Financial Accounting

The business entity concept treats the business as a separate unit, distinct from its owner(s). The business and the owner are two different persons for accounting purposes, although legally a sole proprietorship may not be separate.

• Only the transactions of the business are recorded in its books. The owner's personal transactions are kept out.
• The capital invested by the owner is treated as a liability of the business to the owner (owner's equity).
• If the owner withdraws cash or goods for personal use, it is recorded as drawings.
• The profit of the business belongs to the owner, but it is calculated separately for the business.

This concept helps to find the true profit and financial position of the business.

Working

• Debtors after further bad debts = 55,000 - 5,000 = Rs 50,000
• Required provision at 10% = Rs 5,000
• Existing provision = Rs 500, so the charge to profit and loss = 5,000 - 500 = Rs 4,500

Provision for Bad Debts Account

(Total bad debts charged to profit and loss are 2,000 + 5,000 = Rs 7,000, and the provision charged is Rs 4,500.)

Adjusted cash book balance

Bank Reconciliation Statement as on 31st Chaitra

The going concern concept assumes that a business will continue its operations for an indefinite period in the future and will not be liquidated or reduced in scale. Because of this assumption:

• fixed assets are recorded at cost and written off through depreciation over their useful lives, not shown at their realisable (sale) value;
• prepaid expenses are carried forward, and outstanding expenses and long-term liabilities are recorded in the normal way;
• the financial statements are prepared on the normal basis of valuation.

The concept does not apply if the business is expected to close down, when assets are valued at their break-up values.

Working

Entries

• Bad debts written off: Bad Debts A/c Dr 3,000, To Debtors A/c 3,000.
• Total bad debts (200 + 3,000) = Rs 3,200 transferred to Income Statement.
• Existing provision Rs 5,000 exceeds the required Rs 4,700, so Rs 300 is released to the Income Statement.

Provision for Bad Debts Account

Effect on Income Statement: Bad debts Rs 3,200 is debited; the reduction in provision Rs 300 is credited. Net charge = 3,200 − 300 = Rs 2,900.

Effect on Balance Sheet: Debtors Rs 47,000 less provision for bad debts Rs 4,700 = Rs 42,300 shown under current assets.

Bank Reconciliation Statement as on 31st Chaitra

The going concern concept assumes that a business will continue to operate for the foreseeable future and has neither the intention nor the need to liquidate or curtail its operations materially. Because of it, assets are recorded at cost less depreciation instead of at forced-sale value, prepaid expenses are carried forward, and fixed assets are depreciated over their useful lives.

The business entity concept treats the business as a separate unit, distinct from its owner. Transactions of the business are recorded from the business's point of view, and the owner's personal affairs are kept out of the books; the owner's investment is treated as a liability (capital) of the business to the owner.

Accounting standards are authorised rules, guidelines and principles issued by a professional or regulatory body that govern how financial transactions are recognised, measured, presented and disclosed in financial statements. They bring uniformity, comparability and reliability. In Nepal the Accounting Standards Board issues them as NFRS (Nepal Financial Reporting Standards, based on IFRS).

An intangible asset is a non-monetary asset of the business that has no physical existence but has value and gives future economic benefit, such as goodwill, patents, copyrights, trademarks and software licences. It is shown in the balance sheet and its cost is written off over its useful life (amortisation).

The accounting period concept states that the life of a business is divided into equal time periods, usually one year, for which the financial results and position are measured and reported. Income and expenses are matched to the period in which they belong, so profit and the balance sheet are prepared at the end of each period (in Nepal, the fiscal year from Shrawan to Ashadh).

In the cash basis of accounting, a transaction is recorded only when cash is actually received or paid. Income is recognised when cash is received and expenses when cash is paid, regardless of the period they relate to. It is simple and used by small businesses and non-profit bodies, but it does not match revenues with expenses, so it gives a less accurate profit and ignores debtors and creditors. It is not accepted under NFRS, which require the accrual basis.

