Test: Financial Statements Of Sole - 2 - Commerce MCQ

Answer:

In a sole-proprietorship business, the Drawings of cash affects the Capital account. This is because the owner of the business is considered the sole proprietor and the capital account represents the owner's investment in the business.

When the owner withdraws cash from the business for personal use, it is considered a withdrawal of capital and reduces the owner's investment in the business. As a result, the capital account is affected.

Therefore, the correct answer is:

• A: Capital account

Explanation:


The given statement states that all direct expenses are credited to the Trading account and all indirect expenses are debited to the Profit and Loss account. Let's break down the statement and understand it in detail:
Direct Expenses:
- Direct expenses are those expenses that are directly related to the production or purchase of goods or services.
- These expenses can be easily traced to a particular product or service.
- Examples of direct expenses include the cost of raw materials, direct labor, direct wages, etc.
Trading Account:
- The Trading account is a part of the final accounts of a business.
- It shows the gross profit or loss made by a business during a specific period.
- The direct expenses are credited to the Trading account because they are directly related to the production or purchase of goods or services.
Indirect Expenses:
- Indirect expenses are those expenses that are not directly related to the production or purchase of goods or services.
- These expenses cannot be easily traced to a particular product or service.
- Examples of indirect expenses include rent, salaries, advertising expenses, etc.
Profit and Loss Account:
- The Profit and Loss account is a part of the final accounts of a business.
- It shows the net profit or loss made by a business during a specific period.
- The indirect expenses are debited to the Profit and Loss account because they are not directly related to the production or purchase of goods or services.
Therefore, based on the given statement, the correct answer is option D: Debited, Debited.

Convention of Conservatism
The convention of conservatism is an accounting principle that requires accountants to anticipate and provide for potential losses but not potential gains. It is also known as the principle of prudence. Creating a provision against fluctuations in the price of an investment is an example of applying the convention of conservatism.
Explanation:
- The convention of conservatism emphasizes the need to be cautious and prudent when recording financial transactions. It suggests that accountants should err on the side of caution and anticipate potential losses or liabilities rather than potential gains or assets.
- Creating a provision against fluctuations in the price of an investment is a conservative approach because it recognizes the possibility of a decline in value and prepares for potential losses.
- The provision serves as a reserve or allowance for potential future losses due to price fluctuations, ensuring that the financial statements reflect a more realistic and conservative estimate of the investment's value.
- By creating a provision, the company acknowledges the uncertainty and risks associated with the investment and ensures that its financial statements provide a more accurate representation of the investment's value.
- This provision helps to protect the company's financial position by providing a buffer against potential losses and ensuring that the financial statements are not overstated.
In conclusion, creating a provision against fluctuations in the price of an investment is an example of applying the convention of conservatism. This accounting convention promotes prudence and the recognition of potential losses, ensuring that the financial statements provide a more conservative estimate of the investment's value.

Types of Accounts Shown in the Balance Sheet:
The balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It consists of various types of accounts, which can be classified as follows:
1. Real Accounts:
Real accounts are also known as permanent accounts and are related to assets, liabilities, and owner's equity. These accounts show the balances of tangible and intangible assets, as well as the debts and obligations of the business. Real accounts are not closed at the end of the accounting period and their balances are carried forward to the next period.
Examples of real accounts include:
- Cash
- Accounts Receivable
- Inventory
- Property, Plant, and Equipment
- Accounts Payable
- Long-term Debt
- Owner's Capital
2. Personal Accounts:
Personal accounts are related to individuals, organizations, or other entities with whom the business has transactions. These accounts represent the balances of parties involved in business transactions. Personal accounts can be further classified into two categories:
a. Natural Personal Accounts: These accounts represent individuals or entities in their natural form, such as customers, suppliers, employees, and owners.
Examples of natural personal accounts include:
- Customer Accounts
- Supplier Accounts
- Employee Accounts
- Owner's Accounts
b. Artificial Personal Accounts: These accounts represent individuals or entities in their legal or artificial form, such as government authorities, banks, and other organizations.
Examples of artificial personal accounts include:
- Tax Authorities
- Banks
- Creditors
- Debtors
3. Nominal Accounts:
Nominal accounts, also known as temporary accounts, are related to revenues, expenses, gains, and losses. These accounts are closed at the end of the accounting period, and their balances are transferred to the owner's capital account or retained earnings. Nominal accounts start with a zero balance at the beginning of each accounting period.
Examples of nominal accounts include:
- Sales Revenue
- Cost of Goods Sold
- Salaries Expense
- Rent Expense
- Interest Income
Conclusion:
In conclusion, the types of accounts shown in the balance sheet are real accounts and personal accounts. Nominal accounts are not directly shown in the balance sheet, but their balances indirectly affect the owner's equity section of the balance sheet.

