Module 1.pptx ppt for accountancy journal

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1. Module 1: Introduction to Accounting, Journal, Ledgers, Trial Balance, Depreciation, stock valuation By Dr Jyoti Bhoj Assistant Professor RICS School of Built Environment, Amity University Noida , UP

2. Business “It is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information. Business is an economic activity undertaken with the motive of earning profits and to maximize the wealth for the owners. Business cannot run in isolation. Largely, the business activity is carried out by people coming together with a purpose to serve a common cause. The business activities require resources (which are limited & have multiple uses) primarily in terms of material, labour , machineries, factories and other services. The success of business depends on how efficiently and effectively these resources are managed.

3. Accounting: The language of business As per the American Institute of Certified Public Accountants (Year 1961): “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money” As per The American Accounting Association (Year 1966): “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of accounting”.

4. Scope of accounting

5. Nature of accounting

6. Uses of Accounting

7. Importance and Purpose of Accounting

8. Role of Accounting Providing Information to the Users for Rational Decision-making Systematic Recording of Transactions Ascertainment of Results of above Transactions Ascertain the Financial Position of Business To Know the Solvency Position

9. Types of Accounting ‘

10. Users of Accounting Information

11. GAAP

12. FUNDAMENTAL ACCOUNTING ASSUMPTIONS Going Concern Assumption:   This concept assumes that an enterprise has an indefinite life or existence. It is assumed that the business has neither intention to liquidate nor to scale down its operations significantly.

13. Relevance: Distinction is made between capital expenditure and revenue expenditure. Classification of assets and liabilities into current and non-current. Depreciation is charged on fixed assets and fixed assets appear in the Balance Sheet at book value, without having reference to their market value.

14. 2. Consistency Assumption:   A ccounting practices once selected and adopted, should be applied consistently year after year. Ensure a meaningful study of the performance of the business for a number of years. It does not mean that particular practices, once adopted, cannot be changed. The only requirement it should be fully disclosed in the financial statements along with its effect on income statement and Balance Sheet. Any accounting practice may be changed if the law or Accounting standard requires so, to make the financial information more meaningful and transparent.

15. Relevance:   It  helps  the  management  in  decision-making  by  utilizing  the comparable financial information.

16. 3. Accrual Assumption:  Accrual concept applies equally to revenue and expenses. All revenue and costs are recognized when they are earned or incurred. It is immaterial, whether the cash is received or paid at the time of transaction or later date Relevance:  Earning of a revenue and consumption of a resource (expenses) can be accurately matched to a particular accounting period.

17. Example: I f a credit sale (Credit for two months) for Rs. 15,000 is made on 15th Feb. 2015, then the revenue earned is to be recorded on 15th Feb. 2015, not on the date of cash realized, i.e., after two months. In case of Expenses, if at the end of the year the two months’ salary is due but not paid, then the expenses of salary will be recorded in the current year in which salary is due, not in the next year in which it will be paid.

18. ACCOUNTING PRINCIPLES Accounting Entity:   An entity has a separate existence from its owner. According to this principle, business is treated as an entity, which is separate and distinct from its owner. Transactions are recorded; analyzed and financial statements are prepared from the business point of view and not of the owner. The owner is treated as a creditor (Internal liability) for his investment in the business. Interest on capital is treated as expense like any other business expense. His private expenses are treated as drawings leadings to reduction in capital.

19. Money Measurement Principle:   According to this principle, only those transactions that are measured in money or can be expressed in term of money are recorded in the books of accounts of the enterprises. Non- monetary events like death of any employee/Manager, strikes, disputes etc., are not recorded at all, even though these also affect the business operations significantly. ,

20. Limitations: It ignores qualitative aspect e.g., efficient human resources (Assets), satisfied customers (Assets) and dishonest employee (liabilities). Value of money (currency) is not stable. To make accounting records simple, relevant, understandable and homogeneous, facts are expressed in a common unit of measurement- money.

21. Accounting Period Principle:   According to this principle, the whole indefinite life of an enterprise is divided into parts, known as accounting period. Accounting period is defined as interval of time, at the end of which the profit and loss account and balance sheet are prepared Accounting period is usually a period of one year and that year may be financial year or calendar year.

