Accountancy T20

7/31/2019 Accountancy T20

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FAST - FI NANCE AND SOFT SKI LLS TRAI NI NGCONTACT DETAI LS:

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ACCOUNTANCY T2 0Account ing is oft en called th e language of business. Its purpose is to comm unicate or rep ort th eresult s of b usiness oper ati ons and its variou s aspect s.

It is th e process of identif ying, m easuring and com m unicating econom ic infor m ation t o perm itinform ed judgment s and decisions by users of the infor mation .

Account ing: Objectives & Limit ation s

Define accountin g. W hat are it s objectives and lim itat ions?

According t o Am erican Institu te of Cert ified Public Account ants (AICPA), "Account ing is th e art o frecording, classifying and summ arizing in a significant m anner and in term s of m oney t ransactions aevents w hich are, in part at least, of a financial character and in terp reting th e results thereof."

Am erican Account ing Association (AAA) has defined account ing as "t he pr ocess of ident ifying,m easuring and comm unicating econom ic inform ation to permit inform ed judgem ents and decisionsusers of t he inform ation."

On analyzing the above def initions th e follow ing characteristics of account ing emerges:

Account ing is the art of recording and classifying different business transactions.

The business tr ansactions may be com pletely or p artially of financial natu re.

Generally the bu siness transactions are described in m onet ary term s.

In accounting process, th e business transaction s are sum m arized and analyzed so as to arrive at am eaningful interpretation.

The analysis and inter pretat ions thus obtained are comm unicated to t hose who are responsible to t akcertain decisions to deter m ine th e fut ure course of business.

The follow ing are the objectives of accoun tin g:

To record t he bu siness tr ansactions in a system atic mann er.

To determ ine the gross prof it and net p rofit earned b y a firm during a specific period.

To know th e financial position of a firm at th e close of th e financial year by way of p reparing the basheet


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To facili tate m anagem ent control.

To assess th e taxable incom e and t he sales tax liabilit y.

To provide requisite inform ation t o different part ies, i.e., own ers, creditors, em ployees, m anagemenGovernm ent, investors, financial instit ut ions, banks etc.

Accounting suffers from the f ollow ing lim itations:

Account ing info rm ation is expressed in term s of m oney. Non m onet ary events or transactions, how eimpor tant, are completely om itted.

Fixed assets are recorded in t he accoun ting records at the o riginal cost, that is, the actual amo unt speon t hem plus all incident al charges. In this way the effect of inflat ion (or deflation) is not t aken intoconsideration. The direct result of t his practice is th at balance sheet do es not represent th e tru efinancial position of th e business.

Account ing info rm ation is somet imes based on estimat es; estim ates are often inaccurate.

Account ing inform ation cannot be used as the only test of m anagerial perform ance on t he basis of mprof its. Profit for a period o f one year can readily be m anipulated by om itt ing such costs asadvertisemen t, research and developm ent, depreciation and so on.

Account ing inform ation is not neut ral or unbiased. Account ants calculate incom e as excess of revenuover expenses. But t hey consider o nly selected revenues and expenses. They do not , for examp le,include, cost o f such items as w ater or air p ollution , employees injuries, etc.

Account ing like any other discipline has to follow certain principles, w hich in cert ain cases arecontr adictory. For exam ple current assets (e.g., sto ck of good s) are valued on the b asis of cost or m arprice w hichever is less follow ing the principle of conservatism . Accordin gly the current assets may bvalued on cost basis in some year and at m arket pr ice in anot her year. In th is m anner, the rule ofconsisten cy is not follow ed regularly.

Functio ns of Account ing

W hat are the various functions of Account ing?

Various Functio ns of Account ing are:

Recording: Accounting record s business tr ansactions in ter m s of m oney. It is essent ially concerned wensuring that all business tr ansactions of financial nature are pro perly recorded . Recording is done in journal , w hich is fur t her subdiv id ed in t o subsidia ry bo oks f rom t he poin t of vie w of co nven ie nce .

Classifyin g: Accou nt ing also facilit ates classification of all bu siness tr ansaction s record ed in jo urn al.Item s of similar natu re are classified und er approp riate heads. The w ork o f classification is done in aboo k called the ledger.


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Sum m arizing: Account ing sum m arizes the classified infor m ation. It is done in a m anner, w hich is usto th e intern al and external users. Intern al users interested in t hese infor m ations are the persons w hom anage the bu siness. External users of inform ation are th e investo rs, credit ors, tax aut horit ies, laborunions, trade associations, shareholders, etc.

Interp retin g: It im plies analyzing and int erpret ing the financial data em bodied in final accoun ts.Interp retat ion of t he data helps th e management , outsiders and shareholders in decision m aking.

Different Systems of Accoun tin g

Explain t he diff erent systems of accounting.

The follow ing are t he b asic systems of recording bu siness transactions:

Cash Basis Account ing: According t o t his system , only actu al cash r eceipts and paym ent s are recordeth e bo oks. The credit transactions are not recorded at all, till actual cash is received o r paid. Thus, ifpurchases are m ade in the year 2002 on credit and paym ent f or pu rchases is m ade in the year 2003,such pu rchases shall be considered to be an expense of th e year 2003 and shall not be recorded in t heyear 2002. This system of account ing is mostly fo llow ed by non-t rading organizations, professionalslawyers, doctor s, chartered account ants, etc.

M ercantile or Accrual System : Accordin g to th is system , all the business transactions pert aining to tspecific period, wh eth er of cash or credit natur e, are recorded in th e books. This system of account inbased on accrual concept, w hich states that revenue is recognized w hen it is earned and expense isrecognized w hen obligation of paym ent arises. Actu al m ovem ent o f cash is irrelevant. M ercantile syof accountin g is w idely followed by th e industrial and com m ercial undert akings because it takes intaccount th e effects of all transaction s already ent ered into .

M ixed System : M ixed system is m odified f orm of p ure-cash-basis account ing. Because of th e fact t hpure cash basis w ould result in balance sheet and incom e stat em ent w ith lim ited u se, it necessitat es tneed o f m ixed accoun ting in w hich som e item s (especially sales and per iod costs are t reated o n cashbasis and som e item s (especially pro duct costs and lo ng-lived asset s) are tr eated o n accrual basis.

Pure cash basis approach w ould change the cost of acquisition o f invento ries from th e prof it of t hat in w hich th e acquisition costs are paid rather t han in th e year in w hich invento ries are sold. Similarlycost of acquisition of fixed assets wou ld reduce the prof its when p aid in cash rather t han in later perw hen t hese long-lived item s are used, th us misleading the results of financial operation.

Em erging Role o f Account ing

Explain briefly the m eaning of

Financial AccountingM anagement AccountingSocial Responsibility Accou nt ing


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Hum an Resource Account ingFinancial Accounting

Financial or t raditio nal account ing:consists of t he classification , recordin g, and analysis of t hetr ansactions of a business in a subjective m anner according t o t he natu re of expend itur e so as to enab

th e presentatio n at period ic intervals, of statem ents of pr ofit or loss of t he business and, on a specifidate, of its financial stat e of affairs. The day-to-day tr ansactions journ alized or r ecorded in subsidiarboo ks are posted in the various ledgers and at t he end of th e account ing period, a Profit and LossAccount and a Balance Sheet are prepared. The emphasis is on t he ascertainm ent and exhibition o f t hprof its earned or losses incurred b y th e business rath er th an on t he aspects of planning and contr ol adecision m aking.

Financial accoun ting safeguards the interests of t he bu siness and its propr ietors and ot her conn ectedw ith it by pro viding suitable account s and info rm ation t o various parties, such as th e shareholders opartn ers, present and prospective creditors and the Governm ent. The accounts are kept in a mann er sas to m eet t he provisions of t he Com panies Act and to p resent correct figures to incom e tax, excise aot her aut horit ies. These account s show ho w gainfully th e resources of t he business w ere emp loyed.

M anagement Accounting

M anagement accoun ting includes all those account ing services by m eans of w hich assistance isrendered to the m anagement at all levels, in form ulation of policy, fixation of plans, control of theirexecution, and m easurem ent of perform ance. M anagement accounting is prim arily concerned with supply of infor m ation wh ich is useful to the m anagement in decision m aking for the efficient runnith e business and th us, in maxim izing profit. M anagem ent account em ploys various techniques, w hicinclude standard costing, budgetary cont rol, m arginal costing, break-even and cost-volum e-profit

analysis, uniform costing and int er-firm com parison, ratio account ing, intern al audit, and capital proassessm ent and cont rol.

Social Responsibility Accounting

Social responsibility account ing is a new phase in t he developm ent of accounting and ow es its birth increasing social awareness, w hich has been part icularly no ticeable over t he last t w o d ecades or so.Social responsibility account ing widen s the scope of account ing by considering the social effects ofbu siness decisions, in addit ion t o th e econom ic effects. Several social scient ists, statesm en and socialw orkers all over the wor ld have been drawing the att ention of t heir government s and t he people intheir countries to t he dangers posed to environment and ecology by the unb ridled industrial growthThe role of business in society is increasingly coming u nder greater scrutiny. The m anagem ent is beinheld responsible not on ly for ef ficient conduct of b usiness as expressed in prof itability, but also fo r it cont ribut es to social w ell being and progress. There is a grow ing feeling th at the concept s of growand prof it as m easured in tr aditional balance sheets and incom e stat em ents are to o narrow to r eflectth e social respon sibility aspects of a business.

