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Question 1 : What is the purpose of posting J.F numbers that are entered in the journal at the time entries are posted to the accounts?

ANSWER:

J.F. number is the number that is entered in the ledger at the time of posting entries into their respective accounts. It helps in determining whether all transactions are properly posted in their accounts. It is recorded at the time of posting and not at the time of recording the transactions.

The purpose of entering the J.F. number in the ledger is because of the below-given benefits.

1. J.F. number helps in locating the entries of accounts in the journal book. In other words, J.F number helps to locate the position of the related journal entry and subsidiary book in the journal book.
2. J.F. number in accounts ensures that recording in the books of original entry has been posted or not.

Question 2 : Describe how debits and credits are used to analyse transactions.

ANSWER:

Debit originated from the Italian word debito, which in turn is derived from the Latin word debeo, which means ‘owed to proprietor’ and credit comes from the Italian word credito, which is derived from the Latin word credo, which means belief, i.e., ‘owed by proprietor’.

According to the dual aspect concept, all the business transactions that are recorded in the books of accounts, have two aspects- debit and credit. The dual aspect can be better understood with the help of an example; bought goods worth Rs 500 on cash. This transaction affects two accounts with the same amount simultaneously. As goods are brought in exchange of cash, so the cash balances in the business reduce by Rs 500, i.e. why the cash account is credited. Simultaneously, the amount of goods increases by Rs 500, so the purchases account will be debited. Debit and credit depend on the nature of accounts involved; such as assets, expenses, income, liabilities, and capital. There are five types of Accounts.

1. Assets– These include all properties or legal rights owned by a firm for its operations, such as cash in hand, plant and machinery, bank, land, building, etc. All assets have debit balance. If assets increase, they are debited and if assets decrease, they are credited.

For example, furniture purchased and payment made by cheque. The journal entry is:

Here, furniture and bank balance, both are assets to the firm. As furniture is purchased, so furniture account will increase and will be debited. On the other hand, payment of furniture is being made by cheque that reduces the bank balance of the business, so bank account will be credited.

2. Expense− It is made to run business smoothly and to carry day to day business activites.

All expenses have a debit balance. If an expense is incurred, it must be debited.

For example, rent paid. The journal entry is:

Here, rent is an expense. All expenses have a debit balance. Hence, rent is debited. On the other hand, as rent is paid in cash that reduces the cash balances, so the cash account is credited.

3. Liability− Liability is an obligation of business. Increase in liability is credited and decrease in liability is debited.

For example, a loan taken from the bank. The journal entry is:

Here, a loan from the bank is a liability to the firm. As all liabilities have a credit balance, so loan from the bank has been credited because it increases the liabilities.

4. Income− Income means profit earned during an accounting period from any source. Income also means excess of revenue over its cost during an accounting period. Income has credit balance because it increases the balance of capital.

For example, rent received from the tenant. The journal entry is:

Here, rent is an income; hence, the rent account has been credited and cash has been debited, as rent received increases the cash balances.

5. Capital− Capital is the amount invested by the proprietor in the business. Capital has credit balance. Increase in capital is credited and decrease in capital is debited

For example, additional capital is introduced by the owner. The journal entry is:

As additional capital is introduced, so the amount of capital will increase, i.e. why, the capital account is credited. On the other hand, as capital is introduced in form of cash, so the cash balances decrease, i.e. why, the cash account is debited.

Question 3 : Differentiate between source documents and vouchers.

ANSWER :

Question 4:

Prepare accounting equation on the basis of the following:

(a) Harsha started the business with cash of Rs 2,00,000

(b) Purchased goods from Naman for cash Rs 40,000

(c) Sold goods to Bhanu costing Rs 10,000/- Rs 12,000

(d) Bought furniture on credit Rs 7,000

ANSWER :

Question 5 :

Show the accounting equation on the basis of the following transaction:

ANSWER :

Question 6: Describe the events recorded in accounting systems and the importance of
source documents in those systems?

