4_B.Com-General-103 (1st Semester) (1).pdf

SELF LEARNING MATERIAL B.Com. – FINANCIAL ACCOUNTING COURSE : B.Com - 103 B.Com. (1st Semester) Directorate of Distance Education DIBRUGARH UNIVERSITY DIBRUGARH - 786 004 BLOCK-1: FINANCIAL ACCOUNTING Unit 1: Financial Statements for Profit Organisation Unit 2: Accounting of Not for Profit Organisation Unit 3: Accounts of Incomplete Records: Single Entry System BLOCK-2: HIRE PURCHASE SYSTEM AND INSTALLMENT ACCOUNTS Unit 1: Hire Purchase and Installment Account Unit 2: Accounting Entries in the Books of Hire Purchaser and Hire Vendor BLOCK- 3: PARTNERSHIP ACCOUNTS Units 1: Dissolution of Partnership Firms Unit 2: Insolvency of Partners Unit 3: Sale of a Firm to a Company: Purchase Considerations and Accounting Entries BLOCK- 4: Royalty Accounts Unit 1: Royalties Accounts Unit 2: Branch Accounts Unit 3: Departmental Accounts BLOCK- 5: INTRODUCTION TO GOVERNMENTACCOUNTING Unit 1: Government Accounting- Basic Understanding Unit 2: System of Financial Administration in India BLOCK- 1: FINANCIAL ACCOUNTING Introduction There are three units in this block. Unit 1 focuses on preparation of financial statements for profit organisations. Likewise, Unit 2 gives emphasis on accounting of not- for- profit organisations. Related concepts of not for profit organisations have been detailed out with accounting problems. Unit 3 concentrates on accounts from incomplete records popularly known as single entry system. While going through the units you will get Self Assessment Questions. At the end of every unit, suggested readings are also given. So, you can refer to these books in case you require deeper and better understanding of related concepts. Unit 1: Preparation of Financial Statements for Profit Organisations Structure 1.0 Objectives 1.1 Introduction 1.2 Preparation of Final accounts 1.2.1 Trading Account 1.2.2 Profit and Loss Account 1.2.3 Balance Sheet 1.2.4 Preparation of Final Accounts with Adjustments 1.3 Let’s Sum Up 1.4 Key Words 1.5 SAQs 1.6 Hints/ Answers of SAQs 1.7 Suggested Readings 1.8 Model Question 1.0 Objectives: After going through this unit, you will be able to: Prepare Trading and Profit and Loss Account Prepare Balance Sheet Prepare both Trading and Profit and Loss Account and Balance Sheet with adjustments. 1.1 Introduction Financial Accounting is that field of accounting which is concerned with the classifying, summarizing, analyzing and reporting of financial transactions pertaining to an entity. Accounting is a process of using financial information so as to show the financial position and financial result of an entity at the end of the financial period. For determining the profit and loss position Trading and Profit & Loss Account is prepared. Likewise, for determining the assets, liabilities and capital position, Balance Sheet is prepared. The entire idea of financial accounting is illustrated with the help of a diagram below: Financial Accounting ↓ Using financial information to determine ↙ ↘ Financial position Financial result ↓ ↓ Balance sheet Profit and Loss Account 1.2 Preparation of final accounts Arithmetical accuracy of maintaining books of accounts can be determined by preparing a Trial Balance with the balances of various ledger accounts at periodical interval. The accounts showing debit balance and accounts showing credit balance are grouped separately and put in one statement. In the credit side (column) of trial balance, items related to both revenue and capital receipts are shown. Contrary to that all the revenue and capital payments are shown in the debit side of trial balance. In other words, the ledger accounts showing credit balance are shown in the credit column and the accounts showing debit balance are shown in the debit column of the Trial Balance. Actually, the Trial Balance is not a formal part of financial accounitng. All the revenue receipts and payments of the trial balance are shown/ transferred in the Trading and Profit & Loss Account and all the capital receipts and payments of Trial Balance are shown in the Balance Sheet relating to a particular accounting year. Trading Account includes all the direct income and expenditure. Direct income and expenditure are those which are directly related to production for a manufacturing concern or related to purchase for a trading concern. Likewise, Profit and Loss Account includes all the indirect incomes and expenditure which are neither directly related to production nor with purchase rather these are related to administration and selling and distribution. 1.2.1Trading Account This account is prepared to know the trading results or gross margin on trading of the business i.e., how much gross profit or loss the business has earned from buying and selling during a particular period. The excess of sales over the cost of goods sold is gross profit. For the purpose of calculating cost of goods sold, we have to take into consideration of opening stock, purchases, direct expenses on purchasing or manufacturing the goods and closing stock. The balance of this account represents gross profit or loss and is transferred to the profit and loss account. The pro-forma of a trading account is given as follows: Trading Account For the year ending 31st March, 2018 Dr. Cr. Particulars Amount Particulars Amount (Rs) (Rs) Sales Opening stock Less: Sales return Purchases Closing stock Less: Purchase return Profit and Loss Account Direct expenses: (Gross loss c/d) Carriage inward and freight Wages Fuel and power Manufacturing expenses Motive power Octroi duty Custom duty Consumable stores Foreman/ works manager’s remuneration Royalty on manufactured goods Profit and Loss Account (Gross profit c/d) Balancing figure will either be gross profit or gross loss. Detailed study of the items posted to the debit side of Trading Account: 1. Opening stock: It means goods lying unsold with the firm at the beginning of the accounting year. Opening stock consists of raw materials, work in progress and finished goods. 2. Purchases: it includes both cash and credit purchases of goods which are for resale. Purchase returns and discount on purchase, if any should be deducted from purchases in the inner column and only net purchases are shown in the outer column. The worth noting points in this respect are: a) Goods purchased but in transit will not affect the trading account. It is better to debit the goods in transit account and credit suppliers account as a liability in the balance sheet. b) Goods purchased for personal use of proprietor out of business funds should be first recorded as ordinary purchases debiting purchase account and crediting suppliers/cash account. Then it should be recorded as goods withdrawn by the proprietor for personal use and entry for that will be: Debit Drawing a/c and Credit Purchase a/c. c) Invoice of goods purchased are received in advance before actual receipt of such goods. For such goods, neither purchase a/c be debited nor goods will be included in closing stock. d) Purchase made under future transactions and goods received on consignment or on behalf of third party should not be included in purchase. e) Purchase of any fixed assets for business use such as furniture, machinery, etc should be kept separate. f) Adjusted purchases: some organizations for comparison purpose prefer to adjust the opening and closing stock through Purchase Account. Entries for this will be as under: For adjustment of opening stock Purchase A/c - Dr To Opening Stock A/c For adjustment of closing stock Closing stock A/c - Dr To Purchases A/c Due to these adjustments there will be no opening stock in the trial balance. Adjusted purchase a/c is shown on the debit side of Trading Account and closing stock (having debit balance) appears as an asset in the Balance sheet. 