Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

Principles and Practice of Accounting

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CA Foundation : Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

The document Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev is a part of the CA Foundation Course Principles and Practice of Accounting.
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ILLUSTRATION 5:- The following is the Trial Balance of C. Wanchoo on 31st Dec. 2017.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Required:- Prepare closing entries for the above items  and Prepare Trading and Profit and Loss Account.

SOLUTION:- 

Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

1.6 BALANCE SHEET:- The balance sheet may be defined as “a statement which sets out the assets and liabilities of a firm or an institution as at a certain date.” Since even a single transaction will make a difference to some of the assets or liabilities, the balance sheet is true only at a particular point of time. That is the significance of the word “as at.” The assets are shown on the right hand side and liabilities and capital on the left hand side.
CHARACTERISTICS:- The balance sheet has certain characteristics, which should be noted. These are the following:
(i) It is prepared at a particular date, rather the close of a day and not for a period. It is true only on that date and not later. Suppose, in the example given above, a part of the goods were sold on 1st January, 2017. This will mean that the value of the Inventory will be reduced, the cash in hand will increase and the capital account will be reduced or increased depending upon loss or profit on sale.
(ii) The balance sheet is prepared only after the preparation of the Prodit and Loss Account. This is the reason why the Prodit and Loss Account (including the Trading Account) and the Balance Sheet are together called Final Accounts (Of course, the Balance Sheet is not an account, the two sides are not the debit and the credit sides.) Without being accompanied by the Profit and Loss Account, the Balance Sheet will not be able to throw adequate light on the financial position of the firm. For that purpose an appreciation of the profits of the firm is necessary.
(iii) Since capital always equals the difference between assets and liabilities and since the capital account will independently arrive at this figure, the two sides of the Balance Sheet must have the same totals. If it is not so, there is certainly an error somewhere.
In the illustration no. 5 worked out above it will be seen that the under mentioned accounts have not been closed even after preparation of the Profit and Loss Account and the transfer of the net profit to the capital account.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Looking at these accounts, one would know that various assets: Cash balance in hand, cash at bank, machinery, furniture etc. that the firm possesses and the amounts that are owing as liability to  trade payables and to the proprietor as capital. The capital, of course, will be the difference between the total of assets and of liabilities. The assets, liabilities and capital are usually presented in a statement called the Balance Sheet. This is given below for the accounts mentioned above.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
ARRANGEMENTS OF ASSETS AND LIABILITIES:-

(1) Assets: Assets may be grouped in one of the following two ways:  
(i) Liquidity: Under this approach, the asset, which can be converted into cash first, is presented first. Those assets, which are most difficult in this respect, are presented at the bottom. As per Liquidity the balance sheet can be prepared as follow:-
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
(ii) Permanence: Assets, which are to be used, for long term in the business and are not meant to be sold are presented first. Assets, which are most liquid, such as cash in hand, are presented at the bottom.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Note:- Some of the assets may be capable of being sold easily like investment in government securities or shares of some companies. They should be treated as liquid or permanent according to the intention of the firm.
(2) Liabilities: Liabilities may also be shown according to the urgency with which payment has to be made. One way is to first show the capital, then long-term liabilities and last of all short term liabilities like amounts due to suppliers of goods or bills payable. The other way is to start with short-term liabilities and then show long term liabilities and last of all capital.
CLASSIFICATION OF ASSETS AND LIABILITIES:-
Assets are basically of two types:
Current Assets: - these assets are meant to be converted into cash as quickly as possible. Generally within one year. For Example:- Cash in hand, Cash at Bank, Trade receivables, Inventories.
Long Term Assets: - Those that are meant to be used by the firm over a long period and not sold the former type of assets is also called fixed assets. For Example Machinery, Building, Long term Investment.
Intangible Assets: - the assets which have no physical existence and cannot be seen or touched are called as Intangible Assets. For example Patents, Copyrights etc.
It is desirable that in the balance sheet the two types of assets should be shown separately and prominently. This would give meaningful and logical information.
Liabilities to outsider will be of two types: Current Liabilities: - this liability must be settled in one year or less. It is also called as short term liability. For Example:-  Creditors, Bills Payable etc.
Long Term Liability: - those liabilities which exists for more than one year are Long term liabilities. For example long term loans from banks. Of course, it will include undistributed profits also.
Sole proprietors generally present Balance Sheet in a horizontal form with “Capital and Liabilities” on the left hand side and ‘Assets’ on the right-hand side. In the Balance Sheet the various items should be grouped suitably as indicated below:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
If course, there is no hard and fast rule regarding presentation of assets, liabilities and equities in the Balance sheet. However, the model presentation shown above has been designed considering the nature of Balance Sheet elements and categorizing them appropriately.
Proper presentation of Balance Sheet items improves understandability of the information desired to be communicated to the users of account.

ILLUSTRATION 6:- Given below Trial Balance of M/s Dayal Bros. as on 31st March, 2017 :
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Required:- Prepare Balance Sheet as on 31st March, 2017.

