Escolar Documentos
Profissional Documentos
Cultura Documentos
UNIT I
Meaning and nature of accounting, Scope of financial accounting, Interrelationship of Accounting with
other disciplines, Branches of Accounting, Accounting concepts and convention, Accounting standards in
India.
[No. of Hrs: 11]
UNIT II
Journal, Rules of Debit and Credit, Sub Division of Journal: Cash Journal, Petty Cash Book,
Purchase Journal, Purchase Return, Sales Journal, Sales Return Journal, Ledger, Trial Balance
[No. of Hrs: 11]
UNIT-III
Preparation of Final Accounts, Profit & Loss Account, Balance Sheet-Without adjustments and
with adjustments.
[No. of Hrs: 11]
UNIT IV
Meaning of Inventory, Objectives of Inventory Valuation, Inventory Systems, Methods of
Valuation of Inventories-FIFO, LIFO and Weighted Average Method, Concept of Deprecation,
Causes of Depreciation, Meaning of Depreciation Accounting, Method of Recording
Depreciation, Methods of Providing Depreciation.
[No. of Hrs: 11]
6. No control on cost: It does not provide for a proper control of materials and
supplies, wages, labour and overheads.
7. No standards to assess the performance: In financial accounting, there is no
such well developed system of standards, which would enable you to appraise the
efficiency of the organisation in using materials, labour and overhead costs. Again,
it does not provide you any such information, which would help you to assess the
performance of various persons and departments in order that costs do not exceed
a reasonable limit for a given quantum of work of the requisite quality.
Accounting Principles
Financial accounting is information that must be processed and reported
objectively. Third parties, who must rely on such information, have a right to be
assured that the data is free from bias and inconsistency, whether deliberate or
not. For this reason, financial accounting relies on certain standards or guides that
are called 'Generally Accepted Accounting Principles' (GAAP).
Principles derived from tradition, such as the concept of matching. In any report of
financial statements (audit, compilation, review, etc.), the preparer/auditor must
indicate to the reader whether or not the information contained within the
statements complies with GAAP.
Principle of regularity: Regularity can be defined as conformity to enforced
rules and laws.
Principle of consistency: This principle states that when a business has fixed a
specific method for the accounting treatment of an item, it will enter all similar
items that follow, in exactly the same way.
Principle of sincerity: According to this principle, the accounting unit should
reflect in good faith the reality of the company's financial status.
Principle of the permanence of methods: This principle aims at maintaining
the coherence and comparison of the financial information published by the
company.
Principle of non-compensation: One should show the full details of the financial
information and not seek to compensate a debt with an asset, revenue with an
expense etc.
Principle of prudence: This principle aims at showing the reality 'as is': one
should not try to make things look rosier than they are. Typically, revenue should
be recorded only when it is certain and a provision should be entered for an
expense, which is probable.
Principle of continuity: When stating financial information, one assumes that
business will not be interrupted. This principle mitigates the principle of prudence:
assets do not have to be accounted at their disposable value, but it is accepted that
they are at their historical value.
particular method is used it should be followed year after year, so that the financial
statements can be analysed and a comparison made.
5. Convention of full disclosure: Convention of full disclosure states that all material
and relevant facts concerning financial statements should be fully disclosed. Full
disclosure means that there should be complete, reasonable and sufficient
disclosure of accounting information. Full refers to complete and detailed
presentation of information. Thus, the convention of full disclosure suggests that
every financial statement should disclose all pertinent information. For example, the
business provides financial information to all interested parties like investors,
lenders, creditors, shareholders etc. The shareholder would like to know the
profitability of the firm while the creditors would like to know the
solvency of the business. This is only possible if the financial statement discloses all
relevant information in a complete, fair and an unprejudiced manner.
6. Convention of conservatism: This concept accentuates that profits should never
be overstated or anticipated. However, if the business anticipates any loss in the
near future, provision should be made for it in the books of accounts, for the same.
