82220_FAM-CUTM

ABM/FAM/BAM/BFA/2013/Dr. PK

I

Finance for Non-finance Managers

1.1.ACCOUNTING

Accounting, as an information system is the process of identifying, measuring and

communicating the economic information of an organization to its users who need the

information for decision making. It identifies transactions and events of a specific entity. A

transaction is an exchange in which each participant receives or sacrifices value (e.g.

purchase of raw material). An event (whether internal or external) is a happening of

consequence to an entity (e.g. use of raw material for production). An entity means an

economic unit that performs economic activities.

1.2. Definition of Accounting

American Institute of Certified Public Accountants (AICPA) which defines accounting 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 a financial character and

interpreting the results thereof”.

1.3. Objective of Accounting

Objective of accounting may differ from business to business depending upon their specific

requirements. However, the following are the general objectives of accounting.

i) To keeping systematic record: It is very difficult to remember all the business

transactions that take place. Accounting serves this purpose of record keeping by promptly

recording all the business transactions in the books of account.

ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e.,

profit earned or loss suffered in business during a particular period. For this purpose, a

business entity prepares either a Trading and Profit and Loss account or an Income and

Expenditure account which shows the profit or loss of the business by matching the items of

revenue and expenditure of the some period.

iii) To ascertain the financial position of the business: In addition to profit, a businessman

must know his financial position i.e., availability of cash, position of assets and liabilities etc.


II

This helps the businessman to know his financial strength. Financial statements are

barometers of health of a business entity.

iv) To portray the liquidity position: Financial reporting should provide information about

how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing,

about its capital transactions, cash dividends and other distributions of resources by the

enterprise to owners and about other factors that may affect an enterprise’s liquidity and

solvency.

v) To protect business properties: Accounting provides upto date information about the

various assets that the firm possesses and the liabilities the firm owes, so that nobody can

claim a payment which is not due to him.

vi) To facilitate rational decision – making: Accounting records and financial statements

provide financial information which help the business in making rational decisions about the

steps to be taken in respect of various aspects of business.

vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts

are compulsorily required to maintain accounts as per the law governing their operations such

as the Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is

also compulsory under the Sales Tax Act and Income Tax Act.

1.4.Types of Accounting

The object of book-keeping is to keep a complete record of all the transactions that place in

the business. To achieve this object, business transactions have been classified into three

categories:

(i) Transactions relating to persons.

(ii) Transactions relating to properties and assets

(iii) Transactions relating to incomes and expenses.

The accounts falling under the first heading are known as ‘personal Accounts’. The accounts

falling under the second heading are known as ‘Real Accounts’, The accounts falling under

the third heading are called ‘Nominal Accounts’. The accounts can also be classified as

personal and impersonal. The following chart will show the various types of accounts:


III

1.4.1. Personal Accounts: Accounts recording transactions with a person or group of persons

are known as personal accounts. These accounts are necessary, in particular, to record credit

transactions. Personal accounts are of the following types:

(a) Natural persons: An account recording transactions with an individual human being is

termed as a natural persons’ personal account. example Kamal’ s account, Mala’s account,

Sharma’s accounts. Both males and females are included in it

(b) Artificial or legal persons: An account recording financial transactions with an artificial

person created by law or otherwise is termed as an artificial person, personal account, e.g.

Firms’ accounts, limited companies’ accounts, educational institutions’ accounts, Co-

operative society account.

(c) Groups/Representative personal Accounts: An account indirectly representing a person

or persons is known as representative personal account. When accounts are of a similar

nature and their number is large, it is better tot group them under one head and open a

representative personal accounts. e.g., prepaid insurance, outstanding salaries, rent, wages

etc. When a person starts a business, he is known as proprietor. This proprietor is represented

by capital account for all that he invests in business and by drawings accounts for all that

which he withdraws from business. So, capital accounts and drawings account are also

personal accounts.

