SYLLABUS MBA 1st SEMESTER, M.D.U., ROHTAK External Marks : 70 Time : 3 hrs. Internal Marks : 30 UNIT-I Financial Accounting-concept, importance and scope, accounting principles, journal, ledger, trial balance, depreciation (straight line and diminishing balance methodology), preparation of final accounts with adjustments. UNIT-II Ratio analysis, fund flow analysis, cash flow analysis. UNIT-III Management accounting-concept, need, importance and scope; cost accounting-meaning, importance, methods, techniques and classification of costs, inventory valuation. UNIT-IV Budgetary control-meaning, need, objectives, essentials of budgeting, different types of budgets; standard costing and variance analysis (materials, labour); marginal costing and its application in managerial decision making. 143
MBA 1st Semester (DDE) UNIT I Q. Define Accounting. Explain its Nature. Ans. Accounting:- Accounting is often called the language of business. The basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are : (i) (ii) Trading, Profit & Loss Account. Balance Sheet. Definition of Accounting : According to American Institute of Certified Public Accountants: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof. According to R.N. Anthony : Nearly every business enterprise has accounting system. It is a means of collecting, summarizing, analyzing and reporting in monetary terms, informations about business. Feature or Characteristics or Nature of Accounting : (1) Recording of Financial Transactions only : Only those transactions and events are recorded in accounting which can be expressed in terms of money. Those transactions which cannot be expressed in terms of money are not recorded in accounting like the value of human resource, strike by employees, and change in managerial policies etc. (2) Recording : Accounting is the art of recording of business transactions according to some specified rules. In a small business where number of transactions is quite small, all transactions are first of all recorded in a 144
book called Journal. But in a big business where the number of transactions is quite large, the Journal is further sub-divided into various subsidiary books such as:- (i) (ii) Cash Book Purchase Book (iii) Sales Book (iv) Purchase Return Book (v) Sales Return Book. The number of subsidiary books to be maintained depends on the size and nature of the business. (3) Classifying : After recording the transactions in journal or subsidiary books, the transactions are classified. Classification is the process of grouping the transactions of one nature at one place, in a separate account. The books in which various accounts are opened is called Ledger. (4) Summarising : Summarising involves the balancing of Ledger accounts and the preparation of Trial Balance with the help of such Balances. Financial Statements are prepared with the help of trial balance. Financial statements are includes:- (i) (ii) Trading, Profit & Loss Account Balance Sheet. (5) Interpretation of the Results : In accounting the results of business are presented in such a manner that the parties interested in the business such as proprietors, managers banks, creditors etc. can have full information about the profitability and the financial position of the business. (6) Communicating : It refers to transmission of summarized and interpreted information to a variety of users. The users are:- (i) Creditors (ii) Investors (iii) Lenders (iv) Government (v) Proprietors (vi) Management (vii) Banks etc. Q. Define Accounting. Also explain its Importance. Ans. Accounting : Accounting is often called the language of business. The basic function of any language is to communicate. Accounting communicates 145
the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:- (i) (ii) Trading, Profit & Loss Account. Balance Sheet. Definition of Accounting : According to American Institute of Certified Public Accountants : Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof. Importance of Accounting : (1) Helpful in Management of Business : Management needs a lot of information for the efficient running of the business. All such information is provided by the accounting which helps the management in the following:- (i) Helpful in Planning : Management would like to know whether the sales are increasing or decreasing and also the speed of increase in the cost of production. All such information is provided by the accounting, which helps the management in estimating the future sales and expenses. It also helps them to estimate the cash receipts and cash disbursements during the next accounting period. (ii) Helpful in Decision-Making : At times, the Management has to take a number of decisions. Accounting provides all the informations required for making such decisions. (iii) Helpful in Controlling : Management would like to see that the cost incurred is reasonable and that no department is overspending. Accounting provides information to the management in this regard. (2) Provides Complete and Systematic Record : Business transactions have grown in size and complexity and it is not possible to remember each and every transaction. Accounting keeps a prompt and systematic record of all the transactions and summarizes them in order to provide a true picture of the activities of the business entity. (3) Information regarding Profit or Loss : Accounting reports the net result of business activities of an accounting period. For this purpose Trading and Profit & Loss Account of the business is prepared at the end of each accounting period. All the items relating to purchase, sales, expenses and revenues (Income) of the business are recorded in Trading, Profit & Loss Account. 146
