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ACCOUNTING.
DEFINITION:
It is the art of recording classifying, and summarizing the business transactions in the books of accounts, as per prescribed rules, which have financial impact and finally, final accounts, are prepared to calculate profit/loss and to show the financial position of the business at the end of year and results of the business are interpreted to the management for decision making.

Explanation of definition:
RECORDING.

This is the basic function of accounting. Recording means to put the transactions in writing in the books of accounts which have financial impact. Recording is done in the book. Journal, Journal is the first book of accounting and this book is further sub-divided into various subsidiary books such as cash journal, purchases journal, sales journal etc. transactions will be recorded in detail in the journal, i.e, date, amount, DR and CR etc.

CLASSIFYING:
Classification is the process of grouping of transaction or entries of one nature at one place. The work of classification is the done in the book termed as Ledger. Account wise record is maintained in ledger. Ledger is prepared from journal. OR it can be prepared directly from available data/information. It is also called T Accounts

SUMMARIZING:
Summarizing involves the preparation of TRIAL BALANCE and TRIAL BALANCE is prepared from ledger by taking out debit and credit balance of different accounts appearing in the Ledger.

FINAL ACCOUNTS.
It includes TRADING & PROFIT AND LOSS ACCOUNT and BALANCE SHEET. Final accounts are prepared from Trial balance. Trading &

profit & loss A/C shows profit or loss of the business at the end of year and BALANCE SHEET shows financial position of the business at the end of year.

Financial impact:
Accounting records only those transactions and events which have financial impact. Transactions which are not of financial character are not recorded in the books of accounts.

Interpretation:
This is final function of accounting. Accounting not only creates data through recording, classifying and summarizing of events but also the recorded financial data is interpreted to the management for decision making.

Prescribed rules:
Rules and regulation or by laws of accounting or procedures of accounting normally called SSAPs (STATEMENTS OF STANDARD ACCOUNTING PRACTICES.) May be called as ACCOUNTING STANDARDS.

Terminology. Business.
Any activity carried out for earning of profits is called business but it must be law full. Business Transaction. Dealing of the business with other parties for sale or purchase or goods, payment of wages, rent and rendering of services etc. Purchases. Buying of goods & services for the business. It has two types. I. II. Cash purchase Credit purchase days etc. (Debtors) Return inwards / Sales return. If goods bought are returned back due to any reason, it is called return outwards or purchase return. Sales. Selling of goods & services by the business. It has also two types. I. Cash sale. Goods sold & cash received on the spot. Goods sold & cash is paid on the spot/occasion Goods sold but cash will be received after few

II.

Credit sale. Goods purchased but payment will be made after few If goods sold are returned back to us due to any

days/month. (Creditors) Return inwards /Sales return. reasons, it is called return inwards or sale return. Asset. Resources of the business with the help of which business in carried out. Examples are cash, machinery, furniture, office equipment, vehicle, lands/building, debtors, stock etc. Assets has two types:
I.

Fixed assets: Those assets which have a long life and are purchased for the purpose to use them in business. Examples are machinery, furniture, office equipment, vehicle, lands/ building etc.

II.

Those assets which are purchased for the purpose of sale to earn profit. OR those assets in which frequent changes occurred due to business transaction. Examples are cash, debtors, stock etc.

Liability. I. II.

Obligations of the business.

Examples

are

creditors,

bankovedraft, loan, accrued salary etc liability has two types: Current liability: those liabilities which are payable within a year. Examples are creditors, bankoverdraft, accrued salary etc. Long term liability: those liabilities which are payable after a year. Investments by the owner in the business. Examples are cash Earning of the business. Examples are sale income, commission Examples are loan, debentures etc. Capital. Income. Expense. Drawings. furniture, computer, machinery etc. received, discount received. Spending of the business. Examples are salary, wages, rent, utility If the owner of the business draws something from the business for bills, office expenses. Advertisement, fuel, repair etc. his personal use it is called drawing. Examples are: Cash withdrawn

Goods withdrawn

Personal bills paid out of the business cash. Discount. Reduction in list price of the goods. It has two types. 1. Cash Discount: 2. Trade discount:

Allowed by shopkeepers to customers. It may be

Discount allowed (expense) and discount received (income). Allowed by one trader to another trader on bulk buying. It is not recorded in the books of accounts. It is only shown in invoices. TYPES OF ACCOUNTS. 1. Asset 2. Liability 3. Capital 4. Income 5. Expense Assets/Expenses Capital/Liability/ Income OR Assets / Expenses INCREASE DECREASE There are five types of accounts. Cash, furniture, land, vehicles, machinery, debtors, stock. Creditor, bank overdraft, loan, accured salary, rent payable. Investment Sale, commission received, discount received. Salary, rent, utility bills, insurance, advertising. Increase Decrease Increase Decrease Dr Cr Cr Dr

Rules of debit (Dr) & Credit (Cr)

Capital / Liability/ Income DECREASE INCREASE

Note: Normally expenses are Debited and incomes are credited. How to apply the rules of Dr & Cr.

Look at the transaction and trace two or more A/C in that transaction.

What is type of these accounts? Apply the rules of Dr & Cr and entry should be completed. Double entry system of accounting. THE EQUAL AMOUNT. Journal. Journal is the first book of accounting n which business transaction are recorded chronologically (day by day or date-wise) in detail as per prescribed procedure/format. Source documents to record transactions in journal are the invoice / bills etc. Format of the journal Date 1995 Jan. 1 Detail Purchases Cash Goods purchased for cash XXX Ledger. It is second book of accounting.

DEBIT MUST HAVE CREDIT FOR

L.F Debit XXX

Credit

It is prepared from journal or it can also be prepared directly from transactions or data given. It is also called T- Form of Accounts

In ledger, record relating to a particular account is maintained in a classified form OR Account wise record is kept.

Format of ---T. A/C. Dr Side 19x5 Cash A/C 19x5 Cr. Side

Trial Balance. It is a statement which is prepared form Ledger by taking out Debit and credit balance different accounts appearing in the ledger.

If the Dr & Cr sides are equal in trial balance it means that accounting records prepared/maintained so for is arithmetically accurate. From trial balance we prepare final accounts at the end of year i.e. Trading & profit and loss a/c and Balance sheet.

Format of the trial balance. Serial No. Name of Account Debit Credit

Final accounts . Finals accounts include the following.

Trading & profit and loss account. Balance sheet.

Trading and profit & loss A/C

It shows gross profit or gross loss and net profit or net loss of the business at the end of year respectively. In T & P & L a/c income and expenses are shown.

Balance sheet. It shows financial position of the business on a particular date. Assets liabilities & capital are shown in balance sheet.
TRADING AND PROFT AND LOSS A/C FOR THE YEAR ENDED DED. 31, 19X5

Sale Less: Return inwards/sale returns Net sales Less: cost of goods sold. Opening stock Add: Purchases Less: Return outwards/purchase return Add: Carriage inwards Less: Closing stock Gross profit Add: Discount received / rent received Net profit Less: Expenses Rent Salaries Wages Insurance xxx xxx xxx xxx xxx xxx xxx xxx xxx xx xxx xxx xxx xxx

xxx

xxx xxx xxx xxx

Advertising Repair and maintenance Bad debts Depreciation on machinery Van running cost Fuel expenses Net profit / net loss

xxx xxx xxx xxx xxx xxx xxx xxx Balance sheet as at December 31, 19X5

Fixed Assets. Plant and machinery Building Motor van Furniture and fitting Current assets. Closing stock Debtors Cash in hand Cash at bank / bank Less: Current liabilities. Creditors Bank overdraft Working capital Capital employed

Cost xxx xxx xxx xxx

Dep. xxx xxx xxx xxx

N.B.V xxx xxx xxx xxx xxx

xxx xxx xxx xxx

xxx xxx xxx xxx xxx

Financed by. Capital Add: Net profit Less: Drawings xxx xxx xxx xxx

BOOKS OF ORIGINAL OR PRIME ENTRIES OR DAY BOOKS OR SUB DIVISION OF JOURNAL.

1. 2. 3. 4. 5. 6.

Cash journal / cash book. Only cash and bank transactions are recorded Sale journal.Only credit sale of goods are recorded. Purchase journal. Only credit purchases of goods are recorded. Return inward / sale return journal. is recorded. Return outward / purchase return journal. purchase return are recorded. General journal / The journal. All other transactions which cannot be recorded in above journals should be recorded in the journal. i.e Purchase and sale of fixed asset on credit. Correction entries. Entries of writing off bad debts. Closing entries. Only return outwards / Only return inward or sale return

Types of ledger. 1. 2. 3.

There are three types of ledgers.

Sale ledger. Personal accounts of debtors are recorded in the sale ledger. Debtors arises from the credit sale. Purchase ledger. General ledger. Personal accounts of creditors are recorded in the All other accounts i.e Assets a/c, liabilities a/c, purchase ledger. Creditors arises from credit purchase. incomes a/c, expenses a/c, capital a/c, sale a/c, purchase a/c, return inward a/c, return outward a/c, etc. are recorded in the General ledger.

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Cash book OR cash journal OR cash day book.

Only cash and bank transactions are recorded in the cash book. 1. 2. Cash and cheque received will be recorded on the Debit side. Cash and cheque paid will be recorded on the credit side. There are two types of the cash book. In two column cash book, cash and bank

Cash transactions have two types.

Types of cash book. 1.

Two column cash book. book.

columns are created on the debit as well as on the credit side of the cash 2. Three column cash book. In three column cash book, cash, bank and discount columns (discount allowed on the debit side and discount received on the credit side) are created on the debit as well as on the credit side of the cash book. Contra entries.

Contra entries are recorded on DR as well as on CR sides of

cash book. There are two contra entries in the cash book. When cash is deposited in to the bank. Bamk Cash When cash is withdrawn from the bank for business use. Cash Bank Format of the Three column cash book.
Date Details LF Dist. Allowed Cash Bank Date Details L Dist. F Received Cash Bank

19x 5

19x5

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Sale journal & sale ledger. Sales journal OR Sales day book.

Only credit sales are recorded in the sale journal.

Source document/original document is sale invoice. Entry Debtor (x,y,z) Sale. Sale invoice. It shows details of quantity sold, unit price, total price, discount and detail about seller and purchaser. It has a consecutive serial number. Format of sales journal. Date 19x5 Jan 1 Jan 12 Jan 25 Jan 29 D Poole T Cock M Nelson D Poole Total transferred to SALE a/c in the GENERAL LEDGER. Sales ledger. Personal accounts of debtors are prepared in the sales ledger. D Poole 19x5 Jan 1 Jan 29 Feb 1 Sale Sale Balance b/d 500 945 1445 1445 D Cock 1445 19x5 Jan 31 Balance c/d 1445 051 052 053 054 Details Invoice No. 500 425 750 945 2620 LF Amount

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19x5 Jan 12 Sale

425 425

19x5 Jan 31 Balance c/d

425 425

Feb 1 Balance b/d General ledger. 19x5 Jan 31 Balance c/d

425 Sales a/c xxx xxx Feb 1 Balance b/d xxx 19x5 Jan 31 Total for month xxx xxx

Purchases journal and purchases ledger. Purchases journal OR purchases day book. Only credit purchases of goods are recorded. Original document /Source document is purchase invoice. Entry Purchase Creditors (A, G, Z) Purchases invoice. It shows details of quantity purchased, unit price, total price, discount and details about the seller and purchase Format of purchase journal. Dated 19x5 Jan 1 Jna 10 Jan 27 Jan 29 B small D cross M mark B small 014 015 019 023 Details Invoice No. L Amount F 435 220 425 900

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Total transferred to purchase a/c in the General ledger. 1980 Purchase ledger. Purchase accounts of creditors are maintained in the purchase ledger. B small 19x5 Jan 31 Balance c/d 1335 1335 19x5 Jan 1 Jan 10 Purchases Purchase 435 900 1335 Feb. 1 D Cross 19x5 Jan 31 Balance c/d 220 220 Feb 1 General ledger. Purchases a/c 19x5 Jan 31 Total for month 1980 1980 Feb 1 Balance b/d 1980 Returns inwards journal / Sales retruns journal OR day book. Only Return inwards or sale returns are recorded in this journal.