3. Direct expenses: These include all the expenses which have been incurred before the goods become ready for sale and are shown on the debit side of Trading Account. The examples of direct expenses are: a) Wages: Amount paid to workers for their services related to factory or may be purchase. b) Octroi Duty: It denotes tariff paid in order to bring the goods into municipal limit. c) Carriage on Purchase: Transportation cost incurred to bring the goods into factory/place of business is called as carriage inward/carriage on purchase. d) Motive Power, Coal, Gas and Fuel: These are direct expenditure to run the machines and other equipments and are shown to the debit side of Trading Account. e) Import duty and dock charges: In case goods are imported from abroad, custom duty, dock charges etc. need to be paid. As these relate to goods purchased, they are shown on the debit side of Trading Account. f) Manufacturing expenses: All expenses incurred in manufacturing the goods in the factory such as factory rent, factory insurance, depreciation on factory machinery, factory lighting, etc are debited to Trading Account. g) Consumable stores: These are incurred to keep the machine in right condition and include engine oil, soft soap, cotton waste, oil, grease and waste consumed in a factory. Let us have some illustrations to understand the points better: Illustration 1.1 Following is the Trial Balance of a sole proprietorship concern. Prepare Trading Account for the year ending 31st March, 2019. Items Debit Balance (Rs.) Credit Balance (Rs.) Opening Stock Purchase 10,000 Wages 1, 00,000 Factory Lighting 5,000 Octroi Duty 5,000 Carriage on Purchase 2,000 Sales 1,000 1, 50,000 1,50,000 1,50,000 # Note: Here in this sum, it is asked to prepare only Trading account. So all the items mentioned are related to production process. Solution Trading and Profit & Loss Account For the year ended on 31st March, 2019 Dr Cr Particulars Rs. Particulars Rs. By Sales 1,50,000 To Opening Stock 10,000 To Purchases 1,00,000 To Wages 5,000 To Factory Lighting 5,000 To Octroi Duty 2,000 To Carriage on Purchase 1,000 To Profit and Loss Account 27,000 (Gross Profit c/d) 1,50,000 1,50,000 By Trading Account 27,000 (Gross Profit b/d) 1.2.2 Profit and Loss Account This account is prepared to calculate the net profit of the business. There are certain items of incomes and expenses of the business which must be taken into consideration for calculating net profit of the business. These are of indirect nature i.e., considering the whole business and relating to various activities which are done by the business for the purpose of making the goods available to the consumers. Indirect expenses may be selling and distribution expenses, management expenses, financial expenses, extra ordinary losses and expenses in maintaining the assets or expenses on assets to keep it in working condition. This account is prepared by putting the nominal account balances which are either indirect income (credited to profit and Loss Account) or indirect expenses (debited to profit and Loss Account) and its final balance (Net profit/Loss) is transferred to capital account. Since the owners are taking the risk of business they have their right to get the entire profit or loss to their favour as such the final affect is to given to the capital account of the owner. Net Profit will increase the balance in capital and Net Loss will reduce the balance in capital. The specimen of the Profit and Loss account is given as under: Profit and Loss Account For the year ending 31st March, 2019 Dr. Cr. Particulars Amount Particulars Amount (Rs) (Rs) By Trading Account To Trading Account (Gross (Gross profit b/d) Loss b/d) By Interest received To selling and distribution By Discount received expenses: By Commission received Advertisement By Rent from tenants Traveler’s salaries, By Income from expenses and commission investments Bad debts By Apprenticeship Go down rent premium Export expenses By Interest on debenture Carriage outwards By Income from other Bank charges sources Agent’s commission By Miscellaneous Upkeep of motor lorries revenue receipts To Management expenses: By Capital Account Rent, rates and taxes ( Net Loss Heating and lighting Transferred to capital a/c) Office salaries Printing and stationery Telephone charges Legal charges Audit fee Insurance General expenses To Depreciation and Maintenance: Depreciation on fixed assets Repairs and maintenance To Financial expenses: Discount allowed Interest on capital Interest on loan Discount on bills To Extra ordinary expenses: Cash defalcation To Capital Account (Net Profit Transferred to capital a/c) Balancing figure will be either net profit or net loss. Important points to be kept in mind at the time of preparation of the Profit and Loss Account are shown as below: a) Salaries: These include salaries paid to office, go down and warehouse staff , marketing personnel should be shown on the debit side of profit and loss account. b) Rent, rates and taxes: These include offices and warehouse rent, municipal rates and taxes. c) Interest: Interest paid on loans, overdrafts and bills overdue is an expense and is taken to the debit of the Profit and Loss Account. Interest received on loans and advanced by the firm on deposits and on securities is a gain/income and is shown on the credit side of profit and loss account. Interest on capital should be shown separately on the debit side and interest on drawings on the credit side of profit and loss account. d) Commission: Commission received for doing the work for other firms may be credited to profit and loss account as a gain and commission payable to the agents employed to sell the firm’s goods is debited as an expense. e) Repairs: Repairs and small renewals or replacement relating to the plant and machinery, fixture, fittings, utensils, etc. are generally included under this heading and such expenditure are debited to profit and loss account. f) Depreciation: It is an expense due to wear and tear, lapse of time and exhaustion of assets used in business. This is loss sustained by fixed assets and should be charged to the debit of profit and loss account. g) Stable expenses: These are incurred for the fodder of the horse and wages paid to persons looking after the stable. h) Trade expenses: These are expenses of a varied nature for which it is not worthy to open separate accounts. These are amalgamated under trade or general or sundry or petty expenses. i) Samples: Samples of the goods manufactured by the business concerns are often distributed free of charge to push up sales. Being indirect expense (sales promotion) these are debited to profit and loss account. j) Advertisement: All sums spent on advertising is charged to profit and loss account. k) Apprentice premium: This is the amount charged from a person to whom training is given by the business. It is a gain and should be credited to profit and loss account. l) Abnormal losses: Some abnormal losses like loss on sale of fixed assets, cash defalcations, stock destroyed by fire not covered by insurance, etc should be debited to profit and loss account. Expenses not be shown in profit and loss account a) Domestic and household expenses b) Income tax c) Life insurance premium 1.2.3 Balance Sheet A Balance Sheet can be simply described as a statement of assets and liabilities on a specific date. A Balance Sheet has two sides. In the left hand side liabilities and capital are shown; whereas in the right hand side, assets are shown. Liabilities are the claims against the assets. Liabilities are divided into: (a) Fixed liability or non- current liabilities under which capital, long term liabilities will come & (b) Current liability which includes all the short term liabilities like creditors (to whom money is due to pay), outstanding expenses, short term loan etc. Assets denote the resources acquired by business from the funds made available either by owners of the business or other financiered. Assets are categorized as: (a) Fixed/ Non-Current assets include all the assets which are bought for use for a long period not for resale, e.g., buildings, machinery, etc. (b) Current assets include short term assets , e.g., closing stock, debtors (from whom money is due to receive), cash, etc.(c) Intangible assets are those assets which cannot be touched or seen physically, e.g., goodwill, patents, etc. (d) Fictitious assets are those assets which cannot be represented using any tangible possession or property, e.g., preliminary expenses, some other deferred revenue expenses yet to be written off. In other words all the capital receipts of the firm are liabilities; whereas all the capital expenditures are assets. Illustration 1.2 Prepare Trading and Profit & Loss Account for the year ended 31st March, 2019 and Balance Sheet as on 31st March, 2019. Trial Balance st as on 31 March, 2019 Debit (Rs.) Credit (Rs.) Land & Building 5, 00,000 Machinery 1, 00,000 Capital 10, 00,000 Sales 6, 00,000 Creditors 10,000 Opening Stock 10,000 Purchases 3, 57,000 Wages 15,000 Salary 25,000 Printing & Stationery 2,000 Freight 1,000 Cash at Bank 2, 32,000 Interest 2,000 Investments 1, 50,000 Goodwill 1, 00,000 Furniture 1, 00,000 Debtor 20,000 -------------- -------------- 16,12,000 16,12,000 -------------- ------------- Solution to illustration 1.2 Trading and Profit & Loss account For the year ending 31st March, 2019 Dr. Cr. Particulars Rs. Particulars Rs. To Opening Stock 10,000 By Sales 6,00,000 To Purchase 3,57,000 To Freight 1,000 To Wages 15,000 To Profit and Loss Account 2,17,000 (Gross Profit c/d) 6,00,000 6,00,000 By Trading Account 2,17,000 To Salary (Gross Profit b/d) 25,000 To Printing & Stationery By Interest 2,000 2,000 To Capital Account (Net Profit transferred) 1,92,000 2,19,000 2,19,000 Balance Sheet as on 31st March, 2019 Liabilities Rs. Assets Rs. Capital 10,00,000 Goodwill 1,00,000 Add: Net profit 1,92,000 11,92,000 Land & Building 5,00,000 Creditors 10,000 Machinery 1,00,000 Furniture 1,00,000 Investment 1,50,000 Debtors 20,000 Cash at Bank 2,32,000 12,02,000 12,02,000 Things to learn from the illustration: In this problem we have recorded all the revenue income and expenditure either in the Trading account or in the Profit and Loss Account. Capital receipts and payments which are referred to as liabilities and assets respectively have been shifted to Balance Sheet. The net profit coming out of the Profit & Loss Account is added with the capital. Capital is the contribution of the owner in the business. And one more thing that is prominent in Balance Sheet is both the sides must tally. 