Fundamental Principles of Accounting 9781642875843, 9788184884517

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Fundamental Principles of Accounting

By

Dr. Sharda Gangwar M.Com. Ph.D. Institute for Excellence in Higher Education, Bhopal.

&

D. K. Gangwar M.Com.

1m GfIimalaya GflublishingGfIouse MUMBA! • NEW DELHI· NAGPUR • BANGALOGf • HYDERABAD • CHENNAI • PUi,E • LUr:KNOW • AH~.'~:i. ,;\~1 "

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Authors No part of this book shall be reproduced, reprinted or translated for any purpose whatsoever without prior permission of the Publisher in writing.

First Edition

2009

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CONTENTS

Chapter - I

1 - 15

Basic Concept and Principles of Accounting

Introduction, Concepts, Definition of book-keeping, Meaning of Accounting, History and Objective of Accounting, Importance of Accounting, Development of Accounting, Functions of Accounting, Limitations, Classification of Accounting Chapter - II

Accounting Concepts and Conventions, Accounting Standards

16 - 24

Basic Accounting Concept, Conventions, Accounting Standard Chapter - III

Recording of Financial Data

25 - 75

Double Entry System of Book-keeping, Journal Rules for Debit & Credit, Sub-divisions of the Journal, Ledger, Ledger Posting, Balancing of an Account, and Advantages of Subsidiary Records Chapter - IV

Trial Balance

76 - 94

Meaning, Characteristics, Objects and Importance, Method of Preparing Trial Balance, Errors, Limitations Suspense Accounts Chapter - V

Errors and their Rectification

95 - 116

Errors in Accounting, Errors Affect the Agreement of Trial Balance, Errors of Pre-final Account Stage, Post Suspense and Post Final Account Stage Chapter - VI

Final Accounts

117 - 129

Trading Account, Profit and Loss Account, Manufacturing Account, Balance Sheet, Classification of Assets and Liabilities, Difference between Trading and Profit and Loss Account Chapter - VII

Final Accounts with Adjustment

130 - 187

Introduction, Objects, Advantages of Balance Sheet, Different Types of Adjustments, Calculation of Manager's Commission on Gross Profit or Net Profit

Chapter - VIII Capital and Revenue

188 - 201

Capital Expenditure, Revenue Expenditure, Deferred Revenue Expenditure, Capital and Revenue Items, Distinction between Capital Expenditure and Revenue Expenditure

Chapter - IX

Self-Balancing Ledger

202 - 237

Meaning, Debtors Ledger, Creditors Ledger, General Ledger, Sectional Balancing, Self Balancing, Interledgers Transfers, Multiple Ledger Contra Balance, Rectification of Errors

Chapter - X

Depreciation Accounts

238 - 271

Meaning, Definition, Objectives of Depreciation, Causes of Depreciation, Methods of Depreciation, Accounting System for Depreciation, Provision and Reserve Meaning, Definition, Objectives of Provision, Different Types of Reserves

International Accounting Standards

272 - 330

Chapter I Basic Concepts and Principles of Accounting

Accounting means to maintain some record for keeping data. In that mattel it is necessary for a man, business and anyone, who records some data, to keel a book as memory of a person is limited and remember various information forever Book-keeping is that part of knowledge which tells us how to keep a record 0 financial transactions. Book-keeping and Accounting process are also considered a: evidence in the courts to prove claims and it is also compulsory for Income-ta) Authority. Nowadays people, who are earning and. spending, must maintain a noteboo~ or diary or register in which details of the transactions have been recorded. The fundamental thought behind this record is to show a correct position relating to « monthly income and expenditure and to know how much money are saved. Then is need for keeping such record in systematic manner, for this purpose are made some rules and accounting standards.

BOOK·KEEPING Book-keeping is a combination two words 'book' + 'keeping' which mean: maintaining the books or accounts in a proper, systematic and ruled way. Firstly the business transactions must be identified and they must be supported by the

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Fundamental Principles of Accounting

documents. In that matter we can say that book-keeping may be described as the recorded book for money and money matters. According to L.e. Cropper "Bookkeeping may be defined as the science of recording transactions in money or money' s worth in such a manner that at any subsequent date, their nature and effect may be clearly understood, and that when required a combined statement of their result may be prepared." R.N. Carter view in reference to book-keeping" Book-keeping is the science and art of correctly recording in books of account all those business transactions that result in the transfer of money ' s worth." North Cort says, "Book-keeping is an art of recording in books of accounts the monetary aspects of financial transactions." N. Sarkar observes "Book-keeping is the science and art of correctly and systematically recording in the books of accounts the business transactions of an individual or a concern in such a way as to show clearly the monetary effects of each of such transactions." In brief, book-keeping is an art and science of correct data recording of the transactions of an organization in a systematic way. It is a record-making phase of accounting. It facilitates easy flow of financial information at any point of time about the concern to all parties connected with it such as investors, creditors, shareholders, Government, researchers and employees. Book-keeping includes recording of journal, posting in ledgers and balancing of accounts. All the records before the preparation of trial balance is the whole subject matter of book-keeping. PROCESS OF BOOK-KEEPING

1. Identifying accounting transactions: All business transactions which are financial in nature and have documentary proof are accounting. Noneconomic activities concerning emotions of love, patriotism and respect do not find place in book-keeping. 2. Initial record of accounting transactions: The identities accounting are passed through subsidiary books, such as purchases books, sales books etc. 3. Preparations of ledger accounts: All the information relating to a particular person, party or items are put together at one place under one head, which is known as ledger account. 4. Balancing ledger accounts: Ledger accounts are balanced, i.e., the difference between the debit and credit side of the ledger accounts are ascertained. Personal accounts show the amount payable to or receivable from them. Asset account shows the value of asset on a particular date. Ledget; account, thus, reveal the balances of expenses, revenue, liability, capital and assets.

Basic Concepts and Principles of Accounting

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5. Preparations of trial balance: Trial balance is prepared with balances shown by the ledger accounts. While passing journal entries and preparing subsidiary books we take into consideration the dual aspect of every transaction, so the debit and credit balance of the trial balance must tally.

ACCOUNTING Accounting means that to calculate accurate profit or loss for period of one year by a business concern and also to know the extent of assets and liabilities possessed by a business for a period. A businessman must keep a systematic record of day-to-day transaction so that it can be known what is the exact position of the business. A systematic record of transaction presents a complete financial frame. Accounting IS the measurement, statement, or provision of assurance about financial information primarily used by lenders, managers, investors, tax authorities and other decision makers to make resource allocation decisions between and within companies, organizations, and public agencies. The terms derive from the use of financial accounts. Accounting has been defined by the AICPA as " The art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character. and interpreting the results thereof." Financial accounting is one branch of accounting and historically has involved processes by which financial information about a business is recorded, classified, summarised, interpreted, and communicated; for public companies and other businessman, who want to know that what is the real profit and financial position of business, this information is generally publicly accessible. Practitioners of accountancy are known as accountants. There are many professional bodies for accountants throughout the world. History of Accounting Early History

Accountancy's infancy dates back to the earliest days of human agriculture and civilization (the Sumerians in Mesopotamia, and the Egyptian Old Kingdom.) Ancient economic thought of the Near East facilitated the creation of accurate records of the quantities and relative values of agricuiLural products, methods that were formalized in trading and monetary systems by 2000 B.C. Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents. The Islamic Quran also mentions simple accounting for trade and credit arrangements Twelfth-century A.D. Arab writer Ibn Taymiyyah mentioned in his book Hisba (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century A.D. These accounting practices were influenced by the Roman and the Persian civilisations that Muslims interacted with.

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Fundamental Principles of Accounting

The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Vmar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Vmar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.