22. Relevance: This Assumption requires showing the allocation of expenses between Capital and Revenue. Portion of Capital Expenditure that is consumed during the current year is charged to Income statement and rest of the portion i.e., Unconsumed portion is shown as an asset in the Balance Sheet. As per income tax law, tax on income is calculated on annual basis from 1st April to 31st March (Financial Year) Timely action for corrective measures can be taken by the Management.

23. Full Disclosure Principle:   Apart from legal requirements all significant and material information relating to the economic affairs of the entity should be completely disclosed in its financial statements and accompanying notes to accounts. The financial statements should act as means of conveying and not concealing the information. Disclosure of information will result in better understanding Enhance ablility to take sound decisions based on the information provided.

24. Materiality Principle:   Disclosure of all material facts is compulsory but it does not imply that even those figures which are irrelevant are to be included in financial statements. o nly those items or information should be disclosed that have material effect and relevant to the users. I tem having an insignificant effect or being irrelevant to user need not be disclosed separately, these may be merged with other item.

25. If the knowledge of any information may affect the user’s decision, it is termed as material information. It should be noted that an item material for one enterprise may not be material for another enterprise Example an item of expenses Rs. 50,000 is immaterial for an enterprise having turnover of Rs. 100 crore.

26. Prudence Principle:   P rofit in anticipation should not be recorded but loss in anticipation should immediately be recorded. The objective of this principle is not to overstate the profit of the enterprise in any case.

27. When different equally acceptable alternative methods are available, the method which having least favorable immediate effect on profit should be adopted, e.g., (1)  Valuation of stock at cost or realizable values, whichever is lower. (2)  Provision for doubtful debts and provision for discount on debtors is made

28. Cost Principle:   An asset is recorded in the books of accounts at its original cost comprising cost of acquisition and all expenditure incurred for making the assets ready to use. This cost becomes the basis of all subsequent accounting transactions for the asset T he acquisition cost relates to the past, it is referred to as Historical cost.

29. Example: Machinery purchased for Rs. 1,50,000 in cash and Rs. 20,000 was spent on installation of machine then Rs. 1,70,000 be recorded as cost of machine in the books and depreciation will be charged on this cost. If market value of machine due to inflation has gone up to Rs. 2,00,000 then the increased value will not be recorded. This cost is systematically reduced from year after year by charging depreciation and the assets are shown in the balance sheet at book value (cost – depreciation).

30. Matching Principle:   All expenses incurred by any enterprises during an accounting period are matched with the revenue recognized during the same period. The matching principle facilitates to ascertain the amount of profit or loss incurred in a particular period by deducting the related expenses from the revenue recognized that period.

31. The following treatment of expenses and revenue are done due to matching principle: (1)   Ascertainment of Prepaid Expenses! (2)   Ascertainment of Income received in advance. (3)   Accounting of closing stock. (4)   Depreciation charged on fixed assets.

32.  Dual Aspect Principle:   Every business transaction has two aspects-a debit and a credit of equal amount. F or every debit there is a credit of equal amount in one or more accounts and vice-versa. The system of recording transaction based on this principle is called as “Double Entry System”. Due to this principle, the two sides of Balance Sheet are always equal and the following accounting equation will always hold good at any point of time.

33. Assets = Liabilities + Capital Example : Ram started business with cash Rs. 1,00,000. It increases cash in assets side and capital in liabilities- side by Rs. 1,00,000. Assets Rs. 1,00,000 = Liabilities + Capital Rs. 1,00,000

34. BASES OF ACCOUNTING  Cash Basis of Accounting :   T ransactions are recorded in the books of accounts only on the receipt/ payment of cash. The income is calculated as the excess of actual cash receipts over actual cash payments Entry  is  not  recorded  when  a  payment  or  receipt  merely  due  i.e., outstanding expenses, Accrued income are not treated. This method is contrary to the matching principle.

35. Accrual Basis of Accounting:   R evenue and expenses are recorded when they are recognized Income is recorded as Income when it is accrued (when transaction takes place) irrespective of cash is received or not. E xpenses are recorded when they are incurred or become due and not when the cash is paid for them. Under the companies’ amendments Act 2013, all companies are required to maintain their accounts according to accrual basis of accounting

36. Difference between accrual basis of accounting and cash basis of accounting

37. Class Activity : Verbal Quiz on GAAP Q1: GAAP stands for: (a) Generally Accepted Accounting Provisions (b) Generally Accepted Accounting Policies © Generally Accepted Accounting Principles (d) None of these

