BAF Financial Accounting Sem I-munotes

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1Unit-1
INTRODUCTION TO ACCOUNTING
STANDARDS
Unit Structure :
1.0 Objectives
1.1 Introduction
1.2 Meaning of Accounting Standards
1.3 Formation oftheAccounting Standards Board
1.4 Scope of Accounting Standards
1.5 Procedure for Issuing an Accounting S tandard
1.6 Compliance withtheAccounting Standards
1.7 Listofthe Accounting Standards asissued byICAI
1.8 List of IAS / IFRS and corresponding IND AS notified by
MCA
1.9 List of IFRS issued by IASB
1.10 Questions
1.0 OBJECTIVES
After st udying the unit students will be able to:
Understand the meaning of Accounting Standard .
Know the scope of Accounting Standard .
Understand the composition, objectives and functions of
Accounting Standard Board.
Explain theprocedure for issuing Accounting Standards.
Know the list of Accounting Standards issued by ICAI
1.1INTRODUCTION
Financial statements are prepared to summarize the end -
result of all the business activities by an enterprise during an
accounting period in monetary terms. These business acti vities
vary from one enterprise to the other. It is very difficult to compare
the financial statements of different reporting enterprises because
of different methods and principles adopted by these business
enterprises in preparing their financial stateme nts. Accounting
standards are evolved to make these methods and principlesmunotes.in

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2uniform and financial statements comparable to the possible extent.
Following are the different group of persons interested in the
financial statements: -
1.Bankers
2.Shareholders
3.Inves tors
4.Creditors
5.Customers
6.Employees
7.Competitors
8.Income tax/Sales tax/Excise authorities
1.2 MEANING OF ACCOUNTING STANDARDS
1.2.1 MEANING
‘Accounting Standards are written, policy documents
issued by expert accounting body or by Government or other
regula tory authorities covering the aspects of recognition,
measurement, treatment, presentation and disclosure of accounting
transaction in the financial statement. ’The main purpose of
formulating accounting standard is to standardize the diverse
accounting po licies with a view to eliminate to the extent possible
the incomparability of information provided in financial statements
and add reliability to such financial statements. Accounting
standards ensure the consistency and the comparability of the
financial statements reported by the different enterprises creating a
general sense of confidence that users have in the fairness and
reliability of the statements they rely.
Accounting Standards will not, however, apply to
enterprises only carrying on the activit ies which are not of
commercial, industrial or business nature, e.g., anactivity of
collecting donations and giving them to flood affected people.
Exclusion of an enterprise from the applicability of the Accounting
Standards would be permissible only if n o part of the activity of
such enterprise is commercial, industrial or business in nature.
Even if a very small proportion of the activities of an enterprise are
considered to be commercial, industrial or business in nature, the
Accounting Standards would apply to all its activities including
those which are not commercial, industrial or business in nature .
1.2.2 OBJECTIVES :
1. To standardise the diverse accounting policies.
2. To standardise the accounting practices.
3. To enhance the reliability of fina ncial statements.
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31.2.3ADVANTAGES:
1.It provides the accountancy profession with useful working rules.
2.It assists in improving quality of work performed by accountant .
3.It strengthens the accountant’s resistance against the pressure
from directors to use accounting policy which may be suspect in
that situation in which they perform their work.
4.It ensures the various users of financial statements to get
complete crystal information on more consistent ba sis from
period to period.
5.It helps the users tocompare the financial statements of two or
more organizations engaged in same type of business
operation.
1.2.4DISADVANTAGES:
1.Users are likely to think that said statements prepared using
accounting standard are foolproof.
2.They have been derived from social pressures which may
reduce freedom.
3.The working rules may be rigid or bureaucratic to some users of
financial statement.
4.The more standards there are, the more costly the financial
statements are t o produce.
1.3FORMATION OF THE ACCOUNTING
STANDARDS BOARD
The Institute of Chartered Accountants of India (ICAI),
recognizing the need to harmonize the diverse accounting policies
and practices in use in India, constituted the Accounting Standards
Board (AS B) on 21stApril, 1977.
1.3.1 COMPOSITION OF THE AC COUNTING STANDARDS
BOARD (ASB)
The composition of the ASB is fairly broad -based and
ensures participation of all interest -groups in the standard -setting
process. Apart from the elected members of the Cou ncil of the ICAI
nominated on the ASB, the following are represented on the ASB:
1.Nominee of the Central Government representing the
Department of Company Affairs on the Council of the ICAI .
2.Nominee of the Central Government representing the Office of
theComptroller and Auditor General of India on the Council of
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43.Nominee of the Central Government representing the Central
Board of Direct Taxes on the Council of the ICAI .
4.Representative of the Institute of Cost and Works Accountants
of India .
5.Repres entative of the Institute of Company Secretaries of
India.
6.Representatives of Industry Associations (1 from Associated
Chambers of Commerce and Industry (ASSOCHAM), 1 from
Confederation of Indian Industry (CII) and 1 from Federation of
Indian Chambers of C ommerce and Industry (FICCI)
7.Representative of Reserve Bank of India
8.Representative of Securities and Exchange Board of India
9.Representative of Controller General of Accounts
10.Representative of Central Board of Excise and Customs
11.Representatives of Academic Institutions (1 from Universities
and 1 from Indian Institutes of Management)
12.Representative of Financial Institutions
13.Eminent professionals co -opted by the ICAI (they may be in
practice or in industry, government, education, etc.)
14.Chairman of the Researc hC o m m i t t e ea n dt h eC h a i r m a no f
the Expert Advisory Committee of the ICAI, if they are not
otherwise members of the Accounting Standards Board
15.Representative(s) of any other body, as considered
appropriate by the ICAI
1.3.2OBJECTIVES OF THE ACCOUNTING STANDARD S
BOARD
The following are the objectives of the Accounting Standards
Board:
i.To conceive of and suggest areas in which Accounting
Standards need to be developed.
ii.To formulate Accounting Standards with a view to assist the
Council of the ICAI in evolving an d establishing Accounting
Standards in India.
iii.To examine how far the relevant International Accounting
Standard/International Financial Reporting Standard can be
adapted while formulating the Accounting Standard and to
adapt the same.munotes.in

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5iv.To review, at regul ar intervals, the Accounting Standards from
the point of view of acceptance or changed conditions, and, if
necessary, revise the same.
v.To provide, from time to time, interpretations and guidance on
Accounting Standards.
vi.To send comments on various consul tative papers such as
exposure drafts, discussion papers etc., issued by
International Accounting Standards Board and various other
International bodies such as Asian -Oceania Standard -Setters
Group (AOSSG).
vii.To carry out such other functions relating to Ac counting
Standards.
1.3.3 FUNCTIONS OF THE ACCOUNTING STANDARDS BOARD
The main function of the ASB is to formulate Accounting
Standards so that such standards may be established by the ICAI
in India. While formulating the Accounting Standards, the ASB wi ll
take into consideration the applicable laws, customs, usages and
business environment prevailing in India.
The ICAI, being a full -fledged member of the International
Federation of Accountants (IFAC), is expected, inter alia, to actively
promote the Int ernational Accounting Standards Board’s (IASB)
pronouncements in the country with a view to facilitate global
harmonization of acc ounting standards. Accordingly, while
formulating the Accounting Standards, the ASB will give due
consideration to Internation al Accounting Standards (IASs) issued
by the International Accounting Standards Committee (predecessor
body to IASB) or International Financial Reporting Standards
(IFRSs) issued by the IASB, as the case may be, and try to
integrate them, to the extent pos sible, in the light of the conditions
and practices prevailing in India.
1.4PROCEDURE FOR ISSUING AN ACCOUNTING
STANDARD
The Accounting Standards are issued under the authority of
the Council of the ICAI. The ASB has also been entrusted with the
responsibil ity of propagating the Accounting Standards and of
persuading the concerned parties to adopt them in the preparation
and presentation of financial statements. The ASB will provide
interpretations and guidance on issues arising from Accounting
Standards. T he ASB will also review the Accounting Standards at
periodical intervals and, if necessary, revise the same. Themunotes.in

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6following procedure is adopted for formulating Accounting
Standards:
1.The ASB determines the broad areas in which Accounting
Standards need to be formulated and the priority in regard to the
selection thereof.
2.In the preparation of Accounting Standards, the ASB will be
assisted by Study Groups constituted to consider specific
subjects. In the formation of Study Groups, provision will be
made fo r wide participation by the members of the Institute and
others.
3.The draft of the proposed standard will normally include the
following:
a)Objective of the Standard,
b)Scope of the Standard,
c)Definitions of the terms used in the Standard,
d)Recognition and measu rement principles, wherever
applicable,
e)Presentation and disclosure requirements.
4.The ASB will consider the preliminary draft prepared by the
Study Group and if any revision of the draft is required on the
basis of deliberations, the ASB will make the sam eo rr e f e rt h e
same to the Study Group.
5.The ASB will circulate the draft of the Accounting Standard to
the Council members of the ICAI and the specified bodies for
their comments.
6.The ASB will hold a meeting with the representatives of
specified bodies t o ascertain their views on the draft of the
proposed Accounting Standard. On the basis of comments
received and discussion with the representatives of specified
bodies, the ASB will finalize the Exposure Draft of the proposed
Accounting Standard .
7.The Expo sure Draft of the proposed Standard will be issued for
comments by the members of the Institute and the public. The
Exposure Draft will specifically be sent to specified bodies (as
listed above), stock exchanges, and other interest groups, as
appropriate.
8.After taking into consideration the comments received, the draft
of the proposed Standard will be finalized by the ASB and
submitted to the Council of the ICAI.
The Council of the ICAI will consider the final draft of the
proposed Standard and if found necessary, modify the same inmunotes.in

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7consultation with the ASB. The Accounting Standard on the
relevant subject will then be issued by the ICAI.
1.5COMPLIANCE WITH THE ACCOUNTING
STANDARDS
Accounting Standards are mandatory from the respective
dates mentioned in the standards. Hence, it is the duty of the
management to see that all the Accounting Standards are complied
with while prepa ring financial statement , in the case of any
deviation, necessary disclosure should be made in the audit report
so as to make the r eaders aware of the deviations.
The mandatory status of an Accounting Standard implies
that while discharging their attest functions, it will be the duty of the
members of the Institute
(a) To examine whether ‘Statements’ relating to accounting matter s
are complied with in the presentation of financial statements
covered by their audit. In the event of any deviation from the
‘Statements’, it will be their duty to make adequate disclosures in
their audit reports so that the users of financial statements may be
aware of such deviations; and
(b) To ensure that the ‘Statements’ relating to auditing matters are
followed in the audit of financial information covered by their audit
reports. If for any reason a member has not been able to perform
an audit in a ccordance with such ‘Statements’, his report should
draw attention to the material departures there from.
1.6LIST OF THE ACCOUNTING STANDARDS AS
ISSUED BY ICAI
The council of the Institute of the Chartered Accountants of
India has so far issued 32 Accountin gStandards, However AS -8
on Accounting for Research and Development (stands withdrawn
after introduction of AS -26), thus effectively there are 31
Accounting standards.munotes.in

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8Accounting
Standard No.Title of Accounting Standard
AS-1 Disclosure of Acco unting Policies
AS-2 Valuation of Inventories
AS-3 Cash Flow Statements
AS-4 Contingencies and Events (Occurring after
the Balance Sheet Date)
AS-5 Net Pro fit or Loss for the Period, Prior
Period Items and Changes in Accounting
Policies
AS-6 Depre ciation Accounting
AS-7 Construction Contracts
AS-8 Accounting for Research and Development
(stand ardwithdrawn after introduction of
AS-26)
AS-9 Revenue Recognition
AS-10 Accounting for Fixed Assets
AS-11 The Effect of Changes in Foreign
Exchange Ra tes
AS-12 Accounting for Government Grants
AS-13 Accounting for Investments
AS-14 Accounting for Amalgamations
AS-15 Employee Bene fits
AS-16 Borrowing Cost
AS-17 Segment Reporting
AS-18 Related Party Disclosures
AS-19 Leases
AS-20 Earnings per Share
AS-21 Consolidated Financial Statements
AS-22 Accounting for Taxes on Income
AS-23 Accounting for Investment in Associates in
Consolidated Financial Statements
AS-24 Discontinuing Operations
AS-25 Interim Financial Reportingmunotes.in

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9AS-26 Intangible Assets
AS-27 Financial Reporting of Interests in Joint
Venture
AS-28 Impairment of Assets
AS-29 Provisions, Contingent Liabilities a nd
Contingent Assets
AS-30 Financial Instruments: Recognition and
Measurement
AS 31 Financial Instruments: Presentation
AS 32 Financial Instruments: Disclosures
1.7LIST OF IAS / IFRS AND CORRESPONDING IND
ASNITIFI ED BY MCA
IASNo. Title Correspondi ng
Converged IND
AS
IAS-1 Presentation of Financial
StatementsIND AS 1
IAS-2 Inventories IND AS 2
IAS-7 Cash Flow Statements IND AS 7
IAS-8 Accounting policies, change in
accounting estimates and errorsIND AS 8
IAS-10 Events after the Balance S heet
dateIND AS 10
IAS-12 Income Taxes IND AS 12
IAS-16 Property, Plants and Equipment IND AS 16
IAS-17 Leases IND AS 17
IAS-19 Employees Benefits IND AS 19
IAS-20 Accounting for Government
Grants and Disclosure of
Government AssistanceIND AS 20
IAS-21 The Effect of Changes in
Foreign Exchange RatesIND AS 21
IAS-23 Borrowing Costs IND AS 23munotes.in

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10IAS-24 Related Party Disclosures IND AS 24
IAS-26 Accounting and Reporting by
Retirement Benefit Plan
IAS-27 Consolidated and Separate
Financial Statemen tsIND AS 27
IAS-28 Investments in Associates and
Joint VenturesIND AS 28
IAS-29 Financial Reporting in Hyper
Inflationary EconomiesIND AS 29
IAS-32 Financial Instruments : -
PresentationIND AS 32
IAS-33 Earnings per Share IND AS 33
IAS-34 Interim Fi nancial Reporting IND AS 34
IAS-36 Impairment Assets IND AS 36
IAS-37 Provisions, Contingent Liabilities
and Contingent AssetsIND AS 37
IAS-38 Intangible Assets IND AS 38
IAS-40 Investment Property IND AS 40
IAS-41 Agriculture IND AS 41
1.8LIST OF IFRSISSUED BY IASB
IFRS: -
The term ‘IFRS’ includes standards and interpretations approved by
IASB and the International Accounting Standards and
interpretations issued by the International Financial Reporting
Interpretations Committee.
International Account ing Standards Board ( IASB) has issued the
following International Financial Reporting Standards (IFRS) :-
IASNo. Title Corresponding
Converged IND AS
IFRS -1 First Time Adoption of IFRS IND AS 1 01
IFRS -2 Share based payments IND AS 10 2
IFRS -3 Business Combination IND AS 10 3
IFRS -4 Insurance Contracts IND AS 10 4munotes.in

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11IFRS -5 Non-currents Assents held for
sale and discontinued
operationsIND AS 10 5
IFRS -6 Exploration for and evaluation
of mineral resourcesIND AS 10 6
IFRS -7 Financial instruments:
disclosu reIND AS 10 7
IFRS -8 Operating segment IND AS 10 8
IFRS -9 Financial instruments IND AS 10 9
IFRS -10 Consolidated Financial
StatementsIND AS 1 10
IFRS -11 Joint Arrangement IND AS 1 11
IFRS -12 Disclosure of Interest in Other
EntitiesIND AS 1 12
IFRS -13 Fair Value Measurement IND AS 1 13
IFRS -14 Regulatory Deferral Accounts IND AS 1 14
IFRS -15 Revenue from contracts with
customersIND AS 1 15
IFRS -16 Leases -
1.9QUESTIONS
1.What do you understand by Accounting standard?
2.What is the need and purpose of accou nting standards?
3.Briefly explain the importance of accounting standards?
4.What is the duty of the auditor in case of non -compliance of
mandatory accounting standard?
5.Briefly explain the procedure for issuing an accounting
standard?
6.Select Correct Alternati ve:
i. Accounting standards are important
1.For making correct financial statements
2.For correct valuation of inventories
3.For correct treatment of depreciation and lease and
investment
4.All of theabovemunotes.in

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12ii. Accounting standards are statements prescribed b y
1.Law
2.Bodies of shareholders
3.Professional accounting bodies
4.All of theabove
iii. The Policy of ‘anticipate no profit and provide for all possible
losses’ arises due to convention of
1.Consistency
2.Disclosure
3.Conservatism
4.All of Above
iv.Accounting has cer tain norms to be observed by the
accountants in recording of transactions and preparation of
financial statements. These norms reduce the vagueness and
chances of misunderstanding by harmonizing the varied
accounting practices. These norms are
1.Accounting regulations.
2.Accounting guidance notes.
3.Accounting standards.
4.Accounting framework.
v. Following is the example of external users:
1.Government.
2.Owners.
3.Management.
4.Employees.
vi. Following is the example of internal users:
1.Government.
2.Investors.
3.Creditors.
4.Employees.
vii. The information provided in the annual financial statements
of an enterprise pertain to
1.Business Industry.
2.Economy.
3.Individual business entity.
4.None of the above.
Answers: i -4, ii-3, iii -3, iv-3, v-1, vi-4, vii -3
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13Unit-2
AS-1 DISCLOSURE OF ACCOUNTING
POLICIES
Unit Structure:
2.0 Objectives
2.1 Introduction
2.2 Meaning a nd Nature of Accounting Policies
2.3 Areas ofdifferent Accounting Policies
2.4 Notes to Accounts
2.5 Disclosure of Accounting Policies
2.6 Disclosure ofC h a n g e in Accounting Policies
2.7 Illustrations
2.8 Practical Applications
2.9 Questions
2.0 OBJECTIVES
After studying the unit students will be able to:
Understand the meaning and nature of accounting policies.
Explain the areas of different accounting policies.
Know the disclosure of accounting policies.
Know the disclosure of change in accounting policies.
Give s ome examples of significant accounting policies .
Solve the practical problems related to accounting policies.
2.1INTRODUCTION
Acco unting Standard (AS) 1 issued by the Accounting
Standards Board, the Institute of Chartered Accountants of India on
‘Disclosure of Accounting Policies’ deals with the disclosure of
significant accounting policies followed in preparing and presenting
financ ial statements. It may be noted that this Accounting Standard
is now mandatory for use by companies listed on a recognized
stock exchange and other large commercial, industrial and
business enterprises in the public and private sectors. Accounting
Standard s are intended to apply only to items which are material.munotes.in

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142.2MEANING AND NATURE OF ACCOUNTING
POLICIES
‘Accounting policies are the specific accounting principles
and methods of applying those principles adopted by the enterprise
in the preparation and pre sentation of the financial statements.’ E.g.
to depreciate fixed asset of the company over a period of time is
accounting policy and which method should follow to depreciate the
asset (SLM or WDV) is method of accounting.
There is no single list of accoun ting policies which are
applicable to all circumstances. The differing circumstances in
which enterprises operate in a situation of diverse and complex
economic activity make alternative accounting principles and
methods of applying those principles accept able.
IMPORTANCE OF ACCOUNTING STANDARD (AS) 1
The view presented in the financial statements of an
enterprise of its state of affairs and of the profit or loss can be
significantly affected by the accounting policies followed in the
preparation and pres entation of the financial statements. The
accounting policies followed vary from enterprise to enterprise.
Disclosure of significant accounting policies followed is necessary if
the view presented is to be properly appreciated. The disclosure of
some of th e accounting policies followed in the preparation and
presentation of the financial statements is required by law in some
cases.
PURPOSE OF ACCOUNTING STANDARD (AS) 1
The disclosure of significant accounting policies and the
manner in which accounting po licies are disclosed in the financial
statements would facilitate better understanding of financial
statements and a more meaningful comparison between financial
statements of different enterprises.
FUNDAMENTAL ACCOUNTING ASSUMPTIONS
The Financial Stateme nts are prepared with the following three
Fundamental Accounting Assumptions. Unless otherwise
speci fied, it is assumed that the Financial Statements are prepared
acco rding to following assumptions:
1.Going Concern,
2.Consistency ,
3.Accrual.munotes.in

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15They are explain ed as follows :
1. Going Concern:
The enterprise is normally viewed as a going concern, that
is, as continuing in operation for the foreseeable future. It is
assumed that the enterprise has neither the intention nor the
necessity of liquidation or of curt ailing materially the scale of the
operations.
2. Consistency:
It is assumed that accounting policies are consistent from
one period to another.
3.Accrual:
Revenues and costs are accrued, that is, recognized as they
are earned or incurred (and not as mon ey is received or paid) and
recorded in the financial statements of the periods to which they
relate.
It is mandatory to disclosure if the above mentioned
assumptions are not followed.
2.3AREAS OF DIFFERENT ACCOUNTING POLICIES
The following are examples o f the areas in which different
accounting policies may be adopted by different enterprises.
Methods of depreciation, depletion and amortization
Treatment of expenditure during construction
Conversion or translation of foreign currency items
Valuation of in ventories
Treatment of goodwill
Valuation of investments
Treatment of retirement benefits
Recognition of profit on long -term contracts
Valuation of fixed assets
Treatment of contingent liabilities.
CONSIDERATIONS IN THE SELECTION OF ACCOUNTING
POLICIES
The primary consideration in the selection of accounting
policies by an enterprise is that the financial statements prepared
and presented on the basis of such accounting policies should
represent a true and fair view of the state of affairs of the enterpri se
as at the balance sheet date and of the profit or loss for the period
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16For this purpose, the major considerations governing the
selection and application of accounting policies are: —
1.Prudence
2.Substance over Form
3.Materiality
They are explained as follows:
1.Prudence : In view of the uncertainty attached to future events,
profits are not anticipated but recognized only when realized
though not necessarily in cash. Provision is made for all known
liabilities and losses even though the amou nt cannot be
determined with certainty and represents only a best estimate in
the light of available information. Example of Prudence is to
select an accounting policy where inventory valuation is at lower
of cost or net realizable value.
2.Substance over Form: The accounting treatment and
presentation in financial statements of transactions and events
should be governed by their substance and not merely by the
legal form. Best example of this assumption can be state is hire
purchase. If company is purchas ing any asset on hire purchase
system then purchaser is not legal owner at the time of
purchase. In hire purchase ownership is transfer red on the
payment of the last installment but actually the asset is in the
possession of purchaser and he is using in hi s business
operation, so substantially he is better owner than legal. It
should be recorded in the books of purchaser.
3.Materiality: Financial statements should disclose all “material”
items, i.e. items the knowledge of which might influence the
decisions of the user of the financial statements. That means if
profit & loss accounts contains an irregular transaction which is
not routine and probably effects shareholders or investors, the
same should be disclosed separately. Example -Any expense
having amount more than Rs.5000 or 1% of turnover whichever
is higher should be disclosed separately rather to club with
miscellaneous expenses.
2.4NOTES TO ACCOUNTS
Notes to accounts are the explanation given by the
management about the items in the financial statement si . e .P r o f i t
and Loss Account and Balance Sheet. The management of the
institute has to give more explanation and information as regards
the items given in the Profit and Loss Account and Balance Sheet
and any other item in the way of notes to accounts. E .g. Disclosuremunotes.in

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17of details of contingent liability by notes to accounts. Notes to
accounts are part and parcel of the financial statement.
2.5DISCLOSURE OF ACCOUNTING POLICIES
To ensure proper understanding of financial statements, it is
necessary that :-
1. All significant accounting policies adopted in the preparation and
presentation of financial statements should be disclosed.
2. The disclosure of the significant accounting policies as such
should form part of the financial statements and the significan t
accounting policies should normally be disclosed in one place.
3. Disclosure of accounting policies or of changes therein cannot
remedy a wrong or inappropriate treatment of the item in the
accounts.
4.Ifthe fundamental accounting assumptions of Goin gC o n c e r n ,
Consistency and Accrual are followed in financial statements,
specific disclosure is not required. If a fundamental accounting
assumption is not followed, the fact should be disclosed.
2.6DISCLOSURE OF CHANGE IN ACCOUNTING
POLICIES
Ac h a n g ei nt h e accounting policies should be made in
the following conditions:
1.Adoption of different accounting policies is required by statue
or for compliance with an Accounting Standard.
2.It is considered that change would result in more appropriate
presentation of financial statement s.
In case if there is a change in accounting policies, the
following information must be disclosed :
1. Any change in the accounting policies which has a material
effect in the current period or which is reasonably expected to have
amaterial effect in later periods should be disclosed.
2. In the case of a change in accounting policies which has a
material effect in the current period, the amount by which any item
in the financial statements is affected by such change should also
bedisclosed to the extent ascertainable. Where such amount is not
ascertainable, wholly or in part, the fact should be indicated.munotes.in

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182.7ILLUSTRATIONS
Significant accounting policies can be found in financial
statements of public companies. Some examples of signif icant
accounting policies are as follows:
1. Inventories
This significant accounting policy comes from 201 7-18
annual financial statements of Zimmer Holdings, Inc.
Inventories are stated at the lower of cost or market, with
cost determined on a first -infirst-out basis.
2. Property and Equipment
This significant accounting policy comes from 201 7-18
annual financial statements of Google, Inc.
We account for property and equipment at cost less
accumulated depreciation and amortization. We compute
deprecia tion using the straight -line method over the estimated
useful lives of the assets, generally two to five years. We
depreciate buildings over periods up to 25 years. Depreciation for
equipment commences once it is placed in service and depreciation
for buil dings and leasehold improvements commences once they
are ready for our intended use. Land is not depreciated
3. Cash and Cash Equivalents
This significant accounting policy comes from 201 7-18
annual financial statements of Hill -Rom, Inc.
We consider inve stments in marketable securities and other
highly liquid instruments with a maturity of three months or less at
date of purchase to be cash equivalents. Investments which have
no stated maturity are also considered cash equivalents.
2.8PRACTICAL APPLICATIONS
1.A Company has switched over to weighted average formula for
ascertaining the cost of inventory, from the earlier practice of using
FIFO. The closing inventory by using FIFO is Rs. 4 lakh and that by
weighted average formula is Rs.3.85 lakh. Explain th e Accounting
Treatment/Disclosures as necessary
Ans: The fact that change in accounting policy pull down profit a nd
value of inventory by Rs.15, 000 is to be disclosed.
2.Shreya’s Ltd. prepared Profit and Loss Account and the Balance
Sheet for the year 2 017-18.The accounting policies about Profit andmunotes.in

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19Loss Account have been disclosed below Profit and Loss Account
and accounting policies about Balance Sheet have been disclosed
before Balance Sheet. Comment
Ans: As per AS -1, the accounting policies adopted for preparation
of final accounts should form part of the final accounts. These
policies should be disclosed at one place only forming part of the
accounts. It should not be disclosed separately.
3.PG Ltd. prepared Profit & Loss Account and Balance Shee to n
cash basis. Comment .
Ans: As per AS -1, accrual basis is the fundamental accounting
assumption. The company follows cash basis. The fundamental
accounting assumption is not followed; it should be disclosed in the
form of a note to the accounts.
4.Akshata Ltd. prepared final accounts for the year 201 7-18.
During the year accident took place in the factory, the worker who
got injured lodged a claim of Rs.3, 00,000 against the company .The
claim is under dispute, the accountant did not mention this in the
accounts, Comment .
Ans. Claim for compensation under dispute is a contingent liability .
As per AS -1, it should be disclosed as a foot -note to the final
accounts. The company must make a disclosure about the
contingent claim.
5.Draft the Accounting policies to be disclosed in the financial
statements for the following items:
i. Revenue Recognition -Sale of goods
Ans. Sales are recognized when good are invoiced and dispatched
to customers and are recorded inclusive of excise duty, net trade
discount a nd sales tax.
ii. Revenue Recognition -Sale of Equipment
Ans. Sale of Equipment is recognized when (1) it has a firm
contract, (2) the product has been shipped to and accepted by the
customer or the service has been provided, and (3) amounts are
reasonabl y assured of collection. Most equipment sales require
installation of the product. As such, revenue is recognized at the
time of delivery and installation at the customer location. Equipment
revenues are based on established prices by product type and
mode l and are net of discounts.munotes.in

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20iii. Revenue Recognition -Sales Return
Ans. A sales return is accepted only when the equipment is
defective and does not meet product performance specifications.
iv. Inventories
Ans. Inventories, other than scrap, are valu ed at cost, on weighted
average basis. Scrap is valued at realizable value.
v. Depreciation –Machinery Spares
Ans. Machinery spares which can be used only in connection with
an item of fixed asset and whose use is expected to be irregular are
capitali zed and depreciated over the residual useful life of the
related plant and machinery.
vi. Depreciation -Fixed Assets
Ans. Fixed assets ( Other than leasehold land, technical knowhow
and temporary structure) are depreciated on straight -line method
(SLM) at the rate and in the manner prescribed in schedule XIV to
theCompanies Act, 1956 by writing off 95% of the cost of the
assets over the specified period of the assets.
6.Explain requirement in the following cases with reference to
DISCLOSURE OF ACCO UNTING POLICIES (AS -1)
1. Where proper disclosures regarding changes in accounting
policies have not been made by a company, in the method of
providing depreciation on plant and machinery from straight line
method to written -down value method an d due to the change the
net profit for the year, the net block as well as the reserves and
surplus lowered by Rs.50,00,000 .
Ans. The company has not disclosed in its accounts the fact of
change, from this year, in the method of providing depreci ation
on plant and machinery from straight line method to written -down
value method, as also the effect of this change. As a result of this
change, the net profit for the year, the net block as well as the
reserves and surplus are lower by Rs.50,00,000 each as compared
to the position which would have prevailed had this change not
been made.
2. Where a company has not disclosed all significant accounting
policies like treatment of research and development costs and has
also not disclosed the accounting policies at one place.munotes.in

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21Ans. The company had disclosed those accounting policies the
disclosure of which is required by the Companies Act, 1956. Other
significant accounting policies, viz., those relating to treatment of
research and development costs have not been disclosed nor have
all the policies been disclosed at one place, which is contrary to
Accounting Standard (AS) 1, `Disclosure of Accounting Policies'
issued by the Institute of Chartered Accountants of India.
2.9 QUESTIONS
1.What is an accounting policy?
2.List out different Accounting policies?
3.Mention the areas in which different policies may be adopted
by different organizations?
4.Write a short note on selection of accounting policies?
5.What are basic accounting assumptions?
6.What are t he disclosure requirements of AS -1 issued byICAI?
7.What do you understand by “notes to accounts”?
8. Select Correct Alternative:
i.Accounting policy is
1.accounting postulate
2.accounting convention
3.accounting standard
4.specific accounting principle or method chosen by
management out of permissible alternatives
ii.Example of accounting policy is
1.Method of depreciation chosen by management
2.Separate entity concept
3.Balance sheet
4.Standard audit
iii.RPC Ltd. follows the written down value method of
depre ciating machinery year after year due to
1.Comparability.
2.Convenience.
3.Consistency.
4.All of the above.
iv.A change in accounting policy is justified
1.To comply with accounting standard.
2.To ensure more appropriate presentation of the financial
statement of the en terprise.
3.To comply with law.
4.All of the above.munotes.in

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22v.Fundamental accounting assumptions are
1.Materiality.
2.Business entity.
3.Going concern.
4.Dual aspect
vi.M/s ABC Brothers, which was registered in the year 2000,
has been following Straight Line Method (SLM) of
depreciation. In the current year it changed its method from
Straight Line to Written down Value (WDV) Method, since
such change would result in the additional depreciation of
Rs. 200 lakhs as a result of which the firm would qualify to
be declared as a sick industrial unit. The auditor raised
objection to this change in the method of depreciation.
The objection of the auditor is justified because
1.Change in the method of depreciation should be done only with
the consent of the auditor .
2.Depreciation method ca nb ec h a n g e do n l yf r o mW D Vt oS L M
and not vice versa .
3.Change in the method of deprecation should be done only if it is
required by some statute and change would result in
appropriate presentation of financial statement .
4.Method of depreciation cannot be c hanged under any
circumstances.
vii.State the case where the going concern concept is applied?
1.When an enterprise was set up for a particular purpose,
which has been achieved, or to be achieved shortly.
2.When a receiver or liquidator has been appointed in ca se of
a company which is to be liquidated.
3.Fixed assets are acquired for use in the business for earning
revenues and are not meant for resale.
4.When an enterprise is declared sick.
viii.Principle requires that the same accounting method should
be used from o ne accounting period to the next.
1.Conservatism.
2.Consistency.
3.Business entity.
4.Money measurement.munotes.in

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23ix.The cost of a small calculator is accounted as an expense
and not shown as an asset in a financial statement of a
business entity due to __________
1.Materiality concept.
2.Matching concept.
3.Periodicity concept.
4.Conservatism concept.
x.It is generally assumed that the business will not liquidate in
the near foreseeable future because of
1.Periodicity.
2.Materiality.
3.Matching.
4.Going concern.
xi.The accounting concept requir ing the practice of crediting
closing stock to the trading account
1.Going concern
2.Cost
3.Matching
4.All of Above
xii.Accounting Principles are generally based on
1.Practicability
2.Subjectivity
3.Convenience in recording
4.All of Above
xiii.“Substance of any transaction shoul d be considered while
recording them and not only the legal form” is the statement
which holds true for
1.Substance over form.
2.Disclosure of accounting policies.
3.Both (a) and (b).
4.None of the three.
xiv.Change in the method of depreciation is change in
________ .
1.Accounting estimate.
2.Accounting policy.
3.Measurement discipline.
4.None of the above.
Answers: i -4, ii-1, iii-3, iv-4, v-3, vi-3, vii -3, viii -2, ix-1, x-4, xi-1, xii -1,
xiii-3, xiv -2
8.State whether the following statements are true or false :
1.The ‘materiality concept’ refers to the state of ignoring small
items and values from accounts.munotes.in

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242.Accounting principles are rules of action or conduct which are
adopted by the accountants universally while recording
accounting transactions.
3.The ‘conserva tism concept’ leads to the inclusion of all
unrealized profits.
4.Accounting concepts are broad assumptions.
5.India is a member of IASC (International Accounting Standards
Committee) .
6.The Institute of Chartered Accountants of India (ICAI), the apex
body o f accounting and auditing, constituted an Accounting
Standards Board (ASB) on April 21, 1977, to pronounce
standards on various items of the financial statements.
Answers: True: 1, 2, 4, 5, 6
False: 3.

