Accounting-System-munotes

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1MODULE -I
1
ACCOU NTING:ANINTRODUCTIO N
Unit Structure
1.1 Accounting: the language of business
1.2 Accounting: an information system.
1.2.1 Definitions
1.2.2 Objectives of accounting
1.2.3 Function of accounting
1.3 Users of accounting inform ation:
1.4 Branches of accounting
1.5 Book -keeping
1.5.1 Accounting cycle
1.5.2 Basic accounting terms
1.6 Tests your understanding:
1.1 ACCOU NTING:THE LA NGUAGE OF BUS INESS
Accounting is a business language. We can use this language to
communicate financial transactions and their results. Accounting is a
comprehensive system to collect, analyzes, and communicates financial
information.
The origin of accounting is as old as money. In early days, the
number of transactions was very small, so every concerned person could
keep the record of transactions during a specific period of time. Twenty -
three centuries ago, an Indian scholar named Kautilya alias Chanakya
introduced the accounting concepts in his book Arthashastra . In his book,
he described the art of proper account keeping and methods of checking
accounts. Gradually, the field of accounting has undergone remarkable
changes in compliance with the changes happening in the business
scenario of the world.
Business is an economic activity undertaken with the motive of
earning profits and to maximize the wealth for the owners. Business
cannot run in isolation. Largely, the business activity is carried out by
people coming together with a purpose to serve a common cause. This
team is often referred to as an organization, which could be in different
forms such as sole proprietorship, partnership, body corporate etc. The
rules of business are based on general principles of trade, social values,munotes.in

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2and statutory framework encompassing national or internationa l
boundaries. While these variables could be different for different
businesses, different countries etc., the basic purpose is to add value to a
product or service to satisfy customer demand.
A bookkeeper may record financial transactions according to
certain accounting principles and standards and as prescribed by an
accountant depending upon the size, nature, volume, and other constraints
of a particular organization.
With the help of accounting process, we can determine the profit
or loss of the bus iness on a specific date. It also helps us analyze the past
performance and plan the future courses of action. As the basic purpose of
business is to make profit, one must keep an ongoing track of the activities
undertaken in course of business.
1.2 ACCO UNTING:ANINFORMATIO NSYSTEM
1.2.1 DEFI NITIO NS
Definition of Accounting
Definition by the American Institute of Certified Public Accountants
(Year 1961):
"Accounting is the art of recording, classifying and summarizing in a
significant manner and in term s of money, transactions and events which
are, in part at least, of a financial character, and interpreting the result
thereof".
Definition by the American Accounting Association (Year 1966):
"The process of identifying, measuring and communicating economi c
information to permit informed judgments and decisions by the users of
accounting".
1.2.2 OBJECTIVES OF ACCOU NTING
ToProviding Information
The primary objective of accounting is to provide useful
information for decision -making to stakeholders such as owners,
management, creditors, investors, etc. Various outcomes of business
activities such as costs, prices, sales volume, value under ownership,
return of investment, etc. are measured in the accounting process.
To keep systematic records:
Account ing is done to keep systematic record of financial
transactions. The primary objective of accounting is to help us collect
financial data and to record it systematically to derive correct and useful
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3Ascertainment of Resu lts
‘Profit/loss' is a core accounting measurement. It is measured by
preparing profit and loss account for a particular period. Various other
accounting measurements such as different types of revenue expenses and
revenue incomes are considered for prep aring this profit and loss account.
Difference between these revenue incomes and revenue expenses is
known as result of business transactions identified as profit/loss.
To ascertain the financial position of the business:
Ab a l a n c es h e e t or a statement of affairs indicates the financial
position of a company as on a particular date. A properly drawn balance
sheet gives us an indication of the class and value of assets, the nature and
value of liability, and also the capital position of the firm. With the help of
that, we can easily ascertain the soundness of any business entity.
To assist in decision -making: To take decisions for the future, one
requires accurate financial statements. One of the main objectives of
accounting is to take right decisions at right time. Thus, accounting gives
you the platform to plan for the future with the help of past records.
To fulfill compliance of Law: Business entities such as companies,
trusts, and societies are being run and governed according to different
legislati ve acts. Similarly, different taxation laws (direct indirect tax) are
also applicable to every business house. Everyone has to keep and
maintain different types of accounts and records as prescribed by
corresponding laws of the land. Accounting helps in ru nning a business in
compliance with the law.
To Know the Solvency Position :Balance sheet and profit and loss
account prepared as above give useful information to stockholders
regarding concerns potential to meet its obligations in the short run as well
as in the long run.
1.2.3 FUNCTIO NOF ACCOU NTING
The main functions of accounting are as follows:
Measurement: Accounting measures past performance of the business
entity and depicts its current financial position.
Forecasting: Accounting helps in fore casting future performance and
financial position of the enterprise using past data.
Decision -making: Accounting provides relevant information to the users
of accounts to aid rational decision -making.
Comparison & Evaluation: Accounting assesses performanc e achieved
in relation to targets and discloses information regarding accounting
policies and contingent liabilities which play an important role in
predicting, comparing and evaluating the financial results.munotes.in

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4Control: Accounting also identifies weaknesses of the operational system
and provides feedbacks regarding effectiveness of measures adopted to
check such weaknesses.
Government Regulation and Taxation: Accounting provides necessary
information to the government to exercise control on die entity as well as
in collection of tax revenues.
1.3USERS OF ACCOU NTINGINFORMATIO N:
Generally users of accounts are classified into two categories:
a)Internal User
b)External User
Following are the various users of accounting information:
i)Investor: They provide capital to business. They need information to
assess whether to buy, hold or sell their investment. Also they are
interested to know the ability of the business to survive, prosper and
to pay divided.
ii)Employees: Growth of employees is directly related to the gro wth of
the organisation and therefore, they are interest to know the stability,
continuity and growth of the enterprise and its ability to provide
remuneration, retirement and other benefits and to enhance
employment opportunities.
iii)Lenders: They are inter ested to know whether their loan -principal
and interest will be paid when due.
iv)Supplier and Creditors: They are also interested to know the ability
of the enterprise to pay their dues that helps them to decide the credit
policy for the relevant concern, r ates to be charged and so on.
Sometime, they also become interested in long term continuation of
theenterprise if their existence becomes dependent on the survival of
thebusiness. Suppose, small ancillary units supply their products to a
big enterprise, if the big enterprise collapses, the fate of the small
units also becomes sealed.
v)Customers: Customers are also concerned with the stability and
profitability of the enterprise because their functioning is more or less
dependent on the supply of goods, sup pose, a company produces
some chemicals used by pharmaceutical companies and supplies
chemicals on three months credit. If all a sudden it faces some trouble
and is unable to supply the chemical, the customers will also be in
trouble.
vi)Government and their agencies: They regulate the functioning of
business enterprise for public good, allocated scarce resources among
competing enterprise, control price, change excise duties and taxes,
and so they have continued interest in the business enterprise.munotes.in

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5vii)Public: The public at large is interested in the functioning of the
enterprise because it may make a substantial contribution to the local
economy in many ways including the number of people employed and
their patronage to local suppliers.
viii)Management: On the basis of Accounts, management determine the
effects of their various decisions on the functioning of the
organisation. This helps them to make further managerial decisions.
External users of accounting
informationExternal users include
Investors
Creditors
Customers
Suppliers
Employees
Government organizations
Internal users of accounting
informationInternal users include
Management
Managers of operations
1.4BRA NCHES OF ACCOU NTING
Following are various branc hes of Accounting.
1.4.1 Financial Account ing
It is commonly termed as Accounting. The American Institute of
Certified Public Accountants defines Accounting as "an art of recoding,
classifying and summarizing in a significant manner and in terms of
money, transactions and events which are in par t at least of a financial
character, and interpreting the results thereof."
1.4.2 Cost Accounting
According to the Chartered Institute of Management Accountants
(CIMA), Cost Accountancy is defined as "application of costing and cost
accounting principle s, methods and techniques to the science, art and
practice of cost control and the ascertainment of profitability as well as the
presentation of information for the purpose of managerial decision -
making."
1.4.3 Management Accounting
Management Accountin g is concerned with the use of Financial
and Cost Accounting information to managers within organizations, to
provide them with the basis in making informed business decisions that
would allow them to be better equipped in their management and control
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61.4.4 Social responsibility Accounting
Social responsibility accounting is concerned with accounting for
social costs incurred by the enterprise and social benefits created.
1.4.5 Human Resource Accounting
Human resource accounting is an atte mpt to identify, quantify and
report investment made in human resource of an organisation that are not
presently accounted for under conventional accounting practice.
1.4.6 Difference between Management Accounting and Financial
Accounting
Management Acc ounting Financial Accounting
1. Management Accounting is
primarily based on the data
available from Financial
Accounting.1. Financial Accounting is based on
the monetary transactions of the
enterprise.
2. It provides necessary information
to the managem ent to assist them in
the process of planning, controlling,
performance evaluation and
decision making.2. Its main focus is on recording
and classifying monetary
transactions in the books of
accounts and preparation of
financial statements at the end of
every accounting period.
3. Reports prepared in Management
Accounting are meant for
management and as per
management requirement.3. Reports as per Financial
Accounting are meant for the
management as well as for
shareholders and creditors of the
concern.
4. Reports may contain both
subjective and objective figures.4. Reports should always be
supported by relevant figures and it
emphasizes on the objectivity of
data.
5. Reports are not subject to
statutory audit.5. Reports are always subject to
statuto ry audit.
6. It evaluates the sectional as well
as the entire performance of the
business.6. It ascertains, evaluates and
exhibits the financial strength of the
whole business.
1.5BOOK -KEEPI NG
As defined by Carter, ‘Book -keeping is a science and ar to f
correctly recording in books -of accounts all those business transactions
that result in transfer of money or money's worth'.
Book -keeping is an activity concerned with recording and classifying
financial data related to business operation in order of its occurrence.munotes.in

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7Book -keeping is a mechanical task which involves:
Collection of basic financial information.
Identification of events and transactions with financial character
i.e., economic transactions.
Measurement of economic transactions in terms of m oney.
Recording financial effects of economic transactions in order of its
occurrence.
Classifying effects of economic transactions.
Preparing organized statement known as trial balance.
The distinction between book -keeping and accounting is given below:
Book -Keeping Accounting
Output of book -keeping is an input
for accounting.Output of accounting permit
informed judgments and decisions
by the user of accounting
information.
Purpose of book -keeping is to keep
systematic record of transactions
and event s of financial character in
order of its occurrence.Purpose of accounting is to find
results of operating activity of
business and to report financial
strength of business.
Book -keeping is a foundation of
accounting.Accounting is considered as a
languag eo fb u s i n e s s .
Book -keeping is carried out by
junior staff.Accounting is done by senior staff
with skill of analysis and
interpretation.
Objects of book -keeping is to
summarize the cumulative effect of
all economic transactions of
business for a given p eriod by
maintaining permanent record of
each business transaction with its
evidence and financial effects on
accounting variable.Object of accounting is not only
bookkeeping but also analyzing and
interpreting reported financial
information for informed decisions.
1.5.1ACCOU NTINGC Y C L E
When complete sequence of accounting procedure is done which
happens frequently and repeated in same directions during an accounting
period, the same is called an accounting cycle.
Steps/Phases of Accounting Cycle
The steps or phases of accounting cycle can be developed as under:
Recording of Transaction: As soon as a transaction happens it is at first
recorded in subsidiary book.munotes.in

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8Journal: The transactions are recorded in Journal chronologically.
Ledger: All journ als are posted into ledger chronologically and in a
classified manner.
Trial Balance: After taking all the ledger account closing balances, a
Trial Balance is prepared at the end of the period for the preparations of
financial statements.
Adjustment Entries:All the adjustments entries are to be recorded
properly and adjusted accordingly before preparing financial statements.
Adjusted Trial Balance: An adjusted Trail Balance may also be
prepared.
Closing Entries: All the nominal accounts are to be close db yt h e
transferring to Trading Account and Profit and Loss Account.
Financial Statements: Financial statement can now be easily prepared
which will exhibit the true financial position and operating results.
1.5.2BASIC ACCOU NTINGT E R M S
In order to un derstand the subject matter clearly, one must grasp
the following common expressions always used in business accounting.
Transaction: It means an event or a business activity which involves
exchange of money or money's worth between parties.
Goods/ Services: These are tangible article or commodity in which a
business deals. These articles or commodities are either bought and sold or
produced and sold.
Profit: The excess of Revenue Income over expense is called profit. It
could be calculated for each tr ansaction or for business as a whole.
Loss: The excess of expense over income is called loss. It could be
calculated for each transaction or for business as a whole.
Asset: Asset is a resource owned by the business with the purpose of
using it for genera ting future profits. Assets can be tangible andintangible .
Tangible Assets are the Capital assets which have some physical
existence. The capital assets which have no physical existence and whose
value is limited by the rights and anticipated benefits tha tp o s s e s s i o n
confers upon the owner are known as intangible Assets. They cannot be
seen or felt although they help to generate revenue in future .
Liability: It is an obligation of financial nature to be settled at a future
date. It represents amount of mo ney that the business owes to the other
parties.munotes.in

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9Contingent Liability: It represents a potential obligation that could be
created depending on the outcome of an event.
Capital: It is amount invested in the business by its owners. It may be in
the form of cash, goods, or any other asset which the proprietor or partners
of business invest in the business activity. From business point of view,
capital of owners is a liability which is to be settled only in the event of
closure or transfer of the business. Hence, it is not classified as a normal
liability.
Drawings: It represents an amount of cash, goods or any other assets
which the owner withdraws from business for his or her personal use
Debtor : The sum total or aggregate of the amounts which the cust omer
owe to the business for purchasing goods on credit or services rendered or
in respect of other contractual obligations, is known as Sundry Debtors or
Trade Debtors, or Trade Payable, or Book -Debts or Debtors.
Creditor: A creditor is a person to whom the business owes money or
money's worth. E.g. money payable to supplier of goods or provider of
service. Creditors are generally classified as Current Liabilities.
Trade Discount: It is the discount usually allowed by the wholesaler to
the retailer com puted on the list price or invoice price.
Cash Discount: This is allowed to encourage prompt payment by the
debtor. This has to be recorded in the books of accounts. This is calculated
after deducting the trade discount.
1.6TEST YOUR U NDERSTA NDING:
1.6.1 Fill in the blanks:
(a)The cash discount is allowed by --------- to the ------------- .
(b)Profit means excess of -------- over ------------- .
(c)Debtor is a person who ------- to others.
(d)In a credit transaction, the buyer is given a -------- facility.
(e)The fixed asset is generally held for ----------- .
(f)The c urrent liabilities are obligations to be settled in ------ period.
(g)The withdrawal of money by the owner of business is called ----------
(h)The amount invested by owners into business is called ----------- .
(i)Transaction means exchange of money or money's worth for ---------- .
(j)The net result of an income statement is ----------- or---------- .
(k)----------------------- The shows financial position of the business as
on a particular date.munotes.in

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10(l)The------------ discount is never entered in the books of accounts.
(m)-------------------------------- Vehicles represent expenditure while
repairs to vehicle would mean expenditure.
(n)-------------------------------- --------- Net worth is excess of over.
Ans 6.1 :
(a)creditor, debtor
(b)income, expenditure
(c)Owes
(d)Credit
(e)Longer period
(f)Short
(g)Drawings
(h)Capital
(i)Value
(j)Profit, loss
(k)Balance sheet
(l)Trade
(m)Capital, revenue
(n)Total assets, total liabilities
1.6.2 Give one word or a term used to describe the fol lowing: -
(a)An exchange of benefit for value
(b)A transaction without immediate cash settlement.
(c)Commodities in which a business deals.
(d)Excess of expenditure over income.
(e)Things of value owned by business to earn future profits.
(f)Amount owed by business to others .
(g)An obligation which may or may not materialise.
(h)An allowance by a creditor to debtor for prompt payment.
(i)Assets like brand value, copy rights, goodwill
Ans 6.2 :
(a)Transaction, (b) credit transaction, (c) goods, (d) loss, (e) Assets,
(f) liability, (g) co ntingent liability, (h) cash discount, (i) intangible
assets
1.6.3Indicate the best answer for each of the following questions:
1.The prime function of accounting is to :
a)Record economic data,
b)Provide the informational basis for action
c)Classifying and rec ording business transaction
d)Attention oneconomic goals
2.The basic function of financial accounting is to:
a)Record all business transaction
b)Interpret the financial data
c)Assist the management if Performing functions effectivelymunotes.in

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113.Management accounting provide s invaluable services to
management in performing :
a)All management functions
b)Co-ordinating management functions
c)Controlling functions
4.Book keeping is mainly concerned with
a)Recording of financial data relating to business operations
b)Designing the system i n recording classifying, summarising the
recorded data
c)Interpreting the data for internal end users
5.An accountant:
a)Often directs and review the work of book keepers
b)Does more of a routine work
c)Is required to have a lower level of knowledge than what is
required of a book keeper.
6.Management accounting:
a)Is a post mortem analysis of the past business activities
b)Is accounting for future
c)Portrays the position of the business as a whole
And 6.3 1 -c, 2–a, 3-a, 4-a, 5-a, 6-b
1.6.4 Define Accounting. S tate its Functions. How does it differ from
Book Keeping?
1.6.5State the person who should be interested in accounting
information
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122
ACCOU NTINGC O NCEPTS, PRINCIPLES
ANDC O NVENSTIO NS
Unit Structure
2.1 Accounting concepts, pri nciple and conventions
2.1.1 Meaning of accounting principles
2.1.2 Accounting concepts
2.1.3 Accounting conventions
2.2 System of book keeping
2.3 Accounting equation
2.4 System of accounting
2.5 Test your understanding:
2.1 ACCOU NTINGC O NCEPT S, PRI NCIPLE A ND
CONVENTIONS
2.1.1ACCOU NTINGPRINCIPLES
It is already been stated in chapter 1 that accounting are the
language of business though which normally a business house
communicate with the outside world. In order to make this language
intelligible and commonly understandable by all, it is necessary that it
should be based on certain uniform scientifically laid down standards.
These standards are termed as accounting principles.
Accounting principles are basic guidelines that provide standa rds
for scientific accounting practices and procedures. They guide as to how
the transactions are to be recorded and reported. They assure uniformity
andunderstand ability . Accounting concepts lay down the foundation for
accounting principles. They are id eas essentially at mental level and are
self-evident. These concepts ensure recording of financial facts on sound
bases and logical considerations.
Accounting conventions are methods or procedures that are widely
accepted. When transactions are recorded or interpreted, they follow the
conventions. Many times, however, the terms -principles, concepts and
conventions are used interchangeably.
2.1.2ACCOU NTINGCONCEPTS
Accounting concepts means the assumption or condition on which
the whole accounting str ucture stands. They are predetermined conditionsmunotes.in

