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Accounting Theory Question
Accounting Theory Question
Ans- Accounting may be defined as the process of recording, classifying, summarizing and
interpreting the financial transactions and communicating the results there of to the persons
interested in such information.
Ans-
A. Business organization
1. Management
2. Owner, shareholder
B. Non business organization
1.school, hospital, religious organizations
C. govt to public
4. What do mean by Comparability and consistency. Distinguish between them 1.53
Financial statements of one accounting period must be comparable to another in order for
the users to derive meaningful conclusions about the trends in an entity's financial
performance and position over time
consistency is use of similar accountancy policies over a period of time. Always FIFO or
always LIFO.
Convention of Consistency
According to this convention accounting principles and methods should remain consistent from
one year to another. The rationale for this concept is that changes in accounting treatment
would make the Profit & Loss and Balance Sheet unreliable for end users. This enables
comparison of performance in one accounting period with that in the past. For example there
are several methods of providing depreciation on fixed assets i.e. fixed installment method,
diminishing balance method etc., But it is expected that the business entity should be
consistent to follow accounting method.
Convention of comparability
Comparability is not an accounting principle. Instead, it is just one of several criteria that is
needed in order for accounting information to be useful to various groups.
Comparability implies the ability for users to be able to compare similar companies in the same
industry group and to make comparisons of performance over time. Much of the work that
goes into setting accounting standards is based around the need for comparability.
Ans-
• Assumptions
- Periodicity Assumption
• Principles
revenue recognition principle (which states that revenues should be recognized when they
are earned, no matter when cash is received
- Matching principle
Matching principle requires that the expenses should be matched with the revenues generated in the relevant
period
• Constraints
- Cost-Benefit Relationship Constraint (Overall, the costs of providing the information would
exceed the benefits of so doing, thereby violating the cost-effectiveness constraint)
- Materiality Constraint (The accountant should attach importance to material details and ignore
insignificant details.)
Different Industry Use Their Own Accountin Process Ignoring Gaap- Rail, Bank, Insurance Etc
- Conservatism Constraint ( According to this convention, in the books of accounts all anticipated losses
should be recorded and all anticipated gains should be ignored.)
- Matching principle
B. ‘Adjusting entries are required by the matching principles of accounting’- do you agree? Explain
Adjusting entries ensure all transactions and events are recorded in compliance with the matching principle.
The matching principle requires revenues and expenses to be properly matched in the same time period.
Once revenue has been recognized in an accounting period, expenses incurred to generate that revenue need to be recorded in
the same accounting period.
Revenue and expense are recorded when events take place, whether cash has been paid/received or not.
C. “Adjusting entries are required by cost principle of accounting”- Do you agree? Explain.
This adjusting entry allocates the historical cost of depreciable assets to depreciation expense, thereby matching the cost of the
asset to revenue over the estimated useful life of the asset.
D. What are principles relating to adjusting journal?B+C
Adjusting Entries are necessary when accrual basis accounting is used.
Adjusting entries allow businesses to adhere to the Matching Principle
-Journalizing
-closing entries
-after close trial balance
-reverse entry
Ans-
For accounting purposes, the going concern assumption states that the financial activities
of a business are assumed to be in operation for an indefinite period of time. This allows
a business to operate with a view towards a long term. This is a very critical assumption
as it provides that there is no short term end point in which all assets need to be sold and
all debt must be paid off. Thus, the going concern assumption makes it possible to
depreciate or amortize assets because we assume that businesses will have a long life.
For example, if the coffee house was going to be sold, its assets would be valued at their
disposal or liquidation value (sales price less expense of disposal). Under the going
concern assumption, the coffee house values its assets at their original cost. As we can
see, the going concern assumption is only inapplicable when business liquidation is
imminent, and it should be used in all other business situations. General purpose
financial statements are prepared on a going concern basis, unless management either
intends to liquidate the entity or to cease operations, or has no realistic alternative but to
do so. Special purpose financial statements may or may not be prepared in accordance
with a financial reporting framework for which the going concern basis is relevant (for
example, the going concern basis is not relevant for some financial statements prepared
on a tax basis in particular jurisdictions). When the use of the going concern assumption
is appropriate, assets and liabilities are recorded on the basis that the entity will be able
to realize its assets and discharge its liabilities in the normal course of busines
Ans- (i) Provides Complete and Systematic Record: In business there are so many transactions therefore it is not possible to
remember all transactions. Accounting keeps a systematic record of all the business transactions and summarized into financial
statements.
(ii) Information Regarding Financial Position: Accounting provides information about the financial position of the business by
preparing a balance sheet at the end of each accounting period.
(iii) Helpful in Assessment of Tax Liability: Accounting helps in maintaining proper records. With the help of these records a
firm can assessed income tax of sales tax. Such records are trusted by income tax and sales tax authorities.
(iv) Information Regarding Profit or Loss: Profit & Loss Account is prepared at the end of each accounting period to know the
net profit earned or net loss suffered at the end of each accounting period.
1. Primary qualities
A) Relevancies
*Predictive value
*Feedback value
* Timeliness
B) Reliability
*Verifiable
*Faithful presentation
*Neutrality
2. Secondary qualities
-Comparability
-Consistency
Ans-
1) Primary qualities of useful accounting information:
Relevance - Accounting information is relevant if it is capable of making a difference in a decision. Relevant information has:
(a) Predictive value
(b) Feedback value
(c) Timeliness
Reliability - Accounting information is reliable to the extent that users can depend on it to represent the economic conditions or
events that it purports to represent. Reliable information has:
(a) Verifiability
(b) Representational faithfulness
(c) Neutrality
2) Secondary qualities of useful accounting information:
• Comparability - Accounting information that has been measured and reported in a similar manner for different
enterprises is considered comparable.
