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					B.Com – I:
Accounting

Study Notes

Compiled by: S.Hussain
                                           Compiled by: S.Hussain
                                           www.a4accounting.net
                                       a4accounting@hotmail.com


                    INDEX
S. NO.       CHAPTER                  PAGE #
1        INTRODUCTION                     3
2        BANK RECONCILIATION STATEMENT    9
3        SPECIAL JOURNALS                 10
4        FINANCIAL STATEMENTS             11
5        DEPRECIATION                     17
6        PARTNERSHIP                      22
7        INVENTORY VALUATION              29
8        VALUATION OF ACCOUNTS RECEIVABLE 33




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                                Chapter # 1
                              INTRODUCTION
ACCOUNTING
Accounting is the process of identifying, measuring, recording and communicating economic
transactions. Measurement is normally made in monetary terms and accountant will prepare records in
the forms of financial statements, such as income statement and balance sheet. The basic phases of
accounting are:
Recording:
Recording is a basic phase of accounting that is also known as bookkeeping. In this phase, all financial
transactions are recorded in a systematical and chronological manner in the appropriate books or
databases. Accounting recorders are the documents and books involved in preparing financial
statements. Accounting recorders include records of assets, liabilities, ledgers, journals and other
supporting documents such as invoices and checks.
Classifying:
The classifying phase of accounting involves sorting and grouping similar items under the designated
name, category or account. This phase uses systematic analysis of recorded data in which all
transactions are grouped in one place. The term "ledger" refers to the book in which classifications are
recorded.
Summarizing:
The summarizing phase of accounting involves summarizing the data after each accounting period, such
as a month, quarter or year. The data must be presented in a manner which is easy to understand and
use by both external and internal users of the accounting statements.
Interpreting:
The interpreting phase of the accounting process in concerned with analyzing financial data, and is a
critical tool for decision-making. This final function interprets the recorded data in a manner which
allows end-users to make meaningful judgments regarding the financial conditions of a business or
personal account, as well as the profitability of business operations. This data is then used to prepare
future plans and frame policies to execute financial plans.

BUSINESS TRANSACTION
Business transactions means that transactions which consist of money. An agreement between a buyer
and a seller to exchange an asset for payment is known as transaction. In accounting, any event or
condition recorded in the book of accounts.
For Example:
     Paid cash to the supplier Rs.40,000.
     Goods returned by the customers worth Rs.1,000.
     Rent paid in advance for three months Rs.30,000.

BUSINESS ENTITY
The unit for which accounting records are maintained and for which financial statements are prepared is
known as business entity.




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                               Chapter # 1
                             INTRODUCTION
ACCOUNTING PERIOD
Accounting period means span of time for which businesses are able to prepare a complete financial
statements for the determination of profit or loss. One complete accounting period should consist of 12
months. Businesses are allowed to divide the accounting period into monthly basis, quarterly or bi-
annually.

HEADS OF ACCOUNTS
There are only five heads of accounts to maintain the books of accounts.
   1) Assets.
   2) Liabilities.
   3) Owner’s equity / Proprietorship.
   4) Revenue and income.
   5) Expenses.

    1) ASSETS
An item of economic value owned by an individual or corporation, especially that which could be
converted to cash. There are two types of assets:
    a) Current assets.
    b) Fixed assets (Non-current assets).

      a) CURRENT ASSETS
The assets of an organization that are constantly changing their form and are circulating from cash to
goods and back to cash again are called current assets.
Cash / Bank:
Legal tender in the form of banknotes and coins.
Accounts Receivable:
The amounts owing to a business from customers for invoiced amounts are called accounts receivable.
Allowance for Bad Debts:
A provision calculated to cover the debts during an accounting period is called allowance for bad debts.
It is contra account of accounts receivable.
Merchandise Inventory:
The item which is purchased for resale is called merchandise and the unsold merchandise is called
merchandise inventory.
Prepaid:
Any amount paid in advance to get services in future is called prepaid.
Supplies:
Any amount paid to purchase office stationary is called supplies and the supplies will consume on future
so this is definitely prepaid but do not use the word “prepaid” before supplies.
Marketable Securities:
A marketable security means that market or organization will provide security against the investment
made.




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                                 Chapter # 1
                               INTRODUCTION
    b) FIXED ASSETS
An asset of a business intended for continuing use, rather than a short-term current asset (such as
merchandise) is called fixed asset. There are two types of fixed assets:
Tangible Fixed Assets:
Those assets which have physical existence are called tangible fixed assets.
Example:         Land, Building, Machinery, Furniture, Equipment, etc.
Intangible Fixed Assets:
Those assets which do not have physical existence are called intangible fixed assets.
Example:         Goodwill, Copyright, Trademark, Patents, etc.

    2) LIABILITIES
Liabilities are legal obligations to pay on demand or in future means commitment date. OR any amount
which is liable to pay is called liabilities.
There are two types of liabilities:

    a) CURRENT LIABILITIES
Amounts owed by a business to other organizations and individuals that should be paid within one year
from the balance sheet date.
Accounts Payable:
Money which is liable to a company by supplier for products purchased on credit.
Accrues Expenses:
The amount for which services are have been used but not paid is called accrued expenses like salaries
earned by employees but not yet paid.
Unearned:
Any amount received in advance to deliver services in future is called unearned.
Bank Overdraft:
A loan made to a customer with a cheque account at a bank in which the account is allowed to go into
debit, usually up to a specified limit.

    b) LONG TERM LIABILITIES
A sum that does not have to be repaid within the next accounting period of a business is called long
term liabilities.
Bank Loan:
A specified sum of money lent by a bank to a customer, usually for a specified time, at a specified rate of
interest is called bank loan. If the time period is les than 12 months, it is treated as current liabilities.
Mortgage:
An interest in property created as a security for a loan or payment of a debt and terminated on payment
of the loan or debt.
Debentures:
Debenture is the most common form of long-term loan taken by a company. It is usually a loan
repayable at a fixed date, although some debentures are irredeemable securities. Most debentures also
pay a fixed rate of interest, and this interest must be paid before a dividend is paid to shareholders.




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                                 Chapter # 1
                               INTRODUCTION
     3) OWNER’S EQUITY
The right of the owner in the business is known as owner’s equity. The owner has the right to make
investment in the business and only he has the right to make withdrawals from business. So he has right
to enjoy the profit of the business. This right is owner’s equity. It is calculated by subtracting total
liabilities from the total assets of the firm. It is also called as Capital.
Capital:
The money, property and other valuables which collectively represent the wealth of an individual or
business is called capital.
Drawings:
An asset (cash or goods) withdrawn from an incorporated business by its owner is called drawings. It is
contra account of capital. It means that it decreases the balance of capital.

    4) REVENUE AND INCOME
Revenue is the total amount of money received by the company for goods sold or services provided
during a certain time period. It also includes all net sales, exchange of assets, interest and other increase
in owner’s equity from operation of business and is calculated before any expenses are subtracted. Net
income can be calculated by subtracting expenses from revenue. OR
The source of earning in the organization from the operational activities of business is called revenue.
Sales:
Merchandise sold to customers or services rendered are called sales.
Sales Return & Allowances:
Goods return by customers is called sales return and allowances. It is contra account of sales.
Sales Discount:
Discount allowed to customers is called sales discount. It is also contra account of sales.
Other examples of revenue are: Commission income, Rent income, Interest income, etc.