The rule for personal accounts is: Debit the receiver

Credit the giver

Accounts

Personal Impersonal

Natural Artificial Representative Real Nominal


IV

1.4.2. Real Accounts: Accounts relating to properties or assets are known as ‘Real

Accounts’, A separate account is maintained for each asset e.g., Cash Machinery, Building,

etc., Real accounts can be further classified into tangible and intangible.

(a) Tangible Real Accounts: These accounts represent assets and properties which can be

seen, touched, felt, measured, purchased and sold. e.g. Machinery account Cash account,

Furniture account, stock account etc.

(b) Intangible Real Accounts: These accounts represent assets and properties which cannot

be seen, touched or felt but they can be measured in terms of money. e.g., Goodwill accounts,

patents account, Trademarks account, Copyrights account, etc.

The rule for Real accounts is: Debit what comes in

Credit what goes out

1.4.3. Nominal Accounts: Accounts relating to income, revenue, gain expenses and losses

are termed as nominal accounts. These accounts are also known as fictitious accounts as they

do not represent any tangible asset. A separate account is maintained for each head or

expense or loss and gain or income. Wages account, Rent account Commission account,

Interest received account are some examples of nominal account.

The rule for Nominal accounts is: Debit all expenses and losses

Credit all incomes and gains

1.5. Accounting: The Language of Business

Accounting is often called the language of business. The basic function of any language is to

serve as means of communication. As the purpose of accounting is to communicate the

performance & health of a business enterprise, it is therefore called as the language of

business. The task of learning accounting is very similar task as of learning a new language.

But accounting is no exactly a foreign language or a new language. In the word of Anthony &

Reece “the problem of learning accounting is more similar that of an American learning to

speak English as it is in Great Britain. For Example the food grain that Americans call

‘Wheat’ is called as ‘Corn’ by British; and the British use the word ‘Maize’ for what


V

Americans call ‘Corn’. Unless they are careful, Americans will fail to recognize that some

words are used in Great Britain in a different sense from that used in America.

Similarly some words, goods, assets, liability, debtors, creditors etc. are used in a different

sense in accounting than in their dictionary meaning. For example the term ‘goods’ appears

in accounting records. Its meaning according to Oxford Advanced Learner’s Dictionary of

Current English is ‘movable property’. However such meaning is incorrect in accounting.

The correct meaning of ‘Goods’ in accounting is ‘the things that purchased for the purpose of

sale’. In accounting goods are usually termed as inventory. In the previous example, the

garments purchased by Mr. Peekey are goods or inventories for his business as they are

meant for sale. If Mr. Peekey purchased a table & a chair for the shop, the table & chair are

not the goods, rather than these are the assets of the business. So we can conclude that the

goods are meant for resale where as the assets help in the operation of the business.

In every language, the grammarians differ regarding sentence structure and choice of words.

Similarly in accounting it also differ as to how a given event should be reported. Languages

evolve & change in response to the changing needs of the society, and so does accounting.

The principle and practices described are used currently in accountings but some of them may

be modified on the basis of the needs of the business organisation. In this way it is the

language of business.

1.6. Accounting Information System

Accounting is a service activity. Its function is to provide useful information about the

business to interested parties, such as management as well as to the external players like

government, public etc.


VI

The Items involved in this figure are explained bellow:

� Owner: Owner contributes money and take the risk of the business. They are

interested to know the profitability and soundness of the business. Owner gets the

information from the financial statement prepared by the organisation.

� Management: The management of the business is greatly interested in knowing the

position of the firm. The accounts are the basis, the management can study the merits

and demerits of the business activity. Thus, the management is interested in financial

accounting to find whether the business carried on is profitable or not. The financial

accounting is the “eyes and ears of management and facilitates in drawing future

course of action, further expansion etc.”

� Creditors: Persons who supply goods on credit are termed as creditors. They supply

goods on credit only when they have faith in sound financial position of the

enterprise. This they can know by accounting information.

� Investors: It is only after knowing the profitability and sound financial position that

investors take decision about making investment and continue investment in an

enterprise. Accounting information is of great use to them in this connection specially

in making judgment for their returns on investments.

