Internal Assignment

Course: Essentials of Financial Accounting

Ans.1. Before opening a Sub Way outlet, Virendra definitely needs to know the meaning of
assets and liability –
Asset is something a person owns. The person has some control over it. Assets are
meant as resources which can be expressed in monetary terms and
are required by a company in order to run and grow its business
successfully. Assets are entirely everything, the business owns in
either cash or property. The word „asset‟ indicates all types of
resources that help to generate revenue, enhance profitability and
generate enough cash flow. Assets are the resources which
regularly help to decrease the level of expenses. In terms of
financial accounting, “An asset is any resource owned by a business or an economic entity,
it is anything tangible or intangible, that can be owned or controlled to create a value and
that is held by an economic entity or a person and that could produce increasing economic
value.” In simple, assets symbolize a value of ownership that can be converted into cash
though cash itself is also measured as an asset.
According to the International Financial Reporting Standards (IFRS) developed by
International Accounting Standards Board (IASB), ‘An asset is a resource controlled by the
entity as a result of past events and from which future economic benefits are expected to
flow to the entity.‟
An item to be an asset, the business should be able to measure the value of the same.

Whereas, Liability is something a person owes. It is just the opposite of assets. It is

defined as obligations that a person has to pay over time. In simple
words, Liability means credit. The word „liability‟ indicates all t ypes
of dues. It can further be explained as a financial responsibility that
individuals or a business entity must meet. For business or an
organisation, liabilities are debts and obligations for the business
and expressed as creditor's claim on business assets. In terms of
financial accounting, “A liability is expressed as a future sacrifice for
the economic benefits that an entity is required to make to other
entities as an outcome of older transactions or other past events.” In simple, liabilities
„reduce‟ or we can say weakens a company's total value.
According to the International Financial Reporting Standards (IFRS) developed by
International Accounting Standards Board (IASB), ‘A liability is a present obligation of the
enterprise arising from past events, the settlement of which is expected to result in an
outflow from the enterprise of resources embodying economic benefits.’

It is also important to know about the composition of assets and liabilities.

Composition of Assets

The assets consist of two types: –

I. Non-Current Assets
II. Current Assets
I. Non-Current Assets:-
Non-current assets are also referred as long-term assets
having a useful life of more than one year. These assets cannot be converted into
cash simply. They are required for the long-term requirements of a business.
Example:-
 Land
 Building
 Heavy machines
 Equipments

It is further classified into Fixed Assets which includes–

 Tangible Assets
 Intangible Assets

i. Fixed Assets – Also known as „hard assets‟ are permanent assets used for a
long term.

a) Tangible Assets – These assets with an economic value have some

physical existence in the sense, we can see and touch it.
Example:-
 Plant & machinery
 Heavy equipments
 Building
 Furniture
 Resources like stock
 Land
 Real property
Tangible Assets are valued as cost less depreciation however land does
not depreciates; rather it is revalued over the time.

b) Intangible Assets – These assets have an economic value but do not exist
physically in the sense, we cannot see or touch these assets.
Example:-
 Market goodwill
 Brand
 Trademark
 Patents
 Copyrights
 Corporate intellectual property
Intangible Assets are valued either on cost or revaluation model.

II. Current Assets:-

Current Assets are also known as Liquid assets as they can be
immediately converted into cash within short period of time or within one year. They
are short term assets and can be used to pay off short term liability i.e. current
liabilities. These assets are required to run day-to-day operations in a business.
Examples of Current Assets–
 Cash and cash equivalents
 Marketable securities
 Accounts receivables
  Inventories
 Prepaid expenses
 Other current assets

Composition of Liabilities

The liabilities consist of two types: –

I. Non-Current Liability
II. Current Liability
III. Contingent Liability

I. Non-Current Liability:-
Non-current liabilities are long-term in nature, also known as
fixed liabilities. Long term liabilities are used for purchasing fixed assets or for
purposes like growth n fixed expansion and includes long-term obligations and debts.
These are not paid or accounted in books during the within one year.
Types of Non-current liabilities are –
 Long-term borrowings
 Long-term provisions
 Deferred tax liabilities
 Other non-current liabilities
Examples:-
 Debentures.
 Bonds payable.
 Long-term loans.
 Long-term lease

