FINANCIAL ACCOUNTING
TOPICS
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BASIC CONCEPTS
BANK RECONCILIATION
TRIAL BALANCE
CAPITAL & REVENUE EXPENDITURE
MODEL QUESTIONS
BASICS OF ACCOUNTING
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DOUBLE ENTRY SYSTEM
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3 TYPES OF ACCOUNTS:
-- REAL: ASSETS OF BUSINESS, TANGIBLE AND
IDENTIFIABLE.
-- PERSONAL: THEY ARE HEADED WITH THE NAME OF
PERSON/BUSINESS/FIRM. DEBTORS OR CREDITORS.
-- NOMINAL: THEY RECORD TRANSACTIONS OF
INTANGIBLES SUCH AS RENT EXPENSES.
.
BASIC RULES OF ACCOUNTING
RULES:
-- REAL : DEBIT THE ACCOUNT WHEN WE PURCHASE
AN ASSET & CREDIT WHEN WE SELL OR
DEPRECIATE.
-- PERSONAL : DEBIT THE RECEIVER OF GOODS &
CREDIT THE GIVER OF GOODS.
-- NOMINAL : DEBIT LOSSES & EXPENSES, CREDIT
INCOMES & GAINS.
-- IN A LEDGER, ASSETS OR LOSSES HAVE DEBIT
BALANCE WHILE LIABILITIES OR GAINS HAVE
CREDIT BALANCE.
BANK RECONCILIATION STATEMENT
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BANK RECONCILIATION( B. R. ) IS BASED ON THE
PRINCIPLE OF DOUBLE ENTRY.
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CREDIT THE GIVER AND DEBIT THE RECEIVER
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B. R. SHOWS CAUSES OF DIFFERENCES BETWEEN CASH
BOOK AND PASS BOOK BALANCE
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DEBIT BALANCE AS PER CASH BOOK IS CREDIT BALANCE
AS PER PASS BOOK = POSITIVE BALANCE
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CREDIT BALANCE IN CASH BOOK IS DEBIT BALANCE IN
PASS BOOK = NEGATIVE BALANCE/OVERDRAFT
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WHETHER WE START WITH CASH OR PASS BOOK
RECONCILIATION ENTRIES WILL REMAIN SAME AS PER
PRINCIPLES
BANK RECONCILIATION STATEMENT
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.
CAUSES OF DIFFERENCES
TREATMENT
CASH/PASS BOOK
DT.
CR.
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CHEQUES ISSUED BUT NOT PRESENTED
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CHEQUES DEPOSITED BUT NOT COLLECTED
√
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BANK CHARGES
√
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INTEREST ON SAVINGS BANK
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INTEREST ON LOAN
√
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AMOUNT PAID BY BANK AS PER
STANDING INSTRUCTIONS
√
.
DIRECT PAYMENTS MADE BY CUSTOMERS
.
DISHONOUR OF CHEQUES RECEIVED
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BANK RECONCILIATION STATEMENT
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CAUSES OF DIFFERENCES
. PAYMENTS SIDE OF CASH BOOK
UNDERCAST
DT.
TREATMENT
CASH/PASS BOOK
CR.
√
. DEPOSIT SIDE OF CASH BOOK
OVERCAST
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. CHEQUE ISSUED BUT NOT TAKEN
IN BANK COLUMN
√
. DEBIT BALANCE X BROUGHT
FORWARD AS CREDIT BALANCE
. CHEQUE ISSUED BUT RECORDED
TWICE
2X
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BANK RECONCILIATION STATEMENT
IMPORTANT : WHETHER WE ARE RECONCILING PASS BOOK OR CASH
BOOK , EACH OF THE RECTIFICATION ENTRIES WILL
APPEAR ON THE SAME SIDE . ADDITION OR SUBRACTION
OF ENTRIES FROM THE OPENING OR GIVEN BALANCE
DEPENDS UPON WHICH SIDE OF THE LEDGER THEY ARE
CAST OR TO BE CAST. THUS WHAT WE SIMPLY NEED TO
KNOW IS WHETHER EACH FIGURE GIVEN IN THE
PROBLEM IS A DEBIT OR CREDIT ENTRY. I WILL EXPLAIN
WITH THE HELP OF A PROBLEM LATER.
