9. FINANCIAL STATEMENTS – Financial Accounting

9 CHAPTER

Financial Statements

MEANING OF FINANCIAL STATEMENTS

Basically, Financial Statements are organised summaries of detailed information about the financial position and performance of an enterprise. Traditionally, the term ‘Financial Statements’ is used to denote only two basic statements which are as under:

  1. Balance Sheet (or Position Statement) which shows the financial position of an enterprise at a particular point of time.
  2. Trading and Profit and Loss Account (or Income Statement) which shows the financial performance of business operations during an accounting period.

Now a days, in addition to the aforesaid two basic financial statements, a Statement of Retained Earnings and a Cash Flow Statement and Value Added Statement are also prepared in practice.

USEFULNESS OF FINANCIAL STATEMENTS

The information contained in these statements is used by the management, present and potential investors, lenders, short-term creditors, employees, customers, governments and their agencies to satisfy some of their different needs for information. Users can get better insight about the financial strengths and weaknesses of the firm if they properly analyses the information from their own points of view. The usefulness of the financial statements for some of the users is explained below:

Users Need for information
  • 1. Short-term creditors [For example, suppliers of raw materials/goods, suppliers of short-term loans]
Short-term creditors need information to determine whether the amount owing to them will be paid when due and whether they should extend, maintain or restrict the flow of credit to an individual enterprise.
  • 2. Long-term creditors [For example, suppliers of long-term loans]
Long-term creditors need information to determine whether their principals and the interest thereof will be paid when due and whether they should extend, maintain or restrict the flow of credit to an enterprise.
  • 3. Present investors [For example, equity shareholders]
Present investors need information to judge prospects for their investment and to determine whether they should buy, hold or sell the shares.
  • 4. Potential Investors [For example, those who want to invest]
Potential investors need information to judge prospects for their investment and to determine whether they should buy, the shares.
  • 5. Management
Management need information to review the firm’s (a) short-term solvency, (b) long-term solvency, (c) activity (viz., effective utilisation of its resources), (d) profitability in relation to turnover, (e) profitability in relation to investments and to decide upon the course of action to be taken in future.
  • 6. Employees
Employees and their representative groups are interested in information about the stability and profitability of the employers. They are also interested in information which enables them to assess the ability of the enterprise to pay remuneration, retirement benefits and to provide employement opportunities.
  • 7. Tax Authorities
Tax authorities need information to assess the tax liabilities of an enterprise.
  • 8. Customers
Customers have an interest in information about the continuation of an enterprise, especially when they have established a long-term involvement with, or are dependent on, the enterprise.
  • 9. Government and their agencies
Government and their agencies are interested in the allocation of resources and, therefore, the activities of enterprise. They also require information in order to regulate the activities of enterprise, determine taxation policies and as the basis the national income and similar statistics.
  • 10. Public
Enterprises affect members of the public in a variety of ways. For example, enterprises may make a substantial contribution to the local economy in many ways including the number of people, they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about trends and recent developments in the prosperity of the enterprise and the range of its activities.

While all the information needs of these users cannot be made by financial statements, there are some needs which are common to all users. The information contents of the financial statements which meet information needs of the investors or providers of risk capital will also meet most of the needs of other users.

ELEMENTS OF FINANCIAL STATEMENTS

The elements directly related to the measurement of financial position are assets, liabilities and equity. The elements directly related to the measurement of profit are income and expenses.

Let us discuss these elements of Financial Statements as follows:

Asset

An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. An enterprise usually employs its assets to produce goods or services capable of satisfying the wants or needs of customers. Since these goods or services can satisfy wants or needs, the customers are prepared to pay for them and hence contribute to the cash flow of the enterprise. Cash itself renders several services to the enterprise because of its command over other resources. The future economic benefits embodied in an asset may flow to the enterprise in a number of ways: (a) an asset may be used singly or in combination with other assets in the production of goods or services to be sold by the enterprise; (b) exchanged for other assets; (c) used to settle a liability; or (d) distribute to the owners of the enterprise.

Many assets have a physical form. For example, land and building, plant, equipment etc. are of physical form. However, physical form is not necessary for the existence of an asset. Patents, copyright, etc. are assets from which future economic benefits are expected to flow to the enterprise and so these are assets to the enterprise although, they do not have any physical form, if controlled by the enterprise.

Many assets for example, receivables and property are associated with legal rights, including ownership. In determining the existence of an asset, the right of ownership is not essential. For example, if a property is held on lease, it is an asset to the enterprise if it controls the benefits which are expected to flow from the property. Thus always legal right of ownership is not a characteristic feature for identifying an asset. What is essential is the controlling right of the benefit emerging from such asset.

The assets of an enterprise result from past transactions or other past events. For example, plant and machinery acquired is a past transaction from which an asset occurred. But the transactions or event expected to occur in future do not give rise to assets. For example, an intention to purchase a machinery does not meet the definition of an asset. There is a close relationship between incurring expenditure and generating assets, which may not necessarily coincide. For acquiring a piece of plant the enterprise needs to incur expenditure. So when expenditure is incurred, this gives an evidence of the existence of an asset. But when the asset is donated to the enterprise, although no expenditure is incurred, an assets is created.

Liability

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. An essential characteristic of a liability is that the enterprise has a present obligation. An obligation is a duty or responsibility to act or perform in a certain way. An obligation may be legally enforceable as a consequence of a binding contract or statutory requirement. Obligations also arise, however, from normal business practice, custom and a desire to maintain good business relations or to act in an equitable manner.

A distinction needs to be drawn between a present obligation and a future commitment. A decision by the management of an enterprise to acquire assets in future does not of itself give rise to a present obligation. An obligation normally arises only when the asset is delivered or the enterprise entries into an irrevocable agreement to acquire the asset.

The settlement of a present obligation usually involves the enterprise giving up resources embodying economic benefit in order to satisfy the claim of the other party. The settlement of a present obligation may be done by: (a) payment of cash, (b) transfer of other assets, (c) provision of services, (d) replacement of that obligation with another obligation, (e) conversion of the obligation to equity. The obligation may also be extinguished when the creditor waives the liability.

Liabilities result from past transactions or other past events. Some liabilities can be measured only by using a substantial degree of estimation. For example, income tax liability of a year may not be exactly known at the time of preparation of financial statements. This will be known only when the assessment will be over at some future date. Some enterprise describe these liabilities as provisions.

Equity

Equity is a residual interest in the assets of the enterprise after deducting its liabilities. In a corporate enterprise equity is suitably sub-classified in the balance sheet. For example, in India equity is classified as Share Capital and Reserve and Surplus. Under each head further details are provided. The creation of reserve is sometime required by statute or other law in order to give the enterprise and its creditors and added measure of protection from future losses. Creation of some reserve may be necessary as per tax law of the country. In India creation of Export Profit Reserve is one such requirement. Normally equity is shown at its paid up value.

Income

Income is increase in economic benefits during the accounting period in the form of inflows or enhancement of assets or decreases of liabilities that result in increase in equity, other than those relating to contribution from equity participants. The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an enterprise and is rendered by a variety of different names, including fees, interest, dividends and rent. Gains represent other items that meet the definition of income and may or may not arise in the course of ordinary activities of an enterprise. Gains include, for example, those arising on disposal of non-current assets. The definition of income also includes unrealised gains. For example, those arising on the revaluation of marketable securities and those resulting from increase in the value of fixed assets. When gains are recognised in the income statement they are usually displayed separately because knowledge of them is useful for making economic decisions. Gains are often reported net of related expenses. Income may also result from settlement of liabilities.

Expenses

Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences in liabilities that result in decreases in equities other than those relating to distribution to equity participants. The definition of expenses encompasses losses as well as those expenses that rise in the course of the ordinary activities of the enterprise. Expenses in the course of the ordinary activities of the enterprise include, for example, cost of sales, wages, manufacturing expenses, depreciation. They usually take the form of an outflow or depletion of an asset such as cash and cash equivalent, inventory, property, plant and equipment.

Losses represent other items that meet the definition of expenses and may or may not arise in the course of the ordinary activities of the enterprise. Loose include, for example, those resulting form disasters such as fire and flood as well as those arising on disposal of non-current assets. The definition of expenses also includes unrealised losses for example, those arising from the effects of increase in the rate of foreign currency. When losses are recognised in the income statement, they are usually displayed separately because such knowledge is useful for the purposes of making economic decisions. Losses are often reported net of related income.

RECOGNITION OF ASSETS, LIABILITIES, INCOME AND EXPENSES

Recognition of an Asset

An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow to the enterprise and the asset has a cost or value that can be measured reliably. An asset is not recognised in the balance sheet when expenditure has been incurred and for which it is considered improbable that economic benefits will flow to the enterprise beyond the current accounting period. Instead such a transaction results in the recognition of an expenditure in the income statement.

Recognition of a Liability

A liability is recognised in the balance sheet with its proposal that an outflow of a resource embodying economic benefits will result in the settlement of a present obligation and the amount on which the settlement will take place can be measured reliably.

Recognition of an Income

Income is recognised in the income statement when there is an increase in the future economic benefits related to an increase in an asset or a decrease of a liability which can be measured reliably. In other words, recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities.

Recognition of Expenses

Expenses are recognised in the income statement when a decrease in future benefits related to a decrease in an asset or an increase of a liability has arisen which can be measured reliably. In other words, recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease of asset.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS

Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement. This involves the selection of the particular basis of measurement. A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. They include the following:

  1. Historical cost Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition and liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.
  2. Current cost Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
  3. Realisable (settlement) value Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the assets in an orderly disposal. Liabilities are carried at their settlements values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
  4. Present value Assets are carried at the present discounted value of the future net cash inflows that the firm is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

The measurement basis most commonly adopted by enterprises in preparing their financial statements in historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value, marketable securities may be carried at market value and pension liabilities are carried at their present value. Furthermore, some enterprises use the current cost basis as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets.

TRADING ACCOUNT

After preparing a tallied trial balance at the end of an accounting period, the next step is to prepare Trading Account.

Meaning of Trading Account

Trading account is one of the financial statements which shows the result of buying and selling of goods and/or services during an accounting period.

Heading of Trading Account

Trading Account is a flow statement and not a static statement. It is prepared for a particulars accounting period and not at a particulars point of time. Hence, it is headed as follows:

Trading Account for the period ended...”

Purpose of Trading Account

Trading account is prepared to know the gross profit or gross loss during the accounting period. The basis for the preparation of this account is the matching of selling prices of goods and services with the Cost of goods sold and services rendered.

Gross Profit means excess of operating revenues over direct operating expenses.

Contents of Trading Account

Items to be shown on the debit side of Trading Account

Trading account is debited with the following items:

  1. Opening Stock refers to the closing stock of unsold goods at the end of previous accounting period which has been brought forward in the current accounting period.
  2. Purchases refer to those goods which have been bought for resale. Purchases include cash as well as credit purchases. The following items are shown by way of deduction from the amount of total purchases:
    1. Purchases Returns or Return Outwards (i.e., goods returned to suppliers).
    2. Goods withdrawn by the proprietor for his personal use.
    3. Goods distributed by way of free samples.
    4. Goods given as charity.
  3. Direct expenses refer to all those expenses which are incurred from the stage of purchase till the stage of making the goods in saleable condition. Such expenses include the following expenses:

    (i) Freight Inwards (ii) Import Duty (iii) Octroi (iv) Carriage Inwards and Cartage Inwards (v) Wages.

Items to be Shown on the Credit Side of Trading Account

Trading Account is credited with the following items:

  1. Sales refer to the sales of those goods which have been bought for resale. Sales include cash as well as credit sales. Sales Returns or Returns Inwards (i.e., goods returned by customers) are shown by way of deduction from the amount of total sales.
  2. Closing Stock refers to the stock of unsold goods at the end of the current accounting period. According to convention of conservatism, stock is valued at cost or net realisable value (NRV) whichever is lower. The rationale behind this practice is to provide for anticipated losses. Closing Stock is accounted for as under:

Preparation of Trading Account

The preparation of a Trading Account requires the passing of entries to transfer the balances of accounts of all the concerned items to the Trading Account. The entries required for such transfer are called ‘Closing Entries’, since such entries will close the accounts of all the concerned items. The following closing entries are passed to give affect to such transfer of balance:

Closure of Trading Account

The Trading Account is closed by transferring its balance to the balance to the Profit and Loss Account by passing the following entry:

Format of a Trading Account

A general format of a Trading Account is shown below:

*Either Gross Profit or Gross Loss shall appear.

Illustration 1 From the following information, prepare the Trading Account for the year ending on 31st March 20X2:

Opening Stock Rs 1,50,000, Cash Sales Rs 60,000, Credit Sales Rs 12,00,000, Returns Outwards Rs 10,000, Wages and Salaries Rs 4,000, Carriage Inward Rs 2,000, Freight Inward Rs 3,000, Cartage Inwards Rs 1,000, Cash Purchases Rs 50,000, Credit Purchases Rs 10,00,000, Returns Inward Rs 20,000, Closing Stock as on 31.3.20X2 Rs 84,000.

Solution

Illustration 2 From the following information, prepare the Trading Account for the year ending on 31st March 20X2.

Adjusted Purchases Rs 11,06,000, Sales Rs 12,40,000, Closing Stock Rs 84,000, Freight and Cartage Inwards Rs 6,000, Wages Rs 4,000, Freight and Cartage Outwards Rs 3,000.

Solution

Notes

  1. Adjusted Purchases = Net Purchases + Opening Stock - Closing Stock
  2. Closing Stock has not been shown on the credit of Trading Account since it has already been adjusted while calculating adjusted purchases.
  3. Freight and Cartage Outwards are indirect expenses and hence not debited to Trading Account.

Illustration 3 From the following information, prepare the Trading Account for the year ending on 31st March 20X2.

Cost of Goods Sold Rs 11,16,000, Sales Rs 12,40,000, Closing Stock Rs 84,000.

Solution

Notes

  1. Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses - Closing Stock.
  2. Closing Stock has not been shown on the credit of Trading Account since it has already been adjusted while calculating Cost of Goods sold.
MANUFACTURING ACCOUNT

Manufacturing Account is prepared by an enterprise engaged in manufacturing activities. It is prepared to ascertain the cost of goods manufactured during an accounting period. This account is closed by transferring its balance to the debit of the Trading Account. A general format of a Manufacturing Account is shown below:

Tutorial Note The amount of depreciation and expenses which has been debited to Manufacturing Account, shall not again be debited to Trading or Profit and Loss Account.

DISTINCTION BETWEEN MANUFACTURING ACCOUNT AND TRADING ACCOUNT

A Manufacturing Account can be distinguished from a Trading Account as follows:

Illustration 4 From the following information, prepare a Manufacturing Account for the year ending on 31st March 20X2:

Solution

PROFIT AND LOSS ACCOUNT

After preparing a Trading Account, the next step is to prepare Profit and Loss Account.