ANSWER :

It is beyond human capabilities to memorize each financial transaction and that is why source documents have their own importance in the accounting system. They are
considered as evidence of transactions and can be presented in a court of law.
Transactions supported by evidence can be verified. Source documents also ensure
that transactions recorded in the books are free from personal biases.
A few events that are supported by the source document are given below.
1. Sale of goods worth Rs 200 on credit, supported by sales invoice/bill
2. Purchase of goods worth Rs 500 on credit, supported by purchase invoice/bill
3. Cash sales worth Rs 1,000, supported by cash memo
4. Cash purchase of goods worth Rs 400, supported by cash memo

5. Goods worth Rs 100 returned by the customer, supported by credit note
6. Return of goods purchased on credit worth Rs 200, supported by debit note
7. Payment worth Rs 1,200 through the bank, supported by cheques
8. Deposits into bank worth Rs 500, supported by pay-in slips.
Out of the above events, only those events that can be expressed in monetary terms,
are recorded in the books of accounts. However, the non-monetary events
are not recorded in accounts; for example, the promotion of the manager cannot be recorded
but an increment in salary can be recorded at the time when salary is paid or due.
Source document in accounting is important because of the below-given reasons.
1. It provides evidence that the transaction has actually occurred.
2. It provides information about the date, amount and parties involved, and other details of a particular transaction.
3. It acts as evidence in a court of law.
4. It helps in verifying the transaction during the auditing process.

Question 7 :

Journalise the following transactions is the journal of M/s. Goel Brothers and post them to the ledger.

ANSWER:

Question 8:

Journalize the following transaction in the books of Sanjana and post them into the ledger:

ANSWER:

Question 9: What entry (debit or credit) would you make to

1. increase revenue,
2. decrease in expense
3. record drawings,
4. record the fresh capital introduced by the owner.

ANSWER :

1. The following entry will be made in the above case
   1. Increase Revenue-Revenue account have always credit balance so credit entry will be made to record increase in revenue.
   2. Decrease in Expense- Expense account always have a debit balance so credit entry will be made to record decrease in expenses.
   3. Record Drawings- Drawings is a reduction of capital balance so debit entry will be made in capital account to record drawings.
   4. Record the fresh Capital Introduced by the Owner- Capital account always have a credit balance so credit entry will be made to record increase in capital.

Question 10: Describe the events recorded in accounting systems and the importance of
source documents in those systems?

Answer: It is beyond human capabilities to memorize each financial transaction and that is why source documents have their own importance in the accounting system. They are
considered as evidence of transactions and can be presented in the court of law.
Transactions supported by evidence can be verified. Source documents also ensure
that transactions recorded in the books are free from personal biases.
A few events that are supported by the source document are given below.
1. Sale of goods worth Rs 200 on credit, supported by sales invoice/bill
2. Purchase of goods worth Rs 500 on credit, supported by purchase invoice/bill
3. Cash sales worth Rs 1,000, supported by cash memo
4. Cash purchase of goods worth Rs 400, supported by cash memo

5. Goods worth Rs 100 returned by the customer, supported by credit note
6. Return of goods purchased on credit worth Rs 200, supported by debit note
7. Payment worth Rs 1,200 through the bank, supported by cheques
8. Deposits into bank worth Rs 500, supported by pay-in slips.
Out of the above events, only those events that can be expressed in monetary terms,
are recorded in the books of accounts. However, the non-monetary events
are not recorded in accounts; for example, the promotion of the manager cannot be recorded
but an increment in salary can be recorded at the time when salary is paid or due.
Source document in accounting is important because of the below-given reasons.
1. It provides evidence that the transaction has actually occurred.
2. It provides information about the date, amount and parties involved, and other details of a particular transaction.
3. It acts as evidence in a court of law.
4. It helps in verifying the transaction during the auditing process.

Question 1: What is matching concept? Why should a business concern follow this concept? Discuss?

ANSWER:

Matching Concept states that all expenses incurred during the year, whether paid or not and all revenues earned during the year, whether received or not, should be taken into account while determining the profit of that year. In other words, expenses incurred in a period should be set off against revenues earned in the same accounting period for ascertaining profit or loss. For example, insurance premium paid for a year is Rs1200 on July 01 and if accounts are closed on March 31, every year, then the insurance premium of the current year will be ascertained for nine months (i.e. from July to March) and will be calculated as,

Rs 1200 − Rs 900 = Rs 300

Thus, according to the matching concept, the expense of Rs 900 will be taken into account and not Rs 1200 for determining profit, as the benefit of only Rs 900 is availed in the current accounting period.

