CHAPTER – 1

SHORT QUESTIONS

1. What is book keeping?

Book keeping is an art and science of recording transactions in money or money’s worth, in the
books of original entry and posting them into the ledger systematically and accurately. This is the
first step in accounting done by junior clerks.

2. What is accounting?

Accounting is the art of recording, classifying and summarizing the business transactions which are
in terms of money and interpreting the results there off.

3. Who is an entrepreneur or proprietor?

A person who starts business on his own initiative for his personal gain, bears all the risks and
reaps all the fruits alone is known as entrepreneur or proprietor.

4. What is an entry?

Records made in the books of accounts, in respect of a transaction or an event is known as entry.

5. What is debit?

An amount entered on the left side of a ‘T’ form ledger account is called ‘debit’. The increase and
decrease liability is also called ‘debit’ which is shortly written as ‘Dr’.

6. What is credit?

An amount entered in the left side of a ‘T’ form account is called ‘Credit’. The increase in liability
and decrease in an asset is also called credit. It is shortly written as ‘Cr’.

7. What is transaction?

Any exchange of goods or services on cash or credit by the business, with a third party is called
transaction.

8. What is account?

An account is a statement of all the transaction relating to a person, asset, expense or income
which have taken place during given period of time with their net effect. It has two sides of debit or
credit.

9. Books of account-:

Registers, journals, ledger and any other book maintained in a business house are the Books of
Account.
10. Debtor-:

Debtor is a person who owns money to the business, on account of credit sale of goods or
services.

11. Creditor-:

Creditor is a person to whom the business owes money on account of credit purchase of goods or
services.

12. Capital-:

The amount of money or money’s worth invested by the proprietor is known as capital. It is the
excess of assets over liabilities of a business.

Capital =assets – liabilities.

13. Net worth or owner’s equity:-

It is the claim of the owner against the assets of the business. It includes capital, profit and
reserves.

14. Total equity:-

The total of owner’s claim and outsider’s claim against the assets of the firm is the total equity.
Total equity= outsider’s claim +owner’s claim

15. Assets:-

The properties owned by the business, having money value and which will enable the firm to get
cash or benefit in future are called assets of the business. Such as cash, goods, furniture,
machinery.

16. Liabilities:-

Outsider’s claim against business or amount owes by the business to outsiders or amount payable
to the outsiders is called “liabilities”.

17. Merchandise or goods:

The commodities purchased by the business for the purpose of selling are called goods.

18. Drawings:

The money or goods used by owner belonging to business. The withdrawal of money or goods
from the business by the proprietor for personal use is called drawings.
19. Revenue:

It is the monetary value of the product or the services sold to the customers during the period. It
results from sales, from service and sources like interest, dividends.

20. Expenses:

The expenditures made by the enterprise to get revenue are called expenses.

21. Loss:

The excess of expenditure over income is called loss. Loss= expenditure-income

22. Profit:

The excess of income over expenditure is called profit. Profit= income- expenditure

LONG QUESTIONS

Q-1 Define accounting. State its importance.

The American institute of certified public accountants has defined the accounting or
financial accounting as “the art or recording, classifying and summarizing in a significant manner in
terms of money transactions and events which is part at least of a financial character and
interpreting the results thereof.

American accounting association defines accounting as” the process of

identifying, measuring and communicating economic information to permit informed judgment and
decision by user of the information.”

From the above definitions it is clear that accounting is the language of business
which reflects the financial position of a business as well as performing, recording and interpreting
activity in order to ascertain profitability of a concern.

The following points highlight the basic features or accounting.

a. Accounting is the art of classifying business transactions.

b. It only records the transactions of a business which are expressed monetary value.
c. It is the art of summarizing financial transactions.
d. It is the process of analyzing and interpreting of financial transactions.
e. The result of such analysis must be communicated to the persons who are to make
decisions or form judgments.

Accounting is entirely different from Book-keeping. Book- keeping is the initial stage of accounting
process. Book-keeping deals with maintenance of records and accounting deals with interpretation
of accounting records in order to ascertain the profit &loss of a business during a period.
Accounting statements are presented on cash basic and accrual basis.

