Unit : I [ 25 % ]Basics of Accounting

Definition of Accounting and its advantages & limitations, Scope of accounting, Branches of Accounting – Financial Accounting – Cost Accounting – Management Accounting, users of Accounting information, Methods of Accounting, Double Entry Accounting System, Types of Accounts and Rules for Debit and Credit. Cash and Credit Transaction, Cash discount and Trade discount.

Preparation of Journal, Ledger and Trial Balance.

Meaning of AccountingIt is common experience of all of us that money must be spent

carefully. If a person is careless in spending money, a day will come when he will be left with no money. Same is true of a business firm.In business numerous transactions take place every day. It is humanly impossible to remember all of them. Hence, it is necessary to record them. The recording of Business transaction is the main function served by Accounting. Accounting is rightly termed as the language of business. With the help of accounting records, the business person is able to ascertain the profit or loss for the specified period and the financial position of his business on given specified date and communicate such information to all interested parties. The accounting information is useful both for the management and the outside agencies like Tax Authorities, Banks, Creditors etc. The management needs it for the purpose of planning, controlling and decision-making. The Banks and Creditors require it for assessing the credit worthiness of the business and the tax authorities use it for determining the amount of Income Tax, Sales Tax etc. In fact, accounting is necessary not only for business organization but also for non-business organizations like schools, colleges, hospitals etc.Definition of Accounting

In the words of Committee on terminology, appointed by the American Institute of Certified Public Accountants,

“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character and interpreting the results thereof.”

This is the popular definition of accounting and it outlines fully the nature and scope of accounting activity.

1. Recording of transactions.This is done in the book termed as “JOURNAL”.

2. Classifying the transactions.This is done in the book termed as “LEDGER”.

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3. Summarising the transactions.This includes preparation of Trial Balance, Profit & Loss Account and Balance Sheet of the Business.

4. Interpreting the results.This involves computation of various accounting ratios etc. to know about the liquidity, solvency and profitability of business.

Scope of Accounting.The scope of accounting can be outlined as follows.1. Accounting is concerned with the transactions and events which are

of a financial character. Such transactions have to be identified by the accountant. He can do so with the help of various bills and receipts.

2. The transactions should be measured or expressed in terms of money.3. The transactions identified and measured are to be recorded in a book

called “JOURNAL”.4. The recorded transactions have to be classified in order to group

transactions of similar nature at one place. This work is done in a separate book called “LEDGER”. In the Ledger a separate account is opened for each group of transactions of similar nature so that all transactions relating to it can be brought at one place.

5. To verify the arithmetical accuracy of the data, a summary of all the ledger accounts is being prepared. This is known as TRIAL BALANCE.

6. To make the summarised data more meaningful and to assess the performance of the business firm at the end of particular period an account known as “ PROFIT & LOSS ACCOUNT “ is being prepared. Also to ascertain the financial position of the business firm on a particular point of time, a statement of affairs known as “ BALANCE SHEET “ is being prepared.

7. To help the management in taking effective decisions and to help in making business more profitable, the financial statements (PROFIT & LOSS A/C AND BALANCE SHEET) are being analysed and interpreted with the statistical tools like ratios, averages, etc.

Advantages of Accounting1. Replaces Memory.

Since all the financial events and transactions are recorded in the books, there is no need to rely on memory. The books of accounts will serve as historical records. Any information required at any time can be easily traced from these records.

2. Provides Control over Assets.Accounting provides information regarding all the assets such as cash in hand, cash at bank, the stock of goods, the amounts receivable from

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various parties, the amounts invested in various other assets etc. Information about such matters help the owners and the management to have better control over the assets and also helps them to make use of the assets in the best possible way

3. Facilitates the preparation of Financial Statements.The business person is always interested in assessing the performance of the business and in ascertaining the financial position of his business at the end of a particular period. With the help of information contained in the accounting records the profit and loss account and Balance Sheet can be easily prepared which in turn will help in assessment of the performance of a business firm.

4. Works as information Tool.Various interested parties such as owners, lenders, creditors etc. can have necessary information at desired intervals to equip them in taking better decisions.

5. Intra Firm comparison & Inter Firm comparison.With the help of accounting information, it becomes possible to compare the present performance of the business firm with its past performance. It also becomes possible to compare the performance of the business firm with other business firms of similar type. These comparisons assist the management and the owner to gear up the business operations for better. It also helps them in taking effective decisions in planning and controlling all business activities.

6. Works as safeguard against possible Fraud and/or Theft.Recorded accounting transactions make it possible to verify arithmetical accuracy which in turn works as moral barries for the persons having malafied intentions of committing fraud. Thus the accounting works as safeguard against frauds and thefts. In large organisation the book-keeping work can be divided amongst many persons which minimize the chances of frauds.

7. Ascertaining value of Business.The accounting records will help in ascertaining the correct value of business in the event of sale of the entire business.

8. Acts as Reliable Evidence.Systematic record of business transactions is generally treated as good evidence in Court of Law in case of disputes.

9. Tax matters.Properly maintained accounting records helps in preparation of tax statements and also helps in explaining the queries raised by the tax authorities.

Limitations of Accounting

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1. The transactions and events which are not of financial character are not being recorded. Facts like quality of human resources, licences possessed, location advantages, business contacts etc. do not find place in the books of accounts. Thus accounting does not provide complete picture of the business.

2. The recorded data is always historic in nature. It always depicts historical value of all assets and liabilities for the business firm. In inflationary trend, to have better idea of the state of affairs of the business, the current values of the assets and liabilities are more relevant. Thus to this extent the accounting does not provide relevant information.

3. Facts recorded in the financial statements are greatly influenced by accounting conventions and personal judgments. Decisions taken on the basis of such information may not prove to be as effective as it should be.

Methods & Systems of Book-keeping.Generally, one of the following three methods of book-keeping is

being followed.Deshi-Nama System

It is one of the methods of Book-keeping followed in India. About 90 % of the businesses are using this method for preparing their books of accounts. This method is very simple less expensive and suitable to all business entities. Under this method two important books are maintained. i.e. (a) Rojmel and (b) Khatavahi.

Double Entry System of Book-keepingIt is a method which has its origin in Europe. Though it is costlier

compared to Deshi Nama System and requires skilled man-power, because it is a scientific and complete method, more and more business firms are now a days following this method.

In this method, the transactions are recorded as per the "RULES OF DEBIT AND CREDIT". In Double Entry Accounting system every business transaction has a two fold effect. The receiving aspect and the giving aspect. Thus, in commercial context it is a famous dictum that

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“Every receiver is also a giver and every giver is also a receiver.”Single Entry System

It is an incomplete form of double entry system of book-keeping. Under this method only one aspect of the transactions is being recorded and so it is known as “ SINGLE ENTRY SYSTEM “. It is in fact a defective and incomplete method because it does not provide all the information of the business. If one who is following this system wants to prepare final accounts, first of all he will have to find out missing information, then only he can proceed further.Branches of Accounting

Accounting has three main branches, viz., Financial Accounting, Cost Accounting, Management Accounting. These branches of accounting have been developed to serve different objectives.Financial Accounting

In the words of Committee on terminology, appointed by the American Institute of Certified Public Accountants,

“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character and interpreting the results thereof.”

Financial Accounting is primarily concerned with record keeping directed towards the preparation of Profit and Loss Account and Balance Sheet. The main purposes of financial accounting are:

1. Recording of the transactions concerning and affecting the business;

2. Preparation of necessary accounts and balance sheet as required by statutes;

3. Apprising the owners of the business about the results of the business over a period of time.

Financial accounting is the accounting for revenues, expenses, assets and liabilities that is commonly carried on in the general office of a business. It is a term often limited to the accounting concerned with published financial reports in contrast to internal aspects of accounting such as cost accounting.

Cost AccountingCost Accounting is the process of ascertaining cost from the point at

which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centre and cost units. It is the process of accounting for costs. It is a systematic procedure for determining the unit cost of output produced or services rendered. Its Primary functions are to ascertain the cost of product and to help the management in the control of cost. So, this branch deals with the classification, recording, allocation, summarization and reporting of current and prospective costs.

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Management Accounting“Such of its techniques and procedures by which accounting mainly

seeks toaid the management collectively have come to be known as Management Accounting.”

- The Institute of Chartered Accountants of India

Management is primarily concerned with the supply of information which is useful to management in decision making for the efficient running of the business and, thus, in maximizing profit. Management Accounting is the reproduction final accounts in such a way as will enable the management to take decisions and to control activities.

Management Accounting is the term used to describe the accounting methods, systems and techniques which coupled with special knowledge and ability, assist management in its task of maximizing profit or minimizing losses.

So, it is the blending together into a coherent whole, Financial Accounting, Cost Accounting and all aspects of financial management.

MEANING OF JOURNAL AND JOURNALISING.A Journal is a book in which the transactions are recorded in the order

in which they occur, i.e. in chronological order. It is called a book of prime entry (also original entry) because all business transactions are entered first in this book. The process of recording a transaction in the Journal is called “Journalising”. An entry made in the Journal is called a ‘Journal Entry’. A format of a Journal is shown below.JOURNAL

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CLASSIFICATION OF ACCOUNTS AND RULES OF DEBIT AND CREDIT

An account is a summary of relevant transactions at one place relating to a particular head. It records not only the amount of transaction but also their effect and direction. The transactions in the journal are recorded on the basis of the rules of debit and credit. For this purpose business transactions have been classified into three categories.

1. Transactions relating to persons.2. Transactions relating to properties and assets.3. Transactions relating to incomes and expenses.

The classification of accounts can be given as under.

Types of account Meaning1. Personal Accounts These accounts relate to natural persons, artificial

persons and representative persons.

2. Real Accounts These accounts relate to the tangible or intangible real assets.

3. Nominal Accounts These accounts relate to expenses, losses, profit & gains.

Thus, three classes of accounts are maintained for recording all business transactions. They are (1) Personal accounts, (2) Real accounts and (3) Nominal accounts.

Basically, debit means to enter an amount on the left side of an account and credit means to enter an amount on the right side of an account. In the abbreviated form Dr. stands for Debit and Cr. stands for Credit. Both debit and credit may represent either increase or decrease depending upon the nature of an account.

The Rules for Debit and Credit are given below.Types of Account Rules for Debit Rules for Credit

1. For Personal Accounts Debit the receiver Credit the giver

2. For Real Accounts Debit what comes in Credit what goes out

3. For Nominal Accounts Debit all expenses & losses Credit all gains & profit

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MEANING OF LEDGERA Ledger is a principal book which contains all the accounts (Assets

Accounts, Liabilities Accounts, Capital Account, Revenue Accounts, Expenses Accounts) to which the transactions recorded in the books of original entry are transferred. As the Ledger is the ultimate destination of all transactions, it is called the “BOOK OF FINAL ENTRY”. It is considered as a permanent record and is frequently referred to. It may be noted that an account is a formal record of all transactions relating to change in particular item. A Ledger may be kept in form of bound books, loose leaf sheets, floppy diskettes (in case computer is used) or any other like device.

POSTINGPosting is the process of transferring transactions recorded in the

books of original entry to the concerned accounts opened in the ledger. It may be daily, weekly, fortnightly, or monthly according to the convenience and requirements of the business. It is necessary to post all journal entries into various accounts in the ledger because posting helps us to know the net effect of various transactions during a given period on a particular account. Posting in the ledger account is considered complete only when both the debit and credit aspects of all journal entries have been posted.

BALANCINGBalance of an account is the difference between the total of debit

items and total of credit items appearing in an account. It signifies the net effect of all transactions posted to that account during a given period. It may be a debit balance or a credit balance or a nil balance depending upon whether the debit or the credit total is higher. Normally, personal accounts and real accounts are balanced. Nominal accounts are not usually balanced but closed by transfer to Trading, and Profit & Loss Account. Balancing an account is necessary to ascertain the effect of all transactions posted to that account during a given period.

