparing this account i.e. incomes and expenditures relating to succeeding or preceding periods are excluded.

Balance Sheet

It is not necessary to prepare balance sheet along with this account.

The balance sheet must be prepared in order to accommodate real and personal accounts along with this account.

Adjustments

No adjustments are required to be made at the end of the year.

In order to find out the true income or expenditure of the current year, all adjustments are made at the end of the year.

System of AccountancyIt is prepared on the basis of cash system of accountancy.

It is prepared on the basis of mercantile system of accountancy.

3.

4. What are the various methods for depreciation? Explain briefly.

Fixed assets differ from each other in their nature so widely that the same depreciation

methods cannot be applied to each. The following methods have therefore been evolved for

depreciating various assets:

Fixed installment or Straight line or Original cost method.

Diminishing Balance Method or Written down value method or Reducing Installment

method.

Annuity Method.

Depreciation fund method or Sinking fund amortization fund method.

Insurance policy method.

Revaluation method.

Sum of the year's digits method (SYD).

Double declining balance method.

Depletion method.

The basis of use system.

Fixed Installment Method or Straight Line Method or Original Cost Method of

Depreciation:

Fixed installment method is also known as straight line method or original cost method.

Under this method the expected life of the asset or the period during which a particular asset will

render service is the calculated. The cost of the asset less scrap value, if any, at the end of its

expected life is divided by the number of years of its expected life and each year a fixed amount

is charged in accounts as depreciation. The amount chargeable in respect of depreciation under

this method remains constant from year to year. This method is also known as straight line

method because if a graph of the amounts of annual depreciation is drawn, it would be a straight

line.

Formula:

The following formula or equation is used to calculate depreciation under this method:

Annual Depreciation = [(Cost of Assets - Scrap Value)/Estimated Life of Machinery]

Journal Entries:

The journal entries that will have to be made under this method are very simple. The journal

entries will be as under:

1. Depreciation account       To Asset account  (Being the depreciation of the asset) 2. Profit and loss account       To Depreciation account  (Being the amount of depreciation charged to Profit and Loss account)

These entries will be passed at the end of each year so long as the asset lasts. In the last year, the scrap

will be sold and with the amount that realised by the sale the following entry will be passed:

3. Cash account       To Asset account  (Being the sale price of scrap realised.)

Advantages:

1. Fixed installment method of depreciation is simple and easy to work out

2. The book value of the asset can be reduced to zero.

Disadvantages:

1. This method, in spit of its being simplest is not very popular because of the fact that

whereas each year's depreciation charge is equal, the charge for repairs and renewals goes

on increasing as the asset becomes older. The result is that the profit and loss account has

to bear a light burden in the initial years of the asset but later on this burden becomes

heavier.

2. Interest on money is locked up in the asset is not taken into account as is done in some

other methods.

3. No provision for the replacement of the asset is made.

4. Difficulty is faced in calculation of depreciation on additions made during the year.

Diminishing Balance Method of Depreciation:

Definition and Explanation:

Diminishing balance method is also known as written down value method or reducing

installment method. Under this method the asset is depreciated at fixed percentage calculated

on the debit balance of the asset which is diminished year after year on account of depreciation.

Journal Entries:

The entries in this case will be identical to those discussed in the case of the fixed installment

method. Only the amount will be differently calculated.

Advantages of Diminishing Balance Method:

1. The strongest point in favor of this method is that under it the total burden imposed on

profit and loss account due to depreciation and repairs remains more or less equal year

after year since the amount after depreciation goes on diminishing with the passage of

time whereas the amount of repairs goes on increasing an asset grow older.

2. Separate calculations are unnecessary for additions and extensions, though in the first

year some complications usually arise on account of the fact that additions are generally

made in the middle of the year.

Disadvantages of Diminishing Balance method:

1. This method ignores the question of interest on capital invested in the asset and the

replacement of the asset.

