PRINCIPLES AND PRACTICE OF ACCOUNTINGgopalbhootca.com/wp-content/uploads/2017/11/CA... · M eaning and Features of consignment business, Di erence between sale and consignment, Accounting

BOARD OF STUDIES

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)(SET UP BY AN ACT OF PARLIAMENT)

PRINCIPLES AND

PRACTICE OF

ACCOUNTING

MODULE – 1

FOUNDATION COURSE

(Modules 1 to 2)

Paper–1, Module–1

© The Institute of Chartered Accountants of India

: Board of Studies DepartmentCommittee/


BEFORE WE BEGIN …

SKILL REQUIREMENTS AT FOUNDATION LEVEL

The Board of Studies, ICAI presents the study material for Foundation (Entry Level Exam to the

Chartered Accountancy Course). The contents have been designed and developed with an objective

to synchronize the syllabus with the guidelines prescribed by IAESB (International Accounting

Education Standards Board), IFAC (International Federation of Accountants), to instill and enhance

the necessary pre-requisites for becoming a well-rounded, competent and globally competitive

Accounting Professional.

The level of complexity of the study material is as per standards accorded by IAESB comprising an

ideal mix of subjective and objective examination pattern to ensure discerning students get through

and seek admission to the CA Course.

The paper of 'Principles and Practice of Accounting' at Foundation level concentrates on

conceptual understanding of fundamentals of accounting. The objective of this paper is to develop

an understanding of the basic concepts and principles of Accounting and apply the same in

preparing financial statements of Non-corporate entities, computing accounting ratios and simple

problem solving.

This Study Material endeavouring towards accounting education, is committed to provide a

framework for understanding accounting discipline and describing the fundamental accounting

concepts and conventions of the basic accounting system. An attempt has been made to provide a

solid foundation on which students can successfully build and enhance their studies.

KNOW YOUR SYLLABUS AND STUDY MATERIAL

The Study Material of Principles and Practice of Accounting has been designed having regard to

the needs of home study and distance learning students. The Study Material has been divided into

eleven chapters, each addressing to a special aspect of accounting. Chapters 1 to 5 lay emphasis on

bookkeeping aspect of accounting whereas chapter 7 deals with preparation of financial statements

of sole proprietors. Chapter 6 covers accounting for special transactions like consignment, joint

ventures, bills of exchange, sale of goods on approval basis, royalty accounts and average due date

which are useful for different business entities. Chapter 8 discusses accounting of partnership firms

and chapter 9 deals with financial statements of Not-for-profit organizations. Chapter 10 explains

basic concepts of company accounts and Chapter 11 is on basic accounting ratios which are used

as a tool used in analysing financial statements and performance of a business entity.

The study material has been bifurcated into two modules (Module I : chapters 1 to 6 and Module

II: Chapters 7 to 11) for the easy handling and convenience of students. It is important to read the

Study Material thoroughly for understanding the coverage of syllabus in the paper of Advanced

Accounting.

FRAMEWORK OF CHAPTERS – UNIFORM STRUCTURE COMPRISING OF SPECIFIC

COMPONENTS

Efforts have been made to present each topic of the syllabus in a lucid manner. Care has been

taken to present the chapters in a logical sequence to facilitate easy understanding by the students.

Sincere efforts have been taken to updated the study material so that it reflects the current position.


The content for each chapter/unit of the study Material has been structured in the following manner

–

Components of each Chapter About the component

1 Learning Outcomes Learning outcomes which you need to demonstrate a�er learning each topic have been detailed in the first page of each chap-ter/unit. Demonstration of these learning outcomes would help you to achieve the de-sired level of technical competence

2 Chapter/Unit Overview As the name suggests, the flow chart/table/diagram given at the beginning of each chap-ter would give a broad outline of the contents covered in the chapter

3 Content of each unit/ chapter �e concepts and provisions of each topic is explained in student-friendly manner with the aid of Examples/ illustrations/ diagrams/flow charts. �ese value additions would help you develop conceptual clarity and get a good grasp of the topic. Diagrams and Flow charts would help you understand the con-cept/application of topic in a better manner.

4 Illustrations involving conceptual understanding

Illustrations would help the students to un-derstand the application of concepts. In ef-fect, it would test understanding of concepts as well as ability to apply the concepts learnt in solving problems and addressing issues.

5 Summary A summary of the chapter is given at the end to help you revise what you have learnt. It would especially facilitate quick revision of the chapter the day before the examination.

6 Test Your Knowledge �is section comprises of number of multiple choice questions, theoretical questions and practical questions which would help stu-dents to evaluate what they have understood a�er studying the chapter. �e questions giv-en in this section have also been supplement-ed with the answers to help the students in evaluating their solutions so that they can know about their grey areas.

We hope that these student-friendly features in the Study Material makes your learning process

more enjoyable, enriches your knowledge and sharpens your application skills.

Happy Reading and Best Wishes!


PAPER – 1 : PRINCIPLES AND PRACTICE OF ACCOUNTING

(One paper – Three hours – 100 Marks)

OBJECTIVE:

To develop an understanding of the basic concepts and principles of Accounting and apply

the same in preparing financial statements, computing accounting ratios and simple problem

solving.