� Consumers: Consumers are interested in the prices of the article manufactured by an

enterprise. This price decision is based on cost of production plus estimated margin of

Users

Internal Owner/ Management

External

Investors / Creditors

Government/ Consumers

Foreigners / Competitors

Research scholars/ Public


VII

profit; hence consumers are interested in accounting information with which an idea

of price structure can be made.

� Research Scholars: Researches are being made in various universities, industries and

in government departments. Accounting information of various enterprises is of great

use to research scholars to make compete report on the project.

� Government: Accounting information is used by the government for the following

purposes: Fixation of tax rates and introduction of new taxes, To assess whether the

unit is going to become sick, To compute national income, To prepare national

accounts, To know industrial growth of the country

� Foreigners: These days the whole world has become one market due to rapid growth

of means of transport and communications. Some foreigners are eager to know the

profitability and financial position of certain enterprises engaged in certain industries.

On the basis of this information they may make an opinion about import, export and

also about collaboration

� Entrepreneurs: - An entrepreneur is eager to know the profitability and financial

position of those enterprises which are already in an industry. It is only after knowing

their position he will make up his mind whether to start similar enterprise or not.

� Taxation Authorities: These days Income-Tax Officer, Sales-Tax Officer and other

taxation authorities also need accounting information.

� Competitors: The persons, who want to compete with a particular enterprise, want to

know its position of its accounting record.

� Trade Associates: These associates compare the performance of their members’ units

and then, if need be demand concessions or exemptions from Government in taxation

and other spheres.

� Stock Exchanges: They require accounting information in connection with listing of

securities and other spheres connected with various dealings in stock exchanges

� Employee: On the basis of profit and loss account of the current year, they can know

current year’s profit and can compare it with the profit of the previous year. In case


VIII

profit is much more than the normal, they may make a demand for bonus or increase

in remuneration. Employees are also eager to know about the continuance of the

organization in future for unlimited period because it will result in the continuance of

their services, therefore, on the basis of balance sheet they may find out the financial

position of the unit.

1.7. Generally Accepted Accounting Principles (GAAP)

The word ‘Principle’ has been differently viewed by different schools of thought. The

American Institute of Certified Public Accountants (AICPA) has viewed the word ‘principle’

as a general law of rule adopted or professed as a guide to action; a settled ground or basis of

conduct of practice” Accounting principles refer, to certain rules, procedures and conventions

which represent a consensus view by those indulging in good accounting practices and

procedures. Canadian Institute of Chartered Accountants defined accounting principle as “the

body of doctrines commonly associated with the theory and procedure of accounting, serving

as an explanation of current practices as a guide for the selection of conventions or

procedures where alternatives exist. Rules governing the formation of accounting axioms and

the principles derived from them have arisen from common experiences, historical precedent,

statements by individuals and professional bodies and regulations of Governmental

agencies”. To be more reliable, accounting statements are prepared in conformity with these

principles. If not, chaotic conditions would result. But in reality as all the businesses are not

alike, each one has its own method of accounting. However, to be more acceptable, the

accounting principles should satisfy the following three basic qualities, viz., relevance,

objectivity and feasibility. The accounting principle is considered to be relevant and useful to

the extent that it increases the utility of the records to its readers. It is said to be objective

to the extent that it is supported by the facts and free from personal bias. It is considered to be

feasible to the extent that it is practicable with the least complication or cost. Though

accounting principles are denoted by various terms such as concepts, conventions, doctrines,

tenets, assumptions, axioms, postulates, etc., it can be classified into two groups, viz.,

accounting concepts and accounting conventions.

1.8. ACCOUNTING CONCEPTS AND CONVENTIONS

1.8.1. Accounting concepts: The term ‘concept’ is used to denote accounting postulates, i.e.,

basic assumptions or conditions upon the edifice of which the accounting super-structure is


IX

Based. The following are the common accounting concepts adopted by many business

concerns.

