Book keeping theory

Distinguish between Trade discount and Cash discount?

Ans: Trade discount is the discount offered by the supplier for the purpose of
promoting the trade activity or increasing the sales on special occasion. Such trade
discount has to be deducted from the purchase price and the net value of purchases
has to be passed through the books of accounts.
Contrary to this, Cash discount is allowed for the purpose of expediting the
payment even before the expiry of credit period. Such cash discount has to be
classified under discount allowed or discount received.
Distinguish between Internal Audit and Statutory Audit.
Ans: Internal Audit is a review of operations and records undertaken within a
business by special assigned to staff. Such staff known as internal auditors carries
out day-to-day checking of the work-in-detail much of which would, otherwise, have
to be done by the statutory Auditor. However, Statutory Audit is done by an
Auditor appointed for the purpose from outside the organisation, particularly by a
Chartered Accountant.
Provision/Reserve which is a charge against profits and a Reserve which
an appropriation of profits.
Ans: The provision/reserve meant for meeting revenue losses namely, Reserve for
bad debts, Reserve for discounts, provision for depreciation etc. are charged
against profits. However, the Reserves created for future purposes viz. General
Reserve, Reserve for Redemption of loans/debentures, Dividend Equilisation
(Repayment) Reserve etc. are appropriated from divisible profits.
Distinguish between a Joint Product and a By-product?
Ans: Usually from a common process, more than one product is obtained.
Sometimes, there is only one main product and the others are not so important. For
example, in a sugar mill, besides sugar, molasses and Bagaree are also produced
which are less important than sugar and hence are called “By-Products”. But, if the
various products are having equal importance such as petrol, diesel oil, kerosene oil
etc., in a refinery, these products are called “Joint Products”. In respect of By-
product, the sale proceeds are credited to the main process account thereby
reducing the cost of the main product. But in case of Joint products, the expenses
incurred in common for the joint process have to be apportioned over the various
products usually on the basis of the market value of each product at the point of
separation.
Distinguish between a shareholder and a Debenture holder.
Ans: The following are the differences between a shareholder and a debenture
holder:
Share holder Debenture holder
1. He is a joint owner of the company. 1. He is a creditor of the company.
2. He receives dividends only when the 2. He receives interest whether the
company makes profits. company makes profits or losses.
3. Repayment cannot be made without 3. Repayment has to be made in
completing legal formalities. At time accordance with terms of the issue
of winding up of the business, he duly treating him as a fully secured
stands the last place with reference to creditor.
repayment.
4. Shares are issued as per the rules 4. No such a rules are laid down.

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SOGE – PART II

laid down in Indian Companies Act.

What is the difference between Receipts & Payments account and Income
& Expenditure account?
Ans: The following the main differences between a receipts & payments account and
an Income & expenditure account.
Receipts & Payments account Income & Expenditure account
1. This is a real account. All receipts 1. This is a nominal account. All
are debited and all payments are expenses are debited and all incomes
credited. are credited.
2. It has cash opening and cash closing 2. There is no opening balance but
balances. there is closing balance by way of
excess/deficit of income over
expenditure.
3. This takes into account both the 3. This takes into account only revenue
capital and Revenue items of receipts items of receipts and payments.
& payments
4. All the items of receipts and 4. Only the revenue items relating to
payments irrespective of the the particular year are taken into
accounting years are taken into account.
account.
5. This is prepared on cash basis. 5. This is prepared on accrual basis.
Distinguish between Reserve and Provision? Give suitable examples?
Ans: A Reserve is an amount set aside out of the profits to provide additional
working capital or to strengthen the liquid resources that may be available for
meeting any unknown contingencies. It is an appropriation on profits made only
when there are profits. And as such the Reserve represents undistributed profits.
E.g.: General Reserve, divided equilised Reserve, Capital reserve.
A Provision is charge on the profit & loss account, which is created to meet a
known liability. The Provision is made even when there are no profits.
E.g.: Provision for bad and doubtful debts, provision for repairs & renewals.
Distinguish between Trade bills and Accommodation Bills:
Ans.: The trade bills are always drawn and accepted based on trade or business
activity in respect of which the value is received. But, an accommodation bill is
always drawn and accepted for accommodation the financial needs only, without
any business relationship between the parties concerned.
Distinguish between First-in-First-Out (FIFO) and Last-in-First-Out
(LIFO) method of valuing the materials?
Ans.; Under First-in-First-Out (FIFO) method, the issues of materials on a job are
priced in chronological order of purchases at their cost price. The materials
received first are to be issued as soon as the requisition for materials are received.
Until the inventory (stock) acquired first is exhausted subsequent inventory price
are not adopted. But, under Last-in-First-Out (LIFO) method the price of materials
issued would be adopted at cost price of the latest lot (batch) of materials
purchases. Until latest lot prices are exhausted, the immediate previous lots price
are not adopted.

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 Book keeping theory

Distinguish between Cost allocation and Cost apportionment?