CONTENTS:

1. Theoretical Framework

(i) Meaning and Scope of accounting

(ii) Accounting Concepts, Principles and Conventions

(iii) Accounting terminology - Glossary

(iv) Capital and revenue expenditure, Capital and revenue receipts, Contingent assets and

contingent liabilities

(v) Accounting Policies

(vi) Accounting as a Measurement Discipline – Valuation Principles, Accounting Estimates.

(vii) Accounting Standards – Concepts and Objectives.

(viii) Indian Accounting Standards – Concepts and Objectives.

2. Accounting Process

(i) Books of Accounts

(ii) Preparation of Trial Balance

(iii) Rectification of Errors.

3. Bank Reconciliation Statement

Introduction, reasons, preparation of bank reconciliation statement.

4. Inventories

Cost of inventory, Net realizable value, Basis and technique of inventory valuation and record

keeping.

5. Concept and Accounting of Depreciation

Concepts, Methods of computation and accounting treatment of depreciation, Change in

depreciation methods.

6. Accounting for Special Transactions

(i) Bills of exchange and promissory notes

Meaning of Bills of Exchange and Promissory Notes and their Accounting Treatment;

Accommodation bills.


(ii) Sale of goods on approval or return basis

Meaning of goods sent on approval or return basis and accounting treatment.

(iii) Consignments

Meaning and Features of consignment business, Difference between sale and consignment,

Accounting treatments for consignment transactions and events in the books of consignor and

consignee.

(iv) Joint Ventures for non-corporate entities

Meaning and Features of joint venture transactions, Distinction between joint venture and

partnership, Methods of maintaining joint venture accounts.

(v) Royalty accounts

Meaning of the term “Royalty” and Accounting Treatment thereof.

(vi) Average due Date

Meaning, Calculation of average due date in various situations.

(vii) Account Current

Meaning of Account Current, Methods of preparing Account Current.

7. Final Accounts of Sole Proprietors

Elements of financial statements, Closing Adjustment Entries, Trading Account, Profit and Loss

Account and Balance Sheet of Manufacturing and Non-manufacturing entities.

8. Partnership Accounts

(i) Final Accounts of Partnership Firms

(ii) Admission, Retirement and Death of a Partner including Treatment of Goodwill

(iii) Introduction to LLPs and Distinction of LLPs from Partnership.

9. Financial Statements of Not-for-Profit Organizations

Significance of Receipt and Payment Account, Income and Expenditure Account and Balance

Sheet, Difference between Profit and Loss Account and Income and Expenditure Account.

Preparation of Receipt and Payment Account, Income and Expenditure Account and Balance

Sheet.

10. Introduction to Company Accounts

(i) Definition of shares and debentures

(ii) Issue of shares and debentures, forfeiture of shares, re-issue of forfeited shares

(iii) Statement of Profit and Loss and Balance Sheet as per Schedule III to the Companies Act,

2013.

11. Basic Accounting Ratios (profitability, solvency, liquidity and turnover)


CONTENTS

MODULE 1

CHAPTER 1 : Theoretical Framework

CHAPTER 2 : Accounting Process

CHAPTER 3 : Bank Reconciliation Statement

CHAPTER 4 : Inventories

CHAPTER 5 : Concept and Accounting of Depreciation

CHAPTER 6 : Accounting for Special Transactions

MODULE 2

CHAPTER 7 : Preparation of Final Accounts of Sole Proprietors

CHAPTER 8 : Partnership Accounts

CHAPTER 9 : Financial Statements of Not-For-Profit Organizations

CHAPTER 10 : Company Accounts

CHAPTER 11 : Basic Accounting Ratios


DETAILED CONTENTS : MODULE–1

Pages

CHAPTER 1: THEORETICAL FRAMEWORK .........................................................................1.1–1.96

Unit 1: Meaning And Scope Of Accounting

Learning Outcomes ...................................................................................................................................................... 1.1

Unit overview.................................................................................................................................................................. 1.2

1.1 Introduction ................................................................................................................................................ 1.2

1.2 Meaning of Accounting ........................................................................................................................... 1.3

1.3 Evolution of Accounting as a Social Science ................................................................................... 1.6

1.4 Objectives of Accounting ....................................................................................................................... 1.7

1.5 Functions of Accounting ......................................................................................................................... 1.8

1.6 Book-Keeping ............................................................................................................................................. 1.8

1.7 Distinction Between Book-Keeping and Accounting ................................................................... 1.9

1.8 Sub-Fields of Accounting......................................................................................................................1.10

1.9 Users of Accounting Information .......................................................................................................1.10

1.10 Relationship of Accounting with other Disciplines .....................................................................1.11

1.11 Limitations of Accounting ....................................................................................................................1.14

1.12 Role of Accountant in the Society .....................................................................................................1.14

Summary ........................................................................................................................................................................1.18

Test Your Knowledge ..................................................................................................................................................1.19

Unit 2 : Accounting Concepts, Principles And Conventions

Learning Outcomes ....................................................................................................................................................1.22

Unit Overview ...............................................................................................................................................................1.23

2.1 Introduction ..............................................................................................................................................1.23

2.2 Accounting Concepts .............................................................................................................................1.24