Luca Pacioli and the Birth of Modern Accountancy Luca Pacioli (1445-1517), also known as Friar Luca dal Borgo, is credited for the "birth" of accounting. His Summa de arithmetica, geometrica, proportioni et proportionalita was a textbook for use in the abbaco schools of northern Italy, where the sons of merchants and craftsmen were educated. It was a compenqium of the mathematical knowledge of his time, and includes the first printed description of the method of keeping accounts that Venetian merchants used at that time, known as the double-entry accounting system. Although Pacioli codified rather than invented this system, he is widely regarded as the ·"Father of Accounting". The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equalled the credits! His ledger had accounts for assets (including receivables and inventories), liabilities, capital, income, and expenses - the account categories that are reported on an organization's balance sheet and income statement, respectively. He demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger. His treatise also touches on a wide range of related topics from accounting ethics to cost accounting. The first known book in the English language on accounting was published in London, England by John Gouge (or Gough) in 1543. It is described as A Profitable Treatyce called the Instrument or Boke to learn to know the good order of the kepyng of the famouse reconynge, called in Latin, Dare and Habere, and, in English, debtor and CreditorJcitation needed] A short book of instructions was also published in 1588 by John Mellis of Southwark, England, in which he says, "I am but the renuer and reviver of an ancient old copies printed here in London the 14 of August 1543: collected, published, made, and set forth by one Hugh Oldcastie, Schoolmaster, who, as reappeared by his treatise, then taught Arithmetics, and this book in Saint Ollaves parish in Marko Lane." Mellis refers to the fact that the principle of accounts he explains (which is a simple system of double entry) is "after the former of Venice." A book described as The Merchants Mirrour, or directions for the perfect ordering and keeping of his accounts formed by way of Debitor and Creditor, after the (so termed) Italian manner, by Richard Dafforne, accountant, published in 1635, contains many references to early books on the science of accountancy. In a chapter in this book, headed "Opinion of Book-keeping's Antiquity," the author states, on the authority of another writer, that the form of book-keeping referred to had then been in use in Italy about two hundred years, "but that the same, or one in many parts very like this, was used in the time of Julius Caesar, and in Rome

Basic Concepts and Principles of Accounting

long before." He gives quotations of Latin book-keeping terms in use in ancient times, and refers to "ex Oratione Ciceronis pro Roscio Comaedo"; and he adds: An early Dutch writer appears to have suggested that double-entry bookkeeping was even in existence among the Greeks, pointing to scientific accountancy having been invented in remote times. There were several editions of Richard Dafforne's book - the second edition in 1636, the third in 1656, and another in 1684. The book is a very complete treatise on scientific accountancy, beautifully prepared and containing elaborate explanations. The numerous editions tend to prove that the science was highly appreciated in the 17th century. From this time on, there has been a continuous supply of literature on the subject, many of the authors styling themselves accountants and teachers of the art, and thus r:roving that the professional accountant was then known and employed. Accountancy Methods and Fields

• Lean accounting • Cost accounting • Cash-basis and accrual-basis accounting • Financial accountancy • fund accounting • Internal and external accountancy • Management accounting • Project accounting • Positive accounting • Social and Environmental accounting • Tax accounting Accounting Principles (A) Personal Account

(B) Real Account (C) Nominal Account

1. Personal Account: Dr. the receiver and Cr. the giver 2. Real Account: Dr. what comes in and Cr. what goes out 3. Nominal Account: Dr. all expenses and losses and Cr. all incomes and gains. This is called Principles of accounting or Golden Principles. Accounting principles, rules of conduct and action are described by various terms such as concepts, conventions, tenets, assumptions, axioms and postulates.

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Fundamental Principles of Accounting

Types of Accountancy

The following list is intended to give some idea of the breadth and scope of the accountancy profession: • lean accounting • auditing • book-keeping • chartered accountant • cost accounting • management accounting • financial accounting • social accounting • forensic accounting • taxation advice • public accountancy • internal accountancy • external accountancy • standard accounting practices • inflation accounting • list of accounting topics • list of accountancy bodies • list of finance topics • list of business law topics Systems of Financial Accounting 1. Cash System 2. Single Entry System 3. Double Entry System 4. Indian System of Accounts Definition of Accounting

The American Institute of Certified Public Accountants has defined accountancy as "the art of recording, classifying and summarizing in a significant manner and in terms of money, transaction and events which are in the part at least of a financial character and interpreting the result thereof." According to the this definition, following points are founded: (a) Recording of transactions and events in terms of money. (b) Classification or preparation of accounts.

Basic Concepts and Principles of Accounting

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(c) Summarizing the accounts or preparation of Profit and Loss Account and Balance Sheet of the business. (d) Interpreting the results. (e) Financial position of the business. Other Definitions of Accounting

According to R.N. Anthonl: "An accounting system is a means of collecting, summarizing, analysing and reporting in monetary terms information about the business." Harold Bierman says: "Accounting may be defined as the identifying, measuring, recording and cummunicating of financial information." On the basis of above definitions we can say that accountancy is the language of business and the activities of business are communicating to those who are related to it, like trader, owner customer, suppliers as well as others through accounting information which has to be suitably recorded, classified, summarized and presented and also interpreting the results. Importance of Accounting

Every person who is involoved in· any business and wants to know that what is his earning and what is future possibility to earn more profit, he has to know about accounting. The progress and reputation of any business is built upon the sound and perfect f.inancial footing. There are many persons who are interested to know about accounting and accounting treatment. Following are the methods institutions who like to use accounting. 1. Capitalists - Persons who invest their own money to the business, they have curiosity in knowing whether the business is being conducted on good basis or not and whether the capital is being employed properly or not. Businessman always keep an eye on the earning from investment. 2. Investors - Investors, who want to invest their money in a business, they know about the progress of business through accounting. The financial statement of the business shows all the financial activities of the business. And also analysis of accounting. 3. Management - For the purpose of future planning, management is interested in knowing the true position of the business. Through the books of accounting, manager can study and analyze the business. 4. Creditor - Creditors, who supply the raw material to the business on credit, they know about the credibility of the firm, their what is the system of their payment and how much time is used to pay money. 5. Customers - Customers, who are the most important part of the business. In absense of customers, we will not earn any profit from the businL'~~. They are interested in getting reduction in the cost of a product. And al:;\)

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Fundamental Principles of Accounting

want to know about the original cost of the product and the final amount of the product. 6. Government - Government intervenes business, if businessman earn much more profit from the business. Government can restrict the business, if businessman demands extra profit.

Development of Accounting Accounting is the process of identifying, measuring and communicating economic information so a user of the information may make informed economic judgments and decisions based on it. Accounting is the degree of measurement of financial transactions which are transfers of legal property rights made under contractual relationships. Non-financial transactions are specifically excluded due to conservatism and materiality principles. At the heart of modern financial accounting is the double-entry book-keeping system. This system involves making at least two entries for every transaction: a debit in one account, and a corresponding credit in another account. The sum of all debits should always equal the sum of all credits, providing a simple way to check for errors. This system was first used in medieval Europe, although claims have been made that the system dates back to Ancient Rome or Greece. According to critics of standard accounting practices, it has changed little since. Accounting reform measures of some kind have been taken in each generation to attempt to keep book-keeping relevant to capital assets or production capacity. However, these have not changed the basic principles, which 'are supposed to be independent of economics as such. In recent times, the divergence of accounting from economic principles has resulted in controversial reforms to make financial reports more indicative of economic reality. Critical approaches such as social accounting challenge conventional accounting, in particular financial accounting, for giving a narrow image of the interaction between society and organisations, and thus artificially constraining the subject of accounting. Social accounting in particular argues that organisations ought to account for the social and environmental effects of their economic actions. Accounting should thus not only embrace descriptions of purely economic events, not to be exclusively expressed in financial terms, aim at a broader group of stakeholders and broaden its purpose beyond reporting financial success.

Function of Accounting Accounting refers to process of preparing and presenting the accounts in a scientific and systematic manner. In other words, accounting is the art of recording, classifying and summarising in a significant manner and in terms of money and transaction. Accounting has to satisfy government and legal requirements also. Following are the functions regarding accounting:

Basic Concepts and Principles of Accounting

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1. Recording of business transactions - The primary function of accounting

is to keep systematic record of financial transactions like journalisation, posting, and preparation of final accounts. The purpose of this function is to report continously to the concern party by means of financial statements.

2. To know actual financial position -

To know financial position, we have to prepare finacial statement like trading account, profit and loss account and balance sheet. On this basis that the earning capacity and financial position of the unit concerned can be found out, which may be of great use to the owner and various other parties.