Balance

1335

19x5 Jan 10 Purchase Balance b/d

220 220 220

19x5 Jan 31 Balance c/d

1980 1980

Source document/ original document is Credit Note. Return inwards Debtors (A,G,Z)

Entry

Credit note: A credit note is sent to customers (Debtors) as an acknowledge of returns inwards/ any others allowances/deductions agreed with customers.

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Format of the returns inwards journal. Date 19x5 Jan 5 D poole 71 72 73 Jan 18 T cock Jan 28 M Nelson Total transferred to return inwards A/C in the GENERAL LEDGER. Sales ledger. D Poole 19x5 Jan 1 Jan 29 Feb 1 19x5 Jan 12 Feb 1 Sale Balance b/d Sale Sale Balance b/d 500 945 1445 1445 T Cock 425 425 425 19x5 Jan 18 Jan 31 Return Inwards Balance c/d 45 380 425 19x5 Jan 5 Jan 31 Return Inwards Balance c/d 50 1395 1445 Details Credit note No. 50 45 25 120 LF Amount

General ledger. Return inwards a/c 19x5 Jan 31 Total for the month 120 19x5 Jan 31 Balance c/d 120

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120 Feb 1 Balance b/d 120 Returns outwards journal /purchase returns journal OR day book.

120

Only return outwards / purchase return are recorded in this journal. Source document / origina document is debit note. Creditor (A, G, Z) Return outwards A debit note is received from suppliers (creditors) as an

Entry Debit note:

acknowledge for the goods returns to him or for any others allowances / deductions obtained from suppliers. Format or Returns outwards journal Date 19x5 Jan 7 B Small 214 245 Jan 15 D Cross Total transferred to return outwards A/C in the GENERAL LEDGER. Details Credit note No. 35 25 60 LF Amount

Purchases ledger. B Small 19x5 Jan 7 Jan 31 Return outwards Balance c/d 35 1300 19x5 Jan 1 Jan 29 Purchases Purchases 435 900

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1335 Feb 1 D Cross 19x5 Jan 15 Jan 31 Return outwards Balance c/d 25 195 220 Feb 1 General ledger. Return outwards a/c 19x5 Jan 31 Balance c/d 60 60 19x5 Jan 31 Total for the month Balance b/d 19x5 Jan 10 Purchases Balance

1335 1300 220 220 195

60 60

Feb 1 Balance b/d 60 General journal / The journal. All other transaction which cannot be recorded in any other journals should be recorded in the journal. i.e Purchase and sale of fixed asset on credit. Correction entries. Closing entries Bad debts entries.

Format of the journal. Date 1995 Jan 1 Machinery Beta Ltd. Purchased Machinery on credit. Details LF Debit xxx xxx Credit

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CAPITAL AND REVENUE EXPENDITURE Expenditure means spending of money for the business. It has two types. CAPITAL EXPENDITURE. capital expenditure. OR Capital expenditure is made when a business spends money for a. b. Purchase of fixed assets Addition to the value of existing fixed assets. Included in such amounts should be those spent on: Bringing them into the business. Legal costs of buying buildings. Carriage inwards on machinery bought.

That expenditure which is beneficial to the

business for a long period of time or for more than one accounting period is called

Any other cost needed to get the fixed assets ready for use or cost incurred on the business for increasing its earning capacity. That expenditure which is beneficial to the

REVENUE EXPENDITURE.

business for one accounting period or less than this is called revenue expenditure. OR any expenditure made for running of day to day business is called revenue expenditure. Examples are payment of the rent, wages, salaries, advertising, insurance, utility bills of the business etc. NOTE: Depreciation All capital expenditures are placed in the balance sheet and all

revenue expenditures are placed in the trading & profit & loss A/C.

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It is the gradual decrease in the value of fixed assets except land due to their usage in the business with the passage of time. It is allocation of cost of assets in to an expense over useful life of the assets.

Factors of depreciation. Cost of an asset Useful life of the assets

Scrape value of the assets (Estimated value of asset which can be realized by sale of asset at end of its useful life. Depreciation is not charged on scrape value of asset.

Methods of depreciation 1. Straight line method / original cost method / fixed installment method.

Formula=

cost of asset----scrape value Life of asset

Or % on the cost of asset.

Depreciation expense will be the same or equal for each year in this method.

2. Reducing balance method/Diminishing balance method/written down value method.

Normally a % is given in the questions. Depreciation expense will be the decreased with the passage of time because depreciation will be calculated on the reduced balance of the asset in this method.

3. Machine hour method. For machinery, aircraft, ships etc. Depreciation is calculated on the basis of machine hour worked. Formula for calculation of depreciation is as under. Depreciation= Cost of asset * number of hours used in current year Estimated total hours of Work during useful life

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4. Sum of year digits method. years.

For various assets, depreciation is calculated

with this method. For example: cost of asset is 30,000. and estimated life is 5 First of all sum (total) of years is made as: 1+2+3+4+5=15 and last fraction will be used to calculated depreciation for first year and son on in the following way. Year 1 2 3 4 5 PARTS EXCHANGE

5/15*30,000=10,000 4/15*30,000= 8,000 3/15*30,000= 6,000 2/15*30,000= 4,000 1/15*30,000= 2,000

This is when the business gives out an old fixed asset and in return gets a new fixed asset. For example an old car is given in exchange of a new car. The value of the asset being given out is decided by a mutual agreement. This value is called as parts exchange value or trade-in-allowance. Accounting treatment is just like treatment of disposal of assets.

DOUBLE ENTRY RECORD FOR DEPRECIATION. Entry for depreciation. P&L A/C Provision for depreciation A/C

Current year depreciation is shown in P&L A/C & Accumulated depreciation (Total Depreciation) in Balance Sheet.

Account to be Prepared. 1. 2. 3. 4. 5. Asset account Asset disposal A/C P&L A/C ---- Extracts Balance sheet----extracts. (Plant, furniture, motor van) Provision for depreciation A/C

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Assets (Plant) 1995 Jan 1 Jul 1 1996 Jan 1 Balance B/D xxx xxx July 1 Cash Cash / Bank Cash / Creditor xxx xxx xxx 1996 Sep 1 Dec 31 Disposal a/c at (cost) xxx Balance C/D xxx xxx P&L a/c (w-1) xxx xxx 1996 Jan 1 Balance B/D xxx xxx xxx Dec 31 P&L a/c (W-2) 1995 Dec 31 Balance C/D xxx xxx

xxx Provision for depreciation A/C 1995 Dec 31 Balance C/D 1996 Sep 30 Disposal a/c Dec 31 Balanc C/D xxx xxx xxx xxx xxx 1995 Dec 31

Asset Disposal A/C 1996 Sep 1 Sep 1 Asset P&L a/c (Profit) xxx xxx xxx 1996 Sep 1 Sep 1 Sep 1 Provision for Dep P&L a/c (Loss) xxx xxx xxx P&L A/C ---- Extracts. 1995 Gross profit NIL Cash/parts exchange value xxx

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Add: profit on disposal (if any) Less expense Provision for depreciation Loss on disposal of asset (if any) Balance sheet-----Extracts. Cost 1995 plant 1996 plant xxx (xxx) xxx xxx Depreciation

xxx xxx xxx xxx N.B.V. (Net Book Value) xxx xxx

Note: In balance sheet only balance C/D will be taken from asset a/c and provision for depreciation a/c for each year. Annual depreciation: Rate of depreciation: Cost of asset *Rate of depreciation Annual depreciation *100 Cost of assets Scrap value: Cost---Accumulated depreciation (Annual depreciation * useful life Useful life: CostScrape value Annual Depreciation

Bad debts, bad debts recovered, provision for doubtful debts and provision for discount on debtors.
Debtors. Entry

It is current asset of the business. It arises from credit sales. Debtor (x) Sale

Bad debts.

That amount of debtors which are not received to the business Bad debts Debtor (x)

due to any reason. It is an expense (loss) of the business. Entry.

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At the end of year bad debt will be closed to P&L A/C P&L A/C Bad debts

Bad debts recovered (income). If amount of bad debts written off previously is received to the business it is called bad debts recovered. Accounting treatment of bad debts recovered.

Entry for reinstatement of debtor a/c Debtor Bad debts recovered. Entry for cash received. Cash Debtor At the end of year bad debt recovered will be closed to P&L a/c Bad debts recovered P&L a/c Provision for doubtful debts.

For first time creation of provision OR for increase in provision. Entry P&L a/c Provision for doubtful debts First time creation of provision for doubtful debts OR for increase in

NOTE:

provision for doubtful devbts is an expense and should be charged to the P&L a/c under the heading of expenses. For decrease in provision Provision for doubtful debts P&L a/c NOTE: Decrease in provision for doubtful debts may be considered as income (saving ) and should be added to the gross profit.

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Provision for discount on debtor. Debtors Less 5% provision for doubtful debts Less 10% provision for discount Accounts to be prepared. Bad debts a/c Bad debts recovered a/c Provision for bad debts a/c Provision for discount on debtors a/c P&L --- Extracts Balance sheet----Extracts. Bad debts a/c ______________________________________________________________ 1995 Dec 31 Various debtors 1996 Dec 31 various debtor/x xxx xxx Bad debts recovered a/c 1995 Dec 31 Balance C/D 1996 Dec 31 P&L a/c (decrease) Dec 31 Balance C/D xxx xxx xxx xxx 1996 Jan 1 Balance B/D xxx Dec 31 P&L a/c (Increase) xxx 1995 Dec 31 P&L a/c (w-1) xxx xxx xxx xxx 1996 Dec 31 P&L a/c xxx xxx 1995 Dec 31 P&L a/c xxx xxx 10,000 500 9,500 950 8550

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xxx Provision for discount on debtors a/c 1995 Dec 31 Balance C/D 1996 Dec 1 P&L a/c (decrease) Dec 31 Balance C/D P&L A/C --- Extracts 1995 Gross profit Add: Bad debts recovered Add: Decrease in provision for doubtful debts Less Expense Bad debts Provision for doubtful debts Balance sheet---Extracts 1995 Current Assets Debtors Less: provision for doubtful debts Other adjustments for final accounts xxx xxx xxx xxx xxx NIL xxx xxx xxx xxx xxx xxx xxx 1996 Jan 1 Balance B/D 1995 Dec 31 P&L a/c

xxx xxx xxx xxx xxx

Dec 31 P&L a/c (Increase) xxx

Adjustments. If business transaction falls within two accounting periods that transaction needs to be adjusted at the end of current year. Accounting period means a period of twelve months.

Assume accounting period ends on Dec. 31, 1995 and on Sep 1. Paid rent for a year 500 PM, this transaction has two parts on Dec 31, 1995

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1995 Sep 1996 Jan 1. First on T&P&L a/c 2. Second on Balance sheet. Types of adjustments. 1. Prepaid expenses (asset)

to

Dec (expired)

August (prepaid or unexpired)

NOTE: Every adjustments has double effect on the final accounts.