• Consistency - Accounting information is consistent when an entity applies the same accounting treatment to similar
accountable events from period to period.
• Accounting Qualities and Useful Information for Analysts
• Here is how these qualities provide analysts with useful information:
• Relevance– Relevant information is crucial in making the correct investment decision.
• Reliability – If the information is not reliable, then no investor can rely on it to make an investment decision.
• Comparability – Comparability is a pervasive problem in financial analysis even though there have been great strides
made over the years to bridge the gap.
Consistency – Accounting changes hinder the comparison of operation results between periods as the accounting
used to measure those results differ
Ans-
• is useful to existing and potential investors and creditors and other users in making rational investment, credit and
similar decisions;
• helps existing and potential investors and creditors and other users to assess the amounts, timing, and uncertainty of
prospective net cash inflows to the enterprise;
• identifies the economic resources of an enterprise, the claims to those resources, and the effects that transactions,
events, and circumstances have on those resources
Ans- "Forensic" means "suitable for use in a court of law". Forensic Accounting utilizes
accounting, auditing, and investigative skills to conduct an examination into a company's
financial statements. Thus, providing an accounting analysis that is suitable for court.
Ans- The statements that are prepared at the end of a particular accounting period to
measure the overall result of business activities and exhibit the financial position of a
business concern are generally called financial statements.
2.Liabilities
A liability is an obligation that a business owes to someone and its settlement involves the
transfer of cash or other resources.
3.Equity:
Equity is what the business owes to its owners.
4.Income & expenses:
Income is increase in economic benefits during the accounting period in the form of inflows or
enhancement of assets or decrease of liability that result in increase in equity. Whereas
expenses are decreases in economic benefits during the accounting period in the form of
outflows or depletion of assets or increases in liabilities that result in decrease in equity
19. Types of financial statement ( P-37) PDF/ What are the 4 financial statements PDF-
41
1. Income Statement
2. Balance Sheet
3. Cash Flow Statement
Ans-
a financial statement that shows how changes in balance sheet accounts and
income affect cash and cash equivalents Essentially, the cash flow statement is
concerned with the flow of cash in and out of the business.
4. Statement of Shareholders’ Equity( withdraw&investment)
20. Do you think that financial statement analysis is an integral part of business analysis?
Ans- Business analysis is the evaluation of a company’s prospects and risks for business
decisions. Financial statements are the most comprehensive source of information
about a company. As a result, financial statement analysis is an integral part of business
analysis.
21. Vertical and Horizontal Analysis of financial statement
The two simplest ways to analyze your financial statements are vertically and
horizontally. A vertical analysis shows you the relationships among components of
one financial statement, measured as percentages. On your balance sheet, each asset
is shown as a percentage of total assets; each liability or equity item is shown as a
percentage of total liabilities and equity. On your statement of profit and loss, each line
item is shown as a percentage of net sales.
A horizontal analysis provides you with a way to compare your numbers from one
period to the next, using financial statements from at least two distinct periods. Each
line item has an entry in a current period column and a prior period column. Those two
entries are compared to show both the dollar difference and percentage change
between the two periods.
Some companies use a sort of combination vertical and horizontal analysis in one.
These reports contain financial data from more than one period, with a vertical
analysis applied to each one. This way you can tell at a glance how statement
components have changed in their proportions from one period to the next, without
any extra math.
•
22. sensitivity analysis for breakeven point (note iq-29)*** bangla p-49
-testing robustness
-understanding relationship between input and out put
- Uncertainty reduction
- searching errors
- Model simplification
23. debit means favorable and credit means1 unfaborable (bangla pdf-40)
No, it’s not so. Both debit & credit balances can be favorable or unfavorable.
For Example, assets have debit balances. So it is favorable for you if you have debit balances.
Expenses also have debit balances. But it is not good for you to have debit balances with
expenses. So debit can be favorable or unfavorable both.
Same is the case with credit balances. Loan accounts have credit balances, so if you more credit
balances with loan, then it is unfavorable for you. On the other hand revenues have credit
balances, so if credit balances increase with revenue accounts, it is favorable for you. So credit
can be favorable or unfavorable both.
2.Liabilities A liability is an obligation that a business owes to someone and its settlement
involves the transfer of cash or other resources.
25. Determining debit credit through accounting equation/ golden rules (ha-3.10).
Ans-
Golden rules of accounting: 3 GOLDEN RULES OF ACCOUNTANCY
Debit The Receiver, Credit The Giver
This principle is used in the case of personal accounts. When a person gives something to the
organization, it becomes an inflow and therefore the person must be credit in the books of accounts.
The converse of this is also true, which is why the receiver needs to be debited.
Debit What Comes In, Credit What Goes Out
This principle is applied in case of real accounts. Real accounts involve machinery, land and building
etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the
existing account balance. This is exactly what needs to be done. Similarly when you credit what goes
out, you are reducing the account balance when a tangible asset goes out of the organization.
Debit All Expenses And Losses, Credit All Incomes And Gains
This rule is applied when the account in question is a nominal account. The capital of the company is a
liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase
the capital and by debiting expenses and losses, you decrease the capital. This is
· In case of Personal Account - Debit the receiver and Credit the giver.
· In case of Nominal Account- Debit all expenses and losses and Credit all income
and liabilities.
· In case of Real Accounts - Debit what comes in and credit what goes out
26. can a business enter in to a transaction in which only the left side of the basic accounting
equation affected. If so give an example
Ans-Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An
example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in
the equipment account which is offset by a decrease in the cash account is a specific example
Here are some transactions that will affect only the right side of the accounting equation- A stock dividend is
declared. The paid-in capital section of stockholders’ equity will increase and the retained earnings section will
decrease
Ans- Ethics is a code or moral system that provides criteria for evaluating right and wrong.
