All questions of Unit 1: Final Accounts of Non-Manufacturing Entities for CA Foundation Exam

Treatment of Purchase Returns in the Trading Account

In the Trading Account, the treatment of purchase returns is to deduct them from purchases on the debit side.

Explanation:
The Trading Account is a financial statement that shows the gross profit or loss of a business. It is prepared to determine the profitability of the trading activities of a company.

1. What are Purchase Returns?
Purchase returns, also known as returns outwards or returns to suppliers, occur when a buyer returns goods to the supplier due to various reasons such as damaged goods, incorrect quantity or quality, or dissatisfaction with the product.

2. Purpose of Trading Account:
The Trading Account is prepared to calculate the gross profit or loss made by a business through its trading activities. It includes the following elements:
- Opening stock
- Purchases
- Purchase returns
- Direct expenses (if any)
- Closing stock

3. Treatment of Purchase Returns:
Purchase returns are deducted from purchases on the debit side of the Trading Account. This is because purchase returns represent a reduction in the total purchases made by the business during a specific period.

When purchase returns are deducted from purchases, the net purchases figure is obtained. Net purchases are the actual purchases made by the business after deducting the returns. This figure is then used to calculate the cost of goods sold and determine the gross profit or loss.

4. Example:
Let's consider an example to understand the treatment of purchase returns in the Trading Account:

Opening stock: $10,000
Purchases: $50,000
Purchase returns: $2,000
Closing stock: $15,000

Calculation:
Net purchases = Purchases - Purchase returns
Net purchases = $50,000 - $2,000 = $48,000

Cost of goods sold = Opening stock + Net purchases - Closing stock
Cost of goods sold = $10,000 + $48,000 - $15,000 = $43,000

Gross profit = Sales - Cost of goods sold

By deducting purchase returns from purchases, we obtain the net purchases figure, which is then used to calculate the cost of goods sold and ultimately determine the gross profit or loss of the business.

Therefore, the correct treatment of purchase returns in the Trading Account is to deduct them from purchases on the debit side.

Direct Expenses in Trading Account

In the context of the Trading Account, direct expenses refer to the expenses that are directly related to the purchase and preparation of goods for sale. These expenses are incurred during the production or acquisition of goods that are intended to be sold by a business. Direct expenses are deducted from the revenue earned from the sale of goods to calculate the gross profit or loss of a business.

Explanation of the Correct Answer: Option C

Expenses that are directly related to the purchase and preparation of goods for sale are considered direct expenses in the Trading Account. Let's further understand why this option is correct:

Direct Expenses

Direct expenses are those expenses that can be directly attributed to a particular product or service. They are incurred in the production or acquisition of goods that are intended to be sold. These expenses are directly related to the core operations of the business and are essential for the generation of revenue.

Examples of Direct Expenses

1. Cost of Goods Sold (COGS): This includes the cost of raw materials, direct labor, and direct overheads incurred in the production of goods for sale. These expenses are directly attributable to the goods produced.

2. Purchase of Goods: The cost of purchasing goods for resale is a direct expense as it is directly related to the procurement of goods for the purpose of sale.

3. Freight and Transportation Charges: Expenses incurred in transporting goods from the supplier to the business premises are considered direct expenses as they are directly related to the purchase and acquisition of goods.

4. Customs Duty: Customs duty paid on imported goods is a direct expense as it is directly related to the acquisition of goods for sale.

5. Direct Labor: The wages paid to workers directly involved in the manufacturing or preparation of goods for sale are considered direct expenses.

Conclusion

In conclusion, direct expenses in the Trading Account are those expenses that are directly related to the purchase and preparation of goods for sale. These expenses are essential for the production or acquisition of goods and are deducted from the revenue generated from the sale of goods to calculate the gross profit or loss of a business.

Net profit or loss is calculated by subtracting total expenses from gross profit.
Total Expenses = $11,000 + $25,000 + $32,000 + $1,000 + $17,000 + $12,000 + $27,000 = $125,000
Net Profit/Loss = Gross Profit - Total Expenses
Net Profit/Loss = $42,000 - $125,000 = Net loss of $83,000

Net profit is calculated by adding other income to gross profit and then subtracting expenses.
Net Profit = Gross Profit + Other Income - Management Expenses
Net Profit = $42,000 + $18,000 - $11,000 = $49,000

The Balance Sheet is not a part of the Income Statement. The Income Statement consists of the Trading account and the Profit and Loss account, which show the performance of the business, whereas the Balance Sheet shows the financial position.