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13which a book keeper must keep in mind while recording transaction in the
books of accounts.
1. Entity Concept: This concept is also known as “Business Entity
Concept" " Accounting Entity Concept"
This co ncept requires that the business and the persons who control
and own the business are two different entities. An accounting
entity is regarded as separate and distinct from its owners. Due to
this concept, the owners and his business are considered to be
separate. I.E as two separate entities.
All transactions of the business are recorded from the point of view
of the business. Personal activities of the owners are not recorded
in the accounting books of the business.
2. Money Measurement Concept: This c oncept states that only
those facts will be recorded in the accounts which can be expressed
interms Money.
If a fact cannot be measured in terms of Money, then such a fact
will not be recorded in the accounts Books. Money is a common
denomination in whic h all transactions are measured for the
purpose of recording in the books of accounts. If different
transactions are not expressed, in terms of money, it will become
meaningless to present the transaction.
For example if two tables and 5 Chairs are purcha sed. The various
quantities of tables and chairs cannot be added. However the value
of two tables and 5 chairs can be measured in terms of Money and
their values can then be added.
3. Cost concept : This concept requires that Assets should be valued
at ac quisition cost. rather than at its Market Values. Though assets
can be disclosed in the balance sheet at different values such as
market value, Realisable value etc. It is proper to show asset at cost
as valuing asset at cost is free from Bias. All other values involve
anelement of subjectivity in the valuation of the asset. For
example an asset may be purchased for Rs 50,000, its market value
be Rs 70,000. However Many a times, Market value of an asset
may not be available. Also many a times Market valu e is not real
market value but it is based on estimation.
4. Going Concern Concept:
According to this concept, the enterprise is normally viewed as a
going concern. It means that it is assumed that the enterprise will
continue their operation is near or foreseeable future. It is assumed
that the enterprise has neither the intention nor the necessity of
liquidation. It is also assumed that the enterprise will not materially
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14While preparing financial statements, it is assumed the Business
activity will continue and there is no intention to close the
business. This concept is a Fundamental Accounting Assumption.
5. Realisation Concept: This concept requires that profits should be
accounted for only when it is ac tually realised. This means that
revenue or profit should be recognised only when sale is affected
or services are rendered. For example if the Market value of an
Asset has increased, but the profit should be recognised only when
the asset is sold.
Howev er it should be noted that revenue may be recognized before
cash is received. It is not necessary that cash should be received.
However Revenue should be recognized only if a legal right to
receive cash is established.
6. Accrual Concept
This Concept re quires that Revenues and costs should be
recognised as and when they are earned or incurred and not as and
when money is received or paid. In other words we should follow
mercantile system of Accounting and not cash system of
Accounting. In cash system of Accounting Revenue is recognised
only when cash is received and expenses are recorded when cash is
paid. However this concept requires that, income and expenditure
should be recorded in the period to which the expense belong and
not in the period in whic h income are received or expenses are paid
7. Dual Aspect.
This concept is the core of Accountancy.
According to this concept, every business transaction is recorded in
the books has of accounts has two aspects. The two fold aspects
are increase or de crease in assets and liabilities. Every transactions
or event has two aspects such as
1. It increases one asset and decreases another asset
2. It increases and asset and increases Liability (including
Capital)
3. It decreases one asset and decreases a l iability (including
Capital)
For example when expenses are incurred, cash is reduced and
capital also reduces.
When Machine is purchased, cash is reduced and book value of
Machine increases.
8. Matching Concept
It is referred to as matching of expenses against incomes. It means
that all incomes and expenses relating to the financial period to
which the accounts relate should be taken in to account without
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159. Full Disclosure Concept
As per this concept, all signi ficant information must be disclosed.
Accounting data should properly be clarified, summarized,
aggregated and explained for the purpose of presenting the
financial statements which are useful for the users of accounting
information. Practically, this prin ciple emphasizes on the
materiality, objectivity and consistency of accounting data which
should disclose the true and fair view of the state of affairs of a
firm.
2.1.3ACCOU NTINGC O NVENTIONS
Accounting convention are the customs or traditions usually
adopted in preparation of accounting conducts or statements. Accounting
systems have been developed in response to the needs of the management
and the outside creditors for making economic decisions.
1. Convention of Consistency:
This concept requires t hataccounting policies adopted in preparing
the financial statements should be consistently followed.
In other words the Accounting policies should not be changed
unless it is absolutely necessary. If Accounting policies such as
Method of depreciation, method of valuation of closing stock etc
are frequently changed then it becomes meaningless to compare
the financial statements of two different periods in which different
accounting policies have been followed.
2. Convention of Disclosure:
This means tha t the accounts must be honestly prepared and they
must disclose all material information. The accounting reports
should disclose full and fair information to the proprietors,
creditors, investors and others. This convention is especially
significant in cas e of big business like Joint Stock Company where
there is divorce between the owners and the managers. Therefore,
The Indian Companies Act, 1956 not only requires that the
accounts of the company must give a true and fair view of the state
of affairs of th e company but it has also prescribed the contents
and forms of Profit and Loss Account and Balance Sheet.
3. Convention of Materiality:
The accountant should attach importance to material detail and
ignore insignificant details. If this is not done accou nts will be
overburdened with minute detail. As per the American Accounting
Association, “anitem should be regarded as material, if there is a
reason to believe that knowledge of it would influence the decision
of informed investor.” Therefore keeping the convention of
materiality in view, unimportant items are either left out or mergedmunotes.in

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164. Convention of Conservatism:
This convention cost of safety is a rule in the minds of
businessman. As per this convention, all anticipated losses are
taken into account but no profits are accounted until they arise.
2.2SYSTEM OF BOOK KEEPI NG
Book keeping, as explained earlier, is art of recording pecuniary
transactions in a regular and systematic manner, this recording of
transaction may be done accordi ng to any of the following system:
a) Single Entry System: An incomplete double entry can be termed as a
single entry system. According to Kohler, “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”. This system has been developed by some business houses,
who for their convenience keep only some essential records. Since all
records are kept, the system is not reliable and can be used only by small
business firm.
b) Double Entry System
It was in 1494 that Luca Pacioli the Italian mathematician, first published
his comprehensive treatise on the principles of Double Entry System. The
use of principles of double entry system made it possi ble to record not
only cash but also all sorts of mercantile transactions. According to it,
every transaction has two fold aspects debit and credit and both the aspects
are to be recorded in the books of accounts.
Features of Double Entry System
Every tra nsaction has two fold aspects, i.e., one party giving the
benefit and the other receiving the benefit.
Every transaction is divided into two aspects, Debit and Credit.
One account is to be debited and the other account is to be credited
Every debit must ha ve its corresponding and equal credit.
Advantages of Double Entry System
Since personal and impersonal accounts are maintained under the
double entry system, both the effects of the transactions are recorded.
It ensures arithmetical accuracy of the books of accounts, for every
debit, there is a corresponding and equal credit. This is ascertained by
preparing a trial balance periodically or at the end of the financial year.
It prevents and minimizes frauds. Moreover frauds can be detected
early.
Errors c an be checked and rectified easily.munotes.in

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17The balances of receivables and payables are determined easily, since
the personal accounts are maintained.
The businessman can compare the financial position of the current
year with that of the past year/s.
The busi nessman can justify the standing of his business in
comparison with the previous year’s purchase, sales, and stocks,
incomes and expenses with that of the current year figures.
Helps in decision making.
The net operating results can be calculated by prep aring the Trading
and Profit and Loss A/c for the year ended and the financial position
can be ascertained by the preparation of the Balance Sheet.
It becomes easy for the Government to decide the tax.
It helps the Government to decide sickness of busine ss units and
extend help accordingly.
The other stakeholders like suppliers, banks, etc take a proper decision
regarding grant of credit or loans.
Limitations of Double Entry System
The system does not disclose all the errors committed in the books
accou nts.
The trial balance prepared under this system does not disclose certain
types of errors.
It is costly as it involves maintenance of numbers of books of
accounts.
2.3ACCOU NTING EQUATIO N
The whole Financial Accounting depends on Accounting Equation
which is also known as Balance Sheet Equation. The basic Accounting
Equation is:
Assets = Liabilities + Owner's equity
or A = L + P
or P = A -L } Where A = Assets, L = Liabilities, P = Capital or L = A
-P
While trying to do this correlation, please note that incomes or gains
will increase owner's equity and expenses or losses will reduce it.
Students are advised to go through the following example to
understand this equation properly.munotes.in

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18Example
Prepare an Accounting Equation from the following transact ions in the
books of Mr. A for January, 2016: -
1.Invested Capital in the firm Rs. 20,000
2.Purchased goods on credit from Das & Co. for Rs. 2,000
3.Bought plant for cash Rs.8,000
4.Purchased goods for cash Rs.4,000
5.Sold goods for cash (cost Rs. 4,000 + Profit Rs .2 , 0 0 0 )R s .6 , 0 0 0 .
6.Paid to Das & Co. in cash Rs.1,000
7.Received from B. Banerjee Rs. 300
8.Paid salary Rs.6,000
9.Received interest Rs5,000
10.Paid wages Rs .3,000
Solution:
Effect of transaction on Assets, Liabilities and Capital
Date Transaction Assets = Liabilities + Capital
January,
2016
1Invested Capital in the
firm ' 20,00020,000-
20,000
2Purchased goods on
credit from Das & Co.
Rs.' 2,000 +2,000 +2,000
Revised Equation 22,000= 2,000+ 20,000
3 Bought Plant for cash '
8,000+8,000
-8,000- -
Revised Equation 22,000 = 2,000+ 20,000
4Purchased goods for
cash ' 4,000+4,000
-4,000- -
Revised Equation 22,000= 2,000+ 20,000
5Sold Goods for cash
(Cost ' 4,000 + Profit '
2,000)+6,000
-4,000+2,000
Revised Equation 24,000 2,000+ 22,000
6Paid to Das & Co. for '
1,000-1,000 -1,000
Revised Equation 23,000= 1,000+ 22,000
7Received from
B.Banerjee for ' 300+300
-300
Revised Equation 23,000 = 1,000+ 22,000munotes.in

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198 Paid salary for ' 6,000 -6,000 -6,000
Revised Equation 17,000 = 1,000 + 16,000
9 Received Interest for '
5,000+5,000 +5,000
Revised Equation 22,000= 1,000+ 21,000
10 Paid Wages for '3,000 -3,000 -3,000
Revised Equation 19,000= 1,000+ 18,000
2.4 SYSTEM OF ACCOU NTING
a) Accrual Basis of Accounting
Accrual Basis of Accounting is a method of recording transactions
by which revenue; costs, assets and liabilities are reflected in the accounts
for the period in which they accrue. This basis includes consideration
relating to deferrals, allocations, depreciation and am ortization. This basis
is also referred to as mercantile basis of accounting.
b) Cash Basis of Accounting
Cash Basis of Accounting is a method of recording transactions by
which revenues, costs, assets and liabilities are reflected in the accounts
for th e period in which actual receipts or actual payments are made.
Distinction between Accrual Basis of Accounting and Cash Basis of
Accounting
Basis of DistinctionAccrual Basis of
AccountingCash Basis of
Accounting
1. Prepaid/Outstanding
Expenses/ accrue d/un
accrued Income in
Balance Sheet.Under this, there may
be prepaid/
outstanding expenses
and accrued/un
accrued incomes in
the Balance Sheet.Under this, there is
no
prepaid/outstanding
expenses or accrued/
unaccrued incomes.
2. Higher/lower Income
in case of prepaid
expenses and accrued
incomeIncome Statement
will show a relatively
higher incomeIncome Statement
will show lower
income.
3. Higher/lower income
incase of outstanding
expenses and un accrued
incomeIncome Statement
will show a relative ly
lower income.Income Statement
will show higher
income.
4. Availability of options
to an accountant to
manipulate the accounts
by way of choosing theUnder thi s, an
accountant has
options.Under this an
accountant has no
option to make a
choice as such.munotes.in

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20most suitable method out
of several alternative
methods of accounting
e.g.
FIFO/LIFO/SLM/WDV
c) Hybrid or Mixed Basis
Under the hybrid system of accounting, incomes are recognised as
in Cash Basis Accounting i.e. when they are received in cash and ex penses
are recognised on accrual basis i.e. during the accounting period in which
they arise irrespective of when they are paid.
2.5TEST YOUR U NDERSTA NDING:
2.5.1 Fill in the blanks:
a) The double entry system of accounting originated in
___________ ____
b) Accounting principle are generally based on ____________.
c) Financial statement is a part of _______________’
d) Accounting equation is capital = _______________ -
__________________.
e) Revenue is generally recognised at the point of sale accor ding to
_______ principle.
Ans: 2.5.1 A -Italy, B -Practicability, C -Accounting, D -Assets,
Liabilities ,E-Revenue recognition.
2.5.2 State whether following statement are True or False.
a)Accounting principles are rules of action or conduct which a re adopted
by the accountants universally while recording accounting
transactions.
b)It is on the basis of going concern concept that the assets are always
valued at market price.
c)The convention of disclosure implies that all material information
should be disclosed in the accounts.
d)The convention of conservatism takes into account all prospective
profit but leave all prospective losses.
e)Since the life of the business is assumed to be indefinite, the financial
statement of the business should be prepared only when it goes into
liquidation.munotes.in

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21f)In accounting all business transactions are recorded as having a dual
aspect.
Ans 2.5.2 : A–True, B -False , C -True, D -False, E -False, F -True.
2.5.3Choose the correct answer.
i. Accounting principles are generally base do n:
a)Practicability
b)Subjectivity
c)Conven ience in recording
ii The system of recording transactions based on dual aspect
concept is called:
a)Double accounting system
b)Double entry system
c)Single entry system
iiiThe practice of appending notes regar ding contingent liabilities in
accounting statements is pursuant to :
a)Convention of consistency
b)Money measurement concept
c)Convention of conservatism
d)Convention of disclosure
IvThe convention of conservatism is applicable:
a)In proving for discount on cre ditor
b)In making provision for bad debts
c)Providing for depreciation
VThe convention of conservatism, when applied to the balance sheet,
result in:
a)Understatement of assets
b)Understatement of liabilities
c)Overstatement of capital
viAll of the following are fundamental accounting concepts except:
a)Dual Aspect
b)Going Concern
c)Full Discloser
d)Business entity
ViiIt is essential to standardize the accounting principles and policies in
order to ensure:
a)Transparency
b)Consistency
c)Comparability
d)All of the above
Ans 2.5.3 : i-a, ii–b, iii-d, iv-b, v-a, vi -c, vii -dmunotes.in

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222.5.4Discuss briefly the basic accounting concepts and fundamentals
accounting assumptions
2.5.5What are the accounting concepts and conventions. Name them
and explain any two accounting concepts in details.
2.5.6Explain any three of following accounting concepts:
a)Money Measurement Concept
b)Business Entity Concept
c)Going concern Concept
d)Realisation Concept
e)Cost Concept
2.5.7Show the effect of the following transactions on the assets,
liabilities and capital of Mr. R Rajkumar through the accounting
equation.
1He started business with cash Rs.20,000
2He purchased goods for cash Rs. 5,000
3Purchased goods on credit from Mr. Madan for Rs.10,000
4Sold goods dor cash costing Rs.8,000 for Rs.10,000
5Withdrew Rs.1,000 f rom business in cash to pay for his private
expenses.
6Electricity bills paid for Rs.500
7He sold goods costing Rs.5,000 to Mr. Sanjay for Rs.6,000
8Rent outstanding Rs.400
9He b orrowed Rs.5,000 from Mr. Lala
10Purchased goods for cash Rs.5,000
munotes.in

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23MODULE -II
3
ACCOU NTINGP R I NCIPLES
Unit Structure
3.1 Introduction
3.2 Accounting Concepts
3.3 Accounting Principles
3.4 Accounting Conventions
3.5 Widely Accepted Accounting Concepts
3.1 INTRODUCTIO N
Accounting is the language of the business. Accounting Principles
are the rules or guidelines which are developed to maintain a uniformity
and consistency in accounting records. This generally accepted
accounting principles (GAAP’s) provides unity of under standing and
unity of approach in the practice of accounting and also in better
preparation of financial statements.
Let us imagine a situation where you give copies of your books of
accounts to three different accountants and you ask them to prepare
financial statements and to compute the income from business for the
financial year on the basis of books of accounts given to them. All three
accountants are ready with the financial statements and all three
accountants have computed different figure of incom e i.e. profit from the
business and that too with very wide variations among them. Guess in
such a situation what impact would it leave on you about accounting
profession. To avoid this, a generally accepted set of accounting
principles/rules have been dev eloped.
Financial statements prepared by the accountants to communicate
financial information to the various users of financial statements for
decision making purpose. Therefore, it is important that financial
statements prepared by different business entities should be prepared on
uniform basis. Also there should be consistency over a period of time in
the preparation of these financial statements. If every accountant starts
following his own methods and concepts for accounting different items
then the re will be confusion.
To avoid confusion and to achieve uniformity, accounting process
is applied within the conceptual framework of ‘Generally Accepted
Accounting Principles’ (GAAPs).munotes.in

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24The term GAAPs is used to describe rules developed for the
preparati on of the financial statements and are called
1.Accounting Concepts;
2.Accounting Conventions;
3.Accounting Postulates ;
4.Accounting Principles
3.2 ACCOU NTINGC O NCEPTS
Accounting Concepts are certain rules that accountant should
follow while recording business transactions and preparing accounts.
E.g. in India there is a basic rule to be followed by everyone that
one should walk or drive on his/her left hand side of the road. It helps in
the smooth flow of traffic. Similarly, there are certain rules that an
accountant should follow while recording business transactions and
preparing accounts .
Accounting concepts lay the foundation on the basis of which the
accounting principles are followed. Concepts constitute the very basis of
accounting. There are various co ncepts of accounting and all have been
developed over the period of time from experience and thus, they are
university accepted rules.
3.3 ACCOU NTINGP R I NCIPLES
Meaning of Principles:
A general law or rule followed or adopted as a guide to action is
known as a principle.
Definitions of Accounting Principles:
1.According to American Institute of Certified Public Accountants
(AICPA) : “The accounting principles are general law or rule adopted
or preferred as a guide to action, a settled ground or basis of conduct
or practice.”
2.According to R.NAntony: “ The rules and conventions of accounting
are commonly referred to as Principles.”
Accounting principles must satisfy following conditions:
1.They should be based on real assumptions;
2.They must be simple, understandable & self explanatory;
3.They must be followed consistently;
4.They should be able to reflect future predictions;
5.They should be informational for the users.munotes.in

