B.Com. (Hons.) CBCS Semester - I FINANCIAL ACCOUNTING PAPER BCH-1.2 SHIV DAS & SONS Publishers & Book-Sellers SECTION A: THEORY UNIT I. ACCOUNTING AS AN INFORMATION SYSTEM Chapter 1. Accounting Theory Chapter 2. Accounting Concepts & Accounting Conventions Chapter 3. Accounting Standards and IFRS Chapter 4. Accounting Process UNIT II. BUSINESS INCOME Chapter 5. Measurement of Business Income Chapter 6. Revenue Concepts Chapter 7. Depreciation Chapter 8. Inventory Valuations Chapter 9. Preparation of Financial Statements For Not For Profit Organizations UNIT III. ACCOUNTING FOR HIRE PURCHASE & INSTALMENT SYSTEMS Chapter 10. Hire Purchase Systems UNIT IV. ACCOUNTING FOR INLAND BRANCHES Chapter 11. Concept of Dependent Branches UNIT V. ACCOUNTING FOR DISSOLUTION OF THE PARTNERSHIP FIRM Chapter 12. Accounting for Dissolution of the Partnership Firm SECTION B: PRACTICAL PROBLEMS (And their solutions) UNIT I. Accounting Process UNIT II. A. Depreciation B. Inventory Valuation C. Income And Expenditure Account UNIT III. Accounting For Hire Purchase & Instalment System UNIT IV. Accounting For Inland Branches UNIT V. Accounting For Dissolution of The Partnership Firm University Question Papers onwards SYLLABUS B.Com. (Hons.) Semester - 1 PAPER BCH-1.2: FINANCIAL ACCOUNTING Duration: 3 hours Objective. To acquire conceptual knowledge of financial accounting and to provide knowledge about the techniques for preparing accounts in different business organizations. Unit I: (a) Theoretical Framework. Accounting as an information system, the users of financial accounting information and their needs. Qualitative characteristics of accounting information. Functions, advantages and limitations of accounting. Branches of accounting. Basics of accounting; cash basis and accrual basis. The nature of financial accounting principles — Basic concepts and conventions; entity, money measurement, going concern, cost, realization, accruals, periodicity, consistency, prudence (conservatism), materiality and full disclosures. Financial accounting standards: Concept, benefits, procedure for issuing accounting standards in India. International Financial Reporting Standards (IFRS); Need and procedures, Convergence to IFRS. Distinction between Indian Accounting Standards (IND ASs) and Accounting Standards (AS). (b) Accounting Process. From recording of a business transaction to preparation of trial balance including adjustments: Capital and Revenue Expenditures & Receipts. Preparation of Profit & Loss Account and Balance Sheet (Sole Proprietorship only). (c) Computerized Accounting Systems Practical Lab Computerized Accounting Systems. Computerized Accounts by using any popular accounting software: Creating a Company; Configure and Features settings; Creating Accounting Ledgers and Groups; Creating Stock items and Groups; Vouchers Entry; Generating Reports-Cash Book, Ledger Accounts, Trial Balance, Profit and Loss Account, Balance Sheet, Funds Flow Statement, Cash Flow Statement, Selecting and shutting a Company; Backup and Restore data of a Company. Unit II: (a) Business Income. Measurement of business income-Net income; the accounting period, the continuity doctrine and matching concept, Objectives of income measurement. Revenue: Concept, Revenue recognition principles, Recognition of expenses. The nature of depreciation. The accounting concept of depreciation. Factors in the measurement of depreciation. Methods of computing depreciation: Straight line method and diminishing balance method; Disposal of depreciable assets — change of method. Inventories: Meaning, significance of inventory valuation, Inventory Record System; periodic and perpetual Methods; FIFO, LIFO and Weighted Average. (b) Preparation of financial statements of not for profit organization. Unit III. Accounting for Hire Purchase and Installment System Calculation of interest, partial and full repossession, Hire Purchase trading (total cash price basis), stock and debtors system. Concepts of operating and financial lease. Unit IV. Accounting for Inland Branches Concept of dependent branches; accounting aspects; debtors system, stock and debtors system, branch final accounts system and wholesale basis system, Independent branches, Concept — Accounting treatment: important adjustment entries and preparation of consolidated profit and loss account and balance sheet. Unit V. Accounting for Dissolution of the Partnership Firm Accounting for Dissolution of the Partnership Firm including Insolvency of partners, sale in a limited company and piecemeal distribution. Note: (i) The relevant Indian Accounting Standards in line with the IFRS for all the above topics should be covered. (ii) Any revision of relevant Indian Accounting Standard would become applicable immediately. (iii) There shall be 4 Credit Hours for Lectures + one Credit hour (Two Practical per week per batch) for Practical Lab + one credit hour for Tutorials (per group). (iv) Examination Scheme for Computerised Accounting System — Practical for 20 marks. The practical examination will be for 1 hour. (v) Theory Exam shall carry 80 marks. UNIT I Accounting As An Information