Meaning of Profit and Loss Account

The Profit and Loss account is one of the financial statement. It shows the financial performance of business during an accounting period.

Purpose of Profit and Loss Account

The Profit and Loss Account is prepared to ascertain the Net Profit earned or net Loss incurred by the business entity during an accounting period.

Net Profit means the excess of all revenue (whether operating or non-operating) over expenses and losses (whether operating or non-operating).

Operating Profit means the excess of operating revenues over operating expenses and losses. It arises as a result of carrying out operating activities. Operating activities are the principal revenue producing activities of the enterprise and other activities that are not investing or financial activities. For example, Sales and Purchased of buildings by Builders and property dealers are operating activities. Granting loans to third parties by them are investing activities. Taking loans from third parties by them are financial activities.

Heading of Profit and Loss Account

Profit and Loss is a flow statement and not a static statement. It is prepared for a particular accounting period and not for a particular point of time. Hence it is headed as follows:

Profit and Loss Account for the period ended....

Contents of Profit and Loss Account

All the indirect revenue expenses and losses (i.e., other than those shown on the debit side of the Trading Account) are shown on the debit side of the Profit and Loss Account, whereas all indirect revenue incomes (i.e., other than those shown on the credit side of the Trading Account) are shown on the credit side of the Profit and Loss Account.

Preparation of Profit and Loss Account

The preparation of the Profit and Loss Account requires (a) to bring down the gross profit/gross loss and (b) to pass the necessary entries to transfer the balances of accounts of all the concerned items to the Profit and Loss Account. The entries required for such transfer are called closing entries since such entries will close the accounts of all the concerned items. The following closing entries are passed to give effect to such transfer of balances:

Closure of a Profit and Loss Account

The Profit and Loss Account is closed by transferring its balance to the Capital Account of the proprietor (in case of a proprietorship concern) or of the partners (in case of a partnership firm) by passing the following entry:

Format of a Profit and Loss Account

A general format of a Profit and Loss Account is shown below:

*Either Net Profit or Net shall appear.

Illustration 5 From the following information, prepare the Profit and Loss Account of a Trader for the year ending on 31st March 20X2:

Solution

Illustration 6 From the following information, prepare the Profit and Loss Account for the year ending on 31 March 20X2:

Solution

BALANCE SHEET [OR POSITION STATEMENT]

After preparing the Profit and Loss Account, the next step is to prepare a Balance Sheet.

Meaning of Balance Sheet

A Balance Sheet is one of the financial statements. A Balance Sheet is a statement of assets and liabilities of an enterprise at a given date. It is called a Balance Sheet because it is a sheet of balances of those ledger accounts which have not been closed till the preparation of the Trading and Profit and Loss Account.

Characteristics of a Balance Sheet

The characteristics of a Balance Sheet are summarized as under:

  1. A Balance Sheet is only a statement and not an account. It has no debit side or credit side. The headings of the two sides are ‘Assets’ and ‘Liabilities’.
  2. A Balance Sheet is prepared at a particular point of time and not for a particular period. The information contained in a Balance Sheet is true only at the particular point of time at which it is prepared.
  3. A Balance Sheet is a summary of balances of those ledger accounts which have not been closed by transfer to the Trading and Profit and Loss Account.
  4. A Balance Sheet shows the nature and value of assets and the nature and the amount of liabilities at a given date.

Need for the Preparation of Balance Sheet

The purposes of preparing a Balance Sheet are as follows:

  1. To ascertain the nature and value of assets of a business.
  2. To ascertain the nature and amount of liabilities of a business.
  3. To find out the financial solvency of an enterprise. An enterprise is considered to be a solvent if its assets exceed its external liabilities.

Heading of Balance Sheet

Balance Sheet is a static statement and not a flow statement. Balance Sheet is prepared at a particular point of time and not for a particular period. Hence it is headed as follows:

“Balance Sheet as at...”

Contents of Balance Sheet

In India the right hand side of a Balance Sheet is called the ‘Assets’ side and the left hand side is called the ‘Liabilities’ side. In some of the other countries (for example Australia). The right hand side of a Balance Sheet is called the ‘Liabilities’ side and the left hand side is called the ‘Assets’ side. The various items which are shown on the assets side and liabilities side are as given on next page.

 

Items to be shown on the Assets side of a Balance Sheet The debit balances of those ledger accounts which have not been closed till the preparation of the Trading and Profit and Loss Account, are shown on the ‘Assets’ side of the Balance Sheet.

 

Assets refer to tangible objects or intangible rights owned by an enterprise and carrying probable future benefits. Usually the following items are included in the Assets:

  1. Fixed Assets Fixed assets refer to those assets which are held for the purposes of providing or producing goods or services and those which are not held for resale in the normal course of business. Fixed Assets may be classified as under:
    1. Tangible Fixed Assets refer to those fixed assets which can be seen and touched e.g., Land and Building, Plant and Machinery, Furniture and Fixture, Motor Vehicles.
    2. Intangible Fixed Assets refer to those fixed assets which can neither seen nor been touched e.g., Goodwill, Patents, Trade Marks.

Note Fixed assets are usually valued at cost less depreciation.

DISTINCTION BETWEEN TANGIBLE ASSETS AND INTANGIBLE ASSETS

Tangible Assets differ from Intangible Assets in the following respects:

  1. Investments Investments represent an expenditure on assets to earn interest, dividend, income, rent or other benefit e.g., Shares, Debentures, Bonds, Investment properties.
  2. Current Assets Current assets are those assets which are held:
    1. in the form of cash e.g., cash in hand and cash at bank,
    2. for their conversion into cash e.g., stock of finished goods, debtors, Bills Receivable, Accrued Income.
    3. for their consumption in the production of goods or rendering of services in the normal course of business e.g., Stock of raw materials, WIP.

Note Current Assets are usually valued at cost or market price whichever is less on the basis of Prudence (or Conservatism) Principle.

DISTINCTION BETWEEN FIXED ASSETS AND CURRENT ASSETS

Fixed Assets differ from Current Assets in the following respects:

Items to be shown on the Liabilities side of a Balance Sheet The credit balances of those ledgers accounts which have not been closed till the preparation of the Trading and Profit and Loss Account are shown on the ‘Liabilities’ side of the Balance Sheet.

  1. Liabilities Liabilities refer to the financial obligations of an enterprise other than owner’s funds. Usually the following items are included in liabilities.
    1. Long-term Liability Long-term Liability refers to that liability which does not fall due for payment in a relatively short period (i.e., normally not more than 12 months from the date of Balance Sheet) e.g., loan from a financial institution, Debentures.
    2. Current Liability Current Liability refers to that liability which falls due for payment in a relatively short period, (i.e., normally a period not more than 12 months from the date of Balance Sheet) e.g., Bills Payables, Trade Creditors, Outstanding Expenses, Bank Overdraft, Instalments of Loan and Deposits payable within 12 months from the date of Balance Sheet.
  2. Capital Capital is the excess of assets over external liabilities. It refers to the amount invested in an enterprise by the proprietor (in case of a proprietorship concern) or partners (in case of a partnership concern), which is increased by the amount of profit earned and is decreased by the losses incurred and the amount withdrawn (whether in the form of cash or kind).

Note Drawings Account (which records the amount withdrawn by the proprietor whether in the form of cash or kind) is closed by transferring its balance to the debit side of the Capital Account. Usually, it is shown by way of deduction from the amount of capital in the Balance Sheet.

Contingent Asset and Contingent Liability

Contingent Asset Contingent asset has been defined by Kohler as “An asset, the existence, value and ownership of which depend upon the occurrence or non-occurrence of a specific event or upon the performance or non-performance of a specified act; contrasts with contingent liability, often growing out of such a liability. Suppose the firm has filed a suit for some property now in the possession of someone else. If the suit is decided in the firm’s favour, the firm will get the property; at the moment it is a contingent asset. Similar would be the position for a patent applied for arising out of the firm’s own research effort. Contingent liability in respect of contract for capital expenditure already entered into will give rise to an asset on payment; at present it is only a contingent asset.

Contingent Liability A contingent liability is one which is not an actual liability but which will become one on the happening of some event which is uncertain. Really, contingent liabilities have two characteristics: (i) uncertainty as to whether the amount will be payable at all; (ii) uncertainty about the amount involved. It is sufficient for the amount of contingent liability to be stated on the face of the balance sheet by way of a note, unless there is a probability that a loss will materialize and its reasonable estimate can be made. In that event, it is no more a continent liability and a specific provision should be made therefor.

The examples of contingent liabilities not provided for include the following:

  1. Arrears of dividends on cumulative preference shares;
  2. Bills of exchange discounted;
  3. Guarantees given by the company to companies under the same management; and
  4. Suit for damages against the company which it is defending.

An example of contingent liability usually provided for is the one in respect of gratuities payable to staff on retirement of death.

An example, not involving loss, is the amount due on partly paid shares or the amount payable on a contract for construction of works. On payment, a corresponding assets will come into existence.

GROUPING AND MARSHALLING OF ASSETS AND LIABILITIES

The term ‘Grouping’ means putting together items of a similar nature under a common heading. For example, under the heading ‘Trade Creditors’ the balances of the ledger accounts of all the suppliers from whom goods have been purchased on credit, will be shown.

The term ‘Marshalling’ refers to the order in which the various assets and liabilities are shown in the Balance Sheet. The assets and liabilities can be shown either in the order of liquidity or in the order of permanency.

Order of Liquidity

  1. The assets are arranged in the order of their liquidity, i.e., the most liquid asset (e.g., cash-in-hand), is shown first. The least liquid asset (e.g., goodwill) is shown last. The least liquid asset does not mean an asset which cannot be encashed.
  2. The liabilities are arranged in the order of their urgency of payment, i.e., the most urgent payment to be made (e.g., ‘short-term creditors’), is shown first. The least urgent payment to be made (e.g., ‘long-term creditors’) is shown last.
  3. Usually, the banking and financial companies, sole proprietorship and the partnership concerns prepare their balance sheet in the order of liquidity.

A general format of a Balance Sheet in order of liquidity is shown below:

 

Balance Sheet of...... as at......

Order of Permanence This order is exactly reverse of the liquidity order.

  1. The assets are arranged in the order of their permanence i.e., the least liquid asset (e.g., goodwill) is shown first and the most liquid asset (e.g., Cash-in-hand) is shown last.
  2. The least urgent payment to be made (e.g., owners) is shown first and the most urgent payment to be made (e.g., short-term creditors) is shown last.
  3. The company as defined under the Companies Act 1956 is required to prepare the balance sheet in order of permanence.

A general format of a Balance Sheet in the order of permanence is shown below:

 

Balance Sheet of......as at......

Illustration 7 From the following information, prepare a Balance Sheet of Mr X as at 31st March 20X2 (a) In order of liquidity, and (b) In order of permanence.

Solution

  1. In order of liquidity

    Balance Sheet of Mr X as at 31st March 20X2

  2. In order of permanence

    Balance Sheet of Mr X as at 31st March 20X2

DISTINCTION BETWEEN TRADING AND PROFIT AND LOSS ACCOUNT AND BALANCE SHEET

The Trading and Profit and Loss Account can be distinguished from the Balance Sheet as follows:

DISTINCTION BETWEEN A TRIAL BALANCE AND A BALANCE SHEET

A Trial Balance can be distinguished from a Balance Sheet as follows:

METHODS OF PRESENTING THE FINAL ACCOUNTS

The Trading and Profit and Loss Account and the Balance Sheet can be presented either in Horizontal Form or in Vertical Form.

  1. Horizontal Form Under this form of presentation, the items are presented in ‘T’ shape. The horizontal forms of presenting the Trading Account, Profit and Loss Account and Balance Sheet are shown on pages 9.8, 9.13 and 9.19 respectively.
  2. Vertical Form Under this form of presentation, the items are presented in a single column statement in a purposeful sequence. The vertical forms of presenting the Income Statement and the Balance Sheet are shown below:

Vertical Form of Profit and Loss Account

Vertical Form of Balance Sheet

A Schedule of Proprietor's Funds

TREATMENT OF SOME ITEMS WHICH MAY BE DIRECT ITEMS/INDIRECT ITEMS/INCOMES/EXPENSES

The treatment of some items which may be direct items/indirect items/incomes/expenses is shown below:

Treatment of some items in the absence of any Specific Information

Illustration 8 The following is the Trial Balance of Shri Ram as at 31st March 20X2:

Additional Information Closing Stock as on 31.03.20X2 was Rs 42,000.

Required Pass the necessary closing entries and adjusting entries and prepare the Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as on that date.

Solution The following are the Closing Entries to be passed.

 

Journal of Shri Ram

Balance Sheet of Shri Ram as at 31 March 20X2

Illustration 9 Taking the same information as given in Illustration 8, prepare the Income Statement and Balance Sheet in vertical form:

Solution

Income Statement for the Period Ended 31st March 20X2

Balance Sheet of Shri Ram as at 31 March 20X2

CLASSIFICATION OF CAPITAL AND REVENUE

The Going Concern Assumption allows the accountant to classify the expenditure and receipts as Capital expenditure, Revenue expenditure, Deferred Revenue expenditure, Capital Receipts, Revenue Receipts. The expenditure and receipts may be classified as follows:

Capital Expenditure

Capital Expenditure is that expenditure which is incurred (a) for acquiring or bringing into existence an asset or advantage of an enduring benefit or (b) for extending or improving a fixed asset or (c) for substantial replacement of an existing fixed asset. An asset or advantage of an enduring nature does not mean that it should last forever, it should not at the same time be so transitory and ephemeral that it can be terminated at any time. Basically, the capital expenditure is incurred with a view to bringing in improvements in productivity or earning capacity. The examples of capital expenditure include cost of land and building, plant and machinery, furniture and fixtures, etc. Such expenditure normally yields benefits which extend beyond the current accounting period.

Revenue Expenditure

Revenue Expenditure is that expenditure which is incurred for maintaining productivity or earning capacity of a business. Such expenditure yields benefits in the current accounting period. The examples of revenue expenditure include Office and Administrative expenses such as Salaries, Rent, Insurance, Telephone Exp., Electricity Charges, etc. Selling and Distribution expenses such as Advertising, Travelling expenses, Commission to Salesman, Sales Promotion Expenses etc. Non-operating expenses and losses such as interest on loan taken, loss by theft, etc.

Deferred Revenue Expenditure

Deferred Revenue Expenditure is that expenditure which yields benefits which extend beyond a current accounting period, but to relatively a short period as compared to the period for which a capital expenditure is expected to yield benefits. Such expenditure should normally be written-off over a period of 3 to 5 years. The examples of such, expenditure include heavy Advertising Campaign, Research and Development Expenditure.

