Commerce ePathshala NOTES
(IGNOU)
Important Questions & Answers
IGNOU
: BCOM
BCOC
131 – FINANCIAL ACCOUNTING
Q - Name the different
parties interested in accounting information, and explain why do they want it.
Ans.
USERS OF FINANCIAL ACCOUNTING INFORMATION
i)
to understand the present position of the
enterprise
ii)
to compare its present performance with
that of its past years
iii)
to compare its present performance with
that of similar enterprises.
Now,
let us see who such parties are and how accounting information is useful to
various parties.
Owners
:
Owners contribute capital and assume the risk of business. Naturally, they are
interested to know the amount of profit earned by the business and so also its
financial position. If however, the management of the business is entrusted to
paid managers, the owners also use the accounting information to evaluate the
performance of the managers.
Managers
:
Accounting information, supplemented by other information, is of immense use to
managers. It helps them to plan, control and evaluate the operations of the
business. They also need such information for various decision making.
Lenders
:
The funds are provided by the owners initially, but if the business requires
more funds they are provided by banks and other lenders of money. Before they
lend money, they would like to know the solvency (i.e.., capacity to repay
debts) of the enterprise, so as to satisfy themselves that their money will be
safe and that they can expect repayment on time.
Creditors
:
Those who supply goods and services on credit are called creditors. Like
lenders, they too want to know about solvency of the enterprise, so as to
decide whether credit can be granted or not.
Prospective
investors : A person who wants to become a partner in
a partnership concern or a person who wants to become a shareholder of a
company, would like to know how safe and rewarding the proposed investment
would be.
Tax
authorities : Tax authorities of the Government are
interested in the financial statements so as to assess the tax liability of the
enterprise.
Employees
:
The employees of the enterprise are also interested in knowing the state of
affairs of the organisation in which they are working, so as to know how safe
their interests are in that organisation.
Q - What are the qualitative
characteristics of accounting information? Briefly Explain.
Ans. QUALITATIVE CHARACTERISTICS OF ACCOUNTING
INFORMATION
Business owners can use
accounting information to conduct a financial analysis of business operations.
Accounting information often has quantitative and qualitative characteristics.
Quantitative characteristics refer to the calculation of financial
transactions. Qualitative characteristics include the business owner’s
perceived importance of financial information. Business owners often require
financial information when making business decisions. Incorrect or
inappropriate information can hamper decision-making or cause business owners
to make incorrect assessments about their companies. Some of the qualitative
characteristics of accounting information are as follows:
(i)
Understandable
Accounting information must be understandable.
This is an important qualitative characteristic for small business owners. Many
small business owners do not have a strong accounting background. Financial
information that is too technical or cannot be understood by a layperson can be
ineffective for business owners. Small business owners often use professional
accountants to complete various accounting functions. Business owners should
choose an accountant who can prepare information in an easily understandable
manner.
(ii)
Usefulness
Business owners need accounting information
that is applicable to the business decision at hand. They can request financial
statements, accounting schedules, reconciliations or cost-benefit analysis. For
example, cost allocation reports may not provide sufficient information for
business owners who must make a decision on hiring employees. Cost allocation
usually refers to applying business costs to goods or services produced by the
company, which has very little to do with human resources. Business owners
should carefully request and review accounting information to ensure that it
provides the most useful information for the decision-making process.
(iii)
Relevance
Accounting information should relate to a
specific time period or contain information regarding individual business
functions. Business owners often conduct a trend analysis when reviewing
financial information. The trend analysis compares historical financial
information to the company’s current accounting period information. Irrelevant
historical information can severely distort the trend analysis process. For
example, reviewing the production process for budgets requires relevant
information on the cost of materials for budgets. Cost information on the
materials to produce COGS would be irrelevant.
(iv)
Reliability
Accounting information must be reliable, so
that business owners can be reasonably assured that accounting information
presents an accurate picture of the company’s financial health. Business owners
often use accounting information to secure external financing for their
business. Information that is not reliable or accurate may cause lenders and
investors to question the business’s management ability. Business owners may
also struggle to secure external financing with poor accounting information.
(v)
Comparable
Comparability
allows business owners to review their company’s accounting information against
that of a competitor. Business owners use comparison to gauge how well their
companies operate under certain market conditions. Owners often use the leading
company of an industry for the comparison process. These companies usually have
the most efficient and effective business operations. Noncomparable accounting
information can make this a difficult process. For example, business owners
should consider preparing financial statements according to standard accounting
principles. The statements can then be compared to other company’s financial
standard prepared in a similar manner.