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25Unit-3

AS-2VALUATION OF INVENTORIES
Unit Structure:
3.0 Objectives
3.1 Introduction
3.2 Objective and Scope ofAS-2
3.3 Measurement of Inventories
3.4 Net Realisable Value
3.5 Disclosures
3.6 Disclosure Practice onV a l u a t i o n ofI n v e n t o r i e s( A S-2)
3.7 Guidance Note onMODVAT /CENVAT issued bythe ICAI
and Valuation ofI n v e n t o r y
3.8 Cost ofI n v e n t o r i e s
3.9 Practical Applications
3.10 Exercises
3.0 OBJECTIVES
After studying the unit students will be able to:
Understand objective and scope of AS -2.
Make the measurement of inventories at various cases.
Solve the examples related to a llocation of Fixed Overheads
Calculate the cost of inventories.
Solve the problems on calculation of the cost of inventories.
3.1INTRODUCTION
Accounting Standard (AS) 2 'V aluation of Inventories', issued
by the Council of the Institute of Chartered Accountants of India
supersedes Accounting Standard (AS) 2, 'Valuation of Inventories',
issued in June, 1981. The revised standard comes into effect in
respect of accounting peri ods commencing on or after 1.4.1999 and
is mandatory in nature. Inventories consist of Finished Goods
which are held for sale in the ordinary course of business, Raw
Material & Work in Progress.munotes.in

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26DEFINITION
1. INVENTORY
Inventories are assets:
Held for sale in the ordinary course of business,
In the process of production for such sale or
In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Inventories encompass goods purchased and held for
resale , for example, merchandise purchased by a retailer and held
for resale, computer software held for resale, or land and other
property held for resale. Inventories also encompass finished goods
produced, or work in progress being produced, by the enterprise
and include materials, maintenance supplies, consumables and
loose tools awaiting use in the production process. Inventories do
not include machinery spares which can be used only in connection
with an item of fixed asset and whose use is expected to be
irregular; such machinery spares are accounted for in accordance
with Accounting Standard (AS) 10,Accounting for Fixed Assets.
2. NET REALISABLE VALUE
Net realizable value is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
3.2OBJECTIVE AND SCOPE OF AS -2
3.2.1 OBLECTIVE
A primary issue in accounting for inventories is the
determination of the value at which inventories are carried in the
financial state ments until the related revenues are recognized. This
Statement deals with the determination of such value, including the
ascertainment of cost of inventories and any write -down thereof to
net realizable value.
3.2.2 SCOPE
This Statement should be applied in accounting for inventories
other than:
a.work in progress arising under construction contracts, including
directly related service contracts (see Accounting Standard (AS)
7, Accounting for Construction Contracts 3);
b.work in progress arising in the ordinary course of business of
service providers;
c.shares, debentures and other financial instruments held as
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27d.producers' inventories of livestock, agricultural and forest
products, and mineral oils, ores and gases to the extent that
they are measured at net realizable value in accordance with
well established practices in those industries.
The inventories referred to in paragraph (d) are measured at net
realizable value at certain stages of production. This occurs, for
example, when agricultural crops have been harvested or mineral
oils, ores and gases have been extracted and sale is assured under
a forward contract or a government guarantee, or when a
homogenous market exi sts and there is a negligible risk of failure to
sell. These inventories are excluded from the scope of this
Statement.
3.3MEASUREMENT OF INVENTORIES
Inventories should be valued at the lower of cost and net
realizable value.
3.3.1 Cost of Inventories
The cost of inventories should comprise all costs of
purchase, costs of conversion and other costs incurred in bringing
the inventories to their present location and condition.
3.3.2 Costs of Purchase
The costs of purchase consist of the purchase price
including duties and taxes (other than those subsequently
recoverable by the enterprise from the taxing authorities), freight
inwards and other expenditure directly attributable to the
acquisition. Trade discounts, rebates, duty drawbacks and other
similar it ems are deducted in determining the costs of purchase.
3.3.3 Costs of Conversion
The costs of conversion of inventories include costs directly
related to the units of production, such as direct labour. They also
include a systematic allocation of fixed an d variable production
overheads that are incurred in converting materials into finished
goods. Fixed production overheads are those indirect costs of
production that remain relatively constant regardless of the volume
of production, such as depreciation an d maintenance of factory
buildings and the cost of factory management and administration.
Variable production overheads are those indirect costs of
production that vary directly, or nearly directly, with the volume of
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28
Fig 3.1: Measurement of Inventory
3.3.4 Allocation of fixed Overheads
The allocation of fixed production overheads for the purpose
of their inclusion in the costs of conversion is based on the normal
capacity of the production fac ilities. Normal capacity is the
production expected to be achieved on an average over a number
of periods or seasons under normal circumstances, taking into
account the loss of capacity resulting from planned maintenance.
The actual level of production may be used if it approximates
normal capacity. The amount of fixed production overheads
allocated to each unit of production is not increased as a
consequence of low production or idle plant.
Unallocated overheads are recognized as an expense in the
period in which they are incurred. In periods of abnormally high
production , the amount of fixed production overheads allocated to
each unit of production is decreased so that inventories are not
measured above cos t. Variable production overheads are
assigned to each unit of production on the basis of the actual use
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291.3.5Examples -Allocation of Fixed Overheads
Example 1 .
Total Production 100 Units
Normal Capacity 50 Units
Goods Sold 80 Units
Closing Stock 20Units
Direct Cost 10 per unit
Fixed Overhead Rs.80
Variable Overhead Rs.120
Ans: Valuation of Stock = Direct Cost + Fixed Cost + Variable Cost
=10 + 0.8 + 1.2
=Rs.12
Fixed Cost= (80/100) = Rs.0.8
Variable cost= (120/100) = Rs.1.2
Note: In case of Actual Production is abnormally high then, Fixed
Overhead is allocated to Finished Goods on actual Production
basis.
3.3.6 Joint Products
A production process may result in more than one product
being produced simultaneously. This is the case, for example,
when joint products are produced or when there is a main product
and a by -product. When the costs of conversion of each produ ct
are not separately identifiable, they are allocated between the
products on a rational and consistent basis. The allocation may be
based, for example, on the relative sales value of each product
either at the stage in the production process when the pro ducts
become separately identifiable, or at the completion of production.
Most by -products as well as scrap or waste materials, by their
nature, are immaterial. When this is the case, they are often
measured at net realizable value and this value is deduct ed from
the cost of the main product. As a result, the carrying amount of the
main product is not materially different from its cost.
3.3.7 Other Costs
Other costs are included in the cost of inventories only to the
extent that they are incurred in bringi ng the inventories to their
present location and condition. For example, it may be appropriate
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30of designing products for specific customers in the cost of
inventories.
Interest and other bo rrowing costs are usually considered as
not relating to bringing the inventories to their present location and
condition and are, therefore, usually not included in the cost of
inventories.
3.3.8 Exclusions from the Cost of Inventories
In determining the cost of inventories in accordance with
paragraph 6, it is appropriate to exclude certain costs and
recognize them as expenses in the period in which they are
incurred. Examples of such costs are:
(a)Abnormal amounts of wasted materials, labour, or other
production costs;
(b)Storage costs, unless those costs are necessary in the
production process prior to a further production stage;
(c) Administrative overheads that do not contribute to bringing the
inventories to their present location and condition; an d
(d) Selling and distribution costs.
3.3.9Cost Formula e
1.Specific Identification Method for –
i)Goods not ordinarily interchangeable;
ii)Goods/services produced and segregated for specific
projects.
Specific identification of cost means that specific costs are
attributed to identify items of inventory. This is an appropriate
treatment for items that are segregated for a specific project,
regardless of whether they have been purchased or produced.
However, when there are large number of items of inventory which
are ordinarily interchangeable, specific identification of costs is
inappropriate since, in such circumstances, an enterprise could
obtain predetermined effects on the net profit or loss for the period
by selecting a particular method of ascertaining the item st h a t
remain in inventories.
2.FIFO, Weighted Average Method in other cases.
The cost of inventories, in other cases should be assigned
by using the first -in, first -out (FIFO), or weighted average cost
formula. The formula used should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory
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31A variety of cost formula eis used to determine the cost of
inventories other than those for which specific identification of
individu al costs is appropriate. The formula used in determining the
cost of an item of inventory needs to be selected with a view to
providing the fairest possible approximation to the cost incurred in
bringing the item to its present location and condition. The FIFO
formula assumes that the items of inventory which were purchased
or produced first are consumed or sold first, and consequently the
items remaining in inventory at the end of the period are those most
recently purchased or produced. Under the weighted average cost
formula, the cost of each item is determined from the weighted
average of the cost of similar items at the beginning of a period and
the cost of similar items purchased or produced during the period.
The average may be calculated on a periodi c basis, or as each
additional shipment is received, depending upon the circumstances
of the enterprise.
3.3.10Techniques for the Measurement of Cost
Techniques for the measurement of the cost of inventories,
such as the standard cost method or the retail meth od, may be
used for convenience if the results approximate the actual cost.
Standard costs take into account normal levels of consumption of
materials and supplies, labour, efficiency and capacity utilization.
They are regularly reviewed and, if necessary, revised in the light of
current conditions.
The retail method is often used in the retail trade for
measuring inventories of large numbers of rapidly changing items
that have similar margins and for which it is impracticable to use
other costing methods . The cost of the inventory is determined by
reducing from the sales value of the inventory the appropriate
percentage gross margin. The percentage used takes into
consideration inventory which has been marked down to below its
original selling price. An a verage percentage for each retail
department is often used.
3.4NET REALISABLE VALUE
3.4.1 MEANING
It means the estimated selling price in ordinary course of
business, less estimated cost of completion and estimated cost
necessary to make the sale. Estimati on of NRV also takes into
account the purpose for which the inventory is held.
3.4.2 When cost of inventories may not be recoverable?
i.If inventories are damaged,
ii.If they have become wholly or partially obsolete,
iii.If their selling prices have d eclined.
iv.If the estimated costs of completion or the estimated costs
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32The practice of writing down inventories below cost to net
realizable value is consistent with the view that assets should not
be carried in excess of amounts expected to be realized from their
sale or use. An assessment is made of net realizable value as at
each balance sheet date.
3.4.3 Net Realizable Value for Raw Material -Para 24 of AS 2
1) If finished goods in which Raw Material is used, is sold at or
above cost, then net realizable value of Raw Material is considered
more than its cost.
2) If finished goods in which Raw Material used is sold below cost,
then net realizable value of Raw Material is equal to replacement
price of Raw Material.
3.4.4 Analysis of Inventory valuation under cost and NRV
Aspects
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33Example 2:
Suppose, there are 1, 00,000 units in stock, of which 60, 000 are to
be delivered for Rs. 40 each as per contract with one of the
customer. Cost of stock is Rs.45 per unit & NRV is estimated of
Rs.50 per unit. What will be the value of stock?
Ans. In this case, 60, 000 units will be valued at Rs. 40 & balance
stock of 40, 000 units will be valued at Rs. 45 per unit.
Example 3:
Items X Y Z Total
Cost 20 16 8 44
NRV 14 16 12 42
How will you value the stock under provisions of AS -2?
Ans:
Items X Y Z Total
Cost 20 16 8 44
NRV 14 16 12 42
Value
(under AS 2)14 16 8 38
3.5DISCLOSURES
The financial statements should disclo se:
i.Accounting policies relating to inventories
ii.Cost formula used
Iii.Carrying amount of inventories with appropriate classifications
Information about the carrying amounts held in different
classifications of inventories and the extent of the cha nges in these
assets is useful to financial statement users. Common
classifications of inventories are raw materials and components,
work in progress, finished goods, stores and spares, and loose
tools.
3.6DISCLOSURE PRACTICE ON VALUATION OF
INVENTORIES (AS -2)
Illustration:
This significant accounting policy comes from 2006 annual financial
statements of Bharat Forge America Inc.munotes.in

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34Inventories are stated at the lower of cost or market, with the cost
determined on the First-In, First -Out ( FIFO) method.
Explain requirement in the following cases with reference to
VALUATION OF INVENTORIES (AS -2)
1.The company is valuing its stocks at `cost' instead of `lower of
cost ornet realizable value". Further, in valuing the closing stock at
cost, the company has in cluded interest and other borrowings in
`cost'.
Ans. That the company is valuing its stocks at ‘cost' instead of
`lower of cost and net realizable value ’.F u r t h e r ,i nv a l u i n gt h e
closing stock at cost, the company has included interest and other
borrowi ngs in ‘cost'. This is not in accordance with principles of
valuation of inventory as laid down in Revised Accounting
Standard AS -2 on Valuation of Inventories , issued by the
Institute of Chartered Accounta nts of India, which recom mends,
inter alia, that the inventories should be valued at `lower of cost
and net realizable value' and that the interest and other borrowing
should not normally be included in the cost.
2.The Company in respect of its Chemical Division fo llowed the
practice of valuing its inventories o nFIFO basis. This year it
changed the basis of valuation from FIFO to LIFO basis. If this
change had not been made, the profit of the Compan yw o u l dh a v e
been higher by Rs. 20 lakhs and inventorie sw o u l dh a v e been
higher by Rs. 20 lakhs.
Ans. The Company in respect of its Chemical Division followed the
practice of valuing its inventories o nFIFO basis. This year it
changed the basis of valuation from FIFO to LIFO basis. Had this
change not been made, the profit of the Company would have been
higher by Rs.20 lakhs and inventories would have been higher by
Rs.20 lakhs. This is not accordance with principles of valuation of
inventory as laid down in Revised Accounting Standard AS -2o n
`Valuation of I nventories', issued by the Institute of Chartered
Accountants of India, which recommends, inter alia, that the
inventories should be value at FIFO and at LIFO.
3.As per the past practice, the excise duty paid on finished
goods inven tory amounting to Rs. 3 crores has been treated as
prepayment till the goods are sold an d estimated excise duty of
Rs.2 crores on finished goods lying in the factory premises but not
cleared from excise bonded warehouse as on March 31, 2011 has
not been included in inventory valuation.munotes.in

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35Ans. As per the past practice, the excise duty paid on finished
goods inventory amounting to Rs. 3 crores has been treated as
prepayment till the goods are sold an d estimated excise duty of
Rs.2crores on finished goods lying in the factory premises but not
cleared from excise bonded warehouse as on March 31, 2011 has
not been provided and hence, not included in inventory valuation.
This treatment, however, has no effect on the profits for the ye ar.
3.7GUIDANCE NOTE ON MODVAT/CENVAT ISSUED
BY THE ICAI AND VALUATION OF INVENTORY
ICAI issued a “Guidance Note on Accounting Treatment for
MODVAT / CENVAT”, with the substitution of the MODVAT Credit
Scheme with CENVAT w.e.f. 1 -4-2000. The re vised Guidance Note
has provided clarification on the above anomaly, with examples on
both the inclusive method (Sec. 145A) and exclusive method (AS -
2), where it is clear that the above anomaly is only in respect of the
disclosure, with no effect on the tot al profit/loss of the enterprise.
Therefore ,for purposes of tax filings and tax audit forms, the
inclusive method should be used as per section 145A of the
Income -tax Act, whereas for purposes of general purpose financial
statements, the exclusive method under AS -2 should be followed.
Inclusive Method (Gross Value Approach)
Raw material is accounted for at gross value inclusive of
specified duty.
CENVAT credit available on final products can be accounted for
through a separate account CENVAT Credit Availe d Account.
Inputs may be consumed partly. CENVAT Credit available
should be segregated into two parts:
-CENVAT Credit on inputs consumed in respect of final
products;
-CENVAT credit on inputs lying in the stock.
CENVAT credit available on inputs co nsumed for final products is
adjusted with the cost of raw material consumed.
CENVAT credit available on inputs lying in the godown should be
adjusted against the value of closing stock of raw material.
Exclusive Method (opening separate CENVAT Credit Ac count)
Specified duty (i.e., duty paid against which CENVAT credit is
available) paid on inputs is debited to a separate account,
namely CENVAT Credit Receivable (Input) Account.munotes.in

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36As and when CENVAT credit is actually utilized against
payment of excise duty on final products, CENVAT Credit
Receivable (Input) Account is credited.
Inputs consumed and inventory is valued excluding specified
duty.
Balance standing in the CENVAT Credit Receivable (Input)
Account is shown on the asset side of the Balance Sheet
under Advances.
3.8COST OF INVENTORIES
A] Cost of Purchase:
I]Purchase Price xx
ii]Duties & Taxes xx
iii]Freight Inward xx
iv]Other Expenditure directly
attributable to acquisition xx xx
Less: i]Duties and Taxes re coverable
from tax authorities xx
ii]Trade discount xx
iii]Rebate xx
iv]Duty Drawback xx
v]Other similar items xx xx xxx
B]Cost of Conversion:
Direct Materials xx
Direct Labour xx
Direct Expenses xx
Systematic allocation of:
Variable Production Overheads xx
Fixed Production Overheads xx xxx
C]Other Costs:
Cost incurred for bringing the
inventories to their present xxx
location and co ndition xxx
3.9 PRACTICAL APPLICATIONS
Illustration 1:(Duties and taxes not recoverable)
Ambalal furnishes you following details
Ascertain the cost of purchase of inventory
i]Purchase of Raw materials Rs. 10 lakhs
ii]Duties and Tax es paid on the
acquisition and are not recoverable Rs. 2 lakhs
iii]Carriage inward Rs. 1 lakhs
iv]Others paid for acquisition of inventory Rs. 1 lakhsmunotes.in

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37Solution:
Cost of Purchase Rs. in lakhs
Cost of Pu rchase of Raw Materials 10
Duties & Taxes not recoverable 02
Carriage inward 01
Other Expenses 01
Total 14
Illustration 2
Big Bagha Associates furnishes you following details from which
you are requir ed to ascertain cost of purchase of inventories.
i]Cost of Purchase of Inventory Rs. 20 lakhs
ii]Duties & Taxes paid and are
recoverable from Tax Authorities Rs. 5 lakhs
iii] Trade Discount Rs. 2 lakhs
iv]Duties & Taxes paid and not recoverable Rs. 2 lakhs
v]Freight Inwards Rs. 1 lakhs
vi] Other Expenses directly attributable
to Acquisition of Inventory Rs. 2 lakhs
Solution : Big Bagha Associates
Calculation of Cost of Purchase Rs.in lakhs
Cost of Purchase 20
Duties & Taxes paid and not recoverable 02
Freight Inward 01
Other Expenses 02
25
Less : Duties & Taxes recoverable from
Tax Authorities 05
Trade Discount 02 07
Total 18
Illustration 3
Chrome Ltd. manufactures different types of Dichromates.
From the following information find the value of inventory per kg
of Sodium Dichromate
Material cost Rs. 150 per kg
Direct Labour Cost Rs. 50 per kg
Direct Variable Production Overheads Rs. 20 per kg
Fixed production overheads for the year on normal capacity of
1,00,000 kgs is Rs. 15 lakhs.
Finished goods on stock at the end of the year 3,000 kgs.
Solution: Chrome Ltd.
Cost per kg of Sodium Dichromate
As per AS -2 cost of conversion incl udes a systematic
allocation of fixed and variable production overheads, which aremunotes.in

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38incurred for converting materials into finished goods. The allocation
of fixed production overhead s is based on normal capacity.
Statement of Cost (Per Kg) Rs.
Material Cost 150
Direct Labour 50
Direct Variable Production Overheads 20
Fixed Production Overheads   15,00,0001, 0 0 , 0 0 015
235
Value of Stock =3,000 kgs @ Rs. 235
=Rs. 7,05,000
Illustration 4
Ind Ltd. manufacture computers, during the year ended 31stMarch,
2008 the company manufactured 550 computers, it has the polic y
of valuing finished stock of goods at a standard cost of Rs. 1.8 lakhs
per computer. The details of the cost are as under;
(Rs. in Lakhs)
Raw material consumed 400
Direct Labour 250
Variable production overheads 150
Fixed production overheads 290
(Including interest of Rs. 100)
Compute the value of cost per computer for the purpose of
closing stock.
Solution: As per AS -2 (Revised) (refer point 3.6), on valuation of
Inventories, finished stock of goods should be valued on the basis
of absorption costing. While absorbing fixed production overheads
the normal production capacity is considered. In this case ,finished
stock has been v alued at a standard cost of Rs. 1.8 lakhs per
computer which incidentally s ynchronizes with the value computed
on the basis of absorption costing as under:
, (Rs. in lakhs)
Materials 400
Direct Labour 250
Fixed production overheads 150
Fixed production overheads 290
Less :Interest 100 190
Total Cost 990
Number of computers produced 550
(Assumed to be normal production)
Cost per computer 990/550 = Rs. 1.80 lakhs
Policy of the company to value closing stock is not as per
AS-2. As per para 18 of AS -2, (refer point 3.9 -1) the techniques ofmunotes.in

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39standard cost method may be used for convenience if the result
approximates to the actual cost and standard cost is regularly
reviewed if necessary. In the instant case, the cost of invent ory can
be conveniently calculated as per absorption costing. Therefore,
there is no reason that standard costing method should be adopted.
Illustration 5
Dolphin Simulators Ltd. manufactures simulators.
Raw material was purchased at Rs. 100 per kg. Pri ce of raw
material is on the decline. The finished goods in which the raw
material is incorporated are expected to be sold at below cost.
10,000 kgs of raw materi al is in stock at the year -end. Replacement
cost is Rs. 80 per kg. How will you value the inve ntory?
Solution :
Dolphin Simulators Ltd.
As per para 24 of AS -2, on valuation of inventories, material and
other supplies held for use in the production of inventories are not
written down below cost if the finished products in which they will
be incorpo rated are expected to be sold at or above cost. However,
when there has been a decline in the price of materials and it is
estimated that the cost of the finished products will exceed net
realisable value, the materials are written down to net realisable
value. Insuch circumstances, the replacement cost of the material
may be the best available measure of their net realisable value.
Hence ,in this case, the stock of 10 ,000 kgs. of raw material will
be valued at Rs. 80 per kg. The finished goods, if on sto ck, should
be valued at cost or net realisable value, whichever is lower.
Illustration 6
Lurcko Pvt. Ltd. manufactures computers. During the year
ended 31stMarch, 20 17, the company manufactured 1000
computers. The break up of cost is as under:
Raw Ma terial Rs. 450 lakhs
Direct Labour Rs. 300 lakhs
Variable Production Overheads Rs. 200 lakhs
Fixed Production Overheads
(Includes interest of Rs. 100 lakhs) Rs. 300 lakhs
Compute the cost per computer for the purpose of closing
stock.
Solution:
As per AS -2 Inventory should be valued as per absorption
costing. The cost is calculated as under :munotes.in

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40Calculation of Cost of Purchase
Rs. in lakhs
Raw Material 450
Direct Labour 300
Variable Product ion Overheads 200
Fixed Production Overheads 300
Less Interest 100 200
1150
Cost per computer = 1,150Lakhs /1,000 =Rs.1.15 lakhs
Note: Interest is excluded from cost of inventory.
Illustration –7
Gurecha Pvt. Lt d. furnishes you following information from
which you are required to value inventory of Finished Goods.
Material cost Rs. 200 per kg.
Direct Labour cost Rs. 40 per kg.
Direct variable production overhead Rs. 20 per kg.
Fixed produ ction charges for the year on normal capacity of
one lakh kgs. is Rs. 20 lakhs. 2000 kgs. offinished goods are on
stock at the year -end.
Solution: Gurecha Pvt. Ltd.
In accordance with paras 8 & 9 of AS -2, (refer point 3.6) the
cost of conversion inclu de a systematic allocation of fixed and
variable production overheads that are incurred in converting
materials into finished goods. The allocation of fixed production
overheads for the purpose of their inclusion in the cost of
conversion is based on the n ormal capacity of the production
facilities.
Thus, cost per kg. of finished goods can be computed as
follows:
Rs Rs.
Material cost 200
Direct Labour cost 40
Direct variable production overhead 20
Fixed producti on overhead
(Rs. 20,00,000/100000) 20 80
280
Thus, the value of 2000 kgs. of finished goods on st ock at
the year -end will be Rs.5,60,000 = (2000 kgs. X Rs. 280)
Illustration 8
Hirel Techno points Associates is a company situat ed at MIDC,
Pune. The company deals in three products A, B and C, which are
neither similar nor interchangeable. At the time of closing of itsmunotes.in

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41accounts for the year 20 16-17; the historical cost and net realisable
values of the items of closing stock are gi ven below:
Items : Historical Cost Net Realisable Value
(Rs. in lakhs) (Rs. in lakhs)
A 25 20
B 20 20
C 10 15
55 55
What will be the value of stock?
Solution: HIREL TECHNOPOINTS, PUNE
Historical Cost or Net Realisable Value whichever is less is
the value of stock. This should be done item by item as given
below:
Rs. in lakhs
A.Net Realisable Value 20
B.Historical Cost 20
C.Historical Cost 10
Value of Closing Stock 50
Illustration 9
The company deals in three products, A, B and C, which are
neither similar nor interchangeable. The Historical Cost and Net
Realizable Value of the items of closing stock for the year 201 6-17
are determined as follows:
Items Historical Cost Net Realizable Value
(Rs. in lakhs) (Rs. in lakhs)
A 40 28
B 32 32
C 16 24
What will be the value of Closing Stock?
Ans: As per Para 5 of AS 2 on Valuation of Inventories, inventories
should be valu ed at the lower of cost and net realizable value.
Inventories should be written down to net realizable value on an
item-by item basis in the given case.
Items Historical Cost Net Realizable
ValueValuation of
closing stock
(Rs. in lakhs) (Rs. in lakhs ) (Rs. in lakhs)
A 40 28 28
B 32 32 32
C 16 24 16
Total 88 84 76
Hence, closing stock will be valued at Rs. 76 lakhs.munotes.in

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42Illustration 10
X Co. Limited purchased goods at the cost of Rs.40 lakhs in
October, 2011 . Till March, 2012, 75% of the stocks were sold. The
company wants to disclose closing stock at Rs.10 lakhs. The
expected sale value is Rs.11 lakhs and a commission at 10% on
sale is payable to the agent. Advice, what is the correct closing
stock to be dis closed as at 31.3.2012.
Ans: As per Para 5 of AS 2 “Valuation of Inventories ”, the
inventories are to be valued at lower of cost and net realizable
value. In this case, the cost of inventory is Rs.10 lakhs. The net
realizable value is 11, 00,000 @90% = Rs.9, 90,000. So, the stock
should be valued at Rs.9, 90,000.
Illustration 11
The Company X Ltd. has to pay for delay in cotton clearing
charges. The company up to 31.3.20 17has included such charges
in the valuation of closing stock. This being in the nature of interest,
X Ltd. decided to exclude such charges from closing stock for the
year 2006 -07. This would result in decrease in profit by Rs.5 lakhs.
Comment.
Ans: As per Para 12 of AS 2 (revised), interest and other borrowing
costs are usually considered as not relating to bringing the
inventories to their present location and condition and are therefore,
usually not included in the cost of inventories. Howeve r, X Ltd. was
in practice to charge the cost for delay in cotton clearing in the
closing stock. As X Ltd. decided to change this valuation procedure
of closing stock, this treatment will be considered as a change in
accounting policy and such fact to be di sclosed as per AS 1.
Therefore, any change in amount mentioned in financial statement,
which will affect the financial position of the company should be
disclosed properly as per AS 1, AS 2 and also a note should be
given in the annual accounts that, had t he company followed earlier
system of valuation of closing stock, the profit before tax would
have been higher by Rs. 5 lakhs.
Illustration 12
Normal capacity = 20 ,000 units
Production = 18 ,000 units
Sales = 16 ,000 units
Closing Stock =2,000 units
Fixed Overheads = Rs. 60 ,000
Calculate cost of fixed overheads to closing stock
Ans: Fixed Overheads = Rs .60,000/20,000 = Rs .3p e ru n i t
Fixed Overheads will be bifurcated into three parts:
Cost of Sales: 16 ,000*3 = 48 ,000
Closing Stock: 2 ,000 *3 = Rs.6,000
Under normal capacity: 2 ,000 *3 = Rs .6,000
(to be charged to P/L A/c)munotes.in

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43Illustration 13
Normal capacity = 20 ,000 units
Production = 25 ,000 units
Sales = 23 ,000 units
Closing Stock = 2 ,000 units
Fixed Overheads = Rs 60, 000
Calculate Cost of fixed overheads to closing stock
Ans: Fixed Overheads = Rs 60 ,000/20 ,000 = Rs .3p e ru n i t
But, Due to production above normal cap acity = Rs .60,000/25,000
= Rs. 2.40 per unit
Cost of Sales: 23 ,000*2.4 = Rs.55,200
Closing Stock: 2 ,000 * 2.4 = Rs.4,800
Illustration 14
Ascertain the cost of Inventory by using the data given below:
i. Purchase Price Rs.20 lakhs
ii. Duties and Ta xes paid on acquisition and are
not recoverableRs.2 lakhs
iii. Freight inward Rs.2 lakhs
iv .Others paid for acquisition of inventory Rs.1 lakhs
Ans. Cost of Purchase:
Cost of Inventory Rs. in lakhs
Purchase Price 20
Duties and Taxes paid on acquisi tion and are not
recoverable02
Freight inward 02
Others paid for acquisition of inventory 01
Total 25
Illustration 15
Zenith Ltd. manufactures computers. During the year ended 31st
March 201 7, the Company manufactured 5 ,000 computers and
incur red following cost:
i. Raw Material Rs.400 lakhs
ii. Direct Labour Rs.400 lakhs
iii.Variable Production overheads Rs.150 lakhs
iv. Fixed Production overheads
(including interest 50 lakhs)Rs.250 lakhs
Compute cost per computer for the purpose of closing stock.munotes.in

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44Ans.Cost of PurchaseRs. in lakhsRaw Material 400Direct Labour400
Variable Production overheads 150
Fixed Production overheads 200
Total 1,150
Note: Interest excluded from cost of Inventory
Cost per Computer (1,150lakhs /5,000) Rs. 23,000
3.10EXERCISE
3.10.1PRACTICAL PROBLEMS
1.How do you ascertain the cost of purchase of inventory by using
the following data
i]Purchase Price Rs. 5,00,000
ii]Duties and Taxes paid on the Acquisition
of Inventory and are not recoverable Rs. 2,00,000
iii]Freight Inward Rs. 1,00,000
iv]Other Expenses for Acquisition of Materials Rs. 2,00,000
[Ans. Rs. 10,00,000]
2.Ganesh Pvt. Ltd. produces product x 2007.
The production cost per unit
Raw Materials Rs. 15
Labour Rs. 6
Direct Expenses Rs. 5
Normal capacity 10,000 units p.a.
Actual production 7,000 units
Fixed Factory overheads Rs. 30,000 p.a.
Closing Stock 2500 units
Calculate the value of closing stock
Normal Capacity 10000units
Actual Production 7000 units
Total Fixed overheads 30000
Fixed overhead per unit 3Rs
Ans. Value of closing stock= 2500 units@29 =72500munotes.in

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453.Company deals in three products X, Y and Z, which are neither
similar nor interchangeable. At the time of closing its account for
the year 2001 -2002. The historical cost and net realisable
values of the items of closing stock are determined as below :
Items Historical Cost Net realisable value
(Rs. in lakhs) (Rs. in lakhs)
X 20 14
Y 16 16
Z 8 12
44 42
What will be the value of closing stock?
[Ans. : Rs. 38]
4.Company is collecting Gumkriya from the plant of forest for
collec ting Gumkriya. Company paid Rs. 5 crores to forest
department as license fee for financial year 2001 -2002. During
the year it collected 1 crore kg. of Gumkriya from the forest a nd
sold 60 thousand kg. for Rs. 12 crores. Other direct expenses
and overheads were Rs. 7 crores for the financial year 2001 -
2002. The company valued the closing stock of 40,000 kg. at
Rs. 4.80 crores following the AS -2. Whether the valuation is
correct.
[Ans. : AS -2d o e sn o ta p p l yt of o r e s tp r o d u c t ]
5.X Ltd. is selling refrigerator; purchase p rice of the Refrigerator is
Rs.15,000 as per the terms of sales. The refrigerator is to be
delivered and installed at customer’s house free of cost. X Ltd.
has hired Y & Co. for the purpose and being paid Rs. 1,000 –
per Refrigerator for delivery and installation. At year ended on
31-3-2002, 10 refrigerator were in stock. The market p rice of the
refrigerator is Rs. 15,750. Calculate the value of closing stock as
per AS -2.
[Ans. : Rs. 1,47,500]
6.Apple Consultancy Ltd. is the management consultant giving the
consultancy in the field of re -structuring, amalgamation and
valuation. The company has got consultancy contract worth
Rs.20 lakhs from Y Ltd. for giving th eir report of restructuring of
the organization. X Consultancies Ltd. commences the work on
1-3-2008 and expect that work will take four month sto be
completed. X Consultancy Ltd. has deployed four senior
consultants for the assignment whose salary is Rs. 20,000 per
month. For the year ended 31 -3-2008. The company values the
work -in-progress of Rs. 80,000 in its financial statement applying
the formula of valuation of cost or nets realisable value
whichever is less as per AS -2.
Is the valuation of W.I.P . of Rs. 80,000 is correct. If not why?
[Ans. : AS -2 does not apply to service contract]munotes.in

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467.Z Ltd. produced 10,000 units of product A during 2007 -2008 per
unit cost is as follows :
Raw Material Rs. 100
Direct wages Rs. 50
Direct Expenses Rs. 2
Rs. 152
Production overhead is Rs. 20,000 of which 40% is fixed. The
company sold 800 units and 2,000 units were in stock as on 31st
March 2008. Normal capacity is 50,000 units.
Calculate the value of closing sto ck.
[Ans .:Rs. 309600]
8.Historical Cost and Net Realibsable Value of five inventory
items are given below :
Items : Historical Cost Net Realisable Value
Rs. Rs.
A 20,000 30,000
B 12,000 10,000
C 12,000 18,000
D 32,000 26,000
E 28,000 26,000
1,04,000 1,10,000
Determine the value of inventory.
[Ans. Rs. 94,000]
9.Cost of Production of Product x 100 is given below :
Direct Material per unit Rs. 150
Direct Wages per unit Rs. 100
Overheads per unit Rs. 50
Rs. 300
As on the balance sheet date ,replacement cost of material is
Rs. 120 per unit. There were 2,000 units of material on 31stMarch,
2008
Calculate the value of stock of material under the followi ng
conditions:
i]Iffinished product is sold at Rs. 320 per unit, what will be the
value of stock of material.
ii]If finished product is so ld at the rate of Rs. 280 per unit, what will
be the value of closing stock of materials.
[Ans. (i) Rs. 3,00,000. (ii) Rs. 2,40,000]
10.Indulkar Ltd. produced 1,00,000 units during the year 2006 -07.
The cost per unit is as follows:
Direct Materials Rs. 100
Direct Labour Rs. 50
Direct Expenses Rs. 10munotes.in

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47Production overheads are Rs. 2,00,000 of which 60% is
variable. The company sold 80,000 units and 20,000 units were in
stock as on 31stMarch, 2007. Normal capacity is 50,000 units.
Calculate the value of Closing Stock.
[Ans. Variable Production Overheads Rs. 1,20,000
Fixed Production Overheads Rs.8 0 , 0 0 0
Variable Production Overheads
per unit Rs. 1,20,000
Rs. 1,00,000 =1.20
Fixed Production Overheads Rs. 80,000 =1.60
Per unit Rs. 50,000
Cost per unit Rs. 162.80
Value of Stock =20,000 x 162.80
=Rs. 32,56,000]
3.10.2THEORY QUESTIONS
1]What are the objectives of AS -2?
2]Under what circumstances AS -2 is applicable?
3]Define the term ‘Inventories’?
4]Write ad e t a i l ednote on ‘Measurement of Inventories’?
5]State and explain important aspec ts of ‘Inventory Valuation’.
6]Write short notes on
i]Treatment of other cost
ii]Inclusion of excise duty in valuation of finished goods
iii]Exclusion from cost of inventories
iv]Disclosure of inventory valuation policy in financial
statement .
v]Cost formula
vi]Net realisable value
7]Explain the following
a]Cost of purchase
b]Cost of conversion
c]Standard method
d]Retail method
e]Specific cost method
f]Net Realisable value
8]Compare the following
i]Standard cos ta n dr e t a i lm e t h o d
ii]Historical cost and Realisable value
9]Briefly explain Main Product, Joint Product and By Product.munotes.in

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483.10.3 OBJECTIVE TYPE QUESTIONS
1. Select Correct Alternative :
1.Under inflationary conditions, ________ method will show
highest value of closing stock?
a.FIFO
b.LIFO
c.Weighted Average
d.None of the above
2.The inventory valuation method that identifies the invoice cost of
each item in ending inventory to determine the cost assigned to
that inventory is the:
a.Weighted -average inven tory method.
b.Retail inventory method.
c.Specific identification method.
d.First-in, First -out method.3.A company had the purchases shown below during the currentyear. On December 31, there were 26 units remaining in endinginventory. These 26 units consisted of 2 from January, 4 fromFebruary, 6 from May, 4 from September and 10 fromNovember. Using the specific identification method, what is thecost of the ending inventory?January10 units @ 120February20 units @ 130May15 units @ 140September12units @ 150November10 units @ 160
a.3,500
b.3,800
c.3,960
d.3,280
4.The original cost of an inventory item is above the replacement
cost. The inventory item's replacement cost is above the net
realizable value. Under the lower of cost or market method, the
inventory item should be valued at:
a.Original cost.
b.Replacement cost.
c.Net realizable value.
d.Net realizable value less normal profit margin.munotes.in

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495.A manufacturer has the following per -unit costs and values for
its sole product:
Cost Rs.10.00
Curre nt replacement cost Rs.5.50
Net realizable value Rs. 6.00
Net realizable value less normal profit margin Rs. 5.20
In accordance with AS 2, what is the per unit carrying value of
inventory in the manufacturer’s statement of financial position?
a.5.20
b.5.50
c.6.00
d.10.00
6.AS-2i sr e l a t e dt o:
a.Valuation of inventories
b.Accounting for Construction Contracts
c.Cash Flow Statements
d.Depreciation accounting
7.Assuming constant inventory quantities, which of the following
inventory -costing methods will produce a lower inv entory
turnover ratio in an inflationary economy?
a.FIFO (first in, first out).
b.LIFO (last in, first out).
c.Moving average.
d.Weighted average.
8.In specific identification method of inventory valuation the
method applicable will be
a.FIFO
b.LIFO
c.Average cos t
d.None of the above
9.Sales for the year ended 31st March, 2005 amounted to
Rs.10, 00,000. Sales included goods sold to Mr. A for Rs. 50,000
at a profit of 20% on cost. Such goods are still lying in the
godown at the buyer’s risk. Therefore, such goods should be
treated as part of
a.Sales.
b.Closing stock.
c.Goods in transit
d.Sales returnmunotes.in

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5010.Approximate actual cost method of inventory valuation is --
a.Actual cost
b.Standard cost
c.Weighted average cost
d.FIFO
11.A company nor mally sells its product for Rs. 20 per unit, which
includes a profit margin of 25%. However, the selling price has
fallen to Rs.15 per unit. This company's current inventory
consist s of 200 units purchased at Rs. 16 per unit. Replace ment
cost has now fallen to Rs. 13 per unit. Calc ulate the value of this
company's inventory at the lower of cost or market.
a.2,600
b.2,550
c.2,700
d.3,000
12.A busines sman purchased goods for Rs.25, 00,000 and sold
70% of such goods during the accounting year ended 31st
March, 2005. The market value o ft h er e m a i ning goods was
Rs.5, 00,000. He val ued the closing stock at Rs.5, 00,000 and
not at Rs.7, 50,000 due to
a.Money measurement.
b.Conservatism.
c.Cost.
d.Periodicity.
13.At the end of the accounting year, material A costing Rs.10,000
was having net realizable value of Rs.9,500 only, while material
B costing Rs.12,000 was having a net realizable value of
Rs.13,000 in the market and material C costing Rs.15,000 was
having net realizable value of Rs.14,000 only. The total amount
of closing stock will be
a.Rs.37, 000.
b.Rs. 35 ,500.
c.Rs. 36,500.
d.Rs. 38,000.
14.The following data has been provided by Omega Ltd.:
Item No. Units Cost per unit Realization value
per unit
1 2 10 11
2 10 5 4
3 2 2 2munotes.in

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51The value of inventory on item by item basis will be
a.Rs. 40.
b.Rs.64.
c.Rs.66.
d.Rs.60.
15.“Inventories should be out of godown in the sequence in which
they arrive” is based on
a.HIFO.
b.LIFO.
c.FIFO.
d.Weighted average.
Answers: 1-a,2-c,3-b,4-c,5-c,6-a,7-a,8-d,9-a, 10-c, 11-a,
12-b,13-b,14-b, 15-c.



