1. Distinguish between financial accounting and management accounting.

Ans. The differences between management accounting and financial accounting include:
1. Management accounting provides information to people within an organisation while financial accounting is mainly for those outside it, such as shareholders 2. Financial accounting is required by law while management accounting is not. Specific standards and formats may be required for statutory accounts such as International Financial Reporting Standards. 3. Financial accounting covers the entire organisation while management accounting may be concerned with particular products or cost centres. Managerial accounting is used primarily by those within a company or organization. Reports can be generated for any period of time such as daily, weekly or monthly. Reports are considered to be "future looking" and have forecasting value to those within the company. Financial accounting is used primarily by those outside of a company or organization. Financial reports are usually created for a set period of time, such as a fiscal year or period. Financial reports are historically factual and have predictive value to those who wish to make financial decisions or investments in a company. Management Accounting is the branch of Accounting that deals primarily with confidential financial reports for the exclusive use of top management within an organization. These reports are prepared utilizing scientific and statistical methods to arrive at certain monetary values which are then used for decision making. Such reports may include:
   

Sales Forecasting reports Budget analysis and comparative analysis Feasibility studies Merger and consolidation reports

Financial Accounting, on the other hand, concentrates on the production of financial reports, including the basic reporting requirements of profitability, liquidity, solvency and stability. Reports of this nature can be accessed by internal and external users such as the shareholders, the banks and the creditors.

Regulation and standardization

While financial accountants follow Generally Accepted Accounting Principles set by professional bodies in each country, managerial accountants make use of procedures and processes that are not regulated by a standard-setting bodies. However, multinational companies prefer to employ managerial accountants who have passed the Certified Management Accountant certification. The CMA is an examination given by the Institute of Management Accountant, a professional organization of Accounting professionals. This certification is different.

Time Period
Managerial Accounting provides top management with reports that are future-oriented, while Financial Accounting provides reports based on historical information. There is no time span for producing managerial accounting statements but financial accounting statements are generally required to be produced for the period of 12 previous months.

Other differences


There is no legal requirement for an organization to use management accounting but publicly-traded firms (limited companies or whose shares are bought and sold on an open market) must, by law, prepare financial account statements. In management accounting systems there is no requirement for an independent external review but financial accounting annual statements must be audited by an independent CPA firm. In management accounting systems, management may be concerned about how reports will affect employees behavior whereas management concerns are about the adequacy of disclosure in financial statements.

2. Write short notes on: a. Dual aspect concept b. Realization concept

ans. a) Dual concept may be stated as "for every debit, there is a credit." Every transaction should have two sided effect to the extent of same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner's equity and outsider's liabilities. This may be expressed in the form of equation:
A-L=P Where A stands for assets of the entity. L stands for liabilities (outsider's claims) of the entity P stands for proprietor's claim (capital) on the entity. (The form of presentation of equation A - L = P is consistent with the legal interpretation of financial position.)

b) According to this concept, revenue is recognized when a sale is made. Sale is considered

to be made at the point when goods passes to the buyer and he becomes legally liable to pay for it. This can be well understood with the help of the following example: A places an order with B for supply of certain goods which are yet to be manufactured. On receipt of the order, B purchases raw materials, employs workers, produces the goods and delivers them to A. A makes payment on receipt of the goods. In this case the sale will be presumed to have been made not at the time of receipt of the order for the goods, but at the time when goods are delivered to A.
3.Explain the rules of posting various transactions into a ledger Ans.
Accounting Defined

Accounting has been defined by the American Institute of Certified Public Accountants, as The art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof

Books of Account

Accounting transactions are recorded in a set of books. The following are referred to as the principal books of account:

1) Journal: The Journal contains details of transactions (other than those relating to receipts or payments in cash or through bank), recorded in chronological order.

Date

Particulars

L/F

Debit (Rs.)

Credit (Rs.)

Journal

2) Ledger: The Ledger contains separate accounts for every type of income, expense, asset, liability

and every person/ organisation with whom any transactions have taken place. An account is a summary of all transactions taking place under that head.

Dr. Date Particulars J/F Amount (Rs.) Date Particulars J/F

Cr. Amount (Rs.)