That expense which has been incurred but paid in advance. Effect:1. Deducted from concerned a/c in T&P&L a/c. (5000-500) 2. Shown as current asset in balance sheet. 2. Accured expenses/Owing/Outstanding. That expense which has been incurred but still not paid. Effect:1. Added to concerned a/c in T&P&L a/c (8000+2000) 2. Shown as current liability in balance sheet. 3. Depreciation. Effect: 1. Shown as an expense in T&P&L a/c under the heading of expenses (Only current year dep. Given in adjustments) 2. Deducted from concerned fixed asset in balance sheet. (Dep. Given I trial balance + current year dep.) 4. Provision for doubtful debts. Effect. 1. If increase shown as an expense in T&P&L a/c under the heading of expenses. If decrease: Added to gross profit. 2. Deducted from debtor in balance sheet. 5. Closing stock. Effect. 1. Shown in COGS in Trading a/c. 2. Show as current asset in the balance sheet. 6. Goods for own use. It means that if owner of the business takes goods for his personal use. (drawing) Effect.1. Deducted from purchases in trading a/c. (150,000-10,000)

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2. Added to drawing in the balance sheet. 7. Treatment of insurance claim. follows. 1. 2. Added to gross profit. Shown in current assets in balance sheet as Insurance claim for damaged stock
TRADING AND PROFIT AND LOSS ACCOUNT INCLUDING ADJUSTMENT

Insurance claim on account of loss due to

theft or fire to stock is an adjustment and will be treated in final accounts as

Sale Less: Return inwards/sale returns Net Sales Less: cost of goods sold. Opening stock Add: purchases Less: Return outwards/purchase return Add: Carriage inwards (See Note-1) Less: closing stock Gross profit Add: Discount received/rent received Add: Decrease provision for doubtful debts Add: profit on disposal of asset or any other income Less: expenses Rent (10,000-2,000) Salaries / wages (15,000+5,000) Insurance xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx

xxx xxx xxx xxx xxx xxx

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Advertising Carriage outwards Repair and maintenance Bad debts Increase in provision for doubtful debts Provision for depreciation on machinery Van running cost Fuel expenses Loss on sale of assets Net profit/Net loss Note-1

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Freight charges / insurance on imported goods Wages and testing expenses Wages for preparing goods for sale BALANCE SHEET AS AT DECEMBER 31, 19X5

Fixed assets. Plant and machinery Building Motor van Furniture and fitting Current assets. Closing stock Debtors Less: provision for doubtful debts Cash in hand Cash at bank Prepayment

Cost xxx xxx xxx xxx

Dep. xxx xxx xxx xxx

B.B.V xxx xxx xxx xxx xxx

xxx xxx (xxx) xxx xxx xxx xxx

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xxx Less current liabilities. Creditors Accrued expenses Working capital Capital employed Financed by Capital Add net profit Less drawings Add long term liabilities Loans Debentures xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

BANK RECONCILIATION STATEMENT

BANK STATEMENT. A statement issued by the bank which shows the details of deposits, withdrawals and balance of the particular bank account at the end of month/ year. ACCOUNT HOLDER RECORD. That record which is maintained by the customer (Account Holder) and this record is normally maintained in a portion of Checque book. NOTE. The record maintained by the customer (Account Holder) and by the bank should be equal, if there is any difference , the following can be reasons:. Reasons of difference between customer record and bank record. 1. Unpresented cheque. for the payment. Cheques issued for payment but not presented to bank

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2. Bank lodgments. Cheques deposited for collection but not collected by the bank so far. (uncredited cheques) 3. Standing order If on instructions of the customer, bank makes regular payments for the school fee, bills, Subscription etc. and charged (Debit) to the Account of the customer, it is called Standing order. It is expense/payment of the customer 4. Direct Debits. If bank Debit the the account of the customer for the bank charges, commision charges etc. it is called direct Debit. It is expense/payment of the customer. 5. Direct credit / Credit transfer. If bank Credit the the account of the customer for the Interest received, Dividend received or for any other Transfer into customer Account, it is called direct credit. It is income / receipt of the customer. . 6. Errors. Will be treated as per situation of errors. What to do. 1. Cash book up date. 2. Bank reconciliation statement. Rules for preparation of cahs book up date and bank reconciliation statement I. If Cash book balance has a Dr balance, than balance of bank statement balance will be CR. And If Cash book has a Cr balance(O/D), than balance of bank statement balance will be DR. II. Except the following two transactions all other transactions will be recorded in the Cash book up date, and these two transactions will be recorded in the Bank Reconciliation Statement. 1. Unpresented cheque 2. Bank lodgements / uncredited cheque III. Cash book Dr. balance Cash book Cr. Balance (O/D) --Unpresented cheques +

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Bank lodgments 1995 Jan 1 Jan 5 Balance b/d Credit transfer

-- xxx xxx xxx xxx xxx 1995 Jan 8 Jan 15 Jan 25 Jan 28 Jan 31

+ Bank charges Bank commission Standing orders Direct debit Balance c/d xxx xxx xxx xxx xxx xxx

Format of cash book up-date (DR. Balance)

Jan 12 Dividend received Jan 17 Direct credit

BANK RECONCILIATION STATEMENT Balance as per cash book (Dr) Add: Unpresented cheques Less bank lodgements / uncredited cheques Balance as per bank statement (Cr) xxx xxx Xxx xxx xxx

Format of the cash book up date (overdraft) (Cr. Balance) 1995 Jan 7 Credit transfer Jan 12 Direct credit Jan 23 Dividend received Jan 25 Balance c/d xxx xxx xxx xxx xxx Format of bank reconciliation statement 1995 Jan 1 Jan 8 Jan 15 Jan 18 Bank b/d (O/D) Bank charges Bank commission Standing orders xxx xxx xxx xxx xxx xxx

Jan 29 Direct debit

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Balance as per cash book, O/D (Cr) Less: unpresented cheques Add bank lodgements/uncredited cheques Balance as per bank statement (Dr) Control accounts. Sale ledger control a/c total debtors a/c 1995 Jan 1 Balance b/d Jan 5 Credit sales /sale journal Jan 8 Dishonoured cheques Jan 13 Refund to customers Jan 25 Bad debts recovered Jan 31 Balance c/d (if any) xxx xxx xxx xxx xxx xxx 1995 Bank b/d (if any) Cash /Bank Return inwards Jan 4 Jan 8 Jan 14 Jan 22 Jan 25 Jan 28 Jan 31

xxx xxx Xxx xxx xxx

xxx xxx xxx xxx xxx

xxx Jan 1

Discontent allowed Bad debit w/off Cash (from bad debts) Recovered) Balance c/d

Jan 17 Interest on overdue debtors xxx

Set off (Purchase ledger)xxx xxx xxx xxx

Purchase ledgers controls account/Total creditors a/c. 1995 Jan 1 Jan 4 Balance b/d (if any) Cash / Bank xxx xxx xxx xxx xxx xxx xxx xxx 1995 Jan 1 Jan 5 Jan 11 Jan 17 Jan 31 Bank b/d Refund to suppliers Interest on overdue accounts Balance c/d (if any) xxx xxx xxx xxx Credit purchases/purchase journal xxx

Jan 10 Return outwards Jan 16 Discount received Jan 20 Set off (slaes ledger) Jan 31 Balance c/d

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NOTE: Cash sales, cash purchases, provision for doubtful debts and trade discount are not recorded in the control accounts. ERRORS AND SUSPENSE ACCOUNT Errors has following two types.

Errors not affecting trial balance agreement Errors affecting trial balance agreement

Types of errors not affecting trial balance agreement. 1. Errors omission. If any transaction has taken place but that is not recorded in the books of accounts. 2. Errors of commission. 3. Errors of principle. Amount is correct Account is wrong If capital expenditures are treated as Revenue expenditures and vice versa. It is called errors of principle. 4. Errors of original entry. Original amount is incorrect Account is correct 5. Complete reversal of entries. recorded as cash paid to D 6. Compensating errors. Sale 50 (Dr) Errors and suspense A/C Errors which affects the agreement of trial balance are the following.

Where correct accounts are used but each item

is shown on the wrong side of the account. Fro example, cash received from D Where two errors of equal amounts, but on the A 50(Cr)

opposite sides of the accoints, cancel out each other, as illustrated below.

Incorrect addition in any a/c Entry on only one side of a/c i.e Dr. side or Cr side. Entering different amount on Dr and Cr sides of an account Trial Balance Dr Cr

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Total so for Suspense a/c

50000 50000

48000 2000 50000

Suspense a/c It is an account opened at the time of need for the time being and deleted from books of accounts when errors have been located and corrected in the record. What to do.

Journal entries including suspense entries.

Suspense a/c Revised profit statement. Revised profit statement. Net profit before correction of errors Add: increase in sale / discount received and other income Decrease in purchases/expenses Less: Decrease in sale / discount received any other income Decrease in purchases /expenses Corrected net profit NOTE: 1. 2. 3. Sale, discount received or any other income, purchases, expenses if credited added to profit. Sale, discount received or any other income, purchases, expenses---if debited--- deducted from profit. Personal accounts (debtors & creditors) assets, liabilities and capital ---- no effect on profit. Accounts from incomplete records / single entry system Definition: It is difficult to define single entry system, however, broadly speaking, it is a defective double entry system. Under this method, sometimes both xxx xxx xxx (xxx) (xxx) xxx

34

the aspects of transactions are recorded, sometimes only one aspect is recorded or sometimes no aspect of transaction is recorded in the books. In short, single entry system may be defined as a system which does not strictly conform to the double entry system of book keeping. Under this system what is found in practice is an intermixture of single entry, double entry and no entry. Defects/disadvantages of single entry system. follows.
1.

The defects of this system are as

Under this system only partial and incomplete record is kept because two fold aspects of transactions are generally ignored. As the two fold aspects of every transition are not recorded, a trial balance cannot be drawn up to test the arithmetical accuracy of the record.

2.

3.

As nominal accounts (income and expenses) are not maintained, a profit and loss account cannot be prepared. As no real accounts are maintained the preparation of a balance sheet is not possible.

4.

Mark-up and margin concept. Mark-up is gross profit expressed as a percentage or fraction of cost of sales. cost price of goods selling price gross profit Gross profit Cost price Gross profit selling price 100= 100= 25 100 25 125 100= 20% OR 1/5 100= 25% OR 100 125 25

Margin is gross profit expressed as a percentage or fraction of selling price.

35

Conversion of mark up into margin If mark up =1/3, margin will be Conversion of mark up into margin If margin = 1/6, mark up will be If margin = 2/5, mark up will be Ascertainment of profit and loss:The following two methods are available to calculate profits when the accounting records of a trader are not maintained properly. First Methodaffairs) In this method the STATEMENT OF PROFIT / LOSS is prepared in the following format. STATEMENT OF PROFIT / LOSS Closing capital Less: opening capital Less: additional capital Add: drawings NOTE: xxx xxx xxx xxx xxx If capital is not given, it can be calculated as follows. Opening assets---opening liabilities closing assets--- closing liabilities Opening capital= Closing capital= Comparison of opening and closing capitals (Statement of = = 1 6-1 2 5-2 OR 2/3 OR 1/5 = 1 3+1 OR 2/7

STATEMENT OF PROFIT /LOSS FOR THE YEAR ENDED ON DECEMBER 31. 19X5 CAPITAL AS AT DECEMBER 31, 19X5 Assets. (closing) Plant and machinery

xxx

36

Building Motor van Furniture Closing stock Debtors Cash in hand Cash at bank Prepayments Less liabilities. Creditors Bank overdraft Accrued expenses (Closing)

xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx xxx xxx xxx xxx

Less capital as at January 1, 19x5 Assets (Opening) Plant and machinery Building Motor van Furniture Closing stock Debtors Cash in hand Cash at bank Prepayments
Less liabilities (Opening)

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Creditors

37

Bank overdraft Accrued expenses

Less additional capital Add drawing Profit (Loss)

xxx xxx xxx xxx

xxx xxx xxx

PROFIT CAN BE CALCULATED BY PREPARATION OF STATEMENT OF AFFAIRS AS ILLUSTRATED BELOW: Format of statement of affairs. Fixed assets. Plant and machinery Building Motor van Furniture and fitting CURRENT ASSETS. Closing stock Debtors Cash in hand Cash at bank Prepayment CURRENT LIABILITIES Creditors Bank overdraft Accrued expenses Working capital Capital employed xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx Cost xxx
xxx xxx xxx

Dep. xxx
xxx xxx xxx

N.B.V xxx
xxx xxx xxx

38

FINANCED BY. Capital Add: profit (Loss) Less drawing xxx ? ? xxx ? SECOND METHOD-CONVERSION INTO DOUBLE ENTRY:Conversion of books from single entry to double entry is possible, when missing figures are calculated from the available records and FINAL ACCOUNTS are prepared to calculate profit/loss. Missing figures can be calculated as follows. Sales ledger controls a/c OR total debtors a/c Opening debtors Closing debtors Credit sales

Cash /cheques received from debtors

Purchase ledger controls a/c. OR total creditors a/c Opening creditors Closing creditors Credit purchases Cash / cheques paid to creditors. Cash / Bank a/c Opening balance Closing balance