2.3 Accounting Principles ............................................................................................................................1.24

2.4 Accounting Conventions ......................................................................................................................1.24

2.5 Concepts, Principles and Conventions - An Overview ...............................................................1.25

2.6 Fundamental Accounting Assumptions..........................................................................................1.35

2.7 Financial Statements ..............................................................................................................................1.35

Summary ........................................................................................................................................................................1.39



Unit 3 : Accounting Terminology – Glossary

Learning Outcomes ...................................................................................................................................................1.43

Accounting Terminology - Glossary ..................................................................................................................... 1.43

Test Your Knowledge ................................................................................................................................................. 1.57

Unit 4 : Capital And Revenue Expenditures And Receipts


Unit Overview ...............................................................................................................................................................1.58

4.1 Introduction ............................................................................................................................................. 1.58

4.2 Considerations in Determining Capital and Revenue Expenditures ................................... 1.59

4.3 Capital Expenditures and Revenue Expenditures....................................................................... 1.59

4.4 Capital Receipts and Revenue Receipts ......................................................................................... 1.61

Summary .......................................................................................................................................................................1.64

Test Your Knowledge .................................................................................................................................................1.64

Unit 5 : Contingent Assets And Contingent Liabilities


Unit Overview ..............................................................................................................................................................1.66

5.1 Contingent Asset .................................................................................................................................... 1.66

5.2 Contingent Liabilities ............................................................................................................................ 1.67

5.3 Distinction Between Contingent Liabilities and Liabilities ..................................................... 1.67

5.4 Distinction Between Contingent Liabilities and Provisions .....................................................1.67


Unit 6 : Accounting Policies


Unit Overview ...............................................................................................................................................................1.70

6.1 Meaning ..................................................................................................................................................... 1.70

6.2 Selection of Accounting Policies ....................................................................................................... 1.71

6.3 Change in Accounting Policies .......................................................................................................... 1.71

Summary .......................................................................................................................................................................1.72


Unit 7 : Accounting As A Measurement Discipline – Valuation Principles, Accounting Estimates


Unit Overview ..............................................................................................................................................................1.74

7.1 Meaning of Measurement ................................................................................................................... 1.75


7.2 Objects or Events to be Measured ................................................................................................... 1.75

7.3 Standard or Scale of Measurement ...................................................................................................1.75

7.4 Dimension of Measurement Scale ................................................................................................... 1.76

7.5 Accounting as a Measurement Discipline ..................................................................................... 1.76

7.6 Valuation Principles ............................................................................................................................... 1.77

7.7 Measurement and Valuation .............................................................................................................. 1.80

7.8 Accounting Estimates ........................................................................................................................... 1.80

Summary ........................................................................................................................................................................1.81


Unit 8 : Accounting Standards


Unit Overview ...............................................................................................................................................................1.84

8.1 Introduction of Accounting Standards ............................................................................................1.85

8.2 Objectives of Accounting Standards ................................................................................................1.85

8.3 Benefits and Limitations of Accounting Standards .....................................................................1.85

8.4 Process of Formulation of Accounting Standards in India .......................................................1.87

8.5 List of Accounting Standards in India ..............................................................................................1.87


Unit 9 : Indian Accounting Standards


Unit overview................................................................................................................................................................1.91

9.1 Need for Convergence towards Global Standards ......................................................................1.91

9.2 International Financial Reporting Standards as Global Standards ........................................1.92

9.3 Benefits of Convergence with IFRSS .................................................................................................1.93

9.4 Development in Indian Accounting Standards (Ind AS) ...........................................................1.93

9.5 List of IND AS .............................................................................................................................................1.94


CHAPTER 2 : ACCOUNTING PROCESS ............................................................................. 2.1–2.116

Unit 1 : Basic Accounting Procedures - Journal Entries


Unit overview.................................................................................................................................................................. 2.1

1.1 Double Entry System ................................................................................................................................ 2.2

1.2 Advantages of Double Entry System .................................................................................................. 2.2


1.3 Account ......................................................................................................................................................... 2.2

1.4 Debit and Credit ......................................................................................................................................... 2.4

1.5 Transactions ................................................................................................................................................. 2.7

1.6 Accounting Equation Approach ........................................................................................................... 2.8

1.7 Traditional Approach..............................................................................................................................2.12

1.8 Modern Classification of Accounts ....................................................................................................2.14

1.9 Journal .........................................................................................................................................................2.14

Summary ........................................................................................................................................................................2.24


Unit 2 : Ledgers


Unit Overview ...............................................................................................................................................................2.31

2.1 Introduction ..............................................................................................................................................2.32

2.2 Specimen of Ledger Accounts ............................................................................................................2.32

2.3 Posting .........................................................................................................................................................2.32

2.4 Balancing an Account ............................................................................................................................2.32

Summary ........................................................................................................................................................................2.37


Unit 3 : Trial Balance


Unit Overview ..............................................................................................................................................................2.41

3.1 Introduction ............................................................................................................................................. 2.41

3.2. Objectives of Preparing the Trial Balance ...................................................................................... 2.42

3.3 Limitations of Trial Balance ................................................................................................................. 2.43

3.4 Methods of Preparation of Trial Balance ........................................................................................ 2.43

