All questions of Adjustments to Financial Statements for Grade 12 Exam

Types of Accounts in Balance Sheet

There are three types of accounts in accounting – Real, Personal, and Nominal accounts. However, in the balance sheet, only two types of accounts are shown, which are as follows:

Real and Personal Accounts

The balance sheet is a statement of assets and liabilities of an organization. It is divided into two main sections – assets and liabilities. The accounts shown in the balance sheet are of two types:

1. Real Accounts: These accounts represent tangible and intangible assets of the organization. They are shown on the asset side of the balance sheet. Examples of real accounts are land, buildings, machinery, patents, trademarks, etc.

2. Personal Accounts: These accounts represent persons, firms, or institutions with whom the organization has transactions. They are shown on the liability side of the balance sheet. Examples of personal accounts are accounts payable, loans payable, salaries payable, etc.

Nominal accounts are not shown in the balance sheet because they are related to the income and expenses of the organization, which are shown in the income statement.

Conclusion

In conclusion, the balance sheet shows only two types of accounts, which are real and personal accounts. Real accounts represent assets, and personal accounts represent liabilities. Nominal accounts are not shown in the balance sheet because they are related to the income and expenses of the organization, which are shown in the income statement.

EBIT (earnings before interest and taxes) is a company's net income before income tax expense and interest expenses have been deducted. EBIT is used to analyze the performance of a company's core operations without the costs of the capital structure and tax expenses impacting profit.

Last option is right I.e debited debited

Therefore, CAPEX is both amortized and depreciated, depending on whether it is tangible or intangible. To quote, "Expenses incurred to acquire intangible assets such as goodwill, patents, etc. are also capital expenditure.

Capital account bcoz due to drawing cash account will be affected which in turn also affect the capital account

An operating expense, operating expenditure, operational expense, operational expenditure or opex is an ongoing cost for running a product, business, or system. Its counterpart, a capital expenditure (capex), is the cost of developing or providing non-consumable parts for the product or system. For example, the purchase of a photocopier involves capex, and the annual paper, toner, power and maintenance costs represents opex.For larger systems like businesses, opex may also include the cost of workers and facility expenses such as rent and utilities.

In accounting, the convention of conservatism, also known as the doctrine of prudence, is a policy of anticipating possible future losses but not future gains. This policy tends to understate rather than overstate net assets and net income, and therefore lead companies to "play safe".

And Loss Statement

A) Balance Sheet. Rent receivable is an asset that represents the amount of rent owed to a business that has not yet been collected. It is reported on the balance sheet under the current assets section.

Debiting Wages Paid for Erection of Machinery to Machinery Account:

When machinery is purchased, it is necessary to install it in the factory. The cost of installation is known as erection cost. Wages are paid for erecting machinery. These wages are debited to the machinery account.

Reasons for Debiting Wages Paid for Erection of Machinery to Machinery Account:

The reasons why wages paid for erection of machinery are debited to machinery account are as follows:

1. Part of the cost of machinery: Wages paid for erection of machinery form a part of the cost of machinery. Hence, they are debited to the machinery account.

2. Capital expenditure: Erection of machinery is a capital expenditure. Hence, wages paid for erection of machinery are debited to the machinery account.

3. Enhances the value of machinery: Erection of machinery enhances the value of machinery. Hence, wages paid for erection of machinery are debited to the machinery account.

4. Directly related to machinery: Wages paid for erection of machinery are directly related to machinery. Hence, they are debited to the machinery account.

Conclusion:

Thus, it can be concluded that when wages are paid for erection of machinery, they are debited to the machinery account.

When ever we do capital expenditures we do it for long period benefits

Accrued income is considered an asset because accrued income is that income which we have earned but have not received. So we take it as an asset.

Because revenue expenditure neither decrease any liability nor creates an asset and option B is suitable for revenue expenditure

Understanding Revenue Classification
When analyzing financial statements, classifying revenue correctly is crucial for understanding a company's financial health. Revenue from sales of goods and services falls under operating activities, specifically as an operating inflow.
What is Operating Inflow?
- Operating inflow refers to cash generated from the core business activities of a company.
- This includes revenue from the sale of goods and services, which is the primary source of income for most businesses.
Why is Sales Revenue an Operating Inflow?
- Sales revenue represents the cash received from customers in exchange for products or services.
- It directly contributes to the company's ability to sustain operations, pay expenses, and invest in growth.
Classification of Cash Flows
- Cash flows are categorized into three main activities:
- Operating Activities: Includes cash transactions related to the company's primary business functions.
- Investing Activities: Involves cash flows from the purchase and sale of long-term assets.
- Financing Activities: Consists of cash flows from transactions with the company’s owners (equity) and creditors (debt).
Conclusion
- Classifying revenue from sales of goods and services as an operating inflow is essential because it reflects the fundamental operations of the business.
- Understanding this classification helps stakeholders assess the company’s performance and operational efficiency.
In summary, sales revenue is categorized as an operating inflow, making option 'B' the correct answer.

