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## Tuesday, January 08, 2013

### IGNOU: PCO - 01 Solved Assignment (2013 - 2014)

Accounting Equation:
The accounting equation is the fundamental equation upon which all double entry accounting is based. Whatever business possesses in the form of assets is financed by proprietor or by outsiders. This equation expresses the equality of assets on one side and the claims of outsiders (liabilities) and owners or proprietors on the other side. Accounting equation signifies that the assets of a business are always equal to the total of liabilities and capital. This relationship is expressed as under:

Assets = Liabilities + Capital
“Accounting Equation remains intact under all circumstances”. This statement can be proved through following examples.

Example.1. Suppose Mr. X starts his business and the following transactions take place:
He started business with cash Rs. 5, 00,000 have been introduced by Mr. X in terms of cash, which is the capital for the business concern. Hence on one hand, the asset (cash) has been created to the extent of Rs. 5, 00,000.
 Assets = Capital + Liabilities Cash = 500000 500000 Nil

Example.2.He purchased furniture for cash worth Rs. 50,000.
This transaction has its effect only on the assets, as one asset has been purchased against the other. In this transaction, furniture is purchased against cash given. Furniture and cash both are assets. Hence furniture is introduced by Rs. 50,000.
 Assets = Capital + Liabilities Cash= 500000-50000=450000 Furniture = 50000 500000 Nil

Example.3. He purchased goods for cash Rs. 10,000
This transaction has its effect only on the assets, as one asset has been purchased against the other. In this transaction, goods are purchased against cash given. Goods (Stock) and cash both are assets. Hence Stock is introduced by Rs. 10,000.
 Assets = Capital + Liabilities Cash= 450000 – 10000= 440000 Furniture = 50000    Stock = 10000 500000 Nil

Example.4. Rent paid Rs. 10,000
This transaction has its effect on cash and capital since rent is expenses and all the expenses directly affects capital.
 Assets = Capital + Liabilities Cash= 440000 – 10000= 430000 Furniture = 50000    Stock = 10000 500000 – 10000 = 490000 Nil

Example.5. Goods purchased on credit Rs. 10000.
This transaction has its effect on stock and creditors. Goods purchased are assets and since cash is not paid, the amount of goods purchased is shown as liability.
 Assets = Capital + Liabilities Cash= 440000 – 10000= 430000 Furniture = 50000    Stock = 10000 + 10000= 20000 500000 – 10000 = 490000 10000

From the above examples, it is clear that Accounting Equation is true under all circumstances.

Q.N.2. Write short notes on the following
(b)Principle of Materiality
The role of this convention cannot be over-emphasised in as much as accounting will be unnecessarily overburdened with more details in case an accountant is not able to make an objective distinction between material and immaterial matters. American Accounting Association (AAA) defines the term materiality as under : “An item should be regarded as material if there is reason to believe that knowledge of its would influence the decision of informed investor”.
Kohler has defined materiality as under : “The characteristic attaching to a statement, fact, or item whereby its disclosure or the method of giving it expression would be likely to influence the judgement of a reasonable person”.
Some of the examples of material financial information to be disclosed are likely fall in the value of stocks, loss of markets due to competition or Government regulation, increase in wage bill under recently concluded agreement, etc. It is now agreed that information known after the date of balance sheet must also be disclosed.
Another example of materiality is the question of allocation of costs. An item of small value may last for three years and technically its cost must be allocated to every one of the three years. Since its value is small, it can be treated as the expense in the year of purchase. Such a decision is in accordance with the principle of materiality. Likewise, unimportant items can be either left out or merged with other items. Sometimes items are shown as footnotes or in parentheses according to their relative importance.
It should be noted that an item material for one concern may be immaterial for another. And similarly, an item material in one year may not be material in the next year. As per A.S. – 1, materiality should govern the selection and application of accounting policies. According to the consideration of materiality financial statement should disclose all items which are material enough to affect evaluations or decisions.