Accrued income refers to income that has been earned but not yet received or recorded in the accounting records. It represents an asset for the company, as the income is expected to be received in the future. Here is a detailed explanation of why accrued income is classified as an asset:
1. Definition of accrued income:
- Accrued income is the income that has been earned but has not been received or recorded in the books of accounts by the end of the accounting period.
- It is also known as outstanding income or income receivable.
2. Characteristics of accrued income:
- Accrued income is recognized when it is earned, regardless of whether the payment has been received or not.
- It is recorded as a receivable in the balance sheet until it is received.
- It is usually represented by an accounts receivable or a current asset account.
3. Reasons for classifying accrued income as an asset:
- Accrued income is an economic benefit that the company is entitled to receive in the future.
- It represents a claim against the debtor for the amount due.
- It increases the company's financial position and its ability to generate cash inflows.
- It is an integral part of the company's working capital and is considered as a current asset.
4. Examples of accrued income:
- Interest income earned but not yet received from investments or loans.
- Rent income earned but not yet received from tenants.
- Service fees earned but not yet received from customers.
In conclusion, accrued income is classified as an asset because it represents an economic benefit that the company is entitled to receive in the future. It is recorded as a receivable in the balance sheet until it is received.

Rent receivable (given in trial balance) is an item of:
Rent receivable is an item of the Balance Sheet.
Explanation:
Rent receivable refers to the amount of rent that a business is entitled to receive from its tenants or clients. It represents the income that is yet to be received by the business.
Importance of the Balance Sheet:
The balance sheet is a financial statement that provides an overview of a company's financial position at a specific point in time. It consists of assets, liabilities, and owner's equity. The balance sheet is important because it helps stakeholders, such as investors and creditors, assess the financial health and stability of a business.
Key Points:
- Rent receivable is an asset for the business, as it represents the right to receive future cash inflows.
- It is classified as a current asset on the balance sheet, as it is expected to be collected within one year.
- Rent receivable is typically listed under the "Accounts Receivable" or "Trade Receivables" section of the balance sheet.
- The balance sheet provides information about the company's assets, liabilities, and owner's equity, and helps in evaluating the overall financial position of the business.

Explanation:
The correct answer is A: Operating profit.
EBIT stands for earnings before interest and taxes. It is a measure of a company's profitability that excludes the effects of interest and taxes. EBIT is calculated by subtracting operating expenses (excluding interest and taxes) from gross profit.
To further explain:
1. Operating profit is another name for EBIT. It represents the profit a company generates from its normal operations before considering interest and taxes.
2. Gross profit is the profit a company makes after deducting the cost of goods sold (COGS) from its revenue. It does not take into account operating expenses, interest, or taxes.
3. Net profit is the remaining profit after deducting all expenses, including operating expenses, interest, and taxes, from the revenue. It represents the final profit available to shareholders.
In summary, EBIT is another term for operating profit and is calculated by subtracting operating expenses from gross profit. Therefore, the correct answer is A: Operating profit.

