Accounting and Indian Taxation

Thursday 28 January 2016

16 Capital and Revenue Items

Learning Objectives:-

To classify and know the distinctions between-

Revenue Item,

Capital Item , and

Deferred Revenue Item.

Tit Bits

- All capital expenditures and receipts are taken to the Balance Sheet.

- All revenue expenditures and receipts are taken to Trading Account / Profit and Loss Account.

Capital Expenditure

Capital Expenditure that results in acquisition of permanent assets.

Such assets are to be used in the business to earn revenue.

Capital Expenditure -

Increases quantity of fixed assets /

Increases quality of fixed assets /

Results in replacement of assets.

Examples:

- Expenses incurred in relation to acquisition of a fixed asset

- Expenses incurred to bring the fixed asset in to working condition

(Installation Wages / Carriage / Repair Charges for Second Hand Assets etc.)

Revenue Expenditure

The amount that is spent to earn revenue is called as 'Revenue Expenditure'.

These are incurred in the regular conduct of the business.

Expenses that are done to retain the earning capacity / working condition of an asset can also be regarded as 'Revenue Expenditure'.

Examples

- Depreciation of fixed assets,

- Interest on borrowings,

- Cost of goods purchased for resale etc.

Deferred Revenue Expenditure

If the benefit for an expenditure is spread over a number of years, it is called as 'Deferred Revenue Expenditure'.

It will be shown on the Assets Side of the Balance Sheet under the heading 'Miscellaneous Expenditure'.

Characteristics:

a) Benefit is enjoyed for more than one year.

b) Non Recurring in nature

Examples:

- Expenses done for Research and Development of a new product or service

- Abnormal Loss arising out of fire or lightning (uninsured)

- Bulk amount spent on advertising

Revenue Receipts

Receipts obtained in normal course or conduct of a business are called as 'Revenue Receipts'.

Examples :

- Receipts from sale of goods

- Commission received

- Interest Received etc.

Capital Receipts

Receipts which are not received in the normal course or conduct of the business activity are called as 'Capital Receipts'.

Examples:

- Receipts from sale of investments / fixed assets

- Receipts on account of secured / unsecured loans etc.

Capital Loss

Loss that do not arise in the regular course of the business is known as 'Capital Loss'.

Example:

- Loss on sale of a fixed asset or investment

Revenue Loss

Losses that arise in the normal course of the business are called as 'Revenue Loss'.

Excess of revenue expenditure over revenue receipts may be called as 'Revenue Loss'.

Distinctions between Capital Expenditure and Revenue Expenditure:

Tit Bits

Even if the expenditure doesn't increase the productive capacity of an asset, it may be capitalized if it increases the asset's value.

For Case studies Please have a look on - Case Studies of Capital and Revenue Items

15 Bank Reconciliation Statement

Learning Objectives

To understand the meaning of Bank Reconciliation Statement.

To know the reasons for difference in the Bank Account and the Bank Column of the Cash Book.

To prepare Bank Reconciliation Statement with these aspects as starting points:

Favourable Balance as per Cash Book,

Unfavourable Balance as per cash Book,

Favourable Balance as per Bank Pass Book, and 4. Unfavourable Balance as per Bank Pass Book.

Bank Reconciliation Statement

Bank Reconciliation Statement is the statement which is prepared to reconcile or equalize the company's Accounts book with Banker's Statement.

It is prepared at regular intervals.

It shows the reasons for disagreement between the balances as per bank column of cash book and bank pass book.

Reasons for difference between Cash Book and Bank Statement

Overdraft - Un-favorable

Overdraft / Un-favorable means that money is drawn in excess from the account.

Balance as per Pass Book Vs. Cash Book - at a glance

BRS with Debit Balance as per Cash Book as starting point

BRS with favourable balance as per pass book as starting point

BRS with unfavourable balance as per cash book as starting point

BRS with unfavourable balance as per pass book as starting point

Note:-

Cash book includes both cash transactions and bank transactions. Mentioning cash book in BRS referred only on bank transactions.

Sometimes bank transactions written as cash transactions also error will also occur. Then in BRS will get affected.

Favorable - Cash book to Pass book (cash book at beginning) (Addition to cash book balance)

Amount appears credit side of cash book but that amount doesn't or lesser than that appears on debit / withdrawal side of Pass book then this transaction should be ADD to cash book balance.

Amount appears credit / deposit side of pass book but that amount doesn't or lesser than that appears on debit side of Cash book then this transaction should be ADD to cash book balance.

Favorable - Cash book to Pass book (cash book at beginning) (Subtraction to cash book balance)

Amount appears Debit side of cash book but that amount doesn't or lesser than that appears on Credit / Deposit side of Pass book then this transaction should be SUBTRACT to cash book balance.

Amount appears Debit / Withdrawal side of pass book but that amount doesn't or lesser than that appears on Credit side of Cash book then this transaction should be SUBTRACT to cash book balance.

