Question No.

1 (A) Distinguish between debt and equity securities and between short-term and long-
term investments.

Debt and equity securities are both types of investments, but they represent different ways of financing
a company and offer investors different rights and risks. Here are the key differences between debt and
equity securities:

1. Ownership vs. Debt:

 Equity securities represent ownership in a company. When you buy equity securities,
such as stocks, you become a partial owner of the company and have voting rights and
the potential to receive dividends.

 Debt securities, on the other hand, represent loans made by investors to the company.
When you buy debt securities, such as bonds or debentures, you are essentially lending
money to the company in exchange for periodic interest payments and repayment of
the principal amount at maturity.

2. Risk and Return:

 Equity securities generally offer higher potential returns but also come with higher risk.
As an equity holder, you share in the company's profits and growth, but you also bear
the risk of losing your investment if the company performs poorly.

 Debt securities typically offer lower returns compared to equity but come with lower
risk. Bondholders have a higher claim on the company's assets in case of bankruptcy,
making debt investments more secure than equity investments.

3. Priority of Payment:

 In the event of bankruptcy or liquidation, debt holders have a higher priority of payment
compared to equity holders. Debt holders are typically paid off before equity holders
receive any proceeds.

 Equity holders are residual claimants, meaning they receive what's left after all debts
and obligations have been paid off.

4. Voting Rights and Control:

 Equity securities often come with voting rights, allowing shareholders to participate in
the company's decision-making processes, such as electing the board of directors or
voting on major corporate actions.

 Debt securities generally do not come with voting rights. Bondholders do not have a say
in the company's management or operations.

5. Dividends vs. Interest:

 Equity investors may receive dividends, which represent a portion of the company's
profits distributed to shareholders. Dividends are typically discretionary and can vary
based on the company's performance and management decisions.
  Debt investors receive interest payments at regular intervals, typically semiannually or
annually, throughout the life of the bond. The interest rate is fixed at the time of
issuance and is contractual.

6. Duration and Maturity:

 Equity securities have no maturity date; investors can hold them indefinitely or sell
them on the secondary market.

 Debt securities have a specified maturity date when the principal amount must be
repaid to the investor. Bonds can have short-term (e.g., less than one year), medium-
term (e.g., 1-10 years), or long-term (e.g., more than 10 years) maturities.

Nature of Investment:

Debt securities represent loans made by investors to the issuing company. Investors essentially lend
money to the company in exchange for periodic interest payments and the return of the principal
amount at maturity.

Equity securities represent ownership in the company. Investors who purchase equity securities, such as
stocks, become partial owners of the company and have certain rights, such as voting rights and the
potential to receive dividends.

Priority of Payment:

Debt holders have a higher priority of payment compared to equity holders. In the event of bankruptcy
or liquidation, debt holders are typically paid off before equity holders receive any proceeds.

Equity holders are residual claimants, meaning they receive what's left after all debts and obligations
have been paid off.

Risk and Return:

Debt securities generally offer lower returns compared to equity securities but come with lower risk.
Bondholders receive fixed interest payments and the return of their principal investment at maturity,
providing a predictable stream of income.

Equity securities typically offer higher potential returns but also come with higher risk. Equity investors
share in the company's profits and growth potential, but they also face the risk of losing their
investment if the company performs poorly.

Voting Rights and Control:

Equity securities often come with voting rights, allowing shareholders to participate in the company's
decision-making processes, such as electing the board of directors or voting on major corporate actions.

Debt securities generally do not grant voting rights. Bondholders do not have a say in the company's
management or operations.

Differences between Short term and long term investments.

Short-term and long-term investments differ primarily in their time horizon, risk level, potential returns,
and liquidity. Here are the key differences between the two:

Time Horizon:

Short-term investments typically have a shorter time horizon, generally ranging from a few days to a few
years. These investments are usually intended to be held for a relatively brief period, often less than one
year.