1.2.2 Preparation of Final Accounts with Adjustments While preparing trading and profit and loss account one point that must be kept in mind is that expenses and incomes for the full trading period are to be taken into consideration. This means that if an expense has been incurred but not paid during that period, a liability for the unpaid amount should be created before the accounts can be said to show the true profit or loss. All expenses and incomes should properly be adjusted through adjustment journal entries. These journal entries are passed at the end of the accounting period are called adjusting entries. Some of the most commonly used adjustments are: a) Closing stock b) outstanding expenses and income c) prepaid income and expenditure d) depreciation e) bad debts and provision for doubtful debts f) interest on capital and drawings The illustration 1.3 will give us idea about how adjustments are actually passed in Trading and Profit and Loss Account and Balance Sheet. Illustration 1.3 Prepare Trading and Profit & Loss Account for the year ended 31st March, 2019 and Balance Sheet as on 31st March, 2019. Trial Balance As on 31st March, 2019 Debit (Rs.) Credit (Rs.) Land and Property 5, 00,000 Machinery 1, 00,000 Capital 10, 00,000 Sales 6, 00,000 Creditors 10,000 Opening Stock 10,000 Purchases 3, 57,000 Wages 15,000 Salary 25,000 Printing & Stationery 2,000 Carriage inward 1,000 Cash at Bank 2, 32,000 Interest 2,000 Investments 1, 50,000 Patents 1, 00,000 Furniture 1, 00,000 Debtor 20,000 ------------ -------------- 16,12,000 16,12,000 -------------- --------------- Adjustments: 1. Closing stock Rs. 30,000 2. Appreciate land and property @10% p.a. 3. Depreciate machinery @10% p.a. & furniture @5% p.a. 4. Write off bad debt Rs. 1000 and create a provision for doubtful debts Rs. 1,500. 5. Outstanding wages Rs. 200. 6. Advance interest received Rs. 100. 7. Prepaid salary Rs. 1,000 Solution to illustration 1.3 Trading and Profit & Loss account For the year ending 31st March, 2019 Dr. Cr. Particulars Rs. Particulars Rs. To Opening Stock 10,000 By Sales 6,00,000 To Purchase 3,57,000 To Carriage inwards 1,000 To Wages 15,000 By Closing Stock 30,000 Add: Outstanding 200 15,200 To Profit and Loss Account 2,46,800 (Gross Profit c/d) 6,30,000 6,30,000 By Trading Account 2,46,800 To Salary 25,000 (Gross Profit b/d) 24,000 Less: Prepaid 1,000 By Interest 2,000 2,000 1,900 To Printing & Stationery Less: Prepaid 100 50,000 To New Bad debts 1,000 By Appreciation in Land 2,500 & Property Add: New Provision 1,500 To Depreciation on Machinery 10,000 15,000 Furniture 5,000 To Capital Account (Net Profit transferred) 2,55,200 2,98,000 2,98,700 Balance Sheet as on 31st March, 2019 Liabilities Rs. Assets Rs. Capital 10,00,000 Patents 1,00,000 Add: Net profit 2,55,200 12,55,200 Land & Building 5,00,000 Creditors 10,000 5,50,000 Add: Appreciation Outstanding wages 200 50,000 Prepaid/advance interest 100 Machinery 1,00,000 90,000 Less: Depreciation 10,000 95,000 Furniture 1,00,000 1,50,000 Less: Depreciation 5,000 1,000 Investments 30,000 Prepaid salary Closing Stock Debtors 20,000 Less: Bad debt 1,000 17,500 19000 2,32,000 Less: Provision 1,500 12,65,500 12,65,500 Cash at Bank Things to learn from the illustration: In this problem, we have seen that all the adjustments are shown twice. Value of land and property got appreciated. Appreciation in the value of an asset has been shown as an income. So, the appreciated amount is added to its original cost and the same amount is also credited to Profit and Loss account as an income. But contrary to that, value of machinery and furniture got depreciated. Depreciation is a loss. So the amount of depreciation is debited to Profit and loss account. Advance interest received is a liability so as the outstanding wages. But prepaid salary is an asset. We must remember, all the prepaid expenses are current assets and all the outstanding expenses are current liabilities. Likewise, all the outstanding incomes are current assets and all the advance incomes are current liabilities. Debtor is an entity to whom the business has lent its money or given its assets/ goods on credit. So, debtor is a current asset. Debtors which cannot be recovered or become irrecoverable are called bad debts. As because bad debt is loss on debtors so it is deducted from debtors. As we know as per the convention of conservatism, we have to anticipate all the future losses. So provision for doubtful has also been deducted from the debtor. 1.3 Let Us Sum It Up So, in this unit we have seen how to prepare the financial statement of a for profit organisation. Basically, we have considered sole proprietorship entity into consideration for preparing financial statements and we have seen that they prepare two statements: 1) Trading and Profit & Loss Account and 2) Balance Sheet. Trading and Profit & Loss Account includes all direct and indirect income and expenditure for a particular year which depicts the profit and loss position of the business. Likewise, Balance Sheet shows capital as well as assets and liabilities position of the business depicting the financial position on the last day of the financial year. 1.4 Keywords Trading and Profit & Loss Account, Balance Sheet, Income, Expenditure, Assets, Liabilities, Capital 1.5 SAQs Choose the correct alternative: 1. Which of the following is not an item under Balance Sheet: a) Furniture b) Cash in hand c) Discount allowed d) Debtors 2. Which of the following is an item under Trading A/C? a) Commission to salesman, b) Office expenses, c) Factory lighting, d) Interest on investment 3.Depreciation is charged on: a) Fixed assets b) Current asset 1.6 Answers of SAQs 1. c 2. c 3. a 1.7 Suggested Readings Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors Pvt Ltd, New Delhi, Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition, Vikas Publishing House New Delhi 1.8 Model Question 1. Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2019 and Balance Sheet as on 31st March, 2019. Trial Balance as on 31st March, 2019 Debit (Rs.) Credit (Rs.) Land 15, 00,000 Plant & Machinery 10, 00,000 Capital 20, 00,000 Sales 25, 30,000 Creditors 40,000 Opening Stock 40,000 Purchases 13, 57,000 Wages 15,000 Salary 55,000 Petty expenses 2,000 Carriage outward 1,000 Cash 2, 32,000 Commission 18,000 Furniture 30,000 Investments 1, 20,000 Goodwill 1, 00,000 Equipments 1, 00,000 Debtor 20,000 Carriage inward 10,000 Trade expenses 10,000 Discount received 4,000 ----------------- ------------ 45,92,000 45,92,000 Adjustments: 1) Closing stock Rs. 25,000 2) Appreciate land by 6% p.a. 3) Depreciate machinery @4% p.a., equipment @ 2% & furniture @3 % p.a. 4) Write off bad debt @3% p.a. Provision for doubtful debt @4% p.a. 5) Outstanding salary Rs. 1800. 6) Advance commission received Rs. 1000. 2. Prepare Trading and Profit & Loss Account for the year ended on 31st March, 2019 and Balance Sheet as on 31st March, 2019. Trial Balance For the year ending 31st March, 2019 Debit (Rs.) Credit (Rs.) Building 20, 00,000 Machinery 5, 00,000 Capital 19, 00,000 Sales 25, 10,000 Creditors 50,000 Opening Stock 40,000 Purchases 13, 57,000 Wages 15,000 Salary 25,000 Factory manager’s salary 12,000 Carriage outward 1,000 Bank 2, 32,000 Commission 10,000 Manufacturing expenses 10,000 Investments 1, 42,000 Equipments 1, 00,000 Debtor 20,000 Carriage inward 10,000 Sundry expenses 10,000 Interest received 4,000 ----------------- ------------ 44, 74,000 44, 74,000 Adjustments: a) Closing stock Rs. 60,000 b) Depreciate building and machinery at 2%, equipment at 3% p.a. c) Factory manager’s salary outstanding Rs. 1,000. d) Write off provision for doubtful debts Rs. 500. Unit 2: Accounting of Not for Profit Organization Structure 2 2.1 Objectives 2.2 Introduction 2.3 Receipts and Payment Account 2.4 Income and Expenditure Account 2.5 Differences Between Income and Expenditure Account and Receipts and Payments Account 2.6 Treatment of Some Important Items 2.7 Let’s Sum Up 2.8 Key Words 2.9 SAQs 2.10 Hints/ Answers of SAQs 2.11 Suggested Readings 2.12 Model Question 2.0 Objectives After going through this unit, you will be able to: Understand the concept of not for profit organization Know the different set of accounts prepared by these organizations Differentiate between receipts and payment account and income and expenditure account Prepare both receipts and payment account and income and expenditure account. 