COMMON PROFICIENCY TEST / {FUNDAMENTALS OF ACCOUNTING @ ede untants of IndiaThe objective of the study material is to provide teaching material to the students to enable them to obtain knowledge and skills in the subject. In case students need any clarifications or have any suggestions to make for further improvement of the material contained herein they may write to the Director of Studies. All care has been taken to provide interpretations and discussions in a manner useful for the students. However, the study material has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees. Permission of the Institute is essential for reproduction of any portion of this material. © The Institute of Chartered Accountants of India All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior permission, in writing, from the publisher. Price : € 300.00 Revised Edition - November 2014 Updated Edition - November 2015 ISBN : 978-81-8441-033-4 Published by The Publication Department on behalf of The Institute of Chartered Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg, New Delhi-110 002, India Designed & Printed at Repro India Limited, 50/2, TTC MIDC Industrial Area, Mahape, Navi Mumbai - 400 710, India November / 2015 / P1854 (Updated) © The Institute of Chartered Accountants of IndiaIAT The paper on Fundamentals of Accounting at CPT Level develops conceptual understanding of fundamentals of accounting. This Study Material endeavouring towards accounting education, is committed to provide a framework for understanding accounting discipline and describing the fundamental accounting concepts and conventions of the basic accounting system. An attempt has been made to provide a solid foundation on which students can successfully build and enhance their studies. The book is divided into nine chapters, each addressing to a special aspect of accounting. Chapters I to 5 lay emphasis on bookkeeping aspect of accounting whereas chapter 6 deals with preparation of financial statements of sole proprietors. Chapter 7 covers accounting for special transactions like consignment, Joint ventures, bills of exchange and sale of goods on approval basis which can be entered into by different forms of business entities viz., sole proprietary concerns, partnership firms or companies. Chapter 8 discusses accounting of partnership firms and chapter 9 explains basic concepts of company accounts. Learning objectives have heen incorporated at the beginning of each chapter/unit to guide students as to the knowledge they should acquire after studying the chapters, Small illustrations have been incorporated in each chapter/unit to explain the concepts/principles dealt with in the chapter/unit. Lot of multiple choice questions have been provided at the end of each chapter/unit which will help students in appearing Common Proficiency Test Examination. These features would add value to the Study Material and aid the students in the learning process. In this revised study material, sincere efforts and care has been taken to incorporate the relevant Section of the Companies Act 2013, to the extent relevant for the students at CPT level. Care has also been taken in revising and improving the other chapters. Certain explanations have been added wherever felt required. In case you need any further clarification/guidance, please send your queries at seema@icai.in, shilpa@icai.in or asha.verma@icai.in © The Institute of Chartered Accountants of India© The Institute of Chartered Accountants of IndiaSear Fundamentals of Accounting (60 Marks) Objective: tem. To develop conceptual understanding of the fundamentals of financial accounting sy Contents 1. Theoretical Framework (@ Meaning and Scope of Accounting, (ii) Accounting Concepts, Principles and Conventions (ii) Accounting Standards ~ concepts, objectives, benefits (iv) Accounting Policies (v) Accounting as a measurement discipline - valuation principles, accounting estimates Accounting Process Books of Accounts leading to the preparation of Trial Balance, Capital and revenue expenditures, Capital and revenue receipts, Contingent assets and contingent liabilities, Fundamental errors including rectifications thereof. 3. Bank Reconciliation Statement 4, Inventories Basis of inventory valuation and record keeping, 5. Depreciation accounting Methods, computation and accounting treatment of depreciation, Change in depreciation methods. 6. Preparation of Final Accounts for Sole Proprietors 7. Accounting for Special Transactions (a) Consignments (b) Joint Ventures (©) Bills of exchange and promissory notes (d) Sale of goods on approval or return basis. 