SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
1 CHAPTER – 1 ACCOUNTING
A systematic record of the daily events of a business leading to presentation to financial picture is known as Accounting or in its elementary stages, stages, as Book keeping. Accounting organizes organizes and summarises economic economic information so that the decision-makers decision-makers can use it. The information is presented in reports called called financial statements. To prepare these statements, accountants accountants analyze, record, quantify, accumulate, accumulate, summarize, classify, report, and interpret economic events and their financial effects on the organization. The series of steps involved in initially recording information and converting it into financial statements is called the accounting system.
The financial picture mostly has two parts,
one showing how much profits has been earned or loss suffered, and other showing assets and liabilities and the proprietors interest in the firm. Even
institution which do not have the earning of profit as an objective must know periodically whether the current income is sufficient to meet the current expenditure and what the financial state of affairs. The American Institute of Certified Public accountants has defined Accounting as:“The art of recording, classifying and summarizing in a significant manner and in term of money transactions and events which are, in part at least, of a financial character, and the interpreting the result thereof.”
ACCOUNTANCY, ACCOUNTING AND BOOK-KEEPING ACCOUNTANCY
Accountancy refers to a systematic knowledge of accounting. It explains explains ‘why to do’ and ‘how to do’ of various aspect of accounting. It tells us why and how to prepare the books of accounts and how to summarize the accounting information and to communicate it to the interested parties.
ACCOUNTING
BOOK-KEEPING
Accounting refers to the actual process of preparing and presenting the accounts. It is the art of putting the academic knowledge of accountancy accountancy into practice. It covers the following activities:(i) Identifying the transactions and event. (ii) Measurin ring the identified transactions and events in common measuring unit. (iii (iii)) Reco ecordin rdingg the the id identif ntifie iedd and measured transactions and events in Journal. (iv) (iv) Clas lassify sifyin ingg the the rec record orded transactions and events in ledger. (v) Summarizing the classified transactions and events in the
Book-keeping is a part of accounting and is concerned with record keeping or maintenance of books of accounting, which is often routine and clerical in nature. It only covers the following four activities: (i) Identifying the transactions and events. (ii) Measurin ring the identified transactions and events in a common measuring unit. (iii (iii)) Reco ecordin rdingg the the ide identif ntifie iedd and measured transactions and events in Proper Books Accounts. (iv) (iv) Cla Classif ssifyying ing the the rec recorde rded transactions and events in ledger.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
form of Income Statement and Position Statement. (vi) (vi) Ana Analys lysing ing the the summ summar ariz izeed results. (vii (vii)) Inte Interp rpre reti ting ng the the anal analys ysed ed results. (vii (viii) i) Comm Commun unic icat atin ingg the the interpreted information to the interested parties. ACCOUNTING CYCLE
An accounting cycle is a complete sequence beginning with the recording of the transactions and ending with the preparation of the final accounts.
SEQUENTIAL STEPS INVOLVED IN AN ACCOUNTING CYCLE: (1) (1) Jour Journa nali lisi sing ng::- Record the transactions in Journal book. (2) Posti ostin ng: - Transfer the transactions recorded in journal, in the respective accounts opened in the ledger. (3) (3) Bala Balanc ncin ing: g:-- Ascertain the difference between the total of debit amount column and the total of credit (4) (4) (5) (6)
amount column of a ledger account. Tria Tr iall Bal Balan ance ce::- Prepare a list showing the balances of each and every account to verify whether the sum of the debit balances is equal to the sum of the credit balances. Income Income Statem Statement ent::- Prepare Trading and Profit and Loss Account to ascertain the profit or loss for the accounting period. Position Position Statemen Statementt (Balanc (Balancee She Sheet): et):-- Prepare the Balance sheet to ascertain the financial position as at the end of the accounting period.
OBJECTIVES OF ACCOUNTING
(i) (ii) (ii) (iii (iii)) (iv) (iv)
To ma maintain ac accounting re records. To calc calcul ulat atee the the resu result ltss of of ope opera rati tion ons. s. To asc ascer erta tain in the the fin finan anci cial al pos posit itio ion. n. To comm commun unic icat atee the the info inform rmat atio ionn to to the the user users. s.
ADVANTAGES OF ACCOUNTING
(1) (1) (2) (2) (3) (3) (4) (4) (5) (5) (6) (7) (7) (8) (8) ⇒ ⇒ ⇒ ⇒
Faci Facili litie tiess to asce ascert rtai ainn net net resu result lt of oper operat atio ions ns.. Faci Facili liti ties es to asce ascert rtai ainn fina financ ncia iall posi positi tion on.. Faci Facili liti ties es the the user userss to take take deci decisi sion ons. s. Faci Facili liti ties es to com compl plyy with with leg legal al requ requir irem emen ents ts.. Faci Facili liti ties es the the set settl tlem emen entt of of tax tax liab liabil ilit ity. y. Assist Assistss the mana managem gement ent in plan plannin ningg and cont control rollin lingg busine business ss activ activiti ities es and and in takin takingg decisi decisions ons.. Faci Facili litie tiess the the asce ascert rtai ainm nmen entt of of val value ue of busi busine ness ss.. Fac Facilit ilitaates tes a compa ompara rati tivve stud study. y.
Limitations of Accounting:
Ignores the qualitative elements. Not free from bias. Estimated position and not real position. Ignore the price level changes in case of financial statement prepared on historical cost.
SPECTRUM STUDY CIRCLE +
⇒
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Danger of window dressing. 3
QUALITATIVE CHARACTERISTICS CHARACTERISTICS OF FINANCIAL STATEMENTS
However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision making needs of user should not be excluded merely on the grounds that it may be too difficult for certain users to understand. financial statement must be relevant to the decision2) Relevance:- To be useful, information given in financial making needs of users. Any materials fact or figure figure should not be omitted. omitted. relevance of information is affected by by its materiality. Its provides a cut-off point point 3) Materialit lity:- The relevance rather than being a primary qualitative characteristics which information must have if it is to be useful. Information is material if its omission of misstatement could be influence the economic decision of the users taken on the basis of the financial financial statements. Materiality depends on the size of the item or error judged in particular particular circumstances of its omission or misstatements. misstatements. information must also be reliable. reliable. Information has the quality quality of reliability 4) Reliability:- To be useful, information when it is free from material material error and bias. If there is fraud or misrepresentation, misrepresentation, the statement statement will not be reliable. 5) Fait Faithf hful ul Repr Repres esen enta tati tion on:: - to be reliable, information must represent faithfully the transaction and other events it either purports to represent or could be reasonably be expected to represent. 6) Su Subs bsta tanc ncee ove overr for form: m:- If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic economic reality and not their legal form. 7) Neutrality:- To be reliable, the information contained in the financial statements must be neutral, that is, free from bias. 8) Prudence:- Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such assets or income are not overstated and liabilities or expenses are not understated. understated. However, the exercise of prudence prudence does not allow, the creation of hidden reserves or excessive excessive provisions, the delib deliberate erate overstatement of liabilities or expenses, because because the financial statements would not be neutral and, therefore, not have the quality of reliability. 9) Completeness:- To be reliable, the information in financial statements must be complete within the bounds of materiality and cost. An omission can cause information information to be false or misleading and thus unreliable and deficient in the term of its relevance. 10) Compar Comparabi abilit lity: y:- The information provided by the financial statements is compared by the management management for decision making. Therefore, uniform accounting methods and policies should be followed from year to year. 1)
Unde Unders rsta tand ndab abil ilit ity: y:-- Financial Statements Statements must be readily understandable understandable by users. users.
Role of Accounts in Society:
The profession of accountant accountant is an instrument of socio-economic socio-economic change and welfare of the society. The modern accountancy accountancy is not like the old book-keeper. He is now expected to perform multifarious duties and and play a great role than he supposed to play play earlier. His area of operation now cover such fields fields as productively, taxation, trade and and industry, law and integrated information system. system. They can also act in the fields relating to financial policies, budgetary budgetary policies and even economic economic principles. At present there are not only financial accountants but highly specialized ones such as Chartered Accountants, Cost Accountants, management Accountants Accountants and other specialist accountants who prepare special reports on the various aspect
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
of expansion and new developments of the enterprise. The services rendered by them to the society include the following: 4 (i) (i) To main mainta tain in the the boo booss of of acc accou ount ntss in in a syst system emat atic ic mann manner er.. (ii) To ac act as as St Statutory Au Auditor. (iii (iii)) To act act as an Int Inteerna rnal Au Audito ditor. r. (iv) (iv) To act as Taxa axation tion Adv Advisor isor.. (v) To act as Financial Ad Advisor. (vi) (vi) To act act as Comp Compaany Law Ad Adviso visor. r. (vii (vii)) To act act as as Man Manag agem emen entt Con Consu sult ltan ants ts.. (viii) (viii) To act act as Liq Liquid uidato ator, r, Arbitr Arbitrato atorr and Receiv Receiver. er. (ix) (ix) To act act as as Mana Manage geme ment nt info inform rmat atio ionn Syst System em Con Consu sult ltan ants ts.. BRANCHES OF ACCOUNTING ⇒ Financial Accounting:- The purpose of this branch of accounting is to keep systematic record to
⇒ ⇒
⇒
ascertain financial performance and financial position and to communicate the accounting information to the interested parties. Cost Accounting:- The purpose of this branch of accounting is to ascertain the cost, to control the cost and communicate information for decision making. Management Accounting:- The purpose of this branch of accounting is to supply any and all information that management may need in taking decision and to evaluate the impact of its decisions and actions. Social Responsibility Accounting:Accounting:- It is accounting for social responsibility aspect of a business. Management is held responsible for what it contributes to the social well being and progress. USERS OF ACCOUNTING DATA
Besides the people of the concerned firm or institution, there are various other parties interested in the financial statement who must make decisions that have economic consequences. Such decision makers include:(i) Shareholder (vi) Suppliers and other trade creditors (ii) Investors (vii) Employees. (iii) Management (viii) Government and their agencies (iv) Lenders (ix) Researcher (v) Customers For example: An investor considering buying stock in either General Motors Ltd. or Volvo Ltd., would consult published accounting accounting reports to compare the most recent financial financial results of the companies. The information in the reports helps the buyer to decide which company would be the better investment choice. A lender considering a loan to a company that want to expand would examine the historical performance of the company and projections the company provided about how the borrowed funds are to be used to produce new business.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Accounting helps decision making by showing where and when money has been spent and commitments have been made, but evaluating performance, and by indicating the financial implications of choosing one plan instead of another. Accounting also helps helps predict the future effects of decisions, and it helps direct direct attention to current problems, imperfection and in inefficiencies, as well as opportunities. 5
FUNCTIONS OF ACCOUNTING DATA
The main functions of Accounting Data are as follows:a) Measu Measure remen mentt of past past per perfor forman mance ce of the entity and depicting its current financial position. b) Fore orecasti astin ng:g:- On the basis of past date we may forecast future performance as financial position of the entity. c) Dec Decisio isionn-M Making king::- Accounting data provides relevant information to the users of accounts to aid decision-making. d) Evaluation:- Assessing performance achieved achieved in relation to target. e) Control:- On the basis of accounting data we can identify weaknesses of the operational system and feed back the effectiveness of measures adopted to check such weaknesses. f) Stewardship:- Accounting for the users of owner’s fund where in the management and owners are separated. g) Govern Governmen mentt Regul Regulati ation on and Taxati Taxation: on:-- Accounting data provides necessary information for government to exercise control on the entity as well as collection for tax revenues.
Relationship of accounting with some other discipline: (a) Accounti Accounting ng and Econo Economics: mics:
Economics is viewed as a science of rational decision making about the efficient use of scarce resources. This many be viewed either either from the relative importance of situations or facts of a single firm or of the country as a whole. Account is viewed as a system, which provide data to the users to permit informed judgment and decisions. It contributed a lot in improving the management management decision making process. But, economic theories influenced the development of the decision making tools used in accounting. At the macro level:-
Accounting provides the data base over which the economic decision models have been developed; micro level data arranged by the accounting accounting system is summed up to get macro level data base. base. (b) Accounti Accounting ng and Statistic Statistics: s:
Accounting records generally generally take a short-term view of events and are confined to a year while statistical analysis is more useful if a longer view is taken for the purpose. purpose. For example, to fit the trend line a longer period will be required. However, statistical method does use past accounting record maintained on a consistent basis. In account, all values are important individually because they relate to business transactions, transactions, while statistics is concerned with the typical value, behaviour or trend over a period or the degree of variation over a series of observations. observations. Accounting records are based based on historical cost of permanent permanent assets, while the current assets are are automatically valued at the current value. value. However, when prices are not stable over a period of time, inflation accounting method are used which require the use of price indices or price deflator which are based based on statistical calculations of price changes. changes. In accounting, a number of financial and other ratios are based on statistical method and several financial calculations are based on statistical framework. fr amework.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Statistical methods are helpful in developing developing accounting data and their their interpretation. For example, time series and cross-sectional comparisons of accounting data is based on statistical techniques, regression analysis of budget and standard cost variances and multiple discriminant analysis are popularly used to identify symptoms of sickness of business firm. Therefore, the study and application of statistical method would add extra edge to the accounting data. 6 (c) Accounti Accounting ng and and Mathema Mathematics: tics:
Knowledge of arithmetic and algebra is a prerequisite for accounting computations and measurements. Calculate of interest and annuity are the examples examples of such fundamental fundamental use. While computing depreciation, finding out instalment in hire purchase and instalment payment transactions, calculating amount to be set aside for repayment of loan and replacement of assets and setting lease rentals, mathematical techniques techniques are frequently used. Accounting data are also presented presented in ratio form. With the advent of the computer, mathematics mathematics is becoming vital part of accounting. accounting. Instead of writing accounts in traditional form, transactions and events can be recorded in the matrix from and the rules of matrix algebra can be applied for classifying and summarizing data. Understanding mathematics mathematics has become a must to grasp the decision models framed by the statisticians, economists and the O.R. experts. experts. In addition to statistical knowledge, knowledge knowledge in geometry and trigonometry seams to be essential to have a better understanding about the accounting communications system. (d) Accounti Accounting ng and and Law: Law:
Since, the various transactions of business professions are governed by various law, the knwoeldge of some important provision of various law is essential for recording r ecording the transactions in accounting record. All transaction with suppliers and customers customers are governed by the Contact Contact Act, the Sale of Goods Act, and the Negotiable Instrument Act etc. The entity itself is created by law. For example, partnership business are controlled controlled by Partnership Act. A company is created and controlled controlled by Companies Act. Similarly, every country country has a set of economics, fiscal and and labour laws. Banking Insurance and electricity company also have to produce financial statement as prescribed by the respective legislation’s controlled controlled such entities. In that way accounting influences influences law and are also influenced by law.