Ledger

3) Cash and Bank Book: The Cash and Bank Book combines the features of the Journal and Ledger, and records transactions involving receipts or payments in cash or through bank.

Dr. Date Particulars L/F Cash (Rs.) Bank (Rs.) Date Particulars L/F Cash (Rs.)

Cr. Bank (Rs.)

Cash and Bank Book General and Subsidiary Ledgers

Most large organisations maintain separate Ledgers and Cash and Bank Books for different types of transactions. For example, the Ledger may be split into General Ledger, Customers Ledger (Accounts Receivable) and Suppliers Ledger (Accounts Payable), and separate books may be maintained for Cash and each Bank Account instead of the Cash and Bank Book.

Subsidiary Books

Generally, a set of subsidiary books is also maintained. Subsidiary books are registers in which frequently occurring transactions are recorded, such as the Purchase Register, Sales Register and Petty Cash Book. The totals of transactions recorded in the subsidiary books are periodically posted to the principal books.

Voucher

Each accounting entry has an underlying document called Voucher in accounting terminology in support of its validity. The term Books of Account generally includes the primary and subsidiary books, as well as the vouchers.

Voucher No.: Date:

Particulars

Debit (Rs.)

Credit (Rs.)

TOTAL

Prepared by:

Authorised by:

Voucher (General Format)

Types of Accounts

Accounts are classified into:

y y y

Personal relating to an individual or firm Nominal relating to a head of income or expenditure Real relating to an asset or a liability

Chart of Accounts

The Chart of Accounts is a list of all accounts created in the ledger of the entity, arranged under the following four principal groups:

y y y y

Liabilities Assets Income Expenditure

Each of the groups has several sub-groups and every such sub-group either has accounts or subgroups as its sub-units, forming a tree structure. Debit and Credit

All amounts recorded in the books of account are placed either to the debit or credit of an account. For any transaction, which account(s) should be debited and which should be credited is determined by the following rule:

DEBIT what comes in, CREDIT what goes out DEBIT the receiver, CREDIT the giver DEBIT all expenses and losses, CREDIT all incomes and gains

The implications of amounts being placed to the debit or credit of an account are as follows:

Type of Account Debit

Implication Credit

a) Personal

The individual/ firm has received some money or other tangible benefit

The individual/ firm has given some money or other tangible benefit

b) Income/ An expense or a loss has been Expenditure incurred c) Asset/ Liability An asset has been acquired or a liability has been paid/ reduced

An income or a profit has been earned An asset has been disposed or a liability has been incurred

Accounting Systems

Two systems exist for recording accounting transactions, viz.:

1) Single Entry System Under this system, only one aspect of each transaction is recorded. This is not a scientific method of accounting and is prone to error and manipulation.

2) Double Entry System Under this system, both aspects of each transaction are recorded, ensuring that the sum of all debits is equal to the sum of all credits. This is the most scientific method of accounting and reduces the occurrence of errors and scope for manipulation.

In either case, the books of account may be maintained either on cash basis (i.e. transactions are recorded only when money is actually received or paid) or on accrual basis (i.e. transactions are recorded when the income or expense accrues, irrespective of the time of actual receipt or payment of the money).

The Companies Act, 1956 requires all companies to maintain books of account under the Double Entry System on accrual basis. Partnership firms and individuals have the option to follow either system.

Capital and Revenue Expenditure

Capital Expenditure is that expenditure which results in the acquisition of an asset (tangible or intangible) which can later be sold or which results in an increase in the earning capacity of a business. Expenditure incurred on acquisition of fixed assets is in the nature of Capital Expenditure.

Items of expenditure whose benefit expires within the year or expenditure incurred for maintaining the business or keeping the assets in good working condition are referred to as Revenue Expenditure. Wages, salaries, electricity, etc. are items of Revenue Expenditure. However, certain expenses such as expenses on formation of the company, the cost of issuing shares and debentures, etc. although apparently revenue in nature, provide an enduring benefit. Such expenses are classified as Deferred Revenue Expenses.