3. For managerial function - Through the accounting process, decision making programme can be made properly. The managerial function and decision making programmes, without accounting, may mislead. Daily transactions and business activities affect to decision making. So it is a most important function of accounting.

4. According to l,aw - Accounting and auditing are the cumpulsory in the case of a registered firm. Without accounting, auditing is not possible .and without accounting a firm is not run properly. Accounting is a base, with its help various returns, documents, a\statements etc. are prepared.

5. For language purpose - Everyone has own language, like this the accounting is the language of business and information about business is L'ummunicated to others through accounting statement. In business many patties are involved like owners, creditors, government, employees and customers are knowing the result of the firm and this can be communicated only through accounting.

6. Protection of assets - In business, different types of assets are included. Accountant is always keen to see that unused and unauthorised assets should not are remain in the business. For this purpose he keeps an eye on the assets. And depreciation is also charged on the value of the asset. All these things compulsory in accounting.

7. Measurement of past performance - Accounting keeps proper record of all economic events, prepares ledger accounts and reports the results of past performance. Here, accounting period is supposed to consist of 12 months. We record and report only those economic events, which have already accrued.

8. Controlling of performance - The actual performance of the business is compared with the desired performance and deviations, if any are ascertained.

9. Honouring legal commitment of the business - Accounting data must be prepared and presented to honour the legal formalities of various acts.

10. Helping decision making - The management is required to formulate future policies and take important decisions. This decision making process needs accounting information as source documents.

Fundamental Principles of Accounting

Chllrll(teristics of Accounting

1. Economic events - An economic event is known as a happening of consequence to a business oraganization. It is related to business which has a definite consequence of increased asset and decreased cash.

2. Identification, measurement, recording and communication Identification involves analysis of the events as regards its materiality which is reflected in accounting books. Measurement involves qualification of business transaction in monetary terms. Recording involves systematic presentation of a transaction to reflect the amount involved and other pertinent details of the transaction. Communication of economic events in a systematic manner aids in managerial decision making. Analysis of reports in terms of ratio, percentage etc. should be done to arrive at effective decision. 3. Organization - The entity performance business activity can be organized by choosing appropriate form of organization. It can either be sole proprietorship, partnership, company, cooperative society on boards .

..J. Interested users of information - The users can be divided into two categories - internal and external. They need accounting information for their decision making purpose. Information is provided as regards sales, ca;:;h, expenses for future decisions.

Basic Concepts and Principles of Accounting

Limitation of Accounting

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Accounting is helpful to determine the financial position of business and also to calculate actual profit or loss of business. But it enables the busIness to take important decisions for future. And one thing, if the businessman has not given actual expenditure and income then it is impossible to calculate the real profit of the business. So we cannot say that the accounting information is cent per cent and true. At times it is biased and manipulated. We take one example, if Ram sold goods to Shyam at Rs. 10,500, but he show in own accounts only Rs. 10,000, how to calculate actual profit of the business. Following are the main limitations of accounting:

1. False Information - Accounting system of any business records only those transactions which are available by the businessman, if businessman gives a wrong information, then it is difficult to calculate accurate profit or loss. 2. Incomplete Information - Accounting system of any business records only those transactions ehich are financial in nature. It records only the quantitative aspect of our transactions. Transactions such as competency of the market and change in the economic and political situations, Government policies, competition in the market and change in consumer behaviour and tastes etc. are not recorded in accounting though they affect the financial soundness of the business. 3. Valueless Assets and deffered revenue expenditure - There are certain assets which do not have real value but they are shown in the Balance sheet and like this some deffered revenue expenditure which are shown in the Balance sheet but they are actually expenditure and create assets of the business. Unvaluable assets are goodwill, patents, preliminary expenses, discount on issue of shares etc. Showing these assets in the books of accounts make its results doubt. 4. Inexactness - Accounting assesses profit or loss of the business on the basis of both the real and assumed estimates. Different firms have their own different methods, so the results of the business will change with change in the practice. Accounting as an Information System

1. Payroll accounting sub-system - Payment of wages and salaries are covered under their sub-system. Various reports like wage bill, overtime payment and payment on account of leave encashment etc. are generated through this sub-system. 2. Fixed assets accounting sub-system - It records the purchase, addition and usage of fixed assets such as land and building, machinery and equipments etc. 3. Inventory accounting sub-system - It is used to record different items purchased and issued specifying the price, quantity and date. Inventory position and valuation reports are generated.

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Fundamental Principles of Accounting

4. Purchase and accounts payable sub-system - It is related to creditor status as regards credit purchase and payment to them. S. Cash sub-system - It deals with receipt and payments of cash in physical place as well as electronic transfer, from electronic transfer it takes through bank transfer and credit card entry. 6. Sales and accounts receivable sub-system - It deals with recording sales, maintaining sales ledger and funds transfer. Periodic report like sales and collection, receivables etc. are generated. 7. Management information as sub-system - It deals with sales and accounts receivable sub-system. Tax accounting sub-system and obtains necessary infOImation for decision making. S. Tax accounting sub-system - It is related to management information sub-system on one hand and budget information system on the other. 9. Budget sub-system - Preparation of budget and its comparison with actual performances are key output of this sub-system. 10. Final account sub-system - It is concerned with costing and budget sub-system and obtains and supplies information to accounting system. 11. Costing sub-system - This is an interlinked sub-system for ascertainment of cost of goods produced. 12. Expenses accounting sub-system - It is related to costing and payroll accounting system. It acquires from and feeds information accounting system. Importance of System Approch to Accounting ~

Accounting information system is an interactive system with marketing, personnel, research and development etc. It aids other sub-system for their effective performance.

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At the organization level it helps internal management and external users like investors, creditors etc. to get a picture of organization at performance.

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It aids quick and effective decision making.

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Accuracy and speed of reporting and flow of information is greatly facilitated.

Classification of Accounting Accounting can be classified into the following categories: 1. Financial accounting - Under this accounting system business transactions are recorded on primary basis to final statement. This accounting system is to record business transactions in the books of accounts in such a way that operating results for a particular period and financial condition ona financial year can know the correct information of the various person.

Basic Concepts and Principles of Accounting

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2. Cost Accounting - For calculating actual cost this accounting system is used. It relates to the collection, classification, ascertainment of cost and its accounting and cost control system relating to the various part of cost and through which we can calculate different costs.

3. Management Accounting - This accounting is used for collecting data with the help of financial accounting. It helps making decision by manager to earn more profit thinks. If at any point management that the profit earning is not proper then they connect the profit to other fields. The accounting which is prepared exclusively for the use of management is called management accounting.

OBJECTIVE QUESTIONS 1. Transaction means (a) Giving of something (b) Taking of something (c) Exchange consisting of giving and taking (d) Exchange, which is stated in monetary value 2. Which is the last step of accounting as a process of information (a) Recording of data in the books of accounts (b) Preparation of summaries in form of financial statements (c) Communication of information (d) Analysis and interpretation of information 3. Use of common unit of measurement and common format of reporting promotes the following characterstics: c,

(a) Comparability (b) Understandability ( c ) Relevance (d) Reliability 4. Information supplied should influence decision maker to take decision is (a)

Reliability

(b) Understandability (c) Comparability (d) Relevance

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Fundamental Principles of Accounting

5. During the lifetime of an entity accounting produce financial statement in accordance with basic accounting concept: (a) Conservation (b) Matching (c) Accounting period (d)

None of the above

6. A concept that a business enterprise will not be sold or liquidated in the near future is known as (a) Going concern (b) Economic activity (c) Monetary unit (d) None of the above 7. The primary qualities that make a accounting information useful for decision making are: (a) Relevance and freedom from bias (b) Reliablity (c) Comparability and consistency (d)

None of the above

Answer 1. Exchange consisting of giving and taking 2. Analysis and interpretation of information 3. Comparability 4. Reliability 5. Accounting period 6. Going concern 7. Relevance and freedom from bias

Theoretical Questions 1. What do you mean by Book-keeping?

