ANJANI EDUCATION- Notes on Accounting

INTRODUCTION TO ACCOUNTING

Transactions and events.

❖ TRANSACTIONS. Is used to mean a business, performance of an act, an agreement.

❖ Events. Is used to mean a happening as a consequence of a transaction, a result.

S.NO CONCEPT
1 Accounting entity concept: A business is treated as a separate entity that is distinct
from its owners and all others economic proprietors. For example in case of prop.
Concern though the legal entity of the business and its proprietor is the same, for the
purpose of accounting they are to be treated as separate from each other. If this
assumption is not followed the financial position and operating result of a business
entity cannot be ascertained.

2. Money measurement assumption: only those transactions which are capable of being
expressed in terms of money are included in the accounting records. The information
which cannot be expressed in terms of money is not included in accounting records.’

3 Going concern concept: it is also known as continuity assumption. According to this

assumption, the enterprise is normally viewed as a going concern that is continuing in
operation for the foreseeable future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing materiality the scale of its
operations. It is because of going concern assumptions.

4 Accounting period assumption; it is also known as periodicity assumption or time

period assumption. According to this assumption, the economic life of an enterprise is
artificially split into periodic intervals which are known as accounting periods, at the
end of which an income statement and position statement are prepared to show the
performance and financial position. The use of this assumption further requires the
allocation of expenses between capital and revenue expenditure.

5 Matching concept: according to this concept the expenses incurred in an accounting

period should be matched with the revenues recognized in that period. This period is
basically an accrual concept. This concept calls for adjustment to be made in respect of
prepaid expenses, outstanding expenses, accrued revenues and unaccured revenues.
Appropriate costs have to be matched against the appropriate revenues for the
accounting period.
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6 Accrual concept: according to this concept all revenues and costs are recognized as
they are earned or incurred and not as money is received or paid. According to AS-1
Disclosure of accounting policy” accrual is one of the fundamentals’ accounting
assumptions that is used in the preparation and presented of financial statements. If this
fundamentals assumption is followed, this fact need not be disclosed in the financial
statements since its acceptance and use are assumed.

7 Conservatism or prudence concept: according to this concept the principle of

anticipate no profit but provide for all probable losses should be applied. The principle
of prudence requires that in the situation of uncertainty and doubt, the business
transactions should be recorded in such manner that the profit and assets are not
overstated and losses period and liabilities are not understated.
E.g. 1. Valuation of stock at lower of cost or Net realizable value.
2. Provision of Bad and doubtful debtors, and provisions for discount on debtors.

8 Duality concept: Two fold of aspect is called dual aspect of a transaction. This duality
is the basis of double entry records. As the name implies, the entry made for each
transaction is composed of two parts- one for debit and second one is credit. Every debit
has equal amount of credit. So the total of all debits must be equal to the all credits.

9 Consistency concept: according to this concept accounting practices should be

followed on a consistent basis from one accounting period to another to achieve
comparability. If consistency is not followed, the intra-firm comparison, inter- firm
comparison cannot be made. According to the AS-1 Disclosure of accounting policies’
consistency is one of the fundamental accounting assumption that is used in the
preparation and presentation of financial statements. If this fundamental is followed,
this fact need not to be disclosed in the financial statements since its acceptance and use
are assumed.

10 Substance over form: transactions and other events should be accounted for and
presented in accordance with their substance and financial reality and not merely with
their legal form.

11 Historical concept: according to this concept, an asset is normally recorded in the

accounting records at the price paid to acquire it at the time of its acquisition. The cost
becomes the basis for the accounts during the period of acquisition and subsequent
accounting periods. If nothing is paid to acquire an asset, the same will not be usually
recorded as an asset. It does not mean that asset will be shown at cost. The cost of an
asset is systematically reduced from year to year by charging depreciation.
\

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Objectives of accounting.
➢ Keeping systematic records.
➢ Protecting and controlling business properties.
➢ Ascertaining the operational profit/Loss.
➢ Ascertaining the financial position of the business.
➢ Facilitating rational decision making.

Branches of Accounting:

➢ Financial accounting: it covers the preparation and interpretation of financial

statement and communication to the users of the accounts.
➢ Management accounting: it is concerned with internal reporting to the managers of a
business unit.
➢ Cost accounting: The process of accounting for cost which begins with the recording
of income and expenditure or the bases on which they are calculated and ends with the
preparation and presentation of periodical statements and reports for ascertaining and
controlling costs.
➢ Social responsibility accounting: it is concerned with the accounting for social costs
incurred by the enterprise and social benefits created.
➢ Human resource accounting: human resource accounting is an attempt to identify,
quantify and report investments made in human resources of an organization that are
not presently accounted for under conventional accounting practice.