Calculation of Operating profit
To calculate the operating profit, we need to subtract the operating expenses from the gross profit. Here are the different formulas for calculating operating profit in various scenarios:
A: Operating Profit = Gross Profit - (Office Admn. Expenses wages exp.)
- This formula is used when the office administration expenses include wages expenditure.
B: Operating Profit = Gross Profit - (Office Admn. Expenses selling and distribution exp.)
- This formula is used when the office administration expenses include selling and distribution expenditure.
C: Operating Profit = Gross Profit - (Factory Admn. Expenses selling and distribution exp.)
- This formula is used when the factory administration expenses include selling and distribution expenditure.
D: Operating Profit = Gross Profit - (Office Admn. Expenses direct exp.)
- This formula is used when the office administration expenses include direct expenses.
Answer: B
- The correct formula for calculating operating profit in this scenario is to subtract the office administration expenses related to selling and distribution from the gross profit.
By using the appropriate formula, we can calculate the operating profit accurately based on the specific scenario and the nature of the expenses included in the calculation.

The arrangement of various assets and liabilities in a particular order is called marshalling.

Marshalling is an important concept in accounting and finance. It involves organizing and presenting financial information in a structured manner. This helps in understanding the financial position of a business and making informed decisions.

Here are the key points to understand about marshalling:

1. Definition: Marshalling refers to the process of arranging assets and liabilities in a specific order, typically from most liquid to least liquid or in order of priority.
2. Objective: The main objective of marshalling is to provide a clear and concise representation of a company's financial position. It helps stakeholders, such as investors, creditors, and management, to analyze and interpret financial information effectively.
3. Order of Presentation: Assets and liabilities can be presented in different orders based on their liquidity or priority. For example, assets like cash, marketable securities, and accounts receivable are generally presented first, followed by inventory, property, plant, and equipment. Liabilities, such as current liabilities and long-term debt, are presented in a similar order.
4. Importance: Marshalling helps in understanding the availability of liquid assets and the company's ability to meet its short-term obligations. It also provides insights into the company's capital structure and financial health.
5. Financial Statements: Marshalling is an integral part of preparing financial statements, such as the balance sheet. The balance sheet presents assets and liabilities in a specific order to provide a snapshot of a company's financial position at a given point in time.
6. Consistency: It is important to maintain consistency in marshalling across financial periods to facilitate meaningful comparisons and analysis.
In conclusion, marshalling is the arrangement of various assets and liabilities in a specific order to present a clear and concise representation of a company's financial position. It helps stakeholders analyze and interpret financial information effectively.

Answer:

1. Introduction:




• Drawings of cash refer to the withdrawal of cash by the owner of a sole-proprietorship business for personal use.




2. Affected Accounts:




• Capital account: The capital account of the sole proprietor is affected by the drawings of cash.




• The drawings are considered as a reduction in the owner's equity in the business.


• When cash is withdrawn, it decreases the capital account.


• It represents the amount of money the owner has taken out of the business for personal use.






3. Not Affected Accounts:




• Shareholder account: Shareholder accounts are not relevant in a sole proprietorship business as it is the ownership structure of a corporation.


• Liability account: Liability accounts represent debts and obligations to third parties, and drawings of cash do not affect them.


• Expense account: Expense accounts represent the costs incurred in the normal course of business operations, and drawings of cash do not affect them.




4. Conclusion:




• The capital account is affected by the drawings of cash in a sole-proprietorship business.


• Drawings of cash reduce the capital account, representing the owner's equity in the business.

