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How to Rectify Errors in Financial Accounts

Useful to B.COM,ICMAP & ICAP Students. Simple to Tough errors and their rectifications. How to Rectify Errors in Financial Accounts. Useful To lecturers Who enter Into Teaching profession. JOIN KHALID AZIZ. ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.

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How to Rectify Errors in Financial Accounts

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  1. Useful to B.COM,ICMAP & ICAP Students Simple to Tough errors and their rectifications How to Rectify Errors in Financial Accounts Useful To lecturers Who enter Into Teaching profession

  2. JOIN KHALID AZIZ • ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. • FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. • COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. • CONTACT: • 0322-3385752 • 0312-2302870 • R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

  3. Let us under stand the basic rules, concepts and conventions • Understanding basic rules of accounting, concepts and conventions help you to under stand the rectification of errors better.

  4. 1.concepts& conventions • Meaning: Basic assumptions upon which the basic process of accounting based. • a] Business entity concept- • b] Dual aspect concept • c] Going concern concept • d] Accounting period concept • e] Cost concept • f] Money measurement concept • g] Matching Concept • Conventions Coservativism Materiality Consistency

  5. a] Business entity concept- • Business is different from the owner • We pass Journal entry when owner contributes towards capital. • When amount / goods withdrawn for personal use we make an entry in the business • When Income tax paid by the owner out of business money we make an entry In the books of accounts.

  6. b] Dual aspect concept • Every debit has equal amount of credit • Asset =Liability • Liability creates asset • If asset>Liability= profit • If Liability> Assets= loss

  7. c] Going concern concept • Business will go for at least for a reasonable period. • Depreciation is provided based on this assumption. • If this assumption is not made all Fixed assets will be valued at realised value like current assets.

  8. d] Accounting period concept • Fixing time limit for accounts • Profit for the period • It can be one week or two week or 6 months/one year or 5 years • But to find profit we normally consider 12 months period • Financial year for income tax point of view 1st April-31st March of the following year • Calendar year –January to December • Dipavali to Dipavali

  9. e] Cost concept • The cost to the organisation (Actual) is recorded in the books • Assets are not recorded according to the market price every year. • Depreciation is calculated on cost not based on market price • Accounting records may not show the real worth of the business • Market price may be disclosed with in bracket in the balance sheet

  10. f] Money measurement concept • Every thing which can be expressed in terms of Money is recorded in the books • Beautiful women are working /Handsome boys working in TEC /Efficient engineers worth Rs.5000 crores –How do you record?. • Good working environment? • Highly motivated employees? • Qualitative information are not accounted.

  11. Answer We do not have record for qualitative aspects. They can enter this transaction under Human resource accounting rather than financial accounting.

  12. g] Matching Concept • Matching Cost with revenue • It is used to estimate correct profits • Accrual/ cash basis of accounting • Even cash paid /received if it belongs to accounting period we consider them as expenditure /income • Salary outstanding for the last month? • Income from Investments yet to be received? • Rent received in advance for next year? • Salary outstanding for the last month to be considered as expense of the current year under accrual basis of accounting.

  13. Matching concept- continues • Income from investment yet to be received to be considered for the current year as it belongs to current year.The year of receipt is not important. • Rent received in advance does not belong to current year under accrual method of accounting as it belongs to next year even though it is received during the current accounting year.

  14. Conventions • Customs and traditions that are followed by the accountants while preparing the financial statements. • Why do we respect elders? • Why do we shake hands? • Why do Young Indians hate receiving dowry? • Why do students come late to class? • Why do Indians work hard?

  15. Coservativism • To be on the safer side • Expect future losses as current year loss • But future income is not treated as current year income. • Stock is valued cost price / market price which ever is lower • Making provision for bad debts is based on this assumptions.

  16. Materiality • Material impact on profitability are considered • Insignificant transactions ignored from recording • Pen purchased, pencil purchased? • It comes under stationary. It can not be disclosed(Shown) separately like pen account or pencil account.

  17. Consistency • Accounting policies and procedures should be followed consistently • Method of depreciation should be followed consistently. • Stock valuation- cost/market price whichever is lower is consistently followed • If not followed it amounts to change in the policy of the company

  18. 2.system of accounting (26) • 1.Cash system: • unless cash received /paid in the accounting year can not be considered as income/expenses respectively

  19. 2.Mercantile • Mercantile/Accrual/due concept: • Even cash received/paid but due for payment/due for receipt (yet to be received/payable) if they belong to current accounting year are considered. • If last year expenditure paid this year? • If you receive/paid in advance ? • If last year expense paid during the current year can not be considered as current year expenditure.In the same way any income received in advance at the end of current year should not be entered as current year income or expenditure.