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253.4 ACCOU NTINGC O NVENTIONS
An accounting convention refers to common practices which are
universally followed in recording and presenting accounting statements of
the business entity. Accounting conventions are followed like customs,
traditions, etc. in a society. They make accounting information more clear
and useful. They have evolved th rough the regular and consistent practice
over the years. They facilitate uniform recording in the books of accounts.
3.5 WIDELY ACCEPTED ACCOU NTINGC O NCEPTS
1.Business Entity Concept
2.Money Measurement Concept
3.Accounting Period(Periodicity) Concept
4.Cost Co ncept
5.Realization Concept or Revenue recognition Concept
6.Matching Concept
7.Accrual Concept
8.Dual Aspect Concept
9.Materiality Concept
10.Conservatism or Prudence Concept
1)Business Entity Concept : Entity Concept states that Business
Enterprise is separate entity from its owner. As per this concept
business transactions to be recorded in business books and owner’s
transactions to be recorded in his personal books.
Entity concept means that enterp rise owes to the owner for capital
provided by the owner.
Example: Mr. A Commenced business by investing Rs. 12,00,000/ -
with which he purchased Equipments & other Fixed assets required in
business for Rs. 10,00,000/ -& kept balance in hand. i.e. Rs. 2,0 0,000/ -
The financial position(Balance sheet) of business is as follows:
Balance SheetLiabilitiesAmount(Rs.)AssetsAmount(Rs.)
Capital 1200000 Equipment & Fixed
Assets1000000
Cash in Hand 200000
1200000 1200000
This means that Business Enterprise owes to Mr. A Rs.12,00,000/ -
now if Mr. A Spends/ uses Rs. 50,000/ -for Household Expenses from
business capital Fund then as per business entity concept it should not be
classified/recorded as business expenses but should be char ged to capital
account i.e. Capital will get reduced by Rs. 50,000/ -& revised Balance
sheet will show following positionmunotes.in

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26Balance SheetLiabilitiesAmount(Rs.)AssetsAmount(Rs.)
Capital 12,00,000 Equipment
&F i x e d
Assets10,00,000
Less:
Drawings(Personal
Expenses.)(50,000) 11,50,000 Cash in
Hand1,50,000
11,50,000 11,50,000
2)Money Measurement Concept: This Concept states that only
monetary transactions i.e. which can be measured in terms of money
are to be recorded. In accounting, a record is made only of those facts
or transactions that can be expressed in monetary terms. It provides a
common unit for measurement, i.e., money for measuring, recording
and summarizing the transaction. Events, which cannot be expressed
in money terms, do not find a place in account books. Example, salary
paid to manager is recorded in account books but his competence is
has no place in account books.
3)Accounting Period / Periodicity Concept: All the transactions are
recorded in the books of accounts on the assumption that profits on
these transactions are to be ascertained for a specified period. This is
known as periodici ty or accounting period concept. Thus, this concept
requires that a balance sheet and profit and loss account should be
prepared at regular intervals. This is necessary for different purposes
like, calculation of profit, ascertaining financial position, ta x
computation etc. Usually one year is taken as one accounting period
which may be a calendar year or a financial year.
Thus, the periodicity concept facilitates in:
(a)Comparing of financial statements of different periods
(b)Uniform and consistent accounting treatment for ascertaining the
profit and assets of the business
(c)Matching periodic revenue with expenses for getting correct results
of the business operations.
4)Cost Concept: As per cost concept value of asset recorded at its
acquisition/purchase cost, in other words, at its historical cost.
For example, if a plot of land is purchased for Rs. 1,50,000 then as
per this concept, the asset will be recorded in the books at Rs.
1,50,000, even if its market value at that time i sR s .2 , 0 0 , 0 0 0 .
5)Realization Concept or Revenue recognition Concept: This
Concept deals with the problem, when the revenue should be
recognized? According to this concept, the sale should be recognised
at the point, when the property in goods passes to the buyer and he
becomes legally liable to pay and other income is recognised, when
they accrue.munotes.in

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27Example: Mr. A places an order with Mr. B for supply of certain
goods, which are yet to be manufactured. On receipt of order, Mr. B
purchases raw materials employ s workers, produces the goods and
delivers finished goods to Mr.A. Mr. A makes payment on receipt of
goods. In this case, the sale will be presumed to have been made not at
the time of receipt of the order for the goods, but at the time, when
goods are del ivered to Mr. A.
6)Matching Concept: In this concept, all expenses matched with
revenue of that period should only be taken into consideration. The
objective of running business is to earn profit in order to ascertain the
profit made by the business during a period. It is necessary that the
revenues of the period should be matched with the cost (Expenses) of
the period. The term matching means appropriate association of related
revenues and expenses.
Example: ABC Ltd. purchases a large appliance from wholes alers for
Rs.5,000 and resells it to a local restaurant for Rs.8,000. At the end of
the period, ABC Ltd. should match the Rs.5,000 cost with the
Rs.8,000 revenue .
7)Accrual Concept: Under Accrual concept/ Accrual basis of
accounting, income must be recorde d in the accounting period in
which it is earned. Therefore, accrued income must be recognized in
the accounting period in which it arises rather than in the subsequent
period in which it will be received. Conversely, prepaid income must
be not be shown as income in the accounting period in which it is
received but instead it must be presented as such in the subsequent
accounting periods in which the services or obligations in respect of
the prepaid income have been performed.
Example: Suppose Mr. Ramesh rents a house from Suresh at
Rs.100,000 per year. Now consider the following three cases in which
Ramesh pays cash to Suresh and records rent expense.
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28In above example, even though cash paid is different in all the
three cases but the rent expense recorded is Rs.1,00,000 in each case.
Justification behind that is the accrual concept of accounting in which
expenses must be recorded in the accounting period in which they are
incurred not in the period in which they arepaid.
Notice that in case “b” Mr. Ramesh has paid Rs.80,000 cash but has
recorded Rs.100,000 expense during the period because the annual rent is
Rs.100,000 not Rs.80,000. The remaining Rs.20,000 will be paid
subsequently. Also notice that in case “c ” Mr. Ramesh has paid
Rs.1,50,000 but has recorded Rs.100,000 expense, the balance of
Rs.50,000 will be adjusted against the rent of subsequent period.
8)Dual Aspect Concept: This is a basic concept of accounting.
According to this concept, every business transactions has dual effect -
1stAspects 2ndAspects
(i)It increases on Asset and decreases other Asset,
[Purchase of Machinery] [Payment of Cash]
(ii)It increases an Asset and simultaneously increase liability,
[Purchase of Machinery] [Payment at future date
(on credit basis) ]
(iii)It decreases one Asset, and decreases one Liability
[Payment of Cash] [Settlement of Liability]
(iv)It increase liability, and decreases simultaneously liabilit y
[Bank Loan Obtained] [Payment to Creditors
(Using Loan Amount) ]
For example, suppose Mr. Rahul purchases Assets of Rs. 1000 00 in
cash. In this business transaction, Mr. Rahul receives the assets of Rs.
100000, but on the other hand, Cash balance will decrease by Rs.
100000 So, Assets Account and Cash Account shall be affected by this
transaction.
Thus in every business transa ction, one aspect represents the assets or
expenses other represents the claim or income and these two expects
are always equal. This approach generates the concept of accounting
equation, which can be summarized as below:
For example, if A starts a business with a capital of Rs. 1,00,000.
There are no aspects of this transaction. On the one hand, the business
has asset (in the form of cash) of Rs. 1,00,000, whil e on the other hand
the business has to pay to the proprietor a sum of Rs. 1,00,000, which
is known as proprietor’s capital. This expression can be shown in the
form of accounting equation as follows:Liabilities = Assets
External Liabilities + Capital = Assetsmunotes.in

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29Capital (Liability) = Cash (Assets)
1,00,000 = 1,00,000
In the example given above, if the Machinery worth Rs. 50,000 is
purchased, the situation will be as follows:
Capital (Rs. 1,00,000) =C a s h( R s .5 0 , 0 0 0 )+M a c h i n e r y( R s .5 0 , 0 0 0 )
Thus, this concept develops a relationship between liabilities and
assets. The Accounting Equation can be technically started as “for
every debit, there is an equivalent credit”. As a matter of fact, the
entire Double Entry System of Book -Keeping is based on this concept.
9)Materiality Concept: As per the concept of mater iality, all the items
having significant economic effect on the business of the enterprise
should be disclosed in the financial statements and any insignificant
item which will only increase the work of accountant but will not be
relevant to the users need should not be disclosed in the financial
statements.
The term materiality depends not only upon the amount of the item but
also upon the size of the business, nature & level of information, level
of the person making decision etc. Moreover an item materi al to one
person may be immaterial to another person. What is important is that
omission of any information should not impair the decision -making of
various users.
10)Conservatism or Prudence Concept: Conservatism states that the
accountant should not antici pate income and should provide for all
possible losses. When there are many alternative values of an asset, an
accountant should choose the method which leads to the lesser value.
Later on we should see that the golden rule of current asset valuation –
‘cost or market price ‘whichever is lower originated from this concept.
Exercise :
1) Provision for bad debts is made due to the principle of :
A. Conservatism
B. Revenue matching
C. Full disclosure
D. Both (a) and (b)
Answer : A
2) Recording of fixed assets at cost ensures adherence of :
A. Conservatism
B. Cost concept
C. Going concern concept
D. Accrual concept
Answer : Bmunotes.in

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303) Fundamental accounting assumptions are :
A. Going concern, conservatism, accrual
B. Going concern, matching , consistency
C. Going concern, consistency, accrual
D. Going concern, entity, periodicity
Answer : C
4) When fixed assets are sold :
A. Total assets will increase
B. Total liabilities will increase
C. Total assets will decrease
D. There is no change in total assets
Answer : D
5) The accounting equation is based on :
A. Going concern concept
B. Dual aspect concept
C. Money measurement concept
D. All of these
Answer : B
6) …… Concept is the basic idea that the business is separate from
owner.
A. Dual aspect
B. Entity
C. Realization
D. Materiality
Answer : B
7) The owner of a company includes his personal medical expenses in
the company’s income statement. Indicate the principle that is
violated.
A. Cost pri nciple
B. Conservatism
C. Disclosure
D. Entity concept
Answer : D
8) Two primary qualitative characteristics of financial statements are :
A. Understandability and materiality
B. Relevance and reliability
C. Materiality and reliability
D. Relevance and understandability
Answer : B
9) Money owed from an outsider is a :
A. Asset
B. Liability
C. Expense
D. Capital
Answer : Amunotes.in

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3110) GAAP’s are
A. Generally accepted accounting policies
B. Generally accepted accounting princip les
C. Generally accepted accounting provisions
D. None of these
Answer : B
11) ….. Refer to the general agreement on the usage and practices in
social or economic life :
A. Accounting assumptions
B. Accounting conventions
C. Accounting policies
D. Accounting principles
Answer : B
12) Double entry principle means :
A. Writing twice the same entry
B. Writing all the entries twice in the book
C. Having debit for every credit and credit for every debit
D. All of the above
Answer : C
13) No inference of profit and the provision making policy for all
possible losses is due to :
A. Convention of consistency
B. Convention of conservatism
C. Convention of disclosure
D. Convention of materiality
Answer : B
14) The underlying accounting principle necessitating amortization of
intangible assets is / are
A. Cost concept
B. Realization concept
C. Matching concept
D. Both b and c
Answer : C
15) If going concern concept is no longer valid, which of the following is
true?
A. All prepaid assets would be completely written off immediately
B. The allowance for uncollectible accounts would be eliminated
C. Intangible assets would continue to be carried at net amortized
historical cost
D. Land held as an investment would be valued at its realizable
value.
Answer : Dmunotes.in

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3216) Window dressing of accounts means :
A. Presenting accounts in a beautiful manner
B. Showing more losses to avoid income tax
C. Showing more profits to attract investment
D. All of the above
Answer : C
17) Which financial statement represents the accounting equation?
Assets = Liabilities + Owner’s equity
A. Income statement
B. Cash flow statement
C. Balance sheet
D. Funds flow statement
Answer : C
18) During the life -time of an entity, accountants prepare financial
statements at arbitrary points of time as per :
A. Prudence
B. Consistency
C. Periodicity
D. Matching
Answer : C
19) The accounting convention of matching means :
A. Profit for the peri od to be matched with sales revenue
B. Profit for the period to be matched with investment
C. Expenses of one period to be matched against the expenses of
another period
D. Expenses of one period to be matched against the revenue of
the same period.
Answer : D
20) Recording of capital contributed by the owner as liability ensures
adherence of principle of
A. Matching
B. Going concern
C. Double entry
D. Separate entity of business
Answer : D
21) Omission of paise and showing the round fi gures in financial
statement is based on :
A. Conservatism concept
B. Consistency concept
C. Materiality concept
D. Realization concept
Answer : Cmunotes.in

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3322) Accounting does not record non -financial transactions because of
A. Accrual concept
B. Cost concept
C. Continuity concept
D. Money measurement concept
Answer : D
23) Which of these not a fundamental accounting assumption?
A. Going concern
B. Consistency
C. Conservatism
D. Accrual
Answer : C
24) Fixed assets and current as sets are categorized as per concept of :
A. Separate entity
B. Going concern
C. Consistency
D. Time period
Answer : D
25) The obligations of an enterprise other than owner’s fund are known
as :
A. Assets
B. Liabilities
C. Capital
D. None of these
Answer : B
26) Which concept requires that only those transactions which can be
expressed in terms of money should be recorded in books of account?
A. Business entity
B. Dual aspect
C. Money measurement
D. None of these
Answer : C
27 An asset was purchased for Rs. 6,60,000. Cash was paid Rs. 1.20.000
and for the balance Rs. 5,40,000 loan was taken. What will be the
effect on fixed assets? It will go up by
A. Rs. 1,20,000
B. Rs. 5,40,000
C. Rs. 6,60,000
D. NIL
Answer : Cmunotes.in

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3428) Cash of Rs. 2,000 is withdrawn for personal expenses. This will be
debited to which account :
A. Drawings A/c
B. Creditor A/c
C. Capital A/c
D. Cash A/c
Answer : A
29) Estimated selling price less estimated cost of sales is
A. Net realizable value
B. Cost of purchase
C. Cost of goods sold
D. None
Answer : A
30) Proprietor is treated as creditor of business due to :
A. Periodicity concept
B. Materiality concept
C. Entity concept
D. Consistency concept
Answer : C
31) Outstanding expenses is included in P & L A/c, according to which
concept
A. Matching
B. Full disclosure
C. Accrual
D. Going Concern
Answer : C
32) Which does not follow dual aspect concept?
A. Increase in one asset, decrease in other
B. Increase in both asset and liability
C. Decrease in one asset, decrease in other
D. Increase in one asset and capital
Answer : C
33) According to which concept, the owner of an enterprise pays the
“interest on drawings”
A. Accrual concept
B. Conservatism concept
C. Entity concept
D. Dual Aspect concept
Answer : C
34) If market value of closing inventory is reduced below cost price,
which concept will play role?
A. Materiality
B. Entity
C.Realization
D. Consistency
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3535) Cost concept basically recognize
A. Fair market value
B. Historical cost
C. Realisable value
D. Replacement cost
Answer : B
36) Matching concept is based on : Revenue -------------- =P r o f i t
A. Liability
B. Expense
C. Asset
D. None
Answer : B
37) Small items like stapler are not shown in books as fixed assets
although they are used in business for long period due to :
A. Consistency
B. Materiality
C. Accrual
D. Cost
Answer : B
38) XYZ Ltd. Follows the written down value method for depreciating
machinery year after year due to
A. Consistency
B. Convenience
C. Comparability
D. Conservatism
Answer : A
39) Human resource cant be shown in the Balance Sheet because of ------
---concept
A. Realisation
B. Conservatism
C. Going concern
D. Money measurement
Answer : D
40) The policy of “anticipate no profit and provide for all possible
lossess” arises due to convention of
A. Consistency
B. Disclosure
C. Conservatism
D. Matching
Answer : C
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364
BASICS OF ACCOU NTINGS T A NDARDS
Unit Structure
4.1 Meaning & Introduction
4.2 Accounting Standards in Brief
4.1 MEA NING&I NTRODUCTIO N
Accounting standards are the written policy documents issued by
the regulatory authority, experts accounting body or by the government
covering various aspects of recognition, treatment, measurement,
presentation & disclosure of accounting transactions and events in the
financial statements. The accountant h as to adhere to various accounting
standards while preparing financial statements of the entities.
Accounting standard provide framework and standard accounting
policies so that the financial statement of different enterprises become
comparable.
The acco unting standards deals with the issues of –
i.Recognition of events and transactions in the financial statements;
ii.Measurement of these transactions and events;
iii.Presentation of these transactions and events in the financial
statements in a manner that is mean ingful and understandable to the
reader; and
iv.The disclosure requirements which should be there to enable public at
large and the stakeholders and the potential investors in particular, to
get insight into what these financial statement are trying to reflec ta n d
thereby facilitating them to take prudent and informed business
decisions.
4.2 ACCOU NTING STA NDARDS I NBRIEFAS-1-Disclosure of Accounting Policies:Accounting Policies refer tospecific accounting principles and the method of applying those principlesadopted by the enterprises in preparation and presentation of the financialstatements.AS-2-Valuation of Inventories:The objective of this standard is toformulate the method of computation of cost of inventories / stock,determine thevalue of closing stock / inventory at which the inventory isto be shown in balance sheet till it is not sold and recognized as revenue.munotes.in

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37AS 3 -Cash Flow Statements:Cash flow statement is additionalinformation to user of financial statement. Thisstatement exhibits the flowof incoming and outgoing cash.This statement assesses the ability of theenterprise to generate cash and to utilize the cash.This statement is one ofthe tools for assessing the liquidity and solvency of the enterprise.AS 4 -Contingencies and Events occurring after the balance sheetdate:In preparing financial statement of a particular enterprise,accounting is done by following accrual basis of accounting and prudentaccounting policies to calculate the profit or loss for the year and torecognize assets and liabilities in balance sheet. While following theprudent accounting policies, the provision is made for all known liabilitiesand losses even for those liabilities / events, which are probable.Professional judgment is required to classify the likehood of the futureevents occurring and, therefore, the question of contingencies and theiraccounting arises.Objective of this standard is to prescribe the accountingof contingencies and the events, which take place after the balance sheetdate but before approval of balance sheet by Board of Directors.T h eAccounting Standarddeals with Contingencies and Events occrring afterthe balance sheet date .AS 5 -Net Profit or Loss for the Period, Prior Period Items andchange in Accounting Policies:The objective of this accountingstandard is to prescribe the criteria for certain items in the profit andloss account so that comparability of the financial statement can beenhanced. Profit and loss account being a period statement covers theitems of the income and expenditure of the particular period. Thisaccounting standard alsodeals with change in accounting policy,accounting estimates and extraordinary i tems.AS 6 -Depreciation Accounting:It is a measure of wearing out,consumption or other loss of value of a depreciable asset arising fromuse, passage of time.Depreciation is nothing but distribution of totalcost of asset over its useful life.AS 7 -Construction Contracts:Accounting for long term constructioncontracts involves question as to when revenue should be recognized
andhow to measure the revenue in the books of contractor.A st h eperiod of construction contract is long, workof construction starts inone year and is completed in another year or after 4 -5y e a r so rs o .Therefore question arises how the profit or loss of constructioncontract by contractor should be determined. There may be followingtwo ways to determine profit or loss: On year -to-year basis based onpercentage of completion or on completion of the contract.AS 8 -Accounting for Research & Development: Accounting forresearch & development, is withdrawn from the date of AS 26,Intangible assets, becoming mandatory for respective enterprises.munotes.in

