Heads of Accounts Side of Trial Balance Reasons

Depreciation Debit Losses

Provision for Depreciation Credit Liability
Returns Inwards Debit Losses
Returns Outwards Credit Gains
Freehold Property Debit Assets
Premises Debit Assets
Leasehold Property Debit Assets
Loose Tools Debit Assets
Petty Cash Debit Assets
Provident Fund Credit Liability
Debentures Purchased Debit Assets
Debentures (from Public) Credit Liability
Loan on Mortgage Credit Liability
Prepaid Expenses Debit Assets
Outstanding Expenses Credit Liability
Bad Debts Recovered Credit Gains
Accrued Incomes Debit Assets
Apprenticeship Premium received Credit Income
Books Debit Assets
Newspaper and Magazine Debit Expenses
Profit and Loss A/c (Dr.) Debit Losses
Profit and Loss A/c (Cr.) Credit Gains
Accumulated Depreciation Credit Liability
Postage and Telegram Debit Expense
Travelling & Conveyance Debit Expenses

Illustration 13.
From the following ledger account balances, prepare a Trial Balance of Mr. Sen for the year ended 31st March,
2015. Capital ` 80,000; Sales `10,00,000; Adjusted Purchase ` 8,00,000; Current A/c(cr) ` 10,000; Petty Cash ` 10,000;
Sales Ledger Balance ` 1,20,000; Purchase Ledger Balance ` 60,000; Salaries `24,000; Carriage Inwards ` 4,000;
Carriage Outward ` 6,000; Discount Allowed ` 10,000; Building ` 80,000; Outstanding Expenses ` 10,000; Prepaid
Insurance ` 2,000; Depreciation ` 4,000; Cash at Bank ` 80,000; Loan A/c (cr) ` 66,000; Profit & Loss A/c(cr) ` 20,000;
Bad Debts Recovered ` 2,000; Stock at 31.03.2015 ` 1,20,000; Interest Received ` 10,000; Accrued Interest ` 4,000;
Investment ` 20,000; Provision for Bad Debts (01.04.2014) ` 6,000; General Reserve ` 20,000.

Solution.
Trial Balance of Mr. Sen
Dr. as on 31st March, 2015 Cr.
Heads of Accounts Amount (`) Heads of Accounts Amount (`)
Adjusted Purchase 8,00,000 Capital 80,000
Petty Cash 10,000 Sales 10,00,000
Sales Ledger Balance 1,20,000 Current A/c 10,000
Salaries 24,000 Purchase Ledger Balance 60,000
Carriage Inward 4,000 Outstanding Expenses 10,000
Discount Allowed 10,000 Loan A/c 66,000

FUNDAMENTALS OF ACCOUNTING 55
 Building 80,000 Profit & Loss A/c(cr) 20,000
Prepaid Insurance 2,000 Bad Debts Recovered 2,000
Depreciation 4,000 Interest Received 10,000
Cash at Bank 80,000 Provision for Bad debts 6,000
Stock (31.03.2015) 1,20,000 General Reserve 20,000
Accrued Interest 4,000
Investment 20,000
Carriage outward 6,000
Total 12,84,000 Total 12,84,000

Note: Closing Stock will appear in Trial Balance since there is adjusted purchase.
Adjusted purchase = Opening Stock + Purchase - Closing Stock.

It may be noted that if only adjusted purchase is considered then the matching concept is affected. Hence, to
satisfy the matching concept, closing stock is also considered in Trial Balance.

Multiple Choice Questions:

1. Purchases book is used to record
(a) All purchases of goods (b) All credit purchase
(c) All credit purchases of goods (d) All credit purchases of assets other than goods
2. Goods bought from Mr. P the payment for which is due after a month__
(a) cash book (b) purchase book (c) sales book (d) purchase return book
3. The source document or voucher used for recording entries in sales book is
(a) invoice received (b) invoice sent out
(c) credit notes sent out (d) debit notes received
4. A debit note issued to a creditor for goods returned by us is to be recorded in the
(a) bills receivable book (b) purchases book
(c) journal proper (general journal) (d) purchases returns book
5. Sales returns book is used to record
(a) Returns of fixed assets sold on credit (b) returns of goods sold for cash
(c) returns of goods sold on credit (d) sale of goods
6. Closing entries are recorded in
(a) cash book (b) ledger (c) journal proper (d) balance sheet
7. Cash book is a
(a) subsidiary book (b) subsidiary journal and ledger
(c) ledger account (d) none of these
8. Cash book is a form of
(a) Trail balance (b) journal (c) Ledger (d) All the above
9. The cash book records
(a) All cash receipts (b) All cash payments (c) All cash receipts and payments
10. Cash book does not record
(a) Credit purchases (b) credit sales
(c) Outstanding expenses (d) All the above transactions
11. Single column cash book may show –
(a) only a debit balance (b) only a credit balance
(c) either debit or a credit balance (d) neither debit nor credit balance
12. A cash book with discount and bank column is called
(a) Single column cash book (b) two column cash book
(c) Three column cash book (d) petty cash book
13. The total of discounts column on the debit side of the cash book, recording cash discount deducted by
customers when paying their accounts, is posted to the
(a) Credit of the discount allowed account (b) Debit of the discount received account
(c) Credit of the discount received account (d) Debit of the discount allowed account

56 FUNDAMENTALS OF ACCOUNTING
14. Trade discount allowed at the time of sale of goods
(a) Is recorded in Sales Book (b) Is recorded in Cash Book
(c) Is recorded in Journal (d) Is not recorded in Books of Accounts
15. The periodical total of the Sales Return Book is posted to the
(a) Debit of Sales Account (b) Debit of Return Account
(c) Credit of Sales Return Account (d) Debit of Debtors Account

Ans: 1.c 2.b 3.b 4.d 5.c 6.c 7.b 8.c 9.c 10.d 11.c 12.c 13.d 14.d 15.b

Fill in the blanks:

1. Debit note is sent by the _____(buyer)
2. Invoice is sent by the _____(seller)
3. Loss of goods due to theft is recorded in _____(journal proper)
4. Credit note is sent by ______(seller)
5. Bad debts written off _____ (journal proper)
6. Opening entries are generally passed through ______(journal proper)
7. A transaction recorded on the debit side of cash book is transferred to the ledger __(credit side of account)
8. If a cheque is returned dishonored, it is recorded in ____ (Bank column on the credit side.)
9. Payments are recorded on the____ side of cash book.(credit)
10. The balance in the petty cash book is ____ (An Asset)
11. The balance on the debit side of the bank column in cash book indicates ____ (Cash at bank)
12. Bank column of the cash book ____ balance (either debit or credit)
13. The periodical total of the sales book is posted to ____(Debit side of sales account)
14. Depreciation on fixed asset is initially journalized in ___ (Journal Proper or General Journal)
15. If Ram has sold goods for cash, the entry will be recorded in ____ (Cash Book)

True or false:
1. Trade discount allowed at the time of sale of goods – is recorded in cash book (FALSE)
2. The periodic total of sales day book is posted to sales return Account (FALSE)
3. Overcastting of purchases journal would affect purchases account (TRUE)
4. Goods worth ` 5000 sold to varsha @ 10% trade discount and 5% sales tax was charged extra. By this transaction
the sales account will be credited with ` 4500 (TRUE)
5. Credit sale of goods – sale invoice and sales book (TRUE)
6. Due to damage of goods Ravi was sent credit note of `200. It will be recorded in – sale book (FALSE)
7. Salaries due for the month will appear no where in cash book (TRUE)
8. Receipts are recorded on the credit side of cash book (FALSE)
9. The main objective of cash book is to know the cash and bank balance of the business (TRUE)
10. Paid insurance by cheque ` 1000 recorded in cash column in debit side (FALSE)

Match the following:

1. Purchases returns book d a) Sales book

2. Sales returns book c b) Purchases book
3. General journal is also known as e c)Credit note
4. Credit sale of goods a d) Debit note
4. Credit purchase of goods b e) Journal proper

FUNDAMENTALS OF ACCOUNTING 57
Illustration 14.
Journalize the following transactions in the books of Gaurav, post them into ledger and prepare trial balance for
June 2015:
June 1: Gaurav started business with `10,00,000 of which 25% amount was borrowed from wife.
June 4: Purchased goods from Aniket worth `40,000 at 20% TD and 1/5th amount paid in cash.
June 7: Cash purchases ` 25,000.
June 10: Sold goods to Vishakha ` 30,000 at 30% TD and received 30% amount in cash.
June 12: Deposited cash into bank ` 20,000.
June 15: Uninsured goods destroyed by fire ` 5,500.
June 19: Received commission ` 3,500.
June 22: Paid to Aniket ` 25,500 in full settlement of A/c.
June 25: Cash stolen from cash box ` 1,000.
June 27: Received from Vishakha ` 14,500 and discount allowed ` 200.
June 30: Interest received ` 2,400 directly added in our bank account.

Solution:
In the books of Gaurav
Journal
Date 2015 Particulars L.F. Amount(`) Amount(`)
1-Jun Cash A/c Dr 1,000,000
To Capital A/c 750,000
To Loan from Wife A/c 250,000
(Being capital brought into business)
4-Jun Purchases A/c Dr 32,000
To Cash A/c 6,400
To Aniket’s A/c 25,600
(Being goods purchased at 20% TD & 1/5th amount paid in cash)
7-Jun Purchases A/c Dr 25,000
To Cash A/c 25,000
(Being cash purchases)
10-Jun Cash A/c Dr 6,300
Vishakha’s A/c Dr 14,700
21,000
To Sales A/c
(Being goods sold at 30% TD & 30% amount received in cash)
12-Jun Bank A/c Dr 20,000
To Cash A/c 20,000
(Being cash deposited in bank)
15-Jun Loss by Fire A/c Dr 5,500
To Purchases A/c 5,500
(Being uninsured goods lost by fire)
19-Jun Cash A/c Dr 3,500
To Commission A/c 3,500
(Being commission received)
22-Jun Aniket’s A/c Dr 25,600
To Cash A/c 25,500
To Discount A/c 100
(Being paid to Aniket in full settlement & discount received)
25-Jun Loss by Theft A/c Dr 1,000
To Cash A/c 1,000
(Being cash stolen)

58 FUNDAMENTALS OF ACCOUNTING
 27-Jun Cash A/c Dr 14,500
Discount A/c Dr 200
14,700
To Vishakha’s A/c
(Being amount received from Vishakha & discount allowed)
30-Jun Bank A/c Dr. 2,400
To Interest A/c 2,400
(Being interest received directly added into bank account)

Cash Account Cr.

Date Particulars J.F. Amount (`) Date Particulars J.F. Amount (`)
1/6/15 To Capital A/c 7,50,000 4/6/15 By Purchases A/c 6,400
1/6/15 To Loan from Wife A/c 2,50,000 7/6/15 By Purchases A/c 25,000
10/6/15 To Sales A/c 6,300 12/6/15 By Bank A/c 20,000
19/6/15 To Commission A/c 3,500 22/6/15 By Aniket’s A/c 25,500
27/6/15 To Vishakha’s A/c 14,500 25/6/15 By Loss by Theft A/c 1,000
30/6/15 By Balance c/d 9,46,400
10,24,300 10,24,300
1/7/15 To Balance b/d 9,46,400
Dr. Capital Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
30/6/15 To Balance c/d 7,50,000 1/6/15 By Cash A/c 7,50,000
7,50,000 7,50,000
1/7/15 By Balance b/d 7,50,000
Dr. Loan from Wife Account Cr.
Date Particulars J.F. Amount (`) Date Particulars J.F. Amount (`)
30/6/15 To Balance c/d 2,50,000 1/6/15 By Cash A/c 2,50,000
2,50,000 2,50,000
1/7/15 By Balance b/d 2,50,000
Dr. Purchases Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
4/6/15 To Cash A/c 6,400 15/6/15 By loss by fire 5,500
4/6/15 To Aniket’s A/c 25,600 30/6/15 By Bal c/d 51,500
7/6/15 To Cash A/c 25,000
57,000 57,000
1/7/15 To Balance b/d 51,500
Dr. Aniket’s Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
22/6/15 To Cash A/c 25,500 4/6/15 By PurchasesA/c 25,600
22/6/15 To Discount A/c 100
25,600 25,600

FUNDAMENTALS OF ACCOUNTING 59
Dr. Vishakha’s Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
10/6/15 To Sales A/c 14,700 27/6/15 By Cash A/c 14,500
27/6/15 By Discount A/c 200
14,700 14,700

Dr. Sales Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
30/6/15 To Balance c/d 21,000 10/6/15 By Cash A/c 6,300
10/6/15 By Vishakha’s A/c 14,700
21,000 21,000
1/7/15 By Balance b/d 21,000

Dr. Bank Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
12/6/15 To Cash A/c 20,000 30/6/15 By Balance c/d 22,400
30/6/15 To Interest A/c 2,400
22,400 22,400
1/7/15 To Balance b/d 22,400

Dr. Loss by Fire Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
15/6/15 To Purchases A/c 5,500 30/6/15 By Balance c/d 5,500
5,500 5,500
1/7/15 To Balance b/d 5,500

Dr. Commission Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
30/6/15 To Balance c/d 3,500 19/6/15 By Cash A/c 3,500
3,500 3,500
1/7/15 By Balance b/d 3,500

Dr. Discount Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
27/6/15 To Vishakha’s A/c 200 22/6/15 By Aniket’s A/c 100
30/6/15 By Balance c/d 100
200 200
1/7/15 To Balance b/d 100

Dr. Loss by Theft Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
25/6/15 To Cash A/c 1,000 30/6/15 By Balance c/d 1,000
1,000 1,000
1/7/15 To Balance b/d 1,000

60 FUNDAMENTALS OF ACCOUNTING
Dr. Interest Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F. Amt. (`)
30/6/15 To Balance c/d 2,400 30/6/15 By Bank A/c 2,400
2,400 2,400
1/7/15 By Balance b/d 2,400

Trial Balance as on 30.6.15

Dr. Cr.
Name of Account (`) (`)
Cash A/c 9,46,400 -----
Capital A/c ----- 7,50,000
Loan from Wife A/c ----- 2,50,000
Purchases A/c 51,500 -----
Aniket’s A/c ----- -----
Vishakha’s A/c ----- -----
Sales A/c ----- 21000
Bank A/c 22,400 -----
Loss by Fire A/c 5,500 -----
Commission A/c ----- 3500
Discount A/c 100 -----
Loss by Theft A/c 1,000 -----
Interest A/c ----- 2,400
Total 10,26,900 10,26,900
Illustration 15.
Journalize the following transactions in the books of M/s Kothari & Sons, post them into ledger and prepare trial
balance for April 2015:
Apr. 1: Commenced business with ` 40,000.
Apr. 4: Bought goods for cash ` 4,000
Apr. 7: Sold goods ` 700
Apr. 10: Bought goods from M/s Bhandari Bros. ` 3,000 at 10% trade discount.
Apr. 14: Purchased machinery of ` 5,000 from M/s Kirloskar Bros.
Apr. 16: Paid for transportation of machinery ` 500 & installation charges ` 300 on it.
Apr. 20: Paid quarterly interest on borrowed amount of ` 5,000 at 12% p.a.
Apr. 24: Supplied goods to M/s Kunal & Sons ` 3,500.
Apr. 27: Paid to M/s Bhandari Bros. ` 2600 in full settlement of account.
Apr. 28: M/s Kunal & Sons returned goods worth ` 300 & paid for ` 1,200 on account.
Apr. 29: Received commission ` 250.
Apr. 30: Paid conveyance to manager ` 450.
Solution:
In the books of M/s Kothari and Sons
Journal
Dr. Cr.
Date Particulars L.F. Amt.` Amt.`
2015
1-Apr Cash A/c Dr 40,000
To Capital A/c 40,000
(Being cash introduced as capital)

FUNDAMENTALS OF ACCOUNTING 61
 4-Apr Purchases A/c Dr 4,000
To Cash A/c 4,000
(Being bought goods for cash)
7-Apr Cash A/c Dr 700
To Sales A/c 700
(Being sold goods for cash)
10-Apr Purchases A/c Dr 2,700
To M/s Bhandari Bros. A/c 2,700
(Being purchased goods at 10% TD)
14-Apr Machinery A/c Dr 5,000
To M/s Kirloskar Bros. A/c 5,000
(Being purchased machinery on credit)
16-Apr Machinery A/c Dr 800
To Cash A/c 800
(Being transportation & installation charges on machinery paid)
20-Apr Interest A/c Dr 150
To Cash A/c 150
(Being paid quarterly interest on borrowed amt.of `5000 at 12% p.a.)
24-Apr M/s Kunal & Sons A/c Dr 3,500
To Sales A/c 3,500
(Being goods sold on credit)
27-Apr M/s Bhandari Bros. A/c Dr 2,700
To Cash A/c 2,600
To Discount A/c 100
(Being paid in full settlement & discount received)
28-Apr Return Inwards A/c Dr 300
Cash A/c Dr 1,200 1,500
To M/s Kunal & Sons A/c
(Being goods returned & received on account)
29-Apr Cash A/c Dr 250
To Commission A/c 250
(Being commission received)
30-Apr Conveyance A/c Dr 450 450
To Cash A/c
(Being conveyance paid to manager)
Total 61,750 61,750
Ledger
Dr. Cash Amount Cr.
Date Particulars J.F Amt. Date Particulars J.F Amt. (`)
(`)
1/4/15 To Capital A/c 40,000 4/4/15 By Purchases A/c 4,000
7/4/15 To Sales A/c 700 16/4/15 By Machinery A/c 800
28/4/15 To M/s Kunal & Sons A/c 1200 20/4/15 By Interest A/c 150
29/4/15 To Commission A/c 250 27/4/15 By M/s Bhandari Bros. A/c 2,600
30/4/15 By Conveyance A/c 450
30/4/15 By Balance c/d 34,150
42,150 42,150
1/5/15 To Balance b/d 34,150

62 FUNDAMENTALS OF ACCOUNTING
Dr. Capital Account Cr.
Date Particulars J.F Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Balance c/d 40,000 1/4/15 By Cash A/c 40,000
40,000 40,000
1/5/15 By Balance b/d 40,000
Dr. Purchases Account Cr.
Date Particulars J.F Amt. (`) Date Particulars J.F Amt. (`)
4/4/15 To Cash A/c 4,000 30/4/15 By Balance c/d 6700
10/4/15 To M/s Bhandari Bros. A/c 2,700
6,700 6,700
1/5/15 To Balance b/d 6,700

Dr. Sales Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Balance c/d 4,200 7/4/15 By Cash A/c 700
24/4/15 By M/s Kunal & Sons A/c 3,500
4,200 4,200
1/5/15 By Balance b/d 4,200
Dr. M/s Bhandari Bros. Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
27/4/15 To Cash A/c 2,600 10/4/15 By Purchases A/c 2,700
27/4/15 To Discount A/c 100
2,700 2,700
Dr. Machinery Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
14/4/15 To M/s Kirloskar Bros. A/c 5,000 30/4/15 By Balance c/d 5,800
16/4/15 To Cash A/c 800
5,800 5,800
1/5/15 To Balance b/d 5,800

Dr. M/s Kirloskar Bros. Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Balance c/d 5,000 14/4/15 By Machinery A/C 5,000
5,000 5,000
1/5/15 By Balance b/d 5,000

Dr. Interest Account Cr.

Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
20/4/15 To Cash A/c 150 30/4/15 By Balance c/d 150
150
1/5/15 To Balance b/d 150

FUNDAMENTALS OF ACCOUNTING 63
Dr. M/S Kunal & Sons Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
24/4/15 To Sales A/c 3,500 28/4/15 By Return Inwards A/c 300
28/4/15 By Cash A/c 1,200
30/4/15 By Balance c/d 2,000
3,500 3,500
1/5/15 To Balance b/d 2,000
Dr. Discount Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Balance c/d 100 27/4/15 By M/s Bhandari Bros. A/c 100
100 100
1/5/15 By Balance b/d 100
Dr. Return Inwards Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
28/4/15 To M/s Kunal & Sons A/c 300 30/4/15 By Balance c/d 300
300 300
1/5/15 To Balance b/d 300
Dr. Commission Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Balance c/d 250 29/4/15 By Cash A/c 250
250 250
1/5/1 By Balance b/d 250
Dr. Conveyance Account Cr.
Date Particulars J.F. Amt. (`) Date Particulars J.F Amt. (`)
30/4/15 To Cash A/c 450 30/4/15 By Balance c/d 450
450 450
1/5/15 To Balance b/d 450

Trial Balance as on 30.4.15

Dr. Cr.
Name of Account (`) (`)
Cash A/c 34,150 -----
Capital A/c ----- 40,000
Purchases A/c 6700 -----
Sales A/c ----- 4,200
M/s Bhandari Bros. A/c ----- -----
Machinery A/c 5,800 -----
M/s Kirloskar Bros. A/c ----- 5,000
Interest A/c 150 -----
M/s Kunal & Sons A/c 2,000 -----
Discount A/c ----- 100
Return Inwards A/c 300 -----

64 FUNDAMENTALS OF ACCOUNTING
 Commission A/c ----- 250
Conveyance A/c 450 -----
Total 49,550 49,550

Illustration 16.

Enter the following transactions in the proper subsidiary books and post them to ledger accounts. Also prepare Trial
Balance:
2015
Jan. 1: Purchased goods worth ` 6,000 from M/s Akshaykumar & Sons.
Jan. 5: Sold goods to M/s Vinay kumar ` 2,000.
Jan. 7: Purchased goods from M/s Vinod Bros. ` 4,000 at 5% TD.
Jan. 9: Sold goods to Pravinkumar on cash ` 500.
Jan. 12: Bought goods from Jayant Kumar ` 3,500 at 10% TD.
Jan. 17: Supplied goods to M/s Rajnikant ` 2,500 at 5% TD.
Jan. 20: Sold furniture to M/s Narendrakumar worth ` 1,200.
Jan. 22: Returned goods to M/s Vinod Bros. ` 500 gross.
Jan. 25: M/s Vinaykumar returned goods worth ` 500.
Jan. 27: Sent debit note to M/s Akshaykumar for ` 200.
Jan. 30: Sold goods to Narendrakumar worth ` 9,000 and received half amount on the spot.
Solution:
Purchases Book
Date Name of Supplier Inward Invoice No. L.F Amt (`)
1/1/15 M/s Akshaykumar 6,000
7/1/15 M/s Vinod Bros. (4000 - 5% TD) 3,800
12/1/15 Jayant Kumar (3500 - 10% TD) 3,150
12,950
Sales Book
Date Name of Customer Outward Invoice No. L.F Amt (`)
5/1/15 M/s Vinaykumar 2,000
17/1/15 M/s Rajnikant (2500 - 5% TD) 2,375
30/1/15 M/s Narendrakumar 4,500
8,875
Return Inwards Book
Date Name of Customer Credit Note No. L.F Amt (`)
25/1/15 M/s Vinaykumar 500
500
Return Outwards Book
Date Name of Supplier Debit Note No. L.F Amt (`)
22/1/15 M/s Vinod Bros.(500 - 5% TD) 475
27/1/15 M/s Akshaykumar 200
675
Dr. Cash Book Cr.
Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
9/1/15 To Sales A/c 500 31/1/15 By Balance c/d 5,000
(Being cash sales)
30/1/15 To Sales A/c 4,500

FUNDAMENTALS OF ACCOUNTING 65
 (Being cash sales)
5,000 5,000
1/2/15 To Balance b/d 5,000

Dr. Purchases Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
31/1/15 To Sundries as per purchases book 12,950
31/1/15 By Balance c/d 12,950
1/2/15 To Balance b/d 12,950 12,950

Dr. Sales Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
31/1/15 To Balance c/d 13,875 9/1/15 By Cash A/c 500
30/1/15 By Cash A/c 4,500
31/1/15 By Sundries as per Sales Book 8,875
13,875 13,875
1/2/15 By Balance b/d 13,875

Dr. Return Inwards Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
31/1/15 To Sundries as per return inwards book 500 31/1/15 By Balance c/d 500
500 500
1/2/15 To Balance b/d 500

Dr. Return Outwards Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
31/1/15 To Balance c/d 675 31/1/15 By Sundries as per return outwards book 675
675 675
1/2/15 By Balance b/d 675

Dr. M/s Akshaykumar Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
27/1/15 To Return Outwards A/c 200 1/1/15 By Purchases A/c 6000
31/1/15 To Balance c/d 5,800
6,000 6,000
1/2/15 By Balance b/d 5,800

Dr. M/s Vinod Bros Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
22/1/15 To Return Outwards A/c 475 7/1/15 By Purchases A/c 3,800
31/1/15 To Balance c/d 3,325
3,800 3,800
1/2/15 By Balance b/d 3,325

66 FUNDAMENTALS OF ACCOUNTING
Dr. Jayant Kumar Account Cr.
Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
31/1/15 To Balance c/d 3,150 12/1/15 By Purchases A/c 3,150
1/2/15 By Balance b/d 3,150

Dr. M/s Vinaykumar Account Cr.

Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
5/1/15 To Sales A/c 2,000 25/1/15 By Return Inwards A/c 500
31/1/15 By Balance c/d 1,500
2,000
1/2/15 To Balance b/d 1,500

Dr. M/s Rajnikant Account Cr.
Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
17/1/15 To Sales A/c 2,375 31/1/15 By Balance c/d 2,375
1/2/15 To Balance b/d 2,375

Dr. M/s Narendrakumar Account Cr.
Date Particulars J.F. Amt (`) Date Particulars J.F. Amt (`)
20/1/15 To Furniture A/c 1,200 31/1/15 By Balance c/d 5,700
30/1/15 To Sales A/c 4,500
5,700 5,700
1/2/15 To Balance b/d 5,700

Dr. Furniture Account Cr.
Date Particulars J.F. Amt(`) Date Particulars J.F. Amt(`)
31/1/15 To Balance c/d 1,200 20/1/15 By M/s Narendra kumar A/c 1,200
1/2/15 By Balance b/d 1,200

Trial Balance as on 31.1.15

Dr. Cr.
Name of Account (`) (`)
Cash A/c 5,000 -----
Purchases A/c 12,950 -----
Sales A/c ----- 13,875
Return Inwards A/c 500 -----
Return Outwards A/c ----- 675
M/s Akshaykumar A/c ----- 5,800
M/s Vinod Bros. A/c ----- 3,325
Jayant Kumar A/c ----- 3,150
M/s Vinaykumar A/c 1,500 -----
M/s Rajnikant A/c 2,375 -----
M/s Narendrakumar A/c 5,700 -----
Furniture A/c ----- 1,200
Total 28,025 28,025

FUNDAMENTALS OF ACCOUNTING 67
Illustration 17.
The total of debit side of Trial Balance of a larger boot and shoe repairing firm as on 31.12.2013 is ` 1,66,590 and that
of the credit side is ` 42,470. After several checking and re-checking the mistakes are discovered:
Items of Account Correct Figure Figures as it appear in the
(as it would be) ` Trial Balance `
Opening Stock 14,900 14,800
Repairs (outstanding) 61,780 61,780 (appear in the Debit side)
Rent & Taxes 2,160 2,400
Sundry Creditors 6,070 5,900
Sundry Debtors 8,060 8,310
Ascertain the correct total of the Trial Balance.
Solution:
Particulars Debit (`) Credit (`)
Total as per Trail Balance 1,66,590 42,470
Opening Stock understated (14,900-14,800) +100 -
Repairs being credit balance, but shown as debit balance -61,780 +61,780
Rent & Taxes overstated (2,400-2,160) -240 -
Sundry Creditors understated (6,070-5,900) - +170
Sundry Debtors overstated (8,310-8,060) -250 -
Total 1,04,420 1,04,420

Illustration:18.
Record following transactions in the Personal Account of Raman:
`
2015 Sept. 1 Sold goods to Raman 5,420
4 Received from Raman cash 5,150
And allowed him discount 270
15 Raman bought goods 6,000
28 Received cash from Raman on account 2,000
Oct.1 Balance from last month b/d 4,000
13 Sold goods to Raman 10,000
20 Received from Raman cash 3,960
And allowed him discount 40
31 Received cash in full settlement of Raman’s account 9,800

Solution:
Raman Account
Dr. Cr.
Date Particulars Amount ` Date Particulars Amount `
Sept.1 To Sales c/d 5,420 Sept.4 By Cash A/c 5,150
15 To Sales 6,000 4 By Discount 270
28 By Cash 2,000
30 By Balance c/d 4,000
11,420 11,420
Oct.1 To Balance b/d 4,000 Oct.20 By Cash 3,960

68 FUNDAMENTALS OF ACCOUNTING
 13 To Sales 10,000 20 By Discount 40
31 Cash 9,800
31 Discount (Balancing figure) 200
14,000 14,000

EXERCISE
1. Journalise the following transactions:
2015 ` 2015 `
Jan 3 Received cash from Ram 15,000 Jan. 17 Receive from Hari 1,100
4 Purchased goods for cash 2,500 20 Bought furniture from Ram 2,200
11 Sold goods to Hari 3,200 27 Paid Rent 480
13 Paid Ramesh 1,400 30 Paid salary 1,100

Ans: Total of Journal: `26,980

2. Journalise the following transactions:

2015 ` 2015 `
Jan 1 Started business with cash 50,000 Jan.15 Paid to M/s Singh & Co. 21,000
2 Paid into bank 36,000 Discount allowed by them 1,000
3 Bought goods from M/s Singh 22,000 25 Sold goods to M/s Ray & Co. 5,000
& Co. on credit
4 Purchased furniture 4,200 26 Received Cheque from M/s Sharda & co. in full 4,560
settlement of amount due by them
Purchased adding machine 8,400 31 Paid for: Electric Charges 100
& typewriter (Payment in all
cases made by cheque)
6 Paid for postage 215 Paid salary 1,500
8 Sold goods for cash 5,400 Paid rent by cheque 2,000
9 Sold goods on credit to M/s 4,600 Drew for private use 3,500
Sharda & co.

Ans: Total of Journal: `1,69,515

3. Journalise the following transactions IN THE BOOKS OF Rama & Co.
2015 ` 2015 `
Jan1 Business started with 50,000 Jan15 Cash paid to Z in full settlement of his account 8,800
Cash deposited in Bank 20,000 16 Cash received from Y in full settlement of his 24,500
account
Goods purchased 10,000 20 Goods sold to B 6,000
2 Furniture purchased for cash 3,000 Goods purchased 9,000
Office Stationary purchased for 2,000 25 Cash withdrawn from bank 5,000
cash
3 Goods purchased from X 20,000 Cash paid to X 4,000
5 Goods sold to Y 25,000 28 Allowed us a discount 100
Paid rent 1,000 Cash received from B 3,000
8 Paid for repairs 800 30 Allowed a discount 200
9 Paid for advertisement 1,500 31 Cash deposited in bank 4,000

FUNDAMENTALS OF ACCOUNTING 69
 Cash paid to X 10,000 Cash paid for electricity 400
discount received 50 Cash paid for Salaries 1,000
10 Good purchased from Z 9,000 Wages paid 500
Goods purchased in cash from A 6,000 Rent paid 400
Ans: Total of Journal: `2,25,950
Prepare the Ledger account of Mr. Solkar from the following:

2015 March 1 Debit balance to his account ` 2,000.

3 Sold goods on credit to him worth ` 10,800
8 Received cash from him `12,600 and allowed discount of ` 200.
10 Solkar bought goods on credit ` 3,000.
15 Received cash from him ` 2,900 and allowed him discount ` 100
20 Purchased goods on credit from Solkar worth ` 2,000
25 Paid cash to Solkar ` 1,000
28 Returned goods to him ` 200.
31 Paid cash to him in full settlement of his account ` 780.

4. Prepare Ledger Accounts for the following transactions

Debit Balance on January1, 2014
Cash in Hand `8,000. Cash at Bank `25,000, Inventory of goods `20,000, Building `10,000. Trade receivables: Vijay
`2,000 and Madhu`2,000
Credit Balance on January1, 2014:
Trade Payables: Anand `5,000, Capital `55,000
Following were further transactions in the month of January, 2014:
Jan. 1 Purchased goods worth `5,000 for cash less 20% trade discount and 5% cash discount.
Jan. 4 Received `1,980 from Vijay and allowed him `20 as discount
Jan. 8 Purchased plant from Mukesh for `5,000 and paid `100 as cartage for bringing the plant to the factory
and another `200 as installation charges.
Jan. 12 Sold goods to Rahim on credit `600
Jan. 15 Rahim became insolvent and could pay only 50 paise in a rupee
Jan. 18 Sold goods to Ram for cash `1,000.

