ACCOUNTING AND FINANCE BANKERS J A I I B PAPER-2 SPECIAL ACCOUNTS - MODULE ‘ C ‘

1. ACCOUNTING AND FINANCE BANKERS J A I I BPAPER-2SPECIAL ACCOUNTS - MODULE ‘ C ‘ By RAVI ULLAL CONSULTANT

2. TOPICS • BANK RECONCILIATION • TRIAL BALANCE • CAPITAL & REVENUE EXPENDITURE • INVENTORY VALUATION • BILLS OF EXCHANGE • CONSIGNMENT ACCOUNT • JOINT VENTURE • LEASING & HIRE PURCHASE • NON-TRADING ORGANISATIONS • DEPRECIATION • MODEL QUESTIONS

3. BASICS OF ACCOUNTING • DOUBLE ENTRY SYSTEM • 3 TYPES OF ACCOUNTS: -- REAL: ASSETS OF BUSINESS, TANGIBLE AND IDENTIFIABLE. -- PERSONAL: THEY ARE HEADED WITH THE NAME OF PERSON/BUSINESS/FIRM. DEBTORS OR CREDITORS. -- NOMINAL: THEY RECORD TRANSACTIONS OF INTANGIBLES SUCH AS RENT EXPENSES. .

4. BASIC RULES OF ACCOUNTING RULES: -- REAL : DEBIT THE ACCOUNT WHEN WE PURCHASE AN ASSET & CREDIT WHEN WE SELL OR DEPRECIATE. -- PERSONAL : DEBIT THE RECEIVER OF GOODS & CREDIT THE GIVER OF GOODS. -- NOMINAL : DEBIT LOSSES & EXPENSES, CREDIT INCOMES & GAINS. -- IN A LEDGER, ASSETS OR LOSSES HAVE DEBIT BALANCE WHILE LIABILITIES OR GAINS HAVE CREDIT BALANCE.

5. BANK RECONCILIATION STATEMENT • BANK RECONCILIATION( B. R. ) IS BASED ON THE PRINCIPLE OF DOUBLE ENTRY. • CREDIT THE GIVER AND DEBIT THE RECEIVER • B. R. SHOWS CAUSES OF DIFFERENCES BETWEEN CASH BOOK AND PASS BOOK BALANCE • DEBIT BALANCE AS PER CASH BOOK IS CREDIT BALANCE AS PER PASS BOOK = POSITIVE BALANCE • CREDIT BALANCE IN CASH BOOK IS DEBIT BALANCE IN PASS BOOK = NEGATIVE BALANCE/OVERDRAFT • WHETHER WE START WITH CASH OR PASS BOOK RECONCILIATION ENTRIES WILL REMAIN SAME AS PER PRINCIPLES

6. BANK RECONCILIATION STATEMENT • CAUSES OF DIFFERENCESTREATMENT CASH/PASS BOOK DT. CR. . • CHEQUES ISSUED BUT NOT PRESENTED √ • CHEQUES DEPOSITED BUT NOT COLLECTED √ • BANK CHARGES √ • INTEREST ON SAVINGS BANK √ • INTEREST ON LOAN √ • AMOUNT PAID BY BANK AS PER √ STANDING INSTRUCTIONS . DIRECT PAYMENTS MADE BY CUSTOMERS √ . DISHONOUR OF CHEQUES RECEIVED √

7. BANK RECONCILIATION STATEMENT • CAUSES OF DIFFERENCES TREATMENT CASH/PASS BOOK DT. CR. . PAYMENTS SIDE OF CASH BOOK UNDERCAST √ . DEPOSIT SIDE OF CASH BOOK OVERCAST √ . CHEQUE ISSUED BUT NOT TAKEN IN BANK COLUMN √ . DEBIT BALANCE X BROUGHT FORWARD AS CREDIT BALANCE 2X . CHEQUE ISSUED BUT RECORDED TWICE √

8. BANK RECONCILIATION STATEMENT IMPORTANT : WHETHER WE ARE RECONCILING PASS BOOK OR CASH BOOK , EACH OF THE RECTIFICATION ENTRIES WILL APPEAR ON THE SAME SIDE . ADDITION OR SUBRACTION OF ENTRIES FROM THE OPENING OR GIVEN BALANCE DEPENDS UPON WHICH SIDE OF THE LEDGER THEY ARE CAST OR TO BE CAST. THUS WHAT WE SIMPLY NEED TO KNOW IS WHETHER EACH FIGURE GIVEN IN THE PROBLEM IS A DEBIT OR CREDIT ENTRY. I WILL EXPLAIN WITH THE HELP OF A PROBLEM LATER.