2.1 Introduction There are some institutions whose main objective is not to earn profit but to render valuable services to its members and to the society, e.g., clubs, schools, colleges, universities, trade unions, NGOs, etc. In order to find out their operating financial results and financial position, they prepare the following statements for the purpose of financial reporting: a) Receipts and Payments Account b) Income and Expenditure Account c) Balance Sheet Let us now discuss in detail about all these three statements prepared by non trading concern: 2.2 Receipts and Payments Account It is an account which summarizes all the cash receipts and cash payments of the organization. It is the summary/substitute of cash book prepared by trading organizations. It is a real account. All the cash receipts are debited and all the cash payments are credited to the account. For example, cash received from sale of goods is taken as receipt and is debited. Contrary to this, cash paid on purchasing materials are credited because it is a payment. One thing should be noted that credit transactions or non cash items are not recorded in Receipts and Payments Accounts. As a result, items like credit purchase or credit sales can’t be recorded. 2.3 Income and Expenditure Account Income and Expenditure Account is a nominal account. It is prepared by non-profit organization in lieu of Trading and Profit and Loss Account. Debit all losses or expenses and credit all incomes or gains is followed while preparing this account. Incomes are shown on the credit side and expenses on the debit side. There is no opening balance but closing balance will show either surplus i.e., excess of income over expenditure or deficit i.e., excess of expenditure over income. Only income and expenses which are revenue in nature are taken into consideration in Income and Expenditure Account i.e., capital items are totally excluded. Moreover, income and expenditure of current year are taken into consideration so any arrear, outstanding, advance relating to period other than the current year are excluded while preparing this account. This account is prepared on accrual basis of accounting and thus all adjustments relating to prepaid or outstanding expenses and incomes related to current year, provision for depreciation or doubtful debts etc are to include in the income and expenditure account. Only nominal accounts are taken into consideration for the preparation of Income and Expenditure Account. Let us now discuss the differences between Receipts and Payments Account and Income and Expenditure Account: 2.4 Differences Between Receipts and Payments Account and Income and Expenditure Account Basis of difference Receipts and Payments Income and A/C Expenditure A/C 1. Type of It is a real account. It is a nominal account. account 2. In lieu of It is prepared in lieu of It is prepared in lieu of cash book. Trading and Profit and Loss account. 3. Basis of It is prepared on cash It is prepared on accrual accounting basis of accounting. basis of accounting. 4. Period All the receipts and Only current period payments whether income and expenditure relating to current period, are taken into succeeding or preceding consideration. periods are taken into consideration. 5. Capital and Both capital and revenue Only revenue items are revenue items are taken into considered. items consideration. 6. Necessity for As it includes revenue It includes only revenue preparation and capital items, items, so for recording of Balance preparation of balance the capital items there Sheet Sheet is ignored. might be a necessity to prepare Balance Sheet. Let us now discuss some important concepts having relation with maintaining financial records and for financial reporting to be made by a non trading concern. In this regard we will also discuss about their accounting treatment. 2.5 Treatment of some important items Legacy: It is the amount which a non trading concern may receive as per the will of a deceased person. It will be shown to the debit side of the receipts and payments account. It should be capitalized being an item of non recurring nature and should be shown on the liabilities side of the balance sheet. Donation: It is the amount which is given to non trading concern by the members of the society. It is put on the receipts side of receipts and payments account. Donation may be general donation or may be a specific donation. If the amount is small and not for a specific purpose then it is credited to income and expenditure account as a revenue income. But if the amount is huge and received for a specific purpose then it is capitalized and shown as a liability in the balance sheet. All the specific donations are treated capital receipts and are shown as liability. Sale of an asset: It is shown as a receipt in the receipts and payments account. To show this item in the income and expenditure account some adjustments are required. The difference between book value and sale proceeds of the asset is required to be shown in the income and expenditure account. If sale value is more than book value, it is profit and taken as income to the credit side of the income and expenditure account. On the other hand, if sale value is less than the book value it indicates a loss on sale so to be treated to the debit side of the income and expenditure account. Sale of newspaper or obsolete items: It is treated as receipt under receipts and payments account and since it is an income revenue in nature so credited to the income and expenditure account. Entrance fee: This fee is generally paid by members normally once in life time. Since it is a receipt for such an institution it is shown to the debit side of the receipt and payment account. As a result, it is considered as a capital receipt in general or it may be partially treated as capital receipt as per the policy of the concern. If the entire amount of entrance fees is treated as capital receipt then it is shown to the liabilities side of the balance sheet. But when it is treated partially as capital and revenue receipt then the revenue part of such income is required to be shown as a revenue income to the credit side of the income and expenditure account. Subscription: It is taken as receipt to the receipt and payment account and it is credited to the income and expenditure account as a revenue income. Only the subscription relating to the current year is required to be shown as revenue income on accrual basis. Life membership fee: It is a one time fees to be paid by those who want to become life member of the institution. A life member need not pay annual membership fees. It is treated as a capital receipt and shown in the receipt and payment account. Since it is a capital receipt not to show in the income and expenditure account. But required to be shown as a liability in the liability side of the balance sheet. When life membership fees is treated one part as capital and another part as revenue income then the revenue income part is to be shown as income to the credit side of the income and expenditure account. Under receipts and payments account, it is taken as receipt. Honorarium: any amount paid to a person (who is not an employee of the organization) for rendering his or her services to the concern is called as honorarium. It is a revenue payment and thus is shown on the payments side of Receipts and Payments Account. In the Income and Expenditure Account, it is shown on the expenditure side. Endowment fund: It is a specific fund created out of contribution as a permanent means of support for any person or institution. Any contribution received for the endowment is to be treated in the fund account and any payment made out of such fund is required to be charged to that fund account only. It is a capital receipt and is shown on the liabilities side of the Balance sheet. Any amount received during the year is to be shown to the receipt side of Receipts and Payments Account Let us consider some illustrations for better understanding the procedure of preparing receipt and payment account and an income and expenditure account: Illustration 2.1 From the following information, prepare, Receipts and Payments Account for the year 2019: Rs. Cash at Bank on 1.1.2019 10,000 Furniture purchased 6,000 Subscription received from members 10,000 Entry fee received 5,000 Donation received 50,000 Books purchased for library 6,000 Miscellaneous expenses incurred 5,000 Subscription receivable 2,000 Solution to illustration 2.1 : Receipts and Payments Account for the year 2019 Dr Cr Receipts Rs. Payments Rs. To Balance b/d 10,000 By Furniture 6,000 To Subscription 10,000 By Books 6,000 To Entry fee 5,000 By Misc. Exp 5,000 To Donation 50,000 By Balance c/d 58,000 75,000 75,000 Things we learnt from the illustration: We have seen all the cash receipts have been debited and all cash payments have been credited in the receipt and payment account. After adjusting receipts and payments, we have found closing cash balance in the credit side at the end of the accounting year and which will be the opening balance of cash in the next year. The item subscription receivable will not appear in the receipt and payment account as cash/bank has not received during the year. This account is prepared on cash basis only. Illustration 2.2 From the following information, prepare, Receipts and Payments Account for the year 2019: Rs. Cash at Bank on 1.1.2019 25,000 Sports materials purchased 10,000 Subscription received from members 10,000 Entrance fee received 5,000 Honorarium paid to coach 5,000 Donation for renovation of playground 50,000 Maintenance of Playground 6,000 