Favorable - Pass book to Cash book (Pass book at beginning)

Vise versa of "Favorable - Cash book to Pass book" that means addition transaction which mentioned in "Favorable - Cash book to Pass book" should do subtract in "Favorable - Pass book to Cash book".

Un-Favorable - Pass book to Cash book (Pass book at beginning)

Same as did in "Favorable - Cash book to Pass book" that means addition transaction which mentioned in "Favorable - Cash book to Pass book" should also do addition in "Un-Favorable - Pass book to Cash book" and subtraction as vice versa.

Un-Favorable - Cash book to Pass book (Cash book at beginning)

Same as did in "Favorable - Pass book to Cash book" that means addition transaction which mentioned in "Favorable - Pass book to Cash book" should also do addition in "Un-Favorable - Cash book to Pass book" and subtraction as vice versa.

14 Suspense Account

Learning Objectives

To understand the meaning, usage, and significance of Suspense Account

To realize how errors affect the financial statements of the next years

To be familiar with the usage of Profit and Loss Adjustment Account to rectify the errors

Need for Suspense Account

Errors affect the agreement of Trial Balance.

This results in delayed preparation of Final Accounts.

To avoid this time delay, the difference in trial balance is kept in an account called 'Suspense Account'.

Suspense Account

If the debit side of trial balance exceeds the credit side, then difference is put on the credit side & suspense account shows a credit balance and on the other hand for the credit side of trial balance i.e., as vice versa.

When all errors affecting the Trial Balance are located, Suspense Account stands closed.

Debit Balance in Suspense Account will be taken to the Assets Side of the Balance Sheet and for Credit Balance as vice versa.

This rectification entries will make existing suspense a/c which appears on Trial balance to be stands closed before preparation of final accounts. So suspense account will disappear in trial balance after update of this rectification entries. Therefore suspense a/c never appears on final accounts.

Rectification of Error on the financial year

Note

Ledger Postings can be prepared for Suspense Account as usual with the difference figure brought forward either on the debit side or credit side as opening balance of next year (If we didn't found the rectifications in the current year).

Profit and Loss Adjustment Account

While preparing final accounts nominal accounts are closed by transfer to either Trading Account or Profit and Loss Account.

The real accounts and personal accounts are carried forward to the next trading period.

Suspense Account appearing in the Balance Sheet will also be carried forward to the next trading period.

To rectify errors in such situations, Profit and Loss Adjustment Account is used.

It will be closed by transfer to Capital Account.

Need:-

Errors rectified in the next or subsequent trading period should not affect the profit or loss of the next trading period.

Rectification of errors by use of Profit and Loss Adjustment Account:

Entertainment expenses Rs.95, though correctly entered in cash book were omitted to be posted in the ledger.

Rectification of Error on the next financial year

13 Rectification of Errors

Objectives

To classify the errors in accounting

To understand the steps to rectify the errors-

Before preparing trial balance

Before preparation of final accounts

After preparation of final accounts

To pass rectification entries for-

One sided errors

Errors affecting two or more accounts

Introduction

Make errors is a human nature. Errors that are committed in various stages of accounting cycle have to be identified and rectified.

This is to ensure the correctness of the figure shown by financial statements.

Types of Errors

Errors of Principle

If the basic accounting concepts, conventions, principles, rules are not followed , it is an error of principle.

Capital and revenue items

Improper valuation

Erratic provisioning

Errors of Omission

If the transaction is omitted either in the journal or subsidiary book or in the ledger, it is known as an 'error of omission'.

Errors of Commission

Error of Commission means doing something that should not have been done.

An error of posting may occur in these ways.

This error may or may not affect Trial Balance.

Error of Duplication

If a transaction has been recorded more than once, it is known as an 'Error of Duplication'.

It will not affect the trial balance as we have made entries for corresponding debits and credits of equal amount.

Effect of Errors on Trial Balance

Stages in Rectification of Errors

After Preparation of Final Accounts

Errors affecting those accounts which appear in Trading Account / Profit and Loss Account must be rectified using profit and Loss Adjustment Account.

This becomes necessary because the error done in the last financial period should not affect the financial status of the next period.

Examples

Sales to Vimala for Rs.5,000/- was posted to the credit of her A/c.

Sales to Vimala should have been posted to debit side of her A/c.

So, to cancel the wrong credit of Rs.5,000/-, debit Vimala's A/c with Rs.5,000/-.

To give the actual effect, debit Vimala's A/c with another Rs.5,000/-

In Practical Manner

Correct entry -

Vimala a/c Dr. 5000

To Sales a/c 5000

Written the wrong entry as -

Vimala a/c Dr. 5000
Sales a/c Dr. 5000

Proof

Rectifying Entry

To cancel that wrongly credited in wrong entry should be delete it. For that debit that account once with amount. Add the same amount with that once to get the correct entry.

To Vimala a/c 5000
To Sales a/c 5000

Behalf of this, suspense a/c will rise in Trial balance:-

Suspense a/c Dr.10000

Now to cancel the Vimala a/c in credit and to place Vimala a/c in debit as correct one,

Finally Remaining

Vimala a/c Dr. 5000

To Sales a/c 5000

Practice this kind of method to solve any Errors in entries. This is the step by step procedure.