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52Unit-4
AS-9 REVENUE RECOGNITION
Unit Structure:
4.0 Objectives
4.1 Introduction
4.2 Purpose
4.3 Non Applicability of AS -9
4.4 Revenue Recognition
4.5 Effect ofU n c e r t a i n t i e s on Revenue Recognition
4.6 Disclosure Requirements
4.7 Practical Applicatio ns
4.8 Exercises
4.0 OBJECTIVES
After studying the unit the students will be able to:
Understand the purpose and scope of AS -9.
Know the non applicability of AS -9
Explain the effects of uncertainties on revenue recognition.
Understand the circumstances i n which revenue recognition has
been postponed.
Recognize revenue practically .
4.1INTRODUCTION
Revenue is the gross inflow of cash, receivables or other
consideration arising in the course of the ordinary activities of an
enterprise from the sale of goods , from the rendering of services
and from the use by others of enterprise resources yielding
interest, royalties and dividends. This Statement AS -9,Revenue
Recognition issued in 1985 deals with the bases for recognition of
revenue in the statement of pro fit and loss of an enterprise. The
statement is concerned with the recognition of revenue arising in
the course of the ordinary activities of the enterprise from
1.The sale of goods,
2.The rendering of services, and
3.The use by others of enterprise resources yielding interest,
royalties and dividends.munotes.in

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53Revenue recognition is mainly concerned with the timing of
recognition of revenue in the statement of profit and loss of an
enterprise. The amount of revenue arising on a transaction is
usually determined by agr eement between the parties involved in
the transaction. When uncertainties exist regarding the
determination of the amount, or its associated costs, these
uncertainties may influence the timing of revenue recognition. This
standard is mandatory for all ent erprises.
4.2PURPOSE
The Purpose of AS -9 is recognizing revenue arising in the
course of the ordinary activities of the enterprise .
SCOPE of AS -9
It includes the following activities:
Sale of goods.
Rendering of services.
Use by others of enterprise resou rces yielding interest,
royalties and dividends.
4.3NON APPLICABLITY of AS -9
This Statement does not deal with the following aspects of revenue
recognition to which special considerations apply:
1.Revenue arising from construction contracts.
2.Revenue arising from hire -purchase, lease agreements.
3.Revenue arising from government grants and other similar
subsidies.
4.Revenue of insurance companies arising from insurance
contracts.
5.Profit or loss on sale of fixed assets
6.Realized or unrealized gains resulting from c hanges in foreign
exchange rates
Examples of items not included within the definition of “revenue” for
the purpose of this Statement are:
1.Realized gains resulting from the disposal of and unrealized
gains resulting from the holding of, non -current assets e.g.
appreciation in the value of fixed assets;
2.Unrealized holding gains resulting from the change in value of
current assets and the natural increases in herds and
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543.Realized or unrealized gains resulting from changes in foreign
exchange rates and adjustments arising on the translation of
foreign currency financial statements;
4.Realized gains resulting from the discharge of an obligation at
less than its carrying amount;
5.Unrealized gains resulting from the restatement of the carrying
amount of an obligation.
4.4REVENUE RECOGNITION
1. Sale of goods
A key criterion for determining when to recognize revenue
from a transaction involving the sale of goods is that the seller has
transferred the property in the goods to th eb u y e rf o ra
consideration. The transfer of property in goods, in most cases,
results in or coincides with the transfer of significant risks and
rewards of ownership to the buyer. However, there may be
situations where transfer of property in goods does n ot coincide
with the transfer of significant risks and rewards of ownership.
Revenue in such situations is recognized at the time of
transfer of significant risks and rewards of ownership to the
buyer. Such cases may arise where delivery has been delayed
through the fault of either the buyer or the seller and the goods are
at the risk of the party at fault as regards any loss which might not
have occurred but for such fault. Further, sometimes the parties
may agree that the risk will pass at a time differen tf r o mt h et i m e
when ownership passes.
At certain stages in specific industries, such as when
agricultural crops have been harvested or mineral ores have been
extracted, performance may be substantially complete prior to the
execution of the transaction g enerating revenue. In such cases
when sale is assured under a forward contract or a government
guarantee or where market exists and there is a negligible risk of
failure to sell, the goods involved are often valued at net realizable
value. Such amounts, wh ile not revenue as defined in this
Statement, are sometimes recognized in the statement of profit
and loss and appropriately described.
Thus ,sale of goods is recognized when
1.The property in goods in transferred for a price.
2.All significant risks and rew ards have been transferred and
no effective control is retained.
3.No significant uncertainty exists regarding the amount of
consideration.
4.It is reasonable to expect ultimate collection of
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552. Rendering of Services
Revenue from service trans actions is usually recognized as
the service is performed, either by the proportionate completion
method or by the completed service contract method.
i)Proportionate Completion Meth od—Performance consists
of the execution of more than one act. Revenue is recognized
proportionately by reference to the performance of each act.
The revenue recognized under this method would be
determined on the basis of contract value, associated costs,
number of acts or other suitable basis. For practical purposes,
when services are provided by an indeterminate number of acts
over a specific period of time, revenue is recognized on a
straight line basis over the specific period unless there is
evidence that some other method better represents the pattern
of performance.
ii)Completed service Contract Method —Performance consists
of the execution of a single act. Alternatively, services are
performed in more than a single act and the services yet to be
performed are so significant in relation to the transaction taken
as a whole that performance cannot be deemed to have been
completed until the execution of those acts. The completed
service contract method is relevant to these patterns of
performance and accordingly revenue is recognized when
the sole or final act takes pla ce and the service becomes
chargeable.
Revenue recognition in rendering of services
Completed service method recognises revenue only
When service complete or substantially complete.
In such cases there are more than one act involved and
revenue is recog nised on' execution of all those acts.
Proportionate completed method
Recognises revenue proportionate with the degree of
completion of services.
There is more than one act involved and revenue is
recognised on execution of certain acts.
Thus, Service is recognized when
Service is recognised either on completed service or
proportionate completion method.
No significant uncertainty exists regarding amount of
consideration.
It is reasonable to expect ultimate collection of
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56EXAMPLES
1]Onsale, buyer takes title and accepts billing but delivery is
delayed at buyer’s request .
Ans. Revenue should be recognised notwithstanding that physical
delivery has not been completed .
2] Sale on approval .
Ans. Revenue should not be recognised until t he goods have been
formally accepted or time for re jection has elapsed or where no
time has been fixed, a reasonable time has elapsed.
3] Sales with the condition of ‘money back if not completely
satisfied .
Ans. It may be appropriate to recognize the sal eb u tt om a k e
suitable provision for returns based on previous experience.
4] Consignment sales .
Ans. Revenue should not be recognised until the goods are sold to
at h i r dp a r t y .
5]Instalment sales .
Ans. Revenue of sale price excluding interest should be recognised
on the date of sale.
6] Special order and shipments .
Ans. Revenue from such sales should be recognized when the
goods are identified and ready for deli very.
7] Where seller concurrently agrees to repurchase the same goods
at a later date .
Ans. The sale should not be recognised, as this is a financial
arrangement.
8] Subscriptions received for publications .
Ans. Revenue received or billed should be de ferred and
recognised either on a straight -linebasis over time or where the
items delivered vary in value from period to period, revenue should
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579] Sale of show tickets .
Ans. Revenue should be recogni sed when the event takes place.
10] Guaranteed sales of agricultural crops .
Ans. When sale is assured under forward contract or government
guarantee, the crops can be recognised at net realizable value
although it does not satisfy the criteria of revenu erecognition.
Rendering of Services
1]Installation Fees
Ans. In cases where installation fees are other than incidental to
the sale of a product, they should be recognised as revenue only
when the equipment is installed and accepted by the customer.
2] Advertisement commission received
Ans. It is recognised when the advertisement appears before
public.
3] Insurance agency commission received
Ans. It is recognised on the effective commencement or renewal
dates of the related policies.
4]Tuition fe es received
Ans. Itshould be recognised over the period of instruction.
5] Admission fees
Ans. Revenue from artistic performances, banquets and other
special events should be recognised when the event takes place.
When a subscription to a number of eve nts is sold, the fee should
be allocated to each event on a systematic and rational basis.
6] Entrance and membership fees
Ans. Revenue recognition from these sources will depend on the
nature of the services being provided. Entrance fee received is
gene rally capitalised. If the membership fee permits only
membership and all other services or products are paid for
separately, or if there is a separate annual subscription, the fee
should be recognised when received. Publications to be provided
during the y ear, it should be recognised on a systematic and
rational basis having regard to the timing and nature of all services
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583. Use of enterprise resources by others:
The use of such enterprise resources by others gives rise to:
(i)Interest —charges fo r the use of cash resources or amounts
due to the enterprise;
(ii)Royalties —charges for the use of such assets as know -how,
patents, trademarks and copyrights;
(iii)Dividends —rewards from the holding of investments in
shares.
Revenue recognition in use of enterprise resources by others
1.Interest : Revenue is recognized on the time basis determined by
the amount outstanding and the rate applicable.
2.Royalty : Revenue is recognized in accordance with the terms of
the relevant agreement.
3.Dividends :Revenue is recognized only when a right to receive
payment is established.
When interest, royalties and dividends from foreign countries
require exchange permission and uncertainty in remittance is
anticipated, revenue recognition may need to be postponed.
4.5EFFECT OF UNCERTAINTIES ON REVENUE
RECOGNITION
1.Recognition of revenue requires that revenue is measurable
and that at the time of sale or the rendering of the service it
would not be unreasonable to expect ultimate collection.
2.Where the ability to assess the ultimate collection with
reasonable certainty is lacking at the time of raising any claim,
e.g., for escalation of price, export incentives, interest etc., and
revenue recognition is postponed to the extent of uncertainty
involved. In such case s, it may be appropriate to recognize
revenue only when it is reasonably certain that the
ultimate collection will be made. Where there is no
uncertainty as to ultimate collection, revenue is
recognized at the time of sale or rendering of service even
though payments are made by installments.
3.When the uncertainty relating to collectability a rises
subsequent to the time of sale or the rendering of the service ,
it is more appropriate to make a separate provision to
reflect the uncertainty rather than to adju st the amount of
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594.An essential criterion for the recognition of revenue is that the
consideration receivable for the sale of goods, the rendering of
services or from the use by others of enterprise resources is
reasonably determ inable. When such consideration is not
determinable within reasonable limits, the recognition of
revenue is postponed.
5.When recognition of revenue is postponed due to the effect
of uncertainties ,i ti s considered as revenue of the period
in which it is pr operly recognized.
4.6DISCLOSURE REQUIREMENTS
In addition to the disclosures required by Accounting
Standard 1 on ‘Disclosure of Accounting Policies’ (AS 1), When
recognition of revenue is postponed due to the effect of
uncertainties, an enterprise sho uld disclose the circumstances in
which revenue recognition has been postponed.
Question: -Explain requirement in the following cases with reference
to REVENUE RECOGNITION (AS -9)
Accounts of certain items of income are recorded on cash basis, As
a result , the net profit for the year and current a ssets are
understated by Rs.20, 000 each .
Ans. Accounts of certain items of income recorded on cash basis
which is not in line with the Accounting Standard 9 regarding
"Revenue Recognition" issued b y the Institute of Chartered
Accountants of India. As a result, the net profit for the year and
current a ssets are understated by Rs.20, 000 each as compared to
the position which would have prevailed if the company has
accounted for interest income on accr ual basis." should be
disclosed.
4.7 PRACTICAL APPLICATIONS
1)Arjun Ltd. sold farm equipments through its dealers. One of the
conditions at the time of sale is payment of consideration in 14
days and in the event of delay interest is chargeable @ 15% per
annu m. The Company has not realized interest from the dealers
in the past. However, for the year ended 31.3.20 18,i tw a n t st o
recognize interest due on the balances due from dealers. The
amount is ascertained at Rs.9 lakhs. Decide whether income by
way of inte rest from dealers is eligible for recognition as per AS
9.
Ans. As per AS 9 “Revenue Recognition”, where the ability to
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60the time of raising any claim, the revenue recognition is postponed
to the extent of uncertainty expected. In such cases, the revenue is
recognized only when it is reasonably certain that the ultimate
collection will be made.
In this case, the company never realized interest for the
delayed payments ma deby the dealers. Hence, it has to recognize
the interest only if the ultimate collection is certain.
Theinterest income hence is not t o be recognized.
2)Y Ltd. used certain resources of X Ltd. In return X Ltd. receives
Rs.10 lakhs and Rs. 15 lakhs as interest and royalties
respectively, from Y Ltd. during the year 20 17–2018. State on
what basis X Ltd. should recognize their revenue, as per AS 9.
Ans. As per AS 9 on ‘Revenue Recognition’, interest of Rs.10
lakhs received in the year 20 17-2018 should be recognized on the
time basis, whereas royalty of Rs.15 lakhs received in the same
year should be recognized on accrual basis as per the terms of
relevant agreement.
3)The Board of Directors of X Ltd. decided on 31.3.20 17t o
increase sale price of certain items of goods sold retrospectively
from 1st January, 20 17. As a result of this decision the company
has to receive Rs.5 lakhs from its cu stomers in respect of sales
made from 1.1.20 17t o3 1 . 3 . 2 0 17. But the Company’s
Accountant was reluctant to make -up his mind. You are asked
to offer your suggestion.
Ans. As per Para 10 of AS 9 ‘Revenue Recognition’, the additional
revenue on account of i ncrease in sales price with retrospective
effect, as decided by Board of Directors of X Ltd., of Rs.5 lakhs to
be recognized as income for financial year 20 16-17, only if the
company is able to assess the ultimate collection with reasonable
certainty. If a t the time of rising of any claim it is unreasonable to
expect ultimate collection, revenue recognition should be
postponed.
4)X Limited has recognized Rs. 10 lakhs on accrual basis income
from dividend on units of mutual funds of the face value of
Rs.50 lakhs held by it as at the end of the financial year 31st
March, 20 17. The dividends on mutual funds were declared at
the rate of 20% on 15th June, 20 17. The dividend was proposed
on 10th April, 20 17by the declaring company. Whether the
treatment is as per the relevant Accounting Standard? You are
asked to answer with reference to provisions of Accounting
Standard.
Ans. Paragraph 8.4 and 13 of Accounting Standard 9 on Revenue
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61not recog nized in the statement of profit and loss until a right to
receive payment is established. In the given case, the dividend is
proposed on 10thApril, 20 17, while it is declared on 15thJune,
2003. Hence, the right to receive payment is established on 15th
June, 20 17. As per the above mentioned paragraphs, income from
dividend on units of mutual funds should be recognized by X Ltd. in
the financial year ended 31stMarch, 20 18.
5)The stages of Production and sale of the producer are as
follows (all in rupees):
Stage Activity Cost to
date(Rs.)Net Realizable
Value (Rs.)
A Raw Materials 45,000 43,000
B WIP 1 47,000 48,000
C WIP 2 50,000 54,500
D Finished Product 55,000 1,10,000
E For Sale 55,000 1,10,000
F Sale Agreed 55,000 1,10,000
G Delivered 56,950 1,10,000
H Paid For 56,950 1,10,000
State and explain the stage at which you think revenue will be
recognized?
Ans. According to As -9, sales will be recognized only when
1. The sale value is fixed and determinable.
2. Property of the goods is transferre d to the customer.
Both these conditions are satisfied at stage F, when sales are
agreed at a price and goods allocated for delivery purpose.
4.8EXERCISE
4.8.1 PRACTICAL PROBLEMS
1. AST Co. Ltd. uses certain resources of BST Co. Ltd. In return
BST Co. Ltd. received Rs. 8 lakhs and Rs. 12 lakhs as interest and
royalties from AST Co. Ltd. during the year 201 7-18.You are
required to state on whether and what basis this revenues can be
recognized by BST Co. Ltd.?
2. X Limited has recogni zed Rs. 10 lakhs on accrual basis income
from dividend on securities of the face value of Rs. 50 lakhs held by
it as at the end of the financial year 31st March, 201 7.T h e
dividends on mutual funds were declared at the rate of 20% on 25th
May, 201 7. The dividend was proposed on 10th April, 201 7by the
declaring company. Whether the treatment is as per the relevant
Accounting Standard? You are asked to answer with reference to
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623. The Board of Directors of X Ltd. decided on 31.3.20 17t o
increas e sale price of certain items of goods sold retrospectively
from 1st January, 20 17. As a result of this decision the company
has to receive Rs.5 lakhs from its customers in respect of sales
made from 1.1.20 17t o3 1 . 3 . 2 0 17. The decision was communicated
tocustomers and was approved. Can X Ltd. recognize revenue
pertaining to increase in sale -price?
4. Goods worth Rs.6 lakhs are supplied to Ram & Co on 15thMarch
2017on sale on approval basis. Comment in light of AS -9w h e t h e r
revenue should be recognized?
4.8.2 THEORY QUESTION
1.When can revenue be recognized in the case of transaction of
sale of goods?
Ans. As per AS 9 Revenue Recognition , revenue from sales
transactions should be recognized when the following
requirements as to performance are satisfied, provided that at
the time of performance ,it is not unreasonable to expect
ultimate collection:
(i)The seller of goods has transferred to the buyer the
property in th e goods for a price or all significant risks and
rewards of ownership have been transferred to the buyer
and the seller retains no effective control of the goods
transferred to a degree usually associated with ownership;
and
(ii)No significant uncertain ty exists regarding the amount of
the consideration that will be derived from the sale of
goods.
2.What are the two general criteria that must be satisfied before a
company can recognize revenue?
3.Explain why, in most cases, a seller recognizes revenue when it
delivers its product rather than when it produces the product.
4.Distinguish between the percentage -of-completion and
completed contract methods of accounting for long -term
contracts with respect to income recognition. Under what
circumstances should a company use the completed contract
method?
5.When does a consignor recognize revenue for a consignment
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634.8.3OBJECTIVE TYPE QUESTIONS
1. Select Correct Alternative:
i. In AS -9R e v e n u er e c o g n i t i o na p p l i e st o
1.Sale of goods only
2.Sale of services only
3.Use of enterprises resources by other only
4.All the above
ii. In AS -9 Revenue recognition requires that revenue from divided
be recognized
1.On date of proposal
2.On date of declaration
3.On date of dispatch of divided warrant
4.On accrual basis
iii. Revenue from sale of products, is generally, realized in the
period in which
1.Cash is collected.
2.Sale is made.
3.Products are manufactured.
4.None of the above.
iv. AS -9 deals with Revenue recognition except:
1.Revenue arising from construction contracts.
2.Revenue arisi ng from hire -purchase, lease agreements.
3.Both (1) & (2)
4.None of these
v. Revenue is the gross inflow of cash through
1.sale of goods,
2.rendering of services,
3.Yielding interest, royalties and dividends.
4.Allof the above
.vi.As per AS 9 items not included in the definition of “revenue” are:
1.Unrealized holding gains resulting from the change in value
of current assets, and the natural increases in herds and
agricultural and forest products;
2.Realized gains resulting from the discharge of an obligation
at less than its carrying amount;
3.Unrealized gains resulting from the restatement of the
carrying amount of an obligation.
4.All of the a bove
Answers: i -4, ii-2, iii-2, iv-3, v-4, vi-4munotes.in

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642.Match the following :
1. AS 1 (i) Revenue Recognition
2. AS 9 (ii)Disclosu re of Accounting
policies.
3. AS 10 (iii) Non -Refundable Taxes
4. AS 2 (iv) Accounting for Fixed Assets.
5. Cost of Purchase include (v) Inventory Valuation
6. Completed contract method (vi) Refundable Taxes
7. Percentage of completion method (vii)Defers recognition until project
is complete
8. Consignment sales (viii)Recognition proportion to work
completed.
(ix)Risks and rewards of ownership
retained by seller
Answers: 1 -ii, 2-i, 3-iv, 4-v, 5-iii, 6-vii, 7 -viii, 8 -ix


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65Unit-5
INVENTORY VALUATION -I
UNIT STRUCTURE
5.0 Objectives
5.1 Introduction
5.2 Importance of inventory / stock valuation
5.3 Methods of stock valuation
5.4 Valuation of stock at lower of cost or market price
5.5 First In First Out (FIFO)
5.6 Average Cost
5.7 Reconciliation at Physical Stock and Stock as Per Stock
Register
5.8 Exercise
5.0 OBJECTIVES
After studying the unit students will be able to:
Understand the meaning of inventory and importance of
inventory valuation.
Explain the methods of stock valuation.
Know the advantages and disadvantages of FIFO method
and Average cost method.
Understand the reconciliation of physical stock and stock as
per stock register.
Solve the problems of stock valuation.
5.1 INTROD UCTION
The stock that kept to meet further requirements of
production and sales is called “Inventory”. The basic reason for
holding stock is to keep up the production activities undisturbed .I t
is neither physically possible nor economically justifiable to wait for
the stocks to arrive at the time when they are actually required.
Therefore, keeping of inventory is a must for the efficient working of
an industrial unit. The principal types of inventories are :
(i)Raw materials and suppliers,
(ii)Work-inprogress and
(iii)Finished goods.munotes.in

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66Raw materials represent goods kept by a manufacturing
firm prior to being utilized in the production process generally
include tools, stores and spares which are consumed in the
production of goods and service.
Work -in progress represent the semi finished goods and
include those materials that have been commuted to production
process but have not yet been converted in to finished goods.
Finished goods are completed goods awaiting sale. In a
manufacturing concern or in case of trading concern, it will
comprise only finished goods or stock in trade owned by it for sale
to customers in the normal course of business.
5.2 IMPORTANCE OF INVENTORY / STOCK
VALUATION
The balance sheet of a concern must show tr ue and fair view
of the financial position of the concern. For this purpose assets
including inventory should be properly valued to exhibit a true and
fair view.
If stock is valued at a value which is less tha nthe actual
value and as a result, the pro fits will reduce. Shareholders would
get less dividend. On the other hand, if inventory is valued at a
value which is more that the actual value, the profits would be
inflated and the shareholders would receive more dividend, a part
of which would thus be paid out of capital. Payment of dividend out
of capital would exhaust the capital and the comp any would be
insolvent. Moreover, under /over valuation of inventory will not only
affect the operating results and financial position of the current
period but will also affect those of the next period.
The following are some of the important reason for too
much emphasis on inventory or stock valuation:
1.Sufficient stock for production / sale proces s:
For all manufacturing and trading concerns, inventory
represents a major current asset investment. Adequate inventory is
essential for the Production / Sales process of an enterprises as
insufficient inventory hampers production and fails to generate
sufficient sales. This shows the necessity for proper valuat ion of
inventory.
2.Proper determin ation of profit :
The proper determination of profit depends upon the proper
valuation. If the ending inventory is valued at a lower figure, profit is
under stated and if it is overvalued, profit is overstated. This sho ws
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673.True financial position :
Over valuation of inventory amounts to window dressing
which gives wrong idea about the liquid position of the company.
The proper valuation of inventories wh ich constitute a significant
portion of current assets is essential so that short term creditors
may not be misled about the liquid position of the company.
Balance sheet can exhibit a true and fair view of the financial
position of a company if there is a proper valuation of inventory
which constitutes a major portion of current assets.
5.3 METHODS OF STOCK VALUATION
Methods of taking inventories / stockMethod of Inventory(2) Perpetual inventory Method (1) Periodic inventory method.
1. Periodic Inventory Method:
Under this method of taking inven tories, value of stock is
determined by physical counting of the stock on the accounting
date of preparation of the final accounts. It is possible that stock
taking may take a week or so in large enterprises and purchases
and sales may have to be suspended for that period to get correct
figure of closing inventory. This method of ascertaining the value of
stock at the end of the year is also known as annual stock taking.
Thus this method is based onphysical stock taking ,itprovides data
once in a year .I tis simple and economical method of stocktaking .It
can be adopted in small concerns .It does not provide basis for
control.
2. Perpetual Inventory Method:
Perpetual Inventory Method is defined as a system under
which records aremaintained by the contr olling department, which
reflects the physical movements of stock and their current balance.
Under this method ,stock registers are maintained to make a record
of the physical movements of stock and their current balance.
Stores ledger is maintained to kee p a record of the receipt and
issue of the materials and also reflects the balance in store.
Similarly, work -in-progress ledger is maintained to give the value of
work -in-progress on hand and af i n i s h e dg o o d sl e d g e ri s
maintained to know the value of finis hed goods on hand. Thus ,this
system provides a running record of inventories on hand at any
time. To ensure the accuracy of perpetual inventory records ,
physical verification of the inventory is made by a program of
continuous stock taking.
It is poss ible that the balance of stock by the perpetual
inventory may differ from the actual balance of stock as ascertained
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68as disclosed by the physical verification and the stocks shown by
stock records should be investigated and rectification will be made.
If the physical verification reveals that actual balance of stock is
more tha nthe balance shown by the stores ledger or work -in-
progress ledger or finished goods ledger ,debit note is prepar ed
and stock record sare adjusted accordingly so that balance may
reconcile with actual balance. A Stock Adjustment Account is
prepared and debited with the shortage of stock and credited with
surplus.
Continuous stock taking is an essential feature of the
perpetual inventory system. But the two terms, perpetual inventory
and continuous stock taking should not be taken as one ; perpetual
means the system of stock records and continuous stock taking
whereas continuous stock taking means only the physical
verificati on of stock records with actual stocks.
In continuous stock taking, physical verification is spread
throughout the year. Every day 10 to 15 items are taken at rotation
and checked in order to maintain surprise element in short
verification and each item is checked for a number of times during
the year. On the other hand, surprise element is missing in case of
periodical checking because checking is usually done at the end of
the year. In short ,this method is based on records. It requires a lot
of recording and is thus expensive. It can be adopted only in big
concerns. It provides data on running basis and thus facilitates the
preparation of financial statements at shorter intervals. It also
provides basis for control by investigation ofthe dis crepancies
arising from the comparison of physical stock with their book
values.
Difference between Periodic Inventory and Perpetual
Inventory .
The following are the main differences between the two
methods of taking inventory.
Periodic Inventory Perpetual Inventory
1.It is based on physical
stock taking1. It is based on records.
2.It provides data
periodically i.e. once in
year.2.It provides the data on running
basis and thus facilitates the
preparation of financial
statements at shorter in tervals.
3.It does not provide basis
forcontrol.3.It provides basis for control by
investigating the discrepancies
arising from the comparison of
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694.It is simple and
economical method of
taking inventory and can
be a dopted in small
concern.4.It is expensive as it requires a lot
of recording because of an
elaborate method of taking
inventory. It can be adopted by
big concerns only.
5.4 VALUATION OF ST OCK AT LOWER OF COST
ORMARKET PRICE
Stock is valued at cost or market price whichever is lower.
Stock is valued at lower of cost or market price to ensure that
anticipated profits must not be accounted for until they have been
realized and that full provision should be made for anticipated
losses. This pri nciple of valuation is on the important accounting
convention of conservatism . Conservatism means taking the
gloomy view of a situation. It is policy of caution or playing safe and
had its origin as a safeguard against possible losses in a world of
uncerta inty. According to this principle of valuation based on
convention of conservatism, if market price of the stock is higher
than the cost of the stock ,the higher amount is ignored in the
accounts because profit is not booked by valuing inventory at
market value which is higher than cost value .It is possible that
dividends to share holders may be distributed out of unrealized
profit. It will not be sound policy and in the future ,if the expected
market price is not realized and there is a loss, unrealized pr ofit
distributed will amount to distribution of divide nd out of capital. On
the co ntrary, if the stock isvalued at market price which is lower
than the cost. In this way, anticipated loss is taken into
consideration and even if a loss occurs in the future , the business
will not be affected adversely because loss has already been
provided by valuing the asset at a lower value and if there is no loss
as expected, it is quite good for the business.
Cost in relation to stock is outlay of cash or its equival ent in
the acquisition or manufacturing of the inventory concerned. In
other words, cost of stock is the sum of the applicable expenditure
and charges directly or indirectly incurred in brining inventory to its
existing condition and location.
Market v alue in relation to stock is the realizable value of the
stock in the market i.e. the price at which it can be replaced, the
valuation of stock aff ects the profit of the year. Therefore ,the
method of valuation of stock should not be changed from year to
year to enable comparison of profits ofdifferent years.
Methods forValuation of Stock :
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705.5 FIRST IN FIRST OUT (FIFO)
5.5.1 Meaning
Under th ismethod ,the earliest lot of mater ials or goods purchased
or goods manufactured are exhausted first and closing stock is out
of the latest consignments received or goods manufactured and is
valued at the cost of such goods. In other words ,cost of goods sold
is calculated keeping in view t he earliest lots exhausted on the
presumption that units are sold in whic h they were acquired. In
short ,under this method ,it is assumed that goods or materials
which are purchased first are issued first .Stock consist of latest
purchase. Hence items lyin g in the stock should be valued at latest
purchase price.
5.5.2 Advantages
(1)This method is simple to understand and easy to operate.
(2)It is logical method because it takes into consideration the
normal procedure of utilizing first those items of inventory which
are received or manufactured first.
(3)This method is very useful when prices are falling because cost
of goods so sold will be high on account of using earliest lots
which are costly.
(4)Closing stock is valued nearer the market pri ce as it would
consist of recent purchase of units.
(5)This method is useful when transactions are not too many and
prices are fairly steady.
(6)This method is useful when inventory is subject to deterioration
and obsolescence.
5.5.3 Disadvantages
(1)This method increases the possible clerical errors if the price
fluctuates , considerably a tevery time as issue of material is
sold, the store ledger clerk will have to go th rough his and
ascertain the price to be changed.
(2)If the prices fluctua te, comparison between different jobs
executed by the concern becomes difficult because one job
started a few minutes later than another of the same nature may
have consumed the supply of lower priced or higher priced
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715.6 AVERAGE COST
The princ ipal on which the average cost method is based is
that all items on the store are so mixed up that consumption of
material or sale of finished goods are carried out at the average
cost of the various items on ha nd. Average may be of two types :
(a)Simple Average Method (not in syllabus)
(b)Weighted Average Method
Stock taking is done which consist of following items : -
1,000 units purchased @ Rs. 10 per unit
2,000 units purchased @ Rs. 11 per unit
3,000 units purchased @ Rs. 12 per unit
Weighted Average Method : This price is obtained by dividing the
total cost of items in stock by the total quantity of items in hand.
Per unit weighted average cost is calculated as follows : -(1.000 10) (2,000 11) (3,000 12)Rs.11.33(1 ,000 2,000 3,000)
The above rate is used to v alue the cost of sale of goods or cost
of consumption of goods.
Weighted average method is quite superior to other methods
and it is better to follow this method. This method can be used with
advantage in those cases where price and quantity vary wid ely.
The average rate does not change with issue but would vary with a
fresh supply of materials received when a new average will have to
be calculated .I na period of fluctuating price ,this method will even
out the fluctuations. This method is goods as the weighted average
rate lies in between the extreme rates as shown by FIFO and LIFO
method. However ,the difficulty is that fresh calculations are needed
at every purchase of materials or goods.
Practical Problems
Problem No: 01
A firm has just completed six months operations from 1st
January, 2000, to 30thJune, 2017. It is about to value its stock at
cost price. It has dealt with only one type of goods. From the
particulars given below, your are required to value closing stock at
the half year ending 30thJune, 2017 under following method of
stock valuation –
(i)FIFO Method and
(ii)Weighted Average Methodmunotes.in

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72Purchase Sales
Date Units RateAmount
Rs.Units RateAmount
Rs.
15-1-17 200 20 8,000 - - -
16-2-17 - - - 300 25 7500
17-3-17 600 22 13,200 - - -
18-4-17 - - - 400 - 12,00
19-5-17 800 25 20,000 - - -
10-6-17 - - - 400 32 12,800
30-6-17 - - - 200 38 7,600
The firm had opening stock of 200 units at Rs .19per unit.
Solution :
We have to prepare ‘Store Ledger’ showing of goods and the
closing stock as on 30th June, 20 17.
STORE LEDGER
FIFO METHOD
Receipt (Purchase) Issue (Sales) Balance
Qty. Qty. Qty.
DateUnitRate
(Rs.)Amount
(Rs.)UnitRate
(Rs.)Amount
(Rs.)UnitRate
(Rs.)Amount
(Rs.)
Op.St.
1-1-
17- - - - - - 200 19 3,800
15-1-
17200 20 4,000 - - - 200 19 3,800
- - - - - - 200 20 4,000
16-1-
17- - - 200 19 3,800
- - - 100 20 2,000 100 20 2,000
17-3-
17600 22 13,200 - - - 100 20 2,000
- - - - - - 600 22 13,200
19-4-
17- - - 100 20 2,000 300 22 13,200
- - - 300 22 6,600
19-5-
17800 25 20,000 - - - 300 22 6,600
- - - - - - 800 25 20,000
10-6-
17- - - 300 22 6,600 700 25 17,500
- - - 100 25 2,500
30-6-
17- - - 200 25 5,000 500 25 12,500
28,500
Cost ofGoods sold
Value ofClosing stockmunotes.in

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73Receipt (Purchase) Issue (Sales) Balance
Qty. Qty. Qty.
DateUnitRate
(Rs.)Amount
(Rs.)UnitRate
(Rs.)Amount
(Rs.)UnitRate
(Rs.)Amount
(Rs.)
1-1-17 - - - - - - 200 19.00 3,800
15-1-17 200 20.00 4,000 - - - 400 19.50 7,800
16-1-17 - - - 300 19.50 5,850 100 19.50 1,950
17-3-17 600 22.00 13,200 - - - 700 21.64 15,150
19-4-17 - - - 400 21.64 8,657 300 21.64 6,493
19-5-17 800 25.00 20,000 - - - 1100 24.08 26,493
10-6-17 - - - 400 24.08 9,634 700 24.08 16,859
30-6-17 - - - 200 24.08 4,817 500 24.08 12,04 2
28,954
Cost ofGoods sold
Value ofClosing stock
Notes :
(i)The rate changes every time goods are purchased. The
average rate is found out by dividing the total amount with the
total units on hand.
(ii)The rate remains unaffected with the issue or sale of goods .
5.7 RECONCILIATION AT PHYSICAL STOCK AND
STOCK AS PER STOCK REGISTER .
Problems of stock taking for the purpose of final accounts:
At the end of the last day of t he accounting year, stocks in
hand are verified and valued for the purpose of recording in the
final accounts. But in case of big organisation s,i tm a yn o tb e
possible to verify the stock exactly on the last date of the
accounting period owing to certain d ifficulties. In such a case, stock
is taken under either few days earlier or later, according to the
situation or convenience and assuring least disturbance in the
normal flow of work. Therefore ,stock taken under circumstances
shall always be subject to s ome adjustments where stock taking is
completed few days before the closing date should be adjusted with
the value of stock taking so as to arrive at the value of stock on the
ending date of accounting year, Similarly, if stock taking takes place
onthedate after the closing date ,the whole of the transactions of
goods from the closing date (*i.e. stock taking date) are to be
adjusted with the value of stock on the date of stock taking so as to
arrive at the value of stock on the closing date of accounting year.munotes.in

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74(A)When stock taking takes place on any date after the year
end dates
If the stock is taken on a later date, the following
adjustments are required to arrive at the stock as on the closing
date.
Statement showing value of stock as to the end of the
accounting year.
Rs.
The value of stock on the later date …. X
Add : Sales at cost between two dates
i.e. date of closing and Date of stock taking (Actual goods
between)X
Add : Purchase returns during the said period X
Less : Purchas e between two dates i.e. date of closing and
date of stock taking (Actual –goods received between
the Two dates) X
Less : Sales return (At cost price) between the above two
dates X
Add : Any under costing in stock sheet X
Less : Anyover co sting in stock sheet X
Less: Any goods held on consignment basis (as Agent) X
Less : Any goods included in stock but title of such has been
transferred to the buyer X
Less : Goods purchased between the two dates but already
received before the closing date (such represents
purchases of next accounting year) (normally it
happens when goods are received first & invoice is
received later on) X
Add : Goods sold between the two dates but already
delivered before Closing date (Such goods repr esents
sales of next accounting Year) (Normally it happens
when goods are delivered to Customer first & invoice
is prepared on later date)Xmunotes.in

