limitations of financial accounting

8/6/2019 Limitations of Financial Accounting

1/47

Internal Users External Users

Financial statement analysis helps usersmake better decisions.

ManagersOfficers

Internal Auditors

ShareholdersLenders

Customers

Purpose of AnalysisPurpose of Analysis


2/47

L imitationsL imitations of of FinancialFinancialAccountingAccountingFinancialFinancial AccountingAccounting permitspermits alternativealternativetreatmentstreatments. .FinancialFinancial AccountingAccounting ignoresignores importantimportantnonnon--monetarymonetary informationinformation. .

FinancialFinancial AccountingAccounting doesdoes notnot provideprovidetimelytimely informationinformation. .FinancialFinancial accountingaccounting doesdoes notnot disclosedisclose thethe

presentpresent valuevalue of of thethe businessbusiness. .


3/47

ACCOUNTING CONCEPTSACCOUNTING CONCEPTS

AccountingAccounting PrinciplesPrinciples maymay bebe defineddefined asasthosethose rulesrules of of actionaction oror conductconduct whichwhich areareadoptedadopted byby thethe accountantsaccountants universallyuniversally whilewhilerecordingrecording accountingaccounting transactionstransactions. .

AA BodyBody of of DoctrineDoctrine. .


4/47

ACCOUNTING CONCEPTSACCOUNTING CONCEPTSSEPARATE ENTITY CONCEPTSEPARATE ENTITY CONCEPT

TheThe EntityEntity isis distinctdistinct andand separateseparatefromfrom thethe OwnersOwners. .

TheThe amountamount of of CapitalCapital investedinvested bybythethe ownerowner isis treatedtreated asas L iabilityL iability of of thetheentityentity. .


5/47

GOINGGOING CONCERNCONCERN CONCEPTCONCEPT

BusinessBusiness entitiesentities havehave lifelife of of infiniteinfinite durationduration. .Management,Management, eventsevents andand opportunitiesopportunities maymaycomecome andand go,go, butbut thethe businessbusiness remainsremains. .

Implications Implications: : depreciationdepreciation used,used, plantplant assetsassetsrecordedrecorded atat costcost insteadinstead of of liquidationliquidation value,value,itemsitems areare labeledlabeled asas fixedfixed oror longlong--termterm. .


6/47

MONEYMONEY MEASUREMENTMEASUREMENT

CONCEPTCONCEPTAccountingAccounting recordsrecords onlyonly monetarymonetarytransactionstransactions. .

ImplicationsImplications: :CertainCertain QualitativeQualitative factors,factors, whichwhich areare vitalvitaltoto thethe healthhealth of of aa BusinessBusiness entityentity suchsuch asas BRAND BRAND IM AGE, IM AGE, BUS I NESS BUS I NESS CONTACTS,CONTACTS,QUAL I TY QUAL I TY OF OF M ANPOWER M ANPOWER ,, areare allallexamplesexamples of of suchsuch factorsfactors whichwhich dodo notnot havehaveanyany measurementmeasurement in in termsterms of of moneymoney. .


7/47

COST CONCEPTCOST CONCEPT

AnAn assetasset isis ordinarilyordinarily recordedrecorded inin thetheaccountingaccounting recordsrecords atat thethe priceprice paidpaid totoacquireacquire it it..AssetAsset isis recordedrecorded atat costcost atat thethe timetime of of itsitspurchasepurchase butbut isis maymay systematicallysystematically bebereducedreduced inin itsits valuevalue byby chargingchargingDepreciationDepreciation. .


8/47

DUA L ASPECT COCEPTDUA L ASPECT COCEPT

EveryEvery businessbusiness transactiontransaction hashas aa dualdual effecteffect. .ForFor everyevery debit,debit, therethere isis anan equivalentequivalent CreditCredit. .

EveryEvery transactiontransaction shouldshould havehave twotwo--sidedsided effecteffecttoto thethe extentextent of of samesame amountamount. .ThisThis conceptconcept hashas resultedresulted inin accounting accounting equation ,equation , whichwhich statesstates thatthat atat anyany pointpoint of of timetimethethe assetsassets of of anan entityentity mustmust bebe equalequal toto thethe totaltotalof of ownersowners equityequity andand outsidersoutsiders liabilityliability. .ASSETS=ASSETS= L IABI L ITIESL IABI L ITIES ++ CAPITA LCAPITA L


9/47

ACCOUNTINGACCOUNTING PERIODPERIOD

CONCEPTCONCEPT

A YEAR.A YEAR.