System Chapter 1. ACCOUNTING THEORY Q. 1. Define accounting and explain the functions of accounting. Ans. Meaning of Accounting. Accounting may be defined as the process of collecting, recording, summarising and communicating financial information. Definition of Accounting. American Institute of Certified Public Accountants (AICPA) defined accounting in 1961 as follows: "Accounting B the art of recording, classifying and summarising, in a significant manner, and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof." From the above the following attributes of accounting emerge: (i) Identifying the financial transactions and events. (a) It is the art of recording business transactions. (iii) It is the art of classifying business transactions. (iv) The transactions or events of business must be recorded in monetary terms. (v) It is the art of summarising financial transactions. (vi) It is an art of analysis and interpretation of these transactions. (vii) The result of such analysis must be communicated to the persons who are to make decisions or form judgement. Functions of Accounting: Financial accounting performs the following functions: 1. Keeping Systematic records. Business transactions are properly recorded, classified and summarised into financial statements — Income Statement (i.e., Profit & Loss Account) and Balance Sheet. 2. Calculation of Profit or Loss. At the end of the accounting period, the income statement, i.e., Profit & Loss Account is prepared to calculate net profit or loss. This is done to know the results of the operations of the enterprise. 3. Ascertainment of financial position. 'Position statement, i.e., Balance Sheet is prepared as at last date of the accounting period to know the financial position of an organisation. 4. Communicating accounting information to the users. Accounting is used to provide financial information in respect of net profit/net loss, assets, liabilities etc., to the interested parties. 5. Meeting legal needs. The provision of various laws such as Companies Act, Income tax and Sales tax Act require the submission of various statements, i.e., annual accounts, income tax returns, returns for sales tax purpose and so on. Accounting system aims at fulfilling the requirement of law. 6. Protect business assets. Accounting keeps proper records of various assets and thus enables the management to exercise proper control over them. 7. Accounting assists the management in the task of planning, control and coordination of business activities. Q. 2. Distinguish between 'Book-keeping' and 'Accounting'. Ans. Book-keeping. Book-keeping is a part of accounting. It is concerned with the recording of business transactions in a systematic manner and classifying them in the ledger. It is mechanical and repetitive in nature. Accounting. Accounting may be defined as the process of collecting, recording, summarising and communicating financial information. Accounting is based on a careful and efficient book-keeping. In fact the process of accounting begins where that of book-keeping ends. Distinction between Book-keeping and Accounting Basis of Distinction Book-keeping Accounting 1. Scope Book-keeping involves: In addition to Bookkeeping, accounting is concerned with: • identifying the transactions; summarizing the classified transactions, analysis and • measuring the identified interpretation of summarized transactions; results and communicating the • recording the measured interpreted information to the transactions; and interested parties. • classifying the recorded transactions. 2. Stages Book-keeping is the primary Accounting is the secondary stage. stage. It begins where book- keeping ends. 3. Objective To maintain systematic To ascertain financial records of financial results. performance (Net Profit/ Net Loss) and financial position and to communicate financial information to various users. 4. Knowledge level The book-keeper is not required The accountant must have to have higher level of higher level of knowledge than knowledge than that of an that of book-keeper. accountant. 5. Who performs Book-keeping work is Accounting work is performed performed by junior staff. by senior staff. 6. Nature of Job The job of book-keeper is often The role of an accountant is routine and clerical in nature. analytical in nature. Q. 3. Write a short note on: Cash basis and Accrual basis of accounting. Ans. Basis of Accounting. For recording business transactions, there are two basis of accounting which are widely accepted: 1. Cash Basis of Accounting 2. Accrual Basis of Accounting 1. Cash Basis of Accounting. Under this basis of accounting actual cash receipt and actual cash payments are recorded. Credit transactions are not recorded at all. Income is merely the difference between the cash receipts and cash payments. Outstanding expenses, prepaid expenses, accrued income and income received in advance are not adjusted while calculating net profit. Cash basis of accounting is very simple as there is no need of adjusting outstanding expenses, prepaid expenses, accrued income and income received in advance. The main disadvantage of cash basis of accounting is that it does not give a true and fair view of the results of the operations of the enterprise. 