Accounting has 3 main branches, namely

i.Financial accounting deals with finance to find out the profit & loss.
ii.Cost accounting deals with costs and cost of production.
iii.Management deals with decision making with the help of accounting.

Importance of accounting:
The importance of accounting can be expressed in term of its usefulness to interested
parties. Accounting provides valuable information to both internal and external parties like owners,
creditors, investors etc.

a. Owners:
The owners are the main source of contribution of capital. They are very much
interested in knowing the earning capacity or profit or loss of a business during the particular
period as well as financial condition on a particular date. They would like to know the appraisal of
past performance and also for an assessment of future prospects.

b. Creditors:
Creditors are the source of supply of finance or raw material for smooth
running of the business. Naturally these creditors are interested to know financial stability of a
concern before granting credits. It is the accounting information which shows the earning capacity
as well as repaying capacity.

c. Investors:
Investors look not only for the earning capacity of a business but also it
financial strength and solvency before deciding whether to subscribe or not for the shares in a
company. They are interested in steady and good return on their capital.

d. Employees:
Employees are interested in earning capacity of a concern as their salaries;
bonus and pension schemes are dependent on this factor for which accounting provides required
information.

e. Government:

Government is interested in accounting statements are reports in order to see the performance of a
particular unit. Its cost streamline and income in order to impose tax and excise duty.

f. Public :
The public consumers is interested in accounting statements in order to know
whether control is exercised on production, setting and distribution expenses in order to reduce the
prices of goods they buy. They can also judge whether the economic resources of the concerns
are being utilized for the benefit of the common man or not.
g. Managers:
The manager of a business needs accounting information of planning,
controlling evaluation or performance and decision making. Their main responsibility is to operate
the business so as to obtain maximum return on capital employed without causing any harm to the
interest or the shareholders. They would like to have data relating to sales, output etc. relating to
next year as also the flow of cash for the propose of planning the activity of a business.

h. Research scholars:
These people are interested in accounting statements and reports in order to
get data for proving their thesis on which they are working and hence to complete their research
projects.

Q-4 What are the limitations of accounting?

Accounting also suffers from certain limitations even through it is useful to various parties. The
following are the main limitations of accounting.

I. No scope for non-monetary transactions:

Accounting only recognize those transaction like efficiency of directors,
managers etc. which have direct impact on profitability or the concern.

II. Fails to consider price level changes:

As per cost concept, the accounting records the cost paid for a product
or asset, but not the market value. Thus, the effect of price level changes is not brought into the
books with the result that comparison between on the various years become difficult.

III. No realistic information:

Accounting information may not be realistic as accounting statements
are prepared by following basic concepts and conventions. For example, the principle of
conservation, the financial statements will not reflect the true position of the business.

IV. Personal bias:

Accounting statements are influenced by the personal judgment of the accountant. He may
select any method of depreciation, valuation or stock etc. such judgment based on integrating and
competency of the accountant will definitely affect the preparation of accounting statements.

V. Permits alternative treatments :

Accounting permits alternative treatments within generally
accounting concepts and conventions. For example, method of charging depreciation may be
straight line method or W.D.V method or some other method. Thus the result, the data may not be
comparable.

VI. Historical data :

 No doubt, the accounting data is historical or past data, which is
no more useful at present as the some other method. Thus the result, the data may not be
comparable.

VII. Historical data :

The accounting data is historical or past data, which is no more
useful at present as the same conditions of the past, may not be existed now. Sometimes profits
may be manipulated with desired interest the suppression or costs, depreciation etc. consequently
real idea or managerial performance may be available by manipulated profit.

VIII. No real test of managerial performance:

Profit earned during an accounting period is test of managerial
performance. Profit may be shown in excess of manipulation of accounts. Thus, real profit earning
capacity is not reflected and thus profit cannot be created as real tool in measuring managerial
performance

Q-5 What are the objectives of accounting?

AICPA defines “accounts as an art of recording classifying and summarizing in terms
of money transactions and events or financial character and interpreting the results there of”.

R.H Anthony defines “accounting is a means collecting, analyzing and reporting in monetary terms,
information about the business”,

On analyzing the various definitions, it is clear that-

 Accounting is an art.
 It involves recording, classifying and summarizing the business transaction only.
 The transactions and events should be expressed in monetary value
 It interprets the results thereof.
 In simple accounting the art of correctly recording day-to-day business transactions
are those expressed in money value. It is a science of keeping business records in
a systematic manner .it is rightly pointed that accounting is the language of
business.
Objectives of accounting:
The following are the objectives of accounting.