9. BANK RECONCILIATION STATEMENT SIMPLY PUT, IF AN ENTRY IS ALREADY THERE BUT EITHER THE WHOLE OR PART IT HAS TO BE RECTIFIED THEN THAT PORTION IS POSTED ON THE OPPOSITE SIDE OF THE ORIGINAL ENTRY.

10. BANK RECONCILIATION STATEMENT ADVANTAGES OF BANK RECONCILIATION . VERIFICATION OF ACCURACY OF ENTRIES . TIMELY CORRECTIVE ACTION . PREVENTS FRAUDS . CONTROL TOOL FOR MANAGEMENT

11. EXAMPLES • X co .was maintaining account with KRB Bank Ltd. On 31st December,2006, Bank column of cash book of company showed a debit balance of Rs. 26000. Cheques deposited into the bank but not credited before 31st December,2006 amounted to Rs.4000 Bank charges of Rs. 500 were debited by the bank but no entry was made by the accountant of the company. From the above particulars, find out the balance as per KRB Bank’s books. • Rs.30500 • Rs.25500 • Rs.21500 • Rs.22500

12. EXAMPLES When overdraft as per cash book and a Cheque of Rs.1000 directly deposited in the bank, but not recorded in cash book---- a) Add Rs.1000 in CB b) Deduct Rs.1000 in CB c) Add Rs.2000 in cash book d) Deduct Rs.2000 in CB Undercasting of the credit side of Cash Book has the same effect as overcasting of the– • Debit side of the pass book. • Credit side of the pass book. • There is no relevance between the two

13. TRIAL BALANCE • DEFINITION • IT IS A STATEMENT SHOWING CREDIT AND DEBIT BALANCES FROM THE LEDGER. • HELPS ARITHMETICAL ACCURACY AND FACILITATES FINAL ACCOUNTS.

14. TRIAL BALANCE • BASIC PRINCIPLE : • SINCE IT IS DOUBLE ENTRY BOOK-KEEPING, HENCE, ASSETS AND EXPENSES ARE DEBIT BALANCES LIABILITIES AND INCOMES ARE CREDIT BALANCES . IN CASE OF ARITHMETICAL INACCURACY IDENTIFY CLERICAL/PRINCIPLE ERRORS AND RECTIFY

15. TRIAL BALANCE • TYPES OF ERRORS: • A) CLERICAL ERRORS • -- ERRORS OF OMISSION --- OMISSION OF TRANSACTION FROM BOOKS --- COMPLETE OMISSION NOT AFFECTING TRIAL BALANCE --- PARTIAL OMISSION AFFECTING TRIAL BALANCE

16. TRIAL BALANCE • -- ERRORS OF COMMISSION --- FIGURE POSTED ON THE WRONG SIDE OR WITH WRONG AMOUNT -- COMPENSATING ERRORS --- ONE ERROR BALANCES ANOTHER ERROR . B) ERRORS OF PRINCIPLE -- ERRORS IN CONTRAVENTION OF ACCOUNTING PRINCIPLES

17. TRIAL BALANCE • RECTIFICATION OF ERRORS IS A SERIES OF STEPS: • PASS THE CORRECT ENTRY • COMPARE THE WRONG ENTRY WITH THE CORRECT ONE • PASS THE RECTIFICATION ENTRY • IF TRIAL BALANCE DOES NOT TALLY THEN DIFFERENCE IS TRANSFERRED TO SUSPENCE ACCOUNT

18. TRIAL BALANCE TYPICAL TRIAL BALANCE N A M EDEBIT CREDIT • CAPITAL X • DRAWINGS X • PURCHASES X • SALES X • EXPENSES X • DEBTORS(CUSTOMRES) X • CREDITORS(SUPPLIERS) X • CASH X • SALES RETURN X