AT THE END OF EACH YEAR, ANAT THE END OF EACH YEAR, ANINCOME STATEMENT ANDINCOME STATEMENT ANDBA L ANCE SHEET IS PREPARED.BA L ANCE SHEET IS PREPARED.


10/47

PeriodicPeriodic MatchingMatching of of CostsCosts andand

RevenuesRevenues ConceptConcept

TheThe incomeincome earnedearned byby aa businessbusiness

duringduring a a yearyear cancan bebe measuredmeasured onlyonlywhenwhen thethe revenuerevenue earnedearned duringduring thetheperiodperiod isis comparedcompared withwith thethe

expenditureexpenditure incurredincurred. .


11/47

REA L ISATION CONCEPTREA L ISATION CONCEPTProfitProfit shouldshould bebe consideredconsidered onlyonly whenwhen realizedrealized. .AtAt whatwhat stagestage thethe profitprofit shouldshould bebe deemeddeemed totohavehave accrued?accrued?AtAt thethe timetime of of receivingreceiving thethe orderorder. . OR OR AtAt thethe timetime of of executionexecution of of thethe orderorder. . OR OR AtAt thethe timetime of of receivingreceiving thethe cashcash..

Revenue Revenue isis recognized recognized onlyonly whenwhen aa salesale isis mademade. .


12/47

ACCOUNTINGACCOUNTING CONVENTIONSCONVENTIONS

CONSERVATISMCONSERVATISMInIn thethe faceface of of uncertainty,uncertainty, accountantsaccountants

look look toto thethe conventionconvention of of conservatismconservatism. .AnticipateAnticipate nono profits,profits, butbut provideprovide forfor allallpossiblepossible losseslosses. .

InventoryInventory valuedvalued atat costcost oror marketmarket pricepricewhicheverwhichever isis lessless..Choosing the option that is least likely to

overstate assets and income


13/47

FU LL DISC L OSUREFU LL DISC L OSURE

RequiresRequires thatthat statementsstatements presentpresentallall informationinformation thatthat isis usefuluseful forfor

usersusers understandingunderstanding. .


14/47

CONSISTENCYCONSISTENCY

AccountingAccounting practicespractices shouldshouldremainremain unchangedunchanged fromfrom oneone periodperiodtoto anotheranother unlessunless usersusers areare

informedinformed of of changechange. .


15/47

MATERIA L ITYMATERIA L ITY

TheThe accountantaccountant shouldshould attachattach importanceimportance to tomaterialmaterial detailsdetails andand ignoreignore insignificantinsignificantdetailsdetails. .IsIs thethe informationinformation relevantrelevant toto users?users?WouldWould usersusers dodo somethingsomething differentdifferent if if theytheyhadhad notnot knownknown aboutabout anan item?item?IsIs thethe naturenature of of thethe itemitem importantimportant forfor thetheusers?users?DoesDoes thethe numbernumber changechange byby 1010%% oror more?more?


16/47

TYPES OF ACCOUNTSTYPES OF ACCOUNTS

PERSONA LPERSONA L ACCOUNTSACCOUNTSNaturalNatural PersonsPersons PersonalPersonal AccountAccount: :

IndividualIndividual humanhuman beingsbeings ee..gg.. RameshsRameshs A/cA/c..ArtificialArtificial PersonsPersons PersonalPersonal AccountAccount: :RecordingRecording transactionstransactions relatingrelating toto limitedlimitedcompanies,companies, Bank,Bank, Firm,Firm, clubclub etcetc..RepresentativeRepresentative PersonalPersonal AccountsAccounts: : ForForexample,example, wageswages outstandingoutstanding Account,Account, PrePre--paidpaid InsuranceInsurance AccountAccount. .


17/47

TYPES OF ACCOUNTS Contd.TYPES OF ACCOUNTS Contd.REA LREA L ACCOUNTSACCOUNTSTangibleTangible ThingsThings: : Goods,Goods, BuildingBuilding etcetc..IntangibleIntangible ThingsThings: : Patents,Patents, GoodwillGoodwill etcetc..

NOMINA LNOMINA L ACCOUNTSACCOUNTSL

osses,L

osses, gains,gains, expenses,expenses, incomesincomes ee..gg.. rent,rent,interest,interest, wageswages etcetc..