(a)Permanent record of all business transaction:

Accounting is defined by Kohler as “the recording and reporting of transactions.” as such; reporting
demands recording business transactions in a systematic manner. The work of recording is
accomplished by the accounting organization set up for the purpose .since it is not possible to
store in mind the numerous business transactions that take place everyday a permanent record of
the same is of absolute necessity and accounting achieves this objective.

(b) External and internal reporting :

The twin objectives of accounting is reporting accounting or finance information pertaining to the
business, the transactions which are systematically recorded , to those who are interested in such
information ,whether those external to business or managerial personnel, get conveyed such
informance as is relevant to their decision objectives ,through the medium of accounting ,

(c) Revaluation of trading result:

Systematic recording of business events or transactions resulting in a proper record of business
events of revenues and expenses relating to the business for a particular period, helps
preparation of the profit and loss account for that period .this account reveals profit or loss which
the business has made or suffered during that period.

(d)Financial position of business:

While the profit and loss account reveals the net result of trading for a particular period, the
balance sheet, that is also prepared with the help of the accounting record, enables those
interested in the business to ascertain its financial position or financial health or soundness as
at a particular date.

(e)Control over assets:

Accounting provides information with regard to business assets such as cash, bank, stock,
debtors, bill receivable, investment etc. such information enables the owner or owner to make the
fullest utilization of resources and effectively protect the same by avoiding idle resources, wastage,
pilferage, bad debts and obsolescence

(f) Comparative study:

Systematic accounting record facilitates performance evaluation by comparing the trading result of
one year with that of any of the previous years or of similar organization such as comparison might
reveal significant factors necessary to be given attention for improving business performance.

(g) Ascertain value of business:

The value of a business as a going concern can only be ascertained by maintaining record of day-
to-day business dealing .such a value is necessary to be determined in the event of sale of
business, for computing the proper purchase price of the business.

(h)Determination of tax:
Properly accounting record is of immense use in the settlement of taxation liability, especially when
the business is assessed to income tax and sales tax.

(i) Evidence in courts:

Systematic record of business transaction can be used as evidence in courts in case of disputes.
(j) Insolvency proceeding:
In case a businessman applies for insolvency or his creditors do so, it becomes fairly easy for him
to get a discharge on the basis of the accounting recording systematically maintained by him.

FUNCTIONS OF ACCOUNTING:

1. Keeping systematic records: - the first and most important function of accounting is
to keep a systematic record of financial transactions, to post them to ledger accounts
and ultimately prepare financial statements.
2. Protection properties of the business:- the second function of accounting is to
protect the property of the business. An accountant has to design such a system of
accounting as protects its properties from an unjustified and unwarranted use.
3. Communicating the results:- the third function of accounting is to communicate the
result obtained from arranging of data to interested parties like proprietors,
employees, government officials, investors, creditors and researchers.
4. Meeting legal requirements:- the fourth and the last function of accounting are to
devise such a system as will meet legal requirements. Under the provisions of law,
business has to file various statements e.g. income tax returns, returns for sales tax
purpose, etc. accounting systems aims at fulfilling the requirement of law.

SCOPE OF ACCOUNTING

1. to check the entries of book-keeping

2. to prepare trial balance
3. to rectify errors & recording of adjustments
4. to analyze interpret the accounting information

Q-6 Who are the parties interested in accounting information?

Management:

A small business is generally carried on by the sole trader or by the partners. But a large business
is usually conducted by an incorporated company which separates management from ownership.
Manager’s responsibility is to operate the business efficiently and maximize the return of capital
without jeopardizing the fund. Management needs accounting information in:

(i) Selecting one alternative proposal.

(ii) Controlling acquisition and maintenance of inventories (stock) cash receipts and payments:

(iii) Planning or budgeting for the future.