(vi) Consistent
Consistency
refers to how business owners and accountants record financial information in a
company’s general ledger. Business owners need to ensure that financial
transactions are handled the same way. Inventory purchases should be recorded
the same way as yesterday, today and tomorrow. This helps companies create
accurate historical records and limit the amount of financial accounts or
journal entries included in their general ledgers.
Q - Describe the advantages and limitations of
accounting.
Ans. ADVANTAGES OFACCOUNTING
The
following are the advantages of a properly maintained accounting system:
1) Replaces memory:
Since all the financial events are recorded in the books, there is no need to
rely on memory. The books of account will serve as historical records. Any
information required at any time can be had from these records.
2) Provides control over
assets: Accounting provides information regarding balance of
cash in hand and at bank, the stock of goods in hand, the amount receivable
from various parties, the amount invested in various other assets, etc.
Information about these matters help owner(s) and management to make use of the
assets in the best possible way.
3) Facilitates the
preparation of financial statements: With the help of
information contained in the accounting records, financial statements viz.,
Profit and Loss Account and Balance Sheet can be easily prepared. These
statements enable the businessman to know the net result of the business during
an accounting period and its financial position.
4) Meets the information
requirements: Various interested parties such as owners,
management, lenders, creditors, etc. get the necessary information at frequent
intervals which help them in their decision-making.
5) Facilitates a
comparative study: The financial Statements prepared will
enable the enterprise to compare its present position with that of its past,
and with that of similar organisations. This helps them to draw useful
conclusions and improve its performance.
6) Assists the management
in many ways: It is possible to identify reasons for
the profit earned or loss suffered. The identification of reasons helps in
taking necessary steps to increase profits further, or to avoid losses.
Accounting information will also help in planning and controlling the
activities of the business.
7) Difficult to conceal
fraud or theft: It is difficult to conceal fraud, theft,
etc. as there is an automatic check in the form of periodic balancing of books
of account. Further, in big organisations, the record keeping work is divided
among many persons. so that chances of committing fraud are minimised.
8) Tax matters :
The Government levies various taxes such as customs duty, excise duty, sales
tax, and income tax. Properly maintained accounting records will help in the
settlement of tax matters with the tax authorities.
9) Ascertaining value of
business: In the event of sale of a business firm, the
accounting records will help in ascertaining the value of business.
LIMITATIONS OFACCOUNTING
The
accounting information is used by various parties who form judgments about the
profitability and the financial soundness of a business on the basis of such
information. It is, therefore, necessary to know about the limitations of
accounting. These are as follows:
1.
They do not record transactions and events which are not of a financial
character. Hence. They do not reveal a complete picture because facts like
quality of human resources, licences possessed, locational advantage, business
contacts, etc. do not find any place in books of account.
2.
The data is historical in nature. The accountants adopt historical cost as the
basis in valuing and reporting all assets and liabilities. They do not reflect
current values, it is quite possible that items like land and buildings may
have much more value than what is stated in the balance sheet.
3.
Facts recorded in financial statements are greatly influenced by accounting
conventions and personal judgements. Hence, they do not reveal the true
picture. In many cases, estimates may be used to determine the value of various
items. For example, debtors are estimated in terms of collectability,
inventories are based on marketability, and fixed assets are based on useful
working life. All these estimates are materially affected by personal
judgements.
4.
Data provided in the financial statements is insufficient for proper analysis
and decision making. It only provides information about the overall
profitability of the business. No information is given about the cost and
profitability of different activities.
Q - Discuss the various stages involved in the
accounting process.
Ans. ACCOUNTING PROCESS
The
accounting process consists of the following four steps :
i)
Recording the Transactions
ii)
Classifying the Transactions
iii)
Summarising the Transactions
iv)
Interpreting the Results
Recording the Transactions
The
accounting process begins with recording of transactions in the books of
original entry. The book used for the original entries is called ‘Journal’.
Business transactions are recorded in the journal as and when they occur in the
order of dates. Entries in the journal are made on the basis of various
vouchers such as cash memos, invoices, receipts, etc.