3.5 Adjusted Trial Balance (Through Suspense Account) ................................................................ 2.47

3.6 Rules of Preparing the Trial Balance ................................................................................................. 2.47

Summary .......................................................................................................................................................................2.49


Unit 4 : Subsidiary Books


Unit Overview ...............................................................................................................................................................2.53

4.1 Introduction ............................................................................................................................................. 2.53


4.2 Distinction between Subsidiary Books and Principal books .................................................. 2.54

4.3 Purchases Book ....................................................................................................................................... 2.56

4.4 Sales Book ................................................................................................................................................. 2.60

4.5 Sales Returns Book or Returns Inward Book ................................................................................. 2.61

4.6 Purchase Returns or Returns Outward Book ................................................................................ 2.61

4.7 Importance of Journal .......................................................................................................................... 2.63

Summary .......................................................................................................................................................................2.65


Unit 5 : Cash Book


Unit Overview ...............................................................................................................................................................2.69

5.1 Cash Book - A Subsidiary Book and a Principal Book ................................................................ 2.70

5.2 Kinds of Cash Book ................................................................................................................................. 2.70

5.3 Posting the Cash Book Entries ........................................................................................................... 2.76

5.4 Petty Cash Book ...................................................................................................................................... 2.76

5.5 Entries for Sale Through Credit/Debit Cards ................................................................................. 2.79

Summary .......................................................................................................................................................................2.81


Unit 6: Rectification Of Errors


Unit Overview ...............................................................................................................................................................2.85

6.1 Introduction ............................................................................................................................................. 2.85

6.2 Stages of Errors ........................................................................................................................................ 2.88

6.3 Types of Errors ......................................................................................................................................... 2.89

6.4 Steps to Locate Errors ........................................................................................................................... 2.90

6.5 Rectification of Errors ............................................................................................................................ 2.91

Summary .................................................................................................................................................................... 2.106

Test Your Knowledge .............................................................................................................................................. 2.107

CHAPTER 3: BANK RECONCILIATION STATEMENT ............................................................3.1–3.33

Learning Outcomes ..................................................................................................................................................... 3.1

Chapter Overview ......................................................................................................................................................... 3.1

1. Introduction ............................................................................................................................................... 3.2

2. Bank Pass Book .......................................................................................................................................... 3.2


3. Bank Reconciliation Statement ........................................................................................................... 3.3

4. Importance of Bank Reconciliation Statement .............................................................................. 3.3

5. Procedure for Reconciling the Cash Book Balance with the Pass Book Balance.............. 3.11

6. Methods of Bank Reconciliation ....................................................................................................... 3.13

Summary .......................................................................................................................................................................3.28


CHAPTER 4: INVENTORIES ..................................................................................................4.1–4.27



1. Meaning ....................................................................................................................................................... 4.2

2. Inventory Valuation.................................................................................................................................. 4.3

3. Basis of Inventory Valuation ................................................................................................................. 4.4

4. Inventory Record Systems ..................................................................................................................... 4.5

5. Formulae/Methods to Determine Cost of Inventory .................................................................... 4.6

6. Inventories Taking .................................................................................................................................. 4.14

Summary .......................................................................................................................................................................4.18


CHAPTER 5: CONCEPT AND ACCOUNTING OF DEPRECIATION .......................................5.1–5.36



1. Introduction ............................................................................................................................................... 5.2

2. Factors in the Measurement of Depreciation ................................................................................. 5.4

3. Methods for Providing Depreciation ................................................................................................. 5.7

4. Profit or Loss on The Sale/Disposal of Property, Plant and Equipment ............................... 5.20

5. Change in the Method of Depreciation ..........................................................................................5.22

6. Revision of the Estimated Useful Life of Property, Plant and Equipment .......................... 5.24

7. Revaluation of Property, Plant and Equipment ........................................................................... 5.24

8. Provision for Repairs and Renewals ................................................................................................. 5.26

Summary .......................................................................................................................................................................5.27



CHAPTER 6: ACCOUNTING FOR SPECIAL TRANSACTIONS ............................................ 6.1–6.163

Unit 1: Bill Of Exchange And Promissory Notes


Unit Overview ................................................................................................................................................................. 6.1

1.1 Bills of Exchange ........................................................................................................................................ 6.2

1.2 Promissory Notes ....................................................................................................................................... 6.3

1.3 Differences - Bill of Exchange and Promissory Note ..................................................................... 6.4

1.4 Record of Bills of Exchange and Promissory Notes ....................................................................... 6.5

1.5 Term of a Bill ................................................................................................................................................ 6.6

1.6 Expiry / Due Date of a Bill ....................................................................................................................... 6.6

1.7 Days of Grace .............................................................................................................................................. 6.6

1.8 Date of Maturity of Bill ............................................................................................................................. 6.6

1.9 Bill at Sight ................................................................................................................................................... 6.7

1.10 Bill after Date .............................................................................................................................................. 6.7

1.11 How to Calculate Due Date of a Bill .................................................................................................... 6.8

1.12 Noting Charges .......................................................................................................................................... 6.8

1.13 Renewal of Bill ............................................................................................................................................ 6.9

1.14 Retirement of Bills of Exchange & Rebate ......................................................................................... 6.9

