Test Your Understanding – IV
\nTick the Correct Answer<\/span><\/p>\nQuestion 1.
\nWhich of the following is not a business transaction?
\n(a) Bought furniture of Rs. 10,000 for business
\n(b) Paid for salaries of employees Rs. 5,000
\n(c) Paid sons fees from her personal bank account Rs. 20,000
\n(d) Paid sons fees from the business Rs. 2,000
\nAnswer:
\n(c) Paid sons fees from her personal bank account Rs. 20,000<\/p>\n
Question 2.
\nDeepti wants to buy a building for her business today. Which of the following is the relevant data for his decision?
\n(a) Similar business acquired the required building in 2000 for Rs. 10,00,000
\n(b) Building cost details of 2003
\n(c) Building cost details of 1998
\n(d) Similar building cost in August, 2005 Rs. 25,00,000
\nAnswer:
\n(a) Similar business acquired the required building in 2000 for Rs. 10,00,000<\/p>\n
Question 3.
\nWhich is the last step of accounting as a process of information?
\n(a) Recording of data in the books of accounts
\n(b) Preparation of summaries in the form of financial statements
\n(c) Communication of information
\n(d) Analysis and interpretation of information
\nAnswer:
\n(c) Communication of information<\/p>\n
Question 4.
\nWhich qualitative characteristics of accounting information is reflected when accounting information is clearly presented?
\n(a) Understandability
\n(b) Relevance
\n(c) Comparability
\n(d) Reliability
\nAnswer:
\n(a) Understandability<\/p>\n
<\/p>\n
Question 5.
\nUse of common unit of measurement and common format of reporting promotes;
\n(a) Comparability
\n(b) Understandability
\n(c) Relevance
\n(d) Reliability
\nAnswer:
\n(a) Comparability<\/p>\n
Test Your Understanding – V<\/span><\/p>\nMr. Sunrise started a business for buying and selling of stationery \u201c with Rs. 5,00,000 as an initial investment. Of which he paid Rs. 1,00,000 for furniture. Rs. 2,00,000 for buying stationery items. He employed a sales person and clerk. At the end of the month he paid Rs. 5,000 as their salaries. Out of the stationery bought he sold some stationery for Rs. 1,50,000 for cash and some other stationery for Rs. 1,00,000 on credit basis to Mr. Ravi. Subsequently, he bought stationery\u2019 items of Rs. 1,50,000 from Mr. Peace. In the first week of next month there was a fire accident and he lost Rs. 30,000 worth of stationery. A part of the’machinery, which cost Rs. 40,000 was sold for Rs. 45,000.<\/p>\n
From the above, answer the following :
\n1. What is the amount of capital with which Mr. Sunrise started business.
\n2. What are the fixed assets he bought?
\n3. What is the value of the goods purchased?
\n4. Who is the creditor and state the amount payable to him?
\n5. What are the expenses?
\n6. What is the gain he earned?
\n7. What is the loss he incurred?
\n8. Who is the debtor? What is the amount receivable from him?
\n9. What is the total amount of expenses and losses incurred?
\n10. Determine if the following are assets, liabilities, revenues, expenses or none of the these: sales, debtors, creditors, salary to manager, discount to debtors, drawings by the owner.
\nAnswer:
\n1. RS. 5,00,000
\n2. Rs. 1,00,000
\n3. Rs. 2,00,000
\n4. Mr. Peace, Rs. 1,50,000
\n5. Rs. 5,000 (salaries)
\n6. Rs. 5,000
\n7. Rs. 30,000
\n8. Mr. Ravi, Rs. 1,00,000
\n9. Rs. 35,000
\n10. Assets – Debtors
\nLiabilities – Creditors
\ndrawings by the owner Revenue – sales
\nExpenses – salary to manager, discount to debtors.<\/p>\n
Short Answer Type Questions<\/span><\/p>\nQuestion 1.
\nDefine accounting?