The main types of cheque are:

• Bearer cheque: payable to the person holding it; it can be cashed by anyone who presents it.
• Order cheque: payable to a named person or to his order; it can be transferred by endorsement.
• Crossed cheque: has two parallel lines across its face, so it is paid only through a bank account and not in cash.
• Open (uncrossed) cheque: can be paid in cash over the counter.
• Post-dated cheque: bears a future date and cannot be paid before that date.
• Stale cheque: presented after the validity period (usually 6 months) and not honoured.
• Self cheque: drawn by the account holder in his own name to withdraw cash.

Accounting equation: Assets = Liabilities + Capital.

(a) Cash Rs 160,000 and furniture Rs 140,000 are invested as capital.

$\text{Assets } (160{,}000 + 140{,}000 = 300{,}000) = \text{Capital } 300{,}000$

(b) Commission received Rs 42,000 includes advance commission of Rs 6,000. Only Rs 36,000 is earned income; Rs 6,000 is unearned (a liability).

$342{,}000 = 6{,}000 + 336{,}000$

Profit for the year is not an OCI item, and gain on sale of investment is recognised in profit or loss, so it is already in the profit. OCI contains only the revaluation loss and the cash flow hedge gain.

Statement of Other Comprehensive Income for the year

Opening share capital Rs 500,000 and retained earnings Rs 100,000. New shares: $3{,}000 \times 100 =$ Rs 300,000 share capital and premium $3{,}000 \times 10 =$ Rs 30,000. Preliminary expenses are an asset and do not enter the equity statement.

Statement of Changes in Equity for the year ended 2021

Depreciation is by the units of activity (service hours/kilometres) method.

$\text{Depreciation per km} = \frac{840{,}000 - 40{,}000}{80{,}000} = \text{Rs } 10$

• 2077: $12{,}000 \times 10 =$ Rs 120,000
• 2078: $14{,}000 \times 10 =$ Rs 140,000

Accounting information is used by many people who make decisions about the business. They are of two groups.

Internal users

• Owners/shareholders: to judge profit, return on investment and safety of capital, and to decide on dividends.
• Management: to plan, control, price products and make decisions on expansion and costs.
• Employees: to assess the stability of the business, their pay, bonus and job security.

External users

• Investors and potential investors: to decide whether to buy, hold or sell shares.
• Creditors and lenders (banks, suppliers): to assess the ability to repay loans and pay for credit purchases.
• Customers: to judge whether the supplier will continue to exist and supply.
• Government and tax authorities (IRD): for taxation, regulation and statistics.
• Regulators and researchers: to check legal compliance (e.g. Company Registrar, Nepal Rastra Bank) and for research and analysis.
• General public: interested in the business's effect on the community, employment and the environment.

Accounting is thus a part of accountancy; accountancy is the larger subject.

Ledger. A ledger is the principal book of accounts in which all transactions already recorded in the journal (or subsidiary books) are classified and posted under separate accounts, such as the cash account, sales account and each debtor and creditor account. Each account has a debit (Dr) side and a credit (Cr) side, and its balance shows the net result of all transactions affecting it.

Why it is prepared

1. Classification: the journal records transactions in date order; the ledger groups all transactions of the same nature in one account.
2. Ascertaining balances: the balance of every account (assets, liabilities, income, expenses, capital) is found at any time.
3. Basis for the trial balance: ledger balances are listed in the trial balance to check arithmetic accuracy.
4. Preparation of final accounts: profit and loss account and balance sheet are prepared from ledger balances.
5. Control and reference: it shows the amounts owed by debtors and to creditors and helps in decisions, control and detection of errors.
6. Legal and permanent record: it is the permanent record of the financial dealings of the business.

Comparative (Horizontal) Analysis of Assets

$\%\text{ change} = \frac{\text{2078} - \text{2077}}{\text{2077}} \times 100$

Interpretation. Total assets grew by 54.22%. The largest growth is in investment (150%) and plant and machinery (75%), showing expansion. Cash and bank fell by 50%, which may signal a liquidity problem, while receivables fell by 40%, suggesting better collection.

Bank Reconciliation Statement of ABC Traders as on 31st Ashadh 2079

Starting from the balance as per bank statement (Cr balance):

Proof from the cash book:

Both balances agree at Rs 26,000, so the reconciliation is correct.