1.15 Insolvency ..................................................................................................................................................6.16

1.16 Accommodation Bills .............................................................................................................................6.19

1.17 Bills of Collection .....................................................................................................................................6.21

1.18 Bills Receivable and Bills Payable Books ..........................................................................................6.22

Summary ........................................................................................................................................................................6.23


Unit 2 : Sale Of Goods On Approval Or Return Basis


Unit Overview ...............................................................................................................................................................6.30

2.1 Introduction ..............................................................................................................................................6.30

2.2 Accounting Records................................................................................................................................6.31

Summary ........................................................................................................................................................................6.38


Unit 3 : Consignment


Unit Overview ...............................................................................................................................................................6.44


3.1 Meaning of Consignment Account .................................................................................................. 6.45

3.2 Distinctions ................................................................................................................................................6.45

3.3 Accounting for Consignment Transactions and Events in the Books of the Consignor 6.46

3.4 Valuation of Inventories ....................................................................................................................... 6.51

3.5 Goods Invoiced above Cost ................................................................................................................ 6.51

3.6 Normal Loss ...............................................................................................................................................6.54

3.7 Abnormal Loss ......................................................................................................................................... 6.54

3.8 Commission ...............................................................................................................................................6.55

3.9 Return of Goods from the Consignee ..............................................................................................6.56

3.10 Account Sales ........................................................................................................................................... 6.56

3.11 Accounting in the Books of the Consignee ....................................................................................6.57

3.12 Advance by the Consignee Vs Security against the Consignment ........................................6.58

Summary .......................................................................................................................................................................6.65


Unit 4: Joint Ventures


Unit Overview ...............................................................................................................................................................6.75

4.1 Meaning of Joint Venture .................................................................................................................... 6.76

4.2 Features of Joint Venture ..................................................................................................................... 6.77

4.3 Distinction of Joint Venture with Partnership .............................................................................. 6.77

4.4 Distinction of Joint Venture with Consignment .......................................................................... 6.78

4.5 Methods of Maintaining Joint Venture Accounts ....................................................................... 6.78

Summary .................................................................................................................................................................... 6.103


Unit 5: Royalty Accounts

Learning Outcomes ................................................................................................................................................ 6.110

Unit Overview ........................................................................................................................................................... 6.110

5.1 Introduction of Royalty and Related Terminologies ............................................................... 6.111

5.2 Accounting Treatment in the Books of Lessee .......................................................................... 6.113

5.3 Accounting Treatment in the Books of Lessor .......................................................................... 6.113

Summary ..................................................................................................................................................................... 6.124

Test Your Knowledge ............................................................................................................................................... 6.124


Unit 6 : Average Due Date


Unit Overview ............................................................................................................................................................ 6.129

6.1 Introduction .......................................................................................................................................... 6.130

6.2 Concept of due date (Date of Maturity) ...................................................................................... 6.131

6.3 Types of Problems ............................................................................................................................... 6.133

Summary .................................................................................................................................................................... 6.146


Unit 7 : Account Current


Unit Overview ........................................................................................................................................................... 6.150

7.1 Introduction .......................................................................................................................................... 6.150

7.2 Preparation of Account Current ..................................................................................................... 6.151

Summary ..................................................................................................................................................................... 6.160



FOUNDATION COURSE

(Modules 1 to 2)

BOARD OF STUDIES

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)(SET UP BY AN ACT OF PARLIAMENT)

PRINCIPLES AND

PRACTICE OF

Paper–1, Module–2


THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

This study material has been prepared by the faculty of the Board of Studies. The objective of the

study material is to provide teaching material to the students to enable them to obtain knowledge

in the subject. In case students need any clarifications or have any suggestions to make for further

improvement of the material contained herein, they may write to the Director of Studies.

All care has been taken to provide interpretations and discussions in a manner useful for the students.

However, the study material has not been specifically discussed by the Council of the Institute or any

of its Committees and the views expressed herein may not be taken to necessarily represent the

views of the Council or any of its Committees.

Permission of the Institute is essential for reproduction of any portion of this material.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or

transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or

otherwise, without prior permission, in writing, from the publisher.

Edition : July, 2017

Website : www.icai.org

E-mail : [email protected]

Committee/ : Board of Studies

ISBN No. : 978-81-8441-871-2

Price (All Modules) : ` 500/-

Published by : The Publication Department on behalf of The Institute of Chartered

Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg,

New Delhi 110 002, India.