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75Add : Any goods sent to consignee between the two dates
(Whether They sold by consignee or not) X
Value of phy sical stock as on the date of closing X
Add : Any goods purchased before closing date hence
included in Purchase of the last accounting year but
not received until the Date of stock -takingX
Add: Any goods sent to customer before closing date o n
approval basis but lying with them as an approved as
on the date closing (Such goods must be taken at cost
price) Value of stock -in-trade as on the date of closing
for inclusion In final accounts.X
B)If stock are taken on an earlier date
If stock is taken on a date before the closing date of
accounting year ,the necessary adjustments should be made in
respect of transactions of goods taken place between the date of
stock -taking and closing date so as to obtain the correct value of
stock as on the closing date.
Statement showing value of stock as on the ending date of
accounting year.
Rs.
The value of stock on the later date X
Add : Purchase between the two dates i.e. from the date
of stock taking to the date of closing (Goods
actually receive d up to the date of closing X
Add: Sales returns (at cost price) between the two dates X
Less: Sales (at cots) between the two dates (goods
actually delivered) X
Less: Purchase returns between the two dates X
Less: Goods sent on approved ba sis (at cost price)
between the two dates X
Less: Goods sent to consignee (at cost price) (whether
sold or not) between the two dates Xmunotes.in

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76Less: Goods received from consignor and held on their
behalf X
Add: Any under costing in stock sheet X
Less: Any over costing in stock sheet X
Value of physical stock on the date of closing X
Add: Goods purchased before the closing date but not
received upto the end of the accounting year
(Goods -in-transit) X
Add: Cost of goods sent o napproval basi sb u tn o t
approved before the closing date still lying with the
customers as on the date of the closing. X
Add: Unsold goods in the hands of the consignee as on
the date of closing. Value of stock -in-trade as on
the date of closing for inclusion in final account s X
5.8 EXERCISE
1. Select the correct alternative:
1.If Cost of goods sold is Rs.80,700, Opening stock Rs.5,800 and
Closing stock Rs.6, 000. Then the amount of purchase will be
(a)Rs.80,500
(b)Rs.74,900
(c)Rs.74,700
(d)Rs.80, 900.
2.If sales are Rs. 2,000 a nd the rate of gross profit on cost of
goods sold is 25%, then the Cost of goods sold will be
(a)Rs. 2,000.
(b)Rs. 1,500.
(c)Rs. 1,600.
(d)None of the above.
3.The total cost of goods available for sale with a company du ring
the current year is Rs.12, 00,000 and the tot al sales during the
period are Rs.13, 00,000. If the gross pro fit margin of the
company is 331/3 % on cost, the closing inventory during the
current year is
(a)Rs.4,00,000
(b)Rs.3,00,000
(c)Rs.2,25,000
(d)Rs.2, 60,000.munotes.in

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774.CL t d .r e c o r d e dt h ef o l l o w i n gi n f o r m a t i o na so nM a r c h3 1 ,2 0 0 5 :
Rs.
Stock as on April 01, 20 16 80,000
Purchases 1, 60,000
Sales 2, 00,000
It is noticed that goods worth Rs.30, 000 were destroyed due
to fire. Against this, the Insurance company accepted a claim of
Rs.20,000. The Company sells goods at cost plus 33 % .The value
of closing inventory, after taking into account the above
transactions is,
(a)Rs.10,000
(b)Rs.30,000
(c)Rs.1,00,000
(d)Rs.60,000
5.Consider the following for Alpha Co. for the year 201 7-18:
Cost of goods available fo r sale Rs.1, 00,000
Total sales Rs. 80,000
Opening stock of goods Rs. 20,000
Gross profit margin 25%
Closing stock of goods for the year 201 7-18was
(a)Rs.80,000
(b)Rs.60,000
(c)Rs.40,000
(d)Rs.36, 000.
6.Cost of physical stock on 15.4. 16 was Rs.3,00,000. Sales
amounti ng Rs.1, 00,000 an d purchases worth Rs.50, 000 were
held between 31.3.1 6and 15.4.1 6. Goods are sold at a profit of
20% on sales. Value of inventory as on 31.3.1 6is
(a)Rs.3, 50,000.
(b)Rs.2, 70,000.
(c)Rs.3, 30,000.
(d)Rs.3, 00,000.
7.Record of purchase of T.V. sets.
Date Quantity Price per unit
Units Rs.
March 4 900 5
March 10 400 5.50
Record of issues
March 5 600 Units
March 12 400 Units
The value of T.V. sets on 15 March, as per FIFO will be
(a)Rs.1,500
(b)Rs.1,650
(c)Rs.1, 575.
(d)None of the three.munotes.in

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788.Goods costing Rs.4, 80,000 were sent on consignment basis.
Goods are invoiced at 125% of the cost price. The invoice price
and the loading will be:
(a)Rs.6,00,000 and Rs.1, 00,000.
(b)Rs.5,00,000 and Rs.1, 00,000.
(c)Rs.6, 00,000 and Rs.1 ,20,000.
(d)Rs.5,00,000 and Rs.1, 20,000.
9.Af i r m dealing in cloth has 15000 meters of cloth on April 1,
2015v a l u e da tR s .1,50,000 according to FIFO. The firm
purchased 20 ,000 meters @ Rs.12 per meter during the year
ending 31st March, 20 16 and sold 30 ,000 meters @ Rs.25 per
meter during the same period . As per FIFO, the closing stock
will be valued at:
(a)Rs.60,000
(b)Rs.1,25,000
(c)Rs.50,000
(d)None of the above.
10.A minimum quantity of stock always held as precaution against
out of stock situation is called _________
(a)Zero stock.
(b)Risk stock.
(c)Base stock.
(d)None of the above.
11.A trader has credited certain items of sales on approval
aggreg ating Rs.60, 000 to Sales Account. Of thes e, goods of the
value of Rs.16, 000 have been returned and taken into stock at
cost Rs.8, 000 though the record of return was omitted in the
acco unts. In resp ect of another parcel of Rs.12,000 (cost being
Rs.6, 000) the period of approval did not expire on the closing
date. Cost of goods lying with customers should be
(a)Rs. 12,000.
(b)Rs. 54,000.
(c)Rs. 6,000.
(d)None of the above.
12.If cost of physical stock o n3 1 . 3 . 2 0 1 8 is Rs.2, 80,000 and out o f
which stock of Rs.1, 20,000 is held as consignee. Goods costing
Rs. 25,000 were damaged beyond repair and were expected to
realize at Rs.5, 000 only. The value of own stock on 31.3.201 8
will be
(a)Rs.2,60,000
(b)Rs.1,60,000
(c)Rs.1,35,000
(d)Rs.1,40,000munotes.in

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7913.Bank overdraf t as per trial balance is Rs.1, 60,000. Bank has
allowed the customer to overdraw 80% of the hypothecated
value of the stock. Hypothecation of stock has been done by the
bank at 80% of the original closing stock value. Th ea m o u n to f
closing stock is
(a)Rs. 2 ,00,000.
(b)Rs. 2, 50,000.
(c)Rs. 1, 02,400.
(d)Rs. 1, 28,000.
14.Mr. Prakash sells goods at 20% ab ove cost. His sales were
Rs.10, 20,000 during the year. However, h e sold damaged
goods for Rs.20,000 costing Rs.30, 000. This sale is inclu ded in
Rs.10, 20,000. The amount of gross profit is:
(a)Rs. 1,90,000
(b)Rs.2,50,000
(c)Rs.2,40,000
(d)Rs.2, 00,000.
15.Opening stock of raw material of a manufacturing concern is
Rs.10, 000, Pu rchase during the year is Rs.2, 00,000, W ages
Rs.50,000, Carriage Rs.5, 000, Fac tory overheads
Rs.1, 25,000 and closing stock of raw material is Rs. 15,000.
The amount to be transferred is
(a)Rs. 3, 75,000 to cost of goods manufactured account.
(b)Rs.3, 75,000 to cost of goods sold account.
(c)Rs. 3, 75,000 to cost of sales account.
(d)Rs. 3, 75,000 to cost to company account.
16.Goods costing Rs. 600 is supplied to Ram at the invoice of 10%
above cost and a trade discount for 5%. The amount of sales
will be
(a)Rs. 627.
(b)Rs. 660.
(c)Rs. 570.
(d)Rs. 620.
17.Goods purchased Rs.1, 00,000. Sales Rs. 90,000. Margi n2 0 %
on sales. Closing stock is
(a)Rs. 10,000.
(b)Rs. 25,000.
(c)Rs. 28,000.
(d)None of the above.
Answers: 1-d,2-c,3-c,4-d,5-b,6-c,7-b,8-c,9-b, 10-c, 11-c, 12-d,
13-b, 14-a, 15-a,16-a,17-c
munotes.in

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80Unit-6
INVENTORY VALUATION II
ILLUSTRATION & EXERCISE
Unit Structure :
6.0 Objectives
6.1 Solved Problems
6.2 Exercises
6.0 OBJECTIVES
After studying the unit ,students will be able to solve the practical
problems on in ventory valuation.
6.1SOLVED PROBLEMS
Illustration No. 1
From the following particulars prepare Stores Ledger for the month
of Mar ch2018
(a) FIFO to “ABC”,
(b) Weighted average to “XYZ”.
ABC XYZ
Stocks ( Kgs)on1-3-20182,000 @ Rs. 28 4,000 @ Rs. 13
Purchases ( Kgs)
[i]On 11 -3-2018 1,800 @ Rs. 27 2,500 @ Rs. 14
[ii]On 21 -3-2018 1,700 @ Rs. 25 2,000 @ Rs. 18
Sales ( Kgs)
[i]On 6 -3-2018 1,300 2,500
[ii]On 15 -3-2018 1,400 2,000
[iii]On 1 8-3-2018 700 1,300
[iv]On 29 -3-2018 1,100 1,700
(IDE, Nov. 1999, adapted )munotes.in

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81Solution :
(A) FIFO to “ABC”
STOCK LEDGER OF ABC
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
01-3-2008 Opening - - - - - 2,000 28.00 56,000
06-3-2008 - - - 1,300 28.00 36,400 700 28.00 19,600
11-3-2008 1,800 27.00 48,600 - - -700
1,80028.00
27.0019,600
48,600
15-3-2008 - - -700
70028.00
27.0019,600
18,9001,100 27.00 29,700
18-3-2008 - - - 700 27.00 18,900 400 27.00 10,800
21-3-2008 1,700 25.00 42,500 - - -400
1,70027.00
25.0010,800
42,500
29-3-2008 - - -400
70027.00
25.0010,800
17,5001,000 25.00 25,000
Therefore, the value of stock of ABC as on 31 -3-2004:
1,000 units @ Rs. 25.00 = Rs. 25,000
(B) Weighted Ave rage (Under Perpetual System of Inventory)
STOCK LEDGER OF XYZ
Date Receipts Issues Balance
Units Price Amt. UnitsWt. Avg.
RateAmt. UnitsWt. Avg.
RateValue
01-3-2008 Opening - - - - - 4,000 13.00 52,000
06-3-2008 - - - 2,500 13.00 32,500 1,500 13.00 19,500
11-3-2008 2,500 14 35,000 - - - 4,000 13.63 54,500
15-3-2008 - - - 2,000 13.63 27,250 2,000 13.63 27,250
18-3-2008 - - - 1,300 13.63 17,712 700 13.63 9,538
21-3-2008 2,000 18 36,000 - - - 2,700 16.87 45,538
29-3-2008 - - - 1,700 16.87 28,67 2 1,000 16,86 6munotes.in

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82Working Notes :
1]Issued of XYZ on March 15 is valued at Rs. 13.63 which is the
weighted average rate, arrived at as follows :
19,500 35,000 54,50013.625r / o13.631, 5 0 0 2, 5 0 0 4 , 0 0 0 
2]Issue of XYZ on March 29 is valued at Rs. 16.87 per kg. which
is the weighted av erage rate arrived at as follows :
9,538 36,000 45,53816.865r / o16.87700 2,000 2,700 
Therefore, the value of stock as on 31 -3-2008 : 1,000 units @
Rs. 16.87 = Rs. 16,867
Illustration : 2
From the following information relating A to Z item, value closing
stock on 31 -12-2008 ap plying –(a) FIFO, (b) Weighted Average
Stocks ( Kgs)on 1-12-2008 5,000 units @ Rs. 14
Purchases ( Kgs)
[i]On 18 -12-2008 4,200 units @ Rs. 13
[ii]On 23 -12-2008 3,800 units @ Rs. 9
Sales ( Kgs)
[i]On 7 -12-2008 1,200 units
[ii]On 16 -12-2008 2,600 units
[iii]On 19 -12-208 1,800 units
[iv]On 30 -12-2008 3,400 units
(IDE, April 1999, adapted)munotes.in

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83Solution :
(A)FIFO
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
01-12-2008 Open ing - - - - - 5,000 14.00 70,000
07-12-2008 - - -1,200 14.00 16,800 3,800 14.00 53,200
16-12-2008 - - -2,600 14.00 36,400 1,200 14.00 16,800
18-12-2008 4,200 13.00 54,600 - - -1,200
4,20014.00
13.0016,800
54,600
19-12-2008 - - -1,200
60014.00
13.0016,800
7,8003,600 13.00 46,800
23-12-2008 3,800 9.00 34,200 - - -3,600
3,80013.00
9.0046,800
34,200
30-12-2008 - - -3,400 13.00 44,200200
3,80013.00
9.002,600
34,200
Therefore, the value of stock as on 31 -12-2008 : 4,000 units @
Rs. 36,800
B]Weighted Average (Perpetual Inventory system)
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. UnitsWt. Avg.
RateAmt. UnitsWt. Avg.
RateValue
01-12-2008 Opening - - - - - 5,000 14.00 70,000
07-12-2008 - - - 1,200 14.00 16,800 3,800 14.00 53,200
16-12-2008 - - - 2,600 14.00 36,400 1,200 14.00 16,800
18-12-2008 4,200 13.00 54,600 - - - 5,400 13.22 71,400
19-12-2008 - - - 1,800 13.22 23,800 3,600 13.22 47,600
23-12-2008 3,800 9.00 34,200 - - - 7,400 11.05 81,80 0
30-12-2008 - - - 3,400 11.05 37,584 4,000 44,216munotes.in

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84Working Notes :
[1]Issue on December 19 is valued at Rs. 13.22 which is the
weighted average rate, arrived at as follows :
16,800 54,600 71 ,40013.222r /o13.221, 2 0 0 4 , 2 0 0 5 , 4 0 0 
[2]Issue on December 30 is valued at Rs. 11.05 per kg. which is
the w eighted average rate arrived at as follows :
47,604 34,200 81 ,80411.054r /o11.053,600 3,800 7,400 
Therefore, the value of stock as on 31-12-2003 : 4,000 units @
Rs.11.05 = Rs. 44,2 16
Illustration : 3
The following particulars have been extracted in respect of
Material X. Pr epare a Stores Ledger Account showing the receipts
and issues, pricing the materials issued on the basis of
(a) Weighted Average and
(b) First In First Out.
[i]01-10-2017Opening Stock 200 units at Rs. 3.50 per unit
[ii]03-10-2017Purchased 300 uni ts at Rs. 4.00 per unit
[iii]13-10-2017Purchased 900 units at Rs. 4.30 per unit
[iv]23-10-2017Purchased 600 units at Rs. 3.80 per unit
Issues :
[i]05-10-2017Issued 400 units
[ii]15-10-2017Issued 600 units
[iii]25-10-2017Issued 600unitsmunotes.in

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85Solution :
(A)FIFO
STOCK LEDGER OF ‘X’
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
01-10-2017 Opening - - - - - 200 3.50 700
03-10-2017 300 4.00 1,200 - - -200
3003.50
4.00700
1,200
05-10-2017 - - -200
2003.50
4.00700
800100 4.00 400
13-10-2017 900 4.30 3,870 - - -100
9004.00
4.30400
3,870
15-10-2017 - - -100
5004.00
4.30400
2,150400 4.30 1,720
23-10-2017 600 3.80 2,280 - - -400
6004.30
3.801,720
2,280
25-10-2017 - - -400
2004.30
3.801,720
760400 3.80 1,520
Therefore, the value of stock as on 31 -10-2017:4 0 0u n i t s@
Rs. 3.80 = Rs. 1,520
(B)Weighted Average (Perpetual Inventory System)
STOCK LEDGER OF ‘X’
Date Receipts Issues Balance
Units Price Amt. UnitsWt.
Avg.
RateAmt. UnitsWt.
Avg.
RateValue
01-10-2017 Opening - - - - - 200 3.50 700
03-10-2017 300 4.00 1,200 - - - 500 3.80 1,900
05-10-2017 - - - 400 3.80 1,520 100 3.80 380
13-10-2017 900 4.30 3,870 - - -1,000 4.25 4,250
15-10-2017 - - - 600 4.25 2,550 400 4.25 1,700
23-10-2017 600 3.80 2,280 - - -1,000 3.98 3,980
25-10-2017 - - - 600 3.98 2,388 400 3.98 1,592munotes.in

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86Working Notes :
[1]Issue on October 5 is valued at Rs. 3.80 which is the weighted
average rate, arrived at as follows :700 1 ,200 1 ,9003.80200 300 500
[2]Issue on October 15 is valued at Rs. 4.25 which is the weighted
average rate, arrived at as follows :
380 3,870 4,2504.25100 900 1 ,000
[3]Issue on October 25 is valued at Rs. 3.98 which is the weighted
average rate, arrived at as fol lows :
1, 7 0 0 2, 2 8 0 3 , 9 8 03.98400 600 1 ,000
Illustration 4
From the following particulars, prepare stock record by FIFO and
Weighted Average Method.
Date Transaction Units Rate Rs.
04-1-2018 Purchase 40 30
17-1-2018 Purchase 60 28
20-1-2018 Sale 50 35
22-1-2018 Purchase 80 29
25-1-2018 Sale 80 33
28-1-2018 Sale 20 34
30-1-2018 Purchase 100 26
31-1-2018 Sale 90 35
Stock on hand on 1stJanuary 2018 was 50 units @ Rs.25 each.munotes.in

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87Solution :
(A) FIFO
STOCK LEDGER X’
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
01-1-2018Opening - - - - - 50 25.00 1,250
04-1-2018 40 30.00 1,200 - - -50
4025.00
30.001,250
1,200
17-1-2018 60 28.00 1,680 - - -50
40
6025.00
30.00
28.001,250
1,200
1,680
20-1-2018 - - - 50 25.00 1,25040
6030.00
28.001,200
1,680
22-1-2018 80 29.00 2,320 - - -40
60
8030.00
28.00
29.001,200
1,680
2,320
25-1-2018 - - -40
4030.00
28.001,200
1,12020
8028.00
29.00560
2,320
28-1-2018 - - - 20 28.00 560 80 29.00 2,320
30-1-2018 100 26.00 2,600 - - -80
10029.00
26.002,320
2,600
31-1-2018 - - -80
1029.00
26.002,320
26090 26.00 2,340
Therefore, the value of stock as on 31 -01-2008 : 90 units @ Rs.
26 = Rs. 2,340 .
[B]Weighted Average (Perpetual Inventory System)
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. UnitsWt. Avg.
RateAmt. UnitsWt. Avg.
RateValue
01-1-2018Opening - - - - - 50 25.00 1,250
04-1-2018 40 30.00 1,200 - - - 90 27.22 2,450
17-1-2018 60 28.00 1,680 - - - 150 27.53 4,130
20-1-2018 - - - 50 27.53 1,377 100 27.53 2,753
22-1-2018 80 29.00 2,320 - - - 180 28.18 5,073
25-1-2018 - - - 80 28.18 2,254 100 28.18 2,819
28-1-2018 - - - 20 28.18 564 80 28.18 2,255
30-1-2018 100 26.00 2,600 - - - 180 26.97 4,855
31-1-2018 - - - 90 26.97 2,427 90 26.97 2,428munotes.in

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88Working Notes :
[1]Issue on January 20 is valued at Rs. 27.53 which is the
weighted average rate, arrived at as follows :
1, 2 5 0 1, 2 0 0 1, 6 8 0 4 , 1 3 027.533r / o27.5350 40 60 150
[2]Issue on January 25 is valued at Rs. 28.18 per kg. which is the
weighted average rate arrived at as follows:
2,753 2,320 5,07328.183r /o28.19100 80 180
[3]Issue on January 31 is valued at Rs. 26.97 per kg. which is the
weighted average rate arrived at as follows:
2,255 2,600 4,85526.971r / o26.9780 100 180
Therefore, the value of stock as on 31 -1-2004 : 90 units @ Rs.
26.97 = Rs. 2,428 .
[4]Note : The Stock Book entries for both purchases / receipts and
sales / issued are always made at cost. The selling price, even if
given, is to be ignored.
Illustration :5
Sumit Ltd. has purchased and issued the m aterials in the following
order:
Month Date Particulars Units Cost Per Unit Rs.
August, 20 17 01 Purchases 300 3
04 Purchases 600 4
06 Issues 500 -
10 Purchases 700 4
15 Issues 800 -
20 Purchases 300 5
23 Issues 100 -
Ascertain the quantity of closing stock as on 31stAugust, 20 17
and what will be the value under the following methods.
[i]First in first out method.
[ii] Weighted Average method.
(IDE, Nov. 2000, adapted)munotes.in

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89Solution :
(A) FIFO
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. Units Price Amt. Units Price value
1-8-2017 Opening - - - - - Nil Nil Nil
1-8-2017 300 3.00 900 - - - 300 3.00 900
4-8-2017 600 4.00 2,400 - - -300
6003.00
4.00900
2,400
6-8-2017 - - -300
2003.00
4.00900
800400 4.00 1,600
10-8-2017 700 4.00 2,800 - - -400
7004.00
4.001,600
2,800
15-8-2017 - - -400
4004.00
4.001,600
1,600300 4.00 1,200
20-8-2017 300 5.00 1,500 - - -300
3004.00
5.001,200
1,500
23-8-2017 - - - 100 4.00 400200
3004.00
5.00800
1,500
Therefore, the value of stock as on 31 -8-2003 : Rs.2 , 3 0 0
[B]Weighted Average (Perpetual Inventory System)
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. UnitsWt. Avg.
RateAmt. UnitsWt. Avg.
RateValue
01-8-2017 Opening - - - - - Nil Nil Nil
01-8-2017 300 3.00 900 - - - 300 3.00 900
04-8-2017 600 4.00 2,400 - - - 900 3.67 3,300
06-8-2017 - - - 500 3.67 1,834 400 3.67 1,466
10-8-2017 700 4.00 2,800 - - -1,100 3.88 4,266
15-8-2017 - - - 800 3.88 3,103 300 3.88 1,163
20-8-2017 300 5.00 1,500 - - - 600 4.44 2,663
23-8-2017 - - - 100 4.44 444 500 4.44 2,219munotes.in

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90Working Notes :
[1] Issue on August 6 is valued at Rs. 3.67 which is the weighted
average rate, arrived at as follows :
900 2,400 3,3003.666r /o3.67300 600 900
[2] Issue on August 15 is valued at Rs. 3.88 per kg. which is the
weighted avera ge rate arrived at as follows :
1, 4 6 5 2, 8 0 0 4 , 2 6 53.877r / o3.88400 700 1 ,100
[3]Issue on August 23 is valued at Rs. 4.44 per kg. which is the
weighted average rate arrived at as follows:
1, 1 6 1 1, 5 0 0 2, 6 6 14.435r / o4.44300 300 600
Therefore, the value of stock as on 31 -8-2002 : 500 unit s @ Rs.
4.44 = Rs. 2,21 9.
Illustration :6
Following are the purchases and sales of wheat in the
months of March, 20 18. Prepare a statement showing valuation of
stock on the basis of Weighted Average method .
Date Purchases Rate Sales
2018 (Kg.) (Rs.) (Kg.)
March 1 600 4 -
4 - - 300
5 300 3.80 -
10 - - 200
18 200 4.20 -
23 - - 400
29 400 4.40 -
31 - - 300
Out of purchases onMarch 5, 50 Kgs were returned to the
supplier on March 8.Out of Sales on March 23, a customer returned
20 Kgs. on March 26.munotes.in

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91B] Weighted Average (Perpetual Inventory System)
STOCK LEDGER
Date Receipts Issues Balance
Units Price Amt. UnitsWt. Avg.
RateAmt. UnitsWt. Avg.
RateValue
01-3-2018 600 4.00 2,400 - - - 600 4.00 2,400
04-3-2018 - - - 300 4.00 1,200 300 4.00 1,200
05-3-2018 300 3.80 1,140 - - - 600 3.90 2,340
05-3-2018 - - - 50 3.90 195 550 3.90 2,145
10-3-2018 - - - 200 3.90 780 350 3.90 1,365
18-3-2018 200 4.20 840 - - - 550 4.01 2,205
23-3-2018 - - - 400 4.01 1,604 150 4.01 601
26-3-2018 20 4.01 80 - - - 170 4.01 681
29-3-2018 400 4.40 1,760 - - - 5704.282,441
31-3-2018 - - - 300 4.28 1,285 2704.281,156
Working Notes :
[1] Issue on March 5 & March 10 is valued at Rs. 3.90 which is the
weighted average rate, arrived at as follows :
1, 2 0 0 1, 1 4 0 2, 3 4 03.90300 300 600
[2] Purchase returns of 50 kg. are out of the total stock of 600 kg.
which was valued at Rs. 3.90 per kg.
[3] Issue on March 23 is valued at Rs. 4.01 per kg. which is the
weighted average rate arrived at as follows :
1, 3 6 5 8 4 0 2, 2 0 54.01350 200 550
[4] Sales on March 23 are out of stock valued at Rs. 4.01 per kg.
Hence returns of 20 kg. are also taken at a rate of Rs. 4.01 per kg.
[5] Weighted Average Rate on March 31 is arrived at as follows :
681 1 ,760 2,4414.28170 400 570munotes.in

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92Therefore, th e value of stock as on 31 -3-2008 : 270 units @ Rs.
4.28 = Rs. 1,15 6
Illustration : 7
A company deals in 3 products viz. A, B and C. The details for
purchases and sales for January 20 18are as under.
Product A B C
Units Rs. Units Rs. Units Rs.
Selling P rice per
Unit100 200 250
Opening Stock 100 60 100 100 50 120
Purchases :
Jan 9 300 65 200 110 50 135
Jan 20 100 64 50 120 100 140
Jan 29 50 68 50 125 20 130
Closing Stock 140 70 60
You are required to prepare a trading and prof it and loss account
for the month assuming the selling and distribution expenses to be
Rs. 63,000. Use FIFO method for stock valuation.
Solution
Stock Ledger (FIFO Method)
Product –A
Date Purchases Sales Closing Stock
Qty. Rs. Qty. Qty. × Rs. = Amount
01-1-2018 - - 100 × 60 = 6,000
09-1-2018 300 × 65 - 100 × 60 = 6,000
300 × 65 = 19,500
25,500
20-1-2018 100 × 64 - 100 × 60 = 6,000
300 × 65 = 19,500
100 × 64 = 6,400
31,900
29-1-2018 50 × 68 - 100 × 60 = 6,000
300 × 65 = 19,500
100 × 64 = 6,400
50 × 68 = 3,400
35,300
Total Sales 100 ×60 90 × 64 = 5,760
During 300 ×65 50 × 68 = 3,400
January 10 × 64 9,160
410munotes.in

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93Product –B
Date Purchases Sales Closing Stock
Qty. Rs. Qty. Qty. × Rs. = Amount
01-1-2018 - - 100 × 100 = 10,000
09-1-2018 200 × 110 - 100 × 100 = 10,000
200 × 110 = 22,000
32,000
20-1-2018 50 × 120 100 × 100 = 10,000
200 × 110 = 22,000
50 × 120 = 6,000
38,000
29-1-2018 50 × 125 100 × 100 = 10,000
200 × 110 = 22,000
50 × 120 = 6,000
50 × 125 = 6,250
44,250
Total Sales 100×100 20 × 120 = 2,400
During 200 × 110 50 × 125 = 6,250
January 30 × 120 8,650
330munotes.in

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94Product C
Date Purchases Sales Closing Stock
Qty. Rs. Qty. Qty. × Rs. = Amount
01-1-2018 - - 50 × 120 = 6,000
02-1-2018 50 × 135 50 × 120 = 6,000
50 × 135 = 6,750
12,750
20-1-2018 100 × 140 - 50 × 120 = 6,000
50 × 135 = 6,750
100 × 140 = 14,000
26,750
29-1-2018 20 × 130 - 50 × 120 = 6,000
50 × 135 = 6,750
100 × 140 = 14,000
20 × 130 = 2,600
29,350
Total Sales 50 × 120 40 × 140 = 5,600
During 50 × 135 20 × 130 = 2,600
January 60 × 140 8,200
160
Note : 1
Number of units sold during Janua ry:
Product A B C
Opening Stock 100 100 50
Add : Total Purchase 450 300 170
550 400 220
Less : Closing Stock 140 70 60
Units Sold 410 330 160munotes.in

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95Dr. Trading Account Cr.
Particulars Rs. Particulars Rs.
To Opening Stock By sales
A1 0 0×6 0= 6 , 0 0 0 A4 1 0×1 00 = 41,000
B1 0 0×1 0 0= 10,000 B3 3 0×2 0 0=6 6 , 0 0 0
C5 0×1 2 0= 6,000 22,000 C1 6 0×2 5 0=4 0 , 0 0 0 1,47,000
To Purchases By Closing Stock
A 29,300 A 9,160
B 34,250 B 8,650
C 23,350 86,900 C 8,200 26,010
To Gross Profit c/d 64,11 0
1,73,010 1,73,010
Dr. Profit & Loss Account Cr.
Particulars Rs. Particulars Rs.
To Selling & Distribution
Expenses63,000 By Gross Profit b/d 64,110
To Net Profit 1,110
64,110 64,110
6.2EXERCISES
Problem 1
From the following parti culars, value the closing stock
separately under : (A) FIFO; (B) Weighted Average
1stApril, 20 18 Opening Stock 800 @ Rs.4
4thApril, 20 18 Sales 200
8thApril, 20 18 Purchase 1,000 @ Rs.5
10thApril, 20 18 Sales 500
12thApril, 20 18 Sales 200
15thApril, 20 18 Purchase 700 @ Rs.5.50
18thApril, 20 18 Sales 500
20thApril, 20 18 Purchase 1,200 @ Rs.6.00
28thApril, 20 18 Sales 1000munotes.in

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96The market value of 30thApril, 20 18isRs.5.75.
Problem 2
The following is an extract of the record of receipt and issue of
certain chemical sin a chemical factory during the month of March ,
2018 .
Date Particulars Units Rate
2018
March 1Opening balance 500 Tonnes @Rs.200
“3 Issue 70 Tonnes
“4 Issue 100 Tonnes
“5 Issue 80 Tonnes
“1 3 Received 200 Tonnes @Rs.190
“1 4Returned from
Department150 Tonnes
“1 6 Issue 180 Tonnes
“2 0 Received 240 Tonnes @Rs.-192
“2 4 Issue 300 Tonnes
“2 5 Received 320 Tonnes @Rs.194
“2 6 Issue 115 Tonnes
“2 7 Received 350 Tonnes @Rs.195
“3 0 Issue 400 Tonnes
Issues are to be price don the principle of ‘First -in-First-out’
Principle. The stock verifier has found shortage of 10 tonnes on the
22ndJune, 1999 and left a note accordingly.
Prepare aStore Ledger Control Account for the material
showing the above transactions.munotes.in

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97Problem 3
Find the value of closing stock on FIFO method
Receipts : P urchase of Pipes
04.06. 2017 20 Pipes @ Rs. 15.00 each
17.06. 2017 30 Pipes @ Rs. 14.00 each
02.07. 2017 40 Pipes @ Rs. 14.50 each
30.07. 2017 30 Pipes @ Rs. 13.00 each
Sold :
20-6-2017 25 Pipes
05-7-2017 40 Pipes
31.07. 2017 45 Pipes
On 28.07. 2017 , 2 pipes sold on 20.6. 2017 were received
back, out of which one pipe was found damaged on 28.7. 2017 and
had to be discarded .



munotes.in

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98Unit-7
CAPITAL, REVENUE EXPENDITURE
AND RECEIPTS
Unit Structure :
7.0 Objectives
7.1 Introduction
7.2 Characteristics / Tests for Capital or Revenue
7.3 Expenditure
7.4 Capital Expenditure
7.5 Revenue Expenditure
7.6 Distinctions between Capitals Expe nditure and Revenue
Expenditure
7.7 Deferred Revenue Expenditure
7.8 Capital Receipts
7.9 Revenue Receipts
7.10 Distinctions between Capital Receipts and Revenue
Receipts
7.11 Deferred Revenue Income
7.12 Revenue Profit and Capital Profit
7.13 Revenue Loss and Capital Loss
7.14 Effect of Wrong Treatment On Profit
7.15 Illustration
7.16 Exercises
7.0 OBJECTIVES
After studying the unit students will be able to:
Understand the meaning and characteristics of capital
expenditure and revenue expenditure.
Distinguish between capital expenditure and revenue
expenditure.
Understand the meaning and characteristics of capital receipts
and revenue receipts.
Distinguish between capital receipts and revenue receipts.
Understand the meaning and characteristics ofdeferred
revenue expenditure
Know the disclosure of various items in final accounts.munotes.in

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99Recognise with reason the given item is of capital nature or
revenue nature or deferred revenue nature.
7.1 INTRODUCTION
Final Accounts prepared attheend of the year consists of
Income Statement and Balance Sheet. These are prepared from
trial balance. Debit balance shown in trial balance represents either
revenue expenses or capital expenditure, credit balances are either
revenue income or capit al receipts . All revenue expenses & gains /
incomes are transferred to Income Statement .C a p i t a le x p e n d i t u r e
represents assets shown on assets side of the Balance Sheet.
Credit balance represents either gains or capital receipts, various
gains shown in Income Statement and capital receipts shown on
liabilities side of the Balance Sheet. Therefore ,it is very essential to
know, WHICH and WHY, how to distinguishing which are capitals
or revenue? While recording transaction in various books of
accounts, it is necessary to classify them into revenue or capital.
This classification is relevant for adherence to the requirements as
per A.S. 9 & the accounting concept of matching costs with
revenue.
7.2 CHARACTERISTICS / TESTS FOR CAPITAL OR
REVENUE
For deciding whether it is CAPITAL OR REVENUE following
features should be tested.
1.Business Activity / Nature :
In case such activities are recurring nature i.e. purchases or
sales of goods or rendering serves ,it is revenue. Expenditure
pertains to investing /financing activity ,it is capital expenditure.
2.Long / Short Term Benefits :
Benefits of expenditure is for short term, normally it is
Revenue e.g. wages paid, rent paid, while if benefits for long term,
it is capital, e.g. purchase of Plant, Furniture ,e t c.
3.Recoverable :
Amount spent is recoverable in short te rm, it is revenue, if it
is recoverable in long term ,it is capital e.g. sale of goods is
revenue, sale of assets is capital receipts.
4.Recurring -Non-recurring :
Any recurring receipts / payments are recurring in nature,
then it is revenue, if such receipts are non -recurring ,it may be
capital expenditure e.g. issue of shares is capital receipts and
interest received is revenue income.munotes.in

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1005.Effect on Funds andProfits :
Revenue receipts and revenue pa yments affects profits
whereas capital receipts increases funds, capital payments or
expenditure increases assets.
6.Treatment in Final Accounts :
Revenue receipts orpayments are shown in Income
Statement, capital expenditure or receipts are shown in the Balance
Sheet.
7.Materially of amount :
Huge or small amount doesn’t indicate whether it is capital or
revenue.
8.Treatment by other party :
Treatment by other party t o transaction is not relevant. E.g.
furniture sold by furniture manufactures is revenu e receipts for him,
it is capital expenditure for buyer as it is assets purchased ,thus,
there are no clear cut tests / rules ,whether it is capital or revenue,
it can be decided upon nature of transactions / nature of business /
ultimately nature of recei pts or payments.
7.3 EXPENDITURE
7.3.1 Meaning :
As per guidance notes issued by I.C.A.I. in relation to
Financial Statements ,“Expenditure means incurring a liabilit yor
disbursement of cash or transfer of property for the purpose of
obtaining goods , services or assets” Expenditure does not only
involve outflow of resources, but also giving rise to liability or
transfer of property. Such expenses may be Capital or Revenue
expenditure, depends up benefits that firm gets i.e. short term or
long term. A ne x p e n d i t u r ew h e t h e ri ti sC a p i t a lo rR e v e n u ei s
dependent on variou s factors, such as :
7.3.2 Benefit of expenditure :
In case benefit of it is available for short period i.e. less than
12 month s, it isrevenue expenditure. Expenditure is for longer
period i.e. more than one year, it is capital expenditure.
7.3.3 Recurr ing or non -recurring :
Revenue expenditure is reoccurring, is payable again and
again, i.e. rent, wages, salaries etc. It is considered as period cost.
However ,capital expenditure is n ot payable as per period, it is
incurred only when Fixed Assets are purchased.munotes.in

