Theoratical Part

Accounting Concepts and Principles

HM UMAR U MAR FAROOQ FAROOQ RANA.

Forms of Business Entities Sole Proprietorship

Partnership

Corporation

Example No-1: If a business owes a supplier Rs. 1,000 for goods it has purchased,  but does does not have have the money money to make make the payment, payment, the owner owner of the business is personally per sonally liable to make the payment out of his/her other assets.

Example No-2: If a partnership par tnership owes owes a supplier Rs. 1,000 for goods it has purchased, but does not have the money to make the payment, the partners par tners are personally per sonally liable to make the payment. payment.

Accounting concepts 

Actually there are a number of accounting concepts and principles based on which we prepare our accounts

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These generally accepted accounting principles lay lay down accepted assumptions and guidelines and are commonly referred to as accounting concepts

Answer:

The objective of financial reporting is to provide financial information about the reporting repor ting entity that is useful to existing and potential investors, lenders lenders and other creditors in making decisions about providing resources to the entity.

User Groups and information that would be of interest to them: Investors require information to assess the ability of an entity to earn profits and to pay dividends. Principally, they need to decide whether to buy, hold or sell shares. Employees and their representative groups (e.g. (e.g. trade unions), require information to assess the ability of an entity to provide remuneration, retirement benefits and employment opportunities. Lenders are interested in information that enable them to determine whether their loans and interest entitlements will be paid when due. Suppliers require information which will enable them to assess whether the entity has the ability to pay amounts owed owed when they they fall due. Customers are interested in assessing the continuance of an entity where they have a longterm involve involvement ment with them them and/or and/or are dependent dependent on them them for supplies supplies.. Government and their agencies ag encies require information for f or a variety of purposes. pur poses. These include resource allocation decisions (e.g. (e.g. government government grants), grants) , to assess taxable capacity c apacity and for regional and national planning purposes. Public is interested in variety of ways which include employment potential, Corporate Social Responsibility (CSR) activities and for environment assessment purposes. •

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THE COMPONENTS OF FINANCIAL STATEMENTS A full set of financial statements would include the following: •

A statement of financial position;

•

A statement of comprehensive income;

•

A statement of changes in equity (not in this syllabus);

•

A statement of cash flows (not in this syllabus) and

•

notes to the financial statements (not in this syllabus)

THE ELEMENTS OF FINANCIAL STATEMENTS

Assets Meaning 

a resource controlled by the entity;

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as a result of past events; and

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from which future economic benefits are expected to flow to the entity.

Liabilities Meaning 

a present obligation of an entity

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arising from past events events

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the settlement of which is expected to result in an outflow of resources that embody economic benefits.

Equity/Capital Meaning 

Equity is the residual interest in an entity after the value of all its liabilities has been deducted from the value of all its assets.

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Equity of companies may be sub-classified into share capital, retained profits and other reserves.

Income Meaning  Income

includes both revenue and gains .

Financial

performance is measured by profit or loss. Profit is measured as income less expenses.  Revenue Revenue

is income arising in the course of the ordinary activities of the entity. It includes sales revenue, fee income, royalties’ income, rental income and income from investments (interest and dividends). non -current assets. Realised gains  Gains include gains on the disposal of non-current are often reported in the financial statements net of related expenses  A royalty payment is made to the legal owner of the property, patent, copyrighted work or franchise by those who wish to make use of it for the purposes of generating revenue revenue or other such suc h desirable activities.

Meaning  Expenses

arising in the normal course of activities, such as the cost of sales and other operating costs , including depreciation of non-current

assets. Expenses result in the . outflow of assets (such as cash or o r finished goods inventory) or the depletion of assets (for example, the depreciation of noncurrent assets).  Losses

include for example, the loss on disposal of a non-current non-cur rent asset, and losses arising from damage due to fire or flooding . Losses

are usually reported as net of related income. Losses might also be unrealised. Unrealised losses occur when an asset is revalued downwards, downwards, but is not disposed of. For example, and unrealised loss occurs o ccurs when marketable securities owned by the entity are revalued downwards.