5. Enter the following transactions in the subsidiary books of Soundarya Saree Shop.
2014 Purchased from Pathi Silk Kendra, 100 Silk sarees at `250 each.
Aug1
5 Purchased from NSR and company, 200 Kanchi Silk sarees at `1,000 each
7 Sold to Kumar on account, 50 printed sarees at `300 and 100 Kanchi sarees at `1,000 each
8 Claimed for damages from Pathi Silk Kendra `500
9 Returned damaged goods to NSR and Co. 5 Kanchi sarees
12 Purchased from Sudharshan Silks 150 Mysore Silk at `250 each, 100 Handloom sarees at `750 each, less
trde discount at 10%
16 Sold to Kala on account 20 printed sarees at `300 each, 25 Kanchi sarees at `1,300 each, 20 Mysore Silk
sarees at `300 each, less trade discount at 5%.
20 Sold to Kusum sarees, 40 Handloom sarees at `1,000 each
21 Kumar returned, 10 printed sarees and 20 Kanchi sarees
25 Returned to Sudharshan’s Silk, 25 Mysore Silk
27 Returned from Kusum sariees, 10 handloom sarees
30 Purchased from Nandi Silk, 400 Nandi brand sarees at `500 each

70 FUNDAMENTALS OF ACCOUNTING
6. Enter the following transactions in Simple Cash Book and post them into ledger:
2014 July 1 Balance of cash in hand `15,000
8 Purchased goods for cash from X for `3,200
15 Sold goods for cash `4,800
20 Received commission `650
Paid commission `550
31 Paid salary to the office clerk `1,000 and office rent `600

Ans: Cash Book Balance =`7,950

7. Enter the following transactions in a two (Cash & discount) Column and post them into Ledger Accounts:
2014 ` 2014 `
Dec.1 Commenced business with cash 50,000 Dec.16 Paid into bank 10,000
2 Brought goods for cash 28,000 18 Cash sales 2,500
5 Received cash from Arun 2,000 20 Purchased stationery for cash 250
7 Paid cash to Sanjay 2900 23 Paid suresh cash 3900
Discount allowed by him 100 Discount allowed 100
10 Paid wages 3000 26 Received from Rajesh 1,900
14 Received from Rajesh cash 950 Allowed him discount 100
Allowed him discount 50 30 Paid salaries 2,000

Ans: Cash Balance = `7,300, Discount = Dr. `150, Cr. `200

8. Prepare a Three Column Cash Book from following transactions and bring down the balance for the start of
next month
2015 ` 2015 `
Aprl.1 Cash in hand 2,500 Aprl.19 Paid into Bank 400
1 Cash at bank 10,000 23 Withdrew from Bank for private exp. 600
2 Paid into Bank 1,000 24 Received cheque from Patel 1,430
5 Bought furniture and issued cheque 2,000 Allowed him discount 20
8 Purchased goods for cash 500 26 Deposited Patel’s cheque into bank
12 Received from mohinder 980 28 Withdrew cash from Bank for the office use 2,000
14 Cash sales 4,000 30 Paid rent by cheque 800
16 Paid to Amarnath by cheque 1,450
Discount allowed 50

Ans: Cash = (Dr) `7,580, Bank = (Dr.) `5,980, Discount = (Dr.) `40, Cr. `50
9. Prepare a Three Column Cash Book from following transactions having cash, bank and discount columns:
2015Aprl.1 Balance of cash in hand `400, overdraft at Bank `5,000
4 Invested further capital `10,000 out of which `6,000 deposited bank
5 Sold goods for cash `8,000
6 Collected from Sridhar a debtor of last year `8,000 discount allowed `200
7 Paid Ramvilas, out creditor, `2,500, discount allowed by him `65
13 Commission paid to Robert our agent `530
14 Office furniture purchased from Keshar `200

FUNDAMENTALS OF ACCOUNTING 71
 17 Draw cheque for personal use `700
18 Collection from Atal `4,000; deposited in the bank on 19th
20 Draw from bank for office use `500
21 Draw cheque for petty cash `150
29 Drew from the bank and paid salary of office staff `1,500
30 Deposited cash in the bank `10,000

Ans: Cash in hand `7,870, Bank = (Dr.) `12,150, Discount = (Dr.) ` , Cr. `

10. Prepare Columnar Petty Cash Book on imprest system from the following particulars:
2015 ` 2015 `
June 1 Received for petty cash payments 1,000 June 20 Paid for conveyance 44
2 Paid for postage 80 25 Paid for travelling expenses 160
5 Paid for stationery 50 27 Paid for postage 100
8 Paid for advertisement 100 28 Wages to office cleaner 20
12 Paid for wages 40 30 Paid for telegrams 40
16 Paid for carriage 30 30 Sent registered notice to landlord 6

Ans: Petty Cash balance = `330

Multiple Choice Questions:

1. Nominal Account represents
(a) Profit & gain (b) Loss/Expenses (c) None (d) Both (A) and (B)
2. S.B.I Account is a …
(a) Nominal (b) Artificial personal Account (c) Representative personal Account (d) None
3. The process of recording business transactions in a book of original entry is known as
(a) Journal (b) Balance (c) posting (d) none
4. Prepaid rent is a
(a) Nominal A/c (b) representative personal A/c (c) tangible assets account (d) none
5. In an Account if debit > credit side, the balance is known as the
(a) Negative balance (b) Debit balance (c) Positive balance (d) Credit balance
6. A sale of goods to Ram for cash should be debited to:
(a) Ram (b) Cash (c) Sales (d) Capital
7. A withdrawal of cash from business by the proprietor should be credited to
(a) Drawing A/c (b) Capital A/c (c) Cash A/c (d) Purchase A/c
8. Rent Account
(a) Personal (b) Real (c) Nominal (d) None
9. Ledger contains various ____ in it
(a) Transactions (b) Entries (c) Accounts (d) None
10. The process of transfer of entries from day book to ledgers is called ___
(a) Simple posting (b) Journal posting (c) Transaction (d) Ledger posting
11. The rent paid to landlord is credited to
(a) Landlord’s A/c (b) Rent A/c (c) Cash A/c (d) None
12. Which financial statement represents the accounting equation-
Assets = Liabilities + Owner’s equity:
(a) Income Statement (b) Statement of Cash flows (c) Balance Sheet (d) None
13. The debts written off as bad, if recovered subsequently are
(a) Credited to Bad Debts recovered A/c (b) Credited to trade receivables Account
(c) Debited to profit and Loss Account (d) None
14. A trial balance will not balance if ____
(a) correct entry is posted twice

72 FUNDAMENTALS OF ACCOUNTING
 (b) The purchase on credit basis is debited to purchases and credited to cash
(c) ` 500 cash payment to creditors is debited to creditors for ` 50 and credited to cash as ` 500 (d) None of
the above
15. A trial balance shows
(a) Honesty of accountants (b) Accuracy of account
(c) Only arithmetical accuracy of accounts (d) none of these

Ans: 1.d 2.b 3.a 4.b 5.b 6.b 7.c 8.c 9.c 10.d 11.c 12.c 13.a 14.c 15.c

Fill in the blanks:

1. Cash account is ____(Real account)
2. Liability account has ____balance(credit)
3. Interest account ___ balance (‘debit or credit’)
4. Opening entries are generally passed through ____(‘General journal’)
5. goodwill account is a/an ____(‘intangible asset’)
6. The debit balance in a nominal account shows (Ans: Expenditure)
7. The allowance made for prompt payment is called( Ans: Cash discounct)
8. The left hand side of an account is called (Ans: Debit )
9. If the debit side of goods account exceeds the credit side the difference will be – (Ans: Closing stock)
10. The balance of ___account will be shown in the debit column of trail balance. (Assets/Expenses)
11. The equality of debit and credit of the ____does not mean that the individual accounts are also accurate.
(“Trial balance”)
12. Trail balance is statement which shows the _____or the totals of all the accounts. (“balances”)
13. ___lists the balance and the title of account in the ledger an given data (Trial balance)
14. Closing stock appearing in the trial balance is shown on the ____balance sheet (asset side of)
15. The balance of liabilities account will be shown in the ___of the trial balance. (credit column)

True or false:
1. Ram has assets of `20,000/- and liabilities of `4,000/- his capital therefore would be `16,000/- (TRUE)
2. Depreciation is loss (TRUE)
3. Double accounting system owes its origin to Luca pacioli (TRUE)
4. Profit or loss have no effect on network (FALSE)
5. Capital account is a real account (FALSE)
6. Trial balance is a final accounts (FALSE)
7. Trial balance contains the balances of only personal and real accounts (FALSE)
8. After preparation of ledgers, the next is the preparation of trial balance (TRUE)
9. Journal is the book of final entry (FALSE)
10. Trade discount will be entered in the book of accounts (FALSE)

Match the following:

Group –A

Salary account e a)Artificial personal account

Drawings account c b) Representative personal account
Furniture account d c) Personal account
Income received in advance b d) Real account
Modern Academy a e) Nominal account

FUNDAMENTALS OF ACCOUNTING 73
Group- B

Rent account c Real account

Capital account d Artificial Personal account
Goodwill account a Nominal account
Harish Account e Representative personal Account
State Bank of India b Personal account

1.4 DEPRECIATION - METHODS (STRAIGHT LINE AND DIMINISHING BALANCE METHODS)

Depreciation is derived from the Latin word “Depretium”, where “De” – decline “Pretium” – Price. This decline in
price is due to constant use, wear and tear. “Depreciation is the gradual and permanent decrease in the value of
an asset from any cause.

Accounting Standard (AS 10) states that “Depreciation is allocated so as to charge a fair proportion of the
depreciable amount in each accounting period during the expected useful life of the asset.”

Amortization
 Intangible assets such as goodwill, trademarks and patents are written off over a number of accounting
periods covering their estimated useful lives.
 This periodic write off is known as Amortization and that is quite similar to depreciation of tangible assets.
 The term amortization is also used for writing off leasehold premises.
 Amortization is normally recorded as a credit to the asset account directly or to a distinct provision for
depreciation account.
 Though the write off of intangibles that have no limited life is not approved by some Accountants.
 Some concerns do amortize such assets on the ground of conservatism.

Depletion
 This method is specially suited to mines, oil wells, quarries, sandpits and similar assets of a wasting character.
 In this method, the cost of the asset is divided by the total workable deposits of the mine etc. And by following
the above manner rate of depreciation can be ascertained.
 Depletion can be distinguishable from depreciation in physical shrinkage or lessening of an estimated
available quantity and the latter implying a reduction in the service capacity of an asset.

Obsolescence
 The term ‘Obsolescence’ refers to loss of usefulness arising from such factors as technological changes,
improvement in production methods, change in market demand for the product output of the asset or
service or legal or medical or other restrictions.
 It is different from depreciation or exhaustion, wear and tear and deterioration in that these terms refer to
functional loss arising out of a change in physical condition.

Dilapidation
 In one sentence Dilapidation means a state of deterioration due to old age or long use. This term refers to
damage done to a building or other property during tenancy.

74 FUNDAMENTALS OF ACCOUNTING
 Causes of Depreciation

Internal Causes External Causes Time Element Abnormal Occurrence

Wear and Tear Depletion Obsolesce Inadequacy

A. Internal Causes

(i) Wear and tear: Plant & machinery, furniture, motor vehicles etc suffer from loss of utility due to vibration,
chemical reaction, negligent handling, rusting etc.
(ii) Depletion (or exhaustion): The utility or resources of wasting assets (like mines etc.) decreases with regular
extractions.

B. External or Economic Causes

(i) Obsolescence: Innovation of better substitutes, change in market demand, imposition of legal restrictions
may result into discarding an asset.
(ii) Inadequacy: Changes in the scale of production or volume of activities may lead to discarding an asset.

C. Time element: With the passage of time some intangible fixed assets like lease, patents. Copy- rights etc., lose
their value or effectiveness, whether used or not. The word “amortization” is a better term to speak for the
gradual fall in their values.

D. Abnormal occurrences: An accident, fire or natural calamity can damage the service potential of an asset
partly or fully. As a result the effectiveness of the asset is affected and reduced.

FUNDAMENTALS OF ACCOUNTING 75
 Fixed/Equal Installment OR Straight Line Method

Features:

(i) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation.
(ii) Such depreciation becomes an equal amount in each period.
(iii) The formula for calculation of depreciation is :
Depreciation = (V-S)/n
Where, V = Cost of the Asset
S = Residual value or the expected scrap value
n = estimated life of the asset

76 FUNDAMENTALS OF ACCOUNTING
Formula for calculation of rate of depreciation under Written Down Value Method:
Residual Value
1− n
Cost o
fof the Asset

Example:

If a plant costs ` 16,000 with an estimated salvage value of ` 2,000 at the end of third year of its useful life, compute
the rate of depreciation.

 2,000 
100 × 1- 3  = 50%
 1
6
16,
000 

Reducing / Diminishing Balance Method OR Written Down Value Method

Features

Depreciation is calculated at a fixed percentage on the original cost in the first year. But in subsequent years it is
calculated at the same percentage on the written down values gradually reducing during the expected working
life of the asset.

The rate of allocation is constant (usually a fixed percentage) but the amount allocated for every year gradually
decreases.

Methods of Recording Depreciation:

Depreciation can be recorded in the books of account by two different methods. They are discussed below:
1. When a provision for Depreciation Account is maintained:
In case of this method, the amount of depreciation to be charged in a particular year in debited to Depreciation
A/c and credited to Provision for Depreciation Account. The Asset Account appears in the books at original cost.
In case the asset is sold, the provision for Depreciation Account is transferred to the Asset Account. Any amount
released on account of sale of asset is also credited to Asset Account. The balance, if any, in the Asset Account is
transferred to the Profit and Loss Account.
2. When a provision for Depreciation Account is not maintained:
In case a Provision for Depreciation Account is not maintained, the amount of depreciation is debited to the
Depreciation Account and credited to the Asset Account. The Asset Account thus appears in the books at written
down value. The Depreciation Account is transferred to the Profit and Loss account like any other item of expense.

Accounting Treatment under different methods:

Sl. Transaction If Provision for If Provision for Depreciation A/c is maintained

No. Depreciation A/c If Asset Disposal A/c is NOT If Asset Disposal A/c is
is NOT maintained opened opened
(ordinary method)
1. For the purchase Asset A/c Dr. Asset A/c Dr. Asset A/c Dr.
of an asset To Cash/Bank A/c To Cash/Bank A/c To Cash/Bank A/c
(including exp.
Incurred till it is
brought into use)

FUNDAMENTALS OF ACCOUNTING 77
 2. For the Depreciation A/c Dr. Depreciation A/c Dr. Depreciation A/c Dr.
depreciation on To Asset A/c To Prov. for Dep. A/c To Prov. for Dep. A/c
the asset.
3. For the transfer of Profit & Loss A/c Dr. Profit & Loss A/c Dr. Profit & Loss A/c Dr.
depreciation to P To Depreciation A/c To Depreciation A/c To Depreciation A/c
& L a/c
4. When the asset is No Entry No Entry Asset Disposal A/c Dr.
to be sold To Asset A/c
a. For the transfer
of original cost of
the asset to Asset
Disposal A/c
b. For the transfer No Entry Prov. for Dep A/c Dr. Prov. for Dep A/c Dr.
of provision for To Asset A/c To Asset Disposal A/c
Depreciation A/c
c. For the sale of Cash / Bank A/c Dr. Cash / Bank A/c Dr. Cash / Bank A/c Dr.
asset To Asset A/c To Asset A/c To Asset Disposal A/c
d. For the profit on Asset A/c Dr. Asset A/c Dr. Asset Disposal a/c Dr.
the sale of asset. To Profit & Loss A/c To Profit & Loss A/c To Profit & Loss A/c
e. For the loss on Profit & Loss A/c Dr. Profit & Loss A/c Dr. Profit & Loss A/c Dr.
the sale of asset To Asset A/c To Asset A/c To Asset Disposal a/c

Illustration 1
Purchase price of a machine `1,80,000; Freight charges `30,000; installation charges `10,000; residual vale `16,000
and useful life 5 years. Calculate the depreciation for third year under the straight line method. Under straight line
method, the depreciation for each year

Solution:

Depreciation = Cost of Machine +Repair +Installation -Residual Value

Useful Life

Hence, the depreciation for the third year = 1,80,000 + 30,000 +10,000 -16,000 = ` 40,800
5

Illustration 2

Calculate the Rate of Depreciation under Straight Line Method (SLM) in each of the following:-
Machine No. Cost of Machine (`) Expenses incurred at the Estimated Residual Expected Useful Life
time of purchase to be Value (`) in years
capitalized (`)
1 90,000 10,000 20,000 8
2 24,000 7,000 3,100 6
3 1,05,000 20,000 12,500 5
4 2,50,000 30,000 56,000 10

78 FUNDAMENTALS OF ACCOUNTING
Solution:

Ma- Cost of Expenses incurred Depreciation= Total Cost Estimated Expected Rate of
chine Machine at the time of (d-e)/f (`) of Asset = Residual Useful Life Depreciation
No (`) purchase to be (b+c) (`) Value(`) in years under SLM =
capitalized (`) (g/d)×100
a b c g d e f h
1 90,000 10,000 10,000 1,00,000 20,000 8 10%
2 24,000 7,000 4,650 31,000 3,100 6 15%
3 1,05,000 20,000 22,500 1,25,000 12,500 5 18%
4 2,50,000 30,000 22,400 2,80,000 56,000 10 8%

Illustration 3
A machine is purchased for ` 7,00,000. Expenses incurred on its cartage and installation ` 3,00,000. Calculate the
amount of depreciation @ 20% p.a. according to Straight Line Method for the first year ending on 31st March, 2015,
if this machine is purchased on:
(a) 1st April, 2014 (b) 1st July, 2014 (c) 1st October, 2014 (d) 1st January, 2015
Solution:
Here, Total Cost of Asset = Purchased Price + Cost of Cartage and Installation
= ` 7,00,000 + ` 3,00,000 = ` 10,00,000
Period from the date of purchase of date od closing accounts
= Total Cost of Asset × Rate of Depreciation ×
12
(a) The machine was purchased on 1st April, 2012:

12
Amount of Depreciation = ` 10,00,000 × 20% × 12 = ` 2,00,000

(b) 1st July, 2012

9
Amount of Depreciation = ` 10,00,000 × 20% × 12 = ` 1,50,000

(c) 1st October, 2012

6
Amount of Depreciation = ` 10,00,000 × 20% × 12 = ` 1,00,000

(d) 1st January, 2013

3
Amount of Depreciation = ` 10,00,000 × 20% × 12 = ` 50,000

Illustration 4
A company whose accounting year is the calendar year, purchased on 1st April, 2013 Machinery costing ` 30,000.
It purchased further machinery on 1st October, 2013 costing ` 20,000 and on 1st July, 2014 costing ` 10,000. On
1st January, 2015 on third of the Machinery installed on 1st April, 2013 became obsolete and was sold for ` 3,000.
Show how machinery account would appear in the books of the company, it being given that machinery was
depreciated by fixed installment method at 10 p.c. per annum.

Solution:
Dr. Machinery Account Cr.
2013 Particulars ` 2013 Particulars `
Apr.1 To Bank A/c 30,000 Dec.31 By Depreciation A/c (on ` 30,000 for nine months and on 2,750
` 20,000 for 3 months)
To Bank A/c 20,000 Dec.31 By Balance c/d 47,250

FUNDAMENTALS OF ACCOUNTING 79
 50,000 50,000
2014
Jan.1 To Balance 47,250 2014
b/d
July1 To Bank A/c 10,000 Dec.31 By Depreciation A/c (on ` 50,000 for one year and on ` 10,000 5,500
for 6 months)
2005
Dec.31 By Balance c/d 51,750
57,250 57,250
2015 2015
Jan.1 ToBalance b/d 51,750 Jan. 1 By Bank a/c 3,000
Jan.1 By Profit and Loss A/c (loss on sale) (1) 5,250
Dec.31 By Depreciation (on `50,000 for one year) A/c 5,000
Dec.31 By Balance c/d 38,500
51,750 51,750
2016
Jan.1 To Balance b/d 38,500

Working Note:
(1) Calculation of Loss on sale of 1/3 of the Machinery
` `
Value of Machinery 10,000
Less: Depreciation for 2013 for 9 months 750
Depreciation for 2014 1,000
1,750
Written down value of Machinery 1-1-2015 8,250
Less: Amount realized 3,000
Loss transferred to profit and loss A/c 5,250

Illustration 5
On July 1, 2012 Granites Ltd. purchased second hand machine for `40,000 and reconditioned the same by spending
`6,000. On January 1, 2013 a new machine was purchased for `24,000. On June 30, 2014 the machine purchased
on January 1, 2013 was sold for `16,000 and another machine was installed at a cost of `30,000.
The company writes of 10% on original cost every year on March 31. Show the Machinery account update.

Solution:
Dr. Machinery Account Cr.
Date Particulars ` Date Particulars `
1-7-12 To Bank (`40,000 46,000 31-3-13 By depreciation A/c
+ `6,000) 9 10
` 46,000 × × = 3,450
12 100
3 10
1-1-13 To Bank 24,000 ` 24,000 ×12 ×100 = 600 4,050

31-3-13 By balance c/d 65,950

70,000 70,000
1-4-13 To Balance b/d 65,950 31-3-14 By depreciation A/c (on ` 70,000 at 10%) 7,000

80 FUNDAMENTALS OF ACCOUNTING
 31-3-12 By balance c/d 58,950
65,950 65,950
1-4-14 To balance b/d 58,950 30-6-14 By Bank (Sale of Machinery) 16,000
30-6- To Bank 30,000 30-3-15 By P & L A/c (1) 4,400
14
31-3-15 By Depreciation (2) 7,450
By balance c/d 61,100
88,950 88,950
1-4-15 To balance b/d 61,100

Working Notes:
1. Calculation of Loss on sale of machinery:
Cost of Machinery on 1-1-2013 24,000
3 10 600
Less: Depreciation upto 31-3-2013 (` 24,000 × × )
12 100 23,400
Less: Depreciation upto 31-3-2014 (on ` 24,000 at 10%) 2,400
21,000
3 10 600
Less: Depreciation till the date of sale of machinery i.e. (30-6-2014) (` 24,000 × × )
12 100 20,400
Less: Amount realized on sale of machinery 16,000
4,400
Loss on sale of machinery 4,400

2. Calculation of depreciation on the balance of machinery form 1-4-2014 to 31-3-2015:

Depreciation on the machinery sold for 3 months form 1-4-2014 to 30-6-2014 (date of sale) (` 24,000 600
3 10
×12 ×100 )
On ` 46,000 at 10% 4,600
9 10 2,250
On ` 30,000 at 10% for 9 months (` 30,000 × × )
12 100
7,450

Illustration 6
A company purchased some machineries for `1,00,000 on 1st April, 2011. It charges depreciation @ 10% p.a. on
reducing balance method every year. On 30th September, 2015 a part of machinery was sold for `14,000, the
original cost of the machine was `20,000. Calculate the profit or loss on sale of machinery.
Solution:
Particulars Amt. (`) Amt. (`)
Original cost of the machines as on 1.4.2011 20,000
(-) Depreciation for the year 2011-12 2000
2012-13 1800
2013-14 1620
2014-15 1458
2015-16 656 (7534)
Written down value as on 30-9-2015 12466
Sales price 14000
Profit on sale of machinery 1534

FUNDAMENTALS OF ACCOUNTING 81
Illustration 7
On 1.1.2013 a machine was purchased for `1,00,000 and `50,000 was paid for installation. Assuming that the rate of
depreciation was 10% on Reducing Balance Method, calculate amount of depreciation upto 31.12.2015.

Solution:
Year Opening Book Value (`) Rate Depreciation (`) Closing Book Value (`)
2013 1,50,000 10% 15,000 1,35,000
2014 1,35,000 10% 13,500 1,21,500
2015 1,21,500 10% 12,150 1,09,350

Note: Cost of the machine (i.e. Opening Book Value for the year 2013)
= Cost of Purchase + Cost of Installation
= ` 1,00,000 + ` 50,000 = ` 1,50,000

Illustration 8
A Manufacturing concern whose books are closed on 31st March, Purchased Machinery for `1,50,000 on 1st April
2011. Additional machinery was acquired for ` 40,000 on 30th September, 2012 and for ` 25,000 on 1st April, 2014.
Certain machinery, which was purchased for ` 40,000 on 30th September, 2012, was sold for ` 34,000 on 30th
September, 2014.
Give the Machinery Account for the year ending 31st March, 2015 taking into account depreciation at 10% per
annum on the written-down value.

Solution:
Dr. Machinery Account Cr.
Date Particulars ` Date Particulars `
2011 April To Bank 1,50,000 Mar. 31 By Depreciation 15,000
By Bal. c/d 1,35,000
1,50,000 1,50,000
2012 April 1 To Bal. b/d 1,35,000 2013 Mar. 31 By depreciation (13,500+2,000) 15,500
Sept. 30 To Bank 40,000 By Bal. c/d 1,59,500
1,75,000 1,75,000
2013 Apr.1 To Bal B/d 1,59,500 Mar. 31 By Depreciation (12,150+3,800) 15,950
By Bal. c/d 1,43,550
1,59,500 1,59,500
2014 April 1 To balance b/d 1,43,550 2014 Sept. 30 By Depreciation A/c 1,710
To Bank (additions) 25,000 By Bank A/c 34,000
2014 To P & L A/c (profit on sale of ma- 1,510 2015 Mar. 31 By depreciation (10,935+ 2,500) 13,435
Sept. 30 chinery) (` 34,000 – ` 32,490)
By Balance c/d 1,20,915
1,70,060 1,70,060
2015April1 To Bal. b/d 1,20,915

Calculation of profit on sale of machinery:
Cost of machinery on 30-9-2012 40,000
Less: Depreciation for 2012-2013 (i/1 year) 2,000
2013-14 3,800
2014-15 (1/2 year) 1,710
7,510

82 FUNDAMENTALS OF ACCOUNTING
 32,490
Less: Amount realized on sale of machinery 34,000
Profit on sale of Machinery 1,510

Illustration 9
One lathe machine whose original value was `1,20,000 on 1.4.2013, being the date of installation was sold on
30.9.2015 for `1,00,000. Depreciation is charged at the rate of 10% on reducing balance. Show machinery account
and assets disposable account.

Solution:
Machinery Account
Dr. Cr.
Date Particulars Amt. (`) Date Particular Amt.(`)
2013 Apr. 1 To Balance b/d 1,20,000 2014 Mar 31 By Depreciation A/c (1,20,000*10%) 12,000
Mar 31 By Balance c/d 1,08,000
1,20,000 1,20,000
2014 Apr.1 To Balance b/d 1,08,000 2015 Mar 31 By Depreciation A/c (1,08,000*10%) 10,800
Mar 31 By Balance c/d 97,200
1,08,000 1,08,000
2015 Apr.1 To Balance b/d 97,200 Sep 30 By Machinery disposal A/c 97,200
97,200 97,200

Machinery Disposal Account

Dr. Cr.
Particular Amt. (`) Particular Amt. (`)
To Machinery A/c 97,200 By Bank A/c 1,00,000
To Profit and Loss A/c (profit on sale of Machinery) 7,660 By depreciation A/c (1.4.08-30.9.15) 4,860
1,04,860 1,04,860

Meaning of Provision:

The term ‘provision’ means any amount written off or retained by way of providing depreciation, renewals or
diminution in the value of assets or retained by way of providing for any known liability the amount of which may not
be determined with substantial accuracy. If the amount of such liability can be ascertained it will be a liability and
not a provision. Provisions for depreciation, provision for bad and doubtful debts, provisions for taxation, provision
for repairs and renewal and provision for contingencies are some examples of provisions. It is a charge to profit and
loss account.

The main purpose of provision for repairs and renewals is to give a uniform charge to profit and loss account in
respect of machinery. This is all the more necessary as the usefulness of the machinery is also uniform form year
to year. Under this method the total repairs over the life of the asset are estimated and then average is found.
This amount is debited to the profit and loss account of every year and credited to the provisions of repairs and
renewals account. The actual amount of repairs and renewals is debited to the provision for repairs and renewals
account, the balance of the account appears on the liabilities side in the balance sheet. As soon as the life of the
asset is over, the account is automatically closed.

FUNDAMENTALS OF ACCOUNTING 83
Illustration 10
A firm desires to debt its profit and loss account with a uniform figure every year in respect of repairs and renewals.
It expects that considering the life of the asset in question ` 10,000 will be the average amount to be spent per year.
Actual repairs are ` 1,000 in the first year, ` 2,300 in the second year and ` 3,700 in the third year. Show the provision
for repairs and renewals account.

Solution:
Provision for Repairs and Renewals Account
Dr. Cr.
Year 1 To Bank (repairs) 1,000 Year – 1 By P & L A/c 10,000

To Balance c/d 9,000

10,000 10,000

Year II To Bank (repairs) 2,300 Year – II By Balance b/d 9,000

To Balance c/d 16,700 By P. & L. A/c 10,000

19,000 19,000

Year III To Bank (repairs) 3,700 Year III By Balance b/d 16,700

To Balance c/d 23,000 By P & L A/c 10,000

26,700 26,700

Meaning of Reserve
Any sum which is appropriated out of profit and loss appropriation account is not meant to cover up liability,
contingency, commitment. Or reduction in the value of an asset is a reserve. It is provided for meeting prospective
losses or liabilities, creation of reserves to increase the working capital in the business, strengthen its financial position
to equalize the dividend during the period of inadequate profit and to comply with legal requirements. Sometimes
the amount is not kept in the business as additional working capital but is invested in the purchase of outside
securities, then it is called reserve fund and not a reserve. Reserve may be (i) capital reserve and (ii) revenue serve.

EXERCISE:
1. M/s Suba Pharmaceuticals has imported a machinery on 1st July, 2012 for `1,60,000 paid custom duty and
freight `80,000 and incurred erection charges ` 60,000. Another local machinery costing `1,00,000 was purchased
on January 1 , 2013. On 1st July, 2014 a portion of the imported machinery (value one third) got out of order and
was sold for `34,800. Another machinery was purchased to replace the same for `50,000. Depreciation is to be
calculated at 20% p.a. on straight line method. Show the machinery account for 2012, 2013 and 2014.

Ans: Balance in Machinery Account `2,05,000; Loss on sale `25,200

2. A manufacturing concern, whose books are closed on 31st March, purchased machinery for ` 1,50,000 on 1st
April 2010. Additional machinery was acquired for ` 40,000 on 30th September 2011 and for ` 25,000 on 1st April,
2013. Certain machinery, which was purchased for ` 40,000 on 30th September, 2011 was sold for ` 34,000 on
30th September, 2013. Give the machinery account for the year ending 31st March, 2014 taking into account
depreciation at 10% per annum on the written – down value.

Ans: Balance in Machinery Account `1,20,915; Profit on sale of Machinery = `1,510

3. A Transport company purchased 5 trucks at `2,00,000 each on April 1. 2012. The company observes calendar
year as its accounting year.
On October 1, 2014 one of the trucks is involved in an accident and is completely destroyed. Insurance company
pays `90,000 in full settlement of the claim. On the same day the company purchases an used truck for `1,00,000
and spends `20,000 on its overhauling.

84 FUNDAMENTALS OF ACCOUNTING
Prepare truck account (in clummnar form) for the three years ending on December, 2014 if the company writes off
depreciation @ 20% per annum on
Original cost method and
diminishing balance method.

Ans: Balance i) `4,74,000; Loss on sale of machinery `10,000

ii) `5,49,200; Loss on sale of machinery `25,600

Multiple Choice Questions:

1. Depreciation refers to the process of __-
(a) Asset valuation (b) Allocation of cost of the assets over the period of its life
(c) verification of assets (d) increasing or decreasing the value of asset
2. In case the depreciable assets are revalued, the provision for depreciation is based on
(a) market value of the assets (b) historical cost of assets (c) depreciated value of the assets (d) The revalued3.
amount over the estimate of the remaining useful life of such asset
3. Which of the following is the internal causes for depreciation?
(a) wear and tear (b) depletion or exhaustion (c) both a & b (d) none of the above
4. Which are the methods of depreciation is prescribed by the income tax act __
(a) straight line and annuity method (b) sinking fund and double declining method
(c)equal installment and written down value method
(d) production hour and sum of year’s digit method
5. Depreciation is not provided for which of the following asset?
(a) goodwill (b) land (c) inventory of goods (d) both B & c
6. Obsolescence means decline in the value due to
(a) physical wear and tear (b) efflux of time
(c) fall in market price (d) innovations and inventions
7. The depreciation account is closed at the end of the year by transfer to the
(a) general reserve a/c (b) profit and loss a/c
(c) provision for depreciation a/c (d) fixed asset a/c
8. Which of the following is an external cause for depreciation
(a) Obsolescence (b) time element (c) abnormal occurrences (d) all of the above
9. Accumulated depreciation is an example of
(a) A liability (b) An expense (c) An income (d) An unrecorded revenue
10. Purchase price of machine 8.90,000, freight and cartage 7000, installation charges 30,000, Insurance charges
20000, residual value is 40,000, estimated useful life 5 years. Calculate the amount of annual depreciation
under straight line method?
(a)1,77,400 (b) 181400 (c) 197400 (d) 177900
11. Depreciation of a ten-year lease is best done on the method
(a) WDV (b) SLM (c) Annuity method (d) both a & b
12. Original cost is ` 1,50,000 residual value is 10,000, depreciation for 3rd year @ 10% p.a. under WDV method___
(a) 14.000 (b) 12150 (c) 11,340 (d) 12,240
13. For charging depreciation, on which of the following assets, the depletion method is adopted?
(a) plant & machinery (b) land & building (c) goodwill (d) Wasting assets like mines and quarries
14. The value of an asset after deducting depreciation from the historical cost is known as
(a) Fair value (b) market value (c) net realizable value (d) book value
15. If the original cost of the machine = 1,00,000, life = 5years residual value = 2.000. If the depreciation for 4th year
as per SLM is 19,600, then the rate of depreciation p.a. is
(a) 10% (b) 15% (c) 20% (d) 5%

FUNDAMENTALS OF ACCOUNTING 85
Answer:

1. (b) 2. (d) 3. (c) 4. (c) 5. (d) 6. (d) 7.(b) 8. (a) 9.(a) 10.(a) 11.(b) 12.(b) 13.(d) 14.(d) 15.(c)
Fill in the blanks:
1. Depreciation means ____(decrease in the value of an asset.)
2. Amortization means ____(charging a period with the proportionate cost of an intangible asset.)
3. Depreciation accounts is _____type of account (Nominal)
4. _____ is a charge against the profits.(Provision)
5. The amount of depreciation charged on a machinery will be debited to ____ account (Depreciation)
6. Profit on sale of machinery is ____ to P & L. (credited)
7. The amount charged to depreciation declines in ____ (reducing balance method.)
8. Formula to calculate rate of depreciation under diminishing balance method ____ (1- n√(R/C))
9. Depreciation is a ____ item (non- cash)
10 . Obsolescence of a depreciable asset is caused by ___ changes. (Technological)
11. In case of down ward revaluation of an asset which is for the first time revalued, the account debited is ____
(profit and loss account.)
12. ____ is an expenses accruing from use of fixed assets.( Depreciation)
13. For providing depreciation on hand tools, the appropriate method of depreciation is ___ (Revaluation
method)
14. In ____ method physical wear and tear are more important than economic obsolescence. (straight line)
15. Formula to calculate depreciation under straight line method _____ (Cost of the Asset – Estimated Scrap
Value / Estimated Life Time)
True or false:
1. In case of mineral resources depreciation is not provided, but depletion is charged (TRUE)
2. Under straight line method the cost of the asset written off in equal proportion, during its economic life (TRUE)
3. Depreciation is charged on tangible fixed assets and it is not charged on any current asset (TRUE)
4. Depreciation is a process of allocation and not of valuation (TRUE)
5. An asset is purchased for ` 25,000, depreciation is to be provided annually according to straight line method
useful life if the asset is 10 years and scrap value is 5000. Is the rate of depreciation is 10% (FALSE)
6. If the written down value of the machine on 1-1-95 is 9,72,000 what will be the value of machine on 1-1-93. If
the method is RBM and rate of depreciation is 10%. The value on 1-1-93 is 12,00,000 (TRUE)
7. Under the RBM of depreciation, the value of machinery never comes to zero and, under SLM of depreciation
the value of machinery comes to zero at the end of its useful life. (TRUE)
8. Original cost of a machine was ` 2,52,000. Salvage value was 12,000, Depreciation for 2nd year @ 10% under
WDV method is 21,600. (TRUE)
9. The portion of the acquisition of cost of the asset, yet to be allocated is known as written down value (TRUE)
10. Under diminishing balance method, depreciation decrease every year. (TRUE)

Match the following:

Group - I
1.Patent b a) No depreciation
2.Building d b) Amortization
3.Mineral deposit e c)Wear and tear
4.Land a d)Depreciation
5. Internal cause c e) Depletion

86 FUNDAMENTALS OF ACCOUNTING
Group - II

1. Depreciation d Written down value method

2. Straight line method b Equal installment method
3. Fixed assets e Depletion method
4. Reducing balance method a As-6
5. Units of production method c As-10

1.5 RECTIFICATION OF ERRORS

Every concern is interested in ascertaining its true profit and financial position at the close of the trading year. But
inspite of the best efforts of the book-keeper and the accountant certain errors are committed in the recording of
the transactions which affect the final accounts of the concern. It, therefore, becomes utmost important for the
book-keeper and the accountant to locate such errors and rectify them so that correct profit and financial position
of the concern may be ascertained. So whenever errors in accounting records come to notice, they should be
rectified without waiting till the end of the accounting year when Trial Balance is to be prepared.

Stages of Errors:

Errors may occur at any of the following stages of the accounting process:
At the Stage of Recording the Transactions in Journal
Following types of errors may happen at this stage:
i) Errors of principle,
ii) Errors of omission,
ii) Errors of commission.

AT THE STAGE OF POSTING THE ENTRIES IN LEDGER

i) Errors of omission:
a) Partial omission,
b) Complete omission.
ii) Errors of commission:
a) Posting to wrong account,
b) Posting on the wrong side,
c) Posting of wrong amount.

AT THE STAGE OF BALANCING THE LEDGER ACCOUNTS

a) Wrong totaling of accounts,
b) Wrong balancing of accounts.

AT THE STAGE OF PREPARING THE TRIAL BALANCE

a) Errors of omission,
b) Errors of commission:
1. Taking wrong account,
2. Taking wrong amount,
3. Taking to the wrong side.

On the above basis, we can classify the errors in four broad categories:
1. Errors of Principle,
2. Errors of Omission,
3. Errors of Commission,
4. Compensating Errors.

FUNDAMENTALS OF ACCOUNTING 87
Types of Errors

Basically errors are of two types:

a) Errors of principle: When a transaction is recorded in contravention of accounting principles, like treating the
purchase of an asset as an expense, it is an error of principle. In this case there is no effect on the trial balance
since the amounts are placed on the correct side, though in a wring account. Suppose on the purchase of
a typewriter, the office expenses account is debited; the trial balance will still agree.

Clerical errors: These errors arise because of mistake committed in the ordinary course of the accounting work.
These are of three types:

(i) Errors of Omission: If a transaction is completely or partially omitted from the books of account, it will be case
of omission. Examples would be: not recording a credit purchase of furniture or not posting an entry into the
ledger.
(ii) Errors of Commission: If an amount is posted in the wrong account or it is written on the wrong side or the totals
are wrong or a wrong balance is struck, it will be a case of “errors of commission”.
(iii) Compensating Errors: if the effect of errors committed cancel out, the errors will be called compensating
errors. The trial balance will agree. Suppose an amount of `10 received from A is not credited to his account
and the total of the sales book is `10 in excess. The omission of credit to A’s account will be made up buy the
increased credit to the Sales Account.

From another point of view, error may be divided into two categories:
a) Those that affect the trial balance –because of the errors that trial balance does not agree; and
(i) Wrong casting of the subsidiary books
(ii) Wrong balancing of an account
(iii) Posting an amount on the wrong side
(iv) Wrong posting, i.e., writing the wring amount
(v) Omitting to post an amount from a subsidiary book
(vi) Omitting to post the totals of subsidiary book
(vii) Omitting to write the cash book balances in the trial balance
(viii) Omitting to write the balance of an account in the trial balance.
(ix)Writing a balance in wrong column of the trial balance
(x) Totaling the trial balance wrongly.

b) The errors that do not affect the trial balancing are the following:
i) Omitting an entry altogether from the subsidiary book
ii) Making an entry in the wrong subsidiary book
iii) Posting an amount in a wrong account but on the correct side, e.g., an amount to be debited to A is
debited to B, the trial balance will still agree.

88 FUNDAMENTALS OF ACCOUNTING
A chart of the types of errors is given below:

ERRORS

Errors of Principle (treating a revenue expense as capital Clerical Errors

expenditure or vice versa or the sale of a fixed asset as
ordinary sale). Trial Balance will agree

Errors of omission Errors of Commission Compensating Errors

Trial Balance will
agree

Omitting an entry Omitting to post the ledger

completely from the account from the subsidiary
subsidiary books. Trial books. Trial Balance will not
Balance will agree agree

Writing the wrong Wrong casting Posting the wrong Posting an Wrong
amount in the subsidiary of subsidiary amount in the amount on the balancing of an
books. Trial Balance will books ledger wrong side. account
agree.