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38AS 9 -Revenue Recognition: The standardexplains as to when therevenue should be recognized in profit and loss accountand also statesthe circumstances in which revenue recognition can be postponed.Revenue means gross inflow of cash, receivable or other considerationarising in the course of ordinary activities of an enterprise such as thesale of goods, rendering of services, and use of enterprises resourcesby other yielding interest, dividend and royalties. In other words,revenue is a charge made to customers / clients for goods supplied andservices rendered.AS 10 -Accounting for Fixed Assets:AS 10 prescribes accounting forfixed assetsused by entity in the business. AS defines term fixed asset.It is an asset, which is held with intention of being used for thepurpose of producing or providing goods and services not held for salein the normal course of business and expected to be used for more thanone accounting period.AS 11 -The Effects of changes in Foreign Exchange Rates :Effectof Changes in Foreign Exchange Rate shall be applicable in Respect ofAccounting Period commencing on or after 01 -04-2004 and ismandatory in nature.This accounting Standard applicable toaccounting for transaction in foreign currencies in translating in thefinancial statement of foreign operations. Effect of changesin foreignexchange rate, an enterprises should disclose following aspects:
a)Amount Exchange Difference included in Net profit or Loss;
b)Amount accumulated in foreign exchange translation reserve;
c)Reconciliation of opening and closing balance of Foreign Exchangetranslation reserve;AS 12 -Accounting for Government Grants:Accounting standard 12deals with accounting for government grants both capital and revenue
from government. Government Grants are assistance by the Govt. inthe form of cash or kind to an enterprise in return for past or futurecompliance with certain conditions. Government assistance, whichcannot be valued reasonably, is excluded from Govt. grants,. Thosetransactionswith Government, which cannot be distinguished from thenormal trading transactions of the enterprise, are not considered asGovernment grants.AS 13 -Accounting for Investments:AS 13 provides accountingprinciples for investments in the financial statement and relateddisclosure requirements. As per AS 13 Investment meansthe assetsheld for earning income by way of dividend, interest and rentals, forcapital appreciation or for other benefits.AS 14 -Accounting for Amalgamation:This standard prescribesaccounting for amalgamation .This accounting standard deals withaccounting to be made in books of Transferee Company in case ofamalgamation. The standard is applicable when acquired company ismunotes.in

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39dissolved and separate entity ceasedexist and purchasing companycontinues with the business of acquired companyAS 15 -Employee Benefits:Accounting Standard 15 prescribes theaccounting and disclosure for employee benefits .This Standard coversall forms of employee benefits i.e. Short term employee benefits(Salaries, Leave, bonus, housing, mediclaim etc.), Post employmentbenefits (gratuity, pension, post employment medical care etc.) andother long term employee benefits a nd termination benefits.AS 16 -Borrowing Costs :Enterprises are borrowing the funds toacquire, build and install the fixed assets and other assets, these assetstake time to make them useable or saleable, therefore the enterprisesincur the interest(cost on borrowing) to acquire and build these assets.The objective of the Accounting Standard is to prescribe the treatmentof borrowing cost(interest + other cost) in accounting, whether thecost of borrowing should be included in the cost of assets or not.AS 17 -Segment Reporting:An enterprise needs in multipleproducts/services and operates in different geographical areas.Multiple products / services and their operations in differentgeographical areas are exposed to different risks and returns.Information about multiple products / services and their operation indifferent geographical areas are called segment information.S u c hinformation is used to assess the risk and return of multipleproducts/services and their operation in different geographical areas.
Disclosure of such information is called segment reporting.AS 18 -Related Party Disclosure:Sometimes business transactionsbetween related parties lose the feature and character of the armslength transactions. Related party relationship affects the volume anddecision of business of one enterprise for the benefit of the otherenterprise. Hencedisclosure of related party transaction is essentialfor proper understanding of financial performance and financialposition of enterprise.AS 19 -Accounting for leases:Lease is an arrangement by which thelesser gives the right to use an assetfor given period of time to thelessee on rent. It involves two parties, a lessor and a lessee and an assetwhich is to be leased.The lessor who owns the asset agrees to allowthe lessee to use it for a specified period of time in return of periodicrent payments.AS 20 -Earning Per Share: Earning per share (EPS) is afinancialratio that gives the information regarding earning available to eachequity share.It is very important financial ratio for assessing the stateof market price of share. This accounting standard gives computationalmethodology for the determination and presentation of earning pershare, which will improve the comparison of EPS. The statement ismunotes.in

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40applicable to the enterprise whose equity shares or potential equityshares are listed in stock exchange.AS 21 -Consolidated Financial Statements: Theobjective of thisstatement is to present financial statements of a parent and itssubsidiary (ies) as a single economic entity.In other words the holdingcompany and its subsidiary (ies) are treated as one entity for thepreparation of these consolidated financial statements. Consolidatedprofit/loss account and consolidated balance sheeta r ep r e p a r e df o rdisclosing the total profit/loss of the group and total assets andliabilities of the group. As per this accounting standard, the conslidatedbalance sheet if prepared should be prepared in the manner prescribedby this statement.AS 22 -Accounting for Taxes on Income:This accounting standardprescribes the accounting treatment for taxes on income. Traditionally,amount of tax payable is determined on the profit/loss computed as perincome tax laws.AS 23 -Accounting for Investments in Associates in consolidatedfinancial statements:The accounting standard was formulated withtheobjective to set out the principles and procedures for recognizingthe investment in associates in the consolidated financial statements ofthe investor, so that the effect of investment in associates on thefinancial position of the group is indicated.AS 24 -Discontinuing Operations:The objective of this standard is toestablish principles for reporting information about discontinuingoperations.The focus of the disclosure of the Information is about theoperations which the enterprise plans to discontinuerather thandisclosing on the operations which are already discontinued. However,the disclosure about discontinued operation is also covered by thisstandard.AS 25 -Interim Financial Reporting (IFR):Interim financialreporting is the reporting for periods of less than a yeargenerally for aperiod of 3 months.AS 26 -Intangible Assets : An Intangible Asset is an Identifiable non -
monetary Asset without physical substanceheld for use in theproduction or supplying of goods or services for rentalsto others orfor administrative purposeAS 27 -Financial Reporting of Interest in joint ventures:JointVenture is defined as a contractual arrangement wherebytwo or moreparties carry on an economic activity under 'joint control' .Controlisthepower to govern the financial and operating policies of aneconomic activityso as to obtain benefit from it. 'Joint control' is thecontractually agreed sharing of control over economic activity.munotes.in

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41AS 28 Impairment of Assets:The dictionary meaning of 'impairmentof asset' is weakening in value of asset. In other words when the valueof asset decreases, it may be called impairment of an asset. As per AS -
28 asset is said to be impaired when carrying amountof asset is morethan itsrecoverable amount .
Carrying Amount means book value of Asset
Recoverable Amount means Market value of AssetAS 29 -Provisions, Contingent Liabilities And ContingentAssets: Objective of this standard is to prescribe theaccounting forProvisions, Contingent Liabilities, Contingent Assets, Provision forrestructuring cost
Provision: It is a liability, which can be measuredonly by using asubstantial degree of estimation
.
Liability: A liability is present obligationof the enterprise arising frompast events the settlement of which is expected toresult in an outflowfrom the enterprise of resources embodying economic benefits.Exercise :
1) The accounting standards are mandatory for
A. Companies
B. Partnership concern
C. Charitable organizations
D. Sole proprietorship
Answer : A
2) Accounting standards refers to specific accounting :
A. Principle
B. Methods of applying those principles
C. Both a and b
D. None
Answer : C
3) Construction Contract :
A. AS-5
B. AS-6
C. AS-7
D. AS-9
Answer : C
4) Accounting standards ----------- the status
A. Can over -ride
B. Cannot over -ride
C. May over -ride
D. None
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425) Revenue Recognition is
A. AS-9
B. AS-12
C. AS-10
D. AS-11
Answer : A
6) AS-8 on accounting for research and development :
A. Is replaced by As -26
B. Is applicable only to listed companies
C. Is mandatory for research institutions
D. Is still in use
Answer : A
7) The purpose of accounting standards is to :
A. Harmonies accounting policies
B. Eliminate the non comparability of financial statements
C. Improve reliability of financial statements
D. All of the above
Answer : D
8) AS-2i so n:
A. Disclosure of accounting policies
B. Valuation of inventories
C. Revenue recognition
D. Depreciation accounting
Answer : B
9) AS are issued by
A. Central Government
B. Company Law Board (CLB)
C. ICAI
D. Income Tax Department
Answer : C
10) Till date the no of Standards issued are
A. 29
B. 30
C. 31
D. 32
Answer : D
11) Accounting Standard 6 is on :
A. Disclosure of accounting policies
B. Depreciation
C. Valuation of Inventories
D. Contingent Asset and Contingent Liabilities
Answer : B
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435
INTRODUCTIO NTO IFRS
Unit Structure
5.1 Introduction
5.2 Purpose
5.3 Scope
5.4 International Financial Reporting Standards
5.1 INTRODUCTIO N
IFRS stands for International Financial Reporting Standards.
IFRS are developed by International Accounting st andards boards (IASB).
IFRS is set of standards used in many parts of the world, including the
European Union, Hong Kong, Australia, Malaysia, Russia, South Africa,
Singapore etc. for preparation of financial statements. Different
Countries uses differen t set of accounting standards while preparation of
financial statements for e.g. India uses its own set of Accounting standards
issued by the ICAI, United states have their US GAAP, Canada has its
Canadian GAAP and United Kingdom has its UK GAAP.
Concept ual Framework
Introduction: Financial statements are prepared and presented for
external users by many many entities around the world. Although such
financial statements may appear similar from country to country, there are
differences which have probabl y been caused by a variety of social,
economic and legal circumstances and by different countries having in
mind the needs of different users of financial statements when setting
national requirements.
The International Accounting Standards Board is commi tted to
narrowing these differences by seeking to harmonize regulations,
accounting standards and procedures relating to the Preparation and
presentation of financial statements. It believes that further harmonization
can best be pursued by focusing on fin ancial statements that are prepared
for the purpose of providing information that is useful in making
economic decisions.
The Board believes that financial statements prepared for the
purpose of making economic decisions meet the common needs of most
users. This is because nearly all users are making economic decisions, for
example:
(a) to decide when to buy, hold or sell an equity investment.
(b) to assess the stewardship or accountability of management.
(c) to assess the ability of the entity to pay and provide other benefits to its
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44(d) to assess the security for amounts lent to the entity.
(e) to determine taxation policies.
(f) to determine distributable profits and dividends.
(g) to prepare and use national income statistics.
(h) to regulate the activities of entities.
The Board recognises, however, that governments, in particular,
may specify different or additional requirements for their own purposes.
These requirements should not, however, affect financial statements
published for the ben efit of other users unless they also meet the needs of
those other users.
5.2 PURPOSE
This Conceptual Framework sets out the concepts that underlie the
preparation and presentation of financial statements for external users. The
purpose of the Concept ual Framework is:
(a)Toassist the Board in the development of future IFRSs and in its
review of existing IFRSs;
(b) T o assist the Board in promoting harmonisation of regulations,
accounting standards and procedures relating to the presentation of
financi al statements by providing a basis for reducing the number of
alternative accounting treatments permitted by IFRSs;
(c)Toassist national standard -setting bodies in developing national
standards;
(d)Toassist preparers of financial statements in applying IFRSs and in
dealing with topics that have yet to form the subject of an IFRS;
(e)Toassist auditors in forming an opinion on whether financial
statements comply with IFRSs;
(f)Toassist users of financial statements in interpreting the information
contained in financial statements prepared in compliance with IFRSs;
and
(g)Toprovide those who are interested in the work of the IASB with
information about its approach to the formulation of IFRSs.
5.3 SCOPE
The Conceptual Framework deals with:
(a) the o bjective of financial reporting;
(b) the qualitative characteristics of useful financial information;
(c) the definition, recognition and measurement of the elements from
which financial statements are constructed; and
(d) concepts of capital and capital m aintenance.munotes.in

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455.4 INTER NATIO NAL FI NANCIAL REPORTI NG
STANDARDS
International Financial Reporting Standards in a broad sense comprise:
Conceptual Framework for Financial Reporting —stating basic
principles and grounds of IFRS
IAS—standards issued befo re 2001
IFRS —standards issued after 2001
SIC—interpretations of accounting standards, giving specific
guidance on unclear issues
IFRIC —newer interpretations, issued after 2001
IFRSs
IFRS 1: First time Adoption of International Financial Reporting
Standard s
IFRS 2: Share -based Payment
IFRS 3: Business Combinations
IFRS 4: Insurance Contracts
IFRS 5: Non -current Assets Held for Sale and Discontinued Operations
IFRS 6: Exploration for and Evaluation of Mineral Resources
IFRS 7: Financial Instruments: Disclosu res
IFRS 8: Operating Segments
IFRS 9: Financial Instruments
IFRS 10: Consolidated Financial Statements
IFRS 11: Joint Arrangements
IFRS 12: Disclosure of Interests in Other Entities
IFRS 13: Fair Value Measurement
IFRS 14: Regulatory Deferral Accounts
IFRS 15: Revenue from Contracts with Customers
IASs
IAS 1: Presentation of Financial Statements
IAS 2: Inventories
IAS 7: Statement of Cash Flows
IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10: Events after the Reporting Period
IAS 11: Construction Contracts*
IAS 12: Income Taxes
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46IAS 17: Leases
IAS 18: Revenue*
IAS 19: Employee Benefits
IAS 20: Accounting for Government Grants and Disclosure of
Government Assistance
IAS 21: The Effects of Ch anges in Foreign Exchange Rates
Note: IAS 3, 4, 5, 6, 9, 13, 14, 15, 22, 25, 30, 31 and 35 have been
superseded SICs
SIC 7: Introduction of the Euro
SIC 10: Government Assistance –No Specific Relation to Operating
Activities
SIC 15: Operating Leases –Incentives
SIC 25: Income Taxes –Changes in the Tax Status of an Entity or its
Shareholders
SIC 27: Evaluating the Substance of Transactions Involving the Legal
Form of a Lease
SIC 29: Service Concession Arrangements: Disclosures
SIC 31: Revenue –Barter Tra nsactions Involving Advertising Services
SIC 32: Intangible Assets –Web Site Costs
Note: SIC 1, 2, 3, 4, 5, 6, 8, 9, 11, 12, 13, 14, 16, 17, 18, 19, 20, 21, 22,
23, 24, 26, 28, 30, 33 have been superseded
*Will be superseded by IFRS 15 as of 1 January 2017
IFRICs
IFRIC 1: Changes in Existing Decommissioning, Restoration and Similar
Liabilities
IFRIC 2: Members' Shares in Co -operative Entities and Similar
Instruments
IFRIC 4: Determining whether an Arrangement contains a Lease
IFRIC 5: Rights to Interests Arising from Decommissioning, Restoration
and Environmental Rehabilitation Funds
IFRIC 6: Liabilities Arising from Participating in a Specific Market -
Waste Electrical and Electronic Equipment
IFRIC 7: Applying the Restatement Approach under IAS 29 Financ ial
Reporting in Hyperinflationary Economies
IFRIC 10: Interim Financial Reporting and Impairment
IFRIC 12: Service Concession Arrangements
IFRIC 13: Customer Loyalty Programmes*munotes.in

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47IFRIC 14: IAS 19 –The Limit on a Defined Benefit Asset, Minimum
Funding Requ irements and their Interaction
FRIC 15: Agreements for the Construction of Real Estate*
IFRIC 16: Hedges of a Net Investment in a Foreign Operation
IFRIC 17: Distributions of Non -cash Assets to Owners
IFRIC 18: Transfers of Assets from Customers*
IFRIC 19 : Extinguishing Financial Liabilities with Equity Instruments
IFRIC 20: Stripping Costs in the Production Phase of a Surface Mine
IFRIC 21: Levies
Note: IFRIC 3, 8, 9 & 11 have been withdrawn

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48Module -III
6
CAPITAL A NDR E V E NUE EXPE NDITURE -
DEFERRED REVE NUE EXPE NDITURE -
CAPITAL A NDR E V E NUE RECEIPTS
Unit Structure
6.0 Objectives
6.1 Introduction
6.2 Misclassification and effect of error
6.3 Capital and Revenue -
6.4 Revenue expenditure
6.5 Distinction between capital expenditure and Revenue expenditure
6.6 Distinction between capital receipt and Revenue receipt
6.7 Tests to be applied to transactions
6.8 For Capital Receipt/ Revenue Receipt
6.9 Deferred Revenue Expenditure -(DRE)
6.0 OBJECTIVES
To help the learner understand the concept of Capital and Revenue
To help the learner distinguish between capital and revenue
transactions
To help the learner understand the importance of correctly
identifying the capital and revenue transactions, the effect of
errors due to misclassification and its presentation in the financial
statements
To help the learner know about the deferred revenue expenditure
and its presentation in financial statements.
6.1 INTRODUCTIO N
The Final Accou nts prepared at the end of the year consists of
Profit and Loss account and Balance sheet. The final accounts are
prepared from Trial balance which gives a list of accounts showing debit
balances and credit balances. The accounts appearing in the trial ba lance
are to be taken to the trading, profit and loss account or balance sheet. Themunotes.in