Ans.: Cost allocation and cost apportionment both are the means of distributing
overhead costs on cost units or cost centres. Cost allocation is the process of
distributing the overheads to the cost centres where the cost is easily identifiable.
(E.g. Air conditioner)
If the overheads are not easily identifiable such overheads also are
distributed on the various cost units or cost centres based on a percentage. Such
distribution is called Cost apportionment.
Distinguish between Capital and Revenue expenditure?
Ans.: The Capital expenditure is of the nature of non-recurring expenditure and
usually refers to the acquisition of the assets. Thus, such expenditure is shown on
the assets side of the balance sheet. However, Revenue expenditure is of the
recurring nature, which is incurred to maintain the assets or business, concerned.
Hence, Revenue expenditure is debited to the Revenue account viz. trading account
or the profit & loss account.
Distinguish between Reserve Fund and Reserve Account?
Ans.: Reserve Fund is created by way of setting apart a portion of the current year’s
profit for future purposes by charging to profit and loss appropriation account.
Thus, this is a capital reserve, which is shown on the liabilities side of the balance
sheet. But, a Reserve Account is a Revenue reserve created for the purpose of
meeting the revenue losses either in the current year or in the near future. This
reserve is created by debit to profit and loss account. E.g. Reserve for bad and
doubtful debts, Reserve for discount on debtors etc. These Reserves are deducted
from sundry debtors on the assets side of the balance sheet.
Distinguish between Interim Dividend and Final dividend?
Ans.:- Dividend is the portion of the profit distributed to the shareholders
according to the holdings. The declaration of dividend may be by way of either a
fixed amount per share or a percentage on the capital. Interim Dividend is declared
before the close of the company’s financial year either out of profits accruing or out
of profits carried forward from the previous years. The Final Dividend is the
dividend declared by the company’s management duly keeping in view the amount
of undistributed profits while preparing the annual financial statements after close
of accounting period. Both the Interim and final dividend are charged to the profit
and loss appropriation account.
Distinguish between general reserve (contingent reserve) and special
reserve?
Ans.: A general reserve is created by setting aside a portion of the annual profit
each year for meeting unforeseen contingencies such as trading losses or financial
stringencies or for expansion of business. Thus this reserve is meant for general
purposes and is also known as a contingency reserve. However, a special reserve is
created for specific purposes namely dividend equalization reserve utilized for
keeping the dividend rate up in the years of low profit.
Distinguish between General Reserve and capital Reserve?
Ans.: General Reserve is created out of the revenue profits by setting apart a
portion thereof for future purposes by debit to the profit and loss appropriation
account. This general reserve is fully available for utilisation by the management in
the manner they intend to utilize. However, the Capital Reserve is of capital nature,
which is created out of the capital profits outside the scope of the normal business
of the company. E.g. Sale of assets for profit, forfeiture of shares etc. The Capital

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SOGE – PART II

Reserve cannot be utilized by the management for the minimum period of 3 years
and without the prior approval of the company law code.
Distinguish between Amortisation and depreciation?
Ans.: Amortisation refers to redemption or repayment of a liability by creating a
sinking fund for this purpose such sinking fund is created by debit to the Profit &
loss appropriation account.
Depreciation refers to gradual and permanent reduction in the value of the
asset due to regular wear and tear etc. The annual depreciation is debited to profit
& loss account and is deducted from the value of the asset on the assets side of the
balance sheet.
Distinguish between accrued liabilities and contingent liabilities?
Ans.: Accrued liabilities are liabilities already incurred which are provided for in
the accounts and are exhibited in the liabilities side of the balance sheet. However
Contingent liabilities are not the liabilities as on date, but may become liabilities at
a future date. Hence provision for these contingent liabilities are not made in
accounts but these liabilities are indicated by means of footnotes below the balance
sheet.
Distinguish between cash system and mercantile system of accounts?
Ans.: Under cash system, entries are made only when cash is received or paid and
accounting is based purely on cash basis. Under mercantile system, record of
transaction is made on the basis of amounts having become due for payment or
received and the accounting is on accrual basis.
Distinguish between Ordinary and preferential shares?
Ans.: Ordinary shares are such shares which do not enjoy any special privilege but
are entitled to surplus profit or a portion of the sale without any ceiling limit that
may be available after all the preferential right has to the dividend are met.
Preferential shares are such shares, which have a prior claim on any available
profit on divided.
Distinguish between financial accounting and cost accounting?
Ans.: (I) Financial accounting are based on actual facts and figures while cost
accounts are prepared partly from facts and figures and partly from estimates.
(ii) Financial accounts provide for information in totals of purchases, sales, stock
in trade, profit or loss of the concern for the year. Cost accounts provide an
analytical view of each contract, job or process.
(iii) Financial accounts reveal the financial working results of the concern, which
work for earning profit. Cost accounts are generally concerned with
manufacturing operations.
(iv) Financial accounts do not provide information for preparation of job
estimates, cost per unit produced for the purpose of tendering for contracts.
However, cost accounts provide for such information.
What is the difference between cost Audit and Financial Audit.
Ans.: The functions of Cost Audit and Financial Audit are the same. The basic
principles adopted are common to both types of Audit but they differ from each
other in the methods of approach and the purposes they are required to serve. The
main points or difference are:-