Long-term investments, on the other hand, are held for an extended period, often spanning several
years or even decades. Investors typically maintain long-term investments for the achievement of
financial goals in the distant future, such as retirement or funding a child's education.

Risk Level:

Short-term investments generally involve lower risk compared to long-term investments. They are
typically more conservative and focused on preserving capital rather than seeking high returns. Common
short-term investments include cash equivalents, money market instruments, and short-term bonds.

Long-term investments often entail higher risk because they are exposed to market fluctuations and
economic cycles over an extended period. However, they also have the potential to generate higher
returns over time. Examples of long-term investments include stocks, real estate, and long-term bonds.

Potential Returns:

Short-term investments typically offer lower potential returns compared to long-term investments.
Because of their shorter duration and lower risk, short-term investments usually provide lower yields or
interest rates.

Long-term investments have the potential to generate higher returns over time, although they may
experience more volatility in the short term. Historically, assets like stocks and real estate have provided
higher average returns over long investment horizons compared to cash equivalents or bonds.
Liquidity:

Short-term investments are often highly liquid, meaning they can be easily converted into cash with
minimal impact on their value. This liquidity is essential for investors who may need access to their
funds quickly for unexpected expenses or opportunities.

Long-term investments may have lower liquidity compared to short-term investments. Assets such as
real estate or long-term bonds may take time to sell, and there could be transaction costs or penalties
associated with early withdrawal or selling before maturity.

Purpose:

Short-term investments are typically used for immediate or near-term financial goals, such as building
an emergency fund, saving for a vacation, or setting aside funds for upcoming expenses.

Long-term investments are geared towards achieving major financial objectives that are further in the
future, such as retirement planning, wealth accumulation, or funding education expenses for children.

In summary, short-term investments are characterized by their shorter time horizon, lower risk, lower
potential returns, high liquidity, and suitability for immediate financial needs. Long-term investments,
on the other hand, are held for an extended period, involve higher risk and potential returns, may have
lower liquidity, and are designed to meet long-term financial goals.

Question No. 1 (B).

Describe how to report equity securities with controlling influence.

Answere

When reporting equity securities with controlling influence, also known as investments in subsidiaries,
the reporting entity (parent company) needs to follow specific accounting and reporting guidelines,
typically outlined in accounting standards such as Generally Accepted Accounting Principles (GAAP) or
International Financial Reporting Standards (IFRS). Here's a general overview of how to report equity
securities with controlling influence:

Determine Control: The reporting entity must assess whether it has control over the subsidiary. Control
is generally defined as having the power to govern the financial and operating policies of another entity
so as to obtain benefits from its activities. This is usually indicated by ownership of more than 50% of
the voting rights of the subsidiary.

Consolidation: If the reporting entity has control over the subsidiary, it consolidates the subsidiary's
financial statements with its own. Consolidation involves combining the assets, liabilities, equity,
revenues, and expenses of the parent company and its subsidiary into a single set of financial
statements.

Preparation of Consolidated Financial Statements: The consolidated financial statements include:

Consolidated Balance Sheet: This presents the combined assets, liabilities, and equity of the parent
company and its subsidiary.

Consolidated Income Statement: This shows the combined revenues, expenses, gains, and losses of the
parent company and its subsidiary.

Consolidated Statement of Cash Flows: This presents the combined cash inflows and outflows of the
parent company and its subsidiary.

Elimination of Intercompany Transactions: In preparing the consolidated financial statements,

intercompany transactions and balances between the parent company and its subsidiary are eliminated
to avoid double counting. This includes intercompany sales, purchases, dividends, and loans.

Equity Method: If the reporting entity has significant influence over, but not control of, the subsidiary
(usually indicated by ownership of 20% to 50% of the voting rights), it accounts for the investment using
the equity method. Under this method, the investor recognizes its share of the subsidiary's net income
or loss in its own income statement and adjusts the carrying value of the investment accordingly.