II. Current Liability:-

Current Liabilities are the short-term debts which are paid in less
than or within a year or we can say within one business cycle. These liabilities occur
in day-to-day operations and are settled against current assets.
Some Examples of current liabilities are:-
 Accounts payable
 Short-term borrowings
 Dividends
 Income taxes owed
 Notes payable
III. Contingent Liability:-
A Contingent Liability is like a budding liability that may arise in
the future. It can be predicted, and if it has been estimated with a reason then it
should be recorded in the accounting books.
Examples of contingent liabilities are:-
 Pending lawsuits
 Any claim against a product
 Loan guarantee, etc.

Hence, consistent tracking of assets and liabilities help leaders of the business to make
correct decisions on new expenditures and to specialise in the financial strength of the
corporate.
Thus, now Virendra can easily decide on what are the requirement of assets and liabilities
by his business.

Image source: 1. https://images.app.goo.gl/vhVoaoKhJTZvyuEMA

2. https://images.app.goo.gl/8kgxagXtutzR13tE9

Ans.2. The term ‘Expenditure‟ means spending something. The spending can be a sum of
cash or can also be the exchange of some valuable item in exchange of goods or services. It
is a process of causing a liability for acquiring a commodity or we can say an asset.
The word „expense‟ is very alike to expenditure however expense shows the reduction
in value of the asset while expenditure means obtaining the asset.
In financial terms, Expenditure is the amount spent or liability incurred for acquiring assets,
goods or services.

Expenditure is categorised into:-

 Capital Expenditure
 Revenue Expenditure

i. Capital Expenditure:-These are long-term expenditures, incurred for high-value

assets or for improving the existing assets that have longer duration requirements,
which does not get entirely used in the particular time, in the sense, does not get
exhausted in the accounting year and benefits the business in the future years for a
longer time, and is irreversible as it will have a great impact on the business.
Examples of Capital Expenditures – includes the amount spent to acquire or
improve assets such as- land, buildings, manufacturing plants, machines,
equipments, vehicles, computer, furnishings, fixtures, etc.
Capital Expenditures are of two types:-
 Maintenance Expenditure:-made for maintenance on assets
 Expansion Expenditure:-for expansion leading to future growth.

ii. Revenue Expenditure:-These are short-term expenditures, not incurred for high-
value assets; instead, these are incurred on day-to-day basis and are consumed
within an accounting year. It is basically recurring in nature and doesn‟t benefit the
business, however nor leads to any kind of loss too.
Examples of Revenue Expenditures – rent, salaries and wages, insurance,
fees, routine repairs, certain expenses like advertising, internet, travel, etc.

Classification of above mentioned transactions into capital expenditure and revenue

expenditure is as follows:-

Capital Expenditure Amount Revenue Expenditure Amount

1 Machinery purchased 10,00,000 1 Maintenance Charges 20,000
2 Import charges 2,00,000
3 Transportation charges 1,00,000
4 Installation fees 50,000

Reasons for classification –

 1. Machinery purchased – The Company purchased machinery worth 10 lakhs, this will
be considered as Capital Expenditure as the cost of the machinery is high and the
useful life of machinery is going to be definitely more than one year that means it is a
long-term expenditure and will benefit the company for longer duration. In addition, the
value of the machinery is going to be depreciated as it is an asset.

2. Import charges – The import charges are paid for 2 lakhs, this will be considered as
Capital Expenditure as again the value is high and is incurred only for one-time, in
importing the machinery which is having a long-term benefit on the business. This is
basically a maintenance expenditure incurred to maintain the machinery brought.

3. Transportation charges – The transportation charges are paid for 1 lakh, this will be
considered as Capital Expenditure as it is made for one-time and was incurred to
bring the machinery at its location, therefore will form an irreversible impact on the
business as paid to improve the brought asset, having a long-term effect. Also the
charge for the transportation is of high cost.