Ethical standards in written or unwritten laws were made to provide justice to the injured
ones, ensure equal opportunity to all without discrimination, protect the interest of all sections of
the society and guard the value systems based on culture and faith of the people.
Importance
Ethical behavior and corporate social responsibility can bring significant benefits to a business. For example, they may:
1. Quality maintenance :
attract customers to the firm's products, thereby boosting sales and profits
2. Employe welfare
make employees want to stay with the business, reduce labor turnover and therefore increase productivity
attract more employees wanting to work for the business, reduce recruitment costs and enable the company to get
the most talented employees
3. Proper distribution of profit/ information
Attract investors and keep the company's share price high, thereby protecting the business from takeover.
4. Well payment system
Goodwill in supplier, money market
Unethical behavior or a lack of corporate social responsibility, by comparison, may damage a firm's reputation and make it less
appealing to stakeholders. Profits could fall as a result.
28. What is posting/how does it helps in recording process (BANGLA PDF-41)
Ans-
Ans- The accounting cycle is a methodical set of rules to ensure the accuracy and
conformity of financial statements
1. Analyzing and recording transactions via journal entries
2. Posting journal entries to ledger accounts
3. Preparing unadjusted trial balance
4. Preparing adjusting entries at the end of the period
5. Preparing adjusted trial balance
6. Preparing financial statements
7. Closing temporary accounts via closing entries
8. Preparing post-closing trial balance
30. Difference between T-Account and Three- Colum form of accounting (Note-194)
Ans-
T-account describes the appearance of the bookkeeping entries. If a large letter T were
drawn on the page, the account title would appear just above the T, debits would be listed
under the top line of the T on the left side and the credits would be listed under the top line
of the T on the right side, with the middle line separating the debits from the credits
Dr. Cr.
DaTe Particulars L.F. Cash Date Particulars L.F. Cash
Three columns are used to display the account names, debits, and credits with the debit balances
listed in the left column and the credit balances are listed on the right.
Date Account Titles L.F. Dr. Cr. Balance
Dr. Cr.
31. What are the loan provision requirements for bank as per BRDP circular (Note-
563)
Ans- As per BRPD circular 14 the loan provisioning requirement for the banks is as follows:
General provision:
1. @ 0.25% against all unclassified loans of Small and Medium Enterprise (SME) as defined by the SME @1% against all
unclassified loans (other than loan under Consumer Financing, SMA & SME).
2. @ 5% on the unclassified amount for Consumer Financing whereas it has to be maintained @2% on the unclassified amount
for (i) Housing Finance and (ii) Loans for professionals to set up business under Consumer Financing Scheme
3. 1% on the off- balance sheet exposures.
4. @5% on the outstanding amount of loans kept in the Special Mention Account.
specific Provision:
1. i) Sub-standard 20%
ii) Doubtful 50%
iii) Bad/Loss 100%
Short term Agriculture and small loan provision:
i) Bad/Loss all loan except classified 100%
ii) Bad/Loss 100%
32. What are the main differences between single step and multiple step income
statement? Which method is followed in banks? (PDF P-50)
Single-step income statement – the single step statement only shows one category of income and one
category of expenses. This format is less useful of external users because they can't calculate many
efficiency and profitability ratios with this limited data.
In a single-step income statement, you present a single subtotal for all revenue line items, and a
single subtotal for all expense line items, with a net gain or loss appearing at the bottom of the
report.
Multi-step income statement - the multi-step statement separates expense accounts into more relevant
and usable accounts based on their function. Cost of goods sold, operating and non-operating expenses
are separated out and used to calculate gross profit, operating income, and net income.
The multi-step income statement involves the use of multiple sub-totals within the income
statement, which makes it easier for readers to aggregate selected types of information within
the report. The usual subtotals are for the gross margin, operating expenses, and other income,
which allow readers to determine how much the company earns just from its manufacturing
activities (the gross margin), what it spends on supporting operations (the operating expense
total) and what component of its results do not relate to its core activities (the other income
total).
Ans- Adjusting entries are journal entries that are made at the end of an accounting period to adjust
the balances in various general ledger accounts to more accurately state the revenue and expenses
in the income statement and the asset and liabilities in the balance sheet at the end of the
period. 4 types of adjusting entry
• Accrued Income – income earned but not yet received
• Accrued Expense – expenses incurred but not yet paid
• Deferred Income – income received but not yet earned
• Prepaid Expense – expenses paid but not yet consumed
34. What do you mean by in co. terms and FOB shipping point and Fob Destination
(p-7)
Ans- A series of three-letter trade terms related to common contractual sales practices,
the Incoterms rules are intended primarily to clearly communicate the tasks, costs, and
risks associated with the transportation and delivery of goods.
The term, FOB Shipping Point, indicates that the sale occurred at the shipping point—at
the seller's shipping dock. FOB Destination indicates that the sale will occur when it
arrives at the destination—at the buyer's receiving dock.
35. What do you mean by 2/10, n/30, FOB shipping and Fob Destination(p-11)
Ans –
2/10, n/30-
the buyer can choose either of the following:
• Pay within 10 days and deduct 2% of the net amount (invoice amount minus any
authorized returns and/or allowances), or
• Pay the full amount in 30 days with no discount.
2/EOM-
2% discount if paid within the last date of month of supply.
Ans-
Ans- valuation accounts - These are the accounts of provision for depreciation and provision for doubtful debts.
Where fixed assets are maintained in the books of accounts at original cost, to reflect the actual book value of the
assets, a provision for depreciation account on the credit is maintained. In the balance sheet, it is shown as
deduction from the original cost of the asset. Similarly, if the debtors' personal accounts are retained at total amount
due, a valuation account on the credit - provision for doubtful debts is required. In the balance sheet, it is shown as a
reduction from sundry debtors account to reflect estimated realizable value.
The amount of accumulated depreciation is used to determine a plant asset's book value (or carrying value).
38. Accumulated depreciation is a contra asset account-explain.(p-194)
Ans-
A contra account is an account which partially or wholly offsets another account. Contra accounts
are used to change the carrying amount of an asset. The contra account accumulates amounts that
are typically subtracted from the original asset balance, such as depreciation. The contra
accounts are also referred to as valuation accounts. Asset Contra accounts have a credit
balance, which is the offset against the asset account. Examples of valuation and contra
accounts include:
• Allowance for doubtful accounts (contra valuation account to Accounts Receivable)
• Accumulated depreciation (contra valuation account to Plant & Equipment)
• Unrealized gain or loss on investments (contra valuation account to Long-term
investments)
For financial reporting purposes, the Company may report assets net of their respective
valuation or contra accounts.
Accumulated depreciation is the total amount of an asset's cost that has been allocated as
depreciation expenses. Accumulated depreciation is a "contra-asset" account, meaning it is an
asset account with a credit balance, and it cuts against the values recorded in the associated
asset accounts. This account should not be approached as a valuation method; it is an allocation
method. Long-term assets (such as buildings) will see their value fluctuate with market
conditions. Depreciation is not intended to track this value; it is intended to move the cost of an
asset gradually over to the income statement as an expense. For example, imagine your firm
purchases a piece of machinery for $10,000 (note that this example will work equally well with
other currencies). The machinery is expected to last 10 years and has no salvage value. Using
straight-line depreciation (the most common method), the yearly expense is (10,000 / 10) or
$1,000.
Ans-
40. Adjusting Entry ensure matching principle and revenue recognition (p-569)
Ans- Adjusting entries ensure all transactions and events are recorded in compliance with the
matching principle.
The matching principle requires revenues and expenses to be properly matched in the same
time period.
Once revenue has been recognized in an accounting period, expenses incurred to generate that
revenue need to be recorded in the same accounting period.
• Recognizing Revenue
Accounting rules require that companies not make a journal entry to record a revenue until it
has been earned based on the completion of a product delivery or service performance.
Companies may receive prepayments in cash from customers from time to time for future
sales. However, companies may not record the total cash receipts as revenue at the time of the
cash transaction because the sales have yet to take place. By the end of an accounting period, if
a part of the sales has taken place, companies can recognize that part as revenue. In other
situations, certain revenues simply accrue with the passage of time, such as interest revenue or
rent revenue, and companies don't record them every step of the way until the end of an
accounting period.
41. Adjusting Entries are required by cost principle (P-20)
Ans-
Cost principle: Revenue and expense are recorded when events take place, whether cash has been paid/received or
not.
This adjusting entry allocates the historical cost of depreciable assets to depreciation expense, thereby matching the
cost of the asset to revenue over the estimated useful life of the asset.
General concept that you should only record an asset, liability, or equity investment at its original acquisition cost
Ans- Closing entries are journal entries made at the end of an accounting period to transfer temporary accounts to
permanent accounts. An "income summary" account may be used to show the balance between revenue and expenses, or they
could be directly closed against retained earnings where dividend payments will be deducted from. This process is used to reset
the balance of these temporary accounts to zero for the next accounting period
Ans-
A statement of the assets, liabilities, and capital of a business or other organization at a
particular point in time, detailing the balance of income and expenditure over the
preceding period.
Statement of Financial Position, or Balance Sheet, presents the financial position of an entity at any given
date. A Statement of Financial Position has three main components:
• Assets: Something a business owns or controls.
• Liabilities: Something a business owes to someone
• Equity: What the business owes to its owners. This represents the amount of capital that is left in
the business after its assets are used to pay off its outstanding liabilities.
Ans- To calculate the gain or loss on the sale of an asset, you compare the amount of cash received for the asset to the
asset’s book (carrying) value at the time of the sale. If the cash received is greater than the asset’s book value, the difference is
recorded as a gain. If the cash received is less than the asset’s book value, the difference is recorded as a loss.
In order to have the book value at the time of the sale, you must record the depreciation expense up to the date of the sale.
If the asset is exchanged instead of sold, the accounting treatment will often be different.
assets 2008 : 2007
cash $21,000 : 54,000
Land $350,000 : 300,000
building(net) $680,000 : 700,000
Equipment $520,000 : 340,000
...depreciation=$60,000
...paid $50,000 for land intended for a new plant site
...purchased computer terminals for $90,000
Ans- Revenue expense are costs in the for day-to-day running of the business for example servicing a machine, spare parts
etc. Revenue expenditure is normally charged against profit in the Income statement in the year it is expensed.
Capital expenditure is on an item that will help generate profits over the longer term (12 months or more) so a purchase of a
machine or van etc. The item is depreciated over the items useful life and each depreciable amount is charged to the Income
statement in the year the item has help generate profit.
47. difference between perpetual and periodic inventory (note iq-21) perpetual
Ans- The periodic and perpetual inventory systems are different methods used to track the quantity
of goods on hand. The more sophisticated of the two is the perpetual system, but it requires much
more record keeping to maintain.
The periodic system relies upon an occasional physical count of the inventory to determine the
ending inventory balance and the cost of goods sold, while the perpetual system keeps continual
track of inventory balances. There are a number of other differences between the two systems, which
are as follows:
1. Accounts. Under the perpetual system, there are continual updates to either the general
ledger or inventory journal as inventory-related transactions occur. Conversely, under a
periodic inventory system, there is no cost of goods sold account entry at all in an accounting
period until such time as there is a physical count, which is then used to derive the cost of
goods sold.
3. Cost of goods sold. Under the perpetual system, there are continual updates to the cost of
goods sold account as each sale is made. Conversely, under the periodic inventory system,
the cost of goods sold is calculated in a lump sum at the end of the reporting period, by
adding total purchases to the beginning inventory and subtracting ending inventory.
4. Cycle counting. It is impossible to use cycle counting under a periodic inventory system,
since there is no way to obtain accurate inventory counts in real time (which are used as
a baseline for cycle counts).
5. Purchases. Under the perpetual system, inventory purchases are recorded in either the raw
materials inventory account or merchandise account (depending on the nature of the
purchase), while there is also a unit-count entry into the individual record that is kept for
each inventory item. Conversely, under a periodic inventory system, all purchases are
recorded into a purchases asset account, and there are no individual inventory records
to which any unit-count information could be added.
This list makes it clear that the perpetual inventory system is vastly superior to the periodic
inventory system. The only case where a periodic system might make sense is when the amount
of inventory is very small, and where you can visually review it without any particular need for
more detailed inventory records. The periodic system can also work well when the warehouse staff
is poorly trained in the uses of a perpetual inventory system, since they might inadvertently record
inventory transactions incorrectly in a perpetual system
48. inventory and merchandise inventory (p-369)
for example, because a cheque or a list of cheques issued by the organization has not been presented to
the bank, a banking transaction, such as a credit received, or a charge made by the bank, has not yet been
recorded in the organization's books, or either the bank or the organisation itself has made an error. Bank
reconciliation statement is a form that allows individuals to compare their personal bank account records
to the bank's records of the individual's account balance in order to uncover any possible discrepancies.
Bank reconciliation is Analysis and adjustment of differences between the cash balance shown on a bank
statement, and the amount shown in the account holder's records. This matching process involves making
allowances for checks issued but not yet presented, and for checks deposited but not yet cleared or
credited. And, if discrepancies persist, finding the cause and bringing the records into agreement.
1. Bank reconciliation statement ensures the accuracy of the balances shown by the pass
book and cash book.
2. Bank reconciliation statement provides a check on the accuracy of entries made in
both the books.
3. Bank reconciliation statement helps to detect and rectify any error committed in both
the books.
4. Bank reconciliation statement helps to update the cash book by discovering some
entries not yet recorded.
5. Bank reconciliation statement indicates any undue delay in the collection and
clearance of some cheques.
Ans- Reversing entries, or reversing journal entries, are journal entries made at the
beginning of an accounting period to reverse or cancel out adjusting journal entries
made at the end of the previous accounting period. This is the last step in the
accounting cycle. Reversing entries are made because previous year accruals and
prepayments will be paid off or used during the new year and no longer need to be
recorded as liabilities and assets.
Ans- A subsidiary ledger contains the details to support a general ledger control account. For
instance, the subsidiary ledger for accounts receivable contains all of the information on each
of the credit sales to customers, each customer’s remittance, return of merchandise, discounts,
and so on. With these details in the subsidiary ledger, the Accounts Receivable account in the
general ledger can be a control account. As a control account, it will simply report the
aggregate amounts of the accounts receivable activity.
Ans- 1.
1. Ratios deal mainly in numbers not quality
2. Ratios largely look at the past, not the future
3. Inflation does not reflect properly
4. Improper information
5. Unselected methods for comparison
56. What is liquidity of a business. How can the liquidity of a firm be assessed.
Ans-
Ability of a firm to pay the current liability
i) current ratio- The current ratio is a liquidity ratio that measures a company's
ability to pay short-term and long-term obligations. To gauge this ability, the
current ratio considers the current total assets of a company (both liquid and
illiquid) relative to that company's current total liabilities.
ii) liquidity ratio- The liquidity ratio, then, is a computation that is used to measure a
company's ability to pay its short-term debts.
iii) working capital ratio- indicates whether a company has enough short term assets
to cover its short term debt.
57. Discuss different types of ratios (p-72)
Ans-
1. Liquidity
The most common liquidity ratio is the current ratio, which is the ratio of
current assets to current liabilities. This ratio indicates a company's ability to
pay its short-term bills. A ratio of greater than one is usually a minimum because
anything less than one means the company has more liabilities than assets. A high
ratio indicates more of a safety cushion, which increases flexibility because some of
the inventory items and receivable balances may not be easily convertible to cash.
Companies can improve the current ratio by paying down debt, converting short-term
debt into long-term debt, collecting its receivables faster and buying inventory only
when necessary.
2. Solvency
Solvency ratios indicate financial stability because they measure a company's debt
relative to its assets and equity. A company with too much debt may not have the
flexibility to manage its cash flow if interest rates rise or if business conditions
deteriorate. The common solvency ratios are debt-to-asset and debt-to-equity. The
debt-to-asset ratio is the ratio of total debt to total assets. The debt-to-equity ratio is
the ratio of total debt to shareholders' equity, which is the difference between total
assets and total liabilities.
3. Profitability- how much capable a firm to use it’s
4. Efficiency- Two common efficiency ratios are inventory turnover and receivables
turnover.
Ans- Adjusting entries are made at the end of the accounting period before the financial statements to make sure the
accounting records and financial statements are up-to-date.
Reversing entries are made on the first day of an accounting period to remove any adjusting entries necessary to avoid the
double counting of revenues or expenses.
Reversing Entries
Review the original journal entry posted into the general ledger. Note which account received the debit and which one received
the credit.
Write the reversing entry opposite of the original. For example, debit the account previously credited and credit the account
previously debited.
Post the entry into the general ledger. Enter the date, account numbers, dollar amounts and a brief description for the journal
entry.
Double-check the entry after posting to ensure the original entry reversed in the general ledger.
Adjusting Entries
Write a journal entry that debits an expense account for an accrual or a prepaid asset for a deferral. The credit will be a payable
for an accrual and an asset for a deferral.
Post the entry into the general ledger. Enter the date, account numbers, dollar amounts and a brief description for the journal
entry.
Enter a reversing entry into the ledger once the company realizes the accrual or deferral. Reverse the accounts to debit and
credit following the instructions from Section 1 of this article.
1. Errors of Omission
2. Errors of Commission
3. Compensating Errors
4. Errors of Principl
Ans –doing or not doing any action before publishing financial statement
Window dressing is actions taken to improve the appearance of a company's financial statements.
Window dressing is particularly common when a business has a large number of shareholders, so that
management can give the appearance of a well-run company to investors who probably do not have
much day-to-day contact with the business. It may also be used when a company wants to impress a
lender in order to qualify for a loan. If a business is closely held, the owners are usually better
informed about company results, so there is no reason for anyone to apply window dressing to the
financial statements.
Examples of window dressing are: Md. Abul Khairat(Tushar),
Cash. Postpone paying suppliers, so that the period-end cash balance appears higher than it should
be.
Accounts receivable. Record an unusually low bad debt expense, so that the accounts receivable
(and therefore the current ratio) figure looks better than is really the case.
Fixed assets. Sell off those fixed assets with large amounts of accumulated depreciation
associated with them, so the net book value of the remaining assets appears to indicate a relatively
new cluster of assets.
Revenue. Offer customers an early shipment discount, thereby accelerating revenues from a future
period into the current period.
Depreciation. Switch from accelerated to straight-line depreciation in order to reduce the amount
of depreciation charged to expense in the current period. The mid-month convention can also be used
to further delay expense recognition.
Expenses. Withhold supplier expenses, so that they are recorded in a later period.
These actions are taken shortly before the end of an accounting period.
The window dressing concept is also used by fund managers, who replace poorly-performing
securities with higher-performing ones just before the end of a reporting period, to give the
appearance of having a robust set of investments.
The entire concept of window dressing is clearly unethical, since it is misleading. Also, it merely
robs results from a future period in order to make the current period look better, so it is extremely
short-term in nature
Ans- Comprehensive income is the sum of net income and other items that must
bypass the income statement because they have not been realized, including
items like an unrealized holding gain or loss from available for sale securities
and foreign currency translation gains or losses.
x) GAAP(P-33)
regards to capital risk, market risk and operational risk. The purpose of the
ANS-Off-balance sheet (OBS) item means an asset or debt or financing activity not on the company's balance sheet. Items
that are considered off balance sheet are generally ones in which the company does not have legal claim or responsibility for.
Off balance sheet items are of particular interest to investors trying to determine the financial health of a company. These
items are harder to track, and can become hidden liabilities. For example, a company that is being sued for damages would not
include the potential legal liability on its balance sheet until a legal judgment against it is likely and the amount of the judgment
can be estimated; if the amount at risk is small, it may not appear on the company's accounts until a judgment is rendered.
•
Ans- According to this convention, in the books of accounts all anticipated losses
should be recorded and all anticipated gains should be ignored.
Ans- Opportunity cost refers to a benefit that a person could have received, but
gave up, to take another course of action. Stated differently, an opportunity
cost represents an alternative given up when a decision is made. This cost is,
therefore, most relevant for two mutually exclusive events. In investing, it is the
difference in return between a chosen investment and one that is necessarily
passed up.
Ans-
A tangible asset is an asset that has a physical form. Tangible assets include
both fixed assets, such as machinery, buildings and land, and current assets,
such as inventory. ...
Ans-
cash and other assets that are expected to be converted to cash within a year.
Ans-
Ans- Operating activities are the functions of a business related to the provision
of its offerings. These are the company's core business activities, such as
manufacturing, distributing, marketing and selling a product or service.
Ans- The two simplest ways to analyze your financial statements are vertically and
horizontally. A vertical analysis shows you the relationships among components of
one financial statement, measured as percentages. On your balance sheet, each asset
is shown as a percentage of total assets; each liability or equity item is shown as a
percentage of total liabilities and equity. On your statement of profit and loss, each line
item is shown as a percentage of net sales.
A horizontal analysis provides you with a way to compare your numbers from one
period to the next, using financial statements from at least two distinct periods. Each
line item has an entry in a current period column and a prior period column. Those two
entries are compared to show both the dollar difference and percentage change
between the two periods.
Some companies use a sort of combination vertical and horizontal analysis in one.
These reports contain financial data from more than one period, with a vertical
analysis applied to each one. This way you can tell at a glance how statement
components have changed in their proportions from one period to the next, without
any extra math.
Ans- An adjusted trial balance is a listing of all company accounts that will
appear on the financial statements after year-end adjusting journal entries
have been made.
Preparing an adjusted trial balance is the fifth step in the accounting cycle and
is the last step before financial statements can be produced.
Ans-
FIFO and LIFO accounting are methods used in managing inventory and
financial matters involving the amount of money a company has tied up within
inventory of produced goods, raw materials, parts, components, or feed stocks.
Ans- The periodic system relies upon an occasional physical count of the
inventory to determine the ending inventory balance and the cost of goods sold,
while the perpetual system keeps continual track of inventory balances
Ans- An irrelevant cost is a cost that will not change as the result of a
management decision. However, the same cost may be relevant to a different
management decision. Consequently, it is important to formally define and
document those costs that should be excluded from consideration when
reaching a decision.
Ans- A graphic that shows the relationship between a company's earnings (or
losses) and its sales. The chart tells how different levels of sales affect a
company's profits. Companies can use profit-volume charts to establish sales
goals, to analyze whether a potential project is likely to be profitable and to see
the maximum potential profit or loss of a given project, as well as where the
breakeven point lies.