Trial Balance will not agree

Steps to Locate Errors:

Even if there is only a very small difference in the trial balance, the errors leading to it must be located and rectified.
A small difference may be the result of a number of errors. The following steps will be useful in locating errors:
i) The two columns of the trial balance should be totaled again. If in place of a number of accounts, only one
amount has been written in the trial balance the list of such accounts should be checked and totaled again.
List of Trade receivables is the example from which Trade receivable balance is derived.
ii) It should be seen that the cash and bank balances have been written in the trial balance.
iii) The exact difference in the trial balance should be established. The ledger should be gone through it is
possible that a balance equal to the difference has been omitted from the trial balance. The difference
should also be halved; it is possible that balance equal to half the difference has been written in the wrong
column.
iv) The ledger accounts should be balanced again.
v) The casting of subsidiary books should be checked again, especially if the difference is `1, `100 etc.
vi) If the difference is very big, the balance in various accounts should be compared with the corresponding
accounts in the previous period. If the figures differ materially the cases should be seen; it is possible that an
error has been committed. Suppose the sales account for the current year shows a balance of `32,53,000
whereas it was `36,45,000 last year; it is possible that there is an error in the Swales Account.
vii) Postings of the amounts equal to the difference or half the difference should be checked. It is possible that
an amount has been omitted to be posited or has been posted on the wrong side.
viii) If there is still a difference in the trial balance, a complete checking will be necessary. The posting of all the
entries including the opening entry should be check. It may be better to begin with the nominal accounts.

Rectification of Errors:
Errors should never be corrected by overwriting. If immediately after making an entry it is clear that an error has
been committed, it may be corrected by neatly crossing out the wrong entry and making the correct entry. If
however the errors are located after some time, the correction should be made by making another suitable entry,

FUNDAMENTALS OF ACCOUNTING 89
called rectification entry. In fact the rectification of an error depends on at which stage it is detected. An error can
be detected at any one of the following stages:
a) Before preparation of Trial Balance
b) After Trial Balance but before the final account are drawn.
c) After final accounts, i.e., in the next accounting period.

Before Preparation of Trial Balance:

(i) The sales book for November is undercast by `200. The effect of this error is that the Sales Account has been
credited short by `200. Since the account is posted by the total of the sales book, there is no error in the
accounts of the customers since they are posted with amounts of individual sales. Hence only the Sales
Accounts is to be corrected. This will be done by making an entry for `200 on the credit side: “By Undercasting
of Sales Book for November `200”.
(ii) While posting the discount column on the debit side of the cash book the discount of `10 allowed to Ramesh
has not been posted. There is no error in the cash book, the total of discount column presumably has been
posted to the discount account on the debit side. The error is in not crediting Ramesh by `10. This should now
be done by the entry “By omission of posting of discount on `10”.
(iil) `50 was received from Mahesh and entered on the debit side of the cash book but was not posted to his
account. By the error, which affects only the account of Mahesh, `50 has been omitted from the credit side
of his account. The rectification will be by the entry. “By Omission of posting on the `50.”
(iv) Goods purchased from Vinod for `1,000 was wrongly credited to Vimal account by `100. Again we cannot
pass a complete journal entry for rectifications even through two accounts are involved. The rectification will
be done by the entry “To wrong posting on `100” in the debit of Vimal account and “By omission of posting
on `1,000” in the credit of Vinod account.

After Trial Balance but before Final Accounts

The method of correction of error indicated so far is appropriate when the errors have been located before the
end of the accounting period. After the corrections the trial balance will agree. Sometimes the trial balance is
artificially made to agree inspite of errors by opening suspense account and putting the difference in the trial
balance to the account – the suspense account will be debited if the total of the credit column in the trial balance
exceeds the total of the debit column; it will be credited in the other case.

One must note that such agreement of the trial balance will not be real. Effort must be made to locate the errors.

The rule of rectifying errors detected at this stage is simple. Those errors for which complete journal entries were
not possible in the earlier stage of rectification (i.e., before trial balance) can now be rectified by way of journal
entry(s) with the help of suspense account, for it these errors which gave rise to the suspense account in the trial
balance. The rectification entry for other type of error i.e., error affecting more than one account in such a way
that a complete journal entry is possible for its rectification, can be rectified in the same way as in the earlier stage
(i.e., before trial balance).

In a nutshell, it can be said that each and every error detected at this stage can only be corrected by a complete
journal entry. Those errors for which journal entries were not possible at the earlier stage will now be rectified by a
journal entry(s), the difference or the unknown side is being taken care of by suspense account. Those errors for
which entries were possible even at the first stage will now be rectified in the same way.

Suppose, the sales book for November, 2010 is cast `100short; as a consequence the trial balance will not agree.
The credit column of the trial balance will be `100 short and Suppose Account will be credited by `100. To rectify
the error the Sales Account will be credited (to increase the credit to the right figure. Since now one error remains,
the suspense Account must be closed – it will be debiting the Suspense Account. The entry will be:

90 FUNDAMENTALS OF ACCOUNTING
Suspense Account Dr. `100
To Sales Account `100
(Correction of error of Undercasting the sales Book for Nov. 2010)

Illustration: 1
Correct the following errors without opening a Suspense Account
a) The Sales Book has been totaled `100 short.
b) Goods worth `150 returned by Green & Co. have not been recorded anywhere.
c) Furniture purchased from Gulab & Bros., `1,000 has been entered in Purchases Day Book.
d) Discount allowed to G. Mohan & Co. `18 has not been entered in the Discount Column of the Cash Book. The
account of G. Mohan & Co. has, however, been correctly posted.

Solution:

If a Suspense Account is not opened:

a) Since sales book has been cast `100 short, the Sales Account has been similarly credited `100 short. The
correcting entry is to credit the Sales Account by `100 as “By wrong totaling of the Sales Book `100”.
b) To rectify omission, the Return Inwards Account has to be debited and the Account of Green & Co. credited.
The entry:
Returns Inward Account Dr. `150
To Green & Co. `150
(Goods returned by the firm, previously omitted from the Returns Inward Book)
c) By this error Purchases Account has to be debited by `1,000 whereas the debit should have been to the
Furniture Account. The correcting entry will be:
Furniture Account Dr. `1,000
To Purchase Account `1,000
(Correction of the mistake by which purchases Account was debited instead of the Furniture Account)
d) In this case the account of the customer has been correctly posted; the discount account has been debited
`18 short since it has been omitted from the discount column on the debit side of the cash book. The discount
account should now be debited by the entry. “To Omission of entry in the Cash Book `18”.

Correction in the Next Accounting Period

Rectification of errors discussed so far assumes that it was carried out before the books were closed for the
concerned year. However, sometimes, the rectification is carried out in the next year, carrying forward the balance
in the Suspense Account or even transferring it to the Capital Account. Suppose, the Purchase Book was cast short
by `1,000 in December, 2014 and Suspense Account was opened with the difference in the trial balance. If the
error is rectified next year and more than the amount relating to year 2014 and thus the profit that year 2014 will be
less than the actual for that year. Thus, correction of errors in this manner will ‘falsify’ the Profit and Loss Account.

To avoid this, correction of all amounts concerning nominal account, i.e., expenses and incomes should be through
a special account styled as “Prior Period Items” or “Profits and Loss Adjustment Account”. The balance in the
account should be transferred to the Profits and Loss Account. However, these Prior Period Items should be charged
after deriving net profit of the current year. ‘Prior Period items’ are material income or expenses which rise in the
current period as a result of errors or omissions in the preparation of the financial statements of one or more periods.
Prior Period Items should be separately disclosed in the current statement of profit and loss together with their nature
and amount in a manner that their impact on current profit or loss can be perceived.

FUNDAMENTALS OF ACCOUNTING 91
Illustration: 2
Mr. A closed his books of account on September 30, 2014 in spite of a difference in the trial balance. The difference
was `830 the credits being short; it was carried forward in a suspense account in 2015 following errors were located:
(i) A sale of `2,300 to Mr. Lala was posted to the credit of Mr. Mala.
(ii) The total of the Returns Inward Book for July, 2014 `1,240 was not posted in the ledger.
(iii) Freight paid on a machine `5,600 was posted to the Freight account as `6,500.
(iv) White carrying forward the total in the Purchase Account to the next page, `65,590 was written instead of
`56,950.
(v) A sale of machine on credit to Mr. Mehta for `9,000 was not entered in the books at all. The book value of
machine was `7,500. The firm has the practice of writing off depreciation @10% on the balance at the end of
the year.
Pass journal entries to rectify the errors. Have you any comments to make?

Solution:

Journal of Mr. A
Date Particulars L.F. Dr.(`) Cr.(`)
2011 Mr. Mala A/c Dr. 2,300
(i) Mr. Lala A/c Dr. 2,300
To Suspense A/c 4,600
(Correction of error by which a sale of `2,300 to Mr. Lala was posted to the
Credit of Mrs. Mala)
(ii) Profit and Loss Adjustment A/c Dr. 1,240
To Suspense A/c 1,240
(Rectification of omission to post the total of Returns Inward Book for July, 2014)
iii) a) Machinery A/c Dr. 5,600
Suspense A/c Dr. 900
To Profit & Loss Adjustment A/c 6,500
(Correction of error by which freight paid for a machine `5,600 was posted to
Freight Account at `6,500 instead of capitalizing it)
b) Profit & Loss Adjustment A/c Dr. 560
To Plant and Machinery A/c 560
(Depreciation @ 10% charged on freight paid on a machine capitalized)
iv) Suspense A/c Dr. 8,640
To Profit & Loss Adjustment A/c 8,640
(Correction of wrong carry forward of total in the purchase Account to the next
page `65,590 instead of `56,950)
v) Mr. Mehta Dr. 9,000
To Plant & Machinery A/c 6,750
To Profit & Loss Adjustment A/c 2,250
(Correction of omission of sale of machine on credit to Mr. Mehta for `9,000
with a book value of `7,500 on which depreciation @10% has been charged
in 2010)

92 FUNDAMENTALS OF ACCOUNTING
Comments:
The Suspense Account will not appear as shown below:

Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
` `
2015 To Profit and Loss Adjustment A/c 900 2014 By Balance b/d 830
To Profit and Loss Adjustment A/c 8,640 By Sundries: 2,300
Mr. Mala
Mr. Lala 2,300
By Profit and Loss Adjustment A/c 1,240
By balance c/d 2,870
9,540 9,540

Since the suspense Account still shows a balance, it is obvious that there are still some errors left in the books.

Profit & Loss Adjustment Account

(For Prior Period Items)
Dr. Cr.
Date Particulars Amount ` Date Particulars Amount `
2015 To Suspect A/c 1,240 2015 By Machinery A/c 5,600
To Plant & Machinery A/c 560 By Suspense A/c 900
To Balance c/d 15,590 By Suspense A/c 8,640
By Mr. Mehta 2,250
17,390 17,390

ERRORS DISCLOSED BY TRIAL BALANCE:

The following errors are disclosed by Trial balance.
a) Posting of transaction in wrong side of the account.
b) Posting of transaction on correct side with wrong amount.
c) Errors in totaling.
d) Error is made in carrying forward.
e) Wrong balancing in the ledger account.
f) Posting of one aspect of Journal entry in Ledger account.
g) Recording of one aspect of entry twice.
Recording in subsidiary book and not posted to concerned amount.

Illustration: 3
Rectify the following errors assuming that the errors were detected
(a) Before the Preparation of Trial Balance;
(b) After the preparation of Trial Balance and
(c) After the preparation of Final Accounts.
(i) Purchase Plant for ` 10,000 wrongly passed through Purchase Account.
(ii) Sales Day Book was cast short by ` 1,000.
(iii) Cash paid to Mr. X for ` 1,000 was posted to his account as ` 100.
(iv) Purchase goods from Mr. T for ` 3,500 was entered in the Purchase Day Book as ` 500.
(v) Paid salary for ` 3,000 wrongly passed through wages account.

FUNDAMENTALS OF ACCOUNTING 93
Solution:

In the Books of …………………….

Journal (without narration)

Date Before preparation of Trial Balance After preparation of Trial Balance After preparation of Final Accounts

Dr. Cr. Dr. Cr. Dr. Cr.

(i) Plant A/c 10,000 Plant A/c 10,000 Plant A/c 10,000
To Purchase A/c. 10,000 To Purchase A/c. 10,000 To P&L Adjustment A/c 10,000

(ii) Sales account will be credited Suspense A/c Dr. 1,000 Suspense A/c Dr. 1,000
with ` 1,000 To Sales A/c. 1,000 To P&L Adjustment A/c 1,000

(iii) X Account will be debited when X A/c Dr. 900 X A/c Dr. 900
` 900 To Suspense A/c. 900 To Suspense A/c 900

(iv) Purchase A/c Dr. 3,000 Purchase A/c Dr. 3,000 P&L Adjustment A/c Dr. 3,000
To T A/c 3,000 To T A/c 3,000 To T’s A/c. 3,000

(v) Salary A/c Dr. 3,000 Salary A/c Dr. 3,000 P&L Adjustment A/c. Dr. 3,000
To Wages A/c 3,000 To wages A/c. 3,000 To P&L Adjustment A/c 3,000

Illustration: 4
A merchant, while balancing his books of accounts notices that the T.B. did not tally. It showed excess credit of `
1,700. He placed the difference to Suspense A/c. Subsequently he noticed the following errors:
(a) Goods brought from Narayan for ` 5,000 were posted to the credit of Narayan’s A/c as ` 5,500
(b) An item of ` 750 entered in Purchase returns book was posted to the credit of Pandey to whom the goods had
been returned.
(c) Sundry items of furniture sold for ` 26,000 were entered in the sales book.
(d) Discount of ` 300 from creditors had been duly entered in creditor’s A/c but was not posted to discount A/c.
Pass necessary journal entries to rectify these errors. Also show the Suspense A/c

Solution:

(a) Goods bought from Narayan are posted to credit of his A/c as ` 5,500 instead of ` 5,000. Here, it is correct to
credit Narayan’s A/c. But the mistake is extra credit of ` 500. This is one sided error, as posting to purchases A/c is
correctly made. So the rectification entry will affect the suspense A/c. This needs to be reversed by the rectification
entry:
Narayan’s A/c Dr. 500
To Suspense A/c 500

(b) Goods bought from Pandey were returned back to him. It should have appeared on the debit side of his A/c.
For rectifying we will need to debit his A/c with double the amount i.e. ` 1500 (` 750 to cancel the wrong credit and
another ` 750 to give effect for correct debit) and the effect will go to Suspense A/c. The correction entry is:
Pandey A/c Dr. 1,500
To Suspense A/c 1,500

(c) Sale of furniture was recorded in sales book. What’s wrong here? Remember that sales book records sale of
goods only and nothing else. Sale of furniture will appear in either cash book (if sold for cash) or journal proper (if

94 FUNDAMENTALS OF ACCOUNTING
sold on credit). Hence, wrong credit to Sales A/c must be removed and credit should be given to Furniture A/c. It’s
important to note that this rectification entry will not affect the Suspense A/c. The correction entry is:
Sales A/c Dr 26,000
To Furniture A/c 26,000

(d) The discount received from creditor is not entered in discount A/c but was correctly recorded in creditors’ A/c.
This is one sided error and will therefore be routed through suspense for correction. A discount is received; it must
be credited being an income.
Suspense A/c Dr 300
To Discount received A/c 300

Let us now see how suspense A/c will Look like. Excess credit of ` 1,700 in Trial Balance will be shown on the debit
side of suspense A/c. This will bring in total debit equal to total credit.

Dr Suspense Account Cr
Date Particulars J. F. Amount ` Date Particulars J. F. Amount `
To Balance b/d 1,700 By Narayan 500
To Discount received 300 By Pandey 1,500
2,000 2,000

Please observe that after correcting passing all rectification entries, the Suspense A/c tallies automatically.

Illustration: 5
Pass necessary journal entries to rectify the following errors:
(a) An amount of ` 200 withdrawn by owner for personal use was debited to trade expenses.
(b) Purchase of goods of ` 300 from Nathan was wrongly entered in sales book.
(c) A credit sale of ` 100 to Santhanam was wrongly passed through purchase book.
(d) ` 150 received from Malhotra was credited to Mehrotra.
(e) ` 375 paid as salary to cashier Dhawan was debited to his personal A/c.
(f) A bill of ` 2,750 for extension of building was debited to building repairs A/c
(g) Goods of ` 500 returned by Akashdeep were taken into stock, but returns were not posted.
(h) Old furniture sold for ` 200 to Sethi was recorded in sales book
(i) The period end total of sales book was under cast by ` 100
(j) Amount of ` 80 received as interest was credited to commission.

Solution:
Sl. No. Particulars Debit (`) Credit (`)
(a) Wrong Entry Trade Expenses Dr 200
To Cash 200
Correct entry Drawings Dr 200
To cash 200
Rectification entry Drawings Dr 200
To Trade Expenses 200
(b) Wrong Entry Nathan Dr 300
To Sales 300
Correct entry Purchases Dr 300
To Nathan 300
Rectification entry Purchases Dr 300
Sales Dr 300
To Nathan 600

FUNDAMENTALS OF ACCOUNTING 95
 (c) Wrong Entry Purchases Dr 100
To Santhanam 100
Correct entry Santhanam Dr 100
To Sales 100
Rectification entry Santhanam Dr 200
To Sales 100
To Purchases 100
(d) Wrong Entry Cash Dr 150
To Mehrotra 150
Correct entry Cash Dr 150
To Malhotra 150
Rectification entry Mehrotra Dr 150
To Malhotra 150
(e) Wrong Entry Dhawan Dr 375
To cash 375
Correct entry Salary Dr 375
To cash 375
Rectification entry Salary Dr 375
To Dhawan 375
(f) Wrong Entry Building Repairs Dr 2,750
To Cash 2,750
Correct entry Buildings Dr. 2,750
To Cash 2,750
Rectification entry Buildings 2,750
To Building Repairs 2,750
(g) Wrong Entry No entry passed
Correct entry Sales Returns Dr 500
To Akashdeep 500
Rectification entry Sales Returns Dr 500
To Asashdeep 500
(h) Wrong Entry Sethi Dr 200
To Sales 200
Correct entry Sethi Dr 200
To Furniture 200
Rectification entry Sales Dr 200
To Furniture 200
(i) Wrong Entry No entry passed
Correct entry Suspense Dr 100
To Sales 100
Rectification entry Suspense Dr 100
To Sales 100
(j) Wrong Entry Cash Dr 80
To Commission 80

96 FUNDAMENTALS OF ACCOUNTING
 Correct entry Cash Dr 80
To Interest 80
Rectification entry Commission Dr 80
To Interest 80

Illustration: 6
Rectify the following error and find out the effect of the errors on Net Profit.
i) Purchases of `300 from Raman passed through Sales Book
ii) Bill received from Ramu for `500 passed through Bills Payable Book.
iii) An item of `150 relating to Prepaid Rent was omitted to be brought forward from last year.
iv) `400 paid to Mehta B, against our acceptance was debited to Mehta N.
v) Received `300 from Ajit whose account for `300 was written off earlier and posted to the credit of Amit.
vi) Transistor sold to Karun for `750 passed through Sales Book twice.

Solution:
RECTIFYING ENTRIES
Particulars L.F. Dr.(`) Cr.(`)
(i) Purchase A/c Dr. 300 600
Sales A/c Dr. 300
To Raman A/c
(Being the amount passed through sales book cancelled and debited to purchases
account)
(ii) Bills Receivable A/c Dr. 500 1,000
Bills Payable A/c Dr. 500
To Ramu’s A/c
(Being prepaid Insurance omitted to bring into books of accounts earlier, now brought
into books of accounts)
iii) Prepaid Insurance A/c Dr. 150 150
To Suspence A/c
(Being prepaid Insurance omitted to bring into books of accounts earlier, now brought
into books of accounts))
iv) Bills Payable A/c Dr. 400 400
To N. Mehta A/c
(Being the amount wrongly debited to N. Mehta cancelled)
v) Ajit A/c Dr. 300 600
Amrit a/c Dr. 300
To Bad Debts Recovered A/c
(Being the amount credited to Ajit account cancelled and credited to bad debts
recovered)
vi) Sales A/c Dr. 750 750
To Karun A/c
(Being wrong credit given to sales account cancelled)

Illustration: 7
Following errors were detected in the Accounts of AA Ram and Sons for the year ended 30th June, 2015:
i) A builder’s bill for `2,700 for the erection of a small shed was debited to repairs account.
ii) A cheque for `300 received from Rahim Bux and Co. was dishonoured and debited to allowances account.
iii) Goods to the value of `150 returned by Chandmal Bros. were included in stock, but no entry was made in the
books.
iv) Repairs to plant amounting to `567 had been charged to plant and machinery account
v) Wages paid to the firm’s own workmen for making certain additionas to machinery amounting to `550 were
posted to wages account.
vi) A cheque for `75 received from Lala Ram was credited to the account of Tika Ram and debited incorrectly
to cash account.

FUNDAMENTALS OF ACCOUNTING 97
vii) A sum of `100 drawn by the proprietor for personal use was debited to travelling expenses account.
Give journal entries to correct these errors. Which of these errors, if any, will cause disagreement of the trial
balance? Give reasons for your answer.

Solution:
JURNAL ENTRIES
Particulars L.F. Dr.(`) Cr.(`)
(i) Building A/c Dr. 2,700
To Repairs A/c
2,700
(Being a builder’s bill for the erection of a small shed wrongly debited to Repairs
Account, now corrected)
(ii) Rahim Bux & Co.A/c Dr. 300
To Allowances A/c
300
(Being a cheque received from Rahim Bux & Co. dishonoured was wrongly
debited to Allowances Account, now rectified)
iii) Returns Inwards A/c Dr. 150
To Chandmanl Bros.A/c 150
(Being goods returned by Chandmal Bros. omitted to be recorded, now recorded)
iv) Repairs A/c Dr. 567
To Plant and Machinery A/c
567
(Being repairs to plant and machinery wrongly debited to Plant and Machinery
Account, now corrected)
v) Plant & Machinery A/c Dr. 550
To Wages A/c
550
(Being wages paid for making certain additions to machinery wrongly debited to
Wags Account, now rectified)
vi) a) Tika RamA/c Dr. 75
To Lala RamA/c
75
(Being cheque received from Lala Ram wrongly credited to Tika Ram instead of
to Lala Ram, now corrected)
b) Bank A/c Dr. 75 75
To Cash A/c
(Being cheque received from Lala Ram wrongly debited to Cash Account instead
of to Bank A/c, now rectified)
vii) Drawings A/c Dr. 100 100
To Travelling Expenses A/c
(Being amount drawn by the proprietor wrongly debited to Travelling Expenses
account, now corrected)

Illustration: 8
On going through the Trial balance of Ball Bearings Co. Ltd. You find that the debit is in excess by `150. This was
credited to “Suspense Account”. On a close scrutiny of the books the following mistakes were noticed:
1) The totals of debit side of “Expenses Account” have been cast in excess by `50
2) The “Sales Account” has been totaled in short by `100.
3) One item of purchase of `25 has been posted from the day book to ledger as `250.
4) The sale return of `100 from a party has not been posted to that account through the Party’s account has
been credited.
5) A cheque of `500 issued to the Suppliers’ account (shown under Trade payables) towards his dues has been
wrongly debited to the purchases.

98 FUNDAMENTALS OF ACCOUNTING
6) A credit sale of `50 has been credited to the Sales and also to the Trade receivables Account.
i) Pass necessary journal entries for correcting the above;
ii) Show how they affect the Profits; and
iii) Prepare the “Suspense Account” as it would appear in the ledger.

Solution:

JURNAL ENTRIES
Particulars L.F. Dr.(`) Cr.(`)
Suspense A/c Dr. 50
To Expenses A/c 50
(Being the mistake in totaling of Expenses A/c, rectified)
Suspense A/c Dr. 100
To Sales A/c 100
(Being the mistake in totaling of Sales A/c, rectified)
Supplier A/c Dr. 225
To Sales A/c 225
(Being the mistake in posting from Day Book to Ledger rectified
Sales Returns A/c Dr. 100
To Suspense A/c 100
(Being the sales return from a party not posted to “Sales Returns” now rectified)
Trade Payable A/c Dr. 500
To Purchases A/c 500
(Being the payments made to supplier wrongly posted to purchases now rectified)
Trade Receivables a/c Dr. 100
To Suspense A/c 100
(Being the sales wrongly credited to Customer’s Account now rectified)

Dr Suspense Account Cr
Particulars ` Particulars `
To Expenses A/c 50 By Difference in Trial balance 150
To Sales A/c 100 By Trade payables 225
To Balance c/d 425 By Sales Returns A/c 100
By Trade Receivables 100
575 575
By Balance b/d 425

Since the Suspense Account does not balance, it is clear that all the errors have not been traced. As a result of the
above corrections the Net Profit will be:

Particulars ` `
Mistake in totaling in “Expenses” 50
Mistake in totaling in “Sales” 50
Mistake in posting from day book to Ledger under “Purchases” 500
Omission in positing under “Sales Returns” 100
650 100
Net Increase 550
As a result of these adjustments, the Profits will be increased by `550The books of accounts of A Co. Ltd. for the

FUNDAMENTALS OF ACCOUNTING 99
Illustration: 9
The books of accounts of A Co. Ltd. for the year ending 31.3.2015 were closed with a difference in books carried
forward. The following errors were detected subsequently:
(a) Return outward book was under cast by ` 100.
(b) ` 1,500 being the total of discount column on the credit side of the cash book was not posted.
(c) ` 6,000 being the cost of purchase of office furniture was debited to Purchase A/c.
(d) A credit sale of ` 760 was wrongly posted as ` 670 to the customers A/c. in the sales ledger.
(e) The Sales A/c. was under casted by `10,000 being the carry over mistakes in the sales day book.
(f) Closing stock was over casted by `10,000 being casting error in the schedule or inventory. Pass rectification
entries in the next year.
Prepare suspense account and state effect of the errors in determination of net profit of last year.

Solution:
In the Books of A Co. Ltd.
Journal
Date 2015 Particulars L/ Amount Amount
F (`) (`)
(a) Apr1 Suspense A/c Dr. 100
To Profit & Loss Adjustment A/c 100
(Returns outward book was under cast now rectified).
(b) Suspense A/c Dr. 1,500
To Profit & Loss Adjustment A/c 1,500
(Discount received was not recorded, now rectified).
(c) Office Furniture A/c Dr 6,000
To Profit & Loss Adjustment A/c 6,000
(Office furniture purchased wrongly debited to Purchase A/c. not rectified.)
(d) Debtors’ A/c Dr. 90
To Suspense A/c. 90
(Debtors account was posted ` 670 in place of ` 760, now rectified.)
(e) Suspense A/c. Dr. 10,000
To Profit & Loss Adjustment A/c. 10,000
(Sales account was under casted, now rectified)
(f) Profit & Loss Adjustment A/c. Dr. 10,000
To Suspense A/c. 10,000
Closing Stock was overcastted, now rectified.)

Dr. Suspense Account Cr.

Date Particulars Amount(`) Date Particulars Amount(`)
2015 To Profit & Loss Adj. A/c 100 2015 By Difference in Trial Balance 21,510
Apr.1 ‘’ ‘’ 1,500 Apr.1 `` Debtors A/c. 90
“““ 10,000
“““ 10,000
21,600 21,600

Particulars Increase (+) ` Decrease (-) `

Item (a)…………………………….. - 100
(b)………………………………. - 1,500

100 FUNDAMENTALS OF ACCOUNTING

 (c)……………………………….. - 6,000
(d) No effect - -
(e)……………………………….. - 10,000
(f)……………………………….. 10,000 -
10,000 17,600
Profit will be decreased by 7,600 -
17,600 17,600

EXERCISE:
1. How will you rectify the following errors discovered before preparation of the trial Balance?
a) `1,000 spent for repairs of buildings has been posted to building account
b) A sale of `730 to mohinder Singh has been entered in the Sales Book as `370.
c) Goods worth `500 purchased from Bankey Lal have been omitted to be recorded in the books.
d) `400 paid as salary to a clerk has been debited to his personal account
e) `75 discount allowed by a creditor has been debited to Discount account
f)The Total of Sales Book has been added `100 too much.
g) Office furniture purchased for `1,800 has been passed through the Purchases Book.

2. Write out the journal entries to rectify the following errors using a suspense account:
i) The total of discount allowed from the cash book for the month of December 2015 amounting to `350 was
not posted
ii) An amount of `175 entered in the sales return book has been posted to the debit of Ram, who had returned
the goods.
iii)Bad debts aggregating to `250 were written off during the year in the sales ledger, but were not adjusted
in the general ledger
iv)Goods of the value of `500 returned to Shyam were entered in the sales day book and posted there from
to the credit of his account.
v) A sale of `800 made to Mohan was correctly entered in the sales day book but wrongly posted to the debit
of Mahesh as `80.

3. The debit side of the Trial Balance Showed `1,000 less than the credit side. The suspense account was debited
with `1,000. Later on following errors were detected. Prepare suspense account passing the necessary
rectification entries without giving narrations:
a)Goods return by a customer `300 entered in the customer’s account but not entered in the sales returns
account.
b) Goods sold to Mahesh on credit for `700 was entered in the sales book but not posted to his account.
c) 580 paid by Varsha traders was credited to their account S `508.
d) `260 due from Dinesh was not entered in the schedule of S. Drs.
e) Purchases book was overcast by `188.

Ans: Total of suspense Account = `1,260

4. Following mistakes were located in the books of a concern after its books were closed and a Suspense
Account was opened in order to get the Trial Balance agreed:
i) Sales Day Book was overcast by `100
ii) A sale of `50 to x was wrongly debited to the account of Y.
iii) General expenses of `18 were posted in the general Ledger as `80
iv) A bill receivable for `155 was passed through Bills Payable Book. The bill was given by P.

FUNDAMENTALS OF ACCOUNTING 101

v) Legal expenses of `119 paid to Mr. Duftry were debited to his personal account
vi) Cash received from C. Dass has been debited to G. Dass `150.
vii) While carrying forward the total of one page of the purchases book to the next, the amount of `1,235 was
written as `1,325.
Find out the nature and amount of the Suspense Account and pass entries for the rectification of the above errors
in the subsequent year’s book.

Ans: Suspense Account Cr. Balance = `352

Multiple Choice Questions:
1. Whenever errors are noticed in the accounting records, they should be rectified _____
(a) At the time of preparation of trial balance b) without waiting the accounting year to end (c) After the
preparation of final accounts (d) in the next accounting year
2. A trial balance will not tally if __
(a) correct journal entry is posted twice (b) credit purchase debited to purchases and credited
to cash (c) 5000 cash paid to creditors is debited to creditors for 500 and credited to cash as 5000
(d) none of the above
3. Sales of shyam of 500 not recorded in the books would affect __
(a) shyam’s account (b) sales account (c) Sales account and shyam’s account (d) cash account
4. Errors of carry forward from one year to another affects __
(a) personal account (b) real account (c) nominal account (d) both a and b
5. Goods worth `272 returned by Lala passed through the books as `722. The rectification entry is
(a) Lala will be debited by `450 (b) Lala will be debited by `272
(c) Lala will be credited by `722 (d) Lala will be credited by `272
6. If a receipt of 200 from rajesh (debor) has not been recorded in the books the profits would show
(a) An increase of `2,000 (b) A decrease of `200
(c) Neither an increase nor a decrease (d) None of the above
7. A credit purchase of `950 from sudhir was recorded in purchases book as `590. The rectification entry is __
(a) purchases account will be debited by `360 (b) sudhir will be credited by `590
(c) purchases account will be debited by `950 (d) sudihir will be credited by `950
8. Which of these errors affect only one account
(a) errors of casting (b) errors of carry forward (c) errors of posting (d) All the three
9. If goods worth `1750 returned to supplier is wrongly entered in sales returns book as `1570, then __
(a) net profit will decrease by `3140 (b) Gross profit will increase by `3320
(c) gross profit will decrease by `3500 (d) Gross profit will decrease by `3320
10. Which of the following is one sided error
(a) `500 purchase of old equipment not recorded in the books of account at all
(b) `500 being expense on travelling expense credited to travelling expenses (c) both (d) none
11. Which of the following errors affects the agreement of a trial balance?
(a) Mistake in balancing an account (b) omitting to record a transaction entirely in the subsidiary
books (c) recording of a wrong entry in the subsidiary books
(d) Posting an entry on the correct side but in the wrong account
12. Which of the these errors affect only one account
(a) errors of casting (b) errors of carry forward (c) errors of posting (d) All the three
13. Which of these errors affect two or more accounts
(a)errors of complete omission(b) errors of principle(c) errors of posting to wrong account (d) all the three
14. Which of the following error is an error of principle
(a) `5,000 received from sham credited to Ram A/c.
(b) `5,000 incurred on installation of new plant debited to travelling expenses A/c

102 FUNDAMENTALS OF ACCOUNTING

 (c) `500 paid for wages debited to salary A/c
(d) `500 being purchase of raw material debited to purchase A/c `50
15. `200 paid as wages for erecting a machine should be debited to
(a) repair account (b) Machine account (c) capital account (d) furniture account

Ans: 1.b 2.c 3.c 4.d 5.a 6.c 7.a 8.d 9.d 10.b 11.a 12.d 13.d 14.b 15.b
Fill in the blanks:

1. Unintentional omission or commission of amounts and accounts in the process of recording transactions are
known as ___ (errors.)
2. In case trial balance does not agree difference is put to _____ (Suspense account.)
3. If an effect of an error is cancelled by the effect of some other error, it is commonly known as ____
(Compensating errors)
4. The equality of debts and credits can be tested periodically by preparing a _________(trail balance).
5. It is easy to detect ____ (error) than to ____ (frauds.)
6. On purchase of old furniture, the amount spent on its repair should be debited to furniture ____ (account.)
7. A credit sale wrongly passed through purchases book will ___ the trial balance. (Affect)
8. Goods sold to sethi for `640 was recorded in his account as `460. In the rectifying entry, sethi’s account will be
debited with _____ (`180)
9. Casting errors is an error in ____(totaling.)
10. Goods sold to Busy & co on credit, worth `4,000 were not recorded in books. The rectification entry is ____
(sales account will be credited.)
11. Treating revenue expenses as a capital expenditure is an example of ___(principle) errors
12. The difference in the trial balance is transferred to _____ account. (suspense)
13. ` 200 received from smith whose account was written off as a bad debt should be credited to ____(bad
debts recovered account)
14. ____amount will be credited in Gopal Account when goods purchased from Gopal for `3,600 but way
recorded as `6,300. (`3,600)
15. Rectified entries to be passed in _____(journal proper)

True or false:
1. Error of commission permit the trial balance to agree (FALSE)
2. The discount column of the cash book is not posted is an example of error of omission (TRUE)
3. Full omission do not affect trial balance (TRUE)
4. An error in wrong casting of the sales day book will not affect the personal account of debtors (TRUE)
5. Mistake in balancing an account will affect the agreement of a trial balance (TRUE)
6. Total of purchase journal is short by `1,000 will not affect trial balance (FALSE)
7. Recording a transaction in a wrong book of original entry with wrong amount will affect the trial balance
(FALSE)
8. Under casting or overcastting of a subsidiary book is an example of error of commission (TRUE)
9. The mistake of treating a liability as on income or vice versa will affect the trial balance (FALSE)
10. ` 500 purchase of old equipment not recorded in the books of account at all is an one sided error (FALSE)
Match the following:
Group A
1. Compensating errors c a) Not recording a business transaction
2. Error of omission a b) Charging a revenue item to capital
3. Error of principle b c) Writing a debit item on the credit side and vice versa.
4. Error of commission e d) Error in totaling
5. Error of omission d e) Errors which are not disclosed by trial balance

FUNDAMENTALS OF ACCOUNTING 103

Group B

1. Clerical errors c a)If the transaction is recorded partly.

2. Error is made in carry forward d b) If the entry is recorded twice.
3. Error of commission b c) Errors raised due to negligence, overlook
4. Error of principle e d) Errors which are disclosed by trial balance
5. Error of omission a e) Errors which are not disclosed by trial balance

1.6 OPENING ENTRIES, TRANSFER ENTRIES, ADJUSTMENT ENTRIES, CLOSING ENTRIES

Opening Entries: The opening entry is an item which is passed in the Journal proper or General Ledger.

The purpose of passing this entry is to record the opening balances of the accounts transferred from the previous
year to the New Year. The accounts which are appearing on the assets side of balance sheet are debited in the
opening entry while which accounts are appearing in the liabilities side are credited.

At the end of each accounting period, the books of accounts need to be closed for preparation of final accounts.
Also, in the beginning of the new accounting period, new books of accounts are to be opened. For this purpose,
opening and closing entries need to be passed. These entries are passed in journal proper.

The entry can be given as:

All Asset A/c’s Dr
To All Liabilities A/c
To Owners’ Capital A/cs

Illustration 31.

Consider the following balances in the Balance Sheet as on 31st March 2014. Pass the opening entry on 1st April
2015.