1. Business Entity Concept

2. Money Measurement Concept

3. Going Concern Concept

4. Dual Aspect Concept

5. Periodicity Concept

6. Historical Cost Concept

7. Matching Concept

8. Realization Concept

9. Accrual Concept

i) Business Entity Concept: A business unit is an organization of persons established to

accomplish an economic goal. Business entity concept implies that the business unit is

separate and distinct from the persons who provide the required capital to it. This concept can

be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The

equation clearly shows that the business itself owns the assets and in turn owes to various

claimants. It is worth mentioning here that the business entity concept as applied in

accounting for sole trading units is different from the legal concept. The expenses, income,

assets and liabilities not related to the sole proprietorship business are excluded from

accounting. However, a sole proprietor is personally liable and required to utilize non-

business assets or private assets also to settle the business creditors as per law. Thus, in the

case of sole proprietorship, business and non-business assets and liabilities are treated alike in

the eyes of law. In the case of a partnership, firm, for paying the business liabilities the

business assets are used first and it any surplus remains thereafter, it can be used for paying

off the private liabilities of each partner. Similarly, the private assets are first used to pay off

the private liabilities of partners and if any surplus remains, it is treated as part of the firm’s

property and is used for paying the firm’s liabilities. In the case of a company, its existence

does not depend on the life span of any shareholder.

ii) Money Measurement Concept: In accounting all events and transactions are recode in

terms of money. Money is considered as a common denominator, by means of which various


X

facts, events and transactions about a business can be expressed in terms of numbers. In other

words, facts, events and transactions which cannot be expressed in monetary terms are not

recorded in accounting. Hence, the accounting does not give a complete picture of all the

transactions of a business unit. This concept does not also take care of the effects of inflation

because it assumes a stable value for measuring.

iii) Going Concern Concept: Under this concept, the transactions are recorded assuming

that the business will exist for a longer period of time, i.e., a business unit is considered to be

a going concern and not a liquidated one. Keeping this in view, the suppliers and other

companies enter into business transactions with the business unit. This assumption supports

the concept of valuing the assets at historical cost or replacement cost. This concept also

supports the treatment of prepaid expenses as assets, although they may be practically

unsalable.

iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction

has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The

basic principle of double entry system is that every debit has a corresponding and equal

amount of credit. This is the underlying assumption of this concept. The accounting equation

viz., Assets = Capital + Liabilities or Capital = Assets – Liabilities, will further clarify this

concept, i.e., at any point of time the total assets of the business unit are equal to its total

liabilities. Liabilities here relate both to the outsiders and the owners. Liabilities to the owners

are considered as capital.

V) Periodicity Concept: Under this concept, the life of the business is segmented into

different periods and accordingly the result of each period is ascertained. Though the business

is assumed to be continuing in future (as per going concern concept), the measurement of

income and studying the financial position of the business for a shorter and definite period

will help in taking corrective steps at the appropriate time. Each segmented period is called

“accounting period” and the same is normally a year. The businessman has to analyse and

evaluate the results ascertained periodically. At the end of an accounting period, an Income

Statement is prepared to ascertain the profit or loss made during that accounting period and

Balance Sheet is prepared which depicts the financial position of the business as on the last

day of that period. During the course of preparation of these statements capital revenue items

are to be necessarily distinguished.


XI

vi) Historical Cost Concept: According to this concept, the transactions are recorded in the

books of account with the respective amounts involved. For example, if an asset is purchases,

it is entered in the accounting record at the price paid to acquire the same and that cost is

considered to be the base for all future accounting. It means that the asset is recorded at cost

at the time of purchase but it may be methodically reduced in its value by way of charging

depreciation. However, in the light of inflationary conditions, the application of this concept

is considered highly irrelevant for judging the financial position of the business.

vii) Matching Concept: The essence of the matching concept lies in the view that all costs

which are associated to a particular period should be compared with the revenues associated

to the same period to obtain the net income of the business. Under this concept, the

accounting period concept is relevant and it is this concept (matching concept) which

necessitated the provisions of different adjustments for recording outstanding expenses,

prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course

of preparing the financial statements at the end of the accounting period.

viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made.