(a) Value Added Statement

Application of value added

(b) Net profit for the year

Depreciation 15% on reducing balance, charged for the period of ownership in each year. Machine A (Rs 400,000, 1 Jan 2019) is sold on 30 June 2021; Machine B (Rs 300,000) is bought on 30 June 2020.

Workings

• 2019: A: $400{,}000 \times 15\% = 60{,}000$; book value 340,000.
• 2020: A: $340{,}000 \times 15\% = 51{,}000$; B: $300{,}000 \times 15\% \times \tfrac{6}{12} = 22{,}500$; book values A 289,000, B 277,500.
• 2021: A (6 months to date of sale): $289{,}000 \times 15\% \times \tfrac{6}{12} = 21{,}675$; book value at sale $289{,}000 - 21{,}675 = 267{,}325$. Profit on sale $= 280{,}000 - 267{,}325 = 12{,}675$. B: $277{,}500 \times 15\% = 41{,}625$; book value 235,875.

Machinery Account

Introduction. Just as a language lets people communicate ideas, accounting communicates the financial affairs of a business to those interested in it. The statement "accounting is the language of business" means that the performance, position and results of every business are expressed and understood through accounting information, in the form of money.

Why accounting is called the language of business

1. Records business transactions: every business activity (sales, purchases, expenses, borrowing) is turned into a standard monetary record in the journal, ledger and trial balance, just as ideas are put into words and sentences.
2. Communicates to users: financial statements (income statement, balance sheet, cash flow statement, statement of changes in equity) tell owners, managers, investors, creditors, employees, government and the public how the business is doing.
3. Common and universal terms: terms such as assets, liabilities, capital, revenue, debit and credit have the same meaning for all businesses, and accounting standards (NFRS/IFRS) make statements understood across countries.
4. Helps in decisions: owners decide on investment and dividends, managers on pricing, costs and expansion, banks on lending, tax authorities on tax. Without accounting information these decisions would be guesses.
5. Measures performance and position: profit or loss and the financial position at a date are expressed in numbers that can be compared between periods and between firms through ratio and trend analysis.
6. Control and planning: budgets and accounting records show whether plans are met, where costs are wasted and where action is needed.
7. Legal and evidence value: accounts are required by company, tax and audit laws and serve as evidence in disputes, loan applications and tax assessment.
8. Interprets results: through analysis and interpretation the "language" tells a story, for example rising receivables with falling cash points to a collection problem.

Limitations of the language. Like any language, accounting must be properly understood. It records only transactions measurable in money, ignores things like staff skills and goodwill built internally, depends on estimates and accounting policies, and is based on historical cost. A user without accounting knowledge may misunderstand it.

Conclusion. Accounting is rightly called the language of business because it converts business activities into a standard, understandable form and communicates them to all interested parties for decision-making. A person who cannot read accounts cannot understand the business.

An accounting standard is a set of authoritative written rules, principles and guidelines issued by a recognised professional or regulatory body, which prescribes how transactions and events are to be recognised, measured, presented and disclosed in financial statements. In Nepal, the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of Nepal (ICAN) issues the Nepal Financial Reporting Standards (NFRS), which are based on IFRS.

Needs (importance) of accounting standards

1. Uniformity and consistency: They reduce the variety of accounting policies, so that similar transactions are treated alike across firms and periods.
2. Comparability: Users can compare the financial statements of different companies and of the same company over time.
3. Reliability and credibility: Following accepted rules makes the statements more trustworthy for investors, lenders, regulators and the public.
4. Transparency and disclosure: Standards require adequate disclosure of accounting policies and material information, which reduces manipulation and window dressing.
5. Guidance for preparers and auditors: They give a benchmark for preparing statements and a basis on which auditors form an opinion.
6. Basis for law and regulation: They help the Companies Act, tax authorities and regulators (Nepal Rastra Bank, SEBON) to enforce proper reporting.
7. International acceptance: Adoption of NFRS/IFRS helps in attracting foreign investment and raising capital abroad.