2. What is the aim of Book-keeping and Accountancy? 3. Write history of Accounting. 4. Distinguish between Book-keeping and Accountancy. 5. Describe the advantages of Book-keeping.

Basic Concepts and Principles of Accounting

6. Write the merits of Accountancy. 7. Write short note on Accounting. 8. Describe the conventions of Accounting. 9. Explain going concern concept. 10. Give the classification of Accounting. II. What is the Importance of System Approch to Accounting? 12. How is Accounting as an information system? 13. What is the functions of Accounting? 14. Write the Accounting Principles. 15. What are the basic concept of Financial Accounting?

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Chapter II Accounting Concepts and Conventions, Accounting Standards

In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. The theory of accounting has, therefore, developed the concept of a "true and fair view." The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business activities. To support the application of the "true and fair view", accounting has adopted certain concepts and conventions that help to ensure that accounting information is presented accurately and consistently.

Accounting Concepts The fundamental ideas or basic assumptions underlying the theory and practice of financial accounting and broad making rules for all accounting activities, developed by professionals are listed and discussed below:

Accounting Concepts and Conventions, Accounting Standards

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• Entity concept - Business is assumed to have a distinct entity, i.e., existence other than the existence of its proprietors and other business units. We as an accountant, will have to record business transactions from firm's point of view and never from the viewpoint of proprietors. • Dual aspect concept - Every business transaction has double effect. There are two sides of every transaction. This is evident when we study the accounting term, i.e., assets, capital and liabilities.

• Going concern concept - While recording business transactions in the books of accounts, we assume that the business will be carried on indefinitely. This is why, the business purchase fixed assets like land and building, plant and machinery, vehicles and furniture etc. • Accounting period concept - The concept of accounting period facilitates the business in assessing worth after a year. In order to make accounting meaningful, useful and legal accounting year cannot be ignored by any business house. • Money measurement concept - In accounting, we identify and record only those business transactions which are financial in nature. Accounting transactions must have their monetary value. The worth of the transaction must be measured in terms of money. • Historical cost concept - According to this concept all business transactions must be recorded in the books of accounts at their montary cost of acquisition. The use of historical cost as the basis provides verifiable and objectives accounting information. • Realization concept - Accounting should disclose all the material information and assets realisation account, here means the information and realisation which would have changed the results of the business, if it would have been disclosed. • Accounting methods (includes a discussion on the concept of accruals) - The assumption of verifiable objectives that every business record must be based and supported by documentary evidence like receipts, bill, invoices, cash memos etc. • Understandability - According to this accounting concept every accounts and other business papers must be understandable. Accountant can understand if all the papers are understandable. • Conservatism - The business according to this principles adopts a safe policy. It accounts for all the prospective losses but leaves aside all the profits. • Comparability - Business is a going concern. It has to continue indefinitely. Important conclusions are drawn by comparing accounting statements of the current year with statements of the previous years. Accurate comparisons can be made if the methods and practice of accounting and presentation of accounts does not change.

•

Fundamental Principles of Accounting

• Accrual (also known as Matching principle) - According to this principle income can be ascertained by matching revenue of the business with its costs.

ACCOUNTING CONCEPTS Four important accounting concepts underpin the preparation of any set of accounts: Going Concern

Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities.

Consistency

Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.

Prudence

Profits are not recognized until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (they are "provided for" in the accounts as soon as there is a reasonable chance that such costs will be incurred in the future.

Matching (or "Accruals")

Income should be properly "matched" with the expenses of a given accounting period.

Accounting Conventions

• Convention of disclosure - This convention is also known as convention of full disclosure. Accounting must disclose all material information. It should be honestly prepared free from any bias, favour or prejudice. Figures should be correct. • Convention of materiality - Accounting should disclose all the material information. Materiality, here means the information which would have changed the results of the business, if it would have been disclosed. • Convention of consistency - Business is a going concern. It has to continue indefinitely. Important conclusions are drawn by comparing accounting statements of the current year with statements of the previous years. Accurate comparisons can be made if the methods and practice of accounting and presentation of accounts does not change. The most commonly encountered convention is the "historical cost convention." This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost. Under the "historical cost convention", therefore, no account is taken of changing prices in the economy.

Accounting Concepts and Conventions, Accounting Standards

•

The other conventions you will encounter in a set of accounts can be summarized as follows: Monetary measurement

Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc.

Separate Entity

This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.

Realization

With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. "For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.

Materiality

An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgment. Where decisions are required about the appropriateness of a particular accounting judgment, the "materiality" convention suggests that this should only be an issue if the judgment is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts.

Characteristics of Accounting Information

There is general agreement that, before it can be regarded as useful in satisfying needs of various user groups, accounting information should satisfy the following criteria: ~he

Criteria

What it means for the preparation of accounting information

Understandability

This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities.

•

Fundamental Principles of Accounting

Relevance

This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view usually in the context of making a decision (e.g., should I invest, should I lend money to this business? Should I work for this business?)

Consistency

This implies consistent treatment of similar items and application of accounting policies.

Comparability

This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.

Reliability

This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g., by a potential investor).

Objectivity

This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest.

Accounting Policies The concepts provide a broad framework for the preparation of financial statements; each accounting procedure needs to define a set of accounting policies consistent with the nature of its business. These policies provide clear guidelines for revenue, inventory and fixed assets valuation. The policy on revenue recognition provides guidelines wjth respect to the timing and the amount of revenue to be recognized. The policy depends on the concept of conservation and realization essentially. The most standard time of revenue recognition is at the time of delivery of goods. Inventory valuation is most important in determining the cost of goods sold and the profits of an entity. Inventories can be valued using several methods. The common ones that are used are FIFO, LIFO method etc .. Depreciation is important factor to determine the value of fixed assets. Different depreciation method can be used for calculating the value of assets like fixed installment method, reducing balance method, annuity method, insurance policy method and depreciation fund method. Policy can be used for any method of depreciation.

Accounting Standards Issued by ICAI To date, the Institute of Chartered Accountants of India has issued 31 Accounting Standards. These were numbered AS-l to AS-31 in serial order, of which AS-8 is no longer in force having been merged with AS-26.

Accounting Concepts and Conventions, Accounting Standards

•

ICAI has set an internal deadline of aligning its Accounting Standards with IFRS by April 2011.

As well as accounting standards, the Institute has issued Accounting Standard Interpretations to help in interpreting the standards. At present there are 29 ASls. ASls are regarded as interpretations of the Accounting Standard that they relate to; therefore, non-compliance with an ASI is considered as non-compliance of the related Accounting Standard itself. Accounting Standards in India

All the member-countries, including India, have taken upon themselves the task of prescribing acrounting standards. In 2001, the Government constituted the Accounting Standards Board. The Institute of Chartered Accountants of India, the apex body of accounting and auditing, constituted an Accounting Standards Board on April 21, 1977, to pronounce standards on various items of the financial statements. This Board has been releasing standards from time to time. Certain of the standards have also been revised/deleted/curtailed in the light of new and additional Standards as well as the experience of the industry. Till now, 29 Accounting Standards have been issued by the ICAI as against the 41 International Accounting Standards. There are also five International Financial Statements Reporting Standards (lFRS). Concept of true and fair: The financial statements of an entity cannot be said to be showing a true and fair view unless these financial statements have been drawn up in accordance with the broad accounting framework which is synonymous to Generally Accepted Accounting Principles (GAAPs).

Procedure for Standard Setting (1) Accounting standard setting, by its very nature, involves reaching an

optimal balance of the requirements of financial information for various interest groups having a stake in financial reporting. (2) To reach a consensus, to the extent possible, as to the requirements of the relevant interest-groups and, thereby, bringing about general acceptance of the accounting standards among such groups, considerable research, consultations and discussions with the representatives of the relevant interest-groups at different stages of standard formulation becomes necessary. (3) The standard-setting procedure of the ASB, as briefly outlined below, is designed in such a way so as to ensure such consultation and discussions. (4) Identification of the broad areas by the ASB for formulating the accounting standards.