8, Partnership Accounts Final accounts of partnership firms - Basic concepts of admission, retirement and death of a partner inchiding treatment of goodwill. 9. Introduction to Company Accounts Issue of shares and debentures, forfeiture of shares, re-issue of forfeited shares, redemption of preference shares. © The Institute of Chartered Accountants of IndiaCONTEN' UhitT! Meaning and Scope of Accounting 1 2. Chapter Introduction Meaning of Accounting 2.1 Procedural Aspects of Accounting Evolution of Accounting as a Social Science Objectives of Accounting Functions of Accounting Book-keeping 6.1 Objectives of Book-keeping Distinction between Book-keeping and Accounting Sub-fields of Accounting, Users of Accounting Information Relationship of Accounting with Other Disciplines Limitations of Accounting Role of Accountant in the Society 12.1 Areas of Service 12.2 Chartered Accountant in Industry 12.3 Chartered Accountant in Public Sector Enterprises 12.4 Chartered Accountant in Framing Fiscal Policies 12.5 Chartered Accountant and Economic Growth Unit2: Accounting Concepts, Principles and Conventions 1 Introduction Accounting Concepts Accounting Principles Accounting Conventions Concepts, Principles and Conventions - an Overview Fundamental Accounting Assumptions Financial Statements 7.1 Qualitative Characteristics of Financial Statements Unit3: Accounting Standards — Concepts, Objectives, Benefits 1 Introduction Concepts Objectives. Benefits and Limitations Overview of Accounting Standards in India ‘Unit 4: Accounting Policies 1 2. 3. Meaning Selection of Accounting Policies Change in Accounting Policies © The Institute of Chartered Accountants of India 12 14 15 18 19 1.10 1.10 ul 1a 113 113 114 118 119 119 1.22 1.22 1.22 1.22 1.26 1.27 1.27 127 1.27 1.39 139 1.39 1.48 148 149 149 149 161 161 1.62CONTENTS [Unit's Accounting as a Measurement Discipline - Valuation Principles, Accounting Estimates 1 Meaning of Measurement Objects or Events to be Measured Standard or Scale of Measurement Dimension of Measurement Scale Accounting as a Measurement Discipline Valuation Principles Measurement and Valuation Accounting Estimates CEE enn bares Uniti? Basic Accounting Procedures - Journal Entries 1. Double Entry System 2. Advantages of Double Entry System 3. Account 4. Debit and Credit 5. Transactions 6. Accounting Equation Approach 7. Traditional Approach 7.1 Classification of Accounts 7.2. Golden Rules of Accounting 8. Journal 8.1 Journalising Process 82. Points to be taken into care while recording a transaction in the Journal 9. Advantages of Journal Unit2: Ledgers 1. Introduction 2. Specimen of Ledger Accounts 3. Posting 3.1, Rules regarding posting of entries in the Ledger 4, Balancing an Account Unit 3: Trial Balance 1 Introduction Objectives of preparing the Trial Balance Limitations of Trial Balance Methods of preparation of Trial Balance Adjusted Trial Balance (Through Suspense Account) Rules of preparing the Trial Balance Unit 4: Subsidiary Books 1. Subsidiary Books and their advantages Distinction between Subsidiary Books and Primary Books Purchases Book 3.1. Posting the Purchases Book © The Institute of Chartered Accountants of India 1.66 1.67 1.67 1.68 1.68 1.69 172 173 24 24 24 25 28 29 213 213 214 214 244 215 2.27 2.30 2.30 2.30 2.30 231 2.38 2.38 2.39 2.39 244 244 2.55CONTEN' 4, 7, Sales Book 4.1 Posting the Sales Book 4.2. Sales Book with Sales Tax column Sales Returns Book or Returns Inward Book Purchase Returns or Returns Outward Book 6.1 Posting of the Return Books 6.2. Bills Receivable Books and Bills Payable Books Importance of Journal Unit: Cash Book 1 2. Cash Book - A Subsidiary Book and A Principal Book Kinds of Cash Book 2.1 Simple Cash Book 2.2. Double-column Cash Book 2.3. Three-column Cash Book Posting the Cash Book entries Petty Cash Book 4.1 Imprest System of Petty Cash 4.2. Advantages of Petty Cash Book 43. Posting the Petty Cash Book Entries for Sale through Credit/Debit Cards 5.1 Accounting for Credit/Debit Card Sale ‘Unit’6 Capital and Revenue Expenditures and Receipts 1 Introduction Considerations in determining Capital and Revenue Expenditures Capital Expenditures and Revenue Expenditures Deferred Revenue Expenditures Capital Receipts and Revenue Receipts ‘Unit 7: Contingent Assets and Contingent Liabilities 1 2. 3. 