Drawings

Receipts & Payment a/c and Income & Expenditure a/c, Non Trading organization / business, ,
Objective of this organization is not to earn profit, but to serve the community in different areas, Education in far away areas, Health facilities, Recreation facilities,

39

Sports facilities etc. These organizations arc called N.G.O. Examples are Libraries, Sports club, Social club, Social societies etc. Accounts maintained during the year: 1. Receipts & Payment a/c. and any cash / cheque paid is recorded on the credit side. Sources of Receipts/ Incomes. Subscription income. t Donations income. Li fc membership fee. Registration fee. Sale of old newspapers/books. Any other income. Ancillary ActivitiesNon trading organizations often engage in activities which are ancillary to their main object in order to increase their income; and these activities includes sale of old newspapers, old equipments and publications and specially provide Bar facilities, Provision of refreshment and rallies scheme. For this purpose a separate Trading a/c should be prepared and profit or loss on this account will be transferred to Income & Expenditure a/c. (Cash book)

It is just like cash book. Any cash/ cheque received is recorded on the debit side

Treatment of special items

Some times items like Donations, Life membership may be treated as per instruction given in. the question. Normally they arc treated as income of the organization. Accounts to be prepared at the end of year. 1. Bar .Trading a/c. 2. Income & expenditure a/c 3. Balance Sheet FORMAT OF BAR TRADING ACCOUNT

40

Sale Less cost of goods sold Opening stock Add purchases (see note) Add carriage inwards Less return outwards /purchase return Less closing stock Gross profit Add any other income Less expenses Bar salaries Bar wages Net profit/Net loss

xxx xxx xxx xxx xxx xxx

xxx

xxx xxx xxx xxx xxx

xxx xxx xxx xxx

NOTE: For calculation of bar purchases, always creditors a/c may be prepared 19x5 Dec 31 cash / bank Dec 31 balance c/d xxx xxx xxx FORMAT OF INCOME & EXPENDITURES ACCOUNT. INCOME. Subscription income (W-1) Donations income Life membership fee. Registration fee. xxx xxx xxx xxx 19x5 Jan 1 Balance b/d xxx xxx Dec 31 Purchases (Bal. Fifure) xxx

41

Sale of old newspapers/books. Profit on bar trading a/c or any other income LESS: EXPENDITURES. Rent Salaries / wages Insurance Advertising Repair and maintenance Bad debts Depreciation on machinery Fuel expenses xxx xxx xxx xxx xxx xxx xxx xxx

xxx xxx xxx

Loss on bar trading a/c or any other loss xxx Surplus/Deficiency Surplus: Excess of income over expenditures Deficiency: Excess of expenditures over income Subscription account 19x5 Jan 1 Balance b/d Opening (Arrears/Due) xxx Dec 31 Refund Dec 31 Income & Expenditure a/c xxx xxx xxx BALANCE SHEETEXTRACTS. FINANCED BY. Capital fund/ accumulated fund Add surplus / deficiency xxx xxx 19x5

xxx xxx

Jan 1 Balance b/d opening (in advance) xxx Dec 31 Bank xxx xxx

Dec 31 Balance c/d closing (in advance) xxx

Dec 31 Balance c/d Closing (Arrears/Due)xxx

xxx

If capital fund / accumulated fund is not given, it can be calculated as:

42

Opening assets-opening liabilities in the following format. Opening assets. Plant and machinery Building Motor van Furniture and fitting Closing stock Debtors Cash in hand Cash at bank Prepayment Less Opening liabilities: Creditors Bank overdraft Accrued expenses Capital fund / accumulated fund xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Manufacturing Accounts. It is prepared by Manufacturing business which are engaged in the Production of certain goods. It shows the costs of the Production of goods, i.e. cost of materials, labours and factory overheads. It is an? expense/ cost account. Manufacturing cost/Elements of cost: . There are following three elements of costs. 1. Material cost. Material costs has following two types. Direct material cost. Cost of that material which is basic requirement/need for Indirect material cost. Cost of that material which is helping element for the Labour costs has following two types. the production of a product. For example wood for furniture making. completion of a product. For example paint or glue or steel-bar used in furniture making. 2. Labour cost.

43

Direct labour cost. Cost of that labour which is directly engaged in the production of a product. For example labour directly engaged for conversion of wood into furniture as per design. Indirect labour cost. Cost of that labour which is engaged for the help of direct labour in the production of a product. For example store man, security guard, -cleaner sand other helping labour. 3. Factory overhead. All indirect manufacturing costs of a product. Examples includes: Indirect material cost Indirect labour cost Deprecation of factory machinery/building. Rent of factory building Fuel expenses | Utility bills of factory Repair and maintenance of factory Insurance of factory machinery/ building Stocks in the manufacturing business. manufacturing Business. -| 1. Raw material stock 2. Work in progress (incomplete goods) 3. Finished goods (Goods ready for sale) Accounts to be prepared. Manufacturing a/c Trading & Profit and loss a/c Balance sheet Manufacturing account Opening stock of raw material Add purchase of raw material xxx xxx | There are three types of stocks in

44

Less return outwards/ P/Return Add carriage inwards Less closing stock of raw material Cost of raw material used

xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Add direct labor cost / direct wages / factory wages /mft. Wages Add direct expense (if any) (Royalty) Prime cost Add F.O.H Indirect material cost Indirect labour cost Depreciation of factory machinery/building Rent of factory building Fuel expenses Utility bills of factory Repair and maintenance of factory Loose tools expenses Insurance of factory machinery /building Total factory cost Add W.I.P Opening stock Less W.I.P closing stock Production cost of goods completed

TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 19X5

Sale Less return inwards /sale returns Net sale

xxx xxx xxx

45

Less cost of goods sold Opening stock of finished goods Less closing stock of finished goods Gross profit Add discount received / rent received Less: expenses Rent Salaries Wages Insurance Advertising Carriage outwards Repair and maintenance Bad debts Provision for bad debts Van running cost Fuel expenses Net profit / Net loss Balance sheet Current assets Stock of raw material (closing) Work in progress Finished goods Per unit cost= Prime cost= Conversion cost= (closing) (closing) total cost of production Number of units produced direct material cost + direct labour cost direct labour cost + FOH xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx Xxx

46

Total factory cost= direct material cost + direct labour cost + FOH DEPARTMENTAL ACCOUNTS: If a business has different departments, then at the end of year trading & profit & loss a/c is prepared department wise in columns form in this type of business expenses has two types.

Direct expense: department.

All direct expense are charged to the particular

Common expense: These expenses are allocated/distributed among the department on certain basis given in the question or equally. Examples of these expenses are:

Rent

utility bills

salaries expense repair and maintenance

insurance

Advertising fuel expenses

For example, there are three department i.e A,B, V. Rent of 50,000 is distributed in the ratio of 2:2:1 in the following way. 50,000*2/5=20,000 50,000*2/5=20,000 50,000*2/5=20,000 For example repair is 30,000 and is distributed equally in the following way. 10,000 10,000 10,000 For example repair is 30,000 and is distributed in the following way on % basis. A 50%, B20%, C 30%. (30,000*50%) (30,000*20%) (30,000*30%) 15,000 6,000 9,000

A2/5= B2/5= C2/5=

A B C

A B C

47

DEPARTMENTAL TRADING & PROFIT & LOSS ACCOUNT A Deptt Sale Less: cost of goods sold. Opening stock Add: purchases Add: carriage inwards/tpt.expenses. Less: return outwards/purchase return Less: Closing stock Gross profit Add: discount received/rent received Less expenses Rent Salaries Wages Insurance Advertising Repair and maintenance Bad debts Depreciation on machinery Van running cost Fuel expenses Net profit/net loss xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx B Deptt. xxx Total xxx

48

NOTE: For all departments one balance sheet will be prepared. Partnership Account. Partnership. When two or more than two persons carry out business for earning profit it is called partnership. Partnership agreement /Deed 1. Capital contribution. Amount invested by the each partner in the business. A B C 2. Profit or loss sharing ratio. It must be agreed among the partners and it can be on following basis. On the basic of capital Equally

(from book)

Main points of consideration in partnership.

50,000 100,000 70,000

% basic, A.40%, B.40%, C.20% Proportion A 2 2/5 B 2 2/5 C 1 1/5

3. Interest on drawing. Income of business Expense of partners 4. Interest on capital. Expense of business Income of partners
5.

Salary/Bonus/Commission of partners Expense of business

49

Income of partners Accounts to be prepared

1. Trading & profit & loss appropriation a/c 2. Partners current a/c (Represented a/c of partners)

3. Balance sheet T & P & L Appropriation A/C. Net profit Add interest on drawings A B Less interest on capital A B Less salary/Bonus A B Less Good will written off (if any) Less Share of profit. (As per ratio) A B xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

PARTNERS CURRENT A/C A Balance b/d (if any) Drawings Interest on drawing Balance c/d xxx xxx xxx xxx B xxx xxx xxx xxx Balance b/d Interest on capital Salary/Bonus Share of profit Interest on loans A xxx xxx xxx xxx xxx B xxx xxx xxx xxx xxx

50

xxx

xxx

Xxx

xxx

Partners current A/C can also prepared in column form as under. A Balance b/d (Opening balance) Add interest on capital Add salary / Bonus Add interest on loans Less Drawing Less interest on drawing Balance c/d Balance sheet-extracts. Finance by Capital A B Current A/C Add: Long term liabilities. Loan Partnership Changes. The partnership changes includes the following 1. 2. 3. Admission of a new partner Retirement or death of and existing partner Changes in profit & loss sharing ratio among the existing partner A B xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx B xxx xxx xxx xxx xxx xxx xxx xxx

51

When above mentioned partnership changes take place, the following two issues should be properly treated in the books of accounts I. II. Revaluation of assets Goodwill On a change in the partnership business , assets are revalued and increase or decrease in the value of assets are recorded in a revaluation account and profit or loss on revaluation account will be transferred to capital account of partners. (Profit on credit side of capital a/c and loss on debit side of capital a/c) Entries for revaluation of assets Nature of transaction 1. Increase in value of asset 2. Decrease in values of assets 3. Provisions for depreciation on revalued asset 4. Profit on revoluation 5. Loss on revoluation Details Assets a/c Revoluation a/c Revoluation a/c Asset a/c Provision of depreciation Revaluation a/c Revaluation a/c Capital a/c of partner Capital a/c of partner Revaluation xxx xxx xxx xxx xxx xxx xxx xxx Debit xxx Credit xxx

Revaluation of assets

a/c After1-3 Revaluation a/c will be prepared in the following format. Revaluation a/c 19x5 Jan31 Decreasein assets Jan31 Capital a/c A xxx xxx 19x5 Jan 31 Jan 31 Increase in assets Capital a/c xxx xxx

52

B C

xxx (if loss) xxx

xxx If Cr side is greater than Dr side, there is profit on revolution a/c and vice versa. Profit or loss on revaluation a/c will be distributed among partner in old ratios. Good-will :Reputation of business among the customers or good image/good name of Business among by customers. Calculation of good-will : Purchaser price /purchase consideration Less: Net wroth /value of business Good-will Net wroth /value of business Assets---Liabilities Treatment of goodwill on a change in a partnership Goodwill should be valued and the following accounting entries are made in partnership books. Nature of transaction A. If goodwill is to be retained /shown /opened in the books. Partners capital a/c(old ratio) Capital a/c credited and goodwill shown in B/sheet under fixed assets B. If goodwill is not to be retained I. Good will Partners capital a/c (old ratio) xxx xxx xxx xxx Details Goodwill Debit xxx Credit xxx xxx xxx xxx (Takeover)

53

/shown /opened in the books. II Capital a/c (including new ratio) Goodwill a/c xxx OR Capital a/c (including new partner /new ratio) Partner capital a/c (old ratio) (In B situation goodwill may be adjusted as illustrated below) Assume goodwill is 50,000 and old ratio is equal between A &B. On admission of C, new ratio is 2/5,2/5&1/5. Partner A B C Old ratio 25,000 25,000 ______ New ratios 20,000 20,000 10,000 xxx

