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SCANNER: FINANCIAL ACCOUNTING (Dec 2008 To June 2011)
UNIT – 1 - ACCOUNTING CONVENTIONS AND PRACTICES
Objective -Type Questions:
Q1. Distinguish between liability and provisions. [Ref: Q1. (a), June ’09 / Paper-5] 3
Ans: A provision is a liability which can be measured only by using a substantial degree of estimation. Provisions can be distinguished from other liabilities such as trade payables and accruals because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement. A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

Q2. State whether following statements are true or false: [Ref: Q1. (d), June ’09 / Paper-5] 4
(i) Goodwill is a fictitious asset.
Ans: Goodwill is the value of a firm's reputation, its good brand name and favourable contacts in the market. Goodwill is considered as an intangible asset of the firm. It means it cannot be seen or touched like other assets of the firm. It does not have any physical existence. It just has a capability to help the business in earning more and more profits. On the contrary, fictitious assets are neither tangible nor intangible assets. They are the expenses or losses which are still to be charged (debited) from the profit.
(ii) Land is a depreciable asset.
Ans: Depreciation is charged to keep the asset intact with the market value of the asset. Value of assets will decrease due to the usage and also because of the efflux of time. Because of the above said reason value of the asset will be reduced every year by way of depreciation. Rate of depreciation, amount and method will be adopted because of the regulations and convenience. In case of land the value is keep on increasing and hence we are not providing for depreciation. If the value decreases definitely it should be recognised in the books by way of depreciation. We cannot provide for appreciation because it is a notional profit.

Q3. How do the limitations of financial statements also become the limitations of Analysis of Financial statements? [Ref: Q1. (a), Dec ’09 / Paper-5] 2
Ans: Since analysis of financial statements is based on the information given in the financial statements, it suffers from all such limitations from which the financial statements suffer such as Historical records, variation in accounting policies and practices etc.

Q4. Fill in the blanks:
(i) Increase in one equity with no change in the asset will result in Decrease in Equity.
(ii) Final Accounts of a company are prepared according to Section 210 of the Companies Act, 1956 [Ref: Q1. (c), Dec ’09 / Paper-5] 1+1

Q5. Correct the following Statement: Depreciation Accounting is the process of valuation of the asset and not the process of allocation. [Ref: Q5. (c), (iii), June ’10 / Paper-5] 1
Ans: Depreciation Accounting is the process of cost allocation of the asset and not valuation of the asset.
Depreciation spreads the cost of a fixed asset over the useful life of that asset so a portion of that cost is recognized as an expense in each period that the asset is in service. The original cost, less the accumulated depreciation is the net book value of the asset. The net book value may not represent the actual market value of the asset. Depreciation is not concerned with the market value but rather the value of the contribution that the asset makes to the business.

Q6. Explain the following in single sentences: [Ref: Q1. (c), Dec ’10 / Paper-5] 1×2=2
(i) Net Realisable value: The value of an asset that can be realized by a company or entity upon the sale of the asset, less a reasonable prediction of the costs associated with the sale.
(ii) Personal Accounts: PERSONAL ACCOUNTS represents money due to or due from a person or group of persons.

Q7. From the four alternatives given against each statements, choose the correct alternative:
(i) Depreciation accounting is a process of
(A) Apportionment
(B) Valuation
(C) Allocation
(D) Appropriation

(ii) Which of the following is a Capital Expenditure?
(A) Freight and cartage on purchase of new machine
(B) Legal expenses in connection with defending a title of firm’s property
(C) Expenditure on painting of factory shed
(D) Wages paid to machine operation [Ref: Q1. (f), Dec ’10 / Paper-5] 1×2=2

Q8. From the four alternative answers given against each statement indicate the correct alternative:
(i) An amount spent for inauguration of new factory building is
(A) Revenue Expenditure
(B) Capital Expenditure
(C) Prepaid Expenditure
(D) None of the above [Ref: Q1. (b), June ’11 / Paper-5] 1

Q9. Choose the appropriate answer in each case from the given alternative answers (= 1 mark) and also given reason for your choice (= 1 mark): 
                (i) Purchase price of a machine is Rs. 44,500; Installation charges Rs. 10,000; Freight and Cartage Rs. 4,000; Insurance charges Rs.10, 000; Residual Value Rs. 14,000; Estimated useful life 5 years. The annual amount of depreciation under Straight line method would be:
                (A) Rs. 90,000 (B) Rs. 88,000 (C) Rs. 87,000 (D) None of these [Ref: Q1. (d), June ’11 / Paper-5] 2
Ans: Depreciation = (Cost of assets+installation charges+freight and cartage+insurance charges-residual value)/life of assets.
                Depreciation = 44500+10000+4000+10000-14000 /5 = 54500/5 = 

Q10. State the conditions to be satisfied for payment of dividend out of capital profits. [Ref: Q1. (e), June ’11 / Paper-5] 2
Ans: Following conditions is to be satisfied for payment of dividend out of capital profits:
a)      there is no restriction in the Articles regarding distribution of dividend out of capital profits
b)      the profit is realised in cash.
c)       dividend remains as profit after revaluation of all assets and liabilities.
d)      Out of accumulated profits, dividend cannot be paid unless current losses are made good.