    5) EXPENSES
The cost paid to earn revenue from business activities is called expenses. There are two types of
expenses:

    a) REVENUE EXPENDITURE
The expenditure which is benefited for limited time period maximum for one year is called revenue
expenditure. It is classified as an “expense” and charged to the income statement in the accounting
period in which it is made. For example, rent expense, interest expense, salaries expense, bad debts
expense, depreciation expense, utilities expense, purchases, etc.
Purchases:
Purchase of merchandise only is treated as purchases in merchandising business. Purchase discount and
purchase return and allowances are the contra accounts of purchases.
Bad Debts Expense:
An amount owed by a debtor that is likely to be unpaid is called bad debts expense. It is charged to the
income statement of the period.




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                                Chapter # 1
                              INTRODUCTION
Depreciation Expense:
A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence.
Most assets lose their value over time (in other words, they depreciate), and must be replaced once the
end of their useful life is reached. There are several accounting methods that are used in order to write
off an asset's depreciation cost over the period of its useful life. Because it is a non-cash expense,
depreciation lowers the company's reported earnings while increasing free cash flow.

     b) CAPITAL EXPENDITURE
The expenditure incurred for acquiring a fixed asset or which results in increasing the earning capacity of
the business is known as capital expenditures. The benefits of capital expenditures are generally availed
in several accounting years. It is classified as an “asset” in the balance sheet. For example: Building,
equipment, furniture, machinery, etc.

CONTRA ACCONTS
Contra accounts are the opposite accounts of its main account. They are used always to reduce its main
account balance. Some examples of contra accounts are given below:
MAIN ACCOUNT                    CONTRA ACCOUNT
All fixed assets (except land). Allowance for depreciation.
Accounts receivable.            Allowance for bad debts.
Capital.                        Drawings.
Sales.                          Sales return and allowances / Sales discount.
Purchases.                      Purchase return and allowances / Purchase discount.

DEBIT
Debit means to write on the left hand side of account.

CREDIT
Credit means to write on the right hand side of account.

RULES OF DEBIT AND CREDIT
          Head of Accounts            Increases                                    Decreases
Assets                     Recorded as Debit                             Recorded as Credit
Liabilities                Recorded as Credit                            Recorded as Debit
Owner’s Equity             Recorded as Credit                            Recorded as Debit
Revenue & Income           Recorded as Credit                            Recorded as Debit
Expenses                   Recorded as Debit                             Recorded as Credit

ACCOUNTING CYCLE
   Journal Entries:
    The transaction is recorded in journal as a debit and credit.
   Post to Ledger:
    The journal entries are transferred to the appropriate T-accounts in the general ledger.




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                                Chapter # 1
                              INTRODUCTION
       Trial Balance:
        A trial balance is calculated to verify that the sum of debits is equal to the sum of credits.
       Adjusting Entries:
        Adjusting entries are made for accrued and differed items. The entries are journalized and
        posted to the T-accounts in the general ledger.
       Adjusted Trial Balance:
        A new trial balance is calculated after making the adjusting entries.
       Financial Statement:
        Income statement, balance sheet and cash flow statements are prepared.
       Closing Entries:
        Transfer the balances of temporary accounts to owner’s equity account.
       After-Closing Trial Balance:
        A final trial balance is calculated after the closing entries made.
       Reversing Entries:
        Reverse the necessary adjusting entries (optional).

ACCOUNTING EQUATION
A balance sheet is so called because its two sides must always balance. The sum of assets shown on the
balance sheet must equal the equities. This relationship between assets and equities may be stated as:
Assets = Liabilities + Owner’s Equity

GENRAL JOURNAL
It is the simplest and the most flexible type of journal. The general journal can be used to record any
kind of transactions. For each transaction, it provides date, name of the accounts included, the amount
of each debit and credit, references, an explanation of transaction and a column to which each debit and
credit was recorded. The debits of a transaction must always equal to the credits.

GENRAL LEDGER
Ledger accounts are maintained to get the latest or accurate balance of each and every account because
ledger account is prepared on individual basis; we post all transactions from general journal to general
ledger account. There are two sides of ledger account. Left side is used for debit and right for credit
amount of that particular account. After the completion of posting, we just calculate the balance of
every account.

TRIAL BALANCE
A Trial Balance is a statement of ledger account balances within a ledger, at particular instance.
Its main purpose is to check mathematical\arithmetic accuracy of accounting. It is not an account. After
the closing process of footing and balancing of each and every account, and all the ledger accounts are
summarized into a statement known as trial balance. Since equal amounts of debit and credit are
recorded in the ledger accounts of each transaction, therefore, the sum of debit and credit must be
equal, if the balances had been extracted correctly.




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         Chapter # 2
BANK RECONCILIATION STATEMENT
BANK RECONCILIATION STATEMENT
Bank Reconciliation Statement is prepared in every organization after receiving the bank statement is
not supposed to agree. After of the said statement, the balance should be equal. The differences
between Cash Book and bank reconciliation statement can be arises due to following reasons:

ADD IN BANK STATEMENT
   Un-cleared cheques.
   Unrecorded cheques.
   Last day deposit cheques.
   Late deposit cheques.
   Cheques deposited but not shown in bank statement.
   Outstation cheques.
   Deposit in transit.
   Any error made by bank which results decrease in balance.

LESS FROM BANK STATEMENT
   Un-presented cheques.
   Outstanding cheques.
   Cheques issued but not shown in bank statement.
   Any error made by bank which results increase in balance.

ADD IN CASH BOOK
   Note/bill received by bank as per instructions.
   Interest on note/bill received by bank as per instruction.
   Interest credited by bank.
   Dividend collected by bank as per instructions.
   Any amount of profit received by bank as per instructions.
   Direct deposit by customer into bank account.
   Error by company which results decrease in receipt side or increase in payment side.

LESS FROM CASH BOOK
   Note/bill paid by bank as per instructions.
   Interest on note/bill paid by bank as per instructions.
   Interest debited by bank.
   Any amount of liability or expenses paid by bank as per instructions.
   Zakat deductions.
   Bank service charges.
   Collection charges.
   Dishonored cheques.
   Post dated cheques.
   Mark up.
   Error by company which results increase in receipt side or decrease in payment side.



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                              Chapter # 3
                           SPECIAL JOURNALS
SPECIALIZED JOURNALS
Special journals are maintained on monthly basis to know what actual amount is on debtors and
creditors. There are six types of special journals.

    1) PURCHASE JOURNAL
Purchase journal is used to record all the transactions related to the purchase of merchandise on
account only. No cash transactions are recorded in purchase journal.

    2) PURCHASE RETURN AND ALLOWANCE JOURNAL
Purchase return and allowance journal is used to record all the transactions related merchandise
returned to suppliers.

    3) SALES JOURNAL
Sales journal is used to record all the transactions related to the sale of merchandise on account only.
No cash transactions are recorded in sales journal.

    4) SALES RETURN AND ALLOWANCE JOURNAL
Sales return and allowance journal is used to record all the transactions related merchandise returned
by customers.

   5) CASH RECEIPTS JOURNAL
Cash receipts journal is used to record all the transactions related to the receipts of cash.

   6) CASH PAYMENTS JOURNAL
Cash payments journal is used to record all the transactions related to the payments of cash.

CONTROL ACCOUNTS
Control accounts are accounts in which the balances are designed to equal the aggregate of the
balances on a substantial number of subsidiary accounts. Examples are the sales ledger control account
(or total debtors account), in which the balance equals the aggregate of all the individual debtors’
accounts, the purchase ledger control account (or total creditors account), which performs the same
function for creditors.

