Financial Accounting: Concepts & Applications Textbook

(i) FI NANCI AL ACCOUNTI NG Conce pts a ndAppli ca tions (Te xta ndAssig nme nts) (ii) (iii) FI NANCI AL ACCOUNTI NG Conce pts a ndAppli ca tions (TextandAssignments) J. R. Monga Formerly Associate Professor of Commerce Shri Ram College of Commerce University of Delhi Raj Bahadur Assistant Professor College of Vocational Studies University of Delhi Computerised Accounting Systems Anuradha Aggarwal Assistant Professor Shri Ram College of Commerce University of Delhi Professional Advisor CA Dr. Girish Ahuja SCHOLAR Tech Press (iv) All Rights Reserved : No part of this book, including its style and presentation, may by reproduced, stored in a retrieval system, or transmitted in any form or by any means—electronic, mechanical photo-copying, recording or otherwise without the prior written consent of the author. Warning : The doing of an unauthorised act in relation to a copyright work may result in both civil claim for damages and criminal prosecution. Special Note : Photocopy or Xeroxing of educational books without the written permission of publisher is illegal and against Copyright Act. General : While every effort has been made to present authentic information and avoid errors, the author and the publisher are not responsible for the consequences of any action taken on the basis of this book. SCHOLAR Tech Press An Imprint of MKM PUBLISHERS Pvt. Ltd. New Delhi Sales Office : MKM Publishers Pvt. Ltd. 4782, 23 Darya Ganj, New Delhi-110002 Phones : 011- 40224951, Mob: 9810153571 E-mail : info@scholartechpress.in  © Publisher  First Edition : 1980 Thirty Sixth Revised and Updated Edition : 2020  Printed in India at : Nisha Enterprises Sahibabad, Ghaziabad, U.P.  ISBN: 978-81-933917-2-3 (v) Dedicated at the Holy Feet of Shirdi Sai Baba & Parthi Sathya Sai Baba (vi) Preface to the First Edition (Extracts) The ‘topic in financial accounting’, though not the only one, is not just another text book on accounting. It is intended to impart knowledge about the conceptual aspects of accounting-some of them written by eminent authors-have discussed the conceptual framework but the treatment is scanty because bulk of the material is devoted to mechanical aspects only. in this book, howerver, an attempt has been made to integrate both the aspects in the best possible manner and to suit the requirements of B. Com students whose courses of readings have undergone tremendous changes recently. In this book, the functional approach to the subject has been followed and thus very important issues have ben explained with the help of suitable example(s). Along with this, suitable graded comprehensive illustrations have been added beginning from the easy to moderately difficult and complicated ones. in addition, the model questions on thory and selected practial problems at the end of the book would give sufficient practice to the students on the topics that have been discussed in the text. The material in the book has been extensively drawn form the works of distinguished authors on the subject and thir names have been given inthe bibliography appended at the end of the book. The arrangement and presentation has been tailored to facilitate the students in the understanding of what accouning is and what accounting cna do for them. It is sincerely hoped that the topics in the text would be fourn useful not onloy by the B.com students but even by those preparing for post graduate and professional examinations specially those relating to flwo statemetns, inventory valuation, depreciation, price level changes etc. An opportunity is afforded to gratefully acknowledge the assistance rendered by my colleagues and friends in completing the book. I am particularly indebted to Sh. Balraj Gupta of Sri Venkateshwara College, Sh. G. K. Ahuja, F.C.A and Sh. Ramesh Chand ACA, my colleagues in the Department of Commerce for sugesting many improvements from time to tiem. S. Pirithi Pal Singh Chauhan. A.C.A., Senior Accounts Officer, India Tourism Development Corporation, was kind enough to go through the manuscripts of some of the topics and made valuable suggestions. Mrs. Kuldip Rani Bhardwaj, the first professional and qualified Librarian of Shri Ram College of commerce deserve special mention for having made available to me the necessary boks at the time when my movements were resticted due to an accident. I am thankful to my wife Mrs. Sashi Monga for having extended her fullest co-operation in completing the task in time and Sh. Surinder Malik of National Publishing House who afforded me an opportunity for writing this book. I would welcome and gratefully acknowledge any suggestions for the betterment of the book in subsequent editions. J. R. Monga (vii) OM SHREE SAI RAM Preface to the 36th Edition We are glad to present, before the faculty and students, the new revised and updated edition of Financial Accounting: Concepts and Applications. As the syllabus has been revised by the university under LOCF scheme, new chapters namely: Conceptual Framework of Accounting, Overview of Partnership Accounts (Fundamentals of Partnership, Admission of a New Partner and Retirement/ Death of a Partner) and Departmental Accounts have been included in the book. Accounting for leases has also been updated. As per suggestions received from teaching fraternity following alterations have been done in this new edition of book: Chapter 8: Final Accounts  Theory of GST has been incorporated with journal entries of GST (regarding SGST, CGST and IGST).  GST has been incorporated in practical problems (wherever necessary). Chapter 10: Accounting for PPE & Depreciation  Theory portion has been aligned in systematic manner.  Problems on changes in method of charging depreciation have been revised as per requirements of AS-10.  Problems and solutions have been modified as per prospective method only with conformity of AS-10. Chapter 13: Accounting for Leases  More theory and journal entries in the books of lessor and lessee have been incorporated. Chapter 15: Departmental Accounting  More illustrations have been added.  Problems based on – only two or three departments have been retained/ modified as per requirement of syllabus passed in guideline meeting of the Department of Commerce. Chapter 16: Partnership (An Overview)  Contents have been reduced and only main points of concern topics have been discussed.  Chapter has been reduced from 110 pages to 53 pages only. Chapter 17: Dissolution of Firm  The whole chapter has been streamlined.  More illustrations and problems in exercise have been incorporated on the topic “Maximum Possible Loss Method”. It is hoped that the new edition of the book would meet the requirements of the students and teaching fraternity. The language of the book continues to be simple and all the important aspects have been explained point wise as required by the students. We have also received spontaneous help from the teaching community of various colleges and private institutions as well as the students of the subject. It is hoped that they will continue to do the same in future too. We are thankful to Dr. Inderjeet Singh (Principal), Sh. S.K Bhatia and Dr. Surender Singh, College of Vocational Studies, Sh. Pradeep Aggarwal, Moti Lal Nehru College, Mrs. Madhu Jain, Maitreyi College, Amita Motwani, Jesus and Mary College, Dr. Rajiv Kaur, Aditi Mahavidyalaya and Dr. Gurchan Sachdeva, P.G. D.A.V. College for encouraging us to revise and upgrade the present edition of book. For all queries relating to sale and specimen copies, you may contact Shri Atul Malik on his Mobile No. 9810153571. J.R. Monga Raj Bahadur rajbahadur@cvs.du.ac.in 9873899846 (viii) Acknowledgement Sincere thanks to Sh. Ashok Gupta and Sh. Gurcharan Sachdeva, P.G.D.A.V. College and Mrs. Madhu Jain, Maitreyi College and Jitender Chawala, Dayal Singh College (Morning) for pointing out glaring errors. I am also grateful to Sh. PD Saini, Aryabhatta College, Sh. Ashok Paswan, Hindu College and Mrs. Veena Jain, Vivekanand College for valuable feedback about the book. I would also like to mention the name of Mrs. Rajiv Kaur, Aditi College for encouraging me to remain on the job of writing work. The unconditional support rendered by following teachers is praiseworthy: Ms. Surender Kaur : Sh. Gurjinder Singh : Dr. Rajiv Kaur : Ms. Indu Dahiya : Ms. Rashi Paliwal : Ms. Anu Priya : Sh. Dilip Kumar Gupta : Sh. P. D. Sani : Ms. Pritika Dua : Ms. Deepti Singh : Ms. Reena Talwar : Ms. Arshi : Sh. K.M. Bansal : Sh. Sujeet Kumar : Sh. M.P. Meena : Sh. S. K. Bhatia : Ms. Neerja Arya : Ms. Sunita Goel : Ms. Minakshi : Ms. Tonika Rana : Ms. Vani Kanojia : Sh. Deepak Sehgal : Ms. Depali Sehgal : Sh. Kishore : Ms. Meenu : Ms. Jyoti Paul : Sh. Arun Kumar : Sh. Amit : Ms. Indu Gupta : Ms. Neha Birwal : Sh. Anurag : Ms. Nidhi Gupta : Ms. Rupal : Ms. Sonal Sharma : Aacharya Narender Dev College Aacharya Narender Dev College Aditi College Aditi College Aditi College ARSD College ARSD College Aryabhatta College Aryabhatta College Bharti College Bharti College Bharti College Bhim Rao Ambedkar College Bhim Rao Ambedkar College Bhim Rao Ambedkar College College of Vocational Studies College of Vocational Studies Daulat Ram College Daulat Ram College Daulat Ram College Daulat Ram College Deen Dayal Upadhaya College Deen Dayal Upadhaya College Delhi College ofArts and Commerce Deshbandhu Gupta College Dyal Singh College Dyal Singh College Dyal Singh College Dyal Singh College (E) Dyal Singh College (E) Dyal Singh College (E) Gargi College Gargi College Hansraj College Ms. Sneha : Ms. Preetinder Kaur : Sh. 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Amit Kumar Mrs. Madhu Jain Ms. Priyanka Shani Ms. Karishma Ms. Jaspal Sahni Ms. Kanwaljeet Kaur Ms. Tajinder Kaur Hansraj College Hansraj College Hansraj College Hindu College Hindu College Indraprastha College for Women Indraprastha College for Women Janki Devi Memorial College Janki Devi Memorial College Jesus and Mary College Jesus and Mary College Kalindi College Kalindi College Kalindi College : Kamla Nehru College : Kamla Nehru College : Keshav Mahavidhalya : Keshav Mahavidhalya : Kirori Mal College : Kirori Mal College : Lady Shri Ram College : Laxmi Bai College : Laxmi Bai College : Laxmi Bai College : Maharaja Aggarsen College : Maharaja Aggarsen College : Maharaja Aggarsen College : Maharaja Aggarsen College : Maiteryi College : Maiteryi College : Maiteryi College : Mata Sundri College : Mata Sundri College : Mata Sundri College Ms. Kiranpreet : Mata Sundri College Ms. Puneet Kumar Dhingra Ms. Manpreet Kaur Ms. Jaspreet Kaur Sh. Pradeep Aggarwal Ms. Divya Gupta Ms. Monika Sh. Ravinder Ms. Renu Ms. Poonam Khanna Sh. Surender Singh Sh. Rakesh Sh. Gurucharan Sachdeva Ms. Sonika Nagpal Sh. Abdesh Tiwari Ms. Karishma Saraswati Sh. Rajender Kumar Sh. Nirmal Kumar Ms. Laxmi Ms. Ritu Vats Sh. Pankaj Gupta Ms. Archna Chauhan Sh. Mohinder Sh. Bateshwar Singh Sh. Dhani Ram Ms. Charu Kapoor Sh. Ashok Sehgal : : : : : : : : : : : : : : : : : : : : : : : : : : Sh. Nwang Jiachhen : SRCC Mrs. Saroj Joshi : SRCC Dr. Alok Kumar : SRCC Ms. Deepika Bansal : SRCC Ms. Richa Goel : SRCC Ms. Kavita Aggarwal : SRCC Sh. R.K. Sen : SRCC Sh. Manpreet Sharma : SRCC Mata Sundri College Mata Sundri College Mata Sundri College Moti Lal Nehru College Moti Lal Nehru College Moti Lal Nehru College (E) Moti Lal Nehru College (E) Moti Lal Nehru College (E) Moti Lal Nehru College (E) P.G. D.A.V. College P.G. D.A.V. College P.G. D.A.V. College P.G. D.A.V. College (E) P.G. D.A.V. College (E) P.G. D.A.V. College (E) Rajdhani College Rajdhani College Rajdhani College Ram Lal Anand College Ramanujan College Ramanujan College Ramanujan College Ramjas College Ramjas College Ramjas College SRCC Sh. Anil Kumar : SRCC Ms. Pooja Dhingra : SRCC Ms. Promila Bhardwaj Sh. Rajkumar Ms. Amla Gour Sh. Radheshyam Sh. S.C Panda Ms. Kanika Ms. Ritika Sh. K. L. Dhaiya Sh. K.B. Gupta Sh. N.K. Aggarwal : : : : : : : : : : Satyawati College Satyawati College Satyawati College Satyawati College Satyawati College (E) Satyawati College (E) Satyawati College (E) School of Open Learning School of Opening Learning School of Open Learning (ix) Sh. Rakesh Ms. Shikha Rajput Sh. Hashir Sh. Brijesh Yadav Sh. Anil Kumar Ms. Rachna Ms. Aarti Kadyan Ms. Chandani Sh. Y.P. Tyagi Sh. N.K. Puri Sh. M.C. Sharma Ms. Vinney Narang Sh. Ramesh Kumar Ms. Vinita Sh. Ritesh Ms. Monika Sh. Rohit Shah Sh. Manu Umesh Sh. A.K. Tripathi Sh. Rajinder Sh. Manu Umesh Ms. Nirmal Tiwari : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College : Shaheed Bhagat Singh College (E) : Shaheed Bhagat Singh College (E) : Shaheed Bhagat Singh College (E) : Shaheed Bhagat Singh College (E) : Shaheed Sukhdev College : Shivaji College : Shivaji College : Shyam Lal College : Shyam Lal College : Shyam Lal College (E) : Shyam Lal College (E) : Shyam Lal College (E) : Shyam Lal College (E) : Shyama Prasad Mukherji College for Women Ms. Alpna : Shyama Prasad Mukherji College for Women Ms. Prabha Rana : Shyama Prasad Mukherji College for Women Ms. Silky Jain : Sri Aurobindo College Sh. Prem : Sri Aurobindo College Sh. Bunny Singh : Sri Aurobindo College Dr. R. K. Batra : Sri Aurobindo College (E) Ms. Rovika : Sri Aurobindo College (E) Sh. R.K. Mishra : Sri Aurobindo College (E) Ms. Manju Bhatia : Shri Guru Gobind Singh College Ms. Navdeep Kaur : Shri Guru Gobind Singh College Ms. Surjeet Kaur : Shri Guru Gobind Singh College Ms. Meenu Gupta : Shri Guru Gobind Singh College Sh. Daya Shankar : Shri Guru Nanak Dev Khalsa College Ms. Manmeet : Shri Guru Nanak Dev Khalsa College Sh. A. K. Kaushik : Shri Guru Nanak Dev Khalsa College Sh. Mahesh Kumar : Shri Guru Nanak Dev Khalsa College Sh. Bibhu Prasad : Sri Guru Teg Bahadur Khalsa College Ms.Era Khemchandani: Sri Guru Teg Bahadur Khalsa College Sh. S.K. Sharma : Sri Guru Teg Bahadur Khalsa College Sh. Ajit Singh : Shri Venketashwara College Ms. Shilpa : Shri Venketashwara College Sh. Om Dutta : Swami Shradhanand College Sh. R K Joshi : Swami Shradhnand College Sh. L R Paliwal : Swami Shradhnand College (x) Ms. Madhu Monga Ms. Veena Jain Ms. Meenakshi Aggarwal Dr. Mohd. Rizwan Ahmed Sh. Ashok Kumar : : : : : Swami Shradhnand College Vivekananda College Vivekananda College Zakir Hussain College Zakir Hussain College Dr. Pakiza Sh. S.C. Bhatia Ms. Urmila Bharti Sh. Deepak Batra : : : : Zakir Hussain College (E) Zakir Hussain College (E) Zakir Hussain College (E) Bhai Parmanand Institute of Business Studies The following owners of coaching centres always remain alert and active in pinpointing short comings in the text and practicals: A.K. Dugglal : Duggal College of Education, Rajouri Garden Sh. Vijay Kumar : Elite Academy Shastri Nagar Gulab Singh : S.S. Coaching Centres, Virender Nagar, Janakpuri Sh. Chirag Sharma : Sarswati Academy for Professionals, Tilak Nagar Rajesh Sinha : Aadharshila Institute, Uttam Nagar Rajinder Kalra : Kalra Institute of Commerece, Hari Nagar G.N. Joshi (Tutor) : Shree Apartment, Rohini Reena Banga : Banga Institute, Janakpuri Sh. Sukesh C. Khajuria : Commerce Classes 4 U, Jammu Sh. Anil Mehra : Unique Academy, Netaji Nagar Sh. Vikas Vijay : Teaching Point Tutorial Inderlok Sh. Sonu Arora : Sonu Institute of Commerce and Science, Hudson Lane and Outram Lane CA Ajay Verma : Institute of Commerce, Patel Nagar CA Ashok Mahajan : Tutor, Rohini CMA Joshi : Tutor, Rohini Vimal Kumar : Tutor, Dilshad Garden Chandra Mohan Gupta : Tutor, Rohini, Sector-13 DOWN MEMORY LANE Dr. Balbir Singh, Sh. S.P. Jain, Sh. R.S. Aggarwal, Sh. S.K. Jain and Sh. G.R. Sahni, Mrs. Usha Jain, Sh. S. C. Malhotra, Sh. Rajeshwar Sharma, Sh. S.C. Aggarwal. (xi) B.Com (Hons.) Semester - I (CBCS) Paper BCH 1.2: Financial Accounting Duration: 3Hrs. Marks: 100 Credits: 6 Course Objective This course provides conceptual knowledge of financial accounting and the techniques for preparing accounts in different types of business organisations. Course Learning Outcomes After the successful completion of this course, the student will be able to: CO1: Understand the theoretical framework of accounting and to prepare financial statements CO2: Explain and determine depreciation and value of inventory CO3: Learn accounting for hire purchase transactions, leases, branches and departments CO4: Understand the concepts of partnership firm and prepare accounts for dissolution of a partnership firm CO5: Develop the skill of preparation of trading and profit and loss account and balance sheet using computerized accounting. Course Contents Unit-1: Introduction Conceptual Framework: Accounting principle, Concepts and Conventions, Introduction to Accounting Standards and Indian Accounting Standards (AS & Ind AS), Accounting Process: Journal, Ledger, Trial Balance, Financial Statements (overview), Capital Expenditure (and Receipts), Revenue Expenditure (and Receipts) and Deferred Revenue Expenditure. Preparation of Financial Statements of a Profit Making Sole Proprietorship Trading Firm with Additional Information, Preparation of Financial Statements of a Not for Profit Organisations. Unit-2: Depreciation Accounting and Inventory Valuation Accounting for Plant Property and Equipment & Depreciation: Meaning of Depreciation, Depletion and Amortization, Objective and Methods of Depreciation (Straight line, Diminishing Balance), Change of Method, Inventory Valuation: Meaning, Significance of Inventory Valuation, Inventory Record System-Periodic and Perpetual, Methods of Inventory Valuation-FIFO, LIFO and Weighted Average (Relevant Accounting Standards as Applicable) Unit-3: Special Types of Accounting Hire Purchase Accounting: Calculation of Interest, Partial and Full Repossession, Profit Computation (Stock & Debtors System only), Accounting for Leases: Concept, Classification of Leases (simple practical problems), Accounting for Branches (excluding foreign branches): Dependent Branches (‘Debtors System’and ‘Stock & Debtors System’) and Overview of Independent Branches. Departmental Accounting: Concept, Type of Departments, Basis of Allocation of Departmental Expenses, Methods of Departmental Accounting (excluding memorandum stock and memorandum mark-up account method) (Relevant Accounting Standards as Applicable) Unit-4: Accounting for Partnership Firm Partnership Accounts: Fundamentals, Admission, Retirement and Death of a Partner (only an overview), Accounting for Dissolution of Partnership Firm: Dissolution of Partnership Firm including Insolvency of Partners (excluding sale to a limited company), Gradual Realization of Assets and Piecemeal Payment of Liabilities Unit-5: Computerized Accounting System Computerized Accounting System: Computerized Accounts by using any Popular Accounting Software: Creating a Company; Configure and Features Settings; Creating Accounting Ledgers and Groups, Creating Stock Items and Groups; Vouchers Entry; Generating Reports – Cash Book, Ledger Accounts, Trail Balance, Profit and Loss Account, Balance Sheet, Funds Flow Statement, Cash Flow Statement, Selecting and Shutting a Company; Backup and Restore of Data of a Company Note: Latest Accounting Standards to be followed (xii) (xiii) CONTENTS UNIT – I : INTRODUCTION 1. INTRODUCTION • Financial Accounting • Accounting as an Information System • The Users of Accounting Information • Qualitative Characteristics of Accounting Information: 1. Understandability 2. Relevance 3. Reliability 4. Comparability • Functions of Accounting • Advantages of Accounting • Limitations of Accounting • Branches or Divisions of Accounting • Bases of Accounting • Cash Basis of Accounting • Accrual Basis of Accounting • Difference Between Cash Basis and Accrual Basis of Accounting • Systems of Accounting 1.1 - 1.13 2. CONCEPTUAL FRAMEWORK • Meaning • Levels of Conceptual Framework • How does the Framework Affect the Application of Accounting Standards? • Who Benefits from a Framework and why is it Needed? 2.1 - 2.4 3. FINANCIAL ACCOUNTING PRINCIPLES • Nature of Accounting Principles • Characteristics of Accounting Principles • Basic Concepts • The Entity Concept • Money Measurement Concept • The Going Concern Concept • The Cost Concept • Periodicity Concept (The Accounting Period Concept) • The Realisation Concept • The Accrual Concept • Accounting Conventions • Accounting Concepts Vs. Accounting Conventions • Consistency Convention • The Prudence Convention (Convention of Conservatism) The Materiality Convention • The Full Disclosure Convention 3.1 - 3.13 4. FINANCIAL ACCOUNTING STANDARDS • Introduction • Concept of Accounting Standards • Accounting Concepts and Accounting Standards • Benefits of Accounting Standards • Procedure for Issue of Accounting Standards in India • Objectives of Accounting Standards • Salient Features of Accounting Standard (AS) - I: Disclosure of Accounting Policies • Nature of Accounting Policies • Fundamental Accounting Assumptions • Difference Between Fundamental Assumptions and Accounting Policies • Importance of Accounting Policies • Sources of Accounting Policies • Selection of Accounting Policies • Changes in Accounting Policies • Disclosure of Accounting Policies • Reasons for Disclosure in Accounting Policies • Appendix: Ind AS (Indian Accounting Standard)-8 4.1 - 4.14 5. INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs)/Ind-AS • Background • Meaning and Features • Need for IFRSs • Some Clarifications • Benefits of Convergence to IFRSs • Procedures • Difficulties or Challenges in Adopting IFRSs • Meaning of Indian Accounting Standard (Ind-AS) • Distinction Between Indian Accounting Standards (Ind AS) and Accounting Standards (AS) • Roadmap or Implementation of Ind-AS in India 5.1 - 5.10 6. ACCOUNTING PROCESS : AN OVERVIEW • Concept of Accounting Process • The Journal (Or Journal Proper) • Journalising • Analysis and Journalising of Some Business Transactions • Analysis of Business Transactions • Types of Entries • Opening Entry • Ledger: Meaning and Features • Standard Form of a Ledger Account • Posting of Transactions From General Journal • Interpretation of a Ledger Account • Balancing of Accounts • Balancing of Personal Accounts • Balancing of Real Accounts • Balancing of Nominal Accounts • Subsidiary Books • Cash Book : A Journalised Ledger • Single Column Cash Book • Cash Book with Discount Columns • Cash Book with Discount, Office Cash and Bank Columns [The Record of Bank Transactions] • Posting of Cash-Book with Discount, Office Cash and Bank Columns • Petty Cash Book • The Imprest System • Purchases Book • Posting of the Purchases Book • Sales Book • Posting of the Sales Book • Purchases Returns Book • Posting of Purchases Returns Book • Sales Returns Book • Posting of Sales Returns Book • Bills Receivable Book • Bills Payable Book • Posting of Bills Receivable and Bills Payable Books• Nature and Features of a Trial Balance • Objects of a Trial Balance • Limitations of a Trial Balance • Format of a Trial Balance • Preparation of a Trial Balance • Check List of Most Frequent Debit and Credit Balances• Trial Balance : Not a Conclusive Proof of Accuracy • Errors Disclosed by a Trial Balance 6.1 - 6.52 (xiv) 7. CAPITAL AND REVENUE ITEMS 7.1 - 7.8 • Capital Expenditures • Revenue Expenditures • Distinction Between Capital and Revenue Expenditures • Revenue Expenditures Becoming or to be Treated as Capital Expenditures • Deferred Revenue Expenditures • Distinction between Capital Expenditures and Deferred Revenue Expenditures • Capital and Revenue Receipts • Capitalised Expenditure 8. FINAL ACCOUNTS OF NON-CORPORATE ENTITIES 8.1 - 8.114 • Trading Account • Direct Expenses on Goods • Profit and Loss Account • Preparation of Profit and Loss Account • Difference Between Outstanding Income and Accrued Income • Meaning of Operating Profit • Meaning of Non-operating Profit • Consideration of Some Individual Items • Manufacturing Account • Difference Between Trading Account and Manufacturing Account • Balance Sheet • Classification of Assets • Classification of Liabilities • Capital or Owner(s)’ Equity • Grouping and Marshalling • Advantages of Marshalling • Methods of Marshalling • Adjustments • Most Frequent Adjustment Entries • Consideration of Some Important Points while Preparing the Final Accounts of a Sole Trader • Adjustments at a Glance • Profit and Loss Appropriation Account 9. FINAL ACCOUNTS OF NOT-FOR-PROFIT ORGANISATIONS •Meaning • Types or Forms • Characteristics or Features of NPOs • Need for Maintaining Accounts • Difference Between Profit Making (Trading) and Not- For Profit (Non-trading) Organisations • Books of Account and Registers • Final Accounts • Receipts and Payments Account • Features of Receipts and Payments Account • Advantages of Receipts and Payments Account • Disadvantages or Limitations of Receipts and Payments Account • Difference Between Cash Book and Receipts and Payments Account • Distinction Between Receipt and Income • Difference Between Payment and Expenditure • Income and Expenditure Account • Features of Income and Expenditure Account • What is Income • What is Expenditure or Expense • Distinction Between Income and Expenditure Accouts and Receipts and Payments Account • Difference Between Income and Expenditure Account and Profit and Loss Account • Balance Sheet • Difference Between Capital and Capital Fund • Treatment of some Special Items in the Final Accounts of a NPO • Rules Regarding Income and Expenses Related to a Particular Fund • Preparation of Income and Expenditure Account and Balance Sheet from the given Receipts and Payments Account • Preparation of Receipts and Payments Account • When Balance Sheets are to be Prepared • Receipts and Expenditure Account 9.1 - 9.119 UNIT – II : DEPRECIATION ACCOUNTING AND INVENTORY VALUATION 10. ACCOUNTING FOR PROPERTY, PLANT AND EQUIPMENT & DEPRECIATION 10.1 - 10.70 • Introduction • Property Plant and Equipment • Objectives of AS-10 PPE • Scope of AS-10 PPE • Definitions • Subsequent Costs (Repairs and Maintenance) • Measurement at Recognition • Revaluation of Assets • Depletion, Amortization and Obsolescence • Accounting Concept of Depreciation • Characteristics of Depreciation • Need or Necessity for Depreciation • The Causes of Depreciation • Factors or Elements Affecting Depreciation • Is Depreciation a Source of Funds? • Calculation of Depreciation for Assets Purchased During the Year • Accounting Treatment • Methods of Providing Depreciation • Component Accounting • Example of Component Accounting • Straight Line Method (Fixed or Equal Instalment Method) • Diminishing Balance Method • Difference between Straight Line Method and Diminishing Balance Method • Units of Production Method • Sale or Disposal of Fixed Assets • Provision for Depreciation Accounts • Change of Method (Prospectively) • Assets Disposal (Scrapped) Account • Loss by Accident and Insurance Claim 11. INVENTORIES (AS - 2) 11.1 - 11.39 • Meaning of Inventory • Objectives of Inventory Valuation • Accounting Standard (AS)-2 (Revised) • Objective and Scope of Ind. AS-2 • Definitions • Measurement • Cost of Inventories • Cost Formulas • Costs not Included • Recognition as an Expense • Disclosure • Inventory Systems • Points of Difference (Periodic vs. Perpetual Inventory System) • Methods of Valuation of Inventories • Valuation of Stock (FIFO) • Valuation of Stock (Weighed Average) UNIT – III : SPECIAL TYPES OF ACCOUNTING 12. ACCOUNTING FOR HIRE PURCHASE • Meaning of Hire Purchase System • Legal Position • Features of Hire Purchases System • Legal Position on Default • Difference Between Hire Purchase System and Credit Sale • Instalment Purchase System • Features of 12.1 - 12.96 (xv) Instalment Purchase System • Difference Between Hire Purchase System and Instlament System • Meaning of Technical Terms used In the Hire Purchase Agreement • Calculation of Interest • Accounting Treatment in Hire Purchaser’s Books • Accounting Treatment in the Books of Hire Vendor • Preparation of Necessary Accounts • Accrual System of Hire Purchase • Default and Repossession • Full Repossession • Partial Repossession • Hire Purchase Trading Account • Hire Purchase Trading Account at Cost Price • Hire Purchase Trading Account at Selling Price • Repossession of Goods • Conservatism Principle and Profit on Revaluation • Calculation of Missing Figure • Stock and Debtors System • Instalment System: Accounting Treatment 13. ACCOUNTING FOR LEASES • Concept and Procedure • Purchasing and Leasing an Asset • Advantages of Leasing • Disadvantages of Leasing • Main Types of Leasing • Operating or Non-Pay out Lease • Financial or Full Pay-Out Lease • Financial Lease vs. Operating Lease • Accounting for Finance Leases (Books of Lessee) • Interest Rate Implicit on Lease • Accounting for Finance Lease (Books of Lessor) • Accounting for Operating Lease • Difference between AS-19 and Ind AS-116 13.1 - 13.17 14. ACCOUNTING FOR INLAND BRANCHES 14.1 - 14.70 • Nature of Branch Accounting • Features of Dependent Branches • Accounting For Dependent Branches • Debtors System • Salient Features of Debtors System • Memorandum Branch Debtors Account • Transferred to Branch at Loaded Price • Stock and Debtors System • Branch Stock Account • Branch Adjustment Account • Branch Profit and Loss Account • Branch Expenses Account • Branch Assets Account • Accounting Treatment for Stock-debtors System • Cash Losses at Branch • Treatment of Surplus or Small Gains • Loss of Branch Stock • Branch Debtors Account • Branch Expenses Account • Branch Adjustment Account • Local Purchases by the Branch • Independent Branches (An Overview): Branch Keeping Full System of Accounting • Goods-in-Transit • Cash (Remittances) in-Transit • Accounts of Fixed Assets • Inter-Branch Transcations 15. DEPARTMENTAL ACCOUNTING 15.1 - 15.22 • Meaning and Purpose • Advantages of Departmental Accounting • Difference between Departmental Accounting and Branch Accounting • Methods of Departmental Accounting • Allocation of Expenses • Types of Departments • Inter-Department Transfers (Transfer from one Department to Another) UNIT – IV : ACCOUNTING FOR PARTNERSHIP FIRM 16. PARTNERSHIP ACCOUNTS: AN OVERVIEW 16.1 - 16.53 Fundamentals of Partnership: • Definition and Essentials • Nature of Partnership • Minimum and Maximum Numbers of Partners • Partnership Deed • Contents of Partnership Deed • Provisions of Partnership Act Affecting Accounting Treatment • Capital Accounts • Fixed Capital Accounts • Fluctuating Capital Accounts • Distinction between Fixed and Fluctuating Capital Accounts • Profit and Loss Appropriation Account • Interest on Capital • Interest on Drawings • Partners' Salaries • Partners' Loan Accounts • Capital Accounts • Capital Ratio • Past Adjustments • Guarantee of Profit to a Partner. Admission of a Partner: • Changes in Profit Sharing Ratio • Meaning of Goodwill • Methods of Valuation of Goodwill • Accounting Treatment of Goodwill • No Goodwill Account in the Books of Account • Revaluation of Assets and Liabilities • When the Revised Values are not to be Recorded in the Books • Treatment of Undistributed Profits/Reserves • Adjustment Regarding Capitals • Adjustment of Joint Life Policy. Retirement/Death of a Partner: • Effect of Retirement/Death • Calculation of the amount to be paid • Mode of Payment • Calculation of Gaining or Benefit Ratio • Valuation of Goodwill • Accounting Treatment of Goodwill • Revaluation of Assets and Liabilities • Reserves and Undistributed Profits or Losses • Calculation of profit on the Date of Retirement/Death • Adjustment of Capitals • Repayment of the Amount due • Accounting Implications 17. ACCOUNTING FOR DISSOLUTION OF PARTNERSHIP FIRM • Meaning and Legal Position • Settlement of Accounts • Firm Debts Vs. Private Debts • Distinction Between Private Debts and Firm’s Debts • Accounting Treatment • Distinction Between Realisation Account and Revaluation Account • Journal Entries • Accumulated Reserves, Profits, Losses and Fund Accounts • Goodwill on Dissolution • Unrecorded Assets and Liabilities • Insolvency of Partner(s) • Decision in Garner Vs. Murray 17.1 - 17.104 (xvi) • Fixed Vs. Fluctuating Capitals • When All Partners Are Insolvent • Piecemeal Distribution • Order of Payment • Proportionate or Surplus Capital Method • Maximum Possible Loss Method UNIT – V : COMPUTERIZED ACCOUNTING SYSTEM 18. COMPUTERISED ACCOUNTING SYSTEM 18.1 –18.54 • Background • Advantages of Computers in Accounting • Disadvantages of Computers • Accounting Process (or Cycle) • Gateway of Tally Screen • Steps for Creation of Final Accounts in Tally • Buttons at Gateway of Tally Related to Company • General • Numeric Symbol • Accounts/Inventories Information • Groups formation (under inventory Info.) • Types of Vouchers • Conversion of Voucher from one Type to Another • Generating Reports • Trial Balance • Cash Flow Statement • Fund Flow Statement • Selecting and Shutting a Company • Backup and Restore Data of the Company Examination Paper with Solution (2019) E.1 – E.16 1 I ntroduction FINANCIAL ACCOUNTING In accounting literature, the two terms, namely: Accounting and Financial Accounting are used interchangeably. But accounting is a tree while financial accounting is one of its branches. All accounting work in the beginning was in the nature of financial accounting which was used to record business transactions for a certain period usually called accounting period. Then, these transactions were classified and summarized in the form of profit and loss account to calculate or find out profit or loss for the accounting period which is generally of one year. Financial Accounting also helps to know the financial position of the business enterprise as on the last date of the accounting period in the form of assets possessed or owned by it (the enterprise) and the liabilities owing to others. The statement showing the Financial Position is technically called the Balance Sheet. ACCOUNTING AS AN INFORMATION SYSTEM Accounting is often referred to as the language of business. The primary aim or purpose of a language is to serve as a means of communication. Accounting is used to communicate financial and other information to people, organisations, Governments etc., about various aspects of business and non-business enterprises. Accounting information is used when Mr. A applies for a loan at a bank or when A submits his income-tax returns. Business enterprises use accounting for their day-to-day activities and to report the results of these activities to their owners, creditors, employees and Governmental agencies. The accounting is, therefore, also an information system. In today’s society, many persons and agencies outside the management are involved in the economic life of an organisation. These persons frequently require financial or accounting information to make reasoned choices among alternative uses of scarce or limited resources in the conduct of the business and economic activities. For example, shareholders must have financial information in order to measure management’s performance and to evaluate their own investments. Potential investors need financial data in order to compare prospective investments. Creditors must consider the financial strength of the business before granting loans. Also labour unions, financial analysts and economists often expect a considerable amount of financial data. Finally, many laws require that extensive financial information be reported to the various Government departments or agencies such as income-tax, sales tax and excise authorities, tribunals etc. Simply stated, actual accounting is concerned with communicating the results of the operations of an organisation. The term ‘system’ is well recognised. A system is a set of elements which operate together in order to attain a goal. The following are examples of some systems and are analysed in this manner: System Elements Basic Goals College Teachers, Students, Library, Office Education Hospital Doctors, Medicines, Equipments, Building Treatment of Patients Police Men, Equipment, Communication network, Building Crime Control [1.1] 1.2 Financial Accounting: Concepts and Applications Simply stated accounting system converts inputs (financial transactions) into outputs (financial statements) and it is given below: Inputs Business Transactions and Events (Collection of Data) Process Accounting Concepts and Conventions Output Profit and Loss Account Balance Sheet Cash-Flow Statement THE USERS OF ACCOUNTING INFORMATION There are various groups of people who use accounting information for their different needs. These users of accounting information may be classified into two categories namely, (i) Internal users and (ii) External users. (i) Internal users: They are directly involved in running or managing the business enterprise such as officers, and partners (directors in the case of joint stock companies) and owners or sole traders. They need accounting information for the efficient running of the business enterprise. Their needs are met from the use of income statement (Profit and Loss Account), Balance Sheet and Cash-Flow Statement. Internal users have direct access to lot of private and confidential reports known as internal reports which contain valuable information relating to manufacturing cost of a product, pricing of different products for sale purpose; whether the product should be manufactured or purchased from outside; whether a new product is to be launched (introduced) or a particular product should be discontinued. (ii) External users: Persons, individuals or organisations, who have some present or future interest in the economic activities of the business enterprise are external users. They are not part of management team. They make use of published annual reports which contain income statement, balance sheet and cashflow statement. The annual reports also contain important information about the activities of the business enterprise. The external users are: shareholders (investors) of a joint stock company, trade or labour unions of employees, creditors (suppliers of goods and services on credit), customers, government, researchers and so on. Following table indicates some of the users of accounting information and their needs for specific information: Users (i) Owners or Proprietors or Partners Need for information Their need for accounting information is mainly concerned with the financial position of the firm, rate of return on the capital employed and efficient utilisation of scarce resources. (ii) Existing shareholders (Present Investors) They are interested in the profitability and solvency of the company. They also want to know whether the profits of the company are increasing or decreasing, whether the company shall pay more dividends in future. On the basis of trends in profitability, they decide whether they should invest more money in the company or they should hold the present number of shares or they should sell out their investments or shares etc.. (iii) Potential investors (Those who intend or want to invest) Basically they will be interested not only in the dividends of the current year only but they are also interested in the information about the dividends paid in the past few years. They can determine that this progress or trend will be maintained in future as well. The statement of the chairman of the company in the annual reports provides some indication about the future progress of the company. So it is necessary that accounting information helps them whether they should buy the shares of the company or not (iv) Management With the separation of management and ownership in the case of joint stock companies, the managers are responsible for carrying on the business activities of an enterprise. They need accounting information – (a) To set targets for future periods; (b) To observe and measure the performance of the various departments within a business enterprise; Introduction 1.3 (c) To evaluate the performance against the targets highlighting the departures or deviations from the targets and (d) To take corrective steps if there are shortfalls. In addition, the management also needs information (for all types of business organisations) to review the firm’s: (a) Short-term and long-term solvency. (b) Profitability in relation to total sales; (c) Effective utilization of limited resources and (d) Profitability in relation to capital employed so that management can take necessary action to run the business smoothly. (v) Creditors and shortterm lenders Creditors include suppliers of goods and services on credit. Short-term lenders are generally commercial banks who lend money for short periods. They need accounting information to know whether the borrowing business firm shall be able to pay interest periodically or regularly and also pay back the principal amount on maturity date. Their specific interest lies in solvency, liquidity and profitability of the business enterprise. (vi) Long-term lenders This category includes debentureholders, industrial banks non-banking financial institutions etc. They are interested in the regular interest payments on their loans and also the repayment of principal amount when the same is due or repayable. They are, therefore, interested in profitability, liquidity, solvency for payment of loan amount. The availability of cash flow statement in addition to income statement and balance sheet has considerably helped to judge the liquidity position of the enterprise. (vii) Employees through labour unions Employees who are represented by labour unions are interested in more salaries, overtime payments, bonus, medical facilities etc., and interested in the earning capacity of the firm. Accouting information provides facts and figures about the earning capacity and thus increases their bargaining power. Financial reports highlight what the management is doing for the welfare of the employees and what they intend to do in future. (viii) Government(s) The economic activities of central, state and local governments are financed through collection of tax. Thus, the accounting information about business activities is very helpful in the collection of income tax, goods and services tax (GST), customs duties, excise duties and so on. Each tax requires special accounting information of various business enterprises. Any distortion or manipulation in the accounting information would adversely affect the welfare policies of the government because of less collection of tax. (ix) Regulatory Agencies A number of regulatory authorities or agencies like Securities Exchange Board of India (SEBI), the Insurance Regulatory Authority, the Reserve Bank of India etc., need accounting information for the efficient operations of the capital markets. (x) Individuals and Society People are affected by the economic activities or operations of a business enterprise in their localities. The accounting information discloses the well-being or prosperity of various business enterprises and also the type of activities in their localities. Such information would be useful to know the employment opportunities in a local area. Society as a whole is affected by water and air pollution from industrial activities. The accounting information would disclose how much money has been spent to control such pollution. This is known as social responsibility or green accounting. QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION Qualitative characteristics are the attributes (or features) that make the accounting information given in financial statements (income statement, balance sheet and cash-flow statement) useful to users. There are four principal qualitative characteristics as follows: 1. Understandability; 2. Relevance; 3. Reliability; and 4. Comparability. 1. Understandability An essential quality of the accounting information is that it must be readily understandable by users. The accounting information must be presented in a manner that the users such as investors, creditors, employees or even Government etc., understand the same. For this purpose, it is assumed that users have a reasonable knowledge of economic and business activities and accounting and they devote time and energy to study the 1.4 Financial Accounting: Concepts and Applications accounting information. Information about complex matters, that should be included in the financial statements because of its relevance for decision making, should not be excluded on the ground that it is difficult for certain users to understand. 2. Relevance Accounting information has the quality of relevance when it influences the economic decisions of the users by helping them to evaluate past, present or future events. For example, information in respect of dividends paid by the companies in the previous years is relevant because it would help the investors to estimate dividends for future years. Similarly, the information regarding past performance and financial position may also be used for predicting wage payments, share price movements and ability of the enterprise to meet its commitments as they fall due. Materiality: The qualitative characteristic of relevance requires that no material information is omitted. Information is material, if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of the users taken on the basis of the financial information. For example, a business enterprise applies for a bank loan. The manager of the bank finds, on the basis of the accounting or financial information, that the firm is profitable and its financial position (i.e., assets are more than liabilities) is very sound. However, the firm is facing a court case in respect of million of rupees payable to sales tax authorities. Now this information is material vis-a-vis relevant and must be disclosed in the financial statements so that the banker can take a decision to grant a loan to the firm. 3. Reliability Accounting information is reliable when it is free from personal bias so that it can be independently verified. For example, recording of a fixed asset, say machine, at the actual cost (price paid) and not at the market price is most reliable because the actual cost can be independently verified in a contract of sale or invoice. In other words, information must be factual. Reliability has the following characteristics, namely: faithful representation ; substance over form ; neutrality ; prudence, completeness, timeliness and verifiability. (i) Faithful representation: It means that accounting information is based on actual events. For example, purchase of building is based on actual event and there is a proper business transaction in the books of account. Furthermore, the balance sheet should represent faithfully the transactions resulting in assets, liabilities and owner’s capital of the enterprise at the reporting date which meet the recognition criteria. (ii) Substance over form: The transactions and other events in the books of account must be presented in accordance with their substance and economic reality and not merely their legal form. For example, a firm purchases a piece of land after making full payment to the seller. However, the documents and legal formalities are yet to be completed. Now according to the principle of substance over form, the firm can record the purchase of the land transaction in its books of account even though the registration process is yet to be completed. (iii) Neutrality: Financial accounting information should be neutral in the sense that it should not favour one group of users over another. It should not be designed for the benefit of single user or give one user an advantage over other users. Neutrality is significant especially for the external users of the accounting information. Within the enterprise, neutrality is less important for the simple reason that all the internal users have access to the information. The financial statements must disclose the actual position in respect of operating results and financial position. For example, if the goods purchased in the last week of the accounting period, say, march end, are recorded in the next accounting period, it would obviously affect the income statement by higher reported income (or less loss) for the current accounting period favouring the management at the cost of other users like investors and creditors. All contingent liabilities must be disclosed only as footnote to the financial statements so that users can easily find out what the actual position is. (iv) Prudence: The preparers of the financial statements have to make estimates in respect of certain events and transactions such as the probable useful life of the fixed assets like plant and machinery for depreciation purpose, collectability of debtors and bills receivable regarding provision for doubtful debts, the provision for warranty claims and so on. While making the estimates about uncertainty of events, the accountant must be prudent in preparing the financial statements. Prudence means playing safe and with caution Introduction 1.5 in the exercise of judgements needed in making the estimates required under conditions of uncertainties e.g. assets and income are not overstated and liabilities or expenses are not understated. (v) Completeness: An omission may make information to be false or misleading and hence unreliable and short of relevance. For example a loss of ` 50,000 by fire not covered by insurance is a material loss for a small enterprise. Full disclosures must be made of all significant information in a manner that is understandable and does not mislead creditors, investors, and other users of the financial statements irrespective of the costs involved. (vi) Timeliness: The utility of accounting information decreases with age. The more quickly the information is communicated to the users, the more it is likely to influence their decisions. So the accounting information must be available to the decision makers before it loses its capacity to influence their decisions. For example, it is likely to be more useful to know the position of an enterprise for 2014 in early 2015 than to receive this information a year later. (vii) Verifiability: Verifiability ensures the truthfulness of the recorded transactions which can be independently checked by persons other than the accountant himself. For example, the information contained in the purchase invoices, sales invoices, property deeds and other similar documents must be the same as reported in the financial statements. This can be independently checked by anyone interested to ascertain the true position. 4. Comparability Users must be able to compare the financial statements of an enterprise over a period of time so as to enable them study the trends in its financial position, operating results and cash flows. Users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, operating results and cash flows. Comparability is possible when different enterprises in the same industry use the same accounting principles and methods from year to year. Consistency therefore, does not permit the switching of accounting methods of inventory valuation and depreciation from year to year. The consistency principle does not mean that a particular method of accounting once adopted cannot or should not be changed. Accounting methods and principles change on account of changes in the legal, social and economic environments. When change in an accounting method is needed because of proper reporting or has been necessitated by statute such as the Companies Act or Income Tax Act, it should be changed. FUNCTIONS OF ACCOUNTING Financial accounting performs the following major functions: (i) Maintaining systematic records: Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statements–income statement and the balance sheet. (ii) Communicating the financial results: Accounting is used to communicate financial information in respect of net profits (or loss), assets, financial liabilities etc., to the interested parties. (iii) Meeting legal needs: The provisions of various laws such as Companies Act, Income Tax and Sales Tax Acts require the submission of various statements, i.e., annual accounts, income tax returns, returns for sales tax purposes and so on. (iv) Protecting business assets: Accounting maintains proper records of various assets and thus enables the management to exercise proper control over them with the help of following information regarding them: (a) How much is the balance of cash in hand and cash at bank? (b) What is the position of inventories? (c) How much money is owed by the customers? (d) How much money is owing to the creditors? (e) What is the position of various fixed assets and how these are being used? (v) Accounting assists the management in the task of planning, control and co-ordination of business activities. (vi) Stewardship or Trusteeship: In the case of limited companies, the management is entrusted with the resources of the enterprise. The managers are expected to act true trustees of the funds and the accounting helps them to achieve the same. (vii) Fixing responsibility: Accounting helps in the computation or calculation of the profits of different departments of an enterprise. This would help in fixing the responsibility of each departmental head. 1.6 Financial Accounting: Concepts and Applications ADVANTAGES OF ACCOUNTING There is some overlapping between the functions of accounting and advantages of accounting. Hence, a repetition of some of the functions of accounting under the present heading, namely: advantages of accounting which are summarised as under: (i) Maintenance of records rather than memory: All business transactions are systematically recorded in various books of accounts. It is not possible at all to do any type of business by just remembering the transactions which have grown in size and have become complex or difficult. Human memory is limited by its very nature. Hence, business transactions must be recorded early in the books of account (i.e., General journal or special purpose subsidiary books, as the case may), so that necessary information about them is available in time and free from bias. (ii) Preparation of financial statements: When the business transactions are maintained in a proper manner, it becomes possible to prepare two basic financial statements, namely: (a) The income statement (i.e., profit and loss account) to ascertain the profit and or loss for an accounting period. (b) The balance sheet to ascertain the financial position of the business as on the last date of the accounting period, that is, the position of assets, liabilities and owner(s)’ capital on that date. (iii) Comparison of results: A properly recorded accounting information is very helpful to compare the profit (or loss) amount and financial position of one year with those of previous years. It is called intrafirm comparison. Not only this, it is also possible to compare the financial results of one firm with that of another. It is called inter-firm comparison. (iv) Assistance to management: The accounting information helps the management to plan its future activities by preparing budgets in respect of sales, production, expenses, cash, etc. Accounting helps in co-ordination of various activities in different departments by providing financial details of each department. The managerial control is achieved by analyzing in money terms the departures or deviations from the planned activities and by taking corrective measures or steps to improve the situation in future. (v) As legal evidence: Systematically recorded accounting information provides documentary evidence in a court of law for disputes regarding the amount owing to the creditors and recovery of money from debtors. (vi) Helps in taxation matters: Income tax, sale tax or vat (value added tax) authorities could be convinced about the amount of taxable income, or actual sales, as the case may be, with the help of written records. (vii) Ascertainment of value of business: Accounting information can be used to determine the proper price or value of business in case a sole trader, a partnership firm or when a company wish to sell its business to any person or entity. (viii) Raising loans: Accounting is of great help to lenders who want to give loans to any business enterprise. (ix) Control over assets or properties: Accounting facilitates control over assets or properties of the business enterprise by providing information as to cash and bank balances, stock in hand, sundry debtors, fixed assets etc.. (x) Prevention of errors and frauds: Accounting records are subject to auditing in most of the cases. Auditing helps detection of errors and frauds that have taken place during the year and takes steps to prevent their recurrence (to occur again) in future. LIMITATIONS OF ACCOUNTING There is no disadvantage of the accounting. However it is not free from limitations which are outlined as under: (i) No recording of non-monetary transactions: Financial accounting records only those transactions which are expressed or measured in money only. It means there is no place for non-monetary or non-financial transactions though these events are important for the efficient or smooth running of the business enterprise e.g., health of the salesmen, the hard work done by the owners or chairman of the company and so on. Thus, accounting does not provide complete information about all the events of a firm. Introduction 1.7 (ii) No information about the present value of the business: Assets are recorded on the basis of cost concept. It means, for recording purpose, original cost is the basis for the new assets and book-value (original cost minus depreciation) for the used assets. In this way market values of the assets are ignored. So the effect of inflation (or deflation) on value of fixed assets is not taken into consideration. The effect of this practice is that the balance sheet does not disclose the true financial position of the business enterprise. (iii) Use of estimates or personal judgement: Accounting records sometimes do not give exact information since accounting information is based on estimates or personal judgement. For example it is not possible to predict accurately the actual useful life of fixed assets for the purpose of depreciation expenses. Similarly the accountant may select any method of depreciation, valuation of stock and treatment of deferred revenue expenditure. Such judgement is based on the qualification and credibility of the accountant and may affect the outcome or result of financial statements. (iv) Window dressing: Sometimes the accountant may resort to (or indulge in) ‘window dressing’ (impressive but not real or true) in the balance sheet by showing items like debtors or stock without provision for doubtful debts or obsolescence. In such a case the balance sheet cannot give a true and fair view of the financial position of the business enterprise. (v) Unrealistic accounting information: Accounting information may not be realistic even when financial statements are prepared on the basis of basic accounting concepts and conventions. According to going concern concept, business entity will have indefinite life and thus assets are recorded at cost or book value which may not be actually realisable because of low market value. (vi) Accounting information is not natural or unbiased: Accountants calculate income as excess of revenues over expenses recorded in monetary terms. Hence they do not include the costs of air pollution, water pollution, employees’ accidental injuries and so on. (vii) Lack of consistency: Accountants have to follow certain generally accepted accounting principles for recording the business transactions. If these principles are not followed uniformly year after year, the accounting information may become inconsistent. For example the stock of goods in hand is valued on the basis of cost or market price whichever is less on the basis of conservatism or prudence convention. Accordingly stock in hand may be valued on cost basis in one year and at market price in another year. In this manner convention of consistency may be violated. (viii) No basis for managerial efficiency: Accounting information cannot be used as the only test of managerial efficiency or managerial performance on the basis of more profits. Profit or income for a period of certain year can be inflated by omitting such expenses as advertisement expenses, cost of research and development, depreciation expense and so on. (ix) Disclosure of only material items: In the financial statements only material items are disclosed in detail. In this manner the insignificant items, though important, are ignored. (x) Historical information only: Accounting records only past or historical events. So they may not be of much use in the present or current situation. BRANCHES OR DIVISIONS OF ACCOUNTING Accountants tend to specialise in various types of accounting work and this has resulted in the development of different branches of accounting. Some of the divisions of accounting are given as: (i) Financial accounting: Accounting designed or meant for outsiders (persons other than owners and managers) is known as financial accounting. It is concerned with the recording of business transactions and the periodic preparation of income statement, balance sheet and cash-flow statement from such records. In this manner, the financial accounting is useful for ascertaining profit or loss made for a given period and financial position at the end of the given period and also the sources and uses of cash for the given period. (ii) Management accounting: It is concerned with the interpretation of accounting information to guide the management for future planning, decision-making, control, etc., Management accounting, therefore, serves the information needs of the insiders, e.g., owners, managers and employees. 1.8 Financial Accounting: Concepts and Applications (iii) Cost accounting: It has been developed to ascertain the costs incurred for carrying out various business activities and to help the management to exercise strict cost control. (iv) Tax accounting: This branch of accounting has grown in response to the difficult tax laws such as relating to income tax, sales tax, excise duties, customs duties, etc.. An accountant is required to be fully aware of various tax legislations. (v) Social accounting: This branch of accounting is also known as social reporting or social responsibility accounting. It discloses the social benefits created and the costs incurred by the enterprise. Social benefits include such facilities as medical, housing, education, canteen, provident fund and so on while the social costs may include such matters as extra hours worked by employees without payment, environment pollution, unreasonable terminations, etc.. (vi) Human resources accounting: It is concerned with the human resources of an enterprise. Accounting methods are applied to evaluate the human resources in money terms so that the society might judge the total work of the business enterprises including its non-human net assets. It is, therefore, an accounting for the people of the organisation. Unfortunately no objectively verifiable method has been developed for universal application. (vii) National accounting means the accounting for the resources of the nation as a whole. It is generally not concerned with the accounting of individual business entities and is not based on generally accepted accounting principles. It has been developed by the economists and the statisticians. (viii) Green accounting: The concept of green accounting is related to the calculation of national income in which standard measures of income and output are Gross National Product (GNP) Gross Domestic Product (GDP) Gross National Income (GNP) etc. In simple words, Green Accounting is a kind of accounting that tries to take into consideration the environmental costs in the calculation of operating income of an enterprise. (ix) Creative accounting: Creative accounting is nothing but the manipulation of the operating results and financial position of the company, of course, within the confines (limits) of the accounting standards. It means though accounting standards are followed yet the manipulation is done by adopting such practices as recognition of premature or fictitious revenues (e.g. , showing stock at sale price), reducing the rate of depreciation or artificially increasing the life of the fixed assets and so on. Investors and other users of accounting information must educate themselves about the creative accounting and fraud detection methods. (x) Forensic accounting: The integration of accounting, auditing and investigative skills has opened up a unique branch known as forensic accounting. It is defined an accounting method that deals with the relation and application of a system that is used to record and summarise business and financial transactions. Forensic accounting provides an accounting or financial analysis that is suitable to the court of law which will form the basis for discussion or debate and ultimately to decision by the court on scam or fraudulent matters. It means forensic accountant is required to pay attention to the smallest datail, analyse accounting or financial information thoroughly, think creatively, possess common business sense, computer skills, excellent communication skills and puzzle solving ability that can be used to reconstruct the details of past or historic accounting transactions and be able to tell the story. BASIS OF ACCOUNTING There are primarily two basis of accounting, namely: Cash basis and accrual basis explained below: Cash Basis of Accounting Under this basis, income is calculated on the basis of cash transactions only while the credit transactions are ignored (or not considered at all). Similarly expenses are recorded only when they are paid in cash. So the income or profit is the excess of cash receipts in respect of sale of goods, services and other income resulting from the sale of properties in cash over actual cash payments in respect of purchase of goods, Introduction 1.9 properties and expenses say, on rent, salaries, stationery, electricity etc. Thus, credit transactions are not considered at all including adjustments for outstanding (unpaid) expenses or accrued (or unearned) income items. In short, under the cash basis of accounting income or profits is calculated with the help of Receipts and Payments Account only. This method is useful for professional people like doctors, advocates, engineers, chartered accountants, broker, and small traders where credit income is of doubtful nature. Advantages (i) This basis is simple to use and does not require technical knowledge of accountancy. (ii) There is no scope for estimates or personal judgements because cash transactions are recorded only when actual cash is received or paid. (iii) This basis is suitable for business firms having most of the transactions in cash. Disadvantages (i) Cash basis does not give a true and fair view of profit or loss and the financial position of the business enterprise. The reason is that it does not take into consideration outstanding expenses, prepaid expenses, unearned income and income received in advance which may play more important role in some cases in the calculation of actual profit or loss. (ii) There is no scope for matching principle because the purchase of fixed asset is treated as complete expense in the year of purchase rather than the periods which benefit from the use of fixed assets. (iii) There is enough possibility of manipulating (or wrong calculation of) the profit figure. It may either by delaying the payments or making payments earlier than the due date. Similarly receipts or income may be postponed or collected early. (iv) As capital and revenue items are treated at par (i.e., same), there is no consistency in the profit or loss figure of different accounting periods. (v) Cash basis of accounting is not recognised by the Companies Act. Accrual Basis of Accounting Under accrual basis of accounting, only revenue items are taken into account for income determination and capital expenditures are ignored. Income (revenue) is recognized when it is earned and not when the money is actually received later on. Similarly expenses are recognized when due or incurred and not when actual payments are made for them. Thus, credit sales are part of total income and rent due to landlord or salaries unpaid to the employees are part of total expenses. It means revenues and expenses for income determination are considered on the basis of the accounting period to which they belong or relate. In simple words, the income accrued or earned in the current accounting period becomes the income of the current accounting year whether the actual cash for that item of income is received in the current year or it was received in the previous year or it will be received in the next year. The same is true of expense items. Advantages (i) It is based on all business transactions of the year in respect of income and expense items and not simply relating to cash transactions. Thus it discloses correct profit or loss. (ii) This basis of accounting can be (and in fact is) used in all types of business enterprises. (iii) It is more suitable for the application of matching principle i.e. matching of revenue and expense items. (iv) It is more scientific and rational basis of accounting. (v) There is a consistency in the computation of profit or loss of different years because it makes distinction between capital and revenue expenditures. (vi) It is recognized by the Companies Act. 1.10 Financial Accounting: Concepts and Applications DIFFERENCE BETWEEN CASH BASIS AND ACCRUAL BASIS OF ACCOUNTING Points of Difference Cash Basis Accrual Basis 1. Cash vs. Credit transactions There is no recording of outstanding and prepaid income or expenses. The basis of records is only cash transactions It includes both cash and credit transactions. Hence items like outstanding expenses and income and prepaid income and expenses are to be found in the balance sheet. 2. Effect of the prepaid expenses and accrued income Income statement or profit and loss account will show lower income if there are items of prepaid expenses and accrued (earned) income Income statement will show relatively higher income if there are items of prepaid expenses and accrued incomes 3. Effect of outstanding expenses and unearned income Income statement will show higher income if there are items of outstanding expenses and income received in advance Income statement will show lower income if there are items of outstanding expenses and income received in advance 4. Simple vs. Technical Cash basis of accounting is simple to adopt since no technical knowledge is required in recording cash receipts and cash payments. Accrual basis of accounting is technical in nature since income is computed after taking into account outstanding and accrued items in the calculation of profit or loss account 5. Unreliable vs. Reliable It is unreliable basis of accounting for income determination because cash basis of accounting does not make distinction between revenue and capital items Accrual basis of accounting is reliable basis because income determination is done on the basis of revenue items only 6. Options regarding valuation of Inventories and Depreciation technical method An accountant has no option to value inventories at cost or market, whichever is less. Also there is no choice regarding the method of depreciation. An accountant has the option to follow alternative methods of inventory valuation like LIFO, FIFO or Weighted average method and alternative methods of depreciation like SLM, WDV etc.. 7. Legal Position It is not recognized under the Act Companies Accrual basis of accounting is recognized under the Companies Act 8. Preference Enterprises with mostly cash transactions prefer this basis of accounting Enterprises with cash and credit transactions adopt accrual basis of accounting. Cash basis of accounting is suitable only for professional people like doctors, advocates, chartered accountants etc.. Accrual basis of accounting is appropriate for enterprises with profit motive. 9. Suitability SYSTEMS OF ACCOUNTING Primarily there are two systems of accounting which are used as a basis for recording day-to-day business transactions in a systematic manner. They are: single entry system and Double entry system. In addition, there is the Indian system of book-keeping as a third system. However, the Indian system combines the features of both - the single entry system and double entry system. (i) Single Entry System Also known as accounts from incomplete records, this system ignores the two-fold or dual aspect of recording the transactions. According to Kohler (in Dictionary For Accountants), it is a system of book- keeping in which, as a rule, only records of cash and personal accounts are maintained; it is always incomplete double entry, varying with circumstances. (ii) Double Entry or English System Under this system every business transaction has a two-fold effect in the form of receiving some benefit as against a loss or giving or sacrifice of some benefit simultaneously, that is, at the same time. When both these aspects are properly or systematically recorded, it is known as double entry system. Under this system, transactions can be recorded in two different ways, namely: (a) Accounting Equation method; (b) Application of double entry principles. Introduction 1.11 (iii) Indian system It is popularly known as Deshi: (indigenous) system of book-keeping which is followed throughout the country for a long time. This system has no written rules like those debits and credits followed in english system of double entry. Even then this deshi system enables the book-keeper to draw a trial balance and balance sheet. Over a period of time, in its modern form, it is almost merged with the double entry system. SPACE FOR REVISION 1.12 Financial Accounting: Concepts and Applications Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. Discuss the nature of accounting as an information system. Write short note on purposes and limitations of accounting. [B.Com. (Hons.) Delhi 1992, 2005] Discuss the nature of accounting as an information system. In what way is accounting information useful for : (i) owners, (ii) managers, (iii) creditors and (iv) employees of a business. [B.Com. (Hons.) Delhi 1992] Define relevance and reliability. What characteristics are needed for information to be relevant ? Reliable? What are the main divisions of accounting ? Distinguish between accrual and cash bases of accounting [B.Com. (Hons.) Delhi 1998, 1999] Write short note on mercantile system of accounting. [B.Com. (Hons.) Delhi 1992] 4. 5. 6. 7. OBJECTIVE ASSIGNMENTS WITH ANSWERS True/False 1. State, giving reasons in brief, whether each of the following statement is ‘true’ or ‘false’ : (i) Accounting, as a language, is used to communicate financial information by the Government only. (ii) Accounting and book-keeping are two terms that have the same meaning. (iii) Accounts help in determining the tax liability. (iv) All assets owned by an enterprise are its goods. (v) Accounting originated along with the origin of money. (vi) Accounting is only an art and not a science. (vii) Accounting information can be presented for non-monetary events also. (viii) The traditional definition of accounting is still valid. (ix) All the transactions in a business enterprise are recorded on cash basis. (x) Short term creditors and long-term lenders require same type of accounting information. Answers With Reasons (i) (ii) (iii) (iv) (v) (vi) False : Accounting is done not only by the Government rather it is required for all entities—business or non-business where finances are involved. False : Book-keeping is the first stage of accounting work namely recording, classifying and summarising of financial business transactions. The work of accountant begins from where the work of book-keeper ends. True : Accounting helps in the calculation of profits which are subject to tax liability. False : Only those assets which are purchased for immediate sale are goods. False : Accounting had been in existence since 3000 BC—much before the money was introduced. Money facilitated proper recording of transactions as a common mode of measurement only. False : Accounting is both an art as well as science. Actual recording of transactions is an art. It is a science because it has to follow certain generally accepted accounting principles or rules while recording the transactions. Introduction (vii) 1.13 False : Non-monetary events cannot be recorded because accounting is essentially money based discipline. Non-monetary events are social in nature. (viii) True : Traditional definition provides the first step in recording the transactions along with the classification and summarisation functions of accounting. (ix) False : In almost every business enterprise most of the transactions are credit transactions. They are recorded on earning (accrual) basis rather than on cash basis. (x) False : Short term creditors are more interested in immediate liquidity position while long term lenders are primarily concerned with overall financial position and profitability of the business entity. 2 Conce ptua lFra me w ork MEANING A conceptual framework can be defined as a system of ideas and objectives that lead to the creation of a consistent set of rules and standards. Specifically in accounting, the rules and standards set the nature, functions and limits of financial accounting and financial statements. The main reasons for developing an agreed conceptual framework are that it provides: • a framework for setting accounting standards; • a basis for resolving accounting disputes; • fundamental principles which then do not have to be repeated in accounting standards. The conceptual framework is composed of a basic objective, fundamental concepts, and recognition, measurement, and disclosure concepts. LEVELS OF CONCEPTUAL FRAMEWORK The conceptual framework has the following 3 levels: 1. First level: The objective of financial reporting, the “why” or purpose of accounting. 2. Second level: The qualitative characteristics and the elements of financial statements, which form a bridge between the 1st and 3rd levels. 3. Third level: Recognition, measurement, and disclosure concepts, the “how” or implementation. First Level: Basic Objective The basic objective of financial reporting is the foundation of the conceptual framework and requires that generalpurpose financial reporting provide information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity. In order to understand general-purpose financial reporting, users need reasonable knowledge of business and financial matters. Second Level: Qualitative Characteristic of Accounting Information Companies must decide what type of information to disclose and how to disclose it. These choices are determined by which method or alternative provides the most decision-useful information. The qualitative characteristics of accounting information distinguish better and more useful information from inferior and less useful information. The fundamental qualities of accounting information are: (a) Relevance – information that is capable of making a difference in a decision. (b) Predictive value means that the information can help users form expectations about the future. (c) Confirmatory value means that the information validates or refutes expectations based on previous evaluations. 2.2 Financial Accounting: Concepts and Applications (d) Materiality means that information is material if omitting it or misstating it could influence decisions that users make on the basis of the reported financial information. Faithful representation – numbers and descriptions match what really happened or existed. Comprised of Completeness means that all necessary information is provided. Neutrality means that the information is unbiased. Free from error means that the information is accurate. (e) Comparability means that companies record and report information in a similar manner. Consistency is another type of comparability and means the company uses the same accounting methods from period to period. (f) Verifiability means that independent people using the same methods arrive at similar conclusions. (g) Timeliness means that information is available before it loses its relevance. (h) Understandability means that reasonably informed users should be able to comprehend the information that is clearly classified and presented. Basic Elements (Also Consult Chapter on Final Accounts) An important aspect of developing an accounting theoretical structure is the body of basic elements or definitions. Ten basic elements that are most directly related to measuring the performance and financial status of a business enterprise are formally defined below: 1. Assets: Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. 2. Liabilities: Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. 3. Equity: Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest. 4. Investments by Owners: Increases in net assets of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it. Assets are most commonly received as investments by owners, but that which is received may include services or satisfaction or conversion of liabilities of the enterprise. 5. Distributions to Owners: Decreases in net assets of a particular enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interests (or equity) in an enterprise. 6. Comprehensive Income: Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. 7. Revenues: Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. 8. Expenses: Outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations. 9. Gains: Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners. 10. Losses: Decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners. Conceptual Framework 2.3 Basic Assumptions In the practice of financial accounting, certain basic assumptions are important to an understanding of the manner in which data are presented. The following four basic assumptions underlie the financial accounting structure: Economic Entity Assumption: Economic activity can be identified with a particular unit of accountability in a manner that assumes the company is separate and distinct from its owners or other business units. Going Concern Assumption: In the absence of contrary information, a company is assumed to have a long life. The current relevance of the historical cost principle is dependent on the going-concern assumption. Monetary Unit Assumption: Money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. The monetary unit is assumed to remain relatively stable over the years in terms of purchasing power. In essence, this assumption disregards any inflation or deflation in the economy in which the company operates. Periodicity Assumption: The economic activities of a company can be divided into artificial time periods for the purpose of providing the company’s periodic reports. Basic Principles Certain basic principles are followed by accountants in recording and reporting the transactions of a business entity. These principles relate to how assets, liabilities, revenues, and expenses are to be identified, measured, and reported. Measurement Principle: A ‘mixed-attribute’ system permits the use of various measurement bases. Historical Cost Principle: Acquisition cost is considered a reliable basis upon which to account for assets and liabilities of a company. Historical cost has an advantage over other valuations, as it is thought to be verifiable. Fair Value Principle: Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in on orderly transaction between market participants at the measurement date. Recently, GAAP has increasingly called for the use of fair value measurements in the financial statements. Revenue Recognition Principle: Revenue is recognized at the time in which the performance obligation is satisfied. Expense Recognition Principle: Recognition of expenses is related to net changes in assets and earning revenues. The expense recognition principle is implemented in accordance with the definition of expense by matching efforts (expenses) with accom-plishment (revenues). Product costs, such as material, labor, and overhead, attach to the product, and are recognized in the same period the products are sold. Period costs, such as officers’ salaries and other administrative expenses, attach to the period, and are recognized in the period incurred. Full Disclosure Principle: In the preparation of financial statements, the accountant should include sufficient information to influence the judgment and decision of an informed user. Cost Constraint Although accounting theory is based upon certain assumptions and the application of basic principles, there are some exceptions to these assumptions. One exception is often called a constraint, and sometimes justifies departures from basic accounting theory. Cost-benifit: Cost-benefit relationship relates to the notion that the benefits to be derived from providing certain accounting information should exceed the costs of providing that information. The difficulty in cost-benefit analysis is that the costs and especially the benefits are not always evident or measurable. 2.4 Financial Accounting: Concepts and Applications HOW DOES THE FRAMEWORK AFFECT THE APPLICATION OF ACCOUNTING STANDARDS? Concepts Statements do not affect practice directly. They do not change existing generally accepted accounting principles (GAAP). Certain aspects of existing GAAP conflict with the framework. For example, museum collections meet the Concepts Statements definition of an asset, but existing GAAP does not require those assets to be recognized in the financial statements. The framework affects practice over time because of its influence in the development of new accounting standards. WHO BENEFITS FROM A FRAMEWORK AND WHY IS IT NEEDED? (i) The Accounting Standard Boards are the most direct beneficiary of the framework. The framework provides the Boards with a foundation for setting standards and concepts to use as tools for resolving accounting and reporting questions. The Boards staff is guided by pertinent concepts that might provide guidance in developing its analysis of issues for consideration by theBoards, as well as in making its recommendations to the Boards when developing accounting standards. Consequently, those concepts are an important aspect of the Board’s discussions of issues and for making its decisions about a specific standard. (ii) The framework provides a basic reasoning on which to consider the merits of alternative solutions to complex financial accounting or reporting problems. Although it does not provide all the answers, the framework narrows the range of alternative solutions by eliminating some that are inconsistent with it. It thereby contributes to greater efficiency and consistency in the standard-setting process by avoiding the necessity of having to redebate fundamental issues such as “what is an asset?” time and time again. (iii) A guiding principle of the Board is to be objective in its decision making and to ensure, insofar as possible, the neutrality of information resulting from its standards. The use of an agreed-upon framework reduces the influence of personal bias on standard-setting decisions. Without the guidance provided by an agreedupon conceptual framework, standard-setting would be quite different because it would be based on the personal frameworks of individual members of the Board. A framework also should reduce political pressures in making accounting judgments. (iv) The Accounting Standard Boards is not the only beneficiary of the framework. The credibility of financial reporting is enhanced when objectives and concepts are used to provide direction and structure to financial accounting and reporting. The framework helps by leading to the development of standards that are not only internally consistent but also consistent with each other. As a result, both preparers and users of financial statements benefit from financial statements that are based on a body of accounting requirements that are more internally consistent. (v) The framework further helps users of financial reporting information to better understand that information and its limitations. It also provides a frame of reference for understanding the resulting standards. That frame of reference is useful to preparers who apply those standards and to auditors who examine the resulting reports, as well as to students who study accounting and the faculty who teach it. 3 Fina nc ia lAccountingPrinc iple s NATURE OF ACCOUNTING PRINCIPLES The dictionary meaning of the word principle is : “a fundamental truth or law as the basis of action.” The term principle generally suggests universal application of rules and a degree of permanence which is not possible in accounting. Accounting is a social science and not a physical science. Thus, the essential feature of accounting principles is that they are flexible rather than precise or rigid. They are not discovered and there are no laboratory tests. Accounting principles are man-made and are derived from experience and reason. Accounting principles are judged on their general acceptability rather than universal acceptability to the makers and users of financial statements. Hence they are popularly called Generally Accepted Accounting Principles (GAAP). Accounting Principles Board (APB) in Statement No. 4 (1970) of the AICPA (USA) stated that : “generally accepted accounting principles incorporate the consensus at any time as to which economic resources and obligations should be recorded as assets and liabilities, which changes in them should be recorded, how the recorded assets and liabilities and changes in them should be measured, what information should be disclosed and how it should be disclosed and which financial statements should be prepared.” CHARACTERISTICS OF ACCOUNTING PRINCIPLES The main characteristics of accounting principles may be summarised as under : (i) Accounting principles have been developed to ensure uniformity and easy understanding of the accounting information. (ii) Accounting principles are man-made in the sense that like that of principles of physical science such as chemistry, physics etc. are not laboratory tested principles. They are simple guidelines based on usage, reason and observations over a period of time. (iii) Accounting principles are not final statements. They are subject to modifications depending upon the changes in business practices, government policies and requirements of the users of accounting information. (iv) The general acceptance of accounting principles depends upon how well these principles meet or satisfy three conditions, namely : (a) Relevance, (b) Objectivity and (c) Feasibility. (a) Relevance : A principle is relevant if it results in information that is meaningful and useful to the users of the financial statements (b) Objectivity : Similarly a principle is objective to the extent that accounting information is free from personal bias or judgements of those who provide it. Objectivity means verifiability, that is, there is some way of finding out the correctness of the information reported. (c) Feasibility : A principle is feasible if it can be used without much complexity or cost. It applies to time, labour and cost of providing accounting information and its accuracy in relation to probable use and resulting benefits. For example it is easy to record an asset at cost price since it saves time and labour in obtaining market price of the asset at different times. 3.2 Financial Accounting: Concepts and Applications BASIC CONCEPTS The literary meaning of a concept is a general idea or an opinion. An accounting concept is therefore basically an opinion about the way the business transactions are to be recorded. It is an assumption and not a fact and thus it is not subject to any proof or evidence. Accounting concepts have gradually developed over a period of time because of following factors: (a) Improvement in technology, globalization of business activities and introduction of new types of business transactions. (b) Changes in legal, economic and social environments. Existing laws are modified or amended and new laws are introduced and this requires the new accounting concepts in the field of income tax, sales tax, value added tax and so on. Economic data especially for planning purpose are created out of accounting or financial data. Similarly social environment which deals with poverty, social security, pollution etc., has to take into consideration the accounting information and measurements. Features of Accounting Concepts (i) Accounting concepts are not static for all times : In fact they have been continuously changing and evolving. Accounting would have been an easy subject to study if its concepts were fixed and well established for all times to come like concepts of natural sciences. In that case accounting would become less interesting and much less useful. (ii) Different accounting concepts are not independent of each other : In fact they are closely interrelated so much so that any change or modification in one accounting concept automatically results in change or modification of other concepts. For example, there is close relationship between historical cost concept and matching of cost and revenue items. (See Accrual Concept) THE ENTITY CONCEPT Meaning : The entity concept assumes that the firm or enterprise and its owner(s) are two separate entities for accounting purposes. For example, when the owner invests or introduces money (the capital) in the business, the business entity (or firm) receives the asset cash and the capital of the business is treated as a liability of the business entity (or firm) towards its owner. Similarly when the owner withdraws the cash for his personal use (e.g., payment of school fee) the accounts would show that cash in the business is reduced and so too his capital though his personal cash has increased. In this way the business and personal transactions are not mixed up. In other words, this concept requires that for accounting purposes only, a distinction should be made between: (a) personal transactions and business transactions, and (b) transactions of one business entity with those of another business entity. It must be clearly noted that concept of separate entity or business entity is applicable to all types of business organisations, namely: sole proprietorship, partnership firm and a joint stock company only for accounting purpose and not for legal purpose. Entity concept can be easily applied in the case of a limited liability company because it is a legal entity separate from its shareholders; it can sue and be sued in its own name instead of in the name of all its owners. But it is very difficult to apply entity concept in the case of a traditional partnership (as against Limited Liability Partnership) and even more so in the case of a sole trader or one-man business. Here in real sense, the owner is the business and his private estate can be used legally for business losses. But the accounting ignores this legal position and maintains the distinction between business and its owner(s) Effects: The business entity has the following effects : (i) Only the transactions of the business are recorded and not the personal transactions of the owner(s). (ii) Income or profit is the property of the business entity unless it is distributed to the owner(s). (iii) The personal assets of the owner(s) are not taken into consideration while calculating the value of the assets of the business enterprise. Financial Accounting Principles 3.3 (iv) The capital of the proprietor is considered as a liability of the business to its owner(s); the drawings and losses are regarded as reductions of this liability while profits and additional capital introduced are treated as an increase in this liability. (v) The profit or loss of the business entity can be easily and correctly calculated. (vi) The financial position of the firm can be easily and correctly calculated. (vii) The entity concept has enabled the development of responsibility accounting. It is possible to know not only the profit or loss of the business enterprise on the whole but also of its various departments. This is helpful in fixing the responsibility of different heads or incharges of departments. In conclusion, all transactions are recorded as they affect the business and not the owner(s) of the business entity. The business and private transactions are not mixed up. MONEY MEASUREMENT CONCEPT Meaning : In accounting a record is made only of those transactions or events which can be expressed in terms of money only. Money means currency of the country, e.g., Rupee in India. Dollar in U.S.A., Yen in Japan, Pound in United Kingdom and so on. Non-monetary events such as the strike in the factory, retirement of the general manager, the good quality of the products produced by the firm etc., cannot be recorded because these events cannot be expressed in terms of money. Money measurement concept also means that the business transactions are recorded in the books of account in terms of nominal value of money at the time of recording the transactions. The changes in purchasing power or value of money are ignored. In fact, it is assumed that purchasing power of money does not change from time to time. This assumption assures objectivity of the accounting information. Benefits : This concepts offers following benefits : (i) Money is a common unit of recording the transactions relating to assets, liabilities, incomes, losses and capital and therefore helpful in preparing the profit and loss account and the balance sheet. In the absence of money, it is not possible to add or subtract or multiply or divide the items given in different units like kilograms, gallons, square metres etc.. Similarly it is not possible to determine the value of business in the form of one building, 10 tonnes of stock of goods, two computers, four tables, 10 chairs and so on because they cannot be added up to give any meaningful figure. But if these items are expressed in terms of money (common rupee unit) as bank balance of ` 50,000, building of ` 50 lacs, four tables of ` 6,000,10 chairs of ` 10,000, 10 tonnes of stock of goods for ` 70,000, two computers of ` 40,000, it is possible to add up the money values of all these items and state that the value of the business is ` 51,76,000. (ii) Since the business transactions are recorded on the assumption that value of money does not change from time to time, assets purchased on different dates can be easily added up for the purpose of knowing the value or worth of the business at any time on any date. Limitations : This concept is subject to following limitations : (a) As only monetary transactions are recorded and non-monetary transactions such as efficiency of the employees, health of the chairman or owner of the firm, strike by the employees, goodwill or trade mark resulting from successful running of the business etc., are completely ignored, this concept does not give complete picture of all events or happenings in the business firm. (b) As monetary concept ignores changes in purchasing power of money, it is not possible to know the real worth of the business enterprise though the assets are expressed in terms of money. For example, under inflationary conditions (period of increasing prices) the purchasing power of money decreases with every increase in prices of goods and services. But this fact is not recorded in the books of account; because it is assumed that money is a stable unit. Assets are recorded at the actual prices paid for them from time to time for the sake of objectivity. For example, a piece of land bought in 2001 for ` 5 lacs continues to be shown at this figure though its present value may be ` 50 lacs. In this way the real worth of the business is adversely or badly affected. 3.4 Financial Accounting: Concepts and Applications So under inflationary conditions the financial statements prepared on historical cost basis are thoroughly unreliable and irrelevant for judging the profitability and financial position of the business enterprise. THE GOING CONCERN CONCEPT Meaning : Every business enterprise is assumed to be a going concern in the sense that it has a continuity of life and there is a neither the intention nor the necessity to dissolve the firm in the near foreseeable future. However, it must be made clear that going concern concept does not mean permanent continuance of the business firm. All that it means is that the firm will continue long enough to carry out the present plans and meet future obligations. Benefits of the Going Concern Concept : The benefits of the going concern concept may be noted as under : (i) This concept enables the preparation of financial statements, namely: profit and loss account, balance sheet and cash-flow statement on yearly basis because the firm is presumed to have longer life than one year. (ii) The going concern concept makes possible a clear distinction between revenue expenditures and capital expenditures. Since the business enterprise is assumed to have long life, those expenditures whose use or benefit will expire or end within year (e.g., stationery, rent, electricity, salaries etc..) are treated as revenue expenditures and those expenditures whose benefit will be available for many years (e.g., building, machinery furniture and the like) are treated as capital expenditures. The yearly benefit of capital expenditures is treated as depreciation. (iii) Assets are classified as fixed assets to be used for more than one year and current assets to be used only for one year. Similarly liabilities are also classified as long term liabilities and short term liabilities. (iv) The fixed assets are valued for the balance sheet purpose at their cost price on purchase and afterwards at cost minus depreciation and not at their market or realizable values. If we value the assets at market price, it would be difficult to compare the financial position of two or more years. (v) Investors are assured that they will continue to get income, if any, on their investments in the near future. (vi) It is under this concept that useful life of the fixed asset is estimated for the purpose of calculating the depreciation so that there is proper matching of the revenue of the current year with the cost of the asset (i.e., depreciation). (vii) It is because of this concept that outstanding expenses and accrued income, and prepaid income and income received in advance are adjusted while preparing the final accounts of the business enterprises. (viii) The outsiders enter into long-term contracts with the firm to give long-term loans to the firm and invest money in the debentures of the company because the investors feel that the business is a going concern. (ix) The going concern concept is responsible for the accounting period concept since the life of the business is dividend into accounting periods of one year. The going concern concept is not valid when the business entity has been running at a loss for a number of years and there is no hope for its revival. Moreover if the workers have not been paid their salaries and interest payments are not made regularly to the lenders and the payment of principal amount is in doubt, going concern concept can not be used. THE COST CONCEPT Meaning of cost concept: The cost concept means that a fixed asset like building or machine or furniture etc., is recorded in the books of account at the price actually paid for it; it is called its acquisition cost which includes purchase price, the amount spent in installing and all expenses paid in making the asset ready for use. Financial Accounting Principles 3.5 The market price of the fixed asset is ignored. It is the cost price which forms the basis for the calculation of depreciation, profit or loss on the sale of fixed assets. Historical cost : As the acquisition or original cost relates to the past, it is referred to as historical cost. The cost concept is applicable only to fixed assets and not for current assets because only fixed assets are shown in the balance sheet at their respective cost prices; current assets are generally shown at cost price or market price whichever is lower or less. It is clarified that cost concept does not mean that the fixed assets always appear at their respective cost prices throughout their useful lives. It means that fixed assets should appear in the books of account at their respectives cost prices only in the year of their purchases and in subsequent or future years they should appear at their cost prices less depreciation written to date, that is, at book values or carrying values. The effect of the cost concept is that if a firm does not pay anything for a fixed asset, that fixed asset would not be recorded in the books of account. So the goodwill appears in the balance sheet only if the enterprise has purchased this intangible asset for a price. This is also true of other intangible assets like trade marks, copyrights and patents. The Justifications for the Cost Concept are given as under: (i) The main reason for the cost price is that it is objectively verifiable. The cost price is the actual price agreed between the purchaser and seller who are parties to a contract and this fact can be verified by anyone by going through the books of account. (ii) The cost concept does not permit the enterprise to give arbitrary or imaginary price to a fixed asset. (iii) A market value or current value of fixed assets is not stable. It undergoes frequent changes with the result that financial statements will have to be changed every year and comparison becomes difficult. Moreover, recording at market value is both costly and time consuming. (iv) The cost concept is in line with the going concern concept which assumes that the business firm will continue to carry on its business for an indefinite period and so there is no need to consider the market or realizable value of the fixed assets. Benefits : The benefits of the cost concept are summarized as under : (i) Market values change every year when the financial statements are prepared. It would make the preparation of financial statements difficult and time consuming because no easy record of market values can be made. (ii) The cost concept is objectively verifiable because the cost recorded in the books of account is based on actual contract between the buyer and the seller. (iii) The estimation of the amount of depreciation on fixed assets is very easy and simple because for the calculation of depreciation, only the cost price and an estimate of useful life of the fixed asset are required. (iv) The cost concept recognizes the fact that depreciation is the process of allocation of the cost of an asset over its useful life and not a process of valuation (i.e., based on market value of the fixed asset.) Limitations: The limitations or drawbacks of the cost concept are : (i) Fixed assets for which nothing has been paid (or no cost incurred) are not recorded in the books of account. For example, the knowledge and technological skill built inside the enterprise, a favourable location, brand name and reputation of the business, (etc., goodwill) find no mention in accounting records, though they are all valuable assets. (ii) The cost concept ignores the effect of inflation with the result that depreciation based on historical costs will be charged (or matched) with revenues earned at current prices. In this way the profit or income figure would be distorted and cannot be relied on. (iii) The actual information needed by management, investors, creditors, financial analysts, government etc., 3.6 Financial Accounting: Concepts and Applications may be the current values of the assets and therefore values based on historical cost may not be useful for their purposes. (iv) Both fixed assets and current assets are acquired at cost agreed upon by the buyer and the seller. But under the cost concept, only fixed assets are shown at cost or book value (cost minus depreciation) as the case may be. Current assets are shown at cost or marked price whichever is lower. (v) Under the cost concept, the market values are ignored, with the result that the balance sheet does not disclose the real worth of the business. PERIODICITY CONCEPT (THE ACCOUNTING PERIOD CONCEPT) Reasons for accounting period concept: The accounting period concept is related to going concern concept which presumes that a business is likely to continue for an indefinite period of time. The true income or loss can be ascertained only on the closure of the business by comparing the capital at the end arrived after adjustments for drawings in cash and goods and introduction of additional capital by the owner(s) with the capital at the start of business. But the owners cannot wait until the business is closed to know how much income has been earned or loss incurred. It will not serve any useful purpose. The owners or investors want to know periodical progress or performance of the business enterprise because it will be helpful to take corrective steps if the performance is not successful or upto the mark. The investors will be discouraged to make investments. The Income Tax Act and the Companies Act require the preparation of income statement (profit and loss account) on yearly basis. Moreover, for the purpose of reporting to creditors, bankers and other lenders, the income is to be calculated and financial position ascertained yearly and reported to various users of accounting information annually. This has necessitated the introduction of accounting period concept. Meaning of accounting period concept: Accounting period means that the working life of the business firm should be split (or divided) into convenient short periods of time or regular intervals called accounting periods and net profit (or loss) and the financial position should be ascertained at the end of each accounting period by preparing profit and loss account and the balance sheet. The length of the accounting period depends on the nature of the business and the needs or requirements of the owners of the business. Thus, the accounting period may be three months, six months, a year or even more than one year. However accounting period is normally of one year beginning on a specific date and ending 12 months later. For example, an accounting period for a calendar year begins on 1 January and ends on 31 December while a financial year begins on 1 April and ends on 31 March next year or any other year of 12 months, say, Dusherra year, Deepawali year, Vaisakhi year, Pongal year, and so on. Benefits of accounting period concept: The benefits of the accounting period concept are summarized as follows : (i) The concept enables the preparation of financial statements — the profit and loss account and balance sheet and cash-flow statement— of an enterprise annually. (ii) This concept has enabled preparation of income statement on accrual basis in the sense that matching of expenses and revenue is taken into consideration by making these items belong to the same accounting period. (iii) This concept enables the business firms to distribute their income at regular intervals (iv) This concept facilitates the comparison of net income and financial position of one year with that of another year. This is useful to management for planning and in improving the efficiency of the business. (v) Inter-firm comparison, that is, comparison between other firms is also possible. However the management prepares interim reports even for shorter periods, say for one quarter or even one month. Such reports help the investors in deciding to buy, retain or sell their investments in shares or debentures. Financial Accounting Principles 3.7 THE REALISATION CONCEPT Meaning of realisation concept: In accounting, income or profit means excess of revenue over expenses. The realization concept is related to revenues only and not to the expenses. Revenues are gross inflow of cash or bills receivable or other considerations from the following activities of the business enterprises : (i) Sale of goods (ii) Rendering of services such as repair job, consultancy, installation of machinery and so on. (iii) The use by others of entity resources yielding interest, rent, royalty, dividends and the like. Realisation means as to when a business transaction such as sale of goods or service etc., gives legal right to the receipt of money or money’ worth. It means realization concept is related to the point of time at which revenues is to be recognized. Thus, the essence of the realization concept is the timing of revenue recognition. For example, Maruti-Suzuki Ltd. produces a Motor vehicle in 2013, keeps it throughout 2014 and sells it 2015 for ` 3,50,000 and collects cash in 2016. The problem is as to when revenue should be recognized in the books of account. According to realization or revenue recognition concept, the revenue of ` 3,50,000 is realized in the year 2015. For this purpose three conditions must be fulfilled: (a) The goods have been transferred to the customer or service has been performed, (e.g., repair job is done), as the case may be, and the customer becomes legally liable to pay. (b) The revenue can be objectively measured or determined in money. (c) There is an independent transaction between the business enterprise and some third or unrelated party. So when an order is received from a customer only, it does not amount to recognition of revenue unless other conditions are fulfilled. Similarly even if an advance payment is received from a customer, the same does not amount to revenue recognition. Revenues from interest, rent, royalty, commission etc., are recognized on time-basis. For example, the interest earned in March 2015 even when received in April 2015 will be treated as revenue for the financial year ending 31 March 2015. Similarly rent received in advance in March 2015 will be treated as revenue for the financial year beginning from 1 April 2015. Exceptions : Concept of realisation is basically related to the timing of revenue recognition. There are few exceptions to the sale, performance and use of firm’s resources by others criteria : (i) Realised gain from disposal or unrealised gain from holding non-current assets like machinery, building etc. (ii) Unrealised gain from the change in the value of current assets i.e. from the holding of stock in trade etc. (iii) Realised or unrealised gain from the change in the value of foreign exchange rate. (iv) Realised gain from payment or discharging an obligation (e.g. creditors) at less than the carrying or book value. (v) Unrealised gain resulting from revaluation or restatement of carrying amount of an obligation. Benefits of realisation concept : The benefits of realisation concept are summarized as under: (i) The realization concept ensures that there can be no profit without the sale of goods or performance of service and use of firm’s resources by others. It is because of this concept that unrealized profits resulting from valuation of assets are ignored. Thus, profit is not earned on the basis of an order just received from a customer. Revenue is earned only when the order is executed and the customer becomes legally liable to pay for the goods sold to him or service performed for him. (ii) This concept ensures that an advance payment for goods received from a customer is not treated as revenue. 3.8 Financial Accounting: Concepts and Applications (iii) This concept is a check on the management intending to inflate the profit by recording the income not realized (or earned) (iv) The realization concept provides verifiable evidence for revenue recognition. (v) This concept ensures the determination or calculation of correct profit or loss. THE ACCRUAL CONCEPT Meaning : The accrual concept is applicable to the recognition of both the revenues and expenses. The accrual concept means that all transactions must be recorded whether they are settled in cash or not. According to this concept, revenues are recognized when they simply become receivable though cash is not received, and the expenses are recognized when they simply become payable though no cash is paid immediately and both are recorded in the accounting period to which they are related. It means that a simple promise by a customer to pay cash in future for sale of goods and services is considered as revenue and similarly a promise on the part of the firm to make payments in future for goods and services acquired is regarded an expense. The accrual concept therefore makes a distinction between the actual receipt of cash and the right to receive cash as regards revenue and actual payments of cash and obligations to pay cash as regards expenses. Revenues may be defined as the right to receive cash and when a firm sells goods for ` 45,000 on 25 March, 2015 and the payment not received until 10 April 2015, the amount is due and payable to the firm on the date of sale, i.e., 25 March, 2015 and must be included in the revenue for the year ending 31 March, 2015 though not received on this date. Similar rules apply to expenses. For example, if the firm receives goods costing ` 15,000 on 29 March, 2015 but the payment is made on 2 April 2015 the accrual concept requires that expense must be recorded for the year ending 31 March, 2015 although no payment has been made until 31 march, 2015 and the person to whom the payment should have been made is shown as creditor. So the accrual concept requires that revenue is recognized when realised and expenses are recognized when they become due and payable without regard to the time of cash receipt or cash payment. Accrual concept also implies that if some revenue is received but it is not earned (there is no legal right to receive it), it should be recorded as revenue received in advance and should be treated as liability in the balance sheet and not revenue of the current year. Similarly if some payment is made but no expense is incurred (that is no legal obligation to pay) such payment should be recorded as an asset in the balance sheet and not as an expense of the current year. Benefits of the accrual concept : This concept offers the following benefits : (i) This concept has been responsible for the application of accrual basis of accounting as against cash basis of accounting. (ii) This concept is of great help in the preparation of financial statements since all transactions are recorded whether they are settled in cash or not. (iii) This concept has given solid accounting principle regarding recognition of both revenues and expenses. Accordingly revenues accrue in that year in which they are earned and not necessarily in the year in which cash is actually received for them. And expenses accrue in the year in which they are incurred and not in the year they are actually paid. This principle has made it possible to take into consideration the total revenues earned as well as received in cash during the accounting period. Similarly, it is possible to take into account both total expenses incurred and actually paid in cash during the accounting period. Moreover it is accrual concept on the basis of which revenues received in the current accounting period but belonging to next accounting periods are adjusted (or deducted) from the total revenues received during the accounting period. Similarly expenses paid for the next accounting period(s) are adjusted (or deducted) from the total expenses paid in the current year. Prepaid revenues and revenues received in advance and expenses paid in advance and outstanding expenses are shown in the balance sheet. It is technically referred to as matching process. In this manner the financial statements disclose true and fair view of the operating results and financial position of the accounting period. (iv) It is because of accrual concept (which has introduced into accounts accrual basis of accounting) that interest on capital, interest on drawings, provision for depreciation, provision for doubtful debts Financial Accounting Principles 3.9 etc., are recorded though no cash is received or paid for them, for preparing the financial statements of the business firm ACCOUNTING CONVENTIONS An accounting convention is a rule or an accepted method or procedure or a statement of practice which is adopted either by general agreement or common consent which may be in writing or implied. Accounting conventions are in fact based on customs or practices which have been in use for a long period of time and which guide the accountants while recording the business transactions and preparing the profit and loss account and the balance sheet. ACCOUNTING CONCEPTS VS. ACCOUNTING CONVENTIONS Accounting concepts may be treated as necessary assumptions which form the foundation of the accounting principles. On the other hand, accounting conventions are lamp posts or guidelines to procedures based on custom, usage or general agreement. Although some authors on accounting do not make any distinction between accounting concepts and accounting conventions and treat them synonymous (same or identical), yet there are some differences between them. The main points of differences are given in the following table : Points of Difference Accounting Concepts Accounting Conventions (i) Assumptions vs. customs Accounting concepts are basic assumptions, accepted true, on the basis of which business transactions are recorded in the books of account. Accounting conventions are guidelines accepted by general agreements or usage which are followed in the preparation of the profit and loss account and balance sheet. (ii) Personal judgement or Bias There is no personal judgement or bias in the adoption of accounting concepts. Individuals bias may play an important role in the adoption of accounting conventions. (iii) Importance Accounting concepts are foundations of systematic and proper recording Accounting conventions are not so important as accounting concepts (iv) Maintenance of accounts vs. Financial statements Accounting concepts are concerned with the maintenance of accounts Accounting conventions are used for preparing the profit and loss account and the balance sheet. (v) Uniformity in Use There is a uniform use of accounting concepts in different type of business organizations There is no uniformity in the application of accounting conventions in different enterprises. (vi) Legal Position Accounting concepts are established by law Accounting conventions are established by common accounting practices (vii) Number There are many accounting concepts The number of accounting conventions are limited to few. (viii) Consistency Accounting concepts are internally consistent in the same organization There is no internal consistency in the application of accounting conventions even in the same organization. Benefits of Accounting Conventions: The benefits of Accounting Conventions are given below : (i) Accounting conventions ensure the truthfulness or authenticity of the financial statements. (ii) Accounting conventions make the preparation and presentation of the financial statements easy. (iii) Accounting conventions enable the inter-firm and intra-firm comparisons of the financial statements because of the element of uniformity (iv) Accounting conventions make the financial statements clear and meaningful. Types : The major basic accounting conventions are listed below: (i) Convention of Consistency (ii) Convention of Conservatism or Prudence Convention (iii) Convention of Materiality (iv) Convention of Full Disclosure. 