2. This method cannot reduce the book value of an asset to zero if it is desired.

3. Very high rate of depreciation would have to be adopted otherwise it will take a very long

time to write an asset down to its residual value

Annuity Method of Depreciation:

According to this method, the purchase of the asset concerned is considered an investment of

capital, earning interest at certain rate. The cost of the asset and also interest thereon are written

down annually by equal installments until the book value of the asset is reduced to nil or its

bread up value at the end of its effective life. The annual charge to be made by way of

depreciation is found out from annuity tables. The annual charge for depreciation will be credited

to asset account and debited to depreciation account, while the interest will be debited to asset

account and credited to interest account.

Depreciation Fund Method or Sinking Fund Method of Depreciation:

Definition and Explanation:

Depreciation fund method is also known as sinking fund method or amortization fund

method. Under this method, funds know as depreciation fund or sinking fund is created. Each

year the profit and loss account is debited and the fund account credited with a sum, which is so

calculated that the annual sum credited to the fund account and accumulating throughout the life

of the asset may be equal to the amount which would be required to replace the old asset. In

order that ready funds may be available at the time of replacement of the asset an amount equal

to that credited to the fund account is invested outside the business, generally in gilt-edged

securities. The asset appears in the balance sheet year after year at its original cost while

depreciation fund account appears on the liability side.

Insurance Policy Method of   Depreciation:

Definition and Explanation:

Insurance policy method is a slight modification of the depreciation fund method or sinking

fund method. Under this method the amount represented by the depreciation fund, instead of

being used to buy securities, is paid to an insurance company as premium. The insurance

company issues a policy promising to pay a lump sum at the end of the working life of the asset

for its replacement.

Revaluation Method of Depreciation:

As the name implies under revaluation method, the assets are valued at the end of each period

so that the difference between the old value and the new value, which represents the actual

depreciation can be charged against the profit and loss account. This method is mostly used in

case of assets like bottles, horses, packages, loose tools, casks etc. On rare occasions when on

revaluation the value of an asset is found to have increased, it being of temporary nature not

taken into account.

Sum of the Years' Digits Method of Depreciation:

Definition and Explanation:

Sum of the Years' Digits Method an accelerated method of depreciation which is also based on

the assumption that the loss in the value of the fixed asset will be greater during the earlier years

and will go on decreasing gradually with the decrease in the life of such asset. The SYD is found

by estimating an asset's useful life in years, then assessing consecutive numbers to each year, and

totaling these numbers.

Double Declining Balance Method of Depreciation:

Double declining balance method is another type of accelerated depreciation method

followed generally in USA. The depreciation expense is computed by multiplying the asset cost

less accumulated depreciation by twice the straight line rate expressed in percentage. No

provision is made for salvage value of the asset.

Depletion Method of Depreciation:

Depletion method of depreciation is especially suited to mines, quarries, sand pits, etc.

According to it the cost of the asset is divided by the total workable deposits. In this way, rate of

depreciation per unit of output is ascertained. Depreciation in any particular year is charged on

the basis of the output during that year.

Basis of Use System of Depreciation of Depreciation:

One of the chief factors causing depreciation is use. For example in the case of plant and

machinery, it is the total number of hours for which the machines work is the main factor and not

their life. Therefore, depreciation should be charged on the basis of use. In order to calculate, the

total number of hours for which the machine is estimated to work is ascertained. The net cost of

the asset is divided by the number of hours estimated and the result would give the amount of

depreciation per hour. Each year depreciation would be written off at this rate on the number of

hours worked during the year

5. Problem in straight line method.

On 1st January 1991 X purchased machinery for Rs. 21,000. The estimated life of the machine

is 10 years. After it its breakup value will be Rs. 1,000 only. Calculate the amount of annual

depreciation according to fixed installment method (straight line method or original cost method)

and prepare the machinery account for the first three years.

Machinery Account

  Debit Side     Credit Side  

    Rs.     Rs.

