Showing posts with label Accounting Errors. Show all posts
Showing posts with label Accounting Errors. Show all posts

Preparation of Final Accounts

6:57 PM imran ali

The final accounts include trading account, profit and loss account and balance sheet. They are prepared normally with the help of trial balance. Sometime, ledger balances and additional information may be given. While preparing final accounts, we need to mind the relation of trial balance with final account.
  1. Debit items of trial balance generally appear either on the debit side of trading or profit and loss account or on the assets side of the balance sheet.
  2. Credit items of trial balance generally appear either on the credit side of the trading or profit and loss account or on the liability side of the balance sheet.


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Introduction to Final Accounts

6:45 PM imran ali

After the completion of preparing Trial Balance, Final Accounts are prepared to ascertain the net result i.e. profit or loss and the financial position of the business. In other words, a business can find out the profit or loss made by the business through the final accounts. They are prepared at the close of the accounting period with the help of trial balance. It is the final step of accounting circle which includes:
  1. Trading Account.
  2. Profit and Loss Account.
  3. Balance Sheet.
In case of manufacturing concern, a separate manufacturing account must be prepared before preparing trading account. Final accounts are prepared mainly for following two objectives.
  1. To ascertain the net result i.e. profit or loss made by the business firm during the accounting period.
  2. To know the financial position of the business i.e. assets and liabilities of the business as on given date.
The net result of the business operation is disclosed by the profit and loss account and the financial position of the business is shown by the balance sheet.


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Generally used Terms in Accounting

6:35 PM imran ali

Journal Entry, Ledger, Trial Balance, Trading Account, Manufacturing Account, Profit and Loss Account, Gross Profit or Loss, Net Profit or Loss, Profit and Loss Appropriation Account, Balance Sheet, Current Assets, Fixed Assets, Fictitious Assets, Investment, Current Liabilities, Permanent Liabilities, Marshalling of Assets and Liabilities, Liquidity, Permanency, Final Account, Closing Stock, Outstanding Expenses, Prepaid, Depreciation, Bad Debts, Provision for Bad Debts, Provision for Discount, Drawing, Accrued Income, Interest on Capital, Interest on Drawing etc........


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Revenue Loss

6:43 PM imran ali

Revenue losses are those losses which are occurred during the normal course of business activities. They are shown on the debit side of Profit and Loss Account. The some example of revenue losses are as follows:
  • Loss on sale of trading goods.
  • Loss on leakage or theft of goods.
  • Loss on goods lost by fire etc.


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Capital Loss

6:40 PM imran ali

Capital losses are those losses which are incurred at the sale of fixed assets. It also consists the losses on raising capital. Such losses are shown on asset side in the balance sheet. The some example of capital losses may be as follows:
  • Loss on sale of machinery at lower price than its book value.
  • Loss or discount on issue of shares.
  • Loss or discount on issue of debentures.


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Revenue Profit

6:36 PM imran ali

Revenue profit are those profit which is generated by the activities of day to day business operation since the main target of a business is to earn such revenue profits. Such profit is shown in Profit and Loss Account. The following are the some example of revenue profits:
  • Profit earned on the sale of trading goods.
  • Commission earned.
  • Income from investment.
  • Discount received etc.


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Capital Profit

6:23 PM imran ali

Capital profits are those profits which are earned by selling fixed assets or issuing shares or debentures. They should be transferred to capital reserve account, which appear in the balance sheet as liability. The some example of capital profits are as follows:
  • Income earned by selling fixed assets in more value than its book value.
  • Income earned by issuing shares or debentures at premium.
  • Income earned by forfeiting the shares.


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Revenue Receipt

6:16 PM imran ali

Revenue receipts are generated in the day to day operation of business. A big portion of revenue receipts is occupied by the amount obtained from the regular sales of trading goods or services. The following are the some example of revenue receipts:
  • Amount received from sale of trading goods.
  • Amount received from sale of services.
  • Interest received.
  • Commission, discount received.
  • Rent received etc.


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Capital Receipts

7:33 PM imran ali

Those receipts which are generated in the form of capital is called capital receipts. It denotes the amount received by a firm from the owner or from outsiders like creditors, debenture holders as a loan. It also includes the amount received from the sale of fixed assets.

Some examples of capital revenue are as follows:
  • Amount received by issuing shares and debentures.
  • Amount received from owner as additional capital or share capital.
  • Bank loan.
  • Loan from others financial institutions or persons.
  • Amount received by selling fixed assets.