Accounting Concepts

Accounting Concepts  Business

entity  Capital and Revenue Expenditures  Going Concern  Historical Cost  Prudence/conservatism  Materiality over form for m  Substance over  Completeness  Objectivity  Consistency  Accruals/matching  True and fair view

Business Entity 

Meaning The business and its i ts owner(s) are two separate existence entity  Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business  It requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner. Example: Imran Khan sets up a sole trader business as a builder, builder, and he calls the  business ‘IK Builders’. Legally Legally, IK Builders does not have have a separate legal personali per sonality ty.. The debts d ebts of IK I K Builder Bui lderss are debts of Imran Im ran Khan. K han. However However,, for the purpose of financial reporting, the business is accounted for as 

Capital expend expenditure iture Capital expenditure is expenditure made to acquire or improve long term assets that are used by the business: Examples include:  purchase of property, plant and equipment, office equipment; and motor vehicles;  installation costs associated with new equipment; improvements and additions to existing non-current assets  improvements (for example, building extensions, installation of airconditioning etc.)  Fees paid to raise long term finance are also deemed to be capital in nature. 

OTHER EXAMPLES EXAMP LES OF CAPIT C APITAL AL EXPENDITURES EXPENDIT URES 

Purchase of furniture, motor motor vehicles, electric motors, office equipment, loose loose tools and other tangible assets.

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Cost of acquiring intangible assets like goodwill, patents, copy rights, trade marks, patterns and designs etc.

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Addition or extension of assets.

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Money spent on installation and erection erection of plant and machinery machiner y and other fixed assets.

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Wages paid for the construction of building.

Revenue expenditure Revenue Revenue expenditure is expenditure on day-to-day operating expenses. Examples include:  Purchase of goods meant for resale in the normal course of  business;  Purchase of raw materials and components used to manufacture goods for resale in the normal course of business;  Expenditures made to meet the day to day running costs of a  business (for example, rent, energy, energy, wages etc.) non-cur rent assets.  Expenditures made to repair non-current  Expenditures made to distribute goods to customers. administer ing a business (for example, accounting  Costs of administering services, license fees etc.)

Example: A business has two identical vehicles each with engine problems. 

Vehicle A engine is repaired –  repaired – costs costs associated with the repair are revenue expenditure

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Vehicle B engine is replaced –  replaced – this this is capital expenditure. expenditure.

Example:

A business entity borrows $100,000 from a bank for five years and pays interest of $8,000 on the loan for the first year. The loan is a non-current liability (and part of the long-term ‘capital’ of the business – a –  a capital receipt) but the interest is an expense (revenue expenditure).

Following are the examples of revenue expenditure. 

Wages paid to factory workers.

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Oil to lubricate machines.

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Power required to run machine or motor.

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Expenditure incurred in the ordinary conduct and administration of business, i.e. rent, , carriage on saleable goods, salaries, wages manufacturing expenses, commission, legal expenses, insurance, advertisement, advertisement, free samples, postage, printing charges c harges etc.

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Repair and maintenance expenses incurred incur red on fixed assets.

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Cost of saleable goods.

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Depreciation of fixed assets used in the business.

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Interest on borrowed money.

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Freight, transportation, insurance paid on saleable goods.

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Petrol consumed in motor vehicles.

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Service charges to motor vehicles.

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Bad debts.

Capitalisation, Revenue and capital income The IASB defines ‘capitalisation’ ‘capitalisation’ as recognising a cost as an asset or part par t of the cost of as an asset. So when an item of cost is ‘capitalised’ it is treated as an asset rather than an expense.  Revenue income is income arising from the normal operations of a business from its investments. investments.  Examples include:  Revenue from the sale of goods.  Capital receipts are receipts of ‘long term’ ter m’ income, such as money from a bank loan, or new money invested by the  business owners owners (which is called ‘capital’).