3.10 Financial Accounting: Concepts and Applications CONSISTENCY CONVENTION Consistency convention means that the same accounting practices will be used for similar items from one accounting period to another. It means that accounting information is useful only if it can be compared with the similar information within same firm for few years and with similar information between two or more firms for the same period. But this is possible only when the business firms use the same methods in respect of such important items as inventory valuation, depreciation of fixed assets, provision for doubtful debts, treatment of deferred revenue expenditures and the like in the preparation of financial statements: the income statement (Profit and Loss Account) and the balance sheet. For instance, if inventory valuation is done at cost price or market price whichever is lower or First-in First out (FIFO) basis or Weighted Average basis etc., the same methods should be continued for all the years. The same holds good for a particular method of depreciation. A change in method of inventory valuation or depreciation may affect the income determination as well as inventory cost and book values of fixed assets in the assets side of the balance sheet. Consistency requires that same accounting methods will be used for similar items over period of time. Further, consistency convention does not mean that the same method of valuation should be followed for both the current assets and fixed assets. What it really means is that whatever accounting practice is followed for a particular asset, the same should be followed for that asset from year to year. Types : There are three types of consistencies, namely : (i) Vertical consistency : It is to be found within an inter-related group of financial statements bearing the same date. Vertical consistency would occur when fixed assets have been shown at cost price or historical cost and in the interrelated income statement depreciation has also been charged on the historical cost of the assets. (ii) Horizontal consistency : This consistency is to be found between financial statements of one entity from period to period and thus enabling the comparison of performance of the business entity in one year to be made in the subsequent year. (iii) Third dimensional consistency : This type of consistency assists in making comparison of the performance of one business entity with the other business entity in the same trade and on the same date. However, the consistency principle does not mean that a particular method of accounting once adopted can never be changed. Accounting being social science, there is a scope for desirable changes as a result of changes in the circumstances in which accounting operates. The only requirement is that when a change is made, it should be fully disclosed in the financial statements along with its effect in terms of rupee amounts on the reported income and financial position of the year in which the change is made. Limitations : The limitations of convention of consistency are listed as under : (i) The consistency convention may deliberately understate revenues and disclose pessimistic or gloomy picture of financial position. (ii) Financial statements may not show a true and fair view of the states of affairs of the business entity. (iii) The convention of consistency may encourage the creation of secret reserves by making consistently excess provision for future contingencies. (iv) Convention of consistency goes against the convention of full disclosure THE PRUDENCE CONVENTION (Convention of Conservatism) The prudence convention or convention of conservatism means policy of playing safe or caution. It means that while recording the business transactions and preparing the financial statements, the accountant should take into consideration all prospective or future losses and risks and make adequate provisions for them but the prospective profits should not be taken into consideration, that is, they should be ignored. The working rule is : anticipate no gains or profits but provide for all possible losses and in doubt write them off. Financial Accounting Principles 3.11 Thus, the accountant should record not only actual losses like bad debts but also make provision for those losses which are likely to occur like provision for doubtful debts. Thus, it is on account of this convention of conservatism or prudence convention that the accountant makes provision for discount on debtors, provision for fluctuations in market prices of investments, provision for premium on the redemption of debentures, writing off intangible assets like goodwill, patent, trade marks etc.. Similarly, in the valuation of stock in hand if the market price is less than its cost price, stock-in-hand would be recorded at the market value. But if the market price of the inventory has increased, the unrealized gain should not be recorded unless the stock is actually sold. The future is full of uncertain events and so something should be done to meet future uncertainties. Hence the making of provision for future losses and no provision for unrealized future profits. Effect : The effect of this convention is that the financial statements disclose the actual results and no artificial gains through the techniques of window dressing which means any practice that attempts to make a situation look better than what it really is. It must be clearly noted that there should be no deliberate attempt to understate the values of assets THE MATERIALITY CONVENTION The convention of materiality means that in accounting only important and relevant information should be provided to the users of financial information, that is, only material information should be supplied. Materiality cannot be defined precisely. The general rule is that an item should be regarded as material (i.e., significant) if there is reason to believe that knowledge of that item would influence or affect the decisions of the users of the financial statements such as to invest or not to invest in the enterprise or to give loan or not to give loan to the business firm. It may be clarified that the term materiality is relative in the sense that an item may be material for one type of user of acconting information while it may be insignificant for other users. For instance the long-term creditors may be interested in the current value of, say, building or plant while bankers may not attach any importance to it while advancing short term loans. Similarly, where amounts of expenditure involved are insignificant they are not treated as capital expenditure and hence no need for depreciation. For example, a pair of scissors in an office could be used for a number of years but still it is treated as an expense for the accounting period in which they are purchased since the clerical cost of recording depreciation on such an item would exceed the cost of the item. Similarly pencils, ball pens, sharpeners, waste paper baskets, etc., are treated expenses when they are bought although technically they are assets of the company. The omission of paise in the financial statements is simply due to their immaterial effect on the financial statements. It would not affect the important decisions to be made by the statements users. The rationale behind convention of materiality is that if material as well as insignificant business transactions are recorded in the books of account, the accounting records will be burdened with unnecessary details. THE FULL DISCLOSURE CONVENTION The convention of full disclosure suggests that every financial statement should fully disclose all relevant information that affects the average investor. Full disclosure means that there should be full, fair and adequate disclosure of accounting information.Adequate means minimum set of information to be disclosed; fair indicates an equitable treatment of users and full refers to complete and detailed presentation of information. For example, if the income statement shows net sales at ` 1,27,500, it is important for the reader to know the amount of gross sales which may be ` 1,50,000 and the sales returns ` 22,500. The disclosure of 15 per cent sales returns may help the users to find out the actual sales position. But there will not be any investigation if only ` 1,27,500 is shown in the income statement. No multipurpose statement has been devised as yet to serve the requirements of different users like creditors, investors, government, etc. Therefore, whatever details are available, that must be honestly reported and additional information must be appended to the financial statements. It would be more appropriate if a summary of the accounting policies followed in the preparation of financial statements is appended. For example in a balance sheet the basis of valuation of assets, such as investments, inventories, land and buildings etc. should be clearly stated. Similarly any change in the method of depreciation must also be indicated. 3.12 Financial Accounting: Concepts and Applications The rationale behind this convention is that the financial statements are used by external users who make important decisions on the basis of information contained in then. Hence, the financial statements should state all the material facts with as much information as possible. Exclusion of material facts makes the financial statements, not only incomplete but also unreliable. SPACE FOR REVISION Financial Accounting Principles 3.13 Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. What is the nature of financial accounting principles ? Enumerate briefly their main characteristics. What is meant by generally accepted accounting principles ? [B.Com. (Hons.) Delhi 1981, 2002] Explain the meaning and significance of following : (a) The Business Entity Concept. [B.Com. (Hons.) Delhi 1981, 1982, 1992, 2004] (b) The Going Concern Concept [B.Com. (Hons.) Delhi 1980, 1981, 1989, 2004, 2005] (c) The Money Measurement Concept. [B.Com. (Hons.) Delhi 1981, 1982, 1984, 1991, 1995, 2004] 4. Explain briefly : (a) Cost Concept [B.Com. (Hons.) Delhi 1986] (b) Convention of Consistency [B.Com. (Hons.) Delhi 1985, 1987] (c) Dual Aspect Concept [B.Com. (Hons.) Delhi 1980, 1983, 2004] (d) Accrual Concept [B.Com. (Hons.) Delhi 1983] (e) Concept of Materiality [B.Com. (Hons.) Delhi 1983, 1990] 5. Write short note on the convention of full disclosure [B.Com. (Hons.) Delhi 1991, 2005, 2007] 6. Explain the Accounting Equation. Describe its role. [B.Com. (Hons.) Delhi 1994] 7. Briefly explain the concept of Conservatism. Give examples. [B.Com. (Hons.) Delhi 1981, 1997] 8. Explain the accounting concept of periodic matching of costs and revenues. [B.Com. (Hons.) Delhi 1998, 2000] 9. “Revenue is recognised when a sales transaction is made or when services are rendered.” State three exceptions to this general rule. [B.Com. (Hons.) Delhi 2014] 10. Explain the convention of ‘Materiality’ giving examples. Does materiality contradict ‘Full disclosure’? [B.Com. (Hons.) Delhi 2019] 4 Fina nc ia lAccountingSta nda rds INTRODUCTION Accounting, as a language of business, has come to be regarded as an information system which communicates or provides financial results or figures to the creditors, investors employees, owners, management, Government and so on through financial statements like Balance Sheet and Profit and Loss Account for their respective uses. It therefore becomes necessary that the financial statements should not simply focus on true and fair view of the net worth and profitability of a particular business entity but they must be comparable with the financial statements of other business enterprises. It is possible only when financial transactions are recorded by adopting uniform accounting methods or practices and policies. For example, it is possible to value the closing stock in more than one way, that is, by adopting lower of cost or market (L.C.M.) price method or First-in first out (FIFO) method or Last-in-first out (LIFO) method or Weighted Average Method and so on. Fixed assets may be valued on the basis of original cost minus depreciation to date or replacement cost. Further depreciation may be charged on the basis of straight line method or diminishing balance method or any other method. Similarly an expenditure on a certain item may be treated as a capital expenditure or a revenue expenditure e.g., large expenditures on the repairs of a machine or building. If the financial accounting process is not properly regulated, there is a possibility of financial statements, providing a misleading or distorted picture of the business rather than the true state of affairs. Thus, there is always an urgent need to adopt uniform accounting methods and policies to record business transactions of the same type to achieve comparability, consistency, and reliability of financial position and operating results of various business enterprises. It is particularly important in an era of globalization if foreign capital is to be attracted in local markets. The foreign investor must feel satisfied that the financial position and operating results are based on internationally acceptable rules. Accounting standards provide a framework of uniform accounting methods and policies to reduce or in certain cases to eliminate altogether wide or large variations in accounting treatments of various items so that the financial statements of different business enterprises become comparable. In practice this task is difficult at the international level because accounting methods and policies in different countries are influenced by company laws, taxation policies and economic conditions. CONCEPTS OF ACCOUNTING STANDARDS Accounting standards are defined as codified or written statements, or documents of accounting rules and guidelines or practices for preparing the uniform and consistent financial statements relating to recognition, measurement and disclosures of accounting transactions. Accounting standards may also be defined as written policy documents issued by expert accounting body (e.g., Institute of Chartered Accountants of India), or by Government (e.g., the Companies Act, Income Tax Act) or its regulatory body (e.g., Securities and Exchange Board of India popularly known as SEBI) covering such aspects as recognition of events, measurement, presentation and disclosure of accounting transactions and events in the financial statements, namely: Balance Sheet and Profit and Loss Account. 4.2 Financial Accounting: Concepts and Applications The focus of the accounting standards is to convey the same meaning of any accounting concept to all users of accounting information in the same sense so that uniformity and comparability in financial statements is achieved. Accounting standards may also be termed as codified forms of generally accepted accounting principles. The essence of the accounting standards is that they provide specific guidelines as to how the various items which go to make up the financial statements should be dealt with in accounts and disclosed in the annual reports relating to net income and financial position. For example, accounting standard may define the term depreciation and prescribe a definite method of charging depreciation in respect of various items of fixed assets with minor modifications in respect of special assets. In this way, the accounting standard would reduce the options or methods of recording certain business transactions so that financial statements become more meaningful and comparable under various heads. ACCOUNTING CONCEPTS AND ACCOUNTING STANDARDS The following are the points of difference between accounting concepts and accounting standards : (i) Concepts are in the nature of general statements like entity concept, monetary concept etc., and do not provide solutions to specific problems. On the other, hand, accounting standard will aim at specific solutions to specific issues such as inventory valuation, depreciation of fixed assets, valuation of fixed assets, revenue recognition etc.. (ii) A concept may allow alternative treatments for the same items. For example, according to cost concept, fixed assets may be valued by using original cost or replacement cost or realizable cost etc.. Similarly inventories may be valued by adopting cost or market price whichever is less or FIFO or LIFO or Weighted Averge Method etc.. But the accounting standards on valuation of fixed assets and inventory valuation may limit the number of methods of valuation for these items. (iii) Accounting concepts are unwritten general statements about the rules or guidelines for recording business transactions. On the other hand, accounting standards are written or codified statements issued by institutions of professional accountants specifying uniform rules or practices for preparing financial statements. (iv) Accounting concepts do not have a legal status. But the accounting standards are legally recognized by Government, (Companies Act) or regulatory agencies like Securities and Exchange Board of India (SEBI). (v) In the absence of universal concepts, the financial statements of different firms are not comparable. But the accounting standards are mandatory in most of the cases. So the financial statements, being uniform, are comparable. (vi) Accounting concepts do not restrict the discretionary power of the accountant in the recording process because there is no legal restriction. But the accounting standards limit the area within which the accountant has to function and in this manner accounting standards are similar to some of the laws. BENEFITS OF ACCOUNTING STANDARDS The significance or utility or benefits of accounting standards are given below: (i) Easy intra-firm and inter-firm comparability : As the same accounting methods and policies are adopted in the preparation and presentation of financial statements, accounting standards facilitate or help in comparing the financial statements of various years of the same enterprise (intra-firm) and among various enterprises in the same industry (inter-firm). Thus, accounting standards are helpful in intra-firm and inter-firm comparisons of operating results and financial position. Financial Accounting Standards 4.3 Accounting standards, to a limited extent, also facilitate comparison of financial statements of business enterprises located or situated in different countries of the world. It is possible only by harmonizing accounting standards of different countries. (ii) Reliability and credibility : Accounting information is used by various groups of persons which include investors, creditors, lenders, trade unions, management, Government officials etc.. The use of accounting standards create a sense of confidence among the users of accounting information. The accounting standards ensure the use of uniform or standardised rules and guidelines for accounting process of recording and preparing the financial statements. In this way, accounting information is presented in a transparent manner and it automatically enhances or increases the reliability and credibility of financial statements. (iii) True and fair view of the financial position : In order to present a true and fair view of the financial position for users of accounting information, it is necessary to use accounting standards. (iv) Improve the quality of financial reporting : Accounting standards improve the quality of financial reporting in the sense that financial reports are prepared using not only standard formats but also easily understandable common terms with same meanings attached to them. For example, the Companies Act prescribes a common balance sheet format for all companies engaged in general business. The balance sheet contains standard terms like share capital, reserves and surplus, Current and Non-current assets, Non-current and current liabilities, and so on. All these increase the quality of the information contained in the financial statements. There are certain areas where important information is not required to be disclosed by law. But accounting standards may call for disclosure beyond that required by law e.g., disclosure of cash flows in terms of operating, investing and financial activities. And also disclosure of non-cash transactions as a footnote to cash-flow statements. (v) Reduction in alternative accounting practices : Accounting standards reduce or bring down the number of alternative accounting practices for recording and presenting the business transactions. For example, accounting standard on Depreciation Accounting (AS-6) limits the number of depreciation methods. Similarly Accounting Standard (AS)-2: Valuation of Inventories limits the choices of inventory valuations. (vi) Efficiency of management : Accounting standards are very helpful in assessing or evaluating the efficiency of management in respect of liquidity, profitability, solvency, debtors turnover, sales turnover and so on. In the absence of accounting standards the financial position and operating results (profitability) cannot be compared and hence overall efficiency of management cannot be judged by way of such comparisons. (vii) Value of accounting information : Accounting standard provides a definite structure of accounting framework by giving definition of accounting terms or standard rules for valuation and measurements etc.. In this manner use of accounting standards increases the value of accounting information. (viii) Useful to accountants and auditors : The use of accounting standards reduce the work of the accountants and auditors since they have to work within a definite accounting framework. It is the duty of the auditors to ensure that financial statements have been prepared in accordance with the relevant accounting standards. They will make adequate disclosures in their audit reports to enable the users of accounting information to know if certain aspects of the accounting standards have not been followed such as valuation of fixed assets or inventories. So the auditors can escape or avoid court cases and penalties under the Companies Act due to insufficient disclosures and due to adoption of inappropriate accounting policies. (ix) Reduction of manipulation and frauds : The use or adoption of accounting standards has minimized, to a large extent, manipulations, frauds and use of inappropriate accounting policies in the preparation of financial statements. This is true because accounting standards prescribe appropriate accounting policies and adequate financial disclosures in recording accounting transactions and in preparing profit and loss account and balance sheet. (x) Resolving conflict of financial interest : In a number of cases, there is a conflict of interest amongst various users of the financial information. For instance, the shareholders and creditors may have opposite 4.4 Financial Accounting: Concepts and Applications or contrary interests in assessing or evaluating the profitability and net worth of the business enterprise. Shareholders are interested in more profitability than the financial position while the creditors are concerned equally with the profitability and financial position. Accounting standards are helpful in resolving such a conflict of interests because financial statements prepared on the basis of accounting standards or uniform accounting practices are acceptable to all groups of users of accounting information. PROCEDURE FOR ISSUE OF ACCOUNTING STANDARDS IN INDIA Recognising the need to harmonise or narrow down or reduce the number of alternative accounting policies and practices, the Institute of Chartered Accountants of India (ICAI) constituted an Accounting Standard Board (ASB) on April 21, 1977. The main function of ASB is to formulate the accounting standards from time to time and then they are issued by the Council of ICAI. While formulating the accounting standards, ASB will take into consideration the applicable laws, customs, usages and requirements of business enterprises. ICAI is member of International Accounting Standards Board (IASB) and ASB gives due consideration to International Accounting Standards and try to integrate them, to the extent possible, in the light of practices prevailing in India. Broadly, the following procedure is adopted for issuing Accounting Standards: (i) ASB determines the main areas or subjects in which accounting standards are required. (ii) In the selection of specific subjects and preparation of accounting standards, ASB is assisted by study groups. In the formation of study groups, provision is made for wide participation by the members of ICAI and others concerned with the subject. (iii) ASB will also hold dialogue or talk with representatives of Government, public sector undertakings, industry and other organisations for knowing their views. (iv) Based on the discussions with interested parties to the subject of the standard, an exposure draft of the proposed standard will be prepared. The draft would normally include: (a) Objectives of the standard (b) Scope of the standard (c) Definitions of the terms used in the standard (d) Recognition of the measurement principles, wherever applicable (e.g., valuation of inventories, valuation of fixed assets etc.) (e) Presentation and disclosure requirements. ASB will consider the preliminary draft and if any revision is required, ASB will refer the same to the Study Group. (v) ASB will circulate the Draft of the proposed standard to the Council members of ICAI and other specified bodies such as Department of Corporate Affairs (DCA) Comptroller and Auditor General of India (CAG), Central Board of DirectTaxes (CBDT), RBI, ICWA, ICSI, SEBI etc. (vi) ASB will hold a meeting with the representatives of specified bodies [as Listed above (v)] to ascertain their views on the draft of the proposed Accounting Standard. On the basis of the comments received, ASB will finalise the Exposure Draft of the proposed accounting standard. (vii) The Exposure Draft will be issued for comments by members of the ICAI and public. The Exposure Draft will specifically be sent to specific bodies [as listed above (v)], stock exchanges and other interested groups as appropriate. (viii) After taking into consideration the comments received, the draft of the proposed standard will be finalized by ASB and submitted to the Council of the ICAI. (ix) The Council of the ICAI will consider the final draft of the proposed standard and if found necessary, modify the same in consultation with ASB. The Accounting Standard on the relevant subject will then be issued by the Council of ICAI in the latest issued of its journal, namely: The Chartered Accountant Financial Accounting Standards 4.5 OBJECTIVES OF ACCOUNTING STANDARDS The following are the main objective of accounting standards in India. (i) To standardise the diverse (different) accounting policies and practices with a view to eliminate the non-comparability of financial statements and provide reliability to the financial statements. (ii) To facilitate the analysis of financial statements by bringing uniformity. (iii) To help the users of financial statements in taking or making decisions. SALIENT FEATURES OF ACCOUNTING STANDARD (AS) - I: DISCLOSURE OF ACCOUNTING POLICIES AS – 1 deals with the disclosure of significant accounting policies followed in preparing and presenting financial statements. The main requirements of AS – 1 are : (i) Disclosure of all significant policies followed in the preparation of profit and loss account and the balance sheet. (ii) The primary consideration in the selection of accounting policies by an enterprise is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the financial position as at balance sheet date and of the profit or loss for the period ended on that date. (iii) The major considerations governing the selection and application of accounting policies are : (a) prudence, (b) substance over form and (c) materiality (iv) Disclosure of fundamental assumptions, namely : going concern, consistency and accrual, is necessary if they are not followed. (v) Disclosure of accounting policies should form part of the financial statements i.e., they should be disclosed at one place instead of being scattered over several statements, schedules and notes. NATURE OF ACCOUNTING POLICIES Accounting policies refer to specific accounting principles and methods of applying those principles by various enterprises in the preparation and presentation of financial statements, namely, the Income Statement, the Balance Sheet and the Cash-Flow Statement. Thus, accounting policies mean specific guidelines or rules which must be taken into consideration while recording the business transactions in the books of account and their ultimate presentation in the form of financial statements. There is no single list of accounting policies which are applicable to all enterprises and in all circumstances. The differing circumstances in which enterprises operate and the complex nature of economic activities necessitate the use of alternative accounting principles and methods of applying those accounting principles which are most acceptable. The choice of the appropriate accounting principles and the methods of applying those principles in the specific circumstances of each enterprise requires considerable judgement and personal wisdom by the management of the enterprises. The following examples would highlight the nature of different accounting policies adopted by different enterprises particularly the corporate form of business enterprises : Areas (i) Methods of depreciation, depletion and amortisation Differing Accounting Policies (i) Straight Line Method; Written Down Value Method (ii) Treatment of expenditure during construction (ii) Capitalisation of expenses; treatment as deferred revenue expenditure (iii) Conversion or translation of foreign currency transactions (iii) Credit or debit to reserves or credit or debit direct to profit and loss account (iv) Valuation of inventories (iv) FIFO, LIFO, Weighted Average Method etc 4.6 (v) Financial Accounting: Concepts and Applications Treatment of goodwill (v) (vi) Valuation of retirement benefits (vi) (vii) Treatment of investments (vii) (viii) Recognition of revenues in hire purchase (ix) Recognition of profit on long-term contracts (x) Valuation of fixed assets Make provision as per actuarial method or some rational consistent basis Cost, fair value, lower of cost and fair value (viii) At the time of receiving each instalment, or transactions when all the instalments have been received (ix) Percentage of completion method, completed contract method, different procedures for measuring percentage of completion (x) (xi) Treatment of contingent liabilities Amortize immediately or over a number of years (xi) Cost less depreciation, fair value, replacement cost Making of provision or a simple note to the accounts The above list of examples is not intended to be exhaustive or complete in all respects. It simply provides an insight into the adoption of different accounting policies by the enterprises in presenting the required accounting information. FUNDAMENTAL ACCOUNTING ASSUMPTIONS Certain fundamental accounting assumption underline the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. Disclosure is necessary if they are not followed. The following have been generally accepted as fundamental accounting assumption : (a) Going 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 the intention nor the necessity of liquidation or curtailing materially the scale of the operations. (b) Consistency : It is assumed that accounting policies are consistent from one period to another. (c) Accrual : Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. ATTENTION PLEASE (i) If nothing has been written about the fundamental assumptions in financial statements, it is assumed that fundamental accounting assumptions have been followed in the preparation of the financial statements. (ii) If any fundamental assumption has not been followed, then this fact must be disclosed in financial statements. DIFFERENCE BETWEEN FUNDAMENTAL ASSUMPTIONS AND ACCOUNTING POLICIES The fundamental assumptions and the accounting policies differ in respect of following matters : (i) AS regards number : AS – 1 provides for only three fundamental assumptions namely : going concern, consistency and accrual, which are applied in all circumstances. But there may be different accounting policies adopted by different enterprises (ii) As regards disclosure : There is no need for any disclosure if all the fundamental assumptions have been incorporated in the financial statements. Disclosure is necessary if a particular accounting policy has been adopted. (iii) Disclosure, when necessary : In case, an enterprise has not followed fundamental assumptions, it must disclose this fact in the annual accounts along with the reasons for not doing so. In the case of accounting Financial Accounting Standards 4.7 policies, disclosure is necessary only when there is a change in the subsequent year. The annual accounts must disclose the reasons for change and the financial effects of such a change (iv) Option : There is no option or choice available regarding the adoption of fundamental accounting assumptions. However, the firm has an option to select a particular policy e.g. change in depreciation method or in respect of valuation of inventories IMPORTANCE OF ACCOUNTING POLICIES It is clear from the various examples of accounting policies that they play a very significant role in shaping the financial statements right from the stage of income measurement to the presentation and disclosure of the information pertaining to assets and liabilities of a business enterprise. In order to appreciate or understand the operating results and the financial position of a business enterprise, it is absolutely necessary to know as to what accounting policies have been adopted in the preparation and presentation of annual accounts and also the effect of departures, if any, of accounting policies on the financial results when compared to preceding year(s). Thus, knowledge of accounting policies is of great help in the working out of inter-firm comparisons. SOURCES OF ACCOUNTING POLICIES Business enterprise is a part of the social system or society. Financial reporting is the responsibility of the corporate form of business organisation. In this way, Accounting and Reporting are not separate from the social system. The accounting policies adopted by a business enterprise in the financial reporting through balance sheet, income statement and cash-flow statement, determine, the quality and truthfulness of the operating results, financial position and the movement of cash over a given period of time. The accounting policies have evolved over a period of time and owe their origin to the following environmental factors : (i) Legal system : In order to protect the public interest (i.e., of investors, creditors, employees etc.) and to resist the manipulation of accounting information, the Governments usually make specific laws such as Companies Act, Income Tax Act, GST Act, Excise Laws etc. These Acts lay down guidelines for the preparation of annual accounts so as to provide a uniformity in the presentation of accounting information. For example, the Companies Act provides detailed instructions regarding the preparation of profit and loss account, methods of depreciation and presentation of financial position etc. Similarly, the Income tax Act provides guidelines for the calculation of taxable income. (ii) Political system : Accounting policies of socialistic countries are different from countries under market economy or capitalistic system. (iii) Professional accounting bodies : The various statements (accounting standards, guidelines etc.) of professional accounting bodies such as Institute of Chartered Accountants of India combined with the efforts of Government and other regulatory agencies (Securities and Exchange Board of India) and progressive management have provided a number of acceptable alternative accounting policies particularly in the case of corporate enterprises. (iv) Economic and educational developments : Higher socio-economic and educational developments have also contributed to the development of accounting policies. Eminent authors of accounting books have played an important role in the development of accounting principles to ensure a system of providing uniform accounting information for the same type of business enterprises. Consumerism, as it is called, is beginning to produce accounting changes. SELECTION OF ACCOUNTING POLICIES The major considerations governing the selection and application of accounting policies are : (i) Prudence : In view of the uncertainty regarding future events, the working rule is : Anticipate no gains but provide for all possible losses and if in doubt, write them off. It means that profits are not anticipated but recognised only when realised though not necessarily in cash. Thus, provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. 4.8 Financial Accounting: Concepts and Applications (ii) Substance over form : The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not by their legal form. It means that some business transactions have legal form which is different from the fundamental commercial reality or substance. For example, in hire purchase transactions, the legal position (or firm) is that the hire purchaser does not become the (legal) owner of the asset until he has paid all the instalments. However, the substance (or commercial reality) is that the asset is immediately acquired by the hire purchaser and he has a loan to assist him in the purchase which he pays over a period of time. The substance of this transaction is that it is a normal credit sale and reservation of title clause in the contract becomes important only when the buyer becomes insolvent. So, for accounting purpose, the asset can be recorded at full cost price by the purchaser. Similarly, substance over form would require that a large corporation (e.g., a multinational one) which owns several legally independent entities prepare consolidated profit and loss account and a consolidated balance sheet for all entities though legally it is not required to do so. (iii) Materiality: Financial statements should disclose all material items, i.e. items the knowledge of which might influence the decisions of the users of the financial statements. CHANGES IN ACCOUNTING POLICIES It is emphasised that there is no single list of accounting policies which are applicable to all enterprises in all circumstances. Accounting policies vary from enterprise to enterprise for obvious reasons. For example, it is not possible to recommend the same accounting policies for paper mill and a textile mill. Not only this, accounting policies may vary even from year to year in the same enterprise. An enterprise is at liberty to change either all or some of these accounting policies in the future. But if a change in an accounting policy has a material effect on the operating results or financial position in the current year or may have material effect in the subsequent periods, the same must be disclosed together with reason. For example, if the enterprise changes the method of depreciation in accordance with the provisions of Companies Act or Income Tax Act and carrying cost of the assets, the same must be disclosed in the annual reports. DISCLOSURE OF ACCOUNTING POLICIES AS – 1, provides for the following matters regarding disclosure of accounting policies : (a) It is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. This is necessary for the proper understanding of the financial statements; (b) Such disclosures should form part of the financial statements; (c) It would be helpful to the reader of financial statements if they are all disclosed at one place; (d) Disclosure in the case of change in accounting policy : Any change in an accounting policy which has a material effect should be disclosed. The amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in an accounting policy which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted. Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item in the accounts. REASONS FOR DISCLOSURE IN ACCOUNTING POLICIES The need for disclosure of accounting policies arises because accounting policies may differ from enterprise to enterprise and for different years within the same enterprise. Accounting policies means principles and methods to apply principles adopted by an organisation in the preparation and presentation of financial statements. For example, inventory valuation is principle while Last-in-First out (LIFO) or Weighted Average Method is application of principle. Hence it becomes necessary to disclose accounting policies such as Depreciation on fixed assets, Valuation of Inventories, Valuation of investments. Treatment of goodwill, Treatment of foreign currency transactions, Treatment of Government grants and other such policies mentioned in this chapter. Financial Accounting Standards 4.9 APPENDIX IND. A S (Indian A ccountingStandard)-8 :A ccountingPolicie s, Chang e s in A ccountingEstimate s andErrors OBJECTIVE AND SCOPE The primary objective of Ind.As (Indian Accounting Standard) 8 is to prescribe the criteria for selecting and changing accounting policies along or together with accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of errors. Regarding scope this standard shall be applied in selecting and applying accounting policies and accounting for changes in accounting policies, changes in accounting estimates and correction of prior-period accounting errors. DEFINITIONS Accounting policies are specific principles, conventions, rules and practices applied by an entity or enterprise in preparing and presenting financial statements. A change in accounting estimate is an adjustment of carrying amount of an asset or a liability or related expenses (e.g. consumption of an asset). Such changes result from new information or new development resulting from reassessing the expected future benefits and obligations associated with the asset or liability. Such new developments cannot be termed as correction of errors. Material omissions or misstatements of terms should be regarded as material only if they can effect the decisions of the users. Prior period errors are omissions from and misstatements in the financial statements of an entity for one or more prior periods. Information that was available and should have been taken into account or misuse of reliable information in the preparation and presentation of financial statements is termed or classified as an error. Errors include calculation errors, incorrect application of accounting policies, misrepresentations or fraud. Retrospective application is applying new accounting policy to transactions and other events as if that policy had always been applied. Retrospective restatement means restating the amount of elements in the financial statements as if prior period error had never occurred. Prospective application means the application of a change in accounting policy to transactions and other events occurring in the current and future periods affected by the change Impracticable: Error correction may be impracticable when the— (a) Effect cannot be determined (b) Assumptions on management intent must be made (c) Restatement requires evidence that is not available. In short, applying a requirement is impracticable when the firm cannot apply it after making every reasonable effort to do so. 4.10 Financial Accounting: Concepts and Applications ACCOUNTING POLICIES Selection and Application of Accounting Policies Simply stated the entity should apply relevant accounting standard while determining the accounting policies. If the entity prepares a cash-flow statement, it should follow the procedure laid down in Ind.AS 7: Statement of Cash Flows. If no Indian Accounting Standard is available Judgment should be applied by management by taking into consideration relevant and reliable criterion. Judgement may be based on the publications of other Accounting standard bodies such as IFRSs, other industry practices, accounting literature or interpretations. Consistency of Accounting Policies An entity should apply its accounting policies consistently for similar transactions or events or categories unless differently required by Ind.AS. (Indian Accounting Standard). Moreover, accounting policies should be consistent from period to period to allow comparisons to be made. Changes in Accounting Policies Accounting policies are changed only if following conditions are satisfied: (i) If changes are required by Indian Accounting Standards or IFRSs and (ii) Changes will result in better, reliable and more relevant information. For example, an entity has been following LIFO method not permitted by Ind.AS 2. So the entity will have to change its policy to FIFO or Weighted Average method. One more example relating to consistency—If the entity is charging depreciation according to straight line method, it must continue to follow the same method so as to allow the users to compare one period income with that of another period. Further, if an enterprise is using the Financial Statements for the first time and applies Ind.AS (IAS) 39: Financial Instruments. This is not change in accounting policy. Application of changes in accounting policies: It is to be noted that: (a) transitional provisions may apply if there is specific transitional provision in Ind.AS (Indian Accounting Standard) (b) if there is no transitional provision, apply the accounting policy retrospectively (c) for a voluntary change of policy, comparative figures must also be changed if standard has no transitional provision. (d) early application of standard is not a voluntary change in accounting policy. For example, a new standard has been used which would come into force three years after the date of use. The entity introduces the standard in the current year which is permitted but not compulsory. This is voluntary change in policy. Hence, no change in comparative figures is necessary. RETROSPECTIVE APPLICATION If accounting policy is applied retrospectively, it requires adjustment of opening balance of each component of the equity. Limitations of retrospective application: A change in accounting policy will be applied only when from when it is practicable. However, it is impracticable to apply a change in accounting policy retrospectively then: (a) apply the change to the earliest period that is practicable if it is impracticable to determine period specific effect of change in policy; Financial Accounting Standards 4.11 (b) if not possible to determine the cumulative effect of the change, then prospectively apply to the earliest period that is practicable. DISCLOSURE The disclosure aspect can be explained in terms of: (i) When change is required by Ind.AS (ii) When change is voluntary When change is required by Ind.AS. (i) Nature of change in policy (ii) Give reasons why new accounting policies provide reliable and relevant information (iii) Amount of the adjustment relating to prior period not presented (iv) If retrospective application is not practicable, explain how the change in policy was applied. When change is voluntary (i) The title of the Ind. AS. (ii) Nature of change in policy (iii) Description of the transitional provisions (iv) Reasons for applying voluntary change (v) Effective date for application of the standard or mandatory date (vi) Discussion of the effect of the standard or a statement that the effect is not known. CHANGES IN ACCOUNTING ESTIMATES Estimates require personal Judgements based on the latest available information e.g. estimates are needed for bad debts, useful life of the fixed assets, inventory obsolescence and warranty obligations. Estimates may change on the availability of new information. Thus, a change in estimate does not involve a change in the amounts of prior period item because it is not a correction of error. For example, in the case of profit or loss I recognize the change in estimates from the subsequent dates or prospectively if it only affects that period or future periods (if applicable). In the case of balance sheet, adjust the carrying amount of the related asset, liability or equity item in the period of change. In sum, no change in estimates retrospectively. Disclosure (i) Nature and amount of change that has an effect in the current period or expected to have in future. (ii) Fact that the effect of future periods is not disclosed because of impracticability. ERRORS The Ind. As-I requires that all errors must be corrected retrospectively. Further, it is necessary to restate the comparative amounts for periods in which error occurred and if the error occurred before that date. It means restatement of opening balances of assets, liabilities and equity for earliest periods present. Limitations of retrospective restatement: If it is impracticable to determine the period-specific effects of error, restate the opening balance for earliest period practicable. Disclosure of Prior-Period Items (i) Nature of the prior-period error 4.12 Financial Accounting: Concepts and Applications (ii) Amount of the correction at the beginning of earliest period presented. (iii) If retrospective is impracticable explain how the error was corrected. STATUS OF THE ACCOUNTING STANDARDS ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Number of the Accounting Standard (AS) Title of the Accounting Standard Date from which mandatory (accounting periods commencing on or after) AS - 1 Disclosure of Accounting Policies 1-4-1993 AS - 2 (Revised) Valuation of Inventories 1-4-1999 AS - 3 (Revised) Cash-Flow Statement 1-4-2001 AS - 4 (Revised) Contingencies and Events Occuring after the Balance Sheet Date 1-4-1998 AS - 5 (Revised) Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies 1-4-1996 AS - 6 (Revised) Withdrawn and included in AS-10 PPE 1-4-2016 AS - 7 (Revised) Accounting for Construction Contracts 1-4-2003 AS - 8 Withdrawn and included in AS-26 AS - 9 Revenue Recognition 1-4-1993 AS - 10 (Revised) Property Plant and Equipments 1-4-2016 AS - 11 (Revised) The Effects of Changes in Foreign Exchange Rates (Revised 2003) 1-4-2004 AS - 12 Accounting for Govt. Grants 1-4-1994 AS - 13 Accounting for Investments 1-4-1995 AS - 14 Accounting for Amalgamations 1-4-1995 AS - 15 Accounting for Retirement Benefits in the Financial Statements of Employers 1-4-1995 AS - 16 Borrowing Costs 1-4-2000 AS - 17 Segment Reporting 1-4-2001 AS-18 Related Party Disclosures 1-4-2001 AS-19 Leases 1-4-2001 AS-20 Earning Per Shares 1-4-2001 AS -21 Consolidated Financial Statement 1-4-2001 AS -22 Accounting for Taxes on Income 1-4-2001 AS -23 Accounting for Investment in Associates in Consolidated Financial Statements 1-4-2002 AS-24 Discontinuing operations 1-4-2004 AS -25 Interim Financial Reporting 1-4-2002 AS-26 Intangible Assets 1-4-2003 AS-27 Financial Reporting of Interests in Joint Venture 1-4-2002 — Financial Accounting Standards 4.13 AS-28 Impairment of Assets 1-4-2004 AS-29 Provisions, Contingent liabilities and Contingent assets 1-4-2004 AS-30 Financial Instruments: Recognition and Measurement and Limited Revision to AS-2, AS - 11 (Revised 2003), AS - 21. AS - 23, AS - 26, AS - 27. 1-4-2011 AS-31 Financial Instruments – Presentation 1-4-2011 AS-32 Financial Instruments Disclosures 1-4-2011 4.14 Financial Accounting: Concepts and Applications Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. 4. 5. 6. What is meant by accounting standards ? State briefly the merits of issuing accounting standards. [B.Com. (Hons.) Delhi 2011] What are the main objectives of accounting standards ? Give a brief description of the procedure for issuing accounting standards in India. Mention any seven areas of disclosure as per AS - 1. [B.Com. (Hons.) Delhi 2014] Write a short note on significance of accounting standards in the changing global economic and business environment. [B.Com. (Hons.) Delhi 2013] Explain the need and importance of Accounting Standards. [B.Com. (Hons.) Delhi 2019] 5 I nte rna tiona lFina nc ia l Re portingSta nda rds (I FRSs)/I ndAs BACKGROUND International Financial Reporting Standards (IFRSs) are the globally accepted accounting standards adopted by International Accounting Standard Board (IASB) from International Accounting Standard Committee (IASC 1973-2000). IASC was established in 1973 to formulate or prepare and publicise in public interest, the standards to be followed in the preparation of financial statements and to promote their acceptance and adoption by different countries of the world. The standards issued by the Board of IASC are designated as International Accounting Standards (IASs). International Accounting Standards Committee was suspended in the year 2001 and International Accounting Standard Board (IASB) was formed and given the responsibility of setting accounting standards. IASB adopted all the standards issued by the Board of IASC and these accounting standards continue to be designated as International Accounting Standards (IASs). IASB has replaced some IASs with new IFRSs and has adopted new IFRS on topics for which there was no previous IAS. MEANING AND FEATURES Meaning : IFRSs is a set of accounting standards, that is, a series of pronouncements (opinions) issued by International Accounting Standard Board explaining how different types of business transactions and events should be reported in financial statements. It also includes guidelines and interpretations approved by IASB. The main goal of IFRSs is to permit international comparisons possible. Features : The main features of IFRSs are explained as under : (i) IFRSs are principle-based accounting standards as compared to rule-based accounting standards. It means that the companies have to report the essence of each small transaction which is to be finally audited and approved. In this manner the transaction cannot be manipulated easily. Note : Rule-based accounting standards like Indian Accounting Standards are long and complex which attempt to deal with all types of situations. (ii) IFRSs are drafted in a lucid (clear and simple) language and are easy to understand and apply. (iii) IFRSs emphasise that the treatment of various transactions should be based on their economic substance rather than their legal form. For instance, in a hire purchase transaction, the hire purchaser can record the hire purchase asset at its total cost rather than its installments actually paid. (iv) Under the IFRSs, the historical cost concept of recording the fixed assets has been replaced by current cost system for a more accurate and realistic financial position of the business enterprise. (v) Under IFRSs, the assets, liabilities, revenues and expenses are reported not in local currency but in its functional currency; it means the currency of the place or environments where the entity operates which may be different from the local currency of the country. (vi) Under IFRSs the useful life of the assets has to be reassessed or computed again and again until the asset is actually removed from the books of account. 5.2 Financial Accounting: Concepts and Applications (vii) IFRSs make it compulsory or mandatory to adopt Component Accounting. The accountant has to maintain a separate record of cost of a significant component of equipment in relation to its total cost and charge depreciation separately. It means that the depreciation expense is not calculated simply on the total value of an asset but on the cost of important parts of the equipment or asset. For example, in the case of a Railway Coach, the depreciation may be calculated separatly for its wheels and the main body of the coach respectively. It may be clarified that the Schedule VI of the Companies Act is based on the IFRSs relating to the Presentation of Financial Statements. According, (a) the assets and liabilities have been divided into current and non-current groups as against the earlier presentation on the liquidity basis. (b) the statement of profit and Loss is also based on functional grouping of production expenses, administrative expenses and selling and distribution expenses. So is the case with the classification of revenue items. NEED FOR IFRSs The financial statements, compiled from financial information, are useful only if they are reliable, relevant and comparable in respect of operating results (i.e., performance) in the form of profit or loss and also financial position based on true or proper valuation of a business entity or enterprise. Due to globalization, foreign capital has made inroads into domestic markets. This has led to failure in comparison of financial statement of companies of different countries. In order to have one accounting language for business transactions, many countries have switched to IFRSs. Such qualities would prove helpful to the users of the financial statements or accounting information in making financial decisions as to whether to invest or not; whether to supply goods on credit or not; whether to grant loan or not and so on. The financial statements, therefore, would be informative too for the shareholders and the public. For the past few years the professional accounting bodies or institutions have developed their own local Generally Accepted Accounting Principles (GAAPs) like US GAAPs U.K. GAAPs or Accounting Standards (AS) in India The financial statements prepared on the basis of local GAAPs or accounting standards fail to present a uniform picture of performance and financial position of even the companies in the same industry. This has made the users confused. Such a situation is not conducive for globalization process in which the funds or capital must come from outside the boundaries or borders of individual countries. Corporate sector needs urgently the convergence of Indian Accounting Standards with IFRSs because it brings consistency to the field of accounting. A strong need for adoption of IFRSs is that it would bring uniformity, comparability, transparency, rationalization and adaptability in financial statements besides the tough or rigid rules for the preparation and presentation of the same (the financial statements) The investors and creditors are not very happy and infact feel frustrated when companies prepare financial statements or financial reports using different accounting standards. It must be made clear that high quality accounting standards, like IFRSs can make the world’ capital markets more efficient. The process of convergence will allow the investors and creditors to compare financial statements without adjusting for national accounting differences. Specifically the need for accounting standard convergence arises from the following genuine and pressing reasons : (i) Easy access to global or international capital markets : In order to mobilise or raise more capital for growth or expansion, companies have to look beyond the boundaries of their respective countries. Foreign investors rely on IFRSs compliance financial statements. In fact a financial reporting system of global standards is a prerequisite (necessary condition) for attracting foreign investors in the country. Hence the local or say Indian Financial Statements will be liked by the foreign investors and would enable them to have more business collaborations or joint ventures because of greater transparency in business deals. (ii) Low cost of raising funds abroad : At present the companies have to prepare two sets of financial statements – one set based on local GAAPs or standards and another set of financial statements on the International Financial Reporting Standards (IFRSs)/Ind-As 5.3 basis of conversions to US GAAPs or U.K. GAAPs, as the case may be. The IFRSs based financial statements would require less number of chartered accountants and the financial statements could be prepared at lesser cost. Better access to and reduction in cost of capital raised from global capital markets arises as IFRSs are now accepted as a standard financial reporting system for businesses seeking to raise funds overseas or abroad. (iii) Easy comparisons : The adoption of IFRSs brings companies or business entities on an international common platform and would increase uniformity in accounting principles. The uniformity in accounting and disclosure standards will enable all stakeholders or users of accounting information to understand easily the performance of various business entities and make comparisons across industries and countries. (iv) True or fair valuations : The term fair value is used to estimate the value at which the asset could be sold in the market. Many multinational corporations or companies failed in the past e.g., Enron and are still failing because of erroneous or incorrect valuation of their assets and liabilities. There is a wide gap between Indian Accounting Standards and U.S. GAAPs in the valuation process. For example, Accounting Standards (ASs) in India permit valuation of assets on the basis of historical cost. But in U.S. fair value costing on market-to-market basis is practiced. IFRSs would create a common or uniform procedure for the valuation of assets and liabilities. (v) Better quality of financial reporting : The adoption of IFRSs would result in uniformity in accounting information and it would automatically result in better quality of financial reporting. The rationale of IFRSs is to improve the quality of financial reporting. (vi) Increased trust and reliance : Adoption or implementation of IFRSs in different countries including India would lead to increased trust and reliance placed by investors, financial analysts and other users of accounting information in financial statements of the companies.The reason is that IFRS is treated as standard reporting method or framework for the preparation of credible financial statements. (vii) Difficult to commit fraud : Traditional rule-based system of accounting has many loopholes which make it easy to commit frauds. The major example is that of U.S. multinational company, Enron wherein it was possible to commit all frauds they wanted to by citing their own rules for recording the transactions and by following minimum technical requirements. On the other hand, the IFRSs require the companies to report the essence of each minute or smallest transaction which is to be finally audited and approved. (viii) No multiple reporting : At present the companies located in different countries have to prepare a dual or double set of financial statements for external reporting, i.e., one set of financial statements for use in the home country and the other set for the foreign country where it has also business interest or where it operates. But if IFRSs are implemented, it would eliminate this multiple reporting. SOME CLARIFICATIONS 1. Whether the converged standards will be called as IFRSs in India? The answer is No. The proposed name for converged standards in India is : Ind-AS. The financial statements prepared under these converged standards will be called as India-AS Financial statements. 2. What is the status of existing accounting standards? What would happen to the already notified accounting standards? The existing set of Indian Accounting Standards (ASs) will continue to be in force. These accounting standards will be applicable to those entities (enterprises) which are not required to migrate (shift) to Indian equivalents to – IFRSs Ind-ASs BENEFITS OF CONVERGENCE TO IFRSs Convergence with IFRSs helps the economy in general and investors, industry as well as the accounting professionals in particular. The benefits of convergence are described below : (i) Benefits to economy : Convergence will benefit the economy by increasing growth of its international 5.4 Financial Accounting: Concepts and Applications business. It facilitates maintenance of orderly (well organised) and efficient capital markets and also helps to increase the capital formation and hence the economic growth. It encourages international investing and thereby leads to more foreign capital flows in the country. (ii) Transparency and comparability : Convergence with IFRSs would provide transparency and comparability to the companies’ activities and overall performance. Transparency is provided because of common standards and comparability in each country, industry and company. Since the IFRSs have universal or global application, relationship can be built across the world with suppliers, investors and companies The nations will have to move along with others as their business relationships are also global or international. (iii) Benefits to the investors : Investors want accounting information that is more relevant, reliable, timely and comparable across the world. Financial statements prepared on a common set of accounting standards (IFRSs) would help the investors to better understand investment opportunities as against the financial statements, prepared using a different set of national or local accounting standards. (iv) Easy access to international capital markets : Convergence to IFRSs would definitely help the Indian companies to have easy access to international capital markets. Several domestic companies are mobilising globally huge financial resources to meet their funds or capital requirements. Today most of the stock exchanges demand information as per IFRSs and convergence to IFRSs would enable Indian companies to access the global financial markets easily. (v) Lower cost of capital : Cost of raising capital or funds can be minimized under IFRSs as there is no need to prepare a dual (double) set of financial statements. (vi) Benefits to industry : The industry can raise capital from foreign markets if it can create confidence in the minds of foreign investors that their financial statements are IFRSs complied. With the differences in the accounting standards from country to country, the multinational companies face a multitude of accounting requirements prevailing in different countries. The burden of financial reporting is lessened with adoption or convergence of accounting standards because of low cost of preparing the financial statements. (vii) Eliminating the need for multiple reporting : The task of maintaining different set of financial reports and statements can be eliminated by adopting the provisions under IFRSs by all group enterprises. (viii) Benefits to companies : IFRSs provide improved management information which facilitates decision making. On implementation by companies, it brings out better access to foreign capital and facilitates the process of mergers and acquisitions. (ix) Benefits to accounting professionals : Adoption or convergence with IFRSs also benefits the accounting professionals in a way that they are able to sell their services as experts in different parts of the world. It offers them more opportunities in any part of the world if uniform accounting practices prevail throughout the world. (x) New opportunities : Advantages of convergence with IFRSs will not be restricted to the Indian corporate sector only. It will perhaps open up plethora or abundance of opportunities in services sector like banking and insurance. With a wide pool of accounting professionals, India can emerge as an accounting services hub (centre or focal point) for the world community. As fair price valuation is the central theme of IFRSs, it can provide lot of new opportunities to the chartered accountants and cost accountants. PROCEDURES The dictionary meaning of the word ‘procedure’ is: the way of doing something. In the context of IFRSs, it means how a particular country can implement or comply with the International Financial Reporting Standards (IFRs) There are two alternative procedures available to a country for compliance or implementation of IFRSs, namely: (i) Adoption or (ii) Convergence. International Financial Reporting Standards (IFRSs)/Ind-As 5.5 Meaning of IFRSs Adoption Simply stated IFRSs adoption means accepting or endorsing an IFRS in its original form. It means adoption does not permit any change in the language or format of IFRS framed by IASAB. Meaning of Convergence with IFRSs In general terms, convergence means to achieve harmoney or co-ordination with IFRSs and not complete adoption. India has decided to go for convergence route. The Institute of Chartered Accountants of India (ICAI), has clarified that the convergence with IFRSs does not mean adoption of IFRSs in full. ICAI has cited a statement given in the International Accounting Standard (IAS): I Presentation of Financial Statement: “Financial Statement shall not be described as complying with IFRSs unless they comply with the requirement of IFRSs”. Therefore, it does not mean or imply that financial statements prepared in accordance with the national accounting standards draw unreserved statement of compliance with IFRSs only when IFRSs, are adopted word by word. In other words the IAS - 1 has not used the words ‘unreserved statement of compliance’. ICAI has further clarified the International Accounting Standard Board (IASB) accepted in its “Statement of Best Practices: Working Relationships between the IASB and other Accounting Setters” that: “adding disclosure requirement or removing optional treatment does not create non-compliance with IFRSs. Indeeded the IASB aims to remove optional treatments from IFRSs. The above mentioned statement makes it clear that if a country wants to add a disclosure that is considered necessary in the local environment (or condition) or removes optional treatments, this will not amount to non-compliance with IFRSs. So in the Indian context convergence with IFRSs means adoption of IFRSs with modifications where necessary. The procedure for issuing Ind-AS is similar to the procedure for issuing Financial Accounting Standards (AS). The procedure may be summarised as under : i) Accounting Standard Board issues exposure draft on converged accounting standard, that is, accounting standard (AS) converged to Ind-AS/IFRS ii) After approval these converged Ind- AS used to be sent to the National Advisory Committee on Accounting Standards (NACAS) But after the formation of National Financial Reporting Authority (NFRA) as incorporated in Companies Act 2013, these will be sent to NFRA. iii) On approval from NFRA the same are notified in the official Gazette iv) The date of implementation may be separately announced in an official Gazette at a later date. Furthermore, it must be clearly noted the Accounting Standard Board has to take into consideration the following points while adopting the International Financial Reporting Standards, namely : a) Local legislation or regulation : Accounting Standard must ensure that IFRSs (Ind AS) are in accordance with the provisions of local laws such as the Companies Act 2013 or Income tax Act etc. b) Endorse the IFRS in the form of IFRS equivalent Indian Accounting Standards for the local regulatory framework with changes, if necessary, in public interest or for removing optional treatments and adding disclosure requirements. c) Approval of NFRA : The Accounting Standard Board must present the adopted IFRS for approval of National Financial Reporting Authority for the purpose of Government Notification. Moreover if Accounting Standard Board is of the opinion that an issue requires interpretation of IFRSs, it would request the International Financial Reporting Interpretation Committee (IFRIC) of International Financial Accounting Standard Board to resolve or address the issue, On the other hand, if an issue relates to particular 5.6 Financial Accounting: Concepts and Applications legislature or other local requirement. Accounting Standard Board may issue guidelines if it believes that it is necessary to avoid incompatibility or collision with IFRSs. DIFFICULTIES OR CHALLENGES IN ADOPTING IFRSs India faces various difficulties or challenges in adopting IFRSs. because of variances or differences between Indian Accounting Standards (ASs) and IFRSs. These include the following: (i) Concept : IFRSs are more principle-based and allow more flexibility to the preparers of the financial statements. Thus, there is a scope of subjective judgement with the result the information in the financial statements is presented on the basis of substance rather than rule. In this way financial statements provide more desired results to the satisfaction of the investors and creditors. For example under IFRSs, the Redeemable Preference Shares are treated as liabilities because of their nature since the money has to be returned to the preference shareholders after a certain period of time. Similarly, the convertible debentures are treated as part of equity share capital as they will remain with the company for the period equity share capital does. On the other hand Indian Accounting Standards (ASs) are rigid because they are rules-based and the choice of reasonable judgement is almost absent, As rules play the major role, flexibility or subjective judgement is not permitted in Indian ASs. For example the Redeemable Preference Shares are part of share capital though the money has to be returned after certain years. Similarly debentures are treated liability in all cases whether the debentures are convertible or non-convertible. (ii) Legal requirements : Application or use of IFRSs is purely based on the need and requirements of investor’s whose interests are given priority over law. In fact law is made in accordance or conformity with IFRSs. In Indian Accounting Standards (ASs) the legal requirements get priority or preference over investor’s needs. Different regulatory bodies along with Companies Act, Banking Companies Act etc. require or demand the organisations governed by them to prepare and present their financial statements as per their norms or rules. For example, the financial statements of joint stock companies must be prepared as per schedule III of the companies Act 2013; the financial statements of banking Companies Act as per Banking Companies Act and in the case of insurance companies financial statements should be in accordance with the norms or rules prescribed by Insurance Regulatory and Development Authority (IRDA) (iii) Framework or structure : IFRSs provide a wide framework for financial reporting where a clear guidance for setting standards has been provided. In the framework given by IFRSs, Assets, Liabilities and Equity (share capital) are clearly defined. But no such framework is present for Indian Accounting Standards where components of financial statements are clearly defined. (iv) True and fair view : In IFRSs based financial statements the valuation of assets is based on the concept of fair value that is on market to market value basis. Thus, the ture and fair concept has no relevance and IAS - I also ignores this concept. In India accounting is done on historical cost basis. So there is an emphasis on the concept of true and fair view. (v) Presentation : International Accounting Standard – 1 : Presentation of financial statements clearly provides guidelines and overall requirements in presenting financial statements of companies. It requires certain information in respect of operating and investing activities, discontinued operations, financing activities and equity. Accounting Standard (AS) – I : Disclosure of Accounting Policies does not define clear requirements for disclosure in the financial statements. Different regulatory bodies also provide a format for International Financial Reporting Standards (IFRSs)/Ind-As 5.7 the organisations regulated by them. For companies, Schedule III of the Companies Act 2013 prescribes the format for the balance sheet and profit and loss account. For insurance companies, Insurance Regulatory And Development Authority (IRDA) specifies how the financial statements will be prepared. In addition to the above, the following points must also be seriously considered for the proper implementation of IFRSs : (i) Training : For successful implementation of IFRSs there is urgent need to train teachers, students, auditors, tax professionals etc. There is also a need for introducing IFRSs as full subject in universities and chartered accountancy syllabi. There is an urgent need to build adequate IFRS skills among Indian accounting professionals to manage the conversion projects for Indian Companies. (ii) Taxes : The IFRS convergence will have significant effect on financial statements and consequently on tax liability because of true and fair valuation process. So the tax authorities should ensure that there is a clarity on the tax treatment of items arising out of convergence to IFRSs. (iii) Communication : It is important to educate the financial analysts in managing market expectations because IFRSs may considerably change reported earnings and various performance indicators or ratios. (iv) Distributable profits : Unrealised profit or loss is another issue in the convergence with IFRSs. Since IFRSs are based on fair value concept, it is difficult to ignore this concept. It will have to be ensured that distribution of unrealized profit does not lead to the reduction in share capital. (v) Information Systems : Under IFRSs converged accounting standards, information must be collected from every section of the organization and used for disclosure purposes. In such situations, business enterprises need to increase their Information Technology (IT) security, in order to minimize potential fraud, cyber terrorism and data corruption. INDIAN ACCOUNTING STANDARDS (IND-AS) Each country has its own set of rules and regulations for accounting and financial reporting. When an enterprise decide to raise funds from foreign market/investors, the rules and regulations of investor’s country will apply and this in turn will require that the enterprise is in a position to understand the differences between the rules governed by foreign country for financial reporting as compared to its own country of origin. Therefore translation and re-instatements are of utmost importance in a world that in rapidly globalizing. Internationally the investors and financial analysis prefer to compare financial statements based on similar accounting standards and this has led the growing support for an internationally accepted set of accounting standards. The harmonization of financial reporting all over the world will definitely help to raise faith and confidence of investors, specially for making their decisions and assess their risks. In Indian context it was also not possible to adopt globally accepted accounting standards i.e. IFRSs in its original form due to deviations in various factors like economic environment, legal requirements, political environment etc. Due to deviations in various factors global standards have been accepted in India but after making some modifications as per the requirements of economic conditions and legal positions (Tax Laws). Meaning of Indian Accounting Standard (Ind-AS) Indian Accounting Standard (Ind-AS) are converged International Financial Reporting Standards (IFRSs) issued by the government of India under the supervision and control of Accounting standards board (ASB) of ICAI and in consultation with National Advisory Committee of Accounting Standard (NACAS). National Advisory Committee on Accounting Standard (NACAS) recommend these standards to ministry of corporate affairs (MCA). MCA has to spell out the accounting standards applicable for companies in India. The Ind-AS are named and numbered in the same way as the corresponding IFRSs. 5.8 Financial Accounting: Concepts and Applications List of Ind-AS 101 First Time Adoption of Indian Accounting Standards 102 Share Based Payment 103 Business Combinations 104 Insurance Contracts 105 Non-current Assets Held for Sale and Discontinued Operations 106 Exploration for and Evaluation of Mineral Resources 107 Financial Instruments: Disclosures 108 Operating Segments 109 Financial Instruments 110 Consolidated Financial Statements 111 Joint Arrangements 112 Disclosure of Interests in Other Entities 113 Fair Value Measurement 114 Regulatory Deferral Accounts 1 Presentation of Financial Statements 2 Inventories 7 Statement of Cash Flows 8 Accounting Policies, Changes in Accounting Estimates and Errors 10 Events after the Reporting Period 11 Construction Contracts 12 Income Taxes 16 Property, Plant and Equipment 17 Leases 18 Revenue 19 Employee Benefits 20 Accounting for Government Grants and Disclosure of Government Assistance 21 The Effects of Changes in Foreign Exchange Rates 23 Borrowing Costs 24 Related Party Disclosures 27 Separate Financial Statements 28 Investment in Associates and Joint Ventures 29 Financial Reporting in Hyperinflationary Economies 32 Financial Instruments: Presentation 33 Earnings per Share 34 Interim Financial Reporting 36 Impairment of Assets 37 Provisions, Contingent Liabilities and Contingent Assets 38 Intangible Assets 40 Investment Property 41 Agriculture International Financial Reporting Standards (IFRSs)/Ind-As 5.9 DISTINCTION BETWEEN INDIAN ACCOUNTING STANDARDS (IND AS) AND ACCOUNTING STANDARDS (AS) India has followed the policy of convergence with the International Financial Reporting Standards and the Indian Accounting Standards so formulated are called Ind As. The Institute of Chartered Accountants of India (ICAI) examines and considers the legal or regulatory framework and economic environment in India while formulating Ind As. The main points of distinction between Ind AS and AS are given below : 1. AS were based on International Accounting Standards (IAS) formulated by International Accounting Standards Board (IASB). But the Ind AS are based on standards issued by International Financial Reporting Standards Board. 2. Accounting standards were mainly adopted on the basis of International Accounting Standards with the result that those were primarily a reproduction of the relevant International Accounting Standards. But the Ind As are based on the convergence with the International Financial Reporting Standards keeping in mind the legal, economic and social environment in the country. 3. Accounting standards are rule based which are long, complex and with avoidable details. But Ind As are principle based. Ind As report only the essence of each small transaction which is finally audited. 4. AS are drafted in in technical language with more than one option as in the case of Accounting Standard on inventory valuation. But Ind As are drafted in a lucid (simple and clear) language. 5. Accounting standards are issued under the authority of the Council of ICAI while the Ind As require the notification from Ministry of Corporate Affairs for date of issue of various Ind As. 6. Ind As are based on the concept of fair value of fixed assets. The term fair value is used to estimate the value at which the asset could be sold in the market. But the Accounting Standards follow the age old concept of historical cost. 7. Ind As will ensure that there is no multiple reporting for companies located in different countries that use one set of financial statements in the home country and the other set for the foreign country. The multiple reporting has to be done when financial statements are based on Accounting Standards mainly because of historical cost concept. 8. AS are rule based system of accounting and hence responsible for many frauds. But Ind AS are principle based and require the companies to report the essence of each smallest transaction which is finally audited and approved. 9. AS are not treated with trust and reliance by the international investors. But Ind As based on Internal Financial Reporting Standards would lead to increased trust and reliance because IFRS is treated as standard reporting method or framework for the preparation of credible financial statements. 10. AS do not ensure uniformity in accounting information. But Ind As would ensure the improvement and quality of financial reporting. ROADMAP OR IMPLEMENTATION OF IND-AS IN INDIA The Ministry of Corporate Affairs issued a notification in the form of Companies (Indian Accounting Standards) Rules, 2015 on 16 th February 2015. The Rules specify that Indian Accounting Standard (Ind-AS) are applicable to certain class or types of companies and set out the dates for their applicability. I. Voluntary Adoption Companies may voluntarily adopt Ind-AS for financial statements for accounting periods beginning or after 1 st April 2015. If they do they will be required to prepare the comparative figures of the previous accounting period as per Ind-AS. Once a company decides to follow the Ind-AS, it will be required to follow them in the subsequent financial statements. 5.10 Financial Accounting: Concepts and Applications II. Mandatory Adoption 1. The following companies must prepare the financial statements on the basis of Ind AS from the accounting periods beginning on or after 1 st April, 2016: (a) Companies whose equity and/or debt securities are listed or are in the process of listing on any stock exchange in India or outside India and having a net worth of ` 500 crores or more. (b) Unlisted companies having a net worth of ` 500 crores or more. (c) Holding, subsidiary, joint venture or associate companies of the above stated listed and unlisted companies. These companies will be required to prepare comparative financial statements based on Ind AS for the periods ending 31 st March, 2016 or thereafter. 2. The following companies will have to adopt Ind AS for financial statements based on Ind AS for the periods on or after 1 st April, 2017 (a) Companies whose equity and /or net debt securities are listed or are in the process of being listed within India or outside and having a net worth of less than ` 500 crore. (b) Unlisted companies having a net worth of ` 250 crores or more but less than ` 500 crore. (c) Holding, subsidiary, joint venture or associate companies of the above stated entities. These companies will also be required to prepare comparatives for these financial statements for the period ending 31 st March, 2017 thereafter. 3. The above stated roadmap is not applicable to : (a) Companies whose securities are listed or in the process of listing on SME Exchanges. (b) Insurance companies, banking companies and non-banking finance companies. (c) Companies not covered by the road map in the mandatory categories as stated above. These companies shall continue to comply with the existing accounting standards unless they voluntarily choose otherwise. Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. 4. What is meant by International Financial Reporting Standards (IFRSs). What are the main features of IFRSs. Briefly explain any four needs of IFRs. [B.Com. (Hons.) Delhi 2017] What do you understand by convergence of IFRs? Is there any need for such convergence? [B.Com. (Hons.) Delhi 2016] What are the main requirements for the proper implementation of IFRSs. 6 AccountingProce ss :An Ove rvie w CONCEPT OF ACCOUNTING PROCESS Accounting process is the complete sequence of accounting procedures which begin with the recording of business transactions from source documents in the journal purpose or special purpose subsidiary books, as the case may be, and end with the preparation of two basic financial statements, namely: the income statement (or profit and loss account) and the balance sheet. In the case of Limited Liability Companies, the cash flow statement is also prepared. The essential steps in the Accounting Process are : (i) To enter the transactions in the source documents such as purchase invoice, sales invoice, cash receipts, bank pay-in-slips etc.. (ii) To record or enter the transactions in the general journal or special purpose subsidiary books, as the case may be, datewise as and when they occur. (iii) Classifying the transactions (i.e., the entries found in the general journal or subsidiary books) to post or transfer those entries in the appropriate accounts in the ledger. (iv) To enter the adjustments, if any, in the general journal (v) To balance the various accounts in the ledger to prepare the trial balance in order to check the arithmetical accuracy of the ledger accounts. (vi) To prepare the final accounts or final statements in the form of trading and profit and loss account (i.e., income statement) and balance sheet from the trial balance and the adjustments, if any, at the end of the accounting period to ascertain profit or loss of the business for the accounting period and the financial position of the business at the end of the accounting period. THE JOURNAL (OR JOURNAL PROPER) Meaning : The term ‘journal’ is derived from the French word ‘jour’ which means a day. Journal, therefore, means a day book or daily record. And since business transactions are first (or originally) recorded chronologically (in order of dates) in the journal from the ‘source documents’, journal is referred to as book of original or prime entry. Essential features : The followings are the essential features of Journal proper: (i) It is a day book or day record because it records transactions the same day. (ii) It is a chronological record book since transactions are recorded in order of their date of occurrence. (iii) It is a book of original entry or first entry since all transactions are first recorded in journal proper. (iv) It gives the complete picture of each transaction at one place in respect of debit and credit and also the explanation of the transaction. (v) As a legal evidence in a court of law, it has more weightage than ledger. 6.2 Financial Accounting: Concepts and Applications (vi) The business transactions with their debits and credits can be easily posted (transferred) to ledgers. Thus journal is gateway to ledger. JOURNALISING Recording business transactions in the journal with the help of debit-credit rules of the double entry system is called the Journalising. The following procedure is followed for making each entry in the general journal : (i) Each transaction is analysed in terms of number of accounts affected. As a rule, every transaction has at least two accounts, corresponding to its giving and receiving aspects. The account of the business enterprise recording the transaction is never taken into consideration. (ii) Find out the types of the accounts affected in a transaction, that is, personal, real or nominal. (iii) The next step is to apply the rules of debit and credit to each type of affected account. For the sake of convenience the rules are repeated as under : Types of Accounts Debit Credit Personal Accounts The Receiver The Giver Real Accounts What Comes In (Property acquired) What Goes Out (Property disposed off or sold) Nominal Accounts Losses and Expenses Income and Gains (iv) Finally, the equality of debit and credit amounts must be established. The following is the typical form of a General Journal : General Journal Date [Account Titles and Explanation] Year (i) Account Debited Month Day Particulars Voucher No. Ledger Folio Debit Amount ` Credit Amount ` (ii) Account Credited (iii) Narration (i.e., explanation of the transaction). ANALYSIS AND JOURNALISING OF SOME BUSINESS TRANSACTIONS 1. Shweta commences a business with a capital of ` 10,00,000 trading under the name of Sai General Stores. It must be stated at the outset that we are concerned only with the transactions of Sai General Stores and not with that of its owner. It is simple to understand that for the purpose of accounting records, the business, that is, Sai General Stores and its owner, Shweta, are two separate entities irrespective of the fact that Shweta is the sole owner of her business. The transactions between Shweta and her business will be recorded in the personal account of Shweta in the same way as transactions with the customers of the business are recorded. (i) The accounts affected in the transaction are : Account of the owner Shweta and Cash account. (ii) The class or the nature of the accounts: Shweta’s Account—Personal Account and Cash Account— Real Account, because cash is a property. (iii) Applying the rules of Debit and Credit: Cash has come in—Debit: Cash Account. Shweta—a personal account, is the giver of money to the business and therefore Credit: Shweta’s Account. (iv) Equality of debit and credit amounts is common to all transactions and hence not repeated. The term Shweta’s Capital Account is used so as to distinguish the introduction of cash by persons other than the owner. Accounting Process : An Overview 6.3 2. Paid into Dena Bank ` 2,50,000. (i) The two accounts affected are : Cash Account and Bank Account. (ii) They belong to : Real Account— Cash. Personal Account—Bank. (iii) Apply the Debit-Credit rule: Cash is going out of business and therefore Cash Account will be credited; Dena Bank Account is a personal account that receives the benefit or receiver of cash. Hence Dena Bank Account will be debited. 3. Bought goods for ` 2,20,000. In this case the goods have been bought for cash. This is implied from the transaction since the name of the party or the words ‘on credit’ are missing. (i) The accounts affected are : Purchases Account and Cash Account. (ii) Purchases Account is a nominal account because it is an expense of the business. Hence, Debit: Expenses and Losses. Purchase account may also be treated as real account because ‘goods’ is a thing of value. Cash Account is also a real account. (iii) Purchases Account is debited because of an expense or goods come into the business and cash account is credited since cash has gone out of the business. 4. Bought goods from Shri Hari Chand for ` 1,10,000. In this transaction, it is not clear whether the goods are purchased for cash or on credit. But when supplier’s name is given and the word ‘paid’ or ‘for cash’ is missing, it can be safely presumed that the purchases are made on credit. (i) Analysing the transaction, we find the two accounts affected are : Purchases and Hari Chand’s Accounts. (ii) Purchases Account is a nominal account or real account as stated in Transaction no. 3 and Hari Chand’s Account is a personal account. (iii) Since purchases are an expense or goods come in, Debit : Purchases Account and as the benefit is given by Hari Chand, Credit : Hari Chand’s account. 5. Bought office furniture from Goldage and Co. for ` 75,000. (i) The two accounts in this business transaction are : Office Furniture and Goldage and Co. Accounts. (ii) Office Furniture is a property and therefore a real account while Goldage and Co. is a personal account, a firm made up of person(s) doing business. (iii) Since furniture is coming in, Office Furniture account is debited and not the purchases account because it is not the goods meant for sale but it would be retained in the business as an asset. Goldage and Co., being a personal account and the giver of the benefit, will be credited. 6. Goods sold to Shri Hira Lal for ` 1,25,000. This is a credit transaction for the reasons explained in connection with Transaction no. 4. Analysing the transaction, we find that :(i) The two accounts affected are : Sales Account and Hira Lal’s Account. (ii) Sales Account is a real account as the goods are affected and Hira Lal’s account is a personal account. Since goods are going out, the sales account is credited (sales account may also be treated as an income and hence a nominal account. Credit: Income and gains) and the account of Hira Lal would be debited, being the receiver of the goods. 7. Bought building for cash ` 5,25,000. (i) The two accounts affected are : Building and Cash. (ii) Building is a property and thus real account and cash is also a property, a real account. (iii) Building comes into the business and thus Building Account will be debited; cash goes out of the business, Cash Account will be credited. 8. Paid ` 1,50,000 for goods received from Arun Udyog. (i) In this business transaction the accounts affected are : Purchases Account and Cash Account. It may be noted that the account of Arun Udyog is not affected since the firm, the supplier, has received the payment. (ii) Purchases Account is a nominal account. (iii) Purchases Account is debited and Cash Account is credited since cash goes out of the business. 9. Received a sum of ` 50,000 being rent for the portion of a building let out. (i) The two accounts are : Cash Account and Rent Account. (ii) Cash is a real account and rent is a 6.4 Financial Accounting: Concepts and Applications nominal account. (iii) Applying the debit-credit rules for each, we find cash is coming in and Cash Account will be debited while rent is received, it is an income and therefore Rent Account is credited. 10. Goods sold to Shyamji for cash ` 1,50,000 (i) The two accounts affected are : Cash Account and Sales Account. Shyamji’s account is not affected since payment has been received for the sales. (ii) Sales is an income account and cash is a real account. (iii) Cash Account will be debited as cash comes into the business and Sales Account is credited as it is a nominal account. Sales account may also be treated as a real account. Credit: What goes out. 11. Shweta, the proprietor contracted with Jain Construction Co. for the renovation of the building at an estimated cost of ` 1,25,000. Although event has occurred but since it does not involve any transfer of money or money’ worth for the time being, it would not be recorded in the account books. Hence no entry. 12. Paid a monthly salary to Mr. Balram, the manager ` 15,000. In this transaction the two accounts affected are : Salary Account and Cash Account. Though Balram receives salary as a manager, his personal account will not be affected. The reason is not difficult to explain. The payment has been made to him by the business in return for his services rendered as a manager and therefore he is not liable to return the corresponding value. The Salary is an expense and hence a nominal account. It would be debited while Cash, being the real account, will be credited. The rule is : The account of a party who receives a fresh benefit from the business will be debited only if he has to return the corresponding value at a later date. Similarly the account of a party which gives a fresh benefit to the business would be credited only if the business is to return him corresponding value at a later date. 13. Received commission from Mr. Kishan Chand ` 5,000. In this case the two accounts affected are : Commission Account and Cash Account. Kishan Chand’s Account is not affected since he is paying the business the commission for the services rendered by the business and therefore there is no obligation to refund the amount. Cash has come in and Cash Account is debited and commission is a gain or income account and Commission Account is credited. 14. Bought shares in D.C.M. Ltd. for ` 45,000. The purchase of shares is an investment. The two accounts affected are : Investment Account and Cash Account. Investment Account is a real Account since shares represent the acquisition or purchase of property. Investment account would be debited as shares come in and Cash Account is credited, as cash goes out of the business. 15. Paid by cheque for fire insurance premium ` 20,000. (i) The two accounts affected are : Bank Account and Fire Insurance Account. (ii) Bank Account is a personal account because it is an account with a banker. Fire Insurance Account is a nominal account since it is a business expense. Insurance Account will be debited and Bank Account is credited since the banker is giving or paying the insurance premium. 16. Paid Shweta’s life insurance premium ` 9,000. The two accounts affected are : Cash Account and Drawings Account. The life insurance premium is a personal expense and not a business expense. Thus life insurance is not at all considered. Drawings Account is personal account and Cash Account is real account. Debit: Drawings Account, the receiver and Credit : Cash Account since it goes out of the business. 17. Paid for an insertion in the Times of India ` 20,000. The concerned accounts are : Advertisement Account and Cash Account. Advertisement is a business expense and thus a nominal account and Cash Account is a real account. Debit: Advertisement Account and Credit: Cash Account. 18. Bank collected dividends on our investments ` 16,000. Accounting Process : An Overview 6.5 The accounts affected are : Dividends Account and Bank Account. Since dividends are received on investments made out of business funds, they are business income and hence nominal account. Bank Account is a personal account. Debit: Bank Account (Receiver of benefit); Credit: Dividends Account (business income). 19. Paid Shri Hari Chand on account ` 70,000. The term ‘on account’ means that the business enterprise already owes some money to Shri Hari Chand and the same is being paid now partly. In this transaction the account receiving the benefit is Hari Chand’s Account and cash goes out of the business. Hence, Debit: Hari Chand’s account; Credit: Cash Account. 20. Withdrawn from Bank ` 55,000. The treatment is simple as the cash has come in and the Bank has given the same. Debit: Cash Account (i.e., real account — debit : what comes in) : Credit: Bank Account (i.e., personal account — credit: the giver). 21. Borrowed from Bank ` 65,000. This transaction involves two accounts, namely: Cash Account and Bank loan Account. Cash Account is a real account and Bank Loan Account a personal account. Since cash comes in, Cash Account would be debited while the giver is the bank, Bank Loan Account will be credited. The term Bank loan (or Bank Overdraft) is used to distinguish the withdrawals from the bank : the money belonging to the business as against the loan taken from the bank. 22. Received from Shri Hira Lal a bill at two months for ` 40,000. In this transaction, the two accounts affected are : Bills Receivable Account (i.e., negotiable instrument which is a sort of deferred payment device) and Hira Lal’s Account. Bills Receivable Account is a real account and it will be debited while the personal account of Hira Lal is credited since he gives the bill. 23. Accepted the Bill drawn by Shri Hari Chand ` 20,000. In this transaction the bill on which the business is liable to make payment has gone out of business and Hari Chand has received the same. The two accounts affected are: Bills Payable Account being the real account and the Account of Hari Chand, the personal account. Hence, Debit: the receiver, i.e., Hari Chand; Credit: What goes out, i.e., Bills Payable. 24. Paid Shri Mohan Lal cash ` 1,250 in lieu of a cheque. This item comprises of two transactions which must be recorded simultaneously. The two transactions are : (i) Receipt of a cheque from Mohan Lal and (ii) Payment of cash to Mohan Lal. As regards the first transaction Cash Account is debited on the assumption that the cheque is treated as cash. But if the cheque is immediately paid into the bank, the Bank Account will be debited. Mohan Lal’s account, however, will be credited since his is a personal account and he is the giver of the cheque. In the second transaction, Debit: Mohan Lal’s Account since he receives the cash (i.e., a benefit) and Credit: Cash Account since cash goes out. 25. Paid for repairing the office furniture ` 5,000. The two accounts affected are : Repairs Account and Cash Account. It must be noted that the Furniture Account is not affected at all since furniture neither comes in nor goes out. Repairs Account, being an expense account, comes in the category of nominal accounts and it will be debited and cash account being real account, is credited as cash goes out. 26 Gave loan to Rachna ` 1,60,000 @ 10%. The two accounts affected are: Rachna’ Loan Account and Cash Account. Rachna ’s Loan Account is personal Account and Cash Account which is real account. Debit : Rachna’ Loan Account, being receiver of the benefit and Credit: Cash Account because cash is going out of business. 27. Returned Goods to Hari Chand ` 10,000. The two accounts involved are : Hari Chand and Purchase Returns Account. Hari Chand Account is a 6.6 Financial Accounting: Concepts and Applications personal account. Debit : the receiver of the benefit. Purchases returns account is real account Credit ; What goes out. Hari Chand is the receiver of the benefit goods while goods are moving out of the firm. Purchase Returns may also be treated as nominal account. Returns of goods is saving in expense which is equivalent to income and hence Purchase Returns Account is credited. The latest trend is to treat Purchases Returns Account as a nominal account. 28. Opened a Bank Account for ` 20,000. The two accounts involved are : (i) Bank Account — the Personal Account. Debit: the receiver of the benefit cash; (ii) Cash Account is Real Account. Credit: What goes out. Bank is receiving the benefit and cash is going out of business firm. 29. Charged Renu ` 5,000 commission for services rendered. The two accounts affected are : Renu and Commission. Renu’s account is personal account and Debit: the Receiver of the benefit, that is Service. Commission Account is nominal account. Credit: Incomes and gains. Renu is the receiver of the benefit service and commission earned is income of the business. 30. Rachna agreed to pay interest of ` 16,000 on the amount (` 1,60,000) advanced to her. The two accounts involved are Rachna’ loan account and not Rachna’ and Interest on loan Account. Rachna’ loan account is a personal account. Debit: The receiver of the benefit (Loan). Interest on Loan is the income on loan. It is a nominal account. Credit: The income and Gains. Rachna is getting the benefit for using the loan while interest is income to the firm. 31. Paid income tax ` 1,50,000 The two accounts involved are : Drawings Account and Cash Account. Drawings account is a personal account. Income tax paid is to be treated as personal expense of the owner. Debit: The Receiver of the benefit; cash account is a real account. Credit: What goes out. When income tax is paid by firm it is the personal expense of the owner who receives the benefit. Cash account is a real account. Credit: What goes out, that is cash. 32. Allowed discount to Hira Lal ` 2,500 The two accounts affected are : Discount Allowed and Hira Lal. Discount Allowed account is a nominal account and Hira Lal account is personal account. Debit: Discount Allowed Account (for expenses and losses) and Credit: Hira Lal Account (for the benefit given to him for discount). Cash is not involved. 33. Discount received from Hari Chand ` 1,500 The two accounts affected are: Discount Received and Hari Chand Account. Discount Received Account is a nominal account and Hari Chand’ Account is a personal account. Debit: Hari Chand Account (for receiving the benefit of prompt payment). Credit: Discount Received Account (for income and gains) 34. Railways freight paid on furniture ` 1,200 The two accounts affected are: Furniture Account (Railway freight paid on furniture is to be treated as a part of cost of furniture) and Cash Account. Both are real accounts. Debit : Furniture Account (What comes in ); Credit: Cash Account (What goes out). 35. Hira Lal returns goods ` 4,500 The two accounts affected are : Sales Returns and Hira Lal. Sales Returns Account is real account or nominal account. Hira Lal’ Account is personal account. Debit: Sales Returns Account (for goods comes into business, if treated as real account or debit for loss of income, if treated as nominal account; Credit: Hira Lal’ Account (for giving loss of income to the firms). At present sales Returns Account is treated as nominal account. 36. Till taking for the month ` 15,000 Till taking means cash sales, Thus, two accounts involved in this transaction are: Accounting Process : An Overview 6.7 (i) Cash Account and (ii) Sales Account. Cash Account is a real account and Sales Account may be treated either as real account or nominal account. Debit: Cash Account (for cash comes into the firms). Credit: Sales Account (for goods go out of business if treated as real account or sales is income, if treated as nominal account). 37. Bank charges ` 250 The bank charges are due on account of the banking service provided by the banker. So the two accounts affected are : (a) Bank Charges Account and (b) Bank Account. Bank charges account is a nominal account Debit : The Expenses and Losses; Credit: Bank Account (Giver of the service). ANALYSIS OF BUSINESS TRANSACTIONS Taking the transactions of Sai General Stores, given under the heading Analysis of Business transaction above the journal entries are given below: Sai General Stores General Journal S.No. Particulars L.F. Debit (Accounts & Explanation) 1. 2. 3. 4. 5. 6. 7. 8. 9. Credit Amount (`) Cash Account To Shweta’s Capital Account (Being capital introduced by the owner in cash) Dr. Bank Account To Cash Account (Being cash deposited with Dena Bank Dr. Purchases Account To Cash Account (Being goods bought for cash) Dr. Purchases Account To Hari Chand’s Account (Being goods bought on credit from Shri Hari Chand) Dr. Office Furniture Account To Goldage & Co. Account (Being furniture bought on credit) Dr. Hira Lal’s Account To Sales Account (Being goods sold to Hira Lal on credit) Dr. Building Account To Cash Account (Being Building bought for cash) Dr. Purchases Account To Cash Account (Being goods bought from Arun Udyog for cash) Dr. Cash Account Dr. 10,00,000 10,00,000 2,50,000 2,50,000 2,20,000 2,20,000 1,10,000 1,10,000 75,000 75,000 1,25,000 1,25,000 5,25,000 5,25,000 1,50,000 1,50,000 50,000 To Rent Account (Being rent received for letting out a portion of the building) 10. 11. Cash Account To Sales Account (Being goods sold for cash to Shyamji) No Entry Amount (`) 50,000 Dr. 1,50,000 1,50,000 6.8 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. Financial Accounting: Concepts and Applications Salaries Account To Cash Account (Being salary paid to the manager) Dr. 15,000 15,000 Cash Account Dr. To Commission Account (Being commission received in cash from Kishan Chand) Investments Account To Cash Account (Being the purchase of shares in DCM Ltd.) Dr. Insurance Account To Bank Account (Being premium on fire insurance of the business paid by cheque) Dr. Drawings Account To Cash Account (Being premium on life insurance of the owner paid in cash) Dr. Advertisement Account To Cash Account (Being payment made for an insertion in the Times of India) Dr. Bank Account To Dividends Account (Being dividends collected by bank on behalf of the firm) Dr. Hari Chand’s Account To Cash Account (Being payment made to Shri Hari Chand for goods bought on credit previously) Dr. Cash Account To Bank Account (Being cash withdrawn from the bank for office use) Dr. Cash Account To Bank Loan Account (Being money borrowed from the bank) Dr. 5,000 5,000 45,000 45,000 20,000 20,000 9,000 9,000 20,000 20,000 16,000 16,000 70,000 70,000 55,000 55,000 65,000 65,000 Bills Receivable Account Dr. To Hira Lal’s Account (Being a bill of exchange received from Shri Hira Lal) 40,000 Hari Chand’s Account To Bills Payable Account (Being a bill accepted for Shri Hari Chand) Dr. 20,000 (i) Bank Account To Mohan Lal’s Account (ii) Mohan Lal’s Account To Cash Account (Being cash paid to Mohan Lal in lieu of cheque) Dr. 1,250 Dr. 1,250 40,000 20,000 1,250 1,250 Repairs Account To Cash Account (Being payment made for the repairs of furniture) Dr. Rachna’ Loan Account To Cash Account (Being loan given to Rachna) Dr. Hari Chand’ Account To Purchases Returns Account (Being goods returned to Hari Chand) Dr. 5,000 5,000 1,60,000 1,60,000 10,000 10,000 Accounting Process : An Overview 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 6.9 Bank Account To Cash Account (Being opening of a bank account for ` 20,000) Dr. Renu’ Account To Commission Account (Being commission earned for service rendered) Dr. Rachna’ Loan Account To Accrued interest Account (Being interest accrued on the amount advanced to Rachna) Dr. Drawings Account To Cash Account (Being income tax paid on behalf of the owner, Shweta Dr. Discount Allowed Account To Hira Lal’ Account (Being discount allowed to Hira Lal for prompt payment by customer) Dr. Hari Chand’ Account To Discount Received Account (Being discount earned for prompt payment to Hari Chand, the supplier of Goods) Dr. Furniture Account To Cash Account (Being payment of railway freight treated as a cost of furniture) Dr. Sales Returns Account To Hira Lal’ Accounts (Being goods returned by Hira Lal) Dr. Cash Account To Sales Account (Being cash sales made) Dr. Bank Charges Account To Bank Account Dr. 20,000 20,000 5,000 5,000 16,000 16,000 1,50,000 1,50,000 2,500 2,500 1,500 1,500 1,200 1,200 4,500 4,500 15,000 15,000 250 250 (Being bank charges by the Banker) TYPES OF ENTRIES Entries in the general journal may be divided into two classes : (i) Simple Entry. (ii) Compound Entry. A simple entry is one in which only two accounts are affected viz., one account to be debited and another to be credited with an equal amount. On the other hand, whenever a journal entry involves more than just two accounts, it is called compound entry. In a compound entry, there may be: (a) Several accounts to be debited and only one account to be credited; or (b) One account to be debited and several other accounts to be credited; or (c) Several accounts to be debited and several other accounts to be credited. Journal entries falling within classes (a) and (b) are generally termed as ‘single compound entries’ and those in class (c) are generally termed as ‘double compound entries’. However in all cases the total of debit amounts must be equal to the total of credit amounts., OPENING ENTRY At the beginning of each accounting period, the business entity has to record transactions in a new set of books of account. The accounts with the balances in the previous year, consisting of Real and Personal Accounts are entered in the new books of account with the help of an Opening Entry. All the assets accounts are debited and all the liabilities accounts are credited. The difference between assets and liabilities is to be credited to capital account as shown below: 6.10 Financial Accounting: Concepts and Applications Date Particulars Debit April 1 Cash Account Dr. 5,000 Machinery Account Dr. 70,000 Furniture Account Dr. 10,000 Stock Account Dr. 30,000 Debtors Account Dr. 50,000 To Bills Payable Account Credit 2,000 To Creditors Account 22,000 To Capital Account (Being recording of the opening balances of assets, liabilities and capital) 1,41,000 LEDGER : MEANING AND FEATURES The ledger is the principal book of account which contains detail information about the transactions connected with any individual account at a glance. For instance all the transactions that have taken place with Manvi are recorded in Manvi’s Account. Similarly all items relating to sales, purchases, bank, machine, building etc. are recorded or entered in their respective accounts. Also all transactions relating to income and expenses like interest, commission received, rent paid, stationery etc. are entered in their respective accounts. Hence (i) All personal accounts would show how much money the business enterprise owes to his creditors and the amounts it can recover from its debtors. (ii) The real accounts would show the values of the properties, e.g., building, machinery, furniture, and also the position of stock, bills receivables etc. (iii) The nominal accounts would show the sources of income, e.g., sales, commission, interest, discount etc., and also the amount spent on various items or heads of expenses e.g. salaries, rent, etc.. STANDARD FORM OF A LEDGER ACCOUNT The following is the specimen ruling of the standard form of a ledger account: Name of the Account (Account Title) Page No................ Dr. Debit side Date 20... Particulars (Account Credited) Jan. 1 To Credit side Folio Amount ` Date 20... Particulars (Account Debited) Jan. 10 By Folio Cr. Amount ` POSTING OF TRANSACTIONS FROM GENERAL JOURNAL Transactions are first entered in the subsidiary books or book(s) of original entry and then transferred to the ledger. This process is called posting. So posting is another way of saying transferring. The aim of the posting is to make classified and summarised record of an account in respect of various transactions that affect it (account). Illustration (Journal Entries And Their Posting) Journalise the following transactions and post them to ledger : ` January 1. Started business with cash by T 2. Bought goods for cash 15,000 1,000 Accounting Process : An Overview 6.11 3. Bought goods from A 3,000 4. Sold to B 4,000 5. Paid A on account 2,000 6. Bought goods from P for cash 7,000 7. Received from B cash in full settlement 3,880 8. Returned to P goods worth 200 9. Paid salaries 700 10. Received from ‘G’ a fifty rupee note and gave him the change for it 11. Commission received on sale of other goods 12. Deposited with the bank 13. Paid rent by cheque 100 14. Withdrawn for personal use goods ` 300; cash ` 200 500 500 2,000 Solution : Journal Entries Date Particulars L.F. (Accounts & Explanation) Jan. 1 Jan. 2 Jan. 3 Jan. 4 Jan. 5 Jan. 6 Jan. 7 Jan. 8 Jan. 9 Cash Account To T’s Capital Account (Being the capital introduced by T, the proprietor) Dr. Purchases Account To Cash Account (Being goods purchased for cash) Dr. Purchases Account To A’s Account (Being the goods bought on credit from A) Dr. B’s Account To Sales Account (Sales made to B on credit) Dr. A’s Account To Cash Account (Payment made to A for purchases made) Dr. Purchases Account To Cash Account (Goods bought from P for cash) Dr. Cash Account Discount Allowed Account To B’s Account (Being the amount received from B for credit sales to him in full settlement) Dr. Dr. P’s Account To Purchases Returns Account (Being goods returned to P) Dr. Salaries Account To Cash Account (Being salaries paid) Dr. Jan. 10 No Entry Debit Credit ` ` 1 12 15,000 2 1 1,000 2 3 3,000 4 5 4,000 3 1 2,000 2 1 7,000 1 6 3,880 120 15,000 1,000 3,000 4,000 2,000 7,000 4,000 6 8 200 9 1 700 200 700 6.12 Financial Accounting: Concepts and Applications Jan. 11 Cash Account Dr. 1 500 To Commission Received Account 500 (Being commission received in cash) Jan. 12 Bank Account Dr. To Cash Account 11 2,000 1 2,000 (Amount deposited with the Bank) Jan. 13 Rent Account Dr. To Bank Account 7 100 11 100 (Being rent paid by cheque) Jan. 14 Drawings Account Dr. 13 500 To Purchases Account 2 300 To Cash Account 1 200 (Being the cash and goods withdrawn by the proprietor for personal use) Posting to Ledger Page 1 Dr. Cash Account Date Particulars (Account credited) J.F. Jan. 1 T’s Capital Account 1 Jan. 7 B’s Account Jan. 11 Commission Received Amount ` Cr. Date Particulars (Account debited) J.F. 15,000 Jan. 2 Purchases Account 1 1,000 1 3,880 Jan. 5 A’s Account 1 2,000 1 500 Jan. 6 Purchases Account 1 7,000 Jan. 9 Salaries Account 1 700 Jan. 12 Bank Account 1 2,000 Jan. 14 Drawings Account 1 2,000 Account Dr. Purchases Account Date Particulars (Account credited) J.F. Amount Date Cr. Particulars (Account debited) J.F. ` Jan. 2 Cash Account 1 1,000 Jan. 3 A’s Account 1 3,000 Jan. 6 Cash Account 1 7,000 Amount ` Amount ` Jan. 14 Drawings Account 1 300 (i) J.F. mens journal folio that is, the page number of journal (ii) The number given in the J.F. Columns are assumed numbers. Page 3 Dr. A’s Account Date Particulars (Account credited) Jan. 5 Cash Account J.F. 1 Amount ` 2,000 Cr. Date Particulars (Account debited) J.F. Jan. 3 Purchases Account 1 Amount ` 3,000 Accounting Process : An Overview 6.13 Page 4 Dr. B’s Account Date Particulars (Account credited) Jan. 4 Sales Account J.F. 1 Amount ` 4,000 Cr. Date Particulars (Account debited) J.F. Amount ` Jan. 7 Cash Account 1 3,880 Jan. 7 Discount Account 1 120 Page 5 Dr. Date Sales Account Particulars (Account credited) J.F. Amount ` Cr. Date Particulars (Account debited) J.F. Jan. 4 B’s Account 1 Amount ` 4,000 Page 6 Dr. Discount Allowed Account Date Particulars (Account credited) J.F. Jan. 7 B’s Account 1 Amount ` Date Particulars (Account debited) Cr. J.F. Amount ` 120 Page 6 Dr. P’s Account Date Particulars credited) Jan. 8 Purchase Returns Account J.F. 1 Amount ` Date Cr. Particulars debited) J.F. Amount ` 200 Page 7 Dr. Date Jan. 13 Rent Account Particulars (Account credited) Bank Account J.F. Amount Date ` 1 Cr. Particulars (Account debited) J.F. Amount ` 100 Page 8 Dr. Date Purchase Returns Account Particulars (Account credited) J.F. Amount Date ` Jan. 8 Cr. Particulars (Account debited) J.F. P’s Account 1 Amount ` 200 Page 9 Dr. Date Salaries Account Particulars (Account credited) J.F. Amount Date ` Jan. 9 Cr. Particulars (Account debited) Cash Account J.F. Amount ` 1 700 6.14 Financial Accounting: Concepts and Applications Page 10 Dr. Date Commission Received Account Particulars (Account credited) J.F. Amount Date Particulars (Account debited) Jan. 11 Cash Account ` Cr. J.F. Amount ` 1 500 Page 11 Dr. Date Jan. 12 Bank Account Particulars (Account credited) Cash Account J.F. Amount Date ` 1 2,000 Cr. Particulars (Account debited) Jan. 13 J.F. Amount ` Rent Account 100 Page 12 Dr. Date T’s Capital Account Particulars (Account credited) J.F. Amount Date ` Jan. 1 Particulars (Account debited) Cash Account Cr. J.F. Amount ` 1 15,000 Page 13 Dr. Drawings Account Date Particulars (Account credited) J.F. Amount Jan. 14 Purchases Account 300 Jan. 14 Cash Account 200 ` Date Cr. Particulars (Account debited) J.F. Amount ` INTERPRETATION OF A LEDGER ACCOUNT The interpretation of a particular account in the ledger would depend upon its nature, i.e., Personal, Real or Nominal. In this illustration, the first account is cash account. It is real account and the rule for this type of account is - Debit: What comes in; Credit: What goes out. Thus, the ‘debit’ side of the cash account indicates the amount of cash coming into business from different sources, e.g., T’s capital account, B’s account and commission received account. Regarding personal accounts, we find that the rule : Debit: The receiver; Credit: The giver, has been complied with. For example in A’s account we have written ‘purchases’ in the credit side since, ‘A’ gives the goods to the business and when he receives cash, his account has been debited with cash. Similarly the nominal accounts have also been posted on the basis of the rules applicable to them. Debit: All losses and expenses; Credit: All incomes and gains. Accordingly the salaries account has been debited indicating the payment in cash. The commission received account on the other hand represents income to the business and accordingly credited indicating the receipt of cash. BALANCING OF ACCOUNTS Balancing is the process of equalising the two sides of an account. Each account in the ledger receives both debit and credit entries at some time or the other. Sometimes the debit and credit amount entries will Accounting Process : An Overview 6.15 equal each other. But if one side has greater amount than the other side, we call the difference as the Balance. A debit balance indicates that the total amount on the debit side is more than the total amount on the credit side while a credit balance shows that the total amount of the credit side is more than the total amount of the debit side. Obviously some amount will have to be added to the short side to make it equal to or balance with the greater side. The balance of an account may be either debit or credit except in the case of cash account where it will always be a debit balance. If the sum of debit amounts equals the sum of credit amounts, it is a closed account and the account is said to have no balance. BALANCING OF PERSONAL ACCOUNTS A personal account may have a debit balance when the individual is regarded as the debtor or credit balance indicating that he is creditor. But if both the sides of a personal account are equal, the person concerned is neither debtor nor creditor and the account is said to have no balance. BALANCING OF REAL ACCOUNTS The real accounts represent the accounts of properties or assets owned by the business. All property accounts will have either a debit balance or no balance but never a credit balance. BALANCING OF NOMINAL ACCOUNTS The nominal accounts represent the expenses incurred or incomes earned. These accounts are not balanced; they are transferred, at the end of each accounting period, to trading account or profit and loss account, as the case may be. SUBSIDIARY BOOKS A subsidiary book, other than general journal, is always a special subsidiary book or journal because it is used to record only one type of business transactions. An analysis of the business transactions in a typical trading business would show that the following transactions occur most frequently and therefore necessitate the use of special purpose journals or subsidiary books : (1) (2) (3) (4) (5) (6) (7) Specific Transactions Cash receipts and cash payments Petty cash payments Credit purchases of goods Credit sales of goods Goods returned by the customers Goods returned to suppliers Bills receivables Special Purpose Journal or Subsidiary Books (1) Cash Book (2) Petty Cash Book (3) Purchases Book (4) Sales Book (5) Sales Returns Book (6) Purchases Returns Book (7) Bills Receivable Book (8) Bills payables (8) Bills Payable Book CASH BOOK : A JOURNALISED LEDGER It is desirable that the cash transactions must be recorded immediately as far as possible so as to avoid errors, omissions or frauds. This would also help the trader to know at once the position of cash in time. Cash book performs the functions of both journal and ledger at the same time. A journal is a book of original entry while a ledger is a principal book of account. So cash book is also called a journalised ledger. The reason is that a cash book is similar to journal (or subsidiary book) for the following reasons: (i) All cash transactions are first recorded in the cash book as is the case with credit purchases and credit sales transactions which are first recorded in the purchases book and sales book respectively. (ii) Like journal, all transactions in the cash book are recorded chronologically that is date-wise. (iii) Narration may also be given in the cash-book. 6.16 Financial Accounting: Concepts and Applications Cash book is also a ledger account for the following reasons : (i) Like a ledger account, cash book has also two sides namely Debit side and Credit side. (ii) The recording of transactions in the cash book is on the pattern of a ledger account. There is no need to open a separate cash or bank account in the ledger. Cash book is balanced like a ledger account. (iii) Like a ledger account ‘To’ in the debit side and 'By' in the credit side may also be used. (iv) Like a ledger, cash book is also a book of final entry. Types of Cash Book: There are many types of cash book namely (i) single column cash book for recording cash transactions only. (ii) cash book with cash and discount columns involving loss or gain on account of discount. (iii) cash book with cash, bank and discount columns for recording cash and bank transactions simultaneously including loss or gain on discount allowed and discount received respectively. (iv) cash book with discount and bank columns. (v) Petty cash book for recording payment of small expenditures along with receipts of small amounts from the head cashier. SINGLE COLUMN CASH BOOK This type of cash book contains one amount column on each side of the cash book. It is just like a cash account in the ledger. All cash receipts are recorded on the debit side and all payments are entered on the credit side respectively. Posting : Though there is no need to open cash account in the ledger yet recording of cash transactions in the cash book means recording only one aspect of each transaction in the cash account. The other aspect of a transaction needs to be posted. When the accounts entered in the cash book are posted, the double entry will be completed. The procedure for posting is : (i) Debit the accounts mentioned in the credit (payments) side as : To Cash Account, and (ii) Credit the accounts mentioned or entered on the debit side as : By Cash Account. CASH BOOK WITH DISCOUNT COLUMNS Treatment of cash discount : Where cash discounts are allowed and received respectively, additional columns are provided on the debit side for discount allowed and on the credit side for discount received. It must be stated that the discount columns in the cash book are not parts of the cash book but are memoranda (provisional) columns because discount account is a nominal account while cash account is a real account. On balancing the cash book, therefore, the discount columns are simply totalled but not balanced. Posting of the cash book with discount columns is done as follows : (i) Cash or amount columns : Debit the accounts entered on the credit side as : To Cash Account with the amount written in the cash or amount column; Credit the accounts entered on the debit side as : “By Cash Account” with the amount written in cash column. (ii) Discount columns : Debit the particular personal account mentioned on the credit side as To Discount Received Account with the amount mentioned in the Discount Received Column on the credit side of the cash book and credit the concerned personal account mentioned on the debit side as By Discount Allowed Account with the amount entered in Discount Allowed Column on the debit side of the cash book Accounting Process : An Overview 6.17 CASH BOOK WITH DISCOUNT, OFFICE CASH AND BANK COLUMNS [THE RECORD OF BANK TRANSACTIONS] As a result of the development of banking and consequently the increased use of the cheques, it is convenient to adopt a combined cash book to record both office cash and bank transactions. The cash book is ruled with three amount columns on either side of the cash book, namely, 'Discount, Office Cash and Bank'. Cash columns or Office cash columns in such a case will record actual cash received (in the form of currency notes and coins) in the debit side and payments in the office cash column in the credit side. Cheques received should be entered on the debit side of the bank column on the assumption that cheques received are immediately deposited with the bank. This is in fact the actual business practice. The same procedure is adopted also when the cash is deposited with or paid into the bank. Payments by cheques should be entered on the credit side in bank column and also when the cash is withdrawn from the bank. In fact, if by a transaction the bank balance increases, the bank column is debited and if decreases, the bank column is credited. Illustration (Cash Book With Discount, Office Cash And Bank Columns) Record the following transactions in the cash book with cash and bank columns: ` Oct. 01 Cash balance 200 Oct. 01 Bank balance 500 Oct. 02 Cash received from sale of shares 12,000 Oct. 02 Paid into Bank 10,000 Oct. 03 Paid Amrit by cheque 2,400 Oct. 03 Received cheque from Amit 1,960 Oct. 03 Allowed him discount Oct. 04 Paid wages by cash Oct. 10 Paid Amit's cheque into Bank Oct. 16 Bought goods for cash Oct. 18 Paid for stationery cash 300 Oct. 19 Paid Hema by cheque 750 Oct. 19 Discount allowed by her Oct. 19 Drawn from Bank 640 Oct. 20 Received from cash sales 340 Oct. 24 Cash withdrawn for personal use 400 Oct. 24 Received from Dev Anand 40 500 1,200 50 3,600 Allowed him discount 150 Oct. 25 Paid into bank 400 Oct. 26 Issued cheques for purchases 400 Paid salary by cash 650 Received cheque from Sanjay and paid into Bank Drew cheque for office use 800 600 Oct. 27 Cash Account Bank Account Sales Account Dev Anand's Account Cash Account Sanjay's Account Bank Account Balance b/d Oct. 10 Oct. 19 Oct. 20 Oct. 24 Oct. 25 Oct. 27 Oct. 27 20 x ... Nov. 1 (c) (c) (c) (c) 19,340 190 3,930 600 — — 3,600 340 640 — 1,960 — — — 150 — — — 40 — 8,870 13,660 800 400 1,960 10,000 Purchases Account Salary Account Cash Account Balance c/d Oct. 26 Oct. 27 Oct. 31 Bank Account Drawings Account Cash Account Hema's Account Stationery Account Purchases Account Bank Account Wages Account Amrit's Account Bank Account Particulars (Accounts debited) in the ledger) Oct. 26 Oct. 25 Oct. 24 Oct. 19 Oct. 19 Oct. 18 Oct. 16 Oct. 10 Oct. 04 Oct. 03 Amit's Account — 500 Oct. 03 (c) 12,000 200 Cash Account — — Oct. 02 Date Investment Account ` Bank Oct. 02 Office Cash ` Oct. 02 ` Discount Balance b/d L.F. Oct. 01 Receipt No. 20 x ... Particulars (Accounts Credited in the ledger) Cash Book with Discounts Office Cash And Bank Columns 20 x ... Date Dr. Receipt No. (c) (c) (c) (c) (c) L.F. 50 — — — — — — 50 — — — — — — ` Discount 19,340 3,930 — 650 — 400 400 — — 300 1,200 1,960 500 10,000 Office Cash ` 13,660 8,870 600 — 400 — — 640 750 — — — — 2,400 ` Bank Cr. 6.18 Financial Accounting: Concepts and Applications Accounting Process : An Overview 6.19 Solution : EXPLANATIONS Oct. 02: Sale of shares means that the business entity has sold its investments in shares. Oct. 02: Paid into bank means deposit of office cash into bank. In this way office cash goes out of business (Credit : What Goes Out) and the bank receives the cash (Debit : The Receiver) because bank means the banker, a personal account. So there is a contra entry. Oct. 03: Cheque received from Amit is treated as cash because it has not been deposited immediately. It is being deposited on October 10. Hence a contra entry is required on this date. Credit: What Goes Out; Debit : The Receiver. Oct. 19: The amount is being withdrawn from the bank for office use. Hence cash is coming into the office (Debit : What Comes In) and the bank is the giver of the cash (Credit : The Giver). Hence a contra entry is required to show increase in office cash and decrease in bank balance. Oct. 24: Cash withdrawn for personal use will not increase the office cash. Hence no contra entry. It is a simple case in which one party gives the cash i.e. the banker (Credit : The Giver) and the another party receives the cash, that is the proprietor. The name of the account is Drawings Account. It is a personal account. Hence, Debit : The Receiver. Oct. 27: Since a cheque received from Sanjay is paid into bank on the same day, the entry has been made directly in the bank column on the debit side of the cash book because Debit : The Receiver. POSTING OF CASH-BOOK WITH DISCOUNT, OFFICE CASH AND BANK COLUMNS The posting is done as : Debit side or Receipts Side : Each account in the particulars column of the debit side of the cash book (except Cash and Bank) is credited with amount(s) appearing against its name in the cash or bank columns (or both cash and bank columns) as well as in the discount column. Debit: Discount Allowed Account in the ledger with the total of discount column as : "Total discount allowed as per cash book" (since discount allowed is a loss account) in the debit side. Credit Side or Payments Side : Each account in particulars column of the credit side of the cash book (except Cash and Bank) is debited with the amount(s) in the cash column or bank column (or both cash and bank columns) as well as in the discount column. Discount Received Account is opened in the ledger and is credited with the total of the discount column as : “Total discount received as per cash book” (since discount received is a gain account) in the credit side. The opening balance of cash and bank is never posted including the contra accounts. The balancing is done only for the cash and bank columns. The discounts columns in the debit and credit sides are never balanced but simply totalled. PETTY CASH BOOK Meaning and need : In every business, there is the need to make provision for a large number of payments in cash of small amounts. Such payments may be made on items like postage, carriage, printing and stationery, travelling expenses, etc.. These are usually termed as petty cash payments. A proper record for such payments is necessary because— (i) In a big business the number of petty payments is large. (ii) These payments occur at regular intervals. (iii) It is usually not possible to issue a cheque in payment of any of them. (iv) The person receiving payment may be an employee of the business. (v) In the total they may amount, period by period, to small sum. In a business where the policy is to deposit all cash receipts and make all payments by cheques, it will find that petty payments can be made more conveniently with cash. From the standpoint of the business, it is most desirable to separate the record of the petty cash payments from the main cash book. Such a necessity arises 6.20 Financial Accounting: Concepts and Applications even in the case of a business which does not deposit all receipts in the bank. For this reason, a separate subsidiary book or book of original entry called Petty Cash Book is used. It has on the credit side, analysis columns with appropriate headings for the more usual classes of petty expenses. The Petty Cashier, receives cash (or cheque) for the estimated amount of payments for a certain period of time frequently. The petty cashier keeps the cash in the office and uses it to pay out only such expenses as he is authorised to do against a proper receipt or voucher for each item of payment. In certain cases it is not possible to obtain receipts or vouchers especially when the payment is made for items like postage stamps or taxi charges. In such a case the printed vouchers, bearing the name of the business firm, are used and the employee claiming cash for bus or taxi fare etc., has to fill up the same. THE IMPREST SYSTEM Meaning and advantages : The method of dealing with petty cash payments which is generally adopted nowa-days is known as the imprest system. In this system, a definite sum of money, say, ` 2,000 is allotted to the petty cashier. This sum is handed over to the petty cashier for the first time and at regular intervals, say, monthly or when he uses the whole amount(s), he is given a fresh cheque for the exact amount spent by him. Therefore, the petty cashier has the same fixed amount at the beginning of each new period. In other words, the balance of petty cash in hand is generally the fixed imprest amount unless more amount is required. Illustration (Petty Cash Book) On March 1, 20x..... a cheque of ` 20,000 was handed over to the petty cashier to pay petty cash expenses for the month which were as follows : ` March 1 4 5 6 7 8 9 10 12 13 14 15 16 25 26 27 28 29 30 Postage stamps Carriage Bus fare Postal stamps Fare to Ghaziabad Short-hand note books Envelopes Advertisement charges for an insertion in the Times of India Pencils and pins Taxi fare to Supervisor Cost of one bottle of ink Telegram to branch Registered notice to Shyam Trunk calls Files Printer’ cartridges Computer paper Office cleaning Window cleaner 2,000 500 540 210 215 1,200 412 2,570 415 610 415 520 420 1,530 1,284 2,040 3,500 1,000 500 Enter these transactions in analysis form of Petty Cash Book. Bank Account 20,000 Postage and Telegrams Account Printing and Stationery Account Travelling Expenses Account 4,680 9,266 1,365 20,000 Particulars (Details) ` 2,000 — — 210 — — — — — — — 520 420 1,530 — — — — — 4,680 ` 2,000 500 540 210 215 1,200 412 2,570 415 610 415 520 420 1,530 1,284 2,040 3,500 1,000 500 19,881 119 20,000 — — — — — 1,200 412 — 415 — 415 — — — 1,284 2,040 3,500 — — 9,266 ` — — 540 — 215 — — — — 610 — — — — — — — — — 1,365 ` — 500 — — — — — — — — — — — — — — — — — 500 ` — — — — — — — 2,570 — — — — — — — — — — — 2,570 ` — — — — — — — — — — — — — — — — — 1,000 500 1,500 ` Voucher Total Postage, Printing Travelling Carriage AdverOffice No. amount Telephones and Expenses tisement Expenses paid and Stationery (cleaning) Telegrams Apr 1 119 Balance b/d 19,881 Bank-Cheque received Mar 31 balance c/d Mar 1 Bank (Cheque received) Mar 1 Postage stamps Mar 4 Carriage Mar 5 Bus fare Mar 6 Postal stamps Mar 7 Fare to Ghaziabad Mar 8 Note books Mar 9 Envelopes Mar 10 Advertisement Mar 12 Pencils & Pens Mar 13 Taxi fare Mar 14 Bottle of ink Mar 15 Telegram Mar 16 Registered notice Mar 25 Trunk calls Mar 26 Files Mar 27 Printer’s Cartridges Mar 28 Computer paper Mar 29 Office cleaning Mar 30 Window cleaner Amount Date received ` 20.x.... Petty Cash Book Ledger FolioAccount Accounting Process : An Overview 6.21 6.22 Financial Accounting: Concepts and Applications PURCHASES BOOK The purchases book is used to record the purchases of goods on credit only. If any property other than goods is bought on credit, it should not be recorded in this book. Similarly the cash purchases are also not recorded in this book. Thus, a business transaction must fulfill the following two conditions before it is entered in the purchases book : (i) The credit purchases involving no payment of cash on the spot. (ii) The articles, goods, or merchandise purchased, are those which are meant for sale and not as a property or asset of the business. POSTING OF THE PURCHASES BOOK The posting of the purchases book in the ledger requires the opening of two types of accounts. One type consists of only one account, namely: Purchases Account which is debited with totals of the amount column of Purchases Book. Another type consists of the accounts of individual suppliers and these personal accounts are credited with the relevant amount of purchases and words "By Purchases Account" are mentioned in the Particulars column. SALES BOOK The sales book or sales day book is written up in the same way as the purchases book. It is used to record only the sale of goods on credit. Thus, the following two points must be kept in mind before a sale is entered in this book : (i) that the transaction involves sales on credit only with no immediate cash payment; (ii) that the sale is of goods only in which the business enterprise deals. POSTING OF THE SALES BOOK The double entry in the ledger in respect of sales book is completed by opening two types of accounts: (i) In one type Sales Account is credited with the total amount of the sales taken from the relevant amount column of the sales book. (ii) In another set, the account(s) of individual customer(s) are debited with the amount and words: To Sales Account are mentioned in the Particulars column. PURCHASES RETURNS BOOK (RETURNS OUTWARDS BOOK) It is very common for a business firm to return some of the goods bought to the suppliers (or vendors) because the goods may not meet the requirement of the purchaser. POSTING OF PURCHASES RETURNS BOOK The posting of the purchases returns book is done as follows : (i) A new account called Purchases Returns Account is opened in the ledger. The periodic (weekly or fortnightly or monthly) total of the amount column is credited to the Purchases Returns Account. It means that we use only the credit side of the Purchases Returns Account as follows: (a) In the date column, we write the date of closing the Purchases Returns Book. (b) In the particulars column we write : By Total Purchases Returns as per Purchases Returns Book (c) In the ledger folio column we write the page number of the Purchases Returns Book. (d) In the amount column, we write the total of the amount column of the Purchases Returns Book. (ii) We now debit the accounts of the suppliers to whom the debit notes are sent with the respective amounts of the goods returned. It means that we do not open the new accounts of the suppliers. In fact we use the debit side of the already opened (existing accounts) of the suppliers : (a) In the Date Column, we write the date of the goods returned (b) In the particulars column, we write : To Purchases Returns Account (c) In the ledger folio column, we write the page number of Purchases Returns Book (d) In the amount column we write the net amount of the goods returned. It must be Accounting Process : An Overview 6.23 kept in mind that the posting in the accounts of suppliers is done date-wise, that is, as and when the goods are returned. SALES RETURNS BOOK (RETURNS INWARDS BOOK) Sales Returns Book is also a special purpose subsidiary book. It is used to record goods returned to the business firm by the customers and since the goods are coming into the business, it is also called Returns Inward Book. The specimen of Sales Returns Book is given below : Date Particulars (Name of the customers) L.F. Credit ` Year Month Amount Day (i) Name of the Customers who have returned the goods. (ii) When Credit Note No. is not available, enter the description of the goods returned. POSTING OF SALES RETURNS BOOK The posting of the Sales Returns Book is done as follows : (i) We open a new account called Sales Returns Account or Returns Inwards Account and debit it with the total amount of the Sales Returns Book. It means that we use only the debit side of this account and fill up the details as : (a) In the date column we write the last date of the Sales Returns Book (b) In the particulars column we write : By Total Sales Returns As Per Sales Returns Book (c) In the Journal folio column, we write the page number of the Sales Returns Book. (d) In the Amount Column, we write the total net amount of the goods received from the customers. In this way, the double entry in the ledger is completed. (ii) We now credit the accounts of the customers to whom the credit notes have been sent with the amount of the goods returned by them. It means that we do not open the new accounts of the customers. In fact, we use the credit side of the already opened (i.e. existing accounts) accounts of the customers: (a) In the Date Column, we write the date of the Goods received from the customer (b) In the Particulars Column, we write : Sales Returns Account; (c) In the Folio Column, we write the page number of the Sales Returns Book: (d) In the Amount Column, we write the net amount of the goods received from customers. Posting in the accounts of the customers is done date-wise, that is, as and when the goods are received from them. BILLS RECEIVABLE BOOK This book is used to record the details of bills receivable on which the business enterprise will receive the amounts from other parties in future. The entries to be made in this book include the name of the acceptor (debtor), the terms, due date, the amount and other details. BILLS PAYABLE BOOK This is also a book of original entry and is used to record the particulars of all the 'bills payable's accepted by the business enterprise for the purpose of paying at a future date the amounts due by it (the business enterprise or trader) to its creditors. The entries to be made in this book relate to the name of the drawer, the name of the payee, the period, the due date, and other particulars. Then the acceptance is duly returned to the drawer. POSTING OF BILLS RECEIVABLE AND BILLS PAYABLE BOOKS The total of the amount column of the Bills Receivable Book is debited to the Bills Receivable Account while the amount of each bill receivable is posted to the credit of the account of the party from whom it is 6.24 Financial Accounting: Concepts and Applications received. Similarly, the amount of each bills payable is posted to the debit side of the drawer's account in the ledger and the total of the amount column of the Bills Payable Book is posted to the credit side of Bills Payable Account in the ledger. NATURE AND FEATURE OF A TRIAL BALANCE A trial balance is a schedule or list of the names and balances (both debit and credit) of all the accounts appearing in the ledger including cash and bank balances from the cash book. The main features of a trial balance may be noted as follows : (i) It is not an account, and so double entry system of book-keeping has no role in its preparation. (ii) It is simply a list or schedule of balances of all accounts, (personal, real and nominal) appearing in ledger including the balances of cash book. (iii) It can be prepared any time during the year i.e. on monthly or quarterly or yearly basis. (iv) It is a method of checking or testing the accuracy of the transactions recorded in different books of original entry and their posting to ledger. (v) Some errors may not be revealed even by the trial balance such as errors of principle or compensatory errors. (vi) The abbreviations Dr. and Cr. are never written on the left-hand and right-hand corners respectively of its top. (vii) It is prepared on a particular date. OBJECTS OF A TRIAL BALANCE The objects of a trial balance are : (i) it is a test of the arithmetical accuracy of the books; (ii) it is a proof that double entry of each transaction has been recorded; (iii) it provides the basis for the preparation of final accounts or financial statements—profit and loss account and the balance sheet; (iv) it provides a summary of all transactions of an accounting period so that management can use figures for comparison purposes. LIMITATIONS OF A TRIAL BALANCE A trial balance suffers from the following limitations : (a) It does not guarantee that all transactions have been currectly analysed and posted in proper accounts. For example, if the wages paid for the installation of a machine have been debited to Wages Account instead of Machine Account, the trial balance would still tally. (b) It can be prepared only by those enterprises which make use of double entry system. So the small firms cannot afford to adopt this system because of high costs. (c) It does not ensure that all transactions have been actually recorded in the subsidiary books. For example if purchases bills were to be completely omitted, that trial balance would still agree. (d) If a trial balance has not been prepared accurately, the final accounts prepared from such a trial balance would not be reliable. In fact such final accounts would not serve the specific requirements of the various users of the accounting information. FORMAT OF A TRIAL BALANCE Trial balance is not an account. It is only a list of or schedule of balances of ledger accounts including cash and bank balances. The abbreviations Dr. and Cr. are never written on the left hand and right Accounting Process : An Overview 6.25 hand corners of its top. It is a prepared on a particular date. Trial balance is prepared on General Journal Sheet with two amount columns for debit and credits balances. The accounts having debit balances are entered in the debit amount column and credit balance accounts are entered in the credit amount column. The sums of each column should be equal. The standard format of a trial balance is given below : Trial Balance As on...........(Closing Date) Name of the Account L.F. Debit Balance ` Credit Balance ` Illustration (Preparation of Trial Balance) Arrange the following balances taken from the ledger of Sapna, Komal and Co. into a trial balance at 31 March....... ` Cash 9,200 Trade debtors 15,000 Rent 4,800 Stores 18,000 Salaries payable 1,500 Insurance 3,600 Other expenses 5,500 Land 10,000 Depreciation 800 Accumulated depreciation 2,400 Salaries 20,400 Motor vehicle 4,000 Trade creditors 25,000 Cost of goods sold 54,000 Advance from a customer 1,400 Sales 90,000 Drawings 2,000 Capital 27,000 Solution: Trial Balance of Sapna, Komal and Co. As on 31 March..... L.F. Debit Balance ` Credit Balance ` 9,200 — 15,000 — Rent 4,800 — Stock 18,000 — — 1,500 Insurance 3,600 — Other expenses 5,500 — 10,000 — Name of the Account Cash Trade debtors Salaries payable Land 6.26 Financial Accounting: Concepts and Applications Depreciation Accumulated depreciation Salaries Motor vehicle — — 2,400 20,400 — 4,000 — — 25,000 54,000 — Trade creditors Cost of goods sold 800 Advance from customers — 1,400 Sales — 90,000 2,000 — — 27,000 1,47,300 1,47,300 Drawings Capital PREPARATION OF A TRIAL BALANCE There are three methods of preparing a trial balance, namely : (i) Trial balance with net or ultimate debit and credit balances; (ii) Trial balance with totals : Under this method, the trial balance is prepared by taking into consideration the total of each side of various accounts without balancing them in the form of debit and credit balances respectively. (iii) Trial balance with balances and totals : As the name implies under this method, trial balance is prepared by combining the first and second methods. However, in practice the trial balance is prepared with debit and credit balances of various accounts in the ledger along with balances in the cash book. The students may be asked in an examination problem to prepare a trial balance from a given list of balances extracted from the ledger. This involves the selection of debit and credit balances. The following rules may be helpful in this regard : Debit Balances : assets, drawings, sundry debtors, losses and expenses. Credit Balances : liabilities, capital, sundry creditors, gains and incomes. CHECK LIST OF MOST FREQUENT DEBIT AND CREDIT BALANCES Debit Balances Debit Balances Credit Balances Cash in hand Interest paid Capital Cash at bank Leasehold or Free-hold Sundry creditors Drawings premises Bank overdrafts Purchases Profit & loss account (Dr.) Bills payable Office furniture or Freight & excise duty Sales furniture & fixtures Loose tools Purchases returns Land and buildings Motive power Discount received Machinery Office equipment Loans (credit) Opening stock Debit balances Provision for bad and Debit balances Motor repairs & doubtful debts Closing stock maintenance Returns outwards Sundry debtors Stock of stationery Profit & loss account (Cr.) Postage and telegrams Purchase of stationery Outstanding salaries, rent etc. Accounting Process : An Overview 6.27 Rent, rates, taxes Post-dated cheques Provision for discount on Salaries Accrued income debtors Wages Goodwill Income received in advance Carriage – inwards Patents Provision for depreciation Discount allowed Trade marks Reserve fund and other funds Lighting and heating Preliminary expenses Mortgage payable Printing & stationery Unexpired expenses Rent income Gas, water, electricity e.g. insurance Interest income Stable expenses Work-in-progress Accumulated depreciation Repairs and renewals Petty cash Provision for discount Cartage Prepayments (payments on creditors Travelling expenses in advance) Insurance Investments Sundry expenses Audit fees General expenses Legal charges Loans (debit) Maintenance Bad debts Employer's contribution Bills receivable to provident fund Plant equipment Import and export duties and outwards Depreciation expense Plant & machinery Returns inwards Illustration (Correcting A Wrong Trial Balance) The clerk of a firm wrongly prepared the trial balance. You are required to draw up a correct trial balance stating reasons in brief : Trial Balance For the Year Ending 31 March 20... Debit Balance Credit Balance ` ` Capital – 20,000 Drawings – 5,000 Purchases – 90,000 1,30,000 — Returns inwards 700 — Returns outwards 900 — Carriage inwards 1,100 — Carriage outwards 800 — Duty on purchases 2,000 — 11,000 — Motor Van — 6,000 Salaries — 5,000 Sales Opening stock 6.28 Financial Accounting: Concepts and Applications Rent 2,000 — Taxes 300 — Insurance 600 — Sundry Debtors 8,000 — Sundry Creditors 6,000 — Cash in hand 500 — Cash at bank — 2,500 1,000 — – 20,400 1,64,900 1,48,900 Furniture Land Solution : (Correct) Trial Balance As On 31 March 20… (i) Debit Balance Credit Balance ` ` — 20,000 Drawings (ii) 5,000 — Purchases (iii) 90,000 — — 1,30,000 700 — — 900 1,100 — 800 — 2,000 — Opening Stock 11,000 — Motor Van (vii) 6,000 — Salaries (viii) 5,000 — Rent 2,000 — Taxes 300 — Insurance 600 — — 6,000 8,000 — 500 — Cash at bank (xi) 2,500 — Furniture 1,000 — Land (xii) 20,400 — 1,56,900 1,56,900 Capital Sales (iv) Returns Inwards Returns Outwards (v) Carriage Inwards Carriage Outwards (vi) Duty on purchases Sundry Creditors (ix) Sundry Debtors (x) Cash in hand FOR REASONS ATTENTION PLEASE (i) Trial balance shows different balances on a particular date and not ‘for the year’. Hence it is headed ‘as on’ and ‘not for the year’. (ii) Drawings are personal expenses made by the proprietor out of business cash. It has therefore a debit balance. Accounting Process : An Overview 6.29 (iii) Purchases represent an expense. Debit: All Expenses OR Purchases represent current asset goods (real account) which come into the business. (iv) Sales represent income or revenue, a nominal account, hence a credit balance. (v) Returns outwards means saving in expenses. Hence a nominal account or Returns outwards means goods moving out of the business; credit what goes out. (vi) Carriage outwards is an expense on sale; hence it has a debit balance. (vii) Motor Van is an asset—a real account i.e. debit what comes in; hence a debit balance. (viii) Salaries are expenses—a nominal account and so has debit balance. (ix) Sundry creditors are liabilities on the business; hence a credit balance. (x) Sundry debtors are assets of the business; hence a debit balance. (xi) Cash at bank is an asset representing the account of banker—a debtor; hence a debit balance. (xii) Land is an asset —a real account—debit what comes in; hence a debit balance. TRIAL BALANCE : NOT A CONCLUSIVE PROOF OF ACCURACY The agreement of the two sides of the trial balance, though a prima facie test of arithmetical accuracy, is not a conclusive or absolute proof of the accuracy of the entries in the books of original entry and their postings to the ledger. In other words, the trial balance may agree without disclosing certain errors. The following classes of errors are not disclosed by the trial balance : 1. Errors of omission : When a transaction is not recorded at all or partially recorded in the book of original entry, both its debit and credit aspects would be omitted. The trial balance, therefore, is not affected. 2. Errors in the book(s) of original entry : The trial balance would not be affected if an entry is in a wrong book of original entry or entered in the proper subsidiary book but with a wrong amount. 3. Errors of commission: Such errors consist of entries of the transactions in a wrong account of the same class. It means the posting of an item is made to the correct side (debit or credit) but of wrong account e.g., debiting or crediting R.N. Tiwari's Account instead of A.N. Tiwari's Account. 4. Errors of principle : An item of nominal account entered into a real account or vice versa. For example a sum of ` 50 paid on the repairs of furniture is debited to furniture account and not repairs account. The errors of principle do not affect the agreement of the trial balance because they are correctly recorded so far as the debit or credit side of the wrong class of account is concerned. 5. Compensatory errors : These errors, also called self-balancing or equalising errors, do not affect the agreement of the trial balance because errors on one side of the ledger account are compensated by errors of the same amounts on the other side e.g., Parveen's account debited with ` 150 instead of ` 120 and Bindiya's account with ` 200 instead of ` 230. ERRORS DISCLOSED BY A TRIAL BALANCE The foregoing discussion should not lead to the conclusion that the trial balance is a useless statement. It is definitely a sure test of detecting most of the mechanical or clerical errors such as : (i) Omission in postings : An item entered in the relevant subsidiary book like cash book but left out of the ledger, e.g., ` 500 paid for rent, though entered in the cash book yet not posted to the Rent Account in the ledger. (ii) Posting on the wrong side of an account e.g., cash received from Amit wrongly posted to the debit side of the Amit's account. (iii) Posting of wrong amount : The examples are : ` 65 written as 56; mistakes made in postings such as 8 taken as 0; or 3 for 5 and vice versa. (iv) Double postings : An item posted twice in a ledger account, e.g., a sum of ` 500 paid to Mohan posted twice in his account. 6.30 Financial Accounting: Concepts and Applications (v) Incorrect casting : The total of sales account undercast by ` 1,000, i.e., ` 5,000 instead of ` 6,000. (vi) Errors in casting a book of original entry, e.g., the total of sales book ` 50,000 may be posted as ` 5,000. (vii) Omission to write in trial balance the balance of an existing account, e.g., the balance of opening stock account ` 2,500 not entered in the trial balance. (viii) Errors in adding up columns of trial balance. (ix) Missing of balances in extracting lists of debtors or creditors. SPACE FOR REVISION Accounting Process : An Overview 6.31 Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. 4. 5. 6. 7. Enumerate the various steps in the Accounting Process. Define a general journal; state its features. Define a Ledger. Why is it known as the principal book of account ? Give its features. Define the terms balance and balancing. What is the importance of balancing? What are different types of subsidiary books ? “Cash book is both a book of original entry and a book of final entry” Explain. What are different types of cash book ? How do they differ from one another ? Give the ruling of a columnar cash book. 8. Explain, in brief, the analytical petty cash book on imprest system. 9. What is a trial balance ? What are its uses ? 10. What are the mistakes that the trial balance shows and what mistakes does it not show ? PRACTICAL ASSIGNMENTS 1. 2. 3. 4. 5. 6. Journalise the following transactions in the books of Dilip : (a) A cheque for ` 950 is sent to Anand and Co., a creditor in full settlement of the amount due ` 975 (b) A sum of ` 500 is received from B and Co. against a debt previously written off. Study carefully the following transactions of Kalicharan and state with reasons the accounts to be debited and credited in his books in each case : (i) Kalicharan started his business with cash ` 20,000. (ii) Purchased from Biswanath goods for cash 5,000. (iii) Bought from Parasanna goods on credit for ` 2,000. (iv) Bought office furniture for cash ` 5,000. (v) Paid office rent ` 3,000. Journalise the following transactions : (i) Received on sale of investments ` 56,000. (ii) Mr. Gopinath, a typist, was paid his salary by cheque ` 12,000. Journalise the following transactions in the books Aasha Rani : (i) Received from Keshav ` 950 and discount allowed to him @ 5% (ii) Purchased furniture from Yashpal and Co. for ` 20,000, out of which ` 15,000 was paid to them by cheque immediately. Journalise the following transactions : (i) Depreciate furniture purchased for ` 10,000 @ 10% per annum for 3 months. (ii) Received from Murthy ` 1,950 in full settlement of his account for ` 2,000. Journalise the following transactions in the books of Basu : (a) Basu sold goods to Chowdhary for ` 750 against a cheque. (b) Received as commission ` 400 6.32 7. 8. 9. 10. 11. 12. 13. 14. 15. Financial Accounting: Concepts and Applications (c) Bank paid ` 300 directly for insurance premium of Basu (d) Cash deposited into bank ` 5,000 (e) Withdrawn cash from bank for personal expenses ` 850. Pass the necessary journal entries for the following : (i) A fire occurred on 15 March 2017 and stock of ` 25,000 was destroyed. The Insurance Company accepted a claim for ` 22,000 (ii) Wages ` 450 were paid for erection of plant. If the owner' equity is ` 98,765 and total assets ` 9,98,877 what will be the total liabilities. Journalise the following : (i) Machine with original cost of ` 3,000 was sold for ` 4,300. Depreciation provision to date was ` 300. ` 30 were paid for removing the machine from the plant. ` 43 were paid commission to the selling agent. (ii) Paid Mukund ` 325 for goods bought from him last month for 340 in full settlement. Give journal entries for the following : (i) Goods worth ` 5,000 given as charity (ii) Received ` 975 from Hari Krishana in full settlement of his account ` 1,000 (iii) Received a first and final dividend of 60 paise in a rupee from the official receiver of Mr. Rajan who owed ` 10,000. Journalised the following transactions in the books of Shri Muralidhar, a timber merchant, giving suitable illustrations : (a) Issued a cheque in favour of M/s Karanvir Timber Company on account of the purchase of timber of ` 75,000 (b) Paid ` 2,500 in cash for installation of a machinery (c) Timber sold costing ` 60,000 to Kalu Ram at an invoice price 10% above cost less 5% trade discount. (d) Paid ` 500 to repair second hand furniture. Record the following transactions in the journal of Rose : (i) Purchase of an accounting machine for ` 3,800 on credit from Aditi Ltd. (ii) Goods were distributed from stock as free samples to the value of ` 250 as part of an advertising compaign. (iii) A Rose drew a cheque for ` 550 on the business bank account to pay for a bicycle for his own private use. (iv) Anand, a customer, returned goods invoiced at ` 120 because they were unsuitable. Journalise the following transactions : (i) Paid ` 25 as wages for installation of machine. (ii) Sold goods to Kangli. List price ` 2,000. Sales subject to 10% trade discount and 5% cash discount; Payment is made immediately. Kangli availed of cash discount. (iii) Supplied goods costing ` 600 to Shalu. Issued invoice at 10% above cost less 5% trade discount. (iv) Goods costing ` 1,000 distributed as samples. (v) Goods costing ` 500 was stolen in transit. (vi) Cash embezzled by Renu, an employee, ` 4,500. Journalise the following transactions in the books of Mahavir. (i) Bought goods on credit from A for ` 400 (ii) Goods returned by B ` 50. (iii) Paid carriage inwards ` 100. Journalise the following transactions. (a) Drew goods for private use –` 500. (b) Paid office rent to landlord –` 2000. (c) ` 700, due from a customer Anmol was written off as bad. Accounting Process : An Overview 6.33 (d) Bought stationery –` 300. (e) Sold goods to Rakesh –` 5,000. 16. Record the following transactions completed during the month of June of the current year in the general journal: ` 1 Paid rent for the month 300 2 Paid cash for office stationery 30 8 Purchased office equipment on account 5,000 13 Paid advertising expenses 300 15 Received cash from customers on account 4,000 18 Paid creditors on account 2,000 25 Withdrew cash for personal use 1,000 29 Paid telephone bill 300 30 Fees earned and billed to customers 10,000 30 Paid for repairs to typewriter 150 30 Paid electricity bill for the month 200 17. Journalise the following transactions in the books of Nidhi : Jan. 1 Commenced business with ` 15,000; of which ` 5,000 deposited in the bank. Jan. 3 Bought furniture –` 2,000 Jan. 8 Purchased goods from Shyam ` 10,000 Jan. 10 Sold goods to Mani for ` 50,000 and accepted a cheque for ` 3,000 which was sent to bank. Jan. 15 Returned goods to Shyam worth ` 500 as the goods were damaged in transit. Jan. 20 Sold goods for cash ` 800 at a trade discount of 5% Jan. 22 Purchased goods worth ` 600 by paying cheque at a trade discount of 10% Jan. 25 Paid rent for the month – ` 550 Jan. 26 Paid Shyam ` 80,000 on account by cheque Jan. 30 The above cheque was returned by Shyam since the signature on it did not tally. Payment was made in cash immediately. 18. Enter the following transactions in the general journal of Shri Pankaj Kukreja : ` Jan. 1 Commenced business with cash 1,50,000 Jan. 2 Deposited with the bank 1,00,000 Jan. 4 Bought goods from Reema 50,000 Jan. 6 Sold goods to Samita 10,000 Jan. 8 Bought goods for cash 30,000 Jan. 10 Received cash from Samita 4,900 Discount allowed 100 Jan. 12 Paid Reema by Cheque 35,000 Received discount 200 Jan. 15 Returned damaged goods to Reema 2,000 Jan. 19 Samita returns damaged goods 1,500 Jan. 25 Paid salaries 15,000 Jan. 28 Paid House Tax 2,000 Jan. 30 Paid for stationery 500 Jan. 31 Paid for carriage outwards 150 6.34 Financial Accounting: Concepts and Applications 19. Journalise the following : ` (i) Paid by cheque insurance premium 400 (ii) Paid by cheque life insurance premium 500 (iii) Drew a cheque for petty cash 200 (iv) Sent out our acceptance at two months for 1,000 to Madhu (v) Bills payable due this day met at bank 500 (vi) Received B’s acceptance for ` 700 from A in settlement of latter’s account for 750 (vii) Sold goods for cash 1,000 (viii) Discounted Amit’s acceptance for 1,000 at 980 (ix) Sold goods to Malti and she endorsed Renu's bill to us for 500 (x) Bank collected interest on our investments 450 (xi) Received a cheque for cash sales 900 (xii) Received dividend on shares of D.C.M. Ltd. 530 (xiii) Paid into bank. 2,000 (xiv) Received a cheque for commission due to us 76 (xv) Bought Government bonds for 50,000 (xvi) Paid for postage 20 (xvii) Paid for general expenses ` 50, salaries ` 5,000, rent ` 2,500. (xviii) Purchased machinery for 1,50,000 (xix) Bank charges made by bank 20 (xx) Paid for an advertisement in The Pioneer Newspaper 1,500 (xxi) Bought goods from R and Co. for ` 7,000, accepted their bill for ` 1,500 and gave them a cheque for the balance (xxii) Sold goods to Rita Agencies for ` 6,000, received their acceptance for ` 2,000 and balance in cash (xxiii) Returned goods to Sujata 500 (xxiv) Chandra returned goods to us 150 (xxv) Endorsed N's acceptance for ` 550 over to M on account for 500 (xxvi) Bought from Lata cosmetics for proprietor's wife 40 (xxvii) Bought National Savings Certificates 5,000 (xxviii) Received dividends on shares 6,000 (xxix) Paid by cheque Malhotra Enterprise's bill for repairs of machinery 100 (xxx) Received a cheque for ` 1,100 from Beena to be credited to Neena for 1,000 (xxxi) Received from Tara by cheque 800 (xxxii) Paid Tara's cheque into bank (xxxiii) Bank returned Tara's cheque dishonoured. (xxxiv) Borrowed from the bank 5,000 (xxxv) Repaid Anshu's loan of ` 2,000 with interest 150 (xxxvi) Paid professional tax to city corporation 500 20. Write up ledger accounts from the following transactions and balance the accounts : 20... Jan. 1 I commence business with cash ` 41,200, stock-in-trade ` 21,700 and Machinery ` 67,000 Jan. 2 I buy goods for ` 80,000 from B. Sen on credit Jan. 5 I pay wages ` 5,000 Accounting Process : An Overview Jan. 6.35 9 I buy stationery for ` 200 Jan. 10 I sell goods for ` 51,000 to T. Das on credit Jan. 15 I pay B. Sen ` 30,000 Jan. 16 I buy goods from B. Sen for ` 40,000 on credit Jan. 20 T. Das pays me ` 40,000 Jan. 25 I pay B. Sen ` 35,000 Jan. 26 I buy goods for cash ` 5,000 Jan. 28 I withdraw cash from business ` 1,000 for fees of the school of my daughter 21. On 1 January 20... the following were the ledger balances of Shri Ram Chander : Cash in hand –` 2,000; cash at bank –` 45,000; Bills payable –` 6,000; Zahir–` 5,000 (Dr.) Stock –` 25,000; Gautam –` 14,000 (Cr.); Narayan –` 10,000 (Dr.); Ramneet –` 5,600 (Cr.). Other transactions during the month were : ` Jan. 2 Bought goods from Gautam 6,000 Jan. 4 Sold Goods to Narayan 7,000 Jan. 6 Bought goods from Ramneet 7,200 Jan. 10 Sold to Zahir 3,000 Jan. 15 Paid to Gautam by Cheque 8,000 Jan. 20 Received from Narayan Allowed him discount 11,000 110 Jan. 20 Accepted Ramneet’ draft (Bills Payable) at 3 Months 7,000 Jan 22 Sold goods to Narayan 3,000 Jan. 24 Paid rent by cheque 1,200 Jan. 28 Sold to Zahir 4,000 Jan. 31 Paid salaries by cheque 5,000 Make journal entries and post them to ledger 22. Prepare Salma' account as it would appear in the books of Anupama : ` 20… Jan. 1 Sold goods to Salma 10,000 Jan. 3 Received from Salma 5,000 Jan. 5 Purchased goods from Salma 4,000 Jan. 7 Paid to Salma 3,000 Jan. 10 Sold goods to Salma Allowed her discount 20,000 2,000 Jan. 15 Salma returns goods 3,000 Jan. 17 Received cash from Salma 10,000 Jan. 20 Sold goods for cash to Salma 5,000 Jan. 22 Purchased goods from Salma Discount received from her 10,000 1,000 Jan. 27 Goods received from Salma 3,000 Jan. 31 Paid to Salma Jan. 31 Jayanti returned goods to Rani Mukherjee ` 5,000 5,000 6.36 Financial Accounting: Concepts and Applications 23. Prepare Rajaram's Account in the ledger of Jayaram and Jayaram's account in the ledger of Rajaram : ` Jan. 1 Jayaram sold goods to Rajaram 30,000 Jan. 6 Rajaram paid cash to Jayaram 20,000 Jan. 14 Rajaram returned goods to Jayaram 1,000 Jan. 20 Jayaram bought goods from Rajaram 12,500 Jan. 24 Jayaram paid cash to Rajaram 5,000 Jan. 30 Jayaram returned goods to Rajaram 500 24. Record the following transactions in the journal of Kapil and open only the personal accounts in the ledger and balance them : Jan. 1 Kapil started business with –` 85,000 Jan 5 Purchased goods from Manisha –` 19,000 Jan 7 Purchased a PC for ` 29,000 from M/s Electronics Ltd. Jan 10 Goods returned to Manisha for ` 1,200 Jan 12 Paid for printing and stationery to New Delhi Stationery Store –` 6,000 Jan. 14 Goods sold to Ravi for ` 5,600 Jan. 20 Paid to Manisha ` 8,900 and discount received ` 100 Jan. 24 Goods retuned by Ravi –` 200 Jan. 26 Paid to Manisha –` 3,000 Jan 30 Cash received from Ravi –` 2,900 25. From the following transactions make journal entries and prepare only Purchases Account : (i) Purchased goods for ` 30,000 at 20% trade discount (ii) Goods taken away for personal use –` 500 (iii) Goods destroyed by fire –` 1,000 (iv) Goods given away as charity –` 800 (v) Goods distributed as free samples –` 400 (vi) Goods eaten by rats –` 300 (vii) Goods given to employees as part of their salary as a part of food for work programme ` 2,000. (viii) Goods stolen for ` 1,200; Insurance claim admitted in full. 26. Write up the account of Madhvi from the following transactions : March 20... ` Jan. 1 Jayaram sold goods to Rajaram 30,000 Jan. 1 Bought goods from Madhvi 40,000 Jan. 5 Paid her on account 25,000 Jan. 10 Returned goods to her 2,000 Jan. 17 Sold goods to her 8,000 Jan. 20 Received goods returned by her 1,000 Jan. 25 Madhvi paid us cash 5,000 Jan. 30 Paid her cash 2,000 27. In which book, the following transactions would be recorded : (i) Purchase of building for business on cash. (ii) Purchase of patents on credit. (iii) Purchase of inventories for cash. (iv) Purchase of merchandise on credit. Accounting Process : An Overview 6.37 (v) Sale of raw materials for cash. (vi) Sale of finished goods on credit. (vii) Sale of old typewriter for cash at a loss of ` 1,000. (viii) Return of goods to supplier. (ix) Purchase of goodwill for cash. (x) Revaluation of machine by ` 10,000. 28. Enter the following transactions into a single column cash book of Mata Sundri and extract the balance at the end of the month : 2017 ` Jan. 1 Cash in hand 50,000 Jna. 2 Introduced more capital 1,50,000 Jan. 3 Purchased goods for cash 40,000 Jan. 6 Sold Goods to Ameena Stores for cash 80,000 Jan. 8 Bought office furniture 10,000 Jan. 10 Paid for stationery purchased 5,000 Jan. 15 Received from Rati, a customer 2,500 Jan. 18 Paid to Neera, a creditor 7,500 Jan. 20 Paid to Bhargva on account 25,000 Jan. 25 Cash sales 20,000 Jan. 28 Paid Rent 3,000 Jan. 30 Paid Salaries 12,000 Jan. 31 Bought Goods 1,75,000 29. Enter the following transactions in cash book with cash and discount columns and balance the same : 2017 ` Feb. 1 Cash in hand 5,000 Feb. 3 Received from Sondhi (discount ` 2,000) 40,000 Feb. 5 Paid cash to Govinda 10,000 Feb. 7 Paid to Subash (discount ` 500) 14,500 Feb. 10 Purchased goods from Fardeen 15,000 Feb. 15 Cash sales 22,000 Feb. 17 Paid Malini 11,000 Feb. 18 Received from Sri Krishan on account (Discount ` 1,000) 21,000 Feb. 22 Paid cartage 250 Feb. 25 Paid rent 5,500 Feb. 26 Received commission 2,700 Feb.28 Paid to Fardeen on account (discount ` 500) 12,500 Feb.28 Received interest on bank account in cash 2,500 Feb. 28 Paid electricity bill 785 Feb.29 Purchased goods for cash 35,000 30. Maintain the cash book of Harish who deposits all receipts into the Bank and makes all payments through cheques: Jan. 1 Started business by opening Bank Account with ` 1 Lakh. Jan. 2 Purchased furniture ` 12,000 cheque No. 001 Jan. 3 Bought goods from Kareem ` 3,000 on credit Jan. 5 Sold goods for cash ` 5,000 to Aswin. 6.38 Financial Accounting: Concepts and Applications Jan. 6 Paid Kareem ` 2,975 in full settlement, cheque No. 002 Jan. 7 Abdullah sent an advance of ` 5,000 for goods to be supplied next week. 31. Mr. Rokadiya maintains cash book with bank columns. Enter the following transactions of 21 May 2004 in the Cash Book and balance the same : (i) Balance at the beginning of the day : ` Cash 150 State Bank of India 25,000 Bank of India (overdraft) 3,000 (ii) Received a cheque of ` 5,350 from Merwan Bros, in full settlement of invoice for ` 5,500. The cheque was deposited in Bank of India, who charged ` 3 as collection charges. (iii) Cash purchases ` 10,000. Paid bearer cheque on State Bank of India. (iv) Transferred ` 5,000 from State Bank of India to Bank of India. (v) Withdrew ` 5,000 from State Bank of India –` 3,000 for office use and ` 2,000 for personal use. (vi) Paid advance salary to manager ` 1,000 by bearer cheque on Bank of India. 32. Anand owed ` 2,800 to Bank and had cash ` 460 on hand on 1-4-17 April 2 he drew cash for office use ` 1,600; and paid wages ` 1,000. April 7 he sold goods for ` 400 and bought goods for ` 300 April 9 he received cheque for ` 1,350, in full settlement for ` 1,400 from Ajit. Deposited the same in Bank. April 11 he paid Ramvilas by cheque ` 890, in full settlement for ` 900. April 15 he received ` 215 for sale of old newspapers. April 17 he bought one bicyle by cheque for ` 1,150; he also paid municipal taxes ` 200 in cash. April 18 he received back Ajit's cheque dishonoured from Bank. Bank charged ` 10 towards the same. April 20 He received from Ajit a fresh cheque for the total amount. (Including bank charges) April 21 He deposited Ajit's cheque into Bank. Prepare his Three Columnar Cash Book. 33. Enter the following transactions in a Cash Book Jan. 1 Cash in hand ` 5,374, Balance at bank ` 15,490 Jan. 3 Cash sales ` 6,400 Jan. 5 Paid into bank ` 7,000 Jan. 6 Received a cheque for ` 700 from Satyam Jan. 8 Paid into bank Satyam's cheque Jan. 10 Paid to Anurag by cheque ` 980 and discount allowed by him ` 20 Jan. 12 Cash purchases ` 2,500 Jan. 14 Withdrew from bank for office use ` 5,000 Jan. 15 Received cheque for ` 950 from Lakshman and allowed him discount ` 50 Jan. 18 Cash sales ` 7,500 Jan. 19 Paid into bank Lakshman's cheque and cash ` 4,000 Jan. 21 Cash paid for stationery ` 120 Jan. 23 Paid commission to Rakesh ` 500 Jan. 25 Received cheque for ` 1,000 from Mohan and paid the same into Bank. Jan. 27 Lakshman's cheque dishonoured Jan. 29 Drew a cheque for ` 800 for personal use Jan. 31 Paid salaries by cheque ` 1,500 and by cash ` 500 Jan. 31 Bank charges ` 20 and insurance premium ` 520 as shown in Pass Book. Accounting Process : An Overview 34. 35. 36. 6.39 Make out the three column cash book of M/s Ram and Mohan from the following particulars ` April 1 Cash in hand 300 Bank Overdraft 450 Paid salaries for March 250 April 2 Purchased goods for cash 30 Cash sales 80 April 3 Issued cheque in favour of Krishna & Co. to settle his account for ` 270 260 April 4 Received cash from Dhawan X Co. (discount allowed ` 15) 235 April 5 Received cheque from Ali Bros. (in full settlement of their debt of ` 200) 190 April 5 Cash sent to bank 200 April 5 Cheque issued in favour of Ravi Bros. for purchase of furniture 150 April 6 Cheque of Ali Bros. dishonoured, Bank debits in respect of charges 2 April 6 Paid rent by cheque 100 April 6 Bank collects interest on securities 150 John Smith, a merchant, does not pay all cash received into his bank. He desires to record all cash received and paid and all his bank transactions in one cash book. His transactions during the first few days of January 2017 were as under : ` Jan. 1 Cash in hand. 1,500 Bank Overdraft. 720 Received cash from A.B. (after allowing him discount ` 10). 150 Jan. 2 Paid into Bank. 1,450 Jan. 3 Drew cheque for C.D. (after deducting discount ` 30). 270 Jan. 4 Received cheque from E.F. (after allowing him discount ` 300) and paid it in bank. 2,700 Jan. 5 Drew from Bank. 200 Jan. 6 Paid wages by cheque. 300 Jan. 7 E.F.'s cheque returned dishonoured. Jan. 8 Received cash from, G.H. (after allowing discount ` 20). 480 Jan. 9 Paid into Bank. 250 Jan.10 Paid cash to J.K. (after deducting discount ` 40). 360 Jan.11 Bank charges. 10 You are required to record these transactions in a suitable form of cash book. On 1 March 2017 Mohan had the following assets and liabilities : Building ` 1,000; Y's acceptance ` 2,000; Due from David ` 2,000; Due from Krishan ` 2,500; Cash ` 500; S.R. Mills' shares ` 2,000; Z's acceptance ` 1,000; Stock in hand ` 12,000. Overdraft at bank ` 2,000; Bills payable ` 1,600; Due to James ` 3,000; Due to Abdul ` 1,025; Reserve for doubtful debts ` 225; Wages due `150. The following were his transactions for the month : ` March 1 Paid wages due. 150 March 5 Sold goods to Raghavan less 5% for cash in ten days. 1,000 March 5 Sold goods to David less 10% trade discount. 3,000 6.40 37. 38. Financial Accounting: Concepts and Applications March 8 Cash takings paid into bank. 2,500 March 9 Paid Abdul by cheque in full settlement. 1,000 March 12 Sent David a credit note for ` 200 for an allowance claimed by him for inferior goods. March 13 Received from Raghavan a cheque for the amount due and paid the same into bank. March 18 Discounted Y's acceptance at bank for 1,980 March 19 Z became insolvent; received from him a first and final dividend of twenty-five paise in the rupee. March 20 Withdrew from bank for office use. 500 March 21 Raghavan's cheque was returned dishonoured and the discount was disallowed. March 25 Purchased goods from James. 1,000 March 29 Sold S.R. Mills' shares ` 1,000 at a premium of 5% less brokerage 1%. March 29 Paid into bank. 1,000 March30 Paid James by cheque in full settlement. 3,990 Record the above in Mohan's Journal and Cash Book and close the Cash Book. Prepare a suitable cash book only. Enter the following transactions in a suitable cash book of Bhaskar Reddy and strike the balance at the end of the month : ` Jan. 1 Cash in hand. 5,000 Jan. 2 Opened a Bank Account and deposited office cash therein 3,750 Jan. 3 Purchased office furniture and paid off by a cheque. 250 Jan. 6 Purchased stationery. 50 Jan. 8 Cash purchases. 200 Jan. 9 Paid to Mani Lal as price for goods by cheque. 1,000 Jan.10 Received from Kartar Singh payment for goods in cash ` 500 and by cheque ` 1,250 and deposited into bank. 1,750 Jan.12 Cash sales. 350 Jan.16 Kartar Singh's cheque returned dishonoured by the Bank 1,250 Jan.18 Cash purchases (in cash ` 500 and by cheque ` 450). 950 Jan.20 Withdrew cash from Bank for personal use. 100 Jan.22 Sold goods for cash and deposited the cash into Bank. 1,200 Jan.26 Kartar Singh paid cash in lieu of dishonoured cheque. 1,250 Jan.28 Paid office rent. 500 Jan.30 Paid salary to staff. 1,000 From the following particulars prepare three column cash book for January 2017. Balance the cash book on 31 January 2017 : Jan. 1 Cash on hand ` 500; Credit balance with Canara Bank ` 1,000. Jan. 5 Sale proceeds of household furniture ` 7,000 was deposited with the bank. Jan. 9 A cheque of ` 10,000 was given to M. Patel on account. Jan.12 Received a cheque of 3,000 in full settlement from Khanna & Co. Jan.13 The above cheque was deposited in the bank. Jan.16 The bank returned the cheque of Khanna & Co. as dishonoured. Accounting Process : An Overview 39. 40. 41. 6.41 Jan.18 Cash sales ` 2,500. Jan.20 Cash advance ` 1,000 for travelling given to the salesmen. Jan.25 Received cash ` 2,500 from Rao Bros, in full settlement of ` 2,600 due from them. Jan.28 Paid cash ` 1,500 to Cheri & Co. in full settlement of ` 1,650. Jan.29 Drew for office use ` 3,000 from bank. Jan.30 Paid salaries ` 2,300, rent ` 1,000 and sundry expenses ` 700 by cash. Enter the following transactions in a Three-Column Cash Book : ` Jan. 1 Cash in hand 410 Jan. 1 Balance at Bank 8,920 Jan. 2 Cash sales 4,500 Jan. 3 Paid into Bank 4,000 Jan. 5 Purchased stationery 100 Jan. 8 Paid Mahesh by cheque 280 discount received 20 Jan.12 Gave a cheque for cash purchases 1,500 Jan.15 Drew for personal use 500 Jan.18 Received from Suresh, a cheque for ` 1,970 in full settlement of account of ` 2,000 Jan. 20 Drew from Bank 1,000 Jan. 21 Paid wages 100 Jan.25 Bank returns cheque of Suresh dishonoured Jan.31 Bank charges as per Pass Book 10 Enter the following transactions in the three column cash book of Sunil and balance the same as on 31-10-2017. ` Jan. 1 Cash in hand 5,400 Cash at bank 1,475 Jan. 2 Issued cheque to Sekhar 850 discount received 150 Jan. 3 Paid salaries 1,150 Jan. 5 Cash received from sale of investments ` 4,900 out of which ` 1,250 was deposited into bank Jan. 6 Received from Vikram a cheque of ` 775 in settlement of his account for 950 Jan. 9 Received from Naidu ` 1,150, discount allowed 50 Jan.10 Withdrew for personal use by cheque 175 Jan.11 Bank charges as per pass book 10 Jan.14 Interest received from Manohar 140 Jan.16 Goods sold 7,000 Jan.18 Bank collected dividends on shares 360 Purchased from Wahed 2,400 Jan.20 Paid rent 400 Enter the following transactions in cash book with cash discount and bank columns : April 1 Balance of cash in hand ` 400, overdraft at bank ` 5,000 4 Invested further capital ` 10,000 out of which ` 6,000 deposited in bank 6.42 42. 43. 44. Financial Accounting: Concepts and Applications 5 Sold goods for cash ` 8,000 6 Collected from Sridhar, a debtor of last year ` 8,000 discount allowed ` 200 7 Paid Ramvilas, our creditor, ` 2,500 discount allowed by him ` 65 13 Commission paid to Robert our agent ` 530 14 Office furniture purchased from Keshav ` 200 17 Drew cheque for personal use ` 700 18 Collection from Atal ` 4,000; deposited in the bank on 20 April 20 Drew from bank for office use ` 500 21 Drew for petty cash ` 150 29 Drew from the bank and paid salary of office staff ` 1,500 30 Deposited cash in the bank ` 10,000 Write out an analytical petty cash book from the following transactions. Aug.1 Issued a cheque of ` 100 to Petty Cashier. 2 Paid electricity ` 3.25 4 Paid Telephone charges ` 2.50 8 Paid for Printing ` 3.75 15 Paid for stationery ` 6 20 Purchased post cards ` 3 The Petty Cashier who maintains an imprest of ` 500 submitted on 31st March the list of expenses as follows : Travelling Expenses ` 52; Carriage ` 25 Postage ` 78; Stationery ` 87 Show the entries to be made by the Main Cashier. Prepare the columnar Petty Cash Book of Rajan Ltd., for the month of January, under the imprest system. The petty cash limit fixed was ` 2,500 and the cashier draws money under the imprest petty cash system as and when the balance available with him is below ` 500. The petty cash transactions for the month of January 2017 are given below : ` Jan. 1 Opening balance. 2,500 Jan. 1 Paid towards conveyance charges. 420 Jan. 3 Purchase of stationery. 830 Jan. 5 Wages to Sweeper. 210 Jan. 5 Paid towards conveyance charges. 620 Jan. 7 Postage stamps purchased. 1,100 Jan. 9 Wages to Sweeper. 420 Jan. 10 Telegram charges paid. 95 Jan. 16 Conveyance charges paid. 225 Jan. 16 Wages to Sweeper. 490 Jan. 19 Postage stamps purchased. 810 Jan. 19 Telegram charges. 140 Jan. 22 Entertainment expenses. 313 Jan. 25 Wages to Sweeper. 630 Jan. 25 Taxi charges paid. 276 Jan. 28 Postage stamps purchased. 360 Jan. 31 Entertainment expenses. 270 Jan. 31 Wages to Sweeper. 420 Accounting Process : An Overview 45. 46. 47. 48. 6.43 The following is the summary of the petty cash transactions of a business enterprise for May 20... May 1 Received from Cashier ` 3,000 on petty cash float ` May 2 Postages 180 ` May 3 Travelling 120 24 Delivery Van 5,000 km. service 440 May 4 Cleaning 150 26 Petrol 180 May 7 Petrol for Van 220 27 Cleaning 210 May 8 Travelling 250 29 Postage 50 May 9 Stationery 170 30 Petrol 140 May 11 Cleaning 180 May 14 Postage 50 May 15 Travelling 80 May 18 Stationery 90 May 18 Cleaning 230 May 20 Postage 130 Required : (a) Rule up a suitable petty cash book with analysis columns for expenditure on cleaning, motor expenses, postage, stationery, travelling; (b) enter up month's transactions; (c) enter the receipt of the amount necessary to restore the imprest and carry down the balance for the commencement of the following month; and (d) state how the double entry for the expenditure is completed. Prepare the Purchases Book M/s Fancy Dress Mart : June 2 Purchased from Gupta of Guntur : 100 T Shirts at ` 80 per Shirt 4 Sold to Burman of Bombay : 50 T Shirts at ` 120 per Shirt 6 Purchased from Vijay of Vijawada : 100 Bush shirts at ` 90 each 8 Bought from Bombay Furniture Mart, Bandar : 10 Chairs at ` 80 each Enter the following transactions in the Purchases Book of Premdas and also show the Purchases Account. Jan. 1 Purchased from Mohan on credit four reams of white paper at ` 65 per ream. 2 Purchased from Gopi 4 dozen ink bottles at ` 48 per dozen. 3 Purchased from Rao two dozen writing Pads at ` 96 per dozen 4 Returned two defective pads to Rao. 5 Purchased from Kishore 3 dozen balls pens at ` 15 per dozen. The transactions of a business in January were as follows : Jan. 4 Bought goods from B & Co., less 20% trade discount, ` 2,000. Jan. 6 Returned goods to B & Co., (Gross) ` 400. Jan. 9 Sold goods to A & Co., less 15% Trade discount ` 1,000. Jan. 12 A & Co. returned goods (net) ` 100. Jan. 15 Advised D & Co., to despatch goods worth ` 2,000 gross to C & Co., under advice to us. 6.44 49. Financial Accounting: Concepts and Applications Jan. 17 D & Co., advised us of the despatch of goods to C & Co., and sent their invoice for ` 2,000 off 20% trade discount. Jan. 20 C & Co., returned to us goods invoiced to them at ` 200 which we promptly returned to D & Co., with our debit note. Jan. 23 Bought goods worth ` 3,000 from F & Co., and sent them to E & Co., with our invoice for ` 3,600. Record the transactions in subsidiary books. Enter the following transactions of Sachin, a dealer in electrical goods, in the purchases book for the month of May : May 03 Purchased from General Supplies Co. Ltd. : 12 Transistor Radio sets at ` 200 each. 10 Electric Toasters at ` 100 each. 3 Electronic Clocks at ` 200 each. Less : Trade Discount 20 per cent on all items. May 06 Purchased from Topaz Ltd. : 6 Electric Razors at ` 20 each. 24 Battery Torches at ` 20 each. May 07 Purchased from Radio House : 5 Colour Televisions at ` 6,000 each. 2 Portable B/W Televisions at ` 1,500 each. May 20 Purchased from Philps India Ltd. : 200 light bulbs at ` 5 each. Less : Trade Discount at 20 per cent. 50. Enter the following transactions in the sales day book. At the end of the month, total the day book and indicate the amount to be posted to general ledger : April 01 Sold office furniture to Ahmed, list price ` 4,800 allowing him 20 per cent trade discount. Invoice No. 8152. April 08 Sold 4 filing cabinets to Mohan Lal at list price of ` 1,000 each. Invoice No. 8264. April 18 Sold 6 Typewriters to Anupum Commercial College at ` 1,800 each. Trade Discount of 15 per cent was allowed. Invocie No. 8267. April 28 51. Sold office furniture to Royal Industries Ltd. List price ` 6,000. Trade Discount of 20 per cent was allowed. Invoice No. 8276. Write up the appropriate journals of Ashwani for the month of March from the following information : March 6 Received invoice from Sachin : 3 Dining Tables at ` 3,600 each. 3 Chairs at ` 1,600 each. All subject to 25 per cent trade discount. March 9 Sent invoice to Kapil : 2 Dining tables at ` 4,300 each. 2 Occasional Tables at ` 900 each. All subject to 20 per cent discount. March 14 Invoiced to Rashi : 5 Carpets at ` 600 each. subject to 20 per cent trade discount. Accounting Process : An Overview March 21 6.45 Received an invoice from Shweta : 2 Dining Tables at ` 7,000 each. 4 Corner Tables at ` 360 each. All subject to 20 per cent trade discount. March 30 Received credit note from Shweta : 1 Corner table damaged as invoiced on 21 March. 52. Shri Suraj Bhan commenced business with ` 18,000 in cash on 1 March 2017. The following are his transactions for the month. Enter them in proper books. 2017 ` March 1 Deposited in bank 15,000 March 2 Purchased office furniture for cash 700 March 3 Bought goods for cash 1,500 March 5 Sold goods to Roshan Lal : 20 metres nylon cloth @ ` 14 per metre 10 metres shirting @ ` 15 per metre March 8 Received from Roshan Lal on account 200 March 9 Roshan Lal returned goods : 10 metres of nylon cloth @ ` 14 per metre March 15 Drew from bank cash for office 1,000 March 18 Bought of Munshi Ram goods 60 metres shirting @ ` 12 per metre 45 pieces dril @ ` 30 per piece March 19 Sold goods for cash 200 March 20 Paid cash for stationery 5 March 21 Paid cash for carriage 7 March 22 Received from Roshan Lal 50 Discount allowed 10 March 23 Goods returned to Munshi Ram 15 metres shirting @ ` 12 per metre 5 pieces dril @ ` 30 per piece March 26 Paid Munshi Ram cash 1,550 Discount allowed 40 March 31 Paid salary by cash 150 March 31 Paid rent for the month 100 53. Mr. Problem is the owner of a business. From the following balances extracted from his ledger, prepare a trial balance as on 31 March 2017 : ` Purchases 4,06,750 Sales 9,82,000 Creditors 63,000 Debtors 1,45,000 Capital 7,10,000 Drawings 52,450 Insurance 6,000 General Expenses 30,000 6.46 Financial Accounting: Concepts and Applications Salaries 1,50,000 8% Deposit with banks 75,000 Machinery 3,00,000 Building 3,00,000 Stock on 1-4-2016 57,600 Carriage on purchases 20,400 Carriage on sales 32,400 Fuel and power 47,300 Wages 1,04,800 Returns inwards 6,800 Returns outwards 5,000 Interest on bank deposit received 5,800 Cash at bank 29,300 Cash in hand 2,000 54. From the following information taken from the ledger of Raveena, prepare a trial balance : ` Purchases 21,750 Discount allowed 1,300 Wages 6,500 Salaries 2,000 Sales 35,000 Travelling expenses 400 Commission (Dr.) 425 Carriage inward 275 Administration expenses 105 Trade expenses 600 Interest 250 Building 5,000 Furniture 200 Debtors 4,250 Capital ? Creditors 2,100 Cash in hand 7,045 55. The following balances have been taken from theledger of Mr. Lakhpati as at 31 March 2017 : ` (i) Stock (1-4-16) 30,000 (ii) Purchases (Adjusted) 60,000 (iii) Capital 45,000 (iv) Drawings 11,000 (v) Wages 3,700 (vi) Salary 6,800 (vii) Travelling expenses 600 (viii) Rent and insurance 2,000 (ix) Interest received 400 (x) Sales 1,56,300 Accounting Process : An Overview (xi) (xii) (xiii) (xiv) (xv) (xvi) (xvii) (xviii) (xix) (xx) (xxi) (xxii) (xxiii) (xxiv) 6.47 Cash at bank 8,000 Sundry creditors 35,000 Bad debits 1,400 Provision for bad debts 2,500 Building 6,000 Plant and machinery 10,000 Furniture 5,000 Sundry Debtors 50,000 Sundry expenses 1,800 Stock (31-3-17) 40,000 Outstanding salary 700 Outstanding wages 500 Prepaid insurance 600 Depreciation on Plant and Machinery 2,500 Building 500 Furniture 500 Hint. : Since the purchases are the adjusted one, stock at the end would also appear in the balance sheet. 56. From the following balances extracted from the books of Preeti Khanna, prepare Trial Balance as on 31 December 2016 : ` ` Purchases 90,000 Returns outward 3,000 Wages 6,000 Salaries 12,000 Rent and taxes 2,400 Insurance 800 Travelling expenses 4,800 Discount 900 Interest 1,200 Sales 1,00,500 Returns inward 4,000 Bad debts 600 Bank 10,000 Sundry creditors 50,000 Cash 34,000 Buildings 10,000 Machinery 14,000 Sundry debtors 80,000 Furniture 1,000 Capital 1,10,000 Loan 45,800 Drawings 15,000 Trade expenses 200 Advertisements 2,400 Stock (1.1.2016) 20,000 Closing stock 37,500 57 . The following trial balance was drawn by a trainee book keeper but his superviser was not very pleased. Although both sides were equal, he did not think that the statement was correct : Trial Balance As At 31 March 2017 Debit (`) Credit (`) Capital 26,850 — Insurance expenses — 3,150 Stock 1.4.2016 11,175 — Purchases during the year 69,300 — Sales — 1,18,275 Salaries expenses 18,615 — Lighting and heating 930 — 6.48 Financial Accounting: Concepts and Applications Plant and Machinery Delivery expenses Rates paid Rent received Accumulated depreciation Rent paid Delivery vehicle Cash Trade creditors Trade debtors Bank overdraft Carriage outwards Outstanding rent 58. 10,800 — 1,170 — 1,050 3,345 4,425 330 14,775 — 2,925 — 1,500 1,67,190 — 690 — 1,815 — — — — — 41,760 — 1,500 — 1,67,190 Prepare a correct trial balance. The undermentioned Trial Balance was drafted by a senior secondary school student. But due to his defective knowledge of the subject, it has been done incorrectly. You are now requested to redraft the Trial Balance correctly stating your reasons for the correction : Trial Balance For The Year Ended 31 March 2017 Debit (`) Credit (`) Capital 1,00,000 Opening stock 16,590 — Closing stock — 20,580 Sundry creditors — 12,500 Sundry debtors 20,670 — Fixed assets 79,000 — Gross purchases 60,920 — Gross sales — 1,02,600 Returns inwards 2,400 — Returns outwards — 1,230 Carriage inwards 800 — Carriage outwards — 1,850 Import duty 1,200 — Export duty — 800 Wages and salaries 31,400 — Bills receivable 15,000 — Bills payable — 8,000 Rent receivable 3,800 — Interest paid — 1,100 Bank overdraft 11,000 — Cash in hand 380 — Commission received — 870 Rates and taxes 7,130 — Discount allowed — 760 2,50,290 2,50,290 Accounting Process : An Overview 59. 60. 6.49 Enter the following transactions in proper books, post them to ledger and extract a trial balance : 2017 ` Jan. 1 Chandrika Commenced business with cash 60,000 Jan. 2 Goods purchased for cash 9,000 Jan. 03 Goods purchased from Lala Ram 12,000 Jan. 4 Sold goods for cash 18,000 Jan. 5 Goods sold to Kanta 15,000 Jan. 7 Goods returned by Kanta 3,000 Jan. 7 Goods returned to Lala Ram 600 Jan. 8 Furniture bought for cash 1,200 Jan. 9 Paid cartage 300 Jan.10 Cash received from Kanta allowed her discount 5% 12,000 Jan.11 Cash paid to Lala Ram 11,100 and he allowed as discount 300 Jan.12 Paid for Shiv Ratri festival 600 Jan.13 Goods sold for cash 18,000 Jan. 14 Goods purchased for cash 9,000 Jan.15 Goods sold to Dharam Veer 15,000 Jan.16 Goods purchased from Hem Lata 6,000 Jan. 17 Goods returned by Dharam Veer 600 Jan.18 Cash paid by Dharam Veer 14,100 Discount allowed 300 Jan.19 Goods returned to Hem Lata 600 Jan.20 Cash paid to Hem Lata 4,500 Discount received 150 Jan.23 Old newspapers sold to Narender on credit 75 Jan.24 Paid for interest 300 Jan.30 Paid for salaries 1,500 Jan. 30 Deposited with bank 75,000 Record the following transactions of Shri Bala ji in proper books and post them to ledger and draw out a trial balance. 2017 April 1 Assets : Cash in hand –` 1,000; Cash at bank –` 1,500; Luxmi ` 4,000, Sita Ram –2,500; Furniture 5,000; Building–` 40,000; Stock –` 40,500. Liabilities : Sundry Creditors : Atma Ram & Sons –` 2,300; Giani General Stores –` 4,500. April 2 Cash sales 15,000 April 4 Employed Munnabhai, sales supervisor and received from him security deposit 25,000 April 5 Purchased goods from Bhima 50,000 April 7 Sold goods to Tina 20,000 April 8 Luxmi Cleared her account less 5% discount April 10 Payment made to Atma Ram & Sons less discount 8% in full settlement April 12 Cash sales 22,000 April 15 Sita Ram clears his account April 18 Sale of old newspapers 150 6.50 Financial Accounting: Concepts and Applications April 20 April 22 April 24 April 25 April 25 April 26 April 27 April 27 April 28 April 28 April 29 April 30 Sold goods to Bihari Lal 11,000 Bought goods from Giani General Stores 22,000 Bought stationery 250 Paid Giani General Stores and availed a discount of 5% 20,000 Returned defective goods to Giani General Stores 500 Sold goods to Nidhi 15,000 Paid rent to Anand Sharma, the landlord 500 One old typewriter fully depreciated sold for 550 Paid insurance premium 450 Repairs to building 750 Cash sales 45,000 Paid Bhima 30,000 Discount received 1,500 April 30 Sales Returns from Nidhi 2,000 April 30 Paid school fees of Balaji’ daughter Ratna 1,500 April 30 Paid sales tax 2,500 61. On April 1, 2017, the account books of Shri Ratan Lal Arora disclosed the following position : Bank ` 12,000; Cash ` 2,000; Stock of goods ` 6,000; Debtors : Ashok ` 600, Baldev ` 1,500; Creditors : Jagdish ` 4,000. His transactions for the month of April were as under : ` 1 Bought goods for cash. 420 2 Sold goods to Ashok. 1,620 3 Bought from Jagdish. 512 3 Received cheque from Ashok for ` 1,600, allowed him discount. 100 3 Paid cash to Jagdish deducting discount ` 10. 200 3 Cash sales. 500 5 Paid trade expenses. 08 6 Furniture bought and paid for by cheque. 200 7 Purchased goods for cash. 380 7 Withdrew from bank. 200 8 Received commission. 44 9 Sold to Ashok. 600 10 Interest received. 20 10 Bought from Jagdish 2,200 10 Rent received from sub-tenant. 180 10 Paid cash into bank. 300 11 Sold for cash. 1,400 12 Paid to Jagdish on account. 400 12 Cash takings. 1,200 13 Withdrew from bank. 100 14 Cartage paid in cash. 10 15 Paid to Jagdish on account by cheque. 200 16 Bought from Kishan Lal. 6,412 17 Paid rent by cheque. 380 Accounting Process : An Overview 6.51 18 19 20 20 21 22 23 24 25 26 27 28 Sold to Baldev. Paid for advertisements. Cash sales. Paid to Jagdish : Cheque ` 1,500; discount gained ` 100. Bought for cash. Sold to Ashok. Sold to Baldev. Paid into Bank. Paid cash for commission. Received by cheques from Baldev ` 4,610; discount allowed ` 80. Bought of Kishan Lal. Sold to Chander. Allowed discount to Ashok ` 68 and received cash ` 3,000. 28 Sold to Deepa. 28 Drew for personal use (cash ` 20, cheque ` 150). 28 Bought from Rizvi. 31 Discount allowed by Kishan Lal in his invoice dated 27 January. (balance paid in cash) Salaries paid. Prepare Cash Book, Sales Book, Purchases Book and the Trial Balance. 4,690 400 900 1,600 200 2,464 1,086 1,086 300 4,690 1,630 864 3,068 1,062 170 1,834 110 500 ANSWERS GUIDE 8. 20. 21. 22. 23. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. ` 9,00,112 Total of Trial Balance ` 2,35,900 Capital of Shri Ram Chander ` 61,400 Balance of Salma’s account on 31st Jan 20... ` 2,000 Balance of Raja Ram’s account as on 31st Jan 20... ` 2,000 Balance of Jaya Ram’s account as on 31st Jan 20... ` 2,000 Balance in Purchases Account ` 19,900 Balance of Madhvi’s Account ` 9,000 (i) Cash Book; (ii) General Journal; (iii) Cash Book; (iv) Purchase Book; (v) Cash Book; (iv) Sales Book; (vii) Cash Book and General Journal (viii) Purchase Returns Book; (ix) Cash Book; (x) General Journal. Balance of Cash Book on 31st Jan, 2017 ` 25,000. Balance of Cash Book on 28th Feb., 2017 ` 3,665. Balance of Cash Book ` 95,025. Balance of Cash Book: Cash Balance ` 3,150; Balance with SBI ` 5,000; Balance with BOI ` 6,347 Balance of Cash Book: Cash Balance ` 1,175; Bank Balance ` 5,040 (Cr.); Balance of Cash Book: Cash Balance ` 9,654; Bank Balance ` 19,370 Cash Balance ` 135; Bank Balance ` 612 (Cr.) Cash Balance ` 270; Bank Balance ` 200 Cash Balance ` 2,290; Bank Balance ` 8,440 Cash Balance ` 1,100; Bank Balance ` 3,150 Cash Balance ` 2,000; Bank Balance ` 7,000 (Cr.) Cash Balance ` 1,710; Bank Balance ` 9,630 Cash Balance ` 13,390; Bank Balance ` 2,825 6.52 Financial Accounting: Concepts and Applications 41. 42. 43. 44. 45. 46. 47. 48. Cash Balance ` 7,870; Bank Balance ` 12,150 Balance ` 81.50 Balance ` 258 Balance ` 1,450; Imprest Cash received ` 1,050 Balance ` 130; Imprest Cash received ` 2,870 ` 17,000 ` 689 Purchases Book ` 6,200; Purchases Returns Book ` 480 Sales Book ` 6,450; Sales Return Book ` 300. ` 38,200 ` 21,820 Purchases Book ` 24,052; Sales Book ` 10,720 Cash Book Balances: Cash ` 438; Bank ` 14,000; Sales Book ` 430; Sales Return Book ` 140; Purchases Book ` 2070; Purchases Return Book ` 330 ` 17,65,800 ` 50,100 2,40,400 3,09,300 1,67,190 2,40,000 Purchases Book ` 18,000; Purchases Return Book ` 1,200; Cash Book : Cash Balance ` 9,000; Bank Balance ` 75,000; Sales Book ` 30,000; Sales Return Book ` 3,600; Trial Balance ` 1,28,475 Shri Balaji Capital ` 87,700; Cash Book: Cash Balance ` 56,934; Bank Balance ` 1,500; Trial Balance ` 2,68,084 Trial Balance ` 47,512; Cash Book: Cash Balance ` 3,810; Bank Balance ` 16,866 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 7 Ca pita la ndRe ve nueI te ms CAPITAL EXPENDITURES Capital expenditure is money spent on the purchase of permanent or fixed assets for use in the business for long period and not for immediate resale or on the permanent improvement of or addition to or extension of an existing asset with a view to increase the earning capacity of the business enterprise. Examples of capital expenditures fall into four groups : (i) Tangible fixed assets such as plant and machinery, land, building, furniture, fixtures and fittings, motor vehicles, office equipments (e.g., typewriters, calculating machines, computers). Legal expenses paid in connection with the purchase of property (e.g., registration charges), and expenses of delivering or installing fixed assets like machinery are included in the cost of fixed assets. (ii) Intangible fixed assets like goodwill, trade marks, patents, copyrights etc. (iii) Investment in shares and debentures of other companies for a long period. (iv) Cost of financing a fixed asset (i.e., interest paid on loans to purchase a fixed asset) is added to its cost only for the period up to the time or before the asset is put to use. REVENUE EXPENDITURES Revenue expenditure is money spent on materials and services which are used by a business enterprise in carrying out normal business activities and maintenance of fixed assets and to maintain productivity and earning capacity (and not to increases) of firms. The direct benefit of such an expenditure is available in the accounting period itself or one year at the most. Examples are : (a) The cost of finished goods or materials used in the manufacture of goods intended for resale. (b) Establishment costs, that is, rent, rates, heat, light, repairs to property etc.. (c) Administrative costs, that is, wages, salaries, telephone, postage, stationery etc.. (d) The costs of selling and distributing the goods, that is, commission, advertising, carriage outwards etc.. (e) Financial costs, that is, cash discount, interest on borrowings. (f) All expenses incurred for maintaining the efficiency or upkeep of fixed assets by means of repairs, replacement, renewable and insurance. Revenue expenditure gives benefit for the current accounting period or at the most for one year only. DISTINCTION BETWEEN CAPITAL AND REVENUE EXPENDITURES (i) Nature of spending : Capital expenditure is the amount spent on acquiring a permanent asset while revenue expenditure is incurred for carrying on business and maintaining the fixed assets efficiently. 7.2 Financial Accounting: Concepts and Applications (ii) Earning capacity : Capital expenditure increases the revenue earning capacity of the business. But revenue expenditure does not do so e.g., an expenditure incurred to increasing the seating capacity of a cinema theatre is capital expenditure since it will increase the earning capacity. The replacement of small screen with a wide screen is a revenue expenditure because it does not increase the earning capacity. (iii) Value addition : Capital expenditure may add to the value of an existing asset while the revenue expenditure will not add any value to net assets. (iv) Disclosure : Capital expenditure is shown in the balance sheet while the revenue expenditure is transferred to trading or profit and loss account. FOR YOUR ATTENTION The facts and circumstances of each case would determine the nature of the expenditure. An expenditure does not become capital because the amount involved is more. Similarly revenue expenditure does not always mean small amount. For example, repair of a factory building for ` 2,50,000 is revenue expenditure while purchase of a machine for only ` 5,000 is a capital expenditure. REVENUE EXPENDITURES BECOMING OR TO BE TREATED AS CAPITAL EXPENDITURES There are certain types of revenue expenditures which become capital expenditures depending upon the nature of the transactions as explained below : (i) Wages : Normally “wages” constitute a revenue item. But when wages are paid to a workman to install a new machine, they are added to the cost of the machine making is a capital expenditure. Similarly wages paid to workers engaged in the construction of a fixed asset such as building, bridge etc. are treated as a cost of the relevant fixed asset. (ii) Repairs : The money spent on repairs of a second hand machine amounts to capital expenditure since the repairs are necessary to put the machine to use. However repairs done later on for efficient running of the machine are treated as revenue expenditure. (iii) Legal expenses incurred in the purchase of fixed assets must be treated as part of the cost of the asset. (iv) Transportation costs incurred in moving a new machine or a second hand machine from the place of manufacturer to the business premises are added to the cost of machine or any other fixed asset. (v) Raw materials and stores consumed in the construction or making of a fixed asset are also treated as cost of the asset. (vi) Interest on capital paid during the construction works or machine or building must be treated as capital expenditures. (vii) Development expenditures : In certain enterprises such as tea, coffee, rubber plantations and colleries (mines), considerable money has to be spent on development work before production starts. All such expenditures are called development expenditures and must be treated as capital expenditures. DEFERRED REVENUE EXPENDITURES There are certain expenditures which are primarily revenue in nature but the benefit from which is not consumed in the year in which the expenditure is incurred. Such expenditures are called deferred revenue expenditures. Such expenditures are carried forward or spread over a number of accounting periods during which the business is expected to benefit from the same. Types : Deferred revenue expenditures are of following types : (i) Expenses which are wholly paid in advance and for which the benefit is received in future, e.g., prepaid insurance, prepaid salaries, prepaid rent, prepaid subscriptions and so on. (ii) Expenses which provide part of the benefit during the current accounting period itself and the Capital and Revenue Items 7.3 remaining benefit in the subsequent or future accounting periods. For example a business enterprise spends ` 2,00,000 on advertisement campaign in 2014 and its benefit is estimated to be available for five years. In this case only a proportionate amount, that is, ` 40,000 (one-fifth of ` 2,00,000) would be charged against the profits of the year 2014 and the balance will be shown as a temporary asset in the balance sheet to be written off in future accounting periods. It is termed as fictitious asset and although it is shown on the assets side of the balance sheet, it is really not an asset at all. (iii) Expenses which are incurred once a while or very rarely. Such expenses are not incurred in the normal course of business but for a special purpose. Examples are : expenses incurred on the formation of company called preliminary expenses; expenses incurred on the issue of shares and debentures; development expenditures like market research and so on. As a rule such expenses are in the nature of revenue expenditures and must be debited to the profit and loss account immediately but it is not done and they are spread over a number of years. DISTINCTION BETWEEN CAPITAL EXPENDITURE AND DEFERRED REVENUE EXPENDITURE The distinction between capital expenditure and revenue expenditure is quite difficult to make and one has to do it not on any sound reasons but rather arbitrarily: (i) The main characteristic of capital expenditure is that it results in a benefit which will accrue to the business enterprise for a long time, e.g., purchase of a machine likely to be used for say 10 years. Deferred revenue expenditure also results in a benefit which will accrue in future period but generally for 3 to 5 years. (ii) Furthermore, the capital expenditure is usually capable of being reconverted into cash though may be at a loss. This is not possible in case of deferred revenue expenditure; for instance the benefit of a heavy advertising campaign may be available for the next five years but the business enterprise cannot sell the advertising results to another firm. (iii) Sometimes heavy losses such as due to an earthquake are also treated as deferred revenue expenditure in the sense that they are written off over 3 to 4 years. Such a loss cannot be termed as capital expenditure. Example 1 Classify the following between capital and revenue giving reasons for the same : (i) ` 5,000 spent towards additions to the machinery. (ii) Repairs for ` 1,000 necessitated by negligence. (iii) ` 500 spent to remove a worn out part and replace it with a new one. (iv) ` 100 wages paid in connection with the erection of a new machinery. (v) Old machinery of book value ` 7,500 worn out, dismantled at a cost of ` 1,000 and scrap realised for ` 100. (vi) Second hand motor car purchased for ` 10,000 and spent ` 1,000 for repairs immediately. (vii) Employees State Insurance premium ` 600 paid. (viii) Insurance claim of ` 5,000 received from the insurance company for loss of goods by fire of ` 6,000. Solution : (i) Capital expenditure since it will result in an increase in the earning capacity of the business. (ii) Revenue expenditure since it is not going to improve the asset any way. (iii) Revenue expenditure since the expenditure is in the nature of repairs and maintenance. It will only maintain the existing capacity of the asset. 7.4 Financial Accounting: Concepts and Applications (iv) Capital expenditure because the amount spent is upto the point an asset is ready for use. (v) Old machinery with value of ` 7,500 less ` 100 realised on selling of scrap will be treated as revenue alongwith dismantled charges of ` 1,000. The amount realised from sale of scrap is capital receipt. (vi) Capital expenditure. Motor car purchased for ` 10,000 whether second hand or new will be treated as capital expenditure, and also the amount spent for its repairs is a capital expenditure so as to make it ready for use. (vii) Revenue expenditure since it is purely a business expenditure. (viii) Revenue expenditure i.e., ` 1,000. Example 2 Show by giving reasons whether the following items of expenditure are capital or revenue : (i) Damages paid on account of breach of contract to supply certain goods. (ii) Cost of pulling down an old building preparatory to building a new one. (iii) Cost of cleaning and levelling land purchased for business use. (iv) Premium paid for a lease. (v) Canal irrigation charges paid to Government. (vi) A Tractor standing in the books at ` 15,000 was sold for ` 30,000. (vii) ` 5,00,000 received from an issue of further shares, the expenses of issue being ` 5,000. Solution : (i) Damages paid on account of the breach of contract to supply certain goods are revenue expenditures incurred in the ordinary course of business. (ii) The cost of pulling down an old building preparatory to building a new one is capital expenditure as it is a part of the cost of the new building. (iii) The cost of cleaning and levelling land purchased for business use is capital expenditure as it has been incurred for making the land ready for use. (iv) Capital expenditure since leasehold property is a fixed asset. (v) Revenue expenditure as it represents the cost of cultivation. (vi) ` 30,000 received from the sale of a Tractor is a capital receipt, and ` 15,000 is a capital profit as it results from the sale of a fixed asset. (vii) ` 5,00,000 is a capital receipt and ` 5,000 being the cost of issue is a deferred revenue expenditure because no asset is created. Example 3 State with reasons whether the following expenditures of a limited company are capital or revenue : (a) Legal expenses incurred in raising a debenture loan. (b) Legal expenses incurred in an action for infringement of its trade mark. (c) Legal expenses incurred in purchasing landed property. (d) Legal expenses incurred in defending a suit for breach of contract to supply goods. (e) Legal expenses incurred in an income tax appeal. Solution : (a) Capital expenditure because the expenses have been incurred for obtaining capital of the business. More appropriately deferred revenue expenditure because no asset is created. Capital and Revenue Items 7.5 (b) Revenue expenditure, as they have been incurred for maintaining a fixed asset. (c) Capital expenditure as they constitute the cost of fixed asset. (d) Revenue expenditure, as the expenses have been incurred for carrying on the business. (e) Revenue expenditure since the expenses are incurred to carry on the business. CAPITAL AND REVENUE RECEIPTS Capital receipts are contributions into the business by the proprietor, partners or shareholders (in the case of a joint stock company) towards the capital of the firm. And also any sums received from debentureholders, any loans and the proceeds of sale of any fixed assets of a business enterprise (not being in the nature of a normal sale). Revenue receipts or incomes are the moneys received from firm's activity in the normal course of business such as sales revenue, commissions and fees received for services rendered, interest on any investment, discounts received etc.. The following guidelines are helpful in deciding about capital or revenue receipt : (a) The nature of the receipt is to be decided from the point of the person receiving it and not the source by which the payment was made. For example, the payment of interest out of capital by a company, when it is yet to commence its business is a capital expenditure for the company but it is a revenue receipt for the person (Shareholder) receiving it. (b) The intention of the owner of the property is also material in deciding the nature of the receipt especially in a single transaction. For example, the receipt from the sale of securities (e.g., shares) held on as investment is a capital receipt but if the securities are held for speculative purpose, the sale proceed constitutes revenue receipt. (c) Sale of fixed assets like machinery, building or furniture is a capital receipt while the sale of inventories is a revenue receipt. (d) A receipt in lieu of source of income is capital receipt, e.g., compensation received on death or permanent disability because such receipt is a substitution of source of income. (e) When a sum is received for the surrender of certain right, it is a capital receipt e.g., compensation paid by Municipal Corporation on acquisition of agricultural land for the construction of roads or bridges. It is capital receipt since it is in lieu of the right to work on the farm. But where the sum received is in the nature of compensation for the loss of future profit, it is a revenue receipt. CAPITALISED EXPENDITURE Where an expenditure is incurred as an important part of an asset such as in the construction or installation of an asset or expenditure is required to increase the earning capacity, such expenditures are treated as part of the asset and are added to the cost of the asset. This process is called capitalisation of the expenditure. Some of the examples of capitalised expenditure may be noted as : (i) Expenses on the formation of a joint stock company. (ii) Cost of issuing shares and debentures such as legal expenses, underwriting commission etc. (iii) Expenses on installation of assets. Thus, capitalised expenditures are added to the cost of fixed assets to increase its total cost. 7.6 Financial Accounting: Concepts and Applications Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. Distinguish between Capital and Revenue Expenditures, giving examples of each. [B.Com. (Hons.) Delhi 2002, 2004, 2009] Explain the concept of deferred revenue expenditures by giving suitable examples. How is it different from capital expenditures? Explain the concept of Deferred Revenue Expenditure by giving suitable examples. How is it different form capital expenditure ? [B.Com. (Hons.) Delhi 2014] PRACTICAL ASSIGNMENTS 1. Ms. Gopika, an accountant seeks your help on the classification of following transactions : (i) ` 20,000 received from parents on birthday (Parents give gift every year) (ii) One of the tenants who was paying only a nominal rent of ` 50 per month was tempted to vacate by giving ` 1,00,000 as compensation. New tenant was immediately taken at ` 1,000 rent per month. The compensation was for the cost of furniture etc. incurred by the old tenant (iii) Imported goods worth ` 2,00,000 confiscated by customs authorities for contraventions of law. (iv) Cost of improving the seating capacity of a cinema hall. (v) Heavy legal expenses incurred by Times of India newspaper to defend defamation case. 2. State giving reasons whether the following items are to be considered as capital, revenue or deferred revenue : (i) Cost of acquisition of a copyright and brand mane (ii) Cost of designing a new jewellery product which ultimately could not be produced on commercial basis (iii) Cost of alteration of a commercial building in accordance with the Master Plan issued by a State Government. (iv) Replacement of a wooden ceiling with a guarantee of 15 years (v) Replacement of an open tempo body with a closed refrigerated body. (vi) Contribution paid to Municipal Corporation for road development in the surrounding areas. 3. State with reasons whether you would classify the following items as capital or revenue or deferred revenue : (i) Carriage inward and freight for bringing the furniture from the dealer. (ii) Expenditure incurred to provide an additional Exit to a PVR cinema on instructions from Municipal Corporation of Delhi. (iii) Compensation received from the Delhi Metro Rail Corporation for compulsory acquisition of land for construction of railway station. (iv) Compensation of ` 2,50,000 paid for termination of service indulging in illegal union activities (v) Expenditure incurred on five MBA students for learning in new marketing techniques in China. Expenditure includes their lodging boarding, travelling and training expenses. (vi) Amount received from a relative staying in Germany. (vii) Travelling expenses of a business executive for going to Japan to Purchase a new machinery Capital and Revenue Items 7.7 4. Would you consider the following items chargeable to capital expenditure or revenue? (i) Premium given for a lease (ii) Costs attending a mortgage. (iii) Commission on issue of debentures. (v) Accrued dividend or interest included in the cost price of an investment. 5. The Swan Industries Ltd. removed their factory to a more suitable premises and given below are some of their transactions : (a) A sum of ` 4,750 was expended on dismantling, removing and reinstalling Plant, Machinery and Fixtures. (b) The removal of stock of the old factory to the new, cost ` 500. (c) Plant and Machinery which stood in the books at ` 75,000 included a machine at a book value of ` 1,500. This being obsolete was sold off at ` 500 and was replaced by a new machine costing ` 2,400. (d) The freight and carriage on new machine amounted to ` 150 and erection charges cost ` 275. (e) A sum of ` 1,200 was spent on painting the new Factory. State which items of expenditure would be charged to capital and which to revenue. 6. A newly set up manufacturing concern had incurred various types of expenses during the construction period e.g., (i) Travelling expenses of a director for trip abroad for purchasing capital goods. (ii) Salaries and wages paid to non-technical staff. (iii) Salaries and wages paid to technical staff for erection of machineries. (iv) Miscellaneous expenses such as rent, stationery, postage and telegram etc. 7. State with reasons whether the following are Capital or Revenue Expenditures: (i) Freight and cartage on the new machine ` 150 and eviction charges ` 200. (ii) Fixtures of the book value of ` 1,500 was sold off at ` 600 and new fixtures of the value of ` 1,000 was acquired, cartage on purchase ` 50. (iii) A sum of ` 100 was spent on painting the factory. (iv) ` 5,150 spent on repairs before using a second hand car purchased recently to put it in usable condition. 8. State the nature (capital or revenue) of the following expenditures which were incurred by M/s. Surya Brothers during the year ending 31 Mach 2008 : (i) ` 2,050 were spent on reparing a second hand machine which was purchased on 8 April, 2007 and ` 500 were paid on carriage and freight in connection with its acquisition. (ii) Sum of ` 30,000 was paid as compensation to the two employees who were retrenched. (iii) ` 650 were paid in connection with carriage on goods purchased. (iv) ` 10,000 customs duty paid on import of a machinery for modernisation of the factory production during the current year and ` 5,000 paid on import duty for purchase of raw materials. (v) ` 15,000 interest had accrued during the current year on term loans obtained and utilised for the construction of factory building and purchase of machineries; however production has not commenced till the last date of the accounting year. 9. State with reason whether the following items are to be considered as capital or revenue expenditure : (i) A sum of ` 2,50,000 is incurred in remodelling a showroom resulting in the increase of the value of the show room by ` 1,75,000. (ii) The cost of removing a machine from old factory to the new one amounts to ` 25,000. (iii) A sum of ` 5,00,000 spent on research and development results in the increased utility of a certain brand of refrigerator. 7.8 Financial Accounting: Concepts and Applications (iv) Expenses incurred on research work for the promotion of a ‘X’ brand of detergent washing powder does not produce any fruitful results. (v) Cost of conversion of gas plant to oil fuel plant for generation of electricity amounted to ` 1,50,000. (vi) Compensation paid to a retrenched employee for loss of employment ` 55,000. 10. State with Reasons, how would you classify the following expenditure : (i) Overhauling expenses of ` 25,000 for the engine of a Motor Car to get better fuel efficiency. (ii) Inauguration expenses of ` 25 lakhs incurred on the opening of a new manufacturing unit in an existing business. (iii) Compensation of ` 2.5 crores paid to workers who opted for voluntary retirement. ANSWERS GUIDE 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (i) Capital receipt (ii) Capital receipt (iii) Revenue expenditure (iv) Capital expenditure (v) Revenue expenditure. (i) Capital Expenditure (ii) Defeered Revenue Expenditure (iii) Revenue Expenditure (iv) Revenue Expenditure (v) Capital Expenditure (vi) Revenue Expenditure (i) Capital expenditure (ii) Revenue expenditure (iii) Capital receipt (iv) Revenue expenditure (v) Capital Expenditure (vi) Capital receipt (vii) Capital expenditure (i) Capital (ii) Capital (iii) Capital (iv) Revenue Capital Expenditure : (a), (c), (d); Revenue Expenditure : (b), (e). (i) Capital (ii) Capital (iii) Capital (iv) May be Capitalised. (i) Capital (ii) Loss of ` 900 being revenue expenses and ` 1,050 capital expenditure (iii) Revenue and (iv) Capital Capital expenditure—(i), (iv)—import duty on Machinery, (v) Revenue expenditure—(ii), (iii), (iv)— import duty on raw materials. Capital expenditure—(iii) Revenue expenditure—(i), (ii), (iv), (v), (vi). (i) Capital Expenditure (ii) Revenue Expenditure (iii) Revenue Expenditure. 8 Fina lAccounts ofNonCorpora teEntitie s The term final accounts is used to include a package of accounts such as : (i) trading account, (ii) profit and loss account and, (iii) a balance sheet. Although balance sheet is not an account but only a statement, it is treated as a part of final accounts for all practical purposes. TRADING ACCOUNT Trading Account is prepared to know whether the firm has made gross profit or suffered gross loss. Gross profit or gross margin is the excess of net sales revenue over cost of goods sold, that is : Gross Profit = Net Sales Revenues–Cost of goods Sold; where : Net Sales Revenues = Cash Sales plus Credit Sales minus Sales Returns (Returns Inwards). Goods sent on sale or approval are not part of sales until approval is received. Cost of Goods Sold = Opening Stock + Net Purchases – Stock at the end + Direct Expenses. Net purchases = Cash Purchases + Credit Purchases – Purchases Returns (Returns Outwards). Cost of the goods available for sale = Opening stock plus net purchases minus stock at the end. Goods received on consignment basis are never treated as purchases. Similarly, goods received on sale or return basis are never treated as purchases. Reason: Trading account is prepared before the preparation of profit and loss account for the following reasons : (i) It shows the result of trading activities relating to purchases and sales of goods and services; (ii) It enables to compare the position of opening stock with the closing stock; (iii) It is possible to justify the value of purchases made and the direct expenses incurred during the accounting period; (iv) It is possible to make comparative study of purchases, sales and direct expenses for different years; (v) It will be possible to calculate different accounting ratios such as gross profit ratio, stock turnover ratio and so on; (vi) It helps in the calculation of gross profit so that the management can find out the scope of absorbing the indirect expenses. DIRECT EXPENSES ON GOODS Direct expenses are all those expenses incurred in bringing the goods to the place of business or trade until the goods are placed in a saleable position. The direct expenses may include : (i) railway freight, or lorry freight, (ii) carriage or carriage inward or carriage on purchases, (iii) transit-insurance, (iv) packing and forwarding expenses by vendor, (v) excise duty. 8.2 Financial Accounting: Concepts and Applications A trader who imports goods, the direct expenses will cover: (i) packing and forwarding charges by the exporters, (ii) export duty if any, (iii) loading charges, (iv) import duty, (v) shipping or air freight, (vi) marine insurance, (vii) custom duty, (viii) clearing charges, (ix) carriage from the docks to the trader's place of business, (x) octroi, (xi) dock dues. A manufacturer incurs, in addition to these, manufacturing costs such as : (i) wages and salaries, (ii) factory rent, (iii) factory insurance, (iv) factory heating, (v) foreman and supervisor's salary, (vi) factory maintenance and cleaning, (vii) fuel, coal, gas and water, (viii) power, (ix) factory lighting, (x) royalty on production. The trading account is debited with : (a) opening stock, (b) net purchases, and (c) direct expenses and credited with : (a) net sales and (b) stock at the end. Closing stock : It is generally given at the foot of trial balance. But if it is given in the trial balance, it will not be shown in the credit side of the trading account because it is already deducted from the net purchases. It means purchases have already been adjusted. Hence, it will be shown only in the assets side of the balance sheet. Gross Profit : When the credit side of the trading account exceeds the debit side, the difference is gross profit. Gross loss : When the debit side exceeds the credit side, the difference is gross loss. Gross profit or gross loss is transferred to the profit and loss account. Final Accounts of Non-Corporate Entities 8.3 (Pro-Forma) Trading Account For the Year Ending on (Closing Date of Accounting Period) Dr. Cr. ` Particulars Opening stock : ---------- Raw Materials Particular ` Sales Less : Sales Returns or Work in progress Returns Inwards Finished goods Stock at the end or Closing stock : Purchases ---------- Raw materials Less: Purchase Returns or Returns outwards work in progress Finished goods Expenses incurred in acquiring and bringing Profit and Loss Account goods purchased to the business premises : (Gross Loss) Freight cartage ATTENTION PLEASE carriage or carriage inwards or carriage on purchase Import Duty Clearing Charges (i) (ii) If the credit side total amount exceeds debit side total amount there is a gross profit If debit side total amount exceeds Dock Dues the credit side total amount, Excise Duty there is gross loss Octroi The words ‘To’ and ‘By’ in the debit and credit sides respectively are not Factory expenes : Lighting, heating, rent and rates insurance of factory used these days. (iii) There can be either gross profit or Fuel (coke, coal wood etc) gross loss and not both in one Wages (Direct or productive or manufacturing) trading account Motive power, Gas, electricity in factory Consumption of stores (engine oil, soft soap, cotton waste etc.) Royality on production Profit and Loss Account (Gross profit) PROFIT AND LOSS ACCOUNT After the calculation of the gross profit or gross loss, the next step is to prepare the profit and loss account to determine or find out the amount of net profit of the business enterprise. Profit and loss account whether prepared separately or along with Trading Account is an account which shows the net profit or loss of a business entity for a given or particular accounting period. The net profit or net loss is the profit earned or loss suffered after deducting or adding, as the case may be, the indirect business expenses, namely: administrative, maintenance, (Repairs and Depreciation) selling and distribution, financial and miscellaneous expenses, if any, from the gross profit. It is the ultimate or final profit or loss of a business firm. 8.4 Financial Accounting: Concepts and Applications PREPARATION OF PROFIT AND LOSS ACCOUNT In order to prepare the profit and loss account, gross profit or gross loss, as calculated in the trading account, is transferred to the profit and loss account. If there is a gross profit, it is entered or written as the first item on the credit side of profit and loss account. Other items of non-trading income such as rent receivable, interest on investments, discount received, commission received, bad debts recovered and even the profit on sale of fixed assets are also entered on the credit side of the profit and loss account. If there is a gross loss transferred or brought forward from trading account, the profit and loss account begins with gross loss as the first item on the debit side. Other items on the debit side include indirect or running revenue expenses of the business such as establishment or office expenses, selling and distribution expenses and financial expenses not entered in the trading account. After all the items of incomes and expenses are entered, the profit and loss account is balanced. If the total amount on the credit side of the profit and loss account exceeds the total amount of the debit side, the balance or difference is called net profit. But if the total amount on the debit side exceeds the total amount on the credit side the balance or difference is net loss. The net profit is transferred to the credit side of the capital account of the owner while the net loss is transferred to the debit side of the capital account of the owner. In this manner the profit and loss account is closed. Now profit is added to the amount of capital and it thus, increases the capital in the balance sheet. Net loss is deducted from the amount of capital and hence, decreases the capital in the balance sheet. A summary of the foregoing procedure in respect of Profit and Loss Account is given as under : Profit and loss account is credited with: (i) Gross profit (ii) Indirect incomes such as rent receivable, commission receivable, interest on drawings and other interest receivable, discount earned or received, bad debts recovered etc., Profit and loss account is debited with: (a) Gross Loss, if any (b) Establishment Expenses: like rent, rates and taxes, office lighting and heating etc., general insurance. (c) Administrative Expenses: like salaries, insurance, printing and stationery, postage and telegram, telephone and fax charges, audit fees, legal expense etc.. (d) Selling and Distribution Expenses : such as advertisements, travelling expenses, carriage and freight outwards or rates, commission paid, bad debts etc.. (e) Maintenance Expenses : such as repairs, depreciation of fixed assets. (f) Financial expenses such as cash discount allowed, interest on loan taken, interest on capital etc.. (g) Miscellaneous expenses. (PRO-FORMA) PROFIT AND LOSS ACCOUNT For the Year Ended (Closing Date of the Accounting Period) Dr. Particulars Trading Account (Gross Loss, if any) Cr. ` Particulars Trading Account Rent and Rates (Gross Profit, if any) Lighting and Heating Incidental Income or Gains Office Salaries Rebates Office Salaries and Wages Cash Discount Received Office Insurance Commission Received ` Final Accounts of Non-Corporate Entities 8.5 Sundry Expenses or Bank Interest Received General Expenses Interest or Dividends on Printing and Stationery Investments Repairs and Renewals Rent Received Telephone and Fax Expenses Gain on the Sale of Accountancy Fees Fixed Assets, Investments etc. Legal Charges Bad Debts Recovered Audit Fees Special Bonuses Received Staff Bonuses from Suppliers Bank Charges and Commission Provision or Reserve for Interest Paid (on mortgage loan, or bank loan) Discount on Creditors Motor Expenses Capital Account Advertising (Transfer of net loss, if any.) Traveller's Salaries and Commission Cash Discount Allowed Bad Debts Free Samples Loss on Sale of Fixed Assets Brokerage Carriage Outward Warehouse Rent Warehouse Insurance Delivery Van Expenses Packing Expenses Depreciation on Different Assets Provision or Reserve for Bad and Doubtful Debts; Provision or Reserve for Discount on Debtors; Any other provisions for Expenses e.g., Loss by fire Interest on loan; Cost of discounting the bill Capital Account (Transfer of net profit, if any) The words ‘To’ and ‘By’ in the debit and credit sides respectively are generally not used these days. DIFFERENCE BETWEEN OUTSTANDING INCOME AND ACCRUED INCOME Both these terms refer to the income receivable or income earned but not received by the business entity and are added to income when accounts are finalised on accrual basis. Outstanding income means that amount of income which is due and receivable but not yet received. There is a legal right to receive it immediately from the other party. Accrued income means that amount which has been earned but not yet due. The accrued income is calculated on day-do-day basis and there is no legal right to force the other party to pay it immediately. Suppose a firm has invested ` 50,000 in 12% Debentures on 1 January 2012. Interest is payable half yearly on 30 June and 31 December respectively. The firm closes its books on 31 March. Now if the interest has not been paid by the company for the half year ending on 31 December even on 31 March, 2013, it is a case of outstanding interest. But interest for three months—from 1 January to 31 March 2013—is accrued in the sense that it is simply earned but not due or receivable. 8.6 Financial Accounting: Concepts and Applications MEANING OF OPERATING PROFIT It is described as the excess of gross profit over operating expenses. Operating expenses are incurred for carrying on business activities. Examples of operating expenses are : rent of the building, repairs to the machinery, electricity bill, salaries to the office staff, salesmen's commission and the like. The main criterion in the calculation of operating profit is that the revenues are earned from and expenses are incurred on the normal business activities involving sale and purchase of goods in which the business enterprise engages itself. Obviously the operating profit will not include the profit resulting from the sale of fixed assets, interest on investments etc., since these are not a part of normal business activities. Operating loss occurs when operating expenses exceed the gross profit. MEANING OF NON-OPERATING PROFIT Non-operating profit results from sources other than the normal activities of the business enterprise. When a trading concern gets rent from a piece of vacant land owned by it, it would be treated as a non-operating profit. Similarly dividends or interest or both received on investments or interest on fixed deposit account with bank or profit on the sale of fixed assets are all non-operating profits because they accrue to the business enterprise not from normal activities which are but incidental to its main or normal activities. It is relevant to state that non-operating expenses or deductions which are incidental to the main activities of the business enterprise include the interest paid on the borrowings. In practice the non-operating profit is adjusted against non-operating expenses or losses (i.e., loss on the sale of fixed assets). However, there is no restriction if they are shown separately. CONSIDERATION OF SOME INDIVIDUAL ITEMS The following are some of the individual items which must be kept in mind while preparing Trading and Profit and Loss Account : Stock : Opening and closing balances of stocks should be included in the trading account on the debit side and credit side respectively. In case the closing stock is given in the trial balance, it must not be transferred to the credit side of the trading account; it will then be shown in the assets side of the balance sheet only. Purchases and purchases returns : Purchases and purchases returns balances need not be shown separately in the trading account. Instead purchases returns should be deducted from purchases and only the net amount should be shown in the debit side of the trading account. In addition, the following points should be noted in respect of purchases : (i) Purchases of fixed assets such as machinery, building, furniture, land etc. should not be included. And if such items are wrongly included in purchases, the same must be deducted. (ii) If the goods have been purchased for personal use of the proprietor and are included in the purchases, the same must be deducted from the purchases. (iii) Goods received on approval or on consignment basis should be excluded from purchases, if they are included in the purchases. Adjusted Purchases: When closing stock is given in the trial balance, it means closing stock is already deducted from the purchases or the purchases are adjusted. In such a case, as mentioned above, closing stock is not shown in the credit side of the trading account; it will then be shown in the assets side of the balance sheet only. Sales and sales returns : From the total sales of goods should be deducted sales returns and only net sales should be shown in the credit side of the trading account. Goods sold on approval basis should not be included in sales. They should be shown in the balance sheet as part of the closing stock at their cost price. And if the goods sold on approval are included in the sales and approval has not been received in the Final Accounts of Non-Corporate Entities 8.7 current accounting period, the same must be deducted from the sales as well as from debtors on the other hand. The same must be adjusted by adding in closing stock at their cost price in Trading Account as well as in Balance Sheet. Carriage, carriage on purchases and carriage inward : These are transportation expenses incurred on purchases of goods and are debited to trading account. Carriage outward or on sales however, should be included in the profit and loss account. Freight : Freight paid on the purchase of goods is a direct expense and therefore, should be included in the trading account. Freight paid on any asset like furniture, plant and machinery etc., must be debited to the relevant asset account itself. Dock dues and clearing charges : These are paid on goods imported from foreign countries. These are direct expenses and should be debited to trading account. Duties paid on exports and forwarding charges should be included in the profit and loss account. Work-in-progress: This item represents partly finished goods. Its opening balance should be debited to trading account and the balance at end is first credited to trading account and then shown on the assets side of the balance sheet. Royalties : These are payments for acquiring the right to use patents in the production process. Royalties on the production basis should be debited to trading account if there is no separate manufacturing account e.g., production of coal or medicines; otherwise they are debited to profit and loss account e.g., royalties on the sale of books. Motive power (or factory power): This item includes gas, electricity or water power used to operate the machines and therefore, should be debited to trading account. Fuel (coal, coke, wood etc.) and power: These items form part of manufacturing expenses and therefore, should be debited to trading or manufacturing account, as the case may be. Office lighting : It refers to lighting charges incurred in providing light in the office. It should be entered in the debit side of the profit and loss account. Lighting : This item means office lighting and should be entered in the debit side of profit and loss account. Office heating : Enter in the debit side of profit and loss account. Heating : It is presumed to be factory heating and so enter in the debit side of the trading account. Repairs and renewals : It is a maintenance expense and should be entered in the debit side of profit and loss account. Stores : These include engine oil, soft soap, cotton waste etc. The quantity actually consumed should be debited to trading account and the unused portion is shown as an asset in the balance sheet. Turnover : This term is used to denote total sales, generally total annual sales of the firm. Trade discount : It is never shown as a separate item in the trading account. Trade discount allowed on sales is deducted from the amount of sales and that relating to purchases should be deducted from purchases. Wages /wages and salaries : If this item appears in the trial balance simply as wages without being specifically mentioned as productive or unproductive, it should be presumed to be productive and transferred to trading account. But when this item is combined with any other unproductive items like salaries, the treatment would be as follows : (i) the combined item of wages and salaries would be debited to trading account, (ii) the combined item of salaries and wages would be debited to profit and loss account. However, if there is no production activity (i.e., the absence of plant and machinery item in the examination problem), the distinction is meaningless and the item wages and salaries will be debited to profit and loss account. 8.8 Financial Accounting: Concepts and Applications Income tax : Advance payment of income tax is not related to business and represents a personal expense of the proprietor and is therefore, added to his Drawings Account. Loose tools : Its opening balance is given in the trial balance while balance at the end is indicated in the form of an adjustment. Thus, the difference between the value of loose tools in the beginning and its value at the end of the period represents the used part and should be written off as loss on revaluation (loose tools consumed) in the debit side of the profit and loss account. Octroi : It means a toll or tax levied at the gate of a city on articles brought in from other cities. As it is a tax on purchases, it is direct expense and so debited to trading account. Packing charges or packing materials : When the goods cannot be sold without a proper packing or container, such packing or container forms part of the finished product. For example, fruit juice cannot be sold without packing or ink without bottle. These types of packings constitute direct expenses and thus, charged to trading account. But if the packing expenses are incurred to make the goods more attractive (i.e. fancy packing) for sale or dispatch to customers, such expenses are charged to profit and loss account. Unused stock of packing material is an asset. Duty on purchases : Any duty paid on the purchases is a direct expense and so debited to trading account. Charity : Charity is something given in kind or cash for helping others or for a cause. It is an indirect expenditure and charged to profit and loss account irrespective of the amount or purpose of charity. Life insurance premium is paid on the life policy of the owner(s) and should be charged to the drawings account. Employee's insurance scheme : Any contribution made by the proprietor is a part of the salary of the employee and hence, is to be debited to profit and loss account. Bonus in kind and cash is added to the salaries account to be ultimately charged to profit and loss account. Interest on capital: It means interest allowed to the owner on his capital invested in the business. It is a financial expense and should be debited to the profit and loss account of a sole trader. In a partnership firm it is debited to profit and loss appropriation account. Interest on drawings: It means interest charged on the amount withdrawn by the owner in cash or kind, from the business. It is an income to the business and so it is entered in the credit side of the profit and loss account of the sole trader. In a partnership firm, it is entered in the credit side of profit and loss appropriation account. Trade expenses: It means general expenses and should be debited to profit and loss account. MANUFACTURING ACCOUNT Many business entities engage in manufacturing activities and this involves the purchasing of raw materials and incurring labour and other costs in converting the raw materials into finished goods. For this purpose, a manufacturing account is prepared in order to ascertain the cost of producing the goods. This account is also normally prepared at the end of the accounting period. Both direct and indirect expenses associated with the manufacturing process are debited to the manufacturing account. The balance of this account representing cost of the goods produced is then transferred to the Trading Account. The order of presentation of the final accounts is as under : (a) Manufacturing Account (b) Trading Account (c) Profit and Loss Account (d) Profit and Loss Appropriation Account (in a partnership or a limited company) (e) Balance Sheet. Final Accounts of Non-Corporate Entities Dr. 8.9 (PRO-FORMA) MANUFACTURING ACCOUNT Direct Materials ` ` Closing Stock: Opening Stock : Raw Materials xx Work-in-progress Purchases : xx Raw materials xx Work-in-progress xx Carriage inwards xx Cr. ` Raw materials xx Work in progress xx ` xx Cost of the goods transferred to Trading Account xx xx xx Direct Labour Factory wages xx Direct Expenses Factory rent xx Fuel, power, gas etc. xx Factory insurance xx xx Depreciation on factory building etc. Manufacturing over-heads xx xx xx xx xx DIFFERENCE BETWEEN TRADING ACCOUNT AND MANUFACTURING ACCOUNT (i) Trading account is prepared to find out the gross profit (or loss) while manufacturing account shows the cost of the goods produced. (ii) When trading and manufacturing accounts are prepared separately, manufacturing account deals with the raw materials, and work-in-progress while the trading account would deal with finished goods only. Illustration 1 (Manufacturing account) The following were some of the ledger balances in books of Shalu and Company on 31 March 2020. ` Particulars Particulars ` Provision for depreciation: Work-in-progress 34,000 Leasehold building 12,000 Plant and machinery 28,700 31,600 Fixtures and fittings 2,800 Repair to building 4,800 23,000 Carriage outwards 7,300 15,000 Materials purchases Stock of finished goods on 1.4.2019 Raw materials stock on 1 April 2019 Bank overdraft Direct wages 1,10,000 Factory rates 7,900 Sales Leasehold buildings at cost Factory Power 4,78,000 60,000 1,25,300 Direct fees 3,500 Returns inwards 2,000 Carriage inwards Replacement costs of fixed assets 6,800 15,000 9,900 Plant and machinery at cost 75,200 Indirect wages 97,300 Additional Information: (i) The factory buildings are held on a 30 years lease. (ii) Stocks on 31 March 2020 were : Raw materials—` 26,000; Work-in-progress ` 36,000; Finished goods— ` 29,000. 