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Advantages of accounting

1. Aids to replace memory.

2. Aids to comply with legal requirments.
3.Ascertainment of net results of the operations.
4. Aids to ascertain financial position.
5. Aids the user to take decisions.
6. Assist the management.
7. Act as legal evidence.
8. Aids to raising loans.
9. Aids to the ascertainment of value of business.

Difference between Cash Discount and Trade Discount

S.NO BASIS CASH DISCOUNT TRADE DISCOUNT
1 When allowed It is allowed when payment is It is allowed on certain quantity
made before a certain date. being purchased or as a trade
practice.
2. Purpose Allowed for encourage early Allowed to promote sales.
cash payment.
3 Deduction Not deducted from the invoice. It is deducted from invoice.
4 Vary with May be with period within May be with the quantity of goods
which payment is to be made. purchased.
5 Entry A separate a/c is open for cash It is not recorded in the books.
discount.
6 When offered It is offered at the time of It is offered at the time of purchase
getting quick payment. or sales.

DISTINCTION BETWEEN ACCRUAL BASIS AND CASH BASIS OF ACCOUNTING

S.NO ACCRUAL BASIS CASH BASIS
1 This basis is recognized in the This basis is not recognized under company
company act, 1956. act 1956.
2 Enterprises with cash and credit Enterprises with mostly cash transactions
transactions prefer this basis. prefer this basis.

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 ANJANI EDUCATION- Notes on Accounting
3 Business enterprises with profit
motive ascertain their profit or loss
under accrual basis of accounting.
4 It is technical because it involves the
adjustments of a/c for preparing final
a/c.
5 There may be o/s, prepaid expenses,
accrued incomes and incomes
received in advance in the balance
sheet.
6 This basis of accounting based on the
complete records of the financial
transactions gives a true and fair
view of profit or loss for a period and
also exhibits true and fair financial
position of the business on a
particular day.
7 It is a reliable basis of accounting.
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Professional people like, doctors, C.A,
Lawyers etc. and small non-trading
concerns ascertain their profit of loss under
cash basis.
It is simple because it does not require any
technical knowledge.
There are no o/s expenses, prepaid
expenses, accrued incomes and incomes
received in advance in the balance sheet
This basis of accounting does not based on
the complete records of the financial
position of the business because it does not
take in to consideration o/s transactions.
It is not a reliable basis of accounting.
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 ANJANI EDUCATION- Notes on Accounting

PROCEDURE
Procedure of accounting divided into two parts:
1. Generating financial information. 2. Using financial information.

1 Identifying the transactions and events: Accounting identifies the transactions and
events of a specific entity. A transaction is an exchange in which each party receives
or sacrifices some values. An event is a happening of consequence to an entity (use of
raw material for production.)
2 Measuring the identified transactions and events: accounting measures the
transactions and events in terms of a common measurements unit that is the ruling
currency of a country.
3 Recording: it is concerned with the recording of identified and measured financial
transactions in an order manner, soon after their occurrence in the proper books of
accounts.
4 Classifying: it is concerned with the systematic analysis of the recorded data. It
includes the grouping of similar types of transactions. The book containing detailed
information is called ledger.
5 Summarizing: it is concerned with the preparation and presentation of the classified
data in the form of financial statements. In this accountant prepare trail balance, P/L
a/c, balance sheet and cash flow statements.
6 Analysis and interpretations: it involves establishing relationship between various
financial items to evaluate the performance.
7 Communicating: it is concerned with the transmission of summarized, analyzing and
interpreted information to the end users to enable them to make relational decisions.

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Generating Financial Information

identifications of
transactions and
events.

interpreting and measuring of

communication. transactions and
events.

summarising Recording and

and analysing. classifying.

User of financial information:

Internal Users.
External
Users.

Directors.

Partners. Investors

Managers. Officers. Lenders.