If Revenues >Expenses- Profit If Revenues< Expenses- Loss (4) Information Regarding Financial Position : For a businessman, merely ascertaining profit or loss of the business is not sufficient. The businessman must also know the financial health of the business. For this purpose a statement called Balance Sheet is prepared which shows the assets on the one hand and the liabilities and capital on the other hand. Balance Sheet describe the following : (i) How much the business has to recover from Debtors? (ii) How much the business has to pay to Creditors? (iii) How much the business has in the form of (a) Cash-in-hand (b) Cash at Bank (c) Closing Stock (d) Fixed Assets. (5) Enables Comparative Study : By keeping a systematic record accounting helps the owners to compare one year s costs, expenses, sales and profit etc. with those of other years. Such a comparison provides the useful information on the basis of which important decisions can be taken more judiciously. (6) Provide Informations to Various Parties : Another main objectives of accounting is to communicate the accounting information to various users like: (i) Creditors (ii) Investors (iii) Lenders (iv) Government (v) Proprietors (vi) Management (vii) Banks etc. (7) To Know the Liquidity Position : Another objective of accounting is to provide information about liquidity position. For this purpose it prepares a Cash Flow Statement. It depicts inflows and outflows of cash from operating, investing and financing activities. (8) To File Tax Returns : One of the main objectives of accounting is to provide bases for filing tax returns relating to income tax, sales tax, value added tax, service tax, etc. (9) Facilitates Sale of Business : If a business entity is being sold, the accounting information can be utilized to determine the proper purchase price. (10) Helpful in Raising Loans : Accounting information is of great help while raising loans from banks or other financial institutions. Such institutions 147
before sanctioning loan screen various financial statements of the firm such as final accounts, fund flow statement, cash flow statement etc. (11) Helpful in Prevention and Detection of Errors and Frauds. Q. Define Accounting. Also explain its Scope. Ans. Accounting : Accounting is often called the language of business. The basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:- (i) (ii) Trading, Profit & Loss Account. Balance Sheet. Definition of Accounting : According to American Institute of Certified Public Accountants : Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof. Scope of Accounting : In order to appreciate the exact nature and scope of accounting, we must understand the following aspects of accounting: (1) Economic Events : Accounting records only economic events. An economic event is a transaction which can be measured and expressed in terms of money. (2) Identification : It means determining what transactions are to be recorded. It involves observing events and selecting those events that are of financial character and relate to the organization. (3) Measurement : It means quantification of business transactions into financial terms by using monetary units. (4) Recording : Accounting is the art of recording of business transactions according to some specified rules. In a small business where number of transactions is quite small, all transactions are first of all recorded in a book called Journal. But in a big business where the number of transactions is quite large, the Journal is further sub-divided into various subsidiary books such as:- 148 Cash Book Purchase Book Sales Book Purchase Return Book Sales Return Book.
The number of subsidiary books to be maintained depends on the size and nature of the business. (5) Classification : After recording the transactions in journal or subsidiary books, the transactions are classified. Classification is the process of grouping the transactions of one nature at one place, in a separate account. The books in which various accounts are opened is called Ledger. (6) Summarising : Summarising involves the balancing of Ledger accounts and the preparation of Trial Balance with the help of such Balances. Financial Statements are prepared with the help of trial balance. Financial statements are includes:- (i) (ii) Trading, Profit & Loss Account Balance Sheet. (7) Communication : It refers to transmission of summarized and interpreted information to a variety of users. The users are:- (i) Creditors (ii) Investors (iii) Lenders (iv) Government (v) Proprietors (vi) Management (vii) Banks etc. (8) Interpretation of the Results : In accounting the results of business are presented in such a manner that the parties interested in the business such as proprietors, managers banks, creditors etc. can have full information about the profitability and the financial position of the business. Q. Define Accounting. Explain its Objectives Or Functions and Branches Or Types. Ans. Accounting : Accounting is often called the language of business. The basic function of any language is to communicate. Accounting communicates the results of the business to the users of accounting information to enable them to make effective decisions. To communicate information, accounting follows a systematic process of recording, classifying and summarizing of numerous business transactions resulting in creation of financial statements. The two most important financial statements are:- (iii) Trading, Profit & Loss Account. (iv) Balance Sheet. Definition of Accounting : According to American Institute of Certified Public Accountants : 149
Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof. Objectives or Functions of Accounting:- objectives, functions or utility of accounting:- The following are the main (1) To keep a Systematic record of business transactions : The main objective of accounting is to maintain complete record of business transactions according to some specified rules. For this purpose all the business transactions are first of all recorded in Journal or Subsidiary Books and then posted into Ledger. (2) To Calculation Profit or Loss : The second main objective of accounting is to calculate the net profit earned or loss suffered during a particular period. For this purpose Trading and Profit & Loss Account of the business is prepared at the end of each accounting period. All the items relating to purchase, sales, expenses and revenues (Income) of the business are recorded in Trading, Profit & Loss Account. If Revenues >Expenses- Profit If Revenues< Expenses- Loss (3) To know the exact reasons leading to net profit or net loss. (4) To Know the Financial Position of the