Hum an Resource Account ing


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It is another new field of account ing which seeks to report and emphasize the import ance of hum anresources in a com pany's earnings. It is based on th e fact t hat t he on ly real long lasting asset w hich anorganization possesses is the quality of t he peop le wo rking in it. This system of account ing is concerw ith " the process of identifying and m easuring data about hum an resources and comm unicating thiinform ation t o int erested parties."

How does management Account ing differs from Financial Account ing? Explain briefly, howm anagem ent account ing helps th e management of a company in m aking its decisions.

Financial or tr aditional accounting con sists of th e classification, record ing, and analysis of t hetr ansactions of a business in a subjective m anner according t o t he natu re of expend itur e so as to enabth e presentatio n at period ic intervals, of statem ents of pr ofit or loss of t he business and, on a specifidate, of its financial stat e of affairs. The day-to-day tr ansactions journ alized or r ecorded in subsidiarboo ks are posted in the various ledgers and at t he end of th e account ing period, a Profit and LossAccount and a Balance Sheet are prepared. The emphasis is on t he ascertainm ent and exhibition o f t hprof its earned or losses incurred b y th e business rath er th an on t he aspects of planning and contr ol adecision m aking.

M anagem ent account ing includes all tho se accounting services by m eans of w hich assistance isrendered to the m anagement at all levels, in form ulation of po licy fixation of plans and control of thexecution, and m easurem ent of perform ance. M anagement accounting is prim arily concerned with supply of infor m ation wh ich is useful to the m anagement in decision m aking for the efficient runnith e business and th us, in maxim izing profit. M anagem ent account em ploys various techniques, w hicinclude standard costing, budgetary cont rol, m arginal costing, break-even and cost-volum e-profitanalysis, uniform costing and int er-firm com parison, ratio account ing, intern al audit, and capital proassessm ent and cont rol.

Difference

Financial accoun ting dep icts th e past position o f t he concern, w hile m anagem ent account ing stressesfuture .

Financial accoun ting keeps a record o f very large numb er of daily business transaction s and preparesvarious financial statem ents according t o accountin g principles and standards. In m anagem entaccount ing t here is no such com pulsion. It lays emp hasis on analysis and standards.

M anagement accounting provides data to m anagers to help them in m aking decisions about the fu tu

To the contr ary, financial accounting aims at m eeting the requ irem ent s of ou tside parties w ho havefinan cial stake in t he business.

Financial accoun ting is mandat ory for all joint stock com panies and b usiness organizations but th is isthe case w ith m anagement accounting.

Interested Groups


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Stat e the grou p of per sons having an interest in a business organization and examine t he natur e oftheir inform ation head?

There are various parties interested in t he financial statem ent s. Accoun ting info rm ation is useful tovarious internal & external users listed below :

Shareholder s: Since shareholders have invested in th e com pany so they are interested in th e financialstatements.

Credit ors: Creditor s may be short -term or long-term . The m ain concern of the credit ors is focused oth e credit w ort hiness of t he firm and its ability to m eet its financial obligations. They are therefor econcerned w ith t he l iquidity o f t he firm, i t s profitabili ty and financial soundness.

M anagement: M anagement requires accounting inform ation for planning, organizing, and controlpurp oses. The em phasis on efficient & effective m anagem ent of o rganizations has considerablyextended the dem and for accounting information.

Em ployees: The import ance of harmonious industrial relations betw een m anagement & employeescannot be over -emp hasized. The emp loyees have a stake in t he ou tcom es of several managerialdecisions. Greater emp hasis on industrial democracy throu gh emp loyee participation in m anagem endecisions has im port ant im plication for the supply inform ation to emp loyees. M atters l ike sett lem ew ages, bonus, & p rofit sharing rest on adequat e disclosure of relevant facts.

Governm ent: Governm ent u ses financial inform ation for com piling stat istics concerning calculationprofitabili ty, taxes, com putation of national incom e, and determ ination of t he industrial grow th.

Sto ck Exchanges: Several stock exchanges also require accoun ting inform ation for listing of securit ie

Consum ers & Other s: Consum er or ganizations, media, w elfare organizations and pu blic at large are ainter ested in con densed accounting inform ation in ord er to appraise the efficiency and social role ofenterprises in different sectors of t he economy.

Role of Accountant s

Discuss the r ole of account ants in m odern business organization.

Role of Accoun tant s in M odern Business Organization:

Account ing is an age-old prof ession. In old days of account ing, th e m ain function of an account ant wto m aintain the records of th e business. However over t he years, the role of an account ant hasunder gone a sea change. W ith t he inception of joint stock com pany form of an organization, theprof ession o f accountancy has com e to be recognized as one of th e lucrative professions. Accountantcan be broadly divided into t w o categories nam ely, Accoun tant s in public practice and Accoun tant s em ploym ent. Account ants in public practice (practicing chartered accountant s) are mem bers of theInstit ut es of Chart ered Accountant s of India. The accountant render s valuable service to t he society the follow ing m anner:


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W riting up Account s for Preparing Financial Stat emen ts: Professional account ants of fer services forw riting up account s and preparing financial stat emen ts. By m aintaining proper boo ks of accounts anrecords he assists m anagem ent to a great ext ent in the f ield of planning, decision-m aking andcontr olling. A system atic record also enables the bu siness to com pare one year s results w ith t hose oot her years.

Audit of Account s: Condu cting of audit is one of t he m ost impor tant funct ions of a professionalaccount ant w here his specialized tr aining, skills and judgm ent are mo st often called into play. Auditsatisfies th e users of financial stat ement s th at th e accounting infor m ation cont ained in these statem eis tr ue and reliable and t hat account s have been prepared in accordance w ith t he accoun ting stand ardIt, th us, adds credibility t o financial stat em ent s prepared by th e business. He also po ints out th eshortcom ing and suggests ways to o vercom e them .

Role as M anagem ent Accountant : A m anagement accountant helps th e managemen t in planning andcontr ol of organizational activities and th eir perform ance evaluation.

Help to governm ent , Revenue Departm ent and Tax Payer: Chart ered account ant plays an imp ort ant rin ensuring that t he Governm ent gets its proper share of taxes and at t he same t ime t he tax payer is nexploited. Chartered account ant is instrum ent al in preparing the financial statem ents of th e enterpr iHe also pr epares the retur ns for t ax purposes. He also appears before t he t ax aut horit ies on b ehalf ofth e taxpayer. He also does th e wo rk of certification of docum ents in m any cases.

Role as Cost Accountant : As a cost accoun tant , he m aintains the costing records and ascertains the coof pro duct or service. He provides costing inform ation int rodu ces cost control and cost red uctionm eth ods and assists the m anagem ent in fixing appropriat e selling prices.

Role in M erger, Liquidatio n, etc: The services or advice of chartered account ants are frequent ly sougin the form ation, merger or l iquidation o f l imited com panies. They are called upon t o undert akeinvestigation for achieving greater ef ficiency in m anagem ent and find o ut th e reasons for increase odecrease in prof its. They act as executors and tru stees under a w ill or trust deed t o carry out t headministration of the estate or sett lement s.

Accoun ting Personnel

W rit e a shor t no te on Finance Officer.Finance is the life b lood o f bu siness. Procuring financial resources and t heir judicious ut ilization are tw o im port ant activities of financial management w hich is a specialized fun ction. The finance m ana

has to str ike a balance bet w een the curren t n eeds of t he ent erprise for cash and the need s of t heshareholders for adequate ret urn. The financial m anagem ent of a large com pany is usually th eresponsibility o f t he finance director w ho m ay be in place of or in addition t o t he controller. Oftenfinance manager and cont roller are int er-changeable term s and only one of t hese tw o positions may foun d in a comp any. The finance manager is also concerned w ith im plemen ting t he financial policy th e board of directors, m anaging liquidity, preparation of b udgets, adm inistr ation of bu dgetary contsystem , managing prof itability, etc.


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W e w ill now discuss th e rules & conven tions of account ing. The rules and convent ions of account incomm only referred to as the conceptual framew ork of accounting. As with any discipline or body oknow ledge, som e und erlying theor etical str uctur e is required if a logical and useful set o f pr actices a

procedur es are to be develop ed for reaching the goals of t he prof ession and fo r expanding know ledgth at field. Such a body of principles is needed t o help answ er new questions that arise.

Account ing theory m ay be defined as logical reasoning in the fo rm of a set of broad prin ciples th at

Provide a general fram e of reference by wh ich account ing practice can be evaluated.

Guide the development of new practices & procedures.

Provide a coherent set of logical principles th at form th e general fram e of refer ence for th e evaluatiand developm ent of sound account ing practices.

Basic Accou nt ing Con cepts

W hat d o you m ean by basic account ing concepts?

Account ing has come t o present statu s aft er a period of several hundred years. During this periodcertain accounting assum pt ions, concepts and convent ions have emer ged. Account ants universally inth e recording, classification, sum m arization and rep ort ing of the t ransactions follow t hese. Accountassumpt ions, concepts and convent ions are called Generally Accepted Accoun ting Principles (GAAP)since they h ave been comm only accept ed by pro fessional accoun ting w orld as general guidelines forpreparing financial stat em ents and repor ts. Thus account ing principles are rules of action adopted byaccountants.

Account ing principles are m an-made. Un like the principles of physical and natu ral sciences, accountprinciples are not etern al trut hs. They have been evolved over th e years keeping in view t heir relevaobjectivit y and feasibility. Accountin g Stand ard Board (ASB) of th e Institut e of Charter ed AccountaIndia makes account ing rules in India. Know ledge of account ing concepts facilitates the learning ofaccount ing, the language of business, by users of accoun ting infor m ation. The users of account inginfor m ation include shareholders, investo rs, lenders, suppliers of good s and services (credito rs),custo m ers, em ployees, governm ent and its agencies and p ublic at large.