Suppliers

Govt

Employee

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BASIC CONCEPTS
TYPES OF ACCOUNTS

PERSONAL A/C IMPERSONAL A/C

REAL NOMINAL

NATURAL ARTIFICIAL REPRESENTATIVE

TANGIBLE INTANGIBLE

Accounting
Traditional Classification of accounts

Types of accounts Meaning Examples

Personal accounts These accounts relate to
natural persons, artificial
persons and representative
persons.
Real A/c These accounts relate to the
tangible or intangible real
assets.
Nominal A/c These accounts relate to
expenses, losses, profits and
gains.
Natural – Ram’s A/c
Artificial – Ram & co.
Representative –
outstanding salary a/c
Tangible – land a/c
Intangible – goodwill
Expenses – purchases a/c
Loss – loss by fire a/c
Profits & gains – sales a/c
Discount received a/c

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Classification of accounts based on accounting equation

Types of
accounts Meaning Examples

Assets a/c These accounts relate to tangible or Land, Building, Cash,

intangible real assets. Goodwill, patents
Liabilities a/c These accounts relate to the financial Trade creditors, outstanding
obligations of an enterprise, towards expenses, bank overdraft,
outsiders. and long-term loans.

Capital a/c These accounts relate to owners of an
enterprise.
Revenue a/c These accounts relate to the amount
charged for goods sold or services
rendered or permitting others to use
enterprise resources yielding interest,
royalty or dividend.
Expenses These accounts relate to the amount
accounts incurred or lost in the process of
earning revenue.
Capital a/c, Drawing a/c
Sales a/c, discount received
a/c, dividend received a/c,
royalty received a/c, interest
received.
Purchases a/c, discount
allowed, and royalty paid a/c,
interest, and loss by fire.

Rules for debit and credit when the accounts are classified as personal, real and nominal.

Types of accounts Rules for debit Rules for credit

For personal accounts Debit the receiver Credit the giver

For real accounts Debit what comes in Credit what goes out

For nominal accounts Debit all losses and Credit all gains and
expenses profits

Rules for debit and credit when the accounts are classified on accounting equation basis.

Types of accounts Rules for debit Rules for credit

For assets accounts Debit the increase Credit the decrease

For liabilities accounts Debit the decrease Credit the increase
For capital accounts Debit the decrease Credit the increase
For revenue accounts Debit the decrease Credit the increase

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For expenses accounts Debit the increase Credit the decrease

Classification of accounts
1. Capital account Personal
2. Drawing account Personal
3. Ram account Personal
4. Bank account Personal
5. Bank overdraft Personal
6. A & Co. Personal
7. A Ltd. Personal
8. Outstanding wages Personal
9. Commission received in advance Personal
10. Prepaid insurance Personal
11. Commission account Nominal
12. Entertainment expenses Nominal
13. Bank Interest Nominal
14. Printing & Stationery Nominal
15. Interest paid Nominal
16. Goodwill account Real
17. Copyrights Real
18. Patents Real
19. Bad debts written off Nominal
20. Bad debts recovered Nominal
21. Building Real
22. Furniture Real
23. Loan from Ram Personal
24. Loan to Ram Personal
25. Profit & Loss account Nominal
26. Revaluation account Nominal
27. Consignment account Nominal
28. Joint venture account Nominal
29. Sales account Nominal
30. Purchases account Nominal
31. Sales return Nominal
32. Purchase return Nominal
33. Interest accrued Nominal
34. Cash Real
35. Carriage inward Nominal
36. Carriage outward Nominal
37. Trade debtors Personal
38. Trade creditors Personal
39. Dividend received Nominal

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40. Partner’s current account Personal

41. Partner’s capital account Personal
42. Outstanding wages Personal
43. Depreciation Nominal
44. Cash discount Nominal
45. Advance to supplier Personal
46. Discount allowed Nominal
47. Bank charges Nominal

Accounting terminology

1. Assets – Assets are future economic benefits, the rights of which are owned or controlled by
an organization or individuals.

Types of assets:
a. Fixed assets: these assets are acquired for long term use in the business and are not
meant for resale. These assets increase the profit earning capacity of the business.
Example: land and building, plant and machinery
b. Floating assets or current assets or circulating assets: the values of these assets keep
on changing. Example: cash, bank, bills receivable
c. Fictitious assets: assets, which are not convertible into cash, are known as fictitious
assets. For example: preliminary and promotion expenses.
d. Wasting assets: these are those assets which are exhausted by regular extraction of
materials out of total resources. Mines & quarries are the examples of wasting assets.
e. Tangible and intangible assets: tangible assets are those assets which can be seen and
touched, such as building, land, plant, furniture. Intangible assets are those assets which
do not have a physical existence and which cannot be seen or touched such as goodwill,
patents, trademarks and prepaid expenses. Intangible assets are also valuable assets.