  20. 3.Types of Expenditure • A) Capital expenditure • B) Revenue expenditure • C) Deferred Revenue expenditure

  21. JOIN KHALID AZIZ • ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. • FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. • COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. • CONTACT: • 0322-3385752 • 0312-2302870 • R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

  22. A) Capital expenditure(30) • Expenditure incurred which will : • Increase Production capacity • Increase earning capacity • Reduction in the cost of operation. Example: purchase of fixed assets Purchase of Machinery purchase of investment If such expenditure is not to do with the basic functions of the business such expenditure is capital expenditure. How do you consider if you buy goodwill, copy right or patent right?

  23. Capital expenditure-continue(page-30) Both tangible and intangible assets included Intangible assets such as patent right, copy right, technical know-how, franchises, goodwill etc., Depreciation is provided on fixed assets. Depreciation appears in the profit and loss account The asset appears in the Balance sheet (after deducting depreciation) The life is more than one year They should not appear in the profit and loss account

  24. Revenue Expenditure • Expenditure incurred which will : • Not Increase Production capacity • Not Increase earning capacity • maintain the capacity No Depreciation is provided on current assets which will appear in the profit and loss account They appear in the profit and loss account The life is not more than one year They should not appear in the balance sheet

  25. Wrong treatment? • When goods purchased(dealer in such goods) it is a revenue expenditure. It should appear either in the trading account or profit and loss account. • If it appears as an asset , then you inflate the profits which gives a wrong profit to the firm.It also affects the assets(over stated) which gives over stated financial position.

  26. Example: • Your father purchased 20 kg rice bag costing Rs.600 and your mother purchased a fridge for Rs. 15000 on the same day.Rise is to be treated as monthly expenditure where as fridge to be treated as long term expenditure(Capital expenditure). • Instead, if such purchase of rice accounted with fridge it means monthly expenditure decreased and long term expenditure is increased. • Accounting point of view rice goes to trading account to find out cost of the month and fridge goes to Balance Sheet on the asset side as a part of asset.

  27. Suppose fridge cost is added with rice, then your monthly expenditure will be high and asset account is reduced. • The indirect impact is that depreciation would not have been provided on such asset as it is included with revenue(Rise)account which affects profits. • Example-2: • Building purchased for Rs.20,00,000 entered into purchase account.Building depreciates by 10% under straight line method.

  28. Here it is entered into purchase account. It means you are treating it as goods(dealer in real estate) which is a revenue expenditure instead of capital expenditure.Your profit is less by Rs. 20,00,000. But had been entered into building account the profit would have been more by Rs.20,00,000. • Because it is entered in the purchase account we had forgotten to provide depreciation of Rs.2,00,000 which should had been done. • Net effect to rectify the error is:- Increase the profits by Rs.18,00,000. And increase the asset should be increased by 18,00,000.

  29. Suppose you are a dealer in building(Real estate) • Purchase of building is considered as goods(dealer in building).The entry made in purchase account is correct. No need to rectify such transaction. • Suppose you buy furniture(dealer) for Rs.20000 entered into furniture account.What is the effect? How do you rectify?

  30. Here the mistake is that revenue expenditure is treated as capital expenditure.The correct journal entry is Purchase a/c debit and cash a/c credit. • Wrong entry is: Furniture a/c debit and cash is credited. • In the absence of information we assume the mistake with respect to furniture and purchase but there is no mistake with respect to cash account because cash payment is correct.

  31. Deferred revenue expenditure(page-30) • Deferred means- postponed • Heavy revenue expenditure • Vodafone incurred 200 crores for advertisement after merger with Hutch • It can not be written off within a year • It appears in the balance sheet as last item • Every year some amount is written off in the profit and loss account. • Research and development expenditure, initial advertisement expenditure, preliminary expenditure are example

  32. 5.Double entry / Single entry • Is Accounting based on business concept or religious concept? • Giving first and receiving later. • Giving cash receiving machinery • We consider both aspects such as debit and credit

  33. Rules of accounting • Personal rule/Account-supplier debtors, owner, banker, outstanding wages • Real rule/Account- cash, bank, building, furniture, goodwill, patent rights • Nominal rule/account: income and expenditure: salary, rent , insurance, commission, internet expenses, cell phone expenses.

  34. Personal rule • Debit the receiver • credit the giver • Example: Computer chips purchased on credit from wipro • Here credit Wipro as Wipro is the giver of computer. • Sold goods to Meena • Meena is the receiver-debit

  35. Exercise • Amount collected from debtors? • Amount deposited to bank? • Amount collected from debtor: Cash and debtor are important.Cash is related to real rule • Debit what comes in and credit what goes out • Therefore cash to be debited and debtors belong to personal rule.Credit the giver. Therefore credit debtor account. • Cash deposited to bank : JE: Bank a/c debit and cash to be credited.