For example, creating provision for doubtful debts, discount on debtors, writing off
intangible assets like goodwill, patent and so on should be taken in to consideration
Traditionally, accounting follows the rule 'anticipate no profit and provide for all
possible losses.' For example, the closing stock is valued at cost price or market
price, whichever is lower. The effect of the above is that in case market price has
come down then provide for the 'anticipated loss', but if the market price has
increased then ignore 'anticipated profits'. The convention of conservatism is a
valuable tool in situation of
ambiguity and qualms.
UNIT-II
JOURNALISING TRANSACTIONS
Account
An accounting system keeps separate record
of each item like assets, liabilities, etc. For example, a separate record
is kept for cash that shows increase and decrease in it.
This record that summarizes movement in an individual item is called an Account.
Each element/sub-element of
the balance sheet is named as "Account", having three parts
viz title, left side (Debit or Dr) and a right side (Credit or Cr). Technically, these are
also called `Ledger Accounts'.
Account Payable: An amount owed to
a supplier for good or services purchased on credit; payment is
due within a short time period, usually 30 days or less.
Notes Payable: A liability expressed by a written promise
to make a future payment at a specific time,
OR are obligations (short term debt) evidenced by
a promissory note? The proceeds of the note are used
to purchase current assets (inventory & receivables).
Dual Aspect of Transactions
For every debit there is
an equal credit. This is also called the dual aspect of the transaction i.e. every
transaction has two aspects, debit and credit and they are always equal. This mean
s that every transaction should have two-sided effect. For example
Mr. A starts his business and he initially invests Rupees 100,000/in cash for his business. Out of this cash following items are purchased in cash
A building for Rupees 50,000/-;
Furniture for Rupees 10,000/-; and
A vehicle for Rupees 15,000/This means that he has spent a total of Rupees 75,000/and has left with Rupees 25,000 cash. We will
apply the Dual Aspect Concept on these events from the viewpoint of business.
When Mr.A invested Rupees 100,000/ the cash account benefited from him. The ev
ent will be recorded in the books of business as,
Debit
Cash
Rs.100, 000
Credit
Mr. A
Rs.100, 000
Analyse the transaction. The account that received the benefit, in this case is
the cash account, and the account that provided the benefit is that of Mr. A.
Building purchased The building account benefited from cash account
Debit
Building
Rs.50, 000
Credit
Cash
Rs.50, 000
Assets
Assets are the properties and possessions of the business.
Properties and possessions can be of two types:
1. Tangible Assets that have physical existence
( are further divided into Fixed Assets and Current Assets)
2. Intangible Assets that have no physical existence
Examples of both are as follows:
Accounting Equation
From the above example, if the debits and
credits are added up, the situation will be as follows:
Debits
Cash
Rs.100, 000/Building
50,000/-
Furniture
10,000/Vehicle
15,000/Credits
Mr. A
Rs.100, 000/Cash
75,000/
*Rules of Debit and Credit
From our discussion up to this point, we have established following rules for Debit and Credit:
Any account that obtains a benefit is Debit.
OR
Anything that will provide benefit to the business is Debit.
Both these statements may look different but in fact if we
consider that whenever an account benefits as
a result of a transaction, it will have to return that benefit to
the business then both the statements will
look like different sides of the same picture.
For credit,
Any account that provides a benefit is Credit.
OR
Anything to which the business has a responsibility to return a benefit in future is C
redit.
As explained in the case of Debit, whenever an account provides benefit to
the business the business
will have a responsibility to return that benefit at some time in future and so it
is Credit.
*Rules of Debit and Credit for Assets
Similarly we have
established that whenever a business transfers a value / benefit to
an account and as a
result creates some thing that will provide future benefit; the `thing' is termed
as Asset. By combining
both these rules we can devise following rules of Debit and Credit for Assets:
o When an asset is created or purchased, value / benefit is transferred
to that account, so it
is Debited
I.
Increase in Asset is Debit
Reversing the above situation if the asset is sold, which is termed as
disposing off, for
o
JOURNAL
The word Journal has been derived from the French word JOUR means daily
records. Journal is a book of original entry in which transactions are recorded as
and when they occur in chronological order (in order of date) from source
documents. Recording in journal is made showing the accounts to be debited and
credited in a systematic manner. Thus, the journal provides a date-wise record of
all the transactions with details of the accounts and amounts debited and credited
for each transaction with a short explanation, which is known as narration.
