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Individuals and business houses should keep a systematic record of all their financial
transactions. This will help them keep track of all their dealings. In addition, it is
mandatory under various fiscal laws, for individuals and business houses to maintain
accounts.
Accounting has gone through radical changes from its earliest form as a recording
activity to its present importance which stems from the objective of providing socio-
economic information for decision making.
Accounting is concerned with the processes of recording, sorting, and summarizing data
resulting from business operations and events.
The above definition does not clearly reflect the present role performed by accounting.
A widely accepted definition of the term accounting is given by American Accounting
Association, which is as follows:
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Objectives of Accounting
This information helps the management in ensuring that the assets do not
remain idle or under-utilized.
• To ascertain the financial position of the business : The profit and loss accounts
reflects the performance of the business during a particular period. How ever, it
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is also necessary to know the financial position i.e. where do we stand. What we
owe and what we own. The objective is met by Balance Sheet, which shows the
state of affairs of assets and liabilities as on a given date. It serves as barometer
for ascertaining the financial health of the business.
• To help rational decision – making : Accounting these days has taken upon itself
the task of collection, analysis and reporting of information at the required
points of time to the required level of authority in order to facilitate rational
decision making.
Q2.Explain the meaning & significance of the following (i) Dual aspect (ii) Consistency
(iii) Materiality (iv) Full disclosure (v) Cost Concept
This principle is the core of accountancy. All business transactions are recorded
having a dual aspect.
Let’s understand the three concepts, which are part of dual concept
Assets: It is expenditure for acquiring valuable resources, which benefit the future
activity of the business. E.g. building, land, machinery, furniture, debtors, bills
receivable, cash in hand etc.
Capital: The proprietor brings capital in to the business out of which the business
purchases assets for its use.
Creditors: In case the capital introduced by the proprietor is not sufficient the
business takes to borrowings from other parties. And now since total assets of the
business are acquired out of the money contributed by the proprietors and creditors of
the business.
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Each transaction has two aspects. With every increase in the money owed to others,
there must be an increase in Assets or loss. Thus at any time the accounting equation
is :
Assets = Liabilities + Capital or alternatively;
Capital = Assets – Liabilities
For example, a proprietor brings in Rs. 1,00,000 in cash as capital to start a small
business. Rs 1,00,000 is the Capital and corresponding amount of Rs.1,00,000 will
appear as cash on hand (Assets).
(ii) Consistency :
(iii) Materiality:
The disclosure concept implies that accounts must be honestly prepared and all
material information must be disclosed therein. The notion is so important that
Companies Act makes ample provisions for the disclosure of essential information in
company accounts.
The term disclosure does not imply that all information that anyone could conceivably
desire to be included in accounting statements. The term only implies that there is to
be a sufficient disclosure of information, which is of material interest to the
proprietors, present and potential creditors and investors. The practice of appending
notes relative to various facts or items which do not find place in accounting
statements is in pursuance to the concept of full disclosure of material facts. Examples
are:
(a) Contingent liabilities appearing as a note.
(b) Market value of investment appearing as a note.
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The cost concept does not mean that assets are always shown year after year for an
indefinite period at the cost price. The assets recorded at cost price at the time of
purchase are systematically reduced by the process called depreciation.
When all the accounts of a concern are thus balanced off they are put in a lost, debit
balances on one side and credit balances on the other side. The list so prepared is
called trial balance. The total of the debit side of trial balance must be equal to that of
its credit side. This is based on the principle that in double entry system, for every
debit there must be a corresponding credit. The preparation of a trial balance is an
essential part of the process because if totals of both the sides are the same then it is a
conclusive proof of arithmetical accuracy. It must be noted that equalizing the two
sides of a trial balance is not the sole conclusive proof of accuracy of accounts. If
the trial balance agrees, it does not mean that now there are no errors in accounts.