SOLUTION:- 
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

ILLUSTRATION 7:- The balance sheet of Thapar on 1st January, 2017 was as follows:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
During 2017, his Profit and Loss Account revealed a net profit of ₹15,30,000. This was after allowing for the following :
(a) Interest on capital @ 6% p.a.
(b) Depreciation on Plant and Machinery @ 10% and on Furniture and Fixtures @ 5%.
(c) A provision for Doubtful Debts @ 5% of the trade receivables as at 31st December, 2017.
But while preparing the Profit and Loss Account he had forgotten to provide for (1) outstanding expenses totaling ₹1,80,000 and (2) prepaid insurance to the extent of ₹20,000.
His current assets and liabilities on 31st December, 2017 were : Inventories ₹14,50,000; Trade receivables ₹20,00,000; Cash at Bank ₹10,35,000 and Trade payables  ₹11,40,000.
During the year he withdrew ₹6,00,000 for domestic use.
Required:- Draw up his Balance Sheet at the end of the year.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

1.7 SEQUENCE OF ACCOUNTING PROCEDURE OR THE ACCOUNTING CYCLE:- What has been done so far shows that the accounting process in the following order :
(i) recording the transactions in the journal or journalising;
(ii) preparing ledger accounts on the basis of the journal or posting into the ledger;
(iii) taking out the trial balance to check arithmetical accuracy;
(iv) preparing the  trading and profit and loss account or the income statement for the period concerned; and
(v) preparing the balance sheet to show the financial position at the end of the period.

1.8 OPENING ENTRY:- We have seen that on commencing a new business one debits the cash account and credits the capital account with the amount introduced. A firm closes the books of account at the end of each year and starts new books in the beginning of each year. The first entry in the journal is to record the closing balances of various assets and liabilities at the end of the previous year as the opening balances in the beginning of the new year. The balance sheet prepared at the end of the year records these balances and is the basis for this first entry. It is called the opening entry.
The assets shown in the balance sheet are debited and the liabilities and the capital account credited. 

ILLUSTRATION 8:- Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Required:- From the above given balance sheet prepare the relevant opening entry.
SOLUTION:- The Opening Entry :01-01-2018
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Posting the Opening Entry:- All the assets show debit balance. Such accounts are opened and the relevant amounts written on the debit side as “To Balance b/d”. Following is the cash account arising from the entry given above.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Similarly account should be opened for all other assets and relevant amount should be posted on the Dr. side.
The accounts of liabilities show credit balances. An account for each liability is opened and the relevant account is written on the credit side as “By Balance b/d”. This is shown below by opening the accounts of Mahendra & Sons mentioned in the entry given above.
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
By posting the opening entry completely all the accounts of assets and liabilities in the beginning are opened. We illustrate below a complete cycle of journalising, posting and trial balance.
Students should work through the following illustration given by way of practice on the method of making adjustments in some of the accounts contained in a Trial Balance and afterwards preparing the final Account.

ILLUSTRATION 9:- Shri Mittal gives you the following Trial Balance and some other information:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Closing Inventory on 31st March, 2017 was valued at ₹1,00,000.
Required:- Prepare final accounts of Shri Mittal for the year ended 31st March, 2017.
SOLUTION:-
 Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Note: As loan and overdraft taken at year end so no interest shown.

ILLUSTRATION 10:- Mr. Mohan gives you the following trial balance and some other information:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Other Information:-
(i) Closing Inventory was ₹1,80,000;
(ii) Depreciate Furniture @ 10% p.a.
Required:- Prepare Trading and Profit and Loss Account for the year ended on 31.3.2017 and Balance Sheet of Mr. Mohan as on that date.
SOLUTION:- 
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

ILLUSTRATION 11:- The Balance Sheet of Mr. Popatlal, a merchant on 31st March, 2017 stood as below:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Required:- Show opening journal entry on 1st April, 2017 in the books of Mr. Popatlal.

Solution:- 

Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

ILLUSTRATION 12:- The following is the schedule of balances as on 31.3.17 extracted from the books of Shri Gavaskar, who carries on business under the same name and style of Messrs Gavaskar Viswanath & Co., at Bombay:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Prepare Trading and Profit and Loss Account for the year ended 31st March 2017 and the Balance Sheet as at that date after making provision for the following:
1. Depreciate:  (a) Building used for business by 5 percent; (b) Furniture and fixtures by 10 percent; One steel table purchased during the year for ₹14,000 was sold for same price but the sale proceeds were wrongly credited to Sales Account; (c) Office equipment by 15 percent; Purchase of a typewriter during the year for ₹40,000 has been wrongly debited to purchase; and (d) Motor car by 20%.
2. Value of stock at the close of the year was ₹4,40,000.
3. Two month’s rent for godown is outstanding.
4. Interest on loan from Viswanath is payable at 12 percent per annum, this loan was taken on 1.5.2016.
5. Reserve for bad debts is to be maintained at 5 percent of Sundry  Debtors.
6. Insurance premium includes ₹40,000 paid towards proprietor’s life insurance policy and the balance of the insurance charges cover the period from 1.4.2016 to 30.6.17