(e) Accounti Accounting ng and and Managem Management: ent:
Management is broad occupational field, which comprises many functions and application of many disciplines. Accountants are well placed placed in the management and play a key role in the management management team. A large number of accounting information information is prepared for management decision decision making. Although management management relies on the other data sources also. Accounting data are used used as basic source document. document. In the management management team an accountant is in a better position to understand understand and use such data. Accounting is an essential essential service function of management. management.
MEASUREMENT BASE:
There are fount accepted accepted measurement measurement bases. These are the following:following:1. Hist Histor oric ical al Cos Cost: t:-- According to this base: The assets are recorded at an amount of cash or cash equivalents paid or the fair value of consideration given at the time of acquisition. Liabilities are recorded at the amount of the proceeds received in exchange for the obligation.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
In Some circumstances a liabilities
2. Curr Curren entt Cost Cost::- Under current cost measurement base:
3.
Assets are carried at the amount cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would required to be settle the obligation currently. 7 Real Realis isab able le val value ue ::- As per realisable value:Assets are carried at the amount of cash or equivalents that could currently be obtained by selling the assets in an orderly disposal Liabilities are carried at their settlement values; i.e. the undiscounted amounts amounts of cash or cash equivalents expressed to be paid to satisfy the liabilities in the normal course of business.
4. Pres Presen entt Val Value ue::- As per present value:
An asset is carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of further net cash outflows that are expected to be required to settle the liabilities in the normal course of business.
ACCOUNTING CONCEPT
(i) (ii) ii)
Business entity concept:- Treat a business as distinct from the person who owns it. Money ney mea measurem uremen entt conc oncept: pt:- Accounting records only those transactions, which are expressed in
The following are the accounting concepts: concepts: (i) Business en entity co concept. (ii) Money me measurem rement co concept (iii) Cost concept (iv) Going concern concept (v) Dual aspect concept (vi) Realization concept. (vii) Accrua rual co concept.
(iii) (iv) iv) (v)
monetary term.
Cost Co Concept:- Transactions is entered in the books of account at the amount actually involved. Going oing concer ncern n Con Concept cept::- It is assumed that business will exist for a long time and transactions are
recorded from that point of view. Dual Aspect concept:- Each transaction has two aspects; if a business has acquired assets, it must have resulted in one of the following:(a) Some other other assets assets have have been been given up. up. (b) The obligati obligation on to pay for it has arisen; arisen; or rather, rather, (c) There has been been a profit, leading to an an increase in the amount amount that the business business owes to the proprietors, or (d) The proprietor has has contributed money for the the acquisition of of assets. ACCOUNTING EQUATIONS
ASSETS = Liabilities + Capital
or
CAPITAL = As Asset – Liabilities
SPECTRUM STUDY CIRCLE +
(vi)
(vii) vii)
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Realization Co Concept:- Accounting is a historical record of transactions; it records what has
happened. It does not anticipated events though though anticipated adverse effects effects of events that have already occurred are usually recorded. This concept stops the business firms form inflating their profits by recording sales and income that are likely to accrue. Unless the money has been been realized – either cash has been been received or a legal obligation to pay has been assumed by the customers – no sale can be said to have taken place and no profit or income can be said to have arisen. 8 Acc Accrual ual Conce oncept pt::- If an event has occurred or a transaction tr ansaction has been interred into, its consequences consequences will follow. Normally, all transactions are settled in cash cash but even if cash settlement has not taken place, it is proper to bring the transaction or the event concerned in to the books. FUNDAMENTAL ACCOUNTING ASSUMPTION
The following are the fundamental accounting accounting assumptions:(a) Going Concern: Concern:-- The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations. (b) Consistency:- It is assumed that accounting policies are consistent from one period to another. A change in an accounting accounting policy is made only in certain exceptional exceptional circumstances. (c) (c) Accr Accrua ual: l:-- Revenue and costs are accrued, i.e., recognized as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the period to which they relate. ACCOUNTING CONVENTIONS REGARDING FINANCIAL STATEMENTS
In order to make the information contained in the financial f inancial statements clear and meaningful, these are drawn up according to the following convention:accounting practices should remain the same from one year year to another. If a (i) Consistency:- The accounting change become necessary, necessary, the change and its it s effects should be stated clearly. (ii) (ii) Disclo Disclosur sure: e: Apart Apart from from lega legall requir requireme ements nts good good accoun accountin tingg practi practices ces also also dem demand and that that all all significant information should be disclosed. (iii) Conservatism: Financial Statements are usually usually drawn up on rather a conservation conservation basis. Windowdressing i.e. showing a position better than what is not permitted. It is also not proper to show a position substantially worse than than what it is. In other words secret reserve are not permitted. permitted. Question: Elucidate “accounting convention of conservatism”. conservatism”. Ans.: ‘Conserva ‘Conservatism tism conventio convention’ n’ states that that the accountants accountants should should not anticipate anticipate income income and should should provide for all possible losses. The underlying principle is that revenues revenues should only be recognized recognized when there is reasonable certainly certainly about their realization. At the same time television must be made for all possible liabilities, whether the amount is known with certainly or is based on lesser value must be selected. To illustrate, inventories are recorded at the cost or market value whichever is less or if there a possibility that a debt may not be realized, a specific amount is charged against profits as a provision for doubtful debts.
ACCOUNTING POLICIES
The accounting policy refer to specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial f inancial statements.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
There is no single list of accounting policies, which is applicable to all enterprise in all circumstances. The choice of the appropriate appropriate accounting principles in specific specific circumstances of each enterprise calls for considerable judgment by the management of the enterprise. The area where in different accounting policies are frequently encountered:encountered:-
(1) Method of depreciation, depletion and amortization; amortization; (2) Treatment of expenditure expenditure during construction; (3) Conversion or translation of of foreign currency currency items; items; (4) Valuable Valuable of invento inventories; ries; (5) Treatment Treatment of Goodwi Goodwill; ll; (6) Valuation Valuation of inves investmen tments; ts; (7) Treatment Treatment of retiremen retirementt benefits; benefits; (8) Recogniti Recognition on of profit on long term contracts contracts;; (9) Valuation Valuation of fixed fixed assets assets;; (10)Treatment of contingent liabilities.
CONSIDERATION IN THE SELECTION OF ACCOUNTING POLICIES:
Disclosure of Accounting Policy:
9
The primary consideration in selection of Accounting Policies by an enterprise is that the financial statement is prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as the Balance Sheet date and of the profit or loss for the period ended on that date. The major considerations governing the selection and application of accounting policies are the following:(a) Prudence:- In view of uncertainty attached to future events, profits are not anticipated but recognized only when realised realised through not necessarily necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represent only a best estimate in the light available information. (b) Substance over form:- The accounting treatment and presentation in financial statements of transactions and events events should be governed by their their substance and not merely by the legal legal form. For example: (i) Where Where righ rights ts and and inte interes restt in a prop propert ertyy stand standss trans transfer ferred red while while legal legal docu documen mentat tation ion for the transfer is yet to be completed, the transaction should be recorded as a sale in the books of transferor and acquisition in the books of transferee. (c) Materiality: - Financial statement should disclose all “ material” items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements.
(a) All significant accounting accounting policies adopted in preparation and and presentations presentations of financial statement should be disclosed. (b) The disclosure of the the significant accounting accounting policies as such such should form a part part of the financial statements and the significant accounting policies should normally be disclosed in one place. Change in Accounting Policies:
The change in Accounting Policy is recommended only in the following circumstances: (i) (i) If itit is req requi uire redd by stat statut utee for for comp compli lian ance ce wit withh an acco accoun unti ting ng sta stand ndar ard. d. (ii) (ii) If it is consid considere eredd that that the chan change ge would would result result in in a more more appro appropri priate ate pres presen entat tation ion of of the financial statements of an enterprise.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Disclosure in case of change in accounting policy: Case
(i) (i)
If change ange has has a mate materi rial al effe ffect in in cu curre rrent period and the effect of change is ascertainable. (ii) (ii) If chan change ge has has a mate materi rial al effe effect ct in curr curren entt period and the effect of change in not ascertainable, ascertainable, wholly or in part. (iii) (iii) If cha chang ngee has has no mate materia riall effe effect ct in curre current nt period but which is reasonably expected to have a material effect in later period.
Disclosure Requirement
(i)
The am amount of of ch change sh should be be disclosed . The fact should should disclosed. disclosed.
(ii) (ii)
The fac fact of of su such change nge shou should ld be appropriately disclosed.
SYSTEM FOR RECORDING THE TRANSACTIONS:
There are two systems for recording the transactions: (i) Single Entry System. (ii) Double En Entry Sy System.
DOUBLE ENTRY SYSTEM
CASH AND MERCANTILE SYSTEM OF ACCOUNTING: Cash system:- In this system, entries are made only when cash is received or paid, no entry being
The Double Entry system of accounting accounting is the only real system of accounting. accounting. This system recognizes recognizes that every transaction is a double-sided double-sided affair. If one receives something then either either a) some some othe otherr pers person on has has giv given en it, it, or or b) Stock Stock of of somet somethin hingg else else has has dimin diminish ished, ed, or c) Some Some serv servic icee has has been been rend render ered ed.. Is one losses something in the sense that either cash (or its equivalent) has to be given up (or is irretrievable lost), then a corresponding benefit benefit must have been received. received. For good and accurate results results a transaction should be recorded in both aspects. Advantages of double entry system: (i) The accur accuracy acy of the the acc accoun ountin tingg work work can can be be ensur ensured, ed, throug throughh the the devic devices es of of the the trial trial bala balance nces. s. (ii) (ii) The prof profit it earne earnedd or loss loss suff suffere eredd durin duringg a perio periodd can can be asce ascerta rtaine inedd togeth together er with with detai details. ls. (iii) The finan financial cial posit position ion of of the firm or or instituti institution on conce concerned rned can be ascer ascertaine tainedd at the the end end of of each each period through preparation of the balance sheet. (iv) The system system permits permits accounts accounts to be kept in as much details details as necessa necessary ry and and therefore therefore afford significant information for the purpose of control etc. (v) Result Result of of one year year may be be compa compared red with with thos thosee of the the previo previous us year yearss and and reason reasonss for the the chan change ge may be ascertained. ascertained.
made when payment payment or receipt. The mercantile system is better better normally since it takes into account the amounts that become due. Mercantile / Accrual system:- Under this system, a record is made on the basis of amounts having become due for payment payment or receipt. The mercantile system is better better normally since it takes into account the amounts the become due.
Distinguish between Accrual Basis of Accounting and Cash Basis of Accounting: Accrual Basis Cash Basis
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
(i) (i)
Unde Underr th this syst systeem, the there re may may be be pre prepa paid id / (i) Under th this, there is no prepaid / outstanding expenses and accrued / outstanding expenses or accrued / unaccrued unaccrued income in the balance sheet. income. (ii) (ii) Inco Income me Stat Statem emen entt wil willl sho show w a rela relati tive vely ly higher income in case of prepaid expenses (ii) (ii) Inc Income ome sta state teme mennt wil willl sh show lo lower wer and accrued income. income. (iii) (iii) Inco Income me stat statem emen entt wil willl sho show w a rela relati tive vely ly lower income in case of outstanding expenses and unaccrued income . (iii (iii)) Inco Income me stat statem emen entt wil willl sho show w hig highe her r (iv) (iv) Th Thee basi basiss is is reco recogn gniz ized ed unde underr the the income. Companies Act. 1956. (iv) (iv) Th Thee bas basis is is not not reco recogn gniz ized ed unde underr the the Companies Act.1956.
a)
b)
c)
The Elements of Financial Statements:
The elements directly related to the measurement of financial position are assets, liabilities and equity. These are are defined as follows:An Assets is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. These assets may be classified as follows:(i) Current Assets (ii) Fixed As Assets: (a) Tangible Tangible fixed assets assets (b) Intangible Intangible fixed fixed assets. assets. A Liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise or resources embodying embodying economic benefits. benefits. Liabilities may be broadly classified as follows: (a) curren currentt Liabil Liabiliti ities es (b) Long-Term Long-Term Liabilitie Liabilitiess Equity is the residual interest in our remaining claim against the assets of the enterprise after deducting all its liabilities. When the business is first started, the owner’s owner’s equity is measured the total amount invested by the owners. Owners’ equity = Assets – Liabilities The rule for writing up accounts of various types are as follows: Assets: Increase on the left hand or the debit side and decrease on the right hand or credit side. Ex.: When cash is received, cash account should be debited and when it is paid, the account
should be credited. Liabilities: Increase on the credit side and decrease on the debit side. Capital: Increase on the credit side and decrease on the debit side. Expenses: Increase on the debit side and decrease on the credit side. Income or Gains: Increase on the credit side and decrease on the debit side.
IMPORTANT TERMS USED IN FINANCIAL STATEMENTS S.No.
Terms
Definitions
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
1.
Accrual
2.
Accrual Ba Basis of of Ac Accounting
3.
Accrued Assets
4.
Accrued Expenses
5.
Accrued Liability
6.
Accrued Revenue
7.
Accu Accumu mula late tedd Depr Deprec ecia iati tion on
8.
Advance
9.
Amortisation
10.