Miscellaneous expenses incurred 5,000 Salary payable to staff 4,000 Solution to illustration 2.2 : Receipts and Payments Account for the year 2019 Dr Cr Receipts Rs. Payments Rs. To Balance b/d 25,000 By Sports materials 10,000 To Subscription 10,000 By Maintenance of playground 6,000 To Entrance fee 5,000 By Honorarium 5,000 To Donation for renovation 50,000 By Misc. Expenses 5,000 of playground By Balance c/d 64,000 90,000 90,000 Things we have learned from the illustration: Similar to the earlier problem, here also all the cash receipts have been debited and all cash payments have been credited to the receipt and payment account. After adjusting receipts and payments, we have found closing cash balance in the credit side which will be the opening balance of cash for the next year. Salary payable to staff will not appear in the receipt and payment account as it has not affected in the cash position of the entity. Illustration 2.3 From the following information prepare Income and Expenditure Account for the year ended on 31st December, 2019 and Balance Sheet as on 31st December, 2019. Particulars Rs. Particulars Rs. Books for library 15,000 Donation for building 40,000 Maintenance of library 16,000 Entrance fee 5,000 Salary to librarian 10,000 Interest on bank deposit 6,000 Purchase of furniture 24,000 Sale of newspaper 4,000 Sundry expenses 10,000 Life membership fee 10,000 Salary to staff 5,000 Capital fund at the beginning 35,000 of the year Cash 20,000 Solution to 2.3 Income and Expenditure Account For the year ending 31st December, 2019 Dr. Cr. Expenditure Rs. Income Rs. To Maintenance of library 16,000 By Interest on bank deposit 6,000 To Salary to librarian 10,000 By Sale of newspaper 4,000 To Sundry expenses 10,000 By Deficit 31,000 To Salary to staff 5,000 (Excess of expenditure over income) 41,000 36,000 Balance Sheet as on 31st December, 2019 Liabilities Rs. Assets Rs. Capital fund 35,000 Books for library 15,000 Less: Deficit 31,000 4,000 Furniture 24,000 Donation for building 40,000 Cash 20,000 Entrance fee 5,000 Life membership fee 10,000 59,000 59,000 Things to be taken care of: All the revenue items are shown in Income and Expenditure A/C and all the capital items are put in the Balance Sheet. The Income and Expenditure shows deficit so it is deducted from capital fund. 2.6 Let Us Sum Up Not for profit organizations, e.g., clubs, schools, colleges, etc. in order to find out their financial position, they prepare: d) Receipts and Payments Account e) Income and Expenditure Account f) Balance Sheet 1.3 SAQs Choose the correct alternative 1. Receipts and Payment Account is a: a) Real A/c b) Personal A/c c) Nominal A/c d) Valuation A/c 2. Income and expenditure account includes: a) Only capital items b) only revenue items c) both revenue and capital items d) None of the above 2.8 Answers of SAQs 1. a 2. b 2.9 Suggested Readings Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors Pvt Ltd, New Delhi, Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition, Vikas Publishing House New Delhi 2.10 Model Questions 1. Write down the differences between Receipts and Payments Account and Income and Expenditure Account. 2. Write down the treatments of following items: a) Legacy b) Life membership fee c) Entrance fee 2. From the following information, prepare Receipts and Payments Account for the year 2019: Rs. Cash at Bank on 1.1.2019 28,000 Billiard table purchased 10,000 Subscription received from members 10,000 Entrance fee received 7,000 Honorarium paid to coach 15,000 General donation 70,000 Newspaper and magazines purchased 6,000 Unit 3: Accounts of Incomplete Records: Single Entry System Structure 3.0 Objectives 3.1 Introduction 3.2 Single Entry System 3.2.1 Salient features of single entry system 3.2.2 Advantages of single entry system 3.2.3 Disadvantage of single entry system 3.2.4 Difference between single entry and double entry system 3.3 Profit Determination under Single Entry System 3.4 Let Us Sum It Up 3.5 Key Words 3.6 SAQs 3.7 Hints/ Answers of SAQs 3.8 Suggested Readings 3.9 Model Question 3.0 Objectives After going through this unit, you will be able to: Interpret accounting for incomplete records. Understand the salient features of single entry system. Distinguish between single entry and double entry system. Ascertain profits/loss from single entry records. 3.1 Introduction In the previous unit, we have understood the accounting of not for profit organization. Prior to that, we learnt how to prepare the final accounts of profit making entity. In this unit, we will learn about the accounting records kept under single entry system or incomplete records. Basically in double entry system, all the transactions are recorded recognizing their two fold aspects i.e., against every debit there is equal and corresponding credit. But in single entry system the two fold affects of all the transactions are not taken into consideration. Under this system, with respect to some transactions both the aspects debit and credit are taken into consideration; while with respect some transactions only one aspect is recorded and with respect to some transactions no records are maintained. Therefore, it is called a system of double entry, single entry and no entry. As such, we cannot say that it is a system; rather it is a style of maintaining accounting data in an incomplete form. Under this system, no records are maintained with respect to certain transactions like bad debt, depreciation etc. With respect to cash transactions only the cash aspect is recorded like cash purchase of assets, cash sales etc. Transactions which are credit in nature like credit sales of goods, credit purchase of goods both the aspects are recorded. Only the personal accounts are maintained in its full form and content but so far the nominal and real accounts are concerned no records are made available under the incomplete system of accounting. 3.2 Single Entry System In this section, you will learn the fundamentals of single entry system. Firstly, let us have a discussion on salient features of single entry system: 3.2.1 Salient features of single entry system The salient features of single entry system are as follows: a) Maintain personal accounts: usually under this system, personal accounts are maintained while real and nominal accounts are avoided. b) Maintain cash book: Under this system, cash book is maintained, which unusually takes into account both personal transactions and business transactions. c) Dependence on original voucher/evidences: In order to collect the necessary information one has to depend on original voucher, e.g., the figure of credit purchase may not be readily available. It is required to calculate on the basis of original invoices received from suppliers along with other details available in regard to transactions with the suppliers like returns, discount etc. d) No uniformity: The system may differ from organizations to organizations depending upon their individual requirement. e) Suitability: This system is suitable or normally practiced by small, proprietary concerns or sometime may be suitable to small partnership concerns. Limited companies cannot adopt this system due to legal requirements relating to maintenance of account. Let us now discuss on the advantages and disadvantages of single entry system: 3.2.2 Advantages of single entry system a) Simple and easy method of recording transaction: Single entry system does not need any special accounting knowledge or expertise to record financial transaction of the business. It can be maintained easily by the business owner no need to appoint any expert person to do accounting work. b) Economical: It is less costly system of recording business transactions compared to double entry system. It is economical because of limited number of transactions and limited numbers of books (only personal account and cash account) are maintained. c) Suitable for small business concerns: Double entry system is very expensive and time consuming because books of accounts are to maintain in a formal way in quite a good number of books of accounts. So, small firms with limited financial transactions prefer single entry system. d) Time saving: Single entry system is less time consuming because of limited number of books and limited type of transactions are recorded. 