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Finance for Non-finance Managers
1.1.ACCOUNTING
Accounting, as an information system is the process of identifying, measuring and
communicating the economic information of an organization to its users who need the
information for decision making. It identifies transactions and events of a specific entity. A
transaction is an exchange in which each participant receives or sacrifices value (e.g.
purchase of raw material). An event (whether internal or external) is a happening of
consequence to an entity (e.g. use of raw material for production). An entity means an
economic unit that performs economic activities.
1.2. Definition of Accounting
American Institute of Certified Public Accountants (AICPA) which defines accounting as
the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events, which are, in part at least, of a financial character and
interpreting the results thereof.
1.3. Objective of Accounting
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business
transactions that take place. Accounting serves this purpose of record keeping by promptly
recording all the business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e.,
profit earned or loss suffered in business during a particular period. For this purpose, a
business entity prepares either a Trading and Profit and Loss account or an Income and
Expenditure account which shows the profit or loss of the business by matching the items of
revenue and expenditure of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman
must know his financial position i.e., availability of cash, position of assets and liabilities etc.
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This helps the businessman to know his financial strength. Financial statements are
barometers of health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about
how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing,
about its capital transactions, cash dividends and other distributions of resources by the
enterprise to owners and about other factors that may affect an enterprises liquidity and
solvency.
v) To protect business properties: Accounting provides upto date information about the
various assets that the firm possesses and the liabilities the firm owes, so that nobody can
claim a payment which is not due to him.
vi) To facilitate rational decision making: Accounting records and financial statements
provide financial information which help the business in making rational decisions about the
steps to be taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts
are compulsorily required to maintain accounts as per the law governing their operations such
as the Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is
also compulsory under the Sales Tax Act and Income Tax Act.
1.4.Types of Accounting
The object of book-keeping is to keep a complete record of all the transactions that place in
the business. To achieve this object, business transactions have been classified into three
categories:
(i) Transactions relating to persons.
(ii) Transactions relating to properties and assets
(iii) Transactions relating to incomes and expenses.
The accounts falling under the first heading are known as personal Accounts. The accounts
falling under the second heading are known as Real Accounts, The accounts falling under
the third heading are called Nominal Accounts. The accounts can also be classified as
personal and impersonal. The following chart will show the various types of accounts:
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1.4.1. Personal Accounts: Accounts recording transactions with a person or group of persons
are known as personal accounts. These accounts are necessary, in particular, to record credit
transactions. Personal accounts are of the following types:
(a) Natural persons: An account recording transactions with an individual human being is
termed as a natural persons personal account. example Kamal s account, Malas account,
Sharmas accounts. Both males and females are included in it
(b) Artificial or legal persons: An account recording financial transactions with an artificial
person created by law or otherwise is termed as an artificial person, personal account, e.g.
Firms accounts, limited companies accounts, educational institutions accounts, Co-
operative society account.
(c) Groups/Representative personal Accounts: An account indirectly representing a person
or persons is known as representative personal account. When accounts are of a similar
nature and their number is large, it is better tot group them under one head and open a
representative personal accounts. e.g., prepaid insurance, outstanding salaries, rent, wages
etc. When a person starts a business, he is known as proprietor. This proprietor is represented
by capital account for all that he invests in business and by drawings accounts for all that
which he withdraws from business. So, capital accounts and drawings account are also
personal accounts.
The rule for personal accounts is: Debit the receiver
Credit the giver
Accounts
Personal
Impersonal
Natural Artificial Representative Real Nominal
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1.4.2. Real Accounts: Accounts relating to properties or assets are known as Real
Accounts, A separate account is maintained for each asset e.g., Cash Machinery, Building,
etc., Real accounts can be further classified into tangible and intangible.
(a) Tangible Real Accounts: These accounts represent assets and properties which can be
seen, touched, felt, measured, purchased and sold. e.g. Machinery account Cash account,
Furniture account, stock account etc.
(b) Intangible Real Accounts: These accounts represent assets and properties which cannot