SUBSIDIARY LEDGER
Subsidiary ledgers are the individual account of each customer or supplier.




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                      Chapter # 4
                 FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Financial statement is a written report which quantitatively describes the financial health of a company.
This includes an income statement, balance sheet, cash flow statement and statement of changes in
equity. Financial statements are usually compiled on a quarterly and annually basis.

INCOME STATEMENT
Income statement shows the financial performance of the business. It shows the result of operations for
a period. It consists of revenue and expenses. When total revenues exceed the total expenses, the
resulting amount is net profit. When expenses exceed revenues, the resulting amount is net loss.
Net profit/loss = Net sales – Cost of goods sold – Operating expenses + Other income.

Performa of Income Statement:
Sales                                                                                 XXX
Less: Sales discount                                                   XXX
Less: Sales returns and allowances                                     XXX          (XXX)
Net sales                                                                                             XXX
Less: Cost of Goods Sold:
Merchandise inventory (beg)                                                           XXX
Add: Net Purchases:
Purchases                                                              XXX
Add: Transportation in                                                 XXX
Delivered purchases                                                    XXX
Less: Purchase discount                                              (XXX)
Less: Purchase returns & allowances                                  (XXX)
Net purchases                                                                         XXX
Merchandise available for sale                                                        XXX
Less: Merchandise inventory (end)                                                   (XXX)
Cost of goods sold                                                                                  (XXX)
Gross profit                                                                                          XXX
Less: Operating Expenses:
Office salaries expense                                                               XXX
Insurance expense                                                                     XXX
Bad debts expense                                                                     XXX
Office rent expense                                                                   XXX
Repair expense                                                                        XXX
Depreciation expense                                                                  XXX
Total operating expenses                                                                           (XXX)
Profit/loss from operation                                                                     XXX/(XXX)
Add: Other Income:
Commission income                                                                                    XXX
Net profit/Loss                                                                                XXX/(XXX)




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                       Chapter # 4
                  FINANCIAL STATEMENTS
BALANCE SHEET
Balance sheet shows the financial position of business. It is listing of firm’s assets, liabilities and owner’s
equity on a given date. It is a quantitative summary of company’s financial condition at a specific point
in time, including assets, liabilities and net worth. The first part of balance sheet shows all the
productive assets a company owns, and the second part shows all the financing methods (such as
liabilities and owner’s equity).

Performa of Balance Sheet:
                        ASSETS                                                 EQUITIES
Current Assets:                                       Liabilities:
Cash                                              XXX Current Liabilities:
Accounts receivable                  XXX              Accounts payable                                      XXX
Les: All for bad debts             (XXX)          XXX Notes payable                                         XXX
Merchandise inventory                             XXX Accrued expenses                                      XXX
Prepaid expenses                                  XXX Unearned income                                       XXX
Office supplies                                   XXX Total current liabilities                             XXX
Accrued income                                    XXX Long Term Liabilities
Total current assets                              XXX Mortgage payable                          XXX
Fixed Assets:                                         Other long term liabilities               XXX
Equipment                            XXX              Total long term liabilities                           XXX
Less: All for depreciation         (XXX)              Total liabilities                                     XXX
Total fixed assets                                XXX Owner’s Equity:
                                                      Capital                                  XXX
                                                      Add: Net profit/loss               XXX/(XXX)
                                                                                               XXX
                                                      Less: Drawings                         (XXX)
                                                      Total owner’s equity                                  XXX
Total assets                                      XXX Total equities                                        XXX

ADJUSTMENTS
Adjustments are made on the date of closing before preparation of complete financial statements for
the determination of profit or loss. Some of the items which have already been recorded in the books or
which have not yet been recorded in the books, have to adjust and make adjusting entry. This is very
much important for the calculation of fair profit or loss.

       Adjustment for bad Debts:
Bad debts expense                                 DR.
          Allowance for bad debts                         CR.
If trial balance shows the debit balance of allowance for bad debts and the data for adjustment shows
an amount, the entry will be passed by adding both amounts of trial balance and data for adjustment. If
trial balance shows the credit balance of allowance for bad debts and data for adjustment shows an
amount, the entry will be passed by subtracting the trial balance amount from the amount of data for
adjustment.



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                       Chapter # 4
                  FINANCIAL STATEMENTS
    Adjustment for Depreciation:
Depreciation expenses                            DR. (with the depreciation amount for the period)
       Allowance for depreciation                        CR. (with the depreciation amount for period)

     Adjustment for Accrued Expense:
Salaries expense                                DR. (with unpaid amount)
         Salaries payable                                 CR. (with unpaid amount)
There could be any other expense in place of salaries like interest, insurance and rent.

    Adjustment for Accrued Income:
Commission receivable                         DR. (with receivable amount)
        Commission income                               CR. (with receivable amount)
There could be any income in place of commission like interest and rent.

     Adjustment for Asset Approach:
Insurance expense                              DR. (with expired amount)
        Prepaid insurance                                CR. (with expired amount)
There could be any expense in place of insurance like rent and office supplies.

     Adjustment for Expense Approach:
Prepaid insurance                              DR. (with prepaid amount)
        Insurance expense                                CR. (with prepaid amount)
There could be any expense in place of insurance like rent and office supplies.

    Adjustment for Liability Approach:
Unearned commission                           DR. (with income amount)
        Commission income                               CR. (with income amount)
There could be any income in place of commission like rent.

    Adjustment for Income Approach:
Commission income                             DR. (with unearned amount)
        Unearned commission                            CR. (with unearned amount)
There could be any income in place of commission like rent.

REVERSING ENTRIES
Reversing entries are based on adjusting entries and recorded in the books on the first day of new
accounting period. It is optional. There are only four adjusting entries which are required to be reversed.
     Accrued expense.
     Accrued income.
     Expense approach.
     Income approach.




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                      Chapter # 4
                 FINANCIAL STATEMENTS
CLOSING ENTRIES
Closing entries are made at the end of an accounting period to close off the revenue and expense
ledgers to the income summary account (expense and summary account or profit and loss account).
Revenue and expenses are temporary accounts for the period that why they are required to be closed to
get the net profit or loss.

Performa of Closing Entries:
     Entry to close all expenses:
Expense and revenue summary                    DR.
       Merchandise inventory (beg)                       CR.
       Purchases                                         CR.
       Sales return and allowances                       CR.
       Sales discount                                    CR.
       Transportation – in                               CR.
       Salaries expense                                  CR.
       Depreciation expense                              CR.
       Bad debts expense                                 CR.
       Rent expense                                      CR.
       Office supplies expense                           CR.
       Insurance expense                                 CR.
       Interest expense                                  CR.

     Entry to close all revenue:
Sales                                          DR.
Merchandise inventory (end)                    DR.
Rent income                                    DR.
Commission income                              DR.
Purchase returns and allowances                DR.
Purchase discount                              DR.
        Expense and revenue summary                      CR.

    Entry to transfer net profit to capital account:
Expense and revenue summary                     DR.
       Capital                                           CR.

    Entry to transfer net loss to capital account:
Capital                                         DR.
        Expense and revenue summary                      CR.

    Entry to close drawings account into capital account:
Capital                                      DR.
        Drawings                                      CR.




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                       Chapter # 4
                  FINANCIAL STATEMENTS
OPENING ENTRY
Opening entry is made to open a business. All the assets and liabilities must be entered into the
accounts, together with the owner’s equity. Opening entry is made on the first day of new accounting
period.