19. TRIAL BALANCE • TYPICAL ERRORS: • -- CLERICAL: • A) SALARY PAID 1000/- BUT POSTED AS 10, 000/-. • RECTIFICATION: CREDIT SALARY WITH 9000/-. • B) SALARY PAID 1000/- BUT POSTED IN RENT A/C. • RECTIFICATION: DEBIT SALARY AND CREDIT RENT WITH 1000/-. • C) GOODS WORTH 100/- SOLD TO VIJAY WRONGLY RECORDED IN PURCHASE REGISTER. • RECTIFICATION: CREDIT SALES AND PURCHASE A/Cs WITH 100/- EACH AND DEBIT VIJAY WITH 200/-.

20. TRIAL BALANCE AFTER TRIAL BALANCE IS PREPARED ONE FINDS . D) SALES OF 500/- POSTED AS 5000/- WHILE RENT PAID 500/- POSTED AS 5000/-. . RECTIFICATION: DEBIT SALES WITH 4500/-, CREDIT SUSPENCE WITH 4500/-, CREDIT RENT WITH 4500/-, DEBIT SUSPENCE WITH 4500/-. • E) SALARY PAID AS 1000/- BUT POSTED AS 10,000/- IN RENT A/C. • RECTIFICATION: DEBIT SALARY WITH 1000/- SUSPENCE WITH 9000/-; CREDIT RENT WITH 10000/- • F) A PURCHASER’S DEBIT BALANCE OF 9000/- HAS NOT BEEN TAKEN. • RECTIFICATION: DEBIT DEBTORS, CREDIT SUSPENCE TO THE EXTENT OF 9000/-.

21. Rectification of Errors-Examples (1) Rs. 5000 paid as wages for installing the machinery should be debited to----- • Wages A/c • Machinery a/c • Capital A/c • None of the above (2) Sales to Navin of Rs.1000 is debited to Ravin A/c. this will be rectified by----- • Debiting Navin a/c and Crediting Ravin A/c • Debiting both Accounts • Debiting Ravin a/c and Crediting Navin A/c • Debiting Navin A/c and crediting Sales A/C

22. Rectification of Errors-Examples (1) Rs. 5000 paid as wages for installing the machinery should be debited to----- • Wages A/c • Machinery a/c • Capital A/c • None of the above (2) Sales to Navin of Rs.1000 is debited to Ravin A/c. this will be rectified by----- • Debiting Navin a/c and Crediting Ravin A/c • Debiting both Accounts • Debiting Ravin a/c and Crediting Navin A/c • Debiting Navin A/c and crediting Sales A/C

23. Rectification of Errors-Examples • Credit sale of Rs.5000 to Suresh is posted to his credit, then rectification is • Credit Suresh to the extent of Rs.10,000 • Credit Suresh to the extent of Rs.5,000 • Debit Suresh to the extent of Rs.10,000 • Debit Suresh to the extent of Rs.5000 • Freight expenses for carrying New Machinery is carried to Traveling Exp. a/c. Choose the correct rectification entry • Debit machinery a/c and credit Traveling Exp a/c. • Credit machinery a/c and debit Freight Exp a/c • Credit profit and loss account and debit Freight Exp a/c. • Debit profit and loss a/c( P&L a/c) and credit Traveling Exp a/c.

24. CAPITAL AND REVENUE EXPENDITURE BASIC PRINCIPLE: . ALL EXPENSES AND RECEIPTS OF REVENUE NATURE ARE TAKEN TO TRADING AND PROFIT & LOSS ACCOUNT . ALL EXPENDITURES AND RECEIPTS OF CAPITAL NATURE ARE TAKEN TO BALANCE SHEET

25. CAPITAL AND REVENUE EXPENDITURE REVENUE RECEIPTS/PAYMENTS : . ARE SMALLER IN SIZE(RELATIVELY) . ARE RECURRING IN NATURE . THE BENEFITS ARE OVER A SHORTER PERIOD (1 YEAR) . THE PURPOSE IS TO RUN THE BUSINESS ON A DAY TO DAY BASIS . MAINTAIN ASSETS IN WORKING CONDITION