8.10 Financial Accounting: Concepts and Applications (iii) Depreciate plant and machinery at 12-1/2% using the straight line method and fixtures and fittings at 10% using written down value method. (iv) The factory production was charged to finished goods at cost. Prepare a manufacturing account for the year ending on 31 March 2020. Solution : Shalu Manufacturing Account For The Year Ended 31 March 2020 ` Stock (1.4.2019) : ` Stock at the end (31.3.2020) Raw materials 23,000 Work-in-progress 34,000 Purchases 57,000 1,25,300 Carriage inwards 6,800 Direct wages Raw materials 26,000 Work-in-progress 36,000 62,000 Cost of goods transferred to Trading Account 3,68,400 1,10,000 Manufacturing overheads : Building repairs Factory rates Factory power Indirect wages Depreciation on : Factory building Plant and machinery 4,800 7,900 9,900 97,300 2,000 9,400 1,31,300 4,30,400 4,30,400 BALANCE SHEET The profit and loss account or trading and profit & loss account shows only the net profit or loss of a business enterprise for a given accounting period. But the owner or proprietor(s) also wants to know the financial position of his business firm on the closing or last date of the accounting period. For this purpose the owner(s) or proprietor(s) prepares a statement of assets and liabilities of his firm as on the closing date of the given accounting period including his capital. This statement of assets and liabilities on the closing date of the given accounting period is known as balance sheet. A few definitions of balance sheet may be noted as under: (a) “The balance sheet is a statement at a particular date showing on one side, the trader’ property and possessions and on the other side his liabilities” (Palmer) (b) “A balance sheet is an item-wise list of assets, liabilities and proprietorship of a business at a certain date.” (Freeman) (c) “A balance sheet is a statement prepared with a view to measure the exact financial position of a business on a particular date” (J.R. Batliboi) Thus, a balance sheet is a statement of the total assets and liabilities (including capital) of the owner(s), of an organization or a business enterprise at a particular date usually the last day of the accounting period. CLASSIFICATION OF ASSETS An asset is any object or thing, tangible or intangible that is of value to its possessor. Assets are thus, all types of properties owned by a business firm and amounts of debts due to the business enterprises from other persons. Assets are generally classified as: (i) Current Assets, or Floating Assets or Circulating Assets. Final Accounts of Non-Corporate Entities 8.11 (ii) Liquid or Quick Assets. (iii) Investments. (iv) Fixed Assets (v) Tangible Fixed Assets. (vi) Intangible Fixed Asset. (vii) Wasting Fixed Assets. (viii) Fictitious Assets. (ix) Contingent Assets. Current assets : These assets consist of cash and other temporary held assets such as debtors, bills receivable, stock of goods (inventories), raw materials, prepaid expenses etc., that are reasonably expected to be converted into cash or be sold or be consumed within one year. The debtors and bills receivable are expected to be realised in cash. The stock of goods (inventories) is expected to be sold either for cash or on credit (to debtors), to be converted into cash. The raw materials or office supplies like stationery are to be consumed. Prepaid expenses are treated as current assets not because that they will be converted into cash but no current assets would be required for their purchase during the accounting period. The current assets are also known as floating assets or circulating assets which are continually being turned over. For example, in the course of business transactions cash is used to purchase goods for resale; goods are then sold for cash or on credit in the form of debtors and bills receivable which are again realised in cash and cash is again used to purchase goods for resale; goods are then sold for cash and this cycle repeats again and again in the accounting period. Whether a particular item is a current asset or not would depend upon the nature of the business or the purpose for which it is acquired. For example, furniture is a current asset for a firm of furniture and fixed asset where it is to be retained and not sold immediately. Liquid assets or quick assets and non-liquid assets : Current assets are again sub-divided into these two categories. Liquid or quick assets are in the form of cash in hand and at bank and other current assets which can be converted into cash without much loss such as Government securities, bills receivable, debtors etc. Non-liquid assets cannot be readily converted into cash and also not without much loss such as inventories. Investments: This item refers to the money invested in shares and debentures of joint stock companies and government bonds for the purpose of earning dividend and interest, as the case may be. Investments may be short-term investments or long-term investments. Short-term investments are held by the firm to make quick gains from their sale in the market. The purpose is not to retain them but to sell when their prices rise. Short-term investments may be grouped with current assets, while long-term investments are shown under the heading investments. Long-term investments : Investments in shares, debentures, bonds or even fixed deposits that will be retained for more than one year appear under the heading : investments. Also such items as land held for future expansion and not being used now in the business operations would be shown here. Fixed assets : The term fixed assets is used for long-lived or permanent assets that are acquired for use in operating or running the business rather than for resale as goods. In other words, these assets are not turned over or sold at a profit but are retained for many accounting periods. Examples are : land, building, plant and machinery, furniture etc., These assets are listed in the balance sheet not according to their liquidity but from most permanent to less permanent. Tangible fixed assets are those assets which have physical existence and are concrete items such as buildings, machines, furniture, etc.. 8.12 Financial Accounting: Concepts and Applications Intangible fixed assets are assets having no physical existence but yield or give benefit to the owners. They are non-visible and derive their value from the rights conferred upon their owner by possession. Examples are : goodwill, patents, trade marks, copyrights etc.. Wasting fixed assets are assets which are used up or consumed in the course of working e.g., mines, quarries, oil wells. Fictitious assets are not assets at all since they are not represented by any tangible possessions. They appear in the assets side simply because of a debit balance in a particular account not yet written off e.g., debit balance in the profit and loss account or advertisement suspense account etc.. Contingent assets : Contingent assets are not assets proper but come into existence upon the happening of a certain event(s) or the expiry of certain time. If that event(s) happens, the asset becomes available otherwise not e.g., sale agreement to acquire some property, hire purchase contracts, uncalled share capital of a limited company. In the absence of any legal right to the properties at that times, these properties are recognised only as contingent assets and are not entered in the accounts. Example are : tax claims, insurance claims, claims against creditors pending settlement. In practice, no reference is made to contingent assets in the balance sheet. At the most, they may form part of notes below the balance sheet. CLASSIFICATION OF LIABILITIES The term liability refers to an obligation to transfer money as a result of past transactions e.g. purchase of a fixed asset or a current asset on credit or repayment of loan or rendering of services by others. Liabilities are therefore, amounts owed by a business firm to other parties either for purchase of assets or goods on credit or services received on credit or for the loans taken. Capital is also a liability of the business firm to the owner(s) or proprietor(s). Current liabilities : Current liabilities are those debts at the balance sheet date that must be paid either immediately or within one year. Common current liabilities are : (i) Creditors (or Accounts payable) : This liability arises from the purchase of goods on credit or use of services not yet paid or money borrowed (loan from a bank) for a short period (non-trade creditors). The balance sheet simply shows the total amounts payable to trade or non-trade creditors and not the names of individual creditors. (ii) Bills payable (or Notes payable) : It is a written promise to pay money to a creditor for the purchase of goods or services used in the business or the money borrowed. (iii) Outstanding liabilities : They represent liabilities for expenses incurred but not yet paid as on the balance sheet date e.g., outstanding wages, salaries, commission, interest, taxes etc... (iv) Income received in advance (Unearned revenues) : This item of liability is to be found in the balance sheet of firms dealing in the publication of newspapers and magazines. Long-term liabilities : These liabilities are not to be paid within one year. Long-term liabilities may be classified as secured loans or unsecured loans in the balance sheet. Secured loans :When a business obtains a loan against the security of a specific fixed asset, it is secured or mortgage loan. If the payment is not made to the creditor(s) in time in accordance with the terms of mortgage, the creditor can sell the asset to satisfy his claim from the proceeds of sale and any shortage is paid to and surplus received from him. Unsecured loans do not have any asset attached to them as security. Contingent liabilities : A contingent liability arises on the happening of an unfavourable event in future. There is no actual legal obligation to pay on the date of balance sheet. (a) Contingent liability on bills discounted : If a bills receivable is discounted with the bank or endorsed to a third party, there is a contingent liability to the bank or endorsee until the bill is paid by the acceptor on the due date. (b) Contingent liability as a surety for another person : If A stands surety for B in respect of a payment of debt to C, this obligation is a contingent liability to the surety A until the payment is made by principal debtor B since A will be called upon to pay C if B does not make the payment. Final Accounts of Non-Corporate Entities 8.13 (c) Contingent liability in respect of pending law suit : A suit pending against the business enterprise is a contingent liability since the suit may be decided against it and therefore, it may become liable to pay compensation. When a contingent liability becomes a real liability on the happening of an event, it will either result in a loss or it will give an asset of equal amount in exchange. For example, when a bill of exchange endorsed or discounted is dishonoured by the acceptor, the business enterprise will have to pay the amount to the endorsee or the bank as the case may be. It becomes an actual liability on it. But after the money has been paid on behalf of the acceptor, he (the acceptor) becomes debtor of the firm for the payment of liability. However, if the acceptor does not own any property, the contingent liability will result in a loss to the business. A contingent liability must be distinguished from an estimated or disputed liability; the latter is a definite obligation but the amount is uncertain at the balance sheet date. As the contingent liability is not an actual liability it is not recorded in the balance sheet. It is simply mentioned by way of footnote or explanation to the balance sheet. CAPITAL OR OWNER(S)’ EQUITY Capital represents the amount invested by the owner(s) in the business enterprises. The capital is entered on the liabilities side of the balance sheet because the business enterprise owes this amount to the owner(s) or proprietor(s). GROUPING AND MARSHALLING The real and personal accounts in balance sheet should be arranged in such a way that anyone reading them can immediately get a true and fair view of the firm's financial position. This is achieved by Grouping and Marshalling of various items in the balance sheet. The term ‘grouping’ means putting together, under the common heading, the items of the same nature. For example, the term trade debtors should include the accounts of only debtors arising from the credit sale of goods and not from lending of money. The term ‘marshalling’ denotes the order or classes in which the assets and liabilities are stated in the balance sheet. The items in the balance sheet are generally marshalled in the following two ways : (i) in order of liquidity or according to time i.e., the assets being stated in the order in which they can be converted into cash and the liabilities in the order in which they have to be paid off—current or long-term according to whether they will be used or disposed off within one year or more than one year, or (ii) in order of permanence or according to purpose. It is generally found that a business firm has a main purpose such as producing goods or services for sale. Most of the assets are held for use in this main purpose e.g., plant, machinery, furniture. But assets may be acquired for a subsidiary purpose as well. For example, shares or debentures may be purchased for speculative purposes. In this case, a separate sub-classification may be used for shares held for investments. Although this criterion will most often affect the assets but it can affect the classification of liabilities too. The typical example is loan from a bank. Banks normally provide funds for short-term and therefore, bank loan is a shortterm liability. However, banks may grant loans to purchase property or to expand business. In such a case the bank loan would be classified as a long-term liability. ADVANTAGES OF MARSHALLING The following advantages of grouping and marshalling may be noted as under: (i) It is easy to know the financial position of the enterprises. (ii) It is helpful to know whether the fixed and long-term borrowed capital is sufficient to purchase fixed assets. (iii) It is also helpful to know the position of the current assets in relation to current liabilities. It is easy to know the amount of working capital. 8.14 Financial Accounting: Concepts and Applications (iv) It is easy to know whether the liquid assets are sufficient to pay current liabilities. METHODS OF MARSHALLING There are generally two methods of arranging assets in the balance sheet, namely; (i) In order of liquidity or reliability, and (ii) In order of permanence When the assets are arranged in order of liquidity, the assets which can be converted into cash early are listed first and the assets which cannot be easily converted to cash or realized are listed next. But when the assets are arranged in order of permanence, the most permanent assets are listed first and the assets which change their form frequently are listed next. The liabilities are also listed in two ways: (i) In order of priority or urgency of payment. (ii) In order of permanence. In the first method, the liabilities which are payable either immediately or in the near future are listed first and long-term liabilities are listed next. According to second method, the liabilities are listed in order of permanence. The permanent (capital) or long-term (Debentures or long-term loans) liabilities are listed first and liabilities payable soon are shown next. Mixed Method of Marshalling: Some authors suggest a third method of marshalling assets and liabilities in which assets are arranged in order of permanence or performance while liabilities are shown in order of payment and vice versa. Balance Sheet As On .... (i) In Order of Liquidity Liabilities (i) ` Current Liabilities ——— Short-term loans ——— Assets (i) Bank loan Current Assets ——— Cash in hand ——— Cash at Bank Bank overdraft ——— Bills Receivable ——— Bills payable ——— Sundry Debtors ——— Sundry Creditors ——— Prepaid Expenses ——— Outstanding Expenses ——— Accrued Incomes ——— Income received in (ii) ` Short-term Investments Advance ——— Fixed Liabilities ——— (ii) Mortgage Loans ——— (iii) Fixed Deposits (iii) Capital Current Account (s) Capital Account (s) Stock in hand ——— Long-term Investments ——— Fixed Assets ——— ——— Loose tools ——— ——— Furniture and fittings ——— ——— Motor Vehicles ——— Plant and Machinery ——— Land and Buildings patents. ——— Trade marks copyrights goodwill Final Accounts of Non-Corporate Entities 8.15 Balance Sheet As On .... (In Order of Permanence) ` Liabilities (i) (ii) Capital ` Assets (i) Fixed Assets Current Account(s) ——— Goodwill ——— Capital Account(s) ——— Patents ——— Fixed Liabilities Trade Marks Mortage loans ——— copyrights ——— Fixed Deposits ——— Land and Buildings ——— Plant and Machinery ——— (iii) Current Liabilities Incomes Received in Advance ——— Motor Vehicles ——— Outstanding Expenses ——— Furniture and fittings ——— Sundry Creditors ——— Loose tools ——— Long-Term Investments ——— Bills Payable ——— (ii) Bank loan or Overdraft ——— (iii) Short-term Loans ——— Current Assets Short-term investments ——— Accrued Income ——— Prepaid Expenses ——— Stock in hand ——— Sundry Debtors ——— Bills Receivable ——— Cash at Bank ——— Cash in hand ——— Illustration 2 (Final Accounts) From the trial balance of Ashanti Devi given below, prepare final accounts for the period ending on 31 March, 20........ Trial Balance of Ashanti Devi As On 31 March 20...... Debit ` Credit ` — 1,01,500 Cash in hand 6,470 — Cash in bank 17,190 — Opening stock 40,000 — 6,600 — Name of the Account Capital account Furniture account Sundry Debtors: Musica 18,500 Manohar electronics 4,000 Veer traders 3,400 Bills payable account — 13,000 Advertising account 500 — Trade expenses account 100 — Salaries and wages account 2,000 — Office stores account 1,200 — 50 — Travelling charges account 8.16 Financial Accounting: Concepts and Applications Telephone charges account Rent account 250 — 1,500 — Stationery account 150 — Discount allowed account 170 — Discount received account — 320 3,000 — Bad debts account Trade Creditors: — Tony limited — 16,000 Rhytham corner — 28,000 Modern electronics — 4,000 — 38,900 Sales account Delite Safe Co. Purchases account Sales returns account — 1,600 91,940 — 2,000 — Purchases returns account — 3,200 Post-dated-cheque account 5,000 — Drawings account 2,500 — 2,06,520 2,06,520 Stock in hand at end : Goods ` 1,00,000; Office stores ` 500. Solution : Ashanti Devi Dr. Trading Account For The Year Ended On 31 March, 20×... ` Particulars To Opening stock To Purchases 3,200 To Profit and Loss A/c By Sales 88,740 By Closing stock Less : Returns 38,900 2,000 36,900 1,00,000 8,160 (Gross Profit) Dr ` Particulars 40,000 91,940 Less : Returns Cr. 1,36,900 1,36,900 Profit and Loss Account For The Year Ended On 31 March, 20×... ` Particulars To Advertisement 500 To Trade expenses 100 To Salaries and wages 2,000 To Travelling expenses 8,160 (Gross Profit) By Discount received 320 1,500 To Stationery To Discount allowed 150 170 To Bad debts Less : Stock in hand By Trading Account 250 To Rent To Net profit transferred to Capital Account ` Particulars 50 To Telephone expenses To Office stores Cr. 3,000 1,200 500 700 60 8,480 8,480 Final Accounts of Non-Corporate Entities 8.17 Balance Sheet As At 31 March, 20 ×... ` Liabilities Assets ` Bills payable 13,000 Cash 6,470 Trade creditors 48,000 Bank 17,190 Debtors 25,900 Delite safe company 1,600 Capital 1,01,500 Less : Drawings Add : Net Profit Post-dated-cheque 2,500 Closing Stock 99,000 Office stores 60 99,060 Furniture 1,61,660 5,000 1,00,000 500 6,600 1,61,660 ADJUSTMENTS The trial balance contains only those items which have been recorded in the books of account during the accounting period and does not contain those items which are not recorded although such unrecorded items belong to the current accounting period. The adjustments in final accounts simply mean bringing into record all those items which have not yet been included in the trial balance with the help of adjustment entries. The rationale or logic behind the adjustments is that the final accounts must be prepared on accrual basis. It means that in the profit and loss account we should include all the expenses which belong to current accounting period whether they are actually paid in cash or not and all the incomes of the current accounting period whether they are actually received in cash or not. Thus, adjustments are necessary for correct matching of revenues and expenses incurred to earn those revenues. Adjustments are also made to record assets and liabilities at their correct values by taking into account non-cash expenses and non-cash incomes such as depreciation of fixed assets, interest on capital and interest on drawings. Furthermore, the anticipated losses such as provision for bad debts and provision for discount on debtors and anticipated income like provision for discount on creditors are also incorporated through adjustment entries. MOST FREQUENT ADJUSTMENT ENTRIES The most frequently made adjusting entries are listed in the following paragraphs: (i) Stock at the end : The closing inventory after proper valuation is incorporated in the final accounts with the help of following journal entry : Stock at the end Account To Trading Account Dr. Stock account is debited so that the asset on hand may appear in the balance sheet. The trading account is credited so that cost of the goods available for sale (i.e., opening stock plus purchases made during the year) already recorded in that account, may be reduced by the stock at the end, to give the cost of the goods sold. The stock-on-hand which appears in the Trial balance is the opening stock or stock on hand at the beginning of the period. But if the closing stock also appears in the trial balance, it means that the double entry was completed in the accounting period itself by already reducing the purchases by making the following entry: Stock at the end Account To Purchases Account Dr. Hence, Stock-at-the-end will then be shown only in the assets side of the balance sheet. (ii) Outstanding expenses (Unpaid expenses) : Expenses are generally recorded only when they are paid in cash. But certain expenses like salaries, wages, rent etc., are incurred during the accounting period 8.18 Financial Accounting: Concepts and Applications but the payment for them might not have been made during that accounting period. Such expenses are called oustanding (unpaid) expenses. The failure to record an unpaid expense in the accounts results in an understatement of that expense and also an understatement of a liability. In order to avoid understatement of these expenses and liabilities, an adjustment entry is passed to increase the expense and liability : Relevant Expense Account Dr. (It will go to Trading or To Outstanding Expenses Profit and Loss Account) Account (It will appear in the balance sheet as a liability) But if outstanding expenses are given in the trial balance, the same will be shown only in the liabilities side of the balance sheet because the above adjustment entry has already been made in the accounting period itself. Example 1 A firm pays salaries for any month on the seventh day of next month. The monthly bill is ` 2,000. The accounting period ends on 31 March. How would you state the total amount of salaries for the year. Answer : In the trial balance, there must be salaries paid for 11 months only since the payment is made on the seventh day of next month. The salaries for the month of March must be paid on 7th of April of the next accounting period. The salaries account would be adjusted as : Dr. Salaries Account Particulars To Balance b/d (As given in trial balance) Cr. ` 22,000 Particulars By Profit and Loss Account ` 24,000 To Oustanding Salaries Account (For March) 2,000 24,000 Dr. 24,000 Outstanding Salaries Account Particulars To Balance c/d ` 2,000 Cr. Particulars ` By Salaries Account 2,000 By Balance b/d 2,000 (For Balance Sheet) Balance Sheet As At 31 March, 20… Labilities Outstanding Salaries ` Assets ` 2,000 Result : The adjusting procedure stated above enables the firm to record the salaries as expense of the 12 months rather than expense paid for 11 months. In addition, the balance sheet will show a liability in the form of unpaid salaries at the end of the accounting period. Omitting such an adjustment would mean an overstatement of net profit of ` 2,000 and an understatement of liability of `2,000 in the balance sheet. Similar considerations apply to all outstanding expenses. (iii) Accrued income : There is usually no record in the account books regarding items of income which have not been received. Examples are interest on bank deposits, debentures, commission, dividends on shares and services rendered but neither billed nor income received by the end of the accounting period. Uncollectable income that has been earned but is not yet due and collectible and which increases or accumulates with the passage of time is known as accrued income. The failure to record income earned but not received results in : (i) understatement of income, Final Accounts of Non-Corporate Entities 8.19 and (ii) understatement of assets (representing money to be collected at a later date). Thus, it becomes necessary to make an adjustment entry which would increase the asset in the balance sheet and income in the profit and loss account. The entry is : Accrued Income Receivable Account Dr. (will appear as an asset) To Income Account (will appear on the Credit side of Profit and Loss Account) In case accrued income appears in the trial balance, it will be taken to the assets side of the balance sheet only because adjustment entry has already been made. Example 2 A business enterprise owns ` 10,000, 12% Debentures on which interest is receivable on 30 June and 31 December and the accounting period ends on December 31. The interest has been received only on 30 June. What is your reaction ? Answer : The interest has been accruing between June 30 and December 31 (for six months) for which an adjusting entry is needed. The reason is simple: there has been an accumulation of income and good accounting on accrual basis requires that income must be recorded in the period in which it is earned. The relevant entry is: Accrued Interest Receivable Account To Interest Account Dr. ` 600 ` 600 (Being six months's interest on ` 10,000 @ 12% accrued but not received) Assume that before recording the above entry, the interest account has a credit balance of ` 600 representing the interest received for six months during the year. The posting of the adjusting entry for accrued interest would show the following position : Dr. Interest Account Particulars To Profit and Loss Account Cr. ` 1,200 Particulars By Balance b/d 600 By Accrued Interest 600 1,200 Dr. 1,200 Accrued Interest Receivable Account Particulars ` To Interest Account 600 To Balance b/d 600 ` Cr. Particulars By Balance c/d ` 600 (For Balance Sheet) Balance Sheet As At 31 December 20… Liabilities ` Assets ` Accrued Interest 600 Obviously the adjusting entry will have the effect of increasing the amount of income transferred to the credit of profit and loss account while the debit balance in the accrued interest account will appear as an asset in the balance sheet. (iv) Prepaid expenses (Expenses paid in advance) : Sometimes the payments for certain expenses, have to be made in advance with the result that there will be some unexpired portion of expenses at the 8.20 Financial Accounting: Concepts and Applications end of the accounting period which relates to the future periods. The typical examples are insurance premium, rent, rates, etc. An adjusting entry is made as : Prepaid Expenses Account (or Expenses paid in advance) To Expenses Account Dr. The amount of prepaid expenses will appear as an asset in the balance sheet while amount of appropriate expense account will be reduced with the amount of prepaid expenses. It is this reduced amount that will be transferred to profit and loss account. But if the prepaid expenses are given in the trial balance, the same will be shown only in the assets side of the balance sheet because adjustment entry has already been made on the trial balance date. Example 3 A firm pays yearly insurance premium ` 1,200 on July 1, every year. The accounting period ends on March 31. Make the adjustment for the purpose of preparing final accounts. Answer : ` Prepaid Insurance Account Dr. To Insurance Account ` 300 300 The ledger account will then be: Dr. Insurance Account Cr. ` Particulars To Balance b/d 1,200 Particulars By Prepaid Insurance Account 300 By Profit and Loss Account 900 1,200 Dr. 1,200 Prepaid Insurance Account Particulars ` To Insurance Account 300 To Balance b/d (For Balance Sheet) 300 ` Cr. Particulars By Balance c/d ` 300 Balance Sheet As At 31 March 20..... ` Labilities Assets Prepaid Insurance ` 300 (v) Income received in advance (unearned income) : Revenues are sometimes received in advance for commodities to be supplied or for services to be rendered in future, e.g., subscriptions, apprentice premium, or the insurance premium received by an insurance company. That portion of revenue received in advance that is unearned at the end of the accounting period is known as income received in advance or unearned income. Income received in advance or unearned income is in the nature of a liability for the simple reason that it creates an obligation to refund the amount or provide goods/ services at some future date. The required adjusting entry is : Income Account Dr. To Income Received in Advance Account (will be shown as a deduction from the relevant income account in the Profit and Loss Account) (will appear as a liability in the balance sheet) If it is given in the trial balance, it will be shown only in the liabilities side of the balance sheet because adjustment entry has already been made. Final Accounts of Non-Corporate Entities 8.21 Example 4 A publication house receives subscriptions amounting to ` 20,000 during the current accounting period but ` 2,000 are in respect of subscriptions for next year. Show the necessary adjustments in different accounts. Answer : Dr. Subscriptions Account ` Particulars To Subscriptions Received in Advance 2,000 To Profit & Loss Account Cr. Particulars By Balance b/d 20,000 18,000 20,000 Dr. ` 20,000 Subscriptions Received in Advance Account Particulars By Balance c/d ` 2,000 Particulars Cr. ` By Subscriptions Account 2,000 By Balance b/d (For Balance Sheet) 2,000 Balance Sheet As At.... Liabilities Subscriptions received in advance (vi) ` Assets ` 2,000 Depreciation of PPE (Tangible) : The cost of a fixed asset is charged as an expense over a period of its useful life. The expense is known as depreciation. Normally depreciation is provided after the trial balance date. Fixed assets are presented in financial statement at historical cost basis, but, revaluation model may be applied, which is optional (as per AS-10). It is not done during ordinary course of business unless management feels that historical cost does not represent true and fair value. If revaluation is done, obviously it will increase or decrease the value of concern assets. If there is decrease in revaluation of assets it should directly charged to profit and loss account. While increase in value of assets, should directly credited to owner’s interest by opening ‘Revaluation Reserve Account’ which is a restricted reserve. Revaluation reserve can be utilised to write off excess depreciation arising on revaluation, to write off loss on sale of fixed assets and balance, if any, should be transfer to General Reserve in owner’s interest. Thus, an adjustment is needed in the relevant accounts before the final accounts are prepared. The required adjustment entries are : (i) Depreciation Account To Individual Asset Account Dr. But when the fixed asset is required to be maintained at its original cost, the entry will be : (ii) Depreciation Account Dr. To Provision For Depreciation Account (iii) Profit and Loss Account Dr. To Depreciation Account (iv) Revaluation Reserve Account Dr. To Depreciation Account (excess depreciation) To Loss on Sale of Assets To General Reserve (Balancing Figure) 8.22 Financial Accounting: Concepts and Applications Example 5 The following balances were extracted at the end of the accounting period from the books of P : ` Plant and Machinery 20,000 Furniture 5,000 Building 50,000 Depreciation is to be charged as : 20% on Plant and Machinery, 10% on Furniture and 5% on Building. Outline the procedure and show how the financial statements are affected. Answer : The total amount of depreciation is : ` Plant and Machinery (20% on ` 20,000) 4,000 Furniture (10% on ` 5,000) 500 Building ( 5% on ` 50,000) 2,500 7,000 The adjusting entries are : ` (i) Depreciation Account Dr. To Plant and Machinery Account 4,000 To Furniture Account 500 To Buildings Account (ii) ` 7,000 2,500 Profit and Loss Account Dr. To Depreciation Account 7,000 7,000 Effect On Financial Statements Dr. Particulars To Balance b/d Plant and Machinery Account Cr. ` ` 20,000 Particulars By Depreciation Account By Balance c/d 20,000 To Balance b/d Dr. Particulars To Balance b/d 16,000 Furniture Account Cr. ` ` 5,000 Particulars By Depreciation Account By Balance c/d Dr. Particulars To Balance b/d 500 4,500 5,000 4,500 Building Account Cr. ` ` 50,000 Particulars By Depreciation Account By Balance c/d 50,000 To Balance b/d 16,000 20,000 5,000 To Balance b/d 4,000 47,500 2,500 47,500 50,000 Final Accounts of Non-Corporate Entities Dr. 8.23 Depreciation Account ` Particulars To Plant and Machinery Account 4,000 To Furniture Account 500 To Building Account 2,500 Cr. ` Particulars By Profit and Loss Account 7,000 7,000 7,000 Balance Sheet (Assets Side) ` Assets ` Plant & Machinery 20,000 Less : Depreciation 4,000 Furniture 5,000 Less : Depreciation Buildings Less : Depreciation 500 16,000 4,500 50,000 2,500 47,500 Depreciation in the trial balance along with Revaluation Reserve: When the depreciation is given in the trial balance, it means that the asset(s) has been credited with the amount of depreciation and the necessary debit to depreciation account made. The Revaluation Reserve is kept for writing off excess depreciation and loss on sale of assets. If there is any excess depreciation it must be adjusted again Revaluation Reserve as per AS-10 PPE (revised). The only entry then would be to transfer the depreciation account to Profit and Loss Account and excess depreciation to Revaluation Reserve Account. (vii) Bad Debts : Losses on account of uncollectable debts are called bad debts. Such a loss is recorded in the books by making following adjusting entry: Bad Debts Account Dr. To Debtors Account The Profit and Loss Account is debited with the amount of bad debts in the balance sheet, the debtors' balance will be reduced by the same amount in the assets side of the balance sheet. Bad debts in the trial balance : When the amount of bad debts is given in the trial balance itself, no adjusting entry is required. It simply means that the amount in the debtors account has already been reduced by making entry for bad debts before the trial balance is extracted. Only the bad debts account will be transferred to profit and loss account. (viii) Provision for bad and doubtful debts : In addition to writing off bad debts known to be bad, provision must be made for any debts, the recovery of which is doubtful. Such a treatment is based on the simple logic that bad debts should be charged to profit and loss account in the period in which they are incurred. The method for providing for doubtful debts is : the amount to be provided is debited direct to Profit and Loss Account and credited to Provision for Bad and Doubtful Debts Account; the balance on the bad debts actually written off is debited direct to Profit and Loss Account. Example 6 The following figures have been extracted from the account books of a business house : Bad Debts written off during the year : ` 1,000 Debtors on December 31, 20.... ` 10,000 It is desired to make a provision of 5% on debtors. Write up the relevant ledger accounts. 8.24 Financial Accounting: Concepts and Applications Answer : Dr. Particulars To Balance b/d Bad Debts Account Cr. ` ` 1,000 Dr. Particulars To Balance c/d Particulars By Profit and Loss Account 1,000 Bad Debts Account Cr. ` ` 500 Particulars By Profit and Loss Account 500 (5% on ` 10,000) By Balance b/d 500 When there is already a provision for bad debts in existence (old), only the difference between the new provision and old provision is debited to Profit and Loss Account provided the new provision is more than the old provision. Example 7 The following figures relate to a trader : ` Bad and Doubtful Debts Provisions at January 1, 20..... 500 (Cr.) Bad Debts written off during the year ending on December 31, 20.. 700 The provision is to be maintained at 10% on sundry debtors which stood at ` 10,000 on December 31, 20..... Answer : The problem can be dealt with as follows : Dr. Particulars To Balance b/d Dr. Particulars Bad Debts Account Cr. ` ` 700 By Profit and Loss Account 700 Provision for Bad And Doubtful Debts Cr. ` ` To Balance c/d (Required i.e., 10% on 10,000) Particulars 1,000 Particulars By Balance b/d (given) 500 By Profit and Loss Account 500 1,000 1,000 By Balance b/d 1,000 If the closing provision (new) is less than the opening provision (old), the profit and loss account would be credited with the amount of the reduction. (ix) Provision for discount on debtors : When the provision for bad and doubtful debts has been deducted from the total debtors, the balance so arrived represents good or sound debtors, who might claim cash discount by making prompt payments. The discount so allowed is an expense to the business. Provision for discount is generally made with the object of charging against the current accounting period the estimated cash discounts which will ordinarily be allowed to debtors on sales during the period for making prompt payments. The entry is: Profit and Loss Account Dr. To Provision for Discount On Debtors Account Final Accounts of Non-Corporate Entities 8.25 Example 8 From the following data, make necessary adjustments for provision for discount on debtors : ` Discounts allowed during the year on December 31, 20..... 1,000 Discount Provision as at January 1, 20..... 400 Debtors (good) as at December, 31, 20...... 10,000 Provision for discount to be made at 8% Answer : Dr. Discount Allowed Account Cr. ` ` Particulars To Total Discount As Per Cash Book 1,000 Dr. Particulars By Profit and Loss Account 1,000 Provision for Discount on Debtors Account Cr. ` ` Particulars To Balance c/d (8% on ` 10,000) 800 Particulars By Balance b/d 400 By Profit and Loss Account 400 800 800 Example 9 The following figures appear in the books of Archana : ` 20...... Jan.1 Dec. 31 Provision for bad and doubtful debts 800 Provision for discount allowed 600 Discounts allowed during the year 800 Bad debts written off 400 Debtors (per ledger) 10,000 Write off further bad debts 200 Create 10% provision for bad and doubtful debts Provide for discount on debtors at 10% Answer : Dr. Particulars Bad Debts Account Cr. ` ` To Balance b/d 400 To Debtors (written off) 200 Particulars By Profit and Loss Account 600 Dr. Particulars To Balance c/d (See working notes) 600 600 Provision for Bad And Doubtful Debts Account Cr. ` ` 980 Particulars By Balance b/d 800 By Profit and Loss Account 180 980 980 By Balance b/d 980 8.26 Financial Accounting: Concepts and Applications Dr. Discount Allowed Account Cr. ` ` Particulars To Sundries as per Cash Book Dr. 800 Particulars By Profit and Loss Account 800 Provision for Discount Allowed Account Cr. ` ` Particulars To Balance c/d 882 (See working notes) Particulars By Balance b/d 600 By Profit and Loss Account 282 882 882 WORKING NOTES (1) Provision for bad and doubtful debts would be created as shown below : ` Debtors (Given) 10,000 Less : Bad debts Additional 200 9,800 Less : Provision for bad and doubtful debts — 10% on 9,800 980 8,820 (2) The discount provision : 10% on 8,820 (3) Balance Sheet As on 31 December 20..... 882 ` Assets side Sundry Debtors (10,000 – 200) 9,800 Less : Provision for bad and doubtful debts 980 8,820 Less : Provision for discount on debtors (10% on 8,820) 882 7,938 (x) Provision for discount on creditors : Provision for discounts which would be allowed by the creditors are also made in a manner similar to those stated above. The prompt payments made to creditors result in gains and it would be wrong to state the creditors at their gross values when the possibilities of earning the discounts exist. The adjusting entry for this purpose is : Provision for Discount On Creditors Account Dr. To Profit and Loss Account In practice, the provision for discount receivable are often not made for reasons of conservatism. (xi) Interest on capital : It is a common practice, especially in individual proprietorship and partnership firms to charge interest on the capital employed by the proprietor/partners. The idea is to know whether the profits of the business are more than what would be earned from simple investments outside the business. The adjusting entries are : Interest on Capital Account Dr. To Capital Account (s) Profit and Loss Account To Interest on Capital Account Dr. Final Accounts of Non-Corporate Entities 8.27 Alternatively Profit and Loss Appropriation Account Dr. To Capital Account(s) When interest on capital is given in the trial balance, it will be transferred to the debit side of the Profit and Loss Appropriation Account only. (xii) Interest on drawings : The purpose of charging interest on drawings is to create an awareness regarding the interest which would have to be paid if money is borrowed from other sources. Further it may be effective check on reckless withdrawals by the various partners in a partnership firm. The adjusting entry (combined) is : Capital Account Dr. To Profit and Loss Appropriation Account If this item is given in the trial balance, it will be credited to Profit and Loss Appropriation Account only. (xiii) Expense stock : It is not uncommon to find in a business firm the stock of minor items like stationery or advertising material in addition to the usual stock of goods for resale. The stock of these items must be dealt within the account to which it relates. It will be included in the particular expense figure in the profit and loss account and not in the stock of goods figures in the trading account. The entry for recording closing expense stock will be. Expense Stock Account Dr. To Expense Account Example 10 The Trial Balance of a trader shows the following items in respect of stationery : ` Opening Stock 2,000 Stationery purchased 5,000 A note to the Trial Balance disclosed that stationery on hand was valued at ` 1,000. How would you deal with this item in the final accounts. Answer : The net debit to Profit and Loss Account shall be calculated as under : Stationery ` Opening stock 2,000 Add : Purchases 5,000 7,000 Less : Stock in hand 1,000 Stationery used 6,000 (Debit Profit and Loss Account) If the closing stock of stationery is shown as a part of the Trial Balance, it implies that the Stationery Account has already been adjusted. Using the figures given above the Trial Balance would then show : Stationery Account 6,000 (Profit and Loss Account) Stationery Stock (closing) 1,000 (Balance Sheet) (xiv) Stock destroyed by fire or other calamity would be dealt with by making the following adjusting journal entries : (a) If not insured 8.28 Financial Accounting: Concepts and Applications Profit and Loss Account Dr. To Trading Account (b) If fully insured Insurance Company Account Dr. (to be shown in the assets side of balance sheet) Dr. (Balance sheet) To Trading Account (c) If partly insured Insurance Company Account Profit and Loss Account Dr. To Trading Account (Unrecovered amount) (Total) Example 11 Stock at the end of a business entity is ` 50,000. It is informed that goods amounting to ` 5,000 were destroyed by fire during the accounting period. Make necessary adjusting entries when : (a) the stock is not insured. (b) stock is fully insured; and (c) stock was partly insured and the insurance company has agreed to pay ` 2,500. Answer : In all the three situations stated in (a), (b) and (c) the closing stock in the trading account (credit side) and balance sheet (assets side) would appear at ` 50,000 that is : Stock Account Dr. ` 50,000 ` 50,000 To Trading Account (a) When it is not insured: Now if the stock destroyed by fire is taken out of trading account the gross profit would be reduced (or gross loss would be increased) and the management might be unnecessarily prompted to investigate into the reasons for reduction in gross profits. Such loss therefore, is shown in the profit and loss account on the assumption that nothing unusual has happened in so far as trading account is concerned. The entry in case (a) is : ` Profit and Loss Account Dr. 5,000 To Trading Account (b) 5,000 When the goods are fully insured Insurance Company Dr. 5,000 To Trading Account (c) ` 5,000 When the goods are partly insured Insurance Company Account Dr. 2,500 Profit and Loss Account Dr. 2,500 To Trading Account 5,000 But if the insurance company has paid ` 2,500 before the closing date, the entry would be: Profit and Loss Account To Trading Account Dr. ` 2,500 ` 2,500 (xv) Income tax and advance payment of income tax : The tax paid on the income in the case of a sole trader is a personal expense and is therefore, deducted from his capital account. Final Accounts of Non-Corporate Entities 8.29 Example 12 The trial balance of a proprietory concern shows the following balances : Income tax Dr. ` 5,000 Income tax paid in advance Dr. ` 1,500 Interest on advance payment of tax Cr. ` 50 Answer : (a) Income tax paid, that is ` 5,000, is a personal expense (Drawings) and would be deducted from the capital account. (b) Advance payment of income tax is also an item of drawings and will be deducted from the capital account. (c) Interest on advance payment of tax is a part of proprietor's personal income (and not business income) and thus, it would be added to his capital account. (xvi) Withdrawals, samples (free gifts) etc. When the goods are withdrawn by the proprietor for his personal use or for distribution as samples, they cannot be treated as part of the sales. Instead the purchases must be adjusted for such items by giving a proper credit to the same. Example 13 From a general store, washing soap was taken out for the following purposes: (i) personal use, ` 1,000; (ii) distributed to staff ` 15,000; and (iii) distributed as samples, ` 10,000. Suggest proper accounting treatment. Answer : In all these three cases the soap taken out of the store cannot be included in the sales since the withdrawal is at cost and therefore, no profit accrues to the business. Hence, only purchases would be adjusted as under : ` Drawings Account Dr. 1,000 Salaries Account Dr. 15,000 Advertisement or Sales Promotion Account Dr. To Purchases Account ` 10,000 26,000 (xvii) Life insurance premium : Life insurance premium should also be treated as an item of drawings in the sole proprietorship or partnership business. (xviii) Salaries and wages : In such a case, the wages part is treated as non-productive and the combined amount is taken to profit and loss account. But if 'wages and salaries' are grouped, the salaries part is treated as non-productive and the combined account is transferred to trading account. And if there is no manufacturing activity, wages and salaries are taken to Profit and Loss Account. (xix) Insurance premium : In the absence of any information, this item in the trial balance indicates the insurance of the office-cum-shop and is therefore, transferred to profit and loss account. But the insurance premium (s) paid on factory building, factory machines, goods purchased etc., is treated as direct expense and is transferred to trading account. Example 14 (Debtors and dishonoured bills etc.) Assume the following information : Debtors given in the trial balance amounting to ` 50,000 include a sum of ` 10,000 in respect of a dishonoured bill of Manish who has been found insolvent. A dividend of 75% would be received from his estate. Make a provision for bad and doubtful debts at 10% on debtors. 8.30 Financial Accounting: Concepts and Applications Answer : Since Manish could pay only ` 7,500 (i.e., 75% of 10,000), the amount to be written off as bad debt was ` 2,500 for which the entry is : Bad Debts Account Dr. ` 2,500 ` 2,500 To Debtors Account Provision for bad and doubtful debts would be calculated on ` 40,000 at 10% i.e. ` 4,000. This is explained below: ` Total Debtors 50,000 Less : Bad debts 2,500 47,500 Less : Amount of dividend to be recovered from the estate of Manish (75% of ` 10,000) 7,500* Remaining balance 40,000 * This amount represents definitely good debtors and hence, there is no need for provision. In order to calculate provision for bad and doubtful debts on debtors, the deductions in respect of bad debts and definitely good debts must be made. (xx) Bad debts written off recovered : When the amount written off as bad is recovered in the near future, it is treated an item of gain and is therefore, credited to profit and loss account. The following entry is generally made: Cash (or Bank) Account Dr. To Bad Debts Recovered Account (Being the amount recovered previously written off as bad) The ‘bad debts recovered’ account will be transferred to the credit side of the profit and loss account by making following entry : Bad Debts Recovered Account Dr. To Profit and Loss Account It may be noted that ‘bad debt recovered’ account is a new title distinct from ‘bad debts’ account; the former represents gain while latter records a loss. Alternatively, the following methods are also suggested : (a) Debit cash and, Credit bad debts account so that the total amount to be written off as bad for the period is reduced; or (b) (i) Debit customer, Credit bad debts account (ii) Debit cash Credit customer. It is maintained that the method (a) is more direct but method (b) provides in the personal account concerned a record which may afford useful information at some future date. However, in practice neither method (a) nor method (b) is adopted (xxi) Calculation of commission : It is common practice to pay managers etc., commission on net profit. There is no difficulty in its computation if the commission is payable as a percentage of net profit before charging such commission. The simple calculation is done as under. Manager's Commission = Rate × Profit before Commission/100 Final Accounts of Non-Corporate Entities 8.31 On the other hand if the commission is payable at a fixed percentage after charging such commission, the formula used is : Manager's Commission = (Rate/100 + Rate) × Profit before Commission Example 15 Assume the following information is supplied to you : ` Particulars Gross Profit ` 50,000 Salaries 10,000 Rent 4,000 Office expenses 12,000 Selling expenses 5,000 Advertisement 8,000 Profit before commission 39,000 11,000 Calculate manager's commission at 10% of the net profit : (a) before charging such commission; (b) after charging such commission. Answer : (a) Commission before charging such commission = (10 × 11,000 / 100) = ` 1,100 (b) Commission payable after charging such commission = (10 × 11,000 / 100 + 10) = (10 × 11,000/110) = ` 1,000 ` This can be verified as follows : Profit before commission 11,000 Less: Amount of commission 1,000 Profit after commission 10,000 10% of ` 10,000 = ` 1,000 OR Suppose. Profit after charging commission 100 Commission at 10% 10 Profit before charging commission 110 Commission on ` 110 is : 10 Commission on ` 11,000 : (10/110) × 11,000 = ` 1,000 (xxii) Goods purchased included in closing stock but not recorded in the purchases book: When goods purchased on credit have been physically received and are included in the stock at the end (closing stock) but have not been entered in the purchases book, this is an error of omission. So an adjusting entry has to be made to record this omitted entry at the time of preparing the final accounts. The entry is: Purchases Account To Sundry Creditors Account Dr. 8.32 Financial Accounting: Concepts and Applications In the final accounts, the following treatment is done: (a) Add the omitted amount to the other purchases in the trading account. (b) The amount owing to the creditors must be added to the sundry creditors on the liabilities side of the balance sheet. (c) No change is made in the amount of closing stock. (xxiii) Hidden or implied adjustments: Some of the adjustments are not specifically stated but have to be inferred or understood from the indirect clue given in the trial balance itself. Such adjustments are called hidden or latent or implied adjustments as are explained with the help of following examples: Example – I6 10% loan ` 2, 00,000 taken on 1-4-2016 given in the credit column of the trial balance. Interest paid ` 15,000 given the debit column of the trial balance. Trial balance is as on 31-3-2017 Answer : The total interest payable for the accounting period covering 1-4-2016 to 31-3-2017 is ` 2,00,000  10 = ` 20,000. 100 But interest paid as per trial balance is ` 15,000; hence, interest outstanding (unpaid) is ` 20,000 – ` 15,000 = ` 5,000. Outstanding interest of ` 5,000 is a hidden adjustment because accounts are prepared on accrual basis and the profit and loss account will be debited with ` 20,000 (15,000 + 5,000) Example – 17 Salaries paid ` 2,00,000 given in the debit column of the trial balance (there are 12 employees with a monthly salary of ` 20,000 each) Answer : Total salaries payable to 12 employees @ ` 20,000 each come to ` 2,40,000. Hence, outstanding salary ` 40,000 (2,40,000 – 2,00,000) is a hidden adjustment. Example I8 Rent paid ` 1,20,000 given in the debit column of the trial balance (monthly rent is ` 9,000) Answer : Rent payable for the whole year is ` 1,08,000 (9,000 × 12) but actual rent paid is ` 1,20,000. Hence, ` 12,000 (1,20,000 – 1,08,000) is rent paid in advance and represents hidden adjustment. (xxiv) GST: Goods and service Tax (GST) is a destination based tax and levied at a single point at the time of consumption of goods or services by the end user or consumer. It is based on the concept of value added tax (VAT). GST is a kind of tax which is levied on every value addition at each stage of life cycle of a product i.e. on purchase of raw material, manufacturing and sale to consumers. Section 366 of constitution of India defines GST as “any tax on supply of goods or services or both except taxes on supply of the Alcoholic Liquor for human consumption”. Composition of GST: Levy and collection of GST follows a dual structure, in which tax is administered, collected and shared by both centre and state governments including Union Territory based on Intra-state and Inter-state transactions. Supply of goods or services provided, may divided into two parts namely: (a) Intra State: When supplier of goods or service provider and their purchaser or receiver both are Final Accounts of Non-Corporate Entities 8.33 in the same state or UT, then it is said intra state supply. In such transactions GST is levied by both centre and State/UT. GST levied by centre is called CGST and by state/UT is called SGST/ UTGST as the case my be. (b) Inter State: When supplier of goods or service provider and consumer/purchaser of goods or consumer of services are in two different states or Union territory. In such transactions IGST (Integrated Goods and Service Tax) is levied and collected by Central Government. Input Tax Credit (ITC) The credit available to a registered dealer for GST paid at the time of purchase of goods and services in the normal course of business is termed as Input Tax Credit (ITC). Such purchases are called inward supplies. Similarly, when goods and services are sold by a registered dealer are known as outward supplies. The registered dealers can be set off Input Tax Credit against the tax collected on outward supplies (sales of goods or services). Input Tax Credit (ITC) is utilised as per section 49 of GST Act-2017, in the following manner: (i) ITC of integrated tax (IGST) shall first be utilised towards payment of output integrated tax (IGST) and the amount remaining, if any, may be utilised towards payment of output CGST and output SGST, as the case may be. (ii) ITC of CGST shall be first utilised against output CGST and the amount remaining, if any, may be utilised towards payment of output IGST. (iii) ITC of SGST shall be first utilised towards payment of output SGST and the amount remaining, if any, may be utilised towards payment of output IGST. (iv) ITC of UTGST shall be first utilised against output UTGST and balance, if any, may be utilised towards payment of output IGST. Accounting treatment for GST (Input GST/Output GST): 1. At the time of purchase of Goods or an item of PPE: Purchases/PPE A/c Dr. Input IGST/CGST/SGST A/c Dr. To Vendors/Suppliers’ A/c [Amount Due] To Bank A/c [Amount Paid] 2. For purchases returns: Supplier’s A/c Dr. To Purchases Return A/c To Input IGST/CGST/SGST A/c 3. At the time of sale of goods or services: Bank A/c Dr. [Amount Received] Debtors A/c Dr. [Amount Due] To Sales A/c To Output IGST/CGST/SGST A/c 4. For sales return: Sales Return A/c Dr. Output IGST/CGST/SGST A/c Dr. To Debtors A/c 8.34 Financial Accounting: Concepts and Applications 5. For abnormal loss of goods/Drawings in goods/Goods distributed as free samples/Goods given as Charity. Charity/Abnormal loss/Drawings/Advertisement A/c Dr. To Purchases A/c To Input IGST/CGS/SGST Ac/ Accounting entries for setting off input GST against output GST (i) For Input CGST against output CGST: Output CGST A/c Dr. To Input CGST A/c (ii) For Input CGST against output IGST: Output IGST A/c Dr. To Input CGST A/c (iii) For Input SGST against output SGST: Output SGST A/c Dr. To Input SGST A/c (iv) For Input SGST against output IGST: Output IGST A/c Dr. To Input SGST A/c (v) For Input IGST against output IGST: Output IGST A/c Dr. To Input IGST A/c (vi) For making payment of GST: Input IGST A/c Dr. Input CGST A/c Dr. Input SGST A/c Dr. To Bank A/c (Being the balance in Input IGST/CGST after setting-off, represents net tax liability and need to be paid) Example – 19 M/s Raj Enterprise has a sum of ` 1,15,000 on account of input tax credit of CGST in the Electronic Credit Ledger. The output GST payable as per Electronic Liability Register are as under : GST Payable/Output GST ` Outward IGST 30,000 Outward CGST 70,000 Outward SGST 25,000 Determine the order of utilisation of ITC on account of CGST and prepare the statement showing the amount due, adjusted and payable in cash. Final Accounts of Non-Corporate Entities 8.35 Answer : Statement showing amount due, adjusted and payable in cash Particulars Output GST (Tax Liability) IGST CGST SGST 30,000 70,000 25,000 — (70,000) — (30,000) — — NIL NIL 25,000 *Input tax credit of CGST as per e-record to the extent of CGST liability from output CGST *Input tax credit of CGST against IGST upto the liability of IGST Net liability to be paid as per e-record Remaining balance in ITC of CGST of ` 15,000 will be carried forward to next month and will reflect in Electronic Credit Ledger (e-record): Example – 20 Give journal entries for the following in the books of Mr. Singh of Punjab: (i) Purchased goods from Raman of Allahabad for ` 70,000 and paid 18% as IGST. (Inter state transaction). (ii) Purchased goods from Shivani of Punjab for ` 1,00,000 and paid 12% as CGST and SGST for both. Mr. Singh paid 40% of the amount by cheque. (iii) Goods costing 10,000 were found defective and had to return to Shivani. (iv) Sold goods to Suhail of Mumbai for ` 80,000 along with 18% IGST, received half payment in cash. (Inter state transaction). (v) Sold goods to Raja Ram of Punjab for ` 1,20,000 along with 12% CGST and 12% SGST. He paid 60% amount by cheque. (vi) Out of the goods sold goods worth ` 20,000 return by Raja Ram. (vii) Goods costing ` 5,000 which were purchased from Raman were distributed as free samples. (viii) Goods costing ` 6,000 which were purchased from Shivani were destroyed by fire. Mr. Singh’s Books Journal Entries S.No. Particulars L.f Dr. (`) (i) Purchases A/c Dr. 70,000 Input IGST A/c Dr. 12,600 To Raman (ii) (iii) Cr. (`) 82,600 Purchases A/c Dr. 1,00,000 Input CGST A/c Dr. 12,000 Input SGST A/c Dr. 12,000 To Shivani 74,400 To Bank A/c 49,600 Shivani To Purchases Return A/c Dr. 12,400 10,000 To Input CGST A/c 1,200 To Input SGST A/c 1,200 8.36 Financial Accounting: Concepts and Applications (iv) (v) Suhail Dr. 47,200 Bank A/c Dr. 47,200 To Sales A/c 80,000 To Output IGST A/c 14,400 Raja Ram Dr. 59,520 Bank A/c Dr. 89,280 To Sales A/c (vi) 120,000 To Output CGST A/c 14,400 To Output SGST A/c 14,400 Sales Return A/c Dr. 20,000 Output CGST A/c Dr. 2,400 Output SGST A/c Dr. 2,400 To Raja Ram (vii) Advertisement A/c 24,800 Dr. 5,900 To Purchases A/c 5,000 To Input IGST A/c (viii) Loss by fire A/c 900 Dr. To Purchases A/c 7,440 6,000 To Input CGST A/c 720 To Input SGST A/c 720 CONSIDERATION OF SOME IMPORTANT POINTS WHILE PREPARING THE FINAL ACCOUNTS OF A SOLE TRADER (i) Items appearing in the trial balance: An item appearing in the trial balance would appear only in one place: either in the trading account or in the profit and loss account or in the balance sheet. Examples (a) An item in the debit column may be an expenses or an asset. An expense would be entered in the debit side of the trading account or the profit and loss account; an asset would be shown on the assets side of the balance sheet. (b) An item in the credit side is either an income item or a liability item. Income item would be recorded in credit side of trading account (e.g., sales) or in the credit side of profit and loss account (e.g., interest) But if the item represents the amount payable, it is a liability and would be entered on the liabilities side of the balance sheet. (ii) Items given outside the trial balance or adjustment items: Adjustment items have to complete the double entry aspect and have to appear twice in the final accounts e.g., (i) (ii) First, in the trading account or profit and loss account, as the case may be. Second in the balance sheet Final Accounts of Non-Corporate Entities 8.37 In some cases, first in the trading account, second in the profit and loss account and third in the balance sheet e.g., goods lost by fire and there is an insurance claim. (iii) Trade Expenses: Trade expenses generally represent office or sundry expenses. So these expenses must be shown in the profit and loss account. But if both trade expenses and office, general or sundry expenses in the same trial balance or examination problem are given, the treatment is: (a) Enter trade expenses in the trading account. (b) Enter office, general or sundry expenses in the profit and loss account. Note: The issue is debatable and suggestions with reasons are welcome. (iv) Trade discount given in trial balance: Generally trade discount is not an item of the trial balance because the same is deducted from the purchases or sales at the time of making entry in the purchase book or invoice and only net amount is recorded in the books of account e.g. purchase account or sales account as the case may be. However, if the trade discount is deliberately given in the trial balance, it must be deducted from the purchases (if trade discount is given in the credit column) or from the sales (if trade discount is given in the debit column). But in no case trade discount is to be entered in the profit and loss account. (v) Discount on sales given in the trial balance: It is to be treated as cash discount allowed to customers and must be entered on the debit side of the profit and loss account (suggestions are welcome in writing) (vi) Discount on purchases in the trial balance: It is to be treated cash discount received from suppliers and must be entered on the credit side of the profit and loss account (suggestions are welcome in writing) (vii) Bank in the debit column of the trial balance or cash at bank is an asset. But bank in credit column of the trial balance or bank overdraft is a liability. Mere bank item without Debit or Credit is treated as cash at bank. ADJUSTMENTS AT A GLANCE (A) YEAR-END ADJUSTMENTS Adjustment Trading and Profit & Loss A/c Balance sheet 1. Closing Stock Show.on Credit side of Tr. A/c Show on Asset side 2. Outstanding Expenses Add to Expenses A/c Show on Liability side 3. Prepaid Expenses Deduct from Expenses A/c 4. Income Received in Advance Deduct from IncomeA/c Show on Liability side 5. Accrued Income Add to Income A/c Show on Asset side 6. Bad Debts Show on Debit side of P & L A/c Deduct from Debtors on Assets side 7. Provision for Doubtful Debts on Debtors New Reserves Less : Old Reserve Final Figure Deduct new reserve from Debtors on Assets side xx xx xx Show on Asset side Note : if final figure is positive (+) show on Debit side, if negative (–) show Credit side of P & L A/c 8.38 8. Financial Accounting: Concepts and Applications Provision for Discount on Debtors New Reserve Less: Old Reserve Final Figure xx xx xx Deduct new reserve from Debtors on Assets side Note : If final figure is positive (+) show on Debit side, if negative (–) show Credit side of P & L A/c 9. Provision for Discount on New Reserve xx Deduct new reserve from Creditors Less: Old Reserve Final Figure xx xx Creditors on Liability side Note: If final figure is positive (+) show on credit side, if negative (-) showDebit side of Profit and Loss Account 10. Depreciation Show on Debit side of P & L A/c Deduct from Asset 11. Interest on Investment & Loans Account Show on Credit side of P & L loan A/c on Assets side Add to investment A/c or 12. Uninsured goods lost (a) Show cost on Cr. of Trading A/c — (b) Show cost on Dr. of P & L A/c — 13. Goods lost; Insurance Claim Due (a) Show full cost on Cr. of Trading Alc (b) Show loss (cost–claim) on Dr. of P & L A/c Show Insurance Claim due on asset side 14. Goods given away as Samples (a) Deduct from Purchases A/c — (b) Show cost on Dr. of P & L A/c 15. Goods taken by Proprietor Deduct from Purchase A/c Debit to Capital A/c 16. Unrecorded Purchases Add to Purchases as per T.B. Add to creditors as per T.B. 17. Unrecorded Sales Add to Sales as per T.B. Add to Debtors as per T.B. 18. Capital expenditure treated as revenue expenditure Deduct from Expenses A/c 19. Bills Receivable Dishonoured Deduct from B/R Add to Asset A/c Add to Debtors 20. Bills Payable Dishonoured and deduct from B/P, – Add to Sundry creditors both on liabilities side 21. Deferred Expenses Show amount written off on side of P & L A/c Debit Show amount not w/o on asset side 22. Capital Receipt treated as Revenue Receipt Add to Liability or deduct from Asset A/c Deduct from Income A/c 23. Profit on Sale of Asset Show profit on Cr. of P & L A/c Deduct W.D.V. from Assets A/c 24. Loss on Sale of Asset Show Loss on Dr. of P & L A/c Deduct W.D.V. from Assets A/c Final Accounts of Non-Corporate Entities 8.39 (B) ADJUSTMENTS ALREADY MADE IN TRIAL BALANCE: Account in Trial Balance Profit & Loss Account Balance Sheet 1. Prepaid Expenses — Show on Asset side 2. Outstanding Expenses — Show on Liability side 3. Income Received in Advance A/c — Show on Liability side 4. Income Due not Received A/c Show on Asset side 5. Depreciation A/c Show on Debit side 6. Closing Stock A/c — Show on Asset side 7. Provision for Depreciation A/c — Deduct from Asset Account in Balance (C) HIDDEN ADJUSTMENTS MADE IN TRIAL BALANCE: Trial Balance on 31 March Trading, Profit & Loss A/c Balance Sheet 1. Rent Paid (including ` 500 for April) Deduct ` 500 from Rent paid A/c Show ` 500 as Rent Prepaid on Assets side. 2. Rent paid (upto Feb.) ` 2,200 Add ` 200 to Rent Paid A/c Show ` 200 as Outstanding Rent on Liability side. 3. Rent Received (upto Feb.) ` 3,300 Add ` 300 to Rent Received A/c Show ` 200 as Outstanding Rent Due on Asset side. 4. Rent Received (incl. ` 200 for April) Deduct ` 200 from Rent Received A/c Show ` 200 as Advance Rent on Liabilities side. 5. Leasehold Lands: ` 5,00,000 (For 5 years from 1-4-2013) Write off ` 1,00,000 on Dr. side of P and L A/c Deduct ` 1,00,000 from Leasehold Land on Asset side 6. (a) Loan from ABC ` 10,000 Add ` 200 to Interest Paid A/c Show ` 200 as Interest Due (b) Interest paid to ABC @ 5% p.a. ` 300 7. on Liabilities side (a) Machinery (W.D.V.) ` 4,000 Show Profit ` 1,400 on Cr. Deduct ` 4,000 from Machinery (b) Machinery sold : ` 5,400 side Account in Balance Sheet Illustration 3 (Prepaid Insurance And Provision For Bad Debts) Saroj Khanna has been trading for some years in food grains. The following list of balances has been extracted from her ledger as on 31 March 2020, the end of her most recent financial year : ` Capital Sales 83,887 2,59,870 Trade creditors 19,840 Returns out 13,407 Provision for bad debts 512 Discount Allowed 2,306 Discount Received 1,750 Purchases 1,35,680 8.40 Financial Accounting: Concepts and Applications Return inwards 5,624 Carriage outwards 4,562 Drawings 18,440 Carriage inwards 11,830 Rent, Rates and Insurance 25,973 Electricity 11,010 Postage, Stationary and Telephone 2,410 Advertising 5,980 Salaries and Wages 38,521 Bad Debts 2,008 Cash in hand 534 Cash at Bank 4,440 Stock as at 1 April, 2019 15,654 Trade Debtors 24,500 Fixtures and Fittings at cost 1,02,990 Provision for depreciation on: Fixtures and Fittings at 31 March, 2020 63,020 Depreciation 12,074 Stock as at 31 March, 2020 17,750 The following additional information as on 31 March 2020 is available : (i) Insurances have been prepaid by ` 1,120 (ii) Electricity is accrued by ` 1,360 (iii) Rates have been prepaid by ` 5,435. (iv) The provision for bad debts is to be adjusted so that it is 3% of trade debtors. Prepare final accounts. Solution : Saroj Khanna Trading And Profit and Loss Account For The Year Ended 31 March, 2020 Dr. ` Particualrs Opening Stock Purchases Less : Returns 15,654 1,35,680 13,407 To Carriage inwards Sales Less : Returns 2,59,870 5,624 2,54,246 1,22,273 1,04,489 2,54,246 Salaries and Wages 2,54,246 38,521 Discount Allowed 2,306 Gross Profit b/d Carriage Outwards 4,562 Discount Received Less : Prepaid (1,120+5,435) ` Particualrs 11,830 Gross Profit c/d Rent, Rates and Insurance Cr. 25,973 6,555 19,418 1,04,489 1,750 Final Accounts of Non-Corporate Entities Electricity 8.41 11,010 Add : Outstanding 1,360 12,370 Postage, Stationery & Telephone 2,410 Advertising 5,980 Bad Debts 2,008 Depreciation 12,074 Provision for Doubtful Debts 735 Less : Old Provision 512 Net Profit transferred to Capital Account 223 6,367 1,06,239 1,06,239 Note: The words ‘To’ and ‘By’ need not be used Balance Sheet of Saroj Khanna As On 31 March 2020 ` Liabilities Capital Add : Net Profit Less : Drawings Trade Creditors Outstanding for Electricity ` Assets 83,887 Cash in hand 534 6,367 Cash at Bank 4,440 90,254 Trade Debtors 18,440 24,500 71,814 Less : Provision 19,840 Stock in hand 1,360 735 23,765 17,750 Fixtures and Fittings 1,02,990 Less : Provision for Depreciation 63,020 39,970 Prepaid Insurance 1,120 Prepaid Rates 5,435 93,014 93,014 Illustration 4 (Adjusted Purchases) From the undermentioned trial balance of Banerjee, prepare the final accounts for the year ended 31st March, 2020 and the Balance Sheet as at that date: Particulars Debit ` Credit ` 50,000 — 2,10,000 — 45,000 — Returns 1,500 2,500 Wages 45,300 — Salaries 39,000 — Office Expenses 15,400 — Carriage Inwards 1,200 — Carriage Outwards 2,000 — 750 1,200 Land and Buildings Purchases (Adjusted) Stock (March 31, 2020) Discounts 8.42 Financial Accounting: Concepts and Applications Bad Debts 1,200 — Sales — 3,85,000 Capital Account — 1,15,000 Chatterji’s Loan A/c (taken on 1-10-2019 @ 18% p.a.) — 25,000 1,500 — — 1,500 Plant and Machinery 50,000 — Furniture and Fixtures 20,000 — Bills Receivable 20,000 — Sundry Debtors 40,000 — — 25,000 Cash at Bank 16,000 — Office Equipment 12,000 — Bills Payable — 12,350 Expenses Payable — 3,300 5,70,850 5,70,850 Insurance Commission Sundry Creditors The following adjustments be taken care of: (i) Depreciate Land and Buildings @ 6%, Plant and Machinery @ 10%, Office equipment @ 20% and Furniture and Fixtures @ 15%. (ii) Create a provision for bad and doubtful debts at 2% on debtors. (iii) Insurance premium includes ` 250 paid in advance. (iv) Provide interest on capital @ 10% p.a. and salary to Banerjee ` 15,000 p.a. (v) 10% of the final profit is to be kept in General Reserve. Solution : Mr. Banerjee Trading and Profit & Loss Account For The Year Ending on March 31, 2020 Particulars Purchases (Adjusted) Less: Returns Amount ` 2,10,000 2,500 Wages Particulars Sales 2,07,500 Less: Sales Returns Amount ` 3,85,000 1,500 3,83,500 45,300 Carriage inwards 1,200 Gross Profit c/d 1,29,500 3,83,500 3,83,500 Salaries 39,000 Gross Profit b/d Office expenses 15,400 Discount Received 1,200 Commission 1,500 Carriage outwards 2,000 Discount Allowed 750 Insurance Less: Prepaid Bad Debts 1,500 250 1,250 1,200 Provision for Doubtful Debts (2% of ` 40,000) 800 1,29,500 Final Accounts of Non-Corporate Entities 8.43 Interest on Chatterji’s Loan outstanding 2,250 [` 25,000 @ 18% for 6 months] Depreciation on: Land & Buildings 3,000 Plant & Machinery 5,000 Office Equipments 2,400 Furniture & Fixtures 3,000 13,400 Interest on Capital 11,500 Salary to Banerjee 15,000 Transfer to General Reserve 2,965 Net Profit Transferred to Capital Account 26,685 1,32,200 1,32,200 WORKING NOTES (i) Profit ` 29,650 before transfer to General Reserve is arrived as follows : ` [1, 29, 500 + 1, 200 + 1, 500 – 39, 000 – 15, 400 – 2, 000 – 750 – 1, 250 – 1, 200 – 800 – 2, 250 – 13, 400 – 11, 500 – 15, 000) = ` 29, 650] Transferred to General Reserve = ` 29, 650 × (ii) 10 100 = ` 2, 965 Net Profit = ` 29,650 – ` 2,965 = ` 26,685 Balance Sheet of Mr. Bannerji As On March 31, 2020 ` Liabilities ` Assets Bills Payable 12,350 Land and Buildings 50,000 Sundry Creditors 25,000 Less : Depreciation 3,000 Expenses Payable 3,300 Plant and Machinery 50,000 25,000 Less : Depreciation 5,000 Chatterjee’ loan Outstanding Interest 2,250 Furniture and Fixtures General Reserve 2,965 Less : Depreciation Capital 1,15,000 Office Equipment Add : Interest on Capital 11,500 Less : Depreciation Salary 15,000 Current Assets Net Profit 26,685 1,68,185 Less : Provision Bills Receivable Prepaid Insurance Cash at Bank 2,39,050 45,000 20,000 3,000 17,000 12,000 2400 Stock Debtors 47,000 9,600 45,000 40000 800 39,200 20,000 250 16,000 2,39,050 8.44 Financial Accounting: Concepts and Applications Illustration 5 (Application of Revaluation Model: AS-10 PPE) The following is the trial balance extracted from the books of Akhilesh as on 30 September 2019 : Particulars Debit Amount Credit Amount ` ` — 1,00,000 78,000 — Capital Account Plant and Machinery Furniture 2,000 — 60,000 1,27,000 1,000 750 30,000 — 425 800 45,000 25,000 7,550 — 10,000 — 1,200 — — 525 10,000 — Advertisements 2,000 — Cash 6,900 — 2,54,075 2,54,075 Purchases and Sales Returns Opening stock Discount Sundry Debtors/Creditors Salaries Manufacturing wages Carriage outwards Provision for doubtful debts Rent, rates and taxes Prepare trading and profit and loss account for the year ended 30 September 2019 and a balance sheet on that date after taking into account the following adjustments: (a) Closing stock was valued at ` 34,220. (b) Provision for doubtful debts is to be kept at ` 500 (c) Depreciate plant and machinery @ 10% p.a. (d) The proprietor has taken goods worth ` 5,000 for personal use and additionally distributed goods worth ` 1,000 as samples. (e) Purchase of furniture ` 920 has been passed through purchses book. (f) On 30th September, 2019, it was decided by the management to revalue the machine at ` 75,000 before charging depreciation. Solution : Akhilesh Trading And Profit and Loss Account Dr. For the Year Ended 30 September, 2019 ` Particulars Opening Stock Purchases Less : Returns 30,000 Less : Drawings Sales Less : Returns 750 Stock at the end 5,000 54,250 ` Particulars 60,000 59,250 Cr. 1,27,000 1,000 1,26,000 34,220 Final Accounts of Non-Corporate Entities 8.45 Less : Samples 1,000 53,250 Less : Furniture purchased 920 52,330 Manufacturing wages 10,000 Gross Profit c/d 67,890 1,60,220 Salaries 7,550 Rent, rates and taxes 10,000 Carriage outwards 1,200 Advertisement 2,000 Depreciation on Plant and Machinery (75,000 × 10 ÷ 100) 7,500 Discount Allowed 1,60,220 Gross Profit b/d 67,890 Discount Received 800 Provision for bad debts 25 (525–500) 425 Machinery (Loss on Revaluation) 3,000 Advertisements (Samples) 1,000 Net Profit transferred to Capital Account 36,040 68,715 68,715 Balance Sheet of Akhilesh As On 30 September 2019 Liabilities Capital Add : Net Profit ` 1,00,000 36,040 1,36,040 ` Assets Fixed Assets Plant and Machinery 78,000 Less : Loss on Reveluation 3,000 Less : Drawings (Goods withdrawn for personal use) 75,000 5,000 Less : Depreciation 7,500 67,500 Furniture Add : Purchased 2,000 920 2,920 1,31,040 Sundry Creditors 25,000 Current Assets Cash in hand 6,900 Sundry Debtors 45,000 Less : Provision 500 Stock at the end 34,220 1,56,040 1,56,040 Illustration 6 (Application of Revaluation Model: AS-10 PPE) The following is the schedule of balances on 31-3-2020 extracted from the books of Shri Gavaskar: Particualrs Debit ` Credit ` Cash in hand 1,400 — Cash at bank 2,600 — 86,000 — Sundry debtors 44,500 8.46 Financial Accounting: Concepts and Applications Stock as on 1-4-2019 62,000 — Furniture and fixtures 21,400 — Office equipment 16,000 — Buildings 60,000 — Motor car 20,000 — Sundry creditors — 43,000 Loan — 30,000 Reserve for bad debts — 3,000 1,40,000 — Purchase return — 2,600 Sales — 2,30,000 4,200 — 11,000 — Rent for godown 5,500 — Interest on loan 2,700 — Rates and taxes 2,100 — Discount allowed to debtors 2,400 — — 1,600 Freight on purchases 1,200 — Carriage outwards 2,000 — 12,000 — Printing and stationery 1,800 — Electric charges 2,200 — Insurance premium 5,500 — General office expenses 3,000 — Bad debts 2,000 — Bank charges 1,600 — Motor car expenses 3,600 — — 1,62,000 4,72,200 4,72,200 Purchases Sales returns Salaries Discount received from creditors Drawings Capital Account Prepare Trading and Profit & Loss Account for the year ended 31-3-2020 and the Balance Sheet as on that date after making provision for the following: (i) Depreciate: (a) Building by 5%; (b) Furniture and fixture by 10%; (c) Office equipments by 15%; and (d) Motor car by 20%. (ii) Value of stock at the close of the year was ` 44,000. (iii) Reserve for bad debts is to be maintained at 5% of sundry debtors. (iv) Insurance premium includes ` 4,000 paid towards proprietor’s life insurance policy and the balance of the insurance charges cover the period from 1-4-2019 to 30-6-2020. Final Accounts of Non-Corporate Entities 8.47 (v) On 31st March, 2020 it was decided by the management to revalue the office equipments at ` 20,000 before charging current depreciation. Solution : Shri Gavaskar Trading and Profit and Loss Account For the Year Ending 31 March 2020 ` Particulars Opening Stock Purchases Less: Returns 62,000 1,40,000 2,600 Freight on Purchases ` Particulars Sales 2,30,000 Less: Returns 1,37,400 Closing Stock 44,000 69,200 2,69,800 Salaries 11,000 Rent for godown 5,500 Interest on loan 2,700 Rates and Taxes 2,100 Discount allowed 2,400 Carriage outwards 2,000 Printing and stationery 1,800 Electric charges 2,200 Less: Drawings 2,25,800 1,200 Profit & Loss Account (Gross Profit) Insurance premium 4,200 2,69,800 Trading A/c (Gross Profit) Discount Received 69,200 1,600 5,500 4,000 1,500 Less: Prepaid 300 1,200 Office expenses 3,000 Bank charges 1,600 Motor car expenses 3,600 Bad Debts 2,000 Provision for Doubtful Debts (New) Less: Old provision 4,300 3,000 1,300 Depreciation on: Buildings 3,000 Furniture & fixtures 2,140 Office Equipment (3,000 – 600) 2,400 Motor car 4,000 Net Profit transferred to Capital Account 11,540 16,860 70,800 70,800 8.48 Financial Accounting: Concepts and Applications Balance Sheet As At 31st March, 2020 Liabilities Amount ` Assets Amount ` Sundry Creditors 43,000 Cash in hand 1,400 Loan 30,000 Cash at Bank 2,600 Capital Add: Net Profit 1,62,000 16,860 1,78,860 Less: Drawings: LIC Premium Other Drawings Revaluation Reserve Sundry Debtors 86,000 Less: Provision 4,300 Stock at the end (4,000) (12,000) 44,000 Prepaid Insurance 1,62,860 4,000 Less: Excess Depreciation (3,000 – 2,400) (600) 3,400 Furniture and Fixtures 81,700 300 21,400 Less: Depreciation 2,140 Office Equipment 20,000 Less: Depreciation 3,000 17,000 Building Less: Depreciation 60,000 3,000 57,000 Motor Car 20,000 Less: Depreciation 2,39,260 4,000 19,260 16,000 2,39,260 Note: As per AS-10 (PPE), any increase on revaluation should be credited to revaluation reserve and any excess depreciation arising on that account should be charged against revaluation reserve account. Illustration 7 (Calculation of Accrued Interest) From the following balances taken from the Ledger of Ms. Angelina on 31 March, 2020, prepare the Trading And Profit and Loss Account for the year ended 31 March, 2020 and the Balance Sheet on that date : ` ` Sundry Creditors 19,000 Bad debts 100 Building 15,000 Loan from Victoria 2,500 Income Tax 1,025 Sundry Debtors 9,500 Loose Tools 1,000 Investments 6,500 Cash at Bank 16,200 Bad debts Reserve 1,600 Sundry Expenses Bank Interest (credit) Purchases Wages Carriage Inwards Sales Motor Van Cash in hand 1,990 75 1,57,000 10,000 1,120 1,85,000 12,500 335 Rent and Rates Furniture 850 3,000 Stock (1.4.2019) 27,350 Capital 47,390 Discount Allowed 630 Dividend Received 535 Drawings Bills Payable 2,000 10,000 Adjustments : (i) Write off further ` 300 as bad debts out of Sundry Debtors and create a reserve for bad debts at 20% on Debtors. (ii) Dividend accrued and due on Investments is ` 135. Rates paid in advance ` 100 and wages owing ` 450. Final Accounts of Non-Corporate Entities 8.49 (iii) On 31.3.2020, Stock was valued at ` 15,000 and Loose Tools were valued at ` 800. (iv) Write off 5% for depreciation on Building and 40% on Motor Van. (v) Provide for interest at 12% p.a. due on loan taken on 1-6-2019. (vi) Manager is entitled to a commission of 5% on net profits. Solution Ms. Angelina Trading And Profit and Loss Account Dr. For The Year Ended 31 March, 2020 ` Particualrs Opening Stock 27,350 Purchases Wages Add : Outstanding 1,57,000 Cr. ` Particualrs Sales 1,85,000 Closing stock 15,000 10,000 450 10,450 Carriage inwards 1,120 Gross Profit c/d 4,080 2,00,000 Rent and rates Less : Prepaid 850 100 Sundry expenses Gross Profit b/d 750 1,990 Interest on loan [note (i)] 250 Depreciation : On Building @ 5% On Motor van @ 40% On Loose tools 2,00,000 4,080 Bank interest 75 Dividend on investment 535 Add : Accrued & due 135 Net Loss (transferred to Capital 750 670 5,385 Account) 5,000 200 5,950 Discount allowed 630 Bad debts (` 100 + ` 300) 400 Bad debts reserve : New 1,840 Less : Bad debts reserve (Old) 1,600 240 10,210 10,210 Balance Sheet of Ms. Angelina As At 31 March, 2020 ` Liabilities Capital : Opening Balance Less : Net Loss Building 47,390 Less : Depreciation @ 5% 5,385 Motor van 42,005 Less : Drawings Less : Depreciation @ 40% 2,000 Loan from Victoria 1,025 15,000 750 5,000 Investments Add : Dividend accrued & due 7,500 800 Furniture 38,980 2,500 14,250 12,500 Loose tools 40,005 Less : Income tax ` Assets 3,000 6,500 135 6,635 8.50 Financial Accounting: Concepts and Applications Sundry creditors : For Goods 19,000 For Outstanding wages 450 Interest accrued on loan 250 Bills Payable Closing stock Sundry debtors 15,000 9,500 19,700 Less : Bad debts 300 10,000 Less : Reserve for bad 9,200 debts @ 20% 1,840 7,360 Cash at bank 16,200 Cash in hand 335 Prepaid rates 100 71,180 71,180 WORKING NOTES (i) Interest accrued on loan from Victoria on ` 2,500 @ 12% p.a. for 10 months = ` 250. (ii) As there is net loss, the manager is not entitled to commission. Illustration 8 (Adjustment of Purchases and Sales) The following is the Trial Balance of Kanshi Ram on 31 March, 2020 : Particulars Debit ` Credit ` — 8,00,000 Drawings 60,000 — Opening Stock 75,000 — Capital Purchases 15,95,000 — Freight on Purchases 25,000 — Wages (11 months upto 28-2-2020) 66,000 — — 23,10,000 Sales Salaries 1,40,000 — Postage, Telegrams, Telephones 12,000 — Printing and Stationery 18,000 — Miscellaneous Expenses 30,000 — Creditors Investments Discounts Received Debtors Bad Debts — 3,00,000 1,00,000 — — 15,000 2,50,000 — 15,000 — — 8,000 Building 3,00,000 — Machinery 5,00,000 — Provision for Bad Debts Furniture 40,000 — Commission on Sales 45,000 — — 12,000 24,000 — 1,50,000 — 34,45,000 34,45,000 Interest on Investments Insurance (Year upto 31-7-2020) Bank Balance Final Accounts of Non-Corporate Entities 8.51 Adjustments : (i) Closing Stock ` 2,25,000. (ii) Machinery worth ` 45,000 purchased on 1-10-19 was shown as Purchases. Freight paid on the Machinery was ` 5,000, which is included in Freight on Purchases. (iii) Commission is payable at 2.5% on Sales. (iv) Investments were sold at 10% profit, but the entire sales proceeds have been taken as Sales. (v) Write off Bad Debts ` 10,000 and create a provision for Doubtful Debts at 5% of Debtors. (vi) Depreciate Building by 2.5% p.a. and Machinery and Furniture at 10% p.a. Prepare Trading And Profit and Loss Account for the year ending 31 March, 2020 and a Balance Sheet as on that date. Solution Mr. Kanshi Ram Trading And Profit and Loss Account Dr. For The Year Ended 31 March, 2020 ` Particualrs Opening Stock Purchases 75,000 15,95,000 Account Freight on Purchases Less : Transfer to Machinery Account Wages Add : Outstanding Sales Closing Stock 45,000 ` Particualrs Less : Sale of Investments Less : Transfer to Machinery Cr. 23,10,000 1,10,000 22,00,000 2,25,000 15,50,000 25,000 5,000 20,000 66,000 6,000 Gross Profit c/d 72,000 7,08,000 24,25,000 Salaries 1,40,000 24,25,000 Gross Profit b/d 7,08,000 Postage, Telegrams, Telephones 12,000 Interest on Investments 12,000 Printing and Stationery 18,000 Profit on sale of Investments 10,000 30,000 Discounts received 15,000 Miscellaneous Expenses Commission on Sales 45,000 Add : Outstanding 10,000 Insurance Less : Prepaid 55,000 24,000 8,000 Bad Debts 15,000 Add : Further Written off 10,000 16,000 25,000 Provision for Doubtful Debts (5% of ` 2,40,000) Less : Old Provision 12,000 8,000 4,000 Depreciation on : Building Machinery (` 50,000 + ` 2,500) Furniture Net Profit 7,500 52,500 4,000 64,000 3,81,000 7,45,000 7,45,000 8.52 Financial Accounting: Concepts and Applications Balance Sheet of Mr. Kanshi Ram As On 31 March, 2020 ` Liabilities ` Assets Capital 8,00,000 Building 3,00,000 Add : Profit 3,81,000 Less : Depreciation 7,500 2,92,500 11,81,000 Less : Drawings 60,000 11,21,000 Machinery 5,00,000 Additions Creditors 50,000 3,00,000 Outstanding Expenses : Wages 6,000 Commission 10,000 16,000 5,50,000 Less : Depreciation 52,500 Furniture 40,000 Less : Depreciation 4,000 Debtors 4,97,500 36,000 2,50,000 Less : Bad Debts 10,000 2,40,000 Less : Provision for Doubtful Debts 12,000 Prepaid Insurance 2,28,000 8,000 Stock 2,25,000 Bank Balance 1,50,000 14,37,000 14,37,000 Illustration 9 (Notional Value of Rent of the Building) From the following trial balance of Celina prepare Trading and Profit and Loss Account for the year ending 31 March, 2020 and a Balance Sheet as on that date after taking into consideration the adjustments given at the end : Trial Balance As On 31 March, 2020 Particulars Purchases and Sales Wages Capital National Insurance Debit ` Credit ` 6,99,200 7,40,000 900 — — 48,500 300 — Carriage Inwards 400 — Carriage Outwards 500 — Lighting 600 — Rates and Insurance 400 — Stock on 31-3-2020 61,250 — 1,750 — 100 600 30,000 — Debtors and Creditors 6,000 20,000 Furniture 8,000 — Dividend — 300 8,09,400 8,09,400 Cash in hand Discounts Building Final Accounts of Non-Corporate Entities 8.53 Adjustments : (i) Rates and insurance include a premium of ` 300 per annum paid upto 30 September 2020. (ii) National Insurance balance includes employees contribution of ` 150 also. Wages are shown "net" after deducting the above employees contribution. (iii) Owing to the nature of employment some employees are housed in the building of the business, the rented value of which is ` 500 p.a. (iv) Sales as shown in the Trial Balance include the sale of old furniture (on 30 September, 2019) realising ` 200. The book value of this furniture was ` 300 at the commencement and the rate of depreciation on this asset has all along been 20% p.a. (v) The manager is to get a commission of 1/10 of net profits after charging his commission. (vi) Depreciate Building by 5%. Solution Celina Trading And Profit and Loss Account Dr. For The Year Ended 31 March, 2020 ` Particualrs Purchases 6,99,200 Wages : Net paid Add : Employees contribution to National insurance Add : rental value of building Cr. ` Particualrs Sales 7,40,000 Less : Sale of furniture 7,39,800 900 150 500 Carriage inwards 1,550 400 Gross Profit c/d 38,650 7,39,800 National insurance 150 (Employer's contribution) Carriage outwards 500 Rates and insurance 400 Less : Prepaid 150 250 Lighting 600 Discount 100 Loss on sale of furniture 200 7,39,800 Gross Profit b/d 38,650 Discount 600 Dividend 300 Rental value of building occupied by 500 employees 70 Depreciation (i) Building 1,500 (ii) Furniture (1,540 + 30) 1,570 Manager's commission due 3,210 10    35, 310 ×  110  Net Profit 32,100 40,050 40,050 8.54 Financial Accounting: Concepts and Applications Balance Sheet of Celina As On 31 March, 2020 ` Liabilities Sundry creditors 20,000 Manager's commission due 3,210 Capital 48,500 Add : Net profit 32,100 ` Assets Cash in hand 1,750 Sundry Debtors 6,000 Closing stock 80,600 61,250 Prepaid insurance 150 Furniture 8,000 Less : Book value of furniture sold 300 7,700 Less : Depreciation 1,540 Buildings 6,160 30,000 Less : Depreciation 1,500 1,03,810 28,500 1,03,810 WORKING NOTES (i) Employees contribution to national insurance and rental value of building occupied by workers are part of gross wages. (ii) Calculation of depreciation and loss on sale of furniture : (a) Furniture sold : Book value at the beginning 300 Depreciation for 6 months 30 Book value on the date of sale 270 Sale price 200 Loss on sale 70 (b) Furniture in hand (Depreciation 20% on 7,700) Depreciation ` 1,540 + ` 30 1,540 1,570 Illustration 10 (Provident Fund and Goods Lost in Fire) The following is the Trial Balance of Mr. Mahesh as on 31.12.2019. Prepare a Trading and Profit and Loss Account for the year 2019 from it and a Balance Sheet as on 31.12.2019 : Particulars Purchases Opening Stock Salaries Dr. ` Cr. ` 1,80,000 — 10,000 — 6,600 — P.F. remittance including Proprietor's contribution 50% Rent @ 250 p.m. 1,200 2,750 — 29,000 — Wages 3,000 — Furniture and fittings 5,000 — 550 — 1,500 — 10,500 — 900 — Machinery Electricity Trade expenses Debtors Interest on loan Final Accounts of Non-Corporate Entities 8.55 Commission Building 200 — 30,000 — Sales 2,05,000 Loan (10% Interest) 10,000 Creditors 15,000 Capital 55,000 Drawings 5,000 — Cash 1,200 — 2,86,200 2,86,200 (i) On 1.1.2019, machinery worth ` 5,000 was sold for ` 4,000 and credited to machinery account. (ii) Wages include ` 1,000 paid for machinery erection charges. (iii) Purchases include cost of Moped Scooter for ` 5,000. (iv) Proprietor has taken goods costing ` 1,000 for which no entry has been made. (v) Sundry debtors include ` 500 which have become bad. (vi) Provide 10% reserve for bad debts. (vii) Electricity outstanding ` 50. (viii) Goods costing ` 5,000 were destroyed by fire, and insurance claim was received for ` 4,000. (ix) Provide depreciation at 10% on machinery, furniture and moped scooter. Provide depreciation @ 5% on building. (x) Closing stock is ` 12,000. Solution Mr. Mahesh Trading And Profit and Loss Account Dr. For The Year Ended 31 December, 2019 ` Particualrs Opening stock Purchases Less : Cost of the scooter 10,000 1,80,000 Particualrs Sales Profit and Loss Account (Loss by fire) 5,000 Stock at the end Cr. ` 2,05,000 5,000 12,000 1,75,000 Less : Drawings 1,000 Wages 3,000 Less : Erection charges of machinery 1,000 Profit and Loss Account (Gross Profit) 1,74,000 2,000 36,000 2,22,000 Salary paid in cash 5,400 Trading Account (Gross Profit) Add : Provident fund contribution : Insurance Company Employee 600 Employer 600 Rent 6,600 2,750 Add : Outstanding Electricity Add : Outstanding 250 Add : Outstanding 3,000 550 50 Trade expenses Interest 2,22,000 600 1,500 900 100 1,000 36,000 4,000 8.56 Financial Accounting: Concepts and Applications Commission 200 Bad debts 500 Provision for bad debts 1,000 Trading Account (Loss by fire) 5,000 Machinery (Loss on sale) 1,000 Depreciation on : Building Machinery 1,500 2,900 Moped Scooter 500 Furniture 500 Net Profit 5,400 14,200 40,000 40,000 Balance Sheet of Mr. Mahesh As On 31 December, 2019 ` Liabilities ` Assets Capital 55,000 Building Add : Net Profit 14,200 Less : Depreciation 30,000 1,500 28,500 69,200 Less : Drawings 63,200 Machinery Creditors 6,000 15,000 Add : Erection charges 10% Loan 10,000 Outstanding expenses : 100 Rent 250 Electricity 50 400 Less : Depreciation 2,900 Moped Scooter 5,000 Less : Depreciation 600 Employer 600 1,000 29,000 P.F. Contribution : Employee 1,000 30,000 Less : Loss on sales Interest 29,000 Furniture 1,200 Less : Depreciation 500 26,100 4,500 5,000 500 4,500 Stock 12,000 Cash 1,200 Debtors Less : Bad debts 10,500 500 10,000 Less : Provision for doubtful debts Insurance Company 89,800 1,000 9,000 4,000 89,800 Illustration 11 (Commission on profit after charging such commission) From the following balances extracted from the books of Mr. Yellow, prepare Trading and Profit and Loss Account for the year ended 31.3.2020 and a Balance Sheet on that date : ` ` Purchases 71,280 Capital account 60,000 Computer at cost 18,380 Creditors 13,000 Bills payable 10,220 (bought on 31.3.2020) Cash at bank 4,000 Discount 22,000 Cash in hand 2,836 Sales 60,720 Final Accounts of Non-Corporate Entities 8.57 Furniture and fittings at cost 1,540 Rent 12,540 Bills receivable Returns outwards 11,432 Rent due 320 6,720 Trade charges 920 Sundry debtors 34,156 Drawings 5,200 Discount 540 Wages 1,800 Salaries 16,780 Returns inwards 1,000 1,77,692 1,77,692 Adjustments : (i) Stock at the end at cost ` 25,600 (market-value ` 26,200). (ii) ` 6,000 paid to Mrs. Red against Bills payable were debited by mistake to Mr. Green's account and included in the list of sundry debtors. (iii) Travelling expenses paid to sales representatives ` 5,000 for the month of March 2020 were debited to his personal account and included in the list of sundry debtors. (iv) Depreciation on furniture and fittings shall be provided at 10% p.a. (v) Provide for doubtful debts at 5% on sundry debtors. (vi) Goods costing ` 1,500 were used by the proprietor. (vii) Salaries included `12,000 paid to sales representative who is further entitled to a commission of 5% on net sales. (viii) Stationery charges ` 1,200 due on 31.3.2020. (ix) Purchases included opening stock valued at cost ` 7,000. (x) Sales representative further entitled to an extra commission of 5% on net profit after charging his extra commission. Solution Mr. Yellow Trading And Profit and Loss Account Dr. For The Year Ended 31 March, 2020 ` Particualrs Opening stock Purchases Less : Returns 7,000 64,280 ` Particualrs Sales Less : Returns 11,432 Cr. Stock at the end 60,720 1,000 59,720 25,600 52,848 Less : Drawings Wages Gross Profit c/d 1,500 51,348 1,800 25,172 85,320 Salaries 16,780 Travelling expenses 5,000 Salesman's commission (5% on ` 59,720) 2,986 85,320 Gross Profit b/d 25,172 Discount 22,000 8.58 Financial Accounting: Concepts and Applications Stationery charges due 1,200 Rent 12,540 Discount 540 Trade charges 920 Depreciation on furniture and fittings 154 Provision for doubtful debts 1,158 Additional commission to salesman 281 Net Profit transferred to Capital Account 5,613 47,172 47,172 Balance Sheet of Mr. Yellow As On 31 March, 2020 ` Liabilities Yellow's capital 60,000 Less: Drawings 6,700 (5,200+1,500) Add: Net Profit Sundry Creditors Bills Payable (10,220 – 6,000) Computer at cost 18,380 Furniture and fittings 53,300 5,613 ` Assets 1,540 Less: Depreciation 58,913 Stock in hand 13,000 154 1,386 25,600 Sundry debtors 34,156 4,220 Less: Travelling expenses (5,000) 3,267 Less: Payment against Outstanding expenses : Commission to salesman Rent Due Stationery 320 Bills Payable (6,000) 1,200 23,156 Less: Provision for doubtful debts 1,158 21,998 Bills Receivable 6,720 Cash in hand 2,836 Cash at bank 4,000 80,920 80,920 Illustration 12 (Trade Expenses and Office Expenses Given Simultaneously) The following trial balance has been extracted from the books of Ms. Naina. Prepare the final accounts for the year ended 31 March 2020 and a Balance Sheet on that date: Particulars Debit Credit ` ` Drawings 35,000 — Buildings 60,000 — Debtors and creditors 50,000 80,000 3,500 2,900 3,00,000 4,65,000 7,100 5,100 3,000 — Returns Purchases and sales Discount Life insurance Cash 30,000 — Stock (opening) 12,000 — Bad debts Reserve for bad debts Carriage inwards Wages Machinery 5,000 — — 17,000 6,200 27,700 8,00,000 Furniture 60,000 Office Expenses 35,000 Final Accounts of Non-Corporate Entities 8.59 Bank commission 2,000 Bills receivable/payable 60,000 40,000 Trade expenses/Capital 13,500 9,00,000 15,10,000 15,10,000 Adjustments : (i) Depreciate building by 5%; furniture and machinery by 10% p.a. (ii) Trade expenses ` 2,500 and wages ` 3,500 have not been paid as yet. (iii) Allow interest on capital at 5% p.a. (iv) Make provision for doubtful debts at 5%. (v) Machinery includes ` 2,00,000 of a machine purchased on 31 December 2019. Wages include ` 5,700 spent on the installation of machine. (vi) Stock on 31 March 2020 was valued at ` 50,000. Solution : Ms. Naina Trading and Profit and Loss Account Dr. For The Year Ending On 31 March, 2020 ` Particulars Opening Stock Purchases Less : Returns Wages Less : for installation of machine 12,000 3,00,000 2,900 Cr. ` Particulars Sales 4,65,000 Less : Returns 2,97,100 Stock at the end 3,500 4,61,500 50,000 27,700 5,700 22,000 Add : Outstanding 3,500 Carriage inwards Trade expenses Add : Outstanding Gross Profit c/d 25,500 6,200 13,500 2,500 16,000 1,54,700 5,11,500 Office Expenses 35,000 5,11,500 Gross Profit b/d Discount 7,100 Discount Bank commission 2,000 Reserve for bad and doubtful debts Bad debts 5,000 (17,000 – 2,500) 1,54,700 5,100 14,500 Depreciation on : Building 3,000 Machine 65,143 Furniture 6,000 Net Profit c/d 51,057 1,74,300 Interest on Capital 45,000 1,74,300 Net Profit b/d 51,057 Balance of Profit transferred to Capital Account 6,057 51,057 51,057 8.60 Financial Accounting: Concepts and Applications Balance Sheet As On 31 March, 2020 ` Liabilities ` Assets Creditors 80,000 Cash in hand 30,000 Bills Payable 40,000 Bills Receivable 60,000 Outstanding Wages 3,500 Debtors Outstanding Trade Expenses 2,500 Less : Provision Capital 9,00,000 Add : Interest on Capital 60,000 Less : Depreciation 9,51,057 6,000 Machinery 35,000 3,000 54,000 8,00,000 Add : Installation charges 5,700 9,16,057 Less : Life Insurance 47,500 50,000 Furniture 6,057 Less : Drawings 2,500 Stock in hand 45,000 Net Profit 50,000 8,05,700 9,13,057 Less : Depreciation 65,143 Building 60,000 Less : Depreciation 3,000 10,39,057 7,40,557 57,000 10,39,057 FOR YOUR ATTENTION Depreciation on machinery has been calculated as under : Book value of the machinery as per Trial Balance 8,00,000 Add : Installation charges 5,700 8,05,700 10% Depreciation on ` 6,00,000 for one year 60,000 10% Depreciation on ` 2,05,700 (2,00,000 + 5,700) for 3 months 5,143 65,143 Illustration 13 (Interest Received For Late Payment and Application of Revaluation Model: AS-10 PPE) The following is the trial balance of a trader as on 31-3-2020 : Particulars Cash in hand ` ` 8,000 Land and Building 40,000 Plant and Machinery 20,000 Debtors and Creditors 25,000 Stock 1-4-19 10,000 15% Investment 1-4-19 20,000 Purchases and Sales 95,000 1,90,000 Bills Payable and Bills Receivable 15,000 21,000 Wages 8,000 Salaries 16,000 Rent and Rates 15,000 Drawings 5,000 Carriage outward 6,000 60,000 Final Accounts of Non-Corporate Entities 8.61 Customs duty on purchase 16,000 Customs duty payable 25,000 Fire Insurance Premium 15,000 Advertisement 20,000 Provision for bad debt 2,000 Bad debts 6,000 Interest 2,000 Furniture 20,000 Capital 60,000 3,60,000 3,60,000 Additional Information to be adjusted: (i) Stock on 31st March 2020 was valued at ` 60,000. (ii) Bill receivable includes a bill of ` 4,000 which has become bad. (iii) Sale also includes sale of furniture on 1-4-19 for ` 10,000 (Book value ` 12,000) (iv) Wages include ` 6,000 spent on erection of machine on 1-4-19. (v) Depreciate machinery by 10%, furniture by 20%. (vi) Appreciate building by 10%. (vii) Interest includes ` 200 received from a debtor for late payment and balance for investment. (viii) Bad debts recovered ` 500 were taken as receipt from debtors. (ix) On 31st March, 2020, machinery was revalued at ` 25,000 (excluding wages and before charging current year’s depreciation). Prepare Trading and Profit and Loss Account for the year ending 31-3-20 and a Balance Sheet as on that date. Solution : A Trader Trading And Profit and Loss Account Dr. For the Year Ending 31 March 2020 ` Particulars 10,000 Sales Purchases 95,000 Less: for furniture 8,000 Less: For machine 6,000 Custome duty Stock at the end 1,90,000 10,000 1,80,000 60,000 2,000 16,000 Gross profit c/d 1,17,000 2,40,000 2,40,000 Salaries 16,000 Gross profit b/d Rent and rates 15,000 Bad debts recovered Carriage outward 6,000 Building Account Fire Insurance 15,000 (10 % of ` 40,000) Advertisement 20,000 Interest for late payment Bad Debts ` Particulars Opening stock Wages Cr. 6,000 1,17,000 500 4,000 200 8.62 Financial Accounting: Concepts and Applications Add: Bills receivable dishonoured 4,000 Less: Provision for Doubtful debts 10,000 2,000 8,000 Loss on sale of furniture (12,000 – 10,000) 2,000 Depreciation on Machine 2,600 Depreciation on Furniture 1,600 Net profit transferred to capital account Interest on investments (2,000 – 200) 1,800 Add: Outstanding 1,200 3,000 38,500 1,24,700 1,24,700 Balance Sheet As On 31 March 2020 ` Liabilities ` Assets Capital 60,000 Cash in hand Add: Net profit 38,500 Land and Building 98,500 Add: Appreciaton (10%) Less: Drawings 93,500 Plant and Machinery Creditors 60,000 Add: Wages Bills payable 21,000 Customs duty payable 25,000 Revaluation Reserve Less: Excess Depreciation 5,000 8,000 5,000 500 4,500 40,000 4,000 44,000 25,000 6,000 31,000 Less: Depreciation (10%) 3,100 Furniture 20,000 Less: Sale 12,000 27,900 8,000 Less: Depreciation (20%) 1,600 Debtors 6,400 25,000 Add: Bad debts recovered wrongly deducted 500 Investments 25,500 20,000 Accrued interest on investments 1,200 Bills receivable 15,000 Less: Bad Debts 4,000 Stock at the end 11,000 60,000 2,04,000 2,04,000 FOR YOUR ATTENTION Bad debts recovered have been treated as receipt from debtors. It means debtors have been wrongly reduced by ` 500. Hence, the debtors should be increased by making following rectifying entry: Dr. Cr. Debtors Account 500 To Bad Debts Recovered Account 500 And Bad Debts Recovered Account would be Transfered to Profit and Loss Account. Note: As per AS-10 (PPE), any increase on revaluation should be credited to revaluation reserve and any excess depreciation arsing on that account should be charged against revaluation reserve account. Final Accounts of Non-Corporate Entities 8.63 PROFIT AND LOSS APPROPRIATION ACCOUNT The net profit calculated in the Profit and Loss Account is carried down to a new account to record the items of appropriation as against charges against the profit. Such appropriations include interest on capitals, interest on drawings, transfer to reserves, salaries to partners etc. This is achieved by preparing Profit and Loss Appropriation Account. Illustration 14 (Final accounts of a partnership firm) An extract of the trial balance as at 31 Dec. 2019 of the firm of William and Moraes is available. The partners share profits and losses in the proportion of 60% and 40% respectively, with following further stipulations : (i) Each partner is entitled to be paid ` 2,000 p.m. by way of salary; and (ii) Interest at the rate of 15% will be charged on drawings other than salary. Trial Balance as at 31.12.2019 Dr. ` Cr. ` William – 80,000 Moraes – 80,000 Sundry creditors – 35,000 1,82,000 – Goodwill 20,000 – Stock-in-trade (31.12.2019) 42,250 – Sundry debtors 71,450 – Cash in hand 13,300 – 3,000 – Capital Accounts : Fixed assets Staff salary advance Partners’s salaries 48,000 Office expenses outstanding 1,000 Depreciation 18,000 – Staff salaries 20,000 – – 2,40,000 18,000 – 4,36,000 4,36,000 Trading Account (Gross Profit) Office expenses Utilising the following additional information, you are required to prepare : (i) Profit and Loss Account for the year 2019. (ii) Balance Sheet as at 31 December 2019; and (iii) Partners’s Capital Accounts. Additional Information : (a) A persual of the payment vouchers for January 2020 indicates payment of salaries of ` 2,000 and office expenses of ` 8,000, relating to periods before 31.12.2019. (b) Partners have drawings in their accounts as follows : Moraes : on 1.1.2019 ` 20,000 William: on 1.5.2019 ` 20,000 (c) ` 1,000 out of staff salary advance account is to be carried forward to 2020. 8.64 Financial Accounting: Concepts and Applications Solution Dr. M/s. William And Moraes Profit and Loss Account For The Year Ending 31 December 2019 Particulars Staff Salaries Add : Outstanding Office expenses Add : Outstanding ` ` 22,000 2,000 Cr. ` Particulars Gross Profit b/d 2,40,000 24,000 18,000 8,000 Depreciation 26,000 18,000 Profit T/F to P/L Appropriation A/c 1,72,000 2,40,000 2,40,000 Net Profit for the Year Partner’s salaries : 1,72,000 Interest on drawings : Williams 24,000 Moraes 24,000 48,000 Williams 2,000 Moraes 3,000 5,000 Net profit transferred to Partners’s Capital Accounts : Williams 77,400 Moraes 51,600 1,29,000 1,77,000 1,77,000 Balance Sheet As On 31.12.2019 ` Liabilities Capital Accounts : Williams Add : Net Profit Goodwill 1,00,000 Fixed Assets 77,400 Less: Depreciation 1,77,400 Less : Drawings 20,000 1,57,400 Less : Interest on Drawings Moraes Add : Net profit ` Assets 2,000 1,55,400 20,000 2,00,000 18,000 1,82,000 Stock in trade 42,250 Sundry debtors 71,450 Cash in hand 13,300 Prepaid salary 1,000 1,00,000 51,600 1,51,600 Less : Drawings 20,000 1,31,600 Less : Interest on Drawings 3,000 Sundry creditors 1,28,600 35,000 Outstanding Office expenses 9,000 Salaries 2,000 11,000 3,30,000 3,30,000 Final Accounts of Non-Corporate Entities 8.65 Illustration 15 The following is the trial balance of MNS, a partnership firm as on 31 March 2020: Debit (`) Credit (`) M 40,000 — N — 10,000 S — 25,000 M — 1,00,000 N — 80,000 S — 50,000 22,000 — 1,45,000 20,000 Sales and Returns 12,000 5,68,000 Wages and Salaries 15,000 — 1,12,000 — 11,000 — Office Salaries 8,000 — Rent and Rates 6,000 — Insurance (including ` 5,000 for the year ending 30-9-2020) 7,500 — Printing and Stationery 4,000 — General Expenses 3,500 — Cash in hand 17,000 — Patents 22,000 — — 2,000 Postage 9,000 — Repair to Machinery 6,250 — Plant and Machinery 1,30,000 — Buildings 2,50,000 — Computer Purchased on 1-1-2020 1,25,000 — 45,000 — Sundry Creditors — 80,000 Outstanding Expenses — 15,000 4,750 — — 45,000 9,95,000 9,95,000 Current Accounts: Capital Accounts: Opening Stock Purchases and Returns Bills Receivable Power Discount Sundry Debtors Electricity Loan from Q Adjustments (i) Interest on Capitals at 5%. (ii) Profits and Losses are to be shared in the ratio of 2:2:1. (iii) Provision for doubtful debts is to be made at 6% on debtors. 8.66 Financial Accounting: Concepts and Applications (iv) Of the bills receivables, a bill of ` 10,000 is dishonoured. No entry has been made in the books of account; of the ` 10,000 only ` 5,000 is likely to be recovered. (v) The firm received some stationery items on 31 March 2020 amounting to ` 2,000 but the bill for the same is not recorded in the books of account. (vi) Depreciate plant and machinery at 15% p.a., building at 10% p.a. and computer at 20% p.a. (vii) Stock on 31 March 2020 was ` 80,000 at cost though the market value of the same was ` 70,000. Prepare final accounts for the accounting period ending on 31 March 2020. Solution: Dr. Trading and Profit and Loss Account for the year Ending on 31 March 2020 ` Particulars Opening Stock Purchases Less: Returns 22,000 1,45,000 20,000 Wages and Salaries 15,000 Power 11,000 Gross Profit c/d ` Particulars Sales Less: Returns 1,25,000 Cr. Stock at the end 5,68,000 12,000 5,56,000 70,000 4,53,000 6,26,000 6,26,000 Office Salaries 8,000 Gross Profit b/d Rates and taxes 6,000 Discount Insurance 7,500 Less: Prepaid 2,500 Printing and Stationery 4,000 Add: Unrecorded Bills 2,000 4,53,000 2,000 5,000 6,000 General Expenses 3,500 Repair to Machinery 6,250 Postage and Telegrams 9,000 Electricity 4,750 Depreciation on: Plant and Machinery 19,500 Building 25,000 Computer 6,250 Bad Debts written off 5,000 Provision for Doubtful Debts 2,700 Net Profit transferred to Profit and Loss Appropriation Account 3,48,050 4,55,000 Dr. 4,55,000 Profit and Loss Appropriation Account ` Particulars Interest on Capital Particulars Profit and Loss Account M 3,000 N 4,500 Cr. ` 3,48,050 Final Accounts of Non-Corporate Entities S 8.67 3,750 11,250 Profit for Distribution (3,48,050 – 11,250 = 3,36,800) M 1,34,720 N 1,34,720 S 67,360 3,48,050 3,48,050 Balance Sheet As at 31 March 2020 ` Liabilities Capital Accounts ` Assets Building M 1,00,000 N 80,000 Plant and Machinery S 50,000 Less: Depreciation 2,30,000 Current Accounts M: Interest on Capital Net Profit N: Interest on Capital Net Profit S: Interest on Capital Net Profit Less: Depreciation Computer Less: Depreciation (40,000) 3,000 1,34,720 97,720 10,000 4,500 1,34,720 Loan from Q 1,30,000 19,500 1,10,500 1,25,000 6,250 1,18,750 Stock at the end 70,000 Prepaid Insurance 2,500 Sundry Debtors 45,000 Add: 10,000 Bills Dishonoured 55,000 Less: Bad Debts 5,000 50,000 96,110 Less: Provision on ` 45,000 2,700 47,300 45,000 Sundry Creditors: For Goods 2,25,000 22,000 3,750 67,360 25,000 Patents 1,49,220 25,000 2,50,000 Bills Receivable 80,000 For Stationery 2,000 For Expenses 15,000 Less: Dishonoured Cash in hand 7,15,050 1,12,000 10,000 1,02,000 17,000 7,15,050 Illustration 16 (Partners are allowed interest and salaries) Shah, Rukh and Khan carried on a retail business in partnership. The partnership agreement provides that: (1) The partners are to be credited at the end of each year with salaries of ` 10,000 to Shah and ` 5,000 each to Rukh and Khan, and with interest at the rate of 9% p.a. on the balance at the credit of their respective accounts at the commencement of the year. (2) No interest to be charged on drawings. (3) After charging salaries and interest on capital, profits and losses are to be divided in the following ratio : 5 : 3 : 2. 8.68 Financial Accounting: Concepts and Applications The Trial Balance of the firm as at 31 March 2020, was as follows: Particualrs Dr. ` Cr. ` – – Shah – 80,000 Rukh – 50,000 Khan – 30,000 Shah – 16,000 Rukh – 12,000 Khan – 8,000 – 4,65,000 Capital Accounts: 1.4.2019: Current Accounts: 1.4.2019 Sales Trade Creditors 47,000 Furniture and Fittings 22,000 – Freehold Premises (Purchased during the year) 60,000 – Leasehold Premises 45,000 – Addition & Alternation to Leasehold Premises (1-4-2019) 25,000 – 2,80,000 – Stock as on 1.4.2019 42,000 – Salaries and Wages 64,000 – Office and Trade Expenses 45,200 – Rent, Rates and Insurance 10,500 – 3,500 – 30,600 – – 500 43,700 – Purchases Professional charges Debtors Provision for Doubtful Debts Balance at Bank Drawings: – Shah 17,000 – Rukh 11,000 – Khan 9,000 – 7,08,500 7,08,500 You are given the following additional information: (1) Stock on 31st March, 2020 was valued at ` 36,000. (2) A debtor of ` 600 is to be written off and provision against the remaining debtors should be 5%. (3) Provide for the following: Salaries and Wages : ` 6,000; office and trade expenses ` 400. (4) Prepaid rates etc. ` 2,500. (5) Depreciate Furniture and Fittings by 10%. (6) Professional charges include ` 2,500 fees paid in respect of the acquisition of the leasehold premises, whose fees are to be capitalised. (7) The cost and the additions and alternations to the leasehold premises are to be written off over twenty five years, commencing on 1st January, in the year in which the premises were acquired. Final Accounts of Non-Corporate Entities 8.69 You are required to prepare: (a) The Trading and Profit & Loss Account for the year ended 31 March 2020. (b) The Balance Sheet as on the date. (c) Partner’s Current Accounts. Solution: Dr. Trading and Profit and Loss Account For the Year Ended 31 March, 2020 ` Particulars Opening Stock 42,000 Purchases 2,80,000 Gross Profit c/d 1,79,000 Particulars Sales Closing Stock 5,01,000 Salaries & Wages paid 64,000 Add: Outstanding 6,000 Office and Trade Expenses Add: Outstanding 4,65,000 36,000 5,01,000 Gross Profit b/d 1,79,000 70,000 47,600 10,500 Less: Prepaid 2,500 Professional Charges 3,500 Less: Transferred to Leasehold Premises 2,500 Bad Debts ` 45,200 2,400 Rent, Rates & Insurance Cr. 8,000 1,000 600 Add: New provision for Doubtful debts Less: Old provision 1,500 500 1,600 Depreciation on: Furniture & Fittings 2,200 Leasehold Premises 2,900 Net Profit c/d 5,100 45,700 1,79,000 1,79,000 Profit & Loss Appropria tion Account For the Year Ended 31 March 2020 ` Particulars Salaries to Partners: Particulars Net Profit b/d Shah 10,000 Rukh 5,000 Khan 5,000 20,000 Interest on Partners’ Capitals (including Current A/c, Opening Balance at 9%): Shah 8,640 Rukh 5,580 Khan 3,420 17,640 ` 45,700 8.70 Financial Accounting: Concepts and Applications Profit transferred to Shah 4,030 Rukh 2,418 Khan 1,612 8,060 45,700 45,700 Shah’s Current Account ` Particualrs ` Drawings 17,000 Balance b/d 16,000 Balance c/d 21,670 Profit & Loss Appropriation Account: Particualrs Salaries 10,000 Interest 8,640 Profit 4,030 38,670 38,670 Rukh’s Current Account ` Particulars Particulars ` 12,000 Drawings 11,000 Balance b/d Balance c/d 13,998 Profit & Loss Appropriation Account: Salaries 5,000 Interest 5,580 Profit 2,418 24,998 24,998 Khan’s Current Account ` Particulars Particulars ` 8,000 Drawings 9,000 Balance b/d Balance c/d 9,032 Profit & Loss Appropriation Account: Salaries 5,000 Interest 3,420 Profit 1,612 18,032 18,032 Balance Sheet As On 31 March 2020 ` Liabilities Capitals: ` Assets Bank Shah 80,000 Rukh 50,000 Khan 30,000 Debtors Less: Bad Debts 1,60,000 Current Accounts: 43,700 20,600 600 20,000 Less: Provision for Doubtful Shah 21,670 Debts Rukh 13,998 Stock Khan 9,032 Trade creditors 44,700 Prepaid Rent & Rates 37,000 Furniture & Fittings Outstanding Expenses: Less: Depreciation Office & Trade Exps. 2,400 Salaries & Wages 6,000 8,400 1,500 18,500 36,000 2,500 22,000 2,200 Leasehold 45,000 Add: Additions 27,500 19,800 72,500 Less: Depreciation Freehold Premises 2,50,100 2,900 69,600 60,000 2,50,100 Final Accounts of Non-Corporate Entities 8.71 EXPLANATORY NOTES (1) Interest on each partner’s capital account is charged on the balances including the balances on current accounts. (2) An amount of ` 2,500 for fees paid in respect of the acquisition of the leasehold premises is capitalised. It means it is to be added to the cost of leasehold premises. (3) Cost of leasehold premises will be 45,000 + 25,000 + 2,500 = ` 72,500 (4) Amount to be written off every year will be: 72, 500 = 2, 900. It should be debited to Profit & Loss Account and deducted from cost of the leasehold premises 25 in the Balance Sheet. (5) Capital accounts are maintained as per fixed capital method. Illustration 17 (Goods sent on Approval and GST) Hemlata, the proprietor-cum-accountant of general store, has prepared the following trial balance as on 31 March 2020 : Purchases Sales Stock of goods on 1.4.2019 Cash in hand Cash at Bank Hemlata’s Capital Drawings Rates and taxes Salaries Postages and telephones Salesmen’s commission Insurance Advertising Furniture and fittings Printing and stationery Motor car Bad debts Discounts General expenses Carriage inwards Carriage outwards Wages Outstanding liability for expenses Sundry creditors Sundry debtors Output CGST Output SGST Input CGST Input SGST Debit ` Credit ` 3,10,000 – 50,000 2,100 12,000 – 4,000 5,000 32,000 11,500 35,000 9,000 17,000 22,000 3,000 48,000 2,000 4,000 14,000 10,000 22,000 20,000 11,000 – 1,00,000 – 4,15,000 – – – 2,88,600 – – – – – – – – – – – – – – – – – 40,000 – 2,000 4,000 3,000 3,000 7,49,600 7,49,600 Required: Prepare Trading and Profit and Loss Account for the year ended on March 31, 2020 and Balance Sheet as on that date after taking into consideration the following information : (i) Cost of goods in stocks as on 31 March 2020, ` 1,45,000. (ii) Hemlata had withdrawn goods worth ` 5,000 during the year which were purchased on 5% CGST and 5% SGST each. 8.72 Financial Accounting: Concepts and Applications (iii) Printing and stationery expenses of ` 11,000 relating to 2018-19 accounting year had not been provided in that year but were paid in this year by debiting outstanding liabilities. (iv) Purchases include purchase of furniture worth ` 10,000. (v) Debtors include ` 5,000 bad debts. (vi) Creditors include a balance of ` 4,000 to the credit of Zarina; it has been settled only for ` 1,000. (vii) Sales include goods worth ` 15,000 sent to Kishore Kumar on approval and remaining unsold as on 31 March 2020. The cost of the goods was ` 10,000. These goods involve CGST and SGST @5% each. (viii) Provision for bad debts is to be created at 5% on sundry debtors. (ix) Depreciate furniture and fittings by 10%; motor car by 20%. (x) The salesmen are entitled to a commission of 10% on total sales excluding GST. Solution Hemlata Trading And Profit and Loss Account For The Year Ended 31 March, 2020 Dr. Cr. ` Particulars Opening stock Purchases Less : Furniture 50,000 3,10,000 5,000 4,15,000 Closing stock 15,000 2,95,000 20,000 Carriage inwards 10,000 approval 10,000 1,55,000 1,80,000 5,55,000 Salaries 32,000 Rent and taxes 5,000 Postages and telephone 5,55,000 Gross Profit b/d Income from settlement of creditors 1,80,000 3,000 11,500 Insurance 9,000 Printing & stationery 3,000 General expenses 14,000 Carriage outwards 22,000 Discounts Bad debts 4,00,000 1,45,000 Add : Cost of the goods sent on Wages Gross Profit c/d Sales Less : Goods sent on approval 10,000 3,00,000 Less : Drawings (on cost) ` Particulars 4,000 2,000 Add : Further bad debts 5,000 Add : New Provision 3,925 Advertising 10,925 17,000 Salesmen’s commission 35,000 Add : Outstanding 5,000 40,000 Depreciation on : Furniture 3,200 Machinery 9,600 Net Profit 12,800 1,775 1,83,000 1,83,000 Final Accounts of Non-Corporate Entities 8.73 Balance Sheet Of Hemlata As On 31 March, 2020 ` Liabilities Capital : ` Assets Input CGST Opening balance 2,88,600 Add : Net Profit 1,775 1,500 Furniture & fittings 22,000 Addition during the year 10,000 2,90,375 32,000 Less : Outstanding liability for Less : Depreciation printing etc., of 2018-19 11,000 3,200 Motar car Less : Drawings (4,000 + 5,500) 48,000 Less : Depreciation including GST 9,500 2,69,875 28,800 9,600 Stock in trade at cost 38,400 1,55,000 Sundry debtors Sundry creditors 37,000 Liability for expenses 5,000 As per trial balance 1,00,000 Less : Sales on approval (Salesmen’s commission) including GST Output SGST (Payable) 16,500 500 83,500 Less: Bad debts 5,000 78,500 Less: Provision for doubtful debts 3,925 74,575 Cash at bank 12,000 Cash in hand 2,100 3,12,375 3,12,375 WORKING NOTES: Journal Entries (i) Sales (Approval) A/c Dr. 15,000 Output CGST A/c Dr. 750 Output SGST A/c Dr. 750 To Debtors A/c (ii) Drawings A/c 16,500 Dr. 5,500 To Purchases A/c 5,000 To Input CGST A/c 250 To Input SGST A/c 250 Statement Showing Adjustments of GST Particulars IGST CGST SGST Output GST — 2,000 4,000 Adjustments on account of sales on Approval — (750) (750) — 1,250 3,250 — 3,000 3,000 Output GST (Tax Liability) (A) Input GST Adjustments on account of Drawing in goods Input GST (Net Input Tax Credit) (B) — (250) (250) — 2,750 2,750 — 1,500 (Dr.) 500 (Cr.) (i) Surplus on account of input CGST can not be set-off against output SGST and remaining balance to be shown on Assets side to take benefit in next accounting year. (ii) There is shortfall in Input SGST while setting-off ouput SGST against Input SGST i.e. [2,750 – 3,250 = (500)] to be recorded on liability side of balance sheet. 8.74 Financial Accounting: Concepts and Applications Illustration 18 From the following trial balance of Mr. Pankaj, prepare final accounts for the year ended 31 March 2020 after giving effect to adjustments : ` Opening stock 1,00,000 Debtors 40,000 Bank 2,000 Sundry assets 2,02,500 ` Capital 1,60,000 Creditors 35,100 Sales 3,02,000 Discount 4,000 Bad debts 1,000 Provision for Accrued income 1,500 bad & doubtful debts 6,000 Salaries outstanding 2,000 Purchases 1,23,500 Depreciation 4,500 Income tax Loan 10,000 10,500 Salaries 4,600 Wages 28,000 Interest on loan for six months 1,000 5,19,100 5,19,100 Adjustments : (i) Closing stock on 31 March, 2020 amounted to ` 20,000. (ii) There was a loss of stock by fire ` 25,000 on 20 March 2020. However a claim of ` 10,000 was admitted by the insurance company. (iii) Debtors include ` 5,000 due from Khushi and creditors include ` 10,000 due to Khushi. (iv) Sales include ` 6,000 sent to a credit customer on approval on 25 March, 2020. Profit equal to 1/5 of cost had been added to determine the sale price. However, customer has not given his approval till 31 March, 2020. (v) Debtors include bad debts amounting to ` 3,000; create reserve for doubtful debts @ 5%. (vi) ` 1,200 paid as rent was debited to landlord’s account and included in debtors. (vii) Furniture of the book value of ` 6,000 on 31.3.2020 was sold off at ` 4,000 in part exchange for new furniture costing ` 5,000. However, a net invoice of ` 1,000 was passed through the purchase day book. (viii) A dishonoured cheque for ` 5,000 has not been recorded. It is expected that only 20% of the amount will be recovered. Solution Pankaj Dr. Trading Account For The Year Ending On 31 March, 2020 ` Particulars Opening Stock Purchases Less: Wrongly recorded (ii) 1,00,000 1,23,500 1,000 ` Particulars Sales Less : Sales on approval basis (iv) 1,22,500 Cr. 3,02,000 6,000 2,96,000 Loss of stock by fire 25,000 20,000 Wages 28,000 Stock-in-hand Profit and Loss Account 95,500 Stock on approval (iv) 5,000 (Gross Profit) 3,46,000 3,46,000 Final Accounts of Non-Corporate Entities 8.75 Dr. Cr. Profit and Loss Account For The Year Ending On 31 March 2020 ` Particulars ` Particulars Salaries 4,600 Trading Account (Gross Profit) Depreciation 4,500 Discount Interest on loan 95,500 4,000 1,000 Add : Outstanding 1,000 Loss of stock by fire 2,000 15,000 Rent 1,200 Loss on sale of furniture 2,000 Provision for doubtful debts (i) 3,240 Capital Account (Net Profit) 66,960 99,500 99,500 Balance Sheet Of Mr. Pankaj As At 31 March, 2020 ` Liabilities Capital Less: Income Tax 1,60,000 Sundry Assets 10,500 66,960 Salaries outstanding 2,16,460 2,000 2,000 Less: Dishonoured cheque (iii) 5,000 3,000 10,000 Creditors Less: Common debts on approval 5,000 Accrued income Debtors 1,000 11,000 35,100 5,000 2,01,500 20,000 1,500 Insurance Company Bank balance Add: Interest Outstanding 1,000 Closing Stock: in hand Bank overdraft : Loan 2,02,500 Less: Adjustment (ii) 1,49,500 Add: Profit ` Assets 10,000 40,000 Less: Approval (6,000) Landlord (1,200) Bad debts (3,000) Common debts (5,000) 30,100 24,800 Less: Provision 1,240 23,560 Add: Recoverable amount of dishonoured cheque (iii) 2,62,560 1,000 24,560 2,62,560 (i) Provision For Doubtful Debts Particulars Bad Debts ` Particulars ` 1,000 Balance b/d 6,000 Profit and Loss Account 3,240 (appearing in trial balance) Bad Debts 3,000 (Balancing Figure) (appearing in adjustments) Bad Debts 4,000 (dishonoured cheque) Balance c/d 1,240 9,240 9,240 8.76 Financial Accounting: Concepts and Applications (ii) Net entry for adjustment relating to furniture account is : Loss On Sale Of Furniture Account Dr. 2,000 To Furniture Account 1,000 To Purchases Account 1,000 (iii) Adjustment entry for dishonoured cheque is : Debtors Account Dr. 1,000 Bad Debts Account Dr. 4,000 To Bank Account 5,000 (iv) Journal entries for adjusting sale on approval basis are as follows : (a) Sales Account Dr. 6,000 To Debtors Account (b) Stock on Approval Account To Trading Account 6,000 Dr. 5,000 5,000 Illustration 19 (Overcasting of Stock) On 31 March, 2020 the following Trial Balance was prepared from the books of Mr. Maneet: Particulars Debit Credit ` ` 30,600 10,000 5,000 — Plant and Machinery 75,000 — Purchases (Adjusted) 1,90,000 — — 70,000 Freehold Premises 50,000 — Salaries 21,000 — Wages 24,400 — Postage and Stationery 1,750 — Carriage in 1,750 — Carriage out 1,000 — 950 — — 350 Office charges 1,500 — Cash at Bank 5,300 — Cash in Hand 800 — Bills Payable — 7,000 General Reserve — 20,000 Sales — 3,31,700 30,000 — 4,39,050 4,39,050 Debtors and Creditors Bills Receivables Capital Account Bad debts Bad debts provision Closing stock Final Accounts of Non-Corporate Entities 8.77 The following adjustments are required: (a) Maneet gets a salary of ` 12,000 p.a. (b) Allows interest on capital @ 10% p.a. (c) Bed debts provision is 2½% on Debtors. (d) 10% of net profit to be carried to General Reserve. (e) It was discovered in April 2019 that the stock as on 31st March, 2018 were overcast by ` 1,000. However, no entry was passed in April 2019. (f) Depreciate Plant and machinery @10% and Freehold Premises @ 2% p.a. Prepare the Trading and Profit and Loss Account of the firm for the year ended 31 March, 2020 and a Balance Sheet as at that date. Solution : Maneet Trading And Profit and Loss Account For The Year Ending 31 March, 2020 Dr. ` Particulars Purchases (adjusted) Less: Overvalued Stock 1,90,000 1,000 Wages Carriage Inwards Gross Profit c/d Particulars Sales ` 3,31,700 1,89,000 24,400 1,750 1,16,550 3,31,700 Salary 21,000 Salary to Maneet 12,000 Interest on Capital Cr. 3,31,700 Gross Profit b/d 1,16,550 6,900 10% of 69,000 (70, 000  1, 000) Postage and Stationery 1,750 Carriage Outward 1,000 Bad Debts 950 Provision for Doubtful Debts (765  350) 415 Office Charges 1,500 Depreciation on: Plant and Machinery 7,500 Furniture and Freehold Premises 1,000 General Reserve 6,254 (10% of ` 62,535) Net Profit transferred to Maneet’ Capital Account 56,281 (62,535 – 6,254) 1,16,550 1,16,550 8.78 Financial Accounting: Concepts and Applications Balance Sheet As At 31 March 2020 ` Liabilities Capital 70,000 Less: Overvalued Stock 1,000 Add: Salaries Add: Interest on Capital Add: Net Profit Addition Creditors Bills Payable 30,600 Less: Provision 765 Plant and Machinery 12,000 Less: Depreciation 7,500 6,900 Freehold Premises 50,000 56,281 Less: Depreciation 1,000 20,000 6,254 Debtors 69,000 1,44,181 General Reserve ` Assets 29,835 75,000 Bills Receivable 67,500 49,000 5,000 Cash in hand 800 26,254 Cash at Bank 5,300 10,000 Stock at the end 30,000 7,000 1,87,435 1,87,435 Illustration 20 (Sales on Approval) Given below is the Trial Balance of Mr. Alok, a trader, as on 31-3-2020 : Particulars Cash in hand Debit Credit ` ` 5,000 — Land and Building 80,000 — Plant and Machinery 50,000 — Debtors & Creditors 25,000 40,000 Stock on 1-4-2019 10,000 — 15% Investments on 1-4-2019 20,000 — Purchases and Sales 95,000 1,90,000 — 20,000 28,000 — Bank Overdraft Wages Salaries 16,000 — Rent, Rates and Taxes 15,000 — 6,000 — Bad Debts Drawings Bills Receivable & Bills Payable Carriage Inwards Custom Duty on Purchases Life Insurance Premium Advertisement 5,000 — 15,000 46,000 6,000 — 16,000 — 4,000 — 30,000 — Provision for Doubtful Debts — 2,000 Interest on Investments — 2,000 Sundry Expenses 11,000 — Furniture 20,000 — — 1,57,000 4,57,000 4,57,000 Capital Final Accounts of Non-Corporate Entities 8.79 Additional information: (i) Stock on 31-3-2020 was valued at ` 40,000. (ii) Included in debtors are ` 8,000 due from Ram and included in creditors are ` 6,000 due to Ram. (iii) Bills Receivables include a bill of ` 5,000 received from Varun, which has been dishonoured. (iv) Sales include ` 5,000 for the goods sold on approval basis. Goods are sold at a profit of 25% on cost. Approval was not received upto 31-3-2020. (v) Wages include ` 5,000 spent on the erection of machinery. (vi) Create a provision for doubtful debts at 5% on debtors. (vii) Prepaid rates and taxes amounted to ` 2,000. (viii) Depreciate machinery by 10%. (ix) Advertisement includes ` 20,000 spent at the time of launching a new product. It is policy of the business to write off such expense in 5 years Prepare Trading and Profit and Loss Account for the year ended 31 March, 2020 and a Balance Sheet as on that date. Solution : Alok Dr. Trading And Profit and Loss Account For the Year Ending on 31 March 2020 ` Particulars Opening Stock Wages Less: For Erection of Machinery 10,000 28,000 5,000 Cr. ` Particulars Sales Less: Sale on approval 1,90,000 5,000 23,000 1,85,000 Stock at the end (Capitalised) 40,000 Add: Cost of the Purchases 95,000 Carriage inwards goods sold on approval 4,000 6,000 Custom Duty on Purchases 16,000 Gross Profit c/d 79,000 2,29,000 Salaries Rent, Rates and Taxes Less: Prepaid 16,000 15,000 2,000 Bad Debts 30,000 Less: Carried Forward 16,000 Depreciation of Machines Net Profit transferred to Capital Account 2,29,000 Gross Profit b/d Interest on Investments 13,000 6,000 Advertisement Trade Expenses 44,000 79,000 2,000 Add: Accrued Provision for Doubtful 14,000 Debts (old) 11,000 Less: New Provision 3,000 1,000 2,000 950 1,050 5,500 17,550 83,050 83,050 8.80 Financial Accounting: Concepts and Applications Balance Sheet As On 31 March 2020 ` Liabilities Capital 1,57,000 Add: Net Profit 17,550 1,74,550 Less: Life Insurance Policy (5,000) 1,65,550 Creditors Less: Due to Ram Land and Building Plant and Machinery Add: Wages (4,000) Drawings 40,000 6,000 34,000 ` Assets 80,000 50,000 5,000 55,000 Less: Depreciation 5,500 49,500 Furniture 20,000 Stock at the end (40, 000 + 4, 000) 44,000 15% Investments Add: Interest accrued Bank overdraft 20,000 Bills Receivable Bills Payable 46,000 Less : Dishonoured Debtors Less : Sale on Approval 20,000 1,000 21,000 15,000 5,000 10,000 25,000 5,000 20,000 Less : Due from Ram 6,000 14,000 Add : Varun (for Bills Dishonoured) 5,000 19,000 Less: Provision 950 18,050 Cash in hand 5,000 Prepaid Tax etc. 2,000 Advertisement Suspense Account (Deferred) 2,65,550 16,000 2,65,550 Illustration 21 (General Manager’s and Works Manager’s Commission) From the following balances and information for the year ended 31 December 2019, prepare the final accounts of Priyanka Jhoonjhoonwala: Debit Plant and Machinery ` 18,000 Depreciation on plant Credit Capital Sales and machinery 2,000 Bank overdraft Repairs to plant 1,600 Salaries outstanding Wages Salaries Income Tax 28,000 4,000 500 Cash 2,000 Land 24,500 Depreciation on building Purchases less returns 2,500 1,23,500 Accrued income 1,500 Bills Receivable 30,000 Bad debts 1,000 ` 60,000 2,49,000 13,800 2,000 Bills payable 3,000 Provision for bad debts 6,000 Discount on purchases 4,000 Creditors 23,300 Final Accounts of Non-Corporate Entities 8.81 Debtors 35,000 Opening stock 37,000 Building 50,000 3,61,100 3,61,100 Adjustments: (i) Stock on 31-12-2019: Market value ` 40,000; Cost price ` 30,000 (ii) Write off ` 3,000 bad debts and maintain a provision of 5% on debtors. (iii) Goods costing ` 5,000 were sent to a customer on sale or return basis on 30 December 2019. These were recorded as actual sale. The rate of gross profit was 1/6 of sale. (iv) ` 1,200 paid as rent of the office were debited to Landlord account and were included in the list of sundry debtors. (v) General manager is to be given commission at 10% after charging the commission of works manager and his own on net profits. (vi) Works manager is to be given commission at 5% after charging the commission of general manager and his own on net profits. Solution : Dr. Priyanka Jhoonjhoonwala Trading And Profit and Loss Account For The Year Ending 31 December 2019 ` Particulars Opening stock 37,000 Purchases less returns Cr. ` Particulars Sales 1,23,500 Less: Goods sent on sale Wages 28,000 or approval at sale price Gross profit c/d 89,500 2,49,000 6,000 Stock in hand at cost 30,000 Stock with customers at cost 5,000 2,78,000 2,78,000 Depreciation on plant and machinery 2,000 Gross profit b/d Repairs to plant 1,600 Provision for bad debts 6,000 Salaries 4,000 Less: New provision 1,240 Depreciation on building 2,500 Discount on purchases Rent of office 1,200 Bad debts 1,000 Additional 3,000 2,43,000 89,500 4,760 4,000 4,000 General manage commission 7,214 Works manager’s commission 3,607 Net profit transferred to capital account 72,139 98,260 98,260 8.82 Financial Accounting: Concepts and Applications Balance Sheet As On 31 December 2019 ` Liabilities ` Assets Capital 60,000 Land 24,500 Add Net Profit 72,139 Plant and Machinery 18,000 Building 50,000 1,32,139 Less: Income Tax 500 1,31,639 Bank Overdraft 13,800 Creditors 23,300 Debtors 35,000 Less: Rent to Landlord Wrongly included 1,200 33,800 Bills Payable 3,000 Less: Goods sent on approval Outstanding Salaries 2,000 (5,000 + 1/5 of 5,000) Outstanding Works Manager’s Commission 3,607 Less: Additional bad debts Outstanding General Manager’s Commission 7,214 6,000 27,800 3,000 24,800 Less: Provision for bad debts 1,240 23,560 Bills Receivable 30,000 Accrued Income 1,500 Stock in hand 30,000 Stock with customers on approval basis at cost 5,000 Cash in hand 2,000 1,84,560 1,84,560 FOR YOUR ATTENTION Commission payable to general manager and works manager being 10% and 5% of net profits after charging their respective share of commission of 15% (10%  and 5%) . Hence, out of 115%, General manager’s share is 10% and works manager’ss share is 5% which can be shown as: General Manager : 82, 960 × Works Manager : 82,960 × 10 115 = ` 7, 214 5 = ` 3, 607 115 ADDITIONAL ADJUSTMENTS 1. Stock used for personal use treated as sales Effect: (a) Deduct from sales in the Trading Account (b) Deduct from Debtors in the Assets side in the Balance Sheet (c) Deduct from the purchase (d) Add to drawings or deduct from capital (e) The journal entries are : (i) Sales Account To Debtors Account Dr. Final Accounts of Non-Corporate Entities 8.83 (ii) Drawings Account Dr. To Purchases Account 2. Stock used as stationery The journal entry is Stationery Account Dr. To Opening Stock Or To Purchase Account Effect : (i) Deduct from the opening stock or Purchases Account in the Trading Account (ii) Show in the debit side of the profit and Loss Account 3. Purchases of next accounting period not recorded in the current year but included in the stock. No Journal Entry Effect : The closing stock must be reduced both in (a) The Trading Account and (b) In the Assets in the Balance Sheet 4. Purchases of Current Period neither recorded nor included in the stock The adjustment entry is Purchases Account Dr. To Sundry Creditors Account Effect: (i) Add to purchases in the Trading Account (ii) Add to sundry creditors in the Liabilities side in the Balance Sheet (iii) Add to closing stock in the Trading Account (iv) Add to closing stock in the Assets side 5. (a)Purchases of the current accounting period recorded but not included in the stock because of goods received or delivered late No Adjustment Entry Effect : Increase the closing stock in the trading account and show it the Assets side in the Balance Sheet. (b) But if the above purchases relate to the next accounting period. The Adjustment Entry : Creditors Account To Purchases Account Effect : (a) Deduct from purchases (b) Deduct from creditors. 