Limitations of accounting standards

1. Choice of alternatives: Some standards still allow alternative treatments, so complete uniformity is not achieved.
2. Rule-based rigidity: Rigid application may not suit the special circumstances of every business.
3. Judgement and estimates: Many items (depreciation, provisions, fair value) depend on management's judgement, which can be misused.
4. Cost and complexity: Applying standards needs trained staff, systems and fees, which is a heavy burden for small firms.
5. Lag behind business reality: Standards take time to be issued, so new types of transactions may remain uncovered.
6. Historic-cost orientation and non-financial matters: They do not capture non-monetary factors such as human resources or environmental impact.
7. Weak enforcement: Penalties for non-compliance may be weak, and a conflict with the law of the country may limit their use.

(a) Statement of Profit or Loss of KK Company for the year ended 31 December 2021

(b) Statement of Financial Position of KK Company as at 31 December 2021

The two sides agree at Rs 668,000. No adjustment for loan interest is given, so none is made.

Statement of Cash Flows of ABC Company for the year ended 31 December 2021 (indirect method)

Working notes

• Purchase of PPE: closing 600,000 = opening 500,000 + purchases - depreciation 90,000, so purchases = Rs 190,000.
• Purchase of investments: 110,000 - 40,000 = Rs 70,000.
• Tax paid: opening liability 0 + provision 21,250 - closing liability 21,250 = Rs 0.
• Share capital issued: 590,000 - 500,000 = Rs 90,000. Loan raised: 150,000 - 100,000 = Rs 50,000.

The closing balance of Rs 40,000 agrees with the cash in the statement of financial position.

Figures for 2021 (Rs): current assets 190,000; current liabilities 50,000; inventory 60,000 (opening 40,000); total liabilities 200,000; equity 615,000; total capital 815,000; sales 1,200,000; cost of sales 800,000; net profit 75,000; account receivables 30,000 (opening 40,000). Averages are used for turnover and return ratios, and all sales are taken as credit sales.

(a) Current ratio

$\frac{\text{Current assets}}{\text{Current liabilities}}=\frac{190{,}000}{50{,}000}=3.8:1$

(b) Acid test ratio

$\frac{190{,}000-60{,}000}{50{,}000}=2.6:1$

(c) Debt to total capital ratio

$\frac{\text{Total debt}}{\text{Total capital}}=\frac{200{,}000}{815{,}000}=24.54\%$

(d) Stock turnover ratio

Average stock $=\frac{40{,}000+60{,}000}{2}=50{,}000$

$\frac{800{,}000}{50{,}000}=16\text{ times}$

(e) Total assets turnover ratio

Average total assets $=\frac{670{,}000+815{,}000}{2}=742{,}500$

$\frac{1{,}200{,}000}{742{,}500}=1.62\text{ times}$

(f) Net profit margin

$\frac{75{,}000}{1{,}200{,}000}\times100=6.25\%$

(g) Return on equity

Average equity $=\frac{490{,}000+615{,}000}{2}=552{,}500$

$\frac{75{,}000}{552{,}500}\times100=13.57\%$

(h) Return on assets

$\frac{75{,}000}{742{,}500}\times100=10.10\%$

(i) Average sales period (collection period)

Average receivables $=\frac{40{,}000+30{,}000}{2}=35{,}000$

(j) Account receivable turnover ratio

$\frac{1{,}200{,}000}{35{,}000}=34.29\text{ times}$

$\text{Average sales period}=\frac{365}{34.29}=10.65\text{ days}$

(k) Comment on the results

The company is strongly liquid and lightly geared, and it uses its stock, assets and receivables efficiently. Only the net profit margin (6.25% against 12%) fails the standard, so management should control distribution and administrative expenses or raise selling prices. The very high current ratio suggests that some current assets may be lying idle and could be used more productively.

1. Sales book over-cast by Rs 3,000

Sales and the Sales Book total were overstated, so the Sales Account was credited with Rs 3,000 too much. The error is removed by debiting Sales.

(The Suspense A/c is used because the error affected only one account and the trial balance disagreed.)

2. Rs 10,000 for carriage of vehicle debited to Carriage A/c

Carriage on a vehicle is capital expenditure and should be added to the cost of the vehicle.