Disclosure: The reporting entity must provide adequate disclosure in its financial statements about its
investments in subsidiaries. This typically includes information about the nature of the investments, any
restrictions on the ability to access or use assets, and any significant terms and conditions of the
investments.

Compliance with Accounting Standards: Ensure that the reporting entity complies with relevant
accounting standards (e.g., GAAP, IFRS) and regulatory requirements governing the reporting of
investments in subsidiaries.

It's important for the reporting entity to carefully assess its level of influence or control over the
subsidiary and apply the appropriate accounting treatment in accordance with the applicable accounting
standards. Additionally, engaging qualified accounting professionals or consultants can ensure
compliance with reporting requirements and accurate financial reporting.
Question No. 2.

General Electronics uses a sales journal, a purchases journal, a cash receipts journal, a cash
disbursements journal, and a general journal as illustrated in this chapter. General recently
completed the following transactions a through h. Identify the journal in which each transaction
should be recorded.

a. Paid cash to a creditor. e. Borrowed cash from the bank.

b. Sold merchandise on credit. f. Sold merchandise for cash.

c. Purchased shop supplies on credit. g. Purchased merchandise on credit.

d. Paid an employee’s salary in cash. h. Purchased inventory for cash.

Answere:

Here's the breakdown of each transaction and the journal where it should be recorded:

a. Paid cash to a creditor.

This transaction involves a cash disbursement, so it should be recorded in the cash disbursements
journal.

b. Sold merchandise on credit.

Sales made on credit are typically recorded in the sales journal.

c. Purchased shop supplies on credit.

Purchases made on credit are usually recorded in the purchases journal.

d. Paid an employee’s salary in cash.

Cash payments, such as paying salaries, are recorded in the cash disbursements journal.

e. Borrowed cash from the bank.

Borrowing cash involves receiving cash, so it should be recorded in the cash receipts journal.

f. Sold merchandise for cash.

Cash sales are recorded in the cash receipts journal.

g. Purchased merchandise on credit.

Purchases made on credit should be recorded in the purchases journal.

h. Purchased inventory for cash.

Cash purchases, such as buying inventory for cash, are recorded in the cash disbursements journal.

In summary:

Transaction a should be recorded in the cash disbursements journal.

Transaction b should be recorded in the sales journal.

Transaction c should be recorded in the purchases journal.

Transaction d should be recorded in the cash disbursements journal.

Transaction e should be recorded in the cash receipts journal.

Transaction f should be recorded in the cash receipts journal.

Transaction g should be recorded in the purchases journal.

Transaction h should be recorded in the cash disbursements journal.

Question No. 3

What do you know about event and transactions? Explain. Also, describe 5 events and 5 transactions
which change the equity.

Answere

In accounting, events and transactions are fundamental concepts that relate to the changes in a
company's financial position. They both play crucial roles in recording, analyzing, and reporting financial
information.

Events:
Events are happenings that affect a company's financial position and are recorded in the financial
statements. Events can be either internal or external to the organization. Internal events are those that
originate within the company, such as depreciation of assets or issuance of dividends. External events
are those that occur outside the company, such as changes in economic conditions or regulatory
changes.

Transactions:

Transactions are specific exchanges or interactions that involve the transfer of goods, services, or money
between two parties. Transactions are typically recorded in a company's accounting records and
financial statements. They can include sales of products, purchases of assets, payment of expenses,
borrowing of funds, etc.

Changes in Equity:

Equity represents the residual interest in the assets of a company after deducting liabilities. Changes in
equity occur as a result of various events and transactions that impact the company's financial position.
Here are five events and five transactions that can change equity:

Events:

Net Income/Loss: This event occurs when the company generates profits or incurs losses from its
operations.

Dividends Declared: When a company distributes profits to its shareholders in the form of dividends, it
reduces retained earnings, thus impacting equity.

Stock Splits: A stock split increases the number of shares outstanding, which affects the equity portion of
each shareholder.