Classifying the
Transactions
The
second step is to group the transactions of similar nature and post them in
different accounts in another book called the ‘Ledger’. For example, all
transactions relating to cash are brought together and are recorded at one
place in Cash Account in the ledger. Similarly, dealings with different persons
are recorded separately in the account of each person. The accounts so prepared
are totaled and balanced periodically to know the net effect of related
transactions. Summarising the
Transactions
The
next step is to prepare a year-end summary known as ‘Final Accounts. But before
final accounts are prepared, we prepare a statement called ‘Trial Balance’ to
test the arithmetical accuracy of the work done. In other words, the trial
balance is prepared to find out whether the Principle of Double Entry has been
strictly followed or not, while recording the transaction. Then, with the help
of the trial balance and some other relevant information we prepare the final
accounts. The objectives of preparing the final accounts are: (i) to know the
net result of business activities, and (ii) to know the financial position of
the business. The final accounts consist of an income statement called ‘Trading
and Profit and Loss Account’, and a position statement called ‘Balance Sheet’.
The Trading and Profit and Loss Account is prepared to know whether the
business unit has earned profit or incurred loss. The Balance Sheet is prepared
to know the financial position of the business, i.e., what the business owns
and what it owes.
Interpreting the Results
The
results are then analysed and interpreted with a view to assess the performance
of the business, its future profit-earning capacity and its ability to pay
short-term and long-term debts. The results and conclusions thus arrived at are
reported to the interested parties like investors, management, bankers,
creditors, tax authorities, etc.
The
balances on various accounts shown in the Balance Sheet will then be
transferred to the new books of account for the next year. The process of
recording transactions for the next year is again started, this continuous
process of accounting is referred to as the ‘Accounting Cycle’ because it
repeats itself.
Q - State the benefits of Accounting Standards.
Ans. BENEFITS OF
ACCOUNTING STANDARDS
There
are many benefits of accounting standards. Let us discuss the main benefits of
Accounting Standards one by one.
1) Standardized
Accounting: Perhaps the most important advantage of
the FASB standard setting for businesses is the uniform set of accounting
principles it promotes. The FASB clearly states the generally-accepted
accounting principles that businesses must follow to avoid confusion. For
example, the FASB prevents businesses from using one method for calculating
inventory at the beginning of a fiscal year and finishing the year with another
method. Without the accounting standards set forth by the FASB, businesses
could use accounting methods that portray financial data inaccurately to
investors.
2) Problem Identification:
The FASB standard setting provides a framework upon which potential accounting
problems are identified and corrected. Because all businesses in the US use the
same accounting principles, any problems or inadequacies in the accounting
process are quickly identified and reported to the FASB. The FASB then
investigates the problem and, if needed, modifies or writes a new accounting
rule for the accounting process. For example, if businesses find that reporting
a certain type of liability on their income statement unfairly lowers their net
income, they can appeal to the FASB so that it can identify problems with the
standard setting.
3) Private Regulation:
The FASB is a private entity with no affiliation to the US government. Despite
this, the Securities and Exchange Commission relies on the FASB to set the
accounting rules that all companies in the US must follow. The SEC can
technically create an accounting oversight board or government agency to set
accounting rules. However, using the FASB eases the burden on the US government
and lets the private sector dictate accounting rules.
4) International
Accounting Standard: The FASB is advantageous because it
actively promotes an internationally recognized set of accounting rules.
Globalization has deeply connected foreign financial markets; a standard set of
accounting rules would make financial reporting more accurate and fair between
countries. One of the goals of the FASB is to make financial reporting more
uniform globally with the cooperation of the International Accounting Standards
Board (IASB).
Q - What do you mean by accounting concepts?
Briefly explain the accounting concepts which guide the accountant at the recording
stage.
Ans. Concepts to be
Observed at the Recording
Stage The following concepts will guide us in
identifying, measuring and recording transactions.
Business
Entity Concept
Business
entity means a unit of organised business activity. In that sense, a provision
store, a cloth dealer, an industrial establishment or electricity supply
undertaking, a bank, a school, a hospital, etc. are all business entities.
From
the accounting point of view, every business enterprise is an entity separate
and distinct from its proprietor(s)/owner(s). The accounting system gives
information only about the business and not about its owner(s). In other words,
we record those transactions in the books of account which relate only to the
business. The owner’s personal affairs (his expenditure on housing, food,
clothing, etc.) will not appear in the books of account of his business.
However, when personal expenditure of the owner is met from business funds it
shall also be recorded in the business books. It will be recorded as drawings
by the proprietor and not as business expenditure.