List t he basic accou nt ing concept s.

The Instit ut e of Chartered Account ants of Ind ia in its Account ing Stand ard-I (AS-I) has stat ed t hat gconcern, accrual and consistency are fund ament al account ing assum pt ions. For t he sake of convenienall account ing concepts are discussed un der t w o h eadings:

Basic account ing concepts


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Accoun ting concepts related t o incom e measurem ent

Basic Account ing Con cept s are:

Ent ity Concept

M oney M easurement Concept

Going Concer n Con cept

Cost Con cept

Dual Aspect Con cept

Full Disclosure Concept

Objectivity Concept

Accrual Concep t

Accoun ting concepts related t o incom e measurem ent are:

The Time Period Concept (Periodicity Concept)

The Revenu e Recognit ion (Realisatio n) Concept

The M atching Concept

The M ateriality Concept

The Consisten cy Con cept

The Conservat ism (Prud ence) Con cept

Basic Accoun tin g Con cept s: Det ails

Explain t he f ollow ing Basic accounti ng concepts:

Ent ity Concept


Going Concer n Con cept

Cost Con cept

Dual Aspect Con cept

Full Disclosure Concept


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Objectivity Concept

Accrual Concep t

Entity Concept

In accoun ting, the ent ity of business is considered separate f rom th e existence of it s own ers. Accounare kept for the ent ity as distinct from ow ners. Thus, mo ney invested b y the proprietor by w ay of cais considered to be the liability of the bu siness to t he propriet or. If proprieto r w ithdr aws som e cash goods, they are t reated as drawings but not as business expense. Capital is reduced b y t he amo unt ofdraw ings. The pr inciple of separate en tit y is quite visible in t he case of corp orat e bodies since acom pany is a legal ent ity separate fro m th e shareholders wh o ow n it. In case of a corpo rate body t heliability o f th e shareholders is limit ed to t he extent of t he value of shares held by t hem . But in case onon-corp orate b odies th e ow ners or partners rem ain legally liable for t he debts of t he business evenafter it s closure. Their private proper ty can be sold to discharge the liability of t he firm .


In accoun ting, a record is m ade only of t hose facts or transaction s that can be expressed in m onet aryterm s. It pro vides a com m on yardstick, i.e., money f or m easuring, recording and summ arizing thetr ansaction. Events, which cannot b e expressed in m oney t erm s, do not find a place in account boo ksFor exam ple, salary paid to m anager is recorded in account books but his comp etence, w hich cannot expressed in mo netary t erm s, is not r ecorded in th e books. The application of m oney m easurem entconcept m akes account ing data and infor m ation relevant, sim ple, understandable, hom ogeneous andcom parable. The main advantage of mo ney m easurem ent concept is th at even a layman is able tounderstand and appreciate t he things stated in term s of m oney. However, the concept suffers from t

following flaw s:M oney do es not have a constant value. The value of mo ney changes because of inflation or d eflationthe country.

All business assets cannot be m easured in m oney t erm s. It is very difficult t o calculate t he value ofgoodwill or m easure the com petency or m orale of employees.

Going Concern Concept

This concept assum es that t he business will exist fo r certain for eseeable fut ure w ith t he specified gofor specified dur ation. Thus recording and valuation of long-term assets and liabilities are based on tassumpt ion. Fixed assets are recorded on histor ical costs and wr itt en dow n over th e expected life of assets. Sim ilarly long-ter m liabilit ies, i.e., deben tu res, pref eren ce shares, lon g-term loans are raised ath eir term s of repaym ent are settled on t his assum pt ion. The going concern concept is th e backbone account ing and is based on th e follow ing assum pt ions:

Business has an indefin ite life.


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Assets are depreciated on th e basis of t heir expected life wit hout caring for t heir current values.

In case of inn ovations or new invention s, th eir effect is measured in financial term s and assets aredepreciated to allow f or such innovation s or invent ions.

How ever, if it is certain that a particular ventur e will exist only for a limited perio d, the account ingrecords w ill be kept accordingly. Furt her, if in the long run a business decides to revalue th e assets antr ansfer t he surplus or def icit to capital reserve, it w ill not be taken as violation of th e going concernconcept. Here r evaluation is on a perm anent basis to reflect curr ent values of assets.

Account ing Stand ard (AS)-l states "t he ent erprise is norm ally view ed as a going concern, t hat is, ascontinuing in operation for the fo reseeable future. I t is assum ed th at t he enterprise has neither theinten tion n or t he necessity of liquidat ion or of curt ailing materially the scale of operat ions." Continof activity is to be tru e of all typ es of bu siness enter prises. The assump tion does not im ply theperm anent existen ce of an ent erprise. It simp ly assum es stability and continuit y for a period of t imelong enough to carry out present plans, contracts and comm itm ents.

Cost Concept

According t o t his concept, all transactions and event s are recorded in th e book" of account at the actprice involved. This price is called cost. All assets are carried in t he bo oks of accounts fr om year to yat t heir acquisition cost (also called h isto rical cost) irrespective of any change in th eir m arket value.Acquisition cost is considered highly objective, reliable, definit e and free f rom bias. Thus w hen am achine is purchased for Rs. 5 lakhs, t ransport atio n expenses are Rs. 20,000, installatio n expen ses areRs. 10,000, t he m achine is valued at Rs. 5,30,000. This is th e histor ical cost of m achine. How ever, t hecost con cept creates difficulties in its application in th e follow ing situat ions:

(a) W hen du e to price rise, the pr ices of all com m odit ies go up substantially, th e financial position ofirm depicted on cost concept basis does not reflect t rue picture.

(b) Financial statem ents of t w o or m ore firms set up at different points of t im e prepared on historiccost basis are no t comp arable due t o changes in prices.

(c) Depreciation is com put ed on historical cost. This understat es depreciation w hen curr ent value ofasset is very h igh. So it becom es necessary to r evalue th e assets.

(d) This concept implies recording of all assets for w hich costs have been incurred but th e assets likem anagerial competence, reputation or goodw ill of the firm acquired over a period of t ime are notrecorded.

(e) The exception to this concept o f valuing assets at cost irrespective o f it s market value is the valuaof inven to ries. According to AS-2, invent ories should b e valued at cost o r m arket price w hichever islower.

In spite o f t he lim itation s, cost concept is still considered highly objective and free fro m bias.


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Dual Aspect Concept

Every tr ansaction ent ered int o by a firm has tw o aspects, viz., debit and credit. Debit represents creaof or addit ion to an asset or an expense or th e reduction or elim ination of a liability. Credit m eansreduct ion or elim ination of an asset or an expense or th e creation of or add ition of a liability. Theref

according t o du al aspect concept, at any t im e, the t ot al assets of a business are equal to it s tot alliabilities. In the equatio n form :

Assets = Capit al + Liabilit ies

Assets denot e the resources own ed by a business w hile the t erm liability r efers to extern al claim . Ancapital is th e claim of t he ow ners against t he assets of t he bu siness. The system of account ing, whichrecords bot h t he aspects of a t ransaction ever, is based on Do uble Entry System of b ookkeeping.

Full Disclosure Con cept

Account ing records are m eant fo r t he use of ow ners, investors, lenders, creditor s, bankers, emp loyeeand Governm ent for various purpo ses. They m ust be prepared honestly and all m aterial inform ationshould be disclosed for t he benefit of i ts users. An attem pt should be m ade to m ake the inform ationrevealed mor e meaningful to all those wh o are entitled t o receive it. In case of a holding com pany,account s of subsidiary com panies should be att ached wit h th ose of the hold ing com pany. Suff icientannexures should f ollow t he income statem ent and t he balance sheet t o m ake the full disclosure. ThCom panies Act 1 956 has taken sufficient precaution s in this regard. This is in keeping wit h t he latesttr end of financial statem ent s as a means of conveying and not concealing info rm ation.

The Accoun ting Standard-l (AS-I) issued by t he Institut e of Chartered Account ants of India m entio nabout 'Disclosure o f Account ing Policies' in paragraph 24-27 as follow s:

24. All significant account ing policies adopt ed in t he preparatio n and pr esentatio n of financialstatem ents should be d isclosed.

25. The disclosure of th e significant accoun ting po licies as such should f orm part of t he financialstatem ents and t he significant account ing policies shou ld norm ally be disclosed at o ne place.

26. Any change in the account ing policies w hich has a material effect in the current period w hich isreasonably expected t o have a m aterial effect in later period should be disclosed. In the case of a chain accounting policies w hich has a material effect in the current period, the amount by w hich any iteth e financial stat emen ts is affected by each change should also be disclosed t o t he exten t ascertainabW here such account is not ascertainable, w holly or in part , the fact should be indicated.

27. If t he f undam ent al accountin g assumpt ions, viz., going concern, consistency and accrual, arefollow ed in financial stat em ent s, specific disclosure is not required . If a fundam ental account ingassumpt ion is not follow ed, the fact should be disclosed.

Objectivity Concept


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This concept im plies th at all account ing records should be support ed by pr oper do cum ents, e.g.,invoices, cash mem os, correspond ence, agreement s etc. These docum ents supply the info rm ation o nth e basis of w hich entr ies are m ade in the b ooks of account. The account ing entries are based onobjectively verifiable evidence.