Subodh’s Capital A/c 2,75,000

Loan from HH bank 4,25,000
Plant and machinery 3,30,000
Cash in hand 20,000
Balance at CC bank 1,75,000
Trade Debtors 3,55,000
Closing stock 1,35,000
Trade Payables 2,95,000
Outstanding Expenses 40,000
Prepaid Insurance 20,000

Solution:

The opening entry will be as follows:

Plant and machinery A/c Dr 3,30,000

Cash in hand A/c Dr 20,000

104 FUNDAMENTALS OF ACCOUNTING

 Balance at CC bank A/c Dr 1,75,000

Trade Debtors A/c Dr 3,55,000

Closing stock A/c Dr 1,35,000

Prepaid Insurance Dr 20,000

To Subodh’s Capital A/c 2,75,000

To Loan from HH bank A/c 4,25,000

To Trade Payables A/c 2,95,000

To Outstanding Expenses 40,000

A/c
(Being Opening entry)

CLOSING ENTRIES: All the expenses and gains or income related nominal accounts must be closed at the end of the
year. In order to close them, they are transferred to either Trading A/c or Profit and Loss A/c. Journal entries required
for transferring them to such account is called a ‘closing entry’.

The Closing Entries are passed on the basis of trial balance for transferring the balances to Trading and profit and
loss A/c. These entries are mainly for:

a) For transferring purchases and direct expenses (goods related) to Trading A/c
Trading A/c Dr
To Opening stock A/c
To Purchases A/c
To Factory expenses A/c
To Freight & carriage inward A/c

b) For transferring sales and closing stocks

Sales A/c Dr
Closing Stock A/c Dr
To Trading A/c

c) For transferring gross profit or gross loss to P & L A/c

For Gross Profit
Trading A/c Dr
To P & L A/c

For Gross Loss

P & L A/c Dr
To Trading A/c

d) For transferring expenses

P & L A/c Dr
To Respective expense A/c

e) For transferring Incomes

Respective income A/c’s Dr
To P & L A/c

FUNDAMENTALS OF ACCOUNTING 105

f) For transferring Net profit or Net loss
For Net Profit
P & L A/c Dr
To Capital A/c
For Net Loss
Capital A/c Dr
To P & L A/c

Illustration 1
Pass closing entries for the following particulars as on 31st March 2015 presented by X Ltd.

Particulars Amount (`)

Opening stock 10,000
Purchases 50,000
Wages 5,000
Returns outward 5,000
Sales 1,00,000
Returns inward 10,000
Salaries 8,000
Insurance 1,000
Bad debts 3,000
Interest received 3,000
Discount allowed 4,000
Discount received 3,000
Closing stock 15,000

Solution:
In the Books of X Ltd.
Journal
Dr. Cr.
Date 2015 Particulars LF Amount(`) Amount(`)
March 31st
Trading A/c Dr. 75,000
To, Opening Stock A/c 10,000
To, Purchases A/c 50,000
To, Wages A/c 5,000
To, Returns inward A/c 10,000
(Transfer to balances for closing the latter accounts)
Sales A/c Dr 1,00,000
Returns outward A/c Dr. 5,000
Closing Stock A/c Dr. 15,0000
To, Trading A/c 1,20,000
(Transfer of balances for closing the former accounts)
Trading A/c Dr. 45,000
To, Profit and Loss A/c 45,000

106 FUNDAMENTALS OF ACCOUNTING

 (Gross profit transferred)
Profit and Loss A/c Dr. 16,000
To, Salaries A/c 8,000
To, Insurance A/c 1,000
To, Bad Debts A/c 3,000
To, Discount allowed A/c 4,000
(Transfer of balances for closing the latter accounts)
Interest received A/c Dr. 3,000
Discount received A/c Dr. 3,000
To, Profit and Loss A/c 6,000
(Transfer of balances for closing the former accounts)
Profit and Loss A/c Dr. 35,000
To, Capital A/c 35,000
(Net profit transferred to Capital A/c)

Transfer Entries: When it is necessary for an amount or balance of one account to be transferred to some other
account, it is done by means of a transfer journal entry in the Journal Proper.
i.e., Amount withdrawn from Capital
Capital A/c Dr.
To, Drawings A/c

Illustration 2
Following Balances appeared in the books of Patnayak on 31st March, 2014. Pass the necessary opening entry for
2014-15:
Credit balances: Capital `30,000; Bills Payable `5,000; Creditors `10,000
Debit balances: Furniture `4,000; Machinery `18,000; Debtors `12,000; B/R `9,000; Cash `2,000

SOLUTION:
OPENING ENTRY IN THE BOOKS OF PATNAYAK
Date Particulars L.F. Dr. Amount ` Cr. Amount `
2012 Apr. 1 Furniture A/c Dr 4,000
Machinery A/c Dr 18,000
Debtors A/c Dr 12,000
Bills Receivable A/c Dr. 9,000
Cash A/c Dr. 2,000
To Capital A/c 30,000
To Bills Payable A/c 5,000
To Creditors A/c 10,000
(Being opening entry)
45,000 45,000

ADJUSTMENT ENTRIES

Under accrual basis of accounting, incomes are recognized when these are earned and not when cash is actually
received. Similarly, expenses are recognized when these are incurred and not when actual payments are made.
This means at the end of the accounting year, there may be certain incomes earned but not received (i.e., accrued
income) and incomes received but not earned (i.e. income received in advance). Similarly, there may be certain

FUNDAMENTALS OF ACCOUNTING 107

expenses like wages and salaries which are due but not actually paid (i.e. outstanding expenses) and certain
expenses may have been paid but not due (i.e. prepaid expenses). These accrued incomes, incomes received in
advance, outstanding expenses and prepaid expenses etc. require adjustments at the end of the year so that true
net income is determined on accrual basis. Besides these, there are other items like closing stock, depreciation etc.
which need adjustment.

Adjustment entries are passed either before or after preparation of trial balance. But generally adjustments are
made after trial balance has been prepared. In such a case, i.e., when adjustments are given outside the trial
balance, the dual effect of the adjustment will be in the final accounts itself. In other words, each adjustment will
be treated twice while preparing trading and profit and loss account and balance sheet. For example, if wages
are outstanding, and it is given outside the trial balance, it will be shown on the debit side of the trading account
as an expense and then as a liability in the balance sheet.

However, adjustments are sometimes made before the preparation of the trial balance, in which case adjustments
appear in the trial balance. In such a case, in the preparation of final accounts, these adjustments appear only
once.

Principal type of transactions requiring adjustments are given below along with their adjustment entries.

Common Adjustments
1. Closing stock
2. Outstanding expenses
3. Prepaid
4. Accrued incomes
5. Income received in advance
6. Depreciation on fixed assets
7. Bad debts
8. Provision for bad and doubtful debts
9. Provision for discount on debtors
10. Provision for discount on creditors
11. Interest on capital
12. Interest on drawings
13. Interest on loan/investments/ deposits
14. Manager’s commission
15. Drawing of goods by proprietor for personal use
16. Goods on sale or approval
17. Goods distributed as free samples
18. Loss of stock by fire, theft, etc.

1. Closing Stock:
It was stated earlier in this chapter in relation to trading account items that closing stock generally given outside the
trial balance as an adjustment. The adjustment entry for closing stock is:
Closing stock A/c ……Dr.
To Trading A/c
As it is given outside the trial balance, it is treated twice in final accounts i.e., it appears in trading account on the
credit side and also in the balance sheet asset side.

When closing stock appears in the trial balance:

Sometimes closing stock is recorded in the books before the trial balance is prepared. In such a case purchases are
adjusted for opening and closing stock. The following two entries are passed:
(i) Purchases Account ……Dr.

108 FUNDAMENTALS OF ACCOUNTING

 To opening stock
By this entry, the opening stock account is closed and it has the effect of increasing the amount of purchases.

(ii) Closing stock Account ……Dr.

To purchases
This entry (ii) reduces the amount of purchases and opens a new account i.e. closing stock account. This closing
stock account then appears in the trial balance. In such a case, closing stock will not appear in the trading
account because purchases figure appearing in the trial balance stands adjusted for stocks and is called Adjusted
purchases. This Adjusted purchases appear in the trading account and the closing stock will appear only in the
balance sheet assets side.

2. Outstanding expenses:
These are the expenses like wages, salaries, rent etc. which have been incurred but not paid at the end of the ear.
For example, wages of `4,000 which have become due on 31st March but not paid in the financial year, is termed
as outstanding wages. The adjustment entry is:
Wages Account …..Dr. 4,000
To Wages outstanding Account 4,000
It will be added in wages shown in the trading Account and will also be shown as a liability in the balance sheet.

3. Prepaid or unexpired expenses

These are the expenses which are paid in the current accounting year but the benefit of this is to be received
in the next accounting year. For example, insurance premium of `6,000 for one year is paid on 1st Jan. and the
accounting year closes on 31st March. This means insurance premium for nine months i.e. for April 1st to Dec…, 31st
amounting to `4,500 has been paid in advance i.e., prepaid. The adjustment entry is:
Prepaid Insurance Account …..Dr. 4,500
To Insurance Account 4,500
As a result of this, `4,500 will be deducted from insurance premium of `6,000 in the Profit and Loss Account. It will
also be shown as an asset in the Balance sheet at `4,500 as prepaid (or unexpired) Insurance Premium Account.

4. Accrued Income:
(Income earned but not received). This is the income which is earned during the current accounting year but is not
received during that year. In may relate to incomes like rent, commission, interest etc. For example, if a business has
purchased 8% Government Bonds of ` 1,00,000 on which interest is payable on 30th June and 31st Dec., then for
the accounting year ending on 31st March, interest for three months i.e. Jan, Feb and March amounting to `2,000
will be taken as accrued interest because this amount has become due on 31st march but will be payable on 30th
June. The following adjustment entry will be passed on 31st March.
Accrued Interest Account ….Dr. 2,000
To Interest Account 2,000
Accrued interest will be shown on the credit side of profit and loss account and also on the assets side of the
balance sheet.

5. Income Received in Advance:

(unearned Income): This is the income which has been received in the current year but against which services will
be provided in the next accounting year. For example, rent of building let out has been received in advance for
one year on 1st Jan. @ `5,000 per month i.e., `60,000 . If accounting year ends on 31st March, then rent for 9 months
i.e., form April 1 to Dec. 31 amounting to `45,000 has been received in advance. On 31st March, the adjustment
entry to be passed is as follows:
Rent Received Account ….Dr. 4,5000
To Rent Received in Advance Account 45,000
In the profit and Loss Account, this rent received in advance will be deducted from rent received on the credit side

FUNDAMENTALS OF ACCOUNTING 109

and in the balance sheet rent received in advance will be shown as a liability.
6. Depreciation on Fixed Asset:
Depreciation has been discussed in detail in a separate chapter. The following entry is passed for depreciation:
Depreciation Account ….Dr.
To Fixed Asset Account
Depreciation amount is shown as an expense on the debit side of the Profit and Loss Account and in the Balance
Sheet, depreciation amount is deducted from the fixed asset.

7. Bad Debts:
When a business sell goods on credit basis, some of the customers may fail to pay. Bad debts represent that amount
which is lost due to non-recovery from credit customers. In other words, losses on account of non-recoverable debts
are called bad debts. Adjustment entry for recording bad debts is as under:
Bad debts Account …..Dr.
To Debtors Account
In the Profit and Loss Account, bad debts is shown on the debit side and in the Balance Sheet, the amount of bad
debts is deducted from debtors. When bad debts appear in the Trial Balance, it will be shown only in Profit and Loss
Account as an expenses.
Sometimes bad debts written off are recovered in the subsequent accounting year. In such a case, the recovered
amount is credited to Bad Debts Recovered Account and then shown in the credit side of Profit and Loss Account
as this represents a gain.

8. Provision for Bad (and Doubtful) Debts:

As matter of principle, all bad debts should be debited to Profit and Loss account of the year in which the related
credit sales take place. But this is very difficult because the actual writing off bad debts will be in some subsequent
year. In order to ensure proper matching of revenues and expenses and calculate the true profit, it is necessary that
a provision for the likely amount of bad debts is made at the end of the accounting year. Such a provision is to be
created on the balance of debtors account as a fixed percentage which may be based on the past experience.
The following journal entry is passed for creating a provision of bad and doubtful debts.
Profit and Loss Account ….Dr.
To Provision for Bad (and Doubtful) Debts Account
This provision for bad debts is debited to Profit and Loss Account and in the Balance sheet, it is deducted from
debtors.

Illustration 3
The following items appear in the Trial Balance as on 31st March, 2015.

Dr. ` Cr. `
Sundry debtors 42,000
Bad debts 3,500

Adjustments:

1. After the trial balance was prepared, it was found that a debtor Z will not be able to pay ` 2,000 because of
his insolvency.
2. Create 6% provision for bad debts.
Pass the necessary adjustment entries in journal and show how these would appear in the profit and loss Account
and Balance sheet as on 31st March, 2015.

110 FUNDAMENTALS OF ACCOUNTING

Solution:
Adjustment Entries

Date Particulars Dr. ` Cr. `

1 Bad debts Accounts ……Dr 2,000
To Z (Debtor)
2,000
(Being the amount due for z became irrecoverable)
2 Profit and Loss Account ……Dr. 2,400
To Provision for bad debts Account
2,400
(Being 6% provision for bad debts on ` 40,000 i.e., 42,000-2,000)

Profit and loss Account

For the year ending 31st March, 2015

Particulars ` Particulars `
To Bad debts (as given in trial balance) 3,500
Add: Additional bad debts 2,000
Add: provision for bad debts 2,400 7,900

Balance Sheet
As on 31st March, 2015

Liabilities ` Assets `
Sundry debtors 42,000
Less: Additional Bad debts 2,000
40,000
Less: provision for Bad debts 2,400 37,600

The provision for bad debts created is carried forward to the next accounting years. The bad debts that will arise in
the next year will be met out of this provision. In other words, bad debts when written off will be debited to provision
for bad debts where such a provision exists.

Illustration: 4

The following extracts from the trial balance as on 31st March, 2015 are given

Particulars Dr. ` Cr. `

Sundry debtors 42,000
Bad debts 3,500
Provision for bad debts 3,800

Adjustments:
1. Additional bad debts ` 2,000
2. Maintain the provision for bad debts at 10% of debtors.
Show the relevant entries in the profit and Loss Account and Balance Sheet as on 31st March, 2015.

FUNDAMENTALS OF ACCOUNTING 111

Solution:
Profit and Loss Account
For the year ending 31st March, 2015

Particulars ` Particulars `
To bad debts (as given in trial balance) 3,500
Add: Additional bad debts 2,000
5,500
Add: provision for bad Debts (New) 4,000
9,500
Less: old provision for bad debts 3,800 5,700

Balance Sheet as on 31st March 2015

Liabilities ` Assets `
Sundry debtors 42,000
Less: bad debts 2,000
40,000
Less: New provision 4,000 36,000

Important Points:
1. When bad debts are given as an adjustment outside the trial balance, then such an amount of bad debts
is deducted from debtors (as given in the trial balance) and the provision for bad debts is calculated on the
balance amount of debtors.
2. Provision for bad debts account in the beginning of the year appears in the trial balance on the credit side.
But the amount of bad debts in the trial balance appears on the debit side.

9. Provision for discount on debtors:

This provision is created for allowing discount to debtors to encourage prompt payments. The amount of this
provision is calculated after deducting bad debts and provision for bad debts from the debtors.

Illustration 5
Debtors as per trial balance ` 31,000
Adjustments: Provide `1,000 for bad debts, Create 5% provision for bad debts and 2% provision for discount on
debtors. Pass Journal entry for provision for discount on debtors and show how it will appear in the balance sheet.

Solution:
Debtors after providing for bad debts = ` 31,000- 1,000 = `30,000
Provision for bad debts = `30,000 x 5% = `1,500.
Balance amount of debtors = `30,000 – 1,500 = ` 28,500
Provision for discount on debtors = ` 28,500 x 2% = ` 570

The following adjustment entry will be passed

Profit and Loss Account …Dr. 570
To Provision for Discount on Debtors Account

This amount of ` 570 appears on this debit side of Profit and Loss Account and in the Balance Sheet it is deducted
from debtors as shown below:

112 FUNDAMENTALS OF ACCOUNTING

 Balance Sheet as on……

Liabilities ` Assets `

Debtors 31,000

Less: Bad debts 1,000

30,000

Less: provision for

Bad debts 1,500

28,500

Less: provision for

Discount on debtors 570 27,930

10. Provision for discount on creditors:

Similar to provision for discount on debtors, a firm may create provision for discount on creditors. For this the following
adjustment entry is passed:

Provision for Discount on Creditors Account …..Dr.

To Profit and Loss Account

This provision appears on the credit side of the Profit and Loss Account and in the balance sheet it is deducted from
creditors.
It is important to note that creating a provision for discount on creditors is against the accounting principle of
conservatism. However, it is an accepted accounting practice.

11. Interest on Capital:

Sometimes interest on capital of proprietor or partners is to be provided and treated as business expense. For this,
the following adjustment entry is passed.
Interest on Capital Account …….Dr.
To Capital A/c (of proprietor or partners)

This entry will have the effect of increasing the balance in capital account by the amount of interest as it appears
in the balance sheet. In the Profit and Loss Account, interest on capital appears on the debit side as an expense.

12. Interest on drawings:

Drawings means the cash or goods withdrawn by the owner for his personal use. Sometimes, interest on such
drawings is charged and treated as business income. For charging interest, the following entry is passed:
Capital A/c (of proprietor)
To Interest on drawings A/c

Interest on drawings is shown on the credit side of Profit and Loss Account and in the Balance Sheet it is deducted
from the Capital Account of the proprietor or partner.

13. Interest on loan or deposit when rate of interest is given:

Sometimes, the trial balance includes Loan Account (Cr. Side) or Deposit Account (Dr. side) carrying a specific
rate of interest. In such a case, one should check in the trial balance that interest at the rate given is shown as an
expense or income, as the case may be. In case interest account does not appear, it means the entire interest
should be treated as outstanding, even if problem is silent in this regard. If interest item appears in the trial balance,
it should be checked that the interest is for the full period. In case, it is less, the remaining part should be treated as
outstanding and if it is for more than, say 12 months the difference should be treated as prepaid. For example, trial
balance shows the following:

FUNDAMENTALS OF ACCOUNTING 113

Preparation of Trading Account
Illustration 1.
Following are the ledger balances presented by M/s. P. Sen as on 31st March 2015.
Particulars Amount Particulars Amount
Stock (1.4.2014) 10,000 Sales 3,00,000
Purchase 1,60,000 Return Inward 16,000
Carriage Inwards 10,000 Return Outward 10,000
Wages 30,000 Royalty on Production 6,000
Freight 8,000 Gas and Fuel 2,000

Additional Information:
(1) Stock on 31.3.2015: (i) Market Price ` 24,000; (ii) Cost Price ` 20,000;
(2) Stock valued ` 10,000 were destroyed by fire and insurance company admitted the claim to the extent of `
6,000.
(3) Goods purchased for ` 6,000 on 29th March, 2015, but still lying in-transit, not at all recorded in the books.
(4) Goods taken for the proprietor for his own use for ` 3,000.
(5) Outstanding wages amounted to ` 4,000.
(6) Freight was paid in advance for ` 1,000.

Solution:

In the books of M/s. P. Sen

Trading Account
Dr. For the year ended 31st March, 2015 Cr.
Particulars Amount Amount Particulars Amount Amount
To Opening Stock 10,000 By Sales 3,00,000
To Purchase 1,60,000 Less: Return Inward 16,000 2,84,000
Less: Return Outward 10,000 By Closing Stock 20,000
1,50,000 Add: Stock Destroyed 10,000
Less: Goods taken by Proprietor 3,000 30,000
1,47,000 Add: Goods-in-Transit 6,000 36,000
Add: Goods-in-transit 6,000 1,53,000
To Wages 30,000
Add: Outstanding 4,000 34,000
To Carriage Inwards 10,000
To Freight 8,000
Less: Prepaid 1,000 7,000
To Gas & Fuel 6,000
To Profit & Loss A/c (Gross Profit 98,000
transferred)
3,20,000 3,20,000

Note:
(a) Stock should be valued as per cost price or market price whichever is lower.
(b) The claim which was admitted by insurance company and the loss of stock, will not appear in Trading Account.

178 FUNDAMENTALS OF ACCOUNTING

Profit and Loss Account:
The following items will appear in the debit side of the Profit & Loss A/c:

(i) Cost of Sales:

This term refers to the cost of goods sold. The goods could be manufactured and sold or can be directly identified
with goods.

(ii) Other Expenses:

All expenses which are not directly related to main business activity will be reflected in the P&L component. These
are mainly the Administrative, Selling and distribution expenses. Examples are salary to office staff, salesmen
commission, insurance, legal charges, audit fees, advertising, free samples, bad debts etc. It will also include items
like loss on sale of fixed assets, interest and provisions. Students should be careful to include accrued expenses as
well.
The following items will appear in the credit side of Profit & Loss A/c:

(i) Revenue Incomes:

These incomes arise in the ordinary course of business, which includes commission received, discount received etc.

(ii) Other Incomes:

The business will generate incomes other than from its main activity. These are purely incidental. It will include items
like interest received, dividend received, etc .The end result of one component of the P&L A/c is transferred over
to the next component and the net result will be transferred to the balance sheet as addition in owners’ equity.
The profits actually belong to owners of business. In case of company organizations, where ownership is widely
distributed, the profit figure is separately shown in balance sheet.

Dr. Profit and Loss Account for the year ended Cr.

Particulars Amount Particulars Amount

Gross Loss Gross Profit
(transferred from Trading A/c) (transferred from Trading A/c)
Administrative expenses Other Income
Office salaries Interest received
Communication Commission received
Travel & Conveyance Profit on sale of assets
Office rent Rent received
Depreciation of office assets Net loss
Audit fees Total
Insurance
Repairs & maintenance
Selling & Distribution expenses
Advertising
Salesmen commission
Delivery van expenses/Depreciation
on delivery vans/Bad debts
Financial expenses
Bank charges
Interest on loans
Loss on sale of assets
Net profit
Total

FUNDAMENTALS OF ACCOUNTING 179

Trading and Profit and Loss Account (Vertical Format)
Particulars Schedule Amount
Income
Sales and operating income 1 XXXX
Other income 2 XXXX
Total XXXXX
Expenditure
Cost of goods sold 3 XXXX
Operating and other expenses 4 XXXX
Depreciation / Amortisation XXXX
Interest XXXX
Total XXXXX
Add /Less: Exceptional Items XXXX
Profit /(Loss) before Tax XXXXX
Less: Tax XXXX
Profit/ (Loss) after Tax XXXXX

Illustration 2.
Indicate where the following items will be shown in various components of Trading Account and P & L Account:
(1) Wages (2) Salaries to office staff
(3) Depreciation on office car (4) Power & fuel
(5) Repairs to machinery (6) Maintenance of office building
(7) Purchase returns or return outwards (8) Closing stock of WIP
(9) Opening stock of finished goods (10) Interest received
(11) Commission paid (12) Telephone
(13) Travel & conveyance (14) Insurance
(15) Audit fees (16) Carriage inward
(17) Freight outward (18) Bad debts
(19) Provision for outstanding rent (20) Return inwards or sales returns
(21) Discount earned (22) Depreciation on delivery van
(23) Printing and stationery (24) Sales

Solution:
Item Treatment Where
Wages Trading A/c Dr
Salaries to office staff P & L A/c Dr.
Depreciation on office car P & L A/c Dr.
Power & fuel Trading A/c Dr.
Repairs to machinery P& L A/c Dr
Maintenance of office building P & L A/c Dr
Purchase returns or return outward Trading A/c Dr less from purchases
Closing stock of WIP Trading A/c Cr
Opening stock of finished goods Trading A/c Dr
Interest received P & L A/c Cr

180 FUNDAMENTALS OF ACCOUNTING

 Commission paid P & L A/c Dr
Telephone P & L A/c Dr
Travel & conveyance P & L A/c Dr
Insurance P & L A/c Dr
Audit fees P & L A/c Dr
Carriage inward Trading A/c Dr
Freight outward P & L A/c Dr
Bad debts P & L A/c Dr
Provision for outstanding rent P & L A/c Dr
Return inwards or sales returns Trading A/c Cr less from sales
Discount earned P & L A/c Cr
Depreciation on delivery van P & L A/c Dr
Printing and stationery P & L A/c Dr.
Sales Trading A/c Cr.

Preparations of Profit & Loss Account

Illustration 3.
From the following particulars presented by Sri Tirlhankar for the year ended 31st March 2015, Prepare Profit and
Loss Account.
Gross Profit ` 1,00,000, Rent ` 22,000; Salaries, ` 10,000; Commission (Cr.) ` 12,000; Insurance ` 8,000; Interest (Cr.) `
6,000; Bad Debts ` 2,000; Provision for Bad Debts (1.4.2012) ` 4,000; Sundry Debtors ` 40,000; Discount Received `
2,000; Plant & Machinery ` 80,000.
Adjustments:
(a) Outstanding salaries amounted to ` 4,000;
(b) Rent paid for 11 months;
(c) Interest due but not received amounted to ` 2,000
(d) Prepaid Insurance amounted to ` 2,000;
(e) Depreciate Plant and Machinery by 10% p.a.
(f) Further Bad Debts amounted to ` 2,000 and make a provision for Bad Debts @5% on Sundry Debtors.
(h) Commissions received in advance amounted to ` 2,000.

Solution:
In the Books of Sri Tirlhankar
Profit and Loss Account
for the year ended 31st March 2015
Dr. Cr.
Particulars Amount (`) Amount (`) Particulars Amount (`) Amount (`)
To, Rent 22,000 By Trading A/c (Gross Profit) 1,00,000
Add: Outstanding 2,000 24,000 By Commission 12,000
To, Salaries 10,000 Less: Received in advance 2,000 10,000
Add: Outstanding 4,000 14,000 By Interest 6,000
To, Insurance 8,000 Add: Accrued Interest 2,000 8,000
Less: Prepaid 2,000 6,000 By Discount received 2,000
To, Bad Debts 2,000 By Provisions for Bad Debts 4,000
Add: further Bad Debts 2,000 4,000 Less: New Provision @ 5% on 1,900 2,100
(` 40,000 – ` 2,000)
To, Depreciation on Plant & 8,000
Machinery @10% on ` 80,000

FUNDAMENTALS OF ACCOUNTING 181

 To, Capital A/c 66,100
(Net Profit Transferred)
1,22,100 1,22,100

Profit and Loss Appropriation Account:

We know that the net profit or loss is added to or deducted from owner’s equity. The net profit may be used by the
business to distribute dividends, to create reserves etc. In order to show these adjustments, a P & L Appropriation
A/c is maintained. Distribution of profits is only appropriation and does not mean expenses. After passing such
distribution entries, the remaining surplus is added in owner’s equity. The format of P & L Appropriation A/c is given
below:
Dr. Profit and Loss Appropriation Account for the year ended Cr.
Particular Amount Particulars Amount
To Proposed Dividend By Net profit transferred from P&L A/c
To Transfer to General Reserve
To Surplus carried to Capital A/c
Total Total

Illustration 4.
X,Y and Z are three Partners sharing profit and Losses equally. Their capital as on 01.04.2014 were: X `80,000; Y `
60,000 and Z ` 50,000. They mutually agreed on the following points (as per partnership deed) (a) Interest on capital
to be allowed @ 5% p.a. (b) X to be received a salary @ ` 500 p.m. (c) Y to be received a commission @ 4% on
net profit after charging such commission. (d) After charging all other items 10% of the net profit to be transferred
General Reserve. Profit from Profit and Loss Account amounted to ` 66,720. Prepare a Profit and Loss Appropriation
Account for the year ended 31st March, 2015.

Solution:

Particulars Amount(`) Amount (`) Particulars Amount(`) Amount(`)

To, Interest on Capital: By, Profit and Loss A/c 66,720
X 4000
Y 3000
Z 2500
“ Salaries 9,500
X : (`500 x 12)
“ Commission 6,000
Y
“ General Reserve 19701
“ Net Divisible Profit 4,925
X 14,775
Y 14,775
z 14,775
44,325
66,720 66,720

Workings:
1. Net Profit before charging Y’s Commission = ` (66,720 – 15,500) = ` 51,220 Less: Y’s Commission @ 4% i.e.
( 4/104 × ` 51,220) = ` 1,970
2. Transfer to General Reserve = ` 49,250 × 10% = ` 4,925

Balance Sheet: Horizontal format of Balance Sheet is also used by the business other than company

182 FUNDAMENTALS OF ACCOUNTING

A. Liabilities

(a) Capital:
This indicates the initial amount the owner or owners of the business contributed. This contribution could be at the
time of starting business or even at a later stage to satisfy requirements of funds for expansion, diversification etc.
As per business entity concept, owners and business are distinct entities, and thus, any contribution by owners by
way of capital is liability.

(b) Reserves and Surplus:

The business is a going concern and will keep making profit or loss year by year. The accumulation of these profit
or loss figures (called as surpluses) will keep on increasing or decreasing owners’ equity. In case of non-corporate
forms of business, the profits or losses are added to the capital A/c and not shown separately in the balance sheet
of the business.

(c) Long Term or Non-Current Liabilities:

These are obligations which are to be settled over a longer period of time say 5-10 years. These funds are raised by
way of loans from banks and financial institutions. Such borrowed funds are to be repaid in installments during the
tenure of the loan as agreed. Such funds are usually raised to meet financial requirements to procure fixed assets.
These funds should not be generally used for day-to-day business activities. Such loan are normally given on the
basis of some security from the business e.g. against a charge on the fixed assets. So, long term loan are called as
“Secured Loan” also.

(d) Short Term or Current Liabilities:

A liability shall be classified as Current when it satisfies any of the following:
 It is expected to be settled in the organisation’s normal Operating Cycle,
 It is held primarily for the purpose of being traded,
 It is due to be settled within 12 months after the Reporting Date, or
 The organization does not have an unconditional right to defer settlement of the liability for at least 12 months
after the reporting date (Terms of a Liability that could, at the option of the counterparty, result in its settlement
by the issue of Equity Instruments do not affect its classification) Current liabilities comprise of :

(i) Sundry Creditors –

Amounts payable to suppliers against purchase of goods. This is usually settled within 30-180 days.

(ii) Advances from customers –

At times customer may pay advance i.e. before they get delivery of goods. Till the business supplies goods to them,
it has an obligation to pay back the advance in case of failure to supply. Hence, such advances are treated as
liability till the time they get converted to sales.

(iii) Outstanding Expenses:

These represent services procured but not paid for. These are usually settled within 30–60 days e.g. phone bill of Sept
is normally paid in Oct.

(iv) Bills Payable:

There are times when suppliers do not give clean credit. They supply goods against a promissory note to be signed
as a promise to pay after or on a particular date. These are called as bills payable or notes payable.

(v) Bank Overdrafts:

Banks may give fund facilities like overdraft whereby, business is permitted to issue cheques up to a certain limit. The
bank will honour these cheques and will recover this money from business. This is a short term obligation.

FUNDAMENTALS OF ACCOUNTING 183

B. Assets
In accounting language, all debit balances in personal and real accounts are called as assets. Assets are broadly
classified into fixed assets and current assets.

(a) Fixed Assets:

These represent the facilities or resources owned by the business for a longer period of time. The basic purpose of
these resources is not to buy and sell them, but to use for future earnings. The benefit from use of these assets is
spread over a very long period. The fixed assets could be in tangible form such as buildings, machinery, vehicles,
computers etc, whereas some could be in intangible form viz. patents, trademarks, goodwill etc. The fixed assets
are subject to wear and tear which is called as depreciation. In the balance sheet, fixed assets are always shown
as “original cost less depreciation”.

(b) Investments:
These are funds invested outside the business on a temporary basis. At times, when the business has surplus funds,
and they are not immediately required for business purpose, it is prudent to invest it outside business e.g. in mutual
funds or fixed deposit. The purpose if to earn a reasonable return on this money instead of keeping them idle. These
are assets shown separately in balance sheet. Investments can be classified into Current Investments and Non-
current Investments. Non-current Investments are investments which are restricted beyond the current period as to
sale or disposal.
Whereas, current investments are investments that are by their nature readily realizable and is intended to be held
for not more than one year from the date on which such investment is made.

(c) Current Assets:

An asset shall be classified as Current when it satisfies any of the following :
 It is expected to be realised in, or is intended for sale or consumption in the organisation’s normal Operating
Cycle,
 It is held primarily for the purpose of being traded,
 It is due to be realised within 12 months after the Reporting Date, or
 It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a Liability for at least
12 months after the Reporting Date.

Current assets comprise of:

(i) Stocks:
This includes stock of raw material, semi-finished goods or WIP, and finished goods. Stocks are shown at lesser of the
cost or market price. Provision for obsolescence, if any, is also reduced. Generally, stocks are physically counted
and compared with book stocks to ensure that there are no discrepancies. In case of discrepancies, the same are
adjusted to P & L A/c and stock figures are shown as net of this adjustment.

(ii) Debtors:
They represent customer balances which are not paid. The bad debts or a provision for bad debt is reduced from
debtors and net figure is shown in balance sheet.

(iii) Bills receivables:

Credit to customers may be given based on a bill to be signed by them payable to the business at an agreed date
in future. At the end of accounting period, the bills accepted but not yet paid are shown as bills receivables.

(iv) Cash in Hand:

This represents cash actually held by the business on the balance sheet date. This cash may be held at various
offices, locations or sites from where the business activity is carried out. Cash at all locations is physically counted
and verified with the book balance. Discrepancies if any are adjusted.

(v) Cash at Bank:

Dealing through banks is quite common. Funds held as balances with bank are also treated as current asset, as it is

184 FUNDAMENTALS OF ACCOUNTING

to be applied for paying to suppliers. The balance at bank as per books of accounts is always reconciled with the
balance as per bank statement, the reasons for differences are identified and required entries are passed.

(vi) Prepaid Expenses:

They represent payments made against which services are expected to be received in a very short period.

(vii) Advances to suppliers:

When amounts are paid to suppliers in advance and goods or services are not received till the balance sheet date,
they are to be shown as current assets. This is because advances paid are like right to claim the business gets.
Please note that both current assets and current liabilities are used in day-to-day business activities. The current assets
minus current liabilities are called as working capital or net current assets. The following report is usual horizontal
form of balance sheet. Please note that the assets are normally shown in descending order of their liquidity. Also,
capital, long term liabilities and short term liabilities are shown in that order.

In case other than Company :

Capital & Liabilities Amount Assets Amount

Capital Fixed Assets:
(separate figures are shown for Land less depreciation
each owner) Building less depreciation
Long term Liabilities: Plant and Machinery
Loans from banks or financial less depreciation
Institutions Vehicles less depreciation
Current Liabilities: Computer systems less depreciation
Sundry creditors Office equipments less depreciation
Bills payable Current Assets:
Advances from customers Stocks
Outstanding expenses Sundry debtors less provisions
Bills receivables
Cash in hand
Cash at bank
Prepaid expenses
Advances to suppliers

Illustration 5.
From the following particulars prepare a Balance Sheet of Mr. X, for the year ended 31st March, 2015. Capital :
` 2,00,000: Drawings : ` 40,000 ; Cash In Hand : ` 15,000 ; Loan from Bank : ` 40,000; Sundry Creditors : ` 40,000; Bills
Payable : ` 20,000; Bank Overdraft : ` 20,000; Goodwill : ` 60,000; Sundry Debtors : ` 80,000; Land and Building : `
50,000; Plant and Machinery : ` 80,000; Investment : ` 20,000; Bills Receivable : ` 10,000. Cash at Bank : ` 25,000.

The following adjustments are made at the time of preparing final accounts:
(i) Outstanding Liabilities for : Salaries ` 10,000; wages ` 20,000; Interest on Bank Overdraft ` 3,000; and Interest
on Bank Loan ` 6,000.
(ii) Provide Interest on Capital @ 10% p.a.
(iii) Depreciation on Plant and Machinery by 10% p.a.
(iv) Bad Debts amounted to ` 10,000 and make a provision for Bad Debts @ 10% on Sundry Debtors.
(v) Closing stock amounted to ` 1,20,000.

Net profit for the year amounted to ` 96,000 after considering all the above adjustments.

FUNDAMENTALS OF ACCOUNTING 185

Solution:

Liabilities Amount Amount Assets Amount Amount

(`) (`) (`) (`)
Capital Goodwill 60,000
2,00,000
Add: Interest on Capital @ 10% 20,000 Land & Building 50,000
Add: Net Profit 96,000 Plant & Machinery 80,000
3,16,000 Less: Depreciation @ 10% 8,000 72,000
Less: Drawings 40,000 2,76,000 Investment 20,000
Bank Overdraft 20,000 Closing Stock 1,20,000
Add: Out. Interest 3,000 23,000 Sundry Debtors 80,000
Bank Loan 40,000 Less: Bad Debts 10,000
Add: Out. Interest 6,000 46,000 70,000
Sundry Creditors 40,000 Less: Prov. for bad debts @ 10% 7,000 63,000
Bills Payable 20,000 Bills Receivable 10,000
Outstanding Liabilities: Cash at Bank 25,000
Salaries 10,000 Cash in Hand 15,000
Wages 20,000 30,000
4,35,000 4,35,000

Manufacturing Account:
Those concerns which convert raw materials into finished goods are required to find out the cost of goods
manufactured besides gross and net profit of the concern. These are manufacturing cum trading concerns. In
order to have full information about the cost of goods manufactured, these concerns firstly prepare manufacturing
Account and then prepare – Trading and profit and loss account.