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1017.3.4 Decreases Cost of production / increased earning
capacity
Expenses onincreasing earning capacity are treated as
capital expenditure where as expenses incurre dfor keep ing assets
in working condition are revenue expenditure.
7.4 CAPITAL EXPENDITURE
7.4.1 Meaning:
Capital Expenditure means an expenditure ca rring probable
future benefit [Guidance Notes -I.C.A.I.] Eric. Kohler has defined
Capital expenditure as “exp enditure intended to benefit future
periods, an addition to fixed assets. The term is generally restricted
to expenditure that add to Fixed Assets units or those have effects
of increasing earning capacity, efficiency, life span or economy of
an existing a ssets.”
In short ,Capital Expenditure means :
i)Expenditure incurred for acquisition of Fixed Assets.
ii)Expenditure incurred in connection toacquisition of Fixed
Assets.
iii)Expenditure which results in increases earning capacity of
business.
iv)Expenditure which decreases cost of operation.
Balance in capital expenditure being an asset is carried
forwardto subsequent period; still it is fully depreciated or disposed
off. Depreciation is charged annually either on book value or cost of
Fixed Assets.
7.4.2 Characteristics / Tests :
If expenditure has any of the following features, then it is
treated as Capital Expenditure.
1.Long Term Benefits :
The benefits of capital expenditure can beenjoy edfor long
periods and future period of time e.g. purchased of Pl ant &
Machinery.
Any expenditure incurred in connection with acquisition of
fixed assets, e.g. Custom duty paid on machinery imported,
installation cost of machinery.
2.Investing Activity :
Such expenditure pertains to investing activity. Capital
expend iture helps to set up and develop a business. It creates and
increases earning capacity of the business. It gives birth to a new
source of income. It leads to acquisition of new asset. Examplesmunotes.in

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102areFixed Assets like Machinery, Furniture & Fixtures, Compute r,
etc.
3.Recoverable :
Money spent on capital expenditure can be recovered
though income generated by the Assets itself or even by selling the
assets at the end of its economic life or at the time of replacement
of assets.
4.Non-recurring :
Capital exp enditure is non -recurring in nature, i.e. it need not
be incurred again and again. If a firm takes Building on rent, it is
payable every month, but if it purchased Building ,it does not
purchase another building for many years.
5.Effect on Funds and Profit s:
Capital expenditure decreases funds in current year as
money goes out of business. But it may increase profits in future
from income d erived by using such assets . Investment purchased
is capital expenditure, income earn edfrom investment is Revenue
Receipt.
6.Increases in performance of existing Assets :
Normally amount spent is large, but not necessarily, e.g.
Calculator purchased, it is shown in the Balance Sheet as assets at
book value [cost less depreciation].
7.4.3 Examples of Capital Expenditure :
Purchase of any Fixed Asset for use in the business, as per
AS-10, cost of fixed asset includes :
a.Cost of purchase ofFixed Assets.
b.Custom duty, taxes, cusses on cost.
c.Freight paid for transportation to factory site.
d.Professional charges paid in connect ion with acquisition of
Fixed Assets, Installation of assets e.g. Legal charges paid
for preparing documents, project report, conducting
feasibility study, market surveys, negotiations for
Collaboration etc.
e.Office and administrative expenditure connected with
project.
f.Interest on lo an taken for purchase of Fixed Assets till it is
put to use.
g.Any expenditure incurred during construction period.
h.Cost of an addition or extension to an existing asset.
i.Cost of development of Wasting Assets.
j.Cost of acquisi tion of an Intangible Assets.munotes.in

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1037.5 REVENUE EXPENDITURE
7.5.1 Meaning :
1.REVENUE EXPENDITURE
Revenue expenditure means expenditure incurred for
carrying out the day to day business activities and from which no
future benefits expected. [Guidance Notes -ICAI].
Eric Kohler has defined revenue expenditure as
“Expenditure charged against operations, a term used to contrast
with capital expenditure”.
Any expenditure which is not capital expenditure is Revenue
Expenditure. The items of expenditure having immediate or short -
term benefices less than 12 months are treated as Revenue
Expenditure.
2.COST
Cost means amount of expenditure incurred on a specific article,
product or activity [Guidance notes ICAI]. Thus ,cost may be the
cost of an asset or cost of g oods or cost of services.
3.Expenses
Expenses means:
a)A cost relating to the operation during the accounting period.
b)A cost relating to the income earned during the accounting
period.
c)A cost whose benefits do not extend beyond the accounting
period.
d)An e xpired cost i.e. that portion of expenditure from which no
further benefits are expected. [Guidance Notes ICAI].
e)Expenditure incurred to maintain assets in working condition.
f)Expenditure of revenue nature incurred after the plant starts
commercial producti on.[AS-10].
g)Research and development cost written off.
In short, Revenue expenses means operating costs,
matching costs, period cost, product cost and expired costs
incurred during theaccounting year.
7.5.2 Characteristics / Test:
If expenditure h ave any of the following characteristics or
tests, it should be treated as Revenue Expenditure :munotes.in

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1041.Business Activity :
The expenditure tha t pertain to business activity is recorded
asrevenue expenditure, as it helps to run a business and earn
income. Examp les are purchase of goods, fees paid etc.
2.Maintain Assets :
Expenditure that helps to maintains fixed assets in working
condition is treated as revenue expenditure. e.g. repairs,
maintenance .
3.Not Recoverable :
Money spent on revenue expend iture is no ti r r e t r i e v a b l y
gone. It can be recovered hence expired costs and revenue losses
are treated as revenue expenditure.
4.Recurring :
Revenue expenditure is recurring in nature. A same type of
expenditure is incurred again and again. e.g. salaries paid, rent ,
traveling expenses, audit fees.
5.Reduces Funds and Profits :
Revenue expenditure reduces both funds and profits of the
current year. As money goes out, the funds available with the
concern are reduced. And as the money goes out irretrievably (i.e.
neve r to comes back) ,it reduces the profits of the concern.
7.5.3 Disclosure in final accounts :
Revenue expenditure pertains to current year is shown as
expenditure in the Profit & Loss A/C.H o w e v e r ,p a r to ft h e
expenses, if pertains to next year ,is show ni nt h e Balance Sheet as
prepaid expenditure, on the assets side. Revenue expenditure
incurred but not paid is taken in Profit & Loss A/Cand it is shown in
theBalance Sheet as liabilities.
7.5.4 Examples:
1.Cost relating to business activities during t he accounting year is
treated as revenue expenditure i.e.
Cost of production [ purchases of goods, wages paid.
manufacturer expenses etc.]
Cost of administration [salaries, rent, pr inting & stationery,
audit fees etc.]
Selling & Distribution cost [commissi on, traveling expenses,
advertisement ,etc.]
Cost of raising finance [interest on loans, debentures
interest, and cash discount ,etc.]munotes.in

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1052.Cost relating to income earned during the same accounting
period are treated as revenue expenditure e.g. carriage, fre ight,
buying expenses, interest on loans.
Costs whose benefits do not extend beyond the accounting year
are treated as revenue expenditure i.e. white w ashing factory,
loose tools and packing materials.
Expired Costs : Expenditure from which no future be nefits
expected is treated as revenue expenditures e.g. Depreciation
on Fixed Assets, when any asset is sold at loss, book value
represents loss on sale of assets, it is treated as expired cost &
written off as expired cost, debited to Profit and Loss A/C.
Revenue Loss :istreated as revenue expenditure e.g. goods
destroyed by fire, bad debts and unsalable goods written off .
Revenue losses arises in respect of business activities [trading
or / and manufacturing] or in respect tocurrent assets such as
stock, cash lost, debtors etc.
Revenue expenditure incurred after the plant has begun
commercial production is treated as expenses .AS-10.
Expenditure on repairs which maintains the standard of
performance of an existing fixed assets and machinery spares
consumed are treated as revenue expenditure .A.S.-10.
According to A.S. 8, any Research & Development costs
incurred but it is not certain whether it will give rise to any
benefit in future can be treated as revenue expenditure.
7.6 DISTINCTIONS BETWEE NCAPITAL
EXPENDITURE AND REVENUE EXPENDITURE
No. Capital Expenditure Revenue Expenditure
1. Itsbenefit extends for more
than one accounting year .It benefits only for current
accounting year [12 months]
2. It is incurred for acqui sitionof
fixed assets .It is incurred for earning
revenue .
3. It may be incurred to improve
the existing fixed assets held
bytheconcern .It maintained fixed assets in
working condition .
4. It increases revenue earning
capacity .It does not change revenue
earning capacity .munotes.in

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1065. It benefit sm o r et h a no n e
accounting year.It benefits only in thesame
accounting year .
6. It decreases funds, but
benefits for longer period .It decreases funds as well
as profits of business .
7. It may decreases cost of
producti on.It decreases profits of
current year .
8. It is shown on assets side of
Balance Sheet .It is shown as expense in
Revenue A/C.
9. Examples = goodwill, plant &
machinery, land, building,
furniture & fixtures, railway
sidings etc.Examples = purchases of
goods, wages, salaries,
legal fees, rents. Insurance,
carriage, interest, selling
expenses, commission. etc.
CHECK YOUR PROGRESS
1.Fill in the blank s
a.Revenue expenditure is shown on ------------- side of Profit &
Loss A/ C.
b.-------------- expenditure is incurred for acquisition of Fixed
Assets.
c.-------------- expenditure benefits only in same accounting
year.
d.Purchase of goods is the example of ------------------
expenditure.
e.Goodwill is the --------------------------- expenditure.
f.Cost relating to income earned during the --------- accounting
period are treated as revenue expenditure.
g.Expenditure from which no future benefits expected is
treated as -------------- expenditures.
h.Goods destroyed byfire is a ------------------------- expenditure.
i.Expenditure pertains to investing /financing activity is --------
expenditure.
j.Custom duty, taxes, cusses on cost is a -----------
expenditure.
k.Expenditure which results in increas ei n earning capacity of
business is ---------------------- expenditure
l.Expenditure whic h decreases cost of operation is --------------
expenditure.munotes.in

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1072.Enlist the tests for treating the expenditure as Revenue.
3.Define the following terms:
a.Revenue expenditure
b.Capital expenditure
c.Cost
d.Expenditure
7.7 DEFERRED REVENUE EXPENDITURE
7.7.1 Meaning:
Deferred Revenue Expenditure is that of revenue
expenditure which is carried forward on the presumption th at it will
benefit over subsequent periods.
Guidance note issued by ICAI “Deferred Revenue
Expenditure is that part of expenditure for which payme nt has been
made or a liability incurred but which is carried forward on
presumption that it will benefit over a subsequent period or
periods”.
Theyare of a Quasi Capital Expenditure. Any heavy revenue
expenditure which is incurred in one year but it islikely to benefit
more than one accounting year, are considered as deferred
revenue expenditure. To defer means to postpone. Deferred
Revenue Expenditure has mixed nature and has same features of
both revenue and capital expenditure.
7.7.2 Medium term Benefits:
The Deferred Revenue Expenditure has medium term
benefits, may be 3 to 4 years ,therefore ,cost of expenditure is
divided in say 3 to 4, or 5 years, thepart of Deferred Revenue
Expenditure benefit for current year debited to Profit & Loss A/C,
remaining balance carried to subsequent years ti ll It isf u l l yw r i t t e n
off. e.g. Discount allowed Rs. 1,00,000 on issue of Debentures,
Debenture, likely to beredeem edafter 10 years. The benefit sof
issue of Debentures are for 10 years. Every year 1,00,000 /10 =
Rs.10,000 shall be written off, balance in Discount on issue of
Debentures carried forward. After ten year ,there will be no balance
in that account.
7.7.3 Nature of Expenses :
Deferred Revenue Expenditure should be Revenue
Expenditure by natu re in the first instance, for example,
advertisement. But its matching with revenue may be deferred
considering the benefit to be accrued in future.munotes.in

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1087.7.4 Revenue Expenses, Deferred Revenue Ex penditure &
Prepaid Expenditure :
At h i nl i n eo fd i f f e r e n c e exists between revenue expenses,
deferred revenue expenditure and prepaid expenses. Revenue
Expenditure is short time expenses, benefits of all these are
excused in the same accounting year. In some cases ,part of
Revenue Expenses is treated as Deferred Re venue Expenditure
and is carried forward on the presumption that it will benefit over
subsequent period or periods. e.g. heavy advertisement for new
product launch in the market, such expenses may be assumed, it is
going to benefit for 3 to 5 years, hen ceit can be treated as
Deferred Revenue Expenditure. The benefits available from prepaid
expenses can be precisely [not presumption] estimated but that is
not so in case of Deferred Revenue Expenditure. e.g. Insurance
premium paid for the year ended 30thJune2 0 1 8Rs. 24,000/ -
Accounting year ended 31stMarch 201 8. In this case three months
premium pertains to subsequent period, = 24000/12*3 = Rs. 6000.
Amount is ascertained and carried forwards according as prepaid
insurance Rs. 6000/ -.
7.8 CAPITAL RECEIPT S
7.8.1 Meaning:
Receipts means an amount received by a concern either
during its business activity [supply of goods or services] or during
its financing [obtaining money as capital or loan or sale of assets] .
Receipt arising out of business activity is known as revenue
receipts, wherever receipts arising out of financing activity are
known as capital receipts or liability.
Capital receipts means an amount received by a concern in
the course of financing activity [obtaining money as cap ital or loan
orsale of Assets]. A concern need money to carry on its business
activities and investing activities. The money is obtained either from
the owner or loans or sales of assets or sales of investment. Capital
receipts are non -recurring in nature.
Capital means the amount invested in the concern by its
owners, it to be refunded only when the concern finally stops its
business and is closed down.
Liability means amounts received as loan basis from outsiders
e.g. from Bank, financial institution.
Capital receipt s are recognized on accrual basis as soon as the
rights of receipts are established. Capital receipts are not
credited to Profit & Loss A/C, it is shown as the liability or it may
reduce from Fixed Asset. However ,it may be credited to Profit &
Loss A/C tothe profit realized on sale of asset .munotes.in

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1097.8.2 Characteristics / Tests :
If receipts have any of the following features, then it should
be treated as Capital Receipts:
Financing Activity :
Receipts which arises from financi ngl activities are
concerned as Capital Receipts. It provides funds to acquire
new fixed assets. e.g. capital introduced, loan taken from
sale of assets ,etc.
Non-recurring :
Capital receipts are always non -recurring in nature. Such
amounts are not received again and again. These are l ong
term commitments.
Returnable :
Money received as loan is returnable, as per various terms
agreed upon. Capital introduced is paid back to owner when
business is closed down.
Effect on fund and profits :
Capital receipts increases fund available to business in the
year of receipts, as money comes in the business. But it may
decreases profits in future as one has to pay interest on
loan. However ,in long term ,it will increase profits of the firm.
e.g. Say you are borrowing @ 12%; return on investment to
firm say 18% and then extra 6% increases return to owner,
without additional capital. This is possible only when returns
are high erfrom thebusiness.
7.8.3 Disclosure in Final Accounts:
Capital receipts are shown in Balance Sheet on liability side .
Capital receipts from sale of fixed assets are deducted from
concern edfixed assets.
7.8.4 Example:
a)Additional capital introduced by the owner Rs. 1,50,000.
b)Loan of Rs. 5,00,000 taken from H.D.F.C. Bank.
c)Investment costing Rs. 75,000 sold.
d)Grants from government received Rs.1,75,000 for
construction of building.
7.9 REVENUE RECEIPTS
7.9.1 Meaning :
Revenue receipts are those items of income, which are
received or accrued in ordinary course of business. Revenue
receipts means receipts from customers f or sale of goods ormunotes.in

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110rendering services or for use of funds or use of assets.
[Guidance Notes -I.C.A.I.] Revenue receipts are recurring
in nature; this gives rise to Gross Income regularly so long
as the business continues.
Income means revenue earn ed during the particular
accounting year.
7.9.2 Characteristics / Tests :
If receipts have any of the following features, then it should
be treated as Revenue Receipts :
a)Business Activity :
Receipts in course of business activities are recorded as
Revenue Receipts e.g. Sale of goods, interest received, dividend
received, discount earned, etc.
b)Recurring :
Reve nue Receipts are recurring in nature. Same types of
receipts are received again and again on regular basis, periodically
received in gap of two or three months, like interest on loan given.
c)NotReturnable :
Revenue Receipts are not returnable / refundable. It needs
not be paid back as concern has supplied goods or rendered
services to customers. Amounts received for sale of goods or
rendering re verses, in normal case ,money is not to be refunded to
customers back. Legal ownership iswith seller and need not to be
paid back.
d)Increase in funds and profits :
Revenue receipts increases both funds and profits of the
current year. As money received inthefrom of income ,it increases
profits and it is not to be refunded .Itincreases funds available at
disposals with the concern.
7.9.3 Disclosure in final accounts :
Revenue receipts pertaining to current year are credited to
Profit & Loss A/C.R evenue receipts re lating to future period shown
in the Balance Sheet as received in advance, on liability side. [as
income received in advance]. However income is different than
receipts. Income excludes revenues relating to the further period,
received in advance & includes income earned in current year but
not received [income receivable] and income received in earlier
years for current year.munotes.in

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1117.9.4 Examples:
Sales of goods:
Goods means the commodities in which the concern deals.
Sales of goods wheth er manufactured or purchased are revenue
income.
Revenue is said to be arise from sale of goods when sale is
complete and the buyer has no legal right to return the goods or
ask for refund. If at the time of receipts, sale is not complete or
buyer has ri ght to ask for refund, [sale on approval, goods sent on
consignment] then it is treated as advance and the receipt is based
on advance and not as revenue. Only when the sale is complete,
such advance is to be treated as revenue.
Rendering of Services :
Services means ‘AID TO TRADE’, such as marketing,
financing, administration, distribution, transport etc. Receipts are
taken as revenue when services are provided.
Interest :
Interest is taken as income on loan given by the concern.
Amount received when such loan itself is return ed,t h e ni ti s
capital receipt.
Dividend :
Receipt is treated as dividend when it is in the form of a reward
from investment in shares. Amount is received on sales of such
shares themselves are treated as capital receipts.
Royalty:
Receipt is treated as royalty when it is received for used of
assets such as know -how, patents, trademarks and copyrights.
Amount received on outright sales of such patents etc. are
capital receipts.
Insurance claim :
Compensation received from in surance company for loss of
current assets e.g. loss of goods, loss of cash due to theft etc.,
are treated as revenue receipts.
7.9.5 GOVERNMENT GRANTS
Grants received from Government are of two types. Grants
received for capital expenditure is capital receipt e.g. for road
construction, for Equipments to be purchased. However ,grant
received tore-imbrue or compensate for specified revenue
expenditure or revenue losses are revenue receipts. [e.g. salary
grant, rent, power grant] are treated as Revenue R eceipts [A.S. -
15 on Government Grants]. In brief, any receipt is recurring &munotes.in

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112benefits are likely to be lost for not more than 12 months, are
Revenue Receipts.
7.10DISTINCTIONS BETWEEN CAPITAL RECEIPTS
AND REVENUE RECEIPTS
No. Capital Receipts Revenu eR e c e i p t s
1. It is non -recurring innature . It is recurring innature .
2. It arises from financial /
investing activity .It arises from business
activity .
3. Capital receipts which are
liabilities are to be repaid as
per terms .They are not repaid in
normal course of business .
4. They are not gains to the
concern .They are gains to the
concern .
5. They appear in Balance
Sheet .They appear in Income
Statement.
6. Capital receipts are
recognized on accrual basis
but not match edwith capital
expenditu re.Revenue receipts are
matched with Revenue
expenditure at the end of
accounting year.
7. Examples of capital receipts
are capital brought in by
owner, loan taken, sale of
fixed assets and sale of
investment.Examples of revenue
receipts ar e sale of go ods,
rent received, interest
received ,discount earned,
income from investment etc.
8. Capital receipts may be
capital profit, it increases
funds available .In increases profits as we ll
as funds of business
concern.
CHECK YOUR PROGRESS
1.Fill in the bla nks
a.Commission received is -------------- receipt .
b.Rent received by sub -letting premises is ------------- receipt .
c.Sale proceeds on sale of old car is ------------- receipt .
d.Sale of furniture by furniture dealer is ------------- receipt .
e.--------------- means assets held for short period.
f.Capital of owner of business is shown on -------------- side of
balance sheet.
g.------------- assets does not have physical identity.
h.Grants received from Government for capital expenditure is
a------------------------- -receipt .munotes.in

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113i.Grant received for road construction is a ------------ receipt.
j.Grant received for re -imbrues or compensate for specified
revenue expenditure or revenue losses are--------------
receipts.
k.Sales of goods whether manufactured or purchased are ------
income.
l.Revenue receipts pertaining to current year are ------------ to
Profit & Loss a/c.
m.Revenue receipts relating to ---------- period shown in the
balance sheet as received in advance, on -------- side.
n.Deferred revenue expenditure should be --------- -expenditure
bynature in the first instance.
o.Discount on issue of debenture is a ---------------- expenditure.
2.Define the following terms:
a.Revenue receipts
b.Capital receipts
c.Deferred revenue expenditure
3.What is the difference between income and receipt.
7.11DEFERRED REVENUE INCOME
7.11. 1Meaning :
Deferred Revenue Income means income received in
advance before it is earn ed, which is carried forward to subsequent
period to which it relates [Guidance note -ICAI] such income is
received in advance. Suc h items of income is shown as ‘Income
received in advance’ on the liability side of Balance Sheet.
7.11. 2Examples :
Club annual membership fees received in advance from
some members is to be treated as income received in advance, to
be carr iedforward to the period it belongs.
Education alinstitution fees may be collected for entire
course, say three years, two years fees received is income
received in advance.
Grants received from Government for acquiring depreciable
assets are treated as deferr ed income. Proportionate amount of
grant basined on useful life of asset [i.e. total gra ntd i v i d e db yt h e
useful life of assets] is taken as income every year and credited to
Profit & Loss A/ C.[A.S. -15 on Government Grants -I.C.A.I.]munotes.in

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1147.12 REVENUE PROF IT AND CAPITAL PROFIT
Business activities give rise to revenue profit whereas
investing and financing activities give rise to capital profit. Revenue
profit / operating profit mean the net profit arising from the normal
operations / operating activities of the concern. Net operating profit
means excess of gross operating income over total operating
expenditure during the particular period. Capital profit arises when
assets or investment sold at higher price than cost. Shares are
issued by the company at higher price than face value / nominal
value, extra amount received is credited to Securities Premium A/C
and not to Profit and Loss A/C. In case of sale of Fixed Assets ,
difference between sale proceeds and cost is capital profit,
difference between cost and book value is revenue profit. e.g. Plant
costing Rs. 7,50,000/ -book value on date of sale Rs. 4,50,000/ -
[due to depreciation], sold for 9,00,000/ -
Capital profit = 9,00,000 -7,50,000= Rs. 1,50,000 [sale proceeds -
cost]
Revenue profit = 7,50,000 -4,50,000 = Rs. 3,00,000 [cost -book
value]
7.13 REVENUE LOSS AND CAPITAL LOSS
Revenue due to business activity is revenue loss, e.g. loss
on sale of goods, bad debts, goods lost by theft. Such revenue
losses are expired cost and debited to Profit & Lo ssA/C.O nt h e
other hand, losses due to investing and financing activity is capital
loss.Capital loss due to investing activity is debited to Profit and
Loss A/C as expired cost with no future benefits whereas losses
due to capital, financing i.e. discou nt on issue of shares is carried
forward as ‘fictitious assets’ shown in the Balance Sheet under the
heading “ Miscellaneous Expenditure ”.
7.14 EFFECT OF WRONG TREATMENT ON PROFIT
We believe that to erris human, to ignore its effect will cost
on someone, who may blame accountant.
Any error in classification of payments / receipts will affect
final accounts. Every receipts and payments are classified into
either Revenue or Capital. Revenue expenditure & incomes are
transferred to Profit & Loss A/Cto as certain net profit or loss for the
period .Capital expenditure and capital receipts are shown in the
balance sheet. Balance shown in the balance sheet are carried
forward to subsequent period. Thus ,any error in classification will
effect on accuracy of en tire final accounts. Effect of such error can
be as under :-munotes.in

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1151. Revenue Expenditure is shown as Capital Expenditure:
Revenue expenditure wrongly capitalized will increase profits
of this year and assets are overvalued, depreciation part in
subsequent year shall decrease profits of all subsequent years e.g.
Repairs to Machinery Rs. 60.000 wrongly debited to M achinery
A/C. Since it is wrongly capitalized, expenditure not debited to Profit
& Loss A/C profit shall be shown at higher amount and also at
higher a mount, in subsequent year ,due to higher depreciation ,it
will reduce profits.
2. Capital Expenditure is shown as Revenue Expenditure :
As capital expenditure is debited to Profit & Loss A/C,P r o f i t
& Loss A/C will show lower profit and Balance Sheet shows lower
assets. It will affect profits / loss in subsequent years also, as
depreciation shall not becharged, as entire amount is already
debited to Profit & Loss A/C e.g. Furniture purchased for
Rs.51,000, wrong lyrecorded in purcha se day book. In this case,
gross profit as well as net profit reduced by Rs. 51,000/ -.Furniture
is not added to furniture in Balance Sheet. So ,Balance Sheet
shows fixed assets lower by Rs. 51,000 if this type of error results in
to Window Dressing.
3. Capital Receipts are shown as Revenue Receipts:
The Profit & Loss A/C shows higher profits and the Balance
Sheet shows lower liabilities or higher assets. e.g. Sale of old
assets for Rs. 25,000 recorded in Sales Day Book. In this case, as
sales are shown a t higher amount, Gross Profit, Net Profit shall be
higher, since it is not deducted from assets, they are shown at
higher amount by Rs. 25,000. Profit or loss on sale of assets are
also not accounted. Deposit received from customers’ Rs. 27,000,
wrongly cr edited to interest A/C, profit shown by Profit & Loss A/C
will be higher and liabilities are shown lower by Rs. 27,000.
4. Revenue Receipts are shown as Capital Receipts:
The Profit & Loss A/C shows lower profit and the Balance
Sheet shows higher liabili ties, or lower assets e.g. Commission
received Rs. 71,000, from Z & Co. credited to Z & Co., income is
shown less and Z & Co. as liability.
Sale of goods wrongly credited to Furniture A/C, sales is
shown lower results in lower income and Furniture is re duced by
the same amount, assets are shown at lower amount.munotes.in

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1167.15 ILLUSTRATION
Illustration 1:
State with reason whether following are capital or revenue
expenditure:
i)Rs.12,000, paid for removable of stock to new site.
ii)Purchase of NOKIA mobile pho neRs.5,000 for office work.
iii)Expenses incurred in connection with obtaining a licence for
starting the factory for Rs.27,000.
iv)Legal fees to acquire property Rs.10,000 .
v)The amount spent for replacement of work out part of
machine Rs.50,000.
vi)Money spent to reduce working expenses Rs.25,000.
vii)Ring & Pistons of an engine were changed at cost of
Rs.10,000 to get fuel efficiency.
Solution :
i)Rs.12,000, paid for removable of stock to new site is
revenue expenditure .This is neither bring enduring benefit
nor en hanc ethe value of the asset.
ii)Purchase of NOKIA mobile phone Rs.5,000 iscapital
expenditure ; as it is incurred for acquisi tion of fixed assets.
iii)Money paid Rs.27,000 for obtaining license to start a factory
is a capital expenditure .T h i si sa ni t e mo fe xpenditure
incurred to acquire the right to carry on business.
iv)Legal fees to acquire property Rs.10,000 arepart of cost of
that property. It is incurred to possess the ownership rights
of the property andhence it is a capital expenditure .
v)The amount sp ent for replaceme nt of work out part of
machine Rs.50,000 isrevenue expen diture since it is part
of its maintenance cost. If was incurred to keep machine in
working condition.
vi)Money spent onreducing working expenses Rs.25,000 is
capital expenditure ,a sitgenerates long term benefit to the
entity. It is part of intangible fixed assets. if is incurred for
any specific assets then it is also capital expenditure .It
should be capitalized.
vii)Rs.10,000 spent in changing rings and pistons of an engine
to get fuel efficiency is capital expenditure .T h i si sa n
expenditure on improvement of fixed assets .Itresults in
increasing profit earning capacity of the business by cost
reduction.munotes.in

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117Illustration 2:
State whether the following expenditure is a capital, rev enue
or deferred revenue expenditure. Give reasons :
1.Legal expenses incurred in connection with issue of capital.
2.Cost of replacement of a defective part of the machinery.
3.Expenditure incurred in preparing a project report.
4.Expenditure for training empl oyees for better running of
machinery.
5.Expenditure incurred for repairing cinema screen.
Solution:
1.Deferred revenue expenditure :Legal expenses incurred in
connection with issue of capital are not treated as revenue
expenditure because the fund s from issue of shares will benefit
the concern for many years, it is not treated as capital
expenditure because it does not create any real asset. Hence ,it
is treated as deferred revenue expenditure and written off over
certain number of years.
2.Revenue expenditure : As replacement of a defective part will
help to maintain the machinery in working condition.
3.Capital expenditure : If the project is implemented; as
according to Accounting Standard 10 ,all expenditure till a
project commences is capitalized . However, if the project is
given up or not implemented and the amount is small ,it will be
written off as revenue expenditure (as expired costs which will
bring no benefit in future); if the project is not implemented and
the amount is heavy, it will be treated as deferred revenue
expenditure.
4.Revenue expenditure :A se x p e n d i t u r ef o rt r a i n i n ge m p l o y e e s
for better running of machinery is cost of administration related
to normal business activities incurred in order to earn income
during the year.
5.Revenu e expenditure : As expenditure incurred for repairing
cinema screen is a cost incurred to maintain an existing asset in
working condition.
Illustration 3:
State, with reasons, whether you would consider the
following as capital expenditure or revenue exp enditure :
1.Amount spent on uniform of workers.
2.White -washing of the factory building.munotes.in

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1183.Cost of stores consumed in manufacturing machinery for
installation in own factory.
4.Wages paid for construction of the building extension.
5.Import duty on raw materia l purchased.
(June 1980, adapted)
Solution :
1.Revenue expenditure :A sa m o unt spent on uniform of workers
is an administration cost related to normal business activities.
2.Revenue expe nditure :A sw h i t e -washing of the factory of
building is a cost of maintai ning an asset in working condition.
3.Capital expenditure : As cost of stores consumed in
manufacturing machinery for installation in own factory is a
direct cost incurred for manufacturing an asset which is to be
capitalized as per Accounting Standard 10.
4.Capital expenditure : As wages paid for construction of an
extension to an existing asset is a direct cost incurred for
acquiring an asset which is to be capitalized as per Accounting
Standard 10.
5.Revenue expenditure :A si m p o r td u t yo nr a wm a t e r i a l
purchased is a direct product cost related to normal business
activities incurred in order to earn income during the year.
Illustration 4:
State with reasons, whether you would consider the following as
capital expenditure or revenue expenditure.
1.Raw material co sting $ 2,000/ -was imported when 1 dollar was
worth Rs. 40; when payment was actually made the foreign
exchange was purchased at the rate of 1 dollar equal to Rs. 42.
2.Premium paid in connection with acquisition of leasehold
premises.
3.Renovation of factor y canteen.
4.Fees paid for renewal of licence for factory.
(April 1984 adapted)
Solution :
1.Revenue Expenditure :As due to change in exchange rate, raw
material cost, which is a direct product cost, has gone up. Cost
of raw materials = 2000 × 40 = `80,000 . it is purchased of
goods. However, extra amount paid 2000 × (42 -40) = 4,000munotes.in

Page 119

119shall be treated as loss due to exchange fluctuation is also
revenue expenditure, should be debited to profit & loss a/c.
2.Capital expenditure : As premium paid in connection w ith
acquisition of leasehold premises is a direct cost incurred in
connection with the acquisition of an asset to be added to the
cost of the asset [Accounting Standard 10].
3.Revenue expenditure : As renovation of factory canteen helps
to maintain the asset in working condition .
4.Revenue expenditure : As fees for renewal of factory licence is
a recurring expenditure incurred in the course of normal
business activities.
Illustration 5:
Electric Engineers Private Limited removed their factory to a
more suita ble premises in Navi Mumbai. State with reasons the
accounting tr eatment for the following items :
1.A sum of Rs.99,500 was spent for dismantling, removing and re -
installing plant, machinery and fixtures.
2.The removal of stock from the old factory to the new at a cost of
Rs.1,000.
3.Plant and Machinery which stood in the books at `1,50,000
included a machine at a book value of Rs. 1,50,000 included a
machine at a book value of Rs. 3,400. This being obsolete, was
sold off at Rs. 900 and was replaced by a new mac hine which
cost Rs. 4,800.
4.The freight and cartage on the new machine amounted to `300
and erection charges Rs.550.
5.The furniture appeared in the books at Rs.15,000. Of these,
some portion of the book value at Rs.3,000 was discarded and
sold at Rs.1,200. N ew furniture of the book value of `2,400 was
acquired.
6.A sum of Rs.2,200 was spent on painting the new factory
(Oct. 1981, adapted)
Solution:
1.Deferred revenue expenditure : Cost of dismantling, removing
and re -installing plant etc. is not treated as rev enue expenditure
because it is not a normal operating cost. If itis not treated as
capital expenditure because it does not create any real asset.munotes.in

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120Hence it is treated as deferred revenue expenditure and written
off over certain number of years.
2.Revenue ex penditure : As removal of stock from the old factory
to the new is a normal operating cost related to a current asset
(stocks) and not capital asset.
3.When a machine costing Rs.3,400 is sold for Rs.900 received
onsale of machinery is treated as capital re ceipt ;a n dt h eb o o k
value of the machine becomes Rs.2,500. As the machine has
been sold atits book value represents an ‘expired cost’ with no
future benefits i.e. loss on sale of asset which is to be written off
by debit to the Profit and LossAccount. Co st of new machine
(Rs.4,800) will be treated as Capital expenditure .
4.Capital expenditure : As freight and cartage on the new
machine as well as the erection cost is a direct cost of bringing
an asset to a condition where it can be put to use, which is
capitalized as per Accounting Standard 10.
5.Loss on sale of old furniture ( Rs.3,000 -Rs. 1,200) is written off
as expired cost by debit to the Profit and Loss Account ; cost of
new furniture ( Rs.2,400) will be treated as Capital expenditure.
6.Capital expenditur e:painting the new factory is a direct cost till
an asset is first put to use, which is capitalized as per
Accou nting Standard 10.
Illustration 6:
State with reasons whether the following are Capital or
Revenue Expenditure:
1.Freight and cartage on new m achine Rs.150, and erection
charges Rs.200.
2.Fixtures of the book value of Rs.1,500 was sold off at Rs.600
and fixtures of the value of Rs.10,000 was acquired, cartage on
purchase Rs.50.
3.A sum of Rs.100 was spent on painting the factory.
4.Rs.5,150 spent on repairs before using a second -hand car
purchased recently to put it in useable condition.
(FY, March 1995, adapted)
Solution :
1.Capital expenditure :Freight and cartage on new machine and
erection charges are capitalized as all costs till an asset is
installed are added to its cost as per Accounting Standard 10.
2.When fixtures are sold atRs.600.Amount received on sale are
treated as Capital receipt and credited to Fixtures A/C;t h e
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121(1,500 -600) is treated as an expense (expired cost) and written
off by debit to the Profit and Loss Account cost of new fixtures
(Rs.10,000) and cartage ( Rs.50) will be treated as Capital
expenditure .
3.Revenue expenditure :As painting the factory helps to maintain
the asset in good working condition.
4.Capital expenditure :Repairs before using a second -hand car
purchased recently to put it in useable condition are capitalized
as per Accounting Standard 10 which states that all direct costs
of bringing the asset to i ts working condition for its intended use
form part of the cost of the asset.
Illustration 7:
State with reasons whether the following items relating to a
sugar mill company are capital or revenue:
1.A motor truck costing Rs.15,000 and standing in the boo ks at
Rs.7,250 was sold for Rs.12,000.
2.Rs.20,000 received from the issue of further shares, the
expenses of the issue being Rs. 2,500.
3.Rs.75,000 being cost of land purchased for agricultural farm and
`450 paid for land revenue.
4.Rs.1,50,000 paid for excise duty on sugar manufactures.
5.Rs.50,000 invested in a government loan, interest received
Rs.4,500
6.Rs.60,000 spent on construction of railway siding.
(FY, March 1996; adapted).
Solution :
1.Capital receipt :A s Rs.12,000 is received from sale of a capital
asset. The profit on sale of asset ( Rs.12,000 -Rs. 7,250) will be
credited to the profit and loss account as an extraordinary item
of income on sale of motor truck.
2.Capital receipt :(Rs.20,000) : As amount has been received
from issue of shares in the cour se of financing activity of the
company. Rs.2,500 spent as expenses on issue of shares will
be treated as deferred revenue expenditure. Itis not treated as
revenue expenditure because it is not a normal operating cost. It
is a nonrecurring expenditure. It is not treated as capital
expenditure because it does not create any real asset. Hence it
is treated as deferred revenue real asset. Hence ,it is treated as
deferred revenue expenditure and written off over certain
number of years.munotes.in