business : For a businessman, merely ascertaining profit or loss of the business is not sufficient. The businessman must also know the financial health of the business. For this purpose a statement called Balance Sheet is prepared which shows the assets on the one hand and the liabilities and capital on the other hand. (5) To ascertain the progress of the business from year to year. (6) To prevent and detect errors and frauds. (7) To Provide Informations to Various Parties : Another main objectives of accounting is to communicate the accounting information to various users. (8) To Know the Liquidity Position : Another objective of accounting is to provide information about liquidity position. For this purpose it prepares a Cash Flow Statement. It depicts inflows and outflows of cash from operating, investing and financing activities. (9) To File Tax Returns : One of the main objectives of accounting is to provide bases for filing tax returns relating to income tax, sales tax, value added tax, service tax, etc. Branches OR Types of Accounting : Branches of accounting are : (1) Financial Accounting : It covers the preparation and interpretation of 150
financial statements and communication to the users of accounts. The final step of financial accounting is the preparation of Trading and Profit & Loss Account and the Balance Sheet. (2) Management Accounting : The main purpose of Management Accounting is to present the accounting information in such a way as to assist the management in planning and controlling the operations of a business. The management accountant uses various techniques and concepts to make the accounting data more useful for managerial decision making. (3) Tax Accounting : The branch of accounting which is used for tax purpose is called tax accounting. Income Tax and Sale Tax are computed on the basis of this accounting. (4) Cost Accounting : The main purpose of cost accounting is to calculate the total cost and per unit cost of goods produced and services rendered by a business. It also estimates the cost in advance and helps the management in exercising strict control over cost. (5) Social Responsibility Accounting : The society provides the infrastructure and the facilities without which business cannot operate at all. Hence the business also has a responsibility to the society. There is a growing demand for reports on activities which reflect the contribution of an enterprise to the society. Social responsibility accounting is the process of identifying, measuring and communicating the contribution of a business to the society. In social responsibility accounting techniques have been developed for measuring the cost of these contribution and the benefits to the society. Q. What do you mean by Accounting Principles or (GAAP)? Explain and illustrate fully. Ans. Accounting Principle : The accounting statements are needed by various parties who have interest in the business, namely, proprietors, investors, creditors, government and many other. Accounting statements disclose the profitability and solvency of the business to various parties. It is therefore, necessary that such statements should be prepared according to some standard language and set rules. These rules are usually called General Accepted Accounting Principles (GAAP). Kinds of Accounting Principles : Accounting principles are described by various terms such as assumptions, conventions, concepts, doctrine, postulate etc. These principles can be classified mainly into two categories:- (A) (B) Accounting Concepts or Assumptions Accounting Conventions. 151
Kinds of Accounting Principles Accounting Concepts or Assumptions Business Entity Concept Money Measurement Concept Going Concern Concept Accounting Period Concept Accounting Conventions Convention of Full Disclosure Convention of Consistency Convention of Conservatism Convention of Materiality Historical Cost Concept Dual Aspect Concept Revenue Recognition Concept Matching Concept Accrual Concept Objectivity Concept (A) Accounting Concepts or Assumptions : Accounting concepts define the assumptions on the basis of which financial statements of a business entity are prepared. The word concept means idea or notion, which has universal application. These accounting concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these basic concepts or assumptions. These concepts guide how transactions should be recorded and reported. Following may be treated as basic concepts or assumptions : (1) The Business Entity Concept : Entity concept states that business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. Business transactions are recorded in the business books of accounts and owner s transactions in his personal books of accounts. Business unit should have a completely separate set of books and we have to record business transactions from firm s point of view and not from the point of view of the proprietor. Example : 152
(i) (ii) The proprietor is treated as a creditor of the business to the extent of capital invested by him in the business. The capital is treated as a liability of the firm because it is assumed that the firm has borrowed funds from its own proprietors instead of borrowing from outside parties. It is for the reason that we also allow interest on capital and treat it as an expense of the business. Similarly, the amount withdrawn by the proprietor from the business for his personal use is treated as his drawings. (iii) The proprietor s house, his personal investment in securities, his personal car and personal income and expenditure are kept separate from the accounts of the business entity. (iv) If the proprietor has some other business entity doing another business, the records of that business should also be kept separate. The concept of separate entity is applicable to all forms of business organizations, i.e. sole proprietorship, partnership or a company. (2) Money Measurement Concept : As per this concept, only those transactions, which can be measured in terms of money are recorded. Transactions, even if, they affect the results of the business materially, are not recorded if they are not convertible in monetary terms. Transactions and