Professional Documents
Culture Documents
1
CHAPTER – 1
ACCOUNTING
A systematic record of the daily events of a business leading to presentation to financial picture is known as
Accounting or in its elementary stages, as Book keeping. Accounting organizes and summarises economic
information so that the decision-makers can use it. The information is presented in reports called financial
statements. To prepare these statements, accountants analyze, record, quantify, accumulate, summarize,
classify, report, and interpret economic events and their financial effects on the organization.
The series of steps involved in initially recording information and converting it into financial
statements is called the accounting system.
The financial picture mostly has two parts, one showing how much profits has been earned or loss
suffered, and other showing assets and liabilities and the proprietors interest in the firm. Even
institution which do not have the earning of profit as an objective must know periodically whether the
current income is sufficient to meet the current expenditure and what the financial state of affairs.
The American Institute of Certified Public accountants has defined Accounting as:-
“The art of recording, classifying and summarizing in a significant manner and in term of money
transactions and events which are, in part at least, of a financial character, and the interpreting the
result thereof.”
ACCOUNTING CYCLE
An accounting cycle is a complete sequence beginning with the recording of the transactions and ending
with the preparation of the final accounts.
SEQUENTIAL STEPS INVOLVED IN AN ACCOUNTING CYCLE:
(1) Journalising:- Record the transactions in Journal book.
(2) Posting: - Transfer the transactions recorded in journal, in the respective accounts opened in the ledger.
(3) Balancing:- Ascertain the difference between the total of debit amount column and the total of credit
amount column of a ledger account.
(4) Trial Balance:- Prepare a list showing the balances of each and every account to verify whether the
sum of the debit balances is equal to the sum of the credit balances.
(5) Income Statement:- Prepare Trading and Profit and Loss Account to ascertain the profit or loss for the
accounting period.
(6) Position Statement (Balance Sheet):- Prepare the Balance sheet to ascertain the financial position as at
the end of the accounting period.
OBJECTIVES OF ACCOUNTING
(i) To maintain accounting records.
(ii) To calculate the results of operations.
(iii) To ascertain the financial position.
(iv) To communicate the information to the users.
ADVANTAGES OF ACCOUNTING
(1) Facilities to ascertain net result of operations.
(2) Facilities to ascertain financial position.
(3) Facilities the users to take decisions.
(4) Facilities to comply with legal requirements.
(5) Facilities the settlement of tax liability.
(6) Assists the management in planning and controlling business activities and in taking decisions.
(7) Facilities the ascertainment of value of business.
(8) Facilitates a comparative study.
Limitations of Accounting:
⇒ Ignores the qualitative elements.
⇒ Not free from bias.
⇒ Estimated position and not real position.
⇒ Ignore the price level changes in case of financial statement prepared on historical cost.
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of expansion and new developments of the enterprise. The services rendered by them to the society include
the following:
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(i) To maintain the boos of accounts in a systematic manner.
(ii) To act as Statutory Auditor.
(iii) To act as an Internal Auditor.
(iv) To act as Taxation Advisor.
(v) To act as Financial Advisor.
(vi) To act as Company Law Advisor.
(vii) To act as Management Consultants.
(viii) To act as Liquidator, Arbitrator and Receiver.
(ix) To act as Management information System Consultants.
BRANCHES OF ACCOUNTING
⇒ Financial Accounting:- The purpose of this branch of accounting is to keep systematic record to
ascertain financial performance and financial position and to communicate the accounting information
to the interested parties.
⇒ Cost Accounting:- The purpose of this branch of accounting is to ascertain the cost, to control the cost
and communicate information for decision making.
⇒ Management Accounting:- The purpose of this branch of accounting is to supply any and all
information that management may need in taking decision and to evaluate the impact of its decisions
and actions.
⇒ Social Responsibility Accounting:- It is accounting for social responsibility aspect of a business.
Management is held responsible for what it contributes to the social well being and progress.
Accounting helps decision making by showing where and when money has been spent and commitments
have been made, but evaluating performance, and by indicating the financial implications of choosing one
plan instead of another. Accounting also helps predict the future effects of decisions, and it helps direct
attention to current problems, imperfection and in inefficiencies, as well as opportunities.
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FUNCTIONS OF ACCOUNTING DATA
The main functions of Accounting Data are as follows:-
a) Measurement of past performance of the entity and depicting its current financial position.
b) Forecasting:- On the basis of past date we may forecast future performance as financial position of the
entity.
c) Decision-Making:- Accounting data provides relevant information to the users of accounts to aid
decision-making.
d) Evaluation:- Assessing performance achieved in relation to target.
e) Control:- On the basis of accounting data we can identify weaknesses of the operational system and
feed back the effectiveness of measures adopted to check such weaknesses.
f) Stewardship:- Accounting for the users of owner’s fund where in the management and owners are
separated.
g) Government Regulation and Taxation:- Accounting data provides necessary information for
government to exercise control on the entity as well as collection for tax revenues.
Statistical methods are helpful in developing accounting data and their interpretation. For example,
time series and cross-sectional comparisons of accounting data is based on statistical techniques,
regression analysis of budget and standard cost variances and multiple discriminant analysis are
popularly used to identify symptoms of sickness of business firm.
Therefore, the study and application of statistical method would add extra edge to the accounting
data.
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(c) Accounting and Mathematics:
Knowledge of arithmetic and algebra is a prerequisite for accounting computations and measurements.
Calculate of interest and annuity are the examples of such fundamental use. While computing
depreciation, finding out instalment in hire purchase and instalment payment transactions, calculating
amount to be set aside for repayment of loan and replacement of assets and setting lease rentals,
mathematical techniques are frequently used. Accounting data are also presented in ratio form.
With the advent of the computer, mathematics is becoming vital part of accounting. Instead of writing
accounts in traditional form, transactions and events can be recorded in the matrix from and the rules of
matrix algebra can be applied for classifying and summarizing data.
Understanding mathematics has become a must to grasp the decision models framed by the statisticians,
economists and the O.R. experts. In addition to statistical knowledge, knowledge in geometry and
trigonometry seams to be essential to have a better understanding about the accounting communications
system.