2. Accrual Basis of Accounting. Under accrual basis of accounting net income for a period is the result of the revenue realised in the period and the cost expired during the year. Accrual basis of accounting is a method of recording transactions by which revenue, costs, assets and liabilities are reflected in the accounts for the period in which they occur. The accrual basis of accounting is widely used. Although this basis is not simple but it gives a true and fair view of the results of the operation's of the business and of financial position of the business. It is recognised by the Companies Act. Q. 4. Distinguish between Cash and Accrual Basis of Accounting. Ans. Distinction between Cash and Accrual Basis of Accounting Cash Basis of Accounting Accrual Basis of Accounting (i) In this: case only cash transactions are In this case both cash and credit transactions recorded. are recorded. (ii) Under this basis there is no outstanding or Under this basis there may be outstanding prepaid expenses and income accrued or expenses, prepaid expenses, accrued income received in advance in the Balance income and income received in advance in Sheet. the Balance Sheet. (iii) Income statement will show lower Income statement will show relatively income in case there are items of prepaid higher income if there are items of expenses and accrued income. prepaid expenses and accrued income. (iv) Income statement will show relatively Income statement will show relatively higher income if there are items of lower income if there are items of outstanding expenses and income received in outstanding expenses and income received advance. in advance. (v) This basis of accounting is simple because This basis of accounting is technical it does not require any technical knowledge. because it involves the adjustments of accounts for preparing the final accounts. (vi) It is not a reliable basis of It is a reliable basis of accounting because it makes a complete record of all cash and accounting because accurate profit or loss can credit transactions. It ascertains correct not be ascertained under this basis. profit or loss. (vii) This basis is not recognised under the This basis is recognised under the Companies Act, 2013. Companies Act, 2013. (viii) Under this method an accountant has Under this basis an accountant has the no such option to follow alternative method option of following alternative method of of depreciation or valuation of inventory. depreciation (i.e., SLM or DBM) or method of valuation of inventory (i.e., LIFO or FIFO etc.) Q. 5. Write a note on: Accounting as an information system. Ans. Accounting as an Information system. According to American Accounting Association, "Accounting is the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of information." As an information system, accounting collects data and communicates economic information about the organisation to a wide variety of users whose decisions and actions are related to its performance. Accounting process begins with the identification of- transactions and ends with the preparation of financial statements. Every step in the process of accounting generates information. Generation of information is not an end in itself. It is a means to facilitate the dissemination of information among different user groups. Such information enables the interested parties to take appropriate decisions. Accounting is often called the language of business. The basic function of language is to serve as a means of communication. Accounting serves this function. It communicates the results of business operations to various parties who have a stake in the business viz., the proprietor, creditors, investors, government and other agencies. The accounting is, therefore, also an information system. Accounting information system should be such that the financial statements and reports can be prepared not only at the end of the accounting year but also on quarterly and monthly basis as the information may be timely communicated. Accounting information system should be designed to meet the requirements of both internal and external users. Q. 6. Who are the various users of accounting information? Explain their information needs. Ans. Users of Accounting Information and their Needs. There are a number of groups who have a vested interest in the accounting information of the business. They may be internal users (e.g., owners, management, employees etc.) or external users. Users need accounting information to know the liquidity, solvency and profitability of the enterprise. Following are some of the users who use the accounting information: Users Need for Information 1. Owners/ They are interested to know the financial position of a concern, rate of return on the capital employed, proper' and effective utilisation Proprietors and of available resources. partners 2. Creditors and other Since they have provided the funds, they are interested to get their Lending Institutions funds as well as interest thereon when due. As such, they are naturally interested to know the profitability and short-term solvency of the business. 