(iv) Appraising the performance; and

(v) Devising remedial measures for the deviations of the actual results from the budgeted targets.
Creditors:

Creditors may be short term viz. suppliers of goods ,lenders of temporary advance or
long term viz. mortgages, debenture holders etc. although both are interested in the stability and
earning of the debtor firm yet the former specially looks to its short term solvency i.e. liquidity
whereas the latter is interested in the long term solvency of the firm.

Employee:

Steady employment and stability of business go together .again trade unions are
interested in sharing the profit of the firm of bonus. Therefore, the employees are naturally
interested in the accounting information provided by the annual accounting reports.

Government:

Many products now –a-days are subjected to excise duty and sales tax. also the
government regulates the prices of essential goods e.g. drugs,fertilizer,ghee etc. so the
government is interested to know the costing information to administer excise duties and to
regulate the prices of products government is also interested in the accounting information on the
profits for income tax purposes.

Consumers:

Price increase is disfavored in almost all the quarters. Accordingly a producer

endeavors to reduce his product cost as also its selling price. Recently consumer protection
association have been formed to exercise control on the business and industry and also to make
them aware of the “social responsibility towards society”. Thus, consumers also need accounting
information.

Research:

The financial statements, being a mirror of business conditions are of inestimable value
for research into business affairs. These statements are therefore of great interest to scholars
undertaking research in accounting theory as well as business affairs and practices.

Q-7 What are the advantages of Accounting?

(1) Information regarding performance and position:

Accounting cycle after recording moves on to prepare final accounts which reveal how
much profit has been earned or loss suffered during the period ?under this system balance sheet is
also prepared which tells the financial position of a business on that date .
(2) Helps in employing with legal formalities:
Now-a-days business is to deal with various tax regulating authorities like sales tax,
central excise; income tax etc. these require filling of periodic returns and submitting proof of
activities records maintained under accounting system help in preparing such return also such
records when audited are trusted by the authorities.

(3) Help in raising loans:

Almost every business requires additional funds for its growth. Such requirements are met
by institutions like commercial banks, financial institutions in the form of granting loans. These
institutions before sanctioning loans screen various statements prepared under accounting
information such as final accounts, flow statements etc.

4) Useful for owner/management:

Accounting helps and guides the management/owners in planning the business activities,
taking certain decisions where have of alternatives is involved and controlling the business
operations to ensure the achievement of goals.

(5) Provides complete and scientific record:

Accounting is meant to maintain complete record of financial transactions during the accounting
period of an entity as such this limitation of human memory is no handicap because of accounting
system.

(6) Valuation of business:

If business need be sold as a going concern then the latest balance sheet prepared is
likely to form the basis of bargaining the amount which should be realized .it helps both the buyer
as well as seller of the business.

(7) Evidence in legal matters:

Properly maintained accounts, supported by authenticated documents can be produced
as a proof of matters and are likely to be admitted by the courts as evidence.

(8) Enables comparison:

Enables comparison of costs expenses, sales and profit etc of the entity of the current
year with previous years and also with other units of the same trade/industry.
Q-8 Difference between “accounting”and”book-keeping”.
Points of Book-keeping Accounting
Difference

1.object The object of book-keeping is to The object of accounting is to record,

prepare original books of accounts, classify, summarize, and interpret the
trial balance and final accounts. business transactions.

2.scope It has limited scope and is concerned It has a wide scope and covers book-
with recording, classifying and keeping plus analysis and
summarizing of business transactions. interpretation.

3.level of It is restricted to clerical work and is It is concerned with all levels of

work done by lower levels of management. management .lower level clerks
prepare the accounts, medium level
report it and top level interpret it.

4.mutual It has to depend on accounting for It has to depend on book-keeping for

dependence making the accounting records more getting the required information from
useful. accounting records and for making
them useful for planning, control and
decision making.

5.results of It shows the net result and financial It analyses the operating results and
the position of the business as the scope financial position of the business.
business extends only up to the preparation of
final accounts.