With old ratios capital a/c of old partner will be credited and with new ratios capital a/c of all partner (including new)will be debited. Capital Account of partners 19x5 A Loss on revaluation xxx a/c Goodwill (new ratio) xxx Balance c/d xxx xxx xxx B xxx C 19X5 Balance b/d Profit on revaluation a/c xxx Bank (new partner capital) xxx Goodwill (old ratio)-A Goodwill (old xxx xxx xxx ____xxx A xxx xxx B xxx xxx xxx C

54

ratio-B) Profit or loss on revaluation account and goodwill treatment is always shown in partner capital account . Format of the balance sheet. On amalgations the following accounting procedure will be observed . For each firm 1.Partner,s capital accounts will be adjusted for the following For goodwill __ as already done Profits of losses on revaluation of assets ___as already done Current accounts of partners are closed to capital accounts. Assets taken over by partner should be debited to their capital accounts at the agreed values Profit or loss on disposal of assets should be transferred to capital accounts in the partner old profit sharing ratios. Adjustments of capital account balance for new firm by the introduction or withdrawal of cash. 2. The adjusted balance sheets may be prepared. Capital Account of partner 195 A B C 195 A B C

55

Current a/c (if any) Loss on revolution a/c Loss on sale of assets ( if any) Good will ( new ratio) B Car ( taken over by partner) Bank ( balancing figures) Balance c/d Given to partners

xxx

xxx

xxx

Balance b/d Profit on revolution a/c

xxx xxx xxx

xxx xxx xxx

xxx --xxx

xxx Current a/c

xxx

xxx

xxx Profit on sale of assets ( if any) xxx xxx xxx

xxx

xxx

xxx Good will( old ratio)- A xxx xxx ---

---

---

xxx Good will ( old ratio) B xxx --xxx ----xxx

xxx

xxx --

Bank ( Balancing figures)

xxx

xxx x xx

Taken from partners

xxx

xxx

xxx

xxx

xxx

xxx

Dissolution of partnerships Partnership assets are sold out profits or losses on realization are apportioned to the partners capital accounts in their profit sharing ratio. The balance of cash is

56

used to pay creditors and expenses of dissolution and finally to repay the balance on their capital accounts to the partners. Note: Unrecorded goodwill and assets revaluation are not relevant in this topic. Transfer the balances on the partners current accounts to their capital accounts as current accounts are no more required as business is ended. Accounts to be prepared on dissolution 1. 2. 3. Realization account Capital a/c of partners Bank

First of all open a realization account to record the sale of assets and proceed to make the accounting entries in the following order. Nature of transaction 1. Transfer of asset at to realization a/c(All fixed asset and stock at NBV) 2. Proceeds of sale of assets 3. Assets taken over by partner (at valuation) 4. Cost /Expenses of dissolution 5. Payment of creditors and discount received from creditors. 6. Cash received from Creditors a/c Bank Realization a/c Xxx Xxx Xxx Xxx a/c Realization a/c Bank a/c Xxx Xxx Xxx Bank (cash ) a/c Capital a/c of partner concerned Realization Xxx Xxx Xxx Realization Xxx Xxx Xxx Details Realization a/c Asset a/c Debit Xxx Credit Xxx

57

debaters and for bad debts and discount allowed

7. Credit balance on

Bank Realization a/c Debtors a/c Realization a/c Partner capital a/c Xxx Partner ,s capital a/c Realization a/c Partner loan a/c Bank xxx Partner capital a/c Bank xxx Xxx Xxx Xxx Xxx Xxx

realization a/c (profit )

8. Debit balance on

realization a/c (profit) 9. Repayment of partner loan to firm 10. Repayment of partners capital debit balance on partners capital

Note : Bank a/c , Debtors , creditors , loan should be dealt directly in bank a/c. After making entries 1-6 realization a/c will be prepared and profit or loss on realization a/c will be transferred to partners capital account on basis of existing ratios. Dissolution of partnerships Partnership assets are sold out profits or losses on realization are apportioned to the partners capital accounts in their profit sharing ratio. The balance of cash is used to pay credit and expenses of dissolution and finally to repay the balance on their capital account to the partners. Note: Unrecorded goodwill and asset revelation are not relevant in this topic.

58

Transfer the balance on the partner, s current account to their capital accounts as current accounts are no more required as business is ended. Accounts to be prepared on dissolution Realization accounts 1. Capital a/c of partners 2. Bank First of all open a Realization account to record the sale of assets and proceed to make the Accounting entries in the following order. Nature of transaction Details 1. Transfer of assets at to realization a/c( all Realization a/c fixed assets and stock at NBV) 2. 3. 4. 5. 6.
7. 8.

Debit Credit xxx Asset a/c xxx xxx xxx xxx xxx xxx xxx

Proceeds of sale of assets Assets taken over by partner( at valuation) Cost / Expenses of dissolution Payment of creditors and discount received from creditors Cash received from debtors and for bad Realization a/c debts and discount allowed. Credit balance on realization a/c ( Profit) Debit balance on Realization a/c ( Loss0) Repayment of partners loan to firm. balance on partners capital a/c a/c Bank Realization a/c Debtors a/c xxx Realization a/c Partner capital a/c Partner capital a/c Partner loan a/c Realization a/c Bank xxx xxx xxx xxx xxx xxx xxx Creditors a/c Bank Realization xxx Bank account xxx Bank ( cash) Realization a/c xxx Realization a/c xxx Capital a/c of partner concerned

9.

10. Repayment of partners capitals debits

59

Partner capital a/c Bank

xxx xxx

Note: Bank a/c debtors Creditors loans should be dealt directly in bank a/c. After making entries 1-6 Realization a/c will be prepared or loss on Realization a/c will be transferred to partner capital account on basis of existing ratios. Realization Account 195 xxx Dec 31 Plant Machinery Stock Dec 31 Debtors( Dist. Allowed/ bad debts) Dec 31 Bank ( dissolution expenses) Dec 31 Capital: A B xxx Creditor( Dist. Received) xxx Dec 31 Capital: xxx xxx xxx 195 Current a/c ( if any) Loss on Realization a/c Realization a/c car A xxx xxx B C xxx xxx 195 Balance b/d Current a/c Profit on realization a/c Bank ( balancing figure) xxx xxx Bank (balancing A xxx xxx xxx B xxx xxx xxx C xxx ---xxx A B xxx xxx xxx xxx xxx xxx Partners capital a/c (asset takeover) xxx 195 Dec 3 Bank (Sale of assets) xxx

60

figure) xxx 19x5 Dec 31 xxx Dec 31 Realization a/c (sale of assets Dec 31 Debtors (cash received) Dec 31 Capital: C xxx xxx xxx xxx Dec 31 Capital: B xxx xxx Sale of partnership to limited company OR Conversion of partnership into limited company A partnership may be sold to an existing limited company or the partners may from a limited company and sell the partnership business to it in order to obtain the benefits of limited liability. In either case it makes no difference to the entries required in the partnership books. The limited company may pay for the partnership business in cash or by issuing shares (Ordinary & Preference) and possibly to the partners or by a combination of cash, shares and debentures. Accounting entries of the dissolution of a partnership still apply but the procedure which follower after the is modified as follows. Nature of Transaction 1. Purchase consideration Details LTD Co. a/c Debit xxx Credit A xxx xxx Balance b/d xxx xxx Bank Account 19x5 Dec 31 Balance b/d (if any-O/D) xxx Creditors (cash paid) xxx Loan a/c xxx Realization a/c-dissolution exp xxx xxx xxx

61

Realization a/c 2. Payment in cash Bank LTD Co. a/c xxx

xxx

xxx

3. Payment in preference shares

Preference shares in LTD LTD Co. a/c

xxx xxx xxx xxx

4. Payment in ordinary shares

Ordinary shares in LTD LTD Co. a/c

5. Payment in debenture 6. Closure of partners capital a/c

Debenture in LTD LTD Co. a/c Partners capital a/c LTD Co. a/c

xxx xxx xxx xxx

Distribution of shares, debentures and cash to the partners as per direction in the question. Note: In the absence of any directions in the question, where the partners are to continue as directors of the limited company, receiving salaries and shares of profits, us the following procedure: Partners salaries A ward the partners, directors salaries equal to their partnership a loan which will be transferred to the limited company. Where rate of interest on the debentures is different from that paid on the loan the amount of the debentures

62

allocated to the partner must be such as will give him the same amount of interest each ear as he received from the partnership. Interest rate of loan Formula to convert loan into debenture: Amount Interest Debenture Partnership shares of profit Preserve the partners profit sharing ratio by allocation ordinary shares in their respective capital/profit sharing ratio so that the balance on the capital account of the partner with the lowest capital/profit sharing ratio is satisfied in fully by his allocation of ordinary shares. Satisfy any balances remaining on partners capital accounts with preference shares (or cash). Accounts to be prepared 1. 2. 3. 1. 2. 3. 4. 19x5 Dec 31 xxx Machinery xxx Stock Co. LTD xxx Plant Realization Account Limited Company Account Capital Account of Partners Transfer all assets on Dr. side of Realization Account: Transfer all liabilities on Cr side of Realization Account. (Taken over) Purchase price on Fr side of Realization Account Calculate profit or loss on Realization Account Realization Account 19x5 Dec 31 Creditors xxx rate of of loan X

Steps to prepare Realization Account:

63

xxx Debtors xxx Bank xxx

Dec 31

Capital:

A B

xxx

xxx Dec 31 xxx B xxx Xxx CO. LTD Realization xxx Ordinary shares 10% Preference shares 8% Debenture xxx Partners capital account A B C A B C xxx xxx xxx xxx Capital: A

64

Current a/c (if any) Loss on Realization a/c Ordinary shares Preference shares (Balancing figure) Debenture

.. xxx xxx xxx

.. xxx

xx x

Balance b/d Current a/c

xxx xxx xxx xxx

xxx xxx xxx .

xxx .. xxx .

xx xxx .. x xx x xxx .. xx x Profit on realization a/c Loan

. .

xxx

xxx

xx

xxx

xxx

xxx

x Ordinary shares CO. LTD xxx Capital: xxx xxx xxx ___ xxx 10% Preference shares CO. LTD xxx Capital: A C ___ ___ xxx xxx xxx ___

65

xxx 8% Debenture CO. LTD xxx ___ xxx Loan A/C CO. LTD xxx ___ xxx Introduction to the final accounts of limited company. Features of a company. Capital: Capital: A

xxx

xxx ___ xxx

xxx ___ xxx

It is establish ed by a group of people who are called shareholder (owner) of a company Separate legal entity (name) from its owners. Minimum 2, Maximum No limit , in case of plc and 2 to 50 in case of pvt. Ltd Perpetual life Capital contributed by purchase of shares. Profit distributed to owners is called dividend Board of director elected by share holder s will responsible for running of day to day affairs of the business. Types of company. The following are two types of company 1. Public limited company.