3.2.3 Disadvantages of single entry system The system suffers from certain demerits. Some of those are as follows: a) Arithmetical accuracy cannot be checked: Under double entry system, Trial Balance is prepared to check arithmetical accuracy of books of accounts. Single entry system itself is an incomplete record so it is not possible to prepare trial balance. b) True profits cannot be ascertained: In the absence of complete information for sales, purchases and other expenses, it is not possible to draw a conclusion on the actual operating result of such concern. c) Financial position of the business cannot be judged: In the absence of sufficient figures of profit and adequate information about assets and liabilities of the business, the Balance Sheet cannot reflect true financial position of the business. d) Difficulty in planning and decision making: Since the system doesn’t provide accurate details on financial position of the business, it is difficult to take any managerial decision and to make plans for future. Let us now discuss on the differences between double entry system and single entry system of book keeping: 3.2.3 Difference between double entry and single entry system The following are the differences between double entry and single entry system: a) Single entry method of maintaining accounts is an incomplete record of the financial transactions whereas double entry system of accounting is a complete record of financial transactions. b) In single entry system, only personal accounts are maintained whereas in double entry system in addition to personal account, real and nominal accounts are also maintained. c) Books maintained by single entry system are not reliable whereas books maintained under double entry system are systematic so reliable. d) Arithmetical accuracy of recording the transactions cannot be checked under single entry system whereas under double entry system, arithmetical accuracy of the accounting records can be checked by preparing trial balance. 3.3 Profit Determination under Single Entry System Now let us discuss how the profit determination under single entry system: The profit or loss in case of single entry system can be computed under two different methods: a) Net worth method or capital comparison method; and b) Conversion method Net worth method/ capital comparison method According to this method, the profit or loss made by business is computed by comparing the net worth of the business on two different dates. Firstly, Statement of Affairs on two different dates is prepared. Thereafter, to determine the profit/loss position a Statement of Profit/Loss is prepared. Statement of affairs is a statement showing assets, liabilities and capital of the entity based on records available maintained on the basis of single entry system. Small traders and their firms do not maintain their books of accounts as per double entry system. As such, the number of financial transactions recorded by these firms is limited. However, at the end of the financial year, these firms also want to know the position of the business. For this purpose, statement of affairs is prepared at the beginning and at the end of the period to determine the overall change in the capital during the financial year. To prepare this statement we have to refer some documents available related with purchase of assets and due consideration may be given for depreciation and any addition made to that asset during the current year. Since they maintain records of credit transactions so it is possible to ascertain anything due and receivable from creditors and debtors respectively this can be put in the statement of affairs. After putting the assets and liabilities the capital figure is calculated as a balancing figure of the statement. As we have learnt the theoretical aspects of single entry system, now let us solve some illustrations to understand the concept better: Illustration 3.1: Mr. Arun keeps his books under single entry system. His position of assets and liabilities on 1st January, 2019 was: Cash at bank Rs. 5,000; Cash in hand Rs. 1,000; Stock Rs. 7,000; Sundry debtors Rs. 8,400; Plant & Machinery Rs. 6,500; Bills Receivable Rs. 2,600; Creditors Rs. 2,500; Bills Payable Rs.4,000. On December 31, 20019, his position was as follows: Cash at bank Rs. 4,300; Cash in hand Rs. 1,700; Stock Rs. 9,000; Sundry debtors Rs. 6,000; Plant & Machinery Rs. 6,500; Bills Receivable Rs. 3,200; Creditors Rs. 1,600; Bills Payable Rs.3,200. During the year, Mr. Arun introduced further capital of Rs. 2,000 and his drawings were Rs. 800 per month. Depreciate plant & machinery @ 5% p.a. and create a provision for doubtful debts @5% p.a. From the above information, prepare a statement showing profit or loss made by Mr. Arun for the year ended on 31st December, 2019. Solution to Illustration 3.1: Statement of Affairs of Arun As on 1.1. 2019 Liabilities Rs. Assets Rs. Capital 24,000 Cash at bank 5,000 (Balancing figure) Cash in hand 1,000 Creditors 2,500 Bills Receivable 2,600 Bills Payable 4,000 Sundry Debtors 8,400 Stock 7,000 Plant & machinery 6,500 30,500 30,500 Statement of Affairs of Arun As on 31.12.2019 Liabilities Rs. Assets Rs. Capital 25,275 Cash at bank 4,300 (Balancing figure) Cash in hand 1,700 Bills Payable 3,200 Bills Receivable 3,200 Creditors 1,600 Debtors 6,000 Less: Provision 300 5,700 Stock 9,000 Plant & Machinery 6,500 6,175 Less: Depreciation 325 30,075 30,075 Statement of Profit of Arun For the year ending 31.12.2019 Particulars Rs. Capital as on 31.12.2019 25,275 Add: Drawings made during 2019 (Rs. 800× 12) 9,600 --------------------- -34,875 2,000 Less: Fresh capital introduced --------------------- Adjusted capital as on 31.12.2019 -32,875 Less: Capital as on 1.1.2019 24,000 ---------------- 8,875 Profit made during 2019 Things to learn from the illustration: We know the accounting equation is [Assets - Liabilities=Capital]. So additional capital introduced is deducted from closing capital. Drawings represent the amount taken by the owner of the business for his personal use in anticipation of profit. The amount of drawing is added with the capital at the end. Since the closing adjusted capital is greater than the opening capital, the entity could earn profit during the year. Conversion method Conversion method means converting the accounts from single to double entry. If it is desired to change the system of accounting from single entry to double entry on a given date, the following procedure should be adopted: Preparation of statement of affairs: The statement of affairs should be prepared on the date on which the shifting from single entry to double entry is to be made. Prepare cash and bank summary: It should be seen that cash and bank balances shown in the statement of affairs must reconcile with the cash and bank balance as shown by the cash book. Moreover, bank balance as shown by the bank column of the cash book and the pass book are to reconcile if there is any discrepancy is noticed. Prepare total debtors and total creditors account: Similarly, the amount of debtors and creditors shown in the statement of affairs should agree with the total of debit and credit balance extracted from the individual accounts of debtors and creditors. For bringing into books the various assets and liabilities appearing in the statement of affairs, an opening journal entry should be made as follows: Various Assets A/c –Dr To Various Liabilities A/c To Capital A/c (balancing figure) (Being balances of assets and liabilities brought forward from statement of affairs) Thereafter, the books can be opened under the double entry. In future, all transactions should be recorded according to the double entry system by maintaining the subsidiary books and then posting the transactions into the ledger accounts in the ledger book. Now let us solve one numerical problem to have better understanding: Illustration 3.2 Ranjit commenced business as a cloth merchant on 1.1.2018 with a capital of Rs. 10,000. On the same date, he purchased furniture by paying cash Rs. 3,000. From the following particulars obtained from his books kept under single entry, you are asked to prepare a Trading and Profit & Loss Account for the year ended on 31st December, 2018 and a Balance Sheet as on the same date. Particulars Rs. Sales (inclusive of cash Rs. 7,000) 17,000 Purchases (inclusive of cash Rs. 4,000) 15,000 Ranjit’s drawings 1,200 Salaries to staff 2,000 Bad debts written off 500 Business expenses 700 Ranjit took cloth worth Rs. 500 from the shop for his personal use and paid Rs. 200 to his daughter, but omitted to record these transactions in his books. On 31 st December, 2018, his sundry debtors were Rs. 5,200 and sundry creditors Rs. 3,600. Stock in hand on 31st December, 2018 was Rs. 6,500. Solution to Illustration 3.2: Trading and Profit & Loss Account of Ranjit For the year ended on 31st December, 2018 Dr. Cr. Particulars Rs. Particulars Rs. To Purchases 15,000 By Sales 17,000 Less: Drawings 500 14,500 By Closing Stock 6,500 Gross Profit c/d 9,000 23,500 23,500 To Salaries 2,000 By Gross Profit b/d 9,000 To Bad debts 500 To Business expenses 700 To Net Profit 5,800 9,000 9,000 Balance Sheet of Ranjit As on 31.12.2018 Liabilities Rs. Assets Rs. Capital 10,000 Cash Balance 2,800 Less: Drawings 1,900 Sundry Debtors 5,200 8,100 Closing Stock 6,500 Add: Net Profit 5,800 13,900 Furniture 3,000 Sundry Creditors 3,600 17,500 17,500 *Drawings= Rs. 1,200+ Rs. 500+ Rs.200= Rs. 1,900 Working Notes: 1) Receipts and Payments Account For the year ending 31.12.2018 Receipts Rs. Payments Rs. To Capital A/C 10,000 By Furniture 3,000 To Cash Sales 7,000 By Cash Purchase 4,000 To Sundry Debtors 4,300 By Drawings (1200+200) 1,400 (Working Note 2) By Salaries 2,000 By Business Expenses 700 By Sundry Creditors 7,400 (Working Note 2) By Balance c/d 2,800 21,300 21,300 2) Sundry Debtors Account Dr. Cr. Particulars Rs. Particulars Rs. To credit Sales 10,000 By Cash (Balancing 4,300 figure) By Bad Debts 500 By Balance c/d 5,200 10,000 10,000 3) Sundry Creditors Account Dr. Cr. Particulars Rs. Particulars Rs. To Cash (Balancing 7,400 By Credit Purchases 11,000 figure) To Balance c/d 3,600 11,000 11,000 Things to learn from this illustration: The money given by Ranjit to his daughter and cloth taken by him from his business is taken as his drawings. The value of cloth taken has been deducted from purchase. Figures of cash, debtors and creditors were not directly given. So with the help of preparing concerned accounts in the working notes, we have found the missing figures and by incorporating the figures in the Profit & Loss A/C we have tried to showcase the profit and loss position of the business. Unlike net worth method, by following conversion method, we have calculated gross profit, net profit and also found the operating expenses of the business. 