CHAPTER – 2
Q-1 Explain the various Accounting concepts.
ACCOUNTING CONCEPTS:

Accounting is a language of business through which normally a business house

communicates to the outside world in financial terms, so to make this language understandable
and definable it is essential to develop certain uniform principle and standards which is known as
accounting principles. It may be defined as those rules of action adopted by the accountants
universally at the time of recording transactions. It provides the complete guidelines and
instructions to the accounts through which they can consider and record the transaction. They are
of two types:-

1. Accounting concept:-

It includes those basic conditions and assumptions upon which the science of accounting is based.

i) Separate entity concept.

ii) Ongoing concern concept

iii) Money measurement concept

(iv) Dual aspect concept

v) Cost concept

vi) Periodicity concept

vii)matching concept

viii) Realization concept

2. Accounting conventions:-

It includes those customs and traditions which guide the accountant while preparing the accounting
statements:-

i) Convention of conservatism (traditional approach)

ii) Convention of full disclosure

iii) Convention of consistency

(iv) Convention of materiality

Now, the above concept and conventions are being explained below:-

i) Separate entity concept:

It means the entity of business and businessman is separate although the

business has been developed by the businessman. So the accountant concentrates only on the
business affairs which are separate from the private affairs of businessman.

ii) On going concern concept:

It is assumed that the business will continue for a fairly long period because the
accountant in this regard will estimate the life of assets, can make policies, implement procedures,
set targets etc. it is also important for the Entrepreneur that the business should continue for a long
period so that his interest will protect as well as repay the liabilities are paid in time.

iii) Money measurement concept:

Accountants record only those transactions which can be identified in terms of

money, other items which are beyond the measuring capacity in terms of money are excluded from
accounting terms for e.g man power is definitely an asset for the company but its valuation in terms
of money is not possible hence it is not taken into consideration in the books of accounts.

iv) Dual aspect concept:-

It indicates that give/to give and take/to take is the two definite part every kind of
business transaction. One of the parts in debit and the other part is called credit. Without
considering both these parts, transaction will not complete.

v) Cost concept:-

The accountant considers only the consideration against the item which is purchased which means
the cost of acquisition or say the landed price in which the item is acquired. But if the market value
is more than the cost it will not be considered.

vi) Periodicity concept: -

The main motto of business entity is to earn profit and it will be determined only in the
accounting period which will be divided into a proper period. A 12 month period, will be termed
as proper and adequate. Generally this 12 months period is known as the accounting year.

vii) Matching concept:-

Accounting means matching of contrast. It means Debit is matched with credit to get the
balance, expenses are matched with incomes to get the profit/loss and liabilities are matched
with Assets to get the status.

viii) Realization concept:-

Transfer of goods takes place only when the right of ownership has been transferred to the buyer
which is determined or governed by the agreement of sale. Only then the seller/buyer records the
transaction accordingly seller bing the buyer in case of any breach or realizes his consideration
against of sale.

Q-2 Explain the various Accounting conventions.

a. Convention of disclosure:
The disclosure of all significant information is one of the important
accounting conventions. It implies that accounts should be prepared in such a way that all
materials information clearly disclosed to the reader. This information should not only include
figures given in the final account but also information which occurs after the preparation of the
balance sheet. The object on this convention is to make free judgment & there is no scope of
concealment of facts.

b. Convention of consistency :
It means the same accounting principles should be used for preparing
financial statements for different periods. It enables the management to draw important
conclusions regarding the working of the concern over a longer period. It facilities a comparison in
the performance of different periods. If different principles are applied in different periods, then the
result will not be comparable.

c. Convention of conservation:
It refers to cautions approach or policy of play safe. This convention
ensures that uncertainties and risks inherent in business transaction should be given a due
consideration. If there is a possibility of loss, it should be prospect of profit should be ignored upon
the time, it does not materialize. Provision for doubtful debts, valuation of closing stock at cost
price or invoice price whichever is less is the examples of this convention.

d. Convention of materiality:
According to this convention only those events should be recorded
which have a significant bearing and insignificant things will not materially affect the records of the
business. It should be seen that the effects should be worth the labour involved in it. Materiality
depended on a ration judgment.

Q-2 What is need for Accounting standard? State the various

accounting standard prescribed by IASC & ICAI of India.
Kohler defines accounting standards as “A mode of conduct imposed on
accounts by custom, law or professional body”

Need:

The propose of an accounting standards is serve as a working basis for the

institution of procedure, subject to internal and external constraints imposed on the
accountants so as to ensure uniformity in the preparation and presentation of financial
statements.