Firms having limited number of transactions record those in journal and from there
post these to the concerned ledger accounts. Firms having large number of
transactions, maintain some special purpose journals such as, Purchase Book, Sales
Books, Returns books, Bills Book, Cash Book, Journal proper etc.
Format of Journal:
The following is the format of Journal.
Amount
Date
Particulars
(ii)
L.F
(iii)
Debit
Credit
Rs.
Rs.
(iv)
(i)
Ledger Folio (L.F): Journal is the original record of the business transactions. All
entries from the journal are posted in the ledger accounts. The page number or
folio number of the ledger account where the posting has been made from the
journal is recorded in the L.F column of the Journal. Each entry in the journal must
be explained in brief. This brief explanation of the entry is called Narration. Thus,
Narration gives a brief explanation of the transaction for which the entry has been
passed is given. It enables the persons going through the journal entry to have an
idea about the transaction.
Although Journal is chronological record of all business transactions, yet it cannot
provide all information regarding a particular account at one place. The journal
cannot show the net effect of various transactions affecting a particular person,
assets, revenue and expense. For example, if a trader wants to know the amount
due to a particular supplier or the amount due from a particular customer, he will
have to go through the whole journal. It would be a tedious and time consuming
process. To overcome this difficulty, another book of account, in addition to
Journal/special purpose books, is maintained. This book is called Ledger.
Ledger is a book of account which contains a condensed and classified record of all
transactions of the business posted from the journal. It is also called the book of
final entry. In other words, the book, which contains accounts, is known as the
ledger, also called the Principal Book. Ledger provides necessary information
regarding various accounts. Personal accounts in ledger show how much money
firm owes to the creditors and the amount it can recover from its debtors. The real
accounts show the value of properties and also the value of stock. Nominal
accounts reflect the sources of income and also the amount spent on various items.
In accounting all transactions are ultimately recorded in the ledger. In this book,
separate accounts are opened for each account head and all transactions relating
to a particular account head will be posted in the concerned account. An account
for each person, each type of revenue, expense, assets and liability is opened in the
ledger. For example, all transactions relating to a particular supplier; say Vivek will
be posted to the account of Vivek. This helps in ascertaining the amount due to
Vivek.
Ledger is generally maintained in the form of a bound register. First few pages of
the ledger has ordinary horizontal ruling for indexing. Remaining pages area ruled
like an account and is consecutively numbered. The index pages are used for
writing the names of accounts and the Folio No. (Page No.) where a particular
account has been opened for easy location. The ledger may also be maintained in
loose-leaf form instead of one bound book
(a) Consideration of Scattered Information: The ledger brings out the scattered
information from the Journal. It shows the condensed information under each
account head.
(b) Full information at a glance: As the ledger records both the debit and credit
aspects in two different sides, the complete position of an account can be
ascertained at a glance.
(c) Balance: At the end of a specified period, the net effect of transactions on a
particular account head can be ascertained by finding out the balance of that
account. For example, how much is due from a customer or how much is payable to
a creditor or what is the total amount of purchases or what has been the
expenditure on different heads? All these information can be ascertained by
balancing the accounts appearing in the ledger.
(d) Trial Balance: As both the aspects are recorded, the net debit effect and the net
credit on the accounts must be equal on a particular date. This is verified by
preparing a statement called Trial Balance. This is possible only if the ledger
accounts are maintained.
(e) Preparation of final accounts: Ledger is the store-house of all information
relating to the transactions. It facilitates the preparation of a Profit and Loss
Account from the balances of revenue and expenses accounts. It also, facilitates
the preparation of a Balance Sheet from the balances of assets, liabilities and
capital accounts.
Purpose of Ledger:
A businessman requires various information to ascertain the net results, financial
position and progress of the business. Ledger can provide various information,
which are given below.
(a) Information regarding Debtors: A trader can know the amount of money
receivable from various customers and others who are known as debtors.
(b) Information regarding Creditors: A trader can know the amount of money
payable to various suppliers and others who are known as creditors.