Ans-
Permanent accounts, which are also called real accounts, are company accounts whose
balances are carried over from one accounting period to another. Permanent accounts are the
accounts that are seen on the company's balance sheet and represent the actual worth of the
company at a specific point in time.
The permanent accounts are classified as asset, liability, and owner's equity accounts, with the
exception of the owner's drawing account.
Contra account is an account that appears as a subtraction from another account on balance
sheet of a company. For example, provision for bad debts is a contra account of accounts
receivable. Accounts receivable is the main account with a debit normal balance and provision
for doubtful debts is an account with credit normal balance which offsets the main account.
Msath- 1. Journal
3.Iinventory (solution-c-5,26)
4. Ratio Analysis (Note-88)(p-71)
BEP
Depreciation is a method of allocating the cost of a tangible asset over its useful life. Businesses
depreciate
long-term assets for both tax and accounting purposes & A decrease in an asset's value caused by
period, which is usually over the asset's estimated useful life. A good way to think of this is to consider
amortization to be the cost as the asset is consumed or used up while generating sales or profits for a
company. Intangible assets can include a patent, trademark or trade name, or a copyright.
Depletion is a periodic charge to expense for the use of natural resources. Thus, it is used in situations
where a company has recorded an asset for such items as oil reserves, coal deposits, or gravel pits.
Window dressing?
Window Dressing: Window dressing refers to actions taken or not taken prior to issuing financial
statements in order to improve the appearance of the financial statements.
Here is an example of window dressing. A company operates throughout the year with a negative
balance in its general ledger Cash account. (Its balance at the bank is positive due to the time it takes for
its checks to clear its bank account.) Since the financial statements report the Cash amount appearing in
its general ledger account, the financial statements would report a negative amount of Cash. However,
the company does not want its December 31 balance sheet to report a negative cash balance, since it
will be reviewed by many outsiders. To avoid reporting negative cash balance the company does not
make the payments for amounts that should be paid between December 26 and December 31. This
postponement of payments allows its book amount of Cash to temporarily be a positive amount. Then
on January 2, the company issues checks for all of the amounts that normally would have been paid at
the end of Decembe
Q.1 Define Accounting. What is GAAP (Generally accepted Accounting Principles)? Explain briefly
the Accounting Principles.p-19
Ans Accounting may be defined as the process of recording, classifying, summarizing and interpreting
the financial transactions and communicating the results there of to the persons interested in such
information. GAAP (Generally Accepted Accounting Principles): It is a Technical concept that
describes the basic
rules, concepts, conventions and procedures that represent accepted accounting practices at a particular
time. Accounting principles can be divided into two parts:
1.Principle
The term concept includes thosebasic assumptions, conditions and ideas upon which the science of
accounting is based. Conventions used to signify the customs or traditions as a guide to the preparation of
accounting statements.
Accounting Concepts :
(1) Entity Concept: According to this concept business is treated as a separate unit and distinct from its
proprietors.
(2) Dual Aspect Concept: According to this concept every transaction has two sides at least. If one
account is debited, any other account must be credited. Every business transaction involves duality of
effects. (i) Yielding of that benefit (ii) The giving of that benefit.
(3) Going Concern Concept: This concept assumes that the business will continue to exist for a long
period in the future. There is neither the necessity nor the intention to liquidate it.
(4) Accounting Period Concept: According to this concept the entire life of the concern is divided in
time intervals for the measurement of profit at frequent intervals.
(5) Money Measurement Concept: Only those transactions and events are recorded in accounting which
is capable of being expressed in terms of money.
(a) An asset is ordinarily entered in the accounting records at the price paid to acquire it.
(b) This cost is the basis for all the subsequent accounting for the asset.
(7) Matching Concept: In determining the net profit from business operations all cost which is applicable
to revenue of the period should be charged against that revenue.
(8) Accrual Concept: This concept helps in relating the expenses to revenue for a given accounting
period.
(9) Realization Concept: According to this concept, revenue is recognized when sale is made and sale is
considered to be made when a goods passes to the buyer and he becomes legally liable to pay for it.
(10) Verifiable objectivity Concept: This concept means that all accounting transactions that are
recorded in the books of accounts should be evidenced and supported by business documents.
(2) Convention of Materiality: The accountant should attach importance to material details and ignore
insignificant details.
(3) Convention of Consistency: This convention describes that accounting principles and methods
should remain consistent in order to enable the management to compare the results of the two periods.
These principles should not be changed year after year.
(4) Convention of Conservatism: According to this convention, in the books of accounts all anticipated
losses should be recorded and all anticipated gains should be ignored.
However, if the amount of default is, say, $2 million, the information becomes relevant to the users as it
may affect their view regarding the financial performance and position of the company.
(i) Provides Complete and Systematic Record: In business there are so many transactions therefore it is
not possible to remember all transactions. Accounting keeps a systematic record of all the business
transactions and summarized into financial statements.
(ii) Information Regarding Financial Position: Accounting provides information about the financial
position of the business by preparing a balance sheet at the end of each accounting period.
(iii) Helpful in Assessment of Tax Liability: Accounting helps in maintaining proper records. With the help
of these records a firm can assessed income tax of sales tax. Such records are trusted by income tax and
sales tax authorities.
(iv) Information Regarding Profit or Loss: Profit & Loss Account is prepared at the end of each accounting
period to know the net profit earned or net loss suffered at the end of each accounting period.
(i) Possibilities of Manipulation: Accounts can be manipulated, so that the financial statements may
disclose a more favourable position then the actual position for example closing stock may be
overvalued in accounts.
(ii) It includes only Economic Activities: Non-monetary transactions are not recorded in accounts.
Transactions which can not be expressed in money cannot find place in accounts. Qualitative aspects of
business units like management abour relations, efficiency of management etc. are wholly omitted from
the books of accounts.