TRIAL BALANCEAll transactions are first juornalised in the JOURNAL or the

SUBSIDIARY BOOKS where from these entries are transferred to relevant accounts in the ledger. At the end of the year in order to verify whether the books of accounts are written properly and correctly, trader prepare a statement which is known as TRIAL BALANCE. It is prepared mostly on the basis of the balances of various accounts in the ledger.

A trial balance is a statement of assets and liabilities as on a particular date. It is stepping stone in the preparation of Final Accounts.

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This statement is a link between the ledger and the Final Accounts. Trial balance is not a final proof that books of accounts have been written accurately. It only indicates arithmetical accuracy in writing books of accounts. An agreed trial balance is a must for the preparation of final accounts. Disagreement of trial balance clearly indicates that there are errors. On the other hand trial balance agrees even when there are errors.

A Trial Balance is a statement which shows either the balances or total amounts of debit items and credit items of all the accounts in the ledger and the Cash and Bank balances. It may be noted that a trial balance is a statement and not an account and is prepared on a particular date and not for a particular period. A Trial Balance may be prepared either following Balance Method or Total Amount Method.Balance Method:-

Under this method, the balances of all the accounts (including Cash and Bank Account) in the ledger are incorporated in the trial balance. It may be noted that a trial balance by this method can be prepared only when all the ledger accounts have been balanced.Total Amount Method:-

Under this method, the total amount of debit items and credit items in each ledger account are incorporated in the trail balance. It may be noted that a trial balance by this method can be prepared immediately after the completion of posting from the books of original entry to the ledger.

1. All accounts of expenses (including purchases and losses) will be debit balances.

2. All accounts of incomes (including sales and gains) will be credit balances.

3. All accounts of assets will be debit balances.4. All accounts of liabilities will be credit balances.5. Capital a/c will normally be credit balance.6. Drawings a/c will be debit balance.7. Rent, Discount, Commission, Interest is usually indicated by

mentioning Dr. or Cr. Against each item OR the word ‘received’ or ‘paid’ is written after each item.

Book-Keeping and AccountancyBook-keeping: Book-keeping is a process of using business

transactions in books of account. It includes entering the transactions in the books of original entry like journal or other subsidiary books, posting them into the ledger and preparing a trial balance at the end of a specified period.

Accountancy: Accountancy is something more than book-keeping. It includes preparing final accounts after the accounts are written, analysing and interpreting them, rectifying the errors etc. Accountancy is therefore, used at the higher level of management. It assists the management in taking important policy decisions.

Cash and Credit Transactions.

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Cash transactions: A transaction in which there is a receipt or payment of cash is a cash transaction. Cash balance is affected by such transaction.Credit transactions: In credit transaction, there is no receipt or payment of cash immediately, but it is postponed to some future date. Cash balance is not affected by such transaction.

If the word ‘CASH’ is mentioned in the transaction, it is treated as cash transaction.If the transaction does not mention the word ‘CASH’ but contains only the name of a

person, it is a credit transaction.If the transaction does not indicate ‘CASH’ or ‘CREDIT’, and does not mention the name

of any person, then it must be cash transaction.If in a transaction, the name of any person is mentioned and also cash

receipt or payment is indicated, then it is a cash transaction.

Mr. X has prepared the following notes from the vouchers of his business transaction for July 2008. State the accounts to be debited and credited as per the rules of debit and credit.1 Started business with cash Rs. 100000.2. A loan of Rs 15000 received from Mr. F.3. Deposited Rs. 5000 in the Current account with Bank of India4. Purchased goods for Rs. 25000.5. Sold goods of Rs. 5000 for cash.6. Purchased goods of Rs. 5000 for cash from Mr. Y.7. Purchased goods of Rs. 6000 from Mr. J.8. Purchased goods of Rs. 4000 from Mr. C. on credit.9. Sold goods of Rs. 2000.10. Sold goods of Rs. 1000 to Ms. S. for Cash.11. Sold goods of Rs. 2200 to Mr. R. and Sold goods of Rs. 5000 to Mr. N. on Credit.12. Goods of Rs. 1000 returned by Mr. R. Goods of Rs 500 returned to Mr. J.13. Wages paid Rs. 1000.14. Insurance premium of the shop Rs. 300 is paid by cheque.15. Commission received Rs. 500.16. Loan of Rs. 5000 given to Mr. G.17. Paid Rs. 750 to Mr. J.18. A cheque for Rs. 1000 received from Mr. R.

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19. Mr. N has paid Rs. 500 on our behalf to to Mr. C.20. Purchased Furniture of Rs.5000.21. A piece of land of Rs. 10000 was given by the proprietor for the business.22. Furniture worth Rs.200 was sold at cost.23. Purchased Machinery of Rs.50000.24. Purchased a Cycle of Rs.1500.25. Purchased stationery of Rs.500.26. Withdrawn Rs.2000 from the business for personal use.27. Paid house rent (for residence) Rs.500.28. A table of Rs.500 purchased by exchanging goods.29. Goods of Rs.500 distributed as samples.30. Withdrawn Rs.1000 from the current account of Bank of India.31. Rs.5000 given to Mr. F against loan account.31. Bank of India has debited a service charge of Rs.20 in our account.

Tr. No.

Name of the A/c Type of the Account

Reason for DebitingAnd Crediting

Debit/Credit

Amount Rs.

1 Cash A/cCapital A/c

Real A/cPersonal A/c

Cash comes inProprietor is giver

DebitCredit

100000

100000

2 Cash A/cLoan of Mr. F

Real A/cPersonal A/c

Cash comes inMr. F is giver

DebitCredit

1500015000

3 Bank of India A/cCash A/c

Personal A/cReal A/c

Bank is receiverCash goes out

DebitCredit

50005000

4 Purchases A/cCash A/c

Real A/cReal A/c

Goods comes inCash goes out

DebitCredit

2500025000

5 Cash A/cSales A/c

Real A/cReal A/c

Cash comes inGoods goes out - Sales

DebitCredit

50005000

6 Purchase A/cCash A/c

Real A/cReal A/c

Goods comes inCash goes out

DebitCredit

50005000

7 Purchase A/cMr. J. A/c

Real A/cPersonal A/c

Goods comes inMr. J. is giver

DebitCredit

60006000

8 Purchase A/cMr. C. A/c

Real A/cPersonal A/c

Goods comes inMr. C. is giver

DebitCredit

40004000

9 Cash A/cSales A/c

Real A/cReal A/c

Cash comes inGoods goes out

DebitCredit

20002000

10 Cash A/c Real A/c Cash comes in Debit 1000

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Sales A/c Real A/c Goods goes out credit

1000

11 Mr. R. A/cSales A/c

Personal A/cReal A/c

Mr. R is receiverGoods goes out

debitcredit

22002200

11 Mr. N. A/cSales A/c

Personal A/cReal A/c

Mr. N. is receiverGoods goes out

debitcredit

50005000

12 Sales Return A/cMr. R. A/c

Real A/cPersonal A/c

Goods comes inMr. R. is giver

debitcredit

10001000

12 Mr. J. A/cPurchase Return A/c

Personal A/cReal A/c

Mr. J. is receiverGoods goes out

debitcredit

500500

13 Wages A/cCash A/c

Nominal A/cReal A/c

Expenses are incurredCash goes out

debitcredit

10001000

14 Insurance Prem. A/cBank of India

Nominal A/cPersonal A/c

Expenses are incurredBank is the giver

debitcredit

300300

15 Cash A/cCommission A/c

Real A/cNominal A/c

Cash comes in Income received

debitcredit

500500

16 Mr. G. Loan A/cCash A/c

Personal A/cReal A/c

Mr. G is receiverCash goes out

debitcredit

50005000

17 Mr. J. A/cCash A/c

Personal A/cReal A/c

Mr. J is receiverCash goes out

debitcredit

750750

18 Bank A/cMr. R. A/c

Personal A/cPersonal A/c

Bank is receiverMr. R. is giver

debitcredit

10001000

19 Mr. C. A/cMr. N. A/c

Personal A/cPersonal A/c

Mr. C. is receiverMr. N. is giver

debitcredit

500500

20 Furniture A/cCash A/c

Real A/cReal A/c

Furniture comes inCash goes out

debitcredit

50005000

21 Land a/cCapital A/c

Real A/cPersonal A/c

Land comes inOwner is the giver

debitcredit

1000010000

22 Cash A/cFurniture A/c

Real A/cReal A/c

Cash comes inFurniture goes out

debitcredit

200200

23 Machinery A/cCash A/c

Real A/cReal A/c

Machinery comes inCash goes out

debitcredit

5000050000

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24 Vehicle A/cCash A/c

Real A/cReal A/c

Cycle comes inCash goes out

debitcredit

15001500

25 Stationery A/cCash A/c

Nominal A/cReal A/c

Expenses incurredCash goes out

debitcredit

500500

26 Drawings A/cCash A/c

Personal A/cReal A/c

Owner is the receiverCash goes out

debitcredit

20002000

27 Drawing A/cCash A/c

Personal A/cReal A/c

Owner is receiverCash goes out

debitcredit

500500

28 Furniture A/cSales A/c

Real A/cReal A/c

Furniture comes inGoods goes out

debitcredit

500500

29 Sample Exp. A/cGoods Given as Samples A/c

Nominal A/cReal A/c

Exp. IncurredGoods goes out

debitcredit

500500

30 Cash A/cBank of India

Real A/cPersonal A/c

Cash comes inbank is giver

debitcredit

10001000

31 Mr. F. Loan A/cCash A/c

Personal A/cReal A/c

Mr. F. is receiverCash goes out

debitcredit

50005000

31 Bank Charges A/cBank of India

Nominal A/cPersonal A/c

Exp. incurredBank is giver as services provided by bank

debitcredit

2020

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1. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for January 2003.Started business with Cash Rs.150000Brought personal Furniture in the business worth Rs.10000Personal motor car was sold for Rs.25000 and out of the consideration

received, Cash of Rs.20000 was brought into the business.Started a business with cash Rs.50000, Furniture Rs.10000, Machinery

Rs.25000Commenced a business with a capital of Rs.40000Brought additional capital of Rs.10000Withdrawn cash for personal use Rs.1000Withdrawn goods of Rs.1500 for personal purposeLife insurance premium paid Rs.2000College fees paid Rs.3000 for his sonPaid premium Rs.500 for his personal accident policyPaid Rs.700 for personal food grain bill of Rs.750Invite a friend for dinner.

2. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for February 2003.Commenced business with Cash Rs.60000Purchased goods Rs.20000Purchased goods Rs.10000 for cashPurchased goods for cash from Mr. A Rs.25000Purchased goods from Mr. B Rs.20000Purchased goods from Mr. C Rs.20000 and paid him Rs.10000 cashPlaced an order with Mr. D for supplying goods Rs.2000Sold goods Rs.4000Sold goods Rs.3000 for cashSold goods to Mr. E Rs.5000Sold goods to Mr. F Rs.4000 for cashSold goods to Mr. G Rs.8000 and Rs.1000 received CashGoods worth Rs.2000 given as samplesGoods worth Rs.3000 given to Draught Relief fundGoods worth Rs.1000 given as charityReceived an order for supplying goods of Rs.9000 form Mr. HGoods received from Mr. D as per our orderGoods sent to Mr. H as per his orderGoods received back from Mr. E for Rs.1000 as it was not according to

the quality.we have returned the goods worth Rs.800 to Mr. BPurchased Furniture for Rs.10000Purchased Machinery for Rs.25000Purchased Furniture Rs.10000 for cashPurchased Machinery Rs.10000 from Mr. I for cashPurchased Laboratory Equipment for Rs.5000 form Mr. JPurchased a Computer system for Rs.30000

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Goods costing Rs.4000 was completely destroyed by fire. The goods were not insured

Goods costing Rs.1000 was stolen from the godownGoods worth Rs.1000 soaked by rain and nothing can be realized from

the said goodsGoods of Rs.5000 received as samples from Mr. AA

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3. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for March 2003.Started a business with Cash Rs.40000, Furniture Rs.10000 and

Machinery Rs.50000Purchased goods of Rs.10000 @ 10 % Trade DiscountPurchased goods of Rs.5000 @ 10 % trade discount for cashPurchased goods of Rs.15000 @ 10 % trade discount firm Mr. APurchased goods of Rs.15000 @ 10 % trade discount form Mr. B and

paid half the amountPurchased goods of Rs.30000 @ 15 % trade discount from Mr. C and

paid one third amount by cashSold goods of Rs.2000 @ 10 % trade discountSold goods of Rs.3000 @ 10 % trade discount for cashSold goods of Rs.4000 to Mr. D @ 5 % trade discountSold goods of Rs.5000 to Mr. R @ 10 % trade discount and half the

amount was receivedSold goods of Rs.3000 to Mr. K @ 10 % trade discount and one third

amount is received cash and balance by chequePurchased goods worth Rs.10000 @ 10 % trade discount and 5 % cash

discountPurchased goods worth Rs.6000 from Mr. K @ 10 % trade discount and

5 % cash discountPurchased goods worth Rs.5000 from Mr. X @ 10 % trade discount and

5 % cash discount. Paid half the amount by cashSold goods worth Rs.8000 to Mr. Z @ 10 % trade discount and 5 % cash

discount. Received a cheque for half the amountPurchased Furniture for Rs.15000 @ 10 trade discountPurchased Machinery for Rs.20000 @ 10 % trade discount from Patel

MachineryPurchased balance and weight for Rs.500Paid Rs.1000 for installation charges for machinerySold goods for Rs.1000 to Patel MachinerySold goods for Rs.2000 to J. Furniture Mart

4. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for April 2003.Started a business with Cash Rs.15000, Furniture Rs.10000Paid wages Rs.1000Paid Salaries Rs.4000Paid Labour charges Rs.200 for Machinery installationReceived Cash from Mr. S Rs.4000Received a cheque of Rs.5000 form Mr. MPaid Rs.2000 to Mr. NPaid Rs.3000 to Mr. V in full settlement of his account of Rs.3100Received Rs.4000 form Mr. W in full settlement of his account of

Rs.4200Paid salary to Accountant Rs.2500 for March 1999.Advertisement expenses paid Rs.1000

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Office rent paid Rs.1000 for March 99.Printing and Stationary bill of Rs.1000 paidInterest paid cash Rs.1000 to Mr. R for amount borrowed for business

5. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for May 2003.

Started a business with Cash Rs.50000Opened a bank account with Dena Bank Rs.10000Received a cheque of Rs.5000 from Mr. D and paid into the bankPurchased Furniture worth Rs.5000 and paid a cheque for the sameWithdrawn from bank Rs.1000 for personal usePaid Life Insurance premium of his son Rs.500 by chequeGiven a cheque of Rs.2000 to Mr. K on accountDena Bank has debited Rs.20 as bank chargesBank has Credited Rs.50 as interestGiven a cheque of Rs.500 to Mr. J in full settlement of his account of Rs.540Paid Rs.450 for Insurance Premium for goods by a crossed chequeWithdrawn Cash Rs.1000 from the bank for office useReceived a cheque of Rs.600 form Mr. G in full settlement of his account of Rs.650

6. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for June 2003.Commenced a business with cash Rs.30000, Machinery Rs.10000 and

stock Rs.3000Goods of Rs.8000 purchased on credit from Patel TradingCash Sales Rs.10000Goods of Rs.5000 sold to Mr. X,half the amount received in cashGoods of Rs.4000 were damaged by rain and insurance company has

accepted a claim of Rs.2800Goods of Rs.1000 were given as Charity in “Narmada rehabilitation”Goods of Rs.1500 were returned to Patel Trading50 shares of Shah & Co. were purchased. Market price per share is

Rs.100 brokerage paid at 2 %A machine of Rs.4500 was purchased from unique corporation and a

cheque is given to them. Installation charges paid Rs.500Mr. X has returned goods of Rs.1000 and for the balance of the amount

received a crossed cheque from himPersonal furniture of Rs.15000, brought in the business.Goods of Rs.1000 were withdrawn for the personal use

7. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for July 2003.To satisfy the additional requirements, a loan of Rs.18000 was received

from Patel Bros. at 8 % interestCash Rs.6000 deposited in Dena Bank

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A cheque of Rs.3000 and a cash of Rs.5000 were received towards the receivable of Rs.8000 from Mr. X

A cheque of Rs.6000 is given to Mr. PCash Rs.1000 withdrawn from the bank of household expenseA cheque of Rs.600 given to R. Bros. towards our debtsMr. H has given Rs.500 to Mr. K on our behalf, according to our

instructionsPersonal motor car was sold for Rs.20000 and out of this,Rs.15000

brought in the businessWithdrawn Rs.1500 from the bank for business purpose.A dividend warrant of Rs.2400, was deposited into bankPaid cash towards interest to Patel Brothers for one month.

8. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for August 2003.Started business with cash Rs.20000, Machinery Rs.5000, Furniture

Rs.4000Paid Rs.500 for the expenses of ice-cream, at the time of inauguration of

the businessPaid office expenses by cheque of Rs.1000Paid fire insurance premium of Rs.1000Paid life insurance premium of Rs.4000A commission of Rs.1200, received by a crossed cheque which was

deposited into bankConsignment-commission of Rs.1000 received in cashPaid house rent Rs.300 and a cheque of Rs.1500 is given for shop rentGoods of Rs.1500 destroyed in railway accidentAn appointment of Mr. R is made with a monthly salary of Rs.1000Paid Rs.1000 in a Gujarat Flood Relief FundPaid income tax Rs.500

9. Journalise the following transactions, post them into Ledger and prepare a Trial Balance in the Books of Mr. R. Patel for September 2003.Started business with cash Rs.15000, stock of goods Rs.10000,

receivable from Mr. D Rs.5000, a loan from Mr. U Rs.8000 and a debt of Rs.2000 to Mr. W.

Opened a bank account by depositing cash Rs.8000 with Punjab National Bank

Goods of Rs.2000 purchased for cash from R. Patel & Co.Cash sales Rs.3000 to J. Joshi & Co.A typewriter of Rs.5000 purchased for cash, from Godrej & co.Goods of Rs.8000 purchased at 10 % trade discount from Rajani TradersGoods of Rs.2000 were sold at 10 % trade discount and 5 % cash

discount to Mashar & Co.An order is placed with Reliance Trading to supply the goods of Rs.3000Goods of Rs.2000, are returned to Rajani TradersSalary paid by cheque Rs.1300Withdrawn from bank Rs.1300 for household expenses and Rs.1000 for

shop Exp.

18

Purchased 50 shares of Reliance Industries, at a market price of Rs.120 and paid the amount through cheque including a brokerage of 2 %

Goods received from Reliance Trading as per our orderBusiness furniture of Rs.1200, were sold for Rs.800 for cashPurchased a furniture of Rs.1500 from Modern Furniture Mart, on creditFrom Western Trading Co. purchased goods of Rs.8000 at 10 % trade

discount and 2 % cash discount, if the payment is made within 15 days

Goods of Rs.500 given for Drought Relief FundSettled the account with Rajani Traders, by giving him a cheque of

Rs.5000Half of the goods purchased from Western Trading Co., were sold to CD

Traders for Rs.4500 on creditHalf of the goods sold to CD Traders were received back and the same

was returned to Western Trading Co.As more finance is required in the business, a loan of Rs.8000 is

borrowed from Mr. Dhamesha and that amount is deposited into bankAccount of Western Trading Co. is settledPaid stationery expenses Rs.300Paid telephone bill by cheque Rs.650Bank has credited Rs.30 in our pass-book for interestMr. D has given a crossed cheque, of the amount after deducting

discount of 2 %. The cheque was deposited into a bankAs more finance is required in the business, cash Rs.5000 is brought in

the businessGoods of Rs.3200 are damaged by flood and the insurance company has

accepted a claim of Rs.1700 for the same10. Journalise the following transactions, post them into Ledger and prepare

a Trial Balance in the Books of Mr. R. Patel for October 2003.He has brought in cash Rs.20000 for the expansion of the business.

Other balance were stock of goods Rs.20000, receivable from Mr. R Rs.10000, debt to Mr. P Rs.10000, furniture Rs.25000 and bank balance Rs.10000

Purchased goods of Rs.14000 at 10 % trade discount from Rajani Traders, on credit

As more finance is required in the business, a loan of Rs.12000 is received from Mr. P. Pandya at 12 % interest

Goods of Rs.12000 were purchased at 2 % cash discount, from Parag Stores, on credit

Half of the goods purchased from Parag Stores, were sold to Krishna Traders at a price, so as to realise 20 % profit on cost price

Remaining half of the goods purchased from Parag Stores, were sold to Raj & Co. on credit, at a price, so as to realise 20 % profit on selling price

Krishna Traders has returned goods of Rs.1200, which were not according to the sample

Raj & Co. has returned half the goods, which we have returned to Parag Stores

A business furniture of Rs.8000, was sold to Paras Furniture Mart on credit, for Rs.6200

19

An order is placed with Mr. A to supply the goods of Rs.4000 to Mr. J.on our behalf

Mr. A. has sent the goods according to our order and instructions and an invoice for the same is sent to us, for an amount after deducting 10 % trade discount

We have sent bill no.48 for Rs.5000 to Mr. J.Bank has debited Rs.40 in our pass-book for bank chargesA crossed cheque of Rs.13350 is received from Mr. R which was

deposited in the bankMr. P has paid cash Rs.13350 and settled his account

Following expenses are paid in cash : Salary Rs.800, Wages Rs.20, Sales tax RS.350

20

Unit : II [ 25 % ]Final Accounts and Accounting Ratios

Preparation of Final Accounts (Sole Proprietorship only)Preparation of Trading A/c, Profit & Loss A/c and Balance Sheet covering simple adjustments.

Accounting Ratios.Meaning, Advantages and Limitations of Accounting ratios.Computation of following ratios only.1. Gross Profit Ratio 2. Net Profit Ratio 3. Stock Turnover Ratio4. Operating Ratio 5. Current Ratio 6. Liquid Ratio7. Debtors Ratio 8. Creditors Ratio 9. Return on Capital Employed10. Earning Per Share 11. Return on shareholders fund

BASIC ACCOUNTING CONCEPTSImportance & meaning

The Financial transactions are recorded to prepare the Financial Statements in which number of parties (groups) such as owners, management, creditors, potential investors, employees, Government etc. are interested. Therefore it is necessary that the financial transactions are recorded in such a way that they be understood in the same sense in which they are written. Uniformity in understanding of accounting records and comparison of one account with the other is possible only when some standard language is used or found certain accounting principles-concepts are followed.

Accounting concepts comprise set of rules, which have been developed over a course of period on the basis of usage, reason and experience.

They are underlying principles, followed at the time of writing accounts, (even without knowing them) to make the accounting convey the same meaning to all people as far as possible and to make the accounts more meaningful.

Basic Accounting Concepts are as under1. Business Entity Concept

21

According to this concept business is treated as an entity apart from its owners and other parties/groups interested therein.

All the transactions of the business are recorded in the books of business from the point of view of the business. The personal assets and liabilities of the owner and personal transactions of the owner are neither recorded nor reported while preparing the accounts of the business.

The concept of separate entity is applicable to all forms of business organization such as ownership business, partnership firm, company etc.2. Dual Aspect Concept

This concept propounds that all business transactions are recorded as having dual aspect. When the owner brings capital into the business it gives rise to two effects. On one side capital is increased and on the other side assets of the business (cash or in other form) are increased. If the funds of the owner are insufficient the business has to borrow money from other parties. which may be in the form of loan and/or credit facility. It again gives rise to two effects. On the one hand liabilities of the business will be increased and on the other hand it will be increased the assets of the business.

At every stage Capital + Liabilities will remain equal to assets of the business. This can also be expressed as under.Capital + Liabilities = Assets or Capital = Assets - Liabilities

The system of recording transactions based on this concept is called “Double Entry System”.3. Going Concern Concept

This concept assumes that a ‘Business Entity’ will continue to operate indefinitely and it will not be wound up within the foreseeable future, it will be able to meet all its contractual obligations and use its resources according to plans and predetermined goals.