(c) Information regarding Purchases and Sales: The total purchase of goods and the
total sale of goods during a specific period can be known by preparing Purchase A/c
and Sales A/c.
(d) Information regarding Revenue and Expenses: The amount of revenue earned
from different sources and the amount of expenses incurred on different accounts
heads for a particular period may be known from the ledger.
(e) Information regarding Assets and Liabilities: The amount of various types of
assets such as Land, Building, Machinery, cash in hand, cash at bank, etc. and the
amount of various liabilities can be obtained from ledger.
Sub-divisions of Ledger:
Ledgers may be sub-divided in the following manner:
Personal Ledger
(i)
Debtors ledger or Sales Ledger and
(ii)
Creditors ledger or Bought Ledger.
General or Nominal Ledger.
These are explained below:
A. Personal Ledger: The ledger which contains the accounts of persons, firms or
organisations to whom goods are sold on credit or from which goods are bought on
credit, is known as personal ledger. Generally personal ledgers are sub-divided into
(i) Debtors ledger or Sales Ledger and
(ii) Creditors ledger or Bought Ledger.
(i) Debtor ledger or Sales ledger: In this ledger, the accounts of all Debtors for
goods sold are maintained. Posting is made from Sales Day Book, Purchase Returns
Book, Cash Book, Bills Receivable Book and Journal Proper for the transactions
affecting the accounts of Debtors.
(ii) Creditors Ledger or Bought Ledger: In this ledger, the accounts of all Creditors
for goods purchased are maintained. Posting is made from Purchases Day Book,
Purchase Returns Book, Cash Book, Bill Payment Book and Journal proper for the
transactions affecting the accounts of Creditors.
(B) General Ledger: This ledger contains all accounts other than the accounts of
Debtors and Creditors for goods. All accounts falling in the category of Assets,
Liabilities (except debtors and creditors for goods), Capital, Revenue and Expense
are maintained in this proper ledger. For example, if a machine is sold to Ram on
credit, his account will appear in General Ledger; again, if goods are sold to him on
credit, his account will appear in the Debtors Ledger. General Ledger is also known
as Impersonal Ledger or Nominal Ledger.
Date
Particulars
J. Debit
F Amount
(Rs.)
Credit
Debit Balance
Amount Or
(Rs.)
(Rs.)
Credit
In this form of ledger, balance is ascertained after every transaction. This method is
generally used in bank. Where the accounts are maintained in computers through
the use of accounting software like Tally, accounts are also prepared in this from.
(b) A vertical or T shaped form is ruled as under:-
AB & Co Account
Dr.
Cr.
Particulars
Date
1
J. Amount
J.
Date Particulars
F. (Rs.)
F.
Amount
(Rs.)
J.F (Journal Folio): In this column, the page number of the Journal where the
transaction was originally recorded is mentioned. It helps in locating the entry in
the Journal. Again, in Journal the page number of the Ledger where the account
appears is written in the Ledger Folio column.
Features of Ledger accounts:
In T shaped form of writing up a ledger account, balance is ascertained
periodically. In this book T shaped form of Ledger Account has been used. Such
Ledger Account has the following features:
(a) Two sides: A Ledger Account has two sides, namely Left hand and Right hand
side. Left hand side is called the Debit side while the right hand side is called the
Credit side.
(b) Recording of two aspects: Posting is made on the debit side of the ledger
account which has been debited in the journal and the account which has been
credited in the journal is posted on the credit side of the ledger account
(c) Balancing: Each account in the ledger is balanced independently. This is done by
ascertaining the difference between the total of the Debit side and total of the
Credit side.
Closing and Opening Balance
The balances of account ascertained at the end of a particular period are known as
closing balances. These balances become the opening balances in the next period.
Ledger posting means making entries of the transactions in the ledger books from
the journals. Posting is a process of transferring debit and credit aspects of the
entries appearing in the journal and other books of original entry to the debit and
credit sides of the relevant accounts in the ledger. Postings are made using the
word To and By as a prefix. For debit side entry To prefix is used and for credit
side entry By prefix is used. The aim of posting is to make a classified and
summarised record of all business transactions under appropriate account heads.