26. CAPITAL & REVENUE EXPENDITURE • CAPITAL RECEIPTS/PAYMENTS: • ARE USUALLY LARGE(RELATIVELY) • ARE NON-RECURRING IN NATURE • THE BENEFITS ARE OVER LONGER DURATION • THE PURPOSE IS TO ENHANCE PRODUCTIVITY OF THE ASSETS

27. CAPITAL AND REVENUE EXPENDITURE • THERE ARE CERTAIN EXPENDITURES WHICH ARE OTHERWISE REVENUE IN NATURE BUT SOMETIMES UNUSUALLY LARGE AND WHOSE BENEFIT TO THE ORGANISATION MAY ACCRUE AFTER FEW YEARS.THESE MAY BE TREATED AS DEFERRED REVENUE EXPENDITURE , CARRIED TO THE BALANCE SHEET , AND WRITTEN OFF TO THE PROFIT & LOSS ACCOUNT OVER A PERIOD OF TIME.

28. CAPITAL AND REVENUE EXPENDITURE SAME IS THE CASE WITH CERTAIN RECEIPTS SUCH AS SALE OF ASSETS, WHERE THE RECEIPTS UPTO BOOK VALUE IS DEDUCTED FROM THE ASSET, AND , IF BETWEEN BOOK VALUE & COST AS REVENUE RECEIPT & ABOVE COST AS CAPITAL RECEIPT. . THERE IS A THIN LINE BETWEEN CAPITAL & REVENUE CLASSIFICATION. FOR INSTANCE REPAIRS TO MACHINERY WHICH KEEPS THE ASSET IN WORKING CONDITION IS CHARGED TO THE P & L A/C WHILE BETTERMENT EXPENSE IS CAPITALISED.

29. CAPITAL & REVENUE EXPENDITURE • EXAMPLES OF EACH TYPE OF CLASSIFICATION: • CAPITAL NATURE: -- PURCHASE OF ASSETS SUCH AS BUILDING, MACHINERY, VEHICLES. -- EXPENDITURE IN PURCHASE /SETTING UP OF CAPITAL GOODS/ASSETS -- EXCESS OF SALE PRICE OF ASSET OVER ITS COST PRICE -- FUNDS RAISED THRU BANKS/INSTITUTIONS -- FUNDS RAISED THRU ISSUE OF SHARES, & DEBENTURES

30. CAPITAL AND REVENUE EXPENDITURE • REVENUE NATURE: • ALL TRANSACTIONS RELATING TO NOMINAL ACCOUNTS • EVEN CERTAIN EXPENSES OF NON-RECURRING NATURE BASED ON MATERIALITY CONCEPT • EXCESS OF SALE VALUE OF ASSET OVER W D VALUE UPTO COST OF ASSET

31. CAPITAL AND REVENUE EXPENDITURE • DEFERRED REVENUE EXPENDITURE: • LARGE ADVERTISING EXPENDITURE FOR(SAY) LAUNCH OF A PRODUCT • EXPENDITURE FOR RAISING OF FUNDS INCLUDING PREPARATION OF PROJECT REPORT • INITIAL EXPENSES FOR SETTING UP OF A COMPANY

32. Cap. & Rev. Expenditure-Examples (1)Cost of replacement of defective parts of the machinery is ----- • Capital expenditure • Revenue expenditure • Deferred revenue expenditure (2) Loss of goods due to fire Rs.8000 is a revenue expenditure because---- • It is recurring • Amount involved is small • Loss is arising out of business operations

33. Cap. & Rev. Expenditure-Examples (3) Expenditure incurred in acquiring the patents rights for the business is an example of ---- • Capital expenditure • Deferred revenue expenditure • Revenue expenditure (4) Professional fees paid in connection with acquisition of leasehold premises is---- • Capital expenditure • Deferred revenue expenditure • Revenue expenditure

34. Examples (5)Preliminary expenses , discount allowed on issue of shares are the examples of • Capital expenditure • Deferred revenue expenditure • Revenue expenditure (6) Machinery costing Rs.10,000, whose current book value is Rs.7000 is sold for Rs.12000 what is the amount of capital & revenue receipt • Capital receipt of Rs. 2000 & Rev. Receipt of Rs.10000 • Capital receipt of Rs. 9000 & Rev. Receipt of Rs.3000 • Capital receipt of Rs. 12000 & Rev. Receipt of Rs.Nil