be seen, touched or felt but they can be measured in terms of money. e.g., Goodwill accounts,
patents account, Trademarks account, Copyrights account, etc.
The rule for Real accounts is: Debit what comes in
Credit what goes out
1.4.3. Nominal Accounts: Accounts relating to income, revenue, gain expenses and losses
are termed as nominal accounts. These accounts are also known as fictitious accounts as they
do not represent any tangible asset. A separate account is maintained for each head or
expense or loss and gain or income. Wages account, Rent account Commission account,
Interest received account are some examples of nominal account.
The rule for Nominal accounts is: Debit all expenses and losses
Credit all incomes and gains
1.5. Accounting: The Language of Business
Accounting is often called the language of business. The basic function of any language is to
serve as means of communication. As the purpose of accounting is to communicate the
performance & health of a business enterprise, it is therefore called as the language of
business. The task of learning accounting is very similar task as of learning a new language.
But accounting is no exactly a foreign language or a new language. In the word of Anthony &
Reece the problem of learning accounting is more similar that of an American learning to
speak English as it is in Great Britain. For Example the food grain that Americans call
Wheat is called as Corn by British; and the British use the word Maize for what
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Americans call Corn. Unless they are careful, Americans will fail to recognize that some
words are used in Great Britain in a different sense from that used in America.
Similarly some words, goods, assets, liability, debtors, creditors etc. are used in a different
sense in accounting than in their dictionary meaning. For example the term goods appears
in accounting records. Its meaning according to Oxford Advanced Learners Dictionary of
Current English is movable property. However such meaning is incorrect in accounting.
The correct meaning of Goods in accounting is the things that purchased for the purpose of
sale. In accounting goods are usually termed as inventory. In the previous example, the
garments purchased by Mr. Peekey are goods or inventories for his business as they are
meant for sale. If Mr. Peekey purchased a table & a chair for the shop, the table & chair are
not the goods, rather than these are the assets of the business. So we can conclude that the
goods are meant for resale where as the assets help in the operation of the business.
In every language, the grammarians differ regarding sentence structure and choice of words.
Similarly in accounting it also differ as to how a given event should be reported. Languages
evolve & change in response to the changing needs of the society, and so does accounting.
The principle and practices described are used currently in accountings but some of them may
be modified on the basis of the needs of the business organisation. In this way it is the
language of business.
1.6. Accounting Information System
Accounting is a service activity. Its function is to provide useful information about the
business to interested parties, such as management as well as to the external players like
government, public etc.
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The Items involved in this figure are explained bellow:
Owner: Owner contributes money and take the risk of the business. They are
interested to know the profitability and soundness of the business. Owner gets the
information from the financial statement prepared by the organisation.
Management: The management of the business is greatly interested in knowing the
position of the firm. The accounts are the basis, the management can study the merits
and demerits of the business activity. Thus, the management is interested in financial
accounting to find whether the business carried on is profitable or not. The financial
accounting is the eyes and ears of management and facilitates in drawing future
course of action, further expansion etc.
Creditors: Persons who supply goods on credit are termed as creditors. They supply
goods on credit only when they have faith in sound financial position of the
enterprise. This they can know by accounting information.
Investors: It is only after knowing the profitability and sound financial position that
investors take decision about making investment and continue investment in an
enterprise. Accounting information is of great use to them in this connection specially
in making judgment for their returns on investments.
Consumers: Consumers are interested in the prices of the article manufactured by an
enterprise. This price decision is based on cost of production plus estimated margin of
Users
Internal Owner/ Management
External
Investors / Creditors
Government/ Consumers
Foreigners / Competitors
Research scholars/ Public
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profit; hence consumers are interested in accounting information with which an idea
of price structure can be made.
Research Scholars: Researches are being made in various universities, industries and
in government departments. Accounting information of various enterprises is of great
use to research scholars to make compete report on the project.
Government: Accounting information is used by the government for the following
purposes: Fixation of tax rates and introduction of new taxes, To assess whether the
unit is going to become sick, To compute national income, To prepare national
accounts, To know industrial growth of the country
Foreigners: These days the whole world has become one market due to rapid growth