Descriptive & Practical Questions:
Q1. Materiality concept. [Ref: Q8. (e), Dec ’08 / Paper-5] 3
Ans: Materiality: Materiality deals with the relative importance of accounting information. In order to make financial statements more meaningful and to economize costs, accountants should incorporate in the financial statements only that information which is material and useful to users. They should ignore insignificant details.
American Accounting Association (AAA) defines the term materiality as under: “An item should be regarded as material if there is reason to believe that knowledge of it’s would influence the decision of informed investor”.
Kohler has defined materiality as under: “The characteristic attaching to a statement, fact, or item whereby its disclosure or the method of giving it expression would be likely to influence the judgement of a reasonable person”.
Some of the examples of material financial information to be disclosed are likely fall in the value of stocks, loss of markets due to competition or Government regulation, increase in wage bill under recently concluded agreement, etc. It is now agreed that information known after the date of balance sheet must also be disclosed.

Q2. What are the objects of charging depreciation and problems of measurement of depreciation? Explain. [Ref: Q2. (b), June ’09 / Paper-5] 5
Ans: Objectives for providing depreciation
a)      Recovery of cost incurred on fixed assets over their useful life for replacement of assets.
b)      To find out correct cost of goods manufactured.
c)       To find out correct profit for the year.
d)      To provide for replacement of assets.
e)      To find out correct financial position.
f)       To reduce tax burden.
Problems of measurement of depreciation
1.       Difficulty of ascertaining working life: It is really difficult to summaries the exact working life of an asset.
2.       Estimation of residual value: Residual value depends upon usage of assets, market conditions, technological advancements, etc. It is not possible to make correct estimation of scrap value.
3.       Unwarranted happenings: Change of law, technological development, innovations. etc., may cause a drastic reduction or writing off of an asset. These external factors suddenly affect the pre-determined quantum of depreciation.

Q3. State the advantages and disadvantages of Weighted Average method of valuation of inventory. [Ref: Q5. (b), June ’09 / Paper-5] 5
Ans: For finding out the weighted average rate for stock valuation both quantity and price of different lots of materials existing in the stock are considered. The weighted average rate is found by adding the costs of all lots held at the time of issue and then dividing that total cost by the total quantity of the materials held. Once a rate is calculated it is applied until a new purchase is made. It does not consider whether the quantities purchased earlier have already been consumed.
Advantages:
(1) If prices fluctuate considerably and issue of materials has to be made in several lots, this method becomes very much useful.
(2) Weighted average rate is mathematically sound as it considers both quantity and price.
(3) During inflation, the value of stock becomes much more realistic.
(4) One rate can be consistently applied till a new purchase is made.
Disadvantages:
(1)    The prices at which goods are issued do not reflect their actual costs.
(2)    Closing stock cannot show the current market price.
(3)    Where purchases and receipts of materials are frequent, this method results into mathematical complications.
(4)    If arithmetical accuracy is ignored at the time of calculating the weighted average rate, unrealised profit or loss may creep into the value of materials.

Q4. A contractor whose books are closed on 31St December undertook a contract for construction of building on 1.4.2009. His books of accounts reveal the following information on 31.12.2009:
Materials sent to site Rs. 2, 92,000, labour engaged Rs. 7, 08,000, Foreman’s salary Rs. 87,500. During the year plant costing Rs. 3, 50,000 was installed at site for 150 days, scarp value being Rs. 20,000. (estimated life 5 years) Supervisor’s salary Rs. 5,000 per month (he devotes approximately 2/3rd of his time to this work). Administration expenses amounted to Rs. 1, 60,000. Materials at site on 3 1.12.2009 was valued at Rs. 30,200. Unsuitable materials costing Rs. 7,200 was sold for Rs. 6,000. A part of the plant costing Rs. 8,400 found unsuitable to the contract was sold at a profit of Rs. 1,600 without being put to use. The contract price was Rs. 25, 00,000. On 31.12.2009 2/3rd of the contract was complete. Architect’s certificate covered 50% of the contract value. Amount received on account by the contractor is Rs. 8, 75,000. Depreciation is charged on time basis.
Prepare the Contract Account and state how much profit should be credited to the Profit and Loss Account. [Ref: Q7. June ’10 / Paper-5] 15

Q5. Write Short Notes on:
(c) Cum-interest and ex-interest price. [Ref: Q8. (c), June ’10 / Paper-5] 5

Q6. Distinguish between Reserve and provisions. [Ref: Q6. (b), Dec ’09 / Paper-5] 5
Ans: Difference between reserves and surplus
(1) Provision is made to meet known liability the amount of which cannot be ascertained with substantial accuracy. Reserve is created to meet unexpected losses and contingencies likely to arise in future.
(2) Provision can be used only for meeting the specific purpose for which it has been made. Reserve can be used for any purpose unless it is created for a specific purpose.
(3) Provision is a charge on profits and reduces the amount of net profits. Reserves is an appropriation of profits and reflects undistributed profits.
(4) Provision is to be made even if there are no profits. Reserve is created only when there are profits.
(5) Provision creation is compulsory. Reserves creation is at the discretion of management with the exception of debenture redemption reserve for which the Companies Act has made a provision in certain cases.
(6) Provision is meant for meeting expected losses and cannot be used for dividend distribution. Reserves is a part of owner’s funds and can be used for distribution of dividends.

Q7. Write notes on: Accounting Bases [Ref: Q8. (d), Dec ’09 / Paper-5] 3
Ans: BASES OF ACCOUNTING
There are three bases of accounting in common usage. Any one of the following bases may be used to finalise accounts.
1. Cash basis
2. Accrual or Mercantile basis
3. Mixed or Hybrid basis.
Accounting on ‘Cash basis: Under cash basis accounting, entries are recorded only when cash is received or paid. No entry is passed when a payment or receipt becomes due.
Accrual Basis of Accounting or Mercantile System: Under accrual basis of accounting, accounting entries are made on the basis of amounts having become due for payment or receipt.
Mixed or Hybrid Basis of Accounting: When certain items of revenue or expenditure are recorded in the books of account on cash basis and certain items on mercantile basis, the basis of accounting so employed is called ‘hybrid basis of accounting’.

Q8. From the following information prepare
(i) Fixed Assets Account and
(ii) Accumulated Depreciation Account:
Particulars
Opening Balance
Closing balance
Fixed Assets
400000
550000
Accumulated Depreciation
80000
135000
Additional Information:
A part of a machine costing Rs. 60,000 has been sold for Rs. 30,000, on which accumulated depreciation was Rs. 15,000. [Ref: Q3. (b), June ’10 / Paper-5] 5
Fixed Assets Account
Particulars
Amount
Particulars
Amount
To Opening Balance
To Cash (Purchase)
400000
210000
By Cash  (Sale of Machine)
By Accumulated Depreciation A/c
By Profit and Loss A/c (Loss on sale)
By Closing Balance
30000
15000
15000
550000

610000

610000

Accumulated Depreciation Account
Particulars
Amount
Particulars
Amount
To Fixed Assets Account
(Depreciation on machinery sold)
To Closing Balance
15000

135000
By Opening balance
By Profit and Loss A/c (Depreciation during the year)
80000
70000

150000

150000

Q9. State the various accounting concepts. [Ref: Q5. (b), Dec ’10 / Paper-5] 5
Ans: Accounting concepts: The term ‘concept’ is used to denote accounting postulates, i.e., basic assumptions or conditions upon which the accounting structure is based. The following are the common accounting concepts adopted by many business concerns.
        I.            Business Entity Concept
      II.            Money Measurement Concept
    III.            Going Concern Concept
    IV.            Dual Aspect Concept
      V.            Periodicity Concept
    VI.            Historical Cost Concept
  VII.            Matching Concept
VIII.            Realisation Concept
    IX.            Accrual Concept

i) Business Entity Concept: Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it.
ii) Money Measurement Concept: According to this concept, only those events and transactions are recorded in accounts which can be expressed in terms of money.
iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that the business will exist for a longer period of time.
 iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits.
V) Periodicity Concept: Under this concept, the life of the business is segmented into different periods and accordingly the result of each period is ascertained.
vi) Historical Cost Concept: According to this concept, the transactions are recorded in the books of account with the respective amounts involved.
vii) Matching Concept: The essence of the matching concept lies in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.
viii) Realisation Concept: This concept assumes or recognizes revenue when a sale is made.
ix) Accrual Concept: According to this concept the revenue is recognized on its realization and not on its actual receipt.

Q10. Write Short Notes on: Contingent liability [Ref: Q8. (d), Dec ’10 / Paper-5] 3
Ans: Contingent Liability: A future uncertain liability which is dependent on the happening of some event is called Contingent Liability. It may or may not arise in future. E.g.: Bills receivable discounted, claims against the company, guarantee given etc.
                No journal entries are made for contingent liabilities because no definite amount is determined at the time of entry and no entry can be made on the basis of just expectations only.   That is why the contingent liabilities are not shown in trial balance. These are only shown as foot notes of trial balance and balance sheet.