2. Capital: the amount invested by the businessman into the business is called the capital.
Capital may be of three types:
a. Fixed capital: this is the capital invested in or represented by fixed assets.
b. Circulating capital: capital invested in or represented by current assets.
c. Working capital: current assets - current liabilities

3. Stocks:
a. Livestock: animal assets used in the business. Examples: cow, horses.
b. Dead stock: assets, which are non-living, examples- plant, machinery, and furniture.

For a trader ‘stock will be the finished stock’.

For a manufactured ‘stock shall consist ‘a. raw material b. work in process c. finished stock.

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Always keep in mind that stock is always calculated at cost or market price whichever is
less.(concept of conservatism)

Source document of journal.

➢ Cash memo: when goods are sold or purchased for cash, the firm receives or gives
cash memos which provide details regarding cash transactions. These documents
become the basis for recording transactions in the books of a/cs.
➢ Pay in slip: This form is available from a bank for depositing cash or cheques in a bank
a/c. the counterfoil is returned to the depositor by the cashier after his signatures.
Generally firms get these slips bound in a book so that counterfoil remain in place and
are not lost.
➢ Invoice or Bill: this document is prepared when goods are sold or purchased on credit.
A sale bill is prepared to record credit sales. It contains information such as name of the
party to whom goods are sold, the description of goods sold and the total amount of
sales. The original copy is sent to the buyer and carbon copy is kept as evidence of sales
for future reference.
➢ Receipt: when a firm receives cash from customers it issue a receipt which is a proof of
receiving cash. It is prepared in duplicate, the original copy is handed over to the party
making payment and duplicate copy is kept as record for future reference. This
document contains the details such as date, amount, and name of the party and nature
of payment.
➢ Debit note & credit note: these notes are prepared when goods are returned to the
supplier or when an additional amount is recoverable from a customer.
1. Debit note: For the party from whom the money is recoverable this document
becomes debit note.
2. Credit note: For the party who is recover the amount the document become credit
note (usually in red ink) when goods are returned by a customer, a proper credit
note should be sent to him.

Subsidiary Books

Book Recording
Cash Book Cash receipt and cash payment
Purchase Book` Credit purchase of Goods
Purchase Return Book Return of those Goods which were earlier bought on credit
Sales book Credit sales of goods
Sales return book Return of those goods which were earlier sold on credit`

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Bills Receivable Book Receipts of B/R,Prommissory Notes and Hundis

Bills Payable B/P,Promissory Notes and Hundis accepted

Discoverer of double entry system – Lucas Pacioli

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JOURNAL, Ledger & Cash Book

Journal is a book of original entry, which contains daily records of all business
transaction. The procedure adopted for recording or entering a transaction in journal is known
as ‘Journalizing.

Features of Journal
(i) Journal is a book of original entries.
(ii) All the transactions are firstly recorded in journal.
(iii) In journal, all the business transactions are recorded in chronological order.
(iv) At the end of each journal entry, narration is given.
(v) A single journal entry may also have a record of more than one transaction. Such
type of an entry is called ‘Compound Entry.’
(vi) In journal entry, dual aspect is followed i.e. each journal entry has debit and credit
aspect.
(vii) Balancing is not done in journal.
(viii) It is not necessary to use the word ‘A/c’ after the personal accounts.

LEDGER
Ledger is a book, which contains a classified and permanent record of all the transactions of
a business.
Distinction between journal and ledger
Journal Ledger
Book of original or prime entry. Book of final or secondary entry.
First stage. Second stage
Prepared on the basis of source documents Prepared on the basis of journal.
of transactions.
Prepared in chronological order Not necessary
5 columns 8 columns
It is not balanced. All ledger accounts (except nominal
account) are balanced.
Narration after each entry Narration is not given.
Process of recording is called The process of recording in the ledger is
‘journalizing’. called Posting’.

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COMPOUND ENTRY
When more than two accounts are involved in a transaction and the transaction is recorded
by means of a single entry instead of passing several journal entries, such single journal
entry is termed as ‘Compound Journal Entry’. A compound entry may also be passed if
there are more transactions of the same nature taking place on the same date. It may be
recorded in the following three ways:
a. By debiting one account and crediting two or more accounts; or
b. By debiting two or more accounts and crediting one account; or
c. By debiting several accounts and crediting several accounts.