Sale is considered to be complete when the ownership and property are transferred from the

seller to the buyer and the consideration is paid in full. However, there are two exceptions to

this concept, viz., 1. Hire purchase system where the ownership is transferred to the buyer

when the last instalment is paid and 2. Contract accounts, in which the contractor is liable to

pay only when the whole contract is completed, the profit is calculated on the basis of work

certified each year.

ix) Accrual Concept: According to this concept the revenue is recognized on its realization

and not on its actual receipt. Similarly the costs are recognized when they are incurred and

not when payment is made. This assumption makes it necessary to give certain adjustments in

the preparation of income statement regarding revenues and costs. But under cash accounting

system, the revenues and costs are recognized only when they are actually received or paid.

Hence, the combination of both cash and accrual system is preferable to get rid of the

limitations of each system.

x) Objective Evidence Concept: This concept ensures that all accounting must be based on

objective evidence, i.e., every transaction recorded in the books of account must have a

verifiable document in support of its, existence. Only then, the transactions can be verified by


XII

the auditors and declared as true or otherwise. The verifiable evidence for the transactions

should be free from the personal bias, i.e., it should be objective in nature and not subjective.

However, in reality the subjectivity cannot be avoided in the aspects like provision for bad

and doubtful debts, provision for depreciation, valuation of inventory, etc., and the

accountants are required to disclose the regulations followed.

1.9.2. Accounting Conventions

The following conventions are to be followed to have a clear and meaningful information and

data in accounting:

i) Consistency: The convention of consistency refers to the state of accounting rules,

concepts, principles, practices and conventions being observed and applied constantly, i.e.,

from one year to another there should not be any change. If consistency is there, the results

and performance of one period can he compared easily and meaningfully with the other. It

also prevents personal bias as the persons involved have to follow the consistent rules,

principles, concepts and conventions. This convention, however, does not completely ignore

changes. It admits changes wherever indispensable and adds to the improved and modern

techniques of accounting.

ii) Disclosure: The convention of disclosure stresses the importance of providing accurate,

full and reliable information and data in the financial statements which is of material interest

to the users and readers of such statements. This convention is given due legal emphasis by

the Companies Act, 1956 by prescribing formats for the preparation of financial statements.

However, the term disclosure does not mean all information that one desires to get should be

included in accounting statements. It is enough if sufficient information, which is of material

interest to the users, is included.

iii) Conservatism: In the prevailing present day uncertainties, the convention of

conservatism has its own importance. This convention follows the policy of caution or

playing safe. It takes into account all possible losses but not the possible profits or gains. A

view opposed to this convention is that there is the possibility of creation of secret reserves

when conservatism is excessively applied, which is directly opposed to the convention of full

disclosure. Thus, the convention of conservatism should be applied very cautiously.

1.10. Accounting Equation


XIII

The entire financial accounting system is based on the accounting equation. As we know that

for operating a business unit we need the economic resources and this is being supplied by

someone. These economic resources which are possessed by the business is known as assets.

Is obvious that some amount is contributed by the proprietor of the business and some

amount is contributed by the outsiders.. The amount contributed by the proprietor is known as

capital and the amount which owed by the business to the outsiders is known as liability. If

the total contribution is made by the proprietor, then the total assets equal to equity or capital.

However if the amount is contributed includes outsider’s amount in that case the total assets

will be equal to capital and liability.

The two sides of equation will always be equal. On the one side total resources

possessed and on the other side it will represent from where all these resources are obtained.

The equity of two sides will always be true, no matter how many transactions are entered in

to. The actual assets, capital and liability may change but the equality of the assets with that

of total capital and liabilities will always hold true.

The equation based on the principle that accounting deals with property and rights to

property and the sum of properties owned is equal to the sum of the rights to the properties.

The properties owned by a business are called assets and the rights to properties are known as

liabilities or equities to the business.