Rules generally followed while posting the transactions in the Ledger:
The following basic rules are to be followed while posting the transactions in the
ledger:
(a) Separate accounts should be opened in the ledger for posting the different
transactions recorded in the journal.
(b) All the transactions pertaining to one account head should be posted to that
account.
(c) Two aspects of the business transaction namely debit and credit aspects
should be posted on the debit side and credit side of the account respectively.
Basic points regarding posting:
Basic points to be kept in mind before posting are:
1. Opening of separate accounts: Separate accounts should be opened for
different account heads in the ledger for posting the different transactions
recorded in the journal. For example: Cash A/c, salary A/c, purchases A/c etc.
2. One account for each kind of transactions: One account should be opened
for each kind of transaction. Transactions taking place during an accounting period
relating to that particular account should be posted to that account only. If more
than one account is opened for one kind of transactions, the object of
summarisation of transactions of similar nature will not be achieved. For example, it
may be found that in the journal, Cash A/c has been debited during a week, say on
six different dates and the same account has been credited on four different dates.
For recording in Cash A/c, only one Cash A/c will be opened for transactions taking
place on all the days and posting of all entry relating to Cash A/c will be made in
that account only.
Methods of Posting:
There are three methods of posting from Journal to Ledger:
a. Entry wise posting: Posting of each journal entry in the affected account
heads may be made before proceeding to the next entry.
b. Account head wise posting: Posting may be made account head wise i.e.
posting of all Debits and Credits relating to one particular account head may be
made before taking up another account head.
c. Page wise posting: Posing may be made in all account heads appearing in one
particular page of the journal before taking up the next page.
(name
of
the
account
credited)
Step 4: In the J.F. column on the credit side, the Folio (page) number of the
Journal where the transaction has been originally recorded should be entered. Also
the Folio (page) number of the ledger in which the concerned account appears,
should be entered in the Ledger folio column of the Journal for cross reference.
Step 5: In the Amount column on the credit side, the amount as
recorded in the
journal against the account where the posting has been made should be entered.
Note: When the debit aspect of a transaction entered in the journal is posted in the
ledger, only the debit side of that account is affected; when the credit aspect of a
transaction entered in the journal is posted in the ledger, only credit side of that
account is affected. In order to have a complete record of each transaction, both
the
aspects
will
Posting of simple Journal Entry:
have
to
be
posted.
Illustration:
On 1st January 2008, Srinath started business with a capital Rs. 18,000
Journal of M/s Srinath
Date
Particulars
2008
Jan1
Cash A/c
Dr.
To Capital A/c
(Being cash brought in as
capital)
L.
F.
Dr.
Amount
(Rs.)
Cr.
Amount
(Rs.)
18,000
18,000
After posting the accounts in the ledger and balancing the same, a statement is
prepared to show separately the debit and credit balances. Such a statement is
known as Trial Balance.
The Trial Balance is a statement which shows the closing balances, debit balances
as well as credit balances of all ledger accounts. This statement is always prepared
in T Shape. In the left hand side, debit balances and in the right hand side, credit
balances of ledger accounts are written and both sides are totalled. The totals of
the both the sides, should always be equal. This equality in the totals of debit side
and credit side ensures the completion of double entry system of book-keeping. It
also ensures the arithmetical accuracy of ledger accounts.
Objects of Trial Balance:
The following are the objectives of preparing the Trial Balance.
1. Ascertainment of arithmetical accuracy of the ledger accounts: The Trial Balance
is a test of arithmetical accuracy of ledger accounts. If the totals of two sides of
Trial Balance i.e. debit side and credit side are equal, it ensures the arithmetical
accuracy of the ledger accounts. It means that there is no mistake in totalling the
debit side and credit side of all the ledger accounts.
2. Help in the preparation of Final Accounts: Trial Balance facilitates the preparation
of Trading Account, Profit and loss Account and the Balance Sheet. Preparation of
these financial statements is very clumsy. If the ledger accounts balances are
collected and grouped under the two headings of Debit and Credit in the Trial
Balance, it becomes easier to prepare the final accounts.