Example: A paid Rs. 900 in full settlement of Rs. 1000.

Journal entry will be
Cash account Dr. 900
Discount account Dr. 100
To A 1000

OPENING ENTRY
A journal entry by means of which the balance of various assets, liabilities and capital appearing
in the balance sheet of previous accounting period are brought forward in the books of the
current accounting period, is known as ‘Opening entry

CASH BOOK
Meaning: Cash book may be defined as the record as the record of transactions concerning
cash receipts and cash payments. In other words, in cash book, all transactions (i.e. receipts and
payments of cash) are recorded as soon as they take place. Cash book is in form of an account
and actually it serves the purpose of cash book also. It has two sides- debit side and credit side.
On the debit side, all receipts of cash are recorded while on the credit side, all the payments of
cash are recorded. In case of cash transactions, only a single aspect of transactions is recorded in
ledger because the other aspect has to be recorded in cash book. Cash book, thus serves the
purpose of a book of original entry as well as that of ledger a/c.

Petty cash Book: petty cash book is the book which is used for the purposes of recording the
payment of petty expenses. All the petty or small day to day transactions of cash recorded in the
petty cash book. Petty cash balances held in the form of notes and coins rather than bank
deposits and is used in payment of minor exps. E.g. Office tea, Newspapers, pens and bus fares.

Features of petty cash book:

1. Amount received from main cashier recorded on the left hand side column.
2. Payment of petty cash expenses are recorded on the right hand side.
3. It can never show a credit balances because the cash payments can never exceed the
cash receipts.

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4. Its balance not spent petty cash in hand

5. Recording is done on the basis of internal as well as external vouchers. Whenever
external vouchers are not received, (e.g. in case of auto rickshaw charges, coolie
charges, postage stamps.), internal vouchers are prepared and got verified by an
authorized person.

Advantages of petty cash book:

1. It saves the times of chief cashier.
2. The chances of mistakes are reduced since the chief cashier regularly examines
the petty cash book.
3. Petty expenses are kept within the limits of imprest since the petty cashier can
never spend more than the available petty cash.

4. The benefits of specialization are available since recording of cash transactions

is divided between main cash book and petty cash.
5. The record of petty cash is checked by the cashier, periodically so that a
mistake, if committed is soon rectified.

Journal proper:
Meaning: journal proper is used for making the original record of those transactions because
of their importance or rareness of occurrence which do not find a place in any of the other
books of original entry.
Entries recorded in the journal proper as follows:
( a) Opening entries;
Assets a/c Dr ***
To Liabilities a/c Cr ***
To Capital a/c Cr ***
(b) Closing entries: such entries are used at the end of the accounting year for closing off
account relating to expenses and revenues. These a/c are closed off transferring their
balances to the Trading and p/L a/c.
(c) Transfer entries. These are passed in the journal proper for transferring an item, entered is
one a/c to another a/c.
(d) Rectification entries: mistakes made in passing an entry should be recorded be corrected
by passing another entry in the journal proper and the practice of erasers should not be
tolerated.
( e) Adjustment entries: adjustment entries is an amendment to an accounting figure which is
basically correct but which needs to allow for some circumstances not recorded in the book
keeping system.

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Adjustment entries have a dual effect, they affect either Trading & p/L a/c but definitely the
b/s.
(f) Purchases of asset on credit: The following entry is made:
Assets a/c Dr ***
To creditors for asset a/c Cr ***
(g) Sale of worn out or obsolete asset (on credit): when obsolete assets are sold out on
credit, these are recorded in the journal proper.
(h) Purchase of stationery on (Credit): The following entry is made:
Stationery a/c Dr ***
To creditors for stationery a/c Cr ****

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CAPITAL AND REVENUE ITEMS

“Capital items are those, the benefit of which is received over a number of accounting periods
and revenue items are those the full benefit of which is received in the normal accounting
period.”
Carter

“Capital expenditure may be described as outlay resulting in the increase or acquisition of asset
or increase in the earning capacity of a business.
William pickles

Deferred revenue expenditure

A heavy expenditure of revenue nature, the benefit of which is likely to extend beyond current
year in which it is incurred is called as “deferred revenue expenditure.”