Equities may be divided in to equities of creditors representing debts of the business

known as liabilities and the equity of owner known as capital. Taking this in to account, the

accounting equation may be as below:

Assets = Liabilities +Capital Or

Capital =Assets –Liabilities Or

Liabilities = Assets –Capital

Assets: Assets are the economic resources of the organization. It includes both tangible and

intangible items. For example tangible assets include land, building, furniture, machinery,

goods, stock equipments etc. Similarly intangible assets includes goodwill, copy right, patent,

trademark etc.


XIV

Liabilities: It the amount of obligation of the organization to pay outsiders. It includes

creditors, bills payable, bank overdraft, bank loan, outstanding expenses, income received in

advance etc.

Capital: It the amount contributed by the proprietor to start a business. It is the initial capital

brought in to the business.

Example-1: Prepare accounting equation and also prepare balance sheet. Particulars Amount Started business with capital Purchased goods for credit Rs2,000 and for cash Sold goods cost price Rs5,000 for Rent paid Commission received Bank loan taken Paid to the creditors in full settlement of account

10,000 3,000 6,000 100 500 2,000 1,900

Example-2: Prepare accounting equation and balance sheet Particulars Amount Commenced business with goods Rs6,000 and for cash Purchased goods on credit from Mr.X Goods withdrawn for private use Interest on capital due Cash withdrawn from bank for private use

14,000 2,000 500 300 500

Example -3: Prepare accounting equation and balance sheet Particulars Amount Commenced business with bank balance Purchased furniture Purchased goods for Rs3,000 and on credit Sold goods to Y cost price Rs3,000 for Rent received

25,000 1,000 7,000 4,000 1,000

SUGGESTED ANSWERS FOR ASSIGNMENT OF ACCOUNTING EQUATIONS 1. Accounting equation of.. as on …. Transactions cash goods liability capital Started business with capital Purchased goods New equation Sold goods New equation Rent paid New equation Commission received Bank loan taken New equation Paid to creditors

10,000 (-)3,000 7,000 6,000 13,000 (-) 1,000 12,000 500 12,500 2,000 14,500

5,000 5,000 (-) 5,000 Nil Nil Nil Nil

2,000 2,000 2,000 2,000 2,000 2,000 4,000

10,000 10,000 1,000 11,000 (-)1,000 10,000 500 10,500 10,500


XV

New equation (-) 1,900 12,600

Nil

(-)2,000 2,000

100 10,600

Balance Sheet as on …………… Liabilities and capital Amount Assets Amount Capital Creditors

10,600 2,000 12,600

Cash 12,600 12,600

2. Accounting equation of ..as on….. Transactions Goods Cash Liability Capital Commenced business Purchased goods on credit New equation Goods drawn for private use New equation Int.on capital New equation Cash withdrawn for private use New equation

6,000 2,000 8,000 (-)500 7,500 7,500 7,500

14,000 14,000 14,000 14,000 (-) 500 13,500

2,000 2,000 2,000 300 2,300 2,300

20,000 20,000 (-)500 19,500 (-)300 19,200 (-) 500 18,700

Balance Sheet as on ……………… Liability and capital Amount Assets Amount Capital Creditors Interest due

18,700 2,000 300 21,000

Goods Cash

7,500 13,500 21,000

3. Accounting equation of .. as on… Transaction Bank FF Goods Debtor(Y) Liability Capital Commenced business Furniture purchased New equation Purchased goods New equation Sold goods to Y New equation Rent received New equation

25,000 (-)1,000 24,000 (-)3,000 21,000 21,000 1,000 22,000

1,000 1,000 1,000 1,000 1,000

10,000 10,000 (-)3,000 7,000 7,000

4,000 4,000 4,000

7,000 7,000 7,000 7,000

25,000 25,000 25,000 1,000 26,000 1,000 27,000


XVI

Balance Sheet as on …………………. Liabilities and capital Amount Assets Amount Capital Creditor for goods

27,000 7,000 34,000

Bank Furniture Goods Debtors (Y)

22,000 1,000 7,000 4,000 34,000

Final Accounts Accounts prepared on any pre-determined date, on the expiry of definite period, to ascertain profit or loss and financial condition of business are known as final accounts. In other words final accounts refer to those accounting statements which are prepared (i) to ascertain profit or loss during accounting year at the expiry of accounting period (ii) to know the financial condition of the business at the end of the accounting period.