L.F.
Debit
(Rs.)
Balance
Credit Balance
(Rs.)
Total:
6. Write (a) names of all accounts having a closing balance in the Heads of Account
column. (b) Ledger Folio number of the ledger where the particular account is
balanced, in the L.F column. (c) the amount of debit balance in Debit Balance
column and (d) the amount of credit balance in credit Balance column.
7. Add the debit Balance column and credit Balance column and write these two
totals at the bottom of the two columns.
8. See that totals of both debit balance and credit balance column agree or not.
If we want to prepare the Trial Balance under T shape format, then the following
format should be used but, the procedure of prepare it (i.e. steps of preparation) is
the same
UNIT III
FINAL ACCOUNTS
So far, we have discussed that how the business transactions are recorded in
Journal and ledger and how to detect and rectify the errors and how to prepare
Trial Balance.
Is quite natural that the businessman is interested in knowing whether his
business is running on Profit or Loss and also the true financial position of his
business. The main aim of Bookkeeping is to inform the Proprietor, about the
business progress and the financial position at
the right time and in the right way. Preparation of Final accounts is highly possible
only after the preparation of Trial Balance.
Final Accounts
Trading & Profit and Loss A/c Balance sheet
1. Trading and Profit and Loss A/c is prepared to find out Profit or Loss.
2. Balance Sheet is prepared to find out financial position a if concern.
Trading and P&L A/c and Balance sheet are prepared at the end of the year or at
end of the part. So it is called Final Account.
Revenue account of trading concern is divided into two-part i.e.
1. Trading Account and
2. Profit and Loss Account.
TRADING ACCOUNT
Trading refers buying and selling of goods. Trading A/c shows the result of buying
and selling of goods. This account is prepared to find out the difference between the
Selling prices and Cost price. If the selling price exceeds the cost price, it will bring
Gross Profit. For example, if the cost price of Rs. 50,000 worth of goods are sold for
Rs. 60,000 that will bring in Gross Profit of Rs. 10,000.
If the cost price exceeds the selling price, the result will be Gross Loss. For
example, if the cost price Rs. 60,000 worth of goods are sold for Rs. 50,000 that
will result in Gross Loss of Rs. 10,000.
Thus the Gross Profit or Gross Loss is indicated in Trading Account.
Items appearing in the Debit side of Trading Account.
1. Opening Stock: Stock on hand at the commencement of the year or period is
termed as the Opening Stock.
2. Purchases: It indicates total purchases both cash and credit made during the
year.
Trading account reveals Gross Profit or Gross Loss. Gross Profit is transferred to
credit side of Profit and Loss A/c. Gross Loss is transferred to debit side of the Profit
Loss Account.
Thus Profit and Loss A/c is commenced. This Profit & Loss A/c reveals Net Profit or
Net loss at a given time of accounting year.
Items appearing on Debit side of the Profit & Loss A/c
The Expenses incurred in a business is divided in too parts. i.e. one is Direct
expenses are recorded in trading A/c., and another one is Indirect expenses, which
are recorded on the debit
side of Profit & Loss A/c. Indirect Expenses are grouped under four heads:
1. Selling Expenses: All expenses relating to sales such as Carriage outwards,
Travelling Expenses, Advertising etc.,
2. Office Expenses: Expenses incurred on running an office such as Office Salaries,
Rent, Tax, Postage, Stationery etc.,
3. Maintenance Expenses: Maintenance expenses of assets. It includes Repairs and
Renewals, Depreciation etc.
4. Financial Expenses: Interest Paid on loan, Discount allowed etc., are few
examples for Financial Expenses.
Item appearing on Credit side of Profit and Loss A/c.
Gross Profit is appeared on the credit side of P & L. A/c. Also other gains and
incomes of the business are shown on the credit side. Typical of such gains are
items such as Interest received, Rent received, Discounts earned, Commission
earned.
BALANCE SHEET
Trading A/c and Profit & Loss A/c reveals G.P. or G.L and N.P or N.L respectively,
Besides the Proprietor wants
i. To know the total Assets invested in business
ii. To know the Position of owners equity
iii. To know the liabilities of business.