Introduction:
In accounting, a drawings account is used to track the withdrawals made by the owner(s) of a business for personal use. It represents the amount of money or assets taken out of the business by the owner(s) for personal use.
Explanation:
The nature of the drawings account determines the type of account it falls under. Here's a breakdown of the different types of accounts and why a drawings account is categorized as a personal account.
1. Personal Account:
- A personal account represents individuals, including the owner(s) of a business.
- It records transactions related to individuals or entities outside the business.
- Drawings account falls under this category because it represents the withdrawals made by the owner(s) for personal use.
2. Company Drawing Account:
- A company drawing account is not a recognized accounting term.
- It is possible that the term "company drawing account" refers to a separate account created within a company's general ledger to track the withdrawals made by the company for various purposes other than personal use.
- However, in the given context, the term "drawings account" refers to the account used by the owner(s) for personal withdrawals.
3. Nominal Account:
- A nominal account represents income, expenses, gains, and losses.
- Drawings account is not an income, expense, gain, or loss, but rather a representation of the owner's personal withdrawals. Therefore, it is not a nominal account.
4. Real Account:
- A real account represents assets, liabilities, and equity.
- While drawings account affects the equity of the business, it is specifically related to the owner's personal withdrawals. Therefore, it is not considered a real account.
Conclusion:
Based on the above explanations, it can be concluded that a drawings account is categorized as a personal account in accounting.

Principle of Conservatism and its application:
The principle of conservatism is a fundamental accounting principle that suggests that accountants should be cautious and exercise a degree of skepticism when recording and reporting financial transactions. It aims to ensure that financial statements provide a fair and accurate representation of a company's financial position.
The principle of conservatism is applied through various accounting practices, including:
1. Provision for bad and doubtful debts:
- This practice involves setting aside a portion of the company's income as a provision to cover potential losses from customers who may default on their payment obligations.
- It is a conservative approach as it recognizes the possibility of non-payment and reduces the reported accounts receivable and income accordingly.
2. Depreciation on assets:
- Depreciation is the systematic allocation of the cost of an asset over its useful life.
- By charging depreciation, the value of the asset is gradually reduced on the balance sheet, reflecting its diminishing value and conservatively representing the true economic value of the asset.
3. Recording outstanding expenses:
- Outstanding expenses refer to expenses that have been incurred but not yet paid.
- By recording outstanding expenses, the financial statements reflect a more conservative estimate of the company's liabilities, as these expenses are recognized even though they have not yet been settled.
Conclusion:
The principle of conservatism requires accountants to adopt a cautious and skeptical approach when recording and reporting financial transactions. It is applied through practices such as provision for bad and doubtful debts, depreciation on assets, and recording outstanding expenses. These practices help ensure that financial statements provide a fair and conservative representation of a company's financial position. Therefore, option A, which includes all of the above practices, is the correct answer.

Revenue expenditure is intended to benefit the current period.
Revenue expenditure refers to expenses incurred by a business or organization in its regular operations to generate revenue. These expenses are typically recurring and are essential for the day-to-day functioning of the business. Here are the key points to understand:
1. Definition: Revenue expenditure includes expenses such as salaries and wages, rent, utilities, raw materials, advertising, repairs, and maintenance.
2. Purpose: The main objective of revenue expenditure is to support the current operations and activities of the business. It is aimed at generating revenue and maintaining the regular flow of business operations.
3. Period of benefit: Revenue expenditure is incurred in the current period and is expected to provide benefits within the same accounting period. These expenses are necessary to keep the business running smoothly and generate revenue in the short term.
4. Impact on income statement: Revenue expenditure is recorded as an expense on the income statement, reducing the net income for the current period. It is deducted from the revenue earned to calculate the net profit or loss.
5. Examples: Examples of revenue expenditure include wages paid to employees, utility bills, inventory purchases, marketing expenses, and repairs and maintenance costs.
In conclusion, revenue expenditure is intended to benefit the current period by supporting the day-to-day operations of the business and generating revenue in the short term. It is essential for the smooth functioning of the business and is recorded as an expense on the income statement.