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1223.Rs.75,000 will be trea ted as capital expenditure as agricultural
land is a capital asset; Rs.450 paid for land revenue is revenue
expenditure in the course of normal operations of business.
4.Revenue expenditure : Excise duty on sugar manufactured is
the cost incurred during the course of normal business
operations incurred in order to earn income. It is recurring
expenses payable on manufacture of excisable goods.
5.Capital expenditure : Purchase of government loan is an
investment which will be returned on due date. Interest recei ved
Rs.4,500, being income revenue income to be credit to Profit &
Loss A/C .
6.Capital expenditure : As cost of construction of railway siding is
for acquisition of a capital asset.
Illustration 8:
State which of the following items are capital, revenue a nd
deferred revenues. Explain with reasons.
1.Expenditure incurred on overhauling machinery.
2.Taxes paid.
3.Wages paid to the workers for election of a new machinery.
4.Cost of goodwill.
5.Heavy expenditure incurred on advertisements.
6.Cost of construction of ab u i l d i n g .
7.Machinery costing Rs.10,000 sold for Rs.12,000
8.Purchased machinery for Rs.15,000.
(FY, October 1996; adapted)
Solution :
1.Revenue expenditure :A se x p e n d i t u r ei n c u r r e do no v e r h a u l i n g
machinery helps to maintain the machinery in working conditi on.
2.Revenue expenditure : If taxes are on goods purchased e.g.
sales tax (Income tax is treated as drawings), goods
manufactured, then excise duty has to pay.
3.Capital expenditure :Wages paid to workers for erection of a
new machinery are capitalized as al l costs till an asset is
installed are added to its cost as per Accounting Standard 10.
4.Capital expenditure :As cost of goodwill is an acquisition of
capital (intangible) asset.
5.Deferred revenue expenditure :I ft h eh e a v ye x p e n d i t u r e
incurred on advertisem ents is going to benefit for a number of
years.munotes.in

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1236.Capital expenditure : As cost of construction of a building helps
to create a capital asset.
7.Capital receipt :A st h ea m o u n to f Rs.10,000 is received on sale
of fixed asset. Profit on sale ( Rs.2,000) is credi ted to the Profit &
Loss A/c as an extra -ordinary item of income.
8.Capital expenditure : As it is an acquisition of a fixed asset.
Illustration 9:
State whether the following expenditure is a capital, revenue
or deferred re venue expenditure. Give reasons :
1.Legal expenses incurred in connection with issue of Equity
Shares of the company.
2.Cost of replacement of a defective part of the machinery.
3.Expenditure incurred in preparing a project report.
4.Expenditure for training employees for better running of
machinery.
5.Purchase of machinery for sale.
6.Daily wages paid to office peon.
(FY, April, 1996, adapted)
Solution:
1.Deferred revenue expenditure : Legal expenses incurred in
connection with issue of equity shares are not treated as
revenue expenditure becaus e the funds received from issue of
shares will benefit the concern for many years. It is not treated
as capital expenditure because it does not create any real
asset. Hence ,it is treated as Deferred Revenue Expenditure
and written off over certain number of years.
2.Revenue expenditure : As replacement of a defective part will
help to maintain the machinery in working condition.
3.Capital expenditure : If the project is implemented; as
according to Accounting Standard 10 ,all expenditure till a
project commence s is capitalized. However, if the project is
given up or not implemented and the amount is small ,it will be
written off as revenue expenditure (as expired costs which will
bring no benefit in future); if the project is not implemented and
the amount is he avy, it will be treated as Deferred Revenue
Expenditure.
4.Revenue expenditure :A se x p e n d i t u r ef o rt r a i n i n ge m p l o y e e s
for better running of machinery is cost of administration related
to normal business activities incurred in order to earn income
during the year.munotes.in

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1245.Revenue expenditure : As expenditure incurred for purchase of
machinery for sale is a direct product cost related to normal
business activities incurred in order to earn income during the
year.
6.Revenue expenditure : As daily wages paid to office peo ni s
cost of administration related to normal business activities
incurred in order to earn income during the year.
Illustration 10:
State whether the following expenditure is a capital, revenue
ordeferred re venue expenditure. Give reasons :
1.Payment for purchase of goods.
2.Payment for purchase of stationery.
3.Payment for purchase of a car.
4.Payment for heavy inaugural expenses.
5.Partial refund of capital to a partner.
6.Payment of a loan taken earlier.
7.Payment of salaries.
8.Wages for erection or machiner y.
(FY, October, 1996 adapted)
Solution :
1.Revenue expenditure : As expenditure incurred for purchase of
goods is a direct product cost related to normal business
activities incurred in order to earn income during the year.
2.Revenue expenditure : As purchas e of stationary is cost of
administration related to normal business activities incurred in
order to earn income during the year.
3.Capital expenditure : As purchase of a car helps to create a
capital asset.
4.Deferred revenue expenditure :H e a v yi n a u g u r a le x p enses are
not treated as revenue expenditure because these will benefit
the concern for many years. These are not treated as capital
expenditure because these expenses do not create any real
asset. Hence these are treated as deferred revenue expenditure
and written off over certain number of years.
5.Capital expenditure :A sp a r t i a lr e f u n do fc a p i t a lt oap a r t n e r
reduces the liabilities of the concern.
6.Capital expenditure :A sp a y m e n to fal o a nt a k e ne a r l i e r
reduces the liabilities of the concern.munotes.in

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1257.Revenue ex penditure : As salaries is cost of administration
related to normal business activities incurred in order to earn
income during the year.
8.Capital expenditure : As wages for erection of machinery is a
direct cost incurred for acquiring an asset which is to b e
capitalized as per Accounting Standard 10.
Illustration 1 1.:
State, with reasons, whether you would consider the
following as capital exp enditure or revenue expenditure :
1.Stock of Rs.25,000 was destroyed by fire of which Rs.15,000
was received from the Insurance Company.
2.The concern spent Rs.1,00,000 on heavy advertisement
campaign to introduce a new product in the market.
3.Cost of dismantling a plant from a particular locality and
reinstalling the same in another locality.
4.Cost of transporting newly purchased furniture.
5.Amount spent by factory in overhauling its plant which has
enhanced the life of the plant by five years.
6.Travelling expenses for a trip abroad for purchase of capital
goods.
7.Amount spent on replacement of defective part of an old pl ant.
8.Cost of Goodwill purchased.
(FY, May 1998, adapted)
Solution :
1.Revenue loss / expenditure :O fn e ta m o u n to f Rs.10,000 as
loss of stock by fire is related to loss of current assets (stocks)
and not capital assets. Insurance claim received is revenue
receipts.
2.Deferred revenue expenditure :E x p e n s e so nh e a v y
advertiseme nt campaign to introduce a new product in the
market are not treated as revenue expenditure because these
will benefit the concern for many years. These are not treated
as capital expen diture because these expenses do not create
any real asset. Hence these are treated as deferred revenue
expenditure and written off over certain number of years.
3.Deferred revenue expenditure : Cost of dismantling a plant
from a particular locality and rein stalling the same in another
locality is not treated as revenue expenditure because it will
benefit the concern for many years. It is no treated as capitalmunotes.in

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126expenditure because it does not create any real asset. Hence ,it
is treated as deferred revenue expe nditure and written of fover
certain number of years.
4.Capital expenditure : As cost of transporting newly purchased
furniture is a direct cost incurred for acquiring an asset which is
to be capitalized as per Accounting Standard 10.
5.Capital expenditure :A m ount spent by factory in overhauling its
plant which has enhanced the life of the plant by five years is an
expenditure which helps to improve the standard of
performance (working life) of an existing asset and is to be
capitalized as per Accounting Standa rd 10.
6.Capital expenditure : As traveling expenses for a trip abroad for
purchase of capital goods is a direct cost incurred for acquiring
an asset which is to be capitalized as per Accounting Standard
10.
7.Revenue expenditure :A sa m o u n ts p e n to nr e p l a c e m e n t of
defective part of an old plant will help to maintain the plant in
working condition.
8.Capital expenditure : As cost of Goodwill purchased is a direct
cost incurred for acquiring an asset which is to be capitalized
as per Accounting Standard 10.
Illust ration 12:
State, with reasons, whether you would consider the
following as capital exp enditure or revenue expenditure :
1.Professional fees paid in connection with acquisition of
leasehold premises.
2.Cost of registration and documentation of a newly formed
company.
3.Compensation paid to a retrenched employee for loss of
employment.
4.Expenditure incurred on purchase of cloth for uniform of
employe es.
5.Payment of import duty on purchase of raw materials.
(FY, November 1998, adapted)
Solution:
1.Capital expendi ture: As professional fees paid in connection
with acquisition of leasehold premises is a direct cost incurred in
connection with the acquisition of an asset to be added to the
cost of that asset [Accounting Standard 10].munotes.in

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1272.Deferred revenue expenditure : Cost of registration and
documentation of a newly formed company is not treated as
revenue expenditure because it will benefit the concern for
many years. It is not treated as capital expenditure because it
does not create any real asset. Hence it is treated a sd e f e r r e d
revenue expenditure and written off over certain numbers of
years. This type of expenses may be group known as
prelim inary expenses.
3.Revenue expenditure : As compensation paid to a retrenched
employee for loss of employment is an administrative
expenditure incurred in the course of normal business activities.
However, if the amount is heavy, it may be treated as Deferred
Revenue Expenditure, as it is a non -recurring expenditure, not
in the normal course of business which benefits the business for
many years by way of reduction in salary .
4.Revenue expenditure : As purchase of cloth for uniform of
employees is an administrative expenditure incurred in the
course of normal business activities.
5.Revenue expenditure : As payment of import duty on purchase
of raw materials is a direct product cost incurred in the course of
normal business activities in order to earn income. It should be
added to cost of material purchase d.
Illustration 1 3:
Saraswati Sisters removed their factory to their New Mumbai
prem ises. They carried out the following transactions: -
1.Cost of dismantling, transporting and re -installing the plant
Rs.50,500.
2.An old plant having depreciated value of Rs.60,000 was sold for
Rs.55,000.
3.A new machine was purchased for Rs.2,00,000 and install ed at
the cost of Rs.35,000.
Apportion these into capital and revenue.
(IDE March 2000, adapted)
Solution :
1.Deferred revenue expenditure : Cost of dismantling,
transporting and re -installing plant etc. is not treated as revenue
expenditure because it is not a normal operating cost. It is not
treated as capital expenditure because it does not create any
real asset. Hence it is treated as deferred revenue expenditure
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1282.Capital receipt :As the machine has been sol d,its book value
represents an ‘expired cost’ with no future benefits i.e. loss on
sale of asset which is to be written off .Rs.55,000 is treated as
capital receipt.
3.Capital expenditure :Cost of new machine ( Rs.2,00,000) will
be treated as capital expend iture. Installation cost ( Rs.35,000) is
a direct cost of bringing an asset to a condition where it can be
put to use which is capitalized as per Accounting Standard 10.
Therefore ,cost of machinery shall be Rs.2,35,000.
7.16 EXERCISES
1.Write short noteson
a) Capital Expenditure
b) Deferred Revenue Expenditure
c) Capital Profit
d) Revenue Expenditure
e) Revenue Profit.
2.Distinguish between
a) Capital expenditure & revenue expenditure .
b) Revenue expenditure & deferred revenue expenses .
c) Revenue r eceipts & income .
d) Revenue profits & capital profit .
e) Re venue receipt & capital receipt.
3. Practical problems
Exercise 1 : S. Jaggi sells and services typewriters. State which of
the following are capital expenditure and which are revenue
expend iture, giving reasons for your answer.
a.Purchase of a typewriter for office use.
b.Purchase of typewriters for re -sale.
c.Traveling expenses to service typewriters.
d.Purchase of spare parts to service typewriters.
e.Wages of mechanic
f.Wages of office staff.
g.Telephone charges.
h.Purchase of tools for servicing work.
[Ans. Capital -(a), (h); Revenue -other]
Exercise 2 :Indicate -briefly giving your reasons in each case -
which of the following represent capital receipts, capital
expenditure, revenue income, revenue expenditure.munotes.in

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129a.Interest on bank overdraft .
b.Purchase of typewriter for re -sale by the Office Supplies Co.
c.Purchase of typewriter for office use by the Sonali Social
Club.
d.Sale of a delivery van by Office Supplies Co.
e.Receipt of commission by a f irm of brokers.
[Ans. CR -(d); CE -(c); RI -(e); RE -(a), (b)]
Exercise 3 :State which of the following are Capital Expenditure
and which are Revenue Expenditure, giving reasons in each case.
i)Payment by cheque for carriage on purchases.
ii)Purchase of packing material for distribution of goods from
the Calcutta Paper Mill Ltd.
iii)Purchase of duplicator for use in own office from Gulab &
Co.
iv)The firm acquired a private car from B. Raha, one of the
partners of the firm.
[Ans. RE -(i) & (ii); CE -(iii) & (iv)]
Exercise 4:During the year 201 7A. Ashar had the following
transaction s:-
1.Purchased a new motor van Rs.17,500 from B.G. Traders Ltd.
on credit.
2.Paid cheque Rs.740 to Office Furnishing Ltd. being Rs.650 for a
new office desk and Rs.90 for repair of an existing desk.
3.Paid Rs.1,420 by cheque for repairs and improvements to
premises. Rs.1,000 of this amount is to be capitalized.
4.Purchased additional premises for Rs.30,000 which was paid by
cheque.
State the total amount of capital expenditure inv olved in the above
transactions.
[Ans. Capital expenditure -Rs. 49,150]
Exercise 5:State with reasons whether the following are Capital or
Revenue expenditure :
1.Expenses incurred in connection with obtaining a licence for
starting the factory were Rs. 8,000.
2.Rs.1,500 paid for removal of stock to a new site.
3.Rings and Pistons of an engine were changed at a cost of Rs.
4,000 to get fuel efficiency.munotes.in

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1304.Rs. 2,500 spent as lawyer’s fee to defend a suit claiming that
the firm’s factory site belonged to the pla intiff. The suit was not
successful.
5.Rs. 8,000 were spent on advertising the introduction of a new
product in the market, the benefit of which will be effective
during four years.
6.A factory shed was constructed at a cost of Rs.1,20,000. A sum
ofRs.7,000 had been incurred in the construction of temporary
huts for storing building material.
[Ans. : CE -(i), (iii), (vi), RE -(ii), (iv); DRE -(v)]
4.Objectives type Questions:
Multiple Choice Questions:
1)Amount received from insurance company on accoun to f
machinery damaged completely by fire.
a)Capital Receipts b)Revenue Receipt
c)Revenue Expenditure d)Capital Expenditure
2)Subsidy of Rs.20,000 received from Government by a
manufacturing concern. 
a)Capital Receipt b)Capital Expenditure
c)Deferred Revenue income d)Revenue Receipts
3)Grant Rs.5,00,000 received from Government for construction
of Building.
a)Revenue income b)Capital Income
c)Capital Receipts d)Non of the above
4)Amount received from I.F.C.I. as a medium te rm loan for
working capital.
a)Deferred Revenue income b)Capital Receipt
c)Revenue Receipts d)Capital Profit
5)Painting of office premises Rs.---1,00,000 once in five year.
a)Revenue Expenditure b)Revenue loss
c)Deferred Revenue Expenditur ed)Capital Expenditure
Ans. : 1 -a, 2-d, 3-c, 4-b, 5-c
Multiple Choice Question s:
Pick up the correct an swer from the following choices :
1)Amount received from S.B.I. as a term loan.
a)Revenue Receipt b)Capital Receipt
b)Capital L oss d)Non of abovemunotes.in

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1312)Dividend on shares received
a)Deferred Revenue Income b)Revenue expenses
c)Revenue Income d)Capital Gain
3)Insurance claim received for loss of stock by fire.
a)Revenue Loss b)Capital Loss
c)Revenue Receipt d)Capita l Receipt
4)Subsidy of Rs.10,000 received from Government for purchase
of computer.
a)Capital Receipt b)Revenue Receipt
c)Capital Loss d)Liability payable
5)Audit fees paid to Chartered Accountant.
a)Revenue Expenditure b)Capital Expend iture
c)Capital Loss d)Revenue Receipts
6)Legal fees paid to l awyer to defe ndcivil suit.
a)Capital Expenditure b)Revenue expenditure
c)Deferred Revenue expenditure d)Non of the above
7)Travelling expenses of the director on trips abroad f or purchase
of machinery.
a)Revenue expenditure b)Capital Expenditure
c)Revenue Loss d)All of the above
Ans. : 1 -b, 2-c, 3-c, 4-a, 5-a, 6-b, 7-b
Multiple Choice Questions:
Pick up the correct answer from the following choices :
1)A bad debts recovered during the year.
a)Capital receipt b)Revenue Receipt
b)Revenue loss d)Capital expenditure
2)Sale of old plant & machinery at loss.
a)Capital loss b)Capital gain
c)Capital Receipt d)Revenue receipt
3)Heavy advert isement expenditure to launch a new product.
a)Revenue Expenditure b)Capital expenditure
c)Deferred Revenue Expenditure d)Revenue loss
4)Annual white -washing expenses.
a)Capital Expenditure b)Revenue Expenditure
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1325)Goods withdrawn by proprietor for own use.
a)Capital Gain b)Capital loss
c)Capital Receipt d)Non of the above
6)Stationery purchased for office use.
a)Revenue expenditure b)Capital expenditure
c)Revenue l oss d)Capital loss
7)Amount spend on the overhauling of old machinery purchased.
a)Capital expenditure b)Revenue expenditure
c)Deferred revenue expenditure d)Capital loss
8)Placed a norder for purchase of plant.
a)Capital expenditure b)Revenue expenditure
c)Revenue loss d)Noneof the above
Ans. : 1 -b, 2-c, 3-c, 4-b, 5-d, 6-a, 7-a, 8-d
Match the following columns :
Column A Column B
1)Capital work -in-progress a)Deferred revenue expenditure
2)Raw materia l purchase db)Capital Receipt
3)Heavy advertisement c)Investment
4)Sale of old furniture d)Revenue expenditure
5)Purchase of shares e)Drawing
f)Capital expenditure
g)Deferred revenue income
Ans. : 1 -g, 2-d, 3-a, 4-b, 5-c
Match the following columns :
Column A Column B
a)Capital receipt i)Profit for current year
b)Revenue expenditure decrease ii)Sundry debtors
c)Current assets iii)Current liability
d)Bills payable iv)Revenue expenditure
e)An Ex penditure from which no
future benefit is expectedv)Non-recurring nature
f)Capital introduced by the
proprietorvi)Capital receipt
vii) Fixed Assets
viii) Fictitious assets
Ans. : a -v, b-i, c-ii, d-iii, e-iv, f-vimunotes.in

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133State with rea sons whether the following statements are True
or False.
i)Legal fees paid to acquire a property iscapital expenditure.
ii)Expenses incurred on the repairs & white washing for the first
time on purchase of an old building are revenue expenditure.
iii)Amount spent for replacement of worn out part of machine is
revenue expenditure
iv)Expenditure means payment made by business to obtain some
benefit.
v)Capital expenditure is recurring in nature.
vi)Intangible asset is an asset which ha sa physical identify.
vii)Revenue expenditure reduces profit & funds for the year.
Ans. : True : i, ii, iv, vii
False : iii, v, vi
State with reasons whether the following statements are True
or False.
a)Carriage paid for purchases of machinery is capital exp enditure.
b)Repairs to furniture Rs.500 is capital expenditure.
c)A petrol car engine was replaced by a diesel engine is revenue
expenditure.
d)Purchase of 10% Govt. loan is capital expenditure.
e)Custom duty paid on import of raw materials is reve nue
expenditure.
f)A sum of Rs.45,000 was spent on painting of office building
once in five years is revenue expenditure.
Ans. : True : a, d, e,
False : b, c, f.

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134Unit-8
FINAL ACCOUNTS OF MANUFACTURING
CONCERN [PROPRIETARY FIRM]
UNIT STRUCTURE
8.0 Objectives
8.1 Introduction
8.2 Manufacturing Account
8.3 Trading Account of A Manufacturer
8.4 Profit & Loss Account
8.5 Balance Sheet
8.6 Specimen Forms
8.7 Adjustments
8.8 Exercise
8.0 OBJECTIVES
After studying the unit ,students will be able to:
Understand the meaning, purpose, form and items of
Manufacturing A/ C.
Understand the form and items of Trading A/ Cand Profit &
Loss A/ C.
Know the mean ing and form of Balance sheet.
Draw the specimen forms of final accounts.
Understand the meaning, types and closing entries for
adjustments.
8.1 INTRODUCTIO N
All business transactions are recorded in books of accounts .
The prima ry function of accounting is to a ccumulate accounting
data in a manual that the amount of profit or loss suffered during
the period can be determined along with status of the business in
financial terms. Final Accounts are prospered for this purpose. Final
Accounts are also known as Financial Statements. Preparation of
Final Accounts is last phase of the accounting process.
The accounting process starts from recording all business
transactions i nset of books. At the end of accounting year ,amunotes.in

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135statement is proposed listing all ba lances namely De bit&C r e d i t .
This statement iscalled Trial Balance. The total of debit and credit
balances must tally with each other.
This chapter deals with preparation of Final Accounts of
manufacturing concern carried on by sole proprietor .Sole
proprietor concern means business is camped and headed by one
person only.
Final Accounts of Manufacture rs include Manufacturing A/C,
Trading A/C, Profit & Loss A/ Cand Balance Sheet. Normally Final
Accounts are prepared for a period of 12 months, calle das
Accounting Year, Calendar Year (ending on 31stDecember) o r
Financial Year / Govt Year (ending on 31stMarch) or it many any
other year ended (Diwali).
The purpose of preparing Manufacturing A/ Cis to ascertain
cost of goods produced during the per iod.Manufacturing A/ Cis
part of Final Account, it addition to Trading A/Cand Profit & Loss
A/C.Costs of finished goods produced are the ntransferred to
Trading Account. Trading andProfit & Loss A /Cis prepared to find
out gross profit and net profit/l oss ofthe year. These accounts
measure the result of business operations. It is essential to match
revenues of an accounting period with costs assignable in earning
the said revenues. This process is known as“The Matching
Concept” which leads to the prep aration of Final Accounts .Balance
Sheet is prepared to show the financial position of the business at
the end of accounting year.
Once all the adjustment entries are passed, the Trial
Balance contains a ready list of the closing balances of all ledger
accounts. The Trial Balance can now be directly used for preparing
the Final Accounts i.e. the Profit & Loss Account and the Balance
Sheet. In case of a Manufacturer, the Profit & Loss Account is
divided into: (a) Manufacturing Account ,(b) Trading Account and
(c) Profit & Loss Account. In case of a trader, the Profit & Loss
Account is divided into: (a) Trading Account, and (b) Profit & Loss
Account. Each account in the Trial Balance must be shown in either
the Profit & Loss Account or the Balance Sheet.
8.2MANUFACTURING ACCOUNT
8.2.1Meaning :
A manufacturer sells fin ished goods manufactured by
himself in his factory; while a trader sells good spurchased by him
from the manufacturer. The manufacturer p urchases raw materials
and converts them into finish ed goods by means of machinery andmunotes.in

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136labour in the factory. So ,it is necessary for a manufacturer to
spend on wages to workers, on the manufacturing process, on the
factory etc. The manufacturer ,therefore ,prepares a “Manufacturing
Account” to find out his cost of finished goods manufactured.
Manufacturing A/ Cmeans an account showing the summary of the
cost of the manufacturing activity during theaccounting year.
8.2.2 Purposes
The manufacturing account serves the following purposes.
i)It shows to tal cost of finished goods manufactured.
ii)It also shows cost of rawm a t e r i a l consumed.
iii)It also provide details of appropriate i.e. direct and indirect
manufacturing cost.
iv)Comparison of cost offinished goods as per Manufacturing
Account and as per cost records kept by Costing Department .
v)Finished goods manufactured may be transferred to Trading
at market price. In such care production profit can be
ascertained.
8.2.3 FORM
Manufacturing Account is a ledger account. Its title is wri tten
as Manufacturing Account for the year ended ….. It is divided into
two equal sides Debit and Credit, (see Worksheet 6.5 for specimen
Manufacturing Account .)
8.2.4 ITEMS
A Manufacturing Account contains the following items:
1.Opening Stock of WIP:
The opening stock of Work -in-process (WIP) is shown as the
first item on the debit side of the Manufacturing Account. Work -
in-process means raw materials not yet fully converted into
finished goods, also k nown as partly finished goods. The value
of Work -in-Process ismade up of the cost of raw material and
the manufacturing expenses incurred for processing.
2.Raw Materials:
Next, the consumption of raw materials (also called Rs.direct
materials’) is shown as follows :
Opening stock of raw materials.
Add :Purchase of raw materials
Add :Direct Purchase Expenses
(Carriage inwards, freight inwards, octroi, customs duties)
Less :Purchase returns of raw materials
Less :Closing stock of raw materials
= Consumption of raw materia lsmunotes.in

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137Direct purchase expenses means all expenses incurred in
connection with purchase of raw materials e.g. transportation,
loading and unloading, coolie charges ,insurance etc. Goods may
be purchased locally or imported from other countries. Local
purchases involve expenses of Carriage inward, Freight inward,
Coolie charges and cartage etc. Imported goods involves i mports
expenses of dock dues, customs duties, insurance etc. These
expenses increase the cost of purchased raw materials.
a)Carriage Inward: Carriage expenses means expenses for
transporting goods. These are also known as freight, cartage,
coolie and cartage etc. The expenses for transporting the goods
purchased from the supplier to manufacturer’s premises, known
as Carriage inward .Freig ht inward etc. are debited to the
Manufactur ing Account. The expenses on transporting the
goods sold from manufacturer’s premises to the customer,
known as Carriage outward, Freight outward, are debited to the
Profit & Loss A/ C. The expenses on transportin g new machinery
etc. purchased are debited to the Machinery A/ C.i . e .t h a t
expense sare capitalized.
b)Octroi Duty: Octroi duties mean the taxes paid to a Municipality
on goods brought within the municipal area from outside. Octroi
on purchase of goods i s debited to the Manufacturing Account.
Octroi on machinery purchased is debited to the Machinery A/ C.
c)Dock Dues, Custom Duties: Dock dues mean the expenses of
unloading the goods in a port. Custom duties means the taxes
paid to the Government; on good si m p o r t e df r o mo t h e r
countries, also known as import duties. Freight, insurance, dock
dues and customs duties on imports of Raw Materials are
debited to the Manufacturing Account. However, if goods are
sold to other countries (exported), expenses on such exports
(freight, dock dues for loading the goods on ship, export duties
etc.) should be debited to the Profit & Loss Account, since they
are selling expenses .Dock dues and custom duties on
machinery imported are debited to the Machinery A/ C.
(3)Wages: These include the wages paid to workers directly
engaged in production, also known as direct or productive
wages or direct labour costs. (A combined item of Wages and
Salaries appearing in the trial balance is shown in the
Manufacturing Account, while a co mbined item of Salaries and
Wages is shown in the Profit & Loss Account).
(4)Manufacturing Expenses: These include the expenses directly
connected to manufacture such as royalty, hire charges of
special machinery, design expenses etc. While royalty for u sing
know -how connected with manufacturing process is taken tomunotes.in

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138Manufacturing Account, royalty for use of trade mark is a selling
expense shown in the Profit and Loss Account .
(5)Factory Expenses : These include all expenses incurred at the
factory such as (a) stores, oil, grease (b) salary to supervisors
(c) power and fuel (d) repairs and maintenance of factory
building and machinery (e) depreciation of factory assets such
as factory building and machinery (f) rent, rates and taxes,
insurance, lighting o f factory building and so on.
(6)Closing Stock of WIP: The value of closing stock of work -in-
process is shown on the credit side of the Manufacturing
Account.
[Note: Alternatively, instead of showing opening WIP on debit and
closing WIP on credit, the difference between the opening and
closing stocks of WIP is calculated first. If opening stock is more
than closing stock, the difference (opening stock of WIP –closing
stock of WIP) is shown on the debit side of the Manufacturing A/ C;
if closing stock is more than opening stock (closing stock of WIP –
opening stock of WIP), the difference is shown on the credit side of
the Manufacturing A/ C].”
(7)Sale of Scrap: Sale of scrap is shown on the credit side of the
Manufacturing Account.
(8)Cost of Product ion: The cost of production of goods is found
out by balancing the Manufacturing Account. The Manufacturing
Account is balanced like a ledger account. We take the totals of
both the debit and credit sides of the Manufacturing A/ C.I na
Manufacturing A/ C,the debit side will always be bigger than the
credit side. This indicates the Net Cost of Production of the
concern. Thus, Gross cost of production Less WIP (Closing)
and Sales of scrap = Net cost of production. We write the
amount of cost of production on the credit side of the
Manufacturing A/ Cand carry it down to the debit side of the
Trading Account. The cost of production (also known as cost of
manufacture or cost of goods produced is transferred to the
Trading Account in order to find out the Gross Pr ofit or Gross
Loss on sale of finished goods.
8.2.5CLOSING ENTRIES :
The following worksheet shows entries to be passed to
transfer the closing balances of the Goods Accounts and other
Manufacturing Expenses Accounts, to the Manufacturing Account:munotes.in

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139WORKSHEET 1:CLOSING ENTRIES
(MANUFACTURING A/C)
No. Entries Amount
(1) Transfer Debit Balances : Dr. Cr.
Manufacturing Account Dr. X
To Opening Stock of WIP A/c X
To Raw Material Purchases A/c X
To Direct Purchase E xpenses A/c X
To Wages A/c X
To Manufacturing Expenses A/c X
To Factory Expenses A/c X
(2) Closing Stock of WIP :
Closing Stock of WIP A/c Dr. X
To Manufacturing Account X
(3) Sales of Scrap :
Sales of Scrap A/c Dr. X
To Manufacturing Account X
(4) Transfer Cost of Production to Trading
A/c.
Trading Account Dr. X
To Manufacturing Account X
8.2.6TRANSFER AT PRICE HIGHER -THAN -COST :
1)Transfer at Sales Price or Cost + Fixed %:Wehave already
seen how manufacturing account is prepared when the
manufactured items are transferred at cost to the Trading
account. However, the items produced by the manufacturing
section may be transferred to the Trading A/ Cat a price higher
than the cost i.e. (i) at cost plus a mark -up (e.g. cost + 25%); or
(ii) at selling price.
2)Entries for Transfer: If the goods are transferred at a higher -
than-cost price, the transfer to the Trading A/ Cw i l lb e credited
to the Manufacturing Account at the transfer value (i.e. loaded
price or selling price) and not at cost of manufacturing. The
excess of transfer price over the cost of manufacturing will
indicate the manufacturing profit. If, cost of manufacturing is
more than the transfer price it shows asmanufacturing loss.munotes.in

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1403)Closing Stock of Finished Good at Transfer Value: If some
of the manufactured goods remain unsold and form part of the
closing stock of finished goods at the year -end, such closing
stock will be valued at the transfer price in Trading A/ C.
If the transfers to the Trading Account were made at cost price,
the closing stocks would also be valued at cost and no further
adjustment is needed.
If all the goods transferred at higher -than-cost have bee n sold, it
means that the anticipated profits have been actually earned
and no further adjustment need be made.
However, if any of the finished goods transferred to the Trading
Account at loaded price or selling price are in stock, the value of
the stock needs to be adjusted. Thus, if the cost is Rs.100 and
the goods are transferred at Rs.120,t h ep r o f i te l e m e n t( Rs.20)
is included in the closing stock. Otherwise ,it will amount to
taking credit for anticipated or unrealised profit which is against
the ac counting principle of “conservatism.” Unrealised profit
included should be considered asStock Reserve.
4)Stock Reserve: The unrealised profit in closing stock is
eliminated by creating a stock reserve in respect of the stock of
manufactured goods. The amount of stock reserve is calculated
by the following formula:
Stock reserve =
Transfer Value of Stock ProfitIncludedinTransferPriceTransferPrice5)Entry for Stock Reserve: The creat ionofthe reserve is made
by the concern in the General Profit and Loss Account as
follows:
Profit of Lo ss A/c. Dr.
ToStock Reserve A/c.
(Being the reserve created for unrealised profit included in
closing stock)
6)Balance Sheet: The relevant part of the Balance Sheet will
appear as follows:munotes.in

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141Balance Sheet as at….
Assets Rs.
Current Assets :
Closing Stock (Transfer Value) xx x y
Less : Stock Reserve (xx) XX
XX
7) Next Year: In the beginning of the next year, the above entry
is reversed as follows:
Stock Reserve A/c. Dr.
To Profit & Loss A/c.
8.3 TRADING ACCOUNT OF A MANUFACTURER
8.3.1 ITEMS
1)Opening Stock of Finished Goods: The opening stock of
Finished Goods (FG) is shown as the first item on the debit side
of the Trading Account.
2)Cost of Finished Goods manufactured: Next, the Cost of
goods manufactured transferred from the Manufacturing
Account is shown on debit side of the Trading Account.
3)Sales of Finished Goods: The net sales of finished goods
(sales less returns) are shown on the credit side of the Trading
Account.
4)Other Out Going of Finished Goods : Sometimes, the Trial
Balance or it may be given by way of adjustment may contain
Other Goods Accounts such as Goods Lost by Fire A/c, Goods
Withdrawn by Proprietor, Goods Distributed as Free Samples,
etc. These accounts re cord the cost of finished goods lost,
withdrawn or distributed. Since goods go out, these accounts
areshown on credit side.These balances are transferred on the
credit of the Trading Account.
5)Closing Stock of Finished Goods: The closing stock of
Finished Goods is shown as the next last item on the credit side
of the Trading Account.
6)Gross Profit or Gross Loss: The final result is found out by
balancing the Trading Account. The Trading Account is
balanced like a ledger account. We take the totals of both the
debit and credit sides of the Trading A/c. If the credit side is
higher, it indicates that the value of sales is more than the cost
of goods manufactured & sold. This is called the Gross Profitmunotes.in

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142earned by the business. Thus, Income From Goods S old Less
Cost of Goods Sold = Gross Profit. We write the amount of
Gross Profit on the debit side and carry it down on credit side of
the Profit and Loss Account. If the debit side is higher ,it
indicates that the cost of manufacture is more than the value of
sales. This is called Gross Loss. Gross Loss = Cost of Goods
Sold L ess Sales . We write the amount of Gross Loss on the
credit side of the Trading A/c and carry it down to the debit side
of the Profit and Loss Account. The Gross Profit or Gross Loss
istransferred to the Profit and Loss Account in order to find out
the Net Profit or Net Loss after deducting other indirect
expenses. Thus ,Gross Profit Less Expenses = Net Profit .In
case expenses are more than Gross Profit, then it amounts
to Net Loss.
8.3.2Closing Entries :
The following worksheet shows entries to be passed to
transfer the closing balances of the Sales Accounts and other
Accounts, to the Trading Account:
WORKSHEET 2:CLOSING ENTRIES (TRADING A/C)
A/o. Entries Amount
(1) Transfer Deb it Balances : Dr. Cr.
Trading Account Dr. X
To Opening Stock of Finished Goods A/c X
To Returns Inwards A/c X
(2) Transfer Credit Balances :
Sales of Finished Goods A/c. Dr. X
Finished Goods Los t/Taken/Distributed A/c X
(at cost) Dr. X
To Trading A/c X
(3) Closing Stock of Finished Goods
Closing Stock of Finished Goods A/c Dr. X
To Trading Account X
(4) Transfer Gross Profit or Gross Loss to
Profit & Loss A/c:
(i) Gross Profit :
Trading Account Dr. X
To Profit & Loss A/c X
(ii) Gross Loss :
Profit & Loss A/c Dr. X
To Trading Account Xmunotes.in

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1438.4 PROFIT & LOSS ACCOUNT
8.4.1Meaning
Closing balances of all nominal accounts, relating to the
remaining income and expenses are transferred to Profit & Loss
A/c. Debit side of the Profit & Loss A/c shows expenses like
Administrative Expenses, Selli ng E xpenses, Financial Expenses,
Depreciation and other Unusual Expenses and Losses. Credit side
of the Profit & Loss A/c shows Other Business Income sand Gains.
The balance of the Profit & Loss A/c shows the result of business
operations during the year. The net profit or net loss shown by the
Profit & Loss A/c is transferred to the Capital Account of the
proprietor.
8.4.2 FORM
Profit & Loss Account is a ledger account. Its title, is written
as “Profit & Loss Account for year ended…. .“It is divided into two
equal sides: Debit and Credit as per the specimen shown in
Worksheet 7.
8.4.3 ITEMS
The following items normally appear in a Profit & Loss
Account.
(1)Gross Profit or Gross Loss b/d : The Gross profit b/d from the
Trading Account is the first i tem on the credit side of the Profit &
Loss Account. If there is Gross loss, it is the first item shown on
the debit side of the Profit & Loss Account.
(2)Administrative Expenses: Administrative expenses are the
expenses incurred to plan, organize, admi nister and control the
business. Examples are (a) Salaries to office staff, (b) Rent,
rates, insurance, lighting of office, (c) Printing, telephones, telex,
postage, (d) Depreciation and repairs of office equipments,
building, furniture, vehicles, (e) Lega l charges, Audit charges,
Bank charges etc.
(3)Selling and Distribution Expenses: Selling expenses are the
expenses incurred to create and increase demand for goods.
Distribution expenses are the expenses incurred from the time
goods sold leave the trad er’s premises till the goods reach the
customer. Examples are (a)Packing materials (b) Salaries of
Sales and Distribution staff (c) Traveling, Conveyance (d)
Commission or discount on sales (Advertisement or showroom
expenses (f) Warehouse or sales office rent, rates, insurance,
lighting etc. (g) Freight outward, carriage outwards, expenses
on exports (h) Depreciation and repairs or delivery van, vehicles
etc.munotes.in