Understanding the Closing Stock Journal Entry
At the end of the accounting year, businesses need to account for their closing stock, which is the inventory that remains unsold. The journal entry for recording closing stock directly impacts the Trading Account.
Correct Journal Entry
The correct entry to record closing stock is:
- Debit Closing Stock Account
- Credit Trading Account
This is represented as:
- Debit: Closing Stock Account
- Credit: Trading Account
Why This Entry is Made
- Reflects Inventory Value: Closing stock represents the value of unsold goods, which is an asset. By debiting the Closing Stock Account, we acknowledge this asset on the balance sheet.
- Impact on Trading Account: Credit to the Trading Account reduces the cost of goods sold (COGS) for the year. This adjustment ensures that the profit/loss reflects only the actual goods sold during the period.
Alternative Options Explained
- Option B (Debit Trading Account, Credit Closing Stock): This would incorrectly increase COGS and not accurately represent the closing stock as an asset.
- Option C (Debit Purchases Account, Credit Closing Stock): This does not make sense as purchases are recorded during the period, not at year-end.
- Option D (Debit Closing Stock, Credit Purchases Account): This entry mixes concepts as purchases are separate from closing stock evaluation.
Conclusion
The proper journal entry helps maintain accurate financial statements, ensuring stakeholders have a clear view of the company’s financial position. Always remember, the closing stock impacts both the balance sheet and the trading results of a business.

The net effect on the Profit and Loss Account is the difference between the discount received and the discount allowed.
Net Effect = Discount Received - Discount Allowed
Net Effect = $18,000 - $19,000 = Net loss of $1,000

Non-manufacturing entities are businesses that do not engage in the production or manufacturing of goods. Instead, they focus on providing services or selling goods in their original form without any processing. The true statement regarding non-manufacturing entities is option 'B': They sell goods in their original form without processing.

Explanation:

1. Non-manufacturing entities do not engage in processing:
Non-manufacturing entities primarily focus on providing services rather than producing or processing goods. They may offer a wide range of services, such as consulting, banking, insurance, healthcare, education, transportation, etc.

2. Selling goods in their original form:
While these entities may sell goods, they do so without any processing or alteration. Goods are sold as they are received from suppliers or manufacturers. For example, a retail store that sells clothing buys the clothes from manufacturers and sells them to customers without making any changes to the product.

3. Differentiating manufacturing and non-manufacturing entities:
Manufacturing entities, on the other hand, are involved in the production or processing of goods. They take raw materials or components and transform them into finished products through various manufacturing processes. These finished products are then sold to customers.

4. Examples of non-manufacturing entities:
Some examples of non-manufacturing entities include service-based businesses like banks, hospitals, law firms, restaurants, hotels, airlines, etc. These entities primarily provide services or sell goods in their original form without any processing.

In conclusion, the true statement regarding non-manufacturing entities is that they sell goods in their original form without processing. These entities focus on providing services or selling goods without engaging in the manufacturing or processing of goods.

Closing inventory is valued at cost or net realisable value, whichever is lower, to ensure that the inventory is not overstated on the financial statements.

Formula to Calculate Cost of Goods Sold (COGS)

The formula to calculate the cost of goods sold (COGS) is:

Opening Stock + Purchases - Closing Stock

Explanation

COGS refers to the direct costs incurred in producing or acquiring the goods that are sold by a company. It includes the cost of raw materials, direct labor, and any other direct costs associated with the production or acquisition of goods. COGS is an important figure used in determining the profitability of a company.

To calculate COGS, the following components are considered:

1. Opening Stock: Opening stock refers to the value of inventory or goods held by a company at the beginning of an accounting period. It represents the cost of inventory from the previous period that is available for sale in the current period.

2. Purchases: Purchases represent the cost of goods acquired by a company during the accounting period. This includes the cost of raw materials or finished goods purchased from suppliers.