MEASUREMENT BASE:
There are fount accepted measurement bases. These are the following:-
1. Historical Cost:- According to this base:-
The assets are recorded at an amount of cash or cash equivalents paid or the fair value of
consideration given at the time of acquisition.
Liabilities are recorded at the amount of the proceeds received in exchange for the obligation.
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ACCOUNTING CONCEPT
The following are the accounting concepts:
(i) Business entity concept.
(ii) Money measurement concept
(iii) Cost concept
(iv) Going concern concept
(v) Dual aspect concept
(vi) Realization concept.
(vii) Accrual concept.
(i) Business entity concept:- Treat a business as distinct from the person who owns it.
(ii) Money measurement concept:- Accounting records only those transactions, which are expressed in
monetary term.
(iii) Cost Concept:- Transactions is entered in the books of account at the amount actually involved.
(iv) Going concern Concept:- It is assumed that business will exist for a long time and transactions are
recorded from that point of view.
(v) Dual Aspect concept:- Each transaction has two aspects; if a business has acquired assets, it must
have resulted in one of the following:-
(a) Some other assets have been given up.
(b) The obligation to pay for it has arisen; or rather,
(c) There has been a profit, leading to an increase in the amount that the business owes to the
proprietors, or
(d) The proprietor has contributed money for the acquisition of assets.
ACCOUNTING EQUATIONS
ASSETS = Liabilities + Capital or CAPITAL = Asset – Liabilities
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(vi) Realization Concept:- Accounting is a historical record of transactions; it records what has
happened. It does not anticipated events though anticipated adverse effects of events that have
already occurred are usually recorded.
This concept stops the business firms form inflating their profits by recording sales and income that
are likely to accrue. Unless the money has been realized – either cash has been received or a legal
obligation to pay has been assumed by the customers – no sale can be said to have taken place and no
profit or income can be said to have arisen.
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(vii) Accrual Concept:- If an event has occurred or a transaction has been interred into, its consequences
will follow. Normally, all transactions are settled in cash but even if cash settlement has not taken
place, it is proper to bring the transaction or the event concerned in to the books.
FUNDAMENTAL ACCOUNTING ASSUMPTION
The following are the fundamental accounting assumptions:-
(a) Going Concern:- The enterprise is normally viewed as a going concern, that is, as continuing
in operation for the foreseeable future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing materially the scale of the
operations.
(b) Consistency:- It is assumed that accounting policies are consistent from one period to
another. A change in an accounting policy is made only in certain exceptional circumstances.
(c) Accrual:- Revenue and costs are accrued, i.e., recognized as they are earned or incurred (and
not as money is received or paid) and recorded in the financial statements of the period to
which they relate.
ACCOUNTING CONVENTIONS REGARDING FINANCIAL STATEMENTS
In order to make the information contained in the financial statements clear and meaningful, these are drawn
up according to the following convention:-
(i) Consistency:- The accounting practices should remain the same from one year to another. If a
change become necessary, the change and its effects should be stated clearly.
(ii) Disclosure: Apart from legal requirements good accounting practices also demand that all
significant information should be disclosed.
(iii) Conservatism: Financial Statements are usually drawn up on rather a conservation basis. Window-
dressing i.e. showing a position better than what is not permitted. It is also not proper to show a
position substantially worse than what it is. In other words secret reserve are not permitted.
Question: Elucidate “accounting convention of conservatism”.
Ans.: ‘Conservatism convention’ states that the accountants should not anticipate income and should
provide for all possible losses. The underlying principle is that revenues should only be recognized when
there is reasonable certainly about their realization. At the same time television must be made for all
possible liabilities, whether the amount is known with certainly or is based on lesser value must be selected.
To illustrate, inventories are recorded at the cost or market value whichever is less or if there a possibility
that a debt may not be realized, a specific amount is charged against profits as a provision for doubtful debts.
ACCOUNTING POLICIES
The accounting policy refer to specific accounting principles and the methods of applying those
principles adopted by the enterprise in the preparation and presentation of financial statements.
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There is no single list of accounting policies, which is applicable to all enterprise in all
circumstances. The choice of the appropriate accounting principles in specific circumstances of each
enterprise calls for considerable judgment by the management of the enterprise.
(i) Under this system, there may be prepaid / (i) Under this, there is no prepaid /
outstanding expenses and accrued / outstanding expenses or accrued / unaccrued
unaccrued income in the balance sheet. income.
(ii) Income Statement will show a relatively
higher income in case of prepaid expenses (ii) Income statement will show lower
and accrued income. income.
(iii) Income statement will show a relatively
lower income in case of outstanding expenses
and unaccrued income . (iii) Income statement will show higher
(iv) The basis is recognized under the income.
Companies Act. 1956.
(iv) The basis is not recognized under the
Companies Act.1956.
CHAPTER – 2
JOURNALIZING, POSTING & BALANCING
1. Assets Accounts These accounts relate to tangible or intangible real assets. Eg. Land A/c, Building
A/c, cash A/c, Patents, Goodwill, Trademark etc.
2. Liabilities Accounts These accounts relate to the financial obligations of an enterprise towards
outsiders. Eg Trade creditors, Bills Payable , Bank Overdraft, Loans, Outstanding
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Exp. etc.
3. Capital Accounts These accounts relate to owners of an enterprise. Eg. Capital A/c, Drawings A/c.
4. Revenue Accounts These accounts relate to the amount charged for goods sold or services rendered
or permitting others to use enterprise’s resources yielding interest, royalty or
dividend. Eg. Sales A/c, Discount Received A/c, Dividend Received A/c, Interest
Received A/c.
5. Expenses Accounts These accounts relate to the amount incurred or lost in the process of earning
revenue. Eg. Purchase A/c, Discount allowed A/c, Royalty paid A/c, Interest
payable A/c, Loss by Fire A/c etc.
JOURNAL
A Journal is a book in which transactions are recorded in the order in which they occur i.e., in chronological
order. A journal is the primary books of account under which all the transactions are recorded with
complete narration on the basis of the three basic rules given for recording the transactions. The process of
recording a transaction in a journal is called Journalizing. An entry made in the journal is called a ‘Journal
Entry’.
A journal entry is an analysis of all the effect of a single transaction on the various accounts, usually
accompanied by an explanation. For each transaction, this analysis identifies the accounts to be debited or
credited.