DEFINITION
The Word Balance Sheet is defined as a Statement which sets out the Assets and
Liabilities of a business firm and which serves to ascertain the financial position of
the same on any particular date.
On the left hand side of this statement, the liabilities and capital are shown. On the
right hand side, all the assets are shown. Therefore the two sides of the Balance
sheet must always be equal. Capital arrives Assets exceeds the liabilities.
UNIT IV
Inventory Valuation Method and Depreciation
Inventory for a merchandising business consists of the goods available for resale to
customers. However, retailers are not the only businesses that maintain inventory.
Manufacturers also have inventories related to the goods they produce. Goods
completed and awaiting sale are termed "finished goods" inventory. A manufacturer
may also have "work in process" inventory consisting of goods being manufactured
but not yet completed. And, a third category of inventory is "raw material,"
consisting of goods to be used in the manufacture of products.
Inventory Costing Methods
The value of a company's shares of stock often moves significantly with information
about earnings. Why begin a discussion of inventory with this observation? The
reason is that inventory measurement bears directly on the determination of
income! The slightest adjustment to inventory will cause a corresponding change in
an entity's reported income.
Recall from earlier chapters this basic formulation:
Notice that the goods available for sale are "allocated" to ending inventory and cost
of goods sold. In the graphic, the inventory appears as physical units. But, in a
company's accounting records, this flow must be translated into units of money.
The following graphic illustrates this allocation process.
Observe that if $1 less is allocated to ending inventory, then $1 more flows into
cost of goods sold (and vice versa). Further, as cost of goods sold is increased or
decreased, there is an opposite effect on gross profit. Thus, a critical factor in
determining income is the allocation of the cost of goods available for sale between
ending inventory and cost of goods sold:
charges (if money was borrowed to buy the inventory), storage costs, and
insurance on goods held awaiting sale would not be included in inventory accounts;
instead those costs would be expensed as incurred. Likewise, freight-out and sales
commissions would be expensed as a selling cost rather than being included with
inventory.
COSTING METHODS
Once the unit cost of inventory is determined via the preceding logic, specific
costing methods must be adopted. In other words, each unit of inventory will not
have the exact same cost, and an assumption must be implemented to maintain a
systematic approach to assigning costs to units on hand (and to units sold).
To solidify this point, consider a simple example. Mueller Hardware has a nail
storage barrel. The barrel was filled three times. The first filling consisted of 100
pounds costing $1.01 per pound. The second filling consisted of 80 pounds costing
$1.10 per pound. The final restocking was 90 pounds at $1.30 per pound. The
barrel was never allowed to empty completely and customers have picked all
around in the barrel as they bought nails. It is hard to say exactly which nails are
"physically" still in the barrel. As one might expect, some of the nails are probably
from the first filling, some from the second, and some from the final. At the end of
the accounting period, Mueller weighs the barrel and decides that 120 pounds of
nails are on hand. What is the cost of the ending inventory? Remember, this
question bears directly on the determination of income!
To deal with this very common accounting question, a company must adopt an
inventory costing method (and that method must be applied consistently from year
to year). The methods from which to choose are varied, generally consisting of one
of the following:
1. First-in, first-out (FIFO)
2. Last-in, first-out (LIFO)
3. Weighted-average
Each of these methods entails certain cost-flow assumptions. Importantly, the
assumptions bear no relation to the physical flow of goods; they are merely used to
assign costs to inventory units. (Note: FIFO and LIFO are pronounced with a long
"i" and long "o" vowel sound.) Another method that will be discussed shortly is the
specific identification method. As its name suggests, the specific identification
method does not depend on a cost flow assumption.
FIRST-IN,FIRST-OUT CALCULATIONS
With first-in, first-out, the oldest cost (i.e., the first in) is matched against revenue
and assigned to cost of goods sold. Conversely, the most recent purchases are
assigned to units in ending inventory. For Mueller's nails the FIFO calculations
would look like this:
Useful Life or Economic Life is the time period for machine is expected to operate
efficiently. It is the life for which a machine is estimated to provide more benefit
than the cost to run it. Grouping of Fixed Assets
Major groups of Fixed Assets:
Land
Building
Plant and Machinery
Furniture and Fixtures
Office Equipment
Vehicles
No depreciation is charged for `Land'. In case of `Leased Asset/Lease Hold Land'
the amount paid for It is charged over the life of the lease and is called
Amortization.