4. Installation fees – The installation fees is paid for Rs.50,000 to the engineer, this is a
Capital Expenditure because the cost is high and is made for installing a machinery
having long-term effect in the business, therefore will be considered as irreversible too.
Installation fees is a one-time expenditure and can be called as maintenance
expenditure as made for maintaining the asset.

5. Maintenance charges – The maintenance charges will be paid regularly for

Rs.20,000 annually by the company, thus, this will be considered a Revenue
Expenditure as the charges are recurring expenses to maintain the asset in order, and
will be incurred every year until the life of asset expires. Also, the benefit for this
expense made, will be received in the same accounting period.

Depreciation:-

Depreciation is calculated to charge on an asset to show how much value of physical assets
is used in the business.
Depreciation is a process that depicts fall in the value of a non-current/fixed asset because
of usage, lapse of time or obsolescence.

Amount of Depreciation = [(Original cost of machinery – Scrap value) / Useful life of asset]

When rate of depreciation is given,

Amount of Depreciation = Original cost of machinery x Rate

Calculation of Depreciation on the cost of the machinery is as follows:-

Given:-
Cost of Machinery = 10,00,000
Import charges = 2,00,000
Transportation charges = 1,00,000
Installation charges = 50,000
Rate of depreciation = 10%
Total cost of Machinery = 10,00,000 + 2,00,000 + 1,00,000 + 50,000 = 13,50,000
Amount of Depreciation = 13,50,000 x 10/100
= ₹ 1,35,000

Ans.3. a. Every business or any organisation definitely wants to know the earned income
and incurred expenses during a particular time, usually at time of closing the books. Thus
Profit & Loss account is prepared.

A Profit & Loss Account is prepared to determine net profit earned or net losses
incurred by the business during an accounting period. It is prepared after preparing Trading
Account and starts with Gross Profit (transferred from trading Account) on the credit side.
[Trading Account is considered as first stage in the preparation of final accounts and is
prepared to determine Gross Profit and Gross Loss incurred in the accounting year. The
difference in the two sides is either Gross Profit or Gross Loss]. Usually entities prefer a “T”
form for preparing the Trading and P&L Account.

Below is the Trading and P&L Account for the above mentioned company, ABC Ltd. –

In the books of ABC Ltd.

Trading Account
For the year ended 31st March, 2020
Dr. Cr.
Particulars Amount Particulars Amount

To Purchase A/c 6,00,000 By Sales A/c 8,00,000

To Gross Profit 2,00,000

8,00,000 8,00,000

Profit and Loss Account

For the year ended 31st March, 2020

Dr. Cr.
Particulars Amount Particulars Amount
By Gross Profit 2,00,000

To Salaries A/c 1,10,000 By Interest 1,000

To Stationary A/c 7,000
To Discount A/c 5,000
To Rent A/c 60,000

To Net Profit A/c 19,000

2,01,000 2,01,000
Ans.3. b. Balance Sheet is prepared after preparing Trading and Profit & Loss Account, to
know the financial position of a business at the time of closing the books. It can help the
users to check creditworthiness of the firm.

In financial terms, a Balance Sheet shows two sides namely, Assets and Liabilities, for
a given period of time. The Debit balances of closed ledger accounts are shown on the
„Asset‟ side, and Credit balances on the „Liability‟ side.

Following is the Balance Sheet for the above mentioned company, ABC Ltd. –

In the books of ABC Ltd.

Balance Sheet

As on 31st March 2020

Liabilities Amount Assets Amount

F Ltd.'s A/c 1,50,000 Cash A/c 4,03,000

Mathew's A/c 50,000 Bank A/c 2,46,000
Capital A/c 10,00,000 Tom's A/c 70,000
Add: Net Profit 19,000 10,19,000 Investments 1,00,000
Furniture 1,50,000
Plant & Machinery 2,50,000

12,19,000 12,19,000

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