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 Book keeping theory

1. Financial Audit covers the financial Accounts and does not go into detailed
verification of costing transactions. The Cost Audit costing records are verified
in detail.
2. Financial Audit aims at securing the correctness of recording and accounting of
transactions through vouching. Cost Audit on other hand, lays stress on
propriety of expenditure and efficiency of performance.
3. Financial Audit is usually a postmortem check to see that expenditure recorded
has been actually incurred. It is concerned with past records and does not give
any suggestion for rectification of the failure. Cost Audit, besides checking of
cost records ensures a forward approach.
4. The main difference is an accounting treatment to certain cost factors such as
valuation of stock, treatment of interest, depreciation under or over absorption
of overheads, deferred revenue expenditure etc. are reflected in the difference
in the approach of Cost Audit and Financial Audit.
What are the advantages of Cost Accounting as compared to Financial
Accounting? (or)
Distinguish between Cost Accounting and Financial Accounting?
Ans.: The following are the main advantages of Cost Accounting:
(i) Cost Accounting system provides for measuring the efficiency of the concern
for the maintenance and further improvement. The cost per unit in one
period can be compared with that of another period or the actual cost for
assessing the performance of the production concerned.
ii) This system reveals the various activities bringing profits as well as losses to
enable the review of the production policies for the best advantages of the
concerned.
iii) This system enables fixing the selling/contract prices in advance for giving
quotations.
iv) Costing helps management to plan the various activities of production
keeping in view the availability of materials and stores and in detecting the
unnecessary losses.
v) In times of slums/depressions, the price has to be reduced even below the cost
of production. Costing provides for properly reducing the prices.
vi) Some of the important decisions viz. need for replacement of the men by
machinery or to manufacture the articles or to purchase them in the market
etc. are possible only when Costing system is available.
vii) Exact causes for profits or losses are known.
viii) The good system of costing gives an independent and more reliable check on
the accuracy of the financial Accounting duly providing for reconciliation of
the profits.
Write short notes on?
Ans.:--- Processing costing is applicable in cases where the manufacture of products
is carried out process by process. In such cases, the product of process would be
the raw material for the next process. This system is used to ascertain the cost of
each process of manufacture, which is normally applicable to food industry,
chemical industry. Etc.

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SOGE – PART II

Cost Unit: Cost Unit means cost of production of each unit which includes cost of
materials used, wages spent, other expenses incurred in the factory and such
expenses for bringing the goods to premises where they are to be sold. The
Administrative and selling expenses are not included in the unit cost.
Production Overheads: In addition to the prime cost of direct materials, direct
labour and other direct expenses, the indirect expenses on works in the factory are
also required to be added to the cost of production. These factory overheads are of
general nature, which are apportioned proportionately to the cost of production.
Cost Centre: For the purpose of cost control, a person or item of equipment or a
location may be determined as a centre for ascertainment of cost. Such a person or
item of equipment or a location is known as Cost centre. In a manufacturing
concern, the cost centres may be according to the pattern of the layout of the
sections of the factory namely production sections and service section. Cost
centres lay down the spheres of responsibility, common base of costs and area of
cost control.
Sinking Fund: A Sinking fund is a fund built up or created by regular contribution
and the interest received by investing the amount so contributed along with the
interest and thereon. The purpose of creating a sinking fund is either to repay a
pending liability on certain future day or to replace a wasting asset on expiry of the
life period thereof. This is a specific fund that cannot be kept idle or diverted for
other purposes.
Idle time: Workers are bound to waste some time. Time wasted is idle time. Idle
time may be unavoidable. Avoidable idle time is abnormal and any wages paid for
such time should be debited to costing profit & loss account. Normal idle time is
part of cost of production. The wages paid for normal idle time should be included
in factory expenses.
Labour turn-over: Labour turnover may be defined as the rate of change in the
composition of the labour force of an organisation. High rate of labour turnover
denotes that labour is not stable and there are frequent changes in the labour force
of the organisation. The high labour turnover rate is an important indication on
high labour costs, which is not desirable.
Goodwill: Goodwill is the value of the reputation of a business in respect of profit
earning capacity in future over and above the normal level of profits earned by the
undertakings belonging to the same class of business. It is a valuable asset if the
concern is profitable and the value is less of the concern is a loosing concern.
Floating assets: Floating assets are such assets acquired by the concern on
temporary basis and not on fixed basis. Stock-in-trade, sundry debtors, loose tools
etc. are the examples of floating assets. These assets are also called as current
assets. These assets are valued at cost or the market price whichever is lower.
Deferred Revenue Expenditure: A heavy expenditure of revenue nature incurred for
getting the benefits thereof over a number of years is treated as deferred revenue
expenditure. Such expenditure is written off the profit & loss account uniformly
over the number of years in which it is estimated that benefits would accrued to
business concerned. Such treatment also is justified as the annual accounts are
prepared on the basis of matching principle prescribing comparison of the probable
expenses during the year with probable income during that year. The unabsorbed
deferred Revenue expenditure is shown on the assets side of the balance sheet till it
is fully written off.
Accrual concept: If an event occurs or a transaction has been entered into, its
consequences will follow. Normally, all transactions are settled in cash but even if
cash settlement has not yet taken place, it is proper to bring the transaction or the