Accrual Concept

This assumpt ion is core of m ercantile system o f accounting. According to th is concept r evenue and care recognized as they are earned o r incurred (and n ot as mo ney is received or p aid), The accrualconcept result in the recognition and recording of revenue t ransaction w hen th e right t o receiverevenue arises wh ich can b e in cash or in kind, e.g., the credit sales of Rs. 50,000 w ill be included in tsales but goods sent o n appr oval for sale will no t b e treat ed as sales, because of th e uncert aintyinvolved in t he t ransaction. Sim ilarly, w hile ascertaining the p rofit or lo ss, not only t hose expenses,w hich have been paid in cash, should b e considered, but also expenses th at have accrued b ut not paidshould be taken int o accoun t. The application of accrual concept helps in depiction of tim e financial

position o f t he ent erprise as th e costs and revenue is recognized w hen t hey are incurred.Accoun ting Concepts Related to Income M easurem ent

One im port ant ob jective of accoun ting is to ascertain the results of operatio ns of an or ganisation fo rperiod of t ime. In case of pro fit or iented organisation , the income statem ent summ arises th e resultsits operatio ns for a given period o f t ime, generally a year. The going concern concept of account ingassumes that th e life of a bu siness is perpetual. Such being t he case, ow ners, m anagem ent and ot herinterested parties cannot w ait indefinitely to know how m uch incom e has been earned by the b usineThey wo uld like to kn ow at least o n a period ical basis th e results of operation s of the bu siness. Thisbrings into p lay certain concept s, w hich are related t o incom e m easurem ent . These are discussed

below:

The Tim e Period Concept (Periodicity Concept)

This concept ind icates that th e prof itability of a business is to be m easured p eriodically. The period fw hich incom e is m easured is called th e account ing period. For t he purpo se of exter nal report ing, th eaccount ing period is generally one year. Thus, accounting prof it is the result of com pleted t ransactioduring t he accounting perio d. For incom e tax pu rposes, a business has compu lsorily t o adopt financiyear beginning on 1st April in any calendar year and ending on 31st M arch in th e next calendar year i ts accounting year. However, for internal report ing the profit abili ty report can be p repared mo nthlquarterly or half yearly depending on the nature of project to facil itate bett er control and evaluatioperformance.

The Revenu e Recognit ion (Realisation ) Con cept

According t o t his concept , revenue is considered as being earned on t he date on w hich it is realised.Revenue is thu s recognised in t he Prof it and Loss Account of an enter prise w hen a sale is m ade orservice is ren der ed to cust om ers. Accordin g to Account ing Stan dard -9 (AS-9) in case of sale of goods


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revenue w ill be recognised w hen t he seller of goods has transferred t o the buyer t he propert y in gooand no significant uncertaint y exists regarding the sales price. In a transaction involving th e renderinservices, revenue should be recognised w hen services have been rendered to th e satisfaction of t hecusto m er and w hen no significant uncert ainty exists regarding the amo unt of consideration. Accordito Anth ony and Reece, "The conservatism concept suggests the per iod w hen revenue should berecognised. Anoth er concept , the realisation con cept indicates the am ount of revenue t hat should berecognised fr om a given sale".

The M atching Concept

Deducting expenses from revenues arrives at accoun ting pro fit. How ever, accountant s carry forw ardexpenses unt il they can be identified w ith t he revenue of part icular accoun ting year and carry forw areceipts unt il they can be r egarded as revenue of th e part icular year. Thus, this principle is veryim port ant for corr ect determ ination of pro fit, w hich is also a m easure of perfor m ance. All expensesgenerate revenue in th e current account ing period are recognised as expenses of t he current p eriod.Cost of goods sold and o perating expenses incurred du ring th e current period are recognised asexpenses of t he current period and will be matched w ith t he revenue of the current period. Incom esreceived in advance or relat ing to earlier periods m ust not be t aken into account . Sim ilarly, expensespaid in advance are also to b e ignored w hile com put ing the income of curr ent accounting period .

The M ateriality Concept

According t o t his concept , financial statem ent s should d isclose all mater ial items, i.e., item s theknow ledge of w hich might influence the decisions of the user of t he financial statem ents. What ism aterial may, how ever, differ from concern to concern and year to year. Kohler has defined m ateriaas 'th e characteristic att aching to a statem ent , fact or item w hereby its disclosure or th e met hod o f

giving it expression w ould be likely to influen ce the judgem ent of a reasonable person.' Thus wh en tevent is m aterial, it shou ld be disclosed. But if t he item or event is imm aterial, it m ay not b e disclosis on t he basis of m ateriality concept th at item s of station ery are considered to have been used upeither at th e t ime o f purchase or at th e t im e of t heir issue from stores.

The Consisten cy Concept

The Generally Accepted Account ing Principles (GAAP) perm it m ore t han one m etho d of describingident ical operating situatio ns. For example, a firm m ay have different m ethod s of pr oviding deprecion f ixed assets or invent ory valuation o r m aking provision for likely bad debt s, w hich are perm issiblunder t he GAAP. As a result , the f irm w ill report different amou nts of income in different years forsam e account ing transaction s. Inconsistency will make th e tw o financial statem ents incom parable. Ifor t his reason t hat th e consisten cy principle requires th at th e basis of incom e measuremen t andpreparat ion of financial statem ent s should remain consisten t for int ra-firm and inter-firm comparisAccount ing Stan dard -I (AS-I) also stat es th at it is assumed t hat accou nt ing policies are consiste nt f roone period to another. Thus, a firm should follow same accounting m ethods and procedures from yeto year. How ever, it is perm itt ed to change them if it has a sound r eason t o do so. But th e effect of s


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a change mu st be disclosed in th e financial stat emen ts of t he year in which change took place to enabth e users to be aw are of th e lack of consistency.

The Con servatism (Pruden ce) Concept

As the t erm suggests its tradition al approach of playing safe or being cautious in recognising all th epossible losses but ignoring all probable pr ofit s. This is also kn ow n as pruden ce concept implying t hcom m on and accepted behaviour o f account ing or providing for f ut ure losses. Though this approachleads to creation of secret reserves and understat emen t of incom e; it also of safeguards the int erest oout siders by preventing the m anagem ent fr om r ecognising unrealised, profit s and providing for allfut ure losses. There are few instances, w hich illustrate th e acceptance and adherence of t his concept

Invento ries are valued at low er of cost or m arket price.

Providing for doubt ful debts and discount allowed to debtors but ignoring the probable discountreceived from creditor t i l l the t im e final paym ents are made.

All the f ixed assets are valued on h isto rical costs irrespective of th eir m arket p rice except in th e caserevaluation of business.

Preference of w ritten do w n value met hod o ver straight-line met hod o f depreciation, since the earlieone, provides for m ore depr eciation in t he initial years of use.

Valuing Joint Life Insurance Policy at it s surren der value irrespective of am ount of instalm ent s paid.

Account ing was developed as a system fo r report ing infor m ation to t he ow ners including shareholdand ot her investors of th e business. In the pro cess of it s evolut ion, account ing has branched of f into distinct directio ns- financial account ing & the second as managerial account ing. The financial accoundeals w ith inf orm ation p rocessing for external uses and m anagerial accounting deals w ith inf orm atiprocessing for internal uses.

Account ing info rm ation generally encom pass inform ation pro cessing for bot h intern al & external u

Purp oses of Accounting Inform ation

W hat are t he purposes of accounting inform ation?

Score Keeping: The score-keeping funct ion is one t he prim ary purp oses of accounting info rm ation. Ibasically deals w ith t he financial health of t he ent erprise. In oth er w ords, it answers: How are w e doGood, bad or indifferent ? Though it appears to be a simple question , a m om ent s reflection w ill showth at it is not th at simple. It involves answering questions such as: W hat is doing good? Wh at is doingbad? Is prof it earned good ? If so, how m uch? Is it t hat pro fit alone is not sufficient? Thus we can go increasing the str ing of qu estion s intending to furt her clarify the basic question. Thus, score keepingtw o aspects, one is th at of keeping record of actual data on perform ance a constant p rocess ofm easurem ent and valuation. The ot her aspect is concerned w ith put ting the data in relation topredeterm ined standards. In order t o answ er the question w hether th e performance is good, bad or


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indifferen t w e have to have a constant p rocess of com parison against some n orm s, standard orbenchm arks. This is achieved by preparing a series or repor ts based on com parison o f actual dat a witthe planned data.

Att entio n Directing Attent ion directing is not hing but t he pro cess of giving a signal to t he user of

account ing inform ation about th e need to t ake a decision. As such the accoun ting infor m ation supplarouses the user s att ention t o t ake decision. For example, a report f rom an accountant com paring thactual perfo rm ance data against bud get dat a is a score keeping record. In th e hands of a decision-m akit is an att ention directing inform ation. This w ould enable him to imm ediately focus his att ention odeviations or variances from th e budgets or th e plants. A w hole series of actions will be triggered byth is, namely, evaluation o r reasons for t he deviations, remedial action s to be t aken, mod ifications infeedback for future and so on.

Problem Solving: The prob lem solving function of accounting infor m ation in volves provisions of suinform ation, wh ich enables the m anager t o find solutions to t he problem s. There are m any problemw hich account ing inform ation could highlight and pro vide for t heir possible solut ions, such as m akbuy decisions wit h respect to com ponent s, parts or produ cts, contin ue or drop d ecisions wit h respto prod uct lines, leasing or acquisition decisions w ith r espect t o asserts etc. prob lem solving istherefore an im portant purpo se of accounting inform ation system .

Uses of Earnings Inform ation

Explain uses of earnings inform ation.