1991 Jan. 1  To Bank account 21,000 1991 Dec. 31  By Depreciation account 2,000

      1991 Dec. 31  By Balance c/d 19,000

           21,000     21,000

       1992 Jan. 1  To Balance b/d 19,000 1991 Dec. 31  By Depreciation account 2,000

      1991 Dec. 31  17,000

           15,000     15,000

       1993 Jan. 1 To Balance b/d 17,000 1991 Dec. 31  By Depreciation account 2,000

      1991 Dec. 31  By Balance c/d 15,000

           17,000     17,000

6. Problem in Diminishing balance method or written down value.

On 1st January, 1994, a merchant purchased plant and machinery costing Rs. 25,000. It has been

decided to depreciate it at the rate if 20 percent p.a. on the diminishing balances method (written

down value method). Show the plant and machinery account in the first three years.

Plant and Machinery Account

 Debit Side

   Credit Side

 

Date  Rs

Date  Rs

1994 Jan. 1 To Cash 25,000 1994 Dec. 31 By Depreciation 5,000*

      " By Balance c/d 20,000

       

    25,000     25,000

       

1995 Jan. 1 To Balance b/d 20,000 1995 Dec. 31 By Depreciation 4,000**

      " By Balance c/d 16,000

       

    20,000     20,000

       

1996 Jan. 1 To Balance b/d 16,000 1996 Dec. 31 By Depreciation 3,200***

        By Balance c/d 12,800

       

    16,000     16,000

       

Formula or equation for the depreciation calculation may be written as follows:

*First year: 25,000 × 20% = 5000

**Second Year: (25000 - 5000) × 20% = 4,000

***Third Year: [25000 - (5,000 + 4,000)] × 20% = 3,200

UNIT-V

Section- A

1) Single entry system of Book-Keeping is

a) Complete

b) Accepted by tax authorities

c) Followed by many all

d) All the statements are in correct

Ans: d

2) By preparing the total debtors account. We can find out

a) Credit sales

b) Credit purchases

c) Capital

d) Net profit

Ans: b

3) Single entry system offers

a) A complete record

b) An Incomplete record

c) Accuracy

d) Clarity

Ans: b

4) Trial Balance can be prepared in case the books are maintained according to single entry

system.

Ans: False

5) Under net worth method of single entry, profit is ascertained by calculating the increase in net

worth after adjusting for drawings and additions to capital.

Ans: True

Section – B

1. What is single entry system? Explain its salient features.

Meaning Of Single Entry System

Single entry system is an incomplete form of recording financial transactions. It is the system,

which does not record two aspects or accounts of all the financial transactions. It is the system,

which has no fixed set of rules to record the financial transactions of the business. Single entry

system records only one aspect of transaction. Thus, single entry system is not a proper system of

recording financial transactions, which fails to present complete information required by the

management. Single entry system mainly maintains cash book and personal accounts of debtors

and creditors. Single entry system ignores nominal account and real account except cash account.

Hence, it is incomplete form of double entry system, which fails to disclose true profit or loss

and financial position of a business organization.

Features of Single Entry System

The following are the main features of single entry system:

1. No Fixed Rules

Single entry system is not guided by fixed set of accounting rules for determining the amount of

profit and preparing the financial statements.

2. Incomplete System

Single entry system is an incomplete system of accounting, which does not record all the aspects

of financial transactions of the business.

3. Cash Book

Single entry system maintains cash book for recording cash receipts and payments of the

business organization during a given period of time.

4. Personal Account

Single entry system maintains personal accounts of all the debtors and creditors for determining

the amount of credit sales and credit purchases during a given period of time.

5. Variations in Application

Single entry system have no fixed set of principles for recording financial transactions and

preparing different financial statements. Hence, it has variations in its application from one

business to another.

2. Explain two methods of ascertaining profit in single entry system.

Every business firm wishes to ascertain the results of its operations to assess its efficiency and success and failures. This gives rise to the need for preparing the financial statements to disclose:

(a) The profit made or loss sustained by the firm during a given period; and

(b) The amount of assets and liabilities as at the closing date of the accounting period.