Questions from C.A Foundation exams and other exams

State with reasons, whether the following statements are true or false.
1. Pre-operative expenses are revenue expenses.
False: pre-operative expenses are incurred prior to commercial production are generally
capitalized, these are not revenue expenditure.

2. Heavy expenditure incurred on advertisement at the time of introducing a new product is

deferred revenue expenditure.
True: as the benefit out of heavy expenditure would accrue over a period, it is considered as
deferred revenue expenditure.

3. Expenses incurred to keep the machine in working condition are a capital expenditure.
False: it is revenue expenditure as it is not increasing the benefits but only keeping
machine in working condition.

4. An expenditure intended to benefit the current period is revenue expenditure.

True: revenue expenditure is that expenditure the benefit of which does not extend beyond
the current accounting period.
5. Amount written off from the cost of fixed assets is capital expenditure.
False: amount written off from the cost of fixed assets is treated as revenue expenditure and
charged to profit and loss account. Depreciation is an example of such written off.
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1. Wages paid to workers to produce a tool to be actively consumed is capital expenditure.

True: wages paid to workers for the creation of an asset to be used in the business is capital
expenditure.

2. Deferred revenue expenditure is current year’s revenue expenditure to be paid in the later
years.
False: deferred revenue expenditure is that expenditure for which payment has been made or
a liability has been incurred but which is carried forward on the presumption that it will be of
benefit over a subsequent period or periods.

3. Expenditure, which result in acquisition of a permanent asset, is a capital expenditure.

True: expenditure which result in acquisition of a permanent asset is a capital expenditure
since it will generate enduring benefits and help in revenue generation over more than one
accounting period.

4. Amount paid acquiring goodwill is deferred revenue expenditure.

False: amount paid for acquiring goodwill is capital expenditure since it involves acquisition
of intangible assets which is classified as fixed asset.

5. Overhaul expenses of second-hand machinery purchased are revenue expenditure.

False: overhaul expenses are incurred to put second machinery in good/working condition to
derive long term benefits of enduring nature. So this is a capital expenditure.
6. Amount spent for replacement of worn out parts of a machine is a capital expenditure.
False: amount spent for replacement of any worn out part of a machine is revenue expenditure
since it is part of maintenance cost.

7. Expenditure incurred on white washing of factory building done after every six months is
revenue expenditure.
True: these expenses are incurred in the course of normal maintenance of the asset and are,
therefore revenue expenditure.

8. Temporary shed put up at a project site to house materials is a capital expenditure.

True: temporary shed put up at a project site to house materials is incidental to the main
construction and the expenditure on it, is a part of construction cost. Therefore, it is a capital
expenditure.

9. Legal fees paid to acquire a property are capital expenditure.

True: legal fees paid to acquire a property are a part of the cost of that property. Hence it is
taken a s capital expenditure.
10. Expenditure on renovation of a theatre which has increased the seating capacity by 10% is
deferred revenue expenditure.
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False: it is a capital expenditure as it has contributed to the revenue earning capacity of the
business over more than one accounting period.

11. Overhauling expenses of Rs. 25000 for the engine of a motor car to get better fuel efficiency
is a capital expenditure.
True: overhauling expenses are incurred for the engine of a motor car to derive better fuel
efficiency. These expenses will reduce the running cost in future and thus the benefit is in
form of endurable long term advantage. So this expenditure should be capitalized.

12. Inauguration expenses incurred on the opening of a new unit in an existing business is a
capital expenditure.
False: this expenditure is in the nature of revenue expenditure as the expenditure may not
generate any enduring benefit to the business over more than one accounting period.

13. Compensation paid to workers, who opted for voluntary retirement is a revenue expenditure.
True: the amount paid to workers on voluntary retirement is in the nature of revenue
expenditure.

14. Expenditure incurred in connection with obtaining a license for starting the factory.
Ans. It is a capital expenditure. It is incurred for aquiring a right to carry on business for a
long period.
15. Expenditure incurred for removal of stock to a new site
Ans. This is revenue expenditure. Because it is not increasing the value of asset.

16. Rings and pistons of an engine were changed to get fuel efficiency
Ans. It is revenue expenditure because, the changes of rings and piston will restore the
efficiency of the engine only and it will not increase to the capacity of the engine.

17. Expenditure spent as lawyer’s fee to defend a suit claiming that the firm’s factory site
belonged to the plaintiff. The suit was not successful.
Ans. This is revenue expenditure.