Answer:
Definition:
Expenditure incurred to reduce operating expenses refers to the costs incurred by a company to decrease its day-to-day expenses. These expenses are typically aimed at improving efficiency, reducing waste, or optimizing operations.
Detailed
The correct answer to the question is option D: Capital expenditure. Here's why:
1. Capital Expenditure:
- Capital expenditure refers to the expenses incurred for acquiring or improving long-term assets that provide benefits over multiple accounting periods.
- These expenditures are typically associated with the purchase, construction, or improvement of fixed assets such as land, buildings, machinery, or equipment.
- Investments made in capital expenditure aim to enhance productivity, efficiency, or capacity in the long run.
- By investing in capital assets, a company can reduce its operating expenses by minimizing maintenance costs, improving production processes, or increasing overall efficiency.
2. Deferred Revenue Expenditure:
- Deferred revenue expenditure refers to the expenses that are incurred for creating future benefits or advantages for the business.
- These expenses are typically revenue in nature but are spread over multiple accounting periods.
- Examples of deferred revenue expenditure include advertising expenses, research and development costs, or training expenses.
- While these expenditures may indirectly contribute to reducing operating expenses, they are not specifically incurred for that purpose.
3. Promotional Expenditure:
- Promotional expenditure refers to the costs incurred for marketing and advertising activities aimed at promoting a company's products or services.
- While promotional activities can indirectly impact operating expenses by increasing sales or brand visibility, they are not specifically incurred to reduce operating expenses.
4. Revenue Expenditure:
- Revenue expenditure refers to the day-to-day expenses incurred by a company to maintain its ongoing operations.
- These expenses are typically recurring in nature and are necessary for generating revenue in the current accounting period.
- While revenue expenditure is essential for the smooth functioning of a business, it does not directly aim to reduce operating expenses.
In conclusion, any expenditure specifically incurred to reduce operating expenses falls under the category of capital expenditure. Capital investments are made to improve long-term efficiency and productivity, leading to cost savings in the future.

Answer:
The wages paid for the erection of machinery are debited to the Machinery account. Here's a detailed explanation:
- When machinery is purchased and installed, it is considered a capital expenditure and is recorded in the Machinery account.
- Wages paid for the erection or installation of machinery are directly related to the acquisition and installation of the machinery.
- These wages are considered as part of the cost of the machinery.
- Therefore, to properly account for the cost of the machinery and include the wages paid for its erection, these wages are debited to the Machinery account.
- This ensures that the total cost of the machinery, including the wages, is accurately recorded in the books of accounts.
- By debiting the wages to the Machinery account, the cost of the machinery is increased and reflected in the balance sheet as an asset.
- On the other hand, if the wages were debited to the Wages account, it would distort the profit and loss statement since the wages are not related to the regular day-to-day operations of the business.
- Hence, the correct option is B: Machinery account.

Preliminary expenses:
Preliminary expenses refer to the costs incurred by a company before its incorporation or during the early stages of its operations. These expenses are considered as an investment in the establishment of the company and are not directly related to the generation of revenue.
Preliminary expenses can be categorized into different types based on their nature and treatment in the financial statements. The options provided in the question are:
A: Revenue receipt:
- Revenue receipts are the income received by a company from its regular business activities.
- Preliminary expenses do not fall under the category of revenue receipts as they are not generated from the normal business operations.
- Therefore, option A is incorrect.
B: Deferred revenue receipt:
- Deferred revenue receipts are the income received in advance for goods or services that will be provided in the future.
- Preliminary expenses are not deferred revenue receipts as they are not related to the future provision of goods or services.
- Therefore, option B is incorrect.
C: Fictitious asset:
- Fictitious assets are those assets that do not have a physical existence but are represented by intangible rights or benefits.
- Preliminary expenses are considered as fictitious assets as they represent the expenditure incurred in the initial stages of the company's formation.
- These expenses are written off over a period of time and are not considered as tangible assets.
- Therefore, option C is correct.
D: Deferred capital receipt:
- Deferred capital receipts are the funds received by a company in advance for the issuance of shares or debentures.
- Preliminary expenses are not deferred capital receipts as they are not directly associated with the capital raised by the company.
- Therefore, option D is incorrect.
In conclusion, the correct answer is option C: Fictitious asset. Preliminary expenses are treated as fictitious assets in the financial statements of a company.