38. Answer: c

39. Q2: Which accounting principle states that companies and owners should be treated as separate entities? (a) Monetary Unit Assumption (b) Business Entity Concept © Periodicity Assumption (d) Going Concern Concept

40. Answer: b

41. Q3: Cost or expenses must be recorded at the same time as the revenue to which they correspond is specified by which principle? (a) Matching Principle (b) Going Concern Principle (c) Consistency Principle (d) Prudence Principle

42. Answer: a

43. Q4: Which concept states that “for every debit, there is a credit”? (a) Money Measurement Concept (b) Accounting Period Concept © Separate Entity Concept (d) Dual Aspect Concept

44. Q5: For measuring income, the most acceptable method is? (a) To apply normal rate of return on capital invested (b) To apply the average return in industry on capital © To match the cost with revenue (d) To find out the difference in net worth as on two dates

45. Answer: c

46. Case Study: China's Evergrande property developer

47. Evergrande is China’s second-largest real estate company. As the company struggled to repay creditors, global markets responded with selloffs. After missing four payments, the company made a key payment to bond holders, staving off default. Questions loom about a government bailout and whether Evergrande is in fact too big to fail.

48. o ne of the most significant financial fraud cases ever ‘O verstatement occurred as Evergrande recognised sales relating to pre-sold properties that were not yet completed or delivered to the clients. The practice of recognising revenue from pre-sold properties that were not yet completed or delivered is risky. The outcome depends heavily on the future financial health of the company

49. Which Principle is Violated?

50. ACCOUNTING EQUATION The accounting equation is the foundation of double-entry accounting, representing the relationship between a company’s assets, liabilities, and equity. 

51. ASSET Assets can be described as the value of the things owned by the firm for the purpose of using them in the business. They are not meant for sale. Expenditure that occurred in acquiring these valuable articles is also considered as asset.   Assets can be of different types I.e. Fixed, Floating, Fictitious, Intangible, and Liquid. Assets are purchased to increase the earning capacity of the business. The value of these assets keeps on changing from time to time. Some of the assets are as follows: Cash in Hand, Cash at Bank, Sundry Debtors, Bills Receivables, Investments, Plant & Machinery, Equipment and Tools, Furniture and Fittings, Closing Stock, Prepaid Expenses, Accrued Income, Etc. 

52. LIABILITY Liability can be described as any claim of outsiders against the business or against the assets of the business. It is the amount that the firm is liable to pay to the outside party. The proprietor’s claim against the business is termed as an internal liability.  External liabilities are of three types: Creditors for Goods-  Sundry Creditors and Bills Payable. Creditors for Expenses – Outstanding Salaries, Unpaid Wages, Rent Due. Other Liabilities-  Bank Loan, Bank Overdraft, Partner’s Loan, Etc.  The value of liabilities also keeps on changing from time to time. An increase in the value of liabilities means that the firm has to pay more and a decrease in the value suggests that the firm has to pay less.

53. EQUITY The amount invested by owners in the business whether in cash or kind is called Equity or capital. The Owner of the business can be a single person in a sole proprietorship, two or more than two in partnership, and many as shareholders in a company. Equity can also be described as the owner’s claim against the assets of the business or the Owner’s Fund. It can be further enumerated as under: Capital Reserve, General Reserve, or Reserve Fund Profit or Retained Earning and Interest on Capital

54. FORMULA Accounting Equation Formula Assets = Liabilities + Equity Assets = Liabilities + Equity (Shareholder’s Fund) Liabilities = Assets – Equity (Shareholder’s Fund) Equity (Shareholder’s Fund) = Assets – Liabilities

55. Numerical Q 1 : What will be effect of the following on the Accounting Equation? ( i ) Started business with cash ₹ 45,000 (ii) Opened a Bank Account with a deposit of ₹ 4,500 (iii) Bought goods from M\s. Sun & Co. for ₹ 11,200

56. Answer 1 : Liabilities = 11,200 Capital = 45,000 Assets = Liabilities + Capital = 45,000 + 11,200 = 56,200 Q.2 Show the Accounting Equation for the following transactions:

57. Answer 2:

58. Q 4:  Prepare an Accounting Equation and Balance Sheet on the following basis:

59. Double entry book- keeping

60. TYPES OF ACCOUNTS AND GOLDEN RULES OF ACCOUNTS

61.  Example : Suppose you purchase Rs 1,000 worth of goods from Company ABC. In your books: Debit your  Purchase account  (receiver). Credit  Company ABC  (giver). Date Account Debit Credit XX/XX/XXXX Purchase 1,000 Accounts Payable 1,000 Example: If you pay Rs 500 cash to Company ABC for office supplies: Debit  Company ABC  (receiver). Credit your (the giver’s)  Cash account . Date Account Debit Credit XX/XX/XXXX Cash Rs 500 Company ABC Rs 500

62. Example: Debit what comes in and credit what goes out : Suppose you sell goods worth ₹15,000 to Customer ABC: Debit your  Accounts Receivable  (receiver) by ₹15,000. Credit your (the giver’s)  Sales account  by ₹15,000. Example : If you purchase a machine for ₹50,000: Debit your  Machinery account  (receiver) by ₹50,000. Credit your (the giver’s)  Cash account  by ₹50,000.

63. Journal This is the basic book of original entry. In this book, transactions are recorded in the chronological order, as and when they take place. Afterwards, transactions from this book are posted to the respective accounts. Each transaction is separately recorded after determining the particular account to be debited or credited.

64. Example: Goods Purchased on credit for Rs.30,000 from M/s Govind Traders on December 24, 2017, involves only two accounts: (a) Purchases A/c (Goods), (b) Govind Traders A/c (Creditors).

65. Example: Office furniture is purchased from Modern Furniture’s on July 4, 2017 for ` 25,000 and ` 5,000 is paid by cash immediately and balance of ` 20,000 is still payable. It increases furniture (assets) by ` 25,000, decreases cash (assets) by ` 5,000 and increases liability by ` 20,000.

66. Exercise 1:

67. Answer

68. Exercise 2:

69. PREPARATION OF LEDGER Many of the business transactions are repetitive in nature. They can be easily recorded in special journals, each meant for recording all the transactions of a similar nature. For example, all cash transactions may be recorded in one book, all credit sales transactions in another book and all credit purchases transactions in yet another book and so on. These special journals are also called daybooks or subsidiary books. Transactions that cannot be recorded in any special journal are recorded in journal called the Journal Proper. Special journals prove economical and make division of labor possible in accounting work.

70. Cash Book Cash book is a book in which all transactions relating to cash receipts and cash payments are recorded. It starts with the cash or bank balances at the beginning of the period. Generally, it is made on monthly basis. This is a very popular book and is maintained by all organisation , big or small, profit or not-for profit. It serves the purpose of both journal as well as the ledger (cash) account. It is also called the book of original entry. When a cashbook is maintained, transactions of cash are not recorded in the journal, and no separate account for cash or bank is required in the ledger.

71. Single Column

72. Example

73. Double Column Cash Book There are two columns of amount on each side of the cash book. In fact, now-a-days bank transactions are very large in number. In many organisations , as far as possible, all receipts and payments are affected through bank.

74. Example

75. Petty Cash Book In every organisation , a large number of small payments such as conveyance, cartage, postage, telegrams and other expenses (collectively recorded under miscellaneous expenses) are made. These are generally repetitive in nature. If all these payments are handled by the cashier and are recorded in the main cash book, the procedure is found to be very cumbersome. The cashier may be overburdened and the cash book may become very bulky. To avoid this, large organisations normally appoint one more cashier (petty cashier) and maintain a separate cash book to record these transactions. Such a cash book maintained by petty cashier is called petty cash book.

76. Imprest system The petty cashier works on the Imprest system. Under this system, a definite sum, say ` 2,000 is given to the petty cashier at the beginning of a certain period. This amount is called imprest amount. The petty cashier goes on making all small payments out of this imprest amount and when he has spent the substantial portion of the imprest amount say `1,780, he gets reimbursement of the amount spent from the head cashier. Thus, he again has the full imprest amount in the beginning of the next period.

77. Example:

78. Exercise: Prepare ledger accounts with one column cash book

79. Exercise:

80. Purchases (Journal) Book All credit purchases of goods are recorded in the purchases journal whereas cash purchases are recorded in the cash book.

81. Purchases Return (Journal) Book In this book, purchases return of goods are recorded. Sometimes goods purchased are returned to the supplier for various reasons such as the goods are not of the required quality, or are defective, etc. For every return, a debit note (in duplicate) is prepare and the original one is sent to the supplier for making necessary entries in his book.