Capital Receipts Vs Revenue Receipts

There is no specific test to draw a clear cut demarcation between a capital receipt and a revenue receipt. In order to determine whether a receipt is capital or revenue in nature, one has to look into its true nature and substance over the form in the hands of its receipts. For example, sale proceeds of a land in the hands of a dealer in real estate is revenue receipt whereas the same in the hands of a dealer in cars is a capital receipt.

The examples of capital receipts include sale of fixed assets, capital contribution, loaned receipts, and the examples of revenue receipts include sale of stock-in-trade, revenue from services rendered in the normal course of business, revenue from permitting others to use the assets of the enterprise, such as interest, rent, royalty.

Illustration 9 State with reasons whether the following are Capital or Revenue Expenditure.

  1. Expenses on a foreign tour for purchasing a new machinery.
  2. Freight and insurance on the new machinery.
  3. Customs duty paid on import of a machinery.
  4. Cartage paid to bring the new machines to factory.
  5. Wages paid in connection with the erection of new machinery.
  6. Rs 1,000 spent on repairing a second hand machine before put to use.
  7. Rs 2,000 spent to remove a worn out part and replaced it with a new engine.
  8. A petrol driven engine of a passenger bus was replaced by a diesel engine.
  9. Rs 8,00,000 spent on advertising the introduction of a new product in the market, the benefit of which will be effective for 3 to 5 years.
  10. Rs 5,000 spent on repainting the factory.
  11. Heavy amount spent on research for a particular product which ultimately did not result in success.
  12. Repair Rs 2,000 necessitated by negligence of an operator of machine.
  13. Rs 10,000 paid as compensation to employees who were retrenched.
  14. Interest on a term loan for the purchase of machinery. The commercial production has not begun till the last day of the accounting year.
  15. Interest on a term loan for the purchase of machinery. The commercial production has already begun.
  16. Compensation paid for breach of contract to acquire stock-in-trade.
  17. Rs 30,000 spent as lawyer’s fee to defend a suit that firm’s factory belonged to the plaintiff. The suit was not successful.

Solution

  1. Items referred to in (a) to (f) represent capital expenditure since these expenditures are incurred up to the point the machine is ready for use.
  • g. It should be treated as revenue expenditure since it is incurred to keep the asset in working order. Such expenditure has neither resulted in increasing the life or efficiency of an existing asset nor in bringing into existence a new asset and as such cannot be treated as capital expenditure.
  • h. Such expenditure should be treated as capital expenditure since it will increase the profit capacity of the business through lowering of costs.
  • i. Such expenses should be treaded as a deferred revenue expenditure and should be written-off each year over a period of 3 to 5 years.
  • j. Such expenses should be treated as a revenue expenditure since it is incurred to maintain the factory in good condition.
  • k. Such expenses should be treated as a revenue expenditure if the amount is immaterial having to the given circumstances, since the research has not resulted in creation of patent right, etc. However, if the amount is material, such expenditure may be treated as a deferred revenue expenditure and may be written-off over a period of 3 to 5 years.
  • l. Such expenses should be treated as revenue expenditure since it is incurred to keep the asset in working order.
  • m. Such expenses should be treated as revenue expenditure since it is neither bringing the benefit of enduring nature nor enhancing the value of any asset.
  • n. Such expenditure should be treated as capital expenditure since the commercial production has not begun till the last day of the accounting year.
  • o. Such expenditure should be treated as revenue expenditure since the commercial production has already begun.
  • p. Such expenditure should be treated as revenue since it is neither bringing the benefit of enduring nature nor enhancing the value of any asset.
  • q. Such expenditure should be treated as revenue expenditure since it is incurred for the upkeep of fixed asset.
RATIONALE OF MAKING ADJUSTMENTS AT THE TIME OF PREPARING THE FINAL ACCOUNTS

The important considerations in the preparation of Final Accounts with adjustments are as under:

  1. Revenue Recognition Principle which requires that generally the revenue should be recognized in the period in which the sale is deemed to have occurred.
  2. Matching Principle which requires that the expenses should be recognized in the same period as associated revenues. Expenses recognition is tied to revenue recognition. Let the expenses follow the revenue.

    All incomes, expenditures and losses of revenue nature are shown in the Trading and Profit and Loss Account. In order to prepare the Trading and Profit and Loss Account on accrual basis, generally the following guidelines are followed in practice:

  1. Any expenditure which has already been paid but pertains to the succeeding period(s) is excluded.
  2. Any expenditure which pertains to the current accounting period whether paid in cash or not, is included.
  3. Income or receipt which has already been received but pertains to the succeeding period(s) is excluded.
  4. Income or receipt which pertains to the current accounting period whether received in cash or not, is included.

The usual items of adjustments have been discussed below:

ADJUSTMENT OF CLOSING STOCK

Closing Stock refers to the stock of unsold goods at the end of current accounting period which is carried forward in the next accounting period as opening stock. The stock of finished goods is valued at cost or net realisable value whichever is lower. Its accounting treatment is summarized as under:

Note If closing stock already appears in the Trial Balance, then no adjusting entry is required to be passed since it has already been taken into account while computing the amount of ‘Adjusted Purchases’ or ‘Cost of Goods Sold’ Such closing stock still will be shown only in the Balance Sheet and not in the Trading Account.

Illustration 10 Closing Stock as at 31st March 20X2 Rs 100 appears outsides the Trial Balance. Accounts are closed on 31st March. Pass an adjusting entry and show how this will appear in final accounts.

Solution

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF OUTSTANDING EXPENSES

Outstanding Expenses refer to those expenses which have been incurred but not paid during the current accounting period. Its accounting treatment is summarized as follows:

Note If outstanding expenses already appear in the Trial Balance, then no adjusting entry is required to be passed since these expenses have already been taken into account while computing the amount of relevant expenses. Such outstanding expenses will be shown only in the Balance Sheet and not in the Income Statement.

Illustration 11 Salary has been paid for 11 months from April 20X1 to February 20X2 @ Rs 100 p.m. Salary for the month of March has not yet paid. Accounting year is financial year. Pass an adjusting entry and show how this will appear in final accounts.

Solution

Adjusting Entry

Closing Stock Dr. Rs 100
To Outstanding Salary A/c Rs 100

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF PREPAID EXPENSES (OR UNEXPIRED EXPENSES)

Prepaid expenses refer to those expenses which have been paid during the current accounting period but the benefit of which will accrue in the subsequent accounting period or periods.

Its accounting treatment is summarised as follows:

Note If prepaid expenses already appear in the Trial Balance, then no adjusting entry is required to be passed since these expenses have already been excluded while computing the amount of relevant expense. Such prepaid expenses will be shown only in the Balance Sheet and not in the Income Statement.

Illustration 12 On 1.10.20X1, a Fire Insurance Premium of Rs 720 paid on a policy which will expire on 30.9.20X2. Accounts are closed on 31st March. Pass an adjusting entry and show now this will appear in final accounts.

Solution

Adjusting Entry

Prepaid Insurance A/c Dr. Rs 360
To Insurance Premium A/c Rs 360

Balance Sheet as at 31st March 20X2

DISTINCTION BETWEEN OUTSTANDING EXPENSE AND PREPAID EXPENSE

Outstanding expense differs from prepaid expense in the following respects:

DISTINCTION BETWEEN DEFERRED REVENUE EXPENSES AND PREPAID EXPENSES

The Guidance Note on “Terms used in Financial Statement” issued by the Institute of Chartered Accountants of India (ICAI), defines deferred revenue expenditure as that expenditure for which payment has been made or a liability incurred, but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods. “In short, it refers to that expenditure that is, for the time being, deferred from being charged to income. Such suspension of ‘charging off’ operation may be due to the nature of expenses and the benefit expected therefrom. So long as deferred revenue expenditure is not written-off, this is shown on the assets side of the Balance Sheet under the head “Miscellaneous Expenditure”.

Deferred revenue expenditure should be revenue expenditure by nature in the first instance, for example, advertisement. But its matching with revenue may be deferred considering the benefit to be accrued in future.

A thin line of difference exists between deferred revenue expenses and prepaid expenses. The benefits available from prepaid expenses can be precisely estimated but that is not so in case of deferred revenue expenses. Heavy advertising to launch a new product is a deferred expense since the benefit from it will be available over the next three to five years but one cannot say precisely how long. On the other hand, insurance premium paid say, for the year ending 30th June 20X2, when the accounting year ends on 31st March 20X2, will be an example of prepaid expenses to the extent of premium relating to three months period, i.e., from 1st April 20X2 to 30th June 20X2. Thus, the insurance protection will be available precisely for three months after the close of the year and the amount of the premium to be carried forward can be calculated exactly.

Deferred expenses are considered fictitious assets but prepaid expenses are considered as current assets.

ADJUSTMENT OF ACCRUED INCOME

Accrued income refers to that income which has been earned but not received during the current accounting period. Its accounting treatment is summarised as follows:

Note If Accrued Income already appears in the Trial Balance, then no adjusting entry is required to be passed since it has already been taken into account while computing the amount of relevant income. Such accrued income will be shown only in the Balance Sheet and not in the Income Statement.

Illustration 13 On 1.4.20X1 a loan of Rs 10,000 was given to Ram at a rate of interest of 12%, per annum. During the year, interest was received for 11 months from April to February Interest for the month for March has not yet been received: Accounting year is financial year. Pass an adjusting entry and show how this will appear in final accounts.

Solution

Adjusting Entry

Accrued Interest A/c Dr. Rs 100
To Interest A/c Rs 100

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF UNACCRUED INCOME (OR UNEARNED INCOME)

Unaccrued income refers to that income which has been received but not earned during the current accounting period. Its accounting treatment is summarised as follows:

Note If Unaccrued Income already appears in the Trial Balance, then no adjusting entry is required to be passed since it has already been excluded while computing the amount of relevant income. Such unaccrued income will be shown only in the Balance Sheet and not in the Income Statement.

Illustration 14 On 1.2.20X2, a loan of Rs 10,000 was given to Ravi at a rate of interest of 12% per annum and Accounting year is financial year. Interest was received for 3 months from February to April. Pass an adjusting entry and show how this will appear in final accounts.

Solution

Adjusting Entry

Interest A/c Dr. Rs 100
To Interest A/c Rs 100

Balance Sheet as at 31st March 20X2

DISTINCTION BETWEEN ACCRUED INCOME AND UNACCRUED INCOME

Accrued Income differs from Unaccrued Income in the following respects:

Illustration 15 [Adjustment of Outstanding, Prepaid, Accrued and Unaccrued Interest]

Following are the extracts of a Trial Balance as at 31st March 20X2:

Required Show how these items will appear in the final accounts.

Solution

Balance Sheet as at 31st March 20X2

Note In the absence of any information regarding the dates of 9% Loan from Shri Ram and 10% Loan to Shri Fakir Chand, it is reasonable to assume that these loans are outstanding since beginning of the accounting year.

ADJUSTMENT OF DEPRECIATION

Depreciation represents that portion of the cost of a fixed asset which has been used in the business for the purpose of earning profits. Its accounting treatment is summarised as follows:

Note If depreciation already appears in the Trial Balance, then no adjusting entry is required to be passed since it has already been taken into while computing the closing book value of the relevant fixed asset. Such depreciation will be shown only in the Income Statement and not in the Balance Sheet.

Illustration 16 On 1.1.20X2, a machine costing Rs 10,000 and a piece of furniture costing Rs 20,000 were purchased. Write 5% off the furniture and depreciate the machinery @ 10% p.a. Accounting year is financial year. Pass an adjusting entry and show how this will appear in final accounts.

Solution

Adjusting Entry

Depreciation A/c Dr. Rs 1,250
To Furniture A/c Rs 1,000
To Machinery A/c Rs 250

Balance Sheet as at 31st March 20X2

Note Deprecation on furniture has been charged for the full year because a flat rate of 5% (and not 5% p.a.) has been given, whereas depreciation on machinery has been charged for three months from 1st January to 31st March.

Illustration 17 [When Fixed Assets have been acquired during the year]

Following are the extracts of a Trial Balance as at 31st March 20X2:

Required Show how the these items will appear in the final accounts in each of the following alternative cases:

Case (a) A Machine costing Rs 20,000 was purchased on 1st July 20X1. Wages Rs 1,000 for its erection have been debited to Wages Account. Provide depreciation on Plant and Machinery @ 10% p.a.

Case (b) A Machine costing Rs 20,000 was purchased on 1st July 20X1 but it was not recorded in the books as no payment was made for it. Wages Rs 1,000 paid for its erection have been debited to Wages Account. Provide depreciation on Plant and Machinery @ 10% p.a.

Case (c) A Machine costing Rs 20,000 was purchased during the year 20X1-20X2. Wages Rs 1,000 paid for its erection have been debited to Wages Account. Provide depreciation on Plant and Machinery @ 10% p.a.

Case (d) A Machine costing Rs 20,000 was purchased during the year 20X1-20X2. Wages Rs 1,000 paid for its erection have been debited to Wages Account. Write 10% off the Plant and Machinery.

Case (e) A Machine costing Rs 20,000 was purchased on 1st July 20X1. Wages Rs 1,000 paid for its erection have been debited to Wages Account. Write 10% off the Plant and Machinery.

Solution

Case (a)

Balance Sheet as at 31st March 20X2

Case (b)

Balance Sheet as at 31st March 20X2

Case (c)

Balance Sheet as at 31st March 20X2

Note In the absence of actual date of purchase, depreciation has been provided for an average period of 6 months.

Case (d)

Balance Sheet as at 31st March 20X2

Note Depreciation has been charged for full years since the blanket rate of 10% without per annum is given.

Case (e) Some solution as given in case (d) since the depreciation is to be charged for full year irrespective of the date of purchase as the rate of 10% without per annum is given.

Illustration 18 [When Accumulated Depreciation is given]

Following are the extracts of a Trial Balance as at 31st March 20X2

Required Show how these items will appear in the final accounts in each of the following alternative cases:

Case (a) Provide depreciation on Plant and Machinery Rs 8,000.

Case (b) Provide depreciation according to straight line method on plant and machinery @ 10% p.a.

Case (c) Provide depreciation according to written down value method on Plant and Machinery @ 10% p.a.

Case (d) A Machinery Costing Rs 20,000 was purchased on 1st October 20X1, Wages Rs 1,000 paid for its erection have been debited to Wages Account. Provide depreciation according to written down value method on Plant and Machinery @ 10 p.a.

Case (e) A Machinery costing Rs 20,000 was purchased on 1st October 20X1 but it was not recorded in the books as no payment was made for it. Wages Rs 1,000 paid for its erection have been debited to Wages Account. Provide depreciation according to written down value method on Plant and Machinery @ 10% p.a.

Solution

Profit and Loss Account for the Year Ended 31st March 20X2

Balance Sheet as at 31st March 20X2

Case (b) Same solution as in Case (a) since depreciation @ 10% p.a. on Rs 80,000 comes to Rs 8,000.