66

Minimum number of shareholders 2, Maximum no limit. Capital should be at least 50000/ Shares are transferable to any body/shares are traded at stock exchange. Private limited company. Minimum number of shareholders 2, max. 50. Capital can be less than 50000/ Shares are not transferable/shares are not traded at stock Exchange. It is also called family business Share. A share is a share in the share capital of a company .(owner the following are two types of shares. ship certificates) Types of share 1. Preference shares Rate of dividend is fixed .10%,20% At the time of payment of dividend preference will be given to shareholder 2. Ordinary share or common share. Rate of dividend is not fixed it is decided by board of directors at the end of year in annual general meeting (AGM) considering profit of company in that particular year. After payment to preference shareholders dividend id paid to ordinary shareholders Capital structure Capital structure of limited company is consisted of following three components. Total number of share(Ordinary /common or preference) Face value per share

67

Total amount of share capital (ordinary /common or preference)

Types of capital . The following are the types of capital . 1.Authorsed share capital ./Registered capital . Total capital of the company which is allowed by the gov,t,to subscribe/issue 10%50,000 preference shares@1 each 100,000 Ordinary shares @1each 2. for subscription . 10%,40,000 preference shares @1each40,000 50,000 Ordinary share @1 each among shareholder is called dividend /common or preference). Dividend is of two types I Interim dividend :Declared and paid during the year: II Proposed /final dividend : Declared at end of year and paid in the next year thats why it is also current liability of business Accounts to be prepared. 1. T &P&L Appropriation A/C 2. Balance sheet FORMAT OF TRADING AND PROFIT & LOSS APROPRIATION A/C 50,000 .Dividend is Issued share capital That part of authorized capital which is issued to public 50,000 100,000

Dividend :That portion of profit which is distributed always calculated on issue share capital . (Ordinary

68

Sale Less :Returned /sale returns Net sales Less: cost of goods sold. Opening stock Add: purchases Add; carriage inward Less: Returned outwards/ purchases return Less closing stock Gross profit Add: Discount received / Rent received Add: Decrease in provision for doubtful debted Add: profit on disposal of asset or Any other income Less: Expenses Rent Salaries Wages Insurance Advertising Repair and maintenance Bad debts Increase in provision for doubtful debt Carriage inwards Depreciation on machinery Van running cost xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

xxx

xxx xxx xxx xxx xxx xxx

69

Fuel expenses Loss on disposal of assets Net profit for the year before taxation Less: corporation tax Net profit for the year after tax Less: Appropriation Transfer to general reserve Interim dividend : Preference shares Ordinary shares Proposed Dividend : Retained profit for the year Add: Retained profit of last year (if any) Retained profit for the year C/D Fixed Assets, Cost Plant and machinery Building Motor Van Furniture and fitting xxx xxx xxx xxx Preference shares Ordinary shares

xxx xxx xxx xxx xxx xxx

xxx xxx xxx xxx xxx xxx xxx xxx Dep. xxx xxx xxx xxx xxx N.B.V xxx xxx xxx xxx

CURRENT ASSETS
Closing stock Debtors Less;: Provision for doubtful debts xxx xxx xxx xxx

70

Cash in hand Cash at bank/ Bank Prepayment

xxx xxx xxx

Less: Creditors due within one years:

Credit Bank Overdraft Accrued Expenses Taxation Proposed dividend Proposed dividend on preference shares Proposed dividend on ordinary shares xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Less: Credit due after one years.

Loans Debentures xxx xxx xxx xxx

Capital and Reserves.

10%, 40,000 preference shares@ 1 each 50,000 Ordinary shares @ 1 each General Reserve Share Premium Profit& loss A/c xxx xxx xxx xxx xxx xxx

Reserves

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This is a form capital is internally generated not provided by the shareholders. They are either created out of profit or through various adjustments to capital structure of a company or through the valuation of fixed assets. Reserves has two types. I. 1. Revenue Reserves II. Capital Reserves Revenue Reserves . Revenue reserves are created by voluntary/ transfer

from P&L appropriation A/C into particular reserve. Examples include General Reserves, Assets replacement reserve, foreign exchange reserve and profit & loss a/c (Retained profits). Profit retained for business are not distributed among shareholder are Revenue which are also called distribution reserves, which means that dividend can be paid out of these reserves. Entry II. P&L appropriation a/c Revenue Reserves

Capital Reserves.
These reserves are not created out of profits of a

company but are required by law under different circumstances. They are also Statutory Reserves| They include share premium Asset revolution reserve and Capital redemption reserves. They are non- distributable reserves and divided can not be paid out of these reserves. Bonus share Dividend Revenue Reserves Capital Reserves

ISSUE OF SHARES
The sequence of transaction is as follow both for ordinary and preference shares. Nature of transaction 1. Issue of prospectus With application Details No entry Debit Xxx Credit Xxx

2. Receipt of application Bank a/c

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money 3. Refund of application money to unsuccessful applications 4. Receipt of allotment money & shares to the applicants 5. Transfer of application money to capital a/cOR Share premium a/c

Application & allotment a/c Bank a/c Bank a/c Application and allotment a/c Application and allotment a/c Capital a/c Share premium a/c Bank a/c 1st call or 2nd call a/c

Xxx Xxx Xxx Xxx Xxx Xxx Xxx

Xxx xxx

Xxx Xxx xxx

6. Receipt of 1st call or

2nd Call money. 7. Transfer of call money to capital a/c (ordinary or preference )OR share premium a/c

1st call or 2nd call a/c capital a/c share premium a/c

Ordinary or preference share capital account

Balance c/d xxx xxx Share premium account Ordinary share capital xxx Application & allotment xxx Application & allotment First & final call

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Balance c/d

xxx xxx

First &final

xxx xxx

Bank Account
Application &allotment Application& allotment Call xxx xxx xxx xxx Application and allotment account Ordinary Share Capital a/c Share Premium a/c Bank (Refund) xxx Bank (application money) xxx Bank (allotment money) xxx First or Second call Account xxx x xx xxx xxx xxx Application & allotment Balance c/d xxx xxx

Ordinary Capital /Share premium a/c xxx Bank Xx x BONUS SHARES

Company reserves belong to the ordinary shareholders. Director of a company may transfer with the agreement of the shareholders some of the balance on the reserves to the Ordinary share capital account. The directors will then issue to the ordinary shareholders additional share certificate equal to the amount of the reserves transferred in proportion to the shares they already hold. These new shares are known as bonus shares because the shareholders do not pay any additional cash for them .An issue of bonus shares is also known as a scrip issue. The accounting entries for issue of Bonus Shares are: Share Premium Profit & loss a/c

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Bonus shares a/c 2. Bonus shares a/c Ordinary shares capital account OR Share premium Profit & loss a/c Ordinary share capital account Effect of bonus on shares on Balance sheet I II 1. Reserves will decrease Ordinary share capital will increase Theses reserve must be considered as part of the long term of the capital of the company. If they are returned in the balance sheet as reserve real capital employed in the business is obscured. 2. 3. The reserve may be capital reserve which cannot be distributed to the shareholders as cash dividends. It may not be financially product to distribute the revenue reserves as cash dividends because the liquidity position of the company may not permit this sort of distribution anyway. Rights Issue The preliminary formalities involved in issuing shares to the general public can be a very expenses matter. A private company may not make such an offer in any case. The directors may therefore decide to raise additional capital by a right issue for which the formalities are less demanding. A right issue is one in which shares are offered to existing shareholder not to general public. The expenses and inconvenience of preparing a full prospectus as for the public issue.

The reason why directors may propose a bonus issue is:

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An additional advantage of a right issue is that control of the company remains with the existing shareholders. Normal accounting entries will be passes on the occasion Of right issue. Effect of issue of right shares on balance sheet. I II Cash will increase Ordinary share capital will increase

Convertible loan stock:

Gives the holders the opportunity at a future date to convert the loan into Ordinary shares of the company at a predetermined price. If, when the time arrives for the stock holders to exercise their option, the market value of the shares is higher than the predetermined price, the debenture holders could find the exchange attractive. On the other hand, if the share value is below the predetermined price, they would be unlikely to exercise their option. Advantages of exercising the option are: 1. The debenture holders continue to have an interest in the company and will be Able to attend and vote at company meetings. 2. 3. Dividends on shares may be likely to exceed the interest on debentures. There is also possibility that value of shares should be increased with passage of time in a healthy company. Effect of conversion of convertible loan stock into Ordinary shares on Balance Sheet. I convertible loan stock will decrease II ordinary Share Capital will increase Redemption and purchase of own shares by a company A company is permitted by the companies Act, 1985, to issue redeemable preference shares. A company may issue redeemable preference shares because

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1They may be redeemed when there is a surplus of capital and the surplus funds cannot be put to profitable use. Capital may be needed in the medium term for a project but the project may be expected to generate sufficient funds in due course to enable the capital to be repaid. If a shareholder in a family company dies his personal representatives may require money as a matter of some urgency to pay taxes. Companies are permitted to redeem their own shares in the following two methods: 1 Out of the proceeds of a new issue of shares. In this method cash is made available for redemption of shares by issue of new shares and share premium a/c is used if shares are to be redeemed at premium. The amount of the premium which may be debited to share premium accounts limited to: The premium on the shares when they were issued and, The balance presently standing to the credit of the share premium account (i.e. the share premium account must not end up with a debit balance) Entry Redeemable preference shares a/c *** Premium on redemption shares a/c Profit & loss a/c Cash a/c 2 shareholders. *** *** ***

By capitalizing profits that would otherwise be distributable to the

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In this method first of all capital Redemption Reserve will be created from General reserves. Shares may be redeemed at a premium, the premium on redemption may charges to share premium account only if: 1 2 The shares to be redeemed were originally issued at a premium and The shares are to be redeemed out of the proceeds of a new issue of shares. The accounting enteries for Redemption of shares are: 1. For creation of Capital Redemption Reserve General Reserve Profit &loss a/c Capital Redemption Reserve a/c 2. For redemption of shares &payment of cash Redemabe Preference shares a/c Premium on redemption of shares a/c Profit &loss a/c Cash a/c 3 For capitalization of Capital Redemption Reserve Capital Redemption Reserve a/c Ordinary Share Capital Account Effect of redemption of preference shares on Balance Sheet: I II Redeemable preference shares capital will be decreased Share Premium a/c will be decreased (if needed) Cash will be decreased A debenture is a document containing details of a loan obtained by a company. The loan may be secured on the assets of the company. Debenture carries a fixed rate of interest. Debenture is usually redeemable on or before a specified date. Debenture holders are Creditors, not owners of the company as shareholders are. Debentures

78

Debenture should always be shown as long term liabilities (amounts falling due after one year) Redemption Of Debentures----Same like redemption of preference shares Effect of Redemption of Debenture on Balance Sheet. I II Debenture will be decreased Cash be decreased

Share Premium a/c OR Profit & loss a/c will be decreased (if needed) Cash flow statement for the year ended 31December 19-3 1. Net cash inflow (outflow) from operating activities (W-1) xxx 2. Returns on investments and servicing of finance Interest received Interest paid Drawing (if any) Net cash inflow (outflow) from ROI & SOF 3. Taxation paid (Previous year) 4. Investing activities/Capital expenditure Purchase of tangible fixed assets Sale of plant and machinery Net cash inflow (outflow) from investing activities 5. Payments of Divends Interim divided paid Proposed dividend (previous year) Net cash inflow (outflow) before financing activities 6. Financing activities Issue of Ordinary /Preference share capital Sale of debenture of goes getting loans xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

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Redemption of debenture Repayment of loans Net cash inflow (outflow) from financing activities Increase / (Decrease) in cash (W-1) xxx

xxx xxx xxx

Cash flow from operating activities

Operating profit /Net profit before interest & tax Add: Depreciation for year Loss on sale of fixed assets Goodwill written-off Increase in provision for doubtful debts Reserve ((if any) Less: profit on sale of tangible fixed assets Decrease in provision for doubtful Less increase in current assets Add: Decrease in current assets Less Decrease in current liabilities Add: Increase in current liabilities Net cash inflow (outflow) from operating activities xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

Analysis of changes in cash and equivalents during the year

Balance at 1January Net cash inflow (Outflow) Balance at 31December Interpretation of Accounts /Accounting OR Financial Ratio xxx xxx

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Accounting Ratio: Accounting ratios are calculated from Trading & profit & loss account and Balance sheet. It is the relationships among figure appearing in the final accounts of a listed Company. It can be expressed in terms of %, proportion or in times. It is normally used for analysis and decision making purpose. Types of Ratio. 1. 2. 3. 4. There are main four types of ratio. Profitability ratio Financial ratio Investment ratio Utilization of ratio Gross profit*100 Sale II.Net profit ratio III. ROCE (Return on capital employed ) =Profit before interest &Tax*100 Capital employed
IV. Return on Equity = Profit before tax & after preference divided *100

1. Profitability ratio I. Gross profit ratio = =

Net profit*100 Sale

Ordinary share capital +Reserve V. Expenses/operating expenses =particulars expenses*100 Sale

2. Financial ratios.
Current ratio or working capital ratio = Current assets Current liability Standard ratio: 2:1 II. Liquid ratio/Acid test ratio /Quick ratio= Current assets closing stock

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Current liabilities Standard ratio:1:1 III. Stock Turnover ratio = Average stock IV. V. Debtors ratios. Creditor Cost of goods sold = Times Average stock Opening stock + closing stock 2 Average number of days in which debtors pay to the Creditor Credit Purchase Investment ratios 1. Gearing ratio = Fixed cost capital * 100 Total capital Note: Fixed cost capital includes long term loan, preference shares and Ordinary share capital + Reserves + Fixed cost capital. Earning for ordinary. Number of ordinary shares Note : Earning means profits after tax and divided on preference shares. III. IV. V. VI. Price earning ratio (PER) Market price of share EPS Dividend covers Dividend yield Earning Yield II. shares Profit available to pay ordinary dividend Ordinary divined. Declared rate of dividend* Nominal value of share Market price of shares I. Dividend yield dividend cover. Earnings Market price per shares * Number of bank overdraft. Total Capital: II. Earning per share. ( EPS) * 365 = xxx days.

business.

