Essentials of Financial Accounting

1. Accounting is a process of collecting, organizing, and analyzing information. It

is used in business management to make decisions about products and services,
resources, debt and equity, and taxes. The advantages of accounting are that it
helps you understand where your money is coming from and where it's going
however accounting has its own limitations. Do you agree on that? Discuss
suitable points to support your answer. (10marks)

SOLUTION:

Introduction:

Accounting is the system of maintaining the records of business transactions. It

serves different targets, affords numerous blessings, and suffers from certain
limitations. The primary objective of keeping books of bills in a business is to
hold a systematic file of business transactions by figuring out a business's
financial events and transactions and recording them in the right books of money
owed systematically.

Concept and application:

Let us have examined the different objectives of accounting. Those are:

a. To determine the profit or lack of the business:

One of the number one accounting goals is to decide the business's financial
performance, i.e., to check how much the income earned or the loss suffered by
the company during the period under review. To determine the same, the
enterprise prepares an income or loss or trading declaration and a earnings and
loss statement at the end of every accounting duration.

b. To determine the financial role of the business

The next objective of the accounting manner is to check the business's economic
function, which is decided thru the stability sheet, also called the declaration of
financial role. It suggests the location of assets, liabilities, and capital at the
cease of the economic period.

c. To provide the required economic information to different users

Any other goal of accounting is to offer accounting statistics to the customers of
financial information like proprietors, buyers, creditors, employees, government
authorities, etc. The accounting information allows the users to make good
selections about the funding within the business entity.
d. Supporting management in exercising controls

The control calls for accounting statistics to exercise the required internal
powers. The monetary records supplied by books of bills help the authority
decide if the internal financial controls are adequate.

Advantages of accounting

Some blessings of accounting are as beneath:

1. Provides information about financial performance through financial

statements like income & loss bills, balance sheets, cash flow statements, etc. As
a result, it enables knowing the net results obtained from enterprise activities of
an accounting period. It assists the control in planning and controlling activities
by providing the required financial information through financial statements.

2. Maintaining a periodic report of the accounting facts and business

transactions assists in getting a comparative analysis. It helps in intra-firm
assessment (contrast of accounting points of a single firm from one accounting
duration to another) and inter-firm comparison (review of economic facts of 1
firm with that of another). It eliminates the requirement to memorize complete
transactions as the whole path is available within the points organized
systematically.

3. Accounting helps with the proper and trouble-loose settlement of various

Tax Liabilities by recording extraordinary revenue streams and allowable
deductions.

Limitations of Accounting

The process of accounting has numerous limitations. Those are:

1. It can be influenced by utilizing bias or judgment

Accounting cannot be completely free from personal bias or judgment. Though

majorly commercial enterprise transactions are recorded based on documentary
evidence, in some cases, they may be recorded primarily based on some
estimates. For example, a provision for bad debt is based totally on assessments,
or depreciation is charged based on the estimated beneficial existence of an
asset. Such estimates require private judgment. Since there is no uniformity in
making such estimates, the internet earnings or loss may vary under different
situations or on being calculated by other persons.

2. It does not display the realizable value

Accounting is 'historical' in nature. Assets are recorded at their original/
historical value, with less depreciation. It no longer reflects the current market
price of the purchase. The market price may determine how much cash may be
generated on the sale of assets. Similarly, the accounting statements prepared
using the historic cost do now not account for the modifications within the time
value of cash. Accordingly, the figures offered ignore charge stage changes.

3. Absence of Qualitative facts

Accounting records the most helpful information on the monetary transactions of

a business; it accordingly ignores the qualitative factor of the enterprise, which
cannot be measured in financial terms. Those elements include nicely-
maintained exertions of family members, control's popularity, and so forth.

4. Affected by Window Dressing

Because the financial statements gift the financial position of the business and
offer facts that could affect the investment decisions of proposed buyers, the
management might also choose to present a more excellent favorable function
than the real one by manipulating the books of debts. This type of practice is
known as window dressing. A few examples of window dressing are – treating
revenue expenditure as capital expenditure or vice versa. When the books of
debts are manipulated, they do now not provide an accurate and truthful view of
the entity's economic function.

Conclusion:

The above dialogue may be used to conclude that audit has several benefits and
serves extraordinary business objectives. The business can overcome accounting
limitations by being more vigilant and truer while conducting the process.

2. Vijaya Brothers has the following refrigerator in inventory as on March 31,

2023

Item Quantity Cost per unit Net realizable value

Godrej 2 Star 15 20000 28000

Samsung Direct Cool 35 25000 23000

Sony Direct Cool 50 12000 16000

 Motorola 100 35000 30000

Discuss the Accounting Standard & applicability of the Accounting Standard

which talks about inventory valuation. Also, find out the overall value of
inventories under each item as per the applicable accounting standard.
(10marks)

Break up:
4 marks for identifying value of inventory
6 marks for – Discuss the Accounting Standard & applicability of the Accounting
Standard which talks about inventory valuation

SOLUTION:

Introduction:

The term inventory refers to stock objects that are held for change by the
business.