Therefore, the problem faced in this situation is how to use the available information in the incomplete records to ascertain the profit or loss for the particular accounting year and to determine the financial position of an entity as at the end of the year. This can be done in two ways:

1. Preparing the Statement of Affairs as at the beginning and as at the end of the accounting period, called statement of affairs or net worth method.

2. Preparing Trading and Profit and Loss Account and the Balance Sheet by putting the accounting records in proper order, called conversion method.

Section – c

1. What are the differences between single entry system and double entry system of book keeping?

The following are the differences between single entry and double entry system:

1. Meaning

Single entry system is an incomplete system of recording financial transactions. Double entry

system is a complete system of recording and reporting financial transactions.

2. Duality

Single entry system is not based on the concept of duality. Double entry system is based on the

concept of duality.

3. Accounts

Single entry system maintains only personal accounts of debtors and creditors and cash book.

Double entry system all personal, real and nominal accounts.

4. Trial Balance

Single entry system cannot prepare a trial balance and hence, arithmetical accuracy of books of

accounts cannot be checked. Double entry system prepares trial balance and hence, arithmetical

accuracy of the books of accounts can be checked.

5. Profit or Loss

Single entry system cannot ascertain the true amount of profit or loss of the business as it does

not maintain nominal accounts. Double entry system ascertains true profit or loss of the business

as it maintains all nominal accounts.

6. Financial Position

Single entry system cannot ascertain the true financial position of the business because it does

not maintain real accounts except cash book. Double entry system ascertains financial position of

the business as it maintains all personal and real accounts.

7. Suitability

Single entry system is suitable to a small business where only limited number of transactions are

performed. Double entry system is suitable for a large business.

8. Tax Purpose

Single entry system is not acceptable for the purpose of assessment of tax. Double entry system

is acceptable for the purpose of assessment of tax. 

2. What is a “Statement of affairs”? How does it differ from Balance sheet?

Correct final accounts of a business can be prepared in the records are maintained under the

double entry system. How every where the record is incomplete, and it is not all possible to

complete it by double entry, in such cases the final accounts can be only approximately prepared

by means of a statement of affairs. In appearance the statement of affairs is similar to

a balance sheet

Both statement of affairs and balance sheet show the assets and liabilities of a business entity on

a particular date. However, there are some fundamental differences between the two. A statement

of affairs is prepared from incomplete records where most of the assets are recorded on the basis

of estimates as compared to a balance sheet which is prepared from records maintained on the

basis of double entry book-keeping and all assets and liabilities can be verified from the ledger

accounts. Hence, a balance sheet is more reliable than a statement of affairs. The objective of

preparing a statement of affairs is to ascertain the amount of capital account as on that date

whereas a balance sheet is prepared to know the financial position of the business at a particular

date. In statement of affairs, an item of assets or liabilities may get omitted and this omission

may remain unknown because the effect of this omission gets adjusted in the capital account

balance and the total of both sides of statement match. However, in case of a balance sheet the

possibility of omission of any item is remote because in case of an omission, the balance sheet

will not agree and the accountant will trace the missing item from accounting records. These

differences have been shown in a tabular form as under:

3. What are the advantages and disadvantages of single entry system?

The following are the notable disadvantages of single entry system:

1. Simple and EasySingle entry system is simple to understand and easy to maintain as it has no fixed set of principles to follow while recording financial transactions.

2. EconomySingle entry system is an economical system of recording financial transactions. It does not require hiring skilled accounting personnel to record financial transactions of the business. Further, it does not require large number of books to record the limited number of financial transactions.

3. Easy to Calculate ProfitUnder single entry system, the amount of profit can be determined easily. The amount of profit or loss of the period can be determined by making comparison between the amounts of closing capital and opening capital.

4. Suitable for Small BusinessThe single entry system is simple, easy, and economical system. It is suitable for small businesses because they cannot afford the cost of double entry system. Besides, small business is not required to maintain their books of accounts under double entry system.

The following are the notable disadvantages of single entry system

1. Unscientific and Unsystematic

The single entry system is unsystematic and unscientific system of recording financial

transactions. It does not have any set of fixed rules and principles for recording and reporting the

financial transactions.