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VII. 4. 1. II.

Interest cover = Utilities of resources ratio. Utilities of capital employed = Utilization of total assets =

Profit before interest & tax Interest charges Sale Sale Total asset = = Times Times

Capital employed

Total assets include fixed assets and current assets. III. IV. Utilization of fixed assets = Utilization of current assets = Sale Fixed assets Sale Current assets COST AND MANAGEMENT ACCOUNTING. Cost Accounting is classifying, recording and a appropriate a allocation of expenditures for the determination of the costs of products of services, and for the presentation of arranged data for purpose of control and guidance of management . It includes the ascertainment of the cost of every order ,job , contract, process, service or unit as may be appropriate. It deals with the cost of production ,selling and distribution of the product Cost Accounting is the application of costing and cost accounting principles, methods and techniques to control cost and ascertainment of profitability. The following are the main objectives of cost accounting : :To ascertain the cost per unit of different products manufactured by a business . : To provide a correct analysis of cost by different elements of cost both by processes or operations. :To disclose souse of source of wastage whether of material , time or expenses or in the use machinery , equipment and tools and to prepare such reports which may be necessary to control such wastage. = Times = Times

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:To provide requisite data and service as a guide to price fixing of products manufactured or services rendered. :To ascertain the profitability of each product and advice the management as to how these profits can be maximized. :To revel sources for economy by installing and implementing a system of cost control for materials , labour and overheads. :To present and interpret data for management planning ,decision making and control . :To help in the preparation of budgets and implementation of budgetary control. :To organize an effective information system so that different levels of management may get the required information at the right time in right from for carrying out their individual responsibilities in an efficient manner. :To guide management in the formulation and implementation of incentive bonus plans based on productivity and cost saving. :To supply useful data to the management to take various financial decisions such as introduction of new products, replacement of lab our by machine etc. :To organize the internal audit systems to ensure effective working of different departments. : To provide specialized services of cost audit in order to prevent the errors and frauds and to facilitate prompt and reliable information to the management. Broadly speaking , the above objective can be regrouped under the following three heads : 1. Ascertainment and analysis of cost and income by product, function and responsibility. 2. Accumulation and utilization of cost for control purpose to have the minimum possible cost consistent with maintenance of quality. This objective is achieved through fixation of targets, ascertainment of actual and targets and reporting deviations to the management for decisions making. 3. Providing useful data to the management for decisions making .

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Cost classification
Cost classification is the process of grouping costs according to their common characteristics. The important ways of classification are: 1. 3. 5. 7. By Nature of Element As Direct and Indirect By controllability By Time 2. 4. 6. 8. By Functions By Variability By Capital or Revenue According to Planning and control

Now few classification will be discussed in detail. By Nature or Element. According to this classification, the costs are divided into three categories i.e. (elements of product cost) I Materials: Material cost has following two types.

Direct materials cost. Cost of that material which is basic requirement /need
for the production of a product . For example wood for Furniture making.

Indirect materials cost. Cost of that material which is helping element for
the completion. II Labour cost has following two types Direct labour cost . Cost of that labour which is directly engaged for conversion of wood into furnitures as per design. Indirect labour cost. Cost of that labour which is engaged for the help of direct labour in the production of a product . For example store man, security guard, cleaners, and other helping labour. III FOII :All indirect manufacturing cost of products. Example includes: Indirect material cost Indirect labour cost Deprecation of factory machinery /building Rent of factory building Fuel expenses Utility bills of factory

85

Repair and maintenance of factory Insurance of factory machinery /building As direct and indirect. Accounting to this classification, total cost is divided into direct costs and indirect costs. Direct cost are those which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Example are: I II III IV Direct Materials cost. Direct labour cost Direct expenses Loose tool expenses By variability .Accounting to this classification, costs are classified according to their behavior in relation to change in the level of activity or volume of production. On this basis, costs are classified into three groups .i.e. fixed, variable and semi-variable I Fixed Costs (period Costs) Costs are commonly described as those which remain fixed in total irrespective of increase or decrease in the volume of output or productive activity for a given period of time . Fixed cost per unit decrease as production increases and increases as production decline .These costs are known as period costs because these are dependent on time rather than on output . Examples pf foxed costs are: Rent, Maintenance cost Insurance of factory building, Deprecation (if straight line method is used) II Variable Costs (direct costs) Costs are those which vary in total in direct proportion to the volume of output. Such costs are known as product costs because they depend on the quantum of output rather than on time. Examples are: i. ii. iii. iv. Direct Materials cost. Direct Labour cost. Direct expenses. Variable FOH.

86

iii.

Semi- variable Cost are those which are party fixed and partly variable.

For example telephone expenses include a fixed portion of monthly charge plus variable charge according to calls; thus total telephone are semi- variable.

Manufacturing Accounts. It is prepared by Manufacturing businesses

which are engaged in the production of certain goods. It show the cost of the production of goods i.e. cost of materials labors and factory overheads. It is and expense/ cost account.

Manufacturing cost/ Elements of cost.

1.

Material cost.

Material costs has followings two types.

Direct material cost. cost of that material which is basic

requirement/ need for the production of a product. For example wood for furniture making.

Indirect material cost. Cost of that material which is helping

element foot the completion of a product. For example paint or glue or steel- bar used in furniture making. 2.

Labor cost.

Labor cost has following two types.

Direct labor cost. Cost of that labor which is directly engaged in

the production of a product. For example labor directly engaged for conversion of wood into furniture as per design.

Indirect labor cost. Cost of that labour which is engaged for the
help of direct labour in the production of a product. For example store men security guard cleaner sand other helping labour.

3.

Factory overhead.

All indirect manufacturing costs of a product.

Example includes: Indirect material cost Indirect labour cost. Deprecation of factory machinery/ building.

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Rent of factory building. Fuel expenses Utility bills of factory Repair and maintenance of factory Loose tools expenses Insurance of factory machinery/ building

Stock in the manufacturing business.

1. 2. 3. Raw martial stock. Work in progress( incomplete goods} Finished goods (Goods ready for sale}

Main Points Profit/ loses on manufacturing.

The difference between cost of manufacturing and cost of bought- in goods is a factory profit or profit on manufacturing and increases the profits of the firm and if the cost of production exceeds the cost of similar bought in goods, a factory loses on manufacturing Manufacturing profit OR factory profit i. i. II. Added to cost of production Deducted from cost of production.Ii. ii. Added to net profit Manufacturing loss OR factory loss Deducted from net profit Elimination of unrealized manufacturing profit on unsold stock of The prudence concept requires that profit shall not be anticipated before it is realized. If the valuation of closing stock of finished goods includes an element of factory profit this unrealized profit must be laminated in the profit and loss account and balance sheet by making an appropriate provision. i. Creation/ increase in provision. Profit and loss account.

finished goods.

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Provision account ( with the amount of creation or increase) Decrease in provision: Provision account; Profits and loss account ( with the amount of decrease) ii. goods. In balance sheet ; deduct provision from stock of closing finished

Accounts to be prepared.
Manufacturing a/c Trading& P&L a/c Balance Sheet. Manufacturing account. Opening stock of raw material Add : purchase of raw material Add : carriage inwards Less : Return outwards/P/return Less closing stock of raw material Cost of raw material used Add: direct labor cost/ direct wages/ factory wags/ Mfg. wages Add: direct expenses ( if any) ( Royalty) Prime cost Add: F.O.H Indirect material cost Indirect labor cost Deprecation of factory machinery/ building Rent of factory building Fuel expenses Utility bills of factory xxx. xxx. xxx xxx xxx. xxx. xxx. xxx. xxx. xxx. xxx. xxx

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Repair and maintenance of factory

xxx xxx xxx xxx xxx

Loose tools expenses ( opening stock + purchases closing stock) Insurance of factory machinery / building Total factory cost/ total manufacturing cost Add : factory profit or manufacturing profit ( loss) xxx

Trading & Profit & Loss A/C

Sales xxx

Less: cost of goods sold.

Opening stock of finished goods Add: Production cost of goods completed Less: closing stock of finished good Gross Profit Add ; Rent received/Discount received Add : Decrease in provision for unrealized profit on unsold stock. xxx xxx xxx xxx xxx xxx xxx

Less; Expenses
Rent Salaries/ Wages Insurance Advertising Bad debts Depreciation on Furniture Fuel. Expenses Increase in provision for unrealized profit on unsold stock xxx xxx xxx xxx xxx xxx xxx xxx xxx

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Net profit/ Net loss Add: Factory profit or manufacturing profit ( loss) xxx

xxx xxx

Balance sheet Current assets

Stock of raw Material ( closing) Work in progress Finished goods Loose tools ( closing) ( closing) ( closing) xxx xxx xxx xxx

Matrial / Stock costing

There are two system of material costing or inventory control. Perpetual inventory system.

A Perpetual inventory system is one in which a running balance is maintained of stock After every purchase and sale of stock in Material card or store card or Bin card.

This system is normally adopted permanently by the big business units which have a lot of daily transactions.( purchase/ sale)

Expensive system because certain employed to be engaged for maintaining record of stock transactions and stationary will also be consumed largely. Following three methods are used in this system: o FIFO o LIFO o Average cost method Proper material. Card/Bin card to be prepared

Format of bin card/ material card

Date
Units

Purchase/Receipts
Unit cost Total cost Units

Sale/Issue
Unit cost Total cost Units

Balance
Unit cost Total cost

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2.

Periodic inventory system

A periodic inventory system is one in which only the totals of purchases and sales are record at the end of each accounting period and a new balance is calculated at the end of particular period.

This system is normally adopted by small business units which have few transactions over a particular period.( purchase/ Sale)

Less expensive because no need to engage employees for maintaining record of stock transaction. Following three methods are also used in this system: o FIFO o LIFO o Average cost method Advantages and disadvantages at page No 324 of Randal book. To be prepared Calculation of profit

Calculation of value of closing stock under FIFO, LIFO, AVCO.