Subtract the cost of goods sold from gross revenue to determine gross profit. ... Subtract your total operating expenses from your gross profit to calculate your operating profit. Divide your operating profit by your gross revenue to calculate your operating profit margin.

Principle of Conservatism

The principle of conservatism states that accounting should be done in a cautious and prudent manner. It means that while recording transactions, one should always err on the side of underestimating revenues and overestimating expenses.

Provision for Bad and Doubtful Debts

To adhere to this principle, provision is made for bad and doubtful debts. This means that an estimated amount is set aside to cover any potential losses from customers who may not be able to pay their debts. This provision is made at the end of each accounting period, based on past experience, and is recorded as an expense.

Depreciation

Depreciation is another way in which the principle of conservatism is followed. Depreciation is the reduction in the value of an asset over time due to wear and tear, obsolescence, or other factors. To account for this, a certain amount of the cost of the asset is charged as an expense each year, reducing the value of the asset on the balance sheet.

Recording of Outstanding Expenses

The principle of conservatism also requires that outstanding expenses be recorded. Outstanding expenses are expenses that have been incurred but not yet paid. This includes things like rent, salaries, and taxes. These expenses are recorded as liabilities on the balance sheet, reducing the amount of profit reported on the income statement.

Conclusion

In conclusion, the principle of conservatism requires that accounting be done in a cautious and prudent manner. This includes making provision for bad and doubtful debts, charging depreciation on assets, and recording outstanding expenses. These practices help to ensure that financial statements accurately reflect the true financial position of a company.

Trade Mark is Tangible assets

A trademark is a form of intellectual property that consists of a recognizable sign, design, or expression which identifies products or services of a particular source from those of others. It is a valuable asset for a business as it helps in distinguishing its products or services from competitors in the market.

Definition of Tangible Assets:
Tangible assets are those assets that have a physical existence and can be touched, felt, or seen. These assets are typically long-term in nature and provide economic benefits to the business over a period of time. Examples of tangible assets include buildings, machinery, vehicles, and inventory.

Explanation:
A trademark, although intangible in nature, can be considered as a tangible asset for the following reasons:

1. Physical Representation: While a trademark itself may not have a physical form, it is often represented by a physical logo, symbol, or design that is used to identify the products or services of a business. This physical representation can be considered as a tangible asset.

2. Monetary Value: Trademarks can have significant monetary value for a business. A well-established and recognized trademark can enhance brand reputation and customer loyalty, resulting in increased sales and revenue. This monetary value makes trademarks similar to other tangible assets like buildings or machinery, which also have economic value.

3. Transferability and Sale: Trademarks can be bought, sold, or licensed to other businesses. The transferability and sale of trademarks are similar to tangible assets, where ownership can be transferred and monetary value can be exchanged.

4. Depreciation: Like tangible assets, trademarks can also be subject to depreciation. The value of a trademark may decrease over time due to changes in market conditions, competition, or legal factors. This depreciation is accounted for in the financial statements of a business, similar to tangible assets.

In conclusion, while trademarks are intangible assets in terms of legal classification, they can be considered as tangible assets due to their physical representation, monetary value, transferability, and depreciation characteristics.

The items included in the adjustment of net income to obtain cash flow from operating activities are:
- Depreciation expense for the period.
- The change in deferred taxes.
- The amount by which equity income recognized exceeds cash received.
Explanation:
When preparing the statement of cash flows using the indirect method, net income is adjusted to obtain cash flow from operating activities. This adjustment is necessary to reflect the actual cash inflows and outflows related to the operating activities of the business. The following items are included in this adjustment:
1. Depreciation expense for the period:
- Depreciation is a non-cash expense that reduces the carrying value of long-term assets over their useful lives.
- It is added back to net income because it does not involve an actual outflow of cash.
2. The change in deferred taxes:
- Deferred taxes represent the difference between the tax expense recorded in the income statement and the actual taxes payable.
- Any change in the deferred taxes during the period is added or subtracted to adjust net income to cash flow from operating activities.
3. The amount by which equity income recognized exceeds cash received:
- Equity income is the share of profits or losses from an equity investment accounted for under the equity method.
- If the equity income recognized exceeds the cash received during the period, the excess amount is added back to net income.
Therefore, all of the above items (A, B, and C) are included in the adjustment of net income to obtain cash flow from operating activities.