•

Fundamental Principles of Accounting

(5) Constitution of the study groups by the ASB for preparing the preliminary drafts of the proposed accounting standards. (6) Consideration of the preliminary draft prepared by the study group by the ASB and revisio)1, if any, of the draft on the basis of deliberations at the ASB. (7) Circulation of the draft, so revised, among the Council members of the ICAI and 12 specified outside bodies such as the Standing Conference of Public Enterprises (SCOPE), the Indian Banks' Association, Confederation of Indian Industry (ClI), the Securities and Exchange Board of India (SEBI), the Comptroller and Auditor General of India (C& AG) and the Department of Company Affairs, for comments. (8) Meeting with the representatives of specified outside bodies to ascertain their views on the draft of the proposed accounting standard. (9) Finalization of the exposure draft of the proposed accounting standard on the basis of comments received and discussion with the representatives of specified outside bodies. (10) Issuance of the exposure draft inviting public comments. (11) Consideration of the comments received on the exposure draft and

finalization of the draft accounting standard by the ASB for submission to the ICAI for its consideration and approval for issuance. (12) Consideration of the draft accounting standard by the Council of the Institute, and, if found necessary, modification of the draft in consultation with the ASB. (13) The accounting standard, so finalized, is issued under the authority of the Council. I mportance of Accounting Standards

Acc()unting standards are most important for removing the complexities in accounting practice and for incorporating credibility in the system. They are also important for preparation of final account, of any type of business. Accounting standards based on internal and external compulsions. The objectives of accounting standards are simplification, standardization, and reporting and easy procedure to maintain accounting records. Graphic Definition of Accounting

The acconting equations Assets = Liabilities + Owner's Capital and financial statements are the main area of financial accounting. The trial balance which is usually prepared using the Double-entry accounting system forms the basis for preparing the financial statements. All the figures in the trial balance are rearranged to prepare profit and loss account and balance sheet. There are certain accounting standards that determine the format for these accounts

•

Accounting Concepts and Conventions, Accounting Standards

(SSAP, FRS, IPS). The financial statements will display the income and expenditure for the company and a summary of the assets, liabilities, and shareholders or owners' equity of the company on the date the accounts were prepared to. Assets, Expenses, and Withdrawals have norm\ll debit balances (when you debit these types of accounts you add to them) ... remember the word A WED which represents the first letter of each type of account.

Liabilities, Revenues, and Capital have normal credit balances (when you credit these you add to them). or

o = Dr

r - - -____________________~A~

/

______________________

Cr Retained Earnings (profit)

____________

Cr Liabilities

Cr OwnerS' Equity

Assets

~A

~

Cr Common Stock

__________________________

Cr

Revenue \~--------------------~/

\~----------------------------------------~I increased by debits

increased by credits

Crediting a credit Thus ------------------,> account increases its absolute value (balance) Debiting a debit Debiting a credit Thus ----------------:> account decreases its absolute value (balance) Crediting a debit When you do the same thing to an account as its normal balance it increases; when you do the opposite, it will decrease. Much like signs in math: two positive numbers are added and two negative numbers are also added. It is only when you have one positive and one negative (opposites) that you will subtract. Meaning of the Accounting Equation

The value of a company can be understood simply as the useful assets that ownership of a company entitles one to claim. This value is known as Owners' Equity. Some assets of a company, however, cannot be claimed as equity by the owners of a company because other people have legal claim to them - for example, if the company has borrowed money from the bank. The value of a resource claimable by a non-owner is called a liability. All of the Assets of a company can be claimed by someone, whether owner or not, so the sum of a company's equity

•

Fundamental Principles of Accounting

and its liabilities must equal the value of its Assets. Thus the accounting equation describes what portion of a company's assets can be claimed by the owners. Various account types are classified as 'credit' or 'debit' depending on the role they play in the accounting equation. Assets = Liabilities + Equity

or Assets - Liabilities - Equity = 0 Another way of stating it is: Equity = Assets - Liabilities which can be interpreted as: "Equity is what is left if all assets have been sold and all"

Objective of Accounting Accounting means to maintain some record for keeping a data. In that matter it is necessary for a man, business or anyone else, who record the data, to keep a book due to the fact that memory of no person is limited and one can remember various information forever. Book-keeping is that part of knowledge which tells us how to keep a record financial transactions. Book-keeping and Accounting process are also considered as evidence in the courts to prove claims and it is also compulsory for Income-tax Authority. Nowadays people, who are earning and spending, must maintain a notebook or diary or register in which details of the transaction have been recorded. The fundamental thought behind this record is to show a correct position relating to a monthly income and expenditure and to know how much money saved. The need for keeping such record in systematic manner - for this purpose we have made some rules and accounting standards.

Theoretical Questions 1. Explain the accounting concept. 2. What do you mean by Historical Cost Concept? 3. What criteria should be adopted to Characterise of Accounting Information? 4. What do you mean by Accounting conventions? 5. Write short note on monetary measurement. 6. What is the Procedure for standard setting? 7. Give the Importance of Accounting Standards. 8. How to make Accounting Policies? 9. Give the meaning of the accounting equation. 10. Write objective of Accounting.

Chapter III Recording of Financial Data

Every transaction has two asp~cts - A system of accounting in which both the aspects of each transaction are recorded as per prescribed rules is called Double Entry System. It does not mean that every transaction is recorded two times, but one aspect is recorded at one place and other aspect is recorded at other place, e.g., Rs. 500 are received from Mohandra - this is a transaction. In this transaction cash is received and Mohandra has given this cash. Thus, it has two aspects -

i) Receiving of cash ii) Giving by Mohandra

One of these aspects is debited and the other is credited according to certain prescribed rules.

MEANING OF DEBIT The word debit has been derived from the Latin word "debitum." Its meaning is 'due for that.' In fact, debit is a symbol of accounting, which is used to make the rules of accounting clear and operative.

•

Fundamental Principles of Accounting

Characteristics1. Where a transaction is entered into, two aspects are affected. Both of these aspects are recorded. If one aspect is recorded and 'other is omitted, then it is not justified. Thus, the first principle of Double Entry System is that both the aspects are recorded, hence it is treated as a characteristics of double entry . . 2. Both personal and impersonal aspects of a transaction are recorded in Double Entry System. It is possible that both the aspects of a transaction may be personal or both may be impersonal or one may be personal and the other may be impersonal. 3. In Double Entry System one aspect is debited while other aspect is credited. It does not mean that any aspect may be debited and any aspect may be credited. There are certain rules of debiting various aspects of a transaction and 'credits and debits are made on the basis of these rules. 4. Since'one aspect of each transaction is debited ana other aspect is credited, therefore, total of all debits is always equal to the total of all credit. This helps in finding out arithmetical accuracy of accounting record. Preparing trial balance does this.

Advantages Double Entry System is the only scientific system of systematic recording transaction. Some of the important advantages are:

1. Complete record of every transaction - Business transactions are classified as assets, liabilities, expenses, revenue, and capital and recorded accordingly. 2. Scientific System - This system is the only sCientific system of recording business transactions. It helps attain the objectives of recording. 3. Reliable information at a glance - The system keeps complete records of business transactions in a systematic and scientific way, so requisite information can be obtained at a glance. The information supplied by the system is also reliable. 4. Verification of information - The business can verify the value of assets and scrutinize the records, if necessary on the basis of documentary proofs as vouchers. 5. A check on the accuracy of accounts - By the use of this system the accuracy of the accounting work can be established through the device of the trial balance. 6. Knowledge of fmancial position of the firm - The financial position of the firm or the institution concerned can be ascertained anhe end of each period, through preparation of the balance sheet.

•

Recording of Financial Data

7. Knowledge of assets and liabilities of the business - Position statement also known as Balance Sheet is prepared. It reflects the values of aspects and liabilities of the business at the end of accounting year.

8. Full details for purposes of control -

This system permits accounts to be kept in as much detail as necessary, thus affords significant information for purpose of control, etc.

9. Comparative studies -

Financial statement prepared on the basis of Double Entry System can be compared with the statements of previous years. The actual performance can be compared with the desired performance. Weaknesses can be detected and remedial meawres will be applied.

10. Helps management in decision-making -

The management may be

able to obtain good information for its work.