Accounting equation: $\text{Assets}=\text{Liabilities}+\text{Owner's Equity}$

1. Shares issued: $5{,}000\times\text{Rs }100=\text{Rs }5{,}00{,}000$. Cash increases and share capital increases.
2. Wages paid Rs 26,000, of which Rs 2,000 is advance (prepaid) wages. Wages expense is Rs 24,000, which reduces equity. Prepaid wages of Rs 2,000 is an asset. Cash falls by Rs 26,000.

Total assets $=4{,}74{,}000+2{,}000=\text{Rs }4{,}76{,}000$

Total equity $=5{,}00{,}000-24{,}000=\text{Rs }4{,}76{,}000$

Hence Assets (Rs 4,76,000) = Liabilities (nil) + Owner's Equity (Rs 4,76,000).

A credit note is a document sent by the seller to the buyer (or by the buyer's request) stating that the buyer's account has been credited with an amount, usually for goods returned, overcharge or allowance.

Why it is prepared

• When goods sold are returned by the customer (sales return) or are damaged or defective.
• When the seller has overcharged the customer or allows a price reduction.
• It is the basis for recording the entry in the Sales Returns Book (Returns Inward Book) and for crediting the customer's account.
• It informs the customer that the amount due from him has been reduced.

Accounting is the process of identifying, recording, classifying, summarising and communicating the financial information of an entity. The information is meaningful because it helps users make economic decisions, such as whether to invest, lend, buy or sell.

Use of accounting information by different users

• Owners and investors: to judge profitability and the safety of their investment, and to decide whether to buy, hold or sell shares.
• Management: for planning, budgeting, controlling costs, pricing and deciding on expansion.
• Creditors and banks: to assess liquidity and solvency before giving credit or loans.
• Employees: to assess the stability of the firm and bargain for wages and bonus.
• Government and tax authorities: to assess tax liability and regulate business.
• Customers and suppliers: to judge whether the firm can continue and supply or pay.
• Researchers and the public: to study trends and the firm's contribution to the economy.

Why the information is meaningful

• The financial statements (income statement, balance sheet, cash flow statement) show profit, financial position and cash flows.
• Accounting follows standards and concepts, so the information is relevant, reliable, comparable and understandable.
• Past records allow comparison between periods and between firms, and support forecasting.

Therefore accounting provides meaningful information on which economic decisions are based.

Debtors after writing off additional bad debts

$220{,}000-20{,}000=\text{Rs }200{,}000$

New provision required $=10\%\times200{,}000=\text{Rs }20{,}000$

Existing provision $=\text{Rs }20{,}000$ (credit balance)

Additional provision required $=20{,}000-20{,}000=\text{nil}$

Provision for Doubtful Debts Account

Effect on Income Statement

Balance sheet: Sundry debtors Rs 200,000 less provision for doubtful debts Rs 20,000 gives Rs 180,000.

The pass book shows an overdraft, so the bank balance is a credit balance. First the cash book balance is found from the pass book, then it is corrected for the cash book errors.

Bank Reconciliation Statement

Check (corrected cash book). Overdraft as per cash book 43,800, less under-cast 2,000, less excess bank charges 800, add interest debited by bank 3,000 = Rs 44,000. Pass book overdraft 20,000, less uncollected cheques 6,000, add unpresented cheques 30,000 = Rs 44,000. The two agree, so the statement is correct.

Only credit purchases are entered in the purchase book. The cash purchase of 28 March is recorded through the cash book and appears directly in the purchase account. No rate of trade discount is given for the Anal Book Shop purchase, so 10% is assumed.

(a) Purchase Book

(b) Purchase Account

Net purchases for the month are Rs 22,880.

Assumptions: the part payment to Tata Group and all expenses are paid in cash; the cheque from Mr. Sharma and the loan from NMB Bank are deposited in Nabil Bank; interest on the loan is not accrued as no period is given; the whole year's rent is expensed as paid.