A well-known is any subject that provides specific guidelines and benchmarks for
evaluation. Accounting requirements are fixed on guiding ideas and providing
uniform practices and accounting techniques.

Concept and application:

Business entities in India can be divided into corporate and non-corporate

entities. Accounting standards are announced by using the Ministry of corporate
affairs for company entities. For non-corporate entities, like SMEs, Accounting
requirements are issued by way of the accounting requirements board (ASB) of
ICAI in India. They're based on usually established accounting principles in
India and aim to make economic statements more understandable.

Accounting standards become operative from the date specified in the

fashionable. They set out a uniform code of excellent practices by supplying
investor-cantered and across-the-world-recognized accounting policies to clarify
how the monetary statements' records should be interpreted. The Institute of
Chartered Accountants of India (ICAI) constituted the accounting standards
board in April 1977. It is responsible for formulating standards on significant
accounting subjects based on global developments and criminal requirements in
India. Primarily, ASB is engaged in figuring out the areas which require
uniformity. The research shows draft requirements are organized after
discussions with representatives from different sectors like government, public
sector undertakings, industries, and agencies.

In the given case, the stock value is to be decided, ruled utilizing accounting
standard-2 'Valuation of inventory.' This widespread's objective is to offer a way
of calculating the value at which the inventory ought to be valued and shown on
the balance sheet.

What is an inventory?

Inventories are belongings held on the market within the regular direction of the
business, gadgets of cloth that are in production for sale (WIP). These raw
substances will be eaten up in the production system or used to render services.
Accounting standard- 2 applies to all inventories, viz., raw materials, WIP, and
finished items. However, it does not follow to:

1. Work-in-progress (WIP) under a construction agreement

2. Work-in-progress (WIP) under carrier contracts

3. WIP arising in the ordinary route of business of service providers

4. Shares, debentures, and different financial gadgets held as stock in trade;

5. Livestock, agricultural products, mineral oils, ores, and gases. It will no

longer follow the volume in their dimension at NRV, following the practices
applicable within the applicable industries.

Inventory valuation

According to the accounting famous, inventories must be valued at a lower cost

or net realizable value. The term price here includes all charges of:

1. Purchases

2. Conversion

3. Other costs

That is incurred in bringing the inventory to its present place and condition.

Net realizable value

It is the predicted amount that may be obtained by selling a product in the

market in the regular route of commercial enterprise, much less the estimated
production and completion value and different costs essential to make the
product saleable.
Purchase cost

The purchase fee consists of the purchase rate, which includes all taxes and
duties other than the ones whose credit is available on a future date, freight
inwards, and different expenses directly related to the acquisition of the product.
Prices like alternate discounts, duty rebates and disadvantages, and other
comparable gadgets must be excluded from the purchase cost.

Price of conversion

It includes all expenses incurred in converting the raw material into a finished
product, like the exertions costs. Fixed and variable production overheads must
also be systematically included in the conversion cost.

Other costs

Some fees are incurred in bringing the stock to its present region and making
them usable. Such costs ought to be blanketed in the inventory value best to the
volume directly attributable to the inventory. For example, the price of the
installation of an Air conditioner.

Borrowing charges are not covered in any other cost as they are not incurred in
bringing the stock to its present condition and location.

The following fee is excluded while measuring the value of inventory

1. Abnormal wastage of cloth, hard work, and production value

2. Administrative overheads

3. Selling and distribution overheads

4. Garage charges while they are necessary for the production process.

Within the given case, Vijaya Brother has an inventory of refrigerators. The cost
and net realizable value of every item on the list are shown. We are required to
fee the merchandise based on AS -2. Hence, we can take the lower price amongst
fees and net realizable value for each item.

Table showing the valuation of each item of inventory

Item Quantity Cost per Net Value of inventory

unit (a) realizable (lower of a or b)
value (b)

Godrej 2 Star 15 20000 28000 20000

 Samsung Direct 35 25000 23000 23000
Cool

Sony Direct Cool 50 12000 16000 12000

Motorola 100 35000 30000 30000

Conclusion:

Accounting standards improve the transparency of financial reporting and help

in increasing financial accountability. Accounting standards are relevant to the
company's financial reporting.

Compliance with accounting standards is mandatory. If there is any non-

compliance, it must be disclosed in financial statements along with their
economic effect.

3. Consider the following transaction pertaining Ammar’s business.

1. Started business with cash Rs 3 lacs

2. Purchased goods for cash Rs 1.2 lacs
3. Purchased goods on credit Rs 60000
4. Purchased furniture for cash Rs 20000
5. Deposited RS 50000 in the bank
Perform transaction analysis for each transaction undertaken and present
accounting
equation for these transactions

SOLUTION:

Introduction:

A transaction analysis involves evaluating the business transaction to determine

its impact. An accounting equation is framed following the double-entry system
of accounting. Under this system, every debit has an equal credit or vice versa.
To be correct, the debits must be equal to credits.