Case (c)

Balance Sheet as at 31st March 20X2

Case (d)

Balance Sheet as at 31st March 20X2

Case (e)

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF INTEREST ON CAPITAL

Interest on capital means the cost of using the capital invested in an enterprise by the proprietor (in case of a proprietorship concern) or partners (in case of a partnership concern). Its accounting treatment is summarised as follows:

Illustration 19 On 01.04.20X1 the capital invested Rs 10,000. Interest on capital to be allowed @ 12% p.a. Accounting year is financial year. Pass an adjusting entry and show how these items will appear in final accounts.

Solution

Adjusting Entry

Interest on Capital A/C Dr. Rs 1,200
To Capital A/c Rs 1,200

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF INTEREST ON DRAWINGS

Interest on drawings means the cost of using the sum of money or other asset (e.g. goods) withdrawn by the proprietor (in case of proprietorship concern) or partners (in case of a partnership concern). Its accounting treatment is summarised as follows:

Illustration 20 On 1.4.20X1 Capital invested Rs 20,000. During the year total drawings made Rs 10,000. Interest on drawings to be charged @ 12% p.a. Accounting year is financial year. Pass an adjusting entry and show how these items will appear in final accounts.

Solution

Adjusting Entry

Capital A/c Dr. Rs 600
To Interest on Drawings A/c Rs 600

Balance Sheet as at 31st March 20X2

Note In the absence of exact dates of drawings, the interest on drawings has been calculated for an average period of 6 months, assuming that the drawings were made evenly throughout the year.

ADJUSTMENT OF ABNORMAL LOSS OF STOCK

The abnormal loss of stock is an avoidable loss and is usually caused by fire, theft, abnormal spoilage/leakage/breakages/pilferage, etc. Its accounting treatment is summarised as follows:

Illustration 21 A fire broke out on 30th March 20X2 in the godown and stock costing Rs 1,000 was destroyed. The insurance company, admitted a claim of 60% only. Accounting year is financial year. Pass an adjusting entry and show how these items will appear in final accounts.

Solution

Adjusting Entry

Loss of Stock by Fire A/c Dr. Rs 1,000
To Trading A/c Rs 1,000
Insurance Co. Dr. Rs 600
To Loss of Stock by Fire A/c Rs 600

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF BAD DEBT

Bad Debt refers to a debt which became irrecoverable. In other words, it represents the amount due from the customers, which could not be recovered. Its accounting treatment is summarised as follows:

Illustration 22 Mr X, a debtor for Rs 5,000, has become insolvent and nothing could be recovered from him. Debtors (including Mr X) appear at Rs 2,05,000 in the Trial Balance as at 31st March 20X2. Accounting year is financial year. Pass an adjusting entry and show how these items will appear in the final accounts.

Solution

Adjusting Entry

Bad Debts A/c Dr. As 5,000
To Mr X As 5,000

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF PROVISION FOR DOUBTFUL DEBTS

A provision for doubtful debts refers to a provision created to cover the loss of possible bad debts by means of a predetermined percentage of net debtors (i.e., debtors less bad debts) with a view to bnng in a certain element of certainty in the amount of bad debts charged for each accounting period. Its accounting treatment is summarised as given on next page.

Illustration 23 Following are the extracts from the Trial Balance of a firm, as at 31st March 20X2:

Additional Information

  1. After preparing the Trial Balance, it is learnt that Mr X, a debtor has become insolvent and nothing could be recovered from him and, therefore, the entire amount of Rs 5,000 due from him was irrecoverable.
  2. Create 10% provision for doubtful debts.

Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

Solution

Journal

Balance Sheet as at 31st March 20X2

Illustration 24 Following are the extracts from the Trial Balance of a firm as at 1 March 20X2:

Additional Information

  1. Additional bad debts Rs 5,000.
  2. Maintain the provision for doubtful debts @ 10% on debtors.

Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

Solution

Journal

Balance Sheet as at 31st March 20X2

Illustration 25 [When Provision for Doubtful Debts does not appear in the Trial Balance]

Following are the extracts of a Trial Balance as at 31.3.20X2:

Required Show how these items will appear in the final accounts in each of the following alternative cases:

Case (a) If no other information is given.

Case (b) Further bad debts amounted to Rs 6,000.

Case (c) Increase bad debts by Rs 6,000.

Case (d) Sundry Debtors include an amount of Rs 6,000 due from a customer who has become insolvent.

Case (e) Bad Debts increased to Rs 6,000.

Case (f) Make a provision for doubtful debts @ 10% on debtors.

Case (g) Further bad debts amounted to Rs 6,000. Make a provision for doubtful debts @ 10% on debtors.

Case (h) Bad debts increased to Rs 6,000. Make a provision for doubtful debts @ 10% on debtors.

Case (i) Debtors include Shyam for dishonoured bill of Rs 800. Half the amount of Shyam’s bill is irrecoverable. Create a provision @ 5% on debtors.

Solution

Case (a)

Case (b)

Case (c) Same solution as given in Case (b).

Case (d) Same solution as given in Case (b).

Case (e)

Case (f)

Case (g)

Balance Sheet as at 31st March 20X2

Case (h)

Profit and Loss Account for the Year Ended 31st March 20X2

Balance Sheet as at 31st March 20X2

Case (i)

Illustration 26 [When Provision for Doubtful Debts already appears in Trial Balance]

Following are the extracts of a Trial Balance as at 31st March 20X2:

Required Show how these items will appear in the final accounts in each of the following alternative cases:

Case (a) If provision for doubtful debt is no longer required.

Case (b) Further Bad Debts amounted to Rs 6,000 and provision for doubtful debts is no longer required.

Case (c) Further Bad Debts amounted to Rs 14,000 and provision for doubtful debts is no longer required.

Case (d) Increase Bad Debts by Rs 6,000 and provision for doubtful debts is no longer required.

Case (e) Bad Debts increased to Rs 16,000 and provision for doubtful debts is no longer required.

Case (f) Increase the Bad Debts Provision by Rs 1,000.

Case (g) Increase the Bad Debts provision to Rs 16,000.

Case (h) Make a provision for doubtful debts @ 5% on debtors.

Case (i) Further Bad Debts amounted to Rs 6,000. Maintain a provision for doubtful debts @ 5% on debtors.

Case (j) Further Bad Debts amounted to Rs 6,000. Maintain a provision for doubtful debts @ 2%.

Case (k) Bad Debts increased to Rs 6,000. Bad Debts provision to be increased by Rs 6,000.

Solution

Case (a)

Balance Sheet as at 31st March 20X2

Case (b)

Balance Sheet as at 31st March 20X2

Case (c)

Balance Sheet as at 31st March 20X2

Case (d) Same solution as in Case (b).

Case (e) Same solution as in Case (c).

Balance Sheet as at 31st March 20X2

Case (g) Same solution as in Case (f).

Case (h)

Balance Sheet as at 31st March 20X2

Case (i)

Balance Sheet as at 31st March 20X2

Case (j)

Case (k)

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF PROVISION FOR DISCOUNT ON DEBTORS

Provision for Discount on Debtors refers to the provision created to provide for discount likely to be allowed on good debtors (i.e., Sundry Debtors less additional bad debts given outside the Trial Balance and the provision for doubtful debts). Its accounting treatment is summarised as under:

Illustration 27 Following are the extracts from the Trial Balance of a firm as at 31st March 20X2:

Additional Information

  1. Credited a provision for doubtful debts @ 10% on debtors.
  2. Credit a provision for discount on debtors @ 2% on debtors.
  3. Additional Discount given to the debtors Rs 5,000.

Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

Solution

Journal

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF RESERVE FOR DISCOUNT ON CREDITORS

Reserve for discount on creditors refers to the reserve created for discount likely to be earned from creditors on their payments. Its accounting treatment is summarised as under:

Note According to Prudence Principle, discount likely to be earned from creditors being an unrealized gain should not be accounted for.

Illustration 28 Following are the extracts from the Trial Balance of the firm as at 31st March 20X2:

Additional Information

  1. Additional discount received from creditors after closing the accounts Rs 1,000.
  2. Create a serve for discount on creditors @ 2%.

Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

Solution

Journal Proper

ADJUSTMENT OF COMMISSION ON PROFIT

Commission on profit is the remuneration on the basis of certain percentage of profits. Such profits may be either before or after charging such commission. In the absence of any information, commission is allowed as a percentage of net profit before charging such commission. Its accounting treatment is summarised as under:

Illustration 29 The net profit of a firm amounts to Rs 10,500 before charging commission. The manager of the firm is entitled to a commission of 5% on the net profits. Calculate the commission payable to the manager in each of the following alternative cases:

Case (a) If the manager is allowed commission on the net profit before charging such commission, and

Case (b) If the manager is allowed commission on the net profit after charging such commission. Also show its treatment in Final Accounts ending on 31st March 20X2.

Solution

Case (a) Commission

= Rs 10,500 x 5/100 = Rs 525

Case (b)

Let the net profit after charging the commission be = Rs 100
Commission @ 5% on net profit =Rs 5
Therefore, net profit before charging such commission = Rs 100 + Rs 5 = Rs 105
Commission = Rs 10,500 x 5/105 = Rs 500

Thus, in such a case, in the form of a formula, the manager’s commission may be expressed as under:

Commission

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF GOODS SENT ON APPROVAL

Goods sent on ‘approval’ or ‘on sale or return’ basis mean the delivery of the goods to the customers with the option to retain or return them within a specified period. When such transactions are few, these transactions are accounted for as an ordinary sale. If at the year end, goods are still lying with customers and the specified period has not yet expired, the original entry made for sale is cancelled. Like an ordinary closing stock, such goods are considered as stock lying with customers on behalf of sellers and are valued at cost. Its accounting treatment is summarised as follows:

Illustration 30 Following are the extracts of a Trial Balance as on 31.3.20X2:

Additional Information Goods costing Rs 600 were sent to a customer on sale or return for Rs 700 on 30 March 20X2 and has been recorded in the books as actual sales. Stock-in-hand on 31st March 20X2, was valued at Rs 6,250.

Required Show how these items will appear in the Final Accounts.

Solution

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF GOODS-IN-TRANSIT

Generally, Goods-in-Transit refer to those goods which have been purchased but not received during the current accounting period. These goods should be treated as part of closing stock. Its accounting treatment is summarised as follows:

Illustration 31 Invoices for Goods costing Rs 10,000 have been entered on 27th March 20X2 but the goods have not yet been received till 31st March 20X2. Accounting year is financial year. Pass the necessary adjusting entry and show the treatment in Final Accounts.

Solution

Adjusting Entry

Goods-in-Transit A/C Dr. Rs 10,000
To Trading Ale Rs 10,000 (Being the goods purchased but not yet received) Rs 10,000

Balance Sheet as at 31st March 20X2

ADJUSTMENT OF PROVIDENT FUND

Provident fund scheme is a retirement benefit scheme to which both employer and employee contribute.

Under this scheme a stipulated sum (which cannot be less than employer’s contribution which at present is 10% of salary) is deducted from the employee’s salary.

The employer also contributes not less than 10% of salary to this scheme. The amount of both these contributions is required to be invested in accordance with the Provident Fund Act, 1952.

The various journal entries required to be passed are summarised as follows:

 

1. To Account for employee's contribution to P.F.
Salary and Wages A/c Dr.
To Employee's contribution to P.F. A/c
To Cash A/c/Bank A/c
2. To account for employer's contribution to P.F. Dr.
Salary and Wages A/c Dr.
To Employer's contribution to P.F. A/c
3. To Acount for investment of both the contributions to P.F.
Employees' contribution to P.F. A/c Dr.
Employer's contribution to P.F. A/c Dr.
To Bank A/c

Illustration 32 Following are the extracts from the Trial Balance of a firm as at 31st March 20X2.

Additional Information Provide for employer’s share of P.F. equivalent to employee’s share to P.F.

Required Pass the necessary journal entries and show the treatment in Final Accounts.

Solution

Journal

Profit and Loss Account for the Year Ended 31st March 20X2

Balance Sheet as at 31st March 20X2

Illustration 33 Following are the extracts from the Trial Balance of a firm as at 31st March 20X2.

Required Pass the necessary journal entry and show the treatment in final accounts.

Solution

Journal

Profit and Loss Account for the Year Ended 31st March 20X2

Illustration 34 Following are the extracts from the trial Balance Sheet of a firm as at 31st March 20X2.

Additional Information Provide for employer’s share of P.F. equivalent to employee’s share to P.F.

Required Pass the necessary journal entries and show the treatment in final accounts.

Solution

Journal

Profit and Loss Account for the Year Ended 31st March 20X2

Balance Sheet as at 31st March 20X2

Illustration 35 Give the necessary adjusting entries for the following items appearing outside the Trial Balance as on 31st March 20X2.

  1. Closing Stock in hand as on 31st March 20X2 Rs 10,000
  2. Salary due but not paid Rs 1,000
  3. Unexpired Insurance on 31st March 20X2 Rs 2,000
  4. Rent received in advance Rs 3,000
  5. Interest due but not received Rs 600
  6. Depreciation on fixed assets @ 33 ½%
  7. Bad debts to be written-off Rs 5,000
  8. Create Provision for Doubtful Debts @ 10%
  9. Create Provision for Discount on debtors @ 2%
  10. Create Reserve for Discount on creditors @ 2%
  11. Allow Interest on capital @ 10% p.a.
  12. Charge Interest on drawings @ 12% p.a.

Other Information as per Trial Balance: Fixed Assets Rs 60,000; Debtors Rs 2,05,000; Creditors Rs 1,00,000; Capital Rs 5,00,000; Drawings Rs 20,000.

Solution

Journal

Note In the absence of exact dates of drawings, the interest on drawings has been calculated for an average period of 6 months assuming that the drawings were made evenly throughout the year.

TREATMENT OF ITEMS OF ADJUSTMENT APPEARING OUTSIDE THE TRIAL BALANCE

If any item of adjustment appears outside the Trial Balance, it will be shown at two appropriate places in the final accounts. The treatment of such items has been shown below:

Treatment of items of Adjustments Appearing Outside the Trial Balance

TREATMENT OF ITEMS OF ADJUSTMENTS APPEARING IN THE TRIAL BALANCE

If any item of adjustments appears inside the Trial Balance, it will be shown only at one appropriate places in the final accounts. The treatment of such item has been shown below:

Treatment of items of Adjustment Appearing inside the Trial Balance

Illustration 36 The following is the Trial Balance of Mr Wise as at 31st March 20X2.

Additional Information

  1. Closing Stock as on 31st March 20X2 was Rs 42,000.
  2. Rent is payable at the rate of Rs 300 per month.
  3. Insurance Premium was paid for the year ending on 30th June 20X2.
  4. Write off further Rs 5,000 as bad.
  5. Create Provision for discount on Debtors @ 2%.
  6. Create a Provision for Doubtful debts @ 10%.
  7. Create a Reserve for discount on Creditors @ 2%.
  8. Provide for depreciation on fixed assets @ 10% p.a.

Required Prepare Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as at 31st March 20X2.

Solution

Balance Sheet as at 31st March 20X2

SOLVED PROBLEMS

Problem 1 Following are the extracts from the Trial Balance of a firm as on 31st March 20X2:

Additional Information

  1. Additional Bad Debts Rs 4,000
  2. Additional Discount allowed to Debtors Rs 1,000
  3. Maintain a provision for bad debts @ 10% on debtors
  4. Maintain a provision for discount @ 2% on debtors.

Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

Solution

Journal

Ledger Accounts

An Extract of Balance Sheet as at 31st March 20X2

Problem 2 Following are the extracts from the Trial Balance of a firm as at 31st March 20X2:

Additional Information

  1. Additional discount received from creditors after closing the accounts Rs 1,000.
  2. Maintain a reserve for discount on creditors @ 2%.

Required Pass the necessary journal entries and show the relevant account (including final accounts).

Solution

Journal

An Extract of Balance Sheet as at 31st March 20X2

Problem 3 A trader maintained provision for doubtful debts @ 2½% a Provision for Discount @ 1% on debtors and Reserve for discount @ 1% on creditors which on 1st April 20X0 stood at Rs 1,500, Rs 500 and Rs 400 respectively. His balances on 31.03.20X1 and on 31.03.20X2 were as follows:

Required Prepare Bad Debts A/c, Provision for Doubtful Debts A/c, Discount Allowed A/c, Provision for Discount on Debtors A/c, Discount Received A/c, Reserve for Discount on Creditors A/c, and Profit and Loss A/c.

Solution

Problem 4 A book-keeper has submitted to you the following Trial Balance wherein the totals of the Debit and Credit balances are not equal:

You are required to

  1. Redraft the Trial Balance correctly as at 31st March 20X2.
  2. Prepare a Trading and Profit and Loss Account and a Balance Sheet after taking into account the following adjustments.
    1. Stock on hand on 31st March 20X2 was valued at Rs 1,800.
    2. Depreciate Fixtures and Fittings by Rs 25.
    3. Rs 35 was due and unpaid in respect of salaries.
    4. Rates and insurance had been paid in advance to the extent of Rs 40.

Solution

Corrected Trial Balance as at 31st March 20X2

Balance Sheet as at 31st March 20X2

Problem 5 The following Trial Balance has been extracted from the books of Shri Santosh Kumar on 31st March 20X2:

The following additional information is available:

  1. Stock on 31st March 20X2 was Rs 30,800.
  2. Depreciation is to be charged on Plant and Machinery at 5% p.a. and Furniture and Fixtures at 6% p.a. Loose Tools are revalued at Rs 16,000.
  3. Provision for Doubtful debts is to be maintained at 5% on Sundry Debtors.
  4. Remuneration of Rs 2,000 paid to Mr B. Barua, a temporary employee, stands debited to his personal account and it is to be corrected.
  5. Unexpired insurance was Rs 400.

Required Prepare Trading and Profit and Loss Account for the year ended 31st March 20X2 and a Balance Sheet as on that date.

Solution

Balance Sheet as at 31st March 20X2

Problem 6 The following Trial Balance extracted from the books of a Merchant Mr Nageswara Rao on 31.03.20X2.

Adjustments

  1. Stock on hand on 31.03.20X2 Rs 3,250.
  2. Depreciate Buildings @ 5% p.a.; Furniture @ 10% p.a.; Motor Vehicles @ 20% p.a.
  3. Rs 85 is due for interest on Bank Overdraft.
  4. Salaries Rs 300 and Taxes Rs 200 are outstanding.
  5. Insurance Premium amounting Rs 100 prepaid.
  6. One-third of the commission received is in respect of work to be done next year.
  7. Write off a further sum of Rs 100 as bad debts from Debtors and create provision for Doubtful Debts @ 5% on debtors.

Required Prepare a Trading and Profit and Loss Account and the Balance Sheet.

Solution

Balance Sheet of Mr Nageswara Rao as at 31st March 20X2

Problem 7 From the Trial Balance of Mr A as given on next page, prepare a Trading and Profit and Loss A/c for the year ending 31st March 20X2 and a Balance Sheet as on that date.

Adjustments

  1. Wages include Rs 2,000 for erection of new machinery on 1.4.20X1.
  2. Stock on 31st March 20X2 was Rs 40,925.
  3. Provide depreciation on machinery @ 5% p.a.
  4. Salaries unpaid Rs 800.
  5. Half the amount of Shyam’s bills is irrecoverable.
  6. Create a provision at 5% on other debtors.
  7. Rent paid up to 31st July 20X2.
  8. Insurance unexpired Rs 300.

Solution

Balance Sheet as at 31st March 20X2

Note It has been assumed that rent (Rs 2,000) was paid on 1.4.20X1 for 16 months ending 31st July 20X2. Alternatively, it could have been assumed for 12 months. In that case, prepaid rent will be Rs 667, and net profit will be Rs 7,327.

Problem 8 Prepare Trading and Profit and Loss Account and Balance Sheet from the following particulars as at 31st March 20X2:

 

Trial Balance

Further, you are required to take into consideration the following information:

  1. Salary Rs 100 and taxes Rs 400 are outstanding but insurance Rs 50 prepaid.
  2. Commission amounting to Rs 100 has been received in advance for work to be done next year.
  3. Interest accrued on investments Rs 210.
  4. Provision for Doubtful Debts is to be maintained at 20%.
  5. Depreciation on furniture is to be charged at 10% p.a.
  6. Stock on 31st March 20X2 was valued at Rs 4,500.
  7. A fire occurred on 25 March 20X2 in the godown and stock of the value of Rs 1,000 was destroyed. It was fully insured and the insurance company admitted the claim in full.

Solution

Balance Sheet as at 31st March 20X2

Problem 9 From the following balances taken from the Ledger of Shri Krishna on 31st March 20X2, prepare the Trading and Profit and Loss Account for the year ended 31st March 20X2 and the Balance Sheet as at 31st March 20X2 of Shri Krishna:

Adjustments to be taken into account

  1. Write off further Rs 300 as bad out of Sundry Debtors and create a Provision for Doubtful Debts at 20% on Debtors.
  2. Dividends accrued and due on Investments is Rs 135. Rates paid in advance Rs 100 and wages owing Rs 450.
  3. On 31.3.20X2 stock was valued at Rs 15,000 and Loose Tools were valued at Rs 800.
  4. Write off 5 per cent for depreciation on Buildings and 40 per cent on Motor Van.
  5. Provide for interest at 12 per cent per annum due on Loan taken on 1.6.20X1.
  6. Income tax paid has to be treated as Drawings.

Solution

Balance Sheet as at 31st March 20X2

Problem 10 The following is the trial balance or Shri Ram at 31st March 20X2 and it is desired to prepare final accounts showing the results of the transactions of the year:

The following adjustments are to be made:

  • a. Stock-31st March 20X2
Rs 52,000
  • b. Rent due but not paid, 31st March 20X2
Rs 2,000
  • c. Lighting due but not paid, 31st March 20X2
Rs 300
  • d. Insurance paid in advance
Rs 100
  • e. Depreciation-to be written off:
    Plant and Machinery @ 33-1/3%
    Office Furniture @ 10%
    Motor Van @ 33-1/3
  • f. The provision for doubtful debts has to be increased to Rs 3,000.
  • g. Discounts at 2-1/2% (Two and half per cent) on Debtors and Creditors are to be provided.

Solution

Balance Sheet as at 31st March 20X2

Problem 11 From the following figures extracted from the books of Shri Govind, you are required to prepare a Trading and Profit and Loss Account for the year ended 31st March 20X2 and a Balance Sheet as on that date after making the necessary adjustments.

Adjustments

  1. Stock on 31st March 20X2 was valued at Rs 72,600.
  2. A new machine was installed during the year costing Rs 15,400 but it was not recorded in the books as on payment was made for it. Wages Rs 1,100 paid for its erection have been debited to wages account.
  3. Depreciate Plant and Machinery by 33-1/3%

    Furniture by 10%

    Freehold property by 6%.

  4. Loose tools were valued at Rs 1,760 on 31.3.20X2.
  5. Of the Sundry Debtors Rs 660 are bad and should be written off.
  6. Maintain a provision of 5% on Sundry debtors for doubtful debts.
  7. The manager is entitled to a commission of 10% of the net profits after charging such commission.

Solution

Balance Sheet as at 31.3.20X2

SOLVED PROBLEMS (ADVANCED)

Problem 12 On 31st March 20X2 the following Trial Balance has been extracted from the books of a merchant.

Prepare Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as on that date after considering the following matters:

  1. Depreciate Land and Building at 5% p.a. and Motor Vehicles at 15% p.a.
  2. Goods costing Rs 600 were sent to a customer on sale or return for Rs 700 on 30th March 20X2 and has been recorded in the books as actual sales.
  3. Salaries amounting to Rs 700 and Rates amounting to Rs 400 are due.
  4. A fire broke out on 1 April 20X2 destroying goods worth Rs 200.
  5. The Provision for Doubtful Debts is to be brought up to 5% on Sundry debtors.
  6. Stock in hand on 31st March 20X2 was valued at Rs 6,250.
  7. Goods costing Rs 500 were taken away by the proprietor for his personal use, no entry has been made in the books of accounts.
  8. Prepaid insurance amounted to Rs 175.
  9. Provide for manager’s commission at 5% on net profit after charging such Commission.

Solution

Balance Sheet as at 31st March 20X2

Note An event occurring after the date of Balance Sheet (i.e., fire as on 1.4.20X2) does not affect the Balance Sheet.

Problem 13 The following Trial Balance of Shri Om, as on 31st March 20X2. You are requested to prepare the Trading and Profit and Loss Account for the year ended 31st March 20X2 and a Balance Sheet as on that date after making the necessary adjustment:

The following adjustments arc to be made:

  1. Stock on 31st March 20X2 was valued at Rs 7,25,000.
  2. A Provision for Doubtful Debts is to be created to the extent of 5 per cent on Sundry Debtors.
  3. Depreciate—Furniture and Fittings by 10%, Motor Car by 20%.
  4. Shri Om had withdrawn goods worth Rs 25,000 during the year.
  5. Sales include goods worth Rs 75,000 sent out to Shanti & Company on approval and remaining unsold on 31st March 20X2. The cost of the goods was Rs 50,000.
  6. The Salesmen were entitled to a Commission of 5% on total sales.
  7. Debtors include Rs 25,000 bad debts.
  8. Printing and Stationery expenses of Rs 55,000 relating to 20X0-20X1 had not been provided in that year but was paid in this year by debiting outstanding liabilities.
  9. Purchases include purchase of Furniture worth Rs 50,000.

Solution

Balance Sheet as at 31.3.20X2

Problem 14 From the following trial balance and additional information prepare. Trading and Profit and Loss Account of Mr Bharat Tulsian for the year ended 31st March 20X2 and Balance Sheet as on that date:

Additional Information

  1. Closing Stock at market price as at 31st March 20X2 was Rs 61,500. However its cost was Rs 80,000.
  2. A machine costing Rs 20,000 was purchased on 1st July 20X1. Wages Rs 1,000 for its erection have been debited to Wages Account. Provide depreciation on Plant and Machinery @ 10% p.a.
  3. Sundry Debtors include an amount of Rs 5,000 due from a customer who has become insolvent. Maintain the provision for doubtful debts @ 10% and for discount @ 2% on debtors. Also create a reserve for discount on creditors @ 2%.
  4. Dividend accrued and due on investments Rs 500.
  5. Loose Tools were valued at Rs 4,000.
  6. Credit Purchase Invoice amounting to Rs 4,000 had been omitted from the books.
  7. Received credit purchase invoice of Rs 6,000 on 27th March 20X2 but the goods were not received till the end of the accounting year.
  8. The salesmen were entitled to a commission of 5% on total sales. The sales manager is entitled to commission of 1% on Gross Profit.
  9. Sales include goods worth Rs 75,000 sent out to Mr Clever on approval and remaining unsold on 31st March 20X2. The cost of such goods was Rs 50,000.
  10. Fire occurred on 23rd March 20X2 and Goods costing Rs 10,000 (Selling Price Rs 15,000) were destroyed. The insurance company accepted claim for 60% only and paid the claim money on 10th April 20X2.
  11. Investments include shares of X Ltd. purchased for Rs 3,000 and it was decided to write off this investment as the company is under liquidation.

Solution

Balance Sheet of Mr Bharat Tulsian as at 31st March 20X2

Problem 15 From the following trial balance and additional information of Mr Tushar Tulsian, a proprietor. Prepare Trading, Profit and Loss Account for the year ending on 31st March 20X2 and the Balance Sheet as at that date:

Additional Information

  1. Wages include (i) a sum of Rs 4,000 spent on the erection of a cycle shed for employees and customers, (ii) Rs 2,000 for erection of new machinery on 1.1.20X2.
  2. Provide 5% depreciation on machinery and building.
  3. Remuneration of Rs 2,000 paid to Sh B. Barua, a temporary employee, stands debited to his personal account.
  4. Sundry creditors include an amount of Rs 5,500 received from Rahul and credited to his account. The amount was written off as a bad debt in the previous year.
  5. Goods costing Rs 500 were taken by the proprietor for his personal use but no entry has been made in the books of accounts.
  6. Goods costing Rs 600 were sent to a customer on sale or return for Rs 700 on 30th March 20X2 and has been recorded in the books as actual sale.
  7. A fire occurred on 25th March 20X2 in the godown and stock of Rs 1,000 was destroyed, it was fully insured but the insurance company admitted the claim to the extent of 60% only.
  8. Half the amount of Shyam’s bill is irrecoverable.
  9. Create a provision of 5% on other debtors.
  10. 50% of Printing and Advertising is to be carried forward as a charge in the following year.
  11. One third of the commission received is in respect of work to be done next year.
  12. Rent has been paid for 11 month but has been received for 13 months.
  13. Included amongst the Debtors is Rs 3,000 due from Ram and included among the Creditors Rs 1,000 due to him.
  14. Provide for Personal Income Tax @ 10% of Net Profit in excess of Rs 50,000.
  15. Stock in hand on 31st March was valued at Rs 1,11,888.
  16. Manager is entitled to a commission of 5% on Net Profit after charging his commission.

Solution

Balance Sheet of Mr Tushar Tulslan as at 31st March 20X2

PROFESSIONAL EXAMINATION PROBLEMS

Problem 1 The following is the Trial Balance of Hari as at 31st March 20X2:

The following adjustments are to be made:

  1. Included amongst the Debtors is Rs 3,000 due from Ram and included among the Creditors Rs 1,000 due to him.
  2. Provision for Doubtful Debts be created at 5% and for Discount @ 2% on Sundry Debtors.
  3. Depreciation on Furniture and Fittings @ 10% shall be written off.
  4. Personal Purchases of Hari amounting to Rs 600 had been recorded in the Purchases Day Book.
  5. Interest on Bank Loan shall be provided for the whole year.
  6. A quarter of the amount of Printing and Stationery Expenses is to be carried forward to the next year.
  7. Credit Purchase Invoice amounting to Rs 400 had been omitted from the Books.
  8. Stock on 31.3.20X2 was Rs 78,600.

Required Prepare (i) Trading and Profit and Loss for the year ended 31.3.20X2 and (ii) Balance Sheet as at 31st March 20X2.

Solution

Note It has been assumed that the given closing stock includes goods costing Rs 400 the credit purchase invoice in respect of which has been omitted from books.

 

Balance Sheet as at 31st March 20X2

Working Notes

  1. Calculation of Provisions
    Rs
    A. Debtors as per Trial Balance 24,000
    B. Less: Due from Ram 1,000
    C. Debtors subject to provision [A - B] 23,000
    D. Less: Provision for Doubtful Debts @ 5% on Rs 23,000 1,150
    E. Debtors considered good [C-D] 21,850
    F. Provision for Discount @ 2% on Rs 21,850 437
  2. Closing Creditors

    = Creditors (given) + Purchase invoice omitted - Set off in respect of Ram

    = Rs 14,800 + Rs 400 Rs 1,000 = Rs 14,200

Problem 2 From the following trial balance and information, prepare Trading and Profit and Loss Account of Mr Rishabh for the year ended 31st March 20X2 and a Balance Sheet as on that date:

Information

  1. Stock of General goods on 31.3.20X2 valued at Rs 27,300.
  2. Fire occurred on 23rd March 20X2 and Rs 10,000 worth of general goods were destroyed. The Insurance Company accepted claim for Rs 6,000 only and paid the claim money on 10th April 20X2.
  3. Bad Debts amounting to Rs 400 are to be written off. Provision for Doubtful debts is to be made at 5% and for discount at 2% on debtors. Make a provision of 2% on creditors for discount.
  4. Received Rs 6,000 worth of goods on 27th March 20X2 but the invoice of purchase was not recorded in Purchases Book.
  5. Rishabh took away goods worth Rs 2,000 for personal use but no record was made thereof.
  6. Charged depreciation at 2% on Land and Buildings, 20% on Plant and Machinery, and 5% on Furniture.
  7. Insurance prepaid amounts to Rs 200.

Solution

Balance Sheet as at 31st March 20X2

THEORETICAL QUESTIONS

Multiple Choice Questions

  1. Return outwards appearing in Trial Balance are deducted from:
    1. Sales
    2. Purchases
    3. Returns Inwards
    4. Closing Stock
  2. Return Inwards appearing in Trial Balance are deducted from:
    1. Purchases
    2. Sales
    3. Returns Outward
    4. Closing Stock
  3. Salaries and Wages appearing in Trial Balance are shown:
    1. on the debit side of Trading Account
    2. on the debit side of Profit and Loss Account
    3. on the liabilities side of the Balance Sheet
  4. Wages and salaries appearing in Trial Balance are shown:
    1. on the debit side of Profit and Loss Account
    2. on the debit side of Trading Account
    3. on the liabilities side of the Balance Sheet
  5. Outstanding wages appearing in Trial Balance are shown:
    1. on the debit side of Profit and Loss Account
    2. on the debit side of Trading Account
    3. on the liabilities side of the Balance Sheet
  6. Freight inward appearing in Trial Balance are shown:
    1. on the debit side of Profit and Loss Account
    2. on the debit side of Trading Account
    3. on the liabilities side of the Balance Sheet
  7. Carriage outwards appearing in the Trial Balance are shown:
    1. on the debit side of Profit and Loss Account
    2. on the debit side of Trading Account
    3. on the liabilities side of the Balance Sheet
  8. Apprenticeship Premiums received appearing in the Trial Balance are shown:
    1. on the debit side of Profit and Loss A/c
    2. on the credit side of Profit and Loss A/c
    3. on the Assets side of the Balance Sheet
  9. Discounts Allowed appearing in the Trial Balance are shown:
    1. on the debit side of Trading Account
    2. on the debit side of Profit and Loss A/c
    3. on the Assets side of the Balance Sheet
  10. Closing Stock appearing in the Trial Balance is shown:
    1. on the credit side of Profit and Loss A/c
    2. on the credit side of Trading A/c
    3. on the Assets side of the Balance Sheet
  11. Sales of scrap of raw materials appearing in the Trial Balance are shown:
    1. on the credit side of Trading Account
    2. on the credit side of Manufacturing Account
    3. on the credit side of Profit and Loss A/c
  12. Goodwill is:
    1. Current Asset
    2. Fictitious asset
    3. Tangible asset
    4. Intangible asset
  13. Prepaid wages Rs 2,500, appear in A’s Trial Balance. These will appear in—
    1. Trading Account
    2. Profit and Loss Account
    3. Balance Sheet
    4. Manufacturing Account
  14. Drawings are deducted from:
    1. Sales
    2. Purchases
    3. Returns outward
    4. Capital
  15. Income tax paid by Mr A amounts to Rs 3,000. The accounting treatment is:
    1. To be credited to the Profit and Loss Account
    2. To be ignored altogether
    3. To be deducted from capital
    4. To be debited to the Trading Account
  16. A’s Trial balance shown the Opening stock Rs 20,000, it will be:
    1. Debited to the Trading Account
    2. Debited to the Profit and Loss Account
    3. Deducted from the closing stock in the Balance Sheet
  17. B’s Trial Balance contains the following information: Bad debts Rs 1,000, Provision for Doubtful debts Rs 1,500. It is desired to make a Provision for Doubtful Debts of Rs 2,000 at the end of the year. The amount to be debited to the Profit and Loss Account is:
    1. Rs 4,500
    2. Rs 5,000
    3. Rs 1,500
    4. Rs 3,500
  18. C’s Trial Balance provides you the following information: Bad debts Rs 800, Provision for Doubtful debts Rs 2,000. It is desired to maintain a Provision for Doubtful debts of Rs 1,000. The accounting treatment of these adjustments is:
    1. Rs 1,800 to be debited to the Profit and Loss Account
    2. Rs 200 to be credited to the Profit and Loss Account
    3. Rs 200 to be debited to the Profit and Loss Account
    4. Rs 4,200 to be debited to the Profit and Loss Account
  19. D’s Trial Balance contains the following information: Discount allowed Rs 500. Provision for discount on debtors Rs 1,100. It is desired to make a provision for discount on debtors of Rs 1,800 at the end of the year. The amount to be debited to the Profit and Loss Account is:
    1. Rs 1,200
    2. Rs 3,200
    3. Rs 700
    4. Rs 2,200
  20. E’s Trial Balance contains the following information: Discount received Rs 1,000, Provision for discount on creditors Rs 1,600. It is desired to maintain a provision for discount on creditors at Rs 1,100. The amount to be credited to the Profit and Loss Account is:
    1. Rs 1,500
    2. Rs 3,500
    3. Rs 1,000
    4. Rs 500
  21. F’s capital on 1 January 20X2 Rs 45,000, Interest on drawings Rs 5,000, Interest on capital Rs 2,000, Drawings Rs 14,000, Profit for the year Rs 15,000. His capital as on 31.12.20X2 is:
    1. Rs 67,000
    2. Rs 43,000
    3. Rs 47,000
    4. Rs 69,000
  22. C’s Trial Balance contains the following information: Bad debts Rs 4,000, Provision for Doubtful debts Rs 5,000, Sundry debtors Rs 25,000. It is desired to create a provision for bad debts at 10% on sundry debtors at the end of the year. Sundry debtors will appear in the Balance Sheet at a figure of:
    1. Rs 22,500
    2. Rs 21,000
    3. 18,000
    4. Rs 15,500
  23. H’ s Trail Balance contains the following information:
    Bad debts Rs 3,000
    Discount allowed Rs 3,000
    Provision for discount on debtors Rs 3,200
    Provision for Doubtful Debits debts Rs 3,500
    Sundry Debtors Rs 50,000

    All the end of the year, it is desired to maintain a provision for debts at Rs 4,000 and provision for discount on debtors at Rs 2,000. Sundry Debtors will appear in the Balance Sheet at a figure of:

    1. Rs 44,000
    2. Rs 38,000
    3. Rs 44,700
    4. Rs 32,300
  24. I’ s Trail balance as at 31st December 20X2, contains the following information: 12% Bank loan Rs 40,000, Interest paid Rs 3,800. Interest debited to the Profit and Loss Account is:
    1. Rs 4,800
    2. Rs 5,000
    3. Rs 5,500
    4. Rs 1,000

    [Answer: 1. (b), 2. (b), 3. (b) 4. (b), 5. (c), 6. (b) 7. (a), 8. (b), 9. (b), 10. (c), 11. (b), 12. (d), 13. (c), 14. (d) 15. (c), 16. (a), 17. (c), 18. (b) 19. (a), 20. (d), 21. (b), 22. (a), 23. (a), 24 (a)]

Classification Questions

  • 25. Classify the following under Personal, Real and Nominal account.

    (a) Manufacturing Account (b) Trading Account (c) Profit and Loss Account (d) Bills Receivable Account (e) Bills Payable Account (f) Prepaid Rent Account (g) Outstanding Salary Account (h) Unexpired Insurance Account (i) Depreciation Account (j) Drawings Account (k) Capital Account (l) Accrued Interest (m) Interest on Capital (n) Interest on Drawings (o) Goodwill (p) Patent and Trade Marks.

  • 26. State whether the following expenditure is capital or revenue and why? Give reasons for your answers:
    • 1. Expenditure incurred on repairs and whitewashing at the time of purchase of an old building in order to make it usable.
    • 2. Expenditure incurred to provide one more exit in a cinema hall in compliance with a government order.
    • 3. Registration fees paid at the time of purchase of a building.
    • 4. Expenditure incurred on the maintenance of a tea garden which will produce tea after four years.
    • 5. Depreciation charged on plant.
    • 6. The expenditure incurred in erecting a platform on which a machine will be fixed.
    • 7. Advertising expenditure, the benefits of which a will last for five years.
    • 8. Rs 1,000 spent on repairs of a machine.

      [Answer: Capital 1, 2, 3, 6, Revenue 5, 8, Deferred Revenue 4, 7]

True or False Questions

  • 27. State with reasons whether each of the following statement is true or false?
    • 1. Financial statements are organised summaries of detailed information about the financial position and performance of an enterprise.
    • 2. The term ‘Financial Statements’ is used to denote basic statement ‘Balance Sheet’.
    • 3. Manufacturing Account is prepared by an enterprise engaged in manufacturing activities with a view to ascertain the gross profit.
    • 4. Manufacturing Account is closed by transferring its balance to the credit side of Trading Account.
    • 5. A Balance Sheet is a statement of assets and liabilities of an enterprise for a particular accounting period.
    • 6. Grouping means putting together items of similar nature under a common heading.
    • 7. Marshalling refers to the order in which the various assets and liabilities are shown in the Balance Sheet.
    • 8. The most liquid asset is shown first and the most urgent payment to be made is shown last in order of liquidity.
    • 9. The least liquid asset is shown first and the least urgent payment to be made is shown last in order of permanence.
    • 10. Trade Discount received is treated as an item of revenue and is shown on credit side of the Profit and Loss Account.
    • 11. Profit is the excess of revenues for the period over the payments for the period.
    • 12. Profit is the excess of receipts for the period over the expenses for the period.

      [Answer: True—1, 6, 7, False—2, 3, 4, 5, 8, 9 10, 11, 12]

  • 28. State with reasons whether the following statements are True or False:
    • 1. Depreciation is an amortised expenditure.
    • 2. Prudence is a concept to recognise unrealised profits and not losses.
    • 3. Pre-operative expenses are revenue expenses.
    • 4. Heavy expenditure incurred or advertisement at the time of introducing a new product is a Deferred Revenue Expenditure.
    • 5. Capital + Long Term Liabilities = Fixed Assets + Current Assets + Cash - Current Liabilities.
    • 6. Net Profit is reflected in higher cash balances and Net Loss is reflected in Lower Net Worth.
    • 7. Profit and Loss Account shows the financial position of the concern.
    • 8. Expenses incurred to keep the machine in working condition is capital expenditure.
    • 9. The balance in the Petty Cash book represent expense.
    • 10. An expenditure intended to benefit the current period of a revenue expenditure.
    • 11. A withdrawal of cash from the business by the proprietor should be charged to Profit and Loss Account as an expense.
    • 12. The Trial Balance ensures the arithmetical accuracy of the books.
    • 13. Finished Goods are normally valued at cost or market price, whichever is higher.
    • 14. Accrual concept implies accounting on cash basis.
    • 15. Depreciation cannot be provided in case of loss, in a financial year.
    • 16. Amounts written off from the cost of Fixed Assets is Capital Expenditure.
    • 17. Wages paid to workers to produce a tool to be captively consumed is capital expenditure.
    • 18. Deferred Revenue Expenditure is current year’s revenue expenditure to be paid in later years.
    • 19. Providing depreciation in accounts reduces the amount of profit available for dividend.
    • 20. Fixed Assets are stated in the Balance Sheet at their market value.
    • 21. A Profit and Loss Account is a point statement whereas a Balance Sheet is period statement.
    • 22. Contingent liability is an ascertained liability but its amount and due date are indeterminate.
    • 23. M/s Ram & Co. did not provide any depreciation on Plant and machinery, as its market value is much higher than the cost of purchase.
    • 24. The proprietor of a shop feels that he has made a loss due to closing stock being zero.
    • 25. Expenditure which results in acquisition of a permanent asset is a capital expenditure.
    • 26. A tallied Trial balance will not reveal compensating errors and errors on account of wrong balancing.
    • 27. Trial Balance is prepared after preparing the Profit and Loss Account.
    • 28. Sale of Office Furniture should be credited to Sales Account.
    • 29. Wage paid for erection of machinery are debited to Profit and Loss Account.
    • 30. Amount paid for acquiring Goodwill is deferred revenue expenditure.
    • 31. The provision for discount on Debtors is calculated before deducting the provision for doubtful debts from Debtors.
    • 32. Patent right is in the nature of Nominal Account.
    • 33. A bill given to a creditor is called Bill Payable.
    • 34. The trial balance checks the honesty of the book-keeper.
    • 35. Overhaul expenses of a second-hand machinery purchased are revenue expenditure.
    • 36. The balance in the Cash Book shows net income.
    • 37. Goodwill is not a fictitious asset.
    • 38. Purchase of office furniture has been debited to general expenses account. It is a compensating error.
    • 39. In accounting, all business transactions are recorded as having dual aspect.
    • 40. Loss of Stock is said to be abnormal loss when such loss is due to inherent characteristics of the commodities.
    • 41. Major repair charges including replacement of certain workout parts incurred before using a second-hand Car purchased recently is a capital expenditure.
    • 42. There exists difference between the Written Down Value method and Diminishing Balance method of depreciation.
    • 43. The debts written off as bad, if recovered subsequently are credited to debtors account.
    • 44. The gain from sale of capital assets not to be added to revenue to ascertain the net profit of a business.
    • 45. The expressions-depreciation is to be charged at 10% and 10% p.a. on furniture and fittings carry the same meaning.
    • 46. Error of principle involves an incorrect allocation of expenditure or receipt between capital and revenue.