FORMAT:
Date Particulars L.F. Amount (Dr.) Amount (Cr.)
Note:- The ‘Ledger Folio column’ is filled in at the time of posting into the ledger and not at the time of
journalizing.
ADVANTAGES OF JOURNAL
♦ Chronological record:- It records the transactions in the order in which they occur.
♦ Explanation of transaction:- Each journal entry in the journal carries narration which gives a brief
explanations of the transaction.
♦ Recording the both aspects:- Both the aspect (i.e., debit and credit) of a transaction are recorded in
the journal. Since the amounts recorded in both debit amount column and credit amount column
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must be equal, the possibility of accounting error is reduced and the detection of errors, if any,
committed becomes easy.
LIMITATIONS OF JOURNAL:
When the number of transactions is large, it is practically impossible to record all the transactions
through one journal because of the following reasons:
(i) The system of recording all the transactions in a journal required (a) the writing down of the
name of account involved as many times as the transactions occur; and (b) an individual posting
of each account debited and credited and hence involves the repetitive journalizing and posting
labour.
(ii) Such system does not provide the information on prompt basis.
(iii) Such a system does not facilitate the installation of an internal check system since, the journal
can be handled by only one person.
(iv) The journal becomes bulky and voluminous.
To overcome and shortcomings of the use of the journal only as a book of original entry, the journal is
subdivided into special journal.
NARRATION:
The narration is the explanation of the entry and facilitates quick understanding. The length of the
narration depends on the complexity of the transaction and whether management wants the journal itself
to contain all relevant information. Most often narration are in brief.
S.No. Particulars Amount (Dr.) Amount (Cr.)
1. On bringing of Capital in Cash:
Cash Account ...........…...........… Dr.
To Capital Account
(Being cash brought as capital in to business)
2. On brining of capital in the mode of cheque:
Bank Account ...........…...........… Dr.
To Capital Account
(Being capital brought into business)
3. On deposit of cash into bank:
Bank Account ...........…...........… Dr.
To Cash Account
(Being Cash deposited into bank)
4. On purchase of assets for cash.
Assets (name of assets) Account ...........…. Dr.
To Cash Account.
(Being assets purchase for cash)
5. On purchase of assets on credit:
Assets Account ...........…...........…. Dr.
To Supplier Account
(Being assets purchased on credit from .............)
6. On sale of goods for cash.
Cash Account ...........…...........…… Dr.
To Sales Account
(Being goods sold for cash)
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COMPOUND ENTRY:
When more than two accounts are involved in a transaction and the transaction is recorded by means of
single journal entry instead of passing several journal entries, such single journal entry is termed as
‘Compound Journal Entry’. A compound journal may also be passed if there are more transactions of
the same nature, taking place on the same date. It may be recorded in the following three way:
(i) by debiting one account and crediting two or more accounts; or
(ii) by debiting two or more accounts and crediting one account; or
(iii) by debiting several accounts and crediting several accounts.
Example:-
Paid Rs. 920 to Mr. Gopal in full settlement of his account of Rs. 1,000.
Gopal A/c ...........… Dr. 1000
To Cash a/c 980
To discount received A/c 20
(Being cash paid to Gopal in full settlement of his account)
OPENING ENTRY
A Journal entry by means of which the balances of various assets, liabilities and capital appearing in the
balance sheet of previous accounting period are brought forward in the books of current accounting
period, is known as ‘Opening Entry’.
While passing an opening entry. All those accounts which denote what the business possesses (assets)
are debited and all the accounts showing amounts due by the business (liabilities) are credited.
⇒ If Capital is not given, it can be easily found out by deducting liabilities from assets.
Opening entries are the following:
Cash Account ............. Dr.
Cash at Bank Account ............. Dr.
Sundry Debtors Account ............. Dr.
Stock Account ............. Dr.
Fixed Assets Account ............. Dr.
To Sundry Creditors Account
To Capital Account
⇒ The opening entry is made in the journal. At the end of the trading period, closing entries are made,
the object being to close the books.
LEDGER:
A ledger is a principal book, which contains all the accounts to which the transactions recorded in the
books of original entry are transferred. As the ledger is the ultimate destination of all transactions, the
ledger is called the ‘Book of Final Entry.’
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The ledger may be kept in the form of a bound book, a loose-leaf set of pages, or some kind of electronic
storage device such as magnetic tape or floppy diskettes or CDs, but it is always kept current in a
systematic manner.
Utility of the ledger:
⇒ It provides complete information about all the accounts in one book.
⇒ It enables to ascertain what the main item of revenues are.
⇒ It enables to ascertain what the main item of expenses are.
⇒ It enables to ascertain what the assets are and of what value.
⇒ It enables to ascertain what the liabilities are and of what amounts.
⇒ It facilitate (i.e. make easy) the preparation of Final Accounts.
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CHAPTER – 3
SUBSIDIARY BOOKS
When number of transactions is numerous, it is practically impossible to record all the transactions through
one journal because of a its limitations. To overcome the shortcomings of the use of the journal entry, the
journal is divided into special journals.
The journal is subdivided in such a way, that a separate book is used for each category of transactions,
which are repetitive in nature and are sufficiently large in number.
Special journal, refer to the journals meant for specific transactions of similar nature. Special journals are
also known as subsidiary books or day-book.
In any large business organization, the following special journal (or subsidiary books) are generally used:
Name of Books Transactions to be recorded
[I] Cash Journals:
(a) Cash Book (simple) ⇒ Cash transactions
(b) Cash book with discount column ⇒ Cash and discount transactions
(c) Cash Book with bank and ⇒ Cash, Bank and discount transactions
(d) Petty Cash Book ⇒ Petty Cash transactions
[II] Goods Journals:
(a) Purchase book ⇒ Credit purchase of goods.
(b) Sales book.
⇒ Credit sales of goods
(c) Sales return book
⇒ Goods returned by those customers to whom
(d) Purchase returns book goods were sold on credit.
⇒ Goods returned to those suppliers from goods
[III] Bills of Journals: were purchased on credit
(a) Bills receivable book.
(b) Bills payable ⇒ Bills receivable Drawn
book. ⇒ Bills payable accepted.