of means of transport and communications. Some foreigners are eager to know the
profitability and financial position of certain enterprises engaged in certain industries.
On the basis of this information they may make an opinion about import, export and
also about collaboration
Entrepreneurs: - An entrepreneur is eager to know the profitability and financial
position of those enterprises which are already in an industry. It is only after knowing
their position he will make up his mind whether to start similar enterprise or not.
Taxation Authorities: These days Income-Tax Officer, Sales-Tax Officer and other
taxation authorities also need accounting information.
Competitors: The persons, who want to compete with a particular enterprise, want to
know its position of its accounting record.
Trade Associates: These associates compare the performance of their members units
and then, if need be demand concessions or exemptions from Government in taxation
and other spheres.
Stock Exchanges: They require accounting information in connection with listing of
securities and other spheres connected with various dealings in stock exchanges
Employee: On the basis of profit and loss account of the current year, they can know
current years profit and can compare it with the profit of the previous year. In case
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profit is much more than the normal, they may make a demand for bonus or increase
in remuneration. Employees are also eager to know about the continuance of the
organization in future for unlimited period because it will result in the continuance of
their services, therefore, on the basis of balance sheet they may find out the financial
position of the unit.
1.7. Generally Accepted Accounting Principles (GAAP)
The word Principle has been differently viewed by different schools of thought. The
American Institute of Certified Public Accountants (AICPA) has viewed the word principle
as a general law of rule adopted or professed as a guide to action; a settled ground or basis of
conduct of practice Accounting principles refer, to certain rules, procedures and conventions
which represent a consensus view by those indulging in good accounting practices and
procedures. Canadian Institute of Chartered Accountants defined accounting principle as the
body of doctrines commonly associated with the theory and procedure of accounting, serving
as an explanation of current practices as a guide for the selection of conventions or
procedures where alternatives exist. Rules governing the formation of accounting axioms and
the principles derived from them have arisen from common experiences, historical precedent,
statements by individuals and professional bodies and regulations of Governmental
agencies. To be more reliable, accounting statements are prepared in conformity with these
principles. If not, chaotic conditions would result. But in reality as all the businesses are not
alike, each one has its own method of accounting. However, to be more acceptable, the
accounting principles should satisfy the following three basic qualities, viz., relevance,
objectivity and feasibility. The accounting principle is considered to be relevant and useful to
the extent that it increases the utility of the records to its readers. It is said to be objective
to the extent that it is supported by the facts and free from personal bias. It is considered to be
feasible to the extent that it is practicable with the least complication or cost. Though
accounting principles are denoted by various terms such as concepts, conventions, doctrines,
tenets, assumptions, axioms, postulates, etc., it can be classified into two groups, viz.,
accounting concepts and accounting conventions.
1.8. ACCOUNTING CONCEPTS AND CONVENTIONS
1.8.1. Accounting concepts: The term concept is used to denote accounting postulates, i.e.,
basic assumptions or conditions upon the edifice of which the accounting super-structure is
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Based. The following are the common accounting concepts adopted by many business
concerns.
1. Business Entity Concept
2. Money Measurement Concept
3. Going Concern Concept
4. Dual Aspect Concept
5. Periodicity Concept
6. Historical Cost Concept
7. Matching Concept
8. Realization Concept
9. Accrual Concept
i) Business Entity Concept: A business unit is an organization of persons established to
accomplish an economic goal. Business entity concept implies that the business unit is
separate and distinct from the persons who provide the required capital to it. This concept can
be expressed through an accounting equation, viz., Assets = Liabilities + Capital. The
equation clearly shows that the business itself owns the assets and in turn owes to various
claimants. It is worth mentioning here that the business entity concept as applied in
accounting for sole trading units is different from the legal concept. The expenses, income,
assets and liabilities not related to the sole proprietorship business are excluded from
accounting. However, a sole proprietor is personally liable and required to utilize non-
business assets or private assets also to settle the business creditors as per law. Thus, in the
case of sole proprietorship, business and non-business assets and liabilities are treated alike in
the eyes of law. In the case of a partnership, firm, for paying the business liabilities the
business assets are used first and it any surplus remains thereafter, it can be used for paying
off the private liabilities of each partner. Similarly, the private assets are first used to pay off
the private liabilities of partners and if any surplus remains, it is treated as part of the firms