Going Concern Meaning  The business will continue in operational existence for the foreseeable future 

This means that financial statements are prepared on the assumption that the entity does not intend i ntend to go into nor will be forced into liquidation.

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The going concern concer n assumption is particularly par ticularly relevant relevant for the valuation of assets.

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Example Possible losses form the closure of business will not be anticipated in the accounts Prepayments, depreciation provisions provisions may be carried carri ed forward  Prepayments, in the expectation of proper matching against the revenues revenues of future periods  Fixed assets are recorded at historical cost 

Historical Cost 

Meaning 

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Assets should be shown on the balance sheet at the cost of purchase instead of current value

Example 

The cost of fixed assets is recorded at the date of acquisition cost. The acquisition cost includes all expenditure made to prepare the asset for its intended use. It included the inv i nvoice oice price of the assets, freight charges, insurance or installation costs

Prudence/Conservatism Meaning  In the times of uncertainty assets and incomes should not be overstated ov erstated and liabilities and losses should not be understated.  –

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Revenues Revenues and profits are not anticipated. Only Only realized profits with reasonable certainty are recognized in the profit and loss account However, provision is made for all known expenses and losses whether the amount is known for certain or just an estimation This treatment minimizes minimizes the reported profits and the valuation of assets

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Example Stock valuation sticks to rule of the lower of cost and net realizable value  The allowance for doubtful debts should be made over their useful economic  Fixed assets must be depreciated over lives 

Materiality Meaning i f omitting it or misstating it could  Information is material if influence decisions that users make on the basis of financial information about a specific reporting entity. entity.  The relevance of information is affected by its materiality. whic h is too trivial tr ivial to affect a user’s user’s understanding  An error which of financial statement is referred to as immaterial.  –

Materiality depends on the size and nature of the item

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Example Small payments such as postage, stationery and cleaning expenses should not be disclosed separately. They should be grouped together as sundry expenses  The cost of small-valued assets such as pencil sharpeners and paper clips should be written off to the profit and loss account as revenue expenditures, although although they can last for more than one accounting period 

Materiality: A business busi ness owes Mr A Rs. 1,000,000 and is owed owed Rs. 950,000 by Mr B. Instead of showing an asset of Rs. 950,000 and a liability of Rs. 1,000,000, the business shows a single liability of Rs. 50,000. This is a material misstatement. Although the amount is correct it hides the fact that the amount is in fact made of two much larger amounts. A user would be unable to judge the risk associated with Mr B’s ability of pay unless the two amounts are shown separately.

Substance over form Meaning 

financial information must account for transactions and other events in a way that reflects their substance and economic reality (in other words, their true commercial commercial impact) rather than their legal form. for m.

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If there is a difference between economic substance and legal form, for m, the financial information should represent the economic substance.

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Company A is essentially an agent agen t for Company B, and so should only record a sale on behalf of Company B in the amount of the related commission. However, Company A wants its sales to appear larger, so it records the entire amount of a sale s ale as revenue.

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Company Company D creates creates bill and hold paperwork paperwork to legitimize legitimize the sale of goods goods to customers where the goods have not yet left the premises of Company D. D.

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Leased asset

Completeness Meaning 

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The objective of financial reporting is to provide provide useful information. Information Information is only useful if a person can rely on it. To be reliable, reliable, information should be complete, complete, subject to materiality and cost. (There is no need to include information if it is not material, and greater accuracy is not required if the cost of obtaining the extra information is more than the benefits that the information will provide to its users).

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Completeness

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A company rents office space at a cost of Rs. 6,000,000 per year paid 12 months in arrears ar rears (this means that the company pay the rent at the end of the year). The first payment is due on 30 June Year 2. The company prepares its financial financi al statements to 31 December each year. The company will not have have received an invoice for the rent when it is preparing its financial statements for 31 December Year 1 If the company does not accrue for the expense that relates to the 6 months to 31December year 1 the information infor mation would would be incomplete.