Comprehensive Income: Comprehensive income includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.

Revaluation of Assets: If the company revalues its assets (e.g., property, plant, and equipment) upward
or downward, it impacts the equity value.

Transactions:

Issuance of Stock: When a company issues new shares of common stock, it increases equity.

Purchase of Treasury Stock: Buying back shares of its own stock decreases equity.

Payment of Dividends: Actual payment of dividends to shareholders reduces equity.

Issuance of Bonds: Issuing bonds increases liabilities and equity, as bonds represent a form of
borrowing.

Recognition of Revenue: When a company recognizes revenue from sales of goods or services, it
increases equity.

These events and transactions directly impact the equity section of the company's balance sheet and are
essential for understanding the financial health and performance of the organization.

Question No. 4. (A)

Explain the steps in processing transactions and the role of source documents. Also describe the ledger
and chart of accounts.

Answer

Processing transactions involves several steps to accurately record and document financial activities
within a business. These steps typically include:

Identification of Transactions: The process begins with identifying the various transactions that occur
within the business. This could include sales transactions, purchases of goods or services, payments to
suppliers, payroll transactions, etc.

Source Documents: Source documents are the original records that provide evidence of a transaction.
These documents can include invoices, receipts, purchase orders, sales orders, bank statements, checks,
contracts, and other relevant paperwork. Source documents serve as the basis for recording
transactions accurately and provide supporting documentation for auditing purposes.

Recording in Journals: Once transactions are identified and supported by source documents, they are
recorded in chronological order in appropriate journals. Journals are books of original entry where
transactions are first recorded before being transferred to the ledger. Common types of journals include
the sales journal, purchases journal, cash receipts journal, and cash disbursements journal.

Posting to Ledgers: The next step involves posting the entries from the journals to the general ledger.
The ledger is a master document or a collection of accounts that summarizes all transactions affecting
each account in the accounting system. It consists of individual accounts for assets, liabilities, equity,
revenue, and expenses. Each transaction is posted to the appropriate accounts in the ledger, updating
their balances accordingly.
Trial Balance: Once all transactions have been posted to the ledger, a trial balance is prepared to ensure
that debits equal credits and that the ledger is in balance. The trial balance lists all the accounts and
their balances, providing a snapshot of the financial position of the business at a specific point in time.

Adjusting Entries: Adjusting entries are made at the end of an accounting period to update account
balances and ensure that they reflect the correct financial position of the business. These entries
typically involve accruals, deferrals, depreciation, and other adjustments necessary for accurate financial
reporting.

Financial Statements: Finally, financial statements such as the income statement, balance sheet, and
statement of cash flows are prepared using the information from the ledger and adjusting entries. These
statements provide a summary of the company's financial performance and position for a specific
period.

Role of Source Documents:

Source documents play a crucial role in the transaction processing cycle by providing evidence of the
occurrence of a transaction. They serve as the primary record of business activities and provide
documentation for auditing, verification, and reference purposes. Without source documents, it would
be challenging to accurately record and validate transactions, leading to potential errors and
discrepancies in the accounting records.

Ledger and Chart of Accounts:

Ledger: The ledger is a central repository of all accounts maintained by a business. It consists of
individual accounts for each asset, liability, equity, revenue, and expense category. Transactions are
recorded and summarized in the ledger, providing a detailed record of all financial activities within the
organization. The ledger serves as the foundation for preparing financial statements and facilitates the
analysis of financial performance.