The business entities follow this concept mainly to ascertain the true profit or loss during an accounting period. It is possible that in the same accounting period, the business may either pay or receive payments that may or may not belong to the same accounting period. This leads to either overcasting or undercasting of the profit or loss, which may not reveal the true efficiency of the business and its activities in the concerned accounting period. Similarly, there may be various expenditures like purchase of machinery, buildings, etc. These expenditures are capital in nature and their benefits can be availed over a period of time. In such cases, only the depreciation of such assets is treated as an expense and should be taken into account for calculating profit or loss of the concerned year. Thus, it is very necessary for any business entity to follow the matching concept.

Question 2: What is the money measurement concept? Which one factor can make it difficult to compare the monetary values of one year with the monetary values of another year?

Answer:

Money Measurement Concept states that only those transactions and events are recorded in accounting that is capable of being expressed in terms of money. An event even though may be very important for business, will not be recorded in the books of accounts unless its effect can be measured in terms of money. For Example, a business has 5 machines then this thing cannot be added up unless expressed in terms of money. In order to record this item, we must have to express it in monetary terms say Rs. 1,00,000. Thus, the money measurement concept enables consistency in maintaining accounting records.
But on the other hand, the adherence to the money measurement concept makes it difficult to compare the monetary values of one period with that of another. It is because of the fact that the money measurement concept ignores the changes in the purchasing power of the money, i.e. only the nominal value of money is concerned with and not the real value. What Rs 1 could buy 10 years back cannot buy today; hence, the nominal value of money makes comparison difficult. In fact, the real value of money would be a more appropriate measure as it considers the price level (inflation), which depicts the changes in profits, expenses, incomes, assets, and liabilities of the business.

Question 3: International Financial Reporting Standards (IFRS):-

Answer:

Globalization has unified different economies of the world. Enterprises are carrying on business worldwide. As accounting is the language of business, different enterprises around the world should not be speaking different languages in their financial statements. It will be very difficult to understand and compare these statements.
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standard Board (IASB). IASB replaced International Accounting. Standard Committee (LASC) in 2001.LASC was formed in 1973 to develop accounting standards that have global acceptance and make different accounting statements of different countries similar and comparable.
Assumptions in IFRS:-
The underlying assumptions in IFRS are as follows:

1. Measuring Unit Assumption:- Current purchasing power is the measuring unit which means that assets in the balance sheet are shown at current or fair value and not at historical cost.
2. Constant Purchasing Power Assumption:- It means that the value of capital is to be adjusted for inflation at the end of the financial year.
3. Accrual Assumption:- Transactions are recorded as and when they occur and the date of settlement is irrelevant.
4. Going Concern Assumption:- It is assumed that the life of the business is infinite.

Question 4 : What is the money measurement concept? Which one factor can make it difficult to compare the monetary values of one year with the monetary values of another year?

ANSWER:

Money Measurement Concept states that only those events that can be expressed in monetary terms are recorded in the books of accounts. For example, 12 television sets of Rs10,000 each are purchased and this event is recorded in the books with a total amount of Rs 1,20,000. Money acts a common denomination for all the transactions and helps in expressing different measurement units into a common unit, for example rupees. Thus, money measurement concept enables consistency in maintaining accounting records. But on the other hand, the adherence to the money measurement concept makes it difficult to compare the monetary values of one period with that of another. It is because of the fact that the money measurement concept ignores the changes in the purchasing power of the money, i.e. only the nominal value of money is concerned with and not the real value. What Rs 1 could buy 10 years back cannot buy today; hence, the nominal value of money makes comparison difficult. In fact, the real value of money would be a more appropriate measure as it considers the price level (inflation), which depicts the changes in profits, expenses, incomes, assets and liabilities of the business.

Question 5 : When should revenue be recognised? Are there exceptions to the general rule?

Answer

Revenue is recognised only when it is realised i.e., when a legal right to receive it arises. Thus credit sales are treated as revenue on the day sales are made and not when cash is received from the buyers. Similarly, rent for the month of March even if received in April month will be treated as revenue of the financial year ending 31st March.
There are two exceptions to this rule:
→ In case of sales on installment basis, only the amount collected in installments is treated as revenue.
→ In case of long-term construction contracts, proportionate amount of revenue, based on part of the contracted completed by the end of the financial year is treated as realised.