4, Contingent Assets Contingent Liabilities Distinction between Contingent Liabilities and Liabilities Distinction between Contingent Liabilities and Provisions Unit 8 : Rectification of Errors 1 2. Introduction Stages of Errors 2.1 At the stage of Recording the Transactions in Journal 2.2 Atthe stage of Posting the Entries in Ledger 2.3 At the stage of Balancing the Ledger Accounts 24. At the stage of Preparing the Trial Balance Types of Errors Steps to locate Errors © The Institute of Chartered Accountants of India 2.55 2.56 257 2.60 2.61 261 2.62 2.62 2.68 2.68 2.68 2.70 271 2.75 275 2.76 2.80 2.80 281 2.82 2.87 2.88 2.88 2.89 291 2.98 2.98 2.99 2.99 2.103 2.106 2.106 2.106 2.106 2.106 2.107 2.109CONTENTS 5, Rectification of Errors 5.1 Before preparation of Trial Balance 5.2 After Trial Balance but before Final Accounts Correction in the next Accounting period (eer acerca: Introduction Bank Pass Book Bank Reconciliation Statement Importance of Bank Reconciliation Statement Ascertaining the causes of difference of Bank Balance in bank column of the Cash-Book and in Pass-Book 5.1 Timing differences 5.2. Differences arising due to Errors in Recording the Entries Procedure for reconciling the Cash-Book balance with the Pass-Book balance Methods of Bank Reconciliation 7.1 Bank Reconciliation Statement without Preparation of Adjusted Cash-book 7.2. Bank Reconciliation Statement after the Preparation of Adjusted Cash-book Chapter 4 - Inventori Meaning Inventory Valuation Basis of Inventory Valuation Techniques of Inventory Valuation 4.1. Historical Cost Methods 4.2. NonHistorical Cost Methods Inventory Record Systems 5.1 Periodic Inventory System 5.2. Perpetual Inventory System Distinction between Periodic Inventory System and Perpetual Inventory System Inventories Taking, Introduction 1.1. Concept of Depreciation 1.2. Objectives for providing Depreciation Factors in the Measurement of Depreciation, Methods for providing Depreciation © The Institute of Chartered Accountants of India 2.109 2.110 2.115 2.133 32 33 33 34 34 34 37 39 3.10 3.10 314 42 43 44 45 46 4.10 412 412 412 413 413 52 52 53 54 55CONTEN' 3.1 Straight Line Method 3.2. Reducing Balance Method 3.3. Sum of Years of Digits Method 34 Annuity Method 35. Sinking Fund Method 3.6 Machine Hour Method 37 Production Units Method 38 Depletion Method Profit or Loss on the Sale/ Disposal of depreciable assets Change in the Method of Depreciation Revision of the estimated useful life of the depreciable asset Revaluation of depreciable assets Provision for repairs and renewals TCO a ou Eten ae Corrie ole Proprietor: Wait! Final Accounts of Non-Manufacturing Entities 1. Introduction 2. Preparation of Final Accounts 2.1 Inter-relationship of the two statements 2.2. Matching Principle 2.3 Anexception Trading Account 3.1 Trading Account Items 3.2 Closing entries in respect of Trading Account 4. Profit and Loss Account 4.1, Closing entries 4.2 Adjustments Certain adjustments and their treatments 6. Balance Sheet 6.1. Characteristics 6.2. Arrangements of Assets and Liabilities 6.3 Classification of Assets and Liabilities 7. Sequence of Accounting procedure or the Accounting cycle 8 Opening Entry 8.1 Posting the Opening Entry 9. Provisions and Reserves 10. Limitations of Financial Statements Unit2 Final Accounts of Manufacturing Entities 1. Introduction 2. Purpose © The Institute of Chartered Accountants of India 64 65 6.6 67 68 68 69 61 614 6.16 6.19 6.21 6.26 6.27 6.27 6.28 632 632 6.33 640 642 645 645CONTENTS 3. Manufacturing Costs 3.1 Direct Manufacturing Expenses 3.2 Indirect Manufacturing Expenses 33 By-Products 4. Design of a Manufacturing Account ead Unit 1: Consignment ror ee meee 1. Meaning of Consignment Account 2. Distinction between Consignment and Sale 3. Accounting for Consignment Transactions and Events in the books of the Consignor 4, Valuation of Inventories 5. Goods Invoiced above Cost Abnormal Loss Normal Loss ‘Commission 8.1. Ordinary Commission 82. Del-credere Commission 83 Overriding Commission 9. Return of Goods from the Consignee 10. Account Sales 11. Accounting Books of the Consignee 12._ Advance by the Consignee vs security against the Consignment Unit2: Joint Ventures 1. Meaning of Joint Venture 2. Features of Joint Venture 3. Distinction of Joint Venture with Partnership 4. Methods of maintaining Joint Venture Accounts 4.1 When separate set of books are maintained 4.2. When no separate set of books are maintained Unit3: Bills of Exchange and Promissory Notes Bills of Exchange Promissory Notes Record of Bills of Exchange and Promissory Notes Term of a Bill Expiry/Due date of a Bill Days of Grace Date of Maturity of Bill Bill at Sight Bill after Date © The Institute of Chartered Accountants of India 645 646 6.46 6.46 647 73 77 77 7.10 7a 7a 7a 7A 71 7a 742 7A2 713 734 735 7.35 7.36 737 7.40 7.65 7.87 7.68 7.70 7.70 7.70 770 7.70 7.70CONTEN' 10. i. 12. 1B. 14. 16. 16. 17. 