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144(4)Finance & Interest Expenses: Finance expenses are the
expenses incurred to obtain loans, bank charges and cash
discount to debtors etc. The other item shown under this head is
interest paid on loans.
(5)Losses: Losses include amounts lost by the business by way of
Goods lost by fire, Goods distributed as free samples, B ad
debts, Loss on sale of fixed assets etc. These are debited to the
Profit & Loss Account.
(6)Other Income : Other income includes amounts received by
way of interest on loans given, dividends received on amounts
invested in shares, rent received from premises given on rent,
discount received, commission received, Profit on sale of fixed
assets and so on. All these amounts/income sare credited to the
Profit & Loss Account.
(7)Gains: Gains includes amounts received by the business by
way of recovery of bad debts, subsidies or grants received etc.
These are credited to the Profit & Loss Account.
(8)Appropriations: Appropriations mean amounts transferred out
of net profits for payment of income -tax or creating a reserve
(e.g. reserve for contingencies). These appear on the de bit side
of the Profit & Loss A/c . Income Tax is considered as personal
expenses. There fore,it should be treated as Drawings.
9)Net Profit or Net Loss: The net profit or the net loss is found
out by balancing the Profit & Loss Account. The Profit & Los s
Account is balanced like a ledger account. We take the totals of
both the debit and credit sides of the Profit & Loss Account. If
the credit side is higher, it indicates that the Total Income is
more than the Total Expenses. This is called the Net Profit
earned by the business. Thus ,I n c o m eL e s sE x p e n s e s=N e t
Profit. In the next step, the amounts of income tax or transfer to
Reserves etc. (known as Rs.appropriations’ out of profits) are
debited to the Profit and Loss Account. Appropriations can be
made only after ascertaining the amount of net profits (as the
amount of income -tax depends upon the amount of net profits).
Then, write the amount of Net Profit on the debit side and
transfer it to the credit of the Capital Account.
If the debit side is hig her, it indicates that the Expenses are
more than Income. This is called Net Loss. Thus, Expenses Less
Income = Net Loss . In case of net losses, there can be no
appropriations (e.g. no income -tax is payable if there is a net loss).
We write the amount of N et Loss on the credit side of the Profit &
Loss Account A/c and transfer it to the debit of the Capital Account.
The Net Profit or Net Loss belongs to the owner and hence ismunotes.in

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145transferred to the Capital Account. The net profit is a reward to the
owner for hi s money invested in the business, for his efforts in
running the business and for the risks taken by him.
8.4.4 Closing Entries :
The following work -sheet shows entries to be passed to
transfer the closing balances of the Nominal Accounts to the Profit
& Loss Account:
WORKSHEET 4: CLOSING ENTRIES (P & L A/C)
No. Entries Amount
(1) Transfer Debit Balances : Dr. Cr.
Profit & Loss Account Dr. X
To Various Expense Accounts X
To Various Losses Accounts X
(2) Transfer Credit Balances :
Various Income Accounts Dr. X
Various Gains Accounts Dr. X
To Profit & Loss Account X
(3) Appropriations :
Profit & Loss Account Dr. X
ToIncome -tax (Drawings) X
To Reserve (e.g. Contingency Reserve) A/c X
(4) Transfer Net Profit or Net Loss to Capital A/c
(i) Net Profit:
Profit & Loss Account Dr. X
To Capital A/c X
(ii) Net Loss :
Capital A/c X
To profit & Loss A/c X
CHECK YOUR PROGRESS
1.Define the following terms
a.Appropriations
b.Finance expenses
c.Selling and distribution expenses
d.Administration expensesmunotes.in

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146e.Manufacturing A/c
f.Direct Expenses
g.Stock reserve.
2.Fill in the blanks:
a.If the debit side of the Profit and Loss A/c is higher, it
indicates ---------------- .
b.Gross loss is shown on the ---------------- side of the P &L A/c.
c.--------- side of the Profit & Loss A/c shows Expenses.
d.The Income From Goods Sold Less Cost of Goods Sold = ---
------------------ .
e.Manufacturing Account is prepared to find out cost of --------- .
f.Opening and closing balances of finished goods are shown
on the ----------------------- A/c.
3.Enlist the items to be shown on the debit side of the
Manufacturing A/c.
4.Give the formula for calculating the consumption of raw
materials.
8.5 BALANCE SHEET
8.5.1Meaning
From the Trial Balance, all Nominal (manufacturing
Expenses) Accounts are tr ansferred to the manufacturing and
Trading Account and all the Nominal Acc ounts of Income and
Expenses are transferred to the Profit & Loss Account. At this
stage, only the Real Accounts pertaining toAssets and the
Personal Accounts of debtors, creditors and liabilities remain in the
Trial Balance .All these remaining accounts are shown in a
statement known as the Balance Sheet. Balance Sheet is a
statement containing the list of all Real and Personal Accounts as
on a particular day, normally the year end. The Real Accounts and
Personal Accounts are classified in the Balance She et into Assets
and Liabilities. Debtors are included under Assets and Creditors
and Capital Account are shown under liabilities. Hence, Balance
Sheet also means a statement of assets and liabilities of the
business as on the last day of the accounting year .Balance Sheet,
thus, shows the financial position of the business i.e. what it
owns and what it owes.
Balance Sheet is not an account; it is a statement. As its
name suggests, it is a Sheet of Balances, remaining after the
Manufacturing, Trading and Profit & Loss Account is prepare d.
While preparing a Balance Sheet, no closing entries are passed, as
the balance sare not transferred from the Trial Balance, but only
listed in the Balance Sheet. Various Assets & External Liabilities
may be transferred to Capital Account by passing following entries.munotes.in

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147Date Particulars L. F. Dr.
Rs.Cr.
Rs.
31.3 1] Capital A /c Dr. X
To Fixed Assets A /c X
To Current Asset s X
[Being various asse tst r a n s f erred
to capital A/c]
2] Loans A/c Dr. X
Sundry creditors A/c Dr. X
Bills Payable A/c Dr. X
Other Sunday Liabilities A/c Dr. X
To Capital A/c X
After passing above entries at the end of the year, all
accounts are closed.
In next year above ent ries are revised, to open books of
Accounts.
The balances appearing in the Balance Sheet are carried
forward as the opening balances of these accounts in the ledger of
the next year. A Balance Sheet need not be balanced; its totals
must always tallied. The Total Assets must always be equal to the
Total Liabilities.
8.5.2 Form:
The title is written as Balance Sheet as on…B a l a n c eS h e e t
is not an Account, hence the words DR. and CR. are not required .
Balance Sheet is vertically divided into two side: Left Hand Side
and Right Hand Side. Left hand side of the Balance Sheet shows
Liabilities like Capital, Reserves, Loans, Creditors for goods,
outstanding expenses etc. Right hand side of the Balan ce Sheet
shows Assets e.g. Fixed Assets (Gross Cost Less Depreciation),
Investments, Current Assets like pre -paid expenses, advances,
debtors, stock, cash bank etc. (See Worksheet 8.)
8.5.3 Order :
The Various items of assets and liabilities are listed in the
order of permanence of the items. On the Assets side, the
permanent or the long term items i.e. the Fixed Assets are shown
first, followed by short term assets i.e. the current assets. On the
Liabilities side, the long term liabilities i.e. Capital and Loans aremunotes.in

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148shown first, followed by short term liabilities i.e. current liabilities. In
case ,the items are shown in order of liquidity, the assets and
liabilities are shown in the reverse order, i.e. short term items are
shown first, followed by long term items.
8.5.4 Items :
(1)Fixed Assets: Fixed Assets are items like Goodwill, Land ,
machinery, building and trucks etc, which benefit the business for a
long term. Fixed assets are not normally sold: Fixed Assets may be
tangible or intangible. Tangib le Assets are items like machinery,
building etc. which physically exist (tangible means that which can
be touched). Intangible Assets are invisible items like Goodwill,
Patent, and Trade Marks etc. which do not physically exist, but do
benefit the busines so v e ral o n gp e r i o do ft i m e .G o o d w i l lm e a n st h e
reputation of a concern which attracts more and more customers to
it., enables to earn more super profit on Capital employed. Patent
means a legal right of an inventor or of a new product to exclusively
use or sell such product. Trade Mark is a registered name or
symbol of a product which can be used only by the owner of the
trade mark.
(2) Investments: Investments includes items like Shares,
Debentures and Savings certificates etc. which earn interest or
dividends.
(3)Fictitious Assets: Fictitious Assets include items like Deferred
Revenue Expenses, Preliminary Expenses etc. Deferred Revenue
Expenses is defined as the expenses which are carried forward as
their benefit is also available in subsequent year s. To defer means
to carry forward. For example ,if advertising expenses of
Rs.1,00,000 incurred in 2012 are expected to benefit the business
for 5 years, the entire amount of Rs.1 ,00,000 is not debited to the
Profit & Loss Account in 2012. Onl y1 / 5thamount ( Rs.20,000) is
debited to the Profit & Loss Account every year for 5 years from
2012 to 2016. The amount not yet written off at the year end will be
shown as Deferred Advertising Expenses on the Asset side in the
Balance Sheet.
(4)Current Assets: Current Assets are items like cash, debtors,
stock etc. which remain in the business only for a short time [less
than 12 months]. Current assets are constantly changed into cash.
Thus, goods are sold and cash is received, debtors pay their dues
and cash is received and so on. Current Assets also includes
Pre-paid Expenses and Income Receivable.
(5)Capital: Capital means the amount due to the owner of the
business. Capital is shown on liabilities side of the Balance Sheet
asfollows:munotes.in

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149Capital A/c b/d (opening balance)
Add: Net Profits for the year
Less: Net Loss for the Year
Less: Drawings
= Closing Balance of Capital
(6)Reserves: Reserve means part of profits “reserved” for future
use. It is an amount set aside out of profits to meet any unknown
sudden liability in future. Out of Net Profits, some amount is
transferred first to the Reserve, only if it is asked the only part of
profitto be transferred to reserve and only the balance is
transferred to the Capital Account.
(7)Loan s:Loans include Bank Loans and the amounts borrowed
from others on which interest is paid.
(8)Current Liabilities: Current Liabilities are short term liabilities.
These include creditors for goods, outstanding expenses, various
provisions for expenses, income received in advance ,Bank over
draft.Current liabilities are payable with in 12 months.
CHECK YOUR PROGRESS
1.Fill in the blanks:
a.A Balance Sheet need not be balanced; its totals must
always ------------------- .
b.Balance Sheet is not an Account ,itis a----------------------- .
c.Left hand side of the Balance Sheet shows ---------------- .
d.Right hand side of the Balance Sheet shows -------------- .
e.Goodwill and patents are -------------------- assets.
f.Deferred Revenue Expenses is a --------------------- -asset.
g.Balance Sheet is a statement containing the list of all ---------
and----------- Accounts.
h.Current assets are constantly changed into ----------------- .
i.Current liabilities are payable within ---------- months.
j.The items which earn interest or divi dends are termed as ---.
2.Enlist the items shown on the assets side of the Balance Sheet.
3.Define the following terms:
a.Balance Sheet
b.Current Assets
c.Tangible Assets
d.Intangible Assets
e.Capital
f.Current Liabilitiesmunotes.in

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1508.6 SPECIMEN FORMS:
8.6.1 Specimen Form of Manufacturing Account
Dr. Manufacturing Account for the year ended… Cr.
Particulars Rs. Rs. Particulars Rs.
To Work -in-process
(Opening)xxx By Work -in-process
(Closing)xxxx
To Raw materials
consumed:By Sales of scrap xxxx
Opening Stock xxx By Trading Account xxxx
Add : Purchase xxx (Cost of production
tfd Bal.)
Add : Purchase expenses
-Carriage Inward xxx
-Octroi duty xxx
-Dock dues xxx
-Custom duties xxx
Less : Purchase Returns (xxx)
Less : Closing stock of
materials(xxx) xxxx
To Direct Wages xxxx
To Direct manufacturing
expenses
To Royalty related to
manufacturexxx
To Hire of special
machineryxxx
To Design Expenses xxx xxxx
To Direct factory
expenses
To Stores, oil, grease xxx
To Salary to supervisors xxx
To Power and fuel xxx
To Repairs of factory
assetsxxx
To Deprecation on factory
assetsxxx
To Rent, lighting of
factory buildingxxx xxxx
Total xxxx Total xxxxmunotes.in

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1518.6.2 Trading Account for the yea r ended …..
Dr. Cr.
Particulars Rs. Particulars Rs.
To Opening stock (FG) xxxx By Sales xxxx
To Manufacturing Less:R eturn inwards xxxx xxxx
Account (cost of xxxx By Goods lost or
destroyedxxxx
Production tfd.) By Goods taken by
proprietorxxxx
ToPurchase of FG By Goods given as free
samplexxxx
To Gross profit c/d xxxx By Closing stock (FG) xxxx
By Gross loss c/d xxxx
Total xxxx Total xxxx
8.6.3 WORKSHEET 7: PROFIT & LOSS ACCOUNT
Profit & Loss Account for the year ended……
Dr. Cr.
Particulars Rs. Particular Rs.
ToGross Loss xxxx By Gross Profit b/d xxxx
b/d Other Income or Gains
To Administrative
Expensesxxxx By Commission received xxxx
To Rent, insurance &
repairsxxxx By Discount receive d xxxx
To Office salaries xxxx By Provision for discount xxxx
To Postage, telephones, xxxx From creditors
Telex etc. xxxx By Interest on loans xxxx
To Printing & stationery xxxx Given to outsiders xxxx
To Fees (legal/audit etc.) By Income (dividend )o n xxxx
To Sundry/general xxxx Investments
Expenses xxxx By Profit on sale of fixed
To Selling & Distribution xxxx Assets
Expenses xxxx By Net loss tfd. to capital
To Salesmen’s salaries, xxxx
Commission, etc, xxxx
ToTraveling xxxxmunotes.in

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152To Carriage outwards,
Freight, duties xxxx
To Warehousing charges
To Packing expenses xxxx
To Royalties on sale xxxx
To advertising & sales xxxx
Promotion expenses
To Goods given as free
Samples
To Financial Expenses &
Interestxxxx
xxxxx
To Interest & bank
chargesxxxx
To Bad debts & provision
forBad debtsxxxx
To Discount given
Toprovision for discount
onDebtorsxxxx
Depreciation xxxx
To Depreciation on :
-Building xxxx
-Motor vehicl es/delivery
vans
-Office equipments
To Unusual Expenses or
Losses
To Goods lost or
destroyed
(Cost less insurance
claim)
To Loss on sale of fixed
Assets
To Appropriations
To Reserves
To Net profit tdf. to
Capital … .. xx
Total xxxx Total xxxxmunotes.in

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1538.6.4 WORKSHEET 8: BALANCE SHEET :
There may be either Net Profit or Net Loss.
Balance Sheet as at ……….
Liabilities Rs. Assets Rs.
Capital A count : Fixed Assets
Balance b/d (opening) x Goodwill xxxx
Land xxxx
Add : Fresh capital x Plants & machinery xx
Brought in
Add : Net profit for the x Less : Depreciation x
Years xxxx
Less : Drawing xx Premises/Building x
xxxx
Less : Loss during the -Less Depreciation x
Year xx xxxx
Reserves Vehicles
General Reserve xx
Loans -Less : Depreciation xx
Loans from bank xx xxxx
Bank overdraft xx xxxx Furniture & fittings xx
Current Liabilities
Sundry creditors xx -Less Depreciation xx xxx
Less : Provision for xx Investments xxxx
Discount Investment in xxxx
Bills payable xx Shares/bonds xxxx
Outstanding expense xx Current Assets xxxx
Income received in Closing Stock xxxx
Advance xxxxx Debtors xx xxxx
-Less; Prov, for bad x xxxx
Debts x
-Recoverable x
-Less : Prov, for
Discounts xx
-Relisable xxmunotes.in

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154Loans and ad vance xx
Given xx
Bills receivable xx
Prepaid expenses xx
Cash at bank xx
Cash in hand
Fictitious assets
Deferred expenses
Not written off xx
Capital account debit
Balance xx xxx
Total xxxx Total xxxx
8.7 ADJUSTMENTS:
8.7.1 Meaning:
The trial Balance prepared indicates summery of all actual
transactions recorded in the Book of Accounts. The trial balance
ignores items not yet record edin the books of accounts. e.g.
closing sto ck, outstanding expenses, prepaid expenses,
Depreciation, bad about etc. unless & until these items are not give
true and fair view of business operations and financial position .
These items must be recorded in books of accounts .T h eb o o k
balances need to be adjusted from all items which pertain sfor the
period but not recorded in books. Adjustments mean recording
such items relating the current year but not appearing in the Trial
Balance.
8.7.2 Accounting:
Adjustment entries are passed in the journal p roper at the
end of the year. Entries are passed by following rules of debit &
credit, then they are posted into the ledger. It should be noted that
each adjustment ha stwo effect sin the final Accounts.
Adjustments may be given below theTrial Balance, or may
be given in the Trial Balance, called implied adjustment,munotes.in

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155Adjustment Journal Entries Manufacturing
Trading
Profit & Loss A/c.Balance Sheet
1) Closing Stock
(Goods
Purchased but
remain unsold). .
a.Raw Material .i. Stock ofRaw
Material A/cDr
To Raw Material
Consumed.Debit from R aw
material
Purchases, or debit
side of
Manufacturing A/c.Show as “Stock of
Raw Material on
Asset Side ”
b.Work in
Progressii. Stock of work
in progress A/c Dr
ToTrading A/cCredit side of mfg
A/c Show on cred it
side of Trading A/c.Show as “ Stock of
W.I.P on Asset
Side.
Show as“Stock of
Finished Goods ”
onAsset Side.
c. Finished
Goods.iii. Stock of
Finished Goods
A/c Dr. To
Trading A/c.- All st ock may be
as under Stock of
Raw Material
Stock W.I.P. S tock
ofFinished Goods
2) Prepaid
ExpensesPrepaid
Expenses A/c. Dr
To Expenses.
A/c.Deduct from the
conserved Expense
on debit side.Show as “Prepaid
Expenses” on
asset side.
3) Outstanding
expense related
to current year
but not record /
paid.Expense A /c Dr
To outstanding
expenses A /cAdd to concerned
exp. on debit side.Show on
“outstanding exp.”
onliabilities side.
4)Income
ReceivableIncome
Receivable A/c Dr
To Income A/c.Add to Concerned
income on credit
side.Show “income
Receivable” on
asset side.
5) Income
Received in
advance income
Received but not
accru ed. i.e.
relates to
subsequent year.Income A/c Dr.
ToIncome
Received in
allowance A/c.Deduct from
concerned income
on credit side.Show as |income
received in
advance ”a so n
liabilit ies side
6) Depreciation Depreciation A/c
Dr.
ToFixed Asset
A/cDepreciation on
factory Assets debit
to mfg. a/c
Depreciation on
other asset debit to
profit & A/c.Deduct
Depreciation from
Concerned Asset
on asset side. OR
Add to provision
for depreci ation
A/cmunotes.in

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1567) Goods
destroyed Lost &
Stolen.
a) Uninsured
goods. Good lostLoss by Fire/Theft
A/c. Dr. To
trading A/c. or
Topurchases
A/c.a)” Loss by fire”
debit A/c profit &
loss A/c.
b) Credit Cost of
goods lost to
trading A/c.-
8) Unrecorded
Sales.Sundry debtors
A/c Dr To Sales
A.c.Add to sales on
Credit side of
trading a/c.Add to Sunday
debtors on assets
side.
9) Unrecorded
Sales (return)
Good Returned
by Customer but
Credit not, is not
Prepared.
Recorded.Sales Return A/c
Dr.
ToSund ry
Debtor .Deduct from Sales
Credit side of
Trading A/c.Deductfrom
Sunday Debtor on
Asset Side .
10) Unrecorded
Purchases:
Goods Purchase
but not recorded
in Purchase day
book.Purchase A/c Dr
To Supplier A/c.Add to Purchase on
debit side ofm f g .
A/cOr Trading A/c.Add to Sunday
Credi torson the
Liabilities Side .
11) Unrecorded
Purchase return.
Goods retuned
to suppliers but
debit note not
prepaid
preceded .Supplier A/c Dr.
To Purchase
Return A/cDeduct from
Purchase on debit
side of mfg. A/c Or
Trading A/c. .Deduct from
Sunday Cred itors
on the liabilities
side.
12)G o o d s
distributed as
freesample .Free samples A/c
Dr
ToTrading A/c.Deceit toP&LA / c
asAdvertisement
A/c
Credit to Trading
A/cas goods
distributed as free
samples.-
13] Good
withdrew by
owner for
personal useDrawingsA/c Dr.
To Trading A/c.Credit to Trading
A/c as personal use
good swithdrawn
forown use.Deduct from
capital on
Liabilities Side
14] Interest on
LoanoutstandingInterest A/c Dr.
ToL o o n A/cAddedtointerest
on debit side Profit
& Loss A/C.Add to Loon, as
interest
outstanding on
Liabilities Side.munotes.in

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15715)G o o dS o l d
onapprove not
yetapproved .
Goods sold on
Sales or Return
basis Customer
save right to
returngoodsa)Forconsolation
of Sales
a) at s ales Price
Sales A/c Dr To
Custom er
b) For stock with
Customer at cost.
Stock on approval
A/cDr
To Trading A/c.a) Deduct from
Sales on Trading
A/c Credit Side.
b) Credit to Trading
A/c on stock with
customer i.e. add to
closing stock.a)Deduct from
Sunday Debtor on
asset side.
b) Add to Closing
Stock on asset
side.
16)Bad debts
/Further bad
debit to be
written offBad debts A/c Dr
To Sunday
Debtors.Add Bad depts. on
debit side of Profit
& Loss A/c. [as new
bad debts]Deduct from
Sunday debtors an
Assets Side .
17) Provision for
Bad Debts /
doubtful debts:
Provision m ade
for future out of
present credit
sales.Profit &Loss Ac
Dr.
To R.D.D. A/cProfit & loss A/c
Debit Side
To new BDD x (Adj)
+B a dd e b t sx( T r i a l
Bal)
+N e wB add e b t sxx(adj)
-Old R.D.Dxx(T.Bal)Asset Side Sundry
Debtors x –
Further / New Bod
debts)x) x –New
R.d.d. X = x (x)
final Balance after
all other
adjustment t ilting
toSunday
Debtors.
18)Reserves for
Discount on
Debtors :
Provision m ade
forDiscount on
Debtors:Discount A/c Dr
ToR . F . D . C . A/cWhen old R.D.D is
more th anr e q u i r e d
should be credited
to profit & loss A/c.
Add to discount on
the debit side of the
Profit & Loss A/c.Deduct from
Sunday debtors on
Asset side, after
adjustment as
R.D.D.
19) Reserve for
discount on
Creditors :Reserve for
discount on
Creditors A/c Dr
To Discount A/c.Add it discount on
Credit side of the
Profit & Loss A/c.Deduct from
sundry Creditors
onLiabilities Side .
8.7.3 HIDDEN ADJUST MENT/TEMPLED ADJUSTMENT.
Sometimes information about adjustments isgiven in the trial
balance. These adjustments should be considered while preparing
final accounts.
For example, Trial balance shows the following information.munotes.in

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158Trial Balance as on 31stDecember 2012.
No. Particulars Rs. Rs.
1 Rent (11 months) 22,000
2 Insurance (For the Year 31.3.13) 12,000
3 10% Govt Bonds (30 -06-12) 1,00,000
4 Interest on Govt Bonds - 2,500.
5 12% Investment (Face value Rs.
1,00,000)1.12.000
6 Interest on investment - 9,000.
7 18% Bank Loan (01.10.12) 2,00,000
8 Advertisement (3 years) 30,000.
9 Building Rent (3/4 Factory) 60,000
Solution: Explanation:
1) Rent Paid for 11 months Rs.22,000. It implies that Rent for one
month is outstanding.
=22,000 / 11 = Rs.2,000.
Add to Rent on Debit side of P & L A/c, Show in the Bal ance Sheet
Liabilities
2)Insurance Premium Paid for the year ended 3 1/03/13. Trial
Balance as on 31/12/12.
Therefore ,3 months insurance is paid in advancedPrepaid
Insurance = 12,000 x 3 /12=Rs.3,000/ -.
Less from insurance on P & L A/c. Debit Side and write on Asset
side of Bal ance Sheet.
3and 4:10% G ovt Bonds Purchased on 30 -06-12; Interest on
Bonds for SDC months = 1,00,000 x 10% x612=Rs.5,000/ -.O u to f
Rs.5,000, Rs.2,500 are only received. Balance interest
Rs.2,500/ -still not received. It is outstanding. Income on date of
Balance Sheet. Add to interest on credit side of P & L. A/c. and
show onasset side of Balance sheet as Interest Account bat not
received.
5 and 6: 12% Investment face value of Rs.1,00,000 Purchase for
Rs.1,12,000 . Interest on this investment received Rs.9,000 only.
Interest should be always calculated on face value.
Interest for the year = 1 ,00,000 x 12 %
=Rs.12,000/ -.munotes.in

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159Out of this ,Rs.9,000/ -only received. Balance Rs.3,000 still
receivable. Add tocredit side of P & L A/c to income and show on
assets side ofBalance sheet as Interest Receivable.
7.18% Bank Loa nt a k e no n1stOct. 12.
Therefore ,3 months interest due to be provided
Outstanding Interest = 2,00,000 x 18% x 3/12
=Rs.9,000/ -.
Add to interest on Debit side of P & L A/c andadd to Bank Loan on
Liabilities Side of Balance Sheet.
8.Advertisemen tRs.30,000 paid for 3 years.
Two years advertisement 3,00,000 x23=Rs.20,000 is prepaid.
Prepaid Advertise ment Rs.20,000, deduction from
Adve rtisement on debit side of P & L A/c show on Assets Side of
Balance Sheet ,a sa Prep aidInsurance.
9.Building Rent Rs.60,000.34Offices .T h e r e f o r e ,6 0 , 0 0 0x34=Rs.45,000 should be
debit edto the Manufacturing A/c. balance (i.e.14)Rs.15,000 to be
debite dt oProfit & Loss A/c.
Journal Entries
No Particulars J.H. Rs. Rs.
1 Rent A/c. Dr. 2000
ToOutstanding Rent A/c 2000
2 Prepaid Insurance A/c Dr. 3000
To insurance A/c 3000
3-4Interest Receivabl eA / c Dr. 2500
To interest. A/c 2500
5-6Interest Receiv able A/c Dr. 3000
ToInterest A/c. 3000
7 Interest A/c. Dr. 9000
To 18% Bank Loan. A/c 9000
8 Prepaid Advertisement A/c Dr. 20,000
ToAdvertisement A/c 20,000
9 Manufacturing A /c Dr. 45,000
Profit & Loss A/c Dr. 15,000
To Building Rent A/c. 60,000.munotes.in

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1608.8 EXERCISE S
1.Write Short note on
a.Manufacturing A/c
b.Work in Progress.
c.Transfer of G oods at price higher than cost.
d.Stock Reserve
e.Trading A/c
f.Current Assets
2.Explain goods sold on sales or return basi s.
3.Why Manufacturing A/c is prepared.
4.Explain how to calculate Raw Material consumed.
5.Objective Type Questions :
a.Multiple Choice Qu estion
1. Debit Balance of Manufacturing A/c show:
a) Gross Profit b) Gross Loss,
c) Net Loss d) None of above.
2. Carriage inward shown in Trial Balance de bited to:
a) Manufacturing A/c b) Profit& Loss A/c
c) Capital A/c d) Selling & Distribut ion exp.
3. Raw Material Consumed istransfe rredto:
a) Trading A/c b) Purchase A/c
c) Manufacturing A/c d) Balance Sheet.
4. Sale of scrap iscredited to:
a) Manufacturing A/c. b) Cash/Bank A/c
c) Raw Material Consumer d) Trading A/c.
5. Cred it Balance in Trading A/c shows.
a) Net Loss b) Cost of Goods sold
c) Gross Profit d) Gross Loss.
6. Carriage on machinery purchased debited to:
a) Manufacturing A/c b) Trading A/c
c) Plant & Machinery A/c d) Trading A/c
7. Prepaid I nsurance shown in the Trial Balance is shown in:
a) Profit & Loss A/c
b) Liability side of Balance Sheet
c) Asset Side of Balance Sheet
d) Deducted insurance on Dr. side of Profit & Loss A/c.munotes.in

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1618. Consumption of Raw Materials shown to:
a)CreditSide of Trading A/c
b) Credit side of Profit a Loss A/c
c)Debit Side ofManufacturing A/c
d) Purchases A/c
9. Stock of Raw Material given in Trial Balance isshown on:
a) Debit Side of Manufacturing A/c
b) Credit side of manufacturing A/c
c)Asset gives of the balance sheet
10.Opening work -in-progress app earing in the trial balance is
shown on:
a) Debit Side of manufacturing A/c
b) Trading A/c.
c) Credit side of manufacturing A/c
d) Asses side of Balance sheet
e) Non -of the above.
11.Depreciation of Factory Building is shown under.
a) Trading A/c b) Profit & Loss A/c.
c) Manu facturing A/c d) All of the above .
12.Trade Mark is:
a) Current Assets b) Fix edAsses
c) Intangible Asset d) Movable properties
13.Opening Stock ofR a wM a t e r i a l si s:
a) Add edto purchase of finished Goods.
b) Deducted from Raw Material Consume d.
c) Add edto purchase of Raw Materials.
d) Non eof the above.
14.Reserve for Discount on creditors shows :
a) Credit Balance b) Debit Balance
c)Nil Balance d) Non of above
15.Manufacturing A/c balance always shows.
a) Gross Profit b) Net Profit
c) Cost of production d) Cost of sales.
16.Goodwill is:
a) Current Assets b) Fictitious Assets
c) Fixed Assets d) Terrible Assets
17. Trade Discount shall be shown:
a) Debit Side of Mfg. A/c b) Deducted from purchases
c) Debit side of p & L A/c. d) None of theabove
Ans. 1 -d, 2-a, 3-c, 4-a,5-c,6-c, 7-c,8-c,9-a, 10-a, 11-c,12-c, 13-c,
14-a,15-c, 16-b,17-d.munotes.in

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162b.Fillin The Blanks.
1) Debit balance of Manufacturing A/c indicates _______.
2)P l a n t&m a c h i n e r yi s a--------------- asset.
3) Income received in a dvance isshown on_______ side of
Balance Sheet.
4) Income Tax Paid istransferred to ________ A/c.
5)G o o d sd i stributed asfree sample siscreditedt o_ _ _ _ _A / c .
6)G o o d sw i t h d r a w nb yp r o p r i e t o r iscredited to ______ A./c.
7) Commission paid iscredited to ______ A/c.
8) _______ shows the finical position of business.
9) Manufacturing A/c is prepared only by ____ __.
10) Debit balance of Profit & Loss A/c shows ________.
11)N e tP r o f i t is transferred to ________ A/c.
12) Prepaid Insurance iscredited to ______ A/c.
13) Depreciation on office equipments iscredited to _______ A/c.
14)B a dd e b tw r i t t e n offiscredite d to _____ A/c.
15)_ _ _ _ _ _ _n o t ei sp r e p a r e df o rs a l e sr e t u r n ofgoods.
16) Gross Profit, 25% on cost is equal to _____ % on sales.
17) Bank Overdraft is shown on ______ side of Balance Sheet.
18) Stock of Stationery is shown on ______ side of Balance Sh eet.
19)C a r riage paid on furniture purchased isdebited to _______ A/c.
20) Debit balance of Manufacturing A/c istransferred to ____ A/c.
21)C a r r i a g eo u t ward paid iscredited to _______ A/c.
22)O p e ning stock of work in progress isdebited to _______ A /c.
23) Recovery of bad debts iscredit ed _______ A/c.
24) Octroi paid on plant purchased isdebited to ________ A/c.
Ans.
1) Cost of production, 2)Fixed, 3) Liabilities,
4)Drawing s, 5) Trading A/c, 6)Trading A/c
7) Cash A/c Bank A/c, 8) Balance Sheet 9) Manufacturer
10) Net Loss 11) Capital A/c 12) Insurance A/c,
13) Office Equipment 14)S u n d r y debtors 15)Credit Note
16)20% 17) Liabilities 18)Assets
19) Furniture 20)Trading 21) Cash / Bank A/c,
22)Manufacturing 23)P&L 24)Plantmunotes.in

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163c.Match the following Columns:
1)
COLUMN A COLUMN B
a) Purchase of Raw Material i) Credit Bal ance
b) Bank Overdraft ii) Assets side of Balance Sheet.
c)Outstanding Wages iii) Manufacturing A/c
d) Prepaid Insurance iv) Capital A/c
e) Goodwill v)Liabilities side
vi) Intan gible Assts
Ans. a) -iii,b)-ic ) vd)-ii e) -vi
2)
COLUMN C COLUMN D
i) Income due but not received a) Bills Payable
ii) Current Liabilities b) Manufacturing A/c
iii) Tallied Balance sheet c) Carriage paid on Good sold
iv) Ca rriage Inward d) Capital A/c
v) Drawing s e) Profit Loss A/c
f) As set side of Balance Sheet
j) Arithmetical accountancy
Ans. i) f, ii) –a, iii) –j, iv) b, v) –d
3)
COLUMN E COLUMN F
i) Raw Material consumed a) Profit & Loss A/cCredit Side
ii) Profit on Sale of Assets b) Add edto income.
iii) Accrued Income c) Tangible Assets
iv) Furniture d) Manufacturing A/c
v)Outstanding Expenses inT r i a l
Balancee) Profit & Loss A/c DebitSide
f)Liabilities Side
g)Fixed Asset
Ans. i) –d, ii) –a, iii) –b, iv) –g, v) –fmunotes.in

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164d.State Whether the followin g statements are True or False :-
1) Trial Balance shows financial position of the concern.
2) Goodwill written off is credited to Trading A/c
3)Credit balance of Profit & Loss A/c is net profit
4) Interest on capital is credited to Drawing A/c
5) The Drawing A/c always shows debit balance.
6) Income received in advance is asset.
7)Provision for Depreciation is also kn ownasAccumulate d
Depreciation.
8) Interest on Drawing sis debited to Profit and Loss A/c .
9) Stock is always valued at cost.
10)P r e paid expenses in Trial balance is shown on Assets side of
the Balance Sheet.
11)W i t h d r a w a l of cash by the proprietor is credited to Cash A/c .
12)T r a d i n g A/c shows Net Profit or Net Loss.
13)All income and expenses are shown in the Balance Sheet.
14)Balance Sheet is always prepared for the year ended.
15)C a r r i a g e Outwards iscredited to Trading A/c.
16)C a p i t a l A/c of proprietor is always shown on Asset Side of
Balance Sheet.
17) Manufacturing A/c is prepared to find out Gross Profit.
18)I n t e r e s t oninvestment is calculated on Face Value of the
investment.
Ans. False: 1,2, 4, 6, 7, 9, 12, 13, 14, 15, 16, 17
True: 3, 5, 8, 10, 11 ,1 8
munotes.in

Page 165

165Unit-9
FINAL ACCOUNTS II
UNIT STRUCTURE
9.0 Objectives
9.1 Solved Problems
9.2 Exercise
9.0 OBJECTIVES
After studying the unit students will be able to solve the
practical problems on final accounts.
9.1 SOLVED PROBLEMS
Illustratio n 1: (Mfg. & Tr. A/c)
From the following particulars, prepare a Manufacturing
Account and a Trading Account for the year ended 31 -3-2018.
Particulars Rs. Particulars Rs.
Raw Materials
(1-4-2012)12,000 Carriage Inwards 1,000
Work –in-Progress
(1-4-2012 )8,000 Returns Outward 2,000
Finished Goods
(1-4-20129,000 Royalty on
Production1,000
Purchase of Raw
Materials80,000 Purchase of Finished
goods8,000
Direct Wages 10,000 Carriage Outwards 500
Indirect Wages 8,000 Fuel and Power 2,500
Sales 1,74,0 00Repairs and
Maintenance1,500
Returns Inward 5,000 Raw Materials (31 -3-
2013)6,000
Depreciation on
Factory Assets4,000 Work -in-Progress
(31-3-2013)2,500
Purchase of
Finished Goods37,000 Finished Goods (31 -
3-2013)5,000munotes.in

Page 166

166Adjustments:
(i) Outstand ing Direct Wages amounted to Rs. 3,000; (ii) Prepaid
Fuel and Power amounted to Rs.500.
Manufacturing Accou nt
For the year ended 31 -3-2018
Dr Cr
Particulars Rs. Rs. Particulars Rs.
To Work -in-Progress
(Opening8,000 By Work -in-
Progress
(Closing)2,500
To Raw Materials
consumed :By Trading A/c 1,20,000
Opening Stock 12,000 (Cost of
Production
transferred)
Add : Purchase 80,000
Add : Carriage
Inward1,000
93,000
Less : Returns
outward2,000
91,000
Less : Closing Stock 6,000 85,000
To Direct Wages 10,000
Add : Outstanding 3,000 13,000
To Manufacturing
Expenses :
-Royalty on
Production1,000
To factory Expenses
:
-Indirect Wages 8,000
-Depreciation on
Factory Assets4,000
-Fuel and Power
2,500
Less : Prepaid 500 2,000
- Repairs and
maintenance1,500 15,500
1,22,500 1,22,500munotes.in