BANK RECONCILIATION STATEMENT
SIMPLY PUT, IF AN ENTRY IS ALREADY THERE BUT EITHER
THE WHOLE OR PART IT HAS TO BE RECTIFIED THEN THAT
PORTION IS POSTED ON THE OPPOSITE SIDE OF THE
ORIGINAL ENTRY.
BANK RECONCILIATION STATEMENT
ADVANTAGES OF BANK RECONCILIATION
. VERIFICATION OF ACCURACY OF ENTRIES
. TIMELY CORRECTIVE ACTION
. PREVENTS FRAUDS
. CONTROL TOOL FOR MANAGEMENT
TRIAL BALANCE
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DEFINITION
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IT IS A STATEMENT SHOWING CREDIT AND DEBIT
BALANCES FROM THE LEDGER.
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HELPS ARITHMETICAL ACCURACY AND FACILITATES
FINAL ACCOUNTS.
TRIAL BALANCE
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BASIC PRINCIPLE :
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SINCE IT IS DOUBLE ENTRY BOOK-KEEPING, HENCE,
ASSETS AND EXPENSES ARE DEBIT BALANCES
LIABILITIES AND INCOMES ARE CREDIT BALANCES
. IN CASE OF ARITHMETICAL INACCURACY IDENTIFY
CLERICAL/PRINCIPLE ERRORS AND RECTIFY
TRIAL BALANCE
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TYPES OF ERRORS:
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A) CLERICAL ERRORS
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-- ERRORS OF OMISSION
--- OMISSION OF TRANSACTION FROM BOOKS
--- COMPLETE OMISSION NOT AFFECTING TRIAL
BALANCE
--- PARTIAL OMISSION AFFECTING TRIAL
BALANCE
TRIAL BALANCE
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-- ERRORS OF COMMISSION
--- FIGURE POSTED ON THE WRONG SIDE OR WITH
WRONG AMOUNT
-- COMPENSATING ERRORS
--- ONE ERROR BALANCES ANOTHER ERROR
. B) ERRORS OF PRINCIPLE
-- ERRORS IN CONTRAVENTION OF ACCOUNTING
PRINCIPLES
TRIAL BALANCE
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RECTIFICATION OF ERRORS IS A SERIES OF STEPS:
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PASS THE CORRECT ENTRY
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COMPARE THE WRONG ENTRY WITH THE CORRECT
ONE
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PASS THE RECTIFICATION ENTRY
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IF TRIAL BALANCE DOES NOT TALLY THEN
DIFFERENCE IS TRANSFERRED TO SUSPENCE
ACCOUNT
TRIAL BALANCE
TYPICAL TRIAL BALANCE
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NAME
CAPITAL
DRAWINGS
PURCHASES
SALES
EXPENSES
DEBTORS(CUSTOMRES)
CREDITORS(SUPPLIERS)
CASH
SALES RETURN
DEBIT
CREDIT
X
X
X
X
X
X
X
X
X
TRIAL BALANCE
TYPICAL ERRORS:
-- CLERICAL:
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A) SALARY PAID 1000/- BUT POSTED AS 10, 000/-.
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RECTIFICATION: CREDIT SALARY WITH 9000/-.
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B) SALARY PAID 1000/- BUT POSTED IN RENT A/C.
RECTIFICATION: DEBIT SALARY AND CREDIT RENT WITH
1000/-.
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C) GOODS WORTH 100/- SOLD TO VIJAY WRONGLY
RECORDED IN PURCHASE REGISTER.
RECTIFICATION: CREDIT SALES AND PURCHASE A/Cs
WITH 100/- EACH AND DEBIT VIJAY WITH 200/-.