SOLUTION:-
 Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Working Notes :-
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

1.9 PROVISIONS AND RESERVES:- Provision means “any amount written off or retained by way of providing for depreciation, renewal or diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy”. A provision is a liability which can be measured only by using a substantial degree of estimation.
Thus, a provision may be either in respect of loss in the value of an asset provided or written off on the basis of an estimate or the one in respect of a liability for expenses incurred in respect of a claim which is disputed i.e. when it is a contingent liability. On the occurrence of a diminution in asset values due to some of them having become irrecoverable or Inventory items are lost as a result of some natural calamity, amounts contributed or transferred from profit to make good  the diminution also are described as provision.
The following are instances of amount retained in the business out of earning for different purposes that are described as provisions.
(1) Amount provided for meeting claims which are admissible in principle but the amount whereof has not  been ascertained.
(2) An appropriation made for payment of taxes still to be assessed.
(3) Amount set aside for writing off bad debts or payment of discounts.
The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability is known as reserves. The reserves are primarily of two types: capital reserves and revenue reserves. Also provisions in excess of the amount considered necessary for the purposes these were originally made, are to be considered as reserves. It is thus evident that provisions are a charge against profits, while reserve is an appropriation of profits. Also provisions that ultimately prove to be in excess of amounts required or have been made too liberally are reserves. Such a distinction is essential for disclosing truly in the Balance Sheet the amount by which the equity of shareholders has increased with the accumulation of undistributed profits.
Reserve Fund: It signifies the amount standing to the credit of the reserve that is invested outside the business in securities which are readily realisable e.g., when the amounts set apart for replacement of an asset are invested periodically, in government securities or shares. The account to which these amounts are annually credited is described as the Reserve Fund.
ILLUSTRATION 13:- Crimpson Ltd.’s profit and loss account for the year ended 31st March, 2016 includes the following information:
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Required:- State which one of the items (i) to (vi) above are – (a) transfer to provisions; (b) transfer to reserves; and (c) neither related to provisions nor reserves.
SOLUTION:- (a) Transfer to provisions - (i), (iii) (vi)
(b)  Transfer to reserves - (v)
(c) Neither related to provisions nor reserves - (ii), (iv).
A summary of all adjustments are as follows:- Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev
Unit 1: Final Accounts of Non-Manufacturing Entities (Part - 3) CA Foundation Notes | EduRev

1.10 LIMITATIONS OF FINANCIAL STATEMENTS :- Financial statements suffer from a number of limitations. These must, therefore be studied with care, in order that correct inferences may be drawn. The limitations are less serious if the objective is only to appraise the performance of a single company over a period of year Where, however, a comparison of the working of different companies for the same period is to be made. It can be misleading unless the companies concerned have followed the same system and basis of accounting. On the account, a comparison of the profitability of different industries on the basis of financial statements, should be undertaken only if it is not practicable to make such a comparison on any other basis.
The principal limitations affecting financial statements are the following:
(a) Historical Cost: Accounting records and, on that account, the financial statements are prepared only on the basis of the money value prevailing at the time the transaction were entered into. Thus, the effect of subsequent changes in the value of money is not taken into account. At times this has the effect of making the statements of account quite misleading. Take the obvious example of a house built in 1980, say at the cost of ₹15,000, in 2016 the benefit receivable from its occupation will be as much as that of a house created in 2016, say at a cost of ₹14,50,000. If the house were included in the financial statements at its original cost, as normally it would not convey a true picture except to a knowledgeable person.
The limitations can be serious in the case of other fixed assets that have been working over a long period over which prices have changed radically. It is, however, not easy to get over this diffculty, since revaluation of fixed assets, apart from being costly is not practicable when the value of money is continuously falling. On this account, historical cost continues to be the accepted basis for the preparation of financial statements. Though it may not be possible to do much to remove the limitation mentioned above, one must always remember to read the balance sheet and the profit and loss account in the light of what they cannot reveal as well as what they do.
(b) Intangible strengths and weaknesses: A company may have a number of strengths and weaknesses which cannot be shown in the balance sheet e.g., the loyalty and calibre of its state. These must be kept in mind while judging the financial position of the company.
(c) Perpetual continuity and periodical account: Financial statements ordinarily are drawn up at the end of each year but the accounting record is maintained on the assumption that the business undertaking shall continue to exist forever on the basis of going concern assumption. In consequence, much of the expenditure other than revenue expenditure has to be distributed arbitrarily over a number of years during which benefit of the expenditure is expected to arise. As a result, financial statements of account are not absolutely correct.
(d) Different accounting policies: It is permissible for a company within certain limits to adopt different policies for the preparation of accounts, valuation of various assets and distribution of expenditure over different periods of account. For example, a company may decide to provide annually for payment of pensions and gratuities to state and thus build up a ‘fund’ out of which payments will be made ultimately whereas another company may deal with these only when actual payments are made. Similarly, a company may decide whether or not to include intangible assets amongst its assets or manner in which the amounts thereof should be written off.
(e)  Management policies: Management can have different accounting policies for welfare of the state and public at large.

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