property and is used for paying the firms liabilities. In the case of a company, its existence
does not depend on the life span of any shareholder.
ii) Money Measurement Concept: In accounting all events and transactions are recode in
terms of money. Money is considered as a common denominator, by means of which various
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facts, events and transactions about a business can be expressed in terms of numbers. In other
words, facts, events and transactions which cannot be expressed in monetary terms are not
recorded in accounting. Hence, the accounting does not give a complete picture of all the
transactions of a business unit. This concept does not also take care of the effects of inflation
because it assumes a stable value for measuring.
iii) Going Concern Concept: Under this concept, the transactions are recorded assuming
that the business will exist for a longer period of time, i.e., a business unit is considered to be
a going concern and not a liquidated one. Keeping this in view, the suppliers and other
companies enter into business transactions with the business unit. This assumption supports
the concept of valuing the assets at historical cost or replacement cost. This concept also
supports the treatment of prepaid expenses as assets, although they may be practically
unsalable.
iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction
has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The
basic principle of double entry system is that every debit has a corresponding and equal
amount of credit. This is the underlying assumption of this concept. The accounting equation
viz., Assets = Capital + Liabilities or Capital = Assets Liabilities, will further clarify this
concept, i.e., at any point of time the total assets of the business unit are equal to its total
liabilities. Liabilities here relate both to the outsiders and the owners. Liabilities to the owners
are considered as capital.
V) Periodicity Concept: Under this concept, the life of the business is segmented into
different periods and accordingly the result of each period is ascertained. Though the business
is assumed to be continuing in future (as per going concern concept), the measurement of
income and studying the financial position of the business for a shorter and definite period
will help in taking corrective steps at the appropriate time. Each segmented period is called
accounting period and the same is normally a year. The businessman has to analyse and
evaluate the results ascertained periodically. At the end of an accounting period, an Income
Statement is prepared to ascertain the profit or loss made during that accounting period and
Balance Sheet is prepared which depicts the financial position of the business as on the last
day of that period. During the course of preparation of these statements capital revenue items
are to be necessarily distinguished.
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vi) Historical Cost Concept: According to this concept, the transactions are recorded in the
books of account with the respective amounts involved. For example, if an asset is purchases,
it is entered in the accounting record at the price paid to acquire the same and that cost is
considered to be the base for all future accounting. It means that the asset is recorded at cost
at the time of purchase but it may be methodically reduced in its value by way of charging
depreciation. However, in the light of inflationary conditions, the application of this concept
is considered highly irrelevant for judging the financial position of the business.
vii) Matching Concept: The essence of the matching concept lies in the view that all costs
which are associated to a particular period should be compared with the revenues associated
to the same period to obtain the net income of the business. Under this concept, the
accounting period concept is relevant and it is this concept (matching concept) which
necessitated the provisions of different adjustments for recording outstanding expenses,
prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course
of preparing the financial statements at the end of the accounting period.
viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made.
Sale is considered to be complete when the ownership and property are transferred from the
seller to the buyer and the consideration is paid in full. However, there are two exceptions to
this concept, viz., 1. Hire purchase system where the ownership is transferred to the buyer
when the last instalment is paid and 2. Contract accounts, in which the contractor is liable to
pay only when the whole contract is completed, the profit is calculated on the basis of work
certified each year.
ix) Accrual Concept: According to this concept the revenue is recognized on its realization
and not on its actual receipt. Similarly the costs are recognized when they are incurred and
not when payment is made. This assumption makes it necessary to give certain adjustments in
the preparation of income statement regarding revenues and costs. But under cash accounting
system, the revenues and costs are recognized only when they are actually received or paid.
Hence, the combination of both cash and accrual system is preferable to get rid of the
limitations of each system.
x) Objective Evidence Concept: This concept ensures that all accounting must be based on
objective evidence, i.e., every transaction recorded in the books of account must have a
verifiable document in support of its, existence. Only then, the transactions can be verified by
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the auditors and declared as true or otherwise. The verifiable evidence for the transactions