8.84 Financial Accounting: Concepts and Applications 6. Purchases of personal use not recorded in the books. The Adjustment Entry (a) When paid in cash Drawings Account Dr. To Cash/Bank Account (b) When payable Drawings Account Dr. To Creditors Account Effect : (i) Reduce the capital by the amount of drawings (ii) Reduce the Cash/Bank paid or Increase in the creditors, if payable Note: No entry is needed if paid by the owner himself. 7. Purchases of Assets included in the Purchases (of Goods) The adjustment entry is : Asset Account Dr. To Purchases Account Effect : (a) Add to particular asset in the balance sheet (b) Reduce the purchases in the Trading Account 8. Revenue Expenses wrongly shown as capital expenditure e.g. painting of building charged to Building Account The adjustment entry is: Painting of Building Account Dr. To Building Account Effect : (a) To be deducted from building in the Assets side in the Balance Sheet (b) To be shown as painting expenses in the debit side of profit and Loss Account. Illustration 22 (Omitted Purchases) From the following, prepare the Trading and Profit & Loss Account for the year ended 31 March 2020 and Balance Sheet of Mr. Z as on that date: ` Capital 50,450 Trade Creditors 10,000 Bills Payable 1,000 General Reserve 5,000 Provision for Bad and Doubtful Debts 1,000 Sales Discount Allowed Stock at April 1, 2019 75,000 750 15,000 Final Accounts of Non-Corporate Entities 8.85 Purchases 48,000 Discount Received 400 Building 10,000 Machinery, Plant and Furniture (Cost ` 25,000) 15,000 Book Debts 16,400 Bank Balance (Dr.) 3,400 Investment, 4% Government Loan at par 10,000 Bills Receivable 5,050 Salaries and wages 13,000 Audit Fee 2,000 Office Expenses 2,000 Repairs and Renewals 1,800 Interest Paid 700 Bad Debts Recovered 250 Additional Information: (a) The value of Stock on hand as at 31 March, 2020 was ` 18,000; it included goods costing ` 900 received on 30 March, 2020 in respect of which supplier’s bill had not yet been received. (b) Goods of the cost of ` 1,500 were sent to a customer on sale on approval basis but recorded in Sales Book at Sales Price ` 2,000. Approval for the sales were not received till 31 March, 2020. (c) Provisions were made for doubtful debts to the extent of ` 400 and for depreciation on Building at 2% per annum. (d) Machinery, Plant and Furniture were depreciated at 20% on the diminishing value; Mr. Z however considered that the proper method would be 8% on the original cost and wanted to adopt it from April 01, 2018. WORKING NOTES 1. Goods received but supplier’s bill not received. The goods are related to current year (2019-20) Purchases not recorded. The entry should be— Purchases .................... Dr. 900 To Trade Creditors 900 Effects to be recorded (a) Add ` 900 to Purchases and (b) Add ` 900 to Trade Creditors 2. 3. Goods sent on approval but not yet approved (a) The selling price ` 2,000 should be deducted from sales and from Debtors. (b) The cost price of the goods, that is `, 1,500 should be added to Closing Stock. Plant, Machinery & Furniture — Change of Method of Depreciation. We should try to know the value on 1-12018. ` W.D.V. on 1.4.2019 on 15,000 Add Back : Depreciation already charged 20 of ` 15,000 80 3,750 [as per Trial Balance] 8.86 Financial Accounting: Concepts and Applications or 15,000 × 100 80 18,750 W.D.V. on 1.4.2018 ` Depreciation for 2018-19 [Last year]: Already provided 3,750 To be provided at 8% of ` 25,000 2,000 Excess Depreciation to be Written back 1,750 Annual Depreciation for 2019-20 = 8% of ` 25,000 = ` 2,000 4. Interest Received on Investment 4% of ` 10,000 = ` 400 Main Solution: Mr. Z Trading And Profit and Loss Account for the year ended 31 March, 2020 ` Particulars Opening Stock Purchase Add : Purchae not recorded (WN1) 15,000 48,000 900 Gross Profit c/d ` Particulars Sales 75,000 Less : Selling Price of Goods 48,900 28,600 sent for Approval, but not yet approved 2,000 Closing Stock 18,000 73,000 Add: Cost Price of Goods sent on approval with Customers 1,500 92,500 19,500 92,500 Salaries & Wages 13,000 Office Expenses 2,000 Discounts Received 400 Repairs & Renewals 1,800 Bad Debt Recovered 250 Discount Allowed 750 Audit Fees 2,000 Interest Paid 700 Deperciation: Building Machinery, Plant & Furniture Gross Profit b/d 28,600 Provision for Doubtful Debts: Opening Provision Less: New Provision 1,000 400 Interest on Investment (accrued) 200 2,000 Net Profit transferred to Capital A/c 400 Excess Depreciation Written back 2,200 600 1,750 (WN3) 9,550 32,000 32,000 Balance Sheet As On 31 March 2020 ` Liabilities Capital: Opening Balance Add: Net Profit Building 50,450 9,550 Less: Depreciation 60,000 ` Assets Machinery, Plant & Furniture 10,000 200 15,000 9,800 Final Accounts of Non-Corporate Entities 8.87 General Reserve Trade Creditors Add: Unrecorded amount for purchases Bills Payable 5,000 10,000 900 Added Back—Excess Depreciation Provided 10,900 1,000 1,750 16,750 Less: Current year’s depreciation Stock Add: Goods on Approval lying unapproved Book Debts Less: Goods sent on Approval 2,000 14,750 18,000 1,500 19,500 16,400 2,000 14,400 Less: Provision for Doubtful Debts 400 Bills Receivable Investment in 4% Govt Loan Add: Accrued Interest Receivable Cash at Bank 76,900 14,000 5,050 10,000 400 10,400 3,400 76,900 Illustration 23 (Bad Debts Recovered Recorded As Cash Sales.) From the following balances extracted from the books of a trader on December 31, 2019, prepare a Trading and Profit and Loss Account for the year ended on that date and also a Balance Sheet as at that date: ` Credit Balances ` Drawings Account 7,100 Capital Account 42,500 Plant and Machinery 9,500 Sales Stock on 01-01-2019 14,600 Debit Balances Purchases 1,03,620 Purchase Return 2,910 Bank Overdraft 1,200 Sales Return 2,100 Creditors General Expenses 2,000 Provision for Doubtful Debts Wages 2,400 Rent and Rates 3,200 Bad Debts 1,720 Debtors Cash in Hand 1,19,060 10,000 1,050 30,000 480 1,76,720 Additional Information: (i) Provide 10% depreciation on Plant and Machinery. (ii) Provision for Doubtful Debts is to be increased to 5% of Debtors. (iii) A credit sale of ` 2,000 has not been recorded in the books. 1,76,720 8.88 Financial Accounting: Concepts and Applications (iv) Plant and Machinery worth ` 1,000 purchased during the year (on September 30, 2019) has been included in Purchases. (v) Stock on, 31-12-2019 has been valued at ` 17,300. This does not include the value of the Plant and Machinery bought on 30-09-2019. (vi) Wages includes ` 200 for installation of Plant. (vii) Goods costing ` 600 have been stolen by a dishonest employee. (viii) ` 510 received from a Debtor whose balance was written off as bad has been recorded as cash sale. (ix) A sales Return of ` 500 was not entered in the accounts though it was duly taken in the stock. (x) Goods (cost price ` 720; minimum sale price ` 900) was consigned to an agent. But those remain still unsold. [B.Com. Hons.] Solution: Dr. Trading and Profit & Loss Account for the year ended 31st December, 2019 ` Particulars Opening Stock Purchases 14,600 1,03,620 Sales 1,19,060 Less: Sales Return 2,910 included in Sales 600 1,16,460 510 1,15,950 1,00,110 Add: Unrecorded Credit Sale Less: Cost of Plant & Machinery included in Purchases 2,600 Less : Bad Debts recovered 1,00,710 Less: Goods stolen (at cost) ` Particulars (Note 1) Less: Purchases Return Cr. Closing Stock 2,000 1,17,950 17,300 1,000 99,110 Less: Cost of Goods Sent on Consignment Wages Less: Installation Cost of Plant 720 98,390 2,400 200 Gross Profit c/d 2,200 20,060 1,35,250 1,35,250 General Expenses 2,000 Gross Profit b/d Rent & Rates 3,200 Bad Debts Recovered Bad Debts 1,720 Goods Stolen 20,060 510 600 Provision for Doubtful Debts: New Provision 1,575 Less: Existing Provision 1,050 Depreciation on Plant & Machinery (Note) Capital Account (Net Profit) 525 980 11,545 20,570 20,570 Final Accounts of Non-Corporate Entities 8.89 Balance Sheet as on 31st December, 2019 ` Liabilities Bank Overdraft 1,200 Creditors 10,000 Capital: ` Assets Cash in Hand 480 Debtors 30,000 Add: Unrecorded Credit Sale Opening Balance 42,500 Add: Net Profit 11,545 32,000 Less: Unrecorded Sales Return 54,045 Less: Drawings 7,100 2,000 500 31,500 46,945 Less: Provision for Doubtful Debts 1,575 Stock on Consignment (at Cost) 29,925 720 Stock 17,300 Plant & Machinery 9,500 Add: Purchase not included 1,000 Add: Installation charges 200 10,700 Less: Depreciation (Note) 58,145 980 9,720 58,145 WORKING NOTES 1. ` Sales Return As per Trial Balance 2,100 Add: Sales Return not recorded 500 (also deducted from Debtors) 2,600 2. Depreciation on Plant & Machinery On existing Plant and Machinery for full year 9,500 × 10 = 950 100 On New Purchase (1000 + 200) for 3 months [30-9-19 to 31-12-19] 1,200 × 10 3 30 × = 100 12 980 Illustration 24 (GST) From the following Trial Balance of Sri Narayan, you are required to prepare a Trading and Profit & Loss Account for the year ended 31st March 2020 and a Balance Sheet as on that date: Debit Balance ` Credit Balances Stock on 1 -4-2019 70,000 Capital Plant and Machinery 50,000 Wages outstanding ` 2,00,000 4,000 Rent 3,000 Sales 5,00,000 Depreciation on Plant & Machinery 5,000 Creditors 45,000 Drawings 40,000 Bills Payable 16,000 Wages 20,000 Discount (Cr.) 12,000 2,000 Bank Overdraft 9,000 Commission (Cr.) 8,000 Income Tax Salary for 11 months 11,000 8.90 Financial Accounting: Concepts and Applications Cash 5,000 Buildings Purchase returns 5,000 Output IGST 6,000 8,000 Output CGST 4,000 3,00,000 Output SGST 4,000 1,60,000 Depreciation on Buildings Purchases Debtors 80,000 Bills Receivable 30,000 Discount (Dr.) 2,000 Carriage Inwards 4,000 Bad debts 6,000 Sales returns 3,000 Input IGST 8,000 Input CGST 3,000 Input SGST 3,000 8,13,000 8,13,000 Adjustments: (i) Stock on 31 March 2020 was ` 96,000. (ii) Goods costing ` 6,000 plus IGST @12% were destroyed by fire and the Insurance company accepted a claim for ` 3,600. (iii) ` 1,600 paid as rent of the office was debited to Landlord account and was included in the list of Debtors. (iv) Write off further bad debts ` 4,000; maintain ` 3,220 as provision for bad debts on debtors. (v) One month’s salary was outstanding. Solution: Trading And Profit and Loss Account for the year ended 31 March, 2020 Dr. Cr. ` Particulars Opening Stock Purchases 70,000 Sales 3,00,000 Less: Returns Less: Loss by fire 6,000 Closing Stock Less: Returns 5,000 Carriage Inwards 5,00,000 3,000 4,97,000 96,000 2,89,000 4,000 Wages 20,000 Gross Profit c/d 2,10,000 5,93,000 Salaries ` Particulars 11,000 Add: Outstanding 1,000 Rent 3,000 Add: Debited to Landlord 1,600 Discount Gross Profit b/d 12,000 6,000 Add: Further bad debts 4,000 10,000 Discount Commission 4,600 2,000 Bad debts 5,93,000 2,10,000 12,000 8,000 Final Accounts of Non-Corporate Entities 8.91 Add: Net provision for Bad debts 3,220 13,220 Depreciation on: Plant & Machinery 5,000 Buildings 8,000 Loss by fire 3,120 Net Profit transferred to Capital A/c 1,82,060 2,30,000 2,30,000 Balance Sheet As On 31 March, 2020 ` Liabilities Bills Payable 16,000 Bank Overdraft 9,000 Creditors 45,000 Outstanding Expenses: Cash 5,000 Bills Receivable 30,000 Debtors 80,000 Less: Rent included Salary 1,000 Wages 4,000 Capital ` Assets 1,600 78,400 5,000 Less: Bad debts 4,000 2,00,000 Less: Draw.ings 74,400 40,000 Less: Provision for B.D. 1,60,000 Less: Income tax Insurance Company 2,000 1,58,000 Add: Net Profit 1,82,060 3,220 3,40,060 Output CGST (Payable) 360 Output SGST (Payable) 360 71,180 3,600 Stock 96,000 Plant & Machinery 50,000 Buildings 1,60,000 4,15,780 4,15,780 WORKING NOTES: Journal entries for goods destroyed by fire: (a) Loss by fire A/c Dr. 6,720 To Purchases A/c 6,000 To Input IGST A/c (b) Insurance company A/c Profit & Loss (Loss) A/c 720 Dr. 3,600 Dr. 3,120 To Loss by fire A/c 6,720 Statement Showing Adjustment of GST Particulars ` IGST ` CGST ` SGST Output GST (Tax Liability) 6,000 4,000 4,000 (7,280) (3,000) (3,000) (1,280) 1,000 1,000 1,280 (640) (640) — 360 360 Input tax credit [IGST (8000 – 720)] Surplus of IGST can be set-off against output CGST and output SGST (assumed equally) Output CGST/SGST to be shown as liability 8.92 Financial Accounting: Concepts and Applications Illustration 25 From the following particulars presented by Virat, prepare a Trading Account, Profit & Loss Account for the year ended 31 March, 2020 and Balance Sheet as on that date: ` Debit Balance Plant & Machinery 1,00,000 Drawings 36,000 Purchases 1,20,000 Sales (Net) 4,00,000 Capital 1,00,000 Creditors 40,000 20,000 Sundry Debtors 80,000 Bank Overdraft Wages 20,000 Provision for Bad debts Carriage 6,000 Salaries 14,000 Rent 12,000 Repairs ` Credit Balances 4,000 Cash credit 20,000 Bills Payable 16,000 6,000 Insurance 10,000 Opening Stock 24,000 Land & Buildings 80,000 Furniture 20,000 Discount 40,000 Suspense A/c 32,000 6,00,000 6,00,000 Adjustment: (i) Closing Stock ` 60,000. (ii) Purchases include purchase of materials used for the construction of building ` 10,000. (iii) Sales include sale of furniture at a selling price of ` 2,000 (book value ` 4,000). (iv) Purchased a plant for ` 10,000, wrongly debited to purchase Account. (v) A sale of goods to a customer not debited to customers account ` 32,000. (vi) Stock destroyed by fire amounted ` 20,000. Insurance Company paid only ` 16,000. (vii) Wages include ` 6,000 incurred for the erection of a machinery. (viii) The proprietor Mr. S. Tendulkar took goods for his own use from the business amounted to ` 2,000. (ix) Rent included ` 2,000 paid for Mrs. S. Tendulkar’s residential portion. (x) Purchase of stationery for ` 200 was debited to repairs Account. (xi) A customer’s cheque returned dishonoured wrongly debited to Discount Account ` 2,000. Solution: Dr. Trading And Profit and Loss Account of Virat for the year ended 31 March, 2020 ` Particulars Opening Stock Purchases Less: Building 24,000 1,20,000 10,000 1,10,000 Cr. ` Particulars Sales Less: Furniture Closing Stock 4,00,000 2,000 3,98,000 60,000 Final Accounts of Non-Corporate Entities Less: Drawings 8.93 2,000 Profit and Loss Account 1,08,000 Less: Plant & Machinery 10,000 Wages 20,000 Less: Plant & Machinery 6,000 Carriage 4,000 (Loss on Stock Destroyed by fire) 98,000 14,000 6,000 Gross profit c/d 3,20,000 4,62,000 Salaries 14,000 Rent 12,000 Less: Drawings 2,000 Repairs 6,000 Less: Stationery 200 Insurance 4,62,000 Gross Profit b/d 3,20,000 Provision for bad debts 4,000 10,000 5,800 10,000 Discount 40,000 Less: Cheque Dishonoured 2,000 Loss on sale of furniture 38,000 2,000 Stationery 200 Trading Account (Loss of stock by fire) 4,000 Net Profit transferred to Capital A/c 2,40,000 3,24,000 3,24,000 Balance Sheet of Mr. S. Tendulkar As On 31 March, 2020 ` Liabilities Capital 1,00,000 Plant & Machinery Add: Net Profit 2,40,000 Add: Wages 3,40,000 Less: Drawings 36,000 Purchase 2,000 Rent 2,000 40,000 ` Assests 1,00,000 6,000 1,06,000 3,00,000 Add: Additions 10,000 Land & Building 80,000 Add: Additions 10,000 20,000 Creditors 40,000 Furniture Bank Overdraft 20,000 Less: Sale of furniture Cash Credit 20,000 Stock Bills Payable 16,000 Sundry Debtors Add: Cheque Dishonoured 4,000 1,16,000 90,000 16,000 60,000 80,000 2,000 82,000 Add: Suspense 32,000 Suspense Account 32,000 Less: Debtors 32,000 3,96,000 Illustration 26 (Omitted Purchases and GST with inter state transaction) The following is the Trial Balance of Mr. Lal as at 31st March 2020 : 1,14,000 Nil 3,96,000 8.94 Financial Accounting: Concepts and Applications Particulars Lal’s Capital Opening Stock Purchases and Sales Returns Freight and Carriage Dr. Amount Cr. Amount ` ` — 86,690 46,800 — 3,21,700 3,89,600 8,600 5,800 18,600 — Rent and Taxes 5,700 — Salaries and wages 9,300 — 24,000 14,800 — 20,000 Sundry Debtors and Creditors Bank Loan @ 6% p.a. Bank Interest on Loan Printing and Advertising Miscellaneous Income 900 — 14,600 — — 250 Cash at Bank 8.000 — Discount 1.800 3,190 Furniture and Fittings 5,000 — 11,450 — Insurance 1,300 — Postage and Telegrams 2330 — General Expenses Cash in hand 380 — Travelling Expenses 870 — 40,000 — Drawings Output IGST 5,000 Output CGST 2,000 Output SGST 2,000 Input IGST 3,800 Input CGST 2,100 Input SGST 2,100 5,29,330 5,29,330 The following adjustments should be made : (i) Included amongst the Debtors is ` 3,000 due from Anand and included among the creditors ` 1,000 due to him. (ii) Provision for Bad and Doubtful Debts to be created at 5% and Reserve for Discount 2% on Sundry Debtors. (iii) Depreciate Furniture and Fittings by 10%. (iv) Personal Purchases amounting to ` 600 had been included in the Purchases Day Book. These goods were purchased from supplier who’s business was situated outside the state of Mr. Lal. Therefore IGST was applicable @ 9% (v) Interest on Bank Loan shall be provided for the whole year. (vi) One quarter of the amount of Printing and Advertising is to be carried forward to next year. (vii) Credit purchase invoice amounting to ` 400 had been omitted from the books these goods involve 4% CGST and 4% SGST. (viii) Stock on 31st March, 2020 was ` 78,600. Prepare Trading and Profit and Loss Account for the year ended 31st March, 2020 and Balance Sheet as on that date. [B.Com. (Hons.) Sem. I, 2014 Delhi, Modified] Final Accounts of Non-Corporate Entities 8.95 Solution: Trading And Profit and Loss Account of Mr. Lal For The Year Ended 31 March, 2020 Dr. ` Particulars Opening Stock Purchases 46,800 3,21,700 Less: Returns ` Particulars Sales Returns 5,800 Cr. Stock-at the end 3,89,600 8,600 3,81,000 (8) 78,600 3,15,900 Less: Drawings(4) 600 Add: Omitted 3,15,300 Invoice(7) 400 3,15,700 Freight and Carriage 18,600 Gross Profit 78,500 4,59,600 4,59,600 Rent and Taxes 5,700 Gross Profit Salaries and Wages 9,300 Miscellaneous Income Interest on Bank Loan 900 Add: Outstanding (5) 300 Printing and Advertising: 78,500 250 Discount 3,190 1,200 14,600 Less: Prepaid 3,650 Discount 10,950 1,800 General Expenses 11,450 Insurance 1,300 Postage and Telegrams 2,330 Travelling Expenses 870 Depreciation on furniture and fittings (3) 500 Provision for Bad Debts(2) 1,150 Provision for Discount(2) 437 Net profit transferred and to Capital Account 34,953 81,940 81,940 Balance Sheet As on 31 March 2020 ` Liabilities Capital 86,690 Less: Drawings 40,000 Furniture and fittings (10% of ` 5,000) 46,690 Sundry Debtors Less: Depreciation Less: Personal Purchases 654 Common Debt 46,036 Add: Net Profits Sundry Creditiors Less: Common Debts Less: Provision for Bad Debts 80,989 (5% on ` 23,000) 14,800 500 4,500 24,000 1,000 1,150 21,850 1,000 432 5,000 23,000 34,953 Less: Provision for Discount 437 21,413 (2% on ` 21,850) 13,800 Add: Omitted Invoice ` Assets 14,232 Stock in hand (8) 78,600 8.96 Financial Accounting: Concepts and Applications 6% Bank Loan 20,000 Interest outstanding on bank loan 300 Output IGST Payable 1,022 Prepaid printing and Advertising (6) 3650 Cash in hand 380 Cost at Bank 8,000 1,16,543 1,16,543 Note: Numbers in brackets indicate the respective numbers of adjustments in the question. WORKING NOTES: Journal entries: (i) Drawings A/c Dr. 654 To Purchases A/c 600 To Input IGST A/c 54 (ii) Purchases A/c Dr. 400 Input CGST A/c Dr. 16 Input SGST A/c Dr. 16 To Creditors A/c 432 Statement Showing Adjustment of GST Particulars Output GST (Tax Liability) (A) Input GST (Gross Tax Credit) IGST CGST SGST 5,000 2,000 2,000 3,800 2,100 2,100 (54) 16 16 3,746 2,116 2,116 (1,254) 116 116 116 (116) — 116 — (116) 1,022 — — Adjustments on account of Drawings and omitted purchases Net Input GST (Net input tax credit) Balance (B – A) Surplus of CGST and SGST to be set-off against IGST (section 49 of GST Act 2017) Output IGST Payable Illustration 27 From the following particulars, prepare the Trading and Profit & Loss Account for the year ended 31st December, 2019 and the Balance Sheet as on that date : Particulars ` Particulars ` Building 5,00,000 Loans (1-1-2019) 3,00,000 Machinery 2,20,000 Captial 5,20,000 Furniture 1,00,000 Creditors 4,00,000 Bank 90,000 Purchase Returns 1,00,000 Cash 10,000 Sales Debtors 5,00,000 Provident Fund Deducted Opening Stock 1,20,000 from Salaries Purchases Sales Return Rent 25,00,000 1,20,000 60,000 Establishment 1,60,000 Interest (10%) 20,000 Electricity 10,000 Phone 10,000 32,20,000 10,000 Final Accounts of Non-Corporate Entities 8.97 Commission 60,000 Insurance Premium 10,000 Bad debts 20,000 Bills Receivable 40,000 45,50,000 45,50,000 Adjustments: Provide depreciation on Building @ 5%, Machinery @ 15% and Furniture @ 10%. Stock was not taken on 31st December, 2019 but only on 7/1/2020. The transactions from 1/1/2020 to 7/1/2020 are : Sales ` 2,50,000, Purchase ` 1,50,000. Stock on 7/1/2020 ` 1,80,000 and rate of Gross Profit being 20%. During the year machinery of the value of ` 1,00,000 was destroyed by the fire and the insurance claim was settled at ` 80,000 and credited to Machinery A/C. Also provide Employer's share of P.F. ` 10,000, Provision for Bad debts 5%, Commission of the Manager @ 10% on net profit after providing such commission. [B.Com. (Hons.) Sem. I, 2016 Delhi, Modified] Solution: Trading And Profit and Loss Account for the Year ending 31 December 2019 Dr. ` Particulars Opening Stock Purchases Less: Returns 1,20,000 25,00,000 1,00,000 Gross Profit c/d Sales 60,000 1,60,000 Interest 20,000 Add: Due 10,000 1,20,000 31,00,000 Stock at the end (See Working Note) 2,30,000 33,30,000 Gross Profit b/d Insurance Company 8,10,000 80,000 30,000 Electricity 10,000 Phone 10,000 Commission 60,000 Insurance Premium 10,000 Bad debts 20,000 Provision for Bad Debts 25,000 Loss by fire 32,20,000 24,00,000 33,30,000 Establishment ` Particulars Less: Returns 8,10,000 Rent Cr. 1,00,000 Depreciation on: Building 25,000 Machinery 30,000 Furniture 10,000 65,000 Employer contribution to Provident Fund 10,000 Manager Commission 30,000 Net Profit transferred to Capital Account 3,00,000 8,90,000 8,90,000 8.98 Financial Accounting: Concepts and Applications Balance Sheet As At 31 December 2019 ` Liabilities Capital 5,20,000 Building Add: Net Profit 3,00,000 Less: Depreciation 8,20,000 Machinery 3,00,000 Less: Depreciation 10% Loan Outstanding Interest 10,000 Less: Depreciation Provident Fund: Debtors 10,000 Add: Outstanding 10,000 Outstanding Commission Creditors 500,000 25,000 4,75,000 2,00,000 30,000 Furniture Contribution to Balance given ` Assets 1,70,000 1,00,000 10,000 90,000 5,00,000 Less: Provision 25,000 4,75,000 20,000 Bills Receivable 40,000 30,000 Stock 2,30,000 4,00,000 Bank 90,000 Cash in Hand 10,000 15,80,000 15,80,000 WORKING NOTES (i) Value of Closing Stock As on 31 December 2019 ` Stock-taking on 7-1-2020 1,80,000 Less: Purchase (From 1-1-20 to 7-1-20) 1,50,000 30,000 Add: Cost of Goods sold during 1-1-20 to 7-1-20 Sale 2,50,000 Less: Profit Margin 50,000 2,00,000 2,30,000 (ii) Provision for Doubtful Debts ` Debtors As on 31-12-2019 5,00,000 Provision at 5% on ` 5,00,000 25,000 (iii) Depreciation on Machinery ` Machine 2,20,000 Less: Loss by fire 1,00,000 1,20,000 Add: Insurance claim 80,000 2,00,000 Depreciation on ` 2,00,000 at 15% 30,000 The amount of insurance received should have been credited to insurance claim but wrongly credited to machinery account. The rectification entry should be: Machinery Account To Insurance Co. Dr. 80,000 80,000 Final Accounts of Non-Corporate Entities 8.99 (iv) Manager’s Commission 10% Net Commission after charging Commission means 3,30,000  10 of Net Profit 110 10  30,000 110 (v) Interest on 10% Loan ` 10% Loan 3,00,000 Interest at 10% 30,000 Less: Given in Trial Balance 20,000 Accured /oustanding 10,000 Illustration 28 From the following Trial Balance of a trader on March 31st, 2020, prepare Trading and Profit and Loss Account for the year ending 31st March, 2020 and Balance Sheet as at that date after giving effect to the undermentioned adjustments: Debit Balances Amount Credit Balances ` Drawings 6,000 Amount ` Bank Overdraft 25,000 Wages 15,500 Interest on Investment 5,800 Stock (1.4.2019) 12,800 Bills Payable 4,600 Loan to X 4,000 Interest on loan to X Rent 5,000 Capital General Expenses 1,480 Reserve for bad and Investments Purchases Freight Charges Goodwill 60,000 1,60,000 2,100 6,200 Rate and Taxes 1,800 Sales Return 2,100 3,700 Postage and Telegram 3,800 Land and Buildings 25,000 Plant and Machinery 10,000 Sundry Debtors 16,500 Bad Debts Total Sundry Creditors 250 2,30,000 12,590 900 Cash and Bank Balance Packing Charges Sales 1,00,000 40,000 Bills Receivable Insurance doubtful debts 320 400 1,280 3,78,560 3,78,560 8.100 Financial Accounting: Concepts and Applications Adjustments: (a) Closing Stock as on 31.3.2020 ` 16,000. (b) Goods worth ` 700 were sent on 25.3.2020 as “Sale on Approval basis” for ` 800 and the approval was not received before the end of the month. (c) 20% of the Goodwill is to be written off. (d) Further bad debts were estimated at ` 350. Increase reserve for bad debts to ` 1,500. (e) Depreciate Land and Building by 3% and Plant and Machinery by 10%. (f) Goods worth ` 800 were distributed as free samples. [B.Com. (Hons.) Sem. I, 2017 Delhi, Modified] Solution: Dr. Trading and Profit and Loss Account For The Year Ending 31st March 2020 ` Particulars Opening Stock 12,800 Less: Free Samples Sales 1,60,000 800 Wages 1,59,200 2,100 Gross Profit c/d Less: Goods sent for Approval Stock at the end Add: Returns from Approval (cost) 2,100 800 2,27,100 16,000 700 16,700 54,200 2,43,800 2,43,800 Rent 5,000 Gross Profit b/d General Expenses 1,480 Interest on Investment Rates and Taxes 1,800 Interest on Loan to X Insurance 54,200 5,800 320 900 Postage 3,800 Packing Charges 400 Bad Debts 1,280 Additional 350 Reserve for Bad Debts (1500 – 250) 2,30,000 2,27,900 15,500 Freight Charges ` Particulars Less: Sales Returns Purchases Cr. 1,630 1,250 Depreciation : Land and Building 750 Plant and Machinery 1,000 Goodwill 8,000 Free Samples (costs) Net Profit 800 33,510 60,320 60,320 Final Accounts of Non-Corporate Entities 8.101 Balance Sheet As At 31st March 2020 ` Liabilities Capital 1,00,000 Add : Net Profit 33,510 1,33,510 Less : Drawings 6,000 1,27,510 Bank Overdraft 25,000 Bills Payable 4,600 Creditors 12,590 ` Assets Land and Building (25,000 – 750) 24,250 Plant and Machinery (10,000 – 1,000) 9,000 Goodwill (40,000 – 8,000) 32,000 Stock at the end (16,000 + 700) 16,700 Investment 60,000 Loan to ‘X’ 4,000 Bills Receivables 6,200 Debtors Less: Sale on Approval 16,500 800 15,700 Less: New Bad Debts 350 15,350 Less: Reserve for Doubtful Debts 1,500 13,850 Cash in hand and at Bank 1,69,700 3,700 1,69,700 Illustration 29 From the following Trial Balance of Geeta, you are required to prepare: (i) Trading and Profit and Loss Account for the year ended on 31st March, 2017, and (ii) Balance Sheet as on that date. ` Debit Balances Stock on 1-4-2016 Plant and Machinery 70,000 3,50,000 ` Credit Balances Capital 3,00,000 Wages Outstanding 4,000 Rent 30,000 Sales Depreciation on Plant and Machinery 15,000 Creditors 45,000 Wages 20,000 Bills Payable 16,000 Salary for 11 months 11,000 Discount 12,000 27,000 Commission Cash Purchases Debtors 5,00,000 8,000 2,70,000 80,000 Discount 2,000 Carriage Inwards 4,000 Bad debts 6,000 8,85,000 8,85,000 Adjustments : (i) Stock on 31st March, 2017 was ` 96,000. (ii) Stock destroyed by fire was ` 6,000 and the Insurance Company accepted a claim for ` 3,600. 8.102 Financial Accounting: Concepts and Applications (iii) ` 1,600 paid as rent of the office was debited to Landlord account (included in Debtors). (iv) Write off further bad debts ` 4,000. Sales include sales on return basis. Approval for sale of ` 2,500 has not been received till 31-3-2017. The rate of gross profit on this sale was 25% on cost. [B.Com. (Hons.) 2019, Delhi] Solution: Books of Geeta Trading and Profit & Loss Account for the year ended 31st March, 2017 Dr. ` Particulars Cr. ` Particulars Opening Stock 70,000 Sales 5,00,00 Wages 20,000 Sales on approval (2,500) Closing Stock 96,000 Purchases 2,70,000 Loss by Fire (6,000) Carriage Inwards 2,64,000 Add: Stock on approval (at cost) 2,000 4,97,500 98,000 4,000 Gross Profit 2,37,500 5,95,500 Rent 30,000 Add: Adjusted to landlord 1,600 Depreciation on Plant & Machinery Salary 5,95,500 Gross Profit 2,37,500 31,600 Discount Received 15,000 Commission 12,000 8,000 11,000 Add: Outstanding 1,000 Discount allowed 12,000 2,000 Bad Debts 6,000 Add: Further Bad Debts 4,000 Loss by Fire (Net) 10,000 2,400 Net Profit 1,84,500 2,57,500 2,57,500 Balance Sheet as on 31st March, 2017 ` Liabilities Capital 3,00,000 Add: Net Profit 1,84,500 ` Assets Plant and Machinery 4,84,500 Debtors 3,50,000 80,000 Creditors 45,000 Less: Sales on Approval 2,500 Bills Payable 16,000 Less: Office Rent 1,600 4,000 Wages Outstanding 4,000 Less: Further Bad Debts Salary Outstanding 1,000 Cash 27,000 Insurance Claim (Due) Closing Stock Add: Stock with Customers 5,50,500 71,900 3,600 96,000 2,000 98,000 5,50,500 Final Accounts of Non-Corporate Entities 8.103 Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. 4. 5. 6. 7. What do you mean by final accounts ? What are its constituents ? What are operating and non-operating profits. [B.Com. (Hons.) Delhi 1988, 2005] What are operating profits ? How will you calculate such profits ? [B.Com. (Hons.) Delhi 1989] Distinguish between : (i) Marshalling in order of liquidity and Marshalling in order of permanence. (ii) Profit and Loss Account and Profit and Loss Appropriation Account. [B.Com. (Hons.) Delhi 1989] Write a short note on uses and limitations of financial statements. [B.Com. (Hons.) Delhi 1991] What are the circumstances when closing stock is given : (a) inside the trial balance and (b) outside the trial balance ? Describe the treatment in final accounts under both the circumstances. [B.Com. (Hons.) 1990] What is a contingent liability? Give three examples of contingent liabilities.[B.Com. (Hons.) 2010, 2015] PRACTICAL ASSIGNMENTS 1. Shri Patit Bansali submitted to you the following Trial Balance, which he has not been able to agree. Rewrite the Trial Balance and prepare Trading and Profit and Loss Account for the year ended 31.12.2019 and a Balance Sheet as on that date after giving effect to the undermentioned adjustments : Particulars Captial Opening Stock Closing Stock Drawings Return inward Carriage Inward Dr. ` Cr. ` — 16,000 17,500 — — 18,790 3,305 — — 550 1,240 — Deposit with X — 1,400 Return outward 840 — — 725 800 — 150 — 13,000 — Carriage outward Rent paid Rent outstanding Purchases Sundry Debtors Sundry Creditors Furniture Sales Wages 5,000 — — 4,000 1,500 — — 29,000 850 — Cash 1,370 — Goodwill 1,800 — Advertisement 950 — 48,305 70,465 8.104 Financial Accounting: Concepts and Applications Adjustments : (i) Write off ` 600 as Bad Debts and make Reserve for Bad Debts on Sundry Debtors at 5%. (ii) Stock valued at ` 2,000 was destroyed by fire on 25 December, 2019, but Insurance Company admitted a claim for ` 1,500 only and paid the sum in January 2020. (iii) Depreciate Furniture by 10%. [C.A. (Foundation) May 2001] 2. From the following Trial Balance of Shishir, you are required to prepare Final Accounts for the year ended 31 March, 2020, after making the necessary adjustments : Particulars Dr. ` Cr. ` Capital and Drawings Account 10,000 2,00,000 Freehold Property 60,000 — 1,00,000 — 14,000 — Printing and Stationery 2,000 — Furniture and Fixtures 4,000 — Discount 1,500 — — 5,700 25,000 40,000 Insurance 3,000 — Bad debts 600 — Office Rent 2,600 — Loose Tools 2,000 — — 4,800 40,000 — — 1,000 Cash at Bank 25,000 — Cash in Hand 10,500 — Stock–31 March 2020 74,000 — Trading Profits — 1,17,200 Outstanding Wages–31 March 2020 — 500 Insurance Claim Received For Loss of Goods — 5,000 3,74,200 3,74,200 Plant and Machinery Salaries Bills Payable Debtors and Creditors Provision for Doubtful Debts Loan to Sudhir at 10% on 1 October 2019 Interest on Loan to Sudhir Adjustments : (i) Outstanding salaries ` 700. (ii) Prepaid Insurance ` 400. (iii) Value of loose tools on 31 March 2020–` 1,500. (iv) A new machinery was purchased on credit and installed on 28 February 2020 costing ` 15,000. No entry for the same has yet been made in the books. (v) Depreciate (on closing balance)–plant and machinery at 10 per cent, furniture and fixtures at 5 per cent. (vi) The provision for doubtful debts is to be maintained at 5 per cent. Final Accounts of Non-Corporate Entities 8.105 3. Following is the Trial Balance as at 31.12.20 : Particulars Dr. ` Cr. ` Opening Stock 30,000 — Drawings and Capital 10,000 1,00,000 1,50,000 2,75,000 6,000 — 20,000 — Import Duty 5,000 — Carriage Inwards 4,000 — Insurance 5,000 — Advertisement 10,000 — Furniture 40,000 — Bad Debts 5,000 — Book Debts 50,000 — Creditors — 30,000 Reserve for Bad Debts — 2,000 25,000 — 5,000 — — 8,000 Depreciation of Furniture 5,000 — Depreciation of Loose Tools 5,000 — 30,000 — — 10,000 70,000 — Purchases and Sales (Adjusted) Wages Salaries Loose Tools Rent Discount Received Closing Stock Outstanding Import Duty Premises Commission Received 10,000 Cash Balance 20,000 — Cash at Bank 5,000 65,000 5,00,000 5,00,000 Adjustments : (i) A customer of ` 5,000 is also a creditor of ` 10,000 and create R.B.D. @ 5% p.a. after writing off further bad debt of ` 5,000. (ii) Depreciate Furniture and Loose Tools @ 25% and by ` 10,000 respectively and appreciate Premises by ` 10,000. (iii) Annual Payment are–Salaries ` 25,000 and Rent ` 10,000. (iv) Unexpired Import Duty and Insurance are ` 1,000 each. (v) Sale of Furniture (B.V. NIL) for ` 3,000 to be accounted for as omitted in the books. (vi) Withdrawn from Bank by the owner for domestic use of ` 15,000. Prepare the Final Accounts applying Marshalling of Balance Sheet as at 31.12.20. [B.Com. (Punjab)] 4. A trader maintained Provision for Doubtful Debts @ 5%, Provision for Discount @ 2% on Debtors and Reserve for Discount @ 2% on Creditors which on 1 January 2018 stood at ` 1,500, ` 500 and ` 400 respectively. His balances on 31.12.18 and on 31.12.19 were : 8.106 Financial Accounting: Concepts and Applications 31.12.18 Bad debts written off Discount allowed Sundry debtors Discount received Sundry Creditors 31.12.19 ` ` 1,800 300 600 200 20,000 6,000 300 50 15,000 10,000 Show necessary accounts in the Ledger. [I.C.W.A.] 5. From the following particulars prepare (1) Reserve for Doubtful Debts Account, (2) Reserve for Discount on Debtors, and (3) Reserve for Discount on Creditors for both the years : Balances as on 1 January 2018 : Reserve for doubtful debts ` 1,000; Reserve for discount on debtors ` 500 and Reserve for discount on creditors ` 400. Total debtors as on 31 December 2018 were ` 25,000 after writing off bad debts ` 600 and allowing discount ` 200. Total debtors as on 31 December 2019 were ` 20,000 after writing off bad debts ` 600 and allowing discount ` 50. Total creditors as on 31 December 2018 and 2019 were ` 15,000 and ` 10,000 respectively. Discounts received during the years were ` 300 and ` 50 respectively. Provide 5% as Reserve for doubtful debts, 2-1/2% as Reserve for discount on debtors and 2% as Reserve for discount on creditors 6. The following is the Trial Balance of M/s Pandit Brothers as at their financial year end viz., 31 March 2020 : Particulars Capitals : Dr. (`) Cr. (`) — — H. Pandit — 1,00,000 K. Pandit — 1,00,000 — — 16,000 — Drawings : H. Pandit 16,000 — Buildings K.Pandit 80,000 — Furniture and Fittings 20,000 — Purchases 2,00,000 — — 3,00,000 Stock (1.4.19) 50,000 — Wages and Salaries 44,000 — Rates and Taxes 1,600 — Office Expenses 60,000 — Sundry Debtors 25,000 — Sales Sundry Creditors Cash in hand Bank Overdraft Freight inward — 12,000 400 — — 29,000 28,000 — 5,41,000 5,41,000 The following further information relating to the firm is made available : (i) Stock at the end of the year on 31 March, 2020, was ` 1,14,500 at cost. (ii) There was a fire in the premises on 26 February, 2020, which damaged a portion of stock and the loss was estimated at ` 17,500. Final Accounts of Non-Corporate Entities 8.107 (iii) H. Pandit is in charge of purchases of stock items and is to be paid 2½% commission on such purchases. (iv) A steel table purchased on 1 February, 2020 for ` 3,000 was debited to purchases account. (v) K. Pandit who looks after all aspects other than purchases is entitled to a commission of 5% on net profits after charging such commission and the commission on purchases due to H. Pandit. (vi) Depreciation is to be charged at 2-1/2% p.a. on value of building and at 10% p.a. on furniture and fittings. (vii) Profits/losses are to be shared equally by the partners Prepare Final Accounts for the financial year 2020. Calculations are to be made to the nearest rupee. 7. Following is the trial balance of Ms. Viva as at 31.3.2020 Particulars Dr. ` Cr. ` Drawings and capital 10,000 1,50,000 Purchase ledgers and sales ledgers 70,000 40,000 10% Investments and 15% bank loan 1,00,000 50,000 Purchases and sales 2,00,000 5,00,000 40,000 — Opening stock Outstanding commission — 2,000 5,000 — Wages 17,000 — Salaries 30,000 — Conveyance 10,000 — Import duty 5,000 — Carriage inwards 3,000 — Pre-paid salary Carriage outwards 7,000 — Premises 60,000 — Goodwill 20,000 — Furniture 30,000 Outstanding advertisement — 8,000 Insurance 3,000 — Stationery 10,000 — Preliminary expense 10,000 — — 20,000 1,00,000 — B/R and B/P 60,000 30,000 Trade Expenses 10,000 — 8,00,000 8,00,000 Commission Received Machinery Adjustments : (a) Provide interest on Investments and on Loan for full year. (b) Bank Loan was taken on hypothecation of stock in which bank maintained a margin of 33-1/3%. (c) Closing Stock includes an amount of Sales Return of ` 10,000 and it is to be accounted for. (d) Sales include an amount of approval sale of ` 15,000 and it remained unsold till date; cost price being ` 10,000. (e) Sales include sale proceeds of a furniture on 1.4.2019 for ` 10,000 (B.V. ` 15,000) and purchase includes purchase of a Machinery of ` 40,000 on 1.10.2019 on credit. (f) Depreciate Furniture and Machinery by 20% and 10% and write off goodwill by ` 5,000. (g) A customer for ` 5,000 included in Sales Ledgers, returned 50% of the goods which were sold 20% profit on sales whereas credit sales to another customer of ` 18,000 was made. Both these are to be effected in the books. 8.108 Financial Accounting: Concepts and Applications (h) There was bad debt of ` 5,000 and create R.B.D. and R.D.D. @ 5% and 2% on Debtors. (i) A Bills Receivable of ` 30,000 was relined by a cheque at a rebate of ` 1,000 and a Bills Payable was discharged on due date for ` 10,000 by a cheque. None of them was given effect. Prepare Trading Account; Profit and Loss Acccount and Balance Sheet as at 31.3.20. Hint : Since Loan Contains 1/3rd as margin, stock is 2/3. Hence, stock [50,000 × (3/2)] or ` [(75,000 + 10,000 + 2,500) – (2,500 × 1/5)] or ` 87,000. 8. Mr. Himansu carries on the business as a Retailer. He extracted the following balances from his books of accounts as on 31 December 2019 : Particulars Capital Account Dr. Cr. ` ` — 7,50,000 Drawings 18,000 — Buildings 5,00,000 — Furniture and Fixtures Opening Stock Sales Purchases 20,000 — 2,25,000 — — 18,00,000 13,37,000 — — 2,00,000 Sundry Debtors 5,00,000 — Office Expenses 24,000 — Salaries Sundry Creditors 18,000 — Rent 6,000 — Travelling & Conveyance 4,000 — Insurance Motor Car Expenses Postage & Telephones Electricity Charges 1,000 — 15,000 — 3,600 — 2,400 — 50,000 — Cash in Hand 1,000 — Cash at Bank 10,000 — — 25,000 40,000 — Fixed Deposit with Banks @ 10% interest Loan from HC @ 12% interest Motor Car Printing and Stationery Provision for Bad and Doubtful Debts 5,000 — — 5,000 27,80,000 27,80,000 You are required to prepare a Profit & Loss Account for the year ended 31 December 2019 and a Balance Sheet as on that date after taking into consideration the following adjustments : (i) Closing stock as on 31 December 2019 is valued at ` 64,800. (ii) A customer returned goods on 31 December 2019 amounting to ` 4,000 which was not accounted for but already included in the closing stock at selling price. The cost of the said goods was ` 3,200. (iii) Annual Insurance Premium of ` 1,000 is valid upto 31 March 2020. (iv) Provision for Bad and Doubtful Debts is to be kept at one per cent on Sundry Debtors. (v) Interest on F.D. with Banks and payable on Loan from HC is to be provided. (vi) Provide depreciation on Buildings at 2½%, furniture and fixtures @ 10% and Motor Car @ 20%. (vii) Mr. Himansu has used goods for his personal use costing ` 2,000 for which adjustment is necessary. Final Accounts of Non-Corporate Entities 8.109 9. From the following Trial Balance of Shri Goyal, prepare Trading and Profit and Loss Account for the year ending 31 December 2019 and Balance Sheet on that date after taking into consideration the adjustments given at the end of Trial Balance : Trial Balance As On 31 December 2019 Particulars Sales Purchases (Adjusted) Wages Debit Credit ` ` — 3,70,000 3,49,600 — 10,450 — — 34,250 National Insurance 150 — Carriage Inwards 200 — Carriage Outwards 250 — Capital Account Lighting 300 — Rates and insurance (including premium of ` 150 p.a. paid upto 30 June 2020) 200 — 30,625 — Stock at 31.12.2019 Cash in hand and Bank 875 — — 300 15,000 — 50 — Debtors and Creditors 3,000 10,000 Furniture 4,000 — — 150 4,14,700 4,14,700 Discount earned Plant and Machinery Discount allowed Dividends Adjustments : (i) National insurance also includes employee’s contribution of ` 75. Wages are shown ‘net’ after deducting national insurance contribution borne by the employee. (ii) Owing to the nature of the employment, some employees are housed in the building of the business. The rented value of such portion is assessed at ` 250 p.a. The benefit to the employee’s is treated as wages and rental as income for Shri Goyal. (iii) Depreciate Plant and Machinery at 15% p.a. and Furniture at 10% p.a. (iv) Goods worth ` 2,000 given by Shri Goyal to his son at cost. (v) The manager is entitled to a commission of 20% of the net profits after charging his commission (calculation may be made nearest to the multiple of a rupee). 10. (GST) Mr. Neel of Agra had prepared the following Trial Balance from his Ledger as on 31 March, 2020 : Particulars Stock as on 1 April, 2019 Purchases and Returns Sales and Returns Dr. ` Cr. ` 5,00,000 31,00,000 45,000 55,000 39,50,000 Cash in hand 2,50,000 — Cash at Bank 1,90,000 — Trader’s Capital — 22,59,200 Rates and Taxes 50,000 — Drawings 45,000 — Salaries 95,000 — 1,05,0000 — 90,000 — Postage and Telegram Insurance 8.110 Financial Accounting: Concepts and Applications Salesman Commission 78,000 — Output IGST 60,000 Output CGST 70,000 Output SGST 70,000 Printing and Stationery 95,500 — Advertisement 1,70,000 — Furniture and Fittings 5,50,000 — Motor Car 48,000 — Discounts 50,000 75,000 General Expenses 65,700 — Carriage Inward 10,000 — Carriage Outward 22,000 — Wages 50,000 — 10,00,000 4,00,000 Sundry Debtors/Creditors Input IGST 70,000 Input CGST 1,20,000 Input SGST 1,20,000 69,29,200 69,29,200 You are required to prepare Trading and Profit and Loss Account for the year ended on 31 March, 2020 and Balance Sheet as on that date after making the necessary adjustments. You are provided with the following information : (i) Closing Stock as on 31 March, 2020 ` 1,45,000. (ii) Neel had withdrawn goods worth ` 50,000 from Ram of Rohtak with IGST @12% during the year. (iii) Purchases include Purchase of furniture worth ` 1,00,000 plus 8% CGST and SGST each. (iv) Debtors include ` 50,000 bad debts. (v) Sales include goods worth ` 1,50,000 sent out to NN & Co. of Mumbai on approval and remained unsold as on 31 March, 2020. The cost of the goods was ` 1,00,000. IGST of 12% was applicable on these sales (Inter state transaction). (vi) Provision for Bad debts is to be created ` 40,000 on Sundry Debtors. (vii) Depreciate Furniture and Fittings by 10% and Motor Car by 20%. (viii) The salesman is entitled to a commission of 10% on total sales. 11. The following is the Trial Balance of Shri Arihant as on 31 December, 2019. Particulars Capital Drawings Opening Stock Purchases Freight on Purchases Wages Sales Salaries Travelling Expenses Miscellaneous Expenses Printing and Stationery Advertisement Expenses Postage and Telegrams Discounts Debit ` Credit ` — 14,00,000 75,000 80,000 16,20,000 15,000 1,10,000 — 1,00,000 23,000 35,000 27,000 25,000 13,000 7,600 — — — — — 25,00,000 — — — — — — 14,500 Final Accounts of Non-Corporate Entities 8.111 Bad Debts written off (after adjusting recovery of bad debts of ` 6,000 written off in 2017) Building Machinery Furniture Debtors Provision for Doubtful Debts Creditors Investments (12% purchased on 1-10-19) Bank Balance 14,000 10,00,000 75,000 40,000 1,50,000 — — — — — — — 19,000 1,60,000 6,00,000 — 83,900 — 40,93,500 40,93,500 Adjustments : (i) Closing Stock ` 2,25,000. (ii) Goods worth ` 5,000 were taken for personal use, but no entry was made in the books. (iii) Machinery worth ` 35,000 purchased on 1/1/17 was wrongly written off against Profit and Loss Account. This asset is to be brought into account on 1/1/19 taking depreciation at 10% per annum on straight line basis upto 31/12/18. (iv) Depreciate Building at 2½ % p.a., Machinery at 10% p.a. and Furniture at 10% p.a. (v) Provision for Doubtful Debts should be 6% on Debtors. (vi) The Manager is entitled to a commission of 5% of Net Profits after charging his commission. Prepare Trading and Profit and Loss Account for the year ending 31 December, 2019 and a Balance Sheet as at that date. 12. From the following trial balance and information, prepare Trading and Profit and Loss Account of Mr. Rishabh for the year ended 31 March, 2020 and a Balance Sheet as on that date : Particulars Capital Drawings Land and Buildings Plant and Machinery Furniture Sales Returns Outward Debtors Loan from Gajanand on 1.7.19 @ 6% p.a. Purchases Returns Inward Carriage Sundry Expenses Printing and Stationery Insurance Expenses Provision for Bad and Doubtful Debts Provision for Discount on Debtors Bad Debts Profit of Textile Dept. Stock of General Goods on 1.4.19 Salaries and Wages Creditors Trade Expenses Stock of Textile Goods on 31.3.20 Cash at Bank Cash in Hand Dr. ` Cr. ` — 12,000 90,000 20,000 5,000 — — 18,400 — 80,000 5,000 10,000 600 500 1,000 — — 400 — 21,300 18,500 — 800 8,000 4,600 1,280 2,97,380 1,00,000 — — — — 1,40,000 4,000 — 30,000 — — — — — — 1,000 380 — 10,000 — — 12,000 — — — — 2,97,380 8.112 Financial Accounting: Concepts and Applications Information : (i) Stock of General goods on 31.3.20 valued at ` 27,300. (ii) Fire occurred on 23 March, 2020 and ` 10,000 worth of general goods were destroyed. The Insurance Company accepted claim for ` 6,000 only and paid the claim money on 10 April, 2020. (iii) Bad Debts amounting to ` 400 are to be written off. Provision for Bad and Doubtful debts is to be made at 5% and for discount at 2% on debtors. Make a provision of 2% on creditors for discount. (iv) Received ` 6,000 worth of goods on 27 March, 2020 but the invoice of purchase was not recorded in Purchases Book. (v) Rishab took away goods worth ` 2,000 for personal use but no record was made thereof. (vi) Charge depreciation at 2% on Land and Buildings, 20% on Plant and Machinery, and 5% on Furniture. (vii) Insurance prepaid amounts to ` 200. Preparation of Trading and Profit and Loss A/c and Balance Sheet 13. (GST) From the following balances and information, prepare Trading and Profit and Loss Account of Mr. X of Agra for the year ended 31 March, 2020 and a Balance Sheet as on that date: Particulars Dr. ` Cr. ` X’s Capital Account — 10,000 Plant and Machinery 3,600 — 400 — Depreciation on Plant and Machinery Repairs to Plant 520 — Wages 5,400 — Salaries 2,100 — 100 — Income-tax of Mr. X Cash in hand and at Bank Land and Building Depreciation on Building Purchases 400 — 14,900 — 700 — 25,000 — — 300 Sales — 49,800 Bank Overdraft — 760 Accrued Income 300 — Purchases Return Salaries Outstanding — 400 3,000 — Provision for Bad Debts — 1,000 Bills Payable — 1,600 200 — Bills Receivable Bad debts Discount on Purchases Debtors Creditors Opening Stock — 708 7,000 — — 6,252 7,400 — Output IGST Input IGST 700 500 71,520 71,520 Information : (i) Stock on 31 March, 2020 was ` 6,000. (ii) Write off further ` 600 for bad debt and maintain a provision for Bad Debts at 5% on Debtors. Final Accounts of Non-Corporate Entities 8.113 (iii) Goods costing ` 1,000 were sent to customer in Nagpur for ` 1,200 plus IGST @ 10% on 30 March, 2020 on sale or return basis. This was recorded as actual sales. (iv) ` 240 paid as rent of the office were debited to Landlord account and were included in the list of debtors. (v) General manager is to be given commission at 10% of net profit after charging the commission of the works manager and his own. (vi) Works manager is to be given commission at 12% of net profit before charging the commission of General Manager and his own. 14. (GST) The following is the Trial Balance of Hari as at 31 December, 2019 : Particulars Hari’s Capital Account Stock 1 January, 2016 Sales Returns Inwards Purchases Dr. ` Cr. ` — 76,690 46,800 — — 3,89,600 8,600 — 3,21,700 — — 5,800 19,600 — Rent & Taxes 4,700 — Salaries & Wages 9,300 — Returns Outwards Carriage Inwards Sundry Debtors 24,000 — Sundry Creditors — 14,800 Bank Loan @ 14% p.a. — 20,000 Bank Interest Printing and Stationery Expenses Bank Balance Discount Earned 1,100 — 14,400 — 8,000 — — 3,440 Furniture & Fittings 5,000 — Discount Allowed 1,800 — General Expenses 11,450 — Insurance 1,300 — Postage & Telegram Expenses 2,330 — Cash Balance 380 — Travelling Expenses 870 — 30,000 — Drawings Output CGST 3,000 Output SGST 3,000 Input CGST 2,500 Input SGST 2,500 5,16,330 5,16,330 The following adjustments are to be made : (i) Included amongst the Debtors is ` 3,000 due from Ram and included among the Creditors ` 1,000 due to him. (ii) Provision for Bad and Doubtful Debts be created at 5% and for Discount @ 2% on Sundry Debtors. (iii) Depreciation on Furniture & Fittings @ 10% shall be written off. (iv) Personal purchases of Hari amounting to ` 600 plus 6% CGST and SGST both, had been recorded in the Purchases Day Book. (v) Interest on Bank Loan shall be provided for the whole year. 8.114 Financial Accounting: Concepts and Applications (vi) A quarter of the amount of Printing and Stationery Expenses is to be carried forward to the next year. (vii) Credit Purchase Invoice amounting to ` 400 had been omitted from the Books. (viii) Stock on 31.12.2019 was ` 78,600. Prepare (i) Trading & Profit and Loss Account for the year ended 31.12.2019 and (ii) Balance Sheet as on 31 December, 2019. ANSWERS GUIDE 1. Correct total of trial balance–` 49,990; Gross profit–` 17,490; Net Profit–` 13,545; Total of Balance Sheet–` 30,390. 2. Net Profit–` 91,550; Balance Sheet Total–` 3,43,450. 3. Gross Profit–` 81,000; Net Profit–` 31,750 and Balance Sheet Total–` 2,31,750. 4. Debit Profit and Loss Account with ` 1,300 in 2018 for RDD and Credit Profit and Loss Account with ` 400 in 2019 for RDD. Debit Profit and Loss Account with ` 480 in 2018 and Credit Profit and Loss Account with ` 66 in 2019 for Provision for discount on debtors. 5. For Reserve for Doubtful Debts : Profit and Loss Account is to be debited with ` 850 in 2018 and ` 350 in 2019; For Reserve for Discount to Debtors: Profit and Loss Account is to be debited with ` 293.75 in 2018 and credited with ` 68.75 in 2019. For Reserve for Discount on Creditors: Profit and Loss Account is to be credited with ` 200 in 2018 and debited with ` 50 in 2019. 6. Gross Profit–` 1,08,075, Net Profit–` 23,738 Balance Sheet Total–` 2,38,850. 7. Gross Profit–3,42,500. Net Profit–` 2,50,170; Balance Sheet Toal–` 5,17,670. 8. Gross Profit–` 3,00,000; Net Profit–` 2,00,790, Balance Sheet Total ` 11,58,790. 9. Gross Profit–` 11,350; Net Profit–` 7,229; Balance Sheet Total–` 50,925; Manager’s Commission– ` 1,446 (i.e. 20 × 8,675). 120 10. Gross Profit–` 5,25,000; Net Loss–` 7,03,900; Balance Sheet Total–` 21,70,800. 11. Gross Profit–` 9,05,000; Net Profit–` 6,31,333; Total of Balance Sheet– ` 21,70,900. 12. Gross Profit–` 61,000; Net Profit–` 38,098; Total of Balance Sheet–` 1,73,088. 13. Gross Profit–` 18,100; Net Profit ` 11,845; Total of Balance Sheet–` 33,798. 14. Gross Profit–` 77,500; Net Profit–` 33,503; Total of Balance Sheet–` 1,16,493. 9 Fina lAccounts of NotForProf itOrg a nisa tions MEANING A not-for-profit or simply a non-profit organization (NPO) is formed for promoting a useful object such as art, science, culture, sports, profession, education, charity, religion etc.. NPO is also known as a non-trading organization. NPOs also deal in monetary or financial transactions which are of charitable nature; the purchasing and selling of goods activities are not done by NPOs. The primary aim of NPOs is to give social services to their members or society at large. The social services are given either free of cost or at nominal price without aiming at profit. The NPOs may raise funds to carry out or achieve their objectives. TYPES OR FORMS The NPOs include the following types or forms of institutions, namely: (i) Educational institutions such as schools, colleges, universities etc.. (ii) Professional institutes or associations such as Medical Councils, Bar Councils. Accounting bodies such as Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of India (ICSI) and so on. (iii) Charitable institutions comprising of Dispensaries, Hospitals and other health care centres. (iv) Welfare associations such as Residents Welfare Associations (RWAs), Teachers Organisations, Staff Associations and the like. (v) Cultural institutions like literary societies, art galleries, libraries and so on. (vi) Clubs Like social clubs, sports clubs, entertainment or recreation clubs and so on. (vii) Scholarship foundations for giving scholarships to needy and bright students. (viii) Religious organizations to promote religions such as Janakpur Dharmik Sangh. CHARACTERISTICS OR FEATURES OF NPOS The main features of not-for-profit organisations are summed up as follows: (i) The main aim of NPOs is to give different kinds of services such as education, health care, sports, entertainment etc., to its members or society as a whole. NPOs give these services either free of cost or at nominal cost. (ii) The NPOs have no profit motive. (iii) Normally the NPOs do not undertake business or trading such as purchase and sale of goods. (iv) Their transactions are mainly cash transactions. Normally, they do not have credit transactions. (v) As they do not undertake trading activities, the NPOs do not prepare trading and profit and loss account. 9.2 Financial Accounting: Concepts and Applications (vi) The NPOs are organized as charitable trusts or charitable societies and subscribers to such organizations are called members and not owners. (vii) The NPOs obtain their funds/income in the form of: (a) cash subscriptions from their members (b) donations (c) legacies (d) grants from governments (e) income from investments. (viii) The funds raised by NPOs from different sources are credited to capital fund or general fund or special funds like sports funds, prize funds, tournament funds etc.. (ix) The affairs of NPOs are managed by a managing (or executive) committee elected by their members. (x) The surplus generated by these NPOs by way of excess of income over expendituer is not distributed amongst the members. It is simply added or credited to capital fund. (xi) There is no question of individual or joint ownership of assets of NPOs, by any member or members. (xii) The management of NPOs is entrusted or given to persons who are keen to render a particular type of service without any kind of income in return. Their posts are honorary in nature. (xiii) A NPO is also called a NTO (Non-trading Organisation) because its main activity is not trading in goods. A professional body of chartered accountants or lawyers is also a NTOs. NEED FOR MAINTAINING ACCOUNTS NPOs collect considerable amount of money by way of subscriptions from their members and donations from public at large. Hence it becomes necessary to maintain proper books of account to exercise control over these large funds for the sake of public faith and confidence and to meet statutory requirements. In this way the following objectives are automatically achieved: (i) Misappropriation of funds is avoided (ii) Income and expenditures for a particular accounting period can be easily ascertained. (iii) Financial position at the end of the accounting period is also known. DIFFERENCE BETWEEN PROFIT MAKING (TRADING) AND NOT- FOR PROFIT (NONTRADING) ORGANISATIONS Serial No. (i) Profit Making Organisation Not-For Profit Organisation Formed or set up for trading activities i.e., buying and selling of goods. Formed or set up for the purpose of giving social services. (ii) Main aim is to earn profit. There is no profit motive or responsibility. (iii) Cash and credit transactions are equally important. Most of the transactions are in cash and credit transactions are either few or nil. (iv) Managed by owners. Managed by members. Owners can withdraw profit as return on their capital Members are not entitled to any surplus of a NPO Owners' funds are known as capital Members' funds are known as capital fund or general fund or special funds. (vii) The final accounts of trading concerns consist of trading account, profit and loss account and a balance sheet The final accounts of NPO consist of Receipts and Payments Account, Income and Expenditure Account and a Balance sheet. (viii) Results of trading activities are shown in the profit and loss account Results of social service activity is shown in the Income and Expenditure Account. (ix) Trading concerns or organisations are more concerned with profitability than cash position Non-profit organisations are more concerned with their cash position than with surplus or deficit. (x) Profit and loss account may be sub-divided into trading account, profit and loss account etc., Income and expenditure account is not sub-divided. (v) (vi) Final Accounts of Not-For-Profit Organisations 9.3 (xi) Excess of revenue over expenses is known as net profit. Excess of income over expenditure is called surplus. (xii) Excess of expenses over revenue is called net loss. Excess of expenditure over income is known as deficit. (xiii) Net profit or loss is transferred to capital account of the proprietor or owner. Net surplus or deficit is transferred to capital fund. (xiv) Excess of assets over liabilities on a particular date is called capital. Excess of assets over liabilities is called capital fund. (xv) A trading concern maintains many subsidiary books. NPOs maintain only cash book as, journal. (xvi) The final accounts of a trading concern are normally prepared from the trial balance and the adjustments. The Income and Expenditure Account and the Balance Sheet are generally prepared from the receipts and payments account and other information. The ledger accounts are in large number. The ledger accounts are very few. (xvii) BOOKS OF ACCOUNT AND REGISTERS A not-for-profit organisation has limited or very few transactions relating to goods, debtors and creditors. Thus, it keeps only the basic books of account, namely: (i) cash book (ii) general journal (or journal proper) and ledger. Cash Book: It is used to record only cash receipts and cash payments on different accounts. Cash receipts include subscriptions received in cash, donations, life membership fees, sale of old assets, newspapers and magazines etc.. The payments include purchase of fixed assets, investments, various types of establishment expenses etc. General Journal: It is required to record financial transactions in respect of credit transactions like credit purchase of assets, credit sale of old assets, rectification of errors, opening entries, closing entries, transfer entries etc., on the basis of double entry system of book-keeping. General Ledger: It contains details of personal, real and nominal accounts in routine or usual manner. In addition to the foregoing books of account, a NPO maintains the following registers which are technically not books of account e.g., Membership Register: It contains detailed information about the: (i) name of the member, (ii) address, of the member, (iii) membership number, date of admission to membership (iv) date of termination of the membership. Subscription Register: It is used to record the details of subscriptions received from each member. It shows the name of the subscriber, membership number, amount of subscription, due date of the receipt of subscription, period for which subscription is received, advance subscription, if any and the unpaid or the outstanding amount. Donation Register: It shows the details in respect of the name of donor, address of the donor, amount of donations, purpose of the donation-general or specific, ledger folio, remarks. Property Register: It contains information about the nature of property, date of purchase, name of the vendor or seller, cost of the property, ledger folio, depreciated value of property and so on. Other registers may include entrance fees register, investment ledger, legacies register etc.. FINAL ACCOUNTS The final accounts of a NPO consists of: (i) Receipts and Payments Account (ii) Income and Expenditure Account (iii) Balance sheet at the end of the year. 9.4 Financial Accounting: Concepts and Applications It must be noted that at the beginning of the first year, the NPO has neither any asset nor any liabilities. The final accounts at the end of first year consists these three statements (two accounts and one balance sheet) only. Thus, Income and Expenditure Account and Balance Sheet at the end of first year are prepared with the help of Receipts and Payments Account only. However, at the end of second and subsequent years, the closing balance sheet of the previous year or the opening balance sheet of the current year may be prepared. Hence, the final accounts of a NPO consist of: (i) Opening Balance Sheet (which is closing balance sheet of the previous year) (ii) Receipts and Payments Account (iii) Income and Expenditure Account (iv) Closing Balance sheet. At the end of the year, all entries in the cash book (or cash receipts and cash payments journals) are summarized in Receipts and Payments Account. The adjustments relating to depreciation, outstanding expenses and accrued income are entered in the general journal. Income and expenditure account (which is similar to profit and loss account of trading concern) and Balance sheet are then prepared from Receipts and Payments Account and adjustments entries in the journal. Sometimes the trial balance is prepared by a NPO. In this situation there is no Receipts and Payments Account and the final accounts are prepared from the items given in the trial balance and year end adjustment. The procedure may be show as under: (A) At the end of first year Receipts and Payments Account Revenue Items Capital Items Balance Sheet Income and Expenditure Account (B) At the end of second and subsequent years: Opening Balance Sheet Revenue Items Income and Expenditure Account Receipts and Payments Account Capital Items Balance Sheet Adjustment entries are incorporated to the items in the Receipts and Payments Account wherever they are needed. Final Accounts of Not-For-Profit Organisations 9.5 RECEIPTS AND PAYMENTS ACCOUNT A receipts and payments account is a summary of all cash and bank transactions. It is prepared at the end of the accounting period from the cash book (or the cash receipts journal and cash payments journal). On the debit side, it begins with an opening cash or/and bank balance(s) and records all the items of revenue, receipts and capital receipts in cash whether such cash receipts belong or pertain to current accounting period or past accounting period(s) or future accounting period(s). On the credit side, the first item may be bank overdraft (By Bank Account) and subsequent items include all actual cash payments relating to revenue expenses and capital expenditures (purchases of fixed assets) of current accounting period or previous accounting period(s) or future accounting period(s). In short receipts and payments account records cash receipts and cash payments relating to current accounting period, previous accounting period(s) and even future accounting period(s) and it also includes capital receipts and capital payments in addition to revenue receipts and revenue payments. This account does not record non-cash items At the end of the current accounting period, this account is balanced to ascertain or find out the balance of cash in hand or at the bank. Procedure The annual totals of various items of receipts and payments are found from their respective accounts in the ledger and are then entered in the Receipts and Payments Account. For example, the subscription received every month or quarter from the members is recorded first in the cash book or cash receipts journal and the total of which would be found in the ledger under the heading 'subscriptions account'. It is this total amount which will be recorded in the Receipts and Payments Account. Similarly the different items of payments such as salaries, wages, rent, electricity etc., are first recorded in the cash book or cash payments journal on different dates while the total of these payments is found in the ledger under suitable headings from which they would be transferred to the payments side of the Receipts and Payments Account. FEATURES OF RECEIPTS AND PAYMENTS ACCOUNT The essential features of a receipts and payments account are summarised as under: (i) It is a real account. (ii) It is prepared on the cash basis of accounting. (iii) Its form is similar to cash book (without discount and bank columns) with debit and credit sides. (iv) It is prepared from the cash book or cash receipts journal and cash payments journal. (v) It is prepared at the end of the accounting period. (vi) It starts with opening cash and bank balances in hand on the debit side and bank overdraft, if any, on the credit side (By Bank b/d). (vii) Receipts are shown on the debit side and payments are shown in the credit side of this account. (viii) It includes all receipts and payments made during the current accounting period whether these belong to previous year(s), current year or future (subsequent) year(s). (ix) All the receipts are shown irrespective of their nature, i.e. whether the receipt is revenue (e.g., subscriptions) or capital (sale of a fixed asset) or for special fund (e.g., interest on tournament fund investments). (x) All the payments are shown irrespective of their nature i.e., whether the payment is revenue (e.g., rent, salary, stationery etc. or capital e.g. purchase of furniture, computers etc.) or for special fund (prizes given or paid out of prize fund). (xi) Only actual receipts and payments, made during the accounting period, are recorded. Hence, outstanding expenses and accrued income relating to current year are not recorded. 9.6 Financial Accounting: Concepts and Applications (xii) It does not include non-cash items like bad debts and depreciation. (xiii) The closing balances of cash in hand and bank are shown on the credit side. The closing balance of bank overdraft, if any, is shown on the debit side. (PRO-FORMA) RECEIPTS AND PAYMENTS ACCOUNT Receipts Capital and Revenue (Past, Present And Future) Balance b/d (opening balance) Cash in hand, Cash at Bank Capital Receipts (for past, present and future periods) Legacies Sale of office furniture Sale of sports equipment Donations for special purposes e.g., building, prizes etc. Life Membership fees Sale of investments Endowment fund receipts Receipts on account of special funds e.g., Prize fund, tournament fund. Interest on specific fund investments Entrance fees Revenue Receipts (for past, present and future periods) Subscriptions: Previous year Current year Subsequent year General donations Grants from Government Proceeds from entertainments Interest or dividends on general investments Annual dinner contribution Sale of old newspapers, waste papers etc. Hire or rent of hall Receipts from annual sports Sundry receipts Tennis court receipts Billiard receipts Tennis fees Sale of old sports materials like old bats, old balls, old nets etc. Miscellaneous receipts Balance c/d* (Bank Overdraft) ` Payments Capital and Revenue (Past, Present And Future) ` Balance b/d (Bank Overdraft) Capital Payments (for past, present and future periods) Building construction Books Sports equipment Cost of leasehold Cost of investments Advnace for purchase of buildings Government’s loan/bonds Furniture Revenue Payments (for past, present and future periods) Prizes paid Office expenses Purchase of sports materials Entertainment expenses Printing and stationery Newspapers and periodicals Postages Doctor’s or Secretary honorarium Expenses on special food to patients Repairs and maintenance Tennis expenses Billiard expenses Purchase of medicines Insurance, rent, salaries Advertisement Audit fees Tennis balls Telephone, electricity, fax charges Gardening Bar purchases Bar expenses Annual dinner expenses Match expenses Conveyance and travelling Up-keep of lawns Municipal taxes Charity Printing of year book or SOUVENIR Bank charges Miscellaneous expenses Balance c/d (closing balance) Cash in hand Cash at Bank* *There will be generally either of the two amounts i.e., bank overdraft or cash at bank and not both. Final Accounts of Not-For-Profit Organisations 9.7 ADVANTAGES OF RECEIPTS AND PAYMENTS ACCOUNT The main advantages of receipts and payments account are given as under: (i) It serves as a summary of cash transactions so that it is possible to know at a glance receipts and payments during a period under different heads or accounts titles. (ii) It discloses the cash position of a NPO. (iii) It is useful in the preparation of the income and expenditure account and the balances sheet. DISADVANTAGES OR LIMITATIONS OF RECEIPTS AND PAYMENTS ACCOUNT Receipts and Payments Account has the following disadvantages or limitations: (i) It only shows the cash position because non-cash transactions are not recorded (ii) It does not disclose the surplus or deficit resulting from the activities of a NPO. (iii) It is prepared on cash basis of accounting with the result that outstanding expenses and accrued income items in the form of adjustments are ignored. (iv) Balance sheet cannot be prepared from the given receipts and payments account. (v) It does not show expenses like depreciation of assets and losses like bad debts. (vi) It does not disclose the debtors of many expenses and for this purpose the accountant or treasurer prepares income and expenditure account and balance sheet. DIFFERENCE BETWEEN CASH BOOK AND RECEIPTS AND PAYMENTS ACCOUNT The difference between the two may be noted as under: Cash Book Receipts and Payments Account 1. A cash book is prepared on the basis summary of daily cash transactions. 1. A receipt and payment account is a account of the cash transactions that have occurred during the accounting period. 2. A cash book is a part of double entry book-keeping. 2. A receipt and payment account does not form part of double entry system. 3. A cash book is prepared by every type organisation, that is trading as well as non-trading. 3. A receipt and payment account is organisation, that of prepared for NPO or non-trading concern. 4. A cash book of a trading concern is prepared is a columnar form. 4. A receipt and payment account is not prepared in a columnar form. 5. A cash book is a part of books of account. 5. A receipt and payment account is not part of the books of account. It is only the basis of preparing the final accounts of a NPO. 6. Each transaction is recorded in chronological order, that is, datewise. 6. It is prepared at the end of the period and items are not recorded chronologically, that is, in order of occurrence. 7. Preparation of cash book is essential. 7. Its preparation is not essential. 8. The purpose of the cash book is to indicate the cash and bank balances at the end of every day, every week or every month. 8. The purpose of this account is to help the preparation of final accounts. 9. An item of cash receipt or cash time that item occurs. For example, if salary or wages is paid twelve times in a year, it will be recorded twelve times. 9. Every item of cash receipt and cash payment will be entered in total only once a year. 10. A cash book is prepared from source documents like vouchers and receipts. 10. A receipt and payment account is prepared from entries recorded in the cash book or cash receipts and cash payments journals. 9.8 Financial Accounting: Concepts and Applications DISTINCTION BETWEEN RECEIPT AND INCOME Receipt means the actual cash received and the aggregate of all receipts means the total cash received in the current year. Income means money earned during the year whether cash is actually received or not. Example: Suppose there are 1,000 members of a residents welfare association and each member is to pay a subscription of ` 150 per annum and 950 members pay their subscription for the current year. In that case the receipt is ` = 1,42,000 (` 950 × ` 150) and income is ` = 1,50,000 (` 1,000 × ` 150). However, if all the members pay their subscriptions, both receipt and income will be equal. Thus, income may be either equal or less than the actual receipts. In brief, receipts and income may or may not be equal. Receipts may be more than income in a certain accounting period if some members pay their subscriptions in advance. Income can never be more than receipts. The points of difference between receipts and income are summarised below: Receipt Income 1. Any cash received is receipt. 1. Any cash received may or may not be income; only cash received for the current year is income. 2. Receipt of cash may pertain to any accounting period, that is, past, present or future period(s). 2. Income is confined to only the current year. 3. Receipt may be both of revenue and capital nature. 3. Income is only of revenue nature. 4. In the case of receipt, the cash increases corresponding or equal to the amount of cash. 4. Cash may not increase equal to the amount of income as explained earlier. 5. It is entered on the debit side of the cash book. 5. It is recorded on the credit side of income and expenditure account. 6. It is not included in the income statement for calculating profit or loss. 6. It is a part of income determination process. DIFFERENCE BETWEEN PAYMENT AND EXPENDITURE Payment means actual cash paid during the current accounting period. It includes both the payments for capital items like purchase of fixed assets and payments for revenue items like salaries, rent etc. Further, payments may belong to past, present or future periods. But expenditure means total expenses incurred for the current year whether paid in cash or not. Example: Rent for the building is ` 10,000 per annum. But rent for the month of December is not-paid and accounting period ends on 31 December. In this case expenditure is ` 1,20,000 ( ` 10, 000  ` 12) while payment is only ` 1,10,000 (` 10,000 × ` 11) If no rent is outstanding i.e., rent has been paid for full 12 months, both expenditure and payment will be equal. Thus, payment and expenditure may or may not be equal. But if rent is paid for 13 months, payment will be more than expenditure. The difference between the two is given as under: Payment Expenditures 1. Actual cash paid is payment treated as expenditure. 1. Any cash paid may or may not be treated as expenditure. 2. A payment may be for the current year, past year or future years. 2. It is confined to current year only. 3. A payment may be for the capital item(s) or revenue item(s) 3. Expenditure is of revenue nature only. 4. Cash decreases in proportion to payment. 4. Cash may or may not decrease equal to the amount of expenditure. 5. An item cannot be called a payment unless cash is paid. 5. An item may be an expenditure whether cash is paid or not. 6. It is entered on the credit side of the cash book or receipts and payments account. 6. It is recorded on the debit side of the income and expenditure account. 7. It is not considered in the determination of income on accrual basis and hence, not a part of final accounts. 7. It is included in the final accounts. Final Accounts of Not-For-Profit Organisations 9.9 Illustration 1 : (Preparation of Receipts and Payments Account) From the following particulars of residents welfare association CIA Block Janak Puri, prepare Receipts and Payments Accounts for the year end 31 March 2020: ` (i) (ii) Cash in hand on 1-4-2019 12,000 Cash at bank in fixed deposits 70,000 (iii) Subscriptions received (including ` 5,000 for 2018-19 and ` 2000 for 2020-21) (iv) Subscription due for 2019-20 (v) (vi) (vii) (viii) (ix) (x) Donations 1,15,000 10,000 1,50,000 Entrance fees to be capitalised 19,000 Life membership fees 20,000 10% Investments purchased at cost (market value ` 1,20,000) 1,10,000 Legacies 2,50,000 Grant from civic body for garden maintenance 35,000 Contribution to annual dinner 55,000 Rent paid 10,000 (xiii) General expenses 15,000 (xiv) Printing, postage and stationery 46,000 (xi) (xii) (xv) (xvi) (xvii) (xviii) (xix) (xx) (xxi) (xxii) Newspapers and magazines 9,500 Sale of old newspapers. 2,400 Books purchased 12,800 Sports materials purchased 36,300 Interest on investments received Honorarium to coaches 80,000 Receipts from sports meet 60,000 Sundry receipts (xxiii) Upkeep of grounds (xxiv) Salaries (xxv) 9,000 Sports meet expenses (xxvi) Municipal taxes upto 30 June 2020 (xxvii) Charity (xxviii) Annual dinner expenses 1,14,000 45,000 1,42,000 45,000 6,500 10,200 42,000 Furniture purchased (total price ` 25,000) and paid 20,000 Audit fees 14,500 (xxxi) Water and electricity charges 12,000 (xxxii) Travelling expenses (xxix) (xxx) (xxxiii) Bank charges (xxxiv) Insurance (paid up to 30 June 2020) (xxxv) Cash at Bank 9,600 420 1,500 90,000 9.10 Financial Accounting: Concepts and Applications Solution : Receipts and Payments Account For The Year Ending 31 March 2020 Receipts ` Balance b/d: Payments 10% Investments ` 1,10,000 Cash in hand 12,000 Rent 10,000 Cash at Bank 70,000 General Expenses 15,000 46,000 Subscriptions 1,15,000 Printing, postage and stationery Donations 1,50,000 Newspapers and Magazines 9,500 Entrance fees 19,000 Books purchased 12,800 Life membership fees 20,000 sports materials 36,300 Honorarium to coaches 80,000 45,000 Legacies 2,50,000 Grants from civic body 35,000 Upkeep of ground Contribution to Annual Dinner 55,000 Salaries Sale of old newspapers 2,400 Sports meet expenses Interest on Investments 9,000 Municipal taxes Receipts from sports meet Sundry receipts 60,000 1,14,000 1,42,000 45,000 6,500 Charity 10,200 Annual dinner expenses 42,000 Furniture 20,000 Audit fees 14,500 Water and electricity charges 12,000 Travelling expenses Bank charges Insurance 9,600 420 1,500 Balance c/d: Cash at bank Cash at hand (Balancing figure) 9,11,400 90,000 1,53,080 9,11,400 INCOME AND EXPENDITURE ACCOUNT Receipts and Payments Account does not disclose the surplus or deficit. Accordingly not- for- profit (or nontrading) concerns have to prepare another account to find out surplus or deficit with the help of Income and Expenditure Account. An income and expenditure account is a revenue (or nominal) account of not-for-profit (non-trading) organisations. It is a summary of incomes and expenses or expenditures for a given accounting period generally of one year. It is equivalent to profit and loss account of business enterprises, that is, it serves the purpose of profit and loss account. It is prepared on accrual basis. It does not include the revenue items of the previous year(s) and of future year(s); only current year’ revenue items are included whether such items are received (or paid) in cash or these are outstanding. The term net profit is replaced or substituted by the words: Excess of income over expenditure (or surplus) and the term net loss is replaced or substituted by the words: Excesses of Expenditures over income (or deficit). Final Accounts of Not-For-Profit Organisations 9.11 FEATURES OF INCOME AND EXPENDITURE ACCOUNT (i) It is a revenue or nominal account (ii) It is generally prepared from a given receipts and payments account (sometimes from trial balance also) and other relevant information. (iii) It is prepared on accrual basis of accounting. (iv) It is prepared at the end of the accounting period. (v) It is similar to profit and loss account as all incomes are shown on the credit side and all expenditures are entered on the debit side. (vi) All revenue items pertaining to the current accounting period only are considered revenue items which appear on the debit side of the Receipts and Payments Account are entered on the credit side (i.e. income side) of the Income and Expenditure Account. Similarly all revenue items of current year appearing on the credit side of the Receipts and Payments Account are recorded on the debit side (i.e. expenditure side) of Income and Expenditure Account. The necessary adjustments are made for outstanding expenses and income and also for prepaid income and expenses. (vii) Items of capital nature such as purchases of investments, sports equipments, furniture etc., are ignored for this account. (viii) It also includes non-cash items like depreciation of fixed assets, bad debts etc.. (ix) It includes not only the incomes actually received in cash but also the outstanding or accrued incomes. Similarly it includes outstanding expenditures in addition to the expenses paid in cash. (x) It does not begin with any opening balance. (xi) It has a closing balance in the form of either surplus or deficit. Surplus means excess of income over expenditure and deficit means excess of expenditure over income. (xii) The closing balance is carried forward to balance sheet whereas surplus is added to capital fund while deficit, if any is deducted from capital fund. WHAT IS INCOME In order to become an income item, an item appearing in the debit side of the receipts and payment account, must possess the following features: (i) It is of recurring nature (i.e., a regular income) of not-for-profit (or non-trading) organisations. (ii) It is not meant for a special purpose e.g., donations for building or donations for prize fund etc.. (iii) It must pertain to current period only. WHAT IS EXPENDITURE OR EXPENSE It must be clarified that the two terms expenditure and expense are used interchangeably (in the same sense) for the purpose of income and expenditure account. These must possess the following features: (i) An item of expenditure or expense must be of recurring nature (i.e., regular expense) (ii) It must be useful for the current accounting period only. (iii) It is not a capital expenditure. 9.12 Financial Accounting: Concepts and Applications (PRO-FORMA) INCOME AND EXPENDITURE ACCOUNT FOR THE YEAR ENDING ON ----------- (Last Date of Accounting Period) ` Expenditure ` Income Salaries Subscriptions Printing and stationery Interest on Investments (on Rent, rates and taxes general fund investments only) Electricity and water Newspapers, magazines or periodicals Government grants Telephone charges General Donations Insurance premium Life membership fees (only that Depreciation on: portion which is to be treated as Sale of old newspapers etc. Furniture revenue or income of the current year) Sports equipments etc. Books Audit fees Contribution from annual dinner Less: Expenses on annual dinner Profit from annual sports meet Honorarium Bank charges (Receipts minus expenses) Postage and fax charges Bar receipts Travelling or conveyance expenses Rent from hire of hall Sundry expenses Dividend and interest Repairs and maintenance Tennis court receipts Tennis court expenses Billiard room receipts Billiard room expenses Tennis fees Bar expenses Proceeds from entertainment Lecturers' fees Less: Expenses Bad debts Drama receipts Loss on sale of fixed assets Proceeds from charity show Sundry expenses Less: Expenses Excess of Income over Sale of old fixed assets Expenditures (Surplus) Profit from consumable items: (food, drinks etc.) Sale price of consumable items Less: Cost of consumable items (opening stock + purchases –closing stock) Excess of Expenditures over Income (Deficit). Note : There will be either surplus or deficit. DISTINCTION BETWEEN INCOME AND EXPENDITURE ACCOUNT AND RECEIPTS AND PAYMENTS ACCOUNT Points of Difference Income and Expenditure Account Receipts and Payments Account 1. Nature It is another name for profit and loss account of the non-trading concerns, i.e., clubs, societies, hospitals, educational institutions etc. (Nominal Account) It is a statement of cash transactions for a period (Real Account). 2. Commencement It does not begin with any opening balance. It commences with opening balances of cash in hand and at bank. 3. Outstanding It contains the whole of the expenditure and income of the accounting period i.e., accrued and outstanding items (i.e., based on mercantile system of accounting). It includes only income and expenditure actully received and paid whether for the period ‘covered or not (based on cash (i.e., based system of accounting). Final Accounts of Not-For-Profit Organisations 9.13 4. Period It contains income and expenditure of the current accounting period only. It may comprise not only receipts and payments for the current year but also succeeding years. 5. Form Income is shown on the credit side and the expenses on the debit side. Receipts are entered on the debit side and payments on the credit side. 6. Contents It contains only the items of revenue nature of the current accounting period only. It records both capital and revenue items of any period: current, previous or succeeding years. 7. Object It represents the net result of all the activities during the year resulting in surplus or deficit, as the case may be. It shows merely the cash on hand/bank at the close. 8. Balance Sheet A balance sheet is usually accompanied with this account. No balance sheet is prepared 9. Non-cash items It shows non-cash items like depreciation, bad debts etc.. It does not show non-cash items like depreciation, bad debts etc., 10. Accrued and outstanding items It shows accrued income and outstanding expenses. It does not show accrued income and outstanding expenses. 11. Closing balance of cash and bank It does not show closing balances of cash and bank It shows closing balances of bank. 12. Difference between two sides The balance of this account represents either surplus or deficit, as the case may be and is not carried to the account of next period-instead the surplus is added to or deficit deducted from capital fund. The balance of this account shows only the cash in hand, bank and nothing is done afterwards. DIFFERENCE BETWEEN INCOME AND EXPENDITURE ACCOUNT AND PROFIT AND LOSS ACCOUNT Basis of Distinction Income and Expenditure Account Profit and Loss Account 1. Nature of the Enterprise This account is prepared by the non-trading firms. This account is prepared by trading enterprises. 2. Source of Information This account is prepared from Receipts and Payments Account in from most of the cases. This account is prepared with the help of trial balance. 3. Purpose The purpose of this account is to calculate surplus i.e. excess of income over expenditure or deficit i.e., excess of expenditure over income. This account is prepared to calculate profit or loss of a business organisation. 4. Balance at the end The surplus of this account is added to capital fund and deficit is deducted from the capital fund. The balance of this account is either profit (to be added to capital) or loss (to be deducted from the capital). 5. Use of Surplus Surplus is not available for distribution amongst members. Profit is available for distribution. BALANCE SHEET Background: The Receipts and Payments Account shows only the balances of cash in hand and cash at bank at the end of the accounting period. The Income and Expenditure Account contains information only in respect of income and expense items. It does not provide any information about capital receipts (liabilities) and capital expenditures (assets). None of the foregoing two accounts give a complete picture of the state of affairs or financial position of the not-for-profit (non-trading) enterprises. Hence, in order to know the complete information about the statement of affairs, income and expenditure account must be supplemented by a Balance Sheet. Meaning: The balance sheet of a not-for profit (non-trading) enterprise shows its financial position that is, assets and liabilities at the end of the accounting period. 9.14 Financial Accounting: Concepts and Applications Procedure: The balance sheet of non-profit making entities is prepared in the usual way showing assets on the 'right-hand side' and liabilities on the 'left hand side'. The term capital is not to be found. Instead there will be a capital fund or a general fund or an accumulated fund. This fund represents the net assets of the non-trading institutions and is calculated in the same manner as capital (i.e., excess of assets over liabilities). It is necessary to calculate the value of fund at the start of the accounting period by deducting the opening liabilities from the opening assets. The surplus of the year is added to it or the deficit is deducted from it. It is not uncommon to add some of the capitalised items like legacies, endowment fund and entrance fees to the capital fund. In addition to capital fund, there may be other funds created for specific purposes e.g. Prize Fund. The special fund should be represented by specific asset in the balance sheet usually in the form of special fund investments e.g., Prize Fund Investments. PRO-FORMA BALANCE SHEET AS ON... (CLOSING DATE) ` Liabilities ` Assets Capital Fund Particular Assets Opening balance (if any) Last balance b/d: Add: Excess of Income over Expenditure Add: Purchases in the current year Or Less: Book value of the asset sold Less: Excess of Expenditure over Income Less: Depreciation Capitalised income of the Current year on account of: Closing Balance Legacies Stock of consumable materials Entrance fees (Balance as given in the question) Life membership fees Or (These may be added to the Capital Fund too) Last balance b/d Add: Purchases during the year Special Fund/Donation Less: Value consumed during the year Last balance (if any) Closing balance Add: Receipts for the item during the year Cash in hand Add: Income earned on fund Investment Cash at bank in Current Less: Expenses paid out of fund/donation Account, Fixed Deposit Account etc. Closing Balance Pre-paid Expenses at the end e.g., insurance, Creditors for Purchases of Supplies rent etc. Outstanding Income Bank Overdraft (at the end) Outstanding Expenses Last balance b/d Less: Paid during the year Add: Outstanding at the end Closing Balance Income Received in Advance at the end DIFFERENCE BETWEEN CAPITAL AND CAPITAL FUND The two terms, namely: capital and capital fund are not the same or synonymous. The main differences are outlined below: Capital (i) It is associated with the business organisations with profit motive. Capital Fund (i) This term is to be found in the balance sheet of a not-for-profit or non-trading organisation. Final Accounts of Not-For-Profit Organisations 9.15 (ii) Capital is contributed by the owners of a business to the business organisations. (ii) Capital fund is not contributed by one single member of NPO. It is calculated as excess of assets over the liabilities of a NPO. It is made up of capitalised receipts like endowment receipts, legacies, special donations, entrance fees and surplus (i.e., excess of income over expenditure.) (iii) Capital belongs to the owners because they are its contributors. (iii) Capital fund of a NPO doe not belong to members as they are not its exclusive contributors. (iv) Capital can be withdrawn by the owners of a business entity. (iv) Capital fund cannot be withdrawn by the members of a NPO or nontrading concern. TREATMENT OF SOME SPECIAL ITEMS IN THE FINAL ACCOUNTS OF A NPO The following items are peculiar or special to non-for-profit organisations (NPO): (1) Legacies Legacies are gifts or donations, received in cash or property or both under a will on the death of the donor. Legal representatives give such gifts to the NPOs as per the will of the deceased (i.e., dead person) Legacies are not of recurring nature because such receipts come very rarely. Hence, legacies should be treated as capital receipts added to the capital fund and shown on the liabilities side of the balance sheet. FOR YOUR ATTENTION (a) If legacies or gifts are received for a specific purpose, it is a capital receipt and therefore, should be added as contribution to the specific fund (e.g. Building Fund or Prize Fund) for which it is given and shown on the liabilities side of the Balance Sheet. (b) If a legacy or gift is for general purpose, as per instructions in the examination problem, it should be treated as income and shown on the credit side of the Income and Expenditure Account. (2) Donations It is also a type of gift in cash or in property received from some living person, firm or company. Donations can be for specific purposes or for general purposes: (a) (b) Specific Donations: If the amount received as donation is for a specific purpose such as donation for building or books or other equipment, it is capitalized and is shown in the liabilities side of the Balance Sheet. General Donations: General donations are treated as revenue receipts or income because such donations are generally received every year. It is therefore, shown in the credit side of the Income and Expenditure Account. FOR YOUR ATTENTION The amount of the donations is not the deciding point; what is important is the purpose of donation. A small amount for a specific purpose will not make it a general donation. Similarly a big donation will not make it specific donation if the cash has been received for a general donation. However, the students should follow instructions given in the examination problem, if any. (3) Entrance Fees Or Admission Fees This is the amount of fees received from the new members in addition to the amount of normal or regular subscriptions. (a) As a non-recurring item: Many accountants feel that since the entrance fee is paid only once, it is of non-recurring nature and therefore, should be capitalized and taken directly to the ‘Liabilities’ side of the Balance Sheet. It is also pointed out that the entrance fee paid is in the nature of premium paid by new member towards the capital costs to establish the club or any other charitable institution. (b) As a recurring item: However, there are some accountants who argue that though it is paid by 9.16 Financial Accounting: Concepts and Applications each member only once, the club or institution receives it regularly because of frequent changes in its membership for one reason or the other. Accordingly it should be treated as revenue income and credited to Income and Expenditure Account. In the absence of any specific instructions about entrance fees in the examination problem, entrance fees should be capitalized [Appendix To Accounting Standard (AS) – 9, I.C.A.I]. (4) Life Membership Fees Life membership fees are received once during the life time in one lump sum. So they are non-recurring and should be treated as capital receipt. Such fees are added to the capital fund on the liabilities side of the balance sheet. FOR YOUR ATTENTION Sometime life membership is indicated as for 10 years or 20 years. In such a case a proportion of the life membership should be treated as revenue income and hence, transferred to Income and Expenditure Account every year until written off completely. (5) Endowment Fund Eric Kohler, in Dictionary of Accountants writes that, “Endowment is a fund arising from bequest or gift, the income of which is devoted for a specific purpose.” When a donor donates some cash or property by way of endowment fund, he expects that NPO should not use this fund for its main activities. Only the income earned from the investments of the endowment fund (called Endowment Fund Investments) should be used for financing the main activities. It means that cash received as endowment fund must be invested in some securities or deposited with the bank for regular income. The accounting treatment of the money or property received as endowment is as follows: (a) Endowment fund receipt is a capital receipt and should be shown separately on the liabilities side of the balance sheet. (b) Endowment fund investments, if any, should be shown on the assets side of the balance sheet. (c) Income from the endowment fund investments can be treated as general income and should be entered on the credit side of the Income and Expenditure Account. In this way Endowment Fund would remain intact in the Balance Sheet. (6) Sale of Old Fixed Assets And Investments The amount received from the sale of old fixed assets of a NPO like furniture or computers, buildings etc., or investments is a capital receipt and hence, it should not be entered in the income and expenditure account. In the balance sheet the book value of the old fixed assets, investments sold (and not the selling price of fixed assets or investments sold) should be deducted from the total book value of fixed assets and investments on the assets side of the balance sheet. Only the profit or loss on the sale of old fixed assets or investments has to be entered in the income and expenditure account. For example if the furniture at book value of ` 10,000 is sold for ` 7,500, there is a loss of ` 2,500 and it will be shown in the debit side of the income and expenditure account. On the other hand, if there is a profit on the sale of old fixed assets or investments, it is entered on the credit side of the income and expenditure account. FOR YOUR ATTENTION When the book value of the asset sold is not given in the examination problem, students can make either of the following two assumptions: (a) The book value of the old fixed asset sold is same as the selling price. There will not be any profit or loss on the sale of old fixed asset. The income and expenditure account will not be affected or (b) The book value of the old fixed asset is nil or zero. In this case the profit will be equal to the sale price and should be recorded on the credit side of the income and expenditure account. The authors prefer this (b) assumption. Final Accounts of Not-For-Profit Organisations 9.17 Note for the paper setter: Please indicate the book value of the old fixed asset sold for the sake of uniformity in answers. Note for the students: Students should indicate their preference in the form of foot note at the end of the answer. And the examiner must honour either of the two assumptions made by the students. (7) Sale of Old Sports Equipments Sale price of the old sports equipments like billiard table, tennis tables etc., are capital receipts. The accounting treatment is similar to sale of old fixed assets and investments. (8) Purchase of Sports Materials The amount spent on the purchase of sports materials like tennis balls, cricket bats, balls, net etc. is a revenue expenditure because sports materials are used up in the accounting period itself or at the most within a year. (9) Sale of Sports Materials Sale of sports materials like old bats, old nets, etc., is the regular feature and of recurring nature. The amount received is therefore, treated as an ordinary or revenue income on the assumption that their book value is zero. It is therefore, shown in the credit side of the Income and Expenditure Account. (10) Purchases or Subscriptions for and Sale of Newspapers, Periodicals or Magazines, Journals Purchases or subscriptions for newspapers and periodicals are treated as an ordinary or revenue expenditure and thus, debited to the Income and Expenditure Account. Sale of old newspapers, periodicals etc., are treated as an ordinary or revenue income and thus, credited to Income and Expenditure Account. (11) Government Grants In the absence of specific instructions in the examination problem about the treatment of Government grants received, this item is treated as regular or recurring nature. So it is a revenue receipt or income and the same should be entered in the credit side of the income and expenditure account. But if the government grants are for specific purpose, say, for the construction of the building, the same should not be shown in the income and expenditure account. They should be added to the special fund, say, building fund on the liabilities side of the balance sheet. Such government grants should never be added to the Capital Fund. (12) Payment of Honorarium It is a payment to a person for his specific services rendered by him or her but not as regular employee. For example, the payment made to a Radio or Television artist for his or her specific performance is regarded as honorarium. Similarly the office bearers of a NPO do not work as regular employees but as honorary president, honorary secretary or honorary treasurer. Hence, they are also paid some honorarium and not salary. The purpose is to reimburse their nominal expenses on tea, lunch, petrol or conveyance. The payment of honorarium is a revenue expenditure or revenue payment and is shown in the debit or expenditure side of the Income and Expenditure Account. (13) Receipts from and Payments made for Consumable Items When a social club like Recreation club or Entertainment club or Charitable hospital sells items of regular consumption such as wines, cigarettes, playing cards or medicines, the amount received is a revenue RECEIPT and is therefore, shown in the credit side of the Income and Expenditure Account and the payments made for the purchase of consumable items is a revenue payment and must be shown in the debit or expenditure side of the Income and Expenditure Account. (14) Specific Collections from and their Expenses on Lectures, Dramas, Concerts etc. Specific collections from above stated items and the expenses related to them are respectively revenue receipts and revenue payments. Hence, they should be recorded in the Income and Expenditure Account. 9.18 Financial Accounting: Concepts and Applications There are two alternate accounting treatments stated below: (i) (ii) The receipts from lectures, dramas etc., should be entered on the credit side of the Income and Expenditure Account. And expenses on these items should be recorded on the debit side of the Income and Expenditure Account. Alternately, the expenses on lectures, dramas etc., may be adjusted with the proceeds or receipts from these items. If there is a surplus (proceeds or receipts exceeding expenses) the surplus should be recorded in the credit side of Income And Expenditure Account. If there is deficit, (expenses exceeding proceeds or receipts), the deficit should be recorded on the debit side of the Income and Expenditure Account. (15) Additions, Extensions and Improvements to Fixed Assets Any addition or extension or improvement to a fixed asset like building would increase the earning capacity of the asset. Hence, it is as good as the acquisition or purchase of fixed asset. So it is to be treated as capital expenditure. (16) Other Capital Expenditures The money spent on the purchase of office furniture, books, buildings, land, investments and so on are in the nature of capital or non-recurring expenditures. They are assets proper and are taken to Balance Sheet after deducting depreciation on them. (17) Tax Deducted at Source (T.D.S.) Sometimes interest income or dividend income may be received by the non-trading concern on its investments net of tax from the paying agency which will issue a certificate of the amount of tax deducted at source. The accounting treatment involves the following: (i) Find out the gross amount of interest or dividend e.g., if the interest received is ` 2,400 net of tax at 20%, the gross amount of the interest is [2,400  (100 80)]  ` 3,000. This gross interest will be credited to income and expenditure account or the relevant Fund Account as the case may be. (ii). Tax deducted at source would be shown in the Assets side of the Balance Sheet. In case the income is not taxable the refund can be claimed from the income tax authorities. (18) Other Revenue Expenses All expenses which are incurred for day-to-day performance of activities or operations and are of recurring nature are called revenue expenses. Examples are: salaries, wages, rent, printing and stationery, subscription to newspapers and periodicals, insurance, advertisement, interest, refreshment etc.. Revenue expenses also include expenses incurred on the maintenance of fixed assets e.g., repairs, depreciation etc., All such expenses are debited to the Income and Expenditure Account. (19) Subscriptions Subscriptions by members of a NPO is a regular source of income. They are of recurring nature received at regular intervals of time, say, monthly, or quarterly or half-yearly or yearly, as the case may be. Hence, they should be treated as revenue receipts or income and entered on the credit side of the Income and Expenditure Account. However, special subscriptions (that is subscriptions for a specific purpose) received should not be recorded in the income and expenditure account. Instead they should be shown separately on the liabilities side of the balance sheet. Examples of special subscriptions are given below: (a) Subscriptions received for any specific programme, say, for some drama or play or specific exhibition or prime minister party, chief minister party etc.. (b) Subscriptions received towards a specific fund like tournament fund, prize fund, building fund and so on. (c) Subscriptions for the construction of capital (fixed) asset like construction of pavilion, science block in a school or college etc. Final Accounts of Not-For-Profit Organisations (d) 9.19 Subscriptions for the purchase of any fixed asset say, a machine, computers, laboratory equipments, etc.. Subscriptions capitalized, when there is an instruction in the examination problem to capitalize a part of the subscription received. (e) CALCULATION OF ACTUAL AMOUNT OF ANY INCOME ITEM TO BE POSTED TO INCOME AND EXPENDITURE ACCOUNT The actual amount of an income item, say, subscription or interest or fees or any other income item to be posted (or entered) to the credit side of the Income and Expenditure Account may be calculated in the following manner: (a) Preparing Worksheet or Statement (b) Preparing Ledger Account. (a) Statement or Worksheet of Actual Amount of Subscriptions For the Current Year (i) Total subscriptions received in the current year. ———— (ii) Less: Last year’s outstanding subscriptions and included in the total————subscriptions received during the current year. (iii) Less: Subscriptions of the next or future year(s) received in ———— advance in the current year and included in the total subscriptions received during the current year. (iv) Add: Subscriptions received in advance in the previous year ————belonging to current year. (v) Add: Outstanding subscriptions for the current year.——— (vi) Actual amount of subscriptions for the current year to be posted to the credit side of Income and Expenditure Account. (b) Ledger Account Subscription Account Dr. Cr. Particulars ` To Balance b/d (outstanding subscriptions of last year) (ii) Advance subscriptions of last years (iv) ——— By Cash/Bank Account (balancing figure to be posted in the (Total subscriptions received in the ——— To Balance c/d current year) (i) ——— By Balance c/d (Advance subscriptions for the next year(s) (iii) ` By Balance b/d ——— To Income and Expenditure Account credit side) (vi) Particulars (Total amount of outstanding sub——— scriptions in the current year) (v) ——— EXPLANATIONS (i) As per Receipts and Payments Account. (ii) Will appear in the opening balance sheet. (iii) Will appear in the closing balance sheet. (iv) Will appear in the opening balance sheet. (v) Will appear in the closing balance sheet. (vi) Will be posted in the credit side of the income and expenditure account. ——— ——— 9.20 Financial Accounting: Concepts and Applications CALCULATION OF ACTUAL AMOUNT OF ANY EXPENSE ITEM The actual amount of an expense item, say, salaries or rent or any other item to be posted to the debit side of current year’s Income and Expenditure Account is calculated in the following manner: (a) Preparing Work Sheet or Statement form (b) Preparing Ledger Account (a) Statement or Work Sheet of Actual Amount of Salary For the Current Year (i) Total amount of salaries paid in the current year ———— (ii) Less: Last year’s outstanding salaries paid in the current year and included in the total salaries paid during the current year. ———— (iii) Less: Salaries of the next or future year(s) paid in advance and included in the total salaries paid during the current year. ———— (iv) Add: Current year’s salaries paid in advance in the previous year(s). (v) Add: Outstanding salaries for the current year ———— ———— (vi) Actual amount of salaries for the current year to be posted or entered in the debit side of Income and Expenditure Account. ———— (b) Ledger Account. Salaries Account Dr. Cr. Particulars ` Particulars To Balance b/d (paid in advance last year) (iv) ——— By Balance b/d (ii) (outstanding of last year) Bank/Cash Account (paid in the current year) (i) ——— By Income and Expenditure Account (Balancing Figure) (vi) To balance c/d (v) (outstanding for the current year) ——— By Balance c/d (advance paid for the next year) (iii) ` ——— ——— EXPLANATIONS (i) As per Receipts and Payments Account. (ii) Will appear in the opening balance sheet on the liabilities side. (iii) Will appear in the closing balance sheet on the liabilities side. (iv) Will appear in the opening balance sheet on the assets side. (v) Will appear in the closing balance sheet on the liabilities side. (vi) Will be posted to the debit side of the income and expenditure account. CALCULATION OF ACTUAL AMOUNT OF STATIONERY USED OR PROVISIONS USED OR MEDICINES USED The calculation of the actual amount of stationery used or provisions used or medicines used, as an expense item in the current year, is done in the following manner: (a) Preparing statement or worksheet (b) Preparing Ledger Account Final Accounts of Not-For-Profit Organisations 9.21 Statement or Worksheet Stationery Used in the Current Year Opening stock of stationery Add: Payments for stationery in cash during the current year (ii) ———— Add: Payments made in advance in the previous year(s) belonging to the current year (iii) ———— Creditors for stationery at the end of current year (or outstanding for stationery at the end of the current year) ———— Add: Less: Creditors for stationery at the end of last year paid in the current year included in the total payment for current year ———— Less: Advance payment for stationery at the end of current year and included in the payments of the current year. ———— Less: Stock of stationery at the end of the current year. ———— Actual amount of stationery used in the current year ———— (b) Ledger Account Stationery Account Dr. Cr. Particiulars ` To Balance b/d: (Opening stock) Advance paid last year To Cash/Bank (payments made in the current years) To Balance c/d (creditors for current years) Particulars ` By Balance b/d (creditors of last year) By Income and Expenditure Account (Balancing Figure) By Balance c/d: Closing stock (Advance in the current year) Illustration 2 (Calculation of Current Year’s Subscriptions) From the following details, ascertain the amount of subscription to be credited to income and epxenditure account for the year 2020: ` Subscriptions received in 2020 including ` 20,000 for 2019 and ` 15,000 for 2021 2,45,000 Subscriptions due but not received at the end of the year 2020 were 19,000 Subscriptions received in 2019 in advance for 2020 were 18,400 Solution : ` Total Subscriptions received during 2020 Less: Outstanding subscriptions for 2019 but included in 2020 2,45,000 20,000 2,25,000 Less: Subscriptions paid in advance for 2021 included in 2020 15,000 2,10,000 Add: Subscriptions outstanding for 2020 19,000 2,29,000 Add: Subscriptions of 2020 received in advance in 2019 18,400 2,47,400 9.22 Financial Accounting: Concepts and Applications Dr. Subscriptions Account Cr. Particulars ` Particulars ` Balance b/d 20,000 Balance b/d 18,400 Income and Expenditure Account (Balancing Figure) Bank Account 2,47,400 Balance c/d 2,45,000 Balance c/d 19,000 15,000 2,82,400 2,82,400 Illustration 3 (Calculation of Current Year’s Subscriptions) In 2020, the subscriptions received by Modern Club of Delhi were ` 20,450 including ` 250 for 2019 and ` 500 for 2021. At the end of 2020, subscriptions outstanding for 2020 were ` 750. The subscriptions due but not received at the end of the previous year i.e., 31.12.2019 were ` 400 while subscriptions received in advance on the same date were ` 900. Calculate the amount of subscriptions to be credited to Income and Expenditure Account for the year ending 31.12.2020. Solution : ` Statement of Subscriptions for the Current Year i.e. 2020 Total subscriptions received during 2020 20,450 Add: Outstanding subscriptions for 2020 750 (i) 21,200 Less: Outstanding subscriptions of 2019 received in 2020 250 (ii) 20,950 Add: Subscriptions received in advance in 2019 (belonging to 2020) 900 21,850 Less: Subscriptions received in advance in 2020 (belonging to 2021) Subscriptions for 2020 to be credited to Income and Expenditure Account 500 (iii) 21,350 (iv) EXPLANATIONS (i) This amount i.e., ` 750 is also shown in the Assets side of the closing Balance Sheet. (ii) Since the amount received in 2019 (` 250) is less than what was outstanding (` 400), the difference of ` 150, will be shown in the assets side of the closing Balance Sheet. (iii) This amount (` 500) is shown on the liabilities side of the current year’s Balance Sheet as : Subscriptions Received in Advance. (iv) This amount of current subscriptions (income) is taken to the credit amount column of the Income and Expenditure Account. Dr. Subscriptions Account Cr. Particulars ` ` Balance b/d 400 Income and Expenditure Account (Balancing Figure) Balance c/d Particulars Balance b/d Bank Account 21,350 Balance c/d 500 (750 + 150) 22,250 900 20,450 900 22,250 Illustrations 4 (Calculation of Current year’s Subscriptions) From the following extracts of Receipts and Payments Account and additional information, you are required to calculate the income from subscriptions for the year ending 31 December 2020 and show them in the Income and Expenditure Account and the Balance Sheet of club: Final Accounts of Not-For-Profit Organisations 9.23 Receipts and Payments Account For the Year Ending December 31, 2020 ` Receipts Payments Years 2019 50,000 2020 3,00,000 2021 60,000 4,10,000 Additional Information (i) Subscriptions outstanding on December 31, 2019 60,000 (ii) Subscriptions outstanding on December 31, 2020 50,000 (iii) Subscriptions received in advance on December 31, 2019 60,000 Solution : Subscriptions to be posted to Income side of Income and Expenditure Account for the year ending on December 31, 2020 ` Subscriptions received for 2020 (as per Receipts and Payments Account) 3,00,000 Add: Subscriptions received in advance on December 31, 2019 60,000 3,60,000 Add: Outstanding subscriptions for 2020 (50,000 – 10,000) 40,000 Amount to be transferred to Income and Expenditure Account 4,00,000 Balance Sheet As On 31 December 2020 Liabilities Subscriptions received in advance (See Receipts and Payments Account) ` 60,000 ` Assets Subscriptions outstanding: 2019 2020 10,000 40,000 50,000 EXPLANATIONS (i) Of ` 60,000 subscriptions outstanding in 2019 only ` 50,000 were received in 2020. Hence, outstanding subscriptions of ` 10,000 for 2019 is still outstanding and would be shown in the current year’s balance sheet. (ii) Total subscriptions outstanding on December 31, 2020 are ` 50,000 including ` 10,000 of 2019. So the outstanding subscriptions for 2020 above are only ` 40,000 (i.e. ` 50, 000  ` 10, 000) . Subscriptions Account (2016) Particulars ` Particulars ` Balance b/d 60,000 Balance b/d 60,000 Income and Expenditure Account Balnace c/d 4,00,000 60,000 5,20,000 Bank Account 4,10,000 Balance c/d : 2019 10,000 2020 40,000 50,000 5,20,000 9.24 Financial Accounting: Concepts and Applications Illustration 5 (Calculation of Current Year’s Salaries) In 2020, the actual salaries paid amounted to ` 1,02,000. Ascertain the amount chargeable to Income and Expenditure Account for the year ending on December 31, 2020 from the following additional information: ` Prepaid salaries on 31.12.2019 12,000 Prepaid salaries on 31.12.2020 6,000 Outstanding salaries on 31.12.2019 9,000 Outstanding salaries on 31.12.2020 7,500 Solution : ` Total salaries paid in 2020 1,02,000 Add: Outstanding salaries on 31.12.2020 7,500 1,09,500 Less: Outstanding salaries on 31.12.2019 9,000 1,00,500 Add: Prepaid salaries on 31.12.2019 12,000 1,12,500 Less: Prepaid salaries on 31.12.2020 6,000 Current year’s salaries debited to Income and Expenditure Account Dr. 1,06,500 Salaries Account Cr. Particulars ` Particulars ` Balance b/d 12,000 Balance b/d 9,000 Bank Account 1,02,000 Balance c/d 7,500 Income and Expenditure A/c Balance c/d 1,06,500 6,000 1,21,500 1,21,500 Ilustration 6 (Consumption or Use of Stationery) Calculate the amount of stationery consumed during the year 2020 from the following date: ` Stock of stationery on January 1, 2020 30,000 Creditors for stationery on January 1, 2020 20,000 Advance paid for stationery carried forward from 2019 2,000 Amount paid for stationery during the year 2020 1,08,000 Stock of stationery on December 31, 2020 5,000 Creditors for stationery for December 31, 2020 13,000 Advance paid for stationery on December 31, 2020 3,000 Solution : ` Stock of stationery on January 1, 2020 Add: Payments made for stationery in 2020 (i) 30,000 1,08,000 1,38,000 Final Accounts of Not-For-Profit Organisations 9.25 Less: Payments made for creditors of 2019 (ii) 20,000 1,18,000 Add: Payments made in 2019 but stationery received in 2020 (iii) 2,000 1,20,000 Add: Creditors at the end for stationery purchased on credit (iv) 13,000 1,33,000 Less: Payments made in advance at the end of the year (for stationery to be received in 2021) (v) 3,000 1,30,000 Less: Stock of stationery in hand on 31 December 2020 (vi) Amount of stationery actually used in 2020 (i.e. the amount to be debited to Income and Expenditure Account for 2020) 5,000 1,25,000 Position Relating to Balance Sheet (i) It will appear in the assets side of the opening balance sheet. (ii) It will appear in the liabilities side of the opening balance sheet. (iii) It will appear in the assets side of the opening balance sheet. (iv) It will appear in the liabilities side of the closing balance sheet. (v) It will appear in the assets side of the closing balance sheet. (vi) It will appear in the assets side of the closing balance sheet. Dr. Particulars Stationery Account Cr. ` ` Balance b/d Opening stock Advance Payment Bank account Balance c/d (creditors at the end) Particulars Balance b/d (creditors) 30,000 2,000 1,08,000 13,000 20,000 Income and Expenditure Account (Balancing Figure) 1,25,000 Balance c/d Closing stock 3,000 Payments made in advance 5,000 1,53,000 1,53,000 RULES REGARDING INCOME AND EXPENSES RELATED TO A PARTICULAR FUND As a general rule all items of income and expenses are transferred to the respective credit and debit side of the Income and Expenditure Account. However, there is a departure from this rule in respect of certain items of income and expenses if these are related to a particular or specific fund. Income: Where some income arises on a specific fund investment, the same is not credited to Income and Expenditure Account but is added to that fund direct in the Balance Sheet. For example, if the amount credited to a Tournament Fund is invested in some securities, say, Government Bonds; the interest received from such investments is added to the Tournament Fund in the Balance Sheet and is not transferred to the credit side of Income and Expenditure Account. However, income on non-fund investments is credited to Income and Expenditure Account. Expenses: Similarly, where some expenses are incurred on an item for which a fund exists, such expenses are not taken to Income and Expenditure Account but are directly deducted from the concerned fund in the 9.26 Financial Accounting: Concepts and Applications balance sheet. For example, tournament expenses paid are deducted from the Tournament Fund in the Balance Sheet; prizes awarded from Prizes Fund, charity paid out of Charity Fund and so on. However, if there is no fund in respect of these expenses they would be debited to Income and Expenditure Account only. Illustration 7 (Fund Items) How would you treat the following items in the case of a non-trading concern: (i) Tournament Fund ` 10,000. Tournament Expenses ` 3,000. Receipts from Tournaments ` 4,000. (ii) Billiard Match Expenses ` 1,500. (iii) Prize Fund ` 5,000. Interest on Prize Fund Investment ` 500. Prize paid ` 1,000. Prizes Fund Investments ` 4,000. (iv) Receipts from cinema show tickets ` 2,500. Expenses on cinema show ` 1,500. Solution : (i) There is a specific Tournament Fund. The treatment is done as under: ` Liabilities Side Tournament Fund Add: Receipts from Tournaments 10,000 4,000 14,000 Less: Tournament Expenses Balance to remain in the Liabilities side 3,000 11,000 (ii) There is no specific fund. Hence, ` 1,500 incurred as Billiard Match Expenses would be shown in the debit side of Income and Expenditure Account. (iii) There is a specific fund. The treatment will be as under: ` Liabilities Side Prize Fund Add: Interest 5,000 500 5,500 Less: Prizes paid 1,000 Balance to remain in the Liabilities side 4,500 Interest on Fund Investments is never added to Fund Investment Account. It is in the form of cash when received and the Assets side is already increased because of its effect on the Receipts side of the Receipts and Payments Account. However, the investment would increase only when the amount of interest is also invested. (iv) There is no specific fund. Receipts from cinema show tickets would be shown on the credit side and Expenses on cinema show would be shown on the debit side of Income and Expenditure Account the two items would be adjusted in the same side. Illustration 8 (Fund Items) How will you deal with the following items while preparing for the Delhi Cricket Club’s income and expenditure account for the year ending 31 December, 2020 and its Balance Sheet as on December 31, 2020: ` (i) Donations received during the year for the constructions of a permanent pavilion Expenditures incurred up to 31.12.2020 on its construction. 