This concept forms the basis of depreciation on fixed assets. It also forms the basis of provision for bad debts on debtors and writing off of deferred revenue expenses.4. Accounting Period Concept

The net income of the business can be measured by comparing the net assets of the business existing at one point of time with that of the assets existing at other point of time. This measurement is necessary because only then the corrective steps can be taken if it is disclosed that the business had not been using its full capacity to make more profits.

Twelve months period is normally adopted for this purpose. This time-interval is called accounting period.5. Money Measurement Concept

22

According to this concept in accounting, every transaction is recorded in terms of money. A transaction that cannot be expressed in terms of money is not recorded in books of accounts.

This concept increases the understanding of the state of affairs of the business. Because of this concept it becomes possible to add up various assets such as building of 10 rooms, a piece of land admeasuring 100 acres, 200 tons of raw materials etc. and in turn it becomes possible to generate useful information.6. Cost ConceptThe underlying idea of cost concept is that Every asset is recorded at “cost price”. i.e. the price paid to acquire it and This “cost” forms the basis for all subsequent accounting for that particular asset.

It implies that

If nothing has been paid for acquiring something, it would not be shown in the accounting books as an asset. Increased knowledge of the staff and their experience, self-generated ‘goodwill’ etc. will not appear in account books if they are not being paid for.The market price of the asset will not be considered at the time of preparation of final accounts. i.e. Profit & Loss account and Balance Sheet though it may be more relevant from investors’ point of view.For calculation of depreciation, year after year, over the economic life of the asset the “Cost Price” of the asset will be taken as starting point. i.e. basis.This concept provides a “ relatively objective basis” for accounting. It keeps the accounting free from the bias of the persons preparing accounting reports. Also sometime it is not possible to estimate market value of each asset accurately. This concept leads to the system where estimation of market value is not required. Thus it leads to a system which is more flexible.7. Periodic Matching of Cost and Revenue Concept

‘Accounting Period Concept’ emphasizes the need to select “Particular Period” to be able to measure and determine the ‘income’ properly known as profit.

“Periodic Matching of Cost and Revenue Concept” goes one step ahead. Its underlying logic is that if the revenue is recorded for a particular period of time, to have correct idea as to the profit, gain or loss of the business, all the expenses necessary and/or incidental to earn “that” revenue should be taken into consideration.

If the revenue is recorded by adopting certain method such as “Cash method”, “Mercantile Method” or “Hybrid Method (Mixed Method)”, the same method be adopted for recording expenses, too. The idea is to get correct or ‘near correct’ picture of the performance of the business.8. Verifiable Objective Evidence Concept

23

According to this concept all the accounting transactions should be evidenced and supported by business documents. This evidence should be objective evidences. i.e. free from any bias.9. Realisation Concept

The realisation concept deals with the determination of the point of time when revenues are earned. According to this concept, revenue is realised when goods produced of services rendered by a business enterprise are transferred to a customer either for cash of some other asset or for a promise to pay cash in future.

It implies that revenue is recognised and earned when a firm actually sells goods to a customer. It has nothing to do with the actual receipt of cost or receipt of an order to supply goods unless money has been realised. - i.e. either cash has been received or a legal obligation to pay has been assumed by the customer, no profit or income can arise.10. Accrual Concept

Normally, all transactions are settled in cash. But the accrual concept recognises revenue when it is earned rather than when it is collected and recognises expenses when assets or benefits are used rather than when they are paid for.

It is pertinent to note that as far as accounts of business enterprises registered under The Companies Act 1956 are concerned the observance of this concept has been made statutory requirement.11. Disclosure Concept

This concept implies that the accounts are to be prepared in such a way that it disclose sufficient information which is of material interest to its users. Keeping with this principle, sometimes notes related to various facts or items appearing in the accounts are appended to final accounts.

This concept assumes more importance in the business enterprise where the owner do not have control over the day to day affairs of the business. This is the reason why The Companies Act 1956 has made it obligatory for all the companies to prepare final accounts in the prescribed form and manner specified in Schedule VI of The Companies Act 1956.12. Materiality ConceptThis concept implies that all the items which are material should be included in accounts and the items which are not material should be left out so that the accounting may not be overburdened with minute details. An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of its user.According to this principle unimportant items are left out, merged with other items or are shown as footnotes.It is pertinent to note that item which is material for one may be immaterial for the other item which is material in one year may be immaterial in subsequent year.

24

13. Consistency ConceptThe accounting transactions are recorded following the “Going

Concern Concept”. To make the accounts of one period comparable with that the other period, it is necessary that the accounting practices and methods remain unchanged from one accounting period to another.

The principle of consistency plays important role particularly when alternative accounting methods are available and equally acceptable. According to this principle if in one year certain method is accepted, it is expected that the organisation will continue to follow the same method year after year. However this does not mean that change in method or introduction of improved technique is not permitted. In such circumstance it is desirable to disclose the fact that “ the method has been changed and its material effect on the accounts”.14. Conservatism Concept

This concept implies that the accounting should take into account ‘all prospective losses but leave all prospective profits’.

Keeping with this principle:the closing stock is valued at lower of “cost” or “ net realisable value”the provision for bad and/or doubtful debts is made

The principle of conservatism is generally applied

when there is uncertainty inherent in the activitywhen there are two equally acceptable methodswhen there is judgment based on estimates and doubt exists as to

which of the general estimate is correct.when there is possibility of occurrence of a loss.

1. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel You are required to prepare a Trial Balance.Name of Account Rs. Name of Account Rs.

Capital 200000 Drawings20000

Purchases 150000 Purchase Return 5000

Sales 200000 Cash Balance20000

25

Building 100000 Furniture50000Misc. Income 15000 Div.Income10000Computer System 50000 Loan from Mr.M50000Sales Return 20000 Misc. Expenses10000Office Expenses 15000 Interest Expenses25000Rent paid 20000 Wages10000Salaries 30000 State Bank C/A 5000Bank of Baroda Loan a/c 45000[ Total of trial balance Rs.525000].

2. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel You are required to prepare a Trial Balance.

Name of Account Rs. Name of Account Rs.Sales 150000 Sales Return10000Purchases 120000 Purchase Return

5000Wages 15000 Charity Expenses 5000Audit fees 5000 Advertisement Expenses20000Misc. Expenses 10000 Office Expenses

5000Interest Expenses 20000 Commission Received

5000Sample Expenses 20000 Goods given as samples20000Goods withdrawn-Personal use 20000 Drawing A/c

40000Dividend Income 5000 Rent paid20000

26

Loan given to Mr. K 50000 Furniture20000Bank Loan 100000 Machinery50000Building 100000 Capital

205000[Total of trial balance Rs.510000].

3. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel. You are required to prepare a Trial Balance.

Name of Account Rs. Name of Account Rs.Capital a/c 10000 Creditors 9000

Drawing a/c 2000 Salaries 700

Bank A/c. 9100 Stationery expenses A/c. 350Cash A/c. 5700 Purchases 12500

Furniture 8000 Sales27900

Rent Received 800 Wages 650

Debtors 18000 Freight and Octroi 700Loan from Mr. K. 10000[Total of trial balance Rs.57700].

4. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel. You are required to prepare a Trial Balance.

Name of Account Rs. Name of Account Rs. Cash A/c. 5200 Sales

45000Opening stock of goods 3400 Sales Return a/c 1500Purchases A/c. 22000 Productive Wages A/c. 1200

27

Purchase Return A/c. 1000 Machinery A/c.18000Bad debts A/c. 400 Salary A/c.11900Freight and Octroi A/c. 700 Royalty A/c.

900Post-telegram-telephone 650 Advertisement Expenses 1250Debtors 18000 Creditors12000Drawing A/c. 2400 General Reserve A/c.

4000Bank A/c. 8500 Capital A/c.28000Bank Overdraft 6000 [Total of trial balance96000]

5. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel. You are required to prepare a Trial Balance.Name of Account Rs. Name of Account Rs.Opening stock 5000 Trade mark 9000Purchases 31000 Carriage outward 600Sales 58000 Loss by rain 1500Sales return 3500 Investment in 10%

1200Purchase return 1000 (Govt. Securities)Royalty expenses 2000 Customs duty 3000Carriage inward 2800 Bank balance11000Goods destroyed by rain 1900 Cash balance

5000Travelling Expenses 4800 Provident Fund30000Post office S/A 200 Contribution to P.F.

2100Bad debt 700 Bad debts Reserve 3200

28

Bills Receivable 8000 Bills Payable 4700Suppliers (creditors) 2400 General Reserve 8100Customers (debtors) 20000 Administrative salary

4200Loan from Mr. P. 10000 Electricity Expenses 2200Goodwill 25000 Godown Rent paid 1400Patents 12000 Insurance premium

1200Copyrights 6000 Bad debts recovered 600Apprentice premium Cr. 3000 Investments of P.F.

9000Capital 60000 Drawings10500[Total of trial balance Rs.182900].

6. Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel. You are required to prepare a Trial Balance.Name of Account Rs. Name of Account Rs.Capital 78000 Charity expense A/c.

3800Drawings 7400 Telephone deposit11000Plant and machinery 32000 Bills receivable

3000Productive wages 9000 Bills payable14000Debtors 32000 Loan from Mr. D.13000Creditors 24000 Legal expenses 1100Patents 11000 Tolai expenses 4000Bad debts 1300 Demurrage 1500Bad debts Reserve 800 Remuneration

10500

29

Mahajan lago (Exp.) 400 Discount received 900

Loan advanced to employee 12000 Discount (debit) 400Furniture and Fixtures 15000 Office expenses 2300Goods given for charity 2000 Apprentice premium 5000Cash balance 9800 Dividend income 1400Bank balance 12200 Lease hold premises

14000Interest received 1600 Sales35000Commission received 6600 Purchases 20000Cash balance 4000 Loan from Modi20000Bank overdraft 15400[Total of trial balance Rs.217700].

7. The following is a trial Balance of R. Shah, which tallies, but even though there are some errors in it. Rectify the errors and prepare a new trial balance.

Name of the Accounts L.F.

Debit Rs.

Credit Rs.

30

Capital Drawings Purchases Sales Commission Received Rent received Salary Advertisement Expenses Debts Receivables Carriage outward Bad debt reserve Cash balance Post and telegram Railway freight Bills receivable

4000

6000 200 800 3000

720010000

1200

32400

17000

5000

2000

500

5500 700 550 1150

32400

[Correct total of trial balance Rs.32400].

Mr. A. has prepared the following trial balance, but there are some mistakes in it. Prepare a correct trial balance.

Debit Balances Rs. Credit Balances Rs.

BuildingMachinerySuppliers

30000 10500 8500

CustomersCashRoyalty

19000 3500 1400

31

DrawingsSalesStationeryDiscount ReceivedBad debts recoveredApprentice premiumDemurrageCommission Received Rent receivedLoan from B.

4500 12500 1300 750 900 1200 230 650 3000 7070

81100

CapitalPurchasesCommission to SalesmanCarriage outward

46530 8500 1700

470

81100

[Correct total of trial balance Rs.81100].

9. From the following information Sept 2003 pass journal entries, post them into a ledger and prepare a trial balance for the same in the books of Mr. Jayesh Patel. Started a business with cash Rs.32000, furniture of Rs.6000 and a

loan of Rs.10000 borrowed from Mr. B.Purchased a balance and weight of Rs.800Goods of Rs.10000 were purchased at 5 % trade discount from Mr. V.

and part payment is made of Rs.2000 in cash.Opened a bank account by depositing Rs.15000 into a bank.Paid cash Rs.1500 and a cheque of Rs.3000 to Mr. V.Purchased furniture of Rs.4000 at 5 % cash discount from T.