Appropriation Account
Recognition of revenues and costs as they are earned or incurred (and not not as money money is received received or paid). It includes recognition of transactions relating to assets and liabilities as they occur irrespective of the actual receipts or payments. The me method of of re recording th the trtransactions by by wh which revenues, cost, assets and liabilities are reflected in the accounts in the period in which they accrue. A developing but not yet enforceable claim against another person which accumulates with the passage of time or the rendering rendering of service service or otherwise. It may arise from the rendering of services (including the use of money) which at the date of accounting have been only partly performed, and yet are not billable. An expenses which has been incurred in an accounting period but for which no enforceable claim has become due in that period against the enterprise. It may also from the purchase of services which at the date of accounting have been partly performed, and are not yet billable. A developing but not yet enforceable claim by another person which accumulates with the passage of time or the receipt of service or otherwise. It may arise from the purchase of services services which at the date of accounting accounting have been only partly performed, and are not yet billable. Revenue which has been earned in an accounting period but in respect of which no enforceable claim has become due in that period by the enterprise. It may arise from the rendering of services which at the date of accounting have been partly performed, and are not yet billable. Is the the cumu cumula lati tive ve sum sum of all all depr deprec ecia iati tion on reco recogn gnis ised ed since the date of acquisition of the particulars assets described. Payment made on account of, but before completion of, a contract, or before acquisition of goods or receipt of services. The gradual and systematic writing off of an assets or an account over over an appropriate appropriate period. The amount amount on which amortisation is provided is referred to as amortizable amount. amount. Amortisation also refers to gradual gradual extinction or provision for extinction of a debt by gradual redemption or sinking fund payments or the gradual writing off to revenue of miscellaneous expenditure carried forward, e.g., share issue expenses, preliminary expenses, etc. An account sometimes included as a separate section of the profit and loss statement showing application of
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
11.
Assets
12.
Bad Debts
13.
Book Value
14
Capi Capita tall
15
Capital Assets
16
Capital Employed
17
Capit apitaal Pro Profi fitt and and Cap Capital ital Loss oss
18
Capital Reserve
19
Capital Wo Work in Progress
20
Cash Ba Basis of Ac Accounting
21
Cash Discount
22
Cash Profit
23
Security
24
Contingent Assets
profits towards dividends, reserves, etc. Assets are economic resources that are expected to help generate future cash in flow or reduce or prevent future cash outflows. Example are cash, cash, inventories, equipment equipment etc. Debts owed to an enterprise which are considered to be an irrecoverable. The amount at which an item appears in the books of an account or financial financial statements. It does not refer to any any particular basis on which the amount is determined e.g., cost, replacement value, etc. Gene Genera rall llyy refe refers rs to the the amou amount nt inve invest sted ed in an ente enterp rpri rise se by its owners e.g. paid up share capital in a corporate enterprise. It is also used to refer to the interest of owners in the assets of an enterprise. Assets, including investments not held for sale, conversion or consumption in the ordinary course of business. The finances deployed by an enterprise in its net fixed assets, investments and working capital. Capital employed in an operation may, however, exclude investments made outside that operation. Exccess Ex ess of of pro proce ceeeds rea realise lisedd fro from m th the sal salee, tra trannsfe sfer, or exchange of the whole or a part of a capital assets over its cost. When the result of of this computation is negative, negative, it is referred to as capital loss. A reserve of a corporate enterprise which is not available for distribution. Expenditure on capital assets which are in the process of construction or completion. The me method of of re recording transactions by by which re revenues and costs and assets and liabilities are reflected in the accounts in the period in which actual receipts or actual payments are made. A reduction granted by a supplier from the invoiced price in consideration of immediate payment within a stipulated period The net profit as increased by non-cash costs, such as depreciation, amotisation, etc when the result of the computation is negative, it is termed as cash loss. Security which is given in addition to the principal against the same liability or obligation. obligation. An assets the existence, ownership or value of which may be known or determined only on the occurance or nonoccurance of one or more uncertain future events.
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
25
Contingent Liabilities
26
Cost of purchase
27
Cost of goods sold
28
Cost of Sales
29
Conversion cost
30
Current Assets
31
Current Liability
32
Defferal
33
Deferred expenditure
34
Deferred Revenue
35
Defi Defici cien ency cy
An obligation relating to an existing condition or situation which may arise in future depending on the occurance or non-occurance of one or more uncertain future events. The purchase price including duties and taxes, freight inward and other expenditure directly attributable to acquisition, less trade discounts, rebates duty drawbacks, and subsidies in respect of such purchase. The cost of goods and sold during an accounting period. In manufacturing operation, it includes (a) cost of material (b) labour and factory over heads; selling and administrative expenses are normally excluded. The cost of goods sold plus selling and administrative expenses. Cost incurred to convert raw materials or components into finished or semi-finished semi-finished products. products. This normally includes costs which are specifically attributable to units of production, i.e., direct labour, direct expenses and sub contracted work, and production overheads as applicable in accordance with either the direct costing or absorption costing method. Production overheads overheads exclude expenses expenses which relate to general administration, finance, selling and distribution. Cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business. Liability including loans, deposits and bank overdraft which fall due for payment in a relatively short period, normally not more than twelve months. Postponement of recognition of a revenue or expense after its related receipt or payment (or incurrence of a liability) to a subsequent period to which it applies. Common examples of deferrals include pre-paid rent and taxes, unearned subscriptions received in advance by newspaper and magazine selling companies, etc. Expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods. periods. This is also referred to as deferred revenue expenditure. expe nditure. Revenue or income received or recorded before it is earned and carried forward to a subsequent period or periods to which it relates. Thee exce Th excess ss of liab liabil ilit itie iess over over asse assets ts of an ente enterp rpri rise se at a given date. The debit balance balance in the profit and loss statement.
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
36
Depreciable amount
37
Depreciable asset
38
Depr Deprec ecia iati tion on
39
Depreciation Method
40
Depreciation Rate
41
Dimi Dimini nish shin ingg Bala Balanc ncee Meth Method od
42
Direct Cost
43
Direct costing
44
Discount
45
Expenditure
46
Expense
47
Expired Cost
48
Ordinary Item
The historical cost, or other amount subsituated for historical cost of a depreciable asset in the financial statements, less the estimated residual value. Asset which is expected to be used during more than one accounting period, has a limited useful life, and is held by an enterprise for use in production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business. A meas measur uree of the the wear wearin ingg out, out, cons consum umpt ptio ionn or othe otherr loss loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. It is allocated so as to charge a fair proportion proportion in each accounting period during the useful life of the asset. It includes amortisation of asset whose useful life is predetermined and and depletion of wasting assets. assets. Any method of calculating deprecation for an accounting period. A percentage applied to the historical cost or the substituted amount of a depreciable asset (or in case of diminishing balance method, the historical cost or the substituted amount less accumulated deprecation.) A meth method od unde underr whic whichh the the peri period odic ic char charge ge for for depreciation of an asset is computed by applying a fixed percentage to its historical cost cost or substituted substituted amount less accumulated accumulated depreciation (net book book value). This is also referred to as written down value method. An item of cost that can be reasonable identified with a specific unit of product or with a specific operation or other cost centre. A method whereby the cost is determined so as to include the appropriate share of variable costs only, all fixed costs being charged against revenue in the period in which they are incurred. A reduction from the list price, quoted price or invoiced price. It also refers to the price for obtaining payment on a bill before its maturity. Incurring a liability, disbursement of cash or transfer of property for the purpose of obtaining assets, goods or services. A cost relating to the operations of an accounting period or to the revenue earned during the period or the benefit of which do not extend beyond the period. The proportion of an expenditure from which no further benefit is expected. expected. Also termed as as expense. expense. Gain or loss which arises from events or transactions that
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
49
Fair Market Value
50
Fictitious Asset
51
Fixed asset
52
Fixed cost
53
Free Reserve
54
Franchises and Licenses:
55
Gain
56
Reserve
57
Goodwill
58
Intangible Asset
59
Investment
60
Investments
are distinct from ordinary activities of the enterprise and which are both material and expected not to recur frequently or regularly. This would also include material adjustment necessitated by circumstances, which, though related to previous periods, are determined in the current period. The price that would be agreed to in an open and unrestricted market between knowledge and wiling parties dealing at arm’s length who are fully informed and not under any any compulsion to transact. transact. Arm’s length is a term applied to any transaction on the assumption that the parties to the transactions would act without being influenced by each other or by any other person. Item grouped under assets in a balance sheet which has no real value (e.g. the debit balance of the profit and loss statement.) Asset held for the purpose of providing or producing goods or services and that is not held for resale r esale in the normal course of business. The cost of production which by its very nature remains relatively unaffected in a defined period of time by variations in the volume of production. A reserve the utilisation of which is not restricted in any manner. Franchises and licenses are legal co contract th that grant the buyer the right to sell a product product or service. service. An example is a local McDonald’s name, to acquire branded products such as cups and bags, and to share in advertising and special promotions. promotions. In exchange, exchange, the franchisee franchisee promise to follow McDonalds’s M cDonalds’s procedures procedures and maintain standards of quality, cleanliness, cleanliness, and pricing. pricing. The acquisition costs of franchises and licenses are amortized over their economic lives. A monitary benefit, profits or advantage resulting from a transition or group of transations. A revenue reserve which is not earmarked for a specific purpose. An intangible asset arising from business connections or trade name or reputation of an enterprise. Asset which does not have a physics identity e.g. Goodwill, Patents, Copyright etc. Expenditure on assets held to earn interest, income, profit, or other benefits. Assets held not for operational purposes or for rendering services i.e. assets other than fixed assets or current assets (e.g. securities, shares, debentures, immovable
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
61
Liab Liabil ilit itie iess
62
Lien
63
Long-term Liability
64
Materiality
65
Mortgage
66
Net Assets
67
Oper Operat atin ingg prof profit it
68
Oper Operat atin ingg cycl cyclee
69
Preliminary Expenses
70
Pre-paid Expenses
71
Prior Period Item
72
Provision
properties). The financial obligation of an enterprise other than owners funds. Liab Liabil ilit itie iess are are econ econom omic ic obli obliga gati tion onss of the the orga organi niza zati tion on to outsiders, or claim against against its assets by outsides. An example is debt to bank. Right of one person to satisfy a claim against another by holding or retaining retaining possession of of the other’s assets/property. assets/property. Liability which does not fall due for payment in a relatively short period, i.e., normally a period not more than twelve months. An accounting concept according to which all relatively important and relivant items, ie., items the knowledge of which might influenced the decisions of the user of the financial statements are disclosed in the financial statements. A transfer of interest in specific immovable property for the purpose of securing securing a loan advanced advanced or to be advanced, an existing or further debt or the performance of an engagement which may give rise to a pecuniary liability. The security security is redeemed redeemed when the loan is repaid or the debt discharged or the obligations performed. The excess of the book value of assets (other than fictitious assets) of an enterprise over its liabilities. liabilities. This is also referred to as net worth or shareholde’s funds. Thee net Th net prof profit it aris arisin ingg from from the the norm normal al oper operat atio ions ns and and activities of an enterprise without taking account of extraneous transactions and expenses of a purely financial nature. Thee time Th time span span duri during ng whic whichh cash cash is used used to acqu acquir iree good goodss and services, which cash is used to acquired goods and services, which in term are sold to customers, who is tern pay for their purchases with cash. Expenses relating to the formation of an enterprise. These include legal, accounting and share issued expenses incurred for formation of the enterprise. Payment for expense in an accounting period, the benefit for which will accrue in the subsequent accounting period(s). A material charge or credit which arises in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods. An amount written off or retained by way of providing for deprecation of diminution in value of assets or retained by way of providing for any known liability the
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
73
Provision for Doubtful ful De Debts
74
Reserve
75
Revenue
76
Sales turnover
77 78
Secured Loan Sinking Fund
79
Straight Line Method
80
Sundry Creditor
81
Sundry Debtor
82
Trade Discount
amount of which can’t be determined with substantial accuracy. A provision made for debts considered doubtful ful or or recovery. The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for deprecation or diminution in the value of assets or or for a known liability. The reserves are are primarily of two types: (a) capital reserves and (b) revenue reserves. The gross inflow of cash, receivables or other consideration arising arising in the course course of ordinary ordinary activities of an enterprise from the sales of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured measured by the charges charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources resources by them. It excludes amount amount collected on behalf of third parties such as certain taxes. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration. The aggregate for which sales are effected or services rendered by an enterprise. enterprise. The terms gross turnover turnover and net turnover (or gross sales and net sales) are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts. Loan secured wholly or partially against an asset. A fund created for the repayment of liability or for the replacement of an asset. The method under which the periodic charge for depreciation is computed by dividing the depreciable amount of a depreciable asset by the estimated number of years of its useful life. Amount owed by an enterprise on account of goods purchased or services received or in respect of contractual obligations. Also termed as Trade creditor or account payable. payable. Person from whom amounts are due for goods sold or services rendered or in respect r espect of contractual obligations. Also termed as debtor, trade debtor, or account receivable. The reduction granted by a supplier for the list price of goods or services on business considerations other than
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
83
Trade Mark
84
Transaction
85
Unexpired Cost
86
Variable Cost
87
Work-in-Progress
for prompt payment. Trademarks are distinctive identifications of a manufactured product or of service, taking the form of a name, a sign, a slogan, a logo, or an emblame. An example is an an emblem for Coco-Cola. Trademark, trade names, trade brands, secret formulas, and similar items are property rights with economic lives depending on their length of use. A transaction is any event that both affects the financial position of an entity and can reliably recorded in money terms. Each transaction has counterbalancing entries on the balance sheet so that the total assets always equal the total liabilities and owners’ equity. That portion of an expenditure whose benefit has not yet been exhausted. That cost which varies directly, or nearly directly, with the volume of activity. Work in process includes all materials which have undergone manufacturing or processing operations, but upon which further operations are necessary before the product is ready for sale.
CHAPTER – 2 JOURNALIZING, POSTING & BALANCING
TRADITIONAL CLASSIFICATION OF ACCOUNTS: a) Pers Person onal al Acco Accoun unts ts::- These accounts relate to natural persons, artificial
persons. (creditors, customers, customers, etc)
persons, and representative
b) Impers Impersona onall Accoun Accounts ts:: i) Real Accounts:- These accounts accounts relate to the tangible or intangible real assets.
(i.e. accounts
of properties and assets); and ii) Nominal Accounts:- These accounts relate to incomes, expenses or losses. RULES:- The following three are the basic rules for recording the transaction:1) Personal Personal Accoun Accounts:ts:- Debit Debit the receive receiverr and Credit Credit the giver. giver. 2) Real Accoun Accounts:ts:- Debit Debit what comes comes in and and credits credits what what goes out. out. 3) Nominal Nominal Accounts: Accounts:-- Debit all exp. exp. (and loses) loses) and credit credit all incomes incomes and gains. gains. The left hand side of an account is called the debit side and the right-hand side of an account is called credit side.
ACCOUNTING EQUATION BASED CLASSIFICATION:
1.
Assets Accounts
2.