Question 6 : ‘Only financial transactions are recorded in accounting’. Explain the statement.

Answer :

According to this principle, only those transactions and events are recorded in accounting which are capable of being expressed in terms of money are recorded in the books of accounts, such as the sale of goods or payment of expenses or receipt of income, etc.
An event may be important for the business (such as dispute among the owners or managers, the appointment of a manager, etc.), but it will not be recorded in the books of accounts simply because it can not be converted or recorded in terms of money. For instance, strike by workers may adversely affect the business but it cannot be recorded in the books of accounts unless its effect can be measured in terms of money with a fair degree of accuracy.
Another aspect of this principle is that the transactions that can be expressed in terms of money have to be converted in terms of money before being recorded.It should be remembered that money is the only measurement which enables various things of diverse nature to be added up together and dealt with. The money measurement assumption is not free from limitations. Due to the changes in price, the value of money does not remain the same over a period of time. The value of rupee today on account of rising in price is much less than what it was, say ten years back. As the change in the value of money is not reflected in the book of accounts, the accounting data does not reflect the true and fair view of the affairs of an enterprise. As, such, to make accounting records relevant, simple, understandable and homogeneous, they are expressed in a common unit of measurement,i.e., money.

Question 7 : What are the advantages of Book‐Keeping ?

Answer :

1.  To the Management of a Business 
(a) In evaluating various alternative proposals so as to take maximum benefit from the best alternative.

(b) In deciding matters such as elimination of an unprofitable activity, department or product, replacement of fixed assets, expansion of business etc.

(c) Planning the various activities and planning of revenues and expenses and arranging for finance in case of need.

(d) Comparing various year’s account to know the progress or deterioration of the business and take actions to improve the business.

(e) Accounting information helps in providing evidence in a court of law in case of legal action taken by others.

(f) Accounting information helps in assessing the income tax, sales tax and property tax of the business.

(g) Accounting information constitutes one of the basis for borrowing loans from external source.

(h) It helps to detect errors and frauds that have taken place in the business.

2.  To the Investors:
(a) Types of property owned by the business.

(b) Sources and amount of earnings made or losses incurred by the business.

(c) Particulars such as stock position, debts owed, debts due etc.

(d) Whether rate of earnings is high or low.

3.  To the Employees:
It provides information to employees so as to claim fair wages, bonus, and other welfare facilities.

4.  To the Government:
(a) Accounting information helps Government to extend subsidies and incentives and other exemptions to certain types of business.

(b) The industrial progress can be known by the Government of the country. It can formulate industrial policies for further growth and development of industries.

(c) It enables the Government to assess the income from the industrial sector.

(d) It helps in amending various laws or enacting laws governing the functioning of business enterprises.

(e) It helps the Government in deciding price control, wage fixation, excise duties, sales tax etc.

5.  To the Consumers: 
Customers are not overcharged as selling price is fixed on the total expenses incurred by adding a reasonable rate of profit.

6. To the Prospective Investors: 
It helps the prospective investors in choosing the right type of investment depending upon the profit earning capacity of the business enterprises and the profit earned during past few years.

7.  To the Creditors and Suppliers: 
Creditors can decide the solvency position of the business through the accounting information. Similarly, suppliers can also decide whether goods can be sold in future on credit basis.

Question 8 : Discuss the concept-based on the premise ‘do not anticipate profits but provide for all losses’.

Answer :

According to the Conservatism Principle, profits should not be anticipated; however, all losses should be accounted (irrespective whether they occurred or not). It states that profits should not be recorded until they get recognised; however, all possible losses even though they may happen rarely, should be provided. For example, stock is valued at cost or market price, whichever is lower. If the market price is lower than the cost price, loss should be accounted; whereas, if the former is more than the latter, then this profit should not be recorded until unless the stock is sold. There are numerous provisions that are maintained based on the conservatism principle like, provision for discount to debtors, provision for doubtful bad debts, etc. This principle is based on the common sense and depicts pessimism. This also helps the business to deal uncertainty and unforeseen conditions.

Question 9 : Why is it important to adopt a consistent basis for the preparation of financial statements? Explain.