      [Answer: 1. True; 2. False; 3. False; 4. True; 5. False; 6. First Part False, Second Part True; 7. False; 8. False; 9. False; 10. True; 11. False; 12. True; 13. False; 14. False; 15. False; 16. False; 17. True; 18. False; 19. True; 20. False; 21. False; 22. False; 23. False; 24. False; 25. True; 26. First Part True, Second Part False; 27. False; 28. False; 29. False 30. True; 31. False; 32. False; 33. True; 34. False; 35. False; 36. False; 37. True; 38. False; 39. True; 40. False; 41. True, 42. False; 43. False; 44. True; 45. False; 46. True]

  • 29. State with reasons whether the following statement are true or false:
    • 1. Long-term Liabilities = Fixed Assets + Working Capital - Capital.
    • 2. Net Profit is reflected in higher net worth and Net Loss is reflected in lower cash balance.
    • 3. Balance Sheet shows the financial position of the concern for a particular period.
    • 4. An expenditure to benefit the future years is a revenue expenditure.
    • 5. Finished Goods are normally valued at cost or replacement price whichever is lower.
    • 6. Deferred revenue expenditure is future year’s expenditure to be paid in current year.
    • 7. Fixed assets are stated in the Balance Sheet at their replacement value.
    • 8. Profit and Loss Account shows the financial performance of the concern at a particular date.
    • 9. Contingent Liability is an ascertained liability.
    • 10.Provision is an ascertained liability.

      [Answer: 1. True; 2. First Part True, Second Part False; 3. False; 4. False; 5. False; 6. False; 7. False; 8. False; 9. False; 10. True]

Very Short Answer Type Questions

  1. What are Financial Statements?
  2. What is a Trading Account?
  3. What is need of preparing a Trading Account?
  4. What is Gross Profit?
  5. Why is it wrong to head the Trading and Profit and Loss Account on 31st March 20X1?
  6. How is the balance of Trading Account treated?
  7. What is a Manufacturing Account? What is the object of preparing it?
  8. What is a Profit and Loss Account?
  9. What is the need of preparing a Profit and Loss Account?
  10. What is Net Profit?
  11. How is the balance of Profit and Loss Account treated?
  12. What is a Balance Sheet?
  13. What are the characteristics of a Balance Sheet?
  14. Why is it wrong to head the Balance Sheet for the year ended 31st March 20X2?
  15. What is the need of preparing a Balance Sheet?
  16. What is meant by Grouping of Assets and Liabilities?
  17. What is meant by Marshalling of Assets and Liabilities?
  18. Enumerate the ways in which a Balance Sheet may be marshalled.
  19. At what price should the closing stock be valued and why?
  20. At what price should the fixed assets be valued and why?
  21. Why is it necessary to take into account the closing stock in preparing a Trading Account?
  22. State the effect of undervaluation of closing stock on gross profit.
  23. State the effect of over valuation of closing stock on gross profit.
  24. State the journal entry to open closing stock account for current year.
  25. Name the principle involved in the valuation of inventory.
  26. Name the principle involved in the valuation of Fixed Assets.
  27. Name the principle involved in the classification of assets as fixed and current.
  28. What is a current asset?
  29. What is a current liability?
  30. Mention four items of current assets and two items of current liabilities.
  31. What are closing entries?
  32. Why are the closing entries needed?
  33. Give four examples of closing entries.
  34. Do we need a closing entry for carrying any account to a Balance Sheet?
  35. Give any two examples of Capital Expenditure.
  36. Give any two examples of Revenue Expenditure.
  37. Give any two examples of Capital Receipt.
  38. Give any two examples of Revenue Receipt.
  39. What is an ‘Adjusting Entry’?
  40. What is ‘Prepaid Expense’?
  41. What is an ‘Outstanding Expense’?
  42. What is an ‘Accrued Income’?
  43. What is an ‘Unaccrued Income’?

Short Answer Type Questions

  1. Distinguish between a Manufacturing Account and a Trading Account.
  2. Distinguish between a Trading Account and a Profit and Loss Account.
  3. Distinguish between a Trial Balance and a Balance Sheet Account.
  4. Distinguish between Gross Profit and Net Profit.
  5. Distinguish between Fixed Assets and Current Assets.
  6. Distinguish between Tangible Assets and Intangible Assets.
  7. Distinguish between Capital Expenditure and Revenue Expenditure.
  8. Distinguish between Capital Receipt and Revenue Receipts.
  9. Distinguish between a Revenue Expenditure and Deferred Revenue expenditure.
  10. Classify the following under Personal, Real and Nominal account.

    (a) Manufacturing Account (b) Trading Account (c) Profit and Loss Account (d) Bills Receivable Account (e) Bills Payable Account (f) Prepaid Rent Account (g) Outstanding Salary Account (h) Unexpired Insurance Account (i) Depreciation Account (j) Drawings Account (k) Capital Account (l) Accrued Interest (m) Interest on Capital (n) Interest on Drawings (o) Goodwill (p) Patent and Trade Marks.

  11. State whether the following expenditure is capital or revenue and why? Give reasons for your answers:
    1. (a) Expenditure incurred on repairs and whitewashing at the time of purchase of an old building in order to make it useable.
    2. Expenditure incurred to provide one more exit in cinema hall in compliance with a government order.
    3. Registration fees paid at the time of purchase of a building.
    4. Expenditure incurred in (he maintenance of a tea garden which will produce tea after four years.
    5. Depreciation charged on plant.
    6. The expenditure incurred in erecting a platform on which a machine will be fixed.
    7. Advertising expenditure, the benefits of which a machine will last for five years.
    8. Rs 1,000 spent on repairs of a machine.
  12. How would you treat the following items appearing in the Trial Balance?

    (a) Returns, (b) Carriage, (c) Freight, (d) Wages and Salaries, (e) Salaries and Wages, (f) Discount, (g) Commission, (h) Interest, (i) Rent, (j) Apprenticeship Premium.

  13. Prepare a proforma Balance Sheet in order of liquidity.
  14. Prepare a proforma Balance Sheet in order of permanence.
  15. What does the following indicate?
    1. Debit Balance of a Bank Account
    2. Credit Balance of a Bank Account
    3. Debit Balance of Discount Account
    4. Credit Balance of a Discount Account
    5. Debit Balance of a Trading Account
    6. Credit Balance of a Trading Account
    7. Debit Balance of a Profit and Loss Account
    8. Credit Balance of a Profit and Loss Account
  16. Explain the rationale of preparing a Balance Sheet.
  17. Explain the rationale of making a distinction between Capital and Revenue Expenditure.
  18. Mention any four important adjustments that are made for the preparation of Trading and Profit and Loss Account.
  19. Explain the rationale of making adjustments at the time of preparing the Final Accounts.
  20. How will you deal with the following items appearing in a Trial Balance of a proprietor?

    (a) Closing Stock, (b) Depreciation Account, (c) Prepaid Rent, (d) Outstanding Salary, (e) Accrued Interest, (f) Drawings Account, (g) Income Tax paid, (h) Interest on Capital, (i) Interest on Drawings, (j) Bad Debts if no provision for doubtful debts is appearing in the Trial Balance, (k) Bad Debts if provision for doubtful debts is appearing in the Trial Balance, (l) Discount Allowed if no provision tor discount on debtor is appearing in the Trial Balance, (m) Discount Allowed if provision for discount on debtors is appearing in the Trial Balance, (n) Discount Received if no reserve for discount on creditors is appearing in Trial Balance, (o) Discount Received if reserve for discount on creditors is appearing in the Trial Balance.

  21. While preparing the Final Accounts, how would you deal with the following items appearing in a Trial Balance of a Proprietor?

    (a) Closing Stock, (b) Outstanding Expense, (c) Prepaid Expenses, (d) Accrued Income, (e) Unearned Income, (f) Depreciation, (g) Bad Debts if no provision for doubtful debts is appearing in the Trial Balance, (h) Bad Debts if provision for doubtful debts is appearing in the Trial Balance, (i) Discount Allowed if no provision for discount on debtors is appearing in the Trial Balance, (j) Discount Allowed if provision for discount on debtors is appearing in the Trial Balance, (k) Discount Received if no Reserve for Discount on creditors is appearing in the Trial Balance, (l) Discount Received if Reserve for discount on creditors is appearing in the Trial Balance.

PRACTICAL QUESTIONS

Preparation of Simple Final Accounts

  1. The following is the Trial Balance of Shri Ram as at 31st March 20X2:

    Additional Information Closing Stock as on 31.3.20X2 was Rs 25,200.

    Required Pass the necessary adjusting entries and closing entries and prepare the Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as on that date.

    [Answer: G.P. Rs 37,200, N.P. Rs 1,440, Total of B/S Rs 3,61,200]

  2. Taking the same information as given in Q. 1, prepare the Income Statement and the Balance Sheet in Vertical from.

Preparation of Manufacturing and Trading Account

  • 3. The following balances appeared in the trial balance of GA & Co. an industrial firm:

    At the end of the concerned period, the stock on hand were:

    Rs
    Raw Materials 2,10,000
    Work-in-Progress 60,000
    Finished Goods 3,30,000

    [Answer: Cost of Goods Mfg. Rs 18,80,000, G.P. Rs 2,52,000]

  • 4. You are required to a prepare Manufacturing and Trading Account & Profit & Loss A/c in respect of the month of March 20X1 from the following information provided by Ch. Murari Lal.

    [Answer: Cost of Goods Mfg. Rs 6,40,992, G.P. Rs 3,03,672, N.P. Rs 2,91,672]

  • 5. From the following Trial Balance of S. Ganapati, prepare the Trading and Profit and loss account for the year ended 31st March 20X2 and the Balance Sheet as at that date:

    Adjustment Stock on 31st March 20X2 was valued at Rs 9,000.

    [Answer: G.P. Rs 22,620, N.P. Rs 16,500, Total of B/S Rs 1,97,340]

Adjustments

  • 6. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2:

    Additional Information

    1. Furniture of Rs 20,000 was purchased on 1st July 20X1 Write 10% off the furniture.
    2. Motor Vehicle of Rs 20,000 was acquired on 1st July 20X1. Depreciate the Motor Vehicles @ 20% p.a.
    3. The plant of Rs 20,000 was acquired during the year, charge depreciation on plant @ 10% p.a.

      Required Pass the necessary journal entries and show how the items will appear in the firm’s final accounts.

  • 7. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2

    Additional Information

    1. Additional bad debts Rs 3,000
    2. Maintain the provision for doubtful debts @ 10% on debtors.

      Required Pass the necessary journal entries and prepare and Provision for Doubtful Debts Account and show the relevant accounts (including final accounts).

  • 8. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2:

    Additional Information

    1. Create a provision for doubtful debts @ 10% on debtors.
    2. Create a provision for discount on debtors @ 2% on debtors.
    3. Additional discount given to the debtors Rs 3,000.

      Required Pass the necessary journal entries and show the relevant account (including final accounts).

  • 9. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2:

    Additional Information

    1. Additional Bad Debts Rs 2,400.
    2. Additional Discount Rs 600.
    3. Maintain a provision for doubtful debts @ 10% on debtors.
    4. Maintain a provision for discount @ 2% on debtors.

      Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

  • 10. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2:

    Additional Information

    1. Additional discount received from creditors after closing the accounts Rs 600.
    2. Maintain a reserve for discount on creditors @ 2%.

      Required Pass the necessary journal entries and show the relevant accounts (including final accounts).

  • 11. A trader maintain Provision for Doubtful debts @ 2½% a Provision for Discount @ 1% on debtors and Reserve for discount @ 1% on creditors which on 1st April 20X0 stood at Rs 900, Rs 300 and Rs 240 respectively. His balances on 31.03.20X1 and on 31.03.20X2 were:

    Required Prepare Bad Debts A/c, Provision for Doubtful Debts A/c, Discount Allowed A/c, Provision for Discount on Debtors A/c, Discount Received A/c, Reserve for Discount on Creditors A/c, and Profit and Loss A/c.

  • 12. Following are the extracts from the Trial Balance of a firm as on 31st March 20X2.

    Additional Information

    1. Additional Bad dents Rs 12,000.
    2. Additional discount allowed Rs 3,000.
    3. Additional discount received Rs 3,000.
    4. Maintain a provision for doubtful debts @ 10% on debtors.
    5. Maintain a provision for doubtful @ 2% on debtors and on creditors.

      Required Pass the necessary journal entries and show how the different items will appear in the Firm’s Final Accounts.

  • 13. Following are the extracts of a Trial Balance as on 31.3.20X2:

    Additional Information Goods costing Rs 1,200 were sent to a customer on sale or return for Rs 1,400 on 30th March 20X2 and has been recorded in the books as actual sales. Stock-in-hand on 31st March 20X2, was valued at Rs 12,500.

    Required Show how these items will appear in the Final Accounts.

  • 14. Invoices for Goods costing Rs 6,000 have been entered on 27th March 20X2 but the goods have not yet been received till 31st March 20X2. Accounting year is financial year. Pass the necessary adjusting entry and show the treatment in final Accounts.
  • 15. Give the necessary adjusting entries for the following items appearing outside the Trial Balance as on 31st March 20X2:
    1. Closing Stock in hand as on 31st March 20X2 Rs 6,000
    2. Salary due but not paid Rs 600
    3. Unexpired Insurance on 31st March 20X2 Rs 1,200
    4. Rent received in advance Rs 1,800
    5. Interest due but not received Rs 360
    6. Depreciation on fixed assets @ 33 ⅓%
    7. Bad debts to be written-off Rs 3,000
    8. Create Provision for Doubtful Debts @ 10%
    9. Create Provision for Discount on debtors @ 2%
    10. Create Reserve for Discount on creditors @ 2%
    11. Allow Interest on capital @ 10% p.a.
    12. Charge Interest on drawings @ 12% p.a.

      Other Information as per Trial Balance: Fixed Assets Rs 36,000; Debtors Rs 1,23,000; Creditors Rs 60,000; Capital Rs 3,00,000; Drawings Rs 12,000.