\nAnswer:
\nAccounting – Defined
\n\u201cAccounting is the art of recording classifying and summarising in a significant manner and in terms of money: transactions and events which are, in part at least, of financial character, and interpreting the results there of \u201d
\n– Committee on terminology of the American Institute of Certified Public Accountants<\/p>\n
\u201cAccounting is the science of recording and classifying business 1 transactions and events, primarily of a financial character, and the art of making significant summaries, analysis and interpretations of those transactions and events and communicating the results to persons who\u00a0 must make decisions or form judgement \u201d. – Smith and Ashbourne<\/p>\n
<\/p>\n
Accounting is a larger concept than book-keeping. Besides the function of book-keeping, accounting involves summarizing, analyzing, interpreting the financial statements and communicating the results to the users of these statements. Accounting is the language of business; it means that an enterprise communicates with the outside world, including the proprietors, through accounting statements. One cannot understand the affairs of an enterprise unless the enterprise prepares financial statements intelligibly.<\/p>\n
Question 2.
\nState what is the end product of financial accounting?
\nAnswer:
\nThe basic purposes of financial accounting are the following :<\/p>\n
\n- Calculating the result of business operations.<\/li>\n
- Ascertaining the financial position.<\/li>\n
- Communicating the information to the users.<\/li>\n<\/ul>\n
To calculate the results of operations : To measure the financial performance of an enterprise, the results of operations are ascertained by preparing an Income Statement (also called Profit and Loss Account) which shows the matching of current costs with current revenues during a particular accounting period. A systematic record of incomes and expenses facilitates the preparation of the Income statement.<\/p>\n
To ascertain the financial position : To evaluate the financial strength and weakness of an enterprise, the financial position is ascertained by preparing a Position Statement (also called Balance Sheet) which shows resources (assets) owned by an enterprise and the sources of financing those resources.<\/p>\n
A businessmen wants to know what the business owes to other and what it owns, and what happened to his capital whether the capital has increased, decreased or remained constant. A systematic record of various assets and liabilities facilitates the preparation of a Position statement (also known as Balance Sheet) which answers all these questions.<\/p>\n
<\/p>\n
To communicate the information to the users : Accounting communicates information to internal users and external users. The internal users include all the organisational participants at all levels of management (i.e., top, middle and lower).<\/p>\n
Top level management requires information for planning, middle level management requires information for controlling the operations. For internal use, the information is usually provided in the form of reports, for instance Cash Budget Reports, Production Reports, Idle Time Reports, Feedback Reports, Whether to Retain or Replace an Equipment Decision Reports, Project Appraisal Reports, and the like.<\/p>\n
Since the external users (e.g., Banks, Creditors) do not have direct access to all the records of an enterprise, they have to rely on financial statements as the source of information. External users are basically interested in the solvency and profitability of an enterprise.<\/p>\n
Question 3.
\nEnumerate main objectives of accounting?