The main object of Manufacturing Account is to show:

(i) Cost of finished goods produced and
(ii) Constituent items thereof such as cost of material consumed, productive wages, direct and indirect expenses.

Debit side of manufacturing account starts with the cost of materials consumed, i.e., opening stock of raw materials
plus net purchases less the closing stock of raw materials. Procurement cost e.g., custom duty, landing charges,
excise duty, carriage and freight inwards, insurance on incoming raw materials should also be included with the
cost of raw materials.

Closing stock is taken and valued at lower of cost or net realizable value and is then deducted from the sum of
opening stock and purchases to eliminate the charge to manufacturing account for stock of raw materials in hand
on closing date. Next to raw materials are listed productive wages and direct expenses.
It is followed by debits relating to indirect factory expenses e.g., rents, rates, salaries of supervising staff, power. Light,
heat and fuel, repairs and renewals, depreciation relating to factory property etc.

Total materials, productive wages and direct expenses should be adjusted for opening and closing stock of partly
finished goods or work-in-progress etc. Opening stock of these items should be added at its factory cost value, as
current periods production has benefitted by drawing on the opening stock of partly finished goods. Closing stock
of work in progress should be taken and valued at factory cost and deducted from the resulting total to eliminate
the charge in respect thereof. After this adjustment, the net amount will represent cost of production.

186 FUNDAMENTALS OF ACCOUNTING

Total of debit side will then represent the cost of production of finished goods which is credited to Manufacturing
Account and debited to trading account.
Trading account will show the cost of production of finished goods, opening and closing stock of finished goods,
purchases and sales of finished goods and gross profit.
A specimen of Manufacturing and Trading Account and Profit and Loss Account is given as follows:
` `
To Work-in-progress (Beginning) Xxx By Cost of goods manufactured transferred to Xxx
To Raw Materials consumed: trading A/c (Bal. Fig) Xxx
(opening stock of raw Materials + purchases By Sale of scrap Xxx
during the year – closing stock of Raw materials) By Closing work-in-progress Xxx
To Direct wages Xxx By sales Xxx
To Direct expenses Xxx By closing stock of finished goods Xxx
(as carriage on purchases) Xxx By Gross profit b/s Xxx
Prime cost By All items of incomes and gains Xxx
To Factory expenses: Xxx
To Factory lighting xxx
Factory rent xxx
Factory wages xxx
Depreciation on
Plant & Machinery xxx
Factory supervisor’s salary xxx
Stores consumed etc. xxx
To Opening stock of Finished goods Xxx
To Cost of goods Manufactured transferred Xxx
trading A/c
Xxx
To Gross profit c/d
To Administration Expenses
Xxx
To Selling expenses
Xxx
To Distribution expenses
Xxx
To Financial expenses
Xxx
To Maintenance expenses
Xxx
To Net profit transferred to capital account
Xxx
Xxx
Xxx Xxx
Illustration 6
Prepare a Trading Account of trader for the year ending 31st March, 2014 from following data:
`
Stock on 1-4-2013 2,40,000
Cash purchases for the year 2,08,000
Credit purchases for the year 4,00,000
Cash sales for the year 3,50,000
Credit sales for the year 6,000
Purchases returns during the year 8,000
Sales returns during the year 10,000
Direct expenses incurred:

FUNDAMENTALS OF ACCOUNTING 187

 Freight 10,000
Carriage 2,000
Import duty 8,000
Clearing charges 12,000
Cost of goods distributed as free samples during the year 5,000
Goods withdrawn by the trader for personal use 2,000
Stock damaged by fire during the year 13,000
The cost of unsold stock on 31st March, 2014 was `1,20,000 but its market value was ` 1,50,000.
Solution:
Trading Account of a trader
For the year ending 31st March, 2014
` `
To Opening stock 2,40,000 By Sales:
To Purchases Cash 3,50,000
Cash 2,08,000 Credit 6,00,000
Credit 4,00,000 9,50,000
6,08,000 Less: Sales returns 10,000 9,40,000
Less: Purchases Returns 8,000 By Stock damaged by fire 13,000
6,00,000 By Closing stock 1,20,000
Less: Goods Distributed as free sample 5,000
5,95,000
Less: Goods withdrawn 2,000 for personal use 5,93,000
To Freight 10,000
To Carriage 2,000
To Import duty 8,000
To Clearing changes 12,000
To Gross profit c/d 2,08,000
10,73,000 10,73,000
Illustration 7
Prepare Trading and Profit and Loss Account of M/s Suraj Prakash & Sons for the year ending 31st December, 2014
from following information:
` `
Stock (1-1-2014) 2,00,000 Salaries 30,000
Purchases 2,55,000 Rent, rates & taxes 12,000
Wages 1,00,000 Depreciation 3,020
Carriage 5,000 Repairs 6,000
Purchases returns 13,250 Discount allowed 12,505
Export duty 9,000 Bad debts 9,000
Sales 5,75,000 Advertisement 2,500
Coal & coke 25,000 Gas & water 1,500
Sales returns 10,000 Factory lighting 2,500
Printing & stationery 2,250 General expenses 4,000
Stock (31-12-2015) 3,00,000 3,00,000

188 FUNDAMENTALS OF ACCOUNTING

Solution:
Trading and Profit and Loss Accounts of
M/s Suraj Prakash and Sons
For the year ending 31st December, 2014
For the year ending 31st December, 2014

` `
To Stock (1-1-2014) 2,00,000 By Sales 5,75,000
To Purchases 2,55,000 Less: Sales returns 10,000 5,65,000
Less: Purchases Return 13,250 2,41,750 By Stock (31-21-2014) 3,00,000
To Wages 1,00,000
To Carriage 5,000
To Coal and coke 25,000
To Gas and water 1,500
To Factory lighting 2,500
To Gross profit c/d 2,89,250
8,65,000 8,65,000
To Salaries 30,000 By Gross profit b/d 2,89,250
To Rent, rates & taxes 12,000
To Printing & stationery 2,250
To Depreciation 3,020
To Repairs 6,000
To Export duty 9,000
To Discount allowed 12,505
To Bad Debts 9,000
To Advertisement 2,500
To General expenses 4,000
To Net profit transferred to capital account 1,98,975
2,89,250 2,89,250
Illustration 8
Prepare Manufacturing and trading account for the year ending 30th June, 2015 with following figures extracted
from the books of a manufacturing concern:
Opening stock(`) Closing stock(`)
Raw material 1,20,000 80,000
Work-in-progress 24,000 16,000
Finished goods 86,400 64,000
Transactions during the year:
Purchase of Materials 4,00,000
Wages 2,50,000
Stores consumed 30,000
Indirect wages 72,000
Factory rent 24,000
Depreciation on plant & machinery 40,000
Sales 11,20,000
Purchases of finished goods 10,000

FUNDAMENTALS OF ACCOUNTING 189

Solution:
Manufacturing and Trading Account
For the year ending 30th June, 2015
` `
To Opening Stock: By Closing Stock:
Raw materials 1,20,000 Raw materials 80,000
Work-in-progress 24,000 1,44,000 Work-in-progress 16,000 96,000
To Purchase of materials 4,00,000 By Cost of goods manufactured 8,64,000
trans. to trading A/c
To Wages 2,50,000
To Stores consumed 30,000
To factory rent 24,000
To Depreciation on plant and Machinery 40,000
To Indirect wages 72,000
9,60,000 9,60,000
To Opening stock of finished goods 86,400 By Sales 11,20,000
To Cost of goods manufactured transferred 8,64,000 By Closing stock of Finished 64,000
from manufacturing A/c goods
To Purchase of finished goods 10,000
To Gross profit transferred to profit and loss 2,23,600
account
11,84,000 11,84,000
Illustration 9
Following is the Trial Balance of M/s kasturi Agencies as on 31st March, 2015. Prepare Trading, Profit and Loss Account
for the year ended 31st March, 2015 and a Balance Sheet on that date
Particulars ` `
Capital 1,00,000
Buildings 15,000
Drawings 18,000
Furniture & Fittings 7,500
Motor van 25,000
Loan from Hari @ 12% interest 15,000
Interest paid on above 900
Sales 1,00,000
Purchases 75,000
Opening stock 25,000
Establishment expenses 15,000
Wages 2,000
Insurance 1,000
Commission received 4,500
Sundry debtors 28,100
Bank balance 20,000
Sundry creditors 10,000
Interest 3,000
2,32,500 2,32,500

190 FUNDAMENTALS OF ACCOUNTING

Adjustments: (a) The value of stock on 31-3-2015 was ` 32,000. (b) outstanding wages ` 500 (c) Prepaid Insurance `
300. (d) Commission received in advance ` 1,3000 (e) Allow interest on capital @ 10%. (f) Depreciate building 2 ½%.
Furniture & Fitting 10%, Motor van 10%. (g) charge interest on drawings ` 5000. (h) Accrued Interest ` 500.

Solution:

Trading and Profit and Loss Account of Kasturi Agency for the year ending 31.3.2015
Dr. Cr.
` ` ` `
To Opening Stock 25,000 By Sales 1,00,000
To Purchases 75,000 By Closing Stock 32,000
To Wages 2,000
Add: Outstanding 500 2,500
To Gross Profit c/d 29,500
1,32,000 1,32,000
To Insurance 1,000 By Gross profit 29,500
Less: Prepaid 300 700 By Commission 4,500
To Interest on loan 900 Less: Received in Advance 1,300 3,200
Add: Outstanding 900 1,800 By Interest 3,000
To Establishment expenses 15,000 Add: Accrued interest 500 3,500
To Depreciation By Interest on drawings 500
Buildings 375
Furniture & Fittings 750
Motor van 2,500 3,625
To Interest on capital 10,000
To Net profit transferred to 5,575
capital A/c
36,700 36,700

Balance sheet
as on 31st March, 2015

Liabilities ` ` Assets ` `
Outstanding wages 500 Cash at bank 20,000
Commission received in advance 1,300 Sundry debtors 28,100
Sundry creditors 10,000 Closing stock 32,000
Loan from Hari 15,000 Prepaid insurance 300
Add: Outstanding Interest 900 15,900 Buildings 15,000
Capital 1,00,000 Less: Depreciation 375 14,625
Add: Net profit 5,575 Furniture & Fittings 7,500
Add: Interest on Capital 10,000 Less: Depreciation 750 6,750
1,15,575 Motor Van 25,000
Less: Drawings 18,000 Less: Depreciation 2,500 22,500
Interest on drawings 500 18,500 97,075 Accrued Interest 500
1,24,775 1,24,775

FUNDAMENTALS OF ACCOUNTING 191

Illustrations 10
Following is the Trial Balance of M/s Brijesh and Sons. Prepare final accounts for the year ended on 31st March 2015.
Particulars Debit (`) Credit (`)
Stock as on 01-04-2014 2,00,000
Purchases and Sales 22,00,000 35,00,000
Blils receivables 50,000
Returns 100,000 50,000
Carriage Inwards 50,000
Debtors and Creditors 200,000 4,00,000
Carriage Outwards 40,000
Discounts 5,000 5,000
Salaries and wages 2,20,000
Insurance 60,000
Rent 60,000
Wages and salaries 80,000
Bad debts 10,000
Furniture 4,00,000
Brijesh’s capital 5,00,000
Brijesh’s drawing 70,000
Loose tools 1,00,000
Printing & stationery 30,000
Advertising 50,000
Cash in hand 45,000
Cash at bank 2,00,000
Petty Cash 5,000
Machinery 3,00,000
Commission 10,000 30,000
Total 44,85,000 44,85,000
Adjustments:
(i) Stock on 31st March was valued at Cost price ` 4,20,000 and market price ` 400,000.
(ii) Depreciate furniture @ 10% p.a. and machinery @ 20% p.a. on reducing balance method.
(iii) Rent of ` 5,000 was paid in advance. (iv) Salaries & wages due but not paid ` 30,000.
(iv) Make a provision for doubtful debts @ 5% on debtors.
(v) Commission receivable ` 5,000.

Solution:
Dr. Trading Account for the year ended 31st March 2015 Cr.
Particulars Amount (`) Amount (`) Particulars Amount (`) Amount (`)
To Opening Stock By Sales 35,00,000
To Finished Goods 2,00,000 Less: Sales Returns 1,00,000 34,00,000
To purchases 22,00,000 By Closing Stock
Less: Purchases returns 50,000 21,50,000 Finished goods 4,00,000
To Carriage inwards 50,000
To Wages & Salaries 80,000
To Gross profit c/d 13,20,000
38,00,000 38,00,000

192 FUNDAMENTALS OF ACCOUNTING

Dr. Profit & Loss Account for the Year Ended 31st March 2015 Cr.
Particulars Amount (`) Amount (`) Particulars Amount (`) Amount (`)
To Salaries & Wages 2,20,000 By Gross Profit b/d 13,20,000
Add: Not paid 30,000 2,50,000 By Discount received 5,000
To Depreciation on furniture 40,000 By Commission Received 30,000
To Depreciation of machinery 60,000 Add: Receivable 5,000 35,000
To Insurance 60,000
To Rent 60,000
Less: Paid in advance 5,000 55,000
To Printing & Stationery 30,000
To Advertising 50,000
To Carriage outwards 40,000
To Discounts 5,000
To Bad debts 10,000
To Commission 10,000
To Provision for doubtful debts 10,000
Net Profit 7,40,000
13,60,000 13,60,000

Balance Sheet as on 31st March 2015

Capital & Liabilities ` ` Assets ` `
Brijesh’s Capital 5,00,000 Fixed Assets:
Less: Drawings (70,000) Furniture 4,00,000
Add: Net Profit for the year 7,40,000 11,70,000 Less: Depreciation 40,000 3,60,000
Current Liabilities Machinery 3,00,000
Sundry Creditors 4,00,000 Less: Depreciation 60,000 2,40,000
Outstanding salaries & wages 30,000 Loose tools 1,00,000
Current Assets:
Stocks 4,00,000
Sundry debtors 2,00,000
Less: Provision for doubtful debts 10,000 1,90,000
Bills receivables 50,000
Cash in hand 45,000
Cash at bank 2,00,000
Petty cash 5,000
Prepaid Rent 5,000
Commission receivable 5,000
16,00,000 16,00,000
Notes:
(1) Closing stock is valued at market price here as it is less than cost price (conservatism concept)
(2) Returns in debit column mean sales return, while that in credit column means purchase returns
(3) Discounts in debit column mean allowed (expense) and that in credit means received (income)
(4) Commission in debit column mean allowed (expense) and that in credit means received (income)
(5) There are two peculiar items given in the TB. One is Salaries & wages and the other is Wages and salaries. The
interpretation is – where first reference is made to wages, it’s assumed to be directly for goods and taken to
Trading A/c. If the first reference is to salaries, it’s assumed to be related to office and taken to P & L.

FUNDAMENTALS OF ACCOUNTING 193

EXERCISE:
1. Prepare a Trading Account of Rajesh Kumar for the year ending 31st March, 2015 from the following particulars:
` `
Stock of goods on 1-4-14 2,50,000 Returns to suppliers 25,000
Stock of goods on 31-3-15 4,75,000 Returns by customers 20,000
Purchases – cash 3,70,000 Goods withdrawn by Rajesh Kumar for personal use 21,000
Credit 8,25,000 Goods distributed as free samples during the year 4,000
Sales – cash 5,10,000
Credit 11,50,000
Ans: Gross Profit-`7,20,000
2. From the following balances extracted at the close of the year ended 31st March 2015, prepare profit and loss
Account of M/s. Ashok and Sons:
` `
Gross profit 1,01,000 Discount (Dr.) 500
Carriage outward 2,500 Apprentice premium (Cr.) 1,500
Salaries 5,500 Printing & stationery 250
Rent 4,100 Rates & taxes 350
Fire insurance premium 900 Travelling expenses 200
Bad debts 2,100 Sundry trade expenses 300
Income tax paid 3,500 Rent receive d on sub-letting 1,000
Life insurance premium 3,000

Ans: Net Profit - `86,800/-

3. The following are the balances of Shri Gupta as on 30th June, 2015:
Debit Balance: ` `
Cash in Hand 540 Patents 7,500
Cash at Bank 2,630 Salaries 15,000
Purchases 40,675 General expenses 3,000
Returns Inward 680 Insurance 600
Wages 8,480 Drawings 5,245
Fuel and power 4,730 Sundry debtors 14,500
Carriage on sales 3,200 Credit balances:
Carriage on purchases 2,040 Sales 98,780
Stock (1 July, 2014)
st
5,760 Returns outwards 500
Buildings 22,000 Capital 62,000
Freehold land 10,000 Sundry creditors 6,300
Machinery 20,000 Rent 9,000
Investments 10,000

Taking into account the following adjustments prepare the Trading and Profit and Loss Account and Balance Sheet
as on 30th June, 2015:

(a) Stock on hand on 30th June, 2015 is `6,800. (b) Machinery is to be depreciated at the rate of 10% and patents
at the rate of 20%. (c) Salaries for the month of June, 2015 mounting to `1500 were unpaid (d) Insurance includes a
premium of ` 170 on a policy expiring on 31st December 2015. (e) Bad Debts are ` 725 (f) rent received in Advances
` 1,000. (g) Interest on investment of ` 2,000 is accrued.

194 FUNDAMENTALS OF ACCOUNTING

Ans: Gross Profit = `43,715, Net Profit = `26,275, Balance Sheet Total = ` 91,830

4. Mr. Arvindkumar had a small business enterprise. He has given the trial balance as at 31st March 2015. You are
required to prepare final accounts in the books of Mr. Arvindkumar.

Particulars Debit (`) Credit (`)

Mr. Arvinkumar’s Capital 1,00,000
Machinery 36,000
Depreciation on machinery 4,000
Repairs to machinery 5,200
Wages 54,000
Salaries 21,000
Income tax of Mr. Arvindkumar 1,000
Cash in hand 4,000
Land & Building 1,49,000
Depreciation on building 5,000
Purchases 2,50,000
Purchase returns 3,000
Sales 4,98,000
Citi Bank 7,600
Accrued Income 3,000
Salaries outstanding 4,000
Bills receivables 30,000
Provision for doubtful debts 10,000
Bills payable 16,000
Bad debts 2,000
Discount on purchases 7,080
Debtors 70,000
Creditors 62,520
Opening stock 74,000
7,08,200 7,08,200

Additional information:
(1) Stock as on 31st March 2015 was valued at ` 60,000;
(2) Write off further `6,000 as bad debt and maintain a provision of 5% on doubtful debt;
(3) Goods costing `10,000 were sent on approval basis to a customer for `12,000 on 30th March, 2015. This was
recorded as actual sales.
(4) `2,400 paid as rent for office was debited to Landlord’s Account and was included in debtors.
(5) General Manager is to be given commission at 10% of net profits after charging his commission.
(6) Works manager is to be given a commission at 12% of net profit before charging General Manager’s
commission and his own.

Ans: Gross Profit = `1,81,000, Net Profit = `1,20,000, Balance Sheet Total = `3,39,120

Multiple Choice Questions:

1. The purpose of preparing final accounts is to ascertain ____
(a) profit or loss (b) Capital (c) The value of assets (d) Profit or loss and financial position

FUNDAMENTALS OF ACCOUNTING 195

2. If the manager is entitled to a commission of 5% on profits before deduction this commission, he will get a
commission of ` ___ on a profit of ` 8400
(a) `400 (b) ` 442.11 (c) ` 420 (d) None of these
3. The balance of the petty cash is
(a)An expense (b) An income (c) An asset (d) A liability
4. Fixed assets are
(a) Kept in the business for use over a long time for earning income
(b) Meant for resale
(c) Meant for conversion into cash as quickly as possible
(d) All of the above
5. The manufacturing account is prepared
(a) To ascertain the profit or loss on the goods produced
(b) To ascertain the cost of the manufactured goods
(c) To show the sale proceeds from the goods produced during the year
(d) both (b) and (c)
6. A company wishes to earn a 20% profit margin on selling price. Which of the following is the profit mark upon
cost, which will achieve the required profit margin?
(a)33% (b) 25% (c) 20% (d) None of the above
7. At the time of preparation of financial accounts, bad debts recovered account will be transferred to
(a) Debtors A/c (b) Profit & Loss A/c (c) Profit & loss Adjustment A/c
(d)Profit & loss Appropriation A/c
8. Depreciation appearing in the Trial Balance should be
(a) Debited to P & L A/c (b) Shown as liability in balance sheet
(c) reduced from related asset in balance sheet (d) both (a) and (c) above
9. Gross profit is equal to
(a) sales – cost of goods sold (b) sales – closing stock + purchase
(c) opening stock + purchases – closing stock (d) none of the above
10. The profit and loss Account shows the
(a) financial results of the concern for a period (b) Financial position of the concern on particular date
(c) financial results of the concern on a particular date (d) cost of goods sold during the period
11. Which of the following is not a financial statement?
(a) Profit and loss account (b) Balance sheet (c) funds flow statement (d) Trial balance
12. Based on which of the following concepts, is share capital account shown on the liabilities side of a balance
sheet?
(a) business entity concept (b) money measurement concept
(c) going concern concept (d) matching concept
13. Closing stock appearing in the trial balance is shown in –
(a) trading A/c and balance sheet (b) profit and loss a/c (c) balance sheet only (d) trading A/c only
14. Consider the following data and identify the amount which will be deducted from sundry debtors in Balance
sheet.
Particulars `
Bad debts (from trial balance) 1,600
Provision for doubtful debts (old) 2,000
Current year’s provision (new) 800
(a) ` 400 (b) `800 (c) `2,000 (d) `2,400
15. Inventory is
(a) Included in the category of fixed assets (b) An investment
(c) A part of current assets (d) An intangible fixed asset.
Ans: 1.d 2.c.3.c 4.a 5.b 6.b 7.b 8.a 9.a 10.a 11.d 12.a 13.c 14.b 15.c
Fill in the blanks:

1. Insurance prepaid is shown on the ___of the balance sheet(Asset side)

196 FUNDAMENTALS OF ACCOUNTING

2. If sales are `2000 and the rate of G.P on cost of goods sold is 25%, then the cost of goods sold will be ___(`1600)
3. Goodwill is an _____asset (intangible)
4. ___is the difference between assets and liabilities (Capital)
5. Opening stock `50,000 closing stocks `40,000, purchases `1,90,000, profit margin is 25% on the sales, then sales
are____(2,40,000)
6. Average stock= `12,000, closing stock is `3000 more than opening stock the value of closing stock will be
____(`13500)
7. ____contains closing balances of real and personal account(Balance sheet)
8. Expenses due but not yet paid are known as ___(out-standing expenses)
9. Given old provision for bad & doubtful debt is ` 4,000 sundry debtors `50,000, new PBD required = 10% on
sundry debtors then the amount of additional provision to be credited is ` ____(`1,000)
10. Bills receivable discounted but not due till the date of final accounts is shown in ___(Foot-notes.)
11. ____ are passed at the end of the year.(Closing entries )
12. Assets appearing in the books having no real value are known as ____(Fictitious assets.)
13. Various expenses accounts are closed by ___the profit and loss account and crediting the expenses account.
(debiting)
14. Provisions for bad & doubtful debts account will show ___balance.( credit)
15. Loss on sale of old car is shown on debit side of ___(Profit and loss account.)

True or false:

1. Income earned but not received are called accrued incomes. (TRUE)
2. For a shirt factory, cotton is a finished goods. (FALSE)
3. State the following equation is true/false
Gross profit – direct expenses + purchases + opening stock – closing stock = sales. (FALSE)
4. Carriage on goods purchased is shown on Trading Account. (TRUE)
5. The Balance Sheet will not give the information regarding the financial position as on particular date. (FALSE)
6. Preliminary expenses would be included in balance sheet as current asset (FALSE)
7. Fixed assets are kept in the business for use over a long period.(TRUE)
8. Furniture and fittings is a current asset. (FALSE)
9. In sole trade, income tax is recorded as drawings. (TRUE)
10. All revenue receipts and expenditure are shown in trading and profit & loss account (TRUE)

Match the following:

Group – A
1. Carriage on goods purchased c a) Distribution overhead
2. Freight outward d b) Credit of p& L account
3. Concept relating to Profit and Loss A/c e c) Trading account
4. Packing expenses is example of a d) Debit of P & L A/c
5. Apprenticeship premium received b e) Matching concept

Group-B
1. Gross profit rate on sale is 20% d a) current asset
2. Salary outstanding e b) Not a fixed asset
3. Rent prepaid a c) Book value
4. Fixed deposit in bank b d) 25% on cost
5. Fixed assets are included in Balance sheet at c e) Representative personal account

FUNDAMENTALS OF ACCOUNTING 197

 3.2 NOT-FOR- PROFIT MAKING CONCERN

Preparation of Financial Statements of a Non-Trading Concern

Until now, we have seen accounting treatment for business transaction of business entities whose main objective is
to earn profit. There are certain organisations that are not established for making profit but to provide some service.
These services are generally given to members who make subscriptions to avail them. These are also called as non-
trading entities. The examples of such organisations are:
- Gymkhana / sports clubs
- Educational institutions
- Public hospitals
- Libraries
- Cultural clubs like Rotary or Lions club
- Religious institutions
- Charitable trusts

These organisations get their funds in the form of contributions by way of entrance fees, life membership fees,
annual subscriptions, donations, grants, legacies etc. The accounting of such organisations is based on similar
principles followed by the other organisations. Given the nature of these institutions, there are certain items of
revenue and expenses that need special understanding so that accounting treatment could be correctly decided.

Special Items
There are certain items of revenue and expenses that are unique for the non-trading entities. They could be listed
as:
Revenue items Expenditure items
Donations Upkeep of grounds
Entrance fees Tournament expenses
Subscriptions Prizes
Grants received Events

Let us see what accounting treatment should be given to some of the special items:

(a) Entrance Fees – These are received at the time of admission of a new member and thus are onetime fees.
They are non-recurring in nature. It could be either capitalized as they are non-recurring or taken as revenue
as per the rules of the institution. There’s a view that addition of member is an ongoing activity and thus every
year the institute will get entrance fees. So it may be taken as a normal revenue receipt.
(b) Donations – They could be used for meeting capital or revenue expenses. If donations are received for a
special purpose, the amount is credited to a fund from which the amounts are disbursed. The fund may be
invested in specified securities. Income from such investments is credited to the fund Account only. Small
donation amounts which are not earmarked for any specific purpose may be treated as revenue receipts.
(c) Legacy – Many times trusts are formed in the memory of certain persons by their will. In such case after the
demise of the person, the funds pass on to the institution. Such legacies are of course one-time and therefore
should be taken to the capital fund.
(d) Endowments – Sometimes, donations are also in the form of endowments to be used as per instructions of the
donor. These are to be treated as capital receipts.
(e) Life membership fees – These could be taken as capital receipts and every year a charge is debited based
on some logic. In other words, when received, it could be treated as deferred receipt in the balance sheet
and every year a specific amount is credited to I & E Account.
(f) Subscriptions – These are annual receipts and therefore taken as revenue receipts. These must be recognized
as revenue on the accrual concept.

Financial Statements

198 FUNDAMENTALS OF ACCOUNTING

These non-profit organisations prepare

Receipt and Payment Account – This is similar to cash book. Entries are made on cash basis and items pertaining
to previous year or current year or subsequent years are also recorded. Receipts are shown on debit side and
payments are shown on credit side. Capital as well as revenue items are entered in the R & P Account. This account
is real account in nature. No provisions are recorded in this account. The account has an opening and a closing
balance which is reflected as an asset in the balance sheet.

Features of receipts and payment account

1. It is an Account which contains all Cash and Bank transactions made by a nonprofit organization during a
particular financial period.
2. It starts with the opening balances of Cash and Bank. All Cash Receipts both capital & revenue during the
period are debited to it.
3. All Cash Payments both capital & revenue during the period are credited to this Account. It ends with the
closing Cash and Bank Balances.
4. While recording the Cash and Bank transactions all entries are made on Cash Basis.
5. It is a summary of Cash Book.
6. It follows Real Account.

Receipt and Payment Account

Receipt and Payment Account

Receipts Amount(`) Payments Amount(`)

Starts with opening balance
All receipts - capital or revenue All payments - Capital or revenue
May be related to any period May be related to any period
previous, current or subsequent. previous, current or subsequent.
Ends with closing balance

Income and Expenditure account – This is similar to the Profit and loss Account and is prepared exactly based on
same principles. As the name suggests only revenue items are recorded herein. Incomes are recorded on the
credit side while the expenses on the debit side. Both incomes and expenses must be taken on the basis of accrual
concept. This account should reflect only items that are pertaining to current period. Previous and subsequent year
items are to be excluded. This account shows either a surplus or deficit. Excess of income over expenditure is called
surplus and excess of expenditure over income is called as deficit.

Features of income and expenditure Account

1. It follows Nominal Account.
2. All expenses of revenue nature for the particular period are debited to this Account on accrual basis.
3. imilarly all revenue incomes related to the particular period are credited to this account on accrual basis.
4. All Capital incomes and Expenditures are excluded.
5. Only current year’s incomes and expenses are recorded. Amounts related to other periods are deducted.
Amounts outstanding for the current year are added.
6. Profit on Sale of Asset is credited. Loss on Sale of Asset is debited. Annual Depreciation on Assets is also
debited.
7. If income is more than expenditure, it is called a Surplus, and is added with Capital or General Fund etc. in the
Balance Sheet.
8. If expenditure is more than income, it is a deficit, and is deducted from Capital or General Fund etc. in the
Balance Sheet.

FUNDAMENTALS OF ACCOUNTING 199

 Income and Expenditure Account
Expenses Amount (`) Income Amount (`)
Only revenue expenses Only revenue receipts
Only related to current period. Only related to current period
Shows either surplus Or shows deficit
Balance Sheet – It is prepared as on the last day of the accounting period. It also has assets and liabilities and
prepared based on accounting equation. But, there’s no capital account. Instead there is a capital fund. The
surplus or deficit from Income & Expenditure Account is adjusted against this capital fund at the end of the year.

Difference between Receipts and Payments Account and Income and Expenditure Account
Receipts & Payments Account Income & Expenditure Account
1 It is a summarized Cash Book It closely resembles the Profit & Loss Account of a
Trading concern.
2 Receipts are debited and Payments are credited. Incomes are credited and Expenditures are debited.
3 Transactions are recorded on Cash basis. Transactions are recorded on Accrual Basis
4 Amounts related to previous period or future Transactions are recorded on accrual basis. All
period may remain included. Outstanding amount amounts not related to the current period are
for current year is excluded. excluded. Outstanding amounts of current period are
added.
5 It records both Capital and Revenue transactions. It records Revenue transactions only.
6 It serves the purpose of a Real Account. It serves the purpose of a Nominal Account.
7 It starts with opening Cash and Bank Balances and It does not record such balances, rather its final
ends with closing Cash and Bank Balances. balance shows a surplus or a deficit for the period.
8 It does not record notional loss or noncash It considers all such expenses for matching against
expenses like bad debts, depreciations etc. revenues
9 Its closing balance is carried forward to the same Its closing balance is transferred to Capital Fund or
account of the next accounting Period. General Fund or Accumulated Fund in the same
period’s Balance Sheet.
10 It helps to prepare an Income & Expenditure It helps to prepare a Balance Sheet.
Account.

Difference between Profit and Loss Account and Income and Expenditure Account
Profit and Loss Account Income & Expenditure Account
1 It is prepared by business undertaking. It is prepared by non-trading organizations.
2 The credit balance of Profit and Loss Account Credit balance of Income and Expenditure Account
is known as “net profit” and added to opening is known as excess of income over expenditure or
capital. surplus and added to opening capital fund.
3 The debit balance of this Profit and Loss Account is Debit balance of this Income and Expenditure
known as “net loss” and deducted from opening Account is known as “excess of expenditure over
capital. income’ or deficit and deducted from opening
capital fund.
4 To check correctness of accounts trial balance is To check correctness of accounts, receipts and
prepared before preparing this account. payments account is prepared before preparing this
account.

200 FUNDAMENTALS OF ACCOUNTING

Fund Asset Accounting and its peculiarities:
Following are the concepts of some funds which are generally maintained by organizations:
(i) Capital Fund: It is also called “General Fund” or “Accumulated Fund.” It is actually the Capital of a non-profit
concern. It may be found out as the excess of assets over liabilities. Usually “Surplus” or “Deficit” during a
period is added with or deducted from it. A portion of Capitalised incomes like donations may be added with
it.
(ii) Special Fund: It may be created out of special donation or subscription or out of a portion of the “Surplus”.
For example a club may have a “Building Fund”. It may be used for meeting some specific expenses or for
acquiring an asset. If any income is derived out of investments made against this fund or if any profit or loss
occurs due to sale of such investments, such income or profit or loss is transferred to this fund.

Other Treatments

(a) If the Special Fund is used to meet an expense

Special Fund A/c Dr.
To Bank A/c (amt. of expense)

The balance of the Fund is shown as a liability.

If the balance is transferred to Capital Fund, the entry will be—
Special Fund A/c Dr.
To Capital Fund A/c (Balance of Special Fund)

(b) If the Special Fund is used to purchase an asset

Asset A/c Dr.
To Bank A/c (Cost of the asset)
Special Fund A/c Dr.
To Capital Fund A/c (Special Fund closed)

(iii) Donations
(a) Donation received for a particular purpose should be credited to Special Fund. For example, Donation
received for Building should be credited to Building Fund Account.
(b) For other donations received the by-laws or rules of the concern should be followed.
(c) If there is no such rule, donations received of non-recurring nature should be credited to Capital Fund.
Recurring donations received should be credited to Income & Expenditure Account.
(d) Donation paid by the concern should be debited to Income & Expenditure Account.

(iv) Legacy received: It is to be directly added with Capital Fund after deduction of tax, (if any). It is a kind of
donation received according to the will made by a deceased person.

(v) Entrance Fees or Admission Fees

(a) The rules or by-laws of the concern should be followed.
(b) If there is no such rule, Admission or Entrance Fees paid once by members for acquiring membership
should be added with Capital Fund.
(c) If such fees are of small amounts covering the expenses of admission only, the fees may be credited to
Income & Expenditure Account.

(vI) Subscriptions
a) Annual subscriptions are credited to Income & Expenditure Account on accrual basis.
b) Life membership subscription is usually credited to a separate account shown as a liability.

FUNDAMENTALS OF ACCOUNTING 201

Annual Subscription apportioned out of that is credited to Income & Expenditure Account and deducted from the
liability. Thus the balance is carried forward till the contribution by a member is fully exhausted.

If any member dies before hand, the balance of his life Membership contribution is transferred to Capital Fund or
General Fund.

Illustration: 1
Ujjwal Vavishwa Club was holding a building valuing `10 lakhs as on 31.03.2014. Building Fund stands `8 lakhs and
Cash at Bank is `15 lakhs as on 01.04.2014. During the year 2014-15 donation received for the building fund is `20
lakhs. Give the journal entries and the effect in the Balance Sheet as on 31.03.2015. If
(i) It purchases building of ` 15 lakhs during 2014-15
(ii) It purchases building of ` 30 lakhs during 2014-15

Solution:

(i)
Journal entries
(` in Lakhs)

Date Particulars L.F Debit Credit

Bank A/c Dr. 20
To, Donation for Building Fund A/c 20
(Donation received for Building Fund)
Building A/c Dr. 15
To, Bank A/c 15
(Building purchased utilizing the Building Fund)
Building Fund A/c Dr. 15
To, Capital Fund A/c 15
(Being the capital expenditure transferred to the Capital Fund)

Balance Sheet as on 31.03.2015

Liabilities Amount Amount Assets Amount Amount

(` in Lakhs) (` in Lakhs) (` in Lakhs) (` in Lakhs)
Capital Fund Building 10.00
Add: Building Fund (Amount 15.00 Add: Purchase of building 15.00
Transferred) 25.00
Building Fund 8.00 Bank 15.00
Add: Donation 20.00 Add: Donation Received 20.00
35.00
28.00
Less: Amount trans. to Capital Less: Purchase of Building
Fund 15.00 13.00 15.00 20.00

202 FUNDAMENTALS OF ACCOUNTING

(ii)
Journal entries (` in Lakhs)
Date Particulars L.F Debit Credit
Bank A/c Dr. 20
To, Donation for Building Fund A/c 20
(Donation received for Building Fund)
Building A/c Dr. 30
To, Bank A/c 30
(Building purchased utilizing the Building Fund)
Building Fund A/c Dr. 28
To, Capital Fund A/c 28
(Being the capital expenditure transferred to the Capital Fund)

Balance Sheet as on 31.03.2015

Liabilities Amount Amount Assets Amount Amount
(` in Lakhs) (` in Lakhs) (` in Lakhs) (` in Lakhs)
Capital Fund Building 10.00
Add: Building Fund (Amount 28.00 Add: Purchase of building 30.00 40.00
Transferred)
Building Fund 8.00 Bank 15.00
Add: Donation 20.00 Add: Donation Received 20.00
35.00
28.00 Less: Purchase of Building 30.00 5.00
Less: Amount trans. to
Capital Fund 28.00 NIL
Illustration: 2
On 31st December 2013, a club had subscription in arrears of `16,000 and in advance `4,000. During the year ended
31-12-2014, the club received subscription of `2,08,000 of which `10,400 was related to 2015. On 31st December
2014, there were 4 members who had not paid subscription for 2014 @ `1,600 per person. Write up subscription
Account for the year 2014.
Solution:
A single subscription account should be prepared to reflect both advance and arrears figures. The balancing figure
will reflect the subscription amount that will be recognised as Income and transferred to I & E A/c as shown below:

Dr. Subscription Account Cr.