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TRIAL BALANCE
AFTER TRIAL BALANCE IS PREPARED ONE FINDS
.
.
D) SALES OF 500/- POSTED AS 5000/- WHILE RENT PAID
500/- POSTED AS 5000/-.
RECTIFICATION: DEBIT SALES WITH 4500/-, CREDIT
SUSPENCE WITH 4500/-, CREDIT RENT WITH 4500/-,
DEBIT SUSPENCE WITH 4500/-.
E) SALARY PAID AS 1000/- BUT POSTED AS 10,000/- IN RENT
A/C.
 RECTIFICATION: DEBIT SALARY WITH 1000/- SUSPENCE
WITH 9000/-; CREDIT RENT WITH 10000/
F) A PURCHASER’S DEBIT BALANCE OF 9000/- HAS NOT
BEEN TAKEN.
 RECTIFICATION: DEBIT DEBTORS, CREDIT SUSPENCE TO
THE EXTENT OF 9000/-.
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CAPITAL AND REVENUE EXPENDITURE
BASIC PRINCIPLE:
. ALL EXPENSES AND RECEIPTS OF REVENUE NATURE
ARE TAKEN TO TRADING AND PROFIT & LOSS
ACCOUNT
. ALL EXPENDITURES AND RECEIPTS OF CAPITAL
NATURE ARE TAKEN TO BALANCE SHEET
CAPITAL AND REVENUE EXPENDITURE
REVENUE RECEIPTS/PAYMENTS :
. ARE SMALLER IN SIZE(RELATIVELY)
. ARE RECURRING IN NATURE
. THE BENEFITS ARE OVER A SHORTER PERIOD (1 YEAR)
. THE PURPOSE IS TO RUN THE BUSINESS ON A DAY TO
DAY BASIS
. MAINTAIN ASSETS IN WORKING CONDITION
CAPITAL & REVENUE EXPENDITURE
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CAPITAL RECEIPTS/PAYMENTS:
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ARE USUALLY LARGE(RELATIVELY)
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ARE NON-RECURRING IN NATURE
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THE BENEFITS ARE OVER LONGER DURATION
THE PURPOSE IS TO ENHANCE PRODUCTIVITY OF
THE ASSETS
CAPITAL AND REVENUE EXPENDITURE
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THERE ARE CERTAIN EXPENDITURES WHICH ARE
OTHERWISE REVENUE IN NATURE BUT SOMETIMES
UNUSUALLY LARGE AND WHOSE BENEFIT TO THE
ORGANISATION MAY ACCRUE AFTER FEW YEARS.THESE
MAY BE TREATED AS DEFERRED REVENUE EXPENDITURE ,
CARRIED TO THE BALANCE SHEET , AND WRITTEN OFF TO
THE PROFIT & LOSS ACCOUNT OVER A PERIOD OF TIME.
CAPITAL AND REVENUE EXPENDITURE
SAME IS THE CASE WITH CERTAIN RECEIPTS SUCH AS
SALE OF ASSETS, WHERE THE RECEIPTS UPTO BOOK
VALUE IS DEDUCTED FROM THE ASSET, AND , IF
BETWEEN BOOK VALUE & COST AS REVENUE
RECEIPT & ABOVE COST AS CAPITAL RECEIPT.
. THERE IS A THIN LINE BETWEEN CAPITAL & REVENUE
CLASSIFICATION. FOR INSTANCE REPAIRS TO
MACHINERY WHICH KEEPS THE ASSET IN WORKING
CONDITION IS CHARGED TO THE P & L A/C WHILE
BETTERMENT EXPENSE IS CAPITALISED.
CAPITAL & REVENUE EXPENDITURE
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EXAMPLES OF EACH TYPE OF CLASSIFICATION:
CAPITAL NATURE:
-- PURCHASE OF ASSETS SUCH AS BUILDING,
MACHINERY, VEHICLES.
