MEASUREMENT OF BUSINESS INCOME, CAPITAL AND REVENUE, DEPRECIATION ACCOUNTING, FINAL ACCOUNT, DIBRUGARH UNIVERSITY B.COM 1st SEMESTER (CBCS) NOTES UNIT -2 FINANCIAL ACCOUNTING PART A




FINANCIAL ACCOUNTING
(CBCS)

UNIT -2

A
MEASUREMENT OF BUSINESS INCOME


Q1. What is Business income? What are the features of Business income?
Ans: Business Income: Business is an economic activity which main motive is to earn profit. In accounting, the term income refers to business income. According to American Accounting Association (AAA), business income means, “increase in net assets due to excess of revenue over expenses”. Revenues mean inflow of assets or decrease in liabilities. Expenses mean outflow of assets or increase in liabilities. If revenue exceeds expenses, it would represent income or profit. If expenses exceed revenue, it would represent loss.

Thus,  Net Income = Total revenue – Total expenses.

Features of Business Income:
1. Business income is based on the transactions actually entered into the business enterprise.
2. Business income always pertains to a given accounting period.
3. Business income is based on the recognition and measurement of revenues.
4. Business income requires the measurement of all business expenses in terms of historical cost.
5. Business income is based on the principle of matching realized revenues of the period with corresponding relevant costs.
6. Business income is the excess of the net worth of the business enterprise at the end of accounting period.
7. Business income does not take into account unrealized profits or losses which might result from the holding of fixed assets.


Q2. State the procedure for measurement of business income.
Ans: Following are the procedure for measurement of business income:

a. Selection of Accounting year: Business income pertains to an accounting year which is a period of 12 months. This period may begin from 1st January and end on 31st December (called calendar year) or it may begin from 1st April and end on 31st March.
b. Identification of the revenues of the accounting year so selected: After selection of the accounting year, revenue pertaining to it is identified. Realization concept is followed in the identification of revenues.
c. Identification of costs increased to earn revenue: For the measurement of business income, only expired costs are considered which has been used or consumed to earn revenue. Depreciation is an example of expired cost of an asset.
d. Matching of revenue and costs: For matching of revenue and costs, it is necessary that both belong to the same accounting year. Excess of revenues over costs represents profits and excess of costs over revenues represent loss.

Q3. What are the methods of measuring business income?
Ans: Following are the methods of measuring business income:

a. Net worth method: As per this method, the net worth i.e. capital of a business enterprise at the end of the accounting period is compared with the same at the beginning of the accounting period. If capital at the end of the year is more than the opening capital, there is a profit for the business enterprise or if capital in the beginning is more than the closing capital, there will be a loss.

b. Matching principle: Under this method, income of a business enterprise is determined by matching revenues and expenses pertaining to a given accounting period. This method is based on the income statement. For matching costs with revenues, first revenues are recognized and then costs are incurred for generating those revenues are recognized.

Q4. What are the objectives of Measurement of Business Income?
Ans: Following are the main objectives of measurement of business income:

a. Measure of managerial efficiency: Business income is a test of the efficiency of management and effectiveness of various decisions taken by them. Current year business income when compared with previous year provides a suitable criterion to judge the efficiency of the management.

b. Guide to dividend policy: Dividend policy decides as to which portion of the current income is to be distributed among shareholders and which portion is to be retained in the business. As far as possible only current income should be used to pay dividends.

c. Basis of taxable income: To ascertainment of business income is a base for taxation as income tax is levied on the basis of taxable income.

d. Guide for investments: The shareholders and the prospective investors are interested in the business income in order to decide whether they should hold, buy or sell the securities of the enterprise. Business income is also used to calculate return on capital employed and return on shareholders’ funds.

e. Guide to socio-economic decisions: There are a number of decisions affecting economy and society are taken on the basis of the level of business income. Trade unions can put their claim for increase in their wages and bonus on the basis of current income of the enterprise. Similarly economic policies are framed as per levels of business income.

Q5. State the feature of Accounting Standard-9: Revenue recognition.
Ans: Salient features of Accounting Standard-9: Revenue recognition

a. Measurement of Revenue: Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers/clients for goods supplied and services rendered to them.

b. Applicability: AS-9, explain how and when the revenue is to be recognized. AS-9 deals only with matters relating to revenue which arise in the ordinary course of the business activities.

c. Non-applicability: AS-9 does not deal with the following:
i. Revenue arising from construction contracts;
ii. Revenue arising from hire-purchase, lease agreements;
iii. Revenue arising from government grants and other similar subsidies;
iv. Revenue of insurance companies arising from insurance contracts.

Following are the examples of items not included within the definition of revenue for the purpose of this standard are:
i. Appreciation in the nature of fixed assets;
ii. Unrealized holding gain resulting from the change in value of current assets;
iii. Realized or unrealized gains resulting from changes in foreign exchanges rates.
iv. Realized gains resulting from the discharge of an obligation at less than its carrying amount.
v. Unrealized gains resulting from the re-statement of the carrying amount of an obligation.

d. Timing of revenue recognition: Revenue recognition is mainly concerned with timing of recognition of the revenue in the statement of profit and loss of an enterprise. The agreement between the parties involved in the transaction determines the amount of revenue arising for a transaction. The uncertainties in the determination of the amount shall impact the timings of revenue. The amount of revenue depends on its
(i) Measurability and (ii) Its collection.


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B

CAPITAL AND REVENUE


Q1. What is Capital expenditure and Revenue expenditure?
Ans: Capital Expenditure: It consists of expenditure the benefit of which is not fully consumed in one period but spread over several periods. It includes assets acquired for the purpose of earning and not for resale, improving and extending fixed assets, increasing the earning capacity of the business and raising capital for the business. For example purchasing of new plant, additions to the building etc.

Revenue Expenditure: It consists of expenditure incurred in one period of account, the full benefit of which is consumed in that period. It includes purchasing assets required for resale at a profit or for being made into saleable goods, maintaining fixed assets in good working order, meeting the day-to-day expenses of carrying on business. For example cost of goods, raw materials and stores, depreciation of fixed assets etc.

Q2. What are the distinction between Capital Expenditure and Revenue Expenditure?
Ans: Following are the distinction between Capital Expenditure and Revenue Expenditure:

Q3. What is Deferred Revenue Expenditure?
Ans: Deferred Revenue Expenditure: It is expenditure which would normally be treated as revenue expenditure but it is not written off in one period as its benefit is not completely exhausted in the year in which it is incurred or is of a non-recurring and special nature and is large in amount. It may be spread over a number of years; a proportionate amount being charged to profit and loss account of each year and the balance is carried forward to subsequent years as deferred revenue expenditure and is shown as an asset in the balance sheet.

Q4. What are the distinction between Capital Receipt and Revenue Receipt?
Ans: Following are the distinction between Capital Receipt and Revenue Receipt:

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C

 DEPRECIATION ACCOUNTING

Q1. What is depreciation? What are its features?
Ans. Depreciation is a decline in the book value of depreciable asset during the estimated useful life of the assets. It may be due to wear and tear of assets, efflux ion of time, obsolescence, depletion etc.
                According to CIMA, London, “Depreciation is the permanent decrease in the value of an asset due to use and / or the lapse of the time.”
Following are the features of Depreciation:
a. Depreciation is a non cash expenses.
b. Depreciation may be physical or functional.
c. Depreciation is a process of allocation of cost and not of valuation of fixed assets.
d. Depreciation is charged in respect of fixed assets only.
e. Depreciation is a continuous fall in the utility of a fixed asset till the end of its useful life.

Q2. What are the causes of Depreciation?
Ans. The causes of decline in the book value of fixed assets may be divided into two categories:
i. Physical ii. Functional

The physical causes may be as follows:
a. Wear and Tear: Some assets physically deteriorate due to wear and tear in use.
b. Destruction: The physical destruction of an asset reduces its utility value. The causes of destruction may be due to an accident like fire, flood or similar other havocs.
c. Decay: It refers to lessening in the utility of an asset by the effect of nature e.g. rain, moisture, change in weather and other elements in nature.

The functional causes may be as follows:
a. Obsolescence: When an asset becomes out of date or it goes out of use due to new or improved technology or invention, this is referred to as obsolescence.
b. Inadequacy: It refers to the termination of the use of an asset due to increase in the volume of business activities.
c. Efflux ion of time: These are some assets e.g. lease, patents, licenses, copyrights, etc. which loss their value simply with the efflux ion of time.
d. Depletion: In case of oil wells, mines etc the value is reduced with the extraction of oil and minerals.
e. Exhaustion: Assets like plantations, animals etc. loss their value gradually with the passage of time. They have their own age and exhaust in value after the expiry of certain period of their age.

Q3. What are the need for charging Depreciation?
Ans:
a. Correct calculation of profits: One of the objective of calculating depreciation is to determine the true profits of business.
b. True and fair view in balance sheet: If depreciation is not provided in the books of accounts, the fixed assets will be shown in the balance sheet at a higher value than its real value. As such this overvaluation of fixed assets will not represent a true and fair view of the state of affairs of the business.
c. Distribution of dividend out of profits only: When depreciation is charged to profit and loss account the profit is reduced and the balance of profit left after depreciation is available for distribution as dividend to shareholders.
d. Replacement of assets: Assets used in the business need replacement after the expiry of their useful life. Fresh funds are required to replace old assets.
e. Saving in income tax: When depreciation is debited to profit and loss account the profits are reduced, consequently the tax liability on profit is also reduced.

Q4. What are the methods of charging Depreciation?
Ans: Methods of charging Depreciation
a. Straight line method 
b. Written down value method
c. Sum of the year’s digit method
d. Annuity method
e. Sinking fund method 
f. Insurance policy method
g. Machine hour rate method  
h. Depletion method
i. Revaluation method  
j. Mileage method

Straight line method: under this method a fixed proportion of original cost of the asset in written off annually so that, by the time asset is worn out, its value in the books is reduced to zero or residual value. This method is also known as Fixed Installment Method or Original Cost Method.
Written down value method: Under this method a fixed rate or percentage of depreciation is charged each year on the diminishing value of the asset till the amount is reduced to scrap value.

Q5. What are the differences between Straight line method and Written down value method?
Ans. Following are the differences between Straight line method and Written down value method:


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D

FINAL ACCOUNT


Q1. What are financial statements?
Ans: Financial statements are the end product of accounting records. It is prepared for the purpose of presenting a periodical review on the progress made by the organization. It also provides an overview of business profitability and financial position in both short run and long run. Financial statements also help to identify the strength and weakness of the business.

Q2. What are the objectives of financial statements?
Ans: Following are the objectives of financial statements:
a. To provide reliable financial information about economic resources and obligations of a business firm.
b. To provide other needed information about changes in such economic resources or obligation
c. To provide reliable information about changes in net resources arising out of business activities.
d. To provide financial information that assists in estimating the earning potential of business.
e. To disclose, to the extent possible, other information related to the financial statements that is relevant to the needs of the users of these statements.

Q3. What are the importance’s of financial statements?
Ans: Following are the importance of financial statements:
a. Basis to judge short term solvency: Suppliers of goods and services and other short term creditors are interested in information which enables them  to determine whether amounts owing to them will be paid when due.
b. Basis for making investments: Information contained in the financial statements is used to judge the long term solvency, profitability, dividend payout as well as debt servicing capacity of the concern.
c. Basis for research work: Research scholars make use of financial statements for making analysis and interpretation of data to derive new findings.
d. Importance to the consumers: consumers use financial statements to safeguard their interest in regard to quality of products, price charged and to uphold the consumer movement.
e. Document for fund generation: Financial statements are used as the basis for generating fund from financial institutions.

Q4. Who are the users of financial statements? Explain the information they require from financial statements.
Ans: Users of financial statements may be categorised into two parts:
a. Internal users               b. External users

a. Internal users:
i. Owners: Owners are interested to know the profitability and financial position of the company.
ii. Management: Management is interested in knowing the existing profits, earning per share, chances of survival, possibility of growth and diversification, cost information etc., from the financial statements so that it can chalk out suitable strategy for its entity.
iii. Employees: Employees are interested in job satisfaction, job security, bonus declarations, employee’s welfare scheme etc. of their unit. So they want information on profitability and future prospects of the company.

b. External users
i. Creditors: Creditors are interested in knowing entity’s capability to repay the amount and interest as and when repayment becomes due. So, they are interested in finding out profitability, cash flows etc., of the entity.
ii. Potential investors: The potential investors are keen to know the earning potential of the business and ensure the safety of their investment.
iii. Research scholars: The financial statements being a mirror of the financial position of a firm are of immense value to the research scholar who wants to make a study into financial operations of a particular firm.
iv. Shareholders: Shareholders of the business are interested in the well-being of the business. They are likely to know the earning capacity of the business and its prospects of future growth.
v. Taxation authorities: Income tax authorities are interested in knowing the profits of the business so that tax can be imposed thereon.

Q5. What are the difference between Trial Balance and Balance Sheet?
Ans.  Following are the difference between Trial Balance and Balance Sheet:

Q6.  What is trading account? What are the needs for trading account?
Ans: Trading account is the first part of financial statements which shows the results of buying and selling of goods and services during an accounting period.

Following are the needs for trading account:
a. To ascertain gross profit or gross loss: The main purpose of preparing trading account is to ascertain the gross profit and gross loss of the business arising from buying and selling of goods.
b. To know the direct expenses: All the direct expenses are recorded in the debit of trading account.
c. To make comparison of stock: The comparison of opening and closing stock helps the management to know the increase or decrease in stock.
d. To fix up selling price: The item of trading account facilitates the ascertainment of cost of goods sold, which subsequently helps in fixing up selling price.

Q7. What is profit & loss account? What are the needs for profit & loss account?
Ans: A profit and loss account is an account into which all gains and losses are collected. If the gains exceed the losses, the excess is the net profit; if the losses are greater than the gains the difference is the net loss.
Following are the needs for profit & loss account:

a. Knowledge of net profit or net loss: The profit and loss account is prepared to ascertain the amount of net profit or net loss for a particular period of time.
b. Comparison of profits: The net profit for the current year as disclosed by profit and loss account is compared with the net profit of the last year.
c. Control over expenses: The profit and loss account helps in comparing the indirect expenses of the current year with the previous year expenses.
d. Future planning: On the basis of information disclosed by the profit and loss account, the future course of action may be decided by the management.

Q8. What are the difference between Trading account and Profit & Loss account?
Ans. Following are the difference between Trading account and Profit & Loss account:


Q9. What is Marshalling of Balance Sheet?
Ans: Marshalling denotes the sequence of assets and liabilities to be shown in the balance sheet. There are no statutory guidelines for the sequence or order of assets and liabilities for the preparation of balance sheet of sole proprietor and partnership firm. In case of balance sheet of joint stock companies there is a specific proforma prescribed by the companies Act.

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