Money Measurement Concept
Usually,
business deals in a variety of items having different physical units such as
kilograms, quintals, tons, metres, litres, etc. If the sales and purchases of
different items are recorded in terms of their physical units, adding them
together will pose problems. But, if these are recorded in a common
denomination, their total becomes homogeneous and meaningful. Therefore, we
need a common unit of measurement. Money does this function. It is adopted as
the common measuring unit for the purpose of accounting. All recording,
therefore, is done in terms of the standard currency of the country where
business is set up. For example, in India, it is done in terms of Rupees, in
USA it is done in terms of US Dollars, and so on.
Objective Evidence Concept
The
term objectivity refers to being free from bias or free from subjectivity.
Accounting measurements are to be unbiased and verifiable independently. For 45
this purpose, all accounting transactions should be evidenced and supported by
documents such as bills, invoices, receipts, cash memos, etc. These supporting
documents (vouchers) form the basis for making entries in the books of account
and for their verification by auditors afterwards. As for the items like
depreciation and the provision for doubtful debts where no documentary evidence
is available, the policy statements made by management are treated as the
necessary evidence.
Historical Record Concept
You
know that after identifying the transactions and measuring them in terms of
money, we record them in the books of account. According to the historical
record concept, we record only those transactions which have actually taken
place and not those which may take place (future transactions). It is because
accounting record presupposes that the transactions are to be identified and
objectively evidenced. This is possible only in the case of past (actually
happened) transactions. The future transactions can hardly be identified and
measured accurately. You also know that all transactions are to be recorded in
chronological (date wise) order. This leads to the preparation of a historical
record of all transactions. It also implies that we simply record the facts and
nothing else.
Cost Concept
Business
activity, in essence, is an exchange of money. The price paid (or agreed to be
paid in case of a credit transaction) at the time of purchase is called cost.
According to the cost concept, all assets are recorded in books at their
original purchase price. This cost also forms an appropriate basis for all
subsequent accounting for the assets. For example, if the business buys a
machine for Rs.80,000 it would be recorded in books at Rs.80,000. In case its
market value increases later on to Rs.1,00,000 (or decreases to Rs.50,000) it
will continue to be shown at Rs. 80,000 and not at its market value.
Dual Aspect Concept
This
is the basic aspect of accounting. According to this concept, every business
transaction has a two-fold effect. In commercial context, it is a famous dictum
that “every receiver is also a giver and every giver is also a receiver”. For
example, if you purchase a machine for Rs.8,000 you receive machine on the one
hand and give Rs.8,000 on the other. Thus, this transaction has a two-fold
effect i.e., (i) increase in one asset and (ii) decrease in another. Similarly,
if you buy goods worth Rs.500 on credit it will increase an asset (stock of
goods) on the one hand and increase a liability (creditors) on the other. Thus,
every business transaction involves two aspects: (i) the receiving aspect, and
(ii) the giving aspect. In case of the first example you find that the
receiving aspect is machinery and the giving aspect is cash. In the second
example the receiving aspect is goods and the giving aspect is the creditor. If
complete record of transactions is to be made, it would be necessary to record
both the aspects in books of account. This principle is the core of double
entry book-keeping and if this is strictly followed, it is called ‘Double Entry
System of Book-keeping’ about which you will learn in detail later.
Q - State the Advantages of Subsidiary Books.
Ans. ADVANTAGES OF
SUBSIDIARY BOOKS
The
following are the advantages of having a number of subsidiary books:
i)
Classification of transactions becomes
automatic: As there is a separate book for each type of transactions, the
transactions of same nature are automatically. Brought at we place. For example
all credit purchase of goods are recorded in the purchases book.
ii)
Reference becomes easy: If any reference is
required, it can be traced easily by referring to the appropriate subsidiary
book. You do not have to go through all the transactions recorded in the
journal.
iii)
Facilitates division of work: The division
of journal into various subsidiary books facilitates division of work among
many persons. This, in turn, facilitates prompt recording of transactions and
saves a lot of time.
iv)
More particulars: More details about the
transactions can be given in subsidiary books than would be possible in one
book.
v)
Responsibility can be fixed: The work of
maintaining a particular book can be entrusted to a particular person. He will
be responsible for keeping it up-to-date and in order.
vi)
Facilitates checking: When the Trial
Balance does not agree, the location of errors will be relatively easy.
Q - What is a Journal Proper?
List the transactions recorded in the Journal Proper.
Ans.