Performa of Opening Entry:
Cash                                              DR.
Accounts receivable                               DR.
Merchandise inventory                             DR.
Office supplies                                   DR.
Prepaid expenses                                  DR.
Accrued income                                    DR.
Fixed assets                                      DR.
        Accounts payable                                  CR.
        Accrued expenses                                  CR.
        Unearned income                                   CR.
        Allowance for bad debts                           CR.
        Allowance for depreciation                        CR.
        Other current liabilities                         CR.
        Long term liabilities                             CR.
        Capital                                           CR.

CORRECTION OF ERRORS
Correcting entries are made to correct the error in the books of account. There are two types of errors.
One error where the trial balance still balances. Other error where trial balance does not balances.

ERRORS WHERE TRIAL BALANCE STILL BALANCES
   Error of Omission:       A transaction has been completely omitted from the accounting record.
   Error of Commission: A transaction has been recorded in the wrong account.
   Error of Principle:      A transaction has conceptually been recorded incorrectly.
   Compensating Error: Two different errors have been made which cancel each other out.
   Error of Original Entry: the correct double entry has been made but with the wrong amount.
   Reversal of Entries:     The correct amounts have been posted to the correct accounts but on
    wrong side.

ERRORS WHERE TRIAL BALANCE DOES NOT BALANCES
      A debit entry has been made but no credit entry or vice versa.
      Debit entry is made with different amount and credit entry is made with different account.
      Debit and credit both are made on the same side.
If the debits of trial balance do not agree with the credits of trial balance, then suspense account is used
to correct the difference.




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                      Chapter # 4
                 FINANCIAL STATEMENTS
WORK SHEET
Work sheet is a device which shows the pre-closing trial balance, adjustments, adjusted trial balance,
income statement and balance sheet in a single sheet. Work sheet helps to make different statements in
a single sheet. It is also called ten column work sheet because it contains ten columns. Two columns for
pre-closing trial balance (debit and credit), two columns for adjustments (debit and credit), two columns
for adjusted trial balance (debit and credit), two columns for income statement (debit and credit) and
two columns for balance sheet (debit and credit). Pre-closing trial balance shows the balances before
adjustments. Adjustments columns show the adjustments made at the end of the period to adjust the
expenses and income for the period. Adjusted trial balance column shows the balance of trial balance
accounts after the adjustments. Income statement shows the income and expenses of the period.
Balance sheet shows the financial position of the business. It shows the assets, liabilities and owner’s
equity at the particular date.




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                                 Chapter # 5
                                DEPRECIATION
DEPRECIATION
A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence.
Most assets lose their value over time (in other words, they depreciate), and must be replaced once the
end of their useful life is reached. There are several accounting methods that are used in order to write
off an asset's depreciation cost over the period of its useful life. Because it is a non-cash expense,
depreciation lowers the company's reported earnings while increasing free cash flow.

CAPITAL EXPENDITURE
The expenditure incurred for acquiring a fixed asset or which results in increasing the earning capacity of
the business is known as capital expenditures. The benefits of capital expenditures are generally availed
in several accounting years.

REVENUE EXPENDITURE
An expenditure incurred in the course of regular business a transaction of a concern is availed in the
same accounting year is known as revenue expenditure.

Differences between Capital Expenditure and Revenue Expenditure:
  BASIS OF DIFFERENCE           CAPITAL EXPENDITURE                  REVENUE EXPENDITURE
   1. Purpose              It is incurred for the purchase It is incurred for the maintenance of
                           of fixed assets.                fixed assets.
   2. Earning Capacity     It increases the earning        It does not increase the earning capacity
                           capacity of the business.       of the business.
   3. Periodicity of       Its benefits are spread over a Its benefit is only for one accounting
      Benefit              number of years.                period.
   4. Placement in         It is an item of balance sheet It is an item of trading and profit and
      Financial Statements and is shown as an asset.       loss account and is shown on the debit
                                                           side of either of the two.

SALVAGE VALUE
The net residual value of an asset at the end of its useful life, when it is no longer suitable for its original
use is called salvage value. It is also known as scrap value, residual value or resale value.

BOOK VALUE
The value at which an asset appears in the books of organization (usually as at the date of the last
balance sheet) is called book value. This is the purchase cost or latest revaluation less any depreciation
applied since purchase or revaluation.
Book value = Cost – Allowance for depreciation

DEPRECIABLE COST
The cost of fixed asset which is depreciated during its whole working life is called depreciable cost.
Depreciable cost = Cost – Salvage value




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                                Chapter # 5
                               DEPRECIATION
METHODS OF DEPRECIATION
     1) STRAIGHT LINE METHOD
A method of calculating the depreciation of an asset which assumes the asset will lose an equal amount
of value each year. The annual depreciation is calculated by subtracting the salvage value of the asset
from the purchase price, and then dividing this number by the estimated useful life of the asset. It is also
called fixed installment method because the amount of depreciation remains fixed during the whole life
of asset. Usually this method is used for those fixed assets whose life does not affect it its production.
Yearly depreciation = Cost – Scrap value
                         Estimated Life in years

    2) DIMINISHING BALANCE METHOD
A common depreciation-calculation system that involves applying the depreciation rate against the non-
depreciated balance is known as diminishing balance method. Instead of spreading the cost of the asset
evenly over its life, this system expenses the asset at a constant rate, which results in declining
depreciation charges each successive period. It is also known as declining balance method or reducing
balance method. Usually this method is used for those fixed assets whose life can affect on its
production.
Yearly depreciation = Cost/Book value x Rate (%)

    3) SUM OF THE YEAR’S DIGIT METHOD
Sum of the year’s digit method is a system for calculating the annual depreciation expense for a capital
asset. The calculation involves identifying the number of years over which the asset will be depreciated
and summing all of the numbers while counting back to one. This becomes the denominator in the ratio
used to determine annual depreciation. The numerator is the number of years remaining in the life of
the asset.
Yearly depreciation = Depreciable cost x Yearly fraction

   4) UNIT PRODUCTION METHOD
Accounting method where a provision for depreciation is computed at a fixed rate per unit of product,
based on an estimate of the total number of units the property will produce during its service life. This
method is useful only when the total number of units of production can be accurately estimated.
Rate per unit = Cost – Scrap value
                Estimated life in units
Yearly depreciation = Units produced x Rate per unit

   5) WORKING HOURS METHOD
Accounting method where a provision for depreciation is computed at a fixed rate per hour of machine,
based on an estimate of the total number of hours the machine will work during its service life. This
method is useful only when the total number of hours can be accurately estimated.
Rate per hour = Cost – Scrap value
                Estimated life in hours
Yearly depreciation = Hours worked x Rate per hour




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                                  Chapter # 5
                                 DEPRECIATION
Computation of Cost of Machine:
List price of fixed asset                                             XXX
Less: Trade discount                                                 (XXX)
Invoice price                                                         XXX
Less: Cash discount                                                  (XXX)
Cash price payable                                                    XXX
Add: Sales tax                                                        XXX
Net cash price                                                        XXX
Add: Additional Cost Incurred:
Freight – in                                                XXX
Insurance in transit                                        XXX
Import duty / custom duty                                   XXX
Foundation charges                                          XXX
Installation charges                                        XXX
Testing charges                                             XXX
Total additional cost incurred                                       (XXX)
Total cost of machine                                                 XXX

Entry to Record the Purchase of Fixed Asset:
Fixed asset                             DR. (with net cash price)
        Cash                                    CR. (with net cash price)
(To record the purchase of fixed asset)

Fixed asset                              DR. (with total additional cost incurred)
        Cash                                     CR. (with total additional cost incurred)
(To record the additional cost incurred)

Entry to Record the Depreciation for the Period:
Depreciation expense              DR.
       Allowance for depreciation      CR.