Furniture Mart and paid the amount through cheque.A commission of Rs.800 is received by cheque from Mr. H. Cheque is

deposited in bank.Goods of Rs.12000 were purchased at 15 % trade discount from Mr. P.Goods of Rs.6000 were sold for cash, at 10 % trade discount to Mr. S.A cheque of Rs.2000 is given against the purchase of shares of M. Ltd.Paid Rs.500 for the tuition fees of a son. Goods of Rs.3500 are sold at 10 % trade discount to Mr. K. He has

given a cheque for the amount due.Personal shares of Rs.4500 of H. Ltd. were sold for Rs.5800. Out of

this, Rs.5000 were invested in the business.32

10.From the following transactions, prepare the subsidiary books, post them into ledger and prepare a trial balance in the books of Mr. P. Patel.

Started a business with a personal savings of Rs.30000 and Rs.15000 from the sale proceeds of a personal scooter of Rs.18000, which was sold for Rs.21000

Offerings of Rs. 500 was made in a temple.Goods of Rs.11000 were purchased at 10 % trade discount from Mr.

G.Goods of Rs.5000 were purchased at 5 % trade discount from Mr. A.Goods of Rs.6000 were sold at 25 % profit to Mr. M.Goods of Rs.3000 were sold at 30 % profit to Mr. L. at 10 % trade

discount.Goods of Rs.1200 were sold at 2 % cash discount to Mr. H.Opened a bank account by depositing cash Rs.9000 in bank.Salaries paid Rs.800.Goods of Rs.1000 were purchased for cash at 3 % cash discount from

Mr. R.Paid advertisement expenses Rs.400 by cheque.Sold goods of Rs.500 for cash to Mr. P.Goods of Rs.400 were returned to Mr. A. as it was defective.Goods of Rs.200 were returned by Mr. M.

11.Following Balances are obtained on 31-03-2003 from the Books of Mr. M. Patel. You are required to prepare a Trial Balance.Name of Account Rs. Name of Account Rs.Capital 12000 Bank Balance

3500Drawings 500 Cash Balance 1200Loan from Mr. W. 300 Opening Stock 5000Provident Fund 250 Rent 150P. F. Contribution 80 Interest received 50Vehicle 6220 R. Patel (Creditor) 500Discount allowed 100 P. Parikh (Creditor) 3110Discount received 70 Salary 200Purchases 7000 Machinery 1800

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Sales 9200 Shah Trading Co. (Debtors) 400Purchases returns 350 Travelling expenses 120Sales returns 550 M. Ltd (Creditor) 1400Furniture 450 J. Ltd. (Creditor) 260Stationery Expenses 100 Advertisement Expenses 120[Total of trial balance Rs.27490].

12.In the following Trial Balance prepare a correct Trial Balance as on 31-12-2003.

Name of the Accounts

L.F. Debit Balance Rs.

Credit Balance Rs.

CashCash at BankPurchasesSalesWagesLighting and FuelCarriage inwardCarriage outwardOpening stock of goodsBuildingLandSales returnPurchase returnSalaryMachinery and ToolsPostage, telegrams and stationeryRailway FreightTrade ExpensesOffice Expenses

540 2630

98780 10480 4730

2040

10000

500 15000 27500 1300 800 200 700

40675

3200

5760 30000

680

500

34

Discount (Received)InsuranceDrawingsCapitalSundry DebtorsSundry Creditors Total

600

15000

190800

5245 71000

6300

163360

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FINANCIAL STATEMENTMEANING OF FINANCIAL STATEMENTSBasically, Financial Statements are organised summaries of detailed information about the financial position and performance of an enterprise. Traditionally, the term ‘Financial Statements’ are used to denote only two basic statements as under.Balance Sheet (or Position Statement) that shows the financial position of

an enterprise at a particular point of time.Trading and Profit and Loss Account (or Income Statement) which shows

the results of business operations during an accounting period.Nowadays, in addition to the aforesaid two basic financial statements, a Statement of Retained Earning and a Statement of Changes in the Financial Position are also prepared in practice.Usefulness of Financial StatementsThe information contained in these statements is used by the management, present and potential investors, lenders, short-term creditors, employees, customers, Governments and their agencies to satisfy some of their different needs for information. Users can get better insight about the financial strengths and weaknesses of the firm if they properly analyse the information from their own points of view. The usefulness of the financial statements for some of the users is explained follows.TRADING ACCOUNTAfter preparing a tallied trial balance at the end of an accounting period, the next step is to prepare Trading Account.MeaningTrading account is one of the financial statements, which result of buying and selling of goods and/or services during an accounting period. PurposeTrading account is prepared to know the gross profit or gross loss during the accounting period. The basis for the preparation of this account is the matching of selling prices of goods and services with the cost of goods sold and services rendered.ClosureTransferring its balance to the Profit and Loss Account closes the Trading Account.

Trading Account of Mr. XFor the period ending on……..

Debit Credit

Particulars Rs. Particulars Rs.

To Opening Stock By SalesTo Purchased Less: SR Less: PR By Abnormal loss of stockTo Direct Expenses By Goods withdrawn for personal use To Wages & Salaries By Goods destroyed by fireTo Freight Inwards By Goods given as samples

36

To Carriage Inwards By Goods given as charityTo Cartage Inwards By Goods stolenTo Octroi By Goods sunkTo Custom duty By Goods soaked by rainTo Dock chargesTo DemmurageTo Gross Profit By Gross Loss (Transferred to P & L a/c) (Transferred to P & L a/c

------- ------- ==== ====

PROFIT AND LOSS ACCOUNTAfter preparing a Trading Account, the next step is to prepare a Profit and Loss Account.MeaningThe Profit and Loss account is one of the financial statements. It shows the net result of the business operation during an accounting period.PurposeThe Profit and Loss Account is prepared to ascertain the Net Profit earned or Net Loss incurred by the business as a result of business operations during an accounting period.ContentsAll the indirect revenue expenses and losses (i.e. other than those shown on the debit side of the Trading Account) are shown on the debit side of the Profit and Loss Account, whereas all indirect revenue incomes (i.e. other than those shown on the credit side of the Trading Account) are shown on the credit side of the Profit and Loss Account.ClosureThe Profit and Loss Account is closed by transferring its balance to the Capital Account of the proprietor (in case of a proprietorship concern) or of the partners (in case of a partnership firm)

Profit & Loss Account of Mr. XDebit For the period ending on……

CreditParticulars Rs. Particulars Rs.To Gross Loss (Tr. from Trading a/c) By Gross Profit (Tr. from Trading a/c)To Salaries By Interest income To Rent, Rates By Commission To Fire Insurance By Sale of ScrapTo Repairs By Misc. IncomeTo Depreciation By Rent earnedTo discount Reserve By Profit on sale To Audit Fees of fixed assetsTo Bank charges By Net Loss To Legal charges Tr. To Capital a/cTo Misc. Exp.To Electric light billTo Insurance Premium

37

To Travelling ExpensesTo Discount allowedTo Carriage outwardTo Freight outwardsTo Commission to salesmenTo AdvertisementTo Bad DebtsTo Interest on LoanTo Interest on capitalTo Stationery – Printing ExpensesTo Packaging Exp.To Loss by Theft or Fire To Loss on sale of Fixed assetsTo Net Profit Tr. to Capital a/c

----- -----=== ===

BALANCE SHEETAfter preparing the Profit and Loss Account, the next step is to prepar4 a Balance Sheet.Meaning A Balance Sheet is a financial statement. It is a statement of assets and liabilities of an enterprise at a given date. It is called a Balance Sheet because it is a sheet of balances of those ledger accounts which, have not been closed till the preparation of the Trading, and Profit and Loss Account.CharacteristicsThe characteristics of a Balance Sheet are summaries as under.1. A Balance Sheet is only a statement and not an account. It has no debit

side or credit side. The headings of the two sides are ‘Assets’ and ‘Liabilities’.

2. A Balance Sheet is prepared at a particular point of time and not for a particular period. The information contained in the balance sheet is true only at that particular point of time at which it is prepared.

3. A Balance Sheet is a summary of balances of those ledger accounts which, have not been closed by transfer to Trading and profit and Loss account.

4. A Balance Sheet shows the nature and value of assets and the nature and the amount of liabilities at a given date.

Need for the PreparationThe purpose of preparing a Balance Sheet is as follows.To ascertain the nature and value of assets of a business.To ascertain the nature and amount of liabilities of a business.To find out the financial solvency of an enterprise. An enterprise is

considered to be solvent if its assets exceed its external liabilities.Right hand side of a Balance Sheet is called the ‘Assets’ side and the Left-hand side is called the ‘Liabilities’ side.

Balance Sheet of Mr. X38

As at ………Liabilities Rs. Assets Rs.Capital Goodwill Opening Balance Land Add: Net Profit Building Less: Net Loss Plant & Machinery Less: Drawings FurnitureLoan ToolsIncome received in advance

Vehicles

Deposits TrademarksCreditors Copy RightOut standing Expenses. InvestmentsBank overdraft Closing stockBills payable Stock of StationaryProvident Fund Debtors

Bills receivablePrepaid ExpensesCash at BankCash in HandDeferred Revenue ExpOther Exp. or Loss not written off

Total Total

TRIAL BALANCE AND BALANCE SHEET

TRIAL BALANCE BALANCE SHEET

39

The objective of preparing the trial balance is to verify whether the accounts are arithmetically correct or not.

(1) The objective of the purpose of preparing a balance sheet is to know the financial position of the business.

In a trial balance, balances of all accounts. (Personal, real and nominal) are shown.

In a balance sheet, balances of real accounts and personal accounts only are shown.

In a trial balance, list of balances are shown in two parts as “debit balances” and “credit balances”.

In a balance sheet the relevant balances of accounts are shown in two parts as “capital – liabilities” and “assets”.

Trial balance is prepared before preparing the final accounts.

In the preparation of final accounts, balance sheet is prepared last. Balance sheet is a part of final accounts.

It is not imperative to prepare trial for preparing final accounts.

The balance sheet is a part of final accounts. Hence while preparing final accounts balance sheet must be prepared.

The balance of opening stock is shown in the trial balance while balance of closing stock is generally not shown in it.

As the opening stock is transferred to trading account, there is no balance of it at the end, while closing stock balance is shown in it.

It is not possible to get an idea about the business profit from the trial balance.

Net profit is added in the capital account in balance sheet. Therefore, the financial position of the business is known.

TABLE OF ADJUSTMENTST = Trading a/c, P & L = Profit & Loss a/c B/S = Balance

SheetDr. = Debit Cr. = Credit

Sr. No

Adjustment Adjustment Entry Effects on FinalAccounts

1. Closing Stock Closing Stock a/c Dr To Trading a/c

Shown on Cr. side of T.Shown on Assets side of B/S.

2. Outstanding Exp.

Expenses a/c Dr

To Outstanding Exp. a/c

Shown on Dr. side of T. or P & L by add to respective a/c. Shown on the liability side of B/S

3. Prepaid Exp. Prepaid Exp. a/c Dr

To Exp. A/c

Deducted from the exp. concerned on debit side of profit and loss a/c. Shown on the assets side of B/S.

4. Outstanding Outstanding Income a/c Shown on credit side of P & L a/c, by

40

Income Dr

To Income a/c

adding it to respective income account.Shown on the assets side of balance sheet.

5. Income received in advance

Income a/c Dr To Income received in advance a/c.

Deducted from the concerned income on Cr. Side of P & L a/c.Shown on the liabilities side of B/S.

6. Depreciation on Assets.

Depreciation a/c Dr To Asset a/c.

Shown on the debit side of P & L a/c.Deducted from the concerned assets on assets side B/S.

7. Interest on Capital

Interest on Capital a/c Dr To Capital a/c

Shown on the debit side of P & L a/cAdded to the Capital a/c on the liabilities side of B/S.

8. Interest on Drawings

Drawing a/c Dr To interest on Drawing

Shown on the credit side of P & L a/cAdded to the Drawings deducted from Capital a/c on liabilities side of B/S.

9. Bad Debts Written off

Bad debts a/c Dr

To Debtors a/c.

Shown on the debit side of P & L a/c. added to Bad debts a/c.Deducted from the debtors a/c. On the assets side of B/S.

10. Provision for Doubtful Debts

P & L a/c. Dr To provision for discount reserve on debtors a/c.

Shown on the debit side of P & L a/c. Deducted from the debtors a/c on the assets side of B/S.

11. Provision for discount reserve on debtors

P & L a/c. Dr To Provision for discount Reserve on debtors a/c.

Shown on the Dr. side of P & L a/c.Deducted from the debtors a/c. On the assets side of B/S.

12. When credit purchase was omitted to be recorded

Purchase a/c. Dr

To Creditors a/c

On the debit side of T. It will be added to purchases.In the balance sheet on the liabilities side it will be added to creditors.

13. When credit sales was omitted to be recorded

Debtors a/c. Dr To Sales a/c.

On the credit side of T. It will be added to sales.In the B/S on the assets side, it will be added to debtors.

14. Unrecorded purchases returned

Creditors a/c Dr To Purchase Ret. A/c

Deducted from the purchases in the T.In the B/S on the liabilities side it will be deducted from the creditors.

15. Unrecorded sales returned

Sales returned a/c. Dr To Debtors a/c.

Deducted from the sales in the T.In the B/S on the assets side it will be deducted from the debtors.

16.(I)

Goods gone in other way e.g. goods burnt by fire when the insurance co. has admitted claim for lesser amount

Ins. Co. a/c Dr

Loss by fire a/c Dr

To goods burnt by fire a/c.

On the credit side of T will be shown the cost price of goods burnt.Loss by fire is shown on the debit side of P & L a/c.The amount of claim admitted by Insurance Co. will be shown on assets side of B/S.

(II) Goods taken by personal use is unrecorded.

Drawing a/c. Dr To Goods withdrawn a/c

The B/S if will be added to drawings.The cost price of goods withdrawn will be shown on credit side of T.

(III) Goods distributed as samples for

Advertisement a/c. Dr

Advertisement expense. It will be debited in P & L account.Goods distributed for advertisement,

41

advertisement. To Goods distributed for advertisement a/c.

it will be credited in T.

(IV) Goods stolen Loss by Theft a/c Dr

To Goods stolen a/c

Loss by stolen account, it will be debited in P & L a/c.Goods stolen a/c. It will be credited in T

(V) Goods given as charity

Charity Exp. Dr To Goods given as charity

Charity a/c. as an exp. it will be debited in P & L a/c.Goods given as charity a/c. it will be credited in T.

TREATMENT OF ADJUSTMENTS ITEMS INSIDE THE TRIAL BALANCE

If any item of adjustment appears in the Trial Balance, it will be shown only at the appropriate place in the final accounts. The following table shows how each item of adjustment will be treated if given in the Trial Balance.Item given in Trial Balance

Treatment in Profit & Loss a/c or Other Account

Treatment in Balance Sheet

Closing stock

(b) Outstanding Expense

(c) Prepaid Expense

(d) Accrued Income

Unearned Income

Depreciation

Bad Debts if no Provision for Bad & Doubtful Debts a/c appears

Bad Debts if Provision for Bad & Doubtful Debts a/c appears

Discount allowed if no

X

X

X

X

X

Shown on the debit side of P & L a/c as a separate itemShown on the debit side of P & L a/c as a separate item

Shown on the debit side of Provision for Bad & Doubtful Debts a/cShown on the debit side

Shown on the Assets side as a Current Asset Shown on the Liabilities side as a Current LiabilitiesShown on the Assets side as a Current Asset Shown on the Assets side as a Current AssetShown on the Liabilities side as a Current LiabilitiesX

X

X

X

42

Provision for Discount on Debtors a/c appears

Discount allowed if Provision for Discount on Debtors a/c appears

Discount received if no Reserve for Discount on Creditors a/c appears

Discount received if Reserve for Discount on Creditors a/c appears

Interest on Capital

(n) Interest on Drawings

of P & L a/c as a separate item

Shown on the debit side of Provision for Discount on Debtors a/cShown on the credit side of P & L a/c

Shown on the credit side of Reserve for Discount on Creditors a/cShown on the debit side of P & L a/c as a separate itemShown on the debit side of P & L a/c as a separate item

X

X

X

X

X

43

1. What adjustment entries will you pass in the following situations?(1)Salaries to employees are outstanding for one month at a rate of

Rs.400 per month.(2)Insurance premium paid during the year was Rs.1500, of which

Rs.300 pertain to the next year.(3)A loan of Rs.15000 @ 18 % is given to a friend before six months.

He has not paid any interest, so far, on this loan. He has not paid any interest, so far, on this loan.

(4)A part of the shop was rented at Rs.500 per month and Rs.6500 were received towards rent during the year, of which one month’s rent is received in advance.

2. Prepare final accounts of Mr. P. Patel from the trial balance and additional information given below for the year ended on 31-3-2003.

Debit Balance Amount Rs.

Credit Balance Amount Rs.

DrawingsOpening stockPurchasesSales returnsCarriage inwardsDemurrageCustoms dutySalaries RentRates and taxesBad debts’BuildingInvestment in shareGoodwillDebtorsFurnitureCash balanceAdvertisement Exp.Discount Bank balanceCarriage outwardsBills receivable

5000

8000400001600

5001000

8506000280010002000

80000100002300020000500015503000

7001500012003000

231200

CapitalSalesPurchase returnsCommission receivedInterest CreditorsDiscount Goods given as samples Goods drawn for Personal useBills payableDividend

120000

85600200036001400

10000800

2000240016001800

231200

Additional Information:(1)Closing Stock is of Rs.18000(2)Outstanding salaries payable are Rs.2000

44

(3)Rent Rs.400 is paid in advance.(4)Dividend receivable Rs.800 is outstanding.(5)Interest received in advance is Rs.600.(6)Write off Rs.1000 from debtors as bad debts.(7)Depreciation is to be calculated @ 10 % on building and @ 5 % on

furniture.

3 Prepare final accounts of Mr. P. Patel from the trial balance and additional information given below for the year ended on 31-3-2003.

Debit Balance Amount Rs

Credit Balance Amount Rs

PurchasesOpening stockDebtorsDrawingsSales returnsOctroiSalariesWagesCommission to salesmanRates and taxesTelegrams-postage-StationeryInsurance premiumBad debtsLoss due to theftMotor-carInvestment in SharesCash balanceMachineryTrade marksFurniture

185001350

168502250

450250

5500600300400550420600250

40000100016505000

12000 60

00

113920

SalesCapitalCreditorsPurchases returnsBrokerage ( Commission )RentInterestGoods stolen 18 % loan taken (1-1-2003)

42500380006500

500250720200250

25000

113920

Additional Information:(1)Closing stock is valued at Rs.6900.(2)Salary is paid for 11 months. Salary for March, 2003 is

outstanding.(3)Insurance premium includes Rs.300 for the insurance premium

pertaining to the year ended on 31-12-2003.(4)Commission receivable Rs.125 is outstanding, while rent is

received for 12 months ending on 30-09-2003.(5)Rs.300 are to be written off from debtors, while provision for

doubtful debts is to be maintained @ 5 % on debtors.(6)Depreciation is to be calculated @ 5 % on motor-car and @ 10 % on

machinery.45

(7)Capital Rs.8000 was brought in on 31-12-2002. Interest is to be calculated @ 10 % on capital and Rs.600 to be charged as interest on drawings.

46

4. Prepare final accounts of Mr. P. Patel from the trial balance and additional information given below for the year ended on 31-3-2003.

Name of the Account Debit Balanc

e Rs

Credit Balanc

e RsDrawings and capitalCreditorsBuildingOpening stockBajaj ScooterPurchase returnsSalesDiscount receivedDepreciation on ScooterDebtorsCash and bank balancePurchasesSales returnsRailway freight Show-room expensesBad debts and provision for bad debtsWages and outstanding wagesTelegrams, postage and stationeryAdvertisement expensesDiscount allowed15 % Loan and interest on LoanInvestments and interest on investmentsInsurance premium ( for 12 months ended on 30-6-2003 )Bills Receivable and Bills Payable

14500-

400002500012000

---

1200677502500

45000400020004000

70015001200

10000600150

400012003400

240700

8600050500

---

350090500

900-------

2000500

---

5000600

120024070

0Additional Information:(1)Closing stock is of Rs.12000.(2)Building is to be depreciated @ 5 %. During the year on 30-09-

2002 an addition of Rs.10000 was carried out in the building.(3)Write off Rs.750 from debtors and provide @ 5 % for doubtful

debts.(4)80 % of the advertisement expenses are to be carried to the next

year.(5)Postage stamps on hand are of Rs.100.(6)Interest is to be calculated @ 12 % on capital.(7)Purchase returns for Rs.1000 are not recorded. (8)Interest on investments Rs.300 is yet to be received.

47

5. Prepare final accounts of Mr. P. Patel from the trial balance and additional information given below for the year ended on 31-3-2003.

Particulars Debit Balanc

e Rs

Credit Balance Rs

Capital and drawingsGoodwillStockPurchases and SalesGoods returnedCreditors and debtorsTypewriterManufacturing wagesPrepaid commissionCarriage outwardsBad debts and provision for doubtful debtsDiscountInterest received in advanceRent ( for 12 months ended on 30-9-2003 )Insurance premium (included in it is Rs.600 for the year ended on 31-12-2003 )Salaries and wages for office employeesCash balance and Bank balanceBills of exchangeGoods withdrawn for personal useDiscount reserve on debtors

100003500013000720002000

2050050001200

200500600

1800--

900

18500275002900

--

211600

60400--

125000

500010000

----

400900200

2400-

--

6000800500

211600

Additional Information:(1)Closing stock is of Rs.16000.(2)Rs.1800 for electricity charges for factory are outstanding.(3)Depreciation @ 5 % is to be calculated on typewriter.(4)Rs.500 are to be written off as bad debts and provision for doubtful

debts @ 5 % on debtors and discount reserve on debtors @ 2 % is to be provided.

(5)Goods of the value of Rs.1000 were stolen. Insurance company has accepted the claim for the full amount, It is to be accounted for in the books.

(6)At the time of stock taking, stock of Rs.6000 is found, which remains to be recorded as purchase.

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6. The balance in a trial balance of Mr. S. are as follows as on 31-3-2003

Particulars Debit Balanc

e Rs

Credit Balanc

e RsCapital and drawingsOpening stockPurchases and sales

50004000

32000

90000-

96500Goods returnedRailway freight and octroiSales-taxSalaries ( paid for 11 months )Insurance premium ( for the year ended on 31-12-2003 )Carriage outwardsDiscountBad debts and provision for doubtful debtsBad debts recoveredInvestment in 14 % debentures (Purchased on 1-4-2002 )Interest on 14 % debenturesFactory premisesPatentsDebtors and creditorsCash and Bank overdraftRepairs for factory premises

15002000510099002400

8200560200

-8000

-950008200

1860072402400

210300

1000----

-800900

540-

560--

120008000

-21030

0Adjustments:(1)Closing stock Rs.14000.(2)Personal repairing of Rs.800 is included in repairing for factory

premises.(3)20 % of sales are for export sales on which subsidy @ 5 % is to be

received.(4)Write off Rs.600 from debtors and provide for doubtful debts @ 5 %.

Also provide @ 2 % for discount reserve on debtors.(5)Value of the patents is to be taken as Rs.7200, while depreciation on

factory premises is to be calculated @ 5 % p.a.(6)Interest @ 15 % is outstanding on bank overdraft.(7)Rs.500 yet to be received as sales-tax refund.

49

Ratio Analysis

Ratio Analysis is a very important tool of financial analysis. It is the process of establishing a significant relationship between the items of financial statements to provide a meaningful understanding of the performance and financial position of a firm.

An Accounting Ratio or Financial Ratio may be defined as the mathematical expression of the relationship between two accounting figures. But these figures must be related to each other to produce a meaningful and useful ratio.

Ratios can be classified into different categories depending upon the basis of classification. For easy understanding we can classify the ratios in the following three groups.

1 Revenue statement ratios.(Profit and Loss Account Ratios – ratios calculated on the basis of the item of the Profit and Loss Account only) 1 to 5

2 Balance Sheet Ratios (Ratios calculated on the basis of the figures of Balance Sheet only) 6 to 10

3 Composite Ratios (Mix Ratios – Ratios based on the figures of Profit & Loss A/c as well as the Balance Sheet) 11 to 16

Sr.No.

Ratio Formula Purpose

1 Gross Profit Ratio

Gross Profit x 100Sales

To know whether selling price has been properly fixed and to know the profitability

2 Net Profit Ratio

Net Profit x 100Sales

To have an idea of profitability

3 Operating Ratio

(Cost of Goods Sold + Operating Exp.) x 100Sales

To ascertain the extent of operating expenses

4 Expenses Ratio

Expenses x 100Sales

To know the proportion of each type of expenses to sales

5 Stock Turnover Ratio(Inventory)

Cost of Goods SoldAverage Stock

Avg. Stock = Opening Stock + Closing Stock

2

To know the efficiency of sales

50

6 Current Ratio

(Working Capital Ratio)

Current AssetsCurrent Liabilities

To know the liquid position or the working capital position of the business

7 Liquid Ratio

Liquid Assets Liquid Liabilities

= C/A - Stock C/L – Bank overdraft

To have better idea of the liquid position of the business

8 Proprietary Ratio

Total Shareholder’s FundsTotal Assets – Fictitious Assets

To ascertain the proportion of owner’s funds in the total funds employed

9 Debt Equity Ratio

Total Long Term LiabilitiesTotal Assets – Fictitious Assets

To know the proportion of long term liabilities in relation to owner’s funds

10 Gearing Ratio

Preference Share Capital + DebenturesEquity Share Capital

To know the proportion of fixed dividend bearing securities to equity capital

11 Debtors Ratio

(Debtors + Bills Receivables ) x 365Sales (On Credit)

To know the average period of credit to ascertain the efficiency of credit department

12 Creditors Ratio

(Creditors + Bills Payables) x 365Purchases (On Credit)

To know the average period within which we make payment for credit purchases

13 Return on Capital Employed

Net Profit (EBIT) x 100Capital Employed

(Share Capital + Reserves + Long Term Loans – Fictitious Assets )

To know the profitability of the business

14 Return on Shareholder’s Fund

Net Profit (PAT) x 100Shareholder’s Fund

(Share Capital + Reserves – Fictitious Assets)

To know the profitability from the view point of shareholders

15 Return on Equity Shareholder’s Fund

(Net profit – Preference Dividend) x 100Equity Shareholder’s Fund

(Equity Share Capital+ Reserves – Fictitious Assets)

To know the profitability from the view point of equity shareholders

16 Earning Per Share

Net Profit – Preference Dividend Number of Equity Shares

To know the profitability per equity share

Importance of Ratio Analysis (Advantages)

51

Ratio analysis of the business enterprise is of a interest to a number of parties, mainly, share-holders, creditors, banks, management, Government, perspective investors etc. with different aspects.

1 Aid to measure General EfficiencyRatios enable the mass of accounting data to be summarized and simplified. They act as an index of the efficiency of the enterprise. As such they serve as an instrument of management control.

2 Aid to measure Financial SolvencyRatios are useful tools in the hands of management and other concerned to evaluate the firms performance over a period of time by comparing the present ratio with the past ones. They point out liquid position to meet its short term obligations and long term solvency.

3 Aid in Forecasting and Planning Ratio analysis is and invaluable aid to management in the discharge of its basic function such as planning, forecasting, control etc. The ratios that are derived after analyzing and scrutinizing the past results, help the management to prepare budgets to formulate policies and to prepare the future plan of action etc.

4 Facilitate decision-makingIt throws light on the degree of efficiency of the management and utilization of the assets and that is why it is called surveyor of efficiency. They help management in decision-making.

5 Aid in corrective ActionRatio analysis provides inter firm comparison. They highlight the factors associated with successful and unsuccessful firms. If comparison shows and adverse variance, corrective actions can be initiated. Thus, it helps the management to take corrective action.

6 Aid in Intra Firm ComparisonIntra firm comparisons are facilitated. It is an instrument for diagnosis of financial health of an enterprise. It facilitates the management to know whether the firm’s financial position is improving or deteriorating by setting a trend with the help of ratios.

7 Act as a Good CommunicationRatios are an effective means of communication and play a vital role in informing the position of and progress made by the business concern to the owners and other interested parties. The communications by the use of simplified and summarized rations are more easy and understandable.

8 Evaluation of EfficiencyRatios analysis is an effective instrument which, when properly used, is useful to assess important characteristics of business – liquidity, solvency, profitability etc. A study of these aspects may enable conclusion to be drawn relating to capabilities of business.

9 Effective ToolRatio analysis helps in making effective control of the business. Effective control is the keynote of better management. Figures shown

52

in the financial statements are neither significant nor able to be compared. In fact, they are dump. But ratios have power to speak.

Limitations of Ratios AnalysisRatios suffer from various limitations.

1 Differences in DefinitionsComparison is made difficult due to differences in definitions of various financial terms. Lack of standard formula for working out ratios makes it difficult to compare them.

2 Limitations of Accounting RecordsRatio analysis is based on financial statements which are themselves subject to limitations.

3 Lack of Proper standardsIt is very difficult to ascertain the standard ratio in order to make proper comparison. Because, it differs from firm to firm, industry to industry.

4 No allowances for Price Level Changes.Due to changes in price level of various years, comparison of ratios of such years cannot give correct conclusions. A change in the price level can seriously affect the validity of comparison of ratios computed for different time periods.

5 Changes in Accounting ProcedureComparison between two variables prove worth provided their basis of valuation is identical. But in reality, it is not possible, such as method of valuation of stock (FIFO or LIFO).

6 Qualitative Factors are ignored.Ratios are tools of quantitative analysis only and normally qualitative factors which may generally influence the conclusions derived, are ignored while computing ratios.

7 Limited use of Single RatioA single ratio would not be able to convey anything. Ratios can be useful only when they are computed in a sufficient large number. It too many ratios are calculated, they are likely to confuse instead of revealing meaningful conclusions.

8 Limited useRatio analysis is only a beginning and gives just a fraction of information needed for decision making. Ratio analysis is not a substitute for second judgment. But ratios are tools to aid in applying judgment.

9 Background is overlookedWhen inter-firm comparison is made, they differ in age, size, nature of product etc. there fore ratio analysis cannot give satisfactory results.

10Personal BiasRatios have to be interpreted and different people may interpret the same ratio in different ways.

11Arithmetical Window DressingWindow-dressing means manipulation of accounts in a way so as to conceal vital facts and present the statements in a way to show better position than what is actually is.

53

12Changing PoliciesRatios are computed on the basis of past result. Past is not and indicator of future. Such ratios may provide a glimpse of firm’s past performance. But forecast for the future may not be correct as several other factors like management policies, market conditions etc. may include future operations.

Working Capital = Current Assets – Current Liabilities

Current Assets

Current Liabilities

Fixed Assets Fictitious Assets

Stock Bank overdraft Land & Building Profit & Loss a/c (Debit)

Cash in Hand Creditors Plant & Machinery

Deferred Revenue Exp.

Cash at bank Bill Payable Furniture & fixtures

Preliminary Expenses

Debtors Expenses outstanding

Goodwill Discount on issue of Debentures/shares

Bills Receivable

Interest payable Trade Marks Suspense A/c

Prepaid Expenses

Unpaid Dividend

Patents rights

Income due but not received

Income received in Advance

Railway Sidings

Short term investments

Provision against current assets

Lease hold Properties

Money at call on short notice

Proposed Dividend

Dead Stock

Advances to employees

Provision for Taxation

Live Stock

Other Advances

Provident Fund Vehicles

Ex. 1

54

The following is the Balance Sheet of X Co. Ltd. As on 31-03-2005

Liabilities Rs. Assets Rs.Equity Share Capital 8000 Shares of Rs. 100 each

800000

Goodwill 200000

12 % Preference Share Capital

500000

Fixed Assets 1200000

General Reserve 420000

Investments 160000

Profit & Loss Account 170000

Stock 450000

13.5 % Debentures 300000

Debtors 336000

Creditors 120000

Cash 30000

Bank Overdraft 60000 Preliminary Expenses 24000Out Standing Expenses

30000

2400000

2400000

Details of Profit and Loss Account is as under. Rs.

Total Sales (Cash Sales is one third of the Credit Sales)1360000

Less : Cost of Goods Sold 800000Gross Profit 560000Less : Office, Selling and Financial Expenses 180000Net Profit (Before deducting Income Tax at 50 %) 380000

Opening Stock on 01-04-2004 350000Consider 360 days in a year for your calculations.

Calculate necessary Accounting Ratios.

55

56

Unit : IV [ 25 % ]Marginal Costing

Meaning-Advantages- Limitations, Break Even Point, Margin of Safety, Profit Volume Ratio, Application of Marginal Costing including simple problems on make or buy and product mix.

Marginal Costing

The term ‘Marginal Cost’ is defined as the amount at any given volume of

output by which aggregate costs are changed if the volume of output is

increased or decreased by one unit. It is a variable cost of one unit of a product

or a service.

Definition and Meaning Marginal costing is a principle whereby variable costs are charged to

cost units and the fixed costs attributable to the relevant period is written off in full against the contribution for that period. Marginal Costing is the ascertainment of marginal cost and the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable cost.

‘Marginal costing is the accounting system in which variable costs are charged to the cost units and fixed costs of the period are written off in full against the aggregate contribution. Its special value is in decision-making.

Contribution ProfitIt includes fixed cost and

Profit.Marginal Costing technique

uses the concept of contribution.

At break-even point, contribution equals to fixed cost.

Contribution concept is used in managerial decision-making.

1. It does not include Fixed Cost.

2. Profit is the accounting concept to determine profit of loss of a business concern.

3. Only the sales in excess of break-even points results in profit.

4. Profit is computed to determine the profitability of product and the concern.

Formulae[ Fixed Cost = FC, BEP = Break Even Point, VC = Variable Cost, EP =

Expected Profit, P/v Ratio = Profit Volume Ratio, MS = Margin of Safety]

1. Sales = Variable Cost + Fixed Cost + Profit2. Contribution per unit = Selling price per unit -- Variable Cost per unit

57

3. Total Contribution = Total Sales – Total Variable cost4. Profit volume ratio = Contribution / Sales5. BEP sales (in units) = Fixed Cost / Contribution per unit6. BEP sales (in Rs.) = Fixed Cost / Profit volume ratio7. Sales (in units) to earn EP = (FC + EP) / contribution per unit8. Sales (in Rs.) To earn EP= (FC + EP) / Profit volume ratio9. Margin of Safety = Given Sales – Sales at BEP

Features of Marginal Costing All costs are categorised into fixed and variable costs. Variable cost per

unit is same at any level of activity. Fixed costs remain constant in total regardless of changes in volume.

Fixed costs are considered period costs and are not included in product cost, only variable costs are considered as product costs.

Stock of work-in-progress and finished goods is valued at marginal cost of production.

In marginal process costing, products are transferred from one process to another are valued at marginal costs only.

Prices are determined with reference to marginal cost and contribution margin.

Profitability of departments, products etc. are determined with reference to their contribution margin.

In accounting marginal cost, the overhead control account in the cost ledger represents only the variable overhead. Fixed costs are taken as expenses in the profit and loss account and thus excluded from costs.

Presentation of data is oriented to highlight the total contribution and contribution from each product.

The difference in the magnitude of opening stock and closing stock does not affect the unit cost of production since all the product costs are variable costs.

Advantages. Fixed costs are period costs in nature and it should be charged to the

concerned period irrespective of the quantum or level of production or sale.

In marginal costing as fixed overheads are not changed to the cost of production, the effect of changes in output on cost per unit is avoided. Marginal cost per unit remains unchanged irrespective of changes in the level of production.

Marginal cost method is simple in application and is easy for exercise of cost control. It is more informative and simple to understand.

It helps the management with more appropriate information in taking vital business decisions like make or buy, sub-contracting, export order pricing, pricing under recession, continue or discontinue a product/division/sales territory, selection of suitable product mix etc.