should be free from the personal bias, i.e., it should be objective in nature and not subjective.
However, in reality the subjectivity cannot be avoided in the aspects like provision for bad
and doubtful debts, provision for depreciation, valuation of inventory, etc., and the
accountants are required to disclose the regulations followed.
1.9.2. Accounting Conventions
The following conventions are to be followed to have a clear and meaningful information and
data in accounting:
i) Consistency: The convention of consistency refers to the state of accounting rules,
concepts, principles, practices and conventions being observed and applied constantly, i.e.,
from one year to another there should not be any change. If consistency is there, the results
and performance of one period can he compared easily and meaningfully with the other. It
also prevents personal bias as the persons involved have to follow the consistent rules,
principles, concepts and conventions. This convention, however, does not completely ignore
changes. It admits changes wherever indispensable and adds to the improved and modern
techniques of accounting.
ii) Disclosure: The convention of disclosure stresses the importance of providing accurate,
full and reliable information and data in the financial statements which is of material interest
to the users and readers of such statements. This convention is given due legal emphasis by
the Companies Act, 1956 by prescribing formats for the preparation of financial statements.
However, the term disclosure does not mean all information that one desires to get should be
included in accounting statements. It is enough if sufficient information, which is of material
interest to the users, is included.
iii) Conservatism: In the prevailing present day uncertainties, the convention of
conservatism has its own importance. This convention follows the policy of caution or
playing safe. It takes into account all possible losses but not the possible profits or gains. A
view opposed to this convention is that there is the possibility of creation of secret reserves
when conservatism is excessively applied, which is directly opposed to the convention of full
disclosure. Thus, the convention of conservatism should be applied very cautiously.
1.10. Accounting Equation
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The entire financial accounting system is based on the accounting equation. As we know that
for operating a business unit we need the economic resources and this is being supplied by
someone. These economic resources which are possessed by the business is known as assets.
Is obvious that some amount is contributed by the proprietor of the business and some
amount is contributed by the outsiders.. The amount contributed by the proprietor is known as
capital and the amount which owed by the business to the outsiders is known as liability. If
the total contribution is made by the proprietor, then the total assets equal to equity or capital.
However if the amount is contributed includes outsiders amount in that case the total assets
will be equal to capital and liability.
The two sides of equation will always be equal. On the one side total resources
possessed and on the other side it will represent from where all these resources are obtained.
The equity of two sides will always be true, no matter how many transactions are entered in
to. The actual assets, capital and liability may change but the equality of the assets with that
of total capital and liabilities will always hold true.
The equation based on the principle that accounting deals with property and rights to
property and the sum of properties owned is equal to the sum of the rights to the properties.
The properties owned by a business are called assets and the rights to properties are known as
liabilities or equities to the business.
Equities may be divided in to equities of creditors representing debts of the business
known as liabilities and the equity of owner known as capital. Taking this in to account, the
accounting equation may be as below:
Assets = Liabilities +Capital Or
Capital =Assets Liabilities Or
Liabilities = Assets Capital
Assets: Assets are the economic resources of the organization. It includes both tangible and
intangible items. For example tangible assets include land, building, furniture, machinery,
goods, stock equipments etc. Similarly intangible assets includes goodwill, copy right, patent,
trademark etc.
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Liabilities: It the amount of obligation of the organization to pay outsiders. It includes
creditors, bills payable, bank overdraft, bank loan, outstanding expenses, income received in
advance etc.
Capital: It the amount contributed by the proprietor to start a business. It is the initial capital
brought in to the business.
Example-1: Prepare accounting equation and also prepare balance sheet.
Particulars Amount
Started business with capital
Purchased goods for credit Rs2,000 and for cash
Sold goods cost price Rs5,000 for
Rent paid
Commission received
Bank loan taken
Paid to the creditors in full settlement of account
10,000
3,000
6,000
100
500
2,000
1,900
Example-2: Prepare accounting equation and balance sheet
Particulars Amount
Commenced business with goods Rs6,000 and for cash
Purchased goods on credit from Mr.X
Goods withdrawn for private use
Interest on capital due
Cash withdrawn from bank for private use
14,000
2,000
500
300
500
Example -3: Prepare accounting equation and balance sheet
Particulars Amount
Commenced business with bank balance
Purchased furniture
Purchased goods for Rs3,000 and on credit
Sold goods to Y cost price Rs3,000 for
Rent received
25,000
1,000
7,000
4,000
1,000