Page 167

167Trading Account
For the year ended 31-3-2018
Dr Cr
Particulars Rs. Particulars Rs. Rs.
To Opening stock
(FG)
To Manufacturing
A/c (Cost of
Production tfd.)
To Purchase (FG)
To Gross Profit c/d
(tfd. To P & L A/C )9,000
1,20,000
37,000
8,000By Sales
Less : Returns
Inward
By Closing
Stock (FG)1,74,000
5,000 1,69,000
5,000
1,74,000 1,74,000
Note: The concern is a manufacturer as well as a trader. Hence the
Trading a/c shows purchase of finished goods (f or re -sale) and
closing stock of such goods held for re -sale.
Illustration 2: (Mfg. Tr., P & L A/c + Adjustments)
The following information is given to you from the books of a
manufacturer in respect of the year ending 31stMarch, 201 8.
Particulars Rs. Particulars Rs.
Stock of Raw
Material (1-4-2017)25,000 Electricity &
Telephone6,000
Freight Inward 8,500 Selling Expenses 6,000
Freight Outward 6,000 Miscellaneous
Expenses14,000
Direct Wages 18,000 Stock of Finished
Goods : (31 -3-2018)30,000
Indirect Wages 14,000 Provision for Doubtful
Debts8,500
Sales 4,80,000 Depreciation on Plant
and Machinery4,000
Stationery 1,500 Depreciation of
Office
Traveling Expenses 5,000 Furniture and
Equipments3,000
Salaries (H.O.) 26,000 Repairs to Plant a nd
Machinery4,650munotes.in

Page 168

168Factory Expenses 26,000 Sale of Scrap 3,700
Interest on Loan
paid1,800 Purchase of Raw
Materials2,50,000
Returns -Inward 5,000 Coal Consumed 9,000
Returns -outward 3,500 Work -in-progress
(1-4-2017)7,000
Power and fuel 8,000Bank Interest
received2,600
Adjustments necessary for the following:
(a)Finished goods worth Rs.5,000 were distributed as free
samples.
(b)Al o a nw a so b t a i n e do n1stOctober, 201 7forRs. 50,000
carrying interest 10% p .a.
(c)Bad debts to be written off Rs..750 and provision for doubtful
debts to be maintained Rs.7,000.
(d)Electricity and Telephone to be apportioned as Factory 3/5th
andOffice 2/5th.
(e)A fire occurred destroying finished goods worth Rs.15,000.
Insurance Company admitted a claim of Rs.12,000 not yet
received.
(f)Stock on 31 -3-2018stationery in hand Rs.150, Raw Materials
Rs.22,000. Work -in-Progress Rs.4,000, Finished Goods
Rs.40,000.
You are required to prepare the Manufacturing Account and
Trading Account and Profit and Loss Account for the year ended on
31stMarch 201 8. (ICWA adapted)munotes.in

Page 169

169Solution:
Manufacturing Accoun t
For the year ended 31 -3-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Work -in Progress
(Opening)7,000 By Work -in
Progress
(Closing)4,000
To Raw Materials
Consumed :By Sale of scrap 3,700
Opening Stock 25,000 By Trading A/c 3,44,550
Add : Purchases 2,50,000 (Cost of
production tfd.)
Add : Carriag e
Inwards8,500
2,83,500
Less : Returns
outward ( -)3,500
2,80,000
Less : Closing Stock 22,000 2,58,000
To Wages 18,000
To Factory
Expenses :
Wages indirect 14,000
Factory expenses 26,000
Power and fuel 8,000
Coal consumed 9,000
Electricity and
telephone3,600
(3/5 x 6,000)
Depreciation on
Machinery4,000
Repairs to Plant 4,650 69,250
3,52,250 3,52,250munotes.in

Page 170

170Trading and Profit & Loss Account
Forthe Year ended 31 -3-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening
Stock (FG)30,000 By Sales 4,18,000
To
Manufacturing
A/c3,44,550 Less :
Returns5,000 4,13,000
(Cost of
production
efd.)
To Gross Profit
c/d98,450By Goods
distributed
as
Free
samples5,000
By Goods
destroyed
by fire15,000
By Closing
Stock (FG)40,000
4,73,000 4,73,000
To Salaries 26,000 By Gross
Profit b/d98,450
To Electricity &
Telephon e2,400 By Bank
Interest
received2,600
(2/5x6,000) By Provision
for doubtful750
To Stationery 1,500 Debts not
required
Less : Stock -
in-hand150 1,350 (8,500 -750-
7,000)
To Interest on
loan1,800
Add :
Outstanding700 2,500
[(50,000 x 6/1
2x1 0 % -
1,800]700
To Traveling
expenses5,000
To Selling
expenses6,000
To Fright
outward6,000munotes.in

Page 171

171To
Miscellaneous
expenses14,000
To Loss by fire 15,000
Less : Claim
admitted by
Insurance Co. 12,000 3,000
To
Depreciation
Office
Furniture &
Equipments3,000
To
Advertisement
s5,000
(free samples)
To Net profit
tfd. To Capital
A/c.27,550
1,01,800 1,01,800
Illustration 3:
Vinayaka’s Trial Balance as on 31stMarch 2012 is as follows:
Particulars Dr.Rs. Cr.
Rs.Particulars Dr.Rs. Cr.Rs.
Opening
StockPrinting and
Stationery5,200
-Raw
Materials2,50,000 Bank Charges 2,500
-Work -in-
Progress80,000 Traveling
Expenses10,000
-Finished
Goods2,20,000 Disco unt 3,300
Purchases 2,15,000 Sales Return 11,000
Buildings 1,50,000 Advertisement 5,500
Plant &
Machinery3,60,000 Sales 7,80,000
Furniture 40,000 Capital 8,50,000
Trade Mark 30,000 Sundry
Creditors52,000munotes.in

Page 172

172Wages 83,000 Sundry
Debtors82,500
Factory
Taxes4,000 Discount 2,500
Motive
Power9,000 Miscellaneous
Expenses5,500
Factory
Insurance5,000 Bills Payable 34,000
Salary to
Office Staff11,000 Bill
Receivable16,000
Office Rent 10,500 Corporation
Bank98,000
Carria ge
Inward2,500 Cash on hand 9,000
17,18,500 17,18,500
Adjustments:
(1) Closing Stock: Rs.
Raw Materials 85,000
Work -in-Progress 30,000
Finished Goods 2,05,000
(2) Factory taxes prepaid Rs.2 ,000
(3) Depreciation: Furniture 10%
Plant & Machinery 15%
Trade Mark 20%
Building 5%
Prepare Manufacturing, Trading and Profit & Loss Account for the
financial year 201 7-18and Balance Sheet as on 31 -3-2018.
(IDE, Mar. 2000, adapted)munotes.in

Page 173

173Solution:
VINAY AK
Manufacturing & Trading Account
For the year ended 31 -3-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Work -in-
process
(Opng.)80,000 By Work -
in-process
(CI.)30,000
To Raw
materials
consumed:
Opening
Stock2,50,000By Trading
Account
(Cost of
production
tfd.)5,85,500
Add :
Purchase2,15,000
-Carriage
Inward2,500
4,67,500
Less : Closing
stock85,000 3,82,500
To Direct
Wages83,000
To Direct
factory
expenses
-Factory
Taxes4,000
Less :
Prepaid taxes2,000 2,000
To Motive
Power9,000
-Factory
Insurance5,000
To
Depreciation
Plant &
Machinery
(15%)54,000
6,15,500 6,15,000munotes.in

Page 174

174To Opening
stock (FG)2,20,000 By Sales 7,80,000
To
Manufacturing
AccountLess :
Return
Inwards11,000 7,69,000
(Cost of
production
tfd.).5,85,500 By Closing
stock (FG)2,05,000
To Gross
profit c/d1,68,500
9,74,000 9,74,000
Profi t&L o s sA c c o u n t
For the year ended 31 -3-2018
Dr Cr
Particulars Rs. Rs. Particulars Rs.
To Salaries to
Office Staff11,000 By Gross Profit
B/d1,68,500
To O ffice Rent 10,500 By Discount
Received2,500
To Printing &
stationery5,200
To Bank charges 2,500
To Traveling
Expenses10,000
To Miscellaneous
Expenses5,500
To Advertisement 5,500
To Discount 3,300
To Depreciation on
-Tr. Mark (20%) 6,000
-Building (5%) 7,500
-Furniture (10%) 4,000 17,500
To Net profit tfd.
To capital1,00,000
1,71,000 1,71,000munotes.in

Page 175

175Balance Sheet As At 31 -3-2018
Liabilities Rs. Rs. Assets Rs. Rs.
Capital
Account :Fixed Assets :
Balance
b/d
(opening)8,50,000 Building 1,50,000
Add:-Net
profit for
theyears1,00,000 9,50,000 Less: Depreciation
@5%-7,500 1,42,500
Current
Liabilities :Plant & machinery 3,60,000
Sundry
Creditors52,000 Less : Depreciation
@15%54,000 3,06,000
Bills
Payable34,000 Furniture 40,000
Less : Depreciation
@10%4,000 36,000
Trade Mark 30,000
Less : Depreciation
@20%6,000 24,000
Current Assets :
Closing Stock :
-Raw Materials 85,000
-Work -in-Progress 30,00 0
-Finished Goods 2,05,000 3,20,000
Debtors 82,500
Bills receivable 16,000
Prepaid taxes 2,000
Corporation Bank 98,000
Cash in hand 9,000
10,36,000 10,36,000munotes.in

Page 176

176Illustration 4:
Amar Chemicals has the following L edger Balance as on 31st
March 201 8.
Particulars Dr.Rs. Cr.Rs. Particulars Dr.Rs. Cr.Rs.
Goodwill 50,000 Net Sales 11,00,000
Factory
Shed20,000 Miscellaneous
Income4,000
Machinery 1,30,000 Bad Debts
Reserve5,000
Furniture 8,000 Purcha se of
Materials8,60,000
Investments 10,000 Freight on
Materials50,000
Capital 1,95,000 Factory Power 15,000
Bank Loan 3,00,000 Salaries and
Wages
Creditors 1,50,000 -Factory 1,50,000
Debtors 1,35,000 -Office 65,000
Stock on
1-4-2018Repairs and
Renewals2,500
-Materials 1,30,000 Rent and Taxes 16,500
-Work -in-
Progress7,500 Insurance 3,900
-Finished
Goods82,500 General
Expenses18,100
17,54,000 17,54,000
The following additional information is available:
(1)Closing Stock: Materials Rs.2,10,000 ;W o r k -in-Progress
Rs.12,500and Finishe dG o o d s Rs.2,07,500 .
(2)Depreciation to be provided at 2.5% on Factory Shed, 10%
on Machinery and 15% on Furniture.
(3)Repairs and rent and taxes are to be apportioned betwe en
Factory and Office in the ratio of 3:2.
(4)Reserve for bad and doubtful debts areto be provided at 4% on
debtors.
(5)Insurance Premium covers a period of one month in advance.munotes.in

Page 177

177You are required to prepare Manufacturing, Trading, and Profit and
Loss Account for the year ended 31stMarch 201 8and Balance
Sheet as on that date.
(Mumbai, Nov. 1998, adapted)
Solution:
AMAR CHEMICALS
Manufacturing & Trading Account
Forthe year ended 31 -03-2018
Dr Cr
Particulars Rs. Rs. Particulars Rs.
To Work -in-
process (Opng.)7,500 By Work -in-
process (CI.)12,500
To Raw
materials
consumed :
Opening Stock
Add : Purchase
Add : Freight on
Materials1,30,000
8,60,00 0
50,000By Trading
Account
(Cost of
Production
efd.)10,14,900
10,40,000
Less :Closing
stock2,10,000 8,30,000
ToDirect
factory
expenses
-Factory Power 15,000
-Salary &
wages1,50,000
-Repairs etc.
(3/5)1,500
-Rent & Taxes
(3/5)9,900
-Depreciation
on factory
assets
Factory shed 500
-Machinery 13,000 1,89,900
10,27,400 10,27,400munotes.in

Page 178

178To Opening
stock (FG)82,500 By Sales 11,00,000
To
Manufacturing10,14,900 By Closing
stock (FG)2,07,500
Account (co st of
Production tfd.)
To Gross profit
c/d2,10,100
13,07,500 13,07,500
Profit & Loss Account
Forthe year ended 31 -03-2018
Dr Cr
Particula rs Rs. Rs. Particulars Rs.
To Office Salary & Wages 65,000 By Gross profit b/d 2,10,100
To Repairs & Renewals
(2/5)1,000 By Miscellaneous
Income4,000
To Rent & Taxes (2/5) 6,600
To Insurance 3,900
Less : Prepaid
(3,900 x 1/12)325 3,575
To General Expenses 18,100
To Depreciation on
Furniture1,200
To Reserve for Doubtful
Debts5,400
Less : Old RDD 5,000 400
To Net profit tfd. To capital 1,18,225
2,14,100 2,14,100munotes.in

Page 179

179Balance Sheet
As At 31 -03-18
Liabil ities Rs. Rs. Assets Rs. Rs.
Capital
Account :Fixed
Assets :
Balance b/d
(opening)1,95,000 Goodwill 50,000
Add : Net
profit for the
year1,18,225 3,13,225 Machinery 1,30,000
Loans : Less :
Depreciation
@10%13,000 1,17,000
Loans from
bank3,00,000 Factory
Shed20,000
Current
Liabilities :Less :
Depreciation
@2.5%500 19,500
Sundry
creditors1,50,000 Furniture 8,000
Less
Depreciation
@15%1,200 6,800
Investment 10,000
Current
Assets :
Closing
Stock
-Raw
material2,10,000
-Work -in-
process12,500
-Finished
goods2,07,500 4,30,000
Debtors
Less : Prov.
for bad
debts
Prepaid
insurance1,35,000
5,400
1,29,600
325
7,63,225 7,63,225munotes.in

Page 180

180Illustration 5:
Following is the Trial Balance of Mrs. Rashmi as on 31 -3-2018
Particulars Dr.Rs. Cr.Rs. Particulars Dr.Rs. Cr.Rs.
Capital/Drawings 40,000 8,00,000 Printing and
Stationery41,400
Opening Stock Office Rent 64,600
*R a wM a t e r i a l s 50,800 Bills
Receivable3,01,000
*W o r ki n
progress25,800 Bills
Payable1,00,000
* Finished goods 2,18,000 Sundry
Debtors
and
Creditors6,00,000 4,00,000
Purchase of
Raw Materials22,24,000 Plant and
Machinery16,00,000
Wages 79,200 Motor Car 6,00,000
Power and Fuel 48,500 Returns 24,000 30,000
* Factory Rent 25,000 Interest @
14% on
Investments22,000
Carnage
outward34,700 Investments
(1-4-2011)2,00,000
48,74,000 Bad Debts 10,000
Ins. Durance
Premium51,000 Provision
for Bad and
Cr.
Discount 5,000 19,000 Doubtful
debts6,000
Life
Insurance
Premium
paid8,000
62,51,000 62,51,000munotes.in

Page 181

181a)Closing Stock Cost Price Market Price
Raw Materials 90,000 1,00,000
Work in Progress 90,000 50,000
Finished Goods 4,00,000 3,60,000
b)Depreciate Plant & M achinery @ 15% p.a. and Motor Car @
20% p.a.
c)General Insurance prepaid was Rs.9,000.
d)Provide for outstanding factory rent Rs.13,000.
e)Finished goods costing Rs.20,000 and Raw materials costing
Rs.30,000 were destroyed by fire. Insurance Company
admitted claim of Rs.15,000 for finished goods and Rs.20,000
for Raw Materials by the date of Balance Sheet.
f)Write off Rs.20,000 as Bad debts.
g)Create provision for doubtful debts and provision for discount
on debtors @ 5% and 2% respe ctively.
h)On 30 -3-2018goods costing Rs.40,000 were purchased on
credit (included in closing stock) which remained unrecorded.
i)Purchase include Rs.80,000 in respect of Plant and
Machinery purchased on 1 -10-2011.
j)Proprietor had withdrawn goods at sale price of Rs.30,000
which included profit element of 20% on cost.
This amount was recorded through sales register and was wrongly
debited to Mrs. Rama’s (Debtor) Account. Being the Accountant of
Mrs. Rashmi, you are required to prepare Manufactur ing, Trading
and Profit and Loss Account for year ended 31stMarch, 201 8and
Balance Sheet as at the date.
(Oct. 1996) munotes.in

Page 182

182Solution:
Dr. Mrs. RASHMI
Manufacturing Account
Forthe year ended 31 -03-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Work -in-
Progress
(Opening)25,800 By Work -in-
Progress
(Closing)50,000
To Raw Materials
consumed :By Trading
A/c (Cost of
production
transferred)24,72,3 00
Opening Stock 50,800
Add : Purchases 22,24,000
Add : Unrecorded
purchases40,000
Less : Purchases
Returns30,000
Less : Machinery
Purchased 80,000
Less : Destroyed
by fire30,000
Less : Closing
Stock90,000 20,84,800
To Wages 79,200
To Factory
Expenses.
Factory Rent 25,000
Add : Outstanding 13,000
38,000
Power and Fuel 48,500
Depreciation :
Plant & Machinery2,46,000 3,32,500
25,22,300 25,22,300munotes.in

Page 183

183Trading and Profit and Loss Accou nt
For the year ended 31 -3-2018
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening stock
(FG)2,18,000 By Sales 48,74,000
To Manufacturing
A/c24,72,300 Less : Sales
returns24,000
(Cost of Production
tfd.)48,50,000
To Gro ss profit c/d 25,34,700 Less : Goods
for personal
use30,000 48,20,000
By Goods for
personal use
(cost)25,000
By Goods
destroyed by
fire20,000
By Closing
stock (FG)3,60,000
52,25,000 52,25,000
To Carriage
Outwards34,700 By Gros s
Profit b/d25,34,700
To Discount Allowed 5,000 By Discount
Received19,000
To Printing and
Stationery41,400 By Interest on
Investments22,000
To Insurance 51,000 Add : Interest
Receivable6,000 28,000
Less : Prepaid 9,000 42,000
To Office Rent 64,600
To Bad Debts 10,000
Add : Further Bad
Debts20,000
Add : New R.D.D. 27,500
Less : Old R.D.D. 6,000 51,500
To Provision for
discount on debtors10,450
To Depreciation on
car (20% x 6,00,000)1,20,000
To Loss b yF i r e:
-Raw Materials 10,000
-Finished Goods 5,000 15,000
To Net profit tfd. To
capital21,97,050
25,81,700 25,81,700munotes.in

Page 184

184Balance Sheet
Asa t3 1 -03-2018
Liabilities Rs. Rs. Assets Rs. Rs.
Capita /
Account :Fixed Assets :
Balance b/d
(opening)8,00,000 Plant and
Machinery16,00,000
Add : Net
Profit21,97,050 Add : New
Machinery80,000
29,97,050 16,80,000
Less :
Drawing
[WN3]73,000 29,24,050 Less :
Depreciation
[WN1]2,46,000 14,34,000
Current
Liabilities :Motor Car 6,00,000
Bills Payable 1,00,000 Less :
Depreciation @
20%1,20,000 4,80,000
Sundry
Creditors4,00,000 Investments :
Add :
Unrecorded
Purchase40,000 4,40,000 Investment
(1-4-2017)2,00,000
Outstanding
Rent13,000 Current Assets :
Closing Stock :
-Raw Materials 90,000
-Work in
Progress50,000
-Finished
Goods3,60,000 5,00,000
Debtors 6,00,000
Less : Goods for
own use30,000
5,70,000
Less : Further
Bad Debts20,000
5,50,000munotes.in

Page 185

185Less : Prov. for
doubtful debts
(5/100x5,50,000) 27,500
5,22,500
Less : Prov. for
Discount on
Debtors (2/100 x
5,22,500)10,450 5,12,050
Insurance Claim
:
-for Raw
Materials20,000
-for Finished
Goods15,000 35,000
Bills Receivable 3,01,000
Interest
Receivable
[WN2]6,000
Prepaid
Insurance9,000
34,77,050 34,77050
Working Notes:
1.Depreciation of Plant and Machinery Rs.
Depreciation on Rs.16,00,000 for
Full year @ 15% 2,40,000
Depr eciation on Rs.80,000 for 6 months
(80,000 x 15/100 x 6/12) 6,000
2,46,000
2.Interest Receivable on Investments Rs.
Total Interest on Investments
(2,00,000 x 14/100) 28,000
Less: Interest actually received 22,000
Balance Interest receivable 6,000
3.Total Drawings made Rs.
Drawings as per Trial Balance 40,000
Add: Goods withdrawn for personal use 25,000
Add: Life Insurance paid as per
Trial Balance 8,000
Total Drawings 73,000munotes.in

Page 186

186Illustration 6:
The Trial Balance Mr. Lakhamichand is as below, Prepare final
accounts for the year ended 31 -12-2017.
Debit Balances Rs. Credit Balances Rs.
Cash in hand 1,000 Capital Account 41,860
Machinery 30,000 Sales 1,38,780
Drawings 2,500 R.D.D. 560
Factory, Power
and Fuel450 Sundry Creditors 8,800
Office Salaries 6,225
Carriage outwards 500
Manufacturing
wages9,300
Furniture and
Fixture3,400
Opening Stock :
-Finished goods 4,000
-Work -in-progress 7,250
-Raw Materials 2,800
Carriage Inwards 1,000
Rent ( Factory ¾) 4,000
Sundry Debtors 21,600
Advertisement 775
Printing &
Stationery1,200
Factory Insurance 1,280
Purchase of Raw
Material82,950
Balance at Bank 8,530
Discount Allowed 610
Miscellaneous
Expenses630
1,90,000 1,90,000munotes.in

Page 187

187Adjustments:
(1)Closing Stock: Finished Goods Rs.6,500, Raw Materials Rs.750
and Work -in-progress Rs.4,750.
(2)A Motor car purchased on 1 -10-2017forRs.10,000 has been
include d in purchases.
(3)Depreciate Machinery at 15% p.a., Motor Car at 20% p.a.,
Furniture and Fixtures at 15% p.a.
(4)Provision for R.D.D. should be maintained at 10% of the
debtors.
(5)Provision for unrealised Ren t in respect of portion of the office
sub-let at Rs.120 p.m. from 1 -10-2017has to be made.
(April 96, adapted)
Solution:
LAKHAMICHAND
Manufacturing Account
Forthe year ended 31 -12-2017
Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Work -in-
Progress
(Opening)7,250 By Work -in-
Progres s
(Closing)4,750
To Raw Materials
consumed :
Opening Stock 2,800To Trading
A/c
(Cost of
production
transferred)97,030
Add : Purchases 82,950
Add : Carriage
Inwards1,000
86,750
Less : Motor Car
Purchase10,000
Less : Closing
Stock750 76,000
To Manufacturing
Wages9,300munotes.in

Page 188

188To Factory
Expenses :
Rent
[3/4 x 4,000]3,000
Insurance 1,280
Power and Fuel 450
Depreciation on
Plant4,500 9,230
1,01,780 1,01,780
Trading Account
Forthe year ended 31 -12-2017
Dr. Cr.
Particulars Rs. Particulars Rs.
To Opening stock
(FG)4,000 By Sales 1,38,780
By Closing stock
(FG)6,500 To Manufacturing A/c
(Cost of Production
tfd.)97,030
To Gross profit c/d 44,250
1,45,280 1,45,280
Profit and Loss Account
For the year ended 31 -12-2017
Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Office Salaries 6,225 By Gross
Profit b/d44,250
To Carriage
Outwards500 By Rent
Accrued360
To Office Rent (1/4 x
4,000)1,000
To Advertisement 775
To Pr inting and
Stationery1,200
To Discount Allowed 610munotes.in

Page 189

189To Miscellaneous
Expenses630
To Prov. for Bad &
Doubtful Debts
New R.D.D. 2,160
Less : Old R.D.D. 560 1,600
To Depreciation :
-on Motor Car 500
(10,000x20/100x3/ 12)
-on Furniture &
Fixtures510 1,010
(3,400 x 15/100)
To Net profit tfd. To
capital31,060
44,610 44,610
Balance Sheet
Asa t3 1 -12-2017
Liabilities Rs. Rs. Assets Rs. Rs.
Capital
Account :Fixed Assets :
Balance b/d
(opening)41,860 Plant and Machinery 30,000
Add : Net profit 31,060 Less : Depreciation @
15%4,500 25,500
72,920 Motor Car 10,000
Less :
Drawings2,500 70,420 Less : Depreciation @
20% (for 3 months)500 9,500
Current
Liabilities :
Sundry
creditors8,800 Furniture & Fixtures 3,400
Less : Depreciation @
15%510 2,890
Current Assets :
Closing Stock :munotes.in

Page 190

190-Raw Materials 750
-Work in Progress 4,750
-Finished Goods 6,500 12,000
Debtors 21,600
Less : New R. D.D. 2,160 19,440
Rent Ac crued 360
Balance at Bank 8,530
// Cash in Hand 1,000
79,220 79,220
Illustration 7:
The following balances are extracted from the ledger accounts of
Mr. Bharat as on 31stDecember, 201 7.
Particulars Dr.Rs. Cr.Rs. Particulars Dr.Rs. Cr.Rs.
Mr.
Bharat’s1,40,000 Wages 30,000
Capital Salaries 22,000
Plant and
Machinery45,000 Trade
Opening
StockExpenses 9,000
Raw
Materials20,000 Rent 12,000
Finished
goods5,000 Consignment
(Mr. X) A/c.33,000
Purchases
and Sales3,74,000 4,60,000 Cash 5,000
Debtors
and
Creditors1,35,000 90,000
6,90,000 6,90,000
Adjustments:
(1)Opening stock of finished goods include stock of stationery
ofRs.200.
(2)Closing stock of raw materials Rs. 10,000, closing stock of
finished goods Rs.20,000 (including stock of stationery
Rs.100.)munotes.in

Page 191

191(3)Trade expenses include payment of stationery of Rs.2,000.
(4)Closing creditors include creditors for stationery of Rs.500 for
credit purchase s.
(5)Mr. Bharat sent goods costing Rs.33,000 to Mr. X (consignee)
who sold two third of the quantity for Rs.35,000. The consignee
has incurred expenses of Rs.2,000 and is entitled for
commission of 5% on sales.
(6)Sales include a sum ofRs.32,000 re ceived on sale of all goods
received on behalf of Mr. Y (consignor). Mr. Bharat is entitled to
a commission of 10% on these sales for which no entries were
passed. The expenses of Rs.1,000 for sale on behalf of Mr. Y
are debited to trade expenses (the expe nses should be incurred
by Mr. Y)
(7)Provide 10% depreciation on plant and machinery.
Prepare manufacturing account, trading account and profit
and loss account for the year ended 31stDecember, 201 7and
the Balance Sheet on that date.
(Marc h9 5 ,a d a p t e d )2 0 1 2 .
MR. BHARAT
Manufacturing Account
For the year ended 31 -12-2017
Dr. Cr.
Particulars Rs. Rs. Particulars Rs.
To Raw Materials
consumed
Opening Stock 20,000By Trading A/c
(Cost of
production tfd.)4,18,000
Add : Purchases 3,74, 000
3,94,000
Less : Purchases
of Stationery(500)
Less : Closing
Stock(10,000) 3,83,500
To Wages 30,000
To Factory
Expenses :
To Depreciation
on Machinery4,500
4,18,000 4,18,000munotes.in

Page 192

192Trading Account
Forthe year ended 31 -12-2017
Dr. Cr.
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening
stock (FG)5,000 By Sales 4,60,000
Less : Stock
of Stationery200 4,800 Less :
Consignment
Sales [Y]32,000
To
Manufacturing
A/c Cost of
Production4,18,000
To Gross
profit c/ d38,100 [35,000 –
33,000]2,000 4,30,000
By Closing
stock
Finished
Goods20,000
Less :
Closing
stock of
Stationery 100
19,900
Add : Unsold
Goods of
Consignment
[X]11,000 30,900
4,60,900 4,60,900munotes.in

Page 193

193Profit and Loss Account
For the year ended 31 -12-2017
Dr. Cr,
Particulars Rs. Rs. Particulars Rs.
To Office Salaries 22,000 By Gross
Profit b/d38,100
To Trade
Expenses9,000 By
Commission
from
Consignor3,200
Less : Payment for
Stationery(2,00 0) By Net Loss
tfd. To Capital5,050
Less : Expense of
Consignor Y(1,000) 6,000
To Stationery
Consumed
Opening stock 200
Add : Stationery 2,000
Add : Credit
Purchase500
2,700
Less : Closing
Stock(100) 2,600
To Rent 12,000
To Commission to
Consignee1,750
(5% x 35,000)
To Expenses
incurred by X2,000
46,350 46,350munotes.in

Page 194

194Balance Sheet
Ason31-12-2017
Liabilities Rs. Rs. Assets Rs. Rs.
Capital / Account : Fixed Asset s:
Balance b/d
(opening)1,40,000 Plant and
Machinery45,000
Add : Net profit 5,050 1,34,950 Less :
Depreciation
@1 0 %4,500 40,500
Current Liabilities
Sundry creditors 90,000
Less : Cre ditors for
Stationary500 89,500
Creditors for
stationary500 Current
Assets :
Due to Y 32,000 Closing Stock
:
Less: Commission
(10%)3,200 -Raw
Materials10,000
Less : Expenses of
consignor Y
included in trade1,000 27,800 -Finished
Goods 19,900
Add : Unsold
goods (x)
11,00030,900
-Stock of
stationary100 41,000
Debtors 1,35,000
Consignment
A/c Mr. X33,000
Add : sales of
X2,000
35,000
Less :
Expenses2,000
Less :
Expenses2,000
Less:
Commission
(5%)1,750 31,250
Cash in hand 5,000
2,52,750 2,52,750munotes.in

Page 195

1959.2 EXERCISE
Illustration 1
From the following details for the year ended 31stMarch 201 8
prepare Manufacturing, Trading and Profit & Loss Account ofM/s
Razavi Traders :
Particulars Rs. Particulars Rs.
Opening stock: Electri c and water charges 4,000
Raw Material 60,000 Wages 1,40,000
Work in progress 50,000 Salary of works manager 6,000
Finished goods 75,000 Office salaries 5,000
Purchase of raw materials 3,20,000 Advertisement 2,000
Sales 6,25,000 Deprecation
Purchas er e t u r n s 5,000 -onPlant 3,000
Sales returns 4,000 -on Factory Shed 1,000
Carriage inward 1,500 -on Office Furniture 6,00
Carriage outward 1,000 Closing Stock
Duty and clearing charges 2,000 -Raw material 40,500
Factory rent 3,000 -Work in prog ress 60,000
Office rent 2,000 -Finished goods 55,000
Illustration 2
From the following Trial Balance and additional information of Miss.
Shabana, prepare Manufacturing, Trading and Profit and Loss A/c
for the year ended 31stMarch, 2018 and Balance S heet as on that
date.
Trial Balance
As on 31stMarch, 2018
Particulars Dr.Rs. Cr.Rs.
Bank Overdraft 49,000
Advertising 18,400
Audit Fees 10,500
Bad Debts 1,600
Bills of Exchange 20,350 20,000
Goodwill 50,000
Commission received 1,000
Discount received 2,000munotes.in

Page 196

196Drawings 2,650
Land and Building 40,000
General Expenses 12,350
Insurance 3,150
Interest on Bank Overdraft 2,000
Investment in Shares 56,000
Plant and Machinery 1,00,000
Capital 2,70,000
Purchases 2,10,320
R.D.D. 1,000
Return Inwards 1,280
Return Outwards 3,320
Debtors 81,750
Wages 30,250
Creditors 65,000
Opening Stock 40,000
Sales 3,21,280
Salaries 52,000
7,32,600 7,32,600
The following further information is available:
(1)Closing Stock on 31stMarch, 2018 is Rs.87,000.
(2)Outstanding Wages Rs.2,500.
(3)Insurance is prepaid to the extent of Rs.650.
(4)Depreciate Plant and Machinery @10% p.a. and Land and
Building@5% p.a.
(5)Write off Rs.1,750 for Bad debts. Provide 5% for Doubtful Debts
ondebtors.
(Ans.: G/P –Rs.1,27,250,N/P Rs.–14,150,B a l a n c es h e e tt o t a l -
4,18,000 .)munotes.in

Page 197

197Illustration 3:
From the following particulars presented by Mazumdar Bros,
prepare a Manufacturing Account for the year ended 31 -03-2012.
Particulars Rs. Particulars Rs.
Opening Stock : Carriage Inward 1,000
-Raw Materials 3,000 Hire of Special Plant 2,000
-Work -in-Progress 4,000 Factory Rent 4,000
-Finished Goods 8,000 Repairs to Plant 2,000
Closing Stock : Repairs to Factory 1,000
-Raw Materia ls 1,000 Supervisor’s Salary 8,000
-Work -in-Progress 5,000 Factor yWages 1,000
-Finished Goods 4,000 Royalties on
production2,000
Purchase of Raw
Materials40,000 Works Manager’s
Salary6,000
Wages of workers 20,000 Salary of Works Staff 3,000
Light, Gas etc.
(Factory)2,000


munotes.in

Page 198

198Unit-10
DEPARTMENTAL ACCOUNTS I
UNIT STRUCTURE
10.0Objectives
10.1 Introduction
10.2 Branch Accounts and Departmental Accounts
10.3 Departmental Accounting
10.4 Basis of Allocation
10.5 Inter Department Transfers of Goods / Services
10.6 Closin g Stock at Transfer Value
10.7 Stock Reserve
10.8 Depa rtmental Final Accounts
10.9 Proforma of Departmental Accounts
10.10 Exercise
10.0OBJECTIVES
After studying the unit students will be able to:
Distinguish between Branch and Departmental Store .
Know the purpose of Departmental Store .
Understand the accounting procedure of Departmental Store.
Explain the Basis of allocation of common expenditure and
common income among different departments
Understand the accounting procedure for Inter -Departmental
Transfers of Goods.
Calculate the value of closing stock and preparation of Stock
Reserve A /c.
Prepare Departmental Final Accounts .
10.1INTRODUCTION
A large business concern may be divided into different
segments; each segment is known as department .All departments
operate under one roof. The division into various departments maymunotes.in

Page 199

199be on basis of functions, process esor products or may be any
combination of above as it may be suitable to the organisation .
Management is usually interested in find ingout the working results
of each department to ascertain their relative efficiencies.
Departmental Accounts are of great help to the management as
information for taking various types of decisions. Management can
compare result of one department with other de partments.
Company may intra or inters departmental comparison, may
be again that of same departments in the previous periods. This will
help them to for mulae sound policy of expansion/diversion/ merger
even if require d, may be closing down a particular unprofitable
departments.
10.2BRANCH ACCOUNTS AND DEPARTMENTAL
ACCOUNTS
A business may be expanded having number of branches as
well as having number of departments under one roof. A large
business may have various departmental stores at different pl aces.
e.g. Big Bazaar has department alstores at various places, like in
Mumbai, Pune, Navi Mumbai, Surat, and so on .
Distinguish between Branch & Department alStore
No. Branch Departmental Store
1. Located at different places,
may beindifferent countries .Departmental stores are
always located under one
roof.
2. Normally branches are
open edby manufacturer to
avoid middle man’schain .Normally concerns purchase
different types of goods
directly from manufactures,
sales to end user s.
3. Bran ches sale one type of
goods manufactured by
them .Department alStores
purchase goods from different
manufactures & sales under
one roof.
4. Branches may be domestic
[in same country] & /or
foreign branch es.Departments are located at
one place, under on er o o f
only.
5. Since the branches located
at different places, the
problem of allocation of
common expanses does not
arises .Common expenses are
always allocated in some
ratio.munotes.in

Page 200

2006. Accounting treatments
depends upon types of
branches, i.e. dependent
branch or impendent branch .The departments are located
under one roof, all accounting
records are maintained by
head office.
7. Reconciliation may be
require dfor cash & goods in
transit .Question of such
reconciliation doesn’t arise,
as all departments areat
same place.
8. In case of foreign branch,
question of conversion of
foreign currency in Head
Office currency arises .This problem does not arise
in Departm entalAccount ing.
10.3DEPARTMENTAL ACCOUNTING
10.3.1 Purpose:
InDepartmental Accou nting, if only a single Profit & Loss
Accoun t is prepared for the entire business, then profit / loss of
each department cannot be ascertained. In Departmental
Accounting ,each department is treated as separate entity for the
purpose of recording and repor ting. In same premises ,a separate
Account Department records all transactions of all departments.
Books of Accounts are so designed, so it is possible to prepare
separate Trading A/c, Profit & Loss A/c for each department. The
working of one department ca nbecompared with another
department. It facilities infra / inter comparison for same period w ith
that of same department in the previous periods. This helps
management to formulate sound policy for expansion, merger of
departments, closing of loss making department s.P r e p a r a t i o no f
separate accounts serves the following pur poses :
a)Gross Profit or Loss, Net Profit or Loss of each department
can be ascertained .
b)Running cost of each department can be calculated.
c)Corrective timely measures for inefficient d epartment can be
taken.
d)It helps to fix branch manager’s commission onbasis on
profit.
e)Department altransfers can berecorded at transfer price /
selling price.
f)Stock reserve ,unrealized profit on goods transferred can be
calculated .
g)Assist the manageme nt for controlling the business more
efficiently, intelligently .munotes.in