Objectivity 

Meaning The accounting information should be free from bias and capable of independent verification  The information should be based upon verifiable evidence such as invoices or contracts 

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Example 

The recognition of revenue should be based on verifiable evidence such as the delivery of goods or the issue issu e of invoices

Consistency Meaning  The content of the financial statements must be presented consistently from one period to the next.  –

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Companies should choose the most suitable accounting methods and treatments, and consistently apply them in every period Changes are permitted only when the new method is considered better and can reflect the true and fair view of the financial position of the company The change and its effect on profits should be disclosed in the financial statements

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Examples If a company adopts straight line method and should not be changed to adopt reducing balance method in other period weight-average method as stock valuation  If a company adopts weight-average and should not be changed to other method e.g. e.g. first-in-firstout method 

Accruals/Matching  Meaning  Record the transaction irrespective of receipt and payment of cash.  –

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Revenues Revenues are recognized when they are earned, but not when cash is received received Expenses are recognized as they are incurred, but not when cash is paid The net income for the period is determined by subtracting expenses incurred from revenues revenues earned ear ned

Accruals basis A company prepares its financial statements to the 30 June each year. It sells s ells goods for f or Rs. 50,000 to t o a customer custome r on 6 June Year 2,  but does not not receive a cash cash payment payment from the customer until until 15 August Year 2.

The sale is recognised as income in the year to 30  June Year 2, even even though the cash is not received received until after the end of this financial year.

Accruals

1. Accrued Accrued Revenues  —  Revenues earned but not yet received in cash or recorded. 2. Accrued Accrued Expenses  —  Expenses incurred but not yet paid in cash or recorded. Prepayments

1. Prepaid Expenses  —  Expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned Revenues  —  Revenues received in cash and recorded as liabilities before they are earned.

Accrual Basis: Prepayment 

A company com pany starts star ts in i n business busi ness on o n 1 September Septemb er Year 1.

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It acquires an office for which it pays one year’s rent in advance, to 31 August August Year 2.The cost of the annual rental is Rs. 120,000. The company company prepares its financial statements for a financial period per iod ending on 31 December each year.

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The office rental cost cos t in the period per iod to 31 December Year 1 is i s the cost c ost of just four months’ rent.

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The expense is therefore Rs. 40,000 (Rs. 120,000 * 4/12) in Year 1, and

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there has been a prepayment for Rs. 80,000 that relates to the next financial period, the year to 31 December Year 2.

A company rents office space at a cost of Rs. 6,000,000 per year paid 12 months in arrears arrear s (this means that the company company pay the rent at the end of the th e year). The first payment payment is due d ue on 30 June Year 2. 2. The company prepares prepares its financial statements to 31 December each eac h year. 

The company will not have have received an invoice for the rent when it is preparing its financial statements for 31 December Year 1.

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However, it knows that it has occupied the office space for six months.

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The company would recognise a liability for rental costs for six si x months (Rs. 3,000,000) and also include this as an expense in profit and loss for Year 1.

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This is described as accruing an expense or making an accrual.

Disclosure 

Meaning Financial statements should be prepared to reflect a true and fair view of the financial position and performance of the enterprise  All material and relevant information must be disclosed in the financial statements 

True and fair fair view Meaning

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 faithful aithful financial statements should provide provide a  f representation of all affairs of the company.

A perfectly faithful representation would have three characteristics. It would be:  complete complete - the depiction depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.  neutral neutral /objec /objectiv tivee- the depiction is without bias in the selection or presentation of financial information; infor mation; and  free from from error - where there there are are no errors or omissions in in the description of the phenomenon, and the process process used to produce the reported information has been selected and applied with no errors in the process.