18. A factory shed constructed and amount has also been incurred for the construction of the
temporary huts for storing building materials.
Ans. Cost of construction of factory shed is a capital expenditure; similarly cost of
construction of small huts for storing building materials is also a capital expenditure. Both
amount to acquisition of fixed asset.

24. Amount spent on repairs of various machines.

Ans. It is revenue expenditure.

25. Freight and cartage on the new machine, erection charges.

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Ans. These expenditure are incurred up to the point machine is put to use. So these all are
capital expenditure.

26. Amount spent on repairs before using a secondhand car purchased recently, to put it in
useable condition.
Ans. This is a capital expenditure.

27. Amount spent on new machine to put it into use.

Ans. Capital expenditure.

28. Cost of overhauling second hand machinery purchased.

Ans. Capital expenditure.

30. Wages paid to the workers for erecting a cycle shed.

Ans. Capital expenditure.

29. Cost of constructing a gallery in office.

Ans. Capital expenditure

30. Cost of registration expenses for the newly acquired land.

Ans. Capital expenditure

31. Brokerage and stamp duty on purchase of investment.

Ans: capital expenditure.

32. Legal charges incurred on an sale tax appeal

Ans. Revenue expenditure.

33. Cost of re-painting the factory shed.

Ans. Revenue expenditure.

34. Amount spent on repairs to a second hand engine in order to put it in working order.
Ans. Revenue expenditure.
35. Amount paid for purchasing raw materials.
Ans. Revenue expenditure.

36. Amount spent on dismantling, removing and reinstalling plant, machinery and fixture.
Ans. Capital expenditure
37. Amount spent on uniform of workers.
Ans. Revenue expenditure.
38. Wages paid for construction of the building extension.
Ans. Capital expenditure.

39. Export duty on sale of material

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Ans. Revenue expenditure.

40. Discount on issue of shares/debentures.

Ans. Capital loss.

41. Depreciation on machinery.

Ans. Revenue expenditure.

42. Salaries paid to office staff.

Ans. Revenue expenditure.

43. Cost of goods purchased for sale.

Ans. Revenue expenditure.

44. Interest on loan taken from Bank.

Ans. Revenue expenditure.

45. Expenditure incurred on floating a company.

Ans. Capital loss (preliminary expenses)

46. Expenditure incurred on raising the share capital of a company.

Ans. Preliminary expenses

50. Machinery of book value of Rs. 10000 was sold off at Rs. 6000.
Ans. Capital loss of Rs. 4000

51. Machinery: original cost Rs.60000; book value Rs. 50000 is sold for Rs. 80000.
Ans. Capital profit Rs. 20000, revenue profit Rs. 10000

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. DEPRECIATION

MEANING OF DEPRECIATION ACCOUNTING

According to the American Institute of Certified Public Accountants (AICPA) ,
‘Depreciation Accounting is a system of accounting which aims to distribute cost or the basic
value of tangible capital assets less salvage (if any), over the estimated useful life of the unit
(which may be group of assets) in a systematic and rational manner. It is a process of allocation
and not of valuation.’

According to Accounting standard –6 ‘on ‘depreciation Accounting’ issued by Institute of

Chartered Accountants of India, Depreciation is “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, efflux ion of time or obsolescence
through technology and market changes. Depreciation is allocated so as to charge fair
proportion of the Depreciation (Depreciable) amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortization of assets whose useful life
is predetermined.”

Thus depreciation is a measure of wearing out, consumption or other loss of value of a

depreciable asset arising from use and passage of time. Depreciation is nothing but distribution
of total cost of assets over its useful life.

Meaning of a Depreciable asset

Depreciable assets are those assets which
➢ have a limited useful life
➢ Are expected to be used for more than one accounting period.
➢ Are held for use in production of goods and services
➢ Are not for the purpose of sale in the ordinary course of business.

Depreciation word is used for tangible fixed asset i.e. assets which have physical
substance, e.g.- furniture. It may have different meaning according to usage.
b. Amortization – amortization word is used for assets not having physical
appearance, e.g. – patents, copyrights etc.
c. Depletion – depletion word is used for natural resources e.g – mines, quarries,
mineral ores, and wasting assets.
d. Write off – it is used for fictitious assets i.e. discount on issue of shares etc.

