Category: Accounting

INVENTORY SYSTEMS

Records pertaining to quantity and value of inventory-in-hand can be maintained according

to any of the following two systems:

(I) Periodic Inventory system.

(ii) Perpetual Inventory system.

Periodic Inventory System

In case of this system the quantity and value of inventory is found out only at the end of the accounting period after having a physical verification of the units in hand. The system does not provide the infomiation regarding the quantity and value of materials in hand on a continuous basis. The cost of materials used is obtained by adding the total value of inventory purchased during the period to the value of inventory in hand iii the beginning of the period and subtracting the value of inventory at the end of the period. For example, if the inventory in the beginning was 1,000 units of Rs 10,000, purchases during the period were of 5,(XX) units of Ps 50,000 and the closing inventory 1,500 units of Rs 15,000, the cost of materials used will be taken as Its 45,000 (i.e., Rs 10,000 + Rs 50,000— P.s 15,000). It is, thus, assumed that materials not in stock have been used. No accounting is done for shrinkage, losses, theft and wastage.

Perpetual Inventory System

It is also known an Automatic Inventory System.

According to the Chartered Institute of Management Accountants London, it is “a system of records maintained by the controlling department, which reflects the physical movement of stocks and their current balance.” The definition given by Wheldon is more exhaustive and explanatory. According to him, it is “a method of recording inventory balances after every receipt and issue, to facilitate regular checking and to obviate closing down for stocktaking”.’ In case of this system the stores ledger gives balance of raw materials, work-in-progress ledger gives the balance of work-in-progress and finished goods ledger gives the balance of finished goods in hand on a continuing basis. The basic objective of this system is to make available detailsabout the quantity and value of stock of each item at all times. The system, thus, provides a rigid control over stock of materials as physical stock can regularly be verified with the stock records kept in the stores and the cost office.

Cost of goods sold. Income determination requires in case of both manufacturing and trading concerns, the cost of goods sold. In case of trading concerns, the job is comparatively easy since the cost of goods sold can be easily found out be taking into account the cost at which the goods have been purchased. However, in case of manufacturing concerns, the cost of goods sold is to be found out taking into consideration the cost involved in their manufacture. Manufacturing costs can be both direct as well as indirect. Direct costs are those costs which can be directly, conveniently and wholly identified with specific products, jobs or manufacturing processes, e.g., cost of raw materials used for manufacturing the products, cost of factory labour etc. Indirect manufacturing costs are those costs which cannot be directly be identified with specific jobs products or processes, e.g., salary paid to the factory manager, rent, rates, lighting, depreciation of factory machines, etc. These cost are to be apportioned on different products on some reasonable basis e.g., the salary paid to the factory manager may be charged to different products on the basis of direct wages for each product. Similarly, rent paid for the factory may be charged to different products on the basis of departmental area occupied by each of the production departments. Apportionment of the indirect costs so made cannot be fairly accurate and, therefore, the cost of the products so computed cannot also be very accurate. Moreover, some costs such as depreciation of plant and machinery or depreciation of factory buildings cannot themselves be determined accurately. Depreciation depends on the cost of the assets, its scrap value and the estimated life of the assets. It is very difficult to make a fair estimate about the scrap value and life of the asset. The amount of depreciation charged may not, therefore, be very correct. Thus, when estimation of the various elements which constitute cost cannot correctly by made, the measurement of income on the basis of such estimates cannot also be very accurate.

 

MEANING OF INVENTORY

Inventories are unconsumed or unsold goods purchasecior manufactured. According to the International Accounting Standard: 2 (lAS: 2), inventories are tangible froperty.

(a) held for sale in the ordinary course of business,

(b) in the process of production for such sale, or

(c) to be consumed in the production of goods or services for sale.

Thus, the term inventory includes stock of (i) finished goods, (ii) work in-progress and (iii) raw matcrials and components. In case of a trading concern inventory primarily consists of finished goods while in case of a manufacturing concern, inventory consists of raw materials, components, stores, work-in-process and finished goods.

NET WORTH METHOD 

According to this method, the profit or loss made by the business is computed by comparing the net worth (or capital) of the business on two different dates. For example, ifthe capital of the business on 1.1.1990 was P.s 80,000 and it is Rs 90,000 on 31st December, 1999, it can be said that the business has made profit of P.s 10,000 during the period.

Adjustments. Following adjustments are required for determination ofthe profit in case of this method.