Answer :

It is important to adopt a consistent basis for the preparation of financial statements because it helps in comparability of financial statements. For Example: if a firm choose straight line method for showing depreciation but in the next accounting period switched over to written down method then the results of this year cannot be compared to that of the previous years. However, it does not mean that firm cannot changes its accounting policies. A better method, if available which will lead to better presentation and better understanding of the financial results, the firm may adopt but it must be stated clearly by way of footnotes to enable the users of the financial statements to be aware of the changes.

Question 10 : What is Book-Keeping?

Answer :

Book‐Keeping is a systematic manner of recording transactions related to business in the books of accounts. In Book‐Keeping, transactions are recorded in the order of the dates. An Accountant is a person who records the transactions in the books of the business and is expected to show the financial results of a business for every financial year. A financial year in India is followed from 1st  April to 31st  March.

According to J. R. Batliboi :

“Book‐Keeping is an art of recording business dealings in a set of books.” 

According to R.N  Carter:

“Book‐Keeping  is  an  art  of  recording  in  the  books  of  accounts,  all  those  business  transactions  that  result in transfer of money’s worth” 

Question 1: Distinguish between debtors and creditors; Profit and Gain.

ANSWER: The difference between Debtors and Creditors is given below.

The difference between Profit and Gain is given below.

• Gain− Gain is incidental to the business. They arise from irregular activities or non-recurring transactions; for example, profit on sale of fixed assets, appreciation in value of asset, profit on sale of investment, etc.
• Profit− This refers to the excess of revenue over the expense. It is normally categorised into gross profit or net profit. Net profit is added to the capital of the owner, which increases the owner’s capital. For example, goods sold above its cost

Question 2: What is accounting? Define its objectives.

ANSWER:

Accounting is a process of identifying the events of financial nature, recording them in the journal, classifying in their respective accounts and summarising them in profit and loss account and balance sheet and communicating results to users of such information, viz. owner, government, creditor, investors, etc.

According to the American Institute of Certified Accountants, 1941, “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions, and events that are, in part at least, of financial character and interpreting the results thereof.”

In 1970, the American Institute of Certified Public Accountants changed the definition and stated, “The function of accounting is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions.”

Objectives of Accounting:

1. Recording business transactions systematically− It is necessary to maintain systematic records of every business transaction, as it is beyond human capacities to remember such large number of transactions. Skipping the record of any one of the transactions may lead to erroneous and faulty results.
2. Determining profit earned or loss incurred− In order to determine the net result at the end of an accounting period, we need to calculate profit or loss. For this purpose trading and profit and loss account are prepared. It gives information regarding how much of goods have been purchased and sold, expenses incurred and amount earned during a year.
3. Ascertaining financial position of the firm− Ascertaining profit earned or loss incurred is not enough; proprietor also interested in knowing the financial position of his/her firm, i.e. the value of the assets, amount of liabilities owed, net increase or decrease in his/her capital. This purpose is served by preparing the balance sheet that facilitates in ascertaining the true financial position of the business.
4. Assisting management− Systematic accounting helps the management in effective decision making, efficient control on cash management policies, preparing budget and forecasting, etc.
5. Assessing the progress of the business− Accounting helps in assessing the progress of business from year to year, as accounting facilitates the comparison both inter-firm as well as intra-firm.
6. Detecting and preventing frauds and errors− It is necessary to detect and prevent fraud and errors, mismanagement and wastage of the finance. Systematic recording helps in the easy detection and rectification of frauds, errors and inefficiencies, if any.
7. Communicating accounting information to various users− The important step in the accounting process is to communicate financial and accounting information to various users including both internal and external users like owners, management, government, labour, tax authorities, etc. This assists the users to understand and interpret the accounting data in a meaningful and appropriate manner without any ambiguity.

Question 3: What do you mean by an asset and what are different types of assets?

ANSWER:

Any valuable thing that has monetary value, which is owned by a business, is its asset. In other words, assets are the monetary values of the properties or the legal rights that are owned by the business organizations.

Fixed Assets− These are those assets that are held for the long term and increase the profit earning capacity and productive capacity of the business. These assets are not meant for sale, for example, land, building machinery, etc.

Current Assets− Assets that can be easily converted into cash or cash equivalents are termed as current assets. These are required to run day-to-day business activities; for example, cash, debtors, stock, etc.

Tangible Assets− Assets that have a physical existence, i.e., which can be seen and touched, are tangible assets; for example, car, furniture, building, etc.