2. Incomplete System

Single entry system is incomplete system because it does not record the two aspects or accounts

of all the financial transactions of the business. It does not maintain any record of the

transactions relating to the nominal account and real account except cash account.

3. Lack of Arithmetical Accuracy

Single entry system is not based on the principles of debit and credit. It fails to provide the

arithmetical accuracy of the books of accounts. Trial balance cannot be prepared under this

system to check the arithmetical accuracy of books of accounts.

4. Does Not Reflect True Profit or Loss

Under single entry system, the true amount of profit or loss cannot be ascertained because it does

not maintain the nominal accounts.

5. Does Not Reflect True Financial Position

The single entry system does not maintain real accounts except cash book. Therefore, it cannot

reveal the true financial position of the business.

6. Frauds and Errors

The single entry system of book-keeping is incomplete, inaccurate and unscientific. It does not

help to check the arithmetical accuracy of the books of accounts. Therefore, there is always a

possibility of committing frauds and errors in the books of accounts.

7. Unacceptable for Tax Purpose

The single entry of book keeping has incomplete records of the financial transactions of the

business. Hence, the tax office cannot accept the account maintained under this system for the

purpose of assessment of tax.

4. Prepare the model of statement of affairs and Profit or Loss account.

Under this method, statements of assets and liabilities as at the beginning and at the end of the

relevant accounting period are prepared to ascertain the amount of change in the capital during

the period. Such a statement is known as statement of affairs, shows assets on one side and the

liabilities on the other just as in case of a balance sheet. The difference between the totals of the

two sides (balancing figure) is the capital. Though statement of affairs resembles balance sheet, it

is not called a balance sheet because the data is not wholly based on ledger balances. The amount

of items like fixed assets, outstanding expenses, bank balances, etc. is ascertained from the

relevant documents and physical count.

Once the amount of capital, both at the beginning and at the end is computed with the help of

statement of affairs, a statement of profit and loss is prepared to ascertain the exact amount of

profit or loss made during the Year. The difference between the opening and closing capital

represents its increase or decrease which is to be adjusted for withdrawals made by the owner or

any fresh capital introduced by him during the accounting period in order to arrive at the amount

of profit or loss made during the period. The statement of profit and loss is prepared as

5. Calculate the profit made by Mrs. Vandana during the year using statement of affairs method.

Mrs. Vandana runs a small printing firm. She was maintaining only some records, which she

thought, were sufficient to run the business. On April 01, 2004, available information from her

records indicated that she had the following assets and liabilities:

Printing Press Rs. 5, 00,000, Buildings Rs. 2, 00,000, Stock Rs. 50,000, Cash at bank Rs. 65,600,

Cash in hand Rs. 7,980, Dues from customers Rs. 20,350, Dues to creditors Rs. 75,340 and

Outstanding wages Rs. 5,000. She withdrew Rs. 8,000 every month for meeting her personal

expenses. She had also introduced Rs. 15,000 during the year as additional capital. On March 31,

2005 her position was as follows: Press Rs. 5, 25,000, Buildings Rs. 2, 00,000, Stock Rs. 55,000,

Cash at bank Rs. 40,380, Cash in hand Rs. 15,340, Dues from customers Rs. 17,210, Dues to

creditors Rs. 65,680.

6. Problem.

Mrs. Surabhi started business on Jan 01, 2005 with cash of Rs. 50,000, furniture of Rs. 10,000,

goods of 2,000 and machinery worth 20,000. During the year she further introduced Rs. 20,000

in her business by opening a bank account.

From the following information extracted from her books, you are required to prepare final

accounts for the ended December 31, 2005.

Mrs. Surabhi used goods worth 2,500 for private purposes, which is not recorded in the books.

Charge depreciation on furniture 10% and machinery 20% p.a. on Dec. 31, 2005 her debtors

were worth 70,000 and creditors Rs. 35,000, stock in trade was valued on that date at Rs. 25,000.