7,54,000 5,92,000 Final Accounts of Not-For-Profit Organisations The construction work is continuing; the total estimated construction expenditure of Pavilion being 9.27 20,00,000 (ii) Tournament Fund: Balance as on January 1, 2020 3,760 Subscriptions received during the year 18,400 Expenditure incurred during the year on conducting tournaments 20,200 (iii) Life Membership fees received during the year Give reasons for your answers. 16,000 Solution : (i) Since the donations have been received for a specific purpose, the amount cannot be credited to income and expenditure account; instead ` 7,54,000 would appear in the ‘liabilities side’ of the balance sheet. In other words, it would be capitalised. The total amount spent on the construction of the building is ` 5,92,000. Hence, the building would appear on the assets side at ` 5,92,000 (ii) Tournament Fund (Opening Balance) Add: Subscriptions for tournament fund during the year ` 3,760 18,400 22,160 Less: Expenditure incurred during the year on conducting tournaments Balance at the end in Tournament Fund 20,200 1,960 (iii) Since the Life Membership Fees received is of non-recurring type, it must be capitalised, that is, shown in liabilities side of the balance sheet. Illustration 9 (General) Explain where and how will you treat the following items in the accounts of not-for-profit organizations for the year 2020: (a) (i) Subscriptions received ` 1,50,000 in 2020. (ii) Subscriptions received ` 30,000 in 2019 for 2020. (iii) Subscriptions due for 2020 ` 20,000. (b) (i) Sundry expenses paid in 2020 ` 40,000 including ` 10,000 for 2019. (ii) Sundry expenses payable for 2020 ` 5,000 (iii) Sundry expenses payable for 2019 ` 15,000 (c) (i) Amount received for Prize Fund on 1-1-2020 ` 1,00,000. (ii) Interest on Prize Fund received on 31-12-2020 ` 12,000. (iii) Prizes awarded on 31-12-2020 ` 10,000. (d) (i) New Building purchased on 1-7-2020 ` 26,00,000 (ii) Additions made to buildings upto 31-12-2020 ` 1,40,000 (iii) Whitewashing expenses of building for 2020 ` 10,000. Solution : (a) (i) Subscriptions received in 2020 ` 1,50,000 would be entered on the credit side of the income and expenditure account for the year 2020. (ii) Subscriptions of ` 30,000 received in 2019 for 2020 should be added with subscriptions received for 2020 on the credit side of the income and expenditure account. 9.28 Financial Accounting: Concepts and Applications ` 30,000 would be in the opening balance sheet as subscriptions received in advance on the labilities side. (iii) Subscriptions of ` 20,000 due for 2020 would be added to the subscriptions received for 2020 in the credit side of the income and expenditure account. It would also appear as accrued subscriptions on the assets side of the balance sheet as on 31 December 2020. (b) (i) Sundry expenses of ` 40,000 paid in 2020 would be entered on the debit side of the income and expenditure account. The sundry expenses of ` 10,000 paid for 2019 and included in sundry expenses paid for 2020 should be deducted from sundry expenses on the debit side of income and expenditure account as shown below: Sundry Expenses paid in 2020 40,000 Less: Paid for 2019 10,000 Net amount to be debited 30,000 (ii) Sundry expenses of ` 5,000 payable for 2020 should first be added with sundry expenses paid on the debit side of income and expenditure account. ` 5,000 would also appear on the liabilities side of the closing balance sheet as outstanding sundry expenses. (iii) Sundry expenses of ` 15,000 payable for 2019 would appear on the liabilities side of the opening balance sheet, if opening balance sheet is required since only ` 10,000 is paid for 2019 out of outstanding sundry expenses of ` 15,000, the balance of ` 5,000 is yet to be paid. So it should be added with outstanding liabilities for sundry expenses on the liabilities side of the closing balance sheet. (c) (i) Amount received for Prize Fund on 1-1-2020 is a special fund. It would appear on the liabilities side of the closing balance sheet as a special fund. (ii) Interest of ` 12,000 received on prize fund (investments) should be added to the Prize Fund on the liabilities side of the balance sheet since it is an income relating to special fund. (iii) Prizes of ` 10,000 awarded on 21-12-2020 is an expense related to Prize fund. Hence, it should be deducted from Prize Fund on the liabilities side of the closing balance sheet. (d) (i) New building purchased on 1-7-2020 for ` 26,00,000 would appear on the assets side of the closing balance sheet. (ii) Addition of ` 1,40,000 made to building upto 31-12-2020 should be added with the building on the assets side of the closing balance sheet. (iii) The whitewashing expenses of building ` 10,000 have been incurred on the maintenance of the building purchased. Hence, they are revenue expenditure and should be entered on the debit side of the income and expenditure account. Illustration 10 (Treatment of Special Funds) Following information is available in respect of certain items of a sports club. You are required to show them in the Income and Expenditure Account and Balance Sheet. ` Sports fund 1-1-2020 4,00,000 10% sports fund Investments on 1-1-2020 4,00,000 Interest received on sports fund Investments 30,000 Donations for sports fund 50,000 Sports Prizes awarded 60,000 Expenses on sports events 10,000 General fund 3,00,000 8% General fund Investments on 1-1-2020 3,00,000 Interest on General fund Investments 18,000 Final Accounts of Not-For-Profit Organisations 9.29 Solution : Income and Expenditure Account For the Year Ending on 31 December 2020 ` Expenditure ` Income Interest on General Fund Investments 18,000 Add: Outstanding interest 6,000 24,000 Balance Sheet As On 31 December 2020 (Relevant Information Only) ` Liabilities Sports fund Add: Interest on Sports Fund Investments received Outstanding interest 4,00,000 40,000 4,40,000 Add: Donations 50,000 4,90,000 Less: Less: Sports prizes awarded Prizes on sports events 8% General Fund Investments 4,00,000 3,00,000 Investments 6,000 Note: If there are general fund Investments, then there 4,30,000 must be a general fund 10,000 10,000 Outstanding interest on General Fund 60,000 4,20,000 General Fund 10% Sports Fund Investments Outstanding Interest on sports fund Investments 30,000 10,000 ` Assets at least equal to fund investment. 3,00,000 7,20,000 PREPARATION OF INCOME AND EXPENDITURE ACCOUNT AND BALANCE SHEET FROM THE GIVEN RECEIPTS AND PAYMENTS ACCOUNT The following steps should be considered: Step I :Consider the Receipts side of the Receipts and Payments Account and proceed as follows: (i) Write the opening balances of cash in hand and cash at bank on the assets side of the Opening Balance Sheet. (ii) Enter the receipts of previous year regarding subscriptions, rent etc. on the assets side of the Opening Balance Sheet. (iii) Enter the receipts relating to next year regarding subscriptions received in advance on the liabilities side of the closing balance sheet. (iv) Record the revenue receipts of the current year (after considering other information) on the income side of the income and expenditure account. (v) Enter the capital receipts of the current year on the liabilities side of the closing balance sheet. (vi) In case there is a sale of fixed asset or investment, compare the sale price with the book value of the fixed asset or investments sold and find out profit or loss on sale of fixed asset or investment. Any profit on the sale should be shown in the income side and any loss on the sale of fixed asset or investment on the expenditure side of the income and expenditure account. Step II : Consider the items on the payment side of the Receipts and Payment Account and proceed as follows: (i) Any opening balance of bank overdraft should be shown on the liabilities side of the opening balance stock. 9.30 Financial Accounting: Concepts and Applications (ii) Show payments of the previous year as outstanding liabilities in the opening balance sheet. (iii) Cash in hand and cash at bank at the end should be shown on the assets side of the closing balance sheet. (iv) Enter the revenue payments for the current year (after considering other information) on the expenditure side of income and expenditure account. (v) Enter the capital payments like purchase of assets and investment on the assets side of the closing balance sheet as an addition to the respective assets. (vi) Any payments relating to the next year should be shown as an asset in the closing balance sheet. Step III: Find out the difference between assets and liabilities in the opening balance sheet which is capital fund. Step IV: Balance the Income and Expenditure Account to find out surplus or deficit. Surplus should be added to the capital Fund while deficit should be deducted from the capital fund in the closing balance sheet. Step V: Total up the closing balance sheet. Illustration 11 (General) Calculate the amount to be posted to the Income and Expenditure Account in each of the following cases: (i) There are 1,000 members of a NPO each paying a subscription of `100 p.a. Subscriptions received during the year ` 90,500. (ii) There are 1,000 members each paying ` 100 p.a. Subscriptions received during the year ` 90,000, subscriptions in advance at the beginning of the year ` 9,000. (iii) There are 1,000 members each paying a subscription of ` 150 p.a. Subscriptions outstanding at the beginning of the year ` 15,000; subscriptions received at the beginning of the year ` 25,000; subscriptions received during the year ` 80,000. (iv) Amount paid for stationery during the year ` 50,000; stock of stationery at the beginning and end of the year ` 5,000 and ` 6,000 respectively; creditors for stationery at the beginning and end of the year respectively ` 2,000 and ` 4,000. (v) There are 1,000 members; subscriptions for each member is ` 100 p.a. Subscriptions received during the year ` 85,000; subscriptions received in advance at the end of the year ` 4,000. Solution : ` (i) Subscriptions received Add: Subscriptions outstanding (1,00,000 – 90,500) Total subscriptions to be (1,000×100) posted to income and expenditure account (ii) Subscriptions received Add: Subscriptions received in advance last year 90,500 9,500 1,00,000 90,000 9,000 99,000 Add: Subscriptions outstanding (1,00,000 – 99,000) Total subscriptions to be posted to income and expenditure account (1,000×100) 1,000 1,00,000 Final Accounts of Not-For-Profit Organisations (iii) 9.31 Subscriptions received 80,000 Less: Subscriptions outstanding in the beginning 15,000 65,000 Add: Subscriptions received in advance last year 25,000 90,000 Add: Subscriptions outstanding at the end (1,000×150 – 90,000) To be posted to income and expenditure account (iv) 60,000 1,50,000 Opening stock of stationery 5,000 Add: Payments made during the year 50,000 55,000 Less: Creditors in the beginning 2,000 53,000 Add: Creditors at the end 4,000 57,000 Less: Stock at the end (v) 6,000 Stationery used and to be posted to Income and Expenditure Account 51,000 Subscriptions received during the year 85,000 Less: Received in advance at the end 4,000 81,000 Add: Subscriptions outstanding (1,000×100 – 81,000) 19,000 To be posted to income and expenditure account 1,00,000 Illustration 12 (Calculation of Subscription Income) How will you deal with the following in the Income and Expenditure Account and Balance Sheet of a club as at 31 March 2020: Subscriptions received for 2019-20, `1,25,000, subscriptions outstanding on 31 March 2019, ` 25,000. Subscriptions outstanding on 31 March 2020 ` 15,000. Subscriptions received in advance as on 31 March 2019 ` 20,000. Subscriptions received in advance on 31 March 2020 `14,500. Solution : Income and Expenditure Account (Extract) For the Year Ending 31 March 2020 Dr. Cr. ` ` Subscriptions income for 2019-20 1,20,500 Balance Sheet As on 31 March 2020 (Extract) Liabilities Subscriptions received in advance ` 14,500 Assets Subscriptions Receivable FOR YOUR ATTENTION Subscription income for 2019-20 can be calculated by preparing either a statement or an account. ` 15,000 9.32 (i) Financial Accounting: Concepts and Applications Statement of Subscription Income for 2019-20 ` Subscriptions received in 2019-20 1,25,000 Less: Outstanding for 2018-19 25,000 1,00,000 Add: Outstanding for 2019-20 15,000 1,15,000 Less: Advance as on 31 March 2020 14,500 1,00,500 Add: Advance as on 31 March 2019 20,000 1,20,500 (ii) Subscription Account (2019-20) Dr. Cr. Particulars ` Particulars ` Balance b/d 25,000 Balance b/d 20,000 (Outstanding on 31-3-19) (Advance on 31-3-19) Income and Expenditure Account Receipts and Payments Account (Balancing Figure) 1,20,500 Balance c/d 14,500 1,25,000 (or Bank Account) Balance c/d Outstanding on 31-3-20 1,60,000 15,000 1,60,000 Illustration 13 (Prize Endowment Fund with Prizes Below endowment Income) How will you deal with the following while preparing the final accounts of a NPO for the year ending 31 March 2020: (i) Prizes awarded ` 40,000 (ii) Prize Endowment Fund ` 5,00,000 (iii) 10% Prize Endowment Fund Investment ` 5,00,000 (iv) Donations towards Prize Endowment Fund Investment ` 50,000 (v) Interest received on Prize Endowment Fund Investments ` 50,000 Solution : Balance Sheet As on 31 March 2020 (Extracts) Liabilities Prize Endowment Fund Add: Donations Add: Interest on Prize Endowment Fund Investments Less: Prizes Awarded ` 5,00,000 50,000 Assets 10% Prize Endowment Fund ` 5,00,000 Investments 5,50,000 50,000 6,00,000 40,000 5,60,000 Amount of prizes upto the amount of endowment income from Endowment Fund Investments can be debited or deducted from the Prize Endowment Fund. No entry to Prize Endowment Fund is made in the Income and Expenditure Account. Final Accounts of Not-For-Profit Organisations 9.33 Illustration 14 (Prize Endowment Fund with Prizes Exceeding Endowment Income) How would you deal with the following items while preparing the final accounts of Modern Social Club for the year ending 31 March 2020: ` 70,000 (i) Prizes awarded ` 7,00,000 (ii) Prize Endowment Fund (iii) 8% Prize Endowment Fund Investments on 1 April 2019 ` 7,00,000 (iv) Donations received for Prize Endowment Fund ` 1,00,000 ` 42,000 (v) Interest received on Prize Endowment Fund Investments Solution : Income and Expenditure Account for the year ending 31 March 2020 Dr. Cr. ` Expenditure Prize Awarded ` Income 70,000 Less: Interest Received (42,000) Outstanding Interest (14,000) To be debited 14,000 Balance Sheet As At 31 March 2020 (Extracts) ` Liabilities Prize Endowment Fund 7,00,000 8% Prize Endowment Fund Add: Donations 1,00,000 Investments 8,00,000 Accrued Interest Add: Interest received ` Income 7,00,000 14,000 42,000 Interest Outstanding 14,000 56,000 Less: Prizes Awarded (to the extent of interest received and accrued) 56,000 Nil 8,00,000 Note: The uncovered balance of 14,000 would be debited to Income and Expenditure Account FOR YOUR ATTENTION The amount of prizes awarded exceeding the income from endowment fund investments is debited to Income and Expenditure Account, so that the Prize Endowment Fund must remain inact. This is the only case where entries relating to special fund will be recorded in the Income and Expenditure Account for extra amount; otherwise Income and Expenditure Account records only those entries which show charges in General Fund or Capital Fund. Illustration 15 (Scholarship Fund) The following Balance Sheet, Receipts & Payments Account and adjustments relate to Sagar Academy. Prepare the Income and Expenditure Account for 2020 and the Balance Sheet as on 31 December 2020. 9.34 Financial Accounting: Concepts and Applications Balance Sheet As On 1 January, 2020 ` Liabilities Capital Fund ` Assets 1,80,000 Premises 1,20,000 Equipment Fund 20,000 Furniture 30,000 Scholarship Fund 4,000 Books 16,000 Creditors 6,000 Fixed Deposits 20,000 Prepaid Salaries 2,000 Bank 22,000 2,10,000 Dr. 2,10,000 Receipts and Payments Account For 2020 Cr. ` ` Liabilities Opening Bank Balance 22,000 Fees Received 1,20,000 Payments Salaries 72,000 Scholarship Awarded 3,000 Interest 4,000 Purchase of Equipments 16,000 Sundry Receipts 2,000 Repayment to Creditors 6,000 Miscellaneous Expenses 25,000 Purchase of Books 6,000 Closing Bank Balance 20,000 1,48,000 1,48,000 Additional Information: (i) Depreciate Furniture by 20 per cent and Books by ` 4,000. (ii) Provide for Outstanding Salaries - ` 4,000. Solution : Dr. Sagar Academy Income and Expenditure Account For the Year Ending 31 December, 2020 Cr. ` ` Expenditure Income Salaries 78,000 Fees from members Miscellaneous Expenses 25,000 Interest 4,000 Sundry Receipts 2,000 Depreciation: Books 4,000 Furniture (30,000 × 20%) 6,000 Surplus transferred to Capital Fund 1,20,000 10,000 13,000 1,26,000 1,26,000 Balance Sheet As On 31 December, 2020 ` Liabilities Capital Fund: Opening Balance Add: Surplus Equipment Fund ` Assets Premises 1,80,000 13,000 1,20,000 Furniture: 1,93,000 20,000 Opening Balance Less: Depreciation 30,000 6,000 24,000 Final Accounts of Not-For-Profit Organisations 9.35 Scholarship Fund: Books: Opening Balance 4,000 Less: Scholarship Awarded 3,000 Creditors 6,000 Less: Payment 6,000 Opening Balance 16,000 Add: Purchases 6,000 1,000 22,000 Less: Depreciation — Outstanding Salaries 4,000 4,000 18,000 Fixed Deposits 20,000 Equipments 16,000 Bank Balance 20,000 2,18,000 2,18,000 WORKING NOTES (i) ` Advance / Outstanding Amounts : Salaries As per Receipts & Payments Account 72,000 Add: Outstanding for the current year 4,000 Add: Advance in the previous year 2,000 Posting in Income and Expenditure Account (ii) 78,000 Equipments purchased, being capital expenditure, is not deducted from Equipment Fund. It represents Investment of fund in fixed assets. Illustration 16 (Donations for Building Fund) From the following Receipts and Payments Account of Cosmopolitan Club and the additional information given below, prepare the Income & Expenditure Account for the year ended 31 March, 2020 and the Balance Sheet as on that date: Receipts and Payments Account [2019-20] ` Receipts Balance b/d: Cash 4,000 Bank 30,000 Subscriptions Sale Proceeds of Old Newspapers 34,000 Payments ` Salaries to Staff 25,000 Miscellaneous Expenses 31,000 Balance c/d: 12,800 Cash 6,000 1,200 Bank 41,000 Donation for Building Fund 25,000 Other Donations 30,000 1,03,000 1,03,000 Balance Sheet As At 1 April, 2019 Liabilities Capital Fund Subscription received in Advance ` Assets ` 1,05,600 Cash 4,000 400 Bank 30,000 Furniture 30,000 Building 40,000 Subscription Receivable 1,06,000 2,000 1,06,000 9.36 Financial Accounting: Concepts and Applications Additional information is given below: 2019-2020 ` 1,200 800 (i) Subscription receivable (ii) Subscription received in advance (iii) Charge 10% depreciation on Furniture only. Solution : Cosmopolitan Club Income and Expenditure Account For the Year Ending 31st March, 2020 ` Expenditure ` Income Salaries 25,000 Subscription 11,600 Miscellaneous Expenses 31,000 Other Donations 30,000 Depreciation - Furniture 3,000 Sale of Old News Papers 1,200 Deficit transferred to Capital Fund 16,200 59,000 59,000 Balance Sheet As On 31st March, 2020 ` Liabilities Capital Fund: Opening Balance b/d Less: Deficit ` Assets Building 1,05,600 40,000 Furniture 16,200 Building Fund Subscription Received in Advance 89,400 Opening Balance b/d 25,000 Less: Depreciation 800 30,000 3,000 27,000 Cash in hand 6,000 Cash at Bank 41,000 Subscription receivable 1,200 1,15,200 1,15,200 WORKING NOTES (i) Subscriptions As per Receipts and Payments Account Add: Outstanding for the current year Less: Outstanding for the previous year Less: Advance during the current year Add: Advance during the previous year As per Income and Expenditure Account (ii) ` 12,800 1,200 (2,000) (800) 400 11,600 Other donations are assumed to be for revenue purposes. Illustration 17 (Treatment of Postage Stamps) Prepare an Income and Expenditure Account for the year ended 31 March 2020 and the Balance Sheet as at that date of Modern College from the following: Final Accounts of Not-For-Profit Organisations Receipts Cash on 1 April 2019 Postage Stamps on 1 April 2019 Tuition Fees Fines Grants from State Government Interest on Securities Rent from use of Hall 9.37 ` 20,700 200 59,000 1,000 30,000 300 1,000 ` Payments Pay and Allowances 70,500 Provident Fund Contribution 5,540 Books for Library 4,600 Postage and Telegram 700 Newspapers etc. 300 Science Equipment 480 Laboratory Expenses 500 Payments to Contractor for new building 4,700 Repairs and Maintenance 600 Audit Fees 300 General Charges 580 Cash in hand 22,000 Postage Stamps 700 Printing and Stationery 700 1,12,200 1,12,200 The college had the following assets on 31 March 2019: Furniture - ` 35,000; Land and Buildings - ` 1,60,000; Library Books - ` 24,000; 10% Investments - ` 10,000 and Outstanding Tuition Fees - ` 2,200. Provide for depreciation on the closing balances of the following assets : Land and Buildings @ 5% Furniture @ 15% and Library Books @ 20%. Solution : Modern College Income and Expenditure Account For the Year Ending 31 March, 2020 Expenditure Pay and Allowances Provident Fund Contribution ` 70,500 5,540 ` Income Tuition Fees (59,000  2,200) 56,800 Fines 1,000 30,000 Printing and Stationery 700 Grants Postage and Telegrams 700 Interest on Securities 300 Newspapers 300 Add: Accrued 700 Laboratory Expenses 500 Rent 1,000 Repairs and Maintenance 600 Excess of Expenditure over Income 9,125 Audit Fees 300 General Charges 580 1,000 Depreciation on: Building 8,235 Furniture 5,250 Books 5,720 98,925 98,925 9.38 Financial Accounting: Concepts and Applications Balance Sheet As On 31March, 2019 ` Liabilities Capital Fund (Balancing Figure) 2,52,100 ` Assets Cash 20,700 Postage Stamps 200 Furniture 35,000 Land and Building 1,60,000 Library Books 24,000 10% Investments 10,000 Tuition Fees 2,200 2,52,100 2,52,100 Balance Sheet As On 31March, 2020 ` Liabilities Capital Fund 2,52,100 Less: Deficit 9,125 2,42,975 ` Assets 10% Investments 10,000 Accrued Interest 700 Buildings (1,60,000 + 4,700  8,325) Library Books Additions 1,56,465 24,000 4,600 28,600 Less : Depriciation Furniture Less : Depriciation 5,720 22,880 35,000 5,250 Science Equipment 29,750 480 Cash in Hand 22,000 Postage Stamps 700 2,42,975 2,42,975 ATTENTION PLEASE (i) (ii) (iii) Payment to contractor for the construction of the new building is a capital expenditure; hence, it has been made part of Building Account. Postage and telegram expenses of ` 700 may be divided as : From stamps ` 200 and in Cash ` 500. Interest on securities for full year ought to be `1,000 i.e., 10% of ` 10,000; Hence, accured interst is ` 700 (` 1,000 - ` 300). Illustration 18 (Preliminary) Prepare Income and Expenditure Account and Balance Sheet from the following Receipts and Payments Account for 2020 and Balance Sheet as on 31 December 2019: Dr. Receipts and Payments Accounts for 2020 Cr. ` ` Receipts Balance 1.1.2020 Subscriptions 1,00,000 2019 2,000 2020 21,000 2021 1,000 Payments Expenses Land Interest 2019 12,000 2020 20,000 40,000 4,000 Final Accounts of Not-For-Profit Organisations 9.39 Entrance Fees 8,000 Miscellaneous Expenses 20,000 Lockers’ Rent 7,000 Balance 31.12.2020 83,000 Miscellaneous Income 40,000 1,79,000 1,79,000 Balance Sheet As On 31 December 2019 ` Liabilities Capital Fund 3,36,200 Subscriptions Received in Advance ` Assets Buildings 3,00,000 6,000 Outstanding Subscriptions 3,800 Outstanding Expenses 14,000 Outstanding Lockers’ Rent 2,400 Loan 50,000 Cash 1,00,000 4,06,200 4,06,200 Solution : Dr. Income and Expenditure Account For the Year Ending 31 December, 2020 Cr. ` ` Expenditure Income Expenses 20,000 Subscriptions Miscellanceous Expenses 20,000 Add: Received in Advance for 2020 6,000 Lockers’ Rent 7,000 Less: Received for 2019 2,400 Interest 4,000 Excess of Income over expenditure 27,600 Miscellaneous Income 71,600 21,000 27,000 4,600 40,000 71,600 Balance Sheet As On 31 December, 2020 ` Liabilities Outstanding Expenses 2,000 (14,000  12,000) Assets Buildings 40,000 83,000 1,000 Cash in hand Entrance Fees 8,000 Subscriptions Receivable 50,000 Capital Fund 3,00,000 Land Subscriptions Received in Advance Loan ` 1,800 (3,800  2,000) 3,36,200 Add: Excess of Income over Expenditure 27,600 3,63,800 4,24,800 4,24,800 ATTENTION PLEASE Entrance fees have been capitalised as per Appendix to Accounting Standard - 9. Illustration 19 (Reserve for Tournament Pavilion) From the following information relating to Dadar Cricket Club, prepare Income and Expenditure Account for the year ending 31 December 2020 and a Balance Sheet at that date. An abstract of the Cash Book for the year is as follows: 9.40 Financial Accounting: Concepts and Applications ` Receipts Members’ Subscriptions 10,000 ` Payments Upkeep of Field and Pavilion 4,000 Admission Fees 600 Expenses on tournament 1,400 Sale of old balls, bats etc. 100 Rates and Insurance 400 Hire of ground 600 Telephone 100 8,000 Stationery 200 2,000 General Charges 100 Secretary’s Honorarium 340 Bank Drawn Subscriptions for tournament Donations 20,000 Grass Seeds 60 Bats, Balls etc. 1,400 Bank Lodged 33,300 41,300 41,300 Assets with the Club as at 1 January 2020 were as under: Cash at Bank ` 6,000; Stock of Balls etc. ` 3,000; Printing and Stationery ` 400; Subscriptions Due ` 1,000; Liabilities at that date nil. Donations and Surplus on account of Tournament should be kept in Reserve for a Permanent Pavilion. Subscriptions due at 31 December 2020 amount to ` 1,500. Write off 50% of Bats, Balls Account and 25% off Printing and Stationery Account. Solution : Income and Expenditure Account For the Year Ended 31 December 2020 Dr. Cr. ` Expenditure Upkeep of Field and Pavilion 4,000 Rates and Insurance 400 Income Subscriptions ` 10,000 Less: Due on 1.1.2020 1,000 1,500 Telephone 100 General Charges 100 Add: Due on 31.12.20 Honorarium of Secretary 340 Sale of Old Bats, Balls etc. 100 Hire of Ground 600 Grass Seeds 60 Depreciation of Bats, Balls etc. 9,000 10,500 2,200 Stationery 150 Excess of Income over Expenditure 3,850 11,200 11,200 Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund 10,400 Add: Surplus 3,850 Cash at Bank 14,250 Reserve for Permanent Pavilion: Donations Subscriptions for Tournament Assets 20,000 ` 31,300 Subscriptions Receivable 1,500 Stock of Bats and Balls 2,200 Stock of Stationery 450 2,000 22,000 Less: Expenses on Tournament Admission Fees 1,400 20,600 600 35,450 Cash at Bank = Opening Balance ` 6,000 + Deposit ` 33,300 - withdrawls ` 8,000 = 31,300. 35,450 Final Accounts of Not-For-Profit Organisations 9.41 Balance Sheet As on 1 January, 2020 ` Liabilities Capital Fund (Balancing Figure) 10,400 ` Assets Cash at Bank 6,000 Stock of Bats, Ball etc. 3,000 Stock of Printing and Stationery Subscriptions Receivable 400 1,000 10,400 10,400 Illustration 20 (Receipts and Payments Account and Income and Expenditure Account) Prepare Receipts and Payments Account and Income & Expenditure Account of Western Club for the year 31 December, 2020 : ` Particulars (i) (ii) Subscription Received (including ` 4,000 for earlier years) 30,000 Donation Received 2,000 (iii) Subscription outstanding 6,000 (iv) Rent paid 1,800 Purchase of Furniture (life 10 years) at the beginning of the year 1,000 Purchase of Books 2,500 Purchase of Magazines & Newspapers 1,200 (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) Sale of all old furniture at the beginning of the year (Book value ` 300) 500 Opening Cash and Bank Balance 6,800 Investments Purchased 4,000 Interest on Investment Received 1,000 Bank Charges 20 (xiii) Postage, Telegram & Telephone 1,800 (xiv) Printing & Stationery (one bill of ` 300 for last year) 1,000 (xv) Printer’s Bill outstanding 500 (xvi) Entrance Fees (50% to be capitalised) 1,400 (xvii) Legacies Received (to be capitalised) 2,000 (xviii) Allowances (including ` 200 for last year) 1,800 (xix) Outstanding Allowances 300 Solution : Western Club Receipts and Payments Account For the Year Ended 31 December 2020 Dr. Receipts Opening Cash & Bank Balance Subscription Cr. ` 6,800 30,000 Payments ` Rent 1,800 Furniture 1,000 Donation 2,000 Books 2,500 Interest on Investment 1,000 Magazines and Newspapers 1,200 Entrance Fees 1,400 Investments 4,000 9.42 Financial Accounting: Concepts and Applications Legacies 2,000 Sale of Old Furniture 500 Bank Charges 20 Postage, Telegram & Telephone 1,800 Printing and Stationery 1,000 Allowances 1,800 Closing Cash & Bank Balances 28,580 (Balancing figure) 43,700 Dr. 43,700 Income and Expenditure Account For the Year Ended 31 December, 2020 Cr. ` ` Expenditure Income Allowance (1,800  200 + 300) 1,900 Subscription (30,000  4,000 + 6,000) Rent 1,800 Donation Magazines and Newspapers 1,200 Entrance Fees (50%) Postage, Telegram & Telephone 1,800 Interest on Investment Printing and Stationery (1,000  300 + 500) 1,200 Profit on sale of Furniture (500  300) Bank Charges 32,000 2,000 700 1,000 200 20 Depreciation on Furniture (10% of 1,000) 100 Excess of Income over Expenditure 27,880 35,900 35,900 Illustration 21 (Loss on Sale of Furniture) Given below is the Receipts and Payments Account of ABC Club: Dr. Receipts and Payments Account For the Year Ended 31 December, 2020 Cr. ` ` Receipts Balance b/d: Salary of secretary Cash 60 Bank 3,000 Sale of old furniture on 1 Jan 2020 Sale of old newspapers 3,600 Honorarium 3,060 Subscription (Including subscription for 2019 ` 1,050) Payments 9,000 750 450 Wages 2,400 Charities 2,000 Printing and stationery 300 Postage 100 50 Rent and taxes Legacies 3,000 Upkeep of land 500 Interest of Investments (cost ` 20,000) 1,200 Sports material 2,500 Endowment Fund Proceeds of concerts Advertisement 10,000 1,200 Balance c/d 14,850 800 40 27,900 27,900 Assets and liabilities as on 31 December 2019 and 31 December 2020 are as follows: 31.12.2019 31.12.2020 Subscription in arrear 200 450 Subscription in advance 300 600 2,000 1,080 Furniture Final Accounts of Not-For-Profit Organisations 9.43 Depreciation was 10% p.a. on the furniture left after selling a part of it. It was decided that half of legacies may be capitalised. Prepare Income and Expenditure Account for the year ending 31 December 2020 and a Balance Sheet as on that date. Solution : AUTHOR’S NOTE The question is poorly drafted. When we say, As on...., it means the said figure on that date. So when Subscriptions amounting to ` 200 are in arrear as on 31.12.2019, how the club could receive ` 1,050 for that period. It should have been that ` 200 are still in arrears. The present question should never be set for an examination in future. ABC Club income and Expenditure Account For the Year Ending on 31 December, 2020 Dr. Expenditure Salary Honorarium Cr. ` 3,600 450 Wages 2,400 Charities 2,000 Printing and Stationery 300 Postage 100 Rent and Taxes Subscription 9,000 Less: For 2019 1,050 7,950 Less: Received in Advance in 2020 Add: Received in Advance in 2019 1,200 300 7,650 500 Add: Outstanding for 2020 Depreciation on Furniture 120 Sale of Old Newspapers Loss on Sale of Furniture 50 2,500 600 7,350 Upkeep of Land Sports Materials ` Income 450 50 Legacies 3,000 Less: Capitalised 1,500 Proceeds of Concerts Advertisement 8,100 1,500 800 40 Interest on Investments 1,200 Excess of Expenditure Over Income 1,530 13,220 13,220 Balance Sheet As At 31 December, 2019 Liabilities Subscription Received in Advance Capital Fund (Balancing Figure) ` 300 26,010 Assets ` Furniture 2,000 Subscription Outstanding 1,250 (1,050+200) 26,310 Investments 20,000 Cash in hand 3,060 26,310 9.44 Financial Accounting: Concepts and Applications Balance Sheet As At 31 December 2020 ` Liabilities ` Assets Capital Fund 26,010 Furniture Less: Deficit 1,530 Less: Sold 2,000 800 24,480 Add: Legacies 1,500 25,980 Subscription Received in Advance 600 Endowment Fund 10,000 1,200 Less: Depreciation 120 Investments 20,000 Subscriptions Arrears: For 2019 200 For 2020 450 Cash in hand 650 14,850 36,580 36,580 Calculation of Loss on Sale of Furniture Value of Furniture at the end after depreciation Gross value (Before Depreciation) : 1,080 ` 1,080 1,080  100 90 1,200 Opening Balance 2,000 Balance at the end (before depreciation) 1,200 Book value of Furniture Sold 800 Less: Sale Price 750 Loss on Sale 50 Illustration 22 (Match Fund) The following is the Receipts and Payments Account of Ruby Club for the year ended on March 31, 2020: ` Receipts Balance b/d 4,200 Donation 14,000 Subscriptions : March 31, 2019 2,100 March 31, 2020 39,900 March 31, 2021 2,800 Rent 14,000 Salary: March 31, 2016 2,800 March 31, 2017 8,400 Sports Material 44,800 ` Payments 11,200 12,600 Interest (6% loan) 1,050 Interest on Investment 2,800 Match Expenses 5,600 Entrance Fees 9,800 Newspapers 1,400 Balance 75,600 29,750 75,600 Other Information: As on March 31, 2020, Subscription ` 2,800; Entrance Fees ` 1,400; Rent ` 1,400; Salary ` 2,800 and Repairs ` 700 were outstanding. Donations include ` 7,000 for Match Fund as special donations. On April 1, 2019, the club had: Buildings ` 28,000; Sports Materials ` 14,000; Furniture ` 14,000; Match Fund Investments ` 21,000 (Interest accrued on that ` 700 for the year ended March 31, 2020); Match Fund ` 21,000. Final Accounts of Not-For-Profit Organisations 9.45 Depreciation on Sports Material for current year was charged ` 6,600. Prepare Income and Expenditure Account for the year ended on March 31, 2020 and a Balance Sheet as at that date. Solution : Ruby Club Income and Expenditure Account For the Year Ended 31 March, 2020 Dr. Cr. ` Expenditure Rent 14,000 Add: Outstanding 1,400 Salaries 8,400 Add: Outstanding 2,800 Donations 15,400 Interest on Loan 1,050 Newspapers 1,400 Repair Expenses (Due) 14,000 Less : Received for Match Fund 11,200 ` Income Subscription Add: Outstanding 7,000 7,000 39,900 2,800 42,700 700 Depreciation on Sports Materials 6,600 Surplus 13,350 49,700 49,700 Balance Sheet As On 31 March, 2020 ` Liabilities Subscription Received in Advance 2,800 ` Assets Match Fund Investments 21,000 Interest on Match Fund Investment Accrued 700 Match Fund: As on 1.4.2019 21,000 Add: Donations 7,000 As on 1.4.2019 14,000 Add: Interest Received 2,800 Add: Purchased 12,600 Add: Interest due Less: Expenses Sports Materials: 700 (5,600) 26,600 25,900 Less: Depreciation Cash in hand Outstanding Expenses: 6,600 20,000 29,750 Subscription Due 2,800 1,400 Rent 1,400 Entrance Fees Due Salaries 2,800 Building 28,000 Repairs 700 Furniture 14,000 Loan (1,050 × 100/6) 17,500 Entrance Fees (9,800 + 1,400) 11,200 Capital Fund Opening Balance 42,000 Add: Surplus 13,350 55,350 1,17,650 1,17,650 9.46 Financial Accounting: Concepts and Applications Balance Sheet As On 31 March, 2019 Liabilities Salaries outstanding ` 2,800 ` Assets Cash in hand 4,200 2,100 Match Fund 21,000 Subscription Due Loan (1050 × 100/6) 17,500 Building 28,000 Capital Fund 42,000 Sports Materials 14,000 Furniture 14,000 Match Fund Investments 21,000 (Balancing Figure) 83,300 83,300 Illustration 23 (Calculation of Purchase and Consumption of Medicines) Summary of Receipts and Payments of Kolkata Medical Aid Society for the year ended 31 March, 2019 are as follows: Opening Cash Balance in hand ` 8,000, Subscription ` 50,000, Donation ` 15,000, Interest on Investments @ 9% p.a. ` 9,000, Payment for Medicine Supply ` 30,000. Honoararium to Doctors ` 10,000, Salaries ` 28,000, Sundry Expenses ` 1,000, Equipment purchased ` 15,000, Charity Show expenses ` 1,500, Charity Show collections ` 12,500. Additional Information: 1.4.2019 (`) 31.3.2020 (`) Subscription due 1,500 2,200 Subscription received in Advance 1,200 700 Stock of Medicine 10,000 15,000 Due for Medicine 9,000 13,000 Equipment 21,000 30,000 Building 50,000 48,000 Prepare Income and Expenditure Account for the year ended 31 March 2020 and also the Balance Sheet as on that date. Solution : Kolkata Medical Aid Society Receipts and Payments Account For the Year Ended 31 March, 2020 Dr. Receipts Cash in hand (Opening) Cr. ` 8,000 Payments ` Medicine supply 30,000 Subscriptions 50,000 Honorarium to doctors 10,000 Donation 15,000 Salaries 28,000 Interest on investments 9,000 Charity show collection 12,500 94,500 Sundry expenses 1,000 Purchase of equipment 15,000 Charity show expenses 1,500 Cash in hand 9,000 94,500 Final Accounts of Not-For-Profit Organisations Dr. 9.47 Income and Expenditure Account For The Year Ended 31.3.2020 Cr. ` ` Expenditure Income Medicine consumed (4) 29,000 Subscriptions 51,200 Honorarium to doctor 10,000 Donation 15,000 Salaries 28,000 Interest on investments 1,000 Profit on charity shows: Sundry expenses Depreciation on Show collection Equipment 6,000 Building 2,000 Excess of Income over expenditure (Surplus) Less : Show expenses 9,000 12,500 1,500 11,000 8,000 10,200 86,200 86,200 Balance Sheet As On 31 March, 2020 ` Liabilities Capital Fund: Opening Balance Add: Surplus Subscription received in advance Building 1,80,300 10,200 Less: Depreciation 1,90,500 700 ` Assets 50,000 2,000 Equipment 21,000 Add: Purchased 15,000 48,000 36,000 Amount due for medical supply 13,000 Less: Depreciation Stock of Medicine Investments 6,000 30,000 15,000 1,00,000 Subscription receivable 2,200 Cash in hand 9,000 2,04,200 2,04,200 Balance Sheet as on 31.3.2019 Liabilities ` Assets ` Subscription received in advance 1,200 Building 50,000 Due for medicine Supply 9,000 Equipment 21,000 Stock of Medicine 10,000 Capital Fund (Balancing Figure) 1,80,300 Investments 1,00,000 Subscription due 1,500 Cash in hand 8,000 1,90,500 1,90,500 Subscriptions for the Year Particulars ` Particulars ` Balance b/d 1,500 Balance b/d 1,200 Income & Expenditure A/c Balance c/d 51,200 700 53,400 Cash Balance c/d 50,000 2,200 53,400 9.48 Financial Accounting: Concepts and Applications Purchase of Medicine ` 30,000 + ` 13,000 – ` 9,000 = ` 34,000 Medicine Consumed Opening stock 10,000 Add: Purchases 34,000 44,000 Less: Closing stock 15,000 29,000 Depreciation on Equipment Opening Balance 1.04.2019 21,000 Add: Purchase 15,000 36,000 Less: Balance on 31.03.2020 30,000 6,000 Illustration 24 (General) The Assets and Liabilities position of “WE CARE SPORTS CLUB” was as follows: Particulars 31.03.2019 31.03.2020 ` ` 96,224 86,601 (ii) Bank 10,220 14,470 (iii) Cash 450 650 (iv) Prepaid Insurance 200 — 4,500 3,000 125 — 10,000 — Water 1,000 750 Electricity 1,250 1,000 3,000 4,500 (i) Fixed Assets (v) Subscription received in Advance (vi) Interest outstanding on Loan (vii) Loan (Cr.) (viii) Outstanding Expenses: (ix) Subscription Receivable Receipts and Payments Account For the year ended 31.03.2020 Receipts ` Opening Balance: Payment ` Loan Prepaid 10,000 Rent 11,000 Cash 450 Bank 10,220 Water 12,000 75,000 Electricity 15,000 2,500 Insurance 5,000 Repairs 6,000 Wages 6,000 Telephone 7,200 Subscription Miscellaneous Final Accounts of Not-For-Profit Organisations 9.49 Interest on Loan 250 Miscellaneous 600 Closing Balance: Cash 650 Bank 14,470 88,170 88,170 Prepare the: (i) Income and Expenditure Account for the year ended, and (ii) Balance Sheet as on 31.03.2020. Solution : Dr. “WE CARE SPORTS CLUB” Income and Expenditure Account For the Year Ended 31.03.2020 Cr. ` ` Expenditure Rent 11,000 Water: Income Subscription 75,000 Less: O/S as on 31.3.19 (3,000) Paid during the year 12,000 Add: O/S as on 31.3.20 4,500 Less: O/S as on 31.3.19 (1,000) Add: Prepaid as on 31.3.19 4,500 Add: O/S as on 31.3.20 750 Less: Prepaid as on 31.3.20 (3,000) 11,750 Electricity: Miscellaneous Paid during the year 15,000 Less: O/S as on 31.3.19 (1,250) Add: O/S as on 31.3.20 1,000 Insurance Add: Prepaid as on 31.3.19 78,000 2,500 14,750 5,000 200 5,200 Repairs 6,000 Wages 6,000 Telephone 7,200 Interest on loan 250 Less: O/S as on 31.3.19 125 Miscellaneous 125 600 Depreciation (96,224 – 86,601) 9,623 Surplus 8,252 80,500 80,500 Balance Sheet As On 31.03.2020 ` Liabilities Capital Fund 93,219 Add: Surplus 8,252 Subscription Received in Advance Electricity ` Fixed Assets 86,601 1,01,471 Bank 14,470 3,000 Cash 650 Outstanding Expenses: Water Assets Subscription Receivable 4,500 750 1,000 1,750 1,06,221 1,06,221 9.50 Financial Accounting: Concepts and Applications WORKING NOTE Balance Sheet As On 31 March 2019 ` Liabilities Assets ` Capital Fund (Balancing Figure) 93,219 Fixed Assets Loan 10,000 Cash 450 125 Bank 10,220 Interest on loan Outstanding Subscription Received in Advance 4,500 Outstanding Expenses: Subscription Received Prepaid Insurance Water 1,000 Electricity 1,250 96,224 3,000 200 2,250 1,10,094 1,10,094 Illustration 25 (Treatment of Postage Stamps) From the following receipts and payments account of a club and the additional information, prepare income and expenditure account for the year ended 31 December 2020 and the Balance Sheet at that date: Receipts Cash in hand ` 352 Payments Crockery Purchased ` 265 Current Account with Bank 2,738 Sundries 2,312 6% Fixed Deposit 3,000 Salaries 1,100 Membership Subscription 4,000 Postage Stamps 105 Purchase of Cricket Goods 972 570 (including ` 600 for 2016) Entrance Fees 275 Investments Donations 501 Tournament Expenses Interest on Fixed Deposit 90 Tournament Fund 2,000 Sale of Crockery 300 (Book value ` 120) Upkeep of Lawn Cash in hand Fixed Deposit Additional Information: (i) Monthly salary is ` 100 (ii) The value of issued postage stamps is as follows: 31 December 2019 — ` 75 31 December 2020 — ` 90 (iii) Stock of Cricket Equipment is as follows: 31 December 2019 — ` 321 31 December 2020 — ` 280 (iv) Arrears of membership subscription 2019 — ` 660 2020 — ` 800 400 Balance: Current Account 13,256 1,880 320 2,332 3,000 13,256 Final Accounts of Not-For-Profit Organisations 9.51 Solution: Dr. A Club Income and Expenditure Account For The Year Ending 31 December, 2020 Cr. ` ` Expenditure Sundries Salaries Add: Outstanding for 12th Month 2,312 1,100 100 Income Subscriptions Less: For 2019 1200 Purchases in 2020 800 Donations Opening Stock Add: 600 3,400 Add: For 2020 Postage Stamps: 4,000 75 501 Interest on Fixed Depost 90 105 Add: Accrued 90 180 Profit on sale of crockery Less: Stock at the end 90 Cricket goods 4,200 180 180 90 972 Depreciation on Cricket Equipment (321 – 280) 41 Upkeep of Lawns 400 Excess of Income Over Expenditure 46 5,061 5,061 Balance Sheet As On 31 December 2019 ` Liabilities Capital Fund 7,266 (Balancing Figure) ` Assets Cash in hand 352 Cash at Bank: Current Account 2,738 6% Fixed Deposit 3,000 Crockery 5,738 120 Postage Stamps Stock 75 Stock of Cricket Equipment 321 Subscriptions Receivable 660 7,266 7,266 Balance Sheet As At 31 December 2020 ` Liabilities Outstanding Salary Tournament Fund 100 2,000 Less: Expenses 1,880 Capital Fund 7,266 Add: Surplus Entrance Fees 46 ` Assets Cash in hand 320 Cash at Bank: 120 7,312 275 Current Account 2,332 6% Fixed Deposit 3,000 Accrued Interest Crockery Postage Stamps Stock Cricket Equipment Stock 7,807 5,332 90 265 90 280 Subscriptions Receivable (800 + 60) 860 Investments 570 7,807 9.52 Financial Accounting: Concepts and Applications ATTENTION PLEASE (i) Subscriptions outstanding amounts are for 2019 and 2020 respectively and not on 31 December 2019 and 31 December 2020. (ii) Tournament Fund and Tournament Expenses have been adjusted in the Balance Sheet as on 31 December 2020. (iii) Total interest on Fixed Deposition should be: 6% of ` 3,000 = 180. But the interest received is only ` 90. Hence, ` 90 is yet to be received. (iv) Entrance fees have been capitalised for reasons given in the text. Illustration 26 (Calculation of Subscriptions and Expenses) From the following information supplied by Secretary of the Dahanu Youth Club, prepare the Income and Expenditure Account for the year ending 31 st December, 2020 and the Balance Sheet as on the same date: Cash Balance: 31.12.2019 8,225 31.12.2020 11,900 Investments (31.12-19) 10,750 Furniture & Fittings (31.12.19) 5,000 Purchases of investments during the year 3,850 Entrance Fees (to be capitalised) 8,750 Subscriptions received during the year 69,300 Further information about subscriptions: Arrears of 2019 6,125 Arrears of 2020 5,725 Received in Advance in 2019 1,925 Received in Advance in 2020 1,575 Expenses paid during the year 1,00,625 Further information about expenses: Expenses unpaid in 2020 7,645 Expenses unpaid in 2019 5,375 Expenses prepaid in 2020 2,500 Expenses prepaid in 2019 230 Surplus from Programmes 25,250 Miscellaneous income received in 2020 4,850 Solution: Dr. Dahanu Youth Club Income and Expenditure Account For the Year Ending 31 December, 2020 Cr. ` ` Expenditure Expenses Add: Outstanding in 2020 1,00,625 7,645 1,08,270 Income Subscription Less: Outstanding for 2019 69,300 6,125 63,175 Final Accounts of Not-For-Profit Organisations Less: Outstanding in 2019 9.53 5,375 Add: Outstanding for 2020 5,725 1,02,895 Less: Prepaid in 2020 68,900 2,500 Add: Advance in 2019 1,925 1,00,395 Add: Prepaid in 2019 230 70,825 1,00,625 Less: Advance in 2020 1,575 Surplus from Programmes 69,250 25,250 Miscellaneous Income 4,850 Excess of Expenditure over income 1,275 1,00,625 1,00,625 Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund Add: Entrance Fees 23,030 Cash 8,750 1,275 11,900 Investments 31,780 Less: Deficit ` Assets 10,750 Add: Purchases 30,505 3,850 14,600 Furniture & Fittings 5,000 Subscription received in advance 1,575 Outstanding Subscription 5,725 Outstanding Expenses 7,645 Prepaid Expenses 2,500 39,725 39,725 WORKING NOTE Calculation of Capital Fund: Balance Sheet As On 31 December, 2019 ` Liabilities ` Assets Subscription received in advance 1,925 Cash Outstanding Expenses 5,375 Investments Capital Fund 23,030 (Balancing Figure) 8,225 10,750 Furniture & Fittings 5,000 Outstanding Subscription 6,125 Prepaid Expenses 30,330 230 30,330 Illustration 27 (Incomes and Receipts; Expenditures and Payments) The following information was obtained from the books of Young Bengal Club as on 31.3.2020 to the end of the first year of the club. Prepare Receipts and Payments Account, Income and Expenditure Account for the year ended 31 March 2020 and a Balance Sheet as on that date: (i) Donations Received for Building and Library Book — ` 2,00,000. (ii) Other revenue incomes and actual receipts: Revenue Income (`) Actual Receipt (`) Entrance Fees 17,000 17,000 Subscription 20,000 19,000 600 600 1,600 1,060 — 16,000 Locker Rents Sundry Income Refreshment Account 9.54 (iii) Financial Accounting: Concepts and Applications Other revenue expenditure and actual payments: Revenue Expenditure (`) Actual Payments (`) Land Cost (` 10,000) — 10,000 Furniture (Cost ` 1,46,000) — 1,30,000 Salaries 5,000 4,800 Maintenance of Playgrounds 2,000 1,000 Rent 8,000 8,000 — 8,000 Refreshment Account (iv) Donation to the extent of ` 25,000 was utilised for the purchase of library books, balance was unutilised. In order to keep it safe, 9% Government Bonds of ` 1,60,000 were purchased on 31.3.2020. Remaining amount was put in the Bank on 31.3.2020 under term deposit. Depreciation at 10% p.a. was to be provided for the whole year on Furniture and Library Books. Solution: Dr. Young Bengal Club Receipts and Payments Account For the Year Ending 31 March 2020 Cr. ` ` Receipts Donations for Building and Library Books 2,00,000 Payments Land 10,000 Entrance Fees 17,000 Furniture Subscription 19,000 Salaries 4,800 Maintenance of Playgrounds 1,000 Rent 8,000 Refreshment Account 8,000 Lockers Rent 600 Sundry Income 1,060 Refreshment 16,000 Balance c/d (overdraft) 1,08,140 1,30,000 Library Books 25,000 9% Govt. Bonds 1,60,000 Bank Term Deposit 15,000 3,61,800 Dr. Income and Expenditure Account For the Year Ended 31 st March, 2020 Cr. ` ` Expenditure Salaries Add: 4,800 Outstanding 200 Maintenance of Playgrounds 1,000 Add: Outstanding 1,000 Rent Depreciation: Furniture 3,61,800 5,000 Surplus: Excess of Income Over Expenditure 2,500 Entrance Fees 17,000 Lockers rents 600 Subscription 19,000 2,000 Add: Accrued 1,000 8,000 Sundry income 1,060 14,600 Library Books Income Add: Outstanding 17,100 Refreshment A/c (16,000 – 8,000) 540 20,000 1,600 8,000 15,100 47,200 47,200 Final Accounts of Not-For-Profit Organisations 9.55 Balance Sheet As On 31 st March, 2020 ` Liabilities Capital Fund (Surplus) 15,100 Building and Library 2,00,000 Creditor for furniture 16,000 Outstanding Expenses: Maintenance of Play grounds Land 1,46,000 Less: Depreciation 14,600 Library Books 25,000 Less: Depreciation 200 1,000 Bank overdraft 2,500 9% Govt. Bonds 1,200 1,08,140 ` 10,000 Furniture Room Fund Salaries ` Assets 1,31,400 22,500 1,60,000 Bank: Term Deposit 15,000 Accrued Subscription 1,000 Sundry Income Receivable 540 3,40,440 3,40,440 Illustration 28 (Consumption of Medicines) From the following particulars relating to a Charitable Hospital, prepare Income and Expenditure Account for the year ended 31 December 2020 and a Balance Sheet as at that date: Dr. Receipts and Payments Account For the Year Ending 31 December, 2020 Cr. ` ` Receipts Balance b/d Subscriptions 7,130 Debetor’s Honorarium 9,000 47,996 Suppliers of Medicines 30,590 Donations 4,500 Legacies 10,000 Interest on Investments @ 10% for full year 7,000 Proceeds from Charity Show Payment 10,450 Petty Expenses 461 Salaries 27,500 Equipment Purchased 15,000 Expenses on Charity Show 2,750 Balance c/d 1,775 87,076 87,076 Additional Information: 1.1.2020 31.12.2020 Subscriptions Due 650 800 Subscriptions Received in Advance 254 300 Stock of Medicines 8,910 9,800 Suppliers of Medicines 4,000 2,500 Outstanding Salaries 3,600 4,800 Equipment 21,200 31,600 Buildings (Cost less Depreciation) 90,000 81,000 Solution: Dr. Charitable Hospital Income and Expenditure Account For The Year Ending 31 December 2020 ` Expenditure Doctors’ Honorarium 9,000 Medicines: 8,910 Add: Purchases 30,590 Add: Creditors for Medicines (31.12.2020) 2,500 42,000 ` Income Subscriptions Add: Due on 31.12.2020 Opening Stock Cr. 47,996 800 48,796 Add: Received in Advance on 1.1.2020 254 49,050 9.56 Financial Accounting: Concepts and Applications Less: Stock at the end Less: Creditors on 1.1.2020 Petty Expenses Salaries Add: Outstanding on 31.12.2020 Less: Outstanding on 1.1.2020 Depreciation on Equipment (21,200 + 15,000 – 31,600) Depreciation on Building Expenses on Charity Show 9,800 32,200 4,000 27,500 4,800 32,300 3,600 Less: Due on 1.1.2020 28,200 461 28,700 4,600 Less: Received in Advance in 2020 Donations Interest on Investments Proceeds from Charity Show Excess of Expenditure Over Income 650 48,400 300 48,100 4,500 7,000 10,450 12,661 9,000 2,750 82,711 82,711 Balance Sheet As On 1 January 2020 ` Liabilities Suppliers of Medicines 4,000 Subscriptions Received in Advance 254 Outstanding Salaries 3,600 Capital Fund 1,90,036 (Balancing Figure) Assets Cash in hand Subscriptions Due Stock of Medicines Equipment ` 7,130 650 8,910 21,200 Investments [7,000 × (100/10)] 70,000 Building 90,000 1,97,890 1,97,890 Balance Sheet As On 31 December 2020 ` Liabilities Subscriptions Received in Advance Suppliers of Medicines Outstanding Salaries Capital Fund Less: Deficit Add: Legacies 300 2,500 4,800 1,90,036 12,661 1,77,375 10,000 Assets Cash in hand Subscriptions Receivable Stock of Medicines Equipment Building Investments ` 1,775 800 9,800 31,600 81,000 70,000 1,87,375 1,94,975 1,94,975 Illustration 29 (Donations for Building) The Receipts and Payments Account of Navkar Football Club for the year ending 31 March 2020 was as under: Receipts Balance b/d Subscriptions received Interest Sale of furniture (Book value 14,000) Donations for club building ` 48,000 2,46,000 2,000 10,000 60,000 3,66,000 Payments Purchase of balls Tournament fees Affiliation fees Rent of playground Refreshment expenses Travelling expenses Investments purchased at face value Salary Miscellaneous expenses Balance c/d ` 80,000 10,000 2,000 5,000 4,000 30,000 1,00,000 12,000 8,000 1,15,000 3,66,000 Final Accounts of Not-For-Profit Organisations 9.57 Prepare club’s income and expenditure account for the year ended 31 March 2020 and the balance sheet as on that date after taking the following information into account: (i) The subscriptions received include ` 10,000 outstanding subscriptions of the year 2018-19. Subscriptions for the year 2019-20 amounting to ` 16,000 are still outstanding from members. Some members have paid subscriptions for the year 2020-21 amounting to ` 8,000 which is included in the subscriptions received. (ii) Interest accrued but not received ` 500. (iii) The rent of the playground ` 6,000 and salary ` 5,000 of the year 2019-20 are still outstanding and rent of playground of the year 2018-19 ` 1,000 has been paid during this year. (iv) There is a stock of balls with the club ` 4,000 on 31 March 2020. Solution : Naukar Football Club Income and Expenditure Account For the Year Ended 31 March 2020 ` Expenditure Cost of balls used: Purchases Less: Stock at the end Subscriptions 80,000 4,000 Add: Outstanding for 2019-20 76,000 Tournament fees 10,000 Affiliation fees 2,000 Rent of playground 5,000 Add: 6,000 Outstanding 1,000 Refreshment to players Add: 16,000 2,62,000 Less: Outstanding for 2018-19 10,000 2,52,000 for 2020-21 Interest 10,000 Add: Accrued 8,000 2,44,000 2,000 500 2,500 4,000 Travelling expenses Salary 2,46,000 Less: Received in advance 11,000 Less: Outstanding for 2018-19 ` Income 30,000 12,000 Outstanding 5,000 17,000 Office expenses 8,000 Furniture-Loss on sale 4,000 Excess of Income over Expenditure 85,500 2,46,500 2,46,500 Balance Sheet As On 31 March 2019 Liabilities Outstanding rent ` 1,000 Capital Fund (Balancing Figure) 71,000 72,000 Assets ` Cash 48,000 Subscriptions due 10,000 Furniture 14,000 72,000 9.58 Financial Accounting: Concepts and Applications Balance Sheert As On 31 March 2020 ` Liabilities ` Assets Subscriptions received in advance 8,000 Cash 1,15,000 Outstanding rent 6,000 Investments 1,00,000 Outstanding salary 5,000 Accrued interest 60,000 Subscriptions due Donations for Club Building Capital Fund 71,000 Add: Surplus 85,500 500 16,000 Stock of balls 4,000 1,56,500 2,35,500 2,35,500 Illustration 30 (Prepaid Municipal Taxes) Given below is the Receipts and Payments Account of the National Club for the year ended 31 March 2020. Dr. Cr. ` Receipts Balance b/d 10,250 Subscriptions: ` Payment Salaries 6,000 General expenses 2018-19 400 2019-20 20,500 2020-21 600 Donations 5,400 Investment (Govt. Bonds) Proceeds of entertainment programme 9,500 Municipal taxes Sale of waste papers 450 800 Entertainment programme expenses 4,500 Newspapers 1,500 Charity 3,500 20,000 500 Electricity charges 1,400 Balance c/d 8,900 47,100 47,100 Prepare the club’s income and expenditure account for the year ended 31 March 2020 and the balance sheet as on that date, after taking the following information into account: (i) There are 500 members paying an annual subscription of ` 50 each; ` 500 is still in arrear for 2018-19. (ii) Municipal taxes amounting to ` 400 per annum have been paid up to 30 June 2020 and ` 500 for salaries are outstanding. (iii) Buildings stand in the books at ` 50,000 and it is required to write off depreciation at 5 per cent per annum. (iv) 6 per cent per annum interest is accrued on government bonds for 5 months. Solution : National Club Income and Expenditure Account For the Year Ended 31 March 2020 ` Expenditure Salaries Add: Outstanding General expenses 6,000 500 Subscriptions 6,500 800 ` Income Add: Outstanding Donations 20,500 4,500 25,000 5,400 Final Accounts of Not-For-Profit Organisations Newspapers 9.59 1,500 Municipal taxes 500 Less: Prepaid 100 400 Entertainment expenses 4,500 Charity 3,500 Electiricity charges 1,400 Depreciation on building 2,500 Surplus Proceeds of entertainment programme 9,500 Sale of waste paper 450 Interest on Govt. Bonds 500 19,750 40,850 40,850 Balance Sheet As On 31 March 2020 ` Liabilities Capital Fund 61,150 Add: 19,750 Surplus Buildings 80,900 Subscription received ` Assets Less: Depreciation 50,000 2,500 Investment in Govt. bonds in advance for 2020-21 600 Interest accrued Outstanding salaries 500 Subscriptions due: 47,500 20,000 500 2019-20 4,500 2018-19 500 5,000 Prepaid taxes 100 Cash in hand 8,900 82,000 82,000 Opening Balance Sheet Liabilities Capital Fund ` 61,150 (Balancing Figure) Assets ` Cash 10,250 Buildings 50,000 Subscriptions due 61,150 900 61,150 Illustration 31 (Hidden Adjustment) Following is the Yuvaraj’s Library’s Cash Account for the year ending 31 December 2020: Receipts ` Payments ` Balance b/d 9,000 Salaries and Wages 13,800 Admission Fees 8,000 Books 17,500 Subscriptions Lecture Hall Hire Charges 40,000 6,000 Miscellaneous Receipts 600 Interest on Investments 1,000 Electric Charges 1,500 Outstanding Expenses 1,400 Rent 17,500 5% investments (Purchased on 1.7.2020) 20,000 Donations 10,000 Stationery 2,500 Book Fair Profit 12,000 Balance c/d 12,400 86,600 86,600 9.60 Financial Accounting: Concepts and Applications You are required to prepare an Income and Expenditure Account for the year ended 31 December 2020 and a Balance Sheet as at 31 December, 2020. The following further informations are also made available to you: (i) On 31 December, 2019 the library had the following assets also: Furniture ` 11,000; Books valued at 1,00,000 and investments at a cost of ` 30,000 carrying interest at 5% p.a. (ii) Subscriptions realised in advance this year amounted to ` 5,000 and outstanding liabilities on 31 December, 2016 for salaries and wages ` 1,200 and for Rent ` 1,500. (iii) 60% of the Admission Fees should be capitalised. (iv) Furniture and Library Books are to be depreciated at 6% and 10% p.a. respectively. Solution: Dr. Yuvraj Library Income and Expenditure Account For the Year Ending 31 December, 2020 Cr. ` ` Expenditure Salaries and Wages 13,800 Add: Outstanding Electricity 1,200 Rent 15,000 1,500 17,500 Add: Outstanding 1,500 Stationery Depreciation: Furniture Books 19,000 660 Surplus Admission Fee 8,000 Less: Capitalised (60%) Lecture Hall hire charges 4,800 Miscellaneous Receipts 2,500 11,750 Income 12,410 3,200 6,000 600 Interest on Investment 1,000 Add: Accrued (500 + 500) Donations 1,000 2,000 10,000 Book Fair Profit 12,000 Subscriptions 35,000 18,390 68,800 68,800 Subscriptions Account ` Particulars Income and Expenditure Account 35,000 ` Particulars Receipts & Payments Account 40,000 (Balancing Figure) Balance c/d (Advance) 5,000 40,000 40,000 Balance Sheet As On 31 December, 2020 ` Liabilities Capital Fund Add: Admission Fees Add: Surplus 1,48,600 Furniture 4,800 18,390 Subscription received in Advance Less: Depreciation (6%) 1,71,790 1,200 Rent 1,500 2,700 660 1,00,000 Add: Additions 17,500 1,17,500 10,340 Less: Depriciation (10%) 5% Investments 11,750 30,000 1,05,750 Add: Additions 20,000 50,000 (1.7.2020) Accrued Interest on Investments Cash Balance 1,79,490 11,000 Books 5,000 Expenses Payable: Salaries ` Assets 1,000 12,400 1,79,490 Final Accounts of Not-For-Profit Organisations 9.61 WORKING NOTES Interest on Investments: Due 30,000 × 5% 1,500 Due 20,000 × 5% × 6/12 500 2,000 Received 1,000 Accrued 1,000 Balance Sheet As On 31 December 2019 Liabilities Expenses Payable Capital Fund (Balancing Figure) ` 1,400 1,48,600 Assets Furniture Books 5% Investments Cash 1,50,000 ` 11,000 1,00,000 30,000 9,000 1,50,000 Illustration 32 (Hidden Adjustment) Following is the Receipts and Payments Account of Diamond Literary Club for the year ended on 31 March 2020. Receipts ` Payments ` Cash at Bank 12,500 Salaries 2,500 Subscriptions 52,500 Printing and Stationery 1,250 Annual Day Receipts 26,800 Annual Day expenses 2,500 Mushaira Receipts 22,000 Telephone Charges 2,500 Dividend Receipts 2,000 Sundry Expenses 2,000 1,15,800 Investments in Shares 75,000 Postage and Telegrams 2,250 Building Maintenance 6,000 Rent of Theatre 10,000 Cash at Bank 11,800 1,15,800 Additional Information Supplied: (i) On 1 April 2019 Buildings stood in the books at ` 50,000 and Investments in Shares at ` 5,000. Buildings are subject to depreciation @ 5% p.a. (ii) There are 200 members paying subscription at the rate of ` 250 per annum each. Some members have paid their annual subscription in advance during the year. (iii) As on 1 April 2019, no subscription had been received but subscriptions were outstanding to the extent of ` 1,000 as at 31 March 2019. Subscription accrued as on 31 March 2020 was ` 1,500. (iv) Postage stamps worth ` 250 were in stock with Secretary as on 1 April 2019 and as on 31 March 2020, they were valued at ` 150. (v) Telephone charges paid in advance were ` 300. You are required to prepare Income and Expenditure Account for the year ended on 31 March 2020 and the Balance Sheet as at that date. 9.62 Financial Accounting: Concepts and Applications Solution : Dr. Diamaond Literary Club Income and Expenditure Account For The Year Ending 31 March 2020 Cr. ` ` Expenditure Income Salaries 2,500 Subscriptions Printing and Stationery 1,250 Less: Outstanding on 31 March 2019 1,000 Annual Day Expenses 2,500 51,500 Telephone 2,500 Less: Prepaid 300 Postage Stamps 2,250 Add: Stamps on 1.4.2019 52,500 Add: Outstanding on 31 March 2020 1,500 2,200 53,000 Less: Received in Advance 250 (Balancing Figure) 2,500 Annual Day Income 26,800 2,350 Mushaira Receipts 22,000 Maintenance of Building 6,000 Dividends Depreciation on Building 2,500 Less: Stamps on 31.3.2020 150 Rent of Theatre 3,000 50,000 2,000 10,000 Sundry Expenses 2,000 Excess of Income over Expenditure 69,500 1,00,800 1,00,800 Balance Sheet As On 31 March 2019 ` Liabilities Capital Fund 68,750 (Balancing Figure) ` Assets Cash at Bank 12,500 Buildings 50,000 Subscription Receivable 1,000 Postage Stamp Stock 250 Investments in Shares 5,000 68,750 68,750 Balance Sheet As On 31 March 2020 ` Liabilities Subscriptions Received Buildings in Advance 3,000 Capital Fund 68,750 Add: 69,500 Surplus 1,38,250 50,000 Less: Depreciation 2,500 Investment in Shares 5,000 Add: Purchases 75,000 47,500 80,000 Postage Stamps (Stock) 150 Prepaid Telephone Charges 300 Subscriptions Receivable Cash at Bank 1,41,250 ` Assets 1,500 11,800 1,41,250 Final Accounts of Not-For-Profit Organisations 9.63 Illustration 33 (Stock of Stationery Given) The following is the Receipts and Payments Account of Country Side Club for the year ended 31 December 2020. Receipts and Payments Account ` Receipts Cash in Hand b/d 3,000 Subscriptions : 2019 600 2020 32,400 2021 300 33,300 ` Payments Bank Overdraft 6,200 Investments 6,000 Furniture 2,900 Salaries 12,400 Stationery 1,780 Entrance Fees 1,340 Telephone and Fax 2,840 Dividend Income 1,200 Cash in hand 1,100 580 Cash at Bank 6,200 Sundry Receipts 39,420 39,420 Prepare Income and Expenditure Account of the Club for the year ended 31 December 2020 and a Balance Sheet as at that date taking into account the following additional information: (i) The Club has 3,600 members each paying an annual subscription of ` 10. Subscriptions amounting to ` 180 are still in arrears in respect of the year 2019. (ii) Stock of Stationery on 31 December, 2019 was ` 250 and on 31 December 2020 ` 174. (iii) Entrance fees are to be capitalised. (iv) Salary of ` 1,100 for December 2020 is outstanding while ` 264 was outstanding for December 2019. The Club paid ` 1,000 in the year 2019 towards Telephone Charges of which ` 250 relate to 2020. (v) As on 31 December 2019 Premises stand in the books at ` 49,000 and investment at ` 13,000. Depreciate Premises and Furniture by 10% p.a. Solution: Country Side Club Income and Expenditure Account For the Year Ended 31 December, 2020 ` Expenditure Salaries Add: Outstanding for December 2020 12,400 Subscription 1,100 Add: Outstanding 13,500 Less: Outstanding for December 2019 Stationery Add: Opening Stock 264 Dividend Income 13,236 ` Income Sundry Receipts 32,400 3,600 36,000 1,200 580 1,780 250 2,030 Less: Closing Stock Telephone Add: Advance in 2019 174 1,856 2,840 250 3,090 Depreciation on : Premises 4,900 Furniture 290 Surplus 14,408 37,780 37,780 9.64 Financial Accounting: Concepts and Applications Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund: Opening Add: Entrance Fees Surplus Outstanding Salaries Subscription received in Advance Premises 59,816 1,340 14,408 75,564 1,100 300 ` Assets 49,000 Less: Depreciation @ 10% 4,900 Furniture 2,900 Less: Depreciation @ 10% Investments (13,000 + 6,000) Outstanding Subscriptions 290 44,100 2,610 19,000 3,780 (3,600 + 180) Stationery 174 Cash 1,100 Bank 6,200 76,964 76,964 WORKING NOTE Balance Sheet As On 31 December 2019 Liabilities Capital Fund (Balancing Figure) Bank Overdraft Outstanding Salaries ` 59,816 6,200 264 Assets Cash Outstanding Subscription ` 3,000 780 (600 + 180) Investments 13,000 Premises 49,000 Stationery 250 Prepaid Telephone 250 66,280 66,280 Illustration 34 The following is the Receipts and Payments Account of a cultural society for the year ended 31 December 2020: Receipts Cash in hand, 1 Jan ` 1,500 Subscription: 2019 200 2020 16,200 2021 250 Entertainment Proceeds 2,000 Payments Bank Overdraft, 1 Jan 3,100 Investments in Securities 3,000 Furniture 1,450 Salary 6,200 Printing and Stationery 1,710 1,420 670 Sundry Expenses Interest of securities 480 Balance on 31.12.2020: Sale of Old Chairs 120 21,420 890 Entertainment Expenses Entrance Fees (Book Value: Nil) ` Cash 550 Bank 3,100 21,420 Final Accounts of Not-For-Profit Organisations 9.65 You are required to prepare income and expenditure account of cultural society for the year ended 31 December 2020 and a balance sheet as on that date after considering the following: (i) The society has 1,800 members each paying annual fees of ` 10. Subscriptions amounting to ` 90 were still in arrears for the year 2019. (ii) Stock of Stationery on 31 December 2019 was ` 125 and on 31 December 2020 was ` 87. (iii) Entrance fees are to be capitalised. (iv) Salary of ` 550 for December 2020 is outstanding. Expenses accrued on 31 December 2019 were ` 132. The society had paid ` 500 in 2019 for telephone charges out of which ` 125 related to the year 2020. (v) On 31 December 2019, premises stood in the books at ` 24,500 and investments at ` 6,500. (vi) Depreciate fixed assets by 5%. Solution : Cultural Society Dr. Income and Expenditure Account For the Year Ending 31 December, 2020 Cr. ` ` Expenditure Entertainment Expenses Salaries 1,710 6,200 Add: Outstanding 550 125 Add: 890 Purchase in 2020 Subscriptions Add: Outstanding 6,750 Printing and Stationery: Opening Stock Income 16,200 1,800 Entertainment Proceeds 18,000 2,000 Sale of Old Chairs 120 Interest on Securities 480 1,015 Less: Stock at the end 87 Telephone Charges (Prepaid in 2019) Sundry Expenses 928 125 1,420 Less: Paid for 2019 132 1,288 Depreciation on : Premises 1,225 Furniture 73 Excess of Income over Expenditure 1,298 8,501 20,600 20,600 Balance Sheet As On 31 December 2020 ` Liabilities ` Assets Outstanding Salaries 550 Cash in hand 550 Subscriptions received in Advance (For 2021) 250 Cash at Bank 3,100 Premises Capital Fund Add: Surplus Entrance Fees 29,808 8,501 38,309 670 24,500 Less: Depreciation 1,225 Furniture 1,450 Less: Depreciation Investments 73 6,500 23,275 1,377 9.66 Financial Accounting: Concepts and Applications Add: Purchased in 2020 3,000 9,500 Subscriptions Receivable For 2019 90 For 2020 1,800 Stock of Stationery 39,779 1,890 87 39,779 Calculation of Capital Fund Balance Sheet As On 31 December 2019 Liabilities Outstanding Expenses Bank Overdraft Capital Fund ` 132 3,100 29,808 (Balancing Figure) Assets Cash in hand Premises Investments ` 1,500 24,500 6,500 Prepaid Telephone Expenses 125 Subscriptions receivable (200 + 90) 290 Stock of Stationery 125 33,040 33,040 Illustration 35 (Capital Fund Given) From the following Receipt and Payment Account of Young Friends Mandal, Janak Puri for the year ending 31.12.2020 and the adjustments given below, prepare Income and Expenditure Account for the year ending 31 December 2020 and the Balance Sheet on 31.12.2020 : Dr. Receipts Balance (01.01.2020) Receipts and Payments Account Cr. ` ` Payments 23,000 Taxes 1,500 Donations 5,000 Rent 12,000 Entrance Fees 3,500 Stationery 2,500 Subscriptions 20,000 Wages 3,000 Locker Rent 1,000 Billiard Table 1,950 Income from Annual Programme 1,500 Electrical Fittings 1,150 Sale of Furniture (Cost price ` 20,000) 15,000 Investments Repairs 12,000 800 Annual Programmer Expenses 1,100 Match expenses 3,000 Bank Balance Cash 69,000 25,000 5,000 69,000 Adjustments: (i) Locker rent includes ` 200 for the year 2019 and ` 50 is still outstanding for current year. (ii) Subscriptions include ` 1,000 for the year 2019 and ` 800 are outstanding for this year while ` 200 are received in advance for the year 2021. (iii) Rent ` 800 for the month of December 2020 is still outstanding. Final Accounts of Not-For-Profit Organisations 9.67 (iv) 1/2 of the donations and 1/2 of entrance fees are to capitalised. (v) Opening stock of stationery stood at ` 500 on 1.1.2020, while at the end of the year the stock of stationery stood at ` 1,000. (vi) The assets on 1.1.2020 were: Furniture ` 25,000, Sports Materials ` 5,000, while the Capital Fund on 1.1.2020 stood at ` 54,700. Solution : Dr. Young Friends Mandal Income and Expenditure Account For the Year Ended 31 December, 2020 Cr. ` ` Expenditure Rent 12,000 Add: Outstanding 800 Opening Stock of Stationery 500 Add: Purchases Less: Closing Stock 12,800 Income Donations 5,000 Less: Capitalised 2,500 Entrance Fees 3,500 2,500 Less: Capitalised 3,000 Subscription 1,000 2,000 Less: Outstanding for 2019 3,000 Add: Outstanding for 2020 1,750 2,500 1,750 20,000 1,000 19,000 Wages Repairs 800 19,800 Taxes 1,500 Less: Received in advance for 2021 Annual Programme Expenses 1,100 Locker Rent Match Expenses 3,000 Less: Outstanding for 2019 Loss on Sale of Furniture 5,000 (20,000 – 15,000) 800 200 19,600 1,000 200 800 Add: Outstanding for 2020 50 850 Income from Annual Programme 1,500 Excess of Expenditure over Income 3,000 29,200 29,200 Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund Add: Donations Entrance Fees Less: Deficit ` Assets 54,700 Outstanding Subscription 800 2,500 Outstanding Locker Rent 50 1,750 Furniture 25,000 58,950 Less: Sold 20,000 3,000 55,950 5,000 Stock of Stationery 1,000 Subscription received in advance 200 Billiard Table 1,950 Outstanding Rent 800 Electrical Fittings 1,150 Investments Sports Materials 56,950 12,000 5,000 Bank 25,000 Cash 5,000 56,950 9.68 Financial Accounting: Concepts and Applications Illustration 36 (Trial Balance) From the following Trial Balance prepare an Income and Expenditure Account of the Delhi Club for the year ended 31.12.2020 and a Balance Sheet on that date. Depreciate furniture by 10%, Billiard Tables and Accessories by 20% and China Glass etc. by 33-1/3%. Of the subscriptions ` 400 is paid in advance and ` 250 in arrears. ` 300 is owing for salaries of staff. ` Debit Balances ` Credit Balances Furniture 2,500 Members’ Subscriptions 10,560 Billiard tables and accessories 1,250 Sundry receipts, billiards etc. 1,743 China glass, cutlery etc. 333 Sale of tickets for entertainment 3,234 Repairs 734 Sundry creditors 2,600 Salaries and wages 2,262 Entrance fees (Revenue) Rent and telephone 3,194 Accumulated fund Fuel and light 1,618 Cost of entertainments 2,190 Sundry Expenses 1,600 Cost of annual dinner 448 4,000 760 Sundry debtors 1,170 Cash at Bank 4,800 Cash in hand 174 22,585 22,585 Solution : Delhi Club Income and Expenditure Account For The Year Ending On 31 December 2020 ` Expenditure Repairs 734 Salaries and wages Add: Salaries outstanding 2,262 300 Sale of Tickets for entertainment 3,234 Less: Cost of entertainment 2,190 2,562 Subscriptions Rent and Telephone 3,194 Less: Received in advance Fuel and Light 1,618 Sundry expenses 1,600 Cost of annual dinner 760 Depreciation on: 250 Billiard tables etc. 250 China Glass 111 Excess of Income over Expenditure 1,044 10,560 400 10,160 Add: Outstanding 250 10,410 Sundry receipts : Billiards etc. Furniture ` Income Entrance Fees 1,743 448 611 2,566 13,645 13,645 Final Accounts of Not-For-Profit Organisations 9.69 Balance Sheet As On 31 December 2020 ` Liabilities Accumulated Fund 4,000 Add: 2,566 Surplus Sundry Creditors ` Assets Cash at Bank 4,800 6,566 Cash in hand 174 2,600 Sundry debtors Subscriptions received 1,170 Furniture in Advance Salaries outstanding 2,500 400 Less : Depreciation 250 300 Billiard tables and Accessories 1,250 Less: Depreciation 250 China Glass, cutlery etc. 333 Less: Depreciation 111 Subscriptions outstanding 9,866 2,250 1,000 222 250 9,866 PREPARATION OF RECEIPTS AND PAYMENTS ACCOUNT Receipts and Payments Account includes the actual amount received and actual amount paid during the current accounting period whether the amount belongs to the current or past or future periods and also whether the amount received is on account of capital or revenue items. The Income and Expenditure Account, records only the revenue income and revenue expenditures and that also for the current accounting period only and also on earned (whether actually received in cash or not) and incurred (whether actually paid in cash or not) basis. The following procedure is adopted for preparing Receipts and Payments Account from the given Income and Expenditure Account, additional information etc.. (i) Opening balances of cash in hand and cash at bank should be shown on the debit (receipt) side of the Receipts and Payments Account. (ii) Take into consideration the outstanding or accrued income in the opening balance sheet. If there is no outstanding income at the end or closing balance sheet also, it means the actual receipt of income during the current accounting period and the same should be shown in the receipts side of receipts and payments account. (iii) Consider the outstanding expenses in the opening balance sheet. If this item is not given in the closing balance sheet, it means that such outstanding expenses were paid during the year and the same should be shown in the payments side of receipt and payment account. (iv) Compare closing assets with the opening assets. If the closing balance of assets is more than the opening balance, the difference should be treated as purchase of the assets and the same should be shown in the payments side of the receipts and payments account as shown below (with imaginary figures): Balance of Sports Equipments at the end Add: Depreciation 1,50,000 50,000 2,00,000 Less: Opening balance Purchase of Sports Equipment 1,60,000 40,000 If closing balance of an asset is less than the opening balance, the difference is on account of depreciation which can be verified from the Income and Expenditure Account. 9.70 Financial Accounting: Concepts and Applications If there is a difference even after adjustment of depreciation, it represents sale, and the same should be shown in the receipts side of the receipts and payments account. (v) Deduct outstanding incomes and expenses for the current year from the respective items of incomes and expenses given in the Income and Expenditure Account. The balance should be treated as actual receipts and actual payments and the same should be shown in the Receipts and Payments Account. (vi) Surplus or deficit in the Income and Expenditure Account should be ignored in Receipt and Payment Account. (vii) Any new fund appearing in closing balance sheet may be on account of donations or grants received and the same should be shown on the receipts side of the Receipts and Payments Account. (viii) Any addition to capital fund on account of legacies, entrance fees or life membership fees should be treated as receipts. (ix) Income received in advance appearing in the closing balance sheet is to be treated as receipts during the year. (x) Prepaid expenses appearing in the closing balance sheet should be treated as payments. (xi) Balance the Receipts and Payments Account to find out the closing cash/bank balance. (xii) If closing balances of cash in hand and cash at bank are given, the difference may indicate the opening balance of cash in hand or cash at bank as the case may be. In short, it may be stated that for the purpose of calculating the total receipts and total payments on different terms, we have to adopt exactly the reverse procedure that is followed in calculating the current income or current expenditure. Example I Calculation of Total Receipts e.g., Subscriptions (Using imaginary figures) ` Particulars Subscriptions as per Income and Expenditure Account 2,00,000 Less:Outstanding at the end of the current year 10,000 1,90,000 Less:Received in advance in the previous year 8,000 1,82,000 Add: Received for the previous year 6,000 1,88,000 Add: Received in advance for next year(s) at the end of the current year Total subscriptions received in the current year 2,000 1,90,000 Subscriptions Account Particulars ` Particulars ` Balance b/d 6,000 Balance b/d 8,000 Income and Expenditure Account (Given) 2,00,000 Receipts and Payments Account 1,90,000 (Balancing Figure) Balance c/d 2,000 2,08,000 Balance c/d 10,000 2,08,000 Final Accounts of Not-For-Profit Organisations 9.71 Example II Calculation of Total Payments e.g., Salaries (with imaginary figures) ` Particulars Salaries as per Income and Expenditure Account 1,50,000 Less:Outstanding at the end of the current year 30,000 1,20,000 Less:Paid in advance in the previous year 70,000 50,000 Add: Paid for the previous year 80,000 1,30,000 Add: Paid in advance at the end of the current accounting period 50,000 Total salaries paid in the current year 1,80,000 Salaries Account Particulars ` Particulars ` Balance b/d 70,000 Balance b/d 80,000 Receipts and Payments Account (Balancing Figure) 1,80,000 Income and Expenditure Account (Given) Balance c/d Balance c/d 30,000 2,80,000 1,50,000 50,000 2,80,000 Example III Calculation of Total Amount Spent on Consumable Item e.g., Stationery (with imaginary figures) Particulars Amount of Stationery as per Income and Expenditure Account Less: Stock of stationery in the beginning ` 12,500 3,000 9,500 Add: Paid to the creditors for stationery in the beginning 2,000 11,500 Less: Advance paid for stationery in the previous year 200 11,300 Add: Closing stock of stationery in the current year 500 11,800 Less: Creditors for stationery in the current year i.e., at the end 1,300 10,500 Add: Advance for stationery paid in the current year Total amount paid for stationery in the current year 300 10,800 9.72 Financial Accounting: Concepts and Applications Stationery Account ` Particulars Balance b/d Opening stock Balance b/d (Opening Creditors) 3,000 Paid in Advance Receipts and Payment Account ` Particulars 2,000 Income and Expenditure Account (Given) 200 10,800 Balance c/d : (Balancing Figure) Closing Stock 500 Balance c/d: Paid in Advance 300 Closing Creditors 12,500 800 1,300 15,300 15,300 Illustration 37 (Receipts and Payments Account) From the following Income and Expenditure Account of Daisy Social Club for the year ending on 31 December 2019, Balance Sheet as on 1 January 2020 and additional information: Dr. Expenditure Income and Expenditure Account Cr. ` ` Income Salaries 6,000 Subscription Rent 1,320 Entrance Fees Travelling Expenses 60 Printing and Stationery 120 General Expenses 180 Equipment used 3,000 Surplus 3,120 Donation Interest 13,800 11,280 720 1,200 600 13,800 Balance Sheet As On 1 January 2020 Liabilities Capital Fund ` Assets ` 20,700 Furniture 4,000 Rent outstanding 120 Building 8,000 Salaries outstanding 780 Investment 6,000 Sports Equipment 1,200 Bank 1,680 Accrued Interest 120 Subscriptions due 600 21,600 21,600 Additional Information: Balances as on 31 December 2020 ` Subscription receivable was 960 Salary outstanding was 480 Rent outstanding was 240 Sports equipment was 3,000 Final Accounts of Not-For-Profit Organisations 9.73 Prepare Receipts and Payments Account for the year ending 31 December 2020 and a Balance Sheet as on 31 December 2020. Solution : Receipts and Payments Account For the Year Ending on 31 December 2020 Dr. ` Receipts Balance b/d Subscriptions Add: Outstanding for (2019) 1,680 11,280 Salaries 600 6,000 780 6,780 Less: Outstanding (2020) Rent 960 ` Payments Add: Outstanding (2019) 11,880 Less: Outstanding for (2020) Cr. 10,920 Add: Outstanding (2019) 480 6,300 1,320 120 1,440 Entrance Fees 720 Donations Interest Add: 1,200 600 Outstanding for 2019 120 720 Less: Outstanding (2020) 240 Travelling Expenses 1,200 60 Printing and Stationery 120 General Expenses 180 Sports Equipment at the end 3,000 Add: Used 3,000 6,000 Less: Opening Balance Bank c/d (Balancing Figure) 15,240 1,200 4,800 2,580 15,240 Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund 20,700 Add: Surplus 3,120 23,820 Assets ` Furniture 4,000 Building 8,000 Outstanding Salaries 480 Investments 6,000 Outstanding Rent 240 Bank 2,580 Sports equipment 3,000 Subscriptions Due 24,540 960 24,540 Illustration 38 (Receipts and Payments Account) The following is the Income and Expenditure Account of a Charity Hospital for the year ending 31.12.2020: Expenditure Salaries ` 2,35,000 Diet Expenses 20,000 Rent and Rates Income Subscriptions ` 2,20,000 Donations 40,000 5,000 Interest on Investment for full year 90,000 Insurance 2,000 @ 5% p.a. Office Expenses 8,000 Miscellaneous Receipts 6,000 9.74 Financial Accounting: Concepts and Applications Surgery and Dispensary Expenses 10,000 Depreciation : Building 37,500 Furniture 1,200 Instruments 8,000 Surplus of Income over Expenditure 46,700 29,300 3,56,000 3,56,000 Other information supplied to you are as under: 31.12.2019 ( ` ) 31.12.2020 ( ` ) 2,000 1,500 Cash in Hand Cash at Bank 54,000 ? Building 7,50,000 ? Furniture 20,000 ? Instruments 35,000 ? Subscription outstanding 15,000 45,000 6,000 8,000 18,000 20,000 Subscription received in Advance Salaries outstanding Instruments purchased during the year 2020 were ` 5,000. You are required to prepare the Receipts and Payments Account of the Hospital for the year ended 31 December, 2020 and the Balance Sheet as on that date. Submit your working clearly. Solution : Charitable Hospital Receipts and Payments Account For the Year Ending on 31 December 2020 ` Receipts Balance b/d Salaries Cash 2,000 Bank 54,000 Add: Outstanding (2019) 56,000 Add: Outstanding (2019) 18,000 20,000 2,33,000 2,20,000 15,000 2,35,000 Less: Outstanding (2020) 2,35,000 2,53,000 Less: Outstanding (2020) Subscription ` Payments 45,000 1,90,000 Diet Expenses 20,000 Rent and Rates 5,000 Instruments 5,000 Insurance 2,000 Office Expenses 8,000 Surgery and Dispensary Add: Advance (2020) 8,000 Expenses 1,98,000 Less: Advance (2019) 6,000 10,000 Balance c/d: 1,92,000 Donations 40,000 Interest on investments 90,000 Miscellaneous Receipts 6,000 3,84,000 Cash Bank (Balancing Figure) 1,500 99,500 1,01,000 3,84,000 Final Accounts of Not-For-Profit Organisations 9.75 Balance Sheet As At 31 December 2019 ` Liabilities Capital Fund 26,52,000 Add: Surplus 29,300 Subscriptions Received in Advance Building 26,81,300 8,000 Outstanding Salary 20,000 ` Assets 7,50,000 Less: Depreciation 37,500 Furniture 20,000 Less: Depreciation Instruments Add: Purchased 1,200 7,12,500 18,800 35,000 5,000 40,000 Less: Depreciation Investments (90,000 ÷ 5%) Subscription outstanding 8,000 32,000 18,00,000 45,000 Cash in hand 1,500 Cash at Bank 99,500 27,09,300 27,09,300 Illustration 39 (Receipts and Payments Accounts) From the following Income and Expenditure Account of Diamond Club for the year ended on 31 March 2020 and its Balance Sheet as on 31 March 2019, prepare Receipts and Payments Account for the year ended on 31 March 2020 and a Balance Sheet as at that date : Income and Expenditure Account For the Year Ending 31 March 2020 ` Expenditure Income ` Salaries 50,000 Subscriptions 94,000 Rent 11,000 Entrance Fees 6,000 Travelling Expenses 1,000 Donations Printing and Stationery 1,000 Interest General Charges 1,500 Periodicals 10,000 5,000 500 Surplus 50,000 1,15,000 1,15,000 Balance Sheet As At 31 March 2019 Liabilities ` Outstandings: Assets Furniture 40,000 20,000 Rent 1,000 Sports Equipments Salaries 6,500 Investments Accumulated Fund 1,72,500 ` 1,00,000 Subscription Receivable 5,000 Interest Receivable 1,000 Bank Balance 1,80,000 Other Information as on 31 March 2020: Subscription Receivable ` 8,000; Salaries Outstanding ` 4,000; Rent Outstanding ` 2,000. 14,000 1,80,000 9.76 Financial Accounting: Concepts and Applications Solution : Diamond Club Receipts and Payments Account For the Year Ending 31 March 2020 ` Receipts Balance b/d (Balance as per previous 14,000 Balance Sheet) Subscription Less: Outstanding for 2020 Salaries Add: Paid for 2019 50,000 6,500 94,000 56,500 8,000 Less: Outstanding for 2020 86,000 Add: Receipts for 2019 ` Payments 5,000 Entrance Fees Rent 91,000 Add: Paid for 2019 6,000 Donations 10,000 Interest 5,000 Add: Receipt for 2019 1,000 6,000 4,000 52,500 11,000 1,000 12,000 Less: Outstanding for 2020 2,000 10,000 Travelling Expenses 1,000 Printing and Stationery 1,000 General Charges 1,500 Periodicals 500 Balance c/d 60,500 1,27,000 1,27,000 Balance Sheet As On 31 March 2020 ` Liabilities Accumulated Fund: Opening Balance Add: Surplus 1,72,500 50,000 2,22,500 Outstandings: Assets ` Furniture 40,000 Sports Equipments 20,000 Investments Subscription Receivable Rent 2,000 Bank Balance Salaries 4,000 (Closing Balance as per Receipts and Payments Account) 2,28,500 1,00,000 8,000 60,500 2,28,500 Illustration 40 (Prize Fund And Capitalised Entrance Fees) From the following Income and Expenditure Account and Balance Sheet of a Club, prepare Receipts and Payments Account for the year ending 31 March 2020. Income and Expenditure Account For the Year Ending 31 March 2020 Expenditure Upkeep of Ground ` 10,000 Printing 1,000 Salaries 12,000 Income Subscriptions Sale of old Newspapers ` 17,320 160 Lectures 2,500 Depreciation 1,000 Entrance Fees 1,300 Rent 1,200 Miscellaneous Income 1,100 Deficit 2,820 25,200 25,200 Final Accounts of Not-For-Profit Organisations 9.77 Balance Sheet As On 31 March 2020 ` Liabilities Subscriptions in Advance Prize Fund Add: Less: Interest 100 25,000 9,000 47,000 1,000 Prizes Fund Investments 20,000 26,000 Subscriptions Receivable 2,000 Accumulated Surplus 56,420 Entrance Fees Furniture Ground and Building Prizes Add: ` Assets 24000 700 Cash in hand 2,300 1,300 57,720 Less: Deficit 2,820 54,900 79,000 79,000 The other relevant information is given below: (i) Upkeep of ground ` 600 and Printing ` 240 were paid for the year ending 31 March 2019. (ii) Subscriptions outstanding for 2018-19 were ` 800 and that for 2019-20 were ` 700. (iii) Subscriptions received in advance during 2018-19 were shown at ` 200 and that for 2019-20 at ` 100. Solution : A Club Receipts and Payments Account For the Year Ending 31 March 2020 ` Receipts Balance b/d (Balancing Figure) Subscriptions Add: Outstanding for 2018-19 4,660 17,320 Upkeep of Ground Add: Paid for 2018-19 800 Printing Add: Paid for 2018-19 Add: Received in Advance in 2019-20 100 Salaries 18,220 Less: Outstanding for 2019-20 Less: Advance received in 2018-19 10,000 600 10,600 1,000 240 1,240 12,000 Rent 1,200 700 Prizes Paid 2,000 17,520 Balance c/d 2,300 200 Sale of old Newspapers 17,320 160 Lectures 2,500 Entrance Fees 1,300 Add: 1,300 Capitalised ` Payments 2,600 Miscellaneous Income 1,100 Interest on Investments 1,000 29,340 29,340 9.78 Financial Accounting: Concepts and Applications Illustration 41 (Stock of Stationery) The Income and Expenditure Account of Youth Sports Club for the year ending 31 December 2020 is given below: Income and Expenditure Account ` Expenditure Rent Stationery Wages 1,200 Subscriptions 520 Locker’s Rent 1,365 Repairs ` Income 10,460 350 Subscription for Annual Programme 2,000 475 Expenses of Annual Programme 1,690 Interest 636 Depreciation on Sports Equipments 1,000 Salary 600 Surplus 5,324 12,810 12,810 Additional Information: (i) Locker’s Rent ` 100 has been received for the previous year and ` 50 is still outstanding for the current year (ii) Entrance fee ` 300 have been capitalised. (iii) Subscription ` 150 has been received for the previous year and ` 250 has been received for the next year. (iv) Amount spent on sports equipments ` 4,000 has been capitalised. (v) Salary owing for the current year ` 600. (vi) Closing stock of Stationery is ` 345. (vii) Opening cash balance ` 500. Prepare Receipts and Payments Account for the year ended 31 December 2020. Solution : Dr. Youth Sports Club Receipts and Payments Account For the Year Ended 31 December 2020 Cr. ` ` Receipts Balance b/d Subscription 500 10,460 Add: For 2019 150 Add: For 2021 250 10,860 Payments Rent Stationery 520 Add: Closing Stock 345 Wages Locker’s Rent 350 Repairs Add: 100 Expenses of Annual Programme 450 Interest For 2019 Less: Outstanding for 2020 Subscription for Annual Programme Entrance Fees 50 400 2,000 300 865 1,365 475 1,690 636 Sports Equipments 4,000 Salary 600 Less: Outstanding for 2019 600 Balance c/d (Balancing Figure) 14,060 1,200 — 3,829 14,060 Final Accounts of Not-For-Profit Organisations 9.79 Illustration 42 (Missing Capital Fund) The Income and Expenditure Account of the Goa Club for the year 2020 as follows: Income and Expenditure Account For the Year Ended 31 December 2020 Expenditure Salaries ` ` Income 4,750 Subscriptions 7,500 General Expenses 500 Entrance Fees 250 Audit Fees 250 Contribution for Annual Dinner Secretary’s Honorarium 1,000 Printing and Stationery 450 Annual Dinner Expenses Profit on Annual Sports meet 1,000 750 1,500 Interest and Bank Charges 150 Depreciation 300 Surplus 600 9,500 9,500 The Account had been prepared after the following adjustments: ` Subscriptions outstanding at the end of 2019 600 Subscriptions received in advance on 31 December 2019 450 Subscriptions received in advance on 31 December 2020 270 Subscriptions outstanding on 31 December 2020 750 Salaries outstanding at the beginning of 2020 and at the end of 2019 were respectively ` 400 and ` 450. General expenses include insurance prepaid to the extent of ` 60. Audit fees for 2020 are yet unpaid ` 250. During 2020 audit fees for 2019 were paid amounting to ` 200. Club owned a freehold lease of ground valued at ` 10,000 the Club had sports equipments on 1 January 2020 valued ` 2,600. At the end of the year after depreciation, the equipment amounted to ` 2,700. In 2019 the Club has raised a bank loan of ` 2,000. This was outstanding throughout 2020. On 31 December 2020 cash on hand amounted ` 1,600. Prepare Receipts and Payments Account for the year 2020 and Balance Sheet as at 31 December 2020. Solution : Notes: The problem is silent on two points namely, the opening cash balance on 1.1.2020 and also the opening balance of Capital Fund as on 1.1.2020. These will have to be found out: (i) The first of these two i.e. opening cash balance will be found out by putting the amounts actually received and actually paid during the year 2020, in a Receipts and Payments Account, and the balancing figure on the Receipt side being the opening balance of cash. (ii) When the opening balance of cash is found out, the balance sheet for 2019 will be complied by inserting the items of assets and liabilities in the same; the difference on two sides of the same being treated as Capital Fund as on 31 December 2019, which will be the opening balance of Capital Fund for 2020. On finding the opening balance of capital fund on 1.1.2020 and adding the surplus as shown by Income and Expenditure Account for the year 2020 (which is ` 600) and by posting all the items supplied by the problem into their respective places, we get the Balance Sheet as on 31 December 2020. 9.80 Financial Accounting: Concepts and Applications Goa Club Balance Sheet As On 31 December, 2019 ` Liabilities Capital Fund (Balancing Figure) 11,540 Freehold Lease of Ground Subscriptions Received in Advance 450 Sports Equipment Outstanding Salaries 400 Outstanding Subscription Outstanding Audit Fees 200 Cash in Hand Bank Loan 2,000 ` Assets 10,000 2,600 600 1,390 (From Receipts and Payments Account) 14,590 14,590 Receipts and Payments Account For the Year Ended 31 December 2020 ` Receipts Opening Balance 1,390 (Balancing Figure) Subscriptions Add: Outstanidng for 2019 7,500 Received in advance in 2020 600 450 450 General Expenses 500 Add: Prepaid 270 750 Entrance fees Contribution for Annual Dinner Profit on Annual Sports Meet 400 Less: Outstanding for 2020 60 Audit Fees 250 Less: Outstanding for 2020 250 7,920 Less: Outstanding for 2020 4,750 5,150 7,650 Add: Salaries Add: Paid for 2019 8,100 Less: Received in advance in 2019 ` Payments 4,700 560 — 7,170 Add: Paid for 2019 200 200 250 Secretary’s Honorarium 1,000 1,000 Printing and Stationery 450 750 Dinner Expenses 1,500 Interest and Bank Charges 150 Sports Equipment Purchased (2,700 + 300 – 2,600) 400 Closing Balance 1,600 10,560 10,560 Balance Sheet As On 31 December 2020 ` Liabilities Capital Fund 11,540 Add: Surplus 600 Freehold Lease of Ground 12,140 Subscription Received in Advance 270 Outstanding Audit Fees 250 Outstanding Salary 450 Loan from Bank ` Assets 2,000 Sports Equipments Add: Additions 2,600 400 3,000 Less: Depreciation Outstanding Subscription Prepaid Insurance Cash in Hand 15,110 10,000 300 2,700 750 60 1,600 15,110 Final Accounts of Not-For-Profit Organisations 9.81 Sports Equipment Account ` Particulars Balance b/d (Opening) 2,600 Bank (Purchases) (Balancing Figure) 400 ` Particulars Depreciation 300 Balance c/d 2,700 3,000 3,000 Illustration 43 Prepare Receipts and Payments Account from the following Income and Expenditure Account for the year ending 31 December 2020 and the supplementary notes supplied by a Rotary Club: ` Expenditure ` Income Salaries 3,500 Donations 2,000 Rent 3,000 Entrance Fees (One third) 1,000 Sundry Expenses 750 Subscriptions 4,550 Depreciation 300 Interest 2,500 Supplies for the year 2,500 10,050 10,050 Additional Information: (i) Salaries paid in advance : 2019 – ` 300; 2020 – ` 400. (ii) Salaries outstanding : 2019 – ` 200; 2020 – ` 150. (iii) Subscriptions for 2019 in arrear ` 350, ` 325 of which was received in 2020. (iv) Subscriptions for 2020 unpaid ` 500. (v) Subscriptions paid in advance in 2019 and 2020 amounted to ` 400 and ` 250 respectively. (vi) Sundry assets at the end of 2019 and 2020 stood after depreciation at ` 3,500 and `7,800 respectively. (vii) Balance of cash as on 1 January 2020 was ` 3,150. (viii) Legacies at 1 January and 31 December were respectively ` 7,000 and ` 9,800. Solution : Rotary Club Receipts and Payments Account For the Year Ending 31 December 2020 ` Receipts Balance b/d Subscriptions Add: Outstanding (2019) 3,150 4,550 Salaries Less: Advance (2019) 325 3,500 300 3,200 4,875 Less: Outstanding (2020) ` Payments Add: Advance (2020) 500 400 3,600 4,375 Add: Received in Advance (2020) 250 Add: Outstanding (2019) 4,625 Less: Received in Advance (2019) 400 200 3,800 4,225 Less: Outstanding (2020) 150 3,650 9.82 Financial Accounting: Concepts and Applications Assets Purchased (7,800 + 300 – 3,500) 4,600 3,000 Legacies 2,800 Rent Donations 2,000 Sundry Expenses Entrance Fees 3,000 Balance c/d 2,500 (Balancing Figure) Interest 750 5,675 17,675 17,675 WORKING NOTES (i) ` Assets purchased may also be calculated as follows: Balance in the assets account on 1 January 2020 3,500 Less: Depreciation 300 3,200 Add: Assets Purchased (7,800 – 3,200) 4,600 7,800 (ii) Legacies at 31 December 2020 9,800 Less: Legacies on 1 January 2020 7,000 Received in cash in 2020 2,800 (iii) Entrance fees, treated as revenue income, is only ` 1,000 which is one third of the total. Hence, total Entrance fees received must be ` 1,000 × 3 = ` 3,000 i.e.: 1/3 Entrance Fees = 1,000 1 Entrance Fees = 1,000 × 3 = 3,000 Illustration 44 The Lok Kalyan Dispensary had the following: Dr. Income and Expenditure Account For 2020 ` Expenditure Salaries 23,500 Surgery and Dispensary 3,000 Cr. ` Income Subscriptions 25,000 Interest 9,000 4,000 Rent and taxes 500 Donations Insurance 200 Miscellaneous Receipts Office expenses 800 300 Depreciation: Building 3,750 Furniture 120 Instruments 100 Surplus 3,970 6,330 38,300 38,300 Other Information: Cash in hand and at bank Government Securities (Face value ` 2,00,000) Subscriptions outstanding 31.12.2015 31.12.2016 (` ) (` ) ? 18,700 1,80,000 1,80,000 7,000 10,000 Final Accounts of Not-For-Profit Organisations 9.83 Subscriptions received in advance 200 600 Salaries unpaid 1,000 1,500 Furniture 2,000 1,980 2,00,000 1,96,250 Land and Buildings Instruments 3,500 3,900 Surgery expenses due 200 300 Stock of medicines 300 100 Prepare Receipts and Payments Account for 2020 and also the Balance Sheet. Solution: Dr. Lok Kalyan Dispensary Receipts and Payments Account For the Year Ending 31 December 2020 Cr. ` ` Receipts Cash in hand and at bank 10,800 Payments Salaries: (Balancing Figure) As per Income and Subscriptions: Expenditure Account As per Income and Expenditure 25,000 Add: Outstanding in 2019 10,000 Less: Outstanding in 2020 15,000 Surgery and Dispensary: Account Less: Outstanding for 2020 Add: Outstanding for 2019 7,000 As per Income and Expenditure Received in advance in 2020 200 600 Add: Closing Stock 23,000 3,000 100 3,100 22,400 Interest 9,000 Donations 4,000 Miscellaneous receipts 1,500 Account 21,800 Add: 1,000 24,500 22,000 Less: Received in advance in 2019 23,500 300 Less: Opening Stock 300 2,800 Add: Surgery Expenses due in 2019 200 3,000 Less: Surgery Expenses due in 2020 300 2,700 Rent and Taxes 500 Insurance 200 Office expenses 800 Instruments bought: Closing Balance Add: Depreciation 3,900 100 4,000 Less: Opening Balance 3,500 500 Furniture bought: Closing balance Add: Depreciation 1,980 120 2,100 Less: Opening balance Cash in hand and at bank 46,500 2,000 100 18,700 46,500 9.84 Financial Accounting: Concepts and Applications Balance Sheet, As At 31 December 2020 ` Liabilities Capital Fund: Opening Balance Add: 4,02,200 Surplus 6,330 4,08,530 Subscriptions received in Advance 600 Salaries outstanding 1,500 Surgery expenses due 300 ` Assets Land and buildings 2,00,000 Less: Depreciation 3750 1,96,250 Instruments 3900 Furniture 1,980 Government Securities Stock of Medicines 1,80,000 100 Subscriptions outstanding 10,000 Cash in hand and at bank 18,700 4,10,930 4,10,930 Balance Sheet As At 31 December 2019 ` Liabilities Subscriptions received in Advance 200 Salaries unpaid 1,000 Surgery expenses due 200 Capital Fund 4,02,200 (Balancing Figure) Assets Cash in hand and at bank Government Securities ` 10,800 1,80,000 Subscriptions outstanding 7,000 Furniture 2,000 Land and Buildings Instruments Stock of Medicines 4,03,600 2,00,000 3500 300 4,03,600 WHEN BALANCE SHEETS ARE TO BE PREPARED? Sometimes the examination problem requires the preparation of the Balance Sheet at the beginning of the current accounting period (Opening Balance Sheet) and at the end of the current accounting period (Closing Balance Sheet). The required material is available in the form of a Receipts and Payments Account, Income and Expenditure Account and the Additional Informations. The following procedure is generally adopted: 1. The opening balance sheet is constructed with the help of additional information and the opening balance of cash in hand from the Receipts and Payments Account. 2. The items of ‘Debit’ or ‘Receipts’ side of the Receipts and Payments Account are compared with the ‘Credit’ or ‘Income’ side of the Income and Expenditure Account. The idea is to find out: (i) (ii) Subscriptions in arrears of the previous year (For the Opening Balance Sheet) and of the current year (For the Closing Balance Sheet). Income received in advance (iii) Sale of an asset during the year. (iv) The items which have been capitalised i.e. taken straight to the balance sheet e.g. donation for buildings, endowment fund, legacies etc.. 3. Similarly the ‘Credit’ or ‘Payments’ side of the Receipts and Payments Account is compared with the ‘Expenditure’ or ‘Debit’ side of the Income and Expenditure Account in order to find out: (i) Outstanding expenses during the year. Final Accounts of Not-For-Profit Organisations (ii) 9.85 Prepaid expenses during the year. (iii) Stock of consumbale items e.g. stationery in hand. (iv) Purchase of an asset etc. (v) Depreciation of the assets etc. Illustration 45 (Balance Sheets Only) The Secretary of the Adult Education Society submitted to you the following receipts and payments account and the income and expenditure account for the year ended 31 March 2020: Receipts and Payments Account For the Year Ending 31 March 2020 Dr. ` Receipts Balance b/d 450 Interest Payments Printing Advertisement 2018-19 100 2019-20 150 Staff salary 250 Tuition fees 2019-20 1,000 2020-21 100 1,100 Cr. ` 75 141 1,300 Furniture purchased 670 Rent 520 Miscellaneous expenses 110 Balance c/d 1,374 Entrance Fees 2019-20 420 Membership Fees 2018–19 300 2019–20 1,150 2020–21 390 Miscellaneous income 1,840 130 4,190 4,190 Income and Expenditure Account For the Year Ending 31 March 2020 ` Expenditure Printing 80 Income ` Tuition fees 1,100 1,150 Advertisement 150 Membership fees Rent 600 Miscellaneous income 130 Interest 160 Staff salary 1,200 Miscellaneous expenses 110 Excess of Income over Expenditure 400 2,540 You are asked to give the Balance Sheet of the society as on 31 March 2019 and 31 March 2020. You are further told that the society had the following assets on 31.3.2019: ` Investments 4,000 Furniture 100 Reference books 500 2,540 9.86 Financial Accounting: Concepts and Applications Solution : Adult Education Society Balance Sheet As On 31 March 2019 ` Liabilities Capital Fund 6,350 (Balancing Figure) ` Assets Cash Investments 450 4,000 Accrued interest 100 Membership Fees Accrued 300 Reference Books 500 Furniture 6,350 1,000 6,350 Balance Sheet As On 31 March 2020 ` Liabilities Capital Fund (1.4.2019) 6,350 Add: Entrance Fees (4) 420 Add: Excess of income over expenditure 400 Printing payable Rent Payable Advertisement payable 7,170 5 80 9 Membership fees received in Advance 390 Tuition fees received in Advance (2) 100 ` Assets Cash 1,374 Investments 4,000 Accrued Interest (1) 10 Tuition Fees accrued (2) 100 Staff Salary in Advance (3) 100 Reference books 500 Furniture 7,754 1,670 7,754 ATTENTION PLEASE (i) Interest received as per Receipts and Payments Account is ` 150 while Income and Expenditure Account shows interest income at ` 160. Thus, the difference of ` 10 represents interest income accrued or due but not received. (ii) Tuition fees in the Income and Expenditure Account is shown at ` 1,110. Actual tuition fees received during the year is also ` 1,110. But break up of the tuition fee received shows that ` 100 out of ` 1,110 is for 2020-21, which is received in advance. Since the total amount due is ` 1,110 as against, ` 1,000 received for 2019-20, it means ` 100 is still outstanding. (iii) Actual payments for salaries are ` 1,300 but expenditure is only ` 1,200. Excess amount may relate either to previous year or next year. In this case, it is presumed to be ‘paid in advance’. (iv) Entrance fees has been capitalised since the item does not appear in the credit side of the Income and Expenditure Account. Illustration 46 (Balance Sheets Only) From the following information relating to Delhi Sports Club, prepare the balance sheet as on 1.1.2020 and on 31.12.2020: (i) Assets on 1.1.2020 are — Club grounds and pavilion ` 50,000; Sports equipments ` 30,000; Furniture ` 7,000; Subscription in arrears on that date ` 1,000. Creditors for stationery ` 1,000. Final Accounts of Not-For-Profit Organisations (ii) Receipts Balance b/d 9.87 Receipts and Payments Account For the Year Ending 31 December 2020 ` 5,000 Subscriptions : Payments Printing and Stationery Salaries 2019 900 2020 18,000 2021 ` 3,000 11,000 Advertising 2,000 Fire insurance 1,500 500 Furniture 2,000 300 Investments 18,000 Rent received 2,200 Balance c/d 1,400 Entrance Fees 12,000 Sale of old newspapers 38,900 38,900 (iii) Income and Expenditure Account For the Year Ending on 31 December 2020 Expenditure Salaries Printing and Stationery Audit fees ` Income ` 12,000 Subscriptions 19,000 2,800 Entrance fees 12,000 500 Rent received 2,400 Advertising 2,000 Fire, insurance 1,200 Sale of old newspapers 300 Depreciation on: Sports Equipments Furniture Excess of Income over Expenditure 6,000 800 8,400 33,700 33,700 Solution : Delhi Sports Club Balance Sheet As On 1 January 2020 Liabilities Creditors for stationery Capital Fund ` 1,000 92,000 (Balancing Figure) 93,000 Assets Cash in hand ` 5,000 Grounds and Pavilion 50,000 Sports Equipments 30,000 Furniture 7,000 Subscription receivable 1,000 93,000 9.88 Financial Accounting: Concepts and Applications Balance Sheet As On 31 December 2020 ` Liabilities Creditors for Stationery 800 Outstanding Salary 1,000 Cash in hand 50,000 24,000 500 Sports Equipment (30,000 – 6,000) Subscription received in Advance 500 Furniture (7,000 + 2,000 – 800) Add: 92,000 Surplus 8,400 1,400 Grounds and Pavilion Audit fees outstanding Capital Fund ` Assets 8,200 Investments 1,00,400 18,000 Prepaid insurance 300 Accrued Rent 200 Outstanding Subscriptions: 2019 100 2020 1,000 1,03,200 1,100 1,03,200 Illustration 47 (Balance Sheets Only) The following are the items of Receipts and Payments of the All India Sports Club for 2020 summarised from the books of accounts maintained by the Secretary : ` Receipts Opening Balance (1.1.2020) 4,200 Entrance Fees: 2019 1,000 2020 10,000 Subscriptions : Payments Manager’s Salary 1,000 Printing and Stationery 2,600 Advertising 1,200 Fire Insurance 1,800 Investments 2019 600 2020 15,000 2021 400 Interest on Investments Closing Balance (31.12.2020) Outstanding for 2020 Advertising Audit Fees ` ` 1,500 2,000 400 2,400 Income Entrance Fees 10,500 Subscriptions 15,600 Interest on Investments 4,000 1,600 500 Fire Insurance 1,000 Depreciation 4,940 Excess of Income over Expenditure 34,200 Cr. Manager’s Salary Add: 7,600 Income and Expenditure Account For the Year Ending 31 December 2020 Expenditure Printing and Stationery 20,000 3,000 34,200 Dr. ` 18,160 30,100 30,100 Final Accounts of Not-For-Profit Organisations 9.89 You are required to prepare the Balance Sheets of the Club on 1.1.2020 and 31.12.2020. The book values of the assets on 1.1.2020 were as under: Building — ` 44,000; Furniture — ` 4,000; Cricket Equipments — ` 25,000. The depreciation rate on Building — 5%; on Cricket Equipment – 10% and Furniture – 6%) Solution : All India Sports Club Balance Sheet As On 1.1.2020 ` Liabilities Creditors for Stationery Capital Fund (Balancing Figure) ` Assets 600 Buildings 44,000 78,200 Furniture 4,000 Cricket Equipments 25,000 Cash in Hand 4,200 Entrance Fees Receivable 1,000 Subscriptions Receivable 600 78,800 78,800 Balance Sheet As on 31.12.2020 ` Liabilities ` Assets Subscriptions Received in Advance 400 Buildings Creditors for Stationery 400 Less: Depreciation 2,200 Creditors for Advertising 400 Furniture 4,000 Outstanding Audit Fees 500 Less: Depreciation Capital Fund 78,200 Add: 18,160 Surplus Outstanding Salary 96,360 500 44,000 240 Cricket Equipments 25,000 Less: Depreciation 2,500 41,800 3,760 22,500 Entrance Fees Receivable 500 Subscriptions Receivable 600 Interest on Investments Accrued Prepaid Fire Insurance Investments Cash in Hand 98,560 1,000 800 20,000 7,600 98,560 Illustration 48 (Balance Sheets Only) The ABC Education Society supplies the following information: (i) Income and Expenditure Account For the Year Ending 31 March 2020 Expenditure Salaries Scholarships Rent ` 8,300 41,300 2,800 Income Subscriptions ` 47,800 Government Grants 5,300 Proceeds of Tickets for Entertainment 8,300 9.90 Financial Accounting: Concepts and Applications General Expenses 3,100 Audit Fees 600 Cost of Printing of Tickets and Souvenir 1,500 Cost of Entertainment 3,500 Loss on Sale of Furniture (Book Value ` 800) 300 Depreciation on Furniture 600 Surplus Advertisement in Souvenir 5,100 Interest for full year @ 6% p.a. 1,500 6,000 68,000 68,000 (ii) Receipts and Payments Account For the Year Ending 31 March 2020 ` Liabilities Balance b/d 3,800 Subscriptions 46,000 Assets Salaries Scholarships ` 9,400 40,100 Government Grant 5,300 Rent 2,600 Sale of Tickets 8,300 General Expenses 3,100 Advertisement in Souvenir 4,600 Printing of Tickets and Souvenir 1,200 Interest 1,000 Cost of Entertainment 3,500 Furniture 2,000 Balance c/d 7,600 Sale of Furniture 500 69,500 69,500 On 31 March 2019, Subscriptions due were ` 1,500; Furniture on that date was ` 6,000. Prepare Balance Sheets as on 31 March 2019 and on 31 March 2020. Solution : ABC Education Society Balance Sheet As On 31 March 2019 ` Liabilities Capital Fund 36,300 (Balancing Figure) Assets ` Cash in hand 3,800 Subscription Receivable 1,500 Furniture 6,000 Investments (1,500× 100/6) 36,300 25,000 36,300 Balance Sheet As On 31 March 2020 ` Liabilities Outstanding Expenses: Assets ` Cash in hand 7,600 Rent 200 Prepaid Salary (9,400 - 8,300) 1,100 Audit Fees 600 Subscriptions Receivable 3,300 Printing and Stationery 300 (47,800 – 44,500) Scholarships Capital Fund 1,200 36,300 2,300 Advertisement Suspense Account (Prepaid) 500 Final Accounts of Not-For-Profit Organisations Add: Surplus 9.91 6,000 42,300 Investments 25,000 Accrued Interest (1,500 – 1,000) Furniture Less: Sold 500 6,000 800 5,200 Less: Depreciation 600 4,600 Add: Purchased 44,600 2,000 6,600 44,600 Illustration 49 (Preparation of Balance Sheets) From the following information relating to Dwarka Sports Club, prepare the Balance Sheet as on 1.1.2020 and on 31.12.2020: (i) Assets on 1.1.2020 are – Club grounds and buildings ` 5,00,000; Sports Equipments ` 3,00,000; Furniture ` 70,000; Subscriptions in arrears on that date ` 10,000. Creditors for Stationery ` 5,000. (ii) Receipts and Payments Account For the Year Ending 31 December 2020. Dr. Cr. Receipts Balance b/d ` 50,000 Subscriptions: Payment Printing and Stationery Salaries 2019 9,000 2020 1,80,000 2021 ` 30,000 1,10,000 Advertising 20,000 Fire Insurance 15,000 5,000 Furniture 20,000 3,000 Investments 1,80,000 Rent received 22,000 Balance c/d 14,000 Entrance Fees 1,20,000 Sale of old Newspapers 3,89,000 3,89,000 (iii) Income and Expenditure Account For the Year Ending 31 December 2020 . Dr. Cr. Expenditure Salaries Printing and Stationery Audit fees ` Income ` 1,20,000 Subscriptions 1,90,000 28,000 Entrance Fees 1,20,000 5,000 Rent Received 24,000 Advertising 20,000 Fire Insurance 1,2000 Sale of old newspapers 3,000 Depreciation on: Sports Equipment Furniture Excess of Income over expenditure 60,000 8,000 84,000 3,37,000 3,37,000 9.92 Financial Accounting: Concepts and Applications Solution : Dwarka Sport Club Balance Sheet As on 1.1.2020 ` Liabilities Creditors for Stationery 5,000 Capital Fund 9,25,000 (Balancing Figure) ` Assets Club Grounds and Buildings 5,00,000 Sports Equipment 3,00,000 Furniture 70,000 Subscriptions in Arrears 10,000 Cash in Hand 50,000 9,30,000 9,30,000 Balance Sheet As on 31.12.2020 ` Liabilities Creditors for Stationery 3,000 Outstanding Salary ` Assets Club Grounds and Buildings 5,00,000 10,000 Sports Equipments 3,00,000 Outstanding Audit Fees 5,000 Less: Depreciation 60,000 Subscriptions Received in Advance 5,000 Furniture 70,000 Addition 20,000 Capital Fund Add: Surplus 9,25,000 84,000 10,09,000 2,40,000 90,000 Less: Depreciation 8,000 82,000 Subscription in Arrears 2019 1,000 2020 10,000 Cash in hand 11,000 14,000 Rent Receivable 2,000 Prepaid Fire Insurance 3,000 Investments 10,32,000 1,80,000 10,32,000 RECEIPTS AND EXPENDITURE ACCOUNT The mercantile system may not be adopted by the professional men like doctors, solicitors, accountants, etc., because their number of credit transactions is very small or negligible, if not nil. Hence, they prepare their final accounts on cash basis. As a result of this, they ignore outstanding income. However, they do take into account outstanding expenses. In addition to the cash book, the professional men generally maintain a Stock Register in which a record of the following items is kept: (i) All articles purchased for use in the profession and not for resale e.g., stationery books, surgical instruments, furniture, computers and so on. (ii) All articles, which are purchased for resale such as medicines in the case of a doctor or stamp papers in the case of a solicitor. When any item is consumed or sold or destroyed, it is noted in the stock register itself so that the value of stock in hand on a particular date is easily ascertained and compared with the physical stock. Professional people prepare Receipts and Expenditure Accounts which is based on the information obtained from the cash book and the stock register. Receipts and Expenditure Account is prepared on cash basis. In case the outstanding income is shown, this account is debited with the outstanding income as reserve which Final Accounts of Not-For-Profit Organisations 9.93 nullifies the addition of the outstanding income. However, outstanding expenses are properly recorded and the net result in terms of surplus or deficit is correctly ascertained. Thus, this account is termed as Receipts and Expenditure Account and is different from Receipts and Payments Account which indicates only actual cash disbursements and not outstanding expenses. To sum up, in Receipts and Expenditure Account, income is determined on cash basis and expenditure on accrual basis. Illustration 50 (Receipts and Expenditure Account) Dr. Magazine is a practising Orthopaedic Surgeon. The Receipts and Payments Account for the year ending 31 March 2020 is as follows: Receipts Balance b/d Fees ` Payment ` 10,000 Salaries 15,000 1,50,000 Miscellaneous Receipts 2,500 Sale of old equipments 10,000 (Cost of 15,000) Rent 5,000 Journals etc. 2,000 Books for Library 8,000 Purchase of instruments 20,000 Stationery 200 Conveyance 1,500 Purchase of medicines 25,000 Furniture 2,500 Drawings 75,000 Cash in hand 18,300 1,72,500 1,72,500 His position stood on 1.4.2019 as : Equipments ` 75,000; Medicines ` 10,000. Fees outstanding ` 2,000. Books ` 10,000. Depreciate equipments by 10% and books by 20%. Fees still outstanding ` 5,000. Salaries to Compounders still payable ` 2,000. Stock of medicines ` 2,000. Required: Receipts and Expenditure Account. Solution : Dr. Magazine Receipts and Expenditure Account For the Year Ending 31 March 2020 Dr. ` Expenditure Salaries Add: Outstanding 15,000 2,000 Rent 5,000 Stationery ` Receipts Fees received 17,000 Cr. Add: Outstanding Miscellaneous Receipts 1,50,000 5,000 1,55,000 2,500 200 Journals etc. 2,000 Conveyance 1,500 Loss on the sale of equipments 5,000 Medicines used 33,000 Depreciation on: Equipments 8,000 Books 3,600 Reserve for outstanding fees Surplus 11,600 5,000 77,200 1,57,500 1,57,500 9.94 Financial Accounting: Concepts and Applications Balance Sheet As On 1 April 2019 ` Liabilities Reserve for outstanding fees 2,000 Capital (Balancing Figure) 1,05,000 ` Assets Cash in hand 10,000 Equipments 75,000 Medicines 10,000 Fees outstanding 2,000 Books 10,000 1,07,000 1,07,000 Balance Sheet As On 31 March 2020 ` Liabilities Capital Add: 1,05,000 Surplus Cash in hand 77,200 1,82,200 Less: Drawings Reserve outstanding for fees 75,000 ` Assets 75,000 Add: Purchases 20,000 1,07,200 5,000 18,300 Equipments 95,000 Less: Sale 15,000 80,000 Salaries outstanding 2,000 Less: Depreciation Books Add: Purchases 8,000 72,000 10,000 8,000 18,000 Less: Depreciation 3,600 14,400 Medicines 2,000 Fees outstanding 5,000 Furniture 2,500 114,200 114,200 Illustration 51 (Fund Items) The following is the Receipts and Payments Account of a Charitable Trust for the year ending 31st March, 2020 : Receipts ` Balance b/d : ` Capital Payments : Cash 10,000 Bank 1,40,000 Capital Funds : Donation for Clinic Fund Payments 60,000 Revenue Receipts : Investments 1,00,000 Furniture 40,000 Clinical Equipments 50,000 Revenue Payments: Salaries 62,000 Interest 3,00,000 Medicines 1,40,000 Rent 1,20,000 Scholarships 1,00,000 30,000 Printing etc. Sundries Travelling 8,000 10,000 Balance c/d : Cash 16,000 1,34,000 6,60,000 6,60,000 Final Accounts of Not-For-Profit Organisations 9.95 Trust fund originally consisted of : Building valued at ` 15,00,000, 9% Govt. Securities ` 32,00,000 (Nominal value ` 35,00,000) and Bank balance ` 1,00,000. Bank interest receivable at the end of year was ` 25,000. Interest accrued on investments on 1-4-2019 was ` 35,000 and on 31-3-2020 ` 50,000. The Trust owed suppliers of medicines ` 12,000 and ` 8,000 on 1-4-2019 and 31-3-2020 respectively. Furniture stood in the books at ` 30,000 on 1-4-2019. You are required to prepare final accounts of the Trust for the year ending 31st March, 2020 after providing 2½ % depreciation on the book value of the building and 20% on other assets. B.Com. (Hons.) Sem. I, 2014] Solution : Balance Sheet As At 31 March 2019 ` Liabilities Trust Fund: Building 15,00,000 9% Government Securities 32,00,000 Bank 1,00,000 Suppliers for medicines 48,00,000 12,000 Clinic Fund (Balancing Figure) 1,03,000 Assets ` Cash in hand 10,000 Cash at Bank 1,40,000 Building 15,00,000 9% Government Securities 32,00,000 (Nominal Value 35,00,000) Accrued Interest on Investments 35,000 Furniture 30,000 49,15,000 49,15,000 Calculation of Medicines Consumed Suppliers for Medicines Account Particulars Cash Account Balance c/d ` Particulars ` 1,40,000 Balance b/d 12,000 8,000 Medicines purchased and consumed 1,36,000 (Balancing figures) 1,48,000 1,48,000 Income and Expenditure Account for the year ending 31-3-2020 ` Income ` Salary 62,000 Interest 3,00,000 Depreciation-Building 37,500 Bank Interest Expenditure Scholarship Printing Travelling Expenses Surplus 1,00,000 8,000 3,25,000 Add: Interest accured 10,000 2,72,500 25,000 50,000 3,75,000 Less: Outstanding last year 35,000 3,40,000 Rent Sundries 4,90,000 1,20,000 30,000 4,90,000 9.96 Financial Accounting: Concepts and Applications Balance Sheet As At 31 March 2020 ` Liabilities Trust Fund Add: Surplus 48,00,000 2,72,500 Suppliers for medicines Building 50,72,500 8,000 Further contribution Less: Depreciation on Clinic 1,03,000 9% Government Securities 14,62,500 32,00,000 1,00,000 60,000 Furniture 30,000 1,63,000 Addition 40,000 (10,000) 70,000 (1,36,000) Less: Depreciation on clinic furniture (37,500) New Investments equipment Less: Medicines consumed Depreciation 15,00,000 (Face Value ` 35,00,000) Clinic Fund: Opening Balance ` Assets (14,000) 3,000 Less: Depreciation 14,000 Clinic Equipment 50,000 Less: Depreciation 10,000 56,000 40,000 Cash in hand 16,000 Cash at Bank 1,34,000 Accrued Bank Interest 25,000 Accrued Interest on 9% Investment 50,83,500 50,000 50,83,500 ASSUMPTIONS (i) (ii) Furniture is from Clinic Fund Bank interest has not been divided into general trust income and clinic fund since the details of their balances during the year are not given. This information was needed because part of the bank balance represents clinic fund. Illustration 52 (Revisionary) From the following Receipts and Payments Account of a Cricket Club and additional information, prepare Income and Expenditure Account for the year ended 31st March, 2020 and a Balance Sheet as on that date : Receipts ` Balance b/d : Payments ` Purchase of Balls 65,000 10,000 Cash 10,200 Tournament Fees Bank 30,000 Affiliation Fee for five years 2,000 Rent of Playground 6,000 Travelling Expenses 20,000 Expenses of Variety Programme 15,000 Subscriptions Interest on Investment Sale of ticket for Variety Programme Sale of furniture (30-09-2019) 2,45,000 1,800 20,000 9,000 Refreshment Expenses 4,000 Donation for Building 50,000 Furniture bought on (1-10-2019) 5,000 Legacy 11,000 Advance to Building Contractor 50,000 Repairs 5,000 Salary 15,000 Telephone bill 1,500 Final Accounts of Not-For-Profit Organisations 9.97 Miscellaneous Exps 8,000 12% Investments (F.V. ` 1,70,000) 1-1-2020 1,50,000 By Balance : Cash 8,500 Bank 12,000 3,77,000 3,77,000 Additional Information : (a) Miscellaneous expenses include ` 3,000 for the honorarium. (b) Subscriptions received include ` 9,000 outstanding subscription for the year 2018-19. Subscription for the year 2019-20 amounting to ` 16,000 is still outstanding. Some members have paid subscription for the 2020-21 amounting to ` 8,000 which is included in the subscription received. (c) Face value of 12% investment on 31st March 2019 was ` 15,000 (Cost price ` 12,000). (d) Book value of the furniture sold on 1-4-2019 was ` 12,000 depreciation being 20% p.a. Provide depreciation on new furniture at the same rate. (e) Telephone bill for one quarter is outstanding, the amount outstanding being ` 300. The charge for each quarter is same both for 2018-19 and 2019-20. (f) Unpresented cheques for repairs to building being ` 4,000 for 2018-19 and ` 12,000 for 2019-20. (g) Bank balance, represents 'Balance as per Bank Pass Book'. (h) Stock of balls with the club on 31st March, 2020 amounted to ` 6,000. [B.Com. (Hons.) Sem. I, 2016 Delhi, Modified] Solution : Income and Expenditure Account for the year ending on 31 March 2020 Expenditure ` Miscellaneous Expenses 5,000 Subscriptions Honorarium 3,000 Less: Received for 2018-19 Depreciation on Furniture 1,700 Loss on sale of Furniture 1,800 Add: Subscriptions Outstanding Telephone Bill 1,200 (2019-20) Consumption of Balls 59,000 Tournament Fees 10,000 Affiliation Fees 6,000 Travelling Expenses 20,000 4,000 Repairs 13,000 Salary 15,000 Excess of Income over Expenses 2,45,000 9,000 2,36,000 16,000 2,52,000 Less: Received in Advance (2020-21) 400 Rent of Playground Refreshment Expenses ` Income 8,000 2,44,000 Interest on Investements 6,900 Receipts from Variety Programmes 20,000 Less: Expenses 15,000 5,000 1,15,800 2,55,900 2,55,900 9.98 Financial Accounting: Concepts and Applications Balance Sheet As at 31 March 2020 ` Liabilities ` Assets Legacy 11,000 Cash in Hand Donation for Building 50,000 Cash at Bank (12,000–12,000) Nil Affiliation Fees for four years 1,600 Capital Fund 68,600 Add: Surplus 1,15,800 Outstanding Telephone Bills 1,84,400 300 Subscriptions Received in Advance 8,000 8,500 Advance to Building contractors 50,000 Stock of Balls 6,000 Investments 1,62,000 Accrued Interest 5,100 Furniture 5,000 Less: Depreciation 500 Subscriptions due 4,500 16,000 2,53,700 2,53,700 Balance Sheet As on 1 April 2019 ` Liabilities Outstanding Telephone Bill Capital Fund 600 68,600 (Balancing Figure) ` Assets Cash in Hand 10,200 Cash at Bank as per Cash Book 26,000 (30,000 – 4,000) Investments 12,000 Furniture 12,000 Subscriptions Due 9,000 69,200 69,200 WORKING NOTES (i) ` Interest on Investments 12% on ` 15,000 for one year Add: 12% on ` 1,70,000 for 3 months = 1,800 1,70,000  12  3 100  12 5,100 6,900 (ii) ` Total Telephone bill for four quarters (300 × 4) 1200 Less: Outstanding 300 900 But paid 1500 Hence ` 600 were paid for the previous year 600 ` (iii) Loss on Sale of Furniture Book value on 30-9-2019 Book value on 1-4-2019 Less: Depreciation for six months at 20% p.a. 9,000 12,000 1,200 Final Accounts of Not-For-Profit Organisations 9.99 Less: Book value on 30-9-2019 (10,800) Loss (1,800) ` (iv) Consumption of Balls Purchases 65,000 Less: Stock in Hand on 31-03-2020 6,000 59,000 (v) ` Depreciation on Furniture on 1-10-2019 at 20% on ` 5,000 for 6% months 500 Depreciation on Furniture sold (iii) 1,200 1,700 ` (vi) Affiliation Fees For 5 years 2,000 Less: for current year 1/5 of 2,000 400 Balance in the Balance Sheet 1,600 Illustration 53 The following is the Receipts and Payments Account of a Cultural Society for the year ended on 31 December, 2020: Receipts ` Cash in hand on Jan 1 1,500 Subscription: 2019 200 2020 16,200 2021 250 Entertainment Proceeds 2,000 Payments ` Bank Overdraft Jan 3,100 Investments in securities 3,000 Furniture 1,450 Salary 6,200 Printing and Stationery 890 Entertainment Expenses 1,710 1,420 Entrance Fees 670 Sundry Expenses Interest of securities 480 Balance on 31.12.2020 Sale of Old Chairs 120 Cash 550 Bank 3,100 (Book value : Nil) 21,420 21,420 You are required to prepare income and expenditure account of cultural society for the year ended 31 December, 2020 and a Balance sheet as on the date after considering the following: (i) The society has 1,800 members each paying annual fees of ` 10. Subscriptions amounting to ` 90 were still in arrears for the year 2019. (ii) Stock of Stationery on 31 December, 2019 was ` 125 and on 31 December, 2020 was ` 87. (iii) Entrance fees are to be capitalized. (iv) Salary of ` 550 for December 2020 is outstanding. (v) Expenses outstanding on 31 December, 2019 ` 132. (vi) The society had paid ` 500 in 2019 for telephone charges, out of which ` 125 related to the year 2020. (vii) On 31 December, 2019 premises stood in the books at ` 24,500 and investments at ` 6,500. (viii) Depreciate fixed assets by 5% p.a. [B.Com. (Hons.) Sem. I, 2017 Delhi. Modified] 9.100 Financial Accounting: Concepts and Applications Solution : Cultural Society Income and Expenditure Account for the year Ending 31st March, 2020 ` Expenditure Stationery Consumed : Opening Stock Purchased Subscriptions (1,800 × 10) Entertainment Proceeds 890 Interest on Securities 480 Profit on sale of old chairs 120 Less: Closing Stock 87 2,000 928 6,200 Add: Outstanding 550 Sundry Expenses 1,420 Less: Outstanding for 2019 18,000 125 1,015 Salaries ` Income 132 Telephone Charges 6,750 1,288 125 Depreciation on : Premises 1,225 Furniture (5% on 1,450 for 6 months) 37 1,262 Entertainment Expenses 1,710 Surplus (Excess of Income over Expenditure) 8,537 20,600 20,600 Balance Sheet As At 31st December 2020 Liabilities ` Capital Fund: Opening Balance Add: Entrance Fees Surplus ` Assets Premises 29,808 670 8,537 39,015 24,500 Less: Depreciation 1,225 Furniture 1,450 Depreciation for 6 months 37 23,275 1,413 Investments : Advance Subscription for 2021 250 Opening Balance 6,500 Add: Purchases 3,000 Outstanding Salary 550 Stock of stationery 9,500 87 Outstanding Subscription for 2019 90 for 2020 1,800 1,890 Bank 3,100 Cash 550 39,815 39,815 Opening Balance Sheet Balance Sheet As At 31st December 2019 Liabilities Outstanding Sundry Expenses Bank Overdraft Capital Fund ` 132 3,100 29,808 (Balancing Figure) Assets Premises Investments 24,500 6,500 Stock of Stationery 125 Telephone Charges Prepaid for 2020 125 Outstanding Subscription 290 Cash in hand 33,040 ` 1,500 33,040 Final Accounts of Not-For-Profit Organisations 9.101 Subscription Account (2020) ` Particulars Balance b/d (200 + 90) Income and Expenditure Account (1,800 × 10) 290 18,000 Balance c/d (for 2021) 250 ` Particulars Balance b/d : Nil Cash/Bank: 2019 200 2020 16,200 2021 250 16,650 Balance c/d: for 2019 90 for 2020 (18,000 – 16,200) 1,800 1,890 18,540 18,540 Illustration 54 Prepare an Income and Expenditure Account for a College for the year ended 31st March, 2017 and a Balance Sheet as on that date from the following information : ` Receipts Cash (1-4-2016) Postage Stamps (1-4-2016) Tuition Fees 50,000 Pay and Allowances 700 2,00,000 Fines 10,500 Annual Grant from Government ` Payments Books for Library 50,000 Postage and Stationery 12,000 Newspapers 30,00,000 2,000 Science Lab Equipment 22,000 18,000 Interest on Securities 28,000 Repairs and Maintenance Rent from use of Hall 70,000 Audit Fees Grant for Building Fund 22,00,000 20,00,000 8,000 Additions to college building 30,00,000 Cash in hand (31-3-2017) 46,600 Postage Stamps (31-3-2017) 600 53,59,200 53,59,200 The College had the following assets on 31st March, 2016 : Furniture — ` 3,00,000; College Building — ` 4,00,00,000; Library Books — ` 80,000; Science Equipment — ` 3,00,000; 10% Investments — ` 3,00,000 and outstanding Tuition fees — ` 22,000. Provide for Depreciation on the closing balances of the following assets : Land and Buildings @ 5%; Furniture @ 15% and Library Books and Science Equipment @ 20%. [B.Com. (Hons.) 2019, Delhi] Solution : Income and Expenditure Account Dr. for the year ended 31st March, 2017 Expenditure Pay and Allowances Newspapers Repairs and Maintenance Audit Fees ` 22,00,000 2,000 18,000 8,000 Cr. ` Income Tuition Fees 2,00,000 Less: Outstanding Tuition Fees (PY) 22,000 Fines (collected) Annual Grant from Government 1,78,000 10,500 30,00,000 9.102 Financial Accounting: Concepts and Applications Depreciation: Interest on Securities 28,000 21,50,000 Add: Accrued Interest 2,000 Furniture 45,000 Rent from use of Hall Library Books 26,000 Excess of Expenditure over Income (Deficit) Science Lab Equipments 64,400 College Building 30,000 70,000 12,24,900 22,85,400 45,13,400 45,13,400 Balance Sheet as on 31st March, 2017 Liabilities ` ` Assets Opening Capital Fund 4,10,52,000 Cash 46,600 Deficit (12,24,900) Postage Stamp (12,000 + 600 – 700) 11,900 3,98,27,100 Furniture 3,00,000 Less: Depreciation (45,000) Grant for Building Fund 20,00,000 College Building Addition 2,55,000 4,00,00,000 30,00,000 4,30,00,000 Less: Depreciation (21,50,000) Library Books 80,000 New Purchases 50,000 4,08,50,000 1,30,000 Less: Depreciation (26,000) Science Lab Equipments 3,00,000 Addition 1,04,000 22,000 3,22,000 Less: Depreciation (64,400) 10% Investments 3,00,000 Add: Accrued Interest 4,18,27,100 2,000 2,57,600 3,02,000 4,18,27,100 WORKING NOTE: Balance Sheet as on 1st April, 2016 Liabilities Capital Fund (Balancing Figure) ` 4,10,52,000 Assets Cash Furniture College Building Library Books 50,000 3,00,000 4,00,00,000 80,000 Science Lab Equipments 3,00,000 10% Investments 3,00,000 Outstanding Tuition Fees 4,10,52,000 ` 22,000 4,10,52,000 Final Accounts of Not-For-Profit Organisations 9.103 Assignments THEORY BASE ASSIGNMENTS 1. Distinguish between Income and Expenditure Account and Receipts and Payments Account [B.Com. (Hons.) Delhi 1982, 1985, 2003,2008] 2. How will you deal with (i) specific donations and (ii) legacy in the final accounts of non-trading concerns? [B.Com. (Hons.) Delhi 1985] 3. 