3.4 Let Us Sum It Up The term “single entry” is vaguely used to define the method of maintaining accounts which does not exactly follow the principles of double entry system. It does not mean (as the name goes) that there is one entry for each transaction i.e., only one account is given debit or credit for each transaction. But it simply means that principles of double entry system are not followed under single system. Under this system, only personal accounts are considered for the purpose of generating accounting records whereas real and nominal accounts are ignored under this system. The profit or loss in case of single entry system can be computed with the help of: c) Net worth method or capital comparison method d) Conversion method 3.5 Key Words Single entry system, Double entry system, Net worth method, Conversion method. 3.6 SAQs 1. Single entry system takes into consideration: a) Only personal account b) Only nominal account c) Only real account d) All the accounts 2. Statement of Affairs is prepared under: a) Conversion method b) Net worth method 3.7 Answers of SAQs 1. (a) 2. (b) 3.8 Suggested Readings Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors Pvt Ltd, New Delhi, Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition, Vikas Publishing House New Delhi 3.9 Model Question: Debasish started business on 1.1.2018 with a capital of Rs. 12,000. On the same date, he purchased machinery by paying cash Rs. 3,000. From the following particulars obtained from his books kept under single entry, you are asked to prepare a Trading and Profit & Loss Account for the year ended on 31 st December, 2018 and a Balance Sheet as on the same date. Particulars Rs. Sales (inclusive of cash Rs. 3,000) 14,000 Purchases (inclusive of cash Rs. 2,000) 13,000 Debasish’s drawings 1,200 Salaries to staff 1,500 Bad debts written off 300 Business expenses 700 Debasish spent Rs.500 for his personal use, but omitted to record these transactions in his books. On 31st December, 2018, his sundry debtors were Rs. 5,000 and sundry creditors Rs. 3,600. Stock in hand on 31 st December, 2018 was Rs. 6,100. BLOCK-2: HIRE PURCHASE SYSTEM AND INSTALLMENT ACCOUNTS Introduction There are two units in this block. Unit 1 focuses on basic concepts of hire purchase and installment purchase. Likewise, Unit 2 deals with accounting entries in the books of hire purchaser and hire vendor. Unit 1: Hire Purchase and Installment Account Structure 1.0 Objectives 1.1 Introduction 1.2 Hire Purchase System 1.3 Installment Purchase System 1.4 Differences between Hire Purchase and Installment Purchase 1.5 Let’s Sum Up 1.6 Key Words 1.7 SAQs 1.8 Hints/ Answers of SAQs 1.9 Suggested Readings 1.10 Model Question 1.0 Objectives After going through this unit, you will be able to: Understand the concept of hire purchase system. Understand the concept of installment purchase system. Distinguish between hire purchase and installment purchase system. 1.1 Introduction This unit focuses on basic understanding of the concepts like hire purchase and installment purchase system. Hire purchase contract is a contract between two parties where one party agrees to buy the asset by not paying the total cost of the asset in full to the seller at a time but he agrees to pay the amount on installment basis over a certain period allowed by seller. The ownership of the asset is retained by the seller till the last installment is paid by the buyer. Unlike the hire purchase system, where ownership of the asset is retained by the seller till the last installment is paid by the buyer; In case of installment purchase, ownership of the asset is transferred to the buyer straightway after the agreement. 1.2. Hire Purchase System A hire purchase is a contract where goods are purchased or sold with the stipulations that: a) The delivery of goods is given by the owner of the goods to the hire purchaser; b) The payment of the price for the goods to be made in installments; c) Ownership of the goods passes to the hire purchaser only on payment of all the installments; d) In the event of hire purchaser’s failure to pay any installment, the hire vendor is entitled to seize the goods and adjust the money paid by the hire purchaser against the hire charges for the use of the goods. In hire purchase contract, there are two parties, i.e., hire vendor means the seller and hire vendee means the buyer. The initial amount paid against the asset by the buyer is termed as initial payment or down payment. Thereafter, installments which are also called as hire charges are paid regularly and preferably along with interest. For example: a television costing Rs. 15,000 is purchased by A from B under hire purchase contract. A agrees to pay Rs.5, 000 as the initial payment called down payment. He agrees to pay the remaining amount in 3 equal monthly installments plus interest of 5% p.a. So, after paying off all the installments only A can become the owner of the television though he can use the television after taking delivery of the same. 1.3. Installment Purchase System This system is also termed as deferred installment system. In this system, there is an outright sale of goods with the buyer having the facility to pay the purchase price in certain number of agreed installments. Thus, the installment price includes both the cash price as well as the interest for delayed payment. The possession and legal ownership of the goods passes to the buyer immediately on its delivery. The following are the essential characteristics of this system: a) The buyer gets immediate possession and ownership of the goods; b) The payment of price has to be made by the buyer in agreed installments; c) In the event of default by the buyer in payment of any installment, the seller can file a suit against the buyer for recovery of unpaid price and damages. 1.4 Differences between the Hire Purchase System and Installment Purchase System The following are the differences between the two systems: From Legal View point: a) Transfer of ownership: In case of hire purchase system, the ownership in goods sold passes to the buyer only on payment of the last installment. But in case of installment purchase system, ownership to the buyer is transferred at the time of sale of goods. b) Recovery of goods: In case of hire purchase system, if the buyer fails to pay the last installment, the seller can repossess the goods from the buyer. But in installment purchase system, the seller cannot repossess the goods. He can only sue for recovery of price and damages. c) Forfeiture of installments paid: In case of hire purchase system, in the event of buyer’s default in payment, the seller can forfeit all the money paid by the buyer so far, while in case of installment purchase, the money paid by buyer will be taken as part payment made towards the selling price and the seller can only sue for the balance amount. From Accounting Viewpoint: a) Computation of loss of seizure of goods by the vendor: In case of hire purchase, in the event of seizure of goods by the vendor, due to buyer’s default the loss on seizure of goods has to be computed. However, in installment purchase, the vendor cannot seize the goods and henceforth the need for computation of loss on seizure does not arise. 1.5 Let’s Sum Up Hire purchase contract is a contract between two parties where one party agrees to buy the asset by not paying the total cost of the asset fully to the seller at a time but he agrees to pay the amount on installment basis for a certain period allowed by seller. The ownership of the asset is retained by the seller till the last installment is paid by the buyer. But in installment purchase, the ownership of the asset is transferred straightway after the sales. 1.6 Key Words Cash Price: It refers to the price at which goods are sold under the contract of sale. Down Payment/ Cash Down: It refers to the initial amount which is required to be paid by the hire purchaser to the hire vendor against the cash price of the asset. Hire Vendor: Hire vendor is a person who delivers the goods to the hire purchaser with the intention to sell the goods under hire purchase agreement. 