Single column Cash Book
 Date Receipts Amount Discount Date Payments Amount Discount Mar. 1 Mar. 5 Mar. 10 Mar. 15 Mar. 24 Mar. 26 To Capital A/c To Sales A/c To Naresh and Co. A/c To Sales A/c To Rent A/c To Interest A/c 50,000 20,000 9,800 10,000 600 500 200 Mar. 2 Mar. 13 Mar. 18 Mar. 20 Mar. 28 Mar. 31 Mar. 31 By Purchases A/c By Sunil’s By Furniture A/c By Wages A/c By Drawings A/c By Shyam and Co. A/c By Balance C/d 6,000 5,000 12,000 500 1,500 13,750 52,150 250 90,900 200 90,900 250

After posting the accounts in the Ledger, a statement is prepared to show separately the debit and credit balances and to check the arithmetic accuracy of the accounts of a certain periods such a statement is known as the Trial Balance.
The agreement of a trail balance ensures arithmetical accuracy only.  A concern can prepare trail balance at any time, but its preparation as on the closing date of an accounting year is compulsory.
According to M.S. Gosav “Trail balance is a statement containing the balances of all ledger accounts, as at any given date, arranged in the form of debit and credit columns placed side by side and prepared with the object of checking the arithmetical accuracy of ledger postings”.
Trial Balance is not a complete proof of arithmetical accuracy of account. A Trial Balance in which the credit and debit accounts match does not prove that, all transactions have been recorded in the proper accounts. For example, the wages paid for the installation of machinery had been erroneously recorded by debiting the wages account in the place of machinery account, the Trial Balance would still agree.
Similarly, an agreed Trial Balance does not prove that all transactions have been recorded in the books of original entry. For example, a credit sale invoice were to be completely omitted from being recorded in the sales day book, the error would not be disclosed in the Trial Balance.
To conclude, we can say that a trial balance should not be recorded as a conclusive proof of the correctness of the books of account.

Errors which are not disclosed by a Trial Balance/Limitations of a Trial Balance
Errors of Commission: These are the errors which are committed due to the wrong posting of wrong transaction, wrong totaling or balancing of the accounts, wrong casting of the subsidiary books. Such errors are called Errors of Commission.
Errors of Omission: The errors of omission may be committed at the time of recording the transaction in the books of original entry or while posting to the ledger. These can be of two types:
i) Errors of complete omission
ii) Errors of partial commission
When a transaction is completely omitted from recording in the books of original record, it is an error of complete omission. When a transaction is partially omitted from posting in ledger, it is an error of partial omission.
Error of principle: Accounting entries are recorded as per the generally accepted accounting principles. If any of these principles are violated or ignored, errors resulting from such violation are known as errors of principle. An error of principle may occur due to incorrect classification of expenditure or receipt between capital and revenue.
Compensating errors: When two or more errors are committed in such a way that the effect of these errors on the debits and credits of accounts is nil, such errors are called compensating errors. Such errors do not affect the tally of the trial balance.

Bank Reconciliation Statement
The statement which is prepared for verifying and reconciling the bank balances, shown by the cash book and pass book on a certain date and incorporates the reasons of disagreement between them is called a bank reconciliation statement.
Utility of B.R.S
a)      It gives an authentic proof of the accuracy of the cash and pass book balances.
b)      Entries in both the book are automatically checked.
c)       The cash book may be made up- to-date by recording some hitherto unknown entries.
d)      It helps to detect any mistake in the cash book and pass book

REASONS FOR DISAGREEMENT BETWEEN THE BALANCES OF CASH BOOK AND PASS BOOK:
Ã˜  Cheques deposited but not collected before the date of reconciliation: Cash book show a higher balance than the pass book balance.
Ã˜  Cheques issued but not presented for payment before the date of reconciliation: the balance of the cash book is lower than the balance shown in the pass book.
Ã˜  Cheques /cash directly deposited in the bank by the customers: the balance of the cash book is lower than the balance shown in the pass book.
Ã˜  Payments directly made by the bank on behalf of the business: the pass book shows a lower balance than the cash book
Ã˜  Dividends or interest collected or credited by the bank: The pass book will show a higher balance than the cash book.
Ã˜  Interest on overdraft, commission, bank charges etc., debited by the bank in the pass book: the pass book shows a lower balance than the cash book
Ã˜  Cheques received and entered in the cash book but forgotten to sent to bank: the pass book shows a lower balance than the cash book
Ã˜  Cheques sent to collection but dishonored: the pass book shows a lower balance than the cash book.
Ã˜  Mistakes in cash book: Undercast, overcast,  wrong  balancing and carryforwarding.
Ã˜  Mistakes in pass book: Undercast, overcast,  wrong  balancing and carryforwarding.