1. Journal

2. Ledger (balance form)

Share Capital A/c

Machinery A/c

Purchases A/c

Tata Group A/c

Sales A/c

Mr. Sharma A/c

Loan from NMB Bank A/c

Expense and discount accounts

3. Cash Book (cash and bank columns)

Debit side

Credit side

4. Financial Statements

Trading and Profit and Loss Account for the period

Balance Sheet as at the end of Ashad

5. Cash Flow Statement (direct method)

Closing cash in hand Rs 281,000 plus cash at bank Rs 480,000 equals Rs 761,000, which agrees with the cash book.

A trademark is a distinctive name, symbol, logo, word, design or mark legally registered by a business to identify its goods or services and distinguish them from those of competitors. It gives the owner the exclusive right to use the mark for a fixed period, which is renewable. A trademark is an intangible fixed asset: when it is purchased or registered, its cost is capitalised and written off gradually over its useful life.

A bill of exchange is a written, signed, unconditional order by a creditor (the drawer) directing a debtor (the drawee) to pay a fixed sum of money, either on demand or on a fixed future date, to a named person (the payee) or to the bearer. It becomes binding on the drawee once he accepts it by signing across its face. For the drawer it is a bill receivable, and for the drawee a bill payable. It is a negotiable instrument and is used to settle credit transactions.

Salary is an expense of the business and is paid by cheque, so salary is debited and bank is credited.

Accounting equation: Assets = Liabilities + Capital

Financial position after each transaction:

• After 1: Assets 195,000 = Liabilities 0 + Capital 195,000
• After 2: Assets 245,000 = Liabilities 50,000 + Capital 195,000
• After 3: Assets 225,000 = Liabilities 50,000 + Capital 175,000
• After 4: Assets 225,000 = Liabilities 51,500 + Capital 173,500

(a) A machine is a fixed asset (capital expenditure) and was wrongly debited to Purchases.

(b) Life insurance premium of the proprietor is a personal expense, so it is the proprietor's drawings.

Definition. Accounting is the art of identifying, measuring, recording, classifying, summarising and interpreting financial transactions and events of an organisation, and communicating the results to interested users so that they can make informed decisions. The American Accounting Association describes it as "the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information."

Major objectives

1. Systematic recording of transactions. To keep a complete and permanent record of all financial transactions in the books of account, so that nothing is forgotten.
2. Determining profit or loss. To ascertain the result of operations of a period by preparing the trading and profit and loss account.
3. Showing the financial position. To show the assets, liabilities and capital on a given date through the balance sheet.
4. Providing information to users. To supply useful information to owners, managers, creditors, investors, employees, government and others for decision making.
5. Control over assets and liabilities. To protect business property from misuse and fraud, and to know the amounts receivable from debtors and payable to creditors.
6. Compliance with law. To meet the requirements of tax, company and other laws, and to serve as evidence in legal disputes.
7. Comparison and planning. To allow comparison of results over different periods and with other firms, and to help in budgeting and future planning.

Adjusted cash book balance

Bank Reconciliation Statement as on last day of Chaitra

Assumption: the provision for doubtful debts is maintained at 5% of the ending sundry debtors, so the required provision is 5% of Rs 60,000 = Rs 3,000. If an opening balance exists in the account, only the difference is charged to profit and loss.

(a) Journal entries

(b) Provision for Doubtful Debts Account

The balance of Rs 3,000 is carried forward as the opening provision of the next year. In the balance sheet, sundry debtors Rs 60,000 are shown less provision Rs 3,000, giving net debtors of Rs 57,000.

Only credit purchases are entered in the purchase book. The purchase of Chaitra 8 was made in cash, so it is recorded in the cash book and appears directly in the purchase account. Trade discount on Chaitra 28 is taken on the dining table sets only.

Working

• Chaitra 8 (cash): computer tables 5 x 5,000 = 25,000; chairs 8 x 4,000 = 32,000; total 57,000; less 10% trade discount 5,700; net 51,300.
• Chaitra 15: dressing tables 25,000; T.V racks 8 x 8,000 = 64,000; total 89,000.
• Chaitra 28: dining sets 5 x 10,500 = 52,500; less 5% = 2,625; net 49,875; sofa sets 4 x 7,000 = 28,000; total 77,875.