6
 Book keeping theory

event concerned into the books. The Annual accounts are always prepared on
accrual basis duly taking into account the income accrued but not received and the
expenditure incurred but not paid.
Overheads: Overheads are indirect costs such as (1) Indirect production costs (2)
Selling costs (3) Distribution costs (4) office &Administration costs. These
overheads are also classified as fixed costs, variable costs and semi-variable costs.
These expenses are apportioned or distributed over various productions.
Break even point: For making a decision, the comparison of income and cost thereof
is very vital. The incremental income on every additional unit produced shall be
compared with the incremental cost thereof for deciding the volume of production
activity. The basic consideration is that the fixed expenses remaining unchanged
on account of increase in production, varying costs only change. This concept is
also known as marginal costing. Sales volume (p/v ratio) at which the variable cost
and fixed expenses are fully recovered is known as Break even point. Total of fixed
expenses and profit is termed as contribution. Fixed expenses divided by
contribution per unit is the Break even point of production. Any production units
should not go beyond this BEP.
What are accommodation Bills?
Ans.: Accommodation Bill is a bill drawn, accepted or endorsed without receiving
the value in exchange. Such bills are usually drawn and accepted for mutual
accommodation of both the parties to provide for meeting the financial needs.
Unlike trade bills, these bills are not supported by any trade/business activity.
Is payment of interest to share holders permitted under companies Act?
If so, what are the conditions?
Ans.: Normally, only dividend is payable to share holders when there is profit.
Sometimes, when a company waits a long period before it commences production,
the share holders would be unrest if nothing is paid to them. Under such
circumstances the company is allowed to pay interest on share capital subject to the
following conditions:-
1. The payment shall be authorised by Articles of association or by a special
resolution.
2. Prior sanction of the Central Government (Company Law Board) shall be
obtained.
3. the period shall be as determined by the Central government but shall not
extend beyond six months after completion of construction.
4. A rate of interest shall be as directed by the central government by a
notification.
5. The interest so paid can be treated as part of the cost of construction.
Important points to be kept in view for preparing income & expenditure
Account
Ans.: 1) Revenue items of receipts and expenditure shall be segregated from Capital
receipts and capital expenses. The revenue items shall be taken to income &
expenditure account and the capital items to the balance sheet.
2) Any items revenue receipts or revenue expenses, whether relating to the
previous year or the future years shall be eliminated from the scope of the
income & expenditure account. In other words, income & expenditure account is
prepared duly taking into account the revenue receipts and the revenue
expenditure purely relating to the current year.

7
SOGE – PART II

3) As the income & expenditure account is prepared on accrual basis, the income
accrued but not received and expenditure incurred but not paid shall also be
taken into account.
Preparation of opening balance sheet:
Sometimes, the opening balance sheet (the position of liabilities and assets
at the commencement of the current year) is not given. In such a case the opening
balance sheet is to be prepared duly taking into account the information available
in the problem itself.
Write short notes on provision for taxation on net profit?
Ans.: In respect of a sole trader, the net profit is added to the capital, which is the
personal account of the proprietor. As such, it shall become responsibility of the
trader to include the net profit from the business as business income in his income
tax return as an individual assesse. Thus, provision for taxation shall not be made
in the annual accounts of a sole tradership or partnership firm. However, such
provision for taxation shall be made in respect of a joint stock company as it is the
responsibility of the company to make a such a provision in the annual accounts as
per the provisions contained in the Indian Companies Act.
What are the main features of Receipts & Payments accounts?
Ans.: The following are the main features of the Receipts & Payments account:-
1) The receipts & payments account is of the nature of a real account and hence all
receipts (incomings) are debited and all payments (outgoings) are credited.
2) The account commences with cash opening balance and concludes with cash
closing balance.
3) This account embraces (takes into account) both the capital and revenue items
of Receipts and expenditure.
4) This account takes into account all items of receipts and payments relating to all
the periods irrespective of the period to which they related.
5) The Receipts & Payments account is prepared on cash basis as all cash receipts
and cash payments are taken into account. In other words, this account is a
summary of the cash book.
What is forfeiture of shares? How the forfeiture shares are are issued?
Ans.: If the members (share holders) failed to pay the amounts of calls on
installments on the due dates, the allotments made to them are liable for
cancellation after due final notice to make the payment along with interest such
cancellation is called forfeiture of shares. On forfeiture of shares, the credits
already afforded to share capital account as and when the calls are made or
withdrawn by contra credit to call accounts and credit of the amounts already
received on such forfeited shares to forfeited shares account.
The management of the company may reissue the forfeited shares even at a
discount if necessary and such discount on reissue of the shares is met from the
credit balance of the forfeited shares account. The surplus balance, if any, still
available in forfeited shares account is transferred to Capital reserve account which
is available for utilisation in reducing the fictitious assets such as preliminary
expenses, discount on shares, goodwill etc. or transfer to a special reserve account.
Mention three grounds on which the provision for depreciation is
considered necessary?
Ans.: The need for providing for depreciation is on the following grounds:

8
 Book keeping theory

i) Unless the assets are depreciated, their value will be overstated in the
balance sheet to the extent of reduction in their value and the balance
sheet does not represent true and fair state of affairs of the business.
ii) The regular wear and tear of the assets due to constant use shall be
treated as a charge on the profits of the business so as to ascertain the
accurate financial working results of the business.
iii) Unless the depreciation is provided for in the accounts, it will not be
possible for replacement of the assets after expiry of their life period.
What are accounting errors? How do they occur? How are they rectified?
Ans.: The accounting errors are bound to occur in the process of keeping the books
of account such as passing journal, posting ledger accounts and preparation of trial
balance. These errors are broadly divided into 2 categories viz.
 errors disclosed by trial balance
 errors not disclosed by a trial balance
Errors disclosed by trial balance:
 wrong totally of subsidiary books
 items omitted to be posted from a subsidiary book into ledger
 posting of a wrong amount to a ledger account
 posting an amount on the wrong side of the ledger account
 wrong totaling or wrong balancing of ledger accounts
 an item of subsidiary book posted twice to ledger account
 omission of a balance of an account in the trial balance
 balance of some account wrongly entered in the trial balance
 balance of some account written on wrong side of trial balance
Errors not disclosed by a Trial balance:
1) Omission of an entry altogether in a subsidiary book
2) writing the wrong amount in the subsidiary books
3) posting an item on the correct side but in the wrong account
4) compensating errors
5) errors of principle
The errors disclosed by trial balance are one sided errors, which are rectified
by means of notes on error in which case proposal of a rectification. Journal entry
is not possible. The errors not disclosed by trial balance are always rectified by
proposing rectification journal entries.
Errors located after preparation of trial balance and preparation of final
Accounts:
Some times if the final accounts cannot be delayed on account of
disagreement of the trial balance, the final accounts are prepared duly agreeing the
trial balance by keeping the difference under suspense. If the suspense balance is a
debit balance, it is taken to assets side of the balance sheet. If it is a credit balance,
it is taken to liabilities side of balance sheet. However, it is not the end of it and
affords will be continued to locate the errors in the process of keeping the books of
account. Such be the case, the one sided errors are also rectified by means of
rectification journal entries duly taking the assistance of suspense account by
contra debit or credit. The two sided errors are as usual rectified by means of
rectification journal entries without taking assistance of the suspense account.

9
SOGE – PART II

State with reasons whether the following expenses are Capital or

Reserve in nature?
Repairs on second hand machinery purchased
Ans.: The expenses are capital in nature as they are incurred to put the asset in
usable condition.
Legal expenses incurred to secure a loan
Ans.: The expenditure has to be treated as a deferred Revenue expenditure to be
written off to the profit & loss account over a number of years as the loan obtained
increases the efficiency of the business.
Theft of goods from business
Ans.: The loss of goods is abnormal in nature. Normally, the stocks are insured and
the losses not covered by insurance alone are treated as Revenue losses.
Cost of research which did not result in success
Ans.: The expenditure of revenue nature as it did not result in increase in the
efficiency of the business.
What do you understand by secret reserves? How are secret reserves
created?
Ans.: A secret reserve is a surplus, the existence of which is conceived and which
does not appear in the balance sheet. The secret reserve is created in the following
ways:
1) by undervaluing the assets or by providing excessive depreciation of the assets
or ignoring the appreciation of the assets or omitting the assets altogether,
2) by providing for excessive provisions such as reserve for bad and doubtful debts
3) by overvaluing liabilities
4) by charging capital expenditure to the Revenue account viz. Profit & loss
account
What transactions you expect to be recorded in a Journal and how would
you (Auditor) vouch the entries therein.
Ans.: When the subsidiary books are maintained, the transactions other than those
recorded in purchases book, purchase returns book, sales book, sales returns book,
and cash book, Bills receivable Book and Bills payable book are entered in Journal
proper. The transactions relating to incorporation of the opening and closing
ledger balances, transfer entries, adjusting entries relating to outstanding expenses
and accrued income, rectification of errors are recorded in Journal. However, under
the orthodox system of financial accounting all the transactions of financial
character are recorded in the Journal.
Auditor’s responsibility: The Auditor is required to see that all the debits and the
credits afforded to various accounts either in the journal or the subdivisions of the
Journal are properly posted the respective ledger accounts and that there is no
omission of posting of either debit or credit into the respective ledger accounts, as
such omission may be adversely telling up ascertainment of the financial working
results of the business.
What do Contingent liabilities represent? Give four examples?
Ans.: There are certain liabilities, which may or may not occur. The liability may
arise only on occurrence of a contingency. Such liabilities are called Contingent
liabilities. A business Organisation (Company) will not be making any provision for