-- EXPENDITURE IN PURCHASE /SETTING UP OF
CAPITAL GOODS/ASSETS
-- EXCESS OF SALE PRICE OF ASSET OVER ITS COST
PRICE
-- FUNDS RAISED THRU BANKS/INSTITUTIONS
-- FUNDS RAISED THRU ISSUE OF SHARES, &
DEBENTURES
CAPITAL AND REVENUE EXPENDITURE
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REVENUE NATURE:
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ALL TRANSACTIONS RELATING TO NOMINAL
ACCOUNTS
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EVEN CERTAIN EXPENSES OF NON-RECURRING
NATURE BASED ON MATERIALITY CONCEPT
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EXCESS OF SALE VALUE OF ASSET OVER W D VALUE
UPTO COST OF ASSET
CAPITAL AND REVENUE EXPENDITURE
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DEFERRED REVENUE EXPENDITURE:
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LARGE ADVERTISING EXPENDITURE FOR(SAY)
LAUNCH OF A PRODUCT
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EXPENDITURE FOR RAISING OF FUNDS INCLUDING
PREPARATION OF PROJECT REPORT
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INITIAL EXPENSES FOR SETTING UP OF A COMPANY
DEPRECIATION
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DEPRECIATION IS A CHARGE ON PROFITS, TO
ACCOUNT FOR THE FALL IN THE VALUE( NOTIONAL
OR OTHERWISE ) OF AN ASSET DURING THE PERIOD
OF USE.
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DEPRECIATION OR WRITING OFF OF A CERTAIN
PORTION OF AN ASSET ON AN ANNUAL BASIS IS A
PRUDENT WAY OF SAVINGS FOR REPLACEMENT OF
THE ASSET AFTER ITS USEFUL LIFE IS OVER.
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SINCE DEPRECIATION IS AN OPERATING COST AND
THEREFORE TAX DEDUCTIBLE, EACH YEAR THE
SAVING IS TO THE EXTENT OF (TAX RATE)* ANNUAL
DEPRECIATION.
DEPRECIATION
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DEPRECIATION CAN ALSO BE LOOKED IN A
DIFFERENT WAY.
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DEPRECIATION IS AN ACCOUNTING PROCESS FOR
THE GRADUAL CONVERSION OF THE CAPITALIZED
COST OF FIXED(TANGIBLE) ASSETS INTO EXPENSE.
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SIMILARLY, INTANGIBLE ASSETS ARE CONVERTED
INTO EXPENSE BY AMORTISATION.
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WHILE ASSETS SUCH AS NATURAL RESOURCES ARE
CONVERTED BY PROCESS CALLED DEPLETION.
DEPRECIATION
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WHAT CAUSES DEPRECIATION ?
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SIMPLY WEAR AND TEAR
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OBSOLESCENCE
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PASSAGE OF TIME
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FALL IN VALUE
DEPRECIATION
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IN ORDER TO CALCULATE DEPRECIATION THERE ARE
BASIC ISSUES TO BE ASCERTAINED :
-- ESTIMATED USEFUL LIFE OF THE ASSET(YEARS).
-- THE RESIDUAL VALUE OF THE ASSET.
-- METHOD TO BE USED FOR PROVIDING
DEPRECIATION.
DEPRECIATION
METHODS OF DEPRECIATION :
. STRAIGHT LINE METHOD. EQUAL FRACTION OF THE
NET COST(COST OF THE ASSET LESS THE RESIDUAL
VALUE) IS CHARGED EACH YEAR.
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WRITTEN DOWN VALUE METHOD. EQUAL
PERCENTAGE OF THE WRITTEN DOWN VALUE IN THE
BOOKS OF THE COMPANY IS CHARGED EACH YEAR.
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SINKING FUND METHOD. IT IS STRAIGHT LINE
METHOD BUT THE DEPRECIATION CHARGED OR A
PORTION OF IT IS KEPT AS A RESERVE, INVESTED IN
MARKETABLE SECURITIES. THE FUND GROWS INTO
REPLACEMENT VALUE OF THE ASSET.
END