Question Quest ion No-1:

(Spring-17) (Spring-1 7)

Following Following principles are used by ABC Enterprises for preparation of its financial statements:

a)

Fixed assets are stated at cost less accumulated depreciation.

 b)

Items of capital nature, nature, costing less than Rs. 1,000 are charged to cost.

c)

Stock-in-trade is valued on the same basis as is being followed for last many years.

d)

Appropriate provision is made for bad and doubtful debts. deb ts.

e)

Sales revenue revenue is recorded on dispatch of goods to customers irrespectiv ir respectivee of the date of receipt of payment.

f)

Cost of sales is recorded in the same period in which the revenue earned from the sale is recorded.

followed by ABC Required: Identify and explain the above accounting concepts/principles being followed Enterprises for preparation of its financial statements.

Question Questio n No-2: Consider the following situations:

(Autumn-16) (Autumn-16 )

a)

Due to heavy losses during the current year, Quality Traders (QT) decided to discontinue its operations with effect from 1 August 2016. However, QT’s financial statements for the year ended 30 June 2016 were prepared using the same basis as last year.

 b)

Results of Shan Enterprises Enterpr ises (SE) fluctuate widely from year to year. year. Therefore, Therefore, SE’s SE’s management has decided to create certain cer tain provisions in the periods of higher profits and adjust those provisions in in the period per iod of lesser profits to maintain profits at a consistent level from year to year. year.

Required: 

Identify and explain the accounting concept/principl concept/p rinciple e relevant to each of the above situations.

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Suggest adjustments, adjustments , if any, any, to correct corr ect the financial statements for the year ended 30 June 2016.

(04) (02)

Question Quest ion No-5:

(Autumn-15) (Autumn-15 )

While preparing the financial statements, you are faced with the following situations: 1.

The future existence of the company is uncertain.

2.

The credit cards bills of the proprietor were were paid and charged c harged to the business.

3.

Property, plant and equipment now costs more than the price at which it was purchased at the inception of business. However, the current prices are not reflected in the financial statements.

4.

During the year, year, the company purchased purc hased stationery worth Rs. 30,000. The amount has  been charged to office supplies consumed, consumed , however however major portion of the stationery was consumed after year-end.

5.

The company had a poor p oor trading year and the owners have decided to adopt weighted average valuation method instead of FIFO.

6.

Leased equipment have been recorded as assets as sets although these are not owned by the organization.

Required: State the accounting concept that has been applied or needs to be considered in each of the above situations. (06)

Question Questi on No-6:

(Autumn-15)

Explain the term ter m ‘business transaction’ and discuss whether you would consider the following events as business transactions: 1.

A businessman purchased a vehicle for his private use by drawing cash from business. However, he also uses it for coming to the office.

2.

ABC & Company has paid the electricity bill of one o ne of its partners. par tners. Howe However ver,, the amount is recoverable from that partner.

3.

Furniture and fixtures lying in the office o ffice were destroyed destroyed by fire. Furniture was owned  by one of the partner and it was not in the use of business.

4.

The proprietor provides a generator to the office. The generator is presently not working working and it would have have to be repaired before it can be used. Previously Previously the generator was lying in the proprietor’s house.

5.

Balance recoverable recoverable from an employee was written off after his death.

Question Questi on No-7:

(09)

(Spring-15) (Spring- 15)

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Briefly describe the concept of ‘Substance over form’. Give two examples.

(04)

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Big Traders, who is a multi-million rupees r upees trading house, purchased a calculator for Rs. 1,500. The calculator is to be used for 3 years. year s. Keeping Keeping in view v iew the relevant accounting

Question No-8:

(Spring-15) (Spring-1 5)

Mr. Karobari is a sole proprietor Mr. propr ietor and is engaged in the business of selling plastic bottles to hospitals and dispensaries. Following Following two transactions were recorded in the month of February 2015: 

Goods worth Rs. 57,000 were returned to a credit supplier. supplier.

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A cheque cheq ue for Rs. 15,000 15,000 was drawn for cash.

Required:

eac h of the above two two transactions. (i) Identify the source document and the subsidiary book used for each (02) (ii) Prepare journal entries to record the above two transactions.