Even if the trial balance agrees, some errors may remain undetected and will not be
disclosed by the trial balance. That is the limitation of trial balance. The errors, which
are not disclosed by a trial balance, are as follows:
(i) Omission of an entry in the original book: if an entry has not been recorded in the
original or subsidiary book at all, then both the aspects of the transaction will be
omitted and the trial balance will not be affected. For example, if goods are sold to
A on credit and this fact is omitted to be recorded in Sales Journal, then it will
neither appear on the debit side of A’s A/c, nor on the credit side of Sales A/c in
the ledger. In spite of this omission the trial balance will agree.
(ii) Posting an item on the correct side but to the wrong account: If, suppose, cash
has been received on account from Mohan but this amount has been credited to
Sohan’s A/c instead of Mohan’s A/c, the amount being correct, the trial balance
will agree and it will not reveal this error.
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(iii) Wrong amount entered in the Subsidiary Book: If a credit purchase of Rs. 15000
is wrongly entered in the Purchases Journal as Rs. 1,500 then such error will not
be revealed by the trial balance.
(iv) Compensating error: These are the errors arising from the excess debits or under
debits of accounts being neutralized by the excess credit or under credit to the
same extent of some other accounts. It is very rare that such an error of equal
amounts arise on the debit side as well as on the credit sides of the ledger accounts
but the trial balance will not be affected in spite of this error.
(v) Error of principle: Whenever any amount is not properly allocated between
capital and revenue or some double entry principle is violated, the error so made is
known as error of principle. If wages paid for erection of machinery are debited to
wages account, then this is an error of principle. Wages paid for installation or
erection of machinery is a capital expenditure and should be debited to Machinery
account instead of wages account.
Where a trial balance disagrees and the differences between debit and credit
balances are quite large, it would never be safe to allow these errors to remain
undetected. All possible efforts should be made to localize the cause of the
differences. Final accounts must not be prepared unless and until trial balance
agrees, otherwise final accounts will not present true picture of financial state of
affairs. So in spite of all the limitations, the preparation of trial balance is an
important step, before preparation of final accounts.
Q4. The Trial Balance of “A” traders did not agree. The difference was put in the
Suspense Account & the following Trial Balance was drafted.
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a) Goods drawn by Mr A for his personal consumption of Rs 1500 have not been
recorded
b) Good sold to Mr R of Rs 1250 on credit was debited to H’s a/c for Rs 250 only
c) Wages paid for fittings Rs 500 was debited to Salaries & Wages account
d) Goods purchased from Atul for Rs 2500 on credit was wrongly debited to his
account
e) Bills received from Arun, a customer, for Rs 500 was debited to Ajay’s a/c
f) A credit sale of Rs 1500 was recorded in pirchase Day Books & a Credit
Purchase Rs 2000 was entered in sales Day Book
You are required to pass the rectification entries & redraft the Trial Balance
Suspense Account
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Journal Entires
Particulars Debit
Credit
Drawings a/c to purchase account 1500
Dr 1500
(Being goods withdrawn for personal
consumption by proprietor)
R (Debtors) a/c 1250
Dr 250
To H’s a/c 1000
To Suspense A/c
(Being goods sold to R for Rs 1200
wrongly debited to H’s A/c for Rs 250,
now rectified)
Furniture & Fittings a/c Dr 500
To Salaries Wages a/c 500
(Being wages paid for fittings wrongly
debited to salary & wages now
rectified)
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Trial balance as on 31.03.2001
Particulars Debit Credit
Capital 45000
Drawings 8000
Purchases 91750
Sales 106700
Salaries & Wages 11750
Furniture & Fittings 18000
Sundry Debtors 29750
Sundry Creditors 26750
Stationery 1250
Cash at Bank 5700
Cash at Hand 2300
Bills Receivable 15750
Bills Payable 9000
Rent & Rates 3200
Q.5 What are the causes of difference in the bank balance as shown by the cash book
and the pass book.
Following are the causes of differences in the balances as shown by the cashbook and
the bank passbook on any particular date:
1. Cheques deposited into the bank but not yet collected and credited: When cheques
are deposited, in the books of the concern bank account is immediately debited but in
the books of bank, the concern’s account is not credited until they are actually
collected by the bank. It is quite usual that some of the cheques deposited by the
concern may remain uncollected at the time the passbook is sent for comparison.
2. Cheques issued but not yet presented for payment: Similarly, the entry for the issue
of cheque is made in the books of the concern immediately and the bank account is
credited. But in the books of bank entry for payment can be made only when cheque
is presented for payment. At the time of comparison it is quite possible to find out
some cases where cheques were issued and recorded in the cashbook but not
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presented for payment and remained unrecorded in the bankbooks and thus causing a
difference.
3. Bank charges: Bank renders many services to its clients and for that it levies
charges. The bank makes entry for such charges but corresponding entry for it does
not appear in the cashbook of the concern because it is not known to the client until he
receives a statement. This causes a difference.
4. Amount collected or credited by the bank on standing instructions: Often, a
concern issues standing instructions to the bank to collect on its behalf dividends,
interest etc. on investments. When the bank collects such amounts, it immediately
credits the concern’s account with it. The necessary intimation and advice is sent to
the concerned party after this is done. The concern will debit the bank account in the
cashbook only when it receives such intimation of when it gets the pass book duly
completed from the bank.
5. Amounts paid or debited by the bank on standing instructions: The concern may
also issue standby instructions to the bank for making some payments on its behalf
and debit the concern’s account with it, i.e. life insurance premium, rent payment of
installments, payment of bills payable etc. whenever such payments are made by the
bank, the concern’s account is immediately debited, thus, the pass book balance is
reduced. The concern will credit the bank account in the cashbook only when it gets
intimation of such payment or the passbook from the bank.
6. Interest credited by the bank: Banks, normally do not allow any interest on the
current accounts. But if it is allowed, the concern’s account is credited by the bank,
which will enhance the firm’s balance with the bank. On the other hand, the firm will
record it on the debit side of the bank account in the cashbook only when the
passbook is received.
7. Interest debited by the bank on overdraft: If the firm withdraws more money from
the bank than the available deposits with it, it is called an overdraft. Overdraft facility
is permitted to the party by the bank only when it fulfils certain conditions. The bank
charges interest on overdrawn balances. It debits the customer’s account periodically
with such amount of interest. The firm will record the interest on the credit side of the
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cashbook only when it gets the passbook duly completed. Till then, the two books will
show differences.
8. Direct payment by customers into the bank account: Sometimes customers may
deposit money direct into the firm’s account in the bank. The bank will immediately
record the entry on the credit side of the firm’s account and thus in the pass book and
enhance the balance. But, the firm will debit the bank account in the cashbook only
when it gets the intimation or the passbook. In the mean time if the two balances will
be differing.
9. Dishonour of cheques or bills: When cheques are deposited in the bank for
collection, the firm debits the bank account in the cashbook. It increases the balance
immediately. But the bank will credit the proceeds of cheques only when they are
collected. If due to some reason, some cheques are dishonoured, i.e. not collected, the
bank will not credit the firm’s account. The firm with the bank thus, will be lower
than that in the cashbook.
10. Errors: Differences in the two balances may also be due to some errors in
recording of the transactions by either the firm or the bank. For example, the cheque
deposited in the bank for collection may not be recorded at all; or the cheque may be
forgotten to be sent to the bank though necessary entry has been recorded in the
cashbook.