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Deferred Revenue Expenditure:

7:09 PM imran ali

Deferred revenue expenditure is also called as capitalized expenditure. The benefits of some revenue expenditures may be consumed for several years which are called deferred revenue expenditure. Only a part of it is considered as revenue expenditure and debited to profit and loss account. The remaining amount is put as an asset in the balance sheet.

Some Deferred Revenue Expenditure are as follows:
  • Preliminary expenses.
  • Share underwriting commission.
  • Discount on issue of shares and debentures.
  • Cost of heavy advertisement.


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Revenue Expenditure

7:01 PM imran ali

Those expenditure which are done to operate the business are revenue expenditures. The benefit of such expenses is to utilized in an accounting period. Nature of revenue is repetitive and may incur so many time during the business life. The examples of revenue expenditures are as follows.

1. Expenditures incurred in the normal course of business:
  • Rent, wages, salaries, advertising, legal expense, taxes, insurance premium, fuel, water, lighting, heating, bank charges, telephone, postage, stationery etc.
  • Interest, commission, discount, depreciation, bad debts etc.
2. Expenditures incurred to purchase raw materials or resale goods:
  • Cost of trading (resale) goods.
  • Cost of raw material.
  • Consumable stores.
3. Expenditure incurred to maintain fixed assets for working condition:
  • Repairs and renewals of fixed assets.
  • Replacement of fixed assets.


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Capital Expenditure

6:43 PM imran ali

Capital expenditure is done to acquire the fixed assets. Such fixed assets is acquired for the benefits for more than one accounting year. These expenditure help to earn income, which are shown in the assets side of the balance sheet.

According to Kohler,"Capital Expenditure is an expenditure intended to benefit future periods, in contrast to a revenue expenditure, which benefits a current period, an addition to a capital asset. The term is generally restricted to expenditures that add fixed assets units or that have the effect of increasing the capacity, efficiency, life span or economy of operation of an existing fixed asset."

The some example of capital expenditures are as follows:
  1. Expenditure done for acquiring fixed assets:
  • Purchase of land building, plant and machinery.
  • Purchase of furniture and fixtures.
  • Purchase of trade marks, patents, goodwill, copyrights, patterns and designs.
2. Expenditures incurred for putting an old asset in working condition:
  • Cost of erection of plant and machinery.
  • Cost of repairing (huge amount) fixed assets.
  • Cost of installation of new assets.
3. Expenditure incurred on an existing asset in the improvement or extension of the business:
  • Addition of land, building, machinery etc.
  • Extension of existing fixed assets.
  • Cost of increasing capacity of fixed asset.
4. Expenditure spent on raising the capital:
  • Share underwriting commission.
  • Discount or loss on issue of shares or debentures.
5. Expenditures incurred for the establishment of an organization:
  • Registration fees.
  • Legal and consultancy fees.
  • Advertisement expenses.
6. Expenditure incurred for research, development and inventions.


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Capital and Revenue

6:38 PM imran ali

Capital and revenue are two important basic terms of accounting where the word "Capital" refers to the owner's investment in business in terms of money or its worth. It is invested either to acquire fixed assets or to operate the business smoothly. The term "Revenue" denotes the amount received from sale of goods or rendering of services.

Relating to these two terms, major concepts are as follows:
  1. Capital Expenditure and Revenue Expenditure.
  2. Capital Receipts and Revenue Receipts.
  3. Capital Profit and Revenue Profit.
  4. Capital Loss and Revenue Loss.


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Disposal of Suspense Account

9:15 PM imran ali

There will be no balance left in suspense account if all the errors are located and rectified. Sometime, all the errors may not be rectified then, there will be still some balance in the suspense account which should be transferred to the balance sheet i.e. debit balance in asset side whereas credit balance in the liability side of balance sheet.


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Suspense Account

8:53 PM imran ali

Sometimes, trial balance does not agree due to some errors which have not been found yet. At the same time, if we are required to prepare final acounts as soon as possible, the trial balance is rectified temporally by writing amount in lighter side under the name of 'Suspense Account'. If the credit side is short, the suspense account will be credited and if the credit side is bigger, this account will be debited. The amount standing to the debit or credit of suspense account represents the net effect of one sided error.


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One sided error

8:48 PM imran ali

When one sided errors are located after the preparation of trial balance, they are rectified by passing journal entries. One account either debited or credited and another is suspense account either in debit or credit side. Suspense account is used to rectify only these errors which affect the trial balance. If the rectified account is debited in the entry suspense account will be credited to complete the double entry and vice versa.