Liabilitie Liabilitiess Account Accountss
These accounts accounts relate to tangible or intangible real assets. Eg. Land A/c, Building A/c, cash A/c, Patents, Goodwill, Trademark etc. These These accoun accounts ts relate relate to the financial financial obliga obligations tions of an enterprise enterprise towards towards outsiders. Eg Trade creditors, Bills Payable , Bank Overdraft, Loans, Outstanding
SPECTRUM STUDY CIRCLE +
3. 4.
Capi Capita tall Acco Accoun unts ts Reven Revenue ue Accou Accounts nts
5.
Expen Expenses ses Acco Account untss
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Exp. etc. Thes Th esee acc accou ount ntss rela relate te to to owne owners rs of of an ente enterp rpris rise. e. Eg Eg.. Capi Capita tall A/c, A/c, Draw Drawin ings gs A/c A/c.. These These acc accoun ounts ts relat relatee to the the amoun amountt charge chargedd for good goodss sold sold or serv service icess render rendered ed or permitting others to use enterprise’s resources yielding interest, royalty or dividend. Eg. Sales A/c, Discount Received Received A/c, Dividend Received Received A/c, Interest Received A/c. These These accou accounts nts relat relatee to the amou amount nt incurr incurred ed or lost lost in in the proc process ess of of earnin earningg revenue. Eg. Purchase A/c, Discount Discount allowed A/c, Royalty paid A/c, Interest payable A/c, Loss by Fire A/c etc.
DISTINCTION BETWEEN REAL ACCOUNT AND NOMINAL ACCOUNT Real Account Nominal Account
These accounts relate to properties of the business. ⇒ These accounts are shown in Balance Sheet. ⇒ Closing balances of these accounts are carried over to the next year as opening balances. ⇒ These accounts indicate financial position of the business. ⇒ As per double entry rule, property received is debited and property given is credited. ⇒
⇒ ⇒ ⇒ ⇒ ⇒
These accounts relate to expenses, losses, income and gains. These accounts are shown in profit and loss account. Closing balance of these accounts are closed by transfer to profit and loss account. These accounts assist in calculating profit and loss of the business. As per double entry rule, expenses and losses are debited and income and gains are credited.
JOURNAL
A Journal is a book in which transactions are recorded in the order in which they occur i.e., in chronological order. A journal is the primary books of account under which all the transactions are recorded with complete narration on the basis of the three basic rules given for recording the transactions. The process of recording a transaction in a journal is called Journalizing. An entry made made in the journal is called called a ‘Journal Entry’. A journal entry is an analysis of all the effect of a single transaction on the various accounts, usually accompanied by an explanation. For each transaction, this analysis identifies the accounts to be debited or credited. FORMAT: Date
Particulars
L.F.
Amount (Dr.)
Amount (Cr.)
Note:- The ‘Ledger Folio column’ is filled in at the time of posting into the ledger and not at the time of journalizing.
ADVANTAGES OF JOURNAL ♦ Chronological record:- It records the transactions in the order in which they occur. transaction:- Each journal Each journal entry in the journal carries narration which gives a brief ♦ Explanation of transaction:♦
explanations of the transaction. Recording the both aspects:- Both the aspect (i.e., debit and credit) of a transaction are recorded in the journal. Since the amounts recorded recorded in both debit amount column and credit credit amount column
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
must be equal, the possibility of accounting error is reduced and the detection of errors, if any, committed becomes easy.
LIMITATIONS OF JOURNAL:
When the number of transactions is large, it is practically impossible to record all the transactions through one journal because of the following reasons: (i) The syste system m of record recording ing all the transa transacti ctions ons in a journa journall requi required red (a) the writin writingg down down of of the the name of account involved as many times as the transactions occur; and (b) an individual posting of each account debited and credited and hence involves the repetitive journalizing and posting labour. (ii) (ii) Such Such sys syste tem m does does not not pro provi vide de the the inf infor orma mati tion on on on prom prompt pt bas basis is.. (iii) Such a system system does not facili facilitate tate the the install installation ation of an internal internal chec checkk system system since since,, the journal journal can be handled by only one person. (iv) (iv) Th Thee jou journ rnal al beco become mess bul bulky ky and and vol volum umin inou ous. s. To overcome and shortcomings of the use of the journal only as a book of original entry, the journal is subdivided into special journal. NARRATION:
The narration is the explanation explanation of the entry and facilitates quick understanding. understanding. The length of the narration depends on the complexity of the transaction and whether management wants the journal itself to contain all relevant relevant information. Most often narration are are in brief. S.No.
1.
2.
3.
4.
5.
6.
Particulars
On bringing of Capital in Cash: Cash Account ...........…...........… Dr. To Capital Account (Being cash brought as capital in to business) On brining of capital in the mode of cheque: Bank Account ...........…...........… ...........…...........… Dr. To Capital Account (Being capital brought into business) On deposit of cash into bank: Bank Account ...........…...........… ...........…...........… Dr. To Cash Account (Being Cash deposited into bank) On purchase of assets for cash. Assets (name of assets) Account ...........…. Dr. To Cash Account. (Being assets purchase for cash) On purchase of assets on credit: Assets Account ...........…...........…. ...........…...........…. Dr. To Supplier Account (Being assets purchased on credit from .............) On sale of goods for cash. Cash Account ...........…...........…… Dr. To Sales Account (Being goods sold for cash)
Amount (Dr.)
Amount (Cr.)
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
7.
8.
9.
On sale of goods on credit. Sundry Debtors Account ...........…… To Sales Accounts (Being goods sold to Mr. ............. on credit) On return of goods from customer: Sales Account ...........…...........… ...........…...........… To Sundry Debtors / Cash A/c (Being goods return from Mr. ...........…) On payment re received fr from de debtors: (i) Received in cash: Cash Account ...........…...........… ...........…...........… To Sundry Debtors Account (Being cash received from .............) (ii) (ii)
10. 10.
11
12
13
14
Dr.
Dr.
Dr.
Rece eceived ived by cheq heque and the the sa same is is deposited into bank: Bank Account ...........…...........… ...........…...........… Dr. To Sundry Debtors Account (Being cheque received from customer deposited into bank) On Dish Dishoonou nour of of cheq heque depo eposite sitedd into into Bank: ank: Sundry Debtors A/c ...........…...........… ...........…...........… Dr. To Bank A/c (Being dishonour of cheque received from customer) On Payment re received from debtors: Cash / Bank Account ...........…............. ...........…............. Dr. Discount Account ...........…...........…... ...........…...........…... Dr. To Sundry Debtors Account (Being amount received from ............. after giving a discount @…%) For bad debts: Bad Debts Account ...........…............. ...........…............. Dr. To Sundry Debtors Account (Being amount due from Mr............. is confirmed as bad debts) For pr provision fo for ba bad an and do doubtful de debt: Profit and Loss Account ...........…............. ...........…............. Dr. To Provision for doubtful debt Account (Being prov. made for doubtful debts @ ..% of Sundry debtors) For For tra trans nsfe ferr of of Ba Bad De Debts bts of of pro provvisio isionn for for doubt oubtfu full de debts bts account (if prov. for doubtful debts account maintained) Provision for doubtful debts account ............. Dr. To Bad Debts Account (Being amt. of bad dents trad. to prove for doubtful debts account)
SPECTRUM STUDY CIRCLE +
15
16. 16.
17.
18.
19
20
21
22
23
24
25
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
On purc purchhase ase of raw raw mat mateeria rial / trad tradin ingg go goods ods for for ca cash: sh: Purchase/Goods Account ...........…............. ...........…............. Dr. To Cash Account (Being goods purchased for cash) On purc purcha hase se of raw raw mate materi rial al/t /tra radi ding ng good goodss on cred credit it:: Purchase / Goods Account ...........…............. ...........…............. Dr. To Sundry Creditors Account (Being goods purchased on credit) On return of purchased goods to the supplier: Sundry Creditors Account ...........…............. ...........…............. Dr. To Purchase / Goods A/c (Being goods return to Mr. ...........…) On Payment ma made to su supplier/cred redito itor: Sundry Creditor Account ...........…............. ...........…............. Dr. To cash/Bank account (Being cash / cheque no......paid to Mr.............) On pa payment ma made to to cr creditors af after av availing ca cash discount Sundry Creditors Account ...........…............. ...........…............. Dr. To cash/bank A/c To Discount A/c (being cash/cheque no…..paid to Mr. .... after discount @…%) On payment of expenses: Expenses Account ...........…...........… ...........…...........… Dr. To cash/Bank A/c (Being cash paid for .............) On expenses due but no paid: Expenses Account ...........…............. ...........…............. Dr. To Expenses outstanding/payable outstanding/payable account (Being expenses for the month of .............due but not paid) On income accrue but not received: Income Accrue/Received Accrue/Received A/c ...........…. Dr. To respective Income A/c (Being Income accrues but not received during the year.) On amount withdrawn from bank: Cash Account ...........…...........…. Dr. To Bank A/c (Being amount withdrawn from bank for business use) On am amount wi withdrawn fr from ba bank fo for pri privvate us use: Capital / Drawing Account ...........… Dr. To Bank A/c (Being amount withdrawn from bank for personal use.) On withdrew rew of trading gods for for private use: Capital / Drawing Account ...........…......... Dr.
SPECTRUM STUDY CIRCLE +
26
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
To Purchase / Goods A/c (Being goods withdrew from business for personal use.) For For distr istrib ibuution tion of tra tradin ding good goodss fre free as a sampl amplee: Advertisement A/c ...........…............. ...........…............. Dr. To Purchase A/c. (Being distribution of trading goods free as a sample debited to advertisement A/c and credited to purchases A/c)
COMPOUND ENTRY:
When more than two accounts are involved in a transaction and the transaction is recorded by means of single journal entry instead of passing several journal entries, such single journal entry is termed as ‘Compound Journal Journal Entry’. A compound journal may also be passed passed if there are more transactions transactions of the same nature, taking place place on the same date. It may be recorded in the following three way: (i) (i) by debi debiti ting ng one one acco accoun untt and and cred credit itin ingg two two or more more acco accoun unts ts;; or or (ii) (ii) by deb debit itin ingg two or mor moree acco accoun unts ts and and cre credi diti ting ng one one acc accou ount nt;; or (iii) (iii) by deb debiti iting ng seve several ral accoun accounts ts and and credit crediting ing severa severall acco account unts. s. Example:Paid Rs. 920 to Mr. Gopal in full settlement of his account of Rs. 1,000. Gopal A/c ...........… Dr. 1000 To Cash a/c 980 To discount received A/c 20 (Being cash paid to Gopal in full settlement of his account)
OPENING ENTRY
A Journal entry by means of which the balances of various assets, liabilities and capital appearing in the balance sheet of previous accounting period are brought forward in the books of current accounting period, is known as ‘Opening Entry’. While passing an opening opening entry. All those accounts which de denote note what the business possesses possesses (assets) are debited and all the accounts showing amounts due by the business (liabilities) are credited. ⇒ If Capital is not given, it can be easily found out by deducting liabilities from assets. Opening entries are the following: Cash Account ............. Dr. Cash at Bank Account ............. Dr. Sundry Debtors Account ............. Dr. Stock Account ............. Dr. Fixed Assets Account ............. Dr. To Sundry Creditors Account To Capital Account journal. At the end of the trading period, closing entries are made, made, ⇒ The opening entry is made in the journal. the object being to close the books. LEDGER:
A ledger is a principal book, which contains all the accounts to which the transactions recorded in the books of original entry are transferred. As the ledger is the ultimate destination of all transactions, transactions, the ledger is called the ‘Book of Final Entry.’
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
The ledger may be kept in the form of a bound book, a loose-leaf set of pages, or some kind of electronic storage device such as magnetic tape or floppy diskettes or CDs, but it is always kept current in a systematic manner. Utility of the ledger: ⇒ ⇒ ⇒ ⇒ ⇒ ⇒
It provides complete information about all the accounts in one book. It enables to ascertain what the main item of revenues are. It enables to ascertain what the main item of expenses are. It enables to ascertain what the assets are and of what value. It enables to ascertain what the liabilities are and of what amounts. It facilitate (i.e. make easy) the preparation of Final Accounts.
DISTINCTION BETWEEN JOURNAL AND LEDGER: Journal ⇒ ⇒ ⇒
It is a book of primary entry. It is prepared on the basis of source documents of transactions. Recording of transactions in the journal is
Ledger
⇒
It is book of final or secondary entry. It is prepared on the basis of journal.
⇒
Recording in the Journal is second stage.
⇒
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
25 CHAPTER – 3 SUBSIDIARY BOOKS
When number of transactions is numerous, it is practically impossible to record all the transactions tr ansactions through one journal because of a its limitations. To overcome the shortcomings shortcomings of the use of the journal entry, the journal is divided into special journals. The journal is subdivided in such a way, that a separate book is used for each category of transactions, which are repetitive in nature and are sufficiently large in number. Special journal, refer to the journals meant meant for specific transactions transactions of similar nature. Special journals are also known as subsidiary books or day-book. In any large business organization, the following f ollowing special journal (or subsidiary books) are generally used: Name of Books [I] Cash Journals:
(a) Cash Cash Book Book (simple (simple)) (b) Cash book book with with discount discount column column (c) Cash Book with bank and (d) Petty Petty Cash Cash Book Book
Transactions to be recorded ⇒ ⇒ ⇒ ⇒
[II] Goods Journals:
(a) Purch Purchase ase book book (b) Sales Sales book. book. (c) Sales Sales retur returnn book book (d) Purchase Purchase returns returns book book
⇒ ⇒ ⇒ ⇒
[III] Bills of Journals:
(a) Bills receivabl receivablee book. book. (b) Bills pa payable book.
⇒ ⇒
Cash transactions Cash and discount transactions Cash, Bank and discount transactions Petty Cash transactions Credit purchase of goods. Credit sales of goods Goods returned by those customers to whom goods were sold on credit. Goods returned to those suppliers from goods were purchased on credit Bills receivable Drawn Bills payable accepted.
Advantages of subsidiary Books:-
(i) (ii) (ii) (iii) (iv) (iv) (v)
Division of work. Spe Speciali ializzation tion and eff effic icie ienncy. cy. Saving the time. Avai Availa labi bili lity ty of info inform rmat atio ion’ n’s. s. Facility in in ch checking.