3. Closing Stock: Closing stock refers to the value of inventory or goods held by a company at the end of an accounting period. It represents the cost of inventory that remains unsold or unused at the end of the period.

The formula for COGS (Opening Stock + Purchases - Closing Stock) takes into account the change in inventory levels from the beginning to the end of the accounting period. By subtracting the closing stock from the sum of opening stock and purchases, we arrive at the cost of goods that have been sold during the period.

The COGS figure is important for calculating the gross profit of a company, which is the difference between net sales revenue and COGS. It provides insights into the efficiency of the production or acquisition process and helps in evaluating the overall profitability of a business.

In conclusion, the correct formula to calculate the cost of goods sold (COGS) is Opening Stock + Purchases - Closing Stock. This formula considers the value of inventory at the beginning and end of the accounting period, as well as the cost of goods acquired during the period, to determine the cost of goods sold.

The final accounts of a sole proprietorship are prepared to assess the profitability and financial position of the business. This includes the preparation of an income statement and a balance sheet that reflect the business's performance and financial status at the end of the accounting period.

Capital receipts are proceeds from the sale of fixed assets or additional investments by owners. The sale of old machinery would be considered a capital receipt as it is related to a fixed asset.

Outstanding salaries are added to the salaries expense in the Profit and Loss Account and shown as a liability in the Balance Sheet. This follows the accrual basis of accounting, where expenses are recognized when incurred, not when paid.

Depreciation is an expense and is debited to the Profit and Loss Account. It represents the allocation of the cost of a fixed asset over its useful life.

The Matching Principle in accounting states that expenses should be matched with the revenues they helped generate. This ensures that the income statement reflects the true profit or loss for the period.

Sales returns are deducted from the total sales on the credit side of the Trading Account to reflect the net sales.

Gross profit is the profit calculated after deducting direct expenses (such as cost of goods sold) but before deducting indirect expenses (such as administrative and selling expenses). It is the profit from trading activities before any other overheads or taxes are considered.

The cost of goods sold (COGS) is calculated as:
COGS = Opening Inventory + Purchases + Wages + Carriage Inwards - Closing Inventory
COGS = $10,000 + $60,000 + $5,000 + $3,000 - $20,000 = $58,000

The journal entry to write off bad debts is to debit the Bad Debts Account and credit the Debtors Account, reflecting the loss and reducing the accounts receivable.
Journal Entry: Debit Bad Debts Account $17,000, Credit Debtors Account $17,000

The Trading Account of a non-manufacturing business entity shows the gross profit or gross loss, which is the difference between the sales revenue and the cost of goods sold.

If the credit side (which includes sales and closing inventory) of the Trading Account exceeds the debit side (which includes opening stock, purchases, and direct expenses), it indicates a gross profit.

Carriage inwards refers to the cost incurred to bring the materials to the firm's location and make them available for use, essentially the cost of transporting raw materials to the place where they are needed for production or sale.

Income received in advance is a liability because it represents revenue that has been received but not yet earned. It is an obligation to provide goods or services in the future.

Depreciation expense reduces the net profit because it is an expense.
Effect on Net Profit = Gross Profit - Depreciation Expense
Effect on Net Profit = Decrease by $65,000

Since the net profit is $1,000 more than the gross profit, it indicates that other incomes exceed expenses by $1,000.

If the debit side of the Trading Account exceeds the credit side, it indicates a gross loss. This means that the cost of goods sold and direct expenses are greater than the sales and closing inventory.

Net sales are calculated by subtracting returns inward from total sales.
Net Sales = Sales - Returns Inward
Net Sales = $100,000 - $10,000 = $90,000

The net invoice amount after a trade discount is calculated by subtracting the discount from the invoice price.
Trade Discount = 10% of $1,000 = $100
Net Invoice Amount = Invoice Price - Trade Discount
Net Invoice Amount = $1,000 - $100 = $900

Interest paid on loans is an expense and should be recorded as a debit in the Profit and Loss Account.

The Matching Principle requires that expenses be recorded in the same accounting period as the revenues they help to generate, ensuring that each period's net income or loss reflects the actual economic activity.