Amount paid for acquiring goodwill is considered as a:
- Capital expenditure: The amount paid for acquiring goodwill is considered as a capital expenditure. This is because goodwill is an intangible asset that enhances the reputation and value of a business over time. It is an investment made by the business to generate future benefits.
- Revenue expenditure: Revenue expenditure refers to the expenses incurred in the normal course of business operations to maintain and generate revenue. Acquiring goodwill does not fall under this category as it is a one-time investment made to enhance the long-term value of the business.
- Deferred capital expenditure: Deferred capital expenditure refers to the capital expenditure that is incurred but not immediately reflected in the financial statements. However, the amount paid for acquiring goodwill is usually recognized as an immediate capital expenditure and is not deferred.
- Deferred revenue expenditure: Deferred revenue expenditure refers to the revenue expenditure that is incurred but its benefits are expected to be received over multiple accounting periods. The amount paid for acquiring goodwill is not considered as a deferred revenue expenditure as it is a capital expenditure rather than a revenue expense.
Therefore, the correct answer is B: Capital expenditure.

Financial accounting aims at presenting 'true and fair' view of transactions, profit and loss for a period and Statement of financial position (Balance Sheet) on a given date. It aims at computing 'true and fair' view of the cost of production/services offered by the firm.

False Statement: Capital expenditure gives benefit over a short period.
Explanation:
Capital Expenditure:
- Capital expenditure refers to the funds that a company spends on acquiring, upgrading, or maintaining long-term assets such as property, equipment, or infrastructure.
- It is a significant investment made by a company to improve its productivity, expand its operations, or enhance its earning capacity over a long period of time.
Analysis of the Options:
A: False: Capital expenditure does not give benefit over a short period. It is typically made for long-term purposes and aims to generate benefits over an extended period of time.
B: True: Capital expenditure is recorded in the balance sheet as an asset. It is not immediately expensed but is instead capitalized and depreciated over its useful life.
C: True: Capital expenditure is incurred for increasing the earning capacity of the business. It includes investments in machinery, technology, research and development, and other long-term assets that can contribute to revenue generation and profitability.
D: True: Capital expenditure is generally non-recurring in nature, meaning it is not a regular or repetitive expense. It is a one-time or infrequent investment made by the company.
Conclusion:
The false statement regarding capital expenditure is option A, which claims that it provides benefits over a short period. In reality, capital expenditure is aimed at generating long-term benefits and improving the earning capacity of the business.

Revenue Expenditure:
Revenue expenditure refers to the expenses incurred by a company in its day-to-day operations to generate revenue. These expenses are usually incurred periodically and are not expected to have a long-term benefit for the company. Examples of revenue expenditure include:
(b) Renewal expenses/fee of patent:
- The expenses incurred to renew a patent or intellectual property rights are considered revenue expenditure.
- These expenses are necessary to maintain the legal protection of the patent and enable the company to continue generating revenue from its patented product or process.
(c) Depreciation on fixed assets:
- Depreciation is the gradual decrease in the value of fixed assets over time.
- It is considered revenue expenditure because it represents the allocation of the asset's cost over its useful life.
- Depreciation expense is recognized in the income statement and reduces the company's taxable income.
(d) Repair of machinery normal or due to negligence of operator:
- Expenses incurred for repairing machinery, whether it is due to normal wear and tear or negligence of the operator, are considered revenue expenditure.
- These expenses are necessary to maintain the functionality and productivity of the machinery in the short term.
(e) Expenses for obtaining a license:
- The expenses incurred to obtain a license, such as a business license or a professional license, are considered revenue expenditure.
- These expenses are necessary to legally operate the business and generate revenue.
Conclusion:
The correct option is (b) b,c,d as these expenses are examples of revenue expenditure. Preliminary expenses for floating a company (option a) and expenses for obtaining a license (option e) are examples of capital expenditure.