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49profit and loss account (also known as Revenue Statement) shows the
income and gains on the credit side and the various expenses and losses
are shown on the debit side. The balance sheet is a statement showing the
financial position as on a particular date and shows the capital and
liabilities and assets.
It is necessary to classify the items appearing in the trial balance as
capital or revenue so that they can be correct ly shown in the trading, profit
and loss account or balance sheet as the case may be. Such classification is
necessary to comply with the concept of matching costs and revenue in a
given period.
6.2 MISCLASSIFICATIO NAND EFFECT OF ERROR
Any misclassific ation impacts the correctness and accuracy of the
financial statements –the profit and loss account will not show the correct
Profit/ Loss and the Balance Sheet will not show the true position of assets
and liabilities. Thus due to misclassification, the accuracy of the financial
statements are affected and the statements do not depict the true and fair
view of the state of affairs of the business enterprise.
For example -A computer is purchased and the accountant records the
purchase along with purchase of raw materials in the trading account. The
error will affect the profit or loss position as the transaction has been
wrongly shown in trading account. The computer purchased should have
been recorded as an asset in the balance sheet. In this way the erro r due to
misclassification affects both the revenue statement and the balance sheet.
Effect of error in classification
1)Trading account will not show correct gross profit/ gross loss.
2)Profit and loss account will not disclose true net profit/ net loss.
3)Balance sheet will not disclose true value of Assets and Liabilities.
4)Financial statements will not disclose True and Fair view of the state
of Affairs of the organization.
5)It will be difficult to understand the capitalization of business.
6)These errors aff ect the accounts of the subsequent years
Error in classification Impact on profit and impact on
balance sheet/ value of asset
1)Revenue expenditure is wrongly
treated as capital expenditureProfit will be inflated ,
Value of asset will be inflated.
2)Capital receipt is treated as
revenue receiptProfit will be inflated ,
Value of asset will be inflated.
3)Capital expenditure treated as
revenue expenditureProfit will be deflated ,
Value of asset will be deflated.
4)Revenue receipt wrongly treated
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50It is thus clear that any error in classification or misclassification
impacts the accuracy and correctness of the financial statements and
hence it is very important to classify the transactions as capital or revenue
and disclose the same correctly in the financial statements .
6.3 CAPITAL A ND REVE NUE
Receipt or Expenditure transactions are to be classified as
capital or revenue and further classified as capital expenditure,
revenue expenditure capital rece ipt or revenue receipts.
TRA NSACTIO NS
Expenditure or receipt
Expenditure transactions Receipt transactions
( involves outflow of cash) ( involves inflow of cash)
Capital expenditure / Capital receipt/
Revenue expenditure Revenue receipt
Capital transactions are further classified as capital expenditure
and capital receipt and revenue transactions are classified as revenue
expendi ture and revenue receipt.
Capital expenditure is any expenditure which has any one or all of the
following -
It is a non -recurring expenditure
The benefit of such expenditure is seen for more than one year.
The expenditure increases the revenue earning ca pacity of the
organization.
In short, if the benefits of the expenditure are expected to accrue
for a long time, the expenditure is capital expenditure. Thus capital
expenditure is that expenditure which results in the acquisition of an asset,
tangible o r intangible.
Some common examples of capital expenditure are -
1) Purchase of an asset
Any expenditure that is incidental to the purchase of an asset or has
been incurred to put the asset in working condition for example –
installation charges or commissi oning expenses incurred with reference to
purchase of asset is also to be treated as capital expenditure. All the
expenses incurred on the assets till they yield income are capital in nature.
2) Expenditure during construction -
Any expenditure incurred during construction period or capital
work in progress is considered as a capital expenditure.
3) Expenditure that improves the standard of performance of an existing
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51Any expenditure which extends the useful life of the asset or
improves the effi ciency of the asset is to be capitalized and added to the
cost of the fixed asset
4) Cost of an addition or extension to an existing asset
5) Investment in shares, debentures, immoveable properties
6) Cost of acquiring intangible assets like goodwill, pat ents, copyrights.
7) Cost of acquisition and development of wasting assets like mines, oil -
wells.
Accounting of capital expenditure -Capital expenditures are shown in the
asset side of Balance sheet
6.4 REVE NUE EXPE NDITURE
Revenue expenditure is any expenditure which has any one or all of the
following -
The expenditure is incurred in the day to day conduct of business and
necessary to carry on the business.
The expenditure is recurring in nature
The benefit of such expenditure usually lasts fo r a short period of time
Kohler defines Revenue expenditure as an expenditure charged
against operations.
Any expenditure which is not a capital expenditure and which is
incurred for carrying out the day to day activities of business is called
revenue expenditure.
Some common examples of revenue expenditure are -
1)Expenses relating to business activities -
Expenses of production -Purchase of raw materials,
Expenses of administration -Payment of Office salaries
Expenses of selling and distribution
Finance expenses
2)Expenses which are incurred to maintain the asset in a working
condition -
Repairs and maintenance expenses
3)Expenses incurred to earn income --Interest on loan taken for purchase
of shares
Accounting of Revenue expenditure -Revenue expendit ures are
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52Capital Receipt -
Any receipt or cash inflow which has any one or all of the following
The receipt is non -recurring in nature
The receipts do not arise through normal activities of busi ness
Some common examples of capital receipt are -
a) Amount received on account of issue of fresh share capital/ debentures
b) Amount of loans raised
c) Proceeds on sale of fixed assets
d) Deposits
Accounting of capital receipt -Capital receipts are shown in the
balance sheet.
Revenue receipt
Revenue receipts are those items of income which are received or
accrued in the ordinary course of business.
Any cash inflow generated in the normal course of business
activities are to be treated as revenue receipts -Income generated from
cash/ credit sales, or from services rendered.
Accounting of revenue receipt -Revenue receipts are shown on the
credit side of trading/ profit and loss account
Concept of capital and revenue can be summarized as u nder-
Capital transactions will be recorded in the balance sheet while
revenue transactions will be shown in the revenue statements -Trading,
profit and loss account
.Trading, Profit and loss account (
debit side)Trading, Profit and loss account(
credit side)
Revenue expenditure
To Salary
To rentRevenue receipts
By sale of goods
Balance sheet( Liability side) Balance sheet (asset side)
Capital receipt
Loan from bankCapital expenditure
Plant and Machinery purchasedmunotes.in

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536.5 DISTI NCTIO NBETWEE NCAPITAL
EXPE NDITURE A ND REVE NUE EXPE NDITURE
CAPITAL EXPE NDITURE REVE NUE EXPE NDITURE
It is non -recurring in nature It is recurring in nature
It is shown in the Balance sheet It is shown in the revenue account
It is incurred for acquiring fixed
assets intended for use in businessIt is incurred for carrying out the
day to day activities of the business
It increases the revenue earning
capacity of the concernIt does not increase the revenue
earning capacity of the concern.
Benefit of this expenditure extends
for more than one yearThe benefit of this expenditure is
for a short period
Example -purchase of fixed asset Example –Payment of salaries
6.6 DISTI NCTIO NBETWEE NCAPITAL RECEIPT A ND
REVE NUE RECEIPT
CAPITAL RECEIPT REVE NUE RECEIPT
They are non recurring in nature They are recurring in nature
They appear in the balance sheet -It
is disclosed as a liability in the
balance sheetThey appear in Revenue account -It
is disclosed as an income in the
P&L A/c
Capital receipts which are
liabilities are to be repaidRevenue receipts are not to be
repaid as they are not liabilities.
They are not gains to the concern They are gains to the concern
It represents capital brought in by
the proprietor which are not of
recurring natureIt represents income such as sale of
goods, interest received
Example -Amount received on issue
of debenturesExample -Interest received, recovery
of bad debts
6.7 TESTS TO BE APPLIED TO TRA NSACTIO NS
To classify a transaction as capital or revenue, one may use the
following tests as indicators -
FOR CAPITAL/ REVE NUE EXPE NDITURE
1) What is the period of benefit from expenditure?
2) What is the effect of expenditure?
3) What is the amount of expenditure?munotes.in

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54Period of benefit from expenditure -if the benefit is for short period and
recurring in nature, it is generally treated as Revenue expenditure.
Expenditure which will give benefit for a long period of time and which is
non-recurring in nature will be generally classified as Capital
expendit ure. A non -recurring expenditure is always capital in nature
unless materiality concept emphasizes the importance of recognizing it as
revenue expenditure.
Effect of Expenditure -If the expenditure gives rise to a tangible asset or
right, treat it as cap ital expenditure
Amount of expenditure -Generally the capital expenditures involve huge
amounts but this cannot always be treated as a conclusive , reliable test for
classification
6.8 FOR CAPITAL RECEIPT/ REVE NUE RECEIPT
1)What is the source or cause of receipt or profit?
2)What is the nature of the receipt?
3)What is the impact of the receipt transaction on the profit / loss ?
Source of receipt -If the receipt is from trading transaction, then it should
be treated as revenue receipt. Eg -sale of goods. I f the receipt is from other
transactions, then it should be considered as capital receipt. eg Loan taken
from bank, amount realized on sale of fixed assets. Thus if receipt arises
in the course of business activity, then it is to be treated as revenue rec eipt.
If it arises out of financing activity, it is to be treated as Capital receipt.
Nature of receipt -Non-recurring receipts are capital receipts while
recurring receipts are revenue receipts.
Impact of the transaction on profit/ loss during the yea r-Capital
receipts have no bearing on the profit made or loss incurred during the
year . Only revenue receipts are taken into account to ascertain the profit
made by the business. This is a fairly reliable indicator/ parameter for
classifying transactions as capital receipt/ revenue receipt.
In case of receipts, the general rule is that if the receipt is against
the supply of goods or services and related to period under review, the
receipt is revenue receipt. This will be shown in the P&L A/C .Capital
receipts are to be shown as liability or reduced from assets appearing in
Balance sheet.
Sometimes a part of the receipt may be capital and a part of it may
be revenue -
For example proceeds on sale of asset -
1)If the sale proceeds is less than book value of asset , the receipt is
capital receipt to be deducted from assetmunotes.in

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552)If the sale proceeds is more than book value but less than cost , the
receipts is to be segregated as -
a) equal to book value of asset is capital receipt to be reduced from
asset
b) excess as revenue receipt giving rise to revenue profit.
3) If sale proceeds is more than cost, the receipts are to be accounted for as
under -
a) equal to book value capital receipt to be reduced from asset
b) between book value and cost, revenue receipt giving rise to
revenue profit
c) excess over cost, revenue receip t giving rise to capital profit .
However it is not always easy to classify transactions as capital/
revenue . There is a goo d deal of difference of opinion in deciding whether
a particular item is capital or revenue. Hence it has to be decided based on
the facts of the case on a case to case basis .
For example -Purchase of motor car is a capital expenditure as it involves
acquisition of an asset. However purchase of Motor car by a car dealer
who deals with purchase and sale of motor cars on a regular basis is not a
capital expenditure In the second case the purchase of car is to be treated
as revenue.
Expenditure incurred i n converting an ordinary screen in a cinema
hall to a cinemascope –It is difficult to accurately ascertain the nature of
this transaction. It may be argued that as the seating capacity of the hall
has not changed, it should be treated as revenue expenditu re. However, the
second argument could be cinemascope pictures attract large audience and
as the expenditure will result in higher earnings, it is to be treated as
capital expenditure.
6.9 DEFERRED REVE NUE EXPE NDITURE -(DRE)
According to the Guidance no te issued by ICAI, “Deferred
Revenue Expenditure is that expenditure for which payment has been
made or a liability incurred but which is carried forward on the
presumption that it will be of benefit over a subsequent period/ periods.”
For example -Normal annual advertising expenses is considered as
revenue expenditure and debited to the profit and loss a/c. If the heavy
expenses are incurred on advertising campaign to launch a new product,
then the whole amount should not be debited to P&L a/c of that yea r. The
benefit accrues for a long period of time. Hence so much of the
expenditure as benefits the current year may be considered as revenue and
debited to profit and loss a/c the balance to be shown as deferred
expenditure -revenue expenditure which is de ferred or postponed.munotes.in

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56There are some transactions which may appear revenue in nature
but the benefits of such expenditure are seen for a long period of time
.Such expenses are treated as deferred revenue expenditure. For example -
Heavy advertisement expenses or promotion expenses to launch a product -
As such expenditure yields the benefit for a long period ,it is necessary to
spread the amount over such number of years . If not spread over the
years, then the revenue statement of the year in which th e expenditure was
incurred may not show the true picture of Profit/ loss Hence in order to
have more credible financial statements the expenditure is deferred and a
part of the expenditure is shown in the current year Profit and loss
account. The balance amount ( not yet written off) is shown as a debit
balance in the asset side of the balance sheet.
Other common examples of Deferred revenue expenditure are -
Preliminary expenses
Cost of market research for a new product
Commission on issue of debentures
Cost of issuing shares / debentures or raising loans
Accounting for Deferred Revenue expenditure -For eg -Association
fees paid Rs 60,000 for three years ( 2016 -17, 2017 -18,2018 -19).
1styear-Accounting for the year 2016 -17-This expenditure has to
be shown in Profit and loss a/c. However it is evident that the expenditure
is incurred in the financial year 2016 -17, but the benefit of the expenditure
is enjoyed in the subsequent periods too. Hence the amount of Rs 60,000
should be spread over three ye ars and the annual amount to be determined
( 60000/3) Rs 20,000 .The profit and loss account of the year 2016 -17
will be debited with Rs 20,000. The balance( 60,000 -20,000) Rs 40,000
not written off will be shown in the asset side of balance sheet . Here the
expenditure is –deferred and hence known as DRE.
2ndyear-Accounting for the year 2017 -18-The amount of Rs
20,000 will be debited to profit and loss account and the balance Rs
20,000 (40000 -20000) not written off will be shown in the asset side of
balance sheet
3rdyear-Accounting for the year 2018 -19-The amount of Rs
20,000 will be debited to profit and loss account and there is no balance to
be shown in the balance sheet
Thus the amount has been spread over three years and accounted
for in t he books.
Revenue expenditure that becomes capital expenditure -
The following revenue expenses under certain circumstances
becomes capital expendituremunotes.in

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57Expenses Circumstances
1)Repairs Amount spent on repairs of plant and
machinery, furniture, building which are
regular in nature and incurred to
maintain the asset in a working
condition are to be considered as
revenue expenditure. However repairs to
the second hand assets to improve the
operational efficiency is to be treated as
capital expenditure.
2)Wages Wages paid is a revenue expenditure.
Wages paid for installation of machinery
or construction of fixed assets is
considered as capital expenditure.
3)Legal charges Legal charges are basically revenue in
nature and are shown in the debit side of
P&L a/ c. Legal charges incurred in
connection with purchase of fixed asset
are capital in nature
4)Transport charges Transport charges are basically revenue
in nature. Transport charges incurred for
purchase of machinery , furniture are
capital in nature.
5)Interest on capital Interest on capital paid during the
construction of works, building and
plant is capital in nature.
6)Raw material and
storesThis is basically a revenue expenditure
but if it is used for construction of fixed
assets, it is considered as capital and
added to the cost of the asset
7)Development
expenditureThe development expenditure incurred
during the development period with
reference to tea and rubber plantations
should be treated as capital expenditure
To summarize the revenue ex penditure incurred in connection with
purchase of asset or which is incidental to the purchase of asset, expenses
incurred in development of asset is to be treated as capital expenditure.munotes.in

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58Problems -
Q1-Error in classification or misclassification -
The following is the Trading account for the year ended 31 st March 2016
Particulars Amt( Rs) Particulars Amt (Rs)
To opening stock
To purchases
To wages
To Gross Profit60,000
3,00,000
1,00,000
40,000By Sales
By Closing stock4,00,000
1,00,000
5,00,000 5,00,000
Additional Information -
1)Sales included sales of old furniture Rs 10,000
2)Purchases included purchase of machinery Rs 70,000
3)Some workers were employed for construction of a gallery to the
office building. Wages of these workers amounting to Rs 30,000
were included in the above wages.
Redraft the trading account to arrive at the correct profit after
considering the above additional information -
Solution -There has been an e rror in the classification of items as capital/
revenue.
1) Sale of old furniture is a capital receipt. The same has been wrongly
shown as revenue receipt. Hence Rs 10,000 has to be deducted from
sales.
2) Purchase of Machinery is a capital expenditure. It has been wrongly
shown as revenue and included in the purchases. Rs 70,000 has to be
deducted from purchases and shown in the asset side of Balance sheet.
3) The wages of workers who have been employed for construction of
gallery to office building are of capital nature .Rs 30,000 should be
deducted from wages and added to the cost of office building.
The corrected trading account will be redrafted as under -
Particulars Amt ( Rs) Particulars Amt ( Rs)
To opening stock
To Purchases
Less machinery purchased
To wages
Less capitalized
To gross profit60,000
2,30,000
70,000
1,30,000By sales
Less sale of old furniture
By closing stock3,90,000
1,00,000
4,90,000 4,90,000munotes.in

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59Q2 How would you treat the following items?
1) Carriage paid on purchases Rs 1,000 -Revenue expenditure
2) Expenditure on advertising campaign Rs 500 -Revenue
expenditure
3) Freight and carriage of a new machinery purchased Rs
2,000 -Capital expenditure
4) Spent Rs 6,000 as legal expenses for abuse of trademark –
Revenue expenditure
5) Received Rs 1,00,000 on issue of equity shares -Capital receipt
6) Paid to the government excise duty Rs 50,000 -Revenue
expenditure
7) Paid Rs 70,000 for construction of railway sidings -Capital
expenditure
8) Purchased Lan dR s1 , 0 0 , 0 0 0 -Capital expenditure
9) Labour charge on plant and Machinery Rs 3,000 -Capital
expenditure
10) Repairs to furniture Rs 1,500 -Revenue expenditure
Q3 State with reasons whether the following are capital ,Revenue or
Deferred revenue expenditure
1) Legal expenses in issuing shares and debentures Rs 12,500
2) Legal expenses incurred in an action for infringement of
trademarks
3) Rs 25,000 spent on air -conditioning the office of the Managing
Director
4) Rs 7,000 spent on registration of design
5) Legal expenses in curred in an Income tax appeal
6) Legal expenses Rs 5,000 incurred in connection the purchase of
business premises
7) Rs 1,00,000 paid for the application and allotment of a plot of
land
8) Legal expenses Rs 8,000 incurred in defending a suit for breach of
contr act to supply of goods
(Mumbai University April 2008)
Solution
1) Deferred Revenue expenditure -These expenses should be written
off over certain number of years. These expenses benefit the
organization for m any yearsmunotes.in

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602) Revenue expenditure -These expenses are incurred in the normal
course of operation
3) Capital expenditure -It is capitalized as per AS -10
4) Capital expenditure -It is to be added to the cost of design which
is an asset
5) Revenue expenditure These expenses are incurred in the normal
course of operation
6) Capital Expenditure It increases the cost of business premises
7) Capital Expenditure It increases the cost of land
8) Revenue expenditure These expenses are incurred in the normal
course of busine ss operations.The benefit is exhausted within one
year.
Q4 State with reasons the nature of the following expenses/ receipts
1) Sold investments 4% government securities for Rs 1,40,000
2) Preliminary expenses paid Rs 42,000
3) Carriage outward paid Rs 40,000
4) Import duty paid on purchase of computer equipment Rs 85,000 to
be used in the office
5) Received Rs 5,00,000 on the issue of 5% Debentures
6) Paid Rs 10,000 underwriting commission on issue of shares
7) Legal expenses Rs 6,000 paid in connection with purchase of land
8) Repairing charges Rs 15,000 paid for keeping the machinery in
working condition
(Mumbai University March 2006)
Solution
1) Capital receipt -The amount is received on sale of investment and
not from norm al business activity
2) Deferred Revenue expenditure -The expenditure benefits the
current year and subsequent years and hence the amount has to be
written off over a certain number of years.
3) Revenue expenditure -It is incurred in normal business operations
4) Capital expenditure -It is a direct cost on acquiring of fixed assets
and hence has to be capitalized as per AS -10
5) Capital receipt -The amount is received on issue of Debentures
and not from normal business activity
6) Deferred Revenue expenditure --The expen diture benefits the
current year and subsequent years and hence the amount has to be
written off over a certain number of years.munotes.in