Particulars Amount (`) Particulars Amount (`)

To, Balance c/d (arrears) 16,000 By, Balance c/d (advance) 4,000
To, I & E A/c (income for 2014) (Balance in figure) 1,92,000 By, R & P A/c (received) 2,08,000
By, Balance c/d (arrears) 6,400
To, Balance c/d (advance) 10,400
2,18.400 2,18.400

Illustration: 3
The sports club of Orissa had received in 2013-2014 ` 2,000 towards subscription. Subscription for 2012 -13 unpaid
on1.4.2013 were ` 200.

FUNDAMENTALS OF ACCOUNTING 203

Subscriptions paid in advance on 31.3.2013 were ` 50 and the same on 31.3.2014 was ` 40. Subscriptions for 2013-
2014 unpaid on 31.3.2014 were ` 90.
Show how the subscriptions item will appear in the Income and Expenditure Account.
Solution:
Particulars Amount (`)
Subscriptions received during the year 2013-2014 2,000
Add : Subscription outstanding on 31.3.2014 90
2,090
Less : Subscription outstanding on 1.4.2013 200
1,890
Add : Subscription paid in advance on 31.3.2013 50
1,940
Less : Subscription received in advance on 31.3.2014 40
Subscription Income for 2013-2014 1,900
Illustration: 4
The amount of Subscription appears in the Income and Expenditure Account of South Indian Club is ` 3,000.
Adjustments were made in respect of the following:
Subscription for 2013 unpaid at 1st Jan., 2014, ` 400; ` 200 of which was received in 2014.
Subscription paid in advance at 1.1.2014 ` 100.
Subscription paid in advance at 31.12.2014 ` 80.
Subscription for 2013 unpaid at 31.12.2014 ` 140.
Prepare Subscription Account.

Solution:

Dr. Subscription Account Cr.

Particulars Amount (`) Particulars Amount (`)
To, Balance b/d 400 By, Balance b/d 100
To, Income & Expenditure A/c 3,000 By, Cash Received (bal. fig.) 3,040
To, Balance c/d (paid in advance to 2014) 80 By, Balance (200+140) c/d 340
3,480 3,480
To, Balance b/d: By, Balance b/d (2014) 80
For 2013 200
For 2014 140
Note: Opening outstanding subscription = ` 400 of which ` 200 received in 2014.

Illustration: 5
From the following information, prepare the Subscription Account for the year ending on March, 31, 2015
(i) Subscription in arrears on 31.03.2014 ` 1,500
(ii) Subscription received in advance on 31.03.2014 ` 1,000
(iii) Amount of Subscription received during 2014-15 ` 40,000, which includes `1,000 for the year 2013-14, ` 1,500 for
the year 2015-16.
(iv) Subscription outstanding ` 1,000.

204 FUNDAMENTALS OF ACCOUNTING

Solution:
Dr. Subscription Account Cr.
Particulars Amount (`) Particulars Amount (`)
To, Balance b/d 1,500 By, Balance b/d 1,000
To, Income & Expenditure A/c 39,500 By, Bank A/c 40,000
By, Balance c/d
For 2013-14 500
For 2014-15 1,000
To, Balance c/d
For 2015-16 1,500
42,500 42,500
Illustration: 6
From the following particulars, prepare Receipts and Payments Account
`
Cash in hand 2,000
Cash at Bank 6,000
Subscriptions 3,000
Donations received 2,400
Furniture purchased 1,600
General Expenses 1,000
Postage 400
Stationery 600
Lockers Rent Received 1,800
Office Expenses 800
Closing balance of Cash 7,000
Solution:
Dr. Receipts and Payments Account Cr.
Receipts Amount(`) Payments Amount(`)
To Balance b/d(cash) 2,000 By furniture 1,600
To Balance b/d (Bank) 6,000 By General Exp. 1,000
To subscriptions 3,000 By Postage 400
To Donations 2,400 By Stationery 600
To Locker Rent 1,800 By Office Expenses 800
By Balance c/d (Cash) 7,000
By Balance c/d (Bank) 3,800
15,200 15,200

Illustration: 7
From the following particulars, prepare Income and Expenditure Account.
`
Fees Collected (including `3,000 on account of last year) 28,000
Meeting Expenses 2,000
Travelling & Conveyance 800
Fees for the year outstanding 5,000

FUNDAMENTALS OF ACCOUNTING 205

 Salary paid (including `300 on account of last year) 2,400
Salary outstanding 400
Entertainment Expenses 500
Tournament Expenses 1,000
Purchase of Books and Periodicals (includes `2,000 for purchase of books) 3,000
Rent 1,200
Postage, Telephone and Telegram charges 1,700
Printing & Stationery 500
Donations received 800
Solution:
Dr. Income and Expenditure Account Cr.
Expenditure Amount (`) Amount (`) Income Amount (`) Amount (`)
To Salaries 2,400 By Fees 28,000
Add: O/s Current Year 5,000
Less: O/s last year (300) Less Last Year (3,000)
Add: O/s Current Year 400 30,000
2,500 By Donation Received 800
To Entertainment Exp 500
To Tournament Exp 1,000
To Meeting Exp. 2,000
To Travelling Exp. 800
To Cost of Periodicals (`3,000 - `2,000) 1,000
To Rent 1,200
To Postage, Telephone and Telegram 1,700
charges
To Printing & Stationery 500
To Surplus 19,600
30,800 30,800
Illustration: 8
From the figures given below, prepare an Income and Expenditure Account for 2014
Dr. Receipts and Payments Account Cr.
Receipts Amount (`) Payments Amount (`)
To Opening Balance in hand 200 By Salaries 4,800
To Balance at Bank 1,600 By Rent 500
To subscriptions By Stationery and Postage 200
2013 500 By Bicycle purchased 300
2014 8,300 To National Saving Certificates 3,000
2015 600 By Help to Needy Students 2,000
To Sale of Investments 2,000 By Balance in hand 300
To Sale of Old furniture 300 By Balance at Bank 2,400 2,700
(Book value `400)
13,500 13,500

Subscriptions for 2014 still receivable were `700, interest due on savings certificates `100 and rent unpaid but due
was `60.

206 FUNDAMENTALS OF ACCOUNTING

Solution:
Dr. Income and Expenditure Account for the year ended 31.03.2014 Cr.
Expenditure Amount(`) Income Amount(`)
To Loss on sale of furniture (`400 - `300) 100 By Subscriptions 8,300
To Salaries 4,800 Add: Due 700
To Rent 500 9,000
Add: Outstanding 60 560 By accrued Interest on NSC 100
To Stationery & Postage 200
To help to Needy students 2,000
To Surplus – Excess of Income over Expenditure 1,440
9,100 9,100
Illustration: 9
From the following Receipts and Payments Account and other details of Pattabhi Memorial Trust, which commences
its working from 1st January, 2014 with a capital of `40,000 in cash and furniture `20,000, prepare Income &
Expenditure Account and Balance Sheet.

Dr. Receipts and Payments Account Cr.

Receipts Amount(`) Payments Amount(`)
To Balance b/d 40,000 By Salaries 15,000
To Donations 60,000 By Conveyance 6,000
To Legacies 16,000 By Rent 12,000
To subscriptions 14,000 By Subscriptions to Journals 5,400
To Furniture Sold (on 31.12.2014) 6,000 By Stationery 1,000
By Books 4,000
By Buildings (Purchased on 1.1.2014) 68,000
By Balance 24,600
1,36,000 1,36,000
Additional information:
a) Provide for depreciation on Furniture @10% and on Buildings @10% and on Books `1,000
b) Outstanding subscriptions at the end of the year 2014 `15,000 and subscriptions received in advance for 2015
were `5,000
c) Outstanding expenses: Rent `1,000; Salary `2,000

Solution:
Pattabhi Memorial Trust
Income and Expenditure Account for the year ended 31.12.2014
Dr. Cr.
Expenditure Amount (`) Amount (`) Income Amount (`) Amount(`)
To Salaries 15,000 By Donations 60,000
Add: Outstanding 2,000 17,000 By Subscriptions 14,000
To Conveyance 6,000 Add: Outstanding Subscription 15,000
29,000
To Rent 12,000 Less: Received in Adv. 5,000 24,000
Add: Outstanding rent 1,000 13,000
To Subscriptions to Journals 5,400

FUNDAMENTALS OF ACCOUNTING 207

 To Stationery 1,000
To Depreciation on:
-Furniture @10% 2,000
-Building @10% 6,800
-Books 1,000 9,800
To Loss on sale of 12000
Furniture(20000-2000-6000)
To Surplus –Excess of
Income over Expenditure 19,800
84,000 84,000
Illustration: 10
From the following Receipts and Payments Account of Shyam Club for the year ended 31st December, 2015:

Dr. Receipts and Payments Account Cr.

Receipts Amount (`) Payments Amount (`)
Cash in hand 150 Mowing Machine 1,100
Cash at Bank 2,100 Ground men’s fee 1,500
Subscription 5,800 Rent 500
Rent of the Hall 3,000 Salaries to coaches 4,500
Life Membership fee 2,000 Office Exp 2,400
Entrance fee (income) 200 Sports equipment purchased 1,200
Donations (Gen) 1,500 Cash in hand 350
Sale of Gross 100 Cash at Bank 3,300
14,850 14,850
Subscriptions due on 31st December, 2014 and December, 2015 were `900 and `800 respectively. Subscriptions
received also included subscriptions for the year 2015 `200. Sports equipment in hand on 31st December 2014 was
`1,100. The value placed on his equipment in hand on 31st December 2015 was `1,300. The mowing machine was
purchased on 1st January, 2015 and is to be depreciated @ 20% per annum. Office expenses include `300 for 2014
and `400 are still due for payment.
Prepare Income and Expenditure account and Balance Sheet relating to the year 2015.
Solution:
Shyam Club
Income and Expenditure Account for the year ended 31.12.2015
Dr. Cr.
Expenditure Amount (`) Amount (`) Income Amount (`) Amount (`)
To Ground Men’s Fees 1,500 By Subscriptions 5,800
To Rent 500 Less: Outstanding Last Year 900
To Salaries to Coaches 4,500 4,900
To Office Expenses 2,400 Add: Outstanding this year 800
Add: Outstanding this year 400 5,700
2,800 Less: for 2015 200
Less: Outstanding Last Year 300 5,500
2,500 By Rent of Hall 3,000
To Depreciation: By Entrance fees 200

208 FUNDAMENTALS OF ACCOUNTING

-Mowing Machine 220 By Donations 1,500
-Sports Equipments 1,000 By Sales of Grass 100
(1,100+1,200-1,300) 1,220
To Surplus- Excess of Income over
Expenditure 80
10,300 10,300

Balance Sheet As on 31st December, 2015

Liabilities (`) Assets (`)
Outstanding Office Exp 400 Cash in hand 350
Subscription received in adv. 200 Cash at Bank 3,300
Life membership Fee. 2,000 Subscription Outstanding 800
Capital Fund (1) 3,950 Mowing Machine 1,100
Add: Surplus 80 4,030 Less: Depreciation 220 880
Sports equipment 1,100
Add:-Purchase 1,200
2,300
Less:- Depreciation 1,000 1,300
6,630 6,630
Working Note:
1) Calculation of Beginning Capital Fund:
Balance Sheet as on 31st December, 2014
Liabilities (`) Assets (`)
Outstanding Office Exp 300 Cash in hand 150
Capital fund (Bal. Fig) 3,950 Cash at Bank 2,100
Subscription Outstanding 900
Sports equipment 1,100
4,250 4,250

EXERCISE
1. From the following details prepare Receipts and Payments Account
`
Opening Cash in hand 3,400
Opening Cash at Bank 23,400
Subscriptions received 25,000
Donations collected 5,000
Salaries paid 6,000
Rent Paid 1,000
Tournament Expenses 3,000
Purchase of Investments 10,000
Interest Received 600
Sundry expenses 1,500
Electricity charges 500
Cash in hand at the end 700
Ans: Receipts and Payments A/c Total = `57,400

FUNDAMENTALS OF ACCOUNTING 209

1. From the following Receipts and Payments Account of the Venkateswara Society for the year ended 31.12.2014.
Prepare income and expenditure account for the year ended 31.12.2014

Dr. Cr.
Receipts (`) Payments (`)
To Balance 1-1-2014 3,485 By Books 6,150
To Entrance Fees 650 By Printing & Stationery 465
To Donations 6,000 By News Papers 1,110
To Subscriptions 6,865 By Sports Materials 5,000
To Interest on Bank Deposits 1,900 By Repairs 650
To Sale of furniture 685 By Investments 2,000
To Sale of old news papers 465 By furniture 1,000
To Proceeds from entertainments 865 By Salaries 1,500
To Sundry Receipts 125 By balance (31-12-2014) 3,165
21,040 21,040

The Entrance fees and donations are to be capitalized. Sports materials value `4,000 as on 31.12.2014.

Ans: Surplus = `5,495

3. From the following Receipts and Payments Account of the Guntur Sports Club for the year ended 31.3.2014.
Prepare Income and Expenditure Account
Dr. Cr.
Receipts Amount(`) Payments Amount(`)
To Balance b/d 14,000 By Salaries 1,400
To Subscriptions By Repairs 600
(including `1,000 for the previous year) 18,000 By Purchase of Sports Equipment 2,000
To Legacies 2,000 By Furniture 8,000
To Life Membership Fees 5,000 By Honorarium paid 5,000
To Sale of tickets 500 By Books 2,000
To Lockers Rent 1,500 By Investments 10,000
To Entrance Fees 1,000 By Office Expenses 1,200
To interest on Investments 200 By balance c/d 12,000
42,200 42,200

Additional Information:
a) Outstanding Salaries `600
b) Opening value of sports equipments `1,000 closing value `500
c) Interest accrued on investments `200
d) Subscription receivable for the year 2014 `3,000

Ans: Surplus = `12,100

4. From the following Receipts and Payments Account prepare Final Accounts of Sports Club Account.

210 FUNDAMENTALS OF ACCOUNTING

5.
Dr. Cr.
Receipts Amount(`) Payments Amount(`)
To Subscriptions 15,000 By Land 10,000
To Donations 50,000 By Buildings 40,000
To Legacies 10,000 By Furniture 10,000
To Entrance Fee 5,000 By Sports Material 5,000
To Life Membership Fees 3,000 By Sports Expenditure 6,000
To Sports Income 17,000 By General Exp. 1.000
To Sundries 5,000 By Magazines 1,500
To Sale of old papers 500 By Ground expenses 4,000
By balance c/d 28,000
1,05,500 1,05,500
Capitalize half of donations, legacies, entrance and life membership fee. Subscriptions still outstanding `5,000.
Depreciate fixed assets by 5% and sports material by 10%.

Ans: Surplus = `60,500, Balance Sheet Total = `94,500

6. From the following Receipts and Payments Account additional information prepare the income and expendi-
ture account for the year ended 31st Dec. 2013 and a Balance sheet as on that date of Cosmopolitan club.
Dr. Cr.
Receipts Amount(`) Payments Amount(`)
To Donations 50,000 By Furniture (1-1-2013) 10,000
To Life Membership Fees 10,000 By Buildings (1-1-2013) 40,000
To Legacies 40,000 By Salaries 5,000
To subscriptions 41,000 By Wages 1,000
To Lecturers 9,000 By Entertainments 4,000
To Entertainments 13,000 By News paper subscription 800
To Sale of old papers 500 By Printing & Stationery 1,200
To Sundries 500 By Telephone charges 300
By Gross Seeds 700
By Bats and Balls 5,000
By Balance c/d 95,000
1,64,000 1,64,000

Additional Information:
a) Salaries Outstanding `1,000
b) Printing and Stationery outstanding `200
c) Bats and Balls on 31.12.2013 `3,000
d) Depreciate Buildings at 55
e) Depreciate Furniture at 105
f) Subscriptions include `1,000 relating to 2014
g) Subscriptions payable by members for the year 2013 is `500

Ans: Surplus = `43,500, Balance Sheet Total = `1,45,500

FUNDAMENTALS OF ACCOUNTING 211

7. Laxman Cricket association gives you the following Receipts and payments account for the year ended
31st March, 2014.
Dr. Cr.
Receipts Amount(`) Payments Amount(`)
To Balance b/d By Salaries 22,000
Cash 1,500 By sports Equipment 50,000
Bank 14,200 By Stationery 2,000
To subscriptions 7,50,000 By Maintenance of Ground 8,000
To Admission fee 13,500 By Prizes 1,000
To Interest on investments @10% p.a. for full year 10,000 By Balance c/d
To Donations 2,000 Cash 23,200
Bank 10,000
1,16,200 1,16,200

On 1-4-2013 (`) On 31.3.2014 (`)

i) Subscriptions due 4,000 5,500
ii) Subscriptions received 800 500
iii) Land and buildings (Cost les depreciate) 2,00,0000 1,90,000
iv) Salaries due 1,000 2,000

Prepare Income and Expenditure A/c for the year ended 31st March, 2014 and Balance sheet as on that date.

Ans: Surplus = `58,300, Capital Fund = `3,17,900, Balance Sheet Total = `3,78,700

Multiple Choose Questions:

1. Endowment fund receipt is treated as -
(a) Capital Receipt (b) Revenue Receipt (c) Loss (d) Expenses
2. Which one of the following is not prepared by non-profit organizations
(a) Profit and loss account (b) Income & Expenditure account
(c) receipts and payments account (d) Balance sheet
3. Legacy are generally -
(a) Capitalized (b) Treated Loss (c) Revenue Expenses (d) Deferred Revenue expenses
4. Any donation received for a specific purpose is a
(a) Assets (b) Revenue receipts (c) Capital receipts (d) None of the above
5. The receipts and payments account of a non-profit organization is a
(a) Nominal Account (b) Real Account (c) Income Statement Account (d) Financial Account
6. The capital of a non-profit organization is generally known as
(a) Equity (b) Accumulated Fund (c) Finance Reserve (d) Cash Fund
7. If `1,500 was outstanding at the beginning of the year towards subscription and `10,000 is received during the
year, with `2,500 still outstanding at the end of the year the amount to be taken to receipts and payments
account is
(a) `11,000 (b) `8,500 (c) `10,000 (d) None of the above
8. Any revenue expenses for which a separate fund is available will be
a) Debited to the separate fund
b) Debited to income and expenditure account
c) Capitalized and shown in the balance sheet

212 FUNDAMENTALS OF ACCOUNTING

 d) None of the above
9. Sale of old materials must be shown on the credit side of
a) Cash Book b) Income and expenditure account c) Balance Sheet d) None of the above
10. The information for the preparation of receipts and payments account is taken from
a) Cash Book b) Income and expenditure account c) Cash Book and Balance Sheet d) None
11. Any donation received for a specific purpose is a
a) Capital receipt b) Revenue receipt c) Liability d) None of the above
12. The receipts and payments account shows the following details:
Subscription Arrears `500
Current `10,500
Advance `800
There are `1,200 members each paying an annual subscription of `10. The amount to be credited to income
and expenditure account will be
a) `11,800 b) ` 11,300 c) `12,000 d) None of the above
13. Any income arising from special fund will be credited to
a) Special fund in the balance sheet b) Income and expenditure account
c) General fund in the Balance Sheet d) None of the above
14. ncome and expenditure account shows subscriptions at `10,000. Subscriptions accrued in the beginning of
the year and at the end of the year were `1,000 and `1,500 respectively. The figure of subscriptions received
appearing in receipts and payments account will be
a) `9,500 b) ` 11,000 c) `10,000 d) None of the above
15. Which of the following item(s) is (are) shown in the income and expenditure account
a) Only items of capital nature
b) Only items of revenue nature which are received during the period of accounts
c) Only items of revenue nature pertaining to the period of accounts
d) Bothe the items of capital and revenue nature

Ans: 1.a 2.a 3.a 4.c 5.b 6.b 7.a 8.a 9.b 10.a 11.c 12.c 13.a 14.a 15.c

Fill in the blanks:

1. In a receipts and payments account the payments are recorded on the ___side (Credit)
2. The closing debit balance in the receipts and payments account indicates the ___balance at the end of the
year (Cash)
3. The income and expenditure account is prepared on the basis of ___system of accounting (Mercantile)
4. A debit balance in the income and expenditure account denotes excess of ___ (Expenditure over Income)
5. Income and expenditure matches all ___receipts against Revenue payments pertaining the relevant
accounting year.( Revenue)
6. Any amount received towards Endowment fund is a ___Receipt (Capital)
7. Interest received on special fund investments will be added to ___fund in the balance sheet (Special)
8. Subscriptions received in advance will figure in the ___(Balance Sheet)
9. Any revenue expenditure relating to special fund must be deducted from ___ (Special Fund)
10. Out of `5,00,000 collection for the building `3,00,000 is invested and the balance spent on building. Income
from investments `20,000. The balance to be shown in the building fund ___(`5,20,000)

True or False:
1. Receipts and payments account is nothing but a consolidated summary of the Cash Book. (TRUE)
2. Receipts and payments account is a real account. (TRUE)
3. Income and expenditure account is a real account. (FALSE)
4. Entrance fees unless otherwise stated is to be taken as a capital receipt. (FALSE)
5. Donations unless otherwise stated is to be taken as a capital receipt. (TRUE)

FUNDAMENTALS OF ACCOUNTING 213

6. Sale of old materials must be credited to capital fund in the balance sheet. (FALSE)
7. Income and expenditure relating to special funds should not be dealt with in the income and expenditure
account. (TRUE)
8. Receipts and payments account is a summary of all capital receipts and payments.
9. Any subscriptions received in advance are treated as capital receipts and are therefore taken to the liabilities
side of the balance sheet. (FALSE)
10. Payment of honorarium is treated as a capital expenditure. (FALSE)

Match The Following:

1. Non-trading concerns collects money at Regular in- d a) Entertainment programmes, stage shows
tervals from members. These are known as funds raising programs
2. Non-trading concerns collect amount at the time of e b) Income & expenditure account
admission it is known as
3. Non-trading concerns collect funds through a c) Balance sheet
4. Revenue incomes and expenditures are shown b d) Subscriptions
5. Capital items are shown in c e) Entrance fee

214 FUNDAMENTALS OF ACCOUNTING

STUDY NOTE : 4
FUNDAMENTALS OF COST ACCOUNTING

THIS STUDY NOTE INCLUDES

4.1 Meaning, Definition, Significance of Cost Accounting, its relationship with Financial Accounting & Management
Accounting
4.2 Classification of Costs
4.3 Format of Cost Sheet

4.1 MEANING, DEFINITION, SIGNIFICANCE OF COST ACCOUNTING, ITS RELATIONSHIP WITH

FINANCIAL ACCOUNTING & MANAGEMENT ACCOUNTING

Origin:
All types of businesses, whether service, manufacturing or trading, require cost accounting to track their activities.
[1] Cost accounting has long been used to help managers understand the costs of running a business. Modern
cost accounting originated during the industrial revolution, when the complexities of running a large scale business
led to the development of systems for recording and tracking costs to help business owners and managers make
decisions.

In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable
costs" because they varied directly with the amount of production.[citation needed] Money was spent on labor,
raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the
variable costs for a product and use this as a rough guide for decision-making processes.

Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and fall with volume
of work. Over time, these "fixed costs" have become more important to managers. Examples of fixed costs include
the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production
control, purchasing, quality control, storage and handling, plant supervision and engineering.[2] In the early
nineteenth century, these costs were of little importance to most businesses. However, with the growth of railroads,
steel and large scale manufacturing, by the late nineteenth century these costs were often more important than
the variable cost of a product, and allocating them to a broad range of products led to bad decision making.
Managers must understand fixed costs in order to make decisions about products and pricing.

For example: A company produced railway coaches and had only one product. To make each coach, the
company needed to purchase `60 of raw materials and components, and pay 6 laborers `40 each. Therefore,
total variable cost for each coach was `300. Knowing that making a coach required spending `300, managers
knew they couldn't sell below that price without losing money on each coach. Any price above `300 became a
contribution to the fixed costs of the company. If the fixed costs were, say, `1000 per month for rent, insurance and
owner's salary, the company could therefore sell 5 coaches per month for a total of `3000 (priced at `600 each), or
10 coaches for a total of `4500 (priced at `450 each), and make a profit of `500 in both cases.

Evolution of Cost Accounting:

Every modern business has to make its way through keen competition, uncertainty and risks. Quick changes in
social and economic environment also create impact upon the businesses. Changes in political outlook of the
government of the country also require adjustment in the business policies. Thus, a modern business becomes more
and more complex in nature.

In old times the business concerns were small in size; there was no keen competition; necessity of adjustment
in business outlook due to changes in social, economic and political outlook was rare and the owner/ owners

FUNDAMENTALS OF ACCOUNTING 215

of the business could maintain personal contact with the business sand gather all information relating to the
business whenever necessary. The present-day business is big in size and complex in character and is under keen
competition. So, information relating to the business in detail, appropriate management policy on the basis of
detailed information and proper execution of such policies can only bring about success.

As the successful treatment of a sick person often requires various pathological information, the successful
management of a modern business requires various information regarding the business. The traditional financial
Accounting fails to furnish all information necessary for managing a modern business successfully. Thus, as a branch
of Financial Accounting, cost accounting has evolved and made rapid progress during the last few decades.
This branch of accounting, with its developing techniques and procedures, has been rapidly expanding in the
fields of its application. In recent years, another aspect of accounting, called Management accounting, has been
developed and is being employed in many concerns.

Where Financial accounting limits its activities in determining the financial result of trading during a given period of
time and stating the financial position as on the closing date of the period, Cost Accounting takes the responsibility
of generating information for controlling operations with a view to maximizing efficiency and hence profit, and
Management accounting takes the duty of assisting the management with information for planning and decision
making.

The belief that Cost Accounting developed after the rise of factory systems a result of Industrial Revolution in England,
is not true. Some Cost Accounting principles were found in application as early as 14th century. Some authorities
suggest that, the present day cost Accounting procedure was established at the end of the 19th Century. However,
major developments in the subject were noticed during a quarter century before the end of the Second World War.
The scientific management movement led to the development of standard Costing. After 1945, the need for data
in planning for the future was felt and Cost Accounting developed further. The technique of Cost control is a recent
development. Cost Audit also emerged as a branch and it is developing further.

Meaning of Cost:
It is the amount of resources given up in exchange for some goods or services. The resources given up are expressed
in monetary terms. Cost is defined as the amount of expenditure (actual or notional) incurred on or attributable
to a given thing or to ascertain the cost of a given thing. The cost of an article consists of actual outgoings or
ascertained charges incurred in its production and sale. Cost is a generic term and it is always advisable to qualify
the word cost to show exactly what is means e.g., prime cost, factory cost, sunk cost etc., cost is also different from
value as cost is measured in terms of money whereas value is measured in terms of usefulness or utility of an article.

Meaning of Costing
Costing is a technique and process of ascertaining costs. This technique consists of principles and rules which
govern the procedure of ascertaining the cost of products/services. The process of costing includes routines of
ascertaining costs by historical or conventional costing, standard costing or marginal costing.

Meaning of cost accounting:

Cost Accounting is the classifying, recording and appropriate allocation of expenditure for the determination of
the costs of products or services, and for the presentation of suitable arranged data for purposes of control and
guidance of management. It includes the ascertainment of the cost of every order, job contract, process, service
or unit as may be appropriate. It deals with the cost of production, selling and distribution. It is thus the provision of
such analysis and classification of expenditure as will enable the total cost of any particular unit of production or
service to be ascertained with reasonable degree of accuracy and at the same time to disclose exactly how such
total cost is constituted (i.e., the value of material used, the amount of labour and other expenses incurred) so as
to control and reduce its cost. Thus, cost accounting relates to the collection, classification, ascertainment of cost
and its accounting and control relating to the various elements of cost. It establishers budgets and standard costs
and actual cost of operations, processes, departments or products and the analysis of the variance, profitability
and social use of funds. Accounting to Kohler, “Cost Accounting is the branch of accounting dealing with the
classification, recording, allocation, summarizing and reporting of current and prospective costs.”

216 FUNDAMENTALS OF ACCOUNTING

Meanings of cost accountancy:
Cost Accountancy is the application of costing and cost accounting principles, methods and techniques to the
science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of
information derived there from for purposes of managerial decision making. Thus, cost accountancy is the science,
art and practice of a cost accountant. It is science because it is a body of systematic knowledge having certain
principles which a cost accountant should possess for proper discharge of his responsibilities,. It is an art as it
requires the ability and skill with which a cost accountant is able to apply the principles of cost accountancy to
various managerial problems. Practice includes the continuous efforts of a cost accountant in the field of cost
accountancy. Such efforts also include the presentation of information for the purpose of managerial decision
making and keeping statistical records.

Importance of Cost Accounting

Importance of Cost Accounting may be considered under the following headings:

(A) Importance to Management:

A good Cost Accounting system serves the management in the following ways;

(i) Classification and sub-division of costs:

Costs are collected and classified by various ways in order to provide information to the management for control
purposes and to ascertain the profitability of each area of activity. It enables the concern to measure the efficiency
and then to maintain and improve it.

(ii) Control of material, labour and overhead costs:

Various inventory control techniques or methods of costing are used to control the material cost. For example
fixation of maximum level helps the management to reduce the over-stocking; use of EOQ helps the Purchase
Department to order right quantity. An efficient check on labour and machines is provided by giving detailed
information about availability of machine and labour capacity. The work is so planned that no section is over-
worked and no section remains idle. By classifying the overheads into controllable and uncontrollable or fixed and
variable, helps to control the overhead costs.
Thus cost accounting provides a detailed control of material, labour and overhead costs.

(iii) Price determination:

Cost Accounting helps the management to fix the remunerative selling prices of various items of goods under
different circumstances. During the period of depression a businessman has to become very watchful and
vigilant in tracking down the concealed inefficiencies and sources of wastage, so that he may reduce the cost
of production to the minimum. During depression the businessman has to cut the price to such an extent so as to
recover the variable costs. Cost accounting makes the distinction between fixed and variable costs and helps the
management in determination of prices. If prices are fixed without cost information, it is possible that prices quoted
may be too high or too low.

(iv) Business Policy:

Business policy may require consideration of alternative methods and procedures and this is facilitated by cost
information correctly presented. Cost accounting helps the management to take vital decisions such as introduction
of new product, selection of optimum product mix, utilization of spare capacity, replacement of existing assets, etc.

(v) Standards for measuring efficiency:

It provides the use of standards to assist management in making estimates and plans for future and to provide the
basis for measuring of efficiency. Actual are compared with standards to determine the operating efficiency.

FUNDAMENTALS OF ACCOUNTING 217

(vi) Best use of limited resources:
Cost accounting provides the reliable data of costs with regard to materials, wages and other expenses. This helps
the management to get maximum output at the minimum cost, by indicating where economies may be affected,
waste eliminated and efficiency increased.

(vii) Special factors:

Cost accounting informs the management about the special factors such as optimum profitability, seasonal
variations in volume and costs. Idle time of labour and idle capacity of the machine, etc. It also helps to curtail the
losses during the off season.

(B) Importance to Workers:

Cost accounting discloses the relative efficiencies of different workers and thereby facilitates the introduction
of suitable plans of wage payment to reward efficiency and to provide adequate incentive to the less efficient
workers. A good system of costing promotes prosperity of the business and thus ensures greater security of service
and adequate reward to workers.

(C) Importance to Creditors and Investors:

It enables the creditors and investors to judge the financial strength and credit worthiness of the business. A sound
business concern with a good system of costing can attract more investors than a similar concern without an
adequate system of costing.

(D) Importance to Government:

It facilitates the assessment of excise duty and income tax and the formulation of policies regarding industry, export,
import, taxation, etc. It also facilitates the preparation of national plans for economic development. It provides
ready figures for use by government by application to problems like price fixation, price control, tariff protection,
and wage level fixation, payment of dividends or settlement of disputes.

(E) Importance to General Public:

The ultimate aim of costing is to reduce cost of production to the minimum and maximize the profits of the business.
A part of the benefit resulting from the reduction of the cost is usually passed on to the consumers in the form of
lower prices. Besides the installation of a costing system will infuse confidence in the minds of the public about the
fairness of the prices charged.

Differences between Financial Accounting and Cost Accounting:

Main difference between financial accounting and cost accounting are given as under:

Point of Financial Accounting Cost Accounting

distinction

1. Purpose It provides information about the business in It provides information to the management for
a general way. It tells about the profit and proper planning, operation, control and decision
loss and financial position of the business to making.
owners and other outside parties
2. Form of These accounts are kept in such a way as to These accounts are generally kept voluntarily
accounts meet the requirements of companies Act and to meet the requirements of the management.
Income Tax Act. But now companies Act has made it obligatory
to keep cost records in some manufacturing
industries.

3. Recording It classifies, records and analyses the It records the expenditure in an objective manner
transactions in a subjective manner i.e. i.e., according to the purposes for which the costs
according to the nature of expenses. are incurred.

218 FUNDAMENTALS OF ACCOUNTING

 4. Control It lays emphasis on the recording aspect It provides a detailed system of control for
without attaching any importance of control materials, labour and overhead costs with the
help of standard costing and budgetary control.

5. Periodicity It reports operating results and financial It gives information through cost reports to
of reporting position usually at the end of the year. management as and when desired.

6. Analysis of Financial accounts are the accounts of the Cost Accounting is only a part of the financial
profit whole business. They are independent in accounts and discloses profit or loss of each
nature and disclose the net profit or loss of the product, job or service.
business as a whole.

7. Reporting The costs are reported in aggregate in The costs are broken down on a unit basis in cost
of costs financial accounts accounts.

8. Nature of Financial accounts relate to commercial Cost accounts relate to transactions connected
transactions transactions of the business and include all with the manufacture of goods and services and
expenses viz., manufacturing office, selling include only those expenses which enter in to
and distribution etc.` production.

9. Monetary information is only used (i.e. only Non-monetary information like units is also used
Information monetary transactions are recorded). (i.e., it deals with monetary as well as non-
monetary information).

10. Figures Financial accounts deal mainly with actual Cost accounts deal partly with facts and figures
facts and figures and partly with estimates

11. In devising or operating a system of financial No such reference is possible. Guidance can be
Reference accounting reference can be made in case of had only form a body of convention followed by
difficulty to the company law, case decisions cost accountants.
and to the canons of sound professional
practice.

12. relative Financial accounts do not provide information Cost accounts provide valuable information
efficiency on the relative efficiencies of various workers, on the relative efficiencies of various plants and
plants and machinery. machinery.

13. Stock Stock are valued at cost or market price Stock are valued at cost
valuation whichever is less

14. Type of Financial accounting is a positive science Cost accounting is not only a positive science
science because it is subject to legal rigidity with but also a normative science because it includes
regard to the preparation of the financial techniques of budgetary control and standard
statements costing.

Meaning of Management Accounting:

Management Accounting is primarily concerned with management. It involves application of appropriate

techniques and concepts, which help management in establishing a plan for reasonable economic objective. It
helps in making rational decisions for accomplishment of these objectives. Any workable concept of techniques
whether it is drawn from cost accounting financial accounting, economics, mathematics and statistics, can be used
in management accountancy, The data used in management accountancy should satisfy only one broad test. It
should serve the purpose that it is intended for. A management accountant accumulates synthesis and analysis

FUNDAMENTALS OF ACCOUNTING 219

the available data and present it in relation to specific problems, decisions and day-to-day task of management.
A manger accountant reviews all the decisions and analysis form management’s point of view to determine how
these decisions and analysis contribute to overall organizational objectives. A management accountant judges
the relevance and adequacy of available data from management’s point of view.

Difference between cost Accounting and Management Accounting

Point of Cost Accounting Management Accounting

distinction
1. Deals with It deals with ascertainment, allocation, It deals with the effect and impact of cost on the
apportionment and accounting aspect of business
costs
2. Base It provides a base for management It is derived from both cost accounting and
accounting. financial accounting.

3. Role It is helpful in collecting costing data for the It is a greater degree of relevance and objectivity
management as the management accountant has a clear idea
of the types of costs and items requiring analysis
and states the specific problems of business.

4. Status The status of cost accountant comes after Management accountant is senior in position to
the management accountant cost accountant.