4. Differentiate between Income Outstanding and Income Accrued. [B.Com. (Hons.) Delhi 1989] How would you deal with (i) Donations-general and specific and (ii) Legacy, in the final accounts of a non-trading organisation ? [B.Com. (Hons.) Delhi 1990, 1998, 1999] Explain the conversion of Receipts and Payments Account into an Income and Expenditure Account. [B.Com. (Hons.) Delhi 1995] 5. PRACTICAL ASSIGNMENTS PREPARATION OF INCOME AND EXPENDITURE ACCOUNT 1. (General) Prepare the “Subscriptions Account” from the following items for the year ending on 31 March 2020 : ` (i) Subscriptions in arrear on 31 March 2019 500 (ii) Subscriptions received in advance at 31 March 2019 for 2019-20 1,100 (iii)Total Subscriptions received during 2019-20 35,400 (including ` 400 for 2018-19, ` 1,200 for 2020-21 and ` 300 for 2021-22) (iv) Subscriptions outstanding for 2019-20 400 2. (General) From the following particulars, calculate the amount of subscriptions to be credited to the income and expenditure account for the year ended 31 March 2020 : Outstanding subscriptions Subscriptions received in advance 31.3.2019 (`) 31.3.2020 (`) 1,500 1,200 900 540 A sum of ` 14,670 was received as subscriptions during the year ended 31 March, 2020. Also prepare Subscriptions Account. 3. (General) On the basis of the following information, calculate the amount that will appear against the item ‘stationery used’ in the income and expenditure account for the year ended 31 March, 2020 : ` Stock of stationery as on 1 April, 2019 Creditors for stationery on 1 April, 2019 Amount paid for stationery during the year ended 31 March, 2020 12,000 25,600 1,40,000 Stock of stationery as on 31 March, 2020 23,200 Creditors for stationery as on 31 March, 2020 24,000 4. (General) Calculate the amount of stationery consumed during the calendar year 2020: ` Stock of stationery as on January 1, 2020 3,000 Creditors for stationery on January 1, 2020 2,000 Advance paid for stationery carried from 2019 Amount paid for stationery during the year 200 10,800 9.104 Financial Accounting: Concepts and Applications Stock of stationery on December 31, 2020 500 Creditors for stationery for December 31, 2020 1,300 Advance paid for stationery on December 31, 2020 1,300 [B.Com. (Hons.) Delhi] 5. (General) From the following information, calculate the amount of subscriptions received in advance during 2019-20: (i) Subscriptions received during the year 2019-20 ` 52,500. (ii) There were 200 members paying subscription at the rate of ` 250 p.a. each. (iii) Some members have paid their annual subscription in advance during the year. (iv) As on 1 April 2019, no subscription had been received in advance but subscriptions were outstanding to the extent of ` 1,000 as on 31 March 2019. (v) Subscriptions accrued as on 31 March 2020 ` 1,500. [B.Com. (Hons.) Delhi] 6. (General) The following is the Receipts and Payments Account of an Amusement Club: Receipts And Payments Account For The Year Ended 31 December 2020 ` Receipts Balance b/d : ` Payments Salary of Secretary Cash 60 Bank 3,000 3,600 Honorarium 450 Wages 2,400 Subscriptions (including Charities 2,000 Subscription for the year Printing and Stationery 300 Postage 100 2019 ` 150) 3,060 9,000 Sale of Old Furniture Rent and Taxes on Jan. 1, 2020 750 Sale of Newspapers 50 Legacies 3,000 Interest on Investments 1,200 1,200 Upkeep of the Land 500 Sports Materials 2,500 Balance c/d 14,850 (Cost of Investments ` 20,000) Endowment Fund Receipts 10,000 Proceeds of Concerts 800 Advertisement in the Year Book 40 27,900 27,900 Current assets and liabilities as on December 31, 2019 and 2020 were as follows : 31.12.2019 31.12.2020 ` ` Subscriptions in Arrears 200 450 Subscriptions in Advance 300 600 2,000 1,080 Furniture Depreciation was 10% p.a. on the furniture left after selling a part of it. It was decided that half of the legacies may be capitalised. Prepare Income and Expenditure Account and the Balance Sheet as on that date. [B.Com. (Hons) Delhi] 7. (General) From the following Receipts and Payments Account of Excellent Recreation Club for the year ended 31.3.2020 and additional information given, prepare an Income and Expenditure Account for the year ended 31.3.2020 and Balance Sheet as on 31.3.2020: Final Accounts of Not-For-Profit Organisations Receipts 9.105 ` Opening Balance : Cash in hand and at Bank Subscription 3,180 18,000 ` Payments Secretary’s Salary 12,000 Salaries to Staff 25,000 Charities 1,000 Printing and Stationery 600 Sale of Old Newspapers 2,500 Postage Expenses Legacies 4,000 Rates and Taxes 1,500 Interest on Investments 2,000 Upkeep of the Land 2,000 Endowment Fund Receipts 120 Purchase of Sports 20,000 Materials 10,000 Proceeds of Sport Telephone Expenses 3,480 Advertisement in the and Concerts 4,020 Year Book 5,000 Closing Balance : Cash in hand and at Bank 3,000 58,700 58,700 Assets and Liabilities as on 31.3.2019 and 31.3.2020 were as follows: Subscription in arrears Subscription received in advance Furniture Land 31.3.2019 31.3.2020 ` ` 2,000 1,000 500 400 2,000 1,800 10,000 10,000 Depreciation shall be charged at 10% p.a. under the diminishing value method. Legacies received shall be capitalised. Investments were made in Securities, the rate of interest being 12% p.a., the date of investment was 1.6.2018 and the amount of investments was ` 20,000. Due date of interest 31 March every year. Stock of sports materials on 31.3.2020 were useless and valued at nil price. C.A. (Foundation)] 8. (General) The following is the receipts and payments account of Jyoti Charitable Hospital for the year ended 31 March, 2020 : Receipts Balance b/d Subscriptions Donations ` ` Payments 1,40,000 Payment for medicines 6,00,000 10,00,000 Honorarium to doctor 2,00,000 Salaries 5,50,000 2,90,000 Interest on investments Sundry expenses @ 7% per annum for 10,000 Equipment purchased 3,00,000 the year 1,40,000 Charity show expenses 20,000 Charity show collections 2,00,000 Balance c/d 90,000 17,70,000 17,70,000 Additional information: Subscriptions due Subscriptions received in advance On 1.4.2019 (`) On 31.3.2020 (`) 10,000 20,000 20,000 10,000 Stock of medicines 2,00,000 3,00,000 Creditors for medicines 1,60,000 2,40,000 Equipments 4,20,000 6,00,000 Buildings 8,00,000 7,60,000 9.106 Financial Accounting: Concepts and Applications You are required to prepare income and expenditure account for the year ended 31 March, 2020 and balance sheet as at that date. 9. The following is the Receipts and Payments Account of Delhi Football Association for the first year ending 31 December 2020 : Receipts and Payments Account Receipts Donations ` 50,000 Reserve Fund (Life Locker Rents with matches Furniture 8,000 Revenue Receipts Subscriptions 40,000 Expenses in connection 4,000 Receipts from football matches Pavilion Offices ` (constructed) membership fees and entrance fees received) Payments Investment at cost 900 2,100 16,000 Revenue Payments 5,200 50 Salaries 1,800 Wages 600 Interest on Securities 240 Insurance 350 Sundries 350 Telephone 250 Electricity 110 Sundry expenses 210 Balance in hand 67,840 5,520 67,840 Additional Information (i) Subscriptions outstanding for 2020 are ` 250. (ii) Salaries unpaid for 2020 are ` 170. (iii) Wages unpaid for 2020 are 90. (iv) Outstanding bills for sundry expenses are ` 40. (v) Donations received have to be capitalised. Prepare from the details given above, an Income and Expenditure Account for the year ended 31.12.2020 and the Balance Sheet of the Association as on 31.12.2020. Hint : As the revenue receipts and revenue payments have been separately given, match receipts and expenses would be taken direct to the Balance Sheet. 10. A club gives you the following Receipts and Payments Account for the year ended 31 March, 2020 : Receipts and Payments Account Receipts Balance b/d Subscriptions Miscellaneous income Interest on fixed deposit ` 4,820 28,600 700 2,000 Payments Salaries 12,000 Rent and electricity 7,220 Library books 1,000 Magazines and newspapers Sundry expenses Sports equipments Balance c/d 36,120 ` 2,172 10,278 1,000 2,450 36,120 Final Accounts of Not-For-Profit Organisations 9.107 Figures of other assets and liabilities : 31.3.2019 Outstanding salaries 31.3.2020 ` ` 710 170 Outstanding rent and electricity 864 973 Outstanding for magazines and newspapers 226 340 20,000 20,000 Fixed deposit (10%) with bank Interest accrued thereon 500 500 Subscriptions receivable 1,263 1,575 417 620 Prepaid expenses Furniture 9,600 — Sports equipments 7,200 — Library books 5,000 — The closing values of furniture and sports equipments are to be determined after charging depreciation at 10% and 20% p.a. respectively inclusive of additions, if any, during the year. The library books are revalued at the end of every year and the value at the end of March 31, 2020 was ` 5,250. Required : (i) Balance Sheet as at 31.3.2019 (ii) Income and Expenditure Account for the year ended on March 31, 2020. (iii) Balance Sheet as at 31.3.2020. 11. The following is the Receipts and Payments Account of the Young Club in respect of the year to 31 December 2020: Receipts and Payments Account for the year Ended 31 December 2020 ` Receipts Balance b/d 20,500 Subscriptions : 1,600 2020 42,200 2019 800 Rates Telephone 44,600 Investments 31,000 (In ` 25,000,4% Dividends on investments Salaries Stationery 2021 Sports meeting-Profit Payments ` 41,600 8,000 12,000 2,000 25,000 Stock at par) 20,000 Sundry Expenses Balance c/d 1,16,100 18,500 9,000 1,16,100 The following additional information is available: (i) There are 450 members each paying an annual subscription of ` 100. ` 900 being in arrears for 2019 at the beginning of 2020. (ii) Stock of stationery at 31 December 2019 was ` 1,000; at 31 December 2020 ` 1,800. (iii) At 31 December 2020, the rates were prepaid to the following 31 March, the yearly charge being ` 12,000. A quarter’s charge for telephone is outstanding, the amount accrued being ` 700. Expenses accruing at 31 December 2019 ` 1,400. (iv) At 31 December 2019, the building stood in the books at ` 2,00,000 and it is required to write off depreciation @ 5% p.a. Investments at 31 December 2019 were ` 4,00,000. You are required to prepare an Income and Expenditure Account for the year ended 31 December 2020 and a Balance Sheet as at that date. [I.C.W.A. (Inter)] 12. The following bank and cash summary has been prepared from the records of Evergreen Recreation and Sports Club for the year ending 31 December 2020: 9.108 Financial Accounting: Concepts and Applications Receipts ` Balance b/d : Bar Purchases Cash at Bank 99,700 Cash in hand 2,100 Joining Fees 5,600 Subscriptions 41,200 Bar sales 5,20,000 Receipts from Cricket Festival 31,000 4,12,900 74,100 Electricity 11,000 Rent and Rates 23,000 Postage and Stationery Ground Expenses New Mowing Machine General Expenses 3,500 ` Wages Expenses of Cricket Festival Interest on Loan from Delhi State Government Bonds Payments 7,500 5,600 11,400 7,600 10,200 Purchase of ` 1,00,000 7% Delhi Government Bonds (1-7-20) Balance at Bank Cash in hand 7,03,100 1,00,000 36,200 3600 7,03,100 Additional Information: (i) The bar stock at cost on 31 December 2020 amounted to 42,600 which was ` 2,900 higher than the value of stock on 1 January 2020. (ii) On 31 December 2020, amounts outstanding for rent and electricity amounted to ` 3,500 and 1,200 respectively whilst rates paid in advance amounted to ` 2,100. On 31 December 2019, the corresponding amounts, had been : Rent ` 2,000, electricity ` 1,400 and rates paid in advance ` 1,900. (iii) Fixtures and Fittings on 31 December 2019 were valued at ` 50,400. Depreciation is to be provided at the rate of 12½% p.a. (iv) The amount paid for the new Mowing Machine, purchared on 1 May 2020 represented the net payment after taking into account a trade-in-allowance of ` 1,400 on the old machine. Machines and Equipment were valued at ` 20,000 on 31 December 2019 including old Mowing Machines valued at ` 2,000. Depreciation on machines and equipment is to be provided at 20% p.a. Prepare an Income and Expenditure Account for the year ended 31 December 2020 including the net receipts from the bar and cricket festival and a balance sheet on that date. Joining Fees are to be treated as recurring item. 13. The following is the Receipts and Payments Account of South India Literary Mission for the year ending 31 March, 2020 : Receipts ` Payments ` Cash at Bank 1,25,000 Salaries 25,000 Subscriptions 5,25,000 Printing and Stationery 12,500 Annual Day Receipts 2,68,000 Annual Day Expenses 15,000 Symposium Receipts 2,25,000 Symposium Expenses 1,00,000 Dividends on Shares etc. 25,000 Telephone Charges 20,000 Shares Purchased 7,50,000 Postage and Telegrams 22,000 Building Maintenance 63,400 Cash at Bank 11,68,000 25,000 Sundry Expenses 1,35,100 11,68,000 Following further information is furnished : (i) The value of building owned by the mission stood at ` 5,00,000 on 1 April 2019. Depreciation at 5% is to be provided. Final Accounts of Not-For-Profit Organisations 9.109 (ii) There were 200 members paying subscription of ` 2,500 each. (iii) As on 1 April 2019, no subscription had been received in advance but subscriptions were outstanding to the extent of ` 10,000. As at 31 March 2020 subscriptions outstanding were ` 15,000. (iv) Postage stamps worth ` 2,500 were with the secretary at the beginning of the year and stamps at the end of the year were of the value of ` 1,500. (v) The investment in the shares at the beginning of the year were to the extent of ` 50,000. (vi) An amount of ` 2,500 in respect of Annual Day Receipts was yet to be received. (vii) The rent of the theatre hall, (amounting to ` 25,000) where symposium was held, is still to be paid. (viii) Hire of telephone to the extent of ` 3,000 is paid in advance. Prepare Income and Expenditure Account for the year ended 31March 2020 and the Balance Sheet on that date. 14. The following is the Receipts and Payments Account of the Gujrat Club for the year ended 31 March 2020 : Receipts ` Payments ` Cash at Bank 14,000 Salaries 2,500 Subscriptions 52,500 Printing and Stationery 1,500 Annual day receipts 27,000 Annual day expenses Mushaira receipts 23,000 Mushaira expenses 11,000 2,000 Telephone charges 2,500 Dividends on shares Sundry expenses 2,500 Shares purchased 77,000 Postage & Telegrams 2,200 Building maintenance 6,540 Cash at bank 1,18,500 2,000 10,760 1,18,500 The following further information is furnished : (i) The value of the building owned by the club stood at ` 50,000 as at 1 April 2019. Depreciation at 5% has to be provided. (ii) There were 200 members paying subscriptions at the rate of ` 250 per annum each. (iii) As on 1 April 2019 no subscription had been received in advance but subscriptions were outstanding to the extent of ` 1,000. As at 31 March 2020, subscriptions outstanding were ` 1,500. (iv) Postage stamps worth ` 350 were with the secretary at the beginning of the year and stamps at the end of the year were of the value of ` 100. (v) The investments in shares at the beginning of the year were to the extent of ` 7,000. (vi) An amount of ` 200 in respect of the annual day receipts was yet to be received. (vii) The rent of the theatre amounting to ` 3,000, where the Mushaira (poetic symposium) was held is still to be paid. (viii) Hire of telephone to the extent of ` 250 is paid in advance. You are required to prepare the income and expenditure account for the year ended 31 March 2020 and the Balance Sheet as at 1 April 2019 and 31 March 2020. 15. The following informations were obtained from the books of Delhi Club as on 31.3.2020, at the end of the first year of the Club. You are required to prepare Receipts and Payments Account, Income and Expenditure Account for the year ended 31.3.2020 and a balance Sheet as at 31.3.2020 on mercantile basis : (i) Donations received for Building and Library Room ` 2,00,000. (ii) Other revenue income and actual receipts : 9.110 Financial Accounting: Concepts and Applications Revenue Income Actual Receipts ` ` Entrance Fees 17,000 17,000 Subscription 20,000 19,000 600 600 Locker Rents Sundry Income Refreshment Account 1,600 1,060 — 16,000 (iii) Other revenue expendiure and actual payments : Revenue Expenditure Actual Payments ` ` Land (cost ` 10,000) — 10,000 Furniture (cost ` 1,46,000) — 1,30,000 Salaries 5,000 4,800 Maintenance of Playgrounds 2,000 1,000 Rent 8,000 8,000 — 8,000 Refreshment Account Donations to the extent of ` 25,000 were utilised for the purchase of Library Books, balance was still unutilised. In order to keep it safe, 9% Govt. Bonds of ` 1,60,000 were purchased on 31.3.2020. Remaining amount was put in the Bank on 31.3.2020 under the term deposit. Depreciation at 10% p.a. was to be provided for the whole year on Furniture and Library Books. Preparation of Receipts And Payments Account 16. The income and expenditure accounts of a Repose Club is as follows: Income and Expenditure Account for 2020 Expenditure Salaries ` 17,500 General expenses 5,000 Depreciation 3,000 Surplus ` Income Subscriptions 20,000 Donations 10,500 5,000 30,500 30,500 Adjustments were made in respect of following: (i) Subscriptions for 2019 unpaid at 1 January 2020, ` 2,000; ` 1,800 of which was received in 2020. (ii) Subscriptions paid in advance at 1.1.2020–` 500. (iii) Subscriptions paid in advance at 31.12.2020–` 400. (iv) Subscriptions for 2020 unpaid at 31.12.2020–` 700. (v) Sundry assets at the beginning of period ` 26,000; sundry assets after depreciation, ` 27,000 at the end of the period. (vi) Cash balance on 1 January 2020–` 1,600. Prepare Receipts and Payments Account and Subscriptions Account. [I.C.W.A. (Inter) Adapted] 17. The Income and Expenditure Account of a Club for the year 2020 is as follows: Expenditure ` ` Income Salaries and Wages 9,500 Subscriptions 15,000 Miscellaneous Expenses 1,000 Entrance Fees 500 Audit Fees Honorarium Printing and Stationery Annual Day Celebration 500 2,000 900 Profit on Annual Sports Meet : Receipts 3,000 Expenses 1,500 1,500 Final Accounts of Not-For-Profit Organisations 9.111 Expenses 3,000 Less : Donations 2,000 Interest on Bank Loan 1,000 300 Depreciation on Sports Equipment Surplus 600 1,200 17,000 17,000 Prepare (i) Receipts and Payments Account for the year 2020 and (ii) Balance Sheet as at end of 2020 from the following information : ` (i) Subscriptions Outstanding as at 31.12.2019 1,200 Received in Advance as at 31.12.2019 900 Received in Advance as at 31.12.2020 540 Outstanding as at 31.12.2020 1,500 (ii) Salaries Outstanding as at 31.12.2019 800 Outstanding as at 31.12.2020 900 (iii) Audit Fees The fees for 2020 were outstanding on 31.12.2020 But during 2020, audit fees for 2019 were paid ` 400. (iv) Prepaid insurance as at 31.12.2020 was ` 120. (v) The club had owned grounds having a book value of ` 20,000. The Sports Equipment as on 31.12.2019 and on 31.12.2020 after depreciation amounted to ` 5,200 and ` 5,400 respectively. (vi) In 2019 the club had raised a bank loan of ` 4,000 which was outstanding throughout 2020. (vii) On 31 December, 2020 Cash in hand amounted to ` 3,200. [I.C.W.A. Inter], [C.A. (Inter)] 18. The income and expenditure account of Bharat Club for the year ended 31 March, 2020 was as follows: Expenditure ` ` Income Salaries 1,20,000 Subscriptions 1,70,000 Printing 6,000 Entrance fees 4,000 Postage Telephone General expenses 500 5,500 Audit fees 2,500 Annual dinner expenses 25,000 Depreciation on Sports 7,000 Surplus 36,000 12,000 Interest charges Equipment Contribution for dinner 1,500 30,000 2,10,000 2,10,000 The income and expenditure account has been prepared after taking into consideration the following information: As on As on 31.12.2019 31.12.2020 ` ` Subscriptions outstanding 16,000 18,000 Subscriptions received in advance 13,000 8,400 9.112 Financial Accounting: Concepts and Applications Salaries outstanding 6,000 8,000 Audit fees outstanding 2,000 2,500 1,90,000 1,90,000 52,000 63,000 Buildings Sports Equipment During the year 2019-20, the Bharat Club raised a bank loan of ` 30,000 which was outstanding on 31 March, 2020 also. Cash in hand on 31 March, 2020 was ` 28,500. Prepare the receipts and payments account of the Bharat Club for the year ended 31 March, 2020 and the balance sheet as on that date. [C.S. (Foundation) Modified] 19. From the following particulars relating to Excel Hospital prepare : (i) Receipts & Payments Account for the year ended 31 March, 2020; & (ii) Balance Sheet as on March 31, 2020 Income and Expenditure Account for the year ended 31 March, 2020 ` Expenditure ` Income Medicines used 29,980 Subscriptions Honorarium to visiting doctors 12,000 Donations Salaries 27,500 Interest on Investments@ 11% p.a. Printing & Stationery 1,100 Electricity and Water 6,000 9,500 11,000 Income from film show– 475 Rent 56,000 Proceeds 11,450 Less : Expenses 780 10,670 Depreciation on : Furniture and Fixtures 2,100 Equipment 3,250 Surplus 4,765 87,170 87,170 Additional Information: 31-3-2019 (i) Subscriptions due (ii) Subscriptions Received in Advance (iii) Electricity and Water Bills unpaid (iv) Stock of Medicines (v) (vi) 31-3-2020 120 160 64 100 92 115 7,820 9,750 Estimated value of Equipment 11,600 13,900 Furniture & Fixtures (Cost Less Depreciation) 21,000 18,900 — 10,000 (vii) Land (viii) Interest accrued on Investments in 11% Debentures Costing ` 1,02,500. 3,750 3,750 (ix) Cash in hand 340 160 (x) Cash at Bank 9,000 ? [B.Com. (Hons.) Delhi Modified] 20. Prepare Receipts and Payments Account of Tina Social Club for the year ending 31 March 2020 and also the Balance Sheet as on that dates from the following : Income and Expenditure Account for the Year Ending 31 March 2020 Expenditure Salaries ` Income ` 29,500 Interest 10,000 Stationery 5,000 Donations 15,000 Taxes and Rent 2,500 Subscriptions 25,000 Insurance 1,200 Miscellaneous Receipts Other Expenses 1,800 300 Final Accounts of Not-For-Profit Organisations 9.113 Depreciation : Properties 3,750 Furniture 120 Books 100 Surplus 3,970 6,330 50,300 50,300 Other Informations 31.3.19 Cash in hand and at Bank Investments in Share and Debentures (face value ` 3,00,000) 31.3.20 ` ` ? 23,700 2,80,000 2,80,000 Subscriptions outstanding 7,000 10,000 Subscription received in advance 1,200 1,600 Salaries outstanding Furniture Properties 500 1,000 2,000 1,980 3,00,000 2,96,250 Interest on Investments accrued 1,000 1,000 Books 3,500 3,900 200 300 1,000 800 Stationery payment due Stock of stationery [B. Com. (Hons) Delhi Modified] 21. The following is the income and expenditure account of a club for the year ending 31 March, 2020 : ` Expenditure Provisions used : Opening stock Add : Purchases Less : Closing stock Salaries General expenses Depreciation on equipments Surplus 10,000 1,40,000 1,50,000 5,000 Income Subscriptions Sale of provisions ` 1,45,000 18,000 5,000 1,000 28,000 1,97,000 34,000 1,63,000 1,97,000 The following balance sheets are also given to you : Liabilities On 31.3.19 (`) On 31.3.20 (`) 8,000 10,000 47,000 75,000 55,000 85,000 Equipments (cost less depreciation) 10,000 25,000 Stock of provisions Creditors for provisions Capital fund Assets 10,000 5,000 Subscriptions receivable 5,000 10,000 Cash at bank and in hand 30,000 45,000 55,000 85,000 9.114 Financial Accounting: Concepts and Applications Prepare the receipts and payments account of the club for the year ended 31 March, 2020 PREPARATION OF BALANCE SHEETS 22. Given below is the Receipts and Payments Account and Income and Expenditure Account of Bharat Club for the year ended 31 December 2020. Prepare Balance Sheets as on 1.1.2020 and 31.12.2020. Receipts And Payments Account Receipts Opening Balance Endowments ` 40,000 20,000 Subscriptions 1,02,000 Entrance Fees 8,000 Payments ` Salaries 72,000 Provisions 68,000 Printing and Stationery Bank 7,000 10,000 Donation for Books 13,000 Sports Materials 28,000 Entertainment 40,000 Creditors (2019) 13,000 Sale of old Furniture 7,000 (Book value ` 8,000) Investments (Purchased on 1 July, 2019) at 4% ` 96) Balance c/d 2,30,000 19,200 12,800 2,30,000 Income And Expenditure Account Expenditure Loss on sale of furniture Salaries ` 1,000 Subscriptions 1,00,000 Entrance Fees 4,000 3,000 Provisions 60,000 Sports Materials ` 77,000 Audit Fees Printing & Stationery Income 7,500 20,000 Interest on Investments 800 (4% on ` 20,000) Entertainment 40,000 Excess of Expenditure over Income 1,68,500 23,700 1,68,500 Hint : The investments were purchased on 1 July 2019 and therefore, these were assets on 1 January 2020. As the payment for investments appears in the Receipts and Payments Account of 2020, it is clear that investments were not paid in 2019. Hence, creditors for investments would be shown in the Balance Sheet as at 1.1.2020. 23. The following particulars relate to Delhi Sports Club : Income And Expenditure Account For the Year Ended 31 December, 2020 Expenditure ` Income ` Salaries 1,500 Entrance Fees 10,500 Stationery 2,200 Subscriptions 15,600 Advertising 1,600 Rent Audit Fees Fire Insurance 4,000 500 1,000 Depreciation on Sports Equipment 9,000 Excess of Income over Expenditure 14,300 30,100 30,100 Final Accounts of Not-For-Profit Organisations 9.115 Receipts And Payments Account For The Year Ended 31 December, 2020 ` Receipts Balance b/d 4,200 Entrance Fees 10,500 Subscriptions 2019 600 2020 15,000 2021 400 Rents Received 16,000 3,500 ` Payments Salaries 1,000 Stationery : 2019 400 2020 2,200 2,600 Advertising 1,600 Fire Insurance 1,200 Investments 20,000 Balance c/d 7,800 34,200 34,200 The assets on 1 January, 2020 included club grounds and pavilion ` 44,000; sports equipment ` 25,000 and furniture ` 4,000. Subscriptions in arrears on that date were ` 800. Prepare : (i) Balance Sheet as on 31 December, 2019. (ii) Balance Sheet as on 31 December, 2020. Have you any suggestion regarding Club’s Furniture Account? [B.Com. (Hons) Delhi] 24. You are given : (i) Income and Expenditure Account for 2020; (ii) Receipts and Payments Account for 2020; and (iii) Opening balances as on 1.1.2020. (i) Income and Expenditure Account (2020) ` Expenditure Salaries 11,000 Add : Outstanding 1,000 Insurance 1,500 Less : Prepaid 130 12,000 Income ` Subscriptions 8,000 Medical Fees 14,000 1,370 Medicines 6,000 Surplus 2,630 22,000 22,000 (ii) Receipts and Payments Account (2020) Receipts ` Payments ` Balance b/d (1.1.20) 3,000 Salaries Subscriptions 9,500 Insurance 1,500 Medical Fees 14,000 Medicines 6,000 Medical Equipment 5,000 Investment 5,000 Balance c/d 2,500 Donations 5,500 32,000 12,000 32,000 9.116 Financial Accounting: Concepts and Applications (iii) Opening balances as on 1.1.2020 : ` Medical equipment 32,500 Furniture 5,000 Cash 3,000 Outstanding subscriptions 1,000 Outstanding salary 1,000 Prepare opening and closing balance sheets of Rohan Medicare Club. 25. The following particulars relate to Uttam Nagar Sports Club : Income and Expenditure Account for the Year Ended 31 March 2020 ` Expenditure Income ` Salaries 60,000 Admission Fees 1,50,000 Printing and Stationery 25,000 Subscriptions 2,50,000 Advertising 10,000 Rent Insurance Charges 9,000 Electricity Charges 5,000 48,000 Depreciation on Sports Equipment 1,20,000 Surplus 2,19,000 4,48,000 4,48,000 Receipts and Payments Account for the Year Ended 31 March 2020 ` Receipts Balance b/d 50,000 Admission Fees : 2019-2020 25,000 2020-2021 1,35,000 1,60,000 Subscriptions : 10,000 2019-20 2,30,000 2020-21 20,000 ` Salary (including paid in advance) 75,000 Printing and Stationery 25,000 Advertising 10,000 Insurance (including prepaid) 12,000 Electricity Charges 2018-19 Rent Payments 5,000 Sports Equipment 2,00,000 Balance c/d 1,79,000 2,60,000 36,000 5,06,000 5,06,000 Further on 1 April 2019, the Club had the following assets : (i) Land and Building–` 6,00,000 (ii) Furniture–` 45,000 (iii) Sports Equipments–` 3,00,000 (iv) Subscriptions for 2018-19 ` 12,000 Subscriptions for 2019-20 received in advance were ` 8,000. Outstanding salary was ` 6,000. Admission fees received in advance for 2019-20 were ` 1,25,000. Prepare the opening and closing balance sheets. 26. The Receipts and Payments Account and Income and Expenditure Account of a Snatan Library for the year ended 31 March 2020 was as follows : Final Accounts of Not-For-Profit Organisations 9.117 Receipts and Payments Account for the Year Ended 31 March 2020 ` Receipts Balance b/d 35,000 Subscriptions Payments Payment to Creditors 20,000 Books Purchased 55,000 Printing and Stationery 2018-19 20,000 2019-20 1,75,000 Donations for Reference Books Salary 1,95,000 7,500 Rent Advertisement Miscellaneous Expenses Balance c/d 2018-19 13,000 2019-20 6,500 Interest ` 7,500 62,500 5,000 16,000 1,11,000 19,500 20,000 2,77,000 2,77,000 Income and Expenditure Account for the Year Ended 31 March 2020 Expenditure Audit Fees ` Income ` 6,000 Interest 19,000 Salary 65,000 Subscriptions Miscellaneous Expenses 16,000 Rent Printing and Stationery 7,500 Advertisement 4,500 Depreciation (Building) 37,500 Loss on Revaluation of Books 15,000 Surplus 70,500 2,22,000 1,90,000 13,000 2,22,000 Additional Information: Snatan library had following assets on 1-4-2019 : Building `10,00,000; Books 8,00,000; Furniture 40,000, and Investments– `2,50,000. There were creditors for books– `25,000 on that date. Prepare the balance sheets as on 31 March 2019 and 31 March 2020 respectively : 27. From the following information, prepare opening and closing balance sheets of Thakur Educational Society: Receipt and Payment Account (31.3.20) Receipts Balance b/d ` 55,000 Payments Salaries Tuition Fees 2,15,000 Rent Donations 1,65,000 Printing and Stationery Entrance Fees Government Grants 25,200 4,00,000 Sale of Furniture on 31.3.2020 Entertainments Sports Equipment (31.3.20) Purchase of Furniture (1.4.18) Investments 35,000 1,04,800 10,00,000 ` 2,20,000 35,000 1,15,000 65,000 45,000 1,25,000 Tea and Lunch 52,000 Newspapers and Magazines 15,000 Tours and Entertainments 75,000 Library Books (31.3.20) 1,50,000 Balance c/d 1,03,000 10,00,000 9.118 Financial Accounting: Concepts and Applications Income and Expenditure Account 31.3.20 Expenditure Loss on Sale of Furniture Salaries Rent Printing and Stationery ` 5,000 2,35,000 Income Tuition Fees Donations 48,000 Government Grants 1,02,000 Interest Accrued on Newspapers and Magazines 12,000 Investments Tea and Lunch 65,000 Entertainments Tours and Entertainments 75,000 Deficit ` 2,35,000 65,000 1,00,000 6,250 1,04,800 48,450 Depreciation on Opening Balances : Sports equipment @ 20% 3,000 Furniture @ 10% 4,500 Library Books @ 50% 10,000 5,59,500 5,59,500 ANSWERS GUIDE 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. Subscriptions credited to Income and Expenditure Account–` 35,000. Subscription during the year –`14,730. Stationery used–` 1,27,200. ` 11,500. ` 3,000. Deficit–` 680; Capital Fund—` 24,960; Balance Sheet Total–` 36,380. Deficit–` 24,880; Capital Fund–` 36,680; Balance Sheet Total at the end–` 36,200. Excess of income over expenditure–` 1,30,000; Total of Balance Sheet as on 31 March, 2020 is ` 37,70,000. Capital Fund - ` 33,90,000 Surplus–` 2,470; Balance Sheet total–` 63,870. (i) Capital Fund–` 47,000 [9,600 + 5,000 + 7,200 + 20,000 + 4,820 + 417 + 1,263 + 500 – (710 + 864 + 226). (ii) Deficit–` 2,888. (iii) Balance Sheet Total (31.3.2008)–` 45,595. Surplus–` 5,400; Capital Fund–` 6,24,000; Balance Sheet Total–` 6,31,700. Capital Fund-` 2,10,400; Surplus–` 35,700; Balance Sheet Total–` 2,50,800. Subscriptions received in advance–` 30,000; Surplus–` 6,89,600; Capital Fund on 1-4-20–` 6,87,500 Balance Sheet Total–` 14,32,100. Surplus–` 65,960; Capital Fund–` 72,350; Balance Sheet Total–` 1,44,310. Overdraft in Receipt & Payment A/c ` 1,08,140; Excess of Income over Expenditure ` 15,100; Total of Balance Sheet ` 3,40,440. Subscriptions Received–` 21,000; Total of Subscription Account–` 22,400 Total of Receipts and Payments Account–` 33,100. Cash in hand in 2019–` 2,780; Balance Sheet Total–` 30,220; Capital Fund– ` 23,080. Cash in hand–` 13,600; Total of Balance Sheet–` 2,99,500. Capital Fund ` 2,20,600. Cash at the Bank at the end–` 1,834; Capital Fund–` 1,55,974. Balance Sheet Total on 31 March 2020– ` 1,60,954. Final Accounts of Not-For-Profit Organisations 20. 21. 22. 23. 24. 25. 26. 27. 9.119 Opening Balance of cash and bank–15,800; Balance Sheet Total–6,17,630. Capital fund ` 6,08,400 Total of Receipts and Payments Account–` 2,22,000. Capital Fund–` 35,000; Balance Sheet Total–` 58,800. Capital Fund–` 77,600; Balance Sheet Total as on 31.12.2020–` 93,300; Balance Sheet Total on 31.12.2019– ` 78,000. Capital Fund : ` 40,500; Balance Sheet Total : Opening–` 41,500; Closing– ` 50,130. Balance Sheet total–` 10,07,000 (Opening) and ` 12,42,000 (Closing). Capital fund – ` 8,68,000 Capital Fund as on 1-4-2019–` 21,34,000. Balance Sheet total on 31-3-20–` 22,25,500. Capital Fund–` 90,000. Total of Opening Balance Sheet ` 90,000. Total of Closing Balance Sheet ` 5,07,750. 10 Accountingf orPrope rty, Pla nt, a ndEquipme nt&& De pre c ia tion INTRODUCTION The term Depreciation is concern with Property, plant and equipment. Many business enterprises require different types of Property, plant and equipment for smooth functioning of their business such as land, building, machinery, motor vehicles, furniture, computers air conditioners etc. depending upon their specific requirements. It must be noted that Property, plant and equipment possess the following features such as: (i) long life (ii) held for use in the business firm or for rental and (iii) are not meant for immediate resale. It is true that Property, plant and equipment have a long life yet they cannot be used for ever. There is a bound to be loss of value or quality of these Property, plant and equipment over a period of time whether in use or not and the same to be written as an expense in the Statement of Profit and Loss or Profit & Loss account as the case may be. This chargeable written off amount (loss of monitory value or quality) is technically called depreciation of tangible fixed assets (PPE) or simply concept of depreciation. Thus, the primary or general meaning or concept of depreciation is the loss of value or quality of PPE (tangible fixed assets) through physical wear and tear in use or passage of time or from any other cause. Depreciation included amortization of Property, plant and equipment whose useful life is predetermined. AS-10 and Ind AS-16, ‘Property, Plant and Equipment’ deals with depreciation. According to AS-10: Property, Plant and Equipment are tangible items that: (a) are held for use in production or supply of goods or services for rental to others or for administrative services; and (b) are expected to be use for more than one accounting period. PROPERTY PLANT AND EQUIPMENT OBJECTIVES OF AS-10 PPE The objective of this standard is to prescribe the accounting treatment for property, plant and equipment so that the users of the financial statements can discuss (notice) information about investments made by an enterprise in its property, plant and equipment and changes in its investment made by an enterprise in its property, plant and equipment. The principal or main issues are: (i) the recognition of the assets, (ii) the determination of their carrying amounts and (iii) the depreciation charges and impairment losses in relation to them (i.e. Property, Plant and Equipment.) SCOPE OF AS-10 PPE AS-10 should be applied to accounting for property, plant and equipment except when another Accounting Standard requires or permits a different accounting treatment. 10.2 Financial Accounting: Concepts and Applications This Standard does not apply to : (a) biological assets related to agricultural activity other than bearer plants. This Standard applies to bearer plants but it does not apply to the produce on bearer plants; and (b) wasting assets including mineral rights, expenditure on the exploration for and extraction of minerals, oil, natural gas and similar non-regenerative resources. However, this Standard applies to property, plant and equipment used to develop or maintain the assets described in (a) and (b) above. DEFINITIONS (i) Recognition The cost of an item of property, plant and equipment should be recognised as an asset if, and only if: (a) it is probable that future economic benefits associated with the item will flow to the enterprise; and (b) the cost of the item can be measured reliably. Items such as spare parts, stand-by equipment and servicing equipment are recognised in accordance with this Standard when they meet the definition of property, plant and equipment. Otherwise, such items are classified as inventory. An enterprise evaluates under this recognition principle all its costs on property, plant and equipment at the time they are incurred. These costs include costs incurred: (a) initially to acquire or construct an item of property, plant and equipment; and (b) subsequently to add to, replace part of, or service it. (ii) Biological Asset is a living animal or plant. (iii) Carrying amount is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses. (iv) Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other Accounting Standards. (v) Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. (vi) Enterprise-specific value is the present value of the cash flows an enterprise expects to arise from the continuing use of an asset and from its disposal at the end of its useful life or expects to incur when settling a liability. (vii) Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. (viii) Gross carrying amount of an asset is its cost or other amount substituted for the cost in the books of account, without making any deduction for accumulated depreciation and accumulated impairment losses. (ix) An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. (x) Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and Accounting for Property, Plant and Equipment & Depreciation (b) 10.3 are expected to be used during more than a period of twelve months. (xi) Recoverable amount is the higher of an asset’s net selling price and its value in use. The residual value of an asset is the estimated amount that an enterprise would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. (xii) Useful life is : (a) the period over which an asset is expected to be available for use by an enterprise; or (b) the number of production or similar units expected to be obtained from the asset by an enterprise. Initial Costs: Assets held for administrative purposes. The definition of ‘property, plant and equipment’ covers tangible items which are held for use or for administrative purposes. The term ‘administrative purposes’ has been used in wider sense to include all business purposes other than production or supply of goods or services or for rental for others. Thus, property, plant and equipment would include assets used for selling and distribution, vehicle finance and accounting computers personnel and other functions of an enterprise. Items of property, plant and equipment may also be acquired for safety or environmental reasons. The acquisition of such property, plant and equipment, although not directly increasing the future economic benefits of any particular existing item of property, plant and equipment, may be necessary for an enterprise to obtain the future economic benefits from its other assets. Such items of property, plant and equipment qualify for recognition as assets because they enable an enterprise to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired. For example, a chemical manufacturer may install new chemical handling processes to comply with environmental requirements for the production and storage of dangerous chemicals; related plant enhancements are recognised as an asset because without them the enterprise is unable to manufacture and sell chemicals. The resulting carrying amount of such an asset and related assets is reviewed for impairment in accordance with AS 28, Impairment of Assets. Subsequent Costs (Repairs and Maintenance) An enterprise does not recognise in the carrying amount of an item of property, plant and equipment the costs of the day-to-day servicing of the item. Rather, these costs are recognised in the statement of profit and loss as incurred. Costs of day-to-day servicing are primarily the costs of labour and consumables, and may include the cost of small parts. The purpose of such expenditures is often described as for the ‘repairs and maintenance’ of the item of property, plant and equipment. Initial Costs : Assets held for administrative purpose which are part of tangible assets. MEASUREMENT AT RECOGNITION An items of property, plant and equipment that qualifies for recognition as an asset should be measured at its cost. Elements of Cost : The cost of an item of property, plant and equipment comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. (b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. The initial estimate of costs of dismantling, removing the item and restoring the site on which it is located, referred to as ‘decommissioning, restoration and similar liabilities’, the obligation for which an enterprise 10.4 Financial Accounting: Concepts and Applications incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Examples of directly attributable costs are : (a) costs of employee benefits (as defined in AS 15, Employee Benefits) arising directly from the construction or acquisition of the item of property, plant and equipment; (b) costs of site preparation; (c) initial delivery and handling costs; (d) installation and assembly costs; (e) costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and (f) professional fees. Examples of costs that are not costs of an item of property, plant and equipment are: (a) costs of opening a new facility or business, such as, inauguration costs; (b) costs of introducing a new product or service (including costs of advertising and promotional activities); (c) costs of conducting business in a new location or with a new class of customer (including costs of staff training); and (d) administration and the other general overhead costs. Cost of Self-constructed Asset The cost of a self-constructed asset is determined using the same principle as for an acquired asset. If an enterprise makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale. Therefore, any internal profits are eliminated in arriving at such costs. Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset. Measurement of Cost The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit unless such interest is capitalised. Cost Model After recognition as an asset, an item of property, plant and equipment should be carried at its cost less any accumulated depreciation and any accumulated impairment losses. Revaluation Model After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably should be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations should be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. The fair value of items of property, plant and equipment is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs should be revalued. Accounting for Property, Plant and Equipment & Depreciation 10.5 A class of property, plant and equipment is a grouping of assets of a similar nature and use in operations of an enterprise. The following are examples of separate classes: (a) land; (b) land and buildings; (c) machinery (d) ships; (e) aircraft; (f) motor vehicles; (g) furniture and fixtures (h) office equipment (i) bearer plants. FOR YOUR ATTENTION Bearer plant is a plant that (a) is used in the production or supply of agricultural produce; (b) is expected to bear produce for more than a period of twelve months; and (c) has a remote likelihood of being sold as agricultural produce, expect for incidental scrap sales. The following are not bearer plants: (i) plants cultivated to be harvested as agricultural produce (for example, trees grown for use as lumber); (ii) plants cultivated to produce agricultural produce when there is more than a remote likelihood that the entity will also harvest and sell the plants as agricultural produce, other than as incidental scrap sales (for example, trees that are cultivated both for their fruit and their lumber); and (iii) annual crops (for example, maize and wheat). When bearer plants are no longer used to bear produce they might be cut down and sold as scrap, for example, for use as firewood. Such incidental scrap sales would not prevent the plant from satisfying the definition of a bearer plant. REVALUATION OF ASSETS An increase in the carrying amount of an asset arising on revaluation should be credited directly to owners’ interests under the heading of revaluation surplus. However, the increase should be recognised in the statement of profit and loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in the statement of profit and loss. A decrease in the carrying amount of an asset arising on revaluation should be charged to the statement of profit and loss. However, the decrease should be debited directly to owners’ interests under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset. The revaluation surplus included in owners’ interests in respect of an item of property, plant and equipment may be transferred to the revenue reserves when the asset is recognised. This may involve transferring the whole of the surplus when the asset is retired or disposed off. However, some of the surplus may be transferred as the asset is used by an enterprise. In such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on its original cost. Transfers from revaluation surplus to the revenue reserves are not made through the statement of profit and loss. 10.6 Financial Accounting: Concepts and Applications Revaluation Reserve (Surplus) can be used for: (a) to write off excess depreciation i.e. difference between depreciation charged on historical cost and depreciation charged on revalued price. (b) to write off loss on sale of Assets. Loss on sale of assets should be first adjusted against revaluation reserve and balance if any should be adjusted against Profit and Loss account. (c) after adjusting excess depreciation and loss on sale of assets, if there remains any balance i.e. unused portion of revaluation reserve, should be transfer to General Reserve in owners interest. Depreciation (a) Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item should be depreciated separately. (b) An enterprise allocates the amount initially recognised in respect of an item of property, plant and equipment to its significant parts and depreciates each such part separately. For example, it may be appropriate to depreciate separately the airframe and engines of an aircraft, whether owned or subject to a finance lease. (c) A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item. Such parts may be grouped in determining the depreciation charge. (d) To the extent that an enterprise depreciates separately some parts of an item of property, plant and equipment, it also depreciates separately the remainder of the item. The remainder consists of the parts of the item that are individually not significant. If an enterprise has varying expectations for these parts, approximation techniques may be necessary to depreciate the remainder in a manner that faithfully represents the consumption pattern and/or useful life of the asset. (e) The depreciable amount of an asset should be allocated on a systematic basis over its useful life. (f) The depreciable amount of an asset is determined after deducting its residual value. (g) An enterprise may choose to depreciate separately the parts of an item that do not have a cost that is significant in relation to the total cost of the item. (h) In depreciation charge for each period should be recognised in the statement of profit and loss unless it is included in the carrying amount of another asset. The useful life of an asset is defined in terms of its expected utility to the enterprise. The asset management policy of the enterprise may involve the disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the asset. Therefore, the useful life of an asset may be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the enterprise with similar assets. Retirements Items of property, plant and equipment retired from active service and held for disposal should be stated at the lower of their carrying amount and net realisable value. Any write down in this regard should be recognised immediately in the statement of profit and loss. Derecognisation The carrying amount of an item of property, plant and equipment should be derecognised (removed from the asset account): (a) on disposal (b) when no future economic benefits are expected from its use or disposal. Accounting for Property, Plant and Equipment & Depreciation 10.7 Disclosure The financial statements should disclose, for each class of property, plant and equipment: (a) the measurement basis (i.e., cost model or revaluation model) used for determining the gross carrying amount; (b) the depreciation methods used; (c) the useful lives or the depreciation rates used. In case the useful lives or the depreciation rates used are different from those specified in the statute governing the enterprise, it should make a specific mention of that fact; (d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; and (e) a reconciliation of the carrying amount at the beginning and end of the period showing: (i) (ii) additions; assets retired from active use and held for disposal; (iii) acquisitions through business combinations; (iv) increases or decreases resulting from revaluations and from impairment losses recognised or reversed directly in revaluation reserve (surplus) account in accordance with AS 28; (v) (vi) (vii) (viii) (ix) impairment losses recognised in the statement of profit and loss in accordance with AS 28; impairment losses reversed in the statement of profit and loss in accordance with AS 28; depreciation; the next exchange differences arising on the translation of the financial statements of a nonintegral foreign operation in accordance with AS 11, The Effects of Changes in Foreign Exchange Rates; and other changes. The financial statements should also disclose: (a) the existence and amounts of restrictions on title and property, plant and equipment pledged as security for liabilities; (b) the amount of expenditure recognised in the carrying amount of an item of property, plant and equipment in the course of its construction; (c) the amount of contractual commitments for the acquisition of property, plant and equipment; (d) if it is not disclosed separately on the face of the statement of profit and loss, the amount of compensation from third parties for items of property, plant and equipment that were impaired, lost or given up that is included in the statement of profit and loss; and (e) the amount of assets retired from active use and held for disposal. Selection of the depreciation method and estimation of the useful life of assets are matters of judgement. Therefore, disclosure of the methods adopted and the estimated useful lives or depreciation rates provides users or financial statements with information that allows them to review the policies selected by management and enables comparisons to be made with other enterprises. For similar reasons, it is necessary to disclose: (a) depreciation, whether recognised in the statement of profit and loss or as a part of the cost of other assets, during a period; and (b) accumulated depreciation at the end of the period. 10.8 Financial Accounting: Concepts and Applications Change in useful life of an asset and residual value In accordance with AS-5, an enterprise discloses the nature and effect of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in subsequent periods. For property, plant and equipment, such disclosure may arise from changes in estimates with respect to: (a) residual values; (b) the estimated costs of dismantling, removing or restoring items of property, plant and equipment; (c) useful lives; and (d) depreciation methods. If items of property, plant and equipment are stated at revalued amounts, the following should be disclosed: (a) the effective date of the revaluation; (b) whether an independent valuer was involved; (c) the methods and significant assumptions applied in estimating fair values of the items; (d) the extent to which fair values of the items were determined directly by reference to observable prices in an active market or recent market transactions on arm’s length terms or were estimated using other valuation techniques; and (e) the revaluation surplus, indicating the change for the period and any restrictions on the distribution of the balance to shareholders. EXAMPLES Example-1 (Change in Useful Life) Rachit enterprise owns an asset with original cost of ` 4,00,000 on 1st April, 2015. At the time of acquisition of asset its life was estimated to be 10 years with a scrap value of ` 40,000. After 4 years, on 1st April 2019, management feels to review the useful life and residual value of assets. It was found that after incurring a maintenance expenses (capital nature) of ` 44,000, the life of asset can be extended for a further period of 3 years beyond remaining 6 years, after that it could be fetched for ` 30,000. Calculate the amount of depreciation to be charged for each year, when enterprise follows straight line method of charging depreciation. Solution:  Annual depreciation for first 4 years (4,00,000 – 40,000)/10 =  3,60,000 = ` 36,000 p.a 10 Carrying amount in the begining of 5th year [Original cost – (Annual Depreciation × 4)] = [4,00,000 – (36,000 × 4)] = 2,56,000 (Written Down Values as on 1.4.2019)  After review  remaining useful life = (10 – 4) + 3 = 9 years Revised Depreciation = [(2,56,000 + 44,000) – 30,000] ÷ 9 = ` 30,000 p.a for next 9 years Example-2 (Cost to be Capitalised) Y Ltd., has installed a new plant as per its production requirement. It has incurred following costs: Accounting for Property, Plant and Equipment & Depreciation 10.9 • Cost of the plant ` 3,40,000. • Initial delivery and handling cost ` 27,000. • Cost of site preparation ` 1,13,000. • Consultancy charges at time of acquisition ` 40,000. • Interest expenses paid to supplier for deferred credit ` 36,000. • Estimated dismantling cost to be incurred after 5 years ` 15,000. • Operating losses before or at the time of commercial production ` 26,000. Calculate costs to be capitalised as per Ind AS-16(PPE)? Answer Cost to be capitalised include: • Cost of the plant ` 3,40,000. • Initial delivery and handling cost ` 27,000. • Cost of site preparation ` 1,13,000. • Fees paid to Consultant at the time of acquisition ` 40,000. • Estimated dismantling cost to be incurred after 5 years ` 15,000. Total Cost = (3,40,000 + 27,000 + 1,13,000 + 40,000 + 15,000) = ` 5,35,000.  Interest charges can be capitalised if Ind AS-23( Borrowing Cost) allows  Operating losses can never be considered. Example - 3 (Application of Revaluation Model) X Ltd., having a plant with an initial cost of ` 3,50,000. At the date of revaluation accumulated depreciation amounted to ` 1,70,000. The fair value of plant, by reference to transactions in similar assets, is assessed to be ` 2,30,000. Give necessary journal entries for above ? Answer 1. Accumulated depreciation A/c Dr. 1,70,000 To Plant A/c 2. Plant 1,70,000 A/c Dr. 50,000 To Other Comp. Income A/c 50,000 The net result is that the Plant has a carrying amount of ` 2,30,000 (3,50,000 – 1,70,000 + 50,000). Other Comprehensive Income = Fair value – Revised value = 2,30,000 – (3,50,000 – 1,70,000) = 50,000 DEPLETION, AMORTIZATION AND OBSOLESCENCE In a broad sense, the term depreciation covers depletion, amortisation and obsolescence. However, these terms are used in a particular context: (i) The term depletion is used in relation to natural resources or wasting assets such as quarries, mines, oil wells etc., indicating their physical deterioration or exhaustion of natural resources. As the resource is extracted or removed from the land, its (land) asset value would be reduced or exhausted. This reduction in the value of asset resulting from production is called depletion. 10.10 Financial Accounting: Concepts and Applications (ii) The term amortization refers to loss of economic value of intangible assets like patents, trade marks, goodwill, copyrights and the like. Some intangible assets have limited useful life and are therefore written off and removed from the list of assets. The process of writing of intangible assets is called amortization. (iii) The term obsolescence refers to the decline in the economic value of the asset due to such factors as the invention of new techniques or equipment, change in taste or fashion etc., or inadequacy of the existing fixed asset to produce more for increased demand. ACCOUNTING CONCEPT OF DEPRECIATION The cost of fixed asset is a capital expenditure and it is recorded in the books of account at its original or acquisition cost, that is, its purchase price. However, the fixed asset is used to earn revenues for a number of accounting periods in future with the same acquisition cost until the fixed asset is sold or discarded. It is therefore, necessary that a part of cost of fixed asset is allocated as an expense in each of the accounting period in which the fixed asset is used up or utilised. We call this allocation of cost in the form of an expense in the form of depreciation in accounting or simply accounting concept of depreciation. In brief, accounting for depreciation is an attempt to spread the cost of long-lived asset as an expense to the statement of profit and loss over the useful or economic life of the asset. For example, a business enterprise or a trader purchases a motor vehicle for ` 5,00,000 and after using or utilising it for five years, it is sold for ` 1,00,000. The utilised cost of the motor vehicle to the business is thus, ` 4,00,000 (5,00,000 – 1,00,000). The business enterprise cannot ignore ` 4,00,000 cost of the vehicle. Hence, this cost must be allocated as an expense of the business at the rate of ` 80,000 (4,00,000  5) for each of five accounting periods in which the motor vehicle has been used to earn revenues. This ` 80,000 charge as expenses is called accounting concept of depreciation. In simple words, depreciation is part of the cost of fixed asset utilised during its period of use by the business enterprise. It is the cost for the services obtained from the use of the asset in the same manner as the cost for salaries, rent, electricity etc.. Depreciation is therefore, an important business expense which must be charged to statement of profit and loss before arriving at the net profit for the year. The cost of fixed assets in the form of depreciation has to be matched against the revenues of different years earned from the use of the asset. So in accounting, depreciation means allocation or distribution of the cost of the fixed asset to the years of its use and charge the depreciable cost to Statement of Profit or Loss before arriving at the profits of each of the accounting periods in which the fixed asset has been utilised. According to Accounting Standard (AS) 10 (Revised) : Property, Plant and Equipment, Depreciation is the systematic allocation of the depreciable amount of the asset over its useful life. As stated in the beginning, tangible fixed assets are bought or held by the enterprise or business entity for the purpose of producing goods or providing goods and services. They are not held for sale in the normal course of business activities. In brief tangible fixed assets possess the following features, namely: (i) they are expected to be held or used for long term, that is, generally for more than one accounting period. (ii) they have limited useful life unlike land and (iii) they are held by the enterprise for use in the production or supply of goods and services, for rental to others or for administrative purposes and not for purpose of sale in the ordinary course of business. Depreciable assets are tangible assets: (a) which are available for use during more than one accounting period of generally twelve months. (b) which have limited useful life (c) which are held for use in production or supply of goods and services, for rental to others or for administrative purposes and not for purpose of sale in the ordinary course of business activities. According to As 10 (Revised): Property, Plant and Equipment (PPE), PPE are tangible items that (i) are held for use in production or supply of goods and services, or rental to others or for administrative purposes. Accounting for Property, Plant and Equipment & Depreciation 10.11 (ii) are expected to be used for more than one period of twelve months. In short depreciation is the estimated loss or decline in the value of tangible fixed assets such as property, plant and equipment. It means that property etc. that does not decline in value or whose decline or loss of value cannot be reasonably estimated should not be considered or could not be considered for depreciation purpose. For example, land is generally not subject to depreciation while the building is, though it (Land) may appreciate in value over a period of time. Explanation The term administrative purposes has been used in a wider sense to include all business purposes. Thus, PPE would include assets used for: (a) selling and distribution e.g. Motor vehicles etc., (b) finance and accounting e.g. Computers etc. (c) Personnel and other functions of an enterprise in office space etc. Useful Life According to AS - 10: Property, Plant and Equipment, useful life is either: (a) the period over which an asset is expected to be available for use by an enterprise; or (b) the number of production or similar units expected to be obtained from the asset by an enterprise. CHARACTERISTICS OF DEPRECIATION On the basis of the general meaning of depreciation and its accounting concept, we can outline the characteristics of depreciation as under: (i) Depreciation is a gradual but continuous fall in book value of fixed assets. (ii) Depreciation in accounting is a process of allocating the depreciable cost (cost minus scrap value) over the estimated useful life of the fixed assets. It is not a process of valuation of asset. (iii) Depreciation arises directly through the deterioration because of use and indirectly through obsolescence. (iv) Depreciation is not a substitute for repairs. In fact depreciation is provided along with repairs and maintenance expenses. (v) Depreciation charge is not an exact amount but based on estimate. (vi) Depreciation is purely an internal transaction and so it has no outside connection. (vii) Depreciation has nothing to do with the physical deterioration of fixed assets. (viii) Depreciation is related to tangible fixed assets only and not to the current assets. (ix) Depreciation is a charge against the profits. (x) Depreciation is not a source of funds for the replacement of an asset. (xi) Total depreciation cannot exceed its depreciable value (i.e. cost less scrap value) or original cost where scrap value is nil. (xii) Depreciation has no relationship with the market value of an asset. (xiii) It is related to going concern concept. NEED OR NECESSITY FOR DEPRECIATION The need for charging a reasonable amount of depreciation over the estimated useful life of the asset arises for following purposes or objectives: (i) To calculate the true income : The calculation of income requires matching of costs with revenues. Depreciation is a necessary cost of using the fixed assets. Hence, for calculation of true income, depreciation cost must be matched with the revenues of the given accounting period. 10.12 Financial Accounting: Concepts and Applications (ii) To show the true financial position : For this purpose, assets and liabilities must be stated at their correct values. In the absence of depreciation charge, the asset will be shown at its original cost year after year in the balance sheet. This is an unfair practice and the balance sheet would fail to show the true financial position. Hence, the assets must be shown at cost minus depreciation. (iii) To retain, out of profits, funds for replacement : All fixed assets become useless sooner or later and therefore, must be replaced by the purchase of new assets. Provision for funds has to be made well in advance so that assets are replaced without any financial problem. Provision for depreciation in the statement of profit and loss does not involve the outflow of cash and hence, funds to the extent of depreciation charge over the years will remain in the business and these funds can be easily used for replacement of assets. (iv) To calculate the proper cost of the product : Depreciation is important expense and forms part of the cost of the production. Hence, the business enterprise must allocate the cost of the fixed assets to the products it produces in order to find out their accurate cost of production. (v) To compute tax liability of the owner : In such cases, the rate of depreciation would depend on the relevant tax-laws. (vi) To meet the legal requirements : In the case of joint stock companies, it is necessary to charge depreciation on fixed assets before declaring dividends. (vii) To allocate the cost of fixed assets : The basic objective of depreciation accounting is to allocate the cost of fixed asset to accounting periods which benefit from the use of the asset so that the cost can be charged to the statement of profit and loss of the said periods. THE CAUSES OF DEPRECIATION Depreciation occurs because of decline in the usefulness of the asset. The causes for the decline in the usefulness of the asset may be divided into two categories namely: Physical and Functional. (i) The physical loss of an asset may arise due to wear and tear, passage of time and other causes: (a) Wear and tear from use : It is common knowledge that most fixed assets suffer from wear and tear in use which ultimately renders an asset unusable in course of time. Parts are worn down by friction or they break. There may be other damage such as corrosion. (b) Passage of time : Many long-term assets lose their usefulness with the passage of time simply because they are older–whether they are being used or not. For example, the structure of building comprising of walls, roofs, flooring etc., is subject to automatic decay due to rainfall, heavy storms etc.. Therefore, depreciation must be provided for building. (c) Other physical factors are fire, flood, earthquake or accident. (ii) The functional factors are: inadequacy and obsolescence: (a) Inadequacy : A fixed asset becomes inadequate, if its capacity is not sufficient to meet the demands for increased production e.g., when an old airport terminal building becomes inadequate, it must be abandoned and a new larger one is built to meet the requirements of heavier air traffic. (b) Obsolescence : The most important functional cause is obsolescence which means the reduction of utility of an asset that results from the development of a better machine or process. Thus, new inventions, changes in manufacturing methods (automation), shifts in demand for products or services or any other condition make the asset out of date. (iii) Depletion : There are certain fixed assets of wasting nature due to extraction of minerals or oil from them e.g. quarries, (mines), oil wells. When minerals are extracted, the asset gets depleted. This is called depletion. The cost of such wasting assets has to be allocated in accordance with the quantity of natural resources extracted or anticipated. (iv) Time factor : For certain assets, the life is fixed legally such as leases, patents, copyrights. Providing depreciation on them is called amortisation. Accounting for Property, Plant and Equipment & Depreciation 10.13 FACTORS OR ELEMENTS AFFECTING DEPRECIATION According to AS-10 : Property, Plant and Equipment (PPE), Depreciable amount is the cost of an asset or other amount substituted for cost less residual value. It means that the amount of depreciation to be determined and ultimately charged to statement of Profit and Loss is based on the following elements or factors, namely: 1. Historical Cost : The cost of the asset (historical cost) includes all costs incurred in acquiring or constructing an asset such as purchase price, legal charges, freight etc. necessary for making it ready for bringing the asset to intended location or making ready for the intended purpose of the management. According to Para 17 of AS 10: Property, Plant and Equipment, the cost of an item of Property, Plant and Equipment comprises of: (a) the purchase price including import duties and non-refundable purchase taxes after deducting trade discounts and rebates. (b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by the management. (c) the initial estimates of the costs of dismantling, removing the item and restoring the site on which it is located referred to as decommissioning, restoration and similar liabilities. Note: Recognition of costs in the carrying amount of an asset ceases when the item is not in the location and condition necessary for it to be capable of operating in the manner intended by the management. Carrying amount is the figure at which the asset is shown in the books of account. The following costs are not included in the carrying amount of an item of Property, Plant and Equipment (PPE): (a) costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity. (b) initial operating losses such as those incurred while demand for the output of an item builds up (increases) and (c) costs of relocating or recognising part or all of the operations of an enterprise. Examples of directly attributable costs are as follows (Para 18 of AS-10): (a) Costs of employee benefits arising directly from the construction or acquisition of the item of property, plant and equipments. (b) Costs of site preparations. (c) Initial delivery and handling costs. (d) Installation and assembly costs. (e) Costs of testing whether the asset is functioning properly after deducting the net proceeds from selling any items while bringing the asset to that location and condition (such as samples produced when testing equipment) (f) Professional fees Examples of costs that are not costs of an item of Property, Plant and Equipment (PPE) i.e. tangible fixed assets: (i) Costs of opening a new facility or business, such as, inauguration costs. (ii) Costs of introducing a new product or service (costs of advertising and promotional activities) (iii) Costs of conducting business in a new location or with a new class of customers (including costs of staff training) (iv) Administration and other general overhead costs. 10.14 Financial Accounting: Concepts and Applications Example: A building site may be used for Car Park before the construction starts but such incidental operations are not necessary to bring an item to location and condition necessary for it to be capable of operating in the manner intended by the management. The income and expenses of incidental operations are to be shown in the statement of Profit and Loss. 2. Estimated Residual (Salvage or Scrap) value means the estimated amount which will be recovered when the asset is sold or exchanged for a new asset at the end of its estimated or actual useful service life. The net depreciable cost of the tangible fixed asset to the business (or other) enterprise is therefore, arrived at by deducting the salvage value of the asset from its actual historical cost as described above in point 1. According AS-10 : Property, Plant and Equipment: the residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal if the assets were already of the age and in the condition expected at the end of its useful life. Note: Estimation of residual life is very difficult and cannot be determined objectively. It should be treated nil or ignored if the amount is insignificant. The only way is to ascertain the residual value from the junk market where it exists. It must be remembered that since the residual value is recoverable there is no need to charge depreciation on this value. It cannot be part of cost of the assets. Thus, the amount of depreciation to be written off is equal to: Cost of the asset minus its Residual Value 3. Estimated useful life: The following points are generally recommended in estimating the useful life of tangible fixed assets: (a) The intensity of use : The life of an asset ordinarily depends upon the way in which it is put to use e.g., a truck used on a construction site may have relatively shorter life than a truck used for transportation on National Highways due to good quality of roads. (b) The standard of maintenance, for example, the careful handling and frequent overhauling or repairs usually tend to increase useful life. (c) The replacement policy of the management: Machinery, for example, with an expected physical life of 15 years under normal conditions will have a useful life for depreciation purpose of 10 years if the policy of the management is to exchange or dispose of such asset after 10 years. IS DEPRECIATION A SOURCE OF FUNDS There is popular misconception that depreciation is a source of funds or working capital. In fact it is not so, because funds are generated by the revenues or receipts from sales and other items of extraordinary income (e.g. sale of fixed assets at profit) and not from depreciation. It is true that depreciation is non-cash expense and unlike other operating expenses, does not require the use of funds or working capital but under no circumstances depreciation is source of funds or cash for that matter. The misconception can be cleared with the help of following journal entry that is usually passed or made for depreciation accounting: Depreciation Expense Account Dr. To Fixed Asset Account The depreciation expense account is clearly an expense account while the credit account is contra fixed asset account. How can it be presumed from the above journal entry that the depreciation is source of funds or cash? When the funds from operations are calculated for the purpose of funds flow statement, the depreciation expense figure is added back to the given net profit or income figure. Such a procedure has led to a good deal of confusion because it is often concluded that depreciation is a source of funds e.g., Accounting for Property, Plant and Equipment & Depreciation 10.15 Funds From Operations ` Net Income as Per Income Statement 50,000 Add : Non-cash expense : Depreciation 10,000 60,000 Does it mean that out of total funds from operations (i.e. ` 60,000) the contribution of depreciation is ` 10,000. The answer is ‘no’. It may be explained in this manner. Suppose the firm charges depreciation of ` 40,000 instead of ` 10,000. It would be found that working capital is still ` 60,000 regardless of the amount charged for depreciation. The reason is that the profit or income with ` 40,000 as depreciation would be reduced to ` 20,000. The funds provided by operations, however, would remain at ` 60,000 (20,000 + 40,000). In brief, the depreciation is an expense and an expense can never be source of funds. However, the depreciation indirectly affects the flow of funds which is explained in the following manner: (i) Depreciation affects the cost of production and is considered for determining the price of the product. Thus, it has direct relation to the flow of revenues. (ii) Depreciation is a charge against the profit thus, reducing the profit and consequent tax liability affecting the flow of funds (cash) (iii) No profit can be distributed unless reduced by the amount of tax liability and thus, it reduces the outflow of funds (cash). CALCULATION OF DEPRECIATION FOR ASSETS PURCHASED DURING THE YEAR When an asset is purchased during the year, the following alternatives may be followed: (a) If the rate of depreciation is expressed as 10% or 20% without a mention of per annum, the depreciation would be simply calculated as percentage of the total cost of the asset for full year. This is especially true when date of purchase or date of sale is not given. However, if the date of purchase or sale is given and the rate of depreciation is expressed without per annum, the depreciation must be calculated on the basis of time factor unless the examination problem requires otherwise. (b) If the rate of depreciation is expressed as 10% or 20% per annum and the date of acquisition is also given, the depreciation expense would be calculated with reference to the date of acquisition to the end of accounting period. (c) If the rate of depreciation is expressed per annum and the date of acquisition of the asset is not given, it would be appropriate to calculate depreciation for 6 months on the assumption that it was acquired half way through the year. It will be wrong in this case if the depreciation is charged for full year or no depreciation is charged at all. The point must be clarified by giving specific note to this effect. (d) The effective date for charging the depreciation is that date when the asset has been put to use or where the asset is ready for use irrespective of fact whether it is being used or not. ACCOUNTING TREATMENT There are two alternative methods of accounting entries for recording the depreciation, namely: (i) To reduce the value of asset by charging depreciation directly to the asset account every year i.e., to credit the asset account. (ii) To create a separate provision for depreciation account and accumulate the depreciation amount (year after year) in that account without disturbing the concerned asset account i.e., to credit the provision for depreciation account. 10.16 Financial Accounting: Concepts and Applications Depreciation Directly Charged to Asset Account This accounting procedure is applicable for all the methods of depreciation except for sinking fund method. The journal entry in the books of account is : (i) Depreciation Account Dr. (with the amount of depreciation) To Relevant Asset Account In this manner, depreciation is directly credited to the asset account with the result that the asset account is shown in the balance sheet at its cost or book value less depreciation for the accounting period. Depreciation expense is then transferred to the statement of profit and loss with the help of following journal entry: (ii) Profit and Loss Account Dr. (with the same amount as in [i] above) To Depreciation Account Provision for Depreciation Depreciation may also be recorded with the help of provision for depreciation account as well. The necessary entries are: (i) For charging depreciation Depreciation Account Dr. (with the amount of depreciation) To Provision for Depreciation Account (ii) For closing depreciation account Profit and Loss Account Dr. (same amount as in [i]) To Depreciation Account Under this method, the asset account is not affected by the amount of depreciation and the asset appears in the ledger and balance sheet at its original cost until sold or discarded. The amount in the credit side of the provision for depreciation account shows the total amount of depreciation accumulated to date. However, when the asset is sold or discarded or exchanged for a new asset, the total depreciation for that asset in the provision for depreciation account is transferred to that asset account with the help of following journal entry: Provision for Depreciation Account Dr. To Relevant Asset Account Thus, the balance in the provision for depreciation account always indicates the total depreciation on the unsold assets. In the balance sheet, the asset account is shown at its original cost less accumulated balance in the provision for depreciation account; e.g., Assets Side ` Cost of the Asset Less: Provision for Depreciation ` 1,00,000 20,000 80,000 However, some accountants show the asset at the original cost and provision for depreciation in the liabilities side until the depreciation provision is equal to the original cost of the asset. Difference: It is relevant to highlight the points of difference in the two accounting procedures as given below: Accounting for Property, Plant and Equipment & Depreciation When Depreciation Directly Affects The Asset Account 10.17 When Provision For Depreciation Account is Maintained (i) The asset is shown in the balance sheet at cost/book value less depreciation of the relevant accounting period only. (i) The asset always appears at its original cost in the ledger. (ii) It is not possible to know the total amount of depreciation written off from one balance sheet. (ii) The balance in the provision account shows the total amount of depreciation written off upto the latest balance sheet date. (iii) In the absence of details it is not possible to know whether the asset is new or old. (iii) It is easy to find out the age of the asset simply with the help of cost of asset and accumulated depreciation. METHODS OF PROVIDING DEPRECIATION The total amount of depreciation for an asset is equal to the cost of the asset less its scrap or disposal value at the end of its useful life. Though there is unanimity amongst the accountants regarding the total quantum or measure of depreciation to be written off over the useful life of the asset yet there is difference of opinions so far the apportionment of this total amount between different years is concerned. As a result, the annual charge for depreciation against the statement of profit and loss for the same asset is not uniform for various business enterprises. The reasons are: (i) It is not possible to estimate accurately the useful life of the asset. (ii) It is also not possible to determine accurately the extent of the use of the asset each year of its useful life. (iii) It is not possible to determine the scrap or disposal value at the end of its useful life. (iv) The expenses on the repairs and maintenance of the fixed asset would determine the capacity of the asset to provide useful service to the business enterprise over its life. There are various methods of charging depreciation, (that is allocating cost of tangible fixed assets) each year as given below: (i) Straight Line Method (ii) Diminishing Balance Method or Written Down Value Method. (iii) Annuity Method (iv) Depreciation Fund Method (or Sinking Fund Method) (v) Insurance Policy Method (vi) Machine Hour Rate Method (vii) Units of Production or Output Method (viii) Revaluation Method (ix) Sum-of-the-Years’ Digits Method (x) Group Depreciation Method According to AS-10 : Property, Plant and Equipment, the depreciation method used should reflect the pattern in which the future benefits of the assets are expected to be consumed by the enterprise. A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include: (i) the straight line method (ii) the diminishing balance method, and (iii) the units of production method The detailed discussion of the above three methods follows in the following pages: 10.18 Financial Accounting: Concepts and Applications Some Important Points While solving the problems on Depreciation, it is necessary to focus on the following significant points given below: (i) The depreciation is to be calculated from the date the asset is ready or available for use. It means the date of acquisition or purchase of asset is not relevant when the date of using or availability for its use is given in the examination problem. (ii) When the date of disposal or discardment of asset is given, the date for the calculation of asset is not the date of sale but the date on which the asset was discarded, that is, put out of use. (iii) When the asset is purchased on hire purchase system, the depreciation will be calculated on its cash price because interest is the revenue expenditure and must be transferred to Statement of Profit and Loss. Students must calculate the cash price from the given hire purchase price before charging depreciation, because Hire Purchase Price = Cash Price + Amount of interest included in each instalment (iv) When the enterprise purchases a second hand tangible fixed asset, all expenditures incurred in making the asset usable must be capitalised, that is, added to its cost or purchase price. (v) When the Diminishing Value Method or Written Down Value Method is to be adopted and the scrap or residual value is also given, ignore the scrap or residual value. When the expenses relating to the sale of assets such as dismantling charges are given in the examination problem, the same must be deducted from the sale price to calculate the real or effective sale price. The alternative journal entries are: First Alternative Bank Account Dr. To Asset Account (with sale price minus dismantling charges) Second Alternative Asset Account Dr. To Bank Account (with dismantling charges) Now sale price will not be modified or diluted All these points are to be found in the illustrations that follow. COMPONENT ACCOUNTING A fixed asset may consist of either one item or group of items held by the business enterprise to be used for more than one accounting period. So, the asset may contain one component or more than one component i.e. group of components making one physical unit with one cost. For example when a firm purchases an Aircraft, it contains the following major components namely: • Airframe that is the body of the aircraft • the engines and • the interiors in the form of seatings (chairs), furnishing etc. But the firm records the Aeroplane in the books of account as one unit with one cost. Interestingly the major components of the aeroplane can be physically separated from the principal asset and which have got significantly different costs and different useful lives. Hence, each item should be depreciated separately. It is called component accounting. It means that if an asset has several components which can be physically separated from the main or principal asset and which have got significantly different costs and different useful lives then these should be recognised based on their respective useful lives and these should be depreciated separately. Accounting for Property, Plant and Equipment & Depreciation 10.19 In short, component accounting requires that if an asset has several components which can be physically separated from the principal asset and which have significantly different useful lives then these should be recognised separately and should be depreciated based on their respective useful lives. Para 45 of Accounting Standard (AS) - 10 makes the following reference to Component Accounting: Each part of an item (fixed asset) with a cost that is significant in relation to the total cost of the item should be depreciated separately. A significant part of an asset may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item, such parts may be grouped in determining the depreciation charge. Schedule II of the Companies Act 2013 requires that useful life for significant components of tangible assets should be determined separately. Companies need to identify and depreciate significant components with different useful lives separately. The Ministry of Corporate Affairs vide its notification dated 29th August 2014, has made Component Accounting mandatory for financial year commencing on or after 1st April, 2014. It must be noted that determination of separate components, their individual costs and useful lives is not a simple matter. It requires the involvement of technical experts, and objective judgement before embarking on Component Accounting. Example of Component Accounting A firm purchases a Motor Vehicle for transporting the passengers from New Delhi to Amritsar. costing ` 8 lakhs on 1st April, 2018. The major or significant components of the Motor Vehicle consists of its Main Body costing ` 2,50,000, Interiors, that is, seating arrangement and furnishings costing ` 3,50,000 and Engine ` 2,00,000. The expected useful lives of these components is : Main Body 5 years, Seating units 4 years and Engine 8 years. Calculate the depreciation for the financial year 2018-19. Answer Annual depreciation charge on the basis of component accounting would be as shown below: Depreciation on Component Body = ` 2,50,000/5 = ` 50,000 Depreciation on Component Seating = ` 3,50,000/4 = ` 87,500 Depreciation on Component Engine = ` 2,00,000/8 = ` 25,000 Annual Depreciation of Motor Vehicle = ` 50,000 + ` 87,500 + ` 25,000 = ` 1,62,500 STRAIGHT LINE METHOD (Fixed or Equal Instalment Method) This method assumes that each accounting period receives the same benefit from using the asset as every other period. It is called straight line because it allocates an equal amount of depreciation in each of the accounting periods of the service life of the asset. The depreciation charge for each accounting period is therefore, not affected by the extent of use of the asset (i.e., asset productivity), its age or efficiency. The formula for calculating depreciation charge for each accounting period is : Annual Depreciation = Original Cost – Estimated Salvage Value Estimated useful Life in Years For example, if a machine is purchased for ` 1,00,000 on January 1 and the installation charges are ` 30,000 with an estimated scrap value of ` 10,000 and estimated life of 5 years, the annual depreciation charge on 31 December would be found as under: Depreciation = ` 1, 00, 000 + ` 30, 000 – ` 10, 000 ` 1, 20, 000 = = ` 24, 000 5 5 10.20 Financial Accounting: Concepts and Applications However, if the asset is acquired during the year, the amount of depreciation would be proportionate to the period of use. Rate of Depreciation = r = Amount of Depreciation Original Costs 24, 000 × 100 = 18.46% (App.) 1, 30, 000 The book value of the machine is found by deducting the total accumulated depreciation from the cost. Advantages (i) This method is easy to use. Mathematical calculations are not required. (ii) This method realistically matches cost and revenues. (iii) There is no change either in the rate or the amount of depreciation over the useful life of the asset. Such a procedure provides sound basis for comparison. (iv) This method is recognised by the Accounting Standard (AS)-10 issued by the Institute of Chartered Accountants of India and also by the Companies Act 2013. (v) The valuation of the asset each year in the balance sheet is reasonably fair. Disadvantages (i) It does not take into consideration the interest on the amount invested in the fixed asset. (ii) It is illogical because depreciation is considered a function of time rather than a function of use. (iii) It is based on the wrong assumption of equal utility of the asset during its useful life. (iv) The maintenance of the asset is generally costly in the later years with the result that the total of maintenance costs and depreciation would be greater in later years than in the earlier years. (v) If an additional asset is purchased, the amount of depreciation on that asset has to be recalculated. Hence, a separate calculation has to be made for each item because of difference in useful life and scrap value. Suitability This method is suited in the following cases: (i) Where the useful life of the asset can be estimated accurately; (ii) When repairs/maintenance expenses are uniform for each accounting period; (iii) Where use of the asset is consistent from period to period and therefore each period benefits equally from the use of the asset e.g., furniture, leases, copyright, trade mark etc.. (iv) Where the asset is not likely to become obsolete. Illustration 1 (Straight Line Method) Soloman purchases a machine for ` 1,00,000 on 1 January 2016. Its estimated useful life is 5 years and scrap value ` 10,000. It is decided to write off depreciation under straight line method. Pass necessary journal entries for five years and open necessary accounts in the ledger for the same period. The accounting period ends on 31 March every year. Solution : Annual Depreciation = ` 1,00,000  ` 10,000  ` 18,000 per year 5 18,000  100  18% Rate of Depreciation = 1,00,000 Accounting for Property, Plant and Equipment & Depreciation 10.21 Journal Entries Date 2016 Jan. 1 31 Mar. 2017 31 Mar. 2018 31 Mar. 2019 31 Mar. 2020 31 Mar. 31 Dec. 2021 31 Mar. Particulars Debit ` Machinery Account To Bank Account (Purchase of machine) Dr. Depreciation Account To Machinery Account (Depreciation on machinery for 3 months) Dr. Profit and Loss Account To Depreciation Account (Depreciation charged to profit and loss A/c) Dr. Depreciation Account To Machinery Account (Depreciation of machinery for one year) Dr. Profit and Loss Account To Depreciation Account (Depreciation charge transferred to profit and loss A/c) Dr. Depreciation Account To Machinery Account (Annual depreciation charge) Dr. Profit and Loss Account To Depreciation Account (Depreciation charge transferred to profit and loss A/c) Dr. Depreciation Account To Machinery Account (Annual depreciation charge) Dr. Profit and Loss Account To Depreciation Account (Transfer of annual depreciation to profit and loss A/c) Dr. Depreciation Account To Machinery Account (Annual depreciation charge) Dr. Profit and Loss Account To Depreciation Account (Transfer of depreciation charge to profit and loss A/c) Dr. Bank Account To Machinery Account (Machinery sold for ` 10,000 as scrap) Dr. Depreciation Account To Machinery Account (Depreciation charge for 9 months on ` 90,000 @ 18%) Dr. Profit and Loss Account To Depreciation Account (Transfer of depreciation account to profit and loss A/c) Dr. Credit ` 1,00,000 1,00,000 4,500 4,500 4,500 4,500 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 18,000 10,000 10,000 13,500 13,500 13,500 13,500 10.22 Financial Accounting: Concepts and Applications Dr. 1 Jan. 2016 Bank Account Machinery Account ` 1,00,000 ` 31 March 2016 Depreciation Account (3 Months) Balance c/d Balance b/d 1,00,000 31 March 2017 95,500 Depreciation Account 18,000 Balance c/d 77,500 95,500 1 April 2017 Balance b/d 95,500 31 March 2018 77,500 Depreciation Account Balance c/d 1 April 2018 77,500 31 March 2019 59,500 Depreciation Account 18,000 Balance c/d 41,500 59,500 1 April 2019 Balance b/d 59,500 31 March 2020 41,500 Depreciation Account 18,000 Balance c/d 23,500 41,500 1 April 2020 Balance b/d 18,000 59,500 77,500 Balance b/d 4,500 95,500 1,00,000 1 April 2016 Cr. 41,500 31 December 2020 23,500 Bank Account (Scrap) 10,000 31 March 2021 Depreciation Account 23,500 (for 9 months) 13,500 23,500 DIMINISHING BALANCE METHOD (Written Down Value or Reducing Balance Method) Under this method, a fixed rate or percentage is applied to the original cost in the first year and to the book values in subsequent years. The book value of the asset means the undepreciated balance of the asset cost, i.e., balance of the asset cost not yet depreciated. In other words, the depreciation is calculated on the reducing balance (asset cost minus depreciation) and not on the original cost. The procedure is that depreciation is deducted from the cost of the asset and balance is known as the written down value. In the next accounting period, the fixed percentage is applied to the written down value and not to the original cost. The rate of depreciation remains the same while the amount of depreciation goes on decreasing. The written down value (i.e., the unallocated cost) at the end of the estimated useful life of the asset should equal the estimated salvage value. The rate of depreciation in the diminishing balance method is : r = 1– n S × 100 C where r = the rate of depreciation; n = number of years of asset’s life; s = salvage (or scrap) value and c = cost of the asset. For example, Somesh buys a second hand motor car for ` 40,000 and its scrap value is ` 10,480 and the useful life of the car is 6 years, the rate of depreciation under diminishing balance method would be : r = 1– 6 10, 480 × 100 40, 000 Accounting for Property, Plant and Equipment & Depreciation 10.23 r = 1– 6 0.262 × 100 = 1 – 0.8 × 100 = 20% Illustration 2 (Diminishing Balance and Straight Line Methods) A machine was acquired on 1 April 2019 for ` 15,000. The cost of installation being ` 1,000. It is expected that its scrap value at the end of its working life will be ` 2,000. Write up the machine account for the first two years under diminishing balance method and S.L.M. charging 10% depreciation. Assume that the financial year is followed. Solution: Dr. (i) Machinery Account (Diminishing Balance Method) 1-4-2019 Bank Account ` 16,000 Depreciation Account Balance c/d 16,000 1-4-2020 Dr. Depreciation Account ` 16,000 12,960 Cr. ` 31-3-2020 Depreciation Account (10 % of ` 16,000) Balance c/d 16,000 1-4-2020 1,440 14,400 (ii) Machinery Account (S.L.M.) Bank Account 14,400 31-3-2021 14,400 14,400 Bank Account 1,600 16,000 Balance c/d 1-4-2019 ` 31-3-2020 (10 % of ` 16,000) (15,000 + 1,000) Balance b/d Cr. 1,600 14,400 16,000 31-3-2021 14,600 Depreciation Account 14,400 Balance c/d 12,960 14,600 14,400 ATTENTION PLEASE Under written down value method, scrap value is not deducted and depreciation is calculated on the original cost. Advantages (i) The higher depreciation is charged in the earlier years when the machine is most efficient. This matches higher cost with larger revenues resulting from the increased production. (ii) The obsolescence problem is given due care because the major part of the depreciation is charged in the earlier years and the management has no difficulty in replacing the asset. (iii) The problem of higher maintenance or repair charges is solved since the depreciation expense in later years is lower than the depreciation expense of early years. (iv) The asset will never be completely written off with the result that management can keep a track of the asset. (v) All items including additions are added together and depreciated at the same rate. So no recalculation is necessary when additional assets are purchased. (vi) The method is recognised by AS-10 and Companies Act 2013 and is applicable for income tax purposes. 10.24 Financial Accounting: Concepts and Applications Disadvantages (i) This method requires much figure work. (ii) Such a method involves the use of mathematical tables where the arithmetic is difficult. (iii) It does not take into consideration the interest on the amount invested in the fixed assets. (iv) It takes very long time to write off the asset unless a very high rate of depreciation is applied. The result is that the asset cannot be replaced at the earliest. (v) If the life of the asset is short, the depreciation charge in the earlier years is more having adverse impact on the net profit. Hence, this method is not applied for assets with a very short life. (vi) The depreciation is neither based on the use of the asset nor distributed evenly throughout the useful life of the asset. Suitability: In general this method is suitable to plant and machinery where repairs are heavy in the later years and additions, extensions and substitution are frequent. And also where the possibilities of obsolescence are frequent. DIFFERENCE BETWEEN STRAIGHT LINE METHOD AND DIMINISHING BALANCE METHOD Points of Difference Diminishing Balance Method Straight Line Method 1. Computation Method The depreciation is charged at a fixed rate on the original cost in the first year and on the written down value (cost-minus total depreciation) in the subsequent years. The depreciation is charged at a fixed rate on the original cost of the asset 2. Amount of Depreciation The amount of depreciation goes on decreasing year after year. The amount of depreciation remains the same in all the years of useful life of the asset 3. Effect on Income Statement The total burden on the profit and loss account is same in the early years as well as is the later years because of more depreciation plus repairs cost in the beginning and less depreciation plus more repairs cost in the later years. The total burden on the profit and loss account is more in the later years because the repair charges increase while the amount of depreciation is same. 4. Book Value The book value never becomes zero. The book value of the asset becomes zero or equal to scrap value 5. Calculation It requires the use of mathematical tables It is easy to calculate the rate of depreciation 6. Suitability Repair charges are more in later years and also obsolescence. Where repair charges are less and obsolescence is not frequent UNITS OF PRODUCTION METHOD The units of production method results in a charge based on the expected use or output. In this method the depreciation expense is allocated in proportion to the degree the asset is used for production because the estimation of useful life is done in terms of units of output and not a calendar time period. A machine has the capacity to produce limited number of items and therefore, as an item is produced, the total number of possible units is reduced. As a result of this limitation, the depreciation is related to usage and not to time. In this method an estimate of the capacity of the asset to produce units of a certain item is made. It may be clarified that units-of-production capacity might be miles driven by vehicles, flying hours by aircraft engine, number of stampings for stamping machine, tons of coal in a mine, number of operating hours a machine will provide and so on. The depreciation expense for a particular accounting period is calculated as under: Depreciation Expense Per Unit = Cost minus Salvage Value Total Estimated Units of Output or Service Hours or Any Other Unit Accounting for Property, Plant and Equipment & Depreciation 10.25 Depreciation expense for the accounting period = Depreciation expense per unit (as calculated above) multiplied by the number of units (of output or service hours or any other unit used) pertaining to the accounting period. Example: (Units of Production Method) Anjna Ltd. bought a machine, expected to run or render 36,000 hours of service, for ` 20,000. Its salvage value was estimated at ` 2,000. Calculate the depreciation expense for an accounting period in which it was used for 8,000 hours. Answer: First Step: Depreciation expense per hour : 20,000 – 2,000 36,000 = ` 0.5 or 50 paise per hour Second Step: Depreciation expense for the accounting period : 8,000 × 50 p = ` 4000. Advantages: The following points of merit are generally mentioned for this method: (i) This method relates fixed asset cost to usage, Under the straight line method, the emphasis is on the availability of the asset for use and the depreciation expenses is a measure of such availability whether the asset has been used or not. But unit of production method allocates the cost in terms of use of the asset. (ii) If the actual units produced differ from the original estimate, it would mean that either the asset is not completely depreciated or it produces more units than estimated. Either of the two situations could be easily investigated. (iii) It is further claimed that if the estimate regarding the capacity of the asset can be made with reasonable accuracy, it gives a superior basis for depreciation; the depreciation expense is presumably written off in proportion to the amount of usage and presumably in proportion to the revenue earned in a period. In other words, this method properly matches depreciation cost to revenues. The major disadvantages are : (i) It is difficult in practice to estimate the total number of units likely to be produced during the total operating life of the machine. Instead the ‘time’ of useful life is easy to determine. (ii) A separate record of output for each asset will have to be maintained necessitating extra recordkeeping. Moreover, the records may not be readily available without additional cost and efforts. (iii) This method ignores obsolescence. It is explained as: Suppose the selling price of a product is ` 40 and the cost other than depreciation expense is ` 30 per unit. Each unit requires 10 hours of machine time and 100 units are produced and sold. The cost of the machine is ` 10,000 and the estimated capacity 20,000 hours. ` Sales: 100 units @ ` 40 per units 4,000 Less : Cost other than depreciation (100 × 30) 3,000 1,000 Less : Depreciation expense = ` 10,000 = 50 paise per hour 20,000 100 units × 10 hours × 50 paise 500 Profit 500 Next year as a result of sophisticated machines there is an increase in the general production of the commodity with the result that the selling price drops to ` 30. How can it be said that the machine is making contribution towards revenue? The firm would definitely incur loss unless the machine is replaced. 10.26 Financial Accounting: Concepts and Applications (iv) The balance sheet value would be a pure fiction. Suitability: Units-of-production method is more appropriate for situations in which wear and tear is the major cause of depreciation and the amount of use may vary from period to period. Furthermore, if the asset is uniformly used throughout its useful life, the same allocation would result from either the straight line method or units-of-production method. This method is also easier to apply in case the business is engaged in extracting natural resources e.g. petroleum and other mining products. Illustration 3 (Reducing Balance Method) A machine is purchased for ` 20,000 on 1 April 2018. It is depreciated @ 5% p.a. on reducing balance method for five years, when it becomes obsolete due to new methods of production and is scrapped. The scrap produces ` 5,385 there on and the accounting period ends on 31 March every year. Show the plant account in the ledger for three years. Solution : Dr. Plant Account Date Particulars 1.4.18 Bank ` 20,000 Cr. Particulars 31.3.19 Depreciation 1,000 Balance c/d 19,000 (Purchase of Plant) 20,000 1.4.19 Balance b/d 19,000 20,000 31.3.20 Depreciation Balance c/d 19,000 1.4.20 Balance b/d 18,050 ` Date 950 18,050 19,000 31.3.21 Depreciation Balance c/d 18,050 902 17,148 18,050 SALE OR DISPOSAL OF FIXED ASSETS Assets may be sold or discarded before or on the expiry of its estimated useful life. It would then be necessary to calculate the profit or loss, if any, on such sale. For this purpose, we have to calculate the book value of the asset on the date of sale. The book value is calculated by deducting the total depreciation from the date of purchase of the asset to the date of sale of the asset from the original cost of the asset. It may be noted that: (i) If the sale price is more than book value, the difference is profit on sale. (ii) If the book value is more than the sale price the difference is loss on sale. The relevant journal entries are: (i) On sale of assets Cash/Bank Account Dr. (with the total sale price) Dr. (with the amount of profit) To Asset Account (ii) (a) Profit on sale of asset Asset Account To profit and Loss Account (b) Loss on sale of asset Profit and Loss Account To Aseet Account Dr. (with the amount of loss) Accounting for Property, Plant and Equipment & Depreciation 10.27 Illustration 4 (Diminishing Balance Method– Opening Cost Unknown – Loss on Sale) Paro Ltd. depreciates its machinery at 10% p.a. under the reducing balance method. On 1.1.2020 it had ` 4,05,000 as balance of its Machinery Account. On 31.03.2020 it sold for ` 17,000, part of the machine which it purchased on 1.1.2018 at ` 30,000. On 1.7.2020 it purchased a new machine at a cost of ` 46,500 and installed it on the same day at a further cost of ` 3,500. The company’s policy is to charge depreciation proportionate to actual use during a year made of an asset but to ignore depreciation for any period of less than 182 days. If no further purchase/sale has been made between 2018 and 2020 except those mentioned above, show the Machinery Account in the books of the company between 1.1.2018 and 31.12.2020. [C.A. Inter Adapted] Points to be noted: 1. Machinery Account is to be prepared from 1.1.2018, but its balance is given only on 1.1.2020. So, the original cost on 1.1.2018 should be found out. 2. No depreciation is to be provided on the asset sold in 2020 as it has been used for only 3 months (less than 182 days) in this year. But depreciation should be charged on the machine purchased on 1.7.2020 as it has been used for 182 days or more. WORKING NOTES 1. Original Cost/Value on 1.1.2018 ` Written down value on 1.1.2020  90  of 4, 05, 000  Added Back : Depreciation in 2019  100  W.D Value on 1.1.2019  90  of 4, 05, 000  Added Back : Depreciation in 2018  100  Cost on 1.1.2018 4,05,000 45,000 4,50,000 50,000 5,00,000 2. Profit/Loss on sale on 31.3.2020 ` 1.7.2018 Original Cost 31.12.2018 Less: Depreciation @ 10% p.a. 1.1.2019 31.12.2019 30,000 W.D.Value Less Depreciation @ 10% p.a. 1.1.2020 W.D.Value 3,000 27,000 2,700 24,300 As no depreciation is to be charged for 2020 Book value on 31.3.2020 24,300 Less : Selling Price 17,000 Loss on Sale 7,300 3. Annual Depreciation for 2020 ` On machinery existing 10% of [ ` 4,05,000 – ` 24,300] On new purchase for 1 1 year (1.7.2017 to 31.12.2017) [10% of 50,000 for year] 2 2 38,070 2,500 40,570 10.28 Financial Accounting: Concepts and Applications Solution : Books of Paro Ltd. Machinery Account Dr. ` Date Particulars 1.1.18 Bank A/c (Purchase) 5,00,000 Cr. Date Particulars 31.12.18 Depreciation A/c Balance c/d 5,00,000 1.1.19 Balance b/d 4,50,000 31.12.19 Depreciation A/c 4,50,000 Balance b/d 4,05,000 1.7.20 Bank A/c [46,500 + 3,500] 50,000 4,50,000 5,00,000 Balance c/d 1.1.20 ` 45,000 4,05,000 4,50,000 31.3.20 50,000 31.12.20 Bank A/c (Sale) 17,000 Profit & Loss A/c (loss on sale) 7,300 Depreciation A/c 40,570 Balance c/f 4,55,000 3,90,130 4,55,000 Illustration 5 (Provision for Repairs and Depreciation) Deba Printers Ltd. purchased a Printing Machine on 1.4.2016 for using it for 5 years only. Its cost was ` 86,000 but insurance paid on it and its carrying costs amounted to ` 7,000 and ` 2,000 respectively. Deba Printers Ltd. also estimated a total expense of ` 25,000 on account of its repairs over its work life. The scrap value of the machine was estimated to be ` 5,000. The Annual repairs were: 2016 - 17 Nil 2017 - 18 4,000 2018 - 19 6,000 2019 - 20 7,000 2020 - 21 8,000 On 31.03. 2021 the machine was sold for ` 4,800. Show the necessary accounts in the books of Deba Printers Ltd. over these years. WORKING NOTES Annual Provision for Repairs & Depreciation Original Cost  Insurance  Carriage  Estimated Total Repairs – Residual Value Estimated Years of Working Life ` 1,15, 000 ` 86, 000  ` 7, 000  ` 2, 000  ` 25, 000 – ` 5, 000 = 5 5 = ` 23,000 Solution : Books of Deba Printers Ltd. Provision for Repairs and Depreciation Account Dr. Date 31.3.17 Particulars Balance c/d ` 23,000 Cr. ` Date Particulars 31.3.17 Profit & Loss A/c 23,000 1.4.17 Balance b/d 23,000 Accounting for Property, Plant and Equipment & Depreciation 31.3.18 Repairs A/c 4,000 Balance c/d 42,000 10.29 31.3.18 Profit & Loss A/c 46,000 31.3.19 Repairs A/c 6,000 Balance c/d 59,000 46,000 1.4.18 Balance b/d 42,000 31.3.19 Profit & Loss A/c 23,000 65,000 31.3.20 Repairs A/c 7,000 Balance c/d 75,000 65,000 1.4.19 Balance b/d 59,000 31.3.20 Profit & Loss A/c 23,000 82,000 31.3.21 Repairs A/c 31.3.21 Machinery A/c 8,000 82,000 1.4.20 Balance b/d 75,000 31.3.21 Profit & Loss A/c 23,000 90,000 98,000 Dr. 98,000 Machinery Account Date Particulars 1.4.16 Bank A/c Cost 23,000 ` Cr. Date Particulars ` 31.3.17 Balance c/d 95,000 86,000 Insurance 2,000 Carriage 7,000 95,000 95,000 95,000 1.4.17 Balance b/d 95,000 31.3.18 Balance c/d 95,000 1.4.18 Balance b/d 95,000 31.3.19 Balance c/d 95,000 1.4.19 Balance b/d 95,000 31.3.20 Balance c/d 95,000 1.4.20 Balance b/d 95,000 31.3.21 Provision for Repairs & Dep. A/c 90,000 Bank (Sale) Profit & Loss A/c (Loss) 95,000 Dr. Particulars 31.3.18 Cash A/c 31.3.19 31.3.20 31.3.21 Cash A/c Cash A/c Cash A/c ` 4,000 6,000 7,000 8,000 200 95,000 Repairs Account Date 4,800 Cr. ` Date Particulars 31.3.18 Provision for Repairs & Depreciation A/c 4,000 Provision for Repairs & Depreciation A/c 6,000 Provision for Repairs & Depreciation A/c 7,000 Provision for Repairs & Depreciation A/c 8,000 31.3.19 31.12.20 31.12.21 10.30 Financial Accounting: Concepts and Applications Illustration 6 (Use of Provision for Depreciation Account and Asset Disposal Account) The cost of machinery in use with a firm on 1st April, 2019, was ` 3,00,000 against which the depreciation provision stood at ` 1,20,000 on that date. The firm provided depreciation at 10% p.a. on the diminishing value. On 31st December, 2019, two machines costing ` 30,000 and ` 20,000 respectively, both purchased on 1st October, 2014, had to be discarded because of damage and had to be replaced by two new machines costing ` 45,000 and ` 35,000 respectively. One of the discarded machines was sold for ` 15,000; against the other it was expected that ` 5,000 would be realised. Show the relevant accounts in the ledger of the firm of the year ended 31st March, 2020. [C.U. B.Com. (Hons.) 2001] Solution : Books of..... Machinery Account Dr. Date Particulars ` 1.4.19 Balance b/d 3,00,000 31.12.19 Bank Account (Cost of Machines purchased: 45,000 + 35,000) Cr. Date Particulars 31.12.19 Machinery Disposal (Cost of Machines discarded = 30,000 + 20,000) 80,000 Balance c/d 3,80,000 Dr. Particulars 31.12.19 Machinery Disposal A/c ` 14,411 (Accumulated Depreciation on discarded machines—transferred) [Note 1] 31.3.20 Balance c/d Particulars 31.12.19 Machinery Disposal A/c (Depreciation on discarded machines) [Note 2] 31.3.20 Provision for Depreciation A/c (Current year’s depreciation) [Note 3] Cr. Particulars ` 1.4.19 Balance b/d 1,20,000 31.12.19 31.3.20 Depreciation Account Depreciation Account (Current year’s depreciation) [Note 3] 2,886 16,153 1,24,628 1,39,039 Depreciation Account Date 3,30,000 Date 1,39,039 Dr. 50,000 3,80,000 Provision for Depreciation Account Date ` ` Cr. Date Particulars 31.3.20 Profit & Loss A/c ` 19,039 2,886 16,153 19,039 19,039 Accounting for Property, Plant and Equipment & Depreciation Dr. 10.31 Machinery Disposal Account Date Particulars (`) 31.12.19 Machinery Account (Cost of discarded machines) Cr. ` Date Particulars 31.12.19 Provision for Depreciation Account (Accumulated Depreciation on discarded machines) 50,000 11,525 Depreciation Account 2,886 Machines Scrapped (Expected Value) 5,000 Bank Account (Sale) 15,000 Profit & Loss A/c (Loss) 15,589 50,000 50,000 WORKING NOTES 1. Accumulated Depreciation on discarded machines ` 1.10.16 31.3.17 Original Cost Less: Depreciation (`) 50,000 Depreciation @ 10% p.a. for 6 months 2,500 2,500 47,500 31.3.18 Less: Depreciation @ 10% p.a. 4,750 4,750 42,750 31.3.19 Less: Depreciation @ 10% p.a. 4,275 4,275 38,475 11,525 2. Depreiation on discarded machines in 2019-2020 + 2,886 For 1.4.19 to 31.12.19 @ 10% p.a. on W.D.V. = ` 38,475 × 14,411 10 9  = ` 2885.63 or ` 2886 100 12 ` 3. Depreciation on other machines in 2019-2020 Total Original Cost (of all machines) 3,00,000 Less: Provision for Depreciation (of all machines) 1,20,000 W.D.V. of all machines on 1.4.19 Less: 31.3.2020 1,80,000 W.D.V. of discarded machines on 1.4.19 38,475 W.D.V. of remaining machines on 1.4.19 1,41,525 Depreciation @ 10% (for full year) Add: 14,153 Depreciation on new machines purchased on 31.12.19 [on ` 80,000 @ 10% for 3 months] 2,000 16,153 4. Out of the two machines discarded, one has been sold. The other is expected to realise ` 5,000. It has been shown as machine scrapped. Loss on these machines. ` W.D.V. on 1.4.19 Less: 38,475 Depreciation in 2019 - 20 Value on 31.12.19 2,886 35,589 Less: Amount realised or expected to be realised [ ` 15,000 + ` 5,000] Loss 20,000 15,589 10.32 Financial Accounting: Concepts and Applications Illustration 7 (Depletion Units or Units of Production Method) On 1.1.2018 Mining Corporation Ltd. obtained the lease of a mine for raising mineral ores for 12 years. For this it had to pay ` 4 crore. It was expected that the deposit of ore in the mine would be 25,00,000 tonnes, 80% of which would be raised within the time period of the lease. Depreciation was decided to be provided under the Depletion Unit Method. The working results of Mining Corporation for the first 5 years have been: Year Sales (Tonnes) Closing Stock (Tonnes) 2016 9,000 1,000 2017 21,000 2,000 2018 1,07,000 5,000 2019 2,41,000 4,000 2020 3,07,000 7,000 Show the Lease Account for the first 5 years. WORKING NOTES 1. Cost of Lease ` 4,00,00,000 Estimated Raisings within Lease Period = 80% of 25,00,000 = 20,00,000 tonnes  Depreciation per tonne = 4, 00, 00, 000 = ` 20 20, 00, 000 2. Annual Raisings (tonnes) = Sales (tonnes) + Closing Stock (tonnes) – Opening Stock (tonnes) 2016 9,000 + 1,000 – Nil or 10,000 tonnes 2017 21,000 + 2,000 – 1,000 or 22,000 tonnes 2018 1,07,000 + 5,000 – 2,000 or 1,10,000 tonnes 2019 2,41,000 + 4,000 – 5,000 or 2,40,000 tonnes 2020 3,07,000 + 7,000 – 4,000 or 3,10,000 tonnes 3. Annual Depeciation = Annual Raisings × ` 20 Solution : Books of Mining Corporation Ltd. Mining Lease Account Dr. Date 1.1.16 Particulars Bank Account ` 4,00,00,000 Date Particulars 31.12.16 Depreciation Account [10,000 × ` 20 Balance c/d] 4,00,00,000 1.1.17 Balance b/d 3,98,00,000 31.12.17 Depreciation Account [22,000 × ` 20] 3,98,00,000 Balance b/d 3,93,60,000 31.12.18 Depreciation Account [1,10,000 × ` 20] 3,93,60,000 Balance b/d 3,71,60,000 3,98,00,000 4,40,000 3,93,60,000 22,00,000 3,71,60,000 3,93,60,000 31.12.19 Depreciation Account [2,40,000 × ` 20] Balance c/d 3,71,60,000 2,00,000 3,98,00,000 Balance c/d 1.1.19 ` 4,00,00,000 Balance c/d 1.1.18 Cr. 48,00,000 3,23,60,000 3,71,60,000 Accounting for Property, Plant and Equipment & Depreciation 1.1.20 Balance b/d 3,23,60,000 10.33 31.12.20 Depreciation Account [3,10,000 × ` 20] 62,00,000 Balance c/d 2,61,60,000 3,23,60,000 1.1.21 Balance b/d 3,23,60,000 2,61,60,000 Illustration 8 (Change from diminishing Balance Method to Straight Line Method – Exchange of Asset – Purchase under hire purchase) On 1.1.2020, the Machinery Account of Mama Ltd. consisted of the following machines: Machine No. Date of Purchase Original Cost Written Down Value on 1.1.2020 1 1.1.2016 20,000 12,122 2 1.1.2017 15,000 10,935 3 1.1.2018 10,000 8,100 45,000 32,157 Its Machinery Account for the year ending on 31st December, 2020 was as follows: Dr. Machinery Account Date Particulars ` 1.1.20 Balance b/d 32,157 31.12.20 Bank A/c (for Machine No. 4) Bank A/c Cr. Date Particulars 31.12.20 Depreciation A/c ` 3,216 Balance c/d 48,941 9,000 11,000 52,157 52,157 Additional Information available: 1. Machine No. 4 was purchased under hire purchase. Cash Price of this machine was ` 24,000. Payments were to be made as ` 9,000 down and the balance by two equal instalments of ` 9,000 each payable on 31.12.2021 and on 31.12.2022. 2. Machine No. 5 was purchased in exchange of machine no. 3 whose exchange price was valued at ` 9,000. The balance was paid in cash on the date of its purchase. 3. The company decided that the rate of depreciation be kept at 10% p.a. but that from the end of 2021 it should adopt the Straight Line Method as against Reducing Balance Method followed till 2020 with retrospective effect from 1.1.2016. Show the Machinery Account for the year 2021 and the effects on the Profit & Loss Account for the year ended 31.12.2021. Solution : WORKING NOTES 1. Annual Depreciations on the Machines for 2018 under Straight Line Method Machine No. Original Cost ` Depreciaton @ 10% ` 1 20,000 2,000 2 15,000 1,500 3 — — 4 24,000 2,400 5 [11,000 + 9,000] 2,000 7,900 [(already sold] 10.34 Financial Accounting: Concepts and Applications 2. Short /Excess Depreciation on machines (other than sold up to 31.12.2020) Machine No 1 2 3 4 (2–3) 5 Used for Original Cost W.D.V. on 31.12.20 (90% of value on 1.1. 2020 Depreciation provide so far under Reducing Balance Method Depreciation under Straight Line Method ` ` ` ` 1 2016 to 2020 = 5 years 20,000 90% of 13,122 = 11,810 8,190 10% of 20,000 ×5 = 10,000 2. 2017 to 2020 = 4 years 15,000 90% of 10,935 = 9,842 5,158 10% of 15,000 × 4 = 6,000 3. — — — — — 35,000 21,652 13,348 16,000  Short Depreciation provided = ` 16,000 – ` 13,348 = ` 2,652 3. Profit/Loss on exchange of 3rd Machine ` W.D.Value on 31.12.2020 [90% of 8,100] 7,290 Exchange Price 9,000 Profit on exchange 1,710 4. Payments under Hire Purchase ` H.P. Price [9,000 × 3] 27,000 Exchange Price 24,000 Interests Included 3,000 As the rate of interests is not givin the total interest should be distributed over the two instalments in the ratio of diminishing outstanding balances, that is ` 18,000 : 9,000 or 2 : 1.  Interest included in the instalments : Principal Amount Paid ` Paid on 31.12.2021 2 of ` 3,000 or ` 2,000 3 9,000 – 2,000 = 7,000 Paid on 31.12. 