� Trading Account/ Manufacturing A/c � Profit or loss Account � Balance Sheet.

Trading Account of Mr. X for the year ending….. Particulars Amount Particulars Amount To Opening stock To Purchases To sales return To Carriage To Carriage inward To Freight To Freight inward To Wages To Factory expenses To Stores consumed To Royalty To Motive Power To Coal, coke To Water To Oil To Octroi To Dock charges To Custom Duty To Gross Profit( if profit)

By Sales By Purchase return By closing stock By goods used for personal use By Gross loss( if loss)

Profit &loss account for the year ended… Particulars Amount Particulars Amount To Gross loss b/d To salary To rent,rate,rates To stationary To postage and telegram To audit fees To legal charges To telephone charges To insurance premium To entertainment expenses To repairs

By gross profit b/d By rent By discount By commission By interest By bad debts recovered By apprentice premium By income from investment


XVII

To depreciation To interest To trade expenses To conveyance To charity To bank charges To office expenses To establishment exp To stable expenses To license fees To brokerage To commission To office lighting To advertisement To export duty To discount To packing charges To traveling exp To bad debts To provision for bad debts To net profit transferred to capital account (if profit)

By net loss transferred to capital account (if loss)

Balance sheet of X as on or as at… Liabilities Amount Assets Amount Bank overdraft Bills payable Sundry creditors Short term loans Bank loans Long-term loans Capital

Cash in hand Cash at bank Bills receivable Sundry debtors Closing stock Finished goods Raw materials Work in progress Stationary Goods sent on consignment Long term investments Trade mark Patents Vehicle Furniture Investments Machinery and plant Tools Land and building Goodwill


XVIII

Ex-1: Prepare trading and profit/loss account and balance sheet from the following. Particulars debit credit Drawings and capital Land Premises Goodwill Trademark Plant Fixture Opening stock Bills receivable and payable Debtors and creditors Purchases and sales Returns Carriage inward Carriage outward Freight Wages Coal Factory expenses Salaries Rent Commission Interest Discount Stationary Trading expenses Cash Bank

5,000 25,000 20,000 7,000 13,000 15,000 2,000 18,000 4,000 16,000 80,000 1,000 1,500 500 1,200 22,000 800 4,500 18,000 6,000 2,500 4,000 500 1,800 700 2,70,000

40,000 6,000 24,000 1,50,000 2,000 3,000 6,000 39,000 2,70,000

Closing stock Rs20,000


XIX

Solve: Trading and profit/loss account for the year ended… Particulars Amount Particulars Amount To opening stock To purchases To carriage inward To freight To wages To coal To factory expenses To sales return To gross profit c/d To carriage outward To salaries To rent To commission To discount To stationary To trading expenses To net profit

18,000 80,000 1,500 1,200 22,000 800 4,500 1,000 43,000 1,72,000 500 18,000 6,000 2,500 4,000 500 1,800 18,700 52,000

By sales By purchase return By closing stock By gross profit b/d By interest By discount

1,50,000 2,000 20,000 1,72,000 43,000 3,000 6,000 52,000

Balance sheet of .. as on Liabilities Amount Assets Amount Bills payble Creditors Bankers Capital 40,000 (+)Net profit18,700 _______ 58,700 (-) drawings 5,000

6,000 24,000 39,000 53,700 1,22,700

Cash in hand Debtors Bills receivable Closing stock Fixture Plant Trademark Land Premises goodwill

700 16,000 4,000 20,000 2,000 15,000 13,000 25,000 20,000 7,000 1,22,700

Depreciation

Depreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of

matching the cost of a fixed asset with the revenue (or other economic benefits) it generates

over its useful life. Without depreciation accounting, the entire cost of a fixed asset will be

recognized in the year of purchase. This will give a misleading view of the profitability of the

entity. Methods of depreciation

• Straight Line method

• Diminishing Balance Method


XX

Inventory

Inventories are assets:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or in the

rendering of services.