Concept and application:

In the given cases, the impact of each transaction in the books of accounts will be
as below:

1. Started business with cash Rs 3 lacs

Here the business is commenced by introducing capital of ₹3,00,000. The cash is
brought in, and the capital is recognized in the books. The accounting equation
will be:

Cash = Capital +Liabilities

3,00,000 = 3,00,000+ 0

2. Purchased goods for cash Rs 1.2 lacs

Goods are acquired by paying cash of ₹1.2 lakhs. The goods are brought into the
business, and cash has moved out. The accounting equation will be:
Cash + stock = Capital + Liabilities
3, 00,000-1,20,000 + 1,20,000 = 3,00,000 + 0
1, 80,000 + 1,20,000 = 3,00,000 + 0

3. Purchased goods on credit Rs 60000

In this case, the business has acquired goods on credit. Thus, along with the
goods brought into the business, a liability in the creditor's name is also created.
The accounting equation will be:

Cash + stock = Capital + Creditors

1, 80,000 + 1, 20,000 + 60,000 = 3, 00,000 + 60,000
1, 80,000 + 1, 80,000 = 3, 00,000 + 60,000

4. Purchased furniture for cash Rs 20000

The business has brought new furniture by paying a cash amount of ₹20,000.
The asset in the form of furniture is brought into the business, and the cash
moves out of business. The accounting equation will be:
Cash + stock + Furniture = Capital + Creditors
1, 80,000 -20,000 + 1, 80,000 + 20,000 = 3, 00,000 + 60,000
1, 60,000 + 1, 80,000 + 20,000 = 3, 00,000 + 60,000

5. Deposited RS 50000 in the bank

When cash of ₹50,000 is deposited in the bank, it increases the bank balance
while reducing the cash in hand. The accounting equation will be:
Cash + stock + Furniture + Bank = Capital + Creditors
1, 60,000 -50,000 + 1, 80,000 + 20,000 + 50,000 = 3,00,000 + 60,000
1, 10,000 + 1,80,000 + 20,000 + 50,000 = 3,00,000 + 60,000

Conclusion:

When presented in the form of an accounting equation, the above transactions

show that two or more ledger accounts are affected for every transaction. The
accounting equation is balanced when the assets become equal to liabilities and
Equity.

B. Define the term accounting equation, discuss the impact of each transaction
in the books of accounts. (5marks)
Break up
2+3=5 marks for correctly explaining term accounting equation, the impact of
each transaction.

SOLUTION:

Introduction:

An accounting equation lays down the foundation for the maintenance of the
business's books of accounts. It has three elements, namely, assets, liabilities,
and Equity.
As per a balanced accounting equation,
Assets = Liabilities+ Equity

Concept and application:

As mentioned above, the different elements of an accounting equation must be

present so that the assets are equal to the total liabilities and Equity. The term
equity here means the capital contributed to the business by the owners of the
business. Let us understand these elements of the accounting equation:

a. Assets- These are resources owned by the entity that will likely provide future
economic benefits. Some examples of assets are furniture, building, debtors, etc.

b. Liabilities – These are obligations of the business that are acquired due to past
events and are likely to result in some cash outflow on their satisfaction. Some
examples of liabilities are creditors, loans payable, lease rentals outstanding,
etc.
c. Equity- It represents the ownership of the business and is equal to the amount
contributed by business owners/ investors.

The above business transactions have been analyzed in part (a) of the question.
Let us now understand the impact of these business transactions on the
business.

1. Business commenced by introducing the capital of ₹ three lacs

Mr. Ammar is starting the business by investing cash of ₹ three lacs. As a result,
his Equity will increase by ₹3 lacs.

2. Goods purchased by paying ₹1.2 lacs in cash

Mr. Ammar has purchased goods for cash. It will increase the value of goods
(assets) and reduce his cash balance.

3. Goods purchased on credit

Purchasing goods on credit for ₹60,000 will increase the value of goods by
₹60,000 and will also increase the liabilities by ₹60,000 simultaneously.

4. Purchase of furniture by paying cash of ₹20,000

Mr. Ammar has acquired furniture, which is a fixed asset. It will increase the
value of fixed assets and reduce the cash available to him.

5. Cash of ₹50,000 deposited in the bank

Mr. Ammar has deposited ₹50,000 cash in his bank account. This transaction
will impact the bank balance and the cash in hand. The cash will be reduced, and
the balance in the bank will increase.

Conclusion:

Correct recording of the accounting transaction is necessary for properly

preparing and presenting the books of accounts. They lay down the basis of these
documents, which are then used in preparing the financial statements presented
to investors.