(iii) Price Level Changes not Considered: Fixed assets are recorded in accounts at their original cost.
Sometimes assets remain undervalued particularly land and building. Effect of price level changes is not
considered at the time of preparing accounts.
(iv) Influenced by Personal Judgments: An accountant has to use his personal judgment in respect of
many items. For example, it is very difficult to predict the useful life of an asset.
Q.1 Define Accounting Standards and discuss important features of AS-I, AS-9, AS-14, AS-20.
Ans.: Accounting Standard: Accounting standards are the policy documents issued by the recognized
expert accountancy body relating to various aspects of measurements, treatment and disclosure of
accounting transactions and events.
AS-I : Disclosure of Accounting Policies : The standard issued by Accounting standard Board (ASB)
deals with the disclosure of significant accounting policies followed in preparing and presenting financial
statements. Such disclosure would facilitate a meaningful comparison between financial statements of
different enterprise. Following points are considered in this disclosure:
Going concern, consistency and accrual have been generally accepted as fundamental accounting
assumptions.
The accounting policies refer to the specific accounting principles and the methods of applying those
principles adopted by the enterprise in the preparation and presentation of financial statements.
The basis for the selection of accounting policies is that they should represent a true and fair view of the
state of affairs of the enterprise.
Prudence, Substance over form and Materiality are the major consideration governing the selection of
accounting policies.
Any change in an accounting policy which has a material effect should be disclosed and the significant
accounting policies should normally be disclosed in one place.
AS-9: Revenue Recognition: Revenue recognition is mainly concerned with the timing of recognition of
revenue in the statement of profit and loss of an enterprise. The amount of revenue arising on a
transaction is usually determined by agreement between the parties involved in the transaction. The
statement is Fore more detail:- concerned with the bases for recognition of revenue in the statement of
profit and loss account of an enterprise.
The statement is concerned with the recognition of revenue arising in the course of the ordinary activities
of the enterprise from:-
The use by others of enterprise resources yielding interest, royalty and divided.
Sale of Goods : A key criterion for determine when to recognize revenue from a transaction involving the
sale of goods is that the seller has transferred the property in the goods to the buyer for a consideration.
The transfer of property in goods, in most cases, results in or coincides with the transfer of significant risk
and rewards of ownership to the buyer.
Rendering of Services: Revenue from service transaction is usually recognized as the services is
performed, either by the proportionate completion method or by the completed service method
(i) Proportionate completion method: - Performance consists of the execution of more than one act.
Revenue is recognized under this method would be determined on the basis of contract value, associated
costs, number of acts or other suitable basis.
(ii) Completed service method: - Performance consists of the execution of a single act. Revenue is
recognized when the sale of final act takes place. The use by others of Enterprise Resources Yielding
interest, Royalties and Dividends.
(i) Interest accrues (for the use of cash resources) is recognized on the time basis determined by the
amount outstanding.
(ii) Royalties accrue (for the use of know how, patents, trade marks) in accordance with the terms of
relevant agreement.
(iii) Dividends –rewards (from the holding of investment in shares) is recognized when a right to receive
payment is established.
Recognition of revenue requires that revenue is measurable and that at the time of sale of goods, or the
rendering of services it would not be unreasonable to expect ultimate collection. AS-14 : Accounting for
Amalgamations (Come into effect from 1-4-1995): This Statement deals with accounting for
amalgamations and the treatment of any resultant goodwill or reserves. This statement is directed
principally to Fore more companies although some of its requirements also apply to financial statement
of other enterprise. The following terms are used in this statement with the meaning specified :-
(i) Amalgamation means an amalgamation present to the provision of the companies act 1956 or any
other statute which may be applicable to companies.
(ii) Transferor Company means the company which is amalgamated into another company.
(iii) Transferee Company into which a transferor company is amalgamated. An Amalgamation may be
either:
(i) All assets and liabilities will be the assets and liabilities of Transferee Company.
(ii) Share holders holding not less than 90% of the face value of the equity shares of the transferor
company will be the shareholder of Transferee Company.
(iii) Payment will be made in equity shares to the equity share holders except cash may be paid in respect
of any fractional shares.
(iv) Business of the transferor company will be continued by the Transferee Company.
(v) Book values will be same in the books of Transferee Company. When any one or more above
conditions are not satisfied, an amalgamation should be considered to be an amalgamation in the nature of
purchase. For an amalgamation in the nature of merger, pooling of interest method is applied and for an
amalgamation in the nature of purchase – purchase method is applied.
AS-20: Earning Per Share (Come into effect from 1-4-2001) : It is mandatory in nature, from that date,
in respect of enterprise whose equity shares are listed on a recognized stock exchange in India. The
objective of this statement is to prescribe principles for the determination and presentation of earning per
share which will improve comparison of performance among different enterprises for the same period and
among different accounting periods for the same enterprise. An enterprise should present basic and
diluted earnings per share on the face of the statement of profit and loss for each class of equity shares
that has a different right to share in the net profit for the period.
(A) Basic Earning per Share: Basic earnings per share should be calculated by dividing the net profit or
loss (after deducting preference dividend and any attributable tax there to) for the period, attributable to
equity share holder by the weighted average number of equity shares outstanding during the period.
(B) Fair Value per Share: Fair value per share is calculated by adding the aggregate fair value of the
shares immediately prior to the exercise of the rights to the proceeds from the exercise of the rights, and
dividing by the number of shares outstanding after the exercise of the rights.
(C) Diluted Earning per Share: For the purpose of calculating diluted earning per share, the net profit or
loss for the period attributable to equity share holders and the weighted average number of shares
outstanding during the period should be adjusted for the effects of all dilutive potential equity shares.
Short notes
Ratio analysis formulas (pic-72 to 76, 79, 80-81) p-(3-6)
Bep (pic-83)