Printed by : Nova Publications, Daryaganj

July/2017/P2107 (New)


CONTENTS

MODULE 1

CHAPTER 1 : Theoretical Framework

CHAPTER 2 : Accounting Process

CHAPTER 3 : Bank Reconciliation Statement

CHAPTER 4 : Inventories

CHAPTER 5 : Concept and Accounting of Depreciation

CHAPTER 6 : Accounting for Special Transactions

MODULE 2

CHAPTER 7 : Preparation of Final Accounts of Sole Proprietors

CHAPTER 8 : Partnership Accounts

CHAPTER 9 : Financial Statements of Not-For-Profit Organizations

CHAPTER 10 : Company Accounts

CHAPTER 11 : Basic Accounting Ratios


DETAILED CONTENTS : MODULE–2

Pages

CHAPTER 7 PREPARATION OF FINAL ACCOUNTS OF SOLE PROPRIETORS ....................7.1–7.73

Unit 1 : Final Accounts of Non-Manufacturing Entities


Unit overview.................................................................................................................................................................. 7.1

1.1 Introduction ................................................................................................................................................ 7.2

1.2 Preparation of Final Accounts ............................................................................................................... 7.3

1.3 Trading Account ......................................................................................................................................... 7.6

1.4 Profit and Loss Account .........................................................................................................................7.14

1.5 Certain Adjustments and their Treatments ....................................................................................7.27

1.6 Balance Sheet ............................................................................................................................................7.32

1.7 Sequence of Accounting Procedure or the Accounting Cycle ................................................7.38

1.8 Opening Entry ..........................................................................................................................................7.39

1.9 Provisions and Reserves ........................................................................................................................7.48

1.10 Limitations of Financial Statements .................................................................................................7.52

Summary ........................................................................................................................................................................7.53


Unit 2 : Final Accounts of Manufacturing Entities


Unit Overview ...............................................................................................................................................................7.63

2.1 Introduction ..............................................................................................................................................7.63

2.2 Purpose .......................................................................................................................................................7.63

2.3 Manufacturing Costs ..............................................................................................................................7.64

2.4 Design of A Manufacturing Account ................................................................................................7.66

Summary ........................................................................................................................................................................7.68


CHAPTER 8: PARTNERSHIP ACCOUNTS .......................................................................... 8.1–8.135

Unit 1 : Introduction to Partnership Accounts


Unit Overview ................................................................................................................................................................. 8.1

1.1 Introduction: Why Partnership? .......................................................................................................... 8.2

1.2 Definition and Features of Partnership............................................................................................. 8.2

1.3 Limited Liability Partnership ................................................................................................................ 8.3

1.4 Distinction Between an Ordinary Partnership Firm and An LLP ............................................. 8.4

1.5 Main Clauses in A Partnership Deed .................................................................................................. 8.5

1.6 Powers of Partners.................................................................................................................................... 8.7

1.7 Accounts ...................................................................................................................................................... 8.7


1.8 Profit and Loss Appropriation .............................................................................................................. 8.8

1.9 Fixed and Fluctuating Capital ............................................................................................................ 8.11

Summary .......................................................................................................................................................................8.19


Unit 2: Treatment of Goodwill In Partnership Accounts


Unit Overview ...............................................................................................................................................................8.27

2.1 Goodwill ..................................................................................................................................................... 8.28

2.2 Methods for Goodwill Valuation ....................................................................................................... 8.29

2.3 Need for Valuation of Goodwill ......................................................................................................... 8.36

2.4 Valuation of Goodwill in Case of Admission of a Partner ......................................................... 8.36

2.5 Accounting Treatment of Goodwill in Case of Admission of a New Partner ...…………8.37

2.6 Accounting Treatment of Goodwill in Case of Change in Profit Sharing Ratio ................ 8.42

2.7 Accounting Treatment Of Goodwill in Case of Retirement or Death of a Partner ......... 8.44

Summary .......................................................................................................................................................................8.44


Unit 3 : Admission of A New Partner


Unit Overview ...............................................................................................................................................................8.49

3.1 Introduction ............................................................................................................................................. 8.50

3.2 Revaluation Account or Profit and Loss Adjustment Account ............................................... 8.50

3.3 Reserves in the Balance Sheet ........................................................................................................... 8.58

3.4 Computation of New Profit Sharing Ratio ......................................................................................8.60

3.5 Hidden Goodwill ..................................................................................................................................... 8.69

Summary ........................................................................................................................................................................8.71


Unit 4 : Retirement of A Partner


Unit Overview ...............................................................................................................................................................8.81

4.1 Introduction ............................................................................................................................................. 8.82

4.2 Calculation of Gaining Ratio ............................................................................................................... 8.82

4.3 Revaluation of Assets and Liabilities on Retirement of a Partner ......................................... 8.85

4.4 Reserve ....................................................................................................................................................... 8.86

4.5 Final Payment to a Retiring Partner ..................................................................................................8.88

4.6 Paying a Partner’s Loan in Instalment ............................................................................................. 8.99

4.7 Joint Life Policy ..................................................................................................................................... 8.102

4.8 Separate Life Policy ............................................................................................................................. 8.106

Summary .................................................................................................................................................................... 8.107



Unit 5 : Death of A Partner


Unit Overview ........................................................................................................................................................... 8.116

5.1 Introduction .......................................................................................................................................... 8.117

5.2 Right of Outgoing Partner in Certain Cases to Share Subsequent Profits……………8.117

5.3 Amount Payable to Legal Representatives of Dead Partner ................................................ 8.118

5.4 Special Transactions in Case of Death: Joint Life Policy .......................................................... 8.119

5.5 Special Transactions in Case of Death: Separate Life Policy ................................................. 8.121

5.6 Special Transactions in Case of Death: Payment of Deceased

Partner’s Share ...................................................................................................................................... 8.121

Summary ..................................................................................................................................................................... 8.129