82. Example: Delivery 2 mini T.V.’s and tape recorders were found defective and were returned back vide debit note no. 03/2017. In this case, the purchases return books will be prepared as follows :

83. Sales (Journal) Book All credit sales of merchandise are recorded in the sales journal. Cash sales are recorded in the cash book.

84. Sales Return (Journal) Book This journal is used to record return of goods by customers to them on credit.

85. Journal Proper A book maintained to record transactions, which do not find place in special journals, is known as Journal Proper or Journal Residual Following transactions are recorded in this journal: Opening Entry: In order to open new set of books in the beginning of new accounting year and record therein opening balances of assets, liabilities and capital, the opening entry is made in the journal. 2. Adjustment Entries: In order to update ledger account on accrual basis, such entries are made at the end of the accounting period. Such as Rent outstanding, Prepaid insurance, Depreciation and Commission received in advance. 3. Rectification entries: To rectify errors in recording transactions in the books of original entry and their posting to ledger accounts this journal is used. 4. Transfer entries: Drawing account is transferred to capital account at the end of the accounting year. Expenses accounts and revenue accounts which are not balanced at the time of balancing are opened to record specific transactions. Accounts relating to operation of business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses, etc., and drawing are closed at the end of the year and their Total/balances are transferred to Trading and Profit and Loss account by recording the journal entries. These are also called closing entries.

86. 5. Other entries: In addition to the above mentioned entries in the points number 1 to 4, recording of the following transaction is done in the journal proper : ( i ) At the time of a dishonour of a cheque the entry for cancellation for discount received or discount allowed earlier. (ii) Purchase/sale of items on credit other than goods. (iii) Goods withdrawn by the owner for personal use. (iv) Goods distributed as samples for sales promotion. (v) Endorsement and dishonour of bills of exchange. (vi) Transaction in respect of consignment and joint venture, etc. (vii) Loss of goods by fire/theft/spoilage.

87. Exercise: Perform the complete process of recording the transactions in books and journal proper, posting to ledger and balancing of accounts

88. Trial Balance Trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger with a view to verify the arithmatical accuracy of posting into the ledger accounts. Trial balance is an important statement in the accounting process as it shows the final position of all accounts and helps in preparing the final statements. The task of preparing the statements is simplified because the accountant can take the balances of all accounts from the trial balance instead of going through the whole ledger. It may be noted that the trial balance is usually prepared with the balances of accounts

89. Steps in preparation Ascertain the balances of each account in the ledger. List each account and place its balance in the debit or credit column, as the case may be. (If an account has a zero balance, it may be included in the trial balance with zero in the column for its normal balance). Compute the total of debit balances column. Compute the total of the credit balances column. Verify that the sum of the debit balances equal the sum of credit balances. If they do not tally, it indicate that there are some errors. So one must check the correctness of the balances of all accounts. It may be noted that all assets expenses and receivables account shall have debit balances whereas all liabilities, revenues and payables accounts shall have credit balances

90. Objectives of Preparing the Trial Balance To ascertain the arithmetical accuracy of the ledger accounts. To help in locating errors. To help in the preparation of the financial statements. (Profit & Loss account and Balance Sheet)

91. To Ascertain the Arithmetical Accuracy of Ledger Accounts As stated earlier, the purpose of preparing a trial balance is to asceitain whether all debits and credit are properly recorded in the ledger or not and that all accounts have been correctly balanced. As a summary of the ledger, it is a list of the accounts and their balances. When the totals of all the debit balances and credit balances in the trial balance are equal, it is assumed that the posting and balancing of accounts is arithmetically correct. However, the tallying of the trial balance is not a conclusive proof of the accuracy of the accounts. It only ensures that all debits and the corresponding credits have been properly recorded in the ledger.