(02)

(iii) Assuming the goods returned retur ned to the supplier in transaction tr ansaction 1 above had been wrongly entered as Rs. 75,000 in the subsidiary book, identify the type of error and its possible effect(s) on the accounting records and financial statements of Mr Mr.. Karobari. (06)

Question No-9 

Explain the following accounting terms: A) Prepayment

Question No-10:

(Spring-15) B) Accrued expense

(03)

(Spring-15) (Spring-1 5)

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What are the two main purposes of a trial balance?

(02)

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Briefly describe the primary reason for issuance of various documents used in a system designed to account for sales. (06)

Question No-11:

(Autumn-14)

Name the accounting concepts/principles on which the following rules are based. 1.

Nothing material is left out that would be vital to investors or other users in assessing the underlying events and conditions of the business.

2.

Whether the item in question affects decision of the users of the financial statements?

3.

A company is separate and distinct from its owners.

4.

Financial information infor mation must not only represent relevant phenomena but it must also be complete, c omplete, neutral and free from error.

5.

Expenses incurred in a particular time period should be compared with the revenue earned during the same time period.

6.

Caution should be exercised while preparing financial statements in order to avoid overstatement of net assets and net income.

7.

The assumption that a business entity will continue in existence for the foreseeable future.

8.

Same accounting policy shall be applied to accounting events from period to period.

Question No-12: 

(08)

(Autumn-14)

What is meant by Chart Char t of Accounts? Explain the purpose of creating a chart char t of accounts.

(04)

 Answer Q No-2: (i) (a) Accounting concept that effects preparation of QT's financial fi nancial statements statements for the year ended 30 June 2016 is 'going concern'.This means that financial statements are prepared on the assumption that the entity will continue to operate for the foreseeable future and does not intend to go into nor will be forced into liquidation. (b) After QT's decision to discontinue its operations, QT is no more a going concern. Therefore, as at 30 June 2016, its assets and liabilities should be valued at their estimated disposal value.

(ii) (a) Accounting concept pertaining to this situation is 'true and fair view' (faithful representation).

According to this concept, financial financial statements should give g ive true and fair view/faithful representation of the financial position, financial performance, perfor mance, and changes in financial position of an entity. (b) Making provisions just to even out the profits is against the true and fair view/faithful representation and should be avoided. Therefore, any provisions made on this basis should be reversed immediately immed iately..

ANS Q 3 User Groups and information inform ation that would would be of interest to them: a)

Investors Investors require information to assess the ability of an entity to earn profits and to pay dividends. Principally, they need to decide whether to buy, hold or sell shares.

b)

Employees and their representative groups (e.g. trade unions), require information to assess the ability of an entity to provide remuneration, retirement benefits and employment employment opportunities. oppor tunities.

c)

Lenders are interested in information infor mation that enable enable them to determine whether their loans and interest entitlements will be paid when due.

d)

Suppliers require information which will enable them to assess whether the entity has the ability to pay amounts owed when they fall due.

e)

Customers are interested in assessing the continuance of an entity where they have have a longterm involvement involvement with them them and/or are dependent dependent on them for supplies.

f)

Government Government and their agencies require infor information mation for a variety of purposes. These include resource allocation decisions (e.g. gov government ernment grants), to assess taxable capacity and for regional and national planning purposes.

g)

Public is interested in variety of ways which include employment potential, Corporate Social Responsibility (CSR) activities and for environment assessment purposes.

 Answer Q No-4: a)

Payment of creditors by bank overdraft

 b)

Purchase of machine against cash

c)

Creditors paid through bank

d)

Cash withdrawal by the proprietor

 Answer No-5: 1.

Going concern

2.

Business entity

3.

Historical cost

4.

Materiality/Matching/ Accrual

5.

Consistency

6.

Substance over over form for m

 Answer No-6: Business Transactions: A business transaction is an interaction between a business and customer, customer, supplier or any other party par ty with whom they do business. It is an economic event that must be recorded in the business’s business’s accounting system. I.