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617) Capital expenditure -It is a cost incurred in acquisition of fixed
asset
8) Revenue expenditure -it is incurred for keeping the mac hinery in
working condition
Summary -
An organization has to incur various expenses and receives
different incomes. Some expenses are regular while some are onetime
expenses .The expenses whose benefits will be enjoyed over a long period
are called capital expenditure. Revenue expenditure refers to those
expenses which are incurred for the day to day operations of business.
Receipts whose benefits will be enjoyed over a long period are
classified as capital receipts while day to day operational rec eipts such as
sales are revenue receipts.
ONLY MAI NPOINTS (for revision)
Capital expenditure -Large amount, Increases cost of fixed asset,
increases life of fixed asset, non -recurring in nature, increases profit
earning capacity of the business enterp rise, brings the fixed asset into
working condition, benefit of expenditure is not exhausted within one
year, shown in balance sheet
Revenue expenditure -smaller amount, recurring in nature, benefit is
exhausted within the year, shown in P&L A/c
Capital receipts do not arise in the normal course of operation
Revenue receipts are received in the normal course of operation
Deferred revenue expenditure -basically revenue in nature, benefit not
exhausted within one year, expenditure to be written off over certain
number of years.
Key terms -
Capital expenditure -It is the expenditure which is incurred to raise
earning capacity of an organization.
Revenue expenditure –It is the expenditure which is recurring in nature
incurred in connection with day to day operations of an organization.
Capital receipt -It is a receipt which is not received in the normal course
of operation
Revenue receipt -Revenue receipt is the receipt which is recurring and
received in the normal course of operation.
Deferred Revenue expenditure –It is the revenue expenditure the benefit
of which is not exhausted within one year.munotes.in

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62Test your understanding -
Multiple choice questions -Select the correct alternative and rewrite the
complete sentence
1) Revenue expense is that expense
Which is not recurring in nature
Benefit of which is exhausted in one year
Which increases useful life and productivity of asset
Which is shown on asset side of balance sheet
Ans-Revenue expense is that expense benefit of which is exhausted in one
year
2) Purchase of machinery is a
Deferred revenue expenditure
Capital expenditure
Capital receipt
Revenue expenditure
Ans–Purchase of machinery is a capital expenditure
3)Expenses incurred on installation and erection of new machinery is
Revenue expenditure
Deferred revenue expenditure
Capital expenditure
None of the above
Ans-Expenses incurred on installation and erection of new machinery is
a capital expenditure
4)Following is an example of Deferred Revenue expenditure
Rent of the wa rehouse
Depreciation of Delivery van
Salesmans salary and commission
Heavy advertising expenses incurred to launch a product in the
market
Ans-Following is an example of Deferred Revenue expenditure -Heavy
advertising expenses incurred to launch a produc t in the market
5)Capital expenditure shown as revenue expenditure -
Increases profit
Decreases profit
Decreases net worth
Decreases both profit and net worth
Ans-Capital expenditure shown as revenue expenditure decreases profit
State whether the following statements are True or False -
1)Expenditure intended to benefit current period is revenue expenditure
–TRUE
2)Capital receipt is recurring in nature -FALSE
3)Amount paid for acquisition of patents is a capital expenditure -TRUEmunotes.in

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634)Expenditure on repairs of furniture is a capital expenditure -FALSE
5)If revenue expenditure is shown as capital expenditure, profit and loss
account shows more profit -TRUE
6)Heavy expenses incurred on advertising at the time of introducing a
new product is a deferred revenue expenditure -TRUE
7)Revenue receipt is the receipt which is recurring and received in the
normal course of operation. -TRUE
8)Amount received as subsidy from the state Government is revenue
receipt -TRUE
9)Expenses on extension of a gallery to the building is a revenue
expendi ture-FALSE
10)Recovery of bad debts is a revenue receipt --TRUE
Match the columns and rewrite the answer
COLUM NA COLUM NB
1) Heavy advertisement and
promotion expenses incurred to
launch a producti) revenue expenditure
2) Term loan from bank ii) capital expenditure
3)Renewal of factory licence iii) Capital receipt
4)Sale of goods iv) Deferred revenue expenditure
5) Legal expenses incurred in
connection with purchase of landv) revenue receipt
ANSWERS -(1-iv ,2-iii , 3 -i, 4 -v, 5 -ii,)
Theory Questions -
1.Distinguish between Capital expenditure and Revenue expenditure
2.Distinguish between Capital receipts and Revenue receipts
3.Explain the concept of capital expenditure .
4.Bring out the importance of clas sification of expenditure as capital and
revenue.
5.Explain the concept of revenue expenditure. Give suitable examples.
6.Write short notes on -
Capital expenditure
Revenue expenditure
Capital receipt
Revenue receipt
Deferred Revenue expenditure
munotes.in

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647
DEPRECIATIO N
Unit Structure
7.0 Objectives
7.1 Meaning, Definition and Features of Depreciation
7.2 Depreciation, Depletion and Revaluation
7.0 OBJECTIVES
To help the learner understand the concept of Depreciation
To help the learner understand the need for providing depreciation
To help the learner understand the causes of depreciation
To help the learner understand the calculation of depre ciation, the
methods of providing depreciation and accounting in the books of
accounts
7.1 MEA NING, DEFI NITIO NAND FEATURES OF
DEPRECIATIO N
The word depreciation has been derived from the Latin word
‘Depretium’ which means decline or reduction in price or value. Fixed
assets have a definite life but they lose their value due to usage or passage
of time. Depreciation refers to this decline in value due to usage , passage
of time or due to obsolescence.
Accordin g to William Pickles, Depreciation is the gradual and
permanent decrease in the value of the asset. Depreciation refers to the
decline or reduction in the value of fixed asset. Depreciation is the
permanent and continuing diminution in the quality, quantit y or value of
an asset.
The Institute of Chartered Accountants of India ( ICAI) defines
depreciation as” a measure of the wearing out , consumption or other loss
of a value of a depreciable asset arising from use, efflux of time or
obsolescence through t echnology and market changes”
Reduction in the value of the asset due to their productive use is
called Depreciation. Depreciation in the value of asset is also due to
natural wear and tear.munotes.in

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65Features of Depreciation -
Depreciation is a gradual reduction in the value of an asset
The reduction could be due to various reasons.
Depreciation is charged on assets -fixed assets
Depreciation is a part of operating expenses. It is non cash in
nature as there is no real cash outflow even if it is accounted as an
expense. It is to be provided on fixed assets which are used in the process
of production and in the conduct of business . It is charged to profit and
loss account.
The amount of Depreciation charged to P&L Account has to be
deducted from value of asset shown in the balance sheet.
Depreciation is to be provided even if the business is incurring a
loss.
Depreciation is a gradual and permanent decrease in the value of
asset which is to be accounted for in the financial statements to arrive at
the correct profit/ loss.
Thus, Depreciation means a fall in the quality or value of an asset.
Accounting Standard (AS) -6 (Revise d) deals with Depreciation
Accounting.
Depreciation is to be provided on pro -rata basis for the period for
which the asset was used in a particular year at the specified rate.
The company adopts a policy regarding depreciation and as per
AS-1-namely, d isclosure of Accounting Policies, the method adopted in
providing depreciation should be disclosed in the notes to accounts.
7.2 DEPRECIATIO N, DEPLETIO NAND
REVALUATIO N
Depreciation refers to a decrease in the value of the asset while
depletion refers to the decrease in the value of wasting assets like oil
wells, mines.
Revaluation refers to a revision in the value of the asset which
could mean a decrease or an increase in the value of the asset.
7.2 (A )Need for depreciation -The Companies Act requires companies to
write off or provide for depreciation in a specified manner.
1)To ascertain true and correct profit/ loss -Depreciation is an
operating expense which is provided on assets used in the process of
production. Thus it is an expense to be included in the cost ofmunotes.in

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66production. It is therefore logical that it must be matched with the
income earned and charged to P&L Account to calculate the true and
real profit/ loss of the business. Unless depreciat ion is charged to P&L
Account, the correct profit/ loss cannot be arrived at.
2)To present a true financial position of business -Balance sheet is a
statement which shows the financial position of the business enterprise
as on a particular date. The fixed assets are to be shown at their true
values. The balance sheet shows the true financial position only if the
depreciation is deducted from the value of the asset. If the
depreciation is not provided on assets, the assets will be overvalued
and the balan ce sheet will not reflect the true financial position.
3)Replacement of asset -Every asset has a useful life. At the end of the
useful life of the asset, it needs to be replaced. Providing the
depreciation enables the business to replace the asset.
4)Statutory requirement -It is necessary to charge depreciation to
comply with the provisions made under the Companies Act and the
Income Tax Act. Providing the depreciation enables the business to
compute and pay correct tax on taxable profit.
7.2 (B) Cause s of Depreciation
1)Natural wear and tear -Wear and tear is the main cause of
depreciation. Wear and tear takes place in case of tangible fixed assets
like furniture, machinery due to its use. It the asset is used more, the
wear and tear is also more.
2)Efflux of time -Even if the asset is not used and kept idle, its value
falls over a period of time. Hence depreciation is provided on idle
machinery too.
3)Obsolescence -A loss or reduction on account of new invention is
called as obsolescence. With the new technological improvements,
inventions and improvements in techniques of production, the old
machinery becomes outdated and needs to be replaced.
4)Depletion -An asset like mines, oil wells may get exhausted due to
continuous extraction due to which t he value of the asset goes on
diminishing. There comes a stage when the asset has been completely
utilized and there is nothing left to be extracted. Such a decrease in the
value of the asset is depletion.
5)Natural calamities -An asset may be damaged du e to fire, flood and
lose its value and may be disposed off as scrap. The loss of value is
written off as depreciation.munotes.in

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677.2 (C) Factors affecting Depreciation
a)Cost of the asset -The cost of the asset refers to the purchase price of
the asset. The ex penses related to the purchase of the asset are to be
added to the purchase price to arrive at the cost of the asset. Incidental
expenses like installation charges, wages for erection of asset, freight
and transport charges are to be added to the purchase price. For
example -purchase price of machinery is Rs 1,00,000 and Rs 5,000
were incurred on installation of machinery. The total cost of the asset
is Rs 1,00,000+5,000= 1,05,000
b)Residual value or estimated scrap value -Residual value refers to the
value that can be realized at the end of the useful life of the asset when
the asset will be sold as scrap .Such scrap value is to be deducted from
the cost of the asset.
c)Estimated useful life of the asset -The useful life of the asset in terms
of number o f years that the asset can be put into productive use needs
to be estimated for calculating depreciation.
7.2 (D) Formula for calculating depreciation -After considering the
above factors, the amount of depreciation can be calculated by using
formula -
Depreciation per annum=Original cost of the asset -estimated scrap
value
Estimated useful life of the asset.
Depreciation = original cost of the asset x rate of depreciation (
where the estimated scrap valu e is zero)
Where the original cost of the asset = Purchase price +incidental
charges.
A company purchased machinery for Rs 44,000 and spent Rs 1,000
on the installation. It is estimated that the useful life of the asset is 10
years and at the end of the useful life the residual value is Rs 5,000. The
depreciation per year will be worked out as under Cost of the asset=
44,000+1,000= 45,000
Depreciation p.a = 45,000 -5,000 =4,000
10
Depreciation as per Companies Ac t 2013 for Financial year 2014 -15 and
thereafter. (These provisions are applicable from 01.04.2014 vide
notification dated 27.03.2014. )
a)Depreciation is calculated by considering useful life of asset, cost and
residual value.munotes.in

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68b)Any method WDV or SLM can be used.
c)Schedule –II contains a list of useful life according to class of asse ts
and the residual value shall not be more than five percent of the
original cost of asset. However companies are free to adopt a useful
life different from what specified in Schedule II and residual value
more than 5%. The financial statements shall disc lose such difference
and provide justification in this behalf duly supported by technical
advice.
7.2 ( E) Methods for providing depreciation -
Straight line method or fixed instalment method
Reducing balance method or Written down value method
Annuity method
Depreciation fund method
Insurance fund method
Revaluation method
Sum of the digits method
Depletion method
Machine hour rate method
Repairs provision method.
The first two methods are discussed.
Straight line method (SLM) or fixed instalment method (FIM) or
original cost method
Meaning -Under this method a fixed percentage of the original
value of the asset is written off every year. The value of the asset is
reduced to zero at the end of the u seful life of the asset. As the amount of
depreciation remains constant every year, this method is called as fixed
instalment method.
Reducing balance method (RBM) or Written down method(WDV)
Meaning -Under this method, depreciation is charged at a certai n
percentage each year on the balance of the asset which is brought forward
from the previous year . The amount of depreciation charged in each year
is not fixed but goes on reducing at the later years . As the amount of
depreciation keeps reducing , it is known as reducing balance method.
The depreciation is charged on the written down value of the asset hence
known as written down value method.
7.2 (F) Distinction between FIM and WDV methods –
The following illustration will help to bring out the distin ction
between the two methods -
Let us assume the machinery was purchased for Rs 1,00,000 and
Depreciation is to be provided @10% p.a.munotes.in

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69Year Depreciation as per FIM
@10%Depreciation as per WDV
@10%
1 1,00,000 x 10% for 1
year=10,000
Value of asset at the end of
the first year is 1,00,000 -
10,000= 90,0001,00,000x10%for 1 year=10,000
Value of asset at the end of the
first year is 1,00,000 -10,000=
90,000
2Depreciation @ 10% on
1,00,000= Rs 10,000. Value
of asset at the end of the
second year is 90,000 -
10,000=80,000Depreciation @ 10% on 90,000=
Rs 9,000. Value of asset at the
end of the second year is 90,000
-9,000=81,000
3 Depreciation @ 10% on
1,00,000= Rs 10,000. Valueof asset at the end of the thirdyear is 80,000 -10,000=7 0,000Depreciation @ 10% on 81,000=
Rs 8,100. Value of asset at the
end of the third year is 81,000 -
8,100=72,900
4 Depreciation @ 10% on
1,00,000= Rs 10,000. Value
of asset at the end of the
fourth year is 70,000 -
10,000=60,000 Thus
depreci ation is always @ 10%
of original costDepreciation @ 10% on 81,000=
Rs 8,100. Value of asset at the
end of the fourth year is 72,900 -
7,290=65,610
Thus depreciation is always on
10% on the balance or WDV
The following points are observed from the above table-
The amount of depreciation remains same for all the years as per
the FIM method while it keeps decreasing as per the WDV method.
The value of asset at the end of the tenth year would be zero as per
the FIM while the asset value will never become zero as per the WDV
method.
There is no difference in the amount of depreciation and the value
of asset after charging depreciation in the first year under both the
methods.
Fixed instalment or straight line
methodWritten down value or Reducing
balance method
1)It is a method of depreciation in
which depreciation at fixed
percentage ( rate) is charged every
year on original cost of fixed asset
and the amount of depreciation
remains the same ( constant) every
year1)It is a method of depreciation in
which depreciation at fixed
percentage ( rate) is charged everyyear . The amount of depreciationgoes on reducing every yearmunotes.in

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702)The amount of depreciation is
charged on the original cost of the
asset2)The amount of depreciation is
charged on the written down value
of the asset
3)After certain number of years the
value of the asset becomes zero3) The book value of the asset
never becomes zero
4)This method of depreciation is not
accepted for Income tax purposes4)This method of depreciation is
accepted for calculation and
payment of Income tax
5)This method of depreciation is easy
to calculate and more suitable for
assets of lower value5)This method of depreciation is
suitable for assets of higher value
havin g longer life requiring heavy
expenditure in later life of the
asset
7.2 (G) Accounting treatment of Depreciation -The transactions relating
to purchase of asset and depreciation are recorded through journal entries
and later posted in the relevant ledg er accounts.
Journal entries
A)When Provision for depreciation account is not maintained -
The transactions of purchase of asset, providing depreciation
on asset, sale of asset, profit/ loss on sale of asset are recorded in the
asset account.
For purchase of asset for cash -Asset a/c DrTo cash/ bank a/cFor purchase of asset on creditAsset a/c Dr
To supplier/party a/c
For payment of installationchargesAsset a/c Dr
To cash/ bank a/cFor providing depreciationDepreciation a/c Dr
ToAsset a/c
For transfer of depreciation to
Profit and Loss a/cProfit and Loss a/c Dr
To DepreciationFor sale of assetCash/ bank a/c Dr
To Asset a/c
For loss on sale of asset Profit and Loss a/c Dr
---To Asset a/cFor profit on sale of assetAsset a/c DrTo Profit and Loss a/cAfter passing the journal entries the relevant ledger account s are to
be prepared. The balance in the asset account will be carried down to themunotes.in

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71next accounting period and the balance in the depreciation account will be
transferred to profit and loss a/c.
At the end of the year, while preparing final accounts, Depre ciation
amount will be shown on the debit side of profit and loss account.
The asset will appear in the balance sheet at the written down value
(value after providing for depreciation on the asset)
When the above entries are posted in the asset a /c the entries will
be appearing in the asset account as under
Dr ASSET A/C Cr
Date Particulars AmtDateParticulars Amt
To cash/ bank a/c
(cash Purchase)By Depreciation
( yearly depreciation )
To suppliers a/c
( Credit purchase)By cash/ Bank
( sale of asset)
To cash/ Bank
(installation charges)By profit and loss a/c
(loss on sale)
To profit and loss a/c
( profit on sale)
To balance c/d
( balancing figure)
B)When provision for depreciation account is maintained -
For purchase of asset for cash -
Asset a/c Dr
To cash/ bank a/c
For purchase of asset on credit
Asset a/c Dr
To supplier/ partys a/c
For payment of installation charges
Asset a/c Dr
To cash/ bank a/c
For providi ng depreciation -
Depreciation a/c Dr
To Provision for Depreciation a/c
For transfer of depreciation to Profit and Loss a/c
Profit and Loss a/c Dr
To Depreciation
For sale of asset
Cash/ Bank a/c Dr
To Asset a/cmunotes.in

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72On sale of asset, the amount of provision created for the asset sold is to
be transferred to Asset a/c
Provision for Depreciation a/c D r
To Asset a/c
For profit on sale of asset
Asset a/c Dr
To Profit and Loss a/c
For loss o ns a l eo fa s s e t ----
Profit and Loss a/c Dr
To Asset a/c
Under this method, the amount of depreciation to be provided is
not recorded in the Asset a/c but is shown in the Provision for
Depreciation a/c.
The asset account will always show a debit balance and the
provision for depreciation account will show a credit balance.
The Asset a/c appears in the Balance sheet at its original value on
the Asset side and the provision for depreciation appears in the balance
sheet on the liability side.
Solved Problems -straight line method
1)M/s Raj and Sons purchased Machinery on 1stOctober 2007 at Rs
90,000 and spent Rs 10,000 on its installation. The firm p rovides
depreciation at 10% p.a .under straight line method.
Show machinery a/c and depreciation a/c for the years 2007 -
08,2008 -09 and 2009 -10 assuming books of accounts are closed on 31st
March every year.
Solution -In the books of Raj and Sons
Working note for calculation of depreciation under SLM @ 10%
p.a.
1O c t2 0 0 7 -cost of asset (90,000+10,000) = 1,00,000
Less depreciation @ 10% for 6 months = -5,000
WDV as on 31 March 2008 =9 5 , 0 0 0
Less depre ciation @ 10% for 1 year = -10,000
WDV as on 31stMarch 2009 =8 5 , 0 0 0
Less depr eciation @ 10% for 1 year = -10,000
WDV as on 31stMarch 2010 =7 5 , 0 0 0munotes.in