92. To Help in Locating Errors When a trial balance does not tally (that is, the totals of debit and credit columns are not equal), we know that at least one error has occured . The error (or errors) may have occured at one of those stages in the accounting process: (1) totalling of subsidiary books, (2) posting of journal entries in the ledger, (3) calculating account balances, (4) carrying account balances to the trial balance, and (5) totalling the trial balance columns. It may be noted that the accounting accuracy is not ensured even if the totals of debit and credit balances are equal because some errors do not affect equality of debits and credits. For example, the book-keeper may debit a correct amount in the wrong account while making the journal entry or in posting a journal entry to the ledger. This error would cause two accounts to have incorrect balances but the trial balance would tally. Another error is to record an equal debit and credit of an incorrect amount. This error would give the two accounts incorrect balances but would not create unequal debits and credits. As a result, the fact that the trial balance has tallied does not imply that all entries in the books of original record (journal, cash book, etc.) have been recorded and posted correctly. However, equal totals do suggest that several types of errors probably have not occured

93. To Help in the Preparation of the Financial Statements Trial balance is considered as the connecting link between accounting records and the preparation of financial statements. For preparing a financial statement, one need not refer to the ledger. In fact, the availability of a tallied trial balance is the first step in the preparation of financial statements. All revenue and expense accounts appearing in the trial balance are transferred to the trading and profit and loss account and all liabilities, capital and assets accounts are transferred to the balance sheet.

94. Preparation of Trial Balance Totals method Under this method, total of each side in the ledger (debit and credit) is ascertained separately and shown in the trial balance in the respective columns. The total of debit column of trial balance should agree with the total of credit column in the trial balance because the accounts are based on double entry system. However, this method is not widely used in practice, as it does not help in assuming accuracy of balances of various accounts and and preparation of the fianancial statements

95. Balances Method This is the most widely used method in practice. Under this method trial balance is prepared by showing the balances of all ledger accounts and then totalling up the debit and credit columns of the trial balance to assure their correctness. The account balances are used because the balance summarises the net effect of all transactions relating to an account and helps in preparing the financial statements. It may be noted that in trial balance, normally in place of balances in individual accounts of the debtors, a figure of sundry debtors is shown, and in place of individual accounts of creditors, a figure of sundry creditors is shown

96. Totals-cum-balances Method This method is a combination of totals method and balances method. Under this method four columns for amount are prepared. Two columns for writing the debit and credit totals of various accounts and two columns for writing the debit and credit balances of these accounts. However, this method is also not used in practice because it is time consuming and hardly serves any additional or special purpose

97. Exercise: Rawat’s ledger shows the following accounts for his business. Help him in preparing the trial balance using : ( i ) Totals method (ii) Balances method, (iii) Totals-cum-Balances method.

98. Test your understanding :

99. Significance of Agreement of Trial Balance It is important for an accountant that the trial balance should tally. Normally a tallied trial balance means that both the debit and the credit entries have been made correctly for each transaction. However, as stated earlier, the agreement of trial balance is not an absolute proof of accuracy of accounting records. A tallied trial balance only proves, to a certain extent, that the posting to the ledger is arithmetically correct. But it does not guarantee that the entry itself is correct. There can be errors, which affect the equality of debits and credits, and there can be errors, which do not affect the equality of debits and credits

100. Errors Errors of Commission These are the errors which are committed due to wrong posting of transactions, wrong totalling or wrong balancing of the accounts, wrong casting of the subsidiary books, or wrong recording of amount in the books of original entry, etc. Errors of Omission The errors of omission may be committed at the time of recording the transaction in the books of original entry or while posting to the ledger. These can be of two types: ( i ) error of complete omission (ii) error of partial omission Errors of Principle Accounting entries are recorded as per the generally accepted accounting principles. If any of these principles are violated or ignored, errors resulting from such violation are known as errors of principle. An error of principle may occur due to incorrect classification of expenditure or receipt between capital and revenue.

101. Compensating Errors When two or more errors are committed in such a way that the net effect of these errors on the debits and credits of accounts is nil, such errors are called compensating errors. Such errors do not affect the tallying of the trial balance

102. Rectification of Errors From the point of view of rectification, the errors may be classified into the following two categories : (a) errors which do not affect the trial balance. (b) errors which affect the trial balance

103. Rectification of Errors which do not Affect the Trial Balance The rectification process essentially involves: Cancelling the effect of wrong debit or credit by reversing it; and Restoring the effect of correct debit or credit. For this purpose, we need to analyse the error in terms of its effect on the accounts involved which may be: ( i ) Short debit or credit in an account ; and/or (ii) Excess debit or credit in an account. Therefore, rectification entry can be done by : ( i ) debiting the account with short debit or with excess credit, (ii) crediting the account with excess debit or with short credit