Cash Book:
A cash – Book is special journal journal which is used for recording all cash receipts and cash cash payments. It is a book of original entry, since transactions transactions are recorded for the first time from the source documents. documents. The Cash-Book is a ledger in the sense that it is designed in the form of a Cash Account and records cash receipts on the debit side and cash cash payment on the credit side. Thus, Cash-book is both both a journal and ledger. ⇒ Single Column Cash Book has one amount column on each side. has two amount columns. columns. One for ⇒ Double Column Cash Book (i.e. Cash book with discount Column) has cash and another fro discount. All cash receipts and cash discount allowed are recorded on the debit side and all cash payments and and cash discount received received are recorded on the credit side.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
1. Th Thre reee Col Colum umn n Cash Cash Book Book has three amount columns (one for cash, one for bank and one for discount)
on each side. All cash receipts, deposits into bank and and discount allowed are recorded recorded on debit side and all cash payments, withdrawals withdrawals from bank and discount received received are recorded on the credit side. A three 26
column cash book serves serves the purpose of Cash Account Account and Bank Account. Hence, there is no need to open open these two accounts in ledger.
Petty Cash Book:
Petty cash book is the book which is used for the purposes of recording the payment of petty cash expenses.
Features of Petty Cash Book:
(i) (ii) (ii)
(iii) (iv) (iv) (v)
The amount amount of cash cash receiv received ed from from the main main cashi cashier er is is recor recorded ded on the the left left hand hand side side column column.. The paym paymen ents ts of pett pettyy cash cash expe expense nsess are are record recorded ed on the righ rightt hand hand side side in the resp respec ectiv tivee columns. It can never never show show a credit credit balance balance because because the cash cash payments payments can never never exceed exceed the cash cash receipts. receipts. Its bala balanc ncee repr repres esen ents ts uns unspe pent nt pet petty ty cas cashh in hand hand.. All the the column columnss of expens expenses es are are total totaled ed perio periodic dicall allyy and such such peri periodi odicc totals totals are are indiv individu iduall allyy posted to the debit side of the respective r espective expenses expenses accounts in the ledger by writing ‘To Sundries as per petty Cash Book’.
Advantages:
(i) (ii) (iii) (iv (iv) (v) (vi) (vi)
Saving of chief cashier’s time. Saving labour in posting. Control ov over mi mistakes Con Control trol ove over pe petty tty exp expen ense sess Control over fraud Bene Benefi fits ts of spe speciali ializa zati tioon
Imprest System of Petty Cash Book
The amount which the man cashier hands over to the petty cashier in order to meet the petty cash expenses of a given period in known as ‘IMPREST’ OR ‘FLOAT’. Features of imprest system of petty cash: (i) Estimation by chief ca cashier (ii) Advances by chief ca cashier (iii (iii)) Subm Submis issi sion on of of pett pettyy cash cash boo bookk by by pett pettyy cash cashie ier r (iv) (iv) Ex Exam amin inat atio ionn of of pett pettyy cas cashh boo bookk by by chi chief ef cash cashie ier r (v) Reimbursement of of am amount sp spent (vi) (vi) Avai Availa labi bilit lityy of of sam samee amo amoun untt of of pet petty ty cash cash.. Advantages: (i) Control ov over mi mistakes (ii) Control ov over pe petty ex expenses (iii) Control ov over fr fraud
TRADE DISCOUNT
It is reduction granted by a supplier from the list price of goods or services on business considerations considerations (such as quantity bought, trade practices, etc.) other than for prompt payment. List price is the selling price as printed on the product or in the List/Catalogue of product.
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
CASH DISCOUNT
A reduction granted by a supplier from the invoice price in consideration of immediate payment within a stipulated period. 27
DISTINCTION BETWEEN TRADE DISCOUNT Trade Discount
⇒
It is a reduction granted by a supplier from the list price of goods or services.
It is allowed to promote the sales or as a trade practices. ⇒ It is allowed on purchase of goods. ⇒
⇒ ⇒ ⇒
It is shown by way of deduction in the invoice itself. Trade discount account is not opened in the ledger. It may vary with the quantity purchased
Cash Discount
A reduction granted by a supplier from the invoice price in consideration of immediate payment or payment within stipulated period ⇒ It is allowed to encourage the prompt payment. ⇒
⇒
It is allowed on immediate payment or payment within a specified period. It is not shown in the invoice.
⇒
Cash discount Account is opened in the ledger.
⇒
⇒
It may vary with the period within which the payment is made
Question: (1) What is debit note? Name the book in which entries are recorded on the basis of debit note?
Ans.: A Debit note is a docume document nt prepared prepared by the purchase purchasess to inform the supplie supplierr that his account account has been debited with the amount mentioned mentioned and for the reasons stated therein. therein. Debit note contains the date of return, name of the supplier to whom the goods have been returned, details of the goods returned, reasons for returning the goods. goods. Each debit note is serially serially numbered. The entries in the purchases returns book are usually made on the basis of debit notes issued to the suppliers or credit notes received from the suppliers. (2)
What What is cre credit dit not note? e? Name Name th thee book book in in which which ent entrie riess are are re recor corded ded on the the basi basiss of credi creditt note? note?
Ans.: A Credit Credit note is a documen documentt prepared prepared by the the seller seller to inform the buyer buyer that that his accoun accountt has been been credited with the amount mentioned and and for the reasons stated therein. Credit note contains the date of return of goods, the name of the customer who has returned the goods, details of goods received back and the amount of such such goods. Each credit note in serially numbered. The entries in the sales returns book are usually on the basis of credit notes issued to customers or debit notes issued by the customers.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
CHAPTER – 4 RECTIFICATION OF ERRORS
The term ‘error’ refers to unintentional mistakes in financial information, e.g. mathematical mathematical or clerical mistakes, oversight or misinterpretation of facts, or unintentional misapplication of accounting policies. While recording transactions and events various errors may be committed unintentionally. When a journal entry contains an error, the entry can be erased or crossed out and corrected – if the error is discovered immediately. However, if the errors are detected after posting to ledger ledger accounts, the correcting entries are made. The correcting entry is recorded in journal and posted posted to the general ledger exactly exactly as regular entries are. Example: (i)
28
A repai repairr expen expense sess was was erron erroneou eously sly deb debite itedd to plan plantt and and mach machine inery ry on Novemb November er 25, 25, the the error error is is discovered on December 31: Repair Expenses A/c ............. Dr. Corrective Entry: 31 st Dec.: To Plant and Machinery A/c The corrective entry shows a credit to Plant and Machinery to cancel or offset the erroneous debit to Plant and Machinery. (ii) (ii) A colle collecti ction on on on accou account nt was was erron erroneou eously sly credit credited ed to Sales Sales on on Jan. Jan. 1. 1. The error error is is disco discove vered red on on March 26. Corrective Entry: Marc Marchh 26. 26. Sale Saless Acco Accoun untt .... .................… .….. Dr. Dr. To Sundry Debtor A/c The debit to Sales in the correcting entry offset the incorrect incorrect credit to sales in the erroneous entry. The credit to Accounting Receivable in the correcting entry places the collected amount where it belongs. Some Errors are Counter Balanced:
Accounting errors that are undetected can affect a variety of items, including revenues and expenses for a given period. Some errors are counterbalanced counterbalanced by offsetting errors in the ordinary accounting process in the given period. Such errors are misstate net income in both periods, but by the end of the second period the errors counterbalance or cancel each other out, and they affect the balance sheet of only first period, not the second period. Example: A payment of Rs. 10,000 in March 2003 for Rent Rent for the month April 2003. Instead of recording it as prepaid rent, the payment was recorded as Rent Expenses. The effect of this recording error would be to: (1) Overstate rent expenses expenses for the year 2002-2003 and understate understate year-end assets by Rs. Rs. 10,000 for the first year end; and (2) Understate rent rent expense expense for the second year. year. The errors have no effect on the second year’s ending assets because the same total assets exist whether the rent is recorded as used in April of that year or recorded as used used in full the previous year. The total of the incorrect pretax income for the 2 years would be same with the total of the correct pretax income for the 2 year because the first year’s understatement understatement of pretax income by Rs. 10,000 would counterbalance the second year’s overstatement overstatement of Rs. 10,000. The retained income balance balance at the end of second year would thus be correct on a pretax basis. Errors that are not counterbalanced counterbalanced in the ordinary book-keeping process will keep subsequent balance sheets in error until specific correcting entries are made.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
A Trial Balance is very good way of giving a clear indication indication of some mistakes that may be there.
This will be shown immediately , if the total of the two columns of the trial balance differ. Thus, trial balance is essential to ensure that mistakes mistakes do not remain unearthed. However, the agreement agreement to trial balance does not show conclusively that that no mistakes have remain undetected. undetected. Some errors will not be disclosed by the trial balance whereas some will be. An agreed trial balance, therefore, is only a reasonable proof of arithmetic accuracy of books.
DIFFERENCE IN TRIAL BALANCE:- ERRORS
Apart from error in totaling the two columns of trial balance, the following mistakes will be shown up by the trial balance, because then the trial balance will not agree: a) mistake mistake in transferri transferring ng the balanc balancee of an account account to trial trial balance balance.. 29 b) Omitting Omitting to write the the balance balance of an accou account nt in the trial trial balance. balance. c) ⊥ Mistake in balancing. d) Mistak Mistakee an entr entryy on the the wrong wrong side. side. e) A mistake mistake in the the casting casting of subsid subsidiary iary books. books. f) Omitting Omitting to post the disco discount unt column columnss of the the cash cash book. book.
Inspite of the agreement of the trail balance, the following types of error will not be disclosed because they do not upset the equation: DEBIT = CREDIT.
(i) (i) (ii) (ii) (iii) (iii) (iv) (v)
Omit Omitti ting ng to reco record rd a tra trans nsac acti tion on enti entire rely ly in in sub subsi sidi diar aryy boo books ks.. A wro wrong ng entr entryy in the the subs subsid idia iary ry book books. s. Postin Postingg an entry entry on on the the corre correct ct side side but but in the the wron wrongg accou account nt hea head. d. An error error of of principl principlee – where where by an an assets assets is transfer transferred red as as an expense expense or liabilit liabilityy is treate treatedd as an income. Compensating er errors.
CLASSIFICATION CLASSIFICATION OF ERRORS
(a) Error of Omission (b) Error of commission (c) Error of Principle (d) Compensating error
STEPS TO LOCATE A MISTAKES
A transaction entirely omitted to record in original books or partially omitted while posting. Wrong posting either of amount, or on the wrong side, or in the wrong account. Wrong classification of expenditure or receipt. One error compensated compensated by the another error i.e. an error which cancel themselves out.
THE FOLLOWING STEPS ARE SUGGESTED TO FIND OUT ERRORS: 1) Total Total the debit debit and credit credit columns columns of trial trial balanc balancee again. again. 2) See the balances balances of all accounts, including the cash and bank balances, balances, have been written in the trial balance. 3) Find our the difference in the trial balance. balance. Look for such such accounts accounts as show this account. account. It is possible that the balance of the particular particular account has been omitted omitted from the trial balance. Account showing equal to half the difference should also be checked; the amount may have been written on the wrong side of the trail balance. 4) See that that there are are no mistakes mistakes in the balan balancing cing of the the various various account accounts. s.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
5) Recheck the the totals of the subsidiary books, books, especially especially if the mistake is of 1,10,100 1,10,100 and so so on. 6) If the difference is a large one, compare compare the figure with the trial balance balance of the corresponding date of the previous year. Any account showing rather rather large difference over the figure in the corresponding corresponding trial balance of the previous year, should be rechecked. 7) Posting of all amounts corresponding to the differences or or half the difference should should be checked. 8) If the difference differencess are still not traced traced posting posting of all accounts accounts will will have to be checked checked..
RECTIFICATION RECTIFICATION OF ERRORS
Correction of errors, if located after some time, is always made by a proper journal entry and not by simply crossing the wrong amount amount and inserting the right one. A complete explanation explanation for the correction made should be given so that no difficulty is experienced later when accounts are checked. From the point of view of rectification, errors are of two type:(i)
Erro Er rorr tha thatt af affect the trial ial ba balanc lancee; an and 30
(ii) (ii) Erro Er rors rs that that do not not aff affec ectt the the tria triall bala balanc nce. e. Correction of such error as affect the trial balance would not be through journal entry; only a corrective corrective amount placed on the proper side will suffice. Some of the examples of such types of
errors are as follows:1) An amount of Rs. 150 for a credit sale to Mr X correctly entered entered in the sales sales book, has been debited to his account as Rs. 105. In this case the amount has been correctly entered in the sales book and, therefore, the sales account has been correctly posted. posted. The mistakes lies only in the account account of Mr. X, who should have been debited debited with Rs. 150 and has been been debited, instead, with Rs 105. The correcting entry is to:Mr. X Account Dr. Rs. 45.00 To mistakes in posting on ............. Rs. 45.00 (Being amount wrongly posted in Mr. X A/c for Rs. 105 instead of Rs. 150) 2) An amount of Rs. 150 for a credit sale to D.K.Kapoor, D.K.Kapoor, correctly entered in sales sales book, has been credited to him. In this case also the sales account has been correctly posted and the mistakes lies only in the account of D.K.Kapoor, who has been credited instead of debited. The correcting entry is to debit him with Rs. 300, Rs. 150 to remove the wrong credit and Rs. 150 for the rightful debit. The caption will be “To “To mistake in posting posting on...........…
SUSPENSE ACCOUNT: If the difference in the trial balances is not quickly located, it is usual to put the difference to suspense account in order to make the trial balance balanced.
If the debit side is short, the suspense account account will be debited saying “To differences in trial balance” and ♦ Similarly, the suspense account will be credited if the credit side is short. The difference in the trial balance is due only to type of mistakes which affect only one account such as wrong posting of an account, mistake in totaling a subsidiary book, etc. Such types of mistakes are only reflected in suspense account. When the difference in trial balance is put to suspense account, account, the account to be corrected will be debited or credit as the case may be, and the journal entry will be completed by crediting or debiting the suspense account. account. When all the mistakes have been corrected, the suspense account will show no balance. ♦
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
CORRECTION IN THE NEXT TRADING PERIOD:
Since it is necessary to ascertain the profit or loss of each period separately, it would be necessary to rectify errors in such a way as not to affect the current year’s expenses, losses or incomes. To take an example, if an error committed in 2001-2002 is rectified in 2002-2003 by debiting purchase account, it would mean that it would be treated treated as expenditure for 2002-2003. This would be wrong and the proper way is to leave the purchase account and all other nominal account for 2002-2003 unaffected by error in 2001-2002. For this purpose, a separate account, profit and loss adjustment account, should be opened and all debit and credit in respect of nominal accounts for error committed in previous trading period should be passed through that that account. The balance of this account account is finally transferred to the capital account.