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73Dr Machinery account Cr
Date Particulars Amt Date Particulars Amt
2007
1octTo Bank
To Bank90,000
10,0002008
31marchBy Depreciation
By balance c/d5,000
95,000
1,00,000 1,00,000
2008
1A p r i lTo balance c/d 95,000 2009
31marchBy depreciation
By balance c/d10,000
85,000
95,000 95,000
2009
1A p r i lTo balance b/d 85,000 2010
31marchBy Depreciation
By balance c/d10,000
75,000
85,000 85,000
2010
1A p r i lTo balance b/d 75,000
Dr Depreciation account Cr
Date Particulars Amt Date Particulars Amt
2008
31marchTo Machinery
a/c5,000 2008
31marchBy P&La/c 5,000
5,000 5,000
2009
31marchTo Machinery
a/c10,000 2009
31marchBy P&La/c 10,000
10,000 10,000
2010
31marchTo Machinery
a/c10,000 2010
31marchBy P&La/c 10,000
10,000 10,000
2)Written down value method -
On 1st April 2005,Karan Bros purchased furniture for Rs
40,000.On 1stOctober, 2005,additional furniture was purchased for Rs
20,000.
On 1stOctober 2007, they sold furniture which was purchased on
1stApril 2005 for Rs 28,000.The accounts were closed on 31stMarch
every year .Depreciation was provided @10% p.a. by WDV method
Prepare Furniture account and Depreciation account.
Solution -Working note for calculation of Depreciation @ 10% p.a.
on WDVmunotes.in

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74Particulars Furniture1 Furniture 2 Depreciation
Cost of furniture
Less depreciation( on F -2f o r
6m o n t h s )40,000
4,00020,000
1,000 5,000
WDV 36,000 19,000
Less Depreciation 3,600 1,900 5,500
WDV 32,400 17,100
Less Depreciation ( on F-1f o r
6m o n t h s )1,620 1,710 3,330
WDV 30,780 15,390
Sold for
Loss on sale28,000
2,780
In the books of Karan Bros
Dr Furniture a/c Cr
Date Particulars Amt Date Particulars Amt
2005
1A p r i l
1O c tTo Cash/ Bank
To Cash/ Bank40,000
20,0002006
31marchBy Depreciation
By balance c/d5,000
55,000
60,000 60,000
2006
1A p r i lTo balance b/d 55,000 2007
31marchBy Depreciation
By balance c/d5,500
49,500
55,000 55,000
2007
1AprilTo balance b/d 49,500 2007
1o c t
2008
31MarchBy Depreciation
By cash/ bank
By P& La/c
By Depreciation
By balance c/d1,620
28,000
2,780
1,710
15,390
49,500 49,500
2008
1AprilTo balance b/d 15,390munotes.in

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75Dr Depreciation a/c Cr
Date Particulars Amt Date Particulars Amt
2006
31marchTo Furniture 5,000 2006
31marchBy P&La/c 5,000
5,000 5,000
2007
31marchTo Furniture 5,500 2007
31marchBy P&La/c 5,500
5,500 5,500
2007
1o c t
2008
31marchTo Furniture
To Furniture1,620
1,7102008
31marchBy P&La/c 3,330
3,330 3,330
3)Provision for depreciation -
On 1stApril 2009, following balances appeared in the books of
Mangesh Traders
Machinery a/c Rs 4,00,000 Provision for Depreciation a/c Rs
1,60,000
On the above date , they decided to sell the machinery for Rs
1,00,000 which was purchased on 1stApril 2006 f or Rs 1,50,000.The firm
provides Depreciation on 31 March every year@ 10% p.a. under straight
line method.
Show Machinery account and Provision for depreciation account
as on 31 march 2010.
Solution -Working note Depreciation @10% on SLM
Original cost o f the machinery sold -1,50,000 and depreciation at
10% p.a.is 15,000
Depreciation for three years ( 1 -april 2006 to 31 march 2009) is
15000x 3 years =45,000
WDV as on 31 march 2009 = 150000 -45,000= 105000
Sold for 1,00,000
Loss on sale of machinery 5,000
In the books of Mangesh Tradersmunotes.in

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76Dr Machinery account Cr
Date Particulars Amt Date Particulars Amt
2009
1aprilTo balance
b/d4,00,000 2009
1april
2010
31marchBy cash/bank
By Provision for
Depreciation a/c
By P&L a/c (
Loss on sale)
By balance c/d1,00,000
45,000
5,000
2,50,000
4,00,000 4,00,000
2010
1aprilTo balance
b/d2,50,000
Dr Provision for Depreciation a/c Cr
Date Particulars Amt Date Particulars Amt
2009
1a p r i l
2010
31marchTo Machinery
a/c
To balance c/d45,000
1,40,0002009
1april
2010
31marchBy balance b/d
By Depreciation1,60,000
25,000
1,85,000 1,85,000
2010
1april By balance b/d 1,40,000
Summary
Depreciation is the gradual and permanent decrease in the value of
the asset. Depreciation refers to the decline or reduction in the value of
fixed asset. Depreciation is the permanent and continuing diminution in
the quality, quantity or value of an asset. Depreciation is required to be
provided on fixed assets and charged to Profi t and loss account so that the
correct profit or loss can be ascertained and the balance sheet reflects the
true financial position .Depreciation is caused due to natural wear and tear,
efflux of time, obsolescence, depletion, natural calamities .The three
factors affecting depreciation are -cost of the asset, estimated useful life of
the asset and the residual or scrap value of the asset at the end of its useful
life. Thus, Formula for calculating depreciation ----
Depreciation per annum=Original cost of the asset -estimated scrap
value
Estimated useful life of the asset.munotes.in

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77There are two methods of calculating depreciation . They are -
Straight line method (SLM) or fixed instalment method (FIM)
or original cost method -Under this method a fixe d percentage of the
original value of the asset is written off every year. The value of the asset
is reduced to zero at the end of the useful life of the asset. As the amount
of depreciation remains constant every year, this method is called as fixed
instalment method.
Reducing balance method (RBM) or Written down
method(WDV) -Under this method, depreciation is charged at a certain
percentage each year on the balance of the asset which is brought forward
from the previous year . The amount of depreciation charged in each year
is not fixed but goes on reducing at the later years . As the amount of
depreciation keeps reducing , it is known as reducing balance method.
The depreciation is charged on the written down value of the asset hence
known as written do wn value method.
Accounting Standard (AS) -6 ( Revised ) deals with Depreciation
Accounting.
Depreciation is to be recorded in the debit side of Profit and Loss
account and deducted from the value of the asset in the balance sheet.
Key terms
Depreciati on-Depreciation is the gradual and permanent decrease in the
value of the asset
Cost of the asset -The cost of the asset refers to the purchase price of the
asset. The expenses related to the purchase of the asset are to be added to
the purchase price to arrive at the cost of the asset.
Residual value -Residual value refers to the value that can be realized at
the end of the useful life of the asset when the asset will be sold as scrap
.Such scrap value is to be deducted from the cost of the asset.
Straight line method -It is a method of providing depreciation where the
amount of depreciation remains constant or fixed every year . The
depreciation is charged at a certain rate on the original cost of the asset.
Written down value method -It is a meth od of providing depreciation
where the amount of depreciation goes on reducing every year. The
depreciation is charged on the written down value of the asset.
Objective Questions -(Test your understanding)
State whether the following statements are True or False -
1)There is no need to provide depreciation if the asset is maintained with
care-False
2)Depreciation is charged only on fixed assets –Truemunotes.in

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783)Depreciation is a non cash expense -True
4)Depreciation cannot be provided in case of loss in a financial year-
False
5)Under the written down value method, Depreciation is calculated on
the original cost of an asset -False
6)Depreciation amount is to be added to the value of the asset in the
balance sheet -False
7)Depreciation refers to the reduction in the value of fixed assets -True
8)Depreciation is the same as revaluation –False
9)Depreciation increases the value of asset –False
10)Depreciation is the process of valuation of asset -False
Write the term/ word/ phrase for the following -
1)Type of asset on which depreciation is provided -Fixed assets
2)A gradual, continuous and permanent reduction in the value of fixed
assets due to its use -Depreciation
3)Realizable amount of fixed asset at the end of its estimated life -Scrap/
residual value
4)The method of depreciati on under which depreciation is calculated on
original cost of asset -Straight line/ original cost/ fixed instalment
method
5)The method of depreciation under which depreciation is calculated on
the balance amount -Reducing/ diminishing balance / written down
value method
6)Excess of selling price of a fixed asset over its written down value -
Profit on sale of asset
7)An account to which the balance in the depreciation account is
transferred -Profit and loss account.
8)Method of depreciation in which amount of Depre ciation remains
constant every year –Straight line method/ original cost or fixed
instalment method.
Select the most appropriate alternative and rewrite the sentences -
1)Depreciation arises because of_______
a)Wear and tear
b)Inflation
c)Profit
d)Fall in the valu eo fa s s e t
2)The amount realized at the end of the working life of an asset is called
_____munotes.in

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79a)Market price
b)Original cost
c)Residual value
d)Written down value
3)The profit on sale of asset is debited to _____
a)Reserves a/c
b)Asset a/c
c)Balance sheet
d)Profit and loss a/c
4)The amount of depreciation goes on decreasing every year under the
_____method
a)Revaluation method
b)Straight line method
c)Fixed instalment method
d)Written down value method
5)Wages paid for installation of machinery is debited to
________a ccount
a)Wages a/c
b)Trading a/c
c)Profit and loss a/c
d)Machinery a/c
Answers -
1)a-wear and tear
2)c-residual value
3)b-asset a/c
4)d-written down value method
5)d-Machinery a/c
Problems -DIY
1)From the following particulars , calculate the amount of Depreciation -
a)Cost of fixed asset Rs 1,00,000
b)Installation charges Rs 5,000
c)Scrap value of fixed asset Rs 25,000
d)Estimated life of the fixed asset -Rs 25,000
(A n s w e r -Depreciation Rs 8,000 p.a.)
2)Deluxe company purchased furniture worth Rs 80,000 on 1stApril
2009 and additional furniture on 1stOctober 2009 worth Rs 60,000.On 1st
October 2011,they sold out furniture for Rs 60,000 which was purchasedmunotes.in

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80on Ist April 2009.The books of accounts were closed on 31stMarch every
year and the company charged d epreciation @ 15% p.a. on Fixed
Instalment basis.
Prepare Furniture a/c and Depreciation a/c for the year 2009 -10,
2010 -11,2011 -12.
(Answer -Depreciation -2009-10 Rs 16,500
2010-11Rs 21,000
2011-12 Rs 15,000
Profit on sale of furniture Rs 10, 000
Balance in Furniture a/c Rs 37,500)
3)Atul Traders ,Ratnagiri purchased Machinery for Rs 1,47,000 on 1st
April 2008,and spent Rs 3,000 on its fixation and erection.In the same
year , on 1stOctober, additional machinery costing Rs 50,000 was
purchased.On 1stOctober 2010, the machinery purchased on 1stOctober
2008 was sold for Rs 35,000.Depreciation was provided annually on 31st
March @10% on reducing balance method.
Prepare Machinery account and Depreciation account for three
years.
(Answer -Depreciation 2008 -09 Rs 17,500
2009-10 Rs 18,250
2010-11 Rs 12,150 and on machinery sold Rs 2,138
Loss on sale ---Rs 5,612
Balance on machinery account ----Rs 1,09,350.)
4) Answer in brief -
1)Define Depreciation. Explain the need for provi ding depreciation.
2)What are the causes of depreciation?
3)What are the factors affecting depreciation?
4)Write a note on Straight line method.
5)Explain Written down value method and state how it differs from
straight line method. Compare the methods with examp le .
6)Distinguish between FIM and WDV method of providing depreciation.
munotes.in

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81Module -IV
8
ACCOU NTINGR E C O R D S
Unit Structure
8.1 Introduction
8.2 Process of Transaction and Its Record Generation 8.3 What is an
Account?
8.4 Final Accounts
8.5 Horizontal or ‘T’ Format of Trading & P&L A/C
8.6 Vertical Format of Balance Sheet
8.1INTRODUCTIO N
Accounting involves a series of processes like measuring economic
value of a transaction, recording it and reporting it to various stake
holders. Accounting information is used by a variety of users, like
investors, creditors, workers, manage ment, and government.
Accounting can be divided into financial accounting, management
accounting, auditing, and tax accounting. Financial accounting focuses on the
reporting of an organization's financial information, including the preparation
of financia l statements, to external users of the information, such as investors,
regulators and suppliers and management accounting focuses on
themeasurement, analysis and reporting of information for internal use by
management. The recording of financial transacti ons, so that summaries of
the financials may be presented in financial reports, is known as
bookkeeping, of which double -entry bookkeeping is the most common
system.
Accounting records means internal or external documentary evidence
maintained within the organisation to record the economic transaction which has
taken place. These are important sources of information and evidences that are
used to prepare thefinancial statements.
In book keeping and accountancy we will be recording only
monetary transactio ns.
Accounting records can take on many forms and include:
 Invoices
 Vouchers
 Ledgers
 Journals
 Bank statementsmunotes.in

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82 Contracts and agreements
 Verification statements
 Transportation receipts etc.
Vouchers are most important document in accounting records.
Vouche rs form basis for recording any transaction. Account voucher is
an accounting document representing an internal intent to make a payment
to an external entity, such as a vendor or service provider. A voucher is
produced usually after receiving a vendor inv oice, after the invoice is
successfully matched to a purchase order. A voucher will contain detailed
information regarding the payee, the monetary amount of the payment, a
description of the transaction, and more.
8.2 PROCESS OF TRA NSACTIO NAND ITS RECORD
GENERATIO N
Let us see the entire process of accounting with the help of a chart
Economic transactions occursVouchers are createdTransaction is recorded in primary books i.e.
Journal or subsidiary books
Transactions are posted in Ledger accou nt
At the end of the year ledger accounts are closed
and balances a e found out
Using the closing balances ofthe ledger
accounts a trial balance is drawn as on last
day of the financial year
Closing Adjustment entries are recorded
Final acc ounts are drawn
Now let us discuss the entire procedure in the order of flow chart
1.Economic transactions occurs: In accounts we record only thosemunotes.in

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83transaction which has some monetary value. Accountancy is more of a
historical record as it records whateve rh a p p e n si n money terms. One should
not get confused with non cash and non-monetary transactions. A non cash
transaction can be a monetary transaction e.g providing depreciation on
fixed assets, is a non cash transaction but it is a monetary transaction a sw e
know the amount of depreciation in money terms.
2.Vouchers are created: Whenever any transaction takes place a
voucher is created depending upon the nature of transaction. Vouchers may be
of following types
1. Receipt voucher
2. Payment vouchers
3. Journal vouc hers
4. Cash memo
5. Contra entry vouchers
6. Purchase and returns invoice vouchers 7. Sales and returns
vouchers
A voucher complete in all respects forms basis for recording the
transaction. To be called a complete document it should be properly dated,
amounted, authorised and signed by the party.
Any documentary evidence supporting the entries recorded in the
books of accounts, establishing the arithmetic accuracy of the transaction, may
also be referred to as a voucher for example, a bill, invoice, receipt, sal ary
and wages sheet, memorandum of association, counterfoil of paying -in slip,
counterfoil of cheque book, or trust deed.
Normally the following types of vouchers are used:
(i)Receipt Voucher
(ii)Payment Voucher
(iii)Journal Voucher
(iv)Supporting Voucher
Let us discuss each of these:
(i ) Receipt Voucher:
A Receipt voucher is used to record cash or bank receipt. Receipt
vouchers are of two types which are as follows:
(a) Cash receipt voucher –These vouchers are created whenever any
cash generation transaction occurs. E.g. sale of scrap for cash.
(b) Bank receipt voucher –it indicates receipt of a cheque or demand
draft i.e. money is not received in the form of cash in hand, instead, the
money will be credited to the bank account of the assesse.munotes.in

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84Contents of Recei pt/Credit Voucher:
The following information are usually available from a receipt/credit
voucher:
(a)Names and address of the parties;
(b)Date of preparing the voucher;
(c) Voucher Number;
(d)Amount of the transaction;
(e)Heads of account;
(f)Signature of the person who is preparing the voucher;
(g)Authorized Signatory;
(h)Narrations, i.e., short description of the transaction, and
(i)Number of Supporting Voucher.
ii). Payment/debit Voucher:
Ap a y m e n tv o u c h e ri sj u s tt h eo p p o s i t eo far e c e i p tv o u c h e r .I nt h e
above, cash/ bank was debited, while in this case, cash or bank will be
credited. In the above case, there was an inflow of funds, while in this
case, there is an outflow of funds. A Payment voucher is used to record a
payment of cash or cheque. Payment vouchers are also o f two types
which are:
(a)Cash Payment voucher –it denotes payment of cash
(b)Bank Payment voucher –it indicates payment by cheque or demand
draft i.e. money is not paid in the form of cash in hand, instead, the
money will be debited from the bank account of theassesse
Contents of payment/debit Vouchers:
The following information are normally available from a
debit voucher:
(a) Names and Addresses of the Party (b) Date of voucher; (c)
Voucher Sr. Number; (d) Amount or value of the transaction; (e) Heads of
Account; (f) Signature of the person who is preparing the voucher; (g)
Authorized signatory; (h) Narration i.e., short description of themunotes.in

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85transaction and (i) Number of supporting Vouchers.
The format of a Debit Voucher is presented:
( If the amount o f transaction exceeds Rs. 500 a revenue stamp valued Re
1. should be affixed.)
iii) Journal Voucher:
These vouchers are used for non -cash transactions, they are basically used
as a documentary evidence. e.g., Goods sold on credit. In such cases, the
cash or the bank account of the assesse is unaffected. In the case of
Goods sold on credit, the Voucher would debit the Debtor to whom the
goods are sold on credit, while sales on credit account would be credited
further.
iv) Supporting documents vouchers:
These vouchers are the documentary evidence of transactions
that have happened. For example, you can attach the bill of an expensemunotes.in

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86along with the original voucher just to further support the primary
voucher. Petrol Bills attached with the conveyance vouche rs are a good
example of Supporting Vouchers. Supporting Vouchers are the documentary
evidence of business transactions which have happened.
They are of two types:
(i)External Supporting Vouchers; and
(ii)Internal Supporting Vouchers. (i) External Supporting Vou chers:
These vouchers are prepared by the third parties who are
associated with the firm.
For example:( a)Debit Note Received; (b) Credit Note Received;
(c) Cash Memo Received from the Sellers, etc.
The format of a Supporting Voucher i s presented:
(ii) Internal Supporting Vouchers:
These vouchers are prepared by the internal staff on behalf of ‘the
firm which are accepted by the third parties for the transaction so
happened.
For example:
(a)Counterfoil -of Challan for payment of income tax to a bank;
(b)Counterfoil of pay -in-slip when money is deposited into bank, etc.munotes.in