A businessman leases vehicle from a bank: Purchase of a vehicle is not a business transaction. However, the cash withdrawal is a business transaction.

II.

ABC and Company has paid the electricity bill of one of its partners: partner s: Payment Payment on behalf of the partner par tner is recoverable by the business. Hence this is a business transaction.

III.

Furniture and fixtures owned by a partner but lying in the office were destroyed by fire: It It is not a business transaction as the ownership of furniture fur niture do not lies with the  business entity but to one of the partner. partner.

IV.

The proprietor provides a generator to the office. The generator was previously lying lying in the house of the proprietor: It is a business transaction and it is required to be recorded as capital ca pital invested in business in the form for m of generator. generator. An amount recoverable from an employee was written off after his death: death : This is a business transaction as the employee was working for the business and such waiver is a form of benefit b enefit to the employee.

 Answer  Answer No-7: (a) Substance over form: It is an accounting principle that transactions and other events must be accounted for and presented according to their substance and financial / economic reality instead of according to their legal form.

Example 1: Leased assets: In a financial lease, the lessor obtains title to the assets only at the end of the lease. However However,, the substance of the transaction is that the lessor obtains use of the asset from the outset of the lease. Thus, we we treat the asset as if it was purchased purc hased outright at the start. star t. Example 2: Sale and lease-back agreements:

In such agreements there is a legal form for m of sale with one party par ty having the right to buy the goods back and the other party par ty to sell back. bac k. Howe However ver in substance, there there is a loan by one party to another and so it is recorded. Example 3: Accounting for groups: Although the parent and subsidiaries are separate legal entities, the group is effectively a single operating unit and under the substance substa nce over form concept, a single set of accounts is prepared known as consolidated accounts.

(b) The matching concept directs the Big Traders to expense the cost of the calculator over the period of three years i.e. Rs. 500 per year. However, in view of the materiality concept, Big Traders may may expense the entire cost of Rs. 1,500 in the year of purchase as this transaction would not render the financial statement misleading.

(iii) Type of error and its possible effect(s): effec t(s):   

Type of error: It is an error of original or iginal entry entr y OR transposition error. error. Possible effects may include:

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(net) purchases/cost of sales will be understated.

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Returns outwards/purchases returns will be ov overstated. erstated.

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Supplier/trade payable’s/purchases ledger control account in purchases ledger will be understated.

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Gross profit/profit for the year will be overstated. overstated.

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Trade payables/current payables/current liabilities will be understated. under stated.

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Net assets/net current assets/capital will be ov overstated. erstated.

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Balance sheet will not show a true and fair view.

 Answer No-9: (i) Prepayment: A prepayment prepayment is the amount of money paid in advance for benefits that will be received in the next accounting period. (ii) Accrued expense: An accrual or accrued expense is an amount that an entity owes owes in respect of a benefit it has received in a period but for which it has not yet been invoiced or which has not yet been paid.

 Answer No-10: (a) Purposes of a trial balance: Following Following are the two two main purposes pur poses of a trial tr ial balance: (i) It is a starting star ting point for producing a statement of comprehensive income and a statement of financial position at the end of an accounting period. (ii) It is a useful means of checking arithmetical errors in the accounting system. Error must have have occurred if the totals of debit debi t and credit balances are not equal.

 Answer  Answer No-11: Chart Char t of accounts (COA) is a list of accounts created by a business to be used to organise its financial transactions transactions into identified identified categories of assets, liabilities, equity, equity, income and expenses. The main purpose of creating the chart of accounts are as follows: 

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COA forms the framework framework for summarizing summar izing business operations and to segregate seg regate assets, liabilities, income and expenses. Each account acc ount is identified by a unique code and heading. heading. This allows a business to generate instructions and policies p olicies to be followed by the staff responsible responsible for recording information. The list is typically arranged in the order of the customary appearance of accounts in the financial statements. The structure and headings in the list brings consistency in the posting of transactions.