Intangible Assets− Assets that cannot be seen or touched, i.e. those assets that do not have a physical existence, are intangible assets; for example, goodwill, patents, trademark, etc.

Liquid Assets− Assets that are kept either in cash or cash equivalents are regarded as liquid assets. These can be converted into cash in a very short period of time; for example, cash, bank, bills receivable, etc.

Fictitious Assets− These are the heavy revenue expenditures, the benefit of whose can be derived in more than one year. They represent loss or expense that is written off over a period of time, for example, if advertisement expenditure is Rs 1,00,000 for 5 years, then each year Rs 2,00,000 will be written off.

Question 4: Describe the role of accounting in the modern world.

Answer:

The role of accounting has been changing over the period of time. In the modern world, the role of accounting is not only limited to record financial transactions but also to provide a basic framework for various decision making, providing relevant information to various users, and assists in both short-run and long-run planning. The role of accounting in the modern world are given below.

→ Assisting management- Management uses accounting information for short-term and long-term planning of business activities, to predict the future conditions, prepare budgets, and various control measures.

→ Comparative study- In the modern world, accounting information helps us to know the performance of the business by comparing the current year’s profit with that of the previous years and also with other firms in the same industry.

→ Substitute of memory- In the modern world, every business incurs a large number of transactions and it is beyond human capability to memorize each and every transaction. Hence, it is very necessary to record transactions in the books of accounts.

→ Information to end-user- Accounting plays an important role in recording, summarising, and providing relevant and reliable information to its users, in form of financial data that helps in decision making.

Question 5: Explain the qualitative characteristics of accounting information.

Answer:

The qualitative characteristics of accounting information are:

→ Reliability: Accounting information must be reliable so that business owners can be reasonably assured that accounting information presents an accurate picture of the company. All accounting information is verifiable and can be verified from the source document (voucher), via cash memos, bills, etc. Hence, the available information should be free from any errors and unbiased.

→ Relevance: It means that essential and appropriate information should be easily and timely available and any irrelevant information should be avoided. The users of accounting information need relevant information for decision making, planning, and predicting future conditions.

→ Understandability: Accounting information should be presented in such a way that every user is able to interpret the information without any difficulty in a meaningful and appropriate manner.

→ Comparability: It allows business owners to compare accounting information of a current year with that of the previous years. Comparability enables intra-firm and inter-firm comparisons. This assists in assessing the outcomes of various policies and programs adopted in different time horizons by the same or different businesses. Further, it helps to ascertain the growth and progress of the business over time and in comparison to other businesses.

Question 6: Accounting information refers to financial statements. The information provided by these statements can be categorized into various types. Briefly describe them.

Answer:

1. Types of Accounting Information Accounting information refers to the information provided in financial statements of the business, generated through the process of book keeping and summarising. By using the accounting information, the users are in a position to take the correct decision. The financial statements so generated are the income statement i.e., profit and loss account and the position statement i.e., balance sheet and a Cash Flow Statement. The information made available by these statements can be categorised into the following categories:
   1. Information Related to Profit or Loss during the year: Information about the profit earned or loss incurred by the business during an accounting period is made available through the income statement of the business  i.e., the profit and loss account. Trading account provides information about gross profit or gross loss whereas the profit and loss account provides information about the net profit or net loss during the year. It also gives details of all the expenses and incomes during the year.
   2. Information Related to Financial Position of the business : Information about the financial position of the enterprise is determined through its position statement i.e., the balance sheet.
      It provides information about the assets and liabilities of a business on a particular date. The difference between the two is represented by capital i.e., amount due to owners. In the case of not-for-profit organisation, difference between assets and liabilities is termed as general fund.
   3. Information about Cash Flow during the year : Cash flow statement is a statement that shows inflow and outflow of cash during a specific period. It helps in making various decisions such as payment of liabilities, payment of dividend and expansion of business, etc., as all these are based on availability of cash. It gives a clear picture of the liquidity of the business.

Question 7:

Giving examples, explain each of the following accounting terms:

• Fixed assets
• Revenue
• Expenses
• Short-term liability
• Capital

ANSWER:

• Fixed assets− These are held for long term and increase the profit earning capacity of the business, over various accounting periods. These assets are not meant for sale; for example, land, building, machinery, etc.
• Revenue− It refers to the amount received from day to day activities of business, viz. amount received from sales of goods and services to customers; rent received, commission received, dividend, royalty, interest received, etc. are items of revenue that are added to the capital.
• Capital− It refers to the amount invested by the owner of a firm. It may be in form of cash or asset. It is an obligation of the business towards the owner of the firm, since business is treated separate or distinct from the owner.