31
DISTINCTION BETWEEN ERROR OF PRINCIPAL AND ERROR OF OMISSION Errors of Principal Errors of Omission
⇒
This error does not affect Trial Balance This error is due to wrong classification of Capital and Revenue expenditure or personal and nominal account. This is not a clerical error. This error affects profit of the business. This error will affect value of asset or liability.
⇒
⇒ ⇒ ⇒
⇒ ⇒
This error may affect Trial Balance. This error is due to complete omission of a transaction or partial omission.
This is a error may or may not affect profit of the business. ⇒ This error may or may not affect value of assets or liability. ⇒
CHAPTER – 6 BILLS OF EXCHANGE / PROMISSORY NOTE BILL OF EXCHANGE:“ A Bill of exchange is an instrument in writing containing an unconditional order signed by the maker,
directed a certain person to pay a certain certain sum of money only to or to the order of, a certain person or to the bearer of the instrument.” When such an order is accepted by writing on the face of the order itself, it becomes a valid Bill of Exchange. The essentials are:
1. 2. 3. 4. 5. 6. 7.
A bill bill of exchan exchange ge must must be in in writi writing ng . It must must be date dated. d. The bill bill must must be sign signed ed by the drawer drawer.. The drawer drawer,, the drawee drawee,, and the payee payee must must be be certain. certain. It must must contain contain an an order order to pay pay a certain certain sum of money. money. The money money must must be payable payable to a definite definite person person or or to his order order to the bearer. bearer. The draft draft must be accep accepted ted for payment payment by the the party or or whom the order order is made. made.
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
⇒
The party who make the order (i.e. (i.e. who makes the bill) is known as drawer; drawer; the party who accept accept the order is known as acceptor and the party to whom the amount has to be paid is known as the payee. The drawer and payee can can be the same. same. Specimen of Bill of Exchange. Rs. 10000 Delhi October 25, 2004 Stamp
Three months after the date pay M/s X Brothers to order the sum of Rs. 10,000 for value received. P.K.Singh To M/s Nanda Brothers. Laxmi Nagar, Delhi 110092. PROMISSORY NOTE:
“A Promissory Note is an instrument in writing, not being a bank note or currency note, containing an unconditional undertaking, undertaking, signed by, the maker, to pay a certain sum of money only to, or to the order of a certain person or to the bearer of the instrument.” A Promissory Note has the following characteristics:characteristics:-
1. It must must be in writ writin ing. g. 2. It must contain contain a clear clear promise to pay, pay, mere acknow acknowledg ledgement ement of a debt debt is not a promissory promissory note. note. 3. The promise to pay must be unconditional. “I promise to pay Rs. 5000/- as soon soon as I can” is not an unconditional promise. 4. The promis promisor or or maker maker must must sign sign the the promissor promissoryy note. note. 5. The maker maker must must be a certai certainn perso person. n. 6. The payee payee must must also also be a certa certain. in. 7. The sum payable must be certain and and must must not be capable capable of contingent addition or subtractions. subtractions. “I promise to pay Rs. 5000/- plus all fines” is not certain. 8. Payment Payment must must be be in legal legal money money of of the country. country. 9. It shoul shouldd not be be made made payabl payablee to beare bearer. r. 10. It should be properly properly stamped. stamped. Specimen of Promissory Note: Rs. 10000
Delhi October 25, 2004
Stamp
Three months after the date we promise to pay M/s Alfa & Co. or order the sum of Rs. 10,000 with interest at 6% for value received. Gopal & Sons. DISTINGUISH BETWEEN BILLS OF EXCHANGE AND PROMISSORY NOTE: Bill of Exchange
It is an unconditional order directing a certain person to pay a certain sum of money. ⇒ Generally, there are three parties in the bill of ⇒
Promissory Note ⇒ ⇒
It is an unconditional promise to pay a certain sum of money. There are two parties in a promissory note – the
SPECTRUM STUDY CIRCLE (The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
+
exchange – the drawer, the drawee and the payee. acceptance by the ⇒ A bill of exchange requires acceptance drawee after if is drawn by the drawer. ⇒ Bill of exhange may be payable either on order or to the bearer. ⇒ In case of Bills of Exchange notice of dishonour is given to all parties concerned. ⇒ The maker (Drawer) of the Bill is liable only when drawee does not make payment. ⇒ In case of foreign bills protest is necessary if it is required as per law of the country where bill has been drawn.
promisor or maker and the payee. ⇒ ⇒
This does not require acceptance. acceptance. It is written by the person who will pay the amount. Promissory note can not be payable to bearer.
⇒
In case of promissory note, notice of dishonour is not required. The maker is primarily liable to pay the amount.
⇒
Protest is not required for promissory note.
⇒
CHEQUE:
A cheque is a bill of exchange drawn on a specified specified banker and payable payable on demand. It includes the electronic image of a truncated cheque and a cheque in the electronic form. A cheque is a bill of exchange with two additional qualifications: ⇒ It is always drawn on a specified bank, and ⇒ It is always payable on demand. DISTINGUISH BETWEEN BILLS OF EXCHANGE AND CHEQUE: Bill of Exchange
This requires acceptance by the drawee. ⇒ This can be drawn on any person including bank. ⇒ Notice of dishonour is necessary. ⇒ A bill of exchange may be payable either on demand or after a specified period. ⇒ A bill of exchange generally requires stamping. ⇒ Bills of exchange can not be crossed ⇒ A time bill should be presented on the due date. ⇒
Cheque
This does not require acceptance. ⇒ This can be drawn on Bank only. ⇒ Notice of dishonour is not necessary. ⇒ Cheque is always payable on demand. ⇒
⇒ ⇒ ⇒
This does not require stamping. A cheque may be crossed. A cheque can be presented at any time within six months from the date of cheque.
NEGOTIABILITY:-
Promissory Notes, Bill of Exchange and and Cheque all are negotiable instrument. instrument. The holder can claim payment on them subject to conditions that the holder takes them:i) with withou outt not notic icee of of def defec ectt in in the the titl titlee of of the the trans transfe fero ror, r, i.e i.e.. in in goo goodd fai faith th,, ii) for consideration and iii) Before maturity. Example:
If a steals a bill of exchange and passes it on to B who is not aware of A’s mode of acquiring the bill and who takes it for the value and before the due date of the bill, B will be entitled to get payment on the bill. Here B is a holder in due course. A holder in due course always gets gets a good title in case of forgery.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Moreover, who ever gets the bill after the holder in due course course will also get a good title to it; it has been purged of all defects. The instrument may passed passed on from one person to another by endorsement endorsement and delivery. The liability of the endorser or subsequent subsequent parties is same as in the case of endorsement endorsement of cheque. Thus, if a bill of exchange is dishonoured, i.e. if payment is not made on the due date by the promisor (drawee in case of bill of exhange), money can be claimed form any of the previous endorsers, the payee and the maker of the instrument. DISCOUNTING OF BILLS:
When the bill is taken to a bank and the necessary necessary cash if received, the act is known as discounting. discounting. The bank will always deduct a small sum depending upon the rate of interest and the period of maturity. MATURITY OF A PROMISSORY NOTE OR BILL OF EXCHANGE:
“The maturity of a promissory note or bill of exchange is the date at which it falls due.” A promissory note or bill of exchange may be payable:payable:(i) on demand; or (ii) on a specified date, or (iii (iii)) afte afterr a spe specifie ifiedd per perio iod. d. In the first case, the amount is payable on the instrument, instrument, when the demand is made. made. In the second case, payment can be claimed on a specified date. In the third case, date date of maturity has to be be calculated. Every Every instrument, payable otherwise than ‘on demand’, is entitle to three days of grace . The following instruments are not entitled to ‘days of grace’:
(a) (a) A che chequ que, e, (b) A bill or note payable ‘at sight’ or ‘on presentment’ presentment’ or ‘on demand’. (c) A bill or note note in which no no time is mention mentioned ed
The following instruments are entitled to ‘days of grace;”
(a) a bill or note note payable payable on a specifi specified ed day, (b) a bill or note note payable payable ‘after ‘after sight’, sight’, (c) a bill or note payable payable at a certain certain period period after date, date, (d) a bill or note payable payable at a certain period period after the happening happening of a certain event.
Calculation Of date of maturity:
(1) If a promissory note or or bill of exchange is made payable a stated number of months months after date or after sight or after a certain event, it becomes payable payable three days after the corresponding date of the months after the stated number of months. If the month in which the period would terminate has no corresponding day, the period shall be held to terminate on the last day of such month. (2) In the above case, the day day on which the instrument is drawn, or presented for acceptance acceptance or sight or the day on which the event happens is to be excluded. (3) When the day on on which a promissory promissory note or bill of exchange exchange is at maturity is a public holiday, the instrument shall be deemed deemed to be due on the preceding day. E.g.: A bill falling due for payment on August 15 will have to be paid on August 14. Dishonour:
A bill may be dishonoured either by non-acceptance non-acceptance or by non-payment. non-payment. When an instrument is dishonoured, the holder must give notice of dishonour to the drawer or his previous holders if he wants to make them liable.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Dishonoured by non acceptance: acceptance:
A bill is said to be dishonoured by non acceptance:acceptance:1. When the the drawee drawee does not accept accept it within within 48 hours from from the time of presenta presentation tion for accepta acceptance. nce. 2. When present presentation ation for accept acceptance ance is excuse excusedd and the bill remaine remainedd unaccepte unaccepted. d. 3. When the drawee drawee is incompet incompetent ent to to contra contract. ct. 4. When the the drawee drawee is fictitious fictitious person person or after reasonab reasonable le search, search, can not be found. found. Dishonoured by non payment:
A promissory note, a bill of exchange or cheque is said to be dishounoured by non payment: When the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same; and When presentation for payment is excused and the instrument when overdue remains unpaid. Record of bills of exchange or promissory notes:
A person who receives a promissory note or receives an accepted bill of exchange will treat it as new assets under the name of Bills Receivable. A party who issues a promissory note or accept a Bill of Exchange will treat it as liability under the heading of Bills Payable.
Noting Charges:-
“Noting” must be recorded with Notary Public within a reasonable time after the dishonour and must contain the fact of dishonour, the date of dishonour, the reason if any, given for such dishonour and the noting charges. For this service service they charge charge a small small fee. This fee is known as noting charges. charges. Noting charges charges have to be born by the person responsible responsible for dishonour. Hence, when a bill is disonoured, disonoured, the amount due is the amount of the bill plus the noting charges. However, if the acceptor prove that the bill was not properly properly presented to him for payment, he may escape his liability. Renewal of a Bill: Some time the acceptor is unable to pay the amount and he himself moves that he should be given an extension of time. In such a case, case, a new bill will be drawn drawn and the old bill will be cancelled. If this happens entries should be passed passed for cancellation of the bill as in case of dishonour of bill. When the new will is received, entries for receipt of bill will be repeated. Accommodation of Bills:-
Bills of exchange are usually drawn to facilitate trade tr ade transaction, finance actual purchase and sale of goods. But apart from, financing transaction in goods, bills may also be used for raising r aising fund temporarily. extent of Rs. 10000/- for 3 months. Suppose A need finance to the extent
In this case he may induce his friend B to accept a Bill of Exchange drawn on him for Rs. 10000/10000/- for 3 months. A can, then get the bill discounted with his bank, paying a small sum of discount. Thus he can use the funds for 3 months and just before maturity, he will remit the amount to B to whom the bill will be presented by the bank for payment. If both A and B need need money, the same same device can be used. Either A accept a bill of exchange exchange or B does. does. In either case the bill will be discounted with the bank and proceeds divided between the two parties according to mutual agreement. The discounting charges charges must also be born by two parties in the same ratio in which which
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
the proceeds are divided on the due due date the acceptor will receive from the other party his share. share. The bill will then be met. When bills are used for such purpose, they are known as accommodation bills .
In case of accommodation of bills, all the journal entries are passed in the books of two parties as same in the ordinary bills. The only additional entries to be passed are for sending the remittance to the other parties and also debating the other parties with the requisite amount of discount.
Bankruptcy:
Bankruptcy/ Insolvency of a person means person who has accepted accepted the bill is unable to pay his liabilities and When it is known, the acceptor of the bill has become insolvent, entry for dishonour of his acceptance must be passed. When and if an amount is received, cash amount will be debited and personal account of debtor will be credited. The remaining amount will be irrecoverable and should be WRITTEN OFF AS BAD DEBT. Bills receivable and Bills payable books:
Where the number of bills received or bills issued is large, Bill receivable and bills payable registers are maintained. The bills receivable register is maintained to record the bills received; and The bills payable register is maintained to record the bills issued. CHAPTER – 7 CONSIGNMENT
Consignment Sale
⇒
⇒
Where one person in firm send goods to another person or firm on the basis that the goods will be sold on and the risk of former, it is called consignment sale. The party which send the goods is called consignor and the party to whom goods are sent is called consignee or agent. The consignee does not buy these goods but merely undertake to sell them on behalf of the consignor. The sale proceeds belong to the consignor and the consignee merely get the agreed commission for his service in addition to any expenses he might have incurred. The relationship between the consignor and the consignee is that of principal and agent.
Account Sales
⇒ ⇒
After sale of goods, consignee consignee sends a statement to consignor. consignor. This statement is called account account sales. In this statement gross sales value, expenses and commission of consignee, advance paid by consignee and net amount due by consignee are shown.
Del-Credere Commission
⇒
The additional commission for which the consignee guarantee debt is called del-credere commission. This commission save consignor from loss of bad debts only.
⇒ ⇒
⇒
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
⇒
The agent is responsible for bad debts due but not for loss due to a dispute between the buyer and the seller. The del-credere commission is payable on total sales and not merely on credit sales.
Ordinary Commission
⇒
Ordinary commission is a commission which consignee gets as his remuneration from the consignor for f or the sales made in behalf of the consignor. In this case the consignee does does not guarantee that all those who buy on credit credit will pay up. The consignee is not responsible for bad dents.