CHAPTER 9: FINANCIAL STATEMENTS OF NOT-FOR-PROFIT ORGANIZATIONS ..............91–9.38



1. Introduction ................................................................................................................................................ 9.2

2. Nature of Receipts and Payments Account ...................................................................................... 9.2

3. Income and Expenditure Account ....................................................................................................... 9.3

4. Balance Sheet .............................................................................................................................................. 9.8

5. Educational Institution ..........................................................................................................................9.23

Summary ........................................................................................................................................................................9.29


CHAPTER 10 : COMPANY ACCOUNTS ........................................................................... 10.1–10.90

Unit 1: Introduction to Company Accounts


Unit Overview ...............................................................................................................................................................10.1

1.1 Introduction ..............................................................................................................................................10.2

1.2 Meaning of Company ............................................................................................................................10.2

1.3 Salient Features of a Company ...........................................................................................................10.3

1.4 Types of Companies ...............................................................................................................................10.4

1.5 Maintenance of Books of Account ....................................................................................................10.6

1.6 Preparation of Financial Statements ................................................................................................10.6

Summary ..................................................................................................................................................................... 10.14


Unit 2 : Issue, Forfeiture and Re-Issue of Shares

Learning Outcomes ................................................................................................................................................. 10.17

Unit Overview ............................................................................................................................................................ 10.17

2.1 Introduction ........................................................................................................................................... 10.18

2.2 Share Capital .......................................................................................................................................... 10.18


2.3 Types of Shares ...................................................................................................................................... 10.21

2.4 Issue of Shares for Cash ...................................................................................................................... 10.22

2.5 Subscription of Shares ........................................................................................................................ 10.25

2.6 Shares Issued at Discount .................................................................................................................. 10.30

2.7 Shares Issued at Premium ................................................................................................................. 10.31

2.8 Over Subscription and Pro-Rata Allotment ................................................................................. 10.34

2.9 Calls-In-Arrears and Calls-In-Advance ........................................................................................... 10.36

2.10 Interest on Calls-in-Arrears and Calls-in-Advance .................................................................... 10.38

2.11 Forfeiture of Shares .............................................................................................................................. 10.41

2.12 Re-issue of Forfeited Shares ............................................................................................................. 10.45

2.13 Issue of Shares for Consideration other than Cash................................................................... 10.50

Summary ..................................................................................................................................................................... 10.52


Unit 3 : Issue of Debentures

Learning Outcomes ................................................................................................................................................. 10.61

Unit Overview ............................................................................................................................................................ 10.61

3.1 Introduction ........................................................................................................................................... 10.62

3.2 Meaning ................................................................................................................................................... 10.62

3.3 Features of Debentures ...................................................................................................................... 10.62

3.4 Distinction Between Debentures and Shares ............................................................................ 10.63

3.5 Types of Debentures ........................................................................................................................... 10.63

3.6 Issue of Debentures ............................................................................................................................. 10.64

3.7 Issue of Debentures as Collateral Security .................................................................................. 10.77

3.8 Issue of Debentures in Consideration other than for Cash ….. …. ..................................... 10.79

3.9 Treatment of Discount/Loss on Issue of Debentures .............................................................. 10.81

3.10 Interest on Debentures ...................................................................................................................... 10.82

Summary ..................................................................................................................................................................... 10.84


CHAPTER 11 : BASIC ACCOUNTING RATIOS ................................................................ 11.1–11.49


Chapter Overview .......................................................................................................................................................11.1

1. Introduction ..............................................................................................................................................11.2

2. Ratio and Ratio Analysis ........................................................................................................................11.2

3. Objectives of Ratio Analysis .................................................................................................................11.3

4. Advantages of Ratio Analysis ..............................................................................................................11.3

5. Limitations of Ratio Analysis ................................................................................................................11.4

6. Limitations of the Ratios .......................................................................................................................11.5

7. Types of Ratios ..........................................................................................................................................11.5

Summary ..................................................................................................................................................................... 11.38



After studying this unit, you will be able to:

w Understand the meaning and significance of accounting.

w Understand the meaning of book-keeping and the distinction of accounting with book-keeping.

w Appreciate the evolutionary process of accounting as a social science.

w Explain sub-fields of accounting.

w Identify the various user groups for whom accounting information is to be generated.

w Understand the relationship of accounting with Economics, Statistics, Mathematics, Law and

Management.

w Explain the limitations of accounting.

w Appreciate the enlarged boundary of accounting profession and the areas where in a chartered

accountant plays an important role of rendering useful services to the society.

THEORETICAL FRAMEWORK

UNIT 1: MEANING AND SCOPE OF ACCOUNTING

LEARNING OUTCOMES

1CHAPTER


1.2 PRINCIPLES AND PRACTICE OF ACCOUNTING

1.1 INTRODUCTION

Every individual performs some kind of economic activity. A salaried person gets salary and spends to

buy provisions and clothing, for children’s education, construction of house, etc. A sports club formed

by a group of individuals, a business run by an individual or a group of individuals, a local authority like

Calcutta Municipal Corporation, Delhi Development Authority, Governments, either Central or State, all

are carrying some kind of economic activities. Not necessarily all the economic activities are run for any

individual benefit; such economic activities may create social benefit i.e. benefit for the public, at large.