Advantages of subsidiary Books:-
(i) Division of work.
(ii) Specialization and efficiency.
(iii) Saving the time.
(iv) Availability of information’s.
(v) Facility in checking.
Cash Book:
A cash – Book is special journal which is used for recording all cash receipts and cash payments. It is a
book of original entry, since transactions are recorded for the first time from the source documents. The
Cash-Book is a ledger in the sense that it is designed in the form of a Cash Account and records cash
receipts on the debit side and cash payment on the credit side. Thus, Cash-book is both a journal and
ledger.
⇒ Single Column Cash Book has one amount column on each side.
⇒ Double Column Cash Book (i.e. Cash book with discount Column) has two amount columns. One for
cash and another fro discount. All cash receipts and cash discount allowed are recorded on the debit side
and all cash payments and cash discount received are recorded on the credit side.
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1. Three Column Cash Book has three amount columns (one for cash, one for bank and one for discount)
on each side. All cash receipts, deposits into bank and discount allowed are recorded on debit side and
all cash payments, withdrawals from bank and discount received are recorded on the credit side. A three
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column cash book serves the purpose of Cash Account and Bank Account. Hence, there is no need to open
these two accounts in ledger.
CASH DISCOUNT
A reduction granted by a supplier from the invoice price in consideration of immediate payment within a
stipulated period.
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DISTINCTION BETWEEN TRADE DISCOUNT
Question:
(1) What is debit note? Name the book in which entries are recorded on the basis of debit note?
Ans.: A Debit note is a document prepared by the purchases to inform the supplier that his account has
been debited with the amount mentioned and for the reasons stated therein. Debit note contains the date of
return, name of the supplier to whom the goods have been returned, details of the goods returned, reasons
for returning the goods. Each debit note is serially numbered.
The entries in the purchases returns book are usually made on the basis of debit notes issued to the
suppliers or credit notes received from the suppliers.
(2) What is credit note? Name the book in which entries are recorded on the basis of credit note?
Ans.: A Credit note is a document prepared by the seller to inform the buyer that his account has been
credited with the amount mentioned and for the reasons stated therein. Credit note contains the date of
return of goods, the name of the customer who has returned the goods, details of goods received back and
the amount of such goods. Each credit note in serially numbered.
The entries in the sales returns book are usually on the basis of credit notes issued to customers or
debit notes issued by the customers.
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CHAPTER – 4
RECTIFICATION OF ERRORS
The term ‘error’ refers to unintentional mistakes in financial information, e.g. mathematical or clerical
mistakes, oversight or misinterpretation of facts, or unintentional misapplication of accounting policies.
While recording transactions and events various errors may be committed unintentionally. When a journal
entry contains an error, the entry can be erased or crossed out and corrected – if the error is discovered
immediately. However, if the errors are detected after posting to ledger accounts, the correcting entries are
made. The correcting entry is recorded in journal and posted to the general ledger exactly as regular entries
are.
Example:
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(i) A repair expenses was erroneously debited to plant and machinery on November 25, the error is
discovered on December 31:
Corrective Entry: 31st Dec.: Repair Expenses A/c ............. Dr.
To Plant and Machinery A/c
The corrective entry shows a credit to Plant and Machinery to cancel or offset the erroneous debit to
Plant and Machinery.
(ii) A collection on account was erroneously credited to Sales on Jan. 1. The error is discovered on
March 26.
Corrective Entry: March 26. Sales Account ...........…. Dr.
To Sundry Debtor A/c
The debit to Sales in the correcting entry offset the incorrect credit to sales in the erroneous entry. The
credit to Accounting Receivable in the correcting entry places the collected amount where it belongs.
Errors that are not counterbalanced in the ordinary book-keeping process will keep subsequent
balance sheets in error until specific correcting entries are made.
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A Trial Balance is very good way of giving a clear indication of some mistakes that may be there. This will
be shown immediately , if the total of the two columns of the trial balance differ. Thus, trial balance is
essential to ensure that mistakes do not remain unearthed. However, the agreement to trial balance does not
show conclusively that no mistakes have remain undetected. Some errors will not be disclosed by the trial
balance whereas some will be. An agreed trial balance, therefore, is only a reasonable proof of
arithmetic accuracy of books.
CLASSIFICATION OF ERRORS
(a) Error of Omission A transaction entirely omitted to record in original
books or partially omitted while posting.
(b) Error of commission Wrong posting either of amount, or on the wrong
side, or in the wrong account.
(c) Error of Principle Wrong classification of expenditure or receipt.
(d) Compensating error One error compensated by the another error i.e. an
error which cancel themselves out.
5) Recheck the totals of the subsidiary books, especially if the mistake is of 1,10,100 and so on.
6) If the difference is a large one, compare the figure with the trial balance of the corresponding date of
the previous year. Any account showing rather large difference over the figure in the corresponding
trial balance of the previous year, should be rechecked.
7) Posting of all amounts corresponding to the differences or half the difference should be checked.
8) If the differences are still not traced posting of all accounts will have to be checked.
RECTIFICATION OF ERRORS
Correction of errors, if located after some time, is always made by a proper journal entry and not by
simply crossing the wrong amount and inserting the right one. A complete explanation for the correction
made should be given so that no difficulty is experienced later when accounts are checked.
From the point of view of rectification, errors are of two type:-
(i) Error that affect the trial balance; and
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(ii) Errors that do not affect the trial balance.
Correction of such error as affect the trial balance would not be through journal entry; only a
corrective amount placed on the proper side will suffice. Some of the examples of such types of
errors are as follows:-
1) An amount of Rs. 150 for a credit sale to Mr X correctly entered in the sales book, has been debited to
his account as Rs. 105.
In this case the amount has been correctly entered in the sales book and, therefore, the sales account has
been correctly posted. The mistakes lies only in the account of Mr. X, who should have been debited
with Rs. 150 and has been debited, instead, with Rs 105. The correcting entry is to:-
Mr. X Account Dr. Rs. 45.00
To mistakes in posting on ............. Rs. 45.00
(Being amount wrongly posted in Mr. X A/c for Rs. 105 instead of Rs. 150)
2) An amount of Rs. 150 for a credit sale to D.K.Kapoor, correctly entered in sales book, has been credited
to him.