Accom plishm ents: Profit is an impor tant indicator of t he accom plishm ent o f business. Oth er thingsrem aining sam e, higher the pro fits greater are the accom plishm ents.

Appropriation Decision: An im portant question w ith w hich ow ners of a business are oft en confrontHow m uch m oney can be with drawn w ithout impairing its current level of operations? This questiofact is concerned w ith appropriation decision. A prudent m anagement wou ld not only l ike to m aintthe capital or the present capabili ty of t he enterprise intact but w ould also plan for futur e growt h. Tm aximum amount that the ow ners can withd raw from business for t heir personal expenses should blimited t o t he amount of earnings, wh ich rem ain after m aking good all the resources that have beenused in t he p rocess of generating t hose earnings.

Problem Identification Using Earning Data: From th e earnings data several problem areas can beident ified. This is best done by com put ing ratios i.e., by examining the relation ship of one item of

earnings stat em ent w ith ano th er item . This will be taken up in det ail in a subsequent u nit. At t his stam ay only be stated th at th e lower earnings m y be on account of excessive cost o f input s, excessiveexpenditu re on overh eads or low m argin of profit on sales of excessive pilling of inventor ies or ot heunant icipated losses.

Determining the M arket Value of a Firm : The econom ic value of t he firm is determined b y the size areliability o f t he stream o f earnings (cash flow ) produced by t he business.


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Balance Sheet

W hat is a Balance Sheet? W hat are t he o bjectives of p reparing Balance Sheet? Explain it scharacteristics.

Ans. After ascertaining the pro fit o r loss of t he business, th e businessm an w ants to kno w th e financposition of his business. For th is purpose he pr epares a stat em ent of Assets and Liabilities, wh ich iscalled Balance Sheet. It is prepared on a specified dat e because t he f igure show n in th e Balance Sheettr ue on t hat d ate only. The tot als of t he Assets and Liabilities should be equal. If it is not so, it m eanthat there is som e error.

The Com m itt ee on Term inology of Amer ican Instit ut e of Certif ied Public Account ants has defined tbalance sheet as, "a list o f balances in th e assets and liability accoun ts. This list d epict s the posit ion oassets and liabilit ies of a specific business at a specific poin t o f t im e."

The follow ing are the object ives of pr eparing a balance sheet:

Principal Objective: The main pur pose of pr eparing balance sheet is to know th e financial position obusiness at a part icular d ate.

Subsidiary Objectives: Though the m ain aim is to kn ow th e exact f inancial position o f t he firm at aparticular dat e, yet it serves ot her purp ose as w ell.

I t gives inform ation about the actual and real ow ner s equity. Though t he capital of the ow ner indicow ner s equity, yet some ot her liabilities are to be account ed for against it also.

It helps the firm to m ake provisions against po ssible future losses. A provision is m ade in th e form oReserves.

The Balance Sheet as distinct from oth er financial statem ents has the f ollow ing characteristics:

It is a stat em ent and not an account . Although balance sheet is a part of t he final account s and preparw ith t he help of account s, yet i t is not an account but a statement .

It is always prepared on a particular date, and thu s show s th e position at that d ate and not f or a perio

It has no debit side and credit side. Nor the w ords To and By are used befor e the nam es of t he

account s show n t herein . The headin gs are Liabilities and Assets.

It show s the financial position o f t he business concern.

It show s w hat the firm ow es to ot hers and also w hat others owe to t he firm.

The to t als of Liabilities and Asset s alw ays are eq ual.

Uses of b alance Sheet


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W rit e a short not e on uses of Balance Sheet.

The balance sheet reflects the financial position of th e enterp rise. It pr ovides useful infor m ation t ovariou s users. The balance sheet is described as a snapshot o f t he finan cial position o f a business ent itThe various group s interested in th e comp any can draw useful inferences from an analysis of t he

infor m ation cont ained in the b alance sheet. The balance sheet is also called t he position statem ent .

It show s the financial position o f t he business concern.

I t shows what t he f i rm owes to others and also what ot hers owe t o the f i rm.

It show s th e natur e and value of t he assets.

It also reflects the liquidity of a firm .

The main ob jective of account ing is to convey inform ation. This objective is achieved by differentaccount ing report s prepared by an ent ity. One of the m ost imp ort ant repor ts is the Balance Sheet.

Balance Sheet is concerned w ith repo rt ing the financial position of an entit y at a particular point in tThe balance sheet show s th e assets and liabilities classified and arranged in a specific mann er.

Balance Sheet

W hat is a Balance Sheet and w hat inf orm ation do es it convey to an out sider?

The balance sheet is a statem ent, w hich show s the financial position of a b usiness on a particular datIt is a stat em ent o f balances of all t he account s real and personal, debit balances of all such account srep resent assets and credit balances represent t he liabilities. Thu s, balance sheet show s t he assets andliabilities grouped prop erly classified and arranged in a specific m anner.

The follow ing are the object ives of pr eparing a balance sheet:

Principal Objective: The m ain purpose of preparing balance sheet is to know th e financial position obusiness at a part icular d ate.

Subsidiary Objectives: Though the m ain aim is to kn ow th e exact f inancial position o f t he firm at aparticular dat e, yet it serves ot her purp ose as w ell.

I t gives inform ation about the actual and real ow ner s equity. Though t he capital of the ow ner indicow ner s equity, yet some ot her liabilities are to be account ed for against it also.

It helps the firm to m ake provisions against po ssible futu re losses. A provision is m ade in the fo rm oReserves.


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Wh at inform ation does i t convey to an outsider?

Balance sheet is prepared w ith a view to m easure t he tru e financial position of a business concern at particular point in tim e. It show s th e financial position of a business in a system atic form . It is ascreenshot of the financial position o f t he bu siness. At one glance, the p osition of t he bu siness, at a

particular point o f t im e, can be understood.

The various group s interested in th e comp any can draw u seful inferences from an analysis of t heinform ation contained in t he balance sheet.

Shareholder s usually have tw in int erests, an interest in receiving a regular incom e and an int erest in appreciation of th eir investm ent in shares. Investm ent decisions of the p rospective investo rs and d isinvestm ent decisions of th e existing investors are influenced b y the com position of assets and liabilishow n in the balance sheet.

Sim ilarly, ot her int erested p arties like regulator y and developm ental agencies of t he governm ent,

consumer, and w elfare organization s can derive useful conclusions from a stu dy of t he balance sheetabout t he w orking of t he corporate sector and its contribut ion to the national econom y.

Classification of Item s

Explain th e meaning of:

Ow ner s Equit y

Assets

Fixed Assets

Accrued Liabilities

Cont ingent Liability

Account s Receivables

Ow ner s Equit y

Ow ner s Equity is the residual inter est in t he assets of th e enterp rise. Therefo re the ow ner s equitysection of t he balance sheet shows the am ount the ow ner have invested in t he entity. How ever, theterm inology ow ner s equity varies w ith different for m s of organization depending upon whet her ent erprise is a joint sto ck com pany or sole propr ietorship/ part nership concern.

Sole propriet orship/ partner ship concern: The ow nership equit y in a sole propriet orship or part nershusually report ed in the balance sheet as a single amo unt for each ow ner rath er than distinction bet wth e ow ner s initial investm ent and t he accum ulated earnings ret ained in the bu siness.


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Joint Sto ck Com pany: In the case of jo int stock com panies, according to th e legal requirem ent s, ow nequit y is divided into tw o m ain categories. The first category called share capital or con tr ibuted capIt is th e amo unt th at ow ners have invested d irectly in the business. The second category of ow nersequit y is called ret ained earnings.

In th e ot her w ords Ow ners equity is the claim against the assets of a business entity. It could beexpressed t ot al assets of an ent ity less claims of out siders or liabilities.

Assets

"The ent ire pro perty of all kinds possessed by o r ow ing to a person o r or ganisation is called assets"."Assets are valuable resources ow ned b y a bu siness and acquired at a m easurable m oney cost" . Theym ay be:

Fixed Assets: These are tho se assets, which are acquired fo r relatively long period s for carrying on t hebu siness of t he ent erpr ise. Such asset s are no t m eant for resale. For exam ple, Land and Build ing, Plan

and M achinery etc.

Current Assets: These assets are also t erm ed as Float ing or Circulat ing Asset s. Such asset s are acquirew ith t he intent ion of converting them into their values constantly. The essential difference betw eenCurrent Assets and Fixed Assets is that th e current assets are held essentially for a short p eriod anth ey are m eant for converting int o cash. Unsold stock, debt ors bills receivables, bank balance, cash inhand, etc are some of th e examples of current assets. According to t he Institut e of Chartered PublicAccount ants, U.S.A., " Curren t Assets include cash and o th er assets or resources com mo nly ident ifiedth ose which are reasonably expected to be realised in cash or sold or consum ed during th e norm aloperat ing cycle of th e business.

Fictit iou s Asset s:Assets of no real value but included in th e balance sheet for legal or technical reasonse.g., preliminary expenses.

Tangible and Intan gible Assets: Tangible assets are tho se assets, wh ich can be seen and t ou ched i.e.assets having th eir physical existence e.g. land and building, plant and m achinery, furnit ure and fixtustock-in-trade, cash, etc. Intangible assets cannot be norm ally sold in t he open m arket since they are having any ph ysical existence e.g. goodw ill, patent s, trade m arks, prepaid expenses etc.