(i) Adj ustment for drawings. The proprietor may withdraw money from the business for his personal use. In the absence of any such withdrawal, the capital at the end of accounting period would have been more by the amount ofmoney withdrawn by him. Thus, the amount of drawings should be added back to the capital at the end of the accounting period to find out his true capital on that date.

(ii) Adjustment for capital introduced. The proprietor may introduce further capital in the business during the course of the accounting year. This will increase the capital of the proprietor at the end of the accounting year. It is, therefore, necessary to reduce the amount of capital by the amount of capital introduced by the proprietor during the year in order to ascertain the real increase in the capital of the proprietor on account of profit earned by him during the course of the accounting year.

MANUFACTURING ACCOUNT 

In the preceding pages, we have explained the preparation of the Trading and Profit and Loss Account from the point of view of a trader, i.e., a person who purchases and sells goods. However, a person may manufacture goods by himself for selling them at a profit. In case of such a person, i.e., a manufacturer, it will be necessary to ascertain the cost of manufacturing the goods. In his case, therefore, the profit or loss made by him will be ascertained by preparing the following three accounts:

(i) Manufacturing account This account gives the cost of the goods manufactured by a manufacturer during a particular period.

(ii) Trading account This account gives information about the gross profit or loss made by a manufacturer in selling the manufactured goods. In case a manufacturer also functions as a trader, i.e., besides manufacturing and selling goods of his own, he also purchases arid sells goods of others, he will be a manufacturer-curn-tracler. In such a case, his Trading Account will disclose not only the profit made by him on selling his manufactured goods, but also the profit made by him in selling the goods purchased by him from others.

(iii) Profit and loss account This account gives the overall profit or loss made or suffered by the manufacturer of manufacturer—cum—trader during a particular period.

Capital transactions  

Capital expenditure is expenditure on non-current assets, and capital receipts would result from the disposal of those assets. Other transactions that are regarded as capital transactions are the obtaining of and repayment of non-current finance. Capital transactions initially affect the figures in the balance sheet. Capital transactions are those that affect the organisation in the long term, as well as in the current period

Capital expenditure is the expenditure incurred for acquisition of assets the benefits of which are enjoyed over the years. The benefits of revenue expenditures are exhausted in the year of incurrence. Thus it is seen that utilisation of business capital is made for two distinct purposes:

1) Expenses yielding benefits over the years termed – capital expenditure.

2) Expenditures yielding benefits during the current accounting year – termed as revenue expenditure

Suppose a company incurred an expenditure of Rs. 100000 for advertisement before marketing of a new product

Revenue transactions 

Revenue transactions are those that affect the organisation in the current period. Revenue receipts come from sales, and sometimes in the form of income from investments. Revenue expenditure is expenditure on items that are consumed in the period, for example the running expenses of the organisation, cost of sales, etc. Revenue transactions affect the figures in the income statement.

Examples for Capital Expenditure and Revenue Expenditure

Example 1: 

An agricultural land was purchased for a mill was Rs. 1,00,000. Rs. 1 0 000 was paid for land revenue.

Solution : 

Cost of land amounting to Rs. 1 00 000 will be treated as Capital Expenditure and Land revenue of Rs. 10 000 will be treated as Revenue Expenditure.

Example 2: 

Rs. 50,000 was spent on advertising for the introduction of a new product in the market,the benefit of the market which will be divided for four years.

Solution :

Rs. 50,000 spent on advertising is to be treated as deferred revenue expenditure considering the benefit attributable for four years to come Rs. 12,500 is to be written off every year.

Example 3:

Rs. 10,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged to the plaintiff. The suit was not successful.

Solution : 

Rs. 10,000 incurred for defending the title to the firm’s assets is a revenue expenditure. If, however any expenditure incurred for rectifying the title is a capital expenditure.

ACCOUNTING RECORDS  

There are three vays in which Joint Venture Accounts can be kept. The)’ are as follows:

I. When Separate Set ofBooks for the venture are maintained. This will be necessary when venture is of a large magnitude.

2. When One Venturer keeps the accounts, In this case entire work is entrusted to one of the venturers and the rest simply contribute their share of investment and place it at the disposal of the working venturer.

3. When All Venturers keep accounts, Where venture is not of such magnitude as to warrant a distinct set of books being kept, each venturer will record only such transactions as directly concern him.

In the following pages each of these methods, has been discussed in detail.