During depression, marginal costing indicates the level of price up to which prices can be reduced.

58

In order to capture foreign markets or to accept a special order at a reduced price, it is necessary to arrive at marginal cost. If the fixed costs are fully recovered in home market, it would be worthwhile to sell in the foreign market at a price below the total cost, provided the price is more than marginal cost and it does not affect the prices in the home market.

The use break-even charts and profit-volume graphs, and so on facilitate profit-volume analysis.

The analysis of contribution per key factor or limiting resource is a useful aid in budgeting and production planning.

Pricing decisions can be based on the contribution levels of individual products.

The profit and loss statement is not distorted by changes in stock levels. Stock valuations are not burdened with a share of fixed overhead, so profits reflect sales volume rather than production volume.

Responsibility accounting is more effective when based on marginal costing because managers can identify their responsibilities more clearly when fixed overhead is not charged arbitrarily to their departments or divisions.

Limitations1. Marginal costing does not consider fixed cost. The marginal costing may

be useful guide for price fixing in the short run, but economic prices cannot be set in the long run without considering fixed costs.

2. The time factor is completely ignored. Two jobs may have the same marginal cost, though one may take much longer time to complete than the other.

3. If some special orders are accepted at lower prices below total cost, it may lead to expectation of general lowering of prices for all customers.

Key FactorThe main objective of any business enterprise is to maximise its profits. A

key factor or limiting factor is one, which restricts the production or profitability of the business. There may be scarcity of material, labour, capital, plant-capacity, or even sales.

Profitability = contribution / Key Factor (Scarce factor)

Impact of Selling Price, Fixed Cost and Variable Cost on P.V. ratio, Break-even Point and Margin of Safety.

The Selling Price and Variable Cost has direct impact on the P.V. ratio, since P.V. ratio being a function of contribution to sales. The effects of changes in Selling Price, Variable cost and Fixed Cost on P.V. ratio is explained below:

An increase in selling price increases the amount of contribution and resulting in improvement in P.V. ratio.

The decrease in selling price of a product, result in decrease in contribution and lowering the P.V. ratio.

59

The increase or decrease in fixed cost does not affect the P.V. ratio, even though it may increase or decrease the total profit.

The increase in variable cost per unit will reduce the contribution and result in decrease of P.V. ratio.

The decrease in variable cost per unit will result in improvement of contribution and simultaneously, the P.V. ratio will also increase.

The increase in P.V. ratio means lower break-even point and higher margin of safety.

The decrease in P.V. ratio result in increase of Break-even Point and lower margin of safety.

60

Exercise1 The following information is provided.

Rs.Selling Price per unit 150Variable Exp. Per unit 90Fixed Expenses 900000Present Sales Units 20000

You are required to calculate1 Profit – volume ratio 2 Break – even point in units and in Rs.3 Present profit of the company. 4 Margin of safety.5 New selling price per unit if BEP reduced by 1000 units.6 New break – even point in units and in Rs. If selling price is decreased by 20%.7 New break even point in units and in Rs. If selling price is increased by 10%.8 How many units company has to sell at a selling price of Rs. 150 to earn profit of Rs. 600000.9 How many units company has to sell to earn profit of Rs. 600000 if

selling price per unit is decreased by 20%.

2 The P/V ratio of the company is 50% and the margin of safety is 40%. Find out the break –even point and the net profit is the sales volume is Rs. 120000.

[Margin of safety Rs. 48000, BEP Rs. 72000, Fixed cost Rs. 36000, Profit Rs. 24000]

3 The ratio of variable cost to sales is given to be 70%. The break – even point occurs at 80% of sales.Find out the sales at 100% capacity if fixed costs are Rs.150000.Determine profit at 95% capacity.

[P/V ratio 30%, BEP Rs.500000, Sales at 100% Rs.625000, Profit at 90% Rs.28125]

4 The following information is obtained from the record of a company.Month Sales in Units Profit or LossJanuary 600 Loss Rs.1200February 800 Profit Rs.8400The selling price per unit is Rs.120Find:-1. The sales at break-even point in Rs. and also in units.2. The sales volume in units to earn a profit of Rs.24000.

[P/V ratio 40%, Fixed overheads Rs.30000, BEP sales 625 units, To earn profit of Rs.24000 sales must be of 1125 units.]

5 A Co. produces 1000 units of product X and sells them in the internal market at Rs5 per unit. The marginal cost is Rs.3.75. the total fixed expenses amounts to Rs.1350. the company inquires about the foreign market for this product and finds that it can sell this product in the foreign market at Rs.4.85 per unit.After recovering the loss sustain in the internal market, company wants to earn net profit of Rs.25200. please calculate as to how many extra units company must produce and sell in the foreign market.[23000 units]

6 XY. Ltd. presents the following set of information to you two products X and

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Y.X YRs. Rs.

Direct materials per unit 20 18Direct wages per unit 6 4Selling price per unit 40 30

Fixed overhead during the period expected to Rs.1600 Variable overhead is allocated to products at the rate of 100% of direct wages.Proposed sales mix100 units of X and 200 units of Y150 units of X and 150 units of Y200 units of X and 100 units of YAs a Cost Accountant you are requested to present to the management of XY Ltd. The following:1. The unit marginal cost and unit contribution.2. The total contribution and the resultant profit for each of the above sales

mix.3. The proposed sales mix to earn a profit of Rs.300 and Rs.600 with the

total sales of X and Y being 300 units.

[Contribution is Rs.8 and Rs.4 per unit for X and Y respectively.Profit Rs. Nil, Rs.200 and Rs.400 for proposed sales mix respectively.I. X 175 units and Y 125 units

Equation 8x + 4 (300 – x) = 1900II. X 250 units and Y 50 units.

Equation 8x + 4 (300 – x) = 2200]

7 F. Ltd. Manufactures and sells a product, the selling price and raw material cost of which have remained unchanged during past two years. The following are the relevant data.

Particulars Year 1 Year 2Quantity sold (kg.) 100 150

Rs. Rs.Sales value 20000?Raw materials 10000?Direct wages 3000?Factory Overheads 50005700Profit 20002550

During Year 2, direct wages rates increased by 50%, but there was a saving of Rs.300 in fixed factory overheads. What quantity (in kg) the company should have produced and sold in Year 2 in order to maintain the same amount of net profit per kg. as it earned during Year 1?

[180 kg.]

8 W. Ltd. provides following information.

Sales (100000 units) Rs.100000Variable Expenses Rs. 40000Fixed Expenses Rs. 50000

Find out P/V ratio, Break-even point and Margin of safety and compute how these three will be affected in the following each circumstances.1.Increase of 20% in Number of Units sold.2.Increase of 5% in Variable Cost.

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3.Increase of 10% in Fixed Cost.4.Increase of 10% in Selling price and Decrease in sale of units by 20%.

[P/V 60%, 60%, 58%, 60%, 63%.BEP Rs.83333, 83333, 86207, 91667, 78572MS Rs. 16667, 36667, 13793, 8333, 9428]

9 The following information is supplied in respect of Liberty Watch Factory.

Production 9000 unitsVariable Expenses (per unit ) Rs.10-00Selling Price (per unit) Rs.20-00Fixed Expenses Rs. 6,00,000Calculate:

1. How many units should be produced and sold to reach Break-even point?

2. If selling price per unit is reduced by 10%, then what will be the new break-even point (in units)?

3. What sales are necessary to make a profit of Rs.4,00,000.

[Ans. (1) 60,000 units; Contribution per unit Rs.10; (2) If selling price per unit is reduced by 10%, then New BEP 75000 units (3) 1,00,000 units.]

10 The following information is supplied in respect of a factory:

Output 70,000 unitsFixed Cost Rs. 1,80,000Variable Cost per unit Rs. 5Selling Price per unit Rs. 8

1. What should be output and sales at BEP?2. If the selling price is reduced to Rs.7 per unit, how many units should

be produced to yield the same amount of profit as at present?

[Ans. (1) 60000 units (2) 105000 units]

11 M. Co. provides the following information.Rs.

Sales(11,200 units @Rs.10 per unit) 112000Less: Variable charges 89600

22400Less: Fixed charges 33600

Loss: 112001. What should be the sales to reach BEP?2. What should be the sales to get profit of Rs.11200?

[Ans. (1) Break-even point 16800 units; (2) For getting a profit of Rs.11200, 22400 units should be sold.]

12 From the details given below ascertain (1) Break-even point and (2) sales necessary to earn a profit of Rs.30000.

Selling price per unit Rs.18; Variable expenses per Rs.12; Fixed expenses Rs.120000.

If the selling price comes to Rs.15 and fixed expenses increase by 20% what will be the new break-even point?

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[Ans. (1) BEP 20000 units; (2) To earn profit of Rs.30000, required sales 25000 units. (3) New BEP 48000 units]

13 1-1-97 to 30-6-97 1-7-97 to 31-12-97Sales Rs. 60000 70000Total cost Rs. 54000 62000Profit Rs. 6000 8000

There is no change in Selling Price and Variable Expenses and Fixed Expenses were paid equally for the whole year.Calculate for the whole year 1997(1) Profit volume ratio (2) BEP Sales(3) Fixed Expenses (4) Margin of Safety

[Ans. (1) P/V ratio = 20%In this case, sales increased by Rs.10000 and total cost has increased by Rs.8000. Thus Rs.8000 must be variable expenses because fixed expenses do not increase with sales. Thus Contribution = Sales – Variable Expenses = 10000 – 8000 = Rs.2000.(2) Fixed expenses for year are Rs.12000; Contribution = Sales * P/V Ratio = 60000 * (20/100) = Rs.12000 Less Profit Rs.6000 = Rs.6000 are Fixed Expenses for six months. So fixed cost for twelve months will be Rs.12000 (6000 * 2)(1) Sales at BEP Rs.60000(2) Margin of safety Rs.70000

14 C. Ltd. manufactures two types of products known as ‘A’ and ‘B’. It wants to prepare the budget for 6 months for the period of 1-1-99 to 30-6-99. Its maximum production capacity in respect of product ‘A’ is 5000 units whereas for product ‘B’ it is 2000 units. Raw material is a key factor. Raw material used per unit of product A is 15 kg. Whereas for product ‘B’ it is 10 kg per unit. During these six months total quality of raw material available is 65000 kg. other information is as under:

Per unit of Per unit ofProduct ‘A’ Product ‘B’

Rs. Rs.Raw Materials 40 25Direct Labour 12 8Variable Overhead 3 2Selling Price 100 70State how much of the both products should be manufactured to get maximum profit?

[Ans. (1) Shortage of raw material 30000 kg (2) Contribution per unit: A Rs.45 & B Rs.35; (3) Contribution per kg A Rs.3; B Rs.3.50; More Contribution per kg in B. (4) Optimum Output B 2000 units; A 3000 units. Material used for product B 20000 kg. thus the remaining material 45000 kg. available for A (45000 kg / 15kg = 3000 units of A)]

15 B. Ltd. manufactures two items M and N. M’ ‘N’

Selling price (per unit) Rs.80 Rs.50Direct Material (per unit) Rs.32 Rs.22Direct Labour Hours Per unit 5 hours 4 hours(Rate of labour per hour Rs.2)Variable Overhead (% of direct labour) 100% 100%

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Maximum production capacity of the factory is 20000 units of M and 25000 units of N. If labour hours available are 180000 hours only, then how much of both products be manufactured?

[Ans. (1) shortage 20000 labour hours. (2) Contribution per unit: M Rs.28 & N Rs.12. (3) Contribution per direct labour hour: M Rs.5.60 & N Rs.3. (4) Optimum output: M 20000 units and N 20000 units.]

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Unit : III [ 25 % ]Cost Accounting and Budgetary Control

Cost AccountingMeaning and definition of Cost Accounting – its Advantages & Limitations

Budgetary ControlDefinitions – Advantages – Limitations, Procedure for setting up Budgetary Control, Different types of budgets, Advantages and limitations of Cash Budget and preparation of Cash Budget.

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