Liqu id Assets: Assets t hat can b e easily conver te d int o cash like Bank accoun t, Bills receivables, etc. Am att er o f f act, all curren t assets excluding sto ck-in-hand and prepaid expenses are called liquid asset

W astin g Assets: These are the assets w hich are exhausted w ith, or w hich lose th em selves in, the good sth ey prod uce. M ines and quarr ies are comm on exam ples of such assets. Copyright, pat ent s, tr ademaretc. are also classified as w asting assets since t hey get exhausted w ith th e lapse of tim e.

Fixed Assets


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These are t hose assets, wh ich are acquired f or r elatively long period s for carrying on t he bu siness of ent erprise. Such assets are not m eant f or r esale. For exam ple, Land and Building, Plant and M achineretc. Current assets provide b enefits to th e organization by t heir exchange int o cash. In th e case of fixassets, value addit ion arises by facilitating t he pro cess of p rodu ction o r t rade.

All man m ade things have limited life. In accoun ting, we are concerned w ith t he useful life of t he asUseful life is th e period f or w hich a fixed asset could be econom ically used. Benefits from th e fixedassets will flow to t he organization t hrou ghout it s useful life.

Valuation of th e fixed assets is usually m ade on th e basis of original cost. How ever, since the assets hth e limit ed life the cost w ill be expiring wit h the expirat ion of t he life. Thus, valuation of th e asset ireduced pr opor tionat e to t he expired life of th e asset. Such expired cost is know n as depreciation.

Example: Supp ose a trader bu ys a delivery van at a cost o f Rs. 50,000. Assum e th at t he van w ill have be discarded as junk at th e end o f five years. In t his case w e take a dep reciation of Rs. 10,000 per yeaand th e process of providing depreciation for each year will cont inue. At the end of t he fifth year t hvaluation o f t he asset w ill be zero. The value of th e assets at cost is usually refer red t o as gross fixedassets and the am oun t of depreciation t o dat e as accum ulated dep reciation . Net value of th e asset isusually refer red t o as net fixed assets.

Fixed assets nor m ally include assets such as land, building, plant, m achinery, etc. All these item s, w itexception of land, are depreciated . Land is not subject to depreciate and hence show n separately fromot her f ixed assets.

Accrued Liabilities

Accrued liabilities represents expenses or o bligation s incurred in t he previous account ing period butpayment for t he sam e w ill be made in the n ext period. In m any cases w here payments are madeperiodically, such as w ages, rent and sim ilar items, the last m ont hs payment m any appear as accruedliabilities (especially if the pr actice is to pay th e same o n t he first w orking day of a m ont h). Thisobligation shown on th e balance sheet indicates that t he firm ow ed the said am ount on t he balancesheet date.Cont ingent Liability

These are liabilities w hich w ill exist o r not , will depend on any fut ure incident . For t he sake ofshareholders, it is shown in th e foot not e in the Balance Sheet. The item s, w hich m ay com e under t hsub-heading, are:

Claims against com pany, w hich are still not accepted by t he com pany.

Liability for am ount uncalled on part ly paid shares.

Arrears of fixed cumu lative dividends.

Estim ated am ount of incomplete contracts (capital expenditures), arrangem ent of w hich is not m ade


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Oth er cont ingent liability. For examp le, liability for bill discount ed, disputed liabilities or claim, et c

Account s Receivables

Account s receivables are amo unt s ow ed to th e company by d ebto rs. This is th e reason w hy w e also uthe t erm sundry debtors to denote t he amount s owed t o t he firm. This represents am ount s usuallyarising out of n orm al com m ercial tr ansaction s. In other w ords, accounts receivable or sundry debtrepresents unp aid custo m er account s. These are also kn ow n as trade receivables, since they arise out norm al trading t ransactions. Trade receivables arise directly f rom credit sales and as such pro vide animpor tant inform ation for m anagement and out siders. In m ost situations these accounts are unsecurand have only the personal security of t he custo m er.

It is norm al that som e of th ese accounts default and becom e uncollectible. These collection losses arcalled bad debts. It is not possible for the m anagement t o know exactly w hich accounts and wh atamo unt w ill not collected . How ever, based on past experience, it is possible for t he managem ent t oestim ate t he loss on t he receivables or sundr y debto rs as a w hole. Such estimat es reduce t he grossvalue of account receivable to th eir estimated realizable value. For exam ple:

Account s Receivable 6,00,000

Less: Est im at ed collect ion loss at 5% 30,000

Net realizable value of account s receivable 5,70,000

The estim ated collection loss is variously referred to reserve for doub tf ul debt s, reserve for bad debtreserve for collection losses. It is also no t an u ncom m on p ractice to refer to th is as a provision insteareserve.

It is a usual practice for d ebts to b e evidenced by fo rm al writ ten p rom ises to p ay or accept ance of anorder to pay. These form al docum entary deb ts represent Prom issory Notes Receivable or BillsReceivable. These instrum ents used in trade are negotiable instrum ent s and hence enable t he trader tassign any of his receivables to another part y or a bank for realizing imm ediate liquidity.

It is also u sual for account receivables to b e pledged or assigned m ostly t o b anks against short-t ermcredits in the form of cash credits or overdrafts.

The balance sheet is int ended f or r eport ing the value of assets, liabilities and ow ners' equity at aparticular poin t in t ime. It do es not disclose any th ing about th e details of t he business. So anot her

statem ent is required to summ arize revenues and expenses of t he particular period. This stat em ent isreferred to as profit & Loss Account, Income statement or Income summ ary.

The Profit & Loss account summ arizes all the revenues or incom es and all t he expenses for earning threvenue show ing the net difference, that is profit or loss for t he period.


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Capital Expenditu re and Revenue Expenditu re

W hat do you m ean by Capital Expendit ure and Revenue Expendit ure?

In fact every expen se is expenditur e, but each expenditure is not necessarily an expense. They aredefinit ely not synonyms. Those business expenses, wh ich affect directly t he prof its for t he accoun tinperiod, are called Revenue Expendit ure. Those wh ich do not directly affect t he prof it, but th e benefiw hich result over longer periods of life o f t he bu siness (say five to ten years) are called CapitalExpendit ure. The revenue expenditur e or expense is show n in P & L A/c w hile the capital expenditu rshow n in Balance Sheet .

Capital Expenditure

All expenditur e incurred in acquiring fixed assets, or im proving t he existing o nes by increasing itsefficiency (e.g. by providin g substitu tion, alteration o r renovation ), or effecting econom y in operatiexisting assets (e.g. by att aching pow er m ot or t o hand d riven m achine) are called capital expendit ure

These expenditu res are intended to be perm anently used in business and t hey increase the earningcapacity of th e enter prise. They m ayor m ay not r educe th e existing expenses. The follow ing types ofexpenditu res fall under t his category:

Expendit ure incurred o n any t angible or int angible asset, w hich can be sold or con verted into Cash infuture .

Expendit ure incurred o n imp roving an existing asset so as to increase it s earning capacity.

Expenditure incurred on a new asset t o bring it t o w orkable condition.

Expendit ure for acquiring a capital asset.

The follow ing can be quo ted as exam ples:

Payment for Goodw ill.

Cost of freeho ld Land & Building.

Cost of Leasehold Land.

Paymen t for acquiring Tradem ark, Patent s, Copyright, Pattern & Design etc.

Plant and M achinery and Furnit ure pur chased for th e use in business.

M ot or Car, Truck, etc. for t he use in business.

Installation expenses of Plant & M achinery.

Expenses of Electr ic Fit tin gs.

Addit ion to th e value of pr esent assets.


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Expendit ure on extension o f m ines and gardens.

Acquiring an asset and spending on its erection, et c.

It m ust be rem emb ered th at th e benefits of the capital expendit ure are spread over several years.Hence only a portion o f t hese expenditu re is included in the incom e stat em ent o f each year, Such anexpenditu re w hen incurred is called Capital out lay and t he port ion w hich is earm arked for a particulaccount ing period is called Depreciation. This depreciation goes to t he Profit and Loss A/c (and isreduced fr om th e tot al capital out lay), while t he rest w hich is called cost residue is tr ansferred t obalance sheet. Since capital expend iture are t ransferred to balance sheet th ey are also called balancesheet expenditure.

Revenue Expenditu re

They are all such expenses, w hich are incurred o n t he organisation and fo r runn ing the business. Thebenefit s of such expenses are limit ed to t he account ing period only. They are incurred to m aintain th

earning capacity of th e business, whereas capital expenditure are incurred t o im provin g the earningcapacity o f t he bu siness. The follow ing types of expendit ures are usually called revenue expendit ure

Expendit ure incurred o n acquiring raw m aterial and business good s.

Such expendit ure w hose advant age does not last f or m ore t han a year.

Expenditure incurred fo r the m aintenance of an asset.

Expenses to run th e business efficient ly e.g. office expen ses. Financial expen ses, selling expen ses,distribut ion expenses etc.

The list given u nder can be quo ted as examples:

Cost of Raw m aterial.

Goods pur chased fo r re-sale.

W ages paid.

Adm inistrat ive Expenses w ages, salaries, insurance, rent and advertisemen t etc.

Repairs and up keep of f ixed asset s.

Annual ren t of Leasehold Land.

Loss due t o fire

Distrib ut ion expenses.

Selling expenses.


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Interest o n Loans.

Depreciation, etc.