events that cannot be expressed in terms of money are not recorded in the business books. For example, accounting does not record a quarrel between the production manager and sales manager; it does not report that a strike is beginning and it does not reveal that a competitor has placed a better product in the market. These facts or happenings cannot be expressed in money terms and thus are not recorded in the books. Example : A business on a particular day has 5000 Kilograms of raw materials, 5 Machines, 100 Chairs and 20 Fans. All these things cannot be added up unless expressed in terms of money. In order to make a record of these items, these will have to be expressed in monetary terms such as Raw Materials Rs. 25000, Machines Rs. 200000, Chairs Rs. 5000 and Fans Rs. 8000. As such, to make accounting records relevant, simple, understandable and homogeneous, they are expressed in a common unit of measurement i.e., money. (3) Going Concern Concept : As per this concept it is assumed that the business will continue to exist for a long period in the future. The transactions are recorded in the books of the business on the assumption that it is a continuing enterprise. Example : (i) It is on this concept that we record fixed assets at their original cost and depreciation is charged on these assets without reference to their market value. 153
(ii) It is also because of the going concern concept that outside parties enter into long-term contracts with the enterprise, gives loans and purchase the debentures and shares of the enterprise. (iii) Another example of this concept is that Prepaid Expenses, which have no realizable value are shown as assets in the balance sheet, because the benefits of such expenses will be received in future. (4) Accounting Period Concept : According to this concept accounts should be prepared after every period & not at the end of the life of the st st entity. Usually this period is one calendar year i.e. 1 Jan to 31 December st st or from 1 April to 31 March. According to Amended Income Tax Law, a st business has compulsorily to adopt financial year beginning on 1 April st and ending on 31 March. Apart from this, companies whose shares are listed on the stock exchange are required to publish quarterly results to depict the profitability and financial position at the end of three months period. (5) Historical Cost Concept or Cost Concept : According to this concept, an asset is ordinarily recorded in the books of accounts at the price at which it was purchased or acquired. This cost becomes the basis of all subsequent accounting for the asset. Since the acquisition cost relates to the past, it is referred to as historical cost. This cost is the basis of valuation of the assets in the financial statements. Example : If a business purchases a building for Rs. 500000, it would be recorded in the books at this figure. Subsequent increase or decrease in the market value of the building would not be recorded in the books of accounts. Benefits : (i) It is highly objective and free from bias. (ii) Market values of assets are difficult to be determined. (iii) Market values of the assets may change from time to time and it will be extremely difficult to keep track of up and down of the market price. Limitations : (i) Assets for which nothing is paid will not be recorded. Thus a favourable location, brand name and reputation of the business, knowledge and technological skill built inside the enterprise will remain unrecorded though these are valuable assets. (ii) Historical cost-based accounts may lose comparability. (iii) Many assets do not have acquisition cost. (iv) During periods of inflation, the figure of net profit disclosed by profit and loss account will be seriously distorted because depreciation 154
(v) based on historical costs will be charged against revenues at current prices. Information based upon historical cost may not be useful to management, investors, creditors etc. (6) Dual Aspect Concept : According to this concept, every business transaction is recorded as having a dual aspect. In other words, every transaction affects atleast two accounts. If one account is debited, any other account must be credited. The system of recording transactions based on this concept is called as Double Entry System. It is because of this principle that two sides of the Balance Sheet are always are equal and the following accounting equation will always hold good at any point of time:- Assets = Liabilities + Capital Example : X commences business with Rs. 5 Lacs in cash and takes a loan of Rs. 1 Lac from the bank, and these 6 Lacs are used in buying some assets, say, plant & machinery. The equation will be as follows: Assets OR Capital = Assets - Liabilities = Liabilities + Capital Rs. 6 Lacs = Rs. 1 Lac + Rs. 5 Lacs (7) Revenue Recognition (Realisation) Concept : Revenue means the amount which is added to the capital as a result of business operations. Revenue is earned by sale of goods or by providing a service. Concept of revenue recognition determines the time or the particular period in which the revenue is realized. Revenue is deemed to be realized when the title or ownership of the goods has been transferred to the purchaser and when he has legally become liable to pay the amount. It should be remembered that revenue recognition is not related with the receipt of cash. st Example : For example, if a firm gets an order of goods on 1 January, th st supplies the goods on 20 January and receives the cash on 1 April, the th revenue will be deemed to have been earned on 20 January, as the ownership of goods was transferred on that day. (8) Matching Concept : This concept is very important for correct determination of net profit. According to this concept, all expense are matched with the revenue of that period should only be taken into consideration. This principle is based on accrual concept as it considers the occurrence of expenses and income and do not concentrate on actual inflow or outflow of cash. This principle helps us in finding Net profit or Loss. Following points must be considered while matching costs with revenue: 155