WHEN SEPARATE SET OF BOOKS ARE MAINTAINED 

Where a complete set of books are maintained for the Joint Venture, following accounts are opened: (i) Joint Bank Account (II) Joint Venture Account (iii) Personal accounts of each Venturer.

In this method parties first pay their contribution tojoint funds in the Joint Bank Account and their payments on joint account are made out of Joint Bank Account.

Joint Venture Account is of the nature of an ordinary Trading and Profit & Loss Account.

It is debited with goods purchased, and expenses incurred) while credited with the sales made. It’s balance shows the profit or loss incurred on the joint venture.

Personal account of each venturer is also opened. It is credited with the amount of contribution made by him tothejoint funds and his share ofprofit(and debited in case of loss).

Business Entity Concept: According to this concept, business is treated as an entity separate from its owners, creditors, managers and others. All transactions of the business are recorded in the books of the business from the point of view of the business. Transactions are also recorded between the owner and the firm, for instance, when capital is provided by the owner, the accounting record will show the firm as having received so much money and as owing to the proprietor, means the enterprise is liable to the owner for capital investment made by the owner. Since the owner invested capital, which is also called risk capital he has claim on the profit of the enterprise.

The failure to recognize the business as a separate accounting entity would make it extremely difficult to evaluate the performance of the business since the private transactions would get mixed. The overall effect of adopting this concept is:

— Only the business transactions are recorded and reported and not the personal transactions of the owners.

— Income or profit is the property of the business unless distributed among the owners.

— The personal assets of the owners or shareholders are not considered while recording and reporting the assets of the business entity.

Preparing the balance sheet

The Balance Sheet is a statement which sets out the Assets and Liabilities as on a certain date. It is prepared with a view to measure the true financial position at a particular point of time. The Balance Sheet has the following form.

The balance sheet shows the assets, liabilities and capital that exist at the date at which it is drawn up. It will includeallthe ledger accounts that have balances on them.

It should be noted that the balance sheet is not an ‘account’. Its name is not the balance sheet ‘account’ and it is not part of the double-entry bookkeeping system. The balance sheet, as its name implies, is a list of all the balances in the ledger accounts.

A Balance Sheet has the following characteristics:

a) It is prepared at a particular date and not for a period.
b) it is prepared only after preparation of the Trading and Profit & Loss A/c. Without
the Profit & Loss A/c it will not give the financial position of the firm adequately.
c ) Capital is equal to the difference of assets and liabilities. Therefore the two sides of the balance sheet must have the same totals otherwise it is an indication of the presence of errors.
d) It is not an account but only a statement of assets and liabilities..
e) The balance sheet shows the financial position of a business at going concern concept.

ACCOUNTING EQUATION

All business transactions are recorded as having a dual aspect. The proprietor of the business brings capital into the business out of which the business (a separate entity) purchases assets for its use. Thus, the amount of the assets of a business is equal to the amount of capital contributed by the proprietor of the business.

Thus, Capital = Assets.

In case the capital contributed by the proprietor is insufficient, the business takes borrowing from other parties or outsiders. These parties may give loan or allow credit facilities at the time of purchase of goods. The money which is owed to outsiders and which has to be paid, sooner or latter are called liabilities. For example: Loans, Bank Overdraft, Creditors, Bills Payable, and Outstanding Expenses etc. On the one hand, the loan given by the outside parties increases the assets of the business, on the other hand, claims of creditors and lender of money on the assets of the business increase.

Hence, the sum of resources (assets) = obligations (capital + liabilities)

Therefore, Capital + Liabilities = Assets; or

Capital = Assets — Liabilities.

This equation is known as accounting equation. This equation is based on the concept that for every debit, there is an equivalent credit. The entire system of double entry book-keeping is based on this concept.

This statement is always true no matter what transactions the business undertakes. Any transaction that increases or decreases the assets of the business must increase or decrease its liabilities by an identical amount.

Book Keeping is mainly concerned with recording of financial data relating to the business operations in a significant and orderly manner. It is concerned with the permanent record of all transactions in a systematic manner to show its financial effect on the business. It covers procedural aspects of accounting work and includes record keeping function. It is the science and art of correctly recording of account all those business transactions that result in the transfer of money or money’s worth.

Book Keeping and accounting are often used interchangeably but they are different from each other. Accounting is a broader and more analytical subject. It includes the design of accounting systems which the book keepers use, preparation of financial statements, audits, cost studies, income tax work and analysis and interpretation of accounting information for internal and external end users as an aid to making business decisions. This work requires more skill, experience, and imagination.