(IAS 2)

Inventory must be recorded at the lower of cost or net realizable value.

Cost. Includes the purchase cost and any other costs necessary in bring the inventories to their

present location and condition. These may include costs incurred directly in the production of

inventory such as direct labor and production overheads (i.e. conversion costs) and other

expenses such as transportation and handling charges, taxes and duties that may not be

recoverable from tax authorities. However, costs do not include general and administrative

costs which cannot reasonable attributed to the cost of inventory. Similarly, selling and

distribution expenses, storage costs and excessive expenditure resulting from abnormal

wastage shall not be included in the cost of inventory.

Methods of calculating inventory cost

As inventory is usually purchased at different rates (or manufactured at different costs) over

an accounting period, there is a need to determine what cost needs to be assigned to

inventory. For instance, if a company purchased inventory three times in a year at $50, $60

and $70, what cost must be attributed to inventory at the year end? Inventory cost at the end

of an accounting period may be determined in the following ways:

� First In First Out (FIFO)

� Last In First Out (LIFO)

� Average Cost Method (AVCO)

� Highest in First Out (HIFO)

First In First Out (FIFO)

This method assumes that inventory purchased first is sold first. Therefore, inventory cost

under FIFO method will be the cost of latest purchases. Consider the following example:


XXI

Example

Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as

follows:

January 1 Purchased 5 bikes @ $50 each

January 5 Sold 2 bikes

January 10 Sold 1 bike

January 15 Purchased 5 bikes @ 70 each


The value of 4 bikes held as inventory at the end of January may be calculated as follows:

The sales made on January 5 and 10 were clearly made from purchases on 1st January. Of the

sales made on January 25, it will be assumed that 2 bikes relate to purchases on January 1

whereas the remaining one bike has been issued from the purchases on 15th January.

Therefore, the value of inventory under FIFO is as follows:

Date Purchase Issues Inventory

Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total

Jan 1 5 50 250

5 50 250

Jan 5

2 50 100 3 50 150

Jan 10

1 50 50 2 50 100

Jan 15 5 70 350

5 70 350

Jan 15

7

450

Jan 25

2 50 100

1 70 70 4 70 280

As can be seen from above, the inventory cost under FIFO method relates to the cost of the

latest purchases, i.e. $70.

Last In First Out (LIFO)


XXII

This method assumes that inventory purchased last is sold first. Therefore, inventory cost

under LIFO method will be the cost of earliest purchases. Consider the following example:

Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as

follows:

January 1 Purchased 5 bikes @ $50 each


January 10 Sold 1 bike

January 15 Purchased 5 bikes @ 70 each


The value of 4 bikes held as inventory at the end of January may be calculated as follows:

The sales made on January 5 and 10 were clearly made from purchases on 1st January.

However, all sales made on January 25 will be assumed to have been made from the

purchases on January 15. Therefore, the value of inventory under LIFO is as follows:

Date Purchase Issues Inventory

Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total

Jan 1 5 50 250

5 50 250

Jan 5

2 50 100 3 50 150

Jan 10

1 50 50 2 50 100

Jan 15 5 70 350

5 70 350

Jan 15

7

450

Jan 25

3 70 210 2 50 100

2 70 140

4

240

As can be seen from above, LIFO method allocates cost on the basis of earliest purchases

first and only after inventory from earlier purchases are issued completely is cost from

subsequent purchases allocated. Therefore value of inventory using LIFO will be based on

outdated prices. This is the reason the use of LIFO method is not allowed for under IAS 2.

Good Luck

82220_FAM-CUTM

Documents

Transcript of 82220_FAM-CUTM