11. Detection of fraud - The systematic and scientific recording of business transactions on the basis of this system minimize the chances of embezzlement and frauds. Vouching, verification and auditing of accounts can easily deduct it.

Journal Rules for Debit and credit JOURNAL is the primary book of accounts in which transactions are recorded in a chronological order. It is called the book of original entry because a transaction is first written in journal. An Entry made in Journal is called a Journal Entry. The process of recording a transaction in a journal is known as Journalizing. Entries in the journal may be divided into two groups: (i) Simple Entry and

Oi) Compound Entry A simple entry is one in which only two accounts are affected, i.e., one account is debited and another is credited with an equal amount. A compound entry is one in which more than two accounts are involved. There may be two or more accounts to be debited and only one credited or vice-versa.

Golden Rules for Journalizing In double entry system, to record transactions in journal the accounts affected are either debited or credited. The rules are as follows:

Personal Accounts

Real Accounts

Npminai Accounts

Debit the receiver and credit the giver

Debit what comes in and credit what goes out

Debit all expenses and losses and credit all incomes and gains

•

Fundamental Principles of Accounting

Explanation:

Personal Accounts

In a transaction when Rs. 100 are paid to Ravi, Ravi's Alc is to be debited because Ravi is the Receiver.

Real Accounts In a transaction when good are bought on credit from Dhruv, goods are coming in, hence goods alc will be debited.

Nominal Accounts In this rule various expenses like salaries, rent, postage expenses are debited and commission received will be credited.

Stages of Double Entry System • First stage - When the transaction takes place, it is recorded in the primary book called journal. When the business is a big one, subsidiary books of journal are kept. Thus, recording in journal or in its subsidiary book is the first stage of double entry system. It is also known as original record stage. • Second stage - Records of journal or its subsidiary books are transferred in a classified form to another book which is called ledger. These classified groups are technical known as accounts. Posting in ledger and its maintenance is the stage of Double Entry System. It is also known as classification stage. • Third stage - Balance of each account in ledger is found out and is transferred to a statement which is called 'Trial Balance.' Thus, preparation of trial balance is the third stage of DOllble Entry System of Accounting. • Fourth stage - From trial balance, final accounts are prepared. Final accounts include trading account profit and loss account and balance sheet. In case of manufacturing concern, before trading account, manufacturing account is also prepared. Peparation of these above acounts is the fourth stage of Double Entry System. • Fifth stage. - After preparation of all above accounts, analysis and interpretion of these accounts are made in order to have true and fair idea about the earning capacity and financial position of the entrepreneur. This is the fifith stage of Accounting.

Advantages or Importance of Journal • Analysis of transaction -To record transactions in this book, they have to be analysed, this book tells us which ale is to be debited and which to be credited. • Date-wise Entry -When entry of transactions is made date-wise details can be easily obtained. • Minimum changes of errors - In recording tran,saction in journal chances of errors are very less because both debit and credit aspect is recorded at same place. • Truthful -This helps in satisfying the auditors about truthfulness of transactions.

•

Recording of Financial Data

• Calculation everyday - Firms may like to ascertain the cash balance everyday. Hence, they usually record cash transactions directly in a separate book.

Disadvantages or Limitation of Journal • Errors of Omission - In case of entire transaction not recorded in the books of accounts, the mistake cannot be detected by accounting. The trial balance will tally in spite of a mistake. • Errors of principle - Double entry is based upon the fast that every debit has its corresponding credit. It will not be able to detect the mistake. • Compensating errors - The trial in case af compensating errors also. If Ram's Account is by mistake debited with Rs. 15 lesser and Mohan's account is also by mistake credited with Rs. 15 lesser, the Trial Balance will tally.

Rules of Journalisin,g Any transaction, which is recorded first time in accounting book is called Journal. The recording is made according to accounting rules and these rules are called rules of Journalising. In journal there are three types of accounts. The account of a person, with whom the business deals, is known as Personal Account. The account of business assets, is knowns as Real Account. Third one is the account of Income and Expenditure, is known as Nominal Account. In double entry system every account affects two accounts. According to the rule of accounting one account will be debited and other account will be credited.

TYPES OF ACCOUNT • Personal Account • Real Account • Nominal Account

Rules for Debit and Credit ~

Personal Account -

~

Real Account -

~

Nominal Account and incomes.

Debit the Receiver and Credit the Giver.

Debit what comes in and Credit what goes out. Debit all losses and expenses and Credit all gains

Illustration 1 1. Goods purchased from Ram 2. Goods sold to Shyam 3. Cash paid to Ram 4. Cash Received from Ram 5. Salary paid 6. Commission received

•

Fundamental Principles of Accounting

Solution: 1.

Purchase ale

Dr.

To Ram's ale Explanation

In this entry Goods come, so the purchase or goods account will be debited and since Ram gives the goods then Ram is giver. He comes in personal account and as per rule of personal account is given the credit. 2

Shyam's alc

Dr.

To Sales alc Explanation

Shyam comes in personal account and he is receiver, so the account of Shyam is debited and Goods go out from the business, the rule says, Credit what goes out. 3.

Ram's alc

Dr.

To Cash ale Explanation

Ram comes in personal account and he is receiver, so the account of Ram is debited and the rule of Real account is debit what comes in, credit what goes out. There is cash which goes out from the business. 4.

Cash ale

Dr.

To Ram's alc Explanation

Ram comes in personal account and he is giver, so the account of Ram is credited and the rule of Real account is debit what comes in, credit what goes out. There is cash comes in the business. . 5.

Salary alc

Dr.

To Cash alc Explanation

Salary is expenditure of the business and it comes in Nominal account. the rule of nominal account is all expenses are debited and all incomes are credited, so the salary account is debited and the rule of Real account is debit what comes 111, credit what goes out. There is cash which goes out from the business. 6.

Cash ale To Commission alc

Dr.

Recording of Financial Data

Explanation

•

Commission is a income of the .business and it comes in Nominal account, the rule of nominal account is all expenses are debited and all incomes are credited, so the Commission account is credited and the rule of Real account is debit what comes in, credit what goes out. There is cash which comes in the business. ledger

The books which contain accounts is known as the ledger. Since final information pertaining to the financial position of a business emerges only from accounts, the ledger is also called the Principal Book or Sales Book or journal merely facilitate the preparation of accounts or the ledger and hence are known as Subsidiary Books or Books of Original Entry. The Cash book has a unique position. It is a subsidiary book because cash entries are first entered here and the other accounts are prepared. But the cash book contains the two accounts of cash and bank and hence it is a part and parcel of the ledger also. The cash book thereafter, is both a book of original entry and a principal book. Preparation of ledger Accounts and Posting

First of all the opening entry should be posted as it indicates the balance of assets and liabilities with which the firm starts the new period. The way to post the opening entry is that on the debit side of various assets ( which have to be debited according to the opening entry) one writes. "To balance brought forward" or just "To balance bId", and then the amount. In the case of liabilities and the capital accounts, the entry is By balance bId and then the case of cash and bank balances, balances will be written in the cash book and no separate accounts will be opened. The following shows how the various special purpose subsidiary books and the journal have to be posted. The student must, however, make a note that posting should always be done in the chronological order of transactions. In a few accounts, posting is done in monthly totals, only in these cases posting will be done at the end of the month. Posting the cash book. The debit side of the cash book shows receipts of cash or receipts by bank. One should open all the accounts mentioned on the debit side and credit them because cash has been received in respect of them. Thus if on the debit side of the cash book, one finds the entry. For instance "To Mohan and Co. Rs. 500", it means that cash has been received from Mohan and Co. who therefore, are entitled to a credit.

•

Fundamental Principles of Accounting

Illustration 2 Prepare Ravi's Ale from the details:-

2008

Ravi's

1st Dec. 20 th Dec

Credit BaI. of Ravi's account

24m)

Amount paid to Ravi

18ID)

24th Dec 28 th Dec

Goods purchased from Ravi

Rs.