(a) Purchase Book

(b) Purchase Account

Assumptions: the machine is bought at Rs 200,000 and the 5% discount on settlement (Rs 10,000) is treated as discount received; the part payment of Rs 47,500 to National Goods Supplier is made from the bank (cash in hand cannot cover it together with the electricity bill); electricity is paid in cash; depreciation at 10% is charged on the full cost of machines (Rs 700,000); interest on investment of 10% on Rs 150,000 is Rs 15,000.

1. Journal

2. Ledger (balance form)

Accounts Receivable A/c

Accounts Payable A/c

Closing payables of Rs 140,000 consist of opening Rs 40,000 plus Rs 100,000 owed to National Goods Supplier.

Accumulated Depreciation A/c

3. Triple Column Cash Book

Debit side

Credit side

4. Worksheet and Financial Statements

Worksheet

Income Statement for the year

Balance Sheet as at the end of the year

5. Cash Flow Statement (direct method)

Closing bank Rs 377,500 plus cash in hand Rs 25,000 equals Rs 402,500, which agrees with the cash book.

A trial balance is a statement prepared on a particular date that lists the debit and credit balances of all ledger accounts. Because every transaction has equal debit and credit effects, the total of the debit balances must equal the total of the credit balances. It checks the arithmetical accuracy of the ledger and is the basis for preparing the final accounts.

Book debts are the amounts due to a business from customers (sundry debtors) for goods sold or services rendered on credit, as shown in the books of account. They are reported as an asset (accounts receivable) in the balance sheet. They are called "book" debts because they stand recorded in the books, and the portion unlikely to be recovered is treated as bad debts.

Installation of a new machine is capital expenditure and is added to the cost of the machine. Servicing an old machine is revenue expenditure (repairs).

Assumption: the stationery sold is for cash. Cost of 80% of the stationery is 80% x 75,000 = 60,000, and sales value is 60,000 + 30,000 profit = 90,000.

Accounting equation: Assets = Liabilities + Capital

Total assets Rs 225,000 = Creditors Rs 75,000 + Capital Rs 150,000 (initial capital 120,000 plus profit 30,000).

(a) The cash drawn by the proprietor for his household electricity bill is drawings, not a business expense.

(b) Salary paid to the accountant is a business expense and must be debited to the salary account.

The major functions of accounting are:

1. Recording. Every financial transaction is recorded in the journal and subsidiary books in a systematic, chronological way, from the source documents.
2. Classifying. The recorded transactions are grouped under the heads of assets, liabilities, capital, income and expenses by posting them to ledger accounts.
3. Summarising. The ledger balances are summarised in the trial balance and then in the financial statements, namely the income statement, the balance sheet and the cash flow statement.
4. Analysing and interpreting. The statements are studied with the help of ratios, comparisons and trends, so that their meaning for profitability, liquidity and solvency is understood.
5. Communicating. The results are reported to owners, managers, lenders, government, employees and other users so that they can make decisions.
6. Safeguarding assets and control. Accounting records help to keep track of property, debtors and creditors, and so prevent loss and fraud.
7. Meeting legal requirements. Accounting provides the information needed for taxation, audit, company law and other legal purposes.

Working

• Bad debts written off = 2% of 40,000 = Rs 800
• Receivables after writing off = 40,000 - 800 = Rs 39,200
• Required provision = 5% of 39,200 = Rs 1,960
• Opening provision = Rs 1,200, so additional provision to be created = 1,960 - 1,200 = Rs 760

Journal entries

Provision for Doubtful Debts Account

The cheques and other items already in the cash book are handled as timing differences. The items recorded only in the pass book (bank charge Rs 200 and dividend Rs 4,500) are used to find the unadjusted cash book balance.

Bank Reconciliation Statement

Check: 73,200 - 200 + 4,500 = 77,500, the adjusted cash book balance.

Only credit sales are entered in the sales book. The cash sales of Chaitra 20 are recorded in the cash book and appear directly in the sales account.