  • 16. The following is the Trial Balance of Shri Krishan as on 31 March 20X2.

    Required Prepare the Trading and Profit and Loss Account for the year ending 31st March 20X2 and the Balance Sheet as on 31st March 20X2.

    [Answer: G.P. Rs 3,24,000, N.P. Rs 57,200, Total of B/S Rs 11,31,600]

    [Hint Show all provisions in Balance Sheet only].

  • 17. The Trial Balance of Mr Wise as on 31st March 20X2 was as follows:

    Adjustments

    1. Closing stock as on 31.03.20X2 Rs 21,600.
    2. Interest on Bank overdraft unpaid Rs 275.
    3. Half-yearly Insurance Premium prepaid.
    4. Depreciate Land and Buildings at 10%; Plant and Machinery at 20%.
    5. Write off further Bad debts of Rs 400 and make provisions for required Doubtful debts at 5% on debtors.

      Required Prepare Trading and Profit and Loss Account for the year ended on 31st March 20X2 and a Balance Sheet as on that date.

      [Answer: G.P. Rs 37,100, N.P. Rs 2,525, Total of B/S Rs 2,33,600]

      [Hint Treat Duty paid on Purchases and Packing Expenses as Direct Expenses and show on the debit side of Trading A/c]

  • 18. The following are the balances extracts from the books of Mr Gani as on 31.3.20X2.

    Adjustments

    1. Outstanding: Salaries Rs 2,000; Commission Rs 300; Rent Rs 1,200.
    2. Insurance Premium Prepaid Rs 150.
    3. Maintain Provision for Doubtful Debts at 5%.
    4. Depreciate Machinery by 5% p.a., Motor Car by 10% p.a., Furniture by 4% and Buildings by 3% p,a.
    5. Closing stock as on 31.3.20X2 Rs 30,000.

      Required Prepare Trading and Profit and Loss Account for the year ending 31.3.20X2 and Balance Sheet as on that date.

      [Answer: G.P. Rs 1,05,750, N.P. Rs 66,640, Total of B/S Rs 1,07,340]

  • 19. The following are the balances extracted from the Books of Mr Katchup as on 31st March 20X2.

    Trial Balance as at 31st March 20X2

    Adjustments

    1. Outstanding Expenses: Commission Rs 100; Rent Rs 400.
    2. Insurance prepaid: Rs 50.
    3. Maintain provision for Doubtful Debts at 5% on Debtors.
    4. Stock on 31st March 20X2: Rs 15,000
    5. Interest on Investments at 5% due but not received.
    6. Depreciate: Maruti Car by 10%; Furniture by 2%; Building by 3%.
    7. Provide interest on Capital at 5%.

      Required Prepare Trading and Profit and Loss Account for the year ended 31st March 20X2 and the Balance Sheet as on that date.

      [Answer: G.P. Rs 51,500, N.P. Rs 41,230, Total of B/S Rs 67,530]

  • 20. The following balances are extracted from the books of Smt Earth. Prepare Trading and Profit and Loss Account and Balance Sheet as on 31.3.20X2.

    Adjustments

    1. The value of closing stock Rs 8,000.
    2. Rent outstanding Rs 1,000.
    3. Advance salary paid Rs 1,780.
    4. Dividend accrued but not received Rs 180.
    5. Depreciate computer at 5% p.a., write off patents at 10% p.a.
    6. Create provision for Discount on Debtors and on Creditors at 1% each.
    7. Insurance Premium prepaid Rs 300.

      [Answer: G.P. Rs 1,000, N.L. Rs 26,828, Total of B/S Rs 72,552]

  • 21. The following is the Trial Balance of Mr Tushar Tulsian as at 31st March 20X2.

    Additional Information (a) Closing Stock as on 31st March 20X2 was Rs 25,200. (b) Rent is payable at the rate of Rs 180 per month, (c) Insurance Premium was paid for the year ending on 30th June 20X2. (d) Write off further Rs 3,000 as bad. (e) Create Provision for discount on Debtors @ 2%. (f) Create a Provision for Doubtful debts @ 10%. (g) Create a Reserve for discount on Creditors @ 2%. (h) Provide for depreciation on fixed assets @ 10% p.a.

    Required Prepare Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as at 31st March 20X2.

    [Answer: G.P. Rs 37,200, N.L. Rs 19,440, Total of B/S Rs 3,39,480]

  • 22. An inexperienced clerk, Mr 420 prepared the following Trial Balance as on 31st March 20X2.

    Required Prepare the correct Trial Balance, Trading and Profit and Loss Account for the year ending on 31st March 20X2 and the Balance Sheet as on that date after taking the following adjustments into account.

    Closing stock was valued at Rs 41,000, Depreciate Building and Furniture by 10% p.a. and Plant by 15% p.a. Write-off Bad Debts of Rs 1,000. Outstanding Salary Rs 1,000.

    [Answer: Total of Corrected Trial Balance Rs 3,30,000, G.P. Rs 64,000, N.P. Rs 19,000, Total of B/S Rs 1,90,000]

  • 23. From the following data, prepare the Trading and Profit and Loss Account for the year ending on 31st March 20X2 and a Balance Sheet as on that date.

    Merchandise inventory on 31.3.20X2 is Rs 57,300, Depreciation for current year on Stores equipment, Rs 3,100 and on Office equipment Rs 2,700. Rs 1,600 for rent is due but not paid, Insurance prepaid is Rs 2,750. A typewriter of the value of Rs 5,000 purchased during the year is included in the purchase.

    [Answer: G.P. Rs 1,44,400, N.P. Rs 59,400, Total of B/S Rs 1,60,600]

  • 24. From the following prepare the Final Accounts for the year ending 31st March 20X2.

    Provision for doubtful debts is to be maintained at 5% on debtors. Provision for discount on debtors is to be maintained at 2%. Reserve for discount on creditors is to be maintained at 3%. Depreciate machinery and building @ 10% p.a. and furniture @ 5% p.a. Stock in hand on 31 March 20X2 is Rs 24,000.

    [Answer: G.P. Rs 51,000, N.P. Rs 26,865, Total of B/S Rs 1,20,665]

  • 25. The following trial balance is extracted from tne books of Mr Goyal, a merchant on 31st March 20X2:

    The following adjustments are to be made:

    1. Stock in hand on 31st March 20X2 was Rs 6,500.
    2. Depreciate Building @ 5%, Furniture and Fittings @ 10% and Motor Vehicles @ 20%.
    3. Rs 170 is due for interest on Bank Overdraft.
    4. Salaries Rs 600 and Taxes Rs 400 are outstanding.
    5. Insurance amounting to Rs 200 is prepaid.
    6. One-third of the commission received is in respect of work to be done next year.
    7. Write off further Rs 200 as Bad Debt and Provision for Doubtful Debts is to be made equal to 5% on Sundry Debtors.

      Required Prepare a Trading and Profit and Loss Account for the year ending 31st March 20X2 and a Balance Sheet as on that date.

      [Answer: G.P. Rs 19,380, N.P. Rs 3,312, Total of B/S Rs 40,432]

  • 26. From the following Trial Balance of Mr Good as at 31st March 20X2, you are required to prepare a Trading and Profit and Loss Account for the year ended 31st March 20X2 and a Balance Sheet as at that date after making the necessary adjustments. Also give the Journal entries for adjustments.

     

    Trial Balance

    Adjustments

    1. Stock on 31st March 20X2 was valued at Rs 14,000.
    2. Write off Rs 600 as Bad Debts.
    3. The Provision for Doubtful Debts is to be maintained at 5 per cent on Sundry Debtors.
    4. Create a Provision for Discount on Debtors and Discount on Creditors at 2 per cent.
    5. Provide for depreciation on Furniture and Fixtures at 5 per cent per annum, and on Plant and Machinery at 20 per cent per annum.
    6. Insurance prepaid was Rs 100.
    7. A fire occurred on 25th March 20X2, in the godown and stock of the value of Rs 5,000 was destroyed. It was fully insured and the Insurance Company admitted the claim in full.

      [Answer: G.P. Rs 39,000, N.P. Rs 5,270, Total of B/S Rs 89,670]

  • 27. From the following balances for the year ending 31st March 20X2 and additional information prepare Trading and Profit and Loss Account and the Balance Sheet of Messers SM & Sons:

    Additional Information

    1. Closing Stock was valued at Rs 2,00,000.
    2. Provide depreciation according to straight line on building @ 5% p.a. and furniture @ 10% p.a.
    3. Outstanding Salaries Rs 10,000.
    4. Further bad debts Rs 1,000.
    5. Make provision for doubtful debts @ 3%.

      [Answer: G.P. Rs 3,20,000, N.P. Rs 94,500, Total of B/S Rs 10,84,500]

      [Hint: Sales Tax Payable is a Liability]

  • 28. The Trial Balance of Mr Sun as on 31st March 20X2 was as follows:

    Required Prepare Trading and Profit and Loss Account for the year 31 March 20X2 and the Balance Sheet as on that date after taking into consideration the following information:

    1. Depreciation on furniture is to be charged @ 10%.
    2. Sundry debtors include an item of Rs 5,000 due from a customer who has become insolvent.
    3. Provision for Doubtful debts is to be maintained @ 5% on sundry debtors.
    4. Goods of the value of Rs 15,000 have been destroyed by fire and insurance company admitted a claim for Rs 10,000.
    5. Stock on 31st March 20X2, was Rs 1,25,500.

      [Answer: G.P. 5,27,330, N.P. Rs 3,76,660, Total of B/S Rs 8,03,900]

  • 29. On 31st March 20X2, the following Trial Balance was extracted from the books of Mr Ghayal.

    Required Prepare Trading and Profit and Loss Account for the year ended 31st March 20X2, and Balance Sheet as on that date, after making adjustments for the following matters:

    1. Depreciate Land and Buildings at 2½ per cent and Motor Vehicles at 20 per cent.
    2. Interest on Loan at 6 per cent annum is unpaid for six months.
    3. Goods costing Rs 5,000 were sent to a customer on a sale or return for R 6,000 on 30th March 20X2 and had been recorded in the books as actual sales.
    4. Salaries amounting to Rs 7,500 and rates amounting to Rs 3,500 are outstanding.
    5. Prepaid Insurance amounted to Rs 1,500.
    6. The provision for Doubtful Debts is to be maintained at 5 per cent on Sundry Debtors.
    7. Provide for Manager’s Commission at 10% on net profits after charging such commission.
    8. Stock in hand on 31st March 20X2, was valued at Rs 62,500.

      [Answer: G.P. Rs 3,36,920, N.P. Rs 79,200, Total of B/S Rs 5,76,120]

  • 30. The following Trial Balance was extracted from the books of Mr Selfish as on 31st March 20X2:

    Required Prepare the Trading and Profit and Loss Accounts for the year ended 31st March 20X2, and Balance Sheet as on that date taking into consideration the following information:

    1. Stock in hand on 31st March 20X2 was valued at Rs 3,05,000.
    2. Depreciate Plant and Machinery by 10% p.a., Furniture by 5% p.a. and Motor car by Rs 10,000.
    3. Create provision for doubtful debts at 5% on Sundry Debtors.
    4. A commission of 1% on the gross profit is to be provided to Works Manager.
    5. General Manager is to be allowed a commission @ 2% on net profit after charging Works Manager’s and before charging General Manager’s Commission.

      [Answer: G.P. Rs 9,57,000, N.P. Rs 5,59,510, Total of B/S Rs 19,76,100]

  • 31. From the following Trial Balance of Mr Moon, prepare Trading and Profit and Loss Account for the ended 31st March 20X2 and a Balance Sheet as on that date, after giving effect to the adjustments:

    Adjustments

    1. Increase Bad Debts by Rs 6,000. Make Provision for Doubtful Debts @10% and Provision for Discount on Debtors @ 5%.
    2. The value of the Closing Stock is Rs 1,87,920.
    3. Wages include Rs 2,000 paid for erection of Machinery on 1.4.20X1.
    4. Provide depreciation on Machinery @ 10% p.a.

      [Answer: G.P. Rs 1,47,830, N.P. Rs 1,13,910, Total of B/S Rs 2,92,710]

  • 32. From the following balance taken from the Ledger of Mr Kite on 31st March 20X2, prepare the Trading and Profit and Loss A/c for the year ended 31st March and the Balance Sheet as at 31st March 20X2:

    Adjustments

    1. Write off further Rs 600 as bad out of Sundry Debtors and create a provision for Doubtful Debts @ 20% on Debtors.
    2. Dividends accrued and due on investments is Rs 270, Rates paid in advance Rs 200, Wages owing Rs 900.
    3. On 31st March stock was valued at Rs 30,000 and Loose Tools were valued at Rs 1,600.
    4. Write off 5 per cent for depreciation on Buildings and 40 per cent on Motor Van.
    5. Provide for interest at 12 per cent per annum due on Loan taken on 1.6.20X1.
    6. Income tax paid has to be treated as Drawings.

      [Answer: G.P. Rs 8,160; Net Loss Rs 10,770; Total of B/S Rs 1,42,360]

  • 33. The following is the trial balance of Mr Rain at 31st March 20X2 and it is desired to prepare final accounts showing the results of the transactions of the year:

    Adjustments

    • a. Stock 31st March 20X2 Rs 1,04,000.
    • b. Rent due but not paid (31st March 20X2) Rs 4,000.
    • c. Lighting due but not paid Rs 600.
    • d. Insurance paid in advance Rs 200.
    • e. Depreciation to be written off Plant & Machinery @ 33-1/3%, Office Furniture @ 10%, Motor Van @ 33-1/3%.
    • f. The provision for doubtful debts has to be increased to Rs 6,000.
    • g. Discounts at 2 ½% (two and half per cent) on debtors and creditors are to be provided.

      [Answers: GP Rs 2,33,400, NP Rs 1,15,780, Total of B/S Rs 3,02,980]

  • 34. From the following figures extracted from the books of Mr Gunny, you are required to prepare a Trading and Profit and Loss Account for the year ended 31st March 20X2 and a Balance Sheet as on that date after making the necessary adjustments:

    Adjustments

    1. Stock on 31st March 20X2 was valued at Rs 1,45,200.
    2. A new machine was installed during the year costing Rs 30,800 but it was not recorded in the books as no payment was made for it. Wages Rs 2,200 paid for its erection have been debited to wages account.
    3. Depreciate plant and machinery by 33-1/3%, Furniture by 10%, Freehold property by 5%.
    4. Loose tools were valued at Rs 3,520 on 31.3.20X2.
    5. Of the Sundry debtors Rs 1,320 are bad and should be written off.
    6. Maintain a provision of 5% on Sundry Debtors for doubtful debts.
    7. The manager is entitled to a Commission of 10% of the net profits after charging such commission.

      [Answer: G.P. Rs 2,17,140, N.P. Rs 81,600, Total of B/S Rs 6,50,760]