  36. Real rule • These are the accounts of assets and liabilities • Rule: debit what comes in • Credit what goes out

  37. Nominal rule • Related to Expenses and income • Rule: Debit all expenses and losses • Credit all incomes and gains

  38. Suitable questions to pass journal entry • If cash transaction, person is not important • Every birth of an account there is a death of the account • Ask what comes in? • Or what goes out?

  39. Let us pass Correct Journal entries for a few transactions General rules:- All assets are debited if it comes to business(when you buy for business) All liabilities are credited when borrowed. All expenses are debited and All income and gains are credited. If it is a credit transaction person is important. If it is a cash transaction person is not important.(like cash purchase or cash sales)

  40. Pass Journal entries • 1. Capital introduced by owner Rs. 20 lakhs. • Answer: • Business point of view owner is different from business. Business receives cash and the giver is owner. • JE: Cash a/c debit(Real rule) • Capital a/c credit(Personal rule)

  41. JOIN KHALID AZIZ • ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. • FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. • COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. • CONTACT: • 0322-3385752 • 0312-2302870 • R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

  42. 2. • Borrowed loan Rs. 10,00,000 • Answer: • Cash comes to business and loan vendor account is important. • JE: Cash a/c debit(Real rule) Loan a/c credit(Personal rule)

  43. 3. • Company issues Shares to public Rs.50,00,000. • Answer: • Cash comes to business. Many owners given this money. • JE: Cash a/c debit (Real rule) Share capital a/c credit(Personal rule)

  44. 4. • Partners contributed capital to business: A Rs.55,00,000 cash and B Rs.19,00,000 in cash, building worth Rs.50,00,000, furniture worth Rs.25,00,000 and his good will Rs.10,00,000. • Answer: • JE: 1.Cash a/c debit Rs.55,00,000(Real rule) A’s Capital a/c credit Rs. 55,00,000 (personal rule) 2. Cash a/c debit Rs.19,00,000(Real rule) Building a/c debit Rs. 50,00,000(Real rule) Furniture a/c debit Rs. 25,00,000(Real rule) Good will a/c debit Rs. 10,00,000(Real rule) B’s Capital credit Rs.104,00,000 (Personal Rule) Here cash, building, furniture and good will are assets coming to business therefore debited.The giver is B therefore credited.

  45. 5 Share broker purchased shares Rs. 25,00,000. Answer: Shares are coming to business. First understand the nature of business. Being a share broker shares are considered as goods(a revenue expenditure). Goods are purchased for cash. JE: Purchase of goods a/c debit Rs.25,00,000 (Real rule) Cash a/c credit Rs.25,00,000 (Real rule)

  46. 6. Infosys buy shares of Wipro Rs.20,00,000 for cash. Answer: Here Infosys is not a dealer in shares. It is a capital expenditure. It is not goods. It is a cash transaction. JE: Investments a/c debit Rs.20,00,000(Real rule) Cash(Bank) a/c credit Rs.20,00,000 (Real rule)

  47. 7. • Debentures issued by ICICI Bank for Rs.1 crore. • Answer: ICICI point of view, it is a loan.Cash collected. JE: Cash a/c debit Rs.1 crore(Real rule) Debenture a/c credit rs. 1 crore (personal rule)

  48. 8 Building acquired by Wipro by issue of shares Rs.20,00,00,000. Answer: It is a capital expenditure.Here no cash paid but given shares.The person who supplied shares are share holders(owners) JE: Building a/c debit Rs. 20 crores(Real rule) Share capital a/c Rs.20 crores(personal rule) Note: share capital does not come under real rule but share capital belongs to person who owns them.

  49. 9 Shares of Wipro limited held by Infosys sold for Rs.25,00,000. Answer: The investments sold; the capital receipt. When ever we use the term ‘sales account’ it indicates the goods that the company deal. JE: Cash a/c debit Rs.25,00,000(real rule ) Investments a/c credit Rs. 20,00,000 (Real rule) Profit on sale of investment a/c credit Rs.5,00,000 (Nominal rule)

  50. 10 Salary paid to Kumaran Rs.50,000 Answer: Salary paid for services rendered by Kumaran.Kumaran is not a creditor. Salary is an expenditure. JE: Salary a/c debit 50,000 Cash a/c credit Rs.50,000 If we enter into Kumeran account by using personal rule, kumeran account were to be opened.How do you close his account? Salary is important rater than Kumeran.If you cannot close any time during the life of the company do not open such account. In the same way rent paid to land lord can not be entered into land lord account.Instead it should be entered in the rent account.

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