Capital = Assets − Liabilities.

• Expenses− Expenses are those costs that are incurred to maintain the profitability of business, likerent, wages, depreciation, interest, salaries, etc. These help in the production, business operations and generating revenues.
• Short term liabilities− Those liabilities that are incurred with an intention to be paid or are payable within a year; for example, bank overdraft creditors, bills payable, outstanding wages, short-term loans, etc.

Question 8: Describe the informational needs of external users.

Answer:

The various external users and their needs are:

• Investors and potential investors: information on the risks and return on investment;

• Unions and employee groups: information on the stability, profitability, and distribution of wealth within the business;

• Lenders and financial institutions: information on the creditworthiness of the company and its ability to repay loans and pay interest;

• Suppliers and creditors-information on whether amounts owed will be repaid when due, and on the continued existence of the business;

• Customers-information on the continued existence of the business and thus the probability of a continued supply of products, parts, and after-sales service;

• Government and other regulators- information on the allocation of resources and the compliance to regulations;

• Social responsibility groups, such as environmental groups-information on the impact on the environment and its protection;

• Competitors: information on the relative strengths and weaknesses of their competition and for comparative and benchmarking purposes.

Question 9: Distinguish between financial accounting, cost accounting, and management accounting.

Answer:

Question 10: What are the functions or steps of the accounting process? 

Answer:

 Following attributes or major steps that can be drawn from the definition of Accounting:

① Identifying and Measurement
② Recording
③ Classifying
④ Summarizing
⑤ Analysis, Interpretation, and Communication

(1) Identifying financial transactions and events

Accounting records only those transactions and events which are of financial nature. So, first of all, such transactions and events are identified.

The first step in accounting is to determine what to record, i.e., to identify the financial events which are to be recorded in the books of accounts. It involves observing all business activities and selecting those events or transactions which can be considered as financial transactions.

(2) Measuring the transactions

Accounting measures the transactions and events in terms of money which are considered as a common unit.

In Accounting, we record only those transactions which can be measured in terms of money or which are of financial nature. If a transaction or event cannot be measured in monetary terms, it is not considered for recording in financial accounts.

There are few events directly or indirectly make an effect on the working of a business firm but cannot be recorded in the books of accounts because they cannot be measured in terms of money.
For example, the appointment of a new managing director, signing of contracts, strikes, death of an employee etc is not shown in the books of accounts.

(3) Recording of transactions

Accounting involves recording the financial transactions of inappropriate books of accounts such as journals or Subsidiary Books.

A transaction will be recorded in the books of accounts only if it is considered an economic event and can be measured in terms of money. Once the economic events are identified and measured in financial terms, these are recorded in books of account in monetary terms and in chronological order. The recording should be done in a systematic manner so that the information can be made available when required.

(4) Classifying the transactions

Transactions recorded in the books of original entry – Journal or Subsidiary books are classified and grouped according to nature and posted in separate accounts known as ‘Ledger Accounts’.

Once the financial transactions are recorded in journal or subsidiary books, all the financial transactions are classified by grouping the transactions of one nature at one place in a separate account. This is known as the preparation of Ledger.

(5) Summarising the transactions

It involves presenting the classified data in a manner and in the form of statements, which are understandable by the users.

It includes Trial balance, Trading Account, Profit and Loss Account, and Balance Sheet.

It is concerned with the presentation of data and it begins with a balance of ledger accounts and the preparation of trial balance with the help of such balances. A trial balance is required to prepare the financial statements i.e. Trading Account, Profit & Loss Account, and Balance Sheet.

(6) Analysing and interpreting financial data

Results of the business are analyzed and interpreted so that users of financial statements can make a meaningful and sound judgment.

The main purpose of accounting is to communicate the financial information to the users who analyze them as per their individual requirements.

(7) Communicating the financial data or reports to the users

Communicating the financial data to the users on time is the final step of Accounting so that they can make appropriate decisions. Providing financial information to its users is a regular process.

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