(i) (ii) When an item of revenue is included in the profit and loss account, all expenses incurred on it, whether paid or not, should be show as expenses in the profit and loss account. When some expenses, say insurance premium is paid partly for the next year also, the part relating to next year will be shown as an expense only next year and no this year. (iii) Similarly, income receivable must be added in revenues and incomes received in advance must be deducted from revenues. (9) Accrual Concept : In accounting, accrual basis is used for recording transactions. It provides more appropriate information about the performance of business enterprise as compared to cash basis. Accrual concept applies equally to revenues and expenses. In accrual concept revenue is recorded when sales are made whether cash is received or not. Similarly, according to this concept, expenses are recorded in the accounting period in which they assist in earning the revenues whether the cash is paid for them or not. (10) Objectivity Concept : This concept requires that accounting transaction should be recorded in an objective manner, free from the personal bias of either management or the accountant who prepares the accounts. (B) Accounting Conventions : An accounting convention may be defined as a custom or generally accepted practice which is adopted either by general agreement or common consent among accountants. Accounting conventions differ from concept in respect to the following: (i) (ii) Accounting concepts are established by law while accounting conventions are guidelines based upon general agreement. There is no role of personal judgment or individual bias in the adoption of accounting concepts whereas they may play a crucial role in following accounting conventions. (iii) There is uniform adoption of accounting concepts in different enterprise while it may not be so in case of accounting conventions. Following are the main accounting conventions : (1) Conventions of Full Disclosure : This principle requires that all significant information relating to the economic affairs of the enterprise should be completely disclosed. The principle is so important that the companies Act makes ample provisions for the disclosure of essential information in the financial statements of a company. The proforma and contents of Balance Sheet and Profit and Loss Account are prescribed by Companies Act. Various items or facts which do not find place in accounting statements are shown in the Balance Sheet by way of footnotes. Such as : 156
(i) Contingent Liabilities. (ii) If there is a change in the method of valuation of stock, or for providing depreciation or in making provision for doubtful debts, it should be disclosed in the Balance Sheet by way of a footnote. (iii) Market value of investments should be given by way of a footnote. (2) Convention of Consistency : According to this principle, accounting principles and methods should remain consistent from one year to another. These should not be changed from year to year. If a firm adopts different accounting principles in two accounting periods, the profits of current period will not be comparable with the profits of the preceding period. (3) Convention of Conservatism : According to this principle, all anticipated losses should be recorded in the books of accounts, but all anticipated gains should be ignored. In other words, conservatism is the policy of playing safe. When there are many alternative values of an asset, an accountant should choose the method which leads to the lesser value. Examples of the application of the principle of conservatism : (i) Valuation of closing stock cost or market price whichever is less. (ii) Provision for Doubtful Debts on Debtors. (iii) Joint Life Policies are recorded at Surrender Values. Effects of Principle of Conservatism : (i) (ii) Profit & Loss account will disclose lower profits in comparison to the actual profits. Balance sheet will discloses understatement of assets and overstatement of liabilities in comparison to the actual values. (4) Convention of Materiality : This convention is an exception to the convention of full disclosure. According to this convention, all the items having significant economic effect should be disclosed in financial statements and any insignificant item which will only increase the work of the accountant should not be disclosed in the financial statements. It should be noted that what is material for one concern may be immaterial for another. Thus, the accountant should judge the important of each transaction to determine its materiality. Q. Give Classification Of Accounts. What are the Rules of Journalising? Ans. Classification of Accounts : Classification of Accounts are: Classification of Accounts Personal Accounts Impersonal Accounts Real Accounts Nominal Accounts 157
1. Personal Accounts : The accounts which relate to an individual, firm, company or an institution are called personal accounts. Account of Mohan, Account of D.C.M. Limited, Capital Account of proprietor, etc. are the examples of Personal Accounts. This account is further classified into three categories:- (i) (ii) (iii) Natural Personal Accounts : It relates to transactions of human beings like Ram, Rita, etc. Artificial Personal Account : These accounts do not have a physical existence as human beings but they work as personal accounts. For example: Government, Companies (private or limited), Clubs, Co-operative Societies etc. Representative Personal Accounts : These are not in the name of any person or organization but are represented as personal account. For Example: Outstanding liability account or prepaid account, capital account, drawings account. Golden Rule of Personal Account : Debit the Receiver Credit the Giver 2. Impersonal Account : Accounts which are not personal such as machinery account, cash account, rent account etc. These can be further sub-divided as follows : (i) (ii) Real Account : Accounts which relate to assets of the firm but not debt. For example accounts regarding Land, Building, Investment, Fixed Deposits etc., are real accounts Cash-in-hand and Cash at Bank are also real. Golden Rule of Real Account : Debit what comes in. Credit what goes out. Nominal Account : Accounts which relates to expenses, losses, gains, revenue etc. like salary account, interest paid account, commission received account. Golden Rule of Nominal Account : Debit all expense & Losses. Credit all Incomes & Gains. Q. Define Accounting Cycle OR Process of Accounting. Ans. Accounting Cycle : An accounting cycle is a complete sequence of accounting procedures which are repeated in the same order during each accounting period. The accounting cycle may be shown as below:- 158