5. Outlook Cost accountant has a narrow approach. Management accountant reports the effect of
He has to refer to economic and statistical cost on the business along with cost analysis.
data for analyzing cost effects
6.Tools & It has standard costing, variable costing, Along with these, the management accountant
techniques break even analysis etc., as the basic tools has funds and cash flow statements, ratio analysis
and techniques. etc. as his accounting tools and techniques.

7. Scope It does not include financial accounting, tax It includes financial accounting, cost accounting
planning and tax accounting. tax planning and tax accounting.

8. Period of It is concerned with short-term planning It is concerned with short range and long range
planning planning and uses techniques like sensitivity
analysis, probability structure etc. Its special field is
evaluation of capital investment projects.
9. Assistance It merely assists the management in its It assists and evaluates the management
functions. performance.

10. It is historical in its approach It is futuristic in its approach

Approach

11. It can be installed without management It needs financial and cost accounting as its base
Installation for its installation.

Scope (or Functions) of cost Accountancy

The scope of cost accountancy is very wide and includes the following:

(i) Cost Ascertainment:

It deals with the collection and analysis of expenses, the measurement of production of the different product at the
different stages of manufacture and the linking up of production with the expenses. In fact, the varying procedures

220 FUNDAMENTALS OF ACCOUNTING

for the collection of expenses give rise to the different systems of costing as Historical or Actual costs, Estimated
costs, standard costs etc. Again the varying procedures for the measurement of production have resulted in
different methods of costing such as specific order costing operation costing etc. For linking up of production with
the expenses the different techniques of costing such as marginal cost technique, the total cost technique, direct
cost technique etc., have been evolved. All the three i.e. system, methods and techniques can be used in one
concern simultaneously.

(ii) Cost Accounting:

It is the process of accounting for cost which begins with recording of expenditure and ends with the preparation
of statistical data. It is formal mechanism by means of which costs of products or services are ascertained and
controlled. Cost accounting is helpful to the management in decision making. Decision making requires, apart
from other information, cost information which is provided by cost accounting. Cost can be ascertained either by
following the historical or predetermined system of costing. Cost can be predetermined either by standard costing
or estimated costing. If the cost and financial accounts are kept separately then their reconciliation is also to be
done in order to verify the accuracy of both sets of accounts.

(iii) Cost control:

Cost control is the guidance and regulation by executive action of the costs of operating an undertaking. It aims
at guiding the actual towards the line of targets: regulates the actual if they deviate or vary from the targets:
this guidance and regulation is done by an executive action. The cost can be controlled by standard costing,
budgetary control, proper presentation and reporting of cost data and cost audit.

Objectives of Cost Accounting:

The objectives of cost accounting are ascertainment of cost, fixation of selling price, proper recording and
presentation of cost data to management for measuring efficiency and for cost control. The aim is to know the
methods by which expenditure on materials, wages and overhead is recorded, classified and allocated so that the
cost of products and services may be accurately ascertained; these costs may be related to sales and profitability
may be determined. Yet with the development of business and industry, its objectives are changing day by day.
Following are the main objectives of cost accounting:

(a) To ascertain the cost per unit of the different products manufactured by a business concern.
(b) To provide a correct analysis of cost both the process or operations and by different elements of cost.
(c) To disclose sources for wastage whether of material, time or expenses or in the use of machinery, equipment
and tools and to prepare such reports which may be necessary to control such wastage.
(d) To provide requisite data and serve as a guide to price fixing of products manufactured or services rendered.
(e) To ascertain the profitability of each of the products and advise management as to how these profits can be
maximized.
(F) To exercise effective control of stocks of raw material, work-in-progress, consumable stores and finished goods
in order to minimize the capital locked up in these stocks.
(g) To reveal sources of economy by installing and implementing a system of cost control for materials, labour
and overheads.
(h) To advise management on future expansion policies and proposed capital projects.
9i) To present and interpret data for management planning, decision-making and control.
(i) To help in the preparation of budgets and implementation of budgetary control.
(k) To organize an effective information system so that different levels of management may get the required
information at the right time in right form for carrying out their individual responsibilities in an efficient manner.
(l) To guide management in the formulation and implementation of incentive bonus plans based on productivity
and cost savings.
(m) To supply useful data to management for taking various financial decisions such as introduction of new
products, replacement of labour by machine etc.
(n) To help in supervising the working of punched card accounting or data processing through computers.
(o) To organize the internal audit system to ensure effective working of different departments.

FUNDAMENTALS OF ACCOUNTING 221

 (p) To organize cost reduction, programmers with the help of different departmental managers.
(q) To provide specialized services of cost audit in order to prevent the errors and frauds and to facilitate
prompt and reliable information to management.
(r) To find out costing profit or loss by identifying with revenues the costs of those products or services by selling
which the revenues have resulted.

Broadly speaking, the above objectives can be re-grouped under the following three heads:
(a) Ascertainment and analysis of cost and income by product, function and responsibility.
(b) Accumulation and utilization of cost data for control purposes to have the minimum possible cost consistent
with maintenance of quality. This objective is achieved through fixation of targets, ascertainment of actual,
comparison of actual with targets, analysis of reasons of deviations between actual and targets and reporting
deviations to management for taking corrective action.
(c) Providing useful data to management for taking decisions.

Advantages of Cost Accounting

The main advantages of cost accounting are given below:

1. Profitable and unprofitable activities are disclosed and steps can be taken to eliminate or reduce those
activities from which little or no benefit is obtained or to change the method of production in order to make
such activities more profitable.
2. It enables a concern to measure the efficiency and then to maintain and improve it. This is done with the help
of valuable data made available for the purpose of comparison. For example, if material spent upon a pair
of shoes in 2015 comes to ` 560 and for a similar pair of shoes the amount is ` 600 in 2016, the increase may
be due to increase in prices of material or more wastage in the use of materials of inefficiency at the time of
buying or unnecessarily high prices paid.
3. It provides information upon which estimates and tenders are based. If case of big contracts or jobs, quotations
cannot be given unless the cost of completing the contracts can be found out.
4. It guides future production policies. It explains the cost incurred and profit made in various lines of business
and processes and thereby provides data on the basis of which production can be appropriately planned.
5. It helps in increasing profits by disclosing the sources of loss or waste and by suggesting such controls so that
wastages, leakages and inefficiencies of all departments may be detected and prevented.
6. It enables a periodical determination of profits or losses without resort to stock taking.
7. It furnishes reliable data for comparing costs in different periods, for different volumes of output, in different
departments and processes and in different establishments, this helps in maintaining costs at the lowest point
consistent with the most efficient operating conditions.
8. The exact cause of a decrease or an increase in profit or loss can be detected. A concern may suffer not
because the cost of production is high or prices are low but also because the output is much below the
capacity of the concern. This fact is revealed by cost accounts only.
9. Cost Accounting discloses the relative efficiencies of different workers and thereby facilitates the introduction
of suitable plans of wage payment to reward efficiency and to provide adequate incentive to the less efficient
worker ` A goods system of costing promotes propriety of the business and thus ensures greater security of
service and adequate reward to workers.
10. It enables the creditors and investors to judge the financial strength and credit worthiness of the business. A
sound business concern with a goods system of costing can attract more investors than a similar concern
without an adequate system of costing.
11. Helpful to the Government. It facilitates the assessment of exercise duty and income tax and the formulation
of policies regarding industry, export, import, taxation etc. it also facilitates the preparation of national plans
for economic development. It provides ready figures for use by the Government for application to problems
like price fixation, price control, tariff protection wage level fixation, payment of dividends or settlement of
disputes.
12. Helpful to consumers. The ultimate aim of costing is to reduce cost of production to the minimum and maximize
the profits of the business. A part of the benefit resulting from the reduction of the cost is usually passed on to

222 FUNDAMENTALS OF ACCOUNTING

 consumers in the form of lower prices. Besides, the installation of a costing system will infuse confidence in the
minds of the public about the fairness of the prices charged.
13. Efficiency of public enterprises:
Costing has a more important role to play in public enterprises than in private enterprises. In public enterprises,
primary objective is not to raise profit but it is to serve the society by providing quality goods at cheaper rates.
Therefore, whatever limited information the usual profit and loss account can give in case of private enterprise, is
not available in case of a public enterprise. The efficiency of a public sector can be best judged by comparing
its cost of production with the cost of production of its counterpart in the private sector. Public enterprises lack
the personal initiative and interest of private enterprises. A good system of costing ensures efficient and effective
control through a proper analysis of their working. It provides for graded financial control over expenditure and
avoids conflict of authority. It measures efficiency and profitability of the undertaking to justify its running in the
public sector. It helps management in fixing a reasonable selling price for the products manufactured or services
rendered.

Cost Accounting Standards:

CAS Title
1 Classification of Cost
2 Capacity Determination
3 Overheads
4 Captive Consumption
5 Average (equalized) Cost of Transportation
6 Material Cost
7 Employee Cost
8 Cost of Utilities
9 Packing Material Cost
10 Direct Expenses
11 Administrative Overheads
12 Repairs & Maintenance Cost
13 Cost of Service Cost Centre
14 Pollution Control Cost
15 Selling and Distribution Overheads
16 Cost Accountings Standard on Depreciation and Amortisation
17 Cost Accountings Standard on Interest and Financing Charges
18 Cost Accountings Standard on Research and Development Costs
19 Cost Accountings Standard on Joint Costs
20 Cost Accountings Standard on Royalty and Technical Know-How Fee
21 Cost Accountings Standard on Quality Control
22 Cost Accountings Standard on Manufacturing Cost
23 Cost Accounting Standard on Overburden Removal Cost
24 Cost Accounting Standard on Treatment of Revenue in Cost Statement
Costing – An Aid to Management
Planning, decision- making and control are three important functions of management. It is desirable to have a brief
discussion of these functions.

Planning:
Planning is thinking in advance i.e. looking ahead and deciding in advance what to do, how to do it, when to
do it and who is to do it. In planning, management is concerned with laying down objectives and determining

FUNDAMENTALS OF ACCOUNTING 223

the courses of actions to be followed out of the several alternatives available to achieve those objectives. Thus,
planning is concerned with future activity and formulates budgets to meet the objectives of the organization.

Decision Making:
Since management has to make a choice of one course of action out of the several alternative courses of action
available, it involves decision-making. All rational decisions are based on accounting information. Decisions may
relate to various problems like (i) fixation of price (ii) whether or not price should be reduced for increased level
of sales (iii) whether a change in production should be followed (iv) whether or not factory should operate at full
capacity (v) determination of the most profitable levels or production (vi) whether to make or buy a spare part (vii)
whether a new product should be introduced in the market (viii) whether the product should be exported or not (ix)
whether a particular market should be tapped or not (x) whether a product should be discontinued to avoid the
present loss and (xi) whether or not an investment in a particular asset will be worthwhile.

Controlling:
Controlling is that part of the management activity whereby managers compare actual performance against the
planned performance, find out the deviations and take remedial steps to remove the deviations. Immediate action
should be taken to remove the deviations to make an improvement in the performance because promptness is the
essence of an effective control. Thus, control helps correction. Planning and controlling are interlinked with each
other because a manger cannot control unless he has planned a course of action.
The above functions of management cannot be satisfactorily carried out by financial accounting because of its
limitations. Cost accounting is very helpful in performing the functions of planning decision-making and controlling
effectively.
Cost accounting helps management in carrying out efficiently its functions (i.e. planning budgeting, decision –
making, organizing, control, pricing and evaluation of operating efficiency) by developing practical cost procedures
that provide information useful in controlling the operations of the business enterprise. Cost accounting does this
by analyzing, recoding, standardizing, forecasting, comparing, reporting and recommending. Cost accounting
methods supply the basis of factual information on which management can build up it s presentation of planning
and control. In fact, cost accounting is so closely allied to management that it is difficult to indicate where work of
cost accountant ends and managerial control begins. To quote blocker and weltmet, “In general, it may be said
that cost accounting is to serve management in the execution of policies and in the comparison of actual and
estimated results in order that the value of each policy be appraised and changed to meet future conditions.”

A good system of cost accounting serves management in the following ways:

(a) Classification and sub-divisions of costs:

Costs are collected and classified by various ways in order to provide information to the management for control
purposes and to ascertain the profitability of each area of activity. It enables a concern to measure the efficiency,
and then to maintain and improve it. Unprofitable activities are disclosed and steps can be taken to make an
improvement in those activities.

(b) Control of Materials, Labour and overhead costs”

An efficient check is provided on stores and materials, stores ledger and material Abstracts are maintained which
provide an effective check on the stores and material used in a business. BY adopting the maximum limit for stores
the total capital outlay is controlled and total financial loss due to over-stocking is obviated. Information of stock of
various materials and stores is constantly available. This helps in planning the production according to availability
of materials and fresh stocks can be arranged in time. Loss due to carelessness or pilferage or any other mischief
is detected and steps may thereof, be taken to minimize such loss in future. An efficient check on labour and
machines is provided by giving detailed information about the availability of machine and labour capacity. The
work is so planned that no section is over – worked and no section remains idle. The maintenance of time and
job cards for workers discloses the loss incurred by idle time and indicates the directions in which losses may be
minimized. The relative advantages of remunerating labour on the time or piece work or premium plans may be
ascertained. It also measures the efficiency of the wages system in use. Cost Accounting thus provides a detailed
control of materials and stores and labour costs. Various techniques of materials control are applied in order to
avoid the excessive locking up of capital in stock of materials and stores. Idle time should be kept as low as possible.
By having proper classification of overheads into controllable and uncontrollable or fixed and variable, it helps to

224 FUNDAMENTALS OF ACCOUNTING

control the overhead costs.

(c) Business policies:

Business policy may require the consideration of alternative methods and procedures and this is facilitated by cost
information correctly presented. For example, by the aid of cost reports management can be decide whether
the manufacture of certain products increases overhead expenditure disproportionately or whether to treat by –
product even at a loss to make possible a more important trade in another product. Thus, it helps the management
to take vital decisions such as introduction of a new product, selection of a most profitable product mix, utilization of
spare capacity, exploration of additional market, whether to make or buy, problem of limiting factor, replacement
of existing assets, appraisal of proposed investment to meet expansion programme etc. with the help of marginal
costing techniques and differential cost analysis.

(d) Budgeting:
It provides the use of budgets and performance reports and enables management to correct inefficiencies before
they enter into business. It is a co-ordinate plan of action of every responsible person for comparing the actual
results with the budgets. Two important cost accounting tolls for helping managers are budgets and performance
reports. Budgets are financial and/or quantitative statements prepared and approved prior to a defined period of
time, of the policies to be pursued during that period for the purpose of attaining objectives of the management.
Thus, budgets are the formal quantifications of the plans of management. Performance reports measure actual
performance and give accounts of comparisons of budgets with actual results which facilitate action against those
persons whose performance is less than the performance specified in the budgets. The technique of control through
performance reports is technically known as management by exception, which is the practice of concentrating
on areas whose performance is not upto the mark as it was planned and ignoring areas that are running smoothly
as these were planned.

(e) Standards for measuring efficiency:

It provides the use of standards to assist management in making estimates and plans for future and to provide
the basis of management o efficiency. Actuals are compared with predetermined standards to determine the
operating efficiency.

(f) Best use of limited resources:

In all varied fields we are concerned to make the best use of limited resources that are available to us. Thus the
intension is to obtain the maximum output from a given input. Cost Accounting provides the reliable data of costs
with regard to materials, wages and other expenses. These help management to get maximum output at the
minimum cost by indicating where economies may be affected, waste eliminated and efficiency increased; some
of the loss occasioned by reduced turnover and falling prices may be avoided.

(h) Instrument of Management Control:

It provides management with valuable data for planning, budgeting and control of costs. The organization and
management or undertaking must be planned and controlled in such a way that the desired volume of production
is achieved at the least possible cost in relation to the scheduled quantity of the product. The measurement of the
degree to which this objective is attained, is provided by cost accounting. An efficient system of cost accounting
is, thus, regarded as an important part in the efforts of any management to secure business stability.

(i) Cost Audit:

The operation of a system of cost audit in the organization will assist in prevention of errors and frauds. It will
help to improve cost accounting methods and techniques to facilitate prompt and reliable information to the
management.

(i) Special Factors:

It informs the management about the special factors such as optimum profitability, seasonal variations in volume
and costs, idle time of labour and idle capacity of the machine etc. It also helps to curtail the losses during the off
season.

FUNDAMENTALS OF ACCOUNTING 225

(j) Price Determination:
It helps the management to fix the remunerative selling prices of various items of goods in different circumstances
During the period of depression a businessman has to become very watchful and vigilant in tracking down the
concealed in efficiencies and sources of wastage, so that he may reduce the cost of production to the minimum.
He has to resort to price cutting to such an extent so as to recover variable costs. Cost accounting makes a
distinction between fixed and variable costs and helps the business mean in the determination of prices in the
depression period. The fixation of prices cannot be properly done unless proper figures of cost are available, If
prices are fixed without costing information, it is possible, that prices quoted may be too high to low. In periods of
depression, it may become necessary to reduce the prices even below total cost. It is only costing which will guide
the businessmen in this matter.

(k) Expansion:
Management is able to formulate expansion policy on the basis of estimates of cost for production at various levels
provided by cost accountant.

Characteristics of an Ideal Costing System:

An ideal system of costing is that which achieves the objectives of a costing system and brings all advantages of
costing to the business. Following are the main characteristics which an ideal system of costing should possess or
the points which should be taken into consideration before installing costing system.

i) Suitability to the business: A costing system must be devised according to the nature, conditions, requirements
and size of the business. Any system which serves the purposes of the business and supplies necessary information
for running the business efficiently is an ideal system.
ii) Simplicity: the system of costing should be simple and plain so that it may be easily understood even by a person
of average intelligence. The facts, figures and other information provided by cost accounting must be presented in
the right form at the right time to the right person in order to make it more meaningful.
iii) Flexibility: the system of costing must be flexible so that it may be changed according to change conditions
and circumstances. The system without such flexibility will be outmoded because of fast changes in business and
industry. Thus, the system must have the capacity of expansion or contraction without much change.
iv) Economical: A costing system is like other economic goods. It costs money just like economic goods. If the
system is too expensive, the management may be unwilling to pay as buyers are not willing to pay for the goods if
these are expensive as compared to their utility. A costing system should not be expensive and must be adapted
according to the financial capacity of the business. The benefits to be derived from the system must be more
than its costs as management will be willing to install the system when its perceived expected benefits exceed its
perceived expected costs. In short, the system must be economical taking into consideration the requirements of
the business.
v) Comparability: The costing system must be such so that it may provide facts and figures necessary to the
management for evaluating the performance by comparing it with the past figures, or figures of other concern or
against the industry as a whole or other department of the same concern.
vi) Capability of presenting information at the desired time: The system must provide accurate and timely information
so that it may be helpful to the management for taking decisions and suitable action for the purpose of cost control.
vii) Minimum changes in the existing setup: The existing system of delegation and division of authority and
responsibility must not be disturbed with the costing system. As for as possible the system must be such so that it may
least disturb the existing organizational set up.
Viii) Uniformity of forms: All forms and Performa’s etc. necessary to the system should be uniform in size and quality of
paper. Higher efficiency can be obtained by using colour of the paper to distinguish different forms. Printed forms
should contain instructions as to their use and disposal.
ix) Maximum clerical work: The filling of the forms by foremen and workers should involve little clerical work as
possible as most of workers are not well educated. To ensure reliable statistics, every original entry should be
supported by an examiner’s signatures.
x) Efficient system of material control: there should be an efficient system of stores and stock control as materials
usually account for a greater proportion of the total cost

226 FUNDAMENTALS OF ACCOUNTING

xi) Adequate wage procedure: There should be a well defined wage procedure for recording the time spent by
workers on different jobs, for preparing the wage sheets and for the payment of wages, thus the introduction of well
defined wage system will help to control the cost of labour.
xii) Departmentalization of expenses: A sound plan should be devised for the collection, allocation, apportionment
and absorption of overheads in order to ascertain the cost accurately.
xiii) Reconciliation of cost and financial accounts: If possible the cost and financial accounts should be interlocked
into one integral accounting scheme. If this is not possible the systems should be so devised that the two sets of
accounts are capable of easy reconciliation.
xiv) Duties and responsibilities of the cost accountant: Under a good system of cost accounting the duties and
responsibilities of the cost accountant should be clearly defined. The cost accountant should have access to all
works and departments.

4.2 CLASSIFICATION OF COST

1. By nature or element
- Materials
- Labour
- Expenses

2. By Functions
- Manufacturing and Product Cost
- Commercial Cost

3. By Degree of traceability to product

- Direct Cost
- Indirect Cost

4. By changes in Activity or volume

- Fixed Cost
- Variable Cost
- Semi Variable Cost

5. By controllability
- Controllable Cost
- Un controllable Cost

6. By Normality
- Normal Cost
- Abnormal Cost

7. By Relationship with accounting period

- Capital Cost
- Revenue Cost

8. By Time
- Historical Cost
- Pre-determined Cost

FUNDAMENTALS OF ACCOUNTING 227

9. According to planning
- Budgeted Cost
- Standard Cost

10. By Association with the product

- Product Costs
- Period Costs

11. For Managerial decisions

- Marginal Cost
- Out of pocket Cost
- Differential Cost
- Sunk Cost
- Imputed or Notional Cost
- Opportunity Cost
- Replacement Cost

Now each classification will be discussed in detail.

1. By Nature or Elements or Analytical classification:

According to this classification, the costs are divided into three categories i.e., Materials, Labour and expenses.
There can be further sub classification of each element: For example, material into raw material components, spare
parts, consumable stores, packing material etc. This classification is important as it helps to find out the total cost,
how such total cost is constituted and valuation of work-in-progress.

2. By Functions (i.e., Functional classification).

According to this classification costs are divided in the light of the different aspects of basic managerial activities
involved in the operation of a business undertaking. It leads to grouping of costs according to the broad divisions
or functions of a business undertaking i.e., production, administration, selling and distribution, According to this
classification costs are divided as follows:

Manufacturing and production cost:

This is the total of costs involved in manufacture construction and fabrication of units of production.

Commercial cost:
This is the total of costs incurred in the operation of a business undertaking other than the cost of manufacturing and
production. Commercial cost may further be sub-divided into.
(a) Administrative cost, and
(b) Selling and distribution cost.
These terms will be explained in a subsequent chapter

3. By degree of Traceability to the product (Direct and Indirect):

According to this classification, total cost is divided into direct costs and indirect costs. Direct costs are those which
are incurred for and may be conveniently identified with a particular cost centre or cost unit. Materials used and
labour employed in manufacturing an article or in a particular process of production are common examples of
direct costs. Indirect costs are those costs which are incurred for the benefit of number of cost centers or cost units
and cannot be conveniently identified with a particular cost centre or cost unit. Examples of indirect costs include
rent of building, management salaries, machinery depreciation etc. The nature of the business and the cost unit
chosen will determine which costs are direct and which are indirect. For example, the hire of a mobile crane for
use by a contractor at site would be regarded as a direct cost but if the crane is used as a part of the services of a
factory, the hire charges would be regarded as indirect cost because it will probably benefit more than one cost

228 FUNDAMENTALS OF ACCOUNTING

centre. The importance of the distinction of costs into direct and indirect lies in the fact that direct costs of a product
or activity can be accurately determined while indirect costs have to be apportioned on certain assumptions as
regards their incidence.

4. By changes in Activity or volume:

According to this classification, costs are classified according to their behavior in relation to changes in the level of
activity or volume of production. On this basis, costs are classified into three groups’ viz., fixed, variable and semi-
variable.

(i) Fixed costs:

Fixed costs are commonly described as those which remain fixed in total amount with increase or decrease in the
volume of output or productive activity for a given period of time. Fixed cost per unit decreases as production
increase and increases as production declines. Examples of fixed costs are rent, insurance of factory building,
factory manager’s salary etc. These fixed costs are constant in total amount but fluctuate per unit as production
changes. These costs are known as period costs because these are dependent on time rather than on output. Such
costs remain constant per unit of time such as factory rent of ` 10,000 per month remaining same for every month
irrespective of output of every month.

Classification of Fixed costs:

(a) Committed costs:
These costs are the result of inevitable consequences of commitments previously made or are incurred to maintain
certain facilities and cannot be quickly eliminated. The management has little or no discretion in such type of costs
e.g., rent, insurance, depreciation on building or equipment purchased.

(b) Policy and Managed costs:

Policy costs are incurred for implementing some management policies as executive development, housing etc.
and are often discretionary. Managed costs are incurred to ensure the operating existence of the company e.g.,
staff services.

(c) Discretionary costs:

These costs are not related to the operation but can be controlled by the management. These costs arise from
some policy decisions, new researches etc. and can be eliminated or reduced to a desirable level at the discretion
of the management.

(d) Step Costs:

Such costs are constant for a given level of output and then increase by a fixed amount at a higher level of output.

(ii) Variable costs:

Variable costs are those which vary in total in direct proportion to the volume of output. These costs per unit remain
relatively constant with changes in production. Thus, variable costs fluctuate in total amount but tend to remain
constant per unit as production activity changes. Examples are direct material costs, Direct labour costs, Power,
repairs etc., Such costs are known as product costs because they depend on the quantum of output rather than
on time.

(iii) Semi-variable costs:

Semi-variable costs are those which are partly fixed and partly variable. For example, telephone expenses include
a fixed portion of monthly charge plus variable according to calls; thus total telephone expenses are semi-variable.
Other examples of such costs are depreciation, repairs and maintenance of building and plant etc.

5. By Controllability:
Under this, costs are classified according to whether or not they are influenced by the action of given member of
the undertaking. On this basis costs are classified into two categories:

(i) Controllable costs are those which can be influenced by the action of a specified member of an undertaking,
that is to say, costs which are at least partly within the control of management. An organization is divided into a

FUNDAMENTALS OF ACCOUNTING 229

number of responsibility centers and controllable costs incurred in a particular cost centre can be influenced by
the action of the manger responsible for the centre. Generally speaking, all direct costs including direct materials,
direct labour and some of the overhead expenses are controllable by lower level of management.

(ii) Uncontrollable costs are those which cannot be influenced by the action of a specified member of an undertaking,
that is to say, which are not within the control of management. Most of the fixed costs are uncontrollable. For
example, rent of the building is not controllable and so is managerial salaries. Overhead cost, which is incurred by
one service section and is apportioned to another which receives the service, is also not controllable by the latter.

The distinction between controllable and uncontrollable is sometimes left to the individual judgment and is not
sharply maintained. It is only in relation to a particular level of management or an individual manager that we may
say whether a cost is controllable or uncontrollable. A particular item of cost which may be controllable from the
point of view of one level of management, may be uncontrollable from another point of view. Moreover, there may
be an item of cost which is controllable from long-term point of view and uncontrollable from short-term point of
view. This is partly so in the case of fixed costs.

6. By normality:
Under this, costs are classified according to whether these are costs which are normally incurred at a given level
of output in the conditions in which that level of activity is normally attained. On this basis, it is classified into two
categories.

(a) Normal cost:

It is the cost which is normally incurred at a given level of output in the conditions in which that level of output is
normally attained. It is a part of cost of production.

(b) Abnormal cost:

It is the cost which is not normally incurred at a given level of output in the conditions in which that level of output
is normally attained. It is not a part of cost of production and charged to costing profit and loss account

7. By relationship with accounting period (capital and revenue):

The cost which is incurred in purchasing an asset either to earn income or increasing the earning capacity of the
business is called capital cost, for example, the cost of a rolling machine in case of steel plant. Such cost is incurred
at one point of time but the benefits accruing form it is spread over a number of accounting years. If any expenditure
is done in order to maintain the earning capacity of the concern such as cost of maintaining an asset or running
a business it is revenue expenditure e.g., cost of materials used in production, labour charges paid to convert the
material into production, salaries, depreciation, repairs and maintenance charges, selling and distribution charges
etc. the distinction between capital and revenue items is important in costing as all items of revenue expenditure
are taken into consideration while calculating cost whereas capital items are completely ignored.

8. By Time.
Costs can be classified as (i) Historical costs and (ii) predetermined costs

(i) Historical costs:

The costs which are ascertained after being incurred are called historical costs. Such costs are available only when
the production of particular thing has already been done. Such costs are only of historical value and not at all
helpful for cost control purposes. Basic characteristics of such costs are:
(a) They are based on recorded facts.
(b) They can be verified because they are always supported by the evidence of their occurrence.
(c) They are mostly objective because they relate to happenings which have already taken place.

(ii) Predetermined costs:

Such costs are estimated costs i.e. computed in advance of production taking into consideration the previous
period costs and the factors affecting such costs. Predetermined cost determined on scientific basis becomes
standard cost. Such costs when compared with actual costs will give the reasons of variance and will help the
management to fix the responsibility and to take remedial action to avoid its recurrence in future.

230 FUNDAMENTALS OF ACCOUNTING

Historical costs and predetermined costs are not mutually exclusive but they work together in the accounting
system of an organization. In competitive age, it is better to lay down standards, so that after comparison with the
actual, management may be able to take stock of the situation of find out as to how far the standards fixed by it
have been achieved and take suitable action in the light of such information. Therefore, even in a system when
historical costs are used, predetermined costs have a very important role to play because a figure of historical cost
by itself has no meaning unless it is related to some other standard figure to give meaningful information to the
management.

9. According to Planning and Control:

Planning and control are two important functions of management. Cost accounting furnishes information to the
management which is helpful in the due discharge of these two functions. According to this, costs can be classified
as budgeted costs and standard costs.

Budgeted costs:
Budgeted costs represent an estimate of expenditure for different phases of business operations such as
manufacturing, administration, sales, research and development etc., coordinated in a well convinced framework
for a period of time in future which subsequently becomes the written expression of managerial targets to be
achieved. Various budgets are prepared for various phases, such as raw material cost budget, labour cost budget,
cost or production budget, manufacturing overhead budget, office and administration overhead budget etc.
continuous comparison of actual performance (i.e. actual cost) with that of the budgeted cost is made so as to
report the variations from the budgeted cost to the management for corrective action.

Standard costs:
Budgeted costs are translated in to actual operation through the instrument of standard costs. The chartered
Institute of Management Accountants, London defines “standard cost as the predetermined cost based on a
technical estimate for materials. Labour and overhead for a selected period of time and for a prescribed set of
working conditions”. Thus, standard cost is determination, in advance of production, of what should be the cost.

Budgeted costs and standard costs are similar to each other to the extent that both of them represent estimates for
cost for a period of time in future. In spite of this, they differ in the following aspects:

1. Standard costs are scientifically predetermined costs of every aspect of business activity whereas budgeted
costs are mere estimates made on the basis of past actual financial accounting data adjusted to future trends.
Thus, budgeted costs are projection, of financial accounts whereas standard costs are projection of cost accounts.

2. The primary emphasis of budgeted costs is on the planning function of management whereas the main thrust of
standard costs is on control because standard costs lay emphasis what should be the costs.

3. Budgeted costs are extensive whereas standard costs are intensive in their application. Budgeted costs
represent a macro approach of business operations because they are estimated in respect of the operations of
a department. Contrary to this, standard costs are concerned with each and every aspect of business operation
carried in a department. Thus budgeted costs deal with aggregates whereas standard costs deal with individual
parts which make the aggregate. For example, budgeted costs are calculated for different functions of the
business i.e., production, sales, purchases etc. whereas standard costs are compiled for various elements of costs
i.e., materials, labour and overhead.

10. By Association with the product:

Under this classification, cost can be product costs and period costs.

Product costs: are those costs which are traceable to the product and are included in inventory valuation. Product
costs are inventoriable costs and they become basis for product pricing and cost plus contracts. They comprise
direct materials, direct labour and manufacturing overheads in case of manufacturing concerns. These are used
for valuation of inventory and are shown in the balance sheet till they are sold because such costs provide income
or benefit only after sale. The product cost of goods sold is transferred to the cost of goods sold account.

Period costs are incurred on the basis of time such as rent, salaries etc. These may relate to administration with

FUNDAMENTALS OF ACCOUNTING 231

production and are necessary to generate revenue but cannot be assigned to a product. These are charged to
the period in which these are incurred and treated as expense.
The net income of concern is influenced by both product and period costs. Product costs are included in the cost
of production and do not affect income till it is sold. Period costs are charged to the period in which these are
incurred.

11. For Managerial Decision:

On this basis, costs may be classified into the following costs:

(i) Marginal cost:

Marginal cost is the total of variable costs i.e., prime cost plus variable overheads. It is based on the distinction
between fixed and variable costs. Fixed costs are ignored and only variable costs are taken into consideration for
determining the costs of products and value of work-in-progress and finished goods.

(ii) Out of pocket costs:

This is that portion of the costs which involves payment to outsiders i.e., gives rise to cash expenditure as opposed
to such costs as depreciation, which do not involve any cash expenditure. Such costs are relevant for price fixation
during recession or when make or buy decision is to be made.

(iii) Differential cost:

The change in costs due to change in the level of activity or pattern or method of production is known as differential
cost. If the change increases the cost, it will be called incremental cost. If there is decrease in cost resulting from
decrease in output, the difference is known as decremental cost.

(iv) Sunk cost:

A sunk cost is an irrecoverable cost and is caused by complete abandonment of a plant. It is the written down
value of the abandoned plant less its salvage value. Such costs are not relevant for decision-making and are not
affected by increase or decrease in volume. Thus, expenditure which has taken place and is irecoverable in a
situation, is treated as sunk cost. For taking managerial decision with future implications, a sunk cost is an irrelevant
cost. If a decision has to be made for replacing the existing plant, the book value of the plant less salvage value
(if any) will be a sunk cost and will be irrelevant cost for taking decision of the replacement of the existing plant.

(v)Imputed or notional costs:

Imputed costs and notional costs have the same meaning. The American, equivalent term of the British term
‘notional cost’ is imputed costs. These costs are notional in nature and do not involve any cash outlay. The chartered
Institute of Management Accountants, London, defines notional cost as “the value of a benefit where no actual
cost is incurred”. Even though such costs do not involve any cash outlay but are taken into consideration while
making managerial decisions. Example of such costs are: Notional rent charged on business premises owned by
the proprietor, interest on capital for which no interest has been paid. When alternative capital investment projects
are being evaluated it is necessary to considered the imputed interest on capital before a decision is arrived as to
which is the most profitable project.

(vi) Opportunity cost:

It is the maximum possible alternative earning that might have been earned if the productive capacity or services
had been put to some alternative use. In simple works, it is the advantage, in measurable terms, which has been
foregone due to not using the facility in the manner originally planned. For example, if an owned building is
proposed to be used for a project, the likely rent of the building is the opportunity cost which should be taken into
consideration while evaluating the profitability of the project. Similarly, if the fixed deposit in a bank is withdrawn for
financing a new project, the loss of interest on such fixed deposits is the opportunity cost.

(vii) Replacement cost:

It is the cost at which there could be purchase of an asset or material identical to that which is being replaced or
revalued. It is the cost of replacement at current market

232 FUNDAMENTALS OF ACCOUNTING

(viii) Avoidable and unavoidable cost:
Avoidable costs are those which can be eliminated if a particular product or department with which can be
eliminated if a particular product or department with which they are directly related, is discontinued. For example,
salary of the clerks employed in a particular department can be eliminated, if his department is discontinued.
Unavoidable cost is that cost which will not be eliminated with the discontinuation of a product of department. For
example, salary of factory manager or factor rent cannot be eliminated even if a product is eliminated.

Types of costing:
Following are the main types of costing for ascertaining costs:

1. Uniform costing:
It is the use of same costing principles and/or practice by several undertakings from common control or comparison
of costs.

2. Marginal costing:
It is the ascertainment of marginal cost by differentiation between fixed and variable cost. It is used to ascertain the
effect of changes in volume or type of output on profit.

3. Standard costing:
A comparison is made of the actual cost with a pre-arranged standard and the cost of any deviation (called
variance) is analyzed by causes. This permits the management to investigate the reasons for these variances and
to take suitable corrective action.

4. Historical costing:
It is ascertainment of costs after they have been incurred. It aims at ascertaining costs actually incurred on work
done in the past. It has a limited utility, though comparisons of costs over different periods may yield goods results.

5. Direct costing:
It is practice of charging all direct costs, variable and some fixed costs relating to operations, processes or products
leaving all other costs to b e written off against profits in which they arise.

6. Absorption costing.
It is the practice of charging all costs, both variable and fixed to probations, processes or products. This differs from
marginal costing where fixed costs are excluded.
Costing Methods and Techniques:-
Introduction:-
It is necessary to understand the difference between the costing methods and techniques. Costing methods are
those which help a firm to compute the cost of production or services offered by it. On the other hand, costing
techniques are those which help a firm to present the data in a particular manner so as to facilitate the decision
making as well as cost control and cost reduction. Costing methods and techniques are explained below.

Methods of costing: - The following are the methods of costing.

I. Job Costing: -
Job costing method is used in firms which work on the basis of job work. There are some manufacturing units which
undertake job work and are called as job order units. The main feature of these organizations is that they produce
according to the requirements and specifications of the consumers. Each job may be different from the other
one. Production is only on specific order and there is no predetermining production. Because of this situation, it is
necessary to compute the cost of each job and hence job costing system is used. In this system, each job is treated
separately and a job cost sheet is prepared to find out the cost of the job. The job cost sheet helps to compute the
cost of the job in a phased manner and finally arrives the total cost of production.