⇒
⇒
Discount paid on bills receivable discounted by Consignor
Books of consignor
There are two alternative treatments for the aforesaid discount:a) If discount discount is treated as “consign “consignment ment expenses expenses”” it is debited debited to consignme consignment nt account. account. b) If discount discount is treated treated as “financi “financial al charges”, charges”, it is debited debited to profit profit and loss accoun account.t. To know the profit and the loss made on a consignment separately a consignment account is opened. ⇒ A consignment account is not a personal account but is in the nature of a special type of a trading and profit and loss account which show profit or loss made on the particular consignment. consignment. ⇒ If goods are consigned to a number of parties, the profit and loss on consignment to each consignee may be ascertained separately. ⇒
Journal Entries in the Books of Consignor 1. On dis dispa patc tch h of goo goods ds to to Cons Consig igne nee: e:--
Consignment account ...........…...........… Dr. (with the cost of goods) To goods sent to consignment A/c (being goods sent to M/S ...... at ...... on consignment basis and invoiced at the rate of ...... each)
2.
For payment payment of of expens expenses es by by consign consignor or on on dispatc dispatching hing the goods:goods:-
3.
On recei receipt pt of advanc advancee from from consig consignee nee::-
4.
5.
6.
Consignment account ...........…............. Dr. To Bank Account (with the amount spent) (Being expenses incurred on dispatching the goods on consignment)
Cash / Bank a/c ...........…...........…… ...........…...........…… Dr. To consignee A/c (Being advance received from consignee) consignee)
On the the cons consign ignee ee acc accept epting ing a bill bill of exchan exchange: ge:--
Bill receivable account ...........…............. Dr, To consignee’s personal A/c (The bill of exchange accepted accepted by the consignee M/S.............) On dis disco coun unti ting ng of of bill bill of of exch exchan ange ge::-
Bank a/c ...........…...........… Dr. Discount a/c ...........………. Dr. To Bills Receivable Account (Being bill for Rs. … discounted with bank for Rs. … ie at a discount of Rs. .............) On the consig consignee nee re report porting ing sale sale (As per accou account nt sale):sale):- (with (with gross gross proceed proceed of of sale) sale)
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Consignee’s personal account ...........…............. Dr. To consignment account (Being sale proceed of ..... at Rs. ...... each as per account sales rendered by consignee M/S….) 7.
For For good goodss take taken n over over by by cons consig igne nee: e:--
8.
For expen expenses ses incurred incurred by the consi consignee gnee (accordin (according g to Accou Account nt Sales) Sales)::-
9.
For commis commissio sion n paya payable ble to the consig consignee nee::-
Consignee A/c ...........…...........… Dr. To consignment A/c (Being goods taken over by agent consignee) Consignment Account ...........…............. Dr. To consignees personal account (Being expenses incurred by M/s or M/r …. on …. As per account sales)
Consignment account ...........…...........… Dr. To consignee’s personal account (commission due to Mr./Ms ............. at the rate of .............% on Rs. .............)
10. For stock remaining unsold unsold at the end of period period (i.e. goods lying with consignee) consignee)
Stock on consignment A/c ...........…............. Dr. To consignment A/c (Being goods sent on consignment have not yet been sold by the consignee and still lying with consignee value at cost.)
11. (a) For abnormal abnormal loss of goods goods::
Abnormal loss A/c ...........…............. Dr. To consignment A/c (Being loss occurred due to .............)
(b) On recovery of abnormal loss (fully or partly) from insurance company:
Bank Account / Insurance Co. ............. Dr. To Abnormal loss A/c (Being amount recovered from Insurance company against loss occurred due to .............)
(c) For sale proceed of damaged goods:
Consignee A/c ...........…...........… Dr. To Abnormal loss A/c (Being damaged goods sold by an agent)
Note:- If damaged goods have not been sold, Net realized value of such goods will be include in closing stock on Consignment. (d) For net abnormal loss:
Profit & Loss A/c ...........…...........… Dr. To Abnormal loss A/c (Being net abnormal loss transferred to Profit & Loss A/c)
12. For Normal Normal loss (i.e. (i.e. loss which is inherent inherent and unavoi unavoidable dable): ):
No entry in the books
13. For profit profit earn earn on consign consignment ment::
Consignment Account ...........…...........… Dr. To Profit & Loss A/c (Being Profit earn on consignment transferred to Profit & Loss account)
14. For Loss incurred incurred on Consign Consignment ment::
Profit & Loss Account .......... ...........…... .…........ ........ ... Dr.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
To Consignment A/c (Being loss incurred on consignment transferred to Profit & Loss A/c) Note: the goods sent on Consignment account is transferred to the purchase Account in case the consignor carries in a trading business and to Trading account if the consignor carries on a manufacturing business.
Valuation of closing Stock
Abnormal Loss:
Normal Loss:
The goods lying unsold with the Consignee at the end of the accounting year is usually valued at cost. ⇒ In this case cost means, cost at which goods sent on Consignment plus all expenses incurred till the goods reach the premises of the consignee. ⇒ Such expenses include packing, freight, cartage, insurance in transit, octroi, import duty, customs charges, packing, loading & unloading charges etc. But expenses incurred after the goods have reached the consignee godown are not treated as part of the cost of purchase for valuing stock on hand, i.e. expenses like godown rent, godown insurance, sales expenses etc are not included in the value of stock. The main principal of valuing closing stock at cost or market price whichever is less, is also applicable here.
Abnormal loss of goods occurs due to accidental, mischief or carelessness. e.g. loss occurred due to fire, theft, flood, earthquake, etc. ⇒ Abnormal loss should be debited to abnormal loss account and credited to consignment account. account. ⇒ The amount of loss is ascertained like the value of closing stock at cost; except that ⇒ The expenses incurred on the remaining goods after the loss have to be ignored while calculating the amount of loss because no part of such expenses can be said to have been incurred on the goods lost. account may be debited and ⇒ If abnormal loss is fully or partly covered by insurance, abnormal loss account consignment account account credit with full cost of the goods involved in the loss. f rom the insurance company will be credited to abnormal loss account ⇒ The amount recovered (if any) from and, the balance, if any left in abnormal loss account will be transferred tr ansferred to Profit & Loss Account. Any loss which occurs due to natural causes e.g. normal leakage, loss in weight due to nature of goods, etc. is termed as ‘normal loss’. In certain cases, some loss is inherent inherent and unavoidable. unavoidable. For instance, if a certain quantity of cement is consigned, some of it is bound to be lost because of loading and unloading. Such inherent and unavoidable loss is known as normal loss and should be allowed while calculating the cost of the stock on hand. Such loss inflates the value of closing closing stock. Ex. 200 tones of cement are consigned consigned at Rs. 1,000 per tones, freight being Rs. Rs. 10,000. By the end of the year, the consignee has sold 130 tones of cement and is left with 65 tones of cement, the remaining 5 tones of cement having been been lost due to normal wastage. The closing stock of 65 tones will be valued valued at Rs. 70,000. CHAPTER - 9 CAPITAL AND REVENUE
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
It is necessary to make a distinction between Revenue and capital expenditure and income to determine the correct income of the business. To calculate net profit of the business, only revenue revenue income and expenditure expenditure will be taken into consideration, however business may incur some expenditure of capital nature. The following facts will not be taken in to consideration to decide, whether an expenditure incurred or income earned is capital or Revenue in nature:(i) Source of payment (ii) Quantum of Amount (iii) Nature of recipient (iv) Manner of payment Classification of Expenditure
Classification of Income
[1] Capital Expenditure [1] Capital Income [2] Revenue Expenditure [2] Revenue Income [3] Deferred Revenue Expenditure •
Classification of Receipt
[1] Capital Receipt [2] Revenue Receipt
Capital Expenditure:
Capital expenditure is that expenditure which result in the acquisition of an assets, tangible or intangible, which can be later sold and converted in to cash or which result in an increase in the earning capacity of a business or which afford some other other benefits to the firm. Such expenditure is incurred incurred with a view to brining in improvements in productivity of earning capacity for getting long-term advantages for the business. It is not incurred incurred for day-to-day working of the business. The following types types of expenditure expenditure are treated as – ‘Capital expenditure’. (i) Acquisition of an asset. (ii) Imp Improvement of of fi fixed as assets. (iii) Extension of of an an as asset. (iv) (iv) Putt Puttin ingg the the new new asse assets ts into into wor worki king ng cond condit itio ion. n. (v) (v) Expe Ex pennditu diture re in acqui cquiri rinng the the asset. (vi) (vi) Acqu Acquis isit itio ionn of of a righ rightt to to car carry ry on busi busine ness ss.. Other example are- money paid for goodwill since it will attract the old firm’s customer and thus result in higher sales and profit. Money spent to reduce reduce the working expenses, for example, example, conversation of hand driven machinery to power driven machinery and expenditure which enable a firm to produce a large quantity of goods. It is important to note that all amount spent up to the point an assets is ready for use should be treated as capital expenditure. expenditure. The examples examples are −fees paid to lawyer for drawing up the purchase deed of land, overhaul expenses expenses of second hand machinery machinery etc. Interest paid on loans raised to acquire acquire a fixed asset is particularly noteworthy. Such interest can be capitalized; i.e. added to the cost of the assets but only for the period before the assets is ready for use. It is not necessary that capita expenditure expenditure always generate profit. Even if there is a loss or asset has not been used, such expenditure will be treated as capital expenditure. •
Revenue Expenditure:
Revenue Expenditure is that expenditure which is incurred for maintaining productivity or earning capacity of a business. An item of expenditure whose benefit benefit express within the year or expenditure which merely merely seeks to maintain the business business or keep assets in good working condition condition is revenue expenditure. expenditure. Expenses of following nature are treated as revenue expenses:(i) Expenses fo for ru running th the bu business. (ii) (ii) Expe Ex pens nses es incu incurr rred ed to main mainta tain ined ed the the fix fixed ed asse assets ts.. (iii (iii)) Purc Purcha hase se of mate materi rial al and and goo goodds. (iv) Depreciation.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Such expenditure does not increase the efficiency of the firm, nor does it result in the organization of some thing permanent. •
Deferred Revenue Expenditure
When the benefit of revenue expenditure is available for a period or three more years, such expenditure is then known as ‘deferred revenue expenditure’ and is written off over a period of few years and not wholly in the year in which it is incurred. Ex: If a new firm advertise very heavily in the beginning of the year to capture a position in the market, the benefit of this advertising advertising campaign will last last quite a few years. It will be better to write off the expenditure in three or four years and not only in the first year. When loss of a specially heavy and exceptional nature is sustained, it can also be treated as deferred revenue expenditure. expenditure. If fire or earthquake destroys a building, the loss may may be written off in three or four years. The amount amount net yet written off appears in the balance balance sheet. Only loss arising arising from circumstances beyond one’s control can be deferred revenue expenditure. •
Capital Income:
If any income is derived not by running the business, it is treated as Capital Income. For example, profit on sale of fixed assets over its cost is treated treated as Capital Income. However any profit upto the cost of the asset is treated as Revenue Profit. Example:- A Building had originally cost Rs. 60,000. 60,000. Its present written down value in the books is 45,0000. It is sold for Rs. 65,000. In this case total profit on sale is Rs. 20,000 (65,000 – 45,000). Out of this Rs. 5,000 being excess of sale price over cost [65,000 – 60,000] is capital profit and Rs. 15,000 [60,000 – 45,000] is revenue profit. •
Revenue Income:
Any income or profit derived by carrying on the business or during the course operations is treated as revenue income. income. Ex. profit on sale of goods, dividend or interest interest received, commission or discount discount received. Such income is shown in profit and loss A/c. •
Capital Receipt
Amount received from the proprietors as capital capital or loan receipt is treated as capital receipt. Similarly sale proceeds of permanent permanent or fixed assets are also treated as capital capital receipt. In order to ascertain the profit made by a business, only revenue receipt should be taken in to account. Capital receipts have no bearing on the profit made or loss incurred during a particular year. •
Revenue Receipt
Amount received in the course of normal business transaction is treated as revenue receipt. Total receipt is not necessarily income. income. For example, sale proceeds proceeds of goods are revenue receipt receipt but surplus of sale proceeds after deducting cost of goods sold will be treated revenue income. Question:
(1) State with reason whether the following are capital or Revenue Expenditure: Expenditure: (i) Expen Expenses ses incurr incurred ed in in conne connecte ctedd with with obta obtaini ining ng a licenc licencee for for stari staring ng the the fact factory ory were were 10,00 10,0000 (ii) (ii) Rs. 2,000 2,000 spen spentt as lawy lawyer’ er’ss fee fee to defe defend nd a suit suit claimi claiming ng that that the firm firm’s ’s facto factory ry site site belong belonged ed to to the plaintiff the suit was not successful.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
(iii)
Rs. 12,00 12,0000 interes interestt had accrued accrued during during the year on term term loan loan and and utilise utilisedd for the construct construction ion of factory building and purchase of machineries, however, the production had not commenced till the last date of the accounting year. (iv) (iv) Cost Cost of maki making ng more more exis exists ts in a cin cinem emaa hal hall.l. (v) Expen Expendit diture ure on on acqui acquisit sition ion of Expo Export rt Right Rights, s, when when paymen paymentt is mad madee in inst instalm almen ents. ts. (vi) (vi) Inte Intere rest st on arre arrear arss of of sal sales es tax. tax. (vii) (vii) Less Less due to to devalu devaluati ation on of curre currency ncy on on loan loan taken taken in forei foreign gn curre currenc ncy. y. (viii) (viii) Cost Cost of projec projectt Report Report – Proje Project ct did did not mater material ialize ized. d. Ans.: (1) (i) Money Money paid paid Rs. Rs. 10,0 10,000 00 for obtain obtaining ing a licen license se to to start start a facto factory ry is a capi capital tal expend expenditu iture. re. Th This is is is an item of expenditure incurred to acquire the right to carry on business. The expenses necessary necessary for either establishing the business, like expenses for obtaining the necessary license will be capital expenditure. expenditure. Only the initial expenditure expenditure is capital; renewal fees fees are recenue. (ii) (ii) Rs. 2,00 2,0000 spent spent as lawy lawyer’ er’ss fee in defe defendi nding ng the the title title to the the firm’s firm’s asse assets ts is a reve revenue nue expe expendi nditur ture. e. This is an expenditure incurred for upkeep of a fixed assets. If there is a dispute about the ownership, legal expenses incurred for defending the title will be a revenue expense. (iii) Interest Interest accrued accrued Rs. 12,000 12,000 on term loan obtained obtained and utilise utilisedd for the const constructi ruction on of factory factory building and purchase of machinery should be treated as capital expenditure since commercial production has not begun till the last day of accounting year. (iv) Making Making more more exist exist in a cinema cinema hall does not incre increase ase the the capac capacity ity of the hall hall and, and, there therefore, fore, it should be treated as revenue r evenue expenditure. (v) Thiss is an Thi an expen expendit diture ure of an an endur enduring ing nature nature and will will benef benefit it the the busin business ess for a long long perio period. d. Th This is a kind of intangible assets which will help business business to earn income. Whether payment is made lump sum or in instalments. the nature of expenditure being capital will not change. (vi) When sales sales tax tax is payab payable le in instaleme instalements, nts, any any interes interestt paid paid with amount amount of sales sales tax is similar similar to tax for the business. Further, this expenditure has direct direct relationship with the income earned during the current year. year. Hence, treated Revenue Expenditure. Expenditure. (vii) Treatment Treatment for for such such loss loss will depen dependd on the the fact fact whether whether loan loan amount amount has has been been used used for for acquiring acquiring a fixed asset or it was being used as circulating circulating capital or trading assets. If loan was used for acquitting fixed assets, any loss arising on account of devaluation of currency will be capital loss. But if loan was being used in circulating capital or trading asset, such loss will be treated as Revenue Loss. (viii) (viii) The expen expenditur dituree is not not giving giving any enduring enduring benef benefit it of the the busines business. s. However, However, if amoun amountt is heavy heavy it will be treated as deferred Revenue Expenditure. Expenditure.