SUGGESTED ANSWERS FOR ASSIGNMENT OF ACCOUNTING EQUATIONS
1. Accounting equation of.. as on .
Transactions cash goods liability capital
Started business
with capital
Purchased
goods
New equation
Sold goods
New equation
Rent paid
New equation
Commission
received
Bank loan taken
New equation
Paid to creditors
10,000

(-)3,000

7,000
6,000
13,000
(-) 1,000
12,000
500
12,500
2,000
14,500



5,000

5,000
(-) 5,000
Nil

Nil

Nil

Nil



2,000

2,000

2,000

2,000

2,000
2,000
4,000

10,000



10,000
1,000
11,000
(-)1,000
10,000
500
10,500

10,500

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New equation (-) 1,900
12,600

Nil
(-)2,000
2,000
100
10,600
Balance Sheet as on
Liabilities and capital Amount Assets Amount
Capital
Creditors
10,600
2,000
12,600
Cash 12,600

12,600
2. Accounting equation of ..as on..
Transactions Goods Cash Liability Capital
Commenced
business
Purchased
goods on credit
New equation
Goods drawn
for private use
New equation
Int.on capital
New equation
Cash withdrawn
for private use
New equation
6,000


2,000
8,000

(-)500
7,500

7,500


7,500
14,000



14,000


14,000

14,000

(-) 500
13,500



2,000
2,000


2,000
300
2,300


2,300
20,000



20,000

(-)500
19,500
(-)300
19,200

(-) 500
18,700

Balance Sheet as on
Liability and capital Amount Assets Amount
Capital
Creditors
Interest due
18,700
2,000
300
21,000
Goods
Cash
7,500
13,500

21,000
3. Accounting equation of .. as on
Transaction Bank FF Goods Debtor(Y) Liability Capital
Commenced
business
Furniture
purchased
New
equation
Purchased
goods
New
equation
Sold goods
to Y
New
equation
Rent
received
New
equation
25,000


(-)1,000
24,000

(-)3,000

21,000


21,000


1,000

22,000



1,000
1,000



1,000


1,000




1,000






10,000

10,000

(-)3,000
7,000




7,000










4,000
4,000




4,000






7,000

7,000


7,000




7,000
25,000



25,000



25,000

1,000
26,000



1,000
27,000
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Balance Sheet as on .
Liabilities and capital Amount Assets Amount
Capital
Creditor for goods
27,000
7,000