1600Xl 18500

Paid to Ravi

500

Discount allowed 29 th Dec

3am

Goods purchased from Ravi

Solution Ravi's Ale

Date

J.F Amount Date 2008

Particulars

2008

Particulars

J.F. Amount

20 Dec. To Cash Alc

18CXXJ

1 Dec

By Bal cld

24m)

28 Dec. To Cash Alc

18500

24 Dec

By Purchase Alc

1fiXX>

500

29 Dec

By Purchase Alc

3

28 Dec

To Discount Alc

IDec.

To Bal. cld

33(0)

70000

70000

33(0)

By Bal bid Illustration 3 From the following particulars, prepare Proprietor's Capital Ale:Rs.

2008 pI July

Commenced Business with cash

600Xl

Dec. 31

Net loss as per PIL Alc

29500

Dec 31

Drawings during the period

2500

Capital Ale

Date

Particulars

J.F Amount

Particulars

J.F.

Amount

2008

2008 Dec. 31

Date

To Drawings Ale To Profit & loss Ale

2500

July 1

By Cash Alc

600Xl

29500

•

(Net loss) Dec. 31

To Bal dd

28CXXJ

60000

60000 2f1J)

1 Jan

By Bal bid

28CXXJ

•

Recording of Financial Data

lllustration 4

Enter the following transactions in subsidiary books & post them into ledger accounts: The following balances excited in Tony Brothers Books on Jan. 1 2008. Assets - Cash in hand Rs. 30000, Bank Balance Rs. 45000, Debtors Moni 2000, Harsh Rs. 16000, Sohan Rs. 4000, Stock - Rs. 29000, & Furniture Rs. 6000.

Liabilities - BIP Rs. 32000, Creditors Mr. Soni Rs. 18000, Mr. Y Rs. 12000 & Capital Rs. 70000. During January, the following transactions place. Rs.

2008 Jan. 2

Cash Sales

Jan. 4

Purchase from Soni

2cxxx)

350 meters cotton

@

300 meters silk

Rs. 30 per meter

Jan. 5

BIP paid

Jan. 5

Sold to Moni

@

Rs. 20 per meter 16CXX>

450 meters silk

@

160 meters cotton

Rs. 40 per meter @

Rs. 250 per meter

Jan. 6

Acceptance received from Moni at 4 month for Rs.l2

12000 Bills Payable Book

2003

2003

Jan. 11 Soni

3months

April 14

4IXX)

4000 Journal Proper Date

Particulars

LF

2003 Jan. 1

Amount Debit (Rs.)

Cash Ale

Dr.

3OIXX>

Bank

Dr.

451XX>

Moni's

Dr.

2IXX>

Harsh

Dr.

161XX>

Sohan's Ale

Dr.

4IXX)

Stock Ale

Dr.

~

Furniture Ale

Dr.

6IXX>

Credit (Rs.)

To BIP Ale

321XX>

To Mr. Soni

18(0)

To Mr. Y

121XX>

To Capital Ale

7cxxx)

(For opening entry)

•

Recording of Financial Data

Jan. 9.

Dr. .

Furniture Alc

1

140

Jan. 4

By Purchases Ale

lWX>

2008

.


Sundry Creditors

8,00>

Bills Payable Opening Stock

41200

Wages

8980

Salaries

12(0)

Furniture

2&XX)

Postage

HID

Final Accounts with Adjustment

Power and fuel

1,560

Trade expenses

3,(ill

•

750 10,(00 1,28.60

Bad debts Loan to Rishabh (1-7-08) Cash in hand and at Bank

912

Trade Expenses accrued, not paid 14,520

Drawings Nc

1,00,(00

Capital Nc

9{J76

outstanding Wages 4,58,133

4,58,133

Prepare Trading and Profit and loss account for the year ending December 31st, 2008 and the Balance sheet as on that date after taking into consideration the following information:

1. Depreciation on furniture is to be charged at 10%. 2. Sundry debtors include an item of Rs. 1000 due from a customer who has become insolvent. 3. Reserve for bad debts is to be maintained

@

5% on sundry debtors.

4. Goods of the value of Rs. 1000 have been destroyed fire and insurance company admitted a claim for Rs. 8000. 5. Stock on 31st December, 2008 was Rs. 60000. Solution Trading and Profit and Loss Account for the year ended 31st December, 2008

Expenses/Losses To Opening Stock To Purchases

Amount (Rs.)

Revenue/Gain

41,2ro By Sales 2,63,603 By Closing Stock

Amount (Rs.) 2.88,900

60,(00

To Wages

8,980 By Loss of stock by fire

2,(00

To Fuel and Power

1,560 By Insurance Company

8,(00

To Profit transferred to PIL Nc

435 Less: Bad Debts Less: BID

750 l,ro> 6,886

2,800 Less: Provision required

2,950

To Depreciation on furniture @

43,506

3,936

26,342

To Net Profit transferred to Capital Nc

47,742

47,742 Balance Sheet of Mr. Harsh as on 31st December, 2008

Liabilities

AmountRs.

Assets

AmountRs.

12,860

42,ro> Cash in hand and at Bank

Creditors

• Bills Payable

8,ro> Loan to Rishabh

Outstanding Wages

9,676 Add: Interest Accrued

1O,ro> 300

10,300

Debtors 6O,ro> 912 Less: Provision for BID 1,ro>

Trade Expenses Accrued but not paid Capital Add: Net Profit

I,OO,(XX) 26,342

Less: Drawings

1,26,342 14,520

BID

2,950

6O,ro> 8,ro>

Closing Stock 1,11,822 Insurance Company Furniture

Less: "Depreciation 1,72,410

56,050

28,(XX) 2,800

25,200

.. 1,72,410

General Manager is to be allowed a commission @ 5% on net profit after charging Works Manager's and before charging General Manager's commission.

•

Final Accounts with Adjustment

Illustration 13

From the following Trial Balance of Mr. Narendra as on 31st December, 2009 prepare Trading and Profit & Loss Account and Balance Sheet: Name of Accounts

Dr. (Rs.)

Capital

2,00,(XX)

Purchases and Sales

3,20,(XX)

Cr. (Rs.)

4,20,(XX)

55 ,(xx)

Stock (1.1.2008)

8,(XX)

Return outward lO,(XX)

Manufacturing wages Freight on" purchase

200

Manufacturing expenses

7,(XX)

Fuel and power

1,5(i)

Bad debts

700

Factory light

220

Plant and Machinery

9,980 50,(XX)

Goodwill

35,(XX)

Furniture

25,(XX)

Motor car Salary

19,(XX)

Building

12,(XX)

Hors and Carts

26,600

Sales return

1O,(XX)

(i),(XX)

Bank Loan Creditors

28,(XX) 3,(XX)

Cash in hand

82,(XX)

Cash at Bank

25,(XX)

Debtors

910

Bad debts Reserve Interest and bank charges

1,250

Adjustments: (1) General Manger is to be allowed a commission @5 c7c on net profit after

charging Works Manager's and before charging General Manager's commission (2) Depreciation charged on furniture 7,500, Motor car rs.4,750

@

(3) Create provision on debtors Rs.IAOO (4) Closing stock was Rs. 45,260

20% and Plant and machine,'y Rs.

•

Fundamental Principles of Accounting

. Solution Trading and Profit and Loss Account of Mr. Nerandra. for the year ended 31st March, 2009

Dr.

Cr.

ExpensesILosses

Amount (Rs.)

55,(0) By Sales

To Opening Stock To Purchases Less: Purchases Return

To Manufacturing wages

3,200Xl Less: Sales Return 8,(XX) 3,12,000 By Closing Stock 10,(0)

To Freight on Purchases To Manufacturing Expenses

200 7,(XX)

To Factory, Fuel and Power

I,5W

To Factory Lighting

Amount (Rs.)

1,99,200 8,(0)

4,12,000 45,260

220 69,300 4,57,280

To Gross Profit cld To Salaries To Bad Debts

Revenue/Gain

4,57,280 By Gross Profit bid

69,300

700

Add: New Provision

for BID Less: Old Provision

1,400 2,100 910

1,190

To Depreciation on: Plant and Machinery Furniture

7,500 5,(XX)

Motor car

4,750

17,250

To Interest and Bank Charges

1,250

To Commission payable: Works Manager

1,386

General Manager

1,9ll

To Net Profit transferred To Capital Alc

36,313 69,300

69,300

•

Final Accounts with Adjustment

Balance Sheet as on 31st December, 2008 Liabilities Capital

Add: Net Profit Sundry Creditors

AmountRs.