35. INVENTORY VALUATION • VALUATION OF STOCKS IS IMPORTANT FROM THE POINT OF INCOME DETERMINATION. • THE DANGER COULD BE OF EITHER OVERVALUATION OR UNDERVALUATION OF STOCKS RESULTING IN OVERSTATING OR UNDERSTATING OF PROFITS. • METHODS OF VALUATION: • -- FIFO • -- LIFO • -- AVERAGE OR WEIGHTED AVERAGE COST METHOD • -- BASE STOCK METHOD • -- ADJUSTED SELLING PRICE METHOD

36. INVENTORY VALUATION • UNDER FIFO GOODS ISSUED TO PRODUCTION IS VALUED AT THE EARLIEST PRICE WHEREAS THE CLOSING STOCK IS AT THE LATEST PRICE. • UNDER LIFO GOODS ISSUED TO PRODUCTION IS VALUED AT THE LATEST PRICE WHEREAS THE CLOSING PRICE IS AT THE EARLIEST PRICE. • UNDER WEIGHTED AVERAGE COST METHOD ARITHMETIC MEAN OF TOTAL PRICE BY TOTAL QUANTITY RECEIVED IS TAKEN FOR VALUATION.

37. INVENTORY VALUATION • ADJUSTING SELLING PRICE METHOD IS GENERALLY USED BY SMALL BUSINESSMEN WHO ARE UNABLE TO DIFFERENTIATE VARIOUS COSTS. • HENCE THEY VALUE THE STOCKS AT SELLING PRICE AND THEN REDUCE ITS VALUE TO THE EXTENT OF ESTIMATED GROSS MARGIN.

38. INVENTORY VALUATION • BASE STOCK METHOD IS SIMILAR TO LIFO. CLOSING STOCK IS ALWAYS AT COST AT THE BEGINNING OF BUSINESS. IN TIMES OF INFLATION VERY LOW VALUE OF STOCK MAKES FOR EXCELLENT ACCOUNTING. IT HOWEVER REQUIRES A MINIMUM STOCK TO BE MAINTAINED. • PRESENTLY ACCOUNTING STANDARDS PERMIT FIFO(HISTORICAL PRICE) OR WEIGHTED AVERAGE COST METHOD. • VALUE OF STOCK CAN BE ASCERTAINED BY PERIODIC(PHYSICAL VERIFICATION) OR PERPETUAL INVENTORY ( MAINTAINENCE OF STOCK REGISTER).

39. INVENTORY VALUATION • CHARACTERISTICS OF DIFFERENT METHODS OF INVENTORY VALUATION • FIFO : -- IN RISING MARKET FIFO RESULTS IN HIGHER PROFITS LOCKING UP OF SCARCE W. C. -- GOODS ARE SOLD AT CURRENT HIGHER PRICES WHILE COST OF GOODS REFLECTS LOWER THAN CURRENT COSTS -- IN FALLING MARKET FIFO RESULTS IN LOWER PROFITS .

40. INVENTORY VALUATION • -- LIFO : • -- IN FALLING MARKET THE EFFECT IS THE SAME AS THAT OF FIFO IN RISING MARKET • -- IN RISING MARKET THE EFFECT IS SAME AS THAT OF FIFO IN FALLING MARKET.

41. INVENTORY VALUATION • IN THIS CHAPTER IT IS IMPORTANT TO DISCUSS THE VARIOUS ACCOUNTING CONVENTIONS • CONSERVATISM CONCEPT: RECOGNITION OF INCREASES IN EARNINGS REQUIRES BETTER EVIDENCE THAN DOES RECOGNITION OF DECREASES THAT IS EXPENSES • REALISATION CONCEPT: RECOGNITION OF AMOUNT OF REVENUE THAT HAS CERTAINTY OF REALISATION • MATCHING CONCEPT: RECOGNITION OF REVENUES AND EXPENSES FOR A CERTAIN EVENT.