JOURNAL PROPER
By now, you know what a journal is and what its
sub-divisions are. You also know that the special journals discussed earlier
take care of certain types of transactions which are repetitive and numerous.
However, there are a number of transactions which do not occur frequently and
hence do not warrant preparation of special journals. But they have to be
recorded somewhere. For them, the proper place is the original journal itself,
which is now called ‘Journal Proper’. Thus all events and transactions which cannot
be recorded in any of the special journals maintained by the firm, shall be
recorded in the Journal Proper. Examples of such transactions are:
a) Opening Entry
b) Closing Entries
c) Transfer Entries
d) Adjustment Entries
e) Rectification Entries
f) Miscellaneous Entries
a)
Opening Entry: An opening entry is passed in the journal
for opening a new set of accounts. This may be needed at the time of the
commencement of business or at the commencement of new accounting year.
If a person commences business only with cash, there is
no need to pass a journal entry. The cash brought in is just entered in the
cash book. But, if he also brings some other assets, then an opening entry is
passed in Journal Proper, debiting the concerned assets accounts and crediting
the Capital Account.
b)
Closing Entries: At the end of the accounting year, when
final accounts are prepared, the nominal accounts are closed by transferring
them to Trading Account or Profit and Loss Account. The journal entries passed
for this purpose are called ‘Closing Entries’.
c)
Transfer Entries: When an amount is to be transferred from
one account to another, you have to pass an entry in the Journal Proper in
order to effect the transfer. Such entries are called ‘Transfer Entries’.
Suppose, you want to transfer proprietor’s total drawings made during the year
to his Capital Account. The proprietor’s total drawings appear in Drawings
Account which shows a debit balance. You will transfer the balance of Drawings
Account to Capital Account by passing the following entry in the Journal Proper.
d)
Adjustment Entries: At the time of preparing the final
accounts, it is necessary to bring into the books of account certain unrecorded
items like closing stock, depreciation on fixed assets, interest on capital,
expenses incurred but not yet paid, income earned but not yet received, etc.
Entries passed in the Journal Proper to record such items are called
‘Adjustment Entries’. These entries are explained in detail later.
e)
Rectification Entries: You may commit errors while recording
transactions in various books, and while posting, totalling, balancing, etc.
Such errors are generally corrected through entries in Journal Proper and are
known as ‘Rectification Entries’.
f)
Miscellaneous Entries: In addition to the entries mentioned
above, if there is any transaction which cannot be recorded in any of the
special journals, it will be entered in the Journal Proper. Example of such
transactions are:
i) Credit purchases of fixed assets, investments, etc.
ii) Credit sales of fixed assets, investments etc.
iii) Withdrawal of goods from the business by the owner for his personal
use.
v)
Loss of goods by theft, accident, fire,
etc.
vi)
Special allowances received from suppliers
or given to customers.
vii)
Endorsement or dishonour of bills. vii)
Writing off bad debts.
Q. 9. State the causes for the Disagreement of a Trial Balance.
Ans.
CAUSES FOR THE DISAGREEMENT OF A TRIAL BALANCE
As mentioned earlier, when the Trial Balance does not
tally, it means that there are errors in the books of account. Let us now
analyse the errors which usually affect the Trial Balance and lead to its
disagreement.
1.
Omission of posting in one account: You are aware that both
the debit and credit aspects of a transaction have to be posted in the ledger
accounts. If you post it to the debit of one account and forget its posting to
the credit of the other concerned account, it is bound to affect the Trial
Balance. For example, an amount of Rs.200 received from Ali, correctly entered
on the debit side of the cash book but is not posted to the credit side of
Ali’s Account. This error shall result in the lower credit and hence the Trial
Balance will not tally.
2.
Double posting in one account: If by mistake you post an
entry two times to the debit or to the credit of an account it would result in
extra debit or credit and as such cause disagreement in the Trial Balance. If,
however, the whole entry is posted twice i.e., both the debit and the credit
aspects are posted twice, it won’t affect the Trial Balance. It is because both
the debit and the credit sides will be equally affected.
3.
Posting on the wrong side of an account: When an entry is posted
on the wrong side of an account i.e., instead of debit side it is posted on the
credit side, it would also cause disagreement in the Trial Balance. In such a
situation, the difference will be for double the amount. For example, Rs.300
received from Khan which is correctly entered on the debit side of the Cash
Book, but while posting it to Khan’s Account, it is wrongly posted to the debit
side instead of the credit side. This would mean that a debit of Rs.600 (Rs.300
in Cash Account and Rs.300 in Khan’s Account) has no corresponding credit. So,
in the Trial Balance, the credit side will be lower by Rs.600.