10
 Book keeping theory

such liability in the accounts but has to make a note under the balance sheet about
the contingency of such a liability.
Examples:
1) Law suits pending in a court of law.
2) Amounts remain to be executed in running contracts.
3) Calls yet to be made on the shares/debentures owned by company in other
organisations.
4) Amounts of any guarantee given by the company on behalf of directors or other
officers of the company.
What main points to be examined by the Auditor to ascertain the
correctness of Contingent liabilities?
Ans.: The Auditor should examine the purchase contracts, lease agreements,
minutes of meetings of board of directors etc. to ascertain the existence of
contingent liabilities. The Auditor should see that provision for these contingent
liabilities is not made in Accounts but they are mentioned on the liabilities side of
balance sheet by giving foot notes. He should also ensure that the requirements of
the Indian Companies Act are complied with in regard to disclosure of the
contingent liabilities in the annual financial accounts/Reports.
Bank Reconciliation Statement: In modern days business, most of the business is
carried out through cheques, frequently operating the bank account whenever
cheques are received, the bank column of cash book is debited and there will be
corresponding credits in Bank pass book on their realisation. Similarly, whenever
the cheques are issued the bank column of cash book is credited and the banker
affords debits in pass book on their presentation for payment at the bank counter.
It means that there will be supporting credits in Bank pass book in respect of all the
debits in the bank column of cash book and there will be supporting debits in the
pass book in respect of all the credits in the Bank column of the cash book. A
prudent trader is required to make reconciliation of the entries in the bank column
of cash book with those made by the banker with the pass book, so as to have an
effective control over the cheque transactions. Often the bank balance as per the
cash book does not agree with the balance of the pass book on account of following
reasons:
i) Cheques issued but not yet presented for payment
ii) cheques paid into bank but not yet collected and credited in pass book
iii) Interest on investments, dividends etc. collected directly by the bank and
credited in the pass book but not entered in the cash book.
iv) Bank charges, interest on overdraft, Insurance premium etc. paid directly by
bank understanding instructions and debited in the pass book but not entered
in cash book.
v) Amounts directly deposited by customers into traders’ bank account without his
knowledge.
vi) Cheques issued but not recorded in cash book.
vii) Cheques deposited into bank but not entered in the cash book.
viii) Errors in cash book or in pass book.

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SOGE – PART II

How reconciliation is done?

Ans.: Every trader is required to prepare a reconciliation statement at periodical
intervals duly comparing the entries in the bank columns of cash book with those in
pass book. The entries in the cash book not supported by entries in pass book are
identified and adjusted by adding or deducting to one of these balances so as to
arrive at the balance of the other book.
Explain the ABC analysis technique of better Inventory (stores and
stock) control?
Ans.: Under this method the stores inventory is controlled on a selective basis,
laying more emphasis on high value items. The stores are classified into A, B & C
categories depending upon a value and number of items in each category. Items
under ‘A’ category are not numerous but constitute a major value on which the
Auditor will concentrate more. Items under B category are with more volume (or
quantity) and less value. The Auditor’s check will be far less when compared to
check of ‘A’ category items. ‘C’ category items constitute major volume but of a
little value on which the Auditor’s check will be nominal. This method is also
known as “selective inventory management concept”.
What is meant by depreciation? And why it is provided for in the
Accounts? Explain the various methods for providing for depreciation?
Ans.: The depreciation is a permanent and constant reduction in the value of assets
due to the following reasons;
i) Regular wear and tear on account of continuous usage
ii) Due to efflux of time (e.g. Lease)
iii) the assets becoming obsolete
iv) Exhaustion of the asset etc. (e.g. Mines)
Need for providing depreciation:
i) Depreciation of all the assets represent a revenue loss, which has to be taken
into account, though does not involve in any outflow of the cash, so as to
ascertain the accurate financial working results of the business.
ii) the purpose of providing for depreciation is also to make provision for
replacement of the asset after expiry of its life period.
iii) The accounts are always prepared based on the matching principle namely
probable income to be compared with probable expenditure as they are
prepared on accrual basis. Hence, there is need for providing depreciation.
Methods of providing for depreciation
Straight-line method or original cost method (SLM Method): Under this method,
the annual depreciation is always calculated with reference to the original cost of
the asset. Under this method, the annual depreciation is credited to the asset
account and the value of the asset is reduced from year to year during the life
period of asset.
Written down value method or Reducing balance method (WDVM): Under this
method the annual depreciation is calculated on the opening balance of the asset at
the commencement of each year. Under this method, annual depreciation will be
decreasing from year to year as it is always calculated on the reduced value of the
asset. Under this method also the depreciation is credited to asset account.
Annuity method: Under this method, the value of the asset is increased every year
with an element of interest, had the amount been invested elsewhere. As the value
of the asset is increased, the original cost of the asset as well as the probable