\nAnswer:
\nThe following objectives of accounting may be preceded in brief:
\n1. Maintenance of Business Records : Accounting is the language in which most of the business transactions (financial) and events are expressed. It is an objective to keep a systematic record of these financial transactions. It embraces proper recording to – transactions, classified under appropriate accounts and summarised 1 into financial statements Income Statement and the Position Statement.<\/p>\n
2. Calculation of Profit or Loss : Another objective of accounting is to ascertain the net result of the day-to-day transactions for a period. In other words, to ascertain whether during the period the firm earned a profit or suffered a loss. For this purpose, a statement called the Incomes Statement or the Profit and Loss Account is prepared.<\/p>\n
In this account, the revenues resulting from the transactions of the period and the consequent expenses incurred are recorded. A comparison of the period and the consequent expenses incurred are recorded.<\/p>\n
A comparison of the two shows whether the business earned a profit or incurred a loss. In addition, information is available about sales; opening and closing stocks of goods and the significant factors leading to the profit or the loss of the business.<\/p>\n
Such a profit or loss statement is useful for all parties having stake in business like the management, lenders, investors, the proprietor or the partners or the shareholders, tax authorities and workers, etc. It is so because from its study, the management, can know whether the policies adopted by it were fruitful or not and can decide upon and possible, a change in the selling price or the advertising policy, etc.<\/p>\n
<\/p>\n
Lenders can know from its study whether the firm is likely to earn profits in future also. Investors may also decide on its basis whether or not they should keep their money invested in the firm. Shareholders can make an estimate of the efficiency, success, etc., of the management and may decide accordingly whether to invest or not in the business.<\/p>\n
3. Depiction of Financial Position : For a businessman, it is not sufficient only to ascertain the profit & loss; it is also necessary to know the financial health of the firm. For this purpose, a statement listing assets, liabilities and the owner’s capital is prepared. Such a statement is called the Balance Sheet. An illustration of a Balance Sheet is as follows :
\n
\nJust as a doctor will feel the pulse of a person and know whether he is enjoying good health or not, in the same manner by looking at the Balance Sheet one can know whether the firm is solvent or not. If the assets exceed liabilities, it is solvent. In the other case, it would be insolvent.<\/p>\n
4. Provide information to various users : Making the information available to various groups and managers. This function of accounting is to communicate the financial facts about an enterprise to various interested parties like owners, investors, creditors, employees, government-offices, research scholar\u2019s etc. The purpose of it is to enable these parties to take sound and realistic decision.<\/p>\n
Question 4.
\nList any five users who have indirect interest in 7 accounting.
\nAnswer:
\nFollowing are the interested parties or users of accounting informations other than the owners of a business :
\n1. Lenders: Lenders, i.e., the banks and financial institutions provide funds to the business. These funds may be provided at the time of setting-up the business or at a latter stage for the expansion and development. In practice, they lend money only after satisfying themselves about the repaying capacity, i.e., solvency of the ? business concern. Again, they know about this from the financial statements.<\/p>\n
2. Managers : Managers have to take many decisions such as the determination of selling price, how can the cost be reduced, how 5 can the selling expenses and other expenses be controlled, etc. These decisions can be taken on the basis of the information available. This information is made available to them by the financial statements.<\/p>\n
3. Government: The Government makes use of financial statements for compiling national accounts besides ascertaining the tax liability of the business, timely deposit of statutory and other dues.<\/p>\n
4. Employees or Workers : Employees\/workers may use the financial statements to know whether their dues like provident fund are being deposited regularly and also whether the bonus is being paid as per law.<\/p>\n
5. Researchers : Last but not the least, the financial statements are of immense use to the researchers also undertaking researches in the typical areas like accounting theory, business affairs and practices.<\/p>\n
Question 5.
\nState the nature of accounting information required by long-term lenders?
\nAnswer:
\nIn modem times, banks and financial institutions lend money f to the business; Before providing a loan to a business, they want to judge the repaying capacity of the business. Such information is provided by the accounting alone. Informations regarding the solvency of the financial business are made available only through statements. Financial statements help in assessing the financial capability of the business enterprise and also the expand to which the granting of credit will be safe.<\/p>\n
<\/p>\n
Question 6.
\nWho are the external users of information regarding accounting?
\nAnswer:
\nUsers of Accounting Information and their Need : The users of accounting information include present and potential investors, management, employees, lenders, suppliers and other trade creditors, customers, government and their agencies and the public. These users use accounting information in order to satisfy some of their varied needs for information.
\n
\n
\n
\n<\/p>\n
Question 7.
\nEnumerate informational needs of management.
\nAnswer:
\nManagement is interested to review the firm’s short-term solvency and long-term solvency, effective utilization of resources and profitability in relation to investments and turnover arid to decide upon the future course of action on the above decisions.<\/p>\n
In addition to-the information about the profitability and financial soundness of business, management needs a lot of other informations for the efficient running of the business such as increase or decrease in sales, speed of increase in costs of production etc. All such informations are provided by the accounting which helps the management in planning, decision-making and controlling the business.<\/p>\n
<\/p>\n
Question 8.
\nGive any three examples of revenues.