Capital account

Drawings account is a Personal Account.

Personal accounts are related to individuals, firms, or companies. These accounts represent the people or entities with whom a business has financial transactions. These accounts are classified into three categories: natural persons, artificial persons, and representative personal accounts.

Drawings account falls under the category of natural persons. It is a personal account because it represents the owner of the business or the proprietor who withdraws money or assets from the business for personal use.

Here are the reasons why the correct answer is option 'A', which states that the Drawings account is a Personal Account:

1. Nature of the Account:
- Drawings account represents the owner of the business.
- It records the withdrawal of money or assets by the owner for personal use.
- As it is associated with an individual, it falls under the category of Personal Account.

2. Relationship with the Owner:
- The Drawings account is directly related to the owner of the business.
- It reflects the personal transactions of the owner with the business.
- The withdrawals made by the owner are recorded in this account, reducing the capital invested by the owner.

3. Treatment in Financial Statements:
- The balance of the Drawings account is deducted from the owner's capital in the balance sheet.
- It helps in determining the owner's equity or the net worth of the business.
- The balance of the Drawings account is transferred to the owner's capital account at the end of the accounting period.

In conclusion, the Drawings account is classified as a Personal Account because it represents the owner of the business and records the withdrawals made by the owner for personal use.

Answer: B
Revenue expenditure are those which give the benefit to the business in the short period of time i.e. a year. These are directly charged to the profit & loss account of that particular year.

Trading Account
- Direct Expenses are entered in the Trading Account as they are directly related to the production or purchase of goods that are being traded by the business.
- Direct Expenses include costs such as raw materials, labor, manufacturing expenses, freight, etc., which are incurred to bring the goods to the final stage of sale.
- The Trading Account is a part of the financial statements that shows the gross profit or loss of a business by comparing the net sales revenue with the cost of goods sold.
- By including Direct Expenses in the Trading Account, the business can accurately calculate its gross profit margin and assess the efficiency of its trading activities.
Profit & Loss Account
- The Profit & Loss Account, on the other hand, includes indirect expenses and losses incurred by the business during a specific period.
- Indirect expenses are not directly related to the production or purchase of goods but are necessary for the overall operation of the business, such as rent, salaries, utilities, etc.
- Including Direct Expenses in the Profit & Loss Account would distort the calculation of net profit as it is meant to show the profitability of the business after considering all operating expenses.
Balance Sheet
- The Balance Sheet, on the other hand, is a statement that shows the financial position of a business at a specific point in time by listing its assets, liabilities, and equity.
- Direct Expenses do not directly impact the financial position of the business and hence are not entered in the Balance Sheet.
Therefore, Direct Expenses are entered in the Trading Account to accurately determine the gross profit or loss of the business before considering indirect expenses in the Profit & Loss Account.

Limitation of both the current and quick ratio:
The current ratio and quick ratio are both widely used financial ratios to assess a company's liquidity and ability to meet short-term obligations. However, they have a common limitation related to the liquidity of certain assets in the calculation.

1. Accounts receivable may not be truly liquid:
Accounts receivable refers to the amounts owed to a company by its customers for goods or services provided on credit. While accounts receivable are considered current assets, they may not be truly liquid because there is a risk of non-payment or delays in collection.

Explanation:
When calculating the current ratio, both the current assets and current liabilities of a company are taken into account. Accounts receivable, being a current asset, are included in the numerator of the ratio. However, it is important to note that not all accounts receivable may be collected on time or in full. Some customers may default on their payments, and the collection process can take time. Therefore, the actual liquidity of accounts receivable may be lower than their recorded value on the balance sheet.

Similarly, when calculating the quick ratio, also known as the acid-test ratio, accounts receivable are excluded from the numerator. The quick ratio is a more stringent measure of liquidity as it only considers the most liquid assets, such as cash, marketable securities, and accounts receivable. By excluding accounts receivable, it aims to provide a more conservative assessment of a company's ability to meet short-term obligations. However, this exclusion also highlights the limitation that accounts receivable may not be truly liquid.

Impact:
The limitation of accounts receivable's liquidity affects both the current ratio and quick ratio. If a company has a significant amount of accounts receivable that are not collectible or will be collected over a long period, it can artificially inflate the ratios and provide a misleading picture of the company's liquidity position.