18/47

RU L ES OF DEBIT & CREDITRU L ES OF DEBIT & CREDIT

PERSONA L ACCOUNTSPERSONA L ACCOUNTS

DEBITDEBIT THETHE RECEIVER RECEIVER

CREDITCREDIT THETHE GIVER GIVER


19/47

REA L ACCOUNTSREA L ACCOUNTS

Debit what comes inDebit what comes in

Credit what goes outCredit what goes out


20/47

NOMINA L ACCOUNTSNOMINA L ACCOUNTS

Debit all expenses and lossesDebit all expenses and losses

Credit all gains and incomesCredit all gains and incomes


21/47

Nominal AccountNominal Account Personal AccountPersonal AccountRent AccountRent Account Rent Prepaid A/cRent Prepaid A/c

Outstanding rent A/cOutstanding rent A/c

Interest AccountInterest Account Outstanding intt A/cOutstanding intt A/c

Intt received in advanceIntt received in advanceA/cA/c


22/47

J OURNA L ENTRIESJ OURNA L ENTRIES

RENT PAIDRENT PAIDRent A/cRent A/c = A Nominal A/c= A Nominal A/c

Cash A/cCash A/c = A Real A/c= A Real A/c

Rent A/c.DrRent A/c.Dr

To cash A/cTo cash A/c


23/47

RamRam startsstarts a a businessbusiness withwith capitalcapital of of RsRs..

2020,,000000 ononJ

anuaryJ

anuary 1 1,, 20082008..

HeHe purchasedpurchased FurnitureFurniture forfor cashcash forfor RsRs.. 55,,000000onon J anuaryJ anuary 5 5,, 20082008

HeHe paidpaid rentrent forfor businessbusiness premisespremises RsRs.. 22,,000000onon J anJ an 1010,, 20082008..

HeHe purchasedpurchased goodsgoods onon creditcredit of of RsRs.. 22,,000000fromfrom SureshSuresh onon J anJ an 2020,, 20082008..


24/47

GOODS ACCOUNTGOODS ACCOUNT

GOODS A/C

Purchases A/c Sales A/c Purchases Returns A/c


25/47

J ournaliseJ ournalise thethe followingfollowing transactionstransactions in in thethe book book of of MrMr. . AA..19951995 RsRs..J anJ an11 CommencedCommenced businessbusiness withwith cashcash 3030,,000000J anJ an22 DepositedDeposited inin thethe bank bank 88,,000000J anJ an33PuchasedPuchased goodsgoods fromfrom BB 1010,,000000

44CashCash SalesSales 99,,00000055PurchasedPurchased FurnitureFurniture FromFrom CC 2500250066CashCash PurchasesPurchases 1010,,000000

77SoldSold goodsgoods toto DD 1212,,00000088DD returnsreturns goodsgoods


26/47

J an 13J an 13 D declared insolvent final dividendD declared insolvent final dividendof of 40 Paisa in the rupee received.40 Paisa in the rupee received.


27/47

COMPOUND J OURNA L ENTRYCOMPOUND J OURNA L ENTRY

SometimesSometimes therethere areare aa numbernumber of of transactionstransactionsonon thethe samesame datedate relatingrelating toto oneone particularparticularaccountaccount oror of of thethe oneone particularparticular naturenature. . SuchSuchtransactionstransactions maymay bebe recordedrecorded byby meansmeans of of aasinglesingle journal journal entryentry insteadinstead of of passingpassing severalseveral

journal journal entriesentries. . SuchSuch singlesingle entryentry isis termedtermed asascompoundcompound journal journal entryentry. .


28/47

CompoundCompound entryentry maymay bebe oneone of of thethefollowingfollowing typestypes: : Debiting Debiting oneone account account and and crediting crediting

twotwo or or moremore accountsaccounts. . Debiting Debiting twotwo or or moremore accountsaccounts and and crediting crediting oneone account account. .

Debiting Debiting and and crediting crediting several several accountsaccounts


29/47

EXAMP L ES FOR A COMPOUNDEXAMP L ES FOR A COMPOUNDENTRYENTRY

PaidPaid RsRs.. 980980 toto XX inin fullfull settlementsettlement of of hishisaccountaccount of of RsRs.. 11,,000000..

XX A/cA/c. .DrDr.. 10001000ToTo CashCash A/cA/c 980980

ToTo DiscountDiscount receivedreceived A/cA/c 2020


30/47

ReceivedReceived cashcash RsRs.. 22,,000000 andand aa chequechequeof of RsRs.. 1212,,000000 fromfrom YY inin fullfull settlementsettlementof of hishis accountaccount of of RsRs.. 1414,,100100..