SALE OF FIXED ASSET
A fixed asset can be sold after or before the end of its useful life. If the asset is sold more than its book
value, it is said to be gain on sale but if the asset is sold less than its book value, it is said to be loss on
sale.

Computation of Gain or Loss on Sale:
Cost of fixed asset                                          XXX
Less: Allowance for depreciation up to date                 (XXX)
Net book value                                               XXX
Less: Sold for                                              (XXX)
Gain/Loss on sale                                         XXX/(XXX)




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                                         Chapter # 5
                                        DEPRECIATION
Entry to Record the Sale of Fixed Asset:
(In case of gain):
Cash                                                            DR. (with amount received for sale of fixed asset)
Allowance for depreciation                                      DR. (with accumulated depreciation up top date of sale)
           Gain on sale                                                    CR. (with gain on sale)
           Fixed asset                                                     CR. (with original cost)
------------------------------------------------------------------------------------------------------------------------------------------

(In case of loss):
Cash                                                            DR. (with amount received for sale of fixed asset)
Allowance for depreciation                                      DR. (with accumulated depreciation up top date of sale)
Loss on sale                                                    DR. (with loss on sale)
           Fixed asset                                                     CR. (with original cost)
------------------------------------------------------------------------------------------------------------------------------------------

EXCHANGE OF FIXED ASSET
Fixed asset can be exchanged with other fixed asset. If the value of trade-in-allowance is more than the
book value of fixed asset (old), it is said to be gain on exchange but if the value of trade-in-allowance is
less than the book value of fixed asset (old), it is said to be loss on exchange. Trade-in-allowance is the
value of old fixed asset which is agreed at market for sale.

Computation of Gain or Loss on Exchange:
Cost of fixed asset (old)                      XXX
Less: Allowance for depreciation up to date   (XXX)
Net book value                                 XXX
Less: Trade-in-allowance                      (XXX)
Gain/Loss on exchange                       XXX/(XXX)

Computation of Cash Payment:
Cost of fixed asset (new)                                                  XXX
Less: Trade-in-allowance                                                  (XXX)
Cash payment                                                               XXX




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                                         Chapter # 5
                                        DEPRECIATION
Entry to Record the Exchange of Fixed Asset:
(In case of gain):
Fixed asset (new)                                               DR. (with cost of new fixed asset)
Allowance for depreciation                                      DR. (with accumulated depreciation up top date of sale)
           Gain on exchange                                                CR. (with gain on sale)
           Cash                                                            CR. (with cash payment for exchange)
           Fixed asset (old)                                               CR. (with original cost)
------------------------------------------------------------------------------------------------------------------------------------------

(In case of loss):
Fixed asset                                                     DR. (with cost of new fixed asset)
Allowance for depreciation                                      DR. (with accumulated depreciation up top date of sale)
Loss on exchange                                                DR. (with loss on sale)
           Cash                                                            CR. (with cash payment for exchange)
           Fixed asset (old)                                               CR. (with original cost)
------------------------------------------------------------------------------------------------------------------------------------------

DISCARD
Fixed asset can be retired instead of sale or exchange. If the fixed asset is retired before the end of its
estimated useful life, it is said to be loss on discard.

Computation of Loss on Discard:
Cost of fixed asset                                                        XXX
Less: Allowance for depreciation up to date                               (XXX)
Loss on discard                                                            XXX

Entry to Record the Loss on Discard:
Allowance for depreciation                                      DR. (with accumulated depreciation up top date of sale)
Loss on discard                                                 DR. (with loss on discard)
           Fixed asset                                                     CR. (with original cost)
------------------------------------------------------------------------------------------------------------------------------------------
REVISED DEPRECIATION
When estimated life of fixed asset is changed or salvage value is changed or any capital expenditure
(extra ordinary repair) incurred during the period on the fixed asset, then revised depreciation is
calculated.

Computation of Revised Cost:
Revised cost = Cost – Allowance for depreciation + Extra ordinary repair

Computation of Revised Depreciation by Straight Line Method:
Depreciation = Cost – Allowance for depreciation + Extra ordinary repair – New salvage value
                              Remaining life/Revised life of fixed asset




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                                 Chapter # 6
                                PARTNERSHIP
PARTNERSHIP
Partnership is an association of two or more people (partners) formed for the purpose of carrying on a
business. Partnerships are governed by Partnership Act 1980. Unlike an incorporated company, a
partnership does not have a legal personality of its own and therefore partners are liable for the debts
of firm.

KINDS OF PARTNERS
    1) ACTIVE PARTNER
Investor who participates in the day to day management of the partnership is known as active partner.

    2) SLEEPING PARTNER
Sleeping partner is a partner who shares risks and rewards of an enterprise or venture with other
partners, but does not take part in its day-to-day management.

    3) NOMINAL PARTNER
Nominal partner is a person who has an interest in the success of a partnership firm but, legally, is not
partner because he or she neither owns a part of the firm nor actively participates in its affairs. Often a
nominal partner is a well known, well connected individual whose name lends credibility and recognition
to the firm, and is paid a fee for this service.

PARTNERSHIP DEED
Partnership agreement in writing is called partnership deed. Partnership deed is a document which is
signed by all the partners and which contains all the matters determining and governing the mutual
rights, duties and liabilities of the partners in the conduct and management of the affairs of the
partnership. It may also be referred to as articles of partnership” containing the name, nature of
business, capital, duration of the firm, etc.
The partnership deed usually contains the following clauses.

1. Name and location of business.
2. The nature of the business.
3. The amount of capital to be contributed by each partner.
4. Provisions or reinvestment in business.
5. The duties, powers and obligations of all the partners.
6. Length or life of business.
7. The method of distribution of profit and sharing of the losses.
8. Method of admitting a new partner.
9. Procedure for withdrawal of a partner.
10. The method of valuation of goodwill on and or retirement or death of a partner.
11. Method of revaluation of assets or liabilities on admission, retirement or death of a partner.
12. Procedure to be followed for expulsion of a partner.
13. Arrangements to be followed in case a partner becomes insolvent.
14. Salary, if any, payable to the partners for managing the firm.




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                                          Chapter # 6
                                         PARTNERSHIP
15. The method of preparing accounts and arrangement for audit.
16. Procedure for the dissolution of the firm and settlement of accounts.
17. Arbitration in case of disputes among partners.
18. Operation of bank account.

FORMATION OF PARTNERSHIP
Formation means the establishment of partnership. Two or more than two partners can form a
partnership. Basically there re two situation of formation of partnership. One is that the partners are not
doing there separate business and decided to form a partnership. It means that they do not have any
separate business before the formation of partnership. Other situation is that the partners are sole
traders and were doing there separate business and decided to form a partnership by merging their
businesses. They merge their assets and liabilities at an agreed value.