It m ust, how ever, be rem em bered th at th e exam ples as has been shown abo ve are not universallyaccepted . These are th e heads of expend itur es which by and large, are classified as such. But in actualpractice, w het her an item o f expenditu re is a capital or revenue expenditure w ill depend on its purpand natu re of t he business concern. It m ay vary at diff erent tim es also. For examp le, expendit ure onplant and m achinery is a capital expenditu re, but fo r engineering concern it m ay be revenueexpenditu re, if t he plant is meant for r esale. Sim ilar is th e case of f urnit ure. It is generally a capitalexpenditu re, but it m ay be revenue expendit ure for a dealer in furnitu re. Likewise som e item s, geneof r evenue nat ure m ay have to be capitalized under certain situat ions. They m ay be considered asexceptions to th e general rules. Som e examp les can be given as under:

Except ions t o t he General Rules

Raw M aterials: When raw m aterial is used for t he manu facture, of an asset it is treat ed as Capitalexpenditure.

W ages and Salaries: This is revenue expenditur e. But w hen w ages and salaries are spent fo r t heconstruction of a building or for installation of a m achine then it is treated as Capital expenditure.

Carriage and Freight: These are also revenu e expenditu res but Carriage and Freight p aid for bringing m achine to th e godo w n, then it is treated as Capital expendit ure.

Repairs and Renew als: These are revenue expend itures but w hen an old m achine is purchased and somamo unt is spent to br ing it to a w orkable cond ition t hen it is called Capital expenditure.

Distin guish bet w een Capital Expendit ure and Revenue Expendit ure.

Capital expenditur e is th e capital outlay on acquiring new assets, impr oving the existing ones, not wth e intent ion of reselling them . Revenue expenditu re is th e rout ine types of recurring expenses, w hiare incurred fo r run ning the bu siness. Besides, they include expenses for m aintaining the upkeep of texisting assets.

Capital expendit ure increases the earn ing capacity of th e bu siness, whereas, Revenue expenses do n ot

The benefit s of th e capital expendit ure are alw ays spread over several years, whereas the reven ueexpenditu re provides benefit only for t he account ing period. That is th e reason w hy only a part of t hcapital expenditure is accounted for in th e account ing period and t he balance is show n as an asset in balance sheet. On the o ther h and, the entire amo unt o f t he revenue expenditure is account ed for in taccounting period.


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Deferred Revenue Expendit ure

Explain Deferred Revenue Expendit ure.

Som etim es some expenditu re is incurred w hich by nature is revenue expenditur e, but its benefits arelikely to be derived over a num ber of years. If revenue expenditu re is incurred dur ing the current yebut paid as advance for th e com ing year(s), such expendit ure is called 'Deferred Revenue Expenditu rFor exam ple a firm m ay undert ake a special advertising campaign for a new produ ct and say spendsrupees one lakh over it. The benefit of t his advert isem ent m ay cont inue for say ten years. As such onone-ten th o f th is expenditur e shou ld be considered as revenue expense for th e year and taken to P &A/ c and t he rest as Deferred Revenue Expendit ure and taken to balance sheet as asset. Such expensesare also somet imes called Capitalized Expendit ure. Usually th e deferred revenu e expenditu re are of tfollowing t ypes:

Partly paid in advance. These are expenses, th e benefit s of w hich accrue t o t he current year as also t othe futur e years. The util ized port ion is account ed for the current year and t he unused port ion is shoas asset in th e balance sheet.

W holly paid in advance. These are expenses, th e benefit of w hich does not accrue t o th e curren t yearbut th e amo unt is paid during this period. As such the t ot al am ount is shown as asset in the curren tbalance sheet.

Unusual and abno rm al losses. The business may get a shocking setback if th e t ot al abnorm al losses araccount ed for in o ne year. Loss by thef t o r fire m ay have to be spread over a few years. Som e port ionit is account ed for in th e current year and the unw ritt en port ion is show n as an asset in t he currentbalance sheet. Of course, th is will be a wo rt hless and fictitiou s asset.

Thus, these are revenue expendit ure o f capital natu re. The fo llow ing are its special featur es:

Expenditure for d evelopment , improvem ent and alterations are revenue expenditure but treated ascapital expendit ure.

These expenditures are not imm ediately writ ten off in the year of actual expenditure but split over aperiod of cert ain years as per th e decisions and po licies of t he m anagem ent .

These expendit ures are t reated as assets and shown at the assets side of th e Balance Sheet.

Capit al Receipt s and Revenue Receipt s

Explain Capit al Receipt s and Revenue Receipt s.

Capit al Receipt s and Revenue Receipt s

Revenue receipt s, like revenue expendit ures affect th e P & L A/ c and are show n on its credit side. Careceipts, like capital expendit ures do not aff ect pro fit, and are either show n as a liability o r m ore oft


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as a reduct ion fr om th e assets. Any excess realisation over th e boo k value of an asset m ay, however , tr eated as a revenue receipt and account ed for as such. It is, th erefore, essent ial to know th e distinct i

Exam ples of Capit al Receipt s:

Capital invested by th e ow ners of th e business.

Am ount received from sales of fixed assets or investm ents.

Conversion in to Cash of any Asset except stock.

Loans received .

Exam ples of Revenue Receipts:

Amou nt f rom sale of goods.

Am ount received from rendering services to ot her part ies or int erest received or comm ission receiv

It is very difficult t o m ake a clear-cut distinction bet w een capital receipts and revenue receipts. Thedistinction is im portant both f or income det ermination and taxation pur poses. An im portant featurrevenue receipts has been that t he amount received does not need to be ret urned to anyone.

Capit al Loss and Revenue Loss. Capit al loss is that loss w hich o ccurs due t o sale of som e fixed asset. Fexamples, loss due to issue of shares or d ebent ures at a discount , loss due t o m isapprop riation o f Casfrom th e office or fo rfeit ure of security depo sited fo r gett ing an agency. Revenue losses are th ose low hich occur du e to sale and pu rchase of goods. For exam ple, Bad Debts, loss due to fall in th e price ogoods, etc.

W hereas revenue loss is usually account ed for in t he current year's P & L A/ c, capital loss is usuallyspread over a few years.

W hat do you understand by Trading Account?

TRADING ACCOUNT

The incom e stat emen t is split int o tw o part s. The first is called th e Trading Account and th e second tProfit and Loss Account. The t rading account is designed to show th e gross profit on sale of goods. Tis achieved by sett ing against t he n et proceeds of sale, th e cost of goods sold. The Trading Accountcontains, in a summ arized form , the transaction of t he trader relating to the com m odities in w hich hdeals, thro ughout th e account ing period. All expenses, which relate t o either pu rchase of raw m aterior pro duction o r m anufacturing, are charged to t he Trading A/c. It is prepared to find ou t Gross ProfGross Loss. If th e sales are mo re t han p urchases and expe nses th e result is Gross Profit and vice versa.

In th e beginning of t he year t he bu sinessm an has stock left from th e last year. It is called Opening StoThe goods rem aining unsold t his year is called Closing St ock. W hile prep aring Trading A/ c, Opening is adde d t o t he Purchases and Closing Sto ck is added to t he Sales. Trading A/ c show s the Gro ss Profit


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Gross Loss. The businessm an can, w ith t he help of Tradin g A/ c com pares th e Purchases, Sales andClosing Sto ck of t he current year w ith t hose of t he last years. He can easily find out th e ratio of Grosprof it t o t he Sales and t hus cont rol h is business expenses.

For a sm all businessman, Trading Account serves the pur pose of M anufacturing Account as w ell. But

big businessman usually has to p repare a separate m anufacturing account . The description of thisaccount w ill be given at th e appro priate place on pages to f ollow .

Explain th e imp ort ance of pr eparing Trading Account.

Impo rt ance of Preparing Trading Account

Preparation of Trading account serves th e follow ing objectives and provides data fo r com parisonanalysis and planning for f ut ure grow th . The purp oses are:

It provides inform ation about gross prof it. The current f igure can be comp ared wit h earlier ones andreasons found f or variations. Accordingly plan can be launched for fu tu re grow th o f th e firm.

Ratio of gross prof it t o sales can help t he trader to impr ove his business adm inistrat ion.

Ratio of direct expenses to sales w ill help the t rader to contr ol and rat ionalize the expen ses.

Com parison of 'stock in hand' of th e current year wit h t hose of th e previous years. Reasons for variacan be f ound o ut and steps can be t aken to adjust things m ore profit ably.

Ratio of cost o f goods sold t o t ot al sale proceeds can help the t rader in fixing the p rices of his prod uc

Precautionary m easures can be t aken to avoid po ssible losses by analyzing the it em s of direct expens

The actual perfor m ance show n b y t he Trading Account as regards purchases, sales, stock and cost ofprod uction can be com pared w ith t he desired perf orm ance. In case of w eaknesses, effective correctim easures can be applied. Besides, th e actual p erform ance as disclosed by th e Trading Account iscompared w ith the perform ance of t he previous year. The comparison shows the plus and m inusperfo rm ance of the bu siness. Such point s shou ld be ident ified. M inus points should b e remo ved andplus points should b e re-enforced.

Gross Profit disclosed by t he Trading Accoun t t ells us the upper lim it w ithin w hich one shou ld keepoperat ing expenses of t he business besides saving som ethin g for h imself. In case of new prod ucts, thbusinessman can easily fix up th e selling price of t he pro ducts by add ing the cost of purchases, thepercentage gross profit that he w ould like to m aintain.

Trading Account: Item s

Explain briefly t he item s shown in t he Trading Account .

Import ant Item s of Trading Account are l isted b elow:


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Sto ck - The good s rem aining unsold is called sto ck. It is of tw o t ypes:

Opening Sto ck: In the b eginning of th e year th e businessman has som e unsold good s of t he last year. is called openin g stock. It is show n on t he debit side of Trading A/c.