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CAUSES OF DEPRECIATION

a. Physical wear and tear: when the fixed assets are used, the value of such assets may
decrease, such decrease in the value of assets is said to be due to physical wear and tear.

b. Efflux ion of time i.e. With the passage of time – it means decrease in the value of asset
due to passage of time even if they are not put to any use. Example- when the assets are
exposed to the forces of nature like weather, rains, summer etc.

c. Changes in economic environment, it may be of two types.

Market changes- when the value of an asset decreases due to decrease in demand of an asset
.
d. Technological changes- due to better type of technology available in the market, demand
for a product which was earlier in the market having less quality may decrease.

e. Expiration of legal rights- when the asset usage depends upon the time bound agreement,
the value of such an asset may decrease with passage of time, example – rights of patents.
Purposes of charging depreciation
a. To ascertain the true and fair results of an enterprise – because of matching concept, if
proper depreciation is not charged, it will represent the distorted picture of an enterprise. It is
necessary to charge the depreciation against revenue in each accounting period.
b. To show the assets at their true value – if wrong depreciation is charged, it will show the
wrong value of an asset.
c. To generate funds for replacement of assets- Since depreciation is a non-cash expenditure,
it does not involve cash out-flow, hence the amount of ‘annual depreciation gets accumulated
over the working life of the asset and it becomes easy to replace the asset.
d. Statutory requirement- Section 205 of Companies
Act, 1956 has made it compulsory for a Joint stock company to provide for depreciation in
order to calculate the divisible profits. Income tax Act has also made it compulsory to
calculate depreciation.

Methods of depreciation
1. straight line method or original cost method or fixed installment method
2. written down value method or diminishing balance method
3. sum of digit method
4. sinking fund method
5. insurance policy method

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6. revaluation method
7. machine hour rate method
8. mileage or kilometer method
9. depletion method
10. annuity method

1. Original cost or straight line method or fixed installment method- under this
method of depreciation, a fixed part of the original cost of the asset is written off
each year till the value of asset comes to zero or to its estimated scrap value, if any.
The annual depreciation under this method can be calculated as follows:

Depreciation = cost of asset +Installation charges-Scrap value

______________________________________
Estimated life of asset

Rate of depreciation = annual depreciation

________________ * 100
Original Cost

Illustration1. A Ltd. purchased a machinery costing Rs. 1000000 on 1st April 2006. Its estimated
life is 4 years while its scrap value is estimated a Rs. 100000. Calculate the depreciation to be
charged every year and rate of depreciation and Machinery account for 10 years.
Solution:
Depreciation = cost of asset -Scrap value
______________________________________
Estimated life of asset
Amount of depreciation per year = (1000000-100000)/10
= Rs. 90000
Rate of depreciation =(90000/1000000)*100
=9%
Note: while calculating depreciation, net cost is taken into consideration, but while calculating
rate of depreciation, original cost is taken as denominator.

WRITTEN DOWN VALUE METHOD:

Under this method fixed % depreciation charged on the written down value of the asset
in every year and charged to profit and loss a/c. The rate of depreciation remains same year
after year and amount of depreciation will reduce year by year.
Merits:
1. As the decreasing charge for depreciation cancels out the increasing charges for
repairs over the years, it gives a fair charge for depreciation.
2. The asset is never fully depreciated.

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3. This method is logical in the sense that as the asset grows older the amount of
depreciation also goes on decreasing.
4. This method cannot be applied for assets with a very short life.
Demerits:
1. It is difficult to calculate the rate of depreciation.
2. It does not provide for the replacement of the asset on the expiry of its useful
life.
3. It does not take into consideration the interest on capital invested in the assets.
4. It takes a very long life to write an asset down to its breakup value, unless a very
high rate is used.

Suitability: This method is useful for those assets in relation to which the amount of repairs
and renewals goes on increasing as the asset grows older the possibilities of obsolescence are
more. This method is useful for plant & machinery, building, etc…

Difference between straight line method and written down value method:

S.NO S.L.M W.D.V

1 Depreciation charged on the original
cost of the asset.
2 Depreciation remains same every
year.
3 Book value of asset will be zero after
the useful life of assets.
4 Suitable for assets having shorter life
and lesser value.
5 It is easy to calculate the rate of
deprecation.
6 Total charges against incomes
increases.
Depreciation charged on the written down value
of the assets.
Depreciation reduces year by year.
Book value of asset is never comes to zero.
Suitable for assets having long life and requiring
additions and extensions in its life and
substantial repairs in the later years.
It is difficult to calculate the rate of depreciation.
Total charges against incomes remain more or
less equal.

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