Entry to Record Formation of Partnership:
Cash/Other assets                                               DR. (with investment amount)
           A’s capital                                                     CR. (with investment amount)
-----------------------------------------------------------------------------------------------------------------------------------------
Cash/Other assets                                               DR. (with investment amount)
           B’s capital                                                     CR. (with investment amount)
-----------------------------------------------------------------------------------------------------------------------------------------
                                                                    OR
Cash/Other assets                                               DR. (with investment amount)
           Accounts payable/Other liabilities                              CR. (with liability amount)
           A’s capital                                                     CR. (with net asset amount)
-----------------------------------------------------------------------------------------------------------------------------------------
Cash/Other assets                                               DR. (with investment amount)
           Accounts payable/Other liabilities                              CR. (with liability amount)
           B’s capital                                                     CR. (with net asset amount)
-----------------------------------------------------------------------------------------------------------------------------------------

ADMISSION OF A PARTNER
Admission of a partner means that a new person wants to join the partnership. A new partner can admit
in the partnership by the following ways:
      By purchasing interest of old partners.
      By making investment.




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                                          Chapter # 6
                                         PARTNERSHIP
Admission by Purchase Method:
In this case the new partner purchases the interest of old partner or partners by paying cash to them
from his private sources which is not recorded in the partnership.

Entry to Record the Admission of New Partner by Purchase Method:
Old partners’ capital                                           DR. (with the share purchases by new partner)
           New partner’s capital                                           CR. (with the shares purchased of old partners)
-----------------------------------------------------------------------------------------------------------------------------------------

Admission by Investment:
In this case new partner makes investment in the partnership. When the new partner makes
investment, bonus or goodwill arises in the partnership.

Computation of Bonus:
Old partners’ capital                                                               XXX
Add: New partner’s investment                                                       XXX
Total capital of firm                                                               XXX
For xx interest new partner’s capital (total capital x new partner’s interest)      XXX
Less: New partner’s investment                                                     (XXX)
Bonus to old/new partner                                                         (XXX)/XXX
Negative value shows the bonus goes to old partners and positive value shows the bonus goes to new
partner.

Entry to Record the Admission by Bonus Method:
When bonus goes to new partner:
Cash/other assets                                               DR. (with investment amount)
Old partners’ capital                                           DR. (with the amount of bonus goes to new partner)
           New partner’s capital                                           CR. (with the capital amount)
-----------------------------------------------------------------------------------------------------------------------------------------
When bonus goes to old partners:
Cash/other assets                                               DR. (with investment amount)
           Old partners’ capital                                           CR. (with amount of bonus goes to old partners)
           New partner’s capital                                           CR. (with the capital amount)
-----------------------------------------------------------------------------------------------------------------------------------------

Goodwill Method:
Check:
New partner’s investment                                                                                        XXX
Multiply by opposite interest of new partner                                                                    XXX
Total capital of firm                                                                                           XXX
Less: Old partners’ capital                                                                                     XXX
Less: New partner’s investment                                                                                 (XXX)
                                                                                                             (XXX)/XXX



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                                          Chapter # 6
                                         PARTNERSHIP
Negative amount shows the goodwill goes to new partner and positive amount shows the goodwill goes
to old partners. If goodwill goes to new partner, computation will be started with old partners’ capital.
And if goodwill goes to old partners, computation will be started with new partner’s investment.

Computation of Goodwill to Old Partners:
For xx interest, new partner’s investment                                                                                         XXX
Therefore total capital of firm (new partner’s investment x opposite interest of new partner)                                     XXX
For xx interest old partners’ capital (total capital x old partners’ interest)                                                    XXX
Less: Old partners’ capital before admission                                                                                     (XXX)
Goodwill to old partners                                                                                                          XXX

Entry to Record the Admission of New Partner by Goodwill Method:
Goodwill goes to old partners:
Cash /other assets                                              DR. (with investment amount)
           New partner’s capital                                           CR. (with investment amount)
-----------------------------------------------------------------------------------------------------------------------------------------
Goodwill                                                        DR. (with the amount of total goodwill)
           Old partners’ capital                                           CR. (with their ratio)
-----------------------------------------------------------------------------------------------------------------------------------------

Computation of Goodwill to New Partner:
For xx interest, old partners’ capital                                                                                            XXX
Therefore total capital of firm (old partners’ capital x opposite interest of old partners)                                       XXX
For xx interest new partner’s capital (total capital x new partner’s interest)                                                    XXX
Less: New partner’s investment                                                                                                   (XXX)
Goodwill to new partner                                                                                                           XXX

Entry to Record the Admission of New Partner by Goodwill Method:
Goodwill goes to new partner:
Cash /other assets                                              DR. (with investment amount)
Goodwill                                                        DR. (with total goodwill amount)
           New partner’s capital                                           CR. (with capital amount)
-----------------------------------------------------------------------------------------------------------------------------------------

Sufficient Cash:
In this case new partner’s investment is equal to his/her capital.
For xx interest, old partners’ capital                                                                                            XXX
Therefore total capital of firm (old partners’ capital x opposite interest of old partners)                                       XXX
For xx interest new partner’s capital (total capital x new partner’s interest)                                                    XXX




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                                          Chapter # 6
                                         PARTNERSHIP
Entry to Record the Admission of New Partner by Sufficient Cash:
Cash/other assets                                               DR. (with investment amount)
           New partner’s capital                                           CR. (with capital amount)
-----------------------------------------------------------------------------------------------------------------------------------------

New partner can admit into the partnership after the revaluation of assets of the business. It means that
before the admission of new partner, all the assets and liabilities will be revalued to get the fair value of
business. In that case a revaluation account is created to settle the increase or decrease in the value of
assets and then it is transferred to the old partners’ capital.

RETIREMENT OF A PARTNER
When a partner leaves the partnership and other partners continue the partnership, it is said to be
retirement of a partner.

Retirement by Sell Method:
In this situation, the retiring partner sells his capital interest to remaining partners by taking some cash
from remaining partners which they paid to him/her from their private sources and which is not
recorded in the books.

Entry to Record the Retirement by Sell Method:
Retiring partner’s capital                                      DR. (with capital amount)
           Remaining partners’ capital                                     CR. (with their ratio)
-----------------------------------------------------------------------------------------------------------------------------------------

Retirement by Goodwill Method:
If the retiring partner gets the amount more than his/her capital, it is treated as goodwill goes to retiring
partner and then total goodwill of firm is calculated.

Computation of Goodwill:
Capital of retiring partner                                                                                       XXX
Less: Amount paid to retiring partner                                                                            (XXX)
Excess amount paid to retiring partner                                                                            XXX
Total goodwill of firm (Excess amount x opposite interest of retiring partner)                                    XXX

Entry to Record the Retirement by Goodwill Method:
Goodwill                                                        DR. (with the total goodwill amount)
           Remaining partners’ capital                                     CR. (with their ratio)
           Retiring partner’s capital                                      CR. (with his/her ratio)
-----------------------------------------------------------------------------------------------------------------------------------------
Retiring partner’s capital                                      DR. (with capital after distribution of goodwill)
           Cash                                                            CR. (with amount paid to retiring partner)
-----------------------------------------------------------------------------------------------------------------------------------------




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                                          Chapter # 6
                                         PARTNERSHIP
Retirement by Bonus Method:
When retiring partner gets less than his capital amount, it is treated as bonus and also when retiring
partner gets more than capital amount it is also treated as bonus.