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873. Transaction is recorded in primary books i.e. Journal books:
There are two sets of books maintained in any organisation viz.
primary set of books and secondary set of b ooks. Primary set of books is the
one where initial transaction is recorded. It is the first instance of the
recording of any economic transaction it includes journal and subsidiary
books .
In order to record journal entries, one needs to have knowledge
about following basics of accounting
8.3 WHAT IS A NACCOU NT?
ACCOU NT:An account is a record of all transaction under one room
relating to a particular person, income, expense, property etc.
Types of accounts:
There are three type of accounts in accountin g:
A]Personal account: Ashok, Anil, Dena Bank, Abcd ltd, prepaid or
outstanding incomes or expenses. Personal accounts consist of all those
accounts which are related to a person, business, firm etc. There are also
subtypes of personal account:
I]Natural P ersonal Any person like Peter Account, Ram account etc.
II]Artificial Personal: Any company or group of people like Microsoft
account, Hindustan Petroleum account etc.
III] Representative Personal this type of Personal a/c represents owner
like. Capital a/c, drawings a/c etc.
B]Real account: Real accounts consist of all those accounts which are
related to assets. For example: Plant and Machinery account, Stock
account, Furniture & Fixture, cash etc.
C]Nominal account: Nominal accounts consist of all those accounts
which are related to expenses, losses, Income and Gains.For example: Rent
account, wages account, printing & stationary etc.
Golden rules of accounting
There are three golden rules in accounting to record journal entries. Each of
these rules is a ssociated with separate account.
Personal accounts
"Debit the Receiver, Credit the Giver"
Real accounts
"Debit what Comes In, Credit what Goes out"
Nominal accounts
"Debit all Expenses and Losses, Credit all Income and Gains"munotes.in

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88How to record a journal ent ry
First understand the format of a journal
Date column records date of the transaction
Particulars column records the two effects of a given transaction, by
using at least two ledger accounts, one of which will be debited and
other one credited.
Below t hese two accounts we write brief description of transaction in
brackets prefixing the word ‘Being’, called as narration.
L.F. column records ledger folio or page number where that account
is opened in a leger book.
Debit (Amount) and Credit (Amount) column s records amount against
each ledger account.
Steps to record a journal entry
1.Identify which accounts are involved
2.Identify types of accounts
3.Apply golden rules according to the type of account to determine which
account will be Debited and which ac count will be Credited.
Example: You are writing in the books of Ganesh
Transaction : Cash received from Jagdish Rs5,000, for this transaction
we will pass journal entry by using above mentioned
1 Identify which accounts are involved : a) Cash b) Jagdish
2 Identify types of accounts:
a)Cash : real account
b)Jagdish: personal account
3 Apply golden rules according to the type of account to determine which
account will be Debited and which account will be Credited.
a)Cash : real account so: Debit what comes in
b)Jagdish: personal account: credit the giver
Therefore Cash A/c will be debited and Jagdish A/c will be credited The
entry will be as follows
Cash a/c ----------------------- Dr5,000
To Jagdish a/c ------------------- Cr 5,000
(Being cash received from Jagdish)munotes.in

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89Example: Journalise the following trans actions:
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904. Transactions are posted in Ledger account: Secondary set of
books includes ledger accounts. Now let us see format of a ledger account.
The process of transferring the information contained in a
Journal to a Ledger is called Posting.
i. Posting of debited item in a Journal Entry: The steps to be
followed are:
Identify in the ledger the account to be debited. Then enter the date of
the transaction in the ‘Date’ column on the debit side of the account. Then
write the name of the account which has been credited in the respective
entry in the ‘Particulars’ column on the debit side of the account as
“To (name of account credited)”. Then record the page number of
the Journal where the entry exists in the Journal folio (J.F.) column.
Then rnte rt h er e l e v a n ta m o u n ti nt h e‘ A m o u n t ’ column on the debit
side. Posting credit item in a journal entry: The steps to be followed
are:
Identify in the ledger the amount to be credited then Enter the date
of the transaction in the ‘Date’ column on the credi ts i d e of the account.
Then write the name of the account which has been debited in the respective
entry in the ‘Particulars’ column on the credit side of the account as ‘By
(name of account debited)’. Then record the page number of the Journal
where the e ntry exists in the Journal folio (J.F.) column. Then enter the
relevant amount in the ‘Amount’ column on the credit side.
Thus every transaction has two effects viz debit and credit. In a
journal entry theses are either debited or credited. One should alw ays
remember that total of debit should always match the total of credit.
Consider the simple Journal entry to illustrate the above: On April 16,
2014 Motor car Purchased for cash Rs. 12000
April 16 Motor car A/c ....Dr. Rs. 12,000
To cash Rs. 12,000
(Being the Motor car purchased)
An amount of Rs. 12,000 will be debited to the Motor car account
and credited to cash account. The manner will be: in the Motor car account
in the ‘Particulars’ column we shall write to cash a/c . In the account
of cash will b e written : ‘By Motor car a/c’. The two accounts will, thus
appear as under.:munotes.in

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91Motor car A/c
Dr. Cr.
Date Particulars J.F. Rs. Date Particulars J.F. Rs.
April 16 To CashA/c12,000
Cash a/c
Dr Cr.
Date Particulars J.F. Rs. Date Particulars J.F. Rs
April16 ByMotorcarA/c 12,000
Example 2: Received Rs.14,000 in full settlement of a debt of Rs. 15,000
from Ram on Aug 8, 2014.
SULUTIO N-Journal Entry
Rs. Rs.
Cash A/c Dr. 14,000
Discount allowed A/c Dr 1,000
ToAnant 15,000
(Cash received and
discount allowed)
Ledger A/c
Cash A/c
Dr Cr
Date Particulars L.FRs. Date Particulars L.F Rs.
2014
Aug.8 ToAnant 14,000
Discount Allowed A/c
Dr Cr
Date Particulars L.F Rs. Date Particulars L.F Rs.
2014
Aug.8 ToAnant10 00
Anant’s Account
Dr Cr
Date Particulars L.F Rs. Date Particulars L.F Rs.
2014
Aug. 8 By cash A/c 14,000
By Discount 1,000
Allowed A/cmunotes.in

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925. At the end of the year ledger accounts are closed and
balan ces are found out
Dr. LEDGER ACCOUNT Cr.
DATE PARTICULARS J.F. AMOUNT DATE PARTICULARS J.F. AMOUNT
1.4.16 To abc Account)(xx5.4.16 By opq account)(xx
)(xxTo xyz Account)(xx xxxBy rst Accountxxx
)(xx To Balance c/d )(xx
)(xxx xxxx
Using the closing balances of the ledger accounts a trial balance is
drawn as on last day of the financial year : A trial balance is a list of all
the general ledger accounts of a business. This list will contain the name of
ledger account and the balance of that ledger. Each nominal ledger account
will hold either a debit balance or a credit balance. The debit balance
values will be listed in the debit column of the trial balance and the credit
value balance will be listed in the c redit column. A trial balance always
tallies. Ledger A/Cs which shows a debit balance is put on the Debit side
of the trial balance.
The A/c’s Showing credit balance are put on the Credit side of the
Trial Balance. Accounts which show no balance i.e. whos eDebit and Credit
totals are equal are not entered in Trial Balance.
Then the two sides of the Trial Balance are totaled. If they are
equal it is assumed that there are no arithmetical error in the posting and
balancing of Ledger A/cs.
Normally at the y ear end or whenever a businessman is interested in
knowing the position of various A/C s, the accounts are balanced.
Various steps for this purpose are
(1)Debit and Credit sides of each A/c are totalled.
(2)The difference between the two sides is written on the side which is
shorter so as to make their totals equal.
(3)The words “Balance C/d” i.e. the balance carried down and written
against the amount of difference.
(4)In the next period, the balance is brought down on the other side by
writing the words ‘Balance b/d’ .
(5)If the Debit side exceeds the Credit Side the difference is a Debit
Balance whereas.
(6)If the Credit side exceeds the Debit side the difference is a Credit
Balance.munotes.in

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93Objectives or Functions of Trial Balance
It helps in ascertaining the arithmetical accuracy of ledger
accounts.
Helps in locating errors.
Provides the summary of Ledger A/cs.
Helps in the preparation of Final A/cs.
6. Closing Adjustment entries are recorded Closing entries are
journal entries made at the end of an accounting period to transf er
temporary accounts to permanent accounts. adjusting entries are
journal entries usually made at the end of an accounting period to
allocate income and expenditure to the period in which they actually
occurred. The revenue recognition principle is the ba sis of making
adjusting entries that pertain to unearned and accrued revenues
under accrual -basis accounting. Eg Charging depreciation,
providing for outstanding incomes and expenses etc.munotes.in

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94Treatment of items of Adjustment outside the Trial Balan ce
7. Final accounts are drawn
From the derived trial balance an accountant can prepare final
accounts for the year for which information is available.
Format of final accounts differ from organisation to organisation. Let
us see format of final acco unts for some trading commercial
organisations.
An organisation can adopt either horizontal or vertical format, but
vertical format is compulsory for joint stock companies.munotes.in

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958.4 FI NAL ACCOU NTS
Trading Account
Trading account is prepared to know the g ross profit or gross loss
arising or incurred as a result of the trading activities of a business. In
other worlds, in case of a manufacturing concern a Manufacturing A/c is
prepared to show the result of manufacturing activity,trading account
indicates bu ying and selling of goods. If the amount of sales exceeds
the amount of purchases and the expenses directly connected with
such purchases, the difference is termed as gross profit. On the contrary, if
the purchases, and direct expenses exceed the sales, th e difference is called
gross loss. The purpose of preparing the Trading Account is to find out
the Gross Profit or Gross Loss of a concern during a particular period. The
following equations are highly useful for determination of Gross Need
and Importance of Trading Account
Preparation of Trading Account serves the following objectives:
1. It provides information about Gross Profit and Gross Loss: It informs
of the gross profit or gross loss as a result of buying and selling the
goods during the year. The percentage of Current Year’s gross profit
on the amount of sales can be calculated and compared with those of
the previous years. Thus, it provides data for comparison, analysis and
planning for a future period.
2.It provides information about the direct exp enses: All the expenses
incurred on the purchase and manufacturing of goods are recorded in
the trading account in a summarised form. Percentage of such
expenses on sales can be calculated and compared with those of the
previous years. In this way it enabl es the management to control
and rationalise the expenses.
3.Comparison of closing stock with those of the previous years:
closing stock has to be valued and recorded in a trading account.
This stock can be compared with the closing stock of the previous
years and if the stock shows an increasing trend, the reasons may be
inquired into.
4. It provides safety against possible losses: If the ratio of gross
profit has decreased in comparison to the preceding year, the
businessman can take effective measures to safeguard himself against
future losses. For example, he may increase the sale price of his gods
or may proceed to analyse and control the direct expenses.
8.4 (a) Preparation of Trading Account
Trading Account is a Nominal Account and all expenses which
relate to either purchase or manufacturing of goods are written on the
Debit side of the Trading Account.munotes.in

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96Item written on the Debit side of the Trading Account:
1. Opening Stock: The stock of goods remaining unsold at the end of
the previous year is term ed as the opening stock of the current year. In
other words, the closing stock of the last year becomes the opening stock of
the current year. Opening Stock will include the following:
I.Opening Stock of Raw Material.
II.Opening Stock of Semi -finished goods, an d
III Opening Stock of Finished goods.
2. Purchases and Purchases Returns: Goods which have been
bought for resale are termed as Purchases and goods which are returned to
suppliers are termed as purchase returns or returns outwards. Purchase
Account will be given on the debit side of the trial balance and Purchase
Return Account on the credit side of the trial balance. Purchase returns will
be shown as a deduction from Purchases on the debit side of the trading
account. Purchases include cash as well as cr edit purchases.
3. Direct Expenses: All expenses incurred in purchasing the goods,
bringing them to the godown and manufacture of goods are called direct
expenses. Direct expenses include the following:
I. Wages: Wages are paid to workers who are directl y engaged in the
loading, unloading and production of goods and as such are debited to the
trading account. It should be noted that:
(i)If the item ‘Wages and Salaries’ is given in the question it will be
shown on the trading account. On the contrary, if ‘Sal aries and Wages’ is
given it will be shown on the profit & loss account.
(ii)If wages are paid for bringing a new machine or for its
installation it will be added to the cost of the machine and hence will not be
shown in the trading account.
II. Carriage or Ca rriage Inwards or Freight: These expenses should be
debited to trading account because these are generally paid for bringing the
goods to the factory or place of business. However, if any carriage or
freight is paid on bringing an asset, the amount should be added to the
asset account and must not be debited to trading account.
III. Manufacturing Expenses: All expenses incurred in the manufacture of
goods are shown on the debit side of the trading account such as Coal, Gas,
Fuel, Water, Power, Factory Rent, Factory Lighting etc.
Items written on the Credit Side of the Trading Account:
1.Sales and Sales Returns: Both Cash and Credit sales will be included in
sales. The sales account will be a credit balance whereas, the sales return
account or returns inwards account will be a debit balance. Sales return
will be deducted out of Sales on the credit side of the trading account.
2.Closing Stock: The goods remaining unsold at the end of the year is
known as Closing Stock. It is valued at cost price or market price w hichever
is less. It includes the closing stock of raw material, Closing Stock of semi -
finished goods and Closing Stock of finished goods.munotes.in

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97Normally, the Closing Stock is given outside the Trail Balance. This is so
because its valuation is made after the ac counts have been closed. It is
incorporated in the books by means of the following entry:
Closing Stock
A/c Dr.
To Trading A/c
(Closing Stock transferred to Trading A/c)
When the above entry is passed, the Closing Stock Account is
opened. On the one hand, it will be posted to the credit side of the trading
account and on the other hand, will be shown on the Assets side of the
Balance Sheet, in order to complete the double entry. So metimes, the
Closing Stock is given inside the Trail Balance. This mean that the entry
to incorporate the closing stock in the books has already been passed. It
would imply that the Closing Stock must have been deducted out of Purchases
Account. Hence, in such a case, Closing Stock will not be shown in the
Trading Account but will appear on the Assets side of the Balance Sheet only.
8.4 (b) Profit And Loss Account
Trading account only discloses the gross profit earned as a result of
buying and selling of g oods. However, a businessman has to incur a
number of expenses which are not taken to trading account. Hence, a
businessman is more interested in knowing the net profit earned or net loss
incurred during the year. As such, a Profit & Loss Account is prepar ed
which contains all the items of losses and gains pertaining to the accounting
period. According to Prof. Carter, “A Profit & Loss Account is an account
into which all gains and losses are collected, in order to ascertain the
excess gains over the losses orvice -versa”
.
Need and Importance of Profit & Loss A/c
1.To determine the Net Profit or Net Loss: A Trading Account only
discloses the Gross Profit earned as a result of trading activities,
whereas the Profit & Loss Account discloses the net profit (or ne tl o s s )
available to the proprietor and credited to his capital account.
2.Comparison with previous years’ profit: The net profit of the current year
can be compared with that of the previous years. It enables the
businessman to know whether the business is being conducted efficiently
or no.
3.Control on Expenses: Profit & Loss Account helps in comparing
various expenses with the expenses of the previous year. Also the
percentage of each individual expenses to net profit is calculated and
compared with the simi lar ratio of previous years. Such comparison will
be helpful in taking concrete steps for controlling the unnecessary
expenses.
4.Helpful in the preparation of Balance Sheet: A Balance Sheet can
only be prepared after ascertaining the Net Profit through the
preparation of Profit and Loss Account.munotes.in

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98Preparation of Profit and Loss Account
AP r o f i ta n dL o s sA c c o u n ti ss t a r t e dw i t ht h e amount of gross
profit or gross loss brought down from the Trading Account. As such, all those
expenses and losses which have not been debited to the Trading Account are
now debited to Profit &
Loss Account. These expenses include administrative expenses,
selling expenses, distribution expenses etc. These are called ‘Indirect
Expenses’. Profit and Loss Account is a Nominal Account and as such, all
the expenses and losses are shown on its debit side and all the incomes and
gains are shown on its credit side.
Items written on the Debit side of Profit & Loss Account
1.Gross Loss: If trading account discloses Gross Loss, it is shown on the
debit side first of all.
2.Office and Administrative Expenses: Such as salary of office employees,
office rent, lighting, postage, printing, legal charges, audit fee etc.
3.Selling and Distribution Expenses: Such as advertisement charges,
commission, carria ge outwards, bad -debts, packing charges etc.
4.Miscellaneous Expenses: Such as interest on loan, interest on capital,
repair charges, depreciation, charity etc.
Items written on the Credit side of Profit & Loss Account
1.Gross Profit: the starting point of th eC r .s i d eo fP r o f i ta n dL o s s Account
is the gross profit brought down from the Trading Account.
2.Other Incomes and Gains: All items of incomes and gains are shown on
the credit side of the Profit & Loss Account, such as income from
investments, rent receiv ed, discount received, commission earned, interest
received, dividend received etc.
If the credit side of the profit and loss account exceeds that of debit
side, the difference is termed as net profit. On the other hand, the excess
of the debit side over the credit side is termed as netloss. Net profit is added
to the capital whereas net loss is deducted from the capital.munotes.in

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998.5 HORIZO NTAL OR ‘T’ FORMAT OF
TRADI NG& P&L A/C
E.g. Prepare Trading Account for the year ended 30stMarch, 2013 from the
following balances.
Rs Rs.
Stock(1stApril, 2012) 10,000 Purchases 1,00,000
Wages 5,000 Carriage Inwards 1,000
Sales 1,70,000 Returns Inward 5,000
Returns Outward 8,000 Sales Tax paid 20,000
Freight 500 Octroi d uty 2,500munotes.in

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100Closing stock as on 30stMarch, 2013 was valued at Rs. 20,000 Also, pass
the Closing Entries.
Solution :
TRADI NGA C C O U NT
Dr. for the year ended 30stMarch, 2013 Cr.
Particulars Rs Particulars RsTo opening stock10,000BySalesTo Purcha ses 1,70,000 1,60,0001,00,00090,000Less:SalestaxLess: Returns Outward 5,000 10000 20,00010,0001,000To Wages500By Closing StockTo Carriage Inwards 2,500To freight71,000To Octroi DutyTo Profit and loss A/c1,80,0001,80,000(Gross profit)
VERTICAL FORMAT OF REVE NUE STATEME NTT R A D I NG
&P&L A/C
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101HORIZO NTAL OR ‘T’ FORMAT OF BALA NCE SHEET
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1028.6 VERTICAL FORMAT OF BALA NCE SHEET
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103
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104
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105
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106

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