PurchasedPurchased a a runningrunning businessbusinesscomprisingcomprising of of CashCash RsRs.. 22,,000000,, L andL and RsRs..4040,,000000,, FurnitureFurniture RsRs.. 1010,,000000,, Stock Stock RsRs..

22,,000000,, CreditorsCreditors RsRs.. 88,,000000 andand BillsBillsPayablePayable RsRs.. 55,,000000..


31/47


32/47

OPENING ENTRY CONTD.OPENING ENTRY CONTD.

AllAll AssetsAssets accountsaccounts areare debiteddebited

AllAll liabilitiesliabilities accountsaccounts areare creditedcredited. .

TheThe excessexcess of of assetsassets overover liabilitiesliabilitiesisis thethe ProprietorsProprietors CapitalCapital andand isiscreditedcredited toto hishis capitalcapital accountaccount. .


33/47

Pass the Opening Entry on J an 1, 2008 onPass the Opening Entry on J an 1, 2008 onthe basis of the following information takethe basis of the following information takefrom the business of Mr. A:from the business of Mr. A:

Rs.Rs.Cash in handCash in hand 2,0002,000Sundry DebtorsSundry Debtors 6,0006,000Stock of GoodsStock of Goods 4,0004,000

PlantPlant 5,0005,000L andL and 10,00010,000Sundry CreditorsSundry Creditors 11,00011,000


34/47

DateDate ParticularsParticulars L .F.L .F. Rs.Rs. Rs.Rs.

20082008J an1J an1 Cash A/c.DrCash A/c.Dr 2,0002,000S. Debtors A/c.. DrS. Debtors A/c.. Dr 6,0006,000Stock A/c.DrStock A/c.Dr 4,0004,000Plant A/cDrPlant A/cDr 5,0005,000L and A/cDrL and A/cDr 10,00010,000

To S. CreditorsTo S. Creditors 10,00010,000

To Capital A/cTo Capital A/c 17,00017,000(Being Balances brought forward from the last year)(Being Balances brought forward from the last year)


35/47

DISADVANTAGES OF DOUB L EDISADVANTAGES OF DOUB L EENTRY SYSTEMENTRY SYSTEM

ManyMany importantimportant eventsevents cannotcannot bebe recordedrecordedinin thethe booksbooks of of accountsaccounts simplysimply becausebecausetheythey cannotcannot bebe expressedexpressed inin monetarymonetarytermsterms. .

AA CompensatingCompensating errorerror maymay alsoalso remainremainunderstatedunderstated. .

NotNot suitablesuitable forfor smallsmall businessesbusinesses. .


36/47

L IMITATIONS OF J OURNA LL IMITATIONS OF J OURNA L

SuchSuch aa systemsystem doesdoes notnot facilitatefacilitate thetheinstallationinstallation of of anan internalinternal check check systemsystemsincesince thethe journal journal cancan bebe handledhandled bybyonlyonly oneone personperson. .TheThe J ournalJ ournal becomesbecomes bulkybulky. .

SinceSince thethe numbernumber of of transactionstransactions is islarge,large, suchsuch aa systemsystem doesdoes notnot provideprovidethethe informationinformation in in aa preciseprecise mannermanner. .


37/47

WHAT IS A DISCOUNT?WHAT IS A DISCOUNT?

DiscountsDiscounts areare reductionsreductions to to aabasicbasic priceprice of of goodsgoods ororservicesservices. .


38/47

WHAT IS A TRADEWHAT IS A TRADE

DISCOUNT?DISCOUNT?ManufacturersManufacturers andand DealersDealersoftenoften allowallow toto theirtheir bestbestcustomers,customers, andand thosethose buyingbuyinginin largelarge quantities,quantities, whatwhat isis

knownknown asas tradetrade discountdiscount. .NotNot toto bebe discloseddisclosed inin thethebooksbooks of of accountsaccounts. .


39/47

CASH DISCOUNTCASH DISCOUNT

ALL OWEDALL OWED FOR FOR PROMPTPROMPTPAYMENTPAYMENT. .

DISC L OSEDDISC L OSED ININ THETHEBOOKSBOOKS OFOF ACCOUNTSACCOUNTS. .


40/47

TRADE DISCOUNT Vs CASHTRADE DISCOUNT Vs CASHDISCOUNTDISCOUNT

BASISBASIS TRADETRADEDISCOUNTDISCOUNT

CASHCASHDISCOUNTDISCOUNT

MeaningMeaning A reductionA reduction

granted by agranted by asupplier for thesupplier for thelist price.list price.