2022 1 of ` 3,000 or ` 1,000 3 9,000 – 1,000 = 8,000 Solution : Books of Mama Ltd. Machinery Account Dr. Date 1.1.21 31.12.21 Particulars ` Cr. ` Date Particulars 48,941 31.12.21 Depreciation A/c 7,900 Profit & Loss A/c (Profit on Exchange) 1,710 31.12.21 Profit & Loss A/c (Short Depreciation Adjusted) 2,652 Bank A/c (Bare Instalment Paid for Machine No.4) 7,000 31.12.21 Balance c/d Balance b/d 57,651 47,099 57,651 Accounting for Property, Plant and Equipment & Depreciation Dr. 10.35 Profit & Loss Account for the year ended 31.12 2021 (includes) ` Particulars Machinery A/c (Short Depreciation) 2,652 Depreciation on Machinery 7,900 Hire Purchase Interest 2,000 Particulars Profit & Loss A/c (Profit on Exchange) Cr. ` 1,710 PROVISION FOR DEPRECIATION ACCOUNTS When ‘provision for depreciation account’ is maintained and therefore, asset account appears at its original cost price, the accounting treatment is different. In such a case, accounting entries are required for following two purposes: (a) to remove the sold or discarded asset from the Asset Account and (b) to remove the accumulated depreciation on the asset sold from the provision for depreciation account. This is achieved as follows: (i) Transfer the accumulated depreciation including the depreciation created at the time of sale or discardment to the Asset Account as under: Provision for Depreciation Account Dr. To Asset Account (ii) With the sale price of the asset, if any Cash/Bank Account Dr. To Asset Account (iii) If the amount of accumulated depreciation plus the sale price is less than the original cost of the asset, the difference is a loss on sale and would be transferred to profit and loss account as : Profit and Loss Account Dr. To Asset Account And if there is a profit i.e., original cost of the asset is less than the accumulated depreciation plus the sale price, the entry would be: Asset Account Dr. To Profit and Loss Account In this manner, the asset account and corresponding accumulated depreciation account would be removed from the ledger and also the Balance Sheet. Example A company acquires a Motor Car on 1 January 2016 at a cost of ` 50,000. Depreciation is recorded on straight line basis at the rate of ` 10,000 p.a. and is credited to provision for depreciation account. Assuming that the— (i) Motor Car is sold for ` 5,000 on 1 July 2020 (ii) Motor Car is sold for ` 6,000 on 1 July 2020 (iii) Motor Car is sold for ` 4,000 on 1 July 2020 10.36 Financial Accounting: Concepts and Applications Answer Case (i) : The first entry is to record the depreciation for the current year upto the date of sale: Depreciation Account Dr. 5,000 To Provision for Depreciation Account 5,000 (Recording of depreciation for 6 months from 1.1.2020 to 30.6.2020) The Provision for Depreciation Account now has a credit balance of ` 45,000 accumulated as follows: ` For 2016 10,000 For 2017 10,000 For 2018 10,000 Cost 50,000 For 2019 10,000 Less : Accumulated Depreciation 45,000 For 2020 5,000 (6 months) The Book value of the Motor car is computed as : ` Book Value at the time of sale 5,000 45,000 The second entry is to transfer the accumulated depreciation to Motor Car Account as follows: Provision for Depreciation Account Dr. 45,000 To Motor Car Account 45,000 (Accumulated depreciation transferred to motor car account) The third entry is to record the sale as under: Cash/Bank Account Dr. 5,000 To Motor Car Account 5,000 There is no profit or loss on sale of machinery. It would be noted that the purpose of the foregoing three entries is to : (i) remove the accumulated depreciation on Motor Car from the Provision for Depreciation Account; (ii) record the receipt of cash and (iii) reduce the asset account in the balance sheet. Case (ii) : The entries to record the depreciation for the current year upto the date of sale and the transfer of accumulated depreciation from ‘Provision for Depreciation Account’ to Motor Car Account are the same as in case (i) and are assumed to have been made. The following entries are made to record the sale: Cash/Bank Account Dr. 6,000 To Motor Car Account 6,000 (Receipt of sale price) Motor Car Account Dr. 1,000 To Profit and Loss Account 1,000 (Gain on sale of motor car [6,000 – 5,000]) Case: (iii): Again the entries to record the depreciation applicable to the year of sale and the transfer of accumulated depreciation from ‘Provision for Depreciation Account’ to the ‘Motor Car Account’ are same as in case (i) and are assumed to have been made. The entries to record the sale are: Cash Account To Motor Car Account (Recording of sale price) Dr. 4,000 4,000 Accounting for Property, Plant and Equipment & Depreciation Profit and Loss Account Dr. 10.37 1,000 To Motor Car Account (Loss on sale of Motor car [5,000 – 4,000]) 1,000 Illustration 9 (Sale of Asset) R. Ltd bought a machinery for ` 30,000 on 1 April, 2018. One more machinery was purchased on 1 October, 2018 costing ` 20,000. On 1 July, 2019, a new machinery for ` 10,000 was added to the existing machinery. On 1 January, 2020, one-third of the machinery which was installed on 1 April, 2018 was sold for ` 3,000. Show the Machinery Account in the books of the company. The rate of depreciation is 10% on reducing balance method. The accounting period ends on 31 December each year. Solution : Dr. Machinery Account Date ` Particulars 2018 Date Cr. ` Particulars 2018 1 April Cash Account 30,000 31 Dec. Depreciation Account 1 Oct. Cash Account 20,000 31 Dec. Balance c/d 2,750 47,250 50,000 2019 50,000 2019 1 Jan. Balance b/d 47,250 31 Dec. Depreciation Account 1 July Cash Account 10,000 31 Dec. Balance c/d 5,225 52,025 57,250 2020 1 Jan. 57,250 2020 Balance b/d 52,025 1 Jan. Bank (Sale Price) 3,000 1 Jan. Profit & Loss Account 5,325 (Loss) 31 Dec. Depreciation Account 31 Dec. Balance c/d 4,370 39,330 52,025 52,025 2021 1 Jan. Balance b/d 39,330 WORKING NOTES ` (i) Depreciation in 2018 On ` 30,000 for 9 months 2,250 On ` 20,000 for 3 months 500 2,750 (ii) Depreciation in 2019 On ` 47,250 ( ` 50,000 – ` 2,750) for one year On ` 10,000 (Machine No.3) for 6 months 4,725 500 5,225 10.38 (iii) Financial Accounting: Concepts and Applications Depreciation in 2020 Total reduced balance on 1 Jan. 2020 52,025 Less: Written down value of 1/3rd of Machinery sold 8,325 ` 10,000 – ( ` 750 + ` 925) 43,700 Depreciation on ` 43,700 at 10% on reducing balance method (iv) 4,370 Loss on Sale of Machine Depreciated value at the time of sale 8,325 Less: Sale Price 3,000 5,325 Illustration 10 (Dismantling Charges) X Company purchased a second hand machinery on 1-2-2018 for ` 50,000; paid 11,000 for its over-hauling and ` 5,000 for its installation which was completed by 31-3-2018. The company provides depreciation on its machinery at 15% on diminishing balance method from the date it was put to use and closes its books on 31st December every year. On 1-10-2019, a repair work was carried out on the machine and ` 5,000 were paid for the same. The machine was sold on 31-10-2020, for a sum of ` 11,000 and an amount of ` 1,000 was paid as dismantling charges. Prepare machinery account from 2018 to 2020. The accounting period ends on 31 December. Solution : Dr. Machinery Account Date ` Particulars 2018 Feb. 1 Bank A/c 50,000 Mar. 31 Bank A/c (` 11,000 + ` 5,000) 16,000 (` 11,000 + ` 5,000) 66,000 2019 Jan. 1 Balance b/d 58,575 Cr. Date Particulars 2018 Depreciation Account Dec. 31 Balance c/d 49,789 Jan. 1 58,575 66,000 2019 Depreciation Account Dec. 31 (15% on ` 58,575) 58,575 Balance b/d 7,425 (15% on ` 66,000 for 9 months) Balance c/d 2020 ` 8,786 49,789 58,575 2020 Depreciation Account Oct. 31 (15% on ` 49,789 for 10 months) 6,223 Bank Account (11,000 – 1,000) 10,000 Profit & Loss Account (Loss) 33,566 49,789 49,789 WORKING NOTES (i) (ii) Repairs cost during the use is not capitalised since it is routine expense and it does not increase the capacity of the machine. Cost of dismantling has been deducted from the sale price for calculating loss on sale of machine. Illustration 11 (Provision for Depreciation) A machine is purchased for ` 1,60,000 on 16-6-2015. The company took delivery on 27-06-2015 incurring ` 2,500 for transportation. The machine was installed on 15-07-2015 spending ` 2,000 for wages and ` 1,000 Accounting for Property, Plant and Equipment & Depreciation 10.39 and consultancy fees. Trial run was conducted on 15-11-2015 spending ` 2,500. The machine was put to use on 1-1-2016. Useful life of the machine was expected to be 5 years and scrap value at the end was expected to be ` 12,000. The firm follows straight line method of depreciation. Show Machinery Account and provision for Depreciation account assuming that machine realised ` l3,000 at the end of 5 years. The accounts being closed on 31st December each year. Dr. Machine Account Cr. 16-06-2015 Cash 1,60,000 27-06-2015 Cash 2,500 15-07-2015 Cash 3,000 15-11-2015 Cash 2,500 01-01-2016 Cost 1,68,000 31-12-2016 Balance c/d 1,68,000 01-01-2017 Balance b/d 1,68,000 31-12-2017 Balance c/d 1,68,000 01-01-2018 Balance b/d 1,68,000 31-12-2018 Balance c/d 1,68,000 01-01-2019 Balance b/d 1,68,000 31-12-2019 Balance c/d 1,68,000 01-01-2020 Balance b/d 1,68,000 31-12-2020 Provision for 31-12-2020 Profit and Loss Depreciation Account 1,000 Account Bank Account 1,69,000 Dr. 1,56,000 13,000 1,69,000 Provision for Depreciation Account ` Cr. ` 31-12-2016 Balance c/d 31,200 31-12-2016 Depreciation Account 31,200 31-12-2017 Balance c/d 62,400 01-01-2017 Balance b/d 31,200 31-12-2017 Depreciation Account 31,200 62,400 31-12-2018 Balance c/d 93,600 62,400 01-01-2018 Balance b/d 62,400 31-12-2018 Depreciation Account 31,200 93,600 31-12-2019 Balance c/d 1,24,800 93,600 01-01-2019 Balance b/d 93,600 31-12-2019 Depreciation Account 31,200 1,24,800 31-12-2020 Machine 1,56,000 Account 1,24,800 01-01-2020 Balance b/d 31-12-2020 Depreciation Account 1,56,000 1,24,800 31,200 1,56,000 Calculation of Annual Depreciation Cost of machine including expenses incurred before the machine is put to use Less : Scrap Value 1,68,000 12,000 Depreciable Cost 1,56,000 Depreciation Per Year on Straight Line Method Basis : 1,56,000 `  5 = 31,200 10.40 Financial Accounting: Concepts and Applications Illustration 12 (Provision Method) X purchased a second-hand machinery on 1-2-2015 for ` 80,000; paid ` 12,000 for its overhauling and ` 8,000 for its installation which was completed by 31-3-2015. The company provides depreciation on its machinery at 20% p.a. on diminishing balance method from the date it was put to use and closes its books on 31 December every year. On 1-10-2016, a repair work was carried out on the machine and ` 5,000 were paid for the same. The machine was sold on 31-10-2017 for a sum of ` 21,000 and an amount of ` 2,000 was paid as dismantling charges. Prepare Machinery Account and Provision for Depreciation on Machinery Account from 2015 to 2017. [B.Com. (Hons.) 2019, Delhi] Solution: Dr. Date Machinery Account Particulars ` 1.2.2015 Bank 80,000 31.3.2015 Bank (Overhauling) 12,000 31.3.2015 Bank (Installation) 8,000 Cr. Date Particulars ` 31.12.2015 Balance c/d 1,00,000 1,00,000 1.1.2016 Balance b/d 1,00,000 1,00,000 31.12.2016 Balance c/d 1,00,000 1,00,000 1.1.2017 Balance b/d 1,00,000 1,00,000 31.10.2017 Bank (Sale) (21,000 – 2000) 19,000 Provision for Depreciation 43,333 Profit & Loss Account (Loss on sale) 37,667 1,00,000 Dr. Date 31.12.2015 1,00,000 Provision for Depreciation Account Particulars ` Balance c/d 15,000 Cr. ` Date Particulars 31.12.2015 Depreciation (1,00,000 × 20% × 15,000 31.12.2016 Balance c/d 32,000 Machinery Account 43,333 (Written off) 1.1.2016 Balance b/d 15,000 31.12.2016 Depreciation [1,00,000 – 15,000) × 20%] 17,000 32,000 1.1.2017 Balance b/d 31.10.2017 Depreciation [1,00,000–32000) × 20% × 43,333 15,000 15,000 32,000 31.10.2017 9 ) 12 32,000 10 ] 12 11,333 43,333 Accounting for Property, Plant and Equipment & Depreciation 10.41 Illustration 13 (Sale of Asset) Kavita purchased a machine for ` 80,000 on 1st April 2015. She charges depreciation on Straight Line Method and closes her books on December 31st every year. The machine has a useful life of 8 years after which it can be sold for ` 8,000. She purchased another machine on May 1st 2016 for ` 45,000 with 5 years useful life and nil residual value. In 2017, the first machine was sold for ` 50,000 on June 30th when a new machine was purchased for ` 30,000 with 3 years useful life and ` 3,000 as residual value. Prepare the machinery account for the 3 years ending December 31, 2017. [B.Com. (Hons.) 2019, Delhi] Solution: Dr. Date 1.04.2015 Machinery Account Particulars ` Bank (M-I) 80,000 Cr. Date Particulars 31.12.2015 Depreciation (9 months) 31.12.2015 Balance c/d ` 6,750 73,250 80,000 1.01.2016 Balance b/d (M - I) 73,250 1.05.2016 Bank (M - II) 48,000 80,000 31.12.2016 31.12.2016 Depreciation: M-I 9,000 M - II (8 months) 6,000 Balance c/d: M-I 64,250 M - II 39,000 1,18,250 1.1.2017 30.6.2017 Balance b/d: 64,250 M - II 39,000 103,250 Bank (M - III) 30,000 31.12.2017 31.12.2017 Bank (Sale M - I) 4,500 Profit & Loss (Loss) 9,750 Depreciation: M - II 9,000 M - III (6 months) 4,500 (ii) Depreciation on Second Machine (M-II) = (iii) Depreciation on Third Machine (M-III) = 13,500 Balance c/d: M - II 30,000 M - III 25,500 WORKING NOTE: = 50,000 Depreciation (M - I) (6 months) 1,33,250 (i) Depreciation on First Machine (M-I) 103,250 1,18,250 30.6.2017 M-I 15,000 80,000  8,000 = ` 9,000 p.a. 8 45,000 = ` 9,000 p.a. 5 30,000  3,000 = ` 9,000 p.a. 3 55,500 1,33,250 10.42 Financial Accounting: Concepts and Applications Illustration 14 (Rectification of Errors) A company provides depreciation on plant and machinery at 20% per annum on reducing balance method. On April 1, 2019, the balance of Plant and Machinery Account was ` 5,00,000. It was discovered in 2019-20 that: (i) ` 25,000 being repairs to machinery incurred on June 30, 2017 had been capitalised. (ii) ` 50,000 being cost of a machine purchased on October 1, 2016 had been treated as ordinary goods. Management wants to correct the mistakes while preparing accounts for the year ending March 31, 2020. A plant that costed ` 40,000 on September 30, 2018 was scrapped and replaced with a modern plant on 31 December, 2019 by spending ` 60,000. Calculate the amount of depreciation for the year ended March 31, 2020. Also prepare machinery account upto March 31, 2020. Solution: WORKING NOTES (1) Calculation of Book value of machine (purchased on October 1, 2016) as on April, 2019 ` Cost of machine on October 1, 2016 treated as revenue item 50,000 Less: Depreciation to be written off from 1.10.2016 to 31.3.2017 [ ` 50,000 × 20/100 × 6/12] Book value on 1.4.2017 Less: Depreciation for 2017-18 [ ` 45,000 × 20/100] Book value on 1.4.2018 Less: Depreciation for 2018-19 [ ` 36,000 × 20/100] Book value or written down value (W.D.V.) on 1.4.2019 5,000 45,000 9,000 36,000 7,200 28,800 (2) Calculation of Book Value of repairs which has been wrongly capitalised as on April 1, 2019 ` Value wrongly capitalised on June 30, 2017 Less: Depreciation from June 30, 2017 to March 31, 2018 [ ` 25,000 × 20/100 × 9/12] 25,000 3,750 21,250 Less: Depreciation for 2018-19 [ ` 21,250 × 20/100] Book value on 1st April, 2019 4,250 17,000 (3) Adjustment for mistake of past year = ` 28,800 (Note–1) – ` 17,000 (Note–2) = ` 11,800. ` 11,800 will be transferred to Profit and Loss Account. (4) Book Value of the plant scrapped ` Book value of Plant Scrapped on Sep. 30, 2018 Less: Depreciation for 2018-19 [ ` 40,000 × 20/100 × 6/12] W.D.V. on 1.4.2019 Less: Depreciation from 1.4.2019 to 31.12.2019 40,000 4,000 36,000 5,400 [ ` 36,000 × 20/100 × 9/12] Book value of the plant scrapped on 31.12.2019 30,600 Accounting for Property, Plant and Equipment & Depreciation 10.43 (5) Depreciation to be charged on March 31, 2020 (excluding depreciation on plant scrapped) ` Book value on 1.4.2019 5,00,000 Add: Adjustment (See Working Note–3) 11,800 5,11,800 Less: W.D.V. on 1.4.2019 of plant scrapped on 31.2.2019 36,000 W.D.V. on 1.4.2019 of Plant & Machinery used from 1.4.19 to 31.03.20 4,75,800 Depreciation on ` 4,75,800 @ 20% W.D.V. 95,160 Depreciation on new machinery 20% of ` 60,000 for 3 months (i.e. ` 60,000 × 20/100 × 3/12) 3,000 98,160 Dr. Machinery Account Date Particulars ` 01-04-19 Balance b/d 5,00,000 31-12-19 Bank A/c 31-03-20 Profit & Loss A/c Date Particulars 31-12-19 Depreciation A/c 60,000 11,800 Cr. ` 5,400 Profit & Loss A/c 31-03-20 (Loss due to plant scrapped) 30,600 Depreciation A/c 98,160 [` 28,800 – 17000] [95, 160 + 3,000] – Adjustment for (Note – 5) mistake of Past Years Balance c/d 4,37,640 [Notes – 1, 2 & 3] 5,71,800 5,71,800 Illustration 15 (Purchased on Hire Purchase Basis – S.L.M.) On 1 July, 2017 Gopal Ltd. purchased second-hand machinery for ` 20,000 and spent ` 3,000 on re-conditioning and installing it. On 1 January, 2018 the firm purchased machinery worth ` 12,000. On 30 June, 2019 the machinery purchased on 1 January, 2018 was sold for ` 8,000. On 1 July, 2019 fresh machinery was purchased on instalment basis, payment for the machinery was to be made as follows: 01 July, 2019 ` 5,000 30 June, 2020 ` 6,000 30 June, 2021 ` 5,500 Payments in 2020 and 2021 include interest of ` 1,000 and ` 500 respectively. The company writes off depreciation @ 10 p.a. on original cost. The accounts are closed every year on 31 March. Show the Machinery Account for three years ending 31 March, 2020. Solution : Dr. Machinery Account ` 2017 1 July Bank Account 20,000 Bank Account 3,000 Bank Account 12,000 2018 1 Jan. ` 2018 31 March Depreciation Account 2,025 (1,725 + 300) 31 March 35,000 Cr. Balance c/d 32,975 35,000 10.44 Financial Accounting: Concepts and Applications 2019 1 April 2019 Balance b/d 32,975 31 March Depreciation Account (2,300 + 1,200) Balance c/d 32,975 2019 3,500 29,475 32,975 2019 1 April To Balance b/d 29,475 1 July Hire Vendor 15,000 30 June Depreciation Account (For 3 months) 300 Bank Account 8,000 Profit and Loss Account (Loss) 2,200 2020 Depreciation (2,300 + 1,125) 3,425 31 March Balance c/d 44,475 30,550 44,475 2020 1 April Balance b/d 30,550 Note: Payment for interest under hire purchase sale is not to be added to the cost of the asset for depreciation purpose because depreciation is charged on cash price. Illustration 16 (Straight Line Method) On 1 January 2017, a machinery was purchased by Farzana for ` 20,000. On 1 July 2018 additions were made to the extent of ` 4,000. On 1 April 2019 further additions were made to the extent of ` 2,560. On 30 June 2020, a machinery, the original value of which was ` 3,200 on 1 January 2017 was sold for ` 2,400. Farzana closes her books on 31 December each year. Show the machinery account for four years from 2017 to 2020 in the books of Farzana, If depreciation is charged at 10% under original cost method. Solution : Dr. 1-1-2017 Bank Account Machinery Account ` 20,000 31-12-2017 Depreciation Account Balance c/d 20,000 1-1-2018 Balance b/d Cr. ` 2,000 18,000 20,000 31-12-2018 18,000 Depreciation Account (2,000 + 200) 2,200 1-7-2018 Bank Account 4,000 Balance c/d 22,000 1-1-2019 Balance b/d 19,800 22,000 31-12-2019 19,800 Depreciation Account (2,000 + 400 + 192) 2,592 1-4-2019 Bank Account 2,560 Balance c/d 22,360 1-1-2020 Balance b/d 22,360 30-6-2020 19,768 30-6-2020 Profit and Loss Account 19,768 Depreciation Account Bank Account 320 (Profit) 31-12-2020 Depreciation Account Balance c/d 20,088 160 2,400 2,336 15,192 20,088 Accounting for Property, Plant and Equipment & Depreciation 10.45 WORKING NOTES (i) Calculation of Depreciation For 2017 10% of ` 20,000 for one year 2,000 For 2018 10% of ` 20,000 for one year 2,000 10% of ` 4,000 for six months 2,00 2,200 For 2018 10% of ` 2,560 for nine months 10% of ` 20,000 for one year 10% of ` 4,000 for one year 192 2,000 400 2,592 For 2020 10% of ` 3,200 for 6 months On the machine sold 10% of ` 16,800 (20,000 – 3,200) for one year 160 1,680 10% of 4,000 for one year 400 10% of 2,560 for one year 256 2,336 (ii) ` Profit on sale of machinery Cost of the machine sold 3,200 Less: Depreciation for 2017 @ 10% (320) Depreciation for 2018 @ 10% (320) Depreciation for 2019 @ 10% (320) Depreciation for 6 months in 2020 (160) Book value on the date of sale Add: Profit on sale (2,400 – 2,080) Sale Price 2,080 320 2,400 Illustration 17 (Diminishing Balance Method) On 1-1-2018, machinery was purchased for ` 75,000 and ` 5,000 were spent immediately on its installation. On 1-7-2019 additions were made to the amount of ` 40,000. On 31-3-2020, machinery purchased on 1-72019, costing ` 12,000 was sold for ` 11,000 and on 30-6-2020 machinery purchased on 1-1-2018 costing ` 32,000 was sold for ` 26,700. On 1-10- 2020, additions were made to the amount of ` 20,000. Depreciation was provided at 10% p.a. on the diminishing value method. Show the machinery account for three years 2018 to 2020 (year ended 31 December). Solution : (i) Calculation of loss on machinery sold on 31-3-2020 Cost of the machine on 1-7-2019 Less: Depreciation for 6 months @ 10% ` 12,000 600 11,400 Less: Depreciation for 3 months @ 10% 285 11,115 Less: Sale price Loss on Sale (ii) Calculation of profit on sale of machinery on 30-6-2020 Cost of the machine on 1-1-2018 Less: Depreciation for 2018 11,000 115 ` 32,000 3,200 28,800 10.46 Financial Accounting: Concepts and Applications Less: Depreciation for 2019 2,880 Less: Depreciation in 2020 25,920 For 6 months on ` 25,920 at 10% 1,296 Book value on the date of sale 24,624 Sale Price 26,700 Less: Book Value 24,624 Profit on Sale (iii) (a) 2,076 Depreciation on 31-12-2020 has been calculated as under: Machinery Purchased on 1-1-2019 80,000 Less Sold on 30-6-2020 (cost) 32,000 Less: Depreciation: 4,800 + 4,320 in 48,000 2018 and 2019 respectively 9,120 Book value on 1-1-2020 38,880 Hence, Depreciation for 2020: 10% of ` 38,880 (b) 3,888 Machinery purchased on 1-7-2019 40,000 Less Sold on 31-3-2020 (cost) 12,000 28,000 Less: Depreciation in 2019 for 6 months 1,400 Book Value on 1-1-2020 26,600 Hence, Depreciation for 2020: 10% of ` 26,600 (c) 2,660 Machinery purchased on 1-10-2020 20,000 Depreciation in 2020 for 3 Months 500 Total Depreciation for 2020 : ` 3,888 + ` 2,660 + ` 500 = ` 7,048 Dr. Machinery Account Date Particulars 2018 Bank Jan. 1 (75,000 + 5,000) ` Date Particulars 80,000 2018 Depreciation Dec. 31 80,000 8,000 72,000 80,000 2019 Jan. 1 Balance b/d 72,000 July 1 Bank 40,000 Dec. 31 Depreciation (7,200 + 2,000) Balance c/d 1,12,000 2020 9,200 1,02,800 1,12,000 2020 Jan 1 Balance b/d June 30 Profit and Loss Account 1,02,800 Mar. 31 2,076 Bank Depreciation Bank (Sale) (Profit on sale) Oct. I ` (10% on ` 80,000) Balance c/d 2019 Cr. Profit and Loss Account 20,000 (Additions) 11,000 115 (Loss on sale) 30 June 31 Dec. 1,24,876 285 Depreciation 1,296 Bank (Sale) 26,700 Depreciation 7,048 Balance c/d 78,432 1,24,876 Accounting for Property, Plant and Equipment & Depreciation 10.47 CHANGE OF METHOD Depreciation is non-cash item and a change in method will not result in either cash inflow or cash outflow. As a matter of fact the depreciation method used should reflect the pattern in which future economic benefits of the assets are expected to be consumed by the enterprise. Depreciation thus, reflects the consumption of future benefits by the enterprise, that is, how much the asset would be used in future period(s). Once a firm selects a certain method and rate of depreciation, the same are used consistently to provide comparison of the results of operations (income or loss) of a business enterprise from period to period. However, sometimes it may be decided to change the existing method of depreciation and/or the rate of depreciation. The reasons may be: (i) When the adoption of new method is required by the statute (i.e. law); or (ii) When the adoption of a new method is required for compliance with an accounting standard (iii) When there is a change in the expected pattern of consumption in future benefits (iv) When it is considered that the change would result in a more appropriate preparation or presentation of the financial statements. The same considerations apply to the change in the rate of depreciation. As per AS-10 PPE, method applied to an asset should be reviewed at least at the end of each financial year and if there has been a significant change in the expected pattern of consumption of the future economic benefits from the asset, the method should be changed to reflected the changed pattern. The change in the method of depreciation should be done with prospective effect. PROSPECTIVE EFFECT It means that new method would be given effect from the current accounting period and the depreciation already charged in the previous years is completely or totally ignored. In simple words, the balance of the written down value of the asset on the date of change would be written off during the remaining useful or working life of the asset by applying new method and rate, as the case may be. It may be noted that after the withdrawal of AS-6: Depreciation Accounting and the introduction of AS-10: Property, Plant and Equipment the position has changed. A corporate must change the method with prospective effect and not with retrospective effect which has become a part of the history. Illustration 18 (Change of method form SLM to WDV) A firm purchased one machine for ` 5,00,000 on 1st January, 2017 with an estimated useful life of 5 years. The firm depreciated the machine on the basis of fixed instalment method. After two years, the firm decided to change the method of depreciation to written down value method and the rate of depreciation being 25% per annum. Prepare the machine account for 2017, 2018, 2019 and 2020; the accounting year being January to December. Solution : Machinery Account Date Particulars ` 2017 Jan. 1 Date Particulars ` 2017 Bank Account 5,00,000 5,00,000 Dec. 31 Depreciation A/c 1,00,000 Balance c/d 4,00,000 5,00,000 10.48 Financial Accounting: Concepts and Applications 2018 2018 Jan. 1 Balance b/d 4,00,000 Dec. 31 Depreciation A/c Balance c/d 4,00,000 2019 1,00,000 3,00,000 4,00,000 2019 Jan.1 Balance b/d 3,00,000 Dec. 31 Depreciation Account Balance c/d 3,00,000 2020 75,000 2,25,000 3,00,000 2020 Jan.1 Balance b/d 2,25,000 Dec. 31 Depreciation Account Balance c/d 2,25,000 56,250 1,68,750 2,25,000 WORKING NOTES (i) (ii) In 2017 and 2018 the depreciation was charged on the original cost of ` 5,00,000. From the year 2019, depreciation has been charged on the written value method as the chage of method and rate of depreciation is to be effective on prospective basis as per the requirement of the question and also according to AS-10: Property, Plant and Equipment. Illustration 19 (Change of Method from SLM to WDV) Goodluck Ltd. purchased on 1 January 2017, certain machinery for ` 1,94,000 and spent ` 6,000 on its erection. On 1 July 2017 additional machinery costing ` 1,00,000 was purchased. On 1 July 2019, the machinery purchased on 1 January 2017 has been auctioned for ` 1,00,000 and on the same date, new machinery was purchased at a cost of ` 1,50,000. Depreciation was provided annually on 31 December at the rate of 10% p.a. on the original cost. No depreciation need be charged during the year of sale of machinery for that part of the year when the machine was used. In 2020, however, the company has changed the method of depreciation to written down value method at the rate of 15% p.a. from the straight line method on the balance as appeared in Machinery Account on 1-1-2020 prospectively. Show the machinery account for the period from 2017 to 2020. Solution : Dr. Date Machinery Account Particulars ` 2017 Jan. 1 July 1 Date Particulars ` 2017 Bank Account 1,94,000 Bank Account 6,000 Bank Account 1,00,000 Dec. 31 Depreciation A/c (20,000 + 5,000) Balance c/d 3,00,000 2018 Jan. 1 Cr. 25,000 2,75,000 3,00,000 2018 Balance b/d 2,75,000 Dec. 31 Depreciation A/c (20,000 + 10,000) Balance c/d 2,75,000 2019 30,000 2,45,000 2,75,000 2019 Jan. 1 Balance b/d 2,45,000 July 1 Bank Account 1,50,000 July 1 Bank Account Profit and Loss Account (Loss on sale of machine) 1,00,000 60,000 Accounting for Property, Plant and Equipment & Depreciation Dec. 31 10.49 Depreciation A/c (10,000 + 7,500) 17,500 Balance c/d 2,17,500 3,95,000 2020 3,95,000 2020 Jan. 1 Balance b/d 2,17,500 Depreciation A/c (15% of ` 2,17,500) Dec. 31 32,625 Balance c/d 1,84,875 2,17,500 2,17,500 Illustration 20 (Change of Method from WDV to SLM) The Plant and Machinery Account of a Company had a debit balance of ` 1,47,390 on April 1, 2019. The company was incorporated in April 2016 and has been following the practice of charging full year's depreciation every year on Diminishing Balance system @ 15% p.a. In 2019 it was, however, decided to change the method from Diminishing Balance to Straight Line with prospective effect and to give effect to the change while preparing the final accounts for the year ending 31st March, 2020, the rate of depreciation remaining same as before. In 2019-20, new machinery was purchased at cost of ` 50,000. All the other machines were acquired in 2016-17. Show the Plant and Machinery Account from 2016-17 to 2019-20 as per the provision of AS-10. [B.Com. (Hons.) Sem. I, 2017 Delhi, Modified] Solution WORKING NOTES Calculation of Cost of Plant and Machinery on 1-4-2016 ` 1-4-2016 Suppose the cost on 1-4-2016 100.000 Less: Depreciation 2016-17 15.000 85.000 Less: Depreciation 2017-18 12.7500 72.2500 Less: Depreciation 2018-19 10.8375 Cost on 1-4-2019 61.4125 Cost on 1-4-2016 : Dr. Date and Particulars 147390  100 = 61.412 ` 2,40,000 Plant and Machinery Account Cr. ` ` 1-4-2016 Bank Account Date and Particulars 31-3-2017 2,40,000 Depreciation Account Balance c/d 2,40,000 1-4-2017 Balance b/d 2,40,000 31-3-2018 2,04,000 Depreciation Account Balance c/d 2,04,000 1-4-2018 Balance b/d 36,000 2,04,000 30,600 1,73,400 2,04,000 31-3-2019 1,73,400 Depreciation Account Balance c/d 1,73,400 26,010 1,47,390 1,73,400 10.50 Financial Accounting: Concepts and Applications 1-4-2019 31-3-2020 Balance b/d 1,47,390 Bank Account Depreciation Account 50,000 15% on 1,47,390 = 22,109 15% on 50,000 = 7,500 Balance c/d 1,97,390 29,609 1,67,781 1,97,390 Depreciation for 2019-2020 Based on AS-10 : Property Plant and Equipment (Prospectively) ` Depreciation would be calculated prospectively as under: Book Value on 1-4-2019 (old machinery) 1,47,390 15   Depreciation at 15% 1, 47,390   100  22,109 Depreciation on New Machine 15% on ` 50,000 7,500 Total Depreciation 29,609 Illustration 21 (Straight Line Method and Change to Depletion Method) Neetu Collieries Limited acquired a lease right for 20 years of a mine on January 1, 2015 on a lump sum payment of ` 5,00,000 to the landlord. It was estimated by the expert that the coal deposit of the mine was 20,00,000 tons; 75 per cent of which could be raised within the time period. The company decided to write off the lease account under straight line method of depreciation. The lease account was shown accordingly for the first five years. On 31 December, 2020 the Board of Directors decided to depreciate the lease on ‘Depletion’ method with retrospective effect i.e., from January 1, 2015. The annual raisings were: 2015 20,000 tons 2016 30,000 tons 2017 1,00,000 tons 2018 2,00,000 tons 2019 2,00,000 tons 2020 2,00,000 tons You are required to show the lease account from 1 January 2015 to 31 December 2020 showing your calculations. Solution : Dr. Lease Account Date Particulars Jan. 1, 2015 Bank Account ` 5,00,000 Cr. Date Particulars Dec. 31, 2015 Depreciation Account Balance c/d 5,00,000 Jan. 1, 2016 Balance b/d 4,75,000 25,000 4,75,000 5,00,000 Dec. 31, 2016 Depreciation Account Balance c/d 4,75,000 ` 25,00 4,50,000 4,75,000 Accounting for Property, Plant and Equipment & Depreciation Jan. 1, 2017 10.51 Dec. 31, 2017 Balance b/d 4,50,000 Depreciation Account Balance c/d 4,50,000 Jan. 1, 2018 25,000 4,25,000 4,50,000 Dec. 31, 2018 Balance b/d 4,25,000 Depreciation Account Balance c/d 4,25,000 Jan. 1, 2019 25,000 4,00,000 4,25,000 Dec. 31, 2019 Balance b/d 4,00,000 Depreciation Account Balance c/d 4,00,000 Jan. 1, 2020 25,000 3,75,000 4,00,000 Dec. 31, 2020 Balance b/d 3,75,000 Depreciation A/c Balance c/d 3,75,000 66,667 3,08,333 3,75,000 WORKING NOTE (i) (ii) Depreciation on Depletion Method = 5, 00, 000 = ` 1 / 3 per ton 15, 00, 000 Depreciation for 2020 on Depletion Method: 2,00,000  3 66,667 Note: Since the method of Depreciation is changed in 2020, the depreciation would be calculated prospectively on this date by Depletion Method or Units of Production Method on 2,00,000 units divided by 3. Illustration 22 (Change in Method from SLM to WDV) The book value of Plant and Machinery on 1-1-2018 was ` 2,00,000. New machinery for ` 10,000 was purchased on 1-10-2018 and for ` 20,000 on 1-7-2019. On 1-4-2020, a machinery whose book value had been ` 30,000 on 1-1-2018 was sold for ` 16,000. Depreciation had been charged at 10% p.a. since 2018 on straight line method. It was decided in 2020 that depreciation at the rate of 20% p.a. on diminishing balance method should be charged with prospective effect. Show Plant and Machinery Account upto 31-12-2020 as per the provisions of AS-10. Give your workings clearly. Solution : Dr. Date Plant and Machinery Account Particulars ` 2018 Date Particulars Cr. ` 2018 Jan. 1 Balance b/d Oct. 1 Cash Account 2,00,000 Dec. 31 10,000 Depreciation Account (20,000 + 250) Balance c/d 2,10,000 2019 20,250 1,89,750 2,10,000 2019 Jan. 1 Balance b/d July 1 Cash Account 1,89,750 20,000 Dec. 31 Depreciation Account (20,000 + 1,000 + 1,000) 22,000 10.52 Financial Accounting: Concepts and Applications Balance c/d 1,87,750 2,09,750 2020 2,09,750 2020 Jan. 1 To Balance b/d 1,87,750 April 1 (1,63,750 + 24,000) Depreciation Account 750 Cash Account 16,000 Profit and Loss Account (Loss) Dec. 31 Depreciation Account (20% of 1,63,750 + 24,000) Balance c/d 32,750 1,31,000 1,87,750 (i) 7,250 1,87,750 ` Calculation of loss on machine sold Cost of the machine 30,000 Less : Depreciation for 2018 and 2019 (3,000 × 2) (6,000) Depreciation for 3 months in 2020 (750) Book value on1-4-2020 23,250 Less : Sale Price 16,000 Loss on Sale 7,250 Illustration 23 (Provision For Depreciation, Sale of Asset and Change in Method) On 1 April, 2016 a new plant was purchased for ` 80,000 and a further sum of ` 4,000 was spent on its installation. On 1 October, 2018 another plant was acquired for ` 50,000. Due to an accident on 31 January, 2019 the first plant was totally destroyed and was sold for ` 2,000 only. On 21.4.2019 a second hand plant was purchased for ` 60,000 and a further sum of ` 10,000 was spent for bringing the same to use on and from 15.5.2019, depreciation has been provided at 10 per cent on straight line basis. It was a practice to provide depreciation for full year on all acquisitions made at anytime during any year and to ignore depreciation on any item sold or disposed off during the year. None of the assets were insured. The accounts are closed annually on 31 March. On 1st April 2016, it was decided to follow the rate of 20 per cent on diminishing balance method with prospective effect in respect of the existing items of plant. Required: (i) Plant Account; (ii) Provision for Depreciation Account upto 31st March, 2020. Solution : Dr. Plant Account ` 2016 1 April Cash Account 1 April Cash Account M1 80,000 Cr. ` 2017 31 March Balance c/d 4,000 84,000 2017 1 April 84,000 84,000 2018 To Balance b/d 84,000 2018 31 March Balance c/d 84,000 2019 1 April Balance b/d 84,000 31 Jan. Cash Account (sale of M1) 1 Oct. Cash Account 50,000 31 March Provision for Depreciation A/c 16,800 Profit & Loss Account (Loss) 65,200 Balance c/d 50,000 1,34,000 2,000 1,34,000 Accounting for Property, Plant and Equipment & Depreciation 2019 10.53 2020 1 April Balance b/d (M2) 50,000 21 April Cash Account 60,000 15 May Cash Account M3 31 March Balance c/d 10,000 1,20,000 Dr. 1,20,000 Provision For Depreciation Account Date 1,20,000 ` Particulars 2017 Date Particulars Cr. ` 2017 31 March Balance c/d 8,400 2018 31 March Depreciation A/c 8,400 Balance b/d 8,400 Depreciation A/c 8,400 2017 31 March Balance c/d 16,800 1 April 2018 31 March 16,800 2019 16,800 2018 31 Jan. Plant Account 31 Mar. Balance c/d 16,800 5,000 1 April Balance b/d 2019 31 March Depreciation A/c 21,800 2020 16,800 5,000 21,800 2019 31 March Balance c/d 28,000 1 April Balance b/d 5,000 2020 31 March Depreciation A/c M2 (20% of 45,000) 9,000 M3 (20% of 70,000) 14,000 28,000 23,000 28,000 ASSETS DISPOSAL (SCRAPPED) ACCOUNT Some accountants are of the view that on sale or disposal of a part of the asset, it is appropriate to introduce a new account called Asset Disposal (Scrapped) Account. If the entries for depreciation have been made in the main asset account itself, the book value of the sold or discarded asset should be transferred to Asset Disposal Account as under: Asset Disposal (or Scrapped) Account Dr. To (Main) Asset Account For Sale of Asset Cash/Bank Account Dr. To Asset Disposal Account For Profit on sale Asset Disposal Account Dr. To Profit and Loss Account For Loss Profit and Loss Account To Asset Disposal Account Dr. 10.54 Financial Accounting: Concepts and Applications Illustration 24 (Asset Disposal Account) One Lathe machine whose original value was ` 1,20,000 on 1.4.2018, being the date of installation, was sold on 30.9.2020 for ` 1 ,00,000. Depreciation is charged @ 10% on reducing balance. Show Machinery account and Assets Disposal account. (Year ending 31 March) Solution : Dr. Machinery Account Date Particulars ` 1.4.18 Balance b/d 1,20,000 Cr. Date Particulars 31.3.19 Depreciation Account ` 12,000 Balance c/d Account 1,08,000 1,20,000 1.4.19 Balance b/d 1,08,000 1,20,000 31.3.20 Depreciation 10,800 Balance c/d 97,200 1,08,000 1.4.20 Balance b/d 97,200 Dr. 1,08,000 31.9.20 Asset Disposal Account 97,200 Asset Disposal Account Date Particulars 30.9.20 Machinery A/c 30.9.20 P & L. Account (Profit) ` Cr. Date Particulars 97,200 30.9.20 Bank 7,660 30.9.20 Depreciation ` 1,00,000 4,860 1,04,860 1,04,860 Illustration 25 (Change of Method, Review of Useful Life and Machinery Disposal Account) Machinery Account of Radhu Company Ltd., showed debit balance of ` 32,400 on 1 January 2020, depreciation being provided at 10% p.a. On 1 July, 2020, a part of the machinery purchased for ` 10,000 on 1 January 2018 was sold for ` 7,000 and on the same date a new machinery which cost ` 20,000 was purchased. On 31 December 2020, the company decided to change the method of depreciation from WDV method to straight line method with prospective effect. On the date of change of method of charging depreciation from WDV to SLM, the management of company has decided to review the estimated life of machine and on experts advise it was observed that first and second machine are expected to be work for a further period of 3 years and 10 years respectively. Show machinery Account and Machinery Disposal Account. (Year ending 31 December) Solution : WORKING NOTES (i) Cost price of machinery in hand on 1 January 2020 is arrived at as under: ` Suppose the original cost on 1.1.2018 is : 100 Less: Depreciation at 10% for 2018 10 Written down value on 1.1.2019 90 Less: Depreciation at l0% for 2019 9 Written down value on 1.1.2020 81 If written down value is ` 81, original cost is: 100 If written down value is ` 1, original cost is: If written down value is ` 32,400, original cost is: 100 /81 100 81 × 32, 400 40,000 Accounting for Property, Plant and Equipment & Depreciation (ii) 10.55 ` Depreciation as per new method (SLM) Machine-I 32,400 Less: Sold out portion (written down value on 1.1.2020) (8,100) 24,300 useful life  3 years  Depreciation would be Machine-II 24,300 = ` 8,100 p.a. for next 3 years. 3 (new purchase) on 1st July, 2020 20,000 useful life  10 years Depreciation = (iii) 20,000 6  = 1,000 10 12 Written down value of machinery transferred to Machinery Disposal Account is arrived at as under: Original Cost 10,000 Less: Depreciation for 2018 1,000 9,000 Less: Depreciation for 2019 900 Written down value as on 1.1.2020 8,100 Less: Depreciation for six months up to 1 July 2020 405 7,695 In the absence of specific instructions, the changed method of depreciation is applicable at the end of the accounting period only. Dr. Date Machinery Account Particulars ` 2020 1 Jan. ` Particulars 2020 Balance b/d 32,400 (24,300 + 8,100) 1 July Date Cr. Cash Account 1 July Machinery Disposal Account 31 Dec. Depreciation: 20,000 31 Dec. 8,100 Machine-I 8,100 Machine-II 1,000 Balance c/d Machine-I 16,200 Machine-II 19,000 52,400 Dr. Date ` 2020 1 July 35,200 52,400 Machinery Disposal Account Particulars 9,100 Date Particulars Cr. ` 2020 Machinery Account 8,100 7,695 1 July Depreciation 1 July Cash Account 31 Dec. Profit and Loss Account (Loss) 405 7,000 695 7,695 10.56 Financial Accounting: Concepts and Applications LOSS BY ACCIDENT AND INSURANCE CLAIM Sometimes the fixed asset may be destroyed by fire or accident and if such asset had been insured against such loss, the firm will file a claim with the insurance company. The normal procedure is that the insurance company first admits the claim and then makes the payment at a later date. The accounting treatment is as under: On admission of claim Insurance Company’s Account Dr. To Asset Account On receipt of money claimed Bank Account Dr. To Insurance Company (i) In case the amount of claim is received immediately, students may make the following entry: Bank Account Dr. To Asset Account (ii) The difference in the book value of the asset on the date of accident and the amount of claim admitted by the insurance company would be transferred to profit and loss account. Illustration 26 (Change of Method from SLM to WDV) Neha Limited purchased a second hand machine on 1 January, 2017 for ` 1,60,000; overhauling charges amounted to ` 40,000. Another machine was purchased on 1 July, 2017 for ` 80,000. On 1 July 2019, the machine installed on 1 January 2017 was sold for ` 1,00,000. On the same date another machine was purchased for ` 30,000 and was installed on 30 September, 2019. Under the existing practice, the company provides depreciation at 10% on original cost. However, from the year 2020, it was decided to adopt written down value method and to charge depreciation at 15% per annum. This change was to be made with retrospective as well as prospective effect. Prepare Machinery Account in the books of Neha Limited from 2017 to 2020. (Year ending on 31 December) Solution : Dr. 1-1-17 In the Books of Neha Ltd. Machinery Account ` Bank Account 1,60,000 Bank Account 40,000 1-7-17 Bank Account 31-12-17 Depreciation Account Balance c/d 31-12-18 2,56,000 Depreciation Account (20,000 + 8,000) 2,56,000 ` 2,28,000 30-9-19 Bank Account 2,56,000 2,80,000 Balance c/d Balance b/d 24,000 80,000 1-1-18 1-1-19 ` (20,000 + 4,000) 2,80,000 Balance b/d Cr. 30,000 28,000 2,28,000 2,56,000 1-7-19 Bank Account ` 1,00,000 Depreciation Account 10,000 Profit and Loss Account (Loss) 50,000 Accounting for Property, Plant and Equipment & Depreciation 10.57 31-12-19 Depreciation Account (8,000 + 750) 8,750 Balance c/d 89,250 2,58,000 2,58,000 ` 1-1-20 Balance b/d ` 31-12-20 89,250 Depreciation Account (15% on ` 89,250) 13,388 Balance c/d 75,862 89,250 89,250 Illustration 27 (Machinery Disposal Account and change of method from WDV to SLM) Ahaan Ltd., which depreciates its machinery at 10% on Diminishing Balance Method, had on 1st April, 2019 ` 9,72,000 to the debit of Machinery Account. During the year 2019-20, the machinery purchased on 1st April, 2017 for ` 80,000 was sold for ` 45,000 on 1st October, 2019 and a new machinery at a cost of ` 1,50,000 was purchased and installed on the same date, installation charges being ` 8,000. The company wants to change its method of depreciation from Diminishing Balance Method to Straight Line Method with effect from 1st April, 2019. During 2019-20, the company decided to change its method of charging depreciation from diminishing balance method to straight line method with prospective effect. At the same time management of company feels to review the estimated remaining useful life of machine and it was assessed that machine will probably work for a further period of 6 years with scrap value of ` 7,200. While new machine purchased on 1.10.2019 will be depreciated at 10% p.a on straight line basis. You are required to prepare Machinery account and Machinery disposal account for the year 2019-20. Solution Dr. Machinery Account Date Particulars ` 1.4.19 Balance b/d 9,72,000 (9,07,200 + 64,800) 1.10.19 Bank A/c (1,50,000 + 8,000) 1,58,000 Cr. Particulars 1.10.19 Machinery Disposal A/c 31.3.20 Depreciation A/c (1,50,000 + 7,900) 1,57,900 31.3.20 Balance c/d (7,57,200 + 1,50,100) 9,07,300 11,30,000 Dr. Particulars 1-10-2019 Machinery Account 64,800 11,30,000 Machinery Disposal Account ` ` Date Particulars Cr. ` 1-10-2019 64,800 Bank Account Depreciation Account (for 6 months) Profit and Loss Account (Loss on Sale) 64,800 45,000 3,240 16,560 64,800 WORKING NOTES Calculation of Loss ` Cost of Machine (1-4-2017) Less: Depreciation (2017-18) 80,000 8,000 72,000 10.58 Financial Accounting: Concepts and Applications Less: Depreciation (2018-19) 7,200 Written down value on 1.4.2019 64,800 Less: Depreciation for 6 months upto 30-9-2019 3,240 61,580 Less: Sale Price 45,000 Loss on Sale 16,560 ` Calculation of Book Value of Machine on 1-4-2019 Cost (1-4-2017) 100 Less: Depreciation (2017-18) 10 90 Less: Depreciation (2018-19) 9 81 Gross Value 9,72, 000 × 100 = 81 12,00,000 Less: Sold (Gross Value) 80,000 11,20,000 Depreciation for 2019-20 Written down value of old machine as on 1.4.2019 9,72,000 Less: Sold out part (value on 1.4.2019) 64,800 Value of old machine in use (remaining) 9,07,200 Depreciation on SLM basis When useful life is estimated at 6 years with scrap value of ` 7,200 = 9,07, 200  7, 200 6 = ` 1,50,000 p.a for next 6 years = 1,58, 000  = ` 7,900 New Machine Cost of machine (1.10.2019) = ` 1,58,000 Depreciation @ 10% p.a on SLM basis 10 6  100 12 Illustration 28 (Change of Method & Revision of useful life from WDV to SLM) A taxi company Duck and Duckling Ltd. was formed on 1 January, 2018. The Company depreciates its cars on account @ 20% on Reducing Balance Method. On 1 Jaunary, 2020 the balance in Cars account was ` 90,00,000. On 1 July, 2020, a car purchased on 1 January, 2018, for ` 8,00,000 was sold for ` 4,00,000. On the same day another car was purchased for ` 20,00,000. During 2020, the company decided to change the method of depreciation to Straight Line method with prospective effect. On the occession of change of method of charging depreciation on cars, management call a team of experts for assessing the expected remaining effective life of old cars (excluding sold out car) and expert committee presented its report in which it was concluded that old cars will run for a further period of 3 years with scrap value of ` 88,000 in all, while new car will be expected to run for 10 years. Prepare Cars Account with proper working notes for the year ending 31st December, 2020 as per Accounting Standard 10. Accounting for Property, Plant and Equipment & Depreciation 10.59 Solution Cars Account Date Particulars ` 1.1.20 Balance b/d 90,00,000 Date Particulars 1.7.20 Bank A/c (84,88,000 + 5,12,000) 1.7.20 ` 4,00,000 Dereciation on car sold @ 20% on Bank A/c 20,00,000 31.12.20 31.12.20 ` 8,00,000 for 6 months 80,000 Profit & Loss A/c (Loss on sale) 32,000 By Depreciation: (I) 28,00,000 (II) 1,00,000 29,00,000 By Balance c/d (I) 56,88,000 (II) 19,00,000 1,10,00,000 75,88,000 1,10,00,000 WORKING NOTES (i) ` Calculation of Loss on car sold Original cost of the car 8,00,000 Less: Depreciation for 2018 @ 20% on WDV 1,60,000 6,40,000 Less: Depreciation for 2019 @ 20% on WDV 1,28,000 Written down value on 1.1.2020 5,12,000 Less: Depreciation upto 1.7.2020 for 6 month on ` 8,00,000 80,000 4,32,000 Sale Price of the car 4,00,000 Loss on sale of car (ii) 32,000 Depreciation Value of Cars on 1.1.2020 90,00,000 Less: Value of sold out car (1.1.2020) [see note (i)] (5,12,000) 84,88,000 Life of old Cars (excluding sold out car) is 3 years with scrap value of ` 88,000 Depreciation = 84, 88, 000  88, 000 3 = ` 28,00,000 each year for 3 years  (20, 00, 000  6 = ` 1,00,000  10   12 Depreciation (New Car) =  Illustration 29 (Change of Method from SLM to WDV) ABC Ltd. purchased on 1 October, 2016, a machinery for ` 4,50,000 and spent ` 10,000 on freight and transit insurance. On 25 December, 2016, it further spent ` 40,000 on its erection. The machinery was put to use on 1-1-2017. On 1 July 2017, it purchased another machinery for ` 1,00,000. During the year 2018, it spent ` 10,000 for repairs on 1-4-2018. However, on 1-4-2019, a part of the machinery, put to use on 1-1-2017 costing ` 2,00,000 was sold for ` 1,50,000. On 1-10-2019 it purchased another machinery for ` 3,00,000. 10.60 Financial Accounting: Concepts and Applications On 1 July, 2020, however, machinery purchased on 1 July, 2017 was sold for ` 65,000. Depreciation was charged by the firm @ 10% p.a. by straight line method. During the year 2020, ABC Ltd. decided to change the method of providing depreciation and adopted the Diminishing balance method of charging depreciation @ 10% p.a. At the time of change management feels there is no need to review the useful life of machine. Prepare Machinery Account as per the provisions of AS 10 upto 31-12-2020. Solution In the books of ABC Ltd. Machinery Account Particulars ` 1-1-2017 Balance b/d 5,00,000 1-7-2017 Particulars ` 31-12-2017 Depreciation: 55,000 (50,000 + 5,000) Bank 1,00,000 Balance c/d (4,50,000 + 95,000) 5,45,000 6,00,000 1-1-2018 6,00,000 31-12-2018 Balance b/d 5,45,000 Depreciation (50,000 + 10,000) 60,000 Balance c/d (4,00,000 + 85,000) 4,85,000 5,45,000 1-1-2019 5,45,000 1-4-2019 Balance b/d 4,85,000 1-10-2019 Bank Account 3,00,000 Bank Account (sale price) 1,50,000 Depreciaton (for 3 months) (i) 5,000 Profit and Loss Account (i) (Loss on sale) 5,000 31-12-2019 Depreciation (ii) (30,000 + 10,000 + 7,500) 47,500 Balance c/d (2,10,000 + 75,000 + 2,92,500) 5,77,500 7,85,000 7,85,000 1-1-2020 1-7-2020 Balance b/d Bank (sale price) M2 M1 2,10,000 M2 75,000 M3 2,92,500 5,77,500 65,000 Depreciation (for 6 months) (iii) M2 5,000 Profit and Loss Account (iii) (Loss on sale) 5,000 31-12-2020 Depreciation M1 21,000 M3 29,250 50,250 Balance c/d M1 1,89,000 M2 2,63,250 5,77,500 5,77,500 WORKING NOTES (i) Cost of machine sale as on 1-1-2017 Less: Depreciation @ 10% for one year (2017) 4,52,250 2,00,000 20,000 1,80,000 Accounting for Property, Plant and Equipment & Depreciation Less: Depreciation10% (2018) 10.61 20,000 Bank value on 1-1-19 1,60,000 Less: Depreciation for 3 months (1.1.19 – 31.3.19 5,000 Bank value on 1-4-2019 1,55,000 Less: Sale Price 1,50,000 Loss on sale 5,000 (ii) Depreciation for 2019 I II Book value of machine on 1-1-2019 4,00,000 85,000 Less: Book value of machine sold on 1-1-2019 1,60,000 — 2,40,000 85,000 30,000 10,000 Depreciation @ 10% on SLM basis on ` 3,00,000 and ` 1,00,000 respectively (iii) Cost of machine sold on 1-7-2020 1,00,000 Less: Depreciation for 2017 @ 10% p.a. for 6 months 5,000 Book value on 1-1-2018 95,000 Less: Depreciation for 2018 @ 10% 10,000 Book value on 1-1-2019 85,000 Less: Depreciation for 2019 10,000 Book value on 1-1-2020 75,000 Less: Depreciation for 6 months @ 10% p.a. 5,000 Book value on 1-7-2020 70,000 Less: Sale Price 65,000 Loss on sale of Machinery 5,000 Illustration 30 (Exchange of Old Machine) On 1st January 2017, Riddhi purchased machine ‘A’ for ` 30,000 and machine 'B' for ` 20,000. On 1st January 2018, she purchased a machine ‘C’ for ` 50,000. On 1st January 2019, machine ‘A’ got out of order and a new machine ‘D’ was purchased costing ` 60,000 after surrendering the old one and paying cash ` 45,000. On 1st January 2020, machine ‘C’ purchased on 1st January 2018, was destroyed by fire and insurance company paid ` 30,000 only. Show the Machine account for 2017, 2018, 2019 and 2020. Charge depreciation @ 10% p.a. on the W.D.V. method. Solution Machines Account Particulars ` 1-1-2017 Bank Account (A) ` 31-12-2017 30,000 1-1-2017 Bank Account (B) Particulars Depreciation 5,000 Balance c/d 45,000 20,000 50,000 1-1-2018 50,000 31-12-2018 Balance b/d 45,000 Depreciation (4,500 + 5,000) Bank Account (C) 50,000 Balance c/d 95,000 9,500 85,500 95,000 10.62 Financial Accounting: Concepts and Applications 1-1-2019 31-12-2019 Balance b/d 85,500 Depreciation Bank Account (D) 45,000 Profit and Loss Account Balance c/d 1,30,500 1-1-2020 12,120 9,300 1,09,080 1,30,500 1-1-2020 Balance b/d 1,09,080 Bank (Insurance Co.) 30,000 Profit and Loss Account 10,500 31-12-2020 Depreciation 6,858 Balance c/d 61,722 1,09,080 1,09,080 WORKING NOTES ` Machine A Cost 30,000 Less: Depreciation (2017) 3,000 27,000 (2018) 2,700 24,300 Less: Exchange Value 15,000 Loss 9,300 Entry: Machine Account Dr. 60,000 Profit and Loss A/c Dr. 9,300 To ‘A’ Machine Account 24,300 To Bank Account 45,000 (Exchange of ‘A’ Machine for Machine ‘D’ for ` 45,000 cash; Loss transferred to Profit and Loss Account) Machine C Cost Less: Depreciation 2018 50,000 5,000 45,000 Less: Depreciation 2019 4,500 40,500 Less: Insurance Claim 30,000 Loss 10,500 Depreciation on Machine B Cost Less: Depreciation 2017 20,000 2,000 18,000 Less: Depreciation 2018 1,800 16,200 Accounting for Property, Plant and Equipment & Depreciation 10.63 Less: Depreciation 2019 1,620 14,580 Less: Depreciation 2020 1,458 Written Down Value 13,122 Depreciation on Machine D Cost 60,000 Less: Depreciation (2019) 6,000 54,000 Depreciation (2020) 5,400 Written Down Value 48,600 Total Depreciation on 31 March 2020 Machine B 1,458 Machine D 5,400 6,858 Total Written Down Value on 31 March 2020 Machine B 13,122 Machine D 48,600 61,722 Illustration 31 [Revaluation Model] Rachit Ltd. bought a machine for ` 50,000 on 1st April, 2016. One more machinery was purchased on 1st October, 2016 costing ` 40,000. The rate of depreciation is 10% p.a. on SLM basis. On 1st April 2018, the management of company feels that there is need to revalue the machines. The first machine was revalued at 20% higher than the book value while second machine was revalued at 10% less than the book value. On 1st October 2019, the first machine became obsolete and sold by incurring a loss of ` 7,000. Any excess depreciation arising on revaluation should be charged to revaluation reserve account as per AS-10. Show the Machinery A/c, Depreciation A/c and Revaluation Reserve A/c from 1st April, 2016 to 31st March, 2020. Solution Books of Rachit Ltd. Machinery Account Dr. ` Date Particulars 1-4-2016 Bank (I) 50,000 1-10-2016 Bank (II) 40,000 Date 31-3-2017 Cr. Particulars Depreciation (5,000 + 2,000) 7,000 Balance c/d (45,000 + 38,000) 83,000 90,000 1-4-2017 Balance b/d (45,000 + 38,000) 83,000 90,000 31-3-2018 Depreciation (5,000 + 4,000) 9,000 Balance c/d (40,000 + 34,000) 74,000 83,000 1-4-2018 Balance b/d (40,000 + 34,000) Revaluation Reserve 74,000 83,000 31-3-2019 4,600 Depreciation 9,460 Balance c/d 69,140 Bank (I) 32,300 78,600 1-4-2019 Balance b/d 69,140 78,600 1-10-2019 [42,200 (I) + 26,940 (II)] Depreciation 2,900 31-3-2020 Profit & Loss (loss) 2,920 31-3-2020 Revaluation Reserve (maximum use) 4,080 31-3-2020 Depreciation (II) 3,660 Balance c/d 69,140 ` 23,280 69,140 10.64 Financial Accounting: Concepts and Applications Dr. Depreciation Account Date Particulars 31-3-2017 Machinery ` 7,000 Cr. Date Particulars 31-3-2017 Profit & Loss 7,000 31-3-2018 Machinery 9,000 Machinery 31-3-2018 Profit & Loss 31-3-2019 Profit & Loss Revaluation Reserve (Excess Depreciation) 9,460 Machinery (I) 2,900 31-3-2020 Machinery (II) 3,660 1-10-2020 By Profit & Loss Revaluation Reserve (Excess Depreciation) Particulars 31-3-2019 Depreciation ` 460 Balance c/d Date Particulars 1-4-2018 Machinery 31-3-2020 Depreciation 31-3-2020 Machinery (loss on sale) 60 1-4-2019 Balance b/d ` 4,600 = 4,140 4,140 ` Calculation of Revaluation Reserve (I) ` 40,000 × 20% = 8,000 (II) ` 34,000 × (10%) = (3,400) Revaluation Reserve 4,600 New Depreciation (I) = (50,000 × 10%) + (8,000 × 10%) = ` 5,800 (II) = (40,000 × 10%) – (3,400 × 10%) = ` 3,660 Total Depreciation (New) = ` 9,460 Excess Depreciation For 2019-20 Cr. 4,080 WORKING NOTES For 2018-19 60 4,600 4,140 (1-4-2018) 6,500 4,140 4,600 Revaluation Effect 460 6,560 Revaluation Reserve Account Date 9,000 9,460 6,560 Dr. 9,000 9,000 9,460 1-10-2019 7,000 7,000 9,000 31-3-2018 ` = New Depreciation – Old Depreciation = ` 9,460 – ` 9,000 = ` 460 = [(`5,800 × = ` 6,560 – ` 6,500 = ` 60 6 ) + ` 3,660] – (`2,500 + `4,000) 12 Accounting for Property, Plant and Equipment & Depreciation 10.65 Illustration 32 [Revaluation Model (AS–10 PPE)] Z Ltd. purchased a machinery for ` 5,00,000 (including a boiler of ` 1,00,000) on 1st April, 2017. The company charges decpreciation on Machinery @10% p.a. on WDV method. On 1st April, 2019, the management decided to revalue the machine and on revaluation, boiler part was assessed at ` 5,000 less than its net book value while remaining part of machine was revalued at 20% higher than the book value. The machine was ultimately sold on 1st April, 2020 for ` 2,70,000. Any excess depreciation arising on revaluation should be adjusted against Revaluation Reserve Account. Required: (i) Machinery Account (ii) Depreciation Account (iii) Revaluation Reserve Account Solution Books of Z Ltd. Machinery Account Dr. Date Particulars 1-4-2017 Bank ` Machine 4,00,000 Boiler 1,00,000 Cr. Date Particulars 31-3-2018 Depreciation 5,00,000 ` M 40,000 B 10,000 50,000 Balance c/d M 3,60,000 B 90,000 5,00,000 1-4-2018 Balance b/d 5,00,000 31-3-2019 M 3,60,000 B 90,000 4,50,000 4,50,000 Depreciation M 36,000 B 9,000 45,000 Balance c/d M 3,24,000 B 81,000 4,50,000 1-4-2019 1-4-2019 Balance b/d M 3,24,000 B 81,000 Revaluation Reserve 4,50,000 31-3-2020 Depreciation 31-3-2020 Balance c/d Balance b/d 46,480 4,18,320 4,05,000 59,800 4,64,800 1-4-2020 4,05,000 4,18,320 4,18,320 4,64,800 1-4-2020 Bank (sale) 2,70,000 Revaluation Reserve (loss) 53,820 Profit & Loss (loss) 94,500 4,18,320 10.66 Financial Accounting: Concepts and Applications Dr. Depreciation Account Date Particulars 31-3-2018 Machinery ` 50,000 Cr. Date Particulars 31-3-2018 Profit & Loss ` 50,000 50,000 31-3-2019 Machinery 45,000 50,000 31-3-2019 Profit & Loss 45,000 45,000 31-3-2020 Machinery 46,480 45,000 31-3-2020 Profit & Loss 40,500 Revaluation Reserve (Excess Depreciation) 5,980 46,480 Dr. 46,480 Revaluation Reserve Account ` Date Particulars 31-3-2020 Depreciation 5,980 Balance c/d 53,820 Date Particulars 1-4-2019 Machinery Cr. ` 59,800 59,800 1-4-2020 Machinery (loss on sale) 53,820 59,800 1-4-2020 Balance b/d 53,820 53,820 53,820 WORKING NOTES ` Calculation of Revaluation Reserve Revaluation Effect : (1-4-2019) = Machine ` 3,24,000 × 20% Boiler Revaluation Reserve New Depreciation for (2019-20) = (4,05,000 + 59,800) × 10% Excess Depreciation = New Depreciation – Old Depreciation = ` 46,480 – ` 40,500 = ` 5,980 = 64,800 = (5,000) 59,800 = ` 46,480 Accounting for Property, Plant and Equipment & Depreciation 10.67 Assignments THEORY BASE ASSIGNMENTS 1. 2. 3. 4. What is depreciation ? Why is it needed ? [B.Com. (Hons.) Delhi 1988] Define Depreciation, Depletion and Amortization. [B.Com. (Hons.) Delhi 1989] Explain the nature and need for depreciation. [B.Com. (Hons.) Delhi 1994, 2005] Distinguish between Straight Line Method and Diminishing Balance Method of providing depreciation. [B.Com. (Hons.) Delhi 1997] 5. Explain the disclosure requirement of Accounting Standard - 10 PPE regarding depreciation. 6. Depreciation accounting is a process of allocation and not of valuation. Explain. [B.Com. (Hons.) Delhi Sem.- II, 2011] 7. Define depreciation, depletion, fluctuation, obsolescence and amortization. [B.Com. (Hons.) Delhi 2000] 8. Accumulated depreciation is a sum of cash being accumulated for the replacement of fixed assets. Explain the statement giving reasons [B.Com. (Hons.) Delhi 2001] 9. Specify causes of depreciation. [B.Com. (Hons.) Delhi 2007] 10. Define depreciation. What are the contributory factors for decline in fixed assets? [B.Com. (Hons.) Delhi 2010] 11. Explain: (i) The depreciable cost and (ii) Two reasons for charging depreciation on tangible fixed assets. [B.Com. (Hons.) Delhi 2015] PRACTICAL ASSIGNMENTS 1. (General) Calculate the amount of annual depreciation for three years by : (a) Reducing Balance Method and (b) Straight Line Method (i) Cost of Machinery–` 2,00,000;(ii) Expected Life : 3 Years; (iii) Rate of depreciation : 33 1 3 %;(iv) Scrap Value–` 20,000. 2. (General) X purchased a second-hand machinery on 1.2.2018 for ` 50,000; paid ` 11,000 for its overhauling and ` 5,000 for its installation which was completed by 31.3.2018. The company provides depreciation on its machinery at 15% p.a. on diminishing balance method from the date it was put to use and closes its books on 31 December every year. On 1.10.2019, a repair work was carried out on the machine and ` 5,000 were paid for the same. The machine was sold on 31.10.2020 for a sum of ` 11,000 and an amount of ` 1,000 was paid as dismantling charges. Prepare Machinery Account from 2018 to 2020. [B. Com. (Hons.) Delhi] 3. (General) A transport company purchases 5 Trucks at ` 2,00,000 each on 1 April 2018. The company writes off depreciation @ 20% per annum on original cost and observes calendar year as its accounting year. On 1 October 2020 one of the trucks is involved in an accident and is completely destroyed. Insurance company pays ` 90,000 in full settlement of the claim. On the same day the company purchases a truck for ` 1,00,000 and spends ` 20,000 on its overhauling. Prepare Truck Account for three years ending on 31 December 2020. [B. Com. (Hons.) Delhi] 10.68 Financial Accounting: Concepts and Applications 4. (General) On 1 January 2019 the balance in plant and machinery account was ` 9,00,000 (including ` 1,00,000 which was purchased on 1 January 2018). On 30 January 2019 additional plant was purchased for ` 1,00,000. On 31 December 2019 part of the plant which had cost ` 20,000 on 1 January 2018 was sold for ` 21,000. On 31 December 2019, again a part of the plant was sold for ` 40,000. This was purchased on 1 January 2018 for ` 60,000. Prepare plant and machinery account for two years, that is 2019 and 2020 by providing depreciation at 10% p.a. assuming reducing balance method. [B. Com. (Mumbai University) Adapted] 5. (Change of Method from WDV to SLM) Deva Ltd. charged depreciation on its plant and machinery @ 10% per annum on the diminishing balance method. On 31 March, 2019, the company decided to adopt straight line method of charging depreciation with prospective effect as per AS-10. At the time of change of charging method of depreciation, it was decided by management to review the useful life of Machines and after review, it was found that old machine is expected to run for a further period of 5 years with scrap value of ` 5,990, while new is expected to work for 10 years. On 1 April, 2018, the plant and machinery account stood in the books at ` 2,91,600. On 1 July, 2018 a sum of ` 65,000 was realised by selling a machine cost of which on 1 April, 2016 was ` 90,000. On 1 January, 2019, a new machine was acquired at a cost of ` 1,50,000. Show the plant and machinery account in the books of company for the year ending 31 March, 2020. 6. (Change of Method from WDV to SLM) Hanuman Enterprises purchased on 1.4.2017 certain machinery for ` 72,800 and paid ` 2,200 on its installation. On 1.10.2017 another machinery for ` 25,000 was acquired. On 1.4.2018, the first machinery was sold at ` 50,000 and on the same date a fresh machinery was purchased at a cost of ` 45,000. Depreciation was annually provided on 31 March @10% p.a. on written down value. On 1.4.2019 however, the firm decided to change the method of providing depreciation and adopted the method of providing depreciation on the original cost with prospective effect. On the occasion of change of method the useful life of machines were reviewed and it was found that the Machine which was purchased on 1.10.2017 will expected to run for a further period of 4 years while other machine purchased on 1.4.2018 will expected to run for a further period of 8 years. The scrap value of these machines were estimated at ` 1,375 and ` 500 respectively. Ascertain the value of machinery as on 31.3.2020. 7. (Change of Method from WDV to SLM) Chandrika Ltd. which depreciate its machinery at 10% on diminishing balance method had on 1 January 2020 ` 19,72,000 to the debit of machinery account. During the year 2020, part of the machinery purchased on 1 January 2018 for ` 10,80,000 was sold for ` 10,45,000 on 1 July 2020 and a new machinery at a cost of ` 11,50,000 was purchased and installed on the same date, installation charges being ` 80,000. During 2019-20, the company decided to change its method of charging depreciation from diminishing balance method to straight line method and further decided to review the useful life of Machine. On review, it was found that machine having book value on 1.1.2020 ` 10,97,200 (excluding sold our portion) will run for a further period of 6 years with a scrap value of ` 1,97,200 and on the other hand new machine purchased on 1.7.2020 will expected to run for 10 years with a scrap value of ` 30,000. Show the Machinery Account and ascertain the amount chargeable to Profit and Loss Account and depreciation or obsolescence loss in the year. 8. (Change of Method from SLM to WDV) A purchased on 1 January, 2017 certain machinery for ` 1,94,000 and spent ` 6,000 on its erection. On 1 July, 2017 additional machinery costing ` 1,00,000 was purchased. On 1 July, 2019, the machinery purchased on 1 January, 2017 having become obsolete was auctioned for ` 1,00,000 and on the same date new machinery was purchased at a cost of ` 1,50,000. Depreciation was provided for annually on 31 December at the rate of 10% per annum on the original cost of the machinery. No depreciation need be provided when a machinery is sold or auctioned, for that part of the year in which sale or auction took place. But for the above, depreciation shall be provided on time basis. In 2020, however, A changed this method of providing depreciation and adopted the method of writing off 15% p.a. on the written down value on the balance as appeared in machinery account on 1.1.2020. Show the machinery account for the calendar years 2017 to 2020. [C.A. (Foundation) May 1997 Adapted] Accounting for Property, Plant and Equipment & Depreciation 10.69 9. (Change of Method from WDV to SLM) Ahaan Ltd., which depreciates its machinery at 10% on Diminishing Balance Method, had on 1st April, 2019 ` 9,72,000 to the debit of Machinery Account. During the year 2019-20, the machinery purchased on 1st April, 2017 for ` 80,000 was sold for ` 45,000 on 1st October, 2019 and a new machinery at a cost of ` 1,50,000 was purchased and installed on the same date, installation charges being ` 8,000. The company wants to change its method of depreciation from Diminishing Balance Method to Straight Line Method with effect from 1st April, 2019. During 2019-20, the company decided to change in method of charging depreciation from diminishing balance method to straight line method with prospective effect. At the same time management of company feels to review the estimated remaining useful life of machine and it was assessed that machine will probably work for a further period of 6 years with scrap value of ` 7,200. While new machine purchased on 1.10.2019 will be depreciated at 10% p.a on straight line basis. You are required to prepare Machinery account and Machinery disposal account for the year 2019-20. 10. (Change of Method from SLM to WDV) A firm purchased. on 1 January, 2016, certain machinery for ` 19,40,000 and spent ` 60,000 on its erection. On 1 July in the same year additional machinery costing ` 10,00,000 was acquired. On 1 July, 2018 the machinery purchased on 1 January, 2016 having become obsolete was auctioned for ` 8,00,000 and on the same date fresh machine was purchased at a cost of ` 15,00,000. Depreciation was provided for annually on 31 December at the rate of 10% per annum on the original cost of the asset. In 2019 however, the firm changed this method of providing depreciation and adopted the method of writing off 20% on the written down value. There is no need to review the useful life of machinery. Give the Machinery Account as it would stand at the end of each year from 2016 to 2020. [C.A. (Foundation)] 11. (Change of Method from SLM to WDV) Green Channel Co. purchased a second hand machine on 1 January, 2017 for ` 1,60,000. Overhauling and erection charges amounted to ` 40,000. Another machine was purchased for ` 80,000 on 1 July, 2017. On 1 July, 2019, the machinery installed on 1 January, 2017 was sold for ` 1,00,000. On the same date another machine was purchased for ` 30,000 and was installed on 30 September 2019. Under the existing practice the company provides depreciation @ 10% p.a. on original cost. However, from the year 2020 it decided to adopt WDV method and to charge depreciation @ 15% p.a. This change was to be made with prospective effect and management do not want to review the useful life of machine. Prepare Machinery Account in the books of Green Channel Co. for the years 2017 to 2020. [PE (Examination I)] 12. (Typical) A firm writes off depreciation 95% of the cost of machinery acquired over a period of 10 years by straight line method leaving 5% as estimated scrap value. Full depreciation is written off even if the machinery is in use only for a part of the year. On 31 December 2019, the original cost of machinery in use was as follows : ` Purchased in 2009 or earlier 1,20,000 Purchased in 2011 40,000 Purchased in 2015 30,000 On 30 June 2020 a machine which had cost ` 10,000 in 2008, was disposed off for ` 900 and on 30 November 2020 a machine acquired in 2015 at a cost of ` 15,000 was sold for ` 5,000. On the same date new machinery was acquired for ` 45,000. Prepare machinery account for 2020 the accounts being closed on 31 December each year. 13. [Revaluation Model/Fair Value Method] X Ltd. purchased a machinery for ` 36,00,000 on 1st April, 2014. The life of machine is ten years and it is to be depreciated on straight line basis. 10.70 Financial Accounting: Concepts and Applications The machine was revalued on 1st April, 2016. When half of the machine was assessed at 10% less than the book value and the remaining part was valued at 15% higher than the book value. The machine was ultimately sold on 1st April, 2018 for ` 21,90,000. Excess depreciation on revaluation, if any, should be charge to the revaluation reserve account. Show Machinery A/c, Depreciation A/c and Revaluation Reserve A/c for the above period. 14. [Revaluation Model – AS 10 (PPE)] Vanshika Ltd. purchased fixed assets for ` 4,00,000 on 1st October, 2013. It is the policy of company to charge depreciation @10% p.a. on Written Down Value Method. It was decided by the management to revalue the assets on 1st April, 2015, when 60% of the assets were revalued at 15% higher than the book value and remaining part revalued at 10% less than the book value. On 1st October, 2016, the assets were disposed off for ` 2,10,000. Excess decpreciation on revaluation, if any, should be adjusted against revaluation reserve account. Prepare Fixed Assets A/c, Depreciation A/c and Revaluation Reserve A/c ANSWERS GUIDE 1. Depreciation under Reducing Balance Method : First Year– ` 66,667; Second Year– ` 44,444; Third Year– ` 29,630 Depreciation Under Straight Line Method : ` 60,000 per year. Hints: (i) Under diminishing balance method, scrap value is not deducted while applying the rate of depreciation. (ii) Under straight line method, the rate of depreciation is applied to depreciable cost, i.e. cost – scrap value 1 3 which is in this case 2,00,000 – 20,000 = 1,80,000. Accordingly 33 % of ` 1,80,000 = ` 60,000, the 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. yearly depreciation. Loss on sale–` 33,566. Hints: (i) Repair cost is not to be capitalised since there is no improvement in the capacity of the machine. (ii) Cost of dismantling is to be deducted from the sale price for ascertaining the profit or loss on the disposal or sale of machine. Loss on the truck destroyed ` 10,000. Balance in the Truck Account ` 4,74,000. Profit on sale of first machinery–` 4,800; Loss on sale of second machine–` 8,600 Balance in Plant and Machinery Account–7,52,430 (App.). Loss on sale of machine– ` 1,970; Depreciation on 31 March 2020 for 2019–2020– ` 47,750 (44,000 + 3,750); Balance at the end– ` 3,28,240. Depreciation for 2019–2020– ` 10,000 (5,000 + 5,000); Balance in the machinery account on 31 March 2020– ` 51,875; Loss on sale of machinery–` 17,500. Profit on sale ` 2,13,940; Balance in Machinery Account–` 21,17,200. Balance in Machinery Account on 31 December 2020– ` 1,84,875; Loss on sale of machinery– ` 60,000. Depreciation for 2020– ` 32,625. Loss on sale–16,560; Balance in Machinery Account 9,07,300. Value of machinery as on 31.12.2020 ` 12,32,640 (3,68,640 + 8,64,000) Value of machinery as on 31.12.2020 ` 75,862. Balance in Machinery Account on 31 December 2020 – ` 54,675. Loss – ` 1,450, Profit– ` 400 Loss on sale of machinery (adjusted against revaluation reserve): ` 24,000; Amount transfer to General reserve: ` 30,000; Excess depreciation p.a.: ` 9,000. Loss on sale of machinery (adjusted against revaluation reserve): ` 14,620; Loss adjusted against profit and loss account: ` 82,410; Excess depreciation (2015-16): ` 1,710; (2016-17): ` 770. 11 I nve ntorie s :AS 2 MEANING OF INVENTORY The terms ‘inventory’ or ‘merchandise’ or 'stock-in-trade' means a complete list of goods that a business has for sale at a given time. But in accounting, the inventory (or inventories) includes even those goods that are in various stages of production, that is, work-in-process or work-in-progress. According to Accounting Standard (AS)-2 (Revised), issued by ICAI, Inventories are assets : (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories include goods purchased and held for resale, for example, merchandise (goods) purchased by a retailer and held for resale, computer software held for resale or land and other property held for resale. Inventories also include finished goods produced or work-in-progress being produced by the enterprises and include materials, maintenance supplies, consumable and loose tools awaiting use in the production process. The types of inventories are related to the nature of the business. The inventories of a trading concern consist primarily of products purchased for resale in their existing form. It may also have an inventory of supplies such as wrapping paper, cartons, and stationery. The inventories of a manufacturing concern consist of several types of inventories : raw materials (which will become part of goods to be produced); parts and factory supplies; work-in-process (partially completed products in the factory) and, of course, finished products. Tools are inventory in the hands of a tool manufacturer or hardware store but not in the hands of a carpenter. Marketable securities are inventories in the hands of a stock broker or a dealer but not in the hands of a manufacturer or retailers. Inventory items are purchased and sold regularly in a trading concern or purchased, put into production, converted into a finished product and sold in a manufacturing business. However, inventories do not include machinery spares which can be used only in connection with an item of fixed assets and whose use is expected to be irregular; such machinery spares are accounted for in accordance with Accounting Standard-10 (Revised) : Property, Plant and Equipment. OBJECTIVES OF INVENTORY VALUATION Inventory is generally the largest of the current assets held by a trading or manufacturing enterprise. In some cases it may account for 75% or even more of the total current assets. It is widely recognised that the major asset that affects efficiency of operations is inventory. Both, excess of inventory and its shortage affects the productive activity, and the profitability of the enterprise whether it is manufacturing, trading or service business. Unwise investment in inventories in the first instance and its proper valuation later on also affects the liquidity of the firm and hampers the cash flow management. Thus, the significance of inventory valuation arises from more than one reason as explained in the subsequent paragraphs. Effect on Liquidity : Short-term creditors are interested in the liquidity position of the business enterprise and the general test for liquidity is the aggregated amount of current assets in relation to current liabilities. The proper valuation of inventories which constitute a major proportion of current assets is essential so that this item of current asset is not overstated so as to misstate liquid position of the business. 11.2 Financial Accounting: Concepts and Applications Effect on income statement : The proper determination of income depends on the proper valuation of all assets–fixed and current. Since inventories are generally large and fluctuating in amount, the net income is influenced by the allocation of cost of fixed assets (i.e., depreciation accounting) and valuation method used in determining the ending inventory. Income is affected because an error in inventory valuation will affect the major elements of the income statement such as cost of goods sold, gross profit and ultimatley the net income. The gross profit is directly affected by the stock valuation. The gross profit is the excess of sales revenue over the cost of goods sold. And if the ending inventory is overvalued, gross profit is overstated and an undervaluation of ending inventory understates the gross profit earned. The reason is to be found in the following relationship: Cost of Goods Sold = Opening Stock + Purchases – Closing Stock + Direct Expenses. Thus, higher the amount of ending inventory, the lower the cost of the goods sold and vice versa. Cost of goods sold ultimately affects the gross profit. It is important to note that the ending inventory for one year is also the beginning inventory (or opening stock) of the next accounting period. Any error in ending inventory, therefore, produces an identical error in the opening inventory of the next accounting period. Therefore, the income statement of the second year will also be affected to the full extent of the inventory error made in year one. The resulting overstatement of beginning inventory, because ending inventory of last year was overstated, will result in an understatement of net income in that year. This counter balancing effect of an error in inventory valuation will result in a correct total net income for the two-years period. But it will definitely fail to produce correct income for the individual accounting periods respectively. The effect of any over-or understatement of inventory may be summarised as follows : When ending inventory is overstated, net income for the accounting period will be overstated. When beginning inventory is overstated, net income for the accounting period will be understated. When ending inventory is understated, net income for the accounting period will be understated. When beginning inventory is understated, net income for the accounting period will be overstated. The effect of misstatement of inventory figure on the net income is always through cost of goods sold and gross profit. Effect on balance sheet : As inventory is generally the largest of the current assets owned by a business entity, an error in the valuation of inventories may cause a misrepresentation of its financial position. The balance sheet will not give a true and fair view of the affairs of the business. An under-or-overstatment of stock will result in other mistake in the balance sheet such as the total current assets, total assets, owner(s)’ equity and, the total of liabilities and owner(s)' equity. ACCOUNTING STANDARD (AS)-2 (REVISED) The Institute of Chartered Accountants of India had revised Accounting Standard (AS) – 2 : Valuation of Inventories in March 2016. The revised standard supersedes AS-2 issued in July 1999, and AS – 2 (Revised) comes into effect in respect of accounting period commencing on or after 1 April 2016 and it is mandatory in nature. It is claimed that the revised AS-2 would bring Indian accounting practices relating to inventory valuation at par with best international practices. The standard begins with the definitions of inventories and net realisable value. Inventories are defined as assets (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories : AS - 2 11.3 Inventories are then classified as : (i) goods purchased and held for resale e.g. merchandise, computer software or land and other property held for resale or (ii) finished goods produced or (iii) work-in-progress being produced by the enterprise and include materials, maintenance supplies, consumables and loose tools to be used in the production process. Net releasable value is defined as the estimated selling price in the ordinary course of the business less the estimated costs of completion and estimated costs necessary to make the sale. The standard provides that the acceptable basis for inventory valuation or measurement of inventories is cost or net realisable value whichever is lower or less. Cost: The cost impliedly means historical cost and comprises (i) all costs of purchase, (ii) costs of conversion and (iii) other costs incurred to bring the inventories to their present location and condition. Interest and other borrowing costs are usually not related to bringing the inventories to their present location and condition and hence, usually not included in the cost of inventories. The following costs are expenses and are excluded from the costs of inventories : (i) abnormal amounts of wasted materials, labour or other production costs; (ii) storage costs; (iii) administrative overheads that do not contribute to bringing the inventories to their present location and condition and selling and distribution costs. Cost formulas : AS-2 (Revised) then mentions various formulas for determining the historical cost such as (i) Specific identification of cost, (ii) First-in-First-out (FIFO) and (iii) Weighted average cost. The standard emphasises that the formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. Techniques for the measurement of costs : Standard cost method or the retail method may be used for convenience if the results approximate the actual cost. Inventory valuation below cost : Net realisable value should be used for inventories that are damaged or they have become wholly or partially obsolete or if their selling price has declined. Estimates of net realisable value must be based on the most reliable evidence available at the time the estimates are made as to the amount of inventories are expected to realise. However, materials 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 used are expected to be sold at or above cost. But when there has been a decline in the price of the materials and it is estimated that the cost of the finished products will exceed net realisable value, the materials are written down to net realisable value. In such cases, the replacement cost of materials may be the best available measure of their net realisable value. When an enterprise purchases the inventories in instalments, the difference between the purchase price for normal credit terms and amount paid is to be treated as interest expense over the period of financing as the procedure or arrangement consists of financial element (Amendment in As-2). Nature of the standard : AS – 2 (Revised) is mandatory in nature. It implies that it is the duty of the auditor to examine whether this accounting standard is complied with in the presentation of financial statements 11.4 Financial Accounting: Concepts and Applications covered by their audit. In the event of any deviation from this accounting standard, it will be their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviations. Disclosure requirements : The financial statements should disclose : (a) the accounting policies adopted in measuring inventories, including cost formula used and (b) the total carrying amount of inventories and its classification appropriate to the enterprise. Common classifications of inventories are raw materials components, work-in-progress, finished goods, stores and spares and loose tools. Non-applicability : This standard does not apply to or does not include following items of inventory : (a) work-in-progress arising under construction contracts including directly related service contracts (See AS-7 : Accounting for Construction Contracts); (b) work-in-progress arising in the ordinary course of business of service providers; (c) shares, debentures and other financial instruments held as stock-in-trade; (d) producers’s inventories of livestock, agriculture and forest products and mineral oils, ores and gases to the extent they are measured at net realisable value. OBJECTIVE AND SCOPE OF IND. AS-2 The standard lays down the accounting treatment of inventories. The main issue relating to the accounting for inventories is the determination of cost to be recognised as asset until related revenue is recognised. The standard also provides guidance on cost formula used to assign cost. Ind.AS (IAS)-2 applies to all inventories except the following: (i) Work-in-progress arising from construction contracts. (ii) Financial instruments (Refer to Ind.AS 32) and Ind.AS 109: Financial Instruments : Presentation (iii) Biological assets relating to agricultural activity and agricultural produce at the point of harvest (Ind.AS 41 : Agriculture) (iv) Producers of agricultural and forest products, agricultural produce after harvest and minerals and mineral products measured at net realisable value in accordence with well-establised practices followed in the industries. (v) Commodity Broker-traders who measure Inventories at Fair Value less cost to sell. The reason is that when Inventories are measured at fair value less costs to sell, changes in fair value less cost to sell are automatically recognised in the income statement (Profit and Loss Statement) in the year of change. DEFINITIONS (i) Inventories are assets that are: • held for sale in ordinary course of business • in the process of production for such sale • in the form of materials or supplies to be consumad or used in the production process or in rendering or provision of services. (ii) Fair value: The price that would be received on sale of an asset or a liability extinguisted (or paid to transfer a liability) in an orderly transaction between willing independent traders (or market participants) at measurement date. Inventories : AS - 2 11.5 (iii) Net realisable value: Net realisable value is the estimated selling price (or net amount that an entity expects to realise from sale of inventories) in ordinary course of business less costs of completion and costs (estimated) of sale. Notes: (i) Net realisable value relies on specific business of the firm (ii) Net realisable value may not be related to market price when the firm is supplying goods to clients at contract prices (iii) Fair value is concerned with the market rather than to individual contract. MEASUREMENT Inventories are measured at the lower of cost and net realisable value. COST OF INVENTORIES The cost of inventories includes all costs of production or purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of purchase : The costs of purchase include purchase price plus non recoverable taxes and duties (Import) plus transport and handling costs and other directly attributable costs minus trade discount and rebates Costs of Conversion : It includes costs such as direct labour costs, allocation of fixed and variable production overheads incurred in converting materials into finished goods. Other costs are costs that are incurred to bring inventories to present condition and location. These include inward transportation and storage prior to completion of production and specific design work required for a special client. Borrowing costs can be included in cost of inventories if goods are bought on instalment basis and price includes a financing element. Financing element is an interest expense over the period of credit. COST FORMULAS The cost of inventories should be measured as follows: (a) for interchangeable itam: (i) FIFO (First-in-first-out) (ii) Weighted Average Cost Method (b) For non-interchangeable item Use Specific Identification Method Notes : Use of LIFO (Last-in-first-out) is not allowed. COSTS NOT INCLUDED The following elements of cost are not included in the calculation of cost of inventory: (i) Administrative overheads (ii) Storage costs unless these are necessary in the productive process before the finished product stage (iii) Abnormal waste (iv) Selling and marketing costs 11.6 Financial Accounting: Concepts and Applications RECOGNITION AS AN EXPENSE When inventories are sold, the carrying amount of these inventories shall be recognised as an expense in the period in which the related revenue is recognised. DISCLOSURE The financial statements shall disclose the following information: (i) Accounting policies adopted in measuring inventories including the cost formula used (ii) Total carrying amount of inventories and classification of carrying amount (iii) The carrying amount of inventory carried at fair value less costs to sell (iv) Amount of inventories recognised as expense in the accounting period. (v) Amount of any written down of inventories recognised as an expense in the accounting period (vi) Amount of any reversal of any write down that is recognised as a reduction in the amount of inventories recognised as an expense and circumstances that led to reversal of write down (vii) Carrying amount of inventories pledged as security for liabilities. INVENTORY SYSTEMS There are two principal systems of determining the physical quantities and rupee value of inventories sold and in hand. One is known as the periodic inventory system and the other as the perpetual inventory system. (i) Periodic Inventory System This system requires a physical count of all the inventory items on hand at specific times. The calculation of ending inventory on hand is done by taking an actual physical count (or measure or weight) at the end of an accounting period and then quantity on hand is multiplied by the cost per unit. The benefits of annual count are : (a) Where the physical counting is done on the accounting date, all corrections made will ensure the accuracy of the inventory figure shown in the accounts. In fact, where continuous stock-taking regularly shows significant differences, it is essential to make a year-end physical count to ensure the accuracy of the accounts. (b) It is less expensive than a continuous inventory system. The following drawbacks of this method may be noted : (i) Periodic inventory method is based on the assumption that all goods not accounted or traceable by physical inventory count have been either sold or used. In this manner the losses due to theft, waste, evaporation etc. are included improperly in the cost of the goods sold. (ii) Physical counting at the end of accounting period would adversely affect normal business operations for a number of days. The business units, using this method, often suspend their sales and employ practically the entire staff on the physical count and measurement of the items on hand. (iii) In case income statements are required more frequently than once a year, it would be very expensive if the inventory figures are obtained only by physical count. (ii) Perpetual Inventory System In contrast to the periodic system, the perpetual inventory system requires continuous updating with each purchase or sale transaction. A separate account for each type of inventory is maintained in a card or sheet to Inventories : AS - 2 11.7 record the purchase and sale of each inventory item throughout the year. The system is integrated in accounting records by maintaining usual ledger accounts for each inventory item. The detailed inventory records for each different item must show : (a) Receipts (Purchases); (b) Issues (Sales), and (c) Balance on hand, usually in both quantities and rupee amounts. When goods are purchased or sold, the inventories must be adjusted immediately. In accounting terminology, the increases in inventory items are recorded as debits (or receipts) to the appropriate accounts and decreases (sales) are recorded as credits; the balances of the inventory items accounts are called the book inventories of the items on hand. The quantities of goods on hand as shown by the records must be in agreement with the actual quantity on hand. It is relevant to state that the use of perpetual inventory method does not eliminate the need for a physcial count and valuation. The benefits of a perpetual inventory system may be noted as : (i) The normal business operations are not interrupted and there is no need to put' closed for inventory taking' signs either in departments or in entire business. (ii) It obviates the need for stock taking by actual count at the end of financial period. (iii) In some cases the volume of inventory items may be such as to make a complete count in one day impossible. (iv) In a large business, special staff may be employed for stock taking so that a greater degree of skill in performing the job is built up. (v) Controlling losses is easier under a perpetual system because inventory records continuously indicate the goods that must be on hand. (vi) There is no sudden 'out of stock.' situation leading to customer dissatisfaction or need to shut down production lines. (vii) In case there are irregularities or changes in procedures by storekeepers, it may lead to thorough enquiry and investigation into the same. Perpetual inventory system is costly to maintain especially for those business firms which deal with numerous items of small value but the benefits as noted above are not less significant. POINTS OF DIFFERENCE (i) Periodic inventory system requires a physical count of all the inventory items on hand whereas perpetual inventory system is based on continuous record keeping of various items of inventories. (ii) Periodic system of inventory valuation provides a periodic stewardship of the inventory and little is known about the exact composition and amount of inventory items between actual counts in the beginning and at the end. Perpetual system provides a continuous stewardship of the inventory. Inventory records are continuously updated so that financial statements can be prepared at shorter intervals. (iii) Perpetual system provides a basis for inventory control so that physical stocks can be compared with book records and discrepancies, if any, investigated. This is not feasible under the periodic system. (iv) Periodic system is comparatively simple and less expensive while detailed records and high cost of maintaining them are must for perpetual system. (v) Under periodic system, inventory is directly determined and cost of sales is taken as residual figure. In perpetual system, cost of sales is directly determined and inventory is taken as residual figure. 11.8 Financial Accounting: Concepts and Applications (vi) Under periodic system, cost of sales includes lost goods. In perpetual system, inventory includes lost goods. METHODS OF VALUATION OF INVENTORIES The following methods of inventory valuation are in use : (i) Specific identification of costs; (ii) First-in, First-out (FIFO); (iii) Last-in, First-out (LIFO); (iv) Weighted average method (i) Specific Identification of Costs The essential feature of the specific identification method is that the cost is marked on the unit or on its container or the unit can be located to its purchase invoice or cost record. This method of valuing inventory and cost of goods sold is feasible in those situations where purchases are not frequent and old items do not easily mix up with the new ones e.g., automobiles, the fine diamonds, furniture goods and so on. Thus, this method is appropriate for enterprises that sell relatively few items of high unit cost. This is an appropriate treatment for items that are segregated for a specific project regardless of the fact whatever they have been purchased or produced [AS-2 (Revised) Paragraph 15). The specific identification method is rational and highly satisfactory in matching cost with revenue because of its objectivity since actual costs are attached to the cost of goods and ending inventory. Difficulties In most situations, however, it is neither feasible nor practicable to identify each item of inventory and, therefore, the practice of specific identification of cost may be difficult or impossible to apply or may be considered inadequate because of special existing conditions. New items are mixed up with old units in common storage facilities, that is, on shelves or in bins or in other ways. Physical identification is, therefore, impossible or impracticable. The complications also arise when identical units of a particular inventory item have been bought at different prices and at different times. In such a circumstance, specific identification of costs procedures may prove to be slow, burdensome and costly. For example, a dealer buys different quantities of wheat at different times and at different prices. The 'additions' to the current stock is a continuing proces, while he is selling his stocks to his customers. It would be impossible to identify the wheat stocks in continuing process, while he is selling his stocks to his customers. It would be impossible to identify the wheat sold at the time of purchase and its related purchase price. Furthermore, when units are identical and interchangeable, this method opens the doors to possible profit manipulation through the choice of particular units for delivery. For example, if the management wants to report a higher income, it would simply make sure that the units sold were taken from a lot of lower cost. Finally frequent changes in the acquisition costs during the accounting period may force to charging of inventory expenses to revenue on a basis other than past identifiable costs. (ii) First-In, First-Out (FIFO) This method is based on the assumption that cost should be charged to revenue in the order in which they are incurred, that is, first units received are the first ones to be sold or the units sold in the order in which they were acquired. The ending-inventory is therefore, assumed to be consisting of goods most recently purchased. In sum, FIFO assigns the cost of the earliest units acquired to the withdrawals (issues) and the cost of the most recent acquisition to the ending inventory. The FIFO formula assumes that the items of inventories which were purchased or produced first are consumed or sold first and consequently items remaining in inventory at the end of the period are those most recently purchased or produced. It must be kept in mind that this assumption of cost flow or goods flow need not be true as a physical fact. It relates only to the method of accounting and not to the actual physical movement of the goods. Evaluation of FIFO Method FIFO method of inventory valuation has the following advantages : (i) The assumption that goods purchased first are sold first is in accord with the good and efficient management practice that minimises losses from spoilage and deterioration. Inventories : AS - 2 11.9 (ii) FIFO eliminates the opportunities for income manipulations that are possible if costs are identified with specific units. The reason is that for accounting purpose, assignment of costs against revenue is determined by the order in which costs are incurred regardless of which items are actually sold. (iii) The cost of goods sold closely follows the price trend in market as the goods purchased are assumed to have been sold first, provided there is rapid turnover of inventories; the faster the turnover, the more recent are the historic costs. (iv) FIFO provides a more useful valuation of ending inventory than other methods. The most recent purchases are more indicative of current replacement costs than those purchased earlier. (v) FIFO is simple to operate especially when price level changes are minimum. (vi) FIFO is systematic and objective. The major weakness of the FIFO is that where production cycle is lengthy, it can result in unrealistic measurement of profit in times of changing prices. FIFO does not then match current costs of goods sold with current revenues. Instead, the old units costs are matched with the current sales revenue. So in a period of inflation, income will tend to be overstated and when prices are falling, reported net income will tend to be understated. Other things being equal, users of FIFO method pay more taxes currently when prices are rising. There are also serious practical disadvantages of FIFO method when many lots are purchased during the period at different prices or when goods are returned to stock after subsequent lots have been sold. Illustration 1 (FIFO : Perpetual Inventory System) From the following transactions calculate the cost of ending inventory and cost of goods sold by applying FIFO method under perpetual and periodic inventory systems respectively : Date January 1 February March March April May June 10 13 20 6 12 30 Transactions Units Price Per Unit Opening balance brought forward Purchases Purchases Sold Sold Purchases Sold 1,000 500 400 1,200 500 400 500 20 25 22 .... .... 25 .... Solution FIFO (Perpetual) Date Receipts (Purchases) Units Unit Price ` Issues (Sales) Amount Units Unit Price ` ` Balance (Stock-in hand) Amount — 500 — 25 — 12,500 — — — — — — Mar. 13 400 22 8,800 — — — Mar. 20 — — — April 6 — — — 1,000 200 300 200 May 12 400 25 10,000 — June. 30 — — — 200 300 20 25 25 22 ] ] — ] 22 25 20,000 5,000 7,500 4,400 ] ] — ] Unit Price ` 1,000 1,000 500 1,000 500 400 300 400 20 20 25 20 25 22 25 22 ` Jan. 1 Feb. 10 ] ] Units 4,400 7,500 ] ] ] ] 200 200 400 100 ] ] ] 22 ] 22 25 25 Amount 20,000 20,000 12,500 20,000 12,500 8,800 7,500 8,800 ] ] ] 4,400 ] 4,4,00 10,000 2,500 ] 11.10 Financial Accounting: Concepts and Applications Answer : Perpetual System: Ending Inventory = 100 × ` 25 = ` 2,500 Cost of Goods Sold ` 25,000 + ` 11,900 + 11,900 = ` 48,800 Periodic System : The ending inventory is 100 units and it would be assumed to be part of the most recent purchases because goods of old costs are assumed to be sold first under FIFO. The cost of the ending inventory is : 100 × 25 = 2,500 and therefore the cost of the goods sold is ` 48,800 (i.e., ` 51,300–` 2,500) (iii) Last-In, First-Out (LIFO) As its name implies, the last-in, first-out assigns, to goods sold, the cost of those goods that have been purchased last. Hence, the stock-in-hand (ending inventory) is valued at earlier cost. It is based on the assumption that, irrespective of actual physical flow of goods, the goods-sold are those that have been acquired last and the goods that remain unsold (ending inventory) are those that have been acquired first. So cost of goods sold is based on the price of recently purchased goods and the ending inventory represents the cost of earlier purchases. Advantages (i) Matching current costs with current revenues : The main purpose of inventory valuation is to match costs of goods sold or produced with the revenues they generate. LIFO method aims to match the current costs of acquiring or producing the goods with the current revenues from the sales. The cost of goods sold under this method represents the cost of recent purchases with the result that there is better matching of current costs with current revenues. (ii) In periods of inflation, the higher costs of goods sold are charged against the sales revenues because the basis is the most recent purchases. The ending inventory is valued at lower cost of old purchases. The net result is the reduction in the net income for tax purposes. The saving in tax creates additional working capital because of less cash outflows. (iii) It reflects the usual pricing policy of the business enterprise i.e., increased selling price when replacement cost increases even though ending inventory is still at old lower cost. (iv) It is systematic. Disadvantages (a) It understates the assets because inventory on the assets side of the balance sheet is valued at old and out of date unit costs. (b) It is true that LIFO provides a better matching of current costs with current revenues but it does not correctly match total replacement cost with revenue. Cost of only the most recent purchases are charged against sales revenues rather than the total costs of replacing all the items sold. (c) Cost flows do not correspond to the physical flows of goods. (d) It confuses two distinct processes : (i) the measurement of income and (ii) utilisation of income. (e) It is comparatively difficult to apply. Illustration 2 (LIFO : Perpetual Inventory System) Using the data given in Illustration 1, show the application of LIFO under perpetual and periodic methods respectively. Solution LIFO (Perpetual) Purchases Date Quantity Unit Cost ` 1 — Feb. 10 500 Jan. Sales Total Cost ` Quantity — — 25 12,500 Balance Unit Cost ` Total Cost ` Quantity — — — 1,000 — — — 1,000 500 Unit Cost ` ] Total Cost ` 20 20,000 20 20,000 25 12,500 ] Inventories : AS - 2 March 13 400 11.11 22 8,800 — — — 1,000 500 March 20 — — — 400 500 300 ] ] 22 8,800 25 12,500 20 6,000 400 ] ] 20 20,000 25 12,500 22 8,800 700 20 14,000 April 6 — — — 500 20 10,000 200 20 4,000 May 12 400 25 10,000 — — — 200 400 20 25 4,000 10,000 June 30 — — — 400 20 2,000 100 ] 25 20 ] 10,000 2,000 ] ] 100 ] ] Answer : Perpetual Ending Inventory = 100 × 20 = ` 2,000 Cost of Goods Sold = ` 27,300 + ` 10,000 + ` 12,000 = ` 49,300. Periodic System Ending Inventory = 100 × 20 = ` 2,000 So the cost of goods sold is = ` 49,300 (i.e., 51,300 – 2,000) We find that the cost of ending inventory and cost of goods sold respectively are the same under perpetual and periodic systems because the ending inventory is much lower than the beginning inventory, However, under LIFO assumptions, it is possible to have different inventory values under perpetual and periodic systems. Illustration 3 (LIFO : Perpetual Inventory System) From the following information calculate the cost of goods sold and ending inventory respectively applying the LIFO : Date Transactions Units Opening Stock 200 10 Purchases 400 12 February 12 Withdrawls 500 — March 16 Purchases 300 11 May 19 Sales 200 — June 30 Receipts 100 15 January 1 January 10 Unit Cost ` Solution LIFO (Perpetual) Received Date Units Unit ` 1 10 — 400 Feb. 12 Issued Balance Amount ` Units — 12 — 4,800 — — — — — March 16 300 11 3,300 400 100 — May 19 — — — 200 11 2,200 June 30 100 15 1,500 — — — Jan. Jan. Unit ` — — ] 12 10 — ] Amount ` Units — — 200 200 400 4,800 1,000 — ] 100 100 300 100 100 100 100 100 Units ` ] ] ] 10 10 12 10 10 11 10 11 10 11 15 ] ] ] ] ] Amount ` 2,000 2,000 4,800 1,000 1,000 3,300 1,000 1,100 1,000 1,100 1,500 ] ] ] ] 11.12 Financial Accounting: Concepts and Applications Answer : Perpetual System Cost of goods sold is : ` 8,000 (` 5,800 + ` 2,200) Ending Inventory : ` 3,600 (1,500 + 1,100 + 1000) Periodic System Under periodic method the cost of ending inventory would be calculated as follows : ` Earliest cost relating to goods January 1 : 200 Units @ ` 10 2,000 Next earliest cost January 10 : 100 units @ ` 12 1,200 3,200 Cost of Goods Sold = ` 8,400 (` 11,600 – ` 3,200) (iv) Weighted Average Method The weighted average method of inventory valuation is based on the assumption that all costs can be aggregated and that the cost to be assigned to cost of goods sold and ending inventory should be the weighted average of the cost of the units held for the accounting period. The weighted average unit cost is calculated by dividing the total cost (i.e., Quantity × Cost Per Unit) of similar units of each commodity available for sale during the given period by the the related number of units (aggregate quantity) of that commodity. This is the procedure under periodic method. The weighted average assumes no particular flow of goods. Moving average cost : When a perpetual inventory system is used, the weighted average cannot be applied because weighted average unit cost cannot be calculated until the end of the accounting period. To overcome this difficulty, a moving weighted average unit cost is used because it provides a new unit cost after each purchase. The procedure is : prices for units in the beginning inventory (i.e., opening stock) and in each purchases are multiplied (weighted) by the number of units in the beginning inventory and in each purchase and are then averaged (divided by total number of units) to find out the weighted average cost per unit. Thus, when goods are sold or issued, the moving average unit cost existing at that time is used. It may be added that a new weighted average unit cost is calculated after each purchase at a different price and this unit cost figure is used to price all issue of goods until the next purchase is made. Application of the moving average concept in a perpetual inventory system is explained in Illustration 4 given below: Illustration 4 (Weighted Average Method) Using the information given in Illustration 1, explain the weighted average method under : (a) perpetual inventory system and (b) periodic system for calculating cost of ending inventory and cost of goods sold. Weighted Average (Perpetual) Date Received Quanitity Unit Cost ` Issued Total Cost ` Quantity Unit Cost ` Balance Total Cost ` Quantity Weight Average ` Total Cost ` Jan. 1 — — — — — — 1,000 20.00 20,000 Feb. 10 500 25 12,500 — — — 1,500 21.67 32,500 March 13 400 22 8,800 — — — 1,900 21.74 41,300 March 20 — — — 1,200 21.74 26,088 700 21.74 15,218 April 6 — — — 500 21.74 10,870 200 21.74 4,348 May 12 400 25 10,000 — — — 600 23.91 14,346 June 30 — — — 500 23.91 11,955 100 23.90 2,390 Inventories : AS - 2 11.13 A comparative study of two systems, under FIFO, LIFO and Weighted Average Based on Illustrations 1, 2 and 4 Perpetual Inventory System Methods Periodic Inventory System Cost of Ending Inventory ` Cost of Goods Sold ` Cost of Ending Inventory ` Cost of Goods Sold ` FIFO 2,500 48,800 2,500 48,800 LIFO 2,000 49,300 2,000 49,300 2,390 48,910 2,230 49,070 Weighted Average (Moving) In order to apply weighted average method on a periodic basis, a cost is assigned to all goods, that is, to those that were sold and those in inventory at the end. That represents the weighted average of the cost of all goods available for sale during the period. The cost of the goods on hand at the beginning of the year as well as those purchased during the year would be taken into consideration in the calculation of the weighted average as shown below by using the data in the foregoing Illustration. Ending inventory and cost of goods sold calculated on Periodic Inventory System and a Weighted Average Cost Flow Assumption is as follows: Date Units Unit Cost ` Total Cost ` Jan. 1 1,000 × 20 20,000 Feb. 10 500 × 25 12,500 March 13 400 × 22 8,800 May 12 400 × 25 10,000 2,300 51,300 Weighted Average : ` 51,300 ÷ 2,300 = ` 22.30. Ending Inventory = ` 2,230 (100 × 22.30) Cost of Goods Sold = ` 49,070 (Balancing Figure) Weighted Average Method – An Evaluation The weigthed average method is realistic in the sense that it represents the physical flow of goods when all goods available for sale (i.e., beginning inventory plus all the purchases) are mixed together with one another. This method is objective, consistent and does not permit profit manipulation. The weighted average approach provides the same cost for similar items of equal utility. “In its general effect, the weighted average method gives a middle course between the effects of FIFO periodic and LIFO periodic methods. So this method has neither the strong advantages nor the disadvantages of those methods.” (Charles J Woelfel : Financial Accounting) Illustration 5 (Calculation of Gross Profit) A dress shop has the following transactions during September : September 1 bought 1,200 blouses at ` 20 each September 10 bought 400 blouses at ` 24 each September 12 sold 400 blouses at ` 30 each September 14 bought 600 blouses at ` 30 each September 16 sold 800 blouses at ` 40 each September 20 bought 600 blouses at ` 40 each September 25 sold 700 blouses at ` 50 each Compute : (i) the gross profit earned during September and 11.14 Financial Accounting: Concepts and Applications (ii) the value of stock held on 30 September; using each of the following alternative basis of valuation : FIFO, LIFO, and Weighted Average Cost. Solution Sales = (400 × 30) + (800 × 40) + (700 × 50) = ` 79,000 FIFO : September 12 : Sold 400 Stock Cost of Sales ` ` @ ` 20 (Cost) 800 × 20 400 × 24 September 16 : Sold 800 @ ` 20 (Cost) 400 × 24 600 × 30 September 25 : Sold ] ] 8,000 16,000 400 @ ` 24 (Cost) 9,600 300 @ ` 30 (Cost) 9,000 300 × 30 600 × 40 Cost of Sales ] 42,600 Gross Profit 36,400 Sales 79,000 Closing Stock : ` 9,000 + ` 24,000 = ` 33,000 LIFO : September 12 : Sold Stock Cost of Sales ` ` 400 × 24 (Cost) 9,600 1,200 × 20 September 16 : Sold 600 × 30 (Cost) 18,000 200 × 20 (Cost) 4,000 1,000 × 20 September 25 : Sold 600 × 40 (Cost) 24,000 100 × 20 (Cost) 2,000 900 × 20 Cost of Sales 57,600 Gross Profit 21,400 Sales (12,000 + 32,000 + 35,000) 79,000 Closing Stock : = ` 18,000 Weighted Average : Stock ` September 12 : Sold 400 × 21 Cost of Sales ` 8,400 1,200 × 21 September 16 : Sold 800 × 24 19,200 1,000 × 24 September 25 : Sold 700 × 30 21,000 900 × 30 Cost of Sales 48,600 Gross Profit 30,400 Sales 79,000 Closing Stock : = ` 27,000 Students are adviced to use tables for details. ] ] Inventories : AS - 2 11.15 Illustration 6 (Periodic Inventory System) A company, started on 1 January 2020, purchased raw materials during 2017 as stated below: January 2 800 kg. @ ` 62 per kg. February 26 1,200 kg. @ ` 57 per kg. April 13 2,500 kg. @ ` 59 per kg. July 10 3,000 kg. @ ` 56 per kg. September 18 1,500 kg. @ ` 60 per kg. November 29 1,000 kg. @ ` 65 per kg. While preparing its final accounts on 31 December 2020, the company had 1,300 kg. of raw materials in its godown. Calculate the values of closing stock of raw materials and the cost of sales according to : (i) First-In-First-Out (FIFO) basis, (ii) Last-In-First-Out (LIFO) basis, and (iii) Weighted Average basis. Solution Total Purchases : From January to November 10,000 kg. Less : Closing Stock 1,300 kg. Sales 8,700 kg. ` FIFO Cost of Ending Inventory 300 × 60 = 18,000 1,000 × 65 = 65,000 83,000 Cost of Sales 800 × 62 = 49,600 1,200 × 57 = 68,400 2,500 × 59 = 1,47,500 3,000 × 56 = 1,68,000 1,200 × 60 = 72,000 5,05,500 LIFO Cost of Ending Inventory 500 × 57 = 28,500 800 × 62 = 49,600 78,100 Cost of Sales 1,000 × 65 = 65,000 1,500 × 60 = 90,000 3,000 × 56 = 1,68,000 2,500 × 59 = 1,47,500 700 × 57 = 39,900 5,10,400 Weighted Average 800 × 62 = 49,600 1,200 × 57 = 68,400 2,500 × 59 = 1,47,500 11.16 Financial Accounting: Concepts and Applications 3,000 × 56 = 1,68,000 1,500 × 60 = 90,000 1,000 × 65 = 65,000 Total Cost of Purchase 5,88,500 5,88,500 10,000 ` 58.85 Cost of Ending Inventory 1,300 × 58.85 = 76,505 Cost of Sales 8,700 × 58.85 = 5,11,995 Weighted Average Illustration 7 A company started its business on 1st January, 2020. It purchased and used raw material during the year 2017 as stated below: @ ` 62 per kg. January 10 Purchased 800 Kgs February 28 Purchased 1,200 kgs @ ` 57 per kg. March 10 Issued 1,000 kgs. March 26 Issued 500 kgs. May 20 Purchased 900 kgs @ ` 65 per kg. June 28 Issued 600 kgs. Calculate the value of closing stock of raw materials on June 30 according to (i) Last in First out basis, and (ii) Weighted average basis, using perpetual inventory system. Solution Valuation of Inventories (LIFO) Receipts Date 2020 Issues Balance Units kgs Rate ` Value ` Units Kgs Rate ` Value ` Units Kgs Rate ` Value ` Jan. 10 800 62 49,600 – – – 800 62 49,600 Feb. 28 1,200 57 68,400 – – – 800 62 49,600 1,200 57 68,400 800 62 49,600 200 57 11,400 Mar. Mar. May 10 26 20 June 28 – – 900 – – – 65 – – – 58,500 – 1,000 57 57,000 200 57 11,400 300 62 18600 500 62 31,000 – – – 500 62 31,000 900 65 58,500 500 62 31,000 300 65 19,500 600 65 39,000 Value of Closing Stock 31,000 + 19,500 =` 50,500 Inventories : AS - 2 11.17 Valuation of Inventories (Weighted Average Basis) Receipts Date 2020 Units kgs Rate ` Issues Value ` Units Kgs Rate ` Balance Value ` Units Kgs Rate ` Value ` (W.A) Jan. 10 800 62 49,600 – – – 800 62 49,600 Feb. 28 1,200 57 68,400 – – – 2,000 59 1,18,000 Mar. 10 – – – 1,000 59 59,000 1,000 59 59,000 Mar. 26 – – – 500 59 29,500 500 59 29,500 May 20 900 65 58,500 – – – 1,400 62.86 88,000 Jan. 29 – – – 600 62.86 37,714 800 62.86 50,286 Value of Closing Stock ` 50,286 Illustration 8 From the following information find out the value of stock as on 31-3-2020 according to AS - 2 : (i) Cost of Physical stock on 31-3-2020 was ` 2,00,000. (ii) Cost of stock held as consignee was ` 40,000. (iii) Stock was expected to realise the normal selling price of 150% of cost except for the following goods: (a) goods costing ` 10,000 were damaged and an expenditure of 10% of normal selling price was necessary to realise the cost. (b) goods costing ` 20,000 were damaged beyond repair and were expected to realise ` 5,000 only. Solution: Cost of physical stock Less : 2,00,000 Held as consignee 40,000 1,60,000 Less : Expenditure to realise the cost : Cost Price Add : 10,000 Profit 50% of cost 5,000 Sale Price 150% of cost 15,000 Expenditure : 10% of ` 15,000 1,500 1,58,500 Less : Loss on damaged goods ( 20,000 – 5,000) 15,000 1,43,500 Illustration 9 The following are the details of material of Sai Mills : 01-01-2020 Opening Stock 100 units @ ` 25 per unit 01-01-2020 Purchases 200 units @ ` 30 per unit 15-01-2020 Issued for consumption 100 units 01-02-2020 Purchases 400 units @ ` 40 per unit 15-02-2020 Issued for consumption 200 units 11.18 Financial Accounting: Concepts and Applications 20-02-2020 Issued for consumption 200 units 01-03-2020 Purchases 300 units @ ` 50 per unit 15-03-2020 Issued for consumption 200 units Find out the cost of closing stock as on 31-3-2020 according to : (i) First in first out basis, and (ii) Weighted average price basis, using perpetual inventory system. Also calculate cost of closing inventory on LIFO basis under periodic system. Solutions VALUATION OF STOCK (FIFO) Purchases Issues Balance Qty Rate Values Qty Rate Value Qty Rate Value Units ` ` Units ` ` Units ` ` — — — — — — 100 25 2,500 100 25 2,500 01-10-20 01-10-20 200 30 6,000 15-10-20 — — — 100 25 01-02-20 400 40 16,000 — — 15-02-20 — — 2,500 200 30 6,000 200 30 6,000 200 30 6,000 400 40 16,000 — 200 30 6,000 400 40 16,000 20-02-20 — — — 200 40 8,000 200 40 8,000 01-03-20 300 50 15,000 — — — 200 40 8,000 300 50 15,000 300 50 15,000 15-03-20 — — — 200 40 8,000 Value of Closing Stock (FIFO) = ` 15,000 VALUATION OF STOCK (WEIGHED AVERAGE) Date Purchases Qty Units Rate ` 01-01-20 — — 01-01-20 200 30 Issues Value ` Balance Qty Units Rate ` Value ` Qty Units Rate ` Value ` W.A — — — 100 25 2,500 25 — — — 100 25 2,500 200 30 6,000 28.33 5,667 28.33 6,000 01-01-20 — — — 100 28.33 2,833 200 28.33 01-02-20 400 40 16,000 — — — 200 28.33 5,667 400 40 16,000 36.11 15-02-20 — — — 20-02-20 — 01-03-20 300 50 15,000 15-03-20 — — — Value of Closing Stock (W.A) = ` 13,337 200 36.11 7,222 400 36.11 14.445 36.11 200 36.11 7,222 200 36.11 7,222 36.11 — — 200 36.11 7,222 44.45 300 50 15,000 300 44.45 13,337 200 44.45 8,890 44.45 Inventories : AS - 2 11.19 Value of Closing stock as per LIFO basis under Periodic System. No. of unsold units : (100 + 200 + 400 + 300) – (100 + 200 + 200 + 200) = 1,000 – 700 = 300 units Value of stock (LIFO): 100 units @ ` 25 2,500 200 units @ ` 30 6,000 8,500 Illustration 10 From the following information calculate cost of sales, gross profit, and value of closing stock for the month of January, 2020 according to FIFO, LIFO and weighted average method. Date Particulars No. of Units Rate per Unit (`) 01-01-2020 Opening Stock 500 8 05-01-2020 Purchased 800 9 14-01-2020 Purchased 700 9 21-01-2020 Purchased 1,000 10 23-01-2020 Purchased During January 2020 Sold 500 9 2,900 17 Solution Opening Stock of Material Add: 500 units Purchase of Material 3,000 units [800 + 700 + 1000 + 500] 3,500 units Less: Quantity of Material sold 2,900 units Closing Stock of Material 600 units (i) FIFO Method Cost of Closing Stock = (500  ` 9) + (100  `10) = ` 4,500 + ` 1,000 = ` 5,500 Cost of Goods sold = (500 ` 8) + (800 ` 9) + (700 ` 9) + (900 ` 10) = ` 4,000 + ` 7,200 + ` 6,300 + ` 9,000 = ` 26,500 Sales Value = ` 2,900 ` 17 = ` 49,300 Gross Profit = ` 49,300 – ` 26,500 = ` 22,800 (ii) LIFO Method Cost of Closing Stock = (500  ` 8) + (100  ` 9) = ` 4,000 + ` 900 = ` 4,900 Cost of Goods sold = (500 `9) + (1,000  ` 10) + (700  ` 9) + (700  ` 9) = ` 4,500 + ` 10,000 + ` 6,300 + ` 6,300 = ` 27,100 Sales Value = 2,900 ` 17 = ` 49,300 Gross Profit = ` 49,300 – ` 27,100 = ` 22,200 (iii) Weighted Average Method Cost of total Goods = [(500 ` 8) + (800 ` 9) + (700 ` 9) + (1,000 ` 10) + (500 `9)] = ` 4,000 + ` 7,200 + ` 6,300 + ` 10,000 + ` 4,500 = `32,000 11.20 Financial Accounting: Concepts and Applications Total Quantity of Material = [500 + 800 + 700 + 1,000 + 500] = 3,500 units Weighted Average price = Cost of Closing Stock = 600  ` 9.14 = ` 5,484 Cost of Goods sold = 2,900  ` 9.14 = ` 26,506 Sales Value = 2,900  ` 17 = ` 49,300  Gross Profit = ` 49,300 – ` 26,506 ` 32,000  ` 9.14 per unit 3,500 = ` 22,794 Alternately Cost of the Goods Sold: (500 × 8) + (800 × 9) + (700 × 9) + (1,000 × 10) = 4,000 + 7,200 + 6,300 + 10,000 = 27,500 Total Quantity of Material = 3,000 units Weighted Average = 27,500 ÷ 3000 = 9.17 Balance of Quantity after issue : 3,000 – 2,900 = 100 Rate of Receipt on Last purchase:   Closing Stock (100  9.17)  (500  9) 100  500 917  4500 600  5417  9.03 600 = 600 × 9.03 = 5,418 Cost of Goods sold: (500 × 8) + (800 × 9) + (700 × 9) + (1,000 × 10) + (500 × 9) = 4000 + 7200 + 6300 + 10,000 + 4,500 = 32,000 Less: Closing stock 5,418 26,582 FOR YOUR COMMENTS Please send your comments in writing on the above treatment. This procedure is usually adopted where the final accounts are yet to be prepared. lllustration 11 The following are the details of material in respect of a certain item of M/s. Ajay & Company. 01-01-2020 Purchases 600 units @ ` 20 each 01-02-2020 Purchases 200 units @ ` 24 each 15-02-2020 Sales 200 units @ ` 30 each 01-04-2020 Purchases 300 units @ ` 30 each 15-04-2020 Sales 400 units @ ` 40 each 01-06-2020 Purchases 300 units @ ` 40 each 15-06-2020 Sales 350 units @ ` 50 each Inventories : AS - 2 11.21 Find out the cost of closing stock as on 30-6-2020 according to: (i) First-in-first out basis; and (ii) Weighted average basis, using perpetual inventory system. Solution Dr. Store Ledger FIFO Basis Purchases (In) Date Units Cr. Cost of Sales (Out) Units Stock Rate Amount Rate Amount ` ` ` ` Units Rate Amount ` ` 01-01-20 600 20 12,000 — 600 20 12,000 01-02-20 200 24 4,800 — 600 20 12,000 200 24 4,800 400 20 8,000 200 24 4,800 400 20 8,000 200 24 4,800 15-02-20 01-04-20 15-04-20 01-06-20 — 300 30 200 9,000 — 40 15-06-20 4,000 — 400 300 20 20 8,000 12,000 — 300 30 9,000 200 24 4,800 300 30 9,000 200 24 4,800 300 30 9,000 300 40 12,000 200 24 4,800 150 30 4,500 150 30 4,500 300 40 12,000 16,500* Dr. Weighted Average Cost Basis Purchases (In) Date Units Cr. Cost of Sales (Out) Units Stock Rate Amount Rate Amount ` ` ` ` Units Rate Amount ` ` 01-01-20 600 20 12,000 — 600 20 12,000 01-02-20 200 24 4,800 — 600 20 12,000 200 24 4,800 800 21 16,800 600 21 12,600 600 21 12,600 300 30 9,000 15-02-20 01-04-20 — 300 15-04-20 01-06-20 30 200 9,000 — 300 15-06-20 *Value of Closing Stock 40 — 21 4,200 — 400 12,000 24 9,600 — 350 30 10,500 900 24 21,600 500 24 12,000 500 24 12,000 300 40 12,000 800 30 24,000 450 30 13,500* 11.22 Financial Accounting: Concepts and Applications Illustration 12 Following information is extracted from the books of Satyam India for the month of April 2020: ` 10,00,000 Sales ` 30,000 General Administration Cost Opening Stock: 95,000 units @ ` 5 each ` 4,75,000 Purchases: April 7 2,00,000 units @ ` 3.00 per unit 29 75,000 units @ ` 4.00 per unit 30 Closing Stock 1,20,000 units Compute the following by FIFO and Weighted Average Method of inventory valuation: (a) Value of stock on April, 30. (b) Cost of goods sold for April. (c) Profit or Loss for April. Solution (a) FIFO Method (i) Inventory on April, 30 Units Rate Amount ` ` 45,000 3 1,35,000 75,000 4 3,00,000 1,20,000 Closing Stock 4,35,000 (ii) Cost of goods sold for April ` Opening Stock 4,75,000 Add: Purchases April 7 6,00,000 April 29 3,00,000 9,00,000 13,75,000 Less : Closing Stock Cost of goods sold 4,35,000 9,40,0000 (iii) Profit or Loss for April Cost of goods sold Add : General Administration cost Total Cost (+) Profit [Balancing Figure] Sales (b) 30,000 9,70,000 30,000 10,00,000 Weighted Average Method (i) Inventory on April 30 : Rate on Receipt of 1 st Purchase :  9,40,000 (95, 000  5)  (2,00, 000  3) 2,95, 000 Inventories : AS - 2  11.23 10,75,000 2,95,000 = 3.644 Balance of units after issue of 2,50,000 units = 2,95,000 – 2,50,000 = 45,000 units Rate after Receipt of last Purchase   4,63, 980 1,20,000 (45,000  3.644)  (75,000  4) 45,000  75,000  3.867 Closing Stock = 1,20,000 units × 3.867 = 4,64,040 or ` 4,63,980 The difference of ` 60 is on account of Rounding up (ii) Cost of goods sold ` Opening Stock Add : 4,75,000 Purchase April 01 6,00,000 April 29 3,00,000 9,00,000 13,75,000 Less : Closing Stock 4,64,040 9,10,960 (iii) Profit or Loss for April Cost of Goods Sold 9,10,960 Add : General Administration cost 30,000 Total Cost 9,40,960 Profit 59,040 Sales 10,00,000 Illustration 13 (Damaged Stock) From the following details, find out closing stock as per FIFO Method: Purchase : 2020 February March 4 20 units @ ` 15 per unit 17 30 units @ ` 14 per unit 2 40 units @ ` 14.50 per unit 30 50 units @ ` 13.00 per unit 20 25 units @ ` 20 per unit 5 40 units @ ` 21 per unit 10 10 units @ ` 18 per unit 31 45 units @ ` 15 per unit Sales: 2020 February March On 20 th March, 2020: two units sold on 10 th March, 2020 were returned by the customers. On 29 th March, 2020 : one unit was damaged and it had to be discarded. Also calculate profit. Rate ` Units 20 30 — 40 — — 2 (Returned) — 50 — 2020 Feb.4 Feb. 17 Feb. 20 March 2 March 5 March 10 March 20 March 29 March 30 March 31 Less : Returned Cost of Goods sold — 13.00 — 14.50 — — 14.50 — 14.00 15.00 Receipt Date Solution — 650 29 — — 580 — 420 300 Amount ` 14.50 15.40 13.00 16 29 2 — — — 14.50 14.00 14.50 — 15.00 14.00 — — Rate ` — 1 (Damaged) — 10 25 15 — 20 5 Units Issues (Stores Ledger : FIFO) 1,706 29 1,677 246.50 377.00 — — — 145.00 350.00 217.50 — 300 70 — — Amount ` 21 16 50 –1 16 15 +2 17 15 25 25 40 25 20 30 20 Units Rate ` 13 15.40 13.00 — 15.40 (App.) 14.50 14.50 14.50 14.50 14.50 14.00 14.50 14.00 15.00 14.00 15.00 Balance 273 246.50 650 — 246.50 217.50 29.00 246.50 217.50 362.50 350 580 350 300 420 300 Amount ` 11.24 Financial Accounting: Concepts and Applications Inventories : AS - 2 11.25 Calculation of Profit ` Sales [(25 × 20) + (40 × 21) + (10 × 18) + (45 × 15)] 2,195 Less: Cost of Goods Sold 1,677 Profit 518 Alternately Sales (Including Opening Stock) 2,195 Less: Purchases [(20 × 15) + (30 × 14 )+ (40 × 14.50) + (50 + 13)] 1,950 245 Add: Stock at the end 273 518 ASSUMPTION It is assumed that the unit discarded is normal loss and hence, absorbed by good units and separately not shown in Profit and Loss Statement. Illustration 14 M/s Desai & Co. a trader of Plastic Toys had 12,000 toys valued at ` 3 per toy. His Purchases and Sales during six months ending 31 st March, 2020 were as under March 2020 Toys ` Per Toy 5,000 3.00 10,000 15.10 22 Sales 23 Purchased (Carriage Inward ` 1,000) 25 Sales 26 Purchased (Carriage Inward ` 1,200) 12,000 31 Sales 13,000 8,000 18.10 You are required to ascertain Cost of Stock on hand as on 31st March 2020 under each of the following methods: (1) FIFO (2) Weighted Average Solution 1. FIFO Method: (Stores Ledger : FIFO Method) Date Purchases March’ 20 No. of Toys Rate (`) Issue Amount (`) No. of Toys Balance (Stock) Rate (`) Amount (`) No. of Toys Rate (`) Amount (`) 1 – – – – – – 12,000 3.00 36,000 22 – – – 5,000 3.00 15,000 7,000 3.00 21,000 23 10,000 15.10 1,51,000 – – – 7,000 3.00 21,000 10,000 15.10 1,51,000 25 26 31 Total – 12,000 – 22,000 – 18.10 – – 2,17,200 – 3,68,200 7,000 3.00 21,000 – – – 1,000 15.10 15,100 9,000 15.10 1,35,900 – – – 9,000 15.10 1,35,900 12,000 18.10 2,17,200 18.10 1,44,800 9,000 15.10 1,35,900 4,000 18.10 72,400 8,000 2,59,400 8,000 26,000 1,44,800 11.26 Financial Accounting: Concepts and Applications 2. Weighted Average Method: (Stores Ledger A/c) Date Purchases Issue Balance (Stock) March 20 No. of Toys Rate ` Amount ` No. of Toys Rate ` Amount ` No. of Toys Rate ` Amount ` 1 – – – – – – 12,000 3 36,000 22 – – – (5,000) 3.00 (15,000) 7,000 3 21,000 23 10,000 15.10 1,51,000 – – – 17,000 10.12 1,72,000 25 – – – (8,000) 10.12 (80,941) 9,000 10.12 91,059 26 12,000 18.10 2,17,200 – – – 21,000 14.68 3,08,259 31 – – – (13,000) 14.68 (1,90,827) 8,000 14.68 1,17,432 Value of Closing Stock as on 31st March 2020 As per FIFO Method : 8,000 Units @ ` 18.10 = ` 1,44,800 As per Weighted Average Method : 8,000 Units @ ` 14.68 = ` 1,17,432 EXPLANATIONS (i) As per AS-2 Cost of Stock should include all costs of bringing the goods to their present condition. Hence, the Carriage Inward is added to Purchase/Stock Cost. (ii) The minor difference in figures is on account of rounding up of Weighted Average Rate. Cross Check FIFO Method Weighted Avg. Method Qty. ` Qty. ` Opening Stock 12,000 36,000 12,000 36,000 Add : Purchases / Receipts 22,000 3,68,200 22,000 3,68,200 (26,000) (2,59,400) (26,000) (2,86,768) 8,000 1,44,800 8,000 1,17,432 Less : Sales / Issues = Closing Stock Illustration 15 (Returns Given) Enter following transactions in Stores Ledgers using the FIFO Method. 2020 January 1 Balance 250 units @ ` 10 per unit 3 Issued 50 units on M.R. No. 61 6 Received 800 units vide G.R. No. 13 @ ` 11 per unit 7 Issued 300 units on M.R. No. 63 8 Returned to Stores 20 units on M.R. No. 61 12 Received 300 units vide G.R. No. 26 @ ` 12 per unit 15 Issued 320 units M.R. No. 83 18 Received 100 units vide G.R. Note No. 77 @ ` 12 per unit 20 Issued 120 units M.R. No. 102 23 Returned to vendors 40 units from G.R. No. 77 received on 18 th

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