II. Batch Costing:

This method of costing is used in those firms where productions are made on continuous basis. Each unit coming
out is uniform in all respects and production is made prior to the demand i.e., in anticipation of demand. On batch

FUNDAMENTALS OF ACCOUNTING 233

of production consists of the units produced from the time machinery is set to the time when it will be shut down
for maintenance. For example, if production commences on 1st January 2015 and the machine is shut down for
maintenance on 1st April 2015, the number of units produced in this period will be the size of one batch. The total
cost incurred during this period will be divided by the number of units produced and unit cost will be worked out.
Firms producing consumer goods like television, air-conditioners, washing machines etc use batch costing.

III. Process Costing:

Some of the products like sugar, chemical etc involve continuous production process and hence process costing
method is used to work out the cost of production, The meaning of continuous process is that the input introduced
in the process I travels though continuous process before finished product is produced. The output of process I
becomes input of process II and the output of process II becomes input of the process III. If there is no additional
process, the output of process III will be the finished product. In process costing, cost per process is worked out and
per unit cost is worked out by dividing the total cost by the number of units. Industries like sugar, edible oil, Chemical
are examples of continuous production process and use process costing.

IV. Operating Costing:-

This type of costing method is used in service sector to work out the cost of services offered to the consumers. For
example, operating costing method is used in hospitals, power generating units, Transportation sector etc. A cost
sheet is prepared to compute the total cost and is divided by cost units for working out the per unit cost.

V. Contract Costing:-
This method of costing is used in construction industry to work out the cost of contract undertaken. For example,
cost of constructing a bridge, commercial complex, residential complex, highways etc is worked out by use of this
method of costing. Contract costing is actually similar to job costing, the only difference being that in contract
costing, one construction job may take several months or even years before they are complete while in job costing,
each job may be of a short duration. In contract costing, as each contract may take a long period of completion,
the question of computing of profit, it to be solved with the help of a well defined and accepted method.

Base for selection of suitable Costing method

1. Name of industry Method of costing

2. Sugar industry Process costing

3. Toy making Batch costing

4. Steel or cement Process costing

5. Bicycle manufacturing Multiple costing

6. Steel or cement Process costing

7. Aircraft manufacturing Multiple costing

8. Printing Job costing

9. Hospital Service/operating

10. Pharmaceuticals Process costing

11. Breweries Single unit (or ) output

12. Canteen Operating/service costing

13. House building Contract costing

14. Road transport Operating/service

234 FUNDAMENTALS OF ACCOUNTING

 15. Readymade garments Batch costing

16. Soft drinks Process costing

17. Coal Single unit or output

18. Oil refining Process costing

19. Brick kiln Single unit or output

20. Interior decoration Job costing

21. College Operating/service

22. Advertising Job costing

23. Soap industry Process costing

24. Electricity supply Operating/service

25. Foundries Job costing

26. video/audio manufacturing Multiple costing

27. Sub-assembling Operation costing

Technique of costing:-
As mentioned above, costing methods are for computation of the total cost of production/services offered by
a firm. On the other hand, costing technique help to present the data in a particular format so that decision
making becomes easy. Costing techniques also help for controlling and reducing the costs. The following are the
techniques of costing.

1. Marginal costing:-
This technique is based on the assumption that the total cost of production can be divided into fixed and variable.
Fixed costs remain same irrespective of the changes in the volume of production while the variable costs vary with
the level of production, i.e. they will increase if the production increases and decrease if the production decreases.
Variable cost per unit always remains the same. In this technique, only variable costs are taken into account while
calculating production cost. Fixed costs are not absorbed in the production units. They are written off to the costing
profit and loss account. The reason behind this is that the fixed costs are period costs and hence should not be
absorbed in the production. Secondly they are variable on per unit basis and hence there is not equitable basis
of charging them to products. This technique is effectively used for decision making in the areas like make or buy
decisions, optimizing of product mix, key factor analysis, fixation of selling price, accepting or rejecting an export
offer, and several other areas.

II. Standard costing:-

Standard costs are predetermined costs relating to material, labour and overheads. Though they are predetermined,
they are worked out on scientific basis by conducting technical analysis. They are computed for all elements of
costs such as material, labour and overheads. The main objective of fixation of standard cost is to have benchmark
against which the actual performance can be compared. This means that the actual costs are compared with the
standards. The difference is called as ‘variance’. If actual costs are more than the standard, the variance is adverse
which if actual costs are less than the standard, the variance is favorable. The adverse variances are analyzed and
reasons for the same are found out. Favorable variances may also be analyzed to find out the reasons behind the
same standard costing, thus is an important technique of cost control and reduction.

III. Budget and Budgetary control:-

Budget is defined as a quantitative and/ or a monetary statement prepared to prior to a defined period of time
for the policies during that period for the purpose of achieving a given objective. If we analyze this definition, it
will be clear that a budget is a statement, which may be either in monetary form or quantitative form or both. For

FUNDAMENTALS OF ACCOUNTING 235

example, a production budget can be prepared in quantitative form showing the target production, it can also
be prepared in monetary terms showing the expected cost of production. Some budgets can be prepared only
in monetary terms, e.g., cash budget showing the estimated receipts and payments in a particular period can
be prepared in monetary terms only. Another feature of budget is that it is also ways prepared prior to a defined
period of time which means that budget is always prepared for future and that to a defined future. For example, a
budget may be prepared for next 12 months or 6 months or even for 1 month, but the time period must be certain
and not vague. One of the important aspects of budgeting is that it lays down the objective to be achieved during
the defined period of time and for achieving the objectives, whatever policies are to be pursued are reflected in
the budget.

Budgetary control involves preparation of budgets and continuous comparison of actual with budgets so that
necessary corrective action can be taken. For example, when a production budget is prepared, the production
targets are laid down in the same for a particular period. After the period is cover, the actual production is compared
with the budget and the deviaiotn is found out so that necessary corrective action can be taken.
Budget and budgetary control is one of the important techniques of costing used for cost control and also for
performance evaluation. The success of the technique depends upon several factors such as support from top
management, involvement of employees and coordination within the organization.

Cost Unit
It is a device for the purpose of breaking up or separating cost into smaller sub-divisions attributable to products
and services. It is the unit of product, service or time in relation to which costs may be ascertained, e.g. tone in case
of coal. It must be clearly defined and selected before the process of cost finding can be started. It must not be
too big or too small and must be so selected that expenditure can be associated with it and is appropriate to the
needs of the business. In case of industries rendering service usually the unit is a compound of two measures since
the single measure may be meaningless.

Name of the industry Suitable cost unit

1. Steel making (or) cement industry Cost pr tone

2. Sugar industry Cost per quintal/tone

3. Textile industry Cost per meter

4. Cycle industry Cost per cycle

5. Hospital/nursing home Cost per bed per patient per days

6. Timber industry Cost per foot

7. Pharmaceutical Cost per strip/bottles of diff sizes

8. Brick manufacturing Cost per 1000 bricks

9. Chemical Cost per kg/ tone

10. Soft drinks Cost per case (24)/bottle of diff sizes

11. Aerated water (beer) Cost per liter/barrel

12. Furniture manufacturing Cost per article

13. Coal industry Cost per tonne

14. Confectionary Cost per kg

15. Good carrier/passenger Cost per passenger per km/

16. Hotel Cost per tonne per km

17. Canteen Cost per meal

236 FUNDAMENTALS OF ACCOUNTING

 18. Construction Cost per contract

19. Building Cost per sq. ft

20. Power manufacturing Cost kilowatt per hr.

21. Education Cost per student per year

22. Railways Cost per passenger per km

23. Automobile Cost per each item

24. Professional service Cost per hour

25. BPO services (call centers) Cost per account handled

26. Tele marketing Cost per customer call

27. Gas Cost per Cubic Foot

Cost center:
Common understood, cost centers are sub-units of an organization. We use the terms such as departments, divisions,
regions, and zones etc. that convey the same meaning of cost center. Correct identification of these sub-units is
essential for implementing cost accounting system as the costs are ascertained and controlled with respect to the
cost centers. Cost centers rare sometimes called as centers that add to costs of the organization and only indirectly
add to the profit of the organization.
The official terminology of CIMA defines a cost centre as “ a location, a person or an item of equipment for a group
of them) in or connected with an undertaking, in relation to which costs ascertained and used for the purpose of
cost control”.
(a) A cost centre could be a location or locations like a branch, office or MD’s office
(b) If could be identified as a person such as chairman’s office or Md’s office
(c) If could be equipment or a group thereof such as lathe machines, computers etc.,
(d) It may be a department carrying out a certain activity e.g., production departments like turning fitting,
welding, blending, assembly etc. The activity could be a service activity as well like a stores department,
labour office, accounts departments etc.,

When different responsibility centers are properly setup, cost collection and use of cons information for control
purposes can be done effectively.

Cost Control And Cost Reduction

Cost Control:
“Cost control is an important derivative of cost accounting. Modern business management not only must plan
for the future but also must constantly scrutinize the results of operations, so that, wherever possible, out-of-control
situations can be attacked and eliminated.”

Cost control is the application of management’s discretion to maintain cost within a specified limit. Control is a
management’s function, which aims at attaining management objectives with limited resources available. Cost
control means and includes establishment of standards with a view to assessing results by comparison against them.
It involves improving performance or efficiency to achieve the task assigned. It, therefore, involves:
i) Fixation of standards;
ii) Ascertaining actual results against the standards;
iii) Analysis of the variances; and
iv) Establishing the action that may be called for

Characteristics of a good Cost Control System

FUNDAMENTALS OF ACCOUNTING 237

According to backer and Jacobson an effective cost control is characterized by the following:
(a) Delineation of centres responsibility, i.e., deciding responsibility centres;
(b) Delegation of authority;
(c) Cost standards;
(d) Relevance of controllable cost;
(e) Cost reporting; and
(f) Cost reduction

Cost Reduction:
A cost reduction programme always endeavors to achieve a real and permanent reduction in cost. Cost reduction
starts where cost control ends. It is a challenge to the standard itself. The philosophy behind cost reduction is
that no item of expenditure is in such an idle level as to preclude reduction. By cost reduction is meant “real and
permanent” reduction in cost due to genuine savings in cost. It may mean either i) producing more at the existing
level of expenditure, or ii) producing at the existing level at reduced expenses.

Area of Cost Reduction:

i) Design of the product – Standardization and simplification of the product; this is the most important stage
for controlling and reducing cost, for once a design is approved and arrangements for production made,
choices available in the firm will be limited.
ii) Factory organization and production methods; and
iii) Marketing – points of distribution, transport, channels of distribution, etc.

Distinction between Cost Control and Cost Reduction:

A Cost control technique differs from a cost reduction programme in the sense that it does not accept standards
or budgets as yardstick, rather it always challenges them in order to make improvements.

In practice, however, both these will be working side by side so that it will be impossible to draw a line of demarcation.
Costs may be lower because of lower prices at which, say materials are available in the market; this is welcome
but hardly to feel satisfied at. Real cost reduction comes when a lower quantity of inputs is used per unit of output.
However, if one is able to maintain quality of output by using materials of lower quality or labour of lesser skill, and
thus effecting a saving in prices or wages paid, it will also be a case of real cost reduction.

Elements of cost:
Mere knowledge of total cost cannot satisfy the needs of management. For proper control and managerial
decisions, management is to be provided with necessary data to analyse and classify costs. For this purpose, the
total cost is analysed by elements of cost i.e., by the nature of expenses. Strictly speaking, the elements of cost are
three i.e., materials, labour and other expenses. These elements of cost are further analysed into different elements
as illustrated in the following chart.

Element of cost

Material Labour Other expenses

Direct Indirect Direct Indirect Direct Indirect

Overhead

Production or works Administration Selling overhead Distribution overhead

overheads overheads

238 FUNDAMENTALS OF ACCOUNTING

Now all these terms will be examined in detail one by one.

1. Direct Material:
Direct materials are those materials which can be identified in the product and can be conveniently measured and
directly charged to the product. Thus, these materials directly enter the production and form a part of the finished
product. For example, timber in furniture making, cloth in dress making and bricks in building a house. Following are
normally classified as direct materials:
(i) All raw materials like jute in the manufacture of gunny bags, pig iron in foundry, and fruits in canning industry.
(ii) Materials specifically purchased for a specific job, process or order like glue for book binding, starch powder
for dressing yarn.
(iii) Parts or components purchased or produced like batteries for transistor- radios and tyres for cycles.
(iv) Primary packing materials like cartons, wrappings, cardboard boxes, etc. used to protect finished product
from climatic conditions or for easy handling inside the factory.

From the above discussion it becomes clear that indirect materials are those materials which cannot be classified
as direct materials. Examples of indirect materials are: consumables, like cotton waste, lubricants, brooms, rags,
cleaning materials, materials for repairs and maintenance of fixed assets, high speed diesel used in power generators
etc.

Classification of materials into direct and indirect facilitates material control. Direct materials are usually high value
items as compared to indirect materials and need strict control and critical analysis for reducing their cost. On the
other hand, simple control techniques are sufficient in case of indirect materials being low value items.

However, in some cases, though the material is a part of the finished product yet it is not treated as direct material; for
example, sewing thread in dress making and nails in furniture making. This is because they are used in comparatively
small quantities and it would be futile elaboration to make an analysis of them for the purpose of direct charge.
Such materials are treated as indirect materials. Thus, it can be concluded that the ease and the feasibility with
which a material can be traced into the composition of a finished product will determine what is to be treated as
direct material.

2. Direct Labour:
Direct labour is all labour expended in altering the construction, composition, confirmation or condition of the
product. In simple words, it is that labour which can be conveniently identified or attributed wholly to a particular
job, product or process or expended in converting raw materials into finished goods. Wages of such labour are
known as direct wages. Thus, it includes payment made to the following groups of labour.
(i) Labour engaged on the actual production of the product or carrying out of an operation or process.
(ii) Labour engaged in aiding the manufacture by way of supervision, maintenance, tools setting transportation of
material etc.

Inspectors, analysts etc, specially required for such production.

Wages paid to supervisors, inspectors, etc., though not direct labour, can be treated as direct labour if they are
directly engaged on specific product or process and the hours they spend on it can be directly measured without
much of an effort. Similarly where the cost is not significant like the wages of trainees or apprentices, their labour
though directly spent on a product is not treated as direct labour.

3. Direct Expenses (or chargeable expenses)

All expenses which can be identified to a particular cost centre and hence directly charged to the centre are
known as direct expenses. In other words all expenses (other than direct materials and direct labour) incurred
specifically for a particular product, job, department etc. are called direct expenses. These are directly charged
to the product. Examples of such expenses are royalty, excise duty, hire charges of a specific plant and equipment
cost of any experimental work carried out specially for a particular job, travelling expenses incurred in connection
with a particular contract or job etc.

FUNDAMENTALS OF ACCOUNTING 239

4. Overheads
Overheads may be defined as the aggregate of the cost of indirect materials, indirect labour and such other
expenses including services as cannot conveniently be charged direct to specific cost units. Thus overheads
are all expenses other than direct expenses. In general terms, overheads comprise all expenses incurred for or in
connection with the general organization of the whole or part of the undertaking i.e., the cost of operating supplies
and services used by the undertaking and including the maintenance of capital assets. The main groups into which
overheads may be sub-divided are (i) manufacturing overheads; (ii) Administration overheads (iii) selling overheads
(iv) distribution overheads and (v) research and development overheads.

4.3 FORMAT OF COST SHEET

Cost sheet is a statement designed to show the output of a particular accounting period along with break-up of
costs. The data incorporated in cost sheet are collected from various statements of accounts which have been
written in cost accounts, either day-to-day or regular records.
There is no fixed form for preparation of a cost sheet but in order to make the cost sheet more useful it is generally
presented in columnar form. The columns are for the total cost of the current period, per unit for the current period,
total cost and per unit cost for a preceding period and total and per unit cost for the budget period and so on.
The information to be incorporated in a cost sheet would depend upon the requirement of management for the
purpose of control.

Advantage of cost sheet:

Main advantages of a cost sheet are:
1. It discloses the total cost and the cost per unit of the units produced during the given period
2. It enables a manufacturer to keep a close watch and control over the cost of production
3. By providing a comparative study of the various elements of current cost with the past results and standard
costs, it is possible to find out the causes of variations in cost and to eliminate the adverse factors and
conditions which go to increase the total cost
4. It acts as a guide to the manufacturer and help him in formulating a definite useful production policy
5. It helps in fixing up the selling price more accurately.
6. It helps the business man to minimize the cost of production, When there is a cut throat competition.
7. It helps the business to submit quotations with reasonable degree of accuracy against tenders for the supply
of goods.

The following items are not included in Cost Sheet

a) Income Tax

b) Dividends to shareholders

c) Premium on redemption of shares and debentures

e) Capital losses i.e., loss out of sales

f) Interest on loan or debentures or bank interest

g) Donations

h) Capital expenditure

i) Discounts on shares and debentures

j) Commission to managing directors

240 FUNDAMENTALS OF ACCOUNTING

k) Underwriting commission

l) Writing off goodwill and preliminary expenses

m) Reserve for bad debts

n) Transfer to all reserves or appropriation of profits

o) Share premium

p) Interest on capital

q) Drawing of proprietors

r) All personal expenses of owner

Format of Cost Sheet

Particulars Amount Amount
A. Direct Material opening stock
+ Purchases
+ Carriage inwards
- Closing stock
B. Direct wages
C. Direct Expenses
I. Prime cost (A+B+C)
D. Factory overheads- Indirect materials
Loose tools
Indirect wages
Rent and rates (Factory)
Lighting and heating (F)
Power and fuel
Repairs and Maintenance
Drawing office expenses
Research and experiment
Depreciation – plant (F)
Insurance – (F)
Work manger’s salary
II. Factory cost/works cost (I+D)
E. Office and Administrative Overheads
Rent and rates – office
Salaries – Office
Insurance of office building and equipments
Telephone and postage
Printing and stationery
Depreciation of furniture and office equipments
Legal expenses
Audit fees
Bank charges
III. Cost of production (II + E)
F. selling and distribution overheads

FUNDAMENTALS OF ACCOUNTING 241

 Showroom rent and rates
Sales men’s salaries and commission
Traveling expenses
Printing and stationery – sales department
Advertising
Postage
Collection expenses
Carriage outward
Depreciation of delivery van
Samples and free gifts
IV. Cost of sales (III+F)
V. Profits / loss
VI. sales (IV + V)

A glance at the above cost sheet will reveal that it works out the total cost of production/service in a phased
manner. In other words, total costs are segregated into elements like prime cost, Factory or works cost, cost of
production, cost of sales and finally the profit/loss in worked out by comparing the total cost with the selling price.
Appropriate adjustments are made for opening and closing stock of work in progress and opening and closing
stock of finished goods. The format of cost sheet may be suitably changed according to the requirements of each
firm but the basic form remains the same.

Illustration: 1.
From the following information, find out purchases.
Raw material consumed = `26,500.
Closing Stock = `4,500
Opening Stock = `3,000

Solution:
We Know, Raw Material Consumed = Opening Stock + Purchases – Closing Stock.
Purchases = Raw Material Consumed + Closing Stock – Opening Stock
= ` (26,500 + 4,500 – 3,000)
= ` 28,000.

Illustration: 2.
Prime Cost = `33,500, Depreciation = `1,500. Factory rent is 200% of Depreciation.
Find out the Factory Cost.

Solution:

Particulars `
Prime Cost 33,500
Add: Factory Overheads:
Depreciation 1,500
Factory Rent (`1,500 x 200%) 3,000
Factory Cost 38,000

Illustration: 3.
Cost of Sales = `37,416. Advertisement Expenses = `600. Discount on sales = 50% of advertisement Expenses. Find
Cost of Goods Sold.

242 FUNDAMENTALS OF ACCOUNTING

Solution:
We Know, Cost of Goods Sold + Selling and Distribution Overheads = Cost of Sales.
Both Advertisement Expenses and Discount on sales together constitutes Selling and Distribution Overhead

Particulars `
Cost of Sales 37,416
Less: Selling and Distribution Overheads
Advertisement Expenses 600
Discount on sales( 50% of `600) 300
Cost of Goods Sold 36,516
Illustration: 4.
Factory Cost is `3,95,000. Find Office and Administration overheads cost which is 7.315% of factory cost.

Solution:
Office and Administration Overheads = 7.315% of Factory Cost = 7.315% of `3,95,000 = `28,894.25.

Illustration 5.
Gross Factory Cost = `58,000. Net Factory Cost = `54,000.Opening stock of work-in- progress is `8,000. Find closing
stock of work-in-progress.

Solution:
Net Factory Cost = Gross Factory Cost + Opening Stock in WIP – Closing Stock in WIP
`54,000 = `58,000 + `8,000 – Closing Stock in WIP
Closing Stock in WIP = `66,000 - `54,000 = `12,000

Illustration: 6.
Prime Cost is `41,000. Direct labour cost consists of skilled labour `6,000 and unskilled labour `2,000.Variable works
overhead is 100% of direct wages and fixed works overhead is 60% of direct wages. Sale of scrap is `1,800. Find
works cost.

Solution:

Particulars `
Prime Cost 41,000
Works Overhead:
Add: Variable 100% direct wages 8,000
Add: Fixed 60% direct wages 4,800
Less: Sale of scrap (1,800)
Works Cost 52,000
Illustration 7.
From the information, prepare a statement showing expenses which you would disregard in estimating costs. Rent,
rates and insurance of office `2500, Bad Debt `200, Discount Allowed `300, Bank charges `100 and Donations `150.

Solution:

Expenses excluded from estimating cost `

Donations 150
Discount Allowed 300

FUNDAMENTALS OF ACCOUNTING 243

 Bad debt 200
Total 650

Illustration: 8.
Calculate the amount of direct material if:
Prime cost = `50,000. Direct labour = 70% of prime cost.

Solution:
Prime Cost = `50,000.
Direct Labour = 70% of prime cost = 70% of `50,000 = `35,000.
Direct Material = ` (50,000 – 35,000) = `15,000.

Illustration: 9.
Direct materials cost is `80,000. Direct labour cost is ` 60,000. Factory overhead is ` 90,000. Beginning goods in
process were ` 15,000. The cost of goods manufactured is ` 245,000. What is the cost assigned to the ending goods
in process?

Solution:
Particulars `
Direct Material 80,000
Direct Labour 60,000
Prime Cost 1,40,000
Add: Factory Overhead 90,000
Add: Opening WIP 15,000
Less: Closing WIP -
Cost of goods manufactured (given) 2,45,000
As cost of goods manufactured is given as `2,45,000 so there will be no closing goods in process.

Illustration 10.
Given data that:
Finished goods Opening Inventory ` 30,000
Finished goods Closing Inventory ` 50,000
Cost of goods sold ` 1,90,000
What will be the value of Cost of Production?

Solution:
We Know, Cost of Goods Sold = Cost of Production + Opening stock of finished goods – Closing stock of finished
goods.
Particulars `
Cost of Goods Sold 1,90,000
Add: Closing Stock of finished goods 50,000
Less: Opening stock of finished goods (30,000)
Cost of Production 2,10,000

Illustration: 11
Prepare a statement of cost from the following data to show material consumed, Prime cost, factory cost, Cost of
goods sold and profit.
1-1-2015(`) 31-12-2015(`)
Raw material 60,000 50,000

244 FUNDAMENTALS OF ACCOUNTING

 Work-in-progress 24,000 30,000
Finished goods 1,20,000 1,10,000
Purchase of materials during the year 9,00,000
Wages paid 5,00,000
Factory overheads 2,00,000
Administration overheads 50,000
Selling and distribution overheads 30,000
Sales 20,00,000

Solution:
Statement of cost and profit
Opening stock of raw materials 60,000
Add: purchase of raw materials 9,00,000
9,60,000
Less: Closing stock of raw materials 50,000
Materials consumed 9,10,000
Wages paid 5,00,000
Prime cost 14,10,000
Factory overheads 2,00,000
Add: opening stock or WIP 24,000
16,34,000
Less: closing stock of WIP 30,000
Factory cost 16,04,000
Administrative overheads 50,000
Add: opening stock of finished goods 1,20,000
17,74,000
Less: closing stock of finished goods 1,10,000
Cost of goods sold 16,64,000
Selling and distribution overheads 30,000
Cost of sales 16,94,000
Profit 3,06,000
Sales 20,00,000

Illustration: 12
From the following particulars, prepare cost statement showing the component of total cost and the profit for the
year ended 31st December, 2015.
1-1-2001(`) 31-12-2001(`)
Stock of finished goods 6,000 Stock of finished goods 15,000
Stock of raw materials 40,000 Stock of raw material 50,000
Work-in-progress 15,000 Work-in-progress 10,000
Purchase of raw materials 4,75,000 General expenses 32,500
Carriage inward 12,500 sales for the year 8,60,000
Wages 1,75,000 Income tax 500

FUNDAMENTALS OF ACCOUNTING 245

 Works manager’s salary 30,000 Dividend 1,000
Factory employees salaries 60,000 Debenture interest 5,000
Factory rent, taxes and 7,250 transfer to sinking fund for
Insurance
replacement of machinery 10,000
Power expenses 9,500 goodwill written off 10,000
Other production 43,000 payment of sales tax
expenses
Selling expenses 9,250
Solution:
Statement of Cost and Profit

` `
Opening stock of raw materials 40,000
Add: purchase of raw materials 4,75,000
5,15,000
Less: closing stock of raw materials 50,000
4,65,000
Add: Carriage inward 12,500
Materials consumed 4,77,500
Wages 1,75,000
Prime cost 6,52,500
Factory expenses:
Works manager’s salary 30,000
Factory employees salaries 60,000
Factory rent, taxes and insurance 7,250
Power expenses 9,500
Other production expenses 43,000
Opening work-in-progress 15,000 1,64,750
8,17,250
Less: closing work-in-progress 10,000
Works cost 8,07,250
General expenses 32,500
Cost of production 8,39,750
Add: opening stock of finished 6,000
goods
8,45,750
Less: opening stock of finished goods 15,000
Cost of goods sold 8,30,750
Selling expenses 9,250
Cost of sales 8,40,000
Profit 20,000
Sales 8,60,000

246 FUNDAMENTALS OF ACCOUNTING

Illustration: 13
Mr. Gopal furnishes the following data relating to the manufacture of a standard product during the month of April,
2015:
Raw materials consumed ` 15,000
Direct labour charges ` 9,000
Machine hours worked 900
Machine hour rate 5
Administrative overheads 20% on works cost
Selling overheads ` 0.50 per unit
Units produced 17,100
Units sold 16,000 at ` 4 per unit.
You are required to prepare a cost sheet from the above, showing: (a) the cost per unit (b) profit per unit sold and
profit for the period.

Solution:

STATEMENT OF COST

Total Per unit

Raw materials consumed 15,000
Direct labour charges 9,000
Prime cost 24,000
Factory expenses (900 hrs, @ ` 5 per hr) 4,500
Works cost 28,500
Administrative overheads (20% on works cost) 5,700
Cost of production 34,200 2.00
(` 34,200 ÷ 17,100)

Statement of profit

`
Cost of production of 16,000 units @ ` 2 per unit 32,000
Selling overheads @ 50 paise per unit for 16,000 units 8,000
Cost of sales 40,000
Profit for the period 24,000
Sales (16,000 units @ ` 4 unit) 64,000

Profit per unit sold = = `1.50

EXERCISE:

1. The following data relate to the manufacture of a standard product during the month of March, 2015.
Raw materials 80,000
Direct wages 48,000

FUNDAMENTALS OF ACCOUNTING 247

 Machine hours worked 8,000
Office overhead 10% on works cost
Machine hour rate `4
Selling overhead ` 1.50 p unit
Units produced 4,000
and sold @ ` 50 each 3,600

Prepare cost sheet

You are require to find out from the above showing a) Cost of Production per unit b) Profit per unit sold and profit
for the period.

Ans: a) `44 per unit b) `4.5 per unit, Profit `16,200

2. From the following particulars prepare a cost sheet showing the total cost per tone for the period ended
31st Dec. 2015.

` `
Raw Materials 33,000 Rent and taxes (office) 500
Productive wages 38,000 Water supply (works) 1,200
Unproductive wages 10,500 Factory insurance 1,100
Factory rent and taxes 7,500 Office insurance 500
Factory lighting 2,200 Legal expenses 400
Factory
24,000heating 1,500 Rent of warehouse 300
16,000
Motive power 4,400 Depreciation of
Haulage (works) 3,000 -Plant and machinery 2,000
Directors fees (works) 1,000 -Office building 1,000
Directors fees (office) 2,000 - Delivery vans 200
Factory cleaning 500 Bad debts 100
Sundry office expenses 200 Advertising 300
Estimating expenses(works) 800 Sales department’s salaries 1,500
Factory stationery 750 Upkeep of delivery vans 700
Office stationery 900 Bank charges 50
Loose tools written off 600 Commission on sales 1,500

The total output for the period has been 14,775 tonnes

Ans: Prime Cost `71,000, Factory Cost `1,08,050, Cost of Production `1,13,600, Total Cost `1,18,100, Cost per ton `8/-

Multiple choice questions:

1. The total cost incurred in the operation of a business undertaking other than the cost of manufacturing and
production is known as:
(a) direct cost (b) Variable cost (c) commercial cost (d) conversion cost
2. Which of the following is not a relevant cost?
(a) Replacement cost (b) Sunk cost (c) Marginal cost (d) standard cost
3. Process cost is very much applicable in:
(a) construction industry (b) pharmaceutical industry (c) Air line company (d) none of these
4. he main purpose of cost accounting is to:

248 FUNDAMENTALS OF ACCOUNTING

 (a) maximize profits, (b) help in inventory valuation
(c) provide information to management for decision making (d) Aid in the fixation of selling price
5. Opportunity cost is the best example of:
(a) sunk cost (b) Standard cost (c) relevant cost (d) irrelevant cost
6. Costs are classified into fixed costs, variable costs and semi-variable costs, it is known as
(a) functional classification (b) behavioral classification
(c) element wise classification (d) classification according to controllability
7. Which method of costing is used for determination of costs for printing industry?
(a) process costing (b) operating costing (c) batch costing (d) job costing
8. Over which of the following costs, management is likely to have least control
(a) wages cost (b) building insurance cost
(c) machinery breakdown cost (d) advertisement cost
9. Variable costs are fixed
(a) for a period (b) per unit (c) depends upon the entity (d) for a particular process of production
10. In behavioral analysis’, costs are divided into
(a) production and non-production costs (b) controllable and non-controllable costs
(c) direct and indirect costs (d) fixed and variable costs
11. Prime cost plus factory overheads is known as
(a) factory on cost (b) conversion cost (c) factory cost (d) marginal cost
12. Which of the following items is excluded from cost Accounts?
(a) Income tax (b) interest on debentures (c) cash discount (d) All of these
13. The following is included in financial accounts, but not in cost accounts.
(a) carriage and freight (b) Excise duty (c) Royalty (d) Dividend paid
14. Advertisements are treated as
(a) direct expenses (b) cost of production (c) selling overheads (d) distribution overheads
15. Which cost system description applies to the manufacture of 20 engraved doors for the new club house at a
golf course?
(a) contract (b) process (c) Batch (d) service
16. Prime cost may be correctly termed as
(a) the sum of direct material and labour cost with all other costs excluded.
(b) the total of all cost items which can be directly charged to product units.
(c) The total costs incurred in producing a finished unit.
(d) the sum of the large cost there in a product cost.
17. The guidance and regulation by executive action of the cost of operating an undertaking is said to be
(a) Budgetary control (b) cost control (c) cost analysis (d) None
18. Direct expenses are also known as
(a) Overhead expenses (b) process expenses (c) chargeable expenses (d) None
19. Indirect material cost is a part of
(a) Prime cost (b) Factory overhead (c) chargeable expenses (d) None of these
20. Which of the following is a part of both Prime cost and conversion cost
(a) Direct Material (b) Indirect Labour (c) Indirect Material (d) Direct Labour
21. Statement showing break-up of costs is known as
(a) cost-sheet (b) statement of profit (c) production account (d) Tender
22. The works cost plus administration expenses
(a) Total Cost (b) Cost of production (c) cost of sales (d) Factory cost
23. Directors remuneration and expenses form a part of
(a) Production overhead ( b) Administration overhead (c) Selling overhead (d)Distribution overhead

FUNDAMENTALS OF ACCOUNTING 249

24. Cost reduction is
(a) Long term phenomena (b) It challenges the standards
(c) It is carried out without compromising the quality (d) All of the above
25. Interest on own capital is
(a) Cash cost (b) Notional cost (c) Sunk cost (d) Part of Prime Cost

Ans: 1. c 2. b 3. b 4. c 5. c 6. b 7. d 8. d 9. b 10. d 11. c 12. d 13. d 14. c 15. c 16. b 17. b 18. c 19. b 20. d 21. a
22. b 23. b 24. d 25.b

Fill in the blanks:

1. Costing is a technique of __(ascertaining cost)
2. Cost accountancy is the science, art and ___ if a cost accountant.(practice)
3. Cost accounting serves the information needs of ____(Management.)
4. Cost accounting provides data for ____ decision making.(managerial)
5. Cost accounting has been developed because of ____of financial accounting. (Limitations)
6. The method of costing used in a refinery is ___(process.)
7. For the goods Transport Company ___ is the suitable cost unit.(per ton km)
8. The cost which does not change due to change in volume of production is called ___(fixed cost)
9. The semi- finished goods is also known as ____in cost accounting. (work-in-progress)
10. An item of cost that is direct for the business may be ____for another business.(indirect)
11. The total of all direct expenses is known as _____(prime cost)
12. All costs are ___controllable (not)
13. The aggregate of indirect material indirect labour and indirect expenses together is called ___ (overheads)
14. Factory overheads are also know as ____overheads.(works)
15. Chargeable expenses are an example ___cost.(direct)
16. ____cost are cost which are ascertained after they have been incurred. (Historical)
17. Any expenditure over and above prime cost is known as ___(overheads)
18. In ___the cost of a group of products is ascertained.(Batch Costing)
19. Cost accounting is a separate ___of accounting. (branch)
20. In automobile industry cost unit is ___(number.)
21. ____costs are partly fixed and partly variable in relation to output.(Semi variable)
22. Fixed cost per unit ____with increasing output. (decreases)
23. Wages of delivery van driver is a ___(Distribution Overhead.)
24. Cost accounting deal partly with facts and figures and partly with ____(estimates)
25. Cost accountant provides the detailed information about ____ of various products, processes services
and operations.(costs)

True or False:
1. Process costing method is suitable for coal industry (False)
2. Fixed cost per unit remains fixed but variable cost per unit vary with variation in output (False)
3. Financial accounts provide information for determination of profit or loss (True)
4. Cost accounts provide information for ascertainment of the financial position as on a particular date (false)
5. Cost accounting is an instrument of management control (True)
6. Service costing is used in industries producing goods (False)
7. In construction industry, contract costing is used (True)
8. The process of finding cost is costing (true)
9. Depreciation is an out of pocket cost (false)

250 FUNDAMENTALS OF ACCOUNTING

10. Variable cost per unit varies with increase or decrease in volume of output (false)
11. All costs are controllable (False)
12. Cash discount is excluded from cost sheet (true)
13. Finance expenses are included in cost sheet (False)
14. Discount to customer comes under “distribution cost” (false)
15. Variable overhead cost is a period cost (False)
16. In the cement industries the unit of cost is per tone (true)
17. Scrap is a residue which in a manufacturing process but has no recoverable value (false)
18. Contract costing us a basic method is specific order costing (True)
19. All the indirect cost related to indirect material, Indirect labour and indirect expenses are termed as
overheads (true)
20. Direct wages is a variable cost (True)
21. Historical costs are relevant costs for decision making (False)
22. Contract costing is based on job costing principles (True)
23. Cost accounting is an instrument of management control.(True)
24. Abnormal cost is controllable (True)
25. Fixed cost per unit decreases with rise in output and increases with fall in output (True)

Matching the following:

Business Cost unit

Group-I
1. Tele-marketing d (a) accounts handled
2. Power c (b) Chargeable Hours
3. BPO service a (c) Kilowatt hour
4. Professional service b (d) customer calls made

Group – II
1. Road transport company c (a) process
2. Chemical works a (b) job costing
3. Toy manufacturing d (c) operating costing
4. Interior decoration b (d) batch costing

Group – III
1. Total Fixed Cost c (a) Cost Control
2. Regulation of Cost a (b) What cost should be
3. Timber used in furniture making d (c) Remain constant in total
4. Standard Cost b (d) Direct Material

Group – IV
1. Ship building c (a) Service Costing
2. Readymade garments d (b) Job costing
3. Electric Supply Company a (c) Contract Costing
4. Printing Press b (d) Batch Costing

FUNDAMENTALS OF ACCOUNTING 251