Anyway such economic activities are performed through ‘transactions and events’. Transaction is used

to mean ‘a business, performance of an act, an agreement’ while event is used to mean ‘a happening, as a

consequence of transaction(s), a result.’

An individual invests `2,00,000 for running a stationery business. On 1st January, he purchases goods for

` 1,15,000 and sells for ` 1,47,000 during the month of January. He pays shop rent for the month ` 5,000

and finds that still he has goods worth ` 15,000 in hand. The individual performs an economic activity.

He carries on a few transactions and encounters with some events. Is it not logical that he will want to

know the result of his activity?

UNIT

OVERVIEW

Procedure of Accounting

Using the financial Information

Generating Financial Information

Recording

Input

Posting to

ledger

Preparation

of trial

balance

Preparation

of final

accounts

Internal users

• Board of

Directors

• Partners

• Managers

• Officers

External users

• Investors

• Lenders

• Suppliers

• Govt. agencies

• Customers

Communicating

Information to

users

Economic events and

transactions measured

in financial terms

Accounting Cycle Output

Identification of

transaction

Classifying Summarising Analyzing Interpreting Communicating

Recording of transactions in the books

of original entry


1.3THEORETICAL FRAMEWORK

We see that the individual, who runs the stationery business, earns a surplus of ` 42,000.

`

Goods sold 1,47,000

Goods in hand 15,000

1,62,000

Less : Goods purchased 1,15,000

Shop rent paid 5,000 (1,20,000)

Surplus 42,000

Earning of ` 42,000 surplus is an event; also having the inventories in hand is another event, while purchase

and sale of goods, investment of money and payment of rent are transactions.

Similarly, a municipal corporation got government grant ̀ 500 lakhs for adult education; it spent ̀ 250 lakhs

for purchasing literacy kits, paid ` 200 lakhs to the tutors and is left with a balance of ` 50 lakhs. These are

also transactions and events.

Similarly, the Central Government raised money through taxes, paid salaries to the employees, and spent

on various developmental activities. Whenever receipts of the Government are more than expenses it has

surplus, but if expenses are more than receipts it runs in deficit. Here raising money through various sources

can be termed as transaction and surplus or deficit at the end of the accounting year can be termed as an

event.

So, everybody wants to keep records of all transactions and events and to have adequate information about

the economic activity as an aid to decision-making. Accounting discipline has been developed to serve this

purpose as it deals with the measurement of economic activities involving inflow and outflow of economic

resources, which helps to develop useful information for decision-making process.

Accounting has universal application for recording transactions and events and presenting suitable

information to aid decision-making regarding any type of economic activity ranging from a family function

to functions of the national government. But hereinafter we shall concentrate only on business activities

and their accounting because the objective of this study material is to provide a basic understanding on

accounting for business activities. Nevertheless, it will give adequate knowledge to think coherently of

accounting as a field of study for universal application.

The growth of accounting discipline is closely associated with the development of the business world. Thus,

to understand accounting as a field of study for universal application, it is best identified with recording of

business transactions and communication of financial information about business enterprise to facilitate

decision-making. The aim of accounting is to meet the information needs of the rational and sound decision-

makers, and thus, called the language of business.

1.2 MEANING OF ACCOUNTING

The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated

the following definition of accounting in 1961:

“Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of

money, transactions and events which are, in part at least, of a financial character, and interpreting the result

thereof.”


1.4 PRINCIPLES AND PRACTICE OF ACCOUNTING

As per this definition, accounting is simply an art of record keeping. The process of accounting starts by

first identifying the events and transactions which are of financial character and then be recorded in the

books of account. This recording is done in Journal or subsidiary books, also known as primary books. Every

good record keeping system includes suitable classification of transactions and events as well as their

summarisation for ready reference. After the transactions and events are recorded, they are transferred to

secondary books i.e. Ledger. In ledger, transactions and events are classified in terms of income, expense,

assets and liabilities according to their characteristics and summarised in profit and loss account and balance

sheet. Essentially the transactions and events are to be measured in terms of money. Measurement in terms

of money means measuring at the ruling currency of a country, for example, rupee in India, dollar in U.S.A.

and like. The transactions and events must have at least in part, financial characteristics. The inauguration

of a new branch of a bank is an event without having financial character, while the business disposed of by

the branch is an event having financial character. Accounting also interprets the recorded, classified and

summarised transactions and events.

However, the above-mentioned definition does not reflect the present day accounting function. The

dimension of accounting is much broader than that described in the above definition. According to the

above definition, accounting ends with interpretation of the results of the financial transactions and events

but in the modern world with the diversification of management and ownership, globalisation of business

and society gaining more interest in the functioning of the enterprises, the importance of communicating

the accounting results has increased and therefore, this requirement of communicating and motivating

informed judgement has also become the part of accounting as defined in the widely accepted definition

of accounting, given by the American Accounting Association in 1966 which treated accounting as

“The process of identifying, measuring and communicating economic information to permit informed

judgments and decisions by the users of accounts.”

In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public Accountants (AICPA)

enumerated the functions of accounting as follows:

“The function of accounting is to provide quantitative information, primarily of financial nature, about

economic entities, that is needed to be u

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