\nAnswer:
\nRevenues are the amounts of the business earned by selling its products or providing services to customers, called sales revenue. Other items of revenue common to many businesses are:<\/p>\n
\n- Commission<\/li>\n
- Interest<\/li>\n
- Dividends<\/li>\n
- Royalties<\/li>\n
- Rent received etc.<\/li>\n
- Revenue is also called income.<\/li>\n<\/ul>\n
Revenue in accounting is the income of a recurring (regular) nature from any source. It includes the amount received from sale of goods, rent receipt, commission, dividend and interest received. Any capital nature receipt is not a revenue item.<\/p>\n
Question 9.
\nDistinguish between debtors and creditors.
\nAnswer:
\nFollowing are the differences between debtors and creditors:<\/p>\n
\n\n\n\n Debtors<\/strong><\/p>\n<\/td>\n\n Creditors<\/strong><\/p>\n<\/td>\n<\/tr>\n\n1.\u00a0 \u00a0It represents those persons or firms to whom goods have been sold or services rendered on credit.\u00a0 2. Payment has not been received from the persons or parties. \n3. They still owe some amount to the business.<\/td>\n | 1. It represents those persons or firms from whom goods have been purchased or services taken on credit. \n2. Payment has not been made to the persons or parties. \n3. Some money is still owing to them.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 ,<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\nQuestion 10. \n\u201cAccounting information should be comparable.\u201d Do you agree w’ith this statement. Give two reasons. . \nAnswer: \nComparability : Use must be able to compare the financial statement of an enterprise through time to identify trends in this financial position and performance. Users must also be able to compare the financial statements of different enterprise in order to evaluate their relative financial position, performance and changes in financial position.<\/p>\n Hence the measurement and display of the financial effect of such like transactions and other events must be carried out in a consistent way throughout an enterprise and over time for that enterprise and in a consistent way for different enterprises.<\/p>\n An important implication of this qualitative characteristic is that users be informed of the accounting policies employed in the preparation of financial statements, any changes in those policies and the effects of such changes so that users would be able to identify difference between the accounting policies for like transactions and other various events used by the same enterprise from period to period and by different enterprises, this qualitative characteristic requires pursuance of consistency in choosing accounting policies.<\/p>\n Lack of consistency may disturb the comparability quality of the financial statement information. Mere disclosure of accounting policies and changes therein may not be sufficient. Accordingly, accounting standard on disclosure of accounting policies consider consistency as a fundamental accounting assumption along with accrual, and going concern.<\/p>\n <\/p>\n The basic reasons of comparing financial statement of two or more enterprises are the followings:<\/p>\n \n- Evaluating the financial position of different enterprise.<\/li>\n
- Performance and changes in financial position of different firms.<\/li>\n
- Accounting policies adopted by different firms.<\/li>\n<\/ul>\n
Question 11. \nIf the accounting information is not clearly presented, which of the qualitative characteristics of the accounting information is violated? \nAnswer: \nThe qualitative characteristics of,both reliability and relevance are required to be followed so that truth and fairness of accounting informations be maintained. These may be explained in brief as follows: \nQualitative characteristics of Accounting information : The fundamental characteristics of the financial statement is truth and fairness. It means, Balance Sheet should give a true and fair view of the state of affairs and whereas the Profit and Loss Account should give the true and correct profit or loss for the period. Besides the above fundamental characteristics there are qualitative characteristics (attributes) that make the information content of the financial statements useful to its users.These are: \n(i) Reliability; \n(ii) Relevance. \n(i) Reliability : An accounting information shall have the quality of reliability if it is free from material errors and also bias. The accounting information even if relevant can be of little use unless it is reliable also. Reliability of the information depends, on : \n(a) Neutrality: Neutrality means that the accounting information made available does not suffer from bias. A biased accounting information will be misleading and lead to incorrect analysis and decisions.