34,000
Bank
Furniture
Goods
Debtors (Y)
22,000
1,000
7,000
4,000
34,000
Final Accounts
Accounts prepared on any pre-determined date, on the expiry of definite period, to ascertain
profit or loss and financial condition of business are known as final accounts. In other words
final accounts refer to those accounting statements which are prepared (i) to ascertain profit
or loss during accounting year at the expiry of accounting period (ii) to know the financial
condition of the business at the end of the accounting period.
Trading Account/ Manufacturing A/c
Profit or loss Account
Balance Sheet.
Trading Account of Mr. X for the year ending..
Particulars Amount Particulars Amount
To Opening stock
To Purchases
To sales return
To Carriage
To Carriage inward
To Freight
To Freight inward
To Wages
To Factory expenses
To Stores consumed
To Royalty
To Motive Power
To Coal, coke
To Water
To Oil
To Octroi
To Dock charges
To Custom Duty
To Gross Profit( if profit)
By Sales
By Purchase return
By closing stock
By goods used for personal
use












By Gross loss( if loss)

Profit &loss account for the year ended
Particulars Amount Particulars Amount
To Gross loss b/d
To salary
To rent,rate,rates
To stationary
To postage and telegram
To audit fees
To legal charges
To telephone charges
To insurance premium
To entertainment expenses
To repairs
By gross profit b/d
By rent
By discount
By commission
By interest
By bad debts recovered
By apprentice premium
By income from investment




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To depreciation
To interest
To trade expenses
To conveyance
To charity
To bank charges
To office expenses
To establishment exp
To stable expenses
To license fees
To brokerage
To commission
To office lighting
To advertisement
To export duty
To discount
To packing charges
To traveling exp
To bad debts
To provision for bad debts
To net profit transferred to
capital account (if profit)




















By net loss transferred to
capital account (if loss)
Balance sheet of X as on or as at
Liabilities Amount Assets Amount
Bank overdraft
Bills payable
Sundry creditors
Short term loans
Bank loans
Long-term loans
Capital


Cash in hand
Cash at bank
Bills receivable
Sundry debtors
Closing stock
Finished goods
Raw materials
Work in progress
Stationary
Goods sent on consignment
Long term investments
Trade mark
Patents
Vehicle
Furniture
Investments
Machinery and plant
Tools
Land and building
Goodwill




ABM/FAM/BAM/BFA/2013/Dr. PK
XVIII

Ex-1: Prepare trading and profit/loss account and balance sheet from the following.
Particulars debit credit
Drawings and capital
Land
Premises
Goodwill
Trademark
Plant
Fixture
Opening stock
Bills receivable and payable
Debtors and creditors
Purchases and sales
Returns
Carriage inward
Carriage outward
Freight
Wages
Coal
Factory expenses
Salaries
Rent
Commission
Interest
Discount
Stationary
Trading expenses
Cash
Bank

5,000
25,000
20,000
7,000
13,000
15,000
2,000
18,000
4,000
16,000
80,000
1,000
1,500
500
1,200
22,000
800
4,500
18,000
6,000
2,500

4,000
500
1,800
700

2,70,000
40,000







6,000
24,000
1,50,000
2,000









3,000
6,000



39,000
2,70,000
Closing stock Rs20,000

ABM/FAM/BAM/BFA/2013/Dr. PK
XIX

Solve:
Trading and profit/loss account for the year ended
Particulars Amount Particulars Amount
To opening stock
To purchases
To carriage inward
To freight
To wages
To coal
To factory expenses
To sales return
To gross profit c/d


To carriage outward
To salaries
To rent
To commission
To discount
To stationary
To trading expenses
To net profit
18,000
80,000
1,500
1,200
22,000
800
4,500
1,000
43,000
1,72,000

500
18,000
6,000
2,500
4,000
500
1,800
18,700
52,000
By sales
By purchase return
By closing stock








By gross profit b/d
By interest
By discount
1,50,000
2,000
20,000






1,72,000

43,000
3,000
6,000





52,000
Balance sheet of .. as on
Liabilities Amount Assets Amount
Bills payble
Creditors
Bankers
Capital 40,000
(+)Net profit18,700
_______
58,700
(-) drawings 5,000
6,000
24,000
39,000