1.7 SAQs 1. Hire Vendor under hire purchase contract is? a) Buyer of asset b) Seller of asset 2. In hire purchase system, who retains the right of ownership till last installment paid? a) Vendor b) Vendee 3. In installment system, ownership right is transferred to vendee immediately after sales. a) True b) False 1.8 Hints/ Answers of SAQs 1. B 2. A 3. A 1.9 Suggested Readings Harrison Walter T., et al (2009), “Financial Accounting”, 8th Edition, Prentice Hall Ahmed, N (2008) “Financial Accounting”, Atlantic Publishers and Distributors Pvt Ltd, New Delhi, Maheswari S. N., Sharad ( 2013) “An Introduction to Accountancy” 11th Edition, Vikas Publishing House New Delhi Jain, S.P & Narang K.L (2014) “Financial Accounting”, 2 nd Revised Edition, Kalyani Publisher 1.10 Model Questions 1. What is Hire Purchase Contract? Discuss essential characteristics of Hire Purchase System. 2. What is Installment Purchase Contract? Discuss essential characteristics of Installment Purchase Contract. 3. Differentiate between Hire Purchase and Installment Purchase Contract. Unit 2: Accounting Entries in Hire Purchase System Structure 2.0 Objectives 2.1 Introduction 2.2 Accounting Entries in the books of Hire Purchaser 2.3 Accounting Entries in the books of Hire Vendor 2.4 Let’s Sum Up 2.5 Key Words 2.6 SAQs 2.7 Hints/ Answers of SAQs 2.8 Suggested Readings 2.9 Model Question 2.0 Objectives After going through this unit, you will be able to: Deal with accounting entries in the books of hire vendor. Deal with accounting entries in the books of hire vendee. 2.1 Introduction The previous unit focuses on basic understanding of the concepts like hire purchase and installment purchase system. In this unit, we will try to understand how accounting records are maintained for transactions taking place relating to hire purchase system. Now, let us discuss and understand the accounting entries of hire purchase in the books of both vendor and vendee: 2.2 Accounting Entries in the books of Hire Purchaser/ Hire Vendee There are two methods for making accounting entries of the hire purchase transactions in the books of hire purchaser: a) When asset is recorded at full cash price b) When asset is recorded at the cash price actually paid. a) When asset is recorded at full cash price Here the common notion is that as the hire purchaser has agreed to buy asset so he is considered as the owner of the asset. The following journal entries are recorded in the books of hire purchaser: i. On the purchase of the asset Asset A/C -Dr To Hire vendor A/C (With full cash price of the asset) ii. On making cash down payment Hire vendor - Dr To Cash/ Bank A/C (With actual cash down payment) iii. For interest due Interest A/C – Dr To Hire vendor A/C (Interest is calculated on the outstanding amount when installment becomes due) iv. On payment of hire purchase installments Hire vendor A/C – Dr To Cash/ Bank (With amount of installment paid) v. For depreciation of the asset Depreciation A/C –Dr To Asset A/C (At the end of the accounting period) vi. For transferring of depreciation and interest Profit and Loss A/c - Dr To Depreciation A/c To Interest A/c (Being depreciation transferred to P/L a/c) b) When asset is recorded at the cash price actually paid. Here, it is assumed that the hire purchaser has not become an owner of the asset till he pays the final installment. The following journal entries are recorded: I. On cash down payment Asset A/C - Dr To Cash/ Bank A/C (With the amount of cash down payment) II. On hire purchase installment becoming due Asset A/C - Dr Interest A/C -Dr To Hire vendor A/C (Asset account is debited with the amount of cash price included in each installment. The interest on outstanding cash price is debited to the interest account) III. On making payment of installment Hire vendor A/C –Dr To Cash/ Bank A/C (With the amount of installment paid) IV. For depreciation of the asset Depreciation A/C –Dr To Asset A/C (Depreciation is charged on full cash price of the asset) V. For transferring of depreciation and interest Profit and Loss A/c -Dr To Depreciation A/c To Interest A/c (Being depreciation and interest transferred to profit and loss account) 2.3 Accounting Entries in the books of Hire Vendor The following entries are passed in the books of hire vendor: 1) On sale of goods under hire purchase: Hire Purchaser A/C - Dr To Hire Sales A/C (With full cash price) 2) On receiving cash down payment Cash/ Bank A/C -Dr To Hire Purchaser A/C (With the amount of cash down payment) 3) For interest due Hire Purchaser A/C – Dr To Interest A/C (Interest is calculated when installment becomes due) 4) On getting payment of installment Cash/ Bank A/C -Dr To Hire Purchaser A/C (With the amount of installment received) 5) For transferring of interest Profit & Loss A/c – Dr To Interest A/c (Being interest transferred to Profit and Loss A/c) Let us solve a practical problem to understand it better: Illustration 2.1: The following are the particulars relating to hire purchase: Purchaser: Ram & Co. Seller: Shyam & Co. Asset: Machine Date of Purchase: 1.1.2015 Cash Price: Rs. 12,894 Payments: Rs. 2,000 on signing of agreement and balance in three equal installments of Rs. 4,000 due on 31st December each year. Rate of interest is 5 %p.a. Depreciation is 20% p.a. at written down value method. Make journal entries and prepare necessary ledger accounts in the books of hire purchaser. Solution to illustration 2.1 Working notes: 1.1.2015 Cash Price = Rs. 12,894 1.1.2015 Less: Down Payment = Rs. 2,000 Rs. 10,894 31.12. 2015 Add: Interest Rs. 545 Rs. 11,439 31.12.2015 Less: Installment Rs. 4,000 1.1.2016 Balance Rs. 7,439 31.12.2016 Add: Interest Rs. 372 Rs 7,811 31.12.2016 Installment Rs. 4,000 1.1.2017 Balance Rs. 3,811 31.12.2017 Add: Interest Rs. 189 Rs. 4,000 31.12.2017 Installment Rs. 4,000 1.1.2018 Balance Nil Note: [So, we can see that the payment of installment is completed within three years of its purchase] Calculation of depreciation 1.1.2015 Cost = Rs.12894 31.12.2015 Depreciation = Rs. 2578 1.1.2016 Book value Rs. 10,316 31.12.2016 Depreciation Rs. 2,063 1.1.2017 Book value Rs. 8,053 1.1.2017 Depreciation Rs. 1,611 1.1.2018 Book value Rs. 6,442 Journal Entries in the books of Ram & Co. Dr Cr Date Particulars L/F Amount Amount (Rs) (Rs) 1.1.2015 Machinery A/c - Dr 12,894 To Shyam & Co. A/c 12,894 (Being purchase of machinery on hire purchase) Shyam & Co. A/c – Dr 2,000 31.12.2015 2,000 To Cash A/c (Being down payment made) 31.12.2015 Interest A/c – Dr 545 To Shyam & Co. A/c 545 (Being interest credited to vendor) 4,000 Shyam & Co. A/c – Dr 31.12.2015 4,000 To Cash A/c (Being installment paid) 31.12.2015 Depreciation A/c - Dr 2,579 2,579 To Machinery A/c (Being depreciation charged on machinery) Profit and Loss A/c – Dr 3,124 31.12.2015 To Interest A/c 545 To Depreciation A/c 2,579 (Being balance of interest and depreciation transferred to Profit and loss account) Interest A/c – Dr 372 31.12.2016 372 To Shyam & Co. A/c (Being interest credited to vendor) Shyam & Co. A/c – Dr 31.12.2016 4,000 To Cash A/c 4,000 (Being installment paid) Depreciation A/c - Dr 2,063 To Machinery A/c 2,063 (Being depreciation charged on 31.12.2016 machinery) 31.12.2016 Profit and Loss A/c – Dr 2,435 To Interest A/c 372 To Depreciation A/c 2,063 (Being balance of interest and depreciation transferred to Profit and loss account) 31.12.2017 Interest A/c – Dr 189 To Shyam & Co. A/c 189 (Being interest credited to vendor) 31.12.2017 Shyam & Co. A/c – Dr 4,000 To Cash A/c 4,000 (Being installment paid) 31.12.2017 Depreciation A/c - Dr 1,650 To Machinery A/c 1,650 (Being depreciation charged on machinery) 31.12.2017 Profit and Loss A/c – Dr 1,839 To Interest A/c 189 To Depreciation A/c 1,650 (Being balance of interest and depreciation transferred to Profit and loss account) In the books of Ram & Co. Machinery A/c Dr. Cr Date Particulars J/ Amoun Date Particulars J Amount F t (Rs) / (Rs) F 1.1.15 To Shyam & Co 12,894 31.12.15 By Depreciation 2,579 A/c 31.12.15 By Balance c/d 10,315 12,894 12,894 1.1.16 To Balance b/d 10,315 31.12.16 By Depreciation 2,063 A/c By Balance c/d 8,252 10,315 10,315 1.1.17 To Balance b/d 8,252 31.12.17 By Depreciation 1,650 A/c By Balance c/d 6,602 8,252 8,252 1.1.18 To Balance b/d 6,602 In the books of Ram & Co. Depreciation A/c Dr. Cr Date Particulars J/ Amount Date Particulars J Amount F (Rs) / (Rs) F 31.12.15 To Machinery A/c 2,579 31.12.15 By P/L A/c 2,579 2,579 2,579 31.12.16 To Machinery A/c 2,063 31.12.16 By P/L A/c 2,063 2,063 2,063 31.12.17 To Machinery A/c 1,650 31.12.17 By P/L A/c 1,650 1,650 1,650 In the books of Ram & Co. Shyam & Co. A/c Dr. Cr Date Particulars J/ Amount Date Particulars J Amount F (Rs) / (Rs) F 1.1.15 To cash A/c 2,000 1.1.15 By Machinery 12,894 31.12.15 To Cash A/c 4,000 A/c 31.12.15 To Balance c/d 7,439 31.12.15 By Interest A/c 545 13,439 13,439 31.12.16 To Cash A/c 4,000 31.12.16 By Balance b/d 7,439 31.12.16 To Balance c/d 3,811 31.12.16 By Interest A/c 372 7,811 7,811 4,000 31.12.17 By Balance b/d 3,811 31.12.17 To Cash A/c By Interest 189 4,000 4,000 In the books of Ram &

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