18. How to calculate due date of a bill How to calculate date of maturity in case of time bills Noting Charges Renewal of Bill Accommodation Bills Insolvency Bills of Collection Retirement of Bills of thange Bills Receivable and Bills Payable Books Unit4=)|Sale of Goods on Approval or Return Basis 1 2. Introduction Accounting Records 2.1. When the business sends goods casually on sales or return 2.2. When the business sends goods frequently on sale or return basi 2.3 When the business sends goods numerously on sale or return ere en Unit 1: Introduction to Partnership Accounts Introduction Definition and Features of Partnership Limited Liability Partnership Main Clauses in a Partnership Deed Powers of Partners Accounts 6.1 Profit and Loss Appropriation 62. Fixed and Fluctuating Capital Unit2: Treatment of Goodwill in Partnership Accounts Goodwill Methods for Goodwill valuation Need for Valuation of Goodwill Valuation of Goodwill in case of admission of a Partner Accounting treatment of Goodwill in case of admission of a new Partner Accounting treatment of Goodwill in case of change in profit sharing ratio Accounting treatment of Goodwill in case of retirement or death of a Partner Unit 3 : Admission of a New Partner 1 Introduction Revaluation Account or Profit and Loss Adjustment Account Reserves in the Balance Sheet Computation of new profit sharing ratio Hidden Goodwill © The Institute of Chartered Accountants of India mm mm 772 772 778 778 7.85 7.86 787 797 797 7:98 104 106 82 82 83 83 84 85 85 89 8.24 8.24 8.29 8.29 831 8.36 8.38 8.45 845 8.53 8.56 8.61CONTENTS Unit 4 : Retirement of a Partner 1 Introduction Calculation of Gaining Ratio Revaluation of Assets and Liabilities on retirement of a Partner Reserve Final payment to a Retiring Partner Paying a Partner's loan in instalment Joint Life Policy Separate Life Policy Unit 5 : Death of Partner 1 2. 3. 4, Introduction Special transactions in case of death : Joint Life Policy Special transactions in case of death : Separate Life Policy Special transactions in case of death : Payment of deceased Partner's share eee eo eee Unit1: Introduction to Company Accounts 1. Introduction Meaning of Company Salient Features of a Company ‘Types of Companies Maintenance of Books of Account Preparation of Financial Statements Unit 2: Issue, Forfeiture and Reissue of Shares 1 10. Introduction Share Capital Types of Shares Issue of Shares for Cash 4.1 Journal Entries for issue of shares for cash Subscription of Shares 1 Full Subscription 5.2. Undersubscription Oversubscription Shares issued at Discount Shares issued at Premium. 7.1 Accounting Treatment Oversubscription and Pro-rata Allotment Calls-in-arrears and Calls-in-advance Interest on Calls-in-arrears and Calls-in-advance © The Institute of Chartered Accountants of India 8.68 8.68 8.69 8.70 871 8.86 8.89 8.94 8.100 8.100 8.101 8.102 92 92 93 94 96 96 9.12 912 914 9.16 9.17 9.18 9.18 9.19 9.21 9.25 9.25 9.25 9.29 9.32 9.34CONTENTS i. 12. 13. Forfeiture of Shares 11.1. Forfeiture of Shares which were issued at par 11.2 Forfeiture of Shares which were issued at a premium, 11.3 Forfeiture of fully paid-up shares Re-issue of Forfeited Shares 12.1 Points for Consideration 12.2. Calculation of profit on re-issue of forfeited shares Issue of Shares for Consideration other than Cash Unit3 Redemption of Preference Shares 1 2. 3. 4, Introduction Purpose of issuing Redeemable Preference Shares Provisions of the Companies Act (Section 55) Methods of Redemption of fully paid-up shares 4.1 Redemption of Preference Shares by Fresh Issue of Shares 4.2 Redemption of Preference Shares by Capitalisation of Undistributed Profits 4.3. Redemption of Preference Shares by combination of fresh issue and Capitalisation of Undistributed Profits 44. Sale of Investments to provide sufficient funds for Redemption Redemption of Partly Called-Up Preference Shares Redemption of Fully Called but Partly Paid-Up Preference Shares 6.1 When Calls in Arrears is received by the Company 6.2. Incase of Forfeited Shares Unit 4: Issue of Debentures 1 Introduction Meaning Features of Debentures Distinction between Debentures and Shares Types of Debentures Issue of Debentures 6.1 Accounting entries for issue of Redeemable Debentures 6.2. Accounting for issue of Debentures payable in instalments Issue of Debentures as collateral security Issue of Debentures in consideration other than for cash Treatment of discount/loss on issue of Debentures Interest on Debentures © The Institute of Chartered Accountants of India 9.36 9.37 9.38 9.39 9.39 9.40 9.40 9.46 9.72 9.78 9.78 981 981 9.81 9.86 9.86 9.87 9.87 9.88 9.90 9.90 9.98 9.104 9.105 9.107 9.108