Chart of Accounts: The chart of accounts is a structured list of all the accounts used by a business to
categorize and organize its financial transactions. It provides a systematic framework for recording and
classifying transactions, ensuring consistency and accuracy in the accounting process. The chart of
accounts typically includes a numerical or alphanumeric code for each account, along with a description
of its purpose and function within the accounting system. By standardizing the organization and
classification of accounts, the chart of accounts simplifies financial reporting and analysis, making it
easier to interpret and understand the company's financial position and performance.
(B)

a) Automobiles of Rs. 11000/- and Equipment of Rs. 5600/- purchased on cash.

b) Insurance of amounting to Rs. 3600/- paid in advance.
c) Office Supplies of Rs. 600/- purchased on cash.
d) Office Supplies of Rs. 200/- and equipments of Rs. 9400 purchased on credit.
e) Revenues received from delivery service of Rs. 2500/-
f) Payables paid of Rs. 2400/-
g) Gas and Oil Expense occurred of Rs. 700/-

Question No. 5.

Kearl Associates is a professional corporation providing management consulting services. The company
initially debits assets in recording prepaid expenses and credits liabilities in recording unearned
revenues. Give the entry that Kearl would use to record each of the following transactions on the date it
occurred. Prepare the adjusting entries needed on December 31, 2012.

Answer

To record each transaction for Kearl Associates and prepare the adjusting entries needed on December
31, 2012, considering their accounting treatment of debiting assets for prepaid expenses and crediting
liabilities for unearned revenues, let's address each transaction:

July 1, 2012: Kearl paid a three-year premium of Rs. 5,400 on an insurance policy effective July 1, 2012,
and expires June 30, 2015.

Entry:

Prepaid Insurance 5,400

Cash 5,400
Adjusting Entry on December 31, 2012:

To recognize the portion of the insurance premium that has expired as of December 31, 2012 (6 months
out of 36 months):

Insurance Expense (or Insurance Premium Expense) 900 (5400/36*6)

Prepaid Insurance 900

February 1, 2012: Kearl paid property taxes for the year February 1, 2012, to January 31, 2013. The tax
bill was Rs. 2,400.

Entry:

Prepaid Property Taxes 2,400

Cash 2,400

Adjusting Entry on December 31, 2012:

No adjusting entry needed because the full amount of the prepaid property taxes will be expensed in
the next accounting period.

May 1, 2012: The company paid Rs. 360 for a three-year subscription to an advertising journal. The
subscription starts May 1, 2012, and expires April 30, 2015.

Entry:

Prepaid Advertising 360

Cash 360

Adjusting Entry on December 31, 2012:

To recognize the portion of the advertising subscription that has expired as of December 31, 2012 (7
months out of 36 months):

Advertising Expense 70 (360/36*7)

Prepaid Advertising 70

September 15, 2012: Kearl received Rs. 3,600 in return for providing consulting services for 18 months
beginning immediately.
Cash 3,600

Unearned Consulting Revenue 3,600

Adjusting Entry on December 31, 2012:

To recognize the portion of consulting revenue that has been earned as of December 31, 2012 (4
months out of 18 months):

Unearned Consulting Revenue 800 (3600/18*4)

Consulting Revenue 800

November 1, 2012: Kearl rented part of its office space to Davis Realty. Davis paid Rs. 900 on November
1, 2012, for the next six months’ rent.

Entry:

Cash 900

Unearned Rent Revenue 900

Adjusting Entry on December 31, 2012:

To recognize the portion of the rent revenue that has been earned as of December 31, 2012 (2 months
out of 6 months):

Unearned Rent Revenue 300 (900/6*2)

Rent Revenue 300

November 1, 2012: Kearl loaned Rs. 80,000 to a client. On November 1, the client paid Rs. 14,400,
representing two years’ interest in advance (November 1, 2012, through October 31, 2014).

Entry:

Cash 14,400

Unearned Interest Revenue 14,400

Adjusting Entry on December 31, 2012:

No adjusting entry needed because the full amount of the unearned interest revenue will be recognized
as revenue in future periods.

These entries and adjusting entries accurately reflect Kearl Associates' transactions and ensure
compliance with their accounting policies regarding prepaid expenses and unearned revenues. Adjusting
entries recognize the portion of prepaid expenses and unearned revenues that have been incurred or
earned as of December 31, 2012.