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interest added to the asset will be written off by way of depreciation as per the
Annuity tables. Under this method, annual depreciation is credited to asset account
and the probable interest on the opening value of the asset is added to its value of
debiting.
Sinking Fund method or Depreciation fund method: Under this method, the annual
depreciation, unlike under the other methods, is not credited to asset account but
credited to a separate account viz. Sinking fund account or depreciation Fund
account. The value of the asset is continued to be shown at its original cost till the
last year of the life. The amount kept under fund account is not kept idle and is
invested under depreciation fund investments and interest accrued on such
investment is also credited to the depreciation fund. At the end of the life period of
the asset, the credit balance available in fund account, which included the annual
installments of depreciation and the interest earned on investments, is transferred
to asset account to close the asset account to a nil balance.
Insurance policy method: Under this method, the asset is insured and the annual
premium of the insurance policy is debited to the profit & loss account by way of
depreciation on maturing the policy, the policy amount is used for the purchase of
the new asset.
Revaluation method: Under this method, the value of the asset is reassessed with
reference to the market price at the end of each accounting year and the resultant
reduction in value of asset is debited to profit & loss account by way of
depreciation. (e.g. loose tools)
Machine-Hour rate:- Under this method, the hourly rate of hire charges of
machinery is calculated taking into account the capital cost of the machinery,
interest on capital cost and the depreciation thereof. The Hire charges of the
machinery are credited to asset and debited to various jobs on which the machinery
is used.
What is a Bill of exchange?
Ans.: A bill of exchange is a document in writing, which contains an unconditional
order made by the person called the drawer on the person called Drawee to pay a
certain sum of money to a certain person at a certain date.
What are the main points to be examined in the course of verification of
Inventories and Sundry debtors?
Ans.: Inventories: It is the most important duty of an Auditor to verify the
inventories (stores &Stock) their correct valuation as the goods are easily prone to
misappropriation. It is not possible to Auditor to physically verify the all items of
stock in hand and he has to rely on the certificate furnished by responsible officer
of the Organisation. Thus, he has to examine, in the first instance the efficiency of
the system of internal check. If he is satisfied with the system of internal check, he
can rely upon the certified stock sheets prepared by the organisation. At the same
time, the Auditor has to compare some of the important items with the invoices as
to the prices and for the quantities to compare the stock sheets with the stock
books. The Auditor has also to see that the goods are properly valued at the cost or
realisable value whichever less is. The obsolete or unserviceable stocks are not
listed on the stock sheets as they are required to be written off. Any unfair
valuation of stock should be properly reported upon the Audit Reports.
Sundry Debtors: The system of internal check has to be examined in the first
instance before relying upon the list of debtors certified by the responsible officers
of the undertaking. The Auditor shall conduct a test check of the debtors ledger. It
should verify the accuracy of the debtors list and the actual existence of the debts

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with reference to the confirmation letters or statements of accounts received from

the debtors.
The Auditor should also ensure that the bad debts are unrealisable debts and are
not included in the lists of debtors and that adequate provision for bad and
doubtful debts is made in the account. The balances shown in the balance sheet
should represent good and realisable debts only.
As an Auditor how would you deal with the following?
Reserve for doubtful debts: The Auditor shall see that the reserve for doubtful
debts is provided for all expected losses and as such he has to ensure that (I)
provision is made for all debts in respect of which the law suits are pending before
courts of law (ii) All time-barred debts are treated as bad or doubtful if there is no
hope of their realisation (iii) Adequate provisions for bad debts is made in respect
of the amounts due form the debtors declared insolvent, and that (iv) the debts due
from debtors from whom there is no proper response are treated as doubtful.
Outstanding liability for expenses: While vouching, the Auditor shall examine the
period covered by each payment and see that provision is made for the balance
period if the payment is not made. He should give special attention to all payments,
which periodically become due for payment. As far as possible, he should compare
the expenses of current year with those of the previous year and the matter shall be
investigated in depth in respect of all wide variation to ascertain the correct
position of the expenses incurred but not paid.
Plant and Machinery: The Auditor should thoroughly check the original costs,
additions and alterations to plant & machinery with reference to the schedule of
plant & machinery certified by the responsible officer of the organisation. The
expenditure on repairs & renewals shall be charged as revenue expenditure and
shall not be added to the cost of plant & machinery. New purchases shall be
verified with reference to the purchases invoices etc. The Auditor shall examine the
suitability of the method of depreciation adopted and see that the depreciation
provided for is adequate. He should also take care that the obsolete machinery is
not kept on books of account and that the book value is properly exhibited.
Cash at Bank: - The balance at bank on any given date shall be checked with the
bank scroll. The Auditor shall examine that the bank reconciliation is done up to
date. Care should be taken to see that the time-barred cheques issued but not paid
and the cheques paid in but not realized are reversed in the cash book. The cash
book shall be updated with reference to the entries made in the pass book so as to
supply the omissions in the cash book.
Forfeited shares: The shares issued to the public are bound to be forfeited after
giving a final notice for payment of the calls-in-arrears. Such a decision has to be
taken by the management duly supported by a resolution therefore. The Auditor
has to verify the following points:-
1) Whether such forfeiture is supported by a resolution.
2) Whether the amount already received on forfeited shares is not refunded and
credited to forfeited shares accounts.
3) Whether the credit balance available under forfeited account is treated as
capital of non-recurring profit.
4) the discount on re-issue of forfeited shares is met from forfeited shares account
only and that the net surplus under forfeited shares account is alone transferred
to capital reserve to be shown on the liabilities side of the balance sheet under
the subhead Reserves and surplus.
Cash in Hand: The Auditor has to verify the cash in hand as on the date of account
in the presence of responsible officer if he intended to verify the cash balance on