12 Trail Balance

LEARNING OBJECTIVES

To know the meaning and characteristics of Trial Balance

To prepare a Trial Balance

The debit balances and credit balances of ledger accounts are extracted and written in a Statement Format called 'Trial Balance'.

This is done to check the arithmetic accuracy of accounts.

TIT BITS

Equalizing the two sides of a trial balance is not the sole and conclusive proof of the complete correctness of books.

Trial Balance is a Statement and it is not an account.

PROFORMA OF A TRIAL BALANCE

TIT BITS

Accounts of all assets, expenses, losses and drawings have debit balances.

Accounts of incomes, gains, liabilities and capital have credit balances.

SCHEDULE OF DEBTORS

Instead of writing all individual names of debtors (customers), the total balance is written under the heading "Sundry Debtors" in the Trial Balance.

The list of debtors is termed as 'Schedule of Debtors'.

The word 'Sundry' , in this context, means 'Total'.

SCHEDULE OF CREDITORS

Instead of writing all individual names of creditors (suppliers), the total balance is written under the heading "Sundry Creditors" in the Trial Balance.

The list of creditors is termed as 'Schedule of Creditors'.

The word 'Sundry' , in this context, means 'Total'.

ANALYSIS OF TRIAL BALANCE

TIT BITS

Debit Balance in a Personal Account shows amount receivable.

Credit Balance in a Personal Account shows amounts payable.

11 Distinction Between Journal and Ledger

10 Ledger Posting

LEARNING OBJECTIVES

To prepare the direct ledger postings

To understand the concepts of posting and balancing of accounts

To realize the distinctions between journal and ledger

LEDGER

Classification or grouping that takes in the form of 'Accounts' in a separate book is known as 'Ledger'.

A summary statement of all the transactions relating to a person, asset, expenses or income which have taken place during a given period of time and shows their net effect.

The object of preparing ledger is to ascertain the closing balance in an account as on a given date.

The ledger postings may be done weekly / fortnightly (once in fifteen days) / monthly / quarterly as per the requirements of the concern.

LEDGER - PROFORMA

TIT BITS

While preparing ledger postings, J.F Column (Journal Folio Column) can be used to enter the page number from which the particular transaction has been transferred.

This facilitates easy reference in the future.

LET US TAKE A REVIEW OF A JOURNAL ENTRY AND ITS EFFECT ON THE LEDGER ACCOUNT

APRIL 16TH, 2012: CASH RECEIVED FROM MR. ARUL MOZHI RS. 5,000/-

APRIL 17TH, 2012: CASH DEPOSITED INTO ICICI BANK RS.6,600/-

APRIL 18TH, 2011 : GOODS SOLD ON CREDIT TO MRS. CHITHRA RS. 8,000/-

APRIL 18TH, 2012 : GOODS SOLD ON CASH BASIS TO MRS. CHITHRA RS. 8,000/-

APRIL 20TH, 2012 : GOODS PURCHASED FROM MS.JANAKI RS.80,000/-

APRIL 20TH, 2012 : GOODS PURCHASED RS.55,000/-

APRIL 25TH, 2012 : GOODS WORTH RS.5,000 WERE TAKEN BY OWNER FOR USE IN HIS HOUSE.

APRIL 25TH, 2012 : INTEREST PAID TO MS.ANJALI RS.9,000/-

WHAT IS 'OPENING BALANCE' IN LEDGERS?

The closing balance of the ledger accounts in the last financial period will become the opening balance of the current financial period.

All ledgers need not compulsorily have an opening balance.

Only Balance Sheet items are carried forward to next financial period, except that none of the items will have opening balance in the next financial period.

EXCEPTION 'OPENING BALANCES' NEVER ARISES IN ---

WHAT IS 'OPENING BALANCE' IN LEDGERS?

We have borrowed a sum of Rs.50,000/- from Ms. Jency on 17/08/2012 and repaid the amount in various installments during the accounting period to settle her loan account . So Ms. Jency's Loan Account will have no closing balance at the end of the financial period i.e. 31/03/2013.

So there will be no opening balance in Ms. Jency's Account during the beginning of the next financial period on April 1st, 2013.

In other words matter of that Ms. Jency gets over in the same financial year when it arises. So no opening balance for next financial period.

1) EXAMPLE FOR OPENING BALANCE:-

For example, we have borrowed a sum of Rs.50,000/- from Ms. Jency on 17/08/2012 .We have not repaid the amount during the accounting period. So Ms. Jency's Loan Account will have a closing balance amounting to Rs.50,000/- at the end of the financial period i.e. 31/03/2013.

So there will be an opening balance of Rs.50,000/- in Ms. Jency's Account during the beginning of the next financial period on April 1st, 2013.

2) EXAMPLE FOR OPENING BALANCE:-

On 26/08/2012 a machinery worth Rs.5,00,000/- was bought for cash. As it was employed in use, its earning capacity has decreased by Rs.50,000/- at the end of the first year.