A reductionA reduction

granted forgranted forimmediateimmediatepayment.payment.

PurposePurpose Allowed toAllowed topromote thepromote thesales.sales.

Allowed toAllowed toencourage toencourage topromptpromptpayment.payment.


41/47

DisclosureDisclosure Shown by wayShown by wayof deduction inof deduction in

the invoice itself.the invoice itself.

Not shown inNot shown inthe invoice.the invoice.

L edger AccountL edger Account Trade discountTrade discountis not opened inis not opened inthe ledger.the ledger.

Cash discount isCash discount isopened in theopened in theledger.ledger.


42/47

A A waswas toto receivereceive Rs Rs. . 44 , ,000000 f rom f rom B B . . He He acceptsacceptsonlyonly Rs Rs. . 33 , ,960960 inin f ull f ull settlement settlement. . It It meansmeans heheallowsallows Rs Rs. . 4040 asas discount discount toto himhim. .J ournalJ ournal entryentry: :11.. CashCash A/cA/cDr Dr 39603960

ToTo BB 3960396022.. DiscountDiscount A/cA/c.. ..DrDr 4040

ToTo BB 4040

AA singlesingle entryentry maymay bebe passedpassed inin placeplace of of twotwoentriesentries statedstated aboveabove asas followsfollows::CashCash A/cA/cDr Dr 39603960DiscountDiscount A/cA/c. .DrDr 4040


43/47

J anJ an 11 PurchasedPurchased goodsgoods worthworth RsRs.. 55,,000000forfor cashcash lessless 2020%% tradetrade discountdiscountandand 55%% cashcash discountdiscount. .


44/47

J ournaliseJ ournalise thethe followingfollowing transactionstransactions: :

1.1. PurchasedPurchased goodsgoods fromfrom MukeshMukesh && Co,Co, ononcreditcredit RsRs.. 1010,,000000..

1.1. OnOn ObtainingObtaining deliverydelivery of of goods,goods, itit waswasfoundfound thatthat thethe goodsgoods havehave beenbeen damageddamagedtoto thethe extentextent of of RsRs.. 11,,000000..

1.1. MukeshMukesh && CoCo.. admittedadmitted thethe claimclaim forforbreakagebreakage toto thethe extentextent of of RsRs.. 800800..


45/47

J ournaliseJ ournalise thethe followingfollowing transactionstransactions in in thethe booksbooksof of MrMr. . BharatBharat: :

20072007J anJ an 33 ReceivedReceived a a chequecheque fromfrom RameshRamesh &&CoCo.. onon accountaccount of of goodsgoods soldsold forfor RsRs..22,,000000.. AllowedAllowed himhim 11%% discountdiscount. .

Jan

Jan 44 RameshRamesh && CosCos chequecheque depositeddepositedintointo Bank Bank. .

J anJ an 55 RameshRamesh && CosCos chequechequedishonoureddishonoured. .

Jan

Jan 66 RameshRamesh && CoCo.. settledsettled itsits accountaccount bybymeansmeans of of aa chequecheque forfor RsRs.. 22,,025025,, RsRs.. 1515

beingbeing forfor interestinterest chargedcharged. .J anJ an 77 Bank Bank chargescharges ( ( Half Half yearly)yearly) RsRs.. 100100..


46/47

J ournaliseJ ournalise thethe followingfollowing transactionstransactions: :19991999J anJ an 55 BoughtBought aa horsehorse forfor RsRs.. 600600 andand

aa carriagecarriage forfor RsRs.. 11,,200200 forfordeliveringdelivering goodsgoods toto customerscustomers. .

J anJ an 2020 TheThe horsehorse boughtbought J anJ an 55 dieddied

andand itsits carcasscarcass waswas soldsold forfor RsRs..3030..


47/47

GoodwillGoodwill TradersTraders stock stock waswasdestroyeddestroyed byby firefire inin 20012001 worthworth RsRs..3535,,000000.. GiveGive J ournalJ ournal entriesentries requiredrequired: :WhenWhen thethe stock stock waswas insuredinsured: :

(a)(a) FullFull claimclaim isis acceptedaccepted byby thethe insuranceinsurancecompanycompany. .

(b)(b) 8080%% of of thethe claimclaim isis admittedadmitted byby thethe

companycompany. .

22.. WhenWhen thethe goodsgoods areare notnot insuredinsured

limitations of financial accounting

Documents