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Rectification of Errors

8:35 PM imran ali

As error is a mistake and rectification denotes act of correcting the errors that have already committed in the books of accounts. In other words, rectification of error is a complex job of removing the effect of an error by replacing with correct situation which requires a sound knowledge of the fundamental principles of book-keeping and accounting. Whenever an error is found, it must be rectified because if the errors are not rectified, the profit, the profit or loss and financial position shown by final account will not be accurate.

Methods of Rectifying Errors:
Rectification of errors in the books of account by rubbing or cutting or tearing or putting ink or t-pex etc, reduces the authenticity of accounting records. They may be not be valid too. So, the appropriate methods rectifying errors must be applied. Generally errors are rectified by the following ways:
  1. If an error is located in the subsidiary books before posting in ledgers wrong figure should be truck off and correct figure should be written above the wrong figure by drawing a straight line over the wrong figure.
  2. If a wrong figure has been posted in ledger account, it also may be rectified by neatly crossing out the wrong figure by a single line and writing correct figure above the crossed figure.
  3. If the errors are located after a long time (after closing of books of accounts), it must be rectified by passing journal entries.


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Errors not Disclosed by a Trial Balance

7:24 PM imran ali

It is important to note that the agreement of a trial balance does not prove that all the books of accounts are free of accounting errors in all cases. There may be some errors ever though two sides of a trial balance will agree. It means some errors as given are not disclosed by the trail balance.
  1. Errors of omission: When two aspects debit or credit of a transaction are omitted to record in journal, then they are also not posted to ledger and trial balance. A trial balance is effected by the equal amount.
  2. Errors of commission: When a transaction has been recorded but has been wrongly entered in the books of original entry or posted in the ledger, then it is called an error of commission. Such errors are the result of carelessness of accountants. Errors of commission committed by posting wrong amount of wrong side by totaling or balancing wrong amount in subsidiary books of ledger accounts by making wrong entry in journal or ledger etc. Example, if goods purchased $2010 from John is entered in purchase account as $1020 again John account will be credited by same amount. Both sides have been effected by equal amount so the trial balance shall agree.
  3. Compensating errors: When an error committed previously has been neutralized by another error committed later on, such error is called compensating error. This type of error does not affect the trial balance.
  4. Errors of principles: An error of principle is an error which violets the fundamentals of book-keeping. In other words, such errors are committed when fundamental principles of book-keeping and accountancy are not followed by the accounting staff wrong allocation of expenditure between capital and revenue excess or inadequate provision for depreciation, over or under valuation of stock, furniture purchases is recorded in purchase account etc. are errors of principles.


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Errors Disclosed by a Trail Balance

7:10 PM imran ali

The following errors are revealed by the trial balance showing disagreement.
  1. Posting of wrong amount: Sometimes, wrong amount is posted in one of the two accounts. For example goods sold of $500 are correctly entered in credit side of sales account but it was debited in cash account as $550. There is a difference in amount of $50. As a result trial balance shows the disagreement.
  2. Posting on the wrong side: When an item is by mistake posted on the wrong side of an account in the ledger, it would cause disagreement in the trial balance. Suppose, wages paid of $1500. In this case, wages account must be debited by $1500. But wages account was debited accurately however cash account was also debited instead of crediting it. It created the excess amount in debit side.
  3. Wrong totaling of subsidiary books: When there is error in totaling of subsidiary books, that will cause disagreement of trial balance. Suppose sales book has been totaled $1000 instead of $1050.
  4. Wrong totaling or balancing of ledger account: Sometimes, errors may be committed in writing totaling or balancing of ledger account the trial balance will disagree.
  5. Ommission to post an amount into ledger: When an aspect of transaction is omitted to post in ledger account, the trial balance shows disagreement. For example, cash paid for interest $200. Interest account was debited by the same amount but it was omitted to credit in cash account.
  6. Ommission to enter an amount in trial balance: If an amount is omitted to enter in trial balance while transferring from ledger balances, then the trial balance shows disagreement.


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Types of Errors

6:59 PM imran ali

Errors are committed knowing or unknowing which greatly affect the financial position of the particular organization. Generally there are two types of errors i.e. error of principles and clerical errors. Errors which are aroused when the fundamental principles of book-keeping and accountancy are not followed by the accountants called errors of principles. They may be committed either intentionally or unintentionally. Such errors are not disclosed by trail balance clerical errors are committed due to carelessness, negligence and frauds of accountants. Clerical errors can also be further divided into two i.e.
  1. Errors Disclosed by a Trail Balance
  2. Errors not Disclosed by a Trail Balance


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