Errors Not Revealed by the Trial Balance

A trial balance tests only the arithmetical agreement of total debits and total credits. An error that affects the debit and credit sides equally, or that does not change the totals, leaves the trial balance in agreement. Such errors are not revealed by it.

1. Error of complete omission. A transaction is not recorded at all, so neither a debit nor a credit is made. For example, a credit sale of Rs 10,000 is left out of the sales book and the debtor's account.

2. Error of principle. A transaction is recorded against accounting principles, for example capital expenditure treated as revenue expenditure. Buying furniture and debiting Purchases instead of Furniture A/c is an example. The amount is correct on both sides, but the account head is wrong.

3. Error of commission (wrong account of the same type). An entry is posted to the wrong account but on the correct side. For example, a sale to Ram is debited to Shyam's account. The totals do not change.

4. Compensating errors. Two or more errors cancel each other. For example, the sales account is overcast by Rs 1,000 and the purchases account is also overcast by Rs 1,000. Because the effects offset, the trial balance still agrees.

5. Errors of original entry. A wrong amount is entered in the book of original entry and posted consistently to both accounts. For example, a credit sale of Rs 5,000 is recorded as Rs 500 in the sales book, and Rs 500 is debited to the debtor and credited to Sales.

6. Error of duplication. A transaction is recorded twice in the books of original entry and posted twice, which inflates both sides equally.

7. Reversal of entries. The debit and credit are posted to the correct accounts but on the wrong sides. For example, a payment to Hari is debited to Cash and credited to Hari. Total debits still equal total credits.

Note: Errors of partial omission, such as posting only one side of an entry, wrong totalling or a wrong balance carried forward, do disturb the trial balance and are therefore revealed by it.

Conclusion: These errors can be found only by careful checking of the books, reconciliations and internal checks. They are corrected by journal entries, using a suspense account where needed.

Depreciation is the systematic and gradual reduction in the book value of a fixed asset (such as machinery, furniture, building or vehicle) over its useful life, caused by wear and tear, passage of time, obsolescence or depletion. It is a non-cash operating expense charged against the revenue of each accounting period, and the amount is recorded in the Profit and Loss Account while the same amount is deducted from the asset's value in the Balance Sheet.

Three most common methods of calculating depreciation:

1. Straight Line Method (Fixed Instalment Method) — An equal amount of depreciation is charged every year throughout the useful life of the asset. $\text{Annual Depreciation} = \frac{\text{Cost} - \text{Scrap Value}}{\text{Useful Life}}$

2. Diminishing Balance Method (Written Down Value Method) — Depreciation is charged at a fixed percentage on the reducing (book) value of the asset each year, so the amount goes on decreasing every year.

3. Annuity Method — Depreciation is calculated by treating the cost of the asset as an investment on which interest is also considered, and the total amount charged each year includes both depreciation and interest on the unrecovered capital.

Cash Flow Statement — 5 marks

Meaning: A cash flow statement is a financial statement that shows the inflow and outflow of cash and cash equivalents of an organisation during a particular period. It explains how cash was generated and how it was used in operating, investing and financing activities. It is prepared as per Nepal Accounting Standard (NAS) 3 / IAS 7.

Components (Activities):

1. Operating Activities These are the principal revenue-producing activities of the business. It includes cash received from customers, cash paid to suppliers and employees, income tax paid, etc. It reflects the cash generated from day-to-day operations.

2. Investing Activities These relate to the acquisition and disposal of long-term assets and investments. It includes purchase/sale of fixed assets, purchase/sale of shares and securities of other companies, interest and dividend received, etc.

3. Financing Activities These relate to changes in the size and composition of owners' capital and borrowings. It includes issue of shares, receipt and repayment of loans, and payment of dividend and interest.

Importance:

• Shows the actual cash position and liquidity of the business.
• Helps in planning and forecasting future cash needs.
• Assists in assessing the ability to pay debts and dividends.
• Explains the difference between net profit and net cash balance.