The classification of expenditure into capital and revenue expenditure is required in order to apply the Matching Concept. The general accounting treatment of capital and revenue expenses is as follows: Capital Expenditure The expenditure incurred is shown as an asset on the Balance Sheet. The asset is depreciated over its useful life, and the amount of depreciation debited to the Profit and Loss Account

Revenue Expenditure

The expenditure is debited to the Profit and Loss Account in the year it is incurred

Deferred Revenue Expenditure The expenditure is shown as an asset and debited to ythe Profit and Loss Account in annual instalments over the period for which it provides a benefit

Financial Statements

At the end of the reporting period which is generally one year the accounting transactions for the entire period are summarised into a few statements. The major Financial Statements are:

1) Balance Sheet: Statement of Assets and Liabilities as on a particular date, indicating the financial position of an entity at a given point of time. 2) Profit and Loss Account: Statement of Income and Expenditure for the reporting period, indicating the financial performance of the entity during the reporting period.

Purpose of Financial Statements

To inform the following persons of the financial performance and position of the entity:

1) Management for reviewing their performance during the reporting period 2) Shareholders for assessing the worth of their investments and reviewing the effectiveness of the Management 3) Investors for judging the worth of the entity before deciding to invest 4) Suppliers and Lenders for judging the creditworthiness of the entity before deciding to extend credit 5) Government for calculating the amount of tax to be collected

Accounting Concepts

To ensure uniformity in preparation of accounts across entities, the following concepts are applied when recording accounting transactions:

1) Business Entity Concept: The business for which accounts are maintained is treated as an entity distinct from its owners and managers. 2) Money Measurement Concept: All transactions affecting the business are stated in money terms and recorded in the Books of Account. 3) Dual Aspect Concept: Every transaction has two aspects a debit and a credit and the sum of all debits will equal the sum of all credits. For example, when an asset is acquired, one of the following events will also take place: y another asset is forgone y a liability (obligation to pay) is undertaken

4) 5) 6)

7) 8)

y a profit has been earned Cost Concept: Transactions are recorded at the actual cost. Going Concern Concept: At the time of recording the transactions, it is assumed that the entity will continue to remain in business for as long as can be foreseen. Accrual Concept: Income is recorded when goods are supplied or a service is rendered, even though the money may be received later; expenditure is recorded when goods are procured or a service is availed, even though the money may be paid later. Realisation Concept: Transactions are recorded only when they occur and not in anticipation of their occurrence. Matching Concept: Income and expenses for a period are correlated to ensure that the accounts project an accurate picture. Therefore: y when an income is recorded, all expenses incurred to earn that income must be recorded. y related income and expenditure must be recorded during the same reporting period.

Accounting Conventions

To make the information contained in financial statements clear and meaningful, they are drawn up according to the following conventions:

1) Consistency: Accounting practices should remain the same from year to year. 2) Disclosure: All information which is essential for fully understanding the financial statements should be disclosed in addition to the information required to be disclosed by law. 3) Conservatism: Financial statements should be drawn up on a conservative basis i.e. anticipated income should not be recorded whereas likely losses should be provided for.

Accounting Process

After each transaction

Transaction

Recording in Subsidiary Book

(if applicable)

Generation of Voucher

Recording in Journal/ Cash and Bank Book

Posting into Ledger

At the end of the year

Balancing of Ledger/ Cash and Bank Book

Generation of Trial Balance

Adjustments and Finalisation Entries

Compilation of Profit & Loss Account and Balance Sheet Balancing of Ledger

At the end of the year, the balance in each ledger account is determined by totalling the debit and credit sides of the account and calculating the difference. The difference is the balance in the account, which is then posted on the side which has a smaller total. This process is called balancing.

Generation of Trial Balance

The Trial Balance is a statement showing the balance in each account as on a particular date. It is generated by listing all the accounts in the Ledger with the balance in each account appearing against its name. Under the Double Entry System of Accounting, the totals of the Debit and Credit side of the Trial Balance will always be equal.

Fictitious Limited Trial Balance Sheet as at 31st March 1998

Sr.

Name of the Account

L/F

Debit (Rs.)

Credit (Rs.)