Computation of Bonus (More than Capital):
Capital of retiring partner                                                                                       XXX
Less: Amount paid to retiring partner                                                                            (XXX)
Bonus to retiring partner                                                                                         XXX

Entry to Record the Retirement of Partner by Bonus (More than Capital):
Retiring partner’s capital                                      DR. (with his/her capital)
Remaining partners’ capital                                     DR. (with the distribution of bonus)
           Cash                                                            CR. (with the amount paid to retiring partner)
-----------------------------------------------------------------------------------------------------------------------------------------

Computation of Bonus (Less than Capital):
Capital of retiring partner                                                                                       XXX
Less: Amount paid to retiring partner                                                                            (XXX)
Bonus to remaining partners                                                                                       XXX

Entry to Record the Retirement of Partner by Bonus (Less than Capital):
Retiring partner’s capital                                      DR. (with his/her capital)
           Remaining partners’ capital                                     DR. (with the distribution of bonus)
           Cash                                                            CR. (with the amount paid to retiring partner)
-----------------------------------------------------------------------------------------------------------------------------------------

Before the retirement of the partner, the assets of the business may be revalued to get the fair value of
the business and the capital of retiring partner. In this situation a revaluation account is to be created to
settle the increase or decrease in the value of assets and then transfer it to the all partners’ capital
account. At the time of retirement, the capital of retiring partner is considered after the adjustment of
revaluation of the assets.




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                                  Chapter # 6
                                 PARTNERSHIP
DISTRIBUTION OF PROFIT OR LOSS
When the partnership earns profit or loss, it is distributed among the partners according to their ratio. If
there is no agreement about the ratio of partners, profit or loss will be distributed equally. Profit or loss
will be distributed to the partners after the distribution of salaries, commission, bonus, interest on
capital, and interest on drawings. The profit or loss earned by the partnership firm is transferred to the
partners’ current account instead of their capital account in case of fixed capital. Income Distribution
Summary is prepared for the distribution of profit or loss.

DISSOLUTION / LIQUIDATION OF PARTNERSHIP
Liquidation of partnership means the termination of partnership. It means that the firm will not operate
further. N liquidation, all the assets (inventory and fixed assets) are sold for cash either more than their
book value or less than their book value. The profit or loss arises, if any, from the sale of assets are
recorded in the realization account. Then accounts receivable are collected from customer (equal to
book value or less than value) and payments are paid to the suppliers. Again the differences, if any, are
recorded in the realization account. Goodwill of the firm are closed to the partners; account by debiting
partners’ account and credit the goodwill account. Now the realization (profit or loss) is transferred to
the partners’ capital account. If partners’ capital account show negative balance after the distribution of
realization, it is necessary to know that the partner is solvent or insolvent. If the partner is solvent,
he/she can contribute cash from his private sources. But if the partner is insolvent, he/she can not
contribute cash and his/her loss will have to be distributed among the other partners.




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                           Chapter # 7
                      INVENTORY VALUATION
INVENTORY VALUATION
The valuation on inventory at the end of particular period is called inventory valuation. An inventory
count takes place to confirm that actual quantities support the figures given in the books of accounts.
The differences between the inventories at the beginning and at the end of the period are used in
calculation of cost of goods sold. There are two systems of inventory valuation:
    a) Perpetual Inventory System.
    b) Periodic/physical Inventory System.

    a) PERPETUAL INVENTORY SYSTEM
The process of keeping records in an inventory ledger or on a bin card in which the balance of the
quantity in inventory is entered after each receipt or issue of stock. In some system the value of
inventory balance is also entered after each transaction.
There are three methods on inventory valuation under perpetual inventory system:

   i.    FIFO METHOD (FIRST IN FIRST OUT)
A method of valuing units of merchandise issued from inventory based on using the earliest unit value
for pricing the issues until all the stock received at that price has been used up. The next latest price is
then used for pricing the issues, and so on.

 ii.      LIFO METHOD (LAST IN FIRST OUT)
A method of valuing units of merchandise issued from the inventory by using the latest unit value for
pricing the issues until all the quantity of inventory received at that price is used up. The next earliest
price is then used for pricing the issues, and so on.

 iii.   MOVING AVERAGE METHOD
A method of valuing units of merchandise issued from inventory; it involves the recalculating the unit
value to e used for pricing the issues after each new consignment has been added to the stock. The
average is obtained by dividing the total stock value by the number of units in inventory.

Format of Inventory Card by Perpetual Inventory System:
Date        Received/Purchase            Sale/Issue                                               Balance
           Quantity   Unit cost   Total cost     Quantity   Unit cost   Total cost     Quantity   Unit cost    Total cost




        This column shows the                  This column shows the                 This column shows the
        Total purchases.                       Cost of goods sold.                   Cost of ending inventory.




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                             Chapter # 7
                        INVENTORY VALUATION
Entry to Record the Purchase of Merchandise under Perpetual System:
Merchandise                                                     DR. (with purchase amount)
           Accounts payable/Cash                                           CR. (with cash paid or payable amount)
------------------------------------------------------------------------------------------------------------------------------------

Adjusting Entry under Perpetual System:
Cost of goods sold                                              DR. (with the cost of goods sold)
           Merchandise                                                     CR. (with cost of goods sold)
------------------------------------------------------------------------------------------------------------------------------------

     b) PERIODIC INVENTORY SYSTEM
The counting or evaluating of the inventory held by an organization at the end of particular period is
called periodic inventory system. Same as perpetual inventory system, there are three methods of
inventory valuation under periodic inventory system:
     i.     FIFO Method (First in First Out).
     ii.    LIFO Method (Last in First Out).
     iii.   Weighted Average Method.

Format of Units Purchased, Units Sold and Units at End:
Date: Beginning inventory in units                       @ Rs.xx                                                     XXX units.
Add: Units Purchased During the Period:
Date: Units purchased                            @ Rs.xx         XXX units
Date: Units purchased                            @ Rs.xx         XXX units
Total units purchased during the period                                                                              XXX units
Total units available for sale during the period                                                                     XXX units
Less: Units sold during the period                                                                                   (XXX) units
Unsold units at end                                                                                                  XXX units

After making this schedule, the computation of cost of goods sold or cost of ending inventory takes
place.

Entry to Record the Purchase of Merchandise under Periodic Inventory System:
Purchases                                                       DR. (with purchase amount)
           Accounts payable/Cash                                           CR. (with cash paid or payable amount)
------------------------------------------------------------------------------------------------------------------------------------

Adjusting Entry under Periodic Inventory System:
Merchandise inventory                                           DR. (with cost of ending inventory)
           Expense and revenue summary                                     CR. (with cost of ending inventory)
------------------------------------------------------------------------------------------------------------------------------------




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                         Chapter # 7
                    INVENTORY VALUATION
SPECIFIC IDENTIFICATION METHOD
This method is used in that organization where the prices of inventory are very high with low
transactions. For example, a car dealer sales car with low transactions but with high selling prices. In this
method, it is easy to identify the cost of each unit without using any method.