3. Management Management needs information to review the firm's (i) short-term & long-term solvency, (ii) profitability (iii) effective utilization of available resources; and take necessary action to run the business effectively. 4. Potential Investors Before investing their funds they need accounting information to know past and present profitability of the business, because their (those who want to investment should always be in safe hands. In other words, they invest) need information to judge prospects of an enterprise and to decide whether they should buy the shares of the enterprise, 5. Employees They are interested in information about the earning capacity of the business since their salary, bonus, profit-sharing, welfare and social measures depend upon the profitability of the business. 6. Tax Authorities Tax authorities need information to access the tax liabilities of an enterprise. 7. Government and Government and their agencies are interested in the allocation of their agencies resources and therefore, the activities of the enterprise. They also require information for controlling the activities of the enterprise, determine taxation policies etc. Q. 7. Write a short note on the importance of classifying business expenditure into revenue expenditure, capital expenditure and deferred revenue expenditure. Ans. The two financial statements — Profit & Loss Account and Balance Sheet are related with each other. Both the statements are prepared from the balances appearing in the trial balance. All items appearing in trial balance which are of revenue nature are transferred to Profit and Loss Account and all items of capital nature are taken to the balance sheet. For calculating and correcting the profits for the accounting period, the 'principle of matching of revenue and expenses' is to be applied. If there is an incorrect classification of any item in capital and revenue items, the profit or loss figure as shown by Profit and Loss Account will be wrong. The Balance sheet will not present a true and fair view of the financial affairs on a particular date. In other words, if there is an incorrect classification of item into revenue items and capital items, financial statements will not disclose the true and fair view of the financial position and income of the period. Sometimes some expenditure is incurred which by nature is revenue expenditure, but its benefits are likely to be derived over a number of years. Such expenditure is called a deferred revenue expenditure. Such expenses cannot be transferred to Profit and Loss Account of a particular year and are deferred over a number of years so that profit of a particular year is not unduly affected. In short, deferred revenue expenditure is a type of revenue expenditure which is incurred during the accounting period but is applicable either wholly or in part to future periods. Examples of deferred revenue expenses are as under. (i) Preliminary expenses (ii) Brokerage on Issue of shares and debentures (iii) Heavy amounts of advertisement (iv) Research and Development expenses. Q. 8. Explain the advantages and limitations of Financial Accounting. Ans. Advantages of Financial Accounting: (i) Replacement of Memory. All financial transactions are recorded in a systematic manner in the books of accounts so that there is no need to rely on memory. Human memory is limited by its very nature. Accounting helps to overcome this limitation. (ii) Preparation of financial statements. Systematic records enable the accountants to prepare the Financial Statements — Profit & Loss Account to ascertain profit or loss during a particular accounting period and Balance Sheet to state the financial position of the business on a particular date. (iii) Comparative Study. Systematic maintenance of business records enables the accountant to compare profit of one year with that of earlier years to know the significant facts about the change. (iv) Acts as Legal Evidence. Proper books of accounts maintained in a systematic manner act as legal evidence in case of disputes. (v) Facilitates Raising loans. Accounting facilitates raising loans from lenders by providing them required financial information. (vi) Facilitates the Ascertainment of Value of Business. Accounting facilitates the ascertainment of the value of business in case of transfer of business to another entity. (vii) Assistance to Management. Accounting assists the management in taking managerial decisions. For example, Projected Cash Flow Statement facilitates the management to know about future receipts and payments and to take decisions regarding anticipated surplus or shortage of funds. (viii) Settlement of taxation liability. Accounting facilitates the settlement of tax liability with the authorities by maintaining proper books of accounts in a systematic manner. (ix) Facilitates control over Assets. Accounting facilitates control over assets by providing information regarding Cash Balance, Bank Balance, Stock Debtors, Fixed Assets etc. Limitations of Financial Accounting: