MBC-104: FINANCIAL ACCOUNTING

MODEL ANSWER PAPER

1. Answer the following questions:

a) Name two users of accounting information.
Ans: Management Group: Board of Directors, Mangers, Officers
Financing Group: Investors/ Owner, Lender, Suppliers/ Creditors
Public Group: Government Agencies, Employees, Customers, Researcher
b) What is meant by accounting standard?
Ans: Accounting standard s are accounting rules and procedures relating to measurement, valuation and
disclosure issued by the council of the Institute of Charted Accountants of India. Accounting standards are
stated to be the norms of accounting policies and practices by way of guidelines that should be followed
while preparing accounts and disclosed in the annual financial statements. Accounting standards serve
public interest and are based on a conceptual frame work of accounting mechanism for resolving the
conflicts of interest among the users of accounting information.
c) What is oversubscription of shares?
Ans: When the number of shares applied exceeds the number of shares issued by the company it is called
over subscription. For example, Y Ltd. Issued 10,000 shares of Rs.10 each, but 13,000 application were
received for those 10,000 shares.
d) According to which concept of accounting the outstanding rent for two months 10,000 is added to
the rent actually paid 50,000 (for 10 months) in the profit and loss account.
Ans: Accrual Concept
e) What is marshalling of assets and liabilities?
Ans: The arrangement of assets and liabilities in the balance sheet in the order of liquidity (liquidity
preference method) and order of performance (rigidity preference method).
f) Give an example of transaction which is a contra entry in the triple column cash book.
Ans: 1. Cash deposited into bank, and
2. Cash withdrawn from bank
g) What is meant by redeemable debenture?
Ans: Redeemable debentures are those debentures which will be required by the company at the end of a
specified period or in installation during the lifetime of the company. Repayment of principal sum is made
in accordance with the terms already made known at the time of its issue.
h) The expenses of white wash of the existing building 10,000. Whether this is a revenue or capital
expenditure & why?
Ans: White washing expenses of existing building is revenue expenditure as this is meant for normal
maintenance of the asset.

i) If the value of the plant and machinery is 1,00,000 and a depreciation in diminishing balance
method is charged @ 10% per annum what will be the depreciation in the 3rd year.
Ans:

Particulars Amount (Rs.)

Value of Plant and machinery 1,00,000
Less: Depreciation of 1st year (1,00,000 × 10%) 10,000
Value of Plant and Machinery after 1st year 90,000
Less: Depreciation of 2nd year (90,000 × 10%) 9,000
Value of Plant and Machinery after 2nd year 81,000
Less: Depreciation of 3rd year (81,000 × 10%) 8,100
Value of Plant and Machinery after 2nd year 72,900
 j) In which side of the trial balance the following items shall appear? Drawings, outstanding salary.
Ans: Drawings: Debit
Outstanding Salary: Credit

2. Explain the following:

a. Conservatism convention.
Ans: “No profit or income should be anticipated whereas all known or foreseeable losses or expenses must be
provided for.” The idea behind this principle is that recognition of revenue requires better evidence than
recognition of expenses. The principle emphasizes that revenues are to be recognized only when they are
reasonably certain and expenses are to be recognized only when they are reasonably certain and expenses are to
be recognized only when they are reasonably possible.
b. Going concern concept
Ans: It is presumed that the business concern will continue its operations forever. There is no intention to
dissolve of the business venture in near future. The present resources of the concern are utilized to attain long
term objectives of the business. The concept is very important in relation to the recording of transactions and
preparation of financial statements. For example, it is only this assumption that while preparing final account of
the concern, fixed assets are shown in the balance sheet at diminishing balance method.
3. What are the characteristics of Debenture? Show the journal entries for issue of Debentures at
a. Par
b. Premium
c. Discount
Ans: Characteristics of Debenture
1. It is acknowledges the debt of a company.
2. A predetermined fixed rate of interest is given on debentures.
3. The interest on debentures payable whether the company has earned any profit or not.
4. Debenture holders are the creditors of the company without any voting right.
5. Debentures can be secured (with security) or unsecured (without security).
6. Debentures can be converted into shares in future.
7. At the time of liquidation of the company the amount due ti debenture holders are paid off before the
share holders.

Journal Entries for issue Debentures

a. Debentures issued at Par:
i. When Cash is received
Bank A/c Dr
To Debenture application A/c
(Being the amount received on……..Debentures @ Rs………each)
ii. When the debentures are allotted
Debenture Application A/c Dr
To Debenture A/c
To Debenture Allotment A/c
To Bank A/c (Refund)
(Being the application money appropriated and excess application money refunded)
 b. Debentures issued at a premium:
i. When cash is received
Bank A/c Dr
To Debenture application A/c
(Being the amount received on……..Debentures @ Rs………each)
ii. When the debentures are allotted
Debenture Application A/c Dr
To Debenture A/c (Face Value)
To Debenture Premium A/c (Premium)
To Bank A/c (Refund)
(Being the allotment of …. Debentures of Rs……. Each @ Rs…….each and the refund of excess
money as per Director’s Resolution No……….dated……….)
c. Debentures issued at a Discount:
i. When cash is received
Bank A/c Dr
To Debenture application A/c
(Being the amount received on……..Debentures @ Rs………each)
ii. When the debentures are allotted
Debenture Application A/c Dr
Discount on Issue of Debenture A/c Dr.
To Debenture A/c (Face Value)
To Bank A/c (Refund)
(Being the allotment of …. Debentures of Rs……. Each @ Rs…….each and the refund of excess
money as per Director’s Resolution No……….dated……….)
4. What is double entry system of accounting? State its objectives and features.
Ans: Double entry system of accounting is a generally accepted system of recording business transactions. In
this system, we record the dual effect of a business transaction. Double entry system of book keeping adheres
to the rule, that for each transaction the debit amount must equal the credit amount. The double entry system
seeks to record every transaction in money or money’s worth in its double-the receipt of a benefit by one
account and the surrender of a like benefit by another account, the former entry being to the debit if the account
receiving, the latter to the credit of the account surrendering.
For example, Sagarika Book Store sells books amounting Rs. 5,000, it receives cash on one hand and
gives books on the other. Thus, receiving aspect is cash received and giving aspect is books sold. As both the
aspects are recorded, there will be double entry for every transaction. Therefore, it is called as double entry
system of accounting.

Objectives:
1. To keep complete record of the two aspects of every transaction.
2. To ascertain arithmetical accuracy of books of accounts.
3. To prepare final accounts to obtain the profitability and financial position of a company.
4. To exercise better control over the events and transactions
5. To prevent frauds.
6. To comparison of sales, purchases of different period in order to monitor the performance of company.
7. To determine the amount of cash balance available in the business.
8. To provide information by recording the business transactions in a scientific and systematic manner.
Features:
1. Double entry system records the dual aspects of each transaction.
2. In this system, every transaction is recorded in at least two accounts which show the dual effects of each
transaction.
3. In this system, every receiving aspect has equal and opposite giving aspect.
4. This system provides complete information regarding a transaction by recording it in systematic
manner.
5. This system helps to check the arithmetical accuracy of the books of accounts. It facilitates the
preparation of final accounts at the end of the accounting period.
5. Define share capital. Describe the different divisions of share capital in Joint Stock Company.

Ans: Share capital

The capital of a company is divided into a very large number of equal parts/ units of small
denomination. Each part or unit is called a share. According to section – 2 (46) of the Companies Act 1956, a
share is defined as a share in the share capital of the company and includes stock expect where a distinction
between stock and shares expressed or implied. For example, a company X Ltd. is registered with an authorized
capital Rs. 1000000 divided into 100000 equal parts of Rs. 10. Hence, the value of each share is Rs. 10. It is
called the nominal or face value of a share. All the shares are serially numbered so that each share has a distinct
number. The holder of shares is called a shareholder. Each shareholder is issued a certificate under the common
seal of the company. Such certificate is called a share certificate. A share is a movable property, transferable in
the manner specified in the Articles of Association.
The capital of a company known as share capital is divided into different units with definite value called
shares. The main divisions of share capital are:

Authorized or Nominal or Registered Share Capital

Authorized share capital is the share capital, which the company is authorized to issue by its
memorandum of association. It is the maximum amount up to which a company is authorized to issue shares to
the public without altering the memorandum of association.

Issued Share Capital

It is that part of the Authorized Capital which is issued/ offered to the public for subscription. The
company cannot allot more number of shares than those issued to the public for subscription. For example, if a
company issue 10,000 shares but the public apply for Rs. 9000 shares, then the company can allot only 9000
shares. That part of authorized capital which is not issued to public is called un-issued capital.

Subscribed Share Capital

The nominal value of the shares taken up by the public is subscribed capital subscribed capital will be
equal to issued capital when all the shares offered to the public are taken up by the public. In other words, It is
the part of the issued capital for which is actually subscribed / applied for by the public. That part of the issued
capital which is not subscribed by the public is called unsubscribed capital.

Called up Share Capital

It is that part of the subscribed capital which is called up/ demanded by the company to meet its current
financial requirements. Called up capital is also can equal to the subscribed capital when the board of directors
has called up the total amount payable in the shares. That part of the subscribed capital which is called up/
demanded by the directors of the company is called un-called capital.

Paid up Share Capital

It is that part of the called up capital which is actually paid by the public. The amount which is not paid
by the defaulting shareholders is termed as unpaid capital or calls-in arrear. Hence, paid-up capital represents
the difference between the called up capital and the calls-in-arrear.
 Paid-up Capital = Called-up Capital – Calls-in-arrear

Reserve Capital
A company may determine by a special resolution that any portion of its share capital which has not
been already called up shall not be capable of being called up expect in the event of winding up of the company.
Such type of share capital is known as reserve share capital. such type of share cannot be converted into
ordinary capital without the permission of the court and it cannot be dealt with by the directors in any other
way. The creation of reserve capital is helpful to creditors because this is the amount which can be made
available to them in case of need for distribution in the event of winding up. No accounting entries are required
for the creation reserve capital. Only a note regarding reserve capital may be given in the Balance Sheet.
Example:
A company has Rs. 20,00,000 as its authorized capital divided into 1,00,000 equity shares of Rs. 10 each
and 20,000 preference shares of Rs. 50 each. The company issued 80,000 equity and 10,000 preference shares.
The public subscribed for 60,000 equity shares and 10,000 preference shares. Rs. 8 per share has been called on
equity shares and Rs. 40 has been called on preference shares. All shareholders paid the amount. Calculate the
amount of various types of share capital.
Solution:
Authorized Capital
1,00,000 Equity Shares of Rs. 10 each 10,00,000
20,000 Preference Share of Rs.50 each 10,00,000
20,00,000
Issued Capital
80,000 Equity Shares of Rs. 10 each 8,00,000
10,000 Preference Share of Rs. 50 each 5,00,000
13,00,000
Subscribed Capital
60,000 Equity Shares of Rs. 10 each 6,00,000
10,000 Preference Shares of Rs. 50 each 5,00,000
11,00,000
Called up Capital
60,000 Equity Shares of Rs. 8 each 4,80,000
10,000 Preference Shares of Rs. 40 each 4,00,000

8,80,000
Paid up Capital
60,000 Equity Shares of Rs. 8 each 4,80,000
10,000 preference Shares of 40 each 4,00,000
8,80,000

6. State the different methods of charging depreciation and their relative significance in the books of
account.
Ans: Method of Depreciation:
Various methods of depreciation are generally classified as follows:
i. Straight Line Method
ii. Written down Value Method
iii. Sum of year Digits Method
iv. Annuity Method
v. Sinking Fund Method
vi. Unit of Production Method
1. Fixed Installment / Straight line method.
This method assumes that depreciation is a function of time rather than use. This method is based on the
assumption that each accounting period receives same benefits from using assets. It allocates an equal amount
of depreciation in each accounting periods of the service life of the assets. Under this method a fixed percentage
of original value of the asset is written off every year so as to reduce the asset account to nil or to its scrap value
at the end of the estimated life of the asset.

To ascertain the annual charges

Depreciation = Cost price of asset – Estimated Scrap Value

Estimated life of asset.

Example- Machine cost Rs 11,000

Estimated life 10 years
Scrape value is estimated Rs 1,000/ - at the end of its life, the amount of depreciation would be:
Rs11000 - Rs.1000 = Rs.1000
10
The amount of the depreciation charged during each period of the assets life is constant. It this depreciation
charged is plotted annually on a graph and the point join together then the graph will be a straight line, it is
called straight line method.

It should be noted that if depreciation is given as some percentage per annum and if the asset is
purchased during the accounting year, say on July first, then depreciation on for six months is to be charged.

Merits
a. This method is simple to understand and easy to apply.
b. It realistically matches cost and revenue and determine income of each period easily.
c. It can write down an asset to zero at the end of its working life.
d. This method is very suitable for these assets which have a fixed life i.e. furniture.
e. There is no change either in the rate or the amount of depreciation over the useful life of the
assets. Such a procedure provides for improved comparability.
Demerits
a. It ignores the cost of capital.
b. It is based on the wrong assumption of equal utility of the assets during the useful life.
c. It is also wrong to consider depreciation as a function of time rather than use.
d. The maintenance of asset is generally costly in the later years with the result that deductions
from the revenue would be greater in later years than in the earlier years.

2. Written Down Value Method

Under this method, a fixed percentage is applied to book value of the assets. In other words, the
depreciation is calculated on the reducing balance and not on the original cost. The procedure is that
depreciation calculated is deducted from the cost assets and balance known as the written down value. The
written down value at the end of the estimated useful life of the assets should equal the estimated salvage or
scrap value. Under this method the value of asset never be zero.
The formula for determining the rate of depreciation in diminishing balance method is as follows:

Rate of Depreciation = 1- (n √s/c)

MERITS
a) There is same weightage, in totality, on profit and loss account of depreciation.
 b) Fresh calculation are not necessary when addition of purchase of new Asset
c) This method is recognized by the income-tax authorities of India.
d) It facilitates replacement of fixed assets as it makes more funds available at an early stage.
e) The higher depreciation is charged in the earlier years when the machine is most efficient compared
to later years.

DEMERITS
a) Value of asset can never be zero.
b) Interest on capital invested is not taken into considered.
c) As compared to the straight line method, it is difficult to determine the suitable rate of depreciation.

3. Sum of year Digits Method

This is a version of the reducing installment or diminishing balance method. Under this method
depreciation is calculated by the following formula:
Annual Depreciation = N(C-S)
Sum

Where, C = Acquired Cost or Cost Price of asset

S = Scrap Value of asset
N = Life of asset
Sum = N (N+1)
2

4. Annuity Method:
Annuity method deals with effect of cost of capital in depreciation calculation. The main disadvantages
of the different methods of depreciation discussed earlier are that they do not consider the interest on the capital
invested on fixed assets. Under this method, amount spent on the purchase of an asset is regarded as an
investment which is assumed to earn interested at a certain rate. It makes treatment more explicit by showing
the interest by showing the interest payment in the P&L Account. The assets is, therefore charged with interest
along with actual payment, interest is calculated on the debit balance of the assets at the beginning of the year.
At the same time, fixed amount is charged as a depreciation expense to that it eliminates the asset. The
depreciation will be different according to the rate of interest and according to the period over which the asset is
to be written off. The fixed amount of depreciation as well as the rate of interest is adjusted in such a way that at
the end of life of the asset its book value is reduced to zero. The method is mainly used in the case of costly
leases of long periods.

5. Sinking Fund Method

Under this method, the amount of depreciation goes on accumulating till the asset is completely worn
out. This method provides necessary cash to replace the asset at end of its useful life. The amount of written off
as deprecation should be kept aside and invested in readily saleable securities. The amount of depreciation is
fixed and remains same for every year and is charged to Profit & Loss Account. The amount of depreciation is
invested outside the business every year. The process of investing amount of deprecation and interest goes on
till the time of replacement of asset. The investment accumulates and when the life of asset expires, the
securities are sold and with the sale proceeds a new asset is purchased.
Instead of crediting the asset, another account is credited, which is known as Depreciation Fund
Account. This account is also called every year with any interest earned on investment made.

Journal Entries
First Year
1. For providing annual depreciation
Depreciation A/c Dr.
To Depreciation Fund A/c
 2. For investing the amount of depreciation
Depreciation Fund Investment A/c Dr.
To Bank A/c
3. for transferring depreciation to Profit and Loss Account
Profit and Loss A/c Dr.
To Depreciation A/c
Depreciation Fund Account appears on the liability side and the Depreciation Fund Investment Account on
the assets side of the Balance Sheet.
Subsequent Years
1. For interest received on investment out of depreciation fund
Bank A/c Dr.
To Depreciation Fund A/c
2. For annual instalment of depreciation
Depreciation A/c Dr.
To Depreciation Fund A/c
3. For amount of depreciation and interest earned invested in securities.
Depreciation Fund Investment A/c Dr.
To Bank A/c
4. For transferring depreciation to profit & loss account
Profit and Loss A/c Dr.
To Depreciation A/c
Last Year
1. For interest received on investment
Bank A/c Dr.
To Depreciation Fund A/c
2. For annual instalment of depreciation
Depreciation A/c Dr.
To Depreciation Fund A/c
3. For transferring depreciation to Profit and Loss A/c
Profit and Loss A/c Dr.
To Depreciation A/c
4. For sale of investment
Bank A/c Dr.
To Depreciation Fund Investment A/c
5. For profit on sale of securities
Depreciation Fund Investment A/c Dr.
To Depreciation Fund A/c

Note. If loss reverses entry will be passed

6. For writing off the old asset

Depreciation Fund A/c Dr.
To Asset A/c
7. For transferring the balance of depreciation fund account(if credit balance)
Depreciation Fund A/c Dr.
To Profit and Loss A/c
Note: If debit Balance, reverse entry will be passed.
8. For purchase of the new asset.
New Asset A/c Dr
To Bank A/c
7. Ans:
TRADING AND PROFIT & LOSS A/C
OF M/s MAGNUS
FOR YEAR ENDED 31st December 2008

Amount Amount
Particular Particular
(Rs.) (Rs.)

To Opening Stock 8,000 By Sales 30,500

To Purchases 20,000 Less: Return Inward 1,500
Less: Return Outward 1,000 29,000 29,000
19,000 19,000 By Closing stock 9.000
To Wages 1,200
To Gross Profit c/d 9,800

38,000 38,000
To Salary 4,200 By Gross Profit b/d
Add: Out Standing 300
9,800
4,500 By Discount
To rent 350
4,500 110
Add: Out Standing 200
550
To Bad Debt
550
To Insurance 700
400
Less: Prepaid 100
600
To Depreciation on Machinery
600
(5,000×10%)
To Depreciation on Furniture
500
(2,000×5%)
100
To Net Profit
(Transfer to Capital A/c)
3,260

9,910 9,910

BALANCE SHEET
OF M/s MAGNUS
AS ON DATE 31st December 2008

Amount Amount
Liability Assets
(Rs.) (Rs.)

Capital 50,000 Furniture 2,000

Add: Net Profit 3,260 Less: Depreciation 100
53,260 1,900 1,900
Less: Drawing 4,500 Land and Building 25,000
48,760 48,760 Machinery 5,000
Creditors 10,000 Less: Depreciation 500
 Bills Payable 2,500 4,500 4,500
Outstanding Salary 300 Debtors 14,000
Outstanding Rent 200 Cash in Hand 1,260
Cash at Bank 6,000
Closing Stock 9,000
Prepaid Insurance 100

61,760 61,760

8.
Ans:

Date Discn. Cash Bank Date Discn.

Particulars Particulars
2008 (Rs.) (Rs.) (Rs.) 2008 (Rs.)

1st Jun To Balance b/d 1,00,000 1,50,000 3rd Jun By Purchases A/c
4th Jun To Sales A/c 75,000 5th Jun By Jyoti A/c
8th Jun To Cash A/c (C) 10,000 6th Jun By Wages A/c
9th Jun To Tapan A/c 30,000 7th Jun By Office Salaries A/c
8th Jun By Bank A/c (C)
10th Jun By Insurance A/c
By Balance c/d

--- 1,75,000 1,90,000 ---- 1

To Balance b/d --- 80,000 85,000