Stock valuation statement. Format of calculation of profit ( trading and profit & loss account) FIFO Sales Less: cost of goods sold Opening Stock Add :Purchases Less : closing stock xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx LIFO xxx x AVCO. xx

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Gross profit Rent Advertising Depreciation Net profit x Format of stock valuation statement Stock ( at cost ) as on 10-1-06 xxx xxx xxx xxx (xxx)

xxx x xxx xxx xxx (xxx) xx x

xx xx xxx xxx xxx (xxx) xx x

xx

Add: item which were in stock on 31-12-05 ( at cost) Sales xxx Goods sent to customer on approval xxx Purchase made but not received xxx Damaged stock ( xxx Purchase return/ Return outwards xxx Stock sheet understated xxx Less: item which are not in stock on ====(at cost) Purchases xxx Sales return /Return inwards xxx )

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Stock sheet overstated xxx Stock in hand as at 31-12-2004 xxx Absorption costing: This is a technique of costing in which all cots of a product are considered the product cost and it includes direct material cost, direct labour cost, direct expenses and fixed & variable overheads. Profit statement under absorption costing Sale Less: Cost of goods sold Direct Material Cost Direct labour cost Direct expenses (if any) FOH Fixed Variable Add. Opening stock Less closing stock (To be calculated) Gross profit Overheads xxx xxx xxx xxx xxx xxx xxx xxx It means all direct costs of production and it includes indirect 0

material cost, indirect labour , factory repair , factory fuel expenses , factory rent ,factory utility bills, looses tool expenses, factory insurances , depreciation of factory machinery , depreciation of factory building etc. For distribution of overheads Departments of a business can be divided into two types: I II Production departments----Engaged in production of certain products. Service departments --------Supporting to production departments

Overheads can be divided into two ways. Allocation (Direct expenses ): Expenditure are allocated to a cost centre when it was made specifically for that cost centre. Examples of expenditure which can be allocated are:

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Expenditure Lubricating oil Repairs to racking Food

Cost centre Machine shop Stores Canteen

Apportionment (indirect expenses) :Expenditure which are made for the benefit of the business generally cannot be allocated ; it is apportioned on some equitable basis. Such expenditure are rent, rates insurances heating and lighting etc. Apportionment of indirect expenses to cost centre must be made on fair and reasonable bases. Bases for appointment of overheads: Overheads Building, rent, rates, maintenance, centers Depreciation, Insurance Heating, lighting Plant, machinery and equipment Plant, machinery and equipment asset Cost of store keeping stores requisition Raised by each cost centre Cost of canteen, personnel/administration .Deptt on number of personal /employees of cost Centre To be done GOH Distribution sheet On number or value of On floor area of each cost On floor area of each cost centre depreciation On cost or book value of Asset insurance On replacement or cost value of Basis for apportionment to cost

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Transfer of Services Department cost to production departments Calculation of FOH Rate or OAR FOH Distribution sheet Cost element Basis of Tota Maching Assemb Painting ly Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Xxx Packing Apportionme l nt Indirect material cost Allocated indirect labour cost Factory repairs/maintenance heating Plant depreciation Plant insurance Allocated Floor area Floor area Floor area Cost of plant Replacement value of plant Storekeeping No. of requisitions Total 1st . Apportionment (packing Dept) xxx Xxx Xxx Xxx Xxx xxx Xxx Xxx Xxx Xxx xxx xxx xxx xxx xxx xxx xxx

2nd Apportionment (paint Dept)

xxx

Xxx

Xxx

xxx

Xxx

xxx

xxx

xxx

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FOH Rate OR(Overhead Absorption Rate) department

Estimated FOH of Base

Base for (calculation of FOH Rate) 1. Direct labour hours 2. Machine hours 3. units of producaton 4. Direct material cost 5. Direct labour cost 6. Prime cost Over/under recovery of overheads Overheads absorption rate are based upon budgeted level of activity and if actual expenditure and activity are equal to budget the overheads will be recovered exactly and if actual activity does not correspond to the budget the cover/under recovery of overheads will be resulted. Budgeted/estimated overheads Actual overheads Under estimated esteemed and will be added to cost of production If actual overheads are less than budgeted/estimated overheads , it is over estimated and will be deducated from cost of production Marginal Costing In this techniques of costing only VARIABLE COSTS are considered product cost.i.e.Direct material cost, Direct expenses and variable costs are considered period cost i.e fixed FOH Profit statement under Marginal Costing Sale xxx FOH. Fixed 50,000 60,000 10,000

If actual overheads are than budget/ estimated overheads, it is under

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Less; Variable Cost of goods sold Direct Material Cost Direct Labour Cost Direct expenses (if any) Add. Opening stock Less closing stock (To be calculated) xxx xxx xxx Contribution Margin (sales-variable costs) Less Fixed overheads Net Profit Profit statement under Absorption costing /Marginal costing Absorption costing Sale Less: cost of goods sold Direct Material cost Direct expenses FOH :variable Fixed xxx xxx Xxx Xxx Xxx Add. Opening stock Less closing stock Gross profit /contribution Margin Less: Fixed FOH Profit xxx Xxx Xxx xxx Xxx Xxx Xxx Xxx xxx xxx Xxx Xxx Xxx xxx Marginal costing xxx xxx xxx xxx xxx xxx

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Break even analysis. 1. Break even (units) =Fixed cost =C.M per unit Break even (Currency) =Fixed cost 2. Target profit: x Sale price per unit xxx =xxx C.M. per unit =Fixed cost+target profit C.M. per unit 3. Margin of sagety =Total /current sale-break even sale 500,000-450,000=50,000 CM= CM= Contribution Margin Sale Variable Cost In this techniques of costing cost of production is

Process Costing. that cost centre. Process

charged to particular department or cost centre by preparation of process a/c for costing is used when goods or service are produced in a series of

continuous or respective operations or process . Process costing is appropriate for an industry, such as the manufacture , chemical manufactute etc . Assume production for 2000 units is started and following results obtained: Finished Goods Work in Progress Unit lost Important points 1. Stage of Compleion of WIP. It means that how many units of WIP are completed with reference to material , labour and FOH. For example Material Labour FOH 100 80 50 1500 400 100 2000

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3. Losses/gains: I. II. III. Normal loss -5%,10% Abnormal loss-controllable loss Abnormal gain : 100-105=5 units Some loss of material may be expected in the course of

Normal loss:

processing .This may result from spolage , evaporation or other wastage. Experience will show what percentage of wastage may be expected under normal conditions and this is regarded as normal wastage inherent in the process. The cost of such waste will be borne by good production /output. Abnormal losses and grains: Any wastage in excess of normal is treated as abnormal loss and written off to profit and loss account via abnormal loss account . Calculations of per unit cost: There are two ways to calculate per unit cost in process costing. 1. Calculations of per unit cost If closing WIP is not existed in the questions: Total cost ---sale recovery of normal loss units GOODS UNITS Good units: All units will be considered good units except normal loss units II. If closing WIP is existed in the questions per unit cost will be calculated by preparation of analysis of equivalent units of production in the Following format Cost elements Material Labour FOH 1500 1500 1500 400 320 200 1900 1820 1700 8000 7500 6000 4.22 4.11 3.52 Finished Good +Abnormal Loss-abnormal gain WIP Units Total units Total cost P.U Cost

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11.85 STEPS 1. 2. 3. Normal loss units Finished Good /WIP Abnormal Loss/Gain. Process Account-I Direct Material Cost Additional Mat. Cost if any Direct labour cost Direct expenses FOH Abnormal Gain xxx xxx xxx xxx xxx xxx xxx Abnormal loss WIP(Balancing figure) Xxx Xxx Xxx Xxx Normal Loss (note-i) Finished goods Xxx Xxx Xxx Xxx

Note.1

Recovered amount by sale of scrape units/normal loss units should be Process Account-2

shown in the cost column Direct Material Cost Additional Mat. Cost if any Direct labour cost Direct expenses FOH Abnormal Gain xxx xxx xxx xxx xxx xxx xxx Abnormal loss WIP(Balancing figure) Xxx Xxx Xxx Xxx Normal Loss Finished goods Xxx Xxx Xxx Xxx

Abnormal loss a/c Process-1 xxx Scape value(Recovery) xxx

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xxx Joint product:

P&L Abnormal gains a/c

xxx

Two or more different products may results from one

process .They are not recognizable as different products until they emerge at the point of separation. If the products are known each have a significant sales value, either at the point of separation or after further processing, they are known as joint products are : Example of joint products are : Coal gas production : (I) coal gas Oil refining : (I) petrol (II)coke (II) Diesel oil (III) Lubricants

Methods for calculation of joint products cost. 1. Units of output/ physical units 2. Sale value of the product By products: A by product is produced in a similar manner to a join product, but it has a low sales value compared to the sales values(s) of other man products(s) resulting from the process. Example of by-products are: Garment manufacture: Remain of material (can be sold for various uses.) Founding: Slag (used in construction industries ) Joint cost includes by product cost Total cost Joint cost Budget Estimate of income and expenses of a business over a particular period on the basic of estimated activity. Types of budget 1. Cash budget 2. sale budget 150,000 20,000 130,000 Less: By product cost

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3. production budget 4. Master budget Project trading and profit & Loss a/c Project balance sheet Cash budget Cash budget III. IV. V. Receipts schedule Payment schedule. Cash budget January xxx xxx xxx xxx xxx xxx Payments Cash purchased Paid to creditors Expenses paid Drawings Purchased of fixed assets xxx Loan repaid Any other cash paid xxx Net receipts (payments) Balance b/d ( opening) xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx February xxx xxx xxx xxx xxx xxx March xxx xxx xxx xxx xxx xxx

Format of cash budget Receipts Cash sale Received from debtors Sale of fixed assets Loan obtained Any other cash received

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xxx xxx Cash budget Opening balance of cash/ Balance b/d Recipts - Payment Balance c/d Flexible budget: xxx xxx (xxx) xxx

xxx xxx

xxx xxx

xxx xxx (xxx) xxx

xxx xxx (xxx) xxx

Production budget -------------------------from book ----------page 399 A budget is prepared on the basis of a pre- determined level of activity, however, management may anticipate the actual level of activity being greater or less than budget. The budget may, therefore be flexed i.e prepared for various level of activity to enable realistic comparisons of actual and budget result. Note: The most important thing in budget questions in policy of sales Project trading profit trading and profit & less account and projected balance sheet will be prepared as already done. Standard Costing. It is the pretermined cost of a product. It includes direct material cost,direct labour cost direct expenses and FOH. Assume standard units are 500 units and standard per unit cost is estimated as under: Material Labour FOH 3 met 2 each 2 Houm@2 per hour 100% OF D.labour 4 purchases, payment of expenses and their calculations.

Standard cost per unit Actual data after completion of period OR work Actual output 480

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Actual cost Material Labour FOH Variance Analysis Material Variance 1. Total material cost variance OR overall material variance standard cost of material actual cost of material (St.Qty x. price)-(Actual Qtyx actual price) 2. 3 Material price variance standard price actual price x actual Qty purchased or used Material usage /Quantity varience . (Standard quantity actual quantity ) x standard price Labour variance 1. Total labour cost variance OR Overall labour variance Standard labour cost---Actual hours cost. 3. 4. Labour Rate /wages varience Standard Rate Actual rate x Actual hours worked. Labour Efficienvy Variance Standard hours allowed actual hours worked x standard rate Sale Variance 1. Total sale variance OR overall sale variance Standard sale price- actual sale price (standard sale quantity x standard sale price)-(Actual sale quantity x actual sale price) 2. 3. Sale price variance Standard sale price-actual sale price x actual quantity sold Sale Volume variance Standard sale quantity actual sale quantity x standard sale price xxx xxx xxx

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Investment Appraisal OR Capital Expenditures 1. ARR Accounting or Average rate of return 100 = % Average capital employed average capital employed: of capital employed + working capital. Accounting rate of return (ARR) accounting rate of return calculates average annual profit as a percentage of average capital employed. Accounting capital is calculated as one half of the capital outlay on the project based on the assumption that the fixed assets will be completely deprecation by the end of the project. the return on capital from the project will be compared with the return being earned on the capital already invested in the business. 2. Payback period. Risk is an important factor to be considered in capital expenditure decisions. the sooner the outlay on a project is an a project is covered by the inflow of cash the better this is the payback period. A long period increase the risk that the outlay will not be recouped. The payback period is measured in years. Only cash paid or received enters into the calculated and non-cash item such as deprecation and accruals and prepayment are ignored. Comparison of the payback period of two projects Project 1 Cash ( out flow) Inflow Years 0 (100-000) (100-000) Project 2 Cash ( outflow) Inflow Balance (100,00) Balance (100,00) Net profit

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1 2 3

20,000 40,000 40,000 -

(80,000) (40,000) 25,000 30,000 30,000

15,000 20,000 (40,000)4 (10,000)5 20,000

(85,000) (65,000) -

3.

IRR

Internal Rate of return. IRR= x + pq AC Ad

X = Rate giving positive NPV pq = Distance between two rates used to give NPVs Ac = The positive + negative value Internal rate of return ( IRR) The net present value of a project is calculated by discounting net receipts at rate equivalent to the cost of capital. This shows whether or not future net receipts, when discounted will be at least to the in initial outlay in learns of the present value of money. If a company is to make a profit, it must earn a higher rate of return on an investment than cost of its capital. Management needs to know what rate of return an investment will yield. The expected yield can capital be compared with the rate carned on its other capital. The rate is found by calculated the Internal Rate of Return. The Internal Rate of Return is the discounting rate which equates the discounted net receipts from a project to its cost, i.e. the rate which produces a nil NPV. **************END***************