Conclusion:
In conclusion, the common limitation of both the current ratio and quick ratio is that accounts receivable may not be truly liquid. This means that the recorded value of accounts receivable on the balance sheet may not accurately reflect their actual liquidity, considering the risk of non-payment or delays in collection. It is important for analysts and investors to consider this limitation and assess the quality and collectability of accounts receivable when interpreting these liquidity ratios.

Profit earn through normal activities of business:
There are different types of profits that a business can earn through its normal activities. The options provided are:
A. Operating profit:
- Operating profit is the profit earned from the core operations of a business.
- It is calculated by deducting the operating expenses from the gross profit.
- It reflects the profitability of a company's main business activities.
B. Net profit:
- Net profit is the final profit earned by a business after deducting all expenses, including operating expenses, non-operating expenses, and taxes, from the total revenue.
- It represents the overall profitability of the company.
C. Gross profit:
- Gross profit is the profit earned by a business after deducting the cost of goods sold (COGS) from the total revenue.
- It indicates the profitability of the company's sales activities.
D. Manufacturing profit:
- Manufacturing profit refers specifically to the profit earned in the manufacturing sector.
- It represents the difference between the cost of manufacturing a product and the revenue generated from its sale.
Conclusion:
The profit earned through normal business activities can be classified into different types, including operating profit, net profit, gross profit, and manufacturing profit. In the given options, the correct answer is "A. Operating profit."

Revenue Expenditure

Explanation:

When a company purchases computers for re-sale, it is considered as revenue expenditure. Revenue expenditure refers to the expenses incurred in the normal course of business operations to generate revenue. It is incurred to maintain or improve the earning capacity of the business.

Key Points:

1. Revenue Expenditure: Revenue expenditure is the day-to-day expenses incurred by a business to generate revenue and maintain its operations. It is usually recurring in nature and does not result in the acquisition of any long-term assets.

2. Purpose of Revenue Expenditure: The main purpose of revenue expenditure is to maintain the existing level of business operations and generate revenue. It includes expenses such as rent, salaries, advertising, utilities, and inventory purchases for re-sale.

3. Computers for Re-sale: When a company purchases computers for the purpose of re-selling them, it falls under the category of revenue expenditure. The computers are acquired with the intention of generating revenue through their sale to customers.

4. Non-Capital Expenditure: Capital expenditure, on the other hand, refers to the expenses incurred to acquire long-term assets such as land, buildings, machinery, or vehicles. These assets are not intended for immediate resale but are used in the business for an extended period.

5. Impact on Financial Statements: Revenue expenditure is treated as an expense in the income statement and reduces the company's net income. It is deducted from the revenue generated to calculate the net profit. On the other hand, capital expenditure is recorded as an asset on the balance sheet and is depreciated over its useful life.

6. Decision-Making: Differentiating between revenue and capital expenditure is crucial for financial decision-making. Revenue expenditure is deducted fully in the year it is incurred, while capital expenditure is spread over multiple years through depreciation.

In conclusion, when a company purchases computers for re-sale, it is considered as revenue expenditure. This distinction is important for financial reporting, as revenue expenditure is treated as an expense and deducted in the year it is incurred.

Fictitious Assets

Fictitious assets are assets that do not have a physical existence but are recorded as assets on a company's balance sheet. These assets are not tangible or measurable, and their value cannot be realized or converted into cash. They are usually created as a result of accounting practices or transactions and are not considered real or tangible assets.

Examples of Fictitious Assets

There are several examples of fictitious assets that can be found on a company's balance sheet. One such example is advertising suspense.

Advertising Suspense

Advertising suspense is a fictitious asset that arises when a company incurs advertising expenses but has not yet received the benefits or services associated with those expenses. It represents the prepayment made by the company for advertising services that have not been utilized or received.

When a company pays for advertising expenses in advance, it records the payment as a prepaid expense or advertising suspense. This amount is then gradually allocated to the income statement over the period in which the advertising services are utilized or received by the company.

Explanation of the Answer

In the given options, the only example of a fictitious asset is "Advertising Suspense" (option C). The other options are not fictitious assets because they have a physical existence and can be measured or converted into cash.

- Building (option A): A building is a tangible asset that has a physical existence and can be measured and valued. It is not a fictitious asset.
- Bill receivable (option B): A bill receivable is a financial instrument that represents the amount owed to a company by its debtors. It is a real and measurable asset.
- Cash (option D): Cash is a tangible asset that can be measured and converted into other assets or used for transactions. It is not a fictitious asset.

Therefore, the correct answer is option C - Advertising suspense, as it is the only example of a fictitious asset among the given options.