VALUATION OF INVENTORIES
The revised standard came in to effect in respect of accounting period commencing on or after 1.4.99 and is mandatory in nature. However, this statement statement does not apply in valuation of the following:(a) work- in-progress arising under under construction contract, contract, including directly related service service contact. contact. (b) Work-in-progress arising arising in the ordinary course course of business of service service providers; (c) Shares, debentures debentures and other financial instrument instrument held as as stock-in –trade. –trade. (d) Producers’ inventories inventories of livestock, agricultural agricultural and forest products, products, and mineral oils, ores ores and gases to the extent that they are measured at net realizable value in accordance with well established practices in those industries.
SPECTRUM STUDY CIRCLE +
•
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Valuation:
The principle for valuation is that inventories should be valued at the lower of cost and net realised value. •
Cost of Inventories:
The cost of inventories should comprise all costs of purchase, costs of conversion and other cost incurred in bringing the inventories to their present location and condition. a) Cost of Purchase Purc hase::- The costs of purchase, purchase, consist of the purchase price including including duties and taxes (other than those subsequently recoverable from taxing authorities), freight f reight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the cost of purchase. Note: Cash discount should not be treated as adjustment to the cost of purchase. Such rebate should be treated as separate revenue revenue items and accounted for accordingly. accordingly. Any discretionary discounts discounts given on adhoc basis are also not deductible from the cost of inventory. b) The cost of conversi conv ersion:on:- The costs of conversion of inventories include costs directly related to the units of production , such as direct labour. They They also include include a systematic systematic allocation allocation of fixed and and variable production overheads overheads that are incurred in converting materials into finished goods. ⇒ Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factor buildings and the cost of factory management and administration. ⇒ Variable overhead are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as as indirect materials and indirect labour. The inclusion of cost of conversion conversion as part of inventory cost follows the principle that all costs incurred to bring the inventory to its present location and condition should form part of the inventory costs. Valuation of Joint Products / By-Products: By-Products:
A production process may result in more than one product being produced simultaneously. ⇒ This is the case, for example, when joint products are produced or when there is a main product and a by-product. ⇒ When the cost of conversion of each product are not separately identifiable, they are allocated between the products on a rational and consistent basis. ⇒ The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the product become separately identifiable, or at the completion of production. ⇒ Allocation of costs may also be done on the basis of physical measures of the products or on the basis of technical evaluation. ⇒ Most by-products as well as scrap or waste materials, by their nature, are immaterial. When this is the case, they are often measured at net realizable value and this value is deducted from the cost of the main product. As a result, the carrying amount of the main product is nor materially different from its cost. Costs not included in the valuation of Inventories:
Overhead costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. condition. For example, it may be appropriate to include include overheads
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
other than production overheads such as the costs of t\designing products for specific customers in the costs of inventories. In determining the cost of inventories the following costs are excluded and recognize such costs as expenses in the period in which they are incurred. (a) Abnorm Abnormal al amount amount of waste wastedd mate materia rial,l, labour labour,, or or othe otherr prod product uction ion costs; costs; (b) Storag Storagee costs, costs, unle unless ss those those costs costs are are nece necessa ssary ry in the the produ producti ction on proce process ss prio priorr to the the furthe further r production stage; (c) Admini Administr strati ative ve overh overhead ead tha thatt do not cont contrib ribute ute to brin bringin gingg the inve invento ntorie riess to their their presen presentt locati location on and condition. (d) (d) Sell Sellin ingg and and dis distrib tribuutio tion costs osts.. Warranty expenses incurred after completion of the sale will not form part of cost of inventory because it is not a cost incurred to bring the inventory to its present location location and condition. Warranty expenses should should not be included in cost of inventory even if the warranty warranty is in relation to a manufacturing defect. If a particulars item of inventory has a defect, then the cost of inventory would be the cost of the defective inventory (present condition) and not what the cost of inventory would be if the defect was rectified. Cost Formulae: ⇒
⇒ ⇒
The cost of inventories of items that are not ordinarily interchangeable and goods or services products and segregated for specific projects should be assigned by specific identification of their individual costs. The cost of inventories, other than those dealt with in the specific identification method, should be assigned by using the first-in, first –out (FIFO), or weighted averaged cost formula. Techniques Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate the actual cost.
Determination of Net Realisable Value:
Net realisable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale. ⇒ An assessment is made of net realizable value as at each balance sheet date. ⇒ Estimates of net realisabel value are based on the most reliable evidence available at the time, the estimates are made as to the amount the inventories are expected to realise. ⇒ These estimates takes into consideration fluctuations of price or cost directly relating r elating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date. ⇒ Estimates of net realisable value also take into consideration the purpose for which the inventory is held. ⇒
Inventories are usually written down to net realizable realizable value on an item-by-item basis. In some circumstances, however, however, it may be appropriate to group similar or related item. Net Realisabel Value of Raw Materials: ⇒
Material and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However,
SPECTRUM STUDY CIRCLE +
⇒
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
When there has been a decline in the price of materials and it is estimated that the cost of finished products will exceed net realizable value, the raw materials are written down to net realisable value. In such case the replacement cost of the raw material may be the best available measure of their net realisable value.
Disclosure Requirements:
The financial statements should disclose: ⇒ The accounting policies adopted in measuring inventories, including the cost formula used; and ⇒ The total carrying amount of inventories and its classification appropriate to the enterprise. Wear and Tear DEPRECIATION quantity or value of assets. The net result of an assets Meaning:- Depreciation means a fall in the quality, quantity depreciation is that sooner or latter the assets will become become useless. It is the permanent and continuous continuous decrease in the book value of fixed assets due to use, effluxion of time obsolescence, obsolescence, expiration of legal right or any other cause. Depreciation is not the result of fluctuation in the value of fixed asset since, the fluctuation is concerned with the market price of the fixed asset whereas the depreciation is concerted with the historical cost. Characteristics Characteristics of depreciation: depreciation:
(a) It is related related to depreciab depreciable le fixed fixed asset assetss only. only. (b) It is fall in in the book book value value of depre depreciab ciable le fixed asse assets. ts. (c) The fall in the the book value value of an asset is due due to the use of the asset in business business operations, operations, effluxion of time, obsolescence, expiration of legal rights or any other cause. (d) It is a perman permanent ent decrea decrease se in the book value value of an asset. asset. (e) It is continuo continuous us decrea decrease se in the the book value of an asset. asset. Main causes of Depreciation:
1. 2. 3. 4. 5. 6.
due to to ac actual us use; Efflux Efflux of time – more passa passage ge of time time will cause cause a fall fall in the value value of assets assets even even if it is not used. used. Obsolesc Obsolescence ence – a new new invention invention or a permane permanent nt change change in demand demand may may render render the assets assets unless. unless. Accidents; Depletion Depletion – Value Value of assets assets decrea decreases ses due due to consumpt consumption ion i.e. coal coal mine, mine, stone quarri quarries es etc. Expiratio Expirationn of legal rights rights – When When the use of of asset (e.g. (e.g. Patents Patents,, leases) leases) is governe governedd by the time time bound bound arrangement, the value of such assets may decrease with the passage of time.
Objective for providing Depreciation: Depreciation:
The following are the prime objectives for providing depreciation: 1. Presen Presentat tation ion of corr correc ectt financ financial ial positi position. on. 2. Calc Calcul ulat atio ionn of of cor corre rect ct prof profit it.. 3. Retaining Retaining enoug enoughh funds funds for replaceme replacement nt of assets assets at at the end end of its commer commercial cial life. life. 4. Ascert Ascertain ainmen mentt of corr correct ect cost cost of produc productio tion. n. 5. Correct Correct informa information tion about about value value of asset assetss to financial financial institutio institution. n. 6. Comp Comply ly with with lega legall requ requir irem emen ents ts.. The Basic Factors:
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
For Calculation of depreciation, the basic factors are (i) The cost of the assets; (ii) (ii) Thee esti Th estima mate tedd resi residu dual al or or scra scrapp valu valuee at at the the end end of of its its life life;; and and (iii (iii)) Th Thee esti estima mate tedd numb number er of of year yearss of its its com comme merc rcia iall life. life. Different Approach: Type of Rate of Depreciation given
When the rate of Depreciation with the words ‘per annum’ is given. (e.g. 15% p.a.) p.a.) (a) If the date date of acquis acquisition ition is given given.. (b) If the date if acquisiti acquisition on is snot given. given.
Period for which Depreciation is to be charged
Charge depreciation for the period beginning with the date of acquisition and ending with the date of closing accounting period. ⇒ Charge depreciation for the full year assuming that the assets was purchased / acquired in the beginning of the year; OR ⇒ Charges depreciation for half year assuming that assets was purchased in the middle of the year; ⇒
OR ⇒
When the Flat Rate of Depreciation without the words, ‘per annum’ is given (e.g. 15%)
⇒
Charge no depreciation assuming that the asset was acquired at the end of the year. Charge depreciation for the full year irrespective of the date of acquisition of assets
METHODS OF PROVIDING DEPRECIATION:
(1) (1) (2) (3) (4) (4) (5) (5) (6) (7) (7) (8) (9) (9) (10) (10)
Stra Straig ight ht line line meth methood; Writte Writtenn down down valu valuee metho methodd or Redu Reducin cingg balan balance ce meth method; od; Annuity me method; Depr Deprec ecia iati tion on fund fund meth method od;; Insu Insura rannce fun fund me metho thod; Sum of of di digit me method; Reva Revalu luat atio ionn meth ethod; od; Depletion me method; Mach Machin inee hou hourr rat ratee met metho hod; d; and and Repair Repairss prov provisi ision on metho method. d.
Straight line Method
Under this method, a suitable percentage percentage of original cost is written off the assets every year. This method is useful when the service rendered by the assets is uniform from year to year. Depreciation = Cost of Assets – Scrape Value Useful Life Depreciation Rate = Straight line Dep. × 100 Cost of assets – Scrap Value The period for which the assets is used in a particular year (i.e in the year of acquisition) should also taken into account. Written Down Value Method
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)
Under this method, the rate of depreciation is fixed, but it applied to the value at which the assets stands in the books in the beginning of the year. Under this method the amount of depreciation will reduce every year. The rate of depreciation under this method may be determined by the following formula:Dep. Rate = 1 – n √(Residual √(Residual Value) × 100 Cost of assets Note: If instead of scrap value some amount will have to be spent at the end of the life lif e of the assets, such as on pulling down the building on a leasehold land, such an amount should be added. AVERAGE DUE DATE
If a person owes a number of sums to a person on different dates, he may like to pay the whole amount on such a day as as will involve neither party party in loss of interest. Such a day is known known as Average Average Due Date. It is calculated in the following way:(i) (i) Take ake one one of the the due due da date as the the base base date date.. (ii) (ii) Calcul Calculate ate the numbe numberr of day dayss betwe between en the the base base date date and the due date date of ever everyy transa transacti ction. on. The base base date is not to be taken into account. (iii) Multiply Multiply each each amount amount by its respective respective number number of of days days as as calcu calculated lated in the the secon secondd step. step. (iv) (iv) Add Add the the amou amount ntss and and the the pro produ duct ctss sep separ arat atel ely. y. (v) Divide Divide the the sum sum of of the the produc products ts by by the the total total of of the amoun amounts. ts. Th This is give give the the numb number er of of days days the the aver average age due date is away from the base date. (vi) (vi) Add the the numb number er of of days days to the the base base date date and and thus thus arriv arrivee at the the avera average ge due due date date.. Calculation of Interest with the help of Average Due Date: ⇒ ⇒ ⇒
The average due date determines the day on which various amounts can be settled without loss or gain of interest to either party. If full payment is made on the average due date, no interest is payable. If payment is made after the average due date, Interest will be calculated for the number of days from the average due date to the actual date of payment / settlement.
Days of Grace and date of Maturity:
A bill of exchange or promissory notes matures on the due date on which it falls due and it falls due and it falls due on the third day after the day on which it is expressed to be payable. payable. These extra three days are known as “Days of Grace”. Grace”. When it is an ‘after date bill’, the period is counted from the date drawing the bill but when there is ‘after sight bill’, the period is counted from the date of acceptance acceptance of bill. However, when bill is payable on demand or on presentation, it becomes due immediately on presentation for payment. When the day on which bill or promissory note is at maturity after including three days of grace is a public holiday or Sunday, the due date date will be preceding business day. day. If holiday is emergency or unforeseen unforeseen holiday then the due date shall be the next following day.
SPECTRUM STUDY CIRCLE +
(The Acme of Excellence) 15/22 IInd Floor Ashok Nagar, New Delhi-110018. Ph.: 25499279, 55711031(O), 9810378235(M)