53,700


1,22,700
Cash in hand
Debtors
Bills receivable
Closing stock
Fixture
Plant
Trademark
Land
Premises
goodwill
700
16,000
4,000
20,000
2,000
15,000
13,000
25,000
20,000
7,000
1,22,700

Depreciation
Depreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of
matching the cost of a fixed asset with the revenue (or other economic benefits) it generates
over its useful life. Without depreciation accounting, the entire cost of a fixed asset will be
recognized in the year of purchase. This will give a misleading view of the profitability of the
entity. Methods of depreciation
Straight Line method
Diminishing Balance Method
ABM/FAM/BAM/BFA/2013/Dr. PK
XX

Inventory
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the
rendering of services.
(IAS 2)
Inventory must be recorded at the lower of cost or net realizable value.
Cost. Includes the purchase cost and any other costs necessary in bring the inventories to their
present location and condition. These may include costs incurred directly in the production of
inventory such as direct labor and production overheads (i.e. conversion costs) and other
expenses such as transportation and handling charges, taxes and duties that may not be
recoverable from tax authorities. However, costs do not include general and administrative
costs which cannot reasonable attributed to the cost of inventory. Similarly, selling and
distribution expenses, storage costs and excessive expenditure resulting from abnormal
wastage shall not be included in the cost of inventory.
Methods of calculating inventory cost
As inventory is usually purchased at different rates (or manufactured at different costs) over
an accounting period, there is a need to determine what cost needs to be assigned to
inventory. For instance, if a company purchased inventory three times in a year at $50, $60
and $70, what cost must be attributed to inventory at the year end? Inventory cost at the end
of an accounting period may be determined in the following ways:
First In First Out (FIFO)
Last In First Out (LIFO)
Average Cost Method (AVCO)
Highest in First Out (HIFO)
First In First Out (FIFO)
This method assumes that inventory purchased first is sold first. Therefore, inventory cost
under FIFO method will be the cost of latest purchases. Consider the following example:


ABM/FAM/BAM/BFA/2013/Dr. PK
XXI

Example


Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as
follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January may be calculated as follows:
The sales made on January 5 and 10 were clearly made from purchases on 1st January. Of the
sales made on January 25, it will be assumed that 2 bikes relate to purchases on January 1
whereas the remaining one bike has been issued from the purchases on 15th January.
Therefore, the value of inventory under FIFO is as follows:
Date Purchase Issues Inventory

Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total
Jan 1 5 50 250

5 50 250
Jan 5

2 50 100 3 50 150
Jan 10

1 50 50 2 50 100
Jan 15 5 70 350

5 70 350
Jan 15

7

450
Jan 25

2 50 100


1 70 70 4 70 280
As can be seen from above, the inventory cost under FIFO method relates to the cost of the
latest purchases, i.e. $70.
Last In First Out (LIFO)
ABM/FAM/BAM/BFA/2013/Dr. PK
XXII

This method assumes that inventory purchased last is sold first. Therefore, inventory cost
under LIFO method will be the cost of earliest purchases. Consider the following example:
Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as
follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January may be calculated as follows:
The sales made on January 5 and 10 were clearly made from purchases on 1st January.
However, all sales made on January 25 will be assumed to have been made from the
purchases on January 15. Therefore, the value of inventory under LIFO is as follows:
Date Purchase Issues Inventory

Units $/Units $ Total Units $/Units $ Total Units $/Units $ Total
Jan 1 5 50 250

5 50 250
Jan 5

2 50 100 3 50 150
Jan 10

1 50 50 2 50 100
Jan 15 5 70 350

5 70 350
Jan 15

7

450
Jan 25

3 70 210 2 50 100

2 70 140

4

240
As can be seen from above, LIFO method allocates cost on the basis of earliest purchases
first and only after inventory from earlier purchases are issued completely is cost from
subsequent purchases allocated. Therefore value of inventory using LIFO will be based on
outdated prices. This is the reason the use of LIFO method is not allowed for under IAS 2.

Good Luck