4.
Posting wrong amount in an account: If you post an entry to
the correct side of an account but commit an error in writing the amount, this
would affect the Trial Balance. Suppose, in the above example you post the
entry correctly on the credit side of Khan’s Account but the amount is wrongly
put as Rs.200. It would cause a difference of Rs. 100. In the Trial Balance,
the credit side will be lower by Rs.100.
5.
Wrong totalling of the subsidiary book: If any subsidiary book is
overcast or undercast, it affects the concerned account in ledger. Suppose the
correct total of Sales Journal is Rs.5,600, but it is actually totalled as
Rs.5,300. You know that the total of Sales Journal is posted to the credit side
of the Sales Account. So, the Sales Account will be short by Rs.300, and the
Trial Balance will not tally.
6.
Omitting to post the total of a subsidiary book:
If the total of a subsidiary book is not posted to the concerned account, it
would affect the Trial Balance. Such mistake relates only to the account where
posting was to be done and as such affects only one account. Take for example,
the Sales Journal. If its total of Rs.18,900 is not posted to the credit of
Sales Account, the credit side on the Trial Balance will be lower by Rs.18,900.
7.
Wrong totalling or balancing of an account: When an account is
wrongly totalled or wrongly balanced, this would affect the Trial Balance.
Suppose the debit side of Shyam’s Account is totalled as Rs.1,300 instead of
Rs.1,100. It would lead to wrong balance in Shyam’s Account. Consequently, the
debit total in the Trial Balance will be higher by Rs.200. Similarly, if the
totalling is correctly done but a mistake is committed in balancing the
account, it would also cause a difference in the Trial Balance.
8.
Omission of an account from Trial Balance: You know that all
accounts which show some balance must be included in the Trial Balance. If you
forget to write the balance of any account in the Trial Balance, it will not
tally. In practice, cash book balances are often omitted from Trial Balance.
9.
Writing the balance of an account on the wrong side of the Trial Balance:
If the balance of an account which is to be shown in the debit column of the
Trial Balance is actually shown in the credit column, the Trial Balances will
not tally. It will be affected by double the amount.
10.
Wrong totaling of the Trial Balance : If a mistake is committed
in totalling the Trial Balance amount columns of the Trial Balance itself, the
Trial Balance will not tally. Thus, you learn about various errors which may
cause differences in the Trial Balance. Note that these errors affect only one
aspect (debit or credit). This upsets the debit-credit correspondence leading
to the disagreement of the Trial Balance.
Q - Discuss the errors not disclosed by the Trial
Balance.
Ans. ERRORS NOT
DISCLOSED BY TRIAL BALANCE
As stated earlier, the Trial Balance is only a
reasonable proof (not a conclusive proof) of the arithmetical accuracy of
accounting entries. There is no guarantee that when the Trial Balance has
tallied, there will be no errors left. As a matter of fact, there are a number
of errors which do not affect the Trial Balance at all. They are:
1.
Errors of Principle : When a transaction has not been recorded
as per the rules of debit and credit, or some other accounting principle has
been ignored, the errors so arising are called ‘Errors of Principle’. Example
of such errors are:
i) A credit purchase of a fixed asset recorded in the
Purchases Journal instead of the Journal Proper: This results in debiting the
Purchases Account instead of the concerned fixed asset account. It means that a
capital expenditure has been treated as a revenue expenditure. This is an error
of principle. This does not disturb the debit-credit correspondence. Hence, the
Trial Balance will not be affected.
ii) An expenditure incurred on repairs of machinery
debited to Machinery Account: As per rules it should have been debited to
Machinery Repair Account, as it is a revenue expenditure. Debiting to Machinery
Account amounts to treating it as a capital expenditure. It is therefore an
error of principle. This also does not affect the Trial Balance because the
debit has been duly recorded, though in the wrong account.
iii) Salary paid to Shyam recorded in the Cash Book as
a payment to Shyam : This results in debiting Shyam’s personal account instead
of the Salaries Account. This is also an error of principle and does not affect
the Trial Balance.
2.