Journal entries for recording Depreciation
Purchase of fixed asset
:Debit: Relevant asset account
Credit: Cash, Bank or Payable Account
For recording of depreciation, following two heads of accounts are used:
Depreciation Expense Account Accumulated Depreciation Account
Depreciation expense account contains the depreciation of the current year.
Accumulated depreciation contains the depreciation of the asset from the financial
year in which it was bought up to the present financial year.
Depreciation of the following years in which asset was used is added up in this
account. In other words, this head of account shows the cost of usage of the asset
up to the current year. Depreciation account is charged to profit & loss account
under the heading of Administrative Expenses
In the balance sheet, fixed assets are presented at written down value i.e.
WDV = Actual cost of fixed asset - Accumulated Depreciation
.Journal entry for the depreciation is given below:
Debit: Depreciation Expenses Account
Credit: Accumulated Depreciation
Methods of calculating Depreciation
There are several methods for calculating depreciation. At this stage, we will discu
ss only two of them
namely:
Straight line method or Original cost method or Fixed installment method
Annual Depreciation
= 20 % of cost or Rs.20,000
Annual Depreciation
= 20%
Year 1 Depreciation
= 20 % of 100,000
= 20,000
Year 1 WDV
= 100,000 20,000
= 80,000
Year 2 Depreciation
= 20 % of 80,000
= 16,000
Year 2 WDV
= 80,000 16,000
= 64,000
Written Down Value / Book Value Cost minus Accumulated Depreciation.
In reducing balance method,
a formula is used for calculation the depreciation rate i.e.
Rate = 1
n RV / C
Where:
"RV" = Residual Value
"C" = Cost
"n" = Life of Asset
Calculate the rate if:
Cost
= 100,000
Residual Value (RV)
= 20,000
Life
= 3 years
Rate =
13
20000/100000
= 42%
Year 1
Cost
100,000
Depreciation 100,000 x 42%
(42,000)
WDV (Closing Balance)
58,000
Year 2
WDV (Opening Balance)
58,000
Depreciation
58,000 x 42%
(24,360)
WDV (Closing Balance)
33,640
Year 3
WDV (Opening Balance)
33,640
Depreciation
33,640 x 42%
(14,128)
WDV (Closing Balance)
19,511
The Accounting Standard regarding depreciation was issued at first in 1982. But it
was
revised in 1994.
The revised standard (AS 6) is now mandatorily applicable to all concerns in India
for
accounting periods commencing on or after 1.4.1995. The important matters to be
noted from
(AS 6) are
1. Depreciable Assets are the assets which : (a) are expected to be used for more than one accounting period; and
(b) have limited useful life; and
(c) are held by an enterprise for use in production or supply of goods and services,
for
rental to others or for administrative purposes but not for sale in the ordinary
course of business.
2. Useful Life of a depreciable asset may be either :
(a) the period of its expected working life, or
(b) the number of production or similar units expected to be obtained from the use
of
the asset by the enterprise.
3. (a) The total amount to be depreciated from the value of a depreciable asset
should be
spread over its useful life on a systematic basis.
(b) The method selected for charging depreciation should be consistently followed.
However, if situations demand (like change of statute, compliance with Accounting
Standard, etc.)a change of method may be made. In that case, the depreciation
should be recalculated under the new method with effect from the date of the asset
coming into use, that is, with retrospective effect.
If Depreciation is overcharged earlier, then the following adjustment entry should
be made:
Asset A/c .Dr.
To Profit & Loss Adjustment A/c
If Depreciation is undercharged earlier, then the following adjustment entry should
be made:
Profit & Loss Adjustment A/c..Dr
To Asset A/c
(c) For ascertaining the useful life of a depreciable asset, these factors should be
considered
:
(1) expected physical wear and tear;
REFERENCES:-