The accounting concepts & conventions from the basic accounting theory and practice,
But they have no stationary force on accounting users. They give free hand to
accountants in farming their own rules of procedure and making assumptions, have led to
a variety of accounting practices. Consequently, the financial results of different concerns
cannot be compared and evaluated.
 Therefore, specific accounting standards should be followed in order to make them
uniform. The main purpose of standard is to ensure that financial information is treated in
the financial statements according to specific standards and the methods used by
different enterprise for presenting information should permit appropriate comparisons to
be made.

Development of standards:

The American Association on public accountants in 1894 adopted

resolution recommended the order of presentation of assets on the basic of realization &
in 1910 a committee was appointed to formulate definitions of technical accounting terms.
Later in 1917 the American institute of certificated public accountants prepared
memorandum association also contributed information of concept and standards.

The following institutions contributed to the development of accounting.

i.
Contribution by American accounting association.
ii.
Contribution by the accounting principle board.
iii.
Contribution by the financial accounting standard board of America.
iv.Contribution by the international accounting standards committee of England and Wales
– 1942 to 1969.
v. Contribution by the international accounting standards committee (IASC) in 1973.

The main objective of the committee is to formulate & publish the

accounting standards to be observed in the presentation of financial statement & promote
their published 30 Accounting standards. The first accounting standards were
pronounced in January 1975.

Accounting Standards Prescribed By IAS.

The following are the international accounting standards (IAS) approved by IASC. They
are-

IAS – 1 : Disclosure of accounting policies.

IAS – 2: Valuation & presentation of inventories.

IAS – 3 : Consolidated financial statements

IAS – 4 : Depreciation accounting

IAS – 5: Information to be disclosed in financial statements.

IAS – 6: Accounting response to changing prices.

IAS – 7: Statement of changes in financial position.

 IAS – 8: Unusual and prior period items & changes in accounting policies.

IAS – 9: Accounting for research and development activities.

IAS – 11: contingencies and events occurring after balance sheet date.

IAS – 12: Accounting for taxes and income.

IAS – 13 Presentation of current assets and current liabilities.

IAS – 14: Reporting financial information by segments.

IAS – 15: information reflecting the effects of changing in prices.

IAS – 16: Accounting for property, plant & equipment.

IAS – 17: Accounting for leases

IAS – 18: Revenue recognition.

IAS – 19: Accounting for retirement benefits in the Financial Statement on employees.

IAS – 20 accounting for govt. grants and disclosure of Govt. assistance.

IAS –21: Accounting for business combination.

IAS – 22: Accounting for effects of changes in foreign currency rates.

IAS – 23: Capitalization of borrowing costs.

IAS – 24 : Related party disclosures

IAS –25 : Accounting for investigations.

IAS –26: Accounting for investment in associates

IAS –27 : Financial reporting in Hyper-inflationary economies.

IAS –28: Discloser in the financial statement of bank and similar financial institutions.

ACCOUNTING STANDARDS PRESCRIBED BY ICAI:

In India accounting standard board was constituted in 1947 by the ICAI which recognized
the need to harmonies the diverse accounting policies & practices at present in use in
India and also to fall in line with the developments in the field of accounting at the
international level.
 The ICAI is one of the members of the international Accounting
standards committee (IASC). As since it has agreed to support its objectives by giving
due consideration to the standards on the IASC while formulating its own standards and
integrate them to the extent possible in the light of the conditions and practice used in
India.

The following are the 15 Accounting of Standards (AS) as issued by the

ICAI. They are –

A.S – 1: Disclosure of Accounting Policies

A.S –2: Valuation of inventories

A.S –3: Change in financial position.

A.S – 4: Contingencies and events occurring after the balance sheet date

A.S – 5: Prior period and ex- ordinary items.

A.S – 6: Depreciation Accounting

A.S – 7: Accounting for construction contracts.

A.S – 8: Accounting for research & development

A.S – 9: revenue recognition.

A.S – 10: Accounting for fixed assets.

A.S – 11: Accounting for the effects of changes in foreign exchange rates.

A.S – 12: Accounting for govt. grants.

A.S – 13: Accounting for investments.

A.S – 14: Accounting for amalgamations.

A.S – 15: Accounting for retirement benefits in the financial statement of employers.