GROSS PROFIT METHOD
Merchandise inventory (beginning)                                   XXX
Add: Net Purchases:
Purchases                                                XXX
Add: Transportation-in                                   XXX
Delivered purchases                                      XXX
Less: Purchase return and allowance                     (XXX)
Less: Purchase discount                                 (XXX)
Net purchases                                                       XXX
Merchandise available for sale                                      XXX
Less: Cost of Goods Sold:
Sales                                                    XXX
Less: Sales return                                      (XXX)
Less: Sales discount                                    (XXX)
Net sales                                                XXX
Less: Gross profit (net sales x gross profit rate)      (XXX)
Cost of goods sold                                                (XXX)
Cost of ending inventory                                           XXX

RETAIL PRICE METHOD
                                                                          COST PRICE                RETAIL PRICE
Beginning inventory                                                          XXX                        XXX
Add: Net Purchases:
Purchases                                                    XXX
Add: Transportation-in                                       XXX
Delivered purchases                                          XXX
Less: Purchase return and allowance                         (XXX)
Less: Purchase discount                                     (XXX)
Net purchases                                                                XXX                         XXX
Merchandise available for sale                                               XXX                         XXX
Less: Net Sales:
Sales                                                                                       XXX
Less: Sales return and allowances                                                          (XXX)
Less: Sales discount                                                                       (XXX)
Net sales                                                                                               (XXX)
Ending inventory based on retail price                                                                   XXX




                                                        B.Com - I - Accounting                     Page 31
                                                                                   Compiled by: S.Hussain
                                                                                   www.a4accounting.net
                                                                               a4accounting@hotmail.com

                       Chapter # 7
                  INVENTORY VALUATION
Percentage of Cost =   Merchandise available for sale at cost price                  x 100%
                       Merchandise available for sale at retail price

Cost of ending inventory =       Ending inventory at retail price x Percentage of cost

EFFECTS OF INVENTORY ON FINANCIAL STATEMETS
     Overstatement of Ending Inventory:
Cost of goods sold =    Decrease
Gross profit       =    Increase
Net profit         =    Increase
Capital            =    Increase

     Understatement of Ending Inventory:
Cost of goods sold =    Increase
Gross profit       =    Decrease
Net profit         =    Decrease
Capital            =    Decrease

     Overstatement of Beginning Inventory:
Cost of goods sold =    Increase
Gross profit       =    Decrease
Net profit         =    Decrease
Capital            =    Decrease

     Understatement of Beginning Inventory:
Cost of goods sold =    Decrease
Gross profit       =    Increase
Net profit         =    Increase
Capital            =    Increase

COMPARATIVE INCOME STATEMENT
    PARTICULARS        FIFO                                           LIFO                    WEIGHTED
                                                                                              AVERAGE
Sales                                              XXX                       XXX                     XXX
Less: Cost of Goods Sold:
Opening inventory                     XXX                      XXX                        XXX
Add: Net purchases                    XXX                      XXX                        XXX
Merchandise available for sale        XXX                      XXX                        XXX
Less: Ending inventory               (XXX)                    (XXX)                      (XXX)
Cost of goods sold                                (XXX)                      (XXX)                  (XXX)
Gross profit                                       XXX                        XXX                    XXX




                                                      B.Com - I - Accounting                      Page 32
                                                                                                         Compiled by: S.Hussain
                                                                                                         www.a4accounting.net
                                                                                                     a4accounting@hotmail.com

                          Chapter # 8
                    VALUATION OF ACCOUNTS
                         RECEIVABLE
BAD DEBTS
An amount owed by a debtor that is unlikely to be paid is called bad debts or uncollectible. The full
amount should be written off to the income statement of the period or to a provision for bad debts as
soon as it is foreseen.

DOUBTFUL DEBT
An amount owed to an organization by a debtor that it might well not receive. A provision for doubtful
debts may be created, which may be based on specific debts or on the general assumptions that a
certain percentage of debtors’ amounts are doubtful. As the doubtful debt becomes a bad debt, it may
be written off to the provision for doubtful debts or alternatively charged to the profit and loss account
if there is no provision.

PROVISION FOR BAD DEBTS
A provision calculated to cover the debts during an accounting period that are not expected to be paid.
It is also called allowance for bad debts.

WRITE OFF
To reduce to zero a debt that cannot be collected is known as writing off customer’s account.

RECOVERY OF BAD DEBTS
Debts originally classed as bad debts and written off to the profit and loss account (or to a provision for
bad and doubtful debts) but subsequently recovered either in part or in full. Bad debts recovered should
be written back to the profit and loss account of the period (or to provision for bad and doubtful debts).

     1. Entry to Record Credit Sale During the Year:
Accounts receivable                                             DR. (with amount receivable from customer)
           Sales                                                           CR. (with amount of sale)
----------------------------------------------------------------------------------------------------------------------------------------

     2. Entry to Record the Cash Collected from Customers:
Cash                                                            DR. (with amount received)
           Accounts receivable                                             CR. (with amount received)
----------------------------------------------------------------------------------------------------------------------------------------

     3. Entry to Record Discount Allowed to Customers:
Sales discount                                                  DR. (with discount allowed amount)
           Accounts receivable                                             CR. (with discount allowed amount)
----------------------------------------------------------------------------------------------------------------------------------------




                                                                       B.Com - I - Accounting                                Page 33
                                                                                                         Compiled by: S.Hussain
                                                                                                         www.a4accounting.net
                                                                                                     a4accounting@hotmail.com

                          Chapter # 8
                    VALUATION OF ACCOUNTS
                         RECEIVABLE
     4. Entry to Record the Goods Return by Customers:
Sales returns and allowances                                    DR. (with sales return amount)
           Accounts receivable                                             CR. (with sales return amount)
----------------------------------------------------------------------------------------------------------------------------------------

     5. Entry to Record Promissory Note Received from Customer Against Credit Sale
Note receivable                                                 DR. (with amount of note receivable)
           Accounts receivable                                             CR. (with amount of note receivable)
----------------------------------------------------------------------------------------------------------------------------------------

     6. Entry to Record Advance from Customer/Over-payment by Customer:
Accounts receivable                                             DR. (with amount received in advance)
           Advance from customer                                           CR. (with amount received in advance)
----------------------------------------------------------------------------------------------------------------------------------------

     7. Entry to Record Write off Customer’s Account:
Allowance for bad debts                                         DR. (with amount write off)
           Accounts receivable                                             CR. (with amount write off)
----------------------------------------------------------------------------------------------------------------------------------------

     8. Entry to Record Recovery of Previously Written off Customer’s Account:
Accounts receivable                                             DR. (with amount received)
           Allowance for bad debts                                         CR. (with amount received)
----------------------------------------------------------------------------------------------------------------------------------------
Cash                                                            DR. (with amount received)
           Accounts receivable                                             CR. (with amount received)
----------------------------------------------------------------------------------------------------------------------------------------

     9. Entry to Record the Bad Debts Expense for the Year:
Bad debts expense                                               DR. (with amount of bad debts)
           Allowance for bad debts                                         CR. (with amount of bad debts)
----------------------------------------------------------------------------------------------------------------------------------------




                                                                       B.Com - I - Accounting                                Page 34
                                                               Compiled by: S.Hussain
                                                               www.a4accounting.net
                                                           a4accounting@hotmail.com

                  Chapter # 8
            VALUATION OF ACCOUNTS
                 RECEIVABLE
Computation of Bad Debts Expense by Applying Rate on Net Credit Sales:
Total credit sales                        XXX
Less: Sales return and allowances        (XXX)
Less: Sales discount                     (XXX)
Net sales                                 XXX
Rate of bad debts                         XX%
Bad debts expense for the year            XXX

Computation of Bad Debts Expense by Applying Rate on Accounts Receivable (End):
Accounts receivable at the end of year                    XXX
Rate of bad debts                                         XX%
Allowance for bad debts closing at the end of year        XXX
Less: Allowance for bad debts opening balance            (XXX)
Less: Allowance for bad debts credited during the period (XXX)
Add: Allowance for bad debts debited during the period    XXX
Bad debts expense for the year                            XXX




                                          B.Com - I - Accounting           Page 35

				
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