Particulars Amount
(1) 7100
purchased on 01/01/1997 for Rs. 80000 was sold for Rs. 45000 and new
machinery costing Rs. 150000 was installed at a cost of Rs. 8000. The company
decided to change its method of depreciation from WDV to SLM with effect from
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Machinery Account
Dr
By
depreciation
1/7/1999 3240
(on machinery
sold)
To bank a/c By Loss on
1/7/1999 (Machinery 150000 1/7/1999 Sale of 16560
purchased) machinery
To bank a/c By P/L a/c
1/7/1999 8000 11200
(Installation) adjustment
By
119900
depreciation
By Balance c/d 934100
1130000 1130000
Working Notes 1
Particulars Amount
Value on 1/1/1997 80000
Less: Depreciation for the year (10% on 80000) 8000
Value as on 1/1/1998 72000
Less: Depreciation for 98 (10% on 72000) 7200
Value as on 1/1/1999 64800
Less: Depreciation for (1/2 year)
3240
(64800 x 10/100 x 6/12)
61560
Less: Sale value on 1/7/1999 45000
Loss on sale of machinery 16560
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Working Notes 2
Particulars Amount
Let the book value on 1/1/1997 100
Less: Depreciation for 1997 10
90
Less: Depreciation for 98 9
81
Value of machinery on 1/1/1997
1120000
(972000-64800)/81% = 907200/0.81
Working Notes 3
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1008000
Less: Depreciation of 10% for 98 112000
896000
Working Note 4
Capital expenditure: The capital expenditure is incurred for acquiring long-term advantage
for the business. For example it can be incurred on acquiring an asset which can be sold or
converted into cash or which results in increasing the earning capacity of the business or by
which some other advantage can be brought to business. Following are the examples of such
expenditure –
1. Any asset purchase like Plant, Machinery, Furniture etc.
2. Expenditure incurred on improving the usefulness of the asset.
3. If an existing asset is replaced by a new asset. The expenses on that will be considered as
capital expenditure.
4. Expenses carried on buying copyrights or goodwill.
The criterion to be applied to qualify for capital expenditure to see if the benefit of such
expenditure is derived over number of years or not.
Revenue expenditure: Revenue expenditure is incurred either for maintaining the existing
fixed assets or for meeting the routine expenses of the business.
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Following are the examples of revenue expenditure:
1. Normal routine expenses like cost of administration, cost of manufacturing and selling
products.
2. Maintenance of business e.g. repairs and maintenance of fixed assets etc.
3. Cost of goods purchased for resale.
4. Depreciation of fixed assets, interest on loans for the business.
1. The Capital Expenditure is incurred either for acquiring a new asset or for improving the
existing assets, while revenue expenditure is incurred either for maintaining the existing
fixed assets or for meeting the routine, expenses of the business.
2. Capital Expenditure increases the earning capacity of the business, while revenue
expenditure does not do so. It generally helps in maintaining the existing capacity of the
business.
3. The benefits of capital expenditure are available over a period of time, while benefit of
revenue expenditure is restricted only to accounting period in question.
4. Capital expenditure is recorded (subject to depreciation) in the Balance sheet whereas the
revenue expenditure (subject to adjustment for outstanding and prepaid amount) is
transferred either to Trading account or Profit and Loss account.
Capital Receipts: Capital Receipts consist of additional payments made to the business
either by the shareholders of the company or by the proprietors of the business or receipts
from sale of fixed assets of the business. The capital receipts are different from capital
profits. Receipts denote the entire amount received in cash.
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Revenue Receipts: Any receipt, which is not a capital receipt, is a revenue receipt. Usually
all receipts are revenue receipts. Revenue receipts are different from revenue income.
(a) Capital Receipts are normally of non recurring nature whereas revenue receipts are
normally of recurring nature.
(b) Revenue receipts are obtained in the course of normal trading operations. The receipts,
which are not revenue receipts are regarded as capital receipts.
(c) Revenue receipts are directly credited to the income statement whereas capital receipts
are not directly credited to the income statement.
(d) Capital receipts are normally not available for payment as profit to the owner of the
business where as the revenue receipts net of revenue expenses and expired portions of
capital expenditure/deferred revenue expenditure are available for distribution to the owners
of the business.
Q. 9. Prepare Manufacturing Trading & Profit & Loss A/c for the year ended 31st
March, 1998 & Balance Sheet as at the end of the year.
Trading and Profit & loss account for the year ended 31 march 1998
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To depreciation on
500
furniture
To NET pProfit 33700
64625 64625
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