Working

• Chaitra 6: irons 10 x 500 = 5,000; cooking heaters 4 x 1,550 = 6,200; total 11,200.
• Chaitra 20 (cash): stand fans 15 x 2,000 = 30,000; table fans 12 x 1,500 = 18,000; total 48,000.
• Chaitra 30: CFL bulbs 75 x 60 = 4,500; mercury tubes 40 x 50 = 2,000; total 6,500; less 5% trade discount 325; net 6,175.

(a) Sales Book

(b) Sales Account

Assumptions: the opening assets as printed add up to Rs 1,049,000 against equities of Rs 1,040,000, so cash at bank is taken as Rs 145,000 (a transposition of 154,000) to make the balance sheet agree; all cash payments and receipts not stated otherwise are in cash; the computer is bought on credit and settled in cash after 15 days at 5% discount (Rs 22,800 paid, Rs 1,200 discount); Rastriya Trading Shop is the credit customer; depreciation of Rs 80,000 is charged on machines only.

a) Journal

b) Receivables and Payables Accounts

Receivables A/c

Payables A/c

c) Triple Column Cash Book

Debit side

Credit side

d) Worksheet and Financial Statements

Worksheet

Income Statement for the year

Balance Sheet as at the end of the year

e) Cash Flow Statement (direct method)

Cash in hand Rs 340,700 plus bank Rs 365,000 equals Rs 705,700, which agrees with the cash book. The withdrawal of Rs 50,000 from bank is an internal transfer and is not shown.

Accounting is the process of identifying, recording, classifying, summarising and communicating the financial transactions of an organisation so that users can make decisions.

Users of accounting information

• Internal users: owners and managers, who use it for planning, control and decisions; employees, who are interested in job security and bonus.
• External users: investors and shareholders, lenders and banks, suppliers and creditors, customers, government and tax authorities, and researchers or the general public.

The going concern concept assumes that a business will continue to operate for the foreseeable future and will not be closed or sold off. Because of this, assets are recorded at cost and depreciated over their useful lives, not at their forced sale value, and prepaid expenses and long-term liabilities are shown in the usual way. The concept is set aside only when the business is about to be wound up.

Assumption: the goods are sold at cost price, because no profit is given.

Accounting equation: Assets = Liabilities + Capital

Total assets Rs 340,000 = Liabilities Rs 40,000 + Capital Rs 300,000.

A trial balance is a statement prepared on a particular date that lists the debit and credit balances of all ledger accounts. Under the double entry system the total of the debit balances must equal the total of the credit balances. It is prepared to check the arithmetical accuracy of the books and as the basis for the final accounts.

Errors disclosed by the trial balance (they make the two totals unequal)

• Wrong totalling or balancing of an account
• Posting only one side of an entry, or posting to the wrong side
• Posting a different amount to the debit and to the credit
• Omission of an account balance from the trial balance, or entering a balance twice or on the wrong side
• Errors of carrying forward totals incorrectly

Errors not disclosed by the trial balance (both totals are still equal)

• Error of omission: a transaction is not recorded at all
• Error of commission: posting to a wrong account of the same type, e.g. to Ram's account instead of Shyam's
• Error of principle: wrong classification, e.g. a machine debited to the purchase account
• Compensating errors: errors on opposite sides that cancel each other
• Complete reversal of an entry: debit and credit sides interchanged
• Errors of original entry: the same wrong amount entered on both sides

Only credit sales are entered in the sales book. The sale of 20 account books on Chaitra 10 names no customer, so it is taken as a cash sale and goes directly to the sales account.

Working

• ABC Books: English 100 x 200 = 20,000; Math 200 x 400 = 80,000; total 100,000; less 10% = 10,000; net 90,000.
• Pustak Bhandar: Nepali 100 x 350 = 35,000; economics 200 x 300 = 60,000; total 95,000; less 15% = 14,250; net 80,750.

(a) Sales Book

(b) Sales Account

Where an error leaves a one-sided difference, it is cleared through the suspense account.

Assumptions: all cash payments and receipts not stated otherwise are in cash; the goods bought on credit are from Creditors (a single control account); no closing stock is given, so the whole of purchases is charged against sales; the wages due of Rs 1,000 are added to wages.

1. Journal

2. Ledger (balance form)