Trading, Profit & Loss A/c and Balance Sheet Transactions Journal Books of Original Entry: 1. Cash Book 2. Purchase Book 3. Sales Book 4. Purchase Return Book 5. Bills Receivable Book 6. Bills Payable Book 7. Journal Proper Trial Balance Ledger Diagram : Accounting Cycle (1) Identification of Transaction : Accounting deals with business transactions which are monetary in nature. In other words, the transactions which cannot be measured and expressed in terms of money cannot be recorded in accounting. (2) Journal : Journal is one of the basic book of original entry in which transactions are recorded in a chronological (day-to-day) order according to the principles of double entry system. When the size of business is a small one, it may be possible to record all transactions in the journal but when the size of the business grows and the number of transactions is very large journal is sub-divided into a number of books called subsidiary Books. There are five columns in journal which are:- PROFORMA OF JOURNAL Date Particulars L.F. Amount Dr. Amount Cr. (1) (2) (3) (4) (5) (i) (ii) Date : In the first column, date of transaction is entered. The year and month is written only once, till they change. Particulars : Each transactions affects two accounts out of which one account is debited and other account is credited. 159
(iii) (iv) (v) Ledger Folio or L.F. : All entries from the journal are later posted into the ledger accounts. The page number of the ledger account where the posting has been made from the journal is recorded in the L.F. column of the journal. Amount Dr. : In the fourth column, the amount of the account being debited is written. Amount Cr. : In the fifth column, the amount of the account being credited is written. (3) Ledger : Business transactions are first recorded in journal or Subsidiary books. The next step is to transfer the entries to respective accounts in ledger. This process is called ledger Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount Each ledger account is divided into two equal parts. The left-hand side is known as the debit side and the right-hand side as the credit side. As shown above, there are four columns on each side of an account:- (i) (ii) (iii) (iv) Date : The date of the transaction is recorded in this column. Particulars : Each transaction affects two accounts. Journal Folio or J.F. : In this column page number of the journal or subsidiary book from which the particular entry is transferred, is entered. Amount : The amount is entered in this column. (4) Trial Balance : When posting of all the transactions into ledger is completed and the accounts are balanced off, it becomes necessary to check the arithmetical accuracy of the accounting work. For this purpose, the balance of each and every account in the ledger is put on a list. The list so prepared is called a trial balance. PROFORMA OF TRIAL BALANCE Name of the Accounts L.F. Dr. Balances Cr. Balances Features of a Trial Balance : (i) It is a list of balances of all ledger accounts and the cash book 160
(ii) It is just a statement and not an account. (iii) It is neither a part of double entry system, nor does it appear in the actual books of accounts. It is just a working paper. (iv) It can be prepared at any time during the accounting period, say, at the end of every month, every quarter, every half year or every year. (v) It is always prepared on a particular date and not for a particular period. (vi) It is prepared to check the arithmetical accuracy of the ledger accounts. (vii) If the books are arithmetically accurate, the total of all debit balances of a trial balance will be equal to the total of all credit balances. Objectives of Preparing Trial Balance : (i) To ascertain the arithmetical accuracy of the ledger accounts. (ii) To help in locating errors (iii) To obtain a summary of the ledger accounts (iv) To help in the preparation of final accounts. (5) Trading, Profit & Loss Account And Balance Sheet : After having checked the accuracy of the book of accounts through preparation of Trial Balance, businessman wants to ascertain the profit earned or loss suffered during the year and also the financial position of his business at the end of the year. For this purpose he prepares Final Accounts which are also termed as Financial Statements. These include the following:- Trading Account. Profit and Loss Account. Balance Sheet. Q. Write a Short Note On Double Entry System. Ans. Double Entry System : According to Double Entry System, every transaction has two fold-aspects- debit and credit and both the aspects are to be recorded in the books of accounts. We may define the Double Entry System as the system which records both the aspects of transactions. This principle proves accounting equation i.e. both sides of Balance Sheet always equal. Assets = Liabilities + Capital Advantages of Double Entry System : mentioned advantages : (1) Scientific System (2) Complete Record of Every Transaction (3) Preparation of Trial Balance (4) Preparation of Trading & Profit & Loss A/c (5) Knowledge of financial position of the Business (6) Knowledge of Various Informations. This system affords the under 161