<\/p>\n (b) Prudence : The accounting information prepared on the principle of prudence (conservatism) means that the accounting information is prepared by providing all prospective losses while leaving all prospective profits. In other words, quality as to reliability increases if the accounting information does not paint a better picture than what actually is.<\/p>\n (c) Completeness : The accounting information given should be complete in all respects as incomplete \ninformation may lead to wrong interpretation.<\/p>\n (d) Substance over form : The accounting information to be meaningful should be governed by the substance of the information and not by its legal form alone.<\/p>\n (ii) Relevance : The accounting information, besides disclosing statutorily required disclosures, should disclose other information, after judging its relevance to the decision making need of its users. For example, interest on borrowings is disclosed without stating the rate of interest. The users, therefore, cannot link interest cost to different types of borrowed funds. In the process, they fail to appreciate rationality of financing decisions. Generally, only the statutorily (legal) required information is disclosed.<\/p>\n The information disclosure requirements are set after a public debate reflecting the views of cross-sections of the users. But what is relevant information in a particular circumstance cannot be generalised and specified. It may be noted that relevance of the information is always guided by the principle of materiality.<\/p>\n <\/p>\n Question 12. \nThe role of accounting has changed over the period of time. Do you agree? Explain. \nAnswer: \nToday\u2019s rapidly changing business environment has forced the accountants to reassess their roles and functions both within the organisation and the society. The role of an accountant has now shifted from that of a mere recorder of transactions to that of the member providing relevant information to the decision-making team. Broadly speaking, accounting today is much more that just book-keeping and the preparation of financial reports.<\/p>\n Accountant are now capable of working in exciting new growth areas such as forensic accounting (solving crimes such as computer hacking and the theft of large amounts of money on the internet), e-commerce (designing web-based payment system), financial planning, environmental account etc.<\/p>\n The realisation comes due to the fact that accounting is capable of providing the kind of information that managers and other interested persons need in order to make better decisions, this aspect of accounting gradually assumed so much importance that it was now been raised to the level of an information system.<\/p>\n As an information system, it collects data and communicates economic information about the organisation to a wide variety of users whose decisions and actions are related to its performance.<\/p>\n Question 13. \nGiving examples and explain each of the following accounting terms: \n(i) Fixed Assets \n(ii) Gains \n(iii) Profit \n(iv) Revenue \n(v) Expenses \n(vi) Short-term liability \n(vii) Capital \nAnswer: \nAbove-mentioned accounting terms may be explained as follows: \n(i) Fixed Assets : Fixed assets refer to those assets which are held for the purposes of providing or producing goods or services and those that are not held for resale in the normal course of business. Fixed assets may be classified as follows:<\/p>\n \n- Tangible fixed assets : refer to those fixed assets which can be seen and touched. For example, Land and Building, Plant & Machinery and Furniture.<\/li>\n
- Intangible fixed assets : refer to those fixed assets which cannot be seen and touched. For example, Goodwill, Patent, Trademarks, Copyrights etc.<\/li>\n<\/ul>\n
(ii) Gains : Gains are increases in equity (not assets) from incidental transaction of an entity and from all other transactions and other events and circumstances affecting the entity during the accounting period except those that result from revenues or investment by equity participants. These gains may be operating or non-operating. Example 1 : Profit on sale of marketable securities is usually considered as operating gain. \nExample 2 ; Profit on sale of a fixed asset is usually.considered as non-operating gain.<\/p>\n (iii) Profits: The excess of revenue of a period over its related expenses is accounting year profit. It is of two types:<\/p>\n \n- Net Profit : Net profit means the excess of revenue over expenses.<\/li>\n
- Net Loss : Net loss means the excess of expenses and losses over revenue.<\/li>\n<\/ul>\n
(iv) Revenue : The term \u2018revenue\u2019 refers to the amount charged for the goods sold or services rendered or permitting others to use enterprise\u2019s resources yielding interest, royalty and dividend. For example, sales, commission earned, interest earned, royalty earned, dividend earned.<\/p>\n <\/p>\n (v) Expenses : Expenses are decrease in economic benefits during an accounting period in the form of<\/p>\n | | |