Closing St ock: The goods rem aining un sold at t he end o f t he year is called Closing Sto ck. It i_ sho w n th e credit side of t he Tradin g A/ c. Opening Sto ck is given in t he Trial Balance and Closing St ock is givbelow th e Trial Balance because closing stock is valued aft er t he account s have been closed.

Valuation of Closing Sto ck

Closing St ock is valued at co st price or m arket price w hichever is less. For exam ple, the b usinessm anpurchased goods for Rs. 2,000 bu t at p resent its m arket value is Rs. 2,500. It w ill be valued at Rs. 2,00and n ot at Rs. 2,500. Another goods costs Rs. 3,600 but now its present value are Rs. 2,600. It w ill bevalued at Rs. 2,600. This decision is follow ed on th e principle th at a gain cannot b e t reated a gain unit is actually r eceived bu t a loss is tr eated as loss w hen it is clearly visible. Thus w e can say expect ed

is no gain bu t expected loss is a loss.

Closing Sto ck should be valued very carefully and corr ectly. A list of th e unsold stock should be careprepared and it s price writ ten against every it em. This w ork should be don e by capable and experienperson and checked by some r eliable officer. It should be kept in m ind t hat if the Closing Sto ck werevalued at a higher price the Gross Profit of t he business wou ld be w rong and m isleading.

Good s to be include d in Closing Sto ck

Goods rem aining unsold at th e end of th e year are called Closing Sto ck.

If th ere are ot her branches of t he business the closing sto ck of all the b ranches should be included.

If goods have been sent on Consignment th e stock remaining unsold w ith t he consignee should also bincluded.

If th e businessm an has not t aken into consideration some purchases or sales returns th ese should alsobe includ ed in t he Closing St ock.

Com pon ent of Closing Sto ck

Sto ck of Raw M aterials. If t he businessman is a m anufacturer and he w ill be having some stock of ram aterial at t he end of year it should be included in t he Closing Stock.

Sto ck of Finished Good s. The part of th e finished goods unsold should also be included in t he ClosingStock.

Sto ck of W ork- in-progress. The goods w hich is not ready but is expected t o be ready short ly is calleW ork-in-progress and should also be included in t he Closing Stock.


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Sto res. The goods required for convert ing the raw m aterial into finished good s should also be includin t he Closing Sto ck. e.g., m achine o il, chem icals, coal, gas, etc.

Purchases and Purchases Ret urn s

Purchases Account tells the q uantit y of to tal goods purchased and t he Purchases Retur ns A/c show s tgoods returned ou t of purchases. I t is show n on t he Trading A/ c in the following m anner:

To Purchases

Less Pur chases Ret ur ns

Direct Expen ses

These are tho se expenses that are included in t he m anufactur e of goods or expenses incurred inimpor ting goods and carrying them to the godow n. In other w ords we can say those expenses that arincurred in br inging t he good s to saleable condit ion are called direct expenses. Direct expenses incluthe following:

W ages: It is shown o n th e debit side of the Trading A/c and show s the w ages paid in the pr oduct ion goods.

Not e 1. If wages are paid for b ringing a new m achine or for it s installation , it is treated as part of t heof t he m achine and is show n in t he Assets.

No te 2. If t he expen se is recor ded as 'W ages and Salaries' it w ou ld go to Trading A/ c. If it is 'Salaries W ages' i t w ould go to P & L A/c.

Carriage Inw ard: Carriage paid w ill be show n on th e debit side of t he Trading A/ c. Carriage out w ardshow n on t he debit side of Profit and Loss A/ c.

M anufactur ing Expenses: All those expenses, wh ich incurred in m anufacture of goods, are show n ondebit side of th e Trading A/ c. e.g., factory f uel and oil, factory light ing, coal and gas, etc. If light ing factory and office are given together th en t hey are apportioned.

Carriage and Freight: Carriage and fr eight paid for bringing th e goods pu rchased is a direct expense adebited t o Trading A/c.

Sales and Sales Ret urn s: Sales are show n on th e credit side of t he Tradin g Ale but to arrive at Net Sale

th e Sales retu rns should b e deduct ed.

Profit & Loss Accoun t

W hat is a Profit & Loss Account ? How it is prepared? Why it is prepared?

A Profit and Loss account is an account into w hich all gains and losses are collected in o rder to ascertth e excess of gains over t he losses or vice versa.


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It m ust be remem bered that expenses relating to t he ow ner or partners are not to b e accounted for ith e Profit and Loss A/ c of t he firm . They are personal expenses and hence are t ransferred t o t heDraw ings A/ c of t he ow ner o r part ners. These expenses are usually (i) Life insurance prem ium, (ii)Incom e t ax, and (iii) Household or personal expenses.

The objectives of pr eparing P & L A/ c can be briefly sum m ed up as under:

Provides inform ation about Net Profit ;

Com parison of current year's incom e wit h th at of t he previous year's can be m ade;

Concret e step s m ay be taken to increase the net prof it in fut ure t hrou gh analysis of expenses.

Proper allocation of n et pro fit can be m ade among part ners and provision for various typ es of Reservas also fo r Research and Developm ent program s can be m ade.

Imp ort ance of Profit and Loss Account

The purpo se and im port ance of preparing Profit and Loss Account is as under :

The purpose of prep aring prof it and loss account is to ascert ain the amo unt of net prof it or net loss. is th e actu al profit available to t he prop rieto r and credited t o his capital account. In case of net loss hcapital account w ill be debited . The net prof it is calculated after charging all indirect expenses.

It is an index of t he profit ability or ot herw ise of t he business. The profit f igure disclosed by t he proand loss accoun t fo r a particular period can be com pared w ith t hat of the ot her period . Thus, it helps

ascertaining w het her th e business is being run eff iciently or not .

An analysis of variou s expenses included in th e prof it and loss account and t heir com parison w ith thexpenses of t he previous period s helps in taking steps for effect ive contro l of t he various expenses.

The net profit is m atched w ith t he net sales to calculate net profit ratio ' . This ratio is com pared w ithdesired ratio and if th ere is any short -.com ing, that w ill be rem oved. Sim ilarly expenses ratio t o salecalculated. It w ill always be in th e interest o f t he firm that the expense ratio should be t he m inimum

Allocation of profit am ong the different periods or sett ing aside a part of the p rofit fo r futur econtin gencies can be done. The am ount of pr ovisions, reserves and fun ds to be m aintained depen ds

upon net profit earned by the firm .

W e can adopt effective future l ine of action on t he basis of inform ation available from profit and loaccount regarding net p rofit and oth er expenses.

Last but not the least , w e compare our actual perform ance w ith ou r planned and desired performancidentify w eaknesses and try t o rem ove them .


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Trading and Profit & Loss Account

for t he year ended ---

Par t iculars Rs. Par t iculars Rs.

To Opening Stock XXX By Sales XXX

To Purchases XXX Less: Sales Ret urn XXX XXX

Less: Purchases Ret urn XXX XXX By Closing St ock XXX

To W ages XXX By Gross Loss t / f t o Profit & Loss A/ c XXX

To Carriage and Cart age XXX

To M an uf act u rin g Exp en se s XXX

To Coal, W at er & Gas XXX

To Fact ory Light ing XXX

To Fuel & Pow er XXX

To M ot ive Pow er XXX

To Oct roi XXX

To Fact ory Ren t and Rat es XXX

To Cust om Dut y XXX

To Dock Charges XXX

To Gross Prof it t/ f to P & L A/ c XXX

XXX XXX

Profit & Loss A/ c

To Gross Loss b/ d XXX By Gross Prof it b/ d XXX

(A) Selling and Dist r ibut ion Expenses: Int erest (Cr.) XXX

Advert isem ent XXX Discount (Cr.) XXX


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Travelers Sal& Com m XXX Com m ission (Cr.) XXX

Salesm ans Sal.& Com m XXX Rent f rom Tenant s XXX

Bad Debt s XXX Incom e from Invest m ent XXX

Godow n Rent XXX M iscellaneous Receipt s XXX

Export Expenses XXX Apprent iceship Prem ium XXX

Packing Charges XXX Difference in Expenses (Cr .) XXX

Carriage Out w ard XXX Dividend on Shares XXX

Insurance XXX Int erest on Debent ures XXX

Agent s Com m ission XXX Incom e from any ot her source XXX

Upkeep of M otor Lorries XXX Provision for discount f rom credit ors XXX

(B) M anagem ent Expenses: Int erest on renew al of bills XXX

Rent , Rat es and Taxes XXX By Net Loss t / f t o Capit al A/ c XXX

Heat ing and Light ing XXX

Office Salaries and Wages XXX

Print ing and St at ionery XXX

Post age and Telegram s XXX

Telephone Charges XXX

Legal Charges XXX

Audit fee XXX

Insurance XXX

Upkeep of M otor Car XXX

General Expenses XXX

(C) Depreciation and M aintenance:

Depreciat ion XXX

Repairs and M aint enance XXX


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(D) Financial Expen ses:

Int erest on Capit al XXX

Int erest on Loans XXX

Discount Allow ed XXX

Co st o f Disco un t in g t he b ills XXX

(E) Ext ra-Ord inary Expenses: XXX

Loss by fir e(not covered by insurance) XXX

Cashier defalcat ions XXX

To Net Profit t/ f to Capital A/ c XXX

Tot al XXX Tot al XXX

W hat are t he basic requirem ents of preparin g Prof it & Loss Account ?

Accountancy T20

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Transcript of Accountancy T20