42. INVENTORY VALUATION • CONSISTENCY CONCEPT: ONCE A CERTAIN METHOD IS DECIDED UPON FOR ALL SUBSEQUENT EVENTS OF THE SAME CHARACTER THE SAME METHOD SHOULD BE USED UNLESS THERE IS A SOUND REASON TO CHANGE • MATERIALITY CONCEPT: DEPENDING UPON JUDGEMENT AND COMMON SENSE IMMATERIAL EVENTS / TRIVIAL MATTERS SHOULD NOT BE GIVEN MORE IMPORTANCE THAN WARRANTED. • HISTORICAL COSTS: COST OF ACQUISITION – DISCOUNTS, IF ANY, + COSTS INCIDENTAL TO BRINGING THE ASSET/ ERECTING THE ASSET.

43. BILLS OF EXCHANGE • BILL OF EXCHANGE IS THE VEHICLE FOR CREDIT TRANSACTIONS IN BUSINESS; HAS 3 PARTIES: DRAWER – WHO MAKES THE BILL/ CREDITOR; DRAWEE – ON WHOM THE BILL IS DRAWN; PAYEE -- WHO RECEIVES THE MONEY; SOMETIMES DRAWER & PAYEE ARE THE SAME. ACCEPTANCE TO PAY BY THE DRAWEE IS ESSENTIAL. .

44. BILLS OF EXCHANGE . PROMISSORY NOTE IS SIMILAR ; HAS ONLY 2 PARTIES BUT SIGNED BY DEBTOR; NOTING NECESSARY. . ACCOMODATION BILL : THERE IS NO TRANSACTION; THE BILL IS DISCOUNTED TO RAISE MONEYS FOR BOTH PARTIES, WHO SHARE THE AMOUNT.

45. BILLS OF EXCHANGE • TYPICAL ENTRIES: . THE ENTRIES IN THE BOOKS OF DRAWER ‘A’ ARE: • DIRECT BILL TRANSACTION • BILLS RECEIVABLE a/c DR. TO DRAWEE ‘B’ . CASH a/c DR. TO BILLS RECEIVABLE ( BILL IS MET ON DUE DATE)

46. BILLS OF EXCHANGE BILL ENDORSED TO C . C’s a/c DR. TO BILLS RECEIVABLE ( NO ENTRY WHEN BILL IS MET) BILL SENT FOR COLLECTION . BANK FOR BILL COLLECTION a/c DR. TO BILLS RECEIVABLE . CASH a/c DR. TO BANK FOR BILL COLLECTION ( BILL SENT FOR COLLECTION IS MET) . . .

47. BILLS OF EXCHANGE IN CASE OF DISCOUNTING CASH a/c DR. DISCOUNT a/c DR. TO BILLS RECEIVABLE ( NO ENTRY WHEN BILL IS MET) THE ENTRIES IN THE BOOKS OF DRAWEE ‘B’: .. A’s a/c DR. TO BILLS PAYABLE . BILLS PAYABLE a/c DR. TO CASH ( BILL IS PAID)

48. BILLS OF EXCHANGE • THERE ARE CASES WHEN BILLS ARE DISHONOURED. • IN THAT CASE THE ENTRIES ARE AS FOLLOWS: IN A’s BOOKS: BILL DIRECTLY SENT FOR PAYMENT B’s A/C DR. TO BILLS RECEIVABLE TO CASH ( CASH IS THE NOTING CHARGE) DISHONOUR OF DISCOUNTED BILL . BILLS RECEIVABLE A/C DR. NOTING CHARGES A/C DR. TO CASH (CASH (notary charges) IS PAID TO THE BANK)

49. BILLS OF EXCHANGE • -- B’s a/c DR. • TO BILLS RECEIVABLE • TO NOTING CHARGES • (BILL RETURNED TO ‘A’) DISHONOUR OF BILL SENT BY BANK FOR PAYMENT • BILL RECEIVABLE a/c DR. • NOTING CHARGE a/c DR. • TO CASH • TO BANK FOR BILL COLLECTION ( DISHONOUR OF BILL FOR COLLECTION) . B’s a/c DR. TO BILLS RECEIVABLE TO NOTING CHARGES (BILL RETURNED TO B)

50. BILLS OF EXCHANGE • DISHONOUR OF ENDORSED BILL . BILLS RECEIVABLE a/c DR. • NOTING CHARGES a/c DR. • TO C • B’s a/c DR. • TO BILLS RECEIVABLE • TO NOTING CHARGES (BILL RETURNED TO B)