104. Exercise

105. Rectification of Errors Affecting Trial Balance

106. Rectification of Errors in the Next Accounting Year If some errors committed during an accounting year are not located and rectified before the finalisation of financial statements, suspense account cannot be closed and its balance will be carried forward to the next accounting period. When the errors committed in one accounting year are located and rectified in the next accounting year, profit and loss adjustment account is debited or credited in place of accounts of expenses/losses and incomes/ gains in order to avoid impact on the income statement of next accounting period

107. Exercise: Example; Rectify the following errors : Credit purchases from Raghu Rs. 20,000 ( i ) were not recorded. (ii) were recorded as Rs. 10,000. (iii) were recorded as Rs. 25,000. (iv) were not posted to his account. (v) were posted to his account as Rs. 2,000. (vi) were posted to Reghav’s account. (vii) were posted to the debit of Raghu’s account. (viii) were posted to the debit of Raghav. (ix) were recorded through sales book

108. Example: Depreciation written-off as the machinery Rs. 2,000 ( i ) was not posted at all (ii) was not posted to machinery account (iii) was not posted to depreciation account

109. Exercise: Example: Trial balance of Anurag did not agree. It showed an excess credit Rs. 10,000. Anurag put the difference to suspense account. He located the following errors : ( i ) Sales return book over cast by Rs. 1,000. (ii) Purchases book was undercast by Rs. 600. (iii) In the sales book total of page no. 4 was carried forward to page 5 as Rs. 1,000 instead of Rs. 1,200 and total of page 8 was carried forward to page 9 as Rs. 5,600 instead of Rs. 5,000. (iv) Goods returned to Ram Rs. 1,000 were recorded through sales book. (v) Credit purchases from M & Co. Rs. 8,000 were recorded through sales book. (vi) Credit purchases from S & Co. Rs. 5,000 were recorded through sales book. However, S & Co. were correctly credited. (vii) Salary paid Rs. 2,000 was debited to employee’s personal account.

110. Depreciation Depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological advancement or obsolescence, depletion or other such factors. Thus, the cost of a fixed asset less its estimated residual value represents the total amount to be depreciated.

111. REASONS FOR PROVIDING DEPRECIATION The use of any asset erodes its value due to wear and tear or due to the passage of time, or due to obsolescence resulting from a change in technology. The cost of an asset should be written down to reflect its correct value. Depreciation is a non-cash expenditure–it does not involve an outflow of cash from the business, and therefore results in the accumulation of funds. But since it is debited to the profit and loss account like any other expense, it reduces the taxable profits and, therefore, the burden of tax. The cost of fixed asset is in nature of capital expenditure and is not charged to revenues of accounting period in which it is purchased or the period in which the said asset is sold or discarded. Thus the cost of fixed asset less its salvage value must be allocated in rational manner to the periods that receive benefit from the use of the asset. To maintain the capital invested in the cost of asset intact in business so that it can reinvested in the profit earning process. To allocate cost of fixed assets to products.

112. CONCEPTS OF AMORTIZATION, DEPRECIATION AND DEPLETION

113. Straight Line Method METHODS OF DEPRECIATION

114. Using the straight line depreciation method, the calculation of the annual depreciation charge is as follows: Dpn =(C-R)/N where: Dpn = Annual straight-line depreciation charge, C = Cost of the asset R=Residual value of the asset N = Useful economic life of the asset (years)

115. Declining-Balance Method

116. Q: ABC limited purchases a machine for Rs. 3,00,000/- on April 1, 2005. Depreciation is provided on straight line method. The estimated life of machine is 9 years and the scrap value is Rs. 30,000/- Q: An asset was purchased for Rs. 10,000/- on which depreciation was provided @5% on SLM method, the WDV of the asset at the end of two years will be ? Q: On April 1, 2016, Company A purchased an equipment at the cost of Rs.140,000. This equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value (residual value) will be Rs. 20,000. Company A recognizes depreciation to the nearest whole month. Calculate the depreciation expenses for 2016, 2017 and 2018 using straight line depreciation method. Q: On January 1, 2012, Lynn Corporation purchased a machine for Rs.100,000. Lynn paid shipping expenses of Rs.1,000 as well as installation costs of Rs. 2,400. The machine was estimated to have a useful life of ten years and an estimated salvage value of Rs. 6,000. In January 2013, additions costing Rs. 7,200 were made to the machine. These additions significantly improved the quality of output but did not change the life or salvage value of the machine. If Lynn records depreciation under the straight-line method, what is depreciation expense for 2013.