Errors of Omission: When a transaction is completely or
partially omitted to be recorded in books of account, it is called an ‘Error of
Omission’. If the transaction is omitted to be recorded in the subsidiary books
or its posting is completely omitted, it is called an ‘Error of Complete
Omission’. If, however, the posting is done in one account, but omitted to be
done in the other, it is called an ‘Error of Partial Omission’. For example, if
a credit purchase of goods from Shyam is not recorded in the Purchases Journal
or a credit purchase of furniture from Ram is duly recorded in the Journal
Proper but no posting is done in any of the two accounts involved, then these
will be termed as errors of complete omission. If the purchase of goods from
Shyam is recorded in the Purchases Journal but is omitted to be posted in
Shyam’s Account, it will be called an error of partial omission. Other examples
of partial omission are: omission in carrying forward the total from one page
to the other, omission to balance an account, and so on.
The errors of complete omission do not, affect the
Trial Balance. But the errors of partial omission would certainly cause disagreement
of the Trial Balance because they would lead to either short debit or short
credit.
3.
Some Errors of Commission: When an error is committed in
recording a transaction in the subsidiary book with a wrong amount, or is
committed in posting it to a wrong account or to the wrong side of an account,
it is called an ‘Error of Commission’. Errors like double posting, wrong
totalling of an account, wrong carry forward, wrong balancing, etc., are also
regarded as errors of commission. Such errors will generally affect the Trial
Balance. But, if an error of commission is committed while recording a
transaction in any of the subsidiary books, it shall not affect the Trial
Balance because both the debit and the credit are equally affected. Suppose, a
machine of Rs.5,000 purchased on credit from Gautam is recorded in the journal
for Rs. 5,500. It means both the debit and the credit have been recorded for
Rs.5,500. Hence, the Trial Balance remains unaffected.
4.
Compensating Errors: Those errors which nullify the effect of
each other are called ‘Compensating Errors’. In other words, compensating
errors refer to such a group of errors wherein the effect of one error is
compensated by the effect of another error or errors. Such errors do not affect
the Trial Balance. For example, while posting an entry of Rs.200 to the debit
of Ram’s personal account, we wrongly wrote Rs.400. Then, while posting an
entry of Rs.500 to the debit of some other account we wrote Rs.300. The first
error will result in a higher debit of Rs.200 whereas the second error will
result in a lower debit of Rs.200. Thus, the effect of the first error is
nullified by the effect of the second error. So the Trial Balance will not be
affected. Take another example. The Purchases Journal is overcast by Rs.1,000
which means the Purchases Account will be debited in excess by Rs.1,000. The
sales journal also, by mistake, is overcast by Rs.1000 which means the sales
account will be credited in excess by Rs.1000. These two mistakes together
result in excess debit of Rs.1,000 as well as an excess credit of Rs.1,000.
Thus, they cancel out each other and the Trial Balance remains unaffected.
Q - State the Causes for
Depreciation.
Ans.
CAUSES OF DEPRECIATION
The causes of depreciation can be stated as follows:
1.
Wear and Tear : Wearing out of the asset on account of its
constant use is called wear and tear. This causes a definite reduction in the
value of the asset and is regarded as the major source of depreciation.
2.
Lapse of Time : Normally, the passage of time also causes
some reduction in the value of fixed assets because as they become old their
value stands reduced. That is why the depreciation is usually charged on time
basis. in case of certain assets like lease, patents, etc., the value decreases
with passage of time as they generally have a fixed number of years of legal
life. For example, a building is taken on lease for a period of 10 years
costing Rs. 1,00,000. The yearly depreciation of lease will amount to Rs.
10,000 (1/10 of Rs. 1,00,000) and charged as such to the Profit and Loss
Account every year.
3.
Obsolescence: The acquisition of an improved model may
render the existing machine obsolete. As the new machine performs the same
operation more quickly and/or more economically existing machine is said to
have become out of date or obsolete. This causes a drastic reduction in the
value of existing machinery and the amount of depreciation is bound to be
heavy.
4.
Depletion : Some assets are of a wasting character.
For example mines, quarries, oil wells etc. Due to continuous extraction of
materials the natural resources get depleted. Depreciation, in case of such
assets is often computed on the basis of actual depletion. For example, a coal mine
has the coal deposits of 200 million tons. In the first year we extract 10
m.tons of coal. The depreciation in the first five years shall amount to 10/200
of the cost of mine.
On
the basis of the causes mentioned above, it can be said that depreciation is a
permanent and continuous reduction in the value of an asset due to wear and
tear, passage of time, obsolescence, depletion or any other cause.
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