(7) Comparative Study (8) Lesser possibility of Fraud. (9) Help management in decision making. (10) Legal Approval (11) Suitable for All types of Businessmen. Q. Define Depreciation. What are the Causes & Methods of Depreciation? Ans. Depreciation : In every business there are certain assets of a fixed nature that are needed for the conduct of business operations. Some examples of such assets are Building, Plant & Machinery, Motor Viechles, Furniture, office Equipments etc. These assets have a definite span of life after the expiry of which the assets will lose their usefulness for the business operations. Fall in the value & utility of such assets due to their constant use and expiry of time is termed as depreciation. Definition of Depreciation : According to William Pickles Depreciation may be defined as the permanent and continuing diminution in the quality, quantity or the vale of an asset. Features of Depreciation : 1. Depreciation is decline in the value of fixed assets (except Land) 2. Such fall is of a permanent nature. 3. Depreciation is a continuous process because value of assets will decline by their constant use. 4. Depreciation decreases only the book value of the asset, not the market value. 5. Depreciation is a non-cash expense. It does not involve any cash outflow. Causes of Depreciation : 1. By Constant Use. 2. By Obsolescence 3. By expiry of time. 4. By Accident. 5. By expiry of legal rights. 6. By Depletion 7. By permanent fall in market price. Need, Importance or objects of providing depreciation : 1. For ascertaining the truth profit or loss. 2. For showing the truth true and fair view of the financial position. 3. To ascertain the accurate cost of production. 162
4. To provide funds for replacement of assets. 5. To prevent the distribution of profits out of capital. 6. For avoiding over payment of Income tax. 7. Other objectives. Factors determining the amount of Depreciation : 1. Total Cost of the Asset. 2. Estimated life of Asset. 3. Estimated Scrap Value. Methods of providing or Allocating Depreciation : 1. Straight Line Method. 2. Written Down Value Method. 3. Annuity Method. 4. Depreciation Fund Method. 5. Insurance Policy Method. 6. Revaluation Method. 7. Depletion Method. 8. Machine hour rate Method. Q. Explain Straight Line Method of Depreciation with the help of an Example. Ans. Straight Line Method : This method is also termed as Original Cost Method because under this method depreciation is charged at a fixed percentage on the original cost of the asset. The amount of depreciation remains equal from year to year and as such this method is also known as Equal Installment Method, or Fixed Installment Method. Under this method, the amount of depreciation is calculated by deducting the scrap value from the original cost of the asset and then by dividing the remaining balance by the number of years of its estimated life. Yearly Depreciation = Merits of Straight Line Method : Original Cost of the Asset Estimated Scrap Value Estimated Life of the Asset. 1. Simplicity : Calculation of Depreciation under this method is very simple and as such the method is widely popular. 2. Equality of Depreciation Burden : Under this method, equal amount of depreciation is debited to profit & loss account of each year. Hence, the burden of depreciation on each year s net profit is equal. 3. Assets can be completely written off : Under this method, the book value of an asset can be reduced to net scrap value or zero value, which is not possible under some other methods. 163
4. Knowledge of original cost and upto date depreciation : under this method, the original cost of the asset is shown in the Balance Sheet and the upto-date depreciation is shown as a direct deduction from it. Demerits of Straight Line Method : 1. Difficulty in Computation : When there are different machines having different life-span, the computation of depreciation becomes complicated because depreciation on each machine will have to be calculated separately. 2. Unequal pressure in later years : Repairs charges go on increasing year by year as the asset becomes older but as the equal depreciation is charged under this method each year. 3. Omission of Interest factor : This method does not take into consideration the loss of interest on the amount invested in the asset. 4. Unrealistic to write off the vale of asset to zero : Sometimes, even after the value of an asset is reduced to zero in the books, it continues to be used in the business in actual practice 5. Difficulty in the determination of scrap value : It is quite difficult to assess the true scrap value of the asset after a long period, say 15 or 20 years from the date of its installation. Suitability renewals. Example : : This method is suitable for those assets whose useful life can be st Birla Cotton Mills purchased a machinery on 1 May, 1991 for Rs. 90,000. On 1 July, 1992 it purchased another machinery for Rs. 40,000. st On 31 March, 1993 it sold off the first machine purchased on 1991 for Rs. 58,000 and on the same date purchased a new machinery for Rs. 1,00,000. Depreciation is provided at 20% p.a. on the original cost method. Accounts are st closed each year on 31 December. Show the Machinery Account for three years Dr. Machinery Account Cr. st Date Particulats J.F. Amount Date Particulars J.F. Amount 1991 1991 May 1 To Bank A/c 90,000 Dec.31 By depreciation A/c 12,000 (for 8 months) Dec.31 By Balance C/d 78,000 90,000 90,000 164
1992 1992 Jan1 To Balance B/d 78,000 Dec31 By Depreciation A/c July1 To Bank A/c 40,000 (i) 18,000 (ii) 4,000 22,000 (for 6 months) Dec31 By Balance C/d (i) 60,000 (ii) 36,000 96,000 1,18,000 1,18,000 1993 1993 Jan1 To Balance B/d Mar.31 By Bank A/c 58,000 (i) 60,000 Mar.31 By Dep. A/c 4,500 (ii) 36,000 96,000 (for 3 months) Mar. To Bank A/c 1,00,000 Dec. 31 By Dep. A/c 31 (ii) 8,000 23,000 Mar. To Profit & Loos (iii) 15,000 31 A/c (Profit On machine) Rs. 58,000+ 4,500-60,000 2,500 Dec.31 By Bal. C/d (ii) 28,000 (iii) 85,000 1,13,000 1,98,500 1,98.500 1994 Jan.1 To Bal. B/d 1,13,000 (ii) 28,000 (iii) 85,000 Q. Discuss the Merits And Demerits Of Providing Depreciation By Diminishing Balance Method? Ans. Written Down Value Method : Under this method, as the value of asset goes on diminishing year after year, the amount of depreciation charged every year also goes on declining. 165
