Chapter – 3Accounting from incomplete records

Chapter outcomes:1.Meaning and nature of incomplete records; 2.Reasons for the incomplete records;3.Limitations of incomplete records;4.Distinction between double entry system and incomplete records system;5.Ascertaining profit under the single entry system;6.Distinction between statement of affairs and balance sheet;7.Practical exercises;

Meaning of incomplete records

Incomplete accounting records are those accounting records which at present are not complete according to double entry principles. Many authors describe it as the single entry system but according to the majority of accountants, it is appropriate to describe it as incomplete records because incomplete records contains:1.Both the aspects of some of the transactions;2.Only one aspect of some of the transactions;3.No aspect of some of the transactions.

Reasons for incompleteness in accounting records

Accounting records may be incomplete due to any one or more of the following reasons:

1.The businessman may be ignorant of the separate legal entity assumption;

2.The businessman may be ignorant of the double entry accounting principles;

3.Business may not intentionally maintain proper accounts to evade taxation;

4.Destruction of the books of accounts due to fire, flood etc.

Limitation of incomplete records

Maintenance of incomplete records suffers from the following limitations:1.Arithmetical accuracy of the accounts can not be checked because no agreed trial balance can be prepared;2.True profit or losses can not be ascertained because trading and profit and loss account cannot be prepared;3.True financial position cannot be ascertained because balance sheet cannot be prepared

4. It is difficult to conduct the audit of such records;5. It is difficult to operate internal control system;6. It is difficult to operate internal check system;7. It is difficult to exercise control over assets;8. It is difficult to detect fraud;9. Such records are not recognized by the courts; sales tax and income tax authorities;

Distinction between double entry system and incomplete records system

Basis of distinction Double entry system Incomplete records system

1. Assumptions and principles

It is based on certain assumptions and principles

It is not based on certain assumptions and principles

2. Both aspects of all transactions

Both the aspects of all transactions are recorded

Both the aspects of all transactions are not recorded

3. Nature of accounts maintained

All types of accounts – personal, real and nominal – are maintained

Usually cash and personal accounts are maintained

4. Trial Balance Arithmetical accuracy of the records can be checked by preparing a trial balance

Arithmetical accuracy of the records cannot be checked since trial balance cannot be prepared

5. Determination of true profit or loss

True profits or losses can be determined by preparing trading and profit and loss account

Only estimated profit or losses can be determined since trading and profit and loss account cannot be prepared.

Basis of distinction Double entry system Incomplete records system

6. Financial Position True financial position can be known by preparing a balance sheet

Only estimated financial position can be known on the basis of statement of affairs.

7. Adjustments All types of adjustments made while preparing financial accounts.

No special attention is given to adjustments.

8. Utility It is used by all types of traders.

It is used only by small traders.

9. Recognition Records maintained according to this system are recognised by the government

Records maintained according to this system are not recognised by the government

Ascertaining profit under incomplete records system

The main purpose of any business enterprise is to earn and maximize profit. Hence, every business owner wants to know whether the business has earned profit or suffered loss after a certain period of time, generally after the end of a year.

There are two main methods of ascertaining profit under the incomplete records system:

1.Net worth method or statement of affairs method; and

2.Conversion method

Statement of affairs methodTo ascertain profit, according to incomplete records method, it is necessary to prepare a statement of affairs at the end of the year and also at the beginning of the year, if not already prepared.

Like the balance sheet, the statement of affairs has two sides – the right hand side for assets and the left-hand side for liabilities. To prepare the statement, information has to b e collected from various sources. Information about assets will be available from the cash book, the personal ledger, etc. the value of the closing stock will be ascertained by preparing stock sheets and valuing the stock on hand, at lower of cost and market value. If the trader has any other assets also, like furniture, machinery, etc., the value will be ascertained and included among the assets. The business is likely to have full knowledge of the amounts owning to third parties. The difference between the total of assets and liabilities will be capital.

Capital = Total Assets – Total Liabilities

For ascertaining profit the capital in the beginning of the year must also be ascertained, if necessary, by preparing a statement of affairs as in the beginning of the year.

If the capital at the end of the year exceeds that in the beginning, it can be considered that there has been a profit.

If, on the other hand, the capital in the beginning was more than that at the end, there must have been a loss. However, two adjustments must be kept in mind for ascertaining profit.

The following formula can be used to find out profit or loss:

Profit/ (loss) = (Capital at the end + drawings – additional capital introduced) – (Capital in the beginning)

Distinction between statement of affairs and balance sheet

Basis of distinction Statement of affairs Balance sheet

1. Basis of preparation It is prepared on the basis of some ledger accounts and estimates.

It is prepared on the basis of ledger accounts.

2. Balance of capital account

Balance of capital account is arrived at as a balancing figure.

Balance of capital account is taken from the ledger.

3. Omission of assets/liabilities

Omission of an asset or liability cannot be easily traced

Omission of an asset or liability can be easily traced because of non-agreement of both the sides of balance sheet

Estimated Vs. true financial position

It shows only the estimated financial position

It shows the true financial position.