In this case also the sales account has been correctly posted and the mistakes lies only in the account of
D.K.Kapoor, who has been credited instead of debited.
The correcting entry is to debit him with Rs. 300, Rs. 150 to remove the wrong credit and Rs. 150 for the
rightful debit. The caption will be “To mistake in posting on...........…
SUSPENSE ACCOUNT:
If the difference in the trial balances is not quickly located, it is usual to put the difference to
suspense account in order to make the trial balance balanced.
♦ If the debit side is short, the suspense account will be debited saying “To differences in trial balance”
and
♦ Similarly, the suspense account will be credited if the credit side is short.
The difference in the trial balance is due only to type of mistakes which affect only one account such as
wrong posting of an account, mistake in totaling a subsidiary book, etc. Such types of mistakes are only
reflected in suspense account.
When the difference in trial balance is put to suspense account, the account to be corrected will be
debited or credit as the case may be, and the journal entry will be completed by crediting or debiting the
suspense account. When all the mistakes have been corrected, the suspense account will show no
balance.
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31
DISTINCTION BETWEEN ERROR OF PRINCIPAL AND ERROR OF OMISSION
Errors of Principal Errors of Omission
⇒ This error does not affect Trial Balance ⇒ This error may affect Trial Balance.
⇒ This error is due to wrong classification of ⇒ This error is due to complete omission of a
Capital and Revenue expenditure or personal and transaction or partial omission.
nominal account.
⇒ This is not a clerical error. ⇒ This is a error may or may not affect profit of the
⇒ This error affects profit of the business. business.
⇒ This error will affect value of asset or liability. ⇒ This error may or may not affect value of assets
or liability.
CHAPTER – 6
BILLS OF EXCHANGE / PROMISSORY NOTE
BILL OF EXCHANGE:-
“A Bill of exchange is an instrument in writing containing an unconditional order signed by the maker,
directed a certain person to pay a certain sum of money only to or to the order of, a certain person or to the
bearer of the instrument.”
When such an order is accepted by writing on the face of the order itself, it becomes a valid Bill of
Exchange.
The essentials are:
1. A bill of exchange must be in writing .
2. It must be dated.
3. The bill must be signed by the drawer.
4. The drawer, the drawee, and the payee must be certain.
5. It must contain an order to pay a certain sum of money.
6. The money must be payable to a definite person or to his order to the bearer.
7. The draft must be accepted for payment by the party or whom the order is made.
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⇒ The party who make the order (i.e. who makes the bill) is known as drawer; the party who accept
the order is known as acceptor and the party to whom the amount has to be paid is known as the
payee. The drawer and payee can be the same.
Specimen of Bill of Exchange.
Rs. 10000 Delhi
October 25, 2004
Stamp
Three months after the date pay M/s X Brothers to order the sum of Rs. 10,000 for value received.
P.K.Singh
To
M/s Nanda Brothers.
Laxmi Nagar, Delhi 110092.
PROMISSORY NOTE:
“A Promissory Note is an instrument in writing, not being a bank note or currency note, containing an
unconditional undertaking, signed by, the maker, to pay a certain sum of money only to, or to the order of a
certain person or to the bearer of the instrument.”
A Promissory Note has the following characteristics:-
1. It must be in writing.
2. It must contain a clear promise to pay, mere acknowledgement of a debt is not a promissory note.
3. The promise to pay must be unconditional. “I promise to pay Rs. 5000/- as soon as I can” is not an
unconditional promise.
4. The promisor or maker must sign the promissory note.
5. The maker must be a certain person.
6. The payee must also be a certain.
7. The sum payable must be certain and must not be capable of contingent addition or subtractions. “I
promise to pay Rs. 5000/- plus all fines” is not certain.
8. Payment must be in legal money of the country.
9. It should not be made payable to bearer.
10. It should be properly stamped.
Specimen of Promissory Note:
Rs. 10000 Delhi
October 25, 2004
Stamp
Three months after the date we promise to pay M/s Alfa & Co. or order the sum of Rs. 10,000
with interest at 6% for value received.
Gopal & Sons.
exchange – the drawer, the drawee and the promisor or maker and the payee.
payee.
⇒ A bill of exchange requires acceptance by the ⇒ This does not require acceptance. It is written by
drawee after if is drawn by the drawer. the person who will pay the amount.
⇒ Bill of exhange may be payable either on order ⇒ Promissory note can not be payable to bearer.
or to the bearer.
⇒ In case of Bills of Exchange notice of dishonour ⇒ In case of promissory note, notice of dishonour
is given to all parties concerned. is not required.
⇒ The maker (Drawer) of the Bill is liable only ⇒ The maker is primarily liable to pay the amount.
when drawee does not make payment.
⇒ In case of foreign bills protest is necessary if it is ⇒ Protest is not required for promissory note.
required as per law of the country where bill has
been drawn.
CHEQUE:
A cheque is a bill of exchange drawn on a specified banker and payable on demand. It includes the
electronic image of a truncated cheque and a cheque in the electronic form.
A cheque is a bill of exchange with two additional qualifications:
⇒ It is always drawn on a specified bank, and
⇒ It is always payable on demand.
NEGOTIABILITY:-
Promissory Notes, Bill of Exchange and Cheque all are negotiable instrument. The holder can claim
payment on them subject to conditions that the holder takes them:-
i) without notice of defect in the title of the transferor, i.e. in good faith,
ii) for consideration and
iii) Before maturity.
Example:
If a steals a bill of exchange and passes it on to B who is not aware of A’s mode of acquiring the bill and
who takes it for the value and before the due date of the bill, B will be entitled to get payment on the bill.
Here B is a holder in due course. A holder in due course always gets a good title in case of forgery.
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Moreover, who ever gets the bill after the holder in due course will also get a good title to it; it has been
purged of all defects.
The instrument may passed on from one person to another by endorsement and delivery. The liability of the
endorser or subsequent parties is same as in the case of endorsement of cheque. Thus, if a bill of exchange
is dishonoured, i.e. if payment is not made on the due date by the promisor (drawee in case of bill of
exhange), money can be claimed form any of the previous endorsers, the payee and the maker of the
instrument.
DISCOUNTING OF BILLS:
When the bill is taken to a bank and the necessary cash if received, the act is known as discounting. The
bank will always deduct a small sum depending upon the rate of interest and the period of maturity.
Dishonour:
A bill may be dishonoured either by non-acceptance or by non-payment. When an instrument is
dishonoured, the holder must give notice of dishonour to the drawer or his previous holders if he wants to
make them liable.
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Noting Charges:-
“Noting” must be recorded with Notary Public within a reasonable time after the dishonour and must contain
the fact of dishonour, the date of dishonour, the reason if any, given for such dishonour and the noting
charges. For this service they charge a small fee. This fee is known as noting charges. Noting charges have
to be born by the person responsible for dishonour. Hence, when a bill is disonoured, the amount due is the
amount of the bill plus the noting charges. However, if the acceptor prove that the bill was not properly
presented to him for payment, he may escape his liability.
Renewal of a Bill:
Some time the acceptor is unable to pay the amount and he himself moves that he should be given an
extension of time. In such a case, a new bill will be drawn and the old bill will be cancelled. If this happens
entries should be passed for cancellation of the bill as in case of dishonour of bill. When the new will is
received, entries for receipt of bill will be repeated.
Accommodation of Bills:-
Bills of exchange are usually drawn to facilitate trade transaction, finance actual purchase and sale of goods.
But apart from, financing transaction in goods, bills may also be used for raising fund temporarily.
Suppose A need finance to the extent of Rs. 10000/- for 3 months. In this case he may induce his friend B
to accept a Bill of Exchange drawn on him for Rs. 10000/- for 3 months. A can, then get the bill discounted
with his bank, paying a small sum of discount.
Thus he can use the funds for 3 months and just before maturity, he will remit the amount to B to whom the
bill will be presented by the bank for payment.
If both A and B need money, the same device can be used. Either A accept a bill of exchange or B does. In
either case the bill will be discounted with the bank and proceeds divided between the two parties according
to mutual agreement. The discounting charges must also be born by two parties in the same ratio in which
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the proceeds are divided on the due date the acceptor will receive from the other party his share. The bill
will then be met. When bills are used for such purpose, they are known as accommodation bills.
In case of accommodation of bills, all the journal entries are passed in the books of two parties as same
in the ordinary bills.
The only additional entries to be passed are for sending the remittance to the other parties and also
debating the other parties with the requisite amount of discount.
Bankruptcy:
Bankruptcy/ Insolvency of a person means person who has accepted the bill is unable to pay his liabilities
and
When it is known, the acceptor of the bill has become insolvent, entry for dishonour of his acceptance
must be passed.
When and if an amount is received, cash amount will be debited and personal account of debtor will be
credited.
The remaining amount will be irrecoverable and should be WRITTEN OFF AS BAD DEBT.
CHAPTER – 7
CONSIGNMENT
Consignment Sale
⇒ Where one person in firm send goods to another person or firm on the basis that the goods will be sold
on and the risk of former, it is called consignment sale.
⇒ The party which send the goods is called consignor and the party to whom goods are sent is called
consignee or agent.
⇒ The consignee does not buy these goods but merely undertake to sell them on behalf of the consignor.
The sale proceeds belong to the consignor and the consignee merely get the agreed commission for his
service in addition to any expenses he might have incurred.
⇒ The relationship between the consignor and the consignee is that of principal and agent.
Account Sales
⇒ After sale of goods, consignee sends a statement to consignor. This statement is called account sales.
⇒ In this statement gross sales value, expenses and commission of consignee, advance paid by consignee
and net amount due by consignee are shown.
Del-Credere Commission
⇒ The additional commission for which the consignee guarantee debt is called del-credere commission.
⇒ This commission save consignor from loss of bad debts only.
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⇒ The agent is responsible for bad debts due but not for loss due to a dispute between the buyer and the
seller.
⇒ The del-credere commission is payable on total sales and not merely on credit sales.
Ordinary Commission
⇒ Ordinary commission is a commission which consignee gets as his remuneration from the consignor for
the sales made in behalf of the consignor.
⇒ In this case the consignee does not guarantee that all those who buy on credit will pay up. The
consignee is not responsible for bad dents.
Books of consignor
⇒ To know the profit and the loss made on a consignment separately a consignment account is opened.
⇒ A consignment account is not a personal account but is in the nature of a special type of a trading and
profit and loss account which show profit or loss made on the particular consignment.
⇒ If goods are consigned to a number of parties, the profit and loss on consignment to each consignee may
be ascertained separately.
To Consignment A/c
(Being loss incurred on consignment transferred to Profit & Loss A/c)
Note: the goods sent on Consignment account is transferred to the purchase Account in case the
consignor carries in a trading business and to Trading account if the consignor carries on a
manufacturing business.
Abnormal Loss:
Abnormal loss of goods occurs due to accidental, mischief or carelessness. e.g. loss occurred due to fire,
theft, flood, earthquake, etc.
⇒ Abnormal loss should be debited to abnormal loss account and credited to consignment account.
⇒ The amount of loss is ascertained like the value of closing stock at cost; except that
⇒ The expenses incurred on the remaining goods after the loss have to be ignored while calculating the
amount of loss because no part of such expenses can be said to have been incurred on the goods lost.
⇒ If abnormal loss is fully or partly covered by insurance, abnormal loss account may be debited and
consignment account credit with full cost of the goods involved in the loss.
⇒ The amount recovered (if any) from the insurance company will be credited to abnormal loss account
and, the balance, if any left in abnormal loss account will be transferred to Profit & Loss Account.
Normal Loss:
Any loss which occurs due to natural causes e.g. normal leakage, loss in weight due to nature of goods,
etc. is termed as ‘normal loss’. In certain cases, some loss is inherent and unavoidable. For instance, if a
certain quantity of cement is consigned, some of it is bound to be lost because of loading and unloading.
Such inherent and unavoidable loss is known as normal loss and should be allowed while calculating the
cost of the stock on hand. Such loss inflates the value of closing stock.
Ex. 200 tones of cement are consigned at Rs. 1,000 per tones, freight being Rs. 10,000. By the end of
the year, the consignee has sold 130 tones of cement and is left with 65 tones of cement, the remaining 5
tones of cement having been lost due to normal wastage. The closing stock of 65 tones will be valued at
Rs. 70,000.
CHAPTER - 9
CAPITAL AND REVENUE
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It is necessary to make a distinction between Revenue and capital expenditure and income to determine the
correct income of the business. To calculate net profit of the business, only revenue income and expenditure
will be taken into consideration, however business may incur some expenditure of capital nature.
The following facts will not be taken in to consideration to decide, whether an expenditure incurred or
income earned is capital or Revenue in nature:-
(i) Source of payment (ii) Quantum of Amount
(iii) Nature of recipient (iv) Manner of payment
Classification of Expenditure Classification of Income Classification of Receipt
[1] Capital Expenditure [1] Capital Income [1] Capital Receipt
[2] Revenue Expenditure [2] Revenue Income [2] Revenue Receipt
[3] Deferred Revenue Expenditure
• Capital Expenditure:
Capital expenditure is that expenditure which result in the acquisition of an assets, tangible or intangible,
which can be later sold and converted in to cash or which result in an increase in the earning capacity of a
business or which afford some other benefits to the firm. Such expenditure is incurred with a view to
brining in improvements in productivity of earning capacity for getting long-term advantages for the
business. It is not incurred for day-to-day working of the business. The following types of expenditure are
treated as – ‘Capital expenditure’.
(i) Acquisition of an asset.
(ii) Improvement of fixed assets.
(iii) Extension of an asset.
(iv) Putting the new assets into working condition.
(v) Expenditure in acquiring the asset.
(vi) Acquisition of a right to carry on business.
Other example are- money paid for goodwill since it will attract the old firm’s customer and thus result in
higher sales and profit. Money spent to reduce the working expenses, for example, conversation of hand
driven machinery to power driven machinery and expenditure which enable a firm to produce a large
quantity of goods.
It is important to note that all amount spent up to the point an assets is ready for use should be treated as
capital expenditure. The examples are − fees paid to lawyer for drawing up the purchase deed of land,
overhaul expenses of second hand machinery etc. Interest paid on loans raised to acquire a fixed asset is
particularly noteworthy. Such interest can be capitalized; i.e. added to the cost of the assets but only for the
period before the assets is ready for use.
It is not necessary that capita expenditure always generate profit. Even if there is a loss or asset has
not been used, such expenditure will be treated as capital expenditure.
• Revenue Expenditure:
Revenue Expenditure is that expenditure which is incurred for maintaining productivity or earning capacity
of a business. An item of expenditure whose benefit express within the year or expenditure which merely
seeks to maintain the business or keep assets in good working condition is revenue expenditure. Expenses
of following nature are treated as revenue expenses:-
(i) Expenses for running the business.
(ii) Expenses incurred to maintained the fixed assets.
(iii) Purchase of material and goods.
(iv) Depreciation.
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Such expenditure does not increase the efficiency of the firm, nor does it result in the organization of some
thing permanent.
• Capital Income:
If any income is derived not by running the business, it is treated as Capital Income. For example, profit
on sale of fixed assets over its cost is treated as Capital Income. However any profit upto the cost of the
asset is treated as Revenue Profit.
Example:- A Building had originally cost Rs. 60,000. Its present written down value in the books is
45,0000. It is sold for Rs. 65,000. In this case total profit on sale is Rs. 20,000 (65,000 – 45,000). Out of
this Rs. 5,000 being excess of sale price over cost [65,000 – 60,000] is capital profit and Rs. 15,000
[60,000 – 45,000] is revenue profit.
• Revenue Income:
Any income or profit derived by carrying on the business or during the course operations is treated as
revenue income. Ex. profit on sale of goods, dividend or interest received, commission or discount
received. Such income is shown in profit and loss A/c.
• Capital Receipt
Amount received from the proprietors as capital or loan receipt is treated as capital receipt. Similarly
sale proceeds of permanent or fixed assets are also treated as capital receipt. In order to ascertain the
profit made by a business, only revenue receipt should be taken in to account. Capital receipts have no
bearing on the profit made or loss incurred during a particular year.
• Revenue Receipt
Amount received in the course of normal business transaction is treated as revenue receipt. Total receipt
is not necessarily income. For example, sale proceeds of goods are revenue receipt but surplus of sale
proceeds after deducting cost of goods sold will be treated revenue income.
Question:
(1) State with reason whether the following are capital or Revenue Expenditure:
(i) Expenses incurred in connected with obtaining a licence for staring the factory were 10,000
(ii) Rs. 2,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged to
the plaintiff the suit was not successful.
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(iii) Rs. 12,000 interest had accrued during the year on term loan and utilised for the construction of
factory building and purchase of machineries, however, the production had not commenced till
the last date of the accounting year.
(iv) Cost of making more exists in a cinema hall.
(v) Expenditure on acquisition of Export Rights, when payment is made in instalments.
(vi) Interest on arrears of sales tax.
(vii) Less due to devaluation of currency on loan taken in foreign currency.
(viii) Cost of project Report – Project did not materialized.
Ans.: (1)
(i) Money paid Rs. 10,000 for obtaining a license to start a factory is a capital expenditure. This is
an item of expenditure incurred to acquire the right to carry on business. The expenses necessary
for either establishing the business, like expenses for obtaining the necessary license will be
capital expenditure. Only the initial expenditure is capital; renewal fees are recenue.
(ii) Rs. 2,000 spent as lawyer’s fee in defending the title to the firm’s assets is a revenue expenditure.
This is an expenditure incurred for upkeep of a fixed assets. If there is a dispute about the
ownership, legal expenses incurred for defending the title will be a revenue expense.
(iii) Interest accrued Rs. 12,000 on term loan obtained and utilised for the construction of factory
building and purchase of machinery should be treated as capital expenditure since commercial
production has not begun till the last day of accounting year.
(iv) Making more exist in a cinema hall does not increase the capacity of the hall and, therefore, it
should be treated as revenue expenditure.
(v) This is an expenditure of an enduring nature and will benefit the business for a long period. This
a kind of intangible assets which will help business to earn income. Whether payment is made
lump sum or in instalments. the nature of expenditure being capital will not change.
(vi) When sales tax is payable in instalements, any interest paid with amount of sales tax is similar to
tax for the business. Further, this expenditure has direct relationship with the income earned
during the current year. Hence, treated Revenue Expenditure.
(vii) Treatment for such loss will depend on the fact whether loan amount has been used for acquiring
a fixed asset or it was being used as circulating capital or trading assets. If loan was used for
acquitting fixed assets, any loss arising on account of devaluation of currency will be capital loss.
But if loan was being used in circulating capital or trading asset, such loss will be treated as
Revenue Loss.
(viii) The expenditure is not giving any enduring benefit of the business. However, if amount is heavy
it will be treated as deferred Revenue Expenditure.
VALUATION OF INVENTORIES
The revised standard came in to effect in respect of accounting period commencing on or after 1.4.99 and is
mandatory in nature. However, this statement does not apply in valuation of the following:-
(a) work- in-progress arising under construction contract, including directly related service contact.
(b) Work-in-progress arising in the ordinary course of business of service providers;
(c) Shares, debentures and other financial instrument held as stock-in –trade.
(d) Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to
the extent that they are measured at net realizable value in accordance with well established practices in
those industries.
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• Valuation:
The principle for valuation is that inventories should be valued at the lower of cost and net realised value.
• Cost of Inventories:
The cost of inventories should comprise all costs of purchase, costs of conversion and other cost incurred in
bringing the inventories to their present location and condition.
a) Cost of Purchase:- The costs of purchase, consist of the purchase price including duties and taxes
(other than those subsequently recoverable from taxing authorities), freight inwards and other
expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other
similar items are deducted in determining the cost of purchase.
Note: Cash discount should not be treated as adjustment to the cost of purchase. Such rebate should be
treated as separate revenue items and accounted for accordingly. Any discretionary discounts given on ad-
hoc basis are also not deductible from the cost of inventory.
b) The cost of conversion:- The costs of conversion of inventories include costs directly related to the
units of production , such as direct labour. They also include a systematic allocation of fixed and
variable production overheads that are incurred in converting materials into finished goods.
⇒ Fixed production overheads are those indirect costs of production that remain relatively constant
regardless of the volume of production, such as depreciation and maintenance of factor buildings and the
cost of factory management and administration.
⇒ Variable overhead are those indirect costs of production that vary directly, or nearly directly, with the
volume of production, such as indirect materials and indirect labour. The inclusion of cost of conversion
as part of inventory cost follows the principle that all costs incurred to bring the inventory to its present
location and condition should form part of the inventory costs.
other than production overheads such as the costs of t\designing products for specific customers in the costs
of inventories.
In determining the cost of inventories the following costs are excluded and recognize such costs as expenses
in the period in which they are incurred.
(a) Abnormal amount of wasted material, labour, or other production costs;
(b) Storage costs, unless those costs are necessary in the production process prior to the further
production stage;
(c) Administrative overhead that do not contribute to bringing the inventories to their present location
and condition.
(d) Selling and distribution costs.
Warranty expenses incurred after completion of the sale will not form part of cost of inventory because it is
not a cost incurred to bring the inventory to its present location and condition. Warranty expenses should
not be included in cost of inventory even if the warranty is in relation to a manufacturing defect. If a
particulars item of inventory has a defect, then the cost of inventory would be the cost of the defective
inventory (present condition) and not what the cost of inventory would be if the defect was rectified.
Cost Formulae:
⇒ The cost of inventories of items that are not ordinarily interchangeable and goods or services products
and segregated for specific projects should be assigned by specific identification of their individual
costs.
⇒ The cost of inventories, other than those dealt with in the specific identification method, should be
assigned by using the first-in, first –out (FIFO), or weighted averaged cost formula.
⇒ Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail
method, may be used for convenience if the results approximate the actual cost.
Inventories are usually written down to net realizable value on an item-by-item basis. In some
circumstances, however, it may be appropriate to group similar or related item.
⇒ When there has been a decline in the price of materials and it is estimated that the cost of finished
products will exceed net realizable value, the raw materials are written down to net realisable value.
In such case the replacement cost of the raw material may be the best available measure of their net
realisable value.
Disclosure Requirements:
The financial statements should disclose:
⇒ The accounting policies adopted in measuring inventories, including the cost formula used; and
⇒ The total carrying amount of inventories and its classification appropriate to the enterprise.
Characteristics of depreciation:
(a) It is related to depreciable fixed assets only.
(b) It is fall in the book value of depreciable fixed assets.
(c) The fall in the book value of an asset is due to the use of the asset in business operations, effluxion of
time, obsolescence, expiration of legal rights or any other cause.
(d) It is a permanent decrease in the book value of an asset.
(e) It is continuous decrease in the book value of an asset.
Different Approach:
Type of Rate of Depreciation given Period for which Depreciation is to be charged
When the rate of Depreciation with the words
‘per annum’ is given. (e.g. 15% p.a.)
(a) If the date of acquisition is given. ⇒ Charge depreciation for the period beginning
with the date of acquisition and ending with the
date of closing accounting period.
(b) If the date if acquisition is snot given. ⇒ Charge depreciation for the full year assuming
that the assets was purchased / acquired in the
beginning of the year; OR
⇒ Charges depreciation for half year assuming that
assets was purchased in the middle of the year;
OR
⇒ Charge no depreciation assuming that the asset
was acquired at the end of the year.
When the Flat Rate of Depreciation without the ⇒ Charge depreciation for the full year irrespective
words, ‘per annum’ is given (e.g. 15%) of the date of acquisition of assets
METHODS OF PROVIDING DEPRECIATION:
(1) Straight line method;
(2) Written down value method or Reducing balance method;
(3) Annuity method;
(4) Depreciation fund method;
(5) Insurance fund method;
(6) Sum of digit method;
(7) Revaluation method;
(8) Depletion method;
(9) Machine hour rate method; and
(10) Repairs provision method.
Under this method, the rate of depreciation is fixed, but it applied to the value at which the assets stands in
the books in the beginning of the year. Under this method the amount of depreciation will reduce every year.
The rate of depreciation under this method may be determined by the following formula:-
Dep. Rate = 1 – n √(Residual Value) × 100
Cost of assets
Note: If instead of scrap value some amount will have to be spent at the end of the life of the assets, such as
on pulling down the building on a leasehold land, such an amount should be added.