For Example if a machine is purchased for Rs. 10,000 and depreciation is to be charged at 10% p.a. according to written down value method, the depreciation will be charged as under:- st 1 Year on Rs. 10,000 @ 10% =1,000 nd 2 Year on Rs. 9,000 (10,000-1,000) @ 10% = 900 rd 3 Year on Rs. 8,100 (9,000-900) @ 10% = 810 and so on. It will be observed from the above calculations that each year s depreciation is calculated on the book value of the asset at the beginning of that year, rather than on the original cost. As the value of asset and also the depreciation charged on its goes on reducing year after year, this method is known as Reducing Installment Method. Merits of Written Down Value Method : 1. Easy Calculation : It is easy to calculate the depreciation under this method, even if some new assets are purchased year after year. 2. Equal Charge against income : In this method, the total burden on profit & Loss account in respect of depreciation and repairs put together remains almost equal year after year. 3. No induce pressure in later years : The efficiency of machine is more in the earlier years than in later years. Hence, the depreciation in first few years should be more in comparison to the later years. 4. Balance of asset is never written off to zero : This method ensures that the assets is never reduced to zero. 5. Approved method by Income Tax Authorities : This method of providing depreciation is permissible under Income Tax Regulations. Demerits of Written Down Value Method : 1. Asset can not be completely written off. : Under this method, the value of an asset, even if it becomes obsolete and useless, cannot be reduced to zero and some balance, however small, would continue on asset account. 2. Omission of Interest Factor : This method does not take into consideration the loss of interest on the amount invested in the asset. 3. Difficulty in determining the rate of depreciation : Under this method, the rate of providing depreciation cannot be easily decided. 4. Knowledge of original cost & up to date depreciation not possible : Under this method, the original cost of various assets is not shown in the Balance Sheet. Example : A company had bought machinery for Rs. 100000 including there 166
in a boiler worth Rs 10000 depreciation was charged on reducing balance method at the rate of 10% p.a. for first five year and machinery account was credited accordingly. During the fifth year, the boiler becomes useless on account of damages. The damaged boiler is sold for Rs. 2000 prepares the machinery account for five years. Dr. MACHINERY ACCOUNT Date Particulars Amount Date Particulars Amount Year To Bank A/c 90000 Year By Dep. Ist To Bank A/c 10000 Ist (i) 9000 10000 (Boiler) (ii) 1000 By Bal. C/d (i) 81000 (ii) 9000 9000 100000 100000 Year To Bal. B/d Year By Dep. II (i) 81000 II (i) 8100 (ii) 9000 (ii) 900 9000 90000 By Bal. C/d (i) 72900 81000 (ii) 8100 90000 90000 Year To Bal. B/d Year By Dep. III (i) 72900 III (i) 7290 (ii) 8100 (ii) 810 81000 By Bal. C/d 8100 (i) 65,610 (ii) 7290 81000 81000 Year To Bal. B/d Year By Dep. IV (i) 65610 72900 IV (i) 6561 7290 (ii) 7290 (ii) 729 By Bal. C/d (i) 59049 65610 (ii) 6561 72900 72900 Year To Bal. B/d Year By Bank 2000 V (i) 59049 V By P & L A/c 4561 (ii) 6561 65610 (6561-2000) By Dep. 5905 By Bal. C/d 53144 Year To bal B/d 53144 VI Cr. 65610 65610 167
Q. What do you mean by Final Accounts? What is their Necessity? Ans. Final Accounts : Financial Statements refers to such statements which report the profitability and the financial position of the business at the end of accounting period. The term financial statements include the following:- (1) Trading Account (2) Profit and Loss Account. (3) Balance Sheet (1) Trading Account : Trading account is prepared for calculating the gross profit or gross loss arising or incurred as a result of the trading activities of a business. In other words, it is prepared to show the result of manufacturing, buying and selling of goods. Need and Importance of Trading Account : (i) It provides information about Gross Profit and Gross Loss. (ii) It provides information about the direct expenses. (iii) Comparison of closing stock with those of the previous years. (iv) It provides safety against possible losses. Dr. Format of a Trading Account: Trading Account (for the year ending ) Particulars` Amount Particulars Amount To Opening Stock To Purchases Less : Purchase Reture OR Return Outward To Wages To Wages & Salaries To Direct Expenses To Carriage or To Carriage Inwards or To Carriage on Purchase To Gas, Fuel and Power To Freight, Octroi and Cartage To Manufacturing Expenses or Productive Expenses. To Factory Expense, Such as Factory Lighting, Factor Rent Etc. To Dock Charges To Import duty or Custom Duty To Royalty To Gross Profit Transferred to P & L A/c (Balancing Figure) Rs. By Sales Loss Sales Return OR Returns In wards By Closing Stock By Gross Loss (if any) Transferred to P & L A/c (Balancing Figure) Cr. Rs. 168
(2) Profit & Loss Account : Trading account only disclose the gross profit earned as a result of buying and selling of goods. However, a businessman has to incurr a number of expenses which are not taken into trading account. Hence a businessman is more interested in knowing the net profit earned or net loss incurred during the year. A profit and loss account is an account into which all gains and losses are collected, in order to ascertain the excess of gains over the losses or viceversa. Need and Importance of Profit & Loss Account : (i) To Ascertain the Net Profit & Net Loss (ii) Comparison with previous year s profit. (iii) Control on Expenses (iv) Helpful in preparation of the balance Sheet Format of Profit And Loss Account : Profit And Loss A/c ( for the year ending ) Particulars` Amount Particulars Amount To Gross Profit B/d (transferred from trading A/c) To Office Expenses : To Salaries To Salaries & Wages To Rent, Rate and Taxes To Printing & Staionery To Lighting To Telephone Charges To Audit Fees etc. To Selling & Distribution Expense: To Carriage outward or Carriage on sales To Advertisement To Commission To Bed-Debts To Export Duty To Parcking Exp etc. To Miscellaneous Expenses : To Discount/Discount Allowed To Repairs To Depreciation To Interest To Bank Charges etc. To Net Profit (Transferred to Capital A/c) Rs. By Gross Prfit B/d (Transferred from trading A/c) By Rent form tenant By Discount Received By Commission Received By Any Other Income By Net Loss (if any) Transferred to Capital A/c Rs. 169