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the last day of the accounting year. Otherwise, he has to verify the cash balance
certificate as recorded in the cash book on the last date of the accounting year.
How would you (as an Auditor) verify the following Assets in the Balance
Sheet of a company?
Freehold property: The Auditor should verify the existence of the Freehold Land &
Buildings purchased by the concern (business) legally in the name of the client
(business) by examining the title deeds, purchase agreements etc. he should verify
both the possession and ownership of the client (company or business) of the
assets. He should also verify the assets with the statement of additions made
during the year received from client’s solicitors (lawyers). The value of the assets
must be verified with reference to original cost of the assets and the depreciation
to be written off at the stipulated rate.
If the property is mortgaged, the Auditor should get a certificate from the
mortgages to the effect that they are holding title deeds, which would also include
the outstanding amount of the debt. Expenditure on new constructed Building can
be verified with the Architect certificates and the cash receipts of the contractors.
Furniture and Fixtures: The Auditor should verify the items of furniture and fixture
borne on the Balance Sheet with reference to physical verification report given by
the responsible officers of the company. He should verify that proper method of
providing for depreciation is adopted in the accounts and that unserviceable or
obsolete items of a furniture and fixtures are not kept on records.
How would you as an Auditor verify the following assets in the balance
sheet of a company?
Investments: The Auditor should obtain a schedule of investments showing the face
values, title of each investment, book value, the paid up value, the market value
thereon etc. on the date of the balance sheet. All the investments should be verified
at the same time. The Auditor should verify the deeds of trust wherever the
investments are registered in the name of individuals as nominees. If the deeds of
trust are not in existence, the auditor should obtain certificates from those who are
recommending the investment. He has to make a mention in his report that he
relied upon the certificates of other parties holding the investments.
The basis of valuation of investments depends on the purpose for which they
are held. If they (investment) form part of investments, they are valued at cost
unless there is a serious fall in their market price, which has to be provided for. If
the investments are held as floating assets for shorter period, they would be valued
at cost of market price whichever is lower.
Subsidiary books
Subdivisions of Journal or subsidiary books of account:-
What are the subsidiary Books? How they are maintained?
Ans.:- The orthodox system of financial accounting was found to be meticulous,
monotonous and time taking where by the cost of maintenance of the books of
account was found to be very heavy. So as to reduce the cost of maintenance, the
subdivision of journal is introduced by way of improvisation of the orthodox
system. For this purpose, the areas where the transactions are of repetitive nature
have been identified and a separate journal is prescribed for each of such areas.
They are
i) purchases book in which all credit purchases of goods are recorded
ii) sales book: To account for all transactions relating to goods credit sales of
goods

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SOGE – PART II

iii) Purchase returns book: To account for all returns out of purchases whether
initial purchase was on cash basis or credit basis.
iv) Sales returns Books: - To account for all returns out of sales whether original
sale was on cash basis or on credit basis.
v) Cash Book: To account for cash transactions irrespective of any nature.
vi) Bills receivable book: To account for all the acceptances received from the
debtors.
vii) Bills payable book:- To account for all the acceptances given to the creditors
viii) Journal proper: To account for all the remaining transactions, which do not
find a place in, any of the seven books above? E.g.: Incorporation of opening and
closing ledger balances, credit purchases of assets, credit sale of assets,
incorporation of the outstanding adjustments (income accrued but not received
and expenditure incurred but not paid) at the time of preparation of final
account.
Advantages:
1. As the books are maintained on functional basis, location of the accounting
errors is made easy for their rectification.
2. The cost of maintenance of books of account is considerably reduced.
3. There will be less scope for fraud in handling the business transactions.

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