TOTAL

Trial Balance

Adjustments and Finalisation Entries

Following are some adjustments to be made/entries to be passed at the time of finalising the accounts:

1. Determination of income and expenses not relating to current year 2. Calculation of Depreciation on Fixed Assets and amount of Deferred Revenue Expenses to be amortised 3. Calculation of Provisions to be made for doubtful debts 4. Calculation of Provision for Taxation 5. Valuation of Closing Stock 6. Calculation of Dividend and tax thereon 7. Adjustments relating to prior years 8. Journal Entry for transfer of all current income to the credit of the Profit and Loss Account, and all current expenditure to the debit of the Profit and Loss Account

Compilation of the Profit and Loss Account and the Balance Sheet

The Profit and Loss Account is constructed by simply posting all items of income and expense from the finalisation journal entry. The current year s profit is determined by balancing the account and carried down to the appropriation section of the P&L Account. Entries for appropriations made out of the profit are posted in this section.

All balances remaining in any ledger account after the P&L Account is drawn up are listed in the Balance Sheet. Generally, the assets and liabilities are stated in decreasing order of permanence.

Fictitious Limited Profit and Loss Account for the year ended 31st March

Dr. Particulars 1998 (Rs.) 1997 (Rs.) Particulars 1998 (Rs.)

Cr. 1997 (Rs.)

To Opening Stock of Finished Goods To Raw Materials Consumed

By Sales

By Interest Earned

To Wages and Salaries To Administrative Expenses

By Other Income By Closing Stock of Finished Goods By Net Loss c/d

To Interest and Bank Charges To Sales and Distribution Expenses To Provision for Doubtful Debts To Depreciation To Provision for Taxation To Net Profit c/d

Total

Total

To Balance b/f To Net Loss for the year b/d To Prior Years Adjustments To Transfer to Reserves To Proposed Dividend To Tax on Proposed Dividend To Balance c/f

By Balance b/f By Net Profit for the year b/d By Prior Years Adjustments By Balance c/f

Total

Total

Profit and Loss Account - T Format

4. How can revenue expenditure turn into capital expenditure?

Ans. Capital Expenditure 1. Capital expenditure is that expenditure the benefits of which are not fully consumed in a year but spread over several years. 2. It is the expenditure which results in the purchase or acquisition of asset or property. 3. It is the expenditure incurred in connection with the purchase of asset. 4. It is the expenditure incurred to bring an old asset into working condition. 5. It is the expenditure incurred for extending or improving an existing asset to increase its productivity or to increase the earning capacity of business or to decrease working expenditure. It can be said that the capital expenditure benefits not only in the current accounting year but also many years in the future. The expenditure is generally non-recurring and the amount spent is normally large. However, it should be noted that not every big expenditure is capital expenditure. Capital expenditures are shown in balance sheet. Revenue Expenditure 1. Revenue expenditure is the expenditure which benefits in the current accounting year. It is not carried forward to the next year or years. 2. It is the expenditure which is incurred in the normal course of business to run the business and to maintain the fixed assets of business. 3. It is the expenditure which is incurred on purchase of goods meant for resale or to purchase materials which will be used to convert them into final product. Therefore, revenue expenditure is a recurring expenditure made to maintain the business. The amount spent is generally small and the benefit is for a short period which is not more than a year. All revenue expenditure are charged to trading and profit and loss account. Deferred Revenue Expenditure Deferred revenue expenditure is the expenditure which is originally revenue in nature but the amount spent is so large that the benefit is received for not a year but for many years. A proportionate amount is charged to profit and loss account of each year and balance is carried forward to subsequent years as deferred revenue expenditure. It is shown as an asset in the balance sheet, e.g., heavy expenditure incurred on advertisements.

Capital Receipts Capital receipts are the receipts which are not received in the ordinary course of business. These are non-recurring receipts. Money obtained from the sale of fixed assets or investments, issue of shares or debentures, loans taken are some of the examples of capital receipts. Capital receipts are shown as liability reduced from assets appearing in the balance sheet.

Revenue Receipts Revenue receipts are receipts obtained in the normal course of business. It is a receipt against supply of goods or services. The money obtained from sales, interest, dividend, transfer fees etc. are examples of revenue receipts. Revenue receipts are credited to profit and loss account. Capital Profit Those profits which are not earned during the regular course of business and which are not earned on account of the day-to-day trading activities of the business are capital profits. For example, profit on sale of asset and premium received on issue of shares. These types of profits are normally not taken to profit and loss account but are shown in the liabilities side of the balance sheet. Capital Losses The losses which are not suffered during the regular course of business are called capital losses. For example, discount on issue of shares.