Goodwill

2CXXXXl

36313

Bank Loan Commission Payable 1386

General Manager

1911

Furniture Less: Depreciation

S(XXX) 7500 2S(0) SOO)

Motor Car

19

To Sales Ledger (A-L) Adjustment Nc [In the General Ledger] (Correction arising out of overcastting the (A-L) Sales Book of Rs. 20.) (b) (i)

Return Inward Nc

Dr.

165 165

To Sharma Bros & Co. Nc (The entry for sales return previously omitted.) (ii)

General Ledger Adjustment Nc [In (M-Z) Sales Ledger]

Dr.

165 165

To Sales Ledger (M-Z) Adjustment Nc [In the General Ledger] (The entry in the accounts arising out of the entry recording sales return.) (c) (i)

A. Karim

To A. Salim (Correction of the mistake by which A. Karim was credited instead of A. Salim.)

Dr.

3,215 3,215

•

Fundamental Principles of Accounting

(ii)

General Ledger Adjustment Nc [In (M-Z) Sales Ledger]

3,215

Dr.

To Sales Ledger (M-Z) Adjustment Nc [In the General Ledger]

3,215

(The correcting entry in total accounts relating to the (M-Z) Sales Ledger.) Sales Ledger (A-L)Adjustment Nc

(iii)

3,215

Dr.

[In the General Ledger] To General Ledger Adjustment Nc [In (A-L) Ledger]

3,215

(Correction of the entry in total accounts relating to the (A-L) Sales Ledger.)

Sectional Balancing System Journal

Date

LF.

Particulars Sales Nc

Dr.

Dr.Amt.Rs.

Cr.Amt. Rs.

Xl

To Total Debtors (A-L) Nc

Xl

(Correction of mistake by which (A-L) Sales Book was overcast by Rs. 20.)

165

Credit Sharma Bros & Co. (For return omitted from Returns inward book) Return Inward Nc To Total Debtors (M-Z) Nc

165 Dr.

165 165

(Correction of error as result of omission of return from Mis. Sharma Bros & Co.) A. Karim

Dr.

3,215 3,215

To A. Salim (Wrong credit A. Karim transfer A. Salim) Total Debtors (A-L) Nc

Dr.

To Total Debtors CM-Z) Nc

3,215 3,215

Illustration 4 From the following particulars, prepare the General Ledger Adjustment Account for March 2000. (i) Purchased goods from X. Rs. 20,000.

(ii) Paid Rs. 16,000 after adjusting the initial advance in full given to X. (iii) Paid Rs. 10,000 to R towards purchase made in February in full settlement

of amount due Rs. 10,500.

•

Self-balancing Ledger

(iv) Paid advance to Y Rs. 30,000. (v) Purchased from A goods for Rs. 40,000. (vi) Goods returned to A, Rs. 5,000; settled balance at discount 2%.

(vii) Purchased from Y Rs. 25,000 advance adjusted to the extent of 50% of the purchase. (viii) Received back advance given to P on 20 th February, 2000, Rs. 4,000 after adjustment of pur-chase Rs.16,000. (ix) Goods returned to Q, Rs. 7,500; the purchase was made in February, 2000. (x) Purchased goods from B, Rs. 20,000.

Solution: In the Purchases Ledger General Ledger Adjustment Ale

Dr.

Date

Cr.

Amt. Date

Particulars

Amt.

Particulars .

Rs.· 2(Xl)

2(0)

Marl To Balance bid To Purchase Ledger Adjustment Nc in " 31

18,(0) Marl " 31

General Ledger as under: Purchases To Balance cJd

By Balance bId By purchase Ledger Adjustment Nc in

4,(0) 17,500

Cash Discount received

90,300

1,200

Goods returned

"12,500

Mar 31 By Balance cJd

32,500

1,60,500 Apr. 1 To Balance bid

24,(0)

General Ledger as under: 1,21,(0)

Cash " 31

Rs.

1,60,500

32,500 Apr. 1 By Balance bId

17,500

Working Notes: (i) Balances on March 1, 2000:

Debit balances X

Rs. 4,(0)

Q

Rs. 10,500

R

P

Credit balances

20,(0)

"

~

~

UQQ

.rum

•

Fundamental Principles of Accounting

(ii) Balances on March 31, 2000: y

17,050

B

(iii) Payment and Purchases:

Payment Rs.

Discount Rs.

R

10,00>

Y

30,00>

A p

34,300

B

= Rs.

500

25,00> 700

40,00>

-

-

10,600

-

.l.2OO

2Q.!m

2QJOO

(iv) Purchases Returns

20,00>

16,00>

X

Purchases Rs.

;',000 (A) + Rs. 7,500 (Q)

= Rs.

1,21.00>

12,500

On pI April, 2000, the details of the balances owned by customers were as follows: Rs. A

1,500

B (Considered to be 60% bad; adequate provision maintained)

2,100

C

1,800

Others

3i@

41,00>

...2.QQQ

Less: Advances by E

.32.00! IIIustration S Sales during the month totalled Rs. 1,55,500 including Rs. l,ll.J.OO as cash sales; of the credit sale a sale of Rs. 2,600 was to E. A returned goods to the extent of Rs. 500 and sent bills receivable accepted by X for the balance. A sum of Rs. 450 was received from B and the balance was written off. On instruction from Y, C's balance was transferred to Y's account in the Creditor's Ledger. X's acceptance was dishonoured and noting charges were Rs. 10. G sent an advance of Rs. 1,800 for supply of goods. Out of the amount due from "Others" on April 1, 2000 a sum of Rs. 27,300 was received; the customers had earned 2

X

% discount on the

amount paid. Similarly, out of the sales in April, a sum of Rs. 9,750 had been received, earning discount at the same rate.

•

Self-balancing Ledger

T who owned Rs. 1,180 and G who owned Rs. 800 turned doubtful; a provision of 50% of the amounts due was created. All other debts were considered goods. Prepare Total Debtors Account for April 2000.

Solution: Total Debtors Account

Cr.

Dr.

Date

Particulars

Amt.Rs.

Date Particulars

Apr. 1 To Balance bid

41,(XX)

" 30

To Credit Sales

" 30

To Bills Receivable Ale

44,100 Apr.1 By Balance bId 1,(XX) " 30 By Cash

" 30

To Cash (Noting Charge

" 30

To Balance cld

10 1,800

2(XX)

2,(XX) 39,300

"30 "30

By Discount allowed By Bas debts Alc

1,650

''30

By Return Inward Alc

''30

By Bills Receivable Alc

500 1,(XX)

''30

By Total Creditors Alc

1,800

''30

By Balance cld

87,910 2(XX)

Amt.Rs.

950

40,710 87,910

2(XX)

May 1 To Balance bid

40,710

May

By Balance bId

1,800

Working Notes: Rs. (i)

Cash received FromB

450

FromG

UOO ~

Rs.

27,300

E's X Sales before April 1

~

E's X Sales during April

J2.m

X X= I 97

(ii)

Discount: Rs. 37,050 x 2

Rs. 950

(iii)

The creation of the Provisions for Doubtful Debts will not affect the Total Debtors Account.

•

Fundamental Principles of Accounting

Illustration 6 The undermentioned particulars have been extracted from the books of D.O. Book House. You are required to prepare the sales ledger adjustment account as on 31 5t March, 2000: Debtors on 151 March, 2000

55,842 1,08,606

Sales (including Cash Sales Rs. 10,000)

88,753

Cash received from Debtors

4ro

Discount allowed to DebtorsAcceptance received from Debtors

7,120

Returns from Debtors

5,430

Bills receivable dishonoured

1,120

Bad